UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark one)

 

 

 

Or

 

 

 

 

VORNADO REALTY TRUST

(Exact name of registrant as specified in its charter)

 

 

 

(212) 894-7000

(Registrant’s telephone number, including area code)

 

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

 

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

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

 

As of June 30, 2008, 153,889,331 of the registrant’s common shares of beneficial interest are outstanding.

 

 

 

 

 

VORNADO REALTY TRUST

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

 

See notes to consolidated financial statements (unaudited).

 

 

VORNADO REALTY TRUST

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

 

 

See notes to consolidated financial statements (unaudited).

 

 

VORNADO REALTY TRUST

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

 

See notes to consolidated financial statements (unaudited).

 

 

VORNADO REALTY TRUST

CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED

(UNAUDITED)

 

 

 

 

See notes to consolidated financial statements (unaudited).

 

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Vornado Realty Trust is a fully-integrated real estate investment trust (“REIT”) and conducts its business through Vornado Realty L.P., a Delaware limited partnership (the “Operating Partnership”). All references to “our,” “we,” “us,” the “Company” and “Vornado” refer to Vornado Realty Trust and its consolidated subsidiaries. We are the sole general partner of, and owned approximately 90.3% of the common limited partnership interest in, the Operating Partnership at June 30, 2008.

 

Substantially all of Vornado Realty Trust’s assets are held through subsidiaries of the Operating Partnership. Accordingly, Vornado Realty Trust’s cash flow and ability to pay dividends to its shareholders is dependent upon the cash flow of the Operating Partnership and the ability of its direct and indirect subsidiaries to first satisfy their obligations to creditors.

 

The accompanying consolidated financial statements are unaudited. In our opinion, all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position, results of operations and changes in cash flows have been made. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted. These condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q of the Securities and Exchange Commission (the “SEC”) and should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2007, as filed with the SEC. The results of operations for the three and six months ended June 30, 2008, are not necessarily indicative of the operating results for the full year.

 

The accompanying consolidated financial statements include the accounts of Vornado and the Operating Partnership, as well as certain partially owned entities in which we own more than 50%, unless a partner has shared board and management representation and substantive participation rights on all significant business decisions, or 50% or less when (i) we are the primary beneficiary and the entity qualifies as a variable interest entity under Financial Accounting Standards Board (“FASB”) Interpretation No. 46 (Revised), Consolidation of Variable Interest Entities (“FIN 46R”), or (ii) when we are a general partner that meets the criteria under Emerging Issues Task Force (“EITF”) Issue No. 04-5. All significant inter-company amounts have been eliminated. Equity interests in partially owned entities are accounted for under the equity method of accounting when they do not meet the criteria for consolidation and our ownership interest is greater than 20%. When partially owned investments are in partnership form, the 20% threshold for equity method accounting is generally reduced to 3% to 5%, based on our ability to influence the operating and financial policies of the partnership. Investments accounted for under the equity method are initially recorded at cost and subsequently adjusted for our share of the net income or loss and cash contributions and distributions to or from these entities. Investments in partially owned entities that do not meet the criteria for consolidation or for equity method accounting are accounted for on the cost method.

 

We have made estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

 

Certain prior year balances related to discontinued operations and income tax (expense) benefit have been reclassified in order to conform to current year presentation.

 

In connection with purchase accounting for H Street, in July 2005 and April 2007 we recorded an aggregate of $222,174,000 of deferred tax liabilities representing the differences between the tax basis and the book basis of the acquired assets and liabilities multiplied by the effective tax rate. We were required to record these deferred tax liabilities because H Street and its partially owned entities were operated as C Corporations at the time they were acquired. As of January 16, 2008, we had completed all of the actions necessary to enable these entities to elect REIT status effective for the tax year beginning on January 1, 2008. Consequently, in the first quarter of 2008, we reversed the deferred tax liabilities and recognized an income tax benefit of $222,174,000 in our consolidated statement of income.

 

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

In September 2006, the FASB issued Statement No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States of America and expands disclosures about fair value measurements. SFAS 157 was effective for our financial assets and liabilities on January 1, 2008.  The FASB has deferred the implementation of the provisions of SFAS 157 relating to certain non-financial assets and liabilities until January 1, 2009. This standard did not materially affect how we determine fair value, but resulted in certain additional disclosures. SFAS 157 establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three levels: Level 1 – quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities; Level 2 – observable prices that are based on inputs not quoted in active markets, but corroborated by market data; and Level 3 – unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the highest priority to Level 1 inputs and the lowest priority to Level 3 inputs. In determining fair value, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible as well as consider counterparty credit risk in our assessment of fair value. Financial assets and liabilities measured at fair value in our consolidated financial statements consist of (i) marketable equity securities–available for sale, (ii) derivative positions in marketable equity securities and (iii) the assets of our officers’ deferred compensation plan (primarily marketable equity securities and equity investments in partially owned entities), for which there is a corresponding liability on our consolidated balance sheet. Financial assets and liabilities carried at fair value as of June 30, 2008 are presented in the table below based on the hierarchy used to measure fair value:

___________________

 

In September 2006, the FASB issued Statement No. 158, Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans, an Amendment of SFAS No. 87, 88, 106 and 132R (“SFAS 158”). SFAS 158 requires an employer to (i) recognize in its statement of financial position an asset for a plan’s over-funded status or a liability for a plan’s under-funded status; (ii) measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year (with limited exceptions); and (iii) recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur. Those changes will be reported in comprehensive income. The adoption of the requirement to recognize the funded status of a benefit plan and the disclosure requirements as of December 31, 2006 did not have a material effect on our consolidated financial statements. The requirement to measure plan assets and benefit obligations to determine the funded status as of the end of the fiscal year and to recognize changes in the funded status in the year in which the changes occur is effective on January 1, 2009. The adoption of the measurement date provisions of this standard is not expected to have a material effect on our consolidated financial statements.

 

In February 2007, the FASB issued SFAS 159, which permits companies to measure many financial instruments and certain other items at fair value.  SFAS 159 was effective on January 1, 2008. We have not elected the fair value option for any of our existing financial instruments on the effective date and have not determined whether we will elect this option for any eligible financial instruments we acquire in the future.

 

 

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

In December 2007, the FASB issued Statement No. 141R, Business Combinations (“SFAS 141R”). SFAS 141R broadens the guidance of SFAS 141, extending its applicability to all transactions and other events in which one entity obtains control over one or more other businesses. SFAS 141R also broadens the fair value measurement and recognition of assets acquired, liabilities assumed, and interests transferred as a result of business combinations; and requires that acquisition related costs be expensed rather than included as part of the basis of the acquisition. SFAS 141R expands required disclosures to improve the ability to evaluate the nature and financial effects of business combinations. SFAS 141R is effective for all transactions entered into on or after January 1, 2009. The adoption of this standard on January 1, 2009 could materially impact our future financial results to the extent that we acquire significant amounts of real estate, as related acquisition costs will be expensed as incurred compared to our current practice of capitalizing such costs and amortizing them over the estimated useful life of the assets acquired.

 

In December 2007, the FASB issued Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements - An Amendment of ARB No. 51 (“SFAS 160”). SFAS 160 requires a noncontrolling interest in a subsidiary to be reported as equity and the amount of consolidated net income specifically attributable to the noncontrolling interest to be identified in the consolidated financial statements. SFAS 160 also calls for consistency in the manner of reporting changes in the parent’s ownership interest and requires fair value measurement of any noncontrolling equity investment retained in a deconsolidation. SFAS 160 is effective on January 1, 2009. We are currently evaluating the impact SFAS 160 will have on our consolidated financial statements.

 

In March 2008, the FASB issued Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities – an Amendment of FASB Statement No. 133 (“SFAS 161”). SFAS 161 requires enhanced disclosures related to derivative instruments and hedging activities, including disclosures regarding how an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, and the impact of derivative instruments and related hedged items on an entity’s financial position, financial performance and cash flows. SFAS 161 is effective on January 1, 2009. We believe that the adoption of this standard on January 1, 2009 will not have a material effect on our consolidated financial statements.

 

In May 2008, the FASB issued Staff Position No. APB 14-1, Accounting for Convertible Debt Instruments that may be Settled in Cash upon Conversion (Including Partial Cash Settlement), (the “FSP”). The adoption of this FSP would affect the accounting for our convertible and exchangeable senior debentures and Series D-13 convertible preferred units. The FSP would require the initial proceeds from the sale of our convertible and exchangeable senior debentures and Series D-13 convertible preferred units to be allocated between a liability component and an equity component. The resulting discount would be amortized using the effective interest method over the period the debt is expected to remain outstanding as additional interest expense. The FSP would be effective for our fiscal year beginning on January 1, 2009 and require retroactive application. The adoption of the FSP on January 1, 2009 would result in the recognition of an aggregate unamortized debt discount of $161,259,000 (as of June 30, 2008) in our consolidated balance sheets and additional interest expense in our consolidated statements of income. Our current estimate of the incremental interest expense, net of minority interest, for each reporting period is as follows:

 

 

 

 

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

In May 2008, the FASB issued Statement No. 162, The Hierarchy of Generally Accepted Accounting Principles (“SFAS 162”). The purpose of this statement is to improve financial reporting by providing a consistent framework for determining applicable accounting principles to be used in the preparation of financial statements presented in conformity with GAAP. SFAS 162 will become effective 60 days after the SEC’s approval. We believe that the adoption of this standard on its effective date will not have a material effect on our consolidated financial statements.

 

In May 2008, the FASB issued Statement No. 163, Accounting for Financial Guarantee Insurance Contracts (“SFAS 163”). SFAS 163 was issued to decrease inconsistencies within Statement No. 60, Accounting and Reporting by Insurance Enterprises, and clarify how it applies to financial guarantee insurance contracts issued by insurance enterprises, including the recognition of premium revenue and claim liabilities. SFAS 163 also requires expanded disclosures about financial guarantee insurance contracts. SFAS 163 is effective on January 1, 2009. We believe that the adoption of this standard on January 1, 2009 will not have any effect on our consolidated financial statements.

 

Toys “R” Us (“Toys”)

 

Toys prepares its consolidated financial statements using the historical cost basis (“Recap basis”) of accounting. We account for our investment in Toys on the purchase accounting basis. In July 2008, in connection with an audit of Toys’ purchase accounting basis financial statements for its fiscal years 2006 and 2007, it was determined that the purchase accounting basis income tax expense was understated. Our share of this non-cash charge is $14,900,000, which we recognized as part of our equity in Toys’ net loss in the three months ended June 30, 2008. This non-cash charge has no effect on cash actually paid for income taxes or Toys’ previously issued Recap basis consolidated financial statements.

At June 30, 2008, we owned 32.7% of Toys. Toys’ business is highly seasonal. Historically, Toys’ fourth quarter net income accounts for more than 80% of its fiscal year net income. Because Toys’ fiscal year ends on the Saturday nearest January 31, we record our 32.7% share of Toys’ net income or loss on a one-quarter lag basis. Below is a summary of Toys’ latest available financial information.

