UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

For the quarterly period ended September 30, 2016

OR

For the transition period from                  to                  

Commission file number 1-11690

 

DDR Corp.

(Exact name of registrant as specified in its charter)

 

 

 

3300 Enterprise Parkway, Beachwood, Ohio 44122

(Address of principal executive offices - zip code)

(216) 755-5500

(Registrant’s telephone number, including area code)

 

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of October 31, 2016, the registrant had 366,266,652 outstanding common shares, $0.10 par value per share.

 

 

 

 

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DDR Corp.

QUARTERLY REPORT ON FORM 10-Q

QUARTER ENDED SEPTEMBER 30, 2016

 

TABLE OF CONTENTS

 

 

 

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DDR Corp.

CONSOLIDATED BALANCE SHEETS

(unaudited; in thousands, except share amounts)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.  

 

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DDR Corp.

CONSOLIDATED STATEMENTS OF OPERATIONS 

(unaudited; in thousands, except per share amounts)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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DDR Corp.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited; in thousands, except per share amounts)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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DDR Corp.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

(unaudited; in thousands)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.  

 

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DDR Corp.

CONSOLIDATED STATEMENT OF EQUITY

(unaudited; in thousands)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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DDR Corp.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited; in thousands)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

 

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Notes to Condensed Consolidated Financial Statements

 

 

Nature of Business

DDR Corp. and its related consolidated real estate subsidiaries (collectively, the “Company” or “DDR”) and unconsolidated joint ventures are primarily engaged in the business of acquiring, owning, developing, redeveloping, expanding, leasing and managing shopping centers.  In addition, the Company engages in the origination and acquisition of loans and debt securities, which are generally collateralized directly or indirectly by shopping centers.  Unless otherwise provided, references herein to the Company or DDR include DDR Corp., its wholly-owned and majority-owned subsidiaries and its consolidated joint ventures.  The Company’s tenant base primarily includes national and regional retail chains and local retailers.  Consequently, the Company’s credit risk is concentrated in the retail industry.  

Use of Estimates in Preparation of Financial Statements

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses during the year.  Actual results could differ from those estimates.  

Unaudited Interim Financial Statements

These financial statements have been prepared by the Company in accordance with generally accepted accounting principles for interim financial information and the applicable rules and regulations of the Securities and Exchange Commission.  Accordingly, they do not include all information and footnotes required by generally accepted accounting principles for complete financial statements.  However, in the opinion of management, the interim financial statements include all adjustments, consisting of only normal recurring adjustments, necessary for a fair statement of the results of the periods presented.  The results of operations for the three and nine months ended September 30, 2016 and 2015, are not necessarily indicative of the results that may be expected for the full year.  These condensed consolidated financial statements should be read in conjunction with the Company’s audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

Principles of Consolidation

The condensed consolidated financial statements include the results of the Company and all entities in which the Company has a controlling interest or has been determined to be the primary beneficiary of a variable interest entity (“VIE”).  

All significant inter-company balances and transactions have been eliminated in consolidation.  Investments in real estate joint ventures and companies in which the Company has the ability to exercise significant influence, but does not have financial or operating control, are accounted for using the equity method of accounting.  Accordingly, the Company’s share of the earnings (or loss) of these joint ventures and companies is included in consolidated net income (loss).  

The Company adopted Accounting Standards Update (“ASU”) No. 2015-02, Consolidation (Topic 810):  Amendments to the Consolidation Analysis on January 1, 2016, and reassessed its consolidated and unconsolidated joint ventures under the new standard.  Based on the revised guidance, the Company identified three unconsolidated joint ventures included in the Company’s joint venture investments that, under the new standard, are considered VIEs for which the Company is not the primary beneficiary.  These joint ventures were formed to invest in and own real estate assets.  Each of these joint ventures was deemed to be a VIE under the new guidance as the Company (the non-managing member) does not have substantive kick-out or participating rights in these entities.  The Company determined that it was not the primary beneficiary of these VIEs as the entities’ managing members have the power to direct the activities of the respective entity that most significantly impact the entity’s economic performance.  The Company’s maximum exposure to losses associated with the Company’s VIEs is primarily limited to its aggregate investment, which was $416.3 million and $412.4 million as of September 30, 2016, and December 31, 2015, respectively.

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Statements of Cash Flows and Supplemental Disclosure of Non-Cash Investing and Financing Information

Non-cash investing and financing activities are summarized as follows (in millions):

 

 

Fee and Other Income

Fee and other income was composed of the following (in millions):

 

New Accounting Standards To Be Adopted

Accounting for Leases

In February 2016, the Financial Accounting Standards Board (the “FASB”) issued ASU No. 2016-02, Leases (Topic 842).  The amendments in this update govern a number of areas including, but not limited to, accounting for leases, replacing the existing guidance in ASC Topic No. 840, Leases.  Under this standard, among other changes in practice, a lessee’s rights and obligations under most leases, including existing and new arrangements, would be recognized as assets and liabilities, respectively, on the balance sheet.  Other significant provisions of this standard include (i) defining the “lease term” to include the noncancellable period together with periods for which there is a significant economic incentive for the lessee to extend or not terminate the lease; (ii) defining the initial lease liability to be recorded on the balance sheet to contemplate only those variable lease payments that depend on an index or that are in substance “fixed”; and (iii) a dual approach for determining whether lease expense is recognized on a straight-line or accelerated basis, depending on whether the lessee is expected to consume more than an insignificant portion of the leased asset’s economic benefits.  In addition, this standard impacts the lessor’s ability to capitalize costs related to the leasing of vacant space.  The lease standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years with early adoption permitted.  This standard could have a significant impact on the Company’s consolidated financial statements as the Company has ground lease agreements, in which it could be either a lessor or lessee, at many of its shopping centers.  The Company is currently assessing the impact, if any, the adoption of this standard will have on its consolidated financial statements and has not decided upon the method of adoption.  

Revenue Recognition

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers.  The objective of ASU No. 2014-09 is to establish a single comprehensive five-step model for entities to use in accounting for revenue arising from contracts with customers that will supersede most of the existing revenue recognition guidance, including industry-specific guidance.  The core principle of this standard is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  ASU No. 2014-09 applies to all contracts with customers except those that are within the scope of other topics in the FASB Accounting Standards Codification.  Most significantly for the real estate industry, leasing transactions are not within the scope of the new standard.  A majority of the Company’s tenant-related revenue is recognized pursuant to lease agreements.  The new guidance is effective for public companies for annual reporting periods (including interim periods within those periods) beginning after December 15, 2017.  Early adoption is permitted.  Entities have the option of using either a full retrospective or modified approach to

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adopt ASU No. 2014-09.  The Company is assessing the impact, if any, the adoption of this standard will have on its consolidated financial statements and has not decided upon the method of adoption.

Business Combinations

In September 2015, the FASB issued guidance pertaining to entities that have reported provisional amounts for items in a business combination for which the accounting is incomplete by the end of the reporting period in which the combination occurs and during the measurement period have an adjustment to provisional amounts recognized.  The guidance requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined.  Any adjustments should be calculated as if the accounting had been completed at the acquisition date.  The guidance is effective for public companies for fiscal years beginning after December 15, 2016.  Early adoption is permitted.  Application of the guidance is prospective.  The Company is assessing the impact, if any, the adoption of this standard will have on its consolidated financial statements.

