UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 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, accelerated filer, or a non-accelerated filer.

See definitions of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

x Large Accelerated Filer         o Accelerated Filer         o Non-Accelerated Filer

 

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 September 30, 2007, 152,264,185 of the registrant’s common shares of beneficial interest are outstanding.

 

 

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2

 

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VORNADO REALTY TRUST

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

 

 

See notes to consolidated financial statements.

 

3

 

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VORNADO REALTY TRUST

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

 

 

See notes to consolidated financial statements.

 

4

 

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VORNADO REALTY TRUST

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

 

 

See notes to consolidated financial statements.

 

5

 

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VORNADO REALTY TRUST

CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED

(UNAUDITED)

 

 

 

See notes to consolidated financial statements.

 

6

 

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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 90.0% of the common limited partnership interest in, the Operating Partnership at September 30, 2007.

 

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 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 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, 2006, as filed with the Securities and Exchange Commission. The results of operations for the three and nine months ended September 30, 2007, 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. We consolidate our 47.6% investment in AmeriCold Realty Trust because we have the contractual right to appoint three out of five members of its Board of Trustees, and therefore determined that we have a controlling interest. 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 provision for income taxes have been reclassified in order to conform to current year presentation.

 

 

7

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

In July 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 establishes new evaluation and measurement processes for all income tax positions taken. FIN 48 also requires expanded disclosures of income tax matters. The adoption of this standard on January 1, 2007 did not have a material effect on our consolidated financial statements.

 

In September 2006, the FASB issued Statement No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No. 157 provides guidance for using fair value to measure assets and liabilities. This statement clarifies the principle that fair value should be based on the assumptions that market participants would use when pricing an asset or liability. SFAS No. 157 establishes a fair value hierarchy, giving the highest priority to quoted prices in active markets and the lowest priority to unobservable data. SFAS No. 157 applies whenever other standards require assets or liabilities to be measured at fair value. This statement is effective in fiscal years beginning after November 15, 2007. We believe that the adoption of this standard on January 1, 2008 will not have a material effect on our consolidated financial statements.

 

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 No. 158”). SFAS No. 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 for fiscal years ending after December 15, 2008. 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 Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”). SFAS No. 159 expands opportunities to use fair value measurement in financial reporting and permits entities to choose to measure many financial instruments and certain other items at fair value.  This Statement is effective for fiscal years beginning after November 15, 2007.  We have not decided if we will choose to measure any eligible financial assets and liabilities at fair value upon the adoption of this standard on January 1, 2008.

 

On August 31, 2007, the FASB issued a proposed FASB Staff Position (the “proposed FSP”) that affects the accounting for our convertible and exchangeable senior debentures and Series D-13 convertible preferred units. The proposed FSP requires 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 must be amortized using the effective interest method over the period the debt is expected to remain outstanding as additional interest expense. The proposed FSP, if adopted, would be effective for fiscal years beginning after December 15, 2007 and would require retroactive application. The adoption of the proposed FSP on January 1, 2008 would result in the recognition of an aggregate unamortized debt discount of $190,697,000 (as of September 30, 2007) 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:

 

 

 

8

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

 

Acquisitions:

100 West 33^rd Street, New York City (the “Manhattan Mall”)

 

On January 10, 2007, we acquired the Manhattan Mall for approximately $689,000,000 in cash. This mixed-use property is located on the entire Sixth Avenue block-front between 32^nd and 33^rd Streets in Manhattan and contains approximately 1,000,000 square feet, including 812,000 square feet of office space and 164,000 square feet of retail space. Included as part of the acquisition were 250,000 square feet of additional air rights. The property is adjacent to our Hotel Pennsylvania. At closing, we completed a $232,000,000 financing secured by the property, which bears interest at LIBOR plus 0.55% (5.67% at September 30, 2007) and matures in two years with three one-year extension options. The operations of the office component of the property are included in the New York Office segment and the operations of the retail component are included in the Retail segment. We consolidate the accounts of this property into our consolidated financial statements from the date of acquisition.

 

Bruckner Plaza, Bronx, New York

 

On January 11, 2007, we acquired the Bruckner Plaza shopping center, containing 386,000 square feet, for approximately $165,000,000 in cash. Also included as part of the acquisition was an adjacent parcel which is ground leased to a third party. The property is located on Bruckner Boulevard in the Bronx, New York. We consolidate the accounts of this property into our consolidated financial statements from the date of acquisition.

 

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, a 2,000,000 square foot Manhattan office building, located on the block-front between 51^st and 52^nd Street on Avenue of the Americas, and the 3- building 555 California Street complex (“555 California Street”) containing 1,800,000 square feet, known as the Bank of America Center, located at California and Montgomery Streets in San Francisco’s financial district. The purchase price for our 70% interest in the real estate was approximately $1.8 billion, consisting of $1.0 billion of cash and $797,000,000 of existing debt. Our share of the debt is comprised of $308,000,000 secured by 1290 Avenue of the Americas and $489,000,000 secured by 555 California Street. 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. We consolidate the accounts of these properties into our consolidated financial statements from the date of acquisition.

 

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 the general partners have requested from third parties but have not yet been received. 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.

 

 

 

9

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

1290 Avenue of the Americas and 555 California Street - continued

 

The following summarizes our allocation of the purchase price to the assets and liabilities acquired.

 

 

 

 

Our initial valuation of the assets and liabilities acquired (70% interest) is preliminary and subject to change within the one-year period from the date of closing as additional valuation information becomes available.

 

The following table presents our pro forma condensed consolidated statements of income for the three and nine months ended September 30, 2006 and the nine months ended September 30, 2007, as if the above transaction occurred on January 1, 2006. The unaudited pro forma information is not necessarily indicative of what our actual results would have been had the transaction been consummated on January 1, 2006, nor does it represent the results of operations for any future periods. In our opinion all adjustments necessary to reflect this transaction have been made.

 

 

 

10

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

H Street Building Corporation (“H Street”)

 

In July 2005, we acquired H Street, which owns a 50% interest in real estate assets located in Pentagon City, Virginia and Washington, DC. On April 30, 2007, we acquired the corporations that own the remaining 50% interest in these assets for approximately $383,000,000, consisting of $333,000,000 in cash and $50,000,000 of existing mortgages. These assets include twin office buildings located in Washington, DC, containing 577,000 square feet, and assets located in Pentagon City, Virginia comprised of 34 acres of land leased to three residential and retail operators, a 1,670 unit high-rise apartment complex and 10 acres of vacant land. In conjunction with this acquisition all existing litigation has been dismissed. Beginning on April 30, 2007, we consolidate the accounts of these entities into our consolidated financial statements and no longer account for them on the equity method.

 

Further, we agreed to sell approximately 19.6 of the 34 acres of land to one of the existing ground lessees in two closings over a two-year period for approximately $220,000,000. On May 11, 2007, we closed on the sale of 11 of the 19.6 acres for $104,000,000 and received $5,000,000 in cash and a $99,000,000 note due December 31, 2007. On September 28, 2007, the buyer pre-paid the note in cash and we recognized the net gain on sale of $4,803,000. The balance of the net gain of $11,028,000, representing deferred taxes will be reversed and recognized as income in the first quarter of 2008 when H Street and its affiliates elect to be taxed as REITs. In April 2007, we received letters from the two remaining ground lessees claiming a right of first offer on the sale of the land, one of which has since retracted its letter and reserved its rights under the lease.

 

Our total purchase price for 100% of the assets we will own, after the anticipated proceeds from the land sales, is $409,000,000, consisting of $286,000,000 in cash and $123,000,000 of existing mortgages.

 

Toys “R” Us Stores

 

On May 31, 2007, we acquired four properties from Toys “R” Us (“Toys”) for $12,242,000 in cash, which completed our September 2006 agreement to acquire 43 stores that were closed as part of Toys’ January 2006 store closing program. We consolidate the accounts of these properties into our consolidated financial statements from the date of acquisition. Our $1,045,000 share of Toys net gain on this transaction was recorded as an adjustment to the basis of our investment in Toys and was not recorded as income.

 

India Property Fund LP

 

In 2005 and 2006, we invested $94,200,000 in two joint ventures established to acquire, manage and develop real estate in India. On June 14, 2007, we committed to contribute $95,000,000 to a third venture, the India Property Fund, LP (the “Fund”), also established to acquire, manage and develop real estate in India. We satisfied $77,000,000 of our commitment by contributing our interest in one of the above mentioned joint ventures to the Fund. The Fund will seek to raise additional equity. As of September 30, 2007, we own 95% of the Fund and therefore consolidate the accounts of the Fund into our consolidated financial statements, pursuant to the requirements of FIN 46 R.  

 

Shopping Center Portfolio Acquisition

 

On June 26, 2007, we entered into an agreement to acquire a 15 shopping center portfolio aggregating approximately 1.9 million square feet. The properties are located primarily in Northern New Jersey and Long Island, New York. The purchase price is approximately $351,000,000, consisting of approximately $120,000,000 of cash, $89,000,000 of newly issued Vornado Realty L.P. redeemable preferred and common units and $142,000,000 of existing debt. On June 28, 2007, we completed the acquisition of five of the shopping centers for $116,561,000, consisting of $94,179,000 in cash, $15,993,000 in Vornado Realty L.P. preferred units and $6,389,000 of Vornado Realty L.P. common units. We consolidate the accounts of these properties into our consolidated financial statements from the date of acquisition. The closing of the remaining shopping centers is expected to occur in two additional tranches and be completed by the end of 2007, subject to customary closing conditions.

 

Dispositions:

Vineland, New Jersey Shopping Center Property

 

On July 16, 2007, we sold our Vineland, New Jersey shopping center property for $2,774,000 in cash, which resulted in a net gain of $1,708,000.

