UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-Q

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 [X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2007

OR

 [ ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____________ TO _______________

COMMISSION FILE NO. 1-12494

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CBL & ASSOCIATES PROPERTIES, INC.

(Exact Name of registrant as specified in its charter)

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DELAWARE 62-1545718

(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification Number)

2030 Hamilton Place Blvd., Suite 500, Chattanooga, TN 37421-6000

(Address of principal executive office, including zip code)

423.855.0001

(Registrant’s telephone number, including area code)

N/A

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

As of August 2, 2007, there were 65,657,655 shares of common stock, par value $0.01 per share, outstanding.

 

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CBL & Associates Properties, Inc.

 

Table of Contents

 

 

 

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PART I – FINANCIAL INFORMATION

 

ITEM 1. Financial Statements

 

CBL & Associates Properties, Inc.

Condensed Consolidated Balance Sheets

(In thousands, except share data)

(Unaudited)

 

 

The accompanying notes are an integral part of these balance sheets.

 

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CBL & Associates Properties, Inc.

Condensed Consolidated Statements of Operations

(In thousands, except per share data)

(Unaudited)

 

 

The accompanying notes are an integral part of these statements.

 

4

CBL & Associates Properties, Inc.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

The accompanying notes are an integral part of these statements.         

 

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CBL & Associates Properties, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

(In thousands, except per share data)

 

Note 1 – Organization and Basis of Presentation

 

CBL & Associates Properties, Inc. (“CBL”), a Delaware corporation, is a self-managed, self-administered, fully integrated real estate investment trust (“REIT”) that is engaged in the ownership, development, acquisition, leasing, management and operation of regional shopping malls, open-air centers and community centers. CBL’s shopping center properties are located in 27 states, but primarily in the southeastern and midwestern United States.

 

CBL conducts substantially all of its business through CBL & Associates Limited Partnership (the “Operating Partnership”).  At June 30, 2007, the Operating Partnership owned controlling interests in 72 regional malls/open-air centers, 28 associated centers (each adjacent to a regional shopping mall), four community centers and CBL’s corporate office building. The Operating Partnership consolidates the financial statements of all entities in which it has a controlling financial interest or where it is the primary beneficiary of a variable interest entity. The Operating Partnership owned non-controlling interests in seven regional malls, four associated centers and one community center. Because one or more of the other partners have substantive participating rights, the Operating Partnership does not control these partnerships and, accordingly, accounts for these investments using the equity method. The Operating Partnership had seven mall expansions, three associated/lifestyle centers, one mixed-use center, three community centers (one of which is owned in a joint venture) and an office building under construction at June 30, 2007. The Operating Partnership also holds options to acquire certain development properties owned by third parties.

 

CBL is the 100% owner of two qualified REIT subsidiaries, CBL Holdings I, Inc. and CBL Holdings II, Inc. At June 30, 2007, CBL Holdings I, Inc., the sole general partner of the Operating Partnership, owned a 1.6% general partner interest in the Operating Partnership and CBL Holdings II, Inc. owned a 54.8% limited partner interest for a combined interest held by CBL of 56.4%.

 

The minority interest in the Operating Partnership is held primarily by CBL & Associates, Inc. and its affiliates (collectively “CBL’s Predecessor”) and by affiliates of The Richard E. Jacobs Group, Inc. (“Jacobs”). CBL’s Predecessor contributed their interests in certain real estate properties and joint ventures to the Operating Partnership in exchange for a limited partner interest when the Operating Partnership was formed in November 1993. Jacobs contributed their interests in certain real estate properties and joint ventures to the Operating Partnership in exchange for limited partner interests when the Operating Partnership acquired the majority of Jacobs’ interests in 23 properties in January 2001 and the balance of such interests in February 2002. At June 30, 2007, CBL’s Predecessor owned a 15.0% limited partner interest, Jacobs owned a 19.7% limited partner interest and various third parties owned an 8.9% limited partner interest in the Operating Partnership. CBL’s Predecessor also owned 6.3 million shares of CBL’s common stock at June 30, 2007, for a total combined effective interest of 20.4% in the Operating Partnership.

 

The Operating Partnership conducts CBL’s property management and development activities through CBL & Associates Management, Inc. (the “Management Company”) to comply with certain requirements of the Internal Revenue Code of 1986, as amended (the “Code”). The Operating Partnership owns 100% of the Management Company’s preferred stock and common stock.

 

CBL, the Operating Partnership and the Management Company are collectively referred to herein as “the Company”.

 

The accompanying condensed consolidated financial statements are unaudited; however, they have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and in conjunction with the rules and regulations of the Securities and

 

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Exchange Commission. Accordingly, they do not include all of the disclosures required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting solely of normal recurring matters) necessary for a fair presentation of the financial statements for these interim periods have been included. The results for the interim periods ended June 30, 2007, are not necessarily indicative of the results to be obtained for the full fiscal year.