Derivatives and Hedging

In March 2016, the FASB issued ASU No. 2016-05, Derivatives and Hedging (Topic 815):  Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships (a consensus of the Emerging Issues Task Force).  ASU No. 2016-05 clarifies that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument under Topic 815 does not, in and of itself, require dedesignation of that hedging relationship, provided that all other hedge accounting criteria continue to be met.  For public companies, ASU No. 2016-05 is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years.  Early adoption is permitted.  The Company does not expect that the adoption of this standard will have a material impact on its consolidated financial statements.

Transition to Equity Method Accounting

In March 2016, the FASB issued ASU No. 2016-07, Simplifying the Transition to the Equity Method of Accounting, which eliminates the requirement to apply the equity method of accounting retrospectively when a reporting entity obtains significant influence over a previously held investment.  Instead, the equity method of accounting should be applied prospectively from the date significant influence is obtained.  Investors should add the cost of acquiring the additional interest in the investee (if any) to the current basis of their previously held interest.  For available-for-sale securities that become eligible for the equity method of accounting, any unrealized gain or loss previously recorded within accumulated other comprehensive income should be recognized in earnings at the date the investment initially qualifies for the use of the equity method.  ASU No. 2016-07 should be applied prospectively for investments that qualify for the equity method of accounting in interim and annual periods beginning after December 15, 2016.  Early adoption is permitted.  The Company does not expect that the adoption of this standard will have any material impact on its consolidated financial statements.

Share-Based Compensation

In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718):  Improvements to Employee Share-Based Payment Accounting.  ASU No. 2016-09 impacts certain aspects of the accounting for share-based payment transactions, including income tax consequences, classification of awards as either equity or liabilities, and classification on the statements of cash flows.  ASU No. 2016-09 is effective for public companies for annual reporting periods and interim periods within those years beginning after December 15, 2016.  Early adoption is permitted.  The Company is assessing the impact, if any, the adoption of this standard will have on its consolidated financial statements.

Statement of Cash Flows

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments.  ASU 2016-15 provides guidance on certain specific cash flow issues, including, but not limited to, debt prepayment or extinguishment costs, contingent consideration payments made after a business combination and distributions received from equity method investees. ASU 2016-15 is effective for periods beginning after December 15, 2017 and shall be applied retrospectively where practicable.  Early adoption is permitted.  The Company is in the process of evaluating the impact the adoption of ASU 2016-15 will have on its consolidated statements of cash flows.

 

 

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2.Investments in and Advances to Joint Ventures

At September 30, 2016 and December 31, 2015, the Company had ownership interests in various unconsolidated joint ventures that had an investment in 155 and 168 shopping center properties, respectively.  Condensed combined financial information of the Company’s unconsolidated joint venture investments is as follows (in thousands):

 

 

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Service fees and income earned by the Company through management, leasing and development activities performed related to all of the Company’s unconsolidated joint ventures are as follows (in millions):

 

The Company’s joint venture agreements generally include provisions whereby each partner has the right to trigger a purchase or sale of its interest in the joint venture or to initiate a purchase or sale of the properties after a certain number of years or if either party is in default of the joint venture agreements.  The Company is not obligated to purchase the interests of its outside joint venture partners under these provisions.  

Disposition of Shopping Centers

In the third quarter of 2016, the BRE DDR Retail Holdings III joint venture sold two assets for an aggregate sale price of $6.6 million and recorded a gain on sale of $0.5 million.  In the first quarter of 2016, the DDR–SAU Retail Fund joint venture sold 11 assets for an aggregate sale price of $170.5 million and recorded a gain on sale of $53.4 million, of which the Company’s share was $13.5 million.

 

 

 

In the nine months ended September 30, 2016, the Company acquired the following shopping centers (in millions):

 

 

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The fair value of the acquisitions was allocated as follows (in thousands):

 

 

The Company’s consideration of $146.0 million was paid in cash.  The costs related to the acquisition of these assets were expensed as incurred and included in Other Income (Expense), Net in the Company’s consolidated statement of operations, at September 30, 2016.  Such amounts were considered immaterial.  Included in the Company’s consolidated statements of operations are $3.6 million and $5.8 million in total revenues from the date of acquisition through September 30, 2016 and 2015, respectively, for the properties acquired in 2016 and 2015.

 

 

Other assets consist of the following (in thousands):  

 

 

 

The following table discloses certain information regarding the Company’s Revolving Credit Facilities (as defined below) (in millions):

 

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The Company maintains an unsecured revolving credit facility with a syndicate of financial institutions, arranged by J.P. Morgan Securities, LLC and Wells Fargo Securities, LLC (the “Unsecured Credit Facility”).  The Unsecured Credit Facility provides for borrowings of up to $750 million, if certain financial covenants are maintained, two six-month options to extend the maturity to June 2020 upon the Company’s request and an accordion feature for expansion of availability up to $1.25 billion, provided that new or existing lenders agree to the existing terms of the facility and increase their commitment level.  The Unsecured Credit Facility includes a competitive bid option on periodic interest rates for up to 50% of the facility.  The Unsecured Credit Facility also provides for an annual facility fee, which was 20 basis points on the entire facility at September 30, 2016.  The Unsecured Credit Facility also allows for foreign currency-denominated borrowings.

The Company also maintains a $50 million unsecured revolving credit facility with PNC Bank, National Association (the “PNC Facility” and, together with the Unsecured Credit Facility, the “Revolving Credit Facilities”).  The PNC Facility terms are consistent with those contained in the Unsecured Credit Facility.  

The Company’s borrowings under the Revolving Credit Facilities bear interest at variable rates at the Company’s election, based on either (i) the prime rate, as defined in the respective facility, or (ii) LIBOR plus a specified spread (1.0% at September 30, 2016).  The specified spreads vary depending on the Company’s long-term senior unsecured debt rating from Moody’s Investors Service and Standard & Poor’s.  The Company is required to comply with certain covenants under the Revolving Credit Facilities relating to total outstanding indebtedness, secured indebtedness, maintenance of unencumbered real estate assets and fixed charge coverage.  The Company was in compliance with these financial covenants at September 30, 2016.  

 

 

The following methods and assumptions were used by the Company in estimating fair value disclosures of financial instruments.

Notes Receivable and Advances to Affiliates

The fair value is estimated using a discounted cash flow analysis in which the Company uses unobservable inputs or assumptions such as market interest rates determined by the loan to value and market capitalization rates related to the underlying collateral at which management believes similar loans would be made and classified as Level 3 in the fair value hierarchy.  The fair value of these notes was approximately $450.0 million and $441.5 million at September 30, 2016 and December 31, 2015, respectively, as compared to the carrying amounts of $447.5 million and $437.6 million, respectively.  

Debt

The fair market value of senior notes is determined using the trading price of the Company’s public debt.  The fair market value for all other debt is estimated using a discounted cash flow technique that incorporates future contractual interest and principal payments and a market interest yield curve with adjustments for duration, optionality and risk profile, including the Company’s non-performance risk and loan to value.  The Company’s senior notes are classified as Level 2 and all other outstanding debt is classified as Level 3 in the fair value hierarchy.  

