UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-K

 

 

 

 

Securities registered pursuant to Section 12(g) of the Act:

 

Depositary Shares, each representing a 1/10 interest in 7.99% Series B Cumulative Redeemable Preferred Shares ($.01 par value)

 

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  ý    No  o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ý

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act).  Yes ý    No  o

 

The aggregate market value of the voting shares of the Registrant’s outstanding common shares held by non-affiliates of the Registrant is $3.7 billion based on the last reported sale price on June 30, 2003.

 

The number of  Common Shares outstanding as of February 26, 2004 was 137,933,858 ($.01 par value).

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Definitive Proxy Statement for its 2004 Annual Meeting of Shareholders to be held on April 28, 2004, are incorporated by reference in Part III of this Annual Report on Form 10-K.

 

 

TABLE OF CONTENTS

 

Form 10-K

 

Item No.
PART I
	1.	Business
	2.	Properties
	3.	Legal Proceedings
	4.	Submission of Matters to a Vote of Security Holders
		Executive Officers of the Registrant
PART II
	5.	Market for the Registrant’s Common Equity and Related Stockholder Matters
	6.	Selected Consolidated Financial Data
	7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
	7A.	Quantitative and Qualitative Disclosures about Market Risk
	8.	Financial Statements and Supplementary Data
	9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
	9A.	Disclosure Controls and Procedures
PART III
	10.	Directors and Executive Officers of the Registrant
	11.	Executive Compensation
	12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
	13.	Certain Relationships and Related Transactions
	14.	Principal Accountant Fees and Services
PART IV
	15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K
Signatures

 

 

PART I

 

Item 1.  Business

 

Risk Factors

 

There are certain risk factors associated with an investment of securities issued by Duke Realty Corporation (the “Company”). Discussion of these risk factors can be found within Item 7, Management’s Discussion and Analysis, Financial Conditions and Results of Operations, of this Annual Report Form 10-K and in the Company’s Current Report on Form 8-K dated July 24, 2003.

 

Background

 

The Company is a self-administered and self-managed real estate investment trust (“REIT”), which began operations upon completion of its initial public offering in February 1986. In October 1993, the Company completed an additional common stock offering and acquired the rental real estate and service businesses of Duke Associates, whose operations began in 1972. As of December 31, 2003, the Company’s diversified portfolio of 899 rental properties (including 15 properties totaling 2.8 million square feet under development) encompass over 109.0 million rentable square feet and are leased by a diverse and stable base of approximately 4,100 tenants whose businesses include manufacturing, retailing, wholesale trade, distribution and professional services. The Company also owns or controls nearly 3,800 acres of unencumbered land ready for development.

 

The Company, through its Service Operations, also provides, on a fee basis, leasing, property and asset management, development, construction, build-to-suit, and other tenant-related services for approximately 300 tenants in over 8.4 million square feet of space at properties owned by third-party clients. With 13 primary operating platforms, the Company concentrates its activities in the Midwest and Southeast United States. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, “Financial Statements and Supplementary Data” for financial information. The Company’s rental operations are conducted through Duke Realty Limited Partnership (“DRLP”). In addition, the Company conducts its Service Operations through Duke Realty Services Limited Partnership (“DRSLP”) and Duke Construction Limited Partnership (“DCLP”). All references to the “Company” in this Form 10-K Report include the Company and those entities owned or controlled by the Company, unless the context indicates otherwise.

 

The Company’s headquarters and executive offices are located in Indianapolis, Indiana. In addition, the Company has twelve regional offices located in Atlanta, Georgia; Cincinnati, Ohio; Columbus, Ohio; Cleveland, Ohio; Chicago, Illinois; Dallas, Texas; Minneapolis, Minnesota; Nashville, Tennessee; Orlando, Florida; Raleigh, North Carolina; St. Louis, Missouri; and Tampa, Florida. The Company had 1,011 employees as of December 31, 2003.

 

Business Strategy

 

The Company’s business objective is to increase its Funds From Operations (“FFO”) by (i) maintaining and increasing property occupancy and rental rates through the management of its portfolio of existing properties; (ii) expanding existing properties; (iii) developing and acquiring new properties; and (iv) providing a full line of real estate services to the Company’s tenants and to third-parties. FFO is used by industry analysts and investors as a supplemental operating  performance measure of an equity REIT. 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”). FFO, as defined by NAREIT, represents net income (loss) determined in accordance with accounting principles generally accepted in the United States (“GAAP”), 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 adjustment for unconsolidated partnerships and joint ventures.

 

1

 

Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminish predictably over time. Since real estate values instead have historically risen or fallen with market conditions, many industry investors and analysts have considered presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. Thus, NAREIT created FFO as a supplemental measure of REIT operating performance that excludes historical cost depreciation, among other items, from GAAP net income. Management believes that the use of FFO, combined with the required primary GAAP presentations, has improved the understanding of operating results of REITs among the investing public and made comparisons of REIT operating results more meaningful. Management generally considers FFO to be 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 assists in comparing the operating performance of a company’s real estate between periods or as compared to different companies.

 

As a fully integrated commercial real estate firm, the Company believes that its in-house leasing, management, development and construction services and the Company’s significant base of commercially zoned and unencumbered land in existing business parks should give the Company a competitive advantage in its future development activities.

 

The Company believes that the analysis of real estate opportunities and risks can be done most effectively at regional or local levels. As a result, the Company intends to continue its emphasis on increasing its market share and effective rents in its primary markets where it owns properties. The Company also expects to utilize its nearly 3,800 acres of unencumbered land and its many business relationships with nearly 4,100 commercial tenants to expand its build-to-suit business (development projects substantially pre-leased to a single tenant) and to pursue other development and acquisition opportunities in its primary markets. The Company believes that this regional focus will allow it to assess market supply and demand for real estate more effectively as well as to capitalize on its strong relationships with its tenant base.  In addition, the Company seeks to further capitalize on strong customer relationships to provide third party construction and build-for-sale services outside its primary markets.

 

The Company’s policy is to seek to develop and acquire Class A commercial properties located in markets with high growth potential for Fortune 500 companies and other quality regional and local firms. The Company’s industrial and suburban office development focuses on business parks and mixed-use developments suitable for multiple projects on a single site where the Company can create and control the business environment. These business parks and mixed-use developments generally include restaurants and other amenities, which the Company believes will create an atmosphere that is particularly efficient and desirable. The Company’s retail development focuses on lifestyle, community and neighborhood centers in its existing markets and is developed primarily for held-for-sale opportunities. As a fully integrated real estate company, the Company is able to arrange for or provide to its industrial, office and retail tenants not only well located and well maintained facilities, but also additional services such as build-to-suit construction, tenant finish construction, expansion flexibility and advertising and marketing services.

 

All of the Company’s properties are located in areas that include competitive properties. Institutional investors, other REITs or local real estate operators generally own such properties; however, no single competitor or small group of competitors is dominant in the Company’s current markets. The supply and demand of similar available rental properties may affect the rental rates the Company will receive on its properties.

 

Financing Strategy

 

The Company seeks to maintain a well-balanced, conservative and flexible capital structure by: (i) extending and sequencing the maturity dates of its debt; (ii) borrowing primarily at fixed rates; (iii) generally pursuing current and future long-term debt financings and refinancing on an unsecured basis; and (iv) maintaining conservative debt service and fixed charge coverage ratios. Management believes that these strategies have enabled and should continue to enable the Company to favorably access capital markets for its long-term

 

2

 

requirements such as debt refinancing and financing development and acquisitions of additional rental properties. In addition, as discussed under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the Company has a $500 million unsecured line of credit available for short-term fundings of development and acquisition of additional rental properties. In addition, the Company pursues favorable opportunities to dispose of assets that no longer meet the Company’s long-term investment criteria and re-deploy the proceeds into new investments that the Company believes have excellent long-term growth prospects. The Company’s debt to total market capitalization ratio (total market capitalization is defined as the total market value of all outstanding Common and Preferred Shares and units of limited partnership interest (“Units”) in DRLP plus outstanding indebtedness) at December 31, 2003 was 30.8%. The Company’s ratio of earnings to debt service and ratio of earnings to fixed charges for the year ended December 31, 2003 were 2.10x and 1.81x, respectively. In computing the ratio of earnings to debt service, earnings have been calculated by adding debt service to income from continuing operations before earnings or losses from the sale of land and depreciable property dispositions, net of impairment adjustments and minority interest in earnings of DRLP. Debt service consists of interest expense and recurring principal amortization (excluding maturities) and excludes amortization of debt issuance costs. In computing the ratio of earnings to fixed charges, earnings have been calculated by adding fixed charges, excluding capitalized interest, to income from continuing operations before earnings or losses from the sale of land and depreciable property dispositions, net of impairment adjustments and minority interest in earnings of DRLP. Fixed charges consist of interest costs, whether expensed or capitalized, the interest component of rental expense, amortization of debt issuance costs and preferred stock dividend requirements.

 

Corporate Governance

Since the Company’s inception, it not only has strived to be a top-performer operationally, but also to lead in issues important to investors such as disclosure and corporate governance. The Company’s system of governance reinforces this commitment. Summarized below are the highlights of the Company’s Corporate Governance initiatives.

 

Board Composition		Board is controlled by supermajority (67%+) of Independent Directors
Board Committees		Board Committee members are all Independent Directors
Lead Director		The Chairman of the Corporate Governance Committee serves as Lead Director of the Independent Directors
Board Policies		No Shareholder Rights Plan (Poison Pill)
		Code of Conduct applies to all Directors and Associates; waivers require the vote of Independent Directors
		Effective orientation program for new Directors
		Independence of Directors is reviewed annually
		Independent Directors meet at least quarterly in executive session
		Independent Directors receive no compensation from Duke other than as Directors
		Equity-based compensation plans require shareholder approval
		Board effectiveness and performance is reviewed annually by the Corporate Governance Committee
		Corporate Governance Committee conducts an annual review of the CEO succession plan
		Independent Directors and all Board Committees may retain outside advisors, as they deem appropriate
		Mandatory retirement age for Directors
		Outstanding stock options may not be repriced
		Directors required to offer resignation upon job change
Ownership		Minimum Stock Ownership Guidelines apply to all Directors and Executive Officers

 

3

 

The Company’s Code of Conduct and its Corporate Governance Guidelines are available in the investor information/corporate governance section of the Company’s website at www.dukerealty.com.  A copy of these documents may also be obtained without charge by writing to Duke Realty Corporation, 600 East 96^th Street, Suite 100, Indianapolis, Indiana 46240, Attention: Investor Relations.

 

Other

 

For additional information regarding the Company’s investments and operations, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and Item 8, “Financial Statements and Supplementary Data.” For additional information about the Company’s business segments, see Item 8, “Financial Statements and Supplementary Data.”

 

In addition to this Annual Report, the Company files quarterly and special reports, proxy statements and other information with the SEC. All documents that are filed with the SEC are available free of charge on the Company’s corporate website, which is http://www.dukerealty.com. You may also read and copy any document filed at the public reference facilities of the SEC at 450 Fifth Street, N.W., Washington, D.C. 25049.  Please call the SEC at (800) SEC-0330 for further information about the public reference facilities. These documents also may be accessed through the SEC’s electronic data gathering, analysis and retrieval system (“EDGAR”) via electronic means, including the SEC’s home page on the Internet (http://www.sec.gov). In addition, since some of our securities are listed on the New York Stock Exchange, you can read SEC filings at the offices of the New York Stock Exchange, 20 Broad Street, New York, New York 10005.

 

Item 2.  Properties

 

Product Review

 

As of December 31, 2003, the Company owns an interest in a diversified portfolio of 899 commercial  properties encompassing over 109.0 million net rentable square feet (including 15 properties  comprising 2.8 million square feet under development) and more than 3,800 acres of land for future development.

 

Industrial Properties: The Company owns interests in 642 industrial properties encompassing approximately 81.3 million square feet (74% of total square feet) more specifically described as follows:

•      Bulk Warehouses – Industrial warehouse/distribution buildings with clear ceiling heights of 20 feet or more. The Company owns 425 buildings totaling 68.1 million square feet of such properties.

•      Service Centers – Also known as flex buildings or light industrial, this product type has 12-18 foot clear ceiling heights and a combination of drive-up and dock-height loading access. The Company owns 217 buildings totaling 13.2 million square feet of such properties.

 

Office Properties:  The Company owns interests in 250 office buildings totaling approximately 26.9 million square feet (25% of total square feet) more specifically described as follows:

•      Suburban Office – The Company owns 246 suburban office buildings totaling 26.0 million square feet.

•      CBD Office – The Company owns four downtown office projects totaling approximately 861,000 square feet.

 

Retail Properties:  The Company owns interests in 7 retail projects totaling approximately 800,000 square feet (1% of total square feet). These properties encompass both power and neighborhood shopping centers.

 

Land:  The Company owns or controls more than 3,800 acres of land located primarily in its existing business parks. The land is ready for immediate use and is unencumbered. Over 60.0 million square feet of additional space can be developed on these sites and substantially all of the land is zoned for either office, industrial or retail development.

 

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Service Operations:  The Company provides property and asset management, development, leasing and construction services to third party owners in addition to its own properties. The Company’s current property management base for third parties includes over 8.4 million square feet of properties serving approximately 300 tenants.

