October 22, 2008

An Update on Form 10-K Comments Issued by the SEC

This is an update to our March 25, 2008 REIT Alert titled “Recent Developments in SEC Form 10-K Reviews,” which reported on new comments emerging from the staff of the SEC’s Division of Corporation Finance (the “Staff”) requiring real estate companies to provide detailed descriptions of material properties, disclose specified property operating data and identify the source of funds for any distributions in excess of historical FFO in their Form 10-Ks.

We reviewed more than 80 comment letters issued to real estate companies since the beginning of the year. Although most of the letters contained Staff comments on only the financial statements and the accompanying notes, 18 of these letters contained comments on information presented outside of the financial statements. We found that the Staff most frequently sought additional disclosure or explanation concerning:

  • lease expirations;
  • occupancy rates and annual rents;
  • dividends and distributions in excess of FFO/cash flows;
  • FFO presentation;
  • non-GAAP measures; and
  • trends or uncertainties.

Notably, in only a few instances did the Staff require the company to amend its Form 10-K to include the required disclosure regarding lease expirations, occupancy rates and annual rents and dividends and distributions in excess of FFO/cash flows. Instead, the Staff issued the majority of these comments as “futures comments,” which do not require an immediate amendment of an already-filed report but apply only to future filings. Not all categories of comments were issued to every company, and there were several miscellaneous comments that were issued only once. Below is a brief discussion of the comments most frequently issued.

The Staff’s Comments

Lease Expirations . With nine comments issued pertaining to lease expirations, this was the most commonly issued comment. Most required the company to provide a schedule of lease expirations on a portfolio basis for the next 10 years, including (1) the number of tenants whose leases will expire, (2) the total area in square feet covered by these leases, (3) the annual rent represented by these leases and (4) the percentage of gross annual rent represented by these leases.

Occupancy Rates and Annual Rents . The Staff issued six comments relating to occupancy rates and/or annual rents, generally requiring companies to disclose average occupancy rates and average effective annual rent per square foot or unit for each of the previous five years.

Dividends/Distributions . In two instances, the Staff required companies to identify the source of funds for any distributions made that were in excess of historical funds from operations or cash flow from operating activities as reported in the statement of cash flows.

FFO Presentation . In general, the comments related to the presentation of FFO sought an explanation of the following:

  • where the presentation of FFO excluded items such as amortization of in-place lease intangible assets and impairment and defeasance charges, how the company had satisfied the requirements of Item 10(e) of Regulation S-K, which sets forth criteria for the use of non-GAAP measures;
  • where the company presented “Adjusted FFO” information, how the company had satisfied the requirements of Item 10(e) and Question 8 of the Frequently Asked Questions Regarding the Use of Non-GAAP Financial Measures, which discusses a company’s obligation to demonstrate the usefulness of any non-GAAP financial measure that excludes recurring items, especially if the measure is used to evaluate performance;
  • whether the company was using “Adjusted FFO” as a performance or liquidity measure and how that conclusion was reached;
  • why presentation of FFO that does not meet the NAREIT definition is appropriate; and
  • how management uses FFO per diluted share information to conduct or evaluate its business and in what way it provides meaningful information to investors.

Non-GAAP Measures . In several instances the Staff required companies to explain how their non-GAAP disclosures met the requirements of Item 10(e) and/or Question 8. For example, in one instance the Staff asked for an explanation of how ratios, which are based on either a numerator or denominator that is a non-GAAP measure, comply with all the disclosure requirements of Item 10(e).

Trends or Uncertainties . These comments required companies to disclose any known trends or uncertainties that have had, or that the company reasonably expects will have, an unfavorable material impact on revenues or income from continuing operations, as required by Item 303(a)(3)(ii) of Regulation S-K. Companies should be particularly aware of the requirement to disclose trends or uncertainties in light of recent financial and general economic developments, and should ensure that this disclosure is correct as of the filing date of the Form 10-Q or Form 10-K report rather than only as of the end of the fiscal period covered by the report. By way of example, some of the trends that the Staff specifically focused on were:

  • increases in mortgage loans not earning interest;
  • increases in provisions for loan losses;
  • decreases in origination volume;
  • declines in total revenue, net income and operating cash flows;
  • increases in fixed charges exceeding earnings;
  • the impact of acquisitions/dispositions driven by change in business strategy and related fluctuations in operating results; and
  • property operating and management expenses increasing at a greater rate than revenues for the same properties and the whole portfolio.

Miscellaneous . The Staff also made other comments that did not necessarily fall into one of the above categories and were issued only once. Disclosures required by these comments included the following: a list of tenants that occupy 10% or more of net rentable square feet; the number of properties that fall into various property categories (e.g., full service, limited service and extended stay); a list of properties with a book value equal to 10% or more of total assets as of the end of the company’s most recently completed fiscal year; a list of properties with gross revenue equal to 10% or more of aggregate gross revenues for the last fiscal year; and an explanation of how the percentage of anchors occupied and stores occupied was calculated.

Planning Ahead

Even before companies start preparing their next Form 10-K, they should begin to consider how these comments may affect their disclosure. Given that generating some of this information, such as the schedule of lease expirations, may be time consuming for those companies not already doing so in connection with their Form 10-K filing, companies should begin to take the necessary steps to include this disclosure in their next Form 10-K, and be prepared for a potential Staff comment on these items if they do not.