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

BNA Complex

 

On August 9, 2007, we completed our previously announced sale of Crystal Mall Two, a 277,000 square foot office building located at 1801 South Bell Street in Crystal City, to The Bureau of National Affairs, Inc. (“BNA”), and simultaneously completed the acquisition of a three building complex from BNA. The three buildings acquired contain approximately 300,000 square feet and are located in Washington’s West End between Georgetown and the Central Business District. Vornado received sales proceeds of approximately $103,600,000 from BNA and recognized a net gain of $19,893,000. All of the proceeds from the sale were reinvested in a tax-free “like-kind” exchange in accordance with Section 1031 of the Internal Revenue Code (“Section 1031”). Vornado paid BNA $111,000,000 for the three buildings acquired. We consolidate the accounts of these properties into our consolidated financial statements from the date of acquisition.

 

Arlington Plaza

 

On October 17, 2007, we sold Arlington Plaza, a 188,000 square foot office building located in Arlington, Virginia for $71,500,000, resulting in a gain of $33,900,000 which will be recognized in the fourth quarter of 2007.

 

Investment in McDonald’s Corporation (“McDonalds”) (NYSE: MCD)

 

As of September 30, 2007, we owned 858,000 common shares of McDonalds. These shares are recorded as marketable equity securities on our consolidated balance sheets and are classified as “available for sale.” Appreciation or depreciation in the fair market value of these shares is recorded as an increase or decrease in “accumulated other comprehensive income” in the shareholders’ equity section of our consolidated balance sheets and not recognized in income. At September 30, 2007, based on McDonalds’ September 28, 2007 closing stock price of $54.47 per share, $21,388,000 of appreciation in the value of these shares was included in “accumulated other comprehensive income” on our consolidated balance sheet. During October 2007, we sold all of the McDonalds common shares at a weighted average price of $56.45 per share, resulting in a net gain of $23,090,000 which will be recognized in the fourth quarter of 2007.

 

In addition to the above, at July 1, 2007, we owned 13,695,500 McDonalds common shares (“option shares”) through a series of privately negotiated transactions with a financial institution pursuant to which we purchased a call option and simultaneously sold a put option at the same strike price on McDonalds’ common shares. The option shares had a weighted-average strike price of $32.70 per share, or an aggregate of $447,822,000, expired on various dates between July 30, 2007 and September 10, 2007 and provided for net cash settlement. During the three months ended September 30, 2007, we settled 10,118,800 option shares and received $234,242,000 in cash. At September 30, 2007, there were 3,576,700 option shares remaining in the derivative position at a price of $54.47 per share. During the three months ended September 30, 2007, we recognized a net gain of $28,190,000 as a result of the above transactions. The aggregate net gain recognized for the nine months ended September 30, 2007 was $102,803,000. During the three and nine months ended September 30, 2006, we recognized net gains of $68,796,000 and $60,581,000, respectively.

 

In October 2007, we settled all of the remaining option shares at a weighted average price of $56.24 per share, resulting in a net gain of $6,018,000 which will be recognized in the fourth quarter of 2007.

 

The aggregate net gain realized from inception of our investments in McDonalds in 2005 through final settlement in October 2007 was $289,414,000.

 

 

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

Toys “R” Us (“Toys”)

 

As of September 30, 2007, we own 32.8% of Toys. Below is a summary of Toys’ latest available financial information.

 

 

 

 

 

The business of Toys 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 32.8% share of Toys’ net income or loss on a one-quarter lag basis.

 

Alexander’s (NYSE: ALX)

 

As of September 30, 2007, we own 32.8% of the outstanding common stock of Alexander’s. We manage, lease and develop Alexander’s properties pursuant to agreements, which expire in March of each year and are automatically renewable. As of September 30, 2007, Alexander’s owed us $39,368,000 for fees under these agreements.

 

As of September 30, 2007, the market value of our investment in Alexander’s was $637,643,000, based on Alexander’s September 28, 2007 closing share price of $385.50.

 

The Lexington Master Limited Partnership (“Lexington MLP”)

 

On December 31, 2006, Newkirk Realty Trust (NYSE: NKT) was acquired in a merger by Lexington Corporate Properties Trust (“Lexington”) (NYSE: LXP), a real estate investment trust. We owned 10,186,991 limited partnership units (representing a 15.8% investment ownership interest) of Newkirk MLP, which was also acquired by Lexington as a subsidiary, and was renamed Lexington MLP. The units in Newkirk MLP, which we accounted for on the equity method, were converted on a 0.80 for 1 basis into limited partnership units of Lexington MLP, which we also account for on the equity method. The Lexington MLP units are exchangeable on a one-for-one basis into common shares of Lexington.

 

As of September 30, 2007, we own 8,149,593 limited partnership units of Lexington MLP, or a 7.3% ownership 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. Accordingly, our “equity in net income or loss from partially owned entities” for the three months ended September 30, 2007 includes our share of Lexington MLP’s net income for its three months ended June 30, 2007.

 

As of September 30, 2007, the market value of our investment in Lexington MLP based on Lexington’s September 28, 2007 closing share price of $20.01, was $163,073,000, or $17,238,000 below the carrying amount on our consolidated balance sheet. We have concluded that as of September 30, 2007, the decline in the value of our investment is not “other-than-temporary.”

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

 

GMH Communities L.P. (“GMH”)

 

As of September 30, 2007, we own 7,337,857 limited partnership units (which are exchangeable on a one-for-one basis into common shares of GMH Communities Trust (“GCT”) (NYSE: GCT), a real estate investment trust that conducts its business through GMH and of which it is the sole general partner) and 2,517,247 common shares of GCT, or 13.5% of the limited partnership interest of GMH. We account for our investment in GMH on the equity method and record our pro rata share of GMH’s net income or loss on a one-quarter lag basis as we file our consolidated financial statements on Form 10-K and 10-Q prior to the time that GCT files its financial statements. Accordingly, our “equity in net income or loss from partially owned entities” for the three months ended September 30, 2007 includes our share of GMH’s net income for its three months ended June 30, 2007.

 

As of September 30, 2007, the market value of our investment in GMH and GCT based on GCT’s September 28, 2007 closing share price of $7.75, was $76,377,000, or $27,473,000 below the carrying amount on our consolidated balance sheet. We have concluded that as of September 30, 2007, the decline in the value of our investment is not “other-than-temporary.”

 

Downtown Crossing Joint Venture

 

On January 26, 2007, a joint venture in which we have a 50% interest acquired the Filene’s property located in the Downtown Crossing district of Boston, Massachusetts for approximately $100,000,000 in cash, of which our share was $50,000,000. The venture plans to redevelop the property to include over 1,200,000 square feet, consisting of office, retail, condominium apartments and a hotel. The project is subject to governmental approvals. Our investment in the joint venture is accounted for under the equity method.

 

 

 

 

 

 

 

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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.

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

Notes to preceding tabular information:

 

 

 

 

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

Below is a summary of the debt of partially owned entities as of September 30, 2007 and December 31, 2006, none of which is guaranteed by us.

 

 

 

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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 $3,104,451,000 and $3,323,007,000 as of September 30, 2007 and December 31, 2006, respectively.

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

 

Blackstone/Equity Office Properties Loan

 

On March 29, 2007, we acquired a 9.4% interest in a $772,600,000 mezzanine loan for $72,400,000 in cash. During April and May of 2007, we were repaid the $72,400,000 outstanding balance of the loan.

 

Fortress Loan

 

In 2006, we acquired bonds for $99,500,000 in cash, representing a 7% interest in two margin loans aggregating $1.430 billion. On March 30, 2007, we were repaid $35,348,000. On July 10, 2007 and October 2, 2007, we were repaid an additional $13,221,000 and $13,290,000, respectively. The remaining balance of $37,641,000, is due in December 2007.

 

MPH Mezzanine Loans

 

On June 5, 2007, we acquired a 42% interest in two mezzanine loans totaling $158,700,000, for $66,403,000 in cash. The loans bear interest at LIBOR plus 5.32% (10.44% at September 30, 2007) and mature in February 2008. The loans are subordinate to $2.9 billion of other debt and are secured by the equity interests in four New York City properties: Worldwide Plaza, 1540 Broadway office condominium, 527 Madison Avenue and Tower 56.

 

Manhattan House Loan

 

On October 12, 2007, we were repaid the $42,000,000 outstanding balance of the Manhattan House mezzanine loan.

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

The following summarizes our identified intangible assets (acquired above-market leases and in-place leases), intangible liabilities (acquired below market leases) and goodwill as of September 30, 2007 and December 31, 2006.

 

 

Amortization of acquired below market leases, net of acquired above market leases (a component of rental income) was $24,488,000 and $58,810,000 for the three and nine months ended September 30, 2007, respectively, and $7,087,000 and $15,164,000 for the three and nine months ended September 30, 2006, respectively. The estimated annual amortization of acquired below market leases, net of acquired above market leases for each of the five succeeding years is as follows:

 

 

The estimated annual amortization of all other identified intangible assets (a component of depreciation and amortization expense) 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 properties acquired during 2006 and 2007. Amortization of these acquired below market leases net of acquired above market leases resulted in an increase to rent expense of $394,000 and $1,183,000 for the three and nine months ended September 30, 2007, respectively. The estimated annual amortization of these below market leases for each of the five succeeding years is as follows:

 

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

_______________________

See notes on page 23.

21

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

 

 

_______________________

See notes on following page.

 

22

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

Notes to preceding tabular information:

($ in thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

23

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

Notes to preceding tabular information - continued:

($ in thousands, except per share amounts)

 

 

 

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 $183,000 and $223,000 in the three months ended September 30, 2007 and 2006, respectively and $593,000 and $605,000 in the nine months ended September 30, 2007 and 2006, respectively. The above table excludes fee income from partially owned entities, which is included in income from partially owned entities (see Note 6 – Investments in Partially-Owned Entities).

