-----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, RW6y4Ze7QPdVU4HednO1j4DL6Ndng5gUod/SVRGnlyjZNEIOiQQZiXfa/w/xxApl 2MYvwzRKAJSn9uuUclbVfA== 0000950133-98-001977.txt : 19980518 0000950133-98-001977.hdr.sgml : 19980518 ACCESSION NUMBER: 0000950133-98-001977 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19980331 FILED AS OF DATE: 19980515 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: SEC FILE NUMBER: 001-12452 FILM NUMBER: 98625136 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 1 AVALON PROPERTIES, INC. - 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 March 31, 1998 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: 43,144,853 shares outstanding as of May 11, 1998. ================================================================================ 2 AVALON PROPERTIES, INC. INDEX
PART I FINANCIAL INFORMATION Item 1 Financial Statements Page Condensed Consolidated Balance Sheets as of March 31, 1998 and December 31, 1997................................................................1 Condensed Consolidated Statements of Operations for the three months ended March 31, 1998 and 1997........................................................2 Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 1998 and 1997........................................................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...................................................................25 Item 2 Changes in Securities...............................................................25 Item 3 Defaults upon Senior Securities.....................................................25 Item 4 Submission of Matters to a Vote of Stockholders.....................................25 Item 5 Other Information...................................................................25 Item 6 Exhibits and Reports on Form 8-K....................................................25 Signatures..........................................................................26
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 03/31/98 12/31/97 ------------ ------------ Real estate Land $ 261,150 $ 247,613 Buildings and improvements 1,190,347 1,120,505 Furniture, fixtures and equipment 43,090 39,830 --------- --------- 1,494,587 1,407,948 Less: accumulated depreciation (78,994) (69,932) --------- --------- Net operating real estate 1,415,593 1,338,016 Construction in progress (including land) 127,927 127,038 --------- --------- TOTAL REAL ESTATE, NET 1,543,520 1,465,054 Cash and cash equivalents $ 3,497 $ 6,722 Cash in escrow 3,083 4,109 Resident security deposits 8,448 7,812 Investments in unconsolidated joint ventures 18,052 18,315 Deferred financing costs, net 9,891 10,022 Deferred development costs 8,218 7,207 Prepaid expenses and other assets 16,404 10,462 --------- --------- TOTAL ASSETS $ 1,611,113 $ 1,529,703 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Unsecured Facilities $ 24,000 $ 71,500 Unsecured senior notes, net of unamortized discount 309,683 209,695 Notes payable 224,653 224,934 Payables for construction 13,624 16,311 Accrued expenses and other liabilities 18,561 15,466 Accrued interest payable 4,974 3,041 Resident security deposits 10,235 9,589 -------- -------- TOTAL LIABILITIES 605,730 550,536 -------- -------- Minority interest of unitholders in consolidated operating partnerships 16,167 18,157 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; 43,140,225 and 41, 975,240 shares issued and outstanding at March 31, 1998 and December 31, 1997, respectively 431 420 Additional paid-in capital 1,021,302 987,540 Deferred compensation (5,967) (3,265) Dividends in excess of accumulated earnings (26,638) (23,773) --------- --------- STOCKHOLDERS' EQUITY 989,216 961,010 --------- --------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,611,113 $ 1,529,703 ========= =========
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 -------------------- 3-31-98 3-31-97 ------- ------- Revenue: Rental income $ 55,941 $ 37,152 Management fees 375 255 Other income 136 120 ------- ------- Total revenue 56,452 37,527 ------- ------- Expenses: Operating expenses 20,894 13,532 Interest expense 6,540 3,717 Depreciation and amortization 9,285 6,481 General and administrative expenses 1,400 912 ------- ------- Total expenses 38,119 24,642 ------- ------- Equity in income of unconsolidated joint ventures 651 1,042 Interest income 296 275 Minority interest (411) 94 ------- ------- Income before extraordinary item 18,869 14,296 Extraordinary item -- (1,183) ------- ------- Net income 18,869 13,113 Dividends attributable to preferred stock (4,914) (4,914) ------- ------- Net income available to common stockholders $ 13,955 $ 8,199 ======= ======= Per common share: Income before extraordinary item - basic $ 0.33 $ 0.28 ======= ======= Income before extraordinary item - diluted $ 0.33 $ 0.28 ======= ======= Net income - basic $ 0.33 $ 0.24 ======= ======= Net income - diluted $ 0.33 $ 0.24 ======= =======
See accompanying notes to condensed consolidated financial statements. 2 5 AVALON PROPERTIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Dollars in thousands)
Three months ended ---------------------------- 3-31-98 3-31-97 ------- ------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 18,869 $ 13,113 Adjustments to reconcile net income to cash provided by operating activities: Depreciation and amortization 9,285 6,481 Equity in income of unconsolidated joint ventures 695 (17) Amortization of deferred compensation 371 248 Income allocated to Minority Interest 417 -- Extraordinary item -- 1,183 Decrease in cash in escrow, net 1,036 386 Increase in prepaid expenses and other assets (6,953) (1,763) Increase in accrued expenses, other liabilities and accrued interest payable 5,731 2,882 ------- ------- Total adjustments 10,582 9,400 ------- ------- Net cash provided by operating activities 29,451 22,513 ------- ------- CASH FLOWS USED IN INVESTING ACTIVITIES: Investments in unconsolidated joint ventures (432) (167) Decrease in construction payables (2,687) (1,491) Purchase and development of real estate (87,238) (90,775) ------- ------- Net cash used in investing activities (90,357) (92,433) ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of common stock, net 29,764 269 Dividends paid (21,734) (17,652) Borrowings under notes payable 99,976 -- Repayments of notes payable (281) (321) Borrowings under Unsecured Facilities 59,000 83,000 Repayments of Unsecured Facilities (106,500) (6,500) Redemption of OP Units (1,990) -- Distributions to minority partners (417) -- Payments of deferred financing costs (137) (81) ------- ------- Net cash provided by financing activities 57,681 58,715 ------- ------- Net decrease in cash (3,225) (11,205) Cash and cash equivalents, beginning of period 6,722 14,241 ------- ------- Cash and cash equivalents, end of period $ 3,497 $ 3,036 ======= ======= Cash paid during period for interest, net of amount capitalized $ 4,189 $ 4,858 ======= =======
