-----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, CZ6KJjLgs+Ud0sMF1xaYa7E9At3CGWTAILI4/FNxiozIdvpEUmIDqW4EQj1cZKnp MOa4spkccU1VRdjOVRQ7/A== 0000950133-96-002464.txt : 19961113 0000950133-96-002464.hdr.sgml : 19961113 ACCESSION NUMBER: 0000950133-96-002464 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19960930 FILED AS OF DATE: 19961112 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 SEC ACT: 1934 Act SEC FILE NUMBER: 001-12452 FILM NUMBER: 96659960 BUSINESS ADDRESS: STREET 1: 15 RIVER ROAD STREET 2: SUITE 210 CITY: WILTON STATE: CT ZIP: 06897 BUSINESS PHONE: 2039724000 MAIL ADDRESS: STREET 1: 15 RIVER ROAD STREET 2: SUITE 210 CITY: WILTON STATE: CT ZIP: 06897 10-Q 1 AVALON PROPERTIES FORM 10-Q. 1 ================================================================================ 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 quarterly period ended September 30, 1996 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: 30,735,694 shares outstanding as of November 1, 1996. ================================================================================ 2 AVALON PROPERTIES, INC. INDEX -------
PART I FINANCIAL INFORMATION Item 1 Financial Statements Page ---- Condensed Consolidated Balance Sheets as of September 30, 1996 and December 31, 1995................................................................1 Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 1996 and 1995........................................2 Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 1996 and 1995....................................................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...................................................................24 Item 2 Changes in Securities...............................................................24 Item 3 Defaults upon Senior Securities.....................................................24 Item 4 Submission of Matters to a Vote of Stockholders.....................................24 Item 5 Other Information...................................................................24 Item 6 Exhibits and Reports on Form 8-K....................................................24 Signature...........................................................................25
3 PART I FINANCIAL INFORMATION ITEM 1 FINANCIAL STATEMENTS AVALON PROPERTIES, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited) (Dollars in thousands, except share data)
ASSETS 9-30-96 12-31-95 --------------- ------------- Real estate (Notes 1, 2, 3 and 8) Land $ 158,756 $ 128,754 Buildings and improvements 691,771 521,082 Furniture, fixtures and equipment 26,140 19,369 --------------- ------------- 876,667 669,205 Less: accumulated depreciation (40,685) (27,059) --------------- ------------- 835,982 642,146 Construction in progress (including land) 141,908 113,228 --------------- ------------- TOTAL REAL ESTATE, NET 977,890 755,374 Cash and cash equivalents 2,962 1,801 Cash in escrow 3,694 3,940 Resident security deposits 5,743 4,193 Investments in joint ventures (Note 6) 2,240 1,735 Deferred financing and other costs, net (Notes 2 & 7) 9,109 9,959 Deferred development costs, prepaid expenses and other assets (Note 2) 13,368 9,709 --------------- ------------- TOTAL ASSETS $ 1,015,006 $ 786,711 =============== ============= LIABILITIES AND STOCKHOLDERS' EQUITY Unsecured Facilities (Notes 1, 4 and 8) $ 136,000 $ 58,000 Construction loans -- 10,477 Tax-exempt custodial receipts, net of unamortized discount 43,463 43,333 Unsecured senior notes, 7-3/8% due 2002, net of unamortized discount 99,864 99,846 Mortgage notes payable (Note 1) 134,336 114,900 Unsecured tax-exempt bonds (Note 1) -- 14,130 Payables for construction 14,031 9,710 Accrued expenses and other liabilities 16,402 11,522 Accrued interest payable 2,985 4,477 Resident security deposits 6,529 4,919 --------------- ------------- TOTAL LIABILITIES 453,610 371,314 --------------- ------------- 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 at September 30, 1996 (Note 8) 45 -- Common stock, $.01 par value; 80,000,000 shares authorized; 30,732,361 and 28,373,065 shares issued and outstanding at September 30, 1996 and December 31, 1995, respectively 307 284 Additional paid-in capital 580,486 425,946 Distributions in excess of accumulated earnings (19,442) (10,833) --------------- ------------- STOCKHOLDERS' EQUITY 561,396 415,397 --------------- ------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,015,006 $ 786,711 =============== =============
See accompanying notes to condensed consolidated financial statements. 1 4 AVALON PROPERTIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (Dollars in thousands, except share data)
Three months ended Nine months ended -------------------------------- -------------------------------- 9-30-96 9-30-95 9-30-96 9-30-95 -------------- -------------- -------------- -------------- Revenue: Rental income $ 32,364 $ 24,591 $ 89,286 $ 68,545 Management fees 355 490 1,151 1,485 Other income 92 106 313 332 -------------- -------------- -------------- -------------- Total revenue 32,811 25,187 90,750 70,362 -------------- -------------- -------------- -------------- Expenses: Operating expenses 12,608 9,312 34,776 25,891 Interest expense 2,847 3,065 7,093 7,398 Depreciation and amortization 5,326 4,176 15,025 11,969 General and administrative expenses 996 923 2,846 2,507 -------------- -------------- -------------- -------------- Total expenses 21,777 17,476 59,740 47,765 -------------- -------------- -------------- -------------- Equity in income of joint ventures (Note 6) 282 125 598 309 Interest income 195 247 641 736 Minority interest income (Note 3) 111 143 410 481 -------------- -------------- -------------- -------------- Net income before extraordinary item 11,622 8,226 32,659 24,123 Extraordinary item (Note 7) (2,356) -- (2,356) -- -------------- -------------- -------------- -------------- Net income 9,266 8,226 30,303 24,123 Dividends attributable to preferred stock (2,468) -- (6,070) -- -------------- -------------- -------------- -------------- Net income available to common stockholders $ 6,798 $ 8,226 $ 24,233 $ 24,123 ============== ============== ============== ============== Net income per weighted average common share outstanding (Note 2) $ 0.22 $ 0.29 $ 0.79 $ 0.85 ============== ============== ============== ==============
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 -------------------------------------- 9-30-96 9-30-95 --------------- -------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 30,303 $ 24,123 Adjustments to reconcile net income to cash provided by operating activities: Depreciation and amortization Extraordinary item 15,025 11,969 Decrease in resident security deposits, net of related liability 2,356 -- Decrease in cash in escrow 60 818 Increase in prepaid expenses and other assets 246 204 Increase in accrued expenses, other liabilities and accrued interest payable (4,609) (2,392) Total adjustments 3,182 4,292 --------------- -------------- Net cash provided by operating activities 16,260 14,891 --------------- -------------- 46,563 39,014 --------------- -------------- CASH FLOWS USED IN INVESTING ACTIVITIES: Increase in construction payables 4,321 7,148 Purchase and development of real estate (230,762) (158,809) --------------- -------------- Net cash used in investing activities (226,441) (151,661) --------------- -------------- CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of common stock, net 47,027 329 Issuance of preferred stock, net 107,581 -- Dividends paid (38,912) (30,915) Borrowings under notes 7,000 150,125 Repayments of notes (7,127) (1,673) Borrowings under Unsecured Facilities 216,500 193,625 Repayments of Unsecured Facilities (138,500) (192,395) Borrowings under construction loans 31 3,615 Repayments of construction loans (10,508) (5,172) Payments of deferred financing costs (2,053) (5,579) --------------- -------------- Net cash provided by financing activities 181,039 111,960 --------------- -------------- Net increase (decrease) in cash 1,161 (687) Cash and cash equivalents, beginning of period 1,801 2,862 --------------- -------------- Cash and cash equivalents, end of period $ 2,962 $ 2,175 =============== ============== Cash paid during period for interest, net of amount capitalized $ 7,541 $ 5,331 =============== ==============
