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Section 1: 10-Q (10-Q 9.30.2017)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTER ENDED SEPTEMBER 30, 2017                                       COMMISSION FILE NUMBER 1-07094


390738221_egplogonewa01a02a01a02a01a11.jpg

EASTGROUP PROPERTIES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

MARYLAND
13-2711135
(State or other jurisdiction
(I.R.S. Employer
of incorporation or organization)
Identification No.)
 
 
190 EAST CAPITOL STREET
 
SUITE 400
 
JACKSON, MISSISSIPPI
39201
(Address of principal executive offices)
(Zip code)
 
 
Registrant’s telephone number:  (601) 354-3555
 

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 ( )

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES (x)   NO ( )

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.   
Large Accelerated Filer (x)
 
Accelerated Filer ( )
 
Non-accelerated Filer ( )
 
 
 
 
(Do not check if a smaller reporting company)
Smaller Reporting Company ( )
 
Emerging Growth Company ( )
 
 
                   
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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 (x)

The number of shares of common stock, $.0001 par value, outstanding as of October 20, 2017 was 34,424,668.

-1-



EASTGROUP PROPERTIES, INC. AND SUBSIDIARIES

FORM 10-Q

TABLE OF CONTENTS
FOR THE QUARTER ENDED SEPTEMBER 30, 2017 


 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



-2-





EASTGROUP PROPERTIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)

 
September 30,
2017
 
December 31,
2016
ASSETS
 
 
 
Real estate properties
$
2,306,017

 
2,113,073

Development
204,197

 
293,908

 
2,510,214

 
2,406,981

Less accumulated depreciation
(732,566
)
 
(694,250
)
 
1,777,648

 
1,712,731

Unconsolidated investment
7,836

 
7,681

Cash
10

 
522

Other assets
108,499

 
104,830

TOTAL ASSETS
$
1,893,993

 
1,825,764

 
 
 
 
LIABILITIES AND EQUITY
 

 
 

 
 
 
 
LIABILITIES
 

 
 

Unsecured bank credit facilities
$
216,643

 
190,990

Unsecured debt
653,178

 
652,838

Secured debt
202,178

 
257,505

Accounts payable and accrued expenses
66,830

 
52,701

Other liabilities
28,990

 
29,864

Total Liabilities
1,167,819

 
1,183,898

 
 
 
 
EQUITY
 

 
 

Stockholders’ Equity:
 

 
 

Common shares; $.0001 par value; 70,000,000 shares authorized; 34,424,668 shares issued and outstanding at September 30, 2017 and 33,332,213 at December 31, 2016
3

 
3

Excess shares; $.0001 par value; 30,000,000 shares authorized; no shares issued

 

Additional paid-in capital on common shares
1,031,592

 
949,318

Distributions in excess of earnings
(312,392
)
 
(313,655
)
Accumulated other comprehensive income
2,645

 
1,995

Total Stockholders’ Equity
721,848

 
637,661

Noncontrolling interest in joint ventures
4,326

 
4,205

Total Equity
726,174

 
641,866

TOTAL LIABILITIES AND EQUITY
$
1,893,993

 
1,825,764

 
See accompanying Notes to Consolidated Financial Statements (unaudited).



-3-



EASTGROUP PROPERTIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2017
 
2016
 
2017
 
2016
REVENUES
 
 
 
 
 
 
 
Income from real estate operations
$
68,712

 
63,178

 
202,704

 
186,628

Other revenue
34

 
12

 
90

 
68

 
68,746

 
63,190

 
202,794

 
186,696

EXPENSES
 
 
 
 
 

 
 

Expenses from real estate operations
20,109

 
18,552

 
59,360

 
54,130

Depreciation and amortization
21,011

 
19,361

 
62,101

 
57,756

General and administrative
3,205

 
2,328

 
11,586

 
10,663

Acquisition costs

 
161

 

 
161

 
44,325

 
40,402

 
133,047

 
122,710

OPERATING INCOME
24,421

 
22,788

 
69,747

 
63,986

OTHER INCOME (EXPENSE)
 
 
 
 
 

 
 

Interest expense
(8,704
)
 
(8,841
)
 
(26,405
)
 
(27,078
)
Gain on sales of real estate investments

 

 
21,855

 
42,313

Other
255

 
853

 
725

 
1,502

NET INCOME
15,972

 
14,800

 
65,922

 
80,723

Net income attributable to noncontrolling interest in joint ventures
(88
)
 
(139
)
 
(329
)
 
(438
)
NET INCOME ATTRIBUTABLE TO EASTGROUP PROPERTIES, INC. COMMON STOCKHOLDERS
15,884

 
14,661

 
65,593

 
80,285

Other comprehensive income (loss) - cash flow hedges
224

 
2,606

 
650

 
(6,253
)
TOTAL COMPREHENSIVE INCOME
$
16,108

 
17,267

 
66,243

 
74,032

BASIC PER COMMON SHARE DATA FOR NET INCOME ATTRIBUTABLE TO EASTGROUP PROPERTIES, INC. COMMON STOCKHOLDERS
 
 
 
 
 

 
 

Net income attributable to common stockholders
$
.46

 
.45

 
1.94

 
2.47

Weighted average shares outstanding
34,215

 
32,741

 
33,857

 
32,458

DILUTED PER COMMON SHARE DATA FOR NET INCOME ATTRIBUTABLE TO EASTGROUP PROPERTIES, INC. COMMON STOCKHOLDERS
 
 
 
 
 

 
 

Net income attributable to common stockholders
$
.46

 
.45

 
1.93

 
2.47

Weighted average shares outstanding
34,290

 
32,823

 
33,905

 
32,519

See accompanying Notes to Consolidated Financial Statements (unaudited).

-4-




EASTGROUP PROPERTIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)


 
Common Stock
 
Additional
Paid-In Capital
 
Distributions in Excess of Earnings
 
Accumulated Other Comprehensive Income
 
Noncontrolling Interest in Joint Ventures
 
Total
BALANCE, DECEMBER 31, 2016
$
3

 
949,318

 
(313,655
)
 
1,995

 
4,205

 
641,866

Net income

 

 
65,593

 

 
329

 
65,922

Net unrealized change in fair value of cash flow hedges

 

 

 
650

 

 
650

Common dividends declared – $1.88 per share

 

 
(64,330
)
 

 

 
(64,330
)
Stock-based compensation, net of forfeitures

 
5,653

 

 

 

 
5,653

Issuance of 1,037,605 shares of common stock, common stock offering, net of expenses

 
78,956

 

 

 

 
78,956

Issuance of 2,097 shares of common stock, dividend reinvestment plan

 
170

 

 

 

 
170

Withheld 33,695 shares of common stock to satisfy tax withholding obligations in connection with the vesting of restricted stock

 
(2,505
)
 

 

 

 
(2,505
)
Distributions to noncontrolling interest

 

 

 

 
(308
)
 
(308
)
Contributions from noncontrolling interest

 

 

 

 
100

 
100

BALANCE, SEPTEMBER 30, 2017
$
3

 
1,031,592

 
(312,392
)
 
2,645

 
4,326

 
726,174


See accompanying Notes to Consolidated Financial Statements (unaudited).

-5-



EASTGROUP PROPERTIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
 
Nine Months Ended September 30,
 
2017
 
2016
OPERATING ACTIVITIES
 
 
 
Net income                                                                                                       
$
65,922

 
80,723

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation and amortization                                                                                                       
62,101

 
57,756

Stock-based compensation expense                                                                                                       
4,266

 
3,959

Gain, net of loss, on sales of real estate investments and non-operating real estate
(21,815
)
 
(43,046
)
Changes in operating assets and liabilities:
 

 
 

Accrued income and other assets                                                                                                       
881

 
2,061

Accounts payable, accrued expenses and prepaid rent                                                                                                       
10,586

 
5,221

Other                                                                                                       
765

 
278

NET CASH PROVIDED BY OPERATING ACTIVITIES                                                                                                       
122,706

 
106,952

INVESTING ACTIVITIES
 

 
 

Real estate development                                                                                                       
(80,462
)
 
(94,781
)
Purchases of real estate                                                                                                       
(36,739
)
 
(24,955
)
Real estate improvements                                                                                                       
(18,378
)
 
(17,591
)
Net proceeds from sales of real estate investments and non-operating real estate                                                                                                       
39,934

 
77,298

Repayments on mortgage loans receivable                                                                                                       
96

 
91

Changes in accrued development costs                                                                                                       
2,032

 
7,469

Changes in other assets and other liabilities                                                                                                       
(11,240
)
 
(11,588
)
NET CASH USED IN INVESTING ACTIVITIES                                                                                                       
(104,757
)
 
(64,057
)
FINANCING ACTIVITIES
 

 
 

Proceeds from unsecured bank credit facilities                                                                                          
281,342

 
444,314

Repayments on unsecured bank credit facilities                                                                                                      
(255,988
)
 
(388,569
)
Proceeds from unsecured debt

 
105,000

Repayments on unsecured debt

 
(80,000
)
Repayments on secured debt
(55,478
)
 
(89,295
)
Debt issuance costs                                                                                                       
(129
)
 
(1,165
)
Distributions paid to stockholders (not including dividends accrued on unvested restricted stock)                                                                                                     
(64,623
)
 
(60,418
)
Proceeds from common stock offerings                                                                                                       
78,956

 
29,643

Proceeds from dividend reinvestment plan                                                                                                       
170

 
179

Other                                                                                                       
(2,711
)
 
(2,599
)
NET CASH USED IN FINANCING ACTIVITIES
(18,461
)
 
(42,910
)
DECREASE IN CASH AND CASH EQUIVALENTS
(512
)
 
(15
)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
522

 
48

CASH AND CASH EQUIVALENTS AT END OF PERIOD
$
10

 
33

SUPPLEMENTAL CASH FLOW INFORMATION
 

 
 

    Cash paid for interest, net of amount capitalized of $4,242 and $3,737
       for 2017 and 2016, respectively                                                                                                       
$
24,978

 
25,977


See accompanying Notes to Consolidated Financial Statements (unaudited).

-6-

EASTGROUP PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)



(1)
BASIS OF PRESENTATION
 
The accompanying unaudited financial statements of EastGroup Properties, Inc. (“EastGroup” or “the Company”) have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements.  In management’s opinion, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  The financial statements should be read in conjunction with the financial statements contained in the 2016 annual report on Form 10-K and the notes thereto. Certain reclassifications have been made in the 2016 consolidated financial statements to conform to the 2017 presentation.

