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Section 1: 10-Q (10-Q 06.30.2018)

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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 JUNE 30, 2018                                       COMMISSION FILE NUMBER 1-07094


394320981_egplogonewa01a02a01a02a01a14.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.)
 
 
400 W PARKWAY PLACE
 
SUITE 100
 
RIDGELAND, MISSISSIPPI
39157
(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 July 20, 2018 was 35,737,853.

-1-



EASTGROUP PROPERTIES, INC. AND SUBSIDIARIES

FORM 10-Q

TABLE OF CONTENTS
FOR THE QUARTER ENDED JUNE 30, 2018 


 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



-2-





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

 
June 30,
2018
 
December 31,
2017
ASSETS
 
 
 
Real estate properties
$
2,457,405

 
2,336,734

Development and value-add properties
211,575

 
242,014

 
2,668,980

 
2,578,748

Less accumulated depreciation
(778,676
)
 
(749,601
)
 
1,890,304

 
1,829,147

Unconsolidated investment
7,852

 
8,029

Cash
252

 
16

Other assets
123,318

 
116,029

TOTAL ASSETS
$
2,021,726

 
1,953,221

 
 
 
 
LIABILITIES AND EQUITY
 

 
 

 
 
 
 
LIABILITIES
 

 
 

Unsecured bank credit facilities
$
176,958

 
195,709

Unsecured debt
723,171

 
713,061

Secured debt
194,069

 
199,512

Accounts payable and accrued expenses
56,350

 
64,967

Other liabilities
30,477

 
28,842

Total Liabilities
1,181,025

 
1,202,091

 
 
 
 
EQUITY
 

 
 

Stockholders’ Equity:
 

 
 

Common shares; $.0001 par value; 70,000,000 shares authorized; 35,724,053 shares issued and outstanding at June 30, 2018 and 34,758,167 at December 31, 2017
4

 
3

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

 

Additional paid-in capital
1,144,290

 
1,061,153

Distributions in excess of earnings
(315,355
)
 
(317,032
)
Accumulated other comprehensive income
10,140

 
5,348

Total Stockholders’ Equity
839,079

 
749,472

Noncontrolling interest in joint ventures
1,622

 
1,658

Total Equity
840,701

 
751,130

TOTAL LIABILITIES AND EQUITY
$
2,021,726

 
1,953,221

 
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
 
Six Months Ended
 
June 30,
 
June 30,
 
2018
 
2017
 
2018
 
2017
REVENUES
 
 
 
 
 
 
 
Income from real estate operations
$
73,720

 
67,855

 
145,840

 
133,992

Other revenue
1,165

 
39

 
1,248

 
56

 
74,885

 
67,894

 
147,088

 
134,048

EXPENSES
 
 
 
 
 

 
 

Expenses from real estate operations
21,453

 
20,244

 
42,129

 
39,251

Depreciation and amortization
22,808

 
20,865

 
44,493

 
41,090

General and administrative
3,740

 
2,903

 
7,203

 
8,381

 
48,001

 
44,012

 
93,825

 
88,722

OPERATING INCOME
26,884

 
23,882

 
53,263

 
45,326

OTHER INCOME (EXPENSE)
 
 
 
 
 

 
 

Interest expense
(8,842
)
 
(9,015
)
 
(17,449
)
 
(17,701
)
Gain on sales of real estate investments

 
21,855

 
10,222

 
21,855

Other
222

 
255

 
976

 
470

NET INCOME
18,264

 
36,977

 
47,012

 
49,950

Net income attributable to noncontrolling interest in joint ventures
(37
)
 
(87
)
 
(72
)
 
(241
)
NET INCOME ATTRIBUTABLE TO EASTGROUP PROPERTIES, INC. COMMON STOCKHOLDERS
18,227

 
36,890

 
46,940

 
49,709

Other comprehensive income (loss) - cash flow hedges
1,186

 
(984
)
 
4,792

 
426

TOTAL COMPREHENSIVE INCOME
$
19,413

 
35,906

 
51,732

 
50,135

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

 
 

Net income attributable to common stockholders
$
0.52

 
1.09

 
1.34

 
1.48

Weighted average shares outstanding
35,196

 
33,987

 
34,944

 
33,676

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

 
 

Net income attributable to common stockholders
$
0.52

 
1.08

 
1.34

 
1.47

Weighted average shares outstanding
35,259

 
34,040

 
34,998

 
33,722

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, 2017
$
3

 
1,061,153

 
(317,032
)
 
5,348

 
1,658

 
751,130

Net income

 

 
46,940

 

 
72

 
47,012

Net unrealized change in fair value of cash flow hedges

 

 

 
4,792

 

 
4,792

Common dividends declared – $1.28 per share

 

 
(45,263
)
 

 

 
(45,263
)
Stock-based compensation, net of forfeitures

 
2,929

 

 

 

 
2,929

Issuance of 929,783 shares of common stock, common stock offering, net of expenses
1

 
82,155

 

 

 

 
82,156

Issuance of 1,232 shares of common stock, dividend reinvestment plan

 
108

 

 

 

 
108

Withheld 23,824 shares of common stock to satisfy tax withholding obligations in connection with the vesting of restricted stock

 
(2,055
)
 

 

 

 
(2,055
)
Distributions to noncontrolling interest

 

 

 

 
(108
)
 
(108
)
BALANCE, JUNE 30, 2018
$
4

 
1,144,290

 
(315,355
)
 
10,140

 
1,622

 
840,701


See accompanying Notes to Consolidated Financial Statements (unaudited).