 

These condensed consolidated financial statements should be read in conjunction with CBL’s audited consolidated financial statements and notes thereto included in its Annual Report on Form 10-K for the year ended December 31, 2006.

 

Note 2 – Joint Ventures

 

Equity Method Investments

 

At June 30, 2007, the Company had investments in the following 13 partnerships and joint ventures, which are accounted for using the equity method of accounting:

 

 

 

Condensed combined financial statement information for the unconsolidated affiliates is as follows:

 

 

 

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Cost Method Investments

 

In February 2007, the Company acquired a 6.2% minority interest in subsidiaries of Jinsheng Group (“Jinsheng”), an established mall operating and real estate development company located in Nanjing, China, for $10,125. As of June 30, 2007, Jinsheng owns controlling interests in four home decor shopping malls and two general retail shopping centers.

 

Jinsheng also issued to the Company a secured convertible promissory note in exchange for cash of $4,875. The note is secured by 16,565,534 Series 2 Ordinary Shares of Jinsheng. The secured note is non-interest bearing and matures upon the earlier to occur of (i) January 22, 2012, (ii) the closing of the sale, transfer or other disposition of substantially all of Jinsheng’s assets, (iii) the closing of a merger or consolidation of Jinsheng or (iv) an event of default, as defined in the secured note. In lieu of the Company’s right to demand payment on the maturity date, at any time commencing upon the earlier to occur of January 22, 2010 or the occurrence of a Final Trigger Event, as defined in the secured note, the Company may, at its sole option, convert the outstanding amount of the secured note into 16,565,534 Series A-2 Preferred Shares of Jinsheng (which equates to a 2.275% ownership interest).

 

Jinsheng also granted the Company a warrant to acquire 5,461,165 Series A-3 Preferred Shares for $1,875. The warrant expires upon the earlier of January 22, 2010 or the date that Jinsheng distributes, as a dividend, shares of Jinsheng’s successor should Jinsheng complete an initial public offering.

 

The Company accounts for its minority interest in Jinsheng using the cost method because the Company does not exercise significant influence over Jinsheng and there is no readily determinable market value of Jinsheng’s shares since they are not publicly traded. The Company recorded the secured note at its estimated fair value of $4,513, which reflects a discount of $362 due to the fact that it is non-interest bearing. The discount is amortized to interest income over the term of the secured note using the effective interest method. The minority interest and the secured note are reflected as investment in unconsolidated affiliates in the accompanying consolidated balance sheet. The Company recorded the warrant at its estimated fair value of $362, which is included in other assets in the accompanying consolidated balance sheet. There were no significant changes to the fair values of the secured note and warrant during the three months ended June 30, 2007.

 

Variable Interest Entities

 

In May 2007, the Company entered into a joint venture agreement with certain third parties to develop and operate a lifestyle center in Grand Rapids Township, MI. The Company holds a 50% ownership interest in the joint venture. During the three months ended June 30, 2007, the Company determined that its investment represents a variable interest in a variable interest entity and that the Company is the primary beneficiary. As a result, the joint venture is presented in the accompanying financial statements as of June 30, 2007 on a consolidated basis, with the interests of the third party reflected as minority interest.

 

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In October 2006, the Company entered into a loan agreement with a third party to loan the third party up to $7,300 to fund land acquisition costs and certain predevelopment expenses for the purpose of developing a shopping center. The loan agreement provides that, in certain circumstances, the Company may convert the loan to a 25% ownership interest in the third party. As of December 31, 2006, the Company determined that its loan to the third party was a variable interest in a variable interest entity and that the Company was the primary beneficiary. As a result, the Company consolidated this entity as of December 31, 2006.

 

During the first quarter of 2007, the Company reconsidered its status as the primary beneficiary of this variable interest entity and determined that it no longer was the primary beneficiary. Therefore, the Company ceased consolidating this variable interest entity and has recorded the loan as a mortgage note receivable. The loan bears interest at 9.0% and matures on October 31, 2007.

 

Note 3 – Mortgage and Other Notes Payable

 

Mortgage and other notes payable consisted of the following at June 30, 2007 and December 31, 2006, respectively:

 

 

(1) Weighted-average interest rate including the effect of debt premiums, but excluding amortization of deferred financing costs.

 

During the three months ended June 30, 2007, the Company obtained two separate ten-year, non-recourse loans totaling $207,520 that bear interest at fixed rates ranging from 5.60% to 5.66%, with a weighted average of 5.61%. The loans are secured by Gulf Coast Town Center and Eastgate Crossing. The proceeds were used to retire two variable rate loans totaling $143,258 and to reduce outstanding balances on the Company’s credit facilities.