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 Acquisitions 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 high barrier-to-entry markets of the United States. Additionally, the Company provides management services for communities owned by unrelated parties. During the three months ended March 31, 1998, the Company purchased two apartment communities containing a total of 406 apartment homes for an aggregate contract purchase price of approximately $27,625. During the three months ended March 31, 1998, the Company purchased three tracts of land containing a total of 71.6 acres from unrelated third parties for an aggregate purchase price of approximately $6,871. On January 9, 1998, the Company purchased a 5-story office building located in Alexandria, Virginia for approximately $6,600. The Company has relocated its Mid-Atlantic regional office to this location and it occupies half of the 60,000 net rentable square feet of this office building. The remaining 30,000 square feet is rented to unrelated third party tenants at market rents. On January 15, 1998, the Company entered into a letter of intent with Prudential to purchase the residential component of the Prudential Center in Boston Massachusetts. This property contains approximately 779 apartment homes and related underground parking. Negotiations are ongoing and there can be no assurance that these negotiations will be successful. On March 9, 1998, the Company entered into a definitive merger agreement with Bay Apartment Communities, Inc. ("Bay"), pursuant to which the Company will be merged into Bay, with Bay as the surviving entity (the "Merger"). Under the terms of the agreement, each outstanding common share of the Company will be exchanged for 0.7683 shares of common stock of Bay. The holders of the Company's preferred stock will receive one share of comparable Bay preferred stock for each share of comparable stock they own. The Merger will be accounted for as a purchase of the Company by Bay. The Merger is expected to close in June 1998 and is subject to the approval of both companies' shareholders and other customary regulatory conditions and there can be no assurance that the Merger will be consummated and that the required conditions to closing will be met. The surviving company, to be renamed Avalon Bay Communities, Inc., will (on a pro forma basis as of April 20, 1998) own 141 apartment communities containing 40,700 apartment homes (including those under construction) in 29 markets in 15 states and the District of Columbia. On March 9, 1998, the Company announced that it has entered into a definitive agreement to acquire selected assets on a presale basis from Trammell Crow Residential - Pacific Northwest ("TCR-NW"). The presale acquisitions are expected to be completed during the next 24 to 36 months. The acquisitions include seven communities in the Seattle, Washington market and one community in the 4 7 Portland, Oregon market for a total investment by the Company of up to $279,000. Together, these eight communities are expected to contain 2,411 apartment homes. The Company will manage these communities after acquiring ownership. 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 and the operating partnerships structured as DownREITs. 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 and 7 years, respectively. If there is an event or change in circumstance that indicates an impairment in the value of a community has occurred, the Company's policy is to 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 the community. If such carrying amounts are in excess of the estimated projected operating cash flows 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 are charged to operations as incurred. Significant renovations or betterments which extend the economic useful life of the assets are capitalized. The Company does not 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 Company's Board of Directors approves the decision to sell. Deferred Financing and Development Costs Deferred financing costs include fees and costs incurred to obtain debt 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. Unamortized financing costs are written-off when debt is retired before the maturity date. 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. Recently Issued Accounting Pronouncement On March 19, 1998, the Emerging Issues Task Force of the Financial Accounting Standards Board reached a consensus opinion on issue #97-11, "Accounting for Internal Costs Relating to Real Estate Property Acquisitions" which requires that the internal costs of identifying and acquiring an operating property should be expensed as incurred. The adoption of this issue will have no impact on the Company's financial condition or results of operations since the Company fully expenses these costs. Per Common Share Disclosures Per common share disclosures for the three months ended March 31, 1998 and 1997 are based upon the following basic and diluted weighted average number of shares of common stock outstanding: 5 8
Three months ended -------------------------- 03/31/98 03/31/97 ------------ ------------ Weighted average common shares outstanding- basic 42,618,030 33,478,709 Shares issuable from assumed conversion of: Common stock options 286,316 264,215 Operating partnership units 1,133 36 ------------ ------------ Weighted average common shares outstanding- diluted 42,905,479 33,742,960 ============ ============
