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BFS > SEC Filings for BFS > Form 10-Q on 7-May-2014All Recent SEC Filings

Show all filings for SAUL CENTERS INC



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, 2013. 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 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, 2013.

The following discussion is based primarily on the consolidated financial statements of the Company as of and for the three months ended March 31, 2014. Recent Developments
On March 25, 2014, Thomas H. McCormick tendered his resignation from the Board of Directors of the Company and each of its committees, effective as of April 11, 2014, to pursue other interests. In addition, Mr. McCormick notified the Company's Chairman of the Board that he intended to resign as the Company's President and Chief Operating Officer, which resignation was also effective as of April 11, 2014. Mr. McCormick's resignation was not in connection with any disagreement with the Company about any matter.
The Company entered into a Separation Agreement with Mr. McCormick pursuant to which he will receive certain severance payments in exchange for a release and certain post-employment restrictions and obligations. Mr. McCormick will receive aggregate severance payments totaling $1,075,250, payable on regular payroll dates over the next two years. He will remain a consultant to the Company through May 15, 2014.


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The Board of Directors is evaluating an appropriate replacement. In the interim, the Chief Executive Officer and the Executive Vice-President-Real Estate will manage the day-to-day operations of the Company.
On April 24, 2014, the Company purchased for $11.0 million a single-tenant retail property with a 40,700 square foot furniture store located at 1582 Rockville Pike in Rockville, Maryland, and concurrently sold to the same party, for $11.0 million, the 53,765 square foot Olney Center located in Olney, Maryland. 1582 Rockville Pike is contiguous with and an expansion of the Company's assets at 1500 and 1580 Rockville Pike.
Simultaneously with the sale of the Olney Center, the Company entered into a lease of the property with the buyer and the Company continues to operate and manage the property. The lease term is 20 years and the Company has the option to purchase the property at the end of the lease term. The Company anticipates that this transaction will be accounted for as a secured financing. On April 29, 2014, the Company sold for $7.5 million the 70,040 square foot Giant Center located in Milford Mill, Maryland. As of March 31, 2014, the carrying amounts of the associated assets and liabilities were $0.5 million and $0.1 million, respectively. There was no debt on the property.

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, 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.
During the first quarter of 2014, the Company completed the demolition of Van Ness Square and incurred approximately $503,000 of demolition costs. The Company has received government approvals and building permits and is developing a 271­unit residential project with approximately 9,000 square feet of street-level retail, below street-level structured parking, and amenities including a community room, landscaped courtyards, a fitness room and a rooftop pool and deck. Construction is projected to be completed by late 2015. The total cost of the project, excluding predevelopment expense and land, which the Company has owned, is expected to be approximately $93.0 million, a portion of which will be financed with a $71.6 million construction-to-permanent loan. The Company's tenants were further impacted by winter weather, as heavy snowfall in the Mid-Atlantic states during the first quarter of 2014 hindered the ability of customers to shop. The costs of removing snow from the Company's properties during the three months ended March 31, 2014, was approximately $2.0 million, approximately 60% of which will be billable to tenants.
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 less severe than in many other areas of the country. However, continued economic stress in the local economies where the Company's properties are located resulting from (a) issues facing the Federal government relating to spending cuts and budget policies (b) the severe winter weather conditions may lead to increased tenant bankruptcies, increased vacancies and decreased rental rates.


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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, was 94.3% at March 31, 2014, compared to 92.8% at March 31, 2013.
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 March 31, 2014, 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. As of March 31, 2014, the Company's variable-rate debt consisted of a $14.7 million bank term loan secured by Northrock Shopping Center, and a $15.3 million bank term loan secured by Metro Pike Center. As of March 31, 2014, the Company has availability of approximately $172.0 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 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


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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. 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


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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 March 31, 2014 compared to the three months ended March 31,
Same property revenue and operating income were $52.8 million and $39.6 million,
respectively, for the three months ended March 31, 2014, representing increases
of $4.0 million (8.3%) and $2.5 million (6.9%) over the three months ended
March 31, 2013. Same property comparisons include 50 Shopping Centers and six
Mixed-Use Properties which were in operation for the entirety of both periods.
                             Three Months Ended
                                   March 31,              2013 to 2014 Change
(Dollars in thousands)         2014           2013         Amount       Percent
Base rent                $    40,563        $ 39,740    $      823        2.1  %
Expense recoveries             8,789           7,614         1,175       15.4  %
Percentage rent                  452             600          (148 )    (24.7 )%
Other                          3,143           1,232         1,911      155.1  %
Total revenue            $    52,947        $ 49,186    $    3,761        7.6  %

