ITEM 1. BUSINESS
SECURITY CAPITAL ATLANTIC INCORPORATED
The objective of Security Capital Atlantic Incorporated ("ATLANTIC") is to be the preeminent multifamily real estate operating company in its target market. ATLANTIC is an internally managed, fully integrated operating company with 90 professionals and 520 property-level and support personnel dedicated to carrying out its operating strategy which focuses on the development, acquisition, operation and long-term ownership of multifamily communities. ATLANTIC is a Maryland corporation and has elected to be taxed as a real estate investment trust ("REIT") for federal income tax purposes.
At January 31, 1998, ATLANTIC's portfolio consisted of 28,468 multifamily units, including 6,775 units under construction or in planning, in 17 metropolitan areas and 51 submarkets in growth areas of the south-Atlantic, mid-Atlantic and midwestern regions of the United States. At January 31, 1998, the total expected investment of ATLANTIC's 77 operating communities, including budgeted capital expenditures, was approximately $1.15 billion and the total budgeted development cost of ATLANTIC's 24 communities under construction or in planning was approximately $450.8 million. Additionally, at January 31, 1998, ATLANTIC had land in planning and under control for the development of 1,752 units with a total budgeted development cost of $126.3 million.
To achieve long-term sustainable growth in per share cash flow, ATLANTIC utilizes a highly-focused, value-added operating system. This system is designed to maximize the operating performance of its core portfolio and concentrates its experienced team of professionals on developing and acquiring industry-leading product in targeted submarkets exhibiting strong job growth and favorable demographic trends. Since its inception in 1993, ATLANTIC has employed a research-driven investment approach, deploying its capital in markets and submarkets that exhibit strong long-term market fundamentals. Additionally, ATLANTIC's investment strategy targets one of the largest and most underserved segments of the renter population utilizing a pricing strategy that appeals to the value-conscious resident. See "--Business Strategy--Investment Strategy--Value-Conscious Pricing Approach".
The table below illustrates the growth in ATLANTIC's multifamily portfolio resulting from the execution of its investment strategy (in thousands):
- -------- (1) For operating communities, represents cost, plus budgeted capital expenditures. For communities under construction and in planning, represents total budgeted development cost, which includes the cost of land,
fees, permits, payments to contractors, architectural and engineering fees and interest and property taxes to be capitalized during the construction period. (2) The term "in planning" means that construction is anticipated to commence within 12 months. The term "under control" means that ATLANTIC has an exclusive right (through a contingent contract or letter of intent) during a contractually agreed-upon time period to acquire land for future development of multifamily communities, but does not currently own the land. (3) Does not include land held for future development (construction is not anticipated to commence in the next 12 months), which is less than 1% of assets, based on cost.
The ownership of the common equity of ATLANTIC by Security Capital Group Incorporated ("Security Capital"), ATLANTIC's principal shareholder, dropped from 56.9% at December 31, 1996 to 49.9% at December 31, 1997. Security Capital's ownership interests in the other operating companies in which it invests are generally between 30% and 50%. By not participating in ATLANTIC's future securities offerings on a proportionate basis, Security Capital intends to allow its ownership in ATLANTIC to drop further such that its ownership level in ATLANTIC is more consistent with its other interests.
1997 STRATEGIC ACCOMPLISHMENTS
Operating Accomplishments
. ATLANTIC's growth in 1997 was driven by its successful investment strategy with 50% of growth in its funds from operations produced by the stabilization of new development communities and 28% by the positive impact of acquisitions completed in 1996 and 1997. ATLANTIC's communities that were fully operational throughout 1997 and 1996 realized an increase in adjusted net operating income of 3.49% and generated 22% of ATLANTIC's funds from operations growth. The contribution of ATLANTIC's development activities to funds from operations growth occurred even though the short-term dilution resulting from these activities was greater in 1997 than in 1996 (average of $250.6 million of assets under development or in lease-up during 1997 as compared to $168.4 million during 1996). As these communities reach stabilization in 1998 and subsequent years, they are expected to add significantly to ATLANTIC's long-term performance.
. ATLANTIC generated earnings from operations of $51.1 million in 1997, an increase of $18.1 million over 1996. ATLANTIC's cash flow from operations was $83.1 million for 1997 as compared to $54.4 million for 1996. ATLANTIC's 45 communities that were fully operating for both 1996 and 1997 realized an increase in adjusted net operating income of 3.49%. This increase is the result of a 1.95% increase in ATLANTIC's collections and a 0.47% decrease in ATLANTIC's operating expenses.
. On September 9, 1997, ATLANTIC became an internally managed REIT when it acquired the operations and business of its external REIT management and property management companies in exchange for 2,306,591 shares of ATLANTIC's common stock. Both companies were owned by Security Capital. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations--Merger Transaction".
Investment Accomplishments
. The development of multifamily communities continues to be a major component of ATLANTIC's investment strategy. During 1997, ATLANTIC commenced construction on 3,892 units at a total expected investment of $264.7 million. Of that total, 73.7% were communities that are targeted to the moderate income resident.
. In 1997, ATLANTIC completed construction of seven communities aggregating 2,124 units at a total expected investment of $132.2 million.
. Five developed communities representing a total expected investment of $109.5 million achieved stabilization in 1997, adding 1,892 units to ATLANTIC's stabilized portfolio.
. ATLANTIC continues to take advantage of attractive investment opportunities throughout its target market. During 1997, ATLANTIC acquired six operating communities in five primary target market cities consisting of 1,220 units at a total expected investment of $59.9 million.
. As a result of ATLANTIC's market research efforts, ATLANTIC entered two new markets, Columbus, Ohio and Indianapolis, Indiana, in 1997. These markets have attractive supply and demand characteristics and provide opportunities for long-term growth. ATLANTIC intends to build a regional presence in the midwestern region of the United States.
. ATLANTIC completed the disposition of five communities in 1997 which were no longer consistent with its long-term investment objectives and redeployed the proceeds into strategic acquisitions and developments. ATLANTIC realized an aggregate gain of $1.6 million on proceeds of $66.5 million from these dispositions.
.In 1997, ATLANTIC invested in mortgage notes that are convertible into the common stock of an affiliated, extended-stay lodging company, Homestead Village Incorporated ("Homestead"). At December 31, 1997, these convertible mortgage notes had a fair value of $122.5 million (principal amount of $93.5 million) and were received in exchange for funding $106.0 million of the $111.1 million required by a funding commitment agreement. ATLANTIC expects to fund additional amounts in 1998 increasing the principal amount of the convertible mortgage notes to $98.0 million. As of December 31, 1997, assuming expected full funding and that the mortgage notes are fully converted and assuming the closing price of Homestead common stock on that date, this investment would result in $0.64 of additional value to ATLANTIC's shareholders for each share of common stock owned. See "Item 7. Management's Discussion of Financial Condition and Results of Operations--Liquidity and Capital Resources--Homestead Convertible Mortgages".
Financing Accomplishments
.In July 1997, ATLANTIC received an investment grade rating on its senior unsecured debt. In August 1997, ATLANTIC completed an offering of $100 million of 7.25% senior unsecured notes due 2009 and $50 million of 7.86% senior unsecured notes due 2017. Proceeds from the offering were approximately $148.6 million, net of costs.
. In August 1997, ATLANTIC completed an initial offering of preferred stock. Proceeds from the offering were approximately $48.1 million, net of costs.
. During 1997, ATLANTIC's interest rate on its unsecured line of credit was reduced from LIBOR plus 1.375% to LIBOR plus 0.75%. Additionally, under a new competitive bid option, ATLANTIC may be able to borrow at a lower interest rate spread over LIBOR, depending on market conditions. This option is available on up to $175 million of borrowings on the unsecured line of credit.
. ATLANTIC arranged for a $25 million unsecured line of credit in June 1997 (which was increased to $50 million in January 1998). This line of credit allows ATLANTIC to make same-day borrowings at an overnight interest rate and provides ATLANTIC with additional flexibility in managing its outstanding borrowings and minimizing idle cash balances, thus reducing interest expense.
. In connection with ATLANTIC's acquisition of the management companies owned by Security Capital, ATLANTIC's common shareholders (other than Security Capital) received warrants from Security Capital in September 1997 to purchase 1,675,940 shares of Security Capital's Class B common stock at a price of $28.00 per share.
. ATLANTIC completed a rights offering of common stock in September 1997 at a price of $22.375 per share, generating proceeds of approximately $56.5 million, net of costs.
. ATLANTIC closed two public common stock offerings in 1997, in addition to the rights offering described above, raising net proceeds of $89.6 million.
. In November 1997, a $500 million shelf registration statement was declared effective by the Securities and Exchange Commission. These securities can be issued in the form of senior unsecured debt, preferred stock or common stock on an as-needed basis, subject to ATLANTIC's ability to effect an offering on satisfactory terms. On December 31, 1997, ATLANTIC had $492.6 million of unissued securities available under the shelf registration.
. ATLANTIC's long-term debt as a percentage of total long-term undepreciated book capitalization (the sum of long-term debt and shareholders' equity after adding back accumulated depreciation) was 25.1% at December 31, 1997, a level that provides considerable financial flexibility to ATLANTIC.
ATLANTIC's 1997 strategic accomplishments, highlighted above, are discussed further in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" and in the notes to the Financial Statements in Item 14.
BUSINESS STRATEGY
Overview
To achieve its objective of being the preeminent multifamily real estate operating company in its target market, ATLANTIC has identified a business strategy that includes an operational, investment and financing focus. In addition, ATLANTIC has put an "Operating System" in place that it believes will enable it to successfully carry out this business strategy. ATLANTIC believes that its business strategy and "Operating System" (discussed below) position ATLANTIC to achieve long-term growth in per share cash flow and distributions to its shareholders.
Investment Strategy
ATLANTIC's investment strategy is focused in these areas: extensive real estate research, strong target market, development of multifamily communities, opportunistic acquisitions, value-conscious pricing approach and portfolio and asset optimization.
Extensive Real Estate Research
ATLANTIC is dedicated to ongoing research and development related to markets and products. ATLANTIC conducts comprehensive evaluations of its target market on a submarket-by-submarket basis to identify those submarkets and product types that present attractive growth opportunities. These evaluations, combined with ATLANTIC's extensive market experience in the south-Atlantic, mid-Atlantic and midwestern regions of the United States, enable ATLANTIC to identify submarkets that offer continued opportunities for favorable yields and long-term growth in per share cash flow. In addition to market research, considerable resources are devoted to product research. ATLANTIC continually evaluates and refines its multifamily communities to incorporate technologies and designs that will enhance the long-term livability for its residents.
Strong Target Market
ATLANTIC's south-Atlantic, mid-Atlantic and midwestern target market exhibits strong long-term market fundamentals and provides opportunity for favorable yields and growth on a long-term basis. ATLANTIC believes that population and employment growth are the primary demand generators for multifamily communities. Accordingly, ATLANTIC has identified the following primary target market cities: Atlanta, Georgia; Charlotte, North Carolina; Columbus, Ohio; Indianapolis, Indiana; Nashville, Tennessee; Orlando, Florida; Raleigh, North Carolina; Richmond, Virginia; Southeast Florida (which includes Ft. Lauderdale and West Palm Beach); Tampa, Florida; and Washington, D.C. Based on forecasts published by Woods & Poole Economics, Inc., the projected population growth in ATLANTIC's primary target market cities is 33.7% for the years 1998 through 2017, whereas the projected population growth of the United States as a whole for the same period is 16.7%. For the years 1998 through 2017, job growth is projected to be 27.3% in ATLANTIC's primary target market cities, compared to 19.4% for the United States as a whole. ATLANTIC is continually researching additional submarkets and cities and may add or delete primary target market cities in the future based upon the results of this research.
Development of Multifamily Communities
ATLANTIC's research-driven investment strategy also includes the development of state of the art communities in attractive submarkets that respond to renter preferences and demographic trends. ATLANTIC
believes that developing communities designed for long-term appeal to the renter population will allow ATLANTIC to achieve more consistent rental rate increases and higher occupancies over the long term and thereby realize strong per share cash flow growth. ATLANTIC intends to be a long-term owner of the communities that it develops. Hence, ATLANTIC emphasizes long-term durability by using materials and designs that minimize ongoing operation and maintenance costs.
ATLANTIC carefully manages development risks by obtaining zoning and public approvals prior to purchasing land. ATLANTIC does not take construction risk, but instead uses qualified third-party general contractors to build its communities, using guaranteed maximum price contracts. ATLANTIC also targets markets for development that exhibit population and job growth fundamentals that indicate increases in demand for multifamily product over the long term. ATLANTIC cannot eliminate all development risk, but believes that the opportunities to better control its product and realize higher returns from development communities compensate for any additional risk.
In most cases, ATLANTIC will commence development immediately after acquiring a tract of land. However, in cases where land prices are favorable, ATLANTIC has acquired and will continue to acquire, on an unleveraged basis, prudent amounts of zoned land for the future development of multifamily communities. In addition, to provide for growth, ATLANTIC may utilize options and rights of first refusal in order to control land for the future development of communities.
Over an extended period, management believes that operating results from ATLANTIC's development communities will contribute significantly to ATLANTIC's per share cash flow growth. By year-end 1998, ATLANTIC anticipates that approximately 48.7% of its total portfolio, based on total expected investment, will consist of communities ATLANTIC has developed or is in the process of developing.
Opportunistic Acquisitions
ATLANTIC realizes it is often advantageous to acquire existing multifamily communities in markets that are expected to experience favorable growth in occupancies and rental rates. In many cases, communities can be acquired and redeveloped at prices well below the cost to build a comparable community in the same area. Through the acquisition of an existing operating community, ATLANTIC can obtain a presence in that submarket and benefit from the favorable market conditions.
ATLANTIC's investment professionals have the capability to thoroughly analyze and evaluate communities in an efficient manner which, together with ATLANTIC's access to capital, provides ATLANTIC with a competitive advantage in acquiring multifamily communities. This strategy has resulted in multifamily community acquisitions that have produced attractive returns.
In 1997, ATLANTIC acquired six operating communities consisting of 1,220 units in five primary target market cities, representing a total expected investment of $59.9 million.
Value-Conscious Pricing Approach
ATLANTIC utilizes a price-point strategy in determining the type of multifamily community that is best suited for a particular submarket and prices its units at a level that will appeal to the value-conscious resident. These residents typically fall into the category of moderate income households with incomes ranging from 65% to 90% of the submarket median household income or middle income households with incomes ranging from 90% to 115% of the submarket median household income (as compared to 115% to 140% for upper middle income households). These residents typically are couples, single parents and families with one or two children whose primary focus is on unit livability and practical amenities such as washer/dryer hookups, storage space and playgrounds, in addition to the physical characteristics of the community. ATLANTIC prices the monthly rental rate for units in these communities at $50 to $200 below that of other communities in the submarket that appeal to higher income residents.
ATLANTIC believes that the moderate income segment in particular is a significantly underserved market with limited competition because few competitors in ATLANTIC's primary target market currently focus on communities that appeal to these residents. Also, the lack of financial resources prevents these residents from relocating frequently. Therefore, resident turnover is often significantly lower for these residents. Because the cost of refurbishing and re-leasing a unit ranges from $700 to $1,500, lower resident turnover can have a material impact on a community's profitability. Due to these positive operating characteristics and market fundamentals, ATLANTIC believes that, by focusing on the value-conscious resident, it is favorably positioned to achieve sustainable cash flow growth.
Of ATLANTIC's total portfolio at January 31, 1998, 59 communities with a total expected investment of $897.4 million are communities that are targeted to the moderate income resident. ATLANTIC has 35 communities, with a total expected investment of $564.6 million, that are targeted to the middle income resident because these communities provide some additional amenities. The remaining 7 communities in ATLANTIC's portfolio provide extensive amenities to its residents and are categorized as upper middle income communities. These communities have a total expected investment of $134.0 million.
Portfolio and Asset Optimization
ATLANTIC develops and acquires communities with a view to effective long- term operation and ownership. However, ATLANTIC continually reviews its asset base in light of prevailing market conditions. These reviews assist ATLANTIC in identifying communities in its portfolio that no longer meet its long-term investment objectives. ATLANTIC's asset optimization program allows ATLANTIC to dispose of such assets and redeploy the proceeds, preferably through tax- deferred exchanges, into assets with better prospects for long-term cash flow growth. ATLANTIC's asset optimization strategy is based on the premise that it has a finite amount of investment capital and that this capital should be deployed where it can produce maximum per share cash flow growth. During 1997, ATLANTIC disposed of five operating communities aggregating 1,396 units. These dispositions produced an aggregate gain of $1.6 million on proceeds of $66.5 million, which were redeployed into existing multifamily communities or land to be used for the future development of multifamily communities.
Operating Strategy
As part of ATLANTIC's strategy to increase cash flow and enhance the long- term economic performance of its communities, ATLANTIC actively manages its communities and its operating personnel maintain a customer-driven focus. Approximately 95% of ATLANTIC's operating multifamily units are managed internally, with the balance in various stages of transition from third-party management companies. ATLANTIC's network of 11 local property management offices improves ATLANTIC's ability to respond to changes in local market conditions and in particular to its residents' specific needs. ATLANTIC's operating personnel are dedicated to maximizing the performance of ATLANTIC's communities by providing consistent high-quality customer services to its residents.
ATLANTIC believes that the underlying long-term fundamentals of its target market, including its continued job and population growth, should continue to support strong occupancy levels and allow for consistent increases in rental income. Additionally, ATLANTIC expects to reduce operating costs and improve profit margins through operating efficiencies resulting from the purchasing power and name recognition which result from holding a critical mass in a market and by lower resident turnover from ATLANTIC's increasing focus on value-conscious residents.
Financing Strategy
ATLANTIC's ability to efficiently access the capital markets permits it to capitalize on the development and acquisition opportunities that exist in its target market. In addition, the borrowing capacity available through ATLANTIC's $350 million and $50 million unsecured lines of credit enables ATLANTIC to react quickly to
investment opportunities between securities offerings. ATLANTIC's long-term debt as a percentage of total long-term book capitalization was 25.1% at December 31, 1997, a level that provides considerable flexibility for ATLANTIC to prudently utilize long-term debt as a financing tool in the future. Accordingly, ATLANTIC expects to arrange additional fully amortizing, fixed rate, long-term unsecured debt in the future, the proceeds of which will be used primarily for the reduction of line of credit balances incurred as a result of ATLANTIC's investment activities.
As of March 18, 1998, $211.9 million of borrowings were outstanding under the $350 million and $50 million unsecured lines of credit. ATLANTIC's conservative financing strategy to date has provided ATLANTIC with significant incremental debt capacity and is expected to allow ATLANTIC to take advantage of future investment opportunities on a non-dilutive basis, contributing to ATLANTIC's objective of long-term growth in per share cash flow.
