10-Q 1 form10qsept2003.txt 10Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003 COMMISSION FILE NO. 1-12494 CBL & ASSOCIATES PROPERTIES, INC. ------------------------------------------------------------------------------- (Exact Name of registrant as specified in its charter) DELAWARE 62-1545718 ------------------------------------- ----------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification incorporation or organization) Number) 2030 Hamilton Place Blvd., Suite 500, Chattanooga, TN 37421-6000 ------------------------------------------------------------------------------- (Address of principal executive office, including zip code) Registrant's telephone number, including area code (423) 855-0001 ------------------- N/A ------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) 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 twelve (12) months (or such shorter period that the Registrant was required to file such report) and (2) has been subject to such filing requirements for the past ninety (90) days. YES |X| NO |_| Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). YES |X| NO |_| As of November 11, 2003, there were 30,251,431shares of common stock, par value $0.01 per share, outstanding. 1 CBL & Associates Properties, Inc. PART I - FINANCIAL INFORMATION ITEM 1: Financial Statements..........................................3 ---------------------------- Consolidated Balance Sheets...........................................4 --------------------------- Consolidated Statements Of Operations.................................5 ------------------------------------- Consolidated Statements of Cash Flows.................................6 ------------------------------------- Notes to Unaudited Consolidated Financial Statements..................7 ---------------------------------------------------- ITEM 2: Management's Discussion and Analysis of Financial Condition and Results of Operations...............16 ------------------------------------------------------ ITEM 3: Quantitative and Qualitative Disclosures About Market Risk...........................................32 ------------------------------------------------- ITEM 4: Controls and Procedures.....................................32 -------------------------------- PART II - OTHER INFORMATION ITEM 1: Legal Proceedings........................................33 ------- ----------------- ITEM 2: Changes in Securities and Use of Proceeds................33 ------- ----------------------------------------- ITEM 3: Defaults Upon Senior Securities..........................33 ------- ------------------------------- ITEM 4: Submission of Matters to a Vote of Security Holders......33 ------- --------------------------------------------------- ITEM 5: Other Information........................................33 ------- ----------------- ITEM 6: Exhibits and Reports on Form 8-K.........................33 ------- -------------------------------- SIGNATURE....................................................................35 2 CBL & Associates Properties, Inc. ITEM 1: Financial Statements The accompanying financial statements are unaudited; however, they have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and in conjunction with the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting solely of normal recurring matters) necessary for a fair presentation of the financial statements for these interim periods have been included. The results for the interim periods ended September 30, 2003, are not necessarily indicative of the results to be obtained for the full fiscal year. These financial statements should be read in conjunction with CBL & Associates Properties, Inc.'s audited financial statements and notes thereto included in the CBL & Associates Properties, Inc. Form 10-K for the year ended December 31, 2002. 3 CBL & Associates Properties, Inc. Consolidated Balance Sheets (In thousands, except share data) (Unaudited)
September 30, December 31, 2003 2002 ---------------- ---------------- ASSETS Real estate assets: Land.............................................................. $ 620,818 $ 570,818 Buildings and improvements........................................ 3,683,102 3,394,787 ---------------- ---------------- 4,303,920 3,965,605 Less accumulated depreciation................................... (510,047) (434,840) ---------------- ---------------- 3,793,873 3,530,765 Developments in progress.......................................... 102,099 80,720 ---------------- ---------------- Net investment in real estate assets............................ 3,895,972 3,611,485 Cash and cash equivalents........................................... 25,188 13,355 Receivables: Tenant, net of allowance for doubtful accounts of $2,889 in 2003 and $2,861 in 2002........................................ 41,947 37,994 Other............................................................. 5,130 3,692 Mortgage and other notes receivable................................. 21,900 23,074 Investments in unconsolidated affiliates............................ 77,152 68,232 Other assets........................................................ 63,240 37,282 ---------------- ---------------- $ 4,130,529 $ 3,795,114 ================ ================ LIABILITIES AND SHAREHOLDERS' EQUITY Mortgage and other notes payable.................................... $ 2,618,216 $ 2,402,079 Accounts payable and accrued liabilities............................ 157,837 151,332 ---------------- ---------------- Total liabilities................................................. 2,776,053 2,553,411 ---------------- ---------------- Minority interests.................................................. 494,439 500,513 ---------------- ---------------- Commitments and contingencies (Note 10)............................. Shareholders' equity: Preferred stock, $.01 par value, 15,000,000 shares authorized: 9.0% Series A Cumulative Redeemable Preferred Stock, 2,675,000 shares outstanding in 2003 and 2002.............. 27 27 8.75% Series B Cumulative Redeemable Preferred Stock, 2,000,000 shares outstanding in 2003 and in 2002 .......... 20 20 7.75% Series C Cumulative Redeemable Preferred Stock, 460,000 shares outstanding in 2003 and none in 2002 ....... 5 -- Common stock, $.01 par value, 95,000,000 shares authorized, 30,210,653 and 29,797,469 shares issued and outstanding in 2003 and 2002, respectively.................................. 302 298 Additional paid - in capital...................................... 878,919 765,686 Accumulated other comprehensive loss.............................. -- (2,397) Deferred compensation............................................. (1,706) -- Accumulated deficit............................................... (17,530) (22,444) ---------------- ---------------- Total shareholders' equity...................................... 860,037 741,190 ---------------- ---------------- $ 4,130,529 $ 3,795,114 ================ ================ The accompanying notes are an integral part of these balance sheets.
4 CBL & Associates Properties, Inc. Consolidated Statements of Operations (In thousands, except per share data) (Unaudited)
Three Months Ended Nine Months Ended September 30, September 30, --------------------------- ---------------------------- 2003 2002 2003 2002 ------------- ------------ -------------- ------------ REVENUES: Rentals: Minimum rents..................................... $106,341 $95,012 $313,813 $280,439 Percentage rents.................................. 2,228 2,093 9,756 10,608 Other rents....................................... 1,624 1,277 5,415 5,033 Tenant reimbursements................................ 50,470 43,172 152,644 125,497 Management, development and leasing fees............. 1,221 1,754 3,946 5,507 Other................................................ 3,592 3,135 10,741 11,097 ------------- ------------ -------------- ------------ Total revenues..................................... 165,476 146,443 496,315 438,181 ------------- ------------ -------------- ------------ EXPENSES: Property operating................................... 26,575 24,664 82,886 74,151 Depreciation and amortization........................ 28,385 24,084 82,362 70,183 Real estate taxes.................................... 13,149 11,946 39,947 34,732 Maintenance and repairs.............................. 9,636 9,266 29,792 26,711 General and administrative........................... 7,228 5,499 20,225 16,706 Other................................................ 2,703 2,282 7,359 8,089 ------------- ------------ -------------- ------------ Total expenses..................................... 87,676 77,741 262,571 230,572 ------------- ------------ -------------- ------------ Income from operations............................... 77,800 68,702 233,744 207,609 Interest income...................................... 639 841 1,804 1,824 Interest expense..................................... (38,051) (36,620) (113,369) (107,456) Loss on extinguishment of debt....................... -- (210) (167) (3,399) Gain on sales of real estate assets.................. 837 497 4,943 2,702 Equity in earnings of unconsolidated affiliates...... 922 2,353 3,410 6,455 Minority interest in earnings: Operating partnership.............................. (17,235) (14,599) (55,851) (47,131) Shopping center properties......................... (605) (389) (2,038) (2,522) ------------- ------------ -------------- ------------ Income before discontinued operations................ 24,307 20,575 72,476 58,082 Operating income (loss) of discontinued operations... (32) 417 46 1,428 Gain on discontinued operations...................... 633 165 3,568 1,572 ------------- ------------ -------------- ------------ Net income........................................... 24,908 21,157 76,090 61,082 Preferred dividends.................................. (4,683) (3,692) (12,067) (7,319) ------------- ------------ -------------- ------------ Net income available to common shareholders.......... $20,225 $17,465 $64,023 $53,763 ============= ============ ============== ============ Basic per share data: Income before discontinued operations, net of preferred dividends.................... $0.65 $0.57 $2.02 $1.79 Discontinued operations.......................... 0.02 0.02 0.12 0.11 ------------- ------------ -------------- ------------ Net income available to common shareholders...... $0.67 $0.59 $2.14 $1.90 ============= ============ ============== ============ Weighted average common shares outstanding 30,022 29,616 29,879 28,364 Diluted per share data: Income before discontinued operations, net of preferred dividends.................... $0.63 $0.55 $1.94 $1.74 Discontinued operations.......................... 0.02 0.02 0.12 0.10 ------------- ------------ -------------- ------------ Net income available to common shareholders...... $0.65 $0.57 $2.06 $1.84 ============= ============ ============== ============ Weighted average common and potential dilutive common shares outstanding........................ 31,301 30,476 31,070 29,191 The accompanying notes are an integral part of these statements.
5 CBL & Associates Properties, Inc. Consolidated Statements of Cash Flows (In thousands) (Unaudited)
Nine Months Ended September 30, --------------------------------- 2003 2002 --------------- -------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $76,090 $61,082 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation................................................................ 62,817 56,566 Amortization................................................................ 23,066 15,713 Gain on sales of real estate assets......................................... (4,943) (2,702) Gain on discontinued operations............................................. (3,568) (1,572) Loss on extinguishment of debt.............................................. 167 3,399 Issuance of stock under incentive plan...................................... 1,617 1,503 Write-off of development projects........................................... 153 58 Deferred compensation....................................................... 269 -- Amortization of deferred compensation....................................... 155 -- Minority interest in earnings............................................... 57,889 49,646 Amortization of market value of acquired leases............................. (82) -- Changes in: Tenant and other receivables................................................ (5,697) 1,017 Other assets................................................................ (16,242) (11,429) Accounts payable and accrued liabilities.................................... 3,529 23,258 --------------- -------------- Net cash provided by operating activities........................... 195,220 196,539 --------------- -------------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisitions of real estate assets........................................ (85,416) (54,145) Additions to real estate assets........................................... (69,950) (53,480) Other capital expenditures................................................ (100,492) (70,362) Capitalized interest...................................................... (4,512) (3,454) Additions to other assets................................................. (7,083) (1,537) Proceeds from sales of real estate assets................................. 19,831 83,358 Payments received on mortgage notes receivable............................ 1,174 1,809 Additions to mortgage notes receivable.................................... -- (5,819) Distributions in excess of equity in earnings of unconsolidated affiliates 222 690 Additional investments in and advances to unconsolidated affiliates....... (9,142) (5,955) --------------- -------------- Net cash used in investing activities............................... (255,368) (108,895) --------------- -------------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from mortgage and other notes payable............................ 383,959 565,362 Principal payments on mortgage and other notes payable.................... (282,276) (748,095) Additions to deferred financing costs..................................... (4,462) (5,176) Prepayment penalties on extinguishment of debt............................ -- (1,875) Proceeds from issuance of common stock.................................... 3,574 117,121 Proceeds from issuance of preferred stock................................. 111,272 96,397 Proceeds from exercise of stock options................................... 5,969 4,737 Purchase of minority interest............................................. (21,013) -- Repurchase of preferred stock............................................. -- (5,000) Distributions to minority investors....................................... (54,134) (48,929) Dividends paid............................................................ (70,908) (53,578) --------------- -------------- Net cash provided by (used in) financing activities................. 71,981 (79,036) --------------- -------------- NET CHANGE IN CASH AND CASH EQUIVALENTS....................................... 11,833 8,608 CASH AND CASH EQUIVALENTS, beginning of period 13,355 10,137 --------------- -------------- CASH AND CASH EQUIVALENTS, end of period...................................... $25,188 $18,745 =============== ============== SUPPLEMENTAL INFORMATION: Cash paid for interest, net of amounts capitalized.......................... $111,761 $106,670 =============== ============== The accompanying notes are an integral part of these statements.