(2)
PRINCIPLES OF CONSOLIDATION
 
The consolidated financial statements include the accounts of EastGroup Properties, Inc., its wholly owned subsidiaries and its investment in any joint ventures in which the Company has a controlling interest. At September 30, 2017 and December 31, 2016, the Company had a controlling interest in one joint venture, the 80% owned University Business Center. The Company records 100% of the joint ventures' assets, liabilities, revenues and expenses with noncontrolling interests provided for in accordance with the joint venture agreements.  EastGroup previously owned 80% of Castilian Research Center. During the second quarter of 2016, Castilian Research Center was sold, and the joint venture was subsequently terminated. The equity method of accounting is used for the Company’s 50% undivided tenant-in-common interest in Industry Distribution Center II.  All significant intercompany transactions and accounts have been eliminated in consolidation.

(3)
USE OF ESTIMATES
 
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses during the reporting period and to disclose material contingent assets and liabilities at the date of the financial statements.  Actual results could differ from those estimates.

(4)
REAL ESTATE PROPERTIES
 
EastGroup has one reportable segment – industrial properties.  These properties are concentrated in major Sunbelt markets of the United States, primarily in the states of Florida, Texas, Arizona, California and North Carolina, have similar economic characteristics and also meet the other criteria that permit the properties to be aggregated into one reportable segment.

The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable.  Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows (including estimated future expenditures necessary to substantially complete the asset) expected to be generated by the asset.  If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the asset.  For the periods ended September 30, 2017 and December 31, 2016, the Company did not identify any impairment charges which should be recorded.

Depreciation of buildings and other improvements is computed using the straight-line method over estimated useful lives of generally 40 years for buildings and 3 to 15 years for improvements.  Building improvements are capitalized, while maintenance and repair expenses are charged to expense as incurred.  Significant renovations and improvements that improve or extend the useful life of the assets are capitalized.  Depreciation expense was $17,323,000 and $51,070,000 for the three and nine months ended September 30, 2017, respectively, and $15,855,000 and $47,273,000 for the same periods in 2016.















-7-

EASTGROUP PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The Company’s Real estate properties and Development at September 30, 2017 and December 31, 2016 were as follows:
 
September 30,
2017
 
December 31,
2016
 
(In thousands)
Real estate properties:
 
 
 
   Land                                                                  
$
341,141

 
308,931

   Buildings and building improvements                                          
1,569,982

 
1,435,309

   Tenant and other improvements                                                                  
394,894

 
368,833

Development                                                                  
204,197

 
293,908

 
2,510,214

 
2,406,981

   Less accumulated depreciation                                                                  
(732,566
)
 
(694,250
)
 
$
1,777,648

 
1,712,731


(5)
DEVELOPMENT
 
For properties under development and properties acquired in the development stage, costs associated with development (i.e., land, construction costs, interest expense, property taxes and other direct and indirect costs associated with development) are aggregated into the total capitalized costs of the property.  Included in these costs are management’s estimates for the portions of internal costs (primarily personnel costs) deemed related to such development activities. The internal costs are allocated to specific development properties based on development activity. As the property becomes occupied, depreciation commences on the occupied portion of the building, and costs are capitalized only for the portion of the building that remains vacant.  When the property becomes 80% occupied or one year after completion of the shell construction (whichever comes first), capitalization of development costs, including interest expense, property taxes and internal personnel costs, ceases.  The properties are then transferred to Real estate properties, and depreciation commences on the entire property (excluding the land).

(6)
REAL ESTATE PROPERTY ACQUISITIONS AND ACQUIRED INTANGIBLES
 
Upon acquisition of real estate properties, EastGroup applies the principles of Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 805, Business Combinations. Prior to the Company's adoption of Accounting Standards Update (ASU) 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, effective October 1, 2016, acquisition-related costs were recognized as expenses in the periods in which the costs were incurred and the services were received.

As discussed in Note 18, beginning with acquisitions after October 1, 2016, the Company follows the guidance in ASU 2017-01, which provides a new framework for determining whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. Under the new guidance, companies are required to utilize an initial screening test to determine whether substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets; if so, the set is not a business. EastGroup has determined that its real estate property acquisitions in the first nine months of 2017 are considered to be acquisitions of groups of similar identifiable assets; therefore, the acquisitions are not considered to be acquisitions of a business. As a result, the Company has capitalized acquisition costs related to its 2017 acquisitions.
 
The FASB Codification provides guidance on how to properly determine the allocation of the purchase price among the individual components of both the tangible and intangible assets based on their respective fair values.  Goodwill for business combinations is recorded when the purchase price exceeds the fair value of the assets and liabilities acquired.  Factors considered by management in allocating the cost of the properties acquired include an estimate of carrying costs during the expected lease-up periods considering current market conditions and costs to execute similar leases.  The allocation to tangible assets (land, building and improvements) is based upon management’s determination of the value of the property as if it were vacant using discounted cash flow models. The Company determines whether any financing assumed is above or below market based upon comparison to similar financing terms for similar properties.  The cost of the properties acquired may be adjusted based on indebtedness assumed from the seller that is determined to be above or below market rates.  

The purchase price is also allocated among the following categories of intangible assets:  the above or below market component of in-place leases, the value of in-place leases, and the value of customer relationships.  The value allocable to the above or below market component of an acquired in-place lease is determined based upon the present value (using a discount rate reflecting the risks associated with the acquired leases) of the difference between (i) the contractual amounts to be paid pursuant to the lease over its remaining term, and (ii) management’s estimate of the amounts that would be paid using fair market rates over the remaining term of the lease.  The amounts allocated to above and below market leases are included in Other assets and Other liabilities,

-8-

EASTGROUP PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

respectively, on the Consolidated Balance Sheets and are amortized to rental income over the remaining terms of the respective leases. The total amount of intangible assets is further allocated to in-place lease values and customer relationship values based upon management’s assessment of their respective values.  These intangible assets are included in Other assets on the Consolidated Balance Sheets and are amortized over the remaining term of the existing lease, or the anticipated life of the customer relationship, as applicable.

Amortization expense for in-place lease intangibles was $1,101,000 and $3,455,000 for the three and nine months ended September 30, 2017, and $1,056,000 and $3,202,000 for the same periods in 2016. Amortization of above and below market leases increased rental income by $129,000 and $406,000 for the three and nine months ended September 30, 2017, and $121,000 and $370,000 for the same periods in 2016.

During the first nine months of 2017, EastGroup acquired the following operating properties: Shiloh 400 and Broadmoor Commerce Park in Atlanta and Southpark Corporate Center 5-7 in Austin. The total cost for the properties acquired by the Company during the nine months ended September 30, 2017, was $36,475,000, of which $33,665,000 was allocated to Real estate properties. EastGroup allocated $5,700,000 of the total purchase price to land using third party land valuations for the Atlanta and Austin markets. The market values are considered to be Level 3 inputs as defined by ASC 820, Fair Value Measurement (see Note 16 for additional information on ASC 820). Intangibles associated with the purchase of real estate were allocated as follows: $3,016,000 to in-place lease intangibles and $114,000 to above market leases (both included in Other assets on the Consolidated Balance Sheets), and $320,000 to below market leases (included in Other liabilities on the Consolidated Balance Sheets).

During the year ended December 31, 2016, EastGroup acquired the following development-stage properties: Parc North in Fort Worth (Dallas), Weston Commerce Park in Weston (South Florida), and Jones Corporate Park in Las Vegas. At the time of acquisition, the properties were classified as under construction or in the lease-up phase of development. In addition, the Company acquired Flagler Center, a three-building business distribution complex in Jacksonville, Florida.

The properties purchased in 2016 were acquired for a total cost of $112,158,000, of which $22,228,000 was allocated to Real estate properties and $84,490,000 was allocated to Development. EastGroup allocated $29,164,000 of the total purchase price to land using third party land valuations for the Dallas, South Florida, Las Vegas and Jacksonville markets. The market values are considered to be Level 3 inputs as defined by ASC 820. Intangibles associated with the purchase of real estate were allocated as follows: $5,941,000 to in-place lease intangibles and $393,000 to above market leases (included in Other assets on the Consolidated Balance Sheets), and $894,000 to below market leases (included in Other liabilities on the Consolidated Balance Sheets).

The intangible assets, including in-place lease intangibles, above market leases and below market leases, are amortized over the remaining lives of the associated leases in place at the time of acquisition.

The Company periodically reviews the recoverability of goodwill (at least annually) and the recoverability of other intangibles (on a quarterly basis) for possible impairment.  In management’s opinion, no impairment of goodwill or other intangibles existed during the periods ended September 30, 2017 and December 31, 2016.

(7)
REAL ESTATE SOLD AND HELD FOR SALE/DISCONTINUED OPERATIONS
 
The Company considers a real estate property to be held for sale when it meets the criteria established under ASC 360, Property, Plant and Equipment, including when it is probable that the property will be sold within a year.  Real estate properties held for sale are reported at the lower of the carrying amount or fair value less estimated costs to sell and are not depreciated while they are held for sale.  The Company did not classify any properties as held for sale as of September 30, 2017 and December 31, 2016.

In accordance with FASB ASU 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360), Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, the Company would report a disposal of a component of an entity or a group of components of an entity in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity's operations and financial results when the component or group of components meets the criteria to be classified as held for sale or when the component or group of components is disposed of by sale or other than by sale. In addition, the Company would provide additional disclosures about both discontinued operations and the disposal of an individually significant component of an entity that does not qualify for discontinued operations presentation in the financial statements. EastGroup performs an analysis of properties sold to determine whether the sales qualify for discontinued operations presentation.




-9-

EASTGROUP PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The Company does not consider its sales in 2016 and the first nine months of 2017 to be disposals of a component of an entity or a group of components of an entity representing a strategic shift that has (or will have) a major effect on the entity's operations and financial results.

The Company sold Stemmons Circle and Techway Southwest I-IV during the first nine months of 2017. The properties, which contain 514,000 square feet located in Dallas and Houston, were sold for $38.0 million and the Company recognized net gains on the sales of $21.9 million. The Company also sold 5 acres of land in Dallas for $850,000 and recognized a loss of $40,000.