 

 

 

 

Alexander’s (NYSE: ALX)

 

At June 30, 2008, we owned 32.6% of the outstanding common stock of Alexander’s. We manage, lease and develop Alexander’s properties pursuant to agreements, that expire in March of each year and are automatically renewed. As of June 30, 2008, Alexander’s owed us $42,376,000 for fees under these agreements.

 

Based on Alexander’s June 30, 2008 closing share price on the NYSE of $310.60, the market value (“fair value” pursuant to SFAS 157) of our investment in Alexander’s is $513,754,000, or $373,354,000 in excess of the carrying amount on our consolidated balance sheet.

 

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

The Lexington Master Limited Partnership (“Lexington MLP”)

 

At June 30, 2008, we owned 8,149,593 limited partnership units of Lexington MLP which are exchangeable on a one-for-one basis into common shares of Lexington Realty Trust (“Lexington”) (NYSE: LXP) or a 7.7% limited partnership interest. We record our pro rata share of Lexington MLP’s net income or loss on a one-quarter lag basis because we file our consolidated financial statements on Form 10-K and 10-Q prior to the time that Lexington files its financial statements.

 

Based on Lexington’s June 30, 2008 closing share price of $13.63 on the NYSE, the market value (“fair value” pursuant to SFAS 157) of our investment in Lexington MLP was $111,079,000, or $42,693,000 below the carrying amount on our consolidated balance sheet. Lexington’s common shares have traded at market prices in excess of our carrying amount per unit during the last 12 months. We have the ability and intent to hold these units until they recover in value. In addition, we account for our investment in Lexington MLP on the equity method, under which the carrying amount of our investment is reduced by (i) the amount of distributions we receive from Lexington MLP (current annual run rate of $1.32 per unit) and (ii) our pro rata share of Lexington MLP’s net losses. During the six months ended June 30, 2008, the carrying amount of our investment was reduced by approximately $4,564,000. This reduction would have been greater if Lexington MLP did not have net gains on sales of real estate during this period. Based on these factors, we have concluded that the decline in the value of our investment is not “other-than-temporary” as of June 30, 2008. However, if the current market conditions deteriorate further, or a recovery in market value does not occur, we may be required to record additional unrealized or realized losses in future periods.

 

GMH Communities L.P. (“GMH”)

 

Prior to June 11, 2008, we owned 7,337,857 GMH limited partnership units, which were exchangeable on a one-for-one basis into common shares of GMH Communities Trust (“GCT”) (NYSE: GCT), and 2,517,247 common shares of GCT, or 13.8% of the limited partnership interest of GMH, which had an aggregate carrying amount of $101,634,000, or $10.31 per share/unit. We accounted for our investment in GMH on the equity method and recorded our pro rata share of GMH’s net income or loss on a one-quarter lag basis as we filed our consolidated financial statements on Form 10-K and 10-Q prior to the time that GCT filed its financial statements.

 

Pursuant to the sale of GMH’s military housing division and the merger of its student housing division with American Campus Communities, Inc (“ACC”) (NYSE: ACC), subsequent to June 11, 2008 we received an aggregate of $105,180,000, consisting of $82,142,000 in cash and 753,126 shares of ACC common stock valued at $23,038,000 based on ACC’s then closing share price of $30.59, in exchange for our entire interest in GMH. We subsequently sold all of the ACC common shares. The above transactions resulted in a net gain of $2,038,000, which was recognized in the quarter ended June 30, 2008, and is included as a component of “net gains on disposition of wholly owned and partially owned assets other than depreciable real estate” in our consolidated statement of income.

 

The aggregate net income realized from inception of this investment in 2004 through its disposition was $77,000,000.

 

India Real Estate Ventures

 

We are a partner in four joint ventures established to develop real estate in India’s leading cities. During the six months ended June 30, 2008, we funded $39,077,000 of cash to the four ventures, including $34,077,000 to the India Property Fund L.P. (“IPF”). As of June 30, 2008, our aggregate investment in these four ventures was $83,524,000 and our remaining capital commitment to these ventures is $91,923,000, of which $80,923,000 is to IPF. At June 30, 2008 and December 31, 2007, our ownership interest in IPF was 36.5% and 50.6%, respectively. Based on the reduction of our ownership interest in 2008, we no longer consolidate the accounts of IPF into our consolidated financial statements and beginning on January 1, 2008 we account for our investment in IPF under the equity method.

 

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

The carrying amount of our investments in partially owned entities and income (loss) recognized from such investments are as follows:

 

 

 

_________________________

See notes on following page.

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

Notes to preceding tabular information

(Amounts in thousands):

 

 

 

 

 

 

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

Below is a summary of the debt of partially owned entities as of June 30, 2008 and December 31, 2007, none of which is guaranteed by us.

 

 

 

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

 

 

 

Based on our ownership interest in the partially owned entities above, our pro rata share of the debt of these partially owned entities was $2,998,810,000 and $3,289,873,000 as of June 30, 2008 and December 31, 2007, respectively.

 

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

 

The following is a summary of our investments in mezzanine loans as of June 30, 2008 and December 31, 2007.

 

_____________________

 

 

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

The following summarizes our identified intangible assets, intangible liabilities (deferred credit) and goodwill as of June 30, 2008 and December 31, 2007.

 

 

Amortization of acquired below market leases, net of acquired above market leases (a component of rental income) was $25,858,000 and $20,327,000 for the three months ended June 30, 2008 and 2007, respectively, and $49,129,000 and $34,343,000 for the six months ended June 30, 2008 and 2007, respectively. Estimated annual amortization of acquired below market leases, net of acquired above market leases for each of the five succeeding years is as follows:

 

 

Amortization of all other identified intangible assets (a component of depreciation and amortization expense) was $19,404,000 and $6,779,000 for the three months ended June 30, 2008 and 2007, respectively, and $44,358,000 and $13,084,000 for the six months ended June 30, 2008 and 2007, respectively. Estimated annual amortization of all other identified intangible assets including acquired in-place leases, customer relationships, and third party contracts for each of the five succeeding years is as follows:

 

 

We are a tenant under ground leases for certain of our properties. Amortization of these acquired below market leases resulted in an increase to rent expense of $533,000 and $393,000 for the three months ended June 30, 2008 and 2007, respectively, and $1,066,000 and $777,000 for the six months ended June 30, 2008 and 2007, respectively. Estimated annual amortization of these below market leases for each of the five succeeding years is as follows:

 

 

 

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

The following is a summary of our notes and mortgages payable:

 

_____________________

See notes on page 20.

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

 

 

_______________________

See notes on following page.

 

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

Notes to preceding tabular information (Amounts in thousands):

 

 

 

 

 

 

 

 

 

 

The following table sets forth the details of our fee and other income:

 

 

Fee and other income above include management fee income from Interstate Properties, a related party, of $197,000 and $205,000 for the three months ended June 30, 2008 and 2007, respectively, and $408,000 and $410,000 for the six months ended June 30, 2008 and 2007, respectively. The above table excludes fee income from partially owned entities, which is included in income (loss) from partially owned entities (see Note 4 – Investments in Partially Owned Entities).

 

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

On March 31, 2008, we sold our 47.6% interest in Americold Realty Trust (“Americold”), our Temperature Controlled Logistics segment, for $220,000,000, in cash, which resulted in a net gain of $112,690,000.

 

On June 6, 2008, we sold our Tysons Dulles Plaza office building complex located in Tysons Corner, Virginia for approximately $152,800,000, in cash, which resulted in a net gain of $56,831,000.

 

In accordance with the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, we classified our Temperature Controlled Logistics segment and our Tysons Dulles Plaza office building complex as discontinued operations and reported their revenues and expenses as “income from discontinued operations, net of minority interest” and the related assets and liabilities as “assets related to discontinued operations” and “liabilities related to discontinued operations” for all periods presented in the accompanying consolidated financial statements. The following table sets forth the assets (primarily net book value of real estate) and liabilities (primarily mortgage debt) related to discontinued operations at June 30, 2008 and December 31, 2007.

 

 

 

The following table sets forth the combined results of discontinued operations for the three and six months ended June 30, 2008 and 2007.

 

 

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

The table below computes (i) basic income per common share - which utilizes weighted average common shares outstanding without regard to potential dilutive common shares, and (ii) diluted income per common share - which includes weighted average common shares outstanding and dilutive common share equivalents. Potentially dilutive common share equivalents include our Series A convertible preferred shares, employee stock options and restricted share awards, exchangeable senior debentures due 2025, as well as Operating Partnership convertible preferred units.

 

__________________

 

 

Accumulated other comprehensive (loss) income was $(28,331,000) and $29,772,000 as of June 30, 2008 and December 31, 2007, respectively, and consists primarily of accumulated unrealized (loss) income from the mark-to-market of marketable equity securities classified as available-for-sale.

 

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

Our Share Option Plan (the “Plan”) provides for grants of incentive and non-qualified stock options, restricted stock, stock appreciation rights, performance shares and limited partnership units to certain of our employees and officers. We account for stock-based compensation in accordance with SFAS No. 123: Accounting for Stock-Based Compensation, as amended by SFAS No. 148: Accounting for Stock-Based Compensation - Transition and Disclosure and as revised by SFAS No. 123R: Share-Based Payment (“SFAS 123R”). We adopted SFAS 123R, using the modified prospective application, on January 1, 2006. Stock based compensation expense for the three and six months ended June 30, 2008 and 2007 consists of stock option awards, restricted common shares, Operating Partnership unit awards and Out-Performance Plan awards. We recognized $8,898,000 and $16,973,000 of stock based compensation expense in the three and six months ended June 30, 2008, respectively, of which $4,320,000 and $7,448,000 relates to our 2006 and 2008 out-performance plans. During the three and six months ended June 30, 2007, we recognized $6,973,000 and $12,620,000 of stock based compensation expense, respectively.

 

2008 Stock Options

 

On March 31, 2008, our Compensation Committee approved a grant of Vornado stock options to senior executives and employees. The options were granted with an exercise price 17.5% in excess of the average of the high and low price of our common shares on the New York Stock Exchange on that date. The options are expensed pro rata over the 5-year vesting period in accordance with SFAS 123R.

 

2008 Out-Performance Plan

 

On March 31, 2008, our Compensation Committee approved a $75,000,000 out-performance plan (the “2008 OPP”) that requires the achievement of performance objectives against both absolute and relative thresholds. The 2008 OPP establishes a potential performance pool in which 71 members of senior management have the opportunity to share in if the total return to our shareholders (the “Total Return”) resulting from both share appreciation and dividends for the four-year period from March 31, 2008 to March 31, 2012 exceeds both an absolute and a relative hurdle. The initial value from which to determine the Total Return is $86.20 per share, a 0.93% premium to the trailing 10-day average closing price on the New York Stock Exchange for our common shares on the date the plan was adopted.