 

Property Descriptions

 

The following schedule represents the geographic highlights of the Company’s properties in its primary markets.

 

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Duke Realty Corporation

Geographic Highlights

In Service Properties as of December 31, 2003

 

		Square Feet (1)														Annual Net Effective Rent (2)			Percent of Annual Net Effective Rent
		Industrial				Office				Retail		Overall		Percent of Overall
		Service Center		Bulk		Suburban		CBD
Primary Market
Atlanta		3,214,230		8,859,456		2,247,270		—		4,115		14,325,071		13.48	%	80,590,375			13.67	%
Indianapolis		1,608,384		17,721,945		2,726,050		161,984		82,374		22,300,737		20.99	%	75,960,615			12.89	%
Cincinnati		1,240,393		7,873,090		3,632,071		699,402		601,537		14,046,493		13.22	%	74,036,670			12.56	%
St. Louis		1,334,011		2,942,200		3,516,953		—		—		7,793,164		7.34	%	67,121,068			11.39	%
Columbus		82,520		4,376,427		3,231,852		—		—		7,690,799		7.24	%	46,145,229			7.83	%
Cleveland		60,600		3,358,888		2,173,613		—		—		5,593,101		5.27	%	42,132,283			7.15	%
Minneapolis		2,117,291		3,563,091		975,323		—		—		6,655,705		6.27	%	41,466,448			7.04	%
Raleigh		1,159,756		1,513,910		2,237,183		—		—		4,910,849		4.62	%	39,990,134			6.78	%
Nashville		1,285,261		3,335,928		785,634		—		—		5,406,823		5.09	%	38,270,740			6.49	%
Chicago		276,344		4,121,431		1,718,207		—		50,572		6,166,554		5.81	%	35,514,517			6.03	%
Central Florida		350,493		2,628,772		1,277,439		—		—		4,256,704		4.01	%	25,574,217			4.34	%
Dallas		470,754		5,337,053		152,000		—		—		5,959,807		5.61	%	13,441,731			2.28	%
South Florida		—		—		677,806		—		—		677,806		0.64	%	8,598,504			1.46	%
Other (3)		—		436,139		—		—		—		436,139		0.41	%	557,914			0.09	%
Total		13,200,037		66,068,330		25,351,401		861,386		738,598		106,219,752		100.00	%	$	589,400,445		100.00	%
		12.43	%	62.21	%	23.87	%	0.81	%	0.70	%	100.00	%

 

		Occupancy %
		Industrial				Office
		Service Center		Bulk		Suburban		CBD		Retail		Overall
Primary Market
Atlanta		84.93	%	84.71	%	91.86	%	—		100.00	%	85.89	%
Indianapolis		87.40	%	96.57	%	87.59	%	94.72	%	99.95	%	94.81	%
Cincinnati		79.94	%	91.95	%	87.47	%	93.65	%	98.21	%	90.09	%
St. Louis		90.48	%	95.28	%	88.21	%	—		—		91.27	%
Columbus		100.00	%	71.83	%	87.32	%	—		—		78.64	%
Cleveland		100.00	%	93.45	%	83.42	%	—		—		89.63	%
Minneapolis		88.57	%	92.28	%	86.90	%	—		—		90.31	%
Raleigh		74.00	%	91.86	%	81.69	%	—		—		83.01	%
Nashville		86.38	%	89.95	%	81.99	%	—		—		87.95	%
Chicago		89.05	%	93.74	%	83.02	%	—		100.00	%	90.60	%
Central Florida		86.70	%	84.38	%	74.15	%	—		—		81.50	%
Dallas		95.09	%	94.96	%	100.00	%	—		—		95.10	%
South Florida		—		—		83.47	%	—		—		83.47	%
Other (3)		—		100.00	%	—		—		—		100.00	%
Total		85.75	%	91.13	%	85.90	%	93.85	%	98.54	%	89.29	%

 

(1) Includes all wholly owned and joint venture projects shown at 100% as of report date .

 

(2) Represents the average annual rental property revenue due from tenants in occupancy as of the date of this report, excluding additional rent due as operating expense reimbursements, landlord allowances for operating expenses and percentage rents. Joint Venture properties are shown at the Company’s ownership percentage.

 

(3) Represents properties not located in the Company’s primary markets. These properties are located in similar midwest or southeast markets.

 

6

 

Item 3.  Legal Proceedings

 

Broadband Office, Inc. and Official Committee of Unsecured Creditors of Broadband Office, Inc. recently filed a complaint against a group of real estate investment trusts and real estate operating companies and certain affiliated entities and individuals in connection with the formation and management of Broadband Office. Among the defendants are Duke Realty Corporation, Duke Realty Limited Partnership and Mr. Dennis Oklak, one of the Company’s executive officers. The complaint alleges various breaches of purported fiduciary duties by the defendants, seeks recharacterization or equitable subordination of debt, seeks recovery of alleged avoidable transfers, appears to seek to hold them liable for, among other things, the debt of Broadband Office under alter-ego, veil-piercing and partnership theories, and seeks other relief under other theories. The complaint seeks aggregate damages in excess of $300 million from all of the defendants. The Company believes that it and Mr. Oklak have meritorious defenses to the plaintiff’s allegations and intends to vigorously defend this litigation. Due to the inherent uncertainties of the litigation process and the judicial system, the Company is not able to predict the outcome of this litigation. If this litigation is not resolved in the Company’s favor, it could have a material adverse effect on its business, financial condition and results of operations.

 

Item 4.  Submission of Matters to a Vote of Security Holders

 

No matters were submitted to a vote of security holders during the fourth quarter of the year ended December 31, 2003.

 

EXECUTIVE OFFICERS OF THE REGISTRANT

 

Robert M. Chapman, age 50.  Mr. Chapman has served as Senior Executive Vice President, Real Estate Operations, since November 2003. From 2000 through November 2003, Mr. Chapman served as the Company’s Executive Vice President, Southern Region, responsible for the Company’s Atlanta, Orlando, Tampa, Raleigh, Nashville and Dallas property portfolios. Mr. Chapman was Executive Vice President of the Atlanta/Texas region from 1999 to 2000, and Executive Vice President of Acquisitions and Dispositions from 1997 to 1999. Before joining the Company in 1997, he served as Senior Vice President and Portfolio Manager for The RREEF Funds, and held positions at Gerald Hines Interests and Lincoln Property Company.

 

Matthew A. Cohoat, age 44. Mr. Cohoat was named Executive Vice President and Chief Financial Officer of the Company on January 1, 2004. From 1990 through 2003, Mr. Cohoat held various positions in the Company’s accounting group, most recently that of Senior Vice President and Corporate Controller. From 1982 until 1990 he was employed by Ernst & Young, LLP.

 

James B. Conner, age 45. Mr. Connor has served as Regional Executive Vice President for the Company’s Chicago Region, which includes its Chicago, Minneapolis, St. Louis and Nashville portfolios, since December 2003. Mr. Connor served as Senior Vice President responsible for the Company’s Chicago Operations since joining the Company in 1998. Prior to joining the Company, Mr. Connor held several executive and brokerage positions with Cushman & Wakefield, most recently serving as Senior Managing Director for the Midwest area.

 

Howard L. Feinsand, age 56.  Mr. Feinsand has served as the Company’s Executive Vice President and General Counsel since 1999. Mr. Feinsand served on the Company’s Board of Directors from 1988 to January 2003. From 1996 until 1999, Mr. Feinsand was the founder and principal of Choir Capital Ltd. From 1995 until 1996, he was Managing Director of Citicorp North America, Inc.  He was the Senior Vice President and Manager-Capital Markets, Pricing and Investor Programs of GE Capital Aviation Services, Inc. from 1989 to 1995. From 1971 through 1989, Mr. Feinsand practiced law in New York City.

 

Robert D. Fessler, age 46. Mr. Fessler has served as Executive Vice President of the Company’s Atlanta Region, which includes its Atlanta, Raleigh, Florida and Dallas portfolios since July 2003.  Mr. Fessler was Senior Vice President of Cincinnati Operations from 2001 to July 2003, led the Cincinnati Industrial Group from 1988 through 2001 and was a leasing representative from 1987 to 1988.  Prior to joining the Company, Mr. Fessler worked for the Trammell Crow Company and General Electric Company.

 

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John W. Guinee III, age 48. Mr. Guinee has served as Executive Vice President and Chief Investment Officer of the Company since February 2003. From 1997 through 2001, Mr. Guinee was Executive Vice President and the Chief Investment Officer of Charles E. Smith Residential Realty. From 1985 through 1997, he was Managing Director of LaSalle Advisors (Alex. Brown Kleinwort Benson prior to a merger). From 1982 through 1985, Mr. Guinee was a development manager with Gerald D. Hines Interests in San Francisco.

 

Thomas L. Hefner, age 57.  Mr. Hefner has served as Chief Executive Officer of the Company since 1993 and as its Chairman since 1998. Mr. Hefner has served as a Director of the Company since 1993.

 

Steven R. Kennedy, age 47. Mr. Kennedy was named Executive Vice President, Construction on January 1, 2004. From 1986 until 2004, he served the Company in various capacities in the construction group, most recently as Senior Vice President. Prior to joining the Company, Mr. Kennedy was employed as a project manager for Charles Pankow Builders, Inc., a West Coast-based design-build and general contractor.

 

Dennis D. Oklak, age 50.  Mr. Oklak was named President and Chief Operating Officer of the Company in January 2003. He had been Co-Chief Operating Officer of the Company since April 2002. Mr. Oklak joined the Company in 1986 as Tax Manager and was later named Controller of the Company’s development companies before being named Vice President and Treasurer. In that position, he served as the Chief Accounting Officer with responsibility for financial reporting in public offerings of securities; assisting the vice presidents of each business unit with deal structuring; and supervising all financial aspects of the Company. Mr. Oklak assumed the position of Executive Vice President and Chief Administrative Officer in 1997 and supervised accounting, tax, information technology, human resources and tenant services.

 

Christopher L. Seger, age 36. Mr. Seger was appointed Executive Vice President, National Development/Construction in December 2003. From 2001 to 2003, Mr. Seger was Senior Vice President of the Company’s Florida Group, with responsibility for its office and industrial portfolio in Central and South Florida.  From 1999 to 2001, Mr. Seger was Senior Vice President of the Company’s Indiana Office Group; and from 1993 to 1999 served in the Company’s Acquisitions and Leasing groups.

 

PART II

 

Item 5.  Market for the Registrant’s Common Equity and Related Stockholder Matters

 

The Company’s common shares are listed for trading on the New York Stock Exchange under the symbol “DRE.” The following table sets forth the high and low sales prices of the common stock for the periods indicated and the dividend paid per share during each such period.  Comparable cash dividends are expected in the future. As of February 26, 2004, there were 11,995 record holders of common shares.

 

		2003									2002
Quarter Ended		High			Low			Dividend			High			Low			Dividend
December 31		$	31.76		$	28.19		$	.460		$	25.84		$	21.50		$	.455
September 30		29.40			27.05			.460			28.88			21.40			.455
June 30		29.30			26.10			.455			28.95			25.46			.450
March 31		27.50			24.25			.455			26.50			22.92			.450

 

On January 28, 2004, the Company declared a quarterly cash dividend of $.46 per share, payable on February 27, 2004, to common shareholders of record on February 12, 2004.

 

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A summary of the tax characterization of the dividends paid per common share for the years ended December 31, 2003, 2002 and 2001 follows:

 

 

Item 6.  Selected Consolidated Financial Data

 

The following sets forth selected consolidated financial and operating information on a historical basis for the Company for each of the years in the five-year period ended December 31, 2003. The following information should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, “Financial Statements and Supplementary Data” included in this Form 10-K (in thousands, except per share amounts):

 

 

(1) Funds From Operations (“FFO”) is used by industry analysts and investors as a supplemental operating  performance measure of an equity real estate investment trust (“REIT”). 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”). FFO, as defined by NAREIT, represents net income (loss) determined in accordance with accounting principles generally accepted in the United States (“GAAP”), 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 adjustment for unconsolidated partnerships and joint ventures.

 

Historical cost accounting for real estate assets in accordance with GAAP implicitly assumes that the value of real estate assets diminished predictably over time. Since real estate values instead have historically risen or fallen with market conditions, many industry investors and analysts have considered the presentation of

 

9

 

operating results for real estate companies that use historical cost accounting to be insufficient by themselves. Thus, NAREIT created FFO as a supplemental measure of REIT operating performance that excludes historical cost depreciation, among other items, from GAAP net income. Management believes that the use of FFO, combined with the required primary GAAP presentations, has improved the understanding of operating results of REITs among the investing public and made comparisons of REIT operating results more meaningful. Management considers FFO to be 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 assists in comparing the operating performance of a company’s real estate between periods or as compared to different companies.