 

In March 2007, the Company obtained six separate ten-year, non-recourse loans totaling $417,040 that bear interest at fixed rates ranging from 5.67% to 5.68%, with a weighted average of 5.67%. The loans are secured by Mall of Acadiana, Citadel Mall, The Plaza at Fayette Mall, Layton Hills Mall and its associated center, Hamilton Corner and The Shoppes at St. Clair Square. The proceeds were used to retire $92,050 of mortgage notes payable that were scheduled to mature during the next twelve months and to reduce outstanding balances on the Company’s credit facilities. The mortgage notes payable that were retired consisted of two variable rate term loans totaling $51,825 and three fixed rate loans totaling $40,225. The Company recorded a loss on extinguishment of debt of $227 in the six months ended June 30, 2007, related to prepayment fees and the write-off of unamortized deferred financing costs associated with the loans that were retired.

 

 

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Unsecured Line of Credit

 

The Company has one unsecured credit facility with total availability of $560,000 that bears interest at the London Interbank Offered Rate (“LIBOR”) plus a margin of 0.75% to 1.20% based on the Company’s leverage, as defined in the agreement. The credit facility matures in August 2008 and has three one-year extension options, which are at the Company’s election. At June 30, 2007, the outstanding borrowings of $253,000 under the unsecured credit facility had a weighted average interest rate of 6.22%. Additionally, the Company pays an annual fee of 0.1% of the amount of total availability under the unsecured credit facility.

 

Secured Lines of Credit

 

The Company has four secured lines of credit that are used for construction, acquisition, and working capital purposes, as well as issuances of letters of credit. Each of these lines is secured by mortgages on certain of the Company’s operating properties. Borrowings under the secured lines of credit bear interest at a rate of LIBOR plus a margin ranging from 0.80% to 0.90% and had a weighted average interest rate of 6.13% at June 30, 2007. The Company also pays a fee based on the amount of unused availability under its largest secured credit facility at a rate of 0.125% or 0.250%, depending on the level of unused availability. The following summarizes certain information about the secured lines of credit as of June 30, 2007:

 

 

In addition to the borrowings outstanding on the secured lines of credit, there were letters of credit totaling $768 that were also outstanding as of June 30, 2007.

 

Letters of Credit

 

At June 30, 2007, the Company had additional secured and unsecured lines of credit with a total commitment of $43,295 that are used only for issuing letters of credit. The letters of credit outstanding under these lines of credit totaled $18,718 at June 30, 2007.

 

Covenants and Restrictions

 

Thirty-nine malls/open-air centers, nine associated centers, three community centers and the corporate office building are owned by special purpose entities that are included in the Company’s consolidated financial statements. The sole business purpose of the special purpose entities is to own and operate these properties, each of which is encumbered by a commercial-mortgage-backed-securities loan. The real estate and other assets owned by these special purpose entities are restricted under the loan agreements in that they are not available to settle other debts of the Company. However, so long as the loans are not under an event of default, as defined in the loan agreements, the cash flows from these properties, after payments of debt service, operating expenses and reserves, are available for distribution to the Company.

 

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Maturities

 

The weighted average remaining term of the Company’s consolidated debt was 5.2 years at June 30, 2007 and 4.8 years at December 31, 2006. The Company has one loan in the amount of $40,613 that is scheduled to mature before June 30, 2008. The Company expects to retire or refinance this loan.

 

Note 4 – Shareholders’ Equity and Minority Interests

 

During the three and six months ended June 30, 2007, holders of 24,834 and 220,670 special common units of limited partnership interest in the Operating Partnership, respectively, exercised their conversion rights. The Company elected to pay cash of $916 and $9,423, respectively, in exchange for the special common units.

 

On June 28, 2007, the Company redeemed its 2,000,000 outstanding shares of 8.75% Series B Cumulative Redeemable Stock (the “Series B Preferred Stock”) for $100,000, representing a liquidation preference of $50.00 per share, plus accrued and unpaid dividends of $2,139. In connection with the redemption of the Series B Preferred Stock, the Company incurred a charge of $3,630 to write off direct issuance costs that were recorded as a reduction of additional paid-in capital when the Series B Preferred Stock was issued. The charge is included in preferred dividends in the accompanying consolidated statements of operations for the three and six month periods ended June 30, 2007.