 

The size of the out-performance pool for the 2008 OPP is 6% of the aggregate “out-performance return” subject to a maximum total award of $75,000,000 (the “Maximum Award”). The “out-performance return” is comprised of (i) 3% of the total dollar value of the Total Return in excess of 10% per annum (the “Absolute Component”), plus (ii) 3% of the total dollar value of the Total Return in excess of the Relative Threshold (the “Relative Component”), based on the SNL Equity REIT Index (the “Index”) over the four-year performance period. In the event that the Relative Component creates a negative award as a result of underperforming the Index, the value of any out-performance award potentially earned under the Absolute Component will be reduced dollar for dollar. In addition, awards potentially earned under the Relative Component will be reduced on a ratable sliding scale to the extent the Total Return is less than 10% per annum and to zero to the extent the Total Return is less than 7% per annum. The size of this out-performance pool, if any, will be determined based on the highest 30-trading day trailing average price of our common shares during the final 150 days of the four-year period. During the four-year performance period, participants are entitled to receive 10% of the common dividends paid on Vornado’s common shares for each OPP unit awarded, regardless of whether the OPP units are ultimately earned.

 

The 2008 OPP also provides participants an opportunity to earn partial awards during two interim measurement periods (the “Interim Periods”): (a) one for a period consisting of the first two years of the performance period and (b) one for a period consisting of the final two years of the performance period. For each Interim Period, participants may be entitled to share in 40% ($30,000,000) of the maximum $75,000,000 performance pool if the performance thresholds have been met for the applicable Interim Periods on a pro rated basis. The starting share price for the first Interim Period is $86.20 per share. The starting share price for the second Interim Period is equal to the greater of our common share price on March 31, 2010, or the initial starting share price of $86.20 per share less dividends paid during the first two years of the plan. If the maximum award is earned during the first Interim Period, participants lose the potential to earn the second Interim Period award, but not the potential to earn the remainder of the maximum award over the four-year period. The size of any out-performance pool for an Interim Period will be determined based on the highest 30-day trailing average price of our shares during the final 120 days of the applicable Interim Period.

 

Awards earned under the program (including any awards earned for the Interim Periods), will vest 50% on March 31, 2012 and 50% on March 31, 2013. The 2008 OPP is accounted for in accordance with SFAS 123R. The fair value of the OPP awards on the date of grant, as adjusted for estimated forfeitures, was approximately $21,600,000, which will be amortized into expense over a five-year period beginning on the date of grant through the final vesting period, using a graded vesting attribution model.

 

 

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

At June 30, 2008, $45,690,000 was reserved for outstanding letters of credit under our $1 billion revolving credit facility. Our credit facilities contain financial covenants, that require us to maintain minimum interest coverage and maximum debt to market capitalization ratios, and provides for higher interest rates in the event of a decline in our ratings below Baa3/BBB. Our credit facilities also contain customary conditions precedent to borrowing, including representations and warranties and also contain customary events of default that could give rise to accelerated repayment, including such items as failure to pay interest or principal.

 

In connection with our investments in partially owned entities, we are committed to fund additional capital aggregating $122,178,000. Of this amount, $80,923,000 relates to our equity commitment to IPF which we have pledged as collateral to IPF’s lender and $18,090,000 relates to capital expenditures committed to the Springfield Mall, in which we have a 97.5% interest.

 

In June 2007 we formed Penn Plaza Insurance Company, LLC (“PPIC”), a wholly owned consolidated subsidiary, to act as a re-insurer with respect to a portion of our earthquake insurance coverage and as a direct insurer for coverage for “certified” acts of terrorism and for nuclear, biological, chemical and radiological (“NBCR”) acts, as defined by the Terrorism Risk Insurance Program Reauthorization Act of 2007 (“TRIPRA”). Coverage for “certified” acts of terrorism is fully reinsured by third party insurance companies and the Federal government with no exposure to PPIC. Prior to the formation of PPIC, we were uninsured for losses under NBCR coverage. Subsequently, we have $1.5 billion of NBCR coverage under TRIPRA, for which PPIC is responsible for 15% of each NBCR loss and the insurance company deductible of $1,000,000. We are ultimately responsible for any loss borne by PPIC.

 

Our debt instruments, consisting of mortgage loans secured by our properties (which are generally non-recourse to us), senior unsecured notes, exchangeable senior debentures, convertible senior debentures and revolving credit agreements, contain customary covenants requiring us to maintain insurance. Although we believe that we have adequate insurance coverage under these agreements, we may not be able to obtain an equivalent amount of coverage at reasonable costs in the future. Further, if lenders insist on greater coverage than we are able to obtain, it could adversely affect our ability to finance and/or refinance our properties and expand our portfolio.

 

Each of our properties has been subjected to varying degrees of environmental assessment at various times. The environmental assessments did not reveal any material environmental contamination. However, there can be no assurance that the identification of new areas of contamination, changes in the extent or known scope of contamination, the discovery of additional sites, or changes in cleanup requirements would not result in significant costs to us.

 

We enter into agreements for the purchase and resale of U.S. government obligations for periods of up to one week. The obligations purchased under these agreements are held in safekeeping in our name by various money center banks. We have the right to demand additional collateral or return of these invested funds at any time the collateral value is less than 102% of the invested funds plus any accrued earnings thereon. We had $111,960,000 and $82,240,000 of cash invested in these agreements at June 30, 2008 and December 31, 2007, respectively.

 

On January 16, 2008, our Board of Trustees approved the termination of the Vornado Realty Trust Retirement Plan and the Merchandise Mart Properties Pension Plan. The plans were frozen in 1998 and 1999, respectively. The termination is expected to be completed in the third quarter of 2008. Our current estimate of the cost we will incur during the third quarter of 2008 to buy annuities from an insurance company or to make lump-sum payments to plan participants to terminate both plans is approximately $4,000,000.

 

From time to time, we have disposed of substantial amounts of real estate to third parties for which, as to certain properties, we remain contingently liable for rent payments or mortgage indebtedness that cannot be quantified.

 

We have guaranteed the completion of two joint venture development projects. The aggregate estimated cost to complete these projects is approximately $85,000,000.

 

 

 

 

 

 

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

 

Litigation

 

On January 8, 2003, Stop & Shop filed a complaint with the United States District Court for the District of New Jersey (“USDC-NJ”) claiming we had no right to reallocate and therefore continue to collect $5,000,000 of annual rent from Stop & Shop pursuant to the Master Agreement and Guaranty. Stop & Shop asserted that a prior order of the Bankruptcy Court for the Southern District of New York dated February 6, 2001, as modified on appeal to the District Court for the Southern District of New York on February 13, 2001, froze our right to re-allocate which effectively terminated our right to collect the additional rent from Stop & Shop. On March 3, 2003, after we moved to dismiss for lack of jurisdiction, Stop & Shop voluntarily withdrew its complaint. On March 26, 2003, Stop & Shop filed a new complaint in New York Supreme Court, asserting substantially the same claims as in its USDC-NJ complaint. We removed the action to the United States District Court for the Southern District of New York. In January 2005 that court remanded the action to the New York Supreme Court. On February 14, 2005, we served an answer in which we asserted a counterclaim seeking a judgment for all the unpaid additional rent accruing through the date of the judgment and a declaration that Stop & Shop will continue to be liable for the additional rent as long as any of the leases subject to the Master Agreement and Guaranty remain in effect. On May 17, 2005, we filed a motion for summary judgment. On July 15, 2005, Stop & Shop opposed our motion and filed a cross-motion for summary judgment. On December 13, 2005, the Court issued its decision denying the motions for summary judgment. Both parties appealed the Court’s decision and on December 14, 2006, the Appellate Court division issued a decision affirming the Court’s decision. On January 16, 2007 we filed a motion for the reconsideration of one aspect of the Appellate Court’s decision which was denied on March 13, 2007. We are currently engaged in discovery and anticipate that a trial date will be set for some time in 2008. We intend to vigorously pursue our claims against Stop & Shop. In our opinion, after consultation with legal counsel, the outcome of such matters will not have a material effect on our financial condition, results of operations or cash flows.

 

On May 24, 2007, we acquired a 70% controlling interest in 1290 Avenue of the Americas and the 555 California Street complex. Our 70% interest was acquired through the purchase of all of the shares of a group of foreign companies that own, through U.S. entities, the 1% sole general partnership interest and a 69% limited partnership interest in the partnerships that own the two properties. The remaining 30% limited partnership interest is owned by Donald J. Trump. In August 2005, Mr. Trump brought a lawsuit in the New York State Supreme Court against, among others, the general partners of the partnerships referred to above.   Mr. Trump’s claims arose out of a dispute over the sale price of, and use of proceeds from, the sale of properties located on the former Penn Central rail yards between West 59th and 72nd Streets in Manhattan which were formerly owned by the partnerships. In decisions dated September 14, 2005 and July 24, 2006, the Court denied various of Mr. Trump’s motions and ultimately dismissed all of Mr. Trump’s claims, except for his claim seeking access to books and records. In a decision dated October 1, 2007, the Court determined that Mr. Trump already received access to the books and records to which he was entitled, with the exception of certain documents which were subsequently delivered to Mr. Trump. Mr. Trump has sought re-argument and renewal on, and filed a notice of appeal in connection with, his dismissed claims.  In connection with the acquisition, we agreed to indemnify the sellers for liabilities and expenses arising out of Mr. Trump’s claim that the general partners of the partnerships we acquired did not sell the rail yards at a fair price or could have sold the rail yards for a greater price and any other claims asserted in the legal action; provided however, that if Mr. Trump prevails on certain claims involving partnership matters, other than claims relating to sale price, the sellers will be required to reimburse us for certain costs related to those claims. We believe that the claims relating to the sale price are without merit. All other allegations are not asserted as a basis for damages and regardless of merit would not be material to our consolidated financial statements.

 

There are various other legal actions against us in the ordinary course of business. In our opinion, after consultation with legal counsel, the outcome of such matters will not have a material effect on our financial condition, results of operations or cash flows.

 

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

On January 16, 2008, our Board of Trustees approved the termination of the Vornado Realty Trust Retirement Plan (“Vornado Plan”) and the Merchandise Mart Properties Pension Plan (“Mart Plan”). The termination is expected to be completed in the third quarter of 2008. Our current estimate of the cost we will incur during the third quarter of 2008 to buy annuities from an insurance company or to make lump-sum payments to plan participants to terminate both plans is approximately $4,000,000.

 

The following table sets forth the components of net periodic benefit costs:

 

 

Employer Contributions

 

During the six months ended June 30, 2008 and 2007, we contributed $202,000 and $982,000, respectively, to the plans. We anticipate making additional contributions of $2,315,000 to the plans during the remainder of 2008.

 

In the three and six months ended June 30, 2008, we wrote-off $726,000 and $3,009,000, respectively, of costs associated with acquisitions not consummated (primarily Hudson Rail Yards). In the three months ended March 31, 2007, we wrote-off $8,807,000 of costs associated with The Equity Office Properties Trust acquisition not consummated.

 

In the first quarter of 2008, we determined that an investment in a marketable equity security was “other-than-temporarily” impaired and recorded a non-cash charge of $9,073,000, based on the March 31, 2008 closing share price of this security, which is included in “interest and other investment income” on our consolidated statement of income.

 

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

Below is a summary of net income and a reconciliation of net income to EBITDA⁽¹⁾ by segment for the three months ended June 30, 2008 and 2007.

 

 

The Washington, DC Office segment includes a $56,831 net gain on sale of real estate (included in “Income (loss) from discontinued operations, net”). The Other segment EBITDA includes a $3,468 net loss on the mark-to-market of derivative instruments, a $2,038 net gain on disposition of our 13.8% interest in GMH and a $726 write-off for costs of acquisitions not consummated.

