1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 Form 10-Q [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to _____________ Commission file number 1-11690 ----------------------------------- DEVELOPERS DIVERSIFIED REALTY CORPORATION - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Ohio 34-1723097 - -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 34555 Chagrin Boulevard Moreland Hills, Ohio 44022 - -------------------------------------------------------------------------------- (Address of principal executive offices - zip code) (216) 247-4700 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) - -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) APPLICABLE ONLY TO CORPORATE ISSUERS: ------------------------------------- Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date. 25,056,880 shares outstanding as of May 12, 1997 ---------- ------------ -1-
2 PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Condensed Consolidated Balance Sheets as of March 31, 1997 and December 31, 1996. Condensed Consolidated Statements of Operations for the Three Month Periods ended March 31, 1997 and 1996. Condensed Consolidated Statements of Cash Flows for the Three Month Periods ended March 31, 1997 and 1996. Notes to Condensed Consolidated Financial Statements. -2-
3 DEVELOPERS DIVERSIFIED REALTY CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) <TABLE> <CAPTION> March 31, December 31, ASSETS 1997 1996 - ------ --------- ------------ <S> <C> <C> Real estate rental property: Land $153,826,060 122,696,277 Land under development 21,193,075 27,304,847 Buildings 918,891,039 798,476,568 Fixtures and tenant improvements 16,039,700 14,805,101 Construction in progress 15,380,358 28,364,167 --------------- ------------- 1,125,330,232 991,646,960 Less accumulated depreciation (147,498,338) (142,039,284) --------------- ------------- Real estate, net 977,831,894 849,607,676 Cash and cash equivalents 2,682,400 12,600 Advances to and investments in joint ventures 112,002,221 106,795,688 Other assets 20,737,823 18,709,976 --------------- ------------- $1,113,254,338 $975,125,940 =============== ============= LIABILITIES AND SHAREHOLDERS' EQUITY Unsecured indebtedness: Fixed rate senior notes $291,585,102 $215,492,754 Revolving credit facilities 19,000,000 95,500,000 Subordinated convertible debentures 60,000,000 60,000,000 --------------- ------------- 370,585,102 370,992,754 Mortgage indebtedness: Banks and other financial institutions 106,830,561 107,439,535 --------------- ------------- Total indebtedness 477,415,663 478,432,289 Accounts payable and accrued expenses 26,137,548 20,920,765 Other liabilities 9,396,531 6,436,667 --------------- ------------- 512,949,742 505,789,721 --------------- ------------- Minority equity interest 16,293,180 - Commitments and contingencies Shareholders' equity: Class A - 9.5% cumulative redeemable preferred shares, without par value, $250 liquidation value; 1,500,000 shares authorized; 421,500 shares issued and outstanding at March 31, 1997 and December 31, 1996 105,375,000 105,375,000 Class B - 9.44% cumulative redeemable preferred shares, without par value, $250 liquidation value; 1,500,000 shares authorized; 177,500 shares issued and outstanding at March 31, 1997 and December 31, 1996 44,375,000 44,375,000 Common shares, without par value, $.10 stated value; 50,000,000 shares authorized; 25,055,498 and 21,682,917 shares issued and outstanding at March 31, 1997 and December 31, 1996, respectively 2,505,550 2,168,292 Paid-in-capital 485,525,515 369,417,186 Accumulated dividends in excess of net income (53,154,649) (51,384,259) --------------- ------------- 584,626,416 469,951,219 Less: Unearned compensation - restricted stock (615,000) (615,000) --------------- ------------- 584,011,416 469,336,219 --------------- ------------- $1,113,254,338 $975,125,940 =============== ============= </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -3-
4 DEVELOPERS DIVERSIFIED REALTY CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTH PERIOD ENDED MARCH 31, (UNAUDITED) <TABLE> <CAPTION> 1997 1996 ------------ ----------- <S> <C> <C> Revenues from operations: Minimum rents $27,566,057 $22,682,584 Percentage and overage rents 1,057,039 754,208 Recoveries from tenants 7,225,868 5,743,626 Management fee income 723,260 508,809 Other 881,044 945,465 ------------ ----------- 37,453,268 30,634,692 ------------ ----------- Rental operation expenses: Operating and maintenance 3,566,877 3,037,213 Real estate taxes 4,391,049 3,413,341 General and administrative 2,465,727 1,732,948 Interest expense 8,047,202 7,343,006 Depreciation and amortization 7,406,457 5,904,605 ------------ ----------- 25,877,312 21,431,113 ------------ ----------- Income before equity in net income of joint ventures, minority equity interest and gain on sales of real estate 11,575,956 9,203,579 Equity in net income of joint ventures 2,717,005 2,012,238 Minority equity interest (264,764) -- Gain on sales of real estate 3,525,785 -- ------------ ----------- Net income $17,553,982 $11,215,817 =========== =========== Net income applicable to common shareholders $14,004,076 $7,665,911 =========== =========== Per share data: Net income: Primary $.57 $.39 ==== ==== Fully diluted $.57 $.39 ==== ==== Dividends declared $.63 $.60 ==== ==== </TABLE> THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -4-