Base rent includes $278,500 and $735,600 for the three months ended March 31, 2014 and 2013, respectively, to recognize base rent on a straight-line basis. In addition, base rent includes $363,300 and $439,100, for the three months ended March 31, 2014 and 2013, respectively, to recognize income from the amortization of in-place leases acquired in connection with purchased real estate investment properties.
Total revenue increased 7.6% in the three months ended March 31, 2014 ("2014 Quarter") compared to the three months ended March 31, 2013 ("2013 Quarter") primarily due to (a) the $1.5 million impact of a lease termination at Seven Corners and (b) higher expense recoveries resulting primarily from higher snow removal expenses ($1.2 million).

Operating Expenses
                                           Three Months Ended
                                                March 31,                  2013 to 2014 Change
(Dollars in thousands)                     2014             2013          Amount         Percent
Property operating expenses          $     7,585        $    5,949     $     1,636          27.5  %
Provision for credit losses                  203               264             (61 )       (23.1 )%
Real estate taxes                          5,453             5,763            (310 )        (5.4 )%
Interest expense and amortization of
deferred debt costs                       11,467            11,717            (250 )        (2.1 )%
Depreciation and amortization of
leasing costs                             10,180            16,352          (6,172 )       (37.7 )%
General and administrative                 4,680             3,404           1,276          37.5  %
Acquisition related costs                    163                 -             163             -  %
Predevelopment expenses                      503             2,349          (1,846 )       (78.6 )%
Total operating expenses             $    40,234        $   45,798     $    (5,564 )       (12.1 )%

Total operating expenses decreased 12.1% in the 2014 Quarter compared to the 2013 Quarter primarily due to $6.2 million of lower depreciation expense and $1.8 million of lower predevelopment expense, both of which related to the Company's redevelopment activities at Park Van Ness, partially offset by $1.7 million of higher snow removal costs and $1.1 million of severance costs. Property operating expenses. The increase in property operating expenses for the 2014 Quarter reflects a $1.7 million increase in snow removal costs to $2.0 million compared to $0.3 million in the 2013 Quarter.
Provision for credit losses. The provision for credit losses for the 2014 Quarter represents 0.38% of the Company's revenue, a decrease from 0.54% for the 2013 Quarter.


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Depreciation and amortization of leasing costs. The decrease in depreciation and amortization to $10.2 million in the 2014 Quarter from $16.4 million in the 2013 Quarter was primarily due to $6.2 million of additional depreciation expense recorded in 2013 related to Park Van Ness.
General and administrative expense. The increase in general and administrative expense was primarily due to accrued severance costs totaling approximately $1.1 million.
Predevelopment expenses. Predevelopment expenses represent costs incurred in connection with the redevelopment of Park Van Ness. Predevelopment expenses in the 2014 Quarter were compromised primarily of demolition costs and in the 2013 Quarter were comprised primarily of lease termination costs.

Liquidity and Capital Resources
Cash and cash equivalents totaled $15.4 million and $8.5 million at March 31,
2014 and 2013, respectively. The Company's cash flow is affected by its
operating, investing and financing activities, as described below.

                                             Three Months Ended
                                                  March 31,
(Dollars in thousands)                        2014          2013
Net cash provided by operating activities $   23,925     $ 15,680
Net cash used in investing activities        (13,888 )     (5,064 )
Net cash used in financing activities        (11,983 )    (14,267 )
Decrease in cash and cash equivalents     $   (1,946 )   $ (3,651 )

Operating Activities
Net cash provided by operating activities represents cash received primarily from rental income, plus other income, less property operating expenses, leasing costs, normal recurring general and administrative expenses and interest payments on debt outstanding. The $8.2 million increase in net cash provided by operating activities from 2013 to 2014 is primarily attributable to changes in other assets, accounts payable and deferred income which, in turn, are generally the results of the timing of collection of rents from tenants and payments to vendors.
Investing Activities
Net cash used in investing activities includes property acquisitions, developments, redevelopments, tenant improvements and other property capital expenditures. Tenant improvement and property capital expenditures totaled $3.2 million and $3.6 million for the three months ended March 31, 2014 and 2013, respectively.
Financing Activities . . .

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