OPERATING SYSTEM
Overview
ATLANTIC has 90 professionals and 520 property-level and support personnel dedicated to implementing its highly focused business strategy. In addition to its own personnel, ATLANTIC receives specialized research and administrative services from personnel of Security Capital under an administrative services agreement (the "ASA"). The specialized research and administrative services provided to ATLANTIC under the ASA supplement the work done by ATLANTIC's employees. Security Capital has invested in sophisticated systems and high quality personnel to provide these types of services to its investees, including ATLANTIC. Accordingly, ATLANTIC can obtain these services at a lower cost than the cost ATLANTIC would incur to perform these functions internally. These services are provided at ATLANTIC's option and include payroll and tax administration services, cash management and accounts payable services, data processing and other computer services, human resources, research, insurance administration and legal administration. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations--Merger Transaction".
ATLANTIC believes that its employees along with the services procured from Security Capital under the ASA provide ATLANTIC with high quality and depth of management personnel and resources. These resources are organized into six functional areas which comprise ATLANTIC's "Operating System": research; due diligence and investment analysis; acquisitions; multifamily developments; property management; and capital raising and finance. By focusing on a single discipline, professionals within each of these areas develop substantial expertise. While the interaction and communication among these functional areas remain fluid, the separation promotes certain checks and balances.
Research
ATLANTIC has access, through the ASA, to experienced personnel who are dedicated to the research function. These research specialists conduct comprehensive proprietary evaluations of ATLANTIC's target market on a submarket-by-submarket basis taking into account 24 key variables that have been identified as having the greatest impact on multifamily operating performance. These variables include market demand analysis, detailed supply evaluations of each submarket and other economic and demographic data. This research provides ATLANTIC with the information needed to target specific resident profiles and identify the unit mix, density and amenities that will provide the greatest opportunity for consistent rental rate increases and high occupancies for a particular community.
In addition to dedicated market research and continuous refinement of the traditional multifamily product, considerable resources are devoted to researching new products and businesses. These research and development efforts resulted in the creation of a state of the art extended-stay lodging product, Homestead Village (R). ATLANTIC's investment in Homestead Village (R) properties was sold to the newly formed growth company,
Homestead, in 1996. This transaction resulted in a special distribution to ATLANTIC's shareholders and in ATLANTIC's current investment in convertible mortgage notes from Homestead ("Homestead Convertible Mortgages"). See "Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations--Homestead Transaction" and "-- Liquidity and Capital Resources--Homestead Convertible Mortgages".
Due Diligence and Investment Analysis
ATLANTIC has three full-time professionals dedicated to performing intelligent and thorough due diligence. Prospective property investments are analyzed pursuant to several underwriting criteria, including purchase price, competition and other market factors, and prospects for long-term growth in cash flow. ATLANTIC's investment decisions are based upon the expected contribution of the community to long-term cash flow growth on an unleveraged basis. The expected economic contribution is based on an evaluation of a community's stabilized operations, including an estimate of all cash revenues from leases and other revenue sources, minus expenses incurred in operating the community including real estate taxes, insurance, maintenance, turnover costs (such as carpet and appliance replacement), personnel costs, utility charges and a reserve for capital expenditures.
ATLANTIC believes that its investment committees provide discipline and guidance to its investment process and enable ATLANTIC to achieve its investment goals. All acquisition and development investments must be approved by a four-member investment committee comprised of senior officers and ultimately by the investment committee of ATLANTIC's Board of Directors (the "Board"). The four members of ATLANTIC's senior officer investment committee have a combined 99 years experience in the real estate industry. See "-- Directors and Officers of ATLANTIC". The investment committee receives detailed written analyses and research, in a standardized format, and evaluates all prospective investments pursuant to uniform underwriting criteria prior to making a final determination. The quality of the investment committee process is demonstrated by ATLANTIC's ability to achieve its investment goals with respect to initial return and growth projections.
Acquisitions
ATLANTIC's initial investment activity was concentrated on the acquisition of operating communities in order to provide a base of established multifamily communities to generate cash flow while ATLANTIC's internal development process was put into place. ATLANTIC continues to opportunistically acquire multifamily communities where demographic and market trends indicate a high likelihood of achieving superior operating results. As of January 31, 1998, ATLANTIC's portfolio of communities acquired, net of dispositions, aggregated 18,055 operating units, representing a total expected investment of $932.2 million.
Upon acquisition, ATLANTIC will classify a community as "pre-stabilized". The term "pre-stabilized" means that renovation, repositioning, new management and new marketing programs have not been completed and in effect for a sufficient period of time to achieve 93% occupancy at market rents. Once these programs are completed, a community is then classified as "stabilized". For operating communities acquired by ATLANTIC, stabilized operations generally have been achieved between six and 12 months after acquisition.
Multifamily Developments
ATLANTIC has 15 professionals with substantial multifamily development experience dedicated to its objective of developing state of the art communities designed for long-term appeal to the renter population. ATLANTIC has selectively developed multifamily communities where land costs and demographic and market trends indicate a high likelihood of achieving attractive, sustainable operating results. As of January 31, 1998, ATLANTIC's completed development communities and its owned communities both under construction and in
planning together comprised 42% of its multifamily portfolio, based on total expected investment. As of January 31, 1998, the development portion of ATLANTIC's multifamily portfolio consisted of the following (dollar amounts in thousands):
- -------- (1) For completed communities, represents cost, plus budgeted capital expenditures. For communities under construction and in planning, represents total budgeted development cost, which includes the cost of land, fees, permits, payments to contractors, architectural and engineering fees and interest and property taxes to be capitalized during the construction period. (2) The term "in planning" means that construction is anticipated to commence within 12 months. (3) Does not include land in planning and under control for the development of 1,752 units with a total budgeted development cost of $126.3 million. The term "under control" means that ATLANTIC has an exclusive right (through a contingent contract or letter of intent) during a contractually agreed- upon time period to acquire land for future development of multifamily communities, but ATLANTIC does not currently own the land. (4) Does not include land held for future development (construction is not anticipated to commence in the next 12 months), which is less than 1% of assets, based on cost.
For communities that it is developing, ATLANTIC expects stabilized operations generally to be achieved 12 to 18 months after construction commences. Once a community is completed, it is classified as a pre-stabilized operating community. The community is considered stabilized when it has achieved 93% occupancy at market rents.
Property Management
ATLANTIC emphasizes locally based management through its 11 local offices and its approximately 540 employees working in the property management area. This network allows ATLANTIC to respond quickly to changes in local market conditions and resident needs. ATLANTIC believes it has superior operating procedures, financial controls, information systems and training programs in place and that its property management system positively affects rental returns and occupancy rates. In addition, ATLANTIC utilizes incentive compensation programs for on-site property managers to further improve the performance of the communities. ATLANTIC's strong property management system has contributed to the positive operating results of ATLANTIC's "same store" communities. Net operating income on a same store basis increased 3.49% from 1996 to 1997 for the 45 communities that were fully operational during both periods. See "Item 7. Management's Discussion of Financial Condition and Results of Operations--Results of Operations--Communities Fully Operating Throughout Both Periods--Operating Summary".
ATLANTIC recognizes that a highly focused customer service approach to day- to-day management is essential to maximizing short-term and long-term cash flow from each of its multifamily communities. As a result, ATLANTIC's professionals focus only on ATLANTIC's communities and the needs of ATLANTIC's residents. ATLANTIC's property management personnel work closely together with ATLANTIC's other real estate professionals to develop innovative new programs to maintain high resident satisfaction while maximizing cash flow. Key programs initiated by ATLANTIC's property management team include:
. Revenue sharing arrangements: Agreements with certain cable television and telephone service providers that increase the quality and accessibility of these services to residents and allow ATLANTIC to receive
a percentage of the service providers' revenues generated from subscribing residents. Additionally, these agreements require the telecommunications providers to continually upgrade service to ensure state of the art offerings in this rapidly changing industry.
. Utility submetering: ATLANTIC has implemented submetering programs at approximately 43% of its operating communities as of December 31, 1997 and expects to increase this to approximately 71% of its operating communities by the end of 1998. Under this program, water and sewer usage is individually metered and billed, enabling ATLANTIC to better control operating expenses while providing residents with the incentive to minimize usage.
. Vendor management: ATLANTIC has negotiated purchase agreements with a select group of vendors for its 21 operating communities in Atlanta. These agreements, primarily in the landscaping, make-ready, maintenance and marketing areas, provide ATLANTIC with volume discounts on high quality services and products. By contracting exclusively with these vendors, ATLANTIC's communities benefit from reductions in operating expenses as well as assuring continuity of quality customer service to its residents. ATLANTIC is making similar arrangements in Raleigh and Southeast Florida.
Capital Raising and Finance
ATLANTIC has a team of professionals in place with far reaching experience in the areas of capital raising and finance. Under the ASA, ATLANTIC can utilize Security Capital Markets Group Incorporated ("Capital Markets Group"), a registered broker/dealer subsidiary of Security Capital, to maximize the effectiveness of its financing activities and provide access to major institutional investors. The strategic vision of ATLANTIC's finance professionals has taken ATLANTIC from a privately held to a publicly traded REIT and has produced a conservative balance sheet that provides significant incremental debt capacity that will allow ATLANTIC to take advantage of future investment opportunities.
ATLANTIC raised approximately $700 million through private placements of its Common Shares prior to its initial public offering in October 1996 which raised additional net proceeds of approximately $110 million. Since the initial public offering, ATLANTIC has raised approximately $343 million in net proceeds from public offerings of both debt and equity securities with unaffiliated underwriters or Capital Markets Group, as placement agent.
To meet its short-term borrowing needs, ATLANTIC has a $350 million unsecured line of credit that provides for interest at LIBOR plus 0.75%. ATLANTIC can reduce the margin it pays on this line of credit through a competitive bid option covering up to $175 million of borrowings. ATLANTIC has an additional $50 million unsecured line of credit that allows for same-day borrowings at an overnight interest rate. This facility provides ATLANTIC with additional flexibility to manage its outstanding borrowings and minimize idle cash balances, thus reducing interest expense.
ATLANTIC has a credit enhancement agreement with the Federal National Mortgage Association ("FNMA") covering its tax-exempt bond issues. The agreement allowed ATLANTIC to receive a favorable interest rate on the bond issues and required ATLANTIC to enter into swap agreements to mitigate the interest rate exposure on the nine bond issues with variable interest rates. As a result of the credit enhancement agreement and the swap agreements, ATLANTIC pays interest on these nine variable rate bond issues at an all-in, fixed rate of 6.61%.
DIRECTORS AND OFFICERS OF ATLANTIC
Directors
MANUEL A. GARCIA III--54--Director of ATLANTIC since December 1995 and a Director of Homestead Village Incorporated since April 1997. Since May 1969, Mr. Garcia has been Chief Executive Officer of Davgar Restaurants, Inc. where he is the owner/operator of ten Burger King Restaurants in central Florida, five Pebbles Restaurants, Harvey's Bistro and Manuel's on the 28th Restaurant in Orlando, Florida. Mr. Garcia is a Director
of The Foundation for Orange County Public Schools and the Florida Cities Sports Association and is National Director of Cities in Schools. Mr. Garcia is also a member of the Board of the National Conference of Christians and Jews and an Honorary Director of the Boys' Clubs and Boy Scouts of Central Florida. Mr. Garcia was a member of former President Bush's Drug Advisory Council.
NED S. HOLMES--53--Director of ATLANTIC since May 1994. Mr. Holmes has been the President and Chief Executive Officer of Laing Properties, Inc. since May 1990 and Chairman and President of Parkway Investment/Texas Inc., a Houston- based real estate investment and development company which specializes in residential (apartment and townhouse), commercial (office and warehouse) and subdivision projects since April 1984. Mr. Holmes is a Director of Heritage Bank, a Director of Commercial Bancshares, Inc. and Chairman of the Port Commission of the Port of Houston Authority. He also serves as a Director of the Institute of International Education, the Houston International Protocol Alliance and is Vice Chairman of Greater Houston Partnership.
CONSTANCE B. MOORE--42--Co-Chairman, Chief Operating Officer and Director of ATLANTIC since January 1996, where she has overall responsibility for operations. Ms. Moore had comparable responsibilities with ATLANTIC's former REIT manager from January 1996 to September 1997. From May 1994 to December 1995, Ms. Moore was Managing Director of Security Capital Pacific Trust ("PTR") and Director and Managing Director of PTR's former REIT manager where she had overall responsibility for operations. She was Senior Vice President of Security Capital from March 1993 to April 1994 and is a Director of the National Multi Housing Council.
JAMES C. POTTS--51--Co-Chairman and Chief Investment Officer of ATLANTIC since January 1996 and Director of ATLANTIC since October 1993, where he has overall responsibility for investments. Mr. Potts was Chairman of ATLANTIC from May 1994 to December 1995 and he had comparable responsibilities with ATLANTIC's former REIT manager from October 1993 to September 1997. From December 1992 to April 1994, Mr. Potts was Managing Director of PTR's former REIT manager, where he supervised the asset management of all of PTR's multifamily communities and oversaw the relationship of PTR's REIT manager and property manager, which provided on-site management for these communities.
JOHN M. RICHMAN--70--Director of ATLANTIC since September 1996. Mr. Richman has been Counsel to the law firm of Wachtell, Lipton, Rosen & Katz since January 1990. He was Chairman and Chief Executive Officer of Kraft, Inc. from 1979 to 1989, prior to which he was Senior Vice President--Administration and General Counsel of that company. He is a Director of BankAmerica Corporation and Bank of America National Trust and Savings Association, USX Corporation, and Stream International Inc. He is a Trustee of the Chicago Symphony Orchestra, Northwestern University and The Johnson Foundation. He is a retired director of R.R. Donnelley & Sons Company and served as Acting Chairman and Chief Executive Officer of that company from October 1996 to April 1997. Mr. Richman is a Director of The Chicago Council on Foreign Relations and Lyric Opera of Chicago and a member of The Business Council, The Commercial Club of Chicago and the Economic Club of Chicago.
C. RONALD BLANKENSHIP--48--Advisory Director of ATLANTIC since September 1996 and Director from April 1996 to September 1996. Mr. Blankenship has been Non-Executive Chairman of PTR since June 1997 and Chairman of PTR from June 1991 to June 1997, where he supervises the overall operations of PTR. He was Chairman of PTR's former REIT manager from March 1991 to September 1997 and he has served as Trustee of PTR since June 1991. Mr. Blankenship has been Managing Director of Security Capital since March 1991, and has served as an Advisory Director of Homestead Village Incorporated since October 1996. Mr. Blankenship has served as a Director of Storage USA, Inc. since December 1997.
Senior Officers
ATLANTIC believes that management should have several senior executives with the leadership, operational, investment and financial skills and experience to oversee its entire operations. ATLANTIC believes
that several of its senior officers could serve as the principal executive officer and continue ATLANTIC's performance. The executive officers of ATLANTIC are listed below. All of the executive officers are employees of ATLANTIC except for Mr. Klopf who is an employee of Security Capital. Mr. Klopf's services are provided to ATLANTIC under the ASA.
Members of ATLANTIC's Investment Committee are designated by an asterisk.
*CONSTANCE B. MOORE--See--"Directors".
*JAMES C. POTTS--See--"Directors".
*J. LINDSAY FREEMAN--52--Managing Director of ATLANTIC since December 1997 where he has responsibility for operations and Senior Vice President of ATLANTIC from May 1994 to November 1997. Mr. Freeman had comparable responsibilities with ATLANTIC's former REIT manager from May 1994 to September 1997 and was a Director of that company from March 1995 to September 1997. From June 1980 to March 1994, Mr. Freeman was Senior Vice President and Operating Partner of Lincoln Property Company in Atlanta, Georgia, where he was responsible for acquisitions, financing, construction and management of multifamily communities within the Atlantic region and oversaw operations of 16,000 multifamily units.
*BRADLEY C. MILLER--50--Managing Director of ATLANTIC since December 1997 where he is responsible for investments and Senior Vice President of ATLANTIC from June 1996 to November 1997. Mr. Miller had comparable responsibilities with ATLANTIC's former REIT manager from June 1996 to September 1997 and was Director of that company from February 1997 to September 1997. From October 1979 to May 1996, Mr. Miller was Senior Vice President and Operating Partner of Lincoln Property Company in Tampa, Florida, where he was responsible for acquisitions, financing, construction and management of multifamily properties within the Atlantic region and oversaw the development of over 6,500 new multifamily units and operations of 11,000 multifamily units.
WILLIAM KELL--41--Senior Vice President of ATLANTIC since December 1997 and Controller of ATLANTIC since January 1996, where he supervises accounting and financial reporting for ATLANTIC and Vice President of ATLANTIC from January 1996 to November 1997. Mr. Kell was Vice President of ATLANTIC's former REIT manager from January 1996 to September 1997 where he had comparable responsibilities. From June 1991 to December 1995, Mr. Kell was Vice President and Controller of PTR, where he had overall responsibility for multifamily accounting and financial reporting.
JEFFREY A. KLOPF--49--Senior Vice President and Secretary of ATLANTIC and Security Capital since January 1996, where he provides securities offerings and corporate acquisition services and oversees the provision of legal services for affiliates of Security Capital. Mr. Klopf had comparable responsibilities with the ATLANTIC's former REIT manager from January 1996 to September 1997. From January 1988 to December 1995, Mr. Klopf was a partner of Mayer, Brown & Platt where he practiced corporate and securities law.
Other Officers
RAYMOND D. BARROWS--35--Vice President of ATLANTIC since May 1994, where he is a Development Manager; prior thereto, he supervised the due diligence group. Mr. Barrows was Vice President of ATLANTIC's former REIT manager from May 1994 to September 1997 where he had comparable responsibilities and from
January 1994 to December 1995, he was a member of ATLANTIC's asset management group. Prior thereto, Mr. Barrows was a member of PTR's asset management group. From May 1990 to August 1993, he was Portfolio Manager with The First National Bank of Chicago, where he was responsible for underwriting and structuring transactions for both project and corporate facilities.
LESLIE L. BIVINS--44--Vice President of ATLANTIC since June 1996, where she is responsible for asset and property management for the Southeast region. Ms. Bivins was Vice President of ATLANTIC's former REIT manager from June 1996 to September 1997 and was with ATLANTIC's property manager from May 1994 to September 1997 where she had comparable responsibilities. From January 1992 to May 1994, Ms. Bivins was Senior Regional Manager of Laing Management Company in Atlanta, Georgia, where she was responsible for management of over 2,000 units throughout the southeastern United States.
NEIL T. BROWN--41--Vice President of ATLANTIC since April 1996, where he is responsible for directing the development of new multifamily communities in the Southern region. Mr. Brown was Vice President of ATLANTIC's former REIT manager from April 1996 to September 1997 where he had comparable responsibilities. From July 1992 to December 1995, Mr. Brown was Regional Vice President/Regional Partner of JPI Development Partners, Inc. where he was responsible for all development activity in Florida.
