SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended: June 30, 2003
Commission File No. 1-07533
FEDERAL REALTY INVESTMENT TRUST
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
1626 East Jefferson Street, Rockville, Maryland 20852-4041
(Address of principal executive offices) (Zip Code)
(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.
Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the exchange Act).
Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
Outstanding at July 25, 2003
Federal Realty Investment Trust
S.E.C. FORM 10-Q
June 30, 2003
INDEX
PART I.
Consolidated Statements of Operations (unaudited)
Six months ended June 30, 2003 and 2002
5
Three months ended June 30, 2003 and 2002
6
Consolidated Statements of Shareholders’ Equity (unaudited)
7
Consolidated Statements of Cash Flows (unaudited)
8
PART II.
SIGNATURES
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The following unaudited financial statements have been prepared by management in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and in conformity with rules and regulations of the Securities and Exchange Commission (the “SEC”). Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included and the information contained in these financial statements fairly presents, in all material respects, the financial condition and results of operations of Federal Realty Investment Trust (“the Trust”). The results of operations for the six months ended June 30, 2003, are not necessarily indicative of the results that may be expected for the full year. These financial statements should be read in conjunction with our audited consolidated financial statements and footnotes thereto included in the Trust’s Annual Report on Form 10-K for the fiscal year ended December 31, 2002.
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CONSOLIDATED BALANCE SHEETS
June 30,
2003
(unaudited)
December31,
2002
Real estate, at cost
Operating
Development
Less accumulated depreciation and amortization
Other Assets
Cash
Mortgage notes receivable
Accounts and notes receivable
Insurance reimbursement receivable
Prepaid expenses and other assets, principally property taxes and lease commissions
Debt issue costs, net of accumulated amortization of $4,982 and $6,344, respectively
Liabilities
Obligations under capital leases
Mortgages and construction loans payable
Notes payable
Accounts payable and accrued expenses
Dividends payable
Security deposits
Prepaid rents
Senior notes and debentures
5 1/4% Convertible subordinated debentures
Investors’ interest in consolidated assets
Commitments and contingencies
Shareholders’ equity
Preferred stock, authorized 15,000,000 shares, $.01 par
7.95% Series A Cumulative Redeemable Preferred Shares, (stated at liquidation preference $25 per share), 4,000,000 shares issued in 1997
8.5% Series B Cumulative Redeemable Preferred Shares, (stated at liquidation preference $25 per share), 5,400,000 shares issued in 2001
Common shares of beneficial interest, $.01 par, 100,000,000 shares authorized, 50,493,032 and 44,996,382 issued, respectively
Additional paid in capital
Accumulated dividends in excess of Trust net income
Less:1,463,611 and 1,461,147 common shares in treasury—at cost, respectively
Deferred compensation on restricted shares
Notes receivable from employee stock plans
Accumulated other comprehensive income (loss)
The accompanying notes are an integral part of these consolidated statements.
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CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Revenue
Rental income
Interest and other income
Other property income
Expenses
Rental
Real estate taxes
Total property operating expenses
Property operating income
Interest
Administrative
Restructuring expenses
Depreciation and amortization
Total other expenses
Operating income before investors’ share of operations and discontinued operations
Investors’ share of operations
Income before gain on sale of real estate net of loss on abandoned developments held for sale and discontinued operations
Income (loss) from operations of discontinued assets
Income before gain on sale of real estate net of loss on abandoned developments held for sale
Gain on sale of real estate net of loss on abandoned developments held for sale
Net income
Dividends on preferred stock
Net income available for common shareholders
Earnings per common share, basic
Discontinued operations
Weighted average number of common shares, basic
Earnings per common share, diluted
Weighted average number of common shares, diluted
Income before gain on sale of real estate and discontinued operations
Income before gain on sale of real estate
Gain on sale of real estate
CONSOLIDATED STATEMENTS OF COMMON SHAREHOLDERS’ EQUITY
Additional
Paid-in Capital
Common Shares of Beneficial Interest
Balance, beginning of year
Exercise of stock options
Shares issued under dividend reinvestment plan
Performance and Restricted Shares granted, net of Restricted Shares retired
Issuance of shares in public offering
Shares issued to purchase operating partnership units
Accelerated vesting of options and restricted shares
Balance, end of period
Accumulated Dividends in Excess of Trust Net Income
Dividends declared to common shareholders
Dividends declared to preferred shareholders
Common Shares of Beneficial Interest in Treasury
Performance and Restricted Shares forfeited
Deferred Compensation on Restricted Shares
Performance and Restricted Shares issued, net of forfeitures
Vesting of Performance and Restricted Shares
Subscriptions receivable from employee stock plans
Subscription loans issued
Subscription loans paid
Change due to recognizing gain on securities
Change in valuation on interest rate swap
Other comprehensive income
Total other comprehensive income
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
OPERATING ACTIVITIES
Items not requiring cash outlays
Depreciation and amortization, including discontinued operations
Loss on abandoned developments held for sale
Non-cash portion of restructuring expense
Other, net
Changes in assets and liabilities
(Increase) decrease in accounts receivable
(Increase) in prepaid expenses and otherassets before depreciation and amortization
Increase (decrease) in operating accounts payable,security deposits and prepaid rent
(Decrease) increase in accrued expenses
Net cash provided by operating activities
INVESTING ACTIVITIES
Acquisition of real estate
Capital expenditures—development
Santana Row insurance proceeds
Capital expenditures—other
Proceeds from sale of real estate
(Issuance) of mortgage notes receivable, net
Net cash used in investing activities
FINANCING ACTIVITIES
Borrowing of short-term debt, net
Proceeds from mortgage and construction financing, net of costs
Issuance of common shares
Redemption of Series A Preferred Shares
Payments on mortgages, capital leases and notes payable
Repayment of 5 1/4% Convertible subordinated debentures
Dividends paid
(Decrease) in minority interest, net
Net cash provided by financing activities
(Decrease) increase in cash
Cash at beginning of period
Cash at end of period
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A—ACCOUNTING POLICIES AND OTHER DATA
We are an equity real estate investment trust specializing in the ownership, management, development and redevelopment of high quality retail and mixed-use properties. As of June 30, 2003, we owned or had an interest in 60 community and neighborhood shopping centers comprising approximately 13 million square feet, primarily located in densely populated and affluent communities throughout the Northeast and Mid-Atlantic United States. In addition, we owned 55 urban, mixed-use properties comprising over 2.5 million square feet, and one apartment complex, all located in strategic metropolitan markets across the United States. Our properties, excluding Santana Row, were 93.6% leased at June 30, 2003, 95.0% leased at March 31, 2003 and 96.0% leased at June 30, 2002. Including Santana Row, we were 93.1% leased at June 30, 2003 and 94.3% leased at March 31, 2003. We have paid quarterly dividends to our shareholders continuously since our founding in 1962, and have increased our dividend rate for 35 consecutive years.
Reference should be made to the notes to financial statements included in the Annual Report to shareholders for the year ended December 31, 2002 which contain our accounting policies and other data.
The following table sets forth the reconciliation between basic and diluted EPS:
Six months ending
Three months ending
Numerator
Net income available for common shareholders – basic
Income attributable to operating partnership units
Net income available for common shareholders – diluted
Denominator
Denominator for basic EPS-Weighted average shares
Effect of dilutive securities
Stock options and awards
Operating partnership units
Denominator for diluted EPS
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Reclassifications. Certain components of rental income, other property income, rental expense, real estate tax expense and depreciation and amortization expense on the June 30, 2002 Consolidated Statements of Operations have been reclassified to Income from operations of discontinued assets to assure comparability of all periods presented. In addition, certain December 31, 2002 Balance Sheet accounts and components of the June 30, 2002 Consolidated Statement of Cash Flows have been reclassified to assure comparability of all periods presented.