-5-



EASTGROUP PROPERTIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
 
Six Months Ended June 30,
 
2018
 
2017
OPERATING ACTIVITIES
 
 
 
Net income                                                                                                       
$
47,012

 
49,950

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

 
 

Depreciation and amortization                                                                                                       
44,493

 
41,090

Stock-based compensation expense                                                                                                       
2,823

 
3,087

Net (gain) loss on sales of real estate investments and non-operating real estate
(10,308
)
 
(21,815
)
Gain on casualties and involuntary conversion
(1,150
)
 

Changes in operating assets and liabilities:
 

 
 

Accrued income and other assets                                                                                                       
2,111

 
1,539

Accounts payable, accrued expenses and prepaid rent                                                                                                       
(12,075
)
 
(7,310
)
Other                                                                                                       
828

 
654

NET CASH PROVIDED BY OPERATING ACTIVITIES                                                                                                       
73,734

 
67,195

INVESTING ACTIVITIES
 

 
 

Real estate development                                                                                                       
(61,023
)
 
(47,767
)
Purchases of real estate                                                                                                       
(27,660
)
 
(36,739
)
Real estate improvements                                                                                                       
(16,126
)
 
(11,106
)
Net proceeds from sales of real estate investments and non-operating real estate                                                                                                       
16,826

 
39,934

Proceeds from casualties and involuntary conversion
890

 

Repayments on mortgage loans receivable                                                                                                       
1,958

 
64

Changes in accrued development costs                                                                                                       
7,350

 
2,826

Changes in other assets and other liabilities                                                                                                       
(5,240
)
 
(7,572
)
NET CASH USED IN INVESTING ACTIVITIES                                                                                                       
(83,025
)
 
(60,360
)
FINANCING ACTIVITIES
 

 
 

Proceeds from unsecured bank credit facilities                                                                                          
216,672

 
193,658

Repayments on unsecured bank credit facilities                                                                                                      
(233,989
)
 
(217,640
)
Proceeds from unsecured debt
60,000

 

Repayments on unsecured debt
(50,000
)
 

Repayments on secured debt
(5,570
)
 
(7,098
)
Debt issuance costs                                                                                                       
(1,845
)
 
(110
)
Distributions paid to stockholders (not including dividends accrued on unvested restricted stock)                                                                                                     
(45,449
)
 
(42,690
)
Proceeds from common stock offerings                                                                                                       
74,789

 
69,105

Proceeds from dividend reinvestment plan                                                                                                       
112

 
113

Other                                                                                                       
(5,193
)
 
(2,617
)
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
9,527

 
(7,279
)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
236

 
(444
)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
16

 
522

CASH AND CASH EQUIVALENTS AT END OF PERIOD
$
252

 
78

SUPPLEMENTAL CASH FLOW INFORMATION
 

 
 

    Cash paid for interest, net of amount capitalized of $3,003 and $2,958
       for 2018 and 2017, respectively                                                                                                       
$
16,528

 
17,160


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 2017 annual report on Form 10-K and the notes thereto. Certain reclassifications have been made in the 2017 consolidated financial statements to conform to the 2018 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. During the fourth quarter of 2017, EastGroup closed the acquisition of the 20% noncontrolling interest in two of the four University Business Center buildings; the Company now owns 100% of University Business Center 125 and 175. As of December 31, 2017 and June 30, 2018, EastGroup had an 80% controlling interest in University Business Center 120 and 130.

The Company records 100% of the assets, liabilities, revenues and expenses of the buildings held in joint ventures with the noncontrolling interests provided for in accordance with the joint venture agreements. 

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.  As of June 30, 2018 and December 31, 2017, 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 $18,898,000 and $36,825,000 for the three and six months ended June 30, 2018 and $17,113,000 and $33,747,000 for the same periods in 2017.












-7-

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

The Company’s Real estate properties and Development and value-add properties at June 30, 2018 and December 31, 2017 were as follows:
 
June 30,
2018
 
December 31,
2017
 
(In thousands)
Real estate properties:
 
 
 
   Land                                                                  
$
368,807

 
345,424

   Buildings and building improvements                                          
1,666,438

 
1,587,130

   Tenant and other improvements                                                                  
422,160

 
404,180

Development and value-add properties                                                                 
211,575

 
242,014

 
2,668,980

 
2,578,748

   Less accumulated depreciation                                                                  
(778,676
)
 
(749,601
)
 
$
1,890,304

 
1,829,147


During 2016, a hail storm caused damage to two of EastGroup's properties which were covered by insurance for all losses, subject to the Company's deductibles. The recoveries received for damages were in excess of the sum of the incurred losses for clean-up costs and the net book value written off for the damaged property. After all contingencies relating to the casualties were resolved, the Company recorded casualty gains of approximately $1.15 million during the second quarter of 2018, which is included in Other revenue on the Consolidated Statements of Income and Comprehensive Income. 

(5)
DEVELOPMENT
 
For properties under development and value-add 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.  Effective January 1, 2018, the Company began transferring properties from the development program to Real estate properties at the earlier of 90% occupancy or one year after completion of the shell construction (formerly, the Company transferred at the earlier of 80% occupancy or one year after completion of the shell construction). This change did not materially impact the comparability of the Company's financial statements. Upon transfer, capitalization of development costs, including interest expense, property taxes and internal personnel costs, ceases 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.

The FASB Codification provides a framework for determining whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. Under the 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 determined that its real estate property acquisitions in 2017 and the first six months of 2018 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 capitalized acquisition costs related to its 2017 and 2018 acquisitions.

The FASB Codification also 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 $1,033,000 and $2,045,000 for the three and six months ended June 30, 2018 and $1,233,000 and $2,354,000 for the same periods in 2017. Amortization of above and below market leases increased rental income by $142,000 and $260,000 for the three and six months ended June 30, 2018 and $141,000 and $277,000 for the same periods in 2017.

During the first six months of 2018, the Company acquired the following operating properties: Gwinnett 316 in Atlanta and Eucalyptus Distribution Center in Chino, California. The total cost for the properties acquired by the Company was $27,660,000, of which $27,037,000 was allocated to Real estate properties. EastGroup allocated $11,923,000 of the total purchase price to land using third party land valuations for the Atlanta and Chino (Los Angeles) 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: $1,776,000 to in-place lease intangibles and $1,153,000 to below market leases.

During the year ended December 31, 2017, the Company acquired the following operating properties: Shiloh 400, Broadmoor Commerce Park and Hurricane Shoals 1 & 2 in Atlanta and Southpark Corporate Center 5-7 in Austin. The Company also acquired one value-add property in the development stage, Progress Center 1 & 2 in Atlanta. At the time of acquisition, Progress Center 1 & 2 was classified in the lease-up phase. The total cost for the properties acquired by the Company was $65,243,000, of which $51,539,000 was allocated to Real estate properties and $10,312,000 was allocated to Development and value-add properties. EastGroup allocated $11,281,000 of the total purchase price to land using third party land valuations for the Atlanta and Austin markets. Intangibles associated with the purchase of real estate were allocated as follows: $3,662,000 to in-place lease intangibles, $115,000 to above market leases, and $385,000 to below market leases.

