10-Q 1 l38213e10vq.htm FORM 10-Q e10vq
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
     
x   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 2009
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                     to                     
Commission file number 1-4372
FOREST CITY ENTERPRISES, INC.
 
(Exact name of registrant as specified in its charter)
     
Ohio   34-0863886
     
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
         
Terminal Tower   50 Public Square    
Suite 1100   Cleveland, Ohio   44113
     
(Address of principal executive offices)   (Zip Code)
     
Registrant’s telephone number, including area code   216-621-6060
 
(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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes     o     No     o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer   x Accelerated filer   o 
Non-accelerated filer   o
(Do not check if a smaller reporting company)
Smaller reporting company   o
Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes     o     No     x     
Indicate the number of shares outstanding, including unvested restricted stock, of each of the issuer’s classes of common stock, as of the latest practicable date.
         
Class   Outstanding at December 3, 2009  
Class A Common Stock, $.33 1/3 par value
  133,850,053 shares
 
Class B Common Stock, $.33 1/3 par value
  22,563,412 shares

 


 

Forest City Enterprises, Inc. and Subsidiaries
Table of Contents
                 
              Page  
PART I. FINANCIAL INFORMATION        
       
 
       
           
 
 
       
         
 
 
       
      2  
 
 
       
      3  
 
 
       
      4  
 
 
       
      5  
 
 
       
      6  
 
 
       
      8  
 
 
       
        42  
 
 
       
        75  
 
 
       
        79  
 
 
       
PART II. OTHER INFORMATION        
       
 
       
        79  
 
 
       
        79  
 
 
       
        82  
 
 
       
        83  
 
 
       
  Signatures     88  
       
 
       
  Certifications        

i


 

PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
Forest City Enterprises, Inc. and Subsidiaries
Consolidated Balance Sheets
                 
    October 31, 2009     January 31, 2009  
    (Unaudited)     (As Adjusted)  
    (in thousands)  
Assets
               
Real Estate
               
Completed rental properties
   $ 8,340,178     $ 8,212,144  
Projects under development
    2,693,712       2,241,216  
Land held for development or sale
    221,059       195,213  
     
Total Real Estate
    11,254,949       10,648,573  
 
               
Less accumulated depreciation
    (1,545,892 )     (1,419,271 )
     
 
               
Real Estate, net
    9,709,057       9,229,302  
 
               
Cash and equivalents
    321,804       267,305  
Restricted cash
    363,098       291,224  
Notes and accounts receivable, net
    371,158       427,410  
Investments in and advances to affiliates
    239,936       228,995  
Other assets
    888,564       936,271  
     
 
               
 
Total Assets
   $ 11,893,617     $ 11,380,507  
     
 
               
Liabilities and Equity
               
Liabilities
               
Mortgage debt, nonrecourse
   $ 7,463,623     $ 7,078,390  
Notes payable
    181,374       181,919  
Bank revolving credit facility
    37,016       365,500  
Senior and subordinated debt
    1,075,555       846,064  
Accounts payable and accrued expenses
    1,199,171       1,277,199  
Deferred income taxes
    442,863       455,336  
     
Total Liabilities
    10,399,602       10,204,408  
 
               
Commitments and Contingencies
    -       -  
 
               
Equity
               
Shareholders’ Equity
               
Preferred stock - without par value; 10,000,000 shares authorized; no shares issued
    -       -  
Common stock - $.33 1/3 par value
               
Class A, 271,000,000 shares authorized, 132,769,118 and 80,082,126 shares issued and 132,741,066 and 80,080,262 shares outstanding, respectively
    44,256       26,694  
Class B, convertible, 56,000,000 shares authorized, 22,583,412 and 22,798,025 shares issued and outstanding, respectively; 26,257,961 issuable
    7,528       7,599  
     
 
    51,784       34,293  
Additional paid-in capital
    567,327       267,796  
Retained earnings
    606,872       643,724  
Less treasury stock, at cost; 28,052 and 1,864 Class A shares, respectively
    (154 )     (21 )
     
Shareholders’ equity before accumulated other comprehensive loss
    1,225,829       945,792  
Accumulated other comprehensive loss
    (91,388 )     (107,521 )
     
Total Shareholders’ Equity
    1,134,441       838,271  
 
               
Noncontrolling interests
    359,574       337,828  
     
Total Equity
    1,494,015       1,176,099  
     
 
Total Liabilities and Equity
   $ 11,893,617     $ 11,380,507  
     
The accompanying notes are an integral part of these consolidated financial statements.

2


 

Forest City Enterprises, Inc. and Subsidiaries
Consolidated Statements of Operations

(Unaudited)
                                  
    Three Months Ended October 31,     Nine Months Ended October 31,  
            2008             2008  
    2009     (As Adjusted)     2009     (As Adjusted)  
            (in thousands, except per share data)          
 
                               
Revenues from real estate operations
   $ 306,100      $ 330,381      $ 932,889      $ 960,007  
         
 
                               
Expenses
                               
Operating expenses
    171,684       200,441       532,000       593,306  
Depreciation and amortization
    66,393       64,038       199,659       198,610  
Impairment of real estate
    549       -       3,124       -  
         
 
 
    238,626       264,479       734,783       791,916  
         
 
                               
Interest expense
    (87,863 )     (97,081 )     (258,434 )     (259,450 )
Amortization of mortgage procurement costs
    (3,562 )     (2,838 )     (10,645 )     (8,723 )
Gain (loss) on early extinguishment of debt
    28,902       3,692       37,965       (1,539 )
 
                               
Interest and other income
    5,522       6,752       23,924       27,976  
Gain on disposition of other investments
    -       -       -       150  
         
 
Earnings (loss) before income taxes
    10,473       (23,573 )     (9,084 )     (73,495 )
         
 
                               
Income tax expense (benefit)
                               
Current
    3,991       (4,499 )     (9,537 )     (15,044 )
Deferred
    (6,886 )     (7,417 )     (16,337 )     (13,338 )
         
 
 
    (2,895 )     (11,916 )     (25,874 )     (28,382 )
         
 
                               
Equity in earnings (loss) of unconsolidated entities
    1,364       (3,198 )     (10,477 )     (12,761 )
Impairment of unconsolidated entities
    (13,200 )     -       (34,663 )     (6,026 )
         
 
Earnings (loss) from continuing operations
    1,532       (14,855 )     (28,350 )     (63,900 )
 
                               
Discontinued operations, net of tax:
                               
Operating earnings (loss) from rental properties
    (5,403 )     202       (5,087 )     1,027  
Gain on disposition of rental properties
    -       -       2,784       5,294  
         
 
    (5,403 )     202       (2,303 )     6,321  
         
 
                               
Net loss
    (3,871 )     (14,653 )     (30,653 )     (57,579 )
Net earnings attributable to noncontrolling interests
    (513 )     (4,462 )     (6,199 )     (10,324 )
         
 
                               
Net loss attributable to Forest City Enterprises, Inc.
   $ (4,384 )   $ (19,115 )    $ (36,852 )   $ (67,903 )
         
 
                               
 
                               
Basic and diluted earnings (loss) per common share
                               
Earnings (loss) from continuing operations attributable to Forest City Enterprises, Inc.
   $ 0.01     $ (0.19 )    $ (0.26 )   $ (0.72 )
Earnings (loss) from discontinued operations attributable to Forest City Enterprises, Inc.
    (0.04 )     -       (0.01 )     0.06  
         
 
Net loss attributable to Forest City Enterprises, Inc.
   $ (0.03 )   $ (0.19 )    $ (0.27 )   $ (0.66 )
         
The accompanying notes are an integral part of these consolidated financial statements.

3


 

Forest City Enterprises, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)
                                   
    Three Months Ended October 31,     Nine Months Ended October 31,  
            2008             2008  
    2009     (As Adjusted)     2009     (As Adjusted)  
    (in thousands)  
 
                               
Net loss
   $ (3,871 )    $ (14,653 )    $ (30,653 )    $ (57,579 )
         
 
                               
Other comprehensive income, net of tax:
                               
 
                               
Unrealized net losses on investment securities
    (76 )     (291 )     (189 )     (140 )
 
                               
Foreign currency translation adjustments
    (12 )     (960 )     597       (960 )
 
                               
Unrealized net losses on interest rate derivative contracts
    (3,223 )     (6,594 )     16,346       9,860  
         
 
                               
Total other comprehensive income (loss), net of tax
    (3,311 )     (7,845 )     16,754       8,760  
         
 
                               
Comprehensive loss
    (7,182 )     (22,498 )     (13,899 )     (48,819 )
 
                               
Comprehensive income attributable to noncontrolling interests
    (391 )     (4,554 )     (6,820 )     (11,310 )
         
 
                               
Total comprehensive loss attributable to Forest City Enterprises, Inc.
   $ (7,573 )    $ (27,052 )    $ (20,719 )    $ (60,129 )
         
The accompanying notes are an integral part of these consolidated financial statements.

4


 

Forest City Enterprises, Inc. and Subsidiaries
Consolidated Statements of Equity

(Unaudited)
                                                                                         
                                                                    Accumulated              
    Common Stock     Additional                             Other              
    Class A     Class B     Paid-In     Retained     Treasury Stock     Comprehensive     Noncontrolling        
    Shares     Amount     Shares     Amount     Capital     Earnings     Shares     Amount     Loss     Interest     Total  
     
    (in thousands)  
Nine Months Ended October 31, 2009
                                                                                       
Balances at January 31, 2009, as reported
    80,082     $ 26,694       22,798     $ 7,599     $ 241,539     $ 645,852       2     $ (21 )   $ (107,521 )   $ -     $ 814,142  
Retrospective adoption of accounting guidance for convertible debt instruments
                                    26,257       (2,128 )                                     24,129  
Reclassification upon adoption of accounting guidance for noncontrolling interests
                                                                            337,828       337,828  
     
Balances at January 31, 2009, as adjusted
    80,082     $ 26,694       22,798     $ 7,599     $ 267,796     $ 643,724       2     $ (21 )   $ (107,521 )   $ 337,828     $ 1,176,099  
 
                                                                                       
Net loss
                                            (36,852 )                             6,199       (30,653 )
Other comprehensive income, net of tax
                                                                    16,133       621       16,754  
Issuance of Class A common shares in equity offering
    52,325       17,442                       312,475                                               329,917  
Purchase of treasury stock
                                                    26       (133 )                     (133 )
Conversion of Class B to Class A shares
    215       71       (215 )     (71 )                                                     -  
Exercise of stock options
    15       5                       123                                               128  
Restricted stock vested
    132       44                       (44 )                                             -  
Stock-based compensation
                                    12,815                                               12,815  
Excess income tax benefit (deficiency) from stock-based compensation
                                    (2,007 )                                             (2,007 )
Exchange of Puttable Equity-Linked Senior Notes due 2011 (Note E)
                                    (17,490 )                                             (17,490 )
Purchase of Convertible Senior Note hedge, net of tax (Note E)
                                    (9,734 )                                             (9,734 )
Acquisition of partner’s noncontrolling interest in consolidated subsidiary
                                    3,393                                       (3,393 )     -  
Contributions from noncontrolling interests
                                                                            21,619       21,619  
Distributions to noncontrolling interests
                                                                            (8,628 )     (8,628 )
Change to full consolidation method of accounting for a subsidiary
                                                                            5,010       5,010  
Other changes in noncontrolling interests
                                                                            318       318  
     
Balances at October 31, 2009
    132,769     $ 44,256       22,583     $ 7,528     $ 567,327     $ 606,872       28     $ (154 )   $ (91,388 )   $ 359,574     $ 1,494,015  
     
 
                                                                                       
Nine Months Ended October 31, 2008
                                                                                       
Balances at January 31, 2008, as reported
    78,238     $ 26,079       24,388     $ 8,129     $ 229,358     $ 782,871       36     $ (1,665 )   $ (72,656 )   $ -     $ 972,116  
Retrospective adoption of accounting guidance for convertible debt instruments
                                    26,631       (1,081 )                                     25,550  
Reclassification upon adoption of accounting guidance for noncontrolling interests
                                                                            281,689       281,689  
     
Balances at January 31, 2008, as adjusted
    78,238     $ 26,079       24,388     $ 8,129     $ 255,989     $ 781,790       36     $ (1,665 )   $ (72,656 )   $ 281,689     $ 1,279,355  
 
                                                                                       
Net loss
                                            (67,903 )                             10,324       (57,579 )
Other comprehensive income, net of tax
                                                                    7,774       986       8,760  
Dividends $.24 per share
                                            (24,814 )                                     (24,814 )
Purchase of treasury stock
                                                    17       (651 )                     (651 )
Conversion of Class B to Class A shares
    1,590       530       (1,590 )     (530 )                                                     -  
Exercise of stock options
    43       15                       (1,189 )             (53 )     2,307                       1,133  
Restricted stock vested
    77       26                       (26 )                                             -  
Stock-based compensation
                                    13,556                                               13,556  
Conversion of Class A Common Units
    128       42                       3,736                                       (12,624 )     (8,846 )
Distribution of accumulated equity to noncontrolling partners
                                    (3,710 )                                             (3,710 )
Contributions from noncontrolling interests
                                                                            44,348       44,348  
Distributions to noncontrolling interests
                                                                            (22,381 )     (22,381 )
Other changes in noncontrolling interests
                                                                            12,334       12,334  
     
Balances at October 31, 2008
    80,076     $ 26,692       22,798     $ 7,599     $ 268,356     $ 689,073       -     $ (9 )   $ (64,882 )   $ 314,676     $ 1,241,505  
     
The accompanying notes are an integral part of these consolidated financial statements.

5


 

Forest City Enterprises, Inc. and Subsidiaries
Consolidated Statements of Cash Flows

(Unaudited)
                 
    Nine Months Ended October 31,  
            2008  
    2009     (As Adjusted)  
     
    (in thousands)  
Net Loss
    $ (30,653 )   $ (57,579 )
Depreciation and amortization
    199,659       198,610  
Amortization of mortgage procurement costs
    10,645       8,723  
Impairment of real estate
    3,124       -  
Impairment of unconsolidated entities
    34,663       6,026  
Write-off of abandoned development projects
    21,398       41,452  
Gain on early extinguishment of debt, net of cash prepayment penalties
    (37,965 )     (3,945 )
Other income - gain on sale of an ownership interest in parking management company
    -       (3,350 )
Gain on disposition of other investments
    -       (150 )
Deferred income tax benefit
    (16,337 )     (13,338 )
Equity in loss of unconsolidated entities
    10,477       12,761  
Stock-based compensation expense
    5,692       7,016  
Amortization and mark-to-market adjustments of derivative instruments
    5,046       17,265  
Non-cash interest expense related to Puttable Equity-Linked Senior Notes
    6,048       6,672  
Cash distributions from operations of unconsolidated entities
    25,633       40,317  
Discontinued operations:
               
Depreciation and amortization
    1,347       3,911  
Amortization of mortgage procurement costs
    50       339  
Impairment of real estate
    9,775       -  
Deferred income tax (benefit) expense
    (2,307 )     4,617  
Gain on disposition of rental properties
    (4,548 )     (8,627 )
Cost of sales of land included in projects under development and completed rental properties
    24,521       13,076  
Increase in land held for development or sale
    (5,376 )     (17,164 )
Decrease in notes and accounts receivable
    29,999       20,567  
Decrease in other assets
    16,156       5,538  
(Increase) decrease in restricted cash used for operating purposes
    (12,257 )     538  
Decrease in accounts payable and accrued expenses
    (34,766 )     (44,038 )
     
Net cash provided by operating activities
    260,024       239,237  
     
Cash Flows from Investing Activities
               
Capital expenditures, including real estate acquisitions
    (725,101 )     (828,659 )
Payment of lease procurement costs
    (8,519 )     (22,728 )
Decrease (increase) in other assets
    5,148       (37,533 )
Increase in restricted cash used for investing purposes
    (81,422 )     (123,872 )
Proceeds from disposition of rental properties and other investments
    11,914       15,309  
Increase in investments in and advances to affiliates
    (76,515 )     (41,598 )
     
Net cash used in investing activities
    (874,495 )     (1,039,081 )
     
Cash Flows from Financing Activities
               
Sale of common stock, net
    329,917       -  
Proceeds from Convertible Senior Notes due 2016, net of $6,838 of issuance costs
    193,162       -  
Payment for Convertible Senior Notes hedge transaction
    (15,900 )     -  
Proceeds from Puttable Equity-Linked Senior Notes due 2014, net of $2,803 of issuance costs and discount
    29,764       -  
Purchase of Puttable Equity-Linked Senior Notes due 2011
    -       (10,571 )
Proceeds from nonrecourse mortgage debt
    706,335       1,052,737  
Principal payments on nonrecourse mortgage debt
    (228,246 )     (533,383 )
Proceeds from notes payable
    12,623       55,098  
Payments on notes payable
    (13,168 )     (30,924 )
Borrowings on bank revolving credit facility
    322,500       462,500  
Payments on bank revolving credit facility
    (650,984 )     (288,000 )
Payment of subordinated debt
    (20,400 )     -  
Change in restricted cash and book overdrafts
    12,750       43,993  
Payment of deferred financing costs
    (22,369 )     (31,859 )
Purchase of treasury stock
    (133 )     (651 )
Exercise of stock options
    128       1,133  
Distribution of accumulated equity to noncontrolling partners
    -       (3,710 )
Contributions from noncontrolling interests
    21,619       44,348  
Distributions to noncontrolling interests
    (8,628 )     (22,381 )
Payment in exchange for 119,000 Class A Common Units
    -       (3,501 )
Dividends paid to shareholders
    -       (24,742 )
     
Net cash provided by financing activities
    668,970       710,087  
     
Net increase (decrease) in cash and equivalents
    54,499       (89,757 )
 
Cash and equivalents at beginning of period
    267,305       254,434  
     
Cash and equivalents at end of period
    $ 321,804     $ 164,677  
     
The accompanying notes are an integral part of these consolidated financial statements.

6


 

Forest City Enterprises, Inc. and Subsidiaries
Consolidated Statements of Cash Flows

(Unaudited)
Supplemental Non-Cash Disclosures:
The table below represents the effect of the following non-cash transactions for the nine months ended October 31, 2009 and 2008:
                 
    Nine Months Ended October 31,  
            2008  
    2009     (As Adjusted)  
     
    (in thousands)  
 
               
Operating Activities
               
Increase in land held for development or sale (2)(10)(11)
  $ (43,816 )   $ (31,058 )
Decrease (increase) in notes and accounts receivable (2)(5)(7)(8)
    3,971       (693 )
Decrease (increase) in other assets (2)(5)(7)(8)
    952       (47,012 )
Increase in accounts payable and accrued expenses (1)(2)(5)(7)(8)(11)
    (1,858 )     115,873 )
     
Total effect on operating activities
  $ (40,751 )   $ 37,110  
     
 
               
Investing Activities
               
Decrease (increase) in projects under development (2)(10)(11)(12)
  $ 15,412     $ (108,543 )
(Increase) decrease in completed rental properties (2)(5)(7)(8)(9)(10)(11)
    (3,106 )     29,783  
Non-cash proceeds from disposition of properties (1)
    70,554       26,119  
Decrease in investments in and advances to affiliates (2)(5)(7)
    12,719       31,229  
     
Total effect on investing activities
  $ 95,579     $ (21,412 )
     
 
               
Financing Activities
               
Decrease in nonrecourse mortgage debt (1)(2)(5)(7)
  $ (66,961 )   $ (15,071 )
Increase in senior and subordinated debt (3)
    11,414        
Decrease in deferred tax liability (3)(4)
    (6,218 )      
Increase in additional paid-in capital (3)(4)(6)(9)(12)
    5,320       10,276  
Increase (decrease) in noncontrolling interest (2)(5)(6)(9)
    1,617       (10,873 )
Increase in Class A common stock (9)
          42  
Dividends declared but not yet paid
          (72 )
     
Total effect on financing activities
  $ (54,828 )   $ (15,698 )
     
 
(1)  
Assumption of nonrecourse mortgage debt by the buyer upon disposition of Sterling Glen of Great Neck and Sterling Glen of Glen Cove, supported-living apartment communities in the Residential Group, and Grand Avenue, a specialty retail center in the Commercial Group, during the nine months ended October 31, 2009, and Sterling Glen of Lynbrook, a supported-living apartment community in the Residential Group, during the nine months ended October 31, 2008.
 
(2)  
Change to full consolidation method of accounting from equity method due to the occurrence of a triggering event for Gladden Farms II in the Land Development Group during the nine months ended October 31, 2009 and Gladden Farms in the Land Development Group and Shops at Wiregrass, a retail center in the Commercial Group, during the nine months ended October 31, 2008.
 
(3)  
Exchange of a portion of the Company’s Puttable Equity-Linked Senior Notes due October 15, 2011 for a new issue of Puttable Equity-Linked Senior Notes due October 15, 2014 during the nine months ended October 31, 2009 (see Note E - Senior and Subordinated Debt).
 
(4)  
Recording of a deferred tax asset on the purchased hedge transactions in conjunction with the issuance of the Company’s Convertible Senior Notes due October 15, 2016 during the nine months ended October 31, 2009 (see Note E - Senior and Subordinated Debt).
 
(5)  
Exchange of the Company’s 50% ownership interest in Boulevard Towers, an equity method investment in the Residential Group, for 100% ownership in North Church Towers, an apartment complex in the Residential Group, during the nine months ended October 31, 2009 and exchange of the Company’s controlling ownership interests in seventeen single-tenant pharmacy properties for the noncontrolling ownership interests in two entities during the nine months ended October 31, 2008.
 
(6)  
Acquisition of partner’s 50% noncontrolling interests in Gladden Farms in the Land Development Group during the nine months ended October 31, 2009.
 
(7)  
Change to full consolidation method of accounting from equity method due to the acquisition of a partner’s interest in Village Center apartment community in the Residential Group during the nine months ended October 31, 2008.
 
(8)  
Amounts related to purchase price allocations in the Commercial Group during the nine months ended October 31, 2008 for the following office buildings: New York Times, Twelve MetroTech Center, Commerce Court, Colorado Studios and Richmond Office Park.
 
(9)  
Exchange of the Class A Common Units during the nine months ended October 31, 2008 (see Note P - Class A Common Units).
 
(10)  
Commercial Group and Residential Group outlots reclassified prior to sale from projects under development or completed rental properties to land held for sale.
 
(11)  
Increase or decrease in construction payables included in accounts payable and accrued expenses.
 
(12)  
Capitalization of stock-based compensation granted to employees directly involved with the acquisition, development and construction of real estate.
The accompanying notes are an integral part of these consolidated financial statements.

7


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
A.    Accounting Policies
Basis of Presentation
The interim consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and should be read in conjunction with the consolidated financial statements and related notes included in the Company’s annual report on Form 10-K for the year ended January 31, 2009, including the Report of Independent Registered Public Accounting Firm, as amended on Form 10-K/A filed September 25, 2009 and updated on Form 8-K filed October 19, 2009. The results of interim periods are not necessarily indicative of results for the full year or any subsequent period. In the opinion of management, all adjustments considered necessary for a fair statement of financial position, results of operations and cash flows at the dates and for the periods presented have been included. Effective February 1, 2009, the Company adopted the accounting guidance for convertible debt instruments that may be settled in cash upon conversion and noncontrolling interests. This accounting guidance required the Company to adjust the prior year financial statements to show retrospective application upon adoption.
Retrospective Adoption of Accounting Guidance for Convertible Debt Instruments
The accounting guidance for convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) requires the liability and equity components of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlements) to be separately accounted for in a manner that reflects the issuer’s nonconvertible debt borrowing rate. This accounting guidance changed the accounting treatment for the Company’s 3.625% Puttable Equity-Linked Senior Notes due October 2011 (the “2011 Notes”), which were issued in October 2006, by requiring the initial debt proceeds from the sale of the 2011 Notes to be allocated between a liability component and an equity component. This allocation is based upon what the assumed interest rate would have been on the date of issuance if the Company had issued similar nonconvertible debt. The resulting debt discount will be amortized over the debt instrument’s expected life as additional non-cash interest expense. Due to the increase in interest expense, the Company recorded additional capitalized interest based on its qualifying expenditures on its development projects. Deferred financing costs decreased related to the reallocation of the original issuance costs between the debt instrument and equity component and the gain recognized from the purchase of $15,000,000, in principal, of the 2011 Notes during the three months ended October 31, 2008 was adjusted to reflect the requirements of gain recognition under this accounting guidance (see Note E - Senior and Subordinated Debt).
The following tables reflect the Company’s as reported amounts along with the as adjusted amounts as a result of the retrospective adoption of this accounting guidance:
                                                 
    January 31, 2009  
    As     Retrospective     As  
       Reported        Adjustments        Adjusted     
    (in thousands)  
 
                       
Consolidated Balance Sheet
                       
Real estate, net
    $ 9,212,834     $ 16,468     $ 9,229,302  
Other assets
    936,902       (631 )     936,271  
Senior and subordinated debt
    870,410       (24,346 )     846,064  
Deferred income taxes
    439,282       16,054       455,336  
Additional paid-in capital
    241,539       26,257       267,796  
Retained earnings
    645,852       (2,128 )     643,724  
                                                 
    Three Months Ended October 31, 2008     Nine Months Ended October 31, 2008  
    As     Retrospective     As     As     Retrospective     As  
    Reported(1)     Adjustments     Adjusted        Reported(1)        Adjustments        Adjusted     
    (in thousands, except per share data)  
 
                                               
Consolidated Statements of Operations
                                               
Depreciation and amortization
  $ 63,992     $ 46     $ 64,038     $ 198,474     $ 136     $ 198,610  
Interest expense, net of capitalized interest
    96,661       420       97,081       258,779       671       259,450  
Gain (loss) on early extinguishment of debt
    4,181       (489 )     3,692       (1,050 )     (489 )     (1,539 )
Deferred income tax benefit
    (7,043 )     (374 )     (7,417 )     (12,830 )     (508 )     (13,338 )
Loss from continuing operations
    (14,274 )     (581 )     (14,855 )     (63,112 )     (788 )     (63,900 )
Net loss attributable to Forest City Enterprises, Inc.
    (18,534 )     (581 )     (19,115 )     (67,115 )     (788 )     (67,903 )
Net loss attributable to Forest City Enterprises, Inc.
per share - basic and diluted
  $ (0.18 )   $ (0.01 )   $ (0.19 )   $ (0.65 )   $ (0.01 )   $ (0.66 )
 
(1)   Adjusted to reflect the impact of discontinued operations (see Note K).

8


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
A.    Accounting Policies (continued)
Noncontrolling Interests
In December 2007, the Financial Accounting Standards Board (“FASB”) issued accounting guidance for noncontrolling interests. A noncontrolling interest, previously referred to as minority interest, is the portion of equity in a subsidiary not attributable, directly or indirectly, to a parent. The objective of this accounting guidance is to improve the relevance, comparability and transparency of the financial information that a reporting entity provides in its consolidated financial statements. The Company adopted this accounting guidance on February 1, 2009 and adjusted its January 31, 2009 Consolidated Balance Sheet to reflect noncontrolling interests as a component of total equity. Included in the balance sheet reclass was $58,247,000 of accumulated deficit noncontrolling interests resulting from deficit restoration obligations of noncontrolling partners, previously recorded as a component of investments in and advances to affiliates. In addition, the Company reclassed noncontrolling interests on its Consolidated Statements of Operations for the three and nine months ended October 31, 2008.
During May 2009, the Company acquired the equity interest in a consolidated subsidiary. The basis difference between the Company’s carrying amount and the proceeds paid is recorded as an adjustment to additional paid-in capital in accordance with accounting guidance for noncontrolling interests. Below is the disclosure required by this accounting guidance.
         
    Nine Months Ended  
    October 31, 2009  
    (in thousands)  
Net loss attributable to Forest City Enterprises, Inc.
    $ (36,852 )
Transfer from noncontrolling interests:
       
Increase in Forest City Enterprises, Inc. additional paid-in capital due to acquisition of a consolidated subsidiary’s noncontrolling interest
    3,393  
 
     
 
Pro forma net loss attributable to Forest City Enterprises, Inc.
    $ (33,459 )
 
     
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying consolidated financial statements and related notes. Some of the critical estimates made by the Company include, but are not limited to, estimates of useful lives for long-lived assets, reserves for collection on accounts and notes receivable and other investments, impairment of real estate, other-than-temporary impairments on its equity method investments and the computation of expected losses on variable interest entities (“VIE”). As a result of the nature of estimates made by the Company, actual results could differ.
Reclassification
Certain prior year amounts in the accompanying consolidated financial statements have been reclassified to conform to the current year’s presentation.
Restricted Cash
Restricted cash represents legally restricted deposits with financial institutions for debt service payments, taxes and insurance, collateral, security deposits, capital replacement, improvement and operating reserves, bond funds, development escrows and construction escrows.
Capitalized Software Costs
Costs related to software developed or obtained for internal use are capitalized and amortized using the straight-line method over their estimated useful life, which is primarily three years. The Company capitalizes significant costs incurred in the acquisition or development of software for internal use, including the costs of the software, materials, consultants, interest and payroll and payroll-related costs for employees directly involved in developing internal-use computer software once final selection of the software is made. Costs incurred prior to the final selection of software, costs not qualifying for capitalization and routine maintenance costs are charged to expense as incurred.

