-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Kn4euACX6ZRMQNksSz2S0U7z1RVkjXiNUgPMpkdcEAim1l3mGXuaI4RyvQpOU6iY 6/4SvFR5/7fOupJIjdJMBQ== 0000950133-97-003998.txt : 19971117 0000950133-97-003998.hdr.sgml : 19971117 ACCESSION NUMBER: 0000950133-97-003998 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971114 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: AVALON PROPERTIES INC CENTRAL INDEX KEY: 0000911536 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 061379111 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: SEC FILE NUMBER: 001-12452 FILM NUMBER: 97721916 BUSINESS ADDRESS: STREET 1: 15 RIVER ROAD STREET 2: SUITE 210 CITY: WILTON STATE: CT ZIP: 06897 BUSINESS PHONE: 2037616500 MAIL ADDRESS: STREET 1: 15 RIVER ROAD STREET 2: SUITE 210 CITY: WILTON STATE: CT ZIP: 06897 10-Q/A 1 FORM 10-Q/A TO ALALON PROPERTIES, INC. 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q/A (Amendment No. 1) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1997 Commission file number 1-12452 AVALON PROPERTIES, INC. (Exact name of registrant as specified in its charter) ---------------- Maryland 06-1379111 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 15 River Road Wilton, Connecticut 06897 (Address of principal executive offices) - (Zip Code) (203) 761-6500 (Registrant's telephone number, including area code) ---------------- 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 / / APPLICABLE ONLY TO CORPORATE ISSUERS: ------------------------------------- Indicate the number of shares outstanding of each issuer's classes of common stock as of the latest practicable date: 38,471,981 shares outstanding as of November 7, 1997. ================================================================================ 2 AVALON PROPERTIES, INC. INDEX
PART I FINANCIAL INFORMATION This amendment is filed to correct the typographical error in the earnings per share reported on the Condensed Consolidated Statement of Operations on the Company's Form 10-Q for the quarterly period September 30, 1997 filed on November 14, 1997. Item 1 Financial Statements Page ---- Condensed Consolidated Balance Sheets as of September 30, 1997 and December 31, 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 1997 and 1996 . . . . . . . . . . . . . . . . . . . . . . . 2 Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 1997 and 1996 . . . . . . . . . . . . . . . . . . . . . . . 3 Notes to Condensed Consolidated Financial Statements . . . . . . . . . . . . . . 4 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 PART II OTHER INFORMATION Item 1 Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Item 2 Changes in Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Item 3 Defaults upon Senior Securities . . . . . . . . . . . . . . . . . . . . . . . 23 Item 4 Submission of Matters to a Vote of Stockholders . . . . . . . . . . . . . . . 23 Item 5 Other Information. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Item 6 Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . 23 Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
3 PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS AVALON PROPERTIES, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) (Dollars in thousands, except per share data)
ASSETS 9-30-97 12-31-96 ------------- ------------- Real estate Land $ 206,279 $ 169,079 Buildings and improvements 954,261 754,545 Furniture, fixtures and equipment 32,918 27,455 ------------- ------------- 1,193,458 951,079 Less: accumulated depreciation (63,325) (44,547) ------------- ------------- 1,130,133 906,532 Construction in progress (including land) 89,347 130,827 ------------- ------------- TOTAL REAL ESTATE, NET 1,219,480 1,037,359 Cash and cash equivalents 3,373 14,241 Cash in escrow 20,509 3,945 Resident security deposits 8,063 5,995 Investments in joint ventures 3,327 2,573 Deferred financing, net 7,421 7,702 Deferred development costs 9,611 5,179 Prepaid expenses and other assets 11,253 5,777 ------------- ------------- TOTAL ASSETS $ 1,283,037 $ 1,082,771 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY Unsecured Facilities $ 82,000 $ -- Unsecured senior notes, 7-3/8% due 2002, net of unamortized discount 99,886 99,869 Notes payable 197,897 210,737 Payables for construction 14,771 12,613 Accrued expenses and other liabilities 13,184 10,580 Accrued interest payable 3,201 4,342 Resident security deposits 9,303 6,642 ------------- ------------- TOTAL LIABILITIES 420,242 344,783 ------------- ------------- Minority interest of unitholders in consolidated operating partnership 700 -- Stockholders' equity Preferred Stock, $.01 par value; 20,000,000 shares authorized; 4,455,000 shares of 9% Series A Cumulative Redeemable Preferred Stock issued and outstanding (Aggregate liquidation preference of $111,375) 45 45 4,300,000 shares of 8.96% Series B Cumulative Redeemable Preferred Stock issued and outstanding (Aggregate liquidation preference of $107,500) 43 43 Common Stock, $.01 par value; 80,000,000 shares authorized; 38,453,315 and 33,391,992 shares issued and outstanding at September 30, 1997 and December 31, 1996, respectively 384 334 Additional paid-in capital 887,181 752,159 Deferred compensation (3,583) (1,699) Distributions in excess of accumulated earnings (21,975) (12,894) ------------- ------------- STOCKHOLDERS' EQUITY 862,095 737,988 ------------- ------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,283,037 $ 1,082,771 ============= =============
See accompanying notes to condensed consolidated financial statements. 1 4 AVALON PROPERTIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (Dollars in thousands, except per share data)
Three months ended Nine months ended ----------------------------- ------------------------------ 9-30-97 9-30-96 9-30-97 9-30-96 ----------- ---------- ----------- ---------- Revenue: Rental income $ 44,120 $ 32,364 $ 121,646 $ 89,286 Management fees 280 355 779 1,151 Other income 184 92 457 313 ----------- ---------- ----------- ---------- Total revenue 44,584 32,811 122,882 90,750 ----------- ---------- ----------- ---------- Expenses: Operating expenses 16,550 12,702 44,551 35,025 Interest expense 4,211 2,847 11,850 7,093 Depreciation and amortization 7,558 5,326 21,086 15,025 General and administrative expenses 1,416 902 3,375 2,597 ----------- ---------- ----------- ---------- Total expenses 29,735 21,777 80,862 59,740 ----------- ---------- ----------- ---------- Equity in income of joint ventures 1,799 282 4,145 598 Interest income 430 195 926 641 Minority interest 69 111 210 410 ----------- ---------- ----------- ---------- Income before gain on sale of community and extraordinary items 17,147 11,622 47,301 32,659 Gain on sale of community 677 -- 677 -- ----------- ---------- ----------- ---------- Income before extraordinary items 17,824 11,622 47,978 32,659 Extraordinary items -- (2,356) (1,183) (2,356) ----------- ---------- ----------- ---------- Net income 17,824 9,266 46,795 30,303 Dividends attributable to preferred stock (4,914) (2,468) (14,742) (6,070) ----------- ---------- ----------- ---------- Net income available to common stockholders $ 12,910 $ 6,798 $ 32,053 $ 24,233 =========== ========== =========== ========== Per common share (Note 2): Income before extraordinary items $ 0.34 $ 0.30 $ 0.93 $ 0.87 =========== ========== =========== ========== Net income per common share $ 0.34 $ 0.22 $ 0.89 $ 0.79 =========== ========== =========== ==========
See accompanying notes to condensed consolidated financial statements. 2 5 AVALON PROPERTIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Dollars in thousands)
Nine months ended ----------------------------- 9-30-97 9-30-96 ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 46,795 $ 30,303 Adjustments to reconcile net income to cash provided by operating activities: Depreciation and amortization 21,086 15,025 Equity in income of joint ventures (300) 370 Amortization of deferred compensation 722 280 Gain on the sale of community (677) -- Extraordinary items 1,183 2,356 Decrease in resident security deposits, net of related liability 593 60 Decrease in cash in escrow 191 246 Increase in prepaid expenses and other assets (9,908) (4,384) Increase in accrued expenses, other liabilities and accrued interest payable 1,678 3,182 ---------- ---------- Total adjustments 14,568 17,135 ---------- ---------- Net cash provided by operating activities 61,363 47,438 ---------- ---------- CASH FLOWS USED IN INVESTING ACTIVITIES: Investment in joint venture (454) (875) Increase in construction payables 2,158 4,321 Purchase and development of real estate (217,583) (230,762) ---------- ---------- Net cash used in investing activities (215,879) (227,316) ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of common stock, net 131,505 47,027 Issuance of preferred stock, net -- 107,581 Dividends paid (55,876) (38,912) Borrowings on notes payable 12,088 7,000 Repayments of notes payable (25,058) (7,127) Borrowings under Unsecured Facilities 340,000 216,500 Repayments of Unsecured Facilities (258,000) (138,500) Borrowings under construction loans -- 31 Repayments of construction loans -- (10,508) Payments of deferred financing costs (1,011) (2,053) ---------- ---------- Net cash provided by financing activities 143,648 181,039 ---------- ---------- Net (decrease) increase in cash (10,868) 1,161 Cash and cash equivalents, beginning of period 14,241 1,801 ---------- ---------- Cash and cash equivalents, end of period $ 3,373 $ 2,962 ========== ========== Cash paid during period for interest, net of amount capitalized $ 12,339 $ 7,541 ========== ==========
