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BFS > SEC Filings for BFS > Form 10-K on 10-Mar-2014All Recent SEC Filings

Show all filings for SAUL CENTERS INC

Form 10-K for SAUL CENTERS INC


10-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) begins with the Company's primary business strategy to give the reader an overview of the goals of the Company's business. This is followed by a discussion of the critical accounting policies that the Company believes are important to understanding the assumptions and judgments incorporated in the Company's reported financial results. The next section, beginning on page 36, discusses the Company's results of operations for the past two years. Beginning on page 40, the Company provides an analysis of its liquidity and capital resources, including discussions of its cash flows, debt arrangements, sources of capital and financial commitments. Finally, on page 49, the Company discusses funds from operations, or FFO, which is a non-GAAP financial measure of performance of an equity REIT used by the REIT industry.
The MD&A should be read in conjunction with the other sections of this Annual Report on Form 10-K, including the consolidated financial statements and notes thereto appearing in Item 8 of this report. Historical results set forth in Selected Financial Information, the Consolidated Financial Statements and Supplemental Data included in Item 6 and Item 8 and this section should not be taken as indicative of the Company's future operations. 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 Center 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, management selectively attempts to increase cash flow through a variety of means, or in connection with renovations


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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.
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 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 is actively engaged in a plan for redevelopment but has not committed to any timetable for commencement of construction. In December 2012, the Company purchased for $12.2 million, including acquisition costs, approximately 20,100 square feet of retail space, located on the east side of Rockville Pike near the White Flint Metro station 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. When combining these two properties with our Metro Pike shopping center on the west side of Rockville Pike, the Company's holdings at White Flint total 7.6 acres which are zoned for a development potential of up to 1.5 million square feet of mixed-use space. The Company is actively engaged in a plan for redevelopment but has not committed to any timetable for commencement of construction.
In 2011, the Company acquired three Giant Food-anchored shopping centers located in the Maryland suburbs of the Washington, D.C./Baltimore metropolitan area. The three centers, Kentlands Square II, Severna Park MarketPlace and Cranberry Square, total 636,000 square feet of leasable area. The $170.9 million purchase price, including acquisition costs, was financed with (1) $98.0 million of debt secured by the properties; (2) approximately $17.1 million in cash and borrowings from the Company's revolving credit facility; and (3) $55.8 million from the issuance of equity to a related party.
In light of the limited amount of quality properties for sale and the escalated pricing of properties that the Company has been presented with or has inquired about over the past year, management believes acquisition opportunities for investment in existing and new Shopping Center and Mixed-Use Properties in the near future is uncertain. Because of its conservative capital structure, including its cash and capacity under its revolving credit facility, management believes that the Company is positioned to take advantage of additional investment opportunities as attractive properties are located and market conditions improve. (See "Item 1. Business - Capital Policies"). It is management's view that several of the sub-markets in which the Company operates have, or are expected to have in the future, attractive supply/demand characteristics. The Company will continue to evaluate acquisition, development and redevelopment as integral parts of its overall business plan.
During the most recent downturn in the national real estate market, 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, initially were generally less severe than in many other areas of the country. However, continued economic uncertainty in the local economies where the Company's properties are located resulting from issues facing the Federal government relating to spending cuts and budget policies 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. Vacancies continue to remain elevated in certain submarkets compared to pre-recession levels; however, 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, at December 31, 2013 increased to 93.9% from 92.6% at December 31, 2012, an increase in leased space of approximately 123,100 square feet, primarily caused by the leasing of 70,800 square feet of small shop space in the Shopping Centers and improved leasing at Avenel Business Park.
Because of the Company's conservative capital structure, its liquidity has not been significantly affected by the recent turmoil in the credit markets. 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. As of December 31, 2013, amortizing fixed-rate mortgage debt with staggered maturities from 2015 to 2032 represented approximately 96.3% of the Company's notes payable, thus minimizing refinancing risk. The Company's variable-rate debt consists of a $14.8 million bank term loan secured by the Northrock shopping center and a $15.4 million bank term loan secured by the Metro Pike Center. As of December 31, 2013, the Company has loan availability of approximately $164.2 million under its $175.0 million unsecured revolving line of credit.


