UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

(Mark One)

x                                 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended          March 31, 2007

OR

o                                   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: 1-9044

DUKE REALTY CORPORATION
(Exact Name of Registrant as Specified in Its Charter)

 

Registrant’s telephone number, including area code: (317) 808-6000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x       Noo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):

YES  o     NO  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

 

DUKE REALTY CORPORATION

INDEX

		Page
Part I - Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2007 (Unaudited) and December 31, 2006		2
Consolidated Statements of Operations (Unaudited) for the three months ended March 31, 2007 and 2006		3
Consolidated Statements of Cash Flows (Unaudited) for the three months ended March 31, 2007 and 2006		4
Consolidated Statement of Shareholders’ Equity (Unaudited) for the three months ended March 31, 2007		5
Notes to Consolidated Financial Statements (Unaudited)		6-13
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		14-27
Item 3. Quantitative and Qualitative Disclosures About Market Risk		27
Item 4. Controls and Procedures		27
Part II - Other Information
Item 1. Legal Proceedings		28
Item 1A. Risk Factors		28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		28-29
Item 3. Defaults Upon Senior Securities		29
Item 4. Submission of Matters to a Vote of Security Holders		29
Item 5. Other Information		29
Item 6. Exhibits		30-31

 

PART I - FINANCIAL INFORMATION

Item 1.  Financial Statements

DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except per share amounts)

		March 31,			December 31,
		2007			2006
		(Unaudited)
ASSETS
Real estate investments:
Land and improvements		$	857,809		$	844,091
Buildings and tenant improvements		4,265,873			4,211,602
Construction in progress		451,707			359,765
Investments in unconsolidated companies		514,631			628,323
Land held for development		748,392			737,752
		6,838,412			6,781,533
Accumulated depreciation		(907,095		)	(867,079		)
Net real estate investments		5,931,317			5,914,454
Real estate investments and other assets held for sale		498,249			512,925
Cash and cash equivalents		9,492			68,483
Accounts receivable, net of allowance of $1,128 and $1,088		26,527			24,118
Straight-line rent receivable, net of allowance of $1,996 and $1,915		109,691			105,319
Receivables on construction contracts, including retentions		48,753			64,768
Deferred financing costs, net of accumulated amortization of $22,204 and $19,492		60,898			62,277
Deferred leasing and other costs, net of accumulated amortization of $133,773 and $127,155		374,052			311,553
Escrow deposits and other assets		213,506			174,698
		$	7,272,485		$	7,238,595
LIABILITIES AND SHAREHOLDERS’ EQUITY
Indebtedness:
Secured debt		$	503,400		$	515,192
Unsecured notes		3,135,402			3,129,653
Unsecured line of credit		330,000			317,000
		3,968,802			3,961,845
Liabilities of properties held for sale		152,518			155,185
Construction payables and amounts due subcontractors, including retentions		118,735			136,508
Accrued expenses:
Real estate taxes		63,881			59,276
Interest		38,985			52,106
Other		33,804			63,217
Other liabilities		116,111			118,901
Tenant security deposits and prepaid rents		34,163			31,121
Total liabilities		4,526,999			4,578,159
Minority interest		116,722			156,853
Shareholders’ equity:
Preferred shares ($.01 par value); 5,000 shares authorized; 3,241 shares issued and outstanding		876,250			876,250
Common shares ($.01 par value); 250,000 shares authorized; 136,892 and 133,921 shares issued and outstanding		1,369			1,339
Additional paid-in capital		2,319,643			2,196,388
Accumulated other comprehensive income		5,703			5,435
Distributions in excess of net income		(574,201		)	(575,829		)
Total shareholders’ equity		2,628,764			2,503,583
		$	7,272,485		$	7,238,595

 

See accompanying Notes to Consolidated Financial Statements.