See accompanying notes to condensed consolidated financial statements. 3 6 AVALON PROPERTIES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Dollars in thousands, except per share data) 1. Organization of the Company and Recent Developments Avalon Properties, Inc. (the "Company") is a self-administered and self-managed Real Estate Investment Trust ("REIT"), as defined under the Internal Revenue Code of 1986 (as amended) and was incorporated under the General Corporation Law of Maryland on August 24, 1993. The Company is engaged principally in the development, construction, acquisition and operation of residential apartment communities in the Northeast and Mid-Atlantic regions of the United States. Additionally, the Company provides management services for communities owned by unrelated parties. On July 1, 1997, the Company completed a public offering of 2,163,000 shares of common stock at a gross sales price of $28.0625 per share. The net cash proceeds from the offering of approximately $57,671 were used primarily to repay amounts outstanding under the Company's unsecured credit facilities. On July 18, 1997, the Company sold a garden-style apartment community, Avalon Farm, located in Frederick, Maryland, to a single buyer for a total sales price of $17,047. The net proceeds from the sale of approximately $16,500 will be used for reinvestment in a new acquisition community. The Company recorded a gain of approximately $677 from the sale and structured the sale as a Section 1031 like-kind exchange under the Internal Revenue Code to defer the recognition of the taxable gain. On August 18, 1997, the Company purchased a 3.54 acre tract of land adjacent to an existing community, Avalon Fields, in Gaithersburg, Maryland for $1,400 for the purpose of expanding the existing community. Construction of a new 96 apartment home community, Avalon Fields II, has started and is expected to be completed in the fourth quarter of 1998. 2. Summary of Significant Accounting Policies Principles of Consolidation of the Company The accompanying condensed consolidated financial statements include the accounts of the Company, its wholly owned partnerships and subsidiaries and the operating partnership structured as a DownREIT. All significant intercompany balances and transactions have been eliminated in consolidation. Real Estate Buildings and improvements are recorded at cost and are depreciated on a straight-line basis over their estimated useful lives of 40 years. The Company's policy is to annually assess any impairment in value by making a comparison of the current and projected operating cash flows of each of its communities over its remaining useful life, on an undiscounted basis, to the carrying amount of each community. If such carrying amount is in excess of the estimated projected operating cash flow of the community, the Company would recognize an impairment loss, equivalent to an amount required to adjust the carrying amount to its estimated fair market value. The cost of buildings and improvements include capitalized interest, property taxes and insurance incurred during the construction period. Furniture and fixtures are stated at cost and depreciated over their estimated useful lives of seven years. Expenditures for maintenance and repairs 4 7 are charged to operations as incurred. Significant renovations or betterments that exceed $15 and extend the economic useful life of an asset are capitalized and depreciated over seven years. The Company's policy is not to actively market any of its communities for sale. In the event the Company decides to sell a community, it will be reclassified as "held for sale" when the Board of Directors approves the decision to sell. Deferred Financing and Development Costs Deferred financing costs include fees and costs incurred to obtain financings and are amortized on a straight-line basis over the shorter of the term of the loan or the related credit enhancement facility, if applicable. Fees and other incremental costs incurred in developing new communities are capitalized as deferred development costs and are included in the cost of the community when construction commences. The accompanying condensed consolidated financial statements include a charge to expense for unrecoverable deferred development costs related to pre-development communities that may not proceed to development. Net Income per Common Share Net income per common share for the three months ended September 30, 1997 and 1996 is based upon 38,453,694 and 30,726,468 weighted average shares of common stock outstanding, respectively. Net income per common share for the nine months ended September 30, 1997 and 1996 is based upon 35,889,375 and 30,563,292 weighted average shares of common stock outstanding, respectively. Interim Financial Statements These condensed consolidated financial statements are unaudited and were prepared pursuant to the rules and regulations of the Securities and Exchange Commission. However, in the opinion of the Company's management, all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of the financial statements have been included. The operating results for these periods are not necessarily indicative of the operating results that may be attained for a full fiscal year. The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996. Recently Issued Accounting Pronouncements During 1997, the Financial Accounting Standard Board issued Statements of Financial Accounting Standards No. 128 "Earnings Per Share" ("SFAS 128"), No. 129 "Disclosure of Information About Capital Structure" ("SFAS 129") and No. 130 "Reporting Comprehensive Income" ("SFAS 130"). SFAS 128 simplifies existing computational guidelines, revises disclosure requirements and increases the comparability of earnings per share data. This statement is effective for financial statements for periods ending after December 15, 1997 and requires restatement of all prior period earnings per share data presented. SFAS 129 establishes standards for disclosing information about an entity's capital structure such as information about securities, liquidation preference of preferred stock and redeemable stock. SFAS 130 specifies the presentation and disclosure requirement for reporting comprehensive income which includes those items which have been formerly reported as a component of shareholders' equity. The adoption of SFAS 128, SFAS 129 and SFAS 130 is not expected to have a material impact on the Company's financial condition or results of operations. 5 8 Stockholder's Equity Dividends on the Series A and Series B Cumulative Redeemable Preferred Stock are cumulative from the date of original issue and are payable quarterly on or about the fifteenth day of February, May, August and November of each year, at the annual rate of 9% and 8.96%, respectively, on the liquidation preference of $25 per share. The Series A Preferred Stock is not redeemable prior to February 15, 2001. On or after February 15, 2001, the Series A Preferred Stock may be redeemed for cash at the option of the Company in whole or in part, at a redemption price of $25 per share, plus all accrued and unpaid dividends, if any. The Series B Preferred Stock is not redeemable prior to October 15, 2001. On or after October 15, 2001, the Series B Preferred Stock may be redeemed for cash at the option of the Company in whole or in part, at a redemption price of $25 per share, plus all accrued and unpaid dividends, if any. Reclassifications Certain reclassifications have been made to amounts in prior year financial statements to conform with current year presentations. Specifically, overhead expense related to acquisitions previously classified as general and administrative is now included in operating expenses. 3. Senior Participating Mortgage Note The Company's ownership of the senior participating mortgage note related to the Town Arbor Partnership ("Avalon Arbor") has been accounted for as an investment in real estate. Minority interest represents the excess of the interest income at the pay rate on the mortgage loan over the cash flow from operations generated by the community. This excess is funded from payments drawn from an escrow account established from contributions by the minority partners. At September 30, 1997, the partnership had $2,903 of cash from these contributions available to fund interest payments. The note bears interest at 10.2%. Upon acquisition, the note was restructured to provide for a 9% pay rate. The difference between the stated interest and the pay rate is deferred interest and is added to the principal. The loan also provides for contingent interest of 50% of gross revenues, as defined, and is payable prior to any payments to the partners. No contingent interest has been paid through September 30, 1997. The note entitles the holder to a 50% net residual value of the property at maturity or upon prior disposition of the property. The note may be prepaid subject to stipulated penalties. 4. Unsecured Facilities The Company's unsecured credit facility (the "Unsecured Facility") is provided by a consortium of six banks that provides for $175,000 in short-term credit and is subject to an annual facility fee of $263. The Unsecured Facility expires on March 31, 2000. As of September 30, 1997, approximately $13,025 of available capacity was used to provide letters of credit and $42,000 was borrowed under the facility. Accordingly, the balance that remains available at September 30, 1997 to be drawn under the Unsecured Facility is $119,975. The Unsecured Facility bears interest based upon a LIBOR, Prime or CD rate election at the Company's option. The current pricing is LIBOR plus .80%, provided, however, that up to $75,000 can be competitively bid at lower pricing if market conditions allow. Pricing may be adjusted higher or lower depending on the Company's senior unsecured debt ratings. The Company's supplemental unsecured credit facility (the "Supplemental Unsecured Facility" and together with the Unsecured Facility, the "Unsecured Facilities") is provided by First Union National Bank in the amount of $50,000 and is subject to an annual facility fee of $75. The Supplemental Unsecured Facility expires on March 31, 2000 and bears a current interest rate of LIBOR plus .80%. At September 30, 1997, $2,542 of available capacity was used to provide letters of credit and $40,000 was 6 9 borrowed under the Supplemental Unsecured Facility. Accordingly, the balance that remains available at September 30, 1997 to be drawn under the Supplemental Unsecured Facility is $7,458. The weighted average effective interest rates (excluding the cost of facility fees and unused line of credit fees) on borrowings under the Unsecured Facilities for the nine months ended September 30, 1997 and 1996 were 6.4% and 7.0%, respectively. Including the cost of facility fees and unused fees, the weighted average effective interest rates on borrowings under the Unsecured Facilities for the nine months ended September 30, 1997 and 1996 were 7.0% and 7.6%, respectively. 5. Stockholders' Equity The following summarizes the changes in stockholders' equity for the nine months ended September 30, 1997:
Distributions Additional in excess of Preferred Common paid-in Deferred accumulated Stock Stock capital compensation earnings Total --------- -------- ---------- ------------ ------------- ---------- Stockholders' equity, 12-31-96 $ 88 $ 334 $752,159 $ (1,699) $ (12,894) $737,988 Net income -- -- -- -- 46,795 46,795 Dividends declared -- -- -- -- (55,876) (55,876) Issuance of Restricted Common Stock -- 1 3,566 -- -- 3,567 Deferred compensation, net of amortization -- -- -- (1,884) -- (1,884) Issuance of Common Stock -- 49 131,456 -- -- 131,505 --------- -------- ---------- ------------ ------------- ---------- Stockholders' equity, 9-30-97 $ 88 $ 384 $887,181 $ (3,583) $ (21,975) $862,095 ========= ======== ========== ============ ============= ==========
6. Investments in Joint Ventures At September 30, 1997 and December 31, 1996, investments in joint ventures consist of a 50% general partnership interest in Falkland Partners, a 49% equity interest in Avalon Run, an 86.5% effective equity interest in Town Close Associates (the New Canaan Development Right) and 100% of the operating income from the anticipated Avalon Grove joint venture. The following is a combined summary of the financial position of these joint ventures for the periods presented:
9-30-97 12-31-96 ---------- --------- Assets: Real estate, net $ 99,226 $92,835 Other assets 3,883 5,029 ---------- --------- Total assets $103,109 $97,864 ========== ========= Liabilities and partners' equity: Mortgage notes payable $ 26,000 $26,000 Other liabilities 2,879 3,786 Partners' equity 74,230 68,078 ---------- --------- Total liabilities and partners' equity $103,109 $97,864 ========== =========
At September 30, 1996, the investments in joint ventures include a 50% general partnership interest in Falkland Partners, a 49% equity interest in Avalon Run and an 86.5% effective equity interest in Town Close Associates. The following is a combined summary of the operating results of these joint ventures for the periods presented: 7 10
Three months ended Nine months ended ---------------------- ---------------------- 09-30-97 9-30-96 9-30-97 9-30-96 --------- --------- --------- --------- Rental income $ 4,505 $ 2,586 $11,794 $ 7,257 Other income 11 17 36 45 Operating expenses (1,384) (1,133) (3,793) (3,028) Mortgage interest expense (222) (215) (661) (639) Depreciation and amortization (735) (446) (1,991) (1,266) --------- --------- --------- --------- Net income $ 2,175 $ 809 $ 5,385 $ 2,369 ========= ========= ========= =========
7. Extraordinary Items In March 1997, the unamortized deferred financing costs associated with the early retirement of the Company's previous $165,000 unsecured credit facility were written off. In August 1996, the Company recorded a non-recurring charge to earnings for the recorded value of the unamortized deferred financing costs associated with the refinancing of tax-exempt bonds in conjunction with the completion of the new credit enhancement facility with the Federal National Mortgage Association. 8. Subsequent Events On October 1, 1997, the Company purchased Avalon Colchester (formerly 1470 Beacon Street), a 57 apartment home community in Brookline, Massachusetts for $4,500. This community is near an existing community, Longwood Towers, and the Company will combine the operations of these two communities. On October 8, 1997, the Company purchased interest rate protection in the form of a treasury lock from PaineWebber. The forward commitment of the lock agreement terminates on December 11, 1997. On October 30, 1997, the Company completed a refinancing of approximately $44,000 of tax-exempt bonds related to the Avalon Ridge and Avalon Lea communities. These bonds bear a variable interest rate, will mature on June 15, 2026 and are credit enhanced by the Company's credit enhancement facility with the Federal National Mortgage Association. In connection with this refinancing, the Company purchased an interest rate cap for $101. This cap terminates October 31, 2002 and serves to fix the interest rate on the bonds at 6.9%. 8 11 PART I FINANCIAL INFORMATION (CONTINUED) ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS Certain statements in this Form 10-Q constitute "forward-looking statements" as that term is defined under the Private Securities Litigation Reform Act of 1995 (the "Reform Act"). The words "believe," "expect," "anticipate," "intend," "estimate," "assume" and other similar expressions which are predictions of or indicate future events and trends and which do not relate solely to historical matters identify forward-looking statements. In addition, information concerning construction, occupancy and completion of Development Communities and Development Rights (as hereinafter defined) and related cost and EBITDA estimates, are forward-looking statements. Reliance should not be placed on forward-looking statements because they involve known and unknown risks, uncertainties and other factors, which are in some cases beyond the control of the Company and may cause the actual results, performance or achievements of the Company to differ materially from anticipated future results, performance or achievements expressed or implied by such forward-looking statements. Certain factors that might cause such differences include, but are not limited to, the following: The Company may abandon development opportunities; construction costs of a community may exceed original estimates; construction and lease-up may not be completed on schedule, resulting in increased debt service expense and construction costs and reduced rental revenues; occupancy rates and market rents may be adversely affected by local economic and market conditions which are beyond management's control; financing may not be available on favorable terms; the Company's cash flow may be insufficient to meet required payments of principal and interest; and existing indebtedness may not be able to be refinanced or the terms of such refinancing may not be as favorable as the terms of existing indebtedness. The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto included elsewhere herein. RECENT DEVELOPMENTS Acquisition of Existing Community. On October 1, 1997, the Company purchased Avalon Colchester (formerly 1470 Beacon Street), a 57 apartment home community, in Brookline, Massachusetts for $4,500,000. This community is near an existing community, Longwood Towers, and the Company will combine the operations of these two communities. Sale of Existing Community. On July, 18 1997, the Company sold a garden-style apartment community, Avalon Farm, located in Frederick, Maryland, to a single buyer for a total sales price of $17,047,000. The net proceeds of approximately $16,500,000 from the sale will be used for reinvestment in a new acquisition community. The Company recorded a gain of approximately $677,000 from the sale and structured the sale as a Section 1031 like-kind exchange under the Internal Revenue Code to defer the recognition of the taxable gain. Land Acquisitions for New Development. On August 18, 1997, the Company purchased a 3.54 acre tract of land adjacent to an existing community, Avalon Fields, in Gaithersburg, Maryland for $1,400,000 for the purpose of expanding the existing community. Construction of a new 96 apartment home community, Avalon Fields II, has started and is expected to be completed in the fourth quarter of 1998. Financing Activities. On July 1, 1997, the Company completed a public offering of 2,163,000 shares of common stock at a gross sales price of $28.0625 per share. The net cash proceeds from the offering of approximately $57,671,000 were used primarily to repay amounts outstanding under the Unsecured Facilities. On October 8, 1997, the Company purchased interest rate protection in the form of a treasury lock from PaineWebber. The forward commitment of the lock agreement terminates on December 11, 1997. On October 30, 1997, the Company completed a refinancing of approximately $44,000,000 of tax-exempt bonds related to the Avalon Ridge and Avalon Lea communities. These bonds bear a variable interest 9 12 rate, will mature on June 15, 2026 and are credit enhanced by the Company's credit enhancement facility with the Federal National Mortgage Association. In connection with this refinancing, the Company purchased an interest rate cap for $101,000. This cap terminates on October 31, 2002 and serves to fix the interest rate on the bonds at 6.9%. GENERAL The Company's operations consist of the development, construction, acquisition and operation