Considerable judgment is necessary to develop estimated fair values of financial instruments.  Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize on disposition of the financial instruments.  Debt instruments with carrying values that are different than estimated fair values are summarized as follows (in thousands):

 

 

 

2016 Value Sharing Equity Program

On February 9, 2016, the Company adopted the 2016 Value Sharing Equity Program (the “2016 VSEP”), and performance awards were granted to certain officers, effective February 9, 2016.  Awards made under the 2016 VSEP, if earned, may result in the granting of common shares of DDR and time-vested restricted stock units (“RSUs”) to participants on future measurement dates based

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on a performance period beginning on February 9, 2016, and ending on December 31, 2018 (the “Performance Period”).  As a result, in general, the total compensation available to participants under the 2016 VSEP, if any, will be fully earned only after approximately seven years (the Performance Period and the final four-year time-based vesting period for RSUs).

The 2016 VSEP is designed to allow DDR to reward participants for contributing to its achieving financial performance and allow such participants to share in “Value Created” (as defined below), based upon increases in DDR’s adjusted market capitalization over its initial market capitalization using a starting share price of $17.41 per share (the “Starting Share Price”), over pre-established periods of time.  Under the 2016 VSEP, participants are granted performance-based awards which, if earned, are settled 20% in DDR common shares, and 80% in RSUs that are generally subject to time-based vesting requirements for a period of four years.

Pursuant to the award terms, on five specified measurement dates (the first date occurring on February 23, 2017, with subsequent measurement dates occurring through December 31, 2018), DDR will measure the “Value Created” during the period between the start of the 2016 VSEP and the applicable measurement date.  Value Created is measured for each period for the performance awards as the increase in DDR’s market capitalization on the applicable measurement date (i.e., the product of DDR’s five-day trailing average share price as of each measurement date (price-only appreciation, not total shareholder return) and the number of shares outstanding as of the measurement date), as adjusted for equity issuances and/or equity repurchases, over DDR’s initial market capitalization at the start of the 2016 VSEP utilizing the Starting Share Price.  The ending share price used for purposes of determining Value Created for the performance awards during any measurement period is capped at $25.35 (“Maximum Ending Share Price”).  Because DDR’s initial market capitalization is based on the Starting Share Price, there are no performance awards earned until DDR’s share price exceeds $17.41.

Each participant has been assigned a “percentage share” of the Value Created for the performance awards, and the aggregate percentage share for all participants for the performance awards is 1.4909% if the ending share price for the applicable measurement period is $19.58 or lower.  In addition, each participant’s aggregate total share of Value Created for the performance awards is capped at an individual maximum dollar limit.  After the first measurement date, each participant may earn “performance award shares” (settled as discussed below) with an aggregate value equal to two-sixths of the participant’s percentage share of the Value Created for this award.  After each of the next three measurement dates, each participant may earn performance award shares with an aggregate value equal to three-sixths, then four-sixths and then five-sixths, respectively, of the participant’s percentage share of the Value Created for this award.  After the final measurement date (or, if earlier, upon a change in control, as defined in the 2016 VSEP), each participant may earn performance award shares with an aggregate value equal to the participant’s full percentage share of the Value Created.  In addition, for each measurement date, the number of performance award shares earned by a participant will be reduced by the number of performance award shares previously earned by the participant for prior measurement periods.  

Unless otherwise determined by DDR, the DDR common shares earned under the performance awards will generally be subject to additional service-based restrictions that are expected to vest in 20% annual increments beginning on the date of grant and on each of the first four anniversaries of the date of grant.  After becoming vested, RSUs will be paid in the form of one common share for each such vested RSU.  The fair value of the 2016 VSEP grants was estimated on the date of grant using a Monte Carlo approach model based on the following assumptions:

 

As of September 30, 2016, total unrecognized compensation related to the market metric component associated with the awards granted under the 2016 VSEP was approximately $3.6 million and is expected to be recognized over a weighted-average 6.25-year term, which includes the performance-based and time-based vesting periods.

 

 

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The changes in Accumulated Other Comprehensive Income (Loss) (“OCI”) by component are as follows (in thousands):

 

 

 

The Company recorded impairment charges during the three and nine months ended September 30, 2016 and 2015, based on the difference between the carrying value of the assets and the estimated fair market value as follows (in millions):

 

Items Measured at Fair Value on a Non-Recurring Basis

For a description of the Company’s methodology on determining the fair value, refer to Note 12 of the Company’s Financial Statements filed in its Annual Report on Form 10-K for the year ended December 31, 2015.  

The following table presents information about the Company’s impairment charges on both financial and non-financial assets that were measured on a fair value basis for the nine months ended September 30, 2016, and the year ended December 31, 2015.  The table also indicates the fair value hierarchy of the valuation techniques used by the Company to determine such fair value (in millions).

 

 

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The following table presents quantitative information about the significant unobservable inputs used by the Company to determine the fair value of non-recurring items (in millions, except per square foot, which is in thousands):

 

 

 

 

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The following table provides a reconciliation of net (loss) income from continuing operations and the number of common shares used in the computations of “basic” earnings per share (“EPS”), which utilizes the weighted-average number of common shares outstanding without regard to dilutive potential common shares, and “diluted” EPS, which includes all such shares (in thousands, except per share amounts):

 

The following potentially dilutive securities were considered in the calculation of EPS:

Potentially Dilutive Securities

Common Shares

Common share dividends declared per share were as follows:  

 

 

 

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The tables below present information about the Company’s reportable operating segments (in thousands):

 

 

 

 

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In October 2016, the Company sold 18 wholly-owned operating assets for an aggregate sale price of $483.5 million.

 

 

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Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) provides readers with a perspective from management on the Company’s financial condition, results of operations, liquidity and other factors that may affect the Company’s future results.  The Company believes it is important to read the MD&A in conjunction with its Annual Report on Form 10-K for the year ended December 31, 2015, as well as other publicly available information.

Executive Summary

The Company is a self-administered and self-managed Real Estate Investment Trust (“REIT”) in the business of acquiring, owning, developing, redeveloping, expanding, leasing and managing shopping centers.  In addition, the Company engages in the origination and acquisition of loans and debt securities collateralized directly or indirectly by shopping centers.  As of September 30, 2016, the Company’s portfolio consisted of 343 shopping centers (including 156 shopping centers owned through joint ventures) aggregating approximately 112 million total square feet of gross leasable area (“GLA”).  These properties consist of 329 shopping centers owned in the United States and 14 in Puerto Rico.  At September 30, 2016, the aggregate occupancy of the Company’s operating shopping center portfolio was 93.0% and the average annualized base rent per occupied square foot was $14.72.  

For the nine months ended September 30, 2016, net income attributable to common shareholders increased compared to the prior year, primarily due to lower impairment charges of $104.9 million in 2016, as compared to $279.0 million recorded in 2015, in addition to the transactional impact of the investment activity completed in 2015 and lower interest expense as a result of the repayment of higher interest rate debt through the use of proceeds from asset sales in 2015.

