EastGroup Properties - 10-Q quarterly report FY2012 Q1

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The number of shares of common stock, $.0001 par value, outstanding as of April 24, 2012 was 28,264,303.

The accompanying unaudited financial statements of EastGroup Properties, Inc. (“EastGroup” or “the Company”) have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.  In management’s opinion, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  The financial statements should be read in conjunction with the financial statements contained in the 2011 annual report on Form 10-K and the notes thereto.

Certain reclassifications have been made in the 2011 consolidated financial statements to conform to the 2012 presentation.

The consolidated financial statements include the accounts of EastGroup, its wholly-owned subsidiaries and its investment in any joint ventures in which the Company has a controlling interest.  At March 31, 2012 and December 31, 2011, the Company had a controlling interest in two joint ventures: the 80% owned University Business Center and the 80% owned Castilian Research Center.  The Company records 100% of the joint ventures’ assets, liabilities, revenues and expenses with noncontrolling interests provided for in accordance with the joint venture agreements.  The equity method of accounting is used for the Company’s 50% undivided tenant-in-common interest in Industry Distribution Center II.  All significant intercompany transactions and accounts have been eliminated in consolidation.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and revenues and expenses during the reporting period and to disclose material contingent assets and liabilities at the date of the financial statements.  Actual results could differ from those estimates.

EastGroup has one reportable segment – industrial properties.  These properties are concentrated in major Sunbelt markets of the United States, primarily in the states of Florida, Texas, Arizona, California and North Carolina, have similar economic characteristics and also meet the other criteria that permit the properties to be aggregated into one reportable segment.

The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable.  Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows (including estimated future expenditures necessary to substantially complete the asset) expected to be generated by the asset.  If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the asset.  As of March 31, 2012 and December 31, 2011, the Company determined that no impairment charges on the Company’s real estate properties were necessary.

Depreciation of buildings and other improvements, including personal property, is computed using the straight-line method over estimated useful lives of generally 40 years for buildings and 3 to 15 years for improvements and personal property.  Building improvements are capitalized, while maintenance and repair expenses are charged to expense as incurred.  Significant renovations and improvements that improve or extend the useful life of the assets are capitalized.  Depreciation expense for continuing and discontinued operations was $13,079,000 and $12,089,000 for the three months ended March 31, 2012 and 2011, respectively.

The Company’s real estate properties at March 31, 2012 and December 31, 2011 were as follows:

During the period in which a property is under development, costs associated with development (i.e., land, construction costs, interest expense, property taxes and other direct and indirect costs associated with development) are aggregated into the total capitalized costs of the property.  Included in these costs are management’s estimates for the portions of internal costs (primarily personnel costs) deemed directly or indirectly related to such development activities.  As the property becomes occupied, depreciation commences on the occupied portion of the building, and costs are capitalized only for the portion of the building that remains vacant.  When the property becomes 80% occupied or one year after completion of the shell construction (whichever comes first), capitalization of development costs ceases.  The properties are then transferred to real estate properties, and depreciation commences on the entire property (excluding the land).

Upon acquisition of real estate properties, the Company applies the principles of Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 805, Business Combinations, which requires that acquisition-related costs be recognized as expenses in the periods in which the costs are incurred and the services are received.  The Codification also provides guidance on how to properly determine the allocation of the purchase price among the individual components of both the tangible and intangible assets based on their respective fair values.  Goodwill is recorded when the purchase price exceeds the fair value of the assets and liabilities acquired.  Factors considered by management in allocating the cost of the properties acquired include an estimate of carrying costs during the expected lease-up periods considering current market conditions and costs to execute similar leases.  The allocation to tangible assets (land, building and improvements) is based upon management's determination of the value of the property as if it were vacant using discounted cash flow models.  The Company determines whether any financing assumed is above or below market based upon comparison to similar financing terms for similar properties.  The cost of the properties acquired may be adjusted based on indebtedness assumed from the seller that is determined to be above or below market rates.  

The purchase price is also allocated among the following categories of intangible assets:  the above or below market component of in-place leases, the value of in-place leases, and the value of customer relationships.  The value allocable to the above or below market component of an acquired in-place lease is determined based upon the present value (using a discount rate reflecting the risks associated with the acquired leases) of the difference between (i) the contractual amounts to be paid pursuant to the lease over its remaining term, and (ii) management’s estimate of the amounts that would be paid using fair market rates over the remaining term of the lease.  The amounts allocated to above and below market leases are included in Other Assets and Other Liabilities, respectively, on the Consolidated Balance Sheets and are amortized to rental income over the remaining terms of the respective leases.  The total amount of intangible assets is further allocated to in-place lease values and customer relationship values based upon management’s assessment of their respective values.  These intangible assets are included in Other Assets on the Consolidated Balance Sheets and are amortized over the remaining term of the existing lease, or the anticipated life of the customer relationship, as applicable.

Amortization expense for in-place lease intangibles was $1,069,000 and $557,000 for the three months ended March 31, 2012 and 2011, respectively.  Amortization of above and below market leases decreased rental income by $120,000 and $100,000 for the three months ended March 31, 2012 and 2011, respectively.

