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EGP > SEC Filings for EGP > Form 10-Q on 22-Apr-2013All Recent SEC Filings

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Form 10-Q for EASTGROUP PROPERTIES INC


22-Apr-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.

OVERVIEW
EastGroup's goal is to maximize shareholder value by being the leading provider in its markets of functional, flexible and quality business distribution space for location sensitive tenants primarily in the 5,000 to 50,000 square foot range. The Company acquires, develops and operates distribution facilities, the majority of which are clustered around major transportation features in supply constrained submarkets in major Sunbelt regions. The Company's core markets are in the states of Florida, Texas, Arizona, California and North Carolina.

The Company believes its current operating cash flow and lines of credit provide the capacity to fund the operations of the Company for the remainder of 2013. The Company also believes it can issue common and/or preferred equity and obtain financing from insurance companies and financial institutions. The continuous equity program provided net proceeds to the Company of $13.8 million in the first three months of 2013, as described in Liquidity and Capital Resources. Also in the first quarter, the Company entered into an agreement in principle with an insurance company under which the Company expects to issue $100 million of senior unsecured notes at a fixed interest rate of 3.8%. This transaction is further discussed in Liquidity and Capital Resources.

The Company's primary revenue is rental income; as such, EastGroup's primary challenge is leasing space. During the three months ended March 31, 2013, leases expired on 1,980,000 square feet (6.4% of EastGroup's total square footage of 30,975,000), and the Company was successful in renewing or re-leasing 77% of the expiring square feet. In addition, EastGroup leased 315,000 square feet of other vacant space during this period. During the first three months of 2013, average rental rates on new and renewal leases decreased by 1.1%. Property net operating income (PNOI) from same properties, defined as operating properties owned during the entire current period and prior year reporting period, decreased 0.4% for the quarter ended March 31, 2013, as compared to the same quarter in 2012.

EastGroup's total leased percentage was 94.4% at March 31, 2013, compared to 94.5% at March 31, 2012. Leases scheduled to expire for the remainder of 2013 were 10.7% of the portfolio on a square foot basis at March 31, 2013, and this figure was reduced to 9.5% as of April 19, 2013.

The Company generates new sources of leasing revenue through its acquisition and development programs. EastGroup continues to see targeted development as a contributor to the Company's long-term growth. The Company mitigates risks associated with development through a Board-approved maximum level of land held for development and by adjusting development start dates according to leasing activity. During the first three months of 2013, the Company began construction of five development projects containing 377,000 square feet in Houston, San Antonio, Orlando and Phoenix. EastGroup also transferred three properties (324,000 square feet) in Houston and Orlando from its development program to real estate properties with costs of $20.7 million at the date of transfer. As of March 31, 2013, EastGroup's development program consisted of 16 projects (1,108,000 square feet) located in Houston, San Antonio, Orlando and Phoenix. The projected total cost for the development projects, which were collectively 48% leased as of April 19, 2013, is $84.8 million, of which $35.5 million remained to be invested as of March 31, 2013.

Typically, the Company initially funds its acquisition and development programs through its $250 million lines of credit (as discussed in Liquidity and Capital Resources). As market conditions permit, EastGroup issues equity and/or employs fixed-rate debt to replace short-term bank borrowings. In prior years, EastGroup primarily obtained secured debt. In January 2013, Fitch affirmed the Company's credit rating of BBB, and Moody's assigned the Company a credit rating of Baa2. The Company intends to obtain primarily unsecured fixed rate debt in the future. The Company may also access the public debt market in the future as a means to raise capital.

EastGroup has one reportable segment - industrial properties. These properties are primarily located in major Sunbelt regions of the United States, have similar economic characteristics and also meet the other criteria permitting the properties to be aggregated into one reportable segment. The Company's chief decision makers use two primary measures of operating results in making decisions: (1) property net operating income (PNOI), defined as income from real estate operations less property operating expenses (excluding interest expense, depreciation expense on buildings and improvements, and amortization expense on capitalized leasing costs and in-place lease intangibles), and (2) funds from operations attributable to common stockholders (FFO), defined as net income
(loss) attributable to common stockholders computed in accordance with U.S. generally accepted accounting principles (GAAP), excluding gains or losses from sales of depreciable real estate property and impairment losses, plus real estate related depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. The Company calculates FFO based on the National Association of Real Estate Investment Trusts' (NAREIT) definition.

