Prior to being employed by the Company on November 15, 2005, an officer provided construction management services to the Company. Fees charged by the officer to the Company for the three and six months ended June 30, 2005 totaled $39 and $78, respectively.
The Company has entered into a consulting contract with Ed Feldman, father of the Company’s chairman and CEO, Larry Feldman, to provide professional acquisition services. The agreement pays Mr. Feldman $3 per month commencing July 1, 2005. For the three and six months ended June 30, 2006, Mr. Feldman has received $12 and $18, respectively.
The Company receives rental income from the leasing of retail shopping center space under operating leases. The Company recognizes income from its tenant operating leases on a straight-line basis over the respective lease terms and, accordingly, rental income in a given period will vary from actual contractual rental amounts due as reduced by amortization of capitalized above-market lease values. Amounts included in rental revenue based on recording lease income on the straight-line basis for the three and six months ended June 30, 2006 and 2005 were $254, $441, $163 and $291, respectively.
The minimum future base rentals under non-cancelable operating leases as of June 30, 2006 are as follows:
Minimum future rentals do not include amounts which are payable by certain tenants based upon certain reimbursable shopping center operating expenses. The tenant base includes national and regional chains and local retailers. For the three and six months ended June 30, 2006 and 2005, no tenant exceeded 10% of rental revenues.
At June 30, 2006 and December 31, 2005, amounts due to affiliates primarily reflect obligations to make payments to certain owners of the Predecessor in connection with the Formation Transactions. As part of the Formation Transactions, the owners of the Predecessor are entitled to the following:
Messrs. Feldman, Bourg and Jensen have the right to receive additional OP Units for ownership interests contributed as part of the Formation Transactions upon the achievement of a 15% internal rate of return by the Company from the Harrisburg joint venture on or prior to December 31, 2009. The right to receive such additional OP Units is a financial instrument which is recorded as an obligation of the Company as of the Offering and adjusted to fair value each reporting period until the thresholds have been achieved and the OP Units have been issued. Based on the expected operating performance of the Harrisburg Mall, the fair value is estimated to be $5,303 and is included in due to affiliates at each of June 30, 2006 and December 31, 2005. The fair value of this obligation is assessed by the Company’s management on a quarterly basis.
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FELDMAN MALL PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – UNAUDITED (CONTINUED)
June 30, 2006
(Dollar Amounts in Thousands, Except Share and Per Share Data)
9. Stockholders’ Equity
The Company’s authorized capital stock consists of 250,000,000 shares, $.01 par value, consisting of up to 200,000,000 shares of common stock, $.01 par value per share and up to 50,000,000 shares of preferred stock, $.01 par value per share. As of June 30, 2006 and December 31, 2005, 13,101,400 and 13,050,370 shares of common stock were issued and outstanding, respectively. The Company has not issued any shares of preferred stock as of June 30, 2006. During 2005 and 2006, the Company issued 2,000 and 1,000, respectively, fully vested shares of its common stock to each of its three outside directors.
In January 2005, the Company sold 1,600,000 shares of its common stock at a gross price of $13.00 per share. The net proceeds from this offering were approximately $19,300.
In December 2005, the Company issued 369,375 shares of our common stock in connection with acquiring a long-term lease located at the Tallahassee Mall.
10. Minority Interest
As of June 30, 2006 and December 31, 2005, minority interest relates to the interests in the Operating Partnership that are not owned by the Company, of approximately 10.9% and 11.3%, respectively. In conjunction with the formation of the Company, certain persons and entities contributing ownership interests in the Predecessor to the Operating Partnership received OP Units. Limited partners who acquired OP Units in the Formation Transactions have the right, commencing on or after December 16, 2005, to require the Operating Partnership to redeem part or all of their OP Units for cash, or, at the Company’s option, an equivalent number of shares of the Company’s common stock at the time of the redemption. Alternatively, the Company may elect to acquire those OP Units in exchange for shares of our common stock on a one-for-one basis subject to adjustment in the event of stock splits, stock dividends, issuance of stock rights, specified extraordinary distributions and similar events.
11. Commitment and Contingencies
In the normal course of business, the Company becomes involved in legal actions relating to the ownership and operations of its properties and the properties it manages for third parties. In management’s opinion, the resolutions of these legal actions are not expected to have a material adverse effect on the Company’s condensed consolidated financial position or results of operations.
All of the Company’s malls that have non-owned parcels sharing common areas are subject to reciprocal easement agreements that address use and maintenance of common areas and often address other issues, including use restrictions and operating covenants. These agreements are recorded against the properties and are long term in nature.
In late 2005, the seller of Colonie Center Mall filed an arbitration claim against the Company alleging entitlement to over $4,000 in additional purchase price as a result of the Seller having presented a lease to the Company for a portion of the mall after the Company’s acquisition. That claim was settled in March 2006 for $2,000. The Company has accounted for payment of the additional purchase price as an increase to in-place lease value.
Adjacent to the Stratford Square Mall are six anchor tenant spaces, five of which are owned by third parties and one of which is owned by the Company. The Company has entered into an operating agreement with the owners of these non-owned anchor tenant parcels to share certain operating expenses based on allocated amounts per square foot. The agreement terminates in March 2031.
The purchase price for the Golden Triangle Mall may be increased up to $2,200 if the seller is able to deliver an executed letter with a certain tenant acceptable to the Company and that tenant takes occupancy. As of June 30, 2006, a lease has been signed, however, the tenant is not scheduled to take occupancy until 2007.
As of June 30, 2006, the Company also has commitments to make tenant improvements and other capital expenditures in the amount of approximately $1,706. In addition, in connection with leases that have been signed through June 30, 2006 included in the redevelopment expansion plans of the malls and current redevelopment activity, the Company is committed to, or expected to, spend approximately $43,989 and $44,747 for 2006 and 2007, respectively.
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FELDMAN MALL PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – UNAUDITED (CONTINUED)
June 30, 2006
(Dollar Amounts in Thousands, Except Share and Per Share Data)
11. Commitment and Contingencies – (Continued)
In connection with the Formation Transactions, the Company entered into agreements with Messrs. Feldman, Bourg and Jensen that indemnify them with respect to certain tax liabilities intended to be deferred in the Formation Transactions, if those liabilities are triggered either as a result of a taxable disposition of a property by the Company, or if the Company fails to offer the opportunity for the contributors to guarantee or otherwise bear the risk of loss, with respect to certain amounts of the Company’s debt for tax purposes (the “contributor-guaranteed debt”). With respect to tax liabilities arising out of property sales, the indemnity will cover 100% of any such liability until December 31, 2009, and will be reduced by 20% of the aggregate liability on each of the five following year ends thereafter.
The Company also has agreed to maintain approximately $10,000 of indebtedness, and to offer the contributors the option to guarantee $10,000 of the Operating Partnership’s indebtedness, in order to enable them to continue to defer certain tax liabilities. The obligation to maintain such indebtedness extends to 2013, but will be extended by an additional five years for any contributor that holds (together with his affiliates) at that time at least 25% of the initial ownership interest in the Operating Partnership issued to them in the Formation Transactions. As of June 30, 2006, Feldman Partners, LLC, an affiliate of Larry Feldman and Jeffrey Erhart, currently guarantees $8,000 of the loan secured by the Stratford Square Mall.
12. Borrowings and Joint Venture with Kimco Realty Corp.
During February 2006, the Company entered into a contribution agreement with a subsidiary of Kimco Realty Corp. (“Kimco”) in connection with the Foothills Mall, located in the suburbs of Tucson, Arizona. Under the terms of the contribution agreement, the Company contributed the Foothills Mall to a limited liability company at an agreed value of $104,000, plus certain closing costs (the “Joint Venture”). The transaction closed on June 29, 2006 (the “Closing Date”). The transaction resulted in the Company recognizing a gain totaling $29,968. Pursuant to the terms of the contribution agreement, the Company received approximately $38,900 in net proceeds from the transaction.