Non-cash investing and financing activities: $5,581 of debt was assumed in connection with the Avalon Pines acquisition in May 1996. See accompanying notes to condensed consolidated financial statements. 3 6 AVALON PROPERTIES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Dollars in thousands, except 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 3, 1996, the Company purchased a 47.4 acre tract of land in Nanuet, New York for $7,000. A new 504 apartment home community commenced construction in the third quarter of 1996. On July 23, 1996, the Company purchased Avalon at Fairway Hills II, two luxury garden-style communities (formerly Greenbriar and Fairway Pointe) located in Columbia, Maryland for $32,430. These communities contain a total of 527 apartment homes and, along with another Company-owned community, Avalon Meadows (renamed Avalon at Fairway Hills I), will be operated as two phases of one community. On August 1, 1996, the Company completed a new tax-exempt credit enhancement facility with the Federal National Mortgage Association ("Fannie Mae") that will provide a long-term, cost-effective credit enhancement source for the Company's current and future tax-exempt bond communities. In connection with this facility, the Company completed a refinancing of approximately $91,000. The facility involves eleven communities, seven that are financed with tax-exempt bonds and four previously unencumbered communities that are pledged as additional collateral. On September 25, 1996, the Company purchased Avalon at The Boulders (formerly Boulder Springs) in Richmond, Virginia for $14,831. This luxury garden-style community contains a total of 284 apartment homes. In September 1996, pricing on the Company's unsecured credit facilities ("Unsecured Facilities") was reduced. The consortium of banks providing the Company's $165,000 unsecured credit facility lowered the interest rate charged under the facility to LIBOR plus 1.19% from LIBOR plus 1.44%. After a ratings upgrade from Moody's Investors Service in October 1996, the interest rate was further reduced to LIBOR plus 1.125%. Pricing under the $35,000 unsecured credit facility provided by First Union National Bank was reduced to LIBOR plus .95% from LIBOR plus 1.25%. 2. Summary of Significant Accounting Policies Principles of Consolidation of the Company The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly-owned partnerships and subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. 4 7 Real Estate Buildings and improvements are recorded at cost and are depreciated on a straight-line basis over their estimated useful lives of 40 and 7 years, respectively. 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. Such carrying amounts would be adjusted, if necessary, to reflect an impairment in the value of the assets. 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 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. 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 nine months ended September 30, 1996 and 1995 is based upon 30,563,292 and 28,362,921 weighted average number of shares of common stock outstanding, respectively. Net income per common share for the three months ended September 30, 1996 and 1995 is based upon 30,726,488 and 28,372,588 weighted average number of 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 year ended December 31, 1995. 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 note 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, 1996, the partnership had $3,229 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, 1996. The note entitles the holder 5 8 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 three-year revolving credit facility (the "Unsecured Facility") is provided by a consortium of nine banks ("Bank Group"), led by JP Morgan and Fleet Bank that provides for $165,000 in short-term credit. The Unsecured Facility expires in April 1998. As of September 30, 1996, approximately $8,427 of available capacity was used to provide letters of credit and $105,500 was borrowed under the facility. Accordingly, the balance that remains available at September 30, 1996 to be drawn under the Unsecured Facility is $51,073. The Unsecured Facility bears interest based upon a LIBOR, Prime or CD rate election at the Company's option. Current pricing level is LIBOR plus 1.125%. In January 1996, the Company arranged the two-year supplemental unsecured facility provided by First Union National Bank (the "Supplemental Unsecured Facility") in the amount of $35,000. The Supplemental Unsecured Facility expires in January 1998 and bears a current interest rate of LIBOR plus .95%. At September 30, 1996, $4,030 of available capacity was used to provide letters of credit and $30,500 was borrowed under the Supplemental Unsecured Facility. Accordingly, the balance that remains available at September 30, 1996 to be drawn under the Supplemental Unsecured Facility is $470. The weighted average effective interest rates (excluding the cost of unused fees) on borrowings under the Unsecured Facilities and prior year's Unsecured Facility for the three and nine months ended September 30, 1996 and 1995 were 6.8%, 7.6%, 7.0% and 8.1%, respectively. Including the cost of unused fees, the weighted average effective interest rates on borrowings under the Unsecured Facilities and prior year's Unsecured Facility for the three and nine months ended September 30, 1996 and 1995 were 7.1%, 7.8%, 7.6% and 8.2%, respectively. On May 30, 1995, the Company entered into an interest rate protection agreement in the form of an accreting swap agreement (the "Swap") with a triple A rated counterparty (the "Counterparty"). The Swap specifies that, commencing October 15, 1995, the Company shall pay the Counterparty a fixed rate of 5.89% on an initial principal amount that began at $8,000 and increases in varying amounts to a maximum of $45,000 in February 1997, at which time the agreement terminates. The principal amount in effect at September 30, 1996 is $40,000. In return, the Counterparty will pay to the Company a variable rate payment equal to 30-day LIBOR on the respective principal amounts. This Swap serves to fix the variable component of the Company's total interest rate at 5.89% on the principal amounts during the term of the agreement. Payments made by the Company under this agreement totaled $37 and $83 during the three and nine month period ended September 30, 1996, respectively. 5. Stockholders' Equity The following summarizes the changes in stockholders' equity for the nine months ended September 30, 1996:
Distributions Additional in excess of Preferred Common paid-in accumulated stock stock capital earnings Total ------------ ----------- -------------- ---------------- ------------- Stockholders' equity,12-31-95 $ -- $ 284 $ 425,946 $ (10,833) $ 415,397 Net income -- -- -- 30,303 30,303 Dividends declared -- -- -- (38,912) (38,912) Issuance of common stock -- 23 47,004 -- 47,027 Issuance of preferred stock 45 -- 107,536 -- 107,581 ------------ ----------- -------------- -------------- ------------- Stockholders' equity, 9-30-96 $ 45 $ 307 $ 580,486 $ (19,442) $ 561,396 ============ =========== ============== ============= =============