Stock-Based Compensation. In December 2002 the FASB issued SFAS No. 148, “Accounting for Stock Based Compensation-Transition and Disclosure” an amendment of FASB Statement No. 123, “Accounting for Stock-Based Compensation”. SFAS No. 148 amends the disclosure provisions to require prominent disclosure about the effects on reported net income of an entity’s accounting policy decisions with respect to stock-based compensation. We account for stock options using the intrinsic method in accordance with APB No. 25, “Accounting for Stock Issued to Employees,” as interpreted, whereby if options are priced at fair market value or above at the date of grant, no compensation expense is recognized. The pro forma information is as follows (in thousands except for earnings per share):
Net income as reported
Stock-based employee compensation cost included in net income as reported
Stock-based employee compensation cost under the fair value method of SFAS No. 123
Pro forma net income
Earnings per common share as reported, basic
Earnings per common share as reported, diluted
Pro forma earnings per share, basic
Pro forma earnings per share, diluted
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Variable Interest Entities. On January 31, 2003, the FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN 46”). FIN 46 clarifies existing accounting for whether variable interest entities should be consolidated in financial statements based upon the entity’s ability to finance its activities without additional financial support and whether investors possess characteristics of a controlling financial interest. FIN 46 applies to years or interim periods beginning after June 15, 2003 with certain disclosure provisions required for financial statements issued after January 31, 2003. We are currently evaluating the applicability of FIN 46 to our investments in certain restaurant joint ventures established in 2001 and 2002 at Santana Row and have complied with the disclosure provisions of FIN 46 in these financial statements.
NOTE B—REAL ESTATE ASSETS AND ENCUMBRANCES
On March 21, 2003 a partnership in which one of our wholly owned subsidiaries is the general partner, purchased the 214,000 square foot South Valley Shopping Center in Alexandria, Virginia for a purchase price of approximately $13.7 million in cash, of which $215,000 was allocated to a liability associated with the net fair value assigned to the assumed leases at the property.
On March 31, 2003 the same partnership acquired the leasehold interest, which extends through December 31, 2077, in the 257,000 square foot Mount Vernon Plaza in Alexandria, Virginia for aggregate consideration of approximately $17.5 million in the form of approximately $700,000 of cash, 120,000 partnership units valued at $3.5 million and the assumption of a $13.3 million mortgage. $1.1 million of the net assets acquired was allocated to a liability associated with the net fair value assigned to the assumed leases at the property.
On June 16, 2003 we sold the street retail property located at 4929 Bethesda Avenue in Bethesda, Maryland for $1.5 million resulting in a gain of $551,000.
During the first quarter of 2003 an action was filed by a local governmental authority to condemn a shopping center in Rockville, Maryland, owned by one of our partnerships to facilitate the authority’s redevelopment of its town center. The shopping center has a cost basis of $10.5 million and contributes less than 1% to rental income. The value of the shopping center has yet to be determined and therefore no gain or loss has been recognized at this time. However, we believe we will realize sufficient proceeds from this action and as a result we do not anticipate any impairment to the shopping center.
During the first six months of 2003, we loaned an additional $2.4 million to existing borrowers with a weighted average interest rate of 9.7%.
NOTE C—MORTGAGES AND CONSTRUCTION LOANS PAYABLE, NOTES PAYABLE AND OTHER LONG TERM DEBT
At June 30, 2003 there was $207.0 million borrowed under our $300 million revolving credit facility. The maximum amount drawn during the first six months of 2003 was $207.0
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million. The weighted average interest rate on borrowings for the six months ended June 30, 2003 was 2.1%. The facility requires fees and has various covenants including the maintenance of a minimum shareholders’ equity and a maximum ratio of debt to net worth. At June 30, 2003 we were in compliance with all loan covenants.
On February 11, 2003 the $24.4 million Woodmont East construction loan and the $17.0 million Friendship Center mortgage were paid off through borrowings under our revolving credit facility.
On June 23, 2003 our $75 million, 5 ¼% Convertible Subordinated Debentures originally due to mature on October 28, 2003 were paid off through borrowings under our revolving credit facility.
NOTE D—SHAREHOLDERS’ EQUITY
During the first six months of 2003, options for 409,500 shares at prices ranging from $28.01 to $31.31 per share, fair market value at the dates of award, were awarded to certain of our officers, employees and Trustees. The options vest over a six month period for Trustees and a three year period for officers and employees.
On May 14, 2003 we issued 3.2 million common shares at $30.457 per share ($31.48 gross, before an aggregate 3.25% underwriters discount and selling concession), netting $98.6 million in cash proceeds.
On June 13, 2003 we redeemed our $100 million Series A Cumulative Redeemable Preferred Shares using the proceeds from the May 9, 2003 common stock offering and additional borrowings.
NOTE E—INTEREST EXPENSE
We incurred interest totaling $45.1 million during the first six months of 2003 and $43.2 million during the first six months of 2002 of which $9.3 million and $11.4 million, respectively, was capitalized in connection with development projects. Interest paid was $44.1 million in the first six months of 2003 and $42.4 million in the first six months of 2002.
NOTE F—COMMITMENTS AND CONTINGENCIES
We are involved in various lawsuits and environmental matters arising in the normal course of business. Management believes that such matters will not have a material effect on our financial condition or results of operations.
We are currently committed to invest approximately $8.0 million in six restaurant joint ventures at Santana Row. As of June 30, 2003 we have invested approximately $7.7 million, $2.8 million of which was invested in 2003. We anticipate investing our remaining commitment in the third quarter of 2003. We do not anticipate having to make any further investments beyond our original commitment, nor are we obligated to do so.
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Under the terms of the Congressional Plaza partnership agreement, from and after January 1, 1986 Rockville Plaza Company (“RPC”), an unaffiliated third party, has the right to require us and the two other minority partners to purchase from half to all of RPC’s 37.5% interest in Congressional Plaza, including the Congressional Apartments, at the interest’s then-current fair market value. Based on management’s current estimate of fair market value, our estimated liability upon exercise of the put option is approximately $34.8 million. In conjunction with a redevelopment currently taking place at the property, we have agreed to acquire an additional 7.5% interest in Congressional Plaza from RPC, thereby lowering their ownership percentage to 30%, in exchange for funding approximately $7 million of RPC’s share of the redevelopment cost. The funding will take place through the first three quarters of 2003 and the transaction is anticipated to be completed by year end. After the completion of this transaction, our estimated liability upon the exercise of the put option will be approximately $28 million.
Under the terms of various other partnerships which own shopping center properties with a cost of approximately $103 million, including the two shopping centers purchased in the first quarter of 2003, the partners have the right to exchange their 839,828 operating units for cash or the same number of our common shares, at our option. On February 14, 2003 we paid $333,000 to redeem 12,000 operating units. On April 3, 2003 we issued 64,952 of our common shares valued at $1.9 million in exchange for 64,952 operating units.
Under the terms of four other partnerships which own street retail properties in southern California with a cost of approximately $61 million, if certain leasing and revenue levels are obtained for the properties owned by the partnerships, the other partners may require us to purchase their partnership interests at a formula price based upon property operating income. The purchase price may be paid in cash or for two of the partnerships, a limited number of our common shares at the election of the other partners. In those partnerships, if the other partners do not redeem their interest, we may choose to purchase the limited partnership interests upon the same terms.