Operating partnerships units that were issued based on a common stock price that was higher than the average price during the quarter are excluded from the weighted average calculation, as inclusion of these units would be anti-dilutive. 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 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 the 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, 1997. Reclassifications Certain reclassifications have been made to amounts in prior years' financial statements to conform with current year presentations. Specifically, overhead expenses related to acquisitions and telecommunication costs 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. The excess of the interest income at the pay rate on the mortgage loan over the cash flow from operations generated by the community is reflected in minority interest. This excess is funded from payments drawn from an escrow account established from contributions by the minority partners. At March 31, 1998, the partnership had $2,934 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 March 31, 1998. 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 banks that provides for $175,000 in short-term credit and is subject to an annual fee of $263. The Unsecured Facility expires on March 31, 2000. As of March 31, 1998, approximately $12,873 of available capacity was used to provide letters of credit and $1,000 was borrowed under the facility. 6 9 Accordingly, the balance that remains available at March 31, 1998 to be drawn under the Unsecured Facility is $161,127. 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 in March 2000 and bears a current interest rate of LIBOR plus .80%. At March 31, 1998, $2,560 of available capacity was used to provide letters of credit and $23,000 was borrowed under the Supplemental Unsecured Facility. Accordingly, the balance that remains available at March 31, 1998 to be drawn under the Supplemental Unsecured Facility is $24,440. The weighted average effective interest rates (excluding the cost of facility fees) on borrowings under the Unsecured Facilities for the three months ended March 31, 1998 and 1997 were 6.4% and 6.5%, respectively. Including the cost of facility fees, the weighted average effective interest rates on borrowings under the Unsecured Facilities for the three months ended March 31, 1998 and 1997 were 7.6% and 7.0%, respectively. The Company, among other things, is subject to certain customary covenants under the credit agreements for the Unsecured Facilities including maintaining certain maximum leverage ratios, minimum fixed charge coverage ratio, minimum unencumbered asset and equity levels and is restricted from paying dividends in amounts that exceed 95% of the Company's Funds from Operations, as defined. 5. Stockholders' Equity The following summarizes the changes in stockholders' equity for the three months ended March 31, 1998:
Dividends Additional in excess of Preferred Common paid-in Deferred accumulated Stock Stock capital compensation earnings Total --------- ------- ---------- ------------ ------------ --------- Stockholders' equity, 12-31-97 $ 88 $ 420 $ 987,540 $ (3,265) $ (23,773) $ 961,010 Net income - - - - 18,869 18,869 Dividends declared - - - - (21,734) (21,734) Issuance of Restricted Common Stock - 1 4,008 - - 4,009 Deferred compensation, net of amortization - - - (2,702) - (2,702) Issuance of Common Stock - 10 29,754 - - 29,764 --------- ------- ---------- ------------ ------------ --------- Stockholders' equity, 3-31-98 $ 88 $ 431 $ 1,021,302 $ (5,967) $ (26,638) $ 989,216 ========= ======= ========== ============ ============ =========
6. Investments in Unconsolidated Joint Ventures At March 31, 1998, investments in unconsolidated 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 a 50% general partnership interest in Avalon Grove. The following is a combined summary of the financial position of these joint ventures for the periods presented: 7 10
3-31-98 12-31-97 ------- -------- Assets: Real estate, net $ 97,500 $ 97,964 Other assets 4,533 10,790 ------- -------- Total assets $ 102,033 $ 108,754 ======= ======== Liabilities and partners' equity: Mortgage notes payable $ 26,000 $ 26,000 Other liabilities 4,197 4,164 Partners' equity 71,836 78,590 ------- -------- Total liabilities and partners' equity $ 102,033 $ 108,754 ======= ========
The following is a combined summary of the operating results of these joint ventures for the periods presented:
Three months ended ---------------------- 3-31-98 3-31-97 ------- -------- Rental income $ 4,764 $ 3,373 Other income 7 12 Operating expenses (1,289) (1,128) Mortgage interest expense (197) (196) Depreciation and amortization (753) (571) ------- -------- Net income $ 2,532 $ 1,490 ======= ========
7. Subsequent Events On April 30, 1998, the Company purchased a 480 apartment home community located in the St. Louis metropolitan area for $29,760. 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 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 not be successful in managing its current growth in the number of apartment communities and the related growth of its business operations; the Company's expansion into new geographic market areas may not produce financial results that are consistent with its historical performance; acquisitions of portfolios of apartment communities may result in the Company acquiring communities that are more expensive to manage and portfolio acquisitions may not be successfully completed, resulting in charges to earnings; the Company may fail to secure or 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 included in this report. RECENT DEVELOPMENTS Merger and Geographic Expansion. On March 9, 1998, the Company announced that it has entered into a definitive merger agreement with Bay Apartment Communities, Inc. ("Bay"), pursuant to which the Company will be merged into Bay, with Bay as the surviving entity (the "Merger"). Under the terms of the agreement, each outstanding common share of the Company will be exchanged for 0.7683 shares of common stock of Bay. The holders of the Company's preferred stock will receive one share of comparable Bay preferred stock for each share of comparable stock they own. The Merger will be accounted for as a purchase of the Company by Bay. The Merger is expected to close in June 1998 and is subject to the approval of both companies' shareholders and other customary regulatory conditions and there can be no assurance that the Merger will be consummated and that the required conditions to closing will be met. The surviving company, to be renamed Avalon Bay Communities, Inc., will (on a pro forma basis as of April 20, 1998) own 141 apartment communities containing 40,700 apartment homes in 29 markets in 15 states and the District of Columbia. On March 9, 1998, the Company announced that it has entered into a definitive agreement to acquire selected assets on a presale basis from Trammell Crow Residential - Pacific Northwest ("TCR-NW"). The presale acquisitions are expected to be completed during the next 24 to 36 months. The acquisitions include seven communities in the Seattle, Washington market and one community in the Portland, Oregon market for a total investment by the Company of up to $279,000,000. Together, these eight communities are expected to contain 2,411 apartment homes. The Company will manage these communities after acquiring ownership. 