of apartment communities in the Mid-Atlantic and Northeast regions of the United States. At September 30, 1997, the Company held a fee simple ownership in 47 completed and operating communities (one of which, Avalon at Center Place, is subject to a 149 year land lease), a general partnership interest in two other communities (a 50% interest in Falkland Chase and a 49% interest in Avalon Run), a 99% general partner interest in a partnership structured as a "DownREIT" (Avalon at Ballston - Vermont/Quincy) and a 100% interest in a senior participating mortgage note secured by another community (Avalon Arbor) which is accounted for as an investment in real estate. The Company also has a fee simple ownership interest in nine Development Communities. The Company's real estate holdings consist exclusively of apartment communities in various stages of the development cycle and can be divided into three categories: "Current Communities" are apartment communities where construction is complete and the community has either reached stabilized occupancy or is in the initial lease-up process. A "Stabilized Community" is a Current Community that has completed its initial lease-up and has attained a physical occupancy level of 94% or has been completed for one year, whichever occurs earlier. An "Established Community" is a Current Community that has been a Stabilized Community with stabilized operating costs during the current and the beginning of the previous calendar year such that its year-to-date operating results are comparable between periods. "Development Communities" are communities that are under construction and may be partially complete and operating and for which a final certificate of occupancy has not been received. "Development Rights" are development opportunities in the very earliest phase of the development process for which the Company has an option to acquire land or owns land to develop a new community and where related pre-development costs have been incurred and capitalized in pursuit of these new developments. RESULTS OF OPERATIONS The changes in operating results from period-to-period are primarily the result of increases in the number of apartment homes owned due to the development and acquisition of additional communities. Where appropriate, comparisons are made on a weighted average basis for the number of occupied apartment homes in order to adjust for such changes in the number of apartment homes. For Stabilized Communities (excluding communities owned by joint ventures), all occupied apartment homes are included in the calculation of weighted average occupied apartment homes for each reporting period. For communities in the initial lease-up phase, only apartment homes of communities that are completed and occupied are included in the weighted average number of occupied apartment homes calculation for each reporting period. The analysis that follows compares the operating results of the Company for the three and nine months ended September 30, 1997 and 1996. Net income increased $8,557,000 (92.3%) to $17,823,000 for the three months ended September 30, 1997 compared to $9,266,000 for the comparable period of the preceding year. Net income increased $16,492,000 (54.4%) to $46,795,000 for the nine months ended September 30, 1997 compared to $30,303,000 for the comparable period of the preceding year. The primary reason for these increases is additional operating income from communities developed or acquired during 1997 and 1996. Growth in operating income from 10 13 existing communities as well as the gain recognized from the sale of a community also contributed to these increases. Rental income increased $11,756,000 (36.3%) to $44,120,000 for the three months ended September 30, 1997 compared to $32,364,000 the comparable period of the preceding year. Rental income increased $32,360,000 (36.2%) to $121,646,000 for the nine months ended September 30, 1997 compared to $89,286,000 for the comparable period of the preceding year. Of the increase for the nine month period, $29,824,000 was due to newly completed or acquired communities and $2,536,000 was due to rental rate growth from Established Communities that were owned or completed during the period. Overall Portfolio - The increase in rental income for the three month and nine month period is primarily due to increases in the weighted average number of occupied apartment homes as well as an increase in the weighted average monthly rental income per occupied apartment home. For the three months ended September 30, 1997, the weighted average monthly revenue per occupied apartment home increased $63 (7.0%) to $963 compared to $900 for the comparable period of the preceding year. For the nine months ended September 30, 1997, the weighted average monthly revenue per occupied apartment home increased $66 (7.4%) to $956 compared to $890 for the comparable period of the preceding year. The weighted average number of occupied apartment homes increased from 10,930 apartment homes for the nine months ended September 30, 1996 to 12,265 apartment homes for the nine months ended September 30, 1997 as a result of the development and acquisition of new communities. Established Communities - For the three months ended September 30, 1997, the weighted average monthly revenue per occupied apartment home increased $33 (3.6%) to $943 compared to $910 for the comparable period of the preceding year. The average economic occupancy increased .4% to 96.5% in 1997 from 96.1% in 1996. For the nine months ended September 30, 1997, the weighted average monthly revenue per occupied apartment home increased $30 (3.4%) to $925 compared to $895 for the comparable period of the preceding year. The average economic occupancy increased by .1% to 96.2% in 1997 from 96.1% in 1996. Accordingly, rental revenue from Established Communities increased $989,000 (4.0%) and $2,536,000 (3.5%) for the three and nine month period ended September 30, 1997, respectively, compared to the comparable periods of the preceding year. Management fees decreased $75,000 (21.1%) to $280,000 for the three months ended September 30, 1997 compared to $355,000 for the comparable period of the preceding year. These fees decreased $372,000 (32.3%) to $779,000 for the nine months ended September 30, 1997 compared to $1,151,000 for the comparable period of the preceding year. These decreases are primarily due to a decline in the number of apartment homes managed for third-party owners during 1997. These declines are due to the sale and the cancellation of management contracts of some third-party communities in 1996 as well as the acquisition of one Current Community in the second quarter of 1996 and another Current Community in the second quarter of 1997 that were managed by the Company for third-party owners prior to their acquisitions. Operating expenses increased $3,848,000 (30.3%) to $16,550,000 for the three months ended September 30, 1997 compared to $12,702,000 for the comparable period of the preceding year. These expenses increased $9,526,000 (27.2%) to $44,551,000 for the nine months ended September 30, 1997 compared to $35,025,000 for the comparable period of the preceding year. Overall Portfolio - The $9,526,000 increase for the nine month period is primarily due to the acquisition of new communities, as well as the completion of Development Communities whereby maintenance, property taxes, insurance and other costs are expensed as communities move from the initial construction and lease-up phase to the stabilized operating phase. Established Communities - Operating expenses increased $311,000 (3.7%) to $8,756,000 for the three months ended September 30, 1997 compared to $8,445,000 for the comparable period of the preceding year. Operating expenses increased $384,000 (1.6%) to $24,877,000 for the nine 11 14 months ended September 30, 1997 compared to $24,493,000 for the comparable period of the preceding year. These increases were concentrated in the marketing, maintenance and insurance categories, offset by lower snow removal costs as a result of the mild weather conditions throughout the Northeast and Mid-Atlantic regions during the first quarter of 1997 as compared to the severe winter weather experienced during the first quarter of 1996. Interest expense increased $1,364,000 (47.9%) to $4,211,000 for the three months ended September 30, 1997 compared to $2,847,000 for the comparable period of the preceding year. Interest expense increased $4,757,000 (67.1%) to $11,850,000 for the nine months ended September 30, 1997 compared to $7,093,000 for the comparable period of the preceding year. These increases are primarily attributable to higher average outstanding balances under the Company's Unsecured Facilities (as hereinafter defined) in 1997 compared to 1996. In addition, the Company assumed approximately $29,900,000 of conventional debt resulting from the acquisitions of two communities in 1996 and completed the loan closings related to the tax-exempt financing for the Avalon West and Avalon Fields communities in December 1996 and April 1997, respectively. These increases were offset by lower interest and credit enhancement costs in connection with the completion of the tax-exempt, credit enhancement facility with the Federal National Mortgage Association ("Fannie Mae") in the third quarter of 1996 and lower pricing under the Unsecured Facilities. Depreciation and amortization increased $2,232,000 (41.9%) to $7,558,000 for the three months ended September 30, 1997 compared to $5,326,000 for the comparable period of the preceding year. Depreciation and amortization increased $6,061,000 (40.3%) to $21,086,000 for the nine months ended September 30, 1997 compared to $15,025,000 for the comparable period of the preceding