During the first three months of 2012, EastGroup acquired Madison Distribution Center in Tampa for $3,475,000, of which $3,273,000 was allocated to real estate properties.  The Company allocated $495,000 of the total purchase price to land using third party land valuations for the Tampa market.  The market values are considered to be Level 3 inputs as defined by ASC 820, Fair Value Measurements and Disclosures (see Note 15 for additional information on ASC 820).  Intangibles associated with the purchase of real estate were allocated as follows:  $190,000 to in-place lease intangibles, $20,000 to above market leases (both included in Other Assets on the Consolidated Balance Sheets), and $8,000 to below market leases (included in Other Liabilities on the Consolidated Balance Sheets).  These costs are amortized over the remaining lives of the associated leases in place at the time of acquisition.

EastGroup expensed acquisition-related costs of $19,000 during the three months ended March 31, 2012.  The Company did not expense any acquisition-related costs during the three months ended March 31, 2011.

The Company periodically reviews the recoverability of goodwill (at least annually) and the recoverability of other intangibles (on a quarterly basis) for possible impairment.  In management’s opinion, no impairment of goodwill and other intangibles existed at March 31, 2012 and December 31, 2011.

The Company considers a real estate property to be held for sale when it meets the criteria established under ASC 360, Property, Plant, and Equipment, including when it is probable that the property will be sold within a year.  Real estate properties held for sale are reported at the lower of the carrying amount or fair value less estimated costs to sell and are not depreciated while they are held for sale.  In accordance with the guidelines established under the Codification, the results of operations for the properties sold or held for sale during the reported periods are shown under Discontinued Operations on the Consolidated Statements of Income and Comprehensive Income.  Interest expense is not generally allocated to the properties held for sale or whose operations are included under Discontinued Operations unless the mortgage is required to be paid in full upon the sale of the property.

During the three months ended March 31, 2012, EastGroup’s taxable REIT subsidiary sold two properties in Tampa, which collectively contain 10,500 square feet, for $578,000 and recognized an after-tax gain of $167,000 during the first quarter.  The Company did not sell any real estate properties during 2011.

A summary of the Company’s Other Assets follows:

A summary of the Company’s Accounts Payable and Accrued Expenses follows:

A summary of the Company’s Other Liabilities follows:

The Company applies ASC 260, Earnings Per Share, which requires companies to present basic and diluted earnings per share (EPS).  Basic EPS represents the amount of earnings for the period attributable to each share of common stock outstanding during the reporting period.  The Company’s basic EPS is calculated by dividing net income attributable to common stockholders by the weighted average number of common shares outstanding.

Diluted EPS represents the amount of earnings for the period attributable to each share of common stock outstanding during the reporting period and to each share that would have been outstanding assuming the issuance of common shares for all dilutive potential common shares outstanding during the reporting period.  The Company calculates diluted EPS by dividing net income attributable to common stockholders by the weighted average number of common shares outstanding plus the dilutive effect of unvested restricted stock and stock options had the options been exercised.  The dilutive effect of stock options and their equivalents (such as unvested restricted stock) was determined using the treasury stock method which assumes exercise of the options as of the beginning of the period or when issued, if later, and assumes proceeds from the exercise of options are used to purchase common stock at the average market price during the period.

In May 2004, the stockholders of the Company approved the EastGroup Properties, Inc. 2004 Equity Incentive Plan (the “Plan”) that authorized the issuance of up to 1,900,000 shares of common stock to employees in the form of options, stock appreciation rights, restricted stock, deferred stock units, performance shares, bonus stock or stock in lieu of cash compensation.  The Plan was further amended by the Board of Directors in September 2005 and December 2006.  Total shares available for grant were 1,331,876 at March 31, 2012.  Typically, the Company issues new shares to fulfill stock grants or upon the exercise of stock options.

Stock-based compensation cost was $1,492,000 and $794,000 for the three months ended March 31, 2012 and 2011, respectively, of which $233,000 and $39,000 were capitalized as part of the Company’s development costs.

In March 2012, the Compensation Committee evaluated the Company’s performance compared to a variety of goals for the year ended  December 31, 2011.  Based on the evaluation, 44,789 shares were awarded to the Company’s executive officers at a weighted average grant date fair value of $48.75 per share.  These shares vested 20% on the dates shares were determined and awarded and will vest 20% per year on January 1 of the subsequent four years.  The shares will be expensed on a straight-line basis over the remaining service period.

Also in March 2012, the Committee evaluated the Company’s absolute and relative total shareholder return for the five-year period ended December 31, 2011.  Based on the evaluation, 47,418 shares were awarded to the Company’s executive officers at a grant date fair value of $48.75 per share.  These shares vested 25% on the dates shares were determined and awarded and will vest 25% per year on January 1 in years 2013, 2014 and 2015.

Notwithstanding the foregoing, pursuant to a special vesting provision adopted by the Company’s Compensation Committee, shares issued to the Company’s Chief Executive Officer, David H. Hoster II, will become fully vested no later than January 1, 2015.

Following is a summary of the total restricted shares granted, forfeited and delivered (vested) to employees with the related weighted average grant date fair value share prices.  Of the shares that vested in the first quarter of 2012, the Company withheld 17,927 shares to satisfy the tax obligations for those employees who elected this option as permitted under the applicable equity plan.  As of the vesting date, the fair value of shares that vested during the first quarter of 2012 was $3,191,000.