5 DEVELOPERS DIVERSIFIED REALTY CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTH PERIOD ENDED MARCH 31, (UNAUDITED) <TABLE> <CAPTION> 1997 1996 ------------- ------------ <S> <C> <C> Net cash flow provided by operating activities $ 21,107,035 $ 14,059,965 ------------- ------------ Cash flow provided by (used for) investing activities: Real estate developed or acquired (114,016,759) (23,353,342) (Advances to) repayments from joint ventures, net (5,461,751) (1,147,884) Proceeds from sales of real estate 5,452,034 -- ------------- ------------ Net cash flow used for investing activities (114,026,476) (24,501,226) ------------- ------------ Cash flow provided by (used for) financing activities: Repayment of revolving credit facilities, net (76,500,000) (87,500,000) Proceeds from issuance of Medium Term Notes, net of underwriting commissions and $106,000 of offering expenses paid -- 52,604,000 Principal payments on rental property debt (608,974) (12,148,265) Proceeds from issuance of Fixed Rate Senior Notes, net of underwriting commissions and discounts and $500,000 of offering expenses paid 75,577,000 -- Proceeds from issuance of common shares, net of underwriting commissions and $425,000 and $300,000 of offering expenses paid in 1997 and 1996, respectively 115,831,877 75,389,307 Proceeds from issuance of Class B preferred shares, net of underwriting commissions and $200,000 of offering expenses paid -- 4,182,050 Proceeds from issuance of common shares in conjunction with exercise of stock options, the Company's 401(k) plan and dividend reinvestment plan 613,710 129,240 Dividends paid (19,324,372) (3,433,468) ------------- ------------ Net cash flow provided by financing activities 95,589,241 29,222,864 ------------- ------------ Increase in cash and cash equivalents 2,669,800 18,781,603 Cash and cash equivalents, beginning of period 12,600 12,100 ------------- ------------ Cash and cash equivalents, end of period $ 2,682,400 $ 18,793,703 ============= ============ </TABLE> Supplemental disclosure of non cash investing and financing activities: In conjunction with the acquisitions of certain shopping centers, the Company assumed other liabilities and minority equity interest aggregating approximately $22.9 million for the three month period ended March 31, 1997. In addition, included in accounts payable was approximately $0.3 million relating to construction in progress which did not require the use of cash. For the three month period ended March 31, 1996 included in accounts payable was approximately $0.7 million relating to construction in progress and $13.0 million of dividends declared which did not require the use of cash. THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -5-
6 DEVELOPERS DIVERSIFIED REALTY CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. NATURE OF BUSINESS The Company is a self-administered and self-managed real estate investment trust and is engaged in the business of acquiring, expanding, owning, developing, managing and operating neighborhood and community shopping centers, enclosed malls and business centers. The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. The information furnished reflects all adjustments which are, in the opinion of management, necessary to reflect a fair statement of the results for the interim periods presented, and all such adjustments are of a normal recurring nature. 2. PUBLIC OFFERINGS In January 1997, the Company sold 3,350,000 shares of common stock in an underwritten offering at $36.625 per share. In March 1997, the Company issued $75 million of 7.125% Pass-Through Asset Trust Securities which mature in March 2002. The aggregate net proceeds of approximately $191.4 million from the above offerings were primarily used to retire variable rate indebtedness. 3. EQUITY INVESTMENTS IN JOINT VENTURES: The Company's equity investments in joint ventures at March 31, 1997 were comprised of (i) a 50% joint venture interest in four Community Center Joint Ventures, formed in November 1995 in conjunction with the acquisition of the Homart Community Center Division of Sears, Roebuck and Co. ("Sears"), (ii) a 50% joint venture interest, formed in September 1996, with The Ohio State Teachers Retirement Systems (OSTRS), (iii) a 50% joint venture interest, formed in October 1996, in conjunction with the development of a 443,000 square foot shopping center in Merriam, Kansas, (iv) a 35% joint venture interest in a limited partnership, formed in January 1997, that owns a 286,388 square foot shopping center located in San Antonio, Texas and (v) a 50% joint venture interest in a limited partnership, formed in 1989, that owns a 411,977 square foot shopping center located in Martinsville, Virginia. -6-