6 9 6. Investments in Joint Ventures At September 30, 1996, investments in joint ventures consisted 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 (Development Community). At December 31, 1995, investments in joint ventures also consisted of a 50% general partnership interest in Evergreen Hamden Joint Venture. On February 15, 1996, the Company assigned its 50% partnership interest in Evergreen Hamden Joint Venture to the institutional partner in the joint venture. The following is a combined summary of the financial position of these joint ventures for the periods presented:
9-30-96 12-31-95 ---------- ----------- Assets: Real estate, net $89,009 $60,821 Other assets 4,217 3,964 ---------- ----------- Total assets $93,226 $64,785 ========== =========== Liabilities and partners' equity: Mortgage notes payable $26,000 $34,786 Other liabilities 3,786 3,686 Partners' equity 63,440 26,313 ---------- ----------- Total liabilities and partners' equity $93,226 $64,785 ========== ===========
The following is a combined summary of the operating results of these joint ventures for the periods presented. At September 30, 1995, the investments in joint ventures also included a 50% general partnership interest in Evergreen Hamden Joint Venture:
Three months ended Nine months ended ----------------------------- ----------------------------- 9-30-96 9-30-95 9-30-96 9-30-95 ----------- ------------ ----------- ----------- Rental income $ 2,586 $ 2,299 $ 7,257 $ 6,685 Other income 17 18 45 52 Operating expenses (1,133) (897) (3,028) (2,538) Mortgage interest expense (215) (239) (639) (762) Depreciation and amortization (446) (427) (1,266) (1,278) ----------- ------------ ----------- ----------- Net income $ 809 $ 754 $ 2,369 $ 2,159 =========== ============ =========== ===========
7. Extraordinary Item 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 $91,000 of tax-exempt bonds in conjunction with the completion of the new credit enhancement facility with Fannie Mae. 8. Subsequent Events On October 2, 1996, the Company purchased a 10.8 acre tract of land in Melville, New York for $3,000. A new 154 apartment home community, Avalon Court, will start construction in the fourth quarter of 1996. On October 22, 1996, the Company completed an offering of 4,300,000 shares of 8.96% Series B cumulative redeemable preferred stock. The gross proceeds of the offering totaled $107,500. The net 7 10 cash proceeds from the sale (approximately $104,114) were used to retire indebtedness under the Company's Unsecured Facility. On November 1, 1996, the Company sold two existing communities, Avalon Brooke and Avalon Heights, located in Middletown (Hartford), Connecticut for $32,650. These communities contained a total of 518 apartment homes. In connection with this sale, the Company will recognize a non-recurring gain totaling approximately $8,000. Net proceeds from the sale (approximately $32,000) was used to reduce outstanding balances under the Unsecured Facilities. 8 11 PART I FINANCIAL INFORMATION (CONTINUED) ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto included elsewhere herein. This Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Although the Company believes that the expectations reflected in such forward-looking statements are based on reasonable assumptions, the Company's actual results could differ materially from those set forth in the forward-looking statements. Certain factors that might cause such a difference include, but are not limited to, the following: development opportunities may be abandoned; construction costs of a community may exceed original estimates; construction and lease-up of new communities may not be completed on schedule, resulting in increased interest expense and construction costs and reduced rental revenues; occupancy rates and rents may be adversely affected by local economic and market conditions; 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 the Company may not be able to refinance existing indebtedness or the terms of such refinancing may not be as favorable as the terms of existing indebtedness as well as other factors discussed periodically in the Company's reports filed with the Securities and Exchange Commission, including the reports on Form 10-Q for the quarters ended March 31, 1996 and June 30, 1996 and the Form 10-K for the year ended December 31, 1995. Those factors that might cause such a difference include those set forth under the "Recent Developments," "Liquidity and Capital Resources," "Business Conditions; Inflation" and "Development Communities" sections of this Item 2. RECENT DEVELOPMENTS Acquisitions or Dispositions of Existing Communities. On July 23, 1996, the Company purchased Avalon at Fairway Hills II, two luxury garden-style communities (formerly Greenbriar and Fairway Pointe) located in Columbia, Maryland for $32,430,000. These communities contain a total of 527 apartment homes and, along with Avalon at Fairway Hills I (a community currently owned by the Company), will be operated as two phases of one community. On September 25, 1996, the Company purchased Avalon at The Boulders (formerly Boulder Springs) in Richmond, Virginia for $14,831,000. This luxury garden-style community contains a total of 284 apartment homes. On November 1, 1996, the Company sold two existing communities, Avalon Brooke and Avalon Heights, located in Middletown (Hartford), Connecticut for $32,650,000. These communities contained a total of 518 apartment homes. In connection with this sale, the Company will recognize a non-recurring gain totaling approximately $8,000,000. Net proceeds from the sale (approximately $32,000,000) was used to reduce outstanding balances under the Company's revolving credit facilities ("Unsecured Facilities".) Land Acquisitions for New Development. On July 3, 1996, the Company purchased a 47.4 acre tract of land in Nanuet, New York for $7,000,000. A new 504 apartment home community commenced construction in the third quarter of 1996. On October 2, 1996, the Company purchased a 10.8 acre tract of land in Melville, New York for $3,000,000. Construction of a new 154 apartment home community, Avalon Court, will start in the fourth quarter of 1996. Financing Activities. On August 1, 1996, the Company completed a new tax-exempt credit enhancement facility with the Federal National Mortgage Association ("Fannie Mae") that will provide a long-term cost-effective credit enhancement source for the Company's current and future tax-exempt bond portfolio. In connection with this facility, the Company completed a refinancing of approximately $91,000,000 of its tax-exempt bond portfolio. The facility involves eleven communities, seven that are financed with tax-exempt bonds and four previously unencumbered communities that are pledged as additional collateral. In September 1996, pricing on the Company's Unsecured Facilities was reduced. The consortium of banks providing the Company's $165,000,000 unsecured credit facility ("Unsecured Facility") lowered the interest rate charged under the facility to LIBOR plus 1.19% from LIBOR plus 1.44%. After a ratings upgrade from Moody's Investor Service in October 1996 (see "Liquidity and Capital Resources"), the interest rate was reduced to LIBOR plus 1.125%. Pricing under the $35,000,000 supplemental unsecured credit facility 9 12 ("Supplemental Unsecured Facility") provided by First Union National Bank was reduced to LIBOR plus .95% from LIBOR plus 1.25%. On October 22, 1996, the Company completed an offering of 4,300,000 shares of 8.96% Series B cumulative redeemable preferred stock. The gross proceeds of the offering totaled $107,500,000. The net cash proceeds from the sale (approximately $104,114,000) were used to retire indebtedness under the Company's Unsecured Facility. 