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 at June 30, 2018 and December 31, 2017.

(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 June 30, 2018 and December 31, 2017.

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.

The Company does not consider its sales in 2017 and the first six months of 2018 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.

EastGroup did not sell any properties or land during the second quarter of 2018. The Company sold World Houston 18 and 56 Commerce Park during the first quarter of 2018. The properties, which contain 214,000 square feet and are located in Houston and Tampa, were sold for $14.9 million and the Company recognized gains on the sales of $10.2 million. The Company also sold 11 acres of land in Houston for $2.6 million and recognized a gain of $86,000.


-9-

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

During the year 2017, EastGroup sold two operating properties, Stemmons Circle and Techway Southwest I-IV. Both properties were sold during the three months ended June 30, 2017. The properties, which contain 514,000 square feet and are located in Houston and Dallas, were sold for $38.0 million and the Company recognized gains on the sales of $21.9 million during the second quarter of 2017.

During the year 2017, the Company also sold 19 acres of land in Dallas and El Paso for $3.8 million and recognized net gains of $293,000 (A net loss of $40,000 was recorded in the first quarter of 2017; there were no land sales during the second quarter of 2017).

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:
 
June 30,
2018
 
December 31,
2017
 
(In thousands)
Leasing costs (principally commissions)                                                                                  
$
73,567

 
72,722

Accumulated amortization of leasing costs                                                       
(27,926
)
 
(27,973
)
Leasing costs (principally commissions), net of accumulated amortization
45,641

 
44,749

 
 
 
 
Straight-line rents receivable                                                                                  
34,015

 
31,609

Allowance for doubtful accounts on straight-line rents receivable
(90
)
 
(48
)
Straight-line rents receivable, net of allowance for doubtful accounts
33,925

 
31,561

 
 
 
 
Accounts receivable                                                                                  
3,678

 
6,004

Allowance for doubtful accounts on accounts receivable
(413
)
 
(577
)
Accounts receivable, net of allowance for doubtful accounts
3,265

 
5,427

 
 
 
 
Acquired in-place lease intangibles                                                                                  
21,556

 
20,690

Accumulated amortization of acquired in-place lease intangibles
(10,109
)
 
(8,974
)
Acquired in-place lease intangibles, net of accumulated amortization
11,447

 
11,716

 
 
 
 
Acquired above market lease intangibles                                                                                  
1,533

 
1,550

Accumulated amortization of acquired above market lease intangibles
(890
)
 
(794
)
Acquired above market lease intangibles, net of accumulated amortization
643

 
756

 
 
 
 
Mortgage loans receivable                                                                                  
2,623

 
4,581

Interest rate swap assets
10,140

 
6,034

Receivable for common stock offerings
7,366

(1) 

Goodwill                                                                                  
990

 
990

Prepaid expenses and other assets                                                                                  
7,278

 
10,215

Total Other assets
$
123,318

 
116,029


(1) Payments were received in full on July 2 and 3, 2018.


-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 Unsecured bank credit facilities, Unsecured debt and Secured debt on the Consolidated Balance Sheets.
 
June 30,
2018
 
December 31,
2017
 
(In thousands)
Unsecured bank credit facilities - variable rate, carrying amount
$
99,022

 
116,339

Unsecured bank credit facilities - fixed rate, carrying amount (1) (2)
80,000

 
80,000

Unamortized debt issuance costs
(2,064
)
 
(630
)
Unsecured bank credit facilities
176,958

 
195,709

 
 
 
 
Unsecured debt - fixed rate, carrying amount (1)
725,000

 
715,000

Unamortized debt issuance costs
(1,829
)
 
(1,939
)
Unsecured debt
723,171

 
713,061

 
 
 
 
Secured debt - fixed rate, carrying amount (1)
194,770

 
200,354

Unamortized debt issuance costs
(701
)
 
(842
)
Secured debt
194,069

 
199,512

 
 
 
 
Total debt
$
1,094,198

 
1,108,282


(1)
These loans have a fixed interest rate or an effectively fixed interest rate due to interest rate swaps.
(2)
The Company has designated an interest rate swap to an $80 million unsecured bank credit facility draw that effectively fixes the interest rate on the $80 million draw to 2.020% through the interest rate swap's maturity date of August 15, 2018.  

Until June 14, 2018, EastGroup had $300 million and $35 million unsecured bank credit facilities with margins over LIBOR of 100 basis points, facility fees of 20 basis points and maturity dates of July 30, 2019. The Company amended and restated these credit facilities on June 14, 2018, expanding the capacity to $350 million and $45 million, as detailed below.

The $350 million unsecured bank credit facility is with a group of nine banks and has a maturity date of July 30, 2022. The credit facility contains options for two six-month extensions (at the Company's election) and a $150 million accordion (with agreement by all parties). The interest rate on each tranche is usually reset on a monthly basis and as of June 30, 2018, was LIBOR plus 100 basis points with an annual facility fee of 20 basis points. The margin and facility fee are subject to changes in the Company's credit ratings. The Company has designated an interest rate swap to an $80 million unsecured bank credit facility draw that effectively fixes the interest rate on the $80 million draw to 2.020% through the interest rate swap's maturity date of August 15, 2018. As of June 30, 2018, the Company had an additional $80,000,000 of variable rate borrowings on this unsecured  bank credit facility with a weighted average interest rate of 3.091%. The Company has a standby letter of credit of $674,000 pledged on this facility.

The Company's $45 million unsecured bank credit facility has a maturity date of July 30, 2022, or such later date as designated by the bank; the Company also has two six-month extensions available if the extension options in the $350 million facility are exercised. The interest rate is reset on a daily basis and as of June 30, 2018, was LIBOR plus 100 basis points with an annual facility fee of 20 basis points. The margin and facility fee are subject to changes in the Company's credit ratings. As of June 30, 2018, the interest rate was 3.090% on a balance of $19,022,000.