JOSEPH J. DOMINGUEZ--38--Vice President of ATLANTIC since April 1996, where he is responsible for production of all multifamily communities; prior thereto, he was a member of the development group. Mr. Dominguez was Vice President of ATLANTIC's former REIT manager from April 1996 to September 1997 where he had comparable responsibilities. From November 1984 to August 1995, Mr. Dominguez was Vice President of Operations for The Casden Company, where he had overall responsibility for the start-up and operations of a general contracting subsidiary.
JAN H. EPPS--42--Vice President of ATLANTIC since March 1997, where she has overall responsibility for marketing. Ms. Epps was a Vice President of ATLANTIC's former REIT manager from March 1997 to September 1997 where she had comparable responsibilities. Prior thereto, Ms. Epps was an Operations Manager for ATLANTIC's Mid-Atlantic region and Regional Marketing Manager. From October 1988 to September 1994, Ms. Epps held several property management positions with Trammell Crow and Gables Residential including transition, training and trouble-shooting operations.
NADINE M. FRANCIS--42--Vice President of ATLANTIC since March 1997, where she has overall responsibility for sales, operations, computer training, program development and career development efforts. Ms. Francis was a Vice President of ATLANTIC's former REIT manager from March 1997 to September 1997 where she had comparable responsibilities. From April 1996 to February 1997, Ms. Francis was the Regional Training Manager for ATLANTIC's Mid-Atlantic portfolio and from April 1992 to March 1996 she was self-employed as a training consultant.
RICHARD L. GLEICHAUF--45--Vice President of ATLANTIC since March 1997, where he has been responsible for financial planning and analysis since April 1996. Mr. Gleichauf was Vice President of ATLANTIC's former REIT manager from March 1997 to September 1997 where he had comparable responsibilities. From 1977 to 1996, Mr. Gleichauf was manager with various El Paso Energy Corporation subsidiaries in El Paso, Texas and Paris, France, where he was responsible for financial accounting, budgeting and forecasting, and auditing.
GEORGE E. KELLY--45--Vice President of ATLANTIC since December 1996, where he is a Production Manager; prior thereto he was a member of the development group. Mr. Kelly was Vice President of ATLANTIC's former REIT manager from December 1996 to September 1997 where he had comparable responsibilities. From May 1995 to November 1996, Mr. Kelly was Construction Manager for Security Capital and from February 1995 to April 1995 he was Real Estate and Construction Management Consultant to Security Capital's property management companies. From August 1992 to January 1995, he was Assistant Vice President of The Travelers Realty Investment Company in Atlanta, Georgia.
MONA D. KING--37--Vice President of ATLANTIC since May 1997, where she has overall responsibility for human resources. Ms. King was a Vice President of ATLANTIC's former REIT manager from May 1997 to September 1997 where she had comparable responsibilities. From September 1994 to May 1997, Ms. King was Regional Human Resources Manager for ATLANTIC's property manager. From June 1989 to September 1994, she had a variety of Human Resources positions for Rich's Department Stores.
MARY CAPERTON LESTER--43--Vice President of ATLANTIC since July 1995, where she is responsible for asset and property management for the Mid-Atlantic region; prior thereto, she was a member of the asset management group. Ms. Lester was Vice President of ATLANTIC's former REIT manager from July 1995 to September 1997 and was with ATLANTIC's property manager from June 1994 to September 1997, where she had comparable responsibilities. From May 1993 to May 1994, Ms. Lester was with Summit Management Company, where she specialized in new business development; and from April 1984 to May 1993 she was with Trammell Crow Residential Services, most recently as a Vice President, where she was responsible for property operations, marketing and new business development.
CHRISTOPHER T. NOLAN--34--Vice President of ATLANTIC since February 1998, where he manages the acquisitions group. From January 1997 to February 1998, Mr. Nolan was Managing Director of R&B Realty Group, where he managed their multifamily expansion effort. Mr. Nolan was Vice President of ATLANTIC and ATLANTIC's former REIT manager from December 1995 to January 1997 where he had responsibility for acquisitions. From May 1994 to December 1995, he was a member of ATLANTIC's asset management group and from February 1989 to May 1994, he was a member of USF&G Corporation's real estate division.
GLENN T. RAND--37--Vice President of ATLANTIC since June 1996, where he is responsible for asset and property management for the Florida region. Mr. Rand was Vice President of ATLANTIC's former REIT manager from June 1996 to September 1997 and he was with ATLANTIC's property manager from June 1995 to September 1997 where he had comparable responsibilities. From August 1987 to April 1995, Mr. Rand was Vice President of Trammell Crow Residential and Avalon Properties, where he was responsible for operations and third party management solicitation in southern Florida and the northeastern United States.
JAMES C. ROOT--42--Vice President of ATLANTIC since December 1996, where he is responsible for major capital expenditures. Mr. Root was Vice President of ATLANTIC's former REIT manager from December 1996 to September 1997, where he had comparable responsibilities and prior thereto, he was Construction Services Manager of ATLANTIC, where he was responsible for capital budgeting, major repairs and renovations. From February 1993 to February 1994, Mr. Root was Construction Manager and Consultant in Chicago, Illinois, where he evaluated potential acquisitions for Republic Management, a Houston-based, nationwide property management company. From June 1992 to February 1993, he was Construction Services Director with Genmar Realty Group, Inc. in Chicago, where he established the Construction Department responsible for capital items for a nationwide portfolio of apartment communities.
ANN L. SCHUMACHER--39--Vice President of ATLANTIC since July 1994 and a member of the accounting group since January 1994, where she is responsible for accounting and financial reporting. Ms. Schumacher was Vice President of ATLANTIC's former REIT manager from July 1994 to September 1997, where she had comparable responsibilities. From September 1988 to October 1993, Ms. Schumacher was with Trammell Crow Company, most recently as Regional Controller, where she managed the accounting department for the company's 26 million-square-foot industrial portfolio in Southern California and Arizona.
L. DOUGLAS SNIDER--44--Vice President of ATLANTIC since July 1995, where he is responsible for directing the development of new multifamily communities in the Mid-Atlantic region; prior thereto, he was a member of the development group. Mr. Snider was Vice President of ATLANTIC's former REIT manager from July 1995 to September 1997, where he had comparable responsibilities. From July 1993 to March 1995, Mr. Snider was Vice President of Operations with American Constructors, where he was responsible for all design/build activities. From June 1990 to July 1993, he was Vice President of Robert L. Mayer Corporation, where he was responsible for residential and commercial development activities.
C. MELVIN WHITE--58--Vice President of ATLANTIC since April 1996, where he is a Development Manager; prior thereto he was a member of the development group. Mr. White was Vice President of ATLANTIC's former REIT manager from April 1996 to September 1997, where he had comparable responsibilities. From September 1991 to August 1995, Mr. White was Founder/Partner of Sherrill and Associates, an interior specialty contracting firm.
EMPLOYEES
At January 31, 1998, ATLANTIC had 90 operating professionals and 520 property-level and support personnel dedicated to implementing ATLANTIC's highly focused business strategy. None of ATLANTIC's employees are covered by a collective bargaining agreement. ATLANTIC believes that relations with its employees are good.
COMPETITION
There are numerous commercial developers, real estate companies and other owners of real estate that compete with ATLANTIC in seeking land for development, communities for acquisition and disposition and residents for communities. All of ATLANTIC's multifamily communities are located in developed areas that include other multifamily communities. The number of competitive multifamily communities in a particular area could have a material adverse effect on ATLANTIC's ability to lease units and on the rents charged. In addition, other forms of single family and multifamily residential communities provide housing alternatives to both residents and potential residents of ATLANTIC's multifamily communities.
Few competitors in ATLANTIC's primary target market currently focus on the moderate income resident. Consequently, ATLANTIC believes that moderate income residents are a significantly underserved market with limited competition.
AMERICANS WITH DISABILITIES ACT
ATLANTIC's communities must comply with Title III of the Americans with Disabilities Act (the "ADA") to the extent that such communities are "public accommodations" and/or "commercial facilities" as defined by the ADA. The ADA does not consider multifamily communities to be public accommodations or commercial facilities, except portions of such facilities open to the public, such as the leasing office. Noncompliance could result in imposition of fines or an award of damages to private litigants. ATLANTIC believes that the mandated portions of its communities comply with all present requirements under the ADA and applicable state laws.
ENVIRONMENTAL MATTERS
Under various federal, state and local laws, ordinances and regulations, a current or previous owner, developer or operator of real estate may be liable for the costs of removal or remediation of certain hazardous or toxic substances at, on, under or in its property. The costs of removal or remediation of such substances could be substantial. Such laws often impose such liability without regard to whether the owner or operator knew of, or was responsible for, the release or presence of such hazardous or toxic substances. The presence of such substances may adversely affect the owner's ability to sell or rent such real estate or to borrow using such real estate as collateral. Persons who arrange for the disposal or treatment of hazardous or toxic substances also may be liable for the costs of removal or remediation of such substances at the disposal or treatment facility, whether or not such facility is owned or operated by such person. Certain environmental laws impose liability for the release of asbestos-containing materials into the air, pursuant to which third parties may seek recovery from owners or operators of real properties for personal injuries associated with such materials, and prescribe specific methods for the removal and disposal of such materials, which may result in increased costs in connection with renovations at ATLANTIC's communities.
ATLANTIC has not been notified by any governmental authority of any non- compliance, liability or other claim in connection with any of its communities owned or being acquired at January 31, 1998, and ATLANTIC is not aware of any environmental condition with respect to any of its communities that is likely to be material. ATLANTIC has subjected each of its communities to a Phase I environmental assessment (which does not
involve invasive procedures such as soil sampling or ground water analysis) by independent consultants. While some of these assessments have led to further investigation and sampling, none of the environmental assessments have revealed, nor is ATLANTIC aware of, any environmental liability (including asbestos-related liability) that it believes would have a material adverse effect on its business, financial condition or results of operations. No assurance can be given, however, that these assessments and investigations revealed all potential environmental liabilities, that no prior owner or operator created any material environmental condition not known to ATLANTIC or the independent consultants or that future uses and conditions (including, without limitation, resident actions or changes in applicable environmental laws and regulations) will not result in unreimbursed costs relating to environmental liabilities.
INSURANCE COVERAGE
ATLANTIC carries comprehensive general liability coverage on its owned communities, with limits of liability customary within the industry, to insure against liability claims and related defense costs. Similarly, ATLANTIC is insured against the risk of direct physical damage in amounts necessary to reimburse ATLANTIC on a replacement cost basis for costs incurred to repair or rebuild each community, including loss of rental income during the reconstruction period.
ITEM 2.
ITEM 2. PROPERTIES
PORTFOLIO COMPOSITION
The following table indicates the composition of communities owned by ATLANTIC at January 31, 1998 based upon the primary household income categories of each community's residents:
- -------- (1) Percentages are based on total expected investment which, for operating communities, represents cost, plus budgeted capital expenditures. For communities under construction and in planning, total expected investment represents total budgeted development cost, which includes the cost of land, fees, permits, payments to contractors, architectural and engineering fees and interest and property taxes to be capitalized during the construction period. Does not include land held for future development (construction is not anticipated to commence in the next 12 months), which is less than 1% of assets, based on cost.
GEOGRAPHIC DISTRIBUTION
ATLANTIC has organized the operations within its target market into three geographic regions to more effectively manage its communities. These operating regions are titled: Mid-Atlantic, Southeast and Florida. ATLANTIC's communities are located in 17 metropolitan areas in 9 states and the District of Columbia. The table below demonstrates the geographic distribution of ATLANTIC's portfolio (operating communities and total communities, which includes operating communities and owned communities under construction and in planning) at January 31, 1998:
- -------- (1) Percentages are based on total expected investment which, for operating communities, represents cost, plus budgeted capital expenditures. For communities under construction and in planning, total expected investment represents total budgeted development cost, which includes the cost of land, fees, permits, payments to contractors, architectural and engineering fees and interest and property taxes to be capitalized during the construction period. The term "in planning" means that construction is anticipated to commence within 12 months. Does not include land held for future development (construction is not anticipated to commence in the next 12 months), which is less than 1% of assets, based on cost.
COMMUNITIES
The information in the following table is as of December 31, 1997 for communities owned at December 31, 1997, except total expected investment which is as of January 31, 1998, (dollar amounts in thousands). Additional information on ATLANTIC's communities is contained in Schedule III, Real Estate and Depreciation, in "Item 8. Financial Statements and Supplementary Data". No individual community, or group of communities
operated as a single business unit, amounts to 10% or more of ATLANTIC's consolidated total assets at December 31, 1997 nor does the gross revenue from any such communities amount to 10% or more of ATLANTIC's consolidated gross revenues for the fiscal year ended December 31, 1997.
As of January 31, 1998, ATLANTIC had land in planning and under control for the development of 1,752 units with a total budgeted development cost of $126.3 million. The term "under control" means that ATLANTIC has an exclusive right (through a contingent contract or letter of intent) during a contractually agreed-upon time period to acquire land for future development of multifamily communities, but does not currently own the land. There can be no assurance that such land will be acquired. The unit and total budgeted development cost information for these developments is based on management's best estimates of the cost upon completion of these developments. - -------- * Community developed by ATLANTIC. (1) With respect to communities under construction or communities in planning and owned, represents expected completion date. (2) For operating communities, represents cost, plus budgeted capital expenditures. For communities under construction and in planning, represents total budgeted development cost, which includes the cost of land, fees, permits, payments to contractors, architectural and engineering fees and interest and property taxes to be capitalized during the construction period. The term "in planning" means that construction is anticipated to commence within 12 months. (3) The term "stabilized" means that renovation, repositioning, new management and new marketing programs (or development and marketing in the case of newly developed communities) have been completed and in effect for a sufficient period of time (but in no event longer than 12 months, except in cases of major rehabilitation) to achieve 93% occupancy at market rents. Prior to being "stabilized", a community is considered "pre-stabilized". See "Item 1. Business--Operating System--Acquisitions". (4) Cameron at Hickory Grove is subject to a deed of trust securing mortgage debt of $5.9 million. (5) Community was classified as pre-stabilized in 1997 due to the effects of lease-up activities at Phase II of this community. (6) Community was classified as pre-stabilized at December 31, 1997 as it was undergoing major rehabilitation. (7) Community was stabilized in January 1998. (8) Country Oaks is subject to a deed of trust securing mortgage debt of $5.9 million. (9) The land associated with Arbor Creek is leased by ATLANTIC through the year 2058 under an agreement with the Metropolitan Nashville Airport Authority. (10) Shadowbluff is subject to a deed of trust securing mortgage debt of $5.5 million. (11) Cameron Ridge is subject to a deed of trust securing mortgage debt of $5.7 million.
(12) Community is pledged as additional security under ATLANTIC's 30-year credit enhancement agreement with FNMA. For a discussion of the FNMA credit enhancement agreement. See "Item 1. Business--Operating System-- Capital Raising and Finance". (13) The tax-exempt bond issue associated with this community is included in ATLANTIC's credit enhancement agreement with FNMA. (14) Azalea Park is subject to a deed of trust securing mortgage debt related to $15.5 million of tax-exempt bonds. (15) Cameron Brook is subject to a deed of trust securing mortgage debt related to $19.5 million of tax-exempt bonds (16) Cameron Station is subject to a deed of trust securing mortgage debt related to $14.5 million of tax-exempt bonds. (17) Clairmont Crest is subject to a deed of trust securing mortgage debt related to $11.6 million of tax-exempt bonds. (18) The Greens is subject to a deed of trust securing mortgage debt related to $10.4 million of tax-exempt bonds. (19) WintersCreek is subject to a deed of trust securing mortgage debt related to $5.0 million of tax-exempt bonds. (20) Phase I of Cameron Creek, which consists of 404 units, was acquired in 1994. Phase II of Cameron Creek, which consists of 260 units, was developed by ATLANTIC and completed in 1997. (21) Phase II of Cameron on the Cahaba consists of 250 units and is subject to a deed of trust securing mortgage debt of $8.0 million. (22) Community was classified as pre-stabilized in 1997 due to the transfer of on-site management from a third party to ATLANTIC. (23) Phase I of Colony Woods, which consists of 216 units, was acquired in 1994. Phase II of Colony Woods, which consists of 198 units, was developed by ATLANTIC and completed in 1995. (24) Cameron Cove is subject to a deed of trust securing mortgage debt related to $8.5 million of tax-exempt bonds. (25) Cameron Hidden Harbor is subject to a deed of trust securing mortgage debt of $5.5 million. (26) Phase I of Parrot's Landing consists of 408 units and is subject to a deed of trust securing mortgage debt related to $15.8 million of tax- exempt bonds. (27) Forestwood is subject to a deed of trust securing mortgage debt related to $11.5 million of tax-exempt bonds. (28) The total expected investment cost of this developed community includes a potential incentive payment to the third party developer/manager that had not been earned by them at December 31, 1997. (29) Cameron Villas I is subject to a deed of trust securing mortgage debt of $6.3 million. (30) Phase I of Country Place Village consists of 88 units and is subject to a deed of trust securing mortgage debt of $2.0 million. (31) Foxbridge on the Bay is subject to a deed of trust securing mortgage debt related to $10.4 million of tax-exempt bonds. (32) Cameron Palm Harbor is subject to a deed of trust securing mortgage debt of $5.3 million. (33) Community was leasing completed units at January 31, 1998. (34) The term "in planning" means that construction is anticipated to commence within 12 months. (35) Land held for future development means that construction is not anticipated to commence in the next 12 months.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
ATLANTIC is a party to various claims and routine litigation arising in the ordinary course of business. ATLANTIC does not believe that the results of any of such claims and litigation, individually or in the aggregate, will have a material adverse effect on its business, financial position or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
ATLANTIC's common stock, par value $0.01 per share ("Common Shares"), is listed on the New York Stock Exchange ("NYSE") under the symbol "SCA". The following table sets forth the high and low sales price of the Common Shares as reported in the NYSE Composite Tape and cash distributions per Common Share for the periods indicated.
- -------- (1) The Common Shares commenced trading on the NYSE on October 15, 1996. (2) In light of the transaction with Homestead Village Incorporated ("Homestead") in October 1996 that is discussed in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-- Results of Operations--Homestead Transaction" and ATLANTIC's initial public offering in October 1996, the Board adjusted the distribution in the fourth quarter of 1996.
As of March 18, 1998, ATLANTIC had 47,760,965 Common Shares outstanding, approximately 300 record holders of Common Shares and approximately 3,000 beneficial holders of Common Shares.
In addition to the quarterly cash distributions shown above, the following distributions were made to ATLANTIC's shareholders:
. In connection with ATLANTIC's acquisition of the management companies owned by Security Capital, ATLANTIC's holders of Common Shares (other than Security Capital) as of September 16, 1997 received warrants from Security Capital to purchase 1,675,940 shares of Security Capital's Class B common stock (0.071116 warrants for each Common Share held). Each warrant can be exercised for one share of Security Capital's Class B common stock at an exercise price of $28.00 per share through September 18, 1998. Security Capital issued these warrants, in part, as an incentive to ATLANTIC's shareholders to vote to approve the transaction. The warrants are traded on the NYSE and the December 31, 1997 closing price was $5.25 per warrant. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations--Merger Transaction--Terms of Transaction".