 

Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Cautionary Statement Regarding Forward Looking Statements

 

Certain statements in this Annual Report, including those related to the Company’s 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. These forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause the actual results, performance or achievements of the Company, or industry results, to differ materially from any predictions of future results, performance or achievements that we express or imply in this report. Some of the risks, uncertainties and other important factors that may affect future results include, among others:

 

•      General economic and business conditions;

•      The Company’s continued qualification as a real estate investment trust;

•      Competition for tenants and decrease in property occupancy;

•      Potential increases in real estate construction costs;

•      Potential changes in interest rates;

•      Continuing ability to favorably raise debt and equity in the capital markets; and

•      Other risks inherent in the real estate business including tenant defaults, potential liability relating to environmental matters and liquidity of real estate investments.

 

This list of risks and uncertainties, however, is not intended to be exhaustive. The Company has on file with the Securities and Exchange Commission (“SEC”) a Current Report on Form 8-K dated July 24, 2003, with additional risk factor information.

 

The words “believe,” “estimate,” “expect,” “anticipate” and similar expressions or statements regarding future periods are intended to identify forward-looking statements. Although we believe that the plans, expectations and results expressed in or suggested by our forward-looking statements are reasonable, all forward-looking statements are inherently uncertain as they involve substantial risks and uncertainties beyond the Company’s 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 the Company’s business. Given these uncertainties, we caution you not to place undue reliance on these forward-looking statements. The Company undertakes no obligation to update or revise any of its forward-looking statements for events or circumstances that arise after the statement is made.

 

Business Overview

 

The Company is a self-administered and self managed real estate investment trust that began operations through a related entity in 1972. As of December 31, 2003, the Company:

 

•      Owned or jointly controlled 899 industrial, office and retail properties (including properties under development), consisting of over 109.0 million square feet primarily located in 10 states; and

•      Owned or jointly controlled approximately 3,800 acres of land with an estimated future development potential of more than 60.0 million square feet of industrial, office and retail properties.

 

10

 

The Company provides the following services for its properties and for certain properties owned by third parties:

 

•      leasing;

•      management;

•      construction;

•      development; and

•      other tenant-related services.

 

The Company’s operating results depend primarily upon rental income from its office, industrial and retail properties (“Rental Operations”). The following highlights the areas of Rental Operations that the Company considers critical for future revenue growth (all square footage totals and occupancy percentages reflect both wholly-owned properties and properties in joint ventures):

 

Same Property Performance: The Company tracks same property performance, which measures the performance of properties that were in-service for all reported portions of a two-year period by comparing the results of the second year with the results of the first year. In 2003, net operating income from the same property portfolio decreased by 3.5% from 2002, compared to .3% growth in 2002 over 2001. The current year decline is a result of a decrease of $8.8 million in same property lease termination fees compared to 2002. In addition to the decrease in lease termination fees, the Company increased the use of free rent concessions in 2003 as an incentive to attract quality tenants.

 

Occupancy Analysis: The ability to maintain occupancy rates is a principal driver of the Company’s results of operations. The following table sets forth information regarding the Company’s in-service portfolio of rental properties as of December 31, 2003 and 2002 (square feet in thousands):

 

 

The overall increase in occupancy for 2003 was the result of increased activity primarily in the bulk industrial product, fewer lease terminations through lease buyouts and fewer tenant bankruptcies. An improving economy coupled with increased business spending and aggressive leasing led to the overall occupancy increase. The current year decrease in Service Centers’ occupancy was mainly the result of a tenant terminating 241,000 square feet through a lease buyout in December 2003 in exchange for a termination payment of $3.0 million.

 

Lease Expiration and Renewals: The Company’s ability to maintain and grow its occupancy rates primarily depends upon its continuing ability to re-lease expiring space. The following table reflects the Company’s in-service lease expiration schedule as of December 31, 2003, by product type. The table indicates square footage and annualized net effective rents (based on December 2003 rental revenue) under expiring leases (in thousands):

 

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		Total Portfolio							Industrial					Office					Retail
Year of Expiration		Square Feet		Dollars			%		Square Feet		Dollars			Square Feet		Dollars			Square Feet		Dollars
2004		11,717		$	77,603		11	%	9,092		$	41,621		2,625		$	35,982		—		$	—
2005		13,124		91,409			14	%	10,289		50,825			2,799		40,084			36		500
2006		10,827		76,367			12	%	8,507		44,545			2,318		31,789			2		33
2007		11,192		77,080			12	%	8,490		41,276			2,677		35,527			25		277
2008		13,122		79,650			12	%	10,538		46,383			2,563		32,904			21		363
2009		8,797		58,830			9	%	6,727		31,021			2,050		27,421			20		388
2010		6,956		52,659			8	%	5,053		25,392			1,889		27,031			14		236
2011		3,783		32,904			5	%	2,461		12,290			1,306		20,369			16		245
2012		4,597		28,389			4	%	3,547		13,655			1,043		14,401			7		333
2013		3,725		38,629			6	%	1,673		7,888			1,989		29,826			63		915
2014 and Thereafter		7,002		44,952			7	%	5,151		21,266			1,327		20,150			524		3,536
		94,842		$	658,472		100	%	71,528		$	336,162		22,586		$	315,484		728		$	6,826
Total Portfolio Square Feet		106,220							79,269					26,212					739
Percent Occupied		89.3	%						90.2	%				86.2	%				98.5	%

 

The Company renewed 72.3% of its leases up for renewal in 2003, totaling 8.1 million square feet on which it attained a 1.4% growth in net effective rents. The relatively flat growth in rental rates is indicative of excess vacancies in many of the Company’s markets requiring competitive pricing strategies to retain current tenants.

 

The average term of renewals decreased to 3.5 years in 2003, from 4.4 years in 2002. The Company is currently renewing tenants for shorter terms in anticipation of better market rates for future renewal periods.

 

The Company’s lease renewal percentages over the past three years have remained relatively consistent at a 70-75% success rate despite the relatively weak market conditions. The Company does not currently expect its renewal percentage in 2004 to significantly differ from that experienced in 2003.

 

Future Development: Another source of growth in earnings for the Company is the development of additional rental properties. The Company had approximately 2.8 million square feet of properties under development at December 31, 2003 with total projected costs of approximately $160.3 million. The total projected costs of properties under development at December 31, 2002 was $195.0 million. The lower volume reflects the relative slowdown in business expansion in response to the overall weakened economy, and the Company’s plan to limit the development of speculative properties until activity increases.

 

The properties under development are expected to provide future Rental Operations growth as they are placed in service or, for those properties that are being developed for sale, earnings through Service Operations upon their eventual sale. A summary of the properties under development as of December 31, 2003, follows (in thousands, except percent leased and stabilized returns):

 

 

Acquisition and Disposition Activity: The Company has an active capital recycling program based upon a strategy to dispose of non-strategic assets and utilize the proceeds to fund new development and acquisitions of more desirable properties. Through this program, the Company is continually improving the overall quality of

 

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its investment portfolio. During 2000 and 2001, the Company disposed of over $1 billion of properties, which generated substantially greater proceeds than were required to fund new development and acquisitions. The excess proceeds were utilized to pay down Company debt, which has reduced the Company’s debt-to-total market capitalization ratio to a conservative 30.8% at December 31, 2003.

 

Dispositions of held-for-rental properties slowed in 2003 and 2002, totaling $126 million and $41 million, respectively, as the slower business climate limited reinvestment opportunities. The disposition proceeds were used to partially fund 2003 and 2002 acquisitions of $232 million and $114 million, respectively. The Company will continue to pursue both disposition and acquisition opportunities that arise in 2004. While management expects the volume of acquisitions to exceed dispositions, management cannot predict when or if these opportunities will arise.

 

Funds From Operations

Funds From Operations (“FFO”) is used by industry analysts and investors as a supplemental operating performance measure of an equity real estate investment trust (“REIT”). 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”). FFO, as defined by NAREIT, represents net income (loss) determined in accordance with accounting principles generally accepted in the United States of America (“GAAP”), 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 adjustment for unconsolidated partnerships and joint ventures.

 

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 investors and analysts have considered the presentation of operating results for real estate companies that use historical cost accounting to be insufficient by themselves. Thus, NAREIT created FFO as a supplemental measure of REIT operating performance that excludes historical cost depreciation, among other items, from GAAP net income. Management believes that the use of FFO, combined with the required primary GAAP presentations, has improved the understanding of operating results of REITs among the investing public and made comparisons of REIT operating results more meaningful. Management considers FFO to be 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 assists in comparing the operating performance of a company’s real estate between periods or as compared to different companies.

 

The following table summarizes the calculation of FFO for the years ended December 31 (in thousands):

 

		2003			2002			2001
Net income available for common shares		$	161,911		$	153,969		$	227,743
Add back (deduct):
Depreciation and amortization		196,234			175,621			159,714
Share of adjustments for unconsolidated companies		18,839			17,598			14,177
Loss (Earnings) from depreciated property sales		(22,141		)	(5,949		)	(45,428		)
Minority interest share of add-backs		(18,854		)	(19,353		)	(15,891		)
Funds From Operations		$	335,989		$	321,886		$	340,315

 

Funds From Operations for 2002 and 2001 have been restated to include the effects of the Company’s adoption of the SEC’s July 31, 2003 Staff Policy Statement that clarifies the application of FASB-EITF Topic D-42, “The Effect on the Calculation of Earnings per Share for the Redemption or Induced Conversion of Preferred Stock.” See discussion of Restatement of Net Income below. Additionally, the Company has restated 2002 and 2001 FFO through the adoption of recent guidance from the SEC requiring the inclusion of impairment adjustments in the calculation of FFO.

 

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Results of Operations

A summary of the Company’s operating results and property statistics for each of the years in the three-year period ended December 31, 2003, follows (in thousands, except number of properties and per share amounts):

 

 

Comparison of Year Ended December 31, 2003 to Year Ended December 31, 2002

 

Rental Income from Continuing Operations

Rental income from continuing operations increased from $670.9 million in 2002 to $706.7 million in 2003.  The following table reconciles rental income by reportable segment to the Company’s total reported rental income from continuing operations for the years ended December 31, 2003 and 2002 (in thousands):

 

		2003			2002
Office		$	421,660		$	395,542
Industrial		273,307			264,572
Retail		7,999			6,885
Other		3,756			3,893
Total		$	706,722		$	670,892

 

Although the Company’s three reportable segments comprising Rental Operations (office, industrial and retail) are all within the real estate industry, they are not necessarily affected by the same economic and industry conditions. For example, the Company’s retail segment experienced high occupancies and strong overall performance during 2003, while the Company’s office and industrial segments reflected the weaker economic environment for those property types. The primary causes of the increase in rental income from continuing operations, with specific references to a particular segment when applicable, are summarized below:

 

•      During 2003, in-service occupancy improved from 87.1% at the end of 2002 to 89.3% at the end of 2003. The second half of 2003 was highlighted by a significant increase in the industrial portfolio occupancy of 2.1% along with a slight increase in office portfolio occupancy of .9%. Increased occupancy continues to be management’s primary focus for 2004.

•      Lease termination fees totaled $27.4 million in 2002 compared to $17.2 million in 2003. Most of this decrease was attributable to the office segment, which recognized  $21.1 million of termination fees in 2002 as compared to $11.8 million in 2003. Lease termination fees relate to specific tenants that pay a fee to terminate their lease obligations before the end of the contractual lease term. The high volume of termination fees in 2002 was reflective of the contraction of the business of large office users during that year and their desire to downsize their use of office space. The decrease in termination fees for 2003 was indicative of an improving economy and a more stable financial position of the Company’s tenants. Although there is no way to predict the amount of future lease termination fees, management believes that the amount of these fees will continue to decline in 2004.

 

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•      During the year ended 2003, the Company acquired $232 million of properties totaling 2.1 million square feet. The acquisitions were primarily Class A office buildings in existing markets with overall occupancy near 90%. Revenues associated with these acquisitions totaled $10.2 million in 2003. In addition, revenues from 2002 acquisitions totaled $15.8 million in 2003 compared to $4.8 million in 2002. This significant increase is primarily due to a large office acquisition that closed at the end of December 2002.

•      Developments placed in-service in 2003 provided revenues of $6.6 million, while revenues associated with developments placed in-service in 2002 totaled $13.7 million in 2003 compared to $4.7 million in 2002.

•      Proceeds from dispositions of held for rental properties totaled $126.1 million in 2003, compared to $40.9 million in 2002. These properties generated revenue of $12.5 million in 2003 versus $19.6 million in 2002.

 

Equity in Earnings of Unconsolidated Companies

Equity in earnings represents the Company’s ownership share of net income from investments in unconsolidated companies. These joint ventures generally own and operate rental properties and hold land for development. These earnings decreased from $27.2 million in 2002 to $23.6 million in 2003. This decrease is a result of the following significant activity:

 

•      In 2002, a $1.8 million gain was recognized on a property that was developed and sold upon completion to a third party.

 

•      In 2003, the Company’s total investment in joint ventures decreased. This decrease was the result of the Company acquiring its partner’s interest in three joint ventures, selling its interest in two and one venture being dissolved in the current year. While the number of joint ventures decreased, the joint ventures’ occupancy increased from 93.2% to 94.0% in 2003.