The Company has a directors equity plan that was approved by stockholders and adopted in 2005 (the 2005 Plan), which authorizes the issuance of up to 50,000 shares of common stock through awards of shares and restricted shares granted to non-employee directors of the Company.  The 2005 Plan was further amended by the Board of Directors in May 2006, May 2008 and May 2011.  Stock-based compensation expense for directors was $75,000 and $60,000 for the three months ended March 31, 2012 and 2011, respectively.

The state of the overall economy can significantly impact the Company’s operational performance and thus impact its financial position.  Should EastGroup experience a significant decline in operational performance, it may affect the Company’s ability to make distributions to its shareholders, service debt, or meet other financial obligations.

EastGroup has evaluated all Accounting Standards Updates (ASUs) released by the FASB through the date the financial statements were issued and determined that the following ASUs apply to the Company.

In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, which provides guidance about how fair value should be applied where it is already required or permitted under U.S. GAAP.  The ASU does not extend the use of fair value or require additional fair value measurements, but rather provides explanations about how to measure fair value.  ASU 2011-04 requires prospective application and was effective for interim and annual reporting periods beginning after December 15, 2011.  The Company has adopted the provisions and provided the necessary disclosures beginning with the period ended March 31, 2012.

In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income,  which eliminates the option to present components of other comprehensive income as part of the statement of changes in equity and requires that all nonowner changes in equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  ASU 2011-05 requires retrospective application and was effective for interim and annual reporting periods beginning after December 15, 2011.  The Company has adopted the provisions of ASU 2011-05 and provided the necessary disclosures beginning with the period ended March 31, 2012.

In September 2011, the FASB issued ASU 2011-08, Testing Goodwill for Impairment, which permits an entity to make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test.  Under this ASU, an entity is not required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount.  ASU 2011-08 was effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011.  The Company has adopted the provisions and provided the necessary disclosures beginning with the period ended March 31, 2012.

ASC 820, Fair Value Measurements and Disclosures, defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  ASC 820 also provides guidance for using fair value to measure financial assets and liabilities.  The Codification requires disclosure of the level within the fair value hierarchy in which the fair value measurements fall, including measurements using quoted prices in active markets for identical assets or liabilities (Level 1), quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active (Level 2), and significant valuation assumptions that are not readily observable in the market (Level 3).

The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments in accordance with ASC 820 at March 31, 2012 and December 31, 2011.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments:

Cash and cash equivalents:  The carrying amounts approximate fair value due to the short maturity of those instruments.

Mortgage loans receivable, net of discount (included in Other Assets on the Consolidated Balance Sheets):  The fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities (Level 2 input).

Mortgage notes payable: The fair value of the Company’s mortgage notes payable is estimated by discounting expected cash flows at the rates currently offered to the Company for debt of the same remaining maturities, as advised by the Company’s bankers (Level 2 input).

Unsecured term loan payable:  The fair value of the Company’s unsecured term loan payable is estimated by discounting expected cash flows at the rates currently offered to the Company for debt of the same remaining maturities, as advised by the Company’s bankers (Level 2 input).

Notes payable to banks: The fair value of the Company’s notes payable to banks is estimated by discounting expected cash flows at current market rates (Level 2 input).

On April 2, 2012, the Company repaid a mortgage loan with a balance of $8.7 million, an interest rate of 7.98%, and a maturity date of June 1, 2012.

As of April 25, 2012, EastGroup issued and sold 143,213 shares of common stock under its continuous common equity program during the second quarter of 2012 at an average price of $50.62 per share with net proceeds to the Company of $7.2 million.  The proceeds were used to reduce variable rate bank borrowings.  As of April 25, 2012, the Company has 901,652 shares of common stock remaining to sell under the program.

EastGroup’s goal is to maximize shareholder value by being a leading provider in its markets of functional, flexible and quality business distribution space for location sensitive tenants primarily in the 5,000 to 50,000 square foot range.  The Company acquires, develops and operates distribution facilities, the majority of which are clustered around major transportation features in supply constrained submarkets in major Sunbelt regions.  The Company’s core markets are in the states of Florida, Texas, Arizona, California and North Carolina.

The operations of the Company improved during the three months ended March 31, 2012, compared to the same period of 2011.  Occupancy has stabilized and is currently improving, but the Company still experiences decreases in rental rates.  The Company is able to obtain financing at attractive rates, but lenders’ underwriting standards have become stricter. The Company believes its current operating cash flow and lines of credit provide the capacity to fund the operations of the Company for the remainder of 2012.  The Company also believes it can issue common and/or preferred equity and obtain mortgage financing from insurance companies and financial institutions as evidenced by the closing of a  $54 million, non-recourse first mortgage loan in January 2012 and the continuous common equity offering program, which provided net proceeds to the Company of $17.5 million in the first quarter of 2012, as described in Liquidity and Capital Resources.