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, 1996, the Company owned 42 completed and operating communities, a general partnership interest in two other communities (a 50% interest in Falkland Chase and a 49% interest in Avalon Run) 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 eight Development Communities (as hereinafter defined). One of the eight Development Communities is subject to an agreement to form a joint venture. 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 95% 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 both the current year 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, 1996 and 1995. Net income before extraordinary item increased $8,536,000 (35.4%) to $32,659,000 from $24,123,000 for the nine months ended September 30, 1996 compared to the comparable period of the preceding year. Net 10 13 income increased $3,396,000 (41.3%) to $11,622,000 from $8,226,000 for the three months ended September 30, 1996 compared to the comparable period of the preceding year. The notable reasons for these increases are additional operating income from communities developed or acquired during 1995 and 1996 as well as growth in operating income from existing communities. Rental income increased $20,741,000 (30.3%) to $89,286,000 from $68,545,000 for the nine months ended September 30, 1996 compared to the comparable period of the preceding year. Rental income increased $7,773,000 (31.6%) to $32,364,000 from $24,591,000 for the three months ended September 30, 1996 compared to the comparable period of the preceding year. Of the increase for the nine month period, $17,902,000 was due to newly completed or acquired communities and $2,839,000 was due to rental rate growth from Established Communities that were owned or completed throughout both periods. Overall Portfolio - The $20,741,000 increase in rental income for the 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. The weighted average number of occupied apartment homes increased from 9,100 apartment homes for the nine months ended September 30, 1995 to 10,930 apartment homes for the nine months ended September 30, 1996 as a result of the development and acquisition of new communities. For the nine months ended September 30, 1996, the weighted average monthly revenue per occupied apartment home increased $54 (6.5%) to $890 from $836 compared to the comparable period of the preceding year. For the three months ended September 30, 1996, the weighted average monthly revenue per occupied apartment home increased $48 (5.6%) to $900 from $852 compared to the comparable period of the preceding year. Established Communities - For the nine months ended September 30, 1996, the weighted average monthly revenue per occupied apartment home increased $41 (4.9%) to $880 from $839 compared to the comparable period of the preceding year, and the average economic occupancy declined to 96.1% from 96.5%. For the three months ended September 30, 1996, the weighted average monthly revenue per occupied apartment home increased $42 (4.9%) to $895 from $853, and the average economic occupancy declined to 95.9% from 96.7%. Accordingly, rental revenue from Established Communities increased $2,839,000 (4.5%) and $892,000 (4.1%) for the nine month and three month periods ended September 30, 1996, respectively, compared to the comparable periods of the preceding year. When combined with other income from Established Communities, total revenue from Established Communities increased 4.5% and 4.1% for the nine month and three month periods ended September 30, 1996, respectively, compared to the comparable periods of the preceding year. Management fees decreased $334,000 (22.5%) to $1,151,000 from $1,485,000 for the nine months ended September 30, 1996 compared to the comparable period of the preceding year. These fees decreased $135,000 (27.6%) to $355,000 from $490,000 for the three months ended September 30, 1996 compared to 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 in 1996. This decline is due to the sale and cancellation of management contracts of some third-party communities in 1995 and 1996 as well as the acquisition of two Current Communities in the third quarter of 1995 and one Current Community in the second quarter of 1996 that were previously managed by the Company for third-party owners prior to their acquisition. The Company has decided not to aggressively pursue new fee management business at this time. New fee management business will be accepted in cases where it is profitable and where it presents a possible acquisition opportunity. This creates a very selective environment under which new fee management business will be added and will likely result in an overall decline in this revenue source in the future. Operating expenses, including write-off of deferred development costs, increased $8,885,000 (34.3%) to $34,776,000 from $25,891,000 for the nine months ended September 30, 1996 compared to the comparable period of the preceding year. These expenses increased $3,296,000 (35.4%) to $12,608,000 from $9,312,000 for the three months ended September 30, 1996 compared to the comparable period of the preceding year. 11 14 Overall Portfolio - The $8,885,000 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 operating phase. The increased costs of snow removal and other weather related expenses as a result of the severe winter weather during the first quarter of 1996 also contributed to the increase. Established Communities - Operating expenses increased $1,278,000 (6.0%) to $22,528,000 from $21,250,000 for the nine months ended September 30, 1996 compared to the comparable period of the preceding year. Operating expenses increased $303,000 (4.1%) to $7,678,000 from $7,375,000 for the three months ended September 30, 1996 compared to the comparable period of the preceding year. These increases were concentrated in the maintenance category partially due to the severe winter weather throughout the Northeast and Mid-Atlantic regions during the first quarter of 1996 as well as increases in the property taxes for newly stabilized development communities and marketing expenses. Interest expense decreased $305,000 (4.1%) to $7,093,000 from $7,398,000 for the nine months ended September 30, 1996 compared to the comparable period of the preceding year. Interest expense decreased $218,000 (7.1%) to $2,847,000 from $3,065,000 for the three months ended September 30, 1996 compared to the comparable period of the preceding year. These decreases are primarily attributable to the sale of 2,227,000 shares of the Company's common stock and the sale of 4,455,000 shares of the Company's preferred stock in the first quarter of 1996, as the net cash proceeds from the sales were used to retire indebtedness under the Company's Unsecured Facility, variable rate construction loans and to repay the mortgage note encumbering the Avalon at Carter Lake community. Lower short-term interest rates under the Unsecured Facilities due to structural rate reductions achieved as well as lower LIBOR rates also contributed to the declines. Finally, an increase in capitalized interest due to an increase in the number of apartment homes under construc- tion and lower interest and credit enhancement costs in connection with the completion of the tax-exempt, credit enhancement facility with Fannie Mae are other reasons for the overall declines. Depreciation and amortization increased $3,056,000 (25.5%) to $15,025,000 from $11,969,000 for the nine months ended September 30, 1996 compared to the comparable period of the preceding year. Depreciation and amortization increased $1,150,000 (27.5%) to $5,326,000 from $4,176,000 for the three months ended September 30, 1996 compared to the comparable period of the preceding year. These increases reflect additional depreciation expense for recently acquired and developed communities and the amortization of the costs related to the issuance of tax-exempt custodial receipts in May 1995 as well as the costs related to the closing of the