. ATLANTIC made a special distribution on November 12, 1996 to holders of record of Common Shares on October 29, 1996 ("the Homestead Distribution"). The Homestead Distribution consisted of Homestead common stock and warrants to purchase Homestead common stock, which were received as consideration for the sale of certain assets to Homestead. For book purposes, the Homestead Distribution was valued at $58.2 million, which was based on the estimated fair value of the net assets sold to Homestead. The securities distributed in the Homestead Distribution (0.110875 shares of Homestead
common stock and 0.074384 warrants to purchase shares of Homestead common stock per ATLANTIC Common Share) had a market value of $2.67 per Common Share based on the closing prices of such securities on the American Stock Exchange on November 11, 1996, the day prior to the distribution date. Consequently, the Homestead Distribution resulted in an adjustment of $2.75 per Common Share to ATLANTIC's Common Share price by the NYSE on November 12, 1996. Accordingly, ATLANTIC's October 1996 initial public offering price, as adjusted for the Homestead Distribution, was $21.25 per Common Share (as compared to the pre-adjustment price of $24.00 per Common Share).
ATLANTIC, in order to qualify as a REIT, is required to make distributions (other than capital gain distributions) to its shareholders in amounts at least equal to (i) the sum of (A) 95% of its "REIT taxable income" (computed without regard to the dividends-paid deduction and its net capital gain) and (B) 95% of the net income (after tax), if any, from foreclosure property, minus (ii) the sum of certain items of non-cash income. ATLANTIC's long-term distribution strategy is to distribute what it believes is a conservative percentage of its cash flow, permitting ATLANTIC to retain funds for capital improvements and other investments while funding its distributions. ATLANTIC has paid 17 consecutive quarterly cash distributions on its Common Shares since its inception in October 1993.
ATLANTIC announces the following year's projected annual distribution level after the Board's annual budget review and approval in December of each year. At its December 4, 1997 meeting, the Board announced a projected annual distribution level of $1.60 per Common Share for 1998 and declared a distribution of $0.40 per Common Share for the first quarter of 1998, which was paid on February 26, 1998 to holders of record of Common Shares on February 12, 1998. The payment of distributions is subject to the discretion of the Board and depends upon the financial condition and operating results of ATLANTIC. ATLANTIC's $350 million unsecured line of credit agreement contains covenants which provide that ATLANTIC's distributions for the preceding four quarters may not exceed 95% of funds from operations (as defined in the loan agreement) for the preceding four quarters.
For federal income tax purposes, distributions may consist of ordinary income, capital gains, non-taxable return of capital or a combination thereof. Distributions that exceed ATLANTIC's current and accumulated earnings and profits (calculated for tax purposes) constitute a return of capital rather than a dividend and reduce the shareholder's basis in the Common Shares. To the extent that a distribution exceeds both current and accumulated earnings and profits and the shareholder's basis in the Common Shares, it will generally be treated as a gain from the sale or exchange of that shareholder's Common Shares. ATLANTIC annually notifies shareholders of the taxability of distributions paid during the preceding year. The following summarizes the taxability of cash distributions paid in 1996 and 1995 on the Common Shares and the estimated taxability for 1997.
- -------- (1) Does not include the Security Capital warrants distributed in September 1997 that were valued at $6.88 per warrant or $0.49 per Common Share for federal income tax purposes, all of which is taxable as ordinary income. (2) Does not include the securities distributed in the Homestead Distribution that were valued at $1.91 per Common Share for federal income tax purposes, of which $0.90 was taxable as ordinary income and $1.01 was treated as a return of capital. (3) Under federal income tax rules, ATLANTIC's earnings and profits are first allocated to its preferred stock which increases the portion of the Common Shares distribution classified as return of capital. The portion of distributions characterized as return of capital results primarily from the excess of distributions over earnings primarily because noncash charges such as depreciation are added to earnings in determining distribution levels. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations." (4) ATLANTIC's tax return for the year ended December 31, 1997 has not been filed, and the taxability information for 1997 is based upon the best available data. ATLANTIC's tax returns for prior years have not been examined by the Internal Revenue Service and, therefore, the taxability of distributions is subject to change.
ATLANTIC paid dividends of $0.7845 per share on its Series A Cumulative Redeemable Preferred Stock, par value $0.01 per share, ("Series A Preferred Shares"), in 1997, all of which was treated as ordinary income for federal income tax purposes. Pursuant to the terms of the Series A Preferred Shares. ATLANTIC is restricted from declaring or paying any distribution with respect to its Common Shares unless all cumulative dividends with respect to the Series A Preferred Shares have been paid and sufficient funds have been set aside for Series A Preferred Share dividends that have been declared.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data relating to the historical financial condition and results of operations of ATLANTIC as of and for the years ended December 31, 1997, 1996, 1995 and 1994, and as of and for the period from inception (October 26, 1993) through December 31, 1993 (amounts in thousands, except per share data). Such selected financial data is qualified in its entirety by, and should be read in conjunction with, "Item 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with ATLANTIC's financial statements and the notes thereto included in Item 14 of this report.
The statements contained in this discussion and elsewhere in this report that are not historical facts are 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. These forward-looking statements are based on current expectations, estimates and projections about the industry and markets in which ATLANTIC operates, management's beliefs and assumptions made by management. Words such as "expects", "anticipates", "intends", "plans", "believes", "seeks", "estimates", variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain
risks, uncertainties and assumptions which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements. ATLANTIC undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. ATLANTIC's operating results depend primarily on income from multifamily communities, which is substantially influenced by (i) the demand for and supply of multifamily units in ATLANTIC's primary target market and submarkets, (ii) operating expense levels, (iii) the effectiveness of property-level operations and (iv) the pace and price at which ATLANTIC can acquire and develop additional multifamily communities. Capital and credit market conditions which affect ATLANTIC's cost of capital also influence operating results. See "-- Real Estate Investments--Current Development Activity" and "--Real Estate Investments--1997 Acquisition Activity" for a discussion of risks associated with ATLANTIC's investment activity.
OVERVIEW
ATLANTIC's results of operations, financial position and liquidity have been influenced by its operations of and investments in real estate, which consist entirely of multifamily communities. Detailed information about ATLANTIC's real estate investments at December 31, 1997 and its real estate investment activity during the year then ended is provided under "--Real Estate Investments". A description of the transaction whereby ATLANTIC became an internally managed REIT is included under "--Results of Operations--Merger Transaction--Terms of Transactions". The financial impact of this transaction is discussed under "--Results of Operations--Merger Transaction--Effect on Future Operations".
REAL ESTATE INVESTMENTS
Operating Communities
The following table summarizes ATLANTIC's investment activity with respect to operating communities for 1997, 1996 and 1995 (dollar amounts in thousands):
- -------- (1) In 1997, ATLANTIC combined phases of two communities that previously have been reflected separately. (2) Represents cost, plus budgeted capital expenditures. (3) Acquisitions in 1997 are described under "--1997 Acquisition Activity". (4) Dispositions for each year are discussed under "--Results of Operations-- Gains on Disposition of Real Estate and Valuation of Long-Lived Investments". (5) Includes a community under construction that was disposed of prior to completion.
Communities Under Development
ATLANTIC believes that development of multifamily communities from the ground up which are built for long-term ownership and designed to meet broad renter preferences and demographic trends will provide a greater source of long-term cash flow growth in the future. While ATLANTIC's development activity is dilutive to net earnings and funds from operations in the short term ($0.095 per Common Share in 1997), this activity is expected to add significantly to ATLANTIC's long-term performance as the developments reach stabilization in 1998 and subsequent years as shown in the table under "-- Current Development Activity".
During the construction period, the reduction to interest expense resulting from the capitalization of interest on units under construction is less than the operating income which could be earned on those expenditures if the community were complete and earning a stabilized return, thus resulting in dilution. Essentially, the return on investment during the construction period is equivalent to ATLANTIC's cost of funds.
The lease-up phase commences when units are placed in service. During the lease-up phase, ATLANTIC's policy is to expense operating expenses (including pre-opening marketing expenses) and interest expense, both
of which are capitalized during the construction period. The operating expenses and the interest expense on such completed units will typically exceed rental revenues, due to less than break-even occupancy, thus resulting in dilution in the form of a "lease-up" deficit. These deficits are typically experienced for a period of two to four months after "first units" are placed in service.
Development dilution begins to decline as occupancy increases and revenues from completed units exceed the operating expenses and interest expense associated with such completed units. However, the net operating income generated during this pre-stabilized period is less than the net operating income that would be earned if the community were stabilized. The time required to achieve stabilization generally ranges from six to twelve months after completion of construction. ATLANTIC's portfolio of communities under construction at December 31, 1997 are expected to be stabilized by the first quarter of 2000.
ATLANTIC's development activity for the years indicated is summarized below (dollar amounts in thousands):
- -------- (1) Represents total budgeted development cost, which includes the cost of land, fees, permits, payments to contractors, architectural and engineering fees and interest and property taxes to be capitalized during the construction period. (2) Represents cost, plus budgeted capital expenditures. (3) Developments under construction at December 31, 1997 are discussed under "--Current Development Activity".
Current Development Activity
ATLANTIC's 21 communities under construction at December 31, 1997 are located in nine metropolitan areas. The communities are at various stages of completion as presented below (dollar amounts in thousands):
- -------- (1) Represents total budgeted development cost, which includes the cost of land, fees, permits, payments to contractors, architectural and engineering fees and interest and property taxes to be capitalized during the construction period. (2) Represents the date the first completed units were made available for leasing (or are expected to be made available for leasing). ATLANTIC begins leasing completed units prior to completion of the entire community. (3) The percentage leased is based on total units completed and available for lease at December 31, 1997. (4) A development community is considered in "lease-up" once ATLANTIC begins leasing completed units. (5) This community's first units were delivered in January 1998.
There are risks associated with ATLANTIC's development and construction activities which include: development and acquisition opportunities explored by ATLANTIC may be abandoned; third-party developers constructing ATLANTIC's communities may not perform as contracted resulting in additional costs to ATLANTIC to complete the community; occupancy rates and rents at a newly completed community are dependent on a number of factors, including market and general economic conditions, and may not be sufficient to make the community profitable; financing may not be available on favorable terms to allow ATLANTIC to develop communities as planned; and construction and lease-up may not be completed on schedule, resulting in increased debt service expense and construction costs. Development activities are also subject to risks relating to the inability to obtain, or delays in obtaining, all necessary land-use, building, occupancy and other required governmental permits and authorizations; however, ATLANTIC obtains many approvals prior to the initial land acquisition. The occurrence of any of the events described above could adversely affect ATLANTIC's ability to achieve its projected yields on communities under development or redevelopment.
1997 Acquisition Activity
ATLANTIC completed the acquisition of $59.9 million of operating communities, representing a total of 1,220 units, in 1997. These acquisitions are summarized below (dollar amounts in thousands):
- -------- (1) Represents cost, plus budgeted capital expenditures.
Acquisitions entail risks that investments will fail to perform in accordance with expectations and that estimates with respect to the cost of improvements to bring an acquired community up to standards established for the market position intended for that community will prove inaccurate, as well as general investment risks associated with any new real estate investment. Although ATLANTIC undertakes an evaluation of the physical condition of each new community before it is acquired, certain defects or necessary repairs may not be detected until after ATLANTIC begins operating the community, which could significantly increase ATLANTIC's total investment.
RESULTS OF OPERATIONS
Net earnings attributable to Common Shares for the years ended December 31, 1997, 1996 and 1995 were $51.1 million, $38.6 million and $19.6 million, respectively. Net earnings attributable to Common Shares increased $12.5 million in 1997 over 1996 and $19.0 million in 1996 over 1995.
Property Operations
At December 31, 1997, ATLANTIC had 21,693 operating multifamily units as compared to 19,241 operating multifamily units at December 31, 1996 and 15,823 operating multifamily units at December 31, 1995.
This increased number of communities in operation resulted in increases in rental income ($30.7 million in 1997 over 1996 and $34.1 million in 1996 over 1995), rental expenses and property management fees ($7.3 million in 1997 over 1996 and $10.1 million in 1996 over 1995), real estate taxes ($2.4 million in 1997 over 1996 and $2.7 million in 1996 over 1995), and depreciation ($6.2 million in 1997 over 1996 and $4.9 million in 1996 over 1995).
During the period prior to a community being stabilized (see "Item 1. Business--ATLANTIC's Operating System--Acquisitions"), management begins implementing expense controls, reconfiguring the resident mix, supervising renovations and implementing a strategy to increase rental income. The full benefits of the changes are not reflected until the communities are stabilized. Of ATLANTIC's total operating multifamily communities, based on total expected investment, 22.7% were classified as pre-stabilized at December 31, 1997 as compared to 26.7% at December 31, 1996 and 25.7% at December 31, 1995.
Because ATLANTIC will be completing construction on its current development portfolio and acquiring additional operating communities in its target market, ATLANTIC anticipates increases in rental income and property-level expenses in future periods.
Communities Fully Operating Throughout Both Periods
Operating Summary
ATLANTIC had 45 "same store" communities that were fully operational throughout 1996 and 1997 and 34 "same store" communities that were fully operational throughout 1995 and 1996. The operating performance of these same store communities for the periods indicated was as follows:
- -------- (1) Represents cost, plus budgeted capital expenditures. (2) Collections represent actual rent and other income collected, net of vacancies, bad debts and concessions. (3) Operating expense, as adjusted, represents operating expenses (excluding depreciation and interest expense) as adjusted to remove the accounting differences which result from capitalizing certain costs during the period of pre-stabilization and expensing those costs once the community has reached stabilization. (4) Net operating income, as adjusted, represents total collected revenues less operating expense, as adjusted. (5) Actual operating expense ratio represents actual operating expenses (excluding depreciation and interest expense) as a percentage of total collected revenues.
ATLANTIC's operating results are a function of rental collections and operating expenses. Rental collections are a function of rental rates and occupancy levels achieved. ATLANTIC's operating personnel continually monitor rental rates and occupancy levels in an effort to maximize rental collections. ATLANTIC experienced a small increase in same store community occupancy in 1997 over 1996 (95.24% compared to 94.97%). ATLANTIC's same store average rental rate of $694 per unit for 1997 was 1.6% higher than the 1996 same store average rental rate of $683. Consequently, same store rental collections for 1997 increased by 1.95% over 1996. ATLANTIC expects that rental collections will continue to grow in 1998 at a pace slightly ahead of the growth experienced in 1997.
ATLANTIC's operating expenses as a percentage of rental revenues for ATLANTIC's same store communities have generally remained flat (ranging between 39.5% and 40.8%), primarily due to ATLANTIC's efforts aimed at reducing resident turnover, thereby reducing the costs associated with re- leasing vacated units. ATLANTIC expects operating expenses as a percentage of rental revenues in 1998 to remain at a level consistent with the level achieved over the past two years. The expected trends in rental rates, occupancy and operating expenses are expected to have a positive impact on ATLANTIC's future operating results.
Market Analysis
The following table presents occupancy levels and collections growth for the 45 same store communities by market:
- -------- (1) Represents percentage of operating communities and communities under construction in each market. (2) ATLANTIC's communities in these markets were acquired subsequent to January 1, 1996; therefore, there are no communities for the same store comparison.
While ATLANTIC's same store communities have experienced an overall increase in collections of 1.95% for 1997 as compared to 1996, certain of its primary target market cities have experienced collections decreases. Management believes that the decreases experienced in Charlotte, Nashville, Birmingham and Jacksonville are caused by temporary supply imbalances and that these cities continue to provide opportunities for long-term growth in cash flow. In Atlanta, which represents 44.07% of the same store communities, same store collections grew 1.47% in 1997 over 1996. This small increase was expected since ATLANTIC experienced strong occupancies and rental rates in Atlanta in 1996 associated with the Summer Olympics. In the fourth quarter of 1997, Atlanta's same store collections grew 2.71% over the fourth quarter of 1996. Management believes that this trend will continue and that the Atlanta's same store communities will generate collections growth at or above this level in 1998.
Homestead Transaction
Overview
On October 17, 1996, ATLANTIC sold its moderate-priced, purpose-built, extended-stay lodging facilities known as Homestead Village(R) properties (the "Homestead Assets") to Homestead. In addition, ATLANTIC entered into a funding commitment agreement (the "Funding Agreement") to provide secured financing of up to $111.1 million to Homestead for purposes of completing the development and construction of the properties sold in the transaction. ATLANTIC will receive Homestead Convertible Mortgages with a principal amount of up to $98.0 million in exchange for full funding of up to $111.1 million under the Funding Agreement. The difference represents a mortgage note premium that is being amortized as a reduction to interest income over the term of the Homestead Convertible Mortgages.
The transaction resulted in ATLANTIC receiving 4,201,220 shares of common stock of Homestead in exchange for the Homestead Assets and 2,818,517 warrants, each to purchase one share of Homestead common stock at $10.00 per share, in exchange for entering into the Funding Agreement. The common stock and warrants were distributed to ATLANTIC's shareholders.
ATLANTIC recognized a gain on the sale of the Homestead Assets of $2.8 million, net of costs associated with the transaction.
Interest Income
ATLANTIC began funding under the Funding Agreement in 1997 and funded $106.0 million of the $111.1 million commitment. At December 31, 1997, ATLANTIC had Homestead Convertible Mortgages with a fair value of $122.5 million (principal amount of $93.5 million) and recognized interest income related to these mortgage notes of $4.5 million in 1997. In future years, interest income will be greater than the 1997 level because ATLANTIC will fund the remaining $5.1 million commitment and the full amount of Homestead Convertible Mortgages will be outstanding for the entire year.
The aggregate income recognized on the Homestead Convertible Mortgages consists of (i) the interest income recognized at 9.0% per annum, (ii) the amortization of the original issue premium which reduces income, (iii) the amortization of the discount on the conversion feature which increases income and (iv) the amortization of the deferred commitment fee which increases income. ATLANTIC uses the effective interest method to calculate the amortization of all items associated with the Homestead Convertible Mortgages. The effective interest rate on the funded amount is 8.46% per annum for purposes of calculating net earnings. The effective interest rate on the funded amount is 7.09% per annum for purposes of calculating funds from operations because the amortization of the discount on the conversion feature and the amortization of the deferred commitment fee are deducted from net earnings in calculating funds from operations.
Interest Expense
The following summarizes ATLANTIC's interest expense (in thousands):
Mortgage interest expense increased $1.6 million in 1997 as compared to 1996 and $1.8 million in 1996 as compared to 1995. These increases are the result of additional weighted-average mortgage debt outstanding.
In 1997, ATLANTIC recognized $4.1 million of interest expense on the unsecured senior notes issued in August 1997. ATLANTIC will recognize a full year of interest expense on these notes in 1998.