6 CBL & Associates Properties, Inc. Notes to Unaudited Consolidated Financial Statements (In thousands, except per share data) Note 1 - Organization and Basis of Presentation CBL & Associates Properties, Inc. ("CBL"), a Delaware corporation, is a self-managed, self-administered, fully integrated real estate investment trust ("REIT") that is engaged in the development, acquisition and operation of regional shopping malls and community centers. CBL's shopping center properties are located primarily in the Southeast, as well as in select markets in the Northeast and Midwest regions of the United States. CBL conducts substantially all of its business through CBL & Associates Limited Partnership (the "Operating Partnership"). At September 30, 2003, the Operating Partnership owns controlling interests in 52 regional malls, 20 associated centers (each adjacent to a regional shopping mall), 61 community centers and an office building. The Operating Partnership consolidates the financial statements of all entities in which it has a controlling financial interest. The Operating Partnership owns non-controlling interests in four regional malls, two associated centers and two community centers. Because major decisions such as the acquisition, sale or refinancing of principal partnership assets must be approved by one or more of the other partners, the Operating Partnership does not control these partnerships and, accordingly, accounts for these investments using the equity method. The Operating Partnership currently has under construction one mall, which is owned in a joint venture, three mall expansions, one associated center, two community centers and one community center expansion. The Operating Partnership also holds options to acquire certain development properties owned by third parties. CBL is the 100% owner of two qualified REIT subsidiaries, CBL Holdings I, Inc. and CBL Holdings II, Inc. At September 30, 2003, CBL Holdings I, Inc., the sole general partner of the Operating Partnership, owned a 1.7% general partnership interest in the Operating Partnership and CBL Holdings II, Inc. owned a 52.8% limited partnership interest for a combined interest held by CBL of 54.5%. The minority interest in the Operating Partnership is held primarily by CBL & Associates, Inc. and its affiliates (collectively "CBL's Predecessor") and by affiliates of The Richard E. Jacobs Group, Inc. ("Jacobs"). CBL's Predecessor contributed their interests in certain real estate properties and joint ventures to the Operating Partnership in exchange for a limited partnership interest when the Operating Partnership was formed in November 1993. Jacobs contributed their interests in certain real estate properties and joint ventures to the Operating Partnership in exchange for a limited partnership interest when the Operating Partnership acquired Jacobs' interests in 23 properties in January 2001. At September 30, 2003, CBL's Predecessor owned a 15.8% limited partnership interest, Jacobs owned a 21.6% limited partnership interest and third parties owned an 8.1% limited partnership interest in the Operating Partnership. CBL's Predecessor also owned 2.3 million shares of CBL's common stock at September 30, 2003, for a combined total interest of 19.9% in the Operating Partnership. Under the terms of the Operating Partnership's limited partnership agreement, each of the limited partners has the right to exchange all or a portion of its partnership interests for shares of CBL's common stock or their cash equivalent, at CBL's election. In such case, CBL assumes the limited partner's ownership interests in the Operating Partnership. The number of shares of common stock received by a limited partner of the Operating Partnership upon exercise of its exchange rights will be equal on a one-for-one basis to the number of partnership units exchanged by the limited partner. The amount of cash received by the limited partner, if CBL elects to pay cash, will be based on the trading price at the time of exercise of the shares of common stock that would otherwise have been received by the limited partner in the exchange. Neither the limited partnership interests in the Operating Partnership nor the shares of common stock of CBL are subject to any right of mandatory redemption. 7 The Operating Partnership conducts CBL's property management and development activities through CBL & Associates Management, Inc. (the "Management Company") to comply with certain requirements of the Internal Revenue Code of 1986, as amended (the "Code"). The Operating Partnership has a controlling financial interest in the Management Company based on the following factors: |X| The Operating Partnership holds 100% of the preferred stock and owns 6% of the common stock of the Management Company. Through its ownership of the preferred stock, the Operating Partnership has the right to perpetually receive 95% of the economic benefits of the Management Company's operations. |X| The Operating Partnership provides all of the operating capital of the Management Company. |X| The Management Company does not perform any material services for entities in which the Operating Partnership is not a significant investor. |X| The remaining 94% of the Management Company's common stock is owned by individuals who are directors and/or officers of CBL (with the exception of one individual who is a member of the immediate family of a director of CBL) and whose interests are aligned with those of CBL. These individuals contributed nominal amounts of equity in exchange for their interest in the Management Company's common stock. |X| All of the members of the Management Company's Board of Directors are members of CBL's Board of Directors. All of these factors result in Operating Partnership having a controlling financial interest in the Management Company and, accordingly, the Management Company is treated as a consolidated subsidiary. CBL, the Operating Partnership and the Management Company are collectively referred to herein as "the Company". Note 2 - Investments In Unconsolidated Affiliates The Company owns non-controlling interests in four regional malls, two associated centers and two community centers, as well as one mall under construction, vacant land held for sale or lease and one development property. Condensed combined financial statement information for the unconsolidated affiliates is as follows:
Company's Share for the Total for the Nine Months Nine Months Ended September 30, Ended September 30, --------------------------- -------------------------- 2003 2002 2003 2002 ------------- ----------- ----------- ----------- Revenues $30,354 $41,303 $17,725 $24,382 Depreciation and amortization (5,445) (5,099) (3,001) (3,137) Interest expense (8,601) (10,767) (6,230) (7,301) Other operating expenses (8,888) (11,921) (5,084) (7,489) ------------- ----------- ----------- ----------- Income from operations $7,420 $13,576 $3,410 $6,455 ============= =========== =========== ===========
8 Note 3 - Mortgage and Other Notes Payables Mortgage and other notes payable consisted of the following at September 30, 2003 and December 31, 2002, respectively:
September 30, 2003 December 31, 2002 ------------------------------ --------------------------- Weighted Weighted Average Average Interest Interest Amount Rate(1) Amount Rate(1) -------------- -------------- -------------- ----------- Fixed-rate debt: Non-recourse loans on operating properties $2,233,582 6.76% $1,867,915 7.16% Variable-rate debt: Recourse term loans on operating properties 127,634 2.56% 290,954 3.98% Lines of credit 257,000 2.12% 221,275 2.69% Construction loans -- -- 21,935 3.08% Total variable-rate debt 384,634 2.26% 534,164 3.41% Total -------------- -------------- $2,618,216 6.10% $2,402,079 6.32% ============== ============== (1) Weighted-average interest rate before amortization of deferred financing costs.
On February 26, 2003, the Company obtained an $85,000 non-recourse loan that is secured by Westmoreland Mall and Westmoreland Crossing in Greensburg, PA. The loan bears interest at 5.05% and has a term of ten years with payments based on a 25-year amortization schedule. On February 28, 2003, the Company entered into a new secured credit facility for $255,000. This new credit facility replaced both the Company's $130,000 secured credit facility and its unsecured facility of $105,275. The new credit facility bears interest at LIBOR plus 100 basis points, expires in February 2006, and has a one-year extension, which is at the Company's election. Six regional malls and three associated centers secure the new credit facility. As discussed in Note 6, the Company assumed $40,000 of variable-rate debt in connection with its acquisition of Sunrise Mall on May 1, 2003. The debt bears interest at LIBOR plus 300 basis points, with a floor of 4.90%, and matures in May 2004. This debt was assumed subject to a pre-existing interest rate cap of 5.50%. As discussed in Note 6, on September 10, 2003, the Company assumed $64,245 of non-recourse, fixed-rate debt in connection with its acquisition of Cross Creek Mall. The debt bears interest at a rate of 7.40% and matures in April 2012. Since the debt's stated interest rate of 7.40% was above market rates for similar debt instruments at the date of acquisition, the Company has recorded a debt premium of $10,209, which will be amortized as a reduction to interest expense over the remaining term of the debt. Amortization of the debt premium was not significant for the three months ended September 30, 2003. On September 12, 2003, the Company closed four long-term, non-recourse, fixed-rate mortgage loans totaling $196,000 that are secured by three of the Company's regional malls and one associated center. The loans bear interest at rates ranging from 4.52% to 5.45%, with a weighted average rate of 4.85%, and have terms of five to ten years, with a weighted average term of 6.5 years. In order to fund a portion of its acquisition of the four-mall portfolio discussed in Note 15, the Company obtained a short-term, unsecured credit facility of $130,000 that will bear interest at LIBOR plus 1.30% and mature on January 31, 2004. This credit facility can be extended at the Company's option for two additional periods of four months each. No amounts were outstanding under this facility as of September 30, 2003. On October 1, 2003, the Company borrowed $82,352 under this facility to fund the acquisition of the second and third malls, which was subsequently repaid with proceeds from the sale to Galileo America REIT discussed in Note 15. 9 The Company's secured credit facilities total $365,000, of which $87,846 was available at September 30, 2003. In addition to the $257,000 of outstanding borrowings, there was also $20,154 outstanding for letters of credit under the secured credit facilities. Additionally, the Company had other credit facilities totaling $19,585 that are used only for issuances of letters of credit, of which $6,413 was available at September 30, 2003. As of September 30, 2003, the Company had $10,267 available in unfunded construction loans on operating properties that can be used to replenish working capital previously used for construction. The weighted average remaining term of the Company's consolidated debt was 5.6 years at September 30, 2003 and 5.7 years at December 31, 2002. In May 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections", which rescinds SFAS No. 4. As a result, gains and losses from extinguishments of debt should be classified as extraordinary items only if they meet the criteria of Accounting Principles Board Opinion No. 30 ("APB 30"). SFAS No. 145 was effective for the Company on January 1, 2003. All losses on extinguishment of debt that were classified as an extraordinary item in prior periods have been reclassified as an unusual expense in the accompanying consolidated statements of operations. Seventeen malls, six associated centers and the office building are owned by special purpose entities that are included in the consolidated financial statements. The sole business purpose of the special purpose entities is to own and operate these properties, which are each encumbered by a commercial mortgage backed securities loan. The real estate and other assets owned by these special purpose entities are restricted under the loan agreements in that they are not available to settle other debts of the Company. However, so long as the loans are not under an event of default, as defined in the loan agreements, the cash flows from these properties, after payments of debt service, operating expenses and reserves, are available for distribution to the Company. Note 4 -Derivative Financial Instruments The Company uses derivative financial instruments to manage exposure to interest rate risks inherent in variable-rate debt and does not use them for trading or speculative purposes. At September 30, 2003, the Company had an interest rate cap of 5.50%, which expires May 7, 2004, that was in place on $40,000 of variable-rate debt assumed in connection with the acquisition of Sunrise Mall during the second quarter (see Note 6). At September 30, 2003, the interest rate cap's fair value was $0. During the quarter ended September 30, 2003, the Company had one interest rate swap agreement that expired on August 30, 2003. Other comprehensive income of $626 was recorded during the quarter related to the reduction of this interest rate swap's fair value to zero due to its expiration. The Company is exposed to credit losses if the counterparty to the cap agreement is unable to perform; therefore, the Company continually monitors the credit standing of the counterparty. Note 5 - Segment Information The Company measures performance and allocates resources according to property type, which is determined based on certain criteria such as type of tenants, capital requirements, economic risks, leasing terms, and short- and long-term returns on capital. Rental income and tenant reimbursements from tenant leases provide the majority of revenues from all segments. Information on the Company's reportable segments is presented as follows: 10
