ITEM 1.
BUSINESS
The Company
We are a real estate investment trust, or REIT, that principally acquires, renovates, develops and manages neighborhood and community shopping centers anchored by national and regional supermarket chains and other necessity-oriented retailers, such as drug stores or discount retail stores, in major metropolitan markets of the southern and northeastern United States.
Our property portfolio, as of December 31, 2005, consisted of 192 properties, comprising 125 supermarket-anchored shopping centers, seven drug store-anchored shopping centers, 49 other retail-anchored shopping centers, six development parcels and five non-retail properties, as well as a non-controlling interest in one unconsolidated joint venture that owns a parcel of land. These properties are located in 12 states in the southern and northeastern United States and contain an aggregate of over 19.7 million square feet of gross leasable area, or GLA. Our portfolio includes shopping centers anchored by national and regional supermarkets such as Albertsons, Food Lion, H.E.B., Kash N’ Karry, Kroger, Publix, Randall’s, Shaw’s and Winn-Dixie and other national retailers such as Bed Bath & Beyond, Best Buy, Blockbuster, CVS/pharmacy, Eckerd, Home Depot, Kmart, Lowe’s, Marshall’s, TJ Maxx, Walgreens and Wal-Mart.
We were organized as a Maryland corporation in 1992, completed our initial public offering in May 1998, and have elected to be taxed as a REIT since 1995. We maintain our principal executive and management office at 1600 N.E. Miami Gardens Drive, North Miami Beach, Florida 33179 in the Shops at Skylake.
In this annual report, unless stated otherwise or unless the content requires otherwise, references to “we,” “us” or “our” mean Equity One, Inc. and our consolidated subsidiaries.
Strategy and Philosophy
Our business strategy has been and will continue to be to maximize long-term stockholder value by generating sustainable cash flow growth and increasing the long-term value of our real estate assets. To that end, we now own and manage a portfolio of 194 properties including 127 supermarket-anchored shopping centers. In order to achieve our objectives in the future, we intend to:
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maximize the value of our existing shopping centers by leasing and re-leasing those properties to credit worthy tenants at higher rental rates and by renovating and redeveloping those properties to make them more attractive to such tenants;
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acquire and develop additional neighborhood and community shopping centers in high growth, high density metropolitan areas that are primarily anchored by supermarkets or other necessity-oriented retailers;
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redevelop our existing or newly acquired centers to capitalize on alternative uses for those properties, including mixed-use opportunities such as residential high-rises or related office components.
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recycle our capital by selling or disposing of properties or interests in properties that do not meet our investment criteria, asset type, or geographic focus, or to invest the proceeds of such sales in more stable, attractive properties or markets;
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consider alternative strategies and other lines of business that complement our existing business, leverage our strengths and expertise or utilize our existing portfolio of properties; and
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capitalize on our substantial asset base to effectively access capital to fund our growth.
Asset Management Strategy
Enhancing Portfolio Performance. We believe that the property operating income provided by our existing assets is a stable, predictable source of cash flow from which to fund a portion of our capital needs, including the development and acquisition of new projects, redevelopment of existing projects and the payment of dividends to our stockholders. Our assets generally have experienced stable, moderate growth in standard measures of real estate operating performance. We believe these results are attributable to our ability to attract tenants, actively manage and maintain the high standards and physical appearance of our assets while maintaining competitive tenant occupancy costs. We also believe that we have developed strong, mutually beneficial relationships with credit worthy tenants, particularly our anchor tenants, by consistently meeting or exceeding their expectations and demands. Over the years, this strategy has allowed us to leverage our relationships with existing tenants to lease and re-lease our properties and, therefore, maintain or improve the financial performance of our existing properties or of properties that we acquire.
Dispositions and Capital Recycling. Generally, we hold our properties for investment and for the production of rental income. Over time, when our assets no longer meet our investment criteria, or when sales provide the opportunity for significant gains, we may attempt to sell or otherwise dispose of those assets. In addition, we may seek opportunities to sell properties or portfolios of properties or identify joint venture partners with respect to an interest in our properties in order to recycle our capital and reinvest the proceeds in more stable, attractive properties or markets.
Redevelopment of Existing Centers. We are in the process of renovating or redeveloping a number of under-performing assets in order to make them more attractive for leasing or re-leasing to credit worthy tenants. In addition, we are evaluating alternative uses for certain of our properties, including whether those properties, given their location, are candidates for mixed use, including residential high-rises or related office components.
Growth Strategy
We intend to grow our business by acquiring additional neighborhood and community shopping centers through individual or portfolio property acquisitions, by acquiring privately-held or publicly-traded REITs and real estate companies, by developing new retail properties and by forming joint ventures with third parties to both acquire and develop new properties. We are currently focused on properties located in the southern and northeastern regions of the United States, but may look to expand this geographic focus in the future.
Acquisitions. We generally select properties for acquisition which have or are suitable for supermarket or other anchor tenants that offer daily necessities and value-oriented merchandise. The properties must be well-located, typically in high growth, high-density metropolitan areas, and have high visibility, open air designs, ease of entry and exit and ample parking. Although we focus primarily on well-performing, supermarket-anchored properties with strong cash flows, we also acquire under-performing assets, which are adaptable over time for expansion, renovation or redevelopment. When evaluating potential acquisitions, whether well-performing or under-performing, we consider factors such as:
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the location, construction quality, design and visibility of the property;
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economic, demographic, regulatory and zoning conditions in the property’s local and regional market;
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the tenants’ gross sales per square foot measured against industry standards, and the rent payable by the tenants;
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competition from comparable retail properties in the market area and the possibility of future competition;
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the current and projected cash flow of the property and the potential to increase that cash flow;
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the terms of tenant leases, including the relationship between the property’s current rents and market rents and the ability to increase rents over time;
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the supply of and demand for properties of a similar type in the market area;
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the potential to complete a strategic renovation, expansion or re-tenanting of the property;
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the property’s current expense structure and the potential to increase operating margins; and
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the potential for capital appreciation of the property.
When evaluating acquisitions of portfolios of properties, REITs or companies that own real estate, we review the component properties against the criteria described above, as well as opportunities for synergies and cost savings on a combined basis, the degree of geographic fit with our existing markets or opportunities to expand geographically into new desirable markets, and the extent of non-core assets included in the acquisition.
Developments. Over the next several years, we intend to complete several new development projects, depending on market conditions and capital availability. We employ what we consider to be a disciplined approach to the development process. Our in-house development and construction departments are experienced and are responsible for all aspects of development, including market research, site selection, predevelopment work, construction and tenant coordination. We maintain management control through the entire development process, including frequent internal reviews of costs and leasing status.
The following factors allow us to mitigate the risks associated with development:
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Site Selection: Our development projects are typically located in metropolitan areas that have strong demographic features, such as being densely populated, having higher than average household income or having projected future growth. In addition, we typically select sites within our target markets that are well situated near transportation arteries.
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Pre-Leasing: We typically do not initiate construction of our development projects until we have secured a leasing commitment from an anchor tenant.
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Financing: We typically fund development costs from operating cash flow and our revolving credit facility. This provides us the flexibility to control the pace of development without delays due to outside financing needs.
Joint Ventures. In order to meet our stated objective to grow our business by acquiring and developing additional neighborhood and community shopping centers, we may from time to time enter into joint ventures with land owners and developers. In many of these transactions, we will fund the costs of acquiring and/or developing the properties and we will retain operational control of the venture.
Capital Strategy
We intend to further grow and expand our business by using cash flows from operations, by drawing on our existing credit facilities, or if appropriate market conditions exist, by accessing the capital markets to issue equity, debt or a combination thereof. In addition, as we have in the past, we intend to utilize tax-advantaged structures to acquire properties from sellers who wish to defer capital gains. Such structures may include entering into a joint venture or other type of co-ownership with a seller, in which we would acquire a controlling interest. We may offer the seller an interest in the venture that is convertible or exchangeable for shares of our common stock or otherwise allow the seller to have an equity interest in our company. In addition, if the opportunity arises, we may consider entering into joint ventures with one or more financial institutions for the acquisition of a portfolio of properties or a real estate company. In these transactions, we would typically make a smaller equity investment, of between 10% to 30% of the purchase price and agree to manage and lease the properties for the joint venture.
Financing Strategy. Our financing strategy is to maintain a strong and flexible financial position by limiting our debt to a prudent level and minimizing our variable interest rate exposure. We intend to finance future growth with the most advantageous source of capital available to us at the time of an acquisition. These sources may include selling common stock, preferred stock, debt securities, depository shares or warrants through public offerings or private placements, utilizing availability under our unsecured revolving credit facilities or incurring additional indebtedness through secured or unsecured borrowings either at the parent level or through mortgages with recourse limited to specific properties.
Overview of Significant Business Strategies
The implementation of our business strategy in 2005 produced the following results and activities:
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Our occupancy rate in our core shopping center portfolio was 93.4% at December 31, 2005;
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We achieved a 2.1% increase in same property net operating income, or NOI, excluding termination fees, and an overall NOI margin of 73.6%;
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We increased our rental rate by 4.2% to $15.16 per square foot on 344 lease renewals aggregating 736,000 square feet; and
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We executed 345 new leases totaling 1.4 million square feet at an average rental rate of $10.18 per square foot.
Acquisitions. During 2005, we acquired two retail properties, two non-retail properties, and three land parcels held for future development for aggregate consideration of approximately $54.1 million.
Dispositions. During 2005, we sold four non-core income producing properties that no longer met our investment criteria for an aggregate consideration of approximately $45.7 million encompassing approximately 529,000 square feet of gross leasable area.
Texas Portfolio. In June 2005, we announced that we are exploring strategic alternatives for our Texas portfolio; we are currently considering a possible joint venture transaction with a strategic partner.
Redevelopment of Existing Centers. We reconfigured, redeveloped and re-leased previously vacant anchor and other space at our Centre Pointe Center, where we had a vacant Winn-Dixie store, and Spalding Village, where we had a vacant Kmart store. In addition, we added an out parcel at Walden Woods.
Developments. We completed the development of Waterstone Plaza, an 82,500 square foot supermarket anchored center located in Homestead, Florida. We also added 29,000 square feet of office and retail space to our Shops at Skylake shopping center. In addition, we started the development of two supermarket anchored centers in McDonough, Georgia and Huntsville, Alabama.
Joint Ventures. In February 2005, we entered into a joint venture to acquire a 155 acre development parcel in Pasco County, Florida. We have a 60 percent controlling interest in the venture and expect to receive an eight percent preferred return on our capital investment. We currently expect that upon completion, the project will include office, retail and residential components. Also, in January 2006, we entered into a joint venture to acquire a supermarket anchored shopping center located in St. Pete Beach, Florida. We have a 50 percent interest in the venture and expect to receive an eight percent preferred return on our capital investment. We expect that the project will be a mixed use of retail and residential components.
New Markets. In January 2006, we acquired a property in Enfield, Connecticut to complement the six properties we acquired in 2004 in the Boston, Massachusetts metropolitan area. With the acquisition of these properties in the northeast, we have expanded our geographic presence.
Other Investments. As of December 31, 2005, we directly and indirectly owned approximately 2.4 million ordinary shares in DIM Vastgoed N.V. (“DIM”). DIM is a public company organized under the laws of the Netherlands the shares of which are listed on the Euronext Amsterdam Stock Exchange, and which operates as a closed-end investment company owning and operating a portfolio of 18 shopping center properties aggregating 2.6 million square feet in the southeastern United States. As of February 28, 2006, we have increased our ownership in DIM to approximately 3.6 million shares, representing approximately 48.5% of its total outstanding ordinary shares. We have committed to buy an additional 45,362 ordinary shares of DIM, in September 2007, for total consideration of $941,000.
We hold $14.1 million in original principal amount of Winn-Dixie Stores, Inc. 8.875% senior notes due April 2008.
Unsecured Senior Note Offering. In September 2005, we raised $120 million in an offering of unsecured senior notes with a stated interest rate of 5.375% and matures in October 2015.
Competitive Strengths
We believe that we distinguish ourselves from other owners and operators of community and neighborhood shopping centers in a number of ways, including:
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Shopping Centers Anchored by Supermarkets or Necessity-Oriented Retailers. As of December 31, 2005, shopping centers anchored by supermarkets or other necessity retailers such as drug stores or discount retail stores accounted for 99% of our total annualized minimum rent. We believe that supermarkets and other necessity-oriented retailers are more resistant to economic downturns by the nature of their businesses and generate frequent consumer traffic through our shopping centers. This traffic enhances the quality, appeal and longevity of our shopping centers and benefits our other tenants.
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Attractive Locations in High-Growth Areas. Our portfolio of properties is concentrated in high-density areas that are experiencing high population growth such as Florida, Texas and Georgia. As of December 31, 2005, these states constitute 46.7%, 15.1% and 14.0% of our retail property gross leasable area, respectively. The strong demographics of these and our other markets provide our properties with a growing supply of shoppers and increasing demand for the goods and services of our tenants.
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Diverse Tenant Base. As of December 31, 2005, no single tenant represented more than 10.0% of our annualized minimum rent and only Publix, at 8.4%, represented more than 5.0% of such rent. As of December 31, 2005, we had over 3,200 leases with tenants, including national and regional supermarket chains, drug stores, discount retail stores, other nationally or regionally known stores, a variety of other regional and local retailers and a number of local service providers such as doctors, dentists, hair salons, restaurants and others. We believe that this diversity of tenants enables us to generate more stable cash flows over time and limits our exposure to the financial conditions of any particular tenant.
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Seasoned Management Team. Our senior executives and managers average more than 20 years of experience in the acquisition, management, leasing, finance, development and construction of real estate or retail properties. In particular, we believe that our in-depth market knowledge and the long-term tenant relationships developed by our senior management team provide us with a key competitive advantage.
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Property Acquisition Strengths. We believe we have certain competitive advantages which enhance our ability to capitalize on acquisition opportunities, including our long-standing relationships with bankers, brokers, tenants and institutional and other real estate owners in our current target markets; our access to capital; our ability to offer cash and tax advantaged structures to sellers; and our demonstrated ability to conduct a rapid, efficient and effective due diligence investigation of the property, portfolio or company.
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Development Experience. We have significant experience in both the development and construction of real estate projects which, combined with our valuable relationships with local developers, enhance our ability to identify, design and construct new projects.
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Strong Relationship with Tenants. We believe we have cultivated strong relationships with supermarket and other anchor tenants, which, in combination with our in-depth knowledge of our primary markets, have contributed substantially to our success in identifying, acquiring and operating our properties.
Competition
There are numerous commercial developers, real estate companies, REITs and other owners of real estate in the areas in which our properties are located that compete with us in seeking land for development, properties for acquisition, financing and tenants. Many of such competitors have substantially greater resources than we have. All of our existing properties are located in developed areas that include other shopping centers and other retail properties. The number of retail properties in a particular area could materially adversely affect our ability to lease vacant space and maintain the rents charged at our existing properties.
We believe that the principal competitive factors in attracting tenants in our market areas are location, price, anchor tenants and maintenance of properties. We also believe that our competitive advantages include the favorable locations of our properties, our ability to provide a retailer with multiple locations with anchor tenants and the practice of continuous maintenance and renovation of our properties.
Regulation
Retail properties are subject to various laws, ordinances and regulations. We believe that each of our existing properties maintains all required material operating permits and approvals.
Americans with Disabilities Act. Our properties are subject to the Americans with Disabilities Act of 1990. Under this act, all places of public accommodation are required to comply with federal requirements related to access and use by disabled persons. The act has separate compliance requirements for “public accommodations” and “commercial facilities” that generally require that buildings and services, including restaurants and retail stores, be made accessible and available to people with disabilities. The act’s requirements could require removal of access barriers and could result in the imposition of injunctive relief, monetary penalties or, in some cases, an award of damages. We believe that our properties are in substantial compliance with the requirements under the American with Disabilities Act and have no reason to believe that these requirements or the enforcement of these requirements will have a materially adverse impact on our business.
Environmental Matters
Under various federal, state and local laws, ordinances and regulations, we may be liable for the cost to remove or remediate certain hazardous or toxic substances at our shopping centers. These laws often impose liability without regard to whether we knew of, or were responsible for, the presence of the hazardous or toxic substances. The cost of required remediation and our liability for remediation could exceed the value of the property and/or our aggregate assets. The presence of such substances, or the failure to properly remediate such substances, may adversely affect our ability to sell or rent the property or borrow using the property as collateral. We have several properties that will require or are currently undergoing varying levels of environmental remediation. In some cases, contamination has migrated or is expected to migrate into the groundwater beneath our properties from adjacent properties, such as service stations. In other cases, contamination has resulted from on-site uses by current or former owners or tenants, such as gas stations or dry cleaners, which have released pollutants such as gasoline or dry-cleaning solvents into the soil or groundwater. We believe that, based on environmental studies conducted to date, none of these environmental problems is likely to have a material adverse effect on our financial condition. However, no assurances can be given that environmental studies obtained by us reveal all environmental liabilities, that any prior owner of land or a property owned or acquired by us did not create any material environmental condition not known to us, or that a material environmental condition does not otherwise exist, or may not exist in the future.
Employees
At December 31, 2005, we had 259 full-time employees. Our employees are not represented by any collective bargaining group, and we consider our relations with our employees to be good.
Available Information
The internet address of our website is www.equityone.net. You can obtain on our website, free of charge, a copy of our annual report on Form 10-K, our quarterly reports on Form 10-Q, our Supplemental Information Packages, our current reports on Form 8-K, and any amendments to those or other reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file or furnish such reports or amendments with the SEC. Also available on our website, free of charge, are copies of our Corporate Governance Guidelines, Code of Conduct and Ethics and the charters for each of the committees of our Board of Directors - the Audit Committee, the Corporate Governance and Nominating Committee and the Compensation Committee. Any amendments or waivers to our Code of Business Conduct and Ethics will be disclosed on our website within four business days following the date of the amendment or waiver. Copies are also available free of charge by contacting our Investor Relations Department at:
Equity One, Inc.
N.E. Miami Gardens Drive,
North Miami Beach, Florida 33179
Attn: Investor Relations Department
(305) 947-1664
You may also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549, or you may obtain information by calling the SEC at 1-800-SEC-0300. The SEC maintains an internet address at http://www.sec.gov that contains reports, proxy statements and information statements, and other information which you may obtain free of charge.
ITEM 1A.
ITEM 1A.
RISK FACTORS
Risks Related to Our Business
The risks set forth below are not exhaustive. Other sections of this report may include additional factors that could adversely affect our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for management to predict all risk factors, nor can it assess the impact of all risk factors on our business or the extent to which any factor, or combination of factors, may affect our business. Investors should also refer to our quarterly reports on Form 10-Q and current reports on Form 8-K for future periods for updates to these risk factors.
We are dependent upon certain key tenants and adverse developments in the business of these tenants could have a negative impact on our financial condition.
We own shopping centers which are supported by “anchor” tenants which, due to size, reputation or other factors, are particularly responsible for drawing other tenants and shoppers to our centers. For instance, Publix is our largest tenant and accounts for approximately 2.2 million square feet, or 11.2% of our gross leasable area.
At any time, an anchor tenant or other tenant may experience a downturn in its business that may weaken its financial condition. As a result, tenants may delay lease commencement, fail to make rental payments when due or declare bankruptcy. We are subject to the risk that these tenants may be unable to make their lease payments or may decline to extend a lease upon its expiration. Any tenant bankruptcies, leasing delays or failures to make rental payments when due could result in the termination of the tenant’s lease and material losses to our business and harm to our operating results. For example, on February 22, 2005, Winn-Dixie Stores, Inc., an anchor tenant at 16 of our shopping centers occupying 730,000 square feet of gross leasable area and accounting for approximately $5 million in annualized minimum rent, filed for bankruptcy protection. Winn-Dixie has rejected two leases at our centers in connection with its restructuring activities and closed the stores. It is no longer liable for the payment of rent or other charges at these centers. The two affected stores provided approximately $596,000 in annualized minimum rent. Moreover, the period during which Winn-Dixie may reject leases has not yet expired, and, therefore, it may reject additional leases at our centers. If it elects to close additional stores and terminate those leases, it would adversely affect our operating results, including funds from operations and cash flows. In addition, we own approximately $14.1 million of principal of Winn-Dixie’s senior notes bearing interest at 8.875%. Following Winn-Dixie’s bankruptcy, Winn Dixie has not paid any interest payments on these notes; therefore, there is no guarantee that we will receive any additional payments or any principal payment at maturity.
In addition to the loss of rental payments, a lease termination by an anchor tenant or a failure by that anchor tenant to occupy the premises could result in lease terminations or reductions in rent by other tenants in the same shopping center in the case of leases which permit cancellation or rent reduction if an anchor tenant’s lease is terminated. Vacated anchor tenant space also tends to adversely affect the entire shopping center because of the loss of the departed anchor tenant’s power to draw customers to the center. We cannot provide any assurance that we will be able to quickly re-lease vacant space on favorable terms, if at all. Any of these developments could adversely affect our financial condition or results of operations.
Our growth may be impeded if we are not successful in identifying suitable acquisitions or investments that meet our investment criteria.