On the closing date, the joint venture extinguished the existing first mortgage totaling $54,750 and refinanced the property with an $81,000 non-recourse first mortgage. The $81,000 first mortgage matures in July 2016 and bears interest at 6.08%. The loan may not be prepaid until the earlier of three years from the first interest payment or two years from date of loan syndication and has no principal payments for the first five years and then loan principal amortizes on a 30-year basis thereafter. Simultaneous with the refinancing, Kimco contributed cash in the amount of $14,757 to the Joint Venture. Kimco will receive a preferred return on its capital from the Foothills Mall’s cash flow. Upon a sale or refinancing of the Foothills Mall, Kimco is also entitled to receive a priority return of its capital together with any unpaid accrued preferred return. After certain adjustments, the Company is next entitled to receive an 8% preferred return on and a return of its capital. Thereafter, all surplus proceeds will be split 20% to Kimco and 80% to the Company. Additionally, the Company agreed to serve as the managing member of the limited liability company and will retain primary management, leasing and construction oversight, for which it will receive customary fees. The Company has determined the Joint Venture is not a VIE and accounts for its investment in the Joint Venture under the equity method.
The joint venture agreement includes “buy-sell” provisions commencing in 24 months for the Company and after 47 months from the date allowing either joint venture partner to acquire the interests of the other. Either partner to the joint venture may initiate a “buy-sell” proceeding, which may enable it to acquire the interests of the other partner. However, the partner receiving an offer to be bought out will have the right to buy out such offering partner at the same price offered. The joint venture agreement does not limit the Company’s ability to enter into real estate ventures or co-investments with other third parties.
During February 2006, the Company entered into a promissory note (the “Note”) with Kimco Capital Corp. (the “Lender”), a subsidiary of Kimco, in the amount up to $17,200. The amounts outstanding under the loan bore interest at an interest rate of 8% per annum. On June 29, 2006, the $5,000 outstanding balance was repaid and the Note was extinguished.
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FELDMAN MALL PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – UNAUDITED (CONTINUED)
June 30, 2006
(Dollar Amounts in Thousands, Except Share and Per Share Data)
12. Borrowings and Joint Venture with Kimco Realty Corp. – (Continued)
Summarized initial balance sheet for the Joint Venture is as follows:
| | June 30, 2006 | |
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Investment in real estate | | $ | 90,840 | |
Other assets | | | 1,277 | |
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Total assets | | $ | 92,117 | |
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Mortgage loan payable | | $ | 81,000 | |
Other liabilities | | | 182 | |
Owners’ equity | | | 10,935 | |
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Total liabilities and owners’ equity | | $ | 92,117 | |
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Company’s share of owner’s equity | | $ | (3,822 | ) |
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The difference between the Company’s investment in the Joint Venture and its 30.8% of the partnership owners’ equity is primarily due to the Company recording its remaining interest at historical cost reduced by its share of excess loan proceeds. The amounts presented above are preliminary as of June 30, 2006.
13. Investment in Unconsolidated Real Estate Partnerships
The Company has a 24% limited partnership interest and a 1% general partnership interest in Feldman Lubert Adler Harrisburg, LP (the “Partnership”). The Partnership purchased a regional mall in Harrisburg, Pennsylvania on September 29, 2003. Summarized financial information for this investment, which is accounted for by the equity method, is as follows:
| | June 30, 2006 | | December 31, 2005 | |
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Investment in real estate, net | | $ | 48,994 | | $ | 50,050 | |
Receivables including deferred rents | | | 1,141 | | | 1,182 | |
Other assets | | | 11,287 | | | 11,886 | |
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Total assets | | $ | 61,422 | | $ | 63,118 | |
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Loan payable | | $ | 49,750 | | $ | 49,750 | |
Other liabilities | | | 1,770 | | | 2,330 | |
Owners’ equity | | | 9,902 | | | 11,038 | |
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Total liabilities and owners’ equity | | $ | 61,422 | | $ | 63,118 | |
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Company’s share of owners’ equity | | $ | 2,510 | | $ | 2,794 | |
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The difference between the Company’s investment in the Partnership and its 25% of the Partnership’s owners’ equity is primarily due to the Company’s $500 acquisition of an interest held by a third party in 2004 and unpaid reimbursements of operating costs.
| | Three Months Ended June 30, | | Six Months Ended June 30, | |
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| | 2006 | | 2005 | | 2006 | | 2005 | |
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Revenue | | $ | 2,617 | | $ | 2,586 | | $ | 5,290 | | $ | 5,286 | |
Operating and other expenses | | | 1,475 | | | 1,330 | | | 3,104 | | | 2,785 | |
Interest expense (including the amortization of deferred financing costs) | | | 861 | | | 589 | | | 1,653 | | | 1,234 | |
Depreciation and amortization | | | 837 | | | 793 | | | 1,670 | | | 1,570 | |
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Net loss | | $ | (556 | ) | $ | (126 | ) | $ | (1,137 | ) | $ | (303 | ) |
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Company’s share of net loss | | $ | (139 | ) | $ | (32 | ) | $ | (284 | ) | $ | (76 | ) |
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FELDMAN MALL PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – UNAUDITED (CONTINUED)
June 30, 2006
(Dollar Amounts in Thousands, Except Share and Per Share Data)
13. Investment in Unconsolidated Real Estate Partnerships – (Continued)
The Harrisburg Mall was purchased with (i) the proceeds of a mortgage loan, secured by the mall property and an assignment of rents and leases, and (ii) cash contributions from the Predecessor and its joint venture partner. The construction loan was subsequently amended in October 2004 to increase the lender’s commitment to $46,875. The construction loan initially bore interest at LIBOR plus 3.25% per annum, until a certain anchor tenant occupied its space and began paying rent, at which time the spread became 2.5%. During July 2005, the loan was amended and increased to a maximum commitment of $50,000 through a $7,200 second mortgage with no principal payments until the maturity date, which was extended to March 2008. The interest rate was reduced to LIBOR plus 1.625% per annum. During July 2005, the Partnership increased the borrowings to $49,750 and distributed $6,500 to the partners on a pro rata basis, of which the Company received $1,625. The effective rates on the loan at June 30, 2006 and December 31, 2005 were 6.82% and 5.99%, respectively.
Under certain circumstances the Partnership may extend the maturity of the loan for three, one-year periods. As of June 30, 2006, the Partnership may prepay the loan at any time, without incurring any prepayment penalty. The loan presently has a limited recourse of $5,000 of which our joint venture partner is liable for $3,150 or 63%, and the Company is liable for $1,850 or 37%.
The balance outstanding under the loan was $49,750, as of June 30, 2006 and December 31, 2005, and the Partnership intends to use cash flow from property operations to fund its capital expenditure commitments, which were $550 at June 30, 2006. The Company is required to maintain cash balances with the lender averaging $5,000. If the balances fall below $5,000 in any one month, the interest rate on the loan increases to LIBOR plus 1.875%.
The joint venture agreement includes a “buy-sell” provision allowing either joint venture partner to acquire the interests of the other. Either partner to the joint venture may initiate a “buy-sell” proceeding, which may enable it to acquire the interests of the other partner. However, the partner receiving an offer to be bought out will have the right to buy out such offering partner at the same price offered. The joint venture agreement does not limit the Company’s ability to enter into real estate ventures or co-investments with other third parties. However, the agreement restricts the Company’s ability to enter into transactions relating to the joint venture with the Company’s affiliates without the prior approval of its joint venture partner.
The joint venture has commitments for tenant improvements and other capital expenditures in the amount of $550 to be incurred in 2006 and intends to fund them from operating cash flow. The joint venture has additional renovation cost commitments and anticipates the renovation costs to be $3,400 in 2006 and the balance totaling $14,400 anticipated to be spent thereafter. The joint venture anticipates funding these renovation costs with additional financing activity or equity contributions.
14. Fair Value of Financial Instruments
As of June 30, 2006 and December 31, 2005, the fair values of the Company’s mortgage loans payable and junior subordinated debt, were approximately the carrying values as the terms are similar to those currently available to the Company for debt with similar risk and the same remaining maturities. The carrying amounts for cash and cash equivalents, restricted cash, rents and other receivables, due to affiliates, and accounts payable and other liabilities, approximate fair value because of the short-term nature of these instruments.
