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EGP > SEC Filings for EGP > Form 10-K on 14-Feb-2014All Recent SEC Filings

Show all filings for EASTGROUP PROPERTIES INC

Form 10-K for EASTGROUP PROPERTIES INC


14-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

OVERVIEW
EastGroup's goal is to maximize shareholder value by being a 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 develops, acquires 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 unsecured bank credit facilities provide the capacity to fund the operations of the Company for the next 12 months. The Company also believes it can issue common and/or preferred equity and obtain financing from insurance companies and financial institutions. The continuous common equity program provided net proceeds to the Company of $53.2 million during 2013, as described in Liquidity and Capital Resources. Also during 2013, the Company closed a private placement issuance of $100 million of senior unsecured notes at a fixed interest rate of 3.8% and a $75 million unsecured term loan with a weighted average effective interest rate of 3.752%. These transactions are discussed in Liquidity and Capital Resources.

The Company's primary revenue is rental income; as such, EastGroup's greatest challenge is leasing space. During 2013, leases expired on 6,560,000 square feet (20.2%) of EastGroup's total square footage of 32,464,000, and the Company was successful in renewing or re-leasing 83% of the expiring square feet. In addition, EastGroup leased 1,824,000 square feet of other vacant space during the year. During 2013, average rental rates on new and renewal leases increased by 2.7%. Property net operating income (PNOI) from same properties, defined as operating properties owned during the entire current period and prior year reporting period, increased 1.3% for 2013 compared to 2012.

EastGroup's total leased percentage was 96.2% at December 31, 2013 compared to 95.1% at December 31, 2012. Leases scheduled to expire in 2014 were 11.3% of the portfolio on a square foot basis at December 31, 2013. As of February 13, 2014, leases scheduled to expire during the remainder of 2014 were 9.2% of the portfolio on a square foot basis.

The Company generates new sources of leasing revenue through its acquisition and development programs. During 2013, EastGroup acquired two operating properties (nine buildings totaling 837,000 square feet) in Dallas and Charlotte for $72.4 million and 50.9 acres of development land in Charlotte and San Antonio for $6.6 million. 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 2013, the Company began construction of 13 development projects containing 1,177,000 square feet in Houston, San Antonio, Orlando, Charlotte, Phoenix and Denver. Also in 2013, EastGroup transferred 14 properties (1,025,000 square feet) in Houston, San Antonio and Orlando from its development program to real estate properties with costs of $69.9 million at the date of transfer. As of December 31, 2013, EastGroup's development program consisted of 13 buildings (1,207,000 square feet) located in Houston, San Antonio, Orlando, Charlotte, Phoenix and Denver. The projected total cost for the development projects, which were collectively 58% leased as of February 13, 2014, is $87.4 million, of which $38.2 million remained to be invested as of December 31, 2013.

Typically, the Company initially funds its acquisition and development programs through its $250 million unsecured bank credit facilities (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 March 2013, Moody's Investor Services announced the Company's issuer rating of Baa2, and in December 2013, Fitch affirmed the Company's credit rating of BBB. 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.

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 fiscal years ended December 31, 2013, 2012 and 2011.

                                                              Years Ended December 31,
                                                          2013          2012          2011
                                                                   (In thousands)
Income from real estate
operations                                            $  201,849       185,783       173,008
Expenses from real estate
operations                                                57,885        52,891        48,911
PROPERTY NET OPERATING
INCOME                                                $  143,964       132,892       124,097

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 fiscal years ended December 31, 2013, 2012 and 2011.

                                                                Years Ended December 31,
                                                          2013             2012            2011
                                                                      (In thousands)
NET INCOME                                            $    33,225            32,887        22,834
Interest
income                                                       (530 )            (369 )        (334 )
Equity in earnings of unconsolidated
investment                                                   (366 )            (356 )        (347 )
Other
income                                                       (322 )             (61 )        (142 )
Interest rate swap ineffectiveness                            (29 )             269             -
Gain on sales of non-operating real
estate                                                        (24 )               -           (36 )
Income from discontinued
operations                                                   (887 )          (6,870 )        (269 )
Depreciation and amortization from continuing
operations                                                 65,789            61,345        56,739
Interest
expense                                                    35,192            35,371        34,709
General and administrative
expense                                                    11,725            10,488        10,691
Acquisition
costs                                                         191               188           252
PROPERTY NET OPERATING
INCOME                                                $   143,964           132,892       124,097

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 fiscal years ended December 31, 2013, 2012 and 2011.