Our business strategy is to make future acquisitions of or investments in additional real estate assets or other companies that own real estate. Integral to this strategy will be our ability to expand in the future by identifying suitable acquisition candidates or investment opportunities that meet our criteria and are compatible with our growth strategy. We may not be successful in identifying suitable real estate assets or other businesses that meet our acquisition criteria or completing acquisitions or investments on satisfactory terms. Failures in identifying or completing acquisitions could reduce the number of acquisitions we are able to make and may slow our growth, which could in turn harm our future stock price.
Our investments in development and redevelopment projects may not yield anticipated returns, which would harm our operating results and reduce the amount of funds available for distributions to stockholders.
An important component of our growth strategy is the development of new shopping centers and the redevelopment of properties within our portfolio. However, these developments and redevelopments may not be successful. Expansion, renovation and development projects entail considerable risks as a result of the significant amount of capital expenditures required to complete them, the necessity of various governmental and other approvals, the potential for construction and other delays and other factors, many of which are outside of our control. As a result, we may not be able to timely complete these redevelopment and development projects in accordance with our expectations. In addition, occupancy rates and rents at a newly completed property may not be sufficient to make the property profitable, or development, construction and lease-up activities may not be completed on schedule, resulting in decreased operating income. Moreover, we will on occasion acquire properties with the intention of redeveloping these properties into more valuable assets. However, if those redevelopment efforts are unsuccessful because of changing market conditions or otherwise, then the property may never be profitable.
While our policies with respect to expansion, renovation and development activities are intended to limit some of the risks otherwise associated with such activities, such as initiating construction only after securing commitments from anchor tenants, we will nevertheless be subject to risks that the construction costs of a property, due to factors such as cost overruns, design changes and timing delays arising from a lack of availability of materials and labor, weather conditions and other factors outside of our control, as well as financing costs, may exceed original estimates, possibly making the associated investment unprofitable. Any substantial unanticipated delays or expenses could adversely affect the investment returns from these redevelopment projects and harm our operating results.
We have substantial debt obligations which may reduce our operating performance and put us at a competitive disadvantage.
As of December 31, 2005, we had outstanding debt and other liabilities in the aggregate amount of approximately $1.1 billion. Many of our loan facilities require scheduled principal and balloon payments. In addition, we may incur additional indebtedness in the future. As a result, we are subject to the risks normally associated with debt financing, including the risk that our cash flow will be insufficient to meet required payments of principal and interest, the risk that interest rates may increase on variable-rate debt and the risk that indebtedness on our properties cannot be refinanced at maturity or that the terms of such refinancing will not be as favorable as the terms of such indebtedness.
If our internally generated cash is inadequate to repay our indebtedness upon maturity, then we will be required to repay debt through refinancing or equity offerings. If we are unable to refinance our indebtedness on acceptable terms, or at all, we might be forced to dispose of one or more of our properties potentially upon disadvantageous terms, which might result in losses and might adversely affect our cash available for distribution. If prevailing interest rates or other factors at the time of refinancing result in higher interest rates on refinancing, our interest expense would increase, without a corresponding increase in our rental rates, which would adversely affect our results of operations. Further, if one of our properties is mortgaged to secure payment of indebtedness and we are unable to meet mortgage payments, or if we are in default under the related mortgage or deed of trust, such property could be transferred to the mortgagee, or the mortgagee could foreclose upon the property, appoint a receiver and receive an assignment of rents and leases or pursue other remedies, all with a consequent loss of income and asset value. Foreclosure could also create taxable income without accompanying cash proceeds, thereby hindering our ability to meet the REIT distribution requirements under the Internal Revenue Code.
Future acquisitions of or investments in real estate assets or other companies that own real estate may not yield the returns expected, may result in disruptions to our business, may strain management resources and may result in stockholder dilution.
Our acquisition and investment strategy and our market selection process may not ultimately be successful and may not provide positive returns on our investment. If we acquire a business, we will be required to integrate the operations, personnel and accounting and information systems of the acquired business and train, retain and motivate any key personnel from the acquired business. In addition, acquisitions of or investments in companies may cause disruptions in our operations and divert management’s attention away from day-to-day operations, which could impair our relationships with our current tenants and employees. The issuance of equity securities in connection with any acquisition or investment could be substantially dilutive to our stockholders.
We will face increasing competition for the acquisition of real estate assets, which may impede our ability to make future acquisitions or may increase the cost of these acquisitions.
We compete with many other entities for acquisitions of community and neighborhood shopping centers, including institutional pension funds, other REITs and other owner-operators of shopping centers. These competitors may drive up the price we must pay for real estate assets or other real estate companies we seek to acquire or may succeed in acquiring those companies or assets themselves. In addition, potential acquisition targets may find competitors to be more attractive suitors because they may have greater resources, may be willing to pay more or may have a more compatible operating philosophy. In particular, larger REITs may enjoy significant competitive advantages that result from, among other things, a lower cost of capital and enhanced operating efficiencies. In addition, the number of entities and the amount of funds competing for suitable investment properties may increase. Such competition may reduce the number of suitable properties and increase the bargaining position of the owners of those properties. This will result in increased demand for these assets, and, therefore, increased prices paid for them. If we must pay higher prices for properties, our profitability will be reduced, and our stockholders may experience a lower return on their investment.
Geographic concentration of our properties will make our business vulnerable to economic downturns in Florida or other events, like hurricanes, that disproportionately affect Florida.
Approximately 46.7% of our rental property gross leasable area is located in Florida. As a result, economic, real estate and other, general conditions in Florida will significantly affect our revenues and the value of our properties. Business layoffs or downsizing, industry slowdowns, changing demographics the harmful effects of natural disasters and other similar factors may adversely affect the economic climate in Florida. Any resulting oversupply or reduced demand for retail properties in Florida would adversely affect our operating performance and limit our ability to make distributions to stockholders.
We may experience difficulties and additional costs associated with renting unleased space and space to be vacated in future years.
Our goal is to improve the performance of our properties by re-leasing vacated space. However, we may not be able to maintain the growth in our overall occupancy. Our ability to continue to lease or re-lease vacant space in these or other properties will be affected by many factors, including our properties locations, current market conditions and covenants found in certain leases restricting the use of other space at our properties. For instance, in some cases, our tenant leases contain provisions giving the tenant the exclusive right to sell particular types of merchandise or provide specific types of services within the particular retail center, or limit the ability of other tenants to sell that merchandise or provide those services. When re-leasing space after a vacancy, these provisions may limit the number and types of prospective tenants for the vacant space. The failure to lease or to re-lease on satisfactory terms could harm our operating results.
If we are able to re-lease vacated space, there is no assurance that rental rates will be equal to or in excess of current rental rates. In addition, we may incur substantial costs in obtaining new tenants, including brokerage commission fees paid by us in connection with new leases or lease renewals, and the cost of making leasehold improvements.
Changes in interest rates could adversely affect the market price of our securities.
The market price of our common stock is affected by the annual distribution rate on the shares of our common stock. Increasing market interest rates may lead prospective purchasers of our common stock and other securities to seek alternative investments that offer a higher annual yield which would likely adversely affect the market price of our common stock and other securities. In addition, we have exposure to variable interest rates on balances under our revolving credit facilities, and in connection with $100 million of notional principal amount of our public debt which we swapped to a floating interest rate. As interest rates rise, more of our funds from operations will be required to service these obligations. Finally, increases in interest rates may have the effect of depressing the market value of retail properties such as ours, including the value of those properties securing our indebtedness.
We may be subjected to liability for environmental contamination which might have a material adverse impact on our financial condition and results of operations.
As an owner and operator of real estate and real estate-related facilities, we may be liable for the costs of removal or remediation of hazardous or toxic substances present at, on, under, in or released from our properties, as well as for governmental fines and damages for injuries to persons and property. We may be liable without regard to whether we knew of, or were responsible for, the environmental contamination and with respect to properties previously owned by companies we have acquired, whether the contamination occurred before or after the acquisition. We have several properties in our portfolio that will require or are currently undergoing varying levels of environmental remediation. Although we have environmental insurance policies covering all of our properties, there is no assurance that these policies will cover any or all of the potential losses or damages from environmental contamination; therefore, any liability, fine or damage could directly impact our financial results.
Our financial covenants may restrict our operating or acquisition activities, which may harm our financial condition and operating results.
Our unsecured revolving credit facility with Wells Fargo, our senior unsecured notes payable and much of our existing mortgage indebtedness contain customary covenants and conditions, including, among others, compliance with various financial ratios and restrictions upon the incurrence of additional indebtedness and liens on our properties. Furthermore, the terms of some of this indebtedness will restrict our ability to consummate transactions that result in a change of control or to otherwise issue equity or debt securities. The existing mortgages also contain customary negative covenants such as those that limit our ability, without the prior consent of the lender, to further mortgage the applicable property or to discontinue insurance coverage. If we were to breach covenants in these debt agreements, the lender could declare a default and require us to repay the debt immediately. If we fail to make such repayment in a timely manner, the lender may be entitled to take possession of any property securing the loan.
Certain of our indebtedness may currently be in default as a result of prior issuances of our common stock or prior acquisitions which may serve as a basis for our lenders to accelerate amounts due under the related mortgages or demand payments or fees.
Certain of the mortgages on our properties contain prohibitions on transfers of ownership interests in the mortgagor or its parent without the prior written consent of the lenders, which provisions may have been violated by previous transactions completed by us, including certain merger transactions. A violation could serve as a basis for the lenders to accelerate amounts due under the related mortgages, demand payments or assess fees or penalties.
The outstanding amounts under the mortgages on the affected properties covered by such restrictions on transfer totaled approximately $103.6 million as of December 31, 2005. In the event that the holders declare defaults under the mortgage documents, we could be required to prepay the remaining mortgages from existing resources, refinancing of such mortgages, borrowings under our other lines of credit or other sources of financing. The repayment of these mortgages could have an adverse impact on the operations and affect our ability to make distributions to stockholders.
Our Chairman and Chief Executive Officer and his affiliates own approximately 41% of our common stock and exercise significant control over our company and may delay, defer or prevent us from taking actions that would be beneficial to our other stockholders.
Chaim Katzman, our Chairman and Chief Executive Officer and our largest stockholder, and his affiliates own approximately 41% of the outstanding shares of our common stock and, as a result of a stockholders’ agreement with other of our stockholders, have voting power of almost 48% of our outstanding shares with respect to the election of directors. Accordingly, Mr. Katzman is able to exercise significant control over the outcome of substantially all matters required to be submitted to our stockholders for approval, including decisions relating to the election of our board of directors and the determination of our day-to-day corporate and management policies. In addition, Mr. Katzman is able to exercise significant control over the outcome of any proposed merger or consolidation of our company which, under our charter, the affirmative vote of the holders of a majority of the outstanding shares of our common stock in such instances. Mr. Katzman’s ownership interest in our company may discourage third parties from seeking to acquire control of our company which may adversely affect the market price of our common stock.
Several of our controlling stockholders have pledged their shares of our stock as collateral under bank loans, foreclosure and disposition of which could have a negative impact on our stock price.
Several of our affiliated stockholders that beneficially own a significant interest in our company, including Gazit-Globe, Ltd. and related entities, have pledged a substantial portion of our stock that they own to secure loans made to them by commercial banks.
If a stockholder defaults on any of its obligations under these pledge agreements or the related loan documents, these banks may have the right to sell the pledged shares in one or more public or private sales that could cause our stock price to decline. Many of the occurrences that could result in a foreclosure of the pledged shares are out of our control and are unrelated to our operations. Some of the occurrences that may constitute such an event of default include:
·
the stockholder’s failure to make a payment of principal or interest when due;
·
the occurrence of another default that would entitle any of the stockholder’s other creditors to accelerate payment of any debts and obligations owed to them by the stockholder;
·
if the bank, in its absolute discretion, deems that a change has occurred in the condition of the stockholder to which the bank has not given its prior written consent; and
·
if, in the opinion of the bank, the value of the pledged shares shall be reduced or is likely to be reduced (for example, the price of our common stock declines).
In addition, because so many shares are pledged to secure loans, the occurrence of an event of default could result in a sale of pledged shares that would trigger a change of control of our company, even when such a change may not be in the best interests of our stockholders.
Our organizational documents contain provisions which may discourage the takeover of our company, may make removal of our management more difficult and may depress our stock price.
Our organizational documents contain provisions that may have an anti-takeover effect and inhibit a change in our management. For instance, our charter contains ownership limits and restrictions on transferability of shares of our capital stock in order to protect our status as a REIT. These provisions prevent any one stockholder from owning, actually or constructively, more than 9.9% of the value or number of outstanding shares of our capital stock without our prior consent. In addition, our charter and bylaws contain other provisions that may have the effect of delaying, deferring or preventing a change of control or the removal of existing management and, as a result, could prevent our stockholders from receiving a premium for their shares of common stock above the prevailing market prices. These provisions include the ability to issue preferred stock, advance notice requirements for stockholder proposals, the absence of cumulative voting rights and provisions relating to the removal of incumbent directors. Finally, Maryland law also contains several statutes that restrict mergers and other business combinations with an interested stockholder or that may otherwise have the effect of preventing or delaying a change of control.
We may experience adverse consequences in the event we fail to qualify as a REIT.
Although we believe that we have operated so as to qualify as a REIT under the Internal Revenue Code since our REIT election in 1995, no assurance can be given that we have qualified or will remain qualified as a REIT. In addition, no assurance can be given that legislation, new regulations, administrative interpretations or court decisions will not significantly change the tax laws with respect to qualification as a REIT or the federal income tax consequences of such qualification. Qualification as a REIT involves the application of highly technical and complex provisions of the Internal Revenue Code for which there are only limited judicial and administrative interpretations. The determination of various factual matters and circumstances not entirely within our control may affect our ability to qualify as a REIT. For example, in order to qualify as a REIT, at least 95% of our gross income in any year must be derived from qualifying sources and we must make distributions to stockholders aggregating annually at least 90% of our REIT taxable income, excluding net capital gains. We intend to make distributions to our stockholders to comply with the distribution provisions of the Internal Revenue Code. Although we anticipate that our cash flows from operating activities will be sufficient to enable us to pay our operating expenses and meet distribution requirements, no assurance can be given in this regard.
If we were to fail to qualify as a REIT in any taxable year, we would be subject to federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate income tax rates, and we would not be allowed a deduction in computing our taxable income for amounts distributed to our stockholders. Moreover, unless entitled to relief under certain statutory provisions, we also would be ineligible for qualification as a REIT for the four taxable years following the year during which qualification was lost. Such disqualification would reduce our net earnings available for investment or distribution to our stockholders due to our additional tax liability for the years involved.
Loss of Key Personnel Could Harm Our Business.
Our ability to successfully execute our acquisition and growth strategy depends to a significant degree upon the continued contributions of Chaim Katzman, our Chairman of the Board and Chief Executive Officer, Doron Valero, our President and Chief Operating Officer, and Howard Sipzner, our Executive Vice President and Chief Financial Officer. Pursuant to our employment agreements with Mr. Katzman, he is only required to devote so much of his business time, attention, skill and efforts as shall be required for the faithful performance of his duties. Moreover, there is no guarantee that Mr. Katzman, Mr. Valero or Mr. Sipzner will remain employed with us. While we have employment agreements with these executives, we cannot guarantee that we will be able to retain their services. The loss of the services of Messrs. Katzman, Valero and Sipzner could have a material adverse effect on our results of operations.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2.
PROPERTIES
Our portfolio consists primarily of shopping centers anchored by supermarket and other necessity-oriented retailers and at December 31, 2005 contained an aggregate of approximately 19.7 million square feet of gross leasable area or GLA. Other than our leasehold interests in McAlpin Square shopping center located in Savannah, Georgia, Plaza Acadienne shopping center located in Eunice, Louisiana, Shelby Plaza shopping center located in Shelby, North Carolina, and El Novillo located in Miami, Florida, all of our other properties are owned in fee simple. In addition, some of our properties are subject to mortgages as described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Mortgage Indebtedness.” The following table provides a brief description of our properties as of December 31, 2005:
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(1)
Number of tenants includes both occupied and vacant units.
(2)
Calculated by annualizing the tenant’s monthly base rent payment at December 31, 2005, excluding expense reimbursements, percentage rent payments and other charges.
(3)
Includes supermarket tenants and certain other tenants, as well as, occupants that are on an adjacent or contiguous, separately owned parcel and do not pay any rent or expense recoveries.
(4)
This tenant is on adjacent or contiguous, separately owned parcel.
(5)
There are 539 storage units at this property.
*
Indicates a tenant that has closed its store and ceased to operate at the property, but continues to pay rent under the terms of its lease. The sub-tenant, if any, is shown in parentheses.
Most of our leases provide for the monthly payment in advance of fixed minimum rentals, the tenants’ pro rata share of ad valorem taxes, insurance (including fire and extended coverage, rent insurance and liability insurance) and common area maintenance for the property. They may also provide for the payment of additional rentals based on a percentage of the tenants’ sales. Utilities are generally paid directly by tenants except where common metering exists with respect to a property. In this case, we make the payments for the utilities and are reimbursed by the tenants on a monthly basis. Generally, our leases prohibit the tenant from assigning or subletting its space. They also require the tenant to use its space for the purpose designated in its lease agreement and to operate its business on a continuous basis. Some of the lease agreements with major tenants contain modifications of these basic provisions in view of the financial condition, stability or desirability of those tenants. Where a tenant is granted the right to assign its space, the lease agreement generally provides that the original lessee will remain liable for the payment of the lease obligations under that lease agreement.
Major Tenants
The following table sets forth as of December 31, 2005 the gross leasable area, or GLA of our existing properties leased to tenants in our core shopping center portfolio:
The following table sets forth as of December 31, 2005 the annual minimum rent at expiration attributable to tenants in our core shopping center portfolio:
The following table sets forth as of December 31, 2005 information regarding leases with the ten largest tenants in our core shopping center portfolio:
Lease Expirations
The following tables set forth as of December 31, 2005 the anticipated expirations of tenant leases in our core shopping center portfolio for each year from through 2015 and thereafter:
We may incur substantial expenditures in connection with the re-leasing of our retail space, principally in the form of tenant improvements and leasing commissions. The amounts of these expenditures can vary significantly, depending on negotiations with tenants and the willingness of tenants to pay higher base rents over the terms of the leases. We also incur expenditures for certain recurring capital expenses.
Insurance
Our tenants are generally responsible under their leases for providing adequate insurance on the spaces they lease. We believe that our properties are covered by adequate fire, flood and property insurance, and where necessary hurricane and windstorm coverages all provided by reputable companies. However, certain of our properties are not covered by disaster insurance with respect to certain hazards (such as hurricanes) for which coverage is not available or available only at rates, which in our opinion, are not economically justifiable.
Unconsolidated Joint Venture Investment
As of December 31, 2005, we owned a non-controlling interest in one unconsolidated joint venture which owns a parcel of land that is held for future development or sale.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
Neither we nor our properties are subject to any litigation which we believe will have a material adverse affect on our business financial conditional or results of operations or cash flows. Furthermore, to the best of our knowledge, except as described above with respect to environmental matters, there is no litigation threatened against us or any of our properties, other than routine litigation and administrative proceedings arising in the ordinary course of business, which collectively are not expected to have a material adverse effect on our business, financial condition, results of operations or cash flows.
ITEM 4.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted for stockholder vote during the fourth quarter of 2005.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information and Dividends
Our common stock began trading on the New York Stock Exchange, or NYSE, on May 18, 1998, under the symbol “EQY.” On February 27, 2006, we had approximately 2,000 stockholders of record representing approximately 15,000 beneficial owners. The following table sets forth for the periods indicated the high and low sales closing prices as reported by the NYSE and the distributions declared by us:
Dividends paid during 2005 and 2004 totaled $87.3 million and $80.9 million, respectively. Future declarations of dividends will be made by us at the discretion of our board of directors and will depend upon our earnings, financial condition and such other factors as our board of directors deems relevant. In order to qualify for the beneficial tax treatment accorded to real estate investment trusts under the Internal Revenue Code of 1986, or the Code, we are currently required to make distributions to holders of our shares in an amount equal to at least 90% of our “real estate investment trust taxable income,” as defined in Section 857 of the Code.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
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(1)
Reclassified to reflect the reporting of discontinued operations.
(2)
We believe Funds From Operations (“FFO”) (combined with the primary GAAP presentations) is a useful supplemental measure of our operating performance that is a recognized metric used extensively by the real estate industry, in particular, REITs. Accounting for real estate assets using historical cost accounting under accounting principles generally accepted in the United States of America (“GAAP”) assumes that the value of real estate diminishes predictably over time. The National Association of Real Estate Investment Trusts (“NAREIT”) stated in its April 2002 White Paper on Funds from Operations “since real estate values…have historically risen or fallen with market conditions, many industry investors have considered presentations of operating results for real estate companies that use historical cost accounting to be insufficient by themselves.”
FFO, as defined by NAREIT, is “net income (computed in accordance with GAAP), excluding gains (or losses) from sales of depreciable property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures will be calculated to reflect funds from operations on the same basis.” We believe that financial analysts, investors and stockholders are better served by the presentation of comparable period operating results generated from our FFO measure. Our method of calculating FFO may be different from methods used by other REITs and accordingly, may not be comparable to such other REITs.