The following provides an overview of the Company’s key financial metrics (see Non-GAAP Financial Measures, described later in this section) (in thousands, except per share amounts):

 

In July 2016, the Company named Thomas F. August as president and chief executive officer.  The management team, led by Mr. August, has been reevaluating its overall strategy and key objectives.  In addition, Mr. August, with input from the board of directors, is considering supplementing the current executive team.  Although management and the board of directors are in the process of finalizing an updated detailed strategic plan, the Company has identified deleveraging as one of its top priorities to further lower its risk profile and cost of capital.  At the current time, the Company expects to achieve new leverage targets through, among other options, the sale of additional assets.  As a result, during the third quarter of 2016, the management team and board of directors decided to increase the volume of asset sales and use proceeds to make accelerated progress on the Company’s deleveraging goals.  As a result of the decision to increase asset sales, the Company recorded $104.9 million in consolidated impairment charges on operating shopping centers that management identified as short-term disposition candidates at September 30, 2016.  

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The following is a summary of the Company’s operational and transactional activity execution in the first nine months of 2016.

The Company completed the disposition of $61.3 million and $479.2 million of assets for the three and nine months ended September 30, 2016, respectively, of which DDR’s pro rata share of the proceeds was $55.0 million and $336.6 million, respectively.  In October 2016, the Company sold 18 wholly-owned operating assets for an aggregate sale price of $483.5 million.  The Company also acquired two Prime power centers (i.e., market-dominant prime power centers located in large and supply-constrained markets, occupied by high-quality retailers with strong demographic profiles, which are referred to as “Prime”) in Phoenix, Arizona, and Portland, Oregon, valued at $146.8 million in the aggregate.  The net sale proceeds primarily were used to acquire Prime assets and repay debt.

The Company continued its trend of consistent internal growth and strong operating performance in the first nine months of 2016, as evidenced by the number of leases executed, the upward trend in the average annualized base rental rates, a strong occupancy rate and the achievement of double-digit rental spreads on new leases.

 

 

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RESULTS OF OPERATIONS

 

Shopping center properties owned as of January 1, 2015, but excluding properties under development or redevelopment and those sold by the Company, are referred to herein as the “Comparable Portfolio Properties.”  

 

Revenues from Operations (in thousands)

 

 

 

 

The following tables present the statistics for the Company’s operating shopping center portfolio affecting base and percentage rental revenues summarized by the following portfolios: combined shopping center portfolio, wholly-owned shopping center portfolio and joint venture shopping center portfolio.

 

 

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Expenses from Operations (in thousands)

 

 

 

The decrease in depreciation expense for the Comparable Portfolio Properties was attributable to assets becoming fully amortized in 2015, offset primarily by the write-off of intangible assets associated with certain tenant bankruptcies.

 

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Other Income and Expenses (in thousands)

 

 

 

 

 

The weighted-average interest rate (based on contractual rates and excluding senior convertible debt accretion in 2015, fair market value of adjustments and debt issuance costs) was 4.3% at both September 30, 2016 and 2015.  The change in the weighted-average debt outstanding and weighted-average interest rate was the result of the Company’s disposition of assets with proceeds applied to repay outstanding indebtedness, as well as the focus on the repayment of higher interest rate debt.

Interest costs capitalized in conjunction with development and redevelopment projects and unconsolidated development and redevelopment joint venture interests were $0.7 million and $2.6 million for the three and nine months ended September 30, 2016, respectively, as compared to $1.9 million and $5.1 million, respectively, for the comparable periods in 2015.  The

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decrease in the amount of interest costs capitalized is a result of a change in the mix of active development projects year over year.

 

 

 

Other Items (in thousands)

 

 

 

 

Disposition of Real Estate, Non-Controlling Interests and Net Income (Loss) (in thousands)

 

 

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NON-GAAP FINANCIAL MEASURES

 

Definition and Basis of Presentation

 

The Company believes that Funds from Operations (“FFO”) and Operating FFO, both non-GAAP financial measures, provide additional and useful means to assess the financial performance of REITs.  FFO and Operating FFO are frequently used by the real estate industry, including securities analysts, investors and other interested parties, to evaluate the performance of REITs.

 

FFO excludes GAAP historical cost depreciation and amortization of real estate and real estate investments, which assume that the value of real estate assets diminishes ratably over time.  Historically, however, real estate values have risen or fallen with market conditions, and many companies use different depreciable lives and methods.  Because FFO excludes depreciation and amortization unique to real estate and gains and losses from depreciable property dispositions, it can provide a performance measure that, when compared year over year, reflects the impact on operations from trends in occupancy rates, rental rates, operating costs, interest costs and acquisition, disposition and development activities.  This provides a perspective of the Company’s financial performance not immediately apparent from net income determined in accordance with GAAP.

 

FFO is generally defined and calculated by the Company as net income (loss) (computed in accordance with GAAP), adjusted to exclude (i) preferred share dividends, (ii) gains and losses from disposition of depreciable real estate property and related investments, which are presented net of taxes, (iii) impairment charges on depreciable real estate property and related investments and (iv) certain non-cash items.  These non-cash items principally include real property depreciation and amortization of intangibles, equity income (loss) from joint ventures and equity income (loss) from non-controlling interests and adding the Company’s proportionate share of FFO from its unconsolidated joint ventures and non-controlling interests, determined on a consistent basis.  The Company’s calculation of FFO is consistent with the definition of FFO provided by the National Association of Real Estate Investment Trusts (“NAREIT”).  

 

The Company believes that certain gains and charges recorded in its operating results are not comparable or reflective of its core operating performance.  As a result, the Company also computes Operating FFO and discusses it with the users of its financial statements, in addition to other measures such as net income (loss) determined in accordance with GAAP and FFO.  Operating FFO is generally defined and calculated by the Company as FFO excluding certain charges and gains that management believes are not comparable and indicative of the results of the Company’s operating real estate portfolio.  Such adjustments include gains on the sale of and/or change in control of interests, gains/losses on the sale of non-depreciable real estate, impairments of non-depreciable real estate, gains/losses on the early extinguishment of debt, transaction costs and other restructuring type costs.  The disclosure of these charges and gains is regularly requested by users of the Company’s financial statements.  The adjustment for these charges and gains may not be comparable to how other REITs or real estate companies calculate their results of operations, and the Company’s calculation of Operating FFO differs from NAREIT’s definition of FFO.  Additionally, the Company provides no assurances that these charges and gains are non-recurring.  These charges and gains could be reasonably expected to recur in future results of operations.

 

These measures of performance are used by the Company for several business purposes and by other REITs.  The Company uses FFO and/or Operating FFO in part (i) as a disclosure to improve the understanding of the Company’s operating results among the investing public, (ii) as a measure of a real estate asset’s performance, (iii) to influence acquisition, disposition and capital investment strategies and (iv) to compare the Company’s performance to that of other publicly traded shopping center REITs.

 

For the reasons described above, management believes that FFO and Operating FFO provide the Company and investors with an important indicator of the Company’s operating performance.  They provide recognized measures of performance other than GAAP net income, which may include non-cash items (often significant).  Other real estate companies may calculate FFO and Operating FFO in a different manner.