7 Summarized combined financial information of the Company's joint venture investments is as follows: <TABLE> <CAPTION> March 31, December 31, Combined Balance Sheets 1997 1996 ------------ ------------ <S> <C> <C> Real estate, net $600,747,298 $561,624,478 Other assets 21,434,797 16,012,336 ------------ ------------ $622,182,095 $577,636,814 ============ ============ Mortgage debt $390,789,931 $360,113,705 Amounts payable to DDRC 12,766,605 10,747,149 Other liabilities 9,052,887 7,782,117 ------------ ------------ 412,609,423 378,642,971 Accumulated equity 209,572,672 198,993,843 ------------ ------------ $622,182,095 $577,636,814 ============ ============ <CAPTION> Three Month Period Ended March 31, Combined Statements of Operations 1997 1996 ------------ ------------ Revenues from operations $19,304,067 $14,597,439 ------------ ------------ Rental operation expenses 4,658,868 3,780,114 Depreciation and amortization expenses 2,704,111 2,106,297 Interest expense 6,428,401 4,686,558 ------------ ------------ 13,791,380 10,572,969 ------------ ------------ Net income $5,512,687 $4,024,470 ============ ============ </TABLE> The Company has guaranteed $25 million of joint venture indebtedness and related interest associated with certain mortgage debt. Advances to and investments in joint ventures include acquisition costs related to the Community Center Joint Ventures and the Merriam joint venture of approximately $2.6 million and $0.9 million respectively, and a deferred gain of approximately $6.4 million related to the contribution of the real estate property and mortgage debt to the OSTRS Joint Venture. Included in management fee income for the three month period ended March 31, 1997 and 1996 is approximately $0.6 million and $0.4 million, respectively of fees earned from the Company's Joint Venture interests. Other income for the three month period ended March 31, 1997 and 1996 includes $0.1 million and $0.3 million, respectively, of development fee income from the Community Center Joint Ventures. -7-
8 4. ACQUISITIONS AND PRO FORMA FINANCIAL INFORMATION During the three month period ended March 31, 1997, the Company completed the acquisition of or investment in four shopping centers with an aggregate of approximately 1.4 million Company owned gross leasable square feet (GLA) at an initial aggregate investment of approximately $116.5 million. These properties are summarized as follows: <TABLE> <CAPTION> Year Effective Date Company Location Built of Acquisition GLA ----------------------------- ---- --------------- ----------- <S> <C> <C> <C> Cleveland (North Olmsted), OH 1958 January 1, 1997 463,440 Cleveland (North Olmsted), OH 1987 January 1, 1997 142,947 San Antonio, TX (1) 1996 January 23, 1997 286,388 Phoenix, AZ 1996 February 21, & March 27, 1997 490,885 ----------- 1,383,660 =========== <FN> (1) Property acquired through a joint venture in which the Company owns a 35% interest. </TABLE> The operating results of the acquired shopping centers are included in the results of operations of the Company from the effective date of acquisition. The following unaudited supplemental pro forma operating data is presented for the three months ended March 31, 1996 as if each of the following transactions had occurred on January 1, 1996 (i) the acquisition by the Company of all properties acquired by the Company in 1996 and 1997; (ii) the sale by the Company of 175,000 depositary shares representing 9.44% Class B Cumulative Redeemable Preferred Shares in January 1996, (iii) the completion of the sale by the Company of $111.7 million of Medium Term Notes in 1996, (iv) the completion of the sale by the Company of 2,611,500 Common Shares in March 1996, (v) the completion of the sale by the Company of 3,350,000 common shares in January 1997 and (vi) the completion of the sale by the Company of the $75 million 7.125% Pass through Asset Trust Securities in March 1997. <TABLE> <CAPTION> Three Month Period Ended March 31, ---------------------------------- (in thousands, except per share) 1996 ------- <S> <C> Pro forma revenues $32,367 ======= Pro forma net income applicable to common shareholders $ 9,348 ======= Pro forma net income applicable to common shareholders per common share $ .43 ======= </TABLE> Pro forma information for the three months ended March 31, 1997 is not presented because two of the four acquired properties were either under development or in the lease-up phase and, accordingly, the related operating information for such centers either does not exist or would not be meaningful. The two Cleveland, Ohio properties are included in the Company's actual operating results for the three months ended March 31, 1997. The 1996 pro forma information above does not include revenues and expenses for the five properties acquired by the Company in 1996 prior to their respective acquisition dates because these shopping centers were either under development or in the lease-up phase and, accordingly, the related operating information for such centers either does not exist or would not be meaningful. -8-
9 5. SHAREHOLDERS' EQUITY: The following table summarizes the changes in shareholders' equity since December 31, 1996: <TABLE> <CAPTION> Class A 9.5% Class B 9.44% Cumulative Cumulative Redeemable Redeemable Preferred Preferred Accumulated Shares ($250 Shares ($250 Dividends in Liquidation Liquidation Common Paid-in Excess of Restricted Value) Value) Shares Capital Net Income Stock Total ------------ ----------- ---------- ------------ ------------ ---------- ------------ <S> <C> <C> <C> <C> <C> <C> <C> Balance December 31, 1996 $105,375,000 $44,375,000 $2,168,292 $369,417,186 $(51,384,259) $ (615,000) $469,336,219 Net income 17,553,982 17,553,982 Dividends declared - Preferred Shares (3,549,906) (3,549,906) Dividends declared - Common Shares (15,774,466) (15,774,466) Issuance of Common Shares 335,000 115,496,877 115,831,877 Stock options exercised 2,148 569,913 572,061 Shares issued through employee 401(k) plan 43 15,818 15,861 Shares issued through Dividend Reinvestment Plan 67 25,721 25,788 ------------ ----------- ---------- ------------ ------------ ---------- ------------ Balance