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BFS > SEC Filings for BFS > Form 10-Q on 1-Nov-2013All Recent SEC Filings

Show all filings for SAUL CENTERS INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for SAUL CENTERS INC


1-Nov-2013

Quarterly Report


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

This section should be read in conjunction with the consolidated financial statements of the Company and the accompanying notes in "Item 1. Financial Statements" of this report and the more detailed information contained in the Company's Form 10-K for the year ended December 31, 2012. Historical results and percentage relationships set forth in Item 1 and this section should not be taken as indicative of future operations of the Company. Capitalized terms used but not otherwise defined in this section have the meanings given to them in Item 1 of this Form 10-Q.
Forward-Looking Statements
This Form 10-Q contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements are generally characterized by terms such as "believe," "expect" and "may." Although the Company believes that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, the Company's actual results could differ materially from those given in the forward-looking statements as a result of changes in factors which include, among others, the following:
continuing risks related to the challenging domestic and global credit markets and their effect on discretionary spending;

risks that the Company's tenants will not pay rent;

         risks related to the Company's reliance on shopping center "anchor"
          tenants and other significant tenants;


         risks related to the Company's substantial relationships with members
          of The Saul Organization;


         risks of financing, such as increases in interest rates, restrictions
          imposed by the Company's debt, the Company's ability to meet existing
          financial covenants and the Company's ability to consummate planned and
          additional financings on acceptable terms;

risks related to the Company's development activities;

         risks that the Company's growth will be limited if the Company cannot
          obtain additional capital;


         risks that planned and additional acquisitions or redevelopments may
          not be consummated, or if they are consummated, that they will not
          perform as expected;


         risks generally incident to the ownership of real property, including
          adverse changes in economic conditions, changes in the investment
          climate for real estate, changes in real estate taxes and other
          operating expenses, adverse changes in governmental rules and fiscal
          policies, the relative illiquidity of real estate and environmental
          risks;


         risks related to the Company's status as a REIT for federal income tax
          purposes, such as the existence of complex regulations relating to the
          Company's status as a REIT, the effect of future changes in REIT
          requirements as a result of new legislation and the adverse
          consequences of the failure to qualify as a REIT; and


         such other risks as described in Part I, Item 1A of the Company's Form
          10-K for the year ended December 31, 2012.

General
The following discussion is based primarily on the consolidated financial statements of the Company as of and for the three and nine months ended September 30, 2013.
Overview
The Company's principal business activity is the ownership, management and development of income-producing properties. The Company's long-term objectives are to increase cash flow from operations and to maximize capital appreciation of its real estate investments.
The Company's primary operating strategy is to focus on its community and neighborhood shopping center business and to operate its properties to achieve both cash flow growth and capital appreciation. Management believes there is potential for long term growth in cash flow as existing leases for space in the Shopping Centers and Mixed-Use properties expire and are renewed, or newly available or vacant space is leased. The Company intends to renegotiate leases where possible and seek new tenants for available space in order to optimize the mix of uses to improve foot traffic through the Shopping Centers. As leases expire, management expects to revise rental rates, lease terms and conditions, relocate existing tenants, reconfigure tenant spaces and introduce new tenants with the goals of increasing occupancy, improving overall retail sales, and ultimately increasing cash flow as economic conditions improve. In those circumstances in which leases are not otherwise expiring,