2

DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
For the Three Months Ended March 31,
(in thousands, except per share amounts)

		2007			2006
RENTAL OPERATIONS
Revenues:
Rental income from continuing operations		$	207,447		$	184,077
Equity in earnings of unconsolidated companies		7,691			8,259
		215,138			192,336
Operating expenses:
Rental expenses		50,124			43,907
Real estate taxes		25,746			21,959
Interest expense		45,704			37,013
Depreciation and amortization		67,739			57,630
		189,313			160,509
Earnings from continuing rental operations		25,825			31,827
SERVICE OPERATIONS
Revenues:
General contractor gross revenue		54,157			69,549
General contractor costs		(48,688		)	(64,208		)
Net general contractor revenue		5,469			5,341
Service fee revenue		6,397			4,418
Gain on sale of service operations properties		2,864			247
Total revenue		14,730			10,006
Operating expenses		7,796			5,556
Earnings from service operations		6,934			4,450
General and administrative expense		(13,467		)	(13,938		)
Operating income		19,292			22,339
OTHER INCOME (EXPENSE)
Interest and other income, net		2,418			1,980
Earnings from sale of land, net of impairment adjustment		13,997			1,890
Other minority interest in earnings of subsidiaries		(15		)	(102		)
Minority interest in earnings of common unitholders		(1,391		)	(1,082		)
Income from continuing operations		34,301			25,025
Discontinued operations:
Net income from discontinued operations, net of minority interest		1,202			1,309
Gain on sale of properties, net of minority interest		48,286			459
Income from discontinued operations		49,488			1,768
Net income		83,789			26,793
Dividends on preferred shares		(15,226		)	(12,712		)
Adjustments for redemption of preferred shares		—			(2,633		)
Net income available for common shareholders		$	68,563		$	11,448
Basic net income per common share:
Continuing operations		$	.14		$	.07
Discontinued operations		.36			.01
Total		$	.50		$	.08
Diluted net income per common share:
Continuing operations		$	.14		$	.07
Discontinued operations		.35			.01
Total		$	.49		$	.08
Weighted average number of common shares outstanding		136,823			134,781
Weighted average number of common shares and potential dilutive common equivalents		149,465			149,265

 

See accompanying Notes to Consolidated Financial Statements.

3

DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the three months ended March 31,
(in thousands)
(Unaudited)

		2007			2006
Cash flows from operating activities:
Net income		$	83,789		$	26,793
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation of buildings and tenant improvements		52,143			51,271
Amortization of deferred leasing and other costs		15,596			9,311
Amortization of deferred financing costs		2,865			1,707
Minority interest in earnings		4,924			1,361
Straight-line rent adjustment		(5,773		)	(5,417		)
Earnings from land and depreciated property sales		(65,717		)	(2,395		)
Build-for-sale operations, net		(49,989		)	(36,042		)
Construction contracts, net		6,764			(3,521		)
Other accrued revenues and expenses, net		(33,925		)	(10,945		)
Operating distributions received in excess of (less than) equity in earnings from unconsolidated companies		137			(3,323		)
Net cash provided by operating activities		10,814			28,800
Cash flows from investing activities:
Development of real estate investments		(96,588		)	(84,479		)
Acquisition of real estate investments and related intangible assets		(33,628		)	(631,134		)
Acquisition of land held for development		(34,738		)	(203,159		)
Recurring tenant improvements		(10,333		)	(13,526		)
Recurring leasing costs		(8,164		)	(1,995		)
Recurring building improvements		(974		)	(1,769		)
Other deferred leasing costs		(3,232		)	(8,450		)
Other deferred costs and other assets		403			(15,538		)
Proceeds from land and depreciated property sales, net		176,726			10,402
Capital distributions from unconsolidated companies		53,500			17,740
Advances to unconsolidated companies, net		(33,275		)	(6,313		)
Net cash provided by (used for) investing activities		9,697			(938,221		)
Cash flows from financing activities:
Payments for repurchases of common shares		—			(11,883		)
Proceeds (disbursements) from exercise of stock options		(12		)	4,767
Proceeds from issuance of preferred shares, net		—			177,734
Payments for redemption of preferred shares		—			(75,010		)
Proceeds from unsecured debt issuance		5,812			150,000
Payments on unsecured debt		—			(100,000		)
Proceeds from issuance of secured debt		—			710,450
Payments on secured indebtedness including principal amortization		(12,007		)	(1,808		)
Borrowings on line of credit, net		13,000			125,000
Distributions to common shareholders		(65,004		)	(63,683		)
Distributions to preferred shareholders		(15,226		)	(12,712		)
Distributions to minority interest, net		(4,662		)	(6,366		)
Cash overdrafts		—			4,979
Deferred financing costs		(1,403		)	(18,779		)
Net cash provided by (used for) financing activities		(79,502		)	882,689
Net decrease in cash and cash equivalents		(58,991		)	(26,732		)
Cash and cash equivalents at beginning of period		68,483			26,732
Cash and cash equivalents at end of period		$	9,492		$	—
Other non-cash items:
Assumption of secured debt for real estate acquisitions		$	—		$	137,648
Conversion of Limited Partner Units to common shares		$	117,245		$	252
Issuance of Limited Partner Units for acquisitions		$	11,020		$	—
Elimination upon consolidation of investments in and advances to previously unconsolidated companies		$	94,724		$	—