9


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
A.    Accounting Policies (continued)
At October 31 and January 31, 2009, the Company has capitalized software costs of $8,810,000 and $16,997,000, respectively, net of accumulated amortization of $32,524,000 and $23,302,000, respectively. Total amortization of capitalized software costs amounted to $3,114,000 and $9,475,000 for the three and nine months ended October 31, 2009, respectively, and $3,000,000 and $9,053,000 for the three and nine months ended October 31, 2008, respectively.
Military Housing Fee Revenues
Revenues for development fees related to the Company’s military housing projects are earned based on a contractual percentage of the actual development costs incurred by the military housing projects and are recognized on a monthly basis as the costs are incurred. The Company also recognizes additional development incentive fees based upon successful completion of certain criteria, such as incentives to realize development cost savings, encourage small and local business participation, comply with specified safety standards and other project management incentives as specified in the development agreements. Base development and development incentive fees of $2,723,000 and $9,322,000 were recognized during the three and nine months ended October 31, 2009, respectively, and $16,792,000 and $55,500,000 during the three and nine months ended October 31, 2008, respectively, which were recorded in revenues from real estate operations in the Consolidated Statements of Operations.
Revenues for construction management fees are earned based on a contractual percentage of the actual construction costs incurred by the military housing projects and are recognized on a monthly basis as the costs are incurred. The Company also recognizes certain construction incentive fees based upon successful completion of certain criteria as set forth in the construction contracts. Base construction and construction incentive fees of $1,731,000 and $7,385,000 were recognized during the three and nine months ended October 31, 2009, respectively, and $3,172,000 and $11,022,000 during the three and nine months ended October 31, 2008, respectively, which were recorded in revenues from real estate operations in the Consolidated Statements of Operations.
Revenues for property management and asset management fees are earned based on a contractual percentage of the annual net rental income and annual operating income, respectively, that is generated by the military housing privatization projects as defined in the agreements. The Company also recognizes certain property management incentive fees based upon successful completion of certain criteria as set forth in the property management agreements. Property management, management incentive and asset management fees of $3,634,000 and $11,467,000 were recognized during the three and nine months ended October 31, 2009, respectively, and $3,741,000 and $10,683,000 during the three and nine months ended October 31, 2008, respectively, which were recorded in revenues from real estate operations in the Consolidated Statements of Operations.
Historic and New Market Tax Credit Entities
The Company has certain investments in properties that have received, or the Company believes are entitled to receive, historic preservation tax credits on qualifying expenditures under Internal Revenue Code (“IRC”) section 47 and new market tax credits on qualifying investments in designated community development entities (“CDEs”) under IRC section 45D, as well as various state credit programs. The Company typically enters into these investments with sophisticated financial investors. In exchange for the financial investor’s initial contribution into the investment, the financial investor is entitled to substantially all of the benefits derived from the tax credit, but generally has no material interest in the underlying economics of the property. Typically, these arrangements have put/call provisions (which range up to 7 years) whereby the Company may be obligated (or entitled) to repurchase the financial investor’s interest. The Company has consolidated each of these properties in its consolidated financial statements, and has reflected these investor contributions as accounts payable and accrued expenses in its Consolidated Balance Sheets.
The Company guarantees the financial investor that in the event of a subsequent recapture by a taxing authority due to the Company’s noncompliance with applicable tax credit guidelines it will indemnify the financial investor for any recaptured tax credits. The Company initially records a liability for the cash received from the financial investor. The Company generally records income upon completion and certification of the qualifying development expenditures for historic tax credits and upon certification of the qualifying investments in designated CDEs for new market tax credits resulting in an adjustment of the liability at each balance sheet date to the amount that would be paid to the financial investor based upon the tax credit compliance regulations, which range from 0 to 7 years. Income related to tax credits of $1,956,000 and $7,336,000 was recognized during the three and nine months ended October 31, 2009, respectively, and $1,562,000 and $4,544,000 during the three and nine months ended October 31, 2008, respectively, which was recorded in interest and other income in the Consolidated Statements of Operations.
Termination Benefits
During the three months ended April 30, 2009 and the three months ended January 31, 2009, management initiated involuntary employee separations in various areas of the Company’s workforce to reduce costs, which was communicated to all employees. The Company provided outplacement services to all terminated employees and severance payments based on years of service and certain other defined criteria. In accordance with accounting guidance for costs associated with exit or disposal activities, the

10


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
A.    Accounting Policies (continued)
Company recorded a pre-tax charge for total estimated termination costs (outplacement and severance) of $8,720,000 during the three months ended April 30, 2009 and $8,651,000 during the three months ended January 31, 2009, which is included in operating expenses in the Consolidated Statements of Operations for those respective periods. The expense is included in the Corporate Activities segment. The Company made payments of $5,291,000 related to the termination costs recorded during the three months ended January 31, 2009. The following table summarizes the activity in the accrued severance balance for termination costs:
         
    Total  
    (in thousands)  
 
       
Accrued severance balance at February 1, 2009
    $ 3,360  
 
       
Accrued termination benefits expense
    8,720  
Payments
    (3,122 )
 
     
Accrued severance balance at April 30, 2009
    8,958  
 
       
Accrued termination benefits expense
    -  
Payments
    (2,937 )
 
     
Accrued severance balance at July 31, 2009
    $ 6,021  
 
       
Accrued termination benefits expense
    -  
Payments
    (1,476 )
 
     
Accrued severance balance at October 31, 2009
    $ 4,545  
 
     
Accumulated Other Comprehensive Loss
Net unrealized gains or losses on securities are included in accumulated other comprehensive income (loss) (“OCI”) and represent the difference between the market value of investments in unaffiliated companies that are available-for-sale at the balance sheet date and the Company’s cost. Another component of accumulated OCI is foreign currency translation adjustments related to the Company’s London, England operations whose functional currency is the British pound. The assets and liabilities related to these operations are translated into U.S. dollars at current exchange rates; revenues and expenses are translated at average exchange rates. Also included in accumulated OCI is the Company’s portion of the unrealized gains and losses on the effective portions of derivative instruments designated and qualifying as cash flow hedges. The following table summarizes the components of accumulated OCI included within the Company’s Consolidated Balance Sheets.
                 
    October 31, 2009     January 31, 2009  
    (in thousands)  
 
Unrealized losses on securities
    $ 459     $ 170  
Unrealized losses on foreign currency translation
    1,265       2,258  
Unrealized losses on interest rate contracts
    148,406       174,838  
     
 
    150,130       177,266  
Noncontrolling interest and income tax benefit
    (58,742 )     (69,745 )
     
Accumulated Other Comprehensive Loss
    $ 91,388     $ 107,521  
     

11


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
A.   Accounting Policies (continued)
Fair Value of Financial Instruments
The carrying amount of the Company’s accounts receivable and accounts payable and accrued expenses approximates fair value based upon the nature of the instruments. The Company estimates the fair value of its debt instruments by discounting future cash payments at interest rates that the Company believes approximate the current market. The estimated fair value is based upon market prices of public debt, available industry financing data, current treasury rates, recent financing transactions and other factors. Based on these parameters, the table below contains the estimated fair value of the Company’s long-term debt at October 31 and January 31, 2009.
                                   
    October 31, 2009       January 31, 2009  
    Carrying Value     Fair Value       Carrying Value     Fair Value  
    (in thousands)       (in thousands)  
 
                                 
Fixed
    $ 5,105,131     $    4,667,857         $ 4,941,899     $    4,313,068  
Variable
    3,471,063       3,371,552         3,348,055       3,043,161  
         
Total long-term debt
    $ 8,576,194     $ 8,039,409         $ 8,289,954     $ 7,356,229  
         
See Note H for fair values of other financial instruments.
Derivative Instruments and Hedging Activities
In March 2008, the FASB issued further guidance on disclosures about derivative instruments and hedging activities that amends and expands disclosure requirements with the intent to provide users of financial statements with an enhanced understanding of how derivative instruments and hedging activities affect an entity’s financial position, financial performance and cash flows. These disclosure requirements include a tabular summary of the fair values of derivative instruments and their gains and losses, disclosure of derivative features that are credit risk related to provide more information regarding an entity’s liquidity and cross-referencing within footnotes to make it easier for financial statement users to locate important information about derivative instruments. The Company adopted the financial statement disclosures required by the new accounting guidance on February 1, 2009 (refer to Note G - Derivative Instruments and Hedging Activities for related disclosures).
The Company records all derivatives in the Consolidated Balance Sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts that are intended to economically hedge certain of its risks, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.
Variable Interest Entities
In accordance with accounting guidance on consolidation of variable interest entities (“VIE”), the Company consolidates a VIE in which it has a variable interest (or a combination of variable interests) that will absorb a majority of the entity’s expected losses, receive a majority of the entity’s expected residual returns, or both, based on an assessment performed at the time the Company becomes involved with the entity. VIEs are entities in which the equity investors do not have a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. The Company reconsiders this assessment only if the entity’s governing documents or the contractual arrangements among the parties involved change in a manner that changes the characteristics or adequacy of the entity’s equity investment at risk, some or all of the equity investment is returned to the investors and other parties become exposed to expected losses of the entity, the entity undertakes additional activities or acquires additional assets beyond those that were anticipated at inception or at the last reconsideration date that increase its expected losses, or the entity receives an additional equity investment that is at risk, or curtails or modifies its activities in a way that decreases its expected losses. The Company may be subject to additional losses to the extent of any financial support that it voluntarily provides in the future. Additionally, if different estimates are applied in determining future cash flows, and how the cash flows are funded, it may have concluded otherwise on the consolidation method of an entity.

12


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
A.   Accounting Policies (continued)
The determination of the consolidation method for each entity can change as reconsideration events occur. Expected results after the formation of an entity can vary, which could cause a change in the allocation to the partners. In addition, if the Company sells a property, sells its interest in a joint venture or enters into a new joint venture, the number of VIEs it is involved with could vary between quarters.
During the nine months ended October 31, 2009, the Company settled outstanding debt of one of its unconsolidated subsidiaries, Gladden Farms II, a land development project located in Marana, Arizona. In addition, the Company was informed of the outside partner’s intention to discontinue any future funding into the project. As a result of the loan transaction and the related negotiations with the outside partner, it has been determined that Gladden Farms II is a VIE and the Company is the primary beneficiary, which required consolidation of the entity during the nine months ended October 31, 2009. The impact of the initial consolidation of Gladden Farms II is an increase in real estate, net of approximately $21,643,000 and an increase in noncontrolling interests of approximately $5,010,000. The Company recorded a gain of $1,774,000 upon consolidation of the entity that is recorded in interest and other income in the Consolidated Statements of Operations.
As of October 31, 2009, the Company determined that it was the primary beneficiary of 33 VIEs representing 21 properties (18 VIEs representing 7 properties in the Residential Group, 12 VIEs representing 11 properties in the Commercial Group and 3 VIEs/properties in the Land Development Group). The creditors of the consolidated VIEs do not have recourse to the Company’s general credit. As of October 31, 2009, the Company held variable interests in 40 VIEs for which it is not the primary beneficiary. The maximum exposure to loss as a result of its involvement with these unconsolidated VIEs is limited to the Company’s recorded investments in those VIEs totaling approximately $106,000,000 at October 31, 2009. The Company’s VIEs consist of joint ventures that are engaged, directly or indirectly, in the ownership, development and management of office buildings, regional malls, specialty retail centers, apartment communities, military housing, supported-living communities, land development and The Nets, a member of the National Basketball Association in which the Company accounts for its investment on the equity method of accounting.
The carrying value of real estate, nonrecourse mortgage debt and noncontrolling interests of VIEs for which the Company is the primary beneficiary are as follows:
                 
    October 31, 2009     January 31, 2009  
    (in thousands)  
 
               
Real estate, net
    $ 1,866,000     $ 1,602,000  
Nonrecourse mortgage debt
    $ 1,395,000     $ 1,237,000  
Noncontrolling interest
    $ 90,000     $ 63,000  
In addition to the VIEs described above, the Company has also determined that it is the primary beneficiary of a VIE which holds collateralized borrowings of $29,000,000 (see Note E - Senior and Subordinated Debt) as of October 31, 2009.
New Accounting Guidance
In addition to the new accounting guidance for convertible debt instruments, noncontrolling interests and disclosures about derivative instruments and hedging activities discussed previously in Note A, the following accounting pronouncements were also adopted during the nine months ended October 31, 2009:
In June 2009, the FASB issued accounting standards codification and the hierarchy of generally accepted accounting principles (“GAAP”), that establishes the FASB Accounting Standards CodificationTM (“Codification”) as the source of GAAP recognized by the FASB to be applied by nongovernmental entities. The statement is effective for financial statements issued for interim and annual periods ending after September 15, 2009 and as of this date, the Codification superseded all non-Securities and Exchange Commission accounting and reporting standards. For this quarterly report on Form 10-Q for the quarter ended October 31, 2009, the Company’s references to accounting guidance have been revised to conform with the Codification.
In May 2009, the FASB issued accounting guidance for subsequent events, which establishes guidance for recognizing and disclosing subsequent events in the financial statements. This guidance requires the disclosure of the date through which an entity has evaluated subsequent events. This guidance is effective for interim and annual periods ending after June 15, 2009. The Company has evaluated subsequent events through December 8, 2009, the date that the Company’s consolidated financial statements were issued, for this quarterly report on Form 10-Q for the quarter ended October 31, 2009.
In April 2009, the FASB issued accounting guidance for interim disclosures about fair value of financial instruments. This guidance amends the initial standards on fair value of financial instruments and interim financial reporting to require disclosure about the fair value of financial instruments at interim reporting periods. The guidance is effective for interim reporting periods ending after June 15, 2009 (refer to the “Fair Value of Financial Instruments” section of Note A).

13


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
A.   Accounting Policies (continued)
In April 2009, the FASB issued additional accounting guidance for estimating fair value when the volume and level of activity for the asset or liability have significantly decreased and for identifying circumstances that indicate a transaction is not orderly. The guidance is effective for interim and annual reporting periods ending after June 15, 2009, and shall be applied prospectively. The adoption of this guidance on July 31, 2009 did not have a material impact on the Company’s consolidated financial statements.
Accounting guidance on fair value measurements defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosures about the use of fair value measurements. This guidance does not require new fair value measurements, but applies to accounting pronouncements that require or permit fair value measurements. This guidance is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued two Staff Positions on fair value measurements. The first excludes the FASB accounting guidance on leases and other accounting pronouncements that address fair value measurements for purposes of lease classification or measurement under the guidance on leases. The second delays the effective date of fair value measurements for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to fiscal years beginning after November 15, 2008 and interim periods within those fiscal years. The Company adopted this guidance for its financial assets and liabilities on February 1, 2008 (see Note H - Fair Value Measurements) and for its nonfinancial assets and liabilities on February 1, 2009.
In November 2008, the FASB issued accounting guidance that clarifies the accounting for certain transactions and impairment considerations involving equity method investments. This guidance provides clarification of how business combination and noncontrolling interests accounting will impact equity method investments. This guidance is effective for fiscal years, and interim reporting periods within those fiscal years, beginning on or after December 15, 2008 and early adoption is prohibited. The adoption of this guidance on February 1, 2009 did not have a material impact on the Company’s consolidated financial statements.
In June 2008, the FASB issued accounting guidance addressing whether instruments granted in share-based payment transactions are participating securities. This guidance requires that nonvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents be treated as participating securities in the computation of earnings per share pursuant to the two-class method. This guidance will be applied retrospectively to all periods presented for fiscal years beginning after December 15, 2008. The adoption of this guidance on February 1, 2009 did not have a material impact on the Company’s consolidated financial statements.
In June 2008, the FASB issued accounting guidance for determining whether an equity-linked financial instrument (or embedded feature) is indexed to an entity’s own stock. The guidance on derivative instruments and hedging activities specifies that a contract that would otherwise meet the definition of a derivative but is both (a) indexed to the Company’s own stock and (b) classified in stockholders’ equity in the statement of financial position would not be considered a derivative financial instrument. This guidance provides a new two-step model to be applied in determining whether a financial instrument or an embedded feature is indexed to an issuer’s own stock and thus able to qualify for the derivative instruments and hedging activities scope exception. This guidance is effective for the first annual reporting period beginning after December 15, 2008. The adoption of this guidance by the Company on February 1, 2009 did not have a material impact on its consolidated financial statements.
In April 2008, the FASB issued accounting guidance that amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. This guidance allows the Company to use its historical experience in renewing or extending the useful life of intangible assets. This guidance is effective for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years and shall be applied prospectively to intangible assets acquired after the effective date. The adoption of this guidance on February 1, 2009 did not have any impact on the Company’s consolidated financial statements.
In December 2007, the FASB issued revised accounting guidance on business combinations to provide greater consistency in the accounting and financial reporting of business combinations. This guidance requires the acquiring entity in a business combination to recognize all assets acquired and liabilities assumed in the transaction, establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed and requires the acquirer to disclose the nature and financial effect of the business combination. The guidance is effective for fiscal years beginning after December 15, 2008. In April 2009, the FASB issued accounting guidance that amends and clarifies the provisions related to the initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. This guidance requires that such contingencies be recognized at fair value on the acquisition date if fair value can be reasonably estimated during the allocation period. Otherwise, companies would typically account for the acquired contingencies in accordance with the accounting guidance for contingencies. The adoption of these pronouncements on February 1, 2009 did not have a material impact on the Company’s consolidated financial statements.

14


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
A.   Accounting Policies (continued)
The following new accounting pronouncements will be adopted on their respective required effective date:
In August 2009, the FASB issued amendments to the accounting guidance for the fair value measurement of liabilities. This guidance provides clarification that, in circumstances in which a quoted market price in an active market for the identical liability is not available, the fair value of a liability must be measured by using either (1) a valuation technique that uses quoted prices for identical or similar liabilities or (2) another valuation technique that is consistent with the principles of fair value measurements. In addition, this guidance clarifies that when estimating the fair value of a liability, an entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability, and clarifies how the price of a traded debt security should be considered in estimating the fair value of a liability. This guidance is effective for annual and interim reporting periods beginning after its issuance. The Company is currently evaluating the impact of adopting this guidance on its consolidated financial statements.
In June 2009, the FASB issued amendments to the accounting guidance for consolidation of VIEs to require an ongoing reassessment of determining whether a variable interest gives a company a controlling financial interest in a VIE. This guidance eliminates the quantitative approach to determining whether a company is the primary beneficiary of a VIE previously required by the guidance for consolidation of VIEs. The guidance is effective for annual and interim reporting periods beginning after November 15, 2009. The Company is currently evaluating the impact of adopting this guidance on its consolidated financial statements.
In June 2009, the FASB issued an amendment to the guidance on accounting for transfers and servicing of financial assets and extinguishments of liabilities, which aims to improve the relevance, representational faithfulness and comparability of the information provided in an entity’s financial statements about the transfer of financial assets. The guidance eliminates the concept of a qualifying special-purpose entity and changes the requirements for the derecognition of financial assets. This guidance is effective for annual and interim reporting periods beginning after November 15, 2009. The Company does not expect the adoption of this accounting guidance to have a material impact on its consolidated financial statements.

15


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
B.   Investments in and Advances to Affiliates
Included in investments in and advances to affiliates are unconsolidated investments in entities that the Company does not control and/or is not deemed to be the primary beneficiary, and which are accounted for under the equity method of accounting, as well as advances to partners and other affiliates.
Following is a reconciliation of members’ and partners’ equity to the Company’s carrying value in the accompanying Consolidated Balance Sheets:
                 
            January 31,  
    October 31,     2009  
    2009     (As Adjusted)  
    (in thousands)  
 
               
Members’ and partners’ equity, as below
   $ 527,035      $ 595,163  
Equity of other members and partners
    471,219       534,942  
     
 
               
Company’s investment in partnerships
    55,816       60,221  
Advances to and on behalf of other affiliates
    184,120       168,774  
     
Total Investments in and Advances to Affiliates
   $ 239,936      $ 228,995  
     
Summarized financial information for the equity method investments is as follows:
                 
    (Combined 100%)  
    October 31,     January 31,  
    2009     2009  
    (in thousands)  
Balance Sheet:
               
Completed rental properties
   $ 4,334,121      $ 3,967,896  
Projects under development
    890,582       931,411  
Land held for development or sale
    269,716       278,438  
     
Total Real Estate
    5,494,419       5,177,745  
 
               
Less accumulated depreciation
    (763,985 )     (680,013 )
     
 
               
Real Estate, net
    4,730,434       4,497,732  
 
               
Restricted cash - military housing bond funds
    550,440       795,616  
Other restricted cash
    211,583       207,507  
Other assets
    458,971       482,431  
     
Total Assets
   $ 5,951,428      $ 5,983,286  
     
 
               
Mortgage debt, nonrecourse
   $ 4,557,677      $ 4,571,375  
Other liabilities
    866,716       816,748  
Members’ and partners’ equity
    527,035       595,163  
     
Total Liabilities and Members’/Partners’ Equity
   $ 5,951,428      $ 5,983,286  
     

16


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
B. Investments in and Advances to Affiliates (continued)
                                 
    (Combined 100%)     (Combined 100%)  
    Three Months Ended October 31,     Nine Months Ended October 31,  
    2009     2008     2009     2008  
    (in thousands)     (in thousands)  
Operations:
                               
Revenues
   $ 197,158      $ 222,403      $ 682,898      $ 714,669  
Operating expenses
    (123,318 )     (157,284 )     (454,249 )     (525,674 )
Interest expense including early extinguishment of debt
    (56,789 )     (56,941 )     (170,749 )     (171,777 )
Impairment of unconsolidated entities (1)
    (13,200 )     -       (36,403 )     (45,713 )
Depreciation and amortization
    (35,239 )     (28,352 )     (127,963 )     (106,307 )
Interest and other income
    1,182       13,644       9,954       45,444  
         
 
                               
Loss from continuing operations
    (30,206 )     (6,530 )     (96,512 )     (89,358 )
         
Discontinued operations:
                               
Operating earnings (loss) from rental properties
    (78 )     117       159       416  
Gain on disposition of rental properties (2)
    8,997       400       8,997       3,470  
         
Discontinued operations subtotal
    8,919       517       9,156       3,886  
         
Net loss (pre-tax)
  $ (21,287 )   $ (6,013 )   $ (87,356 )   $ (85,472 )
         
Company’s portion of net loss (pre-tax)
  $ (11,836 )   $ (3,198 )   $ (45,140 )   $ (18,787 )
         
(1)   The following table shows the detail of the impairment of unconsolidated entities:
                                         
            Three Months Ended October 31,   Nine Months Ended October 31,  
            2009     2008   2009     2008
            (in thousands)     (in thousands)  
Apartment Communities:
                                       
Millender Center
  (Detroit, Michigan)    $ 3,247      $ -      $ 10,317      $ -  
Uptown Apartments
  (Oakland, California)     -       -       6,781       -  
Metropolitan Lofts
  (Los Angeles, California)     1,466       -       2,505       -  
Residences at University Park
  (Cambridge, Massachusetts)     -       -       855       -  
Fenimore Court
  (Detroit, Michigan)     -       -       693       -  
Mercury (Condominium)
  (Los Angeles, California)     -       -       -       12,006  
Classic Residence by Hyatt (Supported-Living Apartments)
  (Yonkers, New York)     -       -       4,892       -  
Navy Midwest (Land owned by Military Housing Project)
  (Chicago, Illinois)     -       -       -       30,000  
Specialty Retail Centers:
                                       
Southgate Mall
  (Yuma, Arizona)     -       -       1,611       -  
El Centro Mall
  (El Centro, California)     -       -       -       3,342  
Pittsburgh Peripheral (Land Project)
  (Pittsburgh, Pennsylvania)     7,217       -       7,217       -  
Shamrock Business Center (Land Project)
  (Painesville, Ohio)     1,150       -       1,150       -  
Other
            120       -       382       365  
                 
 
                                       
Total impairment of unconsolidated entities
           $ 13,200      $ -      $ 36,403      $ 45,713  
                 
 
                                       
Company’s portion of impairment of unconsolidated entities
           $ 13,200      $ -      $ 34,663      $ 6,026  
                 
(2)   Upon disposition, investments accounted for on the equity method are not classified as discontinued operations; therefore, gains or losses on the sale of equity method properties are reported in continuing operations when sold. The following table shows the detail of gain on disposition of unconsolidated entities:
                                 
    Three Months Ended October 31,     Nine Months Ended October 31,  
    2009     2008     2009     2008  
    (in thousands)     (in thousands)  
Boulevard Towers (Apartment Community) (a)
(Amherst, New York)                   $ 8,997      $ -      $ 8,997      $ -  
Emery-Richmond (Office Building)
(Warrensville Heights, Ohio)                    -       400       -       400  
One International Place (Office Building)
(Cleveland, Ohio)                    -       -       -       3,070  
         
Total gain on disposition of unconsolidated entities
   $ 8,997      $ 400      $ 8,997      $ 3,470  
         
Company’s portion gain on disposition of unconsolidated entities
   $ 4,498      $ 200      $ 4,498      $ 1,081  
         
(a)  
The Company disposed of its 50% ownership interest in Boulevard Towers in a nonmonetary exchange for 100% ownership interest in North Church Towers, an apartment complex in Parma Heights, Ohio.

17


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
B.   Investments in and Advances to Affiliates (continued)
For the three and nine months ended October 31, 2009 and 2008, Nets Sports and Entertainment, LLC (“NSE”), an equity method investment that owns The Nets and certain real estate in Brooklyn, New York for the proposed sports and entertainment arena, was deemed a significant subsidiary. Summarized statements of operations information for NSE is as follows:
                                 
    Three Months Ended October 31,   Nine Months Ended October 31,
    2009     2008     2009     2008  
    (in thousands)     (in thousands)  
 
Operations:
                               
Revenues
    $ 1,078       $ 2,046       $ 49,723       $ 59,520  
Operating expenses
    (9,856 )     (13,091 )     (70,345 )     (80,427 )
Interest expense
    (5,294 )     (2,856 )     (12,970 )     (9,150 )
Depreciation and amortization
    (195 )     (260 )     (19,986 )     (23,957 )
         
Net loss (pre-tax)
    $ (14,267 )     $ (14,161 )     $ (53,578 )     $ (54,014 )
         
Company’s portion of net loss (pre-tax)
    $ (13,244 )     $ (10,688 )     $ (33,100 )     $ (33,289 )
         
C.   Mortgage Debt, Nonrecourse
As of October 31, 2009, the composition of mortgage debt maturities including scheduled amortization and balloon payments for the next five years are as follows:
                         
                    Scheduled  
    Total     Scheduled     Balloon  
Fiscal Years Ending January 31,   Maturities     Amortization     Payments  
    (in thousands)  
 
                       
2010
    $ 332,363       $ 22,280       $ 310,083  
2011
    674,739       $ 74,021       $ 600,718  
2012
    878,504       $ 71,842       $ 806,662  
2013
    1,178,832       $ 56,346       $   1,122,486  
2014
    889,836       $ 45,915       $ 843,921  
Thereafter
    3,509,349                  
 
                     
Total
    $   7,463,623                  
 
                     
Subsequent to October 31, 2009, the Company addressed approximately $96,301,000 of mortgage debt scheduled to mature during the year ending January 31, 2010 through closed transactions, commitments and/or automatic extensions. The Company also has extension options available on $184,984,000 of mortgage debt scheduled to mature during the year ending January 31, 2010, all of which require some predefined condition in order to qualify for the extension, such as meeting or exceeding leasing hurdles, loan to value ratios or debt service coverage requirements. The Company cannot give assurance that the defined hurdles or milestones will be achieved to qualify for these extensions.
The Company is in current negotiations to refinance and/or extend the remaining $28,798,000 of mortgage debt scheduled to mature during the year ending January 31, 2010. In the unlikely event that an agreement is not reached with a lender to refinance or extend any maturing debt, the encumbered assets could be turned over to the lender in lieu of satisfying the maturing balloon payment. It is management’s belief that it is unlikely that a material number of assets would be turned over to the lenders and the impact of this unlikely event would not have a material effect on the financial condition or operations of the Company.

18


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
D.   Bank Revolving Credit Facility
At October 31 and January 31, 2009, the Company’s bank revolving credit facility provides for maximum borrowings of $750,000,000 and matures in March 2010. The credit facility bears interest at the Company’s option at either a LIBOR-based rate plus 2.50% (2.75% and 2.98% at October 31 and January 31, 2009, respectively), or a Prime-based rate plus 1.50%. The Company has historically elected the LIBOR-based rate option. The credit facility restricts the Company’s ability to purchase, acquire, redeem or retire any of its capital stock, and prohibits the Company from paying any dividends on its capital stock through the maturity date. The credit facility allows certain actions by the Company or its subsidiaries, such as default in paying debt service or allowing foreclosure on an encumbered real estate asset, only to the extent such actions do not have a material adverse effect, as defined in the agreement, on the Company. Of the available borrowings, up to $100,000,000 may be used for letters of credit or surety bonds. The credit facility also contains certain financial covenants, including maintenance of certain debt service and cash flow coverage ratios, and specified levels of net worth (as defined in the credit facility). At October 31, 2009, the Company was in compliance with all of these financial covenants.
Effective October 5, 2009, the Company entered into a Third Amendment to the bank revolving credit facility in connection with the Company’s private placement of its 3.625% Puttable Equity-Linked Senior Notes due 2014 (“2014 Notes”). The amendment permitted the Company to exchange up to $200,000,000 of its 3.625% Puttable Equity-Linked Senior Notes due 2011 for its 2014 Notes and issue up to $75,000,000 in 2014 Notes, provided that the aggregate amount of 2014 Notes does not exceed $200,000,000 (refer to Note E – Senior and Subordinated Debt).
Effective October 22, 2009, the Company entered into a Fourth Amendment to the bank revolving credit facility in connection with the Company’s private placement of its 5.00% Convertible Senior Notes due 2016 (“2016 Notes”). The amendment permitted the Company to issue the $200,000,000 of 2016 Notes and enter into a convertible note hedge transaction in connection with the issuance of these 2016 Notes (refer to Note E – Senior and Subordinated Debt).
During the nine months ended October 31, 2009, the Company primarily used the net proceeds from the May 2009 common stock offering (refer to Note M – Common Stock Offering) and the issuance of the 2016 Notes to reduce outstanding borrowings on the bank revolving credit facility.
The available credit on the bank revolving credit facility at October 31 and January 31, 2009 was as follows:
                 
    October 31, 2009     January 31, 2009  
    (in thousands)  
 
Maximum borrowings
    $ 750,000       $ 750,000  
Less outstanding balances:
               
Borrowings
    37,016       365,500  
Letters of credit
    66,814       65,949  
Surety bonds
    -       -  
     
Available credit
    $ 646,170       $ 318,551  
     
In November 2009, the Company reached an agreement on the principal terms of a new $500,000,000 revolving credit facility with its 15-member bank group, which would mature two years from closing. The Company expects the transaction to close prior to December 31, 2009. In the event the transaction does not close and the revolving credit facility is not otherwise extended, the Company would continue to raise capital through the sale of assets, admitting other joint venture equity partners into some of the Company’s properties, curtailing capital expenditures and/or raising additional funds in a public or private debt or equity offering.