Street Retail San Antonio LP, a wholly-owned subsidiary of the Trust, entered into a Development Agreement (the “Agreement”) on March 13, 2000 with the City of San Antonio, Texas (the “City”) related to the redevelopment of land and buildings that we own along Houston Street. Houston Street and the surrounding area have been designated by the City as a Reinvestment Zone (the “Zone”). The City has agreed to facilitate redevelopment of the Zone by undertaking and financing certain public improvements based on our agreement to redevelop our properties in the Zone. Under the terms of the Agreement, the City issued debt to fund specific public improvements within the Zone. The initial and primary source of funding to the City for repayment of the debt and debt service is the incremental tax revenue that accretes to the City as the taxable value of the redeveloped properties within the Zone increases. We are required to issue an annual letter of credit, commencing on October 1, 2002 through September 30, 2014, that covers our designated portion of the debt service should the incremental tax revenue generated in the Zone not cover the debt service. We posted a letter of credit with the City on September 25, 2002 for $795,000. Our obligation under this agreement cannot be determined at this time because it is dependent on the annual assessed value of the properties in the Zone and the related tax revenue generated. We were not required to provide any funding in 2002 or for
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the semi-annual payment due March 15, 2003. In the event that the current assessed values of the properties in the Zone do not increase as a result of our redevelopment, we would be required to provide some funding under the Agreement prior to its expiration on September 30, 2014, but anticipate that such obligation would not exceed $600,000 in any year and would be between $2 million and $3 million in total. If the Zone creates sufficient tax increment funding to repay the City’s debt prior to the expiration of the Agreement, we will be eligible to receive reimbursement of amounts paid for debt service shortfalls together with interest thereon.
NOTE G—COMPONENTS OF RENTAL INCOME
The components of rental income for the periods ended June 30 are as follows (in thousands):
Retail Properties
Minimum rents
Cost reimbursements
Percentage rents
Apartments
NOTE H—RESTRUCTURING EXPENSE
On December 20, 2002, we announced the resignation of Steven J. Guttman as Trustee, Chief Executive Officer and Chairman of the Board of Trustees effective January 1, 2003. Donald C. Wood, our then President and Chief Operating Officer, was named Chief Executive Officer and a member of the Board of Trustees. Mark Ordan, a member of the Board of Trustees since 1996, was named non-executive chairman of the board. As a result of this transition, we recorded a charge of $13.8 million in the fourth quarter of 2002 for payments and benefits to Mr. Guttman pursuant to his contractual arrangements with the Trust and for other transition related costs. Of this amount, $7.9 million had not been paid as of December 31, 2002. $6.3 million of that unpaid amount was paid in the first six months of 2003 bringing the remaining unpaid balance as of June 30, 2003 to $1.6 million. These unpaid amounts will be paid out over the next three years in accordance with Mr. Guttman’s contractual arrangements.
NOTE I—DISCONTINUED OPERATIONS
During the second quarter of 2003, we sold a street retail property for a gain of $551,000. During the second quarter of 2002 we sold six properties for a combined gain of $19.1 million. The results of operations from these properties, reported as income from operations of discontinued assets in accordance with Financial Accounting Standard No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, was ($10,000) for the six months ended June 30, 2003 and $1,285,000 for the six months ended June 30, 2002. The property sold in 2003 was
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a component of our Mid-Atlantic region. Four of these properties sold in 2002 were components of our Northeast region and two were components of our Western region.
NOTE J—RELATED PARTY TRANSACTIONS
Our former Chairman and CEO, Steven J. Guttman, has an ownership interest in three retailers, comprising approximately 3,500 square feet, at Santana Row. The leases were negotiated at what management believes to be arms length, market terms.
In addition, Nate Fishkin, a former officer whose last day of employment with the Trust was March 31, 2003, has an ownership interest in a retailer occupying approximately 2,600 square feet at Santana Row. This lease was also negotiated at what management believes to be arms length, market terms.
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NOTE K – SEGMENT INFORMATION
We operate our portfolio of properties in three geographic operating regions: Northeast, Mid-Atlantic and West.
A summary of our operations by geographic region is presented below (in thousands):
Six months ended June 30, 2003
Rental expense
Real estate tax
Interest expense
Administrative expense
Income before investors’ share of operations and discontinued operations
Capital expenditures
Real estate assets
Six months ended June 30, 2002
Interest and other income (expense)
Restructuring expense
16
Three months ended June 30, 2003
Three months ended June 30, 2002
There are no transactions between geographic areas.
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The following discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing in Item 1 of this report.
This Quarterly Report on 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. Also, documents that we “incorporate by reference” into this Quarterly Report on Form 10-Q, including documents that we subsequently file with the Securities and Exchange Commission, which we refer to as the SEC, will contain forward-looking statements. 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.” In particular, the risk factors included or incorporated by reference in this Quarterly Report on Form 10-Q describe forward-looking information. The risk factors describe risks that may affect these statements but are not all-inclusive, particularly with respect to possible future events. Many things can happen that can cause actual results to be different from those we describe. These factors include, but are not limited to:
Given these uncertainties, readers are cautioned not to place undue reliance on these forward-looking statements or those incorporated into this Quarterly Report on Form 10-Q. We also make no promise to update any of the forward-looking statements. You should carefully review the risks and the risk factors incorporated herein by reference from our Form 8-K filed on
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March 25, 2003, as well as the other information in our Annual Report on Form 10-K or in this Quarterly Report on Form 10-Q before making any investment in us.
Overview
We are an equity real estate investment trust specializing in the ownership, management, development and redevelopment of high quality retail and mixed-use properties. As of June 30, 2003, we owned or had an interest in 60 community and neighborhood shopping centers comprising approximately 13 million square feet, primarily located in densely populated and affluent communities throughout the Northeast and Mid-Atlantic United States. In addition, we owned 55 urban, mixed-use properties comprising over 2.5 million square feet, and one apartment complex, all located in strategic metropolitan markets across the United States. Our properties, excluding Santana Row, were 93.6% leased at June 30, 2003, 95.0% leased at March 31, 2003 and 96.0% leased at June 30, 2002. Including Santana Row, we were 93.1% leased at June 30, 2003 and 94.3% leased at March 31, 2003.
Outlook
Growth in net income and FFO during 2003 will depend primarily on growth in the core portfolio. Growth of net income from the core portfolio depends, in part, on the general economy, the financial health of our tenants and on our ability, directly or indirectly, to control expenses, some of which are beyond our complete control, such as snow removal, insurance and real estate tax assessments. The current weakening of the retail and overall economic environment could adversely impact us by increasing vacancies and decreasing rents. In past weak retail and real estate environments, however, we have been able to replace weak and bankrupt tenants with stronger tenants. Management believes that due to the quality of our properties, there will continue to be demand for our space.
Growth in the core portfolio, however, will be offset by expenses at Santana Row. Operating and marketing expenses, as well as additional depreciation and interest expense as the project is phased into operation, will have a dilutive effect on 2003 earnings. As a result of the August 2002 fire at Santana Row, as more fully described in this section at “Santana Row”, the projected opening of certain retail spaces has been delayed and approximately 50% of the total residential units for the project scheduled to be phased into service throughout 2003 were destroyed. These delayed openings, while lowering the income we will receive, will not substantially reduce the costs associated with maintaining and operating the infrastructure of the project.
Growth in net income is also dependent on the amount of our leverage and interest rates. Our leverage has increased as we financed our development projects. In addition, to the extent variable-rate debt is unhedged, we will continue to have exposure to changes in market interest rates. If interest rates increase, net income and FFO, as well as the ultimate cost of our development and redevelopment projects, will be negatively impacted.