 

 

24

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

During the three months ended September 30, 2007, we classified our Crystal Mall Two and Arlington Plaza Washington D.C. office properties as discontinued operations. See Note 4. Acquisitions and Dispositions for details. The following table sets forth the assets and liabilities related to discontinued operations at September 30, 2007 and December 31, 2006. Assets related to discontinued operations consist primarily of the net book value of real estate. Liabilities related to discontinued operations consist primarily of below market lease intangibles and deferred tax liabilities established at acquisition.

 

 

The following table sets forth the combined results of operations related to discontinued operations for the three and nine months ended September 30, 2007 and 2006.

 

 

 

25

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

The following table provides a reconciliation of both net income and the number of common shares used in the computation of (i) basic income per common share - which utilizes the weighted average number of common shares outstanding without regard to dilutive potential common shares, and (ii) diluted income per common share - which includes the weighted average common shares and potentially dilutive share equivalents. Potentially dilutive share equivalents include our Series A convertible preferred shares, employee stock options and restricted share awards, exchangeable senior debentures due 2025 as well as Class A Operating Partnership units owned by minority partners and convertible preferred units.

 

__________________

 

26

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

 

 

Substantially all of other comprehensive (loss) income in the three and nine months ended September 30, 2007 and 2006 relates to the mark-to-market of marketable equity securities classified as available-for-sale.

 

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 No. 123R”). We adopted SFAS No. 123R, using the modified prospective application, on January 1, 2006. Stock based compensation expense for the three and nine months ended September 30, 2007 and 2006 consists of stock option awards, restricted common share and Operating Partnership unit awards and our 2006 Out-Performance Plan awards.

 

During the three months ended September 30, 2007 and 2006, we recognized $6,177,000 and $3,245,000 of stock-based compensation expense, respectively and in the nine months ended September 30, 2007 and 2006 we recognized $18,797,000 and $7,018,000 of stock-based compensation expense, respectively.

 

 

27

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

At September 30, 2007, our $1.0 billion revolving credit facility had $47,939,000 reserved for outstanding letters of credit. Our revolving credit facilities contain financial covenants, which 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. At September 30, 2007, AmeriCold’s $30,000,000 revolving credit facility had $19,156,000 reserved for outstanding letters of credit. This facility requires AmeriCold to maintain, on a trailing four-quarter basis, a minimum of $30,000,000 of free cash flow, as defined. Our revolving 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.

 

We have made acquisitions and investments in partially owned entities for which we are committed to fund additional capital aggregating $152,995,000. Of this amount, $95,000,000 relates to our equity commitment to the India Property Fund, LP, and $22,800,000 relates to capital expenditures to be funded over the next four years at the Springfield Mall, in which we have a 97.5% interest.

 

On November 10, 2005, we committed to fund the junior portion of up to $30,530,000 of a $173,000,000 construction loan to an entity developing a mixed-use building complex in Boston, Massachusetts, at the north end of the Boston Harbor. We earn current-pay interest at 30-day LIBOR plus 11%. The loan matures in November 2008, with a one-year extension option. As of September 30, 2007, we have funded $13,787,000 of this commitment.

 

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, or if the Terrorism Risk Insurance Extension Act of 2005 is not extended past 2007, 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 $60,080,000 and $219,990,000 of cash invested in these agreements at September 30, 2007 and December 31, 2006, respectively.

 

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.

 

 

28

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

Insurance

 

We carry commercial liability and all-risk property insurance (fire, flood, rental loss, extended coverage, and “acts of terrorism” as defined in the Terrorism Risk Insurance Extension Act (“TRIA”) which expires in December 2007) with respect to our assets. We also carry earthquake insurance with respect to our California properties.

 

In June 2007, we formed Penn Plaza Insurance Company, LLC (“PPIC”), a wholly owned consolidated subsidiary of the Operating Partnership, to act as a re-insurer with respect to a portion of our earthquake insurance coverage and as a direct insurer for coverage for (i) “certified” acts of terrorism by TRIA, (ii) “non-certified” acts of terrorism, and (iii) nuclear, biological, chemical and radiological (“NBCR”) “certified acts of terrorism” under TRIA. Coverage under (i) and (ii) are fully reinsured by third party insurance companies with no exposure to PPIC. Prior to the formation of PPIC, we were uninsured for losses under NBCR coverage. Subsequently, we are uninsured for the first $100,000,000 of NBCR coverage under TRIA, for which PPIC would be responsible, and ultimately we would bear such loss.

 

Effective as of September 15, 2007, we increased our property insurance per occurrence limits to $1.5 billion from $1.4 billion, including “certified” acts of terrorism. Coverage for “non-certified” acts of terrorism is $500,000,000 per occurrence with a $500,000,000 annual aggregate limit. Earthquake insurance coverage is $150,000,000 per occurrence, subject to a deductible in the amount of 5% of the value of the affected property, with a $150,000,000 annual aggregate limit. The first $10,000,000 above the deductible is provided by PPIC on a reinsurance basis.

 

We continue to monitor the state of the insurance market and the scope and costs of coverage for acts of terrorism. However, we cannot anticipate what coverage will be available on commercially reasonable terms in future policy years.

 

 

 

29

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

Litigation

 

Stop & Shop

 

On January 8, 2003, Stop & Shop filed a complaint with the United States District Court for the District of New Jersey 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. 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. On April 16, 2007, the Court directed that discovery should be completed by December 2007, with a trial date to be determined thereafter. We intend to vigorously pursue our claims against Stop & Shop.

 

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 555 California Street. 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 the general partners have requested from third parties but have not yet been received. 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 flow.

 

30

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

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

 

 

Employer Contributions

 

We made contributions of $1,847,000 and $6,388,000 to the plans during the nine months ended September 30, 2007 and 2006, respectively. We anticipate additional contributions of $444,000 to the plans during the remainder of 2007.

 

In the first quarter of 2007, we wrote-off $8,807,000 of costs associated with the Equity Office Properties Trust acquisition not consummated.

 

Transactions with Affiliates and Officers and Trustees of the Company

 

On March 13, 2007, Michael Fascitelli, our President and President of Alexander’s, exercised 350,000 of his Alexander’s stock appreciation rights (“SARS”), which were scheduled to expire on March 14, 2007 and received $144.18 for each SAR exercised, representing the difference between Alexander’s stock price of $388.01 (the average of the high and low market price) on the date of exercise and the exercise price of $243.83.

 

On March 26, 2007, Joseph Macnow, Executive Vice President – Finance and Administration and Chief Financial Officer, repaid to the Company his $2,000,000 outstanding loan which was scheduled to mature in June 2007.

 

Effective as of April 19, 2007, we entered into a new employment agreement with Mitchell Schear, the President of our Washington, DC Office Division. This agreement, which replaced his prior agreement, was approved by the Compensation Committee of our Board of Trustees and provides for a term of five years and is automatically renewable for one-year terms thereafter. The agreement also provides for a minimum salary of $1,000,000 per year and bonuses and other customary benefits. Pursuant to the terms of the agreement, on April 19, 2007, the Compensation Committee granted options to Mr. Schear to acquire 200,000 of our common shares at an exercise price of $119.94 per share. These options vest ratably over three years beginning in 2010 and accelerate on a change of control or if we terminate his employment without cause or by him for breach by us. The agreement also provides that if we terminate Mr. Schear’s employment without cause or by him for breach by us, he will receive a lump-sum payment equal to one time salary and bonus, up to a maximum of $2,000,000.

 

 

31

 

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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 September 30, 2007 and 2006.

 

EBITDA includes net gains on sale of real estate of $36,725, of which $24,696 is included in the Washington, DC office segment, $3,049 is included in the Retail segment and $8,980 is included in the Other segment. In addition, Other segment EBITDA includes a $18,606 net gain on mark-to-market of derivative instruments and a $1,012 net gain on sale of marketable equity securities.

_______________________

See notes on page 36.

32

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

 

Other Segment EBITDA includes a $70,687 net gain on mark-to-market of derivative instruments, a $10,842 net gain on sale of real estate, and a $8,032 net gain on sale of marketable equity securities.

________________________

See notes on page 36.

 

33

 

---

VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

 

EBITDA includes net gains on sale of real estate of $37,218, of which $24,696 is included in the Washington, DC office segment, $3,049 is included in the Retail segment and $9,473 is included in the Other segment. In addition, Other segment EBITDA includes a $100,060 net gain on mark-to-market of derivative instruments, a $17,699 net gain on sale of marketable equity securities, $8,807 of expense for costs of an acquisition not consummated and $1,677 of expense for our share of India Property Fund LP organization costs.

_______________________

See notes on page 36.

 

34

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

 

EBITDA includes net gains on sale of real estate of $44,611, of which $17,609 is included in the Washington, DC segment $9,218 is included in the Retail segment, $4,835 is included in the Merchandise Mart segment, $2,107 is included in the Temperature Controlled Logistics segment and $10,842 is included in the Other segment. In addition, Other segment EBITDA includes a $65,527 net gain on sale of marketable equity securities and a $65,589 net gain on mark-to-market of derivative instruments.

________________________

See notes on the following page.

 

35

 

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VORNADO REALTY TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

 

Notes to preceding tabular information

 

 

 

36

 

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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 (“the Company”) as of September 30, 2007, and the related consolidated statements of income for the three-month and nine-month periods ended September 30, 2007 and 2006, and of cash flows for the nine-month periods ended September 30, 2007 and 2006. These interim financial statements are the responsibility of the Company’s management.

 

We conducted our reviews in accordance with the 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 the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Vornado Realty Trust as of December 31, 2006, 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 11 to the accompanying financial statements (not presented herein); and in our report dated February 27, 2007, we expressed an unqualified opinion on those consolidated financial statements. We also audited the adjustments described in Note 11 that were applied to reclassify the December 31, 2006 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, 2006.