19


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
E.   Senior and Subordinated Debt
The Company’s Senior and Subordinated Debt is comprised of the following at October 31 and January 31, 2009:
                 
            January 31, 2009  
     October 31, 2009     (As Adjusted)  
    (in thousands)  
 
Senior Notes:
               
3.625% Puttable Equity-Linked Senior Notes due 2011, net of discount
   $ 98,156      $ 248,154  
3.625% Puttable Equity-Linked Senior Notes due 2014, net of discount
    198,399       -  
7.625% Senior Notes due 2015
    300,000       300,000  
5.000% Convertible Senior Notes due 2016
    200,000       -  
6.500% Senior Notes due 2017
    150,000       150,000  
7.375% Senior Notes due 2034
    100,000       100,000  
     
 
               
Total Senior Notes
    1,046,555       798,154  
     
 
               
Subordinated Debt:
               
Redevelopment Bonds due 2010
    -       18,910  
Subordinate Tax Revenue Bonds due 2013
    29,000       29,000  
     
Total Subordinated Debt
    29,000       47,910  
     
Total Senior and Subordinated Debt
   $ 1,075,555      $ 846,064  
     
Puttable Equity-Linked Senior Notes due 2011
On October 10, 2006, the Company issued $287,500,000 of 3.625% puttable equity-linked senior notes due October 15, 2011 (“2011 Notes”) in a private placement. The notes were issued at par and accrued interest is payable semi-annually in arrears on April 15 and October 15. During the year ended January 31, 2009, the Company purchased on the open market $15,000,000 in principal of its 2011 Notes resulting in a gain, net of associated deferred financing costs of $3,692,000, which is recorded as early extinguishment of debt in the Consolidated Statements of Operations. On October 7, 2009, the Company entered into privately negotiated exchange agreements with certain holders of the 2011 Notes to exchange $167,433,000 of aggregate principal amount of their 2011 Notes for a new issue of 3.625% puttable equity-linked senior notes due October 2014. This exchange resulted in a gain, net of associated deferred financing costs of $4,683,000, which is recorded as early extinguishment of debt in the Consolidated Statements of Operations. There was $105,067,000 ($98,156,000, net of discount) and $272,500,000 ($248,154,000, net of discount) of principal outstanding at October 31 and January 31, 2009, respectively.
Holders may put their notes to the Company at their option on any day prior to the close of business on the scheduled trading day immediately preceding July 15, 2011 only under the following circumstances: (1) during the five business-day period after any five consecutive trading-day period (the “measurement period”) in which the trading price per note for each day of that measurement period was less than 98% of the product of the last reported sale price of the Company’s Class A common stock and the put value rate (as defined) on each such day; (2) during any fiscal quarter after the fiscal quarter ending January 31, 2007, if the last reported sale price of the Company’s Class A common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter exceeds 130% of the applicable put value price in effect on the last trading day of the immediately preceding fiscal quarter; or (3) upon the occurrence of specified corporate events as set forth in the applicable indenture. On and after July 15, 2011 until the close of business on the scheduled trading day immediately preceding the maturity date, holders may put their notes to the Company at any time, regardless of the foregoing circumstances. In addition, upon a designated event, as defined, holders may require the Company to purchase for cash all or a portion of their notes for 100% of the principal amount of the notes plus accrued and unpaid interest, if any, as set forth in the applicable indenture. At October 31, 2009, none of the aforementioned circumstances have been met.
If a note is put to the Company, a holder would receive (i) cash equal to the lesser of the principal amount of the note or the put value and (ii) to the extent the put value exceeds the principal amount of the note, shares of the Company’s Class A common stock, cash, or a combination of Class A common stock and cash, at the Company’s option. The initial put value rate was 15.0631 shares of Class A common stock per $1,000 principal amount of notes (equivalent to a put value price of $66.39 per share of Class A common stock). The put value rate will be subject to adjustment in some events but will not be adjusted for accrued interest. In addition, if a “fundamental change,” as defined, occurs prior to the maturity date, the Company will in some cases increase the put value rate for a holder that elects to put their notes.

20


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
E.    Senior and Subordinated Debt (continued)
Concurrent with the issuance of the notes, the Company purchased a call option on its Class A common stock in a private transaction. The purchased call option allows the Company to receive shares of its Class A common stock and/or cash from counterparties equal to the amounts of Class A common stock and/or cash related to the excess put value that it would pay to the holders of the notes if put to the Company. These purchased call options will terminate upon the earlier of the maturity date of the notes or the first day all of the notes are no longer outstanding due to a put or otherwise. In a separate transaction, the Company sold warrants to issue shares of the Company’s Class A common stock at an exercise price of $74.35 per share in a private transaction. If the average price of the Company’s Class A common stock during a defined period ending on or about the respective settlement dates exceeds the exercise price of the warrants, the warrants will be settled in shares of the Company’s Class A common stock.
The 2011 Notes are the Company’s only senior notes that qualify as convertible debt instruments that may be settled in cash upon conversion, including partial cash settlement (see the “Retrospective Adoption of Accounting Guidance for Convertible Debt Instruments” section of Note A). The carrying amounts of the Company’s debt and equity balances related to the 2011 Notes as of October 31 and January 31, 2009 are as follows:
                 
     October 31, 2009     January 31, 2009   
    (in thousands)  
 
               
Carrying amount of the equity component
   $ 16,769      $ 45,885  
     
 
               
Outstanding principal amount of the puttable equity-linked senior notes
   $ 105,067      $ 272,500  
Unamortized discount
    (6,911 )     (24,346 )
     
Net carrying amount of the puttable equity-linked senior notes
   $ 98,156      $ 248,154  
     
The unamortized discount will be amortized as additional interest expense through October 15, 2011. The effective interest rate for the liability component of the puttable equity-linked senior notes was 7.51% for both the three and nine months ended October 31, 2009 and 2008. The Company recorded non-cash interest expense of $1,705,000 and $6,020,000 for the three and nine months ended October 31, 2009, respectively, and $2,239,000 and $6,672,000 for the three and nine months ended October 31, 2008, respectively. The Company recorded contractual interest expense of $2,082,000 and $7,021,000 for the three and nine months ended October 31, 2009, respectively, and $2,571,000 and $7,782,000 for the three and nine months ended October 31, 2008, respectively.
Puttable Equity-Linked Senior Notes due 2014
On October 7, 2009, the Company issued $167,433,000 of 3.625% puttable equity-linked senior notes due October 15, 2014 (“2014 Notes”) to certain holders in exchange for $167,433,000 of 2011 Notes discussed above. Concurrent with the exchange of 2011 Notes for the 2014 Notes, the Company issued an additional $32,567,000 of 2014 Notes in a private placement, net of a 5% discount. Interest on the 2014 Notes is payable semi-annually in arrears on April 15 and October 15, beginning April 15, 2010. Net proceeds from the exchange and additional issuance transaction, net of discounts and estimated offering expenses, was $29,764,000.
Holders may put their notes to the Company at any time prior to the earlier of (i) stated maturity or (ii) the Put Termination Date, as defined below. Upon a put, a note holder would receive 68.7758 shares of the Company’s Class A common stock per $1,000 principal amount of notes, based on a Put Value Price of $14.54 per share of Class A common stock, subject to adjustment. The amount payable upon a put of the notes is only payable in shares of the Company’s Class A common stock, except for cash paid in lieu of fractional shares. If the Daily Volume Weighted Average Price of the Class A common stock has equaled or exceeded 130% of the Put Value Price then in effect for at least 20 trading days in any 30 trading day period, the Company may, at its option, elect to terminate the rights of the holders to put their notes to the Company. If elected, the Company is required to issue a Put Termination Notice that shall designate an effective date on which the holders termination put rights will be terminated, which shall be a date at least 20 days after the mailing of such Put Termination Notice (the “Put Termination Date”). Holders electing to put their notes after the mailing of a Put Termination Notice shall receive a Coupon Make-Whole Payment in an amount equal to the remaining scheduled interest payments attributable to such notes from the last applicable interest payment date through and including October 15, 2013.

21


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
E.    Senior and Subordinated Debt (continued)
Senior Notes due 2015
On May 19, 2003, the Company issued $300,000,000 of 7.625% senior notes due June 1, 2015 in a public offering. Accrued interest is payable semi-annually on December 1 and June 1. These senior notes may be redeemed by the Company, in whole or in part, at any time on or after June 1, 2008 at an initial redemption price of 103.813% that is systematically reduced to 100% through June 1, 2011. As of June 1, 2009, the redemption price was reduced to 102.542%.
Convertible Senior Notes due 2016
On October 26, 2009, the Company issued $200,000,000 of 5.00% convertible senior notes due October 15, 2016 in a private placement. The notes were issued at par and accrued interest is payable semi-annually on April 15 and October 15, beginning April 15, 2010. Net proceeds from the issuance, net of the cost of the convertible note hedge transaction described below and estimated offering costs, was $177,262,000.
Holders may convert their notes at their option at any time prior to the close of business on the second scheduled trading day immediately preceding the maturity date. Upon conversion, a note holder would receive 71.8894 shares of the Company’s Class A common stock per $1,000 principal amount of notes, based on a put value price of approximately $13.91 per share of Class A common stock, subject to adjustment. The amount payable upon a conversion of the notes is only payable in shares of the Company’s Class A common stock, except for cash paid in lieu of fractional shares.
In connection with the issuance of the notes, the Company entered into a convertible note hedge transaction. The convertible note hedge transaction is intended to reduce, subject to a limit, the potential dilution with respect to the Company’s Class A common stock upon conversion of the notes. The net effect of the convertible note hedge transaction, from the Company’s perspective, is to approximate an effective conversion price of $16.37 per share. The terms of the Notes were not affected by the convertible note hedge transaction. The convertible note hedge transaction, which cost $15,900,000 ($9,734,000 net of the related tax benefit), was recorded as a reduction of shareholders’ equity through additional paid in capital.
Senior Notes due 2017
On January 25, 2005, the Company issued $150,000,000 of 6.500% senior notes due February 1, 2017 in a public offering. Accrued interest is payable semi-annually on February 1 and August 1. These senior notes may be redeemed by the Company, in whole or in part, at any time on or after February 1, 2010 at a redemption price of 103.250% beginning February 1, 2010 and systematically reduced to 100% through February 1, 2013.
Senior Notes due 2034
On February 10, 2004, the Company issued $100,000,000 of 7.375% senior notes due February 1, 2034 in a public offering. Accrued interest is payable quarterly on February 1, May 1, August 1, and November 1. These senior notes may be redeemed by the Company, in whole or in part, at any time at a redemption price of 100% of the principal amount plus accrued interest.
All of the Company’s senior notes are unsecured senior obligations and rank equally with all existing and future unsecured indebtedness; however, they are effectively subordinated to all existing and future secured indebtedness and other liabilities of the Company’s subsidiaries to the extent of the value of the collateral securing such other debt, including the bank revolving credit facility. The indenture governing certain of the senior notes contain covenants providing, among other things, limitations on incurring additional debt and payment of dividends.
Subordinated Debt
In November 2000, the Company issued $20,400,000 of 8.25% redevelopment bonds due September 15, 2010 in a private placement, with semi-annual interest payments due on March 15 and September 15. The Company entered into a total rate of return swap (“TRS”) for the benefit of these bonds that was set to expire on September 15, 2009. Under the TRS, the Company received a rate of 8.25% and paid the Securities Industry and Financial Markets Association (“SIFMA”) rate plus a spread. The TRS, accounted for as a derivative, was required to be marked to fair value at the end of each reporting period. As stated in the “Fair Value Hedges of Interest Rate Risk” section of Note G, any fluctuation in the value of the TRS would be offset by the fluctuation in the value of the underlying borrowings. At January 31, 2009, the fair value of the TRS was $(1,490,000), recorded in accounts payable and accrued expenses; therefore, the fair value of the bonds was reduced by the same amount to $18,910,000 (see Note H – Fair Value Measurements). On July 13, 2009, the TRS contract was terminated and subsequently, a consolidated wholly owned subsidiary of the Company purchased the redevelopment bonds at par which effectively extinguished the subordinated debt.

22


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
E.   Senior and Subordinated Debt (continued)
In May 2003, the Company purchased $29,000,000 of subordinate tax revenue bonds that were contemporaneously transferred to a custodian, which in turn issued custodial receipts that represent ownership in the bonds to unrelated third parties. The bonds bear a fixed interest rate of 7.875%. The Company evaluated the transfer pursuant to the accounting guidance on accounting for transfers and servicing of financial assets and extinguishment of liabilities and has determined that the transfer does not qualify for sale accounting treatment principally because the Company has guaranteed the payment of principal and interest in the unlikely event that there is insufficient tax revenue to support the bonds when the custodial receipts are subject to mandatory tender on December 1, 2013. As such, the Company is the primary beneficiary of this VIE and the book value (which approximated amortized costs) of the bonds was recorded as a collateralized borrowing reported as senior and subordinated debt and as held-to-maturity securities reported as other assets in the Consolidated Balance Sheets.
F.   Financing Arrangements
Collateralized Borrowings
On July 13, 2005, the Park Creek Metropolitan District (the “District”) issued $65,000,000 Senior Subordinate Limited Property Tax Supported Revenue Refunding and Improvement Bonds, Series 2005 (the “Senior Subordinate Bonds”) and Stapleton Land II, LLC, a consolidated subsidiary, entered into an agreement whereby it will receive a 1% fee on the Senior Subordinate Bonds in exchange for providing certain credit enhancement. The counterparty to the credit enhancement arrangement also owns the underlying Senior Subordinate Bonds and can exercise its rights requiring payment from Stapleton Land II, LLC upon an event of default of the Senior Subordinate Bonds, a refunding of the Senior Subordinate Bonds, or failure of Stapleton Land II, LLC to post required collateral. The Senior Subordinate Bonds were refinanced on April 16, 2009 with proceeds from the issuance of $86,000,000 of Park Creek Metropolitan District Senior Limited Property Tax Supported Revenue Refunding and Improvement Bonds, Series 2009. The credit enhancement arrangement expired with the refinancing of the Senior Subordinate Bonds on April 16, 2009. The Company recorded $-0- and $132,000 of interest income related to the credit enhancement arrangement in the Consolidated Statements of Operations for the three and nine months ended October 31, 2009, respectively, and $164,000 and $488,000 for the three and nine months ended October 31, 2008, respectively.
On August 16, 2005, the District issued $58,000,000 Junior Subordinated Limited Property Tax Supported Revenue Bonds, Series 2005 (the “Junior Subordinated Bonds”). The Junior Subordinated Bonds initially were to pay a variable rate of interest. Upon issuance, the Junior Subordinated Bonds were purchased by a third party and the sales proceeds were deposited with a trustee pursuant to the terms of the Series 2005 Investment Agreement. Under the terms of the Series 2005 Investment Agreement, after March 1, 2006, the District may elect to withdraw funds from the trustee for reimbursement for certain qualified infrastructure and interest expenditures (“Qualifying Expenditures”). In the event that funds from the trustee are used for Qualifying Expenditures, a corresponding amount of the Junior Subordinated Bonds converts to an 8.5% fixed rate and matures in December 2037 (“Converted Bonds”). On August 16, 2005, Stapleton Land, LLC, a consolidated subsidiary, entered into a Forward Delivery Placement Agreement (“FDA”) whereby Stapleton Land, LLC was entitled and obligated to purchase the converted fixed rate Junior Subordinated Bonds through June 2, 2008. The District withdrew $58,000,000 of funds from the trustee for reimbursement of certain Qualifying Expenditures by June 2, 2008 and the Junior Subordinated Bonds became Converted Bonds. The Converted Bonds were acquired by Stapleton Land, LLC under the terms of the FDA by June 8, 2008. Stapleton Land, LLC immediately transferred the Converted Bonds to investment banks and the Company simultaneously entered into a TRS with a notional amount of $58,000,000. The Company receives a fixed rate of 8.5% and pays the SIFMA rate plus a spread on the TRS related to the Converted Bonds. The Company determined that the sale of the Converted Bonds to the investment banks and simultaneous execution of the TRS did not surrender control; therefore, the Converted Bonds have been recorded as a secured borrowing in the Consolidated Balance Sheets. During the year ended January 31, 2009, one of the Company’s consolidated subsidiaries purchased $10,000,000 of the Converted Bonds from one of the investment banks. Simultaneous with the purchase, a $10,000,000 TRS contract was terminated and the corresponding amount of the secured borrowing was removed from the Consolidated Balance Sheets. On April 16, 2009, an additional $5,000,000 of the Converted Bonds was purchased by one of the Company’s consolidated subsidiaries, and a corresponding amount of a related TRS was terminated and the corresponding secured borrowing was removed from the Consolidated Balance Sheets. The fair value of the Converted Bonds recorded in other assets in the Consolidated Balance Sheets was $58,000,000 at both October 31 and January 31, 2009. The outstanding TRS contracts on the $43,000,000 and $48,000,000 of secured borrowings related to the Converted Bonds at October 31 and January 31, 2009, respectively, were supported by collateral consisting primarily of certain notes receivable owned by the Company aggregating $33,035,000. The Company recorded net interest income of $499,000 and $1,819,000 related to the TRS in the Consolidated Statements of Operations for the three and nine months ended October 31, 2009, respectively, and $640,000 and $2,376,000 for the three and nine months ended October 31, 2008, respectively.

23


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
F.   Financing Arrangements (continued)
Other Structured Financing Arrangements
In May 2004, Lehman Brothers, Inc. (“Lehman”) purchased $200,000,000 in tax increment revenue bonds issued by the Denver Urban Renewal Authority (“DURA”), with a fixed-rate coupon of 8.0% and maturity date of October 1, 2024, which were used to fund the infrastructure costs associated with phase II of the Stapleton development project. The DURA bonds were transferred to a trust that issued floating rate trust certificates. Stapleton Land, LLC entered into an agreement with Lehman to purchase the DURA bonds from the trust if they are not repurchased or remarketed between June 1, 2007 and June 1, 2009. Stapleton Land, LLC is entitled to receive a fee upon removal of the DURA bonds from the trust equal to the 8.0% coupon rate, less the SIFMA index, less all fees and expenses due to Lehman (collectively, the “Fee”). The Fee was accounted for as a derivative with changes in fair value recorded through earnings. On July 1, 2008, $100,000,000 of the DURA bonds were remarketed. On July 15, 2008, Stapleton Land, LLC was paid $13,838,000 of the fee, which represented the fee earned on the remarketed DURA bonds.
During the three months ended October 31, 2008, Lehman filed for bankruptcy and the remaining $100,000,000 of DURA bonds were transferred to a creditor of Lehman. As a result, the Company reassessed the collectability of the Fee and decreased the fair value of the Fee to $-0-, resulting in an increase to operating expenses in the Consolidated Statements of Operations of $13,816,000 for the three months ended October 31, 2008. Stapleton Land, LLC informed Lehman that it determined that a “Special Member Termination Event” had occurred because Stapleton Land, LLC (a) fulfilled all of its bond purchase obligations under the transaction documents by purchasing or causing to be redeemed or repurchased all of the bonds held by Lehman and (b) fulfilled all other obligations in accordance with the transaction documents. Therefore, Stapleton Land, LLC has no other financing obligations with Lehman.
The Company recorded interest income of $-0- related to the change in fair value of the Fee in the Consolidated Statements of Operations for both the three and nine months ended October 31, 2009 and $-0- and $4,546,000 for the three and nine months ended October 31, 2008, respectively.
Stapleton Land, LLC has committed to fund $24,500,000 to the District to be used for certain infrastructure projects and has funded $16,491,000 of this commitment as of October 31, 2009. In addition, on June 23, 2009, another consolidated subsidiary of the Company entered into an agreement with the City of Denver and certain of its entities to fund $10,000,000 to be used to fund additional infrastructure projects and has funded $824,000 of this commitment as of October 31, 2009.
G.   Derivative Instruments and Hedging Activities
Risk Management Objective of Using Derivatives
The Company maintains an overall interest rate risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned decreases in earnings and cash flows that may be caused by interest rate volatility. Derivative instruments that are used as part of the Company’s strategy include interest rate swaps and option contracts that have indices related to the pricing of specific balance sheet liabilities. The Company enters into interest rate swaps to convert certain floating-rate debt to fixed-rate long-term debt, and vice-versa, depending on market conditions or forward starting swaps to hedge the changes in benchmark interest rates on forecasted financings. Option products utilized include interest rate caps, floors, interest rate swaptions and Treasury options. The use of these option products is consistent with the Company’s risk management objective to reduce or eliminate exposure to variability in future cash flows primarily attributable to changes in benchmark rates relating to forecasted financings, and the variability in cash flows attributable to increases relating to interest payments on its floating-rate debt. The caps and floors have typical durations ranging from one to three years while the Treasury options are for periods of five to ten years. The Company also enters into interest rate swap agreements for hedging purposes for periods that are generally one to ten years. The Company does not have any Treasury options outstanding at October 31, 2009.
Cash Flow Hedges of Interest Rate Risk
The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate caps and swaps as part of its interest rate risk management strategy. Interest rate caps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up front premium. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

24


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
G.   Derivative Instruments and Hedging Activities (continued)
The effective portion of changes in the fair value of derivatives designated and qualifying as cash flow hedges is recorded in accumulated OCI and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. The Company recorded interest expense of $-0- and $1,010,000 for the three and nine months ended October 31, 2009, respectively, and $457,000 and $482,000 for the three and nine months ended October 31, 2008, respectively, in the Consolidated Statements of Operations, which represented total ineffectiveness of all cash flow hedges of which $-0- and $928,000 for the three and nine months ended October 31, 2009, respectively, and $131,000 for the three and nine months ended October 31, 2008 represented the amount of derivative losses reclassified into earnings from accumulated OCI as a result of forecasted transactions that did not occur by the end of the originally specified time period or within an additional two-month period of time thereafter. As of October 31, 2009, the Company expects that within the next twelve months it will reclassify amounts recorded in accumulated OCI into earnings as an increase in interest expense of approximately $28,346,000, net of tax. However, the actual amount reclassified could vary due to future changes in fair value of these derivatives.
Fair Value Hedges of Interest Rate Risk
From time to time, the Company and/or certain of its joint ventures (the “Joint Ventures”) enter into TRS on various tax-exempt fixed-rate borrowings generally held by the Company and/or within the Joint Ventures. The TRS convert these borrowings from a fixed rate to a variable rate and provide an efficient financing product to lower the cost of capital. In exchange for a fixed rate, the TRS require that the Company and/or the Joint Ventures pay a variable rate, generally equivalent to the SIFMA rate plus a spread. At October 31, 2009, the SIFMA rate is 0.26%. Additionally, the Company and/or the Joint Ventures have guaranteed the fair value of the underlying borrowing. Any fluctuation in the value of the TRS would be offset by the fluctuation in the value of the underlying borrowing, resulting in no financial impact to the Company and/or the Joint Ventures. At October 31, 2009, the aggregate notional amount of TRS that are designated as fair value hedging instruments under the accounting guidance on derivatives and hedging activities, in which the Company and/or the consolidated Joint Ventures have an interest, is $482,940,000. The Company believes the economic return and related risk associated with a TRS is generally comparable to that of nonrecourse variable-rate mortgage debt. The underlying TRS borrowings are subject to a fair value adjustment (refer to Note H – Fair Value Measurements).
Nondesignated Hedges of Interest Rate Risk
The Company has entered into derivative contracts that are intended to economically hedge certain of its interest rate risk, even though the contracts do not qualify for hedge accounting or the Company has elected not to apply hedge accounting under the accounting guidance on derivatives and hedging activities. In all situations in which hedge accounting is discontinued, or not elected, and the derivative remains outstanding, the Company will report the derivative at its fair value in the Consolidated Balance Sheets, immediately recognizing changes in the fair value in the Consolidated Statements of Operations.
The Company has entered into forward swaps to protect itself against fluctuations in the swap rate at terms ranging between five to ten years associated with forecasted fixed-rate borrowings. At the time the Company secures and locks an interest rate on an anticipated financing, it intends to simultaneously terminate the forward swap associated with that financing. At October 31, 2009, the Company has two forward swaps, with notional amounts of $69,325,000 and $120,000,000, respectively, that do not qualify as cash flow hedges under the accounting guidance on derivatives and hedging activities. As such, the change in fair value of these swaps is marked to market through earnings on a quarterly basis. Related to these forward swaps, the Company recorded $4,344,000 and $(2,800,000) for the three and nine months ended October 31, 2009, respectively, and $2,058,000 and $(75,000) for the three and nine months ended October 31, 2008, respectively, as an increase (reduction) of interest expense in its Consolidated Statements of Operations. During the year ended January 31, 2009, the Company purchased an interest rate floor in order to mitigate the interest rate risk on one of the forward swaps ($120,000,000 notional) should interest rates fall below a certain level.

25


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
G.   Derivative Instruments and Hedging Activities (continued)
The following table presents the fair values and location in the Consolidated Balance Sheet of all derivative instruments as of October 31, 2009:
                                   
    Fair Value of Derivative Instruments
    October 31, 2009
                    Liability Derivatives  
    Asset Derivatives     (included in Accounts Payable  
    (included in Other Assets)     and Accrued Expenses)
    Current             Current        
    Notional     Fair Value     Notional     Fair Value 
    (in thousands)  
Derivatives Designated as Hedging Instruments
                               
 
Interest rate caps and floors
   $ 566,960      $ 2,590      $ -      $ -  
Interest rate swap agreements
    -       -       1,149,421       108,254   (1)
TRS
    11,000       17       471,940       42,148  
 
               
Total derivatives designated as hedging instruments
   $ 577,960      $ 2,607      $ 1,621,361      $ 150,402  
 
               
 
Derivatives Not Designated as Hedging Instruments
                               
Interest rate caps and floors
   $ 1,392,301      $ 537 (2)    $ -      $ -  
Interest rate swap agreements
    21,176       2,161       189,325       36,943  
TRS
    -       -       40,527       11,794  
 
               
Total derivatives not designated as hedging instruments
   $ 1,413,477      $ 2,698      $ 229,852      $ 48,737  
 
               
  (1)   $2,508 of the fair value applies to $300,000 of notional excluded from the associated current notional amount that is covered by other interest rate swaps for the nine months ended October 31, 2009. These swaps are active as of October 31, 2009; however, their effective periods are subsequent to this date.
 
  (2)   $422 of the fair value applies to $1,447,334 of notional excluded from the associated current notional amount that is covered by other interest rate caps for the nine months ended October 31, 2009. These caps are active as of October 31, 2009; however, their effective periods are subsequent to this date.

26


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
G.   Derivative Instruments and Hedging Activities (continued)
The following tables present the impact of gains and losses related to derivative instruments designated as cash flow hedges included in the accumulated OCI section of the Consolidated Balance Sheets as of October 31, 2009, and in equity in loss of unconsolidated entities and interest expense in the Consolidated Statements of Operations for the three and nine months ended October 31, 2009:
                             
            Loss Reclassified from        
            Accumulated OCI        
Three Months Ended October 31, 2009           (Effective Portion)      
                        Loss Recognized in  
                        Interest Expense on  
    Loss     Location on           Derivatives (Ineffective  
    Recognized     Consolidated           Portion and Amounts  
Derivatives Designated as   in OCI     Statements of           Excluded from  
Cash Flow Hedging Instruments(1)   (Effective Portion)     Operations   Amount     Effectiveness Testing)  
          (in thousands)        
 
Interest rate caps, interest rate swaps and Treasury options
   $ (19,258 )   Interest expense    $ (14,143 )    $ -  
Treasury options
    -     Equity in loss of
unconsolidated
entities
    (41 )     -  
 
                     
Total
   $ (19,258 )        $ (14,184 )    $ -  
 
                     
 
Nine Months Ended October 31, 2009      
    (in thousands)  
 
Interest rate caps, interest rate swaps and Treasury options
   $ (16,150 )   Interest expense    $ (41,022 )    $ (1,010 )
Treasury options
    -     Equity in loss of
unconsolidated
entities
    (123 )     -  
 
                     
Total
   $ (16,150 )        $ (41,145 )    $ (1,010 )
 
                     
  (1)   Gains and losses on terminated hedges included in accumulated OCI are being reclassified into interest expense over the original life of the hedged transactions as the transactions are still more likely than not to occur and would not be reflected in the previous table related to the fair value of designated derivatives (see Note H – Fair Value Measurements).
The following table presents the impact of gains and losses related to derivative instruments designated as fair value hedges included in interest expense in the Consolidated Statements of Operations for the three and nine months ended October 31, 2009:
                 
Derivatives Designated as      
Fair Value Hedging Instruments   Net Gain Recognized(1)  
     Three Months Ended     Nine Months Ended   
    October 31, 2009     October 31, 2009  
    (in thousands)  
 
               
TRS
   $ 10,056      $ 17,209  
  (1)   The net loss recognized in interest expense in the Consolidated Statements of Operations from the change in fair value of the underlying TRS borrowings for the three and nine months ended October 31, 2009 was $(10,056) and $(17,209), respectively, offsetting the gain recognized on the TRS (see Note H – Fair Value Measurements).