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On April 23, 2003 we updated our previous announcement regarding the closing of three of our five Kmart locations. Kohl’s Corporation is assuming the previous Kmart lease at Fresh Meadows located in Queens, New York. We will re-claim the leases for both the Flourtown, Pennsylvania and Leesburg, Virginia locations. As of June 30, 2003, these two locations represented approximately 0.15% of our annualized revenues and 1.1% of our total square footage. Based on the demographics at these centers and the rent previously paid by Kmart we believe that these spaces will be re-leased or redeveloped on favorable terms.
2003 Property Acquisitions and Dispositions
Acquisitions
On March 31, 2003 the same partnership acquired the leasehold interest, which extends through December 31, 2077, in the 257,000 square foot Mount Vernon Plaza in Alexandria, Virginia for aggregate consideration of approximately $17.5 million in the form of approximately $700,000 of cash, 120,000 partnership units valued at $3.5 million and the assumption of a $13.3 million mortgage. $1.1 million of the net assets acquired was allocated to a liability associated with the fair value assigned to the assumed leases at the property.
Dispositions
2003 Financing Developments
A $5.9 million loan, which currently bears interest at 7.88% and is secured by an office building in San Francisco, California was due February 28, 2003 but was not repaid on the due date. We are currently negotiating with the borrower to extend the loan for one year. We believe that the loan is collectible and as such, no reserve has been established at this time.
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Santana Row
In 2003, our single largest capital need will be the completion of the development of Phase I and Phase II of Santana Row, a multi-phase mixed-use project being built on 42 acres in San Jose, California in the heart of Silicon Valley. The project will consist of residential, retail and hotel components, creating a community with the feel of an urban district.
Phase I of the project includes Santana Row, the “1,500 foot long main street” and eight buildings which contain approximately 444,000 square feet of retail space, 255 residential units, a 213 room hotel and the supporting infrastructure. The first building, containing 40,000 square feet and occupied by Crate & Barrel, opened on June 27, 2002. Six buildings comprising approximately 317,000 square feet of retail space opened on November 7, 2002. Tenants in the final 87,000 square foot building in Phase I began opening in February 2003. As of June 30, 2003, approximately 325,000 square feet, or 73%, of the Phase I retail space is leased, of which approximately 268,000 square feet, or 60%, of the Phase I retail space is open and 93% of the Phase I residential units are leased of which 81% are occupied.
On August 19, 2002 a fire broke out at Building Seven in the Santana Row project. Building Seven contained approximately 87,000 square feet of retail space, approximately 1,000 parking spaces and 246 residential units. All but eleven of the residential units in the building, which were originally scheduled to open in early 2003, were destroyed. The retail units and parking structure sustained water and smoke damage but were not structurally impaired. The opening of these retail units, originally scheduled for September 2002, was delayed until February 2003. The damage related to the fire was limited almost entirely to this single building. We estimate our loss to be in excess of $100 million, which includes costs to clean-up, repair and rebuild as well as soft (non-construction) costs and lost rents. We believe that our insurance will cover substantially all of our losses from the fire. The cause of the fire is unknown but will not affect our insurance claim. On October 22, 2002, a $20.0 million insurance reimbursement was advanced by the insurance carrier in addition to the $1.0 million initial advance. This advance, the proceeds from the November 19, 2002 note offering and borrowings under our credit facility, were used to pay in full and retire the Santana Row construction loan. Additional insurance
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reimbursements were advanced by the insurance carrier toward the claim on April 23, 2003 ($36.4 million), June 11, 2003 ($14.9 million) and on July 15, 2003 ($16.4 million, included as an Insurance reimbursement receivable as of June 30, 2003) bringing the total amount received to date to $88.8 million. $35.0 million of the April 2003 advance, all of the June 2003 advance and $16.0 million of the July 2003 advance were used to pay down our credit facility. Because our final insurance claim has not yet been submitted, insurance proceeds expected to be received over and above those received to date have not been recorded in our June 30, 2003 financial statements.
$48.4 million of the insurance proceeds received to date represents a reimbursement for costs to rebuild the residential portion of Building 7. We have written off the original construction costs incurred relating to this portion of Building 7 and have recognized a gain of approximately $200,000, included in interest and other income, in the second quarter of 2003.
We estimate the total cost of Phase I to be approximately $445 million, net of anticipated insurance proceeds. As of June 30, 2003, but after applying the $88.8 million of insurance proceeds received through July 15, 2003, we have incurred costs of $443 million including the purchase of all of the project’s land, the construction of Phase I, costs unreimbursed to date associated with the Building Seven fire and related cleanup and costs related to future phases of the project. We estimate that we will spend, net of anticipated insurance proceeds, approximately $2 million more relating to the completion of Phase I of the project.
We are evaluating our Building Seven residential options and alternatives taking into account costs incurred to date, costs to rebuild and market conditions and believe that we will be able to rebuild a residential component for Building Seven on economically favorable terms as part of a future phase of the project.
The success of Santana Row will depend on many factors which cannot be assured and are not entirely within our control. These factors include among others, the demand for retail and residential space, the cost of operations, including utilities and insurance, the availability and cost of capital and the general economy, particularly in the Silicon Valley.
On February 7, 2003, we announced plans for Phase II of Santana Row, which includes approximately 84,000 square feet of retail space on two pad sites and 275 additional parking spaces. 95% of the Phase II retail space has been pre-leased to Best Buy and The Container Store. Total development costs for Phase II are expected to be approximately $27 million. Phase II is scheduled to open in late 2003.
We have not determined the scope of future phases of Santana Row and will not do so until the success of Phase I, Phase II and future demand for rental space is determined. However, as Phases I and II utilize only part of the retail and residential entitlements of the property, and as Phase I includes the costs of land and infrastructure for future phases, we expect to identify and execute relatively small, additional phases on economically favorable terms.
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CEO Transition
Results of Operations
Throughout this section, we have provided certain information on a “same center” basis. Information provided on a same center basis is provided only for those properties owned and operated for the entirety of both periods being compared and includes properties which were redeveloped or expanded during the periods being compared. Properties purchased or sold and properties under development during the periods being compared are excluded from our same center analysis.
Comparison of 2003 to 2002 – Six Months Ended June 30,
Total revenues increased $20.7 million, or 13.7%, to $171.7 million for the six months ended June 30, 2003, as compared to $151.0 million for the six months ended June 30, 2002. The primary components of the increase in total revenues are discussed below.
Rental Income. Rental income consists of minimum rent, percentage rent and cost recoveries for common area maintenance, insurance and real estate taxes. The increase in rental income of $18.6 million, or 13.1%, for the six months ended June 30, 2003, as compared to the six months ended June 30, 2002, is attributable to:
Same center basis for the six months ended June 30, 2003 excludes the street retail property sold in the second quarter of 2003, the six properties sold in 2002, South Valley
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Shopping Center and Mount Vernon Plaza which were acquired in the first quarter of 2003 and Santana Row which was under construction for most of 2002. Same center rental income, excluding the contribution from property redevelopments and expansions, for the six months ended June 30, 2003 increased 6.6% from 2002, reflecting increases due to cost recoveries, retenanting and lease rollovers as described above.
Interest and Other Income. Interest and other income includes interest earned on mortgage notes receivable, overnight cash investments, including tax-deferred exchange escrow deposits if applicable and security deposits. Interest and other income increased $800,000 or 35.7% from $2.1 million for the six months ended June 30, 2002 to $2.9 million for the six months ended June 30, 2003. Interest from mortgage notes receivable decreased approximately $500,000 in 2003 reflecting the payoff of a $10 million mortgage note in July 2002 and the payoff of a $3.2 million note in August 2002 offset by increased interest on other notes. Additionally in 2002, interest and other income included a $1.3 million provision for estimated losses related to various unconsolidated restaurant joint ventures. The $200,000 gain recognized at Santana Row was offset by lower interest on invested funds, reflecting lower cash and non-mortgage note balances.