FFO is presented to assist investors in analyzing our performance. FFO (i) does not represent cash flow from operations as defined by GAAP, (ii) is not indicative of cash available to fund all cash flow needs and liquidity, including the ability to make distributions, and (iii) should not be considered as an alternative to net income (which is determined in accordance with GAAP) for purposes of evaluating our operating performance. We believe net income is the most directly comparable GAAP measure to FFO.
The following table illustrates the calculation of funds from operations for each of the five years in the period ended December 31, 2005 (in thousands):
The following table reflects the reconciliation of FFO per diluted share to earnings per diluted share, the most directly comparable GAAP measure, for the periods presented:
* Earnings per diluted share reflect the add-back of interest on convertible partnership units and the minority interest(s) in earnings of consolidated subsidiaries which are convertible to shares of our common stock.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
The following should be read in conjunction with our consolidated financial statements, including the notes thereto, which are included elsewhere in this annual report.
General. We operate as a real estate investment trust, or REIT, that principally acquires, renovates, develops and manages community and neighborhood shopping centers located predominantly in high growth markets in the southern and northeastern United States. Our shopping centers are primarily anchored by national and regional supermarket chains and other necessity-oriented retailers, such as drug stores or discount retail stores. As of December 31, 2005, our portfolio consisted of 192 properties, comprising 125 supermarket-anchored shopping centers, seven drug store-anchored shopping centers, 49 other retail-anchored shopping centers, six development parcels, and five non-retail properties, as well as a non-controlling interest in one unconsolidated joint venture that owns a parcel of land.
We believe we distinguish ourselves by owning and operating shopping centers anchored by supermarkets and other necessity-oriented retailers in high density areas that are experiencing higher than average population growth or that provide particularly strong barriers to additional competition. Our goal is to own and operate properties containing dominant supermarket operators and a diverse tenant mix. We believe that these characteristics combine to reduce the vulnerability of our properties to economic downturns, enhance consumer traffic through our properties and generate more stable cash flows over time. We derive substantially all of our revenue from tenants under existing leases at our properties.
Our business is generally dependent on the performance of the economy in the areas in which we own properties and the cost of financing available to fund our growth. Changes in the economic environment tend to have a direct effect on our tenants’ businesses and, therefore, their ability to continue to pay us rent. The markets in which we currently own properties have continued to show signs of economic and population growth during 2005. We had a 93.4% occupancy rate at December 31, 2005 and we experienced rental growth in the average minimum rent per square foot on lease renewals during 2005 in our core retail properties. This growth, as well as the relatively low interest rate environment, contributed to the growth in our cash flows. Notwithstanding the current interest rate environment, the Federal Reserve has consistently raised interest rates over the last 18 months and if these increases continue in 2006, our cost of capital will be higher and will adversely affect our operating results.
We will continue to evaluate our properties for possible sales or joint ventures to recycle and redeploy capital. However, these conditions have made it more difficult to acquire properties at what we believe to be attractive yields. Given the current market conditions, we have focused more of our efforts on redevelopments and developments that generally yield higher returns, while presenting greater risk. We are pursuing new development opportunities and alternative mixed-use projects, as well as joint ventures with respect to development projects.
Overview. We focused on acquiring land for future development activities, redeveloping existing properties, and re-leasing vacant anchor space in our centers, as well as exploring strategic opportunities for our Texas portfolio. Our property acquisitions during 2005 were financed using our revolving lines of credit, proceeds from the sale of properties, issuance of public debt and assumed mortgages. In the event we consummate future acquisitions, we anticipate using similar financing sources. However, there can be no assurances that these sources will be available to us in the future at reasonable terms or at all.
The highlights of our 2005 activity include:
·
We acquired two retail properties, two non-retail buildings, and three land parcels held for future development, for aggregate consideration of approximately $54.1 million.
·
We sold four non-core properties for aggregate consideration of approximately $45.7 million.
·
We completed the development of a supermarket anchored shopping center containing 82,500 square feet of gross leasable area located in Homestead, FL, and added 29,000 square feet to an existing center, started development on two supermarket anchored centers and have 15 other significant developments and redevelopments in various stages of construction.
·
In February 2005, we entered into a joint venture that acquired a 155 acre development parcel in Pasco County, Florida. We have a 60 percent controlling interest in the venture and expect to receive an eight percent preferred return on our capital investment. We currently expect that upon completion, the project will include office, retail and residential components. Also, in January 2006, we entered into a joint venture that acquired a supermarket anchored shopping center located in St. Pete Beach, Florida. We have a 50 percent interest in the venture and expect to receive an eight percent preferred return on our capital investment. Upon completion, we expect the project will be a mixed use of retail and residential components.
·
During September of 2005, we raised $120 million in an offering of unsecured senior notes with a stated interest rate of 5.375% and matures in October 2015.
·
We increased the base rental rate by 4.2% on 344 lease renewals aggregating 735,729 square feet to $15.16 per square foot. We executed 345 new leases totaling 1.4 million square feet at an average rate of $10.18 per square foot.
·
At December 31, 2005, we directly and indirectly owned approximately 2.4 million ordinary shares in DIM Vastgoed N.V. (“DIM”). DIM is a public company organized under the laws of the Netherlands the shares of which are listed on the Euronext Amsterdam Stock Exchange, and which operates as a closed-end investment company owning and operating a portfolio of 18 shopping center properties aggregating 2.6 million square feet in the southeastern United States. As of February 28, 2006, we had increased our ownership of DIM to approximately 3.6 million shares, representing approximately 48.5% of its total outstanding ordinary shares. We have committed to buy an additional 45,362 ordinary shares of DIM, in September 2007, for total consideration of $941,000.
·
In June 2005, we announced that we are exploring strategic alternatives for our Texas portfolio; we are currently considering a possible joint venture transaction with a strategic partner.
Business Uncertainties. Our long-term operating cash flow is dependent on the continued occupancy of our properties, the rents that we are able to charge to our tenants and the ability of these tenants to make their rental payments. The main long-term threat to our business is our dependence on the viability of our anchor and other tenants. In 2005, occupancy declined from 94.8% to 93.4% from 2004 resulting mainly from the closure by Winn-Dixie of two of its stores and our decision to terminate other tenants’ leases, usually providing for a lease termination payment. General economic downturns and competition from national and regional supercenters, such as Wal-Mart and Target or other discount retailers, may also have an increasingly adverse impact on the business of our tenants by taking customers or reducing operating margins. For example, on February 22, 2005, Winn-Dixie Stores, Inc., an anchor tenant at 16 of our shopping centers occupying 730,000 square feet of gross leasable area and accounting for approximately $5 million in annualized minimum rent, filed for bankruptcy protection. Winn-Dixie has rejected two leases at our centers in connection with its restructuring activities and closed the stores. It is no longer liable for the payment of rent or other charges at these centers. The two affected stores provided for approximately $596,000 in annualized minimum rent. Moreover, the period during which Winn-Dixie may reject leases has not yet expired, and, therefore, it may reject additional leases at our centers. If it elects to close additional stores and terminate those leases, it would adversely affect our operating results, including funds from operations and cash flows. In addition, we own approximately $14.1 million of principal of Winn-Dixie’s senior notes bearing interest at 8.875%, upon which interest is not being paid. In light of Winn-Dixie’s bankruptcy, there is no guarantee that we will receive any additional payments or any principal payment at maturity.
We believe, however, that our general operating risks are mitigated by concentrating on high-density, urban areas, leasing to the dominant supermarket operators in the markets in which we own properties and maintaining a diverse tenant mix. Other than Winn-Dixie, we are not currently aware of any pending tenant bankruptcies that are likely to materially affect our rental revenues.
In addition, although we have enjoyed a low interest rate environment in recent years, the increase in interest rates over the last 18 months has had, and anticipated future increases in the coming months will have, an adverse effect on the cost of our future borrowings, including borrowings under our revolving credit facilities, which are based on variable interest rates, and the $100 million of our senior notes that we have swapped to a variable rate. As interest rates rise, the interest we incur on these loans will increase.
Notwithstanding these business uncertainties, we are optimistic that we are well positioned to take advantage of the sustained growth of the economy and that growth in rents and occupancy will mitigate increases in operating or financing costs.
Short-Term Liquidity Needs. As of December 31, 2005, we had $102,000 in cash and $185.6 million available to be drawn under our revolving credit facilities. We have drawn an additional $68.0 million during the first two months of 2006 on this facility to fund acquisitions and additional investment in DIM. Our cash flow from operations was $117.2 million for the year ended December 31, 2005.
Our short-term liquidity requirements consist primarily of funds necessary to pay for operating and other expenses directly associated with our portfolio of properties, general and administrative expenses (including payroll and related costs), interest expense and scheduled principal and balloon payments on our outstanding debt, $50 million in senior notes maturing in April 2006, capital expenditures incurred to facilitate the leasing of space (e.g., tenant improvements and leasing commissions), development and redevelopment activities, quarterly dividends paid to our common stockholders and distributions made to holders of operating partnership units.
Historically, we have satisfied these requirements principally through cash generated from operations. We believe that cash generated from operations and borrowings under our unsecured revolving credit facilities will be sufficient to meet our short-term liquidity requirements; however, there are risks inherent in our business, including those risks described in Item 1A - “Risk Factors,” that may have a material adverse effect on our cash flow, and, therefore, on our ability to meet these requirements.
Certain of our mortgage loans involving an aggregate principal balance of approximately $103.6 million contain prohibitions on transfers of ownership which may have been violated by our previous issuances of common stock or in connection with past acquisitions and may be violated by transactions involving the Company’s capital stock in the future. If a violation were established, it could serve as a basis for a lender to accelerate amounts due under the affected mortgage. To date, no lender has notified us that it intends to accelerate its mortgage. In the event that the mortgage holders declare defaults under the mortgage documents, we will, if required, prepay the remaining mortgage from existing resources, refinancing of such mortgages, borrowings under our other lines of credit or other sources of financing. Based on discussions with various lenders, current credit market conditions and other factors, we believe that the mortgages will not be accelerated. Accordingly, we believe that the violations of these prohibitions will not have a material adverse impact on our results of operations or financial condition.
Our current development plans include development and redevelopment projects, the aggregate cost of which (including costs incurred in prior years on these projects) is expected to be approximately $107.2 million and of which $34.4 million remains unfunded based on our current plans. We intend to fund these costs from our unsecured revolving credit facilities and cash generated from operations. We are likely to initiate other projects over the course of which have undetermined costs.
We may incur significant expenditures in connection with the re-leasing of our retail space, principally in the form of tenant improvements and leasing commissions. The amounts of these expenditures can vary significantly, depending on negotiations with tenants and the willingness of tenants to pay higher base rents over the life of the leases. We also incur expenditures for certain recurring capital expenses. We expect to pay for re-leasing and recurring capital expenditures out of cash from operations.
As a REIT, we are required to distribute at least 90% of our taxable income to our stockholders on an annual basis. Therefore, as a general matter, it is unlikely that we will be able to retain any substantial cash balances that could be used to meet our liquidity needs. Instead, these needs must be met with cash generated from current operations and external sources of capital.
During 2005, we paid $87.3 million of dividends on our common stock. The continual payment of dividends is subject to various factors, including the discretion of our board of directors, our ability to pay dividends under Maryland law, the availability of cash to make the necessary dividend payments and the effect of REIT distribution requirements.
Long-Term Liquidity Needs. Our long-term liquidity requirements consist primarily of funds necessary to pay for the principal amount of our long-term debt as it matures, significant non-recurring capital expenditures that need to be made periodically at our properties, development and redevelopment projects that we undertake at our properties and the costs associated with acquisitions of properties or other companies. Historically, we have satisfied these requirements principally through what we believe to be the most advantageous source of capital available at the time, which has included the incurrence of new debt through borrowings under credit facilities and the issuance of debt securities, sales of common stock, capital raised through the disposition of assets, and joint venture transactions. We believe that these sources of capital will continue to be available in the future to fund our long-term capital needs; however, there are risks inherent in our business, including those risks described in Item 1A - “Risk Factors,” that may have a material adverse effect on our ability to access these capital sources.
Our ability to incur additional unsecured debt is dependent upon a number of factors, including our degree of leverage, the value of our unencumbered assets, our credit rating and borrowing restrictions imposed by existing lenders. Currently, we have investment grade credit ratings for our unsecured senior debt from two major rating agencies - Standard & Poor’s and Moody’s Investors Service. A downgrade in outlook or rating by a rating agency can occur at any time if the agency perceives an adverse change in our financial condition, results of operations or ability to service debt. If such a downgrade occurs, it would increase the interest rates currently payable under our existing credit facilities and certain of our debt securities, would likely increase the costs associated with obtaining future financing, and adversely affect our ability to obtain future financing. The indentures under which our publicly traded debt securities are issued also contain certain restrictions on our ability to incur debt and other financial covenants.
The following table sets forth certain information regarding future contractual obligations, excluding interest, as of December 31, 2005 (in thousands):
(1)
$100 million of the outstanding balance has been swapped to a floating interest rate based on the 6 month LIBOR in arrears, plus 0.4375%. The contractual obligations for the unsecured senior notes do not reflect this interest rate swap.
The following table sets forth certain information regarding future interest obligations on outstanding debt as of December 31, 2005 (in thousands):
(2)
$100 million of the outstanding principal balance has been swapped to a floating interest rate based on the 6 month LIBOR in arrears, plus 0.4375%. The interest obligations for the unsecured senior notes presented above assume that the rate that was in effect at December 31, 2005 remains the same for this interest rate swap.
(3)
Interest on the unsecured revolving credit facility is variable; these amounts assume that the weighted average interest rate remains the same as the rate at December 31, 2005.
We have entered into employment contracts with several of our key executives. These contracts provide for base pay, bonuses based on our results of operations, options and restricted stock grants and reimbursement of other various expenses.
Off Balance Sheet Arrangements
We have an off balance sheet joint venture and other unconsolidated arrangements with varying structures. As of December 31, 2005, our off balance sheet arrangements were as follows:
·
Letters of credit totaling $1.4 million have been provided as security for certain performance requirements;
·
We have committed to fund $34.4 million, based on current plans and estimates, in order to complete pending development and redevelopment projects. These obligations, comprised principally of construction contracts, are generally due as the work is performed and are expected to be financed by our available credit facilities;
·
We have committed to buy, in September 2007, an additional 45,362 shares of DIM Vastgoed N.V. ordinary shares for total consideration of $941,000; and
·
We own interests in an unconsolidated joint venture that owns a parcel of land that is held for future development or sale. We are obligated to fund 50% of any working capital that is required (as determined jointly by us and our joint venture partner). The current obligations are a nominal amount to pay property taxes and other carrying costs. The joint venture currently has no outstanding debt obligations or contractual commitments and we have not guaranteed any obligations or retained any contingent interest in any assets.
We expect to fund these obligations from working capital and availability under our revolving credit facilities.
Critical Accounting Policies and Estimates
Management’s Discussion and Analysis of Financial Condition and Results of Operations provides additional information related to our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management evaluates and if necessary, adjusts its estimates and judgments, including those related to real estate and development assets, revenue recognition in conjunction with providing development, leasing and management services and equity in earnings of unconsolidated joint ventures. Management believes that the following critical accounting policies affect its more significant judgments and estimates used in the preparation of our consolidated financial statements.
Real Estate Properties and Development Assets. We capitalize acquisition and construction costs, property taxes, interest and other miscellaneous costs that are directly identifiable with a project, from pre-acquisition until the time that construction is complete and the development is ready for its intended use, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 67 and SFAS No. 34. We allocate the capitalized project costs to the various components of the project based on the components’ relative fair values. Our cost allocation method requires the use of management estimates regarding the fair market value of each project component. Management bases its estimates on current market appraisals, comparable sales, existing sale and purchase contracts, replacement cost, historical experience, and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the fair market values of real estate assets. Actual results may differ from these estimates and anticipated returns on a project, as well as the gain or loss on disposition of the individual project components, could vary significantly from estimated amounts.
On a periodic basis, or whenever events or changes in circumstances indicate, we assess whether the value of the real estate properties may be impaired. A property’s value is impaired only if it is probable that management’s estimate of the aggregate future cash flows (undiscounted and without interest charges) to be generated by the property are less than the historical net carrying value of the property. In management’s estimate of cash flows, it considers factors such as expected future operating income, trends and prospects, as well as the effects of demand, competition and other factors. In addition, the undiscounted cash flows may consider a probability weighted cash flow estimation approach when alternative courses of action to recover the carrying amount of a long lived asset are under consideration or a range is estimated. The determination of undiscounted cash flows requires significant estimates by management and considers the expected course of action at the balance sheet date. Subsequent changes in estimated undiscounted cash flows arising from changes in anticipated actions could impact the determination of whether impairment exists and whether the effects could materially impact the Company’s net income. To the extent that impairment has occurred, the loss will be measured as the excess of the carrying amount of the property over the fair value of the property.
When assets are identified as held for sale, management estimates the sales prices, net of selling costs, of such assets. Assets that will be sold together in a single transaction are aggregated in determining if the net sales proceeds of the group are expected to be less than the net book value of the assets. If, in management’s opinion, the net sales prices of the assets, which have been identified for sale, are expected to be less than the net book value of the assets, an impairment charge is recorded.
We are required to make subjective assessments as to whether there are impairments in the value of our real estate properties and other investments. The assessments have a direct impact on our net income because recording an impairment charge results in an immediate charge to expense.
Business Combinations. We are actively pursuing acquisition opportunities and will not be successful in all cases; costs incurred related to these acquisition opportunities are expensed when it is probable that we will not be successful in the acquisition. The results of operations of any acquired property are included in our financial statements as of the date of its acquisition.
We allocate the purchase price of acquired companies and properties to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values. Fair value is defined as the amount at which that asset could be bought or sold in a current transaction between willing parties (other than in a forced or liquidation sale). In order to allocate the purchase price of acquired companies and properties to the tangible and intangible assets acquired, we identify and estimate the fair value of the land, buildings and improvements, review the leases to determine the existence of, and estimate the fair value of, any contractual or other legal rights and investigates the existence of, and estimate the fair value of, any other identifiable intangibles. Such valuations require management to make significant estimates and assumptions, especially with respect to intangibles.
The cost approach is used as the primary method to estimate the fair value of the buildings, improvements and other assets. The cost approach is based upon the current costs to develop the particular asset in that geographic location, less an allowance for physical and functional depreciation. The assigned value for buildings and improvements is based on an as if vacant basis. The market value approach is used as the primary method to estimate the fair value of the land. The determination of the fair value of contractual intangibles is based on the costs incurred to originate a lease, including commissions and legal costs, excluding any new leases negotiated in connection with the purchase of a property. In-place lease values are based on management’s evaluation of the specific characteristics of each lease and our overall relationship with each tenant. Among the factors considered in the allocation of these values include the nature of the existing relationship with the tenant, the tenant’s credit quality, the expectation of lease renewals, the estimated carrying costs of the property during a hypothetical expected lease-up period, current market conditions and costs to execute similar leases. Estimated carrying costs include real estate taxes, insurance, other property operating costs and estimates of lost rentals at market rates during the hypothetical expected lease-up periods, given the specific market conditions. Above-market, below-market and in-place lease values are determined based on the present value (using a discount rate reflecting the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the leases negotiated and in-place at the time of acquisition and (ii) management’s estimate of fair market lease rates for the property or equivalent property, measured over a period equal to the remaining non-cancelable term of the lease. The value of contractual intangibles is amortized over the remaining term of each lease. Other than as discussed above, we have determined that our real estate properties do not have any other significant identifiable intangibles.
Critical estimates in valuing certain of the intangibles and the assumptions of what marketplace participants would use in making estimates of fair value include, but are not limited to: future expected cash flows, estimated carrying costs, estimated origination costs, lease up periods and tenant risk attributes, as well as assumptions about the period of time the acquired lease will continue to be used in our portfolio and discount rates used in these calculations. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. Assumptions may not always reflect unanticipated events and changes in circumstances may occur. In making such estimates, management uses a number of sources, including appraisals or other market data, as well as, information obtained in its pre-acquisition due diligence and marketing and leasing activities.
Securities. We have investments that consist primarily of equity and debt securities. The equity investments are classified as available-for-sale and recorded at fair value based on current market prices. Changes in the fair value of the equity investments are included in accumulated other comprehensive income (loss). The debt securities are recorded at cost and are classified as held-to-maturity, with the related discount/premium amortized over the life of the investment using the effective interest method.
For securities classified as held-to-maturity, we determine whether a decline in fair value below the amortized cost basis is other-than-temporary. If it is probable that we will be unable to collect all amounts due according to the contractual terms of a debt security, an other-than-temporary impairment is considered to have occurred. The determination of other than temporary decline in value requires significant estimates and assumptions by management and requires the consideration of expected outcomes that are out of management control. Subsequent changes in estimates, assumptions used or expected outcomes could impact the determination of whether a decline in value is more than temporary and whether the effects could materially impact our financial position or net income. If the decline in fair value is judged to be other than temporary, the cost basis of the individual security will be written down to fair value as a new cost basis and the amount of the write-down will be included in earnings (that is, accounted for as a realized loss).