 

Note 5 – Segment Information

 

The Company measures performance and allocates resources according to property type, which is determined based on certain criteria such as type of tenants, capital requirements, economic risks, leasing terms, and short and long-term returns on capital. Rental income and tenant reimbursements from tenant leases provide the majority of revenues from all segments. Information on the Company’s reportable segments is presented as follows:

 

 

 

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Note 6 – Earnings Per Share

 

Basic earnings per share (“EPS”) is computed by dividing net income available to common shareholders by the weighted-average number of unrestricted common shares outstanding for the period. Diluted EPS assumes the issuance of common stock for all potential dilutive common shares outstanding. The limited partners’ rights to convert their minority interest in the Operating Partnership into shares of common stock are not dilutive. The following summarizes the impact of potential dilutive common shares on the denominator used to compute earnings per share:

 

 

 

Note 7 – Comprehensive Income

 

Comprehensive income includes all changes in shareholders’ equity during a period, except those resulting from investments by and distributions to shareholders. Comprehensive income includes other comprehensive income (loss) of $(3,003) and $(646) in the three months ended June 30, 2007 and 2006, respectively, and $(2,472) and $161 in the six months ended June 30, 2007 and 2006, respectively. Other comprehensive income in all periods presented represents unrealized gain (loss) on marketable securities that are classified as available for sale. Comprehensive income was $19,685 and $27,924 for the three months ended June 30, 2007 and 2006, respectively, and $45,259 and $56,986 for the six months ended June 30, 2007 and 2006, respectively.

 

Note 8 – Contingencies

 

The Company is currently involved in certain litigation that arises in the ordinary course of business. It is management’s opinion that the pending litigation will not materially affect the financial position or results of operations of the Company.

 

The Company owns a parcel of land that it is ground leasing to a third party developer for the purpose of developing a shopping center. The Company has guaranteed 27% of the third party’s construction loan and bond line of credit (the “loans”) of which the maximum guaranteed amount is $31,554. The total amount outstanding at June 30, 2007 on the loans was $10,950 of which the Company has guaranteed $2,957. The Company has recorded an obligation of $315 in the accompanying consolidated balance sheet as of June 30, 2007 to reflect the estimated fair value of the guaranty.

 

The Company has guaranteed 50% of the debt of Parkway Place L.P., an unconsolidated affiliate in which the Company owns a 45% interest, which owns Parkway Place in Huntsville, AL. The total amount outstanding at June 30, 2007 was $53,200 of which the Company has guaranteed $26,600. The guaranty will expire when the related debt matures in June 2008. The Company has not recorded an obligation for this guaranty because it has determined that the fair value of the guaranty is not material.

 

 

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The Company has guaranteed the performance of York Town Center, LP (“YTC”), an unconsolidated affiliate in which the Company owns a 50% interest, under the terms of an agreement with a third party that will own property adjacent to the shopping center property YTC is currently developing. Under the terms of that agreement, YTC is obligated to cause performance of the third party’s obligations as landlord under its lease with its sole tenant, including, but not limited to, provisions such as co-tenancy and exclusivity requirements. Should YTC fail to cause performance, then the tenant under the third party landlord’s lease may pursue certain remedies ranging from rights to terminate its lease to receiving reductions in rent. The Company has guaranteed YTC’s performance under this agreement up to a maximum of $22,000, which decreases by $800 annually until the guaranteed amount is reduced to $10,000. The guaranty expires on December 31, 2020. The maximum guaranteed obligation was $21,200 as of June 30, 2007. The Company has entered into an agreement with its joint venture partner under which the joint venture partner has agreed to reimburse the Company 50% of any amounts the Company is obligated to fund under the guaranty. The Company has not recorded an obligation for this guaranty because it has determined that the fair value of the guaranty is not material.

 

The Company has issued various bonds that it would have to satisfy in the event of non-performance. At June 30, 2007, the total amount outstanding on these bonds was $17,062.

 

Note 9 – Share-Based Compensation

 

The compensation cost that was charged against income was $935 and $1,512 for the three months ended June 30, 2007 and 2006, respectively, and $2,198 and $3,765 for the six months ended June 30, 2007 and 2006, respectively. Compensation cost capitalized as part of real estate assets was $204 and $107 for the three months ended June 30, 2007 and 2006, respectively, and $391 and $213 for the six months ended June 30, 2007 and 2006, respectively.

 

The Company’s stock option activity for the six months ended June 30, 2007 is summarized as follows:

 

 

A summary of the status of the Company’s stock awards as of June 30, 2007, and changes during the six months ended June 30, 2007, is presented below:

 

 

 

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As of June 30, 2007, there was $9,981 of total unrecognized compensation cost related to nonvested stock options and stock awards granted under the plan, which is expected to be recognized over a weighted average period of 3.2 years.

 

Note 10 – Noncash Investing and Financing Activities

 

The Company’s noncash investing and financing activities were as follows for the six months ended June 30, 2007 and 2006:

 

 

Note 11 – Discontinued Operations

 

During the three months ended June 30, 2007, the Company entered into an agreement to sell Twin Peaks Mall in Longmont, CO to a third party buyer. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-lived Assets, the property has been classified as held for sale and the related results of operations for all periods presented are included in discontinued operations in the accompanying consolidated financial statements. The sale is expected to close in the third quarter ending September 30, 2007. Proceeds from the sale will be used to reduce outstanding borrowings on the Company’s lines of credit. There were no properties held for sale as of December 31, 2006.