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management selectively attempts to increase cash flow through a variety of means, or in connection with renovations or relocations, recapturing leases with below market rents and re-leasing at market rates, as well as replacing financially troubled tenants. When possible, management also will seek to include scheduled increases in base rent, as well as percentage rental provisions, in its leases.
The Company's redevelopment and renovation objective is to selectively and opportunistically redevelop and renovate its properties, by replacing leases that have below market rents with strong, traffic-generating anchor stores such as supermarkets and drug stores, as well as other desirable local, regional and national tenants. The Company's strategy remains focused on continuing the operating performance and internal growth of its existing Shopping Centers, while enhancing this growth with selective retail redevelopments and renovations.
In October 2013, the Company received government approval and permits to raze the structures at Van Ness Square and commenced demolition. The Company has entered into an arrangement with a general contractor and intends to develop a primarily residential project with street-level retail. The total cost of the project, excluding predevelopment expense and land costs, is expected to be approximately $93.0 million, a portion of which will be financed with a $71.6 million construction-to-permanent loan that closed in October 2013.
During the fourth quarter of 2012, the Company acquired two properties along the Rockville Pike corridor of Rockville, Maryland, one of which is adjacent to one of the Company's existing properties. In December 2012, the Company purchased for $23.0 million, including acquisition costs, approximately 52,700 square feet of retail space, which was 90.5% leased to multiple tenants, located on the east side of Rockville Pike near the Twinbrook Metro Station. The property is zoned for up to 745,000 square feet of rentable mixed-use space. The Company intends to redevelop the site but has not committed to any redevelopment plan or time table.
In December 2012, the Company purchased for $12.2 million, including acquisition costs, approximately 20,100 square feet of mixed-use space, which was 40.5% leased to multiple tenants, located on the east side of Rockville Pike and adjacent to 11503 Rockville Pike, which was purchased in 2010. The property, when combined with 11503 Rockville Pike, will provide zoning for up to 331,000 square feet of rentable mixed-use space for a total development potential of up to 622,000 square feet. The Company intends to redevelop the site but has not committed to any redevelopment plan or time table.
Although there has been a downturn in the national real estate market, to date, the effects on the office and retail markets in the metropolitan Washington, D.C. area, where the majority of the Company's properties are located, have generally been less severe. However, continued economic stress in the local economies where the Company's properties are located may lead to increased tenant bankruptcies, increased vacancies and decreased rental rates. While overall consumer confidence appears to have improved, retailers continue to be cautious about capital allocation when implementing store expansion and vacancies continue to remain elevated compared to pre-recession levels. The Company's overall leasing percentage on a comparative same property basis, which excludes the impact of properties not in operation for the entirety of the comparable periods, was 94.3% at September 30, 2013, compared to 92.7% at September 30, 2012.
The Company maintains a ratio of total debt to total asset value of under 50%, which allows the Company to obtain additional secured borrowings if necessary. And, as of September 30, 2013, amortizing fixed-rate mortgage debt with staggered maturities from 2015 to 2028 represented approximately 96.3% of the Company's notes payable, thus minimizing refinancing risk. During the nine months ended September 30, 2013, the Company repaid in full the $6.9 million remaining balance of the only fixed-rate loan scheduled to mature in 2013 and the $13.5 million remaining balance of the only fixed-rate loan scheduled to mature in 2014. As of September 30, 2013, the Company's variable-rate debt consisted of a $14.9 million bank term loan secured by Northrock Shopping Center, and a $15.5 million bank term loan secured by Metro Pike Center. As of September 30, 2013, the Company has availability of approximately $168.4 million under its $175.0 million unsecured revolving line of credit.
Although it is management's present intention to concentrate future acquisition and development activities on community and neighborhood shopping centers and Mixed-Use Properties in the Washington, DC/Baltimore metropolitan area and the southeastern region of the United States, the Company may, in the future, also acquire other types of real estate in other areas of the country as opportunities present themselves. While the Company may diversify in terms of property locations, size and market, the Company does not set any limit on the amount or percentage of Company assets that may be invested in any one property or any one geographic area.
Critical Accounting Policies
The Company's financial statements are prepared in accordance with accounting principles generally accepted in the United States ("GAAP"), which requires management to make certain estimates and assumptions that affect the reporting of