Goodwill. We are required to perform annual impairment tests of our goodwill, and more frequently in certain circumstances. Goodwill is no longer amortized. The goodwill impairment test is a two-step process, which requires management to make judgments in determining what assumptions to use in the calculation. The first step of the process consists of estimating the fair value of each reporting unit and comparing those estimated fair values with the carrying values, which include the allocated goodwill. If the estimated fair value is less than the carrying value, a second step is performed to compute the amount of the impairment by determining an “implied fair value” of goodwill. The determination of a reporting unit’s “implied fair value” of goodwill requires us to allocate the estimated fair value of the reporting unit to the assets and liabilities of the reporting unit. Any unallocated fair value represents the “implied fair value” of goodwill, which is compared to its corresponding carrying value.
The key assumptions we made to determine the fair value of our reporting units (each property is considered a reporting unit under SFAS No. 142) included (a) net operating income; (b) cash flows; and (c) the estimated fair value, which was based on our experience in evaluating acquisitions and market conditions. A variance in the net operating income or discount rate could have had a significant impact on the amount of the goodwill impairment charge recorded.
Management cannot predict the occurrence of certain future events that might adversely affect the reported value of goodwill that totaled $12.0 million at December 31, 2005. Such events include, but are not limited to, strategic decisions made in response to economic and competitive conditions, the impact of the economic environment on our tenants, or a material negative change in our relationships with significant tenants.
Revenue Recognition. As lessor, we retain substantially all the risks and benefits of property ownership and account for our leases as operating leases. Rental income is recognized over the lease term on a straight-line basis. Revenue from percentage rent is recognized when tenants’ reported sales have reached certain levels specified in the respective leases. Recoveries from tenants for real estate taxes and other operating expenses are recognized as revenue in the period when the applicable costs are incurred. Termination fees are recognized when a tenant’s lease is terminated.
We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of tenants to make required rent payments. The computation of this allowance is based on the tenants’ payment history and current credit quality. If our estimate of collectibility differs from the cash received the timing and amount of our reported revenue could be impacted.
Investments in Unconsolidated Joint Ventures. We do not consider ourselves to be in control of joint ventures when major business decisions require the approval of at least one other managing equity owner. Accordingly, we account for the one joint venture in which we do not retain unilateral control under the equity method.
We calculate the equity in income or loss earned from our unconsolidated joint ventures based on each equity owners’ economic ownership, which is estimated based on anticipated stabilized cash flows as they would be allocated to each equity owner based on how cash flow is distributed. Generally, under the terms of the respective joint venture agreements, net ordinary cash flow is distributed to each equity owner in accordance with such owner’s equity ownership percentages.
Options. The adoption on January 1, 2006 of SFAS 123(R)’s fair value method will have an impact on our results of operations, although it will have no impact on our overall financial position. We estimate that the impact on our results of operations of adopting SFAS 123(R) in 2006, with respect to our prior year and unvested stock option grants only, will be approximately $276,000. However, had we adopted SFAS 123(R) in prior periods, the impact of the standard would have approximated the impact as presented in the disclosure of pro forma net income and earnings per share in Note 1, Stock Options, in the accompanying consolidated financial statements.
There is no observable market for our options. Management must make critical estimates in determining the fair value at the grant date. Variations in the assumptions will have a direct impact on our net income. Critical estimates in valuing the fair value at the grant date and the assumptions that marketplace participants would use in making estimates of fair value include: expected volatility, expected dividends, risk-free interest rate and expected term of the option. Management’s estimate of fair value is based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. Assumptions may not always reflect unanticipated events and changes in circumstances may occur.
Results of Operations
Our consolidated results of operations often are not comparable from period to period due to the impact of property acquisitions, dispositions, developments and redevelopments. The results of operations of any acquired property are included in our financial statements as of the date of its acquisition. A large portion of the change in our statement of operations line items is related to these changes in our property portfolio.
On February 22, 2005, Winn-Dixie Stores, Inc., an anchor tenant in 16 of our shopping centers occupying 730,000 square feet of gross leasable area and accounting for approximately $5 million in annualized minimum rent, filed for bankruptcy protection. Winn-Dixie has closed two of its 16 Winn-Dixie stores in connection with its restructuring activities. The two affected stores provided for approximately $596,000 in annualized minimum rent. If it elects to close more or all of their other stores at our centers and terminate those leases, it would adversely affect our operating results, including funds from operations and cash flows. In addition, we own approximately $14.1 million original principal amount of Winn-Dixie’s 8.875% senior notes. Since it filed for bankruptcy, Winn Dixie has not paid any interest payment on these notes; therefore, there is no guarantee that we will receive any additional payments or any principal payment at maturity.
We derive substantially all of our revenues from rents received from tenants under existing leases on each of our properties. These revenues include fixed base rents, recoveries of expenses that we have incurred and that we pass through to the individual tenants and percentage rents that are based on specified percentages of tenants’ revenues, in each case as provided in the particular leases.
Our primary cash expenses consist of our property operating expenses, which include real estate taxes, repairs and maintenance, management expenses, insurance, utilities and other expenses, general and administrative expenses, which include payroll, office expenses, professional fees and other administrative expenses, and interest expense, primarily on mortgage debt, unsecured senior debt and revolving credit facilities indebtedness. In addition, we incur substantial non-cash charges for depreciation and amortization on our properties. We also capitalize certain expenses, such as taxes and interest, incurred in respect of property under development or redevelopment until the property is ready for its intended use.
In June 2005, we announced our intention to consider strategic alternatives for the properties located in Texas, including a possible sale or joint venture. The classification of the operating results for these properties in previous reporting periods were included in discontinued operations. In December 2005, however, we decided to consider the possibility of a joint venture with a strategic partner through which we would retain an ownership interest in and continue to manage the properties. As a result of our potential significant continuing involvement in these properties, we are required to include the operating results of 31 properties located in Texas in our consolidated income from continuing operations. Despite such treatment, upon completion of a possible joint venture transaction, in which we would have significant influence, the results of operations of the Texas properties would not be consolidated with our results, but would be accounted for under the equity method of accounting. The effect on results of operations for the reporting periods is presented in footnote 10, Dispositions, in the accompanying consolidated financial statements.
Year Ended December 31, 2005 Compared to Year Ended December 31, 2004.
The following summarizes items from our audited consolidated statements of operations that we think are important in understanding our results of operations and/or those items which have significantly changed in 2005 compared to 2004 (in thousands):
Total rental revenue increased by $26.4 million, or 11.6%, to $253.0 million in 2005 from $226.6 million in 2004. The following factors accounted for this difference:
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Properties acquired during 2005 increased rental revenue by approximately $1.4 million;
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The full year 2005 benefited from properties acquired during 2004 which increased rental revenue by approximately $15.1 million;
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Same property rental revenue increased by approximately $7.9 million in 2005 due to higher termination fees, expense recovery revenue and increases in rental rates, and
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The completion of development and redevelopment properties increased rental revenue by approximately $2.5 million.
Property operating expenses increased by $6.7 million, or 11.2%, to $66.8 million for 2005 from $60.1 million in 2004. The following factors accounted for this difference:
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Properties acquired during 2005 increased operating expenses by approximately $576,000;
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Properties acquired during 2004 increased the full year 2005 operating expenses by approximately $1.9 million;
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Same property operating expenses increased by approximately $3.3 million as a result of higher hurricane related clean up and repairs and other maintenance expenses; and
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The completion of development and redevelopment properties increased operating expenses by $500,000.
Rental property depreciation and amortization increased by $7.6 million, or 21.1%, to $43.2 million for 2005 from $35.6 million in 2004. The following factors accounted for this difference:
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Properties acquired during 2005 increased depreciation and amortization by $341,000;
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Properties acquired during 2004 increased the full year 2005 depreciation and amortization expense by approximately $4.3 million;
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Same property depreciation and amortization increased by $2.4 million related to leasing and tenant improvement amortization; and
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Completion of development and redevelopment properties increased depreciation and amortization by $936,000.
General and administrative expenses increased by $680,000, or 4.1%, to $17.3 million for 2005 from $16.6 million in 2004. Included in this increase were $1.0 million of compensation and employment related expenses due to additional staffing related to our growth, expansion into the northeast and additional staffing to meet compliance with the Sarbanes-Oxley Act of 2002; $97,000 related to computer upgrade, software and licenses expenses; $194,000 of additional office expenses and $230,000 of depreciation expense related to additional furniture and fixture purchases. These increases were offset by a reduction of $231,000 in professional fees related to compliance costs incurred in 2004 to implement requirements under the Sarbanes-Oxley Act of 2002 and $680,000 less in abandoned pre-acquisition due diligence costs.
Interest expense increased by $6.1 million, or 13.2%, to $51.8 million for 2005 from $45.7 million in 2004. This difference was primarily due to:
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An increase of $1.9 million attributable to the $200 million unsecured senior notes issued in March 2004 and $1.8 million attributable to the $120 million unsecured senior notes issued in September 2005;
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An increase of $1.6 million in interest expense attributable to an increase in the variable interest rate on the $100 million swap;
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An increase of $1.7 million attributable to the assumption of mortgage debt related to the acquisition of properties during 2004;
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An increase of $1.7 million attributable to outstanding principal balances on our line credit, resulting from the payoff of $26.7 million of mortgage notes, acquisitions of property and development activities and increase in the variable interest rate on the borrowings;
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A decrease of $2.5 million of interest expense attributable to the payoff of $26.7 million of mortgage notes and amortization of loan principal; and
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An increase in capitalized interest due to development and redevelopment activities which decreased interest expense by $150,000.
Investment income increased by $5.6 million or 238.5% to $7.9 million for 2005 from $2.3 million in 2004 due to a $5.0 million gain on the sale of Cedar Shopping Center common and preferred stock and an increase of $906,000 of dividends received on the shares prior to their sale in 2005, offset by a $554,000 reduction in interest income on the Winn Dixie bonds. We ceased recognizing interest income on the bonds until the payment of the interest is received from Winn Dixie.
We sold four properties and at December 31, 2005, have one property held for sale that qualifies for discontinued operations. The $589,000 operating results of these properties are reflected as gain on disposal of income producing properties. The sales of the properties produced an aggregate gain of $11.5 million for 2005. The 2004 income from rental properties held for sale of $6.3 million reflects a reclassification of operations for properties sold during 2004 and 2005 and the one property held for sale that qualifies as discontinued operations. We recognized gains of $22.2 million in 2004 related to the sales of properties during 2004.
During 2004, the limited partners of IRT Partners LP elected to convert their partnership interest for our common stock. This conversion resulted in a decrease in the minority interest.
As a result of the foregoing, net income decreased by $5.1 million, or 5.2 %, to $92.7 million for 2005 from $97.8 million in 2004.
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003.
The following summarizes items from our audited consolidated statements of operations that we think are important in understanding our operations and/or those items which significantly changed in 2004 compared to 2003 (in thousands):
Total rental revenue increased by $49.8 million, or 28.2%, to $226.6 million in 2004 from $176.8 million in 2003. The following factors accounted for this difference:
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Properties acquired during 2004 increased rental revenue by approximately $15.9 million;
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The full year 2004 benefited from properties acquired during 2003 which increased rental revenue by approximately $18.3 million;
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The acquisition of IRT increased rental revenue by approximately $11.2 million;
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Same property rental revenue increased by approximately $1.9 million in 2004 due to higher occupancy at the centers and increases in rental rates; and
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The completion of development and redevelopment properties increased rental revenue by approximately $2.4 million.
Property operating expenses increased by $8.7 million, or 16.9%, to $60.1 million for 2004 from $51.4 million in 2003. The following factors accounted for this difference:
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Properties acquired during 2004 increased operating expenses by approximately $3.6 million;
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Properties acquired during 2003 increased the full year 2004 operating expenses by approximately $3.4 million;
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The acquisition of IRT increased property operating expenses by approximately $1.2 million;
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Same property operating expenses decreased by approximately $345,000 due to lower maintenance expense; and
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The completion of development and redevelopment properties increased operating expenses by $594,000.
Rental property depreciation and amortization increased by $9.6 million, or 36.9%, to $35.6 million for 2004 from $26.0 million in 2003. The following factors accounted for this difference:
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Properties acquired during 2004 increased depreciation and amortization by approximately $2.9 million;
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Properties acquired during 2003 increased depreciation and amortization by approximately $2.3 million;
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The acquisition of IRT increased the full year 2004 depreciation and amortization by approximately $2.8 million;
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Same property depreciation and amortization increased by $285,000 related to leasing and tenant improvement amortization; and
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The completion of development and redevelopment properties increased depreciation and amortization by $1.2 million.
General and administrative expenses increased by $5.6 million, or 50.3% to $16.6 million for 2004 from $11.0 million in 2003. Compensation and employer related expenses increased by $3.3 million, including $2.4 million of deferred compensation expense associated with the issuance of restricted stock that vest over time and $700,000 of compensation and related expenses due to an increase of staffing. The 2004 general and administrative expenses also included an increase in professional fees of $860,000 related to compliance with the Sarbanes Oxley Act of 2002 and a write off of $1.1 million of pre-acquisition due diligence cost related to a corporate transaction that did not materialize.
Interest expense increased by $9.6 million, or 26.6%, to $45.7 million for 2004 from $36.1 million in 2003. This difference was primarily due to:
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An increase of $5.9 million attributable to the $200 million unsecured senior notes issued in March, 2004;
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An increase of $1.8 million attributable to the assumption of debt related to the acquisition of properties during 2004;
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Properties acquired during 2003, including the acquisition of IRT, increased interest expense by $2.9 million due to assumption of mortgage loans;
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Interest incurred on same properties decreased by $485,000 due to the repayment of certain existing mortgage notes;
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Interest on the revolving credit lines decreased by $1.2 million due to repayment of outstanding balances from the proceeds received from the issuance of the senior notes and decreased borrowing activities, and
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A decrease in capitalized interest due to the completion of development and redevelopment activities which increased interest expense by $618,000.
During 2003, we settled certain mortgage notes at a discount and recognized a loss on the extinguishment of debt of $513,000.
During 2004, the limited partners or IRT Partners LP elected to convert their partnership interest for our common stock. This conversion resulted in a decrease in the minority interest.
We sold 14 properties including one property held by a joint venture, and had one property held for sale at December 31, 2004. The $6.3 million of operating results of these properties are reflected as income from rental properties sold or held for sale, and include properties sold in 2005 and the one property held for sale, in which we have no continuing involvement, as of December 31, 2005. The sales of the properties in 2004 produced gains of $22.2 million. The discontinued operations of $8.9 million reflect a reclassification of properties sold during 2003, 2004 and 2005. We recognized gains of $3.1 million in related to the sales of properties during 2003.
As a result of the foregoing, net income increased by $34.2 million, or 53.7 %, to $97.8 million for 2004 from $63.6 million in 2003.
Liquidity and Capital Resources
We anticipate that cash flows from operating activities will continue to provide adequate capital for dividend payments in accordance with the IRS’ REIT requirements and our operating needs. Depending on capital market conditions, we anticipate using cash on hand, borrowings under our existing unsecured revolving credit facilities, assumptions of mortgages, issuance of unsecured public debt and equity as well as other similar financing to provide the necessary capital to meet our needs.
Cash Flows. Net cash provided by operations of $117.2 million for the year ended December 31, included: (i) net income of $92.7 million, (ii) adjustments for non-cash and gain on sale items which increased cash flow by $24.7 million, and (iii) a net change in operating assets over operating liabilities of $262,000, compared to net cash provided by operations of $113.1 million for the year ended December 31, 2004, which included: (i) net income of $97.8 million, (ii) adjustments for non-cash and gain on sale items which increased cash flow by $13.1 million, and (iii), a net change in operating liabilities over operating assets of $2.2 million.
Net cash used in investing activities of $82.4 million for the year ended December 31, 2005 included: the acquisition of (i) three parcels of land held for future development, two retail properties, and two non-retail properties for $54.1 million, (ii) construction, development and other capital improvements of $34.3 million, (iii) increased leasing costs of $5.9 million, (iv) the purchase of securities of $60.6 million, and (v) an increase in notes receivable of $4.2 million, offset by proceeds from the sale of properties of $44.0 million, and proceeds from the sale of securities of $32.7 million. These amounts should be compared to net cash used in investing activities of $244.8 million for the year ended December 31, 2004 which included: (i) the acquisition of three parcels of land held for future development and 17 shopping centers for $255.4 million, (ii) construction, development and other capital improvements of $34.0 million, (iii) increased leasing costs of $6.6 million, and (iv) the purchase of securities of $36.4 million, offset by (a) proceeds from property sales of $72.6 million, (b) distributions from joint ventures of $3.1 million, (c) proceeds from payments of notes receivable of $6.1 million, and (d) proceeds from the sale of securities of $5.8 million.
Net cash used in financing activities of $39.8 million for the year ended December 31, 2005 included: (i) net proceeds from the issuance of senior notes of $118.6 million, (ii) net proceeds from the issuance of common stock of $31.3 million, offset by (a) the repayment of ten mortgage notes aggregating $37.5 million and monthly principal payments on mortgage notes of $10.6 million, (b) cash dividends paid to common stockholders of $87.3 million, (c) net repayments under revolving credit facilities of $53.8 million, and (d) an increase in deferred financing costs of $463,000 related to the issuance of senior notes, and renewal of the revolving credit facility. These amounts should be compared to net cash provided by financing activities of $135.9 million for the year ended December 31, 2004, which included: (i) net proceeds from the issuance of senior notes of $198.5 million, (ii) net proceeds from the issuance of common stock of $57.9 million, and (iii) proceeds from the repayment of notes receivable of $3.5 million, offset by (a) the repayment of eight mortgage notes aggregating $15.9 million and monthly principal payments on mortgage notes of $9.8 million, (b) cash dividends paid to common stockholders of $80.9 million, (c) net repayments under revolving credit facilities of $15.0 million, (d) an increase in deferred financing costs of $1.9 million related to the issuance of senior notes, and (e) miscellaneous uses of $529,000.
Debt. The following is a summary of our borrowings consisting of mortgage notes payable, unsecured senior notes payable and unsecured revolving credit facilities (in thousands):
The weighted average interest rate at December 31, 2005 and 2004 was 7.19% and 7.26%, respectively, excluding the effects of the premium adjustment.
Each of the existing mortgage loans is secured by a mortgage on one or more of our properties. Certain of the mortgage loans involving an aggregate principal balance of approximately $103.6 million contain prohibitions on transfers of ownership which may have been violated by our previous issuances of common stock or in connection with past acquisitions and may be violated by transactions involving our capital stock in the future. If a violation were established, it could serve as a basis for a lender to accelerate amounts due under the affected mortgage. To date, no lender has notified us that it intends to accelerate its mortgage. In the event that the mortgage holders declare defaults under the mortgage documents, we will, if required, prepay the remaining mortgage from existing resources, refinancing of such mortgages, borrowings under our other lines of credit or other sources of financing. Based on discussions with various lenders, current credit market conditions and other factors, we believe that the mortgages will not be accelerated. Accordingly, we believe that the violations of these prohibitions will not have a material adverse impact on our results of operations or financial condition.
In September, 2005, we completed a $120 million offering of 5.375% senior unsecured notes that mature on October 15, 2015. Interest is due semi-annually on April 15 and October 15 of each year commencing on April 15, 2006. The notes were issued at a discount of $614,000 that will be amortized as interest expense over their life.
The indentures under which our unsecured senior notes were issued have several covenants which limit our ability to incur debt, require us to maintain an unencumbered assets ratio above a specified level and limit our ability to consolidate, sell, lease, or convey substantially all of our assets to, or merge with any other entity. These notes have also been guaranteed by most of our subsidiaries.
The interest rate on the 7.77% senior notes is subject to a 50 basis point increase if we do not maintain an investment grade debt rating.
We swapped $100.0 million of the $200.0 million of 3.875% senior notes to a floating interest rate based on 6-month LIBOR in arrears plus 0.4375%.
The weighted average interest rate of the unsecured senior notes at December 31, 2005 and 2004 was 5.2%, and 5.12%, respectively, and excluding the effects of the interest rate swap and premium adjustment.
In January 2006, we amended and restated our unsecured revolving credit facility with a syndicate of banks for which Wells Fargo Bank, National Association is the sole lead arranger and administrative agent. This facility has a maximum principal amount of $275 million and bears interest at our option at (i) LIBOR plus 0.45% to 1.15%, depending on the credit ratings of our senior unsecured long term notes, or (ii) the Federal Funds Rate plus 0.5%. The facility is guaranteed by most of our subsidiaries. Based on our current rating, the LIBOR spread is 0.80%. The facility also includes a competitive bid option which allows us to conduct auctions among the participating banks for borrowings in an amount not to exceed $137.5 million, a $35 million swing line facility for short term borrowing and a $20 million letter of credit commitment and may, at our request, be increased up to a total commitment of $400 million. The facility expires January 17, 2009 with a one-year extension option. In addition, the facility contains customary covenants, including financial covenants regarding debt levels, total liabilities, interest coverage, EBITDA coverage ratios, unencumbered properties and permitted investments. The facility also prohibits stockholder distributions in excess of 95% of funds from operations calculated at the end of each fiscal quarter for the four fiscal quarters then ending. Notwithstanding this limitation, we can make stockholder distributions to avoid income taxes on asset sales. If a default under the facility exists, our ability to pay dividends would be limited to the amount necessary to maintain the Company’s status as a REIT unless the default is a payment default or bankruptcy event in which case we would be prohibited from paying any dividends. The weighted average interest rate as of December 31, 2005 and 2004 was 4.68 % and 2.80%, respectively.