 

During May 2006, the Company sold three community centers for an aggregate sales price of $42,280 and recognized a gain of $7,215. The Company also sold two community centers in May 2006 for an aggregate sales price of $63,000 and recognized a loss on impairment of real estate assets of $274.

 

Total revenues for the properties included in discontinued operations in the accompanying consolidated statements of operations were $1,629 and $3,001 for the three and six month periods ended June 30, 2007, respectively, and $2,997 and $8,020 for the three and six month periods ended June 30, 2006, respectively.

 

Note 12 – Income Taxes

 

The Company has elected taxable REIT subsidiary status for some of its subsidiaries. This enables the Company to receive income and provide services that would otherwise be impermissible for REITs. For these entities, deferred tax assets and liabilities are established for temporary differences between the financial reporting basis and the tax basis of assets and liabilities at the enacted tax rates expected to be in effect when the temporary differences reverse. A valuation allowance for deferred tax assets is provided if the Company believes all or some portion of the deferred tax asset may not be realized. An increase or decrease in the valuation allowance resulting from changes in circumstances that may affect the realizability of the related deferred tax asset is included in income.

 

The Company recorded an income tax provision of $948 and $1,751 for the three and six months ended June 30, 2007, respectively. The provision consists of a current tax benefit of $244 and a deferred tax provision of $1,192, respectively, for the three months ended June 30, 2007, and a current and deferred tax provision of $895 and $856, respectively, for the six months ended June 30, 2007. There was no income tax provision recorded in the three and six months ended June 30, 2006.

 

 

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The Company had a net deferred tax asset of $3,679 at June 30, 2007 and $4,291 at December 31, 2006. The net deferred tax asset at June 30, 2007 and December 31, 2006 primarily consisted of operating expense accruals and differences between book and tax depreciation.

 

The Company reports any income tax penalties attributable to its properties as property operating expenses and any corporate-related income tax penalties as general and administrative expenses in its statement of operations. In addition, any interest incurred on tax assessments are reported as interest expense. The Company reported nominal interest and penalty amounts for the three months ended June 30, 2007 and 2006, respectively, and the six months ended June 30, 2007 and 2006, respectively.

 

Note 13 – Recent Accounting Pronouncements

 

On July 13, 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), which is effective for fiscal years beginning after December 15, 2006. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS No.109, Accounting for Income Taxes, by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition.

 

The Company adopted FIN 48 as of January 1, 2007 and has analyzed its various federal and state filing positions. Based on this evaluation, the Company believes that its accruals for income tax liabilities are adequate and, therefore, no reserves for uncertain income tax positions have been recorded pursuant to FIN 48. Additionally, the Company did not record a cumulative effect adjustment related to the adoption of FIN 48.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework that clarifies the fair value measurement objective within GAAP and its application under the various pronouncements that require or permit fair value measurements, and expands disclosures about fair value measurements. It is intended to increase consistency and comparability among fair value estimates used in financial reporting. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The transition adjustment, which is measured as the difference between the carrying amount and the fair value of those financial instruments at the date SFAS No. 157 is initially applied, should be recognized as a cumulative effect adjustment to the opening balance of retained earnings for the fiscal year in which SFAS No. 157 is initially applied. The provisions of SFAS No. 157 are effective for the Company beginning January 1, 2008. The Company is currently evaluating the impact of adopting SFAS No. 157 on its financial position and results of operations.

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007, although early application is allowed. The Company is currently evaluating the impact of adopting SFAS No. 159 on its financial position and results of operations.

 

 

 

 

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ITEM 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the consolidated financial statements and accompanying notes that are included in this Form 10-Q. In this discussion, the terms “we”, “us”, “our”, and the “Company” refer to CBL & Associates Properties, Inc. and its subsidiaries.

 

Certain statements made in this section or elsewhere in this report may be deemed “forward looking statements” within the meaning of the federal securities laws. Although we believe the expectations reflected in any forward-looking statements are based on reasonable assumptions, we can give no assurance that these expectations will be attained, and it is possible that actual results may differ materially from those indicated by these forward-looking statements due to a variety of risks and uncertainties. In addition to the risk factors described in Part II, Item 1A. of this report, such risks and uncertainties include, without limitation, general industry, economic and business conditions, interest rate fluctuations, costs of capital and capital requirements, availability of real estate properties, inability to consummate acquisition opportunities, competition from other companies and retail formats, changes in retail rental rates in the Company’s markets, shifts in customer demands, tenant bankruptcies or store closings, changes in vacancy rates at our properties, changes in operating expenses, changes in applicable laws, rules and regulations, the ability to obtain suitable equity and/or debt financing and the continued availability of financing in the amounts and on the terms necessary to support our future business. We disclaim any obligation to update or revise any forward-looking statements to reflect actual results or changes in the factors affecting the forward-looking information.