Associated Community Three Months Ended September 30, 2003 Malls Centers Centers All Other Total -------------------------------------- ------------ ------------ ------------ ----------- ----------- Revenues $138,347 $ 6,351 $ 15,800 $ 4,978 $ 165,476 Property operating expenses (1) (48,710) (1,563) (3,388) 4,301 (49,360) Interest expense (34,734) (2,038) (2,013) 734 (38,051) Other expense 0 0 0 (2,703) (2,703) Gain on sales of real estate assets 539 0 1 297 837 ------------ ------------ ------------ ----------- ----------- Segment profit and loss $ 55,442 $ 2,750 $ 10,400 $ 7,607 76,199 ============ ============ ============ =========== Depreciation and amortization (28,385) General and administrative (7,228) Interest income 639 Loss on extinguishment of debt -- Equity in earnings and minority interest in earnings (16,918) ----------- Income before discontinued operations $ 24,307 =========== Capital expenditures (2) $188,880 $ 3,062 $ 14,525 $ 4,066 $ 210,533
Associated Community Three Months Ended September 30, 2002 Malls Centers Centers All Other Total -------------------------------------- ------------ ------------ ------------ ----------- ----------- Revenues $121,271 $ 4,595 $ 15,140 $ 5,437 $ 146,443 Property operating expenses (1) (43,058) (1,046) (3,897) 2,125 (45,876) Interest expense (32,543) (921) (2,201) (955) (36,620) Other expense -- -- -- (2,282) (2,282) Gain on sales of real estate assets (2) -- (21) 520 497 ------------ ------------ ------------ ----------- ----------- Segment profit and loss $ 45,668 $ 2,628 $ 9,021 $ 4,845 62,162 ============ ============ ============ =========== Depreciation and amortization (24,084) General and administrative (5,499) Interest income 841 Loss on extinguishment of debt (210) Equity in earnings and minority interest in earnings (12,635) ----------- Income before discontinued operations $ 20,575 =========== Capital expenditures (2) $ 32,675 $ 1,829 $ 2,228 $ 7,885 $ 44,617
Associated Community Nine Months Ended September 30, 2003 Malls Centers Centers All Other Total -------------------------------------- ------------ ------------ ------------ ----------- ----------- Revenues $417,868 $17,551 $ 45,851 $15,045 $ 496,315 Property operating expenses (1) (143,973) (4,198) (10,513) 6,059 (152,625) Interest expense (101,970) (3,938) (6,002) (1,459) (113,369) Other expense -- -- -- (7,359) (7,359) Gain (loss) on sales of real estate assets 534 -- 754 3,655 4,943 ------------ ------------ ------------ ----------- ----------- Segment profit and loss $172,459 $ 9,415 $ 30,090 $15,941 227,905 ============ ============ ============ =========== Depreciation and amortization (82,362) General and administrative (20,225) Interest income 1,804 Loss on extinguishment of debt (167) Equity in earnings and minority interest in earnings (54,479) ----------- Income before discontinued operations $ 72,476 =========== Total assets (2) $3,351,809 $189,643 $479,600 $109,477 $4,130,529 Capital expenditures (2) $ 326,742 $ 18,303 $ 31,528 $ 4,438 $ 381,011
11
Associated Community Nine Months Ended September 30, 2002 Malls Centers Centers All Other Total -------------------------------------- ------------ ------------ ------------ ----------- ----------- Revenues $ 365,882 $ 14,026 $ 44,962 $ 13,311 $ 438,181 Property operating expenses (1) (127,800) (3,248) (11,629) 7,083 (135,594) Interest expense (91,517) (2,853) (7,243) (5,843) (107,456) Other expense -- -- -- (8,089) (8,089) Gain (loss) on sales of real estate assets (286) -- 68 2,920 2,702 ------------ ------------ ------------ ----------- ----------- Segment profit and loss $ 146,279 $ 7,925 $ 26,158 $ 9,382 189,744 ============ ============ ============ =========== Depreciation and amortization (70,183) General and administrative (16,706) Interest income 1,824 Loss on extinguishment of debt (3,399) Equity in earnings and minority interest in earnings (43,198) ----------- Income before discontinued operations $ 58,082 =========== Total assets (2) $2,856,626 $125,901 $442,572 $122,556 $3,547,655 Capital expenditures (2) $ 227,291 $ 4,232 $ 28,606 $ 44,401 $ 304,530 (1) Property operating expenses include property operating expenses, real estate taxes and maintenance and repairs. (2) Amounts include investments in unconsolidated affiliates. Developments in progress are included in the All Other category.
Note 6 - Acquisitions On May 1, 2003, the Company acquired Sunrise Mall and its associated center, Sunrise Commons, which are located in Brownsville, TX. The total purchase price of $80,686 consisted of $40,686 in cash and the assumption of $40,000 of variable-rate debt. See Note 3 for a description of the assumed debt. On September 10, the Company acquired Cross Creek Mall in Fayetteville, NC for a purchase price of $116,729, which consisted of $52,484 in cash and the assumption of $64,245 of non-recourse, fixed-rate debt. See Note 3 for a description of the terms of the assumed debt. The results of operations of Sunrise Mall, Sunrise Commons and Cross Creek Mall have been included in the consolidated financial statements since their respective dates of acquisition. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed as of the respective acquisition dates.
Land $ 30,757 Building and improvements 168,637 Above-market lease assets 2,629 In-place lease assets 5,539 ----------- Total assets 207,562 Debt (64,245) Debt premium (10,209) ----------- Net assets acquired $ 93,108 ===========
In September 2003, the Company acquired the remaining 25% ownership interest in Waterford Commons, a community center in Waterford, CT, for $2,736 in cash. As a result of the application of SFAS No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Other Intangible Assets", to real estate assets acquired after January 1, 2002, the Company recorded a net reduction in revenues of $17 and $0 related to the amortization of above and below market lease assets during the three months ended September 30, 2003 and 2002, respectively. The Company recorded a net increase of $82 and $0 for the nine months ended September 30, 2003 and 2002, respectively. 12 Note 7 - Discontinued Operations During the nine months ended September 30, 2003, the Company sold three community centers for $9,970 and recognized a net gain on discontinued operations of $3,568. Total revenues from these community centers were $38 and $258 for the three months ended September 30, 2003 and 2002, respectively, and $306 and $792 for the nine months ended September 30, 2003 and 2002, respectively. Note 8- Earnings Per Share Basic earnings per share ("EPS") is computed by dividing net income available to common shareholders by the weighted-average number of unrestricted common shares outstanding for the period. Diluted EPS assumes the issuance of common stock for all potential dilutive common shares outstanding. The limited partners' rights to convert their minority interest in the Operating Partnership into shares of common stock are not dilutive. The following summarizes the impact of potential dilutive common shares on the denominator used to compute earnings per share:
Three Months Ended September 30, Nine Months Ended September 30, -------------------------------- ------------------------------- 2003 2002 2003 2002 ---------------- -------------- --------------- -------------- Weighted average shares outstanding 30,186 29,714 30,001 28,461 Effect of nonvested stock awards (164) (98) (122) (97) Denominator - basic earnings per share 30,022 29,616 29,879 28,364 Effect of dilutive securities: Stock options, nonvested stock awards and deemed shares related to deferred compensation plans 1,279 860 1,191 827 ---------------- -------------- --------------- -------------- Denominator - diluted earnings per share 31,301 30,476 31,070 29,191 ================ ============== =============== ==============
Note 9- Comprehensive Income Comprehensive income includes all changes in shareholders' equity during the period, except those resulting from investments by shareholders and distributions to shareholders. Comprehensive income consisted of the following components:
Three Months Ended September 30, Nine Months Ended September 30, -------------------------------- ------------------------------- 2003 2002 2003 2002 ---------------- -------------- --------------- -------------- Net income $24,908 $21,157 $76,090 $61,082 Gain on current period cash flow hedges 626 799 2,397 3,407 ---------------- -------------- --------------- -------------- Comprehensive income $25,534 $21,956 $78,487 $64,489 ================ ============== =============== ==============
Note 10- Contingencies The Company is currently involved in certain litigation that arises in the ordinary course of business. It is management's opinion that the pending litigation will not materially affect the financial position or results of operations of the Company. Based on environmental studies completed to date, management believes any exposure related to environmental cleanup will not materially affect the Company's financial position or results of operations. The Company has guaranteed 50% of the debt of Parkway Place L.P., an unconsolidated affiliate in which the Company owns a 45% interest, which owns Parkway Place in Huntsville, AL. The total amount outstanding at September 30, 2003, was $58,470, of which the Company has guaranteed $29,235. The guaranty will expire when the related debt matures in December 2003. The Company did not receive a fee for issuing this guaranty. 13 Under the terms of the partnership agreement of Mall of South Carolina L.P., an unconsolidated affiliate in which the Company owns a 50% interest, the Company has guaranteed 100% of the construction debt to be incurred to develop Coastal Grand in Myrtle Beach, SC. The Company received a fee of $1,571 for this guaranty when it was issued during the three months ended June 30, 2003. The Company will recognize one-half of this fee as revenue pro rata over the term of the guaranty until it expires in May 2006, which represents the portion of the fee attributable to the third-party partner's ownership interest. The Company recognized $131 of revenue related to this guaranty during the three months ended September 30, 2003 and $175 during the nine months ended September 30, 2003. Note 11 - Shareholders' Equity and Minority Interest On August 22, 2003, the Company issued 4,600,000 depositary shares in a public offering, each representing one-tenth of a share of 7.75% Series C cumulative redeemable preferred stock with a par value of $0.01 per share. The Series C preferred stock has a liquidation preference of $250.00 per share ($25.00 per depositary share). Dividends on the Series C preferred stock are cumulative, accrue from the date of issuance and are payable quarterly in arrears at a rate of $19.375 per share ($1.9375 per depositary share) per annum. The Series C preferred stock has no stated maturity, is not subject to any sinking fund or mandatory redemption and is not redeemable before August 22, 2008. The net proceeds will be used to partially fund the purchase of the four malls discussed in Note 15 and for general corporate purposes, including funding future developments, expansions and acquisitions. On September 15, 2003, the Company repurchased 460,083 common units in the Operating Partnership from a former executive of the Company who retired in 1997 for $21,013. Note 12 - Stock-Based Compensation Historically, the Company has accounted for stock options using the intrinsic value method of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees". Effective January 1, 2003, the Company will record the expense associated with stock options granted after January 1, 2003, on a prospective basis in accordance with the fair value and transition provisions of SFAS No. 123, "Accounting for Stock Based Compensation". There were no stock options granted during the nine months ended September 30, 2003. No stock-based compensation expense related to stock options granted prior to January 1, 2003, has been reflected in net income since all options granted had an exercise price equal to the fair value of the Company's common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to employee stock options:
Three Months Ended Nine Months Ended September 30, September 30, --------------------------- -------------------------- 2003 2002 2003 2002 ------------- ------------ ------------ ------------ Net income available to common shareholders, as reported $ 20,225 $ 17,465 $ 64,023 $ 53,763 Compensation expense determined under fair value method (150) (163) (451) (488) ------------- ------------ ------------ ------------ Pro forma net income available to common shareholders $ 20,075 $ 17,302 $ 63,572 $ 53,275 ============= ============ ============ ============ Earnings per share: Basic, as reported $ 0.67 $ 0.59 $ 2.14 $ 1.90 ============= ============ ============ ============ Basic, pro forma $ 0.67 $ 0.58 $ 2.13 $ 1.88 ============= ============ ============ ============ Diluted, as reported $ 0.65 $ 0.57 $ 2.06 $ 1.84 ============= ============ ============ ============ Diluted, pro forma $ 0.64 $ 0.57 $ 2.05 $ 1.83 ============= ============ ============ ============
In May 2003, the company granted 43,425 shares of restricted stock to employees under the Company's stock incentive plan. The shares are restricted in that the employee may not sell or otherwise transfer the shares until the restrictions lapse. The restrictions on the shares lapse in equal annual installments over five years. The Company recorded deferred compensation of $1,870, which is being amortized on a straight-line basis to compensation expense over the five-year period the restrictions lapse. The Company recognized $102 and $164 of expense related to these shares during the three months and nine months ended September 30, 2003. 14 Note 13 - Recent Accounting Pronouncements In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 requires that the costs associated with exit or disposal activity be recognized and measured at fair value when the liability is incurred. The provisions of SFAS No. 146 are effective for exit or disposal activities initiated after December 31, 2002. Since the Company typically does not engage in significant disposal activities, the implementation of SFAS No. 146 in 2003 did not have a significant impact on the Company's reported financial results. In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of SFAS No. 5, 57, and 107, and rescission of FASB Interpretation No. 34." The interpretation elaborates on the disclosures to be made by a guarantor in its financial statements. It also requires a guarantor to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee, which is effective for guarantees issued or modified after December 31, 2002. The Company adopted the disclosure provisions of FASB Interpretation No. 45 in the fourth quarter of 2002. In accordance with the interpretation, the Company adopted the remaining provisions of FASB Interpretation No. 45 effective January 1, 2003. See Note 10 for disclosures related to the Company's guarantees. In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51". The interpretation requires the consolidation of entities in which an enterprise absorbs a majority of the entity's expected losses, receives a majority of the entity's expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. Currently, entities are generally consolidated by an enterprise when it has a controlling financial interest through ownership of a majority voting interest in the entity. On October 8, 2003, the FASB deferred the effective date of the consolidation provisions of FASB Interpretation No. 46 until the quarter ending December 31, 2003, for entities formed prior to January 1, 2003. Although the Company is still evaluating the impact of the interpretation, the Company believes it is reasonably possible that an unconsolidated affiliate that is currently accounted for using the equity method may be a variable interest entity under the provisions of the interpretation. The Company owns a 10% interest and has a total investment of $19,435 in this unconsolidated affiliate, which owns one associated center and two community centers. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities". SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. In particular, SFAS No. 149 clarifies under what circumstances a contract with an initial net investment meets the characteristic of a derivative as discussed in SFAS No. 133 and it clarifies when a derivative contains a financing component that warrants special reporting in the statement of cash flows. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003 and is to be applied prospectively. The Company does not believe that the implementation of SFAS No. 149 will materially change the Company's accounting for the kinds of derivatives that the Company has typically obtained in the course of its regular financing activities. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity", which specifies that instruments within its scope are obligations of the issuer and, therefore, the issuer must classify them as liabilities. Financial instruments within the scope of the pronouncement include mandatorily redeemable financial instruments, obligations to repurchase the issuer's equity shares by transferring assets, and certain obligations to issue a variable number of shares. SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003. However, on October 29, 2003, the FASB indefinitely deferred the provisions of SFAS No. 150 related to noncontrolling interests in limited-life subsidiaries. As a result, the implementation of SFAS No. 150 did not have a significant impact on the Company as of September 30, 2003. 15 Note 14 - Noncash Investing and Financing Activities The Company's noncash investing and financing activities were as follows for the nine months ended September 30, 2003 and 2002:
Nine Months Ended September 30, ------------------------- 2003 2002 ------------------------- Debt assumed to acquire property interests $ 114,454 $ 77,103 ========================= Issuance of minority interest to acquire property interests $ -- $ 24,303 =========================
Note 15 - Subsequent Events Acquisitions On July 25, 2003, the Company announced that it had entered into separate agreements to acquire four regional malls for a total purchase price of $340,000. The Company closed on the first mall on September 10, 2003, which is discussed in Note 6. On October 1, 2003, the Company closed on the second and third malls for a total purchase price of $147,275, which consisted of $79,722 in cash and the assumption of $67,553 of non-recourse, fixed-rate debt. The loans mature in 2007 and 2012 and have a weighted average interest rate of 8.6%. Since the interest rates on these loans were above market rates for similar debt instruments at the date of acquisition, the Company has recorded total debt premiums of $11,631, which will be amortized as a reduction to interest expense over the remaining terms of the these loans. The fourth and final mall is scheduled to close in the fourth quarter of 2003. Dispositions On September 24, 2003, the Company formed a joint venture with Galileo America REIT, the U.S. affiliate of Australia-based Galileo America Shopping Trust, to invest in power and community centers throughout the United States. The Company will contribute, in three phases, 90% of its interests in 51 power and community centers for a total price of $516,000. On October 23, 2003, the parties completed the first phase of the transaction when the Company sold its interests in 41 power and community centers to the joint venture for $393,925, which consisted of $255,518 in cash, the payoff of $24,922 of debt on one of the community centers that was sold to the joint venture, the joint venture's assumption of $93,037 in debt and $20,448 representing the 10% interest in the joint venture that the Company retained. The Company used the remaining cash proceeds to reduce outstanding borrowings under the Company's credit facilities. The second phase of the transaction is scheduled to close in January 2004 and the third phase is scheduled to close in January 2005. Pursuant to a long-term agreement, the Company will be the exclusive manager for all of the joint venture's properties in the United States, and will be entitled to management, leasing, acquisition, disposition and financing fees. On October 6, 2003, the Company sold a community center for $760 and recognized a loss of $323. 16 Preferred Stock Redemption On October 29, 2003, the Company exercised its option to redeem all 2,675,000 of the outstanding shares of its 9.0% Series A cumulative redeemable preferred stock at its liquidation preference of $25.00 per share. The liquidation preference, plus accrued and unpaid dividends, will be paid on November 28, 2003. In accordance with Emerging Issues Task Force Topic D-42, issuance costs of $2,181 related to the Series A preferred stock that were recorded as a reduction of additional paid-in capital when the Series A preferred stock was issued will be reflected as an additional preferred dividend in the Company's consolidated statement of operations upon redemption. Note 16 - Reclassifications Certain reclassifications have been made to prior periods' financial information to conform to the current period presentation. ITEM 2: Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of financial condition and results of operations should be read in conjunction with the consolidated financial statements and accompanying notes that are included in this Form 10-Q. Certain statements made in this section or elsewhere in this report may be deemed "forward looking statements" within the meaning of the federal securities laws. Although the Company believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, the Company can give no assurance that these expectations will be attained, and it is possible that actual results may differ materially from those indicated by these forward-looking statements due to a variety of risks and uncertainties. Such risks and uncertainties include, without limitation, general industry, economic and business conditions, interest rate fluctuations, costs of capital and capital requirements, availability of real estate properties, inability to consummate acquisition opportunities, competition from other companies and retail formats, changes in retail rental rates in the Company's markets, shifts in customer demands, tenant bankruptcies or store closings, changes in vacancy rates at the Company's properties, changes in operating expenses, changes in applicable laws, rules and regulations, the ability to obtain suitable equity and/or debt financing and the continued availability of financing in the amounts and on the terms necessary to support the Company's future business. The Company disclaims any obligation to update or revise any forward-looking statements to reflect actual results or changes in the factors affecting the forward-looking information. GENERAL BACKGROUND See Note 1 to the unaudited consolidated financial statements for a description of the Company. The Company classifies its regional malls into two categories - malls that have completed their initial lease-up ("Stabilized Malls") and malls that are in their initial lease-up phase ("Non-Stabilized Malls"). The Non-Stabilized Mall category is presently comprised of The Lakes Mall in Muskegon, MI, which opened in August 2001, and Parkway Place Mall in Huntsville, AL, which opened in October 2002. 17 RESULTS OF OPERATIONS Comparison of Results of Operations for the Three Months Ended September 30, 2003 to the Results of Operations for the Three Months Ended September 30, 2002 The following significant transactions impact the comparison of the results of operations for the three months ended September 30, 2003 to the comparable period ended September 30, 2002: |X| The Company has opened or acquired eight properties since November 1, 2002 (the "Eight New Properties"). Therefore, the three months ended September 30, 2003, include revenues and expenses related to these properties whereas the comparable period a year ago does not include any. The Eight New Properties are as follows:
Open/Acquisition Project Name Location Type of Addition Date ------------------------------- -------------------- ---------------------- ----------------- Parkdale Crossing Beaumont, TX New development November 2002 Westmoreland Mall Greensburg, PA Acquisition December 2002 Westmoreland Crossing Greensburg, PA Acquisition December 2002 Sunrise Mall Brownsville, TX Acquisition May 2003 Sunrise Commons Brownsville, TX Acquisition May 2003 The Shoppes at Hamilton Place Chattanooga, TN New development May 2003 Cobblestone Village St. Augustine, FL New development May 2003 Waterford Commons Waterford, CT New development September 2003
|X| In December 2002, the Company acquired the remaining 35% ownership interest in East Towne Mall, West Towne Mall and West Towne Crossing in Madison, WI (the "New Consolidated Properties"). These properties were consolidated during the third quarter of 2003, but were accounted for as unconsolidated affiliates during the third quarter of 2002.