March 31, 1997 $105,375,000 $44,375,000 $2,505,550 $485,525,515 $(53,154,649) $ (615,000) $584,011,416 ============ =========== ========== ============ ============ ============= ============ </TABLE> 6. REVOLVING CREDIT FACILITIES: In May 1995, the Company obtained a three year $150 million unsecured revolving credit facility from a syndicate of financial institutions for which the First National Bank of Chicago and the First National Bank of Boston serve as agents (the "Unsecured Credit Facility"). In March 1997, the Company renegotiated the terms of this facility to extend the agreement, to May 2000, reduce the specified spread over LIBOR by 15 basis points and introduce a competitive bid feature for up to $75 million of borrowings. Borrowings under this facility bear interest at variable rates based on the prime rate or LIBOR plus a specified spread, currently at 1.10%, depending on the Company's long term senior unsecured debt rating from Standard and Poor's and Moody's Investors Service. The Unsecured Credit Facility is used to finance the acquisition of shopping centers, to provide working capital and for general corporate purposes. At March 31, 1997, $15 million was outstanding under this facility. In addition, the Company maintains a $10 million unsecured revolving credit facility with National City Bank which matures in November 1999 and bears interest at variable rates based on the prime rate or LIBOR plus a specified spread, currently at 1.25%, depending on the Company's long term senior unsecured debt rating from Standard and Poor's and Moody's Investors Service. At March 31, 1997 there was $4 million outstanding under this facility. 7. EARNINGS PER SHARE Primary earnings per share for net income applicable to common shareholders was computed by dividing common share dividends paid or declared for the period by the weighted average number of -9-
10 common shares outstanding plus the undistributed net income (loss) applicable to common shareholders, as appropriate, divided by the weighted average number of common shares and common share equivalents outstanding. Common share equivalents are excluded from the earnings per share calculation where they would be antidilutive. The weighted average number of shares outstanding utilized in the calculations is 24,520,075 and 19,704,565 for the three month periods ended March 31, 1997 and 1996, respectively. Fully diluted earnings per common share were calculated by dividing net income (loss) applicable to common shareholders by the weighted average number of common shares and common share equivalents during the period. Common share equivalents included stock options outstanding and the assumed conversion of the Debentures. For the three month period ended March 31, 1996, the assumed conversion of the Debentures was antidilutive, and was therefore excluded from the calculation. Common share equivalents for purposes of the fully diluted earnings per share were 2,213,590 and 143,987 for the three month periods ended March 31, 1997 and 1996, respectively. As required by APB Opinion No. 15, supplementary pro forma income per share data has been presented in Note 4. 8. SUBSEQUENT EVENTS On May 12, 1997, the Company's shareholders approved an additional 500,000 common shares to be reserved for issuance under the Company's 1992 Employees' Share Option Plan. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and the notes thereto. RESULTS OF OPERATIONS Revenues from Operations Total revenues increased $6.8 million, or 22.3% to $37.4 million for the three month period ended March 31, 1997 from $30.6 million for the same period in 1996. Base and percentage rents for the three month period ended March 31, 1997 increased $5.2 million or 22.1% to $28.6 million as compared to $23.4 million for the same period in 1996. Approximately $0.8 million of the increase in base and percentage rental income is the result of new leasing, re-tenanting and expansion of the Core Portfolio Properties (shopping center properties owned as of January 1, 1996), an increase of 3.9% over 1996 revenues from Core Portfolio Properties. The eight shopping centers acquired by the Company in 1997 and 1996 contributed $4.7 million of additional revenue and the three new shopping center developments contributed $0.7 million. The above increases were offset by the transfer of two properties to a joint venture in September 1996 which reduced revenue by $1.0 million. At March 31, 1997, the occupancy rate of the Company's portfolio, including properties owned through joint ventures, was at 94.1% as compared to 94.2% at March 31, 1996. As of March 31, 1997, the Company had also entered into leases with additional tenants aggregating approximately 300,000 square feet of vacant space, approximately 1.4% of total Company gross leasable area, which was not yet occupied at that date. The average annualized base rent per leased square foot, including those properties owned through joint ventures, was $8.16 at March 31, 1997 as compared to $7.85 at December 31, 1996. Same store sales, for the current twelve month period, increased 3.18% to $229 per square foot as compared to $222 per square foot for the prior twelve month period. -10-