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financial position and results of operations. If judgment or interpretation of the facts and circumstances relating to various transactions had been different, it is possible that different accounting policies would have been applied resulting in a different presentation of the financial statements. The Company has identified the following policies that, due to estimates and assumptions inherent in these policies, involve a relatively high degree of judgment and complexity.
Real Estate Investments
Real estate investment properties are stated at historic cost less depreciation. Although the Company intends to own its real estate investment properties over a long term, from time to time it will evaluate its market position, market conditions, and other factors and may elect to sell properties that do not conform to the Company's investment profile. Management believes that the Company's real estate assets have generally appreciated in value since their acquisition or development and, accordingly, the aggregate current value exceeds their aggregate net book value and also exceeds the value of the Company's liabilities as reported in the financial statements. Because the financial statements are prepared in conformity with GAAP, they do not report the current value of the Company's real estate investment properties.
The Company purchases real estate investment properties from time to time and records assets acquired and liabilities assumed, including land, buildings, and intangibles related to in-place leases and customer relationships based on their fair values. The fair value of buildings is determined as if the buildings were vacant upon acquisition and subsequently leased at market rental rates and considers the present value of all cash flows expected to be generated by the property including an initial lease up period. The Company determines the fair value of above and below market intangibles associated with in-place leases by assessing the net effective rent and remaining term of the in-place lease relative to market terms for similar leases at acquisition taking into consideration the remaining contractual lease period, renewal periods, and the likelihood of the tenant exercising its renewal options. The fair value of a below market lease component is recorded as deferred income and amortized as additional lease revenue over the remaining contractual lease period and any renewal option periods included in the valuation analysis. The fair value of above market lease intangibles is recorded as a deferred asset and is amortized as a reduction of lease revenue over the remaining contractual lease term. The Company determines the fair value of at-market in-place leases considering the cost of acquiring similar leases, the foregone rents associated with the lease-up period and carrying costs associated with the lease-up period. Intangible assets associated with at-market in-place leases are amortized as additional expense over the remaining contractual lease term. To the extent customer relationship intangibles are present in an acquisition, the fair value of the intangibles are amortized over the life of the customer relationship. If there is an event or change in circumstance that indicates a potential impairment in the value of a real estate investment property, the Company prepares an analysis to determine whether the carrying value of the real estate investment property exceeds its estimated fair value. The Company considers both quantitative and qualitative factors in identifying impairment indicators including recurring operating losses, significant decreases in occupancy, and significant adverse changes in legal factors and business climate. If impairment indicators are present, the Company compares the projected cash flows of the property over its remaining useful life, on an undiscounted basis, to the carrying value of that property. The Company assesses its undiscounted projected cash flows based upon estimated capitalization rates, historic operating results and market conditions that may affect the property. If the carrying value is greater than the undiscounted projected cash flows, the Company would recognize an impairment loss equivalent to an amount required to adjust the carrying amount to its then estimated fair value. The fair value of any property is sensitive to the actual results of any of the aforementioned estimated factors, either individually or taken as a whole. Should the actual results differ from management's projections, the valuation could be negatively or positively affected.
When incurred, the Company capitalizes the cost of improvements that extend the useful life of property and equipment. All repair and maintenance expenditures are expensed when incurred. Leasehold improvements expenditures are capitalized when certain criteria are met, including when we supervise construction and will own the improvement. Tenant improvements that we own are depreciated over the life of the respective lease or the estimated useful life of the improvements, whichever is shorter.
Interest, real estate taxes, development-related salary costs and other carrying costs are capitalized on projects under construction. Upon substantial completion of construction and the placement of assets into service, rental income, direct operating expenses, and depreciation associated with such properties are included in current operations and capitalization of interest ceases. Commercial development projects are substantially complete and available for occupancy upon completion of tenant improvements, but no later than one year from the cessation of major construction activity. Residential development projects are considered substantially complete and available for occupancy upon receipt of the certificate of occupancy from the appropriate licensing authority. Substantially completed portions of a project are accounted for as separate projects. Depreciation is calculated using the straight-line method and estimated useful lives generally between 35 and 50 years for base buildings, or a shorter period if management determines that the building has a shorter useful life, and up to 20 years for certain other improvements.