The Company’s primary revenue is rental income; as such, EastGroup’s primary challenge is leasing space.  During the three months ended March 31, 2012, leases expired on 1,523,000 square feet (5.1%) of EastGroup’s total square footage of 30,120,000, and the Company was successful in renewing or re-leasing 86% of the expiring square feet.  In addition, EastGroup leased 568,000 square feet of other vacant space during this period.  During the first quarter of 2012, average rental rates on new and renewal leases decreased by 0.1%.  Property net operating income from same properties increased 2.8% for the quarter ended March 31, 2012, as compared to the same quarter in 2011.

EastGroup’s total leased percentage was 94.5% at March 31, 2012, compared to 91.5% at March 31, 2011.  Leases scheduled to expire for the remainder of 2012 were 11.2% of the portfolio on a square foot basis at March 31, 2012, and this figure was reduced to 8.7% as of April 24, 2012.

The Company generates new sources of leasing revenue through its acquisition and development programs.  During the first three months of 2012, the Company acquired one operating property (72,000 square feet) in Tampa, Florida, and 28.5 acres of development land in Tampa, Florida, and Chandler (Phoenix), Arizona, for $6.2 million.

EastGroup continues to see targeted development as a contributor to the Company’s long-term growth.  The Company mitigates risks associated with development through a Board-approved maximum level of land held for development and by adjusting development start dates according to leasing activity.  During the first quarter of 2012, the Company began construction of one development project containing 88,000 square feet in Orlando.  Also in the first quarter, EastGroup transferred two properties (184,000 square feet) in Houston from its development program to real estate properties with costs of $11.5 million at the date of transfer.  As of March 31, 2012, EastGroup’s development program consisted of eight projects (475,000 square feet) located in Houston, Orlando and San Antonio.  The projected total cost for the development projects, which were collectively 19% leased as of April 24, 2012, is $38.4 million, of which $10.3 million remained to be invested as of March 31, 2012.

During the first three months of 2012, the Company initially funded its acquisition and development programs through its $225 million lines of credit (as discussed in Liquidity and Capital Resources).  As market conditions permit, EastGroup issues equity, including preferred equity, and/or employs fixed-rate debt to replace short-term bank borrowings.

EastGroup has one reportable segment – industrial properties.  These properties are primarily located in major Sunbelt regions of the United States, have similar economic characteristics and also meet the other criteria permitting the properties to be aggregated into one reportable segment.  The Company’s chief decision makers use two primary measures of operating results in making decisions:  (1) property net operating income (PNOI), defined as income from real estate operations less property operating expenses (before interest expense and depreciation and amortization), and (2) funds from operations attributable to common stockholders (FFO), defined as net income (loss) attributable to common stockholders computed in accordance with U.S. generally accepted accounting principles (GAAP), excluding gains or losses from sales of depreciable real estate property and impairment losses, plus real estate related depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures.  The Company calculates FFO based on the National Association of Real Estate Investment Trusts’ (NAREIT) definition.

PNOI is a supplemental industry reporting measurement used to evaluate the performance of the Company’s real estate investments. The Company believes the exclusion of depreciation and amortization in the industry’s calculation of PNOI provides a supplemental indicator of the properties’ performance since real estate values have historically risen or fallen with market conditions.  PNOI as calculated by the Company may not be comparable to similarly titled but differently calculated measures for other real estate investment trusts (REITs).  The major factors influencing PNOI are occupancy levels, acquisitions and sales, development properties that achieve stabilized operations, rental rate increases or decreases, and the recoverability of operating expenses.  The Company’s success depends largely upon its ability to lease space and to recover from tenants the operating costs associated with those leases.

PNOI is comprised of Income from real estate operations, less Expenses from real estate operations.  PNOI was calculated as follows for the three months ended March 31, 2012 and 2011.

Income from real estate operations is comprised of rental income, pass-through income and other real estate income including lease termination fees.  Expenses from real estate operations is comprised of property taxes, insurance, utilities, repair and maintenance expenses, management fees, other operating costs and bad debt expense.  Generally, the Company’s most significant operating expenses are property taxes and insurance.  Tenant leases may be net leases in which the total operating expenses are recoverable, modified gross leases in which some of the operating expenses are recoverable, or gross leases in which no expenses are recoverable (gross leases represent only a small portion of the Company’s total leases).  Increases in property operating expenses are fully recoverable under net leases and recoverable to a high degree under modified gross leases.  Modified gross leases often include base year amounts and expense increases over these amounts are recoverable.  The Company’s exposure to property operating expenses is primarily due to vacancies and leases for occupied space that limit the amount of expenses that can be recovered.

The following table presents reconciliations of Net Income to PNOI for the three months ended March 31, 2012 and 2011.

The Company believes FFO is a meaningful supplemental measure of operating performance for equity REITs.  The Company believes excluding depreciation and amortization in the calculation of FFO is appropriate since real estate values have historically increased or decreased based on market conditions.  FFO is not considered as an alternative to net income (determined in accordance with GAAP) as an indication of the Company’s financial performance, nor is it a measure of the Company’s liquidity or indicative of funds available to provide for the Company’s cash needs, including its ability to make distributions.  In addition, FFO, as reported by the Company, may not be comparable to FFO reported by other REITs that do not define the term in accordance with the current NAREIT definition.  The Company’s key drivers affecting FFO are changes in PNOI (as discussed above), interest rates, the amount of leverage the Company employs and general and administrative expense.  The following table presents reconciliations of Net Income Attributable to EastGroup Properties, Inc. Common Stockholders to FFO for the three months ended March 31, 2012 and 2011.

