UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
For the quarterly period ended September 30, 2009
OR
For the transition period from to
Commission file number: 1-07533
FEDERAL REALTY INVESTMENT TRUST
(Exact Name of Registrant as Specified in its Declaration of Trust)
(301) 998-8100
(Registrant’s Telephone Number, Including Area Code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ¨ Yes ¨ No
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.:
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes x No
The number of Registrant’s common shares outstanding on October 30, 2009 was 61,186,594.
QUARTERLY REPORT ON FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 2009
TABLE OF CONTENTS
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PART I—FINANCIAL INFORMATION
The following balance sheet as of December 31, 2008, which has been derived from audited financial statements, and unaudited interim financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles (GAAP) have been omitted pursuant to those rules and regulations, although the company believes that the disclosures made are adequate to make the information not misleading. It is suggested that these financial statements be read in conjunction with the financial statements and notes thereto included in the company’s latest Annual Report on Form 10-K (as amended). In the opinion of management, all adjustments (consisting of normal, recurring adjustments) necessary for a fair presentation for the periods presented have been included. The results of operations for the three and nine months ended September 30, 2009 are not necessarily indicative of the results that may be expected for the full year.
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Federal Realty Investment Trust
Consolidated Balance Sheets
ASSETS
Real estate, at cost
Operating
Construction-in-progress
Less accumulated depreciation and amortization
Net real estate
Cash and cash equivalents
Accounts and notes receivable
Mortgage notes receivable
Investment in real estate partnership
Prepaid expenses and other assets
Debt issuance costs, net of accumulated amortization of $8,208 and $6,484, respectively
TOTAL ASSETS
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Mortgages payable
Capital lease obligations
Notes payable
Senior notes and debentures
Accounts payable and accrued expenses
Dividends payable
Security deposits payable
Other liabilities and deferred credits
Total liabilities
Commitments and contingencies (Note F)
Shareholders’ equity
Preferred shares, authorized 15,000,000 shares, $.01 par: 5.417% Series 1 Cumulative Convertible Preferred Shares, (stated at liquidation preference $25 per share), 399,896 shares issued and outstanding
Common shares of beneficial interest, $.01 par, 100,000,000 shares authorized, 61,176,306 and 58,985,678 shares issued and outstanding, respectively
Additional paid-in capital
Accumulated dividends in excess of net income
Total shareholders’ equity of the Trust
Noncontrolling interests
Total shareholders’ equity
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
The accompanying notes are integral part of these consolidated statements.
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Consolidated Statements of Operations
(Unaudited)
REVENUE
Rental income
Other property income
Mortgage interest income
Total revenue
EXPENSES
Rental expenses
Real estate taxes
General and administrative
Litigation provision
Depreciation and amortization
Total operating expenses
OPERATING INCOME
Other interest income
Interest expense
Income from real estate partnership
INCOME FROM CONTINUING OPERATIONS
DISCONTINUED OPERATIONS
Income from discontinued operations
Gain on sale of real estate from discontinued operations
Results from discontinued operations
NET INCOME
Net income attributable to noncontrolling interests
NET INCOME ATTRIBUTABLE TO THE TRUST
Dividends on preferred stock
NET INCOME AVAILABLE FOR COMMON SHAREHOLDERS
EARNINGS PER COMMON SHARE, BASIC
Continuing operations
Discontinued operations
EARNINGS PER COMMON SHARE, DILUTED
The accompanying notes are an integral part of these consolidated statements.
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Early extinguishment of senior notes
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Consolidated Statement of Shareholders’ Equity
For the Nine Months Ended September 30, 2009
BALANCE AT DECEMBER 31, 2008
Net income/Comprehensive income
Dividends declared to common shareholders
Dividends declared to preferred shareholders
Distributions paid to noncontrolling interests
Common shares issued
Exercise of stock options
Shares issued under dividend reinvestment plan
Share-based compensation expense, net
Conversion and redemption of OP units
BALANCE AT SEPTEMBER 30, 2009
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Consolidated Statements of Cash Flows
OPERATING ACTIVITIES
Net income
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization, including discontinued operations
Gain on sale of real estate
Other, net
Changes in assets and liabilities, net of effects of acquisitions and dispositions:
Decrease (increase) in accounts receivable
Increase in prepaid expenses and other assets
Increase (decrease) in accounts payable and accrued expenses
Increase in security deposits and other liabilities
Net cash provided by operating activities
INVESTING ACTIVITIES
Acquisition of real estate
Capital expenditures—development and redevelopment
Capital expenditures—other
Proceeds from sale of real estate
Distribution from real estate partnership in excess of earnings
Leasing costs
Issuance of mortgage and other notes receivable, net
Net cash used in investing activities
FINANCING ACTIVITIES
Net (repayment) borrowings under revolving credit facility, net of costs
Issuance of senior notes, net of costs
Purchase and retirement of senior notes/debentures
Issuance of mortgages, capital leases and notes payable, net of costs
Repayment of mortgages, capital leases and notes payable
Extension fee on term loan
Issuance of common shares
Dividends paid to common and preferred shareholders
Distributions to noncontrolling interests
Net cash provided by (used in) financing activities
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of period
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Notes to Consolidated Financial Statements
September 30, 2009
NOTE A—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business and Organization
Federal Realty Investment Trust (the “Trust”) is an equity real estate investment trust specializing in the ownership, management, and redevelopment of retail and mixed-use properties. Our properties are located primarily in densely populated and affluent communities in strategically selected metropolitan markets in the Mid-Atlantic and Northeast regions of the United States, as well as in California. As of September 30, 2009, we owned or had a majority interest in community and neighborhood shopping centers and mixed-use projects which are operated as 84 predominantly retail real estate properties.
We operate in a manner intended to enable us to qualify as a real estate investment trust (or REIT) for federal income tax purposes. A REIT that distributes at least 90% of its REIT taxable income to its shareholders each year and meets certain other conditions is not taxed on that portion of its taxable income which is distributed to its shareholders. Therefore, federal income taxes on our REIT taxable income have been and are generally expected to be immaterial. We are obligated to pay state taxes, generally consisting of franchise or gross receipts taxes in certain states. Such state taxes also have not been material.
Basis of Presentation
Our consolidated financial statements include the accounts of the Trust, its corporate subsidiaries, and all entities in which the Trust has a controlling interest or has been determined to be the primary beneficiary of a variable interest entity (“VIE”). The equity interests of other investors are reflected as noncontrolling interests. All significant intercompany transactions and balances are eliminated in consolidation. We account for our interests in joint ventures, which we do not control or manage, using the equity method of accounting. Subsequent events have been evaluated through November 4, 2009, which is the date the financial statements were issued. Certain 2008 amounts have been reclassified to conform to current period presentation.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America, referred to as “GAAP,” requires management to make estimates and assumptions that in certain circumstances affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and revenues and expenses. These estimates are prepared using management’s best judgment, after considering past, current and expected events and economic conditions. Actual results could differ from these estimates.
Segment Information
Our primary business is the ownership, management, and redevelopment of retail and mixed use properties. We review operating and financial information for each property on an individual basis and therefore, each property represents an individual operating segment. We evaluate financial performance using property operating income, which consists of rental income, other property income and mortgage interest income, less rental expenses and real estate taxes. No individual property constitutes more than 10% of our revenues or property operating income and we have no operations outside of the United States of America. Therefore, we have aggregated our properties into one reportable segment as the properties share similar long-term economic characteristics and have other similarities including the fact that they are operated using consistent business strategies, are typically located in major metropolitan areas, and have similar tenant mixes.
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Notes to Consolidated Financial Statements—(Continued)
Consolidated Statements of Cash Flows—Supplemental Disclosures
The following table provides supplemental disclosures related to the Consolidated Statements of Cash Flows:
SUPPLEMENTAL DISCLOSURES:
Total interest costs incurred
Interest capitalized
Cash paid for interest, net of amounts capitalized
Cash (received) paid for income taxes
NON-CASH FINANCING AND INVESTING TRANSACTIONS:
Mortgage loans assumed with acquisition
Extinguishment of capital lease obligation
Note payable issued with acquisition
Increase in valuation of interest rate swap
Capitalized lease costs are direct costs incurred which were essential to originate a lease and would not have been incurred had the leasing transaction not taken place. These costs include third party commissions and salaries and personnel costs related to obtaining a lease. Capitalized lease costs are amortized over the initial term of the related lease which generally ranges from three to ten years. We view these lease costs as part of the up-front initial investment we made in order to generate a long-term cash inflow and therefore, we classify cash outflows related to leasing costs as an investing activity in our Consolidated Statements of Cash Flows.