 

EXECUTIVE OVERVIEW

 

We are a self-managed, self-administered, fully integrated real estate investment trust (“REIT”) that is engaged in the ownership, development, acquisition, leasing, management and operation of regional shopping malls, open-air centers and community centers. Our shopping center properties are located in 27 states, but primarily in the southeastern and midwestern United States.

 

As of June 30, 2007, we owned controlling interests in 72 regional malls/open-air centers, 28 associated centers (each adjacent to a regional shopping mall), four community centers and our corporate office building. We consolidate the financial statements of all entities in which we have a controlling financial interest or where we are the primary beneficiary of a variable interest entity. As of June 30, 2007, we owned non-controlling interests in seven regional malls, four associated centers and one community center. Because one or more of the other partners have substantive participating rights we do not control these partnerships and joint ventures and, accordingly, account for these investments using the equity method. We had seven mall expansions, three associated/lifestyle centers, one mixed-use center, three community centers (one of which is owned in a joint venture) and an office building under construction at June 30, 2007. We also hold options to acquire certain development properties owned by third parties.

 

The majority of our revenues is derived from leases with retail tenants and generally includes base minimum rents, percentage rents based on tenants’ sales volumes and reimbursements from tenants for expenditures, including property operating expenses, real estate taxes and maintenance and repairs, as well as certain capital expenditures. We also generate revenues from sales of outparcel land at the properties and from sales of operating real estate assets when it is determined that we can realize the maximum value of the assets. Proceeds from such sales are generally used to pay off related construction loans or reduce borrowings on our credit facilities.

 

 

 

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RESULTS OF OPERATIONS

 

The following significant transactions impact the comparison of the results of operations for the three months and six months ended June 30, 2007 to the results of operations for the comparable periods ended June 30, 2006:

 

 

 

 

Comparison of the Three Months Ended June 30, 2007 to the Three Months Ended June 30, 2006

 

Revenues

 

The $11.2 million increase in revenues resulted from an increase of $6.8 million attributable to the revenues from the Comparable Properties and an increase of $2.1 million in revenues from the New Properties. Management, development and leasing fees increased $2.3 million primarily attributable to fees received by, or due to, the Company for managing certain new developments and operating properties.

 

Our cost recovery ratio declined to 102.8% compared to 105.2% for the prior year period. As we continue to convert more and more tenants to fixed common area maintenance arrangements, fluctuations in tenant reimbursements will not correlate as closely with fluctuations in the corresponding expenses as they do with pro rata common area maintenance charges. As a result, there may be more variability in our cost recovery ratio from period to period.

 

Expenses

 

The $2.3 million increase in property operating expenses, including real estate taxes and maintenance and repairs, resulted from increases of $1.9 million from the Comparable Properties and $0.4 million attributable to the New Properties.

 

The $6.3 million increase in depreciation and amortization expense resulted from increases of $5.6 million from the Comparable Properties and $0.7 million from the New Properties. The increase in depreciation and amortization of the Comparable Properties is due to ongoing capital expenditures for renovations, expansions, tenant allowances and deferred maintenance and for the write-off of certain tenant allowances related to early lease terminations.

 

General and administrative expenses increased $1.5 million due to annual increases in salaries and benefits of existing personnel and the addition of new personnel to support our growth.

 

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Other Income and Expenses

 

Interest and other income increased by $0.9 million primarily due to a fee of $1.0 million related to the grant of an access and utilities easement at one of our properties.

 

Interest expense increased by $5.2 million due to additional debt associated with the New Properties as well as the refinancing of certain existing properties with increased principal amounts. In addition, we experienced an increase in the weighted average interest rate of our variable-rate debt as compared to the prior year quarter.

 

Gain on Sales

 

Gain on sales of real estate assets of $2.7 million in the three months ended June 30, 2007 relates to the recognition of gain on one property for which the gain had previously been deferred. Gain on sales of real estate assets of $2.0 million in the three months ended June 30, 2006 relates to the sale of two parcels of land.

 

Income Tax Provision

 

The income tax provision of $0.9 million for the three months ended June 30, 2007 relates to the earnings of our taxable REIT subsidiary and consists of a provision for deferred income taxes of $1.2 million, which is partially offset by a current income tax benefit of $0.3 million.