15. Financial Instruments: Derivatives and Hedging
The following summarizes the notional and fair value of the Company’s derivative financial instrument at June 30, 2006. The notional value is an indication of the extent of our involvement in these instruments at that time, but does not represent exposure to credit, interest rate or market risks:
| | Notional
Value | | Strike
Rate | | Effective
Date | | Expiration
Date | | Fair
Value | |
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Interest Rate Swap | | $ | 75,000 | | 3.75 | % | 2/2005 | | 1/2008 | | $ | 1,920 | |
Interest Rate Swap | | $ | 75,000 | | 4.91 | % | 1/2008 | | 1/2011 | | $ | 1,072 | |
On June 30, 2006, the derivative instruments were reported as an asset at a fair value of approximately $2,992 and is recorded in other assets. Over time, the unrealized gain of $2,936 held in Accumulated Other Comprehensive Income will be reclassified into operations as interest expense in the same periods in which the hedged interest payments affect earnings.
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FELDMAN MALL PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – UNAUDITED (CONTINUED)
June 30, 2006
(Dollar Amounts in Thousands, Except Share and Per Share Data)
15. Financial Instruments: Derivatives and Hedging – (Continued)
The Company hedges exposure to variability in anticipated future interest payments on existing variable rate debt.
16. Subsequent Events
Joint Venture with Heitman Funds – Colonie Center Mall
On August 9, 2006, the Company announced that it has entered into a joint venture agreement with an affiliate of Heitman in connection with the Colonie Center Mall located in Albany, New York. Under the terms of the joint venture, a subsidiary of the Company will convey the property to the venture at an agreed upon value that is currently $101.5 million, plus closing costs. Heitman’s initial contribution will represent 75% of the joint venture equity. The Company will retain 25% of the total equity in the property. In connection with the recapitalization of the mall, the Company plans to recapitalize the current $50.7 million first mortgage bridge loan with a new construction loan. The current loan matures October 2006 and a condition of closing this transaction is to refinance the property with a construction loan facility totaling approximately $108.0 million.
The Company will be the managing member of the joint venture and will be responsible for the management, leasing and construction of the property and will charge customary market fees for such services.
The closing of the joint venture is expected to take place at the end of the third quarter of 2006 and is subject to certain limited and customary due diligence approvals by Heitman, and there is no assurance the transaction will be completed.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We are a fully integrated, self-administered and self-managed real estate company formed in July 2004 to continue the business of our predecessor to acquire, renovate and reposition shopping malls. Our investment strategy is to opportunistically acquire underperforming or distressed malls and transform them into physically attractive and profitable Class A or near Class A malls through comprehensive renovation and repositioning efforts aimed at increasing shopper traffic and tenant sales. Through these renovation and repositioning efforts, we expect to raise occupancy levels, rental income and property cash flow.
We derive revenues primarily from rent and reimbursement payments received by our operating partnership from tenants under existing leases at each of our properties. Our operating results, therefore, will depend materially on the ability of our tenants to make required payments and overall real estate market conditions.
On December 16, 2004, we completed our formation transactions and initial public offering and sold 10,666,667 shares of our common stock and contributed the net proceeds to our operating partnership. Subsequently, on January 15, 2005, we sold an additional 1,600,000 shares of our common stock to underwriters upon their full exercise of their over-allotment option.
A discussion of the results of operations of our company is set forth below. Upon completion of our initial public offering and the formation transactions, we have substantially enhanced our financial flexibility and access to capital compared to our predecessor, which has played an important role in allowing our company to implement our growth and business plan. For the following reasons, the results of operations of our company reported in the second quarter may not be indicative of the results of our future operations:
| • | On June 29, 2006, we contributed the Foothills Mall to a joint venture and retained a 30.8% interest. In connection with this transaction, the joint venture re-financed the existing $54.8 million first mortgage with an $81.0 million first mortgage. As a result of these transactions, we received approximately $38.9 million and recognized a $30.0 million gain on the partial sale of the property in the second quarter 2006 as reported on the condensed statement of operations. A portion of the proceeds from the transaction were used to repay $24.6 million outstanding on our secured line of credit and $5.0 million outstanding to extinguish our credit facility provided by Kimco Realty Corp. |
Critical Accounting Policies
A summary of the accounting policies that management believes are critical to the preparation of the condensed consolidated financial statements are set forth below. Certain of the accounting policies used in the preparation of these condensed consolidated financial statements are particularly important for an understanding of the financial position and results of operations presented in the condensed consolidated financial statements included in this quarterly report on Form 10-Q. These policies require the application of judgment and assumptions by management and, as a result, are subject to a degree of uncertainty. Actual results could differ from these estimates.
Revenue Recognition
Rental revenues from rental retail properties are recognized on a straight-line basis over the non-cancelable terms of the related leases. Deferred rent represents the aggregate excess of rental revenue recognized on a straight-line basis over cash received under applicable lease provisions. Rental revenue, which is based upon a percentage of the sales recorded by tenants, is recognized in the period such sales are earned by the respective tenants.
Reimbursements from tenants, computed as a formula related to real estate taxes, insurance and other mall operating expenses, are recognized as revenues in the period the applicable costs are incurred. Lease termination fees, net of deferred rent and related intangibles, which are included in interest and other income in the accompanying condensed consolidated statements of operations, are recognized when the related leases are cancelled, the tenant surrenders the space, and we have no continuing obligation to provide services to such former tenants.
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Additional revenue is derived from the provision of management services to third parties, including property management, brokerage, leasing and development. Management fees generally are a percentage of managed property cash receipts. Leasing and brokerage fees are earned upon the consummation of new leases. Development fees are earned over the time period of the development activity.
We must also make estimates related to the collectibility of our accounts receivable related to minimum rent, deferred rent, tenant reimbursements, lease termination fees, management and development fees and other income. We analyze accounts receivable and historical bad debts, tenant concentrations, tenant credit worthiness, and current economic trends when evaluating the adequacy of the allowance for doubtful accounts receivable. These estimates have a direct impact on net income, because a higher bad debt allowance would result in lower net income.
Principles of Consolidation and Equity Method of Accounting
Our unaudited condensed consolidated financial statements include all of the accounts of our company, our operating partnership and the wholly owned subsidiaries of our operating partnership by our predecessor. Property interests contributed to our operating partnership in the formation transactions in exchange for OP Units have been accounted for as a reorganization of entities under common control. Accordingly, the contributed assets and assumed liabilities were recorded at our predecessor’s historical cost basis. The combination did not require any material adjustments to conform the accounting principles of the separate entities. The remaining interests, which were acquired for cash, have been accounted for as a purchase, and the excess of the purchase price over the related historical cost basis has been allocated to the assets acquired and the liabilities assumed.
We evaluate our investments in partially owned entities in accordance with FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, or FIN 46R. If the investment is a “variable interest entity,” or a “VIE,” and we are the “primary beneficiary,” as defined in FIN 46R, we account for such investment as if it were a consolidated subsidiary. We have determined that Feldman Lubert Adler Harrisburg L.P. and FMP Kimco Foothills LLC are not VIE’s.
We evaluate the consolidation of entities in which we are a general partner in accordance with EITF Issue 04-05, which provides guidance in determining whether a general partner should consolidate a limited partnership or a limited liability company with characteristics of a partnership. EITF 04-05 states that the general partner in a limited partnership is presumed to control that limited partnership. The presumption may be overcome if the limited partners have either (1) the substantive ability to dissolve the limited partnership or otherwise remove the general partner without cause or (2) substantive participating rights, which provide the limited partners with the ability to effectively participate in significant decisions that would be expected to be made in the ordinary course of the limited partnership’s business and thereby preclude the general partner from exercising unilateral control over the partnership. Based on these criteria, we do not consolidate our investments in the Harrisburg and Foothills joint ventures. We account for our investment in the joint ventures that own the Harrisburg Mall and the Foothills Mall under the equity method of accounting. This investment is recorded initially at cost and thereafter the carrying amount is increased by its share of comprehensive income and any additional capital contributions and decreased by its share of comprehensive loss and capital distributions.
The equity in net income or loss and other comprehensive income or loss from real estate joint ventures recognized by us and the carrying value of our investments in real estate joint ventures are based on our share of cash that would be distributed to us under the hypothetical liquidation of the joint venture, at the then book value, pursuant to the provisions of the respective operating/partnership agreements.