year. These increases reflect additional depreciation expense for recently acquired and developed communities, offset by lower amortization expense of deferred financing costs due to the completion of the new credit enhancement facility with Fannie Mae. General and administrative expenses increased $514,000 (57.0%) to $1,416,000 for the three months ended September 30, 1997 compared to $902,000 for the comparable period of the preceding year. These expenses increased $778,000 (30.0%) to $3,375,000 for the nine months ended September 30, 1997 compared to $2,597,000 for the comparable period of the preceding year. These increases are primarily due to higher telecommunication costs and staff additions related to the implementation of the company-wide systems enhancement program, as well as higher compensation expense under the restricted stock grant program. General and administrative expenses as a percentage of total revenue, however, decreased .2% to 2.7% for the nine months ended September 30, 1997 compared to 2.9% for the comparable period of the preceding year. Equity in income of joint ventures increased $1,517,000 to $1,799,000 for the three months ended September 30, 1997 compared to $282,000 for the comparable period of the preceding year. This income increased $3,547,000 to $4,145,000 for the nine months ended September 30, 1997 compared to $598,000 for the comparable period of the preceding year. These increases are principally the result of the non-recurring income from the anticipated Avalon Grove joint venture in which the Company is allocated 100% of the income prior to the formation of the joint venture. Interest income increased $235,000 to $430,000 for the three months ended September 30, 1997 compared to $195,000 for the comparable period of the preceding year. Interest income increased $285,000 to $926,000 for the nine months ended September 30, 1997 compared to $641,000 for the comparable period of the preceding year. These increases are primarily due to higher average escrowed cash balances in 1997 compared to 1996 from the sale of Avalon Farm that was structured as a Section 1031 like-kind exchange under the Internal Revenue Code whereby the escrowed proceeds from the sale will be used for reinvestment in a new acquisition community. Extraordinary items totaled $1,183,000 for the nine months ended September 30, 1997 and reflects the write-off of unamortized deferred financing costs associated with the early retirement of the Company's previous $165,000,000 unsecured credit facility. 12 15 FUNDS FROM OPERATIONS Management generally considers Funds from Operations ("FFO") to be an appropriate measure of the operating performance of the Company because it provides investors an understanding of the ability of the Company to incur and service debt and to make capital expenditures. The Company believes that in order to facilitate a clear understanding of the operating results of the Company, FFO should be examined in conjunction with net income as presented in the condensed consolidated financial statements included elsewhere in this report. FFO is determined in accordance with a resolution adopted by the Board of Governors of the National Association of Real Estate Investment Trusts, Inc. ("NAREIT"), and is defined as net income (loss) (computed in accordance with generally accepted accounting principles ("GAAP")), excluding gains (or losses) from debt restructuring and sale of property, plus depreciation of real estate assets and after adjustments for unconsolidated partnerships and joint ventures. FFO does not represent cash generated from operating activities in accordance with GAAP and therefore should not be considered an alternative to net income as an indication of the Company's performance or to net cash flows from operating activities as determined by GAAP as a measure of liquidity and is not necessarily indicative of cash available to fund cash needs. Further, FFO as disclosed by other REITs may not be comparable to the Company's calculation of FFO. ANALYSIS OF FUNDS FROM OPERATIONS ($ in 000's)
Three months ended Nine months ended ----------------------------- ---------------------------- 9-30-97 9-30-96 9-30-97 9-30-96 ------------- ------------- ------------- ------------- NET INCOME $ 17,823 $ 9,266 $ 46,795 $ 30,303 Depreciation (real estate related) 7,130 4,783 19,818 13,247 Joint venture adjustment 108 81 278 240 Gain on sale of community (677) -- (677) -- Extraordinary items -- 2,356 1,183 2,356 Preferred stock dividends (4,914) (2,468) (14,742) (6,070) ------------- ------------- ------------- ------------- FUNDS FROM OPERATIONS $ 19,470 $ 14,018 $ 52,655 $ 40,076 ============= ============= ============= ============= CASH FLOW PROVIDED BY (USED IN): Operating activities $ 18,648 $ 16,133 $ 61,363 $ 47,438 Investing activities $ (42,123) $ (104,157) $ (215,879) $ (227,316) Financing activities $ 24,096 $ 88,873 $ 143,648 $ 181,039 WEIGHTED AVERAGE SHARES OUTSTANDING 38,453,694 30,726,468 35,889,375 30,563,292 ============= ============= ============= ============= OTHER CAPITALIZED EXPENDITURES AND OTHER INFORMATION Non-recurring capital expenditures: Community level- non-revenue generating (1) $ 441 $ 453 $ 1,721 $ 1,287 Corporate level (2) $ 185 $ 219 $ 658 $ 1,810 Loan principal amortization payments $ 304 $ 187 $ 946 $ 423 Capitalized deferred financing costs (3) $ 142 $ 1,594 $ 1,011 $ 2,053
- ------------------ Footnotes to Analysis of Funds from Operations (1) The Company expenses all recurring non-revenue generating community expenditures, including carpet and appliance replacements. See "Capitalization of Fixed Assets and Community Improvements." (2) Represents the cost of new office equipment and computer costs related to the implementation of a company-wide systems enhancement plan. (3) Substantially all of the deferred financing costs incurred for the nine months ended September 30, 1997 relate to the costs incurred on the closing of the Avalon Fields tax-exempt bonds, the closing of the new $175 million unsecured credit facility and the refinancing of tax-exempt bonds related to the Avalon Lea and Avalon Ridge Communities. 13 16 CAPITALIZATION OF FIXED ASSETS AND COMMUNITY IMPROVEMENTS The Company maintains a policy with respect to capital expenditures that generally provides that only non-recurring expenditures are capitalized. Improvements and upgrades are capitalized only if the item exceeds $15,000, extends the useful life of the asset and is not related to making an apartment home ready for the next resident. Under this policy, virtually all capitalized costs are non-recurring, as recurring make ready costs are expensed as incurred, including costs of carpet and appliance replacements, floor coverings, interior painting and other redecorating costs. Purchases of personal property (such as computers and furniture) are capitalized only if the item is a new addition (i.e., not a replacement) and only if the item exceeds $2,500. The application of these policies for the nine months ended September 30, 1997 resulted in non-revenue, generating capitalized expenditures for Stabilized Communities of approximately $1,721,000 or $128 per apartment home. For the nine months ended September 30, 1997, the Company charged to maintenance expense, including carpet and appliance replacements, a total of approximately $9,142,000 for Stabilized Communities or $682 per apartment home. Management anticipates that capitalized costs per apartment home will gradually rise as the Company's portfolio of communities matures. The table on the following page is a summary of expenditures for both recurring maintenance costs (expensed) and community upgrades (capitalized) for the nine months ended September 30, 1997. 14 17 EXPENDITURES FOR COMMUNITY AND CORPORATE UPGRADES (CAPITALIZED) AND COMMUNITY MAINTENANCE (EXPENSED) (Dollars in thousands, except per home data)
Number Balance at Balance at Community of Homes 12-31-96 (1) 9-30-97 (1) - ------------------------------------------------ ----------- --------------- ---------------- STABILIZED - ---------- Avalon Watch 512 $ 28,340 $ 28,423 Avalon Pavilions 932 56,523 56,619 Avalon Glen 238 30,077 30,177 Avalon Walk I 430 34,505 34,560 Avalon Walk II 334 23,597 23,719 Avalon View 288 17,773 17,812 Avalon Park 372 19,717 19,945 Avalon at Ballston - Washington Towers 344 36,797 36,887 Avalon at Gayton 328 9,830 9,931 Avalon at Hampton I 186 3,702 3,739 Avalon at Hampton II 231 8,144 8,196 Avalon at Dulles 236 11,599 11,678 Avalon Knoll 300 7,905 7,980 Avalon Lea 296 16,101 16,130 Avalon at Fairway Hills I 192 9,368 9,401 Avalon Ridge 432 25,030 25,184 Avalon at Symphony Glen 174 8,079 8,116 Avalon at Park Center 492 37,337 37,612 4100 Mass. Avenue 308 34,879 34,919 Avalon Woods 268 8,235 8,318 Avalon at Carter Lake 259 11,502 11,560 Avalon Pointe 140 7,748 7,832 Avalon Landing 158 9,261 9,302 Avalon Birches 312 13,419 13,458 Avalon at Lake Arbor 209 11,900 11,914 Avalon at Decoverly 368 30,978 31,108 Avalon Summit 245 16,152 16,287 Avalon Towers 109 15,826 15,895 Longwood Towers 307 16,620 16,623 Avalon Fields 192 14,262 14,298 Avalon West 120 10,624 10,810 Avalon Chase 360 23,615 23,636 Avalon Pines 174 8,578 8,592 Avalon at Fairway Hills II 527 33,807 33,840 Avalon at Boulders 284 16,038 16,064 AutumnWoods 420 30,474 30,593 Avalon Run East 206 16,002 16,000 Avalon Station 223 11,838 11,932 Avalon Cove 504 85,831 89,875 Avalon Crossing 132 13,387 13,771 Avalon Springs 102 13,628 15,799 Avalon at Ballston - Vermont/Quincy (2) 454 -- 46,707 Avalon at Center Place (2) 225 -- 26,411 Avalon at Providence Park (2) 140 -- 11,051 Avalon Gates 340 30,348 34,885 ----------- --------------- ---------------- 13,403 869,376 967,589 ----------- --------------- ---------------- NEW DEVELOPMENTS 3,118 130,212 241,567 - ---------------- OTHER - ----- Avalon at Lexington 198 14,117 14,325 Longwood Towers - Renovation -- 6,829 14,022 Avalon Green 105 12,294 12,424 Avalon Arbor (5) 302 27,822 28,296 Avalon Farm (6) -- 17,332 -- Corporate Level Expenditures -- 3,924 4,582 ----------- --------------- ---------------- Grand Total 17,126 (7) $ 1,081,906 $ 1,282,805 =========== =============== ================