 

Rental Expenses and Real Estate Taxes

The following table reconciles rental expenses and real estate taxes by reportable segment to the Company’s total reported amounts in the statement of operations for the years ended December 31, 2003 and 2002 (in 000’s):

 

		2003			2002
Rental Expenses:
Office		$	104,447		$	92,401
Industrial		36,954			30,252
Retail		926			494
Other		1,690			1,394
Total		$	144,017		$	124,541
Real Estate Taxes:
Office		$	43,049		$	38,608
Industrial		31,123			29,206
Retail		477			445
Other		4,131			3,047
Total		$	78,780		$	71,306

 

The increased rental and real estate tax expenses for 2003, as compared to 2002, was the result of the Company’s increase in average in-service square feet and occupancy. These increases resulted from the Company’s acquisition activities and developments placed in service in 2003.

 

Interest Expense

The Company’s interest expense increased from $114.7 million in 2002 to $129.1 million in 2003.  Although the Company benefited from significantly lower interest rates during the year, interest expense increased because of increased borrowings during the year and a decrease in the amount of interest that was capitalized. The increased borrowings reflected the funding of the Company’s developments during the year and the excess of properties acquired over those disposed. Interest capitalized for 2003 was significantly lower than 2002 as development activity for 2003 was substantially slower than prior years. Development starts for 2003 totaled only $108 million compared to approximately $225 million for 2002. Other significant factors impacting interest expense for 2003 are summarized as follows (in thousands):

 

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•      The Company continued to replace secured debt financing with unsecured debt, and paid off over $120 million of secured loans throughout 2003. The payoffs included secured loans due in 2003 and those due in 2004 and beyond for which the Company was able to take advantage of expired or negotiated lower pre-payment penalties and utilize lower financing costs from unsecured debt offerings or the unsecured line of credit.

•      Approximately $425 million of new unsecured debt was issued in 2003. The Company issued $175 million of seven-year debt in January 2003 at an effective interest rate of 5.37%, $150 million of ten-year debt in May 2003 at an effective interest rate of 4.64% and $100 million of four-year debt in November 2003 at an effective interest rate of 3.63%. The Company retired $175 million of debt in June 2003 that had an effective interest rate of 7.33%.

•      The Company utilized its $500 million unsecured line of credit more heavily in 2003 than it did during 2002 in order to take advantage of the historically low borrowing costs. The balance on the line of credit was $351 million at December 31, 2003 compared to $281 million at December 31, 2002.

 

Depreciation and Amortization Expense

Depreciation and amortization expense for 2003 increased by over $22.5 million compared to 2002 because of an increase in tenant improvements and leasing costs. As discussed earlier, the Company experienced higher overall occupancy and more acquisition activity in 2003, which resulted in increased capital expenditures for tenant improvements and deferred lease commissions as well as increases in held for investment property basis. The following highlights the significant changes in depreciable and amortizable property during 2003:

 

•      The basis of the held for investment property portfolio increased by $166 million as a result of the Company’s development and acquisition activity.

•      The Company incurred tenant improvement costs of $91.3 million in 2003.

•      The Company incurred lease commissions of $41.6 million in 2003.

 

Also contributing to the increased expense in 2003 was the effect of Statement of Financial Accounting Standards No. 141, Business Combinations (“SFAS 141”), on acquisitions. This accounting pronouncement requires the allocation of a portion of a property’s purchase price to intangible assets for leases acquired and in-place at the closing date of the acquisition. These intangible assets are amortized over the remaining life of the leases (generally 3-5 years) as compared to the building basis portion of the acquisition, which is depreciated over 40 years. The amortization associated with the acquired lease intangible assets recorded on 2003 acquisitions totaled $4.2 million.

 

Service Operations

Service Operations primarily consist of leasing, management, construction and development services for joint venture properties and properties owned by third parties. These operations are heavily influenced by the current state of the economy as leasing and management fees are dependent upon occupancy while construction and development services rely on businesses expanding operations. The following highlights the significant components of revenues in Service Operations:

 

•      The Company experienced more than a 2% decrease in its overall gross profit margin percentage in its general contractor business in 2003 because of more competitive pricing in many of its markets.  However, despite this decrease, the Company was able to increase its net general contractor revenues from $21.9 million in 2002 to $26.8 million in 2003 because of a significant increase in volume. This volume increase was attributable to the low cost of financing available to businesses, thereby making it more attractive for them to own instead of lease facilities. The Company has a substantial backlog of $175.6 million for third party work as of December 31, 2003 that will carry into 2004.

•      Property management, maintenance and leasing fee revenues have remained fairly constant between 2002 and 2003 as the number of properties managed by the Company has not changed significantly.

•      Construction management and development activity income represents construction and development fees earned on projects where the Company acts as the construction manager along with profits from the Company’s held-for-sale program under which the Company develops a

 

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property with the intent to sell upon completion. The decrease in revenues from $29.4 million in 2002 to $15.5 million in 2003 is primarily due to fewer properties being sold in 2003 from the held-for-sale program. During 2002, the Company sold eight held-for-sale properties for a pre-tax gain of $28.2 million compared to the sale of four properties in 2003 for a pre-tax gain of $15.4 million in 2003. Profit margins on held-for-sale transactions fluctuate by sale depending on the type of property being sold, the strength of the underlying tenant and the nature of the sale, such as a pre-contracted purchase price for a primary tenant versus a sale on the open market.

 

Service Operations expenses decreased from $38.3 million in 2002 to $37.6 million in 2003.  Included in these amounts are income taxes which decreased to $5.7 million in 2003 from $8.4 million in 2002 primarily as a result of lower income from the disposition of held-for-sale properties. Other Service Operations expenses increased by approximately $2.0 million in 2003 over 2002. This increase was driven primarily from the costs associated with increased third party construction volume.

 

General and Administrative Expense

General and administrative expense decreased from $25.3 million in 2002 to $22.1 million for the year ended December 31, 2003. The decrease is primarily attributable to an increase in construction volume for third party projects resulting in a greater allocation of overhead to Service Operations operating expenses.

 

Other Income and Expenses

Gain on sale of land and depreciable property dispositions, net of impairment adjustment, is comprised of the following amounts in 2003 and 2002:

 

		2003			2002
Gain on sales of depreciable properties		$	0		$	4,491
Gain on sale of joint venture interests		8,639			0
Gain on land sales		7,695			4,478
Impairment adjustment		(560		)	(6,629		)
Total		$	15,774		$	2,340

 

Gain on sales of depreciable properties represent sales of previously held for investment rental properties which did not qualify to be classified as discontinued operations under SFAS 144 (see discussion under Discontinued Operations below). There were no such sales in 2003.

 

In 2003, the Company sold its interests in two joint ventures that owned and operated depreciable investment property. The Company owned 50% of each of these joint ventures.

 

Gain on land sales represents sales of undeveloped land owned by the Company. The Company pursues opportunities to dispose of land in markets with a high concentration of undeveloped land and those markets where the land no longer meets strategic development plans of the Company.

 

The Company recorded $560,000 of impairment charges on three land parcels that were sold in 2003. The Company has analyzed each of its in-service properties and has determined that there are no additional valuation adjustments that need to be made as of December 31, 2003. The $6.6 million adjustment recorded in 2002 was associated with four properties determined to be impaired.

 

Other revenue and expenses is comprised primarily of the write-off of contract development costs for abandoned development projects and gains on terminations of interest rate swaps. In 2003, the Company recorded contract development expenses of $1.0 million compared to $1.2 million in 2002. The Company accumulates costs of potential projects as an asset until such time as the costs are capitalized into a new project or expensed for a failed project.

 

In 2003, the Company terminated four forward starting interest rate swap agreements for a net gain of $643,000. The swap agreements were entered into as hedges for future anticipated debt issuances. These agreements were terminated as a result of the Company’s capital needs being met through the issuance of the Series J Preferred Stock in lieu of the contemplated debt issuances. In 2002, a $1.4 million gain was recognized in connection with a swap that did not qualify for hedge accounting. The Company has no swaps or other derivative instruments outstanding at December 31, 2003. See discussion of the Company’s use of derivative instruments in the footnotes to the financial statements.

 

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Discontinued Operations

The Company adopted Statement of Financial Accounting Standard No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS 144”), on January 1, 2002. SFAS 144 requires the Company to report in discontinued operations the results of operations of a property that has either been disposed or is classified as held-for-sale, unless certain conditions are met.

 

At December 31, 2003, the Company classified the results of operations and gains or losses of 45 buildings as discontinued operations. Of these buildings, 2 were sold in 2002 and 42 were sold in 2003. Impairment charges of $500,000 were recognized in 2003 relating to a single property that was sold in 2003. As a result of the sale, these charges were classified in discontinued operations for 2003. One property is owned at December 31, 2003, and is under contract to sell in 2004. Impairment charges totaling $2.7 million that were recognized in 2002 have been reclassed to discontinued operations as the properties to which they pertain were sold in 2003. Beginning in 2002, results of operations and any gains or losses on all sales of depreciable properties are classified in discontinued operations.

 

Comparison of Year Ended December 31, 2002 to Year Ended December 31, 2001

 

Rental Income from Continuing Operations

Rental income from continuing operations increased from $669.6 million in 2001 to $670.9 million in 2002.  The following table reconciles rental income by reportable segment to the Company’s total reported rental income from continuing operations for the years ended December 31, 2002 and 2001 (in thousands):

 

		2002			2001
Office		$	395,542		$	374,805
Industrial		264,572			272,891
Retail		6,885			18,165
Other		3,893			3,762
Total		$	670,892		$	669,623

 

The following significant fluctuations are the primary causes of the increase in rental income from continuing operations for all three segments, with specific references to a particular segment when applicable:

 

•      Throughout 2002, in-service occupancy decreased from 88.6% at the end of 2001 to 87.1% at the end of 2002.  The decline was the result of the weakened economy and its effect on business in the Company’s markets. These markets experienced a shortage of demand compared to the supply of office and industrial space resulting from downsizing of leased space for existing tenants, the lack of new business growth, and the tendency of existing businesses to hold off on growth plans until the economy improves.

•      Lease termination fees totaled $27.4 million in 2002 compared to $17.9 million in 2001. In 2002, there were significant individual termination fees received, particularly in the office portfolio, where $21.1 million of termination fees were recognized compared to $12.1 million in 2001. This trend was consistent with the continuing decline in occupancy for office space in many of the Company’s markets.

•      In August of 2001, the Company sold 21 properties or approximately 75% of its retail portfolio. As a result of this sale, the Company had eight months of operations associated with these properties in 2001.

 

Equity in Earnings of Unconsolidated Companies

Equity in earnings decreased from $31.4 million in 2001 to $27.2 million for 2002 as a result of the following:

 

•      The Company’s share of lease termination fees for 2001 was approximately $2.1 million, compared to approximately $658,000 in 2002.

•      During 2002, a 50% joint venture had increased interest expense of approximately $900,000 as a result of $71.0 million in debt issued during the second quarter of 2001.

 

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Rental Expenses and Real Estate Taxes

The following table reconciles rental expenses and real estate taxes by reportable segment to the Company’s total reported amounts in the statement of operations for the years ended December 31, 2002 and 2001 (in 000’s):

 

		2002			2001
Rental Expenses:
Office		$	92,401		$	86,782
Industrial		30,252			28,214
Retail		494			1,619
Other		1,394			1,797
Total		$	124,541		$	118,412
Real Estate Taxes:
Office		$	38,608		$	33,893
Industrial		29,206			29,520
Retail		445			1,553
Other		3,047			3,281
Total		$	71,306		$	68,247

 

The Company’s three reportable segments comprising Rental Operations (office, industrial and retail) are all within the real estate industry. The increased rental and real estate tax expense were the result of the Company’s increased real estate assets associated with current year developments and acquisitions.

 

Depreciation and Amortization

Depreciation and amortization expense for the year ended December 31, 2002, increased over the prior year through an increase in the Company’s building asset basis, increased investments in tenant improvements and the expensing of undepreciated tenant improvements associated with the early terminations of tenants.

 

Interest Expense

The $5.2 million increase in interest expense is attributable to the following:

 

•      Interest capitalized on development projects decreased from $25.9 million in 2001 to $13.5 million in 2002 because of decreased development activity by the Company in response to soft demand in most of the Company’s markets.

•      Interest expense on corporate unsecured debt increased from $98.7 million in 2001 to $100.8 million in 2002. The Company issued $150 million of ten-year unsecured debt in August 2002 at an effective interest rate of 5.88% and $50 million of ten-year unsecured debt in September 2002 at an effective interest rate of 5.45%. Also in 2002, the Company paid off $50 million of debt that matured in September, which had an effective rate of 7.31%.

•      Interest expense on the Company’s secured debt decreased from $30.8 million in 2001 to $22.9 million in 2002 as the Company paid off $13.5 million of secured debt throughout 2002 and experienced lower borrowings on its secured line of credit during 2002 compared to 2001.  Additionally, the Company paid off approximately $128.5 million of secured debt throughout 2001.

•      Interest expense on the Company’s $500 million unsecured line of credit decreased by approximately $1.1 million in 2002 compared to 2001 as the Company maintained lower balances on the line throughout most of 2002.

 

Service Operations

Service Operations primarily consist of leasing, management, construction and development services for joint venture properties and properties owned by third parties. Service Operations revenues decreased from $80.5 million for the year ended December 31, 2001, to $68.6 million for the year ended December 31, 2002. The prolonged effect of the slow economy has been the primary factor in the overall decrease in revenues. The Company experienced a decrease of $12.7 million in net general contractor revenues because of a decrease in the volume of construction in 2002, compared to 2001, as well as slightly lower profit margins.