During the twelve months ended December 31, 2016, EastGroup sold the following operating properties: Northwest Point Distribution and Service Centers, North Stemmons II and III, America Plaza, Lockwood Distribution Center, West Loop Distribution Center 1 & 2, two of its four Interstate Commons Distribution Center buildings, Castilian Research Center and Memphis I. The properties, which contain 1,256,000 square feet and are located in Houston, Dallas, Phoenix, Santa Barbara and Memphis, were sold for $75.7 million and the Company recognized net gains on the sales of $42.2 million. The Company also sold 25 acres of land in Houston, Dallas and Orlando for $5.4 million and recognized gains on sales of $733,000.

The results of operations and gains and losses on sales for the properties sold during the periods presented are reported in continuing operations on the Consolidated Statements of Income and Comprehensive Income. The gains and losses on the sales of land are included in Other, and the gains on the sales of operating properties are included in Gain on sales of real estate investments.

(8)
OTHER ASSETS
 
A summary of the Company’s Other assets follows:
 
September 30,
2017
 
December 31,
2016
 
(In thousands)
Leasing costs (principally commissions)                                                                                  
$
70,322

 
65,521

Accumulated amortization of leasing costs                                                       
(26,266
)
 
(26,340
)
Leasing costs (principally commissions), net of accumulated amortization
44,056

 
39,181

 
 
 
 
Straight-line rents receivable                                                                                  
30,739

 
28,369

Allowance for doubtful accounts on straight-line rents receivable
(158
)
 
(76
)
Straight-line rents receivable, net of allowance for doubtful accounts
30,581

 
28,293

 
 
 
 
Accounts receivable                                                                                  
3,907

 
6,824

Allowance for doubtful accounts on accounts receivable
(566
)
 
(809
)
Accounts receivable, net of allowance for doubtful accounts
3,341

 
6,015

 
 
 
 
Acquired in-place lease intangibles                                                                                  
21,814

 
21,231

Accumulated amortization of acquired in-place lease intangibles
(9,664
)
 
(8,642
)
Acquired in-place lease intangibles, net of accumulated amortization
12,150

 
12,589

 
 
 
 
Acquired above market lease intangibles                                                                                  
1,549

 
1,594

Accumulated amortization of acquired above market lease intangibles
(738
)
 
(736
)
Acquired above market lease intangibles, net of accumulated amortization
811

 
858

 
 
 
 
Mortgage loans receivable                                                                                  
4,656

 
4,752

Interest rate swap assets
4,183

 
4,546

Goodwill                                                                                  
990

 
990

Prepaid expenses and other assets                                                                                  
7,731

 
7,606

Total Other assets
$
108,499

 
104,830



-10-

EASTGROUP PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(9)
DEBT

The Company's debt is detailed below. EastGroup presents debt issuance costs as reductions of Secured debt, Unsecured debt and Unsecured bank credit facilities on the Consolidated Balance Sheets.
 
September 30,
2017
 
December 31,
2016
 
(In thousands)
Unsecured bank credit facilities - variable rate, carrying amount
$
137,374

 
112,020

Unsecured bank credit facilities - fixed rate, carrying amount (1)
80,000

 
80,000

Unamortized debt issuance costs
(731
)
 
(1,030
)
Unsecured bank credit facilities
216,643

 
190,990

 
 
 
 
Unsecured debt - fixed rate, carrying amount (1)
655,000

 
655,000

Unamortized debt issuance costs
(1,822
)
 
(2,162
)
Unsecured debt
653,178

 
652,838

 
 
 
 
Secured debt - fixed rate, carrying amount (1)
203,093

 
258,594

Unamortized debt issuance costs
(915
)
 
(1,089
)
Secured debt
202,178

 
257,505

 
 
 
 
Total debt
$
1,071,999

 
1,101,333


(1)
These loans have a fixed interest rate or an effectively fixed interest rate due to interest rate swaps.

Scheduled principal payments on long-term debt, including Secured debt and Unsecured debt (not including Unsecured bank credit facilities), as of September 30, 2017, are as follows: 
Years Ending December 31,
 
(In thousands)
Remainder of 2017
 
$
2,736

2018
 
61,316

2019
 
130,569

2020
 
114,096

2021
 
129,563

2022 and beyond
 
419,813

       Total
 
$
858,093


Properties encumbered by EastGroup's Secured debt were disclosed in the Company's Form 10-K for the year ended December 31, 2016. The following properties were encumbered by one of the Company's secured loans disclosed in the Form 10-K: Colorado Crossing, Interstate I-III, Rojas, Steele Creek 1 & 2, Stemmons Circle, Venture and World Houston 3-9. During the nine months ended September 30, 2017, the Company closed a collateral release for Stemmons Circle. Subsequent to the collateral release, the Company sold Stemmons Circle.


-11-

EASTGROUP PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


(10)
ACCOUNTS PAYABLE AND ACCRUED EXPENSES
 
A summary of the Company’s Accounts payable and accrued expenses follows:
 
September 30,
2017
 
December 31,
2016
 
(In thousands)
Property taxes payable                                                                                  
$
31,408

 
14,186

Development costs payable                                                                                  
11,876

 
9,844

Property capital expenditures payable
3,924

 
2,304

Interest payable                                                                                  
4,329

 
3,822

Dividends payable on unvested restricted stock                                                            
1,237

 
1,530

Book overdraft (1)
7,565

 
14,452

Other payables and accrued expenses                                                                                  
6,491

 
6,563

 Total Accounts payable and accrued expenses
$
66,830

 
52,701


(1) Represents unfunded outstanding checks for which the bank has not advanced cash to the Company.

(11)
OTHER LIABILITIES
 
A summary of the Company’s Other liabilities follows:
 
September 30,
2017
 
December 31,
2016
 
(In thousands)
Security deposits                                                                                  
$
16,361

 
14,782

Prepaid rent and other deferred income                                                     
8,702

 
9,795

 
 
 
 
Acquired below-market lease intangibles
4,071

 
4,012

     Accumulated amortization of below-market lease intangibles
(1,968
)
 
(1,662
)
Acquired below-market lease intangibles, net of accumulated amortization
2,103

 
2,350

 
 
 
 
Interest rate swap liabilities
1,552

 
2,578

Prepaid tenant improvement reimbursements
256

 
343

Other liabilities                                                                                  
16

 
16

 Total Other liabilities
$
28,990

 
29,864


(12)
COMPREHENSIVE INCOME
 
Total Comprehensive Income is comprised of net income plus all other changes in equity from non-owner sources and is presented on the Consolidated Statements of Income and Comprehensive Income. The components of Accumulated other comprehensive income (loss) are presented in the Company's Consolidated Statement of Changes in Equity and are summarized below. See Note 13 for information regarding the Company's interest rate swaps.
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
 
(In thousands)
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS):
 
 
 
Balance at beginning of period
$
2,421

 
(12,315
)
 
1,995

 
(3,456
)
    Change in fair value of interest rate swaps - cash flow hedges
224

 
2,606

 
650

 
(6,253
)
Balance at end of period
$
2,645

 
(9,709
)
 
2,645

 
(9,709
)

-12-

EASTGROUP PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


(13)
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
 
The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risk, including interest rate, liquidity and credit risk primarily by managing the amount, sources and duration of its debt funding and, to a limited extent, the use of derivative instruments.

Specifically, the Company has entered into derivative instruments to manage exposures that arise from business activities that result in the payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company's derivative instruments, described below, are used to manage differences in the amount, timing and duration of the Company's known or expected cash payments principally related to certain of the Company's borrowings.

The Company's objective in using interest rate derivatives is to change variable interest rates to fixed interest rates by using interest rate swaps. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. 

As of September 30, 2017, the Company had seven interest rate swaps outstanding, all of which are used to hedge the variable cash flows associated with unsecured loans. All of the Company's interest rate swaps convert the related loans' LIBOR rate components to effectively fixed interest rates, and the Company has concluded that each of the hedging relationships is highly effective.

The effective portion of changes in the fair value of derivatives designated and qualifying as cash flow hedges is recorded in Other comprehensive income (loss) and is subsequently reclassified into earnings through interest expense as interest payments are made in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the derivatives, which is immaterial for the periods reported, is recognized directly in earnings (included in Other on the Consolidated Statements of Income and Comprehensive Income).

Amounts reported in Other comprehensive income (loss) related to derivatives will be reclassified to Interest expense as interest payments are made on the Company's variable-rate debt. The Company estimates the swap interest payments will be $423,000 over the next twelve months. These payments approximate the expected cash interest payments for the swaps. Since the interest payments on the swaps in combination with the associated debt have been effectively fixed, this estimate is not in addition to the Company's total expected combined interest payments or expense for the next twelve months.

The Company's valuation methodology for over-the-counter (“OTC”) derivatives is to discount cash flows based on Overnight Index Swap (“OIS”) rates.  Uncollateralized or partially-collateralized trades are discounted at OIS rates, but include appropriate economic adjustments for funding costs (i.e., a LIBOR-OIS basis adjustment to approximate uncollateralized cost of funds) and credit risk.  The Company calculates its derivative valuations using mid-market prices.

As of September 30, 2017 and December 31, 2016, the Company had the following outstanding interest rate derivatives that are designated as cash flow hedges of interest rate risk:
Interest Rate Derivative
 
Notional Amount as of September 30, 2017
 
Notional Amount as of December 31, 2016
 
 
(In thousands)
Interest Rate Swap
 
$80,000
 
$80,000
Interest Rate Swap
 
$75,000
 
$75,000
Interest Rate Swap
 
$75,000
 
$75,000
Interest Rate Swap
 
$65,000
 
$65,000
Interest Rate Swap
 
$60,000
 
$60,000
Interest Rate Swap
 
$40,000
 
$40,000
Interest Rate Swap
 
$15,000
 
$15,000

The table below presents the fair value of the Company's derivative financial instruments as well as their classification on the Consolidated Balance Sheets as of September 30, 2017 and December 31, 2016. See Note 16 for additional information on the fair value of the Company's interest rate swaps.