9 12 Possible Sale of Existing Communities. In connection with an agreement executed by the Company in March 1998 which provided for the buyout of certain limited partners in DownREIT V Limited Partnership, the Company granted such partners, or their respective affiliates, the option to purchase two communities owned by the Company and located in Michigan for an aggregate purchase price of approximately $43,000,000. The purchase option expires on July 20, 1998. Acquisitions of Existing Communities. On January 7, 1998, the Company purchased two apartment communities located in the Minneapolis metropolitan area. Carriage Green, a 246 apartment home community located in Eagan, Minnesota, and Summer Place, a 160 apartment home community located in Plymouth, Minnesota, were acquired for $27,625,000. On April 30, 1998, the Company purchased a 480 apartment home community located in the St. Louis metropolitan area for $29,760,000. Land Acquisitions for New Development. On February 26, 1998, the Company purchased a 17.1 acre tract of land in Danbury, Connecticut for $2,100,000. Construction of a new 268 apartment community, Avalon Valley, commenced in the second quarter of 1998. On February 27, 1998, the Company purchased a 32 acre tract of land in Danbury, Connecticut for $3,271,000. Construction of a new 135 apartment home community, Avalon Lake, commenced in the first quarter of 1998. On March 25, 1998, the Company purchased a 22.5 acre tract of land in Wilmington, Massachusetts for $1,500,000. Construction of a new 204 apartment home community, Avalon Oaks, commenced in the second quarter of 1998. GENERAL The Company's operations consist of the development, construction, acquisition and operation of apartment communities in the Mid-Atlantic, Northeast and the Midwest regions of the United States. The Company also recently announced plans to expand to certain high barrier-to-entry markets of the Pacific Northwest. As of March 31, 1998, the Company held a fee simple ownership interest in 55 operating communities (one of which, Avalon at Center Place, is on land subject to a 149 year land lease), a general partnership interest in three other operating communities (a 50% interest in Falkland Chase, a 49% interest in Avalon Run, and a 50% interest in Avalon Grove), a 99% general partner interest in two partnerships structured as DownREITs (Avalon at Ballston Quincy and Avalon a Ballston Vermont, which are operated as a single community, six communities acquired from Trammell Crow Residential - Midwest and a single community located in Westmont, Illinois) and a 100% interest in a senior participating mortgage note secured by another operating community (Avalon Arbor) which is accounted for as an investment in real estate. The Company also holds a fee simple ownership interest in twelve Development Communities. The existing DownREITs have been structured so that substantially all of the economic interests of these partnerships accrue to the benefit of the Company. The Company believes that it is unlikely that the limited partners in these partnerships will receive any financial return on their limited partnership interests other than the stated distributions on their Units of the Operating Partnerships ("Units") or as a result of the possible future conversion of their Units into shares of common stock. The DownREIT partnerships are consolidated for financial reporting purposes. 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 10 13 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 months ended March 31, 1998 and 1997. Net income increased $5,756,000 (43.9%) to $18,869,000 for the three months ended March 31, 1998 compared to $13,113,000 for the comparable period of the preceding year. The primary reasons for this increase are additional operating income from communities developed or acquired during 1998 and 1997, as well as growth in operating income from existing communities. Rental income increased $18,789,000 (50.6%) to $55,941,000 for the three months ended March 31, 1998 compared to $37,152,000 for the comparable period of the preceding year. Of the increase for the three month period, $1,536,000 relates to rental revenue increases from Established Communities and $17,253,000 is attributable to the addition of newly completed or acquired apartment homes. Overall Portfolio - The $18,789,000 increase in rental income for the three 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 12,252 apartment homes for the three months ended March 31, 1997 to 18,082 apartment homes for the three months ended March 31, 1998 as a result of the development and acquisition of new communities. For the three months ended March 31, 1998, the weighted average monthly revenue per occupied apartment home increased $114 (12.4%) to $1,030 compared to $916 for the comparable period of the preceding year. Established Communities - Rental revenue increased $1,536,000 due to strengthening market conditions and the resulting impact on rents and occupancy. Weighted average monthly revenue per occupied apartment home increased $44 (4.9%) to $942 compared to $898 for the comparable period of the preceding year. The average economic occupancy increased .2% from 95.5% to 95.7%. 11 14 Management fees increased $120,000 (47.1%) to $375,000 for the three months ended March 31, 1998 compared to $255,000 for the comparable period of the preceding year. The increase for the three month period is due to certain third-party management contracts acquired in connection with the purchase of a portion of the Trammell Crow Residential - Midwest ("TCR/MW) portfolio in December 1997. Operating expenses increased $7,362,000 (54.4%) to $20,894,000 for the three months ended March 31, 1998 compared to $13,532,000 for the comparable period of the preceding year. Overall Portfolio - This increase 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 $288,000 (2.9%) to $10,123,000 for the three months ended March 31, 1998 compared to $9,835,000 for the comparable period of the preceding year. The increase was concentrated in the maintenance and property taxes categories. Interest expense increased $2,823,000 (75.9%) to $6,540,000 for the three months ended March 31, 1998 compared to $3,717,000 for the comparable period of the preceding year. This increase is primarily attributable to the issuance of $110,000,000 and $100,000,000 unsecured senior notes in December 1997 and January 1998, respectively, as well as the assumption of approximately $27,305,000 of variable tax-exempt debt in connection with the purchase of the TCR/MW