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Deferred Leasing Costs
Certain initial direct costs incurred by the Company in negotiating and consummating successful commercial leases are capitalized and amortized over the initial base term of the leases. Deferred leasing costs consist of commissions paid to third-party leasing agents as well as internal direct costs such as employee compensation and payroll-related fringe benefits directly related to time spent performing successful leasing-related activities. Such activities include evaluating prospective tenants' financial condition, evaluating and recording guarantees, collateral and other security arrangements, negotiating lease terms, preparing lease documents and closing transactions. In addition, deferred leasing costs include amounts attributed to in-place leases associated with acquisition properties.
Revenue Recognition
Rental and interest income is accrued as earned except when doubt exists as to collectability, in which case the accrual is discontinued. Recognition of rental income commences when control of the space has been given to the tenant. When rental payments due under leases vary from a straight-line basis because of free rent periods or scheduled rent increases, income is recognized on a straight-line basis throughout the term of the lease. Expense recoveries represent a portion of property operating expenses billed to tenants, including common area maintenance, real estate taxes and other recoverable costs. Expense recoveries are recognized in the period when the expenses are incurred. Rental income based on a tenant's revenue, known as percentage rent, is accrued when a tenant reports sales that exceed a specified breakpoint specified in the lease agreement.
Allowance for Doubtful Accounts - Current and Deferred Receivables Accounts receivable primarily represent amounts accrued and unpaid from tenants in accordance with the terms of the respective leases, subject to the Company's revenue recognition policy. Receivables are reviewed monthly and reserves are established with a charge to current period operations when, in the opinion of management, collection of the receivable is doubtful. In addition to rents due currently, accounts receivable include amounts representing minimum rental income accrued on a straight-line basis to be paid by tenants over the remaining term of their respective leases. Reserves are established with a charge to income for tenants whose rent payment history or financial condition casts doubt upon the tenant's ability to perform under its lease obligations. Legal Contingencies
The Company is subject to various legal proceedings and claims that arise in the ordinary course of business, which are generally covered by insurance. While the resolution of these matters cannot be predicted with certainty, the Company believes the final outcome of current matters will not have a material adverse effect on its financial position or the results of operations. Once it has been determined that a loss is probable to occur, the estimated amount of the loss is recorded in the financial statements. Both the amount of the loss and the point at which its occurrence is considered probable can be difficult to determine.

Results of Operations
Three months ended September 30, 2013 compared to the three months ended
September 30, 2012
Same property revenue and operating income were $49.0 million and $37.3 million,
respectively, for the three months ended September 30, 2013, representing
increases of $2.4 million (5.1%) and $1.8 million (5.1%) over the three months
ended September 30, 2012. Same property comparisons include 48 Shopping Centers
and six Mixed-Use Properties which were in operation for the entirety of both
periods.
Revenue
                             Three Months Ended
                                 September 30,            2012 to 2013 Change
(Dollars in thousands)         2013           2012         Amount       Percent
Base rent                $    40,110        $ 38,334    $    1,776        4.6  %
Expense recoveries             7,848           7,564           284        3.8  %
Percentage rent                  215             250           (35 )    (14.0 )%
Other                          1,583           1,297           286       22.1  %
Total revenue            $    49,756        $ 47,445    $    2,311        4.9  %

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Base rent includes $794,000 and $1.1 million for the three months ended September 30, 2013 and 2012, respectively, to recognize base rent on a straight-line basis. In addition, base rent includes $429,000 and $350,000, for the three months ended September 30, 2013 and 2012, respectively, to recognize income from the amortization of in-place leases acquired in connection with purchased real estate investment properties.
Total revenue increased 4.9% in the three months ended September 30, 2013 ("2013 Quarter") compared to the three months ended September 30, 2012 ("2012 Quarter") primarily due to increased base rent resulting from
(a) increased leasing at Clarendon Center and Westview, two recently-developed properties ($574,000), (b) rent generated by the properties acquired in 2012 ($410,000), (c) leasing of anchor-tenant spaces at several properties ($326,000), and (d) other base rent increases throughout the core portfolio ($1.0 million), partially offset by (e) reduced base rent at Van Ness Square as a result of the Company's activities to terminate leases ($574,000).