(Dollars in Thousands) 2003 2002 $ Variance % Variance ------------- ------------- ------------ ----------- Total revenues $165,476 $146,443 $19,033 13.0% Expenses: Property operating, real estate taxes and maintenance and repairs 49,360 45,876 3,484 7.6% Depreciation and amortization 28,385 24,084 4,301 17.9% General and administrative 7,228 5,499 1,729 31.4% Other 2,703 2,282 421 18.4% ------------- ------------- ------------ ----------- Total expenses 87,676 77,741 9,935 12.8% ------------- ------------- ------------ ----------- Income from operations 77,800 68,702 9,098 13.2% Interest income 639 841 (202) (24.0)% Interest expense (38,051) (36,620) (1,431) 3.9% Loss on extinguishment of debt -- (210) 210 (100.0)% Gain on sales of real estate assets 837 497 340 68.4% Equity in earnings of unconsolidated affiliates 922 2,353 (1,431) (60.8)% Minority interest in earnings: Operating partnership (17,235) (14,599) (2,636) 18.1% Shopping center properties (605) (389) (216) 55.5% ------------- ------------- ------------ ----------- Income before discontinued operations 24,307 20,575 3,732 18.1% Income from discontinued operations 601 582 19 3.3% ------------- ------------- ------------ ----------- Net income 24,908 21,157 3,751 17.7% Preferred dividends (4,683) (3,692) (991) 26.8% ------------- ------------- ------------ ----------- Net income available to common shareholders $20,225 $17,465 $2,760 15.8% ============= ============= ============ ===========
Revenues The $19.0 million increase in revenues resulted primarily from: |X| an increase in minimum rents and tenant reimbursements of $15.3 million attributable to the Eight New Properties and the New Consolidated Properties, |X| an increase in minimum rents and tenant reimbursements of $5.2 million from the Company's remaining properties, including a reduction in lease termination fees of $0.5 million to $0.5 million in the third quarter of 2003 compared to $1.0 million in the third quarter of 2002. The Company's cost recovery percentage increased to 100.0% for the third quarter of 2003 compared to 92.5% for the third quarter of 2002 due to increases in occupancy and the recovery of capital expenditures from tenants, |X| an increase in percentage rents of $0.1 million, which resulted from a decline at the Company's existing properties of $0.1 million offset by an increase of $0.2 million from the Eight New Properties and the New Consolidated Properties, 18 |X| an increase in other revenues of $0.5 million due to an increase in the revenues of the Company's taxable REIT subsidiary, and |X| a reduction of $0.5 million in management, development and leasing fees, which resulted from a decrease in management and leasing fees related to the New Consolidated Properties. Expenses The $3.5 million increase in property operating expenses, including real estate taxes and maintenance and repairs, resulted from: |X| an increase of $4.3 million attributable to the Eight New Properties and the New Consolidated Properties and |X| a decrease of $0.8 million in general operating expenses at the Company's remaining properties. The increase of $4.3 million in depreciation and amortization expense was primarily due to: |X| an increase of $3.1 million attributable to the Eight New Properties and the New Consolidated Properties and |X| an increase of $1.2 million as a result of the ongoing capital expenditures made by the Company for renovations, expansions, tenant allowances and deferred maintenance at the remaining properties. General and administrative expenses increased $1.7 million primarily as a result of additional salaries and benefits of personnel added to manage newly opened or acquired properties, as well as annual increases in salaries and benefits of existing personnel. Other expense increased due to an increase in operating expenses of the Company's taxable REIT subsidiary. Interest Income The decrease in interest income of $0.2 million results from the decrease in the amount of mortgage and other notes receivable outstanding compared to the prior year period. The decrease in mortgage and other notes receivable primarily relates to mortgage notes receivable from buyers of real estate assets the Company has sold that were repaid and normal amortization of the remaining notes. Interest Expense Interest expense increased by $1.9 million primarily due to the additional debt related to the Eight New Properties and the New Consolidated Properties. Loss on Extinguishment of Debt The loss on extinguishment of debt of $0.2 recognized during the third quarter of 2002 resulted from the write-off of unamortized deferred financing costs related to a loan that was retired before its scheduled maturity date. Gain on Sales of Real Estate Assets The net gain on sales of $0.8 million in the third quarter of 2003 was primarily from gains on sales of two outparcels and a loss on one outparcel. The gain on sales of $0.5 million in the third quarter of 2002 resulted from gains on sales of two outparcels. 19 Equity in Earnings of Unconsolidated Affiliates The consolidation of the New Consolidated Properties during 2003 accounted for the $1.4 million decline in equity in earnings of unconsolidated affiliates. Discontinued Operations Discontinued operations in the third quarter of 2003 represent the net operating loss of two community centers that were each sold for a gain in August 2003. Discontinued operations in the third quarter of 2002 represent the net operating income for the three community centers sold during 2003 plus five community centers and one office building that were sold during the year ended December 31, 2002. In accordance with SFAS No. 144, the results of operations of operating properties that have been sold are reclassified and presented as discontinued operations for all periods presented. Comparison of Results of Operations for the Nine Months Ended September 30, 2003 to the Results of Operations for the Nine Months Ended September 30, 2002 The following significant transactions impact the comparison of the results of operations for the nine months ended September 30, 2003 to the comparable period ended September 30, 2002: |X| The Company has opened or acquired ten properties since May 1, 2002 (the "Ten New Properties). Therefore, the nine months ended September 30, 2003, include a greater amount of revenues and expenses for these properties than the comparable period a year ago. The Ten New Properties are as follows:
Open/Acquisition Project Name Location Type of Addition Date ------------------------------- -------------------- ---------------------- ------------------- Richland Mall Waco, TX Acquisition May 2002 Panama City Mall Panama City, FL Acquisition May 2002 Parkdale Crossing Beaumont, TX New development November 2002 Westmoreland Mall Greensburg, PA Acquisition December 2002 Westmoreland Crossing Greensburg, PA Acquisition December 2002 Sunrise Mall Brownsville, TX Acquisition May 2003 Sunrise Commons Brownsville, TX Acquisition May 2003 The Shoppes at Hamilton Place Chattanooga, TN New development May 2003 Cobblestone Village St. Augustine, FL New development May 2003 Waterford Commons Waterford, CT New development September 2003
|X| In December 2002, the Company acquired the remaining 35% ownership interest in the New Consolidated Properties. The New Consolidated Properties were consolidated during the first nine months of 2003, but were accounted for as unconsolidated affiliates during the first nine months of 2002. 20
(Dollars in Thousands) 2003 2002 $ Variance % Variance ------------- ------------- ------------ ------------ Total revenues $496,315 $438,181 $58,134 13.3 % ------------- ------------- ------------ ------------ Expenses: Property operating, real estate taxes and maintenance and repairs 152,625 135,594 17,031 12.6 % Depreciation and amortization 82,362 70,183 12,179 17.4 % General and administrative 20,225 16,706 3,519 21.1 % Other 7,359 8,089 (730) (9.0)% ------------- ------------- ------------ ------------ Total expenses 262,571 230,572 31,999 13.9 % ------------- ------------- ------------ ------------ Income from operations 233,744 207,609 26,135 12.6 % Interest income 1,804 1,824 (20) (1.1)% Interest expense (113,369) (107,456) (5,913) 5.5 % Loss on extinguishment of debt (167) (3,399) 3,232 (95.1)% Gain on sales of real estate assets 4,943 2,702 2,241 82.9 % Equity in earnings of unconsolidated affiliates 3,410 6,455 (3,045) (47.2) % Minority interest in earnings: Operating partnership (55,851) (47,131) (8,720) 18.5 % Shopping center properties (2,038) (2,522) 484 (19.2)% ------------- ------------- ------------ ------------ Income before discontinued operations 72,476 58,082 14,394 24.8 % Income from discontinued operations 3,614 3,000 614 20.5 % ------------- ------------- ------------ ------------ Net income 76,090 61,082 15,008 24.6 % Preferred dividends (12,067) (7,319) (4,748) 64.9 % ------------- ------------- ------------ ------------ Net income available to common shareholders $64,023 $53,763 $10,260 19.1 % ============= ============= ============ ============
Revenues The $58.1 million increase in revenues resulted primarily from: |X| an increase in minimum rents and tenant reimbursements of $44.4 million attributable to the Ten New Properties and the New Consolidated Properties, |X| an increase in minimum rents and tenant reimbursements of $16.0 million from the Company's remaining properties, including a reduction in lease termination fees of $3.5 million to $2.1 million in the first nine months of 2003 compared to $5.6 million for the same period in 2002. The Company's cost recovery percentage increased to 100.0% for the first nine months of 2003 compared to 92.6% for the comparable period of 2002 due to increases in occupancy and the recovery of capital expenditures from tenants, |X| a reduction in percentage rents of $0.9 million, which resulted from a decline at the Company's existing properties of $1.6 million offset by an increase of $0.7 million from the addition of the properties discussed above, |X| a reduction of $1.6 million in management, development and leasing fees, related to the New Consolidated Properties and |X| a reduction in other revenues of $0.4 million due to a decline in revenues of the Company's taxable REIT subsidiary. Expenses The $17.0 million increase in property operating expenses, including real estate taxes and maintenance and repairs, resulted from: |X| an increase of $14.9 million attributable to the Ten New Properties and the New Consolidated Properties and |X| an increase of $2.1 million in general operating expenses at the Company's remaining properties. The increase of $12.2 million in depreciation and amortization expense was primarily due to: |X| an increase of $9.2 million attributable to the Ten New Properties and the New Consolidated Properties and 21 |X| an increase of $3.0 million as a result of the ongoing capital expenditures made by the Company for renovations, expansions, tenant allowances and deferred maintenance at the remaining properties. General and administrative expenses increased $3.5 million primarily as a result of additional salaries and benefits of personnel added to manage newly opened or acquired properties, as well as annual increases in salaries and benefits of existing personnel. Other expense decreased due to a reduction in operating expenses of the Company's taxable REIT subsidiary. Interest Income Interest income remained essentially the same in 2003 compared to 2002. Interest Expense Interest expense increased $5.9 million primarily because of the additional debt related to the Ten New Properties and the New Consolidated Properties. Loss on Extinguishment of Debt The loss on extinguishment of debt of $167,000 recognized during the first nine months of 2003 resulted from the write-off of unamortized deferred financing costs related to a loan that was retired before its scheduled maturity. The loss on extinguishment of debt in the first nine months of 2002 consisted of prepayment penalties of $1.5 