We also have a $5 million unsecured credit facility with City National Bank of Florida, of which there was a $165,000 outstanding balance as of December 31, 2005 and no outstanding balance at December 31, 2004. This facility also provides collateral for $1.3 million in outstanding letters of credit.
As of December 31, 2005, the availability under the various credit facilities as revised in January 2006, was approximately $185.6 million, net of outstanding balances and letters of credit.
At December 31, 2005, our fully diluted market capitalization totaled $2.8 billion, comprising 75.8 million shares of common stock and $1.0 billion of net debt (excluding any unamortized fair market premium/discount and net of cash). Our ratio of net debt to total market capitalization was 36.5%, and our ratio of net debt to gross real estate cost and securities investments was 48.2%.
Our debt level could subject us to various risks, including the risk that our cash flow will be insufficient to meet required payments of principal and interest, and the risk that the resulting reduced financial flexibility could inhibit our ability to develop or improve our rental properties, withstand downturns in our rental income or take advantage of business opportunities. In addition, because we currently anticipate that only a small portion of the principal of our indebtedness will be repaid prior to maturity, it is expected that it will be necessary to refinance the majority of our debt. Accordingly, there is a risk that such indebtedness will not be able to be refinanced or that the terms of any refinancing will not be as favorable as the terms of our current indebtedness.
Indebtedness
The following table sets forth certain information regarding our indebtedness as of December 31, 2005 (dollars in thousands):
(1)
The rate in effect on December 31, 2005, excludes effect of premium/discounts.
(2)
$100 million of the outstanding balance has been swapped to a floating interest rate based on the 6 month LIBOR in arrears, plus 0.4375%. The indicated rate and weighted average rate for the unsecured senior notes do not reflect this interest rate swap.
(3)
We notified the lender of our intent to prepay these mortgages on March 1, 2006.
Our mortgage and outstanding revolving credit facilities indebtedness outstanding at December 31, 2005 will require approximate balloon and scheduled principal payments as follows (in thousands):
(1)
Excludes the fair value of the interest rate swap.
We may not have sufficient funds on hand to repay these balloon amounts at maturity. Therefore, we expect to refinance this indebtedness either through additional mortgage financing secured by individual properties or groups of properties, by unsecured private or public debt offerings or by additional equity offerings. Our results of operations could be affected if the cost of new debt is greater or lesser than the cost of the maturing debt. If new financing is not available, we could be required to sell assets and our business would be adversely affected.
Development Activity. As of December 31, 2005, we had 17 significant development and redevelopment projects underway or in the planning stage totaling approximately $107.2 million of asset value which we anticipate will require $34.4 million of additional investment to complete based on current plans and estimates. The more significant of these include:
·
The development of two supermarket-anchored shopping centers, in McDonough, Georgia and Huntsville, Alabama;
·
Shops at Skylake in North Miami Beach, Florida, where we are in the process of adding 37,000 square feet of additional retail space;
·
Belfair Towne Village in Bluffton, South Carolina, where we are adding 41,250 square feet of retail space;
·
St. Lucie West Plaza, adjacent to our Cashmere Corners property in Port St. Lucie, Florida, where we are building 20,000 square feet of retail shops;
·
Mariner Crossing in Spring Hill, Florida, where we are building a 6,000 square foot building on an out parcel;
·
West Roxbury in West Roxbury, Massachusetts, where we are adding 8,000 square feet of retail space to the existing center; and
·
Bluebonnet Village in Baton Rouge, Louisiana, where we are adding 10,750 square feet of retail space on an out parcel.
These developments and redevelopments are scheduled for completion starting early 2006.
Shelf Registration. We have a universal shelf registration statement on file with the Securities and Exchange Commission, which will permit us, from time to time, to offer and sell various types of securities, including common stock, preferred stock, debt securities, depositary shares and warrants. The registration statement provides us additional flexibility in accessing capital markets to fund future growth and for general corporate purposes.
Equity. For the year ended December 31, 2005, we issued 595,700 shares of our common stock pursuant to the exercise of stock options at prices ranging from $10.00 to $16.22 per share. We also issued 1.3 million shares of common stock at prices ranging from $20.71 to $23.62 per share pursuant to our Divided Reinvestment and Stock Purchase Plan. As of December 31, 2005, we have 5.7 million shares remaining for sale under our Dividend Reinvestment and Stock Purchase Plan.
Future Capital Requirements. We believe, based on currently proposed plans and assumptions relating to our operations, that our existing financial arrangements, together with cash generated from our operations, will be sufficient to satisfy our cash requirements for a period of at least twelve months. In the event that our plans change, our assumptions change or prove to be inaccurate or cash flows from operations or amounts available under existing financing arrangements prove to be insufficient to fund our expansion and development efforts or to the extent we discover suitable acquisition targets the purchase price of which exceeds our existing liquidity, we would be required to seek additional sources of financing. There can be no assurance that any additional financing will be available on acceptable terms or at all, and any future equity financing could be dilutive to existing stockholders. If adequate funds are not available, our business operations could be materially adversely affected.
Distributions. We believe that we currently qualify, and intend to continue to qualify in the future, as a REIT under the Internal Revenue Code. As a REIT, we are allowed to reduce taxable income by all or a portion of our distributions to stockholders. As distributions have exceeded taxable income, no provision for federal income taxes has been made. While we intend to continue to pay dividends to our stockholders, we also will reserve such amounts of cash flow as we consider necessary for the proper maintenance and improvement of our real estate and other corporate purposes while still maintaining our qualification as a REIT. Our cash distributions for the year ended December 31, 2005 were $87.3 million.
New Accounting Standards
In March 2004, the EITF reached a consensus on EITF Issue No. 03-1, The Meaning of Other Than Temporary Impairment and Its Application to Certain Investments. The guidance prescribes a three-step model for determining whether an investment is other than temporarily impaired and requires disclosures about unrealized losses on investments. The accounting guidance became effective for reporting periods beginning after June 15, 2004, while the disclosure requirements became effective for annual reporting periods ending after June 15, 2004. In September 2004, the FASB issued FASB Staff Position (FSP) EITF 03-1-1, Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, (FSP EITF 03-11). FSP EITF 03-1-1 delayed the effective date for the measurement and recognition guidance contained in paragraphs 10-20 of EITF Issue 03-1. In November 2005, the FASB issued FSP FAS 115-1 and FAS 124-1, The Meaning of Other Than Temporary Impairment and Its Application to Certain Investments. This FSP addresses the determination as to when an investment is considered impaired, whether the impairment is other than temporary, and the measurement of an impairment loss. This statement specifically nullifies the requirements of paragraph 10-18 of EITF 03-1 and references existing other than temporary impairment guidance. The guidance under this FSP is effective for reporting periods beginning after December 15, 2005, and we continued to apply relevant “other-than-temporary” guidance, as provided for in FSP EITF 03-1-1 during fiscal 2005. We do not believe that the adoption of the guidance of FSP FAS 115-1 and FAS 124-1 will have a significant effect on our future consolidated financial statements.
In December 2004, the FASB issued SFAS 123(R), Share-Based Payment. This standard will require compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost will be measured based on the grant date fair value of the equity instruments issued. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. This standard replaces SFAS No. 123 and supersedes Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and applies to all awards granted, modified, repurchased or cancelled after July 1, 2005. In April 2005, the Securities and Exchange Commission (“SEC”) amended the compliance date of SFAS No. 123(R) through an amendment of Regulation S-X. Public companies with calendar year-ends would be required to adopt the provision of the standard effective for fiscal years beginning after June 15, 2005. The adoption on January 1, 2006 of SFAS 123(R)’s fair value method will have an impact on the Company’s results of operations, although it will have no impact on our overall financial position. Management has elected to apply the modified prospective transition method to all past awards outstanding and unvested as of the date of adoption. We estimate that the impact of adopting SFAS 123(R) in 2006 on our prior year and unvested stock option grants only will be approximately $276,000. However, had we adopted SFAS 123(R) in prior periods, the impact of the standard would have approximated the impact as presented in the disclosure of pro forma net income and earnings per share in Note 1, Stock Options, in the accompanying consolidated financial statements.
In December of 2004, the FASB issued Statement 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions. The guidance in APB Opinion No. 29 is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in that Opinion, however, included certain exceptions to that principle. Statement 153 amends Opinion 29 by eliminating the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. This statement shall be applied prospectively and is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. This pronouncement is prospective and has no effect on our financial position or results of operations as of December 31, 2004.
In March 2005, the FASB issued FASB Interpretation (FIN) No. 47, Accounting for Conditional Asset Retirement Obligations, an Interpretation of FASB Statement No. 143, which requires an entity to recognize a liability for the fair value of a conditional asset retirement obligation when incurred, if the liability’s fair value can be reasonably estimated. The Interpretation became effective for us in the fiscal year ended December 31, 2005. The adoption of the provisions of FIN 47 did not have an effect on our consolidated financial position, results of operations or cash flows.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Correction (SFAS 154”), which replaces APB Opinions No. 20 Accounting Changes and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements - An Amendment of APB Opinion No. 28. SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application, on the latest practicable date, as the required method for reporting a change in accounting principle and the reporting of a correction of an error. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005, and is required to be adopted by the Company in the first quarter of 2006. We are currently evaluating the effects of this proposed standard, but we do not expect it to materially impact our financial position, results of operations or cash flows.
In June 2005, the FASB ratified the consensus reached by the EITF regarding EITF No. 05-06, Determining the Amortization period of Leasehold Improvements. The guidance requires that leasehold improvements acquired in a business combination, or purchased subsequent to the inception of a lease, be amortized over the lesser of the useful life of the assets or term that includes renewals that has been reasonably assured at the date of the business combination. The guidance is effective for periods beginning after June 29, 2005. EITF 05-06 did not impact our results of operations, financial position or liquidity.
Environmental Matters
We are subject to numerous environmental laws and regulations. The operation of dry cleaning facilities at our shopping centers is the principal environmental concern. We require that the tenants who operate these facilities do so in material compliance with current laws and regulations and we have established procedures to monitor their operations. Additionally, we use all legal means to cause tenants to remove dry cleaning plants from our shopping centers. Where available, we have applied and been accepted into state sponsored environmental programs. Several properties in our portfolio will require or are currently undergoing varying levels of environmental remediation. However, we have environmental insurance policies covering all of our properties. We believe that the ultimate disposition of currently known environmental matters will not have a material effect on our financial position, liquidity or operations.
Inflation and Recession Considerations
Most of our leases contain provisions designed to partially mitigate the adverse impact of inflation. Most of our leases require the tenant to pay its share of operating expenses, including common area maintenance, real estate taxes and insurance, thereby reducing our exposure to increases in costs and operating expenses resulting from inflation. A small number of our leases also include clauses enabling us to receive percentage rents based on a tenant’s gross sales above predetermined levels, which sales generally increase as prices rise, or escalation clauses which are typically related to increases in the Consumer Price Index or similar inflation indices.
Our financial results are affected by general economic conditions in the markets in which our properties are located. An economic recession, or other adverse changes in general or local economic conditions, could result in the inability of some of our existing tenants to meet their lease obligations and could otherwise adversely affect our ability to attract or retain tenants. Supermarkets, drugstores and other anchor tenants that offer day-to-day necessities rather than luxury items anchor our existing properties. These types of tenants, in our experience, generally maintain more consistent sales performance during periods of adverse economic conditions.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Interest Rate Risk
Interest Rate Risk. The primary market risk to which we have exposure is interest rate risk. Changes in interest rates can affect our net income and cash flows. As changes in market conditions occur and interest rates increase or decrease, interest expense on the variable component of our debt will move in the same direction. We intend to utilize variable rate indebtedness available under our unsecured revolving credit facilities in order to initially fund future acquisitions, development costs and for other operating needs. With respect to our fixed rate mortgage notes and fixed rate senior unsecured notes, changes in interest rates generally do not affect our interest expense as these notes are predominantly at fixed-rates for extended terms. Because we have the intent to hold our existing fixed rate notes either to maturity or until the sale of the associated property, these fixed-rate notes do not pose an interest rate risk to our results of operations or our working capital position, only upon the refinancing of that mortgage. Our possible risk is from increases in long-term interest rates that may occur over a period of several years, as this may decrease the overall value of its real estate.
As of December 31, 2005, we had approximately $193.1 million of outstanding floating rate debt, including $100.0 million of fixed rate borrowings that we have converted to floating rate borrowings through the use of hedging agreements. We do not believe that the interest rate risk represented by our floating rate debt is material as of December 31, 2005, in relation to our $1.0 billion of outstanding debt, $2.0 billion of total assets and $1.8 billion total equity market capitalization as of that date.
If interest rates on our variable rate debt increase by 1%, the increase in annual interest expense on our variable rate debt would decrease future earnings and cash flows by approximately $1.9 million. If interest rates on our variable rate debt decrease by 1%, the decrease in interest expense on our variable rate debt would increase future earnings and cash flows by approximately $1.9 million. This assumes that the amount outstanding under our variable rate debt remains at approximately $193.1 million (including the $100 million of fixed rate debt converted to floating rate debt through the use of hedging agreements), the balance as of December 31, 2005.
The fair value of our fixed rate debt is $816.0 million, which includes the mortgage notes and fixed rate portion of senior unsecured notes payable (excluding the unamortized premium). If interest rates increase by 1%, the fair value of our total fixed rate debt would decrease by approximately $25.4 million. If interest rates decrease by 1%, the fair value of our total outstanding debt would increase by approximately $35.6 million. This assumes that our total outstanding fixed rate debt remains at $816.9 million, the balance as of December 31, 2005.
Hedging. To manage, or hedge, our exposure to interest rate risk, we follow established risk management policies and procedures, including the use of a variety of derivative financial instruments. We do not enter into derivative instruments for speculative purposes. We require that the hedges or derivative financial instruments be effective in managing the interest rate risk exposure that they are designated to hedge. This effectiveness is essential to qualify for hedge accounting. Hedges that meet these hedging criteria are formally designated as such at the inception of the contract. When the terms of an underlying transaction are modified, or when the underlying hedged item ceases to exist, resulting in some ineffectiveness, the change in the fair value of the derivative instrument will be included in earnings. Additionally, any derivative instrument used for risk management that becomes ineffective is marked-to-market each period and would be charged to operations.
We are exposed to credit risk, in the event of non-performance by the counter-parties to the hedge agreements. We believe that we mitigate our credit risk by entering into these agreements with major financial institutions. Net interest differentials to be paid or received under a swap contract and/or collar agreement are included in interest expense as incurred or earned.
During 2004, we entered into a $100.0 million notional principal variable rate interest swap with an estimated fair value of $4.6 million as of December 31, 2005. This swap converted fixed rate debt to variable rate based on the 6 month LIBOR in arrears plus 0.4375%, and matures April 15, 2009.
We have entered into interest rate swap contracts which fix the treasury rate for an anticipated financing in early 2006 at a weighted average interest rate of 4.39% per annum on notional amounts aggregating $95.0 million which expire in March 2006. The Company entered into the interest rate swap contracts to reduce our exposure to the variability in future cash flows attributable to changes in the treasury rate in contemplation of obtaining fixed-rate financing. During 2006, we unwound $75.0 million of the swaps for total settlement proceeds to us of $1.0 million.
The estimated fair value of our derivative financial instruments has been determined using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that we could realize in a current market exchange. The use of different market assumptions or estimation methodologies may have a material effect on the estimated fair value.
Other Market Risks
As of December 31, 2005, we had no material exposure to any other market risks (including foreign currency exchange risk, commodity price risk or equity price risk).
For purposes of the Securities and Exchange Commission's market risk disclosure requirements, we have estimated the fair value of our financial instruments at December 31, 2005. The fair value estimates presented herein are based on pertinent information available to management as of December 31, 2005. Although management is not aware of any factors that would significantly affect the estimated fair value amounts as of December 31, 2005, future estimates of fair value and the amounts which may be paid or realized in the future may differ significantly from amounts presented.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required by Regulation S-X are included in this Form 10-K commencing on page.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
On May 25, 2005, we filed a Current Report on Form 8-K reporting that on May 23, 2005, we notified Deloitte & Touche LLP, our former independent registered public accounting firm, that we had elected to change accounting firms and, therefore, were dismissing Deloitte & Touche.
The decision to change auditors was approved by the audit committee of our board of directors.
Neither Deloitte & Touche’s audit reports on our consolidated financial statements for the two years ended December 31, 2004 contained an adverse opinion or a disclaimer of opinion, or was qualified or modified as to uncertainty, audit scope, or accounting principles.
There were no disagreements with Deloitte & Touche, whether resolved or unresolved, on any matter of accounting principles or practices, financial statement disclosures, or auditing scope or procedure that, if not resolved to Deloitte & Touche’s satisfaction, would have caused Deloitte & Touche to make reference to the subject matter of the disagreement in connection with its report for either of the two years ended December 31, 2004 or any subsequent interim period through May 23, 2005.
On June 17, 2005, the audit committee of our board of directors finalized the engagement of Ernst & Young LLP as our new independent registered public accounting firm. Neither we nor anyone acting on our behalf consulted with Ernst & Young with respect to any of the matters or events set forth in Item 304(a)(2)(i) and (ii) of Regulation S-K.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including the principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(d) under the Securities Exchange Act of 1934, as amended, as of December 31, 2005, the end of the period covered by this report. Based on this evaluation, our principal executive officer and principal financial officer concluded as of the December 31, 2005 that our disclosure controls and procedures were effective at the reasonable assurance level such that the information relating to us and our consolidated subsidiaries, required to be disclosed in our Securities and Exchange Commission (SEC) reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
(b) Management Report on Internal Control over Financial Reporting
The report of our management regarding internal control over financial reporting is set forth in Item 8 of this Annual Report on Form 10-K under the caption “Management Report on Internal Control over Financial Reporting” and incorporated herein by reference.
(c) Attestation Report of Independent Registered Public Accounting Firm
The attestation report of our independent registered public accounting firm regarding internal control over financial reporting is set forth in page of Item 8 of this Annual Report on Form 10-K under the caption “Report of Independent Registered Public Accounting Firm” and incorporated herein by reference.
(d) Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the quarter ended December 31, 2005, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated by reference from our definitive proxy statement to be filed within 120 days after the end of our fiscal year covered by this Form 10-K.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
Incorporated by reference from our definitive proxy statement to be filed within 120 days after the end of our fiscal year covered by this Form 10-K.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Equity Compensation Plan Information
The following table sets forth information regarding securities authorized for issuance under equity compensation plans as of December 31, 2005.
(1)
Includes information related to our 1995 Stock Option Plan, 2000 Executive Incentive Compensation Plan, 1989 IRT Stock Option Plan and 1998 IRT Long-Term Incentive Plan.
The other information required by this item is incorporated by reference from our definitive proxy statement to be filed within 120 days after the end of our fiscal year covered by this Form 10-K.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated by reference from our definitive proxy statement to be filed within 120 days after the end our fiscal year covered by this Form 10-K.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information required and the audit committee’s pre-approval policies regarding the engagement of the principal accountants are incorporated by reference from our definitive proxy statement to be filed within 120 days after the end our fiscal year covered by this Form 10-K.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)
The following consolidated financial information is included as a separate section of this Form 10-K:
(b)
Exhibits: The following exhibits are filed as part of, or incorporated by reference into, this annual report.
EXHIBIT NO.