For a joint venture investment which is not a VIE or in which we are not the general partner, we follow the accounting set forth in AICPA Statement of Position No. 78-9 – Accounting for Investments in Real Estate Ventures (“SOP 78-9”) as amended by EITF 04-05. In accordance with this pronouncement, investments in joint ventures are accounted for under the equity method when our ownership interest is less than 50% and we do not exercise direct or indirect control.
On a periodic basis, we assess whether there are any indicators that the value of an investment in unconsolidated joint ventures may be impaired. An investment’s value is impaired if management’s estimate of the fair value of the investment is less than the carrying value of the investment. To the extent impairment has occurred, the loss shall be measured as the excess of the carrying amount of the investment over the estimated fair value of the investment.
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Investments in Real Estate and Real Estate Entities
Real estate is stated at historical cost, less accumulated depreciation. Improvements and replacements are capitalized when they extend the useful life or improve the efficiency of the asset. Repairs and maintenance are charged to expense as incurred.
The building and improvements thereon are depreciated on the straight-line basis over an estimated useful life of 39 years. Tenant improvements are depreciated on the straight-line basis over the shorter of the lease term or their estimated useful life. Equipment is being depreciated on an accelerated basis over estimated useful lives of five to seven years.
It is our policy to capitalize interest, insurance and real estate taxes related to properties under redevelopment and to depreciate these costs over the life of the related assets. Pre-development costs, which generally include legal and professional fees and other third-party costs related directly to the acquisition of a property, are capitalized as part of the property being developed. In the event a development is no longer deemed to be probable, the costs previously capitalized are written off as a component of operating expenses.
In accordance with SFAS No. 144, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, investment properties are reviewed for impairment on a property-by-property basis whenever events or changes in circumstances indicate that the carrying value of investment properties may not be recoverable. Impairment losses for investment properties are recorded when the undiscounted cash flows estimated to be generated by the investment properties during the expected hold period are less than the carrying amounts of those assets.
Impairment losses are measured as the difference between the carrying value and the fair value of the asset. We are required to assess whether there are impairments in the values of our investments in real estate, including indirect investments in real estate through entities which we do not control and are accounted for using the equity method of accounting.
In connection with the formation transactions, we acquired our predecessor in exchange for the issuance of OP Units in our operating partnership and shares of our common stock. This exchange has been accounted for as a reorganization of entities under common control; accordingly, we recorded the contributed assets and liabilities at our predecessor’s historical cost.
Gains or Losses on Disposition of Real Estate
Gains or losses on the disposition of real estate assets are recorded when the recognition criteria have been met, generally at the time title is transferred and we no longer have substantial continuing involvement with the real estate asset sold.
When we contribute a property to a joint venture in which we have retained an ownership interest, we do not recognize a portion of the proceeds in the computation of the gain resulting from the contribution. The amount of proceeds not recognized is based on our continuing ownership interest in the contributed property that arises due to the ownership interest in the joint venture acquiring the property.
Purchase Price Allocation
We allocate the purchase price of properties to tangible and identified intangible assets acquired based on their fair values in accordance with the provisions of SFAS No. 141, Business Combinations. In making estimates of fair values for the purpose of allocating purchase price, management utilized a number of sources. We also consider information about each property obtained as a result of our pre-acquisition due diligence, marketing and leasing activities in estimating the fair value of tangible and intangible assets acquired.
We allocate a portion of the purchase price to tangible assets including the fair value of the building on an as-if vacant basis, and to land determined either by real estate tax assessments, third party appraisals or other relevant data. Since June 2005, we determine the as-if-vacant value by using a replacement cost method. Under this method we obtain valuations from a qualified third party utilizing relevant third party property condition and Phase I environmental reports. The Company believes the replacement cost method closely approximates its previous methodology and is a better determination of the as-if vacant fair value.
A portion of the purchase price is allocated to above-market and below-market in-place lease values for acquired properties based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining non-cancelable term of the lease. The capitalized above-market and below-market lease values are amortized as a reduction of or an addition to rental income over the remaining non-cancelable terms of the respective leases. Should a tenant terminate its lease, the unamortized portion of the lease intangibles would be charged or credited to income.
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A portion of the purchase price is also allocated to the value of leases acquired, and management utilizes independent sources or management’s determination of the relative fair values of the respective in-place lease values. Our estimates of value are made using methods similar to those used by independent appraisers. Factors considered by management in performing these analyses include an estimate of carrying costs during the expected lease-up periods, considering current market conditions and costs to execute similar leases. In estimating carrying costs, management includes real estate taxes, insurance and other operating expenses and estimates of lost rental revenue during the expected lease-up periods based on current market demand. We also estimate costs to execute similar leases including leasing commissions, legal expenses and other related costs.
Depreciation
The U.S. Federal tax basis for the Foothills and Harrisburg Malls, used to determine depreciation for U.S. Federal income tax purposes, is the carryover basis for such malls. The tax basis for all other properties is our acquisition cost. For U.S. Federal income tax purposes, depreciation with respect to the real property components of our malls (other than land) generally will be computed using the straight-line method over a useful life of 39 years.
Derivative Instruments
In the normal course of business, we are exposed to the effect of interest rate changes and limit these risks by following risk management policies and procedures including the use of derivatives. To address exposure to interest rates, derivatives are used primarily to fix the rate on debt based on floating-rate indices and manage the cost of borrowing obligations.
We may use a variety of derivative instruments to manage, or hedge, interest rate risk. We require that derivative instruments are effective in reducing the interest rate risk exposure that they are designated to hedge. This effectiveness is essential for qualifying for hedge accounting. One of our derivative instruments is associated with forecasted cash flows. In that case, hedge effectiveness criteria also require, among other things, that it be probable that the underlying forecasted cash flows will occur. Instruments that meet these hedging criteria are formally designated as hedges at the inception of the derivative contract.
To determine the fair values of derivative instruments, we use a variety of methods and assumptions that are based on market conditions and risks existing at each balance sheet date. For the majority of financial instruments including most derivatives, long-term investments and long-term debt, standard market conventions and techniques such as discounted cash flow analysis, option pricing models, replacement cost, and termination cost are used to determine fair value. All methods of assessing fair value result in a general approximation of value, and such value may never actually be realized.
Derivative instruments that are reported at fair value and presented on the balance sheet could be characterized as either cash flow hedges or fair value hedges. All of our derivatives are designated cash flow hedges. Cash flow hedges address the risk associated with future cash flows of debt transactions. All hedges held by us are deemed to be fully effective in meeting the hedging objectives established by our corporate policy governing interest rate risk management and as such no unrealized gains or losses due to changes in fair value are reported in earnings. The changes in fair value of hedge instruments are reflected in accumulated other comprehensive income. For derivative instruments not designated as hedging instruments, the gain or loss, resulting from the change in the estimated fair value of the derivative instruments, would be recognized in current earnings during the period of change.
