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EGP > SEC Filings for EGP > Form 10-Q on 21-Oct-2013All Recent SEC Filings

Show all filings for EASTGROUP PROPERTIES INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for EASTGROUP PROPERTIES INC


21-Oct-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 next twelve months. 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 $33.5 million in the first nine months of 2013, as described in Liquidity and Capital Resources. Also, the Company closed the previously announced private placement issuance of $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 nine months ended September 30, 2013, leases expired on 4,836,000 square feet (15.0% of EastGroup's total square footage of 30,298,000), and the Company was successful in renewing or re-leasing 83% of the expiring square feet. In addition, EastGroup leased 1,584,000 square feet of other vacant space during this period. During the first nine months of 2013, average rental rates on new and renewal leases increased by 1.6%. Property net operating income (PNOI) from same properties, defined as operating properties owned during the entire current period and prior year reporting period, increased 2.2% for the quarter ended September 30, 2013, as compared to the same quarter in 2012. For the nine months ended September 30, 2013, PNOI from same properties increased 1.1% as compared to the same period last year.

EastGroup's total leased percentage was 96.3% at September 30, 2013, compared to 95.0% at September 30, 2012. Leases scheduled to expire for the remainder of 2013 were 2.0% of the portfolio on a square foot basis at September 30, 2013, and this figure was reduced to 1.4% as of October 18, 2013.

The Company generates new sources of leasing revenue through its acquisition and development programs. During the first nine months of 2013, the Company closed two operating property acquisitions (nine buildings totaling 837,000 square feet) in Dallas and Charlotte for $72,397,000 and 50.9 acres of development land in Charlotte and San Antonio for $6,567,000. 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 nine months of 2013, the Company began construction of 12 development projects containing 1,093,000 square feet in Houston, San Antonio, Orlando, Charlotte and Phoenix. EastGroup also transferred 12 properties (810,000 square feet) in Houston, San Antonio and Orlando from its development program to real estate properties with costs of $57.3 million at the date of transfer. As of September 30, 2013, EastGroup's development program consisted of 14 projects (1,339,000 square feet) located in Houston, San Antonio, Orlando, Charlotte and Phoenix. The projected total cost for the development projects, which were collectively 55% leased as of October 18, 2013, is $91.4 million, of which $40.2 million remained to be invested as of September 30, 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 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 and nine months ended September 30, 2013 and 2012.

                                       Three Months Ended        Nine Months Ended
                                          September 30,            September 30,
                                        2013         2012        2013        2012
                                                     (In thousands)
Income from real estate operations   $  51,216      46,686     148,484     139,252
Expenses from real estate operations   (14,587 )   (13,580 )   (41,833 )   (39,912 )
PROPERTY NET OPERATING INCOME        $  36,629      33,106     106,651      99,340

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 and nine months ended September 30, 2013 and 2012.

                                            Three Months Ended          Nine Months Ended
                                              September 30,               September 30,
                                            2013           2012         2013         2012
                                                           (In thousands)
NET INCOME                              $     8,514        6,897       23,612       20,502
Interest income                                (133 )        (82 )       (401 )       (248 )
Equity in earnings of unconsolidated
investment                                      (92 )        (89 )       (274 )       (266 )
Other income                                    (34 )        (15 )       (220 )        (43 )
Interest rate swap ineffectiveness                -          269          (29 )        269
Gain on sales of non-operating real
estate                                          (24 )          -          (24 )          -
Income from discontinued operations               -         (133 )          -       (2,397 )
Depreciation and amortization from
continuing operations                        16,948       15,335       48,891       46,510
Interest expense                              8,845        8,426       26,183       26,844
General and administrative expense            2,589        2,453        8,730        8,105
Acquisition costs                                16           45          183           64
PROPERTY NET OPERATING INCOME           $    36,629       33,106      106,651       99,340

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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 reconciliations of Net Income Attributable to EastGroup Properties, Inc. Common Stockholders to FFO Attributable to Common Stockholders for the three and nine months ended September 30, 2013 and 2012.

                                              Three Months Ended          Nine Months Ended
                                                September 30,               September 30,
                                              2013           2012         2013          2012
                                                  (In thousands, except per share data)
NET INCOME ATTRIBUTABLE TO EASTGROUP
PROPERTIES, INC. COMMON STOCKHOLDERS      $     8,363        6,771       23,160        20,146
Depreciation and amortization from
continuing operations                          16,948       15,335       48,891        46,510
Depreciation and amortization from
discontinued operations                             -          101            -           483
Depreciation from unconsolidated
investment                                         33           33          100           100
Depreciation and amortization from
noncontrolling interest                           (58 )        (65 )       (186 )        (191 )
Gain on sales of real estate investments            -            -            -        (1,869 )
FUNDS FROM OPERATIONS (FFO) ATTRIBUTABLE
TO COMMON STOCKHOLDERS                    $    25,286       22,175       71,965        65,179
Net income attributable to common
stockholders per diluted share            $      0.28         0.23         0.77          0.71
Funds from operations (FFO) attributable
to common stockholders per diluted share  $      0.83         0.76         2.39          2.30
Diluted shares for earnings per share and
funds from operations                          30,400       29,030       30,124        28,361

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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. FFO per share for the third quarter of 2013 was $.83 per share compared with $.76 per share for the same period of 2012, an increase of 9.2% per share. For the nine months ended September 30, 2013, FFO was $2.39 per share compared with $2.30 per share for the same period of 2012, an increase of 3.9% per share.