-13-

EASTGROUP PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 
Derivatives
As of September 30, 2017
 
Derivatives
As of December 31, 2016
 
Balance Sheet Location
 
Fair Value
 
Balance Sheet Location
 
Fair Value
 
(In thousands)
Derivatives designated as cash flow hedges:
 
 
 
 
 
 
 
    Interest rate swap assets
Other assets
 
$
4,183

 
Other assets
 
$
4,546

    Interest rate swap liabilities
Other liabilities
 
1,552

 
Other liabilities
 
2,578


The table below presents the effect of the Company's derivative financial instruments on the Consolidated Statements of Income and Comprehensive Income for the three and nine months ended September 30, 2017 and 2016:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
 
(In thousands)
DERIVATIVES IN CASH FLOW HEDGING RELATIONSHIPS
 
 
 
 
 
 
 
Interest Rate Swaps:
 
 
 
 
 
 
 
  Amount of income (loss) recognized in Other comprehensive income (loss) on derivatives                                                                                                     
$
(102
)
 
1,550

 
(996
)
 
(9,279
)
  Amount of loss reclassified from Accumulated other comprehensive income (loss) into Interest expense                                                                                               
326

 
1,056

 
1,646

 
3,026


See Note 12 for additional information on the Company's Accumulated other comprehensive income (loss) resulting from its interest rate swaps.

Derivative financial agreements expose the Company to credit risk in the event of non-performance by the counterparties under the terms of the interest rate hedge agreements. The Company believes it minimizes the credit risk by transacting with financial institutions the Company regards as credit-worthy.

The Company has an agreement with its derivative counterparties containing a provision stating that the Company could be declared in default on its derivative obligations if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender.

As of September 30, 2017, the fair value of derivatives in an asset position related to these agreements was $4,183,000, and the fair value of derivatives in a liability position related to these agreements was $1,552,000. As of September 30, 2017, the Company has not posted any collateral related to these arrangements. If the Company had breached any of the contractual provisions of the derivative contracts, it could have been required to settle its obligations under the agreements at their termination value. The swap termination value of derivatives in an asset position was an asset in the amount of $4,222,000, and the swap termination value of derivatives in a liability position was a liability in the amount of $1,583,000.

(14)
EARNINGS PER SHARE
 
The Company applies ASC 260, Earnings Per Share, which requires companies to present basic and diluted earnings per share (EPS).  Basic EPS represents the amount of earnings for the period attributable to each share of common stock outstanding during the reporting period.  The Company’s basic EPS is calculated by dividing Net Income Attributable to EastGroup Properties, Inc. Common Stockholders by the weighted average number of common shares outstanding. The weighted average number of common shares outstanding does not include any potentially dilutive securities or any unvested restricted shares of common stock. These unvested restricted shares, although classified as issued and outstanding, are considered forfeitable until the restrictions lapse and will not be included in the basic EPS calculation until the shares are vested.

Diluted EPS represents the amount of earnings for the period attributable to each share of common stock outstanding during the reporting period and to each share that would have been outstanding assuming the issuance of common shares for all dilutive potential common shares outstanding during the reporting period.  The Company calculates diluted EPS by dividing Net Income Attributable to EastGroup Properties, Inc. Common Stockholders by the weighted average number of common shares outstanding plus the dilutive effect of unvested restricted stock.  The dilutive effect of unvested restricted stock is determined using the treasury stock method.



-14-

EASTGROUP PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Reconciliation of the numerators and denominators in the basic and diluted EPS computations is as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2017
 
2016
 
2017
 
2016
 
(In thousands)
BASIC EPS COMPUTATION FOR NET INCOME ATTRIBUTABLE TO EASTGROUP PROPERTIES, INC. COMMON STOCKHOLDERS
 
 
 
 
 
 
 
  Numerator – net income attributable to common stockholders                                                                                                     
$
15,884

 
14,661

 
65,593

 
80,285

  Denominator – weighted average shares outstanding                                                                                                     
34,215

 
32,741

 
33,857

 
32,458

DILUTED EPS COMPUTATION FOR NET INCOME ATTRIBUTABLE TO EASTGROUP PROPERTIES, INC. COMMON STOCKHOLDERS
 
 
 
 
 
 
 
  Numerator – net income attributable to common stockholders                                                                                                     
$
15,884

 
14,661

 
65,593

 
80,285

Denominator:
 
 
 
 
 
 
 
    Weighted average shares outstanding                                                                                                     
34,215

 
32,741

 
33,857

 
32,458

    Unvested restricted stock                                                                                                     
75

 
82

 
48

 
61

      Total Shares                                                                                                     
34,290

 
32,823

 
33,905

 
32,519


(15)
STOCK-BASED COMPENSATION
 
EastGroup applies the provisions of ASC 718, Compensation - Stock Compensation, to account for its stock-based compensation plans. ASC 718 requires that the compensation cost relating to share-based payment transactions be recognized in the financial statements and that the cost be measured on the fair value of the equity or liability instruments issued.

Stock-based compensation cost for employees was $1,319,000 and $4,952,000 for the three and nine months ended September 30, 2017, respectively, of which $308,000 and $1,177,000 were capitalized as part of the Company's development costs. For the three and nine months ended September 30, 2016, stock-based compensation cost for employees was $706,000 and $4,371,000, respectively, of which $232,000 and $839,000 were capitalized as part of the Company's development costs.

Stock-based compensation expense for directors was $168,000 and $491,000 for the three and nine months ended September 30, 2017, respectively, and $161,000 and $427,000 for the same periods of 2016.

In March 2017, the Compensation Committee of the Company's Board of Directors (the Committee) evaluated the Company's performance compared to certain annual performance measures (primarily funds from operations (FFO) per share and total shareholder return) for the year ended December 31, 2016.  Based on the evaluation, 36,571 shares were awarded to the Company’s executive officers at the grant date (March 2, 2017) fair value of $74.80 per share.  These shares vested 20% on the date shares were determined and awarded and will vest 20% per year on January 1 in years 2018, 2019, 2020 and 2021.  The shares are being expensed on a straight-line basis over the remaining service period.

Also in March 2017, the Committee evaluated the Company’s total shareholder return, both on an absolute basis for 2016 as well as on a relative basis compared to the NAREIT Equity Index, NAREIT Industrial Index and Russell 2000 Index for the five-year period ended December 31, 2016.  Based on the evaluation, 33,289 shares were awarded to the Company’s executive officers at the grant date (March 2, 2017) fair value of $74.80 per share.  These shares vested 25% on the date shares were determined and awarded and will vest 25% per year on January 1 in years 2018, 2019 and 2020.  The shares are being expensed on a straight-line basis over the remaining service period.

Notwithstanding the foregoing, the shares issued to the Company’s former Chief Financial Officer under these plans became fully vested on the grant date of the awards in the first quarter of 2017.

In the second quarter of 2017, the Committee approved an equity compensation plan for certain of its executive officers based upon certain annual performance measures for 2017, including funds from operations (FFO) per share, same property net operating income change, general and administrative costs, and fixed charge coverage. During the first quarter of 2018, the Committee will measure the Company's performance for 2017 against bright-line tests established by the Committee on the grant date of May 10, 2017.  The number of shares that may be earned for the achievement of the annual performance measures could range from zero to 21,096.  These shares, which have a grant date fair value of $78.18, would vest 20% on the date shares are determined and 20% per year on each January 1 for the subsequent four years. On the grant date of May 10, 2017, the Company began recognizing expense for its estimate of the shares that may be earned pursuant to these awards; the shares are being expensed using the graded

-15-

EASTGROUP PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

vesting attribution method which recognizes each separate vesting portion of the award as a separate award on a straight-line basis over the requisite service period.

Also in the second quarter of 2017, the Committee approved an equity compensation plan for certain of its executive officers based upon the achievement of individual goals for each of the officers included in the plan.  Any shares issued pursuant to the individual goals in this compensation plan will be determined by the Committee in its discretion and issued in the first quarter of 2018.  The number of shares to be issued on the grant date for the achievement of individual goals could range from zero to 5,274.  These shares would vest 20% on the date shares are determined and awarded and 20% per year on each January 1 for the subsequent four years. The Company will begin recognizing the expense for any shares awarded on the grant date in the first quarter of 2018, and the shares will be expensed on a straight-line basis over the remaining service period.

Also in the second quarter of 2017, the Committee approved a long-term equity compensation plan for certain of the Company’s executive officers that includes three components based on total shareholder return and one component based only on continued service as of the vesting dates.

The three long-term equity compensation plan components based on total shareholder return are subject to bright-line tests that will compare the Company's total shareholder return to the NAREIT Equity Index and to the Company's industrial REIT peer group. The first plan will measure the bright-line tests over the one-year period ending December 31, 2017. During the first quarter of 2018, the Committee will measure the Company's performance for the one-year period against bright-line tests established by the Committee on the grant date of May 10, 2017.  The number of shares to be earned on the measurement date could range from zero to 4,730.  These shares would vest 100% on the date the earned shares are determined. On the grant date of May 10, 2017, the Company began recognizing expense for this plan based on the grant date fair value of the awards which was determined using a simulation pricing model developed to specifically accommodate the unique features of the award.

The second plan will measure the bright-line tests over the two-year period ending December 31, 2018. During the first quarter of 2019, the Committee will measure the Company's performance for the two-year period against bright-line tests established by the Committee on the grant date of May 10, 2017.  The number of shares to be earned on the measurement date could range from zero to 9,460.  These shares would vest 100% on the date the earned shares are determined. On the grant date of May 10, 2017, the Company began recognizing expense for this plan based on the grant date fair value of the awards which was determined using a simulation pricing model developed to specifically accommodate the unique features of the award.

The third plan will measure the bright-line tests over the three-year period ending December 31, 2019. During the first quarter of 2020, the Committee will measure the Company's performance for the three-year period against bright-line tests established by the Committee on the grant date of May 10, 2017.  The number of shares to be earned on the measurement date could range from zero to 18,917.  These shares would vest 75% on the date the earned shares are determined in the first quarter of 2020 and 25% on January 1, 2021. On the grant date of May 10, 2017, the Company began recognizing expense for this plan based on the grant date fair value of the awards which was determined using a simulation pricing model developed to specifically accommodate the unique features of the award.

The component of the long-term equity compensation plan based only on continued service as of the vesting dates was awarded on May 10, 2017. On that date, 5,406 shares were granted to certain executive officers subject only to continued service as of the vesting dates. These shares, which have a grant date fair value of $78.18 per share, will vest 25% in the first quarter of 2018 and 25% on January 1 in years 2019, 2020 and 2021. The shares are being expensed on a straight-line basis over the remaining service period.

Also during the second quarter of 2017, 5,169 shares were granted to certain executive officers subject only to continued service as of the vesting dates. These shares, which have a weighted average grant date fair value of $81.27 per share, will vest 20% per year on January 1 in years 2018, 2019, 2020, 2021 and 2022. The shares are being expensed on a straight-line basis over the remaining service period.

