ITEM 1. BUSINESS
THE COMPANY
Summit Properties Inc. (the "Company") is one of the largest developers and operators of luxury garden apartment communities (the "Communities") in the southeastern, southwestern and mid-atlantic United States. The Company's current portfolio consists of 66 apartment Communities with 16,631 apartment homes, including Summit Foxcroft in which the Company has a 75% managing general partner interest. The Company also has five apartment Communities with 1,370 apartment homes under construction and in lease-up for a total of 18,001 apartment homes.
For the year ended December 31, 1998, the average physical occupancy rate of the Company's fully stabilized Communities was 93.3%, and the average monthly rental revenue for these Communities was $763 per occupied apartment home. In addition, the Company has acquisition Communities, stabilized development Communities (i.e. stabilized after January 1, 1996) and Communities in lease-up. A Community is considered to be stabilized at the attainment of 93.0% physical occupancy. A Community which the Company has developed is deemed fully stabilized when stabilized for the two prior years as of the beginning of the current year. A Community which the Company has acquired is deemed fully stabilized when owned by the Company for one year or more as of the beginning of the current year. In 1998, average physical occupancy rates were 93.8% and 93.1% and average monthly rental revenue was $859 and $927 per occupied apartment home for acquisition Communities and stabilized development Communities, respectively. Annual averages for Communities in lease-up are not meaningful as the Communities are in various stages of construction/lease-up during the year. The Company also manages approximately 2,800 apartment homes for unrelated third parties. The Company is a fully integrated organization with multifamily development, construction, acquisition and management expertise which employs approximately 650 individuals.
The Company's business is conducted principally through Summit Properties Partnership, L.P., a Delaware limited partnership (the "Operating Partnership"), of which the Company is the sole general partner and an 86.2% economic owner as of December 31, 1998. The Company's third party management and certain construction and other businesses are conducted through its subsidiaries, Summit Management Company, a Maryland corporation (the "Management Company"), and Summit Apartment Builders, Inc., a Florida corporation (the "Construction Company"). Except where otherwise explicitly noted, the "Company" shall also hereinafter refer to the Operating Partnership, the Management Company and the Construction Company.
The Company has chosen to focus its efforts in the following high growth core markets: Charlotte, North Carolina; Tampa/Sarasota, Florida; Washington, D.C.; Raleigh/Central, North Carolina; South Florida; Atlanta, Georgia; Richmond, Virginia; Orlando, Florida; Indianapolis, Indiana; Dallas, Texas; Austin, Texas and Columbus, Ohio. In keeping with this strategy, the Company has established city operating offices in Charlotte, North Carolina; Tampa, Florida; Bethesda, Maryland; Atlanta, Georgia; Fort Lauderdale, Florida; Dallas, Texas and Raleigh, North Carolina. These city offices have direct responsibility for selecting and overseeing new developments and for managing the Communities in their geographic areas. This decentralized structure enables corporate management to maintain tight controls and allows the Company to compete effectively in its core markets, while efficiently allocating capital to those markets that will yield the highest risk-adjusted return.
OPERATING PHILOSOPHY
The Company seeks to maximize the economic return from its Communities by optimizing the trade-off between increasing rental rates and maintaining high occupancy levels. Consistent with this strategy, the Company is among the rental rate leaders in its markets. Although this strategy may result in slightly lower occupancy rates, the Company believes that the dynamic tension created by this balancing strategy maximizes operating income at the property level and improves growth in the Company's cash flow over the long term. Generally, the Company has found that it is not maximizing property operating income per apartment home when occupancies are above 95%.
Historically, the Company has been able to charge market leading rents to its residents while maintaining high occupancy rates due to: the upscale features of its Communities, the comprehensive service provided by its on-site management and its favorable mix of apartment homes. The Company's geographic market focus and decentralized structure further promote income growth.
GROWTH STRATEGIES
The Company's objective is to create long term value through four strategies: maximizing cash flow from existing Communities, targeting major growth markets, deploying capital strategically and dedication to customer service.
MAXIMIZING CASH FLOW FROM EXISTING COMMUNITIES. The Company seeks to maximize the economic return from its Communities by optimizing the trade-off between increasing rental rates and maintaining high occupancy levels. Consistent with this strategy, the Company is among the rental rate leaders in its markets. The Company's affluent resident profile, well-trained property management staff and management information systems support this strategy. For the year ended December 31, 1998, average rent per occupied apartment home for the Company's fully stabilized Communities increased 3.3%, and property operating income from these Communities increased 3.6% for the same period. Average occupancy, rental revenue and property operating income levels for the Company's fully stabilized Communities are as follows for the years set forth below:
- --------- 1) The Company also has fourteen acquisition Communities, five stabilized development Communities (i.e., stabilized after January 1, 1996) and thirteen Communities in lease-up. In 1998, average physical occupancy rates were 93.8% and 93.1% and average monthly rental revenue were $859 and $927 per occupied apartment home for acquisition Communities and stabilized development Communities, respectively. Annual averages for Communities in lease-up are not meaningful as the Communities were in various stages of construction/lease-up during the year.
2) Property Operating Income is defined as total rental and other property revenues less property operating and maintenance expense (excluding depreciation and amortization).
TARGETING MAJOR GROWTH MARKETS. The Company's existing portfolio and plans for growth focus on core markets that are expected to grow at a greater rate than the national average in population, employment and household formation. The Company's current high growth core markets are as follows: Charlotte, North Carolina; Tampa/Sarasota, Florida; Washington, D.C.; Raleigh, North Carolina; South Florida; Atlanta, Georgia; Richmond, Virginia; Orlando, Florida; Indianapolis, Indiana; Dallas, Texas; Austin, Texas and Columbus, Ohio. The Company's strategy provides geographic diversification that protects it against an economic downturn in any one market, while at the same time benefiting from a tightly targeted focus on a limited number of attractive markets. By focusing only on these markets, the Company gains better brand recognition, builds local expertise and improves operating efficiencies. Within each market there are numerous housing alternatives that compete with the Communities in attracting residents. The Communities compete directly with other rental apartments, condominiums and single-family homes that are available for rent or sale in the markets in which the Communities are located. In addition, various entities, including insurance companies, pension and investment funds, partnerships, investment companies and other multifamily REITs, compete with the Company for the acquisition of existing properties and the development of new properties, some of which may have greater resources than the Company. The Company has not identified any dominant competitor, nor is it currently the dominant competitor, in its markets.
DEPLOYING CAPITAL STRATEGICALLY. Since its initial public offering in 1994, the Company has increased the size of its property portfolio by almost 150% to 16,631 apartment homes. Development of new Communities has been the foundation of the Company's growth. Of its 66 completed Communities, 39 have been developed by the Company or its predecessors. The Company attributes much of its historical cash flow growth to the quality of the apartment Communities it has developed over the years.
The Company maintains an active development program which provides it with a predictable and consistent stream of new revenues. Focusing on development allows the Company to build desirable properties that generate premium rents. It also provides returns which generally exceed those achieved on acquisitions. The Company's development goal is to provide its residents with a community that feels like single-family housing, with front yards, open floor plans, abundant square footage, generous storage and both attached and detached garages. The Company enters into leases with its residents that include provisions which are usual and customary for apartment leases, such as the payment of rent monthly, advance notice in the event of a termination, provision of a security deposit and the imposition by the Company of a charge for rent paid after the fifth day of the month. The leases are predominantly for a term of one year.
The Company employs a combination of local autonomy and centralized oversight in its development process. Development officers live in their respective markets, so that critical decision-making is kept local. Development officers report to a corporate development executive, a process that is designed to ensure consistency in design, building materials and quality.
The Company utilizes the Construction Company in addition to third-party general contractors to build its new Communities. Of the 2,133 apartment homes in development at December 31, 1998, 63% are being built by the Construction Company, which has resulted in higher quality construction, improved timeliness and cost savings.
In 1998, the Company completed development of four Communities, adding 973 apartment homes to the Company's portfolio. These four Communities represent a total investment of approximately $74.4 million. The Communities completed in 1998 are Summit Stonefield, Summit Lake I, Summit Ballantyne II and Summit New Albany.
As of December 31, 1998, the Company had nine apartment Communities under construction (five of which are also in lease-up) containing 2,133 apartment homes, with a budgeted cost of $192.5 million. The following provides summary information regarding the nine Communities under construction as of December 31, 1998 (dollars in thousands):
The Company is optimistic about the operating prospects of the Communities under construction even with the increased supply of newly constructed apartment homes of comparable quality in many of its markets. As with any development project, there are uncertainties and risks associated with the development of the Communities described above. While the Company has prepared development budgets and has estimated completion and stabilization target dates based on what it believes are reasonable assumptions in light of current conditions, there can be no assurance that actual costs will not exceed current budgets or that the Company will not experience construction delays due to the unavailability of materials, weather conditions or other events. Similarly, market conditions at the time these Communities become available for leasing will affect rental rates and the period of time necessary to achieve stabilization, and could result in achieving stabilization later than currently anticipated.
The Company is also conducting feasibility and other pre-development work for twelve new Communities. The Company either owns or holds options to purchase the land for each of these potential developments. For each of these potential Communities, the Company is only in the pre-development phase, and there can be no assurance that all, or any one, of these Communities will be completed. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Development Activity" for a discussion of uncertainties and risks associated with the Company's development activity.
While the Company has emphasized development of new apartment communities as one of its strategies for growth, it also has successfully capitalized on expansion opportunities through the strategic acquisition of properties that meet the Company's investment criteria. The Company has acquired more than 8,612 apartment homes since its formation in 1994. These properties were successfully acquired at prices below their replacement cost and cumulatively have achieved a total unleveraged average yield of 9.86% in 1998. Acquisitions have been concentrated in the Company's targeted core markets in order to further strengthen brand identity and operational efficiencies. The Company's extensive local-market knowledge and development expertise give it an advantage in identifying and underwriting acquisition opportunities which the Company believes will create shareholder value. The Company acquired the following Communities in 1998 (dollars in thousands):
- --------- (1) Includes four Communities located in Dallas, Texas, two Communities located in Austin, Texas and one Community in San Antonio, Texas. The purchase of one of the Communities located in Dallas, Texas was not completed until December 31, 1998.
During 1998, the Company disposed of eight communities for over $130 million. These Communities did not align with the Company's overall long term strategic plan and growth objectives. The prices realized for the 1998 dispositions represent a cost of capital below what could have been achieved through other capital sources, such as common equity. As long as this remains the case, the Company anticipates continuing to use property sales as a source of capital.
DEDICATION TO CUSTOMER SERVICE. Pro-active property management has allowed the Company to maximize cash flow from its portfolio by encouraging local decision-making and rewarding performance, initiative and innovation. The Company's localized property management system, with offices strategically located in seven key cities, gives the Company a distinct advantage in better responding to the needs of each market. The Company has long stressed the importance of developing strong customer relationships with its residents. The Company's total commitment to resident satisfaction is further evidenced by its "Sundown Policy", which mandates a response by the appropriate associate to any resident inquiry or complaint no later than "sundown" of the day on which the inquiry or complaint was received.
The Company has sought to provide its residents with experienced, well-trained and attentive management staffs. Every Community associate enters into a comprehensive training program when he or she is hired. This training program ensures that associates have a clear understanding of their job responsibilities, the high standards of performance expected of them and the Company's operating philosophies. On-going training following each associate's initial employment period further enhances associate productivity. The Company believes that this training regimen along with a proven hiring process has produced a higher quality management staff, evidenced by higher resident satisfaction at the Communities and lower associate turnover.
COMPANY HISTORY
The Company was formed in 1993 to continue and expand the multifamily development, construction, acquisition, operation, management and leasing businesses of the predecessor entities through which the Company historically conducted operations prior to the Initial Offering (as defined below) (the "Summit Entities"). The Summit Entities were founded by the Company's Chairman of the Board, William B. McGuire, Jr., in 1972. In 1981, William F. Paulsen joined the predecessor to the Company as Chief Executive Officer and shepherded the growth of its multifamily development and management activities.
The Company organized itself as a real estate investment trust (a "REIT") and completed its initial public offering (the "Initial Offering") of 10,000,000 shares of common stock, par value $0.01 per share (the "Common Stock") on February 15, 1994 and sold an additional 1,500,000 shares upon exercise of the underwriters' over-allotment option on March 4, 1994. On June 2, 1995, the Company completed a follow-on public offering (the "1995 Offering") of 4,000,000 shares of Common Stock. A second follow-on public offering (the "1996 Offering") of 5,000,000 shares of the Company's Common Stock was completed on August 7, 1996, with an additional 750,000 shares sold upon exercise of the underwriters' over-allotment option on August 12, 1996. In addition, the Company has adopted a dividend reinvestment and stock purchase program for the sale of up to 2,500,000 shares of Common Stock, pursuant to which it sells Common Stock from time to time.
On August 12, 1997, the Company completed a $125 million senior unsecured debt offering. On December 12, 1997, the Company completed an additional $30 million senior unsecured debt offering. The Company has established a program for the sale of up to $95 million aggregate principal amount of Medium-Term Notes due nine months or more from the date of issuance (the "MTN Program"). On July 28, 1998, the Company sold $30 million of notes under the MTN Program. On October 5, 1998, the Company sold $25 million of notes under the MTN Program.
The Company, a Maryland corporation, is a self-administered and self-managed REIT. The Company's Common Stock is listed on the New York Stock Exchange (the "NYSE") under the symbol "SMT". The executive offices of the Company are located at 212 South Tryon Street, Suite 500, Charlotte, North Carolina 28281. The Company's telephone number is (704) 334-9905 and its facsimile number is (704) 333-8340. The Company also maintains offices in Atlanta, Georgia; Tampa, Florida; Bethesda, Maryland; Ft. Lauderdale, Florida; Dallas, Texas and Raleigh, North Carolina.
THE OPERATING PARTNERSHIP
The Operating Partnership was formed on January 14, 1994, and is the entity through which principally all of the Company's business is conducted. The Company controls the Operating Partnership as the sole general partner and as the holder of an 86.2% economic and voting interest in the Operating Partnership as of December 31, 1998. As the sole general partner of the Operating Partnership, the Company has the exclusive power to manage and conduct the business of the Operating Partnership, subject to certain voting rights of holders (including the Company) of the units of limited partnership interest ("Units"), including the consent of holders (including the Company) of 85% of the Units in connection with a sale, transfer or other disposition of all or substantially all of the assets of the Operating Partnership, or any other transaction which would result in the recognition of a significant taxable gain to the holders of Units. The Company's general and limited partnership interests in the Operating Partnership entitle it to share in 86.2% of the cash distributions from, and in the profits and losses of, the Operating Partnership.