portfolio. Depreciation and amortization increased $2,804,000 (43.3%) to $9,285,000 for the three months ended March 31, 1998 compared to $6,481,000 for the comparable period of the preceding year. This increase reflects additional depreciation expense for the increased number of acquired and developed communities in 1998 and 1997. General and administrative expenses increased $488,000 (53.5%) to $1,400,000 for the three months ended March 31, 1998 compared to $912,000 for the comparable period of the preceding year. This increase is primarily due to staff additions related to the growth of the Company's portfolio and higher compensation expense under the restricted stock grant program. Equity in income of unconsolidated joint ventures decreased $391,000 to $651,000 for the three months ended March 31, 1998 compared to $1,042,000 for the comparable period of the preceding year. This decrease is principally the result of the non-recurring income from the Avalon Grove joint venture in which the Company was allocated 100% of the lease-up period income prior to the formation of the partnership in December 1997. Extraordinary items totaled $1,183,000 for the three months ended March 31, 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 The Company's management ("Management") generally considers 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 the 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 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 sales 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. The following table presents an analysis of Funds from Operations for the periods presented (dollars in thousands): 13 16 ANALYSIS OF FUNDS FROM OPERATIONS
Three months ended ---------------------------------------- 3-31-98 3-31-97 ------------------- ------------------ NET INCOME $ 18,869 $ 13,113 Depreciation (real estate related) 8,790 6,138 Joint venture adjustment 177 81 Extraordinary item -- 1,183 Preferred stock dividends (4,914) (4,914) ------------------- ------------------ FUNDS FROM OPERATIONS $ 22,922 $ 15,601 =================== ================== WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC 42,618,030 33,478,709 =================== ================== WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED 42,905,479 33,742,960 =================== ================== OTHER CAPITALIZED EXPENDITURES AND OTHER INFORMATION Capital expenditures: Community level (1) $ 522 $ 439 Corporate level (2) $ 1,732 $ 263 Loan principal amortization payments $ 281 $ 321 Capitalized deferred financing costs (3) $ 137 $ 81
- ------------------ 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) Primarily represents the cost of new offices in Alexandria, Chicago and Minnepolis as well as new computer equipment to absorb additional communities and to support the merged company. (3) Substantially all of the deferred financing costs incurred for the three months ended March 31, 1998 relate to the costs incurred on the closing of the $100 million unsecured senior notes. 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. 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 three months ended March 31, 1998 resulted in non-revenue generating capitalized expenditures for Stabilized Communities of approximately $522,000 or $29 per apartment home. For the three months ended March 31, 1998, the Company charged to maintenance expense, including carpet and appliance replacements, a total of approximately $3,859,000 for Stabilized Communities or $213 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 three months ended March 31, 1998. 15 18 EXPENDITURES FOR COMMUNITY AND CORPORATE UPGRADES (CAPITALIZED) AND COMMUNITY MAINTENANCE (EXPENSED) (Dollars in thousands, except per home data)
Q1 1998 Capitalized Costs ------------------------------------ Acquisitions, Construction Non-Revenue Q1 1998 and Revenue Generating Capx Maintenance Expensed Number Balance at Balance at Generating ------------------- -------------------- Community of Homes 12-31-97 (1) 03/31/98(1) Costs Total Per Home Total Per Home - ------------------------------- -------- ------------- ----------- ------------ ----- -------- ----- -------- STABILIZED Avalon Watch 512 $ 28,423 $ 28,464 $ -- $ 41 $ 80 $ 79 $ 154 Avalon Pavilions 932 56,693 56,717 -- 24 26 156 167 Avalon Glen 238 30,244 30,285 13 28 118 90 378 Avalon Walk I 430 34,587 34,618 -- 31 72 71 165 Avalon Walk II 334 23,740 23,764 -- 24 72 65 195 Avalon View 288 17,812 17,832 -- 20 69 87 302 Avalon Park 372 19,948 19,956 -- 8 22 79 212 Avalon at Ballston - Washington Towers 344 36,893 36,908 -- 15 44 74 215 Avalon at Gayton 328 9,945 10,034 43 46 140 68 207 Avalon at Hampton I 186 3,764 3,824 60 -- -- 44 237 Avalon at Hampton II 231 8,229 8,298 69 -- -- 39 169 Avalon at Dulles 236 11,706 11,719 -- 13 55 84 356 Avalon Knoll 300 8,067 8,111 4 40 133 73 243 Avalon Lea 296 16,130 16,135 -- 5 17 61 206 Avalon at Fairway Hills I 192 9,454 9,456 2 -- -- 37 193 Avalon Ridge 432 25,269 25,278 9 -- -- 88 204 Avalon at Symphony Glen 174 8,166 8,174 1 7 40 47 270 Avalon at Park Center 492 37,658 37,658 -- -- -- 95 193 4100 Mass. Avenue 308 34,931 34,931 -- -- -- 112 364 Avalon Woods 268 8,319 8,324 -- 5 19 40 149 Avalon at Carter Lake 259 11,560 11,560 -- -- -- 60 232 Avalon Pointe 140 7,841 7,851 -- 10 71 29 207 Avalon Landing 158 9,303 9,303 -- -- -- 48 304 Avalon Birches 312 13,461 13,567 101 5 16 56 179 Avalon at Lake Arbor 209 11,950 11,959 -- 9 43 58 278 Avalon at Decoverly 368 31,151 31,154 -- 3 8 58 158 Avalon Summit 245 16,289 16,386 97 -- -- 50 204 Avalon Towers 109 15,943 15,943 -- -- -- 76 697 Longwood Towers 307 21,501 21,501 -- -- -- 80 261 Avalon Fields 192 14,298 14,305 -- 7 36 30 156 Avalon West 120 10,810 10,810 -- -- -- 33 275 Avalon Chase 360 23,661 23,661 -- -- -- 77 214 Avalon Pines 174 8,659 8,664 5 -- -- 28 161 Avalon at Fairway Hills II 527 33,924 33,985 61 -- -- 102 194 Avalon at Boulders 284 16,087 16,126 35 4 14 48 169 AutumnWoods 420 30,631 30,640 1 8 19 73 174 Avalon Run East 206 16,233 16,233 -- -- -- 23 112 Avalon Station 223 12,001 12,014 -- 13 58 55 247 Avalon Cove 504 90,291 90,347 56 -- -- 84 167 Avalon Crossing 132 13,778 13,867 89 -- -- 24 182 Avalon Springs 102 15,775 15,824 49 -- -- 35 343 Avalon at Ballston - Vermont/Quincy 454 46,722 46,722 -- -- -- 114 251 Avalon at Center Place 225 26,424 27,063 523 116 516 59 262 Avalon at Providence Park 140 11,066 11,069 3 -- -- 36 257 Avalon Gates 340 35,369 35,426 57 -- -- 76 224 Avalon at Lexington 198 14,784 14,816 -- 32 -- 53 268 Avalon Green 105 12,439 12,447 -- 8 -- 51 486 Avalon Commons 312 31,732 32,442 710 -- -- 66 212 Avalon Crescent 558 56,625 56,752 127 -- -- 58 104 Avalon Court 154 17,231 17,605 374 -- -- 33 214 Summerplace (2) 160 -- 10,740 10,740 -- -- 33 206 Carriage Green (2) 246 -- 17,775 17,775 -- -- 45 183 Village Park of Westmont 400 25,743 25,747 4 -- -- 104 260 Village Park of Troy 544 31,290 31,290 -- -- -- 117 215 Avalon Heights 225 15,308 15,308 -- -- -- 45 200 Avalon at Willow Lake 230 14,944 15,231 287 -- -- 41 178 Avalon at Geist 146 12,080 12,178 98 -- -- 26 178 Avalon at Montgomery 264 15,153 15,624 471 -- -- 40 152 Avalon Devonshire 498 36,143 36,679 536 -- -- 113 227 Avalon at Danada Farms 295 37,571 37,766 195 -- -- 60 203 Avalon at Stratford Green 192 21,572 21,687 115 -- -- 39 203 Aspen Meadows 214 12,435 12,435 -- -- -- 34 159 -------- ---------- ---------- ------- ----- ------ ----- -------- 18,144 1,329,756 1,362,988 32,710 522 29 3,859 213 -------- ---------- ---------- ------- ----- ------ ----- --------