_______________________

See notes on page 31.

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

 

The Other segment EBITDA includes a $72,074 net gain on mark-to-market of derivative instruments, a $15,778 net gain on sale of marketable equity securities and $1,677 for our share of India real estate ventures organization costs.

 

________________________

See notes on page 31.

 

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

The Washington, DC Office segment includes a $222,174 reduction in income tax expense resulting from a reversal of deferred tax liabilities in connection with the acquisition of H Street, and a $56,831 net gain on sale of real estate (included in “Income (loss) from discontinued operations, net”). The Other segment EBITDA includes, a $112,690 net gain on sale of our 47.6% interest in Americold (included in “Income (loss) from discontinued operations, net”), a $34,200 write-off of pre-development costs, a $21,830 net loss on the mark-to-market of derivative instruments, a $10,300 reversal of a mezzanine loan loss accrual, a $9,073 impairment loss on a marketable equity security, a $3,009 write-off for costs of acquisitions not consummated and a $2,038 net gain on disposition of our 13.8% interest in GMH.

_______________________

See notes on page 31.

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

       

The Washington, DC Office segment includes $1,891 of expense for H Street litigation costs. The Other segment EBITDA includes a net gain of $81,451 on the mark-to-market of derivative instruments, a $16,687 net gain on sale of marketable equity securities, an $8,807 write-off for costs of acquisition not consummated and $1,677 for our share of India real estate ventures organization costs.

________________________

See notes on the following page.

 

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

 

Notes to preceding tabular information

 

 

 

 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

 

Shareholders and Board of Trustees

Vornado Realty Trust

New York, New York

 

We have reviewed the accompanying consolidated balance sheet of Vornado Realty Trust as of June 30, 2008, and the related consolidated statements of income for the three-month and six-month periods ended June 30, 2008 and 2007, and of cash flows for the six-month periods ended June 30, 2008 and 2007. These interim financial statements are the responsibility of the Company’s management.

 

We conducted our reviews in accordance with standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

 

Based on our reviews, we are not aware of any material modifications that should be made to such consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

 

We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Vornado Realty Trust as of December 31, 2007, and the related consolidated statements of income, shareholders’ equity, and cash flows for the year then ended prior to reclassification for the discontinued operations described in Note 9 to the accompanying financial statements (not presented herein); and in our report dated February 26, 2008, we expressed an unqualified opinion on those consolidated financial statements. We also audited the adjustments described in Note 9 that were applied to reclassify the December 31, 2007 consolidated balance sheet of Vornado Realty Trust (not presented herein) for discontinued operations. In our opinion, such adjustments are appropriate and have been properly applied to the previously issued consolidated balance sheet in deriving the accompanying retrospectively adjusted consolidated balance sheet as of December 31, 2007.

 

/s/ DELOITTE & TOUCHE LLP

 

Parsippany, New Jersey

August 5, 2008

 

 

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

Certain statements contained herein constitute forward-looking statements as such term is defined in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are not guarantees of performance. They represent our intentions, plans, expectations and beliefs and are subject to numerous assumptions, risks and uncertainties. Our future results, financial condition and business may differ materially from those expressed in these forward-looking statements. You can find many of these statements by looking for words such as “approximates,” “believes,” “expects,” “anticipates,” “estimates,” “intends,” “plans,” “would,” “may” or other similar expressions in this Quarterly Report on Form 10-Q. Many of the factors that will determine the outcome of these and our other forward-looking statements are beyond our ability to control or predict. For further discussion of factors that could materially affect the outcome of our forward-looking statements and our future results and financial condition, see “Item 1A. Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2007. For these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. You are cautioned not to place undue reliance on our forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q or the date of any document incorporated by reference. All subsequent written and oral forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. We do not undertake any obligation to release publicly any revisions to our forward-looking statements to reflect events or circumstances occurring after the date of this Quarterly Report on Form 10-Q.

 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations include a discussion of our consolidated financial statements for the three and six months ended June 30, 2008. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 reporting periods. Actual results could differ from those estimates.

 

Critical Accounting Policies

A summary of our critical accounting policies is included in our Annual Report on Form 10-K for the year ended December 31, 2007 in Management’s Discussion and Analysis of Financial Condition. There have been no significant changes to our policies during 2008.

 

 

Overview

Business Objective and Operating Strategy

 

Our business objective is to maximize shareholder value. We measure our success in meeting this objective by our total return to shareholders. Below is a table comparing our performance to the Morgan Stanley REIT Index (“RMS”) and the SNL REIT Index (“SNL”) for the following periods ending June 30, 2008:

 

_________________________

 

We intend to achieve our business objective by continuing to pursue our investment philosophy and executing our operating strategies through:

 

 

We expect to finance our growth, acquisitions and investments using internally generated funds, proceeds from possible asset sales and by accessing the public and private capital markets.

 

We have a large concentration of properties in the New York City metropolitan area and in the Washington, DC and Northern Virginia areas. We compete with a large number of real estate property owners and developers, some of which may be willing to accept lower returns on their investments. Principal factors of competition are rent charged, attractiveness of location, the quality of the property and breadth and quality of services provided. Our success depends upon, among other factors, trends of the national, regional and local economies, financial condition and operating results of current and prospective tenants and customers, availability and cost of capital, construction and renovation costs, taxes, governmental regulations, legislation and population trends.

 

Beginning in the second half of 2007, the residential mortgage and capital markets began showing signs of stress, primarily in the form of escalating default rates on sub-prime mortgages, declining residential home values and increasing inventory nationwide. This “credit” crisis spread to the broader commercial credit markets and has reduced the availability of financing and widened spreads. These factors, coupled with a slowing economy, have reduced the volume of real estate transactions and increased capitalization rates. If these conditions continue, our real estate portfolio may experience lower occupancy and effective rents which would result in a corresponding decrease in net income, funds from operations and cash flows. In addition, the value of our investments in joint ventures, marketable securities, and mezzanine loans may also decline as a result of the above factors. Such declines may result in impairment charges and/or valuation allowances which would result in a corresponding decrease in net income and funds from operations.

 

 

Overview – continued

Quarter Ended June 30, 2008 Financial Results Summary  

 

Net income applicable to common shares for the quarter ended June 30, 2008 was $125,386,000, or $0.79 per diluted share, versus $151,625,000, or $0.96 per diluted share, for the quarter ended June 30, 2007. Net income for the quarter ended June 30, 2008 includes $56,831,000 for our share of net gains on sale of real estate. Net income for the quarters ended June 30, 2008 and 2007 also include certain items that affect comparability which are listed in the table below. The aggregate of these items and net gains on sale of real estate, net of minority interest, increased net income applicable to common shares for the quarter ended June 30, 2008 by $45,883,000, or $0.29 per diluted share and increased net income applicable to common shares for the quarter ended June 30, 2007 by $63,111,000, or $0.38 per diluted share.

 

Funds from operations applicable to common shares plus assumed conversions (“FFO”) for the quarter ended June 30, 2008 was $208,260,000, or $1.27 per diluted share, compared to $281,741,000, or $1.72 per diluted share, for the prior year’s quarter. FFO for the quarters ended June 30, 2008 and 2007 include certain items that affect comparability which are listed in the table below. The aggregate of these items, net of minority interest, decreased FFO for the quarter ended June 30, 2008 by $4,227,000, or $0.03 per diluted share and increased FFO for the quarter ended June 30, 2007 by $70,467,000, or $0.43 per diluted share.

 

 

We did not recognize income during the quarter ended June 30, 2008, on certain assets with an aggregate carrying amount of approximately $1.4 billion at June 30, 2008, because they were out of service for redevelopment. Assets under development include all or portions of the Bergen Town Center, 2101 L Street, 220 20^th Street, 1229-1231 25^th Street (“West End 25”), 1999 K Street, 220 Central Park South, 40 East 66^th Street, and certain investments in joint ventures including Beverly Connection, Wasserman and 800 17^th Street/PNC Place investments.

 

The percentage increase in the same-store Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) of our operating segments for the quarter ended June 30, 2008 over the quarter ended June 30, 2007 and the trailing quarter ended March 31, 2008 are summarized below.

_________________________

 

Calculations of same-store EBITDA, reconciliations of net income to EBITDA and FFO and the reasons we consider these non-GAAP financial measures useful are provided in the following pages of Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

 

Overview – continued

Six Months Ended June 30, 2008 Financial Results Summary  

 

Net income applicable to common shares for the six months ended June 30, 2008 was $523,308,000, or $3.26 per diluted share, versus $304,260,000, or $1.92 per diluted share, for the six months ended June 30, 2007. Net income for the six months ended June 30, 2008 includes $62,833,000 for our share of net gains on sale of real estate. Net income for the six months ended June 30, 2008 and 2007 also include certain items that affect comparability which are listed in the table below. The aggregate of these items and net gains on sale of real estate, net of minority interest, increased net income applicable to common shares for the six months ended June 30, 2008 by $305,998,000, or $1.87 per diluted share and increased net income applicable to common shares for the six months ended June 30, 2007 by $59,677,000, or $0.36 per diluted share.

 

FFO for the six months ended June 30, 2008 was $743,471,000, or $4.54 per diluted share, compared to $551,906,000, or $3.36 per diluted share, for the prior year’s six months. FFO for the six months ended June 30, 2008 and 2007 includes certain items that affect comparability which are listed in the table below. The aggregate of these items, net of minority interest, increased FFO for the six months ended June 30, 2008 by $255,382,000, or $1.56 per diluted share and increased FFO for the six months ended June 30, 2007 by $74,641,000, or $0.45 per diluted share.

 

 

In connection with the purchase accounting for H Street, in July 2005 and April 2007 we recorded an aggregate of $222,174,000 of deferred tax liabilities representing the differences between the tax basis and the book basis of the acquired assets and liabilities multiplied by the effective tax rate. We were required to record these deferred tax liabilities because H Street and its partially owned entities were operated as C Corporations at the time they were acquired. As of January 16, 2008, we had completed all of the actions necessary to enable these entities to elect REIT status effective for the tax year beginning on January 1, 2008. Consequently, in the first quarter of 2008, we reversed the deferred tax liabilities and recognized an income tax benefit of $222,174,000 in our consolidated statement of income.

 

The six months ended June 30, 2008 includes a $34,200,000 write-off for our share of two joint ventures’ pre-development costs, of which $23,000,000 represents our 50% share of costs in connection with the abandonment of the “arena move”/Moynihan East portions of the Farley project.

 

 

Overview – continued

The percentage increase in the same-store “EBITDA” of our operating segments for the six months ended June 30, 2008 over the six months ended June 30, 2007 is summarized below.

 

 

 

2008 Dispositions:

 

On March 31, 2008, we sold our 47.6% interest in Americold, our Temperature Controlled Logistics segment, for $220,000,000, in cash, which resulted in a net gain of $112,690,000.

 

On June 6, 2008, we sold our Tysons Dulles Plaza office building complex located in Tysons Corner, Virginia for approximately $152,800,000, in cash, which resulted in a net gain of $56,831,000.