Each Unit may be redeemed by the holder thereof for cash equal to the fair market value of a share of the Company's Common Stock or, at the option of the Company, an equivalent number of shares of Common Stock. The Company presently anticipates that it will elect to issue shares of Common Stock in connection with redemptions of Units rather than paying cash. With each redemption of Units for Common Stock, the Company's percentage ownership interest in the Operating Partnership will increase. In addition, whenever the Company issues shares of Common Stock for cash, the Company will contribute any net proceeds therefrom to the Operating Partnership and the Operating Partnership will issue an equivalent number of Units to the Company.
The Operating Partnership cannot be terminated, except in connection with a sale of all or substantially all of the assets of the Company, for a period of 99 years from the date of formation without a vote of the limited partners of the Operating Partnership.
ITEM 2.
ITEM 2. PROPERTIES
THE COMMUNITIES
The Company owns and operates through the Operating Partnership 66 completed Communities and five Communities which are currently under construction and in lease-up, for a total of 18,001 apartment homes. Forty-two of the Communities have been completed since January 1, 1990 and, as of December 31, 1998, the average age of the completed Communities was approximately 7 years. The following is a summary of Communities by market:
Other non-core markets consist of two Communities in Greenville, South Carolina, two Communities in Cincinnati, Ohio, and one Community in Yardley, Pennsylvania.
All of the Communities target middle to upper income apartment renters as customers and have amenities, apartment home sizes and mixes consistent with the desires of this resident population. The Communities are owned in fee simple and are located in seven states throughout the southeastern, southwestern and mid-atlantic United States (Florida, Georgia, Maryland, North Carolina, South Carolina, Texas and Virginia) as well as in Delaware, Ohio, Indiana and Pennsylvania. The following table highlights certain information regarding the Communities:
- --------- (1) Average physical occupancy is defined as the number of apartment homes occupied divided by the total number of apartment homes contained in the Communities, expressed as a percentage. Average physical occupancy has been calculated using the average occupancy that existed on Sunday during each week of the period.
(2) Represents the average monthly net rental revenue per occupied apartment home.
(3) Collateral for fixed rate mortgage of $146.7 million.
(4) Summit Foxcroft is held by a partnership in which the Company is a 75% managing general partner.
(5) Collateral for a fixed rate mortgage of $8.5 million.
(6) Collateral for letters of credit in an aggregate amount of $52.9 million which serve as collateral for $51.8 million in tax exempt bonds.
(7) Communities that were stabilized in 1998 but were stabilized subsequent to January 1, 1996.
(8) Summit Fair Oaks was acquired on December 31, 1997 and, accordingly, no average occupancy or average rent information is available for 1997.
(9) Summit Las Palmas was acquired effective December 31, 1998 and, accordingly, no average occupancy or average rent information is available for 1998.
(10) Communities that were in lease-up during 1998. These Communities have and are leasing at a rate consistent with the Company's expectations. As with any community in lease-up, there are uncertainties and risks associated with the Company's communities in lease-up. While the Company has estimated completion and stabilization budgets and target dates based on what it believes are reasonable assumptions in light of current conditions, there can be no assurance
that actual costs will not exceed current budgets or that the Company will not experience delays in reaching stabilization of such Communities.
Information with respect to total debt secured by thirty-four of the Company's Communities having an aggregate net book value of $433.5 million as of December 31, 1998, is as follows (in thousands):
Scheduled annual maturities of secured debt is as follows:
- --------- (1) Interest rate as of December 31, 1998.
(2) Annual debt service for variable rate loans represents 1998 costs and includes letter of credit fees and other bond related costs.
Each Community has many of the following features: swimming pools, tennis courts, racquetball courts, volleyball courts, saunas, whirlpools, fitness facilities, picnic areas, large clubhouses and convenient parking facilities. Most of the apartment homes offer amenities that include spacious open living areas, sunrooms, patios or balconies, sunken living rooms, fireplaces, built-in shelves or entertainment centers, large storage areas or walk-in closets, vaulted ceilings, ceiling fans and separate in-home laundry facilities or laundry hook-ups. In addition to these physical amenities, each Community has its own highly-trained and experienced on-site management and maintenance staff to ensure that courteous and responsive service is provided to its residents.
COMMUNITY MANAGEMENT
Each of the Communities is operated by the Company's property management staff. The management team for each Community includes supervision by a regional vice-president and regional property manager, as well as on-site management, maintenance personnel and an off-site support staff. Community management teams perform leasing and rent collection functions and coordinate resident services. All personnel are extensively trained and experienced and are encouraged to continue their education through both Company-designed and outside courses.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor any of the Communities is presently subject to any material litigation nor, to the Company's knowledge, is any litigation threatened against the Company or any of the Communities, other than routine actions for negligence or other claims and administrative proceedings arising in the ordinary course of business, some of which are expected to be covered by liability insurance and all of which collectively are not expected to have a material adverse effect on the business or financial condition or results of operations of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NONE
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock began trading on the NYSE on February 8, 1994 under the symbol "SMT". The following table sets forth the quarterly high and low sales prices per share reported on the NYSE.
On March 11, 1999 the last reported sale price of the Common Stock on the NYSE was $16.69. On March 11, 1999 there were 1,516 holders of record of 28,445,268 shares of the Company's Common Stock.
The Company declared a dividend of $0.4075 per share of Common Stock for each of the four quarters in 1998, which was paid on May 15, 1998 for the first quarter, August 14, 1998 for the second quarter, November 16, 1998 for the third quarter, and February 15, 1999 for the fourth quarter.
The Company declared a dividend of $0.3975 per share of Common Stock for each of the four quarters in 1997, which was paid on May 15, 1997 for the first quarter, August 15, 1997 for the second quarter, November 17, 1997 for the third quarter, and February 14, 1998 for the fourth quarter.
The Company intends to continue to make regular quarterly dividends to holders of shares of Common Stock. Future dividends will be declared at the discretion of the Board of Directors and will depend on actual cash flow of the Company, its financial condition, capital requirements, the annual distribution requirements under the REIT provisions of the Internal Revenue Code, and such other factors as the Board of Directors may deem relevant. The Board of Directors may modify the Company's dividend policy from time to time.
In connection with the purchase on November 4, 1998 of a portfolio of multifamily properties in Texas (the "Ewing Portfolio") consisting of seven Communities located in Dallas, Austin and San Antonio, the Company issued 2,074,615 shares of Common Stock (valued at approximately $37.3 million at the time of the acquisition) to the sellers of the Ewing Portfolio in partial consideration of their interest in the Communities. Such shares of Common Stock were issued in reliance on an exemption from registration under Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act"), and rules and regulations promulgated thereunder. In light of information obtained by the Company in connection with the transaction, management of the Company believes that the Company may rely on such exemption.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial and other information on a consolidated historical basis for the Company and its predecessors, Summit Entities, as of and for each of the years in the five-year period ended December 31, 1998. This table should be read in conjunction with the Consolidated Financial Statements of Summit Properties Inc. and the Notes thereto included elsewhere herein.
SELECTED FINANCIAL DATA SUMMIT PROPERTIES INC. (HISTORICAL)
- --------- (1) For purposes of the 1994 Selected Financial Data, historical information is presented both for the Company and its predecessors, the Summit Entities, provided that historical financial information for its predecessors only includes information relating to the Communities held by the Company immediately following the Initial Offering and the entities which provided property and general management services for those Communities.
(2) Consists of revenues and expenses from property management services provided to Communities owned by unrelated third parties and by certain predecessor partnerships prior to the Initial Offering. Since the Initial Offering, these services have been performed by the Management Company, which is accounted for under the equity method of accounting.
(3) The White Paper on Funds from Operations approved by the Board of Governors of the National Association of Real Estate Investment Trusts ("NAREIT") in March 1995 (the "White Paper") defines Funds from Operations as net income (loss) (computed in accordance with generally accepted accounting principles ("GAAP")), excluding gains (or losses) from debt restructuring and sales of property, plus real estate related depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures. The Company believes Funds from Operations is helpful to investors as a measure of the performance of an equity REIT because, along with cash flows from operating activities, financing activities and investing activities, it provides investors with an understanding of the ability of the Company to incur and service debt and make capital expenditures. The Company computes Funds from Operations in accordance with the standards established by the White Paper, which may differ from the methodology for calculating Funds from Operations utilized by other equity REITs, and, accordingly, may not be comparable to such other REITs. Funds from Operations does not represent amounts available for management's discretionary use because of needed capital expenditures or expansion, debt service obligations, property acquisitions, development, dividends and distributions or other commitments and uncertainties. Funds from Operations should not be considered as an alternative to net income (determined in accordance with GAAP) as an indication of the Company's financial performance or to cash flows from operating activities (determined in accordance with GAAP) as a measure of the Company's liquidity, nor is it indicative of funds available to fund the Company's cash needs, including its ability to make dividends/distributions. Funds from Operations is calculated as follows (dollars in thousands):
(4) Represents the total number of apartment homes in Communities completed and owned by the Company during the period.
(5) Represents the total number of apartment homes in Communities completed and owned by the Company at the end of the period.
(6) The ratios of earnings to fixed charges were computed by dividing earnings by fixed charges. For this purpose, earnings consist of pre-tax income from continuing operations (including gains on sale of real estate) plus fixed charges (excluding capitalized interest). Fixed charges consist of interest expense (whether expensed or capitalized), the estimated interest component of rent expense, and the amortization of debt issuance costs. To date, the Company has not issued any preferred stock; therefore, the ratios of earnings to combined fixed charges and preferred stock dividend requirements are the same as the ratios of earnings to fixed charges presented.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Form 10-K contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), including without limitation statements relating to the operating performance of fully stabilized Communities, estimated net asset value, development activities of the Company and the implementation of the Company's plan to address Year 2000 issues. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995, and is including this statement for purposes of complying with these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are generally identifiable by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project" or similar expressions. The Company's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Although the Company believes that the expectations reflected in such forward-looking statements are based on reasonable assumptions, the Company's actual results and performance of stabilized and development Communities, the estimated net asset value and the actual costs, progress and expenses with respect to its plan to address Year 2000 issues could differ materially from those set forth in the forward-looking statements. Factors which could have a material adverse effect on the operations and future prospects of the Company include, but are not limited to, changes in: economic conditions generally and the real estate market specifically, legislative/regulatory changes (including changes to laws governing the taxation of real estate investment trusts ("REITs"), availability of capital, interest rates, construction delays due to unavailability of materials, weather conditions or other delays, competition, supply and demand for apartment communities in the Company's current and proposed market areas, expenses of or delays in the identification and upgrade or replacement by the Company of its non-Year 2000 compliant computer information systems and computer systems that do not relate to information technology, but include embedded technology, the Year 2000 compliance of vendors (including vendors of the Company's computer information systems) or third party service providers (including the Company's primary bank and payroll processor), generally accepted accounting principles, policies and guidelines applicable to REITs, and those factors discussed in the second paragraph under the heading "Operating Performance of the Company's Fully Stabilized Communities," in the section entitled "Net Asset Value," in the section entitled "Development Activity -- Certain Factors Affecting the Performance of Development Communities," and in the section entitled "Year 2000" on pages 17, 25, 27 and 28 respectively, of this Form 10-K. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
The following discussion should be read in conjunction with the Consolidated Financial Statements of Summit Properties Inc. and the Notes thereto appearing elsewhere herein.
HISTORICAL RESULTS OF OPERATIONS
The Company's net income is generated primarily from operations of its Communities. The changes in operating results from period to period reflect changes in existing Community performance and increases in the number of apartment homes due to development and acquisition of new Communities. Where appropriate, comparisons are made on a "fully stabilized Communities," "acquisition Communities," "stabilized development Communities" and "Communities in lease-up" basis in order to adjust for changes in the number of apartment homes. A Community is deemed to be "stabilized" when it has attained a physical occupancy level of at least 93%. A Community which the Company has acquired is deemed fully stabilized when owned by the Company for one year or more as of the beginning of the year. A Community which the Company has developed is deemed "fully stabilized" when stabilized for the two prior years as of the beginning of the current year. A Community is deemed to be a "stabilized development" when stabilized as of the beginning of the current year but not the entire two prior years. All Communities information presented is before real estate depreciation and amortization expense. Communities' average physical occupancy presented is defined as the number of apartment homes occupied divided by the total number of apartment homes contained in the Communities, expressed as a percentage. Average physical occupancy has been calculated using the average of the occupancy that existed on Sunday during each week of the period. Average monthly rental revenue presented represents the average monthly net rental revenue per occupied apartment home. The Company's methodology for calculating average physical occupancy and average monthly rental revenue may differ from the methodology used by other equity REITs, and accordingly, may not be comparable to such other REITs.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Income before minority interest of unitholders in the Operating Partnership, gain on sale of real estate assets and extraordinary items increased from 1996 ($21.2 million) to 1997 ($27.6 million) and from 1997 to 1998 ($29.3 million) primarily due to increased property operating income at stabilized Communities, as well as new sources of income associated
with acquisition Communities and Communities in lease-up, partially offset by a decrease in property income due to the disposal of certain Communities and an increase in depreciation and interest expense.
OPERATING PERFORMANCE OF THE COMPANY'S PORTFOLIO OF COMMUNITIES
The operating performance of the Communities is summarized below (dollars in thousands):
- --------- (1) Includes Communities which were stabilized during the entire period for each of the comparable periods presented.
(2) The 1998 and 1997 comparison includes the Communities acquired in 1998 and 1997. The 1997 and 1996 comparison includes Communities acquired in 1997 and 1996.
A summary of the Company's apartment homes for the years ended December 31, 1998, 1997 and 1996 is as follows:
OPERATING PERFORMANCE OF THE COMPANY'S FULLY STABILIZED COMMUNITIES
The operating performance of the Communities stabilized during the entire period in both of the comparable periods presented is summarized below (dollars in thousands except average monthly rental revenue):
Rental and other revenue increased from 1997 to 1998 due to higher rental rates. The 2.8% property revenue growth rate was higher than the prior year rate of growth primarily as a result of a stronger demand in the markets in which the Company operates. The higher growth rate was especially noticeable in the Sarasota and Atlanta markets. In 1999 the Company expects the rate of growth to be similar to the growth rate in 1998 given the current health of the national economy as well as a decline in apartment permit issuance in some of the Company's larger markets. The Company believes its expectations relative to property revenue growth are based on reasonable assumptions as to future economic conditions and the quantity of competitive multi-family communities in the markets in which the Company does business. However, there can be no assurance that actual results will not differ from these assumptions, which could result in a lower property revenue growth rate.