16 19 EXPENDITURES FOR COMMUNITY AND CORPORATE UPGRADES (CAPITALIZED) AND COMMUNITY MAINTENANCE (EXPENSED) - CONTINUED (Dollars in thousands, except per home data)
Number Balance at Balance at Community of Homes 12-31-97 (1) 3-31-98 (1) - --------------------------------------- ---------- ------------- ------------- NEW DEVELOPMENTS 3,029 154,762 205,079 - ---------------- ---------- ------------- ------------- OTHER Longwood Towers - Renovation -- 15,876 17,987 Avalon Arbor (4) 302 28,461 28,597 Corporate Level Expenditures -- 6,131 7,863 ========== ============= ============= Grand Total 21,475 (5) 1,534,986 1,622,514 ========== ============= ============= Q1 1998 Capitalized Costs --------------------------------------------- Acquisitions, Non-Revenue Q1 1998 Construction Generating Capx Maintenance Expensed and Revenue ------------------------- -------------------------- Community Generating Costs Total Per Home Total Per Home - --------------------------------------- ----------------- ------------ ---------- ------------- ----------- NEW DEVELOPMENTS 50,317 -- -- 83 N/A - ---------------- ----------------- ------------ ---------- ------------- ----------- OTHER Longwood Towers - Renovation 2,111 (3) -- -- -- -- Avalon Arbor (4) 136 -- N/A 85 281 Corporate Level Expenditures 1,732 -- N/A -- -- ================= ============ ========== ============= =========== Grand Total 87,006 522 N/A 4,027 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 1998. (3) Represents renovation costs incurred. (4) 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. (5) Excludes Falkland Chase, Avalon Run and Avalon Grove, a total of 1,278 apartment homes owned by joint ventures in which the Company holds a 50% interest, 49% interest and 50% interest, respectively. 17 20 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, occupancy levels and the Company's expenses with respect to such apartment homes. The 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 $3,036,000 at March 31, 1997 to $3,497,000 at March 31, 1998 due to the excess of cash provided by financing and operating activities over cash flow used in investing activities. Net cash provided by operating activities increased by $6,938,000 from $22,513,000 to $29,451,000 primarily due to an increase in operating income from newly developed and acquired communities and Established Communities. Cash used in investing activities decreased by $2,076,000 from $92,433,000 to $90,357,000 primarily due to the acquisition of two communities for $45,698,000 in 1997 compared to the acquisition of two communities for $27,625,000 in 1998, offset by an increase in construction costs. Net cash provided by financing activities decreased by $1,034,000 from $58,715,000 to $57,681,000 primarily due to an increase in dividends paid and a decrease in borrowings under the Unsecured Facilities, offset by the net proceeds received from the sale of 923,856 shares of the Company's common stock and the issuance of $100,000,000 unsecured senior notes in January 1998. The Company regularly reviews its short-term liquidity needs and the adequacy of Funds from Operations and other expected liquidity sources to meet these needs. The Company believes that its principal 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. Any short-term liquidity needs not provided by current operating cash flows would be funded from the Company's Unsecured Facilities. 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 three month period ended March 31, 1998 resulted in capitalized expenditures for Stabilized Communities of $29 per apartment home. The Company's 7-3/8%, 6-7/8% and 6-5/8% unsecured senior notes will mature in 2002, 2007 and 2005, respectively. Additionally, mortgage indebtedness on the Avalon Pines and Avalon Walk II apartment communities will mature in 2003 and 2004, respectively. Since Management anticipates that no significant portion of the principal of such indebtedness will be repaid prior to maturity and if Company does 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 2005. 18 21 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 $1.1 billion and over $345 million in the last 5 months. Management follows a focused strategy to help facilitate uninterrupted access to capital. This strategy includes: 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 demand-supply 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 obtain low cost, tax-exempt debt. Such a structure should promote an environment for ratings upgrades that can lead to a lower cost of capital and increased financial flexibility; 5. 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 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 The Company's unsecured credit facility (the "Unsecured Facility") is provided by a consortium of banks that provides for $175,000,000 in short-term credit and is subject to an annual facility fee of $262,500. The Unsecured Facility expires in March 2000. Borrowings under the Unsecured 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 March 31, 1998, $1,000,000 was borrowed, $12,873,000 was used to provide letters of credit and $161,127,000 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 fee of $75,000. The Supplemental Unsecured Facility expires in March 2000 and bears an interest rate of LIBOR plus .80%. At March 31, 1998, $2,560,000 of available capacity was used to provide letters of credit, and $23,000,000 was borrowed under the Supplemental Unsecured Facility. Accordingly, the balance that remains available at March 31, 1998 to be drawn under the Supplemental Unsecured Facility is $24,440,000. 