Results of Operations
Overview
The discussion below relates to the results of operations of our company which, throughout the periods discussed below, was engaged in comprehensive mall renovation and repositioning projects, including the Foothills Mall, which was acquired through a joint venture by our predecessor in 2002 and the Harrisburg Mall, which was acquired through a joint venture by our predecessor in 2003. Subsequent to our initial public offering we acquired the Stratford Square Mall in December 2004. During 2005 and the first half of 2006, we acquired the Colonie Center Mall (February 2005), Northgate Mall (June 2005), and Tallahassee Mall (July 2005), and Golden Triangle Mall (April 2006), collectively the “Acquisition Properties” which, with the exception of the Golden Triangle Mall for the first quarter 2006, are included in our consolidated results for the three and six months ended June 30, 2006, and not included, or partially included, in our results for the three and six months ended June 30, 2005. During the redevelopment and repositioning period, some of our properties may experience decreases in occupancy and corresponding net operating income. We believe these lower occupancy and operating income trends are temporary and will improve once we have completed a significant portion of the redevelopment process. For the following reasons, the results of operations of our company for the three and six months ended June 30, 2006 may not be comparable to the corresponding period in 2005:
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| • | On February 1, 2005, we acquired Colonie Center Mall, located in Albany, New York for an initial purchase price of $82.2 million and funded the purchase price of this acquisition using the net proceeds from a property-level financing of the Stratford Square Mall. At June 30, 2006, shop occupancy, excluding temporary tenants, was 73.7%. |
| • | On June 28, 2005, we acquired the Tallahassee Mall, a 963,000 square foot mall located in Tallahassee, the state capital of Florida. The purchase price of $61.5 million included the assumption of the existing mortgage loan of approximately $45.8 million plus cash in the amount of approximately $16.2 million. The first mortgage assumed by us bears interest at a fixed rate of 8.60% and has a July 2009 maturity date. The property is subject to a long term ground lease that expires in the year 2063 (assuming the exercise of all extension options). The ground lease does not contain a purchase option. At June 30, 2006, shop occupancy, excluding temporary and anchor tenants, was 78.8%. |
| • | On July 12, 2005, we acquired Northgate Mall, a 1.1 million square foot mall located in the northwest suburbs of Cincinnati, Ohio. The purchase price of $110.0 million included the assumption of the existing mortgage loan in the approximate amount of $79.6 million plus cash in the amount of approximately $30.4 million. The first mortgage assumed by us bears interest at a fixed rate of 6.60% and has a September 2012, maturity date. At June 30, 2006, shop occupancy, excluding temporary and anchor tenants, was 76.2%. |
| • | During March 2006, we completed the issuance and sale in a private placement of $28.5 million in aggregate principal amount of fixed/floating rate junior subordinated debt obligation (the “Notes”). The Notes require quarterly interest payments calculated at a fixed interest rate equal to 8.70% per annum through April 2011, and subsequently at a variable interest rate equal to London Interbank Offered Rate (“LIBOR”) plus 3.45% per annum. The Notes mature in April 2036, and may be redeemed, in whole or in part, at par, at our option, beginning after April 2011. |
| • | On April 5, 2006, we acquired the Golden Triangle Mall in the Northeastern Dallas suburb of Denton, Texas, for approximately $40.0 million. The purchase price for the Golden Triangle Mall may be increased up to $2.2 million if the seller is able to deliver an executed lease with Abercrombie & Fitch (Hollister), acceptable to us and the tenant takes occupancy. As of June 30, 2006, the lease has been signed, however the tenant is not scheduled to take occupancy until 2007. Including non-owned anchors, the Golden Triangle Mall is a 765,000 square foot regional mall. At June 30, 2006, excluding temporary tenants, the mall’s occupancy is 61.2%. |
| • | On April 5, 2006, in connection with the acquisition of the Golden Triangle Mall, we entered into a $24.6 million secured line of credit which bears interest at 140 basis points over LIBOR and matures in April 2008. The secured line of credit was fully drawn on the date we acquired the Golden Triangle Mall. The secured line of credit contains certain financial covenants requiring us to, among other requirements, maintain certain financial coverage ratios. The secured line of credit has one extension through April 2009. We repaid the secured line of credit on June 29, 2006 and as of June 30, 2006, there was no outstanding balance on the secured line of credit. |
| • | On April, 7, 2006, we acquired the building occupied by JCPenney and related acreage at Stratford Square Mall for a price of $6.7 million. The purchase price includes assumption of a loan secured by the property and had a principal balance of approximately $3.5 million. The loan is self amortizing, bears interest at a 5.15% fixed rate, and matures in November 2013. |
Comparison of the Three Months Ended June 30, 2006 to the Three Months Ended June 30, 2005
Revenues
Rental revenues increased approximately $5.2 million, or 78%, to $11.8 million for the three months ended June 30, 2006 compared to $6.6 million for the three months ended June 30, 2005. The increase was primarily due to a $5.5 million increase from the Acquisition Properties and a $0.1 million increase at the Foothills Mall primarily due to increased mall occupancy. The increases were partially off-set by $0.4 million lower revenue at Stratford Square Mall and Colonie Center Mall due to lower rental rates upon tenant renewals and lower shop occupancy at Stratford Square Mall.
Revenues from tenant reimbursements increased $2.5 million, or 68%, to $6.3 million for the three months ended June 30, 2006 compared to $3.8 million for the three months ended June 30, 2005. The increase was primarily due to a $2.6 million increase from the Acquisition Properties and a $0.2 million increase at Colonie Center Mall due to higher tenant common area maintenance charges. The increases were partially off-set by $0.3 million lower revenue at Foothills Mall due to lower common area maintenance charges.
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Revenues from management, leasing and development services did not change significantly for the three months ended June 30, 2006 as compared to the three months ended June 30, 2005 and represent management, leasing and construction services for the Harrisburg Mall.
Interest and other income decreased $78,000 to $265,000 for the three months ended June 30, 2006 compared to $343,000 for the three months ended June 30, 2005. The decrease was primarily due to lower lease termination income.
Expenses
Rental property operating and maintenance expenses increased $2.4 million, or 71%, to $5.7 million for the three months ended June 30, 2006 compared to $3.3 million for the three months ended June 30, 2005. The increase was primarily due to a $2.4 million increase from the Acquisition Properties.
Real estate taxes increased $1.1 million, or 86%, to $2.5 million for the three months ended June 30, 2006 compared to $1.4 million for the three months ended June 30, 2005. The increase was primarily due to a $1.0 million increase from the Acquisition Properties and $0.1 million at the Stratford Square Mall due to an increased assessment.
Interest expense increased $3.2 million, or 166%, to $5.1 million for the three months ended June 30, 2006 compared to $1.9 million for the three months ended June 30, 2005. The increase was primarily due to (i) $2.1 million of interest from the Acquisition Properties, (ii) $0.8 million due to the issuance of the Notes, and (iii) $0.4 million due to the secured line of credit.
Depreciation and amortization expense increased $2.9 million, or 109%, to $5.5 million for the three months ended June 30, 2006 compared to $2.6 million for the three months ended June 30, 2005. The increase is primarily due to a $3.0 million increase in depreciation from the Acquisition Properties. The increase was partially off-set by $0.1 million of depreciation expense recorded in the second quarter of 2005 related to an intangible asset not depreciated in the previous three months ended March 31, 2005.
General and administrative expenses increased $451,000, or 33%, to $1.8 million for the three months ended June 30, 2006 compared to $1.3 million for the three months ended June 30, 2005. The increase was primarily due to (i) costs associated with increased overhead for our company’s office relocation and expansion in Phoenix, Arizona, (ii) increase in personnel costs, and (iii) additional costs associated with being a publicly-traded REIT.
Other
Equity in loss of unconsolidated real estate partnership represents our share of the equity in the earnings of the joint venture owning the Harrisburg Mall. The equity in loss of unconsolidated real estate partnership totaled $139,000 for the three months ended June 30, 2006 as compared to $32,000 for the three months ended June 30, 2005. The 2006 loss at the Harrisburg Mall is primarily due to increased depreciation and increased interest expense due to increased loan balance and higher interest rates.
Gain on the partial sale of a property totaled $30.0 million for the three months ended June 30, 2006. This gain represents the contribution of the Foothills Mall into a joint venture on June 29, 2006. We currently have a 30.8% interest in the joint venture.
Minority interest for the three months ended June 30, 2006 and 2005 represents the unit holders in our operating partnership which represents 10.9% and 11.4%, respectively, of our company’s income.
Comparison of the Six Months Ended June 30, 2006 to the Six Months Ended June 30, 2005
Revenues
Rental revenues increased $9.9 million, or 78%, to $22.5 million for the six months ended June 30, 2006 compared to $12.6 million for the six months ended June 30, 2005. The increase was primarily due to a $10.2 million increase from the Acquisition Properties and $0.3 million increase at the Foothills Mall primarily due to increased mall occupancy. The increases were partially off-set by $0.6 million lower rental revenue at the Stratford Square Mall due to reduced occupancy and lower rental rates upon renewal.
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Revenues from tenant reimbursements increased $4.7 million, or 68%, to $11.7 million for the six months ended June 30, 2006 compared to $7.0 million for the six months ended June 30, 2005. The increase was primarily due to a $4.8 million increase from the Acquisition Properties. The increase was partially off-set by $0.1 million at the Foothills and Stratford Square Malls due to lower common area maintenance charges.
Revenues from management, leasing and development services decreased $9,000, or 3%, to $257,000 for the six months ended June 30, 2006 compared to $266,000 for the six months ended June 30, 2005. The decrease was primarily due to the first quarter loss of management fees and leasing commissions earned from previously managed third party office properties.
Interest and other income increased $143,000, or 23%, to $769,000 for the six months ended June 30, 2006 compared to $626,000 for the six months ended June 30, 2005.