 

Pursuant to the sale of GMH’s military housing division and the merger of its student housing division with American Campus Communities, Inc (“ACC”) (NYSE: ACC), subsequent to June 11, 2008 we received an aggregate of $105,180,000, consisting of $82,142,000 in cash and 753,126 shares of ACC common stock valued at $23,038,000 based on ACC’s then closing share price of $30.59, in exchange for our entire interest in GMH. We subsequently sold all of the ACC common shares. The above transactions resulted in a net gain of $2,038,000, which was recognized in the quarter ended June 30, 2008, and is included as a component of “net gains on disposition of wholly owned and partially owned assets other than depreciable real estate” in our consolidated statement of income.

 

2008 Financings:

 

On January 18, 2008, we closed a construction loan providing up to $87,000,000 to finance the residential redevelopment project at 220 20th Street (formally Crystal Plaza Two). The construction loan bears interest at LIBOR plus 1.15% (3.63% at June 30, 2008) and matures in January 2011 with two six-month extension options. As of June 30, 2008, $7,000,000 was drawn under this loan.

 

On February 11, 2008, we completed a $335,000,000 refinancing of the Green Acres regional mall. This interest-only loan has a rate of LIBOR plus 1.40% (3.86% at June 30, 2008) and matures in February 2011, with two one-year extension options. We retained net proceeds of $193,000,000 after repaying the existing loan.

 

On February 20, 2008, we closed a construction loan providing up to $104,000,000 to finance the residential redevelopment project at 1229-1231 25th Street NW (“West End 25”). The construction loan bears interest at LIBOR plus 1.30% (3.76% at June 30, 2008) and matures in February 2011 with two six-month extension options. As of June 30, 2008, $6,500,000 was drawn under this loan.

 

On February 26, 2008, we completed a $150,000,000 financing of our 2101 L Street property located in Washington, DC. The loan bears interest at LIBOR plus 1.20% (3.59% at June 30, 2008) and matures in February 2011 with two one-year extension options. We retained net proceeds of $148,000,000.

 

On March 12, 2008 we completed a $260,000,000 refinancing of the River House Apartment Complex. The financing is comprised of a $196,000,000 interest-only seven year 5.43% fixed rate mortgage and a $64,000,000 interest-only ten year floating rate mortgage at the Freddie Mac Reference Note Rate plus 1.53% (3.68% at June 30, 2008). We retained net proceeds of $205,000,000 after repaying the existing loan.

 

On March 24, 2008, we closed a construction loan providing up to $290,000,000 to finance the redevelopment of a portion of the Bergen Town Center. The interest-only loan has a rate of LIBOR plus 1.50% (4.11% at June 30, 2008) and matures in March 2011 with two one-year extension options. As of June 30, 2008, $158,000,000 was drawn under this loan.

 

On March 27, 2008, we closed a construction loan providing up to $124,000,000 to finance the redevelopment of 1999 K Street. The interest-only loan has a rate of LIBOR plus 1.30% (3.77% at June 30, 2008) and matures in December 2010 with two 6-month extension options. As of June 30, 2008, $31,000,000 was drawn under this loan.

 

 

 

Overview - continued

The following table sets forth certain information for the properties we own directly or indirectly, including leasing activity. The leasing activity presented below is based on leases signed during the period and is not intended to coincide with the commencement of rental revenue recognition in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Tenant improvements and leasing commissions are presented below based on square feet leased during the period, on a per square foot and per square foot per annum basis based on weighted average lease terms and as a percentage of initial rent per square foot.

 

 

 

Overview (continued)

 

 

_______________________________

 

 

Overview - continued

 

Recently Issued Accounting Literature

 

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosures about fair value measurements. SFAS 157 was effective for our financial assets and liabilities on January 1, 2008.  The FASB has deferred the implementation of the provisions of SFAS 157 relating to certain non-financial assets and liabilities until January 1, 2009. This standard did not materially affect how we determine fair value, but resulted in certain additional disclosures. SFAS 157 establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three levels: Level 1 – quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities; Level 2 – observable prices that are based on inputs not quoted in active markets, but corroborated by market data; and Level 3 – unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the highest priority to Level 1 inputs and the lowest priority to Level 3 inputs. In determining fair value, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible as well as consider counterparty credit risk in our assessment of fair value. Financial assets and liabilities measured at fair value in our consolidated financial statements consist of (i) marketable equity securities–available for sale, (ii) derivative positions in marketable equity securities and (iii) the assets of our officers’ deferred compensation plan (primarily marketable equity securities and equity investments in partially owned entities), for which there is a corresponding liability on our consolidated balance sheet. Financial assets and liabilities carried at fair value as of June 30, 2008 are presented in the table below based on the hierarchy used to measure fair value:

 

___________________

 

In September 2006, the FASB issued Statement No. 158, Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans, an Amendment of SFAS No. 87, 88, 106 and 132R (“SFAS 158”). SFAS 158 requires an employer to (i) recognize in its statement of financial position an asset for a plan’s over-funded status or a liability for a plan’s under-funded status; (ii) measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year (with limited exceptions); and (iii) recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur. Those changes will be reported in comprehensive income. The adoption of the requirement to recognize the funded status of a benefit plan and the disclosure requirements as of December 31, 2006 did not have a material effect on our consolidated financial statements. The requirement to measure plan assets and benefit obligations to determine the funded status as of the end of the fiscal year and to recognize changes in the funded status in the year in which the changes occur is effective on January 1, 2009. The adoption of the measurement date provisions of this standard is not expected to have a material effect on our consolidated financial statements.

 

In February 2007, the FASB issued SFAS 159, which permits companies to measure many financial instruments and certain other items at fair value.  SFAS 159 was effective on January 1, 2008. We have not elected the fair value option for any of our existing financial instruments on the effective date and have not determined whether we will elect this option for any eligible financial instruments we acquire in the future.

 

Overview - continued

 

Recently Issued Accounting Literature - continued

 

In December 2007, the FASB issued Statement No. 141R, Business Combinations (“SFAS 141R”). SFAS 141R broadens the guidance of SFAS 141, extending its applicability to all transactions and other events in which one entity obtains control over one or more other businesses. SFAS 141R also broadens the fair value measurement and recognition of assets acquired, liabilities assumed, and interests transferred as a result of business combinations; and stipulates that acquisition related costs be expensed rather than included as part of the basis of the acquisition. SFAS 141R expands required disclosures to improve the ability to evaluate the nature and financial effects of business combinations. SFAS 141R is effective for all transactions entered into on or after January 1, 2009. The adoption of this standard on January 1, 2009 could materially impact our future financial results to the extent that we acquire significant amounts of real estate, as related acquisition costs will be expensed as incurred compared to our current practice of capitalizing such costs and amortizing them over the estimated useful life of the assets acquired.

 

In December 2007, the FASB issued Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements - An Amendment of ARB No. 51 (“SFAS 160”). SFAS 160 requires a noncontrolling interest in a subsidiary to be reported as equity and the amount of consolidated net income specifically attributable to the noncontrolling interest to be identified in the consolidated financial statements. SFAS 160 also calls for consistency in the manner of reporting changes in the parent’s ownership interest and requires fair value measurement of any noncontrolling equity investment retained in a deconsolidation. SFAS 160 is effective on January 1, 2009. We are currently evaluating the impact SFAS 160 will have on our consolidated financial statements.

 

In March 2008, the FASB issued Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities – an Amendment of FASB Statement No. 133 (“SFAS 161”). SFAS 161 requires enhanced disclosures related to derivative instruments and hedging activities, including disclosures regarding how an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, and the impact of derivative instruments and related hedged items on an entity’s financial position, financial performance and cash flows. SFAS 161 is effective on January 1, 2009. We believe that the adoption of this standard on January 1, 2009 will not have a material effect on our consolidated financial statements.

 

In May 2008, the FASB issued Staff Position No. APB 14-1, Accounting for Convertible Debt Instruments that may be Settled in Cash upon Conversion (Including Partial Cash Settlement), (the “FSP”). The adoption of this FSP would affect the accounting for our convertible and exchangeable senior debentures and Series D-13 convertible preferred units. The FSP would require the initial proceeds from the sale of our convertible and exchangeable senior debentures and Series D-13 convertible preferred units to be allocated between a liability component and an equity component. The resulting discount would be amortized using the effective interest method over the period the debt is expected to remain outstanding as additional interest expense. The FSP would be effective for our fiscal year beginning on January 1, 2009 and require retroactive application. The adoption of the FSP on January 1, 2009 would result in the recognition of an aggregate unamortized debt discount of $161,259,000 (as of June 30, 2008) on our consolidated balance sheet and additional interest expense on our consolidated statements of income. Our current estimate of the incremental interest expense, net of minority interest, for each reporting period is as follows:

 

 

 

 

 

 

 

 

 

Overview - continued

 

Recently Issued Accounting Literature - continued

 

In May 2008, the FASB issued Statement No. 162, The Hierarchy of Generally Accepted Accounting Principles (“SFAS 162”). The purpose of this statement is to improve financial reporting by providing a consistent framework for determining applicable accounting principles to be used in the preparation of financial statements presented in conformity with GAAP. SFAS 162 will become effective 60 days after the SEC’s approval. We believe that the adoption of this standard on its effective date will not have a material effect on our consolidated financial statements.

 

In May 2008, the FASB issued Statement No. 163, Accounting for Financial Guarantee Insurance Contracts (“SFAS 163”). SFAS 163 was issued to decrease inconsistencies within Statement No. 60, Accounting and Reporting by Insurance Enterprises, and clarify how it applies to financial guarantee insurance contracts issued by insurance enterprises, including the recognition of premium revenue and claim liabilities. SFAS 163 also requires expanded disclosures about financial guarantee insurance contracts. SFAS 163 is effective on January 1, 2009. We believe that the adoption of this standard on January 1, 2009 will not have any effect on our consolidated financial statements.

 

 

Net Income and EBITDA by Segment for the Three Months Ended June 30, 2008 and 2007

 

Below is a summary of net income and a reconciliation of net income to EBITDA⁽¹⁾ by segment for the three months ended June 30, 2008 and 2007.

 

 

The Washington, DC Office segment includes a $56,831 net gain on sale of real estate (included in “Income (loss) from discontinued operations, net”). The Other segment EBITDA includes a $3,468 net loss on the mark-to-market of derivative instruments, a $2,038 net gain on disposition of our 13.8% interest in GMH and a $726 write-off for costs of acquisitions not consummated.

 

___________________

See notes on page 45.

 

Net Income and EBITDA by Segment for the Three Months Ended June 30, 2008 and 2007 - continued

 

 

The Other segment EBITDA includes a $72,074 net gain on mark-to-market of derivative instruments, a $15,778 net gain on sale of marketable equity securities and $1,677 for our share of India real estate ventures organization costs.

 

______________________________

See notes on following page.