27


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
G.   Derivative Instruments and Hedging Activities (continued)
The following table presents the impact of gains and losses related to derivative instruments not designated as hedging instruments included in interest expense in the Consolidated Statements of Operations for the three and nine months ended October 31, 2009:
                 
Derivatives Not Designated as      
Hedging Instruments   Net Gain (Loss) Recognized  
    Three Months Ended     Nine Months Ended  
    October 31, 2009     October 31, 2009  
    (in thousands)  
 
               
Interest rate caps, interest rate swaps and floors
   $ (4,833 )    $ 1,589  
TRS
    250       (3,261 )
 
           
Total
   $ (4,583 )    $ (1,672 )
 
           
Credit-risk-related Contingent Features
The principal credit risk to the Company through its interest rate risk management strategy is the potential inability of the financial institution from which the derivative financial instruments were purchased to cover all of its obligations. If a counterparty fails to fulfill its performance obligations under a derivative contract, the Company’s risk of loss approximates the fair value of the derivative. To mitigate this exposure, the Company generally purchases its derivative financial instruments from the financial institution that issues the related debt, from financial institutions with which we have other lending relationships, or from financial institutions with a minimum credit rating of AA at the time the transaction is entered into.
The Company has agreements with its derivative counterparties that contain a provision, under which the derivative counterparty could terminate the derivative obligations if the Company defaults on its obligations under its bank revolving credit facility and designated conditions have passed. In instances where subsidiaries of the Company have derivative obligations that are secured by a mortgage, the derivative obligations could be terminated if the indebtedness between the two parties is terminated, either by loan payoff or default of the indebtedness. In addition, one of the Company’s derivative contracts provides that if the Company’s credit rating were to fall below certain levels, it may trigger additional collateral to be posted with the counterparty up to the full amount of the liability position of the derivative contracts. Also, certain subsidiaries of the Company have agreements with certain of its derivative counterparties that contain provisions whereby the subsidiaries of the Company must maintain certain minimum financial ratios.
As of October 31, 2009, the aggregate fair value of all derivative instruments in a liability position, prior to the adjustment for nonperformance risk of $(15,103,000), is $214,242,000, for which the Company had posted collateral consisting of cash and notes receivable of $98,961,000. If all credit risk contingent features underlying these agreements had been triggered on October 31, 2009, as discussed above, the Company would have been required to post collateral of the full amount of the liability position referred to above, or $214,242,000.

28


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
H.   Fair Value Measurements
The Company’s financial assets and liabilities subject to fair value measurements are interest rate caps and swaptions, interest rate swap agreements (including forward swaps), TRS and borrowings subject to TRS (see Note G – Derivative Instruments and Hedging Activities). The Company’s impairment of its unconsolidated entities is also subject to fair value measurements (see Note L - Impairment of Real Estate, Impairment of Unconsolidated Entities, Write-Off of Abandoned Development Projects and Gain (Loss) on Early Extinguishment of Debt).
Fair Value Hierarchy
The accounting guidance related to estimating fair value specifies a hierarchy of valuation techniques based upon whether the inputs to those valuation techniques reflect assumptions other market participants would use based upon market data obtained from independent sources (also referred to as observable inputs). The following summarizes the fair value hierarchy:
    Level 1 – Quoted prices in active markets that are unadjusted and accessible at the measurement date for identical, unrestricted assets or liabilities;
 
    Level 2 – Quoted prices for identical assets and liabilities in markets that are not active, quoted prices for similar assets and liabilities in active markets or financial instruments for which significant observable inputs are available, either directly or indirectly such as interest rates and yield curves that are observable at commonly quoted intervals; and
 
    Level 3 – Prices or valuations that require inputs that are unobservable.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.
Measurement of Fair Value
The Company estimates the fair value of its hedging instruments, which includes the interest rate caps, floors and interest rate swap agreements (including forward swaps), based on interest rate market pricing models. Although the Company has determined that the significant inputs used to value its hedging instruments fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with the Company’s counterparties and its own credit risk utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. As of October 31, 2009, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its hedging instruments’ positions and has determined that the credit valuation adjustments are significant to the overall valuation of one interest rate swap, and are not significant to the overall valuation of all of its other hedging instruments. As a result, the Company has determined that one interest rate swap valuation is classified in Level 3 of the fair value hierarchy and all of its other hedging instruments valuations are classified in Level 2 of the fair value hierarchy.
The Company’s TRS have termination values equal to the difference between the fair value of the underlying bonds and the bonds base (acquired) price times the stated par amount of the bonds. Upon termination of the contract with the counterparty, the Company is entitled to receive the termination value if the underlying fair value of the bonds is greater than the base price and is obligated to pay the termination value if the underlying fair value of the bonds is less than the base price. The underlying borrowings generally have call features at par and without prepayment penalties. The call features of the underlying borrowings would result in a significant discount factor to any value attributed to the exchange of cash flows in these contracts by another market participant willing to purchase the Company’s positions. Therefore, the Company believes the termination value of the TRS approximates the fair value another market participant would assign to these contracts. The Company compares estimates of fair value to those provided by the respective counterparties on a quarterly basis. The Company has determined its fair value estimate of TRS is classified in Level 3 of the fair value hierarchy.
To determine the fair value of the underlying borrowings subject to TRS, the base price is initially used as the estimate of fair value. The Company adjusts the fair value based upon observable and unobservable measures such as the financial performance of the underlying collateral; interest rate risk spreads for similar transactions and loan to value ratios. In the absence of such evidence, management’s best estimate is used. At October 31, 2009, the notional amount of TRS borrowings subject to fair value adjustments are approximately $482,940,000. The Company compares estimates of fair value to those provided by the respective counterparties on a quarterly basis. The Company has determined its fair value estimate of borrowings subject to TRS is classified in Level 3 of the fair value hierarchy.

29


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
H.   Fair Value Measurements (continued)
Items Measured at Fair Value on a Recurring Basis
The Company’s financial assets consists of interest rate caps and floors, interest rate swap agreements with a positive fair value, and TRS with a positive fair value and are included in other assets. The Company’s financial liabilities consists of interest rate swap agreements with a negative fair value (which includes the forward swaps) and TRS with a negative fair value included in accounts payable and accrued expenses and borrowings subject to TRS included in mortgage debt, nonrecourse or accounts payable and accrued expenses. The following table presents information about the Company’s financial assets and liabilities that were measured at fair value on a recurring basis as of October 31, 2009, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value.
                                 
    Fair Value Measurements
    at October 31, 2009
    Level 1   Level 2   Level 3   Total
    (in thousands)  
       
Interest rate caps and floors
    $ -       $ 3,127       $ -       $ 3,127  
Interest rate swap agreements (positive fair value)
    -       2,161       -       2,161  
TRS (positive fair value)
    -       -       17       17  
Interest rate swap agreements (negative fair value)
    -       (52,560 )     (92,637 )     (145,197 )
TRS (negative fair value)
    -       -       (53,942 )     (53,942 )
Fair value adjustment to the borrowings subject to TRS
    -       -       42,131       42,131  
 
               
Total
    $ -       $ (47,272 )     $ (104,431 )     $ (151,703 )
 
               
The table below presents a reconciliation of all financial assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the nine months ended October 31, 2009.
                                         
    Fair Value Measurements
    Nine Months Ended October 31, 2009
                    (in thousands)              
                    Fair value              
                    adjustment              
                    to the              
    Interest Rate   Net     borrowings     Total TRS        
    Swaps   TRS     subject to TRS     Related     Total
             
Balance, February 1, 2009
    $ (113,109 )     $ (67,873 )     $ 59,340       $ (8,533 )     $ (121,642 )
Total realized and unrealized gains (losses):
                                       
Included in interest expense
    -       14,772       (18,102 )     (3,330 )     (3,330 )
Included in other comprehensive income
    17,016       -       -       -       17,016  
Purchases, issuances and settlements
    -       (824 )     893       69       69  
Transfer to Level 2
    3,456       -       -       -       3,456  
             
Balance, October 31, 2009
    $ (92,637 )     $ (53,925 )     $ 42,131       $ (11,794 )     $ (104,431 )
             
I.   Stock-Based Compensation
In April 2009, the Company granted 298,172 stock options and 646,862 shares of restricted stock under the Company’s 1994 Stock Plan. The stock options had a grant-date fair value of $4.56, which was computed using the Black-Scholes option-pricing model with the following assumptions: expected term of 5.5 years, expected volatility of 65.9%, risk-free interest rate of 2.02%, and expected dividend yield of 0%. The exercise price of the options is $7.80, which was the closing price of the underlying stock on the date of grant. The restricted stock had a grant-date fair value of $7.80 per share, which was the closing price of the stock on the date of grant.
At October 31, 2009, there was $8,819,000 of unrecognized compensation cost related to stock options that is expected to be recognized over a weighted-average period of 1.77 years, and there was $13,329,000 of unrecognized compensation cost related to restricted stock that is expected to be recognized over a weighted-average period of 2.52 years.

30


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
I.   Stock-Based Compensation (continued)
The amount of stock-based compensation costs and related deferred income tax benefit recognized in the financial statements are as follows:
                                   
    Three Months Ended October 31,       Nine Months Ended October 31,  
    2009     2008       2009     2008  
    (in thousands)       (in thousands)  
 
                                 
Stock option costs
   $ 1,928      $ 2,318        $ 6,546      $ 7,456  
Restricted stock costs
    1,864       1,743         6,269       5,386  
Performance shares
    -       428         -       714  
           
Total stock-based compensation costs
    3,792       4,489         12,815       13,556  
Less amount capitalized into qualifying real estate projects
    (2,136 )     (2,421 )       (7,123 )     (6,540 )
           
Amount charged to operating expenses
    1,656       2,068         5,692       7,016  
Depreciation expense on capitalized stock-based compensation
    105       61         313       184  
           
Total stock-based compensation expense
   $ 1,761      $ 2,129        $ 6,005      $ 7,200  
           
 
                                 
Deferred income tax benefit
   $ 586      $ 687        $ 2,002      $ 2,350  
           
Accounting guidance on share-based payments requires the immediate recognition of stock-based compensation costs for awards granted to retirement-eligible grantees. The amount of grant-date fair value expensed immediately for awards granted to retirement-eligible grantees during the nine months ended October 31, 2009 and 2008 was $350,000 and $1,298,000, respectively.
In connection with the vesting of restricted stock during the nine months ended October 31, 2009 and 2008, the Company repurchased into treasury 26,188 shares and 17,355 shares, respectively, of Class A common stock to satisfy the employees’ related minimum statutory tax withholding requirements. These shares were placed in treasury with an aggregate cost basis of $133,000 and $651,000, respectively.
J.   Income Taxes
Income tax benefit for the three months ended October 31, 2009 and 2008 was $(2,895,000) and $(11,916,000), respectively. Income tax benefit for the nine months ended October 31, 2009 and 2008 was $(25,874,000) and $(28,382,000), respectively. The difference in the income tax benefit reflected in the Consolidated Statements of Operations versus the income tax benefit computed at the statutory federal income tax rate is primarily attributable to state income taxes, the cumulative effect of changing the Company’s effective tax rate, additional state NOL’s and general business credits, changes to the valuation allowances associated with certain deferred tax assets, and various permanent differences between pre-tax GAAP income and taxable income.
At January 31, 2009, the Company had a federal net operating loss carryforward for tax purposes of $113,458,000 (generated primarily from the impact on its net earnings of tax depreciation expense from real estate properties and excess deductions from stock-based compensation) that will expire in the years ending January 31, 2024 through January 31, 2029, a charitable contribution deduction carryforward of $42,705,000 that will expire in the years ending January 31, 2010 through January 31, 2014 ($5,651,000 expiring in the year ended January 31, 2010), general business credit carryovers of $15,099,000 that will expire in the years ending January 31, 2010 through January 31, 2029 ($36,000 expiring in the year ended January 31, 2010), and an alternative minimum tax (“AMT”) credit carryforward of $28,501,000 that is available until used to reduce federal tax to the AMT amount.
The Company’s policy is to consider a variety of tax-deferral strategies, including tax deferred exchanges, when evaluating its future tax position. The Company has a full valuation allowance against the deferred tax asset associated with its charitable contributions. The Company has a valuation allowance against its general business credits, other than those general business credits which are eligible to be utilized to reduce future AMT liabilities. These valuation allowances exist because management believes at this time that it is more likely than not that the Company will not realize these benefits.
The Company applies the “with-and-without” methodology for recognizing excess tax benefits from the deduction of stock-based compensation. The net operating loss available for the tax return, as is noted in the paragraph above, is significantly greater than the net operating loss available for the tax provision due to excess deductions from stock-based compensation reported on the return, as well as the impact of adjustments to the net operating loss under the accounting guidance on accounting for uncertainty in income taxes. The Company has not recorded a net deferred tax asset of approximately $17,096,000, as of January 31, 2009, from excess stock-based compensation deductions taken on the tax return for which a benefit has not yet been recognized in the tax provision.

31


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
J.   Income Taxes (continued)
Accounting for Uncertainty in Income Taxes
Unrecognized tax benefits represent those tax benefits related to tax positions that have been taken or are expected to be taken in tax returns that are not recognized in the financial statements because management has either concluded that it is not more likely than not that the tax position will be sustained if audited by the appropriate taxing authority or the amount of the benefit will be less than the amount taken or expected to be taken in its income tax returns.
As of October 31 and January 31, 2009, the Company had unrecognized tax benefits of $1,636,000 and $1,481,000, respectively. The Company recognizes estimated interest payable on underpayments of income taxes and estimated penalties that may result from the settlement of some uncertain tax positions as components of income tax expense. As of October 31 and January 31, 2009, the Company had approximately $501,000 and $463,000, respectively, of accrued interest related to uncertain income tax positions. Income tax expense (benefit) relating to interest and penalties on uncertain tax positions of $(87,000) and $37,000 for the three and nine months ended October 31, 2009, respectively, and $35,000 and $(297,000) for the three and nine months ended October 31, 2008, respectively, was recorded in the Consolidated Statements of Operations. The Company settled Internal Revenue Service audits of two of its partnership investments, one during the three months ended October 31, 2009 and one during the nine months ended October 31, 2008, both of which resulted in a decrease in the Company’s unrecognized tax benefits and associated accrued interest and penalties.
The total amount of unrecognized tax benefits that would affect the Company’s effective tax rate, if recognized as of October 31, 2009 and 2008, is $172,000 and $339,000, respectively. Based upon the Company’s assessment of the outcome of examinations that are in progress, the settlement of liabilities, or as a result of the expiration of the statutes of limitation for certain jurisdictions, it is reasonably possible that the related unrecognized tax benefits for tax positions taken regarding previously filed tax returns will materially change from those recorded at October 31, 2009. Included in the $1,636,000 of unrecognized benefits noted above is $1,415,000 which, due to the reasons above, could significantly decrease during the next twelve months.
K.   Discontinued Operations
All revenues and expenses of discontinued operations sold or held for sale, assuming no significant continuing involvement, have been reclassified in the Consolidated Statements of Operations for the three and nine months ended October 31, 2009 and 2008. The Company considers assets held for sale when the transaction has been approved and there are no significant contingencies related to the sale that may prevent the transaction from closing. There were no assets classified as held for sale at October 31 or January 31, 2009.
During the nine months ended October 31, 2009, the Company sold Grand Avenue, a specialty retail center in Queens, New York, which generated a pre-tax gain on disposition of rental properties of $4,548,000. The gain along with the operating results of the property through the date of sale is classified as discontinued operations for the nine months ended October 31, 2009 and 2008.
During the year ended January 31, 2008, the Company consummated an agreement to sell eight (seven operating properties and one property that was under construction at the time of the agreement) and lease four supported-living apartment properties to a third party. Pursuant to the agreement, during the second quarter of 2007, six operating properties and the property under construction were sold. The seventh operating property, Sterling Glen of Lynbrook, was operated by the purchaser under a short-term lease through the date of sale, which occurred on May 20, 2008 and generated a pre-tax gain on disposition of rental properties of $8,627,000. The gain along with the operating results of the property through the date of sale are classified as discontinued operations for the nine months ended October 31, 2008.
The four remaining properties entered into long-term operating leases with the purchaser. On January 30, 2009, the purchase agreement for the sale of Sterling Glen of Rye Brook, whose operating lease had a stated term of ten years, were amended and the property was sold. The operating results of the property for the three and nine months ended October 31, 2008 are classified as discontinued operations. On January 31, 2009, another long-term operating lease with the purchaser that had a stated term of ten years was cancelled and the operations of the property were transferred back to the Company.
During the three months ended October 31, 2009, negotiations related to amending terms of the purchase agreements for the sales of Sterling Glen of Glen Cove and Sterling Glen of Great Neck indicated the carrying value of these long-lived real estate assets may not be recoverable resulting in an impairment of real estate of $7,138,000 and $2,637,000, respectively, which reduced the carrying value of the long-lived assets to the estimated net sales price. The sale of the two properties closed on September 17 and 30, 2009, respectively, resulting in no gain or loss upon disposition. The operating results of the properties, including the impairment charges, are classified as discontinued operations for the three and nine months ended October 31, 2009 and 2008.

32


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
K.   Discontinued Operations (continued)
The following table lists the consolidated rental properties included in discontinued operations:
                               
                Three   Nine   Three   Nine
                Months   Months   Months   Months
        Square Feet/   Period   Ended   Ended   Ended   Ended
Property   Location   Number of Units   Disposed   10/31/2009   10/31/2009   10/31/2008   10/31/2008
 
 
                           
Commercial Group:
                           
Grand Avenue
  Queens, New York   100,000 square feet   Q1-2009   -   Yes   Yes   Yes
 
                           
Residential Group:
                           
Sterling Glen of Glen Cove
  Glen Cove, New York   80 units   Q3-2009   Yes   Yes   Yes   Yes
Sterling Glen of Great Neck
  Great Neck, New York   142 units   Q3-2009   Yes   Yes   Yes   Yes
Sterling Glen of Rye Brook
  Rye Brook, New York   168 units   Q4-2008   -   -   Yes   Yes
Sterling Glen of Lynbrook
  Lynbrook, New York   130 units   Q2-2008   -   -   -   Yes
The operating results related to discontinued operations were as follows:
                                 
    Three Months Ended October 31,   Nine Months Ended October 31,
    2009   2008   2009   2008
    (in thousands)   (in thousands)
 
                               
Revenues from real estate operations
  $ 1,688     $ 4,149        $ 5,476     $ 13,114  
 
                               
Expenses
                               
Operating expenses
    35       416       430       1,604  
Depreciation and amortization
    195       1,451       1,347       3,911  
Impairment of real estate
    9,775       -       9,775       -  
         
 
    10,005       1,867       11,552       5,515  
         
 
                               
Interest expense
    (502 )     (1,883 )     (2,184 )     (5,721 )
Amortization of mortgage procurement costs
    (7 )     (106 )     (50 )     (339 )
 
                               
Interest income
    -       37       -       136  
Gain on disposition of rental properties
    -       -       4,548       8,627  
         
 
                               
Earnings (loss) before income taxes
    (8,826 )     330       (3,762 )     10,302  
         
 
                               
Income tax expense (benefit)
                               
Current
    (3,019 )     110       848       (636 )
Deferred
    (404 )     18       (2,307 )     4,617  
         
 
    (3,423 )     128       (1,459 )     3,981  
         
 
                               
Net earnings (loss) from discontinued operations
  $ (5,403 )   $ 202     $ (2,303 )   $ 6,321  
         

33


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
L.   Impairment of Real Estate, Impairment of Unconsolidated Entities, Write-Off of Abandoned Development Projects and Gain (Loss) on Early Extinguishment of Debt
Impairment of Real Estate
The Company reviews its real estate portfolio, including land held for development or sale, for impairment whenever events or changes indicate that its carrying value of the long-lived assets may not be recoverable. In cases where the Company does not expect to recover its carrying costs, an impairment charge is recorded in accordance with accounting guidance on the impairment of long-lived assets. During the three and nine months ended October 31, 2009, the Company recorded an impairment of certain real estate assets in continuing operations of $549,000 and $3,124,000, respectively. The amounts for 2009 represent impairments of real estate of $2,000,000 primarily related to two land development projects, Gladden Farms and Tangerine Crossing located in Marana and Tucson, Arizona, respectively, and $1,124,000 related to the residential land sale and related development opportunity in Mamaroneck, New York, which occurred during the three months ended April 30, 2009. In addition, included in discontinued operations is an impairment of real estate for two properties that were sold during the three months ended October 31, 2009 (see Note K). These impairments represent a write down to the estimated fair value due to a change in events, such as a purchase offer and/or consideration of current market conditions related to the estimated future cash flows. The Company did not record any impairments of real estate during the three and nine months ended October 31, 2008.
Impairment of Unconsolidated Entities
The Company reviews its portfolio of unconsolidated entities for other-than-temporary impairments whenever events or changes indicate that its carrying value in the investments may be in excess of fair value. An equity method investment’s value is impaired only if management’s estimate of its fair value is less than the carrying value and such difference is deemed to be other-than-temporary. In order to arrive at the estimates of fair value of its unconsolidated entities, the Company uses varying assumptions that may include comparable sale prices, market discount rates, market capitalization rates and estimated future discounted cash flows specific to the geographic region and property type, which are considered to be Level 3 inputs under accounting guidance related to estimating fair value.
The following table summarizes the Company’s impairment of unconsolidated entities for the three and nine months ended October 31, 2009 and 2008, which are included in the Consolidated Statements of Operations.
                                         
            Three Months Ended     Nine Months Ended  
            October 31,   October 31,  
            2009     2008     2009     2008  
                 
            (in thousands)     (in thousands)  
 
                                       
Apartment Communities:
                                       
Millender Center
  (Detroit, Michigan)    $ 3,247      $ -      $ 10,317      $ -  
Uptown Apartments
  (Oakland, California)     -       -       6,781       -  
Metropolitan Lofts
  (Los Angeles, California)     1,466       -       2,505       -  
Residences at University Park
  (Cambridge, Massachusetts)     -       -       855       -  
Fenimore Court
  (Detroit, Michigan)     -       -       693       -  
Mercury (Condominium)
  (Los Angeles, California)     -       -       -       4,098  
Classic Residence by Hyatt (Supported-Living Apartments)
(Yonkers, New York)     -       -       3,152       -  
Specialty Retail Centers:
                                       
Southgate Mall
  (Yuma, Arizona)     -       -       1,611       -  
El Centro Mall
  (El Centro, California)     -       -       -       1,263  
Pittsburgh Peripheral (Land Project)
  (Pittsburgh, Pennsylvania)     7,217       -       7,217       -  
Shamrock Business Center (Land Project)
  (Painesville, Ohio)     1,150       -       1,150       -  
Other
            120       -       382       665  
                 
 
Total Impairment of Unconsolidated Entities.
           $ 13,200      $ -      $ 34,663      $ 6,026  
                 

34


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(Unaudited)
L.   Impairment of Real Estate, Impairment of Unconsolidated Entities, Write-Off of Abandoned Development Projects and Gain (Loss) on Early Extinguishment of Debt (continued)
Write-Off of Abandoned Development Projects
On a quarterly basis, the Company reviews each project under development to determine whether it is probable the project will be developed. If management determines that the project will not be developed, project costs are written off to operating expenses as an abandoned development project cost. The Company may abandon certain projects under development for a number of reasons, including, but not limited to, changes in local market conditions, increases in construction or financing costs or due to third party challenges related to entitlements or public financing. As a result, the Company may fail to recover expenses already incurred in exploring development opportunities. The Company recorded write-offs of abandoned development projects of $3,758,000 and $21,398,000 for the three and nine months ended October 31, 2009, respectively, and $12,500,000 and $41,452,000 for the three and nine months ended October 31, 2008, respectively, which were recorded in operating expenses in the Consolidated Statements of Operations.
Gain (Loss) on Early Extinguishment of Debt
For the three and nine months ended October 31, 2009, the Company recorded $28,902,000 and $37,965,000, respectively, as gain on early extinguishment of debt. The amounts for 2009 include the $24,219,000 gain on early extinguishment of nonrecourse mortgage debt at an underperforming retail project, the $9,466,000 gain on early extinguishment of nonrecourse mortgage debt at Gladden Farms, a land development project located in Marana, Arizona and the $4,683,000 gain related to the exchange of a portion of the Company’s 2011 Notes for a new issue of 2014 Notes (see the “Puttable Equity-Linked Senior Notes due 2011” section of Note E). These gains were partially offset by a charge to early extinguishment of debt as a result of the payment of $20,400,000 in redevelopment bonds by a consolidated wholly-owned subsidiary of the Company (see the “Subordinated Debt” section of Note E). For the three and nine months ended October 31, 2008, the Company recorded $3,692,000 and $(1,539,000), respectively, as gain (loss) on early extinguishment of debt. The amounts for 2008 include gains on the early extinguishment of debt of a portion of the Company’s puttable equity-linked senior notes due October 15, 2011 (see the “Puttable Equity-Linked Senior Notes due 2011” section of Note E) and on the early extinguishment of the Urban Development Action Grant loan at Post Office Plaza, an office building located in Cleveland, Ohio. These gains were offset by the impact of early extinguishment of nonrecourse mortgage debt at Galleria at Sunset, a regional mall located in Henderson, Nevada, and 1251 S. Michigan and Sky55, apartment communities located in Chicago, Illinois, in order to secure more favorable financing terms.
M.   Common Stock Offering
In May 2009, the Company sold 52,325,000 shares of its Class A common stock in a public offering at a price of $6.60 per share, which included 6,825,000 shares issued as a result of the underwriters’ exercise of their over-allotment option in full. The offering generated net proceeds of $329,917,000 after deducting underwriting discounts, commissions and other offering expenses, which were used to reduce a portion of the Company’s outstanding borrowings under its bank revolving credit facility.
N.   Earnings Per Share
Effective February 1, 2009, the Company’s restricted stock is considered a participating security pursuant to the two-class method for computing basic earnings per share. The Class A Common Units issued in exchange for Bruce C. Ratner’s noncontrolling interests in the Forest City Ratner Company portfolio in November 2006, which are reflected as noncontrolling interests in the Company’s Consolidated Balance Sheets, are considered convertible participating securities as they are entitled to participate in any dividends paid to the Company’s common shareholders. The Class A Common Units are included in the computation of basic earnings per share using the two-class method and are included in the computation of diluted earnings per share using the if-converted method. The Class A common stock issuable in connection with the conversion of the 2014 Notes and 2016 Notes are included in the computation of diluted earnings per share using the if-converted method.
The loss from continuing operations attributable to Forest City Enterprises, Inc. for the nine months ended October 31, 2009 and the three and nine months ended October 31, 2008 as well as the net loss attributable to Forest City Enterprises, Inc. for the three and nine months ended October 31, 2009 and 2008 were allocated solely to holders of common stock as the participating security holders do not share in the losses in accordance with earnings per share accounting guidance.

35


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
N.   Earnings Per Share (continued)
The reconciliation of the amounts used in the basic and diluted earnings per share computations is shown in the following table.
                                 
    Three Months Ended     Nine Months Ended  
    October 31,     October 31,  
    2009     2008     2009     2008  
         
 
                               
Numerators (in thousands)
                               
Earnings (loss) from continuing operations attributable to Forest City Enterprises, Inc.
  $ 1,019     $ (19,317 )   $ (34,549 )   $ (74,224 )
Undistributed earnings allocated to participating securities
    (30 )     -       -       -  
     
Earnings (loss) from continuing operations attributable to Forest City Enterprises, Inc. - Basic
  $ 989     $ (19,317 )   $ (34,549 )   $ (74,224 )
Undistributed earnings allocated to participating securities
    30       -       -       -  
     
Earnings (loss) from continuing operations attributable to Forest City Enterprises, Inc. - Diluted
  $ 1,019     $ (19,317 )   $ (34,549 )   $ (74,224 )
     
Net loss attributable to Forest City Enterprises, Inc. - Basic and Diluted
  $ (4,384 )   $ (19,115 )   $ (36,852 )   $ (67,903 )
     
 
                               
Denominators
                               
Weighted average shares outstanding - Basic
    155,314,676       102,845,434       134,602,200       102,714,757  
Effect of stock options and restricted stock
    229,638       -       -       -  
         
Weighted average shares outstanding - Diluted (1)(2)(3)(4)(5)
    155,544,314       102,845,434       134,602,200       102,714,757  
         
 
                               
Earnings Per Share
                               
Earnings (loss) from continuing operations attributable to Forest City Enterprises, Inc. - Basic
  $ 0.01     $ (0.19 )   $ (0.26 )   $ (0.72 )
Earnings (loss) from continuing operations attributable to Forest City Enterprises, Inc. - Diluted
  $ 0.01     $ (0.19 )   $ (0.26 )   $ (0.72 )
 
                               
Net loss attributable to Forest City Enterprises, Inc. - Basic and Diluted
  $ (0.03 )   $ (0.19 )   $ (0.27 )   $ (0.66 )
 
(1)   Incremental shares from dilutive stock options and restricted stock of 82,042 for the nine months ended October 31, 2009 and 422,130 and 597,020 for the three and nine months ended October 31, 2008, respectively, were not included in the computation of diluted earnings per share because their effect is anti-dilutive due to the loss from continuing operations.
 
(2)   Weighted-average options and restricted stock of 4,444,320 and 4,679,029 for the three and nine months ended October 31, 2009, respectively, and 3,506,478 and 2,678,153 for the three and nine months ended October 31, 2008, respectively, were not included in the computation of diluted earnings per share because their effect is anti-dilutive.
 
(3)   Weighted-average shares issuable upon conversion of the convertible Class A Common Units, the 2014 Notes, and the 2016 Notes of 8,322,258 and 5,222,382 for the three and nine months ended October 31, 2009, respectively, and 3,646,755 and 3,802,106 for the three and nine months ended October 31, 2008, respectively, were not included in the computation of diluted earnings per share because their effect is anti-dilutive under the if-converted method.
 