Also during the second quarter of 2017, 12,850 shares were granted to certain non-executive officers subject only to continued service as of the vesting dates. These shares, which have a grant date fair value of $84.57 per share, will vest 20% per year on January 1 in years 2018, 2019, 2020, 2021 and 2022. The shares are being expensed on a straight-line basis over the remaining service period.

During the third quarter of 2017, 282 shares were granted to a newly elected non-employee Director subject only to continued service as of the vesting date. The shares, which have a grant date fair value of $88.86 per share, will vest 25% per year on September 8 in years 2018, 2019, 2020 and 2021. The shares are being expensed on a straight-line basis over the remaining service period.

-16-

EASTGROUP PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


Following is a summary of the total restricted shares granted, forfeited and delivered (vested) to participants with the related weighted average grant date fair value share prices.  Of the shares that vested in the first nine months of 2017, the Company withheld 33,695 shares to satisfy the tax obligations for those participants who elected this option as permitted under the applicable equity plan.  As of the vesting dates, the aggregate fair value of shares that vested during the first nine months of 2017 was $6,441,000.
 
Three Months Ended
 
Nine Months Ended
Award Activity:
September 30, 2017
 
September 30, 2017
 
 
 
Shares
 
Weighted Average Grant Date Fair Value
 
 
 
Shares
 
Weighted Average Grant Date Fair Value
Unvested at beginning of period
152,748

 
$
63.18

 
162,191

 
$
51.98

Granted (1)
282

 
88.86

 
93,567

 
76.74

Forfeited 

 

 
(16,000
)
 
36.98

Vested 

 

 
(86,728
)
 
61.62

Unvested at end of period 
153,030

 
$
63.22

 
153,030

 
$
63.22


(1) Does not include the restricted shares that may be earned if the performance goals established in 2017 for annual and long-term performance periods are achieved. Depending on the actual level of achievement of the goals at the end of the open performance periods, the number of shares earned could range from zero to 59,477.

(16)
FAIR VALUE OF FINANCIAL INSTRUMENTS
 
ASC 820, Fair Value Measurement, defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  ASC 820 also provides guidance for using fair value to measure financial assets and liabilities.  The Codification requires disclosure of the level within the fair value hierarchy in which the fair value measurements fall, including measurements using quoted prices in active markets for identical assets or liabilities (Level 1), quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active (Level 2), and significant valuation assumptions that are not readily observable in the market (Level 3).

The following table presents the carrying amounts and estimated fair values of the Company’s financial instruments in accordance with ASC 820 at September 30, 2017 and December 31, 2016.
 
September 30, 2017
 
December 31, 2016
 
Carrying Amount (1)
 
Fair Value
 
Carrying Amount (1)
 
Fair Value
 
(In thousands)
Financial Assets:
 
 
 
 
 
 
 
Cash and cash equivalents
$
10

 
10

 
522

 
522

   Mortgage loans receivable                                 
4,656

 
4,657

 
4,752

 
4,747

   Interest rate swap assets                             
4,183

 
4,183

 
4,546

 
4,546

Financial Liabilities:
 

 
 

 
 

 
 

 Unsecured bank credit facilities - variable rate (2)
137,374

 
137,380

 
112,020

 
111,923

 Unsecured bank credit facilities - fixed rate (2)
80,000

 
80,002

 
80,000

 
79,998

Unsecured debt (2)
655,000

 
644,834

 
655,000

 
623,147

Secured debt (2)
203,093

 
210,880

 
258,594

 
266,585

   Interest rate swap liabilities                                     
1,552

 
1,552

 
2,578

 
2,578

(1) Carrying amounts shown in the table are included on the Consolidated Balance Sheets under the indicated captions, except as explained in the notes below.
(2) Carrying amounts and fair values shown in the table exclude debt issuance costs (see Note 9 for additional information).

The following methods and assumptions were used to estimate the fair value of each class of financial instruments:

Cash and cash equivalents:  The carrying amounts approximate fair value due to the short maturity of those instruments.
Mortgage loans receivable (included in Other assets on the Consolidated Balance Sheets):  The fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities (Level 2 input).

-17-

EASTGROUP PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Interest rate swap assets (included in Other assets on the Consolidated Balance Sheets): The instruments are recorded at fair value based on models using inputs, such as interest rate yield curves, LIBOR swap curves and OIS curves, observable for substantially the full term of the contract (Level 2 input). See Note 13 for additional information on the Company's interest rate swaps.
Unsecured bank credit facilities: The fair value of the Company’s unsecured bank credit facilities is estimated by discounting expected cash flows at current market rates (Level 2 input), excluding the effects of debt issuance costs.
Unsecured debt:  The fair value of the Company’s unsecured debt is estimated by discounting expected cash flows at the rates currently offered to the Company for debt of the same remaining maturities, as advised by the Company’s bankers (Level 2 input), excluding the effects of debt issuance costs.
Secured debt: The fair value of the Company’s secured debt is estimated by discounting expected cash flows at the rates currently offered to the Company for debt of the same remaining maturities, as advised by the Company’s bankers (Level 2 input), excluding the effects of debt issuance costs.
Interest rate swap liabilities (included in Other liabilities on the Consolidated Balance Sheets): The instruments are recorded at fair value based on models using inputs, such as interest rate yield curves, LIBOR swap curves and OIS curves, observable for substantially the full term of the contract (Level 2 input). See Note 13 for additional information on the Company's interest rate swaps.

(17)
RISKS AND UNCERTAINTIES
 
The state of the overall economy can significantly impact the Company’s operational performance and thus impact its financial position.  Should EastGroup experience a significant decline in operational performance, it may affect the Company’s ability to make distributions to its shareholders, service debt, or meet other financial obligations.

(18)
RECENT ACCOUNTING PRONOUNCEMENTS
 
EastGroup has evaluated all ASUs recently released by the FASB through the date the financial statements were issued and determined that the following ASUs apply to the Company.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The FASB issued further guidance in ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, that provides clarifying guidance in certain narrow areas and adds some practical expedients. ASU 2014-09 will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The effective date of ASU 2014-09 was extended by one year by ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date. The new standard is effective for the Company on January 1, 2018, and the Company plans to use the modified retrospective approach upon adoption. The Company has made significant progress in evaluating the effect of ASU 2014-09 on its consolidated financial statements and related disclosures beginning with the Form 10-Q for the period ending March 31, 2018. The Company has completed its inventory of its sources of revenue and does not believe there will be a material financial statement impact or that its pattern of revenue recognition will be materially impacted by the adoption of ASU 2014-09.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities,which requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset, and eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized costs on the balance sheet. EastGroup plans to adopt ASU 2016-01 effective January 1, 2018. The Company does not anticipate the adoption of ASU 2016-01 will have a material impact on the Company's financial condition or results of operations.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which requires lessees to recognize the following for all leases (with the exception of short-term leases) at the commencement date: (1) a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis; and (2) a right-of-use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. The Company is a lessee on a limited number of leases, including office and ground leases, and while the adoption of ASU 2016-02 will impact the Company's accounting for office and ground leases, the Company anticipates the impact will not be material to its overall financial condition and results of operations. Lessor accounting is largely unchanged under ASU 2016-02. The Company's primary revenue is rental income; as such, the Company is a lessor on a significant number of leases. The Company is continuing to evaluate the potential impacts of the ASU and believes it will continue to account for its leases in substantially the same manner. The most significant changes for the Company related to lessor accounting include bifurcating its revenue into lease and non-lease components and the new standard's narrow definition of initial direct costs for leases. The new definition will result in certain costs (primarily legal costs

-18-

EASTGROUP PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

related to lease negotiations) being expensed rather than capitalized upon adoption of the new standard. Public business entities are required to apply the amendments in ASU 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. EastGroup plans to adopt ASU 2016-02 effective January 1, 2019. The Company is continuing the process of evaluating and quantifying the effect that ASU 2016-02 will have on its consolidated financial statements and related disclosures beginning with the Form 10-Q for the period ending March 31, 2019.

In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The ASU is intended to improve the accounting for share-based payments and affects all organizations that issue share-based payment awards to their employees. Several aspects of the accounting for share-based payment awards are simplified with the ASU, including income tax consequences, classification of awards as equity or liabilities and classification on the Consolidated Statements of Cash Flows. ASU 2016-09 is effective for public business entities for annual periods beginning after December 15, 2016, and interim periods within those fiscal years; early adoption is permitted. EastGroup adopted ASU 2016-09 effective January 1, 2017. As a result, the Company elected to reverse compensation cost of any forfeited awards when they occur and will continue to classify the cash flows resulting from remitting cash to the tax authorities for the payment of taxes on the vesting of share-based payment awards as a financing activity on the Consolidated Statements of Cash Flows. In addition, upon vesting of share-based payments, the Company will withhold up to the maximum individual statutory tax rate and classify the entire award as equity. The adoption of ASU 2016-09 did not have a material impact on the Company's financial condition or results of operations.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which addresses certain cash flow issues, including how debt prepayments or debt extinguishment costs and distributions received from equity method investees are presented. ASU 2016-15 is effective for public business entities for annual periods beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, and the Company has adopted ASU 2016-15 effective January 1, 2017. The adoption of ASU 2016-15 did not have a material impact on the Company's financial condition or results of operations.
   