 

 

Net Income and EBITDA by Segment for the Three Months Ended June 30, 2008 and 2007 - continued

 

Notes to preceding tabular information:

 

 

 

 

 

 

Results of Operations – Three Months Ended June 30, 2008 Compared to June 30, 2007

 

Revenues

Our revenues, which consist of property rentals, tenant expense reimbursements, hotel revenues, trade shows revenues, amortization of acquired below market leases, and fee income, were $674,365,000 for the quarter ended June 30, 2008, compared to $583,220,000 in the prior year’s first quarter, an increase of $91,145,000. Below are the details of the increase (decrease) by segment:

 

 

______________________________

 

 

 

 

 

Results of Operations – Three Months Ended June 30, 2008 Compared to June 30, 2007 (continued)

 

Expenses

Our expenses, which consist of operating, depreciation and amortization and general and administrative expenses, were $438,317,000 for the quarter ended June 30, 2008, compared to $387,769,000 in the prior year’s quarter, an increase of $50,548,000. Below are the details of the increase (decrease) by segment:

 

 

______________________________

 

 

 

 

 

Results of Operations – Three Months Ended June 30, 2008 Compared to June 30, 2007 (continued)

 

Income Applicable to Alexander’s

 

Our 32.6% share of Alexander’s net income (comprised of equity in net income, management, leasing, and development fees) was $15,351,000 for the three months ended June 30, 2008, compared to $9,484,000 for the prior year’s first quarter, an increase of $5,867,000. This increase was primarily due to $7,157,000 of income for our share of the reversal of accrued stock appreciation rights compensation expense in the current quarter, compared to $1,222,000 for our share of such income in the prior year’s quarter.

 

Loss Applicable to Toys

 

Our 32.7% share of Toys’ net loss (comprised of equity in net loss, interest income on loans receivable, and management fees) was $30,711,000 for the three months ended June 30, 2008, or $30,908,000 before our share of Toys’ income tax benefit, compared to $20,029,000, or $34,963,000 before our share of Toys’ income tax benefit for the prior year’s quarter.

 

Toys prepares its consolidated financial statements using the historical cost basis (“Recap basis”) of accounting. We account for our investment in Toys on the purchase accounting basis. In July 2008, in connection with an audit of Toys’ purchase accounting basis financial statements for its fiscal years 2006 and 2007, it was determined that the purchase accounting basis income tax expense was understated. Our share of this non-cash charge is $14,900,000, which we recognized as part of our equity in Toys’ net loss in the three months ended June 30, 2008. This non-cash charge has no effect on cash actually paid for income taxes or Toys’ previously issued Recap basis consolidated financial statements.

Historically, Toys’ fourth quarter net income, which we recorded on a lag basis in our first quarter, accounts for more than 80% of Toys’ fiscal year net income.

 

 

Results of Operations – Three Months Ended June 30, 2008 Compared to June 30, 2007 (continued)

 

Income (Loss) from Partially Owned Entities

Summarized below are the components of income (loss) from partially owned entities for the three months ended June 30, 2008 and 2007.

________________________

 

 

 

 

 

 

 

 

 

Results of Operations – Three Months Ended June 30, 2008 Compared to June 30, 2007 (continued)

 

Interest and Other Investment Income

Interest and other investment income (mark-to-market of derivative positions, interest income on mortgage loans receivable, other interest income and dividend income) was $23,793,000 for the three months ended June 30, 2008, compared to $119,689,000 in the prior year’s quarter, a decrease of $95,896,000. This decrease resulted primarily from:

 

 

Interest and Debt Expense

Interest and debt expense was $150,316,000 in the three months ended June 30, 2008, compared to $140,293,000 in the prior year’s quarter, an increase of $10,023,000. This increase resulted primarily from $19,966,000 of interest expense on $929,811,000 of debt resulting from property acquisitions and refinancings subsequent to the second quarter of 2007, partially offset by reductions in interest expense of (i) $4,095,000 as a result of repaying the $500 million senior unsecured debentures in May 2007, (ii) $3,586,000 due to a 2.77% decrease in weighted average interest rates on our variable rate debt, and (iii) $2,622,000 of higher capitalized interest due to a larger amount of assets under development.

 

Net Gains on Disposition of Wholly Owned and Partially Owned Assets Other than Depreciable Real Estate

Net gains on disposition of wholly owned and partially owned assets other than depreciable real estate was $3,386,000 in the three months ended June 30, 2008, compared to $15,778,000 in the three months ended June 30, 2007. The three months ended June 30, 2008 includes a $2,038,000 net gain on disposition of our 13.8% interest in GMH and net gains on sale of marketable securities. The three months ended June 30, 2007 represents net gains on sale of marketable securities.

 

Minority Interest of Partially Owned Entities

Minority interest of partially owned entities was income of $1,837,000 in the six months ended June 30, 2008, compared to income of $1,346,000 in the prior year’s three months and represents the minority partners’ pro rata share of the net loss of consolidated partially owned entities, including 1290 Avenue of the Americas, 555 California Street, 220 Central Park South, Wasserman and the Springfield Mall.

 

Income Tax Expense

Income tax expense was $4,915,000 in the quarter ended June 30, 2008, compared to $2,508,000 in the prior year’s quarter, an increase of $2,407,000. This increase was primarily due to the acquisitions of 1290 Avenue of the Americas and 555 California Street in May 2007.

 

 

 

Results of Operations – Three Months Ended June 30, 2008 Compared to June 30, 2007 (continued)

 

Discontinued Operations  

The combined results of discontinued operations for the three months ended June 30, 2008 and 2007 include the operating results of Tysons Dulles Plaza, which was sold on June 10, 2008; Americold, which was sold on March 31, 2008; 19.6 acres of land we acquired as part of our acquisition of H Street, of which 11 acres were sold in September 2007; Vineland, New Jersey, which was sold on July 16, 2007; Crystal Mall Two, which was sold on August 9, 2007; and Arlington Plaza, which was sold on October 17, 2007.

 

 

Minority Limited Partners’ Interest in the Operating Partnership

Minority limited partners’ interest in the Operating Partnership was $7,285,000 in the three months ended June 30, 2008, compared to $16,852,000 in the prior year’s quarter, a decrease of $9,567,000. This decrease results primarily from lower net income subject to allocation to the minority limited partners.

 

Perpetual Preferred Unit Distributions of the Operating Partnership

Perpetual preferred unit distributions of the Operating Partnership were $4,818,000 in the three months ended June 30, 2008, compared to $4,819,000 in the prior year’s quarter.

 

Preferred Share Dividends

Preferred share dividends were $14,274,000 in the three months ended June 30, 2008, compared to $14,295,000 in the prior year’s quarter.

 

 

Results of Operations – Three Months Ended June 30, 2008 Compared to June 30, 2007 (continued)

 

EBITDA by Segment

Below are the details of the changes in EBITDA by segment for the three months ended June 30, 2008 from the three months ended June 30, 2007.

 

 

__________________________

 

 

 

Net Income and EBITDA by Segment for the Six Months Ended June 30, 2008 and 2007

 

Below is a summary of net income and a reconciliation of net income to EBITDA⁽¹⁾ by segment for the six months ended June 30, 2008 and 2007.

 

 

The Washington, DC Office segment includes a $222,174 reduction in income tax expense resulting from a reversal of deferred tax liabilities in connection with the acquisition of H Street, and a $56,831 net gain on sale of real estate (included in “Income (loss) from discontinued operations, net”). The Other segment EBITDA includes, a $112,690 net gain on sale of our 47.6% interest in Americold (included in “Income (loss) from discontinued operations, net”), a $34,200 write-off of pre-development costs, a $21,830 net loss on the mark-to-market of derivative instruments, a $10,300 reversal of a mezzanine loan loss accrual, a $9,073 impairment loss on a marketable equity security, a $3,009 write-off for costs of acquisitions not consummated and a $2,038 net gain on disposition of our 13.8% interest in GMH.

___________________

See notes on page 55.

 

Net Income and EBITDA by Segment for the Six Months Ended June 30, 2008 and 2007 - continued

 

 

The Washington, DC Office segment includes $1,891 of expense for H Street litigation costs. The Other segment EBITDA includes a net gain of $81,451 on the mark-to-market of derivative instruments, a $16,687 net gain on sale of marketable equity securities, an $8,807 write-off for costs of acquisition not consummated and $1,677 for our share of India real estate ventures organization costs.

 

______________________________

See notes on following page.

 

Net Income and EBITDA by Segment for the Six Months Ended June 30, 2008 and 2007 - continued

 

Notes to preceding tabular information:

 

 

 

 

 

 

Results of Operations – Six Months Ended June 30, 2008 Compared to June 30, 2007 - continued

 

Revenues

Our revenues, which consist of property rentals, tenant expense reimbursements, hotel revenues, trade shows revenues, amortization of acquired below market leases, net of above market leases, and fee income, were $1,323,647,000 for the six months ended June 30, 2008, compared to $1,116,272,000 in the prior year’s six months, an increase of $207,375,000. Below are the details of the increase (decrease) by segment:

 

 

______________________________

 

 

 

 

 

Results of Operations – Six Months Ended June 30, 2008 Compared to June 30, 2007 - continued

 

Expenses

Our expenses, which consist of operating, depreciation and amortization and general and administrative expenses, were $881,846,000 for the six months ended June 30, 2008, compared to $736,892,000 in the prior year’s six months, an increase of $144,954,000. Below are the details of the increase (decrease) by segment:

 

 

______________________________

 

 

 

 

 

Results of Operations – Six Months Ended June 30, 2008 Compared to June 30, 2007 - continued

 

Income Applicable to Alexander’s

 

Our 32.6% share of Alexander’s net income (comprised of equity in net income, management, leasing, and development fees) was $23,280,000 for the six months ended June 30, 2008, compared to $23,003,000 for the prior year’s six months, an increase of $277,000.

 

Income Applicable to Toys

 

Our 32.7% share of Toys’ net income (comprised of equity in net income, interest income on loans receivable, and management fees) was $49,651,000 for the six months ended June 30, 2008, or $143,373,000 before our share of Toys’ income tax expense, compared to $38,632,000, or $77,095,000 before our share of Toys’ income tax expense for the prior year’s six months. Toys prepares its consolidated financial statements using the historical cost basis (“Recap basis”) of accounting. We account for our investment in Toys on the purchase accounting basis. In July 2008, in connection with an audit of Toys’ purchase accounting basis financial statements for its fiscal years 2006 and 2007, it was determined that the purchase accounting basis income tax expense was understated. Our share of this non-cash charge is $14,900,000, which we recognized as part of our equity in Toys’ net loss in the three months ended June 30, 2008. This non-cash charge has no effect on cash actually paid for income taxes or Toys’ previously issued Recap basis consolidated financial statements.

(Loss) Income from Partially Owned Entities

Summarized below are the components of (loss) income from partially owned entities for the six months ended June 30, 2008 and 2007.

________________________

 

 

 

Results of Operations – Six Months Ended June 30, 2008 Compared to June 30, 2007 - continued

 

Interest and Other Investment Income

Interest and other investment income (mark-to-market of derivative positions, interest income on mortgage loans receivable, other interest income and dividend income) was $37,897,000 in the six months ended June 30, 2008, compared to $173,193,000 in the prior year’s six months, a decrease of $135,296,000. This decrease resulted primarily from:

 

 

On June 5, 2007, we acquired a 42% interest in two MPH mezzanine loans totaling $158,700,000, for $66,000,000 in cash. The loans, which were due on February 8, 2008 and have not been repaid, are subordinate to $2.9 billion of mortgage and other debt and secured by the equity interests in four New York City properties: Worldwide Plaza, 1540 Broadway office condominium, 527 Madison Avenue and Tower 56. As of December 31, 2007, we reduced the net carrying amount of the loans to $9,000,000 by recognizing a $57,000,000 non-cash charge which is included as a reduction of “interest and other investment income” on our consolidated statement of income. On April 2, 2008, we sold a sub-participation interest in the loans for $19,300,000. The sub-participation did not meet the criteria for sale accounting under Statement of Financial Accounting Standard No. 140 Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“SFAS 140”) because the sub-participant is not free to pledge or exchange the asset. In the first quarter of 2008, we reduced our valuation allowance from $57,000,000 to $46,700,000, resulting in the recognition of $10,300,000 of “interest and other investment income” in our consolidated statement of income in the six months ended June 30, 2008.