(4)   Weighted-average performance shares of 172,609 for both the three and nine months ended October 31, 2009, respectively, and 172,609 and 85,054 for the three and nine months ended October 31, 2008, respectively, were not included in the computation of diluted earnings per share because the performance criteria were not satisfied at the end of the respective periods.
 
(5)   The 2011 Notes can be put to the Company by the holders under certain circumstances (see Note E – Senior and Subordinated Debt). If the Company exercises its net share settlement option upon a put of the notes by the holders, it will then issue shares of its Class A common stock. The effect of these shares was not included in the computation of diluted earnings per share for the three and nine months ended October 31, 2009 and 2008 as the Company’s average stock price did not exceed the put value price of the 2011 Notes. These notes will be dilutive when the average stock price for the period exceeds $66.39. Additionally, the Company sold a warrant with an exercise price of $74.35, which has also been excluded from diluted earnings per share for the three and nine months ended October 31, 2009 and 2008 as the Company’s stock price did not exceed the exercise price.

36


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
O.   Segment Information
The Company operates through three strategic business units and five reportable segments, determined in accordance with accounting guidance on segment reporting. The three strategic units/reportable segments are the Commercial Group, Residential Group and Land Development Group (“Real Estate Groups”). The Commercial Group, the Company’s largest business unit, owns, develops, acquires and operates regional malls, specialty/urban retail centers, office and life science buildings, hotels and mixed-use projects. The Residential Group owns, develops, acquires and operates residential rental properties, including upscale and middle-market apartments and adaptive re-use developments. Additionally, the Residential Group develops for-sale condominium projects and also owns interests in entities that develop and manage military family housing. The Land Development Group acquires and sells both land and developed lots to residential, commercial and industrial customers. It also owns and develops land into master-planned communities and mixed-use projects. The remaining two reportable segments are The Nets, a member of the National Basketball Association, and Corporate Activities. The following tables summarize financial data for the Company’s five reportable segments. All amounts are presented in thousands and all prior year amounts are “as adjusted” as applicable.
                                                                       
                  October 31,     January 31,       Three Months Ended October 31,       Nine Months Ended October 31,  
                  2009     2009       2009     2008       2009     2008  
                      Identifiable Assets       Capital Expenditures  
                                   
Commercial Group
                     $ 8,447,933     $ 8,251,407        $ 160,672     $ 176,646        $ 432,946     $ 583,225  
Residential Group
                      2,730,550       2,548,712         105,270       99,247         291,875       244,970  
Land Development Group
                      463,403       431,938         -       93         -       273  
The Nets(1)
                      12,360       (3,302 )       -       -         -       -  
Corporate Activities
                      239,371       151,752         50       106         280       191  
                                   
 
                     $ 11,893,617     $ 11,380,507        $ 265,992     $ 276,092        $ 725,101     $ 828,659  
                                   
                                                                       
    Three Months Ended October 31,       Nine Months Ended October 31,       Three Months Ended October 31,       Nine Months Ended October 31,  
    2009     2008       2009     2008       2009     2008       2009     2008  
    Revenues from Real Estate Operations       Operating Expenses  
                       
Commercial Group
   $ 237,162     $ 240,896        $ 704,586     $ 694,994        $ 113,604     $ 119,363        $ 332,703     $ 363,336  
Commercial Group Land Sales
    4,155       6,747         16,169       20,997         3,030       4,224         10,521       12,596  
Residential Group
    58,663       72,475         198,643       220,172         35,110       44,455         134,110       142,655  
Land Development Group
    6,120       10,263         13,491       23,844         11,224       25,323         24,049       44,847  
The Nets
    -       -         -       -         -       -         -       -  
Corporate Activities
    -       -         -       -         8,716       7,076         30,617       29,872  
                       
 
   $ 306,100     $ 330,381        $ 932,889     $ 960,007        $ 171,684     $ 200,441        $ 532,000     $ 593,306  
                       
 
                       
    Depreciation and Amortization Expense
    Interest Expense
                       
Commercial Group
   $ 50,779     $ 48,019        $ 152,807     $ 151,553        $ 62,770     $ 64,777        $ 175,916     $ 177,171  
Residential Group
    14,660       15,019         43,949       44,114         5,512       12,411         21,460       28,359  
Land Development Group
    222       307         684       739         817       (127 )       1,623       (299 )
The Nets
    -       -         -       -         -       -         -       -  
Corporate Activities
    732       693         2,219       2,204         18,764       20,020         59,435       54,219  
                       
 
   $ 66,393     $ 64,038        $ 199,659     $ 198,610        $ 87,863     $ 97,081        $ 258,434     $ 259,450  
                       
 
                       
    Interest and Other Income
    Net Earnings (Loss) Attributable to Forest City Enterprises, Inc.
                       
Commercial Group
   $ 843     $ 1,255        $ 2,645     $ 7,599        $ 17,973     $ 6,856        $ 43,301     $ 4,868  
Residential Group
    2,712       3,743         12,842       9,861         (1,425 )     1,874         (9,596 )     12,282  
Land Development Group
    1,759       1,676         7,456       9,714         (2,630 )     (5,678 )       3,350       (2,591 )
The Nets
    -       -         -       -         (7,065 )     (6,482 )       (19,619 )     (20,914 )
Corporate Activities
    208       78         981       802         (11,237 )     (15,685 )       (54,288 )     (61,548 )
                       
 
   $ 5,522     $ 6,752        $ 23,924     $ 27,976       $ (4,384 )   $ (19,115 )     $ (36,852 )   $ (67,903 )
                       
 
(1)   The identifiable assets of ($3,302) at January 31, 2009 represent losses in excess of the Company’s investment basis in The Nets.

37


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
O.   Segment Information (continued)
The Company uses a measure defined as Earnings Before Depreciation, Amortization and Deferred Taxes (“EBDT”) to report its operating results. EBDT is a non-GAAP measure and is defined as net earnings excluding the following items: i) gain (loss) on disposition of rental properties, divisions and other investments (net of tax); ii) the adjustment to recognize rental revenues and rental expense using the straight-line method; iii) non-cash charges for real estate depreciation, amortization, amortization of mortgage procurement costs and deferred income taxes; iv) preferred payment which is classified as noncontrolling interests expense in the Company’s Consolidated Statements of Operations; v) impairment of real estate (net of tax); vi) extraordinary items (net of tax); and vii) cumulative or retrospective effect of change in accounting principle (net of tax).
The Company believes that, although its business has many facets such as development, acquisitions, disposals, and property management, the core of its business is the recurring operations of its portfolio of real estate assets. The Company’s Chief Executive Officer, the chief operating decision maker, uses EBDT, as presented, to assess performance of its portfolio of real estate assets by operating segment because it provides information on the financial performance of the core real estate portfolio operations. EBDT measures the profitability of a real estate segment’s operations of collecting rent, paying operating expenses and servicing its debt. The Company’s segments adhere to the accounting policies described in Note A. Unlike the real estate segments, EBDT for The Nets segment equals net earnings (loss). All amounts in the following tables are presented in thousands and all prior year amounts are “as adjusted” as applicable.
(continued on next page)

38


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
O.   Segment Information (continued)
Reconciliation of EBDT to Net Earnings (Loss) by Segment:
                                                 
                    Land                      
    Commercial     Residential     Development             Corporate        
Three Months Ended October 31, 2009   Group     Group     Group     The Nets     Activities     Total  
 
EBDT
   $ 85,114     $ 26,792     $ (3,021 )   $ (7,065 )   $ (16,208 )   $ 85,612  
Depreciation and amortization – Real Estate Groups
    (51,995 )     (19,007 )     (87 )     -       -       (71,089 )
Amortization of mortgage procurement costs – Real Estate Groups
    (3,214 )     (602 )     (65 )     -       -       (3,881 )
Deferred taxes – Real Estate Groups
    (10,078 )     (1,950 )     1,657       -       4,971       (5,400 )
Straight-line rent adjustment
    3,148       16       -       -       -       3,164  
Preference payment (1)
    (585 )     -       -       -       -       (585 )
Gain on disposition of unconsolidated entities, net of tax
    -       2,753       -       -       -       2,753  
Impairment of real estate, net of tax
    -       -       (336 )     -       -       (336 )
Impairment of unconsolidated entities, net of tax
    (4,417 )     (2,885 )     (778 )     -       -       (8,080 )
Discontinued operations, net of tax: (2)
                                               
Depreciation and amortization - Real Estate Groups
    -       (195 )     -       -       -       (195 )
Amortization of mortgage procurement costs - Real Estate Groups
    -       (7 )     -       -       -       (7 )
Deferred taxes - Real Estate Groups
    -       (356 )     -       -       -       (356 )
Impairment of real estate, net of tax
    -       (5,984 )     -       -       -       (5,984 )
     
Net earnings (loss) attributable to Forest City Enterprises, Inc.
   $ 17,973     $ (1,425 )   $ (2,630 )   $ (7,065 )   $ (11,237 )   $ (4,384 )
     
 
                                               
Three Months Ended October 31, 2008
                                               
 
EBDT
   $ 55,892     $ 26,172     $ (13,222 )   $ (6,482 )   $ (18,222 )   $ 44,138  
Depreciation and amortization – Real Estate Groups
    (49,582 )     (18,523 )     (169 )     -       -       (68,274 )
Amortization of mortgage procurement costs – Real Estate Groups
    (2,250 )     (781 )     (81 )     -       -       (3,112 )
Deferred taxes – Real Estate Groups
    (2,016 )     (4,041 )     7,702       -       5,204       6,849  
Straight-line rent adjustment
    4,474       2       (1 )     -       -       4,475  
Preference payment (1)
    (877 )     -       -       -       -       (877 )
Gain on disposition of unconsolidated entities, net of tax
    122       -       -       -       -       122  
Retrospective adoption of accounting guidance for convertible debt instruments
    1,359       306       93       -       (2,667 )     (909 )
Discontinued operations, net of tax: (2)
                                               
Depreciation and amortization - Real Estate Groups
    (300 )     (1,151 )     -       -       -       (1,451 )
Amortization of mortgage procurement costs - Real Estate Groups
    (7 )     (99 )     -       -       -       (106 )
Deferred taxes - Real Estate Groups
    (7 )     (11 )     -       -       -       (18 )
Straight-line rent adjustment
    48       -       -       -       -       48  
     
Net earnings (loss) attributable to Forest City Enterprises, Inc.
   $ 6,856     $ 1,874     $ (5,678 )   $ (6,482 )   $ (15,685 )   $ (19,115 )
     
 
                                               
Nine Months Ended October 31, 2009
                                               
 
EBDT
   $ 217,774     $ 82,117     $ 7,818     $ (19,619 )   $ (65,391 )   $ 222,699  
Depreciation and amortization – Real Estate Groups
    (157,683 )     (59,131 )     (275 )     -       -       (217,089 )
Amortization of mortgage procurement costs – Real Estate Groups
    (9,322 )     (1,951 )     (410 )     -       -       (11,683 )
Deferred taxes – Real Estate Groups
    (12,471 )     (9,929 )     (1,829 )     -       11,103       (13,126 )
Straight-line rent adjustment
    9,510       31       -       -       -       9,541  
Preference payment (1)
    (1,756 )     -       -       -       -       (1,756 )
Gain on disposition of unconsolidated entities, net of tax
    -       2,753       -       -       -       2,753  
Impairment of real estate, net of tax
    -       (897 )     (1,016 )     -       -       (1,913 )
Impairment of unconsolidated entities, net of tax
    (5,404 )     (14,877 )     (938 )     -       -       (21,219 )
Discontinued operations, net of tax: (2)
                                               
Depreciation and amortization – Real Estate Groups
    (107 )     (1,240 )     -       -       -       (1,347 )
Amortization of mortgage procurement costs – Real Estate Groups
    (5 )     (45 )     -       -       -       (50 )
Deferred taxes – Real Estate Groups
    (31 )     (443 )     -       -       -       (474 )
Straight-line rent adjustment
    12       -       -       -       -       12  
Gain on disposition of rental properties
    2,784       -       -       -       -       2,784  
Impairment of real estate, net of tax
    -       (5,984 )     -       -       -       (5,984 )
     
Net earnings (loss) attributable to Forest City Enterprises, Inc.
   $ 43,301     $ (9,596 )   $ 3,350     $ (19,619 )   $ (54,288 )   $ (36,852 )
     
 
                                               
Nine Months Ended October 31, 2008
                                               
 
EBDT
   $ 163,018     $ 73,743     $ (11,524 )   $ (20,914 )   $ (55,888 )   $ 148,435  
Depreciation and amortization - Real Estate Groups
    (155,294 )     (54,648 )     (320 )     -       -       (210,262 )
Amortization of mortgage procurement costs - Real Estate Groups
    (7,282 )     (2,053 )     (335 )     -       -       (9,670 )
Deferred taxes - Real Estate Groups
    (13 )     (3,366 )     9,543       -       1,223       7,387  
Straight-line rent adjustment
    3,256       21       (2 )     -       -       3,275  
Preference payment (1)
    (2,744 )     -       -       -       -       (2,744 )
Preferred return on disposition, net of tax
    -       (128 )     -       -       -       (128 )
Gain on disposition of other investments, net of tax
    -       -       -       -       92       92  
Gain on disposition of unconsolidated entities, net of tax
    663       -       -       -       -       663  
Impairment of unconsolidated entities, net of tax
    (775 )     (2,699 )     (224 )     -       -       (3,698 )
Retrospective adoption of accounting guidance for convertible debt instruments
    4,615       929       271       -       (6,975 )     (1,160 )
Discontinued operations, net of tax: (2)
                                               
Depreciation and amortization - Real Estate Groups
    (678 )     (3,233 )     -       -       -       (3,911 )
Amortization of mortgage procurement costs - Real Estate Groups
    (21 )     (318 )     -       -       -       (339 )
Deferred taxes - Real Estate Groups
    (24 )     (1,260 )     -       -       -       (1,284 )
Straight-line rent adjustment
    147       -       -       -       -       147  
Gain on disposition of rental properties
    -       5,294       -       -       -       5,294  
     
Net earnings (loss) attributable to Forest City Enterprises, Inc.
   $ 4,868     $ 12,282     $ (2,591 )   $ (20,914 )   $ (61,548 )   $ (67,903 )
     
 
(1)   The preference payment represents the respective period’s share of the annual preferred payment in connection with the issuance of Class A Common Units in exchange for Bruce C. Ratner’s noncontrolling interests in the Forest City Ratner Company portfolio. See Note P - Class A Common Units for more information.
 
(2)   See Note K for discontinued operations information.

39


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
P.   Class A Common Units
Master Contribution Agreement
The Company and certain of its affiliates entered into a Master Contribution and Sale Agreement (the “Master Contribution Agreement”) with Bruce C. Ratner (“Mr. Ratner”), an Executive Vice President and Director of the Company, and certain entities and individuals affiliated with Mr. Ratner (the “BCR Entities”) on August 14, 2006. Pursuant to the Master Contribution Agreement, on November 8, 2006, the Company issued Class A Common Units (“Units”) in a jointly-owned limited liability company to the BCR Entities in exchange for their interests in a total of 30 retail, office and residential operating properties, and certain service companies, all in the greater New York City metropolitan area. The Company accounted for the issuance of the Units in exchange for the noncontrolling interests under the purchase method of accounting. The Units may be exchanged for one of the following forms of consideration at the Company’s sole discretion: (i) an equal number of shares of the Company’s Class A common stock or, (ii) cash based on a formula using the average closing price of the Class A common stock at the time of conversion or, (iii) a combination of cash and shares of the Company’s Class A common stock. The Company has no rights to redeem or repurchase the Units. The carrying value of the Units are included as noncontrolling interests on the Consolidated Balance Sheets at October 31 and January 31, 2009. Also pursuant to the Master Contribution Agreement, the Company and Mr. Ratner agreed that certain projects under development would remain owned jointly until such time as each individual project was completed and achieved “stabilization.” As each of the development projects achieves stabilization, it is valued and the Company, in its discretion, chooses among various options for the ownership of the project following stabilization consistent with the Master Contribution Agreement. The development projects were not covered by the Tax Protection Agreement that the parties entered into in connection with the Master Contribution Agreement. The Tax Protection Agreement indemnified the BCR Entities included in the initial closing against taxes payable by reason of any subsequent sale of certain operating properties.
New York Times and Twelve MetroTech Center
Two of the development projects, New York Times, an office building located in Manhattan, New York and Twelve MetroTech Center, an office building located in Brooklyn, New York, recently achieved stabilization. The Company elected to cause certain of its affiliates to acquire for cash the BCR Entities’ interests in the two projects pursuant to agreements dated May 6, 2008 and May 12, 2008, respectively. In accordance with the agreements, the applicable BCR Entities assigned and transferred their interests in the two projects to affiliates of the Company and will receive approximately $121,000,000 over a 15 year period. An affiliate of the Company has also agreed to indemnify the applicable BCR Entity against taxes payable by it by reason of a subsequent sale or other disposition of one of the projects. The tax indemnity provided by the affiliate of the Company expires on December 31, 2014 and is similar to the indemnities provided for the operating properties under the Tax Protection Agreement.
The consideration exchanged by the Company for the BCR Entities’ interest in the two development projects has been accounted for under the purchase method of accounting. Pursuant to the agreements, the BCR Entities received an initial cash amount of $49,249,000. The Company calculated the net present value of the remaining payments over the 15 year period using a discounted interest rate. This initial discounted amount of $56,495,000 was recorded in accounts payable and accrued expenses on the Company’s Consolidated Balance Sheet and will be accreted up to the total liability through interest expense over the next 15 years using the effective interest method.
The following table summarizes the final allocation of the consideration exchanged for the BCR Entities’ interests in the two projects (in thousands):
         
Completed rental properties (1)
   $ 102,378  
Notes and accounts receivable, net (2)
    132  
Other assets (3)
    12,513  
Accounts payable and accrued expenses (4)
    (9,279 )
 
     
Total purchase price allocated
   $ 105,744  
 
     
 
Represents allocation for:
 
(1)   Land, building and tenant improvements associated with the underlying real estate
 
(2)   Above market leases
 
(3)   In-place leases, tenant relationships and leasing commissions
 
(4)   Below market leases

40


 

Forest City Enterprises, Inc. and Subsidiaries
Notes to Consolidated Financial Statements

(Unaudited)
P.   Class A Common Units (continued)
Exchange of Units
In July 2008, the BCR Entities exchanged 247,477 of the Units. The Company issued 128,477 shares of its Class A common stock for 128,477 of the Units and paid cash of $3,501,000 for 119,000 Units. The Company accounted for the exchange as a purchase of noncontrolling interests, resulting in a reduction of noncontrolling interests of $12,624,000. The following table summarizes the components of the exchange transaction (in thousands):
         
Reduction of completed rental properties
   $ 5,345  
Reduction of cash and equivalents
    3,501  
Increase in Class A common stock - par value
    42  
Increase in additional paid-in capital
    3,736  
 
     
Total reduction of noncontrolling interest
   $ 12,624  
 
     
Other Related Party Transactions
During the year ended January 31, 2009, in accordance with the parties prior understanding but unrelated to the transactions discussed above, the Company redeemed Mr. Ratner’s noncontrolling interests in two entities in exchange for the Company’s majority ownership interests in 17 single-tenant pharmacy properties and $9,043,000 in cash. This transaction was accounted for in accordance with accounting guidance on business combinations as acquisitions of the noncontrolling interests in the subsidiaries. The fair value of the consideration paid was allocated to the acquired ownership interests, which approximated the fair value of the 17 single-tenant pharmacy properties. This transaction resulted in a reduction of noncontrolling interests of $14,503,000 and did not result in a gain or loss. The earnings of these properties have not been reclassified to discontinued operations for the three and nine months ended October 31, 2008 as the results do not have a material impact on the Consolidated Statements of Operations.

41


 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) of Forest City Enterprises, Inc. and subsidiaries should be read in conjunction with the financial statements and the footnotes thereto contained in the annual report on Form 10-K for the year ended January 31, 2009, as amended on Form 10-K/A filed September 25, 2009 and updated on Form 8-K filed October 19, 2009.
RESULTS OF OPERATIONS
Corporate Description
We principally engage in the ownership, development, management and acquisition of commercial and residential real estate and land throughout the United States. We operate through three strategic business units and five reportable segments. The three strategic business units/reportable segments are the Commercial Group, Residential Group and Land Development Group (collectively, the “Real Estate Groups”). The Commercial Group, our largest strategic business unit, owns, develops, acquires and operates regional malls, specialty/urban retail centers, office and life science buildings, hotels and mixed-use projects. The Residential Group owns, develops, acquires and operates residential rental properties, including upscale and middle-market apartments and adaptive re-use developments. Additionally, the Residential Group develops for-sale condominium projects and also owns interests in entities that develop and manage military family housing. New York City operations are part of the Commercial Group or Residential Group depending on the nature of the operations. The Land Development Group acquires and sells both land and developed lots to residential, commercial and industrial customers. It also owns and develops land into master-planned communities and mixed-use projects.
Corporate Activities and The Nets, a member of the National Basketball Association in which we account for our investment on the equity method of accounting, are other reportable segments of the Company.
We have approximately $11.9 billion of assets in 27 states and the District of Columbia at October 31, 2009. Our core markets include the New York City/Philadelphia metropolitan area, Denver, Boston, Greater Washington D.C./Baltimore metropolitan area, Chicago and the state of California. We have offices in Albuquerque, Boston, Chicago, Denver, London (England), Los Angeles, New York City, San Francisco, Washington, D.C., and our corporate headquarters in Cleveland, Ohio.
Significant milestones occurring during the third quarter of 2009 included:
    Signing a letter of intent with an affiliate of Onexim Group, an international private investment fund, to create a strategic partnership for the development of the Atlantic Yards project, a 22-acre residential and commercial real estate project in Brooklyn, and the Barclays Center arena, the planned future home of the Nets. As part of the agreement, entities to be formed by Onexim Group will invest $200,000,000 and make certain contingent funding commitments to acquire 45% of the arena project and 80% of the Nets, and the right to purchase up to 20% of the Atlantic Yards Development Company, which will develop the non-arena real estate. We will retain a minority ownership stake in the Nets, and will be the managing partner of the arena and majority owner of the balance of the Atlantic Yards real estate;
 
    The exchange of $167,433,000, or approximately 61.4%, of the $272,500,000 of 3.625% Puttable Equity-Linked Senior Notes due October 2011 for a new issue of 3.625% Puttable Equity Linked Senior Notes due October 2014. In conjunction with the exchange of notes, we also issued an additional $32,567,000 of 3.625% Puttable Equity-Linked Senior Notes due October 2014;
 
    The issuance, at par, of $200,000,000 aggregate principal amount of convertible senior notes due October 2016. Interest on the notes is payable semiannually at a rate of 5.00% per annum. We received net proceeds from the offering of $177,262,000, net of the cost of the convertible note hedge transaction and estimated offering costs;
 
    The $90,000,000 refinancing of 45/75 Sydney Street, a pair of twin office buildings at our University Park at MIT mixed-use, science and technology park in Cambridge, Massachusetts. The seven-year, fixed-rate refinancing, through two insurance companies, represents approximately a 50% increase in principal over the prior in-place financing, while maintaining strong debt service coverage; and
 
    Closing $908,932,000 in nonrecourse mortgage financing transactions.

42


 

Subsequent to October 31, 2009, we achieved the following significant milestones:
    Being chosen to receive an allocation of New Market Tax Credits (“NMTC”) as part of a $5 billion federal program to create jobs and revive neighborhoods. The allocation of $55,000,000 will be used to earn or syndicate tax credits through the investment in real estate development projects located in distressed and low-income communities throughout the country as defined by the US Treasury Department’s CDFI Fund. This is the third time we have received a NMTC allocation, for a total of $151,000,000 in allocations under the program;
 
    The opening of the first Costco in the borough of Manhattan in our East River Plaza retail center. Costco occupies 110,000 square feet on the first floor of East River Plaza. The remainder of the approximately 500,000 square foot retail center, which is more than 90% leased and will also be home to Manhattan’s first Target, is expected to open in 2010;
 
    Coming to an agreement on the principal terms of a new $500,000,000 revolving credit facility with our 15-member bank group which would mature two years from closing. All 14 members of our prior bank group, along with one new bank, are part of the new facility. Upon closing, the new facility will replace the existing $750,000,000 credit facility, which is scheduled to mature in March 2010;
 
    Closing $87,944,000 of nonrecourse mortgage financing transactions that extend debt that would have matured during the remaining three months of our fiscal year ending January 31, 2010;
 
    In a ruling issued on November 24, 2009, the Court of Appeals, New York’s highest court, affirmed the right of the Empire State Development Corporation to use eminent domain to acquire privately-owned properties for inclusion in our Brooklyn Atlantic Yards development project, thereby resolving one of the major remaining hurdles prior to commencing construction of the Barclays Center arena; and
 
    On December 2, 2009, the City of Las Vegas City Council approved the issuance and sale of $185,000,000 of primarily Build America Bonds to finance the construction of a new City Hall building on property we own in downtown Las Vegas. The closing and funding of the Build America Bonds is scheduled for December 17, 2009. We have been engaged by the City of Las Vegas to perform fee services on their behalf for development of the new City Hall project. Construction on the project is scheduled to begin in January 2010.

43


 

Retrospective Adoption of Accounting Guidance for Convertible Debt Instruments
Effective February 1, 2009, we adopted the Financial Accounting Standards Board’s (“FASB”) accounting guidance for convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement). This accounting guidance required us to restate the prior year financial statements to show retrospective application upon adoption. This accounting guidance requires the liability and equity components of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) to be separately accounted for in a manner that reflects the issuer’s nonconvertible debt borrowing rate. This accounting guidance changed the accounting treatment for our 3.625% Puttable Equity-Linked Senior Notes due October 2011 (the “2011 Notes”), which were issued in October 2006, by requiring the initial debt proceeds from the sale of the 2011 Notes to be allocated between a liability component and an equity component. This allocation is based upon what the assumed interest rate would have been on the date of issuance if we had issued similar nonconvertible debt. The resulting debt discount will be amortized over the debt instrument’s expected life as additional non-cash interest expense. Due to the increase in interest expense, we recorded additional capitalized interest based on our qualifying expenditures on our development projects. Deferred financing costs decreased related to the reallocation of the original issuance costs between the debt instrument and equity component and the gain recognized from the purchase of $15,000,000, in principal, of the 2011 Notes during the three months ended October 31, 2008 was adjusted to reflect the requirements of gain recognition under this accounting guidance (see the “Senior and Subordinated Debt” section of the MD&A).
The following tables reflect our as reported amounts along with the as adjusted amounts as a result of the retrospective adoption of this accounting guidance:
    January 31, 2009  
    As     Retrospective     As  
    Reported     Adjustments     Adjusted  
    (in thousands)  
Consolidated Balance Sheet
                       
Real estate, net
   $   9,212,834     $ 16,468     $   9,229,302  
Other assets
    936,902       (631 )     936,271  
Senior and subordinated debt
    870,410       (24,346 )     846,064  
Deferred income taxes
    439,282       16,054       455,336  
Additional paid-in capital
    241,539       26,257       267,796  
Retained earnings
    645,852       (2,128 )     643,724  
                                                 
    Three Months Ended October 31, 2008     Nine Months Ended October 31, 2008  
    As     Retrospective     As     As     Retrospective     As  
    Reported (1)     Adjustments     Adjusted     Reported (1)     Adjustments     Adjusted  
    (in thousands, except per share data)
Consolidated Statements of Operations
                                               
Depreciation and amortization
   $ 63,992     $ 46     $ 64,038     $ 198,474     $ 136     $ 198,610  
Interest expense, net of capitalized interest
    96,661       420       97,081       258,779       671       259,450  
Gain (loss) on early extinguishment of debt
    4,181       (489 )     3,692       (1,050 )     (489 )     (1,539 )
Deferred income tax benefit
    (7,043 )     (374 )     (7,417 )     (12,830 )     (508 )     (13,338 )
Loss from continuing operations
    (14,274 )     (581 )     (14,855 )     (63,112 )     (788 )     (63,900 )
Net loss attributable to Forest City Enterprises, Inc.
    (18,534 )     (581 )     (19,115 )     (67,115 )     (788 )     (67,903 )
Net loss attributable to Forest City Enterprises, Inc.
                                               
per share - basic and diluted
   $ (0.18 )   $ (0.01 )   $ (0.19 )   $ (0.65 )   $ (0.01 )   $ (0.66 )
 
(1)   Adjusted to reflect the impact of discontinued operations (see the “Discontinued Operations” section of the MD&A).