The Company analyzes the following performance trends in evaluating the progress of the Company:

The Company’s management considers the following accounting policies and estimates to be critical to the reported operations of the Company.

The Company allocates the purchase price of acquired properties to net tangible and identified intangible assets based on their respective fair values.  Goodwill is recorded when the purchase price exceeds the fair value of the assets and liabilities acquired.  Factors considered by management in allocating the cost of the properties acquired include an estimate of carrying costs during the expected lease-up periods considering current market conditions and costs to execute similar leases.  The allocation to tangible assets (land, building and improvements) is based upon management’s determination of the value of the property as if it were vacant using discounted cash flow models.  The purchase price is also allocated among the following categories of intangible assets:  the above or below market component of in-place leases, the value of in-place leases, and the value of customer relationships.  The value allocable to the above or below market component of an acquired in-place lease is determined based upon the present value (using a discount rate reflecting the risks associated with the acquired leases) of the difference between (i) the contractual amounts to be paid pursuant to the lease over its remaining term and (ii) management’s estimate of the amounts that would be paid using fair market rates over the remaining term of the lease.  The amounts allocated to above and below market leases are included in Other Assets and Other Liabilities, respectively, on the Consolidated Balance Sheets and are amortized to rental income over the remaining terms of the respective leases.  The total amount of intangible assets is further allocated to in-place lease values and customer relationship values based upon management’s assessment of their respective values.  These intangible assets are included in Other Assets on the Consolidated Balance Sheets and are amortized over the remaining term of the existing lease, or the anticipated life of the customer relationship, as applicable.

During the period in which a property is under development, costs associated with development (i.e., land, construction costs, interest expense, property taxes and other direct and indirect costs associated with development) are aggregated into the total capitalized costs of the property.  Included in these costs are management’s estimates for the portions of internal costs (primarily personnel costs) deemed directly or indirectly related to such development activities.

The Company reviews its real estate investments for impairment of value whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  If any real estate investment is considered permanently impaired, a loss is recorded to reduce the carrying value of the property to its estimated fair value.  Real estate assets to be sold are reported at the lower of the carrying amount or fair value less selling costs.  The evaluation of real estate investments involves many subjective assumptions dependent upon future economic events that affect the ultimate value of the property.  Currently, the Company’s management knows of no impairment issues nor has it experienced any impairment issues in recent years.  EastGroup currently has the intent and ability to hold its real estate investments and to hold its land inventory for future development.  In the event of impairment, the property’s basis would be reduced, and the impairment would be recognized as a current period charge on the Consolidated Statements of Income and Comprehensive Income.

The Company is subject to tenant defaults and bankruptcies that could affect the collection of outstanding receivables.  In order to mitigate these risks, the Company performs credit reviews and analyses on prospective tenants before significant leases are executed and on existing tenants before properties are acquired.  On a quarterly basis, the Company evaluates outstanding receivables and estimates the allowance for doubtful accounts.  Management specifically analyzes aged receivables, customer credit-worthiness, historical bad debts and current economic trends when evaluating the adequacy of the allowance for doubtful accounts.  The Company believes its allowance for doubtful accounts is adequate for its outstanding receivables for the periods presented.  In the event the allowance for doubtful accounts is insufficient for an account that is subsequently written off, additional bad debt expense would be recognized as a current period charge on the Consolidated Statements of Income and Comprehensive Income.

EastGroup, a Maryland corporation, has qualified as a real estate investment trust under Sections 856-860 of the Internal Revenue Code and intends to continue to qualify as such.  To maintain its status as a REIT, the Company is required to distribute at least 90% of its ordinary taxable income to its stockholders.  If the Company has a capital gain, it has the option of (i) deferring recognition of the capital gain through a tax-deferred exchange, (ii) declaring and paying a capital gain dividend on any recognized net capital gain resulting in no corporate level tax, or (iii) retaining and paying corporate income tax on its net long-term capital gain, with shareholders reporting their proportional share of the undistributed long-term capital gain and receiving a credit or refund of their share of the tax paid by the Company.  The Company distributed all of its 2011 taxable income to its stockholders and expects to distribute all of its taxable income in 2012.  Accordingly, no provision for income taxes was necessary in 2011, nor is any significant income tax provision expected to be necessary for 2012.

EastGroup’s assets were $1,292,641,000 at March 31, 2012, an increase of $6,125,000 from December 31, 2011.  Liabilities decreased $2,786,000 to $878,121,000, and equity increased $8,911,000 to $414,520,000 during the same period.  The paragraphs that follow explain these changes in detail.

Real Estate Properties increased $19,015,000 during the three months ended March 31, 2012, primarily due to the purchase of the operating property detailed below, capital improvements at the Company’s properties and the transfer of two properties from Development, as detailed under Development below.  These increases were offset by the sale of two properties in Tampa, which were held in the Company’s taxable REIT subsidiary, for $578,000; the Company recognized an after-tax gain of $167,000 in connection with the sale.

The Company made capital improvements of $4,070,000 on existing and acquired properties (included in the Capital Expenditures table under Results of Operations).  Also, the Company incurred costs of $512,000 on development properties subsequent to transfer to Real Estate Properties; the Company records these expenditures as development costs on the Consolidated Statements of Cash Flows.