 

See accompanying Notes to Consolidated Financial Statements

4

DUKE REALTY CORPORATION AND SUBSIDIARIES
Consolidated Statement of Shareholders’ Equity
For the three  months ended March 31, 2007
(in thousands,  except per share data)
(Unaudited)

											Accumulated
								Additional			Other			Distributions
		Preferred			Common			Paid-in			Comprehensive			in Excess of
		Stock			Stock			Capital			Income (Loss)			Net Income			Total
Balance at December 31, 2006		$	876,250		$	1,339		$	2,196,388		$	5,435		$	(575,829	)	$	2,503,583
Effect of implementing new accounting principle		—			—			—			—			(1,717		)	(1,717		)
Balance at January 1, 2007		$	876,250		$	1,339		$	2,196,388		$	5,435		$	(577,546	)	$	2,501,866
Comprehensive Income:
Net income		—			—			—			—			83,789			83,789
Gains on derivative instruments		—			—			—			268			—			268
Comprehensive income		—			—			—			—			—			84,057
Acquisition of minority interest		—			26			117,219			—			—			117,245
Stock based compensation plan activity		—			4			6,036			—			(214		)	5,826
Distributions to preferred shareholders		—			—			—			—			(15,226		)	(15,226		)
Distributions to common shareholders ($.475 per share)		—			—			—			—			(65,004		)	(65,004		)
Balance at March 31, 2007		$	876,250		$	1,369		$	2,319,643		$	5,703		$	(574,201	)	$	2,628,764

 

See accompanying Notes to Consolidated Financial Statements

5

DUKE REALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.                                      General Basis of Presentation

The interim consolidated financial statements included herein have been prepared by Duke Realty Corporation (the “Company”) without audit (except for the Balance Sheet as of December 31, 2006). The financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and in accordance with Rule 10-01 of Regulation S-X of the Securities Exchange Act of 1934. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. These financial statements should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations included herein and the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2006.

Our rental operations are conducted through Duke Realty Limited Partnership (“DRLP”). Approximately 93.3% of the common partnership interests of DRLP (“Units”) were owned by us at March 31, 2007. The remaining Units in DRLP are redeemable for shares of our common stock on a one-to-one basis. We conduct Service Operations through Duke Realty Services LLC and Duke Realty Services Limited Partnership, and are the sole general partner of both entities. We also conduct Service Operations through Duke Construction Limited Partnership, which is effectively 100% owned by DRLP. The consolidated financial statements include our accounts and our majority-owned or controlled subsidiaries. In this Quarterly Report on Form 10-Q (this “Report”), the terms “we,” “us” and “our” refer to the Company and those entities owned or controlled by the Company.