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PNOI is a supplemental industry reporting measurement used to evaluate the performance of the Company's real estate investments. The Company believes the exclusion of depreciation and amortization in the industry's calculation of PNOI provides a supplemental indicator of the properties' performance since real estate values have historically risen or fallen with market conditions. PNOI as calculated by the Company may not be comparable to similarly titled but differently calculated measures for other real estate investment trusts (REITs). The major factors influencing PNOI are occupancy levels, acquisitions and sales, development properties that achieve stabilized operations, rental rate increases or decreases, and the recoverability of operating expenses. The Company's success depends largely upon its ability to lease space and to recover from tenants the operating costs associated with those leases.

PNOI is comprised of Income from real estate operations, less Expenses from real estate operations. PNOI was calculated as follows for the three months ended March 31, 2013 and 2012.

                                         Three Months Ended
                                              March 31,
                                          2013         2012
                                          (In thousands)
Income from real estate operations     $  48,228      46,383
Expenses from real estate operations     (13,562 )   (12,997 )
PROPERTY NET OPERATING INCOME          $  34,666      33,386

Income from real estate operations is comprised of rental income, expense reimbursement pass-through income and other real estate income including lease termination fees. Expenses from real estate operations is comprised of property taxes, insurance, utilities, repair and maintenance expenses, management fees, other operating costs and bad debt expense. Generally, the Company's most significant operating expenses are property taxes and insurance. Tenant leases may be net leases in which the total operating expenses are recoverable, modified gross leases in which some of the operating expenses are recoverable, or gross leases in which no expenses are recoverable (gross leases represent only a small portion of the Company's total leases). Increases in property operating expenses are fully recoverable under net leases and recoverable to a high degree under modified gross leases. Modified gross leases often include base year amounts and expense increases over these amounts are recoverable. The Company's exposure to property operating expenses is primarily due to vacancies and leases for occupied space that limit the amount of expenses that can be recovered.

The following table presents reconciliations of Net Income to PNOI for the three months ended March 31, 2013 and 2012.

                                                             Three Months Ended
                                                                  March 31,
                                                               2013         2012
                                                              (In thousands)
NET INCOME                                                 $    7,308      5,522
Equity in earnings of unconsolidated investment                   (91 )      (89 )
Interest income                                                  (133 )      (82 )
Other income                                                      (47 )      (14 )
Income from discontinued operations                                 -       (261 )
Depreciation and amortization from continuing operations       15,615     15,734
Interest expense                                                8,621      9,441
General and administrative expense                              3,364      3,116
Acquisition costs                                                  29         19
PROPERTY NET OPERATING INCOME                              $   34,666     33,386

The Company believes FFO is a meaningful supplemental measure of operating performance for equity REITs. The Company believes excluding depreciation and amortization in the calculation of FFO is appropriate since real estate values have historically increased or decreased based on market conditions. FFO is not considered as an alternative to net income (determined in accordance with GAAP) as an indication of the Company's financial performance, nor is it a measure of the Company's liquidity or indicative of funds available to provide for the Company's cash needs, including its ability to make distributions. In addition, FFO, as reported by the Company, may not be comparable to FFO reported by other REITs that do not define the term in accordance with the current NAREIT definition. The Company's key drivers affecting FFO are changes in PNOI (as discussed above), interest rates, the amount of leverage the Company employs and general and administrative expense. The following table presents

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reconciliations of Net Income Attributable to EastGroup Properties, Inc. Common Stockholders to FFO Attributable to Common Stockholders for the three months ended March 31, 2013 and 2012.