 

Property management, maintenance and leasing fee revenues decreased from $22.8 million in 2001 to $14.3 million in 2002 primarily because of a decrease in landscaping maintenance revenue resulting from the sale of the landscaping operations in the third quarter of 2001.

 

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Construction management and development activity income represents construction and development fees earned on projects where the Company acts as the construction manager along with profits from the Company’s held-for-sale program under which the Company develops a property for sale upon completion. The increase in revenues of $10.3 million in 2002 is primarily due to an increase in volume of the sale of properties from the held-for-sale program.

 

Service Operations expenses decreased from $45.3 million in 2001 to $38.3 million in 2002. The decrease was attributable to the decrease in construction and development activity and the reduced overhead costs as a result of the sale of the landscape business in 2001.

 

General and Administrative Expense

General and Administrative Expense increased from $15.5 million in 2001 to $25.3 million for the year ended December 31, 2002. The Company was successful in reducing total operating and administration costs; however, reduced construction and development activities resulted in a greater amount of overhead being charged to general and administrative expense instead of being capitalized into development projects or charged to Service Operations.

 

Other Income and Expenses

Gain on sale of land and depreciable property dispositions, net of impairment adjustment, was comprised of the following amounts in 2002 and 2001:

		2002			2001
Gain on sales of depreciable properties		$	4,491		$	45,428
Gain on land sales		4,478			5,080
Impairment adjustment		(6,629		)	(4,800		)
Total		$	2,430		$	45,708

 

Gain on sales of depreciable properties represent sales of previously held for investment rental properties. Beginning in 2000 and continuing into 2001, the Company pursued favorable opportunities to dispose of real estate assets that no longer met long-term investment objectives. In 2002, the Company significantly reduced the amount of its property sales.

 

Gain on land sales represents sales of undeveloped land owned by the Company. The Company pursues opportunities to dispose of land in markets with a high concentration of undeveloped land and those markets where the land no longer meets strategic development plans of the Company.

 

Other revenue for the year ended December 31, 2002, includes $1.4 million of gain related to an interest rate swap that did not qualify for hedge accounting.

 

Restatement of Net Income

 

In July of 2003, the SEC issued a Staff Policy Statement that clarified the application of FASB-EITF Topic D-42 (Topic D-42), “The Effect on the Calculation of Earnings per Share for the Redemption or Induced Conversion of Preferred Stock.” Under Topic D-42, the difference between the amounts paid to the holders of preferred stock upon redemption and the carrying amount of the preferred stock on the issuer’s balance sheet must be subtracted from net income when computing earnings per share. The Staff Policy Statement clarified that, in computing the reduction in net income, the carrying amount of the preferred stock should be reduced by the issuance costs of the preferred stock. As a result of this clarification, the Company’s net income per share was restated for 2002 and 2001. The impact of this restatement is summarized as follows:

 

		Twelve Months Ended December 31,
		2002			2001
Net income available for common shareholders:
Prior to Topic D-42		161,272			$	229,967
Post adoption of Topic D-42		153,969			$	227,743
Basic net income per common share:
Prior to Topic D-42		$	1.20		$	1.77
Post adoption of Topic D-42		$	1.15		$	1.76
Diluted net income per common share:
Prior to Topic D-42		$	1.19		$	1.75
Post adoption of Topic D-42		$	1.14		$	1.74

 

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Critical Accounting Policies

 

The preparation of the Company’s consolidated financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. The Company’s estimates, judgments and assumptions are continually evaluated based upon available information and experience. Note 1 to the Consolidated Financial Statements includes further discussion of the Company’s significant accounting policies.

 

The Company’s management has assessed the accounting policies used in the preparation of its financial statements and discussed them with the Company’s Audit Committee and independent auditors. The following accounting policies are considered critical based upon materiality to the financial statements, degree of judgment involved in estimating reported amounts and sensitivity to changes in industry and economic conditions:

 

Accounting for Joint Ventures: The Company has equity interests ranging from 10-95% in joint ventures that own and operate rental properties and hold land for development. The Company consolidates those joint ventures that it controls through majority ownership interests or substantial participating rights. Control is further demonstrated by the ability of the general partner to manage day-to-day operations, refinance debt and sell the assets of the joint venture without the consent of the limited partner and inability of the limited partner to replace the general partner. The Company uses the equity method of accounting for those joint ventures where the Company does not have control over operating and financial polices. Under the equity method of accounting, the assets and liabilities of joint ventures for which the Company uses the equity method are not included on the Company’s balance sheet.

 

Cost Capitalization: Direct and certain indirect costs, including interest, clearly associated with the development, construction, leasing or expansion of real estate investments are capitalized as a cost of the property. The following discusses the significant categories of costs incurred by the Company:

 

Within the Rental Operations of the Company, direct and indirect costs are capitalized under the guidelines of SFAS 67, Accounting for Costs and Initial Rental Operations of Real Estate Projects (“SFAS 67”), and interest costs are capitalized under the guidelines of SFAS 34, “Capitalization of Interest Cost” (“SFAS 34”). The Company capitalizes these project costs associated with the initial construction of a property up to the time the property is substantially complete and ready for its intended use. The Company believes the completion of the building shell is the proper basis for determining substantial completion and that this basis is the most widely accepted standard in the real estate industry. The interest rate used to capitalize costs is based upon the Company’s average borrowing rate on existing debt.

 

In addition, the Company capitalizes costs, including interest costs, on vacant space during extended lease-up periods after construction of the building shell has been completed if costs are being incurred to ready the vacant space for its intended use. If costs and activities incurred to ready the vacant space cease, then cost capitalization is also discontinued until such activities are resumed. Once necessary work has been completed on a vacant space, project costs are no longer capitalized. The Company ceases capitalization of all project costs on extended lease-up periods after the shorter of a one-year period after the completion of the building shell or when the property attains a 90% occupancy. The Company follows guidelines in SFAS 34 and SFAS 67 in determining the capitalization of project costs during the lease-up period of a property and believes that this treatment is consistent with real estate industry standards for project cost capitalization.

 

All direct construction and development costs associated with the development of a new property are capitalized. In addition, all leasing commissions paid to third parties for new leases or lease renewals are capitalized. A portion of the Company’s indirect costs associated with its construction/ development and leasing efforts are capitalized. In assessing the amount of indirect costs to be capitalized, the Company first allocates payroll costs, on a department-by-department basis, among activities for which capitalization is warranted (i.e., construction, development and leasing) and those for which capitalization is not warranted

 

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(e.g., property management, maintenance, acquisitions and dispositions and general corporate functions). To the extent the employees of a department split their time between capitalizable and non-capitalizable activities, the allocations are made based on estimates of the actual amount of time spent in each activity. Once the payroll costs are allocated, the non-payroll costs of each department are allocated among the capitalizable and non-capitalizable activities in the same proportion as payroll costs. The capitalized cost pool does not include any costs allocable to its executive officers.

 

To ensure that an appropriate amount of costs are capitalized, the amount of capitalized costs that are allocated to a specific project are limited to amounts using standards developed by the Company. These standards consist of a percentage of the total development costs of a project and a percentage of the total gross lease amount payable under a specific lease. These standards are derived after considering both the amount of costs that would need to be paid by the Company if the services were performed by third parties, and the amounts that would be allocated if the personnel in the departments were working at full capacity. The use of these standards ensures that overhead costs attributable to downtime or to unsuccessful projects or leasing activities are not capitalized by the Company.

 

Impairment of Real Estate Investments: The Company evaluates its real estate investments upon occurrence of significant changes in the operations, but not less than annually, to assess whether any impairment indications are present that affect the recovery of the recorded value. If any real estate investment is considered impaired, a loss is provided to reduce the carrying value of the asset to its estimated fair value. The Company utilizes the guidelines established under SFAS 144 to determine if impairment conditions exist. Under SFAS 144, the Company reviews the expected undiscounted cash flows of each property in its held for rental portfolio to determine if there are any indications of impairment of a property. The review of anticipated cash flows involves subjective assumptions of estimated occupancy and rental rates and ultimate residual value. In addition to reviewing anticipated cash flows, the Company assesses other factors such as changes in business climate and legal factors that may affect the ultimate value of the property. These assumptions are subjective and the anticipated cash flows may not ultimately be achieved.

 

Real estate assets to be disposed of are reported at the lower of their carrying value amount or the fair value less estimated cost to sell.

 

Acquisition of Real Estate Property. The Company treats each material property acquisition as a “business” within the scope of SFAS 141. In accordance with that statement, the Company allocates the purchase price of acquired properties to net tangible and identified intangible assets based on their respective fair value.

 

The allocation to tangible assets (building and land) is based upon management’s determination of the value of the property as if it were vacant using discounted cash flow models similar to those used by independent appraisers. Factors considered by management include an estimate of carrying costs during the expected lease-up periods considering current market conditions, and costs to execute similar leases. The remaining purchase price is allocated among three categories of intangible assets consisting of the above or below market component of in–place leases, the value of in-place leases and the value of customer relationships.

 

•      The value allocable to the above or below market component of an acquired in-place lease is determined based upon the present value (using an interest rate which reflects the risks associated with the lease) of the difference between (i) the contractual amounts to be paid pursuant to the lease over its remaining term, and (ii) management’s estimate of the amounts that would be paid using current fair market rates over the remaining term of the lease. The amounts allocated to above or below market leases are included in deferred leasing and other costs in the balance sheet and are amortized to rental income over the remaining terms of the respective leases.

•      The total amount of intangible assets is further allocated to in-place lease values and to customer relationship values, based upon management’s assessment of their respective values. These intangible assets are included in deferred leasing and other costs in the balance sheet and are depreciated over the remaining term of the existing lease, or the anticipated life of the customer relationship, as applicable.

 

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Valuation of Receivables: The Company is subject to tenant defaults and bankruptcies that could affect the collection of outstanding receivables. In order to mitigate these risks, the Company performs in-house credit

review and analysis on major existing tenants and all significant leases before they are executed. The Company has established the following procedures and policies to evaluate the collectibility of outstanding receivables and record allowances:

 

•      The Company maintains a tenant “watch list” containing a list of significant tenants for which the payment of receivables and future rent may be at risk. Various factors such as late rent payments, lease or debt instrument defaults, and indications of a deteriorating financial position are considered when determining whether to include a tenant on the watch list.

•      As a matter of policy, the Company reserves the entire receivable balance, including straight-line rent, of any tenant with an amount outstanding over 90 days.

•      Straight-line rent receivables for any tenant on the watch list or any other tenant identified as a potential long-term risk, regardless of the status of rent receivables, are reviewed and reserved as necessary. In addition, a general reserve for straight-line rent receivables is provided in an amount equal to 1% to 2% of the outstanding balance.

 

Revenue Recognition on Construction Contracts: The Company recognizes income on construction contracts where the Company serves as a general contractor on the percentage of completion method. Using this method, profits are recorded on the basis of the Company’s estimates of the overall profit and percentage of completion of individual contracts. A portion of the estimated profits is accrued based upon the Company’s estimates of the percentage of completion of the construction contract. Cumulative revenues recognized may be less or greater than cumulative costs and profits billed at any point in time during a contract’s term. This revenue recognition method involves inherent risks relating to profit and cost estimates with those risks reduced through approval and monitoring processes.

 

With regards to critical accounting policies, management has discussed the following with the Audit Committee:

 

•      Criteria for identifying and selecting;

•      Methodology in applying; and

•      Impact on the financial statements.

 

The Audit Committee has reviewed the critical accounting policies identified by the Company.

 

Liquidity and Capital Resources

 

Sources of Liquidity

 

The Company expects to meet its liquidity requirements over the next twelve months, including payments of dividends and distributions as well as recurring capital expenditures relating to maintaining the Company’s current real estate assets, primarily through the following:

 

•      working capital; and

•      net cash provided by operating activities

 

Although the Company historically has not used any other sources of funds to pay for recurring capital expenditures on its current real estate investments, the use of borrowings or property disposition proceeds may be needed to fund such expenditures during periods of high leasing volume. This situation could arise in 2004 if the Company experiences a significant increase in its occupancy.

 

The Company expects to meet its long-term liquidity requirements, such as scheduled mortgage debt maturities, preferred stock redemptions, the retirement of unsecured notes and amounts outstanding under the unsecured credit facility, property acquisitions, financing of development activities and other non-recurring capital improvements, primarily from the following sources:

 

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•      issuance of additional unsecured notes;

•      issuance of additional preferred stock;

•      undistributed cash provided by operating activities, if any; and

•      proceeds received from real estate dispositions.

 

Rental Operations

The Company believes that its principal source of liquidity, cash flows from Rental Operations, provides a stable source of cash to fund operational expenses. The Company believes that this cash-based revenue stream is substantially aligned with revenue recognition (except for periodic straight-line rental income accruals) as cash receipts from the leasing of rental properties are generally received in advance of or in a short time following the actual revenue recognition. The Company is subject to risks of decreased occupancy through market conditions as well as tenant defaults and bankruptcies, and potential reduction in rental rates upon renewal or re-letting of properties, which would result in reduced cash flow from operations. However, management believes that these risks are mitigated by the Company’s strong market presence in most of its locations and the fact that the Company performs in-house credit review and analysis on major tenants and all significant leases before they are executed.