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Although it is management's present intention to concentrate future acquisition and development activities on community and neighborhood shopping centers and office properties in the Washington, D.C./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 consolidated 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 financial position and results of operations. See Note 2 to the Consolidated Financial Statements in this report. The Company has identified the following policies that, due to estimates and assumptions inherent in those 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 generally 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 accreted as additional lease revenue over the remaining contractual lease period. If the fair value of the below market lease intangible includes fair value associated with a renewal option, such amounts are not accreted until the renewal option is exercised. If the renewal option is not exercised the value is recognized at that time. 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. From time to time the Company may purchase a property for future development purposes. The property may be improved with an existing structure that would be demolished as part of the development. In such cases, the fair value of the building may be determined based only on existing leases and not include estimated cash flows related to future leases. 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


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capitalized when certain criteria are met, including when we supervise construction and will own the improvement. Tenant improvements 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. Once construction is substantially complete and the assets are placed in service, rental income, direct operating expenses, and depreciation associated with such properties are included in current operations. 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 of 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. Deferred Leasing Costs
Certain initial direct costs incurred by the Company in negotiating and consummating successful commercial leases are capitalized and amortized over the 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 are 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
Same property revenue and operating income were $194.4 million and $147.3 million, respectively, in 2013 representing increases of $7.8 million (4.2%) and $6.2 million (4.4%) over 2012. Same property comparisons for 2013 and 2012 include 49 Shopping Centers and six Mixed-Use Properties which were in operation for the entirety of 2013 and 2012.


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Same property revenue and operating income were $160.1 million and $119.7 million, respectively, in 2012 representing decreases of $1.5 million (0.9%) and $1.9 million (1.6%) compared to 2011. Same property comparisons for 2012 and 2011 include 46 Shopping Centers and five Mixed-Use Properties which were in operation for the entirety of 2012 and 2011.
The following is a discussion of the components of revenue and expense for the entire Company.

Revenue
(Dollars in thousands)       For the year ended December 31,             Percentage Change
                                                                      2013 from     2012 from
                              2013             2012         2011         2012          2011
Base rent              $    159,898         $ 152,777    $ 138,486        4.7 %        10.3  %
Expense recoveries           30,949            30,391       28,368        1.8 %         7.1  %
Percentage rent               1,575             1,545        1,503        1.9 %         2.8  %
Other                         5,475             5,379        5,521        1.8 %        (2.6 )%
Total revenue          $    197,897         $ 190,092    $ 173,878        4.1 %         9.3  %

Note: (Dollars in thousands)
Base rent includes $3,035, $3,796, and $3,694, for the years 2013, 2012, and 2011, respectively, to recognize base rent on a straight-line basis. In addition, base rent includes $1,692, $1,495, and $1,119, for the years 2013, 2012, and 2011, respectively, to recognize income from the amortization of in-place leases.
Total revenue increased 4.1% in 2013 compared to 2012 primarily due to $7.1 million of higher base rent (a) generated by properties acquired or developed in 2012 (the "New 2012 Properties") ($2.3 million) and (b) increases throughout the portfolio ($6.6 million) partially offset by (c) Van Ness Square ($2.0 million). Total revenue increased 9.3% in 2012 compared to 2011 primarily due to $14.5 million of aggregate revenue generated by Clarendon Center and the three Shopping Center Properties acquired in 2011 (collectively, the "New 2011 Properties"). A discussion of the components of revenue follows. Base rent
The $7.1 million increase in base rent in 2013 compared to 2012 was attributable to (a) the New 2012 Properties ($2.3 million) and (b) increases throughout the portfolio ($6.6 million) partially offset by (c) Van Ness Square ($2.0 million). The $14.3 million increase in base rent in 2012 compared to 2011 was attributable to $12.4 million of increased base rent generated by the New 2011 Properties and $2.3 million of increased base rent in the remainder of the portfolio.
Expense recoveries
Expense recovery income increased $0.6 million in 2013 compared to 2012. Expense recovery income increased $2.0 million in 2012 compared to 2011 primarily due to $1.7 million of increased expense recovery income generated by the New 2011 Properties.
Other revenue
Other revenue increased $0.1 million in 2013 compared to 2012. The decline in other revenue in 2012 compared to 2011 is primarily due to the collection in 2011 of $325,000 of past due rents from a former tenant, partially offset by increased parking income at the Mixed-Use Properties.