Interest expense on line of credit borrowings decreased $1.7 million in 1997 from 1996 and increased $1.2 million in 1996 over 1995. The decrease in 1997 was partially due to a lower weighted-average daily interest rate (7.20% in 1997 as compared to 7.39% in 1996) offset by a slightly higher average outstanding balance ($207.7 million in 1997 as compared to $204.3 million in 1996). Interest expense on line of credit borrowings is also affected by amortization of issuance costs and other loan-related costs. This loan cost amortization was lower in 1997 than in 1996 because ATLANTIC expensed $3.9 million of capitalized loan costs in December 1996 when the secured line of credit was extinguished. See "--Extraordinary Item--Loss on Early Extinguishment of Debt" below. The increase in 1996 was primarily a function of an increase in the average outstanding balance ($204.3 million in 1996 as compared to $178.3 million in 1995) partially offset by a lower weighted- average daily interest rate (7.39% in 1996 as compared to 7.92% in 1995). Amortization of loan costs in 1996 was slightly higher than the 1995 level.
Interest expense recognized on borrowings is offset by the interest capitalized with respect to ATLANTIC's development activities. Capitalized interest decreased $0.1 million in 1997 from 1996 and increased by $5.8 million in 1996 over 1995. Capitalized interest levels are reflective of ATLANTIC's cost of funds and the level of development activity in each year.
Merger Transaction
Terms of Transaction
On September 9, 1997, ATLANTIC acquired the operations and business of Security Capital (Atlantic) Incorporated (the "REIT Manager") and SCG Realty Services Atlantic Incorporated (the "Property Manager"), in exchange for 2,306,591 Common Shares (the "Merger"). The REIT Manager and Property Manager provided management services to ATLANTIC and were wholly owned subsidiaries of ATLANTIC's principal shareholder, Security Capital. The Common Shares issued to Security Capital were valued as of August 6, 1997, the record date for determining ATLANTIC's shareholders entitled to vote on the Merger, at $54.6 million. A per Common Share price of $23.675 (the average market price of Common Shares over the five-day period prior to August 6, 1997) was used to determine the number of Common Shares issued. As a result of the Merger, ATLANTIC has become an internally managed REIT.
Because ATLANTIC, the REIT Manager and Property Manager were under the common control of Security Capital when the Merger was consummated, the difference between the market value as of September 8, 1997 of the Common Shares issued to Security Capital and the value of the net tangible assets of the REIT Manager and Property Manager acquired by ATLANTIC of $50.9 million has been accounted for as a distribution to Security Capital. This distribution is reflected as a deduction from additional paid-in capital.
As part of the Merger, ATLANTIC's common shareholders (other than Security Capital) as of September 16, 1997 received warrants from Security Capital to purchase 1,675,940 shares of Security Capital's Class B common stock (0.071116 warrants for each Common Share held). Each warrant can be exercised for one share of Security Capital's Class B common stock at an exercise price of $28.00 per share through September 18, 1998. Security Capital issued these warrants as an incentive to ATLANTIC's shareholders to vote to approve the Merger and to raise additional equity capital at a relatively low cost, in addition to other benefits.
Effect on Future Operations
As a result of the Merger, ATLANTIC terminated its management agreements with the REIT Manager and Property Manager (which covered approximately 97% of ATLANTIC's operating communities at the time of the Merger). Consequently, ATLANTIC did not incur the costs associated with these agreements after September 8, 1997. However, after the Merger was completed, ATLANTIC did incur, and will continue to incur, certain of the operating costs of the businesses acquired, primarily the personnel costs associated with the employees of the REIT Manager and Property Manager who are now employees of ATLANTIC. In addition, ATLANTIC purchased, and will continue to purchase, certain administrative services from Security Capital under the ASA. The fees payable under the ASA are equal to Security Capital's direct cost plus an overhead factor of 20%. For the initial term of the agreement (September 9, 1997 through December 31, 1998), the fees payable to Security Capital will not exceed approximately $5.2 million, but may be less than that amount as any cost savings will accrue to ATLANTIC. For the period from September 9, 1997 to December 31, 1997, ATLANTIC's costs under the ASA were limited to $1.5 million and ATLANTIC actually incurred $0.7 million of costs for that period. For 1998, ATLANTIC's costs under the ASA cannot exceed $3.7 million.
Costs related to the management function, including charges under the ASA, incurred subsequent to the Merger are collectively referred to as "management costs". Management costs related to property operations are reflected as rental expenses in arriving at net operating income. Certain qualifying management costs related to the acquisition and development of communities have been capitalized as a cost of the respective communities ($1.5 million for the period from September 9, 1997 through December 31, 1997). Management costs that have not been capitalized and are not classified as rental expenses are reflected as general and administrative expenses.
REIT Management Fee Paid to Affiliate
The fee paid by ATLANTIC to the REIT Manager decreased by $1.9 million in 1997 from 1996 and increased by $3.5 million in 1996 over 1995. The decrease in 1997 was due to the termination of the agreement with the REIT Manager as a result of the Merger. See "--Merger Transaction". Because this fee fluctuated with the level of ATLANTIC's cash flow calculated before the fee, the increase in 1996 over 1995 was expected based upon the increase in ATLANTIC's cash flow in 1996 over 1995.
General and Administrative
General and administrative expense increased by $1.7 million in 1997 over 1996, primarily due to costs incurred after the Merger as discussed under "-- Merger Transaction". General and administrative expense is expected to increase in 1998 because the effects of the Merger will be reflected for an entire year.
Gains on Disposition of Real Estate and Valuation of Long-Lived Investments
ATLANTIC's strategy is to build its asset base through the development and acquisition of multifamily communities that will provide long-term growth in cash flow. ATLANTIC's real estate investments have been made with a view to effective long-term operation and ownership. ATLANTIC's "asset optimization program" is based on market research and is aimed at optimizing its portfolio composition. Under this program, ATLANTIC may from time to time dispose of assets that no longer meet its long-term investment objectives and redeploy the proceeds therefrom, preferably through tax-deferred exchanges, into assets with better prospects
for growth. As a result of this asset optimization program, ATLANTIC disposed of five operating communities aggregating 1,396 units in 1997. An aggregate gain of $1.6 million was recognized on proceeds of $66.5 million. The five communities that were disposed of in 1997 accounted for $2.6 million, $3.4 million and $3.2 million of net operating income during 1997, 1996 and 1995, respectively.
ATLANTIC disposed of four communities in 1996 aggregating 1,184 units. An aggregate gain of $6.7 million was recognized on proceeds of $64.2 million. These four communities accounted for $3.6 million and $5.2 million of net operating income during 1996 and 1995, respectively.
In 1995, ATLANTIC disposed of two communities aggregating 596 units. The proceeds from these dispositions were not materially different from the book value of the assets on the date of disposition. These two communities accounted for $2.4 million of net operating income during 1995.
Long-lived investments held and used are periodically evaluated for impairment and provisions for possible losses are made if required. As of December 31, 1997, such investments are carried at cost, which is not in excess of fair market value and no provisions for possible losses have been made. ATLANTIC recognized provisions for possible losses of $0.2 million in 1997 and $2.5 million in 1996 associated with a community that was sold in 1997.
Extraordinary Item--Loss on Early Extinguishment of Debt
In December 1996, ATLANTIC replaced its existing secured line of credit with an unsecured line of credit. Such early extinguishment of debt resulted in the write-off of unamortized loan costs of $3.9 million and is reflected as an extraordinary item in the statement of earnings for the year ended December 31, 1996.
LIQUIDITY AND CAPITAL RESOURCES
Overview
ATLANTIC considers its liquidity and ability to generate cash from operations and financings to be adequate and expects it to continue to be adequate to meet its development, acquisition, operating and debt service needs as well as its commitment to fund the remaining amount under the Funding Agreement and its shareholder distribution requirements.
ATLANTIC expects to finance future activities with cash on hand and borrowings under its unsecured lines of credit prior to arranging long-term financing. The unsecured lines of credit will facilitate an efficient response to market opportunities while minimizing the amount of cash invested in short- term investments at lower yields. At December 31, 1997, ATLANTIC had $210.3 million available for borrowing under these unsecured lines of credit ($188.1 million available at March 18, 1998). Another source of future liquidity and financial flexibility is ATLANTIC's shelf-registered securities ($492.6 million available as of December 31, 1997) which can be issued in the form of unsecured long-term debt, preferred stock or Common Shares on an as-needed basis, subject to ATLANTIC's ability to effect an offering on satisfactory terms. ATLANTIC believes that its current conservative ratio of long-term debt to total long-term undepreciated book capitalization (which was 25.1% at December 31, 1997) provides considerable flexibility to prudently increase its capital base by utilizing long-term debt as a financing tool in the future, while remaining within the framework of the restrictive covenants in ATLANTIC's current debt agreements. Long-term undepreciated book capitalization is defined as the sum of long-term debt and shareholders' equity after adding back accumulated depreciation.
Operating Activities
Cash provided by operating activities was $83.1 million in 1997, an increase of $28.7 million from the 1996 level of $54.4 million. Cash provided by operating activities in 1996 increased by $14.6 million from the 1995 level. These increases are primarily the result of the increased number of communities in operation in each year.
ATLANTIC's policy is to expense, rather than capitalize, repairs and maintenance including carpet and appliance replacements, in determining net income and funds from operations. Only major renovations, replacements or improvements with a substantial expected economic life (such as roofs, parking lots and additions) are capitalized.
Investing and Financing Activities
Cash generated from financing activities, before payment of distributions on Common Shares, has historically been sufficient to meet ATLANTIC's needs for investing activities. ATLANTIC's strategy has been to fund its current investment activities through line of credit borrowings, which are subsequently repaid with proceeds from sales of debt and equity securities. ATLANTIC's investment activities used approximately $295.6 million, $287.4 million and $235.1 million of cash for 1997, 1996 and 1995, respectively. ATLANTIC's financing activities provided net cash flow of $209.4 million, $230.9 million and $195.6 million for 1997, 1996 and 1995, respectively. Cash distributions paid on Common Shares were $66.0 million, $53.1 million and $35.1 million for 1997, 1996 and 1995, respectively, which have been substantially funded by cash generated from operating activities.
1995 Investing and Financing Activities
In 1995, ATLANTIC acquired operating communities aggregating 3,961 units and disposed of two communities aggregating 596 units. Also in 1995, ATLANTIC began construction on 2,214 units and completed construction on its first two internally developed communities consisting of 468 units. See the tables of investment activity under "--Real Estate Investments".
During 1995, ATLANTIC's net additional investment in real estate was $257.7 million bringing its total real estate investment at December 31, 1995 to $888.9 million. Sales of Common Shares generated the largest source of capital in 1995. ATLANTIC sold $205.8 million of Common Shares, net of Common Share repurchases, through two private placements. In connection with the acquisition of certain communities in 1995, ATLANTIC assumed $24.7 million in mortgage debt. Additional borrowings on the line of credit during 1995 aggregated $37.0 million.
1996 Investing and Financing Activities
In 1996, ATLANTIC acquired operating communities aggregating 3,556 units and disposed of four communities aggregating 1,184 units. Also in 1996, ATLANTIC began construction on 2,815 multifamily units and completed construction on three internally developed multifamily communities consisting of 1,046 units. See the tables of investment activity under "--Real Estate Investments".
During 1996, ATLANTIC's net additional investment in real estate was $268.3 million, bringing its total real estate investment at December 31, 1996 to $1.16 billion. In 1996, sales of Common Shares were again ATLANTIC's largest source of capital. ATLANTIC raised net proceeds of $119.1 million from a private placement of Common Shares and ATLANTIC's initial public offering of Common Shares, completed on October 18, 1996, generated net proceeds of $110.0 million.
In connection with the acquisition of certain communities in 1996, ATLANTIC assumed $17.9 million in mortgage debt. Additional borrowings on the line of credit during 1996 aggregated $38.0 million.
1997 Investing and Financing Activities
During 1997, ATLANTIC's net investment in real estate increased by $207.3 million, of which $200.2 million represented development expenditures, bringing its total real estate investment at December 31, 1997 to $1.36 billion. ATLANTIC commenced construction on 3,892 units and completed construction of seven communities aggregating 2,124 units, bringing the total of completed internally developed communities to 12 aggregating 3,638 units. In 1997, ATLANTIC acquired six operating communities aggregating 1,220 units and
disposed of five communities aggregating 1,396 units. See the tables of investment activity under "--Real Estate Investments".
Also during 1997, ATLANTIC funded $106.0 million under the Funding Agreement with Homestead in exchange for Homestead Convertible Mortgages. See "--Results of Operations--Homestead Transaction" and "--Results of Operations--Homestead Convertible Mortgages".
Sales of equity securities and senior unsecured debt securities were the primary source of capital in 1997. ATLANTIC's combined net proceeds from sales of equity and debt securities were approximately $342.8 million. In connection with the acquisition of certain communities, ATLANTIC assumed $16.3 million of mortgage debt. In 1997 ATLANTIC reduced its short-term borrowings from $228.0 million outstanding at December 31, 1996 to $167.4 million outstanding at December 31, 1997.
Homestead Convertible Mortgages
At December 31, 1997, ATLANTIC had funded $106.0 million of its total $111.1 million commitment under the Funding Agreement and expects the remaining $5.1 million commitment to be funded in 1998. Upon expected full funding, ATLANTIC will own Homestead Convertible Mortgages with a principal amount of $98.0 million. The Homestead Convertible Mortgages are convertible into Homestead common stock on a basis of one share of Homestead common stock for every $11.50 of principal amount outstanding. Assuming full funding and full conversion of the outstanding mortgage notes and based on the Homestead common stock closing price on December 31, 1997, ATLANTIC's ownership would result in the following incremental value per ATLANTIC Common Share (in thousands, except per share amounts):
The Homestead Convertible Mortgages, which are not callable until 2001, provide ATLANTIC with another source of future liquidity and financial flexibility. Management intends to monitor its investment in the Homestead Convertible Mortgages and evaluate opportunities to utilize this financial resource.
Commitments
ATLANTIC had communities in various stages of development at December 31, 1997. These developments are shown below and are subject to a number of conditions. ATLANTIC cannot predict with certainty that any of them will be consummated.
- -------- (1) For operating communities, represents cost, plus budgeted capital expenditures. For communities under construction and in planning, represents total budgeted development cost, which includes cost of land, fees, permits, payments to contractors, architectural and engineering fees and interest and property taxes to be capitalized during the construction period. (2) The term "in planning" means that construction is anticipated to commence within 12 months. The term "under control" means that ATLANTIC has an exclusive right (through a contingent contract or letter of intent) during a contractually agreed-upon time period to acquire land for future development of multifamily communities, but does not currently own the land.
ATLANTIC occasionally utilizes derivative financial investments as hedges to manage interest rate risk on anticipated future transactions. ATLANTIC does not use derivative financial instruments for trading purposes. ATLANTIC entered into an interest rate contract with a notional amount of $100.0 million in October 1997 in anticipation of a 1998 debt offering. The fair value of this contract was an unrealized loss of approximately $5.6 million at December 31, 1997, based on quoted market prices and estimates obtained from brokers. Upon completion of the offering, ATLANTIC will defer the loss associated with the contract which will then be amortized as an increase to interest expense over the term of the debt issued.
Impact of Year 2000
ATLANTIC has undertaken a review of all of its computer systems and applications to determine if these programs are Year 2000 compliant and if not, the efforts that will be necessary to bring the programs into compliance. The Year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. Certain computer programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations.
ATLANTIC has not identified any computer system or application for which a failure to be Year 2000 compliant would result in a material adverse impact on ATLANTIC's business activities or results of operations. However, the preliminary results of this review indicate that certain of ATLANTIC's accounting and financial reporting applications are not Year 2000 compliant. In order to enhance operating efficiencies, ATLANTIC has already undertaken a project that will replace these core financial systems with computer software that will better serve ATLANTIC in the future. This new software, that is expected to be fully operational by the first quarter of 1999, is Year 2000 compliant.
ATLANTIC is currently evaluating Year 2000 modifications to other existing software programs. The cost of these modifications is not expected to be material and all conversions and modifications are expected to be completed in a timely manner.
Lines of Credit
On November 24, 1997, ATLANTIC renegotiated its $350 million unsecured line of credit agreement with Morgan Guaranty Trust Company of New York ("MGT"), as agent for a group of lenders. Under the new agreement, borrowings on the unsecured line of credit bear interest at prime or, at ATLANTIC's option, LIBOR plus 0.75%. Under a competitive bid option contained in the new line of credit agreement, ATLANTIC may be able to borrow at a lower interest rate spread over LIBOR, depending on market conditions. This option is available on up to $175 million of borrowings. ATLANTIC pays an annual facility fee of 0.15% on the total line of credit available of $350 million. The line of credit matures in November 1999 and may be extended for one year with the approval of MGT and the other participating lenders.
All debt incurrences under the unsecured line of credit are subject to certain covenants as more fully described in the loan agreement. Specifically, distributions for the preceding four quarters may not exceed 95% of ATLANTIC's funds from operations (as defined in the loan agreement) for the preceding four quarters. ATLANTIC is in compliance with all such covenants.
On June 30, 1997, ATLANTIC entered into a $25 million unsecured borrowing agreement (increased to $50 million on January 20, 1998) with Chase Bank of Texas, N.A. This line of credit, which allows for same day borrowings and more efficient cash management, matures on January 19, 1999 and bears interest at an overnight rate that depends on the availability of funds at the time the borrowing is made. In 1997, the interest rate on these borrowings ranged from 6.31% to 7.38% with a weighted-average daily interest rate of 6.69%.
As of March 18, 1998, $187.0 million of borrowings were outstanding under the $350 million unsecured line of credit and $24.9 million of borrowings were outstanding under the $50 million unsecured line of credit.
Mortgage Debt
At December 31, 1997, ATLANTIC had $170.5 million of mortgage debt consisting of $49.9 million of fixed-rate conventional mortgage debt and $120.6 million of mortgages that secure ten tax-exempt bond issues. This long- term mortgage debt, which is substantially fully amortizing, has a weighted- average all-in interest rate of 6.98%, and an average term to maturity of 21.3 years. The use of mortgage debt to acquire certain communities provides ATLANTIC with favorable and conservative financial leverage on its investment in these communities.
All of ATLANTIC's tax-exempt bond issues are included in a credit enhancement agreement with FNMA. This agreement allowed ATLANTIC to receive a favorable interest rate on the bond issues and required ATLANTIC to enter into swap agreements to mitigate the interest rate exposure on the nine bond issues with variable interest rates. ATLANTIC makes monthly principal payments on all of the bond issues into a principal reserve account based upon a 30-year amortization. The notional amount of the swap agreements is equal to the principal amount of the variable rate bond issues less the balance in the principal reserve fund associated with the variable rate bond issues. ATLANTIC pays interest on the notional amount at an all-in, fixed rate of 6.61%. The swap agreements mature from August 2002 through August 2006. ATLANTIC paid $1.8 million, $1.8 million and $0.6 million more in interest than it received under these swap agreements during 1997, 1996 and 1995, respectively.