Other Property Income. Other property income includes items, which although recurring, tend to fluctuate more than rental income from period to period, such as utility reimbursements, telephone income, merchant association dues, late fees, lease termination fees and temporary tenant income. The increase in other property income of $1.3 million, or 18.6%, for the six months ended June 30, 2003, as compared to the six months ended June 30, 2002, is attributable to increases of $1.4 million at Santana Row as the project began phasing into service in the fourth quarter of 2002 and a $200,000 increase at our redevelopment projects which offset a $300,000 decrease on a same center basis as lower lease termination fees were slightly offset by increased utility recoveries on comparable centers.
Total property operating expenses increased $10.7 million to $57.7 million for the six months ended June 30, 2003, as compared to $47.0 million for the six months ended June 30, 2002. The components of the increase in total property operating expenses are discussed below.
Rental Expense. The increase in rental expense of $9.2 million, or 28.8%, for the six months ended June 30, 2003, as compared to the six months ended June 30, 2002, is attributable to:
Rental expense as a percentage of rental income and other property income, which we refer to as property income, increased from 21.4% for the first six months of 2002 to 24.3% for
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the first six months of 2003 due primarily to the initial operating expenses at Santana Row as the property phases into service and the increased snow removal costs incurred in the first quarter of 2003. Same center rental expense as a percentage of property income increased from 19.9% in 2002 to 21.1% in 2003 again reflecting the large increase in snow removal costs in the first quarter of 2003.
Real Estate Taxes. The increase in real estate taxes of $1.5 million, or 10.3%, for the six months ended June 30, 2003, as compared to the six months ended June 30, 2002, is attributable to increased taxes on new development projects, recently redeveloped properties and overall increases in tax assessments. On a same center basis real estate taxes increased 5.8%.
Property Operating Income. As a result of the changes and variances explained above, property operating income, total income less rental expenses and real estate taxes, increased $10.0 million, or 9.6%, to $114.0 million for the six months ended June 30, 2003 as compared to $104.0 million for the six months ended June 30, 2002. Same center property operating income increased $5.4 million, 5.1% for the six months ended June 30, 2003. Excluding the contribution from property redevelopments and expansions same center property operating income increased 4.4%.
Total other expenses decreased $700,000, or approximately 1.0%, to $77.8 million for the six months ended June 30, 2003 as compared to $78.5 million for the six months ended June 30, 2002. The primary components of the decrease in total other expenses are discussed below.
Interest Expense. In the first six months of 2003, we incurred interest of $45.1 million, of which $9.3 million was capitalized yielding interest expense of $35.8 million, as compared to interest incurred of $43.2 million in 2002, of which $11.4 million was capitalized yielding interest expense of $31.8 million. The increase in interest expense of $4.0 million, or 12.8%, for the six months ended June 30, 2003, as compared to the six months ended June 30, 2002, is attributable to:
The ratio of earnings to combined fixed charges (consisting of interest on borrowed funds, including capitalized interest, amortization of debt discount and expenses and the portion of rent expense representing an interest factor) and preferred dividends was 1.24x and 1.05x for
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the first half of 2003 and 2002, respectively. The ratio of earnings to fixed charges was 1.45x and 1.24x for the first half of 2003 and 2002, respectively. The ratio of earnings before interest, income taxes, depreciation and amortization (“EBITDA”) to combined fixed charges and preferred dividends was 1.63x for the first half of 2003 and 1.36x for the first half of 2002. EBITDA is a non-GAAP financial measure that is presented because it provides useful information regarding our ability to service debt. EBITDA should not be considered an alternative measure of operating results or cash flow from operations as determined in accordance with GAAP. See “EBITDA” in this section for a reconciliation of net income to EBITDA. Excluding the one-time restructuring charge of $8.5 million in the first quarter of 2002, our ratio of earnings to combined fixed charges and preferred dividends was 1.24x and 1.18x for the first half of 2003 and 2002, respectively, the ratio of earnings to fixed charges was 1.45x and 1.39x for the first half of 2003 and 2002, respectively and the ratio of EBITDA to combined fixed charges and preferred dividends was 1.63x for the first half of 2003 and 1.49x for the first half of 2002.
Administrative Expense. The decrease in administrative expense of $75,000, or 1.1%, for the six months ended June 30, 2003, as compared to the six months ended June 30, 2002, is attributable to:
Administrative expenses as a percentage of revenue decreased from 4.3% in the six months ended June 30, 2002 to 3.7% in the six months ended June 30, 2003.
Restructuring Charge and New Business Plan. On February 28, 2002, we adopted a new business plan which returned our primary focus to our traditional business of acquiring and redeveloping community and neighborhood shopping centers that are anchored by supermarkets, drug stores, or high volume, value oriented retailers that provide consumer necessities. Concurrently with the adoption of the business plan, we adopted a management succession plan and restructured our management team. In connection with these changes, we recorded a charge of $18.2 million. This charge included a reserve for a restructuring charge of $8.5 million made up of $6.9 million of severance and other compensation costs for several of our senior officers related to the management restructuring, as well as the write-off of $1.6 million of our development costs. All charges against the reserve, totaling $8.5 million, were expended during 2002.
Depreciation and Amortization Expense. The increase in depreciation and amortization expense of $3.8 million, or 12.1%, for the six months ended June 30, 2003, as compared to the six months ended June 30, 2002 reflects the impact of recent new developments, tenant improvements and property redevelopments which were placed into service throughout 2002 and the first half of 2003.
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Other
Investors’ Share of Operations. Investors’ share of operations represents the minority partners’ interest in the income of certain properties. The slight decrease in investors’ share of operations of approximately $100,000, or 3.2%, for the six months ended June 30, 2003, as compared to the six months ended June 30, 2002, is attributable to the 2002 allocation of the gain on the sale of the street retail property located in Hollywood, California to the minority partner.
Gain on Sale of Real Estate net of loss on Abandoned Developments Held for Sale. On June 16, 2003 we sold the street retail property located at 4929 Bethesda Avenue in Bethesda, Maryland for $1.5 million resulting in a gain of $551,000. In the second quarter of 2002, we sold six properties for a combined gain of $19.1 million. An additional component of our restructuring charge, as described under “Restructuring Charge and New Business Plan,” recorded in the first quarter of 2002 represented an estimated loss of $9.7 million on the abandonment of development projects held for sale, primarily the Tanasbourne development project located in Portland, Oregon, thereby adjusting the value of these assets to their estimated fair value. We are marketing these properties for sale and continue to believe we will realize the adjusted carrying value. The net gain in 2002 from the sale of the six properties less the charge for the abandonment of development projects held for sale was $9.4 million.
Income from Operations of Discontinued Assets. Beginning in 2002, SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” requires that gains and losses from dispositions of properties and all operating earnings from these properties be reported as income from operations of discontinued assets. As a result, previously reported income will be updated each time a property is sold. This requirement is for presentation only and has no impact on net income. The earnings generated from the street retail property sold in the second quarter of 2003 and the six properties sold in the second quarter of 2002 have been reported as income from operations of discontinued assets in accordance with SFAS No. 144. The income (loss) from operations of discontinued assets for the six months ended June 30, 2003 and June 30, 2002 was ($10,000) and $1.3 million, respectively.
Segment Results
We operate our business on an asset management model, where focused teams are responsible for a portfolio of assets. We have divided our portfolio of properties into three operating regions: the Northeast, Mid-Atlantic and West. Each region is operated under the direction of an asset manager, with dedicated leasing, property management and financial staff and operates largely autonomously with respect to day to day operating decisions. Incentive compensation, throughout the regional teams, is tied to the property operating income of the respective portfolios.