 

Credit Facilities

The Company had the following line of credit available (in thousands):

 

Description		Borrowing Capacity			Maturity Date		Interest Rate		Amount Outstanding at December 31, 2003
Unsecured Line of Credit		$	500,000		February 2004		LIBOR + .65	%	$	351,000

 

The line of credit is used to fund development activities to acquire additional rental properties and to provide working capital.

 

In January 2004, the Company renewed the unsecured line of credit, extending the maturity date to January 2007 and lowering the interest rate from LIBOR + .65% to LIBOR + .60%.

 

The line of credit contains financial covenants that require the Company to meet defined levels of performance.  As of December 31, 2003, the Company is in compliance with all such covenants and expects to remain in compliance for the foreseeable future.

 

Debt and Equity Securities

The Company currently has on file with the SEC an effective shelf registration statement that permits the Company to sell up to an additional $670 million of unsecured debt securities as of December 31, 2003.  In addition, the Company has on file with the SEC an effective shelf registration statement that permits the Company to sell up to an additional $400.7 million of common and preferred stock as of December 31, 2003. From time-to-time, the Company expects to issue additional securities under these registration statements to fund development and acquisition of additional rental properties and to fund the repayment of the credit facilities and other long-term debt upon maturity.

 

The indenture governing the Company’s unsecured notes also requires the Company to comply with financial ratios and other covenants regarding the operations of the Company. The Company is currently in compliance with all such covenants and expects to remain in compliance for the foreseeable future.

 

In January 2004, the Company completed a $125 million unsecured debt offering at an effective interest rate of 3.4%, due January 2008.

 

Sale of Real Estate Assets

The Company utilizes sales of real estate assets as an additional source of liquidity. During 2000 and 2001, the Company engaged in a capital-recycling program that resulted in sales of over $1 billion of real estate assets.  In

2002 and 2003, volume was substantially reduced as capital needs were met through other sources and the

 

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slower business climate provided fewer opportunities to profitably reinvest sale proceeds. The Company continues to pursue opportunities to sell real estate assets when beneficial to the long-term strategy of the Company.

 

Uses of Liquidity

 

The Company’s principal uses of liquidity include the following:

 

•      Property investments;

•      Recurring leasing/capital costs;

•      Dividends and distributions to shareholders and unitholders;

•      Long-term debt maturities; and

•      Other contractual obligations.

 

Property Investments

The Company evaluates development and acquisition opportunities based upon market outlook, supply, and long-term growth potential.

 

Recurring expenditures

A summary of the Company’s recurring capital expenditures is as follows for the year ended December 31,  (in thousands):

 

		2003			2002			2001
Tenant improvements		$	35,972		$	28,011		$	18,416
Leasing costs		20,932			17,975			13,845
Building improvements		19,544			13,373			10,873
Totals		$	76,448		$	59,359		$	43,134

 

Dividends and Distributions

In order to qualify as a REIT for federal income tax purposes, the Company must currently distribute at least 90% of its taxable income to its shareholders. The Company paid dividends per share of $1.83, $1.81 and $1.76 for the years ended December 31, 2003, 2002 and 2001, respectively. The Company expects to continue to distribute taxable earnings to meet the requirements to maintain its REIT status. However, distributions are declared at the discretion of the Company’s Board of Directors and are subject to actual cash available for distribution, the Company’s financial condition, capital requirements and such other factors as the Company’s Board of Directors deems relevant.

 

Debt Maturities

Debt outstanding at December 31, 2003, totaled $2.3 billion with a weighted average interest rate of 5.65% maturing at various dates through 2028. The Company had $2.1 billion of unsecured debt and $208.6 million of secured debt outstanding at December 31, 2003. Scheduled principal amortization of such debt totaled $9.0 million for the year ended December 31, 2003.

 

Following is a summary of the scheduled future amortization and maturities of the Company’s indebtedness at December 31, 2003, including the $351 million outstanding on the unsecured line of credit in 2007 maturities to reflect the January 2004 renewal (in thousands):

 

		Future Repayments									Weighted Average Interest Rate of Future Repayments
Year		Scheduled Amortization			Maturities			Total
2004		$	8,064		$	166,834		$	174,898		7.37	%
2005		7,749			205,980			213,729			7.21	%
2006		7,326			180,186			187,512			6.00	%
2007		5,842			565,615			571,457			3.21	%
2008		4,922			134,028			138,950			6.31	%
2009		4,694			275,000			279,694			7.38	%
2010		4,076			175,000			179,076			5.38	%
2011		3,334			175,000			178,334			6.94	%
2012		1,944			200,000			201,944			5.85	%
2013		1,581			150,000			151,581			4.62	%
Thereafter		8,361			50,000			58,361			6.64	%
		$	57,893		$	2,277,643		$	2,335,536		5.65	%

 

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Historical Cash Flows

 

A comparison of the Company’s historical cash flows for 2003, 2002 and 2001 is as follows (in millions):

 

 

Operating Activities

Cash flows from operating activities provide the cash necessary to meet normal, operational requirements.  The receipt of rental income from Rental Operations continues to provide the primary source of revenues and operating cash flows for the Company. However, in 2002, as explained in more detail below, the Company had a large number of sales of buildings developed with the intent to sell, resulting in a significant source of operational cash flows and revenues in 2002 compared to 2001 and 2003. While the Company continues to pursue these opportunities, revenues from rental operations will continue to be the primary source of revenue of the Company. Management continues to focus on increasing occupancy as its primary objective for 2004.

 

•      The Company sold eight build-for-sale properties in 2002 generating sales proceeds of $196.9 million. In contrast, four properties were sold in 2003 with gross proceeds of $50.1 million, and eleven properties were sold in 2001 with gross proceeds of $102.2 million.

•      The Company has a backlog of build-for-sale buildings as of December 31, 2003, with projected project costs of $65.8 million that it anticipates selling throughout 2004.

 

Investing Activities

Investing activities are one of the primary uses of the Company’s liquidity. Development and acquisition activity is necessary to generate additional rental revenues and provide cash flows for operational requirements. Highlights of significant cash uses are as follows:

 

•      Development costs decreased from $251.4 million in 2001 and $158.1 million in 2002 to $129.2 million in 2003. This trend is reflective of the weakened economy and excess supply over demand in many of the Company’s markets. New developments, particularly speculative office, have been limited by management in an effort to focus on lease-ups of existing properties in most markets.

•      Acquisitions of real estate have increased significantly since 2001 as the Company continues to view acquisitions in current markets as sources for growth opportunities.

•      Recurring costs for tenant improvements, lease commissions and building improvements have also continued to increase over the past three years in direct relation to the re-leasing of vacant space. As occupancy fell to a low in 2001, management focused its attention over the past two years on improving and re-letting its existing spaces. Towards the latter half of 2003, occupancy improved in the Company’s in-service portfolio. Management anticipates these costs to remain high in 2004 as occupancy trends upward, but occupancy trends are not predictable.

•      Proceeds from property sales increased in 2003 over 2002 as the Company again looked to dispose of non-strategic assets. The Company experienced significant sales in 2000 and 2001 as efforts were made to de-leverage the balance sheet in anticipation of a slowed economy in 2001 and 2002. This strategy has created a low debt to market capitalization for the Company as of the end of 2003. Sales of property will continue to be utilized as part of the Company’s capital recycling program to fund acquisitions and new development.

 

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Financing Activities

The Company increased its borrowings under both its unsecured line of credit and in the public debt markets as a source of capital over the past two years. In order to enhance its flexibility with respect to its properties, the Company has continued to replace secured debt with unsecured debt. The low leverage resulting from the large volume of property dispositions in 2000 and 2001 provided the Company with the opportunity to borrow funds at very attractive rates. Highlights of significant financing activities are as follows:

 

•      The Company received $425.0 million in proceeds from unsecured debt offerings in 2003 and repaid $135.5 million of secured debt in accordance with the strategy outlined above. The Company has obtained very low coupon rates on its newly issued debt and has staggered the maturity dates over the next 10 years, with no single year having disproportionate maturities.

•      Borrowings on the unsecured line of credit have increased since 2001 as the Company has taken advantage of lower interest rates and excess capacity to fund development, acquisition and working capital needs.  The Company renewed its unsecured line in January 2004, extending the due date to 2007 and lowering the interest rate from LIBOR + .65% to LIBOR + .60%.

 

Credit Ratings

 

The Company is currently assigned investment grade corporate credit ratings on its senior unsecured notes from Fitch Ratings, Moody’s Investor Service and Standard and Poor’s Ratings Group. Currently, Fitch and Standard and Poor’s have assigned a rating of BBB+ and Moody’s Investors has assigned a rating of Baa1 to the senior notes. These ratings could change based upon, among other things, the Company’s results of operations and financial condition.

 

The Company also has received investment grade credit ratings from the same rating agencies on its preferred stock.  Fitch and Standard and Poor’s have assigned a Preferred Stock rating of BBB and Moody’s Investors has assigned a Preferred Stock rating of Baa2. These ratings could change based upon, among other things, the Company’s results of operations and financial condition.

 

Financial Instruments

 

In December 2002, the Company simultaneously entered into two $50 million forward-starting interest rate swaps as a hedge to effectively fix the rate on unsecured debt financings expected in 2003. The fair value of the swaps was a liability of $2.1 million as of December 31, 2002, and was recorded in other liabilities in the accompanying balance sheet.

 

In February 2003, the Company simultaneously entered into two additional $25 million forward-starting interest rate swaps as a hedge to effectively fix the rate on unsecured debt financings expected in 2003. All four swaps qualified for hedge accounting under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (“SFAS 133”); therefore, changes in fair value were recorded in other comprehensive income.

 

In July 2003, the Company terminated the swaps for a net gain of $643,000, which is included in other revenue in the Statements of Operations. The swaps were terminated because the Company’s capital needs were met through the issuance of the Series J Preferred Stock in lieu of the previously contemplated issuance of debt.

 

In July 2001, the Company terminated three interest rate swaps that were tied to an $85 million unsecured term loan. The swaps qualified for hedge accounting under SFAS 133. The cost to terminate the swaps was $548,000, which was recorded as interest expense.

 

In May 2003, the FASB issued Statement No. 150 Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (“SFAS 150”). SFAS 150 establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. SFAS 150 is effective for all financial instruments created or modified after May 31, 2003, and otherwise is effective July 1, 2003. The Company includes the operations of

 

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five joint ventures in its consolidated financial statements. These joint ventures are partially owned by unaffiliated parties that have noncontrolling interests. SFAS 150 requires the disclosure of the estimated settlement value of these noncontrolling interests. As of December 31, 2003, the estimated settlement value of these noncontrolling interests was approximately $4.3 million as compared to the minority interest liability recorded on the Company’s books for these joint ventures of $1.2 million.

 

Off Balance Sheet Arrangements

 

Investments in Unconsolidated Companies

The Company has equity interests ranging from 10 – 64% in unconsolidated joint ventures that own and operate rental properties and hold land for development. The equity method of accounting is used for these investments in which the Company has the ability to exercise significant influence, but not control, over operating and financial policies. As a result, the assets and liabilities of these joint ventures are not included on the Company’s balance sheet.

 

The Company’s investment in unconsolidated companies represents less than 6% of the Company’s total assets as of December 31, 2003. These investments provide several benefits to the Company including increased market share, tenant and property diversification and an additional source of capital to fund real estate projects.

 

The following tables presents summarized financial information for unconsolidated companies for the years ended December 31, 2003 and 2002 (in thousands, except percentages):

		Dugan Realty, LLC						Dugan Texas, LLC						Dugan Office, LLC						Other Industrial and Office Joint Ventures						Total
		2003			2002			2003			2002			2003			2002			2003			2002			2003			2002
Land, buildings and tenant improvements, net		$	727,411		$	739,372		$	209,602		$	214,796		$	91,170		$	94,718		$	145,049		$	183,140		$	1,173,232		$	1,232,026
Land held for development		17,663			18,763			12,710			9,148			4,293			4,294			16,662			6,643			51,328			38,848
Other assets		29,213			26,372			16,535			17,427			2,934			4,654			13,514			19,137			62,196			67,590
		$	774,287		$	784,507		$	238,847		$	241,371		$	98,397		$	103,666		$	175,225		$	208,920		$	1,286,756		$	1,338,464
Property indebtedness		$	409,349		$	408,305		$	16,035		$	17,200		$	69,160		$	69,936		$	83,188		$	84,452		$	577,732		$	579,893
Other liabilities		18,232			17,533			9,342			7,851			3,460			3,790			10,657			22,883			41,691			52,057
		427,581			425,838			25,377			25,051			72,620			73,726			93,845			107,335			619,423			631,950
Owner’s equity		346,706			358,669			213,470			216,320			25,777			29,940			81,380			101,585			667,333			706,514
		$	774,287		$	784,507		$	238,847		$	241,371		$	98,397		$	103,666		$	175,225		$	208,920		$	1,286,756		$	1,338,464
Rental income		$	97,150		$	94,176		$	28,248		$	26,636		$	18,202		$	17,280		$	26,627		$	31,591		$	170,227		$	169,683
Net income		$	23,397		$	28,164		$	12,688		$	13,308		$	1.536		$	1,660		$	3,444		$	7,881		$	41,065		$	51,013
Total square feet		22,761			22,757			5,808			5,878			652			648			4,465			5,452			33,686			34,735
Percent leased		94.8		%	94.1		%	95.0		%	95.3		%	87.4		%	95.3		%	89.4		%	87.2		%	94.0		%	93.2		%
Company																				10.0		%-	10.0		%-
ownership percentage		50.0		%	50.0		%	50.0		%	50.0		%	50.0		%	50.0		%	64.0		%	64.0		%

 

Off Balance Sheet Arrangements

The Company does not have any relationships with unconsolidated entities or financial partnerships, such as “special purpose entities,” which are generally established for the purpose of facilitating off-balance sheet arrangements or other specific purposes.