-11-

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

Scheduled principal payments on long-term debt, including Unsecured debt and Secured debt (not including Unsecured bank credit facilities), as of June 30, 2018, are as follows: 
Years Ending December 31,
 
(In thousands)
Remainder of 2018
 
$
5,730

2019
 
130,569

2020
 
114,096

2021
 
129,563

2022
 
107,769

2023 and beyond
 
432,043

       Total
 
$
919,770


(10)
ACCOUNTS PAYABLE AND ACCRUED EXPENSES
 
A summary of the Company’s Accounts payable and accrued expenses follows:
 
June 30,
2018
 
December 31,
2017
 
(In thousands)
Property taxes payable                                                                                  
$
22,816

 
12,081

Development costs payable                                                                                  
17,049

 
9,699

Real estate improvements and capitalized leasing costs payable
4,463

 
3,957

Interest payable                                                                                  
4,015

 
3,744

Dividends payable on unvested restricted stock                                                            
1,179

 
1,365

Book overdraft (1)
1,448

 
20,902

Other payables and accrued expenses                                                                                  
5,380

 
13,219

 Total Accounts payable and accrued expenses
$
56,350

 
64,967


(1) Represents checks written before the end of the period which have not cleared the bank; therefore, the bank has not yet advanced cash to the Company. When the checks clear the bank, they will be funded through the Company's working cash line of credit.

(11)
OTHER LIABILITIES
 
A summary of the Company’s Other liabilities follows:
 
June 30,
2018
 
December 31,
2017
 
(In thousands)
Security deposits                                                                                  
$
17,317

 
16,668

Prepaid rent and other deferred income                                                     
10,033

 
9,352

 
 
 
 
Acquired below-market lease intangibles
5,288

 
4,135

     Accumulated amortization of below-market lease intangibles
(2,519
)
 
(2,147
)
Acquired below-market lease intangibles, net of accumulated amortization
2,769

 
1,988

 
 
 
 
Interest rate swap liabilities

 
695

Prepaid tenant improvement reimbursements
343

 
124

Other liabilities                                                                                  
15

 
15

 Total Other liabilities
$
30,477

 
28,842



-12-

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

(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 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
June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
 
(In thousands)
ACCUMULATED OTHER COMPREHENSIVE INCOME:
 
 
 
Balance at beginning of period
$
8,954

 
3,405

 
5,348

 
1,995

    Change in fair value of interest rate swaps - cash flow hedges
1,186

 
(984
)
 
4,792

 
426

Balance at end of period
$
10,140

 
2,421

 
10,140

 
2,421


(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 June 30, 2018, 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 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 related to derivatives will be reclassified to Interest expense as interest payments are made or received on the Company's variable-rate debt. The Company estimates the swap interest receipts will be $2,424,000 over the next twelve months. These receipts approximate the expected cash interest receipts due from counterparties for the swaps. Since the interest payments and receipts 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.






-13-

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

As of June 30, 2018 and December 31, 2017, 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 June 30, 2018
 
Notional Amount as of December 31, 2017
 
 
(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 June 30, 2018 and December 31, 2017. See Note 16 for additional information on the fair value of the Company's interest rate swaps.
 
Derivatives
As of June 30, 2018
 
Derivatives
As of December 31, 2017
 
Balance Sheet Location
 
Fair Value
 
Balance Sheet Location
 
Fair Value
 
(In thousands)
Derivatives designated as cash flow hedges:
 
 
 
 
 
 
 
    Interest rate swap assets
Other assets
 
$
10,140

 
Other assets
 
$
6,034

    Interest rate swap liabilities
Other liabilities
 

 
Other liabilities
 
695


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 six months ended June 30, 2018 and 2017:
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
 
(In thousands)
DERIVATIVES IN CASH FLOW HEDGING RELATIONSHIPS
 
 
 
 
 
 
 
Interest Rate Swaps:
 
 
 
 
 
 
 
  Amount of income (loss) recognized in Other comprehensive income on derivatives                                                                                                     
$
1,572

 
(1,531
)
 
5,234

 
(894
)
  Amount of (income) loss reclassified from Accumulated other comprehensive income into Interest expense                                                                                               
(386
)
 
547

 
(442
)
 
1,320


See Note 12 for additional information on the Company's Accumulated other comprehensive income 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 June 30, 2018, the fair value of derivatives in an asset position related to these agreements was $10,140,000. As of June 30, 2018, 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 $10,248,000.


-14-

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

(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.

Reconciliation of the numerators and denominators in the basic and diluted EPS computations is as follows:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2018
 
2017
 
2018
 
2017
 
(In thousands)
BASIC EPS COMPUTATION FOR NET INCOME ATTRIBUTABLE TO EASTGROUP PROPERTIES, INC. COMMON STOCKHOLDERS
 
 
 
 
 
 
 
  Numerator – net income attributable to common stockholders                                                                                                     
$
18,227

 
36,890

 
46,940

 
49,709

  Denominator – weighted average shares outstanding                                                                                                     
35,196

 
33,987

 
34,944

 
33,676

DILUTED EPS COMPUTATION FOR NET INCOME ATTRIBUTABLE TO EASTGROUP PROPERTIES, INC. COMMON STOCKHOLDERS
 
 
 
 
 
 
 
  Numerator – net income attributable to common stockholders                                                                                                     
$
18,227

 
36,890

 
46,940

 
49,709

Denominator:
 
 
 
 
 
 
 
    Weighted average shares outstanding                                                                                                     
35,196

 
33,987

 
34,944

 
33,676

    Unvested restricted stock                                                                                                     
63

 
53

 
54

 
46

      Total Shares                                                                                                     
35,259

 
34,040

 
34,998

 
33,722


(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 $1,108,000 and $2,151,000 for the three and six months ended June 30, 2018, respectively, of which $245,000 and $459,000 were capitalized as part of the Company's development costs. For the three and six months ended June 30, 2017, stock-based compensation cost for employees was $952,000 and $3,633,000, respectively, of which $383,000 and $869,000 were capitalized as part of the Company's development costs.

Stock-based compensation expense for directors was $776,000 and $1,131,000 for the three and six months ended June 30, 2018, respectively, and $161,000 and $323,000 for the same periods of 2017.

In the second quarter of 2017, the Compensation Committee of the Company's Board of Directors (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 measured the Company's performance for 2017 against bright-line tests established by the Committee on the grant date of May 10, 2017, and determined that 21,097 shares were earned. These shares, which have a grant date fair value of $78.18, vested 20% on the date shares were determined and will vest 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 have been 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.  On March 1, 2018, the Committee evaluated the performance of the officers and, in its discretion, awarded 4,554 shares with a grant date fair value of $80.93. These shares vested 20% on the date shares were determined and awarded and will vest 20% per year on each January 1 for the subsequent four years. The Company began recognizing expense for the shares awarded on the grant date of March 1, 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 member companies of the NAREIT industrial index. The first plan measured the bright-line tests over the one-year period ended December 31, 2017. During the first quarter of 2018, the Committee measured 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 determined on the measurement date was 4,257.  These shares vested 100% on March 1, 2018, the date the earned shares were 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, vested 25% in the first quarter of 2018 and will vest 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.