 

/s/ DELOITTE & TOUCHE LLP

 

Parsippany, New Jersey

October 30, 2007

 

37

 

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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 involve risks, uncertainties and assumptions. 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 similar expressions in this quarterly report on Form 10-Q. These forward-looking statements are subject to numerous assumptions, risks and uncertainties. Many of the factors that will determine these items are beyond our ability to control or predict. Factors that may cause actual results to differ materially from those contemplated by the forward-looking statements include, but are not limited to, those set forth in our Annual Report on Form 10-K for the year ended December 31, 2006 under “Forward Looking Statements” and “Item 1. Business – Certain Factors That May Adversely Affect Our Business and Operations.” 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. We expressly disclaim any responsibility to update forward-looking statements, whether as a result of new information, future events or otherwise. Accordingly, investors should use caution in relying on forward-looking statements, which are based on results and trends at the time they are made, to anticipate future results or trends.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations include a discussion of our consolidated financial statements for the three and nine months ended September 30, 2007. 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, 2006 in Management’s Discussion and Analysis of Financial Condition. There have been no significant changes to our policies during 2007.

 

38

 

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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”) for the following periods ending September 30, 2007:

 

 

_________________________

 

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

 

 

Competition

 

We compete with a large number of real estate property owners and developers. Principal factors of competition are rent charged, attractiveness of location and quality and breadth of services provided. Our success depends upon, among other factors, trends of the national 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. Economic growth has been fostered, in part, by low interest rates, Federal tax cuts, and increases in government spending. To the extent economic growth stalls, we may experience lower occupancy rates, which may lead to lower initial rental rates, higher leasing costs and a corresponding decrease in our net income, funds from operations and cash flow. Alternatively, if economic growth is sustained, we may experience higher occupancy rates leading to higher initial rents and higher interest rates causing an increase in our weighted average cost of capital and a corresponding effect on our net income, funds from operations and cash flow. Our net income and funds from operations will also be affected by the seasonality of Toys’ business and competition from discount and mass merchandisers.

 

39

 

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Overview (continued)

Quarter Ended September 30, 2007 Financial Results Summary  

 

Net income applicable to common shares for the quarter ended September 30, 2007 was $116,546,000, or $0.74 per diluted share, versus $113,632,000, or $0.76 per diluted share, for the quarter ended September 30, 2006. Net income for the quarters ended September 30, 2007 and 2006 includes certain items that affect comparability which are listed in the table on page 42. Net income for the quarters ended September 30, 2007 and 2006 also includes our share of net gains on sales of real estate of $31,922,000 and $10,842,000, respectively. The aggregate of these items, net of minority interest, increased net income applicable to common shares for the quarter ended September 30, 2007 by $50,524,000, or $0.31 per diluted share and increased net income for the quarter ended September 30, 2006 by $52,276,000, or $0.34 per diluted share.

 

Funds from operations applicable to common shares plus assumed conversions (“FFO”) for the quarter ended September 30, 2007 was $221,199,000, or $1.35 per diluted share, compared to $204,535,000, or $1.31 per diluted share, for the prior year’s quarter. FFO for the quarters ended September 30, 2007 and 2006 includes certain items that affect comparability which are listed in the table on page 42. The aggregate of these items, net of minority interest, increased FFO for the quarter ended September 30, 2007 by $21,533,000, or $0.13 per diluted share and increased FFO for the quarter ended September 30, 2006 by $42,162,000, or $0.27 per diluted share.

 

Net income per diluted share and FFO per diluted share for the quarter ended September 30, 2007 were negatively impacted by an 8.4 million increase in weighted average common shares outstanding over the prior year’s quarter.

 

We did not recognize income on certain assets with an aggregate carrying amount of approximately $1.1 billion during the quarter ended September 30, 2007, because they were out of service for redevelopment. Assets under development include all or portions of the Bergen Town Center, 2101 L Street, Crystal Mall Two, Crystal Plaza Two, 1999 K Street, 220 Central Park South, 40 East 66^th Street, and investments in joint ventures including our Beverly Connection and Wasserman ventures.

 

The percentage increase (decrease) in the same-store Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) of our operating segments for the quarter ended September 30, 2007 over the quarter ended September 30, 2006 and the trailing quarter ended December 31, 2006 are summarized below.

 

 

 

 

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

 

40

 

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Overview (continued)

Nine Months Ended September 30, 2007 Financial Results Summary  

 

Net income applicable to common shares for the nine months ended September 30, 2007 was $420,806,000, or $2.65 per diluted share, versus $397,202,000, or $2.66 per diluted share, for the nine months ended September 30, 2006. Net income for the nine months ended September 30, 2007 and 2006 includes certain items that affect comparability which are listed in the table on the following page. Net income for the nine months ended September 30, 2007 and 2006 also includes our share of net gains on sale of real estate of $32,415,000 and $44,611,000, respectively. The aggregate of these items, net of minority interest, increased net income applicable to common shares for the nine months ended September 30, 2007 by $111,857,000, or $0.68 per diluted share and increased net income for the nine months ended September 30, 2006 by $115,322,000, or $0.74 per diluted share.

 

Funds from operations applicable to common shares plus assumed conversions (“FFO”) for the nine months ended September 30, 2007 was $773,457,000, or $4.71 per diluted share, compared to $646,881,000, or $4.17 per diluted share, for the prior year’s nine months. FFO for the nine months ended September 30, 2007 and 2006 include certain items that affect comparability which are listed in the table on the following page. The aggregate of these items, net of minority interest, increased FFO for the nine months ended September 30, 2007 by $82,409,000, or $0.50 per diluted share and increased FFO for the nine months ended September 30, 2006 by $75,988,000, or $0.49 per diluted share.

 

The percentage increase (decrease) in the same-store EBITDA of our operating segments for the nine months ended September 30, 2007 over the nine months ended September 30, 2006 is summarized below.

 

 

_____________________

 

41

 

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Overview (continued)

 

 

 

42

 

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Overview (continued)

2007 Acquisitions, Dispositions and Significant Investments

Acquisitions:

100 West 33^rd Street, New York City (the “Manhattan Mall”)

 

On January 10, 2007, we acquired the Manhattan Mall for approximately $689,000,000 in cash. This mixed-use property is located on the entire Sixth Avenue block-front between 32^nd and 33^rd Streets in Manhattan and contains approximately 1,000,000 square feet, including 812,000 square feet of office space and 164,000 square feet of retail space. Included as part of the acquisition were 250,000 square feet of additional air rights. The property is adjacent to our Hotel Pennsylvania. At closing, we completed a $232,000,000 financing secured by the property, which bears interest at LIBOR plus 0.55% (5.67% at September 30, 2007) and matures in two years with three one-year extension options. The operations of the office component of the property are included in the New York Office segment and the operations of the retail component are included in the Retail segment. We consolidate the accounts of this property into our consolidated financial statements from the date of acquisition.

 

Bruckner Plaza, Bronx, New York

 

On January 11, 2007, we acquired the Bruckner Plaza shopping center, containing 386,000 square feet, for approximately $165,000,000 in cash. Also included as part of the acquisition was an adjacent parcel which is ground leased to a third party. The property is located on Bruckner Boulevard in the Bronx, New York. We consolidate the accounts of this property into our consolidated financial statements from the date of acquisition.

 

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, a 2,000,000 square foot Manhattan office building, located on the block-front between 51^st and 52^nd Street on Avenue of the Americas, and the 3-building 555 California Street complex (“555 California Street”) containing 1,800,000 square feet, known as the Bank of America Center, located at California and Montgomery Streets in San Francisco’s financial district. The purchase price for our 70% interest in the real estate was approximately $1.8 billion, consisting of $1.0 billion of cash and $797,000,000 of existing debt. Our share of the debt is comprised of $308,000,000 secured by 1290 Avenue of the Americas and $489,000,000 secured by 555 California Street. 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. We consolidate the accounts of these properties into our consolidated financial statements from the date of acquisition.

 

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 the general partners have requested from third parties but have not yet been received. 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.

 

 

 

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Overview (continued)

1290 Avenue of the Americas and 555 California Street - continued

 

The following summarizes our allocation of the purchase price to the assets and liabilities acquired.

 

 

 

 

Our initial valuation of the assets and liabilities acquired (70% interest) is preliminary and subject to change within the one-year period from the date of closing as additional valuation information becomes available.

 

The following table presents our pro forma condensed consolidated statements of income for the three and nine months ended September 30, 2006 and the nine months ended September 30, 2007, as if the above transaction occurred on January 1, 2006. The unaudited pro forma information is not necessarily indicative of what our actual results would have been had the transaction been consummated on January 1, 2006, nor does it represent the results of operations for any future periods. In our opinion all adjustments necessary to reflect this transaction have been made.

 

 

 

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Overview (continued)

H Street Building Corporation (“H Street”)

 

In July 2005, we acquired H Street, which owns a 50% interest in real estate assets located in Pentagon City, Virginia and Washington, DC. On April 30, 2007, we acquired the corporations that own the remaining 50% interest in these assets for approximately $383,000,000, consisting of $333,000,000 in cash and $50,000,000 of existing mortgages. These assets include twin office buildings located in Washington, DC, containing 577,000 square feet, and assets located in Pentagon City, Virginia comprised of 34 acres of land leased to three residential and retail operators, a 1,670 unit high-rise apartment complex and 10 acres of vacant land. In conjunction with this acquisition all existing litigation has been dismissed. Beginning on April 30, 2007, we consolidate the accounts of these entities into our consolidated financial statements and no longer account for them on the equity method.

 

Further, we agreed to sell approximately 19.6 of the 34 acres of land to one of the existing ground lessees in two closings over a two-year period for approximately $220,000,000. On May 11, 2007, we closed on the sale of 11 of the 19.6 acres for $104,000,000 and received $5,000,000 in cash and a $99,000,000 note due December 31, 2007. On September 28, 2007, the buyer pre-paid the note in cash and we recognized the net gain on sale of $4,803,000. The balance of the net gain of $11,028,000, representing deferred taxes will be reversed and recognized as income in the first quarter of 2008 when H Street and its affiliates elect to be taxed as REITs. In April 2007, we received letters from the two remaining ground lessees claiming a right of first offer on the sale of the land, one of which has since retracted its letter and reserved its rights under the lease.