EastGroup’s investment in development at March 31, 2012 consisted of properties in lease-up and under construction of $28,138,000 and prospective development (primarily land) of $84,565,000.  The Company’s total investment in development at March 31, 2012 was $112,703,000 compared to $112,149,000 at December 31, 2011.  Total capital invested for development during the first three months of 2012 was $12,584,000, which consisted of costs of $11,963,000 and $109,000 as detailed in the development activity table and costs of $512,000 on development properties subsequent to transfer to Real Estate Properties.

During the first quarter of 2012, EastGroup purchased 28.5 acres of development land in Tampa, Florida, and Chandler (Phoenix), Arizona, for $2,715,000.  Costs associated with development land acquisitions are included in the development activity table.  The Company transferred two development properties to Real Estate Properties during the first three months of 2012 with a total investment of $11,518,000 as of the date of transfer.

Mortgage Notes Payable increased $44,223,000 during the three months ended March 31, 2012.  The increase resulted from a $54,000,000 mortgage loan executed by the Company in January 2012, offset by regularly scheduled principal payments of $6,273,000, the repayment of one mortgage of $3,463,000 and mortgage loan premium amortization of $41,000.

Notes Payable to Banks decreased $35,599,000 during the three months ended March 31, 2012, as a result of repayments of $99,494,000 exceeding advances of $63,895,000.  The Company’s credit facilities are described in greater detail under Liquidity and Capital Resources.

Accounts Payable and Accrued Expenses decreased $11,320,000 during the first quarter of 2012.  A summary of the Company’s Accounts Payable and Accrued Expenses follows:

For the three months ended March 31, 2012, Distributions in Excess of Earnings increased $9,372,000 as a result of dividends on common stock of $14,775,000 exceeding Net Income Attributable to EastGroup Properties, Inc. Common Stockholders of $5,403,000.

Additional Paid-In Capital increased $18,249,000 during the three months ended March 31, 2012.  The increase primarily resulted from the issuance of 368,158 shares of common stock under EastGroup’s continuous common equity program with net proceeds to the Company of $17,516,000.  See Note 12 in the Notes to Consolidated Financial Statements for information related to the changes in Additional Paid-In Capital on Common Shares resulting from stock-based compensation.

(Comments are for the three months ended March 31, 2012, compared to the three months ended March 31, 2011.)

Net Income Attributable to EastGroup Properties, Inc. Common Stockholders for the three months ended March 31, 2012, was $5,403,000 ($.20 per basic and $.19 per diluted share) compared to $4,792,000 ($.18 per basic and diluted share) for the same period in 2011.  PNOI increased by $2,888,000, or 9.4%, for the first quarter of 2012 compared to the same period in 2011, primarily due to increases in PNOI of $1,696,000 from 2011 and 2012 acquisitions, $856,000 from same property operations and $338,000 from newly developed properties.  Bad debt expense exceeded termination fee income by $53,000 for the three months ended March 31, 2012.  Termination fee income exceeded bad debt expense by $321,000 for the three months ended March 31, 2011.

Property expense to revenue ratios, defined as Expenses from Real Estate Operations as a percentage of Income from Real Estate Operations, were 28.0% and 28.8% for the three months ended March 31, 2012 and 2011, respectively.  The Company’s percentage of leased square footage was 94.5% at March 31, 2012, compared to 91.5% at March 31, 2011.  Occupancy at March 31, 2012 was 94.0% compared to 90.5% at March 31, 2011.

Interest Expense increased $563,000 in the three months ended March 31, 2012 compared to the same period in 2011.  The following table presents the components of Interest Expense for the three months ended March 31, 2012 and 2011:

 

 

EastGroup’s fixed rate interest expense increased by $769,000 for the three months ended March 31, 2012, as compared to the same period of 2011.  The increase was mainly due to increased fixed rate borrowings.  The Company obtained an unsecured term loan in December 2011 which has a balance of $50,000,000, a fixed interest rate of 3.91%, and a seven year term.  The Company expensed $486,000 for unsecured term loan interest in the first quarter of 2012 compared to zero for the first quarter of 2011.  A listing of new mortgages and mortgages repaid in 2011 and the first quarter of 2012 follows:

Interest costs incurred during the period of construction of real estate properties are capitalized and offset against interest expense.  Capitalized interest increased $203,000 for the three months ended March 31, 2012, as compared to the same quarter of 2011 due to increased activity in the Company’s development program.

Depreciation and Amortization expense from continuing operations increased $1,682,000 for the three months ended March 31, 2012, as compared to the same period in 2011.  Straight-lining of rent increased income by $525,000 for the three months ended March 31, 2012, compared to $564,000 for the same period in 2011.

Capital expenditures for the Company’s operating properties for the three months ended March 31, 2012 and 2011 were as follows:

The Company’s leasing costs (principally commissions) are capitalized and included in Other Assets. The costs are amortized over the terms of the associated leases and are included in Depreciation and Amortization expense.  Capitalized leasing costs for the three months ended March 31, 2012 and 2011 were as follows:

The results of operations for the properties sold or held for sale during the periods reported are shown under Discontinued Operations on the Consolidated Statements of Income and Comprehensive Income.  During 2012, the Company sold two properties, Tampa East Distribution Center III and Tampa West Distribution Center VIII, in Tampa.  During 2011, the Company did not sell any properties.