In the second quarter of 2018, the Committee approved an equity compensation plan for the Company's executive officers based upon certain annual performance measures for 2018, including FFO per share, same property net operating income change, general and administrative costs, and fixed charge coverage. During the first quarter of 2019, the Committee will measure the Company's performance for 2018 against bright-line tests established by the Committee on the grant date of June 1, 2018. The number of shares that may be earned for the achievement of the annual performance measures could range from zero to 24,690. These shares, which have a grant date fair value of $95.19, 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 June 1, 2018, 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 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 2018, the Committee approved an equity compensation plan for EastGroup's 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 2019. The number of shares to be issued on the grant date for the achievement of individual goals could range from zero to 6,173. These

-16-

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

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 2019, and the shares will be expensed on a straight-line basis over the remaining service period. 

Also in the second quarter of 2018, the Committee approved a long-term equity compensation plan for the Company’s executive officers that includes one component based on total shareholder return and one component based only on continued service as of the vesting dates.

The component of the long-term equity compensation plan based on total shareholder return is subject to bright-line tests that will compare the Company's total shareholder return to the NAREIT Equity Index and to the member companies of the NAREIT industrial index. The plan will measure the bright-line tests over the three-year period ending December 31, 2020. During the first quarter of 2021, 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 June 1, 2018.  The number of shares to be earned on the measurement date could range from zero to 27,596.  These shares would vest 75% on the date the earned shares are determined in the first quarter of 2021 and 25% on January 1, 2022. On the grant date of June 1, 2018, 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 June 1, 2018. On that date, 7,884 shares were granted to the Company's executive officers subject only to continued service as of the vesting dates. These shares, which have a grant date fair value of $95.19, will vest 25% in the first quarter of 2019 and 25% on January 1 in years 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 2018, 12,425 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 $95.17, will vest 20% on January 1 in years 2019, 2020, 2021, 2022 and 2023. The shares are being expensed on a straight-line basis over the remaining service period.

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 six months of 2018, the Company withheld 23,824 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 six months of 2018 was $5,142,000.
 
Three Months Ended
 
Six Months Ended
Award Activity:
June 30, 2018
 
June 30, 2018
 
 
 
Shares
 
Weighted Average Grant Date Fair Value
 
 
 
Shares
 
Weighted Average Grant Date Fair Value
Unvested at beginning of period
123,287

 
$
66.20

 
152,926

 
$
63.22

Granted (1) (2)
20,309

 
95.18

 
50,217

 
84.09

Forfeited 

 

 

 

Vested 

 

 
(59,547
)
 
63.77

Unvested at end of period 
143,596

 
$
70.30

 
143,596

 
$
70.30


(1) Includes shares granted in prior years for which performance conditions have been satisfied and the number of shares have been
determined.
(2) Does not include the restricted shares that may be earned if the performance goals established in 2017 for long-term performance
    and in 2018 for annual and long-term performance 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 86,836.

-17-

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

(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 June 30, 2018 and December 31, 2017.
 
June 30, 2018
 
December 31, 2017
 
Carrying Amount (1)
 
Fair Value
 
Carrying Amount (1)
 
Fair Value
 
(In thousands)
Financial Assets:
 
 
 
 
 
 
 
Cash and cash equivalents
$
252

 
252

 
16

 
16

   Mortgage loans receivable                                 
2,623

 
2,552

 
4,581

 
4,569

   Interest rate swap assets                             
10,140

 
10,140

 
6,034

 
6,034

Financial Liabilities:
 

 
 

 
 

 
 

 Unsecured bank credit facilities - variable rate (2)
99,022

 
99,016

 
116,339

 
116,277

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

 
80,000

 
80,000

 
80,003

Unsecured debt (2)
725,000

 
703,703

 
715,000

 
703,871

Secured debt (2)
194,770

 
197,173

 
200,354

 
206,408

   Interest rate swap liabilities                                     

 

 
695

 
695

(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).
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.


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(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. The new standard was effective for the Company on January 1, 2018, and the Company used the modified retrospective approach upon adoption. The adoption of ASU 2014-09 did not have a material impact on the Company's financial condition or results of operations.
 
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 adopted ASU 2016-01 effective January 1, 2018. The adoption of ASU 2016-01 did not 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 change for the Company related to lessor accounting includes the new standard's narrow definition of initial direct costs for leases. The new definition will result in certain costs (primarily legal costs related to lease negotiations) being expensed rather than capitalized upon adoption of the new standard. EastGroup plans to elect the practical expedient permitting lessors to make an accounting policy election by class of underlying asset to not separate non-lease components of a contract from the lease component to which they relate when specific criteria are met (the Company believes its leases meet the criteria). 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 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 adopted ASU 2017-09 on January 1, 2018; the adoption of ASU 2017-09 did not have a material impact on its financial condition or results of operations, as the Company has not had 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

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

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 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 July 2018, the Company closed the acquisition of Siempre Viva Distribution Center in the Otay Mesa submarket of San Diego. The 115,000 square foot multi-tenant distribution center was acquired for $14 million.

EastGroup is currently under contract to sell its 35th Avenue Distribution Center in Phoenix for approximately $8 million. The sale of the 125,000 square foot property is expected to close during the third quarter of 2018.
 