In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. The ASU is intended to provide a new framework for determining whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. Under the new guidance, companies are required to utilize an initial screening test to determine whether substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets; if so, the set is not a business. The Company has determined that some of its real estate property acquisitions may be considered to be acquisitions of groups of similar identifiable assets; therefore, the acquisitions are not considered to be acquisitions of a business. EastGroup adopted ASU 2017-01 for transactions beginning on October 1, 2016. As a result, the Company has capitalized acquisition costs related to its fourth quarter 2016 and first quarter 2017 acquisitions as they were determined not to be acquisitions of a business.
In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Others (Topic 350): Simplifying the Test for Goodwill Impairment, which simplifies the measurement of goodwill impairment by eliminating the requirement of performing a hypothetical purchase price allocation to measure goodwill impairment. The Company adopted ASU 2017-04 effective January 1, 2017, and is applying the new guidance for goodwill impairment tests with measurement dates after January 1, 2017. The adoption of ASU 2017-04 did not have a material impact on the Company's financial condition or results of operations.
In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting, which clarifies what constitutes a modification of a share-based payment award. The ASU is intended to provide clarity and reduce both diversity in practice and cost and complexity when applying the guidance in Topic 718 to a change to the terms or conditions of a share-based payment award. ASU 2017-09 is effective for public entities for annual periods beginning after December 15, 2017, and interim periods within those fiscal years. The Company plans to adopt ASU 2017-09 on January 1, 2018, and it does not anticipate that the adoption of ASU 2017-09 will have a material impact on its financial condition or results of operations, as the Company does not expect to have any modifications to share-based payment awards. However, if the Company does have a modification to an award in the future, it will follow the guidance in ASU 2017-09.
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The ASU is intended to better align a company's financial reporting for hedging activities with the economic objectives of those activities. The transition method is a modified retrospective approach that will require the Company to recognize the cumulative effect of initially applying the ASU as an adjustment to Accumulated other comprehensive income with a corresponding adjustment to the opening balance of retained earnings as of the beginning of the fiscal year the entity adopts the ASU. The primary provision in the ASU that will require an adjustment to beginning retained earnings is the change in timing and income statement presentation for ineffectiveness related to cash flow and net investment hedges. As a result of the transition guidance in the ASU, cumulative ineffectiveness that has previously been recognized on cash flow and net investment hedges that are still outstanding and designated as of the date of adoption will be adjusted and removed from beginning retained earnings and

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EASTGROUP PROPERTIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

placed in Accumulated other comprehensive income. ASU 2017-12 is effective for public business entities for annual periods beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted; however, the Company plans to adopt ASU 2017-12 on January 1, 2019. While the Company continues to assess all potential impacts of ASU 2017-12, it does not expect the adoption to have a material impact on the Company's financial condition or results of operations.
(19)
SUBSEQUENT EVENTS

In September, the Company executed a commitment letter for $60 million of senior unsecured private placement notes with an insurance company. The notes, which are expected to close in mid-December, have a seven-year term and a fixed interest rate of 3.46% with semi-annual interest payments. The notes will not be and have not been registered under the Securities Act of 1933, as amended, and may not be offered or sold in the United States absent registration or an applicable exemption from the registration requirements.

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ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

OVERVIEW
EastGroup’s goal is to maximize shareholder value by being a leading provider in its markets of functional, flexible and quality business distribution space for location sensitive customers (primarily in the 10,000 to 50,000 square foot range).  The Company develops, acquires and operates distribution facilities, the majority of which are clustered around major transportation features in supply constrained submarkets in major Sunbelt regions.  The Company’s core markets are in the states of Florida, Texas, Arizona, California and North Carolina.

EastGroup believes its current operating cash flow and unsecured bank credit facilities provide the capacity to fund the operations of the Company, and the Company also believes it can issue common and/or preferred equity and obtain debt financing. During the first nine months of 2017, EastGroup issued 1,037,605 shares of common stock through its continuous common equity program, providing net proceeds to the Company of $79 million. The Company has also executed a commitment letter for $60 million of senior unsecured private placement notes which it expects to close during fourth quarter 2017. EastGroup's financing and equity issuances are further described in Liquidity and Capital Resources.

The Company’s primary revenue source is rental income; as such, EastGroup’s greatest challenge is leasing space.  During the nine months ended September 30, 2017, leases expired on 5,565,000 square feet (15.0% of EastGroup’s total square footage of 37,051,000), and the Company was successful in renewing or re-leasing 84% of the expiring square feet.  In addition, EastGroup leased 1,831,000 square feet of other vacant space during this period.  During the first nine months of 2017, average rental rates on new and renewal leases increased by 17.1%.  Property net operating income (PNOI) from same properties, defined as operating properties owned during the entire current period and prior year reporting period, increased 2.5% for the nine months ended September 30, 2017, as compared to the same period in 2016.

EastGroup’s total leased percentage was 97.4% at September 30, 2017, compared to 97.3% at September 30, 2016.  Leases scheduled to expire for the remainder of 2017 were 1.0% of the portfolio on a square foot basis at September 30, 2017, and this percentage was reduced to 0.6% as of October 20, 2017.

The Company generates new sources of leasing revenue through its development and acquisition programs. The Company mitigates risks associated with development through a Board-approved maximum level of land held for development and by adjusting development start dates according to leasing activity.   

During the first nine months of 2017, EastGroup acquired 77 acres of development land in San Antonio, Austin, Atlanta and Charlotte for $11.7 million. In addition, the Company began construction of eight development projects containing 987,000 square feet in Dallas, San Antonio, Phoenix, Tampa, Orlando and Charlotte.  EastGroup also transferred 12 properties (2,197,000 square feet) in Dallas, San Antonio, Las Vegas, Orlando, Tampa, Charlotte and Phoenix from its development program to real estate properties with costs of $160.1 million at the date of transfer.  As of September 30, 2017, EastGroup’s development program consisted of 13 projects (1,682,000 square feet) located in 9 cities.  The projected total investment for the development projects, which were collectively 43% leased as of October 20, 2017, is $138 million, of which $51 million remained to be invested as of September 30, 2017.

Also during the nine months ended September 30, 2017, the Company acquired three operating properties containing 421,000 square feet in Atlanta and Austin for $36.5 million.

Typically, the Company initially funds its development and acquisition programs through its $335 million unsecured bank credit facilities (as discussed in Liquidity and Capital Resources).  As market conditions permit, EastGroup issues equity and/or employs fixed-rate debt, including variable-rate debt that has been swapped to an effectively fixed rate through the use of interest rate swaps, to replace short-term bank borrowings. In May, Moody's Investors Service affirmed EastGroup's issuer rating of Baa2 with a stable outlook. A security rating is not a recommendation to buy, sell or hold securities and may be subject to revision or withdrawal at any time by the assigning rating agency. Each rating should be evaluated independently of any other rating. For future debt issuances, the Company intends to issue primarily unsecured fixed-rate debt, including variable-rate debt that has been swapped to an effectively fixed rate through the use of interest rate swaps. The Company may also access the public debt market in the future as a means to raise capital.

EastGroup has one reportable segment – industrial properties.  These properties are primarily located in major Sunbelt regions of the United States, have similar economic characteristics and also meet the other criteria permitting the properties to be aggregated into one reportable segment.  The Company’s chief decision makers use two primary measures of operating results in making decisions:  (1) property net operating income (PNOI), defined as Income from real estate operations less Expenses from real estate

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operations (including market-based internal management fee expense) plus the Company's share of income and property operating expenses from its less-than-wholly-owned real estate investments, and (2) funds from operations attributable to common stockholders (FFO), defined as net income (loss) attributable to common stockholders computed in accordance with U.S. generally accepted accounting principles (GAAP), excluding gains or losses from sales of depreciable real estate property and impairment losses, plus real estate related depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures.  The Company calculates FFO based on the National Association of Real Estate Investment Trusts’ (NAREIT) definition.

PNOI is a supplemental industry reporting measurement used to evaluate the performance of the Company’s real estate investments. The Company believes the exclusion of depreciation and amortization in the industry’s calculation of PNOI provides a supplemental indicator of the properties’ performance since real estate values have historically risen or fallen with market conditions.  PNOI as calculated by the Company may not be comparable to similarly titled but differently calculated measures for other real estate investment trusts (REITs).  The major factors influencing PNOI are occupancy levels, acquisitions and sales, development properties that achieve stabilized operations, rental rate increases or decreases, and the recoverability of operating expenses.  The Company’s success depends largely upon its ability to lease space and to recover from tenants the operating costs associated with those leases.

PNOI is comprised of Income from real estate operations, less Expenses from real estate operations plus the Company's share of income and property operating expenses from its less-than-wholly-owned real estate investments.  PNOI was calculated as follows for the three and nine months ended September 30, 2017 and 2016.
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
 
(In thousands)
Income from real estate operations
$
68,712

 
63,178

 
202,704

 
186,628

Expenses from real estate operations
(20,109
)
 
(18,552
)
 
(59,360
)
 
(54,130
)
Noncontrolling interest in PNOI of consolidated 80% joint ventures
(145
)
 
(190
)
 
(493
)
 
(618
)
PNOI from 50% owned unconsolidated investment
224

 
231

 
673

 
676

PROPERTY NET OPERATING INCOME (PNOI)
$
48,682

 
44,667

 
143,524

 
132,556

 
Income from real estate operations is comprised of rental income, expense reimbursement pass-through income and other real estate income including lease termination fees.  Expenses from real estate operations is comprised of property taxes, insurance, utilities, repair and maintenance expenses, management fees, other operating costs and bad debt expense.  Generally, the Company’s most significant operating expenses are property taxes and insurance.  Tenant leases may be net leases in which the total operating expenses are recoverable, modified gross leases in which some of the operating expenses are recoverable, or gross leases in which no expenses are recoverable (gross leases represent only a small portion of the Company’s total leases).  Increases in property operating expenses are fully recoverable under net leases and recoverable to a high degree under modified gross leases.  Modified gross leases often include base year amounts and expense increases over these amounts are recoverable.  The Company’s exposure to property operating expenses is primarily due to vacancies and leases for occupied space that limit the amount of expenses that can be recovered.