44


 

Net Loss Attributable to Forest City Enterprises, Inc. — Net loss attributable to Forest City Enterprises, Inc. for the three months ended October 31, 2009 was $4,384,000 versus $19,115,000 for the three months ended October 31, 2008. Although we have substantial recurring revenue sources from our properties, we also enter into significant one-time transactions, which could create substantial variances in net earnings (loss) between periods. This variance is primarily attributable to the following increases, which are net of tax and noncontrolling interests:
    $16,599,000 ($27,113,000, pre-tax, which includes $1,903,000 for unconsolidated entities) related to the 2009 early extinguishment of nonrecourse mortgage debt at an underperforming retail project and the gain on early extinguishment of debt on the exchange of a portion of our 2011 Notes for a new issue of puttable equity-linked senior notes due October 15, 2014 (see the “Puttable Equity-Linked Senior Notes due 2011” section of the MD&A);
 
    $7,630,000 ($12,434,000, pre-tax) related to the reduction in fair value of the Denver Urban Renewal Authority (“DURA”) purchase obligation and fee, that resulted from the Lehman Brothers, Inc. bankruptcy in 2008;
 
    $5,352,000 ($8,742,000, pre-tax) of decreased write-offs of abandoned development projects in 2009 compared to 2008;
 
    $2,753,000 ($4,498,000, pre-tax) related to the 2009 gain on disposition of our unconsolidated investment in Boulevard Towers, an apartment community in Amherst, New York;
 
    $1,128,000 ($1,843,000, pre-tax, which includes $1,449,000 for unconsolidated entities) related to an increase in income recognized on the sale of state and federal Historic Preservation Tax Credits and New Market Tax Credits; and
 
    $1,041,000 ($1,700,000, pre-tax) related to the change in fair market value of derivatives between the comparable periods, which was marked to market through interest expense as a result of the derivatives not qualifying for hedge accounting.
These increases were partially offset by the following decreases, net of tax and noncontrolling interests:
    $14,400,000 ($23,524,000, pre-tax) related to the 2009 increase in impairment charges of consolidated (including discontinued properties) and unconsolidated entities;
 
    $2,877,000 ($4,709,000, pre-tax) primarily related to military housing fee income from the management and development of units in Hawaii, Illinois, Washington and Colorado;
 
    $2,448,000 ($3,998,000, pre-tax) related to the 2009 participation payment on the refinancing of 45/75 Sidney Street, office buildings in Cambridge, Massachusetts; and
 
    $2,441,000 ($3,978,000, pre-tax) related to the 2008 lease termination fee income at an office building in Cleveland, Ohio.
Net loss attributable to Forest City Enterprises, Inc. for the nine months ended October 31, 2009 was $36,852,000 versus $67,903,000 for the nine months ended October 31, 2008. This variance is primarily attributable to the following increases, which are net of tax and noncontrolling interests:
    $25,182,000 ($41,134,000, pre-tax, which includes $1,749,000 for unconsolidated entities) related to the 2009 early extinguishment of nonrecourse mortgage debt at an underperforming retail project and Gladden Farms, a land development project located in Marana, Arizona and the gain on early extinguishment of debt on the exchange of a portion of our 2011 Notes for a new issue of puttable equity-linked senior notes due October 15, 2014 (see the “Puttable Equity-Linked Senior Notes due 2011” section of the MD&A);
 
    $10,902,000 ($17,808,000, pre-tax) of decreased write-offs of abandoned development projects in 2009 compared to 2008;
 
    $7,630,000 ($12,434,000, pre-tax) related to the reduction in fair value of the DURA purchase obligation and fee, that resulted from the Lehman Brothers, Inc. bankruptcy in 2008;
 
    $2,784,000 ($4,548,000, pre-tax) related the 2009 gain on disposition of Grand Avenue, a specialty retail center in Queens, New York;
 
    $2,753,000 ($4,498,000, pre-tax) related to the 2009 gain on disposition of our unconsolidated investment in Boulevard Towers;
 
    $2,596,000 ($4,241,000, pre-tax, which includes $1,449,000 for unconsolidated entities) related to an increase in income recognized on the sale of state and federal Historic Preservation Tax Credits and New Market Tax Credits;
 
    $2,203,000 ($3,599,000, pre-tax) related to a gain recognized in 2009 for insurance proceeds received related to fire damage of an apartment building in excess of the net book value of the damaged asset;

45


 

    $1,860,000 ($3,031,000, pre-tax) related to the 2008 participation payments on the refinancing of 350 Massachusetts Avenue, an unconsolidated office building and Jackson Building, a consolidated office building, both located in Cambridge, Massachusetts;
 
    $1,622,000 ($2,649,000, pre-tax) related to the change in fair market value of derivatives between the comparable periods, which was marked to market through interest expense as a result of the derivatives not qualifying for hedge accounting;
 
    $1,467,000 ($2,396,000, pre-tax) related to the 2009 net gain on an industrial land sale at Mesa del Sol in Albuquerque, New Mexico; and
 
    $1,295,000 ($2,039,000, pre-tax) related to a decrease in allocated losses from our equity investment in the New Jersey Nets basketball team (see “The Nets” section of the MD&A).
These increases were partially offset by the following decreases, net of tax and noncontrolling interests:
    $25,418,000 ($41,536,000, pre-tax) related to the 2009 increase in impairment charges of consolidated (including discontinued properties) and unconsolidated entities;
 
    $5,245,000 ($8,117,000, pre-tax) primarily related to military housing fee income from the management and development of units in Hawaii, Illinois, Washington and Colorado;
 
    $5,294,000 ($8,627,000, pre-tax) related to the 2008 gain on disposition of Sterling Glen of Lynbrook, a supported-living apartment community in Lynbrook, New York;
 
    $2,448,000 ($3,998,000, pre-tax) related to the 2009 participation payment on the refinancing of 45/75 Sidney Street;
 
    $2,441,000 ($3,978,000, pre-tax) related to the 2008 lease termination fee income at an office building in Cleveland, Ohio; and
 
    $2,056,000 ($3,350,000, pre-tax) related to the 2008 gain on the sale of an ownership interest in a parking management company.

46


 

Summary of Segment Operating Results – The following tables present a summary of revenues from real estate operations, operating expenses, interest expense, equity in earnings (loss) of unconsolidated entities and impairment of unconsolidated entities by segment for the three and nine months ended October 31, 2009 and 2008, respectively. See discussion of these amounts by segment in the narratives following the tables.
                                                   
    Three Months Ended October 31,       Nine Months Ended October 31,  
    2008       2008  
    2009     (As Adjusted)     Variance       2009     (As Adjusted)     Variance  
    (in thousands)       (in thousands)  
Revenues from Real Estate Operations
                                                 
Commercial Group
   $ 237,162      $ 240,896      $ (3,734 )      $ 704,586      $ 694,994      $ 9,592  
Commercial Group Land Sales
    4,155       6,747       (2,592 )       16,169       20,997       (4,828 )
Residential Group
    58,663       72,475       (13,812 )       198,643       220,172       (21,529 )
Land Development Group
    6,120       10,263       (4,143 )       13,491       23,844       (10,353 )
The Nets
                                     
Corporate Activities
                                     
           
Total Revenues from Real Estate Operations
   $ 306,100      $ 330,381      $ (24,281 )      $ 932,889      $ 960,007      $ (27,118 )
           
 
                                                 
Operating Expenses
                                                 
Commercial Group
   $ 113,604      $ 119,363      $ (5,759 )      $ 332,703      $ 363,336      $ (30,633 )
Cost of Commercial Group Land Sales
    3,030       4,224       (1,194 )       10,521       12,596       (2,075 )
Residential Group
    35,110       44,455       (9,345 )       134,110       142,655       (8,545 )
Land Development Group
    11,224       25,323       (14,099 )       24,049       44,847       (20,798 )
The Nets
                                     
Corporate Activities
    8,716       7,076       1,640         30,617       29,872       745  
           
Total Operating Expenses
   $ 171,684      $ 200,441      $ (28,757 )      $ 532,000      $ 593,306      $ (61,306 )
           
 
                                                 
Interest Expense
                                                 
Commercial Group
   $ 62,770      $ 64,777      $ (2,007 )      $ 175,916      $ 177,171      $ (1,255 )
Residential Group
    5,512       12,411       (6,899 )       21,460       28,359       (6,899 )
Land Development Group
    817       (127 )     944         1,623       (299 )     1,922  
The Nets
                                     
Corporate Activities
    18,764       20,020       (1,256 )       59,435       54,219       5,216  
           
Total Interest Expense
   $ 87,863      $ 97,081      $ (9,218 )      $ 258,434      $ 259,450      $ (1,016 )
           
 
                                                 
Equity in Earnings (Loss) of Unconsolidated Entities
                                                 
Commercial Group
   $ 3,386      $ 2,027      $ 1,359        $ 4,965      $ 4,274      $ 691  
Gain on disposition of Emery-Richmond
          200       (200 )             200       (200 )
Gain on disposition of One International Place
                              881       (881 )
Residential Group
    2,029       2,225       (196 )       4,949       7,335       (2,386 )
Gain on disposition of Boulevard Towers
    4,498             4,498         4,498             4,498  
Land Development Group
    2,304       2,209       95         4,952       6,429       (1,477 )
The Nets
    (10,853 )     (9,859 )     (994 )       (29,841 )     (31,880 )     2,039  
Corporate Activities
                                     
           
Total Equity in Loss of Unconsolidated Entities
   $ 1,364      $ (3,198 )    $ 4,562       $ (10,477 )    $ (12,761 )    $ 2,284  
           
 
                                                 
Impairment of Unconsolidated Entities
                                                 
Commercial Group
   $ 7,217      $      $ 7,217        $ 8,828      $ 1,263      $ 7,565  
Residential Group
    4,713             4,713         24,303       4,398       19,905  
Land Development Group
    1,270             1,270         1,532       365       1,167  
The Nets
                                     
Corporate Activities
                                     
           
Total Impairment of Unconsolidated Entities
   $ 13,200      $      $ 13,200        $ 34,663      $ 6,026      $ 28,637  
           

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Commercial Group
Revenues from Real Estate Operations – Revenues from real estate operations for the Commercial Group, including the segment’s land sales, decreased by $6,326,000, or 2.6%, for the three months ended October 31, 2009 compared to the same period in the prior year. The variance is primarily attributable to the following decreases:
    $3,978,000 related to lease termination fee income in 2008 at an office building in Cleveland, Ohio that did not recur; and
    $2,592,000 related to decreases in commercial outlot land sales primarily at White Oak Village in Richmond, Virginia, Orchard Town Center in Westminster, Colorado and Victoria Gardens in Rancho Cucamonga, California, which were partially offset by increases at Salt Lake City in Utah and Ridge Hill in Yonkers, New York.
These decreases were partially offset by the following increase:
    $5,483,000 related to new property openings as noted in the table below.
The balance of the remaining decrease of $5,239,000 was generally due to downward trends in occupancies and rental rates primarily in the retail sector.
Revenues from real estate operations for the Commercial Group, including the segment’s land sales, increased by $4,764,000, or 0.7%, for the nine months ended October 31, 2009 compared to the same period in the prior year. The variance is primarily attributable to the following increases:
    $19,443,000 related to new property openings as noted in the table below; and
    $3,028,000 related to increased revenues earned on a construction contract with the New York City School Construction Authority for the construction of a school at Beekman, a development project in Manhattan, New York. This represents a reimbursement of costs that is included in operating expenses discussed below.
These increases were partially offset by the following decreases:
    $4,828,000 related to decreases in commercial outlot land sales primarily at Short Pump Town Center in Richmond, Virginia, White Oak Village, Orchard Town Center and Saddle Rock Village in Aurora, Colorado, which were partially offset by increases in commercial outlot land sales at Salt Lake City, Victoria Gardens and Ridge Hill, and
    $3,978,000 related to lease termination fee income in 2008 at an office building in Cleveland, Ohio that did not recur.
The balance of the remaining decrease of $8,901,000 was generally due to downward trends in occupancies and rental rates primarily in the retail sector.
Operating and Interest Expenses – Operating expenses decreased $6,953,000, or 5.6%, for the three months ended October 31, 2009 compared to the same period in the prior year. The variance is primarily attributable to the following decreases:
    $4,016,000 related to decreased write-offs of abandoned development projects; and
    $1,194,000 related to decreases in commercial outlot land sales primarily at White Oak Village, Orchard Town Center and Victoria Gardens, which was partially offset by an increase in commercial outlot land sales at Salt Lake City and Ridge Hill.
These decreases were partially offset by the following increases:
    $3,998,000 related to the 2009 participation payment on the refinancing of 45/75 Sidney Street, office buildings in Cambridge, Massachusetts; and
    $2,075,000 related to new property openings as noted in the table below.
The balance of the remaining decrease of $7,816,000 was generally due to cost reduction activities within the Commercial Group relating to direct property expenses and general operating activities.
Operating expenses decreased $32,708,000, or 8.7%, for the nine months ended October 31, 2009 compared to the same period in the prior year. The variance is primarily attributable to the following decreases:
    $22,546,000 related to decreased write-offs of abandoned development projects in 2009 compared to 2008, which was primarily due to the 2008 write-off at Summit at Lehigh Valley;

48


 

    $2,075,000 related to decreases in commercial outlot land sales primarily at Short Pump Town Center, White Oak Village, Orchard Town Center and Saddle Rock Village, which were partially offset by an increase in commercial outlot land sales at Salt Lake City and Ridge Hill; and
    $1,759,000 related to the 2008 participation payment on the refinancing at Jackson Building, an office building in Cambridge, Massachusetts that did not recur.
These decreases were partially offset by the following increases:
    $6,994,000 related to new property openings as noted in the table below;
    $3,998,000 related to the 2009 participation payment on the refinancing of 45/75 Sidney Street; and
    $3,028,000 related to construction of a school at Beekman. These costs are reimbursed by the New York City School Construction Authority and are included in revenues from real estate operations discussed above.
The balance of the remaining decrease of $20,348,000 was generally due to cost reduction activities within the Commercial Group relating to direct property expenses and general operating activities.
Interest expense for the Commercial Group decreased by $2,007,000, or 3.1%, for the three months ended October 31, 2009 and by $1,255,000, or 0.7%, for the nine months ended October 31, 2009 compared to the same periods in the prior year. The variances are primarily attributable to decreases in variable interest rates offset by increases primarily attributable to the openings of the properties listed in the table below.
The following table presents the increases (decreases) in revenues and operating expenses incurred by the Commercial Group for newly-opened properties for the three and nine months ended October 31, 2009 compared to the same period in the prior year:
                                                       
                        Three Months Ended       Nine Months Ended  
                        October 31, 2009 vs. 2008       October 31, 2009 vs. 2008  
                        Revenues               Revenues        
                        from               from        
            Quarter - Year   Square     Real Estate     Operating       Real Estate     Operating  
Newly - Opened Properties
  Location     Opened   Feet     Operations     Expenses       Operations     Expenses  
                        (in thousands)       (in thousands)  
Retail Centers:
                                                     
Promenade at Temecula Expansion
  Temecula, California   Q1-2009     127,000      $ 580     $ 286       $ 1,307     $ 632  
White Oak Village
  Richmond, Virginia   Q3-2008     800,000       1,438       280         5,113       1,483  
Shops at Wiregrass
  Tampa, Florida   Q3-2008     642,000       2,960       1,088         8,728       3,977  
Orchard Town Center
  Westminster, Colorado   Q1-2008     980,000       137       576         2,404       423  
                               
Office Building:
                                                     
Johns Hopkins — 855 North Wolfe Street
  East Baltimore, Maryland   Q1-2008     279,000       368       (155 )       1,891       479  
                             
Total
                       $ 5,483     $ 2,075       $ 19,443     $ 6,994  
                             
Comparable occupancy for the Commercial Group is 90.1% and 89.4% for retail and office, respectively, as of October 31, 2009 compared to 91.6% and 90.0%, respectively, as of October 31, 2008. Retail and office occupancy as of October 31, 2009 and 2008 is based on square feet leased at the end of the fiscal quarter. Average occupancy for hotels for the nine months ended October 31, 2009 is 68.5% compared to 70.7% for the nine months ended October 31, 2008.
As of October 31, 2009, the average base rent per square feet expiring for retail and office leases is $26.17 and $31.30, respectively, compared to $26.49 and $30.77, respectively, as of October 31, 2008. Square feet of expiring leases and average base rent per square feet are operating statistics that represent 100% of the square footage and base rental income per square foot from expiring leases. The average daily rate (“ADR”) for our hotel portfolio is $139.56 and $146.07 for the nine months ended October 31, 2009 and 2008, respectively. ADR is an operating statistic and is calculated by dividing revenue by the number of rooms sold for all hotels that were open and operating for both the nine months ended October 31, 2009 and 2008.

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Residential Group
Revenues from Real Estate Operations – Included in revenues from real estate operations is fee income related to the development and construction management of military housing projects. Military housing fee income and related operating expenses may vary significantly from period to period based on the timing of development and construction activity at each applicable project. Revenues from real estate operations for the Residential Group decreased by $13,812,000, or 19.1%, during the three months ended October 31, 2009 compared to the same period in the prior year. The variance is primarily attributable to the following decrease:
    $15,617,000 related to military housing fee income from development and management of military housing units located primarily on the islands of Oahu and Kauai, Hawaii, Chicago, Illinois, Seattle, Washington, and Colorado Springs, Colorado (see the “Military Housing Fee Revenues” section below for further detail).
This decrease was partially offset by the following increases:
    $1,598,000 related to the cancellation of a net leasing arrangement whereby we assumed the operations from the lessee at Forest Trace in Lauderhill, Florida; and
    $1,522,000 related to new property openings and acquired properties as noted in the table below.
The balance of the remaining decrease of $1,315,000 was generally due to downward trends in occupancy and net rental rates.
Revenues from real estate operations for the Residential Group decreased by $21,529,000, or 9.8%, during the nine months ended October 31, 2009 compared to the same period in the prior year. This variance is primarily attributable to the following decrease:
    $49,031,000 related to military housing fee income from development and management of military housing units located primarily on the islands of Oahu and Kauai, Hawaii, Chicago, Illinois, Seattle, Washington, and Colorado Springs, Colorado (see the “Military Housing Fee Revenues” section below for further detail).
This decrease was partially offset by the following increases:
    $14,000,000 related to the land sale and related development opportunity in Mamaroneck, New York;
    $7,390,000 related to insurance premiums earned from an owner’s controlled insurance program;
    $5,217,000 related to the cancellation of a net leasing arrangement whereby we assumed the operations from the lessee at Forest Trace; and
    $3,485,000 related to new property openings and acquired properties as noted in the table below.
The balance of the remaining decrease of $2,590,000 was generally due to downward trends in occupancy and net rental rates.
Operating and Interest Expenses – Operating expenses for the Residential Group decreased by $9,345,000, or 21.0%, during the three months ended October 31, 2009 compared to the same period in the prior year. This variance is primarily attributable to the following decreases:
    $6,677,000 related to expenditures associated with military housing fee revenues; and
    $4,725,000 related to write-offs of abandoned development projects.
These decreases were partially offset by the following increases:
    $2,468,000 related to the cancellation of the net lease arrangement at Forest Trace;and
    $355,000 related to new property openings and acquired properties as noted in the table below.
The balance of the remaining decrease of $766,000 was generally due to cost reduction activities within the Residential Group relating to direct property expenses and general operating activities.
Operating expenses for the Residential Group decreased by $8,545,000, or 6.0%, during the nine months ended October 31, 2009 compared to the same period in the prior year. This variance is primarily attributable to the following decrease:
    $32,791,000 related to expenditures associated with military housing fee revenues.

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This decrease was partially offset by the following increases:
   
$14,000,000 related to the cost of the land sale and related development opportunity in Mamaroneck, New York;
 
   
$7,484,000 related to the cancellation of the net lease arrangement at Forest Trace;
 
   
$3,553,000 related to insurance expenses associated with an owner’s controlled insurance program;
 
   
$2,492,000 related to increased write-offs of abandoned development projects; and
 
   
$1,730,000 related to new property openings and acquired properties as noted in the table below.
The balance of the remaining decrease of $5,013,000 was generally due to cost reduction activities within the Residential Group relating to direct property expenses and general operating activities.
Interest expense for the Residential Group decreased by $6,899,000, or 55.6%, during the three months ended October 31, 2009 and $6,899,000, or 24.3%, for the nine months ended October 31, 2009 compared to the same periods in the prior year. These decreases are primarily attributable to decreases in variable interest rates partially offset by increases related to the openings and acquisitions of the properties listed in the below table.
The following table presents the increases in revenues and operating expenses incurred by the Residential Group for newly-opened/acquired properties for the three and nine months ended October 31, 2009 compared to the same period in the prior year:
                                                   
                    Three Months Ended       Nine Months Ended  
                    October 31, 2009 vs. 2008       October 31, 2009 vs. 2008  
                    Revenues               Revenues        
                    from               from        
            Quarter - Year   Leasable   Real Estate     Operating       Real Estate     Operating  
Property
  Location     Opened   Units   Operations     Expenses       Operations     Expenses  
       
                    (in thousands)       (in thousands)  
 
                                                 
Hamel Mill Lofts
  Haverhill, Massachusetts   Q4-2008 (1)   305    $ 217     $ 46       $ 430     $ 872  
Lucky Strike
  Richmond, Virginia   Q1-2008   131     211       57         711       150  
Mercantile Place on Main
  Dallas, Texas   Q1-2008/Q4-2008   366     844       71         2,094       527  
North Church Towers
  Parma Heights, Ohio   Q3-2009 (2)   399     250       181         250       181  
                           
 
                                                 
Total
                   $ 1,522     $ 355       $ 3,485     $ 1,730  
                           
  (1)   Property to open in phases.
  (2)   Acquired property.
Comparable average occupancy for the Residential Group is 90.4% and 92.4% for the nine months ended October 31, 2009 and 2008, respectively. Average residential occupancy for the nine months ended October 31, 2009 and 2008 is calculated by dividing gross potential rent less vacancy by gross potential rent. Total average occupancy excludes military housing units.
Comparable average net rental income (“NRI”) for the Residential Group was 87.3% and 90.2% for the nine months ended October 31, 2009 and 2008, respectively. This decrease is primarily a result of increased vacancies due to soft market conditions and increased rent concessions in an effort to keep occupancy from declining. Comparable average NRI is calculated by dividing gross potential rent less vacancies and rent concessions by gross potential rent for properties that were open and operating in both the nine months ended October 31, 2009 and 2008. Comparable NRI excludes military housing units.
Military Housing Fee Revenues – Revenues for development fees related to our military housing projects are earned based on a contractual percentage of the actual development costs incurred by the military housing projects and are recognized on a monthly basis as the costs are incurred. We also recognize additional development incentive fees upon successful completion of certain criteria, such as incentives to realize development cost savings, encourage small and local business participation, comply with specified safety standards and other project management incentives as specified in the development agreements. Base development and development incentive fees of $2,723,000 and $9,322,000 were recognized during the three and nine months ended October 31, 2009, respectively, and $16,792,000 and $55,500,000 during the three and nine months ended October 31, 2008, respectively, which were recorded in revenues from real estate operations in the Consolidated Statements of Operations.
Revenues for construction management fees are earned based on a contractual percentage of the actual construction costs incurred by the military housing projects and are recognized on a monthly basis as the costs are incurred. We also recognize certain construction incentive fees based upon successful completion of certain criteria as set forth in the construction contracts. Base construction and construction incentive fees of $1,731,000 and $7,385,000 were recognized during the three and nine months ended October 31, 2009, respectively, and $3,172,000 and $11,022,000 during the three and nine months ended October 31, 2008, respectively, which were recorded in revenues from real estate operations in the Consolidated Statements of Operations.

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Revenues for property management and asset management fees are earned based on a contractual percentage of the annual net rental income and annual operating income, respectively, that is generated by the military housing privatization projects as defined in the agreements. We also recognize certain property management incentive fees based upon successful completion of certain criteria as set forth in the property management agreements. Property management, management incentive and asset management fees of $3,634,000 and $11,467,000 were recognized during the three and nine months ended October 31, 2009, respectively, and $3,741,000 and $10,683,000 during the three and nine months ended October 31, 2008, respectively, which were recorded in revenues from real estate operations in the Consolidated Statements of Operations.
Land Development Group
Revenues from real estate operations – Land sales and the related gross margins vary from period to period depending on the timing of sales and general market conditions relating to the disposition of significant land holdings. Our land sales have been impacted by slowing demand from home buyers in certain core markets for the land business, reflecting conditions throughout the housing industry. Revenues from real estate operations for the Land Development Group decreased by $4,143,000 for the three months ended October 31, 2009 compared to the same period in the prior year. This variance is primarily attributable to the following decreases:
   
$4,335,000 related to lower land sales at Summers Walk in Davidson, North Carolina; and
 
   
$1,153,000 related to lower land sales primarily at Legacy Lakes in Aberdeen, North Carolina and Mill Creek in York County, South Carolina, combined with several smaller decreases in land sales at other land development projects.
These decreases were partially offset by the following increase:
   
$1,345,000 related to higher land sales primarily at Gladden Farms in Marana, Arizona and higher unit sales at Rockport Square in Lakewood, Ohio, combined with several smaller increases in land sales at other land development projects.
Revenues from real estate operations for the Land Development Group decreased by $10,353,000 for the nine months ended October 31, 2009 compared to the same period in the prior year. This variance is primarily attributable to the following decreases:
   
$8,109,000 related to lower land sales at Summers Walk and Tangerine Crossing in Tucson, Arizona and lower unit sales at Rockport Square;
 
   
$2,128,000 primarily related to reduced fee income and profit participation due to lower home sales at Stapleton in Denver, Colorado; and
 
   
$2,057,000 related to lower land sales primarily at Legacy Lakes and Mill Creek, combined with several smaller decreases in land sales at other land development projects.
These decreases were partially offset by the following increase:
   
$1,941,000 related to higher land sales primarily at Creekstone in Copley, Ohio and Gladden Farms, combined with several smaller increases in land sales at other land development projects.
Operating and Interest Expenses – Operating expenses decreased by $14,099,000 for the three months ended October 31, 2009 compared to the same period in the prior year. This variance is primarily attributable to the following decreases:
   
$14,216,000 at Stapleton primarily related to the $13,816,000 reduction in fair value of the DURA purchase obligation and fee, that resulted from the Lehman Brothers, Inc. bankruptcy in 2008 (see the “Other Structured Financing Arrangements” section of the MD&A);
 
   
$2,786,000 related to lower land sales at Summers Walk; and
 
   
$1,254,000 primarily related to lower land sales at Legacy Lakes, Mill Creek and other land development projects along with reduced payroll costs and specific cost reduction activities.
These decreases were partially offset by the following increases:
   
$1,657,000 primarily related to higher land sales at Gladden Farms and higher unit sales at Rockport Square, combined with several smaller increases in land sales at other land development projects; and
 
   
$2,500,000 legal settlement related to a former joint venture.

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Operating expenses decreased by $20,798,000 for the nine months ended October 31, 2009 compared to the same period in the prior year. This variance is primarily attributable to the following decreases:
   
$17,954,000 at Stapleton primarily related to the $13,816,000 reduction in fair value of the DURA purchase obligation and fee, that resulted from the Lehman Brothers, Inc. bankruptcy in 2008 (see the “Other Structured Financing Arrangements” section of the MD&A) along with reduced payroll costs and specific cost reduction activities;
 
   
$5,446,000 related to lower land sales at Summers Walk and Tangerine Crossing and lower unit sales at Rockport Square; and
 
   
$2,888,000 primarily related to lower land sales at Legacy Lakes, Mill Creek and other land development projects along with reduced payroll costs and specific cost reduction activities.
These decreases were partially offset by the following increases:
   
$2,990,000 primarily related to higher land sales at Creekstone, Gladden Farms and other land development projects, combined with several smaller increases in land sales at other land development projects; and
 
   
$2,500,000 legal settlement related to a former joint venture.
Interest expense for the Land Development Group increased by $944,000 for the three months ended October 31, 2009 and $1,922,000 for the nine months ended October 31, 2009 compared to the same periods in the prior year. Interest expense varies from year to year depending on the level of interest-bearing debt within the Land Development Group.
The Nets
Our equity investment in The Nets incurred a pre-tax loss of $10,853,000 and $29,841,000 for the three and nine months ended October 31, 2009, respectively, representing an increase in allocated losses of $994,000 and a decrease of $2,039,000 compared to the same periods in the prior year. Generally accepted accounting principles require us to report losses, including significant non-cash losses resulting from amortization, in excess of our legal ownership of approximately 23%. For both the nine months ended October 31, 2009 and 2008, we recognized approximately 62% of the net loss because profits and losses are allocated to each member based on an analysis of the respective member’s claim on the net book equity assuming a liquidation at book value at the end of the accounting period without regard to unrealized appreciation (if any) in the fair value of The Nets.
Included in the losses for the nine months ended October 31, 2009 and 2008 are approximately $12,750,000 and $14,934,000, respectively, of amortization, at our share, of certain assets related to the purchase of the team. The remainder of the losses substantially relate to the operations of the team. Consistent with prior years, the team is expected to continue to operate at a loss for the remainder of 2009.
Corporate Activities
Operating and Interest Expenses – Operating expenses for Corporate Activities increased by $1,640,000 for the three months ended October 31, 2009 and $745,000 for the nine months ended October 31, 2009 compared to the same periods in the prior year. The increase of $1,640,000 for the three months ended October 31, 2009 was primarily attributable to an increase in charitable contributions of $541,000 and other general corporate expenses. The increase of $745,000 for the nine months ended October 31, 2009 was primarily related to company-wide severance and outplacement expenses of $8,720,000 offset by cost savings initiatives that resulted in reductions in compensation and related benefits of $2,195,000, charitable contributions of $1,919,000 and $3,861,000 of general corporate expenses.
Interest expense for Corporate Activities consists primarily of interest expense on the senior notes and the bank revolving credit facility, excluding the portion allocated to the Land Development Group (see the “Financial Condition and Liquidity” section). Interest expense decreased by $1,256,000 for the three months ended October 31, 2009 and increased by $5,216,000 for the nine months ended October 31, 2009 compared to the same periods in the prior year. The decrease of $1,256,000 for the three months ended October 31, 2009 related to reduced interest on the credit facility as a result of decreased borrowings and decreased borrowing costs, reduced non-cash interest expense recognized on our 3.625% Puttable Equity-Linked Senior Notes due 2011, offset with increased interest expense on the corporate interest rate swaps, due to a reduction in the LIBOR rate. The increase of $5,216,000 for the nine months ended October 31, 2009 related to increased interest on the credit facility due to increased borrowings in addition to increased interest expense related to corporate interest rate swaps.
Other Activity
The following items are discussed on a consolidated basis.