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

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Certain statements contained in this report may be deemed “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.  Words such as “will,” “anticipates,” “expects,” “believes,” “intends,” “plans,” “seeks,” “estimates,” variations of such words and similar expressions are intended to identify such forward-looking statements, which generally are not historical in nature.  All statements that address operating performance, events or developments that the Company expects or anticipates will occur in the future, including statements relating to rent and occupancy growth, development activity, the acquisition or sale of properties, general conditions in the geographic areas where the Company operates and the availability of capital, are forward-looking statements.  Forward-looking statements are inherently subject to known and unknown risks and uncertainties, many of which the Company cannot predict, including, without limitation: changes in general economic conditions; the extent of tenant defaults or of any early lease terminations; the Company's ability to lease or re-lease space at current or anticipated rents; the availability of financing; the failure to maintain credit ratings with rating agencies; changes in the supply of and demand for industrial/warehouse properties; increases in interest rate levels; increases in operating costs; natural disasters, terrorism, riots and acts of war, and the Company's ability to obtain adequate insurance; changes in governmental regulation, tax rates and similar matters; and other risks associated with the development and acquisition of properties, including risks that development projects may not be completed on schedule, development or operating costs may be greater than anticipated or acquisitions may not close as scheduled, and those additional factors discussed under “Item 1A. Risk Factors” in Part II of this report and in the Company’s Annual Report on Form 10-K.  Although the Company believes the expectations reflected in the forward-looking statements are based upon reasonable assumptions at the time made, the Company can give no assurance that such expectations will be achieved.  The Company assumes no obligation whatsoever to publicly update or revise any forward-looking statements.  See also the information contained in the Company’s reports filed or to be filed from time to time with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”).


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 15,000 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 six months of 2018, EastGroup issued 929,783 shares of common stock through its continuous common equity program, providing net proceeds to the Company of $82.2 million. Also during the first six months of 2018, the Company closed $60 million of senior unsecured private placement notes and replaced its $300 million and $35 million unsecured bank credit facilities with new $350 million and $45 million facilities. 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 six months ended June 30, 2018, EastGroup executed leases on 3,676,000 square feet (9.6% of EastGroup’s total square footage of 38,424,000). During the first six months of 2018, average rental rates on new and renewal leases increased by 15.1%.  Property net operating income (PNOI) from same properties, defined as operating properties owned during the entire current period and prior year reporting period, increased 4.6% for the six months ended June 30, 2018, as compared to the same period in 2017.

EastGroup’s total leased percentage was 97.0% as of June 30, 2018 compared to 96.8% at June 30, 2017.  Leases scheduled to expire for the remainder of 2018 were 3.9% of the portfolio on a square foot basis at June 30, 2018, and this percentage was reduced to 3.3% as of July 20, 2018.

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 six months of 2018, EastGroup began construction of seven development projects containing 888,000 square feet in Miami, Orlando, Ft. Myers, Atlanta, Dallas, Houston and San Antonio.  EastGroup also transferred eight development projects and value-add acquisitions (1,052,000 square feet) in Orlando, Tampa, Ft. Lauderdale, Ft. Myers, Atlanta, San Antonio and Tucson from its development program to real estate properties with costs of $83.9 million at the date of transfer.  As of June 30, 2018,

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EastGroup’s development program consisted of 17 projects (2,007,000 square feet) located in ten cities.  The projected total investment for the development projects, which were collectively 27% leased as of July 20, 2018, is $171 million, of which $61 million remained to be invested as of June 30, 2018.

Also in the first six months of 2018, the Company sold 214,000 square feet of operating properties and 11 acres of land, generating gross proceeds of $17.5 million. EastGroup recognized $10,222,000 in Gain on sales of real estate investments and $86,000 in Gain on sales of non-operating real estate (included in Other on the Consolidated Statements of Income and Comprehensive Income).

Typically, the Company initially funds its development and acquisition programs through its $395 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 June 2018, 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 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 was calculated as follows for the three and six months ended June 30, 2018 and 2017.
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
 
(In thousands)
Income from real estate operations
$
73,720

 
67,855

 
145,840

 
133,992

Expenses from real estate operations
(21,453
)
 
(20,244
)
 
(42,129
)
 
(39,251
)
Noncontrolling interest in PNOI of consolidated 80% joint ventures
(81
)
 
(137
)
 
(160
)
 
(348
)
PNOI from 50% owned unconsolidated investment
218

 
225

 
435

 
449

PROPERTY NET OPERATING INCOME (PNOI)
$
52,404

 
47,699

 
103,986

 
94,842

 
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

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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.

The following table presents reconciliations of Net Income to PNOI for the three and six months ended June 30, 2018 and 2017.
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
 
(In thousands)
NET INCOME
$
18,264

 
36,977

 
47,012

 
49,950

(Gain) on sales of real estate investments

 
(21,855
)
 
(10,222
)
 
(21,855
)
(Gain) loss on sales of non-operating real estate

 

 
(86
)
 
40

(Gain) on sales of other

 

 
(427
)
 

Interest income
(35
)
 
(61
)
 
(90
)
 
(123
)
Other revenue
(1,165
)
 
(39
)
 
(1,248
)
 
(56
)
Depreciation and amortization
22,808

 
20,865

 
44,493

 
41,090

Company's share of depreciation from unconsolidated investment
31

 
31

 
62

 
62

Interest expense 
8,842

 
9,015

 
17,449

 
17,701

General and administrative expense 
3,740

 
2,903

 
7,203

 
8,381

Noncontrolling interest in PNOI of consolidated 80% joint ventures
(81
)
 
(137
)
 
(160
)
 
(348
)
PROPERTY NET OPERATING INCOME (PNOI)
$
52,404

 
47,699

 
103,986

 
94,842


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 six months ended June 30, 2018 and 2017.
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2018
 
2017
 
2018
 
2017
 
(In thousands, except per share data)
NET INCOME ATTRIBUTABLE TO EASTGROUP PROPERTIES,  INC. COMMON STOCKHOLDERS
$
18,227

 
36,890

 
46,940

 
49,709

Depreciation and amortization
22,808

 
20,865

 
44,493

 
41,090

Company's share of depreciation from unconsolidated investment 
31

 
31

 
62

 
62

Depreciation and amortization from noncontrolling interest
(44
)
 
(49
)
 
(88
)
 
(104
)
(Gain) on sales of real estate investments

 
(21,855
)
 
(10,222
)
 
(21,855
)
FUNDS FROM OPERATIONS (FFO) ATTRIBUTABLE TO COMMON STOCKHOLDERS
$
41,022

 
35,882

 
81,185

 
68,902

Net income attributable to common stockholders per diluted share
$
0.52

 
1.08

 
1.34

 
1.47

Funds from operations (FFO) attributable to common stockholders
   per diluted share
$
1.16

 
1.05

 
2.32

 
2.04

Diluted shares for earnings per share and funds from operations
35,259

 
34,040

 
34,998

 
33,722





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The Company analyzes the following performance trends in evaluating the revenues and expenses 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 second quarter of 2018 was $1.16 per share compared with $1.05 per share for the same period of 2017, an increase of 10.5%. For the six months ended June 30, 2018, FFO was $2.32 per share compared with $2.04 per share for the same period of 2017, an increase of 13.7%.