19 22 Interest Rate Protection Agreements In connection with the refinancing of the tax-exempt bonds related to the Avalon Lea and Avalon Ridge communities in October 1997, the Company purchased an interest rate cap agreement for $101,000. This agreement terminates October 31, 2002 and serves to place a ceiling on the interest rate on the bonds at 6.9%. The Company is not a party to any long-term interest rate agreements, other than the interest rate protection agreement 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 Commitments/Transactions Completed On January 22, 1998, the Company completed a $100,000,000 offering of unsecured senior notes. The notes bear an interest rate at 6.625% payable semi-annually on January 15 and July 15 and will mature on January 15, 2005. The notes were sold at a price of 99.976% par value to yield 6.629% to maturity or a 111 basis point spread over the then-prevailing 7-year U.S. Treasury Note rate. The Company used the net proceeds of approximately $99,400,000 to repay amounts outstanding under the Unsecured Facilities. On January 27, 1998, the Company completed the sale of 923,856 shares of Common Stock to The Prudential Insurance Company of America under its existing shelf registration statement at a net purchase price of $29.09 per share. The net proceeds of approximately $26,872,000 were used to retire indebtedness under the Unsecured Facilities. 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 expected to be completed by the end of June 1998 and is being funded by advances under the Unsecured Facilities, operating cash flow or other financing sources. 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, if necessary, 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): 20 23 AVALON PROPERTIES, INC. DEBT MATURITY SCHEDULE (Dollars in thousands)
Balance Outstanding at -------------------------------- All-in Maturity Community Interest Rate Date 12-31-97 3-31-98 - ----------------------------- -------------- ----------- -------------- ---------------- Tax-Exempt Bonds: Fixed Rate * Avalon Lea 8.02% Jun-2026 $ 16,835 $ 16,835 * Avalon Ridge 8.00% Jun-2026 26,815 26,815 * Avalon at Dulles 7.04% Jul-2024 12,360 12,360 * Avalon Hampton II 7.04% Jul-2024 11,550 11,550 * Avalon at Symphony Glen 7.06% Jul-2024 9,780 9,780 * Avalon View 7.55% Aug-2024 19,315 19,265 * Avalon at Lexington 6.56% Feb-2025 15,071 15,015 * Avalon Knoll 6.95% Jun-2026 13,917 13,878 * Avalon Landing 6.85% Jun-2026 6,892 6,872 * Avalon West 7.73% Dec-2036 8,731 8,716 * Avalon Fields 7.57% May-2027 12,019 11,988 -------------- ---------------- 153,285 153,074 Variable Rate * Avalon at Fairway Hills I Jun-2026 11,500 11,500 * Avalon at Hampton I Jun-2026 8,060 8,060 * Avalon Pointe Jun-2026 6,387 6,387 * Avalon Devonshire Dec-2025 27,305 27,305 -------------- ---------------- 53,252 53,252 Conventional Loans: Fixed Rate Unsecured Senior Notes 7.375% Sep-2002 99,892 99,898 Unsecured Senior Notes 7.035% Dec-2007 109,803 109,808 Unsecured Senior Notes 6.625% Jan-2005 -- 99,977 * Avalon Pines 8.00% Dec-2003 5,433 5,416 * Avalon Walk II 8.93% Nov-2004 12,964 12,911 -------------- ---------------- 228,092 328,010 Variable Rate-None -- -- -------------- ---------------- Total indebtedness - excluding Unsecured Facilities $ 434,629 $ 534,336 ============== ================ Total Maturities ---------------------------------------------------------------------------------- Community 1998 1999 2000 2001 2002 THEREAFTER - ----------------------------- -------- ------------- ----------- -------------- --------------- ------------- Tax-Exempt Bonds: Fixed Rate * Avalon Lea $ -- $ -- $ -- $ -- $ -- $ 16,835 * Avalon Ridge -- -- -- -- -- 26,815 * Avalon at Dulles -- -- -- -- -- 12,360 * Avalon Hampton II -- -- -- -- -- 11,550 * Avalon at Symphony Glen -- -- -- -- -- 9,780 * Avalon View 180 290 330 350 373 17,742 * Avalon at Lexington 170 240 255 271 288 13,791 * Avalon Knoll 124 175 187 200 214 12,978 * Avalon Landing 63 89 95 101 108 6,416 * Avalon West 31 50 53 57 61 8,464 * Avalon Fields 96 137 147 157 169 11,282 -------- ------------- ----------- -------------- --------------- -------------- 664 981 1,067 1,136 1,213 148,013 Variable Rate * Avalon at Fairway Hills I -- -- -- -- -- 11,500 * Avalon at Hampton I -- -- -- -- -- 8,060 * Avalon Pointe -- -- -- -- -- 6,387 * Avalon Devonshire -- -- -- -- -- 27,305 -------- ------------- ----------- -------------- --------------- -------------- -- -- -- -- -- 53,252 Conventional Loans: Fixed Rate Unsecured Senior Notes -- -- -- -- 99,898 -- Unsecured Senior Notes -- -- -- -- -- 109,808 Unsecured Senior Notes -- -- -- -- -- 99,977 * Avalon Pines 86 112 121 131 142 4,824 * Avalon Walk II 149 221 241 264 288 11,748 -------- ------------- ----------- -------------- --------------- -------------- 235 333 362 395 100,328 226,357 Variable Rate-None -- -- -- -- -- -- -------- ------------- ----------- -------------- --------------- -------------- Total indebtedness - excluding Unsecured Facilities $ 899 $ 1,314 $ 1,429 $ 1,531 $ 101,541 $ 427,622 ======== ============= =========== ============== =============== ==============
* Indicates loan is collateralized. 21 24 BUSINESS STRATEGY; INFLATION Management believes that apartment communities present an attractive investment opportunity compared to other real estate investments because a broad potential resident base results in relatively stable demand of all phases of a real estate cycle. The Company intends to pursue appropriate new investments (both acquisitions of new communities and new developments) where constraints to new supply exist and where new household formations have out-paced multifamily permit activity in recent years. The Company has targeted certain high barrier-to-entry markets in the Northeast, Mid-Atlantic and Midwest regions of the United States for investment opportunities. Recently, the Company has begun expanding into selected Pacific Northwest markets and entered into a merger agreement with Bay that will create a combined company with assets in the supply constrained markets of the Mid-Atlantic, Northeast, Midwest and selected West Coast markets. The combined company will have 75% of its assets located in the top 10 apartment markets of the United States, as rated by the January/February 1998 issue of Multi-Housing News. At March 31, 1998, Management had positioned the Company's portfolio of Stabilized Communities, excluding communities owned by joint ventures, to a physical occupancy level of 97.0% and achieved an average economic occupancy of 95.9% for the three months ended March 31, 1998. Average economic occupancy for the portfolio for the three months ended March 31, 1997 was 95.1%. 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 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 May 5, 1998, 12 Development Communities were under construction. The total capitalized cost of these Development Communities, when completed, is currently expected to be approximately $389.2 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 March 31, 1998 and 1997 totaled $2,171,000 and $2,511,000, respectively. The following page presents a summary of Development Communities: 22 25