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Historical operating results for the three regions are as follows (in thousands):
Rental Income
Northeast
Mid-Atlantic
West
Total
Property Operating Income (1)
As of June 30, 2003, 48 of our properties were located in the Northeast region. The Northeast region extends from suburban Philadelphia north through New York and its suburbs into New England and west to Illinois and Michigan.
Rental Income. The increase in rental income of $2.4 million, or 4.0%, for the six months ended June 30, 2003 as compared to the six months ended June 30, 2002, is attributable to:
There was no significant contribution to rental income from property redevelopments or expansions in the first six months of 2003 in the Northeast region.
Property Operating Income. Property operating income consists of rental income, other property income and interest income, less rental expense and real estate taxes. The decrease in property operating income of approximately $700,000, or 1.4%, for the six months ended June 30, 2003 as compared to the six months ended June 30, 2002, is attributable to:
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As of June 30, 2003, 34 of our properties were located in the Mid-Atlantic region. The Mid-Atlantic region extends from Baltimore south to metropolitan Washington, D.C. and further south through Virginia and North Carolina into Florida.
Rental Income. The increase in rental income of $8.2 million, or 12.4%, for the six months ended June 30, 2003 as compared to the six months ended June 30, 2002, is attributable to:
Same center basis for the six months ended June 30, 2003 excludes South Valley Shopping Center and Mount Vernon Plaza, which were acquired in the first quarter of 2003. Same center rental income increased $7.1 million or 10.8% for the six months ended June 30, 2003 as compared to the six months ended June 30, 2002. Excluding the contribution from property redevelopments and expansion, rental income increased 10.1%.
Property Operating Income. The increase in property operating income of $6.0 million, or 12.1%, for the six months ended June 30, 2003 as compared to the six months ended June 30, 2002, is attributable to:
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As of June 30, 2003, 34 of our properties, including Santana Row, were located in the West region. The West region extends from Texas to the West Coast.
Rental. The increase in rental income of $8.0 million, or 47.8%, for the six months ended June 30, 2003 as compared to the six months ended June 30, 2002, is attributable to:
Same center basis for the six months ended June 30, 2003 excludes Santana Row, which was under development for the majority of 2002 and began phasing into service in late 2002 and through 2003. Same center rental income, excluding the contribution from property redevelopments and expansions, for the six months ended June 30, 2003 increased 2.7% from 2002.
Property Operating Income. The increase in property operating income of $4.7 million, or 48.1%, for the six months ended June 30, 2003 as compared to the six months ended June 30, 2002, is attributable to:
Same center property operating income in the six months ended June 30, 2003 increased 3.0% from 2002. Same center property operating income, excluding the contribution from property redevelopments and expansions, for the six months ended June 30, 2003 decreased approximately $100,000 from 2002 due to vacancies at two of the region’s street retail properties.
Comparison of 2003 to 2002 – Three Months Ended June 30,
Total revenues increased $10.6 million, or 14.0%, to $86.4 million for the three months ended June 30, 2003, as compared to $75.8 million for the three months ended June 30, 2002. The primary components of the increase in total revenues are discussed below.
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Rental Income. Rental income consists of minimum rent, percentage rent and cost recoveries for common area maintenance, insurance and real estate taxes. The increase in rental income of $9.1 million, or 12.8%, for the three months ended June 30, 2003, as compared to the three months ended June 30, 2002, is attributable to:
Same center basis for the three months ended June 30, 2003 excludes the street retail property sold in the second quarter of 2003, the six properties sold in 2002, South Valley Shopping Center and Mount Vernon Plaza which were acquired in the first quarter of 2003 and Santana Row which was under construction for most of 2002. Same center rental income, excluding the contribution from property redevelopments and expansions, for the three months ended June 30, 2003 increased 4.6% from 2002, reflecting increases due to cost recoveries, retenanting and lease rollovers as described above.
Interest and Other Income. Interest and other income includes interest earned on mortgage notes receivable, overnight cash investments, including tax-deferred exchange escrow deposits if applicable and security deposits. Interest and other income increased $800,000 or 93.6% from $857,000 for the three months ended June 30, 2002 to $1.7 million for the three months ended June 30, 2003. Interest from mortgage notes receivable decreased approximately $500,000 in 2003 reflecting the payoff of a $10 million mortgage note in July 2002 and the payoff of a $3.2 million note in August 2002. Additionally in 2002, interest and other income included a $1.3 million provision for estimated losses related to various unconsolidated restaurant joint ventures. The $200,000 gain recognized at Santana Row was offset by lower interest on invested funds, reflecting lower cash and non-mortgage note balances.
Other Property Income. Other property income includes items, which although recurring, tend to fluctuate more than rental income from period to period, such as utility reimbursements, telephone income, merchant association dues, late fees, lease termination fees and temporary tenant income. The increase in other property income of $700,000, or 19.4%, for the three months ended June 30, 2003, as compared to the three months ended June 30, 2002, is attributable to increases at Santana Row as the project began phasing into service in the fourth quarter of 2002.
On a same center basis, other property income remained stable as lower lease termination fees were offset by increased utility recoveries.
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Total property operating expenses increased $4.3 million to $28.2 million for the three months ended June 30, 2003, as compared to $23.9 million for the three months ended June 30, 2002. The components of the increase in total property operating expenses are discussed below.
Rental Expense. The increase in rental expense of $2.8 million, or 17.3%, for the three months ended June 30, 2003, as compared to the three months ended June 30, 2002, is attributable to:
Rental expense as a percentage of rental income and other property income, which we refer to as property income, increased from 21.9% for the three months ended June 30, 2002 to 22.8% for the first months ended June 30, 2003 due primarily to the initial operating expenses at Santana Row as the property phases into service. Same center rental expense as a percentage of property income decreased from 20.0% in 2002 to 19.2% in 2003 reflecting the relatively minor $200,000 increase in same center rental expense as compared to the $4.1 million increase in rental income.
Real Estate Taxes. The increase in real estate taxes of $1.5 million, or 19.4%, for the three months ended June 30, 2003, as compared to the three months ended June 30, 2002, is attributable to increased taxes on new development projects, recently redeveloped properties and overall increases in tax assessments. On a same center basis real estate taxes increased 12.9%.
Property Operating Income. As a result of the changes and variances explained above, property operating income, total income less rental expenses and real estate taxes, increased $6.3 million, or 12.2%, to $58.2 million for the three months ended June 30, 2003 as compared to $51.9 million for the three months ended June 30, 2002. Same center property operating income increased $2.6 million, 4.8% for the three months ended June 30, 2003. Excluding the contribution from property redevelopments and expansions same center property operating income increased 4.0%.
Total other expenses increased $5.0 million, or 14.4%, to $39.5 million for the three months ended June 30, 2003 as compared to $34.5 million for the three months ended June 30, 2002. The primary components of the decrease in total other expenses are discussed below.
Interest Expense. In the second quarter of 2003, we incurred interest of $22.4 million, of which $4.1 million was capitalized yielding interest expense of $18.3 million, as compared to interest of $21.7 million in 2002, of which $6.6 million was capitalized yielding interest expense of $15.1 million. The increase in interest expense of $3.1 million, or 20.6%, for the three months ended June 30, 2003, as compared to the three months ended June 30, 2002, is attributable to:
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Administrative Expense. The decrease in administrative expense of $350,000, or 10.0%, for the three months ended June 30, 2003, as compared to the three months ended June 30, 2002, is attributable to lower payroll costs as a result of our 2002 restructuring. Administrative expenses as a percentage of revenue decreased from 4.6% in the three months ended June 30, 2002 to 3.6% in the three months ended June 30, 2003.