Expenses
Rental property operating and maintenance expenses increased $4.8 million, or 76%, to $11.2 million for the six months ended June 30, 2006 compared to $6.4 million for the six months ended June 30, 2005. The increase was due to a $4.9 million increase from the Acquisition Properties partially offset by a $0.1 million decrease in expenses at the Foothills Mall.
Real estate taxes increased $2.1 million, or 82%, to $4.6 million for the six months ended June 30, 2006 compared to $2.5 million for the six months ended June 30, 2005. The increase was primarily due to a $1.9 million increase from the Acquisition Properties and $0.2 million due to increased assessments at Foothills and Stratford Square Malls.
Interest expense increased $5.7 million, or 158%, to $9.3 million for the six months ended June 30, 2006 compared to $3.6 million for the six months ended June 30, 2005. The increase was primarily due to (i) $4.4 million of interest associated with the Acquisition Properties (ii) $0.9 million due to the issuance of the Notes, and (iii) $0.4 million for the secured line of credit.
Depreciation and amortization expense increased $5.4 million, or 122%, to $9.9 million for the six months ended June 30, 2006 compared to $4.5 million for the six months ended June 30, 2005. The increase is primarily due to a $5.4 million increase in depreciation from the Acquisition Properties.
General and administrative expenses increased $1.0 million, or 35%, to $3.7 million for the six months ended June 30, 2006 compared to $2.7 million for the six months ended June 30, 2005. The increase was primarily due to (i) increases in personnel costs, and (ii) additional costs associated with being a publicly-traded REIT, and (iii) office relocation and expansion in Arizona.
Other
Gain on the partial sale of a property totaled $30.0 million for the six months ended June 30, 2006. This gain represents the contribution of the Foothills Mall into a joint venture on June 29, 2006. We currently have a 30.8% interest in the joint venture.
Equity in (loss)/earnings of unconsolidated real estate partnership represents our share of the equity in the earnings of the joint venture owning the Harrisburg Mall. The equity in loss of unconsolidated real estate partnership totaled $284,000 for the six months ended June 30, 2006 as compared to $76,000 for the six months ended June 30, 2005. The 2006 loss at the Harrisburg Mall is primarily due to increased depreciation and increased interest expense due to increased loan balance and higher interest rates.
Minority interest for the six months ended June 30, 2006 and 2005 represents the unit holders in our operating partnership which represents 10.9% and 11.4% of our company’s income.
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Cash Flows
Comparison of the Six months ended June 30, 2006 to the Six months ended June 30, 2005
Cash and cash equivalents were $13.1 million and $45.7 million, respectively, at June 30, 2006 and June 30, 2005.
Cash used in operating activities totaled $0.8 million for the six months ended June 30, 2006, as compared to cash provided by operating activities totaling $4.4 million for the six months ended June 30, 2005. The decrease in cash flow from operating activities is primarily due to (i) an increase in cash paid for interest expense totaling $7.3 million, (ii) an increase in general and administrative costs totaling $1.0 million, (iii) increased payments to vendors due to timing totaling $4.4 million and (iv) decreased cash operating income from the Stratford Square Mall totaling approximately $0.9 million. These decreases in operating cash flow were partially off set by higher cash operating income totaling $8.2 million from the Acquisition Properties and $0.1 million increase at the Foothills Mall.
Net cash used in investing activities for the six months ended June 30, 2006 decreased to $17.9 million for the six months ended June 30, 2006 as compared to $108.2 million for the six months ended June 30, 2005. The decrease was primarily the result of cash required in 2005 for the acquisitions of the Colonie Center Mall and Tallahassee Mall totaling $105.4 million and the net cash received totaling $38.9 million in connection with the partial sale of the Foothills Mall. The decrease was partially offset by $43.2 million for the acquisition of the Golden Triangle Mall and Stratford Square Mall anchor and $10.6 million of higher capital expenditures primarily due to redevelopment at the Colonie Center and Stratford Square Malls.
Net cash provided by financing activities totaled $17.5 million for the six months ended June 30, 2006 as compared to $133.9 million for the six months ended June 30, 2005. The decrease of $116.4 million is primarily due to (i) net proceeds from the 2005 issuance of 1.6 million shares of common stock totaling $17.0 million, net of offering cost payments received in 2005, (ii) $125.8 million proceeds from our mortgages on Stratford Square and Colonie Center Malls received in 2005 and (iii) repayment of mortgage loans payable totaling $0.8 million in 2006 and (iv) the increase of $3.0 million in restricted cash as a collateral deposit to a loan to comply with certain quarterly financial covenants. The 2005 increases were partially off-set by the $29.4 million proceeds from the Company’s issuance of the Notes, and the increase in payment of dividends/distributions in 2006 totaling $2.9 million.
Liquidity and Capital Resources
Overview
As of June 30, 2006, we had approximately $13.1 million in cash and cash equivalents on hand. In addition, our $24.6 million line of credit, secured by the Golden Triangle Mall, had no outstanding borrowings at June 30, 2006. At June 30, 2006, our total consolidated indebtedness outstanding was approximately $294.2 million, or 62% of our total assets.
We intend to maintain a flexible financing position by maintaining a prudent level of leverage consistent with the level of debt typical in the mall industry. We intend to finance our acquisition, renovation and repositioning projects with the most advantageous source of capital available to us at the time of the transaction including traditional floating rate construction financing. We expect that once we have completed our renovation and repositioning of a specific mall asset, we will replace construction financing with medium to long-term fixed rate financing.
Short Term Liquidity Requirements
Our short term liquidity needs include funds to pay dividends to our stockholders required to maintain our REIT status, distributions to unit holders in our operating partnership, funds for capital expenditures and, potentially, acquisitions. Our properties require periodic investments of capital for tenant-related capital expenditures and for general secured line of credit. As of June 30, 2006, we had commitments to make tenant improvements and other expenditures at our properties in the amount of approximately $1.7 million to be incurred during 2006, which we intend to fund from existing cash and cash from operating activities. We expect the cost of recurring capital improvements and tenant improvements for our properties to be approximately $20.7 million for the remainder of 2006. We believe that our net cash provided by operations, our available cash and restricted cash and our secured line of credit will be adequate to fund short-term operating requirements, pay interest on our borrowings and fund distributions in accordance with the REIT requirements of the Federal income tax laws. In addition, during 2006 we have announced/completed the following capital transactions:
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On June 29, 2006, we contributed the Foothills Mall to a joint venture and retained a 30.8% interest. In connection with this transaction, the joint venture re-financed the existing $54.8 million first mortgage with an $81.0 million first mortgage. As a result of these transactions, we received approximately $38.9 million and recognized a $30.0 million gain on the partial sale of the property in the second quarter 2006 as reported on the condensed consolidated statement of operations. A portion of the proceeds from the transaction were used to repay our $24.6 million outstanding on our secured line of credit and $5.0 million outstanding on our Kimco credit facility.
On June 15, 2006, we announced that our Board of Directors declared a dividend of $0.2275 per common share. This distribution reflects the regular dividend for the period April 1, 2006 to June 30, 2006. The dividend was paid on July 15, 2006 to shareholders of record at the close of business on June 30, 2006.
On April 5, 2006, in connection with the acquisition of the Golden Triangle Mall, we entered into a $24.6 million secured line of credit which bears interest at 140 basis points over LIBOR and matures in April 2008. The secured line of credit was fully drawn on the date we acquired the Golden Triangle Mall. The secured line of credit contains certain financial covenants requiring us to, among other requirements, maintain certain financial coverage ratios. The secured line of credit has one extension through April 2009. As of June 30, 2006, there was no outstanding balance on the secured line of credit.
During March 2006, we completed the issuance and sale in a private placement of $28.5 million in aggregate principal amount of fixed/floating rate trust preferred securities issued by one of our wholly owned subsidiaries. The trust preferred securities require quarterly interest payments calculated at a fixed interest rate equal to 8.70% per annum through April 2011, and subsequently at a variable interest rate equal to London Interbank Offered Rate (“LIBOR”) plus 3.45% per annum. The notes mature April 2036, and may be redeemed, in whole or in part, at par, at our option, beginning after April 2011.