 

Our total purchase price for 100% of the assets we will own, after the anticipated proceeds from the land sales, is $409,000,000, consisting of $286,000,000 in cash and $123,000,000 of existing mortgages.

 

Toys “R” Us Stores

 

On May 31, 2007, we acquired four properties from Toys “R” Us (“Toys”) for $12,242,000 in cash, which completed our September 2006 agreement to acquire 43 stores that were closed as part of Toys’ January 2006 store closing program. We consolidate the accounts of these properties into our consolidated financial statements from the date of acquisition. Our $1,045,000 share of Toys net gain on this transaction was recorded as an adjustment to the basis of our investment in Toys and was not recorded as income.

 

India Property Fund LP

 

In 2005 and 2006, we invested $94,200,000 in two joint ventures established to acquire, manage and develop real estate in India. On June 14, 2007, we committed to contribute $95,000,000 to a third venture, the India Property Fund, LP (the “Fund”), also established to acquire, manage and develop real estate in India. We satisfied $77,000,000 of our commitment by contributing our interest in one of the above mentioned joint ventures to the Fund. The Fund will seek to raise additional equity. As of September 30, 2007, we own 95% of the Fund and therefore consolidate the accounts of the Fund into our consolidated financial statements, pursuant to the requirements of FIN 46 (R) - Consolidation of Variable Interest Entities.  

 

Shopping Center Portfolio Acquisition

 

On June 26, 2007, we entered into an agreement to acquire a 15 shopping center portfolio aggregating approximately 1.9 million square feet. The properties are located primarily in Northern New Jersey and Long Island, New York. The purchase price is approximately $351,000,000, consisting of approximately $120,000,000 of cash, $89,000,000 of newly issued Vornado Realty L.P. redeemable preferred and common units and $142,000,000 of existing debt. On June 28, 2007, we completed the acquisition of five of the shopping centers for $116,561,000, consisting of $94,179,000 in cash, $15,993,000 in Vornado Realty L.P. preferred units and $6,389,000 of Vornado Realty L.P. common units. We consolidate the accounts of these properties into our consolidated financial statements from the date of acquisition. The closing of the remaining shopping centers is expected to occur in two additional tranches and be completed by the end of 2007, subject to customary closing conditions.

 

 

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Overview (continued)

Dispositions:

Vineland, New Jersey Shopping Center Property

 

On July 16, 2007, we sold our Vineland, New Jersey shopping center property for $2,774,000 in cash, which resulted in a net gain of $1,708,000.

 

BNA Complex

 

On August 9, 2007, we completed our previously announced sale of Crystal Mall Two, a 277,000 square foot office building located at 1801 South Bell Street in Crystal City, to The Bureau of National Affairs, Inc. (“BNA”), and simultaneously completed the acquisition of a three building complex from BNA. The three buildings acquired contain approximately 300,000 square feet and are located in Washington’s West End between Georgetown and the Central Business District. Vornado received sales proceeds of approximately $103,600,000 from BNA and recognized a net gain of $19,893,000. All of the proceeds from the sale were reinvested in a tax-free “like-kind” exchange in accordance with Section 1031 of the Internal Revenue Code (“Section 1031”). Vornado paid BNA $111,000,000 for the three buildings acquired. We consolidate the accounts of these properties into our consolidated financial statements from the date of acquisition.

 

Arlington Plaza

 

On October 17, 2007, we sold Arlington Plaza, a 188,000 square foot office building located in Arlington, Virginia for $71,500,000, resulting in a gain of $33,900,000 which will be recognized in the fourth quarter of 2007.

 

 

2007 Mezzanine Loan Activity:

 

Blackstone/Equity Office Properties Loan

 

On March 29, 2007, we acquired a 9.4% interest in a $772,600,000 mezzanine loan for $72,400,000 in cash. During April and May of 2007, we were repaid the $72,400,000 outstanding balance of the loan.

 

Fortress Loan

 

In 2006, we acquired bonds for $99,500,000 in cash, representing a 7% interest in two margin loans aggregating $1.430 billion. On March 30, 2007, we were repaid $35,348,000. On July 10, 2007 and October 2, 2007, we were repaid an additional $13,221,000 and $13,290,000, respectively. The remaining balance of $37,641,000, is due in December 2007.

 

MPH Mezzanine Loans

 

On June 5, 2007, we acquired a 42% interest in two mezzanine loans totaling $158,700,000, for $66,403,000 in cash. The loans bear interest at LIBOR plus 5.32% (10.44% at September 30, 2007) and mature in February 2008. The loans are subordinate to $2.9 billion of other debt and are secured by the equity interests in four New York City properties: Worldwide Plaza, 1540 Broadway office condominium, 527 Madison Avenue and Tower 56.

 

Manhattan House Loan

 

On October 12, 2007, we were repaid the $42,000,000 outstanding balance of the Manhattan House mezzanine loan.

 

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Overview (continued)

 

Other Investments:

 

The Lexington Master Limited Partnership (“Lexington MLP”)

 

On December 31, 2006, Newkirk Realty Trust (NYSE: NKT) was acquired in a merger by Lexington Corporate Properties Trust (“Lexington”) (NYSE: LXP), a real estate investment trust. We owned 10,186,991 limited partnership units (representing a 15.8% investment ownership interest) of Newkirk MLP, which was also acquired by Lexington as a subsidiary, and was renamed Lexington MLP. The units in Newkirk MLP, which we accounted for on the equity method, were converted on a 0.80 for 1 basis into limited partnership units of Lexington MLP, which we also account for on the equity method. The Lexington MLP units are exchangeable on a one-for-one basis into common shares of Lexington. 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.

 

As of September 30, 2007, we own 8,149,593 limited partnership units of Lexington MLP, or a 7.3% ownership 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. Accordingly, our “equity in net income or loss from partially owned entities” for the three months ended September 30, 2007 includes our share of Lexington MLP’s net income for its three months ended June 30, 2007.

 

As of September 30, 2007, the market value of our investment in Lexington MLP based on Lexington’s September 28, 2007 closing share price of $20.01, was $163,073,000, or $17,238,000 below the carrying amount on our consolidated balance sheet. We have concluded that as of September 30, 2007, the decline in the value of our investment is not “other-than-temporary.”

 

GMH Communities L.P. (“GMH”)

 

As of September 30, 2007, we own 7,337,857 limited partnership units (which are exchangeable on a one-for-one basis into common shares of GMH Communities Trust (“GCT”) (NYSE: GCT), a real estate investment trust that conducts its business through GMH and of which it is the sole general partner) and 2,517,247 common shares of GCT, or 13.5% of the limited partnership interest of GMH. We account for our investment in GMH on the equity method and record our pro rata share of GMH’s net income or loss on a one-quarter lag basis as we file our consolidated financial statements on Form 10-K and 10-Q prior to the time that GCT files its financial statements. Accordingly, our “equity in net income or loss from partially owned entities” for the three months ended September 30, 2007 includes our share of GMH’s net income for its three months ended June 30, 2007.

 

As of September 30, 2007, the market value of our investment in GMH and GCT based on GCT’s September 28, 2007 closing share price of $7.75, was $76,377,000, or $27,473,000 below the carrying amount on our consolidated balance sheet. We have concluded that as of September 30, 2007, the decline in the value of our investment is not “other-than-temporary.”

 

Downtown Crossing Joint Venture

 

On January 26, 2007, a joint venture in which we have a 50% interest acquired the Filene’s property located in the Downtown Crossing district of Boston, Massachusetts for approximately $100,000,000 in cash, of which our share was $50,000,000. The venture plans to redevelop the property to include over 1,200,000 square feet, consisting of office, retail, condominium apartments and a hotel. The project is subject to governmental approvals. Our investment in the joint venture is accounted for under the equity method.

 

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Overview (continued)

 

Other Investments: (continued)

 

Investment in McDonald’s Corporation (“McDonalds”) (NYSE: MCD)

 

As of September 30, 2007, we owned 858,000 common shares of McDonalds. These shares are recorded as marketable equity securities on our consolidated balance sheets and are classified as “available for sale.” Appreciation or depreciation in the fair market value of these shares is recorded as an increase or decrease in “accumulated other comprehensive income” in the shareholders’ equity section of our consolidated balance sheets and not recognized in income. At September 30, 2007, based on McDonalds’ September 28, 2007 closing stock price of $54.47 per share, $21,388,000 of appreciation in the value of these shares was included in “accumulated other comprehensive income” on our consolidated balance sheet. During October 2007, we sold all of the McDonalds common shares at a weighted average price of $56.45 per share, resulting in a net gain of $23,090,000 which will be recognized in the fourth quarter of 2007.

 

In addition to the above, at July 1, 2007, we owned 13,695,500 McDonalds common shares (“option shares”) through a series of privately negotiated transactions with a financial institution pursuant to which we purchased a call option and simultaneously sold a put option at the same strike price on McDonalds’ common shares. The option shares had a weighted-average strike price of $32.70 per share, or an aggregate of $447,822,000, expired on various dates between July 30, 2007 and September 10, 2007 and provided for net cash settlement. During the three months ended September 30, 2007, we settled 10,118,800 option shares and received $234,242,000 in cash. At September 30, 2007, there were 3,576,700 option shares remaining in the derivative position at a price of $54.47 per share. During the three months ended September 30, 2007, we recognized a net gain of $28,190,000 as a result of the above transactions. The aggregate net gain recognized for the nine months ended September 30, 2007 was $102,803,000. During the three and nine months ended September 30, 2006, we recognized net gains of $68,796,000 and $60,581,000, respectively.

 

In October 2007, we settled all of the remaining option shares at a weighted average price of $56.24 per share, resulting in a net gain of $6,018,000 which will be recognized in the fourth quarter of 2007.

 

The aggregate net gain realized from inception of our investments in McDonalds in 2005 through final settlement in October 2007 was $289,414,000.