2.                                      Reclassifications

Certain 2006 balances have been reclassified to conform to the 2007 presentation.

3.                                      Acquisition

In February 2007, we closed on the acquisition of Bremner Healthcare Real Estate (“Bremner”), a national health care development and management firm.  The primary reason for the acquisition was to expand our development capabilities within the health care real estate market.

The initial consideration paid to the sellers totaled $47.1 million and the sellers will be eligible for further contingent payments over the next three years.

Approximately $38.0 million of the total purchase price is allocated to goodwill, which is attributable to the value of Bremner’s overall development capabilities and their in-place workforce.  Our purchase accounting allocation is preliminary as of March 31, 2007.

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4.                                      Indebtedness

We had an unsecured line of credit available at March 31, 2007, described as follows (dollars in thousands):

		Borrowing			Maturity		Interest		Outstanding Balance
Description		Capacity			Date		Rate		at March 31, 2007
Unsecured Line of Credit		$	1,000,000		January 2010		LIBOR + .53	%	$	330,000

 

We use this line of credit to fund development activities, acquire additional rental properties and provide working capital.

The line of credit provides us with an option to obtain borrowings from financial institutions that participate in the line, at rates lower than the stated interest rate, subject to certain restrictions. Interest rates on the amounts outstanding on the unsecured line of credit as of March 31, 2007, range from LIBOR + .16% to LIBOR + .53% (equal to 5.48% and 5.85% as of March 31, 2007).

The line of credit also contains financial covenants that require us to meet financial ratios and defined levels of performance, including those related to variable rate indebtedness, consolidated net worth and debt-to-market capitalization. As of March 31, 2007, we were in compliance with all covenants under our line of credit.

5.                                      Related Party Transactions

We provide property management, leasing, construction and other tenant related services to unconsolidated companies in which we have equity interests. For the three months ended March 31, 2007 and 2006, we received management fees of $1.3 million and $1.1 million, leasing fees of $505,000 and $665,000 and construction and development fees of $3.6 million and $1.6 million, respectively, from these companies. These fees approximate market rates for these types of services and we have eliminated our ownership percentage of these fees in the consolidated financial statements.

6.                                      Net Income Per Common Share

Basic net income per common share is computed by dividing net income available for common shareholders by the weighted average number of common shares outstanding for the period. Diluted net income per common share is computed by dividing the sum of net income available for common shareholders and the minority interest in earnings allocable to Units not owned by us, by the sum of the weighted average number of common shares outstanding and minority Units outstanding, including any potential dilutive common equivalents for the period.

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The following table reconciles the components of basic and diluted net income per common share for the three months ended March 31, 2007 and 2006, respectively (in thousands):

(1)                                  One of our joint venture partners in one of our unconsolidated companies has the option to convert a portion of its ownership in the joint venture to our common shares.  The effect of this option on earnings per share is dilutive for the first quarter 2007; therefore, conversion to common shares is included in weighted average potential dilutive common equivalents for the quarter.

(2)                                  Excludes (in thousands of shares) 420 and 462 of anti-dilutive shares as of March 31, 2007 and 2006, respectively.  Additionally, we issued Exchangeable Senior Notes (“Exchangeable Notes”) in 2006, which were excluded from earnings per share due to having an anti-dilutive effect for the three-month period ended March 31, 2007.

7.                                      Segment Reporting

We are engaged in three operating segments, the first two of which consist of the ownership and rental of office and industrial real estate investments (collectively, “Rental Operations”). The third segment consists of our build-to-suit for sale operations and providing various real estate services such as property management, maintenance, leasing, development and construction management to third-party property owners and joint ventures (“Service Operations”). Our reportable segments offer different products or services and are managed separately because each segment requires different operating strategies and management expertise.