On February 22, 2006, we executed a revolving promissory note (the “Note”) in the amount of up to $17.2 million with Kimco Capital Corp. (the “Lender”), a subsidiary of Kimco. The amounts outstanding under the loan bore interest at a rate of 8% per annum. The $5.0 million outstanding balance on the note was repaid and extinguished on June 29, 2006.
In addition to the capital requirements for recurring capital expenditures, tenant improvements and leasing commissions, we expect to increase our expenditures for redevelopment and renovation of our recently purchased properties. Those renovation costs will include, among other items, increasing the size of the properties by developing additional rentable square feet. As of June 30, 2006, in connection with signed leases and anticipated leases to be signed during 2006, our related redevelopment and renovation plans are estimated to be $170.0 million to $180.0 million and will total $70.0 million to $80.0 million for the year ending December 31, 2006, of which $18.8 million has been incurred. We believe that our current cash on hand, the capital transactions above and additional financing activity, including property-level construction loans, will be adequate to fund operating and capital requirements.
In addition, as of June 30, 2006, the joint venture owning the Harrisburg Mall has commitments for tenant improvements and other capital expenditures in the amount of $550,000 to be incurred in 2006. The joint venture intends to fund these commitments from operating cash flow and cash on hand and approved state and local government grants and other economic incentives (approximately $8.0 million, of which $5.0 million was received). The joint venture intends to begin a second phase to the renovation of the Harrisburg Mall that will have an anticipated cost of approximately $17.8 million. The joint venture anticipates the renovation costs to be $3.4 million during the remainder of 2006. We anticipate funding the renovation with cash on hand, operating cash flows, additional borrowings and equity contributions from the partners; we are responsible for 25% of any necessary equity contributions. We do not expect that this limitation will have a material impact on our ability to meet our short term liquidity requirements because, once the construction is completed, we expect the joint venture that owns the Harrisburg Mall to refinance this construction loan with alternative mortgage financing.
Long Term Liquidity Requirements
Our long term liquidity requirements consist primarily of funds necessary for acquisition, renovation and repositioning of new properties, non-recurring capital expenditures and payment of indebtedness at maturity. We expect to meet our other long-term liquidity requirements through net cash from operations, existing cash, additional long-term secured and unsecured borrowings and the issuance of additional equity or debt securities, and contributing certain wholly owned properties into joint ventures.
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In the future, we may seek to increase the amount of our mortgages, negotiate credit facilities or issue corporate debt instruments. Any debt incurred or issued by us may be secured or unsecured, long-term or short-term, fixed or variable interest rate and may be subject to such other terms as we deem prudent.
While our charter does not limit the amount of debt we can incur, we intend to maintain a flexible financing position by maintaining a prudent level of leverage consistent with the level of debt typical in the mall industry. We will consider a number of factors in evaluating our actual level of indebtedness, both fixed and variable rate, and in making financial decisions. We intend to finance our acquisition, renovation and repositioning projects with the most advantageous source of capital available to us at the time of the transaction, including traditional floating rate construction financing. We expect that once we have completed our renovation and repositioning of a specific mall asset we will replace construction financing with medium to long-term fixed rate financing. In addition, we may also finance our activities through any combination of sales of common or preferred shares or debt securities, additional secured or unsecured borrowings.
In addition, we may also finance our acquisition, renovation and repositioning projects through joint ventures with institutional investors. Through these joint ventures, we will seek to enhance our returns by supplementing the cash flow we receive from our properties with additional management, leasing, development and incentive fees from the joint ventures. We may also acquire properties in exchange for our OP Units.
We are currently in preliminary discussions with a number of potential sellers of mall properties. We currently have no binding agreement to invest in any property other than the properties we currently own and have announced to acquire. There can be no assurance that we will make any investments in any other properties that meet our investment criteria.
Mortgage Loans
Northgate Mall
On July 12, 2005, we assumed a $79.6 million first mortgage in connection with the acquisition of the Northgate Mall. The stated interest on the mortgage is 6.60%. We determined this rate to be above-market and, in applying purchase accounting, determined the fair market value interest rate to be 5.37%. The above premium was initially $8.2 million and is being amortized over the remaining term of the acquired loan using the effective interest method. We intend to refinance the loan prior to the maturity date.
Tallahassee Mall
On June 28, 2005, we assumed a $45.8 million first mortgage in connection with the acquisition of the Tallahassee Mall. The stated interest rate on the mortgage is 8.60%. We determined this rate to be above-market and, in applying purchase accounting, determined the fair market value interest rate to be 5.16%. The above-market premium was initially $6.5 million and is being amortized over the remaining term of the acquired loan using the effective interest method. We intend to refinance the loan prior to the maturity date.
Colonie Center Mall
In June 2005, we completed a $50.8 million first mortgage bridge financing collateralized by the Colonie Center Mall. The initial bridge loan maturity date was December 1, 2005, which has since been extended to October 2006. We plan to replace the bridge loan with a three to five-year first mortgage loan or extend the current mortgage prior to the October 1, 2006 maturity date.
Harrisburg Mall
The Harrisburg Mall was purchased with (i) the proceeds of a mortgage loan, secured by the mall property and an assignment of rents and leases, and (ii) cash contributions from our predecessor and its joint venture partner. The construction loan was amended in October 2004 to increase the lender’s commitment to $46.9 million and bore interest at LIBOR plus 2.50% per annum. During July 2005, the loan was amended again and increased to a maximum commitment of $50.0 million through a $7.2 million second mortgage with no principal payments until the maturity date, which was extended to March 2008. The interest rate has been reduced to LIBOR plus 1.625% per annum. During July 2005, our operating partnership increased the borrowings to $49.8 million and distributed $6.5 million to its partners on a pro rata basis, of which our Company received $1.6 million. The effective rates on the loan at June 30, 2006 and December 31, 2005 were 6.82% and 5.99%, respectively.
Under certain circumstances our operating partnership may extend the maturity of the loan for three, one-year periods. We may prepay the loan at any time, without incurring any prepayment penalty. The loan presently has a limited recourse of $5.0 million of which our joint venture partner is liable for $3.1 million, or 63%, and the company is liable for $1.9 million, or 37%.
The balance outstanding under the loan was $49.8 million, as of June 30, 2006 and December 31, 2005. We are required to maintain cash balances with the lender averaging $5.0 million. If the balances fall below $5.0 million in any one month, the interest rate on the loan increases to LIBOR plus 1.875%. We intend to refinance the loan prior to the maturity date.
Stratford Square Mall
In January 2005, we completed a $75.0 million, three-year first mortgage financing collateralized by the Stratford Square Mall. The mortgage bears interest at a rate of LIBOR plus 125 basis points and has two one-year extensions. The initial loan to cost ratio is approximately 80%; however, once the intended capital improvements of approximately $30 million have been completed, the total leverage is expected to decrease to approximately 65% of total anticipated cost. We intend to refinance the loan on the maturity date.
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Capital Expenditures
We are required to maintain each retail property in good repair and condition and in conformity with applicable laws and regulations and in accordance with the tenant’s standards and the agreed upon requirements in our lease agreements. The cost of all such routine maintenance, repairs and alterations may be paid out of a capital expenditures reserve, which will be funded by cash flow. Routine repairs and maintenance will be administered by our subsidiary management company.
Off-Balance Sheet Arrangements
Loan Guarantees
See loan guarantees described on “Harrisburg Mall Loan” above.
Forward Interest Rate Swap Contracts
In connection with the Stratford Square Mall mortgage financing, during January 2005, we entered into a $75.0 million swap commencing February 2005 with a final maturity date in January 2008. The effect of the swap is to fix the all-in interest rate of the Stratford Square mortgage loan at 5.0% per annum.
During December 2005, we entered into a $75.0 million swap which commences February 2008 and has a final maturity date in January 2011. The effect of the swap is to fix the all-in interest rate of our forecasted cash flows on LIBOR-based loans at 4.91% per annum.
Tax Indemnifications
In connection with the formation transactions, we entered into agreements with Messrs. Feldman, Bourg and Jensen that indemnify them with respect to certain tax liabilities intended to be deferred in the formation transactions, if those liabilities are triggered either as a result of a taxable disposition of a property by our company, or if our company fails to offer the opportunity for the contributors to guarantee or otherwise bear the risk of loss, with respect to certain amounts of our company’s debt for tax purposes (the “contributor-guaranteed debt”). With respect to tax liabilities arising out of property sales, the indemnity will cover 100% of any such liability until December 31, 2009, and will be reduced by 20% of the aggregate liability on each of the five following year ends thereafter.