11 The increase in recoveries from tenants of $1.5 million is directly related to the increase in operating and maintenance expenses and real estate taxes primarily associated with the 1997 and 1996 shopping center acquisitions and developments. Recoveries were approximately 90.8% of operating expenses and real estate taxes as compared to 89.0% for the same period in 1996. Management fee income and other income increased by approximately $0.1 million which generally relates to an increase in management fee income associated with the formation of several joint ventures. Expenses from Operations Rental operating and maintenance expenses for the three month period ended March 31, 1997 increased $0.5 million, or 17.4% to $3.5 million as compared to $3.0 million for the same period in 1996. An increase of $0.4 million is attributable to the 11 shopping centers acquired and developed in 1996 and 1997 and $0.1 million in the Core Portfolio Properties. Real estate taxes increased $1.0 million, or 28.6%, to $4.4 million for the three month period ended March 31, 1997 as compared to $3.4 million for the same period in 1996. This increase is related to the 11 shopping centers acquired and developed in 1996 and 1997. General and administrative expenses increased $0.7 million, or 42.3%, to $2.5 million for the three month period ended March 31, 1997 as compared to $1.7 million in 1996. The increase is attributable to the growth of the Company primarily related to acquisitions, expansions and developments. The Company continues to maintain a conservative policy with regard to the expensing of all internal leasing salaries, legal salaries and related expenses associated with the leasing and re-leasing of existing space. Total general and administrative expenses were approximately 4.3% and 3.8% of total revenues, including revenues of joint ventures, at March 31, 1997 and 1996, respectively. Depreciation and amortization expense increased $1.5 million, or 25.4%, to $7.4 million for the three month period ended March 31, 1997 as compared to $5.9 million for the same period in 1996. The increase is primarily attributable to the growth related to the 11 shopping centers acquired and developed in 1996 and 1997. Interest expense increased $0.7 million, or 9.6%, to $8.0 million for the three month period ended March 31, 1997, as compared to $7.3 million for the same period in 1996. The overall increase in interest expense for the three month period ended March 31, 1997 as compared to the same period in 1996 is primarily related to the acquisition and development of shopping centers during 1997 and 1996. The weighted average debt outstanding during the three month period ended March 31, 1997 and related weighted average interest rate was $430.9 million and 7.8%, respectively, compared to $397.0 million and 8.1%, respectively, for the same period in 1996. Interest costs capitalized, in conjunction with development and expansion projects, were $0.8 million for the three month period ended March 31, 1997, respectively, as compared to $0.7 million for the same period in 1996. Equity in net income of joint ventures increased $0.7 million, or 35.0%, to $2.7 million for the three month period ended March 31, 1997 as compared to $2.0 million for the same period in 1996. The increase is attributable to the Community Center Joint Ventures, the formation of a joint venture with Ohio State Teachers Retirement Systems ("OSTRS") and the formation of a joint venture in San Antonio, Texas which contributed an additional $0.4 million, $0.2 million and $0.1 million, respectively, of equity in net income of joint ventures for the three month period ended March 31, 1997. -11-
12 The minority equity interest of $0.3 million for the three month period ended March 31, 1997 relates to the Company's investment in two shopping center properties in 1997. The amount represents the priority distribution associated with the minority equity interest. Gain on sales of real estate aggregated $3.5 million for the three month period ended March 31, 1997. In March 1997, the Company sold two business centers in Highland Heights, Ohio aggregating approximately 113,000 square feet for approximately $5.7 million. The two business centers had been vacant for approximately 18 months. Net Income Net income increased $6.3 million to $17.5 million for the three month period ended March 31, 1997, as compared to net income of $11.2 million for the same period in 1996. The increase in net income of $6.3 million is primarily attributable to the increased net operating revenues (total revenues less operating and maintenance, real estate taxes and general and administrative expense) aggregating $4.6 million, resulting from new leasing, retenanting and expansion of Core Portfolio Properties, and the 11 shopping centers acquired and developed in 1996 and 1997. An increase of $0.7 million relates to increased equity income from joint ventures and an increase of $3.5 million relates to a gain on sale of real estate. The increase in net operating revenues, equity income from joint ventures and gain on sale of real estate was offset by increases in depreciation, interest expense and minority equity interest of $1.5 million, $0.7 million and $0.3 million, respectively. FUNDS FROM OPERATIONS Management believes that funds from operations ("FFO") provides an additional indicator of the financial performance of a Real Estate Investment Trust. FFO is defined generally as net income applicable to common shareholders excluding gains (losses) on sale of property, non recurring charges and extraordinary items, adjusting for certain non-cash