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Depreciation and Amortization
We recorded depreciation and amortization of $66,393,000 and $199,659,000 for the three and nine months ended October 31, 2009, respectively, which is an increase of $2,355,000, or 3.7%, and $1,049,000, or 0.5%, compared to the same periods in the prior year.
Impairment of Real Estate
We review our real estate portfolio, including land held for development or sale, for impairment whenever events or changes indicate that our carrying value of the long-lived assets may not be recoverable. In cases where we do not expect to recover our carrying costs, we record an impairment charge in accordance with accounting guidance on the impairment of long-lived assets. During the three and nine months ended October 31, 2009, we recorded an impairment of certain real estate assets in continuing operations of $549,000 and $3,124,000, respectively. The amounts for 2009 represent impairments of real estate of $2,000,000 primarily related to two land development projects, Gladden Farms and Tangerine Crossing located in Marana and Tucson, Arizona, respectively, and $1,124,000 related to the residential land sale and related development opportunity in Mamaroneck, New York, which occurred during the three months ended April 30, 2009. In addition, included in discontinued operations is an impairment of real estate for two properties that were sold during the three months ended October 31, 2009 (see the “Discontinued Operations” section of the MD&A). These impairments represent a write down to the estimated fair value due to a change in events, such as a purchase offer and/or consideration of current market conditions related to the estimated future cash flows. We did not record any impairments of real estate during the three and nine months ended October 31, 2008.
Impairment of Unconsolidated Entities
We review our portfolio of unconsolidated entities for other-than-temporary impairments whenever events or changes indicate that our carrying value in the investments may be in excess of fair value. An equity method investment’s value is impaired only if management’s estimates of its fair value is less than the carrying value and such difference is deemed to be other-than-temporary. In order to arrive at the estimates of fair value of our unconsolidated entities, we use varying assumptions that may include comparable sale prices, market discount rates, market capitalization rates and estimated future discounted cash flows specific to the geographic region and property type, which are considered to be Level 3 inputs under accounting guidance related to estimating fair value.
The following table summarizes our impairment of unconsolidated entities for the three and nine months ended October 31, 2009 and 2008, which are included in the Consolidated Statements of Operations.
                                         
            Three Months Ended     Nine Months Ended  
            October 31,   October 31,  
            2009     2008     2009     2008  
                 
            (in thousands)     (in thousands)  
Apartment Communities:
                                       
Millender Center
    (Detroit, Michigan)       $ 3,247     $ -       $ 10,317     $ -  
Uptown Apartments
  (Oakland, California)     -       -       6,781       -  
Metropolitan Lofts
  (Los Angeles, California)     1,466       -       2,505       -  
Residences at University Park
  (Cambridge, Massachusetts)     -       -       855       -  
Fenimore Court
  (Detroit, Michigan)     -       -       693       -  
Mercury (Condominium)
  (Los Angeles, California)     -       -       -       4,098  
Classic Residence by Hyatt (Supported-Living Apartments)
  (Yonkers, New York)     -       -       3,152       -  
Specialty Retail Centers:
                                       
Southgate Mall
  (Yuma, Arizona)     -       -       1,611       -  
El Centro Mall
  (El Centro, California)     -       -       -       1,263  
Pittsburgh Peripheral (Land Project)
  (Pittsburgh, Pennsylvania)     7,217       -       7,217       -  
Shamrock Business Center (Land Project)
  (Painesville, Ohio)     1,150       -       1,150       -  
Other
            120       -       382       665  
                 
 
                                       
Total Impairment of Unconsolidated Entities
            $ 13,200     $ -       $ 34,663     $ 6,026  
                 
Write-Off of Abandoned Development Projects
On a quarterly basis, we review each project under development to determine whether it is probable the project will be developed. If we determine that the project will not be developed, project costs are written off to operating expenses as an abandoned development project cost. We may abandon certain projects under development for a number of reasons, including, but not limited to, changes in local market conditions, increases in construction or financing costs or due to third party challenges related to entitlements or public financing. As a result, we may fail to recover expenses already incurred in exploring development opportunities. We recorded write-offs of abandoned development projects of $3,758,000 and $21,398,000 for the three and nine months ended October 31, 2009, respectively, and $12,500,000 and $41,452,000 for the three and nine months ended October 31, 2008, respectively, which were recorded in operating expenses in the Consolidated Statements of Operations.

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Amortization of Mortgage Procurement Costs
We amortize mortgage procurement costs on a straight-line basis over the life of the related nonrecourse mortgage debt, which approximates the effective interest method. For the three and nine months ended October 31, 2009, we recorded amortization of mortgage procurement costs of $3,562,000 and $10,645,000, respectively. Amortization of mortgage procurement costs increased $724,000 and $1,922,000 for the three and nine months ended October 31, 2009, respectively, compared to the same periods in the prior year primarily related to new property openings.
Gain (Loss) on Early Extinguishment of Debt
For the three and nine months ended October 31, 2009, we recorded $28,902,000 and $37,965,000, respectively, as gain on early extinguishment of debt. The amounts for 2009 include the $24,219,000 gain on early extinguishment of nonrecourse mortgage debt at an underperforming retail project, the $9,466,000 gain on early extinguishment of nonrecourse mortgage debt at Gladden Farms, a land development project located in Marana, Arizona and the $4,683,000 gain related to the exchange of a portion of the Company’s 2011 Notes for a new issue of 2014 Notes (see the “Puttable Equity-Linked Senior Notes due 2011” section of the MD&A). These gains were partially offset by a charge to early extinguishment of debt as a result of the payment of $20,400,000 in redevelopment bonds by a consolidated wholly-owned subsidiary of ours (see the “Subordinated Debt” section of the MD&A). For the three and nine months ended October 31, 2008, we recorded $3,692,000 and $(1,539,000), respectively, as gain (loss) on early extinguishment of debt. The amounts for 2008 include gains on the early extinguishment of debt of a portion of our puttable equity-linked senior notes due October 15, 2011 (see the “Puttable Equity-Linked Senior Notes due 2011” section of the MD&A) and on the early extinguishment of the Urban Development Action Grant loan at Post Office Plaza, an office building located in Cleveland, Ohio. These gains were offset by the impact of early extinguishment of nonrecourse mortgage debt at Galleria at Sunset, a regional mall located in Henderson, Nevada, and 1251 S. Michigan and Sky55, apartment communities located in Chicago, Illinois, in order to secure more favorable financing terms.
Interest and Other Income
Interest and other income was $5,522,000 and $23,924,000 for the three and nine months ended October 31, 2009, respectively, compared to $6,752,000 and $27,976,000 for the three and nine months ended October 31, 2008, respectively. The decrease of $1,230,000 for the three months ended October 31, 2009 compared to the same period in the prior year is generally due to lower interest earned on our cash and restricted cash balances maintained with financial institutions, offset by an increase of $394,000 related to the income recognition on the sale of historic preservation and new market tax credits. The decrease of $4,052,000 for the nine months ended October 31, 2009 compared to the same period in the prior year is primarily due to the following decreases: $4,546,000 related to the income earned on the DURA purchase obligation and fee in 2008 that did not recur (see the “Other Structured Financing Arrangements” section of the MD&A) and $3,350,000 related to the 2008 gain on the sale of an ownership interest in a parking management company. These decreases were partially offset by a gain recognized in 2009 of $3,599,000 related to insurance proceeds received due to fire damage at an apartment building in excess of the net book value of the damaged asset and an increase of $2,792,000 related to the income recognition on the sale of historic preservation and new market tax credits. The remaining decrease is generally due to lower interest earned on our cash and restricted cash balances maintained with financial institutions.
Income Taxes
Income tax benefit for the three months ended October 31, 2009 and 2008 was $(2,895,000) and $(11,916,000), respectively. Income tax benefit for the nine months ended October 31, 2009 and 2008 was $(25,874,000) and $(28,382,000), respectively. The difference in the income tax benefit reflected in the Consolidated Statements of Operations versus the income tax benefit computed at the statutory federal income tax rate is primarily attributable to state income taxes, the cumulative effect of changing our effective tax rate, additional state NOL’s and general business credits, changes to the valuation allowances associated with certain deferred tax assets, and various permanent differences between pre-tax generally accepted accounting principles (“GAAP”) income and taxable income.
At January 31, 2009, we had a federal net operating loss carryforward for tax purposes of $113,458,000 (generated primarily from the impact on our net earnings of tax depreciation expense from real estate properties and excess deductions from stock-based compensation) that will expire in the years ending January 31, 2024 through January 31, 2029, a charitable contribution deduction carryforward of $42,705,000 that will expire in the years ending January 31, 2010 through January 31, 2014 ($5,651,000 expiring in the year ended January 31, 2010), general business credit carryovers of $15,099,000 that will expire in the years ending January 31, 2010 through January 31, 2029 ($36,000 expiring in the year ended January 31, 2010), and an alternative minimum tax (“AMT”) credit carryforward of $28,501,000 that is available until used to reduce federal tax to the AMT amount.
Our policy is to consider a variety of tax-deferral strategies, including tax deferred exchanges, when evaluating our future tax position. We have a full valuation allowance against the deferred tax asset associated with our charitable contributions. We have a valuation allowance against our general business credits, other than those general business credits which are eligible to be utilized to reduce future AMT liabilities. These valuation allowances exist because we believe at this time that it is more likely than not that we will not realize these benefits.

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We apply the “with-and-without” methodology for recognizing excess tax benefits from the deduction of stock-based compensation. The net operating loss available for the tax return, as is noted in the paragraph above, is significantly greater than the net operating loss available for the tax provision due to excess deductions from stock-based compensation reported on the return, as well as the impact of adjustments to the net operating loss under the accounting guidance on accounting for uncertainty in income taxes. We have not recorded a net deferred tax asset of approximately $17,096,000, as of January 31, 2009, from excess stock-based compensation deductions taken on our tax return for which a benefit has not yet been recognized in our tax provision.
Accounting for Uncertainty in Income Taxes
Unrecognized tax benefits represent those tax benefits related to tax positions that have been taken or are expected to be taken in tax returns that are not recognized in the financial statements because we have either concluded that it is not more likely than not that the tax position will be sustained if audited by the appropriate taxing authority or the amount of the benefit will be less than the amount taken or expected to be taken in our income tax returns.
As of October 31 and January 31, 2009, we had unrecognized tax benefits of $1,636,000 and $1,481,000, respectively. We recognize estimated interest payable on underpayments of income taxes and estimated penalties that may result from the settlement of some uncertain tax positions as components of income tax expense. As of October 31 and January 31, 2009, we had approximately $501,000 and $463,000, respectively, of accrued interest related to uncertain income tax positions. Income tax expense (benefit) relating to interest and penalties on uncertain tax positions of $(87,000) and $37,000 for the three and nine months ended October 31, 2009, respectively, and $35,000 and $(297,000) for the three and nine months ended October 31, 2008, respectively, was recorded in the Consolidated Statements of Operations. We settled Internal Revenue Service audits of two of our partnership investments, one during the three months ended October 31, 2009 and one during the nine months ended October 31, 2008, both of which resulted in a decrease in our unrecognized tax benefits and associated accrued interest and penalties.
The total amount of unrecognized tax benefits that would affect our effective tax rate, if recognized as of October 31, 2009 and 2008, is $172,000 and $339,000, respectively. Based upon our assessment of the outcome of examinations that are in progress, the settlement of liabilities, or as a result of the expiration of the statutes of limitation for certain jurisdictions, it is reasonably possible that the related unrecognized tax benefits for tax positions taken regarding previously filed tax returns will materially change from those recorded at October 31, 2009. Included in the $1,636,000 of unrecognized benefits noted above is $1,415,000 which, due to the reasons above, could significantly decrease during the next twelve months.
Equity in Earnings (Loss) of Unconsolidated Entities – (also see the “Impairment of Unconsolidated Entities” section of the MD&A)
Equity in earnings of unconsolidated entities was $1,364,000 for the three months ended October 31, 2009 compared to equity in loss of unconsolidated entities of $3,198,000 for the three months ended October 31, 2008, representing a variance of $4,562,000. This variance is primarily attributable to the following increases that occurred within our equity method investments:
-   Residential Group
   
$4,498,000 related to the 2009 gain on disposition of our partnership interest in Boulevard Towers, an apartment community in Amherst, New York.
-   Land Development Group
   
$1,874,000 related to the 2009 gain on early extinguishment of nonrecourse mortgage debt at Shamrock Business Center in Painesville, Ohio.
These increases were partially offset by the following decreases:
-   Land Development Group
   
$2,373,000 related to decreased sales at Central Station, located in Chicago, Illinois.
-   The Nets
   
$994,000 related to an increase in allocated losses in The Nets (see “The Nets” section of the MD&A).
The balance of the remaining increase of $1,557,000 was due to fluctuations in the operations of our equity method investments.

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Equity in loss of unconsolidated entities was $10,477,000 for the nine months ended October 31, 2009 compared to $12,761,000 for the nine months ended October 31, 2008, representing a variance of $2,284,000. This variance is primarily attributable to the following increases that occurred within our equity method investments:
-   Residential Group
   
$4,498,000 related to the 2009 gain on disposition of our partnership interest in Boulevard Towers.
-   Land Development Group
   
$2,396,000 related to the 2009 net gain on an industrial land sale at Mesa Del Sol in Albuquerque, New Mexico.
 
   
$1,874,000 related to the 2009 gain on early extinguishment of nonrecourse mortgage debt at Shamrock Business Center.
-   The Nets
   
$2,039,000 related to a decrease in allocated losses in The Nets (see “The Nets” section of the MD&A).
-   Commercial Group
   
$1,272,000 related to the 2008 participation payment on the refinancing at 350 Massachusetts Avenue, an office building in Cambridge, Massachusetts.
These increases were partially offset by the following decreases:
-   Land Development Group
    $6,613,000 related to decreased sales at Central Station.
-   Residential Group
   
$4,207,000 primarily related to lease-up losses at Uptown Apartments, an apartment community in Oakland, California, combined with smaller operating losses at three apartment complexes which were acquired during the second half of 2008.
-   Commercial Group
    $1,081,000 related to the 2008 gains on disposition of our partnership interests in One International Place and Emery-Richmond, office buildings in Cleveland, Ohio and Warrensville Heights, Ohio, respectively.
The balance of the remaining increase of $2,106,000 was due to fluctuations in the operations of our equity method investments.
Discontinued Operations
All revenues and expenses of discontinued operations sold or held for sale, assuming no significant continuing involvement, have been reclassified in the Consolidated Statements of Operations for the three and nine months ended October 31, 2009 and 2008. We consider assets held for sale when the transaction has been approved and there are no significant contingencies related to the sale that may prevent the transaction from closing. There were no assets classified as held for sale at October 31 or January 31, 2009.
During the nine months ended October 31, 2009, we sold Grand Avenue, a specialty retail center in Queens, New York, which generated a pre-tax gain on disposition of rental properties of $4,548,000. The gain along with the operating results of the property through the date of sale is classified as discontinued operations for the nine months ended October 31, 2009 and 2008.
During the year ended January 31, 2008, we consummated an agreement to sell eight (seven operating properties and one property that was under construction at the time of the agreement) and lease four supported-living apartment properties to a third party. Pursuant to the agreement, during the second quarter of 2007, six operating properties and the property under construction were sold. The seventh operating property, Sterling Glen of Lynbrook, was operated by the purchaser under a short-term lease through the date of sale, which occurred on May 20, 2008 and generated a pre-tax gain on disposition of rental properties of $8,627,000. The gain along with the operating results of the property through the date of sale are classified as discontinued operations for the nine months ended October 31, 2008.
The four remaining properties entered into long-term operating leases with the purchaser. On January 30, 2009, the purchase agreement for the sale of Sterling Glen of Rye Brook, whose operating lease had a stated term of ten years, were amended and the property was sold. The operating results of the property for the three and nine months ended October 31, 2008 are classified as discontinued operations. On January 31, 2009, another long-term operating lease with the purchaser that had a stated term of ten years was cancelled and the operations of the property were transferred back to us.

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During the three months ended October 31, 2009, negotiations related to amending terms of the purchase agreements for the sales of Sterling Glen of Glen Cove and Sterling Glen of Great Neck indicated the carrying value of these long-lived real estate assets may not be recoverable resulting in an impairment of real estate of $7,138,000 and $2,637,000, respectively, which reduced the carrying value of the long-lived assets to the estimated net sales price. The sale of the two properties closed on September 17 and 30, 2009, respectively, resulting in no gain or loss upon disposition. The operating results of the properties, including the impairment charges, are classified as discontinued operations for the three and nine months ended October 31, 2009 and 2008.
The following table lists the consolidated rental properties included in discontinued operations:
                             
                Three   Nine   Three   Nine
                Months   Months   Months   Months
        Square Feet/   Period   Ended   Ended   Ended   Ended
  Property   Location   Number of Units   Disposed   10/31/2009   10/31/2009   10/31/2008   10/31/2008
 
 
                           
  Commercial Group:
                           
  Grand Avenue
  Queens, New York   100,000 square feet   Q1-2009   -   Yes   Yes   Yes
 
                           
  Residential Group:
                           
  Sterling Glen of Glen Cove
  Glen Cove, New York   80 units   Q3-2009   Yes   Yes   Yes   Yes
  Sterling Glen of Great Neck
  Great Neck, New York   142 units   Q3-2009   Yes   Yes   Yes   Yes
  Sterling Glen of Rye Brook
  Rye Brook, New York   168 units   Q4-2008   -   -   Yes   Yes
  Sterling Glen of Lynbrook
  Lynbrook, New York   130 units   Q2-2008   -   -   -   Yes
The operating results related to discontinued operations were as follows:
                                 
    Three Months Ended October 31,     Nine Months Ended October 31,  
    2009     2008     2009     2008  
    (in thousands)     (in thousands)  
Revenues from real estate operations
    $ 1,688     $ 4,149       $ 5,476     $ 13,114  
 
Expenses
                               
Operating expenses
    35       416       430       1,604  
Depreciation and amortization
    195       1,451       1,347       3,911  
Impairment of real estate
    9,775       -       9,775       -  
         
 
    10,005       1,867       11,552       5,515  
         
Interest expense
    (502 )     (1,883 )     (2,184 )     (5,721 )
Amortization of mortgage procurement costs
    (7 )     (106 )     (50 )     (339 )
 
Interest income
    -       37       -       136  
Gain on disposition of rental properties
    -       -       4,548       8,627  
         
 
Earnings (loss) before income taxes
    (8,826 )     330       (3,762 )     10,302  
         
Income tax expense (benefit)
                               
Current
    (3,019 )     110       848       (636 )
Deferred
    (404 )     18       (2,307 )     4,617  
 
    (3,423 )     128       (1,459 )     3,981  
         
Net earnings (loss) from discontinued operations
    $ (5,403 )   $ 202       $ (2,303 )   $ 6,321  
         
Disposition of Equity Method Investments
Upon disposition, investments accounted for on the equity method are not classified as discontinued operations in accordance with accounting guidance on the impairment or disposal of long-lived assets; therefore, gains or losses on the sale of equity method investments are reported in continuing operations when sold. On October 6, 2009, we exchanged our 50% ownership interest in Boulevard Towers, located in Amherst, New York, for 100% ownership in North Church Towers, an apartment complex located in Parma Heights, Ohio. The nonmonetary transaction resulted in a gain of $4,498,000 which is included in equity in loss of unconsolidated entities in the Consolidated Statements of Operations. During the three and nine months ended October 31, 2008, we recorded $200,000 and $1,081,000, respectively, related to our proportionate share of the gain on disposition of an equity method investment, Emery-Richmond, located in Warrensville Heights, Ohio ($200,000), and an equity method investment, One International Place, located in Cleveland, Ohio ($881,000), which is included in equity in loss of unconsolidated entities in the Consolidated Statements of Operations.

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FINANCIAL CONDITION AND LIQUIDITY
Ongoing economic conditions have negatively impacted the availability and access to capital, particularly for the real estate industry. Originations of new loans for the Commercial Mortgage Backed Securities market have virtually ceased. Financial institutions have significantly reduced their lending with an emphasis on reducing their exposure to commercial real estate. For those institutions still lending, underwriting standards are being tightened with lenders requiring lower loan-to-values, increased debt service coverage levels and higher lending spreads. While the long-term impact is unknown, borrowing costs for us will likely continue to rise and financing levels will continue to decrease over the foreseeable future.
Our principal sources of funds are cash provided by operations, the bank revolving credit facility, nonrecourse mortgage debt, dispositions of land held for sale as well as operating properties, proceeds from the issuance of senior notes, equity joint ventures and other financing arrangements. Our principal uses of funds are the financing of development projects and acquisitions of real estate, capital expenditures for our existing portfolio and principal and interest payments on our nonrecourse mortgage debt, interest payments on our bank revolving credit facility and previously issued senior notes and repayment of borrowings under our bank revolving credit facility.
Our primary capital strategy seeks to isolate the operating and financial risk at the property level to maximize returns and reduce risk on and of our equity capital. As such, substantially all of our operating and development properties are separately encumbered with nonrecourse mortgage debt. We do not cross-collateralize our mortgage debt outside of a single identifiable project. We operate as a C-corporation and retain substantially all of our internally generated cash flows. This cash flow, together with refinancing and property sale proceeds, has historically provided us with the necessary liquidity to take advantage of investment opportunities. Recent changes in the lending and capital markets substantially reduced our ability to refinance and/or sell property and has also increased the rates of return to make new investment opportunities appealing. As a result of these market changes, we have dramatically cut back on new development and acquisition activities.
Despite the dramatic decrease in development activities, we still intend to complete all projects that are under construction. We continue to make progress on certain other pre-development projects primarily located in core markets. The cash we believe is required to fund our equity in projects under development plus any cash necessary to extend or paydown the remaining 2009 and 2010 debt maturities is anticipated to exceed our cash from operations. As a result, we intend to extend maturing debt or repay it with net proceeds from property sales or future debt or equity financing.
We have proactively taken necessary steps to preserve liquidity by properly aligning our overhead costs with the reduced level of development and acquisition activities and suspension of cash dividends on Class A and Class B common stock. We have also increased liquidity through our May 2009 public offering of 52,325,000 shares of Class A common stock from which we received $329,917,000 in net proceeds, after deducting underwriter discounts, commissions and other offering expenses. We have also effectively extended our unsecured debt maturities by our October 2009 exchange of $167,433,000 of 2011 Notes for a new issue of 3.625% Puttable Equity-Linked Senior Notes due 2014 (“2014 Notes”). Concurrent with the exchange transaction, we generated liquidity by issuing an additional $32,567,000 of 2014 Notes, resulting in net proceeds of $29,764,000 after deducting the discount and estimated offering expenses. In October 2009, we further increased liquidity by issuing $200,000,000 of 5.00% convertible senior notes due 2016, resulting in $177,262,000 of net proceeds after deducting underwriting discounts and estimated offering expenses. We are actively exploring various other options to enhance our liquidity, such as admitting other joint venture partners into some of our properties, potential asset sales and nonrecourse mortgage refinancings. There can be no assurance, however, that any of these other options can be accomplished.
As of October 31, 2009, we had $332,363,000 of mortgage financings with scheduled maturities during the fiscal year ending January 31, 2010, of which $22,280,000 represents scheduled payments. Subsequent to October 31, 2009, we had addressed approximately $96,301,000 of these 2009 maturities, through closed transactions, commitments and/or automatic extensions. We also have extension options available on $184,984,000 of these 2009 maturities, all of which require some predefined condition in order to qualify for the extension, such as meeting or exceeding leasing hurdles, loan to value ratios or debt service coverage requirements. We cannot give assurance that the defined hurdles or milestones will be achieved to qualify for these extensions. We are currently in negotiations to refinance and/or extend the remaining $28,798,000 of scheduled nonrecourse mortgage maturities for the year ended January 31, 2010. We cannot give assurance as to the ultimate result of these negotiations.
As of October 31, 2009, our share of nonrecourse mortgage debt recorded on our unconsolidated subsidiaries amounted to $1,464,577,000 of which $157,804,000 ($3,442,000 represents scheduled payments) was scheduled to mature during the year ending January 31, 2010. Subsequent to October 31, 2009, we had addressed $65,067,000 of these 2009 maturities through closed nonrecourse mortgage transactions, commitments and/or automatic extensions. We also had extension options on $82,711,000 of these 2009 maturities, all of which require predefined condition in order to qualify for the extension, such as meeting or exceeding leasing hurdles, loan to value ratios or debt service coverage requirements. We cannot give assurance that the defined hurdles or milestones will be achieved to qualify for the extensions. We are currently in negotiations to refinance and/or extend the remaining $6,584,000 of scheduled nonrecourse mortgage maturities for the year ended January 31, 2010. We cannot give assurance as to the ultimate result of these negotiations.

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Potential Impacts to Our Financial Condition and Liquidity Relating to Brooklyn Atlantic Yards
We are in the process of developing Brooklyn Atlantic Yards (“Atlantic Yards”), which will cost an approximate $4.9 billion over the anticipated construction and development period. This long-term mixed use real estate project in downtown Brooklyn is expected to feature a sports and entertainment arena for the Nets (“Arena”). Due to the nature and magnitude of the project, there is significant development risk as more thoroughly discussed in our “We are Subject to Real Estate Development Risks” risk factor update for Brooklyn Atlantic Yards included in Part II of this Quarterly Report on Form 10-Q (“Risk Factor”).
Significant site acquisition and construction activities have occurred to date but the master closing will not occur until all negotiations with the state and local governmental authorities are completed and agreements finalized including the successful marketing of tax-exempt financing and other sources of funding to support construction of the Arena (“Master Closing”). Master Closing is currently scheduled to occur in late December 2009.
Upon Master Closing and throughout the long-term development of Atlantic Yards, significant private equity will be required from us, our current partners and any future investors to fund infrastructure and construction. During the three-month period ended October 31, 2009, we entered into a letter of intent with an affiliate of Onexim Group, an international private investment firm, to invest $200,000,000 and make certain contingent funding requirements to acquire 45% of the Arena, 80% of the Nets and the rights to purchase up to 20% of the non-Arena portion of the Atlantic Yards development (“LOI”). The LOI requires certain consents and is subject to the satisfaction of various conditions.
While we believe it is probable that the conditions precedent to Master Closing will occur, there can be no assurance they all will be achieved. In addition, there is no assurance that the investment under the LOI will be realized, that our current partners will fund any future equity requirements or that the project will attract any future investors. If any of the foregoing events do not happen, are significantly delayed, or any of the other development risks occur, we may not be able to develop Atlantic Yards to the full scope intended or at all. This may result in a potential impairment or write-off of our investment as well as other potential ramifications as disclosed in the Risk Factor. As of October 31, 2009, we estimate that the maximum at risk for impairment or write-off, if Master Closing does not occur, is approximately $350,000,000 net of prior amortization. In addition, in a worst case scenario, we could be required to refund public subsidies already received and incur other costs together totaling approximately $230,000,000.
Subsequent to October 31, 2009, we have elected to delay a November 30, 2009 scheduled amortization payment of $5,000,000 on our $162,000,000 nonrecourse mortgage secured by all land owned in the Atlantic Yards footprint and were granted an extension until December 10, 2009. We have commenced negotiations with the lender to modify the terms of the mortgage but can give no assurance that these negotiations will be successful. If no agreement is reached under the nonrecourse loan between the parties, we can relinquish the land to the lender in lieu of payment of the mortgage.
Bank Revolving Credit Facility
At October 31 and January 31, 2009, our bank revolving credit facility provides for maximum borrowings of $750,000,000 and matures in March 2010. The credit facility bears interest at our option at either a LIBOR-based rate plus 2.50% (2.75% and 2.98% at October 31 and January 31, 2009, respectively), or a Prime-based rate option plus 1.50%. We have historically elected the LIBOR-based rate option. The credit facility restricts our ability to purchase, acquire, redeem or retire any of our capital stock, and prohibits us from paying any dividends on our capital stock through the maturity date. The credit facility allows certain actions by us or our subsidiaries, such as default in paying debt service or allowing foreclosure on an encumbered real estate asset, only to the extent such actions do not have a material adverse effect, as defined in the agreement, on us. Of the available borrowings, up to $100,000,000 may be used for letters of credit or surety bonds. The credit facility also contains certain financial covenants, including maintenance of certain debt service and cash flow coverage ratios, and specified levels of net worth (as defined in the credit facility). At October 31, 2009, we were in compliance with all of these financial covenants.
Effective October 5, 2009, we entered into a Third Amendment to the bank revolving credit facility in connection with our private placement of our 3.625% Puttable Equity-Linked Senior Notes due 2014 (“2014 Notes”). The amendment permitted us to exchange up to $200,000,000 of our 3.625% Puttable Equity-Linked Senior Notes due 2011 for our 2014 Notes and issue up to $75,000,000 in 2014 Notes, provided that the aggregate amount of 2014 Notes does not exceed $200,000,000 (refer to the “Senior and Subordinated Debt” section of the MD&A).
Effective October 22, 2009, we entered into a Fourth Amendment to the bank revolving credit facility in connection with our private placement of our 5.00% Convertible Senior Notes due 2016 (“2016 Notes”). The amendment permitted us to issue the $200,000,000 of 2016 Notes and enter into a convertible note hedge transaction in connection with the issuance of these 2016 Notes (refer to the “Senior and Subordinated Debt” section of the MD&A).
During the nine months ended October 31, 2009, we primarily used the net proceeds from the May 2009 common stock offering (refer to the “Common Stock Offering” section of the MD&A) and the issuance of the 2016 Notes to reduce outstanding borrowings on the bank revolving credit facility.