Unsecured Facility and the issuance of $100,000,000 of unsecured senior notes in September 1995, offset by lower amortization expense due to the new Fannie Mae credit enhancement facility. General and administrative expenses increased $339,000 (13.5%) to $2,846,000 from $2,507,000 for the nine months ended September 30, 1996 compared to the comparable period of the preceding year. These expenses increased $73,000 (7.9%) to $996,000 from $923,000 for the three months ended September 30, 1996 compared to the comparable period of the preceding year. These increases are primarily due to the introduction of the amended and restated 1996 and 1995 Equity Incentive Plan (and related legal and proxy costs) as well as staff additions related to growth in the Company's portfolio and the implementation of the company-wide systems enhancement program. Equity in income of joint ventures increased $289,000 (93.5%) to $598,000 from $309,000 for the nine months ended September 30, 1996 compared to the comparable period of the preceding year. This income increased $157,000 to $282,000 from $125,000 for the three months ended September 30, 1996 compared to the comparable period of the preceding year. These increases are principally the result of increased net income from the Falkland Partners joint venture due to an increase in rental revenue as well as the income from the Town Close Associates joint venture that was formed in June 1995. Non-recurring income from the anticipated Avalon Grove joint venture in which the Company is allocated 100% of the lease-up period income also contributed to the increases. 12 15 Extraordinary item of $2,356,000 for the three and nine months ended September 30, 1996 reflects the write-off of the unamortized deferred financing costs associated with the refinancing of the $91,000,000 of tax-exempt bonds in conjunction with the completion of the new credit enhancement facility with Fannie Mae. FUNDS FROM OPERATIONS The Company's management ("Management") generally considers Funds from Operations ("FFO") to be an appropriate measure of the operating performance of the Company. Management believes that in order to facilitate a clear understanding of the operating results of the Company, Funds from Operations should be examined in conjunction with the net income as presented in the condensed consolidated financial statements included elsewhere in this report. Funds from Operations is determined in accordance with a resolution adopted by the Board of Governors of the National Association of Real Estate Investment Trusts, Inc. ("NAREIT"). NAREIT adopted a revised definition of FFO commencing with reporting periods ending after January 1, 1996 and is defined as net income (loss) (computed in accordance with generally accepted accounting principles), excluding gains (or losses) from debt restructuring and sales of property, plus depreciation of real estate and after adjustments for unconsolidated partnerships and joint ventures. The Company adopted the revised definition commencing January 1, 1996. The table on the following page presents an analysis of Funds from Operations under the revised and former definition for the periods presented: 13 16 ANALYSIS OF FUNDS FROM OPERATIONS ($ IN 000'S)
REVISED DEFINITION Three months ended Nine months ended -------------------------- -------------------------- 9-30-96 9-30-95 9-30-96 9-30-95 ------------ ------------ ------------ ------------ NET INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 6,798 $ 8,226 $ 24,233 $ 24,123 Depreciation: Community level 4,783 3,538 13,247 10,455 Corporate level (FF&E) -- -- -- -- Extraordinary item 2,356 -- 2,356 -- Amortization of deferred financing and other deferred costs -- -- -- -- Allocated share of joint venture depreciation 81 79 240 237 Allocated share of joint venture amortization -- -- -- -- ------------ ------------ ------------ ------------ FUNDS FROM OPERATIONS $ 14,018 $ 11,843 $ 40,076 $ 34,815 ============ ============ ============ ============ WEIGHTED AVERAGE SHARES OUTSTANDING 30,726,488 28,372,588 30,563,292 28,362,921 ============ ============ ============ ============ OTHER CAPITALIZED EXPENDITURES AND OTHER INFORMATION Capital expenditures: Community level (1) $ 453 $ 360 $ 1,287 $ 834 Corporate level (2) $ 219 $ 153 $ 1,810 $ 470 Loan principal amortization payments $ 187 $ 128 $ 423 $ 383 Capitalized deferred financing costs (3) $ 1,594 $ 3,024 $ 2,053 $ 5,579
FORMER DEFINITION Three months ended Nine months ended -------------------------- ------------------------------ 9-30-96 9-30-95 9-30-96 9-30-95 ------------ ------------ -------------- -------------- NET INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 6,798 $ 8,226 $ 24,233 $ 24,123 Depreciation: Community level 4,783 3,538 13,247 10,455 Corporate level (FF&E) 132 61 362 166 Extraordinary item 2,356 -- 2,356 -- Amortization of deferred financing and other deferred costs 411 577 1,416 1,348 Allocated share of joint venture depreciation 81 79 240 237 Allocated share of joint venture amortization 2 2 6 6 ------------ ------------ -------------- -------------- FUNDS FROM OPERATIONS $ 14,563 $ $12,483 $ 41,860 $ 36,335 ============ ============ ============== ============== WEIGHTED AVERAGE SHARES OUTSTANDING 30,726,488 28,372,588 30,563,292 28,362,921 ============ ============ ============== ============== OTHER CAPITALIZED EXPENDITURES AND OTHER INFORMATION Capital expenditures: Community level (1) $ 453 $ 360 $ 1,287 $ 834 Corporate level (2) $ 219 $ 153 $ 1,810 $ 470 Loan principal amortization payments $ 187 $ 128 $ 423 $ 383 Capitalized deferred financing costs (3) $ 1,594 $ 3,024 $ 2,053 $ 5,579
- ------------------ 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 leasehold improvements, 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, 1996 relate to the closing of the Supplemental Unsecured Facility and costs incurred related to the credit enhancement facility with Fannie Mae. 14 17 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. Community level 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 (computers, 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, 1996 resulted in capitalized expenditures for Stabilized Communities of approximately $128 per apartment home. For the nine months ended September 30, 1996, the Company charged to maintenance expense, including carpet and appliance replacements, a total of approximately $7,579,000 for Stabilized Communities or $752 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, 1996. 15 18 EXPENDITURES FOR COMMUNITY AND CORPORATE UPGRADES (CAPITALIZED) AND COMMUNITY MAINTENANCE (EXPENSED) (Dollars in thousands, except per home data)