YTD 1997 Capitalized Costs ------------------------------------------------------- Acquisitions, Non-Revenue YTD 1997 Construction Generating Capx Maintenance Expensed and Revenue ------------------------------ ------------------------------ Community Generating Costs Total Per Home Total Per Home - ------------------------------------------ ---------------------- -------------- ------------ -------------- ------------- STABILIZED - ---------- Avalon Watch $ -- $ 83 $ 162 $ 339 $ 662 Avalon Pavilions -- 96 103 421 452 Avalon Glen 7 93 391 204 857 Avalon Walk I 2 53 123 216 502 Avalon Walk II -- 122 365 176 527 Avalon View -- 39 135 300 1,042 Avalon Park 118 110 296 325 874 Avalon at Ballston - Washington Towers -- 90 262 263 765 Avalon at Gayton 32 69 210 245 747 Avalon at Hampton I 12 25 134 155 833 Avalon at Hampton II -- 52 225 168 727 Avalon at Dulles 46 33 140 220 932 Avalon Knoll 55 20 67 248 827 Avalon Lea -- 29 98 233 787 Avalon at Fairway Hills I -- 33 172 151 786 Avalon Ridge 89 65 150 340 787 Avalon at Symphony Glen 3 34 195 164 943 Avalon at Park Center 140 135 274 304 618 4100 Mass. Avenue 15 25 81 290 942 Avalon Woods -- 83 310 149 556 Avalon at Carter Lake -- 58 224 228 880 Avalon Pointe 35 49 350 119 850 Avalon Landing -- 41 259 170 1,076 Avalon Birches -- 39 125 165 529 Avalon at Lake Arbor -- 14 67 256 1,225 Avalon at Decoverly 109 21 57 202 549 Avalon Summit 128 7 29 167 682 Avalon Towers -- 69 633 173 1,587 Longwood Towers -- 3 10 290 945 Avalon Fields -- 36 188 116 604 Avalon West 173 13 108 78 650 Avalon Chase -- 21 58 294 817 Avalon Pines -- 14 80 80 460 Avalon at Fairway Hills II 17 16 30 345 655 Avalon at Boulders -- 26 92 197 694 AutumnWoods 114 5 12 241 574 Avalon Run East (2) -- -- 91 442 Avalon Station 94 -- -- 129 578 Avalon Cove 4,044 -- -- 191 379 Avalon Crossing 384 -- -- 87 659 Avalon Springs 2,171 -- -- 46 451 Avalon at Ballston - Vermont/Quincy (2) 46,707 -- -- 336 740 Avalon at Center Place (2) 26,411 -- -- 86 382 Avalon at Providence Park (2) 11,051 -- -- 63 450 Avalon Gates 4,537 -- -- 81 238 ---------------------- -------------- ------------ -------------- ------------- 96,492 1,721 128 9,142 682 ---------------------- -------------- ------------ -------------- ------------- NEW DEVELOPMENTS 111,355 -- -- 173 N/A - ---------------- OTHER - ----- Avalon at Lexington 208 (3) -- -- 165 833 Longwood Towers - Renovation 7,193 (4) -- -- -- -- Avalon Green 130 -- -- 146 1,390 Avalon Arbor (5) 474 -- N/A 273 904 Avalon Farm (6) (17,332) 36 118 140 458 Corporate Level Expenditures 658 -- N/A -- -- ---------------------- -------------- ------------ -------------- ------------- Grand Total $ 199,178 $ 1,757 N/A $ 10,039 N/A ====================== ============== ============ ============== =============
- -------------------- (1) Costs are presented in accordance with GAAP and exclude the step-up in basis attributed to continuing investors. (2) Acquired in 1997. (3) Payment of contingent land cost to land seller based on operating results. This is the complete and final contingent payment due under the land purchase agreement. (4) Represents renovation costs incurred. (5) Ownership through ownership of the Avalon Arbor mortgage note. See Note 3 to the unaudited condensed consolidated financial statements. Increases in capitalized value relate primarily to accrued interest and do not reflect capitalized community upgrades. (6) Community sold in July 1997. (7) Excludes Falkland Chase and Avalon Run, 876 apartment homes owned by joint ventures in which the Company holds a 50% interest and 49% interest, respectively. 15 18 LIQUIDITY AND CAPITAL RESOURCES Liquidity. A primary source of liquidity to the Company is cash flows from operations. Operating cash flows have historically been determined by the number of apartment homes, rental rates and the Company's expenses with respect to such apartment homes. Cash flows used in investing activities and provided by financing activities have historically been dependent on the number of apartment homes under development and construction or that were acquired during any given period. Cash and cash equivalents increased $411,000 from $2,962,000 at September 30, 1996 to $3,373,000 at September 30, 1997 due to an increase in operating cash flow and a decrease in investing activities, offset by a decrease in cash provided by investing activities. Net cash provided by operating activities increased by $13,925,000 from $47,438,000 at September 30, 1996 to $61,363,000 at September 30, 1997 primarily due to an increase in operating income from newly developed and acquired communities and Established Communities. Cash used in investing activities decreased by $11,437,000 from $227,316,000 at September 30, 1996 to $215,879,000 at September 30, 1997 primarily due to decreased costs related to the development and construction of apartment communities. Net cash provided by financing activities decreased by $37,391,000 from $181,039,000 at September 30, 1996 to $143,648,000 at September 30, 1997 primarily due to the repayment of the loan on the AutumnWoods community and an increase in dividends paid. The Company regularly reviews short-term liquidity needs and the adequacy of Funds from Operations and other expected liquidity sources to meet these needs. The Company's primary short-term liquidity needs are to fund normal recurring operating expenses, debt service payments and the minimum dividend payment required to maintain the Company's REIT qualification under the Internal Revenue Code. Management anticipates that these needs will be fully funded from cash flows provided by operating activities. Normal recurring expenditures for maintenance and repairs (including carpet and appliance replacements) are funded from the operating cash flows of Stabilized Communities and are expensed as incurred. Major upgrades or community improvements are capitalized and depreciated over the expected economic useful life of the item only if the expenditure exceeds $15,000 per occurrence and only if the expenditure extends the economic useful life of the community. Purchases of personal property (such as computers and furniture) are capitalized only if the item is a new addition (i.e., not a replacement) and only if the item exceeds $2,500. The application of these policies for the nine month period ended September 30, 1997 resulted in non-revenue, generating capitalized expenditures for Stabilized Communities of $128 per apartment home. The Company's $100,000,000 unsecured senior notes will mature in 2002. Since Management anticipates that no portion of the principal of such indebtedness will be repaid prior to maturity and the Company may not have funds on hand sufficient to repay such indebtedness, it will be necessary for the Company to refinance this debt. Such refinancing could be accomplished through additional debt financing, which may be collateralized by mortgages on individual communities or groups of communities, by uncollateralized private or public debt offerings or by additional equity offerings. There can be no assurance that such additional debt financing or debt offerings will be available on terms satisfactory to the Company. Currently, no other permanent indebtedness will require balloon payments prior to the year 2002. Capital Resources. To sustain the Company's active development and acquisitions program, continuous access to the capital markets is required. Management intends to match the long-term nature of its real estate assets with long-term cost effective capital. The Company has demonstrated regular and continuous access to the capital markets since its initial public offering, raising approximately $778.5 million and over $492 million in the last 22 months. Management follows a focused strategy to help facilitate uninterrupted access to capital. This strategy includes: 16 19 1. Hire, train and retain associates with a strong resident service focus, which should lead to higher rents, lower turnover and reduced operating costs; 2. Manage, acquire and develop institutional quality communities with in-fill locations that should provide consistent, sustained earnings growth; 3. Operate in markets with growing demand (as measured by household formation and job growth) and high barriers to entry. These characteristics combine to provide a favorable supply-demand balance, which the Company believes will create a favorable environment for future rental rate growth while protecting existing and new communities from new supply. This strategy is expected to result in a high level of quality to the revenue stream; 4. Maintain a conservative capital structure largely comprised of equity and with modest, cost-effective leverage. Secured debt will generally be avoided and used primarily to secure low cost, tax-exempt debt. Such a structure should promote an environment for ratings upgrades that can lead to a lower cost of capital; 5. Conservative accounting practices that provide a high level of quality to reported earnings; and 6. Timely, accurate and detailed disclosures to the investment community. Management believes that these strategies provide a disciplined approach to capital access that is expected to ensure that capital resources are available to fund future portfolio growth. The following is a discussion of specific capital transactions, arrangements