 

Management recognizes the limitations of FFO and Operating FFO when compared to GAAP’s net income.  FFO and Operating FFO do not represent amounts available for dividends, capital replacement or expansion, debt service obligations or other commitments and uncertainties.  Management does not use FFO or Operating FFO as an indicator of the Company’s cash obligations and funding requirements for future commitments, acquisitions or development activities.  Neither FFO nor Operating FFO represents cash generated from operating activities in accordance with GAAP, and neither is necessarily indicative of cash available to fund cash needs.  Neither FFO nor Operating FFO should be considered an alternative to net income (computed in accordance with GAAP) or as an alternative to cash flow as a measure of liquidity.  FFO and Operating FFO are simply used as additional indicators of the

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Company’s operating performance.  The Company believes that to further understand its performance, FFO and Operating FFO should be compared with the Company’s reported net income (loss) and considered in addition to cash flows determined in accordance with GAAP, as presented in its condensed consolidated financial statements.  Reconciliations of these measures to their most directly comparable GAAP measure of net income (loss) have been provided below.  

Reconciliation Presentation

 

FFO and Operating FFO attributable to common shareholders were as follows (in millions):

 

 

 

The Company’s reconciliation of net (loss) income attributable to common shareholders to FFO attributable to common shareholders and Operating FFO attributable to common shareholders is as follows (in millions).  The Company provides no assurances that these charges and gains are non-recurring.  These charges and gains could reasonably be expected to recur in future results of operations.

 

 

 

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FFO at DDR ownership interests considers the impact of basis differentials.  Joint ventures’ FFO and Operating FFO is summarized as follows (in millions):

 

 

 

LIQUIDITY AND CAPITAL RESOURCES

 

The Company continues to strategically allocate cash flow from operating and financing activities in order to strengthen its balance sheet and reduce risk, finance strategic investments and improve its financial flexibility.  The Company periodically evaluates opportunities to further strengthen its financial position for strategic reasons, which may include:  repurchasing or refinancing long-term debt, issuing and selling additional debt or equity securities, obtaining credit facilities from lenders and/or disposing of assets.  

 

The Company’s consolidated and unconsolidated debt obligations generally require monthly or semi-annual payments of principal and/or interest over the term of the obligation.  While the Company currently believes it has several viable sources to obtain capital and fund its business, including capacity under its facilities described below, no assurance can be provided that these obligations will be refinanced or repaid as currently anticipated.  

 

The Company maintains an unsecured revolving credit facility with a syndicate of financial institutions, arranged by J.P. Morgan Securities, LLC and Wells Fargo Securities, LLC (the “Unsecured Credit Facility”).  The Unsecured Credit Facility provides for borrowings of up to $750 million and includes an accordion feature for expansion of availability up to $1.25 billion upon the Company’s request, provided that new or existing lenders agree to the existing terms of the facility and increase their commitment level.  The Company also maintains an unsecured revolving credit facility with PNC Bank, National Association, which provides for borrowings of up to $50 million (together with the Unsecured Credit Facility, the “Revolving Credit Facilities”).  The Company’s borrowings under these facilities bear interest at variable rates based on LIBOR plus 100 basis points at September 30, 2016, subject to adjustment based on the Company’s current corporate credit ratings from Moody’s Investors Service (“Moody’s”) and Standard & Poor’s (“S&P”).

 

The Revolving Credit Facilities and the indentures under which the Company’s senior and subordinated unsecured indebtedness is, or may be, issued contain certain financial and operating covenants including, among other things, leverage ratios and debt service coverage and fixed charge coverage ratios, as well as limitations on the Company’s ability to incur secured and unsecured indebtedness, sell all or substantially all of the Company’s assets and engage in mergers and certain acquisitions.  These credit facilities and indentures also contain customary default provisions including the failure to make timely payments of principal and interest payable thereunder, the failure to comply with the Company’s financial and operating covenants, the occurrence of a material adverse effect on the Company and the failure of the Company or its majority-owned subsidiaries (i.e., entities in which the Company has a greater than 50% interest) to pay, when due, certain indebtedness in excess of certain thresholds beyond applicable grace and cure periods.  In the event the Company’s lenders or note holders declare a default, as defined in the applicable agreements governing the debt, the Company may be unable to obtain further funding, and/or an acceleration of any outstanding borrowings may occur.  As of September 30, 2016, the Company was in compliance with all of its financial covenants in the agreements governing its debt.  Although the Company intends to operate in compliance with these covenants, if the Company were to violate these covenants, the Company may be subject to higher finance costs and fees or accelerated maturities.  The Company believes it will continue to be able to operate in compliance with these covenants in 2016 and beyond.

 

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Certain of the Company’s credit facilities and indentures permit the acceleration of the maturity of the underlying debt in the event certain other debt of the Company has been accelerated.  Furthermore, a default under a loan by the Company or its affiliates, a foreclosure on a mortgaged property owned by the Company or its affiliates or the inability to refinance existing indebtedness may have a negative impact on the Company’s financial condition, cash flows and results of operations.  These facts, and an inability to predict future economic conditions, have led the Company to continue to strengthen its focus on its balance sheet risk and increasing financial flexibility.

 

The Company expects to fund its obligations from available cash, current operations and utilization of its Revolving Credit Facilities; however, the Company may issue long-term debt and/or equity securities in lieu of, or in addition to, borrowing under its Revolving Credit Facilities.  The following information summarizes the availability of the Revolving Credit Facilities at September 30, 2016 (in millions):

 

 

The Company has a $250 million continuous equity program.  At October 31, 2016, the Company had $250.0 million available for the future issuance of common shares under that program.

 

The Company intends to continue to maintain a long-term financing strategy with limited reliance on short-term debt.  The Company believes its Revolving Credit Facilities are sufficient for its liquidity strategy and longer-term capital structure needs.  Part of the Company’s overall strategy includes scheduling future debt maturities in a balanced manner, including incorporating a healthy level of conservatism regarding possible future market conditions.  

As of November 1, 2016, the Company had addressed all 2016 consolidated debt maturities.  The Company is focused on its 2017 debt maturities.  The Company continually evaluates its debt maturities and, based on management’s assessment, believes it has viable financing and refinancing alternatives.  The Company continues to evaluate its debt maturities with the goal of executing a strategy to lower leverage, extend debt duration, and improve the Company’s credit ratings with the goal of lowering the Company's balance sheet risk and cost of capital.

 

Unconsolidated Joint Ventures

 

At September 30, 2016, the Company’s unconsolidated joint ventures have $641.1 million of debt maturing in 2016, of which the Company’s proportionate share is $32.1 million.  In November 2016, $4.7 million of mortgage debt was repaid.  The Company expects the joint ventures to refinance, including through options to extend, these obligations.

 

Cash Flow Activity

 

The Company’s core business of leasing space to well-capitalized retailers continues to generate consistent and predictable cash flow after expenses, interest payments and preferred share dividends.  This capital is available for use at the Company’s discretion for investment, debt repayment and the payment of dividends on common shares.

 

The Company’s cash flow activities are summarized as follows (in thousands):

 

 

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Changes in cash flow for the nine months ended September 30, 2016, compared to the prior-year comparable period are described as follows:

 

Operating Activities:  Cash provided by operating activities increased $49.1 million primarily due to the following:

 

Investing Activities:  Cash provided by investing activities increased $87.4 million primarily due to the following:

 

Financing Activities:  Cash used for financing activities increased $138.2 million primarily due to the following:

 

The Company satisfied its REIT requirement of distributing at least 90% of ordinary taxable income with declared common and preferred share cash dividends of $225.3 million for the nine months ended September 30, 2016, as compared to $203.8 million for the same period in 2015.  Because actual distributions were greater than 100% of taxable income, federal income taxes were not incurred by the Company in the first nine months of 2016.