-22-




The following table presents reconciliations of Net Income to PNOI for the three and nine months ended September 30, 2017 and 2016.
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
 
(In thousands)
NET INCOME
$
15,972

 
14,800

 
65,922

 
80,723

Gain on sales of real estate investments

 

 
(21,855
)
 
(42,313
)
(Gain) loss on sales of non-operating real estate

 
(590
)
 
40

 
(733
)
Interest income
(62
)
 
(63
)
 
(185
)
 
(191
)
Other income 
(34
)
 
(12
)
 
(90
)
 
(68
)
Interest rate swap ineffectiveness

 

 

 
5

Depreciation and amortization
21,011

 
19,361

 
62,101

 
57,756

Company's share of depreciation from unconsolidated investment
31

 
31

 
93

 
93

Interest expense 
8,704

 
8,841

 
26,405

 
27,078

General and administrative expense 
3,205

 
2,328

 
11,586

 
10,663

Acquisition costs 

 
161

 

 
161

Noncontrolling interest in PNOI of consolidated 80% joint ventures
(145
)
 
(190
)
 
(493
)
 
(618
)
PROPERTY NET OPERATING INCOME
$
48,682

 
44,667

 
143,524

 
132,556


The Company believes FFO is a meaningful supplemental measure of operating performance for equity REITs.  The Company believes excluding depreciation and amortization in the calculation of FFO is appropriate since real estate values have historically increased or decreased based on market conditions.  FFO is not considered as an alternative to net income (determined in accordance with GAAP) as an indication of the Company’s financial performance, nor is it a measure of the Company’s liquidity or indicative of funds available to provide for the Company’s cash needs, including its ability to make distributions.  In addition, FFO, as reported by the Company, may not be comparable to FFO reported by other REITs that do not define the term in accordance with the current NAREIT definition.  The Company’s key drivers affecting FFO are changes in PNOI (as discussed above), interest rates, the amount of leverage the Company employs and general and administrative expenses.  The following table presents reconciliations of Net Income Attributable to EastGroup Properties, Inc. Common Stockholders to FFO Attributable to Common Stockholders for the three and nine months ended September 30, 2017 and 2016.
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2017
 
2016
 
2017
 
2016
 
(In thousands, except per share data)
NET INCOME ATTRIBUTABLE TO EASTGROUP PROPERTIES,  INC. COMMON STOCKHOLDERS
$
15,884

 
14,661

 
65,593

 
80,285

Depreciation and amortization
21,011

 
19,361

 
62,101

 
57,756

Company's share of depreciation from unconsolidated investment 
31

 
31

 
93

 
93

Depreciation and amortization from noncontrolling interest
(56
)
 
(49
)
 
(160
)
 
(159
)
Gain on sales of real estate investments

 

 
(21,855
)
 
(42,313
)
FUNDS FROM OPERATIONS (FFO) ATTRIBUTABLE TO COMMON STOCKHOLDERS
$
36,870

 
34,004

 
105,772

 
95,662

Net income attributable to common stockholders per diluted share
$
.46

 
.45

 
1.93

 
2.47

Funds from operations (FFO) attributable to common stockholders
   per diluted share
$
1.08

 
1.04

 
3.12

 
2.94

Diluted shares for earnings per share and funds from operations
34,290

 
32,823

 
33,905

 
32,519








-23-




The Company analyzes the following performance trends in evaluating the progress of the Company:

The FFO change per share represents the increase or decrease in FFO per share from the current period compared to the same period in the prior year.  FFO per share for the third quarter of 2017 was $1.08 per share compared with $1.04 per share for the same period of 2016, an increase of 3.8%. For the nine months ended September 30, 2017, FFO was $3.12 per share compared with $2.94 per share for the same period of 2016, an increase of 6.1%.

For the three months ended September 30, 2017, PNOI increased by $4,015,000, or 9.0%, compared to the same period in 2016. PNOI increased $2,483,000 from newly developed and redeveloped properties, $1,342,000 from same property operations and $917,000 from 2016 and 2017 acquisitions; PNOI decreased $658,000 from operating properties sold in 2016 and 2017.

For the nine months ended September 30, 2017, PNOI increased by $10,968,000, or 8.3%, compared to the same period in 2016. PNOI increased $7,503,000 from newly developed and redeveloped properties, $3,157,000 from same property operations and $2,628,000 from 2016 and 2017 acquisitions; PNOI decreased $2,157,000 from operating properties sold in 2016 and 2017.

The same property net operating income change represents the PNOI increase or decrease for the same operating properties owned during the entire current period and prior year reporting period. PNOI from same properties increased 3.1% for the three months ended September 30, 2017, and increased 2.5% for the nine months ended September 30, 2017, compared to the same periods in 2016.

Same property average occupancy represents the average month-end percentage of leased square footage for which the lease term has commenced as compared to the total leasable square footage for the same operating properties owned during the entire current period and prior year reporting period. Same property average occupancy was 96.4% for the three months ended September 30, 2017, compared to 96.1% for the same period of 2016. Same property average occupancy for the nine months ended September 30, 2017, was 96.6% compared to 96.3% for the same period of 2016.

Occupancy is the percentage of leased square footage for which the lease term has commenced as compared to the total leasable square footage as of the close of the reporting period.  Occupancy at September 30, 2017, was 95.6%.  Quarter-end occupancy ranged from 94.9% to 96.8% over the previous four quarters ended September 30, 2016 to June 30, 2017.

Rental rate change represents the rental rate increase or decrease on new and renewal leases compared to the prior leases on the same space.  Rental rate increases on new and renewal leases (4.6% of total square footage) averaged 20.9% for the third quarter of 2017. For the nine months ended September 30, 2017, rental rate increases on new and renewal leases (17.6% of total square footage) averaged 17.1%.

Lease termination fee income is included in Income from real estate operations. Lease termination fee income for the three and nine months ended September 30, 2017 was $65,000 and $198,000 respectively, compared to $316,000 and $754,000 for the same periods of 2016.

Bad debt expense is included in Expenses from real estate operations. The Company recorded bad debt expense of $134,000 and $332,000 for the three and nine months ended September 30, 2017, respectively, compared to $306,000 and $764,000 for the same periods of 2016.


CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The Company’s management considers the following accounting policies and estimates to be critical to the reported operations of the Company.

Real Estate Properties
The Company applied the principles of Accounting Standards Codification (ASC) 805, Business Combinations, when accounting for purchase of real estate until its adoption of Accounting Standards Update (ASU) 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which was effective October 1, 2016. ASU 2017-01 provides a new framework for determining whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. Under the new guidance, companies are required to utilize an initial screening test to determine whether substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets; if so, the set is not a business. EastGroup has determined that some of its real estate property acquisitions may be considered to be acquisitions of groups of similar identifiable assets; therefore, the acquisitions are not considered to be acquisitions of a business.

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The Financial Accounting Standards Board (FASB) Codification provides guidance on how to properly determine the allocation of the purchase price among the individual components of both the tangible and intangible assets based on their respective fair values.  Goodwill for business combinations is recorded when the purchase price exceeds the fair value of the assets and liabilities acquired.  Factors considered by management in allocating the cost of the properties acquired include an estimate of carrying costs during the expected lease-up periods considering current market conditions and costs to execute similar leases.  The allocation to tangible assets (land, building and improvements) is based upon management’s determination of the value of the property as if it were vacant using discounted cash flow models. The Company determines whether any financing assumed is above or below market based upon comparison to similar financing terms for similar properties.  The cost of the properties acquired may be adjusted based on indebtedness assumed from the seller that is determined to be above or below market rates.  

The purchase price is also allocated among the following categories of intangible assets:  the above or below market component of in-place leases, the value of in-place leases, and the value of customer relationships.  The value allocable to the above or below market component of an acquired in-place lease is determined based upon the present value (using a discount rate reflecting the risks associated with the acquired leases) of the difference between (i) the contractual amounts to be paid pursuant to the lease over its remaining term, and (ii) management’s estimate of the amounts that would be paid using fair market rates over the remaining term of the lease.  The amounts allocated to above and below market leases are included in Other assets and Other liabilities, respectively, on the Consolidated Balance Sheets and are amortized to rental income over the remaining terms of the respective leases. The total amount of intangible assets is further allocated to in-place lease values and customer relationship values based upon management’s assessment of their respective values.  These intangible assets are included in Other assets on the Consolidated Balance Sheets and are amortized over the remaining term of the existing lease, or the anticipated life of the customer relationship, as applicable.

For properties under development and properties acquired in the development stage, costs associated with development (i.e., land, construction costs, interest expense, property taxes and other costs associated with development) are aggregated into the total capitalized costs of the property.  Included in these costs are management’s estimates for the portions of internal costs (primarily personnel costs) deemed related to such development activities. The internal costs are allocated to specific development properties based on development activity.

The Company reviews its real estate investments for impairment of value whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  If any real estate investment is considered permanently impaired, a loss is recorded to reduce the carrying value of the property to its estimated fair value.  Real estate assets classified as held for sale are reported at the lower of the carrying amount or fair value less estimated costs of sale.  The evaluation of real estate investments involves many subjective assumptions dependent upon future economic events that affect the ultimate value of the property.  Currently, the Company’s management has not identified any impairment charges which should be recorded nor has it recorded any impairment charges in recent years.  In the event of impairment, the property’s basis would be reduced, and the impairment would be recognized as a current period charge on the Consolidated Statements of Income and Comprehensive Income.

Valuation of Receivables
The Company is subject to tenant defaults and bankruptcies that could affect the collection of outstanding receivables.  In order to mitigate these risks, the Company performs credit reviews and analyses on prospective tenants before significant leases are executed and on existing tenants before properties are acquired.  On a quarterly basis, the Company evaluates outstanding receivables and estimates the allowance for doubtful accounts.  Management specifically analyzes aged receivables, customer credit-worthiness, historical bad debts and current economic trends when evaluating the adequacy of the allowance for doubtful accounts.  The Company believes its allowance for doubtful accounts is adequate for its outstanding receivables for the periods presented.  In the event the allowance for doubtful accounts is insufficient for an account that is subsequently written off, additional bad debt expense would be recognized as a current period charge on the Consolidated Statements of Income and Comprehensive Income.

Tax Status
EastGroup, a Maryland corporation, has qualified as a real estate investment trust under Sections 856-860 of the Internal Revenue Code and intends to continue to qualify as such.  To maintain its status as a REIT, the Company is required to distribute at least 90% of its ordinary taxable income to its stockholders.  If the Company has a capital gain, it has the option of (i) deferring recognition of the capital gain through a tax-deferred exchange, (ii) declaring and paying a capital gain dividend on any recognized net capital gain resulting in no corporate level tax, or (iii) retaining and paying corporate income tax on its net long-term capital gain, with shareholders reporting their proportional share of the undistributed long-term capital gain and receiving a credit or refund of their share of the tax paid by the Company.  The Company distributed all of its 2016 taxable income to its stockholders and expects to distribute all of its taxable income in 2017.  Accordingly, no significant provision for income taxes was necessary in 2016, nor is any significant income tax provision expected to be necessary for 2017.

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FINANCIAL CONDITION

EastGroup’s assets were $1,893,993,000 at September 30, 2017, an increase of $68,229,000 from December 31, 2016.  Liabilities decreased $16,079,000 to $1,167,819,000, and equity increased $84,308,000 to $726,174,000 during the same period.  The following paragraphs explain these changes in detail.

Assets

Real Estate Properties
Real estate properties increased $192,944,000 during the nine months ended September 30, 2017, primarily due to the transfer of twelve properties from Development (as detailed under Development below), the purchase of the operating properties detailed below and capital improvements at the Company's properties. These increases were partially offset by the operating property sales discussed below.