 

Contractual Obligations

As of December 31, 2003, the Company is subject to certain contractual payment obligations as described in the schedule below (in thousands):

 

28

 

					Payments due by Period
Contractual Obligations		Total			2004			2005			2006			2007			2008			Thereafter
Long-term debt (1)		$	1,984,536		$	174,898		$	213,729		$	187,512		$	220,458		$	138,950		$	1,048,989
Line of credit (2)		351,000			—			—			—			351,000			—			—
Share of mortgage debt of unconsolidated joint ventures (3)		278,732			29,246			65,214			5,627			45,920			985			131,740
Capital leases		2,003			501			501			501			500			—			—
Ground leases		5,657			344			344			355			359			359			3,896
Development and construction backlog costs (4)		196,553			196,553			—			—			—			—			—
Future land acquisitions (5)		13,816			13,816			—			—			—			—			—
Other (6)		5,531			996			943			713			540			327			2,012
Total Contractual Obligations		$	2,837,828		$	416,354		$	280,731		$	194,708		$	618,777		$	140,621		$	1,186,637

 

(1)   This long term debt consists of both secured and unsecured debt.

(2)   In January 2004, the maturity of the Company’s line-of-credit was extended to 2007.

(3)   The Company has guaranteed $92.0 million of the total $278.7 million Company share of unconsolidated joint venture debt.

(4)   Estimated remaining costs on the completion of held-for-rental, held-for-sale and third-party construction projects.

(5)   These land acquisitions are subject to the completion of due diligence requirements, resolution of certain contingencies and completion of customary closing conditions. If the Company were to terminate these contracts, the Company would forfeit its total escrow amount of $100,000 and would have no further contractual obligations.

(6)   This amount consists of operating leases and infrastructure development commitments.

 

Related Party Transactions

 

The Company provides property management, leasing, construction and other tenant related services to properties in which certain executives have ownership interests. The Company had an option to acquire the executive officers’ interests in these properties. Two of these properties, the Bank One Towers office buildings in Cincinnati, Ohio, were acquired in August 2003 at a price of $45.5 million. The terms of this acquisition were reviewed and approved by the independent members of the Company’s Board of Directors. The options on the remaining properties expired in October 2003, as the independent members of the Board of Directors of the Company determined that it was not in the best interests of the Company to exercise the options.

 

The Company received fees totaling $1.2 million, $1.4 million and $1.7 million in 2003, 2002 and 2001, respectively, for services provided to these properties. The fees charged by the Company for such services are equivalent to those charged to third-party owners for similar services.

 

The Company provides property management, leasing, construction and other tenant related services to unconsolidated companies in which the Company has equity interest. For the years ended December 31, 2003, 2002 and 2001, respectively, the Company received management fees of $4.9 million, $4.9 million and $4.7 million, leasing fees of $2.3 million, $2.5 million and $2.8 million and construction and development fees of $1.4 million, $4.5 million and $5.2 million from these unconsolidated compaies.  These fees were charged at market rates and the Company eliminates its ownership percentage of these fees in the consolidated financials.

 

In 2002, the Company received lease termination fees totaling $7.7 million from a tenant that is a subsidiary of Progress Energy, Inc. William Cavanaugh III is President and Chief Executive Officer of Progress Energy, Inc. and a member of the Company’s Board of Directors. The Company’s independent directors approved the transaction and management believes that the amount received approximates a value that would have been charged to tenants with similar lease terms and commitments.

 

The Company has other related party transactions that are insignificant and are at terms that management considers to be arm’s-length and equal to those negotiated with independent parties.

 

Commitments and Contingencies

 

The Company has the following commitments and contingencies in addition to those previously disclosed:

 

In 1998 and 1999, certain members of management and the Board of Directors purchased $69 million of common stock in connection with an Executive and Senior Officer Stock Purchase Plan. The purchases were financed by five-year personal loans from financial institutions. As of December 31, 2003, the outstanding balance on these loans was $11.7 million as some participants have exited the program and repaid their principal balance. These loans were secured by common shares with a fair market value of $18.2 million purchased through this program and owned by the remaining plan participants at December 31, 2003. As a condition of the financing agreement with the financial institution, the Company guaranteed the repayment of

 

29

 

principal, interest and other obligations for each participant, but is fully indemnified by the participants. In the opinion of management, it is not probable that the Company will be required to satisfy these guarantees.

 

In October 2000, the Company sold or contributed industrial properties and undeveloped land with a fair value of $487 million to a joint venture (Dugan Realty LLC) in which the Company has a 50% interest and recognized a net gain of $35.2 million. This transaction expanded an existing joint venture with an institutional real estate investor. As a result of the total transactions, the Company received $363.9 million of proceeds. The joint venture partially financed this transaction with $350 million of secured mortgage debt, the repayment of which was directly or indirectly guaranteed by the Company. The guarantee associated with $260 million of such debt expired in December 2003 without the Company being required to satisfy the guarantee. The remaining $90 million of such debt is still guaranteed by the Company. In connection with this transaction, the joint venture partners were given an option to put up to a $50 million interest in the joint venture to the Company in exchange for common stock of the Company or cash (at the option of the Company), subject to certain timing and other restrictions. As a result of this put option, the Company deferred $10.2 million of gain on sale of depreciated property and recorded a $50 million liability.

 

The Company has guaranteed the repayment of $3.5 million of economic development bonds issued by the City of Carmel, Indiana. The Company will be required to make payments under its guarantee to the extent that incremental taxes from one of its office park developments are not sufficient to pay the bond debt service.  Management does not believe that it is probable that the Company will be required to make any significant payments in satisfaction of this guarantee.

 

The Company has also guaranteed the repayment of a $2 million mortgage loan encumbering the real estate of one its unconsolidated joint ventures. Management believes that the value of the real estate exceeds the loan balance and that the Company will not be required to satisfy this guarantee.

 

The Company has entered into agreements, subject to the completion of due diligence requirements, resolution of certain contingencies and completion of customary closing conditions, for the future acquisition of land totaling $13.8 million. The acquisitions are scheduled to close periodically through 2004 and will be paid for by cash.

 

The Company renewed all of its major insurance policies in 2003. These policies include coverage for acts of terrorism for its properties. The Company believes that this insurance provides adequate coverage against normal insurance risks and that any loss experienced would not have a significant impact on the Company’s liquidity, financial position, or results of operations.

 

Broadband Office, Inc. and Official Committee of Unsecured Creditors of Broadband Office, Inc. recently filed a complaint against a group of real estate investment trusts and real estate operating companies and certain affiliated entities and individuals in connection with the formation and management of Broadband Office. Among the defendants are Duke Realty Corporation, Duke Realty Limited Partnership and Mr. Dennis Oklak, one of the Company’s executive officers. The complaint alleges various breaches of purported fiduciary duties by the defendants, seeks recharacterization or equitable subordination of debt, seeks recovery of alleged avoidable transfers, appears to seek to hold them liable for, among other things, the debt of Broadband Office under alter-ego, veil-piercing and partnership theories, and seeks other relief under other theories. The complaint seeks aggregate damages in excess of $300 million from all of the defendants. The Company believes that it has meritorious defenses to the plaintiff’s allegations and intends to vigorously defend this litigation. Due to the inherent uncertainties of the litigation process and the judicial system, the Company is not able to predict the outcome of this litigation. If this litigation is not resolved in the Company’s favor, it could have a material adverse effect on its business, financial condition and results of operations.

 

The Company is subject to various legal proceedings and claims that arise in the ordinary course of business.  In the opinion of management, the amount of any ultimate liability with respect to these actions will not materially affect the Company’s consolidated financial statements or results of operations.

 

30

 

Recent Accounting Pronouncements

 

In January 2003, FASB issued Interpretation 46, Consolidation of Variable Interest Entities (“Interpretation 46”), which addresses the consolidation of certain entities in which a company has a controlling financial interest through means other than voting rights. This interpretation was revised in December 2003.  For calendar year companies, Interpretation 46 contains an effective date of December 31, 2003 for special purpose entities and periods ending after March 15, 2004 for all other entities. The Company does not own interests in special purpose entities and management does not believe that the adoption of Interpretation 46 will have a material impact on the Company’s financial statements.

 

Item 7A.  Quantitative and Qualitative Disclosure About Market Risks

 

The Company is exposed to interest rate changes primarily as a result of its line of credit and long-term debt borrowings. The Company’s interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows and to lower its overall borrowing costs. To achieve its objectives the Company borrows primarily at fixed rates and may enter into derivative financial instruments such as interest rate swaps, caps and treasury locks in order to mitigate its interest rate risk on a related financial instrument. The Company does not enter into derivative or interest rate transactions for speculative purposes.

 

The Company’s interest rate risk is monitored using a variety of techniques. The table below presents the principal amounts (in thousands) of the expected annual maturities, weighted average interest rates for the average debt outstanding in the specified period, fair values and other terms required to evaluate the expected cash flows and sensitivity to interest rate changes.

 

		2004			2005			2006			2007			2008			Thereafter			Total			Fair Value
Fixed rate secured debt		$	23,924		$	12,760		$	46,491		$	19,490		$	38,094		$	12,701		$	153,460		$	167,586
Weighted average interest rate		7.97		%	7.03		%	7.21		%	7.65		%	5.25		%	7.86		%
Variable rate Treasury based secured debt		$	711		$	741		$	40,781		$	811		$	856		$	11,289		$	55,189		$	55,189
Weighted average interest rate		1.18		%	1.18		%	2.89		%	1.17		%	1.16		%	1.09		%
Unsecured notes		$	150,264		$	200,227		$	100,240		$	200,156		$	100,000		$	1,025,000		$	1,775,887		$	1,943,222
Weighted average interest rate		7.30		%	7.24		%	6.72		%	5.31		%	6.76		%	6.27		%
Unsecured line of credit		$	—		$	—		$	—		$	351,000		$	—		$	—		$	351,000		$	351,000
Weighted average interest rate		N/A			N/A			N/A			1.77		%	N/A			N/A

 

As the table incorporates only those exposures that exist as of December 31, 2003, it does not consider those exposures or positions that could arise after that date. As a result, the Company’s ultimate realized gain or loss with respect to interest rate fluctuations will depend on the exposures that arise during the period, the Company’s hedging strategies at that time, and interest rates.

 

The Company’s unsecured line of credit was renewed in January 2004 with the maturity date being extended to January 2007.  The table above reflects the 2007 maturity date.

 

Item 8.  Financial Statements and Supplementary Data

 

The financial statements and supplementary data are included under Item 15 of this Report.

 

Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

None.

Part III

 

Item 9A. Disclosure Controls and Procedures

 

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in our annual and periodic reports filed with the SEC is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. These disclosure controls and procedures are further designed to ensure that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, to allow timely decisions regarding required disclosure.

 

31

 

Based on the most recent evaluation, which was completed as of December 31, 2003, our chief executive officer, chief operating officer and chief financial officer believe that our disclosure controls and procedures are effective. There have been no significant changes in our internal controls over financial reporting or in other factors that could significantly affect the internal controls over financial reporting subsequent to the date we completed our evaluation.

 

Item 10.  Directors and Executive Officers of the Registrant

 

Information with respect to this item is incorporated by reference from the Company’s 2004 Proxy Statement (the “ 2004 Proxy Statement”) for its Annual Meeting of Shareholders to be held on April 28, 2004. Certain information with respect to the Company’s executive officers appears in Item 4 of this Form 10-K. In addition, the Company’s Code of Conduct and its Corporate Governance Guidelines are available in the investor information/corporate governance section of the Company’s website at www.dukerealty.com.  A copy of these documents may also be obtained without charge by writing to Duke Realty Corporation, 600 East 96^th Street, Suite 100, Indianapolis, Indiana 46240, Attention: Investor Relations.

 

Item 11.  Executive Compensation

 

Information with respect to this item is incorporated herein by reference from the 2004 Proxy Statement.

 

Item 12.  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

Information with respect to this item is incorporated herein by reference from the 2004 Proxy Statement.

 

Item 13.  Certain Relationships and Related Transactions

 

Information with respect to this item is incorporated herein by reference from the 2004 Proxy Statement.

 

Item 14.  Principal Accountant Fees and Services

 

Information with respect to this item is incorporated herein by reference from the 2004 Proxy Statement.