YTD 1996 Capitalized Upgrades Number Balance at Balance at ------------------------------- Community of Homes 12-31-95 (1) 9-30-96 (1) Total Per Home - ---------------------------------- ----------- ------------- -------------- --------------- ------------ STABILIZED - ---------- Avalon Park 372 $ 19,635 $ 19,716 $ 81 $ 218 Avalon at Ballston 344 36,617 36,682 65 189 Avalon at Gayton 328 9,715 9,814 99 302 Avalon at Symphony Glen 174 8,034 8,066 32 184 Avalon at Hampton I 186 3,661 3,712 51 274 Avalon at Hampton II 231 8,093 8,125 32 139 Avalon at Dulles 236 11,540 11,599 59 250 Avalon Knoll 300 7,851 7,886 35 117 Avalon Lea 296 16,057 16,100 43 145 Avalon at Fairway Hills I 192 9,281 9,344 63 328 Avalon Ridge 432 24,874 25,023 149 345 Longwood Towers 250 16,600 16,617 17 68 Avalon Farm 306 17,270 17,306 36 118 Avalon Brooke 280 13,258 13,305 47 168 Avalon Glen 238 30,066 30,075 9 38 Avalon Pavilions 932 56,418 56,491 73 78 Avalon Heights 238 12,217 12,244 27 113 Avalon View 288 17,725 17,778 53 184 4100 Massachusetts Ave. 308 34,859 34,865 6 19 Avalon at Carter Lake 259 11,413 11,484 71 274 Avalon Pointe 140 7,731 7,748 17 121 Avalon Station 127 5,920 5,925 5 39 Avalon Woods 268 8,237 8,235 (2) (7) Avalon at Park Center 492 37,244 37,297 53 108 Avalon at Lexington 198 14,102 14,102 -- -- Avalon Watch 512 28,215 28,308 93 182 Avalon Walk I 430 34,417 34,445 28 65 Avalon Walk II 334 23,537 23,541 4 12 Avalon Landing 158 9,256 9,257 1 6 Avalon Birches 312 13,413 13,416 3 10 Avalon at Lake Arbor 209 11,895 11,899 4 19 Avalon at Decoverly 368 30,947 30,974 27 73 Avalon Summit West 125 6,764 6,764 -- -- Avalon Towers 109 15,820 15,823 3 28 Avalon Green 105 12,017 12,020 3 29 ----------- ------------- -------------- --------------- ------------ 10,077 624,699 625,986 1,287 128 ----------- ------------- -------------- --------------- ------------ NEWLY ACQUIRED/DEVELOPED - ------------------------ Avalon Fields 192 14,103 14,262 159 828 Avalon West 120 6,938 10,550 3,612 30,100 Avalon Station II 96 3,771 5,848 2,077 21,635 Avalon Summit East 120 6,351 9,274 2,923 24,358 Avalon Run East 206 4,421 15,238 10,817 52,510 Avalon Chase (2) 360 -- 23,611 23,611 65,586 Avalon Pines (2) 174 -- 8,577 8,577 49,293 Avalon at Fairway Hills II (2) 527 -- 33,735 33,735 64,013 Avalon at the Boulders (2) 284 -- 16,027 16,027 56,433 ----------- ------------- -------------- --------------- ------------ 2,079 35,584 137,122 101,538 48,840 ----------- ------------- -------------- --------------- ------------ NEW DEVELOPMENTS 2,854 91,990 220,711 128,721 45,102 - ---------------- OTHER - ----- Longwood Towers - Renovation -- 1,089 3,439 2,350 (5) 9,400 Avalon Arbor (3) 302 27,234 27,670 436 1,444 Corporate Level Expenditures -- 1,837 3,647 1,810 -- =========== ============= ============== =============== ============ Grand Total 15,312 (4) $ 782,433 $1,018,575 N/A N/A =========== ============= ============== =============== ============
YTD 1996 Maintenance Expensed ------------------------------ Community Total Per Home - ---------------------------------- -------------- ------------ STABILIZED - ---------- Avalon Park $ 296 $ 796 Avalon at Ballston 243 706 Avalon at Gayton 273 832 Avalon at Symphony Glen 151 868 Avalon at Hampton I 165 887 Avalon at Hampton II 166 719 Avalon at Dulles 223 945 Avalon Knoll 299 997 Avalon Lea 215 726 Avalon at Fairway Hills I 188 979 Avalon Ridge 277 641 Longwood Towers 343 1,372 Avalon Farm 237 775 Avalon Brooke 136 486 Avalon Glen 203 853 Avalon Pavilions 486 521 Avalon Heights 164 689 Avalon View 273 948 4100 Massachusetts Ave. 297 964 Avalon at Carter Lake 211 815 Avalon Pointe 135 964 Avalon Station 99 780 Avalon Woods 159 593 Avalon at Park Center 277 563 Avalon at Lexington 165 833 Avalon Watch 396 773 Avalon Walk I 180 419 Avalon Walk II 159 476 Avalon Landing 155 981 Avalon Birches 182 583 Avalon at Lake Arbor 215 1,029 Avalon at Decoverly 233 633 Avalon Summit West 90 720 Avalon Towers 154 1,413 Avalon Green 134 1,276 -------------- ------------ 7,579 752 -------------- ------------ NEWLY ACQUIRED/DEVELOPED - ------------------------ Avalon Fields 44 229 Avalon West 38 317 Avalon Station II 24 250 Avalon Summit East 62 517 Avalon Run East 24 117 Avalon Chase (2) 347 964 Avalon Pines (2) 48 276 Avalon at Fairway Hills II (2) 83 157 Avalon at the Boulders (2) -- -- -------------- ------------ 670 322 -------------- ------------ NEW DEVELOPMENTS 61 N/A - ---------------- OTHER - ----- Longwood Towers - Renovation -- -- Avalon Arbor (3) 225 745 Corporate Level Expenditures -- -- ============== ============ Grand Total $8,535 N/A ============== ============
(1)Costs are presented in accordance with generally accepted accounting principles ("GAAP") and exclude the step-up in basis attributed to continuing investors. (2)Acquired in 1996. (3)Ownership through ownership of the Avalon Arbor mortgage note. See Note 3 to the condensed consolidated financial statements. Increases in capitalized value relate primarily to accrued interest and do not reflect capitalized community upgrades. (4)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. (5)Represents renovation costs incurred. 16 19 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 active development and construction or that were acquired during any given period. Cash and cash equivalents increased from $2,175,000 at September 30, 1995 to $2,962,000 at September 30, 1996 due to the excess of cash provided by operating and financing activities over cash used by investing activities, primarily due to the completion of the common stock offering in January 1996 and the preferred stock offering in February 1996 as more fully described below: Net cash provided by operating activities increased by $7,549,000 from $39,014,000 to $46,563,000, primarily due to an increase in operating income from newly developed and acquired communities and Established Communities. Net cash used in investing activities increased by $74,780,000 from $151,661,000 to $226,441,000, primarily due to an increase in the number of apartment homes under development from an average of 1,969 in the first nine month period of 1995 to 2,767 in 1996. Net cash provided by financing activities increased by $69,079,000 from $111,960,000 to $181,039,000, primarily due to the excess net proceeds received from the completion of the sale of 2,227,000 shares of the Company's common stock and the sale of 4,455,000 shares of the Company's Series A cumulative redeemable preferred stock in 1996 and increased borrowings under the Unsecured Facilities, offset by 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 (computers, 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, 1996 resulted in capitalized expenditures for Established Communities of $128 per apartment home. Capital Resources. To sustain the Company's active development and acquisitions program, continuous access to the capital markets is required. Management understands the need 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 $553 million in seven offerings over a two-year period and over $400 million in the last year and a half. Management follows a focused strategy to help ensure uninterrupted access to capital. This strategy includes: 1. Hire, train and retain associates with a strong resident service focus, which leads to higher rents, lower turnover and reduced operation costs; 2. Manage, acquire and develop institutional quality communities with in-fill locations that can 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 demand-supply balance, creating a 17 20 favorable environment for future rental rate growth while protecting existing and new communities from new supply. This strategy results 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. Collateralized debt will generally be avoided and used primarily to obtain low cost, tax-exempt debt. Such a structure will promote an environment for ratings upgrades that can lead to a lower cost of capital; 5. Timely, accurate and detailed disclosures to the investment community; and 6. Conservative accounting practices that provide a high level of quality to reported earnings. Management believes that following these strategies provides a disciplined approach to capital access and will help ensure that capital resources are available to fund 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 and Investment Grade Ratings Upgrade The Company's Unsecured Facility is provided by a consortium of nine banks ("Bank Group") led by JP Morgan and Fleet Bank that provides for $165,000,000 in short-term credit. At September 30, 1996, $105,500,000 was borrowed, $8,427,000 was used to provide letters of credit and $51,073,000 was available for borrowing under the Unsecured Facility. In January 1996, the Company arranged the two-year Supplemental Unsecured Facility provided by First Union National Bank in the amount of $35,000,000. The Supplemental Unsecured Facility expires in January 1998 and bears a current interest rate of LIBOR plus .95%. At September 30, 