Depreciation and Amortization Expense. The increase in depreciation and amortization expense of $2.2 million, or 13.9%, for the three months ended June 30, 2003, as compared to the three months ended June 30, 2002 reflects the impact of recent new developments, tenant improvements and property redevelopments which were placed into service throughout 2002 and the first half of 2003.
Investors’ Share of Operations. Investors’ share of operations represents the minority partners’ interest in the income of certain properties. The decrease in investors’ share of operations of approximately $400,000, or 28.2%, for the three months ended June 30, 2003, as compared to the three months ended June 30, 2002, is attributable to the allocation to the operating unit holders their proportionate share of our net income realized in the second quarter of 2002. These unit holders are allocated income as if they held our shares.
Gain on Sale of Real Estate. On June 16, 2003 we sold the street retail property located at 4929 Bethesda Avenue in Bethesda, Maryland for $1.5 million resulting in a gain of $551,000. In the second quarter of 2002, we sold six properties for a combined gain of $19.1 million.
Income from Operations of Discontinued Assets. Beginning in 2002, SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” requires that gains and losses from dispositions of properties and all operating earnings from these properties be reported as income from operations of discontinued assets. As a result, previously reported income will be updated each time a property is sold. This requirement is for presentation only and has no impact on net income. The earnings generated from the street retail property sold in the second quarter of 2003 and the six properties sold in the second quarter of 2002 have been reported as income from operations of discontinued assets in accordance with SFAS No. 144.
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The income (loss) from operations of discontinued assets for the three months ended June 30, 2003 and June 30, 2002 was ($6,000) and $439,000, respectively.
Rental Income. The increase in rental income of $400,000, or 1.3%, for the three months ended June 30, 2003 as compared to the three months ended June 30, 2002, is attributable to increased rental rates at retenanted centers, such as Ellisburg and Finley Square as well as increased rental rates associated with lease rollovers which offset higher vacancy levels at two of the region’s shopping centers.
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There was no significant contribution to rental income from property redevelopments or expansions in the second quarter of 2003 in the Northeast region.
Property Operating Income. Property operating income consists of rental income, other property income and interest income, less rental expense and real estate taxes. The $55,000, or less than 1%, increase in property operating income for the three months ended June 30, 2003 as compared to the three months ended June 30, 2002, is attributable to:
Rental Income. The increase in rental income of $4.5 million, or 13.4%, for the three months ended June 30, 2003 as compared to the three months ended June 30, 2002, is attributable to:
Same center basis for the three months ended June 30, 2003 excludes South Valley Shopping Center and Mount Vernon Plaza, which were acquired in the first quarter of 2003. Same center rental income increased $3.4 million, or 10.1%, for the three months ended June 30, 2003 as compared to the three months ended June 30, 2002. Excluding the contribution from property redevelopments and expansions, rental income increased 9.0%.
Property Operating Income. The increase in property operating income of $3.1 million, or 12.5%, for the three months ended June 30, 2003 as compared to the three months ended June 30, 2002, is attributable to:
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Rental. The increase in rental income of $4.3 million, or 49.9%, for the three months ended June 30, 2003 as compared to the three months ended June 30, 2002, is attributable to:
Same center basis for the three months ended June 30, 2003 excludes Santana Row, which was under development for the majority of 2002 and began phasing into service in late 2002 and through 2003. Same center rental income, excluding the contribution from property redevelopments and expansions was $8.4 million for both the three months ended June 30, 2003 and June 30, 2002 as rental increases were offset by vacancies at one of the regions street retail properties.
Property Operating Income. The increase in property operating income of $3.1 million, or 73.5%, for the three months ended June 30, 2003 as compared to the three months ended June 30, 2002, is attributable to:
Same center property operating income in the three months ended June 30, 2003 decreased approximately $200,000 from 2002 due to the vacancies mentioned above and lower parking revenue. Same center property operating income, excluding the contribution from property redevelopments and expansions, for the three months ended June 30, 2003 decreased approximately $400,000 from 2002.
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Liquidity and Capital Resources
Cash and cash equivalents were $18.6 million and $23.1 million at June 30, 2003 and December 31, 2002, respectively. This $4.5 million decrease is attributable to $76.5 million used in investing activities partially offset by $58.5 million and $13.5 million provided by operating and financing activities, respectively.
For the Six MonthsEnded
Cash Used in Investing Activities
Cash Provided by Operating Activities
Cash Provided by Financing Activities
Decrease in Cash and Cash Equivalents
Cash and Cash Equivalents, Beginning of Period
Cash and Cash Equivalents, End of Period
Investing Activities
The cash used in investing activities for the six months ended June 30, 2003 of $76.5 million is attributable to:
Operating Activities
The cash provided by operating activities for the six months ended June 30, 2003 of $58.5 million is entirely attributable to property operations.
Financing Activities
The cash provided by financing activities for the six months ended June 30, 2003 of $13.5 million is attributable to:
The cash provided by financing activities was partially offset by:
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Debt Financing Arrangements
As of June 30, 2003, we had total debt outstanding of $1.1 billion.
The following is a summary of our total debt outstanding as of June 30, 2003 and 2002 (dollars in thousands):
Description of Debt
Principal Balance
as of
June 30, 2002
Interest Rate
Maturity Date
Mortgage and Construction Loans
Secured Fixed Rate
Leesburg Plaza (1)
164 E. Houston Street (2)
Federal Plaza (3)
Tysons Station (4)
Barracks Road (5)
Hauppauge (6)
Lawrence Park (7)
Wildwood (8)
Wynnewood (9)
Brick Plaza (10)
Mount Vernon (11)
Secured Variable Rate
Woodmont East Construction (12)
Friendship Center (12)
Santana Row Construction (13)
Total Mortgage and Construction Loans
Notes Payable
Unsecured Fixed Rate
Term note with banks (14)
Perring Plaza Renovation (15)
Unsecured Variable Rate
Escondido (Municipal Bonds) (16)
Revolving credit facilities (17)
Total Notes Payable
Senior Notes and Debentures
5.25% Convertible Subordinated Debentures (18)
6.74% Medium Term Notes (19) (20)
6.625% Notes (19)
6.99% Medium Term Notes (19) (21)
6.125% Notes (19) (22)
8.75% Notes (19)
7.48% Debentures (19)(23)
6.82% Medium Term Notes (19)(24)
Total Senior Notes and Debentures
Total Debt Outstanding
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Our credit facility and other debt agreements include financial covenants that may limit our operating activities in the future. These covenants require us to:
We are also obligated to comply with other covenants, including, among others, provisions:
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As of June 30, 2003, we were in compliance with all of the listed financial covenants. If we were to breach any of our debt covenants, including the listed covenants, and did not cure the breach within any 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 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 covenant 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.
Below are the aggregate principal payments required as of June 30, 2003 under our debt financing arrangements by year. Scheduled principal installments and amounts due at maturity are included.
2004
2005
2006
2007
2008 and thereafter
Our organizational documents do not limit the level or amount of debt that we may incur. Also see “Liquidity Requirements” in this section regarding management’s plans with respect to debt maturing in 2003.
Interest Rate Hedging
We enter into derivative contracts, which qualify as cash flow hedges under SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities”, in order to manage interest rate risk. Derivatives are not purchased for speculation.