 

Part IV

 

Item 15.  Exhibits, Financial Statement Schedules, and Reports on Form 8-K

 

(a)   The following documents are filed as part of this Form 10-K:

 

1.      Consolidated Financial Statements

 

The following Consolidated Financial Statements of the Company, together with the Independent Auditors’ Report, are listed below:

 

Independent Auditors’ Report

Consolidated Balance Sheets, December 31, 2003 and 2002

Consolidated Statements of Operations, Years Ended December 31, 2003, 2002 and 2001

Consolidated Statements of Cash Flows, Years Ended December 31, 2003, 2002 and 2001

Consolidated Statements of Shareholders’ Equity, Years Ended December 31, 2003, 2002 and 2001

Notes to Consolidated Financial Statements

 

2.        Consolidated Financial Statement Schedules

 

Schedule III – Real Estate and Accumulated Depreciation

 

32

 

3.      Exhibits

 

The following exhibits are filed with this Form 10-K or incorporated herein by reference to the listed document previously filed with the SEC. Previously unfiled documents are noted with an asterisk (*).

 

Number		Description
3.1		Third Restated Articles of Incorporation of the Company, incorporated by reference from Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2003.
3.2		Third Amended and Restated Bylaws of the Company, incorporated by reference from Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2003.
3.3		Amendment to the Third Restated Articles of Incorporation incorporated by reference from Exhibit 3 of the Company’s Current Report on Form 8-K dated August 25, 2003.
3.4		Amendment to the Third Restated Articles of Incorporation incorporated by reference from Exhibit 3 of the Company’s Current Report on Form 8-K dated February 13, 2004.
4.1		Indenture between DRLP and The First National Bank of Chicago, Trustee, incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed September 22, 1995.
4.2		First Supplement to Indenture, incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed September 22, 1995.
4.3		Second Supplement to Indenture, incorporated by reference to Exhibit 4 to the DRLP’s Current Report on Form 8-K filed July 12, 1996.
4.4		Third Supplement to Indenture, incorporated by reference to Exhibit 4 to the DRLP’s Current Report on Form 8-K filed May 20, 1997.
4.5		Fourth Supplement to Indenture, incorporated by reference to Exhibit 4.8 to the Company’s Form S-4 Registration Statement No. 333-77645 dated May 4, 1999 (Merger Registration Statement).
4.6		Fifth Supplement to Indenture, incorporated by reference to Exhibit 4 to the DRLP’s Current Report on Form 8-K filed June 1, 1998.
4.7		Sixth Supplement to Indenture, incorporated by reference to Exhibit 4 to the DRLP’s Current Report on Form 8-K filed February 12, 1999.
4.8		Seventh Supplement to Indenture, incorporated by reference to Exhibit 4 to the DRLP’s Current Report on Form 8-K filed June 29, 1999.
4.9		Eighth Supplement to Indenture, incorporated by reference to Exhibit 4 to the DRLP’s Current Report on Form 8-K filed November 15, 1999.
4.10		Ninth supplement to Indenture, incorporated by reference to Exhibit 4 to the DRLP’s Current Report on Form 8-K filed March 2, 2001.
4.11		Tenth supplement to Indenture, incorporated by reference to Exhibit 4 to the DRLP’s Current Report on Form 8-K filed August 13, 2002.
4.12		Eleventh supplement to Indenture, incorporated by reference to Exhibit 4 to the DRLP’s Current Report on Form 8-K filed August 26, 2002.
4.13		Twelfth supplement to Indenture, incorporated by reference to Exhibit 4 to DRLP’s Current Report on Form 8-K filed January 16, 2002.

 

33

 

4.14		Thirteenth Supplement to Indenture, incorporated by Reference to Exhibit 4 to DRLP’s Current Report on Form 8-K filed May 22, 2003.
4.15		Fourteenth Supplement to Indenture, incorporated by Reference to Exhibit 4 to DRLP’s Current Report on Form 8-K filed October 24, 2003.
4.16		Fifteenth Supplement to Indenture, incorporated by Reference to Exhibit 4 to DRLP’s Current Report on Form 8-K filed January 9, 2004.
4.17		Sixteenth Supplement to Indenture, incorporated by Reference to Exhibit 4 to DRLP’s Current Report on Form 8-K filed January 23, 2004.
10.1		Second Amended and Restated Agreement of Limited Partnership of DRLP, incorporated by reference from Exhibit 4.1 to DRLP’s Current Report on Form 8-K filed July 16, 1999.
10.2		First Amendment to Second Amended and Restated Agreement of Limited Partnership of DRLP, incorporated by reference from Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000.
10.3		Second Amendment to Second Amended and Restated Agreement of Limited Partnership of DRLP incorporated by reference from Exhibit 10.3 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.
10.4		Third Amendment To Second Amended and Restated Agreement of Limited Partnership of DRLP incorporated by reference from Exhibit 10.4 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.
10.5		Fourth Amendment to Second Amended and Restated Agreement of Limited Partnership of DRLP incorporated by reference from Exhibit 10.5 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.
10.6		Second Amended and Restated Agreement of Limited Partnership of Duke Realty Services Limited Partnership (the “Services Partnership”), incorporated herein by reference to Exhibit 10.3 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1995.
10.7		First Amendment to Second Amended and Restated Agreement of Limited Partnership of the Services Partnership incorporated by reference from Exhibit 10.7 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.
10.8		Second Amendment to Second Amended and Restated Agreement of Limited Partnership of the Services Partnership incorporated by reference from Exhibit 10.8 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.
10.9		Third Amendment to Second Amended and Restated Agreement of Limited Partnership of the Services Partnership incorporated by reference from Exhibit 10.9 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.
10.10		Promissory Note of the Services Partnership, incorporated herein by reference to Exhibit 10.3 to the Company’s Form S-2 Registration Statement No. 33-64038 filed June 8, 1993 (the “1993 Registration Statement”).
10.11		Services Partnership 1993 Stock Option Plan, incorporated herein by reference to Exhibit 10.4 to the 1993 Registration Statement.#

 

34

 

10.12		Amendment One to Services Partnership 1993 Stock Option Plan incorporated by reference from Exhibit 10.12 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.#
10.13		Amendment Two to Services Partnership 1993 Stock Option Plan incorporated by reference from Exhibit 10.13 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002.#
10.14		Amendment Three to Services Partnership 1993 Stock Option Plan incorporated by reference from Exhibit 10.14 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002.#
10.15		Acquisition Option Agreement relating to certain properties not contributed to the Operating Partnership by Duke Associates (the “Excluded Properties”), incorporated herein by reference to Exhibit 10.5 to the 1993 Registration Statement.
10.16		Management Agreement relating to the Excluded Properties, incorporated herein by reference to Exhibit 10.6 to the 1993 Registration Statement.
10.17		Indemnification Agreement, incorporated herein by reference to Exhibit 10.11 to the 1993 Registration Statement.
10.18		1995 Key Employee Stock Option Plan of the Company, incorporated herein by reference to Exhibit 10.13 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1995.#
10.19		Amendment One To The 1995 Key Employees’ Stock Option Plan of Duke Realty Investments, Inc. incorporated by reference from Exhibit 10.19 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.#
10.20		Amendment Two to the 1995 Key Employees’ Stock Option Plan of Duke Realty Investments, Inc. incorporated by reference from Exhibit 10.20 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.#
10.21		Amendment Three to the 1995 Key Employees’ Stock Option Plan of Duke Realty Investments, Inc. incorporated by reference from Exhibit 10.21 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.#
10.22		Amendment Four to the 1995 Key Employees’ Stock Option Plan of Duke Realty Investments, Inc. incorporated by reference from Exhibit 10.22 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.#
10.23		Amendment Five to the 1995 Key Employees’ Stock Option Plan of Duke Realty Investments, Inc. incorporated by reference from Exhibit 10.23 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.#
10.24		Amendment Six to the 1995 Key Employees’ Stock Option Plan of Duke Realty Investments, Inc. incorporated by reference from Exhibit 10.24 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.#
10.25		Amendment Seven to the 1995 Key Employees’ Stock Option Plan of Duke Realty Investments, Inc., incorporated herein by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2002.#
10.26		Amended and Restated Dividend Increase Unit Plan of the Services Partnership incorporated by reference from Exhibit 10.25 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.#

 

35

 

10.27		Amendment One to the Amended and Restated Dividend Increase Unit Plan of Services Partnership incorporated by reference from Exhibit 10.26 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.#
10.28		Amendment Two to the Amended and Restated Dividend Increase Unit Plan of Services Partnership incorporated by reference from Exhibit 10.27 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.#
10.29		Amendment Three to the Amended and Restated Dividend Increase Unit Plan of Duke Realty Services Limited Partnership, incorporated herein by reference to Exhibit 10.5 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2001.#
10.30		1995 Shareholder Value Plan of the Services Partnership incorporated herein by reference to Exhibit 10.15 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1995.#
10.31		Amendment One to the 1995 Shareholder Value Plan of Services Partnership incorporated by reference from Exhibit 10.29 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.#
10.32		Amendment Two to the 1995 Shareholder Value Plan of Services Partnership incorporated by reference from Exhibit 10.30 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.#
10.33		Amendment Three to the 1995 Shareholder Value Plan of Services Partnership incorporated by reference from Exhibit 10.31 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.#
10.34		Amendment Four to the 1995 Shareholder Value Plan of Services Partnership, incorporated herein by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2002.#
10.35		1998 Duke Realty Severance Pay Plan, incorporated herein by reference to Exhibit 10.18 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1998.#
10.36		1999 Directors’ Stock Option and Dividend Increase Unit Plan, incorporated by reference to Annex F to the Prospectus in the Merger Registration Statement.#
10.37		1999 Salary Replacement Stock Option and Dividend Increase Unit Plan is incorporated by reference to Annex G to the Prospectus in the Merger Registration Statement.#
10.38		Amendment One to the 1999 Salary Replacement Stock Option and Dividend Increase Unit Plan of Duke Realty Investments, Inc. incorporated herein by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2002.#
10.39		Amendment Two to the 1999 Salary Replacement Stock Option and Dividend Increase Unit Plan of Duke Realty Investments, Inc. incorporated herein by reference to Exhibit 10.4 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2002.#
10.40		2000 Performance Share Plan of Duke-Weeks Realty Corporation incorporated herein by reference to Proposal 2 of the company’s 2001 Proxy filed March 13, 2001.
10.41		Amendment One to the 2000 Performance Share Plan of Duke-Weeks Realty Corporation incorporated herein by reference to Exhibit 10.6 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2002.
10.42		Amendment Two to the 2000 Performance Share Plan of Duke-Weeks Realty Corporation incorporated herein by reference to Exhibit 10.42 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003.*

 

36

 

10.43		Fourth Amended and Restated Revolving Credit Agreement dated January 22, 2004, among DRLP, as borrower, the Company as General Partner and Guarantor, and Bank One as Administrative Agent and Lender incorporated by reference from Exhibit 10.1 to the Company’s Current Report on Form 8-K filed January 22, 2004.*
11.1		Statement of Computation of Ratios of Earnings to Fixed Charges.*
11.2		Statement of Computation of Ratios of Earnings to Debt Service.*
21.		List of the Company’s Subsidiaries.*
23.		Consent of KPMG LLP.*
24.		Executed powers of attorney of certain directors.*
31.1		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
31.2		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
31.3		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
32.1		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
32.2		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
32.3		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
99.1		Selected Quarterly Financial Information.*

 

# Represents management contract or compensatory plan or arrangement.

 

The Company will furnish to any security holder, upon written request, copies of any exhibit incorporated by reference, for a fee of 15 cents per page, to cover the costs of furnishing the exhibits. Written request should include a representation that the person making the request was the beneficial owner of securities entitled to vote at the Annual Meeting of Shareholders.

 

(b)           Reports on Form 8-K

 

A current report was filed on Form 8-K, dated January 22, 2004, reporting under items 5 and 7 the execution of a new $500 million revolving line of credit.

 

A current report was filed on Form 8-K, dated February 13, 2004, setting forth under item 7 certain exhibits in connection with the closing of the Company’s offering of 6,000,000 Depository Shares each representing 1/10 of a 6.50% Series K Cumulative Redeemable Preferred Shares.

 

(c)           Exhibits

 

The exhibits required to be filed with this Form 10-K pursuant to Item 601 of Regulation S-K or listed under “Exhibits” in Part IV, Item 14(a)(3) of Form 10-K, which are incorporated herein by reference.

 

(d)           Financial Statement Schedule

 

The Financial Statement Schedule required to be filed with this Form 10-K is listed under “Consolidated Financial Statement Schedules” in Part IV, Item 14(a)(2) of this Form 10-K, and is incorporated herein by reference.

 

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Independent Auditors’ Report

 

The Shareholders and Directors of

Duke Realty Corporation:

 

We have audited the consolidated balance sheets of Duke Realty Corporation and Subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, cash flows and shareholders’ equity for each of the years in the three-year period ended December 31, 2003. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule III. These consolidated financial statements and the financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated financial statements and the financial statement schedule based on our audits.

 

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Duke Realty Corporation and Subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule III, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

 

 

KPMG LLP

Indianapolis, Indiana

January 28, 2004

 

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