DEVELOPMENT COMMUNITIES SUMMARY NUMBER OF BUDGETED ESTIMATED ESTIMATED EBITDA AS % APARTMENT COST CONSTRUCTION INITIAL COMPLETION STABILIZATION OF TOTAL HOMES ($ MILLIONS) START OCCUPANCY DATE DATE (1) BUDGETED COST (2) ---------- ----------- ------------- ---------- ------------ -------------- ---------------- Avalon at Fair Lakes Fairfax, VA 234 $ 23.3 Q1 1997 Q4 1997 Q2 1998 Q4 1998 10.4% Avalon at Faxon Park Quincy, MA 171 15.8 Q1 1997 Q4 1997 Q2 1998 Q4 1998 12.1% Avalon Gardens Nanuel, NY 504 53.8 Q3 1996 Q2 1997 Q3 1998 Q1 1999 10.8% Avalon at Cameron Court Alexandria, VA 460 44.7 Q2 1997 Q1 1998 Q4 1998 Q1 1999 11.0% Avalon Fields II Gaithersburg, MD 96 9.2 Q3 1997 Q2 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 Crest Fort Lee, NJ 351 57.4 Q4 1997 Q2 1999 Q4 1999 Q1 2000 10.1% Avalon Cove South Jersey City, NJ 269 51.8 Q1 1998 Q2 1999 Q3 1999 Q4 1999 10.0% Avalon House Bronxville, Ny 110 26.4 Q1 1998 Q2 1999 Q3 1999 Q4 1999 9.7% Avalon Valley Danbury, CT 268 26.1 Q1 1998 Q1 1999 Q3 1999 Q1 2000 10.1% Avalon Lake Danbury, CT 135 17.0 Q2 1998 Q2 1999 Q3 1999 Q1 2000 10.1% Avalon Oaks Wilmington, MA (3) 204 21.9 Q2 1998 Q1 1999 Q3 1999 Q1 2000 10.3% ---------- ----------- ---------------- Total/Average 3,029 $ 389.2 10.3% ========== =========== ================
(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. (3) Financed with tax-exempt bonds. 23 26 DEVELOPMENT RIGHTS The Company is considering the development of 18 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 4,922 institutional-quality apartment homes to the Company's portfolio. At March 31, 1998, the cumulative capitalized costs incurred in pursuit of the 18 Development Rights were approximately $14.4 million, including the capitalized cost of $7.5 million related to the purchase of land in New Canaan, Connecticut. Many of these apartment homes will offer features like those offered by the communities currently owned by the Company. The 18 Development Rights that the Company is currently pursuing are summarized below. DEVELOPMENT RIGHTS SUMMARY
TOTAL ESTIMATED BUDGETED NUMBER OF COST LOCATION HOMES ($ MILLIONS) ------------------ ---------------- -------------- 1. Peabody, MA 434 $ 35.9 2. Hull, MA 162 17.0 3. New Rochelle, NY 408 62.7 4. Stamford, CT 195 30.5 5. Freehold, NJ 452 38.4 6. Herndon, VA 165 19.5 7. Melville - II, NY 340 40.3 8. Orange, CT 172 15.5 9. New Canaan, CT (1) 104 24.1 10. Darien, CT 172 26.1 11. Yonkers, NY 256 33.7 12. Greenburgh - II, NY 500 74.0 13. Greenburgh - III, NY 266 39.3 14. Florham Park, NJ 270 37.5 15. Ridgefield, CT 240 30.2 16. Naperville, IL 200 22.0 17. Westbury, NY 361 47.6 18. Providence, RI 225 26.4 ----------- ----------- Total 4,922 $620.7 =========== ===========
(1) Currently anticipated that the land seller will retain a minority limited partnership interest. 24 27 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Neither the Company nor any of the communities is presently subject to any material litigation nor, to the Company's knowledge, is any litigation threatened against the Company or any of the communities, other than routine actions for negligence or other claims and administrative proceedings arising in the ordinary course of business, some of which are expected to be covered by liability insurance and all of which collectively are not expected to have a material adverse effect on the business or financial condition 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 On January 22, 1998, the Company completed a $100,000,000 offering of unsecured senior notes. The notes bear an interest rate at 6.625% payable semi-annually on January 15 and July 15 and will mature on January 15, 2005. The notes were sold at a price of 99.976% par value to yield 6.629% to maturity or a 111 basis point spread over the 7-year U.S. Treasury Note rate. The Company used the net proceeds of approximately $99,400,000 to repay amounts outstanding under the Unsecured Facilities. On January 27, 1998, the Company completed the sale of 923,856 shares of Common Stock to The Prudential Insurance Company of America under its existing shelf registration statement at a net purchase price of $29.09 per share. The net proceeds of approximately $26,872,000 were used to retire indebtedness under the Unsecured Facilities. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a) Exhibit No. Description 27.1 Financial Data Schedule - Q1 1998 27.2 Financial Data Schedule - Q1 1997 b) On January 15, 1998, the Company filed a Current Report on Form 8-K, reporting under item (5) the pursuit of certain investment opportunities in Boston, Massachusetts and the Pacific Northwest. On January 26, 1998, the Company filed a Current Report on Form 8-K relating to the offering and sale of $100,000,000 aggregate principal amount of the Company's 6 5/8% Senior Notes due 2005. On March 10, 1998, the Company filed a Current Report on Form 8-K, as amended and restated by Form 8-K/A on March 12, 1998, reporting under item (5) the merger agreement between the Company and Bay Apartment Communities, Inc. 25 28 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: May 12, 1998 By /s/ RICHARD L. MICHAUX ------------------------------------------ Richard L. Michaux, Chairman of the Board, Chief Executive Officer and Director (Principal Executive Officer) Date: May 12, 1998 By /s/ THOMAS J. SARGEANT ------------------------------------------ Thomas J. Sargeant, Chief Financial Officer, Treasurer and Secretary (Principal Financial and Accounting Officer) 26 EX-27.1 2 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS DEC-31-1998 JAN-01-1998 MAR-31-1998 3,497 0 0 0 0 16,404 1,622,514 78,994 1,611,113 47,394 558,336 0 88 431 988,697 989,216 0 56,452 0 30,179 0 0 6,540 18,869 0 0 0 0 0 18,869 .33 .33
EX-27.2 3 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS DEC-31-1997 JAN-01-1997 MAR-31-1997 3,036 0 0 0 0 12,719 1,173,435 50,784 1,158,269 35,982 310,334 0 88 335 734,330 1,158,269 0 37,527 0 20,013 0 0 3,717 14,296 0 0 0 1,183 0 13,113 .24 .24
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