DESCRIPTION
3.1
Composite Charter of the Company (Exhibit 3.1) (1)
3.2
Amended and Restated Bylaws of the Company (Exhibit 3.2) (2)
4.1
Indenture dated November 9, 1995 between the Company, as successor-by-merger to IRT Property Company, and SunTrust Bank, as Trustee (Exhibit 4(c)) (3)
4.2
Supplemental Indenture No. 1, dated March 26, 1996, between the Company, as successor-by-merger to IRT Property Company, and SunTrust Bank, as Trustee (Exhibit 4) (4)
4.3
Supplemental Indenture No. 2, dated August 15, 1997, between the Company, as successor-by-merger to IRT Property Company, and SunTrust Bank, as Trustee (Exhibit 4) (5)
4.4
Supplemental Indenture No. 3, dated September 9, 1998, between the Company, as successor-by-merger to IRT Property Company, and SunTrust Bank, as Trustee (Exhibit 4.1) (6)
4.5
Supplemental Indenture No. 4, dated November 1, 1999, between the Company, as successor-by-merger to IRT Property Company, and SunTrust Bank, as Trustee (Exhibit 4.1) (7)
4.6
Supplemental Indenture No. 5, dated February 12, 2003, between the Company and SunTrust Bank, as Trustee (Exhibit 4.1) (8)
4.7
Supplemental Indenture No. 6, dated April 23, 2004, between the Company and SunTrust Bank, as Trustee (Exhibit 4.2) (9)
4.8
Supplemental Indenture No. 7, dated May 20, 2005, between the Company and SunTrust Bank, as Trustee (Exhibit 4.1) (25)
4.9
Indenture, dated September 9, 1998, between the Company, as successor-by-merger to IRT Property Company, and SunTrust Bank, as Trustee (Exhibit 4.2) (6)
4.10
Supplemental Indenture No. 1, dated September 9, 1998, between the Company, as successor-by-merger to IRT Property Company, and SunTrust Bank, as Trustee (Exhibit 4.3) (6)
4.11
Supplemental Indenture No. 2, dated November 1, 1999, between the Company, as successor-by-merger to IRT Property Company, and SunTrust Bank, as Trustee (Exhibit 4.5) (7)
4.12
Supplemental Indenture No. 3, dated February 12, 2003, between the Company and SunTrust Bank, as Trustee (Exhibit 4.2) (8)
4.13
Supplemental Indenture No. 4, dated March 26, 2004, between the Company and SunTrust Bank, as Trustee (Exhibit 4.1) (10)
4.14
Supplemental Indenture No. 5, dated April 23, 2004, between the Company and SunTrust Bank, as Trustee (Exhibit 4.1) (9)
4.15
Supplemental Indenture No. 6 dated May 20, 2005, between the Company and Sun Trust Bank, as Trustee (Exhibit 4.2)(25)
4.16
Supplemental Indenture No. 7 dated September 20, 2005, between the Company and Sun Trust Bank, as Trustee (Exhibit 4.1)(26)
4.17
Supplemental Indenture No. 8 dated December 30, 2005, between the Company and Sun Trust Bank, as Trustee
10.1
Form of Indemnification Agreement (Exhibit 10.1)(30)
10.2
Stock Option Plan, as amended (11)*
10.3
Amended and Restated 2000 Executive Incentive Plan (Annex A) (12)*
10.4
Form of Stock Option Agreement for stock options awarded under the Amended and Restated 2000 Executive Incentive Plan (Exhibit 10.3) (21)*
10.5
Form of Restricted Stock Agreement for restricted stock awarded under the Amended and Restated 2000 Executive Incentive Plan (Exhibit 10.4) (21)*
10.6
IRT 1989 Stock Option Plan, assumed by the Company (13)*
10.7
IRT 1998 Long-Term Incentive Plan, assumed by the Company (14)*
10.8
Employee Stock Purchase Plan (Annex B) (12)*
10.9
Registration Rights Agreement, dated as of January 1, 1996 by and among the Company, Chaim Katzman, Gazit Holdings, Inc., Dan Overseas Ltd., Globe Reit Investments, Ltd., Eli Makavy, Doron Valero and David Wulkan, as amended. (Exhibit 10.6, Amendment No. 3) (15)
10.10
Stock Exchange Agreement dated May 18, 2001 among the Company, First Capital Realty Inc. and First Capital America Holding Corp (16)
10.11
Use Agreement, regarding use of facilities, by and between Gazit (1995), Inc. and the Company, dated January 1, 1996. (Exhibit 10.15, Amendment No. 1) (15)
10.12
Subscription Agreement, dated October 4, 2000, made by Alony Hetz Properties & Investments, Ltd. (Exhibit 10.13) (17)
10.13
Stockholders Agreement, dated October 4, 2000, among the Company, Alony Hetz Properties & Investments, Ltd., Gazit-Globe (1982), Ltd., M.G.N. (USA), Inc. and Gazit (1995), Inc. (Exhibit 10.14) (17)
10.14
First Amendment to Stockholders Agreement, dated December 19, 2001, among the Company Alony Hetz Properties & Investments, Ltd., Gazit-Globe (1982), Ltd., M.G.N. (USA), Inc. and Gazit (1995), Inc. (Exhibit 10.15) (17)
10.15
Second Amendment to Stockholders Agreement, dated October 28, 2002, among the Company Alony Hetz Properties & Investments, Ltd., Gazit-Globe (1982), Ltd., M.G.N. (USA), Inc. and Gazit (1995), Inc. (18)
10.16
Third Amendment to Stockholders Agreement, dated May 23, 2003, among the Company Alony Hetz Properties & Investments, Ltd., Gazit-Globe (1982), Ltd., M.G.N. (USA), Inc. and Gazit (1995), Inc. (9)
10.17
Amended and Restated Employment Agreement dated effective as of January 1, 2002 between the Company and Chaim Katzman (Exhibit 10.1) (1)*
10.18
First Amendment to Amended and Restated Employment Agreement, dated September 1, 2003, with Chaim Katzman (Exhibit 10.1) (19)*
10.19
Amended and Restated Employment Agreement dated effective as of January 1, 2002 between the Company and Doron Valero (Exhibit 10.2) (1)*
10.20
First Amendment to Amended and Restated Employment Agreement, dated September 1, 2003, with Doron Valero (Exhibit 10.2) (19)*
10.21
Second Amended and Restated Employment Agreement, dated September 1, 2003, between the Company and Howard M. Sipzner (Exhibit 10.1) (20)*
10.22
Employment Letter, dated March 11, 2003, by and between Alan Merkur and the Company (Exhibit 10.5) (21)*
10.23
Employment Letter, dated March 24, 2003, by and between Arthur L. Gallagher and the Company (Exhibit 10.6) (21)*
10.24
Registration Rights Agreement, dated October 28, 2002, between the Company and certain Purchasers (Exhibit 99.3) (22)
10.25
Credit Agreement, dated February 7, 2003, among the Company, each of the financial institutions initially a signatory thereto; Commerzbank AG New York and Grand Cayman Branches, Keybank National Association and Southtrust Bank, as Documentary Agents; and Wells Fargo Bank, National Association, as Sole Lead Arranger and Administration Agent (Exhibit 10.1) (10)
10.25
Amendment No. 1 to Credit Agreement, dated as of March 18, 2004, among the Company, Wells Fargo Bank, National Association, in its capacity as contractual representative of the lenders named therein (Exhibit 10.1) (23)
10.26
Amendment No. 2 to Credit Agreement, dated as of July 19, 2004, among the Company, Wells Fargo Bank, National Association, in its capacity as contractual representative of the lenders named therein (Exhibit 10.1) (24)
10.27
Amended and Restated Credit Agreement, dated as of January 17, 2006, among the Company, each of the financial institutions initially a signatory thereto, Wachovia Bank National Association and SunTrust Bank, as Co-Syndication Agents, PNC Bank National Association and JP Morgan Chase Bank, N.A., as Co-Documentation Agents, Bank of America, N.A., Harris Nesbitt (Bank Of Montreal) and Branch Banking and Trust Company, as Managing Agents, and Wells Fargo Bank, National Association as Administrative Agent and as Sole Lead Arranger. (Exhibit 10.1)(27)
10.28
Clarification Agreement and Protocol, dated as of January 1, 2004, among the Company and Gazit-Globe (1982), Ltd. (Exhibit 10.2) (23)
10.29
Employment Agreement dated as of May 26, 2005 between the Company and Alan Merkur (Exhibit 10.1)(28)
10.30
Employment Agreement dated as of May 31, 2005 between the Company and David Briggs (Exhibit 10.2)(28)
10.31
Equity One, Inc. Non-Qualified Deferred Compensation Plan. (Exhibit 10.1) (29)
12.1
Ratios of Earnings to Fixed Charges
21.1
List of Subsidiaries of the Registrant
23.1
Consent of Ernst & Young LLP
23.2
Consent of Deloitte & Touche LLP
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. 1350, as created by Section 906 of the Sarbanes-Oxley Act of
*Identifies employee agreements, management contracts, compensatory plans or other arrangements.
(1)
Previously filed as an exhibit to our Quarterly Report on Form 10-Q for the period ended June 30, 2002, and incorporated by reference herein.
(2)
Previously filed as an exhibit to our Annual Report on Form 10-K for the period ended December 31, 2003, and incorporated by reference herein.
(3)
Previously filed by IRT Property Company as an exhibit to IRT’s Annual Report on Form 10-K for the period ending December 31, 1995, and incorporated by reference herein.
(4)
Previously filed by IRT Property Company as an exhibit to IRT’s Current Report on Form 8-K filed on March 26, 1996, and incorporated by reference herein.
(5)
Previously filed by IRT Property Company as an exhibit to IRT’s Current Report on Form 8-K filed on August 13, 1997, and incorporated by reference herein.
(6)
Previously filed by IRT Property Company as an exhibit to IRT’s Current Report on Form 8-K filed on September 15, 1998, and incorporated by reference herein.
(7)
Previously filed by IRT Property Company as an exhibit to IRT’s Current Report on Form 8-K filed on November 12, 1999, and incorporated by reference herein.
(8)
Previously filed as an exhibit to our Current Report on Form 8-K filed on February 20, 2003, and incorporated by reference herein.
(9)
Previously filed as an exhibit to our Quarterly Report on Form 10-Q for the period ended March 31, 2004, and incorporated by reference herein.
(10)
Previously filed as an exhibit to our Current Report on Form 8-K filed on March 31, 2004, and incorporated by reference herein.
(11)
Previously filed with our definitive Proxy Statement for the Annual Meeting of Stockholders held on June 30, 1999, and incorporated herein by reference.
(12)
Previously filed with our definitive Proxy Statement for the Annual Meeting of Stockholders held on May 21, 2004, and incorporated herein by reference.
(13)
Previously filed by IRT Property Company as an exhibit to IRT’s Current Report on Form 8-K filed on March 22, 1989, and incorporated herein by reference.
(14)
Previously filed by IRT Property Company with IRT’s definitive Proxy Statement for the Annual Meeting of Stockholders held on May 22, 1998, and incorporated herein by reference.
(15)
Previously filed with our Registration Statement on Form S-11, as amended (Registration No. 333-3397), and incorporated herein by reference.
(16)
Previously filed as Appendix A to our definitive Proxy Statement for the Special Meeting of Stockholders held on September 6, 2001 and incorporated herein by reference.
(17)
Previously filed with our Annual Report Form 10-K/A filed on March 18, 2002, and incorporated herein by reference.
(18)
Previously filed as Exhibit 10.1 to our Quarterly Report on Form 10-Q for the period ended September 30, 2002, and incorporated by reference herein.
(19)
Previously filed with our Quarterly Report on Form 10-Q for the period ended September 30, 2003, and incorporated by reference herein.
(20)
Previously filed with our Current Report on Form 8-K filed on January 6, 2004, and incorporated by reference herein.
(21)
Previously filed with our Current Report on Form 8-K filed on February 18, 2005, and incorporated by reference herein.
(22)
Previously filed as Exhibit 2.1 to our Current Report on Form 8-K filed on October 30, 2002, and incorporated by reference herein.
(23)
Previously filed as an exhibit to our Current Report on Form 8-K filed on March 16, 2004, and incorporated by reference herein.
(24)
Previously filed as an exhibit to our Current Report on Form 8-K filed on July 26, 2004, and incorporated by reference herein.
(25)
Previously filed as an exhibit to our Quarterly Report on Form 10-Q for the period ended June 30, 2005, and incorporated by reference herein.
(26)
Previously filed as an exhibit to our Current Report on Form 8-K filed on September 20, 2005, and incorporated by reference herein.
(27)
Previously filed as an exhibit to our Current Report on Form 8-K on January 20, 2006, and incorporated by reference herein.
(28)
Previously filed as an exhibit to our Current Report on Form 8-K on June 1 2005, and incorporated by reference herein.
(29)
Previously filed as an exhibit to our Current Report on Form 8-K on July 7, 2005, and incorporated by reference herein.
(30)
Previously filed as an exhibit to our Annual Report on Form 10-K on March 16, 2005, and incorporated by reference herein.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 1, 2006
EQUITY ONE, INC.
By: /s/ Chaim Katzman
Chaim Katzman
Chairman of the Board and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities, and on the dates indicated.
SIGNATURE
TITLE
DATE
/s/ Chaim Katzman
Chairman of the Board and
March 1, 2006
Chaim Katzman
Chief Executive Officer
(Principal Executive Officer)
/s/ Doron Valero
President, Chief Operating Officer
March 1, 2006
Doron Valero
and Director
/s/ Howard M. Sipzner
Executive Vice President and
March 1, 2006
Howard M. Sipzner
Chief Financial Officer
(Principal Accounting and
Financial Officer)
/s/ Noam Ben Ozer
Director
March 1, 2006
Noam Ben Ozer
/s/ James S. Cassel
Director
March 1, 2006
James S. Cassel
/s/ Robert L. Cooney
Director
March 1, 2006
Robert L. Cooney
/s/ Neal Flanzraich
Director
March 1, 2006
Neal Flanzraich
/s/ Patrick L. Flinn
Director
March 1, 2006
Patrick L. Flinn
/s/ Nathan Hetz
Director
March 1, 2006
Nathan Hetz
/s/ Peter Linneman
Director
March 1, 2006
Peter Linneman
/s/ Shaiy Pilpel
Director
March 1, 2006
Dr. Shaiy Pilpel
/s/ Dori Segal
Director
March 1, 2006
Dori Segal
EQUITY ONE, INC. AND SUBSIDIARIES
Management Report on Internal Control Over Financial Reporting
The management of Equity One, Inc. and subsidiaries (the Company) is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) promulgated under the Securities Exchange Act of 1934, as a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting, which requires the use of certain estimates and judgments, and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
·
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;
·
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
·
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Reasonable assurance is based on the premise that the cost of internal controls should not exceed the benefits derived. Reasonable assurance includes the understanding that there is a remote likelihood that material misstatements will not be prevented or detected in a timely manner. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005. In making this assessment, the Company’s management used the criteria set forth by the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has concluded that, as of December 31, 2005, the Company’s internal control over financial reporting is effective.
Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company’s independent registered public accounting firm has issued an attestation report on our assessment of the Company’s internal control over financial reporting. This report appears on the following page of this Annual Report.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Equity One, Inc.
We have audited management’s assessment, included in the accompanying Management Report on Internal Control over Financial Reporting, that Equity One, Inc. and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of the effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended December 31, 2005 of the Company and our report dated March 1, 2006 expressed an unqualified opinion on those financial statements and the financial statement schedule.
/s/ ERNST & YOUNG LLP
Certified Public Accountants
Miami, Florida
March 1,
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Equity One, Inc.
We have audited the accompanying consolidated balance sheet of Equity One, Inc. and subsidiaries (the “Company”) as of December 31, 2005, and the related consolidated statements of operations, comprehensive income, stockholders' equity, and cash flows for the year then ended. Our audit also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit. The financial statements of Equity One, Inc. and subsidiaries for each of the two years in the period ended December 31, 2004 were audited by other auditors whose report dated March 11, 2005 (March 1, 2006, as to the effects of the discontinued operations described in Note 10), expressed an unqualified opinion on those statements.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the 2005 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Equity One, Inc. and subsidiaries at December 31, 2005, and the consolidated results of their operations and their cash flows for the year ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 1, 2006 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
Certified Public Accountants
Miami, Florida
March 1,
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Equity One, Inc.
North Miami Beach, Florida
We have audited the accompanying consolidated balance sheet of Equity One, Inc. and subsidiaries (the “Company”) as of December 31, 2004 and the related consolidated statements of operations, comprehensive income, stockholders’ equity and cash flows for each of the two years in the period then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Equity One, Inc., and subsidiaries as of December 31, 2004, and the results of their operations and their cash flows for each of the two years in the period then ended, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the company’s internal control over financial reporting as of December 31, 2004, based on the criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report (not presented herein) dated March 11, 2005, expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the company’s internal control over financial reporting.
/s/ DELOITTE & TOUCHE LLP
Certified Public Accountants
Miami, Florida
March 11, 2005 (March 1, 2006, as to the effects
of the discontinued operations described in Note 10)
EQUITY ONE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2005 AND 2004
(In thousands, except per share amounts)
See accompanying notes to the consolidated financial statements.
EQUITY ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
(In thousands, except per share amounts)
EQUITY ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
(In thousands, except per share amounts)
See accompanying notes to the consolidated financial statements.
EQUITY ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
(In thousands, except per share amounts)
See accompanying notes to the consolidated financial statements.
EQUITY ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
YEARS ENDED DECEMBER 31 2003, 2004 AND 2005
(In thousands, except per share amounts)
See accompanying notes to the consolidated financial statements.
EQUITY ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2005, 2004, AND 2003
(In thousands, except per share amounts)
EQUITY ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
(In thousands, except per share amounts)
See accompanying notes to the consolidated financial statements.
EQUITY ONE, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
(In thousands, except per share amounts)
1.
Organization and Basis of Presentation
Organization
Equity One, Inc. operates as a self-managed real estate investment trust (“REIT”) that principally acquires, renovates, develops and manages community and neighborhood shopping centers located predominantly in high growth markets in the southern and northeastern United States. These shopping centers are primarily anchored by supermarkets or other necessity-oriented retailers such as drugstores or discount retail stores.
Basis of Presentation
The consolidated financial statements include the accounts of Equity One, Inc. and its wholly-owned subsidiaries and those partnerships where the Company has financial and operating control. Equity One, Inc. and its subsidiaries are hereinafter referred to as “the consolidated companies” or the “Company.” The Company has a 50% investment in one joint venture which no individual party controls and, accordingly, uses the equity method of accounting for this joint venture.
All significant intercompany transactions and balances have been eliminated in consolidation.
Portfolio
As of December 31, 2005, the Company owned a total of 192 properties, encompassing supermarket-anchored shopping centers, seven drug store-anchored shopping centers, 49 other retail-anchored shopping centers, six retail development parcels and five non-retail properties, as well as a non-controlling interest in one unconsolidated joint venture.
2.
Summary of Significant Accounting Policies
Properties
Income producing property is stated at cost and includes all costs related to acquisition, development and construction, including tenant improvements, interest incurred during development, costs of predevelopment and certain direct and indirect costs of development. Costs incurred during the predevelopment stage are capitalized once management has identified a site, determined that the project is feasible and it is probable that the Company is able to proceed with the project. Expenditures for ordinary maintenance and repairs are expensed to operations as they are incurred. Significant renovations and improvements, which improve or extend the useful life of assets, are capitalized.
The Company is actively pursuing acquisition opportunities and will not be successful in all cases; costs incurred related to these acquisition opportunities are expensed when it is probable that the Company will not be successful in the acquisition.
Depreciation expense is computed using the straight-line method over the estimated useful lives of the assets, as follows:
Business Combinations
The results of operations of any acquired property are included in the Company’s financial statements as of the date of its acquisition.
The Company allocates the purchase price of acquired companies and properties to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values. Fair value is defined as the amount at which that asset could be bought or sold in a current transaction between willing parties (other than in a forced or liquidation sale). In order to allocate the purchase price of acquired companies and properties to the tangible and intangible assets acquired, the Company identifies and estimates the fair value of the land, buildings and improvements, reviews the leases to determine the existence of, and estimates the fair value of, any contractual or other legal rights and investigates the existence of, and estimates the fair value of, any other identifiable intangible assets. Such valuations require management to make significant estimates and assumptions, especially with respect to intangibles.
The cost approach is used as the primary method to estimate the fair value of the buildings, improvements and other assets. The cost approach is based upon the current costs to develop the particular asset in that geographic location, less an allowance for physical and functional depreciation. The assigned value for buildings and improvements is based on an as if vacant basis. The market value approach is used as the primary method to estimate the fair value of the land. The determination of the fair value of contractual intangibles is based on the costs incurred to originate a lease, including commissions and legal costs, excluding any new leases negotiated in connection with the purchase of a property. In-place lease values are based on management’s evaluation of the specific characteristics of each lease and the Company’s overall relationship with each tenant. Among the factors considered in the allocation of these values include the nature of the existing relationship with the tenant, the tenant’s credit quality, the expectation of lease renewals, the estimated carrying costs of the property during a hypothetical expected lease-up period, current market conditions and costs to execute similar leases. Estimated carrying costs include real estate taxes, insurance, other property operating costs and estimates of lost rentals at market rates during the hypothetical expected lease-up periods, given the specific market conditions. Above-market and below-market lease values are determined based on the present value (using a discount rate reflecting the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the leases negotiated and in-place at the time of acquisition and (ii) management’s estimate of fair market lease rates for the property or equivalent property, measured over a period equal to the remaining non-cancelable term of the lease. The value of contractual intangibles is amortized over the remaining term of each lease. Other than as discussed above, the Company has determined that its real estate properties do not have any other significant identifiable intangibles.
Critical estimates in valuing certain of the intangibles and the assumptions of what marketplace participants would use in making estimates of fair value include, but are not limited to: future expected cash flows, estimated carrying costs, estimated origination costs, lease up periods and tenant risk attributes, as well as assumptions about the period of time the acquired lease will continue to be used in the Company’s portfolio and discount rates used in these calculations. Management’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. Assumptions may not always reflect unanticipated events and changes in circumstances may occur. In making such estimates, management uses a number of sources, including appraisals, third party cost segregation studies or other market data, as well as, information obtained in its pre-acquisition due diligence and marketing and leasing activities.
In the event that a tenant terminates its lease, the unamortized portion of each related intangible would be expensed.