million and the write-off of $1.9 million of unamortized deferred financing costs. Gain on Sales of Real Estate Assets The net gain on sales of $4.9 million in 2003 resulted from gains on sales of 14 outparcels and two options on land offset by a loss on one outparcel. The net gain on sales of $2.7 million in 2002 resulted from gains on seven outparcels offset by losses on two outparcels and one department store building. Equity in Earnings of Unconsolidated Affiliates The decrease in equity in earnings of unconsolidated affiliates of $3.0 million was due to a reduction of $3.4 million related to the New Consolidated Properties, offset by improvements in the operations of the remaining unconsolidated affiliates. Discontinued Operations Discontinued operations in 2003 represent the operating income of three community centers that were sold for a gain during the nine months ended September 30, 2003. Discontinued operations in 2002 relate to these three community centers plus five community centers and one office building that were sold during the year ended December 31, 2002. Two community centers and the office building were sold for gains and one community center was sold at a loss during the first nine months of 2002. PERFORMANCE MEASUREMENTS The shopping center business is, to some extent, seasonal in nature with tenants achieving the highest levels of sales during the fourth quarter because of the holiday season. The malls earn most of their "temporary" rents (rents from short-term tenants), during the holiday period. Thus, occupancy levels and revenue production are generally the highest in the fourth quarter of each year. Results of operations realized in any one quarter may not be indicative of the results likely to be experienced over the course of the fiscal year. 22 The Company's consolidated revenues were derived from the Company's property types as follows for the nine months ended September 30, 2003:
Malls 84.2% Associated centers 3.5% Community centers 9.2% Mortgages, office building and other 3.1%
Sales and Occupancy Costs For those tenants who occupy 10,000 square feet or less and have reported sales, mall shop sales in the Stabilized Malls increased by 0.4% on a comparable per square foot basis to $195.89 per square foot for the nine months ended September 30, 2003 from $195.12 per square foot for the nine months ended September 30, 2002. Total sales volume in the mall portfolio, including Non-Stabilized Malls, increased 2.7% to $2.255 billion for the nine months ended September 30, 2003 from $2.195 billion for the nine months ended September 30, 2002. Occupancy costs as a percentage of sales for the Stabilized Malls for the nine months ended September 30, 2003 and 2002, were 13.9% and 13.8%, respectively. Occupancy costs as a percentage of sales are generally higher in the first three quarters of the year as compared to the fourth quarter due to the seasonality of retail sales. Occupancy Occupancy for the Company's portfolio was as follows:
At September 30, --------------------------------- 2003 2002 ----------------- --------------- Total portfolio occupancy 92.4% 92.8% Total mall portfolio 91.7% 91.8% Stabilized Malls (53) 92.1% 92.1% Non-Stabilized Malls (2) 80.2% 87.0% Associated centers 90.6% 95.8% Community centers 94.2% 94.3%
Occupancy for the associated centers declined due to the acquisition of Westmoreland Crossing in Greensburg, PA, in December 2002, which has a 68,000 square foot former Ames store that is vacant. Excluding Westmoreland Crossing, occupancy for the associated centers would have been 94.8% at September 30, 2003. Occupancy for the Non-Stabilized Malls declined because Arbor Place in Douglasville, GA, was moved from the Non-Stabilized Mall category to the Stabilized Mall category. 23 Average Base Rents Average base rents per square foot for the portfolio were as follows:
At September 30, --------------------------- Percentage Increase 2003 2002 (Decrease) ----------- ----------- ------------ Stabilized Malls $24.76 $23.08 7.3% Non-Stabilized Malls 26.48 21.39 23.8% Associated centers 9.77 9.85 (0.8)% Community centers 9.52 9.66 (1.4)%
Leasing Results The Company achieved the following results from new and renewal leasing for the nine months ended September 30, 2003, compared to the base rent at the end of the lease term for spaces previously occupied: CASH FLOWS Cash provided by operating activities decreased $1.3 million during the nine months ended September 30, 2003 compared to the comparable prior year period due to an increase in other assets, an increase in accounts receivable and a decrease in accounts payable and accrued liabilities. These were offset by the additional operations of the Ten New Properties and the New Consolidated Properties. Cash used in investing activities increased $146.5 million primarily due to increases in the amount of real estate assets acquired, capital expenditures related to ongoing renovations of properties and a significant decrease in the amount of proceeds received on sales of real estate assets. Cash provided by financing activities was $72.0 million in 2003 as compared to cash used in financing activities of $79.0 million in 2002. The change was due to a significant decrease in the amount of loan borrowings and repayments, a significant decrease in proceeds from the issuance of common stock, an increase in distributions to minority investors, an increase in the amount of dividends paid and the repurchase of the minority interest held by a former executive of the Company. LIQUIDITY AND CAPITAL RESOURCES The principal uses of the Company's liquidity and capital resources have historically been for property development, expansions, renovations, acquisitions, debt repayment and distributions to shareholders. In order to maintain its qualification as a real estate investment trust for federal income tax purposes, the Company is required to distribute at least 90% of its taxable income, computed without regard to net capital gains or the dividends-paid deduction, to its shareholders. 24 The Company's current capital structure includes: |X| property specific mortgages, which are generally non-recourse, |X| construction loans, term loans, and revolving lines of credit, which are recourse to the Company |X| common stock and preferred stock, |X| joint venture investments and |X| a minority interest in the Operating Partnership. The Company anticipates that the combination of its equity and debt sources will, for the foreseeable future, provide adequate liquidity to continue its capital programs substantially as in the past and make distributions to its shareholders in accordance with the requirements applicable to real estate investment trusts. The Company's policy is to maintain a conservative debt-to-total-market capitalization ratio in order to enhance its access to the broadest range of capital markets, both public and private. Based on the Company's share of total consolidated and unconsolidated debt and the market value of equity described below, the Company's debt-to-total-market capitalization (debt plus market value equity) ratio was 46.9% at September 30, 2003. Equity As a publicly traded company, the Company has access to capital through both the public equity and debt markets. The Company has an effective shelf registration statement with the Securities and Exchange Commission, that authorizes the Company to publicly issue shares of preferred stock and common stock, preferred and common stock represented by depositary shares and warrants to purchase shares of common stock up to $562.0 million, of which $447.0 million remains after the Company's offering of Series C preferred stock that is discussed below. In August 2003, the Company issued 4,600,000 depositary shares in a public offering, each representing one-tenth of a share of 7.75% Series C cumulative redeemable preferred stock with a par value of $0.01 per share. The Series C preferred stock has a liquidation preference of $250.00 per share ($25.00 per depositary share). Dividends on the Series C preferred stock are cumulative, accrue from the date of issuance and are payable quarterly in arrears at a rate of $19.375 per share ($1.9375 per depositary share) per annum. The Series C preferred stock has no stated maturity, is not subject to any sinking fund or mandatory redemption and is not redeemable before August 22, 2008. The net proceeds will be used to partially fund the purchase of the four malls to be acquired as discussed in the Acquisitions section that follows and for general corporate purposes, including funding future developments, expansions and acquisitions. On September 15, 2003, the Company repurchased 460,083 common units in the Operating Partnership from a former executive of the Company who retired in 1997 for $21.0 million. As of September 30, 2003, the minority interest in the Operating Partnership includes the 15.8% ownership interest in the Operating Partnership held by the Company's executive and senior officers that may be exchanged for approximately 8.8 million shares of common stock. Additionally, executive and senior officers and directors own approximately 2.3 million shares of the Company's outstanding common stock, for a combined total interest in the Operating Partnership of approximately 19.9%. Limited partnership interests issued to acquire the Richard E. Jacobs Group's interest in a portfolio of properties in January 2001 and March 2002, may be exchanged for approximately 12.0 million shares of common stock, which represents a 21.6% interest in the Operating Partnership. Other third-party interests may be exchanged for approximately 4.5 million shares of common stock, which represents an 8.1% interest in the Operating Partnership. 25 The Company's total market equity was as follows as of September 30, 2003 (in thousands, except per share data):
Market Shares Price(1) Value --------------- ------------- --------------- Common stock 30,211 $ 49.90 $1,507,529 Operating Partnership units 25,223 49.90 1,258,628 --------------- --------------- Common stock, if fully converted 55,434 2,766,157 =============== --------------- Preferred Stock: Series A 2,675 25.00 66,875 Series B 2,000 50.00 100,000 Series C 460 250.00 115,000 --------------- --------------- 5,135 281,875 =============== --------------- Total market equity $3,048,032 =============== (1) For common stock and operating units, represents closing price of common stock on September 30, 2003. For preferred stock, represents liquidation preference of applicable series of preferred stock.
The Company's executive and senior officers' and directors' ownership interests had a market value of approximately $550.5 million at September 30, 2003. Debt The Company presents its total share of consolidated and unconsolidated debt because the Company believes that this amount provides investors with a clearer understanding of the Company's total debt obligations. The Company's share of mortgage debt on consolidated properties, adjusted for minority investors' interests in consolidated properties, and its pro rata share of mortgage debt on unconsolidated properties, consisted of the following at September 30, 2003 (in thousands):
Minority Company's Share Investors' Company's Weighted of Share of Total Average Consolidated Unconsolidated Consolidated Share Interest Debt Debt Debt of Debt Rate(1) -------------- ---------------- ------------- ----------- ---------- Fixed-rate debt: Non-recourse loans on operating properties $2,233,582 $37,543 $(19,720) $2,251,405 6.78% Variable-rate debt: Recourse term loans on operating properties 127,634 29,235 -- 156,869 2.57% Lines of credit 257,000 -- -- 257,000 2.12% Construction loans -- 29,571 -- 29,571 2.87% Total variable-rate debt 384,634 58,806 -- 443,440 2.33% -------------- --------------- ------------- ----------- Total $2,618,216 $96,349 $(19,720) $2,694,845 6.05% ============== =============== ============= =========== (1) Weighted-average interest rate before amortization of deferred financing costs.