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Operating expenses
(Dollars in thousands)                          For the year ended December 31,              Percentage Change
                                                                                          2013 from    2012 from
                                                2013             2012          2011          2012         2011
Property operating expenses              $     24,559         $  23,794     $  24,715        3.2  %       (3.7 )%
Provision for credit losses                       968             1,151         1,880      (15.9 )%      (38.8 )%
Real estate taxes                              22,415            22,325        18,435        0.4  %       21.1  %
Interest expense and amortization of
deferred debt costs                            46,589            49,544        45,324       (6.0 )%        9.3  %
Depreciation and amortization of
deferred leasing costs                         49,130            40,112        35,298       22.5  %       13.6  %
General and administrative                     14,951            14,274        14,256        4.7  %        0.1  %
Acquisition related costs                         106             1,129         2,534      (90.6 )%      (55.4 )%
Predevelopment expenses                         3,910             2,667             -       46.6  %         NA
Total operating expenses                 $    162,628         $ 154,996     $ 142,442        4.9  %        8.8  %

Total operating expenses increased 4.9% in 2013 compared to 2012 primarily due to $8.0 million of additional depreciation expense and $1.2 million of higher predevelopment expenses related to the redevelopment of Park Van Ness. Total operating expenses increased 8.8% in 2012 compared to 2011 primarily due to increased real estate taxes, interest expense, depreciation expense and predevelopment expense.
Property operating expenses
Property operating expenses increased $765,000 in 2013 compared to 2012. Property operating expenses decreased $921,000 in 2012 compared to 2011 primarily due to lower snow removal costs. Provision for credit losses
The provision for credit losses represents the Company's estimate of amounts owed by tenants that may not be collectible. The $183,000 decrease in 2013 compared to 2012 as well as the $729,000 decrease in 2012 compared to 2011 reflects a general improvement in the retail economy and lack of significant bankruptcy losses among the Company's various tenants. Real estate taxes
Real estate taxes increased $90,000 in 2013 compared to 2012. The $3.9 million increase in real estate taxes in 2012 compared to 2011 is comprised of increased property taxes charged by the District of Columbia and taxes related to the New 2011 Properties.
Interest and amortization of deferred debt Interest expense decreased $3.0 million in 2013 compared to 2012 primarily due to a 30 basis point decrease in the average cost of debt to 5.54% from 5.84%. Interest expense increased $4.2 million in 2012 compared to 2011 primarily due to approximately $4.1 million of interest related to $67.2 million of higher average debt balances and $1.9 million of reduced capitalized interest, partially offset by $2.1 million of lower interest resulting from lower average cost of debt.
Depreciation and amortization
Depreciation and amortization of deferred leasing costs increased by $9.0 million in 2013 compared to 2012 primarily due to $8.0 million of additional depreciation expense on the building at the former Van Ness Square as a result of the reduction of its useful life to four months effective January 1, 2013. Depreciation and amortization of deferred leasing costs increased $4.8 million in 2012 compared to 2011 primarily due to the New 2011 Properties. General and administrative
General and administrative costs increased $677,000 in 2013 compared to 2012 primarily due to (a) increased consulting expense ($495,000) and (b) increased stock option expense ($245,000).


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Acquisition related costs
Acquisition related costs in 2013 totaling approximately $106,000 relate to the purchase of a retail pad with a 7,100 square foot restaurant located in Gaithersburg, Maryland which is contiguous with and an expansion of the Company's other Kentlands assets. Acquisition related costs in 2012 totaling approximately $1.1 million related to the December 2012 purchases of 1500 Rockville Pike and 5541 Nicholson Lane.
Acquisition related costs in 2011 totaling approximately $2.5 million related to the Company's September 23, 2011, purchase of Kentlands Square II, Severna Park MarketPlace and Cranberry Square and the February 17, 2011 purchase of a 3,000 square foot retail property located adjacent to the Company's Van Ness Square in Washington, D.C. . . .

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