Distributions
ATLANTIC's current distribution policy is to pay quarterly cash distributions to shareholders based upon what it considers to be a reasonable percentage of cash flow. Because depreciation is a non-cash expense, cash
flow typically will be greater than earnings from operations and net earnings. Therefore, quarterly cash distributions will be higher than quarterly earnings, resulting in a reduction to shareholders' equity.
Cash distributions paid on Common Shares in 1997, 1996 and 1995 were $1.56 per Common Share, $1.65 per Common Share and $1.60 per Common Share, respectively. Additionally in 1996, ATLANTIC made the Homestead Distribution, which was valued at $58.2 million for book purposes.
ATLANTIC announces the following year's projected annual distribution level after the Board's annual budget review and approval in December of each year. At its December 4, 1997 meeting, the Board announced a projected annual distribution level of $1.60 per Common Share for 1998 and declared a distribution of $0.40 per Common Share for the first quarter of 1998, which was paid on February 26, 1998. The payment of distributions is subject to the discretion of the Board and is dependent upon the financial condition and operating results of ATLANTIC.
Funds from Operations
Funds from operations represents ATLANTIC's net earnings computed in accordance with GAAP, excluding gains (or losses) from real estate transactions, provisions for possible losses, extraordinary items, non-cash interest income from Homestead Convertible Mortgages and real estate depreciation. Funds from operations should not be considered as an alternative to net earnings or any other GAAP measurement of performance as an indicator of ATLANTIC's operating performance, or as an alternative to cash flows from operating, investing or financing activities as a measure of liquidity. ATLANTIC believes that funds from operations is helpful to a reader as a measure of the performance of an equity REIT because, along with cash flow from operating activities, financing activities and investing activities, it provides a reader with an indication of the ability of ATLANTIC to incur and service debt, to make capital expenditures and to fund other cash needs. On January 1, 1996, ATLANTIC adopted NAREIT's revised definition of funds from operations. Under this more conservative definition, loan cost amortization is not added back to net earnings in determining funds from operations. The funds from operations measure presented by ATLANTIC, while consistent with the NAREIT definition, will not be comparable to similarly titled measures of other REITs which do not compute funds from operations in a manner consistent with ATLANTIC. Funds from operations is not intended to represent cash made available to shareholders.
To provide a more meaningful comparison to 1997 results, ATLANTIC believes that funds from operations for 1996 and 1995 should be adjusted to reflect the effects of the sale of the Homestead Assets in 1996. Accordingly, the table below also presents pro forma funds from operations, which have been calculated as if the sale of the Homestead Assets had occurred on January 1, 1995. However, the 1996 and 1995 pro forma funds from operations information does not give effect to or adjust for any other events and is not necessarily indicative of what actual funds from operations would have been if the Homestead transaction had occurred on January 1, 1995.
Funds from operations and pro forma funds from operations were as follows (amounts in thousands):
- -------- (1) Represents the reduction in rental income and rental expenses that would have occurred had the Homestead property that commenced operations in 1996 been sold as of January 1, 1995. (2) Represents the increase in interest expense due to (i) the reduction in capitalized interest that would have resulted from the sale of Homestead Village(R) properties under development and (ii) the increased borrowings necessary to fund the cash payment to Homestead upon closing of the Homestead transaction, as if these two items had occurred on January 1, 1995. (3) Represents the decrease in REIT management fee that would have resulted from the pro forma adjustments.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ATLANTIC's Balance Sheets as of December 31, 1997 and 1996, its Statements of Earnings, Shareholders' Equity and Cash Flows for each of the years in the three-year period ended December 31, 1997 and Schedule III--Real Estate and Accumulated Depreciation, together with the report of Ernst & Young LLP, independent auditors, are included under Item 14 of this report and are incorporated herein by reference. Selected quarterly financial data is presented in Note 10 of Notes to Financial Statements.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE MATTERS
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For information regarding ATLANTIC's executive officers, see "Item 1. Business--Directors and Officers of ATLANTIC". The other information required by this Item 10 is incorporated herein by reference to the description under the captions "Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in ATLANTIC's definitive proxy statement for its 1998 annual meeting of shareholders (the "1998 Proxy Statement").
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated herein by reference to the description under the captions "Election of Directors" and "Executive Compensation" in the 1998 Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by reference to the description under the captions "Principal Shareholders" in the 1998 Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference to the description under the caption "Certain Relationships and Transactions" in the 1998 Proxy Statement.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
The following documents are filed as a part of this report:
(a) Financial Statements and Schedules:
1. Financial Statements: See Index to Financial Statements and Schedule on page 48 of this report, which is incorporated herein by reference.
2. Financial Statement Schedules: Schedule III.
All other schedules have been omitted since the required information is presented in the financial statements and the related notes or is not applicable.
3. Exhibits: See Index to Exhibits on pages 84 and 85 of this report, which is incorporated herein by reference.
(b) Reports on Form 8-K: The following report on Form 8-K was filed during the last quarter of the period covered by this report:
Not Applicable.
(c) Exhibits:
The Exhibits required by Item 601 of Regulation S-K are listed in the Index to Exhibits on pages 84 and 85 of this report, which is incorporated herein by reference.
INDEX TO FINANCIAL STATEMENTS AND SCHEDULE
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders SECURITY CAPITAL ATLANTIC INCORPORATED
We have audited the accompanying balance sheets of Security Capital Atlantic Incorporated as of December 31, 1997 and 1996, and the related statements of earnings, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997. Our audit also included the accompanying Schedule III, Real Estate and Depreciation. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Security Capital Atlantic Incorporated at December 31, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related 1997 financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
Ernst & Young LLP
Dallas, Texas January 27, 1998
SECURITY CAPITAL ATLANTIC INCORPORATED
BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
The accompanying notes are an integral part of the financial statements.
SECURITY CAPITAL ATLANTIC INCORPORATED
STATEMENTS OF EARNINGS (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
The accompanying notes are an integral part of the financial statements.
SECURITY CAPITAL ATLANTIC INCORPORATED
STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997 (IN THOUSANDS)
The accompanying notes are an integral part of the financial statements.
SECURITY CAPITAL ATLANTIC INCORPORATED
STATEMENTS OF CASH FLOWS (IN THOUSANDS)
See Note 11 for information on non-cash investing and financing activities.
The accompanying notes are an integral part of the financial statements.
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1997
NOTE 1 DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
Security Capital Atlantic Incorporated ("ATLANTIC") is an equity real estate investment trust organized as a corporation under the laws of the State of Maryland, which owns, acquires, develops and operates income-producing multifamily communities in the south-Atlantic, mid-Atlantic and midwestern regions of the United States.
Principles of Financial Presentation
The accounts of ATLANTIC and its wholly owned subsidiaries are consolidated in the accompanying financial statements. All significant intercompany accounts and transactions have been eliminated in consolidation.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates.
Cash and Cash Equivalents
ATLANTIC considers all cash on hand, demand deposits with financial institutions and short-term, highly liquid investments with original maturities of three months or less to be cash equivalents.
Real Estate and Depreciation
Real estate is carried at cost, which is not in excess of estimated fair market value. Costs directly related to the acquisition, renovation or development of real estate are capitalized. Costs incurred in connection with the pursuit of unsuccessful acquisitions are expensed at the time the pursuit is abandoned.
Depreciation is computed over the economic useful lives of depreciable property on a straight-line basis. Communities are depreciated principally over 20-40 years for buildings and improvements and 2-10 years for furnishings and other depreciable assets.
Capitalization Policy
Renovations and improvements are capitalized and depreciated over their economic useful lives. Repairs and maintenance, including carpet and appliance replacements, and make-ready expenses (expenses incurred in preparing a vacant multifamily unit for the next resident) are expensed as incurred to the extent they are not acquisition-related renovation costs identified during ATLANTIC's pre-acquisition due diligence. ATLANTIC capitalizes certain qualifying management costs related to the acquisition, development and renovation of multifamily communities.
Cost of Raising Capital
Costs incurred in connection with the issuance of shares are deducted from shareholders' equity. Costs incurred in connection with the incurrence or renewal of debt are capitalized, included with other assets and amortized over the term of the related loan or renewal term.
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Revenue Recognition
Rental and interest income are recorded on the accrual method of accounting. Gains on sales of real estate are recorded when criteria set forth by generally accepted accounting principles have been met. A provision for possible loss is made when collection of receivables is considered doubtful.
Rental Expenses
Rental expenses include utilities, repairs and maintenance, make-ready costs (including carpet and appliance replacement), property insurance, marketing, landscaping, on-site personnel and other administrative costs.
Federal Income Taxes
ATLANTIC has elected to be taxed as a real estate investment trust under the Internal Revenue Code of 1986, as amended. ATLANTIC believes it qualifies as a real estate investment trust. Accordingly, no provisions have been made for federal income taxes in the accompanying financial statements.
Comprehensive Income
ATLANTIC adopted Statement of Financial Accounting Standards ("SFAS") No. 130, Reporting Comprehensive Income, in the fourth quarter of 1997. SFAS No. 130 establishes new rules for the reporting and display of comprehensive income and its components; however, its adoption had no impact on ATLANTIC's net earnings or shareholders' equity. In 1997, ATLANTIC had one item of other comprehensive income, the unrealized gain on the convertible mortgage notes discussed in Note 3. This unrealized gain has been recognized in shareholders' equity. ATLANTIC had no items of other comprehensive income in 1995 or 1996. In accordance with SFAS No. 130, ATLANTIC's statement of shareholders' equity for 1997 displays comprehensive income and its components.
Interest Rate Contracts
ATLANTIC utilizes various interest rate contracts to hedge interest rate risk on anticipated debt offerings. These anticipatory hedges are designated and effective as hedges of identified debt issuances which have a high probability of occurring. Gains and losses resulting from changes in the market value of these contracts are deferred and amortized into interest expense over the term of the related debt issuance.
Per Common Share Data
ATLANTIC adopted SFAS No. 128, Earnings per Share in the fourth quarter of 1997. SFAS No. 128 replaces the presentation of primary and fully diluted earnings per share with a presentation of basic and diluted earnings per share. The adoption of SFAS No. 128 did not result in a restatement of previously reported earnings per Common Share data.
The weighted-average number of shares of common stock, par value $0.01 per share ("Common Shares"), outstanding during the year is used to calculate basic earnings per Common Share. Diluted earnings per Common Share for 1996 and 1997 is computed based on the weighted-average Common Shares outstanding plus the Common Shares that would be outstanding assuming the exercise of dilutive options as of the date the options were granted (3,000 options assumed to be exercised as of October 14, 1996 and 3,000 options assumed to be exercised as of May 29, 1997). All other outstanding options are antidilutive. There were no outstanding options in 1995. See Note 8 for a discussion of all of ATLANTIC's outstanding options. Because the amount of dilutive options is immaterial to the total weighted-average Common Shares outstanding, basic earnings per Common Share and diluted earnings per Common Share are the same.
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The Common Share and per Common Share amounts included in the financial statements have been restated to reflect the reverse Common Share split discussed in Note 7.
NOTE 2 REAL ESTATE
Investment in Real Estate
ATLANTIC's real estate, which consists entirely of multifamily communities, at cost, was as follows (dollar amounts in thousands):
- -------- (1) At December 31, 1997 includes communities which were leasing completed units of $126.0 million (2,323 units) and communities with no completed units of $91.1 million (3,524 units). Unfunded commitments for all communities under construction were $165.8 million at December 31, 1997 which will result in a total completed construction cost of $382.9 million. (2) The term "in planning" means that construction is anticipated to commence within 12 months. The term "under control" means that ATLANTIC has an exclusive right (through a contingent contract or letter of intent) during a contractually agreed-upon time period to acquire land for future development of multifamily communities, but does not currently own the land. (3) Costs for owned communities in planning are primarily for land acquisitions. (4) Unit information is based on management's estimates and is unaudited. (5) ATLANTIC's investment at December 31, 1997 and 1996 in communities in planning and under control for future development was $1.8 million and $1.4 million, respectively. These amounts are classified as other assets. (6) Construction is not anticipated to commence within 12 months. (7) Communities located in Atlanta, Georgia aggregated 28.5% and 30.7% at December 31, 1997 and 1996, respectively, of ATLANTIC's real estate, at cost.
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The changes in real estate, at cost, consisted of the following (in thousands):
Gains from Dispositions of Real Estate
ATLANTIC's real estate investments have been made with a view to effective long-term operation and ownership. Based upon ATLANTIC's market research and in an effort to optimize its portfolio composition, ATLANTIC may from time to time seek to dispose of assets that no longer meet ATLANTIC's investment criteria and redeploy the proceeds therefrom, preferably through tax-deferred exchanges, into assets with better prospects for long-term growth.
As a result of this asset optimization strategy, ATLANTIC disposed of five communities aggregating 1,396 units in 1997. A gain of $1.6 million was recognized on aggregate proceeds of $66.5 million from these dispositions. These five communities accounted for $2.6 million, $3.4 million and $3.2 million of net operating income during 1997, 1996 and 1995, respectively.
ATLANTIC disposed of four communities in 1996 aggregating 1,184 units. A gain of $6.7 million was recognized on aggregate proceeds of $64.2 million. These four communities accounted for $3.6 million and $5.2 million of net operating income during 1996 and 1995, respectively.
In 1995, ATLANTIC disposed of two communities aggregating 596 units. The proceeds from these dispositions were not materially different from the book value of the assets on the date of disposition. These two communities accounted for $2.4 million of net operating income during 1995.
Valuation of Real Estate
SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, which was adopted by ATLANTIC effective January 1, 1996, establishes accounting standards for the review of long-lived assets to be held and used for impairment whenever the carrying amount of an asset may not be recoverable. SFAS No. 121 also requires that certain long- lived assets to be disposed of be reported at the lower of carrying amount or fair value less cost to sell. ATLANTIC periodically evaluates its long-lived investments held and used for impairment and a provision for possible loss is made, if required. ATLANTIC recognized a provision for possible loss of $0.2 million in 1997 and $2.5 million in 1996 associated with a community that was disposed of in 1997. At December 31, 1997, ATLANTIC's investments are carried at cost, which is not in excess of fair market value.
Third-Party Owner/Developer
ATLANTIC entered into a presale agreement in 1995 to acquire a community developed by a third-party owner/developer. This development was funded through a development loan from ATLANTIC. The activities of
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
the third-party owner/developer were consolidated with ATLANTIC's activities. During 1997, the community covered by this agreement was completed and acquired by ATLANTIC as repayment of the development loan. As of December 31, 1997 there were no other development loans outstanding.
NOTE 3 HOMESTEAD TRANSACTION AND HOMESTEAD CONVERTIBLE MORTGAGES
General
On October 17, 1996, ATLANTIC sold its moderate-priced, purpose-built, extended-stay lodging facilities known as Homestead Village(R) properties to Homestead Village Incorporated ("Homestead"). In the transaction, ATLANTIC sold one operating property and 25 properties under construction or in planning (or the rights to acquire such properties) and paid $16.6 million in cash (the "Homestead Assets") and received 4,201,220 shares of common stock of Homestead. In addition, ATLANTIC entered into a funding commitment agreement (the "Funding Agreement") to provide secured financing to Homestead for purposes of completing the development and construction of the properties sold in the transaction. ATLANTIC will receive up to $98.0 million of convertible mortgage notes from Homestead ("Homestead Convertible Mortgages") in exchange for fully funding the $111.1 million required under the Funding Agreement. ATLANTIC received 2,818,517 warrants, each to purchase one share of Homestead common stock at $10 per share, in exchange for entering into the Funding Agreement. ATLANTIC realized a gain on the transaction of $2.8 million, net of expenses.
On November 12, 1996, ATLANTIC distributed the Homestead common stock and warrants to holders of record of Common Shares on October 29, 1996 (the "Homestead Distribution"). The Homestead Distribution consisted of 0.110875 shares of Homestead common stock and 0.074384 Homestead warrants per Common Share.
Carrying Value
At December 31, 1997, ATLANTIC holds Homestead Convertible Mortgages with a principal amount of $93.5 million, as a result of funding $106.0 million of its commitment to Homestead. The difference between the face amount and the amount funded has been recorded as an original issue premium that is being amortized over the term of the Homestead Convertible Mortgages. The value attributed to the conversion feature of the Homestead Convertible Mortgages issued ($6.9 million assuming full funding) has been recorded along with an offsetting discount (deferred credit) in the Homestead Convertible Mortgages' balance. This deferred credit is being amortized over the term of the Homestead Convertible Mortgages. Furthermore, the carrying value of the Homestead Convertible Mortgages has been adjusted to fair value ($122.5 million at December 31, 1997). A fair value adjustment of $16.7 million has been recognized as an unrealized gain and is reflected as a component of comprehensive income in the statement of shareholders' equity. The amount of the adjustment is based upon the conversion value of the Homestead Convertible Mortgages and is calculated using the closing price of Homestead common stock on December 31, 1997 of $15.0625 per share.
The Homestead Convertible Mortgages:
(i) bear interest at 9.0% per annum which is due in interest only payments on a semi-annual basis,
(ii) are convertible at ATLANTIC's option into one share of Homestead common stock for every $11.50 of principal outstanding (approximately 8.5 million shares upon full funding),
(iii) are not callable until 2001 and
(iv) mature October 2006.
The individual Homestead Village(R) properties sold by ATLANTIC serve as collateral individually and in the aggregate under cross-collateral provisions.
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
At December 31, 1997 the carrying value of the Homestead Convertible Mortgages consisted of the following components (in thousands):
Deferred Commitment Fee
ATLANTIC recognized a deferred commitment fee related to the $6.5 million of warrants received from Homestead in return for entering into the Funding Agreement. This commitment fee, which is a component of other liabilities in the balance sheet, is being amortized over the term of the Homestead Convertible Mortgages.
Interest Income Recognized
The aggregate income recognized on the Homestead Convertible Mortgages consists of:
(i) the interest income recognized at 9.0% per annum,
(ii) the amortization of the original issue premium which reduces income,
(iii) the amortization of the discount on the conversion feature which increases income, and
(iv) the amortization of the deferred commitment fee which increases income.
ATLANTIC uses the effective interest method to calculate the amortization of all items associated with the Homestead Convertible Mortgages. The effective interest rate on the funded amount is 8.46% per annum for purposes of calculating net earnings.
NOTE 4 BORROWINGS
Lines of Credit
On November 24, 1997, ATLANTIC renegotiated its $350 million unsecured line of credit with Morgan Guaranty Trust Company of New York ("MGT"), as agent for a group of lenders. Under the new agreement, borrowings on the unsecured line of credit bear interest at prime or, at ATLANTIC's option, LIBOR plus 0.75%. Under a competitive bid option contained in the new line of credit agreement, ATLANTIC may be able to borrow at a lower interest rate spread over LIBOR, depending on market conditions. This option is available on up to $175 million of borrowings. ATLANTIC pays an annual facility fee of 0.15% on the total line of credit available of $350 million. The line of credit matures November 1999 and may be extended for one year with the approval of MGT and the other participating lenders. At December 31, 1997, there were $153.5 million of borrowings outstanding under this line of credit.