For the three months ended June 30, 2018, PNOI increased by $4,705,000, or 9.9%, compared to the same period in 2017. PNOI increased $3,023,000 from same property operations, $2,080,000 from newly developed and value-add properties, and $336,000 from 2017 and 2018 acquisitions; PNOI decreased $739,000 from operating properties sold in 2017 and 2018.

For the six months ended June 30, 2018, PNOI increased by $9,144,000, or 9.6%, compared to the same period in 2017. PNOI increased $5,510,000 from newly developed and value-add properties, $4,181,000 from same property operations and $812,000 from 2017 and 2018 acquisitions; PNOI decreased $1,367,000 from operating properties sold in 2017 and 2018.

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 6.5% and 4.6% for the three and six months ended June 30, 2018, respectively, as compared to the same periods in 2017.

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 96.7% for the three months ended June 30, 2018, compared to 94.9% for the same period of 2017. Same property average occupancy for the six months ended June 30, 2018, was 97.1% compared to 96.2% for the same period of 2017.

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 June 30, 2018, was 96.4%.  Quarter-end occupancy ranged from 94.9% to 96.4% over the previous four quarters ended June 30, 2017 to March 31, 2018.

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 (4.7% of total square footage) averaged 11.9% for the second quarter of 2018. For the six months ended June 30, 2018, rental rate increases on new and renewal leases (9.6% of total square footage) averaged 15.1%.

Lease termination fee income is included in Income from real estate operations. Lease termination fee income for the three and six months ended June 30, 2018 was $8,000 and $139,000 respectively, compared to $24,000 and $133,000 for the same periods of 2017.

Bad debt expense is included in Expenses from real estate operations. The Company recorded net bad debt recoveries of $4,000 for the three months ended June 30, 2018, and net bad debt expense of $86,000 for the six months ended June 30, 2018, compared to bad debt expense of $148,000 and $198,000 for three and six months ended June 30, 2017.



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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 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 value-add 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.


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FINANCIAL CONDITION
EastGroup’s assets were $2,021,726,000 at June 30, 2018, an increase of $68,505,000 from December 31, 2017.  Liabilities decreased $21,066,000 to $1,181,025,000, and equity increased $89,571,000 to $840,701,000 during the same period.  The following paragraphs explain these changes in detail.

Assets

Real Estate Properties
Real estate properties increased $120,671,000 during the six months ended June 30, 2018, primarily due to the transfer of eight projects from Development and value-add properties (as detailed under Development and Value-Add Properties 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 2018
 
Location
 
Size
 
Date
Acquired
 
Cost (1)
 
 
 
 
(Square feet)
 
 
 
(In thousands)
Gwinnett 316
 
Atlanta, GA
 
65,000

 
04/24/2018
 
$
4,147

Eucalyptus Distribution Center
 
Chino, CA
 
182,000

 
06/20/2018
 
22,890

Total Acquisitions
 
 
 
247,000

 
 
 
$
27,037

(1) Total cost of the properties acquired was $27,660,000, of which $27,037,000 was allocated to Real estate properties as indicated above. The Company allocated $11,923,000 of the total purchase price to land using third party land valuations for the Atlanta and Chino (Los Angeles) 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: $1,776,000 to in-place lease intangibles (included in Other assets on the Consolidated Balance Sheets) and $1,153,000 to below market leases (included in Other liabilities on the Consolidated Balance Sheets).   

During the six months ended June 30, 2018, the Company made capital improvements of $15,958,000 on existing and acquired properties (included in the Real Estate Improvements table under Results of Operations).  Also, the Company incurred costs of $5,165,000 on development projects subsequent to transfer to Real estate properties; the Company records these expenditures as development costs on the Consolidated Statements of Cash Flows.

During the six months ended June 30, 2018, the Company sold World Houston 18 in Houston and 56 Commerce Park in Tampa. The properties (214,000 square feet combined) were sold for $14.9 million and the Company recognized gains on the sales of $10.2 million.

Development and Value-Add Properties
EastGroup’s investment in Development and value-add properties at June 30, 2018 consisted of projects in lease-up and under construction of $110,417,000 and prospective development (primarily land) of $101,158,000.  The Company’s total investment in Development and value-add properties at June 30, 2018 was $211,575,000 compared to $242,014,000 at December 31, 2017.  Total capital invested for development during the first six months of 2018 was $61,023,000, which primarily consisted of costs of $41,422,000 and $12,018,000 as detailed in the Development and Value-Add Properties Activity table below and costs of $5,165,000 on projects subsequent to transfer to Real estate properties. The capitalized costs incurred on development projects 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 $1,110,000 and $2,233,000 for the three and six months ended June 30, 2018, respectively, compared to $1,350,000 and $2,594,000 in the same periods of 2017.

During the six months ended June 30, 2018, EastGroup sold 11 acres of development land in Houston for $2,577,000. The Company also transferred eight development projects and value-add acquisitions to Real estate properties during the first six months of 2018 with a total investment of $83,879,000 as of the date of transfer.

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Costs Incurred
 
 
 
Anticipated Building Conversion Date
DEVELOPMENT AND
VALUE-ADD PROPERTIES ACTIVITY
 
 
Costs Transferred in 2018 (1)
 
For the Six Months Ended
6/30/2018
 
Cumulative as of 6/30/2018
 
 
Estimated Total Costs
 
 
 
 
(In thousands)
 
 
LEASE-UP
Building Size (Square feet)
 
 
 
 
 
 
 
 
 
 
Kyrene 202 III, IV & V, Phoenix, AZ
166,000

 
$

 
998

 
12,541

 
13,800

 
09/18
Steele Creek VII, Charlotte, NC
120,000

 

 
745

 
8,542

 
9,300

 
09/18
Horizon XII, Orlando, FL
140,000

 

 
288

 
11,518

 
12,100

 
12/18
CreekView 121 3 & 4, Dallas, TX
158,000

 

 
2,128

 
12,439

 
14,200

 
04/19
Eisenhauer Point 5, San Antonio, TX
98,000

 

 
1,297

 
7,101

 
7,500

 
04/19
Eisenhauer Point 6, San Antonio, TX
85,000

 