Intangibles associated with property acquisitions are included in other assets in the Company’s consolidated balance sheet.
Construction in progress and land held for development
Land held for development is stated at cost. Costs incurred during the predevelopment stage are capitalized once management has identified a site, determined that the project is feasible and it is probable that the Company is able to proceed with the project. Properties undergoing significant renovations and improvements are considered under development. The Company estimates the cost of a property undergoing renovations as a basis for determining eligible costs. Interest, real estate taxes and other costs directly related to the properties and projects under development are capitalized until the property is ready for its intended use. Similar costs related to properties not under development are expensed as incurred. In addition, the Company writes off costs related to predevelopment projects when it determines that it will no longer pursue the project.
Total interest expense capitalized to construction in progress and land held for development was $3,354, $3,204 and $3,822 for the years ended December 31, 2005, 2004 and 2003, respectively.
Property Held for Sale
The Company adopted the provisions of SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, effective January 1, 2002. The definition of a component of an entity under SFAS 144, assuming no significant continuing involvement, requires the sale of retail or industrial operating property and properties classified as held for sale as discontinued operations. Accordingly, the results of operations of properties disposed of, or classified as held for sale after January 1, 2002, for which the Company has no significant continuing involvement are reflected as discontinued operations.
As of December 31, 2005, one non-retail property and 31 properties located in Texas were classified as property held for sale.
In June 2005, the Company announced its intention to consider strategic alternatives for the properties located in Texas, including a possible sale or joint venture. The classification of the operating results for these properties in previous reporting periods were included in discontinued operations. In December 2005, however, management decided to consider the possibility of a joint venture with a strategic partner through which the Company would retain an ownership interest in and continue to manage the properties. As a result of the Company’s potential significant continuing involvement in these properties, the Company is required to include the operating results of 31 properties located in Texas in the consolidated income from continuing operations. Despite such treatment, upon completion of a possible joint venture transaction, in which the Company would have significant influence, the results of operations of the Texas properties would not be consolidated, but would be accounted for under the equity method of accounting. The effect on results of operations for the reporting periods is presented in footnote 10.
Long-lived assets
Long-lived assets, such as property, land held for development, and certain identifiable intangibles, are reviewed for impairment whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. These factors, along with plans with respect to the operations, are considered in assessing the recoverability of long-lived assets. If the Company determines that the carrying amount is impaired, the long-lived assets are written down to their fair value with a corresponding charge to earnings. During the periods presented, no such impairment was incurred.
Cash and cash equivalents
The Company considers highly liquid investments with an initial maturity of three months or less to be cash equivalents.
Accounts Receivable
Accounts receivable include amounts billed to tenants and accrued expense recoveries due from tenants. Management evaluates the collectibility of these receivables and adjusts the allowance for doubtful accounts to reflect amounts estimated to be uncollectible. The allowance for doubtful accounts was $1,533 and $1,400 at December 31, 2005 and 2004, respectively.
Securities
The Company’s investments consist primarily of equity and debt securities. The Company’s equity investments are classified as available-for-sale and recorded at fair value based on current market prices. Changes in the fair value of the equity investments are included in accumulated other comprehensive income (loss). The Company’s debt securities are recorded at cost and are classified as held-to-maturity, with the related discount/premium amortized over the life of the investment using the effective interest method.
For securities classified as held-to-maturity, the Company determines whether a decline in fair value below the amortized cost basis is other-than-temporary. If it is probable that the Company will be unable to collect all amounts due according to the contractual terms of a debt security, an other-than-temporary impairment is considered to have occurred. The determination of other-than-temporary declines in value requires significant estimates and assumptions by management and requires the consideration of expected outcomes that are out of management’s control. Subsequent changes in estimates, assumptions used or expected outcomes could impact the determination of whether a decline in value is other-than-temporary and whether the effects could materially impact the Company’s financial position or net income. If the decline in fair value is judged to be other-than-temporary, the cost basis of the individual security will be written down to fair value as a new cost basis and the amount of the write-down will be included in earnings (that is, accounted for as a realized loss).
As of December 31, 2005, the Company directly or indirectly owned approximately 2,383 shares of DIM Vastgoed N.V. ordinary shares. DIM Vastgoed N.V. (“DIM”) is a public company organized under the laws of the Netherlands whose shares are listed on Euronext Amsterdam, and which operates as a closed-end investment company owning and operating a portfolio of 18 shopping center properties aggregating 2,600 square feet in the southeastern United States. DIM’s capital structure has priority shares and ordinary shares. The priority shares are 100% owned by a foundation that is controlled by two members of the Supervisory Board. The ordinary shares have voting rights, however, only the priority shares have the right to nominate members to the Supervisory Board. As of February 28, 2006, the Company has increased the ownership of DIM’s ordinary shares to approximately 3,574 shares, representing 48.5% of DIM’s total outstanding ordinary shares.
Management believes the investment in DIM should be accounted for as an available-for-sale security, as we are unable to exert significant influence over DIM’s operating or financial policies and, based on DIM’s organizational and capital structure, we are unable to nominate or participate on DIM’s Supervisory Board. If circumstances or our ownership changes, we will reevaluate the status of our investment in DIM and make the applicable change to the accounting treatment, if necessary. We have committed to buy, in September 2007, an additional 45 ordinary shares for total consideration of $941.
As of December 31, 2005, the fair value of the Company’s debt securities is less than the carrying amount of the investment. The Company holds $14,110 in original principal amount of Winn-Dixie Stores, Inc. (“Winn-Dixie”) 8.875% senior notes due April 2008, at a carrying amount of $11,918 and an unrealized loss of $788. The decline in value occurred due to the declaration of bankruptcy by Winn-Dixie in February 2005. Management has considered and evaluated the pertinent facts available to it, including that: (i) Winn-Dixie’s equity at December 31, 2005 had a fair value of approximately $110,626 which we believe is an indicator that the notes are most likely recoverable, (ii) the notes’ decline in value is most likely due in part to the timeliness of the principal and interest payments, (iii) subsequent to the declaration of bankruptcy the notes’ market price has increased in fair value; and (iv) as a bond holder and Winn-Dixie being an anchor tenant in our shopping centers, we have received input from outside advisors in connection with the above, and those analyses and inputs reflect a positive enterprise value. Management believes that these factors provide reasonable assurance that the Company will recover its cost. Accordingly, as of December 31, 2005, the Company expects to recover the carrying amount of the investment. The Company has not recognized any investment income on the notes for the year ended December 31, 2005.
Changes in estimates, assumptions used or expected outcomes could impact the determination of whether a decline in value is other-than-temporary and whether the effects could materially impact the Company’s financial position or net income in future periods. If the market value of the notes remains less than the Company’s carrying amount of the notes for an extended period of time and/or the financial condition and near-term prospects of Winn-Dixie deteriorate or do not otherwise improve in the future, among other factors, the Company may be required to record a write-down of the investment.
Deferred Costs and Intangibles
Deferred costs and intangibles included in other assets consist of loan origination fees, leasing costs and the value of intangible assets when a property was acquired. Loan and other fees directly related to rental property financing with third parties are amortized over the term of the loan which approximates the effective interest method. Direct salaries, third party fees and other costs incurred by the Company to originate a lease are capitalized and are being amortized using the straight-line method over the term of the related leases. Intangible assets consist of in-place lease values, tenant origination costs and above/below market rents that was acquired in connection with the acquisition of the properties and is being amortized using the straight-line method over the terms of the related lease.
Deposits
Deposits included in other assets are composed of funds held by various institutions for future payments of property taxes, insurance and improvements, utility and other service deposits.
Goodwill
Goodwill has been recorded to reflect the excess of cost over the fair value of net assets acquired in various business acquisitions. The Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 142 on January 1, 2002 and no longer amortizes goodwill.
The Company is required to perform annual impairment tests of its goodwill, or more frequently in certain circumstances. The Company has elected to test for goodwill impairment in November of each year. The goodwill impairment test is a two-step process, which requires management to make judgments in determining what assumptions to use in the calculation. The first step of the process consists of estimating the fair value of each reporting unit and comparing those estimated fair values with the carrying values, which include the allocated goodwill. If the estimated fair value is less than the carrying value, a second step is performed to compute the amount of the impairment by determining an “implied fair value” of goodwill. The determination of a reporting unit’s “implied fair value” of goodwill requires the Company to allocate the estimated fair value of the reporting unit to the assets and liabilities of the reporting unit. Any unallocated fair value represents the “implied fair value” of goodwill, which is compared to its corresponding carrying amount. During the periods presented, no impairment of goodwill was incurred.
The key assumptions management employs to determine the fair value of the Company’s reporting units (each property is considered a reporting unit) include (a) net operating income; (b) cash flows; and (c) an estimation of the fair value of each reporting unit, which was based on the Company’s experience in evaluating acquisitions and market conditions. A variance in the net operating income or discount rate could have a significant impact on the amount of any goodwill impairment charge recorded.
Management cannot predict the occurrence of certain future events that might adversely affect the reported value of goodwill that totaled $12,013 at December 31, 2005. Such events include, but are not limited to, strategic decisions made in response to economic and competitive conditions, the impact of the economic environment on the Company’s tenant base, or a material negative change in its relationships with significant tenants.
During 2005, $325 of goodwill was included in the determination of the gain on disposal of income producing properties due to the disposition of certain properties.
Minority interest
On January 1, 1999, Equity One (Walden Woods) Inc., a wholly-owned subsidiary of the Company, entered into a limited partnership as a general partner. An income producing shopping center (“Walden Woods Village”) was contributed by its owners (the “Minority Partners”), and the Company contributed 93.656 shares of the Company’s common stock (the “Walden Woods Shares”) to the limited partnership at an agreed-upon price of $10.30 per share. Based on this per share price and the net value of property contributed by the Minority Partners, each of the partners received 93.656 limited partnership units. The Company has entered into a Redemption Agreement with the Minority Partners whereby the Minority Partners can request that the Company purchase either their limited partnership units or any shares of common stock which they received in exchange for their partnership units at a price of $10.30 per unit or per share no earlier than two years nor later than fifteen years after the exchange date of January 1, 1999. As a result of the Redemption Agreement, the Company has consolidated the accounts of the partnership with the Company’s financial data. In addition, under the terms of the limited partnership agreement, the Minority Partners do not have an interest in the Walden Woods Shares except to the extent of dividends. Accordingly, a preference in earnings has been allocated to the Minority Partners to the extent of the dividends declared. The Walden Woods Shares are not considered outstanding in the consolidated financial statements and are excluded from the share count in the calculation of primary earnings per share.
On December 5, 2000, a wholly owned subsidiary of the Company, Equity One (North Port) Inc., entered into a limited partnership (the “Shoppes of North Port, Ltd.”) as a general partner. The North Port minority partners had the right to redeem their partnership units (“OPUs”) for the Company’s common stock on a one-for-one basis or for cash at an agreed upon price of $11.00 per share no earlier than December 10, 2001, nor later than three and one half years thereafter. During July 2003, North Port Minority Partners redeemed their OPUs in exchange for 261.850 shares of the Company’s common stock. North Port is now a wholly owned subsidiary of the Company.
The Company is the general partner of IRT Partners L.P. (“LP”) and maintains an indirect partnership interest through its wholly-owned subsidiary, IRT Management Company. LP was formed in order to enhance the acquisition opportunities of the Company through a downREIT structure. This structure offers potential sellers of properties the ability to make a tax-deferred sale of their real estate properties in exchange for limited partnership units (“OP Units”) of LP. During September 2004, the outstanding OP Units were redeemed in exchange for 734.266 shares of the Company’s common stock. LP is now a wholly owned subsidiary of the Company.
The Company has a controlling, general partner’s interest in Sunlake Equity Joint Venture. The Company has funded all of the acquisition costs, is required to fund any necessary development and operating costs, receives an 8% preferred return on its advances and is entitled to 60% of the profits thereafter. The minority partners are not required to make contributions and, to date, have not contributed any capital. Accordingly, no minority interest has been recorded. The joint venture is in the process of obtaining the required approvals and permits to continue its business plan.
The Company also has a controlling general partnership interest (75% interest) in Venice Plaza and records a minority interest for the limited partners’ share of equity.
Notes receivable from issuance of common stock
As a result of certain provisions of the Sarbanes-Oxley Act of 2002, the Company is generally prohibited from making loans to directors and executive officers. Prior to the adoption of the Sarbanes-Oxley Act of 2002, the Company had loaned $7,112 to various executives in connection with their exercise of options to purchase shares of the Company’s common stock of which $7,047 has been repaid. The remaining note bears interest only, payable quarterly, at the rate of 5% per annum and the principal is due in June 2007. In accordance with the provisions of the Sarbanes-Oxley Act of 2002, there has been no material modifications to the terms of the outstanding loan granted to executives.
Revenue Recognition
Rental income comprises minimum rents, expense reimbursements, termination fees and percentage rent payments. Minimum rents are recognized over the lease term on a straight-line basis. Expense reimbursements are recognized in the period that the applicable costs are incurred. The Company accounts for these leases as operating leases as the Company has retained substantially all risks and benefits of property ownership. Percentage rent is recognized when the tenant’s reported sales have reached certain levels specified in the respective lease. Termination fees are recognized upon the termination of a tenant’s lease.
The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of tenants to make required rent payments. The computation of this allowance is based on the tenants’ payment history and current credit quality.
Earnings Per Share
Basic earnings per share (“EPS”) are computed by dividing net income by the weighted average number of shares of the Company’s common stock outstanding during the period. Diluted EPS reflects the potential dilution that could occur from shares issuable under stock-based compensation plans, which would include the exercise of stock options, and the conversion of the operating partnership units held by minority limited partners.
Other Income
Other income includes fees earned in connection with certain third-party leasing activities and other third-party management activities. Management and third party leasing fees are recognized when earned.
Income Taxes
The Company elected to be taxed as a real estate investment trust (REIT) under the Internal Revenue Code (“Code”), commencing with its taxable year ended December 31, 1995. To qualify as a REIT, the Company must meet a number of organizational and operational requirements, including a requirement that it currently distribute at least 90% of its REIT taxable income to its stockholders. Also, at least 95% of the Company’s gross income in any year must be derived from qualifying sources. The difference between net income available to common shareholders for financial reporting purposes and taxable income before dividend deductions relates primarily to temporary differences, principally real estate depreciation and amortization, deduction of deferred compensation and deferral of gains on sold properties utilizing like kind exchanges. It is management’s intention to adhere to these requirements and maintain the Company’s REIT status. As a REIT, the Company generally will not be subject to corporate level federal income tax on taxable income it distributes currently to its stockholders. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal income taxes at regular corporate rates (including any applicable alternative minimum tax) and may not be able to qualify as a REIT for four subsequent taxable years. Even if the Company qualifies for taxation as a REIT, the Company may be subject to certain state and local taxes on its income and property, and to federal income and excise taxes on its undistributed taxable income. Accordingly, the only provision for federal income taxes in the accompanying consolidated financial statements relates to the Company’s consolidated taxable REIT subsidiaries (“TRS”). The Company’s TRS’s did not have significant tax provisions or deferred income tax items.
The Company has certain corporate tax attributes carried over from previous mergers (for example, net operating losses, alternative minimum tax credit carry-forwards, etc.). Net operating losses available to the Company are estimated to be approximately $24,469, but their utilization is limited subject to the provisions of the Code Sections 381 and 382. Code Section 1374 imposes a tax on the net built-in gain of C-Corporation assets that become assets of a REIT (i.e. the Company) in a carryover-basis transaction. The estimated net built-in gain at the date of acquisition is approximately $38,390. In lieu of the tax imposed on the transferor C-Corporation, the Company is subject to a Ten-Year Rule, which defers and eliminates recognition of the built-in gain tax liability if the assets subject to the tax are not disposed of within ten years from the date of the acquisition. In addition to the Ten-Year Rule, the Company has the ability to utilize like-kind exchanges, carry-over C-Corporation tax attributes, and other tax planning strategies to mitigate the potential recognition of built-in gain tax.
At December 31, 2005 and 2004, the accompanying financial statement basis of assets and liabilities exceeds the tax basis by approximately $283,663 and $287,019, respectively.
Stock Option and Other Equity-Based Plans
The Company has various stock-based employee compensation plans. Through December 31, 2005, the Company applied APB 25, Accounting for Stock Issued to Employees and related interpretations in accounting for its plans. Accordingly, the Company does not recognize compensation cost for stock options when the option exercise price equals or exceeds the market value on the date of the grant. No stock-based employee compensation cost for stock options is reflected in net income, as all options under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The Company records compensation expense related to its restricted stock plan. 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 123, Accounting for Stock-Based Compensation, to stock-based employee compensation (in thousands, except per share data).
The following is a summary of the Company’s stock option activity for the years ended December 31, 2005, 2004 and 2003:
* Converted to Company options upon merger with IRT
The fair value of each option grant was estimated on the grant date using a binomial option-pricing model with the following assumptions for the years ended December 31, 2005, 2004 and 2003:
The options were granted with an exercise price equivalent to the current stock price on the grant date.
The following table summarizes information about outstanding stock options as of December 31, 2005
Segment information
The Company’s properties are community and neighborhood shopping centers located predominantly in high growth markets in the southern and northeastern United States. Each of the Company’s centers are separate operating segments which have been aggregated and reported as one reportable segment because they have characteristics so similar that they are expected to have essentially the same future prospects. The economic characteristics include similar returns, occupancy and tenants and each is located near a metropolitan area with similar economic demographics and site characteristics.
Use of estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
New accounting pronouncements
In March 2004, the EITF reached a consensus on EITF Issue No. 03-1, The Meaning of Other Than Temporary Impairment and Its Application to Certain Investments. The guidance prescribes a three-step model for determining whether an investment is other than temporarily impaired and requires disclosures about unrealized losses on investments. The accounting guidance became effective for reporting periods beginning after June 15, 2004, while the disclosure requirements became effective for annual reporting periods ending after June 15, 2004. In September 2004, the FASB issued FASB Staff Position (FSP) EITF 03-1-1, Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, (FSP EITF 03-11). FSP EITF 03-1-1 delayed the effective date for the measurement and recognition guidance contained in paragraphs 10-20 of EITF Issue 03-1. In November 2005, the FASB issued FSP FAS 115-1 and FAS 124-1, The Meaning of Other Than Temporary Impairment and Its Application to Certain Investments. This FSP addresses the determination as to when an investment is considered impaired, whether the impairment is other than temporary, and the measurement of an impairment loss. This statement specifically nullifies the requirements of paragraph 10-18 of EITF 03-1 and references existing other than temporary impairment guidance. The guidance under this FSP is effective for reporting periods beginning after December 15, 2005, and the Company continued to apply relevant “other-than-temporary” guidance, as provided for in FSP EITF 03-1-1 during fiscal 2005. The Company does not believe that the adoption of the guidance of FSP FAS 115-1 and FAS 124-1 will have a significant effect on its future consolidated financial statements.
In December 2004, the FASB issued SFAS 123(R), Share-Based Payment. This standard will require compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost will be measured based on the grant date fair value of the equity instruments issued. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. This standard replaces SFAS No. 123 and supersedes Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and applies to all awards granted, modified, repurchased or cancelled after July 1, 2005. In April 2005, the Securities and Exchange Commission (“SEC”) amended the compliance date of SFAS No. 123(R) through an amendment of Regulation S-X. Public companies with calendar year-ends would be required to adopt the provision of the standard effective for fiscal years beginning after June 15, 2005. The adoption on January 1, 2006 of SFAS 123(R)’s fair value method will have an impact on the Company’s results of operations, although it will have no impact on the Company’s overall financial position. The Company has elected to apply the modified prospective transition method to all past awards outstanding and unvested as of the date of adoption. The estimated impact of adopting SFAS 123(R) for 2006, relating to prior year and unvested stock option grants only, will be approximately $276. However, had the Company adopted SFAS 123(R) in prior periods, the impact of the standard would have approximated the impact as presented in the disclosure of pro forma net income and earnings per share in Note 1, Stock Options.
In December of 2004, the FASB issued SFAS 153, Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions. The guidance in APB Opinion No. 29 is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in that Opinion, however, included certain exceptions to that principle. Statement 153 amends Opinion 29 by eliminating the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. This statement shall be applied prospectively and is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. This pronouncement is prospective and has no effect on the Company’s financial position or results of operations as of December 31, 2004.
In March 2005, the FASB issued FASB Interpretation (FIN) No. 47, Accounting for Conditional Asset Retirement Obligations, an Interpretation of FASB Statement No. 143, which requires an entity to recognize a liability for the fair value of a conditional asset retirement obligation when incurred, if the liability’s fair value can be reasonably estimated. The Interpretation is effective no later than the end of fiscal years ending after December 15, 2005. The adoption of the provisions of FIN 47 did not have an effect on the Company’s consolidated financial position, results of operations or cash flows.
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Correction (SFAS 154”), which replaces PB Opinions No. 20 Accounting Changes and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements - An Amendment of APB Opinion No. 28. SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application, on the latest practicable date, as the required method for reporting a change in accounting principle and the reporting of a correction of an error. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005, and are required to be adopted by the Company in the first quarter of 2006. We are currently evaluating the effects of this proposed standard, but management does not expect it to materially impact the financial position, results of operations or cash flows of the Company.