Operating Expenses
                                           Three Months Ended
                                              September 30,                2012 to 2013 Change
(Dollars in thousands)                     2013             2012          Amount         Percent
Property operating expenses          $     6,106        $    5,877     $       229           3.9  %
Provision for credit losses                  191               168              23          13.7  %
Real estate taxes                          5,610             5,535              75           1.4  %
Interest expense and amortization of
deferred debt costs                       11,738            12,322            (584 )        (4.7 )%
Depreciation and amortization of
leasing costs                             10,492            10,237             255           2.5  %
General and administrative                 3,501             3,272             229           7.0  %
Predevelopment expenses                       60             1,870          (1,810 )       (96.8 )%
Total operating expenses             $    37,698        $   39,281     $    (1,583 )        (4.0 )%

Total operating expenses decreased 4.0% in the 2013 Quarter compared to the 2012 Quarter primarily due to $1.8 million of lower predevelopment expense related to the Company's redevelopment activities at Van Ness Square.
Property operating expenses. The increase in property operating expenses for the 2013 Quarter reflects small increases at most properties in the portfolio and the impact of the properties acquired in 2012.
Provision for credit losses. The provision for credit losses for the 2013 Quarter represents 0.38% of the Company's revenue, an increase from 0.35% for the 2012 Quarter.
Interest expense and amortization of deferred debt. Interest expense decreased in the 2013 Quarter compared to the 2012 Quarter primarily because of a decrease in the average cost of debt to 5.54% in the 2013 Quarter from 5.82% in the 2012 Quarter.
Depreciation and amortization of leasing costs. The increase in depreciation and amortization to $10.5 million in the 2013 Quarter from $10.2 million in the 2012 Quarter was primarily due to the impact of the properties acquired in 2012. General and administrative expense. The increase in general and administrative expense was primarily due to (a) increased stock option expense ($137,900), (b) increased consulting expense ($135,000) and (c) increased legal costs ($58,700) partially offset by (d) lower employee benefits ($135,100).
Predevelopment expenses. Predevelopment expenses represent costs incurred, primarily lease termination costs, in connection with the redevelopment of Van Ness Square. There were no lease termination costs in the 2013 Quarter because the last lease was terminated in April 2013.
Nine months ended September 30, 2013 compared to the nine months ended September 30, 2012
Same property revenue and operating income were $145.0 million and $110.0 million, respectively, for the nine months ended September 30, 2013, representing increases of $5.8 million (4.2%) and $4.7 million (4.4%) over the nine months ended September 30, 2012. Same property comparisons include 48 Shopping Centers and six Mixed-Use Properties which were in operation for the entirety of both periods.

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Revenue
                          Nine Months Ended
                             September 30,              2012 to 2013 Change
(Dollars in thousands)    2013          2012             Amount           Percent
Base rent              $  119,403    $ 113,862    $      5,541               4.9 %
Expense recoveries         22,925       22,706             219               1.0 %
Percentage rent             1,153        1,109              44               4.0 %
Other                       4,270        4,129             141               3.4 %
Total revenue          $  147,751    $ 141,806    $      5,945               4.2 %

Base rent includes $2.2 million and $3.4 million for the nine months ended September 30, 2013 and 2012, respectively, to recognize base rent on a straight-line basis. In addition, base rent includes $1.3 million and $1.2 million for the nine months ended September 30, 2013 and 2012, respectively, to recognize income from the amortization of in-place leases acquired in connection with purchased real estate investment properties.
Total revenue increased 4.2% in the nine months ended September 30, 2013 ("2013 Period") compared to the nine months ended September 30, 2012 ("2012 Period") primarily due to increased base rent resulting from (a) increased leasing at Clarendon Center and Westview, two recently-developed properties ($2.1 million),
(b) rent generated by the properties acquired in 2012 ($1.4 million),
(c) leasing of anchor-tenant spaces at several properties ($1.0 million), and
(d) other base rent increases throughout the core portfolio ($2.6 million), partially offset by (e) reduced base rent at Van Ness Square as a result of the Company's activities to terminate leases ($1.5 million).

Operating Expenses
                                          Nine Months Ended
                                             September 30,               2012 to 2013 Change
(Dollars in thousands)                   2013            2012           Amount          Percent
Property operating expenses          $    18,096     $   17,532     $       564             3.2  %
. . .
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