 
870

 
4,920

 
5,200

 
04/19
Falcon Field, Phoenix, AZ
96,000

 

 
4,602

 
7,549

 
9,000

 
05/19
West Road 5, Houston, TX
58,000

 
1,022

 
2,633

 
3,655

 
5,300

 
06/19
Total Lease-Up
921,000

 
1,022

 
13,561

 
68,265

 
76,400

 
 
UNDER CONSTRUCTION
 

 
 

 
 

 
 

 
 

 
 
Broadmoor 2, Atlanta, GA
111,000

 
705

 
3,070

 
3,775

 
7,400

 
10/19
Settlers Crossing 1, Austin, TX
77,000

 

 
3,024

 
4,580

 
7,400

 
10/19
Settlers Crossing 2, Austin, TX
83,000

 

 
3,217

 
4,890

 
8,000

 
10/19
Gateway 1, Miami, FL
200,000

 
9,110

 
4,661

 
13,771

 
22,800

 
11/19
Horizon XI, Orlando, FL
135,000

 
3,171

 
1,578

 
4,749

 
10,400

 
11/19
SunCoast 5, Ft. Myers, FL
81,000

 
2,704

 
447

 
3,151

 
7,700

 
11/19
Airport Commerce Center 3, Charlotte, NC
96,000

 

 
650

 
2,383

 
7,300

 
12/19
Parc North 5, Dallas, TX
100,000

 
1,683

 
244

 
1,927

 
9,200

 
02/20
Tri-County Crossing 1 & 2, San Antonio, TX
203,000

 
2,012

 
914

 
2,926

 
14,600

 
02/20
Total Under Construction
1,086,000

 
19,385

 
17,805

 
42,152

 
94,800

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

 
 

 
 

 
 

 
 
Ft. Myers, FL
488,000

 
(2,704
)
 
114

 
11,522

 
 
 
 
Miami, FL
650,000

 
(9,110
)
 
9,493

 
31,259

 
 
 
 
Orlando, FL
283,000

 
(3,171
)
 
941

 
8,890

 
 
 
 
Tampa, FL
32,000

 

 

 
1,560

 
 
 
 
Atlanta, GA
85,000

 
(705
)
 
63

 
565

 
 
 
 
Jackson, MS
28,000

 

 

 
706

 
 
 
 
Charlotte, NC
654,000

 

 
352

 
7,081

 
 
 
 
Austin, TX
180,000

 

 
409

 
3,429

 
 
 
 
Dallas, TX
375,000

 
(1,683
)
 
467

 
8,380

 
 
 
 
Houston, TX (2)
1,255,000

 
(1,022
)
 
(2,372
)
 
17,796

 
 
 
 
San Antonio, TX
874,000

 
(2,012
)
 
589

 
9,970

 
 
 
 
Total Prospective Development
4,904,000

 
(20,407
)
 
10,056

 
101,158

 


 
 
 
6,911,000

 
$

 
41,422

 
211,575

 


 
 
DEVELOPMENT PROJECTS AND VALUE-ADD ACQUISITIONS TRANSFERRED TO REAL ESTATE PROPERTIES DURING 2018
Building Size (Square feet)
 
 

 
 

 
 

 
 

 
Building Conversion Date
Alamo Ridge IV, San Antonio, TX
97,000

 
$

 
320

 
7,417

 
 
 
03/18
Oak Creek VII, Tampa, FL
116,000

 

 
601

 
6,732

 
 
 
03/18
Weston, Ft. Lauderdale, FL (3)
134,000

 

 
222

 
15,742

 
 
 
03/18
Progress Center 1 & 2, Atlanta, GA (4)
132,000

 

 
143

 
10,476

 
 
 
04/18
Horizon X, Orlando, FL
104,000

 

 
3,352

 
6,902

 
 
 
05/18
SunCoast 4, Ft. Myers, FL
93,000

 

 
71

 
9,191

 
 
 
05/18
Country Club V, Tucson, AZ
305,000

 

 
7,078

 
21,029

 
 
 
06/18
Eisenhauer Point 3, San Antonio, TX
71,000

 

 
231

 
6,390

 
 
 
06/18
Total Transferred to Real Estate Properties
1,052,000

 
$

 
12,018

 
83,879

 
(5)
 
 

(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) Negative amount represents land inventory costs transferred to Under Construction and land sold on 3/28/18.
(3) This project was acquired by EastGroup on 11/1/16 and underwent redevelopment.
(4) This project was acquired by EastGroup on 12/12/17 during the lease-up phase.
(5) Represents cumulative costs at the date of transfer.


-27-




Accumulated Depreciation
Accumulated depreciation on real estate, development and value-add properties increased $29,075,000 during the first six months of 2018 due primarily to depreciation expense, offset by the sale of 214,000 square feet of operating properties during the period.

Other Assets
Other assets increased $7,289,000 during the first six months of 2018.  A summary of Other assets follows:
 
June 30,
2018
 
December 31,
2017
 
(In thousands)
Leasing costs (principally commissions)                                                                                  
$
73,567

 
72,722

Accumulated amortization of leasing costs                                                       
(27,926
)
 
(27,973
)
Leasing costs (principally commissions), net of accumulated amortization
45,641

 
44,749

 
 
 
 
Straight-line rents receivable                                                                                  
34,015

 
31,609

Allowance for doubtful accounts on straight-line rents receivable
(90
)
 
(48
)
Straight-line rents receivable, net of allowance for doubtful accounts
33,925

 
31,561

 
 
 
 
Accounts receivable                                                                                  
3,678

 
6,004

Allowance for doubtful accounts on accounts receivable
(413
)
 
(577
)
Accounts receivable, net of allowance for doubtful accounts
3,265

 
5,427

 
 
 
 
Acquired in-place lease intangibles                                                                                  
21,556

 
20,690

Accumulated amortization of acquired in-place lease intangibles
(10,109
)
 
(8,974
)
Acquired in-place lease intangibles, net of accumulated amortization
11,447

 
11,716

 
 
 
 
Acquired above market lease intangibles                                                                                  
1,533

 
1,550

Accumulated amortization of acquired above market lease intangibles
(890
)
 
(794
)
Acquired above market lease intangibles, net of accumulated amortization
643

 
756

 
 
 
 
Mortgage loans receivable   &