The assets of the Service Operations business segment generally include properties under development.  During the period between the completion of development, rehabilitation or repositioning of a Service Operations property and the date the property is contributed to a property fund or sold to a third party, the property and its associated rental income and rental expenses are included in the applicable Rental Operations segment because the primary activity associated with the Service Operations property during that period is rental activities.  Upon contribution or sale, the resulting gain or loss is part of the income of the Service Operations business segment.

Non-segment revenue consists mainly of equity in earnings of unconsolidated companies and other insignificant rental operations such as retail properties. Segment FFO information (FFO is defined below) is calculated by subtracting operating expenses attributable to the applicable segment from segment revenues. Non-segment assets consist of corporate assets including cash, deferred financing costs and investments in unconsolidated companies. Interest expense and other non-property specific revenues and expenses are not allocated to individual segments in determining our performance measure.

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We assess and measure segment operating results based upon an industry performance measure referred to as Funds From Operations (“FFO”), which management believes is a useful indicator of our operating performance. FFO is used by industry analysts and investors as a supplemental operating performance measure of an equity real estate investment trust (“REIT”) like Duke. FFO is calculated in accordance with the definition that was adopted by the Board of Governors of the National Association of Real Estate Investment Trusts (“NAREIT”). NAREIT created FFO as a supplemental measure of REIT operating performance that excludes historical cost depreciation, among other items, from net income determined in accordance with GAAP. FFO is a non-GAAP financial measure developed by NAREIT to compare the operating performance of REITs. The most comparable GAAP measure is net income (loss).  FFO should not be considered as a substitute for net income or any other measures derived in accordance with GAAP and may not be comparable to other similarly titled measure of other companies.

Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminishes predictably over time.  Since real estate values instead have historically risen or fallen with market conditions, many industry analysts and investors have considered presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves.  FFO, as defined by NAREIT, represents GAAP net income (loss), excluding extraordinary items as defined under GAAP and gains or losses from sales of previously depreciated operating real estate assets, plus certain non-cash items such as real estate asset depreciation and amortization, and after similar adjustments for unconsolidated partnerships and joint ventures.

Management believes that the use of FFO, combined with the required primary GAAP presentations, improves the understanding of operating results of REITs among the investing public and makes comparisons of REIT operating results more meaningful.  Management believes FFO is a useful measure for reviewing comparative operating and financial performance (although FFO should be reviewed in conjunction with net income which remains the primary measure of performance) because by excluding gains or losses related to sales of previously depreciated operating real estate assets and excluding real estate asset depreciation and amortization, FFO provides a useful comparison of the operating performance of our real estate between periods or as compared to different companies.

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The following table shows (i) the revenues and FFO for each of the reportable segments and (ii) a reconciliation of net income available for common shareholders to the calculation of FFO for the three months ended March 31, 2007, and 2006, respectively (in thousands):

		Three Months Ended March 31,
		2007			2006
Revenues
Rental Operations:
Office		$	146,624		$	131,437
Industrial		56,758			49,991
Service Operations		14,730			10,006
Total Segment Revenues		218,112			191,434
Non-Segment Revenue		11,756			10,908
Consolidated Revenue from continuing operations		229,868			202,342
Discontinued Operations		5,745			10,529
Consolidated Revenue		$	235,613		$	212,871
Funds From Operations
Rental Operations:
Office		$	87,848		$	80,464
Industrial		42,483			36,581
Service Operations		6,934			4,450
Total Segment FFO		137,265			121,495
Non-Segment FFO:
Interest expense		(45,704		)	(37,013		)
Interest and other income, net		2,418			1,980
General and administrative expense		(13,467		)	(13,938		)
Gain on land sales, net of impairment		13,997			1,890
Other non-segment income		1,247			1,167
Minority interest		(1,406		)	(1,184		)
Minority interest share of FFO adjustments		(1,263		)	(5,588		)
Joint venture FFO		10,698			9,998
Dividends on preferred shares		(15,226		)	(12,712		)
Adjustment for redemption of preferred shares		—			(2,633		)
Discontinued operations, net of minority interest		(2,232		)	4,215
Consolidated basic FFO		86,327			67,677
Depreciation and amortization on continuing operations		(67,739		)	(57,630		)
Depreciation and amortization on discontinued operations		—			(2,952		)
Company’s share of joint venture adjustments		(4,968		)	(4,702		)
Earnings from depreciated property sales on discontinued operations		51,720			505
Earnings from depreciated property sales — share of joint venture		1,960			2,962
Minority interest share of FFO adjustments		1,263			5,588
Net income available for common shareholders		$	68,563		$	11,448