During 2001, to hedge our exposure to interest rates on our $125 million term loan, we entered into interest rate swaps, which fixed the LIBOR interest rate on the term loan at 5.27%. The current interest rate on the term loan is LIBOR plus 95 basis points, thus fixing the interest rate at 6.22% on notional amounts totaling $125 million. We are exposed to credit loss in the event of non-performance by the counterparties to the interest rate protection agreement should
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interest rates exceed the cap. However, management does not anticipate non-performance by the counterparties. The counterparties have long-term debt ratings of A- or above by Standard and Poor’s Ratings Service (“S&P”) and Aa2 or above by Moody’s Investors Service (“Moody’s”). Although our cap is not exchange traded, there are a number of financial institutions which enter into these types of transactions as part of their day-to-day activities. The interest rate swaps mature concurrently with the $125 million term loan on December 19, 2003. The swaps were documented as cash flow hedges and designated as effective at inception of the swap contract. Consequently, the unrealized gain or loss upon measuring the swaps at their fair value is recorded as a component of other comprehensive income within shareholders’ equity and either a derivative instrument asset or liability is recorded on the balance sheet. At June 30, 2003, a cumulative unrealized loss of $2.4 million, representing the difference between the current market value and the 6.22% fixed interest rate on the swap, was recorded in other comprehensive income with a corresponding derivative liability on the balance sheet. Interest expense of approximately $2.4 million will be reclassified from other comprehensive income into current earnings during the remainder 2003 to bring the effective interest rate up to 6.22%.
Liquidity Requirements
Short-term liquidity requirements consist primarily of obligations under 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 corporate expenditures, non-recurring corporate expenditures (such as tenant improvements and redevelopments) and dividends to common and preferred shareholders. Included in short-term liquidity requirements as of June 30, 2003 is $332 million that represents our revolving credit facility and our term loan which mature on December 19, 2003, which we plan to renew. Overall capital requirements in 2003 will depend upon acquisition opportunities, the level of improvements and redevelopments on existing properties and the timing and cost of future phases of Santana Row. We expect to fund our capital requirements, as well as our development and redevelopment costs, acquisitions and normal recurring operating costs through a combination of cash provided by operating activities, borrowings under our credit facility and other funding sources which may consist of additional and replacement debt, both secured and unsecured, additional equity, joint venture relationships and property dispositions.
We expect to fund our long-term capital requirements, which consist primarily of maturities under our long-term debt, development and redevelopment costs and potential acquisition opportunities through a combination of funding sources which we believe will be available to us including debt, both secured and unsecured, additional equity, joint venture relationships and property dispositions.
The following factors could affect our ability to meet our liquidity requirements:
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REIT Qualification
We intend to maintain our qualification as a REIT under Section 856(c) of the Code. As a REIT, we generally will not be subject to corporate federal income taxes as long as we satisfy certain technical requirements of the Code, including the requirement to distribute 90% of our REIT taxable income to our shareholders.
Funds From Operations
We have historically reported our FFO in addition to our net income and net cash provided by operating activities. 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: income available for common shareholders before depreciation and amortization of real estate assets and before extraordinary items less gains and losses on sale of real estate. NAREIT developed FFO as a relative measure of performance and liquidity of an equity REIT in order to recognize that the value of income-producing real estate historically has not depreciated on the basis determined under GAAP. However, FFO:
We consider FFO a meaningful, additional measure of operating performance because it primarily excludes the assumption that the value of the real estate assets diminishes predictably over time, and because industry analysts have accepted it as a performance measure. 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 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 90% of our REIT taxable income (as defined in the Code). Therefore, a significant increase in FFO will generally require an increase in distributions to shareholders although not necessarily on a proportionate basis.
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The reconciliation of net income available for common shareholders to funds from operations is as follows:
(Gain) on sale of real estate net of loss on abandoned developments held for sale
Depreciation and amortization of real estate assets
Amortization of initial direct costs of leases
Funds from operations for common shareholders
Weighted average number of common shares used to Compute diluted FFO per share
FFO per diluted share
EBITDA
The reconciliation of EBITDA, adjusted for discontinued operations, to net income is as follows:
For the Six
Months Ended
For the Three MonthsEnded
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our use of financial instruments, such as debt instruments, subject 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 its 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. We also enter into derivative financial instruments such as interest rate swaps to mitigate our interest rate risk on a related financial instrument or to effectively lock the interest rate on a portion of its variable rate debt.
The following discussion of market risk is based solely on hypothetical changes in interest rates related to our variable rate debt. This discussion does not purport to take into account all of the factors that may affect the financial instruments discussed in this section.
Interest Rate Risk
Our interest rate risk is most sensitive to fluctuations in interest rates on our variable rate debt. At June 30, 2003, we had $216.4 million of variable rate debt. Based upon this balance of variable operating debt, if interest rates increased 1%, our earnings and cash flows for the year would decrease by approximately $2.2 million. If interest rates decreased 1%, our earnings and cash flows for the year would increase by approximately $2.2 million. We believe that the change in the fair value of our financial instruments resulting from a foreseeable fluctuation in interest rates would be immaterial to our total assets and total liabilities.
Cash Flow Hedges
We use derivative financial instruments to convert a portion of our variable rate debt to fixed rate debt and to manage our fixed to variable rate debt ratio. A description of these derivative financial instruments is contained in “Item 2. Interest Rate Hedging” and is incorporated by reference into this Item 3.
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ITEM 4. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our President and Chief Executive Officer and Senior Vice President and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based closely on the definition of “disclosure controls and procedures” in Rule 13a-15(e)4 promulgated under the Exchange Act. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
On June 30, 2003, we carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief Executive Officer and our Senior Vice President and Chief Financial Officer, of the effectiveness of our design and operation of our disclosure controls and procedures. Based on the foregoing, the President and Chief Executive Officer and our Senior Vice President and Chief Financial Officer concluded that our disclosure controls and procedures were effective.
During the three months ended June 30, 2003, there were no changes in our internal control over financial reporting or in other factors that has materially affected, or is reasonably likely to materially affect our internal control for financial reporting.
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PART II—OTHER INFORMATION
Not applicable.
On April 3, 2003 we issued 64,952 of our common shares valued at $1.9 million in exchange for 64,952 operating units that were initially issued in August 1998 in connection with our acquisition of a shopping center. The shares were issued in a private offering in reliance upon an exemption from the registration requirements of the federal securities laws pursuant to Section 4(2) of the Securities Act of 1933.
At the 2003 Annual Meeting of Shareholders on May 7, 2003 the Shareholders elected Ms. Amy B. Lane, Mr. Walter F. Loeb and Mr. Joseph S. Vassalluzzo as trustees, to serve for the ensuing three years. Holders of 28.4 million shares, 29.7 million shares and 28.6 million shares voted for each trustee, respectively and holders of 1.4 million shares, 200,000 shares and 1.3 million shares withheld their votes for each trustee, respectively.
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A Form 8-K, dated May 23, 2003 was filed on May 29, 2003 in response to Items 5 and 7 announcing the redemption of our 5 ¼% Convertible Subordinated Debentures due 2003.
A Form 8-K, dated May 14, 2003 was filed on May 15, 2003 in response to Items 5 and 7 to file a press release announcing the redemption of our 7.95% Series A preferred shares.
A Form 8-K, dated May 9, 2003 was filed on May 13, 2003 in response to Item 7 to file exhibits in connection with an underwritten public offering of our common shares under our registration statement on Form S-3 (No. 333-100819).
A Form 8-K, dated March 31, 2003 was filed on May 7, 2003 in response to Items 7 and 12 to file a press release announcing our financial results for the quarter ended March 31, 2003 and to file supplemental information related thereto.
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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 duly authorized.
/s/ DONALD C. WOOD
Donald C. Wood
President, Chief Executive Officer and Trustee
(Principal Executive Officer)
/s/ LARRY E. FINGER
Larry E. Finger
Senior Vice President and Chief Financial Officer
(Principal Accounting Officer)
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EXHIBIT INDEX
1