items, principally real property depreciation and equity income (loss) from its joint ventures and adding the Company's proportionate share of FFO of its unconsolidated joint ventures, determined on a consistent basis. The Company calculates FFO in accordance with the foregoing definition, which is substantially the same as the definition currently used by the National Association of Real Estate Investment Trusts ("NAREIT"). Certain other real estate companies may calculate funds from operations in a different manner. For the three month period ended March 31, 1997, FFO increased $4.6 million or 31.3% to $19.1 million as compared to $14.5 million for the same period in 1996. The increase is attributable to the continuing increases in revenues from Core Portfolio Properties, acquisitions and developments. The Company's calculation of FFO is as follows (in thousands): <TABLE> <CAPTION> March 31, 1997 1996 -------- -------- <S> <C> <C> Net income applicable to common shareholders (1) $14,004 $7,666 Depreciation of real property 7,322 5,854 Equity in net income of joint ventures (2,717) (2,012) Joint Ventures FFO (2) 4,051 3,065 Gain on sales of real estate (3,526) -- -------- -------- $19,134 $14,573 ======== ======== </TABLE> (1) Includes straight line rental revenues of approximately $0.3 million and $0.1 million for the three month periods ended March 31, 1997 and 1996, respectively, primarily related to recent acquisitions and new developments. -12-
13 (2) Joint Venture Funds From Operations are summarized as follows: <TABLE> <S> <C> <C> Net income (a) $5,513 $4,024 Depreciation of real property 2,704 2,106 ----- ----- $8,217 $6,130 ====== ====== DDRC Ownership interests (b) $4,051 $3,065 ====== ====== <FN> (a) Includes straight line rental revenue of approximately $0.6 million for the three month periods ended March 31, 1997 and 1996. The Company's proportionate share of straight line rental revenues was $0.3 million for the three month periods ended March 31, 1997 and 1996. (b) At March 31, 1997 the Company owned a 50% joint venture interest relating to 13 shopping center properties and a 35% joint venture interest in one shopping center property. At March 31, 1996 the Company owned a 50% joint venture interest in eleven shopping center properties. </TABLE> LIQUIDITY AND CAPITAL RESOURCES The Company anticipates that cash flow from operating activities will continue to provide adequate capital for all principal payments, recurring tenant improvements, as well as dividend payments in accordance with REIT requirements and that cash on hand, borrowings under its existing revolving credit facilities, as well as other debt and equity alternatives will provide the necessary capital to achieve continued growth. Cash flow from operating activities for the three month period ended March 31, 1997 increased to $21.1 million as compared to $14.1 million for the same period in 1996. The increase is attributable to the 11 acquisitions and developments completed in 1997 and 1996, new leasing, expansion and re-tenanting of the core portfolio properties and the equity offerings completed in 1997 and 1996. An increase in the 1997 quarterly dividend per common share to $.63 from $.60 was approved in December 1996 by the Company's Board of Directors. It is anticipated that the new dividend level will result in a more conservative payout ratio as compared to prior years. A lower payout ratio will enable the Company to retain more capital which will be utilized toward attractive investment opportunities in the development, acquisition and expansion of portfolio properties. The Company's common share dividend payout ratio for the first quarter of 1997 approximated 82.4% of the actual funds from operations. During the three month period ended March 31, 1997, the Company and its joint ventures invested $122.8 million, net, to acquire, develop, expand, improve and re-tenant its properties as follows: (in millions): Acquisitions During the first quarter of 1997 the Company acquired two adjacent shopping center properties in Ahwatukee, Arizona (a suburb of Phoenix), aggregating 490,885 square feet for an aggregate purchase price of approximately $65.3 million. The Company also acquired a majority ownership interest in two adjacent shopping center properties aggregating 606,387 square feet in North Olmsted, Ohio (a suburb of Cleveland) for an initial investment of approximately $38 million. -13-
14 The Company also acquired a 35% ownership interest in a 296,000 square foot shopping center in San Antonio, Texas. This shopping center was acquired at a cost of approximately $38.3 million of which the Company's proportionate share aggregated approximately $13.4 million. Developments The Company has substantially completed the construction of an 84,000 square foot community shopping center in Aurora, Ohio with a Heinen's Supermarket (not owned by the Company) and Revco Drug Store as anchor tenants. Development activity also continues to progress at the Company's shopping centers in Atlanta, Georgia and Framingham, Massachusetts which were acquired in connection with the Community Center Joint Ventures in November 1995. The Atlanta and Framingham centers are scheduled to be substantially completed by the third quarter of 1997. The majority of tenants have opened at each center. Construction has also commenced on the development of four additional shopping centers which include: (i) a 