 

 

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Overview (continued)

 

2007 Financings:

 

On January 26, 2007, we completed a $678,000,000 financing of our Skyline Complex in Fairfax Virginia, consisting of eight office buildings containing 2,560,000 square feet. This loan bears interest only at 5.74% and matures in February 2017. We retained net proceeds of approximately $515,000,000 after repaying existing loans and closing costs, including $5,771,000 for prepayment penalties and defeasance costs which is included in “interest and debt expense” in the nine months ended September 30, 2007.

 

On March 1, 2007, we repaid the $19,394,000 balance of the 1999 K Street mortgage loan.

 

On March 30, 2007, we repaid the $47,011,000 balance of the Crystal Park 2 mortgage loan.

 

On May 11, 2007, we redeemed our $500,000,000 5.625% senior unsecured notes at the face amount plus accrued interest.

 

On May 14, 2007, we completed a $45,000,000 financing of our 866 UN Plaza property. The loan bears interest at LIBOR plus 0.40% and matures in May 2009. The net proceeds were used to repay the existing loan and closing costs.

 

On July 3, 2007, we repaid $21,030,000 of the $46,837,000 outstanding balance of the mortgage loan which was secured by the Garfield, Edison and East Brunswick industrial warehouses. We incurred $1,701,000 of prepayment penalties and defeasance costs which is included in interest and debt expense in the quarter ended September 30, 2007.

 

On September 28, 2007, the Operating Partnership entered into a new $1.510 billion unsecured revolving credit facility, which was increased by $85,000,000 on October 12, 2007 and can be increased up to $2.0 billion during the initial term. The new facility has a three-year term with two one-year extension options, bears interest at LIBOR plus 55 basis points (5.67% at September 30, 2007), based on our current credit ratings and requires the payment of an annual facility fee of 15 basis points. Together with the existing $1.0 billion credit facility we have an aggregate of $2.595 billion of unsecured revolving credit. Vornado is the guarantor of the Operating Partnership’s obligations under both revolving credit agreements. The existing $1.0 billion credit facility’s financial covenants have been modified to conform to the financial covenants under the new agreement. Significant modifications include (i) changing the definition of Capitalization Value to exclude corporate unallocated general and administrative expenses and to reduce the capitalization rate to 6.5% from 7.5%, and (ii) changing the definition of Total Outstanding Indebtedness to exclude indebtedness of unconsolidated joint ventures. Under the new agreement, “Equity Value” may not be less than Three Billion Dollars; “Total Outstanding Indebtedness” may not exceed sixty percent (60%) of “Capitalization Value;” the ratio of “Combined EBITDA” to “Fixed Charges,” each measured as of the most recently ended calendar quarter, may not be less than 1.40 to 1.00; the ratio of “Unencumbered Combined EBITDA” to “Unsecured Interest Expense,” each measured as of the most recently ended calendar quarter, may not be less than 1.50 to 1.00; at any time, “Unsecured Indebtedness” may not exceed sixty percent (60%) of “Capitalization Value of Unencumbered Assets;” and the ratio of “Secured Indebtedness” to “Capitalization Value,” each measured as of the most recently ended calendar quarter, may not exceed fifty percent (50%). The new agreement also contains standard representations and warranties and other covenants. The terms in quotations in this paragraph are all defined in the new agreement, which was filed as an exhibit to our Current Report on Form 8-K dated September 28, 2007, filed on October 4, 2007.

 

On October 11, 2007, we repaid the $51,678,000 balance of the Crystal Gateway N. and Arlington Plaza mortgage loan.

 

 

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Overview (continued)

 

2007 Financings: (continued)

 

2.85% Convertible Senior Debentures due 2027

 

On March 21, 2007, Vornado Realty Trust sold $1.4 billion aggregate principal amount of 2.85% convertible senior debentures due 2027, pursuant to an effective registration statement. The aggregate net proceeds from this offering, after underwriters’ discounts and expenses, were approximately $1.37 billion. The debentures are redeemable at our option beginning in 2012 for the principal amount plus accrued and unpaid interest. Holders of the debentures have the right to require us to repurchase their debentures in 2012, 2017, and 2022 and in certain other limited circumstances. The debentures are convertible, under certain circumstances, for cash and Vornado common shares at an initial conversion rate of 6.1553 common shares per $1,000 of principal amount of debentures. The initial conversion price is $162.46, which represents a premium of 30% over the March 21, 2007 closing price of $124.97 for our common shares. The principal amount of debentures will be settled for cash and the amount in excess of the principal defined as the conversion value will be settled in cash or, at our election, Vornado common shares.

 

We are amortizing the underwriters’ discount on a straight-line basis (which approximates the interest method) over the period from the date of issuance to the date of earliest redemption of April 1, 2012. Because the conversion option associated with the debentures, when analyzed as a freestanding instrument, meets the criteria to be classified as equity specified by paragraphs 12 to 32 of EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s own Common Stock,” separate accounting for the conversion option under SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities” is not appropriate.

 

The net proceeds of the offering were contributed to the Operating Partnership in the form of an inter-company loan and the Operating Partnership guaranteed the payment of the debentures. The Operating Partnership used the net proceeds primarily for acquisitions and investments and for general corporate purposes.

 

On August 31, 2007, the FASB issued a proposed FASB Staff Position (the “proposed FSP”) that affects the accounting for our convertible and exchangeable senior debentures and Series D-13 convertible preferred units. The proposed FSP requires 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 must be amortized using the effective interest method over the period the debt is expected to remain outstanding as additional interest expense. The proposed FSP, if adopted, would be effective for fiscal years beginning after December 15, 2007 and would require retroactive application. The adoption of the proposed FSP on January 1, 2008 would result in the recognition of an aggregate unamortized debt discount of $190,697,000 (as of September 30, 2007) 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:

 

 

 

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Overview (continued)

The following table sets forth certain information for the properties we own directly or indirectly, including leasing activity. Tenant improvements and leasing commissions are presented below based on square feet leased during the period and on a per annum basis based on the weighted average term of the leases.

 

 

The information above does not include 555 California Street, in which we acquired a 70% interest on May 24, 2007, because its operations are included in the “Other” for segment reporting purposes. 555 California Street, located in San Francisco’s financial district, aggregates 1.8 million square feet and is 96.3% occupied as of September 30, 2007.

 

_________________________

See notes on following page.

 

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Overview (continued)

 

 

_______________________________

 

 

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Reconciliation of Net Income and EBITDA – Three Months Ended September 30, 2007 and 2006

Below is a summary of net income and a reconciliation of net income to EBITDA⁽¹⁾ by segment for the three months ended September 30, 2007 and 2006.

 

 

EBITDA includes net gains on sale of real estate of $36,725, of which $24,696 is included in the Washington, DC office segment, $3,049 is included in the Retail segment and $8,980 is included in the Other segment. In addition, Other segment EBITDA includes a $18,606 net gain on mark-to-market of derivative instruments and a $1,012 net gain on sale of marketable equity securities.

___________________

See notes on page 55.

 

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Reconciliation of Net Income and EBITDA – Three Months Ended September 30, 2007 and 2006 (continued)

 

 

Other segment EBITDA includes a $70,687 net gain on mark-to-market of derivative instruments, a $10,842 net gain on sale of real estate and a $8,032 net gain on sale of marketable equity securities.

 

______________________________

See notes on following page.

 

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Reconciliation of Net Income and EBITDA – Three Months Ended September 30, 2007 and 2006 (continued)

 

Notes to preceding tabular information:

 

 

 

 

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Results of Operations – Three Months Ended September 30, 2007 and 2006

Revenues

Our revenues, which consist of property rentals, tenant expense reimbursements, Temperature Controlled Logistics revenues, hotel revenues, trade shows revenues, amortization of acquired below market leases, net of above market leases pursuant to SFAS No. 141 and 142, and fee income, were $853,036,000 for the three months ended September 30, 2007, compared to $675,931,000 for the prior year’s three months, an increase of $177,105,000. Below are the details of the increase (decrease) by segment:

 

______________________________

See Notes on the following page.

 

 

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Results of Operations – Three Months Ended September 30, 2007 and 2006 (continued)

 

Notes to the preceding tabular information:

 

 

 

 

 

 

 

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Results of Operations – Three Months Ended September 30, 2007 and 2006 (continued)

 

Expenses

Our expenses, which consist of operating, depreciation and amortization and general and administrative expenses, were $630,082,000 for the three months ended September 30, 2007, compared to $500,460,000 for the prior year’s three months, an increase of $129,622,000. Below are the details of the increase (decrease) by segment:

 

__________________________

 

 

 

 

 

 

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Results of Operations – Three Months Ended September 30, 2007 and 2006 (continued)

 

Income Applicable to Alexander’s

 

Our 32.8% share of Alexander’s net income (comprised of equity in net income or loss, management, leasing, development and commitment fees) was $12,111,000 for the three months ended September 30, 2007, compared to $3,586,000 for the prior year’s three months, an increase of $15,697,000. This increase was primarily due to $3,075,000 for our share of income in the current quarter for the reversal of accrued stock appreciation rights compensation expense as compared to $10,797,000 of expense in the prior year’s quarter, and an increase of $1,113,000 in development fees in the current quarter.