Property operating and maintenance expenses were relatively stable from 1997 to 1998 increasing by 1.4%. As a percentage of total property revenues, property operating and maintenance expense decreased to 36.6% from 37.1% for the years ended December 31, 1998 and 1997, respectively.
Rental and other revenue increased from 1996 to 1997 due to higher rental rates offset by decreased occupancy. Property operating and maintenance expenses were relatively stable from 1996 to 1997. As a percentage of total property revenues, property operating and maintenance expenses decreased to 37.6% from 38.1% for the years ended December 31, 1997 and 1996, respectively.
OPERATING PERFORMANCE OF THE COMPANY'S ACQUISITION COMMUNITIES
Acquisition communities for the year ended December 31, 1998 consist of the following: Summit Portofino, Summit Sand Lake, Summit Windsor II and Summit Fair Oaks acquired in 1997 (1,290 units); and Summit St. Clair, Summit Club at Dunwoody, Summit at Lenox and six communities (2,017 units) which were owned by Ewing Industries and its affiliates in 1998 (a total of 3,109 units). Summit Mayfaire (144 units), which was acquired effective January 1, 1997, is considered a fully stabilized community in the 1998 and 1997 comparison and therefore is not included in such comparison. Summit Fair Oaks (246 units) was acquired on December 31, 1997, and accordingly, had no 1997 operations. Summit Las Palmas, also acquired from Ewing Industries, was acquired effective December 31, 1998, and, accordingly, its rental operations for 1998 are not reflected in the Company's financial statements. Summit Plantation (262 units) was acquired on April 1, 1996
and is considered a fully stabilized community in the 1998 and 1997 comparison and therefore is not included in such comparisons. The operations of these Communities are summarized as follows (dollars in thousands except average monthly rental revenue):
The decrease in the average monthly rental revenue for the year ended December 31, 1997 as compared to the corresponding period in 1996 is attributable to lower average monthly rental revenue on the 1997 acquisition Communities in comparison to the 1996 acquisition Community. Average monthly rental revenue for the years ended December 31, 1998 and 1997 for the 1997 acquisitions alone was $834 and $813, respectively.
The unleveraged yield on investment for acquisition Communities, defined as property operating income on an annualized basis divided by total acquisition cost, for the year ended December 31, 1998 was 9.12%.
OPERATING PERFORMANCE OF THE COMPANY'S STABILIZED DEVELOPMENT COMMUNITIES
The Company had five Communities with 1,599 apartment homes (Summit Aventura, Summit River Crossing, Summit Fairways, Summit on the River and Summit Russett) which were stabilized during the entire year ended December 31, 1998 but were stabilized subsequent to January 1, 1996. The year ended December 31, 1997 and 1996 comparison represents 1,200 apartment homes (Summit Aventura, Summit River Crossing, Summit Hill II and Summit Green). The operating performance of these stabilized development Communities is summarized below (dollars in thousands except average monthly rental revenue):
The unleveraged yield on stabilized development Communities, defined as property operating income divided by total development cost, for the year ended December 31, 1998 was 10.05%.
OPERATING PERFORMANCE OF THE COMPANY'S COMMUNITIES IN LEASE-UP
The Company had thirteen Communities in lease-up during the year ended December 31, 1998. A Community in lease-up is defined as one that has commenced rental operations but was not stabilized as of the beginning of the current year. The following is a summary of the thirteen Communities in lease-up during 1998 (dollars in thousands):
- --------- (1) These properties stabilized during 1998. The unleveraged yield on these six Communities after reaching stabilization, defined as annualized property operating income divided by total development cost, for the year ended December 31, 1998 was 10.46%.
(2) These properties are included in the Construction in Progress category at December 31, 1998.
(3) Summit Lake II started leasing apartments for January, 1999 move-ins.
OPERATING PERFORMANCE OF SUMMIT MANAGEMENT COMPANY
The operating performance of the Management Company and its wholly-owned subsidiary, the Construction Company, is summarized below (dollars in thousands):
The change in revenue was a result of higher revenues from managing the Company's Communities and higher revenues from construction activity, offset by lower revenues for managing third party Communities in each of the years 1996 compared to 1997 and 1997 compared to 1998. The change in operating expenses was a result of higher construction activity and higher costs of managing the Communities in the years 1998 compared to 1997.
Total average third party apartment homes under management were 3,310, 5,164 and 7,919 during the years ended December 31, 1998, 1997 and 1996, respectively. The decrease from 1997 to 1998 was primarily due to the terminations of the Management Company contracts to manage two portfolios of 1,383 and 667 apartment homes, respectively. The contract to manage the 1,383 apartment home portfolio was terminated as a result of the portfolio changing ownership. The
decrease from 1996 to 1997 was primarily due to the termination of the Management Company's contract to manage a portfolio of 1,422 apartment homes effective December 31, 1996. The contract was terminated as a result of the apartment portfolio changing ownership.
Property management fees include $1.2 million, $1.7 million and $2.3 million of fees from third parties for the years ended December 31, 1998, 1997 and 1996, respectively. Property management fees from third parties as a percentage of total property management revenues were 23.3%, 35.2% and 48.1% for the years ended December 31, 1998, 1997 and 1996, respectively. The Company expects third party management revenue as a percentage of total property management revenues to continue to decline as revenues from the Company's Communities continue to increase.
Construction Company revenues and expenses increased in 1998 compared to 1997 and in 1997 compared to 1996 primarily as a result of the Company's decision to expand its in-house construction operations in the state of Florida to cover the entire geographic area in which the Company operates. All of the Construction Company's income for the years ended December 31, 1998, 1997 and 1996 is from contracts with the Company. The Construction Company is currently building 63% of the Company's apartment homes under construction.
OTHER INCOME AND EXPENSES
Interest income increased by $672,000 to $1.1 million in 1998 compared to 1997, primarily due to interest earned on proceeds from property sales placed in escrow in accordance with like-kind exchange income tax regulations. Interest income decreased by $166,000 to $392,000 in 1997 compared to 1996, primarily due to interest earned in 1996 on the proceeds from a common stock offering prior to using the proceeds to fund development activity.
Other income increased $570,000 to $849,000 in 1998 compared to 1997, primarily as a result of an incentive fee earned in connection with a property that the Company had developed and managed for a third party.
Depreciation expense increased $6.3 million or 28.0% to $29.0 million in 1998 compared to 1997, primarily due to depreciation expense related to the Company's 1997 and 1998 acquisitions and increased depreciation of Communities in lease-up. Depreciation expense increased $4.4 million or 24.4% to $22.7 million in 1997 compared to 1996 due to an increase in depreciation expense related to the 1997 acquisitions and Communities in lease-up.
Interest expense, including amortization of deferred financing costs, increased by $11.5 million for the year ended December 31, 1998 compared to the year ended December 31, 1997. The increase was primarily the result of an increase of $174.8 million in the Company's average indebtedness outstanding and an increase in the effective interest rate of .04% (6.68% to 6.72%). Interest expense, including amortization of deferred financing costs increased by $4.8 million for the year ended December 31, 1997 compared to the year ended December 31, 1996. The increase was primarily the result of an increase of $84.9 million in the Company's average indebtedness outstanding and an increase in the effective interest rate of .24% (6.44% to 6.68%), respectively.
General and administrative expense has remained relatively stable as a percentage of total revenues. As a percentage of total revenues, general and administrative expenses were 2.6%, 2.3% and 2.7% in 1998, 1997 and 1996, respectively.
The $37.1 million gain on sale of assets in 1998 resulted from the disposition of eight communities. The Company retained a 25% interest in five of these communities. The eight communities disposed of were:
The Communities disposed of in 1998 were part of the Company's plan to dispose of assets that no longer meet its growth objectives, to make desired changes in the number of apartment homes in each of the Company's markets, or that are located in smaller markets. The Company believes that by concentrating its efforts and capital in large growth markets it will gain a competitive advantage as it improves operational efficiencies, builds a more significant brand name and improves market knowledge. Also, by disposing of assets that no longer meet the Company's long-term growth objectives,
capital is provided to fund the development of new, higher growth assets. The $4.4 million gain on sale of assets in 1997 resulted from the sale of a community formerly known as Summit Charleston in May 1997.
The extraordinary items in the year ended December 31, 1998 resulted from the write-off of deferred financing costs in conjunction with the replacement by the Company of its prior unsecured credit facility with the Unsecured Credit Facility (as hereafter defined) and prepayment penalties incurred on six mortgage notes which were repaid during the period. The extraordinary items in 1996 resulted primarily from the write-off of deferred financing costs in conjunction with the repayment of debt with the proceeds from a 1996 common stock offering and with the proceeds of the $31.0 million unsecured debt financing received in August 1996.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
The Company's net cash provided by operating activities increased from $55.9 million for the year ended December 31, 1997 to $63.8 million for the same period in 1998, primarily due to a $20.1 million increase in property operating income offset by a $13.8 million increase in interest paid. The increase in interest paid was primarily due to an increase in the average indebtedness outstanding.
Net cash used in investing activities increased from $175.9 million for the year ended December 31, 1997 to $219.2 million for the same period in 1998 due to an increase in the acquisition of Communities and an increase in the construction of Communities, partially offset by higher proceeds from the disposition of Communities. In 1998, the Company acquired ten apartment Communities containing 3,557 apartment homes for a total cost of $268.0 million which included the issuance of $8.4 million worth of Units, the issuance of $37.3 million worth of shares of Common Stock and the assumption of $92.8 million in mortgage debt. In addition, the Company funded $128.4 million in development costs and $10.1 million in capital improvements in 1998. The Company had total net cash proceeds of $130.6 million related to the disposition of Communities, of which $116.5 million was deposited with a qualified intermediary. Approximately $30.2 million of funds deposited with a qualified intermediary were used to fund the purchase of a Community and fund development costs. The remaining $86.3 million in proceeds from the sales are being held in escrow in accordance with like-kind exchange income tax rules and regulations to fund future developments.
Net cash provided by financing activities increased from $119.9 million for the year ended December 31, 1997 to $154.6 million for the same period in 1998, primarily due to an increase in equity proceeds from the Company's dividend reinvestment and stock purchase plan (the "Plan") and an increase in net borrowings from the Company's credit facility offset by a higher repayment of debt, lower borrowings on unsecured bonds, the issuance of notes receivable from employees, the payment of higher dividends and distributions to shareholders and unitholders and a decrease in public stock issuance. Financing activities in 1998 included $131.3 million in net borrowings from the Company's credit facility and $45.9 million in net proceeds from the Plan. Dividend reinvestment and stock purchase proceeds increased from 1997 primarily due to the replacement of the prior dividend reinvestment plan with the Plan which allows direct stock purchases by non-shareholders. These cash inflows were offset by $46.8 million of dividends and distributions and the repayment of mortgage debt of $27.4 million. Mortgage debt repayment included $23.2 million for the prepayment of six mortgage notes.
The ratio of earnings to fixed charges was 2.51 to 1 for the year ended December 31, 1998 compared to 1.93 to 1 for the year ended December 31, 1997. The increase is primarily due to an increase in the gain on real estate assets offset by increased interest charges as discussed in "Historical Results of Operations -- Other Income and Expenses" above.
The Company has elected to be taxed as a Real Estate Investment Trust ("REIT") under Sections 856 and 860 of the Internal Revenue Code of 1986, as amended. REITs are subject to a number of organizational and operational requirements, including a requirement that they currently distribute 95% of their ordinary taxable income. As a REIT, the Company generally will not be subject to federal income tax on net income to the extent taxable income is distributed.
The Company's outstanding indebtedness at December 31, 1998 totaled $726.1 million. This amount includes approximately $270.7 million in fixed rate conventional mortgages, $51.8 million of variable rate tax-exempt bonds, $241.0 million of unsecured notes, $9.1 million of tax-exempt fixed rate loans, and $153.5 million under the Unsecured Credit Facility (as hereinafter defined).
The Company expects to meet its short-term liquidity requirements (i.e., liquidity requirements arising within 12 months) including recurring capital expenditures relating to maintaining its existing properties, generally through its working capital, net cash provided by operating activities and borrowings under its line of credit. The Company considers its cash provided by operating activities to be adequate to meet operating requirements and payments of dividends and distributions.
The Company expects to meet its long-term liquidity requirements (i.e., liquidity requirements arising after 12 months), such as scheduled mortgage debt maturities, property acquisitions, financing of construction and development activities and other non-recurring capital improvements, through the issuance of unsecured notes and equity securities, from undistributed Funds from Operations (see page 30), from proceeds received from the disposition of certain properties, and in connection with the acquisition of land or improved property through the issuance of Units.
LINE OF CREDIT
The Company obtained a new syndicated unsecured line of credit (the "Unsecured Credit Facility") in the amount of $175 million in March, 1998 which replaced the existing $150 million credit facility. The Unsecured Credit Facility was increased in December, 1998 to $200 million. The Unsecured Credit Facility provides funds for new development, acquisitions and general working capital purposes. The Unsecured Credit Facility has a three year term with two one-year extension options and will initially bear interest at LIBOR+90 basis points based upon the Company's current credit rating of BBB- by Standard & Poor's Rating Services and Baa3 by Moody's Investors Service. The interest rate will be reduced in the event an upgrade of the Company's unsecured credit rating is obtained. The Unsecured Credit Facility also provides a bid option sub-facility equal to a maximum of fifty percent of the total facility ($100 million). This sub-facility provides the Company with the option to place borrowings in fixed LIBOR contracts up to 180 days. Upon proper notifications, all lenders participating in the Unsecured Credit Facility may, but are not obligated to, participate in a competitive bid auction for these fixed LIBOR contracts.
MORTGAGE NOTES
On September 23, 1998, the Company consolidated and renewed two mortgage loans which had a $147.2 million balance. The original loans matured in February 2001 ($118.3 million at 5.88%) and December 2005 ($28.9 million at 7.71%). The consolidation and renewal combined the two mortgage loans into one loan at an interest rate equal to the existing weighted average interest rate of the two previous mortgage loans (6.24%) up to February 2001. As of February 2001, the rate of interest on the loan will increase to 6.76% until the loan matures in October, 2008.