In June 2005, the FASB ratified the consensus reached by the EITF regarding EITF No. 05-06, Determining the Amortization period of Leasehold Improvements. The guidance requires that leasehold improvements acquired in a business combination, or purchased subsequent to the inception of a lease, be amortized over the lesser of the useful life of the assets or term that includes renewals that has been reasonably assured at the date of the business combination of purchase. The guidance is effective for periods beginning after June 29, 2005. EITF 05-06 did not impact the Company’s, financial position, results of operations, or cash flows.
Fair value of financial instruments
The estimated fair values of financial instruments have been determined by the Company using available market information and appropriate valuation methods. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methods may have a material effect on the estimated fair value amounts. The Company has used the following market assumptions and/or estimation methods:
Cash and Cash Equivalents and Accounts and Other Receivables. The carrying amounts reported in the balance sheets for these financial instruments approximate fair value because of their short maturities.
Notes Receivable. The fair value is estimated by using the current interest rates at which similar loans would be made. The carrying amounts reported in the balance sheets approximate fair value.
Available for Sale Securities. The fair value estimated at December 31, 2005 and 2004 was $55,648 and $29,297, respectively, based on the closing market prices of the securities. The unrealized holding gain was $3,404 and $4,633 at December 31, 2005 and 2004, respectively.
Debt Securities. The fair value estimated at December 31, 2005 was $13,322, based on the closing market prices of the securities.
Mortgage Notes Payable. The fair value estimated at December 31, 2005 and 2004 was $463,005 and $531,200, respectively, calculated based on the net present value of payments over the term of the loans using estimated market rates for similar mortgage loans and remaining terms.
Unsecured Revolving Credit Facilities. The fair value was estimated by using the current rates at which similar loans would be made and remaining terms. The carrying amounts reported in the balance sheets approximate fair value.
Unsecured Senior Notes Payable. The fair value estimated at December 31, 2005 and 2004 was $453,032 and $351,584, respectively, calculated based on the net present value of payments over the term of the loan using estimated market rates for similar notes and remaining terms.
3.
Properties
Acquisitions
The following table reflects a series of individual properties that were acquired during 2005:
No equity interests were issued or issuable in connection with the above purchases and no contingent payments, options or commitments are provided for in the agreements. No goodwill was recorded in conjunction with any of the individual property acquisitions.
The Company’s allocation of the purchase price for the acquisitions consummated during 2005 is preliminary and is subject to change. The Company is in the process of obtaining additional market data related to the fair value of the land, real property and in-place leases. Management does not believe that any adjustment would have a material effect on the Company’s financial position, results of operations or cash flows.
The amounts assigned to intangibles consisting of in-place leases, lease origination costs and above/below market leases are $654, $172, and $802, respectively. The weighted average amortization period is 10.4 years.
4.
Accounts and Other Receivables
5.
Investments in Joint Ventures
The Company has included in other assets in its consolidated balance sheets at December 31 2005 and 2004, an investment of $285 and $273, respectively, in an unconsolidated joint venture, which owns a parcel of land that is held for future development or sale. The Company is obligated to fund 50% of any working capital that is required (as determined jointly by the Company and its joint venture partner). The current obligations are a nominal amount to pay property taxes and other carrying costs. The joint venture currently has no outstanding debt obligations or contractual commitments and the Company has not guaranteed any obligations of the joint venture.
6.
Other Assets
All amounts assigned to intangible assets are subject to amortization. The gross carrying amount and accumulated amortization of the Company’s intangible assets as of December 31, 2005 and 2004 was $6,789 and $5,390, and accumulated amortization of $1,252 and $212, respectively for in-place leases; $2,725 and $4,029, and accumulated amortization of $625 and $297, respectively, for lease origination costs; and $5,408 and $4,939, and accumulated amortization of $1,107 and $192, respectively for above/below market leases. For the years ended December 31, 2005 and 2004, the amortization for the intangible assets was $624 and $317, respectively. The amortization for the next five years for the recorded intangible assets is approximately $1,206, $1,027, $635, $520, and $414, respectively.
7.
Notes Payable
The following is a summary of the Company’s borrowings, consisting of mortgage notes payable, unsecured senior notes payable and unsecured revolving credit facilities:
The weighted average interest rate of the mortgage notes payable at December 31, 2005 and 2004 was 7.19% and 7.26%, respectively, excluding the effects of the premium adjustment.
Each of the existing mortgage loans is secured by a mortgage on one or more of the Company’s properties. Certain of the mortgage loans involving an aggregate principal balance of approximately $103,620 contain prohibitions on transfers of ownership which may have been violated by the Company’s previous issuances of common stock or in connection with past acquisitions and may be violated by transactions involving the Company’s capital stock in the future. If a violation were established, it could serve as a basis for a lender to accelerate amounts due under the affected mortgage. To date, no lender has notified the Company that it intends to accelerate its mortgage. In the event that the mortgage holders declare defaults under the mortgage documents, the Company will, if required, repay the remaining mortgage from existing resources, refinancing of such mortgages, borrowings under its revolving lines of credit or other sources of financing. Based on discussions with various lenders, current credit market conditions and other factors, the Company believes that the mortgages will not be accelerated. Accordingly, the Company believes that the violations of these prohibitions will not have a material adverse impact on the Company’s results of operations or financial condition.
In September, 2005, the Company completed a $120,000 offering of 5.375% senior unsecured notes that mature on October 15, 2015. Interest is due semi-annually on April 15 and October 15 of each year commencing on April 15, 2006. The notes were issued at a discount of $614 that will be amortized as interest expense over the life of the notes.
The indentures under which the Company’s unsecured senior notes were issued have several covenants which limit the ability to incur debt, require the Company to maintain an unencumbered assets ratio above a specified level and limit the ability to consolidate, sell, lease, or convey substantially all of the assets to, or merge with any other entity. These notes have also been guaranteed by most of the Company’s subsidiaries.
The interest rate on the 7.77% senior notes is subject to a 50 basis point increase if the Company does not maintain an investment grade debt rating.
The Company swapped $100.0 million of the $200.0 million senior notes to a floating interest rate based on the 6-month LIBOR in arrears plus 0.4375%.
The weighted average interest rate of the unsecured senior notes at December 31, 2005 and 2004 was 5.2%, and 5.12%, respectively, excluding the effects of the interest rate swap and premium adjustment.
In January 2006, the Company entered into an amended and restated unsecured revolving credit facility, with a syndicate of banks for which Wells Fargo Bank, National Association is the sole lead arranger and administrative agent. This facility has a maximum principal amount of $275,000 and bears interest at the Company’s option at (i) LIBOR plus 0.45% to 1.15%, depending on the credit ratings of the Company’s senior unsecured long term notes or (ii) Federal Funds Rate plus 0.5%. The facility is guaranteed by most of the Company’s subsidiaries. Based on the Company’s current rating, the LIBOR spread is 0.80%. The facility also includes a competitive bid option which allows the Company to conduct auctions among the participating banks for borrowings in an amount not to exceed $137,500, a $35,000 swing line facility for short term borrowings, a $20,000 letter of credit commitment and may, at the request of the Company, be increased up to a total commitment of $400,000. The facility expires January 17, 2009 with a one-year extension option. In addition, the facility contains customary covenants, including financial covenants regarding debt levels, total liabilities, interest coverage, EBITDA coverage ratios, unencumbered properties and permitted investments. The facility also prohibits stockholder distributions in excess of 95% of funds from operations calculated at the end of each fiscal quarter for the four fiscal quarters then ending. Notwithstanding this limitation, the Company can make stockholder distributions to avoid income taxes on asset sales. If a default under the facility exists, the Company’s ability to pay dividends would be limited to the amount necessary to maintain the Company’s status as a REIT unless the default is a payment default or bankruptcy event in which case the Company would be prohibited from paying any dividends. The weighted average interest rate as of December 31, 2005 and 2004 was 4.68% and 2.80%, respectively.
The Company also has a $5,000 unsecured credit facility with City National Bank of Florida, of which there was a $165 outstanding balance as of December 31, 2005. This facility also provides collateral for $1,283 in outstanding letters of credit.
As of December 31, 2005, the availability under the various credit facilities was approximately $185,552, net of outstanding balances and letters of credit.
Principal maturities (including scheduled amortization payments) of the notes payable as of December 31, 2005 are as follows:
Interest costs incurred, excluding amortization of discount/premium, were $60,496, $55,291 and $45,593 in the years ended December 31, 2005, 2004, 2003, respectively, of which $3,354, $3,204, and $3,822 were capitalized in the years ended December 31, 2005, 2004, 2003, respectively.
8.
Financial Instruments - Derivatives and Hedging
To manage, or hedge, the exposure to interest rate risk, the Company follows established risk management policies and procedures, including the use of a variety of derivative financial instruments. The Company does not enter into derivative instruments for speculative purposes. The Company requires that the hedges or derivative financial instruments be effective in managing the interest rate risk exposure that they are designated to hedge. This effectiveness is essential to qualify for hedge accounting. Hedges that meet these hedging criteria are formally designated as such at the inception of the contract. When the terms of an underlying transaction are modified, or when the underlying hedged item ceases to exist, resulting in some ineffectiveness, the change in the fair value of the derivative instrument will be included in earnings. Additionally, any derivative instrument used for risk management that becomes ineffective is marked-to-market each period.
The Company is exposed to credit risk, in the event of non-performance by the counter-parties to the hedge agreements. The Company believes that it mitigates its credit risk by entering into these agreements with major financial institutions. Net interest differentials to be paid or received under a swap contract and/or collar agreement are included in interest expense as incurred or earned.
During 2004, the Company entered into a $100,000 notional principal variable rate interest swap with an estimated fair value of $4,596 as of December 31, 2005. This swap converted fixed rate debt to variable rate based on the 6 month LIBOR in arrears plus 0.4375%, and matures April 15, 2009.
The Company has entered into interest rate swap contracts which fix the treasury rate for an anticipated financing in early 2006, at a weighted average interest rate of 4.39% per annum on notional amounts aggregating $95,000, and expire in March 2006. The Company entered into the interest rate swap contracts to reduce its exposure to the variability in future cash outflows attributable to changes in the treasury rate in contemplation of obtaining fixed-rate financing. During 2006, the Company unwound $75,000 of the swaps for the total settlement proceeds to the Company of $1,030.
The estimated fair value of the Company’s derivative financial instruments has been determined using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions or estimation methodologies may have a material effect on the estimated fair value.
9.
Consolidating Financial Information
As of December 31, 2005, most of the Company’s subsidiaries have guaranteed the Company’s indebtedness under the unsecured senior debt. The guarantees are joint and several and full and unconditional.
10.
Dispositions
The Company adopted the provisions of SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, effective January 1, 2002. Under SFAS 144, the definition of a component of an entity requires that retail or industrial operating properties that have been sold and properties classified as held for sale, with no significant continuing involvement, be classified as discontinued operations. Accordingly, the results of operations of properties disposed of, or classified as held for sale after January 1, 2002, for which the Company has or expects no significant continuing involvement are reflected as discontinued operations.
The following table reflects properties that were sold during 2005:
As of December 31, 2005, one non-retail property and 31 properties located in Texas were classified as property held for sale.
The summary selected operating results for properties disposed of or designated as held for sale, with no significant continuing involvement are as follows:
In June 2005, the Company announced its intention to consider strategic alternatives for the properties located in Texas, including a possible sale or joint venture. The classification of the operating results for these properties in previous reporting periods were included in discontinued operations. In December 2005, however, management decided to consider the possibility of a joint venture with a strategic partner through which the Company would retain an ownership interest in and continue to manage the properties. As a result of the Company’s potential significant continuing involvement in these properties, the Company is required to include the operating results of 31 properties located in Texas in the consolidated income from continuing operations. Despite such treatment, upon completion of a possible joint venture transaction, in which the Company would have significant influence, the results of operations of the Texas properties would not be consolidated, but would be accounted for under the equity method of accounting.
The summary selected operating results for properties designated as held for sale, with significant continuing involvement are as follows:
11.
Stockholders’ Equity and Earnings Per Share
The following table reflects the change in number of shares of common stock outstanding for the year ended December 31, 2005:
* Includes the grants of 181 shares of “restricted stock” which are subject to forfeiture and vest over a period of one to three years.
** Includes shares surrendered on the exercise of options.
The following table reports dividends paid for the twelve months ended December 31, 2005 and 2004:
The following is a reconciliation of the amounts of net income and shares of common stock used in calculating basic and diluted per-share income (“EPS”) for the years ended December 31, 2005, 2004 and 2003:
Options to purchase 10 shares of common stock at $23.52 per share were outstanding at December 31, 2005, but were not included in the computation of diluted EPS because the option price was greater than the average market price of common shares.
All options outstanding at December 31, 2004 were included in the computation of diluted EPS.
Options to purchase 350 shares of common stock at $16.22 per share were outstanding at December 31, 2003 but were not included in the computation of diluted EPS because the option price was greater than the average market price of common shares.
13.
Benefit Plans
Stock-Based Compensation
On October 23, 1996, the Company adopted the Equity One, Inc. 1995 Stock Option Plan (the “Plan”), which was amended December 10, 1998. The purpose of the Plan is to further the growth of the Company by offering incentives to directors, officers and other key employees of the Company, and to increase the interest of these directors, officers and employees in the Company through additional ownership of its common stock. The effective date of the Plan was January 1, 1996. The maximum number of shares of common stock as to which options may be granted under this Plan is 1,000 shares, which is reduced each year by the required or discretionary grant of options. The term of each option is determined by the Compensation Committee of the Company (the “Committee”), but in no event can be longer than ten years from the date of the grant. The vesting of the options is determined by the Committee, in its sole and absolute discretion, at the date of grant of the option.
On June 23, 2000, the Company, with shareholder approval, adopted the Equity One 2000 Executive Incentive Compensation Plan (the “2000 Plan”). The terms of the 2000 Plan provide for grants of stock options, stock appreciation rights (“SARs”), restricted stock, deferred stock, other stock-related awards and performance or annual incentive awards that may be settled in cash, stock or other property. The persons eligible to receive an award under the 2000 Plan are the officers, directors, employees and independent contractors of the Company and its subsidiaries. Following an amendment to the 2000 Plan, approved by our stockholders on July 28, 2004, the total number of shares of common stock that may be issuable under the 2000 Plan is 5,500,000 shares, plus (i) the number of shares with respect to which options previously granted under the 2000 Plan terminate without being exercised, and (ii) the number of shares that are surrendered in payment of the exercise price for any awards or any tax withholding requirements. In addition to increasing the available shares, the July 2004 amendment expanded the list of business criteria that our compensation committee may use in granting performance awards and annual incentive awards under the 2000 Plan intended to qualify for the exclusions from the limitations of Section 162(m) of the Internal Revenue Code and modified the definition of a “change of control” to include, in addition to other instances, following approval by stockholders of any reorganization, merger or consolidation or other transaction or series of transactions if persons who were stockholders immediately prior to such reorganization, merger or consolidation or other transaction do not, immediately thereafter, own more than 50% of the combined voting power of the reorganized, merger or consolidated company’s then outstanding voting securities (previously the threshold was 26%). The 2000 Plan will terminate on the earlier of the day before the tenth anniversary of the stockholders’ approval of the 2000 Plan or the date on which all shares reserved for issuance under the 2000 Plan have been issued.
Restricted Stock Grants
The Company's Board of Directors grants restricted stock to its officers, directors, and other employees. Vesting periods for the restricted stock are determined by the Company’s Compensation Committee. The Company measures compensation costs for restricted stock awards based on the fair value of the Company’s common stock at the date of the grant and charges to expense such amounts to earnings ratably over the vesting period. During 2005, the Company’s Board of Directors granted 181 shares that have a weighted average fair value at the date of the grant ranging from $20.83 to $23.89 per share. As of December 31, 2005, the Company had 518 shares of non-vested restricted stock grants outstanding. The vesting of the 518 shares is as follows:
401(k) Plan
The Company has a 401(k) defined contribution plan (the “401(k) Plan”) covering substantially all of the officers and employees of the Company which permits participants to defer compensation up to the maximum amount permitted by law. The Company matches 75% of each employee’s contribution up to a maximum of 4.5% of the employee’s annual compensation. Employee’s contributions vest immediately while the Company’s matching contributions vest over three years. The Company’s contributions to the 401(k) Plan for the year ended December 31, 2005, 2004 and 2003 (inception) were $288, $253, and $177, respectively. The 401(k) Plan invests the Company’s matching contributions by purchasing publicly traded shares of the Company’s common stock.
Deferred Compensation Plan
During 2005, the Company established a non-qualified deferred compensation plan that permits eligible employees to defer a portion of their compensation. The deferred compensation liability (included in accounts payable in the accompanying balance sheet) was $147 at December 31, 2005. The Company has established a grantor trust (Rabbi Trust) to provide funding for benefits payable under its non-qualified deferred compensation plan. The assets held in the trust at December 31, 2005 amounted to $147. The Rabbi Trust’s assets consist of short-term cash investments and a managed portfolio of equity securities. These assets are included in other assets in the accompanying balance sheets.
Employee Stock Purchase Plan
Under the 2004 Employee Stock Purchase Plan (the “Purchase Plan”) (implemented in October 2004), Equity One employees, including directors of Equity One who are employees, are eligible to participate in quarterly plan offerings in which payroll deductions may be used to purchase shares of Common Stock. The purchase price per share will be 90% of the average closing price per share of common stock on the NYSE on the five (5) trading days that immediately precede the date of purchase (the “Exercise date”), provided, however, that in no event shall the exercise price per share of common stock on the exercise date of an offering period be less than the lower 85% of (i) the market price on the first day of the offering period or (ii) the market price on the Exercise Date.
14.
Future Minimum Rental Income, Commitments and Contingent Liabilities
Future minimum rental income under noncancelable operating leases approximates the following as of December 31, 2005:
As of December 31, 2005 and 2004, the Company has pledged letters of credit for $1,413 and $1,394, respectively, as additional security for financing.
We have committed to fund $34,400 based on current plans and estimates, in order to complete pending development and redevelopment projects. These obligations, comprised principally of construction contracts, are generally due as the work is performed and are expected to be financed by our available credit facilities.
Certain of the Company’s properties are subject to a ground lease, which are accounted for as operating leases and have annual obligations of approximately $100.
The Company is subject to litigation in the normal course of business, none of which as of December 31, 2005 in the opinion of management will have a material adverse effect on the financial condition, results of operations, or cash flows of the Company.
15.
Related Party Transactions
As of December 31, 2005 and 2004, the Company had outstanding loans to various executives in connection with their exercises of options to purchase shares of the Company’s common stock. The remaining note bears interest only, payable quarterly, at the rate of 5% per annum and is due June 2007. Investment income earned on the loans was $6, $55, and $255 for the years ended December 31, 2005, 2004 and 2003, respectively.
16.
Subsequent Events
During January 2006, the Company acquired two retail properties for total consideration of $56,600. The purchase price was funded from borrowings under our existing credit facility.
As of February 28, 2006, the Company has purchased an additional 1,182 shares of DIM Vastgoed N.V. ordinary shares for total consideration of $24,462. The purchase price was funded from borrowings under our existing credit facility.
17.
Quarterly Financial Data (unaudited)
_____________________
(1)
Reclassified to reflect the reporting of discontinued operations.
(2)
The sum of quarterly earnings per share amounts may differ from annual earnings per share.
* * * * *
SCHEDULE III
EQUITY ONE, INC.
REAL ESTATE INVESTMENTS AND ACCUMULATED EPRECIATION
December 31, 2005
(In Thousands)
S-1
SCHEDULE III
EQUITY ONE, INC.
REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION
December 31, 2005
(In Thousands)
S-2
SCHEDULE III
EQUITY ONE, INC.
REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION
December 31, 2005
(In Thousands)
S-3
SCHEDULE III
EQUITY ONE, INC.
REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION
December 31, 2005
(In Thousands)
S-4
SCHEDULE III
EQUITY ONE, INC.
REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION
December 31, 2005
(In Thousands)
S-5
SCHEDULE III
EQUITY ONE, INC.
REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION
December 31, 2005
(In Thousands)
S-6
SCHEDULE III
EQUITY ONE, INC.
REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION
December 31, 2005
(In Thousands)
S-7
SCHEDULE III
EQUITY ONE, INC.
REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION
December 31, 2005
(In Thousands)
S-8
SCHEDULE III
EQUITY ONE, INC.
REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION
December 31, 2005
(In Thousands)
S-9
SCHEDULE III
EQUITY ONE, INC.
REAL ESTATE INVESTMENTS AND ACCUMULATED DEPRECIATION
December 31, 2005
(In Thousands)
S-10
INDEX TO EXHIBITS
EXHIBIT NO.
DESCRIPTION
4.17
Supplemental Indenture No. 8
12.1
Ratio of Earnings to Fixed Charges
21.1
List of Subsidiaries of the Registrant
23.1
Consent of Ernst & Young LLP
23.2
Consent of Deloitte & Touche LLP
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. 1350, as created by Section 906 of the Sarbanes-Oxley Act of