FASB Accounting Standards Codification
In June 2009, the Financial Accounting Standards Board (“FASB”) issued new accounting requirements, which make the FASB Accounting Standards Codification (“Codification”) the single source of authoritative literature for U.S. accounting and reporting standards. The Codification is not meant to change existing GAAP but rather provide a single source for all literature. We adopted the standard during the quarter ended September 30, 2009, which required us to change certain disclosures in our financial statements to reflect Codification references or “plain English” references rather than references to FASB Statements, Staff Positions or Emerging Issues Task Force Abstracts. The adoption of this requirement did not have a material impact on our consolidated financial statements.
Recently Adopted Accounting Pronouncements
Effective January 1, 2009, we adopted a new accounting standard that broadens and clarifies the definition of a business, which will result in significantly more of our acquisitions being treated as business combinations rather than asset acquisitions. The new requirement is effective for business combinations for which the acquisition date is on or after January 1, 2009, and therefore, will only impact prospective acquisitions with no change to the accounting for acquisitions completed prior to or on December 31, 2008. The new standard requires us to expense all acquisition related transaction costs as incurred which could include broker fees, transfer taxes, legal, accounting, valuation, and other professional and consulting fees. For acquisitions prior to January 1, 2009, these costs were capitalized as part of the acquisition cost. While the adoption did not have a material impact on our financial statements for the three and nine months ended September 30, 2009, the impact to our future consolidated financial statements will vary significantly depending on the timing and number of acquisitions or potential acquisitions, size of the acquisitions, and location of the acquisitions. Based on acquisitions in the last three years, transaction costs for single asset acquisitions typically ranged from $0.1 million to $1.0 million with significantly higher transaction costs for an acquisition of a larger portfolio. The new standard includes several other changes to the accounting for business combinations including requiring contingent consideration to be measured at fair value at acquisition and subsequently remeasured through the income statement if accounted for as a liability as the fair value changes, any adjustments during the purchase price allocation period to be “pushed back” to the acquisition date with prior periods being adjusted for any changes, and the business combination to be accounted for on the acquisition date or the date control is obtained. During 2008, we expensed all acquisition related costs for acquisitions which did not close prior to December 31, 2008.
Effective January 1, 2009, we adopted a new accounting standard that significantly changes the accounting and reporting of minority interests in the consolidated financial statements and requires a noncontrolling interest, which was previously referred to as a minority interest, to be recognized as a component of equity rather than included in the mezzanine section of the balance sheet where it was previously presented. On January 1, 2009, we reclassified $32.4 million from the mezzanine section of the balance sheet to shareholders’ equity. The terminology “minority interest” has been changed to “noncontrolling interest”. The “minority interest” caption on the statement of operations is now reflected as “net income attributable to noncontrolling interests” and shown after
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consolidated net income. This is a presentation only change for minority interest on both the balance sheet and statement of operations and has no impact to net income, total liabilities and shareholders’ equity, or earnings per share. The statement also requires the recognition of 100% of the fair value of assets acquired and liabilities assumed in acquisitions of less than 100% controlling interest with subsequent acquisitions of the noncontrolling interest recorded as equity transactions. The new accounting standard was adopted effective January 1, 2009 and has been applied prospectively except for the presentation changes to the balance sheet and statement of operations which have been applied retrospectively in the 2008 consolidated financial statements. While there was no additional impact on the consolidated financial statements during the three and nine months ended September 30, 2009, the impact on our future consolidated financial statements will vary depending on the level of transactions with entities involving noncontrolling interests.
Effective January 1, 2009, we adopted a new accounting standard that requires enhanced disclosures about an entity’s derivative instruments and hedging activities. The adoption did not have an impact on our consolidated financial statements as we currently have no derivative instruments outstanding.
Effective January 1, 2009, we adopted a new accounting standard which impacts the treatment of unvested share-based payment awards in the earnings per share calculation. The impact of the adoption on our consolidated financial statements is further discussed in Note J to these consolidated financial statements.
Effective January 1, 2009, we adopted a new accounting standard which clarifies the accounting for certain transactions and impairment considerations involving equity method investments. The new accounting standard clarifies that equity method investments should initially be measured at cost, the issuance of shares by the investee would result in a gain or loss on issuance of shares reflected in the income statement of the equity investor, and that a loss in value of an equity investment which is other than a temporary decline should be recognized. The standard was effective on a prospective basis beginning on January 1, 2009, and did not have a material impact on our financial position, results of operations, or cash flows.
During the quarter ended June 30, 2009, we adopted a new accounting standard which requires disclosure regarding the fair value of financial instruments for interim reporting periods as well as in annual financial statements. We have included the additional disclosures in Note E to these consolidated financial statements.
During the quarter ended June 30, 2009, we adopted a new accounting standard which establishes general standards of accounting and disclosure of events that occur after the balance sheet date but before the financial statements are issued or available to be issued and requires disclosure of the date through which subsequent events have been evaluated. We have added disclosure in Note A under “Basis of Presentation” regarding the date through which we have evaluated subsequent events.
Recently Issued Accounting Pronouncements
In June 2009, the FASB issued Statement No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS No. 167”), which provides certain changes to the evaluation of a VIE including requiring a qualitative rather than quantitative analysis to determine the primary beneficiary of a VIE, continuous assessments of whether an enterprise is the primary beneficiary of a VIE, and enhanced disclosures about an enterprise’s involvement with a VIE. The statement is effective January 1, 2010, and is applicable to all entities in which an enterprise has a variable interest. We are currently evaluating the impact SFAS No. 167 will have on our consolidated financial statements.
NOTE B—REAL ESTATE
On June 26, 2009, one of our tenants acquired from us our fee interest in a land parcel in White Marsh, Maryland, that was subject to a long-term ground lease. The ground lease involved an option for the tenant to purchase the fee interest. The sales price was $2.1 million and resulted in a gain of $0.4 million.
The revenue from properties included in discontinued operations was $0 and $0.8 million for the three months ended September 30, 2009 and 2008, respectively, and $0.2 million and $2.8 million for the nine months ended September 30, 2009 and 2008, respectively.
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NOTE C—REAL ESTATE PARTNERSHIP
We have a joint venture arrangement (“the Partnership”) with affiliates of a discretionary fund created and advised by ING Clarion Partners (“Clarion”). We own 30% of the equity in the Partnership and Clarion owns 70%. We hold a general partnership interest, however, Clarion has substantive participating rights and we cannot make significant decisions without Clarion’s approval. Accordingly, we account for our interest in the Partnership using the equity method. As of September 30, 2009, the Partnership owned seven retail real estate properties. We are the manager of the Partnership and its properties, earning fees for acquisitions, dispositions, management, leasing, and financing. We also have the opportunity to receive performance-based earnings through our Partnership interest.
The following tables provide summarized operating results and the financial position of the Partnership:
OPERATING RESULTS
Revenue
Expenses
Other operating expenses
Total expenses
Our share of net income from real estate partnership
BALANCE SHEETS
Real estate, net
Cash
Other assets
Total assets
Other liabilities
Partners’ capital
Total liabilities and partners’ capital
Our share of unconsolidated debt
Our investment in real estate partnership
NOTE D—DEBT
On January 5, 2009, we repaid the $4.4 million mortgage loan on a small portion of Mercer Mall which had an original maturity date of April 1, 2009. This loan was repaid with funds borrowed on our $300 million revolving credit facility.
On various dates from January 12, 2009 to April 1, 2009, we purchased and retired $11.1 million of our 8.75% senior notes. These notes were repaid with funds borrowed on our $300 million revolving credit facility.
On April 14, 2009, we closed on a $24.1 million, ten year loan secured by Rollingwood Apartments in Silver Spring, Maryland. The loan bears interest at 5.54% and matures on May 1, 2019.
On May 4, 2009, we refinanced our then existing $200 million term loan with a new $372 million term loan which bears interest at LIBOR, subject to a 1.50% floor, plus 300 basis points and matures on July 27, 2011. The $200 million term loan and the $135 million outstanding balance on our revolving credit facility were repaid with the proceeds from the new $372 million term loan.
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On June 4, 2009, we closed on a $139.0 million, five year loan secured by Idylwood Plaza, Loehmann’s Plaza, Leesburg Plaza and Pentagon Row. The loan bears interest at 7.50% and matures on June 5, 2014.