MEDIUM-TERM NOTES
The Company has established a program for the sale of up to $95 million aggregate principal amount of Medium-Term Notes due nine months or more from the date of issuance (the "MTN Program"). On July 28, 1998, the Company sold $30 million of notes under the MTN Program. Such notes are due on July 30, 2001 and bear interest at 6.75% per year. On October 5, 1998, the Company sold $25 million of notes under the MTN Program. Such notes are due on October 5, 2000 and bear interest at 6.71% per year. Proceeds from the notes issued in both July and October, 1998 were used to reduce the Unsecured Credit Facility.
SENIOR UNSECURED DEBT OFFERINGS
On August 12, 1997, the Company completed a $125 million senior unsecured debt offering comprised of three tranches. The first tranche, $25 million of 6.80% Notes due August 15, 2002, was priced at 99.940% to yield 6.81%, or 73 basis points over the rate on US Treasury securities with a comparable maturity (the "2002 Notes"). The second tranche, $50 million of 6.95% Notes due August 15, 2004, was priced at 99.764% to yield 6.99% or 81 basis points over the rate on US Treasury securities with a comparable maturity (the "2004 Notes"). The third tranche, $50 million of 7.20% Notes due August 15, 2007, was priced at 99.830% to yield 7.22% or 104 basis points over the rate on US Treasury securities with a comparable maturity (the "2007 Notes" and together with the 2002 Notes and the 2004 Notes, the "August 1997 Notes"). The proceeds from the August 1997 Notes were used to pay down the Company's unsecured line of credit.
On December 17, 1997, the Company completed a $30 million senior unsecured debt offering of 6.625% Notes due December 15, 2003. The Notes were priced at 99.786% to yield 6.67%, or 95 basis points over the rate of US Treasury securities with a comparable maturity (the "December 1997 Notes"). The proceeds of the December 1997 Notes were used to pay down the Company's unsecured line of credit.
In August 1996, the Company obtained $31.0 million of unsecured debt financing from a bank consisting of a $15.0 million unsecured note with a four-year term and a $16.0 million unsecured note with a six-year term, which bear interest at 7.61% and 7.85%, respectively.
MARKET RISK
The fair market value of long-term fixed rate debt is subject to changes in interest rates. Generally, the fair market value of fixed interest rate debt will increase as interest rates fall and decrease as interest rates rise. The estimated fair value of the Company's total fixed rate long-term debt at December 31, 1998 was $521.0 million. A 1% increase from prevailing interest rates at December 31, 1998 would result in a decrease in fair value of long-term debt by approximately $25.7 million. Fair values were determined from quoted market prices, where available, and from information received from investment bankers using current interest rates considering credit ratings and remaining terms to maturity.
COMMON STOCK OFFERING
In August 1996, the Company completed the sale of 5.75 million shares of Common Stock with net proceeds of $97.6 million. Approximately $97.6 million of the aggregate proceeds from the issuance of Common Stock and the $31 million unsecured bank debt financing were utilized to fully repay the outstanding balances under the Company's unsecured line of credit and development loans. The remaining $30.9 million of the proceeds were used to fund current development.
SCHEDULE OF DEBT
The following table sets forth certain information regarding debt financing as of December 31, 1998 and 1997 (dollars in thousands):
- --------- (1) With the exception of the Mortgage Loan referred to in Note 2 below, which has a $146.7 million balance at December 31, 1998, all the secured debt can be prepaid at any time. Such Mortgage Loan can be prepaid after February 15, 2001. Prepayment of all such secured debt is generally subject to penalty or premium; however, the tax exempt mortgage notes can be prepaid at any time without penalty or premium.
(2) Mortgage Loan secured by the following Communities:
(3) Mortgage Loan secured by Summit Simsbury and Summit Touchstone Communities.
(4) The tax exempt bonds (the "Bonds") bear interest at various rates set by a remarketing agent at the demand note index plus 0.50%, set weekly, or the lowest percentage of prime which allows the resale at a price of par. The Bonds are enhanced by letters of credit from a financial institution (the "Credit Enhancements"), each of which Credit Enhancements will terminate prior to the maturity dates of the related Bonds. In the event such Credit Enhancements are not renewed or replaced upon termination, the related loan obligations will be accelerated.
The LIBOR rate at December 31, 1998 was 5.63%.
The Company's outstanding indebtedness (excluding the Unsecured Credit Facility) had an average maturity of 8.1 years as of December 31, 1998. The aggregate maturities of all outstanding debt (excluding the Unsecured Credit Facility) as of December 31, 1998 for each of the years ended after December 31, 1998 are as follows (in thousands):
Of the significant maturities in the above table, $15.0 million and $16.0 million relate to the unsecured bank notes that mature in 2000 and 2002, respectively; $25 million relates to unsecured notes due in 2000; $30 million relates to unsecured notes due in 2001 and $25 million relates to unsecured notes due in 2002.
NET ASSET VALUE
The Company's estimate of net asset value is based on the sum of: 1) the estimated fair market value of stabilized properties determined by applying current market capitalization rates (for recent purchases and sales of comparable properties) to projected cash flows, 2) the cost of any properties acquired during the period under consideration, 3) construction in progress adjusted to estimated fair market value, 4) the implied value of any below market debt (assumable under certain terms and conditions) and 5) other assets including cash and cash equivalents, less total liabilities divided by the weighted average number of common shares and operating partnership units outstanding during the period under consideration. Using this methodology, management's current estimate of net asset value is $23.23 per share as of December 31, 1998. The Company's estimate of net asset value will vary depending on current market conditions.
ACQUISITIONS AND DISPOSITIONS
On April 1, 1996, the Company acquired its joint venture partner's interest in Summit Plantation (formerly Plantation Cove), a 262 apartment community located in Plantation, Florida. The Company paid $6.4 million in cash for the remaining 75% interest in the joint venture.
During the year ended December 31, 1997, the Company completed the acquisition of five Communities: Summit Portofino, purchased on January 6, 1997: Summit Mayfaire, purchased on January 15, 1997: Summit Sand Lake purchased on February 20, 1997: Summit Windsor II, purchased on July 18, 1997: and Summit Fair Oaks, purchased on December 31, 1997 (the "1997 Acquisitions'). The 1997 Acquisitions added a total of 1,434 apartment homes to the Company's portfolio. Total purchase price for the 1997 Acquisitions was $104.5 million which consisted of $15.2 million in assumed debt, 243,608 shares of Common Stock (valued at $4.9 million) issued to the seller, 194,495 Units (valued at $3.9 million) issued to the seller and $78.9 million of cash. Concurrently with the purchase of Summit Portofino, the Company sold 315,029 shares of Common Stock to the public for cash to fund part of the purchase. The Summit Windsor II purchase was
partially funded by the proceeds from the sale of a property formerly know as Summit Charleston in May, 1997. The property formerly known as Summit Charleston was sold for $9.5 million and a gain on the sale of approximately $4.4 million was recognized.
The Company completed the acquisition of three Communities located in Atlanta, Georgia in 1998: Summit St. Clair, purchased effective March 1, 1998, Summit Club at Dunwoody, purchased effective May 22, 1998, and Summit at Lenox, purchased effective July 8, 1998 (the "Atlanta Acquisitions"). The Atlanta Acquisitions added a total of 1,092 apartment homes to the Company's portfolio at an aggregate purchase price of $88.3 million. The Atlanta Acquisitions were financed with the issuance of 259,871 Units (valued at $5.2 million) and the assumption of $8.8 million of mortgage debt. The balance of the purchase price was paid in cash.
On May 18, 1998, the Company sold a Community in Brandon, Florida formerly known as Summit Providence for net proceeds of $23.9 million. A gain on the sale of $8.7 million was recognized. Proceeds from the sale were used to partially fund the acquisition of Summit Club at Dunwoody.
On October 23, 1998, the Company sold a Community in Atlanta, Georgia formerly known as Summit Springs for $17.5 million. The Company recognized a gain of approximately $6.0 million on the sale.
On November 2, 1998, the Company sold a Community in Winston Salem, North Carolina, formerly known as Summit Old Town, for $7.5 million. The Company recognized a gain of approximately $2.3 million from the sale.
On November 4, 1998, the Company acquired a portfolio of multifamily properties in Texas (the "Ewing Portfolio") through a merger with Ewing Industries, a private developer of luxury apartment homes. The Ewing Portfolio consists of 2,465 apartment homes in seven Communities located in Dallas, Austin and San Antonio. The acquisition of the Ewing Portfolio was effected pursuant to an Agreement and Plan of Reorganization dated as of October 31, 1998 (the "Merger Agreement") among the Company, affiliates of the Company including the Operating Partnership, Ewing Industries, Inc., an Ohio corporation ("Ewing Industries"), affiliates of Ewing, and their respective partners, shareholders and members (together with Ewing Industries, "Ewing"). Pursuant to the Merger Agreement, the acquisition was funded through (i) the issuance to Ewing of 1,008,988 shares of Common Stock of the Company and 141,921 Units, valued at $20.7 million in the aggregate, (ii) the assumption of $84.0 million in long-term fixed-rate mortgage indebtedness, (iii) the payment of $50.6 million in cash and (iv) receipt of $3.8 million of credit for customary prorations and reserves. A portion of the consideration was deferred until stabilization of one Community (Summit Las Palmas) which was in lease-up at the time of the acquisition of the Ewing Portfolio. The Summit Las Palmas purchase was closed on December 31, 1998 with the additional consideration of (i) 1,065,627 shares of Common Stock and 36,629 Units valued at $19.8 million in aggregate and (ii) cash in the amount of approximately $600,000.
On December 16, 1998, the Company (i) sold five communities (the "Sold Communities") to Hollow Creek, LLC, a newly-formed North Carolina limited liability company for approximately $68 million and (ii) contributed two communities with an approximate fair market value of $22 million (together with the Sold Communities, the "Joint Venture Communities") to Station Hill, LLC., a newly-formed North Carolina limited liability company (the "LLC"). On the same date, Hollow Creek, LLC contributed the Sold Communities to the LLC. The LLC is a joint venture limited liability company, the membership of which is comprised of the Company and a wholly owned subsidiary of a major financial services company (the "Joint Venture Member"). The disposition was effected pursuant to a Real Estate Sale Agreement dated November 20, 1998 between the Operating Partnership and the Joint Venture Member and pursuant to the Operating Agreement of the LLC, also dated November 20, 1998. The Company's net contribution to the LLC (approximately $5.6 million) represents a 25 percent equity interest in the LLC. In addition, the Company is the managing member of the LLC and will also retain management of the Joint Venture Communities through a management agreement with the LLC. The cash flow of the LLC will be distributed pro rata to each member based on its equity contribution until certain economic benchmarks are achieved, at which point the Company will receive an escalated portion of the cash flow and residual interest. The LLC has obtained five separate mortgages totaling $70,150,000 from Fannie Mae. These mortgages have a ten-year maturity and a 6.70% interest rate. The proceeds of the mortgages were distributed on a pro rata basis to the LLC's two members. The Joint Venture Communities involved in the transaction were Summit Green, Summit Hollow I and II and Summit Creek in Charlotte, North Carolina; Summit Hill I and II in Raleigh, North Carolina and Summit Station in Tampa, Florida. The Joint Venture Communities include a total of 1,433 apartment homes. The Company recognized a gain of approximately $20.2 million on the disposition. The gain is net of a $5.6 million elimination of gain relative to the Company's retained portion of the joint venture. The elimination of the gain reduced the Company's investment in the joint venture to zero at the initial joint venture formation.
Proceeds from the sale of Summit Springs, Summit Old Town and the Sold Communities, were put in escrow with a qualified intermediary in accordance with like-kind exchange income tax rules and regulations. These proceeds will be used to fund future developments.
At December 31, 1998, the Company had six apartment communities for sale with a net book value of approximately $52.5 million. The Company does not anticipate incurring a loss on any individual apartment Community sale. Proceeds from the sale of the Communities will be used to fund future development. The six apartment communities held for sale represented approximately 6% of property operating income for the Company for the year ended December 31, 1998.
DEVELOPMENT ACTIVITY
The Company's developments in process at December 31, 1998 are summarized as follows (dollars in thousands):
- --------- (1) These communities were in lease-up at December 31, 1998.
(2) Consists primarily of land held for development and other predevelopment costs.
Estimated cost to complete the development Communities represents substantially all of the Company's material commitments for capital expenditures at December 31, 1998.
CERTAIN FACTORS AFFECTING THE PERFORMANCE OF DEVELOPMENT COMMUNITIES
The Company is optimistic about the operating prospects of the Communities under construction even with the increased supply of newly constructed apartment homes of comparable quality in many of its markets. As with any development community, there are uncertainties and risks associated with the development of the Communities described above. While the Company has prepared development budgets and has estimated completion and stabilization target dates based on what it believes are reasonable assumptions in light of current conditions, there can be no assurance that actual costs will not exceed current budgets or that the Company will not experience construction delays due to the unavailability of materials, weather conditions or other events.
Other development risks include the possibility of incurring additional cost or liability resulting from defects in construction material and the possibility that financing may not be available on favorable terms, or at all, to pursue or complete development activities. Similarly, market conditions at the time these communities become available for leasing will affect the rental rates that may be charged and the period of time necessary to achieve stabilization, which could make one or more of the development Communities unprofitable or result in achieving stabilization later than currently anticipated. In addition, the Company is conducting feasibility and other pre-development work for twelve potential communities. The Company could abandon the development of any one or more of these potential Communities in the event that it determines that market conditions do not support development, financing is not available on favorable terms or other circumstances prevent development. Similarly, there can be no assurance that if the Company does pursue one or more of these potential communities that it will be able to complete construction within the currently estimated development budgets or that construction can be started at the time currently anticipated.
INFLATION
Substantially all of the leases at the Communities are for a term of one year or less, which coupled with the relatively high occupancy rates, may enable the Company to seek increased rents upon renewal of existing leases or commencement of new leases. The short-term nature of these leases generally serves to reduce the risk to the Company of the adverse effect of inflation.
YEAR 2000
YEAR 2000 INFORMATION AND READINESS DISCLOSURE ACT
The Company supports the exchange of information relating to the Year 2000 issue and designates the following information as the Year 2000 Readiness Disclosure within the meaning of the Year 2000 Information and Readiness Disclosure Act. Information set forth herein regarding the Year 2000 compliance of non-Company products and services are "republications" under the Year 2000 Information and Readiness Disclosure Act and are based on information supplied by other companies about the products and services they offer. The Company has not independently verified the contents of these republications and takes no responsibility for the accuracy or completeness of information contained in such republications.