                                                                       Three Months Ended
                                                                           March 31,
                                                                     2013               2012
                                                            (In thousands, except per share data)
NET INCOME ATTRIBUTABLE TO EASTGROUP PROPERTIES, INC.
COMMON STOCKHOLDERS                                            $       7,154              5,403
Depreciation and amortization from continuing operations              15,615             15,734
Depreciation and amortization from discontinued operations                 -                212
Depreciation from unconsolidated investment                               33                 33
Depreciation and amortization from noncontrolling interest               (62 )              (61 )
FUNDS FROM OPERATIONS (FFO) ATTRIBUTABLE TO COMMON
STOCKHOLDERS                                                   $      22,740             21,321
Net income attributable to common stockholders per diluted
share                                                          $        0.24               0.19
Funds from operations (FFO) attributable to common
stockholders per diluted share                                 $        0.76               0.77
Diluted shares for earnings per share and funds from
operations                                                            29,890             27,718

The Company analyzes the following performance trends in evaluating the progress of the Company:

The FFO change per share represents the increase or decrease in FFO per share from the current period compared to the same period in the prior year. For the three months ended March 31, 2013, FFO was $0.76 per share compared with $0.77 per share for the same period of 2012, a decrease of 1.3% per share.

For the three months ended March 31, 2013, PNOI increased by $1,280,000, or 3.8%, compared to the same period in 2012. PNOI increased $870,000 from 2012 acquisitions and $571,000 from newly developed properties, offset by a decrease of $120,000 from same property operations.

The same property net operating income change represents the PNOI increase or decrease for the same operating properties owned during the entire current period and prior year reporting period. PNOI from same properties decreased 0.4% for the three months ended March 31, 2013, compared to the same period in 2012.

Same property average occupancy represents the average month-end percentage of leased square footage for which the lease term has commenced as compared to the total leasable square footage for the same operating properties owned during the entire current period and prior year reporting period. Same property average occupancy for the three months ended March 31, 2013, was 93.2% compared to 93.9% for the same period of 2012.

The same property average rental rate represents the average annual rental rates of leases in place for the same operating properties owned during the entire current period and prior year reporting period. The same property average rental rate was $5.16 per square foot for the three months ended March 31, 2013, compared to $5.20 per square foot for the same period of 2012.

Occupancy is the percentage of leased square footage for which the lease term has commenced as compared to the total leasable square footage as of the close of the reporting period. Occupancy at March 31, 2013, was 93.6%. Quarter-end occupancy ranged from 93.1% to 94.6% over the period from March 31, 2012 to March 31, 2013.

Rental rate change represents the rental rate increase or decrease on new and renewal leases compared to the prior leases on the same space. Rental rate decreases on new and renewal leases (5.9% of total square footage) averaged 1.1% for the first quarter of 2013.

Lease termination fee income for the three months ended March 31, 2013 was $427,000 compared to $170,000 for the same period of 2012. Bad debt expense for the three months ended March 31, 2013 was $47,000 compared to $223,000 for the same period last year.

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The Company's management considers the following accounting policies and estimates to be critical to the reported operations of the Company.

Real Estate Properties
The Company allocates the purchase price of acquired properties to net tangible and identified intangible assets based on their respective fair values. Goodwill is recorded when the purchase price exceeds the fair value of the assets and liabilities acquired. Factors considered by management in allocating the cost of the properties acquired include an estimate of carrying costs during the expected lease-up periods considering current market conditions and costs to execute similar leases. The allocation to tangible assets (land, building and improvements) is based upon management's determination of the value of the property as if it were vacant using discounted cash flow models. The purchase price is also allocated among the following categories of intangible assets: the above or below market component of in-place leases, the value of in-place leases, and the value of customer relationships. The value allocable to the above or below market component of an acquired in-place lease is determined based upon the present value (using a discount rate reflecting the risks associated with the acquired leases) of the difference between (i) the contractual amounts to be paid pursuant to the lease over its remaining term and
(ii) management's estimate of the amounts that would be paid using fair market rates over the remaining term of the lease. The amounts allocated to above and below market leases are included in Other Assets and Other Liabilities, respectively, on the Consolidated Balance Sheets and are amortized to rental income over the remaining terms of the respective leases. The total amount of intangible assets is further allocated to in-place lease values and customer relationship values based upon management's assessment of their respective values. These intangible assets are included in Other Assets on the Consolidated Balance Sheets and are amortized over the remaining term of the existing lease, or the anticipated life of the customer relationship, as applicable.