 

Loss Applicable to Toys

 

Our 32.8% share of Toys’ financial results (comprised of our share of Toys’ net loss, interest income on loans receivable, and management fees) for the three months ended September 30, 2007 and September 30, 2006 are for Toys fiscal quarters ended August 5, 2007 and July 29, 2006, respectively. In the three months ended September 30, 2007, our loss applicable to Toys was $20,289,000, or $37,855,000 before our share of Toys’ income tax benefit, as compared to $40,699,000, or $45,627,000 before our share of Toys’ income tax benefit in the prior year’s three months. The decrease in our loss applicable to Toys’ before income tax benefit of $7,772,000 results primarily from (i) an increase in Toys’ net sales due to improvements in comparable store sales across all divisions and benefits in foreign currency translation (comparable store sales increases were 1.1% for Toys “R” Us – U.S., 5.9% for Toys “R” Us – International, and 2.2% for Babies “R” Us), (ii) a net gain related to a lease termination, (iii) decreased interest expense primarily due to reduced borrowings and reduced amortization of deferred financing costs, partially offset by, (iv) an increase in selling, general and administrative expenses as a result of higher payroll, store occupancy, corporate and advertising expenses, which as a percentage of net sales were 31.4% and 30.3% for the quarters ended August 5, 2007 and July 29, 2006, respectively.

 

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Results of Operations – Three Months Ended September 30, 2007 and 2006 (continued)

 

Income from Partially Owned Entities

Summarized below are the components of income from partially owned entities for the three months ended September 30, 2007 and 2006.

 

________________________

 

 

 

 

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Results of Operations – Three Months Ended September 30, 2007 and 2006 (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 $56,906,000 for the three months ended September 30, 2007, compared to $98,092,000 for the prior year’s three months, a decrease of $41,186,000. This decrease resulted primarily from a net gain of $68,796,000 from the mark-to-market of the McDonalds derivative position in the three months ended September 30, 2006, as compared to a net gain of $28,190,000 in the three months ended September 30, 2007.

 

Interest and Debt Expense

Interest and debt expense was $165,889,000 for the three months ended September 30, 2007, compared to $115,280,000 for the prior year’s three months, an increase of $50,609,000. This increase was primarily due to (i) $40,025,000 from a $2.8 billion increase in outstanding mortgage debt due to property acquisitions, new property financings and refinancings, (ii) $21,339,000 from the November 20, 2006 issuance of $1 billion convertible senior debentures and the March 21, 2007 issuance of $1.4 billion convertible senior debentures, partially offset by (iii) a $3,961,000 increase in the amount of capitalized interest in connection with properties under development and (iv) $6,847,000 of expense arising from the prepayment of debt in the prior year’s quarter.

 

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

Net gain on disposition of wholly owned and partially owned assets other than depreciable real estate was $1,012,000 and $8,032,000 for the three months ended September 30, 2007, and 2006, respectively, and represent net gains on sale of marketable securities in each period.

 

Minority Interest of Partially Owned Entities

Minority interest of partially owned entities was income of $3,587,000 for the three months ended September 30, 2007, compared to $2,534,000 of income for the prior year’s three 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, the 555 California Street complex, AmeriCold, 220 Central Park South, Wasserman and the Springfield Mall.

 

Provision for Income Taxes

Provision for income taxes was $3,048,000 for the three months ended September 30, 2007, compared to $382,000 for the prior year’s three months, an increase of $2,666,000. This increase results primarily from two H Street corporations which we consolidate as of April 30, 2007, the date we acquired the remaining 50% of these corporations we did not previously own (we previously accounted for our 50% interest on the equity method). Beginning on January 1, 2008, these corporations will elect to be treated as real estate investment trusts under Sections 856-860 of the Internal Revenue Code of 1986, as amended, which will eliminate their Federal income tax provision to the extent that 100% of their taxable income is distributed to shareholders.

 

Income From Discontinued Operations

The combined results of operations of the assets related to discontinued operations for the three months ended September 30, 2007 and 2006 include 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.

.

 

61

 

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Results of Operations – Three Months Ended September 30, 2007 and 2006 (continued)

 

EBITDA by Segment

Below are the details of the changes in EBITDA by segment for the three months ended September 30, 2007 from the three months ended September 30, 2006.

 

 

__________________________

 

 

62

 

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Reconciliation of Net Income and EBITDA – Nine Months Ended September 30, 2007 and 2006

Below is a summary of net income and a reconciliation of net income to EBITDA⁽¹⁾ by segment for the nine months ended September 30, 2007 and 2006.

 

 

EBITDA includes net gains on sale of real estate of $37,218, of which $24,696 is included in the Washington, DC office segment, $3,049 is included in the Retail segment and $9,473 is included in the Other segment. In addition, Other segment EBITDA includes a $100,060 net gain on mark-to-market of derivative instruments, a $17,699 net gain on sale of marketable equity securities, $8,807 of expense for costs of an acquisition not consummated and $1,677 of expense for our share of India Property Fund LP organization costs.

_______________________

See notes on page 65.

63

 

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Reconciliation of Net Income and EBITDA – Nine Months Ended September 30, 2007 and 2006 (continued)

 

 

EBITDA includes net gains on sale of real estate of $44,611, of which $17,609 is included in the Washington, DC segment, $9,218 is included in the Retail segment, $4,835 is included in the Merchandise Mart segment, $2,107 is included in the Temperature Controlled Logistics segment and $10,842 is included in the Other segment. In addition, Other segment EBITDA includes a $65,527 net gain on sale of marketable equity securities and a $65,589 net gain on mark-to-market of derivative instruments.

 

________________________

See notes on the following page.

 

64

 

---

Reconciliation of Net Income and EBITDA – Nine Months Ended September 30, 2007 and 2006 (continued)

 

Notes to preceding tabular information

 

 

 

65

 

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Results of Operations – Nine Months Ended September 30, 2007 and 2006 (continued)

Revenues

Our revenues, which consist of property rentals, tenant expense reimbursements, Temperature Controlled Logistics revenues, hotel revenues, trade shows revenues, amortization of acquired below market leases, net of above market leases pursuant to SFAS No. 141 and 142, and fee income, were $2,382,165,000 for the nine months ended September 30, 2007, compared to $1,978,488,000 for the prior year’s nine months, an increase of $403,677,000. Below are the details of the increase (decrease) by segment:

 

_____________________

See Notes on the following page.

 

 

66

 

---

Results of Operations – Nine Months Ended September 30, 2007 and 2006 (continued)

 

Notes to the preceding tabular information:

 

 

 

 

 

 

67

 

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Results of Operations – Nine Months Ended September 30, 2007 and 2006 (continued)

Expenses

Our expenses, which consist of operating, depreciation and amortization and general and administrative expenses, were $1,754,330,000 for the nine months ended September 30, 2007, compared to $1,434,711,000 for the prior year’s nine months, an increase of $319,619,000. Below are the details of the increase (decrease) by segment:

 

_____________________________

 

 

 

 

 

 

68

 

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Results of Operations – Nine Months Ended September 30, 2007 and 2006 (continued)

Income Applicable to Alexander’s

 

Our 32.8% share of Alexander’s net income (comprised of equity in net income or loss, management, leasing, development and commitment fees) was $35,114,000 for the nine months ended September 30, 2007, compared to $7,569,000 for the prior year’s nine months, an increase of $27,545,000. This increase was primarily due to (i) our $8,991,000 share of income in the current nine month period for the reversal of accrued stock appreciation rights compensation expense as compared to $18,356,000 for our share of expense in the prior year’s nine months, (ii) an increase of $3,101,000 in our equity in earnings of Alexander’s before stock appreciation rights and net gains on sales of condominiums, (iii) an increase of $2,504,000 in development fees in the current period, partially offset by (iv) our $4,580,000 share of Alexander’s net gain on sale of 731 Lexington Avenue condominiums in the prior year’s nine months.

 

Income Applicable to Toys

 

Our 32.8% share of Toys’ net income (comprised of equity in net income, interest income on loans receivable, and management fees) was $18,343,000 for the nine months ended September 30, 2007, compared to $4,177,000 for the prior year’s nine months, an increase of $14,166,000.

 

Income from Partially Owned Entities

Summarized below are the components of income from partially owned entities for the nine months ended September 30, 2007 and 2006.

________________________

 

 

 

 

69

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Results of Operations – Nine Months Ended September 30, 2007 and 2006 (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 $231,890,000 for the nine months ended September 30, 2007, compared to $137,186,000 for the prior year’s nine months, an increase of $94,704,000. This increase resulted primarily from:

 

 

Interest and Debt Expense

Interest and debt expense was $469,659,000 for the nine months ended September 30, 2007, compared to $339,118,000 for the prior year’s nine months, an increase of $130,541,000. This increase was primarily due to (i) $96,532,000 from a $2.8 billion increase in outstanding mortgage debt due to property acquisitions, new property financings and refinancings and repayments, (ii) $53,295,000 from the November 20, 2006 issuance of $1 billion convertible senior debentures and the March 21, 2007 issuance of $1.4 billion convertible senior debentures, partially offset by (iii) an $22,054,000 increase in the amount of capitalized interest in connection with properties under development.

 

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

Net gain on disposition of wholly owned and partially owned assets other than depreciable real estate was $17,699,000 and $65,527,000 for the nine months ended September 30, 2007, and 2006, respectively, and represents net gains on sale of marketable securities in each period.

 

Minority Interest of Partially Owned Entities

Minority interest of partially owned entities was income of $11,819,000 for the nine months ended September 30, 2007, compared to income of $5,378,000 for the prior year’s nine 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, the 555 California Street complex, AmeriCold, 220 Central Park South, Wasserman and the Springfield Mall.

 

Provision For Income Taxes

The provision for income taxes was $6,815,000 for the nine months ended September 30, 2007, compared to $2,362,000 for the prior year’s nine months, an increase of $4,453,000. This increase results from two H Street corporations, which we consolidate as of April 30, 2007, the date we acquired the remaining 50% of these corporations we did not previously own (we previously accounted for our 50% investment on the equity method). Beginning on January 1, 2008, these corporations will elect to be treated as real estate investment trusts under Sections 856-860 of the Internal Revenue Code of 1986, as amended, which will eliminate their Federal income tax provision to the extent that 100% of their taxable income is distributed to shareholders.