The unsecured line of credit replaced a previous secured line of credit which was extinguished in December 1996. Accordingly, ATLANTIC expensed all previously unamortized costs associated with the secured line of credit at that time. These costs aggregated $3.9 million and are reflected as an extraordinary item in ATLANTIC's 1996 statement of earnings.
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
All debt incurrences under the unsecured line of credit are subject to certain covenants. Specifically, distributions for the preceding four quarters, excluding the Homestead Distribution, may not exceed 95% (97% for distributions made before December 31, 1996) of ATLANTIC's funds from operations (as defined in the loan agreement) for the preceding four quarters. ATLANTIC is in compliance with all such covenants.
On June 30, 1997, ATLANTIC entered into a $25 million unsecured borrowing agreement (increased to $50 million on January 20, 1998) with Chase Bank of Texas, N.A. This loan, which allows for same day borrowings and more efficient cash management, matures on January 19, 1999 and bears interest at an overnight rate that depends on the availability of funds at the time the borrowing is made. The interest rate on these borrowings has ranged from 6.31% to 7.38% with a weighted-average daily interest rate of 6.69%. At December 31, 1997, there were $11.2 million of borrowings outstanding under this agreement.
A summary of borrowings on ATLANTIC's lines of credit is as follows (dollar amounts in thousands):
Notes Payable
On August 20, 1997, ATLANTIC completed an offering of $100 million of 7.25% unsecured senior notes due 2009 (the "2009 Notes") and $50 million of 7.86% unsecured senior notes due 2017 (the "2017 Notes" and together with the 2009 Notes, "the Notes"). The Notes are fully amortizing, rank equally with all other unsecured and unsubordinated indebtedness of ATLANTIC from time to time outstanding and bear interest at the stated rates. Interest is payable semiannually in arrears and principal installments are due annually beginning in 2002 for the 2009 Notes and in 2013 for the 2017 Notes. The Notes are redeemable at any time at ATLANTIC's option and are governed by the terms and provisions of an indenture agreement. Net proceeds from the offering were approximately $148.6 million, net of costs.
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Mortgages Payable
Mortgages payable consisted of the following at December 31, 1997 (dollar amounts in thousands):
- -------- (1) This loan is callable at the option of the mortgage lender on September 10, 1998 and at subsequent five-year intervals through September 10, 2013. (2) Interest and principal payments due monthly; balloon payment of $1,849,000 due at maturity. (3) Interest and principal payments due monthly; balloon payment of $4,869,000 due at maturity. (4) Interest and principal payments due monthly; balloon payment of $5,539,000 due at maturity. (5) Interest and principal payments due monthly; balloon payment of $5,556,000 due at maturity. (6) Interest and principal payments due monthly; balloon payment of $4,926,000 due at maturity. (7) Interest and principal payments due monthly; balloon payment of $4,661,000 due at maturity. (8) These communities, in addition to others, are held by Security Capital Atlantic Multifamily Incorporated, a wholly owned subsidiary of ATLANTIC. Security Capital Atlantic Multifamily Incorporated is a legal
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
entity that is separate and distinct from ATLANTIC with separate assets and liabilities and business operations. (9) Interest rate is fixed through swap agreements executed in conjunction with the credit enhancement agreement with the Federal National Mortgage Association ("FNMA"). The swap agreements are discussed in Note 13. (10) ATLANTIC has a 30-year credit enhancement agreement with FNMA related to the underlying tax-exempt bond issues. This credit enhancement agreement requires ATLANTIC to make monthly payments into a principal reserve account based on a 30-year amortization. (11) This rate includes annual fees associated with the mortgage agreements, swap agreements and the credit enhancement agreement and amortization of capitalized costs associated with the mortgage agreements and the credit enhancement agreement. See Note 13.
Real estate with an aggregate undepreciated cost at December 31, 1997 of $78.4 million and $205.8 million serves as collateral for the conventional mortgages payable and the tax-exempt mortgages payable, respectively. Additionally, ATLANTIC has a letter of credit in the amount of $2.5 million that serves as collateral for the tax-exempt mortgages payable.
The changes in mortgages payable were as follows (in thousands):
ATLANTIC is in compliance with all debt covenants required by the mortgage agreements.
Long-term Debt Maturities
Approximate principal payments due on notes payable and mortgages payable during each of the years in the five-year period ending December 31, 2002 and thereafter are as follows (in thousands):
Interest Expense
During 1997, 1996 and 1995, the total interest paid in cash on all outstanding debt was $26.8 million, $24.7 million, and $20.6 million respectively. Interest capitalized as part of the cost of real estate projects under development was $10.2 million, $10.3 million and $4.4 million for 1997, 1996 and 1995, respectively.
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Amortization of loan costs, which is included in interest expense, was $0.4 million, $1.7 million and $1.6 million for 1997, 1996 and 1995, respectively.
NOTE 5 DISTRIBUTIONS AND DIVIDENDS
ATLANTIC made total cash distributions of $1.56 per Common Share in 1997, $1.65 per Common Share in 1996 and $1.60 per Common Share in 1995. On December 4, 1997, ATLANTIC's Board of Directors (the "Board") declared a distribution of $0.40 per Common Share for the first quarter of 1998. The distribution is payable on February 26, 1998 to holders of record of Common Shares on February 12, 1998.
For federal income tax purposes, the following summarizes the taxability of cash distributions paid for 1995 and 1996 and the estimated taxability for 1997:
As part of the merger transaction discussed below, ATLANTIC's common shareholders (other than Security Capital) as of September 16, 1997 received warrants from Security Capital to purchase 1,675,940 shares of Security Capital's Class B common stock (0.071116 warrants for each Common Share held). Each warrant can be exercised for one share of Security Capital's Class B common stock at an exercise price of $28.00 per share through September 18, 1998. Security Capital issued these warrants, in part, as an incentive to ATLANTIC's shareholders to vote to approve the merger transaction. The warrants were valued at $6.88 per warrant for federal income tax purposes, all of which is taxable as ordinary income.
In addition, ATLANTIC made the Homestead Distribution (discussed in Note 3) in November 1996. The Homestead Distribution was recorded at $58.2 million based on the estimated fair value of the net assets sold to Homestead. The securities distributed to each ATLANTIC shareholder in the Homestead Distribution were valued at $1.91 per Common Share for federal income tax purposes, of which $0.90 was taxable as ordinary income and $1.01 was treated as a return of capital.
ATLANTIC paid dividends of $0.7845 per share on its Series A Cumulative Redeemable Preferred Stock ("Series A Preferred Shares") in 1997, all of which was treated as ordinary income for federal income tax purposes. Pursuant to the terms of the preferred shares, ATLANTIC is restricted from declaring or paying any distribution with respect to its Common Shares unless all cumulative dividends with respect to the Series A Preferred Shares have been paid and sufficient funds have been set aside for Series A Preferred Share dividends that have been declared.
ATLANTIC's tax return for the year ended December 31, 1997 has not been filed, and the taxability information for 1997 is based on the best available data. ATLANTIC's tax returns for prior years have not been examined by the Internal Revenue Service and, therefore, the taxability of distributions and dividends is subject to change.
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
NOTE 6 MERGER TRANSACTION
Terms of Transaction
On September 9, 1997, ATLANTIC acquired the operations and business of Security Capital (Atlantic) Incorporated (the "REIT Manager") and SCG Realty Services Atlantic Incorporated ("SCG Realty Services"), ATLANTIC's property manager, in exchange for 2,306,591 Common Shares (the "Merger"). The REIT Manager and SCG Realty Services were wholly owned subsidiaries of ATLANTIC's principal shareholder, Security Capital Group Incorporated ("Security Capital"). The Common Shares issued to Security Capital were valued as of August 6, 1997, the record date for determining ATLANTIC's shareholders entitled to vote on the Merger, at $54.6 million. A per Common Share price of $23.675 (the average market price of Common Shares over the five-day period prior to the August 6, 1997) was used to determine the number of Common Shares issued. As a result of the Merger, ATLANTIC has become an internally managed REIT.
Because ATLANTIC, the REIT Manager and SCG Realty Services were under the common control of Security Capital when the Merger was consummated, the difference between the market value as of September 8, 1997 of the Common Shares issued to Security Capital and the value of the net tangible assets of the REIT Manager and SCG Realty Services acquired by ATLANTIC of $50.9 million has been accounted for as a distribution to Security Capital. This distribution is reflected as a deduction from additional paid-in capital.
Effect on Future Operations
As a result of the Merger, ATLANTIC terminated its REIT management agreement with the REIT Manager and its property management agreements with SCG Realty Services (which covered approximately 97% of ATLANTIC's operating communities). Consequently, ATLANTIC did not incur the costs associated with these agreements after September 8, 1997. However, after the Merger was completed, ATLANTIC did incur, and will continue to incur, certain of the operating costs of the businesses acquired, primarily the personnel costs associated with the employees of the REIT Manager and SCG Realty Services who are now employees of ATLANTIC. In addition, ATLANTIC purchased, and will continue to purchase, certain administrative services from Security Capital under an Administrative Services Agreement ("ASA"). The fees payable under the ASA are equal to Security Capital's direct cost plus an overhead factor of 20%. For the initial term of the agreement (September 9, 1997 through December 31, 1998), the fees payable to Security Capital will not exceed approximately $5.2 million, but may be less than that amount as any cost savings will accrue to ATLANTIC. For the period September 9, 1997 through December 31, 1997, ATLANTIC's costs under the ASA were limited to $1.5 million and ATLANTIC actually incurred $0.7 million of costs for that period. For 1998, ATLANTIC's costs under the ASA cannot exceed $3.7 million.
Costs related to the management function, including charges under the ASA, incurred subsequent to the Merger are collectively referred to as "management costs". Management costs related to property operations are reflected as rental expenses in arriving at net operating income. Certain qualifying management costs related to the acquisition and development of multifamily communities have been capitalized ($1.5 million for the period from September 9, 1997 through December 31, 1997). Management costs that have not been capitalized and are not classified as rental expenses are reflected as general and administrative expenses.
NOTE 7 SHAREHOLDERS' EQUITY
Shares Authorized
At December 31, 1997, 250,000,000 shares were authorized. The Board may classify or reclassify any unissued shares of ATLANTIC's stock from time to time by setting or changing the preferences, conversion or
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
other rights, voting powers, restrictions, limitations as to distributions, qualifications and terms or conditions of redemption of such shares.
Reverse Common Share Split
On September 10, 1996, ATLANTIC completed a one-for-two reverse split of its Common Shares. A transfer from the Common Shares account to additional paid-in capital was made to reflect the reduced number of Common Shares outstanding after the split. All references in the accompanying financial statements to the number of Common Shares and per Common Share amounts have been restated to reflect the reverse split.
Series A Preferred Shares
On August 20, 1997, ATLANTIC completed an offering of 2,000,000 shares of Series A Preferred Shares. These shares have a par value of $0.01 per share and a stated liquidation preference of $25.00 per share. Holders of the Series A Preferred Shares are entitled to receive cumulative preferential cash distributions at a rate of 8.625% per annum. The Series A Preferred Shares are redeemable on or after August 20, 2002 by ATLANTIC for cash at a stated redemption price, plus all accrued and unpaid distributions. Subject to certain exceptions, the holders of Series A Preferred Shares have no voting rights. The Series A Preferred Shares are not convertible into or exchangeable for any other property or securities of ATLANTIC. Proceeds from the offering were approximately $48.1 million, net of costs.
Completed Common Equity Offerings
In May 1997, ATLANTIC completed an underwritten public offering of 4,077,200 Common Shares at a price of $21.50 per share. The proceeds from the sale of these Common Shares, net of underwriters' commissions and other expenses, were approximately $82.2 million.
In connection with the Merger discussed in Note 6, ATLANTIC completed a fully subscribed rights offering pursuant to which 2,552,770 Common Shares were sold at $22.375 per share. Holders of Common Shares received one right for each Common Share held on August 6, 1997 and eight rights were needed to purchase one Common Share. The rights were offered to allow holders of Common Shares (other than Security Capital) the opportunity to maintain their relative ownership in ATLANTIC after the Merger by purchasing additional Common Shares at a price below the price at which Security Capital received Common Shares in the Merger. Proceeds from the offering were approximately $56.5 million, net of costs.
In November 1997, ATLANTIC sold 350,000 Common Shares at a price of $21.0625 per share in a registered offering. Proceeds from the offering were approximately $7.4 million, net of costs.
From inception through May 1996, ATLANTIC raised capital through various private offerings. ATLANTIC sold a total of 31,701,580 Common Shares during this period at prices ranging from $20 to $23.136 per Common Share. In addition, ATLANTIC exchanged 5,000,000 Common Shares at a price of $20 per Common Shares as partial consideration for the acquisition of a pool of communities in May 1994. The acquisition price was negotiated prior to the seller becoming a related party. To facilitate ATLANTIC's transactions with the seller, Security Capital granted the seller certain rights to require Security Capital to purchase the 5,000,000 Common Shares owned by the seller at pre-agreed prices. In consideration for Security Capital purchasing Common Shares in ATLANTIC's private offerings, ATLANTIC assumed Security Capital's obligation with respect to 3,750,000 Common Shares and repurchased these Common Shares from the seller. The remaining 1,250,000 Common Shares were acquired directly from the seller by Security Capital.
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
In October 1996, ATLANTIC completed an initial public offering of 4,940,000 Common Shares at a price of $24.00 per share. After ATLANTIC made the Homestead Distribution discussed in Note 3, the New York Stock Exchange adjusted ATLANTIC's trading price information by $2.75 per Common Share. Accordingly, ATLANTIC's initial public offering price, as adjusted for the Homestead Distribution, was $21.25 per Common Share. The Common Shares, excluding the 416,666 Common Shares sold to Security Capital, were sold through an underwritten offering. The proceeds from the sale of these 4,940,000 Common Shares, net of costs, were approximately $110.0 million.
Shelf Registration
In November 1997, a $500 million shelf registration statement was declared effective by with the Securities and Exchange Commission. These securities can be issued in the form of senior unsecured debt, preferred shares and Common Shares on an as-needed basis, subject to ATLANTIC's ability to effect an offering on satisfactory terms. As of December 31, 1997, $492.6 million of securities were available for issuance under the shelf registration.
Ownership Restrictions and Significant Shareholder
For ATLANTIC to qualify as a REIT under the Internal Revenue Code of 1986, as amended, not more than 50% in value of its outstanding shares of stock may be owned by five or fewer individuals at any time during the last half of ATLANTIC's taxable year. Therefore, ATLANTIC's Charter restricts beneficial ownership (or ownership generally attributed to a person under the REIT tax rules) of ATLANTIC's outstanding shares of stock by a single person, or persons acting as a group, to 9.8% of ATLANTIC's outstanding shares of stock. This provision assists ATLANTIC in protecting and preserving its REIT status and protects the interest of shareholders in takeover transactions by preventing the acquisition of a substantial block of shares unless the acquirer makes a cash tender offer for all outstanding shares.
Shares of stock owned by a person or group of persons in excess of these limits are subject to redemption by ATLANTIC. The provision does not apply where a majority of the Board, in its sole and absolute discretion, waives such limit after determining that the status of ATLANTIC as a REIT for federal income tax purposes will not be jeopardized or the disqualification of ATLANTIC as a REIT is advantageous to the shareholders.
The Board has exempted Security Capital from the ownership restrictions described above. Security Capital owned 49.9% of the outstanding Common Shares as of December 31, 1997. For tax purposes, Security Capital's ownership is attributed to its shareholders.
Purchase Rights
On March 12, 1996, the Board declared and paid a dividend of one preferred share purchase right ("Purchase Right") for each Common Share outstanding at the close of business on March 12, 1996 to the holders of Common Shares on that date. Holders of additional Common Shares issued after March 12, 1996 and prior to the expiration of the rights on March 12, 2006 will be entitled to one Purchase Right for each additional Common Share.
Each Purchase Right entitles the holder, under certain circumstances, to purchase from ATLANTIC two one-hundredths of a share of non-redeemable Series A Junior Participating Preferred Stock of ATLANTIC, par value $0.01 per share (the "Participating Preferred Shares"), at a price of $40 per one one- hundredth of a Participating Preferred Share, subject to adjustment. ATLANTIC has designated an amount of shares equal to two one-hundredths of the total number of Common Shares outstanding at any point in time as Participating
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Preferred Shares. Purchase Rights are exercisable when a person or group of persons (other than certain affiliates of ATLANTIC) acquires beneficial ownership of 20% or more of the outstanding Common Shares, commences or announces a tender offer or exchange offer which would result in the beneficial ownership by a person or group of persons (other than certain affiliates of ATLANTIC) of 25% or more of the outstanding Common Shares or files or announces the intention to file with any regulatory authority an application seeking approval of any transaction which would result in the beneficial ownership by a person (other than certain affiliates of ATLANTIC) of 25% or more of the outstanding Common Shares. Under certain circumstances, each Purchase Right entitles the holder to purchase at the Purchase Right's then current exercise price, a number of Shares having a market value of twice the Purchase Right's exercise price. The acquisition of ATLANTIC pursuant to certain mergers or other business transactions would entitle each holder to purchase, at the Purchase Right's then current exercise price, a number of the acquiring company's common shares having a market value at that time equal to twice the Purchase Right's exercise price. The Purchase Rights held by certain 20% shareholders (other than certain affiliates of ATLANTIC) would not be exercisable. As of December 31, 1997 and 1996, ATLANTIC had no Participating Preferred Shares outstanding and the events required to exercise the Purchase Rights had not occurred. Therefore, the Purchase Rights dividend had no value and was not recorded in the financial statements.
NOTE 8 LONG-TERM COMPENSATION
On September 8, 1997, ATLANTIC's common shareholders approved a long-term incentive plan (the "Incentive Plan") which includes an employee stock purchase plan and a stock option plan. No more than 3,000,000 Common Shares in the aggregate may be awarded under the Incentive Plan and no individual may be awarded more than 500,000 Common Shares in any one-year period. The Incentive Plan has a ten-year term.
Additionally, ATLANTIC has authorized 100,000 Common Shares for issuance under the Share Option Plan for Outside Directors (the "Outside Directors Plan") and 115,000 Common Shares for issuance under the 401(K) Savings Plan and Trust, which became effective on January 1, 1998 and provides for matching employer contributions in Common Shares at 50% of the employee's contribution up to 6%.