During the period in which a property is under development, costs associated with development (i.e., land, construction costs, interest expense, property taxes and other direct and indirect costs associated with development) are aggregated into the total capitalized costs of the property. Included in these costs are management's estimates for the portions of internal costs (primarily personnel costs) deemed directly or indirectly related to such development activities. The internal costs are allocated to specific development properties based on construction activity.

The Company reviews its real estate investments for impairment of value whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If any real estate investment is considered permanently impaired, a loss is recorded to reduce the carrying value of the property to its estimated fair value. Real estate assets to be sold are reported at the lower of the carrying amount or fair value less selling costs. The evaluation of real estate investments involves many subjective assumptions dependent upon future economic events that affect the ultimate value of the property. Currently, the Company's management knows of no impairment issues nor has it experienced any impairment issues in recent years. EastGroup currently has the intent and ability to hold its real estate investments and to hold its land inventory for future development. In the event of impairment, the property's basis would be reduced, and the impairment would be recognized as a current period charge on the Consolidated Statements of Income and Comprehensive Income.

Valuation of Receivables
The Company is subject to tenant defaults and bankruptcies that could affect the collection of outstanding receivables. In order to mitigate these risks, the Company performs credit reviews and analyses on prospective tenants before significant leases are executed and on existing tenants before properties are acquired. On a quarterly basis, the Company evaluates outstanding receivables and estimates the allowance for doubtful accounts. Management specifically analyzes aged receivables, customer credit-worthiness, historical bad debts and current economic trends when evaluating the adequacy of the allowance for doubtful accounts. The Company believes its allowance for doubtful accounts is adequate for its outstanding receivables for the periods presented. In the event the allowance for doubtful accounts is insufficient for an account that is subsequently written off, additional bad debt expense would be recognized as a current period charge on the Consolidated Statements of Income and Comprehensive Income.

Tax Status
EastGroup, a Maryland corporation, has qualified as a real estate investment trust under Sections 856-860 of the Internal Revenue Code and intends to continue to qualify as such. To maintain its status as a REIT, the Company is required to distribute at least 90% of its ordinary taxable income to its stockholders. If the Company has a capital gain, it has the option of (i) deferring recognition of the capital gain through a tax-deferred exchange, (ii) declaring and paying a capital gain dividend on any recognized net capital gain resulting in no corporate level tax, or (iii) retaining and paying corporate income tax on its net long-term capital gain, with shareholders reporting their proportional share of the undistributed long-term capital gain and receiving a credit or refund of their share of the tax paid by the Company. The Company distributed all of its 2012 taxable income to its stockholders and expects to distribute all of its taxable income in 2013. Accordingly, no significant provision for income taxes was necessary in 2012, nor is any significant income tax provision expected to be necessary for 2013.

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FINANCIAL CONDITION

EastGroup's assets were $1,363,655,000 at March 31, 2013, an increase of $9,553,000 from December 31, 2012. Liabilities increased $3,290,000 to $866,216,000, and equity increased $6,263,000 to $497,439,000 during the same period. The paragraphs that follow explain these changes in detail.

Assets

Real Estate Properties
Real Estate Properties increased $26,482,000 during the three months ended March 31, 2013, primarily due to capital improvements at the Company's properties and the transfer of three properties from Development, as detailed under Development below.

During the three months ended March 31, 2013, the Company made capital improvements of $4,960,000 on existing and acquired properties (included in the Capital Expenditures table under Results of Operations). Also, the Company incurred costs of $789,000 on development properties subsequent to transfer to Real Estate Properties; the Company records these expenditures as development costs on the Consolidated Statements of Cash Flows.