 

 

70

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Results of Operations – Nine Months Ended September 30, 2007 and 2006 (continued)

 

Income From Discontinued Operations

The combined results of operations of the assets related to discontinued operations for the nine months ended September 30, 2007 and 2006 include Vineland, New Jersey, which was sold on July 16, 2007; Crystal Mall Two, which was sold on August 9, 2007; Arlington Plaza, which was sold on October 17, 2007; 33 North Dearborn Street, which was sold on March 14, 2006; 424 Sixth Avenue, which was sold on March 13, 2006 and 1919 South Eads Street, which was sold on June 22, 2006.

 

 

EBITDA by Segment

Below are the details of the changes in EBITDA by segment for the nine months ended September 30, 2007 from the nine months ended September 30, 2006.

__________________________

 

 

 

71

 

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Liquidity and Capital Resources – Nine Months ended September 30, 2007 and 2006

Cash Flows for the Nine Months Ended September 30, 2007

Our cash and cash equivalents was $834,274,000 at September 30, 2007, a $1,399,043,000 decrease over the balance at December 31, 2006. This decrease resulted from $3,065,557,000 of net cash used in investing activities, partially offset by, $1,179,421,000 of net cash provided by financing activities and $487,093,000 of net cash provided by operating activities. Property rental income represents our primary source of net cash provided by operating activities. Our property rental income is primarily 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 revolving credit facilities; 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 consolidated outstanding debt was $12,576,484,000 at September 30, 2007, a $3,021,686,000 increase over the balance at December 31, 2006. This increase resulted primarily from the issuance of $1,400,000,000 of convertible senior debentures due 2026 and from mortgage debt associated with asset acquisitions and property refinancings during the current quarter. As of September 30, 2007 and December 31, 2006, our revolving credit facilities had a $94,000,000 balance. During 2007 and 2008, $51,689,000 and $538,198,000 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 $3,104,451,000 at September 30, 2007, a $218,556,000 decrease from the balance at December 31, 2006. This decrease resulted primarily from our $297,906,000 share of Toys’ decrease in outstanding debt.

 

Cash flows provided by operating activities of $487,093,000 was primarily comprised of (i) net income of $463,692,000, after adjustments of $125,150,000 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, (ii) distributions of income from partially owned entities of $18,047,000, partially offset by, (iii) the net change in operating assets and liabilities of $119,796,000.

 

Net cash used in investing activities of $3,065,557,000 was primarily comprised of (i) acquisitions of real estate of $2,775,982,000, (ii) investments in notes and mortgage loans receivable of $211,942,000, (iii) deposits in connection with real estate acquisitions and pre-acquisition costs of $21,231,000, (iv) investments in partially owned entities of $201,432,000, (v) development and redevelopment expenditures of $231,575,000, (vi) investments in marketable securities of $152,683,000, partially offset by, (vii) proceeds received from repayments on mortgage loans receivable of $211,942,000 and (viii) proceeds received from sales of real estate of $217,941,000.

 

Net cash provided by financing activities of $1,179,421,000 was primarily comprised of (i) proceeds from borrowings of $2,517,105,000, 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 $727,730,000, (iii) dividends paid on common shares of $387,268,000, (iv) purchases of marketable securities in connection with the legal defeasance of mortgage notes payable of $109,092,000, (v) distributions to minority partners of $62,169,000, and (vi) dividends paid on preferred shares of $42,940,000.

 

Capital Expenditures

Our capital expenditures consist of expenditures to maintain assets, tenant improvements and leasing commissions. Recurring capital improvements include expenditures to maintain a property’s competitive position within the market and tenant improvements and leasing commissions necessary to re-lease expiring leases or renew or extend existing leases. Non-recurring capital improvements include expenditures completed in the year of acquisition and the following two years that were planned at the time of acquisition as well as tenant improvements and leasing commissions for space that was vacant at the time of acquisition of a property. Our 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.

 

72

 

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Liquidity and Capital Resources – Nine Months ended September 30, 2007 and 2006 (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 nine months ended September 30, 2007.

 

_______________________

 

73

 

---

Liquidity and Capital Resources – Nine Months ended September 30, 2007 and 2006 (continued)

 

Cash Flows for the Nine Months Ended September 30, 2006

 

Our cash and cash equivalents was $386,882,000 at September 30, 2006, a $92,378,000 increase over the balance at December 31, 2005. This increase resulted from $486,838,000 of net cash provided by operating activities, $374,854,000 of net cash provided by financing activities, partially offset by $769,314,000 of net cash used in investing activities. Property rental income represents our primary source of net cash provided by operating activities. Our property rental income is primarily 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 $1 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 consolidated outstanding debt was $7,382,460,000 at September 30, 2006, a $1,139,334,000 increase over the balance at December 31, 2005. This increase resulted primarily from debt associated with asset acquisitions and property refinancings during 2006.

 

Our share of debt of unconsolidated subsidiaries was $3,286,180,000 at September 30, 2006, a $283,834,000 increase over the balance at December 31, 2005. This increase resulted primarily from our $92,120,000 share of an increase in Toys “R” Us outstanding debt and from debt associated with asset acquisitions and refinancings.

 

Cash flows provided by operating activities of $486,838,000 was primarily comprised of (i) net income of $440,364,000, after adjustments of $96,823,000 for non-cash items, including depreciation and amortization expense, the effect of straight-lining of rental income, minority interest expense and net gains on sale of real estate and assets other than depreciable real estate, (ii) distributions of income from partially-owned entities of $27,518,000, partially offset by, (iii) the net change in operating assets and liabilities of $77,867,000.

 

Net cash used in investing activities of $769,314,000 was primarily comprised of (i) investments in notes and mortgage loans receivable of $361,841,000, (ii) capital expenditures of $139,751,000, (iii) development and redevelopment expenditures of $156,051,000, (iv) investments in partially-owned entities of $112,729,000, (v) acquisitions of real estate of $572,472,000, (vi) investments in marketable securities of $83,698,000, (vii) deposits in connection with real estate acquisitions, including pre-acquisition costs, of $21,676,000, (viii) restricted cash, including mortgage escrows, of $2,527,000, partially offset by, (ix) proceeds received on the settlement of derivatives (primarily Sears Holdings) of $135,028,000, (x) proceeds from the sale of real estate of $110,388,000, (xi) distributions of capital from partially-owned entities of $108,779,000, (xii) proceeds from the sale of, and returns of investment in, marketable securities of $157,363,000, and (xiii) proceeds from  repayments on notes and mortgages receivable of $169,746,000.

 

Net cash provided by financing activities of $374,854,000 was primarily comprised of (i) proceeds from borrowings of $1,807,091,000, (ii) proceeds from the issuance of preferred units of $43,862,000, (iii) proceeds of $9,510,000 from the exercise by employees of share options, partially offset by, (iv) dividends paid on common shares of $339,844,000, (v) repayments of borrowings of $802,785,000, (vi) purchases of marketable securities in connection with the legal defeasance of mortgage notes payable of $174,254,000, (vii) dividends paid on preferred shares of $43,257,000, (viii) distributions to minority partners of $65,303,000 and (ix) debt issuance costs of $15,166,000.

 

 

 

74

 

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Liquidity and Capital Resources – Nine Months ended September 30, 2007 and 2006 (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 nine months ended September 30, 2006.

 

___________________

 

75

 

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SUPPLEMENTAL INFORMATION

 

Three Months Ended September 30, 2007 vs. Three Months Ended June 30, 2007

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

 

______________________________________

 

 

 

 

The following table reconciles Net income to EBITDA for the quarter ended June 30, 2007.

 

 

 

76

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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 Generally Accepted Accounting Principles (“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 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 Consolidated 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.

 

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. We believe 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.

 

The calculations of both the numerator and denominator used in the computation of income per share are disclosed in footnote 12 - Income Per Share, in the notes to our consolidated financial statements on page 26 of this Quarterly Report on Form 10-Q.

 

FFO applicable to common shares plus assumed conversions was $221,199,000, or $1.35 per diluted share for the three months ended September 30, 2007, compared to $204,535,000, or $1.31 per diluted share for the prior year’s quarter. FFO applicable to common shares plus assumed conversions was $773,457,000, or $4.71 per diluted share for the nine months ended September 30, 2007, compared to $646,881,000, or $4.17 per diluted share for the prior years nine months. Details of certain items that affect comparability are discussed in the financial results summary of our “Overview.”

 

 

 

77

 

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We have exposure to fluctuations in market interest rates. Market interest rates are highly 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. In addition, we have notes and mortgage loans receivables aggregating $295,889,000, as of September 30, 2007, which are based on variable rates and partially mitigate our exposure to a change in interest rates.

 

Fair Value of Our Debt

 

The carrying amount of our debt exceeds its aggregate fair value, 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, by approximately $421,002,000 at September 30, 2007.

 

Derivative Instruments

 

We have, and may in the future enter into, derivative positions that do not qualify for hedge accounting treatment, including our economic interest in McDonald’s common shares. 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 nine months ended September 30, 2007, we recognized net gains aggregating approximately $18,606,000 and $100,060,000 respectively, from these positions, after all expenses and LIBOR charges.

 

78

 

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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 September 30, 2007, 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.

 

79

 

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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.

 

The following updates the discussion set forth under “Item 3. Legal Proceedings” in our Annual Report on Form 10-K for the year ended December 31, 2006.

 

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 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. On April 16, 2007, the Court directed that discovery should be completed by December 2007, with a trial date to be determined thereafter. We intend to vigorously pursue our claims against Stop & Shop.

 

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 already received access to the books and records to which he was entitled, with the exception of certain documents which the general partners have requested from third parties but have not yet been received. 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.

 

80

 

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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, 2006.

 

None.

 

None.

 

None.

 

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.

 

 

 

81

 

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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.

 

 

 

 

82

 

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EXHIBIT INDEX

 

83

 

---

 

 

84

 

---

 

 

85

 

---

 

 

86

 

---

 

 

87

 

---

 

 

88

 

---

 

 

89

 

---

 

 

90

 

---

 

 

91

 

---

 

 

92

 

---

 

 

93

 

---

 

 

 

94

---