235,000 square foot Phase II development of the Canton, Ohio center which will include Home Place, Service Merchandise, Petsmart and JoAnn Fabrics ETC as anchor tenants; (ii) a 500,000 square foot shopping center in Boardman, Ohio which includes Wal-Mart, Lowe's, Dick's Sporting Goods, Giant Eagle Supermarket, Staples and Petsmart as anchor tenants. The Lowe's, Wal-Mart and Dick's Sporting Goods stores opened during the first quarter of 1997; (iii) a 475,000 square foot shopping center in Stow, Ohio which will include Target (not owned by the Company), Kohl's, Giant Eagle Supermarket (opened fourth quarter 1996), Office Max (opened first quarter 1997) and Stein Mart as anchor tenants and (iv) a 445,000 square foot shopping center in Merriam, Kansas which is being developed through a joint venture formed in October 1996, 50% of which is owned by the Company. This center will include Home Depot, Cinemark, Hen House Supermarket, and Petsmart as anchor tenants. Expansions The Company is currently expanding seven of its shopping centers, including a 50,000 square foot expansion in Birmingham, Alabama; a 98,000 square foot expansion in Spring Hill, Florida; a 30,000 square foot supermarket expansion in Chillicothe, Ohio; a 44,000 square foot expansion in Marietta, Georgia; a 79,000 square foot expansion and redevelopment in Martinsville, Virginia; a 130,000 square foot redevelopment in Winchester, Virginia and an 18,000 square foot retail expansion in East Norriton, Pennsylvania. FINANCING ACTIVITIES The acquisitions, developments and expansions were financed through cash provided from operating activities revolving credit facilities, mortgages assumed and debt and equity offerings. Total debt outstanding at March 31, 1997 was $477.4 million compared to 359.1 million at March 31, 1996. In January 1997, the Company successfully completed a 3,350,000 common share offering and received net proceeds of approximately $116 million which were primarily used to retire variable rate debt. The common share offering significantly strengthened the Company's balance sheet and positioned the Company to continue to take advantage of attractive acquisition, development and expansion opportunities discussed above. -14-
15 In March 1997, the Company issued $75 million of senior unsecured Putable Asset Trust Securities (PATS). The PATS were issued at a discount of 99.53%, have a coupon rate of 7.125% and mature on March 15, 2002. The effective yield to the put date, after adjusting for the call premium and debt issue costs, is approximately 6.9%. In March 1997, the Company extended its $150 million unsecured revolving credit facility, agented by the First National Bank of Chicago and the First National Bank of Boston, for an additional year, through May 2000, and reduced the interest rate 15 basis points and also introduced a competitive bid feature for up to $75 million of borrowings. In March 1997, the Company sold two business centers in Highland Heights, Ohio aggregating approximately 113,000 square feet for approximately $5.7 million and recognized a gain of approximately $3.5 million. The net proceeds of approximately $5.4 million were used to repay revolving credit debt. At March 31, 1997, the Company's capitalization consisted of $477.4 million of debt (excluding the Company's proportionate share of joint venture mortgage debt aggregating $191.4 million), $149.8 million of preferred stock and $945.8 million of market equity (market equity is defined as common shares outstanding multiplied by the closing price of the common shares on the New York Stock Exchange at March 31, 1997 of $37.75) resulting in a debt total market capitalization ratio of .30 to 1.0. At March 31, 1997, the Company's total debt consisted of $455.4 million of fixed rate debt, and $22.0 million of variable rate debt. It is management's intention that the Company have access to the capital resources necessary to expand and develop its business. Accordingly, the Company may seek to obtain funds through additional equity offerings or debt financing in a manner consistent with its intention to operate with a conservative debt capitalization policy and maintain its investment grade ratings with Moody's Investor Services and Standard and Poor's. In June 1996, the Company filed a shelf registration statement with the Securities and Exchange Commission under which $400 million of debt securities, preferred shares or common shares may be issued. As of March 31, 1997, the Company had $218.6 million available under its shelf registration statement. In addition, as of March 31, 1997 the Company had $141 million available under its $160 million of unsecured revolving credit facilities. On March 31, 1997, the Company also had 94 operating properties with $29.6 million or 74.6% of the total revenue for the three month period ended March 31, 1997 which were unencumbered thereby providing a potential collateral base for future borrowings. INFLATION Substantially all of the Company's long-term leases contain provisions designed to mitigate the adverse impact of inflation. Such provisions include clauses enabling the Company to receive percentage rentals based on tenants' gross sales, which generally increase as prices rise, and/or escalation clauses, which generally increase rental rates during the terms of the leases. Such escalation clauses are often related to increases in the consumer price index or similar inflation indices. In addition, many of the Company's leases are for terms of less than ten years, which permits the Company to seek increased rents upon re-rental at market rates. Most of the Company's leases require the tenants to pay their share of operating expenses, including common area maintenance, real estate taxes, insurance and utilities, thereby reducing the Company's exposure to increases in costs and operating expenses resulting from inflation. -15-