INTRODUCTION
The Securities and Exchange Commission has asked all public companies to provide disclosure regarding their Year 2000 readiness. The term "Year 2000 issue" is a general term used to describe various problems that may result from the improper processing by computer systems of dates after 1999. These problems arise from the inability of some hardware and software to distinguish dates before the year 2000 from dates in and after the year 2000. This could result in a system failure or miscalculations causing disruptions of operations. The Year 2000 issue affects virtually all companies and all organizations.
The Company's efforts to address its Year 2000 issues are focused in the following three areas: (i) reviewing and taking any necessary steps to attempt to correct the Company's computer information systems (i.e., software applications and hardware platforms), (ii) evaluating and making any necessary modifications to other computer systems that do not relate to information technology but include embedded technology, such as telecommunications, security, HVAC, elevator, fire and safety systems, and (iii) communicating with certain significant third-party service providers to determine whether there will be any interruption in their systems that could affect the Company.
THE COMPANY'S STATE OF READINESS
The Company has developed a four phase plan to address its Year 2000 issues (its "Year 2000 Plan"). The four phases are (i) Awareness, (ii) Assessment, (iii) Remediation and Implementation and (iv) Testing.
AWARENESS
The Company has made the relevant employees, including its property managers, aware of the Year 2000 issue and collected information from such employees regarding systems that the Company anticipates may be affected. Management will oversee the Company's progress with respect to the implementation of its Year 2000 Plan. In addition, the Year 2000 Plan will be subject to review of the Audit Committee of the Board of Directors.
ASSESSMENT
The Company has substantially completed an assessment of its standard computer information systems and is now taking the further necessary steps to make its core computer information systems, in those situations in which the Company is required to do so, Year 2000 compliant. See "Remediation and Implementation" below. The Company is in the process of attempting to obtain written verification from vendors to the effect that the Company's other (i.e., non-core) standard computer information systems acquired from such vendors correctly distinguish dates before the year 2000 from dates in and after the year 2000. The Company expects that it will receive such verifications, or a commitment from the relevant vendors to provide a solution, by no later than April 30, 1999.
In addition, the Company is currently evaluating and assessing its other computer systems that do not relate to information technology but include embedded technology, such as telecommunications, security, HVAC, elevator, fire and safety systems, and expects that its assessment will be completed by the second quarter of 1999. The Company is aware that such systems contain embedded chips that are difficult to identify and test and may require complete replacement because they
cannot be repaired. Failure of the Company to identify or remediate any embedded chips (either on an individual or aggregate basis) on which significant business operations depend, such as phone systems, could have a material adverse impact on the Company's business, financial condition and results of operations.
The Company rents apartments in its Communities to individuals and does not have a single customer or group of customers who rents a significant number of apartments. The Company's primary purchases are building-related products (e.g., carpets, paint and blinds) and services (e.g., lawn care services), all of which are available from numerous suppliers. The Company's primary financial service providers are its primary bank and payroll processor. The primary bank has provided written verification to the Company that it will be Year 2000 compliant. The Company implemented the payroll processor Year 2000 upgrade in the fourth quarter of 1998. For the foregoing reasons, the Company does not believe that there is a significant risk related to the failure of residents, vendors or third-party goods or service providers to prepare for the Year 2000; however, the costs and timing of third-party Year 2000 compliance is not within the Company's control and no assurances can be given with respect to the cost or timing of such efforts or the potential effects of any failure to comply.
REMEDIATION AND IMPLEMENTATION
The Company's primary uses of software systems are its corporate accounting and property management software. The Company's corporate accounting system is widely used in the real estate industry. A version upgrade, installed in the second quarter of 1998, is designed to be Year 2000 compliant. The Company completed the replacement of its current property management software in October 1998 with a new software system that is also designed to be Year 2000 compliant. This new software is also widely used in the real estate industry. The Company has received written verification from the vendors of each of the corporate accounting and management systems that the relevant software is Year 2000 compliant. The Company had previously planned both the upgrade of the corporate accounting system and implementation of the new property management system, and such changes would have been undertaken without regard to Year 2000 remediation issues. Accordingly, the Company has not deferred any planned information or software projects due to such Year 2000 projects, and the Company is not treating the costs of the above-referenced changes as Year 2000-related expenses.
TESTING
To attempt to confirm that its computer systems are Year 2000 compliant, the Company expects to perform limited testing of its computer information systems and its other computer systems that do not relate to information technology but include embedded technology; however, unless Year 2000 issues arise in the course of its limited testing, the Company will rely on the written verification received from each vendor of its computer systems that the relevant system is Year 2000 compliant. Nevertheless, there can be no assurance that the computer systems on which the Company's business relies will correctly distinguish dates before the year 2000 from dates in and after the year 2000. Any such failures could have a material adverse effect on the Company's business, financial condition and results of operations. The Company began testing in the fourth quarter of 1998 and expects that its testing will be complete by March 31, 1999.
COSTS TO ADDRESS THE COMPANY'S YEAR 2000 ISSUES
Based on current information from its review to date, the Company budgeted $500,000 for the cost of repairing, updating and replacing its standard computer information systems. Because the Company's Year 2000 assessment is ongoing and additional funds may be required as a result of future findings, the Company's current budget amounts may increase as a result of unanticipated delays or preparedness issues. While the Company's efforts to address its Year 2000 issues will involve additional costs, the Company believes, based on available information, that these costs will not have a material adverse effect on its business, financial condition or results of operations. The Company expects to fund the costs of addressing the Year 2000 issue from cash flows resulting from operations. While the Company believes that it will be Year 2000 compliant by December 31, 1999, if these efforts are not completed on time, or if the costs associated with updating or replacing the Company's computer systems exceeds the Company's estimates, the Year 2000 issue could have a material adverse effect on the Company's business, financial condition and results of operations.
RISKS PRESENTED BY YEAR 2000 ISSUES
The Company is still in the process of evaluating potential disruptions or complications that might result from Year 2000-related problems; however, at this time the Company has not identified any specific business functions that are likely to suffer material disruption as a result of Year-2000 related events. It is possible, however, that the Company may identify business functions in the future that are specifically at risk of Year 2000 disruption. The absence of any such determination as of the date of this report represents only the Company's current status of evaluating potential Year-2000 related problems and facts presently known to the Company, and should not be construed to mean that there is no risk of Year-2000 related
disruption. Moreover, due to the unique and pervasive nature of the Year 2000 issue, it is not possible to anticipate each of the wide variety of Year 2000 events, particularly outside of the Company, that might arise in a worst case scenario which might have a material adverse impact on the Company's business, financial condition and results of operations.
THE COMPANY'S CONTINGENCY PLANS
The Company intends to develop contingency plans for significant business risks identified by the Company that might result from Year-2000 related events. Because the Company has not yet identified any specific business function that will be materially at risk of significant Year-2000 related disruptions, and because a full assessment of the Company's risk from potential Year 2000 failures is still in process, the Company has not yet developed detailed contingency plans specific to Year 2000 problems. In the event that the Company concludes that one or more contingency plans are required, development of such contingency plans is currently scheduled to occur no later than June 30, 1999 or as otherwise appropriate.
FUNDS FROM OPERATIONS
The White Paper on Funds from Operations approved by the Board of Governors of NAREIT in March 1995 defines Funds from Operations as net income (loss) (computed in accordance with GAAP), excluding gains (or losses) from debt restructuring and sales of property, plus real estate related depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures. The Company computes Funds from Operations in accordance with the standards established by the White Paper, which may differ from the methodology for calculating Funds from Operations utilized by other equity REITs, and, accordingly, may not be comparable to such other REITs. Funds Available for Distribution is defined as Funds from Operations less capital expenditures funded by operations (recurring capital expenditures). The Company's methodology for calculating Funds Available for Distribution may differ from the methodology for calculating Funds Available for Distribution utilized by other REITs, and accordingly, may not be comparable to other REITs. Funds from Operations and Funds Available for Distribution do not represent amounts available for management's discretionary use because of needed capital expenditures or expansion, debt service obligations, property acquisitions, development, dividends and distributions or other commitments and uncertainties. Funds from Operations and Funds Available for Distribution should not be considered as alternatives to net income (determined in accordance with GAAP) as an indication of the Company's financial performance or to cash flows from operating activities (determined in accordance with GAAP) as a measure of the Company's liquidity, nor are they indicative of funds available to fund the Company's cash needs, including its ability to make dividends/distributions. The Company believes Funds from Operations and Funds Available for Distribution are helpful to investors as measures of the performance of the Company because, along with cash flows from operating activities, financing activities and investing activities, they provide investors with an understanding of the ability of the Company to incur and service debt and make capital expenditures.
Funds from Operations and Funds Available for Distribution are calculated as follows (dollars in thousands):
- --------- (1) Recurring capital expenditures are expected to be funded from operations and consist primarily of exterior painting, new appliances, vinyl, blinds, tile, and wallpaper. In contrast, non-recurring capital expenditures, such as major improvements, water submetering, new garages and access gates, are expected to be funded by financing activities and are therefore not included in the calculation of Funds Available for Distribution.
(2) Non-recurring capital expenditures include major renovations in the amount of $1.3 million in 1998 and $3.5 million in 1997; $1 million and $81,000 for water meters in 1998 and 1997, respectively; $25,000 and $83,000 for new signage in 1998 and 1997, respectively; $561,000 and $239,000 for fitness centers, key controls and other revenue enhancement items in 1998 and 1997, respectively; $446,000 and $252,000 for access gates and security fences in 1998 and 1997, respectively; $215,189 and $21,000 for washer/dryer units in 1998 and 1997, respectively; and $776,000 and $238,000 for improvement at properties acquired or disposed of in 1998 and 1997, respectively. In addition, 1998 and 1997 included $142,000 and $250,000, respectively, of capital expenditures for construction of garages and $191,000 for improvements at Summit Norcroft I done in conjunction with development of Summit Norcroft II in 1998.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
See "Management Discussion and Analysis of Financial Condition and Results of Operations -- Market Risk".
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial statements and supplementary data are contained on the pages indicated on the Index to Financial Statements and Supplementary Data on page 39 of this Report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
Incorporated herein by reference to the Company's definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the end of the year covered by this Form 10-K with respect to its Annual Meeting of Stockholders to be held on May 11, 1999.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Incorporated herein by reference to the Company's definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the end of the year covered by this Form 10-K with respect to its Annual Meeting of Stockholders to be held on May 11, 1999.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by reference to the Company's definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the end of the year covered by this Form 10-K with respect to its Annual Meeting of Stockholders to be held on May 11, 1999.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference to the Company's definitive proxy statement to be filed with the Securities and Exchange Commission within 120 days after the end of the year covered by this Form 10-K with respect to its Annual Meeting of Stockholders to be held on May 11, 1999.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements
The consolidated financial statements of the Company are listed in the Index to Financial Statements on page of this Report.
(b) Reports on Form 8-K
On November 13, 1998, the Company filed a current report on Form 8-K in connection with the acquisition of properties from Ewing Industries and a form 8-K/A-1 was filed on December 1, 1998 to amend the Form 8-K to include financial statements, pro forma financial information and certain exhibits.
On December 16, 1998, the Company filed a Current Report on Form 8-K in connection with the disposition of certain properties. The Form 8-K included pro forma financial information and certain exhibits.
(c) Exhibits
As noted below, certain of the exhibits required by Item 601 of Regulation S-K have been filed with previous reports by the Company and are incorporated by reference herein.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Summit Properties Inc. certifies that it has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in Charlotte, North Carolina on March 16, 1999.
SUMMIT PROPERTIES INC.
/S/ WILLIAM F. PAULSEN ---------------------------------------- WILLIAM F. PAULSEN, CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated.
The following financial statements of the Company required to be included in Item 14(a)(1) are listed below:
SUMMIT PROPERTIES INC.
INDEPENDENT AUDITORS' REPORT
Board of Directors Summit Properties Inc. Charlotte, North Carolina
We have audited the accompanying consolidated balance sheets of Summit Properties Inc. as of December 31, 1998 and 1997 and the related consolidated statements of earnings, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform our audits 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, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 1998 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles.
We consent to the incorporation by reference of the above report in Registration Statement Nos. 333-24669, 33-93540, 333-25575, and 333-51623 on Form S-3, and Registration Statement Nos. 33-88202 and 333-78 on Form S-8 of Summit Properties Inc.
DELOITTE & TOUCHE LLP
Charlotte, North Carolina January 21, 1999
SUMMIT PROPERTIES INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
See notes to consolidated financial statements.
SUMMIT PROPERTIES INC.
CONSOLIDATED STATEMENTS OF EARNINGS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
See notes to consolidated financial statements.
SUMMIT PROPERTIES INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
See notes to consolidated financial statements.
SUMMIT PROPERTIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
See notes to consolidated financial statements.
SUMMIT PROPERTIES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND FORMATION OF THE COMPANY
Summit Properties Inc. (the "Company") was initially organized as a Maryland real estate investment trust on December 1, 1993 under the Maryland Real Estate Investment Trust Act. The Company became a Maryland corporation under the General Corporation Law of Maryland on January 13, 1994. On February 15, 1994, the Company completed an Initial Public Offering ("Initial Offering"). In connection with the Initial Offering, the Company consummated a business combination involving the Partnerships (the "Property Partnerships") which owned the 27 communities (the "Communities") and the affiliated entities which provided development, construction, management and leasing services to each of the Communities prior to the Initial Offering (collectively, "Summit Entities"). A portion of the proceeds from the Initial Offering was used to acquire an economic and voting interest in Summit Properties Partnership, L.P. (the "Operating Partnership"), which was formed to succeed to substantially all of the interests of the Property Partnerships in the Communities and the operations of Summit Entities (the "Formation"). The Company became the sole general partner and the majority owner of the Operating Partnership upon completion of the Initial Offering and, accordingly, reports its investment in the Operating Partnership on a consolidated basis.
In June 1995, the Company completed the sale of 4 million shares of Common Stock, ("1995 Offering"). In August 1996, the Company completed the sale of 5.75 million shares of Common Stock, ("1996 Offering"). The net proceeds of $65.9 million and $97.6 million from the 1995 and 1996 Offerings, respectively, were used to repay mortgage debt and to fund the construction of development communities.
2. BASIS OF PRESENTATION
In conjunction with the Initial Offering, construction, management and leasing activities for third parties were transferred to Summit Management Company (the "Management Company") and its wholly-owned subsidiary, Summit Apartment Builders (the "Construction Company"). The Operating Partnership has a 99% economic interest in the Management Company but controls only 1% of the voting stock. The remaining 99% of the voting stock is held by an executive officer of the Company, which stock is subject to certain restrictions on transfer designed to ensure that the holder of the Management Company's voting stock will have interests aligned with those of the Company. Because of the Company's ability to exercise significant influence, the Management Company is accounted for on the equity method of accounting.