See Note 7 in the Notes to Consolidated Financial Statements for more information related to discontinued operations and gain on sales of real estate investments.  The following table presents the components of revenue and expense for the properties sold or held for sale during 2012 and 2011.

EastGroup has evaluated all Accounting Standards Updates (ASUs) released by the FASB through the date the financial statements were issued and determined that the following ASUs apply to the Company.

In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, which provides guidance about how fair value should be applied where it is already required or permitted under U.S. GAAP.  The ASU does not extend the use of fair value or require additional fair value measurements, but rather provides explanations about how to measure fair value.  ASU 2011-04 requires prospective application and was effective for interim and annual reporting periods beginning after December 15, 2011.  The Company has adopted the provisions and provided the necessary disclosures beginning with the period ended March 31, 2012.

In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income,  which eliminates the option to present components of other comprehensive income as part of the statement of changes in equity and requires that all nonowner changes in equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  ASU 2011-05 requires retrospective application and was effective for interim and annual reporting periods beginning after December 15, 2011.  The Company has adopted the provisions of ASU 2011-05 and provided the necessary disclosures beginning with the period ended March 31, 2012.

In September 2011, the FASB issued ASU 2011-08, Testing Goodwill for Impairment, which permits an entity to make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test.  Under this ASU, an entity is not required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount.  ASU 2011-08 was effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011.  The Company has adopted the provisions and provided the necessary disclosures beginning with the period ended March 31, 2012.

Net cash provided by operating activities was $12,420,000 for the three months ended March 31, 2012.  The primary other sources of cash were from bank borrowings, proceeds from mortgage notes payable and proceeds from common stock offerings.  The Company distributed $14,908,000 in common stock dividends during the three months ended March 31, 2012.  Other primary uses of cash were for bank debt repayments, the construction and development of properties, mortgage note repayments, capital improvements at various properties and the acquisition of properties.

Total debt at March 31, 2012 and December 31, 2011 is detailed below.  The Company’s bank credit facilities and unsecured term loan have certain restrictive covenants, such as maintaining debt service coverage and leverage ratios and maintaining insurance coverage, and the Company was in compliance with all of its debt covenants at March 31, 2012 and December 31, 2011.

EastGroup has a $200 million unsecured revolving credit facility with a group of seven banks that matures in January 2013.  The interest rate on the facility is based on the LIBOR index and varies according to total liability to total asset value ratios (as defined in the credit agreement), with an annual facility fee of 15 to 20 basis points.  The interest rate on each tranche is usually reset on a monthly basis and as of March 31, 2012, was LIBOR plus 85 basis points with an annual facility fee of 20 basis points.  At March 31, 2012, the weighted average interest rate was 1.100% on a balance of $116,000,000.

EastGroup also has a $25 million unsecured revolving credit facility with PNC Bank, N.A. that matures in January 2013.  The interest rate on this facility is based on the LIBOR index and varies according to total liability to total asset value ratios (as defined in the credit agreement), with no annual facility fee.  The interest rate is reset on a daily basis and as of March 31, 2012, was LIBOR plus 165 basis points.  At March 31, 2012, the interest rate was 1.891% on a balance of $2,917,000.

As market conditions permit, EastGroup issues equity, including preferred equity, and/or employs fixed-rate debt to replace the short-term bank borrowings.  Even though mortgage loan proceeds as a percentage of property values have decreased and lenders’ underwriting standards have become stricter, the Company is able to obtain financing at attractive amounts and rates.  The Company believes its current operating cash flow and lines of credit provide the capacity to fund the operations of the Company for the remainder of 2012.  The Company also believes it can obtain mortgage financing from insurance companies and financial institutions and issue common and/or preferred equity.

On January 4, 2012, EastGroup closed a $54 million, non-recourse first mortgage loan with a fixed interest rate of 4.09%, a 10-year term and a 20-year amortization schedule.  The loan is secured by properties containing 1.4 million square feet.  The Company used the proceeds of this mortgage loan to reduce variable rate bank borrowings.

On March 1, 2012, the Company repaid a mortgage loan with a balance of $3.5 million, an interest rate of 5.68%, and a maturity date of June 1, 2012.  Subsequent to quarter-end, EastGroup repaid a mortgage loan with a balance of $8.7 million, an interest rate of 7.98%, and a maturity date of June 1, 2012.

In March 2011, the Company entered into Sales Agency Financing Agreements (the “Agreements”) with BNY Mellon Capital Markets, LLC and Raymond James & Associates, Inc. pursuant to which the Company may issue and sell up to two million shares of its common stock from time to time.  During the three months ended March 31, 2012, EastGroup issued and sold 368,158 shares of common stock at an average price of $48.21 per share with gross proceeds to the Company of $17,751,000.  The Company incurred offering-related costs of $235,000, resulting in net proceeds to the Company of $17,516,000 which were used to reduce variable rate bank borrowings.