 

Discontinued Operations

 

We recognized income from discontinued operations of $0.5 million for the three months ended June 30, 2007, which represents a decline of $8.2 million from the $8.7 million of gain and income from discontinued operations that we recognized during the three months ended June 30, 2006. Discontinued operations in the three months ended June 30, 2007 and 2006 reflects the results of operations of Twin Peaks Mall, which is expected to be sold in the third quarter of 2007, plus the true up of estimated expenses to actual amounts for properties sold during previous periods. Discontinued operations for the three months ended June 30, 2006 also reflects the results of operations and gain on the disposal of five community centers that were sold in May 2006.

 

Comparison of the Six Months Ended June 30, 2007 to the Six Months Ended June 30, 2006

 

Revenues

 

The $16.5 million increase in revenues resulted from an increase of $10.8 million attributable to the revenues from the Comparable Properties, an increase of $3.9 million in revenues from the New Properties, and an increase in management, development and leasing fees of $2.4 million

 

Our cost recovery ratio declined to 100.3% compared to 104.8% for the prior year period. As we continue to convert more and more tenants to fixed common area maintenance arrangements, fluctuations in tenant reimbursements will not correlate as closely with fluctuations in the corresponding expenses as they do with pro rata common area maintenance charges. As a result, there may be more variability in our cost recovery ratio from period to period. In addition, the year-to-date decline is partially due to higher than expected snow removal costs incurred by the Company in the first quarter of 2007 and increases in bad debt expense.

 

 

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Expenses

 

The $9.3 million increase in property operating expenses, including real estate taxes and maintenance and repairs, resulted from increases of $8.6 million from the Comparable Properties and $0.7 million attributable to the New Properties. The increase in property operating expenses of the Comparable properties included a $2.0 million increase in bad debt expense that resulted from bad debt expense of $0.7 million in the six months ended June 30, 2007 compared to a net recovery of $1.3 million in the six months ended June 30, 2006.

 

The $8.8 million increase in depreciation and amortization expense resulted from increases of $7.6 million from the Comparable Properties and $1.2 million from the New Properties. The increase in depreciation and amortization of the Comparable Properties is due to ongoing capital expenditures for renovations, expansions, tenant allowances and deferred maintenance and for the write-off of certain tenant allowances related to early lease terminations.

 

General and administrative expenses increased $2.1 million due to annual increases in salaries and benefits of existing personnel and the addition of new personnel to support our growth.

 

Other Income and Expenses

 

Interest and other income for the six months ended June 30, 2007 increased primarily due to a fee of $1.0 million related to the grant of an access and utilities easement at one of our properties.

 

Interest expense increased by $7.4 million due to the additional debt associated with the New Properties as well as the refinancing of certain existing properties with increased principal amounts. In addition, we experienced an increase in the weighted average interest rate of our variable-rate debt as compared to the prior year period.

 

We recorded a loss on extinguishment of debt of $0.2 million as a result of prepayment fees related to a loan that we retired prior to its scheduled maturity date during the six months ended June 30, 2007.

 

Gain on Sales

 

Gain on sales of real estate assets of $6.2 million in the six months ended June 30, 2007 relates to the sale of six parcels of land. Gain on sales of real estate assets of $2.9 million in the six months ended June 30, 2006 relates to the sale of three parcels of land.

 

Equity in Earnings of Unconsolidated Affiliates

 

Equity in earnings of unconsolidated affiliates decreased $1.5 million primarily due to a lower level of outparcel sales at certain unconsolidated affiliates as compared to the prior year period.

 

Income Tax Provision

 

The income tax provision of $1.8 million for the six months ended June 30, 2007, relates to the earnings of our taxable REIT subsidiary and consists of provisions for current and deferred income taxes of $0.9 million each. We have cumulative stock-based compensation deductions that may be used to offset the current income tax payable of $0.9 million; therefore, we reduced the payable for current period income taxes to zero by recognizing a portion of the benefit of the cumulative stock-based compensation deductions.

 

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Discontinued Operations

 

We recognized income from discontinued operations of $0.5 million for the six months ended June 30, 2007, which represents a decline of $10.5 million from the $11.0 million of gain and income from discontinued operations that we recognized during the six months ended June 30, 2006. Discontinued operations in the six months ended June 30, 2007 and 2006 reflects the results of operations of Twin Peaks Mall which is expected to be sold in the third quarter of 2007, plus the true up of estimated expenses to actual amounts for properties sold during previous periods. Discontinued operations in the six months ended June 30, 2006 also reflects the results of operations and gain on disposal of five community centers that were sold in May 2006.

 

Operational Review

 

The shopping center business is, to some extent, seasonal in nature with tenants achieving the highest levels of sales during the fourth quarter because of the holiday season. Additionally, the malls earn most of their “temporary” rents (rents from short-term tenants), during the holiday period. Thus, occupancy levels and revenue production are generally the highest in the fourth quarter of each year. Results of operations realized in any one quarter may not be indicative of the results likely to be experienced over the course of the fiscal year.