On February 26, 2003, the Company obtained an $85.0 million, non-recourse loan that is secured by Westmoreland Mall and Westmoreland Crossing in Greensburg, PA. The loan bears interest at a fixed rate of 5.05% and has a term of ten years with payments based on a 25-year amortization schedule. 26 On February 28, 2003, the Company entered into a new secured credit facility for $255.0 million. This new credit facility replaced both the Company's $130.0 million secured credit facility and its unsecured facility of $105.3 million. The new credit facility bears interest at LIBOR plus 100 basis points, expires in February 2006, and has a one-year extension, which is at the Company's election. Six regional malls and three associated centers secure the new credit facility. As discussed under Acquisitions, the Company assumed $40.0 million of debt in connection with its acquisition of Sunrise Mall on May 1, 2003. The debt bears interest at LIBOR plus 300 basis points, with a floor of 4.90%, and matures in May 2004. The loan was assumed subject to a pre-existing interest rate cap of 5.50%. On September 10, 2003, the Company assumed $64,245 of debt in connection with its acquisition of Cross Creek Mall. The debt bears interest at a fixed rate of 7.40% and matures in April 2012. Since the debt's stated interest rate of 7.40% was above market rates for similar debt instruments at the date of acquisition, the Company has recorded a debt premium of $10,209, which will be amortized as a reduction to interest expense over the remaining term of the debt. On September 12, 2003, the Company closed four long-term, non-recourse fixed-rate mortgage loans totaling $196,000 that are secured by three of the Company's regional malls and one associated center. The loans bear interest at rates ranging from 4.52% to 5.45%, with a weighted average rate of 4.85%, and have terms of five to ten years, with a weighted average term of 6.5 years. In order to fund a portion of its acquisition of the four-mall portfolio discussed under Acquisitions, the Company obtained a short-term, unsecured credit facility of $130,000 that will bear interest at LIBOR plus 1.30% and mature on January 31, 2004. This credit facility can be extended at the Company's option for two additional periods of four months each. No amounts were outstanding under this facility as of September 30, 2003. On October 1, 2003, the Company borrowed $82,352 under this facility to fund the acquisitions of the second and third malls, which was subsequently repaid with proceeds from the sale to Galileo America REIT discussed under Dispositions. The Company's secured credit facilities total $365.0 million, of which $87.8 million was available at September 30, 2003. Additionally, the Company had other credit facilities totaling $19.6 million that are used only for issuances of letters of credit, of which $6.4 million was available at September 30, 2003. As of September 30, 2003, total commitments under construction loans were $104.8 million, of which $75.2 million was available to be used for completion of construction and redevelopment projects and replenishment of working capital previously used for construction. The Company also had $12.8 million available in unfunded construction loans on operating properties that can be used to replenish working capital previously used for construction. The Company has an interest rate cap of 5.50% that was in place on the $40.0 million of variable rate debt the Company assumed in connection with its acquisition of Sunrise Mall (see Acquisitions). The interest rate cap agreement expires in May 2004. The Company had one interest rate swap agreement on $80.0 million of variable-rate debt that expired on August 30, 2003. The Company expects to refinance the majority of its mortgage notes payable maturing over the next five years with replacement loans. Taking into consideration extension options that are available to the Company, there are no debt maturities through December 31, 2003, other than normal principal amortization. DEVELOPMENTS, EXPANSIONS, ACQUISITIONS AND DISPOSITIONS The Company expects to continue to have access to the capital resources necessary to expand and develop its business. Future development and acquisition 27 activities will be undertaken as suitable opportunities arise. The Company does not expect to pursue these opportunities unless adequate sources of financing are available and a satisfactory budget with targeted returns on investment has been approved internally. The Company intends to fund major development, expansion and acquisition activities with traditional sources of construction and permanent debt financing as well as other debt and equity financings, including public financings and the lines of credit, in a manner consistent with its intention to operate with a conservative debt-to-total-market capitalization ratio. Developments and Expansions The following development projects are currently under construction:
Projected Property Location GLA Opening Date ----------------------------------- --------------------------------- ------------- -------------- MALL ----------------------------------- Coastal Grand Myrtle Beach, SC 902,000 March 2004 (50/50 Joint Venture) MALL EXPANSIONS ----------------------------------- Arbor Place Rich's-Macy's Douglasville, GA 140,000 November 2004 East Towne Mall Madison, WI 139,000 November 2004 West Towne Mall Madison, WI 94,000 November 2004 ASSOCIATED CENTER ----------------------------------- The Shoppes of Panama City Panama City, FL 57,000 February 2004 COMMUNITY CENTERS ----------------------------------- Charter Oak Marketplace Hartford, CT 312,000 November 2004 Garden City Plaza Expansion Garden City, KS 26,500 April 2004 Wilkes-Barre Township Marketplace Wilkes-Barre Township, PA 281,000 May 2004
The following renovation projects are currently under construction:
Property Location Projected Completion Date --------------------- -------------------- -------------------------- Eastgate Mall Cincinnati, OH November 2003 East Towne Mall Madison, WI November 2003 West Towne Mall Madison, WI November 2003
The Company has entered into a number of option agreements for the development of future regional malls and community centers. Except for the projects discussed under Developments and Expansions above and Acquisitions below, the Company does not have any other material capital commitments. Acquisitions On May 1, 2003, the Company acquired Sunrise Mall, a 740,000 square foot regional mall, and Sunrise Commons, a 225,000 square foot associated center, in Brownsville, TX, for a total purchase price of $80.7 million. The total purchase price consisted of $40.7 million in cash and the assumption of a non-recourse loan of $40.0 million that bears interest at 300 basis points over LIBOR, with a minimum rate of 4.90%. This debt was assumed subject to a pre-existing interest rate cap of 5.50%. On July 25, 2003, the Company announced that it had entered into separate agreements to acquire four regional malls for a total purchase price of $340.0 million. The purchase price will consist of cash and the assumption of $170.0 million of non-recourse fixed rate debt with a weighted average interest rate of 7.71%. The Company acquired Cross Creek Mall on September 10, 2003 for a purchase price of $116.7 million, including closing costs. The purchase price consisted of $52.5 million in cash and the assumption of $64.2 million of non-recourse, fixed-rate debt. The debt bears interest at a fixed rate of 7.40% 28 and matures in April 2012. Since the interest rate of 7.40% was above market rates for similar debt instruments at the date of acquisition, the Company has recorded a debt premium of $10.2 million, which will be amortized as a reduction to interest expense over the remaining term of the debt. On October 1, 2003, the Company closed on River Ridge Mall and Valley View Mall for a total purchase price of $147.3 million, which consisted of $79.7 million in cash and the assumption of $67.6 million of debt. The loans mature in 2007 and 2012 and have a weighted average interest rate of 8.6%. Since the interest rates on these loans were above market rates for similar debt instruments at the date of acquisition, the Company has recorded total debt premiums of $11.6 million, which will be amortized as a reduction to interest expense over the remaining terms of the these loans. The fourth mall, Southpark Mall, is scheduled to close in the fourth quarter of 2003. Dispositions On February 28, 2003, the Company sold Capital Crossing, a community center in Raleigh, NC, for $7.8 million and recognized a net gain on discontinued operations of $2.9 million. In addition, the Company sold twelve outparcels, plus two options on land, and recognized a total net gain of $4.9 million during the nine months ended September 30, 2003. In August 2003, the Company sold two community centers, Signal Hills Village in Statesville, NC, and Chester Plaza in Richmond, VA, for a total of $2.2 million and recognized a gain of $0.6 million. On October 6, 2003, the Company sold Colleton Square, a community center in Walterboro, SC, for $0.8 million and recognized a loss of $0.3 million. On September 24, 2003, the Company formed a joint venture with Galileo America REIT, the U.S. affiliate of Australia-based Galileo America Shopping Trust, to invest in power and community centers throughout the United States. The Company will contribute, in three phases, 90% of its interests in 51 power and community centers for a total price of $516.0 million. On October 23, 2003, the parties completed the first phase of the transaction when the Company sold its interests in 41 power and community centers to the joint venture for $393.9 million, which consisted of $255.5 million in cash, the payoff of $24.9 million of debt on one of the community centers that was sold to the joint venture, the joint venture's assumption of $93.0 million in debt and $20.4 million representing the 10% interest in the joint venture that the Company retained. The Company used the cash proceeds to reduce outstanding borrowings under the Company's credit facilities. The second phase of the transaction is scheduled to close in January 2004 and the third phase is scheduled to close in January 2005. Pursuant to a long-term agreement, the Company will be the exclusive manager for all of the joint venture's properties in the United States, and will be entitled to management, leasing, acquisition, disposition and financing fees. OTHER CAPITAL EXPENDITURES The Company prepares an annual capital expenditure budget for each property that is intended to provide for all necessary recurring and non-recurring capital improvements. The Company believes that its operating cash 29 flows will provide the necessary funding for such capital improvements. These cash flows will be sufficient to cover tenant finish costs associated with tenant leases and capital expenditures necessary for the enhancement and maintenance of the properties. For capital expenditures at operating properties, including its share of unconsolidated affiliates' capital expenditures and excluding minority investor's share of capital expenditures, the Company spent $24.3 million during the first nine months of 2003 for tenant allowances, which generate increased rents from tenants over the terms of their leases. Deferred maintenance expenditures, a majority of which are recovered from tenants, were $54.6 million for the first nine months of 2003. Renovation expenditures, which include some deferred maintenance items, were $22.9 million for the nine months ended September 30, 2003, a portion of which is recovered from tenants. Deferred maintenance expenditures and renovation expenditures included $7.7 million for the resurfacing and the improved lighting of parking lots and $7.8 million for roof repairs and replacements. Deferred maintenance expenditures are billed to tenants as common area maintenance expense, and most are recovered over a 5- to 15-year period. Renovation expenditures are primarily for remodeling and upgrades of malls, of which approximately 30% is recovered from tenants over a 5- to 15-year period. OTHER The Company believes the properties are in compliance, in all material respects, with federal, state and local ordinances and regulations regarding the handling, discharge and emission of hazardous or toxic substances. The Company has not been notified by any governmental authority, and is not otherwise aware, of any material noncompliance, liability or claim relating to hazardous or toxic substances in connection with any of its present or former properties. Therefore, the Company has not recorded any material liability in connection with environmental matters. CRITICAL ACCOUNTING POLICIES A critical accounting policy is one that is both important to the presentation of a company's financial condition and results of operations and requires significant judgment or complex estimation processes. The Company believes that its most significant accounting policies are those related to revenue recognition, accounting for the development of real estate assets and evaluating long-lived assets for impairment. Revenue Recognition Minimum rental revenue from operating leases is recognized on a straight-line basis over the initial terms of the related leases. Certain tenants are required to pay percentage rent if their sales volumes exceed thresholds specified in their lease agreements. Percentage rent is recognized as revenue when the thresholds are achieved and the amounts become determinable. The Company receives reimbursements from tenants for real estate taxes, insurance, common area maintenance, and other recoverable operating expenses as provided in the lease agreements. Tenant reimbursements are recognized as revenue in the period the related operating expenses are incurred. Tenant reimbursements related to certain capital expenditures are billed to tenants over periods of 5 to 15 years and are recognized as revenue when billed. The Company receives management, leasing and development fees from third parties and unconsolidated affiliates. Management fees are charged as a percentage of minimum and percentage rents and are recognized as revenue when earned. Development fees are recognized as revenue on a pro rata basis over the development period. Leasing fees are charged for newly executed leases and recognized as revenue when earned. Development and leasing fees received from unconsolidated affiliates during the development period are recognized as revenue only to the extent of the third-party partners' ownership interest. Fees to the extent of the Company's ownership interest are recorded as a reduction to the Company's investment in the unconsolidated affiliate. 