 

The Company declared a quarterly dividend of $0.19 per common share for each of the first three quarters of 2016.  The Board of Directors of the Company expects to continue to monitor the 2016 dividend policy and provide for adjustments as determined to be in the best interests of the Company and its shareholders to maximize the Company’s free cash flow while still adhering to REIT payout requirements.  

 

 

SOURCES AND USES OF CAPITAL

 

Strategic Transaction Activity

 

The Company has been following its portfolio management strategy to recycle capital from lower quality, lower growth potential assets into Prime assets located in large and supply-constrained markets occupied by high credit quality retailers, as well as to lower leverage.  Transactions are completed both on balance sheet and through off-balance sheet joint venture arrangements with top tier, well capitalized partners.

 

Acquisitions

 

During the nine months ended September 30, 2016, the Company acquired two Prime assets (Phoenix, Arizona, and Portland, Oregon) for a gross aggregate purchase price of $146.8 million.  

 

Dispositions

 

In October 2016, the Company sold 18 wholly-owned operating assets for an aggregate sale price of $483.5 million.

 

During the nine months ended September 30, 2016, the Company sold 13 shopping center properties, aggregating 2.2 million square feet, plus non-income producing assets for an aggregate sale price of $302.2 million.  The Company recorded a net gain of $47.5 million.  In addition, two of the Company’s joint ventures sold 13 assets generating gross proceeds of $177.1 million, of which the Company’s proportionate share was $34.4 million.

 

Development and Redevelopment Opportunities

 

One of the important benefits of the Company’s asset class is the ability to phase development and redevelopment projects over time until appropriate leasing levels can be achieved.  To maximize the return on capital spending, the Company generally adheres to strict investment criteria thresholds.  The Company also evaluates the credit quality of the tenants and, in the case of redevelopments, generally seeks to upgrade the retailer merchandise mix.  The Company applies this strategy to both its consolidated and certain

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unconsolidated joint ventures that own assets under development and redevelopment because the Company has significant influence and, in most cases, approval rights over decisions relating to significant capital expenditures.

 

The Company will generally commence construction on various developments only after substantial tenant leasing has occurred and acceptable construction financing is available.  The Company will continue to closely monitor its expected spending for the remainder of 2016 and into 2017 for developments and redevelopments, as the Company considers this funding to be discretionary spending.  The Company does not anticipate expending significant funds on joint venture development projects in 2016.

 

The Company’s consolidated land holdings are classified in two separate line items on the Company’s consolidated balance sheets included herein, (i) Land and (ii) Construction in Progress and Land.  At September 30, 2016, the $2.1 billion of Land primarily consisted of land that is part of the Company’s operating shopping center portfolio.  However, this amount also includes a small portion of vacant land composed primarily of outlots or expansion pads adjacent to the shopping center properties.  Approximately 128 acres of this land, which has a recorded cost basis of approximately $19 million, is available for future development.

 

Included in Construction in Progress and Land at September 30, 2016, were $30 million of recorded costs related to undeveloped land for which active construction has not yet commenced or was previously ceased.  The Company evaluates its intentions with respect to these assets each reporting period and records an impairment charge equal to the difference between the current carrying value and fair value when the expected undiscounted cash flows are less than the asset’s carrying value.  In 2015, the Company determined it would no longer pursue the development of certain of these assets.  

 

Development and Redevelopment Projects

 

As part of its portfolio management strategy to develop, expand, improve and re-tenant various properties, the Company has, at September 30, 2016, invested approximately $260 million in various consolidated active development and redevelopment projects and expects to bring at least $190 million of investments in service in 2016 on a net basis, after deducting sales proceeds from outlot sales.  

 

At September 30, 2016, the Company had one significant consolidated development project, which was as follows (dollars in millions and GLA in thousands):

 

 

The Company’s redevelopment projects are typically substantially complete within a year of the construction commencement date.  The Company sold its major redevelopment asset in Pasadena, California, in January 2016 for a net gain that had net costs incurred of $20.7 million at the time of sale.  At September 30, 2016, the Company’s significant consolidated redevelopment projects were as follows (in millions):

 

 

For redevelopment assets completed in 2016, the assets placed in service were completed at a cost of approximately $126 per square foot, excluding The Pike Outlets, which is a larger scale project (completed at a cost of approximately $309 per square foot).

 

 

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OFF-BALANCE SHEET ARRANGEMENTS

 

The Company has a number of off-balance sheet joint ventures and other unconsolidated entities with varying economic structures.  Through these interests, the Company has investments in operating properties and one development project.  Such arrangements are generally with institutional investors located throughout the United States.

 

The Company’s unconsolidated joint ventures had aggregate outstanding indebtedness to third parties of $3.1 billion at both September 30, 2016 and 2015 (see Item 3. Quantitative and Qualitative Disclosures About Market Risk).  Such mortgages are generally non-recourse to the Company and its partners; however, certain mortgages may have recourse to the Company and its partners in certain limited situations, such as misuse of funds and material misrepresentations.

 

 

CAPITALIZATION

At September 30, 2016, the Company’s capitalization consisted of $5.0 billion of debt, $350.0 million of preferred shares and $6.4 billion of market equity (market equity is defined as common shares and OP Units outstanding multiplied by $17.43, the closing price of the Company’s common shares on the New York Stock Exchange at September 30, 2016), resulting in a debt to total market capitalization ratio of 0.43 to 1.0, as compared to the ratio of 0.47 to 1.0 at September 30, 2015.  The closing price of the common shares on the New York Stock Exchange was $15.38 at September 30, 2015.  The Company’s total debt consisted of the following (in billions):  

 

 

 

It is management’s strategy to have access to the capital resources necessary to manage the Company’s balance sheet, to repay upcoming maturities and to consider making prudent opportunistic investments.  Accordingly, the Company may seek to obtain funds through additional debt or equity financings and/or joint venture capital in a manner consistent with its intention to operate with a conservative debt capitalization policy and to reduce the Company’s cost of capital by maintaining an investment grade rating with Moody’s, S&P and Fitch Ratings, Inc.  The security rating is not a recommendation to buy, sell or hold securities, as it may be subject to revision or withdrawal at any time by the rating organization.  Each rating should be evaluated independently of any other rating.  The Company may not be able to obtain financing on favorable terms, or at all, which may negatively affect future ratings.

 

The Company’s credit facilities and the indentures under which the Company’s senior and subordinated unsecured indebtedness is, or may be, issued contain certain financial and operating covenants, including, among other things, debt service coverage and fixed charge coverage ratios, as well as limitations on the Company’s ability to incur secured and unsecured indebtedness, sell all or substantially all of the Company’s assets and engage in mergers and certain acquisitions.  Although the Company intends to operate in compliance with these covenants, if the Company were to violate these covenants, the Company may be subject to higher finance costs and fees or accelerated maturities.  In addition, certain of the Company’s credit facilities and indentures may permit the acceleration of maturity in the event certain other debt of the Company has been accelerated.  Foreclosure on mortgaged properties or an inability to refinance existing indebtedness would have a negative impact on the Company’s financial condition and results of operations.