and agreements that are important to the capital resources of the Company. Unsecured Facilities On March 31, 1997, the Company obtained a new unsecured credit facility (the "Unsecured Facility") for $175,000,000. This new facility replaced the previous $165,000,000 unsecured credit facility. The new Unsecured Facility is provided by a consortium of six banks and is subject to an annual facility fee of $262,500. The Unsecured Facility expires in March 2000. Borrowings under the new facility bear an interest rate of .80% over LIBOR. A competitive bid option is available for up to $75,000,000 which may result in lower pricing if market conditions allow. At September 30, 1997, $42,000,000 was borrowed, $13,025,000 was used to provide letters of credit and $119,975,000 was available for borrowing under the Unsecured Facility. The Company will use borrowings under the Unsecured Facility for capital expenditures, acquisitions of developed or undeveloped communities, construction, development and renovation costs, credit enhancement for tax-exempt bonds and for working capital purposes. The Company's supplemental unsecured credit facility (the "Supplemental Unsecured Facility" and together with the Unsecured Facility, the "Unsecured Facilities") is provided by First Union National Bank in the amount of $50,000,000 and is subject to an annual facility fee of $75,000. The Supplemental Unsecured Facility expires in March 2000 and bears an interest rate of LIBOR plus .80%. At September 30, 1997, $2,542,000 of available capacity was used to provide letters of credit and $40,000,000 was borrowed under the Supplemental Unsecured Facility. Accordingly, the balance that remains available at September 30, 1997 to be drawn under the Supplemental Unsecured Facility is $7,458,000. Interest Rate Protection Agreements On October 8, 1997, the Company purchased interest rate protection in the form of a treasury lock from PaineWebber. This agreement serves to hedge interest rate risk of the Company's planned corporate 10-year debt offering at an interest rate of 6.125% on a notional amount of $75,000,000. The forward commitment of the lock agreement terminates on December 11, 1997. In connection with the refinancing of the tax-exempt bonds related to the Avalon Lea and Avalon Ridge communities, the Company purchased an interest rate cap for $101. This cap terminates October 31, 2002 and serves to fix the interest rate on the bonds at 6.9% (see "Financing Transactions Completed" on the next page). 17 20 The Company is not a party to any long-term interest rate agreements, other than the interest rate protection agreements described above. The Company intends, however, to evaluate the need for long-term interest rate protection agreements as interest rate market conditions dictate and has engaged a consultant to assist in managing the Company's interest rate risks and exposure. Financing Transactions Completed On July 1, 1997, the Company completed a public offering of 2,163,000 shares of common stock at a gross sales price of $28.0625 per share. The net cash proceeds from the offering of approximately $57,671,000 were used primarily to repay amounts outstanding under the Unsecured Facilities. On October 30, 1997, the Company completed a refinancing of approximately $44,000,000 of tax-exempt bonds related to the Avalon Ridge and Avalon Lea communities. These bonds bear a variable interest rate, will mature on June 15, 2026 and are credit enhanced by the Company's credit enhancement facility with the Federal National Mortgage Association. Future Financing Needs Substantially all of the capital expenditures to complete the communities currently under construction will be funded from the Unsecured Facilities and/or issuance of debt or equity securities. Except for Longwood Towers, the Company has no present plans for any major capital improvements to any of the Current Communities. The renovation of Longwood Towers is being funded by advances under the Unsecured Facilities, operating cash flow or other financing sources over the next year. Management expects to continue to fund deferred development costs related to future developments from Funds from Operations and advances under the Unsecured Facilities. The Company believes that these sources of capital are adequate to take each of the proposed communities to the point in the development cycle where construction can commence. Management anticipates that available borrowing capacity under the Unsecured Facilities and Funds from Operations will be adequate to meet future expenditures required to commence construction of each of the Development Rights. In addition, the Company currently anticipates funding construction of some (but not all) of the Development Rights under the expected remaining capacity of the Unsecured Facilities. However, before the construction of a Development Right commences, the Company intends, as appropriate, to issue additional equity or debt securities, arrange additional capacity under the Unsecured Facilities or future credit facilities or obtain additional construction loan commitments not currently in place to ensure that adequate liquidity sources are in place to fund the construction of a Development Right, although no assurance can be given in this regard. The table on the following page summarizes debt maturities for the next five years (excluding the Unsecured Facilities): 18 21 AVALON PROPERTIES, INC. DEBT MATURITY SCHEDULE (Dollars in thousands)
Balance Outstanding at ------------------------ All-in Maturity Community Interest Rate Date 12-31-96 9-30-97 - ------------------------------------------------ ------------- -------- ---------- ---------- Tax-Exempt Bonds: Fixed Rate * Avalon Lea (Custodial Receipts) 5.71% Nov-07 $ 16,782 $ 16,830 * Avalon Ridge (Custodial Receipts) 5.69% Nov-07 26,724 26,806 * Avalon at Dulles 7.04% Jul-24 12,360 12,360 * Avalon at Hampton II 7.04% Jul-24 11,550 11,550 * Avalon at Symphony Glen 7.06% Jul-24 9,780 9,780 * Avalon View 7.55% Aug-24 19,487 19,365 * Avalon at Lexington 6.56% Feb-25 15,284 15,125 * Avalon Knoll 6.95% Jun-26 14,070 13,956 * Avalon Landing 6.85% Jun-26 6,969 6,912 * Avalon West 7.73% Dec-36 8,771 8,739 * Avalon Fields 7.57% May-27 -- 12,049 --------- --------- 141,777 153,472 Variable Rate * Avalon at Fairway Hills I Jun-26 11,500 11,500 * Avalon at Hampton I Jun-26 8,060 8,060 * Avalon Pointe Jun-26 6,387 6,387 --------- --------- 25,947 25,947 Conventional Loans: Fixed Rate * AutumnWoods (1) 9.25% Nov-97 24,335 -- Unsecured Senior Notes 7.375% Sep-02 99,869 99,886 * Avalon Pines 8.00% Dec-03 5,529 5,466 * Avalon Walk II 8.93% Nov-04 13,149 13,012 --------- --------- 142,882 118,364 Variable Rate-None -- -- --------- --------- Total notes payable - excluding Unsecured Facilities $ 310,606 $ 297,783 ========= ========= Total Maturities ---------------------------------------------------------- Balance Community of 1997 1998 1999 2000 2001 Thereafter - --------------------------------------------------- ------- ------ ------ ------ ------- ---------- Tax-Exempt Bonds: Fixed Rate * Avalon Lea (Custodial Receipts) $ -- $ -- $ -- $ -- $ -- $ 16,830 * Avalon Ridge (Custodial Receipts) -- -- -- -- -- 26,806 * Avalon at Dulles -- -- -- -- -- 12,360 * Avalon at Hampton II -- -- -- -- -- 11,550 * Avalon at Symphony Glen -- -- -- -- -- 9,780 * Avalon View 51 230 290 330 350 18,114 * Avalon at Lexington 54 226 240 255 271 14,079 * Avalon Knoll 38 163 175 187 200 13,193 * Avalon Landing 20 83 89 95 101 6,524 * Avalon West 11 46 50 53 57 8,522 * Avalon Fields 40 127 137 147 157 11,441 ------ ------ ------ ------ ------- --------- 214 875 981 1,067 1,136 149,199 Variable Rate * Avalon at Fairway Hills I -- -- -- -- -- 11,500 * Avalon at Hampton I -- -- -- -- -- 8,060 * Avalon Pointe -- -- -- -- -- 6,387 ------ ------ ------ ------ ------- --------- -- -- -- -- -- 25,947 Conventional Loans: Fixed Rate * AutumnWoods (1) -- -- -- -- -- -- Unsecured Senior Notes -- -- -- -- -- 99,886 * Avalon Pines 32 103 112 121 131 4,967 * Avalon Walk II 48 202 221 241 264 12,036 ------ ------ ------ ------ ------- --------- 80 305 333 362 395 116,889 Variable Rate-None -- -- -- -- -- -- ------ ------ ------ ------ ------- --------- Total notes payable - excluding Unsecured Facilities $ 294 $1,180 $1,314 $1,429 $ 1,531 $ 292,035 ====== ====== ====== ====== ======= =========