For the three months ended September 30, 2013, PNOI increased by $3,523,000, or 10.6%, compared to the same period in 2012. PNOI increased $1,858,000 from 2012 and 2013 acquisitions, $969,000 from newly developed properties and $740,000 from same property operations.

For the nine months ended September 30, 2013, PNOI increased by $7,311,000, or 7.4%, compared to the same period in 2012. PNOI increased $4,115,000 from 2012 and 2013 acquisitions, $2,234,000 from newly developed properties and $1,080,000 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 increased 2.2% for the three months ended September 30, 2013, and increased 1.1% for the nine months compared to the same periods 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 September 30, 2013, was 94.9% compared to 93.9% for the same period of 2012. Same property average occupancy for the nine months ended September 30, 2013, was 93.9% compared to 93.6% 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 $5.19 per square foot for the three months ended September 30, 2013, compared to $5.09 per square foot for the same period of 2012. The same property average rental rate was $5.19 for the nine months ended September 30, 2013, compared to $5.04 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 September 30, 2013, was 95.7%. Quarter-end occupancy ranged from 93.6% to 94.6% over the period from September 30, 2012 to June 30, 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 increases on new and renewal leases (5.7% of total square footage) averaged 2.1% for the third quarter of 2013. For the nine months ended September 30, 2013, rental rate increases on new and renewal leases (17.2% of total square footage) averaged 1.6%.

Lease termination fee income for the three and nine months ended September 30, 2013 was $3,000 and $430,000, respectively, compared to $57,000 and $314,000,respectively, for the same periods of 2012. Bad debt expense for the three and nine months ended September 30, 2013 was $58,000 and $154,000, respectively, compared to $155,000 and $539,000, respectively, for the same periods 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

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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.

FINANCIAL CONDITION

EastGroup's assets were $1,465,647,000 at September 30, 2013, an increase of $111,545,000 from December 31, 2012. Liabilities increased $99,037,000 to $961,963,000, and equity increased $12,508,000 to $503,684,000 during the same period. The paragraphs that follow explain these changes in detail.

Assets

Real Estate Properties
Real Estate Properties increased $142,204,000 during the nine months ended
September 30, 2013, primarily due to the purchase of the operating properties
detailed below, capital improvements at the Company's properties and the
transfer of twelve properties from Development, as detailed under Development
below.
 REAL ESTATE PROPERTIES ACQUIRED IN 2013     Location           Size         Date Acquired        Cost (1)
                                                            (Square feet)                      (In thousands)
Northfield Distribution Center              Dallas, TX           788,000      05/22/2013     $         63,184
Interchange Park II                        Charlotte, NC          49,000      07/01/2013                2,203
                                                                 837,000                     $         65,387

(1) Total cost of the properties acquired was $72,397,000, of which $65,387,000 was allocated to Real Estate Properties as indicated above. Intangibles associated with the purchase of real estate were allocated as follows: $8,399,000 to in-place lease intangibles, $158,000 to above market leases (both included in Other Assets on the Consolidated Balance Sheets) and $1,547,000 to below market leases (included in Other Liabilities on the Consolidated Balance Sheets). All of these costs are amortized over the remaining lives of the associated leases in place at the time of acquisition.

During the nine months ended September 30, 2013, the Company made capital improvements of $16,075,000 on existing and acquired properties (included in the Capital Expenditures table under Results of Operations). Also, the Company incurred costs of $3,708,000 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 September 30, 2013 consisted of properties in lease-up and under construction of $51,208,000 and prospective development (primarily land) of $96,281,000. The Company's total investment in development at September 30, 2013 was $147,489,000 compared to $148,255,000 at December 31, 2012. Total capital invested for development during the first nine months of 2013 was $61,561,000, which primarily consisted of costs of $45,144,000 and $11,420,000 as detailed in the development activity table below and costs of $3,708,000 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 $1,028,000 and $2,873,000 for the three and nine months ended September 30, 2013, respectively, and $655,000 and $2,043,000 for the same periods of 2012. 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.

During the first nine months of 2013, EastGroup purchased 50.9 acres of development land in Charlotte and San Antonio for $6,567,000. Costs associated with development land acquisitions are included in the development activity table. The Company transferred 12 development properties to Real Estate Properties during the first nine months of 2013 with a total investment of $57,330,000 as of the date of transfer.

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                                                            Costs Incurred
                                                                For the Nine     Cumulative                   Building
                                           Costs Transferred    Months Ended       as of        Estimated    Completion
DEVELOPMENT                                   in 2013 (1)         9/30/2013      9/30/2013     Total Costs      Date
                                                                   (In thousands)
                             Building
                               Size
                              (Square
LEASE-UP                       feet)
. . .
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