 

As of April 25, 2012, EastGroup issued and sold 143,213 shares of common stock under its continuous common equity program during the second quarter of 2012 at an average price of $50.62 per share with net proceeds to the Company of $7.2 million.  The proceeds were used to reduce variable rate bank borrowings.  Total shares sold since the start of the continuous equity program in July 2011 were 1,098,348 shares at an average price of $46.16 per share.  As of April 25, 2012, the Company has 901,652 shares of common stock remaining to sell under the program.

The Company anticipates that its current cash balance, operating cash flows, borrowings under its lines of credit, proceeds from new mortgage debt and/or proceeds from the issuance of equity instruments will be adequate for (i) operating and administrative expenses, (ii) normal repair and maintenance expenses at its properties, (iii) debt service obligations, (iv) maintaining compliance with its debt covenants, (v) distributions to stockholders, (vi) capital improvements, (vii) purchases of properties, (viii) development, and (ix) any other normal business activities of the Company, both in the short and long-term.

EastGroup’s fixed, noncancelable obligations as of December 31, 2011, did not materially change during the three months ended March 31, 2012, except for the increase in Mortgage Notes Payable and decrease in Notes Payable to Banks discussed above.

Most of the Company's leases include scheduled rent increases.  Additionally, most of the Company's leases require the tenants to pay their pro rata share of operating expenses, including real estate taxes, insurance and common area maintenance, thereby reducing the Company's exposure to increases in operating expenses resulting from inflation.  In the event inflation causes increases in the Company’s general and administrative expenses or the level of interest rates, such increased costs would not be passed through to tenants and could adversely affect the Company’s results of operations.

EastGroup's financial results are affected by general economic conditions in the markets in which the Company's properties are located.  The current state of the economy, or other adverse changes in general or local economic conditions, could result in the inability of some of the Company's existing tenants to make lease payments and may therefore increase bad debt expense.  It may also impact the Company’s ability to (i) renew leases or re-lease space as leases expire, or (ii) lease development space.  In addition, the economic downturn or recession could also lead to an increase in overall vacancy rates or decline in rents the Company can charge to re-lease properties upon expiration of current leases.  In all of these cases, EastGroup’s cash flows would be adversely affected.

The Company is exposed to interest rate changes primarily as a result of its lines of credit and long-term debt maturities.  This debt is used to maintain liquidity and fund capital expenditures and expansion of the Company’s real estate investment portfolio and operations.  The Company’s objective for interest rate risk management is to limit the impact of interest rate changes on earnings and cash flows and to lower its overall borrowing costs.  To achieve its objectives, the Company borrows at fixed rates but also has two variable rate bank lines as discussed under Liquidity and Capital Resources.  The table below presents the principal payments due and weighted average interest rates for both the fixed rate and variable rate debt.

 

 

 

As the table above incorporates only those exposures that existed as of March 31, 2012, it does not consider those exposures or positions that could arise after that date.  If the weighted average interest rate on the variable rate bank debt as shown above changes by 10% or approximately 11 basis points, interest expense and cash flows would increase or decrease by approximately $133,000 annually.

Certain statements contained in this report may be deemed “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.  Words such as “will,” “anticipates,” “expects,” “believes,” “intends,” “plans,” “seeks,” “estimates,” variations of such words and similar expressions are intended to identify such forward-looking statements, which generally are not historical in nature.  All statements that address operating performance, events or developments that the Company expects or anticipates will occur in the future, including statements relating to rent and occupancy growth, development activity, the acquisition or sale of properties, general conditions in the geographic areas where the Company operates and the availability of capital, are forward-looking statements.  Forward-looking statements are inherently subject to known and unknown risks and uncertainties, many of which the Company cannot predict, including, without limitation: changes in general economic conditions; the extent of tenant defaults or of any early lease terminations; the Company's ability to lease or re-lease space at current or anticipated rents; the availability of financing; changes in the supply of and demand for industrial/warehouse properties; increases in interest rate levels; increases in operating costs; natural disasters, terrorism, riots and acts of war, and the Company's ability to obtain adequate insurance; changes in governmental regulation, tax rates and similar matters; and other risks associated with the development and acquisition of properties, including risks that development projects may not be completed on schedule, development or operating costs may be greater than anticipated or acquisitions may not close as scheduled, and those additional factors discussed under “Item 1A. Risk Factors” in Part II of this report and in the Company’s Annual Report on Form 10-K.  Although the Company believes the expectations reflected in the forward-looking statements are based upon reasonable assumptions at the time made, the Company can give no assurance that such expectations will be achieved.  The Company assumes no obligation whatsoever to publicly update or revise any forward-looking statements.  See also the information contained in the Company’s reports filed or to be filed from time to time with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

(i)      Disclosure Controls and Procedures.

The Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15.  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of March 31, 2012, the Company’s disclosure controls and procedures were effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic SEC filings.

(ii)      Changes in Internal Control Over Financial Reporting.

There was no change in the Company's internal control over financial reporting during the Company's first fiscal quarter ended March 31, 2012, that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

There have been no material changes to the risk factors disclosed in EastGroup’s Form 10-K for the year ended December 31, 2011.  For a full description of these risk factors, please refer to “Item 1A. Risk Factors” in the 2011 Annual Report on Form 10-K.

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date:  April 25, 2012