30 Gain on sales of real estate assets is recognized when title to the asset is transferred to the buyer, if the buyer's initial and continuing investment is adequate and the buyer assumes all future ownership risks of the asset. Capitalization The Company capitalizes predevelopment project costs paid to third parties. All previously capitalized predevelopment costs are expensed when it is no longer probable that the project will be completed. Once development of a project commences, all direct costs incurred to construct the project, including interest and real estate taxes are capitalized. Additionally, certain general and administrative expenses are allocated to the projects and capitalized based on the amount of time applicable personnel work on the development project. Once a project is completed and placed in service, it is depreciated over its estimated useful life. Buildings and improvements are depreciated generally over 40 years and leasehold improvements are amortized over the lives of the applicable leases or the estimated useful life of the assets, whichever is shorter. Ordinary repairs and maintenance are expensed as incurred. Major replacements and improvements are capitalized and depreciated over their estimated useful lives. In accordance with Statement of Financial Accounting Standards Nos. 141 and 142, when operating real estate assets are acquired, the Company estimates the fair value of acquired tangible assets, consisting of land, building and improvements, and identified intangible assets and liabilities generally consisting of the fair value of (i) above and below market leases, (ii) in-place leases and (iii) tenant relationships. The liabilities assumed generally consist of mortgage debt on the real estate assets acquired. The Company allocates the purchase price to the assets acquired and liabilities assumed based on their relative fair values. The Company determines the estimates of fair value based on estimated cash flow projections utilizing appropriate discount and capitalization rates and available market information. The capitalized above market (deferred charge) or below market (deferred credit) intangible is amortized to rental income over the remaining non-cancelable term of the respective leases. The intangible related to in-place leases is amortized over the remaining terms of the respective leases. Any debt premium or discount related to the difference between the face value of the debt assumed and its fair value is amortized to interest expense over the remaining term of the debt. Carrying Value of Real Estate Assets The Company periodically evaluates its real estate assets to determine if there has been any impairment in their carrying values and records impairment losses if the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amounts or if there are other indicators of impairment. At September 30, 2003, the Company did not own any real estate assets that were impaired. ACCOUNTING FOR STOCK OPTIONS See Note 12 to the unaudited consolidated financial statements for a description of the Company's accounting for stock options. RECENT ACCOUNTING PRONOUNCEMENTS As described in Note 13 to the unaudited consolidated financial statements, the FASB has issued certain statements that were effective January 1, 2003. 31 IMPACT OF INFLATION In the last three years, inflation has not had a significant impact on the Company because of the relatively low inflation rate. Substantially all tenant leases do, however, contain provisions designed to protect the Company from the impact of inflation. These provisions include clauses enabling the Company to receive percentage rent based on tenant's gross sales, which generally increase as prices rise, and/or escalation clauses, which generally increase rental rates during the terms of the leases. In addition, many of the leases are for terms of less than ten years, which may enable the Company to replace existing leases with new leases at higher base and/or percentage rents if rents of the existing leases are below the then existing market rate. Most of the leases require tenants to pay their share of operating expenses, including common area maintenance, real estate taxes and insurance, thereby reducing the Company's exposure to increases in costs and operating expenses resulting from inflation. FUNDS FROM OPERATIONS Funds from operations ("FFO") is a widely used measure of the operating performance of real estate investment trusts that supplements net income determined in accordance with generally accepted accounting principles ("GAAP"). The Company computes FFO in accordance with the National Association of Real Estate Investment Trusts' definition of FFO, which is net income (computed in accordance with GAAP) excluding gains or losses on sales of operating properties, plus depreciation and amortization of real estate assets, and after adjustments for unconsolidated partnerships and joint ventures. Beginning with the first quarter of 2003, the Company includes gains on sales of outparcels in FFO to comply with the Securities and Exchange Commission's rules related to disclosure of non-GAAP financial measures. FFO for the comparable periods of 2002 have been restated to include gains on sales of outparcels. The Company believes that FFO provides an additional indicator of the operating performance of the Company's properties without giving effect to real estate depreciation and amortization, which assumes the value of real estate assets declines predictably over time. Since values of well-maintained real estate assets have historically risen or fallen with market conditions, the Company believes that FFO provides investors with a better understanding of the Company's operating performance. The use of FFO as an indicator of operating performance is influenced not only by the operations of the properties and interest rates, but also by the capital structures of the Company and the Operating Partnership. Accordingly, FFO will be one of the significant factors considered by the Board of Directors in determining the amount of cash distributions the Operating Partnership will make to its partners, including the REIT. FFO does not represent cash flow from operations as defined by accounting principals generally accepted in the United States, is not necessarily indicative of cash available to fund all cash flow needs and should not be considered as an alternative to net income for purposes of evaluating the Company's operating performance or to cash flow as a measure of liquidity. For the three months ended September 30, 2003, FFO increased $8.8 million, or 15.4%, to $65.8 million from $57.0 million for the same period in 2002. For the nine months ended September 30, 2003, FFO increased by $28.6 million, or 16.7%, to $200.5 million as compared to $171.9 million for the same period in 2002. The increase in FFO is primarily attributable to the results of operations of the properties added to the portfolio, increases in base rents and tenant reimbursements at the existing properties and increases in gains on outparcel sales. These increases were offset by reductions related to operating properties that were sold and a reduction in lease termination fees. Lease termination fees were $0.5 million and $1.0 million in the three months ended September 30, 2003 and 2002, respectively, and $2.1 million and $5.6 million in the nine months ended September 30, 2003 and 2002, respectively. Gains on sales of outparcels were $0.8 million and $0.5 million in the three months ended September 30, 2003 and 2002, respectively, and $4.9 million and $2.7 million in the nine months ended September 30, 2003 and 2002, respectively. 32 The Company's calculation of FFO is as follows (in thousands):
Three Months Ended Nine Months Ended September 30, September 30, -------------------------- -------------------------- 2003 2002 2003 2002 ------------- ----------- ----------- ------------ Net income available to common shareholders $20,225 $17,465 $64,023 $53,763 Depreciation and amortization from consolidated properties 28,385 24,084 82,362 70,183 Depreciation and amortization from unconsolidated affiliates 982 1,365 3,001 3,137 Depreciation and amortization from discontinued operations 6 98 41 590 Minority interest in earnings of operating partnership 17,235 14,599 55,851 47,131 Minority investors' share of depreciation and amortization in shopping center properties (282) (307) (823) (1,001) Gain on discontinued operations (633) (165) (3,568) (1,572) Depreciation and amortization of non-real estate assets (117) (128) (383) (355) ------------- ----------- ----------- ------------ FUNDS FROM OPERATIONS $65,801 $57,011 $200,504 $171,876 ============= =========== =========== ============ DILUTED WEIGHTED AVERAGE SHARES AND POTENTIAL DILUTIVE COMMON SHARES WITH OPERATING PARTNERSHIP UNITS FULLY CONVERTED 56,884 55,227 56,719 54,013
ITEM 3: Quantitative and Qualitative Disclosures About Market Risk The Company has exposure to interest rate risk on its debt obligations and derivative financial instruments. The Company uses derivative financial instruments to manage its exposure to changes in interest rates and not for speculative purposes. The Company's interest rate risk management policy requires that derivative instruments be used for hedging purposes only and that they be entered into only with major financial institutions based on their credit ratings and other factors. Based on the Company's proportionate share of consolidated and unconsolidated variable rate debt at September 30, 2003, a 0.5% increase or decrease in interest rates on this variable-rate debt would decrease or increase annual cash flows by approximately $2.2 million and, after the effect of capitalized interest, annual earnings by approximately $1.9 million. Based on the Company's proportionate share of consolidated and unconsolidated debt at September 30, 2003, a 0.5% increase in interest rates would decrease the fair value of debt by approximately $56.8 million, while a 0.5% decrease in interest rates would increase the fair value of debt by approximately $58.6 million. See Note 4 to the unaudited consolidated financial statements for a description of the Company's derivative financial instruments. ITEM 4: Controls and Procedures As of the end of the period covered by this quarterly report, an evaluation, under Rule 13a-15 of the Securities Exchange Act of 1934 was performed under the supervision of the Company's Chief Executive Officer and Chief Financial Officer and with the participation of the Company's management, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective. No change in the Company's internal control over financial reporting occurred during the period covered by this quarterly report that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 33 PART II - OTHER INFORMATION ITEM 1: Legal Proceedings None ITEM 2: Changes in Securities and Use of Proceeds None ITEM 3: Defaults Upon Senior Securities None ITEM 4: Submission of Matters to a Vote of Security Holders None ITEM 5: Other Information None ITEM 6: Exhibits and Reports on Form 8-K A. Exhibits 31.1 Certification pursuant to Securities Exchange Act Rule 13a-14(a) by the Chief Executive Officer, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, see page 37. 31.2 Certification pursuant to Securities Exchange Act Rule 13a-14(a) by the Chief Financial Officer, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, see page 38. 32.1 Certification pursuant to Securities Exchange Act Rule 13a-14(b) by the Chief Executive Officer, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, see page 39. 32.2 Certification pursuant to Securities Exchange Act Rule 13a-14(b) by the Chief Financial Officer as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, see page 40. B. Reports on Form 8-K The following items were reported: The outline from the Company's July 25, 2003 conference call with analysts and investors regarding earnings for the quarter ended June 30, 2003, the Company's earnings release and the Company's supplemental information package were furnished on July 25, 2003. The disclosures required by Regulation G related to the Company's 2002 Annual Report on Form 10-K, which was filed on March 21, 2003, were filed on August 5, 2003. 34 The Company's announcement that it had entered into purchase agreements to acquire 100% of the interests in four regional shopping malls was filed on August 15, 2003. The opinion regarding legality, opinion regarding tax matters and consent of counsel pertaining to the Company's shelf registration statement (filed on June 10, 2003), the related prospectus (dated June 10, 2003) and the related prospectus supplement (dated August 6, 2003), related to the Company's public offering of its 7.75% Series C cumulative redeemable preferred stock were filed on August 22, 2003. The underwriting agreement (dated August 6, 2003), pricing agreement (dated August 6, 2003) and press release related to the Company's public offering of its 7.75% Series C Cumulative Redeemable Preferred Stock were filed on August 26, 2003. The related certificate of designations of the Company's 7.75% Series C Cumulative Redeemable Preferred Stock was incorporated by reference from the Company's registration statement on Form 8-A, which was filed on August 21, 2003. The Company filed a Form 8-K on September 19, 2003 that updated Items 6, 7, 8 and 15 of the Company's Annual Report on Form 10-K for the year ended December 31, 2002 to reflect (i) the application of the requirements of Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" and (ii) the adoption of SFAS No. 145, "Rescission of SFAS Nos. 4, 44 and 64, Amendment of SFAS No. 13, and Technical Corrections". The Company's announcement that it had formed a joint venture with Galileo America REIT, the transcript of the Company's prepared remarks from a conference call held on September 24, 2003 to discuss this joint venture and certain supplemental information concerning the properties included in the transaction were filed on September 25, 2003. The outline from the Company's October 29, 2003 conference call with analysts and investors regarding earnings for the quarter ended September 30, 2003, the Company's earnings release and the Company's supplemental information package were furnished on October 29, 2003. 35 SIGNATURE 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. CBL & ASSOCIATES PROPERTIES, INC. /s/ John N. Foy --------------------------------------------------- Vice Chairman of the Board, Chief Financial Officer and Treasurer (Authorized Officer of the Registrant, Principal Financial Officer) Date: November 14, 2003 36 Exhibit 31.1 CERTIFICATION I, Charles B. Lebovitz, certify that: (1) I have reviewed this quarterly report on Form 10-Q of CBL & Associates Properties, Inc.; (2) Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; (3) Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; (4) The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this quarterly report based on such evaluation; and (c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and (5) The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 14, 2003 /s/ Charles B. Lebovitz ------------------------------------ Charles B. Lebovitz, Chief Executive Officer 37 Exhibit 31.2 CERTIFICATION I, John N. Foy, certify that: (1) I have reviewed this quarterly report on Form 10-Q of CBL & Associates Properties, Inc.; (2) Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; (3) Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; (4) The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this quarterly report based on such evaluation; and (c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and (5) The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: November 14, 2003 /s/ John N. Foy ----------------------------------- John N. Foy, Chief Financial Officer 38 Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of CBL & ASSOCIATES PROPERTIES, INC. (the "Company") on Form 10-Q for the three months ending September 30, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Charles B. Lebovitz, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350 (as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002), that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Charles B. Lebovitz ------------------------------------ Charles B. Lebovitz, Chief Executive Officer November 14, 2003 ------------------------------------ Date 39 Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of CBL & ASSOCIATES PROPERTIES, INC. (the "Company") on Form 10-Q for the three months ending September 30, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, John N. Foy, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350 (as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002), that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ John N. Foy ------------------------------------ John N. Foy, Vice Chairman of the Board, Chief Financial Officer and Treasurer November 14, 2003 ------------------------------------ Date 40