1996, $4,030,000 of available capacity was used to provide letters of credit, and $30,500,000 was borrowed under the Supplemental Unsecured Facility. Accordingly, the balance that remains available at September 30, 1996 to be drawn under the Supplemental Unsecured Facility is $470,000. In September 1996, pricing on the Company's Unsecured Facilities was reduced. The consortium of banks providing the Company's $165,000,000 Unsecured Facility lowered the interest rate charged under the facility to LIBOR plus 1.19% from LIBOR plus 1.44%. Following a ratings upgrade from Moody's Investors Service (see below), the interest rate was further reduced to LIBOR plus 1.125%. Pricing under the Supplemental Unsecured Facility provided by First Union National Bank was reduced to LIBOR plus .95% from LIBOR plus 1.25%. The Company will use borrowings under the Unsecured Facilities 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. In October 1996, Moody's Investor Service ("Moody's") raised the Company's ratings on the 7 3/8% senior notes to Baa2 from Baa3. At the same time, Moody's raised its rating on the Company's cumulative redeemable preferred stock to baa3 from ba1 and the ratings on three tax-exempt bond issues that are guaranteed by the Company to Baa2 from Baa3. Interest Rate Protection Agreements The Company entered into another interest rate protection agreement in the form of an accreting swap transaction ("the Swap") with a triple A rated counterparty (the "Counterparty") on May 30, 1995. The Swap serves to fix the floating component of the Company's total interest rate at 5.89% on notional amounts which increase over time. On the 15th day of each month during the term of the agreement, the Company will pay to the Counterparty interest equal to 5.89% on the then principal amount in effect, divided by twelve months. The Counterparty will pay to the Company interest equal to the actual 30 day LIBOR rate on the principal amount then in effect, divided by twelve months. Payments will be based on the following schedule: 18 21
Periods Covered Principal (Notional) Amount in Effect --------------- ------------------------------------- 6/15/96 through 7/15/96 $32,000,000 7/15/96 through 8/15/96 $35,000,000 8/15/96 through 9/15/96 $37,000,000 9/15/96 through 10/15/96 $40,000,000 10/15/96 through 11/15/96 $41,000,000 11/15/96 through 12/15/96 $43,000,000 12/15/96 through 1/15/97 $44,000,000 1/15/97 through 2/15/97 $45,000,000
Payments made by the Company under the Swap totaled $37,000 and $83,000 during the three and nine month periods ended September 30, 1996, respectively. 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 additional 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 August 1, 1996, the Company completed a new tax-exempt credit enhancement facility with Fannie Mae that will provide a long-term cost-effective credit enhancement source for the Company's current and future tax-exempt bond portfolio. In connection with this facility, the Company completed a refinancing of approximately $91,000,000 of its tax-exempt bond portfolio. The facility involves eleven communities, seven that are financed with tax-exempt bonds and four previously unencumbered communities that are pledged as additional collateral. In October 1996, the Company completed an offering of 4,300,000 shares of 8.96% Series B cumulative redeemable preferred stock. The gross proceeds of the offering totaled $107,500,000. The net cash proceeds from the sale (approximately $104,114,000) were used to retire indebtedness under the Company's Unsecured Facility. Financing Commitments The Company has received commitments for tax-exempt financing on the Avalon Fields and Avalon West communities. The Community Development Administration of Maryland has issued $12.1 million of thirty-year fixed-rate bonds, at an all-in rate of 7.55% related to Avalon Fields. The proceeds will be made available to the Company upon completion of documentation. The Massachusetts Housing Finance Agency has issued $8.8 million of tax-exempt bonds to finance the Avalon West community upon completion at an all-in cost of 7.72% for 42 years. Management expects to receive funding under both commitments during the fourth quarter of 1996. Future Financing Needs Substantially all of the capital expenditures to complete the communities currently under construction will be funded from proceeds of permanent financing commitments already in place or from proceeds drawn under Unsecured Facilities, and little, if any, additional capital sources are expected to be needed to complete the communities. 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 a three-year period. 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. 19 22 To continue to implement its growth strategy, the Company will pursue additional capital as needed from sources that may include additional public or private offerings of debt or equity securities, as well as bank or institutional credit facilities. If all of the Development Rights proceed to development, Management believes that additional debt or equity financing will be needed. There can be no assurance that such additional debt financing or debt offerings will be available on terms satisfactory to the Company. Additionally, the Company's Funds from Operations and the availability of additional debt or equity financing can be adversely impacted by negative changes in the economy, particularly as those changes may relate to real estate assets or interest rates. BUSINESS CONDITIONS; INFLATION The Company's principal markets are characterized by high barriers to entry and restrictive zoning which 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 8,800 apartment homes in planning for delivery over the next 36-month period. Estimated absorption during this period totals 12,000 apartment homes, which would create a supply-demand balance that would be favorable for owners of multifamily apartment communities. At September 30, 1996, Management had positioned the Company's portfolio of Stabilized Communities, excluding communities owned by joint ventures, to a physical occupancy level of 96.9%, and achieved an average economic occupancy of 95.3% for the nine months ended September 30, 1996. Average economic occupancy for the portfolio for the nine months ended September 30, 1995 was 95.8%. 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 Stabilized 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 Stabilized 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 rental 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, 1996, eight Development Communities were under construction. The total capitalized cost of these Development Communities, when completed, is currently expected to be approximately $323.8 million. The Company intends to periodically update the projections in the table on the following page to the extent Management believes there may be or has been a material change in these projections on an aggregate basis. There can be no assurance that the Company will complete the Development Communities, that the Company's budgeted costs, leasing, start dates, completion dates, occupancy or estimates of "EBITDA as % of Total Budgeted Cost" will be realized or that future developments will realize comparable returns. The Company maintains an active development capacity that Management anticipates will provide a continuing source of portfolio growth. During the lease-up period of the development process, the Company anticipates that Development Communities will experience operating deficits for a three-to-six month period until such time as the new community approaches stabilized occupancy. The amount and duration of operating deficits 20 23 to be incurred are dependent upon a number of factors, including the size of the community, the season in which leasing activity occurs and the extent to which delivery of new apartment homes coincides with leasing and occupancy of these new apartment homes (which is dependent on local market conditions). Any operating deficits that occur during the initial lease-up phase of a new development are expensed in accordance with GAAP. For the nine months ended September 30, 1996, initial lease-up deficits were not material to the financial position and operating results of the Company. The following page presents a summary of Development Communities: 21 24 DEVELOPMENT COMMUNITIES SUMMARY