                                                                   Years Ended December 31,
                                                              2013              2012            2011
                                                             (In thousands, except per share data)
NET INCOME ATTRIBUTABLE TO EASTGROUP PROPERTIES, INC.
COMMON
STOCKHOLDERS                                            $      32,615           32,384         22,359
Depreciation and amortization from continuing
operations                                                     65,789           61,345         56,739
Depreciation and amortization from discontinued
operations                                                        130              929            712
Depreciation from unconsolidated
investment                                                        134              133            133
Depreciation and amortization from noncontrolling
interest                                                         (240 )           (256 )         (219 )
Gain on sales of real estate
investments                                                      (798 )         (6,343 )            -
FUNDS FROM OPERATIONS (FFO) ATTRIBUTABLE TO COMMON
STOCKHOLDERS                                            $      97,630           88,192         79,724
Net income attributable to common stockholders per
diluted share                                           $        1.08             1.13           0.83
Funds from operations attributable to common
stockholders per diluted share                                   3.23             3.08           2.96
Diluted shares for earnings per share and funds from
operations                                                     30,269           28,677         26,971

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 year compared to the prior year. For 2013, FFO was $3.23 per share compared with $3.08 per share for 2012, an increase of 4.9% per share.

For the year ended December 31, 2013, PNOI increased by $11,072,000, or 8.3%, compared to 2012. PNOI increased $5,903,000 from 2012 and 2013 acquisitions, $3,641,000 from newly developed properties, and $1,660,000 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 1.3% for the year ended December 31, 2013, compared to 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 year ended December 31, 2013, was 94.3% compared to 93.9% for 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 $5.18 per square foot for the year ended December 31, 2013, compared to $5.11 per square foot for 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 December 31, 2013 was 95.5%. Quarter-end occupancy ranged from 93.6% to 95.7% over the period from December 31, 2012 to September 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. For the year 2013, rental rate increases on new and renewal leases (22.3% of total square footage) averaged 2.7%.

For the year 2013, lease termination fee income was $494,000 compared to $389,000 for 2012. Bad debt expense was $268,000 for 2013 compared to $630,000 for 2012.


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) that are 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 2013, 2012 and 2011 taxable income to its stockholders. Accordingly, no significant provisions for income taxes were necessary.


FINANCIAL CONDITION

EastGroup's assets were $1,473,412,000 at December 31, 2013, an increase of $119,310,000 from December 31, 2012. Liabilities increased $91,781,000 to $954,707,000, and equity increased $27,529,000 to $518,705,000 during the same period. The following paragraphs explain these changes in detail.

Assets
Real Estate Properties
Real Estate Properties increased $158,782,000 during the year ended December 31,
2013, primarily due to the transfer of 14 properties from Development, as
detailed under Development below, the purchase of the operating properties
detailed below and capital improvements at the Company's properties. These
increases were offset by the sales of three operating properties in Tampa for
$3,198,000 and 2.2 acres of land in Orlando for $1,394,000.
                                                                               Date
REAL ESTATE PROPERTIES ACQUIRED IN 2013     Location           Size          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
Total Acquisitions                                              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 purchases 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 2013, the Company made capital improvements of $21,438,000 on existing and acquired properties (included in the Capital Expenditures table under Results of Operations). Also, the Company incurred costs of $4,497,000 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 December 31, 2013 consisted of properties in lease-up and under construction of $49,161,000 and prospective development (primarily land) of $99,606,000. The Company's total investment in development at December 31, 2013 was $148,767,000 compared to $148,255,000 at December 31, 2012. Total capital invested for development during 2013 was $76,240,000, which primarily consisted of costs of $52,239,000 and $18,216,000 as detailed in the development activity table below and costs of $4,497,000 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).

EastGroup capitalized internal development costs of $3,730,000 during the year ended December 31, 2013, compared to $2,810,000 during 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 2013, EastGroup purchased 50.9 acres of development land in Charlotte and San Antonio for $6,567,000. Costs associated with these acquisitions are included in the development activity table. The Company transferred 14 development properties to Real Estate Properties during 2013 with a total investment of $69,943,000 as of the date of transfer.


                                                        Costs Incurred
                                              Costs          For the      Cumulative     Estimated     Building
                                           Transferred     Year Ended       as of       Total Costs   Completion
DEVELOPMENT                                 in 2013 (1)     12/31/13       12/31/13         (2)          Date
                                                               (In thousands)
                             Building
                               Size
                              (Square
LEASE-UP                       feet)
Thousand Oaks 3, San
Antonio, TX                    66,000     $      1,232         3,068          4,300         5,000        07/13
Ten West Crossing 2,
Houston, TX                    46,000              908         3,181          4,089         5,300        09/13
Ten West Crossing 3,
Houston, TX                    68,000              693         3,676          4,369         5,300        09/13
World Houston 37,
Houston, TX                   101,000                -         3,705          5,379         7,100        09/13
Chandler Freeways,
Phoenix, AZ                   126,000            1,811         6,047          7,858         8,900        11/13
Total Lease-Up                407,000            4,644        19,677         25,995        31,600
                                                                                                      Anticipated
                                                                                                       Building
                                                                                                      Completion
UNDER CONSTRUCTION                                                                                       Date
Horizon I, Orlando, FL        109,000            2,178         3,123          5,301         7,700        02/14
Steele Creek I,
Charlotte, NC                  71,000              895         3,372          4,267         5,300        02/14
Steele Creek II,
Charlotte, NC                  71,000              894         2,447          3,341         5,300        02/14
. . .
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