Employee Stock Purchase Plan
Under the employee stock purchase plan, certain employees of ATLANTIC purchased 592,020 Common Shares at a price of $22.4375 per share on September 8, 1997. ATLANTIC financed 95% of the total purchase price through ten-year, recourse notes from the participants aggregating $12,614,000. The notes, which have been recorded as a deduction in shareholders' equity, bear interest at the lower of 6% per annum or the dividend yield of a Common Share determined based on the fair market value of a Common Share on the purchase date. The notes are secured by the Common Shares purchased. For each Common Share purchased, participants were granted two options, each to purchase one Common Share at a price of $22.4375 per share. Proceeds from this sale of Common Shares, net of the notes received, were $0.7 million. The change in the notes from employees during 1997 is summarized as follows (in thousands):
Of the notes outstanding at December 31, 1997, $10,575,000 were due from officers of ATLANTIC.
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Stock Options
ATLANTIC has granted stock options under the Incentive Plan and the Outside Directors Plan. Stock options outstanding at December 31, 1997 are as follows:
- -------- (1) Exercise price was equal to market price on the date of grant. (2) Options are fully exercisable. (3) Vesting at various rates over periods from two to ten years. (4) The holders under this plan are awarded dividend equivalent units ("DEUs") each year of the plan based upon a specified grant date. The options awarded will vest beginning on September 8, 1999 at a rate of 25% per year through 2002. (5) These options did not accrue DEUs in 1997 as they were awarded after the DEU grant date.
The weighted average fair value of options granted in 1997 under the Incentive Plan was approximately $1.78 per option. A summary of the status of ATLANTIC's stock option plans as of December 31, 1997 and 1996, and changes during the years ended on those dates is presented below (ATLANTIC's first stock option plan was effective in 1996):
ATLANTIC adopted SFAS No. 123, Accounting for Stock-Based Compensation, which allows ATLANTIC to continue to account for its various stock option plans using Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related interpretations. Under APB 25, if the exercise price of the stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Accordingly, ATLANTIC did not recognize compensation expense in 1997 related to stock options as the exercise price of all options granted was equal to the market price on the date of grant. Had compensation cost for these plans been determined using the option valuation models provided in SFAS No. 123, ATLANTIC's net earnings attributable to Common Shares and earnings per Common Share would change as follows:
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The pro forma amounts above were calculated using the Black-Scholes model and the following assumptions:
Dividend Equivalent Units ("DEUs")
On December 31, 1997 ATLANTIC awarded 1,186 DEUs in the form of Common Shares to the holders of 90,346 stock options at a rate of one Common Share per DEU. The DEUs are awarded on December 31st of each year of the ten-year stock option plan and are vested to the same extent the underlying stock options are vested. The DEUs were valued at $23,700 on the award date based upon the market price of the Common Shares on that date. ATLANTIC recognizes the value of the DEUs awarded as compensation expense over the underlying vesting period.
NOTE 9 REIT MANAGEMENT AND PROPERTY MANAGEMENT AGREEMENTS
REIT Management Agreement
ATLANTIC had an agreement with the REIT Manager to provide management services to ATLANTIC. This agreement was terminated on September 9, 1997 in connection with the Merger discussed in Note 6. This agreement required ATLANTIC to pay an annual fee of 16% of cash flow, as defined, payable monthly. Cash flow was calculated by reference to ATLANTIC's cash flow from operations plus (i) fees paid to the REIT Manager, (ii) extraordinary expenses incurred at the request of the independent Directors of ATLANTIC (of which there were none in the periods reported) and (iii) 33% of any interest paid by ATLANTIC on convertible subordinated debentures (of which there were none in the periods reported); and after deducting (i) regularly scheduled principal payments (excluding prepayments or balloon payments) for debt with commercially reasonable amortization schedules, (ii) assumed principal and interest payments on senior unsecured debt treated as having regularly scheduled principal and interest payments like a 20-year level-payment, fully amortizing mortgage and (iii) distributions actually paid with respect to any non-convertible preferred stock. Cash flow did not include: (i) realized gains or losses from dispositions of investments, (ii) interest income from cash equivalent investments and the Homestead Convertible Mortgages, (iii) provisions for possible losses on investments and (iv) extraordinary items.
The REIT Manager also received a fee of 0.20% per year on the average daily balance of cash equivalent investments. ATLANTIC was required to reimburse the REIT Manager for third-party and out-of-pocket expenses relating to travel, transaction costs and similar costs relating to the acquisition, development or disposition of assets or the obtaining of financing for ATLANTIC and its operations. The REIT Manager paid all of its own salary and other overhead expenses. ATLANTIC did not have any employee expense; however, it did pay all of the third-party costs related to its normal operations, including legal, accounting, travel, architectural, engineering, shareholder relations, independent Director fees and similar expenses, property
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
management and similar fees paid on behalf of ATLANTIC, and travel expenses incurred in seeking financing, community acquisitions, community dispositions and similar activities on behalf of ATLANTIC and in attending ATLANTIC Board, committee and shareholder meetings.
Property Management Agreement
Prior to the Merger, SCG Realty Services provided property management services to ATLANTIC on 97% of ATLANTIC's operating communities. The property management fees paid by ATLANTIC were based upon a percentage of revenues and were at rates prevailing in the markets in which ATLANTIC operated. The property management agreements were terminated on September 9, 1997 in connection with the Merger discussed in Note 6.
NOTE 10 SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Selected quarterly financial data (in thousands except per Common Share amounts) for 1997 and 1996 are as follows:
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The total of the four quarterly amounts of net earnings per Common Share may not equal the total for the year. These differences result from the use of a weighted average to compute the average number of Common Shares outstanding.
NOTE 11 SUPPLEMENTAL CASH FLOW INFORMATION
Non-cash investing and financing activities for the years ended December 31, 1997, 1996 and 1995 are as follows:
(a) In connection with the Merger discussed in Note 6, ATLANTIC issued 2,306,591 Common Shares valued at $51,754,000 to Security Capital in exchange for the operations and business of the REIT Manager and SCG Realty Services and $878,000 of non-real estate assets. ATLANTIC recognized a distribution to Security Capital of $50,876,000 as a result of the Merger.
(b) In 1997, ATLANTIC recognized an unrealized gain on the Homestead Convertible Mortgages of $16,707,000.
(c) ATLANTIC received notes from employees aggregating $12,614,000 for the purchase of Common Shares under an employee stock purchase plan in 1997. ATLANTIC retired $201,000 of these notes in 1997 and acquired the related Common Shares from participants who terminated their employment with ATLANTIC as discussed in Note 8.
(d) ATLANTIC declared a distribution in December 1997 for the first quarter of 1998 in the amount of $19,104,000 and declared a distribution in December 1996 for the first quarter of 1997 in the amount of $14,778,000.
(e) In connection with the acquisition of communities, ATLANTIC assumed mortgage debt of $16,285,000, $17,867,000 and $24,678,000 in 1997, 1996 and 1995, respectively.
(f) As discussed in Note 3, in 1996, ATLANTIC received Homestead common stock valued at $51,717,000 upon the sale of the Homestead Assets (assets with a net book value of $31,028,000 and cash of $16,595,000). A gain of $2,839,000, net of expenses of $1,255,000, was recognized on the transaction.
(g) As discussed in Note 3, in 1996, ATLANTIC received warrants to purchase Homestead common stock valued at $6,511,000 in exchange for entering into the Funding Agreement. The value of the warrants has been recognized as deferred revenue.
(h) ATLANTIC made a $58,228,000 non-cash distribution to its shareholders in November 1996 consisting of the Homestead common stock and warrants.
(i) ATLANTIC was relieved of mortgage debt of $6,500,000 in 1995 due to the disposition of the community that secured the debt.
NOTE 12 FINANCIAL INSTRUMENTS
Derivative Financial Instruments
ATLANTIC occasionally utilizes derivative financial instruments as hedges to manage interest rate risk on anticipated future transactions. ATLANTIC does not use derivative financial instruments for trading purposes.
The primary risks associated with derivative instruments are market risk and credit risk. Market risk is defined as the potential for loss in the value of the derivative due to adverse changes in market prices (interest rates). Through hedging, ATLANTIC can effectively manage the risk of increases in interest rates on future debt issuances. Credit risk is the risk that the counterparty to a derivative contract will fail to perform or meet their financial obligation under the contract.
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
ATLANTIC does not obtain collateral support to financial instruments subject to credit risk but monitors the credit standing of counterparties. As of December 31, 1997, the counterparties to all outstanding contracts were financial institutions with AAA or A+ credit ratings. ATLANTIC does not anticipate non-performance by any of the counterparties to its derivative contracts. Should a counterparty fail to perform, however, ATLANTIC could incur a financial loss to the extent of any positive fair market value of derivative instruments.
The following table summarizes the activity in interest rate contracts for the year ended December 31, 1997 (in millions):
- -------- (1) Includes one contract with a notional amount of $150 million which was settled in August 1997 at a gain of $0.2 million and one contract entered into in anticipation of a 1998 debt offering with a notional amount of $100 million which provides for an interest rate of 6.309%.
Interest Rate Swap Agreements
ATLANTIC entered into interest rate swap agreements on its variable interest rate mortgages and $100 million of short-term borrowings to mitigate its variable interest rate exposure. Under the swap agreements ATLANTIC pays a fixed rate of interest to a swap counterparty pursuant to one agreement and receives a variable rate of interest from a swap counterparty pursuant to another agreement. The amounts received from the variable rate agreement are structured such that these amounts will closely approximate the amount of variable interest due on the underlying borrowings. The difference between the variable amount received and the fixed amount paid represents either the cost or the benefit of the interest rate swap agreement and is recorded as an increase or decrease to the variable interest expense associated with the underlying borrowings.
ATLANTIC has a one-year swap agreement with MGT covering $100 million of borrowings that expires on February 5, 1998. The agreement provides for ATLANTIC to pay a fixed rate of interest of 5.95%, exclusive of any credit spread. A similar swap agreement providing for a fixed rate of interest of 5.96%, exclusive of any credit spread, on $100 million of borrowings was in effect for one year prior to the start of the current agreement. ATLANTIC does not intend to enter into any other swap agreement related to its line of credit borrowings after the current agreement expires. ATLANTIC paid $0.3 million more in interest than it received under these swap agreements during both 1997 and 1996.
All of ATLANTIC's tax-exempt bond issues are included in a credit enhancement agreement with FNMA. The agreement allowed ATLANTIC to receive a favorable interest rate on the bond issues and required ATLANTIC to enter into swap agreements to mitigate the interest rate exposure on the nine bond issues with variable interest rates. ATLANTIC makes monthly principal payments on all of the bond issues into a principal reserve account based upon a 30-year amortization. The notional amount of the swap agreements is equal to the principal amount of the variable rate bond issues less the balance in the principal reserve fund associated with the variable rate bond issues. ATLANTIC pays interest on the notional amount at an all-in, fixed rate of 6.61% as summarized below:
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
- -------- (1) Includes the fixed interest rate provided by the swap agreements, annual fees associated with the swap agreements and credit enhancement agreement and amortization of capitalized costs associated with the credit enhancement agreement.
ATLANTIC paid $1.8 million, $1.8 million and $0.6 million more in interest than it received under these swap agreements during 1997, 1996 and 1995, respectively.
Fair Value
The following disclosure of estimated fair value of financial instruments was determined by ATLANTIC based on available market information and valuation methodologies believed to be appropriate for these purposes. Considerable judgement and a high degree of subjectivity are involved in developing these estimates and, accordingly, they are not necessarily indicative of amounts that ATLANTIC could realize upon disposition. As of December 31, 1997 and 1996, the carrying amount of certain financial instruments employed by ATLANTIC, including cash and cash equivalents, accounts receivable, accounts payable and accrued expenses were representative of their fair value because of the short-term maturity of these instruments. Similarly, the carrying value of the lines of credit balances approximates fair value as of those dates since the interest rate fluctuates based on published market rates. As discussed in Note 3, the Homestead Convertible Mortgages outstanding at December 31, 1997 are reflected at fair value in the balance sheet.
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
As of December 31, 1997 and 1996, the fair value of ATLANTIC's notes payable and mortgages payable has been estimated based on quoted market prices for the same or similar issues or by discounting the future cash flows using rates currently available for debt with similar terms and maturities. As of December 31, 1997 and 1996, the fair value of all derivative financial instruments are amounts at which they could be settled, based on estimates obtained from brokers. The following table reflects the carrying amount and estimated fair value of ATLANTIC's financial instruments (in thousands):
- -------- (1) The increase in the fair value of the notes payable and conventional mortgages payable over the carrying value is a result of a net reduction in the interest rates available to ATLANTIC at December 31, 1997 from the interest rates in effect at the dates of issuance. The notes payable and certain of the mortgages payable contain pre-payment penalties or yield maintenance provisions that would make the cost of refinancing exceed the benefit of the lower rates. (2) As discussed above, in order for ATLANTIC to receive the favorable interest rates under the credit enhancement agreement, ATLANTIC was required by FNMA to enter into interest rate swap agreements to mitigate the variable interest rate exposure. (3) This swap agreement expired on February 5, 1998 and was not replaced.
NOTE 13 COMMITMENTS AND CONTINGENCIES
ATLANTIC is a party to various claims and routine litigation arising in the ordinary course of business. ATLANTIC does not believe that the claims and litigation, individually or in the aggregate, will have a material adverse effect on its business, financial position or results of operations.
ATLANTIC is subject to environmental regulations related to the ownership, operation, development and acquisition of real estate. As part of its due diligence procedures, ATLANTIC has conducted Phase I environmental assessments on each community prior to acquisition. The cost of complying with environmental regulations was not material to ATLANTIC's results of operations. ATLANTIC is not aware of any environmental condition on any of its communities that is likely to have a material adverse effect on its business, financial position or results of operations.
SECURITY CAPITAL ATLANTIC INCORPORATED
SCHEDULE III--REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1997 (IN THOUSANDS)
SECURITY CAPITAL ATLANTIC INCORPORATED
SCHEDULE III--REAL ESTATE AND ACCUMULATED DEPRECIATION--(CONTINUED) DECEMBER 31, 1997 (IN THOUSANDS)
(see notes following table)
SECURITY CAPITAL ATLANTIC INCORPORATED
SCHEDULE III--REAL ESTATE AND ACCUMULATED DEPRECIATION--(CONTINUED) DECEMBER 31, 1997 (IN THOUSANDS)
(see notes following table)
SECURITY CAPITAL ATLANTIC INCORPORATED
SCHEDULE III--REAL ESTATE AND ACCUMULATED DEPRECIATION--(CONTINUED) DECEMBER 31, 1997 (IN THOUSANDS)
(see notes following table)
SECURITY CAPITAL ATLANTIC INCORPORATED
SCHEDULE III--REAL ESTATE AND ACCUMULATED DEPRECIATION--(CONTINUED) DECEMBER 31, 1997 (IN THOUSANDS)
(see notes following table)
SECURITY CAPITAL ATLANTIC INCORPORATED
SCHEDULE III--REAL ESTATE AND ACCUMULATED DEPRECIATION--(CONTINUED) DECEMBER 31, 1997 (IN THOUSANDS)
- ---- (a) For federal income tax purposes, ATLANTIC's aggregate cost of real estate at December 31, 1997 was $1,351,277,000. (b) Pledged as additional collateral under credit enhancement agreement with the Federal National Mortgage Association. (c) Phase I (108 units) was constructed in 1981 and Phase II (240 units) was constructed in 1983. (d) Phase I (332 units) was constructed in 1983 and Phase II (312 units) was constructed in 1985. (e) The land associated with this community is leased by ATLANTIC through the year 2058 under an agreement with the Metropolitan Nashville Airport Authority. (f) The Federal National Mortgage Association credit enhancement agreement requires payments to be made to a principal reserve fund. (g) This community is leasing completed units. (h) 19.24 acres purchased in 1995; 9.86 acres purchased in 1996.
SECURITY CAPITAL ATLANTIC INCORPORATED
NOTE TO SCHEDULE III
DECEMBER 31, 1997 (IN THOUSANDS)
As summary of activity for ATLANTIC's real estate, at cost and accumulated depreciation is as follows:
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, THAT EACH OF SECURITY CAPITAL ATLANTIC INCORPORATED, A MARYLAND CORPORATION, AND THE UNDERSIGNED DIRECTORS AND OFFICERS OF SECURITY CAPITAL ATLANTIC INCORPORATED HEREBY CONSTITUTES AND APPOINTS CONSTANCE B. MOORE, WILLIAM KELL, JEFFREY A. KLOPF, MARK W. PEARSON AND EDWARD J. SCHNEIDMAN ITS, HER OR HIS TRUE AND LAWFUL ATTORNEYS-IN-FACT AND AGENTS, FOR IT, HER OR HIM AND IN ITS, HER OR HIS NAME, PLACE AND STEAD, IN ANY AND ALL CAPACITIES, WITH FULL POWER TO ACT ALONE, TO SIGN ANY AND ALL AMENDMENTS TO THIS REPORT, AND TO FILE EACH SUCH AMENDMENT TO THIS REPORT, WITH ALL EXHIBITS THERETO, AND ANY AND ALL DOCUMENTS IN CONNECTION THEREWITH, WITH THE SECURITIES AND EXCHANGE COMMISSION, HEREBY GRANTING UNTO SAID ATTORNEYS-IN-FACT AND AGENTS, AND EACH OF THEM, FULL POWER AND AUTHORITY TO DO AND PERFORM ANY AND ALL ACTS AND THINGS REQUISITE AND NECESSARY TO BE DONE IN AND ABOUT THE PREMISES, AS FULLY AND TO ALL INTENTS AND PURPOSES AS IT, SHE OR HE MIGHT OR COULD DO IN PERSON, HEREBY RATIFYING AND CONFIRMING ALL THAT SAID ATTORNEYS-IN-FACT AND AGENTS, OR ANY OF THEM MAY LAWFULLY DO OR CAUSE TO BE DONE BY VIRTUE HEREOF.
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.
Security Capital Atlantic Incorporated
/s/ Constance B. Moore By: _________________________________ Constance B. Moore Co-Chairman and Chief Operating Officer
Date: March 19, 1998
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATE INDICATED.
SIGNATURE TITLE DATE
/s/ Constance B. Moore Co-Chairman, Chief March 19, 1998 - ------------------------------------- Operating Officer CONSTANCE B. MOORE and Director
/s/ James C. Potts Co-Chairman, Chief March 19, 1998 - ------------------------------------- Investment Officer JAMES C. POTTS and Director
/s/ William Kell Senior Vice March 19, 1998 - ------------------------------------- President and WILLIAM KELL Controller (Principal Financial Officer)
/s/ Ann L. Schumacher Vice President March 19, 1998 - ------------------------------------- (Principal ANN L. SCHUMACHER Accounting Officer)
/s/ M.A. Garcia III Director March 19, 1998 - ------------------------------------- M.A. GARCIA III
/s/ Ned S. Holmes Director March 19, 1998 - ------------------------------------- NED S. HOLMES
/s/ John M. Richman Director March 19, 1998 - ------------------------------------- JOHN M. RICHMAN
INDEX TO EXHIBITS
Certain of the following documents are filed herewith. Certain other of the following documents have been previously filed with the Securities and Exchange Commission and, pursuant to rule 12b-32, are incorporated herein by reference.