As a result of the Formation, the partners and owners of the entities comprising the Summit Entities have either retained their existing ownership interests, received shares of Common Stock or received limited partnership interests ("Units") in the Operating Partnership. Purchase accounting was applied to the acquisition of all non-controlled interests in which cash consideration was paid. The acquisition of all other interests was accounted for as a reorganization of entities under common control and, accordingly, was reflected at historical cost in a manner similar to that in pooling of interests accounting.
All significant intercompany accounts and transactions have been eliminated in consolidation. The financial statements of the Company have been adjusted for the minority interest of unitholders in the Operating Partnership. Minority interest of unitholders in the Operating Partnership is calculated at the balance sheet date based upon the percentage of Units outstanding owned by partners other than the Company to the total number of Units outstanding. Minority interest of unitholders in Operating Partnership earnings is calculated based on the weighted average Units outstanding during the period. Units can be exchanged for cash, or at the option of the Company, for shares of Common Stock on a one-for-one basis. It is the Company's prior practice and current intention to redeem Units only for shares of Common Stock on a one-for-one basis. With respect to Units issued in conjunction with the initial formation of the Company as a REIT, the redemption of Units for shares of Common Stock is recorded at book value. With respect to Units issued subsequent to that date, the redemption of Units for shares of Common Stock is accounted for as the purchase of a minority interest and, therefore, recorded at the fair market value of the shares of Common Stock issued at the date of the redemption.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REAL ESTATE ASSETS AND DEPRECIATION -- Real estate assets are stated at depreciated cost reduced for any estimated impairment in value of which management believes there is none at December 31, 1998 and 1997.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (Continued)
Expenditures directly related to the acquisition, development and improvement of real estate assets are capitalized at cost as land, buildings and improvements. Improvements are broken down into recurring capital expenditures and non-recurring capital expenditures. Non-recurring capital expenditures primarily consist of the cost of improvements such as new garages, water submeters and improvements made in conjunction with acquisitions and major renovations. All other improvements are deemed as recurring capital expenditures.
Ordinary repairs and maintenance, including carpet replacements and interior painting, are expensed as incurred; major replacements and betterments are capitalized and depreciated over their estimated useful lives. Depreciation is computed on a straight-line basis over the estimated useful lives of the properties (buildings -- 40 years; land improvements -- 15 years; furniture, fixtures and equipment -- 5 to 7 years).
The Company records its real estate assets at cost less accumulated depreciation and adjusts carrying value in accordance with Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of ". SFAS No. 121 requires that long-lived assets such as real estate assets be reviewed whenever events or changes in circumstances indicate that the book value of the asset may not be recoverable. If the sum of the estimated future net cash flows (undiscounted and without interest charges) from an asset to be held and used is less than the book value of the asset, an impairment loss must be recognized in the amount of the difference between book value and fair value as opposed to the difference between book value and net realizable value under the previous accounting standard. For long-term assets like apartment communities, the determination of whether there is an impairment loss is dependent primarily on the Company's estimates on occupancy, rent and expense increases, which involves numerous assumptions and judgments as to future events over a period of many years. Assets to be disposed of are reported at the lower of carrying value or fair value less costs to sell. At December 31, 1998 the Company does not hold any assets that meet the impairment criteria of SFAS No. 121. At December 31, 1998, the Company had six apartment communities for sale with a net book value of approximately $52.5 million. The Company does not anticipate incurring a loss on any individual apartment community sale. The six apartment communities held for sale represented approximately 6% of property operating income for the Company for the year ended December 31, 1998.
RENTAL REVENUE RECOGNITION -- The Company leases its residential properties under operating leases with terms generally one year or less. Rental revenue is recognized on the accrual method of accounting as earned.
PROPERTY MANAGEMENT -- The Management Company provides property management services for both Company owned properties as well as properties owned by third parties. Revenue is recognized when earned, as the services are provided.
CASH AND CASH EQUIVALENTS -- For purposes of the statement of cash flows, the Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.
RESTRICTED CASH -- Restricted cash is comprised primarily of resident security deposits, bond repayment escrows, replacement reserve escrows, and proceeds from apartment community sales deposited with a qualified intermediary in accordance with like-kind exchange rules and regulations.
DEFERRED FINANCING COSTS -- Deferred financing costs include fees and costs incurred in conjunction with long-term financings and are amortized on the straight-line method over the terms of the related debt. Such amortization is included in interest expense in the accompanying consolidated statements of earnings.
INTEREST AND REAL ESTATE TAXES -- Interest and real estate taxes incurred during the construction period are capitalized and depreciated over the lives of the constructed assets. Interest capitalized was $6.1 million, $5.9 million and $4.3 million for the years ended December 31, 1998, 1997 and 1996, respectively.
ADVERTISING COSTS -- The Company expenses advertising costs as incurred.
INCOME TAXES -- The Company elected to be taxed as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended (the "Code"). As a result, the Company generally will not be subject to federal and state income taxation at the corporate level to the extent it distributes annually at least 95% of its taxable income, as defined in the Code, to its stockholders and satisfies certain other requirements. Accordingly, no provision has been made for federal and state income taxes in the accompanying consolidated financial statements.
Financial Accounting Standard No. 109, "Accounting for Income Taxes" requires a public enterprise to disclose the aggregate difference in the basis of its net assets for financial and tax reporting purposes. The carrying value reported in the Company's consolidated financial statements exceeded the tax basis by approximately $90.6 million and $25.3 million, as
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (Continued)
of December 31, 1998 and 1997, respectively. The change between December 31, 1998 and 1997 was primarily due to financial depreciation exceeding tax depreciation by approximately $7.8 million offset by the carrying value exceeding the tax basis by $69.9 million for the Company's 1998 Acquisitions.
A portion of the Company's dividends is deemed as return of capital for shareholder income tax purposes. The percentage of dividends that was return of capital was 18%, 25% and 21% for each of the years ended December 31, 1998, 1997 and 1996, respectively.
PER SHARE DATA -- Basic earnings per share with respect to the Company for the years ended December 31, 1998, 1997 and 1996 are computed based upon the weighted average number of shares outstanding during the period. The difference in "basic" and "diluted" weighted average shares is the dilutive effect of the Company's stock options outstanding (9,384, 36,421 and 26,930 shares added to weighted shares outstanding in 1998, 1997 and 1996, respectively).
ESTIMATES -- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions 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 reporting period. Actual results could differ from those estimates.
COMPREHENSIVE INCOME -- Statement of Financial Accounting Standard No. 130 "Reporting Comprehensive Income" (FAS 130), presents standards for reporting and display of comprehensive income and its components. Besides net income, FAS 130 requires the reporting of other comprehensive income, defined as revenues, expenses, gains and losses that under generally accepted accounting principles are not included in net income. The Company has no items of other comprehensive income in any period presented.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES -- Statement of Financial Accounting Standard No. 133, "Accounting for Derivative Instruments and Hedging Activities" (FAS 133), presents standards for accounting for derivative instruments. FAS 133 is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The Company currently holds no derivative instruments and accordingly does not expect FAS 133 to have an effect on the Company's financial position and results of operations.
4. REAL ESTATE JOINT VENTURES
The Company obtained a 25% interest in a joint venture named Station Hill in exchange for the contribution of two communities. Station Hill also owns five apartment communities previously owned by the Company which were sold to Hollow Creek LLC on December 16, 1998 and were concurrently contributed to Station Hill for a 75% joint venture interest (See Acquisitions and Dispositions -- Note 8). The seven communities are Summit Green, Summit Hill I & II, Summit Creek, Summit Hollow I & II and Summit Station. The Company's initial investment in Station Hill was reduced to zero when the Company eliminated the portion of the gain on disposal related to the percentage of joint venture ownership interest retained. Station Hill is accounted for on the equity method of accounting.
The Company owns a 49% interest in each of two joint ventures ("Construction Projects"). Each joint venture is developing an apartment community which will be accounted for under the equity method of accounting. The projects are both under construction and had no operations as of December 31, 1998. The construction costs will be funded primarily through separate loans to each joint venture from unrelated third parties equal to 100% of the construction costs. During the construction period, in lieu of equity contribution to each of the respective joint ventures, the Company has under certain circumstances, subsequent to demand by the third party lenders, agreed to make contributions which would reduce the respective construction loan by an amount not to exceed 25% of the total construction loan amount. Any such contribution would be deemed to be all or a portion of the equity required to be contributed by the Company to the respective joint venture at the end of the construction and lease up period. The Company has the right to purchase its joint venture partner's interest after the projects are complete.
4. REAL ESTATE JOINT VENTURES -- (Continued)
The following is a condensed balance sheet for each of the joint ventures at December 31, 1998 (in thousands):
Station Hill began operations on December 16, 1998 while the Construction Projects have had no operations. Accordingly the operations of the joint ventures are not material to the Company for the year ended December 31, 1998.
5. PROPERTY MANAGEMENT AND RELATED PARTY TRANSACTIONS
In conjunction with the Formation, construction, management and leasing activities for third parties were transferred to the Management Company, which is accounted for using the equity method of accounting.
The Management Company provides management services to the Company. Total fees for management services were $3.9 million, $3.1 million and $2.4 million for the years ended December 31, 1998, 1997 and 1996, respectively.
In addition, the Management Company provides management services to apartment communities in which executive officers and certain directors of the Company are general partners. The Management Company received management fees of approximately $233,000, $214,000 and $267,000 for the performance of such services for the years ended December 31, 1998, 1997 and 1996, respectively.
Construction Company revenue consists of fees on contracts with the Company. Revenue from contracts with the Company was $1.1 million, $1.1 million and $524,000 for the years ended December 31, 1998, 1997 and 1996, respectively. The Construction Company's profits on these contracts is eliminated in consolidation against the Company's investment in real estate. The Company had a $5.7 million and $4.6 million construction contract payable to the Construction Company as of December 31, 1998 and 1997, respectively.
The Company's investment in the Management Company as of December 31, 1998 and 1997, reported on the equity method, includes the amounts shown below. The Company's investment in the Management Company is not considered material to the consolidated financial statements of the Company taken as a whole (in thousands):
6. NOTES PAYABLE Notes payable consist of the following (in thousands):
The London Interbank Offered Rate (LIBOR) at December 31, 1998 was 5.63%.
MORTGAGE LOANS -- On September 23, 1998, the Company consolidated and renewed two mortgage loans which had a $147.2 million balance. The original loans matured in February 2001 ($118.3 million at 5.88%) and December 2005 ($28.9 million at 7.71%). The consolidation and renewal combined the two mortgage loans into one loan at an interest rate equal to the existing weighted average interest rate of the two previous mortgage loans (6.24%) up to February 2001. As of February 2001, the rate of interest on the loan will increase to 6.76% until the loan matures in October of 2008.
The 8.00% Mortgage Loan requires monthly principal and interest payments on a 30-year amortization schedule with a balloon payment due at maturity in September, 2005.
MORTGAGE NOTES -- The Mortgage Notes bear interest at fixed rates ranging from 6.75% to 9.80% and require monthly interest and principal payments over the life of the notes which range from the year 2002 to 2029. The weighted average interest rate and debt maturity at December 31, 1998 for these ten Mortgage Notes were 7.20% and 8.4 years, respectively.
TAX EXEMPT MORTGAGE NOTES -- The Tax Exempt Mortgage Notes bear interest at fixed rates ranging from 6.95% to 7.25% and require monthly interest and principal payments over the life of the notes. The weighted average interest rate and debt maturity at December 31, 1998 for these two mortgage notes were 7.12% and 27.5 years, respectively.
MEDIUM-TERM NOTES -- The Company has established a program for the sale of up to $95 million aggregate principal amount of Medium-Term Notes due nine months or more from the date of issuance (the "MTN Program"). On July 28, 1998, the Company sold $30 million of notes under the MTN Program. Such notes are due on July 30, 2001 and bear interest at 6.75% per year. On October 5, 1998, the Company sold $25 million of notes under the MTN Program. Such notes are due on October 5, 2000 and bear interest at 6.71% per year.
6. NOTES PAYABLE -- (Continued)
UNSECURED NOTES -- The unsecured notes consist of $25.0 million of notes due 2002, $30.0 million of notes due 2003, $50.0 million of notes due 2004 and $50.0 million of notes due 2007 (collectively, the "Unsecured Notes"). The Unsecured Notes require semi-annual interest payments until the end of the respective terms.
UNSECURED BANK NOTES -- The unsecured bank notes consist of a $16.0 million note due 2002 and a $15.0 million note due 2000 (collectively, the "Unsecured Bank Notes"). The notes require quarterly interest only payments until the end of the respective terms.
UNSECURED CREDIT FACILITY -- In March, 1998, the Company obtained a new syndicated unsecured line of credit (the "Unsecured Credit Facility") in the amount of $175 million which replaced the existing $150 million credit facility. The Unsecured Credit Facility was increased in December, 1998 to $200 million. The Unsecured Credit Facility provides funds for new development, acquisitions and general working capital purposes. The Unsecured Credit Facility has a three year term with two one-year extension options and bears interest at LIBOR + 90 basis points based upon the Company's current credit rating of BBB- by Standard & Poor's Rating Services and Baa3 by Moody's Investors Service. The interest rate will be reduced in the event of an upgrade of the Company's unsecured credit rating. The Unsecured Credit Facility is repayable monthly on an interest only basis with principal due at maturity. The Company's credit facilities had an average interest rate and average balance outstanding during the years ended December 31, 1998, 1997 and 1996 of 6.67%, 6.73%, 6.46% and $98.0, $53.9 million and $9.4 million, respectively. In addition, the maximum outstanding during 1998, 1997 and 1996 was $175.0 million, $121.9 million and $22.4 million, respectively.
The Unsecured Credit Facility also provides a bid option sub-facility equal to a maximum of fifty percent of the total facility ($100 million). This sub-facility provides the Company with the option to place borrowings in fixed LIBOR contract periods of thirty, sixty, ninety and one hundred eighty days. The Company may have up to seven fixed LIBOR contracts outstanding at any one time. Upon proper notifications, all lenders participating in the Unsecured Credit Facility may, but are not obligated to, participate in a competitive bid auction for these fixed LIBOR contracts.