REAL ESTATE PROPERTIES ACQUIRED IN 2017
 
Location
 
Size
 
Date
Acquired
 
Cost (1)
 
 
 
 
(Square feet)
 
 
 
(In thousands)
Shiloh 400
 
Atlanta, GA
 
238,000

 
02/07/2017
 
$
18,712

Broadmoor Commerce Park
 
Atlanta, GA
 
84,000

 
04/26/2017
 
5,363

Southpark Corporate Center 5-7
 
Austin, TX
 
99,000

 
05/12/2017
 
9,590

Total Acquisitions
 
 
 
421,000

 
 
 
$
33,665


(1)
Total cost of the properties acquired was $36,475,000, of which $33,665,000 was allocated to Real estate properties as indicated above. The Company allocated $5,700,000 of the total purchase price to land using third party land valuations for the Atlanta and Austin markets. The market values are considered to be Level 3 inputs as defined by ASC 820, Fair Value Measurement (see Note 16 in the Notes to Consolidated Financial Statements for additional information on ASC 820). Intangibles associated with the purchases of real estate were allocated as follows: $3,016,000 to in-place lease intangibles and $114,000 to above market leases (both included in Other assets on the Consolidated Balance Sheets), and $320,000 to below market leases (included in Other liabilities on the Consolidated Balance Sheets).   

During the nine months ended September 30, 2017, the Company made capital improvements of $19,203,000 on existing and acquired properties (included in the Capital Expenditures table under Results of Operations).  Also, the Company incurred costs of $8,600,000 on development properties subsequent to transfer to Real estate properties; the Company records these expenditures as development costs on the Consolidated Statements of Cash Flows.

During the nine months ended September 30, 2017, the Company sold Stemmons Circle in Dallas and Techway Southwest I-IV in Houston. The properties (514,000 square feet combined) were sold for $38.0 million and the Company recognized gains on the sales of $21.9 million.

Development
EastGroup’s investment in development at September 30, 2017 consisted of properties in lease-up and under construction of $87,007,000 and prospective development (primarily land) of $117,190,000.  The Company’s total investment in development at September 30, 2017 was $204,197,000 compared to $293,908,000 at December 31, 2016.  Total capital invested for development during the first nine months of 2017 was $80,462,000, which primarily consisted of costs of $55,578,000 and $14,819,000 as detailed in the Development Activity table below and costs of $8,600,000 on development properties subsequent to transfer to Real estate properties. The capitalized costs incurred on development properties subsequent to transfer to Real estate properties include capital improvements at the properties and do not include other capitalized costs associated with development (i.e., interest expense, property taxes and internal personnel costs).

The Company capitalized internal development costs of $1,056,000 and $3,650,000 for the three and nine months ended September 30, 2017, respectively, compared to $867,000 and $2,660,000 in the same periods of 2016.

During the nine months ended September 30, 2017, EastGroup purchased 77 acres of development land in San Antonio, Austin, Atlanta and Charlotte for $11,729,000. Costs associated with these land acquisitions are included in the Development Activity table below. These increases were offset by the sale of five acres of land for $850,000 and the transfer of twelve development projects to Real estate properties during the first nine months of 2017 with a total investment of $160,108,000 as of the date of transfer.

-26-



 
 
 
Costs Incurred
 
 
 
Anticipated Building Conversion Date
DEVELOPMENT ACTIVITY
 
 
Costs Transferred in 2017 (1)
 
For the Nine Months Ended
9/30/2017
 
Cumulative as of 9/30/2017
 
 
Estimated Total Costs
 
 
 
 
(In thousands)
 
 
LEASE-UP
Building Size (Square feet)
 
 
 
 
 
 
 
 
 
 
Alamo Ridge IV, San Antonio, TX
97,000

 
$

 
1,073

 
6,018

 
6,600

 
03/18
Eisenhauer Point 3, San Antonio, TX
71,000

 

 
2,107

 
4,855

 
5,900

 
06/18
SunCoast 4, Ft. Myers, FL
93,000

 

 
2,390

 
8,645

 
9,100

 
06/18
Weston, Ft. Lauderdale, FL (2)
134,000

 

 
1,009

 
15,290

 
15,900

 
07/18
Steele Creek VII, Charlotte, NC
120,000

 
2,393

 
5,195

 
7,588

 
8,600

 
09/18
Total Lease-Up
515,000

 
2,393

 
11,774

 
42,396

 
46,100

 
 
UNDER CONSTRUCTION
 

 
 

 
 

 
 

 
 

 
 
Country Club V, Tucson, AZ
300,000

 

 
4,098

 
7,393

 
24,200

 
03/18
Horizon XII, Orlando, FL
140,000

 
3,825

 
5,163

 
8,988

 
12,100

 
11/18
Oak Creek VII, Tampa, FL
116,000

 
2,153

 
3,725

 
5,878

 
7,200

 
11/18
Kyrene 202 III, IV & V, Phoenix, AZ
166,000

 
2,280

 
4,248

 
6,528

 
13,800

 
01/19
CreekView 121 3 & 4, Dallas, TX
158,000

 
3,701

 
3,458

 
7,159

 
14,200

 
02/19
Eisenhauer Point 5, San Antonio, TX
98,000

 
1,253

 
2,515

 
3,768

 
7,500

 
03/19
Eisenhauer Point 6, San Antonio, TX
85,000

 
878

 
1,750

 
2,628

 
5,200

 
03/19
Horizon X, Orlando, FL
104,000

 
2,101

 
168

 
2,269

 
8,000

 
04/19
Total Under Construction
1,167,000

 
16,191

 
25,125

 
44,611

 
92,200

 
 
PROSPECTIVE DEVELOPMENT (PRIMARILY LAND)
Estimated Building Size (Square feet)
 
 

 
 

 
 

 
 

 
 
Phoenix, AZ
96,000

 
(2,280
)
 
120

 
1,733

 
 
 
 
Tucson, AZ (3)

 

 
(417
)
 

 
 
 
 
Ft. Myers, FL
570,000

 

 
361

 
14,004

 
 
 
 
Miami, FL
850,000

 

 
2,511

 
29,755

 
 
 
 
Orlando, FL
418,000

 
(5,926
)
 
791

 
10,994

 
 
 
 
Tampa, FL
32,000

 
(2,153
)
 
17

 
1,545

 
 
 
 
Atlanta, GA
107,000

 

 
675

 
675

 
 
 
 
Jackson, MS
28,000

 

 

 
706

 
 
 
 
Charlotte, NC
748,000

 
(2,393
)
 
1,357

 
8,267

 
 
 
 
Austin, TX
340,000

 

 
5,825

 
5,825

 
 
 
 
Dallas, TX
491,000

 
(3,701
)
 
538

 
9,159

 
 
 
 
El Paso, TX
251,000

 

 

 
2,444

 
 
 
 
Houston, TX (4)
1,476,000

 

 
(227
)
 
21,147

 
 
 
 
San Antonio, TX
965,000

 
(2,131
)
 
7,128

 
10,936

 
 
 
 
Total Prospective Development
6,372,000

 
(18,584
)
 
18,679

 
117,190

 


 
 
 
8,054,000

 
$

 
55,578

 
204,197

 


 
 
DEVELOPMENTS COMPLETED AND TRANSFERRED TO REAL ESTATE PROPERTIES DURING 2017
Building Size (Square feet)
 
 

 
 

 
 

 
 

 
Building Conversion Date
Eisenhauer Point 1 & 2, San Antonio, TX
201,000

 
$

 
19

 
15,795

 
 
 
01/17
South 35th Avenue, Phoenix, AZ (5)
125,000

 

 

 
1,664

 
 
 
01/17
Alamo Ridge III, San Antonio, TX
135,000

 

 
28

 
10,587

 
 
 
02/17
Parc North 1-4, Dallas, TX (6)
446,000

 

 
132

 
32,252

 
 
 
02/17
Madison IV & V, Tampa, FL
145,000

 

 
549

 
8,074

 
 
 
03/17
Jones Corporate Park, Las Vegas, NV (7)
416,000

 

 
275

 
39,815

 
 
 
04/17
Ten Sky Harbor, Phoenix, AZ
64,000

 

 
100

 
5,365

 
 
 
04/17
Steele Creek VI, Charlotte, NC
137,000

 

 
519

 
7,525

 
 
 
04/17
Horizon V, Orlando, FL
141,000

 

 
4,814

 
9,249

 
 
 
05/17
Horizon VII, Orlando, FL
109,000

 

 
1,375

 
8,266

 
 
 
06/17
Eisenhauer Point 4, San Antonio, TX
85,000

 

 
2,544

 
5,197

 
 
 
07/17
CreekView 121 1 & 2, Dallas, TX
193,000

 

 
4,464

 
16,319

 
 
 
08/17
Total Transferred to Real Estate Properties
2,197,000

 
$

 
14,819

 
160,108

 
(8)
 
 

See next page for Development Activity table footnotes.



-27-



(1) Represents costs transferred from Prospective Development (primarily land) to Under Construction during the period. Negative amounts represent land inventory costs transferred to Under Construction.
(2) This project was acquired by EastGroup on 11/1/16 and underwent redevelopment.
(3) Negative amount represents land inventory costs transferred to Real Estate Properties for storage yard and parking lot expansion.
(4) Negative amount represents West Road retention ponds and infrastructure conveyed to West Harris County Municipal Utility District.
(5) This property was redeveloped from a manufacturing building to a multi-tenant distribution building.
(6) This project, which was recently developed by the seller, was acquired by EastGroup on 7/8/16 during the lease-up phase.
(7) This project, which was recently developed by the seller, was acquired by EastGroup on 11/15/16 during the lease-up phase.
(8) Represents cumulative costs at the date of transfer.


Accumulated Depreciation
Accumulated depreciation on real estate and development properties increased $38,316,000 during the first nine months of 2017 due primarily to depreciation expense, offset by the sale of 514,000 square feet of operating properties during the period.

Other Assets
Other assets increased $3,669,000 during the first nine months of 2017.  A summary of Other assets follows:
 
September 30,
2017
 
December 31,
2016
 
(In thousands)
Leasing costs (principally commissions)                                                                                  
$
70,322

 
65,521

Accumulated amortization of leasing costs                                                       
(26,266
)
 
(26,340
)
Leasing costs (principally commissions), net of accumulated amortization
44,056

 
39,181

 
 
 
 
Straight-line rents receivable                                                                                  
30,739

 
28,369

Allowance for doubtful accounts on straight-line rents receivable
(158
)
 
(76
)
Straight-line rents receivable, net of allowance for doubtful accounts
30,581

 
28,293