 

CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS

 

As of November 1, 2016, the Company had addressed all of its 2016 consolidated debt maturities and continues to focus on its 2017 debt maturities.  

 

In conjunction with the development and redevelopment of shopping centers, the Company had entered into commitments with general contractors aggregating approximately $10.7 million for its consolidated properties at September 30, 2016.  These obligations, composed principally of construction contracts, are generally due in 12 to 24 months, as the related construction costs are incurred, and are expected to be financed through operating cash flow, new or existing construction loans, asset sales or Revolving Credit Facilities.

 

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At September 30, 2016, the Company had letters of credit outstanding of $26.3 million.  The Company has not recorded any obligations associated with these letters of credit, the majority of which are collateral for existing indebtedness and other obligations of the Company.

 

The Company routinely enters into contracts for the maintenance of its properties.  These contracts typically can be canceled upon 30 to 60 days’ notice without penalty.  At September 30, 2016, the Company had purchase order obligations, typically payable within one year, aggregating approximately $5.3 million related to the maintenance of its properties and general and administrative expenses.

 

INFLATION

 

Most of the Company’s long-term leases contain provisions designed to mitigate the adverse impact of inflation.  Such provisions include clauses enabling the Company to receive additional rental income from escalation clauses that generally increase rental rates during the terms of the leases and/or percentage rentals based on tenants’ gross sales.  Such escalations are determined by negotiation, increases in the consumer price index or similar inflation indices.  In addition, many of the Company’s leases are for terms of less than 10 years, permitting the Company to seek increased rents at market rates upon renewal.  Most of the Company’s leases require the tenants to pay their share of operating expenses, including common area maintenance, real estate taxes, insurance and utilities, thereby reducing the Company’s exposure to increases in costs and operating expenses resulting from inflation.

 

ECONOMIC CONDITIONS

 

The Company continues to believe there is a favorable landlord dynamic in the supply-and-demand curve for quality locations within well-positioned shopping centers.  Many retailers have aggressive store opening plans for the remainder of 2016 and 2017.  Further, the Company continues to see strong demand from a broad range of retailers for its space, particularly in the off-price sector, which is a reflection of the general outlook of consumers who are demanding more value for their dollars.  This is evidenced by the continued high volume of leasing activity, which was over seven million square feet of space for new leases and renewals for the first nine months of 2016, as well as 11 million square feet of space for new leases and renewals for the year ended December 31, 2015.  The Company also benefits from its real estate asset class (shopping centers), which typically has a higher return on capital expenditures, as well as a diversified tenant base, with only three tenants whose annualized rental revenue equals or exceeds 3% of annualized consolidated revenues and the Company’s proportionate share of unconsolidated joint venture revenues (TJX Companies at 3.9%, Bed Bath & Beyond at 3.4% and Walmart at 3.2%).  Other significant tenants include Target, Kohl’s, PetSmart, Dick’s Sporting Goods, Ross Stores, Lowe’s and Publix, all of which have relatively strong credit ratings, remain well-capitalized and have outperformed other retail categories on a relative basis over time.  In addition, several of the Company’s big box tenants (Dick’s Sporting Goods, Walmart, TJX Companies, Target and Bed Bath & Beyond) have been rapidly growing their omni-channel platform, creating positive sales growth.  The Company believes these tenants will continue providing it with a stable revenue base for the foreseeable future, given the long-term nature of these leases.  Moreover, the majority of the tenants in the Company’s shopping centers provide day-to-day consumer necessities with a focus toward value and convenience, versus high-priced discretionary luxury items, which the Company believes will enable many of its tenants to outperform even in a challenging economic environment.

 

The retail shopping sector continues to be affected by the competitive nature of the retail business and the competition for market share, as well as general economic conditions, where stronger retailers have out-positioned some of the weaker retailers.  These shifts can force some market share away from weaker retailers, which could require them to downsize and close stores and/or declare bankruptcy.  In many cases, the loss of a weaker tenant or downsizing of space creates a value-add opportunity to re-lease space at higher rents to a stronger retailer.  Overall, the Company believes its portfolio remained stable at September 30, 2016, as evidenced by the consistency in the occupancy rate as further described below.  However, there can be no assurance that the loss of a tenant or down-sizing of space will not adversely affect the Company (see Item 1A. Risk Factors in the Company’s Annual Report on

Form 10-K for the year ended December 31, 2015).

 

The Company believes that the quality of its shopping center portfolio is strong, as evidenced by the high historical occupancy rates and consistent growth in the average annualized base rent per occupied square foot.  Historical occupancy has generally ranged from 92% to 96% since the Company’s initial public offering in 1993.  The shopping center portfolio occupancy was 93.0% at September 30, 2016, 93.3% at December 31, 2015, and 92.8% at September 30, 2015.  The minor decrease in occupancy in 2016 since the end of the prior year primarily is attributable to the unabsorbed vacancy resulting from The Sports Authority bankruptcy.  The total portfolio average annualized base rent per occupied square foot was $14.72 at September 30, 2016, as compared to $14.48 at December 31, 2015, and $14.23 at September 30, 2015.  The increase primarily was due to the Company’s strategic portfolio realignment achieved through the recycling of capital from the sale of lower quality assets into the acquisition of Prime power centers with higher growth potential, as well as continued lease up and renewal of the existing portfolio at positive rental spreads.  Moreover, the Company has been able to achieve these results without significant capital investment in tenant improvements or leasing

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commissions.  The weighted-average cost of tenant improvements and lease commissions estimated to be incurred over the expected lease term for new leases executed during the third quarter of 2016 was only $4.73 per rentable square foot.  The Company generally does not expend a significant amount of capital on lease renewals.  The quality of the property revenue stream is high and consistent, as it is generally derived from retailers with good credit profiles under long-term leases, with very little reliance on overage rents generated by tenant sales performance.  The Company is very conscious of and sensitive to the risks posed by the economy, but believes that the position of its portfolio and the general diversity and credit quality of its tenant base should enable it to successfully navigate through potentially challenging economic times.

 

The Company owns 14 assets on the island of Puerto Rico aggregating 4.8 million square feet of Company-owned GLA.  These assets represent 7.5% of the Company’s annualized consolidated revenues for its portfolio at 100% and 5.9% of Company-owned GLA at September 30, 2016.  There is concern about the status of the Puerto Rican economy, the ability of the government of Puerto Rico to meet its financial obligations and the impact of any government default on the economy of Puerto Rico.  The Company, however, believes that its assets are well positioned to withstand continuing recessionary pressures and represent a source of stable, high quality cash flow because the tenants in these assets (many of which are U.S. retailers such as Walmart, TJX Companies, PetSmart and Bed Bath & Beyond) typically cater to the local consumer’s desire for value and convenience and often provide consumers with day-to-day necessities.  However, there can be no assurance that the economic conditions in Puerto Rico will not deteriorate further, which could materially and negatively impact consumer spending and ultimately adversely affect the Company (see Item 1A. Risk Factors in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015).  The Company is regularly monitoring developments in Puerto Rico and routinely re-evaluates its strategic objectives and options with respect to its assets in Puerto Rico.