 

The assets for each of the reportable segments as of March 31, 2007 and December 31, 2006, respectively, are as follows (in thousands):

 

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In addition to revenues and FFO, we also review our recurring capital expenditures in measuring the performance of our individual rental operations segments. These recurring capital expenditures consist of tenant improvements, leasing commissions and building improvements. We review these expenditures to determine the costs associated with re-leasing vacant space and maintaining the condition of our properties. Our recurring capital expenditures by segment are summarized as follows for the three months ended March 31, 2007 and 2006, respectively  (in thousands):

 

8.                                      Discontinued Operations and Assets Held for Sale

We classified the operations of 33 buildings as discontinued operations as of March 31, 2007. These 33 buildings consist of 17 industrial and 16 office properties. Of these properties, ten were sold during the first quarter of 2007, 21 were sold during 2006 and two operating properties are classified as held-for-sale at March 31, 2007.

The following table illustrates the operations of the buildings reflected in discontinued operations for the three months ended March 31, 2007 and 2006, respectively (in thousands):

 

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At March 31, 2007, we classified two properties as held-for-sale and included in discontinued operations.  Additionally, we have classified 21 in-service properties as held-for-sale, but have included the results of these properties in continuing operations, either based on our present intention to sell the majority of our ownership interest in the properties to entities in which we will retain a minority equity ownership interest or because the results of operations for the properties are immaterial.  The following table illustrates the aggregate balance sheet of the aforementioned properties included in discontinued operations, as well as the 21 held-for-sale properties whose results are included in continuing operations, at March 31, 2007 (in thousands):

 

We allocate interest expense to discontinued operations and have included such interest expense in computing net income from discontinued operations. Interest expense allocable to discontinued operations includes interest on any debt on secured properties included in discontinued operations and an allocable share of our consolidated unsecured interest expense for unencumbered properties. The allocation of unsecured interest expense to discontinued operations was based upon the gross book value of the discontinued operations unencumbered population as it related to our entire unencumbered population.

9.                                      Financial Instruments

We are exposed to capital market risk, such as changes in interest rates. In order to manage the volatility relating to interest rate risk, we may enter into interest rate hedging arrangements from time to time. We do not utilize derivative financial instruments for trading or speculative purposes.

In August 2005, we entered into $300.0 million of cash flow hedges through forward-starting interest rate swaps to hedge interest rates on $300.0 million of estimated debt offerings in 2007. The swaps qualify for hedge accounting, with any changes in fair value recorded in Accumulated Other Comprehensive Income (“OCI”). At March 31, 2007, the fair value of these swaps was approximately $10.0 million in an asset position as the effective rates of the swaps were lower than current interest rates at March 31, 2007.

The effectiveness of our hedges will be evaluated throughout their lives using the hypothetical derivative method under which the change in fair value of the actual swap designated as the hedging instrument is compared to the change in fair value of a hypothetical swap.

10.                               Recent Accounting Pronouncements

We adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 (“FIN 48”) on January 1, 2007.  The adoption of FIN 48 did not have a material impact, with an additional tax exposure of approximately $1.7 million recorded as an adjustment to the opening balance of Distributions in Excess of Net Income, on our financial position or results of operations primarily due to our tax status as a REIT. Our uncertain tax positions are immaterial both individually and in the aggregate.

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In September 2006, the FASB issued Statement of Financial Accounting Standard (“SFAS”) No. 157, Fair Value Measurements (“SFAS 157”).  SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosure about fair value measurements.  SFAS No. 157 is effective for fiscal years beginning after November 15, 2007.  Management is currently evaluating the impact the adoption of this statement will have on the Company.