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The available credit on the bank revolving credit facility at October 31 and January 31, 2009 was as follows:
                   
    October 31, 2009     January 31, 2009  
    (in thousands)  
 
               
Maximum borrowings
   $ 750,000     $ 750,000  
Less outstanding balances:
               
Borrowings
    37,016       365,500  
Letters of credit
    66,814       65,949  
Surety bonds
    -       -  
     
Available credit
   $ 646,170     $ 318,551  
     
In November 2009, we reached an agreement on the principal terms of a new $500,000,000 revolving credit facility with our 15-member bank group which would mature two years from closing. We expect the transaction to close prior to December 31, 2009. In the event the transaction does not close and the revolving credit facility is not otherwise extended, we would continue to raise capital through the sale of assets, admitting other joint venture equity partners into some of our properties, curtailing capital expenditures and/or raising additional funds in a public or private debt or equity offering.
Senior and Subordinated Debt
Our Senior and Subordinated Debt is comprised of the following at October 31 and January 31, 2009:
                   
            January 31, 2009  
    October 31, 2009     (As Adjusted)  
    (in thousands)  
Senior Notes:
               
3.625% Puttable Equity-Linked Senior Notes due 2011, net of discount
   $ 98,156     $ 248,154  
3.625% Puttable Equity-Linked Senior Notes due 2014, net of discount
    198,399       -  
7.625% Senior Notes due 2015
    300,000       300,000  
5.000% Convertible Senior Notes due 2016
    200,000       -  
6.500% Senior Notes due 2017
    150,000       150,000  
7.375% Senior Notes due 2034
    100,000       100,000  
     
 
Total Senior Notes
    1,046,555       798,154  
     
 
               
Subordinated Debt:
               
Redevelopment Bonds due 2010
    -       18,910  
Subordinate Tax Revenue Bonds due 2013
    29,000       29,000  
     
Total Subordinated Debt
    29,000       47,910  
     
 
Total Senior and Subordinated Debt
   $ 1,075,555     $ 846,064  
     
Puttable Equity-Linked Senior Notes due 2011
On October 10, 2006, we issued $287,500,000 of 3.625% puttable equity-linked senior notes due October 15, 2011 (“2011 Notes”) in a private placement. The notes were issued at par and accrued interest is payable semi-annually in arrears on April 15 and October 15. During the year ended January 31, 2009, we purchased on the open market $15,000,000 in principal of our 2011 Notes resulting in a gain, net of associated deferred financing costs of $3,692,000, which is recorded as early extinguishment of debt in the Consolidated Statements of Operations. On October 7, 2009, we entered into privately negotiated exchange agreements with certain holders of the 2011 Notes to exchange $167,433,000 of aggregate principal amount of their 2011 Notes for a new issue of 3.625% puttable equity-linked senior notes due October 2014. This exchange resulted in a gain, net of associated deferred financing costs of $4,683,000, which is recorded as early extinguishment of debt in the Consolidated Statements of Operations. There was $105,067,000 ($98,156,000, net of discount) and $272,500,000 ($248,154,000, net of discount) of principal outstanding at October 31 and January 31, 2009, respectively.
Holders may put their notes to us at their option on any day prior to the close of business on the scheduled trading day immediately preceding July 15, 2011 only under the following circumstances: (1) during the five business-day period after any five consecutive trading-day period (the “measurement period”) in which the trading price per note for each day of that measurement period was less than 98% of the product of the last reported sale price of our Class A common stock and the put value rate (as defined) on each such day; (2) during any fiscal quarter after the fiscal quarter ending January 31, 2007, if the last reported sale price of our Class A common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately

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preceding fiscal quarter exceeds 130% of the applicable put value price in effect on the last trading day of the immediately preceding fiscal quarter; or (3) upon the occurrence of specified corporate events as set forth in the applicable indenture. On and after July 15, 2011 until the close of business on the scheduled trading day immediately preceding the maturity date, holders may put their notes to us at any time, regardless of the foregoing circumstances. In addition, upon a designated event, as defined, holders may require us to purchase for cash all or a portion of their notes for 100% of the principal amount of the notes plus accrued and unpaid interest, if any, as set forth in the applicable indenture. At October 31, 2009, none of the aforementioned circumstances have been met.
If a note is put to us, a holder would receive (i) cash equal to the lesser of the principal amount of the note or the put value and (ii) to the extent the put value exceeds the principal amount of the note, shares of our Class A common stock, cash, or a combination of Class A common stock and cash, at our option. The initial put value rate was 15.0631 shares of Class A common stock per $1,000 principal amount of notes (equivalent to a put value price of $66.39 per share of Class A common stock). The put value rate will be subject to adjustment in some events but will not be adjusted for accrued interest. In addition, if a “fundamental change,” as defined, occurs prior to the maturity date, we will in some cases increase the put value rate for a holder that elects to put their notes.
Concurrent with the issuance of the notes, we purchased a call option on our Class A common stock in a private transaction. The purchased call option allows us to receive shares of our Class A common stock and/or cash from counterparties equal to the amounts of Class A common stock and/or cash related to the excess put value that we would pay to the holders of the notes if put to us. These purchased call options will terminate upon the earlier of the maturity date of the notes or the first day all of the notes are no longer outstanding due to a put or otherwise. In a separate transaction, we sold warrants to issue shares of our Class A common stock at an exercise price of $74.35 per share in a private transaction. If the average price of our Class A common stock during a defined period ending on or about the respective settlement dates exceeds the exercise price of the warrants, the warrants will be settled in shares of our Class A common stock.
The 2011 Notes are our only senior notes that qualify as convertible debt instruments that may be settled in cash upon conversion, including partial cash settlement (see the “Retrospective Adoption of Accounting Guidance for Convertible Debt Instruments” section of the MD&A). The carrying amounts of our debt and equity balances related to the 2011 Notes as of October 31 and January 31, 2009 are as follows:
                 
    October 31, 2009     January 31, 2009  
    (in thousands)  
 
               
Carrying amount of the equity component
   $ 16,769     $ 45,885  
     
 
               
Outstanding principal amount of the puttable equity-linked senior notes
   $ 105,067     $ 272,500  
Unamortized discount
    (6,911 )     (24,346 )
     
Net carrying amount of the puttable equity-linked senior notes
   $ 98,156     $ 248,154  
     
The unamortized discount will be amortized as additional interest expense through October 15, 2011. The effective interest rate for the liability component of the puttable equity-linked senior notes was 7.51% for both the three and nine months ended October 31, 2009 and 2008. We recorded non-cash interest expense of $1,705,000 and $6,020,000 for the three and nine months ended October 31, 2009, respectively, and $2,239,000 and $6,672,000 for the three and nine months ended October 31, 2008, respectively. We recorded contractual interest expense of $2,082,000 and $7,021,000 for the three and nine months ended October 31, 2009, respectively, and $2,571,000 and $7,782,000 for the three and nine months ended October 31, 2008, respectively.
Puttable Equity-Linked Senior Notes due 2014
On October 7, 2009, we issued $167,433,000 of 3.625% puttable equity-linked senior notes due October 15, 2014 (“2014 Notes”) to certain holders in exchange for $167,433,000 of 2011 Notes discussed above. Concurrent with the exchange of 2011 Notes for the 2014 Notes, we issued an additional $32,567,000 of 2014 Notes in a private placement, net of a 5% discount. Interest on the 2014 Notes is payable semi-annually in arrears on April 15 and October 15, beginning April 15, 2010. Net proceeds from the exchange and additional issuance transaction, net of discounts and estimated offering expenses, was $29,764,000.
Holders may put their notes to us at any time prior to the earlier of (i) stated maturity or (ii) the Put Termination Date, as defined below. Upon a put, a note holder would receive 68.7758 shares of our Class A common stock per $1,000 principal amount of notes, based on a Put Value Price of $14.54 per share of Class A common stock, subject to adjustment. The amount payable upon a put of the notes is only payable in shares of our Class A common stock, except for cash paid in lieu of fractional shares. If the Daily Volume Weighted Average Price of the Class A common stock has equaled or exceeded 130% of the Put Value Price then in effect for at least 20 trading days in any 30 trading day period, we may, at our option, elect to terminate the rights of the holders to put their notes to us. If elected, we are required to issue a Put Termination Notice that shall designate an effective date on which the holders termination put rights will be terminated, which shall be a date at least 20 days after the mailing of such Put Termination Notice (the “Put Termination Date”). Holders electing to put their notes after the mailing of a Put Termination Notice shall receive a Coupon Make-Whole Payment in an amount equal to the remaining scheduled interest payments attributable to such notes from the last applicable interest payment date through and including October 15, 2013.

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Senior Notes due 2015
On May 19, 2003, we issued $300,000,000 of 7.625% senior notes due June 1, 2015 in a public offering. Accrued interest is payable semi-annually on December 1 and June 1. These senior notes may be redeemed by us, in whole or in part, at any time on or after June 1, 2008 at an initial redemption price of 103.813% that is systematically reduced to 100% through June 1, 2011. As of June 1, 2009, the redemption price was reduced to 102.542%.
Convertible Senior Notes due 2016
On October 26, 2009, we issued $200,000,000 of 5.00% convertible senior notes due October 15, 2016 in a private placement. The notes were issued at par and accrued interest is payable semi-annually on April 15 and October 15, beginning April 15, 2010. Net proceeds from the issuance, net of the cost of the convertible note hedge transaction described below and estimated offering costs, was $177,262,000.
Holders may convert their notes at their option at any time prior to the close of business on the second scheduled trading day immediately preceding the maturity date. Upon conversion, a note holder would receive 71.8894 shares of our Class A common stock per $1,000 principal amount of notes, based on a put value price of approximately $13.91 per share of Class A common stock, subject to adjustment. The amount payable upon a conversion of the notes is only payable in shares of our Class A common stock, except for cash paid in lieu of fractional shares.
In connection with the issuance of the notes, we entered into a convertible note hedge transaction. The convertible note hedge transaction is intended to reduce, subject to a limit, the potential dilution with respect to our Class A common stock upon conversion of the notes. The net effect of the convertible note hedge transaction, from our perspective, is to approximate an effective conversion price of $16.37 per share. The terms of the Notes are not affected by the convertible note hedge transaction. The convertible note hedge transaction, which cost $15,900,000 ($9,734,000 net of the related tax benefit), was recorded as a reduction of shareholders’ equity through additional paid in capital.
Senior Notes due 2017
On January 25, 2005, we issued $150,000,000 of 6.500% senior notes due February 1, 2017 in a public offering. Accrued interest is payable semi-annually on February 1 and August 1. These senior notes may be redeemed by us, in whole or in part, at any time on or after February 1, 2010 at a redemption price of 103.250% beginning February 1, 2010 and systematically reduced to 100% through February 1, 2013.
Senior Notes due 2034
On February 10, 2004, we issued $100,000,000 of 7.375% senior notes due February 1, 2034 in a public offering. Accrued interest is payable quarterly on February 1, May 1, August 1, and November 1. These senior notes may be redeemed by us, in whole or in part, at any time at a redemption price of 100% of the principal amount plus accrued interest.
All of our senior notes are unsecured senior obligations and rank equally with all existing and future unsecured indebtedness; however, they are effectively subordinated to all existing and future secured indebtedness and other liabilities of our subsidiaries to the extent of the value of the collateral securing such other debt, including the bank revolving credit facility. The indenture governing certain of the senior notes contain covenants providing, among other things, limitations on incurring additional debt and payment of dividends.
Subordinated Debt
In November 2000, we issued $20,400,000 of 8.25% redevelopment bonds due September 15, 2010 in a private placement, with semi-annual interest payments due on March 15 and September 15. We entered into a total rate of return swap (“TRS”) for the benefit of these bonds that was set to expire on September 15, 2009. Under the TRS, we received a rate of 8.25% and paid the Securities Industry and Financial Markets Association (“SIFMA”) rate plus a spread. The TRS, accounted for as a derivative, was required to be marked to fair value at the end of each reporting period. As stated in the “Sensitivity Analysis to Changes in Interest Rates” section of the MD&A, any fluctuation in the value of the TRS would be offset by the fluctuation in the value of the underlying borrowings. At January 31, 2009, the fair value of the TRS was $(1,490,000), recorded in accounts payable and accrued expenses; therefore, the fair value of the bonds was reduced by the same amount to $18,910,000. On July 13, 2009, the TRS contract was terminated and subsequently, a consolidated wholly-owned subsidiary of ours purchased the redevelopment bonds at par which effectively extinguished the subordinated debt.

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In May 2003, we purchased $29,000,000 of subordinate tax revenue bonds that were contemporaneously transferred to a custodian, which in turn issued custodial receipts that represent ownership in the bonds to unrelated third parties. The bonds bear a fixed interest rate of 7.875%. We evaluated the transfer pursuant to the accounting guidance on accounting for transfers and servicing of financial assets and extinguishment of liabilities and have determined that the transfer does not qualify for sale accounting treatment principally because we have guaranteed the payment of principal and interest in the unlikely event that there is insufficient tax revenue to support the bonds when the custodial receipts are subject to mandatory tender on December 1, 2013. As such, we are the primary beneficiary of this variable interest entity and the book value (which approximated amortized costs) of the bonds was recorded as a collateralized borrowing reported as senior and subordinated debt and as held-to-maturity securities reported as other assets in the Consolidated Balance Sheets.
Financing Arrangements
Collateralized Borrowings
On July 13, 2005, the Park Creek Metropolitan District (the “District”) issued $65,000,000 Senior Subordinate Limited Property Tax Supported Revenue Refunding and Improvement Bonds, Series 2005 (the “Senior Subordinate Bonds”) and Stapleton Land II, LLC, a consolidated subsidiary, entered into an agreement whereby it will receive a 1% fee on the Senior Subordinate Bonds in exchange for providing certain credit enhancement. The counterparty to the credit enhancement arrangement also owns the underlying Senior Subordinate Bonds and can exercise its rights requiring payment from Stapleton Land II, LLC upon an event of default of the Senior Subordinate Bonds, a refunding of the Senior Subordinate Bonds, or failure of Stapleton Land II, LLC to post required collateral. The Senior Subordinate Bonds were refinanced on April 16, 2009 with proceeds from the issuance of $86,000,000 of Park Creek Metropolitan District Senior Limited Property Tax Supported Revenue Refunding and Improvement Bonds, Series 2009. The credit enhancement arrangement expired with the refinancing of the Senior Subordinate Bonds on April 16, 2009. We recorded $-0- and $132,000 of interest income related to the credit enhancement arrangement in the Consolidated Statements of Operations for the three and nine months ended October 31, 2009, respectively, and $164,000 and $488,000 for the three and nine months ended October 31, 2008, respectively.
On August 16, 2005, the District issued $58,000,000 Junior Subordinated Limited Property Tax Supported Revenue Bonds, Series 2005 (the “Junior Subordinated Bonds”). The Junior Subordinated Bonds initially were to pay a variable rate of interest. Upon issuance, the Junior Subordinated Bonds were purchased by a third party and the sales proceeds were deposited with a trustee pursuant to the terms of the Series 2005 Investment Agreement. Under the terms of the Series 2005 Investment Agreement, after March 1, 2006, the District may elect to withdraw funds from the trustee for reimbursement for certain qualified infrastructure and interest expenditures (“Qualifying Expenditures”). In the event that funds from the trustee are used for Qualifying Expenditures, a corresponding amount of the Junior Subordinated Bonds converts to an 8.5% fixed rate and matures in December 2037 (“Converted Bonds”). On August 16, 2005, Stapleton Land, LLC, a consolidated subsidiary, entered into a Forward Delivery Placement Agreement (“FDA”) whereby Stapleton Land, LLC was entitled and obligated to purchase the converted fixed rate Junior Subordinated Bonds through June 2, 2008. The District withdrew $58,000,000 of funds from the trustee for reimbursement of certain Qualifying Expenditures by June 2, 2008 and the Junior Subordinated Bonds became Converted Bonds. The Converted Bonds were acquired by Stapleton Land, LLC under the terms of the FDA by June 8, 2008. Stapleton Land, LLC immediately transferred the Converted Bonds to investment banks and we simultaneously entered into a TRS with a notional amount of $58,000,000. We receive a fixed rate of 8.5% and pay the SIFMA rate plus a spread on the TRS related to the Converted Bonds. We determined that the sale of the Converted Bonds to the investment banks and simultaneous execution of the TRS did not surrender control; therefore, the Converted Bonds have been recorded as a secured borrowing in the Consolidated Balance Sheets. During the year ended January 31, 2009, one of our consolidated subsidiaries purchased $10,000,000 of the Converted Bonds from one of the investment banks. Simultaneous with the purchase, a $10,000,000 TRS contract was terminated and the corresponding amount of the secured borrowing was removed from the Consolidated Balance Sheets. On April 16, 2009, an additional $5,000,000 of the Converted Bonds was purchased by one of our consolidated subsidiaries, and a corresponding amount of a related TRS was terminated and the corresponding secured borrowing was removed from the Consolidated Balance Sheets. The fair value of the Converted Bonds recorded in other assets in the Consolidated Balance Sheets was $58,000,000 at both October 31 and January 31, 2009. The outstanding TRS contracts on the $43,000,000 and $48,000,000 of secured borrowings related to the Converted Bonds at October 31 and January 31, 2009, respectively, were supported by collateral consisting primarily of certain notes receivable owned by us aggregating $33,035,000. We recorded net interest income of $499,000 and $1,819,000 related to the TRS in the Consolidated Statements of Operations for the three and nine months ended October 31, 2009, respectively, and $640,000 and $2,376,000 for the three and nine months ended October 31, 2008, respectively.
Other Structured Financing Arrangements
In May 2004, Lehman Brothers, Inc. (“Lehman”) purchased $200,000,000 in tax increment revenue bonds issued by DURA, with a fixed-rate coupon of 8.0% and maturity date of October 1, 2024, which were used to fund the infrastructure costs associated with phase II of the Stapleton development project. The DURA bonds were transferred to a trust that issued floating rate trust certificates. Stapleton Land, LLC entered into an agreement with Lehman to purchase the DURA bonds from the trust if they are not repurchased or remarketed between June 1, 2007 and June 1, 2009. Stapleton Land, LLC is entitled to receive a fee upon removal of the DURA

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bonds from the trust equal to the 8.0% coupon rate, less the SIFMA index, less all fees and expenses due to Lehman (collectively, the “Fee”). The Fee was accounted for as a derivative with changes in fair value recorded through earnings. On July 1, 2008, $100,000,000 of the DURA bonds were remarketed. On July 15, 2008, Stapleton Land, LLC was paid $13,838,000 of the fee, which represented the fee earned on the remarketed DURA bonds.
During the three months ended October 31, 2008, Lehman filed for bankruptcy and the remaining $100,000,000 of DURA bonds were transferred to a creditor of Lehman. As a result, we reassessed the collectability of the Fee and decreased the fair value of the Fee to $-0-, resulting in an increase to operating expenses in our Consolidated Statements of Operations of $13,816,000 for the three months ended October 31, 2008. Stapleton Land, LLC informed Lehman that it determined that a “Special Member Termination Event” had occurred because Stapleton Land, LLC (a) fulfilled all of its bond purchase obligations under the transaction documents by purchasing or causing to be redeemed or repurchased all of the bonds held by Lehman and (b) fulfilled all other obligations in accordance with the transaction documents. Therefore, Stapleton Land, LLC has no other financing obligations with Lehman.
We recorded interest income of $-0-, related to the change in fair value of the Fee in our Consolidated Statements of Operations for both the three and nine months ended October 31, 2009 and $-0- and $4,546,000 for the three and nine months ended October 31, 2008, respectively.
Stapleton Land, LLC has committed to fund $24,500,000 to the District to be used for certain infrastructure projects and has funded $16,491,000 of this commitment as of October 31, 2009. In addition, on June 23, 2009, another consolidated subsidiary of ours entered into an agreement with the City of Denver and certain of its entities to fund $10,000,000 to be used to fund additional infrastructure projects and has funded $824,000 of this commitment as of October 31, 2009.
Mortgage Financings
We use taxable and tax-exempt nonrecourse debt for our real estate projects. For those real estate projects financed with taxable debt, we generally seek long-term, fixed-rate financing for those operating projects whose loans mature within the next 12 months or are projected to open and achieve stabilized operations during that same time frame. However, due to the limited availability of long-term fixed rate mortgage debt based upon current market conditions, we are attempting to extend maturities with existing lenders at current market terms. For real estate projects financed with tax-exempt debt, we generally utilize variable-rate debt. For construction loans, we generally pursue variable-rate financings with maturities ranging from two to five years.
We are actively working to refinance and/or extend the maturities of the nonrecourse debt that is coming due in the next 24 months. During the nine months ended October 31, 2009, we completed the following financings:
         
Purpose of Financing   Amount  
    (in thousands)  
 
Refinancings
   $ 277,841  
Loan extensions/additional fundings
    1,095,701  
 
     
 
   $ 1,373,542  
 
     
Interest Rate Exposure
At October 31, 2009, the composition of nonrecourse mortgage debt was as follows:
                                         
                                    Total  
    Operating     Development     Land             Weighted  
    Properties     Projects     Projects     Total     Average Rate  
    (dollars in thousands)  
 
Fixed
   $ 4,019,535     $ -     $ 10,041     $ 4,029,576       6.06%
Variable (1)
                                       
Taxable
    1,428,562       1,028,706       13,392       2,470,660       4.58%
Tax-Exempt
    584,727       335,660       43,000       963,387       1.94%
             
 
   $ 6,032,824     $ 1,364,366 (2)   $ 66,433     $ 7,463,623       5.04%
             
 
Total commitment from lenders
           $ 1,997,553      $ 74,320                  
 
                                   
 
(1)   Taxable variable-rate debt of $2,470,660 and tax-exempt variable-rate debt of $963,387 as of October 31, 2009 is protected with swaps and caps described in the tables below.
(2)   Proceeds from outstanding debt of $137,349 described above are recorded as restricted cash in our Consolidated Balance Sheets. For bonds issued in conjunction with development, the full amount of the bonds is issued at the beginning of construction and must remain in escrow until costs are incurred.

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To mitigate short-term variable interest rate risk, we have purchased interest rate hedges for our variable-rate debt as follows:
Taxable (Priced off of LIBOR Index)
                                 
    Caps     Swaps(1)  
    Notional     Average Base     Notional     Average Base  
Period Covered   Amount     Rate     Amount     Rate  
    (dollars in thousands)  
 
                               
11/01/09-02/01/10 (2)
   $   1,110,439       4.81 %    $   1,161,746       4.94 %
02/01/10-02/01/11
    1,110,116       4.73       1,101,406       4.38  
02/01/11-02/01/12
    16,192       6.50       799,981       5.41  
02/01/12-02/01/13
    476,100       5.50       729,110       5.37  
02/01/13-02/01/14
    476,100       5.50       685,000       5.43  
02/01/14-09/01/17
    -       -       640,000       5.50  
 
(1)   Excludes the forward swap ($120,000,000 notional) discussed below.
(2)   These LIBOR-based hedges as of November 1, 2009 protect the debt currently outstanding as well as the anticipated increase in debt outstanding for projects under development or anticipated to be under development during the year ending January 31, 2010.
Tax-Exempt (Priced off of SIFMA Index)
                                 
    Caps     Swap  
    Notional     Average Base     Notional     Average Base  
Period Covered   Amount     Rate     Amount     Rate  
    (dollars in thousands)  
 
                               
11/01/09-02/01/10
   $    175,025       5.68 %    $    57,000       3.21 %
02/01/10-02/01/11
    175,025       5.84       57,000       3.21  
02/01/11-02/01/12
    131,915       5.83       57,000       3.21  
02/01/12-02/01/13
    12,715       6.00       57,000       3.21  
The tax-exempt caps and swap expressed above mainly represent protection that was purchased in conjunction with lender hedging requirements that require the borrower to protect against significant fluctuations in interest rates. Outside of such requirements, we generally do not hedge tax-exempt debt because, since 1990, the base rate of this type of financing has averaged 2.86% and has never exceeded 8.00%.
Forward Swaps
We purchased the interest rate hedges summarized in the tables above to mitigate variable interest rate risk. We have entered into derivative contracts that are intended to economically hedge certain risks of ours, even though the contracts do not qualify for hedge accounting or we have elected not to apply hedge accounting under the accounting guidance. In all situations in which hedge accounting is discontinued, or not elected, and the derivative remains outstanding, we will report the derivative at its fair value in our Consolidated Balance Sheets, immediately recognizing changes in the fair value in our Consolidated Statements of Operations.
We have entered into forward swaps to protect ourselves against fluctuations in the swap rate at terms ranging between five to ten years associated with forecasted fixed rate borrowings. At the time we secure and lock an interest rate on an anticipated financing, we intend to simultaneously terminate the forward swap associated with that financing. At October 31, 2009, we have two forward swaps, with notional amounts of $69,325,000 and $120,000,000, respectively, that do not qualify as cash flow hedges under the accounting guidance. As such, the change in fair value of these swaps is marked to market through earnings on a quarterly basis. Related to these forward swaps, we recorded $4,344,000 and $(2,800,000) for the three and nine months ended October 31, 2009, respectively, and $2,058,000 and $(75,000) for the three and nine months ended October 31, 2008, respectively, as an increase (reduction) of interest expense in our Consolidated Statements of Operations. During the year ended January 31, 2009, we purchased an interest rate floor in order to mitigate the interest rate risk on one of the forward swaps ($120,000,000 notional) should interest rates fall below a certain level.

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Sensitivity Analysis to Changes in Interest Rates
Including the effect of the protection provided by the interest rate swaps, caps and long-term contracts in place as of October 31, 2009, a 100 basis point increase in taxable interest rates (including properties accounted for under the equity method, corporate debt and the effect of interest rate floors) would increase the annual pre-tax interest cost for the next 12 months of our variable-rate debt by approximately $10,705,000 at October 31, 2009. Although tax-exempt rates generally move in an amount that is smaller than corresponding changes in taxable interest rates, a 100 basis point increase in tax-exempt rates (including properties accounted for under the equity method) would increase the annual pre-tax interest cost for the next 12 months of our tax-exempt variable-rate debt by approximately $10,315,000 at October 31, 2009. This analysis includes a portion of our taxable and tax-exempt variable-rate debt related to construction loans for which the interest expense is capitalized.
From time to time, we and/or certain of our joint ventures (the “Joint Ventures”) enter into TRS on various tax-exempt fixed-rate borrowings generally held by us and/or within the Joint Ventures. The TRS convert these borrowings from a fixed rate to a variable rate and provide an efficient financing product to lower the cost of capital. In exchange for a fixed rate, the TRS require that we and/or the Joint Ventures pay a variable rate, generally equivalent to the SIFMA rate plus a spread. At October 31, 2009, the SIFMA rate is 0.26%. Additionally, we and/or the Joint Ventures have guaranteed the fair value of the underlying borrowing. Any fluctuation in the value of the TRS would be offset by the fluctuation in the value of the underlying borrowing, resulting in no financial impact to us and/or the Joint Ventures. At October 31, 2009, the aggregate notional amount of TRS that are designated as fair value hedging instruments under the accounting guidance on derivatives and hedging activities, in which we and/or the consolidated Joint Ventures have an interest, is $482,940,000. We believe the economic return and related risk associated with a TRS is generally comparable to that of nonrecourse variable-rate mortgage debt. The underlying TRS borrowings are subject to a fair value adjustment.
Cash Flows
Operating Activities
Net cash provided by operating activities was $260,024,000 and $239,237,000 (as adjusted) for the nine months ended October 31, 2009 and 2008, respectively. The net increase in cash provided by operating activities in the nine months ended October 31, 2009 compared to the nine months ended October 31, 2008 of $20,787,000 is the result of the following (in thousands):
         
Decrease in rents and other revenues received
   $    (11,623 )
Increase in interest and other income received
    38,083  
Decrease in cash distributions from unconsolidated entities
    (14,684 )
Decrease in proceeds from land sales - Land Development Group
    (12,038 )
Increase in proceeds from land sales - Commercial Group
    4,364  
Decrease in land development expenditures paid
    26,626  
Decrease in operating expenditures paid
    1,473  
Increase in termination costs paid
    (7,535 )
Increase in restricted cash used for operating purposes
    (12,795 )
Decrease in interest paid
    8,916  
 
   
 
       
Net increase in cash provided by operating activities
   $    20,787  
 
   

67


 

Investing Activities
Net cash used in investing activities was $874,495,000 and $1,039,081,000 for the nine months ended October 31, 2009 and 2008, respectively. Net cash used in investing activities consisted of the following:
                 
    Nine Months Ended October 31,  
            2008  
    2009     (As Adjusted)  
    (in thousands)  
 
               
Capital expenditures, including real estate acquisitions
   $ (725,101 )    $ (828,659 )
 
Payment of lease procurement costs
    (8,519 )     (22,728 )
 
Decrease (increase) in other assets
    5,148       (37,533 )
 
(Increase) decrease in restricted cash used for investing purposes:
               
Beekman, a mixed-use residential project under construction in Manhattan, New York
    (66,358 )     (71,605 )
80 DeKalb Avenue, a residential project under construction in Brooklyn, New York
    (20,536 )     (35,048 )
Promenade in Temecula, a regional mall in Temecula, California
    (10,789 )     -  
Higbee Building, an office building in Cleveland, Ohio
    (8,466 )     -  
Two MetroTech Center, an office building in Brooklyn, New York
    (4,403 )     -  
Easthaven at the Village, an apartment community in Beachwood, Ohio
    (2,045 )     -  
Collateral returned (posted) for a TRS on Sterling Glen of Rye Brook, a supported-living community in Rye Brook, New York
    12,500       (12,500 )
Village at Gulfstream Park, a retail project under construction in Hallandale Beach, Florida
    8,661       -  
One MetroTech Center, an office building in Brooklyn, New York
    7,068       (8,791 )
Promenade Bolingbrook, a regional mall in Bolingbrook, Illinois
    4,355       (5,040 )
New York Times, an office building in Manhattan, New York
    3,081       11,705  
250 Huron, an office building in Cleveland, Ohio
    583       (3,929 )
Sky55, an apartment complex in Chicago, Illinois
    -       4,692  
Proceeds placed in escrow upon sale of Sterling Glen of Lynbrook in Lynbrook, New York, released in Q4 2008
    -       (6,349 )
Other
    (5,073 )</