 

NEW ACCOUNTING STANDARDS

 

New Accounting Standards are more fully described in Note 1, “Nature of Business and Financial Statement Presentation,” of the Company’s condensed consolidated financial statements included herein.

 

FORWARD-LOOKING STATEMENTS

 

Management’s discussion and analysis should be read in conjunction with the Company’s condensed consolidated financial statements and the notes thereto appearing elsewhere in this report.  Historical results and percentage relationships set forth in the Company’s condensed consolidated financial statements, including trends that might appear, should not be taken as indicative of future operations.  The Company considers portions of this information to be “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, both as amended, with respect to the Company’s expectations for future periods.  Forward-looking statements include, without limitation, statements related to acquisitions (including any related pro forma financial information) and other business development activities, future capital expenditures, financing sources and availability and the effects of environmental and other regulations.  Although the Company believes that the expectations reflected in these forward-looking statements are based upon reasonable assumptions, it can give no assurance that its expectations will be achieved.  For this purpose, any statements contained herein that are not statements of historical fact should be deemed to be forward-looking statements.  Without limiting the foregoing, the words “will,” “believes,” “anticipates,” “plans,” “expects,” “seeks,” “estimates” and similar expressions are intended to identify forward-looking statements.  Readers should exercise caution in interpreting and relying on forward-looking statements because such statements involve known and unknown risks, uncertainties and other factors that are, in some cases, beyond the Company’s control and that could cause actual results to differ materially from those expressed or implied in the forward-looking statements and that could materially affect the Company’s actual results, performance or achievements.  For additional factors that could cause the results of the Company to differ materially from those indicated in the forward-looking statements, please refer to Item 1A. Risk Factors in the Company’s Annual Report on

Form 10-K for the year ended December 31, 2015.

 

Factors that could cause actual results, performance or achievements to differ materially from those expressed or implied by forward-looking statements include, but are not limited to, the following:

 

 

 

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The Company’s primary market risk exposure is interest rate risk.  The Company’s debt, excluding unconsolidated joint venture debt (adjusted to reflect the $77.3 million and $78.5 million of variable-rate debt, respectively, that LIBOR was swapped to at a fixed rate of 2.8%, at September 30, 2016 and December 31, 2015) is summarized as follows:

 

 

The Company’s unconsolidated joint ventures’ indebtedness at its carrying value, adjusted to reflect the $42.0 million of variable-rate debt ($2.1 million at the Company’s proportionate share) that LIBOR was swapped to at a fixed rate of 1.9% at September 30, 2016 and December 31, 2015, is summarized as follows:

 

 

The Company intends to use retained cash flow, proceeds from asset sales and variable-rate indebtedness available under its Revolving Credit Facilities to repay indebtedness and fund capital expenditures of the Company’s shopping centers.  Thus, to the extent the Company incurs additional variable-rate indebtedness, its exposure to increases in interest rates in an inflationary period could increase.  The Company does not believe, however, that increases in interest expense as a result of inflation will significantly impact the Company’s distributable cash flow.

 

The interest rate risk on a portion of the Company’s and its unconsolidated joint ventures’ variable-rate debt described above has been mitigated through the use of interest rate swap agreements (the “Swaps”) with major financial institutions.  At September 30, 2016 and December 31, 2015, the interest rate on the Company’s $77.3 million and $78.5 million consolidated floating rate debt, respectively, was swapped to a fixed rate.  At September 30, 2016 and December 31, 2015, the interest rate on $42.0 million of unconsolidated joint venture floating rate debt (of which $2.1 million is the Company’s proportionate share) was swapped to a fixed rate.  The Company is exposed to credit risk in the event of nonperformance by the counterparties to the Swaps.  The Company believes it mitigates its credit risk by entering into Swaps with major financial institutions.

 

The carrying value of the Company’s fixed-rate debt is adjusted to include the $77.3 million and $78.5 million of variable-rate debt that was swapped to a fixed rate at September 30, 2016 and December 31, 2015, respectively.  The fair value of the Company’s fixed-rate debt is adjusted to (i) include the Swaps reflected in the carrying value and (ii) include the Company’s proportionate share of the joint venture fixed-rate debt.  An estimate of the effect of a 100 basis-point increase at September 30, 2016 and December 31, 2015, is summarized as follows (in millions):

 

 

 

 

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The sensitivity to changes in interest rates of the Company’s fixed-rate debt was determined using a valuation model based upon factors that measure the net present value of such obligations that arise from the hypothetical estimate as discussed above.

 

Further, a 100 basis-point increase in short-term market interest rates on variable-rate debt at September 30, 2016, would result in an increase in interest expense of approximately $7.4 million for the Company and $0.7 million representing the Company’s proportionate share of the joint ventures’ interest expense relating to variable-rate debt outstanding for the nine months ended September 30, 2016.  The estimated increase in interest expense for the year does not give effect to possible changes in the daily balance of the Company’s or joint ventures’ outstanding variable-rate debt.

 

The Company and its joint ventures intend to continually monitor and actively manage interest costs on their variable-rate debt portfolio and may enter into swap positions based on market fluctuations.  In addition, the Company believes it has the ability to obtain funds through additional equity and/or debt offerings and joint venture capital.  Accordingly, the cost of obtaining such protection agreements in relation to the Company’s access to capital markets will continue to be evaluated.  The Company has not entered, and does not plan to enter, into any derivative financial instruments for trading or speculative purposes.  As of September 30, 2016, the Company had no other material exposure to market risk.

 

 

The Company’s management, with the participation of the Chief Executive Officer (“CEO”) and Interim Chief Financial Officer (“CFO”), conducted an evaluation, pursuant to Securities Exchange Act Rules 13a-15(b) and 15d-15(b), of the effectiveness of our disclosure controls and procedures.  Based on their evaluation as required, the CEO and CFO have concluded that the Company’s disclosure controls and procedures (as defined in Securities Exchange Act Rules 13a-15(e) and 15d-15(e)) were effective as of the end of the period covered by this Quarterly Report on Form 10-Q to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and were effective as of the end of such period to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act is accumulated and communicated to the Company’s management, including its CEO and CFO, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

During the three months ended September 30, 2016, there were no changes in the Company’s internal control over financial reporting that materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.

 

 

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PART II

OTHER INFORMATION

 

The Company and its subsidiaries are subject to various legal proceedings, which, taken together, are not expected to have a material adverse effect on the Company.  The Company is also subject to a variety of legal actions for personal injury or property damage arising in the ordinary course of its business, most of which are covered by insurance.  While the resolution of all matters cannot be predicted with certainty, management believes that the final outcome of such legal proceedings and claims will not have a material adverse effect on the Company’s liquidity, financial position or results of operations.

 

None.

 

ISSUER PURCHASES OF EQUITY SECURITIES

 

 

 

None.

 

Not applicable.

 

None.

 

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Attached as Exhibit 101 to this report are the following formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Balance Sheets as of September 30, 2016 and December 31, 2015, (ii) Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2016 and 2015, (iii) Consolidated Statements of Comprehensive (Loss) Income for the Three and Nine Months Ended September 30, 2016 and 2015, (iv) Consolidated Statement of Equity for the Nine Months Ended September 30, 2016, (v) Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2016 and 2015 and (vi) Notes to Condensed Consolidated Financial Statements.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

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EXHIBIT INDEX

 

 

 

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