In January 2007, the FASB issued SFAS No. 159, The Fair Value Options for Financial Assets and Financial Liabilities (“SFAS 159”).  SFAS 159 provides a “Fair Value Option” under which a company may irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities.  This Fair Value Option will be available on a contract-by-contract basis with changes in fair value recognized in earnings as those changes occur.  The effective date for SFAS 159 is the beginning of each reporting entity’s first fiscal year end that begins after November 15, 2007.  Management is currently evaluating the impact the adoption of this SFAS 159 will have on the Company.

11.                               Subsequent Events

Declaration of Dividends

The Company’s board of directors declared the following dividends at its April 25, 2007, regularly scheduled Board meeting:

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Statement Regarding Forward Looking Statements

Certain statements contained in this Report, including those related to our future operations, constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  The words “believe,” “estimate,” “expect,” “anticipate,” “intend,” “plan,” “seek,” “may” and similar expressions or statements regarding future periods are intended to identify forward-looking statements.  These forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause our actual results, performance or achievements, or industry results, to differ materially from any predictions of future results, performance or achievements that we express or imply in this Report or in the information incorporated by reference into this Report. Some of the risks, uncertainties and other important factors that may affect future results include, among others:

·     Changes in general economic and business conditions, including performance of financial markets;

·     Our continued qualification as a real estate investment trust, or “REIT”;

·     Heightened competition for tenants and potential decreases in property occupancy;

·     Potential increases in real estate construction costs;

·     Potential changes in the financial markets and interest rates;

·     Our continuing ability to favorably raise funds through the issuance of debt and equity in the capital markets;

·     Our ability to successfully identify, acquire, develop and/or manage properties on terms that are favorable to us;

·     Our ability to successfully dispose of properties on terms that are favorable to us;

·     Inherent risks in the real estate business including tenant defaults, potential liability relating to environmental matters and liquidity of real estate investments; and

·     Other risks and uncertainties described or incorporated by reference herein, including, without limitation, those risks and uncertainties discussed from time to time in our other reports and other public filings with the Securities and Exchange Commission (“SEC”).

This list of risks and uncertainties, however, is only a summary of some of the most important factors and is not intended to be exhaustive. Additional information regarding risk factors that may affect us is included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006, which we filed with the SEC on March 1, 2007, and is updated by us from time to time in Quarterly Reports on Form 10-Q and other public filings.

Although we presently believe that the plans, expectations and results expressed in or suggested by the forward-looking statements are reasonable, all forward-looking statements are inherently uncertain, and subject to change, as they involve substantial risks and uncertainties beyond our control. New factors emerge from time to time, and it is not possible for us to predict the nature, or assess the potential impact, of each new factor on our business. Given these uncertainties, we caution you not to place undue reliance on these forward-looking statements. We undertake no obligation to update or revise any of our forward-looking statements for events or circumstances that arise after the statement is made, except as required by law.

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Business Overview

We are a self-administered and self-managed real estate investment trust (“ REIT”) that began operations through a related entity in 1972. As of March 31, 2007, we:

·                 Owned or jointly controlled 750 industrial, office and retail properties (including properties under development), consisting of approximately 120.7 million square feet; and

·                 Owned or jointly controlled more than 7,700 acres of land with an estimated future development potential of approximately 112 million square feet of industrial, office and retail properties.

We provide the following services for our properties and for certain properties owned by third parties and joint ventures:

·                 Property leasing;

·                 Property management;

·                 Construction;

·                 Development; and

·                 Other tenant-related services.

Acquisition

In February 2007, we closed on the acquisition of Bremner Healthcare Real Estate (“Bremner”), a national health care development and management firm.  The primary reason for the acquisition was to expand our development capabilities within the health care real estate market.

The initial consideration paid to the sellers totaled $47.1 million and the sellers will be eligible for further contingent payments over the next three years.