Development
EastGroup's investment in development at March 31, 2013 consisted of properties in lease-up and under construction of $49,310,000 and prospective development (primarily land) of $94,675,000. The Company's total investment in development at March 31, 2013 was $143,985,000 compared to $148,255,000 at December 31, 2012. Total capital invested for development during the first three months of 2013 was $17,254,000, which primarily consisted of costs of $16,579,000 for properties in lease-up, under construction and prospective development (primarily land) and costs of $789,000 on development properties subsequent to transfer to Real Estate Properties. The capitalized costs incurred on development properties subsequent to transfer to Real Estate Properties include capital improvements at the properties and do not include other capitalized costs associated with development (i.e., interest expense, property taxes and internal personnel costs).

The Company capitalized internal development costs of $1,069,000 and $712,000 for the three months ended March 31, 2013 and 2012, respectively. The increase in capitalized internal development costs in 2013 as compared to 2012 resulted from increased activity in the Company's development program in 2013.

The Company transferred three development properties to Real Estate Properties during the first three months of 2013 with a total investment of $20,735,000 as of the date of transfer.

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                                                            Costs Incurred
                                                                 For the Three    Cumulative                   Building
                                          Costs Transferred in   Months Ended       as of        Estimated    Completion
DEVELOPMENT                                     2013(1)            3/31/2013      3/31/2013     Total Costs      Date
                                                                   (In thousands)
                             Building
                               Size
                              (Square
LEASE-UP                       feet)
World Houston 31B, Houston,
TX                             35,000     $             -              75             3,026         3,900        04/12
Thousand Oaks 1, San
Antonio, TX                    36,000                   -             414             3,953         4,900        05/12
Thousand Oaks 2, San
Antonio, TX                    73,000                   -             473             5,282         5,600        05/12
Beltway Crossing X,
Houston, TX                    78,000                   -             107             3,923         4,800        06/12
Beltway Crossing XI,
Houston, TX                    87,000                   -             378             3,978         4,900        02/13
Total Lease-Up                309,000                   -           1,447            20,162        24,100
                                                                                                              Anticipated
                                                                                                               Building
                                                                                                              Completion
UNDER CONSTRUCTION                                                                                               Date
World Houston 34, Houston,
TX                             57,000                   -             315             2,990         3,900        04/13
World Houston 35, Houston,
TX                             45,000                   -             255             2,368         2,800        04/13
Ten West Crossing 1,
Houston, TX                    30,000                   -           1,495             3,237         3,800        05/13
Thousand Oaks 3, San
Antonio, TX                    66,000               1,232           1,479             2,711         4,600        07/13
Southridge X, Orlando, FL      71,000               1,979             890             2,869         5,100        08/13
Ten West Crossing 2,
Houston, TX                    46,000                 908           1,035             1,943         5,100        08/13
Ten West Crossing 3,
Houston, TX                    68,000                 693           1,434             2,127         4,800        08/13
World Houston 37, Houston,
TX                            101,000                   -           1,569             3,243         6,800        08/13
World Houston 36, Houston,
TX                             60,000                   -           1,065             2,502         5,900        09/13
World Houston 38, Houston,
TX                            129,000                   -             810             3,027         9,000        10/13
Chandler Freeways, Phoenix,
AZ                            126,000               1,811             320             2,131         8,900        10/13
Total Under Construction      799,000               6,623          10,667            29,148        60,700
                             Estimated
                             Building
                               Size
PROSPECTIVE DEVELOPMENT       (Square
(PRIMARILY LAND)               feet)
Phoenix, AZ                   404,000              (1,811 )            87             3,973        30,800
Tucson, AZ                     70,000                   -               -               417         4,900
Denver, CO                     84,000                   -              75               786         7,700
Fort Myers, FL                663,000                   -             108            17,754        48,100
Orlando, FL                 1,355,000              (1,979 )         1,580            26,201        88,000
Tampa, FL                     519,000                   -             153             6,298        30,800
. . .
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