 

Interest and Debt Expense

Interest and debt expense was $298,495,000 in the six months ended June 30, 2008, compared to $270,991,000 in the prior year’s six months, an increase of $27,504,000. This increase resulted primarily from $45,632,000 of interest expense on $929,811,000 of debt resulting from property acquisitions and refinancings subsequent to the first half of 2007, partially offset by $9,177,000 of higher capitalized interest related to a larger amount of assets under development, and $5,771,000 as a result of debt extinguishments in 2007.

 

Net Gains on Disposition of Wholly Owned and Partially Owned Assets Other than Depreciable Real Estate

Net gains on disposition of wholly owned and partially owned assets other than depreciable real estate was $3,386,000 in the six months ended June 30, 2008, compared to $16,687,000 in the six months ended June 30, 2007. The six months ended June 30, 2008 includes a $2,038,000 net gain on disposition of our 13.8% interest in GMH and net gains on sale of marketable securities. The six months ended June 30, 2007 represents net gains on sale of marketable securities.

 

Minority Interest of Partially Owned Entities

Minority interest of partially owned entities was income of $2,243,000 in the six months ended June 30, 2008, compared to income of $1,696,000 in the prior years six months and represents the minority partners’ pro rata share of the net income or loss of consolidated partially owned entities, including 1290 Avenue of the Americas, 555 California Street, 220 Central Park South, Wasserman and the Springfield Mall.

 

 

 

Results of Operations – Six Months Ended June 30, 2008 Compared to June 30, 2007 - continued

 

Income Tax Benefit / Expense

In the six months ended June 30, 2008, we had an income tax benefit of $212,414,000, compared to an expense of $2,597,000 in the prior year’s six months, a decrease of $215,011,000. The decrease results from $222,174,000 for the reversal of deferred taxes recorded in connection with the acquisition of H Street. We were required to record these deferred tax liabilities because H Street and its partially owned entities were operated as C Corporations at the time they were acquired. As of January 16, 2008, we had completed all of the actions necessary to enable these entities to elect REIT status effective for the tax year beginning on January 1, 2008. Consequently, in the first quarter of 2008, we reversed the deferred tax liabilities and recognized an income tax benefit of $222,174,000 in our consolidated statement of income.

 

Discontinued Operations (including $112,690,000 net gain on sale of Americold in 2008)

The combined results of discontinued operations for the six months ended June 30, 2008 and 2007 include the operating results of Tysons Dulles Plaza, which was sold on June 10, 2008; Americold, which was sold on June 30, 2008; 19.6 acres of land we acquired as part of our acquisition of H Street, of which 11 acres were sold in September 2007; Vineland, New Jersey, which was sold on July 16, 2007; Crystal Mall Two, which was sold on August 9, 2007; and Arlington Plaza, which was sold on October 17, 2007.

 

 

Minority Limited Partners’ Interest in the Operating Partnership

Minority limited partners’ interest in the Operating Partnership was $38,955,000 in the six months ended June 30, 2008, compared to $34,029,000 in the prior year’s six months, an increase of $4,926,000. This increase results primarily from higher net income subject to allocation to the minority limited partners.

 

Perpetual Preferred Unit Distributions of the Operating Partnership

Perpetual preferred unit distributions of the Operating Partnership were $9,637,000 in the six-month periods ended June 30, 2008 and 2007.

 

Preferred Share Dividends

Preferred share dividends were $28,549,000 in the six months ended June 30, 2008, compared to $28,591,000 in the prior year’s six months.

 

Results of Operations – Six Months Ended June 30, 2008 Compared to June 30, 2007 - continued

 

EBITDA by Segment

Below are the details of the changes in EBITDA by segment for the six months ended June 30, 2008 from the six months ended June 30, 2007.

 

 

__________________________

 

 

LIQUIDITY AND CAPITAL RESOURCES

 

We may from time to time seek to purchase or retire our outstanding debt securities though cash purchases and/or exchanges for our equity securities, in open market purchases, privately negotiated transactions or otherwise. Such purchases and/or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements and other factors. The amounts involved in connection with these transactions could be material to our consolidated financial statements.

 

Cash Flows for the Six Months Ended June 30, 2008

Property rental income is our primary source of cash flow and is dependent upon the occupancy and rental rates of our properties. Other sources of liquidity to fund our cash requirements include proceeds from debt financings, including mortgage loans and corporate level unsecured borrowings; our $2.6 billion revolving credit facility; proceeds from the issuance of common and preferred equity; and asset sales. Our cash requirements include property operating expenses, capital improvements, tenant improvements, leasing commissions, distributions to our common and preferred shareholders, as well as acquisition and development costs. Our cash and cash equivalents were $1,712,032,000 at June 30, 2008, a $557,437,000 increase over the balance at December 31, 2007. This increase resulted from $453,516,000 of net cash provided by operating activities $68,758,000 of net cash provided by financing activities and $35,163,000 of net cash provided by investing activities. Property rental income represents our primary source of net cash provided by operating activities.

 

Our consolidated outstanding debt was $12,219,332,000 at June 30, 2008, a $323,294,000 increase over the balance at December 31, 2007. This increase resulted primarily from debt associated with property refinancings during the current quarter. As of June 30, 2008 and December 31, 2007, $0 and $405,656,000, respectively, was outstanding under our revolving credit facilities. During 2008 and 2009, $58,057,000 and $421,019,000 of our outstanding debt matures, respectively. We may refinance such debt or choose to repay all or a portion, using existing cash balances or our revolving credit facilities.

 

Our share of debt of unconsolidated subsidiaries was $2,998,810,000 at June 30, 2008, a $291,063,000 decrease from the balance at December 31, 2007. This resulted primarily from a decrease in our share of Toys “R” Us outstanding debt of $187,135,000 and $137,722,000 resulting from the disposition of our 13.8% interest in GMH.

 

Cash flows provided by operating activities of $453,516,000 was primarily comprised of (i) net income of $551,857,000, net of $132,282,000 of non-cash adjustments, including depreciation and amortization expense, the effect of straight-lining of rental income, equity in net income of partially owned entities, minority interest expense, (ii) distributions of income from partially owned entities of $20,051,000, and (iii) the net change in operating assets and liabilities of $13,890,000.

 

Net cash provided by investing activities of $35,163,000 were primarily comprised of (i) proceeds from the sale of real estate and investments (primarily Americold and Tysons Dulles Plaza) of $350,591,000, (ii) distributions of capital from partially owned entities of $140,069,000 and (iii) proceeds received from repayments on mortgage loans receivable of $50,951,000, partially offset by, (iv) development and redevelopment expenditures of $253,159,000, (v) investments in partially owned entities of $96,277,000, (vi) additions to real estate of $97,804,000, (vii) acquisitions of real estate and related investments of $32,484,000 and (viii) investments in notes and mortgage loans receivable of $7,397,000.

 

Net cash provided by financing activities of $68,758,000 was primarily comprised of (i) proceeds from borrowings of $1,215,500,000, partially offset by, (ii) repayments of borrowings of $793,599,000, (iii) dividends paid on common shares of $276,478,000, (iv) distributions to minority partners of $47,083,000 and (v) dividends paid on preferred shares of $28,567,000.

 

Capital Expenditures

Capital expenditures are categorized as follows:

 

Recurring -- capital improvements expended to maintain a property’s competitive position within the market and tenant improvements and leasing commissions for costs to re-lease expiring leases or renew or extend existing leases.

 

Non-recurring -- capital improvements completed in the year of acquisition and the following two years which were planned at the time of acquisition and tenant improvements and leasing commissions for space which was vacant at the time of acquisition of a property.

 

Development and redevelopment expenditures include all hard and soft costs associated with the development or redevelopment of a property, including tenant improvements, leasing commissions and capitalized interest and operating costs until the property is substantially complete and ready for its intended use.

 

 

LIQUIDITY AND CAPITAL RESOURCES - continued

 

Below are the details of capital expenditures, leasing commissions and development and redevelopment expenditures and a reconciliation of total expenditures on an accrual basis to the cash expended in the six months ended June 30, 2008.

 

_______________________

 

 

 

LIQUIDITY AND CAPITAL RESOURCES - CONTINUED

 

Cash Flows for the Six Months Ended June 30, 2007

 

Our cash and cash equivalents were $743,506,000 at June 30, 2007, a $1,489,811,000 decrease over the balance at December 31, 2006. This decrease resulted from $3,166,571,000 of net cash used in investing activities, partially offset by, $1,377,322,000 of net cash provided by financing activities and $299,438,000 of net cash provided by operating activities. Property rental income represents our primary source of net cash provided by operating activities.

 

Our consolidated outstanding debt was $12,572,462,000 at June 30, 2007, a $3,017,664,000 increase over the balance at December 31, 2006. This increase resulted primarily from the issuance of $1.4 billion of convertible senior debentures due 2027 and from mortgage debt associated with asset acquisitions and property refinancings during the current quarter. As of June 30, 2007 and December 31, 2006, our revolving credit facility had a $94,000,000 balance and a zero outstanding balance, respectively.

 

Our share of debt of unconsolidated subsidiaries was $2,989,235,000 at June 30, 2007, a $333,772,000 decrease from the balance at December 31, 2006. This decrease resulted primarily from our $351,302,000 share of Toys’ decrease in outstanding debt.

 

Cash flows provided by operating activities of $299,438,000 was primarily comprised of (i) net income of $332,851,000, after adjustments of $55,919,000 for non-cash items, including depreciation and amortization expense, net gains from derivative positions, the effect of straight-lining of rental income, equity in net income of partially owned entities, minority interest expense, and (ii) distributions of income from partially owned entities of $11,767,000, partially offset by (iii) the net change in operating assets and liabilities of $101,099,000.

 

Net cash used in investing activities of $3,166,571,000 was primarily comprised of (i) acquisitions of real estate of $2,585,928,000, (ii) investments in notes and mortgage loans receivable of $204,914,000, (iii) deposits in connection with real estate acquisitions and pre-acquisition costs of $20,691,000, (iv) investments in partially owned entities of $166,611,000, (v) development and redevelopment expenditures of $140,253,000, and (vi) investments in marketable securities of $151,024,000, partially offset by (vii) proceeds received from repayments on mortgage loans receivable of $113,291,000.

 

Net cash provided by financing activities of $1,377,322,000 was primarily comprised of (i) proceeds from borrowings of $2,510,217,000, of which $1,372,000,000 were proceeds received from the offering of the 2.85% convertible senior debentures due 2027, partially offset by, (ii) repayments of borrowings of $714,873,000, (iii) dividends paid on common shares of $257,943,000, (iv) purchases of marketable securities in connection with the legal defeasance of mortgage notes payable of $86,653,000, (v) distributions to minority partners of $41,929,000, and (vi) dividends paid on preferred shares of $28,645,000.