 

We classify our regional malls into two categories – malls that have completed their initial lease-up are referred to as stabilized malls and malls that are in their initial lease-up phase and have not been open for three calendar years are referred to as non-stabilized malls. The non-stabilized malls currently include Coastal Grand-Myrtle Beach in Myrtle Beach, SC, which opened in March 2004; Imperial Valley Mall in El Centro, CA, which opened in March 2005; Southaven Towne Center in Southaven, MS, which opened in October 2005; and Gulf Coast Town Center in Ft. Myers, FL, which opened in November 2005.

 

We derive a significant amount of our revenues from the mall properties. The sources of our revenues by property type were as follows:

 

 

 

Sales and Occupancy Costs

 

Mall store sales (for those tenants who occupy 10,000 square feet or less and have reported sales) increased by 2.0% on a comparable per square foot basis for the six months ended June 30, 2007 compared with an increase of 3.8% for the six months ended June 30, 2006. Mall store sales for the trailing twelve months ended June 30, 2007 on a comparable per square foot basis were $344 per square foot compared with $335 per square foot for the trailing twelve months ended June 30, 2006.

 

Occupancy costs as a percentage of sales for the stabilized malls were 13.8% for the six months ended June 30, 2007 compared to 13.7% for the six months ended June 30, 2006.

 

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Occupancy

 

The occupancy of the portfolio was as follows:

 

 

 

Timing delays at some of the New Properties have impacted total occupancy. At High Pointe Commons, the anchors have opened but many of the stores are still in the process of taking occupancy. While occupancy was approximately 70% as of June 30, 2007, the project is over 90% leased. At Gulf Coast Town Center, although the project is 97% leased and committed, occupancy was at 56% as of June 30, 2007. Several stores have encountered delays in receiving building permits due to the lengthy process time involved in that geographic area. In addition, the lifestyle center developments generally open in staggered phases, reflecting initial lower occupancy rates, as compared to mall properties in which a greater number of tenants are typically open as of a mall’s grand opening date.

 

Leasing

 

During the second quarter of 2007, the Company revised its lease reporting focus to small shop spaces less than 10,000 square feet in comparison to the previous reporting on spaces less than 20,000 square feet. This change allows for greater consistency and comparability with the data reported by our peers in the retail real estate industry.

 

Average annual base rents per square foot for small shop spaces less than 10,000 square feet were as follows for each property type:

 

 

 

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The following table presents the results we achieved in new and renewal leasing during the three and six months ended June 30, 2007 for small shop spaces less than 10,000 square feet that were previously occupied:

 

 

 

During the second quarter of 2007, on an overall leasing basis, we signed leases totaling approximately 1.2 million square feet, including approximately 0.3 million square feet of development leasing and 0.9 million square feet of leases in our operating portfolio. The 0.9 million square feet was comprised of 0.4 million square feet of new leases and 0.5 million square feet of renewal leases. This compares with a total of 1.0 million square feet of leases signed in the second quarter of 2006, including 0.4 million square feet of development leasing and 0.6 million square feet completed in the operating portfolio. Of the 0.6 million square feet in the operating portfolio, 0.3 million square feet were new leases and 0.3 million square feet were renewals.

 

LIQUIDITY AND CAPITAL RESOURCES

 

There was $58.2 million of cash and cash equivalents as of June 30, 2007, an increase of $29.5 million from December 31, 2006. Cash flows from operations are used to fund short-term liquidity and capital needs such as tenant construction allowances, capital expenditures and payments of dividends and distributions. For longer-term liquidity needs such as acquisitions, new developments, renovations and expansions, we typically rely on property specific mortgages (which are generally non-recourse), construction and term loans, revolving lines of credit, common stock, preferred stock, joint venture investments and a minority interest in the Operating Partnership.

 

Cash Flows

 

Cash provided by operating activities during the six months ended June 30, 2007, increased by $12.3 million to $204.4 million from $192.1 million during the six months ended June 30, 2006. This increase is primarily due to the timing of amounts that were retained in accounts payable at June 30, 2007, in addition to the timing of cash receipts from collections of tenant and other receivables prior to the end of the second quarter.

 

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Debt

 

During the six months ended June 30, 2007, we borrowed $1,047.5 million under mortgage and other notes payable and paid $656.5 million to reduce outstanding borrowings under our lines of credit and repay certain mortgage notes payable. We paid $3.5 million of costs directly related to borrowings and our credit facilities, as well as $0.2 million in prepayment fees related to the retirement of a loan before its scheduled maturity date.

 

The following tables summarize debt based on our pro rata ownership share (including our pro rata share of unconsolidated affiliates and excluding minority investors’ share of shopping center properties) because we believe this provides investors a clearer understanding of our total debt obligations (in thousands):