(1) Note repaid in August 1997. * Indicates loan is collateralized by the community. 19 22 BUSINESS CONDITIONS; INFLATION The Company's principal markets are characterized by high barriers to entry and restrictive zoning and it often takes years to obtain entitlements to build an apartment community. For this reason, little new rental product has been added in recent years. For the markets north of Maryland, Management is not aware of any significant level of planned apartment construction starts. For the Washington, D.C. metropolitan area, permitting activity has increased, with 8,000 apartment homes in planning for delivery over the next 36-month period. Estimated absorption during this period totals 9,000 apartment homes, which would create a supply-demand balance that would be slightly favorable for owners of multifamily apartment communities. At September 30, 1997, Management had positioned the Company's portfolio of Established Communities, excluding communities owned by joint ventures, to a physical occupancy level of 97.3% and achieved an average economic occupancy of 96.2% for the nine months ended September 30, 1997. Average economic occupancy for the Established Communities for the nine months ended September 30, 1996 was 96.1%. This continued high occupancy was achieved through aggressive marketing efforts combined with limited and targeted pricing adjustments. This positioning has resulted in overall growth in rental revenue from Established Communities between periods. It is Management's strategy to maximize total rental revenue through management of rental rates and occupancy levels. If market and economic conditions change, Management may adopt a strategy of maximizing rental rates, which could lead to lower occupancy levels, if Management believes that this strategy will maximize rental revenue. Given the currently high occupancy level of the portfolio, Management anticipates that, for the foreseeable future, any rental revenue and net income gains from currently owned and Established Communities would be achieved primarily through higher rental rates and enhanced operating cost leverage provided by high occupancy, rather than through continued occupancy gains. Substantially all of the leases at the Current Communities are for a term of one year or less, which may enable the Company to realize increased rents upon renewal of existing leases or commencement of new leases. Such short-term leases generally minimize the risk to the Company of the adverse effects of inflation, although as a general rule these leases permit residents to leave at the end of the lease term without penalty. The Company's current policy is to permit residents to terminate leases upon 60-days written notice and payment of one month's rent as compensation for early termination. Short-term leases combined with relatively consistent demand allow rents, and therefore cash flow from the Company's portfolio of apartments, to provide an attractive inflation hedge. DEVELOPMENT COMMUNITIES At September 30, 1997, nine Development Communities were under construction. The total capitalized cost of these Development Communities, when completed, is currently expected to be approximately $295.6 million. There can be no assurance that the Company will complete the Development Communities, that the Company's budgeted costs, leasing, start dates, completion dates, occupancy or estimates of "EBITDA as % of Total Budgeted Cost" will be realized or that future developments will realize comparable returns. In accordance with GAAP, the Company capitalizes interest expense during construction until each building obtains a certificate of occupancy, thereafter, interest for each completed building is expensed. Capitalized interest for the three months ended September 30, 1997 and 1996 totaled $2,076,000 and $3,280,000, respectively. Capitalized interest for the nine months ended September 30, 1997 and 1996 totaled $7,092,000 and $9,690,000, respectively. The following page presents a summary of Development Communities: 20 23 DEVELOPMENT COMMUNITIES SUMMARY
NUMBER OF BUDGETED ESTIMATED ESTIMATED EBITDA AS % APARTMENT COST CONSTRUCTION INITIAL COMPLETION STABILIZATION OF TOTAL HOMES ($ MILLIONS) START OCCUPANCY DATE DATE (1) BUDGETED COST (2) ---------- ------------- -------------- ------------ ------------ --------------- ------------------- Conventionally Financed - ----------------------- Avalon Commons Smithtown, NY 312 $ 32.5 Q1 1996 Q1 1997 Q3 1997 Q4 1997 10.2% Avalon Crescent Tysons Corner, VA 558 57.3 Q1 1996 Q4 1996 Q4 1997 Q1 1998 10.9% Avalon Gardens Nanuet, NY 504 53.3 Q3 1996 Q2 1997 Q4 1998 Q1 1999 10.8% Avalon Court Melville, NY 154 17.8 Q4 1996 Q2 1997 Q4 1997 Q1 1998 10.9% Avalon at Fair Lakes Fairfax, VA 234 23.2 Q1 1997 Q4 1997 Q2 1998 Q4 1998 10.0% Avalon at Faxon Park Quincy, MA 171 15.8 Q1 1997 Q1 1998 Q3 1998 Q4 1998 11.0% Avalon Fields II Gaithersburg, MD 96 9.2 Q3 1997 Q3 1998 Q4 1998 Q1 1999 10.2% Avalon Willow Mamaroneck, NY 227 41.8 Q2 1997 Q3 1998 Q1 1999 Q2 1999 9.2% Avalon at Cameron Court Alexandria, VA 460 44.7 Q2 1997 Q1 1998 Q4 1998 Q1 1999 10.3% ---------- ------------- ------------------- 2,716 $ 295.6 10.4% ========== ============= ===================
------------ (1) Stabilized occupancy is defined as the first full quarter of 94% or greater occupancy. (2) Projected EBITDA represents gross potential earnings projected to be achieved based on current rents prevailing in the respective community's local market (without adjustment for potential growth factors) and before interest, income taxes, depreciation, amortization and extraordinary items, minus (a) economic vacancy and (b) projected stabilized operating expenses. Total budgeted cost includes all capitalized costs projected to be incurred to develop the respective Development Community, including land acquisition costs, construction costs, real estate taxes, capitalized interest and loan fees, permits, professional fees, allocated development overhead and other regulatory fees. 21 24 DEVELOPMENT RIGHTS The Company is currently considering the development of 20 new apartment communities. The status of these Development Rights range from land owned or under contract for which design and architectural planning has just commenced to land under contract or owned by the Company with completed site plans and drawings where construction can commence almost immediately. There can be no assurance that the Company will succeed in obtaining zoning and other necessary governmental approvals or the financing required to develop these communities, or that the Company will decide to develop any particular community. Further, there can be no assurance that construction of any particular community will be undertaken or, if undertaken, will begin at the expected times assumed in the financial projections or be completed at the total budgeted cost. Although there is no assurance that all or any of these communities will proceed to development, the successful completion of all of these communities would ultimately add approximately 5,628 institutional-quality apartment homes to the Company's portfolio. At September 30, 1997, the cumulative capitalized costs incurred in pursuit of the 20 Development Rights were approximately $16.1 million, including the capitalized cost of $6.6 million related to the purchase of land in New Canaan, Connecticut. Many of these apartment homes will offer features like those offered by the communities currently owned by the Company. The 20 Development Rights that the Company is currently pursuing are summarized below. DEVELOPMENT RIGHTS SUMMARY
TOTAL ESTIMATED BUDGETED NUMBER OF COST LOCATION HOMES ($ MILLIONS) ---------------------- ------------- ------------- 1. Freehold, NJ 452 $ 38.7 2. New Canaan, CT (1) 104 24.9 3. Greenburgh - II, NY 500 74.0 4. Greenburgh - III, NY 266 39.3 5. Darien, CT 172 22.3 6. Fort Lee, NJ 351 56.4 7. Peabody, MA 434 35.9 8. Hull, MA 162 15.0 9. Jersey City - II, NJ 269 50.8 10. New Rochelle, NY 408 62.7 11. Melville - II, NY 340 39.8 12. Wilmington, MA 204 19.5 13. Stamford, CT 190 29.6 14. Orange, CT 172 15.7 15. Ridgefield, CT 240 30.2 16. Bronxville, NY (1) 110 24.7 17. Parsippany, NJ 460 64.0 18. Danbury, CT 268 24.4 19. Yonkers, NY 256 33.7 20. Florham Park, NJ 270 37.5 ------------- ------------ Total 5,628 $ 739.1 ============= ============
(1) Currently anticipated that the land seller will retain a minority limited partnership interest. 22 25 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In March 1996, Procida Construction Corporation, the original contractor selected to build Avalon Cove, notified the Company that it was not able to complete the contract within the guaranteed maximum price and subsequently defaulted on its contractual obligations. In April 1996, the Company filed a demand for arbitration with the American Arbitration Association in New York against Procida Construction Corporation to recover any excess over the original guaranteed maximum price contract and instituted suit in the U.S. District Court to compel arbitration. Procida Construction has since filed Chapter 11 Bankruptcy. On October 21, 1997, the United States Bankruptcy court entered an order authorizing a settlement reached between Town Cove Jersey City Urban Renewal Inc. and the debtor, Procida Construction. Pursuant to the settlement Town Cove Jersey City Urban Renewal Inc. agreed to pay the Debtor $387,500.00 and the parties agreed to release one another from any and all claims arising from performance of the work on the project. The settlement was finalized on November 12, 1997. ITEM 2. CHANGES IN SECURITIES None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS None. ITEM 5. OTHER INFORMATION On July 1, 1997, the Company completed a public offering of 2,163,000 shares of common stock at a gross sales price of $28.0625 per share. The net cash proceeds from the offering of approximately $57,671,000 were used primarily to repay amounts outstanding under the Company's Unsecured Facilities. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a) Exhibit No. Description (1) 10.15 New Employment Agreement between the Company and Richard L. Michaux dated July 15, 1997 (1) 10.16 New Employment Agreement between the Company and Charles H. Berman dated July 16, 1997 (1) 27.1 Financial Data Schedule (1) Previously filed as an exhibit to the Company's Form 10-Q for the quarterly period ended September 30, 1997 filed on November 14, 1997. b) Reports on Form 8-K
On July 1, 1997, the Company filed a Current Report on Form 8-K relating to the public offering of 2,163,000 shares of common stock. 23 26 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. AVALON PROPERTIES, INC. Date: November 12, 1997 By /s/ RICHARD L. MICHAUX ------------------------------------------ Richard L. Michaux, Chairman of the Board, Chief Executive Officer and Director (Principal Executive Officer) Date: November 12, 1997 By /s/ THOMAS J. SARGEANT ------------------------------------------ Thomas J. Sargeant, Chief Financial Officer, Treasurer and Secretary (Principal Financial and Accounting Officer) 24 -----END PRIVACY-ENHANCED MESSAGE-----