The Unsecured Credit Facility requires the Company to comply with certain affirmative and negative covenants including the following requirements: (i) the Company maintain its qualification as a REIT; (ii) the Company maintain a ratio of EBITDA (as defined therein) to fixed charges (as defined therein) of not less that 1.75 to 1; (iii) dividends not exceed 90% of funds from operations (as defined therein); (iv) the Company maintain a ratio of total funded debt (as defined therein) to implied capitalization value (as defined therein) of less than .55 to 1; and (v) the Company maintain a ratio of unencumbered asset value (as defined therein) to unsecured debt of less than 1.75 to 1. In addition, the Unsecured Notes and the Unsecured Bank Notes require the Company to comply with certain affirmative and negative covenants including the following requirements: (i) the ratio of unencumbered assets (as defined therein) to unsecured debt equal or exceed 150%; (ii) the ratio of debt to assets (as defined therein) not exceed 60%; and (iii) secured debt not to exceed 40% of assets (as defined therein).
VARIABLE RATE TAX EXEMPT BONDS -- The effective interest rate of the Variable Rate Tax Exempt Bonds was 4.85% for the year ended December 31, 1998. These bonds bear interest at various rates set by a remarketing agent at the demand note index plus 0.50%, set weekly, or the lowest percentage of prime which allows the resale at a price of par. The bonds contain covenants which require that the Company lease or hold for lease 20% (or 25% under certain state or local requirements) of the apartment homes for moderate-income residents. The bonds require maintenance of letters of credit or surety bonds (credit enhancements) aggregating to $52.9 million. The credit enhancements on four of the five tax exempt bonds ($44.2 million of debt) provide for a principal amortization schedule which approximates a 25-year term during the term of the credit enhancement.
Real estate assets with a net book value of $433.5 million serve as collateral for the various debt agreements.
6. NOTES PAYABLE -- (Continued)
The aggregate maturities of all debt for each of the years ending December 31 are as follows (in thousands):
EXTRAORDINARY ITEMS -- The extraordinary items in the year ended December 31, 1998 resulted from the write-off of deferred financing cost in conjunction with the replacement by the Company of its prior credit facility with the Unsecured Credit Facility and prepayment penalties on six mortgage notes which were repaid during the period. The 1996 extraordinary item resulted from the write-off of deferred financing costs on development loans repaid with the proceeds from the 1996 Offering and with the proceeds of the $31.0 million Unsecured Bank Notes. The extraordinary items are net of $86,000 and $110,000 which was allocated to the minority interest of the unitholders in the Operating Partnership, calculated on the weighted average number of Units outstanding in 1998 and 1997 respectively.
7. MINORITY INTEREST
Minority interest consists of the following at December 31, 1998 and 1997 (in thousands):
As of December 31, 1998, there were 32,242,074 Units outstanding of the Operating Partnership, of which 27,805,836, or 86.2% were owned by the Company and 4,436,238, or 13.8% were owned by other partners (including certain officers and directors of the Company).
Proceeds from Common Stock issued by the Company are contributed to the Operating Partnership for an equivalent number of Units. Total Common Stock issued by the Company and contributed to the Operating Partnership for equivalent number of Units was 4.8 million and 1.0 million shares valued at $89.7 million ($18.52 per share average) and $20.7 million ($20.66 per share average) for the years ended December 31, 1998 and 1997 respectively. No individual transaction significantly changed the Company's ownership percentage in the Operating Partnership. The Company's ownership percentage in the Operating Partnership was 86.2%, 85.3% and 84.8% as of December 31, 1998, 1997 and 1996, respectively.
In addition to the amounts in the above, the Company issued shares of Common Stock in exchange for Units owned by other partners on a one-for-one basis. An aggregate of 28,993 shares and 192,463 shares were issued for Units in 1998 and 1997, respectively. The shares exchanged were valued based upon the Company's market price per share and had an aggregate value of $555,000 and $3.9 million in 1998 and 1997, respectively.
Units issued for the purchase of apartment communities were valued based upon the Company's market value price per share of Common Stock as the Units can be exchanged for shares on a one-for-one basis. In addition, of the 438,103 Units issued for the 1997 purchase of apartment communities, 243,608 Units were issued to the Company in exchange for the Company issuing 243,608 shares of Common Stock to the sellers of the apartment communities. Of the 2,253,165 Units issued for the 1998 purchase of apartment Communities, 2,074,615 were issued to the Company in exchange for the company issuing 2,074,615 shares of common stock to the sellers of the apartment communities.
8. ACQUISITIONS AND DISPOSITIONS On April 1, 1996, the Company acquired its joint venture partner's interest in Summit Plantation (formerly Plantation Cove), a 262 apartment community located in Plantation, Florida. The Company paid $6.4 million in cash for the remaining 75% interest in the joint venture.
During the year ended December 31, 1997, the Company completed the acquisition of five communities: Summit Portofino, purchased on January 6, 1997: Summit Mayfaire, purchased on January 15, 1997: Summit Sand Lake purchased on February 20, 1997: Summit Windsor II, purchased on July 18, 1997: and Summit Fair Oaks, purchased on December 31, 1997 (the "1997 Acquisitions"). The 1997 Acquisitions added a total of 1,434 apartment homes to the Company's portfolio. The total purchase price for the 1997 Acquisitions was $104.5 million which consisted of $15.2 million in assumed debt, 243,608 shares of Common Stock (valued at $4.9 million) issued to the seller, 194,495 Units (valued at $3.9 million) issued to the seller and $78.9 million of cash. Concurrently with the purchase of Summit Portofino, the Company sold 315,029 shares of Common Stock to the public for cash to fund part of the purchase. The Summit Windsor II purchase was partially funded by the proceeds from the sale of a property formerly now as Summit Charleston in May, 1997. The property formerly known as Summit Charleston was sold for $9.5 million and a gain of the sale of approximately $4.4 million was recognized.
The Company completed the acquisition of three communities located in Atlanta, Georgia in 1998: Summit St. Clair, purchased effective March 1, 1998, Summit Club at Dunwoody, purchased effective May 22, 1998, and Summit at Lenox, purchased effective July 8, 1998 (the "Atlanta Acquisitions"). The Atlanta Acquisitions added a total of 1,092 apartment homes to the Company's portfolio at an aggregate purchase price of $88.3 million. The Atlanta Acquisitions were financed with the issuance of 259,871 Units (valued at $5.2 million) and the assumption of $8.8 million of mortgage debt. The balance of the purchase price was paid in cash.
On May 18, 1998, the Company sold a community in Brandon, Florida formerly known as Summit Providence for net proceeds of $23.9 million. A gain on the sale of $8.7 million was recognized. Proceeds from the sale were used to partially fund the acquisition of Summit Club at Dunwoody.
On October 23, 1998, the Company sold a community in Atlanta, Georgia formerly known as Summit Springs for $17.5 million. The Company recognized a gain of approximately $6.0 million on the sale.
On November 2, 1998, the Company sold a community in Winston Salem, North Carolina, formerly known as Summit Old Town, for $7.5 million. The Company recognized a gain of approximately $2.3 million from the sale.
On November 4, 1998, the Company acquired a portfolio of multifamily properties in Texas (the "Ewing Portfolio") through a merger with Ewing Industries, a private developer of luxury apartment homes. The Ewing Portfolio consists of 2,465 apartment homes in seven communities located in Dallas, Austin and San Antonio. The acquisition of the Ewing Portfolio was effected pursuant to an Agreement and Plan of Reorganization dated as of October 31, 1998 (the "Merger Agreement") among the Company, affiliates of the Company including the Operating Partnership, Ewing Industries, Inc., an Ohio corporation ("Ewing Industries"), affiliates of Ewing, and their respective partners, shareholders and members (together with Ewing Industries, "Ewing"). Pursuant to the Merger Agreement, the acquisition was funded through (i) the issuance to Ewing of 1,008,988 shares of Common Stock of the Company and 141,921 Units, valued at $20.7 million in the aggregate, (ii) the assumption of $84.0 million in long-term fixed-rate mortgage indebtedness, (iii) the payment of $50.6 million in cash and (iv) receipt of $3.8 million of credit for customary prorations and reserves. A portion of the consideration was deferred until stabilization of one community (Summit Las Palmas) which was in lease-up at the time of the acquisition of the Ewing Portfolio. The Summit Las Palmas purchase was closed on December 31, 1998 with the additional consideration of (i) 1,065,627 shares of Common Stock and 36,629 Units valued at $19.8 million in aggregate and (ii) cash in the amount of approximately $600,000.
On December 16, 1998, the Company (i) sold five communities (the "Sold Communities") to Hollow Creek, LLC., a newly-formed North Carolina limited liability company for approximately $68 million and (ii) contributed two communities with an approximate value of $22 million (together with the Sold Communities, the "Joint Venture Communities") to Station Hill, LLC., a newly-formed North Carolina limited liability company (the "LLC"). On the same date, Hollow Creek, LLC contributed the Sold Communities to the LLC. The LLC is a joint venture limited liability company, the membership of which is comprised of the Company and a wholly owned subsidiary of a major financial services company (the "Joint Venture Member"). The disposition was effected pursuant to a Real Estate Sale Agreement dated November 20, 1998 between the Operating Partnership and the Joint Venture Member and pursuant to the Operating Agreement of the LLC, also dated November 20, 1998. The Company's net contribution to the LLC (approximately $5.6 million) represents a 25 percent
8. ACQUISITIONS AND DISPOSITIONS -- (Continued)
equity interest in the LLC. In addition, the Company is the managing member of the LLC and will also retain management of the Joint Venture Communities through a management agreement with the LLC. The cash flow of the LLC will be distributed pro rata to each member based on its equity contribution until certain economic benchmarks are achieved, at which point the Company will receive an escalated portion of the cash flow and residual interest. The LLC has obtained five separate mortgages totaling $70,150,000 from Fannie Mae. These mortgages have a ten-year maturity and a 6.70% interest rate. The proceeds of the mortgages were distributed on a pro rata basis to the LLC's two members. The Joint Venture Communities involved in the transaction were Summit Green, Summit Hollow I and II and Summit Creek in Charlotte, North Carolina; Summit Hill I and II in Raleigh, North Carolina and Summit Station in Tampa, Florida. The Joint Venture Communities include 1,433 apartment homes. The Company recognized a gain of approximately $20.2 million on the disposition. The gain is net of $5.6 million elimination of gain relative to the Company's retained portion of the joint venture. The elimination of the gain reduced the Company's investment in the joint venture to zero at the initial joint venture formation.
Proceeds from the sale of Summit Springs, Summit Old Town and the Sold Communities were put in escrow with a qualified intermediary in accordance with like-kind exchange income tax rules and regulations. These proceeds will be used to fund future developments.
The following summary of selected unaudited pro forma results of operations presents information as if the Atlanta Acquisitions and the Ewing Portfolio purchase (except Summit Las Palmas) had occurred as of January 1, 1998 for the 1998 pro forma information. Pro forma information for 1998 excludes Las Palmas as it was in construction and lease-up and had insignificant operations. Pro forma information for the year ended December 31, 1997 presents information as if the Summit Lenox and the Ewing Portfolio acquisitions (except for Summit Las Palmas) had occurred as of January 1, 1997. Pro forma information for 1997 has not been presented for Summit St. Clair, Summit Club at Dunwoody and Summit Las Palmas as they were under construction during the period and had insignificant operations. The pro forma information for the year ended December 31, 1998 and 1997 is provided for informational purposes only and is not indicative of results that would have occurred or which may occur in the future (dollars in thousands except per share amounts):
9. NOTES RECEIVABLE FROM EMPLOYEES
On September 8, 1997, the Board of Directors approved a Statement of Company Policy, which has subsequently been amended and restated by the Board, on loans to executive officers and certain key employees relating to purchases of Common Stock (the "Loan Program"). Pursuant to the Loan Program, the Company may lend amounts to certain of the Company's executive officers and certain of its key employees for one or more of the following purposes: (i) to finance the purchase of Common Stock of the Company (a) by certain executive officers on the open market at the then-current market prices and (b) by other eligible employees through the Company's 1996 Non-Qualified Employee Stock Purchase Plan; (ii) to finance an executive officer's or key employee's payment of the exercise price of one or more stock options to purchase shares of Common Stock granted to such employees under the Company's 1994 Stock Option Plan; or (iii) to finance the annual tax liability of certain executive officers related to the vesting of shares of Common Stock which constitute a portion of a restricted stock award granted to such employees under the 1994 Stock Option Plan. The maximum aggregate amount the Company may loan to an executive officer is $500,000, unless otherwise determined on a case-by-case basis by the Board of Directors or the Compensation Committee thereof, and the maximum aggregate amount the Company may loan to a qualified employee other than executive officers is $100,000. Shares of Common Stock which are the subject of a loan serve as collateral for the notes until the notes have been paid in full. Each note bears interest at the applicable federal rate, as established by the Internal Revenue Service, in effect on the date of the note. The notes are payable through the application to the outstanding loan balance of all dividends and distributions related to the collateral stock, first to interest, with
9. NOTES RECEIVABLE FROM EMPLOYEES -- (Continued)
the remainder, if any, to outstanding principal. Each note becomes due and payable in full on the tenth anniversary of the respective note. As of December 31, 1998, the Company had issued loans in the net amount of $2,476,000.
10. COMMITMENTS
The estimated cost to complete nine development projects currently under construction was approximately $82.3 million at December 31, 1998. Anticipated construction completion dates of the projects range from the first quarter of 1999 to the second quarter of 2000.
The Company rents office space in several locations. Rental expense for the years ended December 31, 1998, 1997 and 1996 amounted to $121,000, $101,000 and $109,000, respectively ($406,000 in 1998, $347,000 in 1997 and $376,000 in 1996 including amounts recorded at the Management Company). Future minimum rental payments for the next five years for those operating leases (including the Management Company) that have initial or remaining non-cancelable lease terms in excess of one year are as follows (in thousands):
The Company has employment agreements with all four executive officers. One of the agreements with the executive officers originally provided for a term through February 15, 1999 unless otherwise extended and permitted termination by the executive officer after giving 180 days prior written notice, without breaching such agreements. This agreement has been replaced with an employment agreement providing for termination without cause by either the executive officer or the Company upon 90 days notice. Two of the employment agreements with the executive officers originally provided for terms through February 16, 1996 and December 5, 1998, with automatic extension thereof until such time as terminated pursuant to the terms of such employment agreement. Both of these agreements remain in effect. The remaining employment agreement with the executive officers provides for a term through July 1, 2001, with automatic one year extensions thereof, until terminated pursuant to the terms of such employment agreement.