16 At March 31, 1997, approximately 95.4% of the Company's debt (not including joint venture debt) bore interest at fixed rates with a weighted average maturity of approximately 4.6 years and a weighted average interest rate of approximately 7.8%. The remainder of the Company's debt bears interest at variable rates, with a weighted average maturity of approximately 3.3 years and a weighted average interest rate of approximately 8.4%. As of March 31, 1997 the Company's Community Center Joint Ventures had variable rate debt aggregating approximately $326.0 million in the form of bridge loans which are scheduled to be converted to long-term fixed rate debt through securitizations. The Company's OSTRS Joint Venture has variable rate debt aggregating $24.3 million. The Company's joint venture in San Antonio, Texas has variable rate debt aggregating $26.7 million. The Company intends to utilize variable rate indebtedness available under its revolving credit facilities to initially fund future acquisitions of shopping centers. Thus, to the extent that the Company incurs additional variable rate indebtedness, its exposure to increases in interest rates in an inflationary period would increase. The Company believes, however, that in no event would increases in interest expenses as a result of inflation significantly impact the Company's distributable cash flow. The Community Center Joint Ventures have entered into swap agreements with major financial institutions as a hedge against increasing interest rates associated with the joint ventures' proposed upcoming long term financing. The Company intends to continuously monitor and actively manage interest costs on its variable rate debt portfolio and may enter into swap positions based on market fluctuations. In addition, the Company believes that it has the ability to obtain funds through additional equity and/or debt offerings, including the issuance of medium term notes. Accordingly, the cost of obtaining such protection agreements in relation to the Company's access to capital markets will continue to be evaluated. ECONOMIC CONDITIONS Many regions of the United States, including regions in which the Company owns property, have experienced varying degrees of economic recession. A continuation of the economic recession, or further adverse changes in general or local economic conditions, could result in the inability of some existing tenants of the Company to meet their lease obligations and could otherwise adversely affect the Company's ability to attract or retain tenants. The shopping centers are typically anchored by discount department stores (usually Wal-Mart, Kmart or J.C. Penney), supermarkets, and drug stores which usually offer day-to-day necessities, rather than high-priced luxury items. Since these merchants typically perform better in an economic recession than those who market high priced luxury items, the percentage rents received by the Company have remained relatively stable. In addition, the Company seeks to reduce its operating and leasing risks through ownership of a portfolio of properties with a diverse geographic and tenant base. During 1996 and 1997, certain national and regional retailers experienced financial difficulties and several have filed for protection under bankruptcy laws. Although the Company has experienced an increase in the number of tenants filing for protection under bankruptcy laws, no significant bankruptcies have occurred through May 12, 1997 with regard to the Company's portfolio of tenants. -16-
17 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is not presently involved in any material litigation nor, to its knowledge, is any material litigation threatened against the Company or its properties, other than routine litigation arising in the ordinary course of business and which is expected to be covered by the Company's liability insurance. ITEM 2. MATERIAL MODIFICATIONS OF RIGHTS OF REGISTRANT'S SECURITIES None ITEM 3. DEFAULTS ON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None ITEM 5. OTHER EVENTS None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a) Exhibits - 4.1 Second amendment to credit agreement between the Company and the First National Bank of Chicago and the First National Bank of Boston 11.1 Earnings per Share 27 (a) Financial Data Schedule b) Reports on Form 8-K Date of Report Items Reported -------------- -------------- January 13, 1997 Item 7. Financial Statements, Pro Forma Financial Information and Exhibits -17-
18 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. DEVELOPERS DIVERSIFIED REALTY CORPORATION May 15, 1997 /s/ Scott A. Wolstein - ---------------------------- --------------------------------------- (Date) Scott A. Wolstein, President and Chief Executive Officer May 15, 1997 /s/ William H. Schafer - ---------------------------- --------------------------------------- (Date) William H. Schafer, Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) -18-