NUMBER OF BUDGETED ESTIMATED ESTIMATED APARTMENT COST CONSTRUCTION INITIAL COMPLETION STABILIZATION HOMES ($ MILLIONS) START OCCUPANCY DATE DATE (1) ------------ ------------- ---------------- ----------- ------------ --------------- Conventionally Financed - ----------------------- Avalon Gates Trumbull, CT 340 $ 32.7 Q3 1994 Q2 1996 Q3 1997 Q4 1997 Avalon Crossing Rockville, MD 132 13.5 Q3 1995 Q2 1996 Q4 1996 Q1 1997 Avalon Cove Jersey City, NJ 504 70.5(3) Q4 1994 Q2 1996 Q1 1997 Q2 1997 Avalon Grove(4) Stamford, CT 402 51.3 Q1 1995 Q3 1996 Q2 1997 Q3 1997 Avalon Springs Wilton, CT 102 15.2 Q3 1995 Q3 1996 Q1 1997 Q2 1997 Avalon Crescent Tysons Corner, VA 558 56.7 Q1 1996 Q1 1997 Q4 1997 Q1 1998 Avalon Commons Smithtown, NY 312 30.6 Q1 1996 Q1 1997 Q3 1997 Q4 1997 Avalon Gardens Nanuet, NY 504 53.3 Q3 1996 Q3 1997 Q4 1998 Q1 1999 ------------ ---------- 2,854 $ 323.8 ============ ==========
EBITDA AS % OF TOTAL BUDGETED COST (2) ------------------- Conventionally Financed - ----------------------- Avalon Gates Trumbull, CT 10.0% Avalon Crossing Rockville, MD 11.0% Avalon Cove Jersey City, NJ 11.0% Avalon Grove(4) Stamford, CT 12.2% Avalon Springs Wilton, CT 11.6% Avalon Crescent Tysons Corner, VA 10.2% Avalon Commons Smithtown, NY 11.1% Avalon Gardens Nanuet, NY 10.1% ------------- 10.8% =============
- ------------ The table above includes forward looking information within the meaning of the Private Securities Litigation Reform Act of 1995 regarding the delivery, occupancy and total budgeted cost of newly developed apartment homes. This information is based on a series of projections, estimates and local experience with construction practices that affect construction costs and completion as well as market conditions that affect how quickly a community leases and at what rental rates. The Company's ability to achieve these projections is affected by continued market demand for the Company's new apartment homes as well as other factors discussed periodically in the Company's reports filed with the Securities and Exchange Commission including the reports on Form 10-Q for the quarters ended March 31, 1996 and June 30, 1996 and the Form 10-K for the year ended December 31, 1995. If the Company's performance differs materially from these projections, actual results could vary significantly from the performance projected in the forward looking information. (1) Stabilized occupancy is defined as the first full quarter of 95% 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. (3) In March 1996, 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. The Company selected Tishman Construction Company of New Jersey to be the replacement contractor, and the replacement contractor is currently managing the construction operations. Management expects that total actual costs to exceed the current $70.5 million budget presented herein. The Company is pursuing collection of any excess over the original guaranteed maximum price contract, but no assurance can be provided that collection efforts will be successful. Management believes that the excess cost, even if no recovery from original contractor is made, will not have a material adverse impact on the financial condition or results of operations of the Company. (4) Currently anticipated to be held by a joint venture. 22 25 DEVELOPMENT RIGHTS The Company is considering the development of 20 new apartment communities. The status of these Development Rights range from land 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 5,767 institutional-quality apartment homes to the Company's portfolio. At September 30, 1996, the cumulative capitalized costs incurred in pursuit of the 20 Development Rights were approximately $12.1 million, including the capitalized cost of $5.9 million related to the purchase of land in New Canaan, Connecticut. Many of these apartment homes will offer features like those offered by the communities currently owned by the Company. The 20 Development Rights that the Company is currently pursuing are summarized below. DEVELOPMENT RIGHTS SUMMARY TOTAL ESTIMATED BUDGETED NUMBER OF COST LOCATION HOMES ($ MILLIONS) ---------------------- --------------- ---------------- 1. Fairfax, VA 234 $ 23.2 2. Mamaroneck, NY 227 37.0 3. Melville-I, NY 154 17.8 4. Alexandria, VA 460 45.7 5. Freehold, NJ 452 37.5 6. Quincy, MA 171 15.0 7. New Canaan, CT(1) 104 23.2 8. Greenburgh - II, NY 500 64.2 9. Greenburgh - III, NY 294 37.7 10. Darien, CT 172 20.7 11. Fort Lee, NJ 351 52.6 12. Peabody, MA 434 35.5 13. Springfield, NJ 500 44.9 14. Hull, MA 244 20.3 15. Jersey City, NJ 221 38.5 16. New Rochelle, NY 350 49.4 17. Easton, CT 249 28.2 18. Melville-II, NY 350 36.7 19. Wilmington, MA 204 18.0 20. Gaithersburg - II, MD 96 8.1 ============= ============== Total 5,767 $ 654.2 ============= ============== The table above includes forward looking information within the meaning of the Private Securities Litigation Reform Act of 1995 regarding the total budgeted cost of newly developed apartment homes. This information is based on a series of projections, estimates and local experience with construction practices that affect construction completion. The Company's ability to achieve these projections is affected by continued market demand for the company's new apartment homes, availability of capital as well as other factors discussed periodically in the company's reports filed with the Securities and Exchange Commission, including the report on Form 10-Q for the quarter ended June 30, 1996 and the Form 10-K for the year ended December 31, 1995. If the Company's performance differs materially from these projections, actual results could vary significantly from the performance projected in the forward looking information. There can be no assurance that all or any of these communities will proceed to development. (1) Currently anticipated that the land seller will retain a minority limited partner interest. 23 26 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In March 1996, the original contractor, Procida Construction Corporation, 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. The Company expects total actual costs to exceed the current $70.5 million budget. 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. No assurance can be provided that collection efforts will be successful. Management does not believe that the excess cost, even if no recovery from the original contractor is made, will have a material adverse impact on the financial condition or results of operations of the Company. 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 Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a) Not applicable. b) No reports of Form 8-K have been filed by the Company for the period covered by this report. 24 27 SIGNATURE 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, 1996 By /s/ THOMAS J. SARGEANT -------------------------- Thomas J. Sargeant, Chief Financial Officer, Treasurer and Secretary (Principal Financial and Accounting Officer) 25 EX-27 2 FINANCIAL DATA SCHEDULE.
5 1,000 9-MOS DEC-31-1996 JUL-01-1996 SEP-30-1996 2,962 0 0 0 0 13,368 1,018,575 40,685 1,015,006 39,947 277,663 0 45 307 561,044 1,015,006 0 32,811 0 17,934 0 0 2,847 11,622 0 0 0 2,356 0 9,266 .22 0
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