All four of the executive officers have non-competition agreements with the Company. One of these agreements originally prohibited the executive officer without the prior written consent of the Board of Directors, from competing with the Company for a period of the latter of (1) one year from the termination of their employment with the Company, or (2) any period during which such individuals receive severance payments. That non-competition agreement has been replaced with an agreement which provides that the non-competition provision terminates one year from the date of the agreement. The non-competition agreements for all the executives include (i) provisions prohibiting the hiring or attempted hiring of employees of the Company for two years after termination of employment and (ii) provisions prohibiting the appropriation or attempted appropriation of projects and trade secrets of the Company for one year after termination of employment.
The Company is obligated to redeem each Unit of interest in the Operating Partnership at the request of the holder thereof for cash equal to the fair market value of one share of Common Stock, except that the Company may elect to acquire each Unit presented for redemption for one share of Common Stock. The Company presently anticipates that it will elect to issue Common Stock in connection with such redemption, rather than pay cash.
11. EMPLOYEE BENEFIT PLANS
PROFIT SHARING PLAN
The Company has a defined contribution plan pursuant to Section 401(k) of the Internal Revenue Code which covers all employees with one year or greater service. The Company's contributions are equal to one-half of each employee's contribution up to a maximum of 3% of each employee's compensation. Aggregate contributions of approximately $242,000, $217,000 and $223,000 were made for the years ended December 31, 1998, 1997 and 1996, respectively.
11. EMPLOYEE BENEFIT PLANS -- (Continued)
STOCK OPTION PLAN
In 1994, the Company established the 1994 Stock Option and Incentive Plan under which 1,000,000 shares of the Company's Common Stock were reserved for issuance. The plan provides that the option price shall not be less than the fair market value of the shares at the date of grant. The options vest in three or five annual installments on the anniversaries of the date of grant except for shares granted to independent directors of the Company, which vest on the date of grant.
A summary of changes in common stock options for the three years ended December 31, 1998 is as follows:
Exercise prices for options outstanding as of December 31, 1998 ranged from $17.13 to $20.75. The weighted average remaining contractual life of those options is 6.9 years.
As of December 31, 1998, 1997 and 1996 options to purchase 369,528, 359,218 and 283,228 shares, respectively, of Common Stock were exercisable. The weighted average exercise price for the shares exercisable as of December 31, 1998, 1997 and 1996 was $18.84, $18.86 and $18.36, respectively.
The estimated weighted average fair value of options granted were $2.18 per share in 1998 and $2.10 per share in 1996 (none granted in 1997). The Company applies Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its stock options. Accordingly, no compensation cost has been recognized for its stock options. Had compensation cost for the Company's stock options been determined based on the fair value at the grant dates, consistent with the method of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation", the Company's net income and net income per share for the years ended December 31, 1998 and 1996 would have changed to the pro forma amounts indicated below (dollars in thousands except per share amounts):
The fair value of options granted during 1998 were estimated on the date of grant using the Binomial option-pricing model with the following weighted average assumptions: dividend yield of 9.3%, expected volatility of 20%, risk free interest rate of 6.0%, and expected lives of ten years.
The fair value of options granted in 1996 were estimated on the date of grant using the Binomial option-pricing model with the following weighted-average assumptions: dividend yields ranging from 7.80% to 8.82%, expected volatility of 16%, risk free interest rate of 6.52%, and expected lives of ten years.
In addition, the plan provides for the issuance of stock grants to employees. The Company granted 8,372 shares of restricted stock under the plan in 1998. The market value of the restricted stock totaled $162,000, which was recorded as unamortized restricted stock compensation and is shown as a separate component of stockholders' equity. Unearned compensation is being amortized to expense over the five year vesting period. Restricted stock of 26,528 shares with a market
11. EMPLOYEE BENEFIT PLANS -- (Continued)
value of $546,000 were granted in the year ended December 31, 1997. Restricted stock of 56,046 shares with a market value of $1.0 million were granted in the year ended December 31, 1996. The Company recognized $314,000, $292,000 and $223,000 of expense in the statement of earnings in the years ended December 31, 1998, 1997 and 1996, respectively, relative to the stock grants.
PERFORMANCE STOCK AWARD PLAN
In January, 1998 the Company agreed to award key employees of the Company certain amounts of Common Stock under the Company's Performance Stock Award Plan. The amount of Common Stock to be granted to the key employees is based upon the Company's average annual return (share appreciation and distributions) from the date of the award to the third anniversary of the award. The number of shares to be granted under the performance Stock Award Plan ranges from none (in the event the Company achieves less than a 11% average annual return) to 147,713 (in the event the Company achieves a 15% or greater annual return). The starting Common Stock price for the purposes of calculating appreciation was $21.375 (fair market value at date of award). The Company's stock price at the end of the year is below the starting price for calculating the number of grants, accordingly, no compensation cost was recognized in 1998.
EMPLOYEE STOCK PURCHASE PLAN
In 1996, the Company established a non-qualified employee stock purchase plan. The plan allows Company employees to purchase up to $100,000 (with certain executive officers limited to $25,000) per year of the Company's Common Stock. The price of the shares of the Common Stock purchased will be the lesser of 85 percent of the closing price of such shares either on (a) the first day of each six month purchase period, or (b) the last day of each six month purchase period. Total shares issued under the plan in 1998, 1997 and 1996 were 65,541, 62,117 and 44,362 with a market value of $1.3 million, $1.3 million and $871,000, respectively. An additional 65,730 shares with a market value of $1.1 million were issued in January, 1999 under the plan. The Company recognized $203,000, $265,000 and $151,000 of expense in the statement of earnings in the years ended December 31, 1998, 1997 and 1996, respectively, relative to the employee stock purchase plan.
12. DIVIDEND REINVESTMENT AND DIRECT STOCK PURCHASE PLAN
In November 1997, the Company replaced its existing dividend reinvestment plan with a new dividend reinvestment and direct stock purchase plan ("the Plan"). The Plan provides both new investors and existing shareholders of the Company's stock (including Common Stock and other classes of outstanding stock) with a method to purchase shares of Common Stock under the Stock Purchase Program of the Plan. The Plan also permits shareholders to designate all, a portion or none of the cash dividends on their newly purchased Common Stock and cash dividends on their existing stock for reinvestment in more shares of Common Stock through the Dividend Reinvestment Program of the Plan. With respect to reinvested dividends and optional cash payments, shares of Common Stock will be purchased for the Plan at a discount ranging from 0% to 5% (established by the Company from time to time) from the market price, as more fully described in the Prospectus relating to the Plan. Common Stock will be purchased by the Plan's Agent (First Union National Bank) directly from the Company or in open market or privately negotiated transactions, as determined from time to time by the Company, to fulfill requirements for the Plan. At present, the Company expects that shares usually will be purchased directly from the Company. On December 31, 1998 and 1997, the Company received $9.5 million and $6.5 million under the plan for shares to be issued January 2, 1999 and 1998, respectively. These proceeds are included in accounts payable and accrued expenses at December 31, 1998 and 1997, respectively.
13. SHAREHOLDER RIGHTS AGREEMENT
On December 14, 1998, the Board of Directors adopted a shareholder rights agreement (the "Rights Plan"). In connection with the adoption of the Rights Plan, the Board of Directors declared a dividend distribution of one preferred stock purchase right (a "Right") for each outstanding share of common stock to stockholders of record as of the close of business on December 15, 1998. Currently, these Rights are not exercisable and trade with the shares of the Company's Common Stock. Under the Rights Plan, the Rights generally become exercisable if a person becomes an "acquiring person" by acquiring 15% or more of the Company's Common Stock, or if a person commences a tender offer that would result in that person owning 15% or more of the Company's Common Stock. In the event that a person becomes an "acquiring person,"each holder of a Right (other than the acquiring person) would be entitled to acquire such number of units of preferred stock (which are equivalent to shares of the Company's Common Stock) having a value of twice the exercise price of the Right.
13. SHAREHOLDER RIGHTS AGREEMENT -- (Continued)
If the Company is acquired in a merger or other business combination transaction after any such event, each holder of a Right would then be entitled to purchase, at the then-current exercise price, shares of the acquiring company's common stock having a value of twice the exercise price of the Right. The current exercise price per Right is $45.00.
The Rights will expire at the close of business on December 14, 2008 (the "Expiration Date"), unless previously redeemed or exchanged by the Company as described below. The Rights may be redeemed in whole, but not in part, at a price of $0.01 per Right (payable in cash, shares of the Company's Common Stock or other consideration deemed appropriate by the Board of Directors) by the Board of Directors only until the earlier of (i) the time at which any person becomes an "acquiring person" or (ii) the Expiration Date. At any time after any person becomes an "acquiring person," the Board of Directors may, at its option, exchange all or any part of the then outstanding and exercisable Rights for shares of the Company's Common Stock at an exchange ratio specified in the Rights Plan. Notwithstanding the foregoing, the Board of Directors generally will not be empowered to effect such exchange at any time after any person becomes the beneficial owner of 50% or more of the Company's Common Stock.
Until a Right is exercised, the holder will have no rights as a stockholder of the Company (beyond those as an existing stockholder), including the right to vote or to receive dividends.
In connection with the establishment of the Rights Plan, the Board of Directors approved the creation of Preferred Stock of the Company designated as Series A Junior Participating Cumulative Preferred Stock with a par value of $0.01 per share. The Board also reserved 350,000 shares of preferred stock for issuance upon exercise of the Rights.
14. BUSINESS SEGMENTS
Effective December 31, 1998, the Company adopted Financial Accounting Standards Board (FASB) Statement No. 131, Disclosures about Segments of an Enterprise and Related Information (FAS 131). FAS 131 established standards for the way public enterprises report information about operating segments in annual financial statements. FAS 131 also established standards for related disclosures about products and services, geographic areas and major customers. The adoption of FAS 131 did not affect the Company's results of operations or financial position.
The Company develops and operates luxury garden apartments. The Company only develops apartments for its own use with no development work done for outside third parties. In addition, all the apartments the Company operates are considered "Class A" apartments. Accordingly, there are no product or industry segments within the Company. The Company uses Funds from Operations ("FFO") as a performance measure. The Company computes FFO in accordance with the definition approved by the National Association of Real Estate Investments Trusts. Information for the apartment communities is summarized below:
(1) Capital investment includes costs during the year of the Company's developments and acquisitions as well as capital expenditures on existing properties.
15. SUPPLEMENTAL CASH FLOW INFORMATION Non-cash investing and financing activities for the years ended December 31, 1998, 1997 and 1996 are as follows:
A. The Company purchased the Atlanta Acquisitions and the Ewing Portfolio by issuing 438,421 Units, issuing 2,074,615 shares of Common Stock, assuming mortgage notes, assuming certain liabilities and the payment of cash. The recording of the purchases is summarized as follows (in thousands):
B. The Company disposed of eight communities during 1998 for net proceeds of approximately $130.6 million. $116.5 million of the sales proceeds were deposited with a qualified intermediary in accordance with like-kind exchange income tax rules and regulations. Of the proceeds, $17.6 million was used to fund the acquisition of an apartment community, while an additional $12.6 million was used to purchase land and fund certain development projects. The remaining $86.3 million held by the qualified intermediary is shown in the balance sheet caption "Restricted Cash" and will be used to fund the acquisition of other like-kind property.
C. In the year ended December 31, 1997, the Company purchased five communities (Summit Mayfaire, Summit Portofino, Summit Sand Lake, Summit Windsor II and Summit Fair Oaks). The Company completed the purchase of the five communities by assuming debt, issuing 194,495 Operating Partnership Units, issuing 243,608 shares of Common Stock, assuming certain liabilities and current assets, and the payment of cash. The recording of the purchases is summarized as follows (in thousands):
D. On April 1, 1996, the Company acquired its joint venture partner's interest in the Summit Plantation (formerly Plantation Cove) apartment community. The Company paid $6.4 million in cash for the remaining 75% interest in this joint venture, which is now owned entirely by the Company. The recording of the purchase is summarized as follows (in thousands):
E. The Company issued 8,372, 26,528 and 52,086 (net of 3,960 shares retired) of restricted stock grants in 1998, 1997 and 1996 valued at $162,000, $546,000 and $1.0 million, respectively.
F. The Company accrued a dividend and distribution payable of $12.7 million, $11.0 million and $10.2 million at December 31, 1998, 1997 and 1996, respectively.
G. The Company issued 106,330 Units of the Operating Partnership, valued at $2.1 million at issuance, for the purchase of land in 1996.
16. FAIR VALUE DISCLOSURE AND MARKET RISK OF FINANCIAL INSTRUMENTS The following disclosures of estimated fair value were determined by management using available market information and appropriate valuation methodologies. However, considerable judgment is necessary to interpret market data and develop the related estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that could be realized upon disposition of the financial instruments. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.
Cash and cash equivalents, rents receivable, accounts payable, accrued expenses, security deposits, other liabilities, tax-exempt bond indebtedness and the credit facility are carried at amounts which reasonably approximate their fair values at December 31, 1998 and 1997.
Fixed rate mortgage debt and fixed rate unsecured notes with a carrying value of $520.9 million have an estimated aggregate fair value of approximately $521.0 million at December 31, 1998. Fixed rate mortgage debt and unsecured notes with a carrying value of $400 million have an estimated aggregate fair value of approximately $399.4 at December 31, 1997. Rates currently available to the Company for debt with similar terms and maturities were used to estimate the fair value of this debt.
The fair value estimates presented herein are based on information available to management as of December 31, 1998 and 1997. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively re-valued for purposes of these financial statements since that date, and current estimates of fair value may differ significantly from the amounts presented herein.
The fair market value of long-term fixed rate debt is subject to changes in interest rates. Generally, the fair market value of fixed interest rate debt will increase as interest rates fall and decrease as interest rates rise. The estimated fair value of the Company's total fixed rate long-term debt at December 31, 1998 was $521.0 million. A 1% increase from prevailing interest rates at December 31, 1998 would result in a decrease in fair value of long-term debt by approximately $25.7 million. Fair values were determined from quoted market prices, where available, and from information received from investment advisors using current interest rates considering credit ratings and remaining terms to maturity.
17. GEOGRAPHIC CONCENTRATION
The Company's completed communities are concentrated in four major regions as follows:
The above table does not include Summit Las Palmas (448 apartment homes), which was acquired on December 31, 1998 and therefore had no rental operations. In addition, the properties in Texas were acquired in the fourth quarter of 1998.
18. REAL ESTATE AND ACCUMULATED DEPRECIATION Real estate and accumulated depreciation by