Approximately $38.0 million of the total purchase price is allocated to goodwill, which is attributable to the value of Bremner’s overall development capabilities and their in-place workforce.  Our purchase accounting allocation is preliminary as of March 31, 2007.

Key Performance Indicators

Our operating results depend primarily upon rental income from our office and industrial properties (“Rental Operations”). The following highlights the areas of Rental Operations that we consider critical for future revenue growth. All square footage totals and occupancy percentages reflect both wholly owned properties and properties in joint ventures.

Occupancy Analysis: Our ability to maintain occupancy rates is a principal driver of our results of operations. The following table sets forth occupancy information regarding our in-service portfolio of rental properties (excluding in-service properties developed or acquired with the intent to sell) as of March 31, 2007 and 2006 (in thousands, except percentage data):

		Total				Percent of
		Square Feet				Total Square Feet				Percent Occupied
Type		2007		2006		2007		2006		2007		2006
Industrial		75,628		71,610		69.7	%	69.0	%	92.6	%	94.6	%
Office		32,167		31,613		29.7	%	30.4	%	91.9	%	89.6	%
Other		611		611		0.6	%	0.6	%	96.7	%	99.1	%
Total		108,406		103,834		100.0	%	100.0	%	92.4	%	93.1	%

 

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Lease Expiration and Renewal: Our ability to maintain and grow occupancy rates primarily depends upon our continuing ability to re-lease expiring space. The following table reflects our in-service lease expiration schedule by property type as of March 31, 2007. The table indicates square footage and annualized net effective rents (based on March 2007 rental revenue) under expiring leases (in thousands, except percentage data):

		Total
		Portfolio							Industrial					Office					Other
Year of		Square		Ann. Rent			% of		Square		Ann. Rent			Square		Ann. Rent			Square		Ann. Rent
Expiration		Feet		Revenue			Revenue		Feet		Revenue			Feet		Revenue			Feet		Revenue
2007		7,438		$	44,003		6	%	5,666		$	20,757		1,768		$	23,186		4		$	60
2008		13,838		81,050			12	%	10,572		40,860			3,247		39,855			19		335
2009		11,644		75,237			11	%	8,445		34,103			3,195		41,056			4		78
2010		12,169		93,487			13	%	8,029		35,154			4,129		58,166			11		168
2011		13,517		85,233			12	%	10,071		38,897			3,421		45,754			25		582
2012		9,444		65,770			9	%	6,375		24,623			3,062		40,814			7		333
2013		7,511		67,785			10	%	4,072		17,792			3,405		49,414			34		579
2014		5,620		33,051			5	%	4,259		15,168			1,361		17,883			—		—
2015		6,883		52,944			8	%	4,736		18,775			2,147		34,169			—		—
2016		3,824		25,860			4	%	2,690		9,577			960		14,611			174		1,672
2017 and Thereafter		8,267		68,078			10	%	5,087		22,052			2,870		44,398			310		1,627
		100,155		$	692,498		100	%	70,002		$	277,758		29,565		$	409,306		588		$	5,434
Total Portfolio Square Feet		108,406							75,628					32,167					611
Percent Occupied		92.4	%						92.6	%				91.9	%				96.7	%

 

We renewed 81.6% and 76.4% of our leases up for renewal in the three months ended March 31, 2007 and 2006 totaling approximately 1.9 million and 1.9 million square feet, respectively, on which we attained 5% and 3.8% growth in net effective rents.

The average term of renewals increased from 3.0 years in the three months ended March 31, 2006 to 3.6 years in the three months ended March 31, 2007.

Future Development: Another source of growth in earnings is the development of additional properties. These properties should provide future earnings through income upon sale or from Rental Operations growth as they are placed in service. We had 9.1 million square feet of property under development with total estimated costs of $1.0 billion at March 31, 2007, compared to 9.3 million square feet with total costs of $718.0 million, at March 31, 2006.

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