We also agreed to maintain approximately $10.0 million of indebtedness, and to offer the contributors the option to guarantee $10.0 million of our operating partnership’s indebtedness, in order to enable them to continue to defer certain tax liabilities. Our obligation to maintain such indebtedness extends to 2013, but will be extended by an additional five years for any contributor that holds (together with his affiliates) at that time at least 25% of the initial ownership interest in our operating partnership issued to them in the Formation Transactions. As of June 30, 2006, Feldman Partners, LLC, an affiliate of Larry Feldman and Jeff Erhart, currently guarantees $8.0 million of the loan secured by the Stratford Square Mall.
Funds From Operations
The revised White Paper on Funds From Operations, or FFO, issued by NAREIT in 2002 defines FFO as net income (loss) (computed in accordance with GAAP), excluding gains or losses from the sale of property, plus real estate related depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures. We believe that FFO is helpful to investors as a measure of the performance of an equity REIT because, along with cash flow from operating activities, financing activities and investing activities, it provides investors with an indication of our ability to incur and service debt, to make capital expenditures and to fund other cash needs. We compute FFO in accordance with the current standards established by NAREIT, which may not be comparable to FFO reported by other REITs that interpret the current NAREIT definition differently than us. FFO does not represent cash generated from operating activities in accordance with GAAP and should not be considered as an alternative to net income (determined in accordance with GAAP), as an indication of our financial performance or to cash flow from operating activities (determined in accordance with GAAP) as a measure of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to make cash distributions.
FFO for the periods are as follows (in thousands):
| | Three Months Ended June 30, | | Six Months Ended June 30, | |
| |
| |
| |
| | 2006 | | 2005 | | 2006 | | 2005 | |
| |
| |
| |
| |
| |
Net Income | | $ | 24,352 | (A) | $ | 205 | | $ | 22,974 | (A) | $ | 575 | |
Add: | | | | | | | | | | | | | |
Depreciation and amortization (excluding FF&E) | | | 5,454 | | | 2,557 | | | 9,859 | | | 4,375 | |
FFO contribution from unconsolidated joint venture | | | 209 | | | 148 | | | 388 | | | 312 | |
Minority interest | | | 2,962 | | | 26 | | | 2,795 | | | 74 | |
Less: | | | | | | | | | | | | | |
Gain on partial sale of property | | | (29,968 | ) | | — | | | (29,968 | ) | | — | |
| |
|
| |
|
| |
|
| |
|
| |
FFO available to common stockholders and OP Unit holders | | $ | 3,009 | | $ | 2,936 | | $ | 6,048 | | $ | 5,336 | |
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|
| |
|
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|
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| | |
| (A) | 2006 net income includes early extinguishment of debt totaling $357,000 |
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ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
Our future income, cash flows and fair values relevant to financial instruments depend upon interest rates. Market risk refers to the risk of loss from adverse changes in market prices and interest rates.
Market Risk Related to Fixed Rate Debt
We had approximately $282.6 million of outstanding indebtedness as of June 30, 2006, of which $231.8 million bears interest at fixed rates for some portion or all of the terms of the loans ranging from 5.15% to 8.70%, and $50.8 million which bears interest on a floating rate basis of LIBOR plus 1.40%. Upon the maturity of our debt, there is a market rate risk as to the prevailing rates at the time of refinancing. Changes in market rates on our fixed-rate debt affects the fair market value of our debt but it has no impact on interest expense incurred or cash flow. A 100 basis point increase or decrease in interest rates on our floating/fixed rate debt would increase or decrease our annual interest expense by approximately $2.83 million, as the case may be.
We currently have two $75 million swap contracts that run consecutively through January 2011. A 100 basis point increase in interest rates would increase the fair value of these two swaps by approximately $2.8 million, and a 100 basis point decrease in interest rates would decrease the fair value of these swap contracts by approximately $2.9 million.
Aggregate principal payments of our mortgages as of June 30, 2006 are as follows (in 000’s):
2006 | | $ | 51,722 | |
2007 | | | 2,040 | |
2008 | | | 77,160 | |
2009 | | | 45,618 | |
2010 | | | 1,793 | |
2011 and thereafter | | | 74,892 | |
| | |
|
| |
Total principal payments | | | 253,225 | |
Assumed above-market mortgage premiums, net | | | 11,566 | |
| | |
|
| |
Total | | $ | 264,791 | |
| | |
|
| |
We currently have $29.4 million in aggregate principal amount of fixed/floating rate junior subordinated debt obligation (the “Notes”). The Notes require quarterly interest payments calculated at a fixed interest rate equal to 8.70% per annum through April 2011, and subsequently at a variable interest rate equal to LIBOR plus 3.45% per annum. The notes mature April 2036, and may be redeemed, in whole or in part, at par, at our option, beginning after April 2011.
Inflation
Most of our leases contain provisions designed to mitigate the adverse impact of inflation by requiring the tenant to pay its share of operating expenses, including common area maintenance, real estate taxes and insurance. The leases also include clauses enabling us to receive percentage rents based on gross sales of tenants, which generally increase as prices rise. This reduces our exposure to increases in costs and operating expenses resulting from inflation.
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PART I.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based closely on the definition of “disclosure controls and procedures” (as defined in Rules 13a – 15(c) and 15d – 15(e) under the Exchange Act). In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Also, we have investments in certain unconsolidated entities. As we do not control these entities, our disclosure controls and procedures with respect to such entities are necessarily substantially more limited than those we maintain with respect to our consolidated subsidiaries.
As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.
Changes in Internal Control over Financial Reporting
There were no changes in our company’s internal controls over financial reporting (as such term is defined in Rule 13a – 15(f) and 15d – 15(f) under the Exchange Act) identified in connection with the evaluation of such internal controls that occurred during the quarter ended June 30, 2006 that have materially affected, or are reasonably likely to materially affect, our company’s internal controls over financial reporting.
Notwithstanding the foregoing, a control system, no matter how well designed and operated, can provide only reasonable, not absolute assurance that it will detect or uncover failures within our Company to disclose material information otherwise required to be set forth in our periodic reports.
| | There were no material changes from the risk factors previously disclosed in Part I, “Item 1A. Risk Factors” in the Company’s annual report on Form 10-K/A for the year ended December 31, 2005. |
ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
ITEM 3. | DEFAULTS UPON SENIOR SECURITIES |
ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
We held our annual meeting of stockholders on May 31, 2006 at which the following matters were voted upon:
| | 1. | To elect five directors of the Company to serve until the 2007 Annual Meeting of Stockholders and until their successors are duly elected and qualified. |
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| | 2. | To ratify the selection of KPMG LLP as the independent registered public accounting firm of the Company for the fiscal year ending December 31, 2006. |
The results of the meeting were as follows:
Proposal 1: | | For | | Against | | Abstain | |
| |
| |
| |
| |
James Bourg | | 9,996,199 | | | | 1,558,522 | |
Lawrence Feldman | | 9,995,814 | | | | 1,558,907 | |
Lawrence Kaplan | | 10,341,418 | | | | 1,213,303 | |
Paul McDowell | | 10,341,418 | | | | 1,213,303 | |
Bruce Moore | | 10,341,418 | | | | 1,213,303 | |
Proposal 2: | | For | | Against | | Abstain | |
| |
| |
| |
| |
KPMG LLP | | 10,357,427 | | 2,500 | | 1,194,794 | |
ITEM 5. | OTHER INFORMATION |
| | None |
ITEM 6. | EXHIBITS |
| | 31.1 | Certification by the Chief Executive Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002 filed herewith. |
| | 31.2 | Certification by the Chief Financial Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002 filed herewith. |
| | 32.1 | Certification pursuant to 18 U.S.C. section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 202 filed herewith. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: August 14, 2006
| | | FELDMAN MALL PROPERTIES, INC. |
| | | By: |
/s/ Thomas Wirth
|
| | | |
|
| | | Name: | Thomas Wirth |
| | | Title: | Executive Vice President and Chief Financial Officer |
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No 