 

 

 

 

LIQUIDITY AND CAPITAL RESOURCES - continued

Capital Expenditures

 

Below are the details of capital expenditures, leasing commissions and development and redevelopment expenditures and a reconciliation of total expenditures on an accrual basis to the cash expended in the six months ended June 30, 2007.

 

___________________________

 

 

SUPPLEMENTAL INFORMATION

 

Three Months Ended June 30, 2008 vs. Three Months Ended March 31, 2008

Our revenues and expenses are subject to seasonality during the year which impacts quarter-by-quarter net earnings, cash flows and funds from operations. The business of Toys is highly seasonal. Historically, Toys’ fourth quarter net income, which we recorded on a one-quarter lag basis in our first quarter, accounts for more than 80% of Toys’ fiscal year net income. The Office and Merchandise Mart segments have historically experienced higher utility costs in the first and third quarters of the year. The Merchandise Mart segment also has experienced higher earnings in the second and fourth quarters of the year due to major trade shows occurring in those quarters.

 

Below are the details of the changes in EBITDA by segment for the three months ended June 30, 2008 from the three months ended March 31, 2008.

 

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The following table reconciles net income to EBITDA for the quarter ended March 31, 2008.

 

 

 

 

FUNDS FROM OPERATIONS (“FFO”)

 

FFO is computed in accordance with the definition adopted by the Board of Governors of the National Association of Real Estate Investment Trusts (“NAREIT”). NAREIT defines FFO as net income or loss determined in accordance with GAAP, excluding extraordinary items as defined under GAAP and gains or losses from sales of previously depreciated operating real estate assets, plus specified non-cash items, such as real estate asset depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. FFO and FFO per diluted share are used by management, investors and industry analysts as supplemental measures of operating performance of equity REITs. FFO and FFO per diluted share should be evaluated along with GAAP net income and income per diluted share (the most directly comparable GAAP measures), as well as cash flow from operating activities, investing activities and financing activities, in evaluating the operating performance of equity REITs. Management believes that FFO and FFO per diluted share are helpful to investors as supplemental performance measures because these measures exclude the effect of depreciation, amortization and gains or losses from sales of real estate, all of which are based on historical costs which implicitly assumes that the value of real estate diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, these non-GAAP measures can facilitate comparisons of operating performance between periods and among other equity REITs. FFO does not represent cash generated from operating activities in accordance with GAAP and is not necessarily indicative of cash available to fund cash needs as disclosed in Our Statements of Cash Flows. FFO should not be considered as an alternative to net income as an indicator of our operating performance or as an alternative to cash flows as a measure of liquidity. The calculations of both the numerator and denominator used in the computation of income per share are disclosed in footnote 10 – Income Per Share, in the notes to our consolidated financial statements on page 22 of this Quarterly Report on Form 10-Q.

 

FFO for the Three and Six Months Ended June 30, 2008, and 2007

 

FFO applicable to common shares plus assumed conversions was $208,260,000, or $1.27 per diluted share for the three months ended June 30, 2008, compared to $281,741,000, or $1.72 per diluted share in the prior year’s quarter. FFO applicable to common shares plus assumed conversions was $743,471,000 or $4.54 per diluted share, for the six months ended June 30, 2008, compared to $551,906,000, or $3.36 per diluted share, for the prior year’s six months. Details of certain items that affect comparability are discussed in the financial results summary of our “Overview.”

 

 

 

 

We have exposure to fluctuations in market interest rates. Market interest rates are sensitive to many factors that are beyond our control. Our exposure to a change in interest rates on our consolidated and non-consolidated debt (all of which arises out of non-trading activity) is as follows:

 

 

We may utilize various financial instruments to mitigate the impact of interest rate fluctuations on our cash flows and earnings, including hedging strategies, depending on our analysis of the interest rate environment and the costs and risks of such strategies. As of June 30, 2008, variable rate debt with an aggregate principal amount of $410,998,000 and a weighted average interest rate of 3.80% was subject to LIBOR caps. These caps are based on a notional amount of $412,000,000 and cap LIBOR at a weighted average rate of 6.34%. As of June 30, 2008, we have investments in mezzanine loans with an aggregate carrying amount of $99,788,000 that are based on variable interest rates which partially mitigate our exposure to a change in interest rates on our variable rate debt.

 

Fair Value of Debt

 

As of June 30, 2008, the carrying amount of our debt exceeds its aggregate fair value by approximately $168,803,000, based on discounted cash flows at the current rate at which similar loans would be made to borrowers with similar credit ratings for the remaining term of such debt.

 

Derivative Instruments in Marketable Equity Securities

 

We have, and may in the future enter into, derivative positions in marketable equity securities that do not qualify for hedge accounting treatment. Because these derivatives do not qualify for hedge accounting treatment, the gains or losses resulting from their mark-to-market at the end of each reporting period are recognized as an increase or decrease in “interest and other investment income” on our consolidated statements of income. In addition, we are, and may in the future be, subject to additional expense based on the notional amount of the derivative positions and a specified spread over LIBOR. Because the market value of these instruments can vary significantly between periods, we may experience significant fluctuations in the amount of our investment income or expense.

 

During the three and six months ended June 30, 2008 we recognized net losses of $3,468,000 and $21,830,000, respectively, and during the three and six months ended June 30, 2007 we recognized net gains of $72,074,000, and $81,454,000, respectively, after all expenses and LIBOR charges.

 

 

 

 

Disclosure Controls and Procedures: The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of June 30, 2008, such disclosure controls and procedures were effective.

 

Internal Control Over Financial Reporting: There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Securities and Exchange Act of 1934, as amended) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

 

We are from time to time involved in legal actions arising in the ordinary course of business. In our opinion, after consultation with legal counsel, the outcome of such matters, including the matters referred to below, are not expected to have a material adverse effect on our financial position, results of operations or cash flows.

 

Stop & Shop

On January 8, 2003, Stop & Shop filed a complaint with the United States District Court for the District of New Jersey (“USDC-NJ”) claiming that we had no right to reallocate and therefore continue to collect the $5,000,000 of annual rent from Stop & Shop pursuant to the Master Agreement and Guaranty, because of the expiration of the East Brunswick, Jersey City, Middletown, Union and Woodbridge leases to which the $5,000,000 of additional rent was previously allocated. Stop & Shop asserted that a prior order of the Bankruptcy Court for the Southern District of New York dated February 6, 2001, as modified on appeal to the District Court for the Southern District of New York on February 13, 2001, froze our right to re-allocate which effectively terminated our right to collect the additional rent from Stop & Shop. On March 3, 2003, after we moved to dismiss for lack of jurisdiction, Stop & Shop voluntarily withdrew its complaint. On March 26, 2003, Stop & Shop filed a new complaint in New York Supreme Court, asserting substantially the same claims as in its USDC-NJ complaint. We removed the action to the United States District Court for the Southern District of New York. In January 2005 that court remanded the action to the New York Supreme Court. On February 14, 2005, we served an answer in which we asserted a counterclaim seeking a judgment for all the unpaid additional rent accruing through the date of the judgment and a declaration that Stop & Shop will continue to be liable for the additional rent as long as any of the leases subject to the Master Agreement and Guaranty remain in effect. On May 17, 2005, we filed a motion for summary judgment. On July 15, 2005, Stop & Shop opposed our motion and filed a cross-motion for summary judgment. On December 13, 2005, the Court issued its decision denying the motions for summary judgment. Both parties appealed the Court’s decision and on December 14, 2006, the Appellate Court division issued a decision affirming the Court’s decision. On January 16, 2007, we filed a motion for the reconsideration of one aspect of the Appellate Court’s decision which was denied on March 13, 2007. We are currently engaged in discovery and anticipate that a trial date will be set for some time in 2008. We intend to vigorously pursue our claims against Stop & Shop. In our opinion, after consultation with legal counsel, the outcome of such matters will not have a material effect on our financial condition, results of operations or cash flows.

 

1290 Avenue of the Americas and 555 California Street

 

On May 24, 2007, we acquired a 70% controlling interest in 1290 Avenue of the Americas and the 555 California Street complex. Our 70% interest was acquired through the purchase of all of the shares of a group of foreign companies that own, through U.S. entities, the 1% sole general partnership interest and a 69% limited partnership interest in the partnerships that own the two properties. The remaining 30% limited partnership interest is owned by Donald J. Trump.

 

In August 2005, Mr. Trump brought a lawsuit in the New York State Supreme Court against, among others, the general partners of the partnerships referred to above.   Mr. Trump’s claims arose out of a dispute over the sale price of and use of proceeds from, the sale of properties located on the former Penn Central rail yards between West 59th and 72nd Streets in Manhattan which were formerly owned by the partnerships. In decisions dated September 14, 2005 and July 24, 2006, the Court denied various of Mr. Trump’s motions and ultimately dismissed all of Mr. Trump’s claims, except for his claim seeking access to books and records. In a decision dated October 1, 2007, the Court determined that Mr. Trump had already received access to the books and records to which he was entitled, with the exception of certain documents which were subsequently delivered to Mr. Trump. Mr. Trump has sought re-argument and renewal on, and filed a notice of appeal in connection with, his dismissed claims.  

 

In connection with the acquisition, we agreed to indemnify the sellers for liabilities and expenses arising out of Mr. Trump’s claim that the general partners of the partnerships we acquired did not sell the rail yards at a fair price or could have sold the rail yards for a greater price and any other claims asserted in the legal action; provided however, that if Mr. Trump prevails on certain claims involving partnership matters, other than claims relating to sale price, the sellers will be required to reimburse us for certain costs related to those claims. We believe that the claims relating to the sale price are without merit. All other allegations are not asserted as a basis for damages and regardless of merit would not be material to our consolidated financial statements.

 

Item 1A. Risk Factors

There were no material changes to the Risk Factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2007.

 

None.

 

None.

 

On May 15, 2008, we held our annual meeting of shareholders. The shareholders voted on the following matters: (i) the election of four nominees to serve on the Board of Trustees for a three-year term and until their respective successors are duly elected and qualified, (ii) the ratification of the selection of independent auditors with regard to the current fiscal year and (iii) a shareholder proposal requesting that the Board of Trustees initiate the appropriate process to amend the Company’s governance documents to provide that trustee nominees be elected by an affirmative vote of the majority of votes cast at the annual meeting of shareholders, with a plurality vote standard retained for contested trustee elections, that is, when the number of trustee nominees exceeds the number of board seats. The results of the voting are shown below:

 

 

In addition to the four Trustees re-elected, Steven Roth, Michael D. Fascitelli, Russell B. Wight, Jr., Robert P. Kogod, David Mandelbaum, Dr. Richard West and Candace K. Beinecke continue to serve as Trustees after the meeting.

 

Because of the nature of the above elections, there were no broker non-votes.

 

None.

 

Exhibits required by Item 601 of Regulation S-K are filed herewith or incorporated herein by reference and are listed in the attached Exhibit Index.

 

 

 

 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

EXHIBIT INDEX