Also on June 4, 2009, we completed a cash tender offer for our 8.75% senior notes due December 1, 2009. Approximately $40.3 million of notes were purchased and retired at a 2% premium to par value resulting in a net loss on early extinguishment of approximately $1.0 million including costs of the transaction; this amount is included in “early extinguishment of senior notes” in the consolidated statement of operations. The notes were repaid with funds from our $372 million term loan.
On August 13, 2009, we issued $150.0 million of fixed rate senior notes that mature on August 15, 2014 and bear interest at 5.95%. The net proceeds from this note offering after issuance discounts, underwriting fees and other costs were $147.5 million.
As of and for the three months ended September 30, 2009, the balance outstanding on our revolving credit facility was $0. During the nine months ended September 30, 2009, the maximum amount of borrowings outstanding under our $300 million revolving credit facility was $172.5 million and the weighted average amount of borrowings outstanding was $63.7 million. Our revolving credit facility had a weighted average interest rate, before amortization of debt fees, of 1.37% for the nine months ended September 30, 2009.
Our revolving credit facility, term loan, and certain notes require us to comply with various financial covenants, including the maintenance of minimum shareholders’ equity and debt coverage ratios and a maximum ratio of debt to net worth. As of September 30, 2009, we were in compliance with all loan covenants.
NOTE E—FAIR VALUE OF FINANCIAL INSTRUMENTS
Except as disclosed below, the carrying amount of our financial instruments approximates their fair value. The fair value of our mortgages payable, notes payable, and senior notes and debentures is sensitive to fluctuations in interest rates. Quoted market prices were used to estimate the fair value of our marketable senior notes and debentures and discounted cash flow analysis is generally used to estimate the fair value of our mortgages and notes payable. Considerable judgment is necessary to estimate the fair value of financial instruments. The estimates of fair value presented herein are not necessarily indicative of the amounts that could be realized upon disposition of the financial instruments. A summary of the carrying amount and fair value of our mortgages payable, notes payable and senior notes and debentures is as follows:
Mortgages and notes payable
NOTE F—COMMITMENTS AND CONTINGENCIES
We are currently a party to various legal proceedings. Other than as described below, we do not believe that the ultimate outcome of these matters, either individually or in the aggregate, could have a material adverse effect on our financial position or overall trends in results of operations; however, litigation is subject to inherent uncertainties. Also under our leases, tenants are typically obligated to indemnify us from and against all liabilities, costs and expenses imposed upon or asserted against us (1) as owner of the properties due to certain matters relating to the operation of the properties by the tenant, and (2) where appropriate, due to certain matters relating to the ownership of the properties prior to their acquisition by us.
In May 2003, a breach of contract action was filed against us which alleged that a one page document entitled “Final Proposal” constituted a ground lease of a parcel of property located adjacent to our Santana Row property and gave the plaintiff the option to require that we acquire the property at a price determined in accordance with a formula included in the “Final Proposal.” The “Final Proposal” explicitly stated that it was subject to approval of the terms and conditions of a formal agreement. A trial as to liability only was held in June 2006 and a jury rendered a verdict against us. A trial on the issue of damages was held in April 2008 and the court issued a tentative ruling in April 2009 awarding damages to the plaintiff of approximately $14.4 million plus interest. Based on this tentative ruling, we estimated interest could range from $2.1 million to $8.4 million. Accordingly, considering all the information available to us on May 6, 2009, when we filed our Form 10-Q for the three months ended March 31, 2009, our best estimate of damages, interest, and other costs was $21.4 million. Accordingly, we increased our accrual for the matter from $0.8 million at December 31, 2008, to $21.4 million at March 31, 2009. The increase in our accrual of $20.6 million is presented as a separate line
item in our consolidated statement of operations, and the $21.4 million accrual is included in the “accounts payable and accrued expenses” line item in our consolidated balance sheet as of September 30, 2009.
In June 2009, the court issued a final judgment awarding damages of $15.9 million (including interest) plus costs of suit. In July 2009, we and the plaintiff both filed a notice of appeal. The plaintiff also filed reimbursement motions for $2.1 million of legal fees, expert fees, and court costs of which $1.9 million was subsequently denied.
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We expect the appeal process will take in excess of a year to complete; all judgments will be stayed until completion of the appeals. Given the uncertainty surrounding the final outcome of the lawsuit, no further adjustment was made to the $21.4 million litigation provision accrual. During the three and nine months ended September 30, 2009, we incurred additional legal and other costs related to the lawsuit and appeal process which are also included in the “litigation provision” line item in the consolidated statement of operations. Furthermore, we continue to believe that the “Final Proposal” which included express language that it was subject to formal documentation was not a binding contract and that we should have no liability whatsoever, and will vigorously defend our position as part of the appeal process.
In March 2009, we entered into a settlement agreement with our insurance provider related to repairs we performed on certain condominium units at Santana Row as the result of defective work done by third party contractors. We recovered approximately $0.9 million, net of taxes and fees, which is included in “gain on sale of real estate from discontinued operations” as this is where the related expenses to repair the units were originally recognized.
Under the terms of certain partnership agreements, the partners have the right to exchange their operating partnership units for cash or the same number of our common shares, at our option. A total of 371,260 operating units are outstanding which have a total fair value of $22.8 million, based on our closing stock price on September 30, 2009.
NOTE G—SHAREHOLDERS’ EQUITY
On August 14, 2009, we issued 2.0 million common shares at $57.50 per share, for cash proceeds of approximately $110.0 million net of expenses of the offering.
The following table provides a summary of dividends declared and paid per share:
Common shares
5.417% Series 1 Cumulative Convertible Preferred
NOTE H—COMPONENTS OF RENTAL INCOME
The principal components of rental income are as follows:
Minimum rents
Retail and commercial
Residential
Cost reimbursement
Percentage rent
Other
Total rental income
Minimum rents include $1.3 million and $1.4 million for the three months ended September 30, 2009 and 2008, respectively, and $3.9 million and $4.2 million for the nine months ended September 30, 2009 and 2008, respectively, to recognize minimum rents on a straight-line basis. In addition, minimum rents include $0.4 million and $0.6 million for the three months ended September 30, 2009 and 2008, respectively, and $1.1 million and $1.9 million for the nine months ended September 30, 2009 and 2008, respectively, to recognize income from the amortization of in-place leases. Residential minimum rents consist of the rental amounts for residential units at Rollingwood Apartments, the Crest at Congressional Plaza Apartments, Santana Row, and Arlington East (Bethesda Row). The first rental units at Arlington East were delivered and became rent paying in late May 2008.
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NOTE I—SHARE-BASED COMPENSATION PLANS
A summary of share-based compensation expense included in net income is as follows:
Share-based compensation incurred
Grants of common shares
Grants of options
Capitalized share-based compensation
Share-based compensation expense
NOTE J—EARNINGS PER SHARE
In June 2008, the FASB issued a new accounting standard which requires unvested share-based payment awards that contain non-forfeitable rights to receive dividends (whether paid or unpaid) to be treated as participating securities and should be included in computation of EPS pursuant to the two-class method. As part of our stock based compensation program, we issue restricted shares which typically vest over a three to six year period; these shares have non-forfeitable rights to dividends immediately after issuance. Prior to January 1, 2009, we excluded the unvested shares from the basic EPS calculation and included them in diluted earnings per share using the treasury stock method.
Effective January 1, 2009, we adopted the new accounting standard and have calculated earnings per share under the two-class method. The two-class method is an earnings allocation methodology whereby earnings per share for each class of common stock and participating securities is calculated according to dividends declared and participation rights in undistributed earnings. For each of the three and nine months ended September 30, 2009 and 2008, we had approximately 0.2 million weighted average unvested shares outstanding which are considered participating securities. Therefore, we have allocated our earnings for basic and diluted EPS between common shares and unvested shares; the portion of earnings allocated to the unvested shares is reflected as “earnings allocated to unvested shares” in the reconciliation below.
In the dilutive EPS calculation, dilutive stock options were calculated using the treasury stock method consistent with prior periods; certain stock options have been excluded as they were anti-dilutive. The conversions of downREIT operating partnership units and Series 1 Preferred Shares are anti-dilutive for all periods presented and accordingly, have been excluded from the weighted average common shares used to compute diluted earnings per share.
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EPS for prior periods has been restated to conform to the requirements of the new accounting standard. The implementation did not result in a significant change to basic or diluted earnings per share for the periods presented. The following table provides a reconciliation between basic and diluted earnings per share:
NUMERATOR
Income from continuing operations
Preferred stock dividends
Less: Net income attributable to noncontrolling interests
Less: Earnings allocated to unvested shares
Income from continuing operations available for common shareholders
Net income available for common shareholders, basic and diluted
DENOMINATOR
Weighted average common shares outstanding—basic
Effect of dilutive securities:
Stock options
Weighted average common shares outstanding—diluted
Income from continuing operations attributable to the Trust
NOTE K—SUBSEQUENT EVENTS
In October 2009, we acquired 16.6 acres of riverfront property at Assembly Square in Sommerville, Massachusetts, for use in future development in exchange for $8 million and the sale of 11.9 acres of adjacent inland land.
On October 27, 2009, we repaid $100 million of our existing $372 million term loan. The term loan has an original maturity date of July 27, 2011, however, the loan agreement includes an option to prepay the loan, in whole or in part, at any time without premium or penalty. Due to this repayment, approximately $1.4 million of unamortized debt fees were expensed in October 2009.
Forward-Looking Statements
The following discussion should be read in conjunction with the consolidated interim financial statements and notes thereto appearing in Item 1 of this report and the more detailed information contained in our Annual Report on Form 10-K for the year ended December 31, 2008 filed with the Securities and Exchange Commission on February 26, 2009 and amended on June 25, 2009.
This Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995. When we refer to forward-looking statements or information, sometimes we use words such as “may,” “will,” “could,” “should,” “plans,” “intends,” “expects,” “believes,” “estimates,” “anticipates” and “continues.” Forward-looking statements are not historical facts or guarantees of future performance and involve certain known and unknown risks, uncertainties, and other factors, many of which are outside our control, that could cause actual results to differ materially from those we describe.
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Given these uncertainties, readers are cautioned not to place undue reliance on any forward-looking statements that we make, including those in this Quarterly Report on Form 10-Q. Except as may be required by law, we make no promise to update any of the forward-looking statements as a result of new information, future events or otherwise. You should carefully review the risks and the risk factors included in our Annual Report on Form 10-K (as amended) for the year ended December 31, 2008, before making any investments in us.
Overview
We are an equity real estate investment trust (“REIT”) specializing in the ownership, management, and redevelopment of high quality retail and mixed-use properties located primarily in densely populated and affluent communities in strategically selected metropolitan markets in the Northeast and Mid-Atlantic regions of the United States, as well as in California. As of September 30, 2009, we owned or had a majority interest in community and neighborhood shopping centers and mixed-use projects which are operated as 84 predominantly retail real estate properties comprising approximately 18.2 million square feet. In total, the real estate properties were 94.2% leased and 93.1% occupied at September 30, 2009. A joint venture in which we own a 30% interest owned seven retail real estate properties totaling approximately 1.0 million square feet as of September 30, 2009. In total, the joint venture properties in which we own an interest were 85.6% leased and occupied at September 30, 2009.
2009 Property Disposition
2009 Significant Debt, Equity and Other Transactions
Litigation Provision
In May 2003, a breach of contract action was filed against us which alleged that a one page document entitled “Final Proposal” constituted a ground lease of a parcel of property located adjacent to our Santana Row property and gave the plaintiff the option to require that we acquire the property at a price determined in accordance with a formula included in the “Final Proposal.” The “Final Proposal” explicitly stated that it was subject to approval of the terms and conditions of a formal agreement. A trial as to liability only was held in June 2006 and a jury rendered a verdict against us. A trial on the issue of damages was held in April 2008 and the court issued a tentative ruling in April 2009 awarding damages to the plaintiff of approximately $14.4 million plus interest. Based on this tentative ruling, we estimated interest could range from $2.1 million to $8.4 million. Accordingly, considering all the information available to us on May 6, 2009, when we filed our Form 10-Q for the three months ended March 31, 2009, our best estimate of damages, interest, and other costs was $21.4 million. Accordingly, we increased our accrual for the matter from $0.8 million at
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December 31, 2008, to $21.4 million at March 31, 2009. The increase in our accrual of $20.6 million is presented as a separate line item in our consolidated statement of operations, and the $21.4 million accrual is included in the “accounts payable and accrued expenses” line item in our consolidated balance sheet as of September 30, 2009.
In June 2009, the court issued a final judgment awarding damages of $15.9 million (including interest) plus costs of suit. In July 2009, we and the plaintiff both filed a notice of appeal. The plaintiff also filed reimbursement motions for $2.1 million of legal fees, expert fees, and court costs of which $1.9 million was subsequently denied. We expect the appeal process will take in excess of a year to complete; all judgments will be stayed until completion of the appeals. Given the uncertainty surrounding the final outcome of the lawsuit, no further adjustment was made to the $21.4 million litigation provision accrual. During the three and nine months ended September 30, 2009, we incurred additional legal and other costs related to the lawsuit and appeal process which are also included in the “litigation provision” line item in the consolidated statement of operations. Furthermore, we continue to believe that the “Final Proposal” which included express language that it was subject to formal documentation was not a binding contract and that we should have no liability whatsoever, and will vigorously defend our position as part of the appeal process.
Outlook
We seek growth in earnings, funds from operations, and cash flows primarily through a combination of the following:
growth in our same-center portfolio,
growth in our portfolio from property redevelopments, and
expansion of our portfolio through property acquisitions.
Our same-center growth is primarily driven by increases in rental rates on new leases and lease renewals. Over the long-term, the infill nature and strong demographics of our properties provide a strategic advantage allowing us to maintain relatively high occupancy and increase rental rates. The current economic environment may, however, impact our ability to increase rental rates in the short-term and may require that we decrease some rental rates in the short-term. We seek to maintain a mix of strong national, regional, and local retailers. At September 30, 2009, no single tenant accounted for more than 2.6% of annualized base rent.
Our properties are located in densely populated or affluent areas with high barriers to entry which allow us to take advantage of redevelopment opportunities that enhance our operating performance through renovation, expansion, reconfiguration, and/or retenanting. We evaluate our properties on an ongoing basis to identify these types of opportunities and believe that the decrease in occupancy we have experienced beginning in 2008 as a result of the economic recession will provide future redevelopment opportunities that may not otherwise have been available.
We continue to review acquisition opportunities in our primary markets that complement our portfolio and provide long term opportunities. Generally, our acquisitions do not initially contribute significantly to earnings growth; however, they provide long term re-leasing growth, redevelopment opportunities, and other strategic opportunities. Any growth from acquisitions is contingent on our ability to find properties that meet our qualitative standards at prices that meet our financial hurdles. Changes in interest rates may affect our success in achieving earnings growth through acquisitions by affecting both the price that must be paid to acquire a property, as well as our ability to economically finance the property acquisition.
The current downturn in the economy may impact the success of our tenants’ retail operations and therefore the amount of rent and expense reimbursements we receive from our tenants. We have seen some tenants experiencing declining sales, vacating early, or filing for bankruptcy, as well as seeking rent relief from us as landlord. Any reduction in our tenants’ ability to pay base rent, percentage rent or other charges, will adversely affect our financial condition and results of operations. Further, our ability to re-lease vacant spaces may be negatively impacted by the current economic environment. While we believe the locations of our centers and diverse tenant base should decrease the negative impact of the economic environment, we have and are likely to continue to see an increase in vacancy that will have a negative impact to our revenue and bad debt expense. We continue to monitor our tenants’ operating performance as well as trends in the retail industry to evaluate any future impact.
At September 30, 2009, the leasable square feet in our shopping centers was 93.1% occupied and 94.2% leased. The leased rate is higher than the occupied rate due to leased spaces that are being redeveloped or improved or that are awaiting permits and, therefore, are not yet ready to be occupied. Our occupancy and leased rates are subject to variability over time due to factors including acquisitions, the timing of the start and stabilization of our redevelopment projects, lease expirations and tenant bankruptcies.
Same-Center
Throughout this section, we have provided certain information on a “same-center” basis. Information provided on a same-center basis includes the results of properties that we owned and operated for the entirety of both periods being compared except for properties for which significant redevelopment or expansion occurred during either of the periods being compared and properties classified as discontinued operations.
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RESULTS OF OPERATIONS—THREE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008
Total property revenue
Total property expenses
Property operating income
General and administrative expense
Total other, net
Net income attributable to the Trust
Property Revenues
Total property revenue decreased $0.7 million, or 0.5%, to $131.0 million in the three months ended September 30, 2009 compared to $131.7 million in the three months ended September 30, 2008. The percentage occupied at our shopping centers decreased to 93.1% at September 30, 2009 compared to 94.8% at September 30, 2008. Changes in the components of property revenue are discussed below.
Rental Income
Rental income consists primarily of minimum rent, cost reimbursements from tenants and percentage rent. Rental income decreased $0.4 million, or 0.3%, to $126.2 million in the three months ended September 30, 2009 compared to $126.6 million in the three months ended September 30, 2008 due primarily to the following:
a decrease of $1.9 million at same-center properties due primarily to $2.6 million of lower cost reimbursements,
a decrease of $0.2 million as a result of having demolished an operating property in 2008 for use in future development,
partially offset by
an increase of $ 0.9 million at redevelopment properties due primarily to increased rental revenue from newly created retail and residential spaces, and
an increase of $ 0.7 million attributable to properties acquired in 2008.
Property Expenses
Total property expenses decreased $3.4 million, or 8.0%, to $38.9 million in the three months ended September 30, 2009 compared to $42.2 million in the three months ended September 30, 2008. Changes in the components of property expenses are discussed below.
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Rental Expenses
Rental expenses decreased $3.2 million, or 11.5%, to $24.4 million in the three months ended September 30, 2009 compared to $27.5 million in the three months ended September 30, 2008. This decrease is due primarily to the following:
a decrease of $1.1 million in repairs and maintenance at same-center properties,
a decrease of $0.6 million in marketing expenses at same-center and redevelopment properties,
a decrease of $0.5 million in utilities at same-center properties,
a decrease of $0.4 million in ground rent expense at same-center properties due primarily to the acquisition of the fee interest in two land parcels at Bethesda Row in 2008, and
a decrease of $0.3 million in insurance expense at same-center properties.
As a result of the changes in rental income, rental expenses and other property income, rental expenses as a percentage of rental income plus other property income decreased to 18.8% in the three months ended September 30, 2009 from 21.1% in the three months ended September 30, 2008.
Real Estate Taxes
Real estate tax expense decreased $0.2 million, or 1.4%, to $14.5 million in the three months ended September 30, 2009 compared to $14.7 million in the three months ended September 30, 2008. This decrease is due primarily to a decrease of $0.7 million related to same-center properties partially offset by an increase of $0.6 million related primarily to higher tax assessments at redevelopment properties and properties acquired in 2008.
Property Operating Income
Property operating income increased $2.7 million, or 3.0%, to $92.1 million in the three months ended September 30, 2009 compared to $89.5 million in the three months ended September 30, 2008. This increase is due primarily to growth in earnings at same-center and redevelopment properties and earnings attributable to properties acquired in 2008.
Other Interest Income
Other interest income increased $0.8 million, or 703.5%, to $0.9 million in the three months ended September 30, 2009 compared to $0.1 million in the three months ended September 30, 2008. This increase is due primarily to investing the funds from our second quarter and August 2009 debt and equity transactions on a short term basis in money market and other highly liquid investments while we evaluate the current environment to determine the best use of the proceeds in addition to repaying the 8.75% senior notes that mature in December 2009.
Interest Expense
Interest expense increased $4.9 million, or 19.2%, to $30.2 million in the three months ended September 30, 2009 compared to $25.3 million in the three months ended September 30, 2008. This increase is due primarily to the following:
an increase of $4.0 million due to higher borrowings as a result of the second quarter 2009 debt refinancings completed in advance of debt maturing as well as the issuance of $150.0 million of senior notes in August 2009,
an increase of $1.2 million due to a higher overall weighted average borrowing rate,
an increase of $0.4 million in capitalized interest.
See additional discussion of the debt financings in the second and third quarters of 2009 and the expected uses of the cash proceeds in the Liquidity and Capital Resources section of this Form 10-Q.
Gross interest costs were $31.4 million and $26.2 million in the three months ended September 30, 2009 and 2008, respectively. Capitalized interest was $1.2 million and $0.8 million in the three months ended September 30, 2009 and 2008, respectively.
General and Administrative Expense
General and administrative expense increased $0.4 million, or 6.6%, to $5.7 million in the three months ended September 30, 2009 compared to $5.4 million in the three months ended September 30, 2008. The increase is primarily due to expensing previously capitalized predevelopment costs partially offset by lower personnel related costs and overall cost reduction efforts.
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The $0.3 million litigation provision in the three months ended September 30, 2009 is due to certain costs related to the litigation and appeal process over a parcel of land located adjacent to Santana Row. See Note F to the consolidated financial statements in this Form 10-Q for further discussion on the litigation.
Depreciation and Amortization
Depreciation and amortization expense decreased $0.2 million, or 0.8%, to $28.4 million in the three months ended September 30, 2009 from $28.6 million in the three months ended September 30, 2008. This decrease is due primarily to accelerated depreciation in 2008 related to the change in use of a redevelopment building which was later demolished partially offset by increased depreciation on newly completed redevelopment projects and 2008 acquisitions.
RESULTS OF OPERATIONS—NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008
Total property revenue increased $5.7 million, or 1.5%, to $392.4 million in the nine months ended September 30, 2009 compared to $386.7 million in the nine months ended September 30, 2008. The percentage occupied at our shopping centers decreased to 93.1% at September 30, 2009 compared to 94.8% at September 30, 2008. Changes in the components of property revenue are discussed below.
Rental income consists primarily of minimum rent, cost reimbursements from tenants and percentage rent. Rental income increased $8.2 million, or 2.2%, to $379.5 million in the nine months ended September 30, 2009 compared to $371.3 million in the nine months ended September 30, 2008 due primarily to the following:
an increase of $6.2 million at redevelopment properties due primarily to increased rental revenue from newly created retail and residential spaces and increased cost reimbursements,
an increase of $4.5 million attributable to properties acquired in 2008,
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a decrease of $1.3 million at same-center properties due to $5.1 million lower percentage rent and cost reimbursements offset by $3.3 million increase in minimum rent primarily as a result of increased rental rates on new and renewal leases, and
a decrease of $1.2 million as a result of having demolished an operating property in 2008 for use in future development.
Other Property Income
Other property income decreased $2.8 million, or 22.9%, to $9.3 million in the nine months ended September 30, 2009 compared to $12.0 million in the nine months ended September 30, 2008. Included in other property income are items which, although recurring, tend to fluctuate more than rental income from period to period, such as lease termination fees. This decrease is due primarily to a decrease in lease and other termination fees at same-center properties partially offset by an increase in lease and other termination fees at redevelopment properties.
Total property expenses decreased $0.8 million, or 0.7%, to $121.3 million in the nine months ended September 30, 2009 compared to $122.1 million in the nine months ended September 30, 2008. Changes in the components of property expenses are discussed below.
Rental expenses decreased $2.8 million, or 3.5%, to $78.1 million in the nine months ended September 30, 2009 compared to $81.0 million in the nine months ended September 30, 2008. This decrease is due primarily to the following:
a decrease of $1.4 million in ground rent expense at same-center properties due primarily to the acquisition of the fee interest in two land parcels at Bethesda Row in 2008,
a decrease of $1.3 million in marketing expense at same-center and redevelopment properties,
a decrease of $1.1 million in repairs and maintenance expense, due primarily to lower maintenance costs partially offset by increased snow removal costs, at same-center properties,
a decrease of $0.7 million in insurance expense at same-center properties,
a decrease of $0.4 million in other operating cost, due primarily to lower legal fees, at same-center and redevelopment properties,
a decrease of $0.4 million as a result of having demolished an operating property in 2008 for use in future development,
an increase of $1.8 million in bad debt expense at same-center and redevelopment properties, and
an increase of $1.0 million attributable to properties acquired in 2008.
As a result of the changes in rental income, rental expenses and other property income described above, rental expenses as a percentage of rental income plus other property income decreased to 20.1% in the nine months ended September 30, 2009 from 21.1% in the nine months ended September 30, 2008.
Real estate tax expense increased $2.0 million, or 4.9%, to $43.1 million in the nine months ended September 30, 2009 compared to $41.1 million in the nine months ended September 30, 2008. This increase is due primarily to an increase of $1.2 million related primarily to higher tax assessments at redevelopment properties and an increase of $0.8 million related to properties acquired in 2008.
Property operating income increased $6.6 million, or 2.5%, to $271.1 million in the nine months ended September 30, 2009 compared to $264.5 million in the nine months ended September 30, 2008. This increase is due primarily to growth in earnings at redevelopment properties and earnings attributable to properties acquired in 2008 partially offset by lower earnings in our same-center portfolio as discussed above.
Other interest income increased $0.6 million, or 92.4%, to $1.3 million in the nine months ended September 30, 2009 compared to $0.7 million in the nine months ended September 30, 2008. This increase is due primarily to investing the funds from our second quarter and August 2009 debt and equity transactions on a short term basis in money market and other highly liquid investments while we evaluate the current environment to determine the best use of the proceeds in addition to repaying the 8.75% senior notes that mature in December 2009.
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Interest expense increased $5.5 million, or 7.4%, to $79.6 million in the nine months ended September 30, 2009 compared to $74.2 million in the nine months ended September 30, 2008. This increase is due primarily to the following:
an increase of $8.5 million due to higher borrowings as a result of the second quarter 2009 debt refinancings completed in advance of debt maturing as well as the issuance of $150.0 million of senior notes in August 2009,
a decrease of $3.0 million due to a lower overall weighted average borrowing rate, and
an increase of $0.1 million in capitalized interest.
Gross interest costs were $83.8 million and $78.3 million in the nine months ended September 30, 2009 and 2008, respectively. Capitalized interest was $4.2 million and $4.1 million in the nine months ended September 30, 2009 and 2008, respectively.
Early Extinguishment of Senior Notes
The $1.0 million early extinguishment of senior notes for the nine months ended September 30, 2009 is primarily related to a cash tender offer for our 8.75% senior notes due December 1, 2009. On June 4, 2009, approximately $40.3 million of notes were purchased and retired at a 2% premium to par value resulting in a net loss on early extinguishment of approximately $1.0 million including costs of the transaction.
General and administrative expense decreased $3.3 million, or 16.9%, to $16.2 million in the nine months ended September 30, 2009 compared to $19.5 million in the nine months ended September 30, 2008. The decrease is primarily due to lower legal fees related to the litigation over a parcel of land adjacent to Santana Row and other legal matters as well as lower personnel related costs and overall cost reduction efforts.
The $21.1 million litigation provision in the nine months ended September 30, 2009 is due to increasing the accrual for litigation regarding a parcel of land located adjacent to Santana Row as well as other costs related to the litigation and appeal process. See Note F to the consolidated financial statements in this Form 10-Q for further discussion on the litigation.
Depreciation and amortization expense increased $4.8 million, or 5.9%, to $86.6 million in the nine months ended September 30, 2009 from $81.8 million in the nine months ended September 30, 2008. This increase is due primarily to capital improvements at same-center and redevelopment properties and 2008 acquisitions as well as accelerated depreciation for tenant improvements where the tenant vacated prior to the end of their lease term. This increase is partially offset by accelerated depreciation in 2008 related to the change in use of a redevelopment building which was later demolished.
Income from Discontinued Operations
Income from discontinued operations represents the operating income of properties that have been disposed or will be disposed, which is required to be reported separately from results of ongoing operations. The reported operating income of $0.2 million and $1.7 million for the nine months ended September 30, 2009 and 2008, respectively, represents the operating income for the period during which we owned properties sold in 2009 and 2008.
Gain on Sale of Real Estate from Discontinued Operations
The $1.3 million gain on sale of real estate from discontinued operations for the nine months ended September 30, 2009 consists primarily of $0.9 million in insurance proceeds received related to repairs we performed on certain condominium units at Santana Row as the result of defective work done by third party contractors in prior years and $0.4 million on the sale of our fee interest in a land parcel in White Marsh, Maryland, that was subject to a long-term ground lease. The $7.4 million gain on sale of real estate from discontinued operations for the nine months ended September 30, 2008 consists primarily of a $5.2 million decrease in the warranty reserve for condominium units sold at Santana Row in 2005 and 2006, $1.1 million of accrued state tax refunds applied for in 2008 related to the initial sales of the condominium units, and a $1.0 million gain on the sale of four land parcels in Maryland and Massachusetts.
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In June 2009, the FASB issued new accounting requirements, which make the FASB Accounting Standards Codification (“Codification”) the single source of authoritative literature for U.S. accounting and reporting standards. The Codification is not meant to change existing GAAP but rather provide a single source for all literature. We adopted the standard during the quarter ended September 30, 2009, which required us to change certain disclosures in our financial statements to reflect Codification references rather than references to FASB Statements, Staff Positions or Emerging Issues Task Force Abstracts. The adoption of this requirement did not have a material impact on our consolidated financial statements.
Effective January 1, 2009, we adopted a new accounting standard that significantly changes the accounting and reporting of minority interests in the consolidated financial statements and requires a noncontrolling interest, which was previously referred to as a minority interest, to be recognized as a component of equity rather than included in the mezzanine section of the balance sheet where it was previously presented. On January 1, 2009, we reclassified $32.4 million from the mezzanine section of the balance sheet to shareholders’ equity. The terminology “minority interest” has been changed to “noncontrolling interest”. The “minority interest” caption on the statement of operations is now reflected as “net income attributable to noncontrolling interests” and shown after consolidated net income. This is a presentation only change for minority interest on both the balance sheet and statement of operations and has no impact to net income, total liabilities and shareholders’ equity, or earnings per share. The statement also requires the recognition of 100% of the fair value of assets acquired and liabilities assumed in acquisitions of less than 100% controlling interest with subsequent acquisitions of the noncontrolling interest recorded as equity transactions. The new accounting standard was adopted effective January 1, 2009 and has been applied prospectively except for the presentation changes to the balance sheet and statement of operations which have been applied retrospectively in the 2008 consolidated financial statements. While there was no additional impact on the consolidated financial statements during the three and nine months ended September 30, 2009, the impact on our future consolidated financial statements will vary depending on the level of transactions with entities involving noncontrolling interests.
Effective January 1, 2009, we adopted a new accounting standard that defines unvested share-based payment awards that contain non-forfeitable rights to receive dividends (whether paid or unpaid) as participating securities that should be included in the computation of EPS pursuant to the two-class method. As part of our stock based compensation program, we issue restricted shares which typically vest over a three to six year period; these shares have non-forfeitable rights to dividends immediately after issuance. Prior to January 1, 2009, we excluded the unvested shares from the basic EPS calculation and included them using the treasury stock method in diluted earnings per share. Effective January 1, 2009, we adopted the new accounting standard and have calculated earnings per share for all periods presented under the two-class method. The two-class method is an earnings allocation methodology whereby earnings per share for each class of common stock and participating securities is calculated according to dividends declared and participation rights in undistributed earnings. The implementation did not result in a significant change to basic or diluted earnings per share for all periods presented.
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During the quarter ended June 30, 2009, we adopted a new accounting standard which requires disclosure regarding the fair value of financial instruments for interim reporting periods as well as in annual financial statements. We have included the additional disclosures in Note E to the consolidated financial statements in this Form 10-Q.
Liquidity and Capital Resources
Due to the nature of our business and strategy, we typically generate significant amounts of cash from operations. The cash generated from operations is primarily paid to our common and preferred shareholders in the form of dividends. As a REIT, we must generally make annual distributions to shareholders of at least 90% of our REIT taxable income.
Our short-term liquidity requirements consist primarily of obligations under our capital and operating leases, normal recurring operating expenses, regular debt service requirements (including debt service relating to additional or replacement debt, as well as scheduled debt maturities), recurring expenditures, non-recurring expenditures (such as tenant improvements and redevelopments) and dividends to common and preferred shareholders. Our long-term capital requirements consist primarily of maturities under our long-term debt agreements, development and redevelopment costs and potential acquisitions.
We intend to operate with and maintain a conservative capital structure that will allow us to maintain strong debt service coverage and fixed-charge coverage ratios as part of our commitment to investment-grade debt ratings. In the short and long term, we may seek to obtain funds through the issuance of additional equity, unsecured and/or secured debt financings, joint venture relationships relating to existing properties or new acquisitions, and property dispositions that are consistent with this conservative structure.
At September 30, 2009, we had approximately $124 million of debt maturing during the remainder of 2009. In an effort to ensure availability and provide additional flexibility with our short term capital needs, we entered into certain financing arrangements in advance of our debt maturing. During May and June 2009, we refinanced our then existing $200 million term loan with a $372 million term loan and also entered into two separate mortgage financing agreements collateralized by five of our properties for total funds of $163.1 million. We utilized these funds to repay our $200 million term loan, the $135 million outstanding balance on our revolving credit facility, and approximately $40.3 million of our 8.75% senior notes due December 1, 2009. We will utilize the remaining proceeds to repay our debt maturing during the remainder of 2009 and other capital needs. Additionally, in August 2009, we issued $150.0 million in five-year senior notes which bear interest at 5.95% and 2.0 million common shares for combined net cash proceeds of approximately $257.5 million. As the financings completed in the second quarter 2009 provided adequate capital to fund 2009 debt maturities, the proceeds from the debt and equity offerings in August 2009 are expected to be used to fund potential acquisition opportunities, fund our redevelopment pipeline, reduce amounts outstanding on our $372 million term loan, and for general corporate purposes. The funds from both the second quarter 2009 and August 2009 transactions are being invested on a short term basis in money market and other highly liquid investments while we evaluate the current market environment and the best use for the proceeds.
Due to the refinancing of our maturing debt several months in advance of the maturity as well as additional financings in August 2009, we will incur additional interest expense due to higher interest rates on such debt and due to a temporary increase in our debt outstanding until we can use the proceeds to retire maturing debt or invest in other long term projects. We currently believe that cash flows from operations, secured and unsecured debt financings, the August 2009 equity offering, and our revolving credit facility will be sufficient to finance our operations and fund our capital expenditures.
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Our overall capital requirements during the remainder of 2009 will depend upon acquisition opportunities, the level of improvements and redevelopments of existing properties and the timing and cost of development of future phases of existing properties. While the amount of future expenditures will depend on numerous factors, we expect to incur similar levels of capital expenditures in 2009 compared to prior periods which will be funded on a short-term basis with cash flow from operations and/or the revolving credit facility, and on a long-term basis, with long term debt or equity.
In addition to the uncertain conditions in the capital markets which could affect our ability to access those markets, the following factors could affect our ability to meet our liquidity requirements:
restrictions in our debt instruments or preferred stock may limit us from incurring debt or issuing equity at all, or on acceptable terms under then-prevailing market conditions; and
we may be unable to service additional or replacement debt due to increases in interest rates or a decline in our operating performance.
Cash and cash equivalents were $408.4 million at September 30, 2009, which is a $393.2 million increase from the balance of cash and cash equivalents at December 31, 2008. The significant increase is due to the cash proceeds from financings and an equity offering discussed above. We also have a $300.0 million unsecured revolving credit facility that matures July 27, 2010, subject to a one-year extension at our option, of which we had no outstanding balance at September 30, 2009. During the nine months ended September 30, 2009, the maximum amount of borrowings outstanding under our revolving credit facility was $172.5 million and the weighted average amount of borrowings outstanding was $63.7 million. We expect to utilize cash and our revolving credit facility to fund short-term operating needs, including capital expenditures and acquisitions.
Contractual Debt Obligations – Fixed Rate Debt
The following table provides a summary of our fixed rate debt obligations, including both principal and interest payments, as of September 30, 2009. The table only incorporates debt obligations as of September 30, 2009, and therefore, the table provides limited predictive value for future principal and interest payments.
Fixed rate debt
Total fixed rate debt obligations
Contractual Debt Obligations – Variable Rate Debt
At September 30, 2009, variable rate debt includes our $372 million term loan which bears interest at LIBOR, subject to a 1.50% floor, plus 300 basis points, a $9.4 million bond which has an interest rate of 0.461% at September 30, 2009, and no outstanding balance on our revolving credit facility which bears interest at LIBOR plus 0.425%.
Summary of Cash Flows
Cash provided by operating activities
Cash used in investing activities
Cash provided by (used in) financing activities
Cash and cash equivalents, beginning of year
Cash and cash equivalents, end of period
Net cash provided by operating activities increased $19.7 million to $194.2 million during the nine months ended September 30, 2009 from $174.5 million during the nine months ended September 30, 2008. The increase was primarily attributable to a $13.3 million increase in cash provided by operating activities due primarily to higher accounts payable and accrued expenses balances and lower accounts receivable balances as well as $5.4 million higher net income before gain on sale of real estate, litigation provision, depreciation and amortization, and other non-cash expenses.
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Net cash used in investing activities decreased $86.9 million to $80.3 million during the nine months ended September 30, 2009 from $167.2 million during the nine months ended September 30, 2008. The decrease was primarily attributable to:
$99.6 million decrease in acquisitions of real estate as no acquisitions have occurred in 2009, and
$23.9 million decrease in capital expenditures,
$35.9 million decrease in proceeds from sale of real estate.
Net cash provided by financing activities increased $288.3 million to $279.3 million during the nine months ended September 30, 2009 from $9.0 million used during the nine months ended September 30, 2008. The change was primarily attributable to:
$526.6 million increase in net proceeds from the issuance of mortgages, capital leases and notes payable due substantially to the proceeds from our new $372 million term loan and $163.1 million in new mortgage loans,
$147.5 million issuance of 5.95% senior notes in August 2009, and
$103.3 million increase in net proceeds from the issuance of common shares due primarily to the issuance of 2.0 million shares in August 2009,
$252.5 million increase in net repayments on our revolving credit facility,
$197.1 million increase in repayment of mortgages, capital leases and notes payable due substantially to the payoff of our $200 million term loan in May 2009 and the payoff of a loan secured by a portion of Mercer Mall in January 2009,
$31.5 million increase in repayment of senior notes, primarily due to the $52.3 million purchase and retirement of a portion of our 8.75% senior notes which are due in December 2009, and
$7.6 million increase in dividends paid to shareholders due to an increase in the dividend rate and increased number of shares outstanding.
Off-Balance Sheet Arrangements
We have a joint venture arrangement (“the Partnership”) with affiliates of a discretionary fund created and advised by ING Clarion Partners (“Clarion”). We own 30% of the equity in the Partnership and Clarion owns 70%. We hold a general partnership interest, however, Clarion has substantive participating rights and we cannot make significant decisions without Clarion’s approval. Accordingly, we account for our interest in the Partnership using the equity method. As of September 30, 2009, the Partnership owned seven retail real estate properties. We are the manager of the Partnership and its properties, earning fees for acquisitions, management, leasing and financing. We also have the opportunity to receive performance-based earnings through our Partnership interest. At September 30, 2009, the Partnership had approximately $81.2 million of mortgages payable outstanding; our investment in the Partnership was $28.8 million.
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Debt Financing Arrangements
The following is a summary of our total debt outstanding as of September 30, 2009:
Description of Debt
Mortgage loans (1)
Secured fixed rate
Federal Plaza
Tysons Station
Courtyard Shops
Bethesda Row
White Marsh Plaza (2)
Crow Canyon
Idylwood Plaza
Leesburg Plaza
Loehmann’s Plaza
Pentagon Row
Melville Mall (3)
THE AVENUE at White Marsh
Barracks Road
Hauppauge
Lawrence Park
Wildwood
Wynnewood
Brick Plaza
Rollingwood Apartments
Shoppers’ World
Mount Vernon (4)
Chelsea
Subtotal
Net unamortized discount
Total mortgage loans
Unsecured fixed rate
Perring Plaza renovation
Unsecured variable rate
Revolving credit facility (5)
Term loan (6)
Escondido (Municipal bonds) (7)
Total notes payable
8.75% notes (8)
4.50% notes
6.00% notes
5.40% notes
5.95% notes
5.65% notes
6.20% notes
7.48% debentures
6.82% medium term notes
Net unamortized premium
Total senior notes and debentures
Various
Total debt and capital lease obligations
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Our revolving credit facility and other debt agreements include financial and other covenants that may limit our operating activities in the future. As of September 30, 2009, we were in compliance with all of the financial and other covenants. If we were to breach any of our debt covenants and did not cure the breach within an applicable cure period, our lenders could require us to repay the debt immediately and, if the debt is secured, could immediately begin proceedings to take possession of the property securing the loan. Many of our debt arrangements, including our public notes and our revolving credit facility, are cross-defaulted, which means that the lenders under those debt arrangements can put us in default and require immediate repayment of their debt if we breach and fail to cure a default under certain of our other debt obligations. As a result, any default under our debt covenants could have an adverse effect on our financial condition, our results of operations, our ability to meet our obligations and the market value of our shares. Our organizational documents do not limit the level or amount of debt that we may incur.
The following is a summary of our scheduled principal repayments as of September 30, 2009:
Remainder of 2009
2010
2011
2012
2013
Thereafter
Interest Rate Hedging
We had no hedging instruments outstanding during the nine months ended September 30, 2009. We may use derivative instruments to manage exposure to variable interest rate risk. We generally enter into interest rate swaps to manage our exposure to variable interest rate risk and treasury locks to manage the risk of interest rates rising prior to the issuance of debt. We enter into derivative instruments that qualify as cash flow hedges and do not enter into derivative instruments for speculative purposes.
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Funds From Operations
Funds from operations (“FFO”) is a supplemental non-GAAP financial measure of real estate companies’ operating performance. The National Association of Real Estate Investment Trusts (“NAREIT”) defines FFO as follows: net income, computed in accordance with the U.S. GAAP, plus depreciation and amortization of real estate assets and excluding extraordinary items and gains and losses on the sale of real estate. We compute FFO in accordance with the NAREIT definition, and we have historically reported our FFO available for common shareholders in addition to our net income and net cash provided by operating activities. It should be noted that FFO:
does not represent cash flows from operating activities in accordance with GAAP (which, unlike FFO, generally reflects all cash effects of transactions and other events in the determination of net income);
should not be considered an alternative to net income as an indication of our performance; and
is not necessarily indicative of cash flow as a measure of liquidity or ability to fund cash needs, including the payment of dividends.
We consider FFO available for common shareholders a meaningful, additional measure of operating performance primarily because it excludes the assumption that the value of the real estate assets diminishes predictably over time, as implied by the historical cost convention of GAAP and the recording of depreciation. We use FFO primarily as one of several means of assessing our operating performance in comparison with other REITs. Comparison of our presentation of FFO to similarly titled measures for other REITs may not necessarily be meaningful due to possible differences in the application of the NAREIT definition used by such REITs.
An increase or decrease in FFO available for common shareholders does not necessarily result in an increase or decrease in aggregate distributions because our Board of Trustees is not required to increase distributions on a quarterly basis unless necessary for us to maintain REIT status. However, we must distribute at least 90% of our REIT taxable income (including net capital gain) to remain qualified as a REIT. Therefore, a significant increase in FFO will generally require an increase in distributions to shareholders although not necessarily on a proportionate basis.
Effective January 1, 2009, we adopted a new accounting standard which requires us to calculate FFO per share for all periods presented using the two-class method. The two-class method is an earnings allocation methodology whereby earnings per share for each class of common stock and participating securities is calculated according to dividends declared and participation rights in undistributed earnings. The implementation resulted in no change to FFO per share for the three and nine months ended September 30, 2008.
The reconciliation of net income attributable to the Trust to FFO available for common shareholders is as follows:
Depreciation and amortization of real estate assets
Amortization of initial direct costs of leases
Depreciation of joint venture real estate assets
Funds from operations
Income attributable to operating partnership units
Income attributable to unvested shares
Funds from operations available for common shareholders (2)
Weighted average number of common shares, diluted (1)
Funds from operations available for common shareholders, per diluted share (2)
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Our use of financial instruments, such as debt instruments, subjects us to market risk which may affect our future earnings and cash flows, as well as the fair value of our assets. Market risk generally refers to the risk of loss from changes in interest rates and market prices. We manage our market risk by attempting to match anticipated inflow of cash from our operating, investing and financing activities with anticipated outflow of cash to fund debt payments, dividends to common and preferred shareholders, investments, capital expenditures and other cash requirements.
As of September 30, 2009, we were not party to any open derivative financial instruments. We may enter into certain types of derivative financial instruments to further reduce interest rate risk. We use interest rate protection and swap agreements, for example, to convert some of our variable rate debt to a fixed-rate basis or to hedge anticipated financing transactions. We use derivatives for hedging purposes rather than speculation and do not enter into financial instruments for trading purposes.
Interest Rate Risk
The following discusses the effect of hypothetical changes in market rates of interest on interest expense for our variable rate debt and on the fair value of our total outstanding debt, including our fixed-rate debt. Interest rate risk amounts were determined by considering the impact of hypothetical interest rates on our debt. Quoted market prices were used to estimate the fair value of our marketable senior notes and debentures and discounted cash flow analysis is generally used to estimate the fair value of our mortgage and notes payable. Considerable judgment is necessary to estimate the fair value of financial instruments. This analysis does not purport to take into account all of the factors that may affect our debt, such as the effect that a changing interest rate environment could have on the overall level of economic activity or the action that our management might take to reduce our exposure to the change. This analysis assumes no change in our financial structure.
Fixed Interest Rate Debt
The majority of our outstanding debt obligations (maturing at various times through 2031 or through 2106 including capital lease obligations) have fixed interest rates which limit the risk of fluctuating interest rates. However, interest rate fluctuations may affect the fair value of our fixed rate debt instruments. At September 30, 2009, we had $1.7 billion of fixed-rate debt outstanding. If market interest rates on our fixed-rate debt instruments at September 30, 2009 had been 1.0% higher, the fair value of those debt instruments on that date would have decreased by approximately $61.9 million. If market interest rates on our fixed-rate debt instruments at September 30, 2009 had been 1.0% lower, the fair value of those debt instruments on that date would have increased by approximately $65.9 million.
Variable Interest Rate Debt
We believe that our primary interest rate risk is due to fluctuations in interest rates on our variable rate debt. At September 30, 2009, we had $381.4 million of variable rate debt outstanding which consisted of a $372 million term loan which bears interest at LIBOR, subject to a 1.5% floor, plus 300 basis points and $9.4 million of municipal bonds. Based upon this amount of variable rate debt and the specific terms, if market interest rates increased 1.0%, our annual interest expense would increase by approximately $3.8 million, and our net income and cash flows for the year would decrease by approximately $3.8 million. Conversely, if market interest rates decreased 1.0%, our annual interest expense would decrease by approximately $0.3 million with a corresponding increase in our net income and cash flows for the year.
Periodic Evaluation and Conclusion of Disclosure Controls and Procedures
An evaluation has been performed, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2009. Based on this evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of September 30, 2009 to provide reasonable assurance that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.
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Changes in Internal Control Over Financial Reporting
There has been no change in our internal controls over financial reporting during the quarterly period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II—OTHER INFORMATION
In May 2003, a breach of contract action was filed against us which alleged that a one page document entitled “Final Proposal” constituted a ground lease of a parcel of property located adjacent to our Santana Row property and gave the plaintiff the option to require that we acquire the property at a price determined in accordance with a formula included in the “Final Proposal.” The “Final Proposal” explicitly stated that it was subject to approval of the terms and conditions of a formal agreement. A trial as to liability only was held in June 2006 and a jury rendered a verdict against us. A trial on the issue of damages was held in April 2008 and the court issued a tentative ruling in April 2009 awarding damages to the plaintiff of approximately $14.4 million plus interest. Based on this tentative ruling, we estimated interest could range from $2.1 million to $8.4 million. Accordingly, considering all the information available to us on May 6, 2009, when we filed our Form 10-Q for the three months ended March 31, 2009, our best estimate of damages, interest, and other costs was $21.4 million. Accordingly, we increased our accrual for the matter from $0.8 million at December 31, 2008, to $21.4 million at March 31, 2009. The increase in our accrual of $20.6 million is presented as a separate line item in our consolidated statement of operations.
There have been no material changes to the risk factors previously disclosed in our Annual Report for the year ended December 31, 2008 filed with the Securities and Exchange Commission on February 26, 2009 and amended on June 25, 2009. These factors include, but are not limited to, the following:
risks that our tenants will not pay rent, may vacate early or may file for bankruptcy or that we may be unable to renew leases or re-let space at favorable rents as leases expire;
risks that we may not be able to proceed with or obtain necessary approvals for any redevelopment or renovation project, and that any redevelopment or renovation projects that we do pursue may not perform as anticipated;
risks that the number of properties we acquire for our own account, and therefore the amount of capital we invest in acquisitions, may be impacted by our real estate partnership;
risks normally associated with the real estate industry, including risks that:
occupancy levels at our properties and the amount of rent that we receive from our properties may be lower than expected,
completion of anticipated or ongoing property redevelopments or renovations may cost more, take more time to complete, or fail to perform as expected,
new acquisitions may fail to perform as expected,
competition for acquisitions could result in increased prices for acquisitions,
environmental issues may develop at our properties and result in unanticipated costs, and
because real estate is illiquid, we may not be able to sell properties when appropriate;
risks that our growth will be limited if we cannot obtain additional capital;
risks of financing, such as our ability to consummate additional financings or obtain replacement financing on terms which are acceptable to us, our ability to meet existing financial covenants and the limitations imposed on our operations by those covenants, and the possibility of increases in interest rates that would result in increased interest expense; and
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risks related to our status as a real estate investment trust, commonly referred to as a REIT, for federal income tax purposes, such as the existence of complex tax regulations relating to our 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.
None.
A list of exhibits to this Quarterly Report on Form 10-Q is set forth on the Exhibit Index immediately preceding such exhibits and is incorporated herein by reference.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto authorized.
Senior Vice President,
Chief Financial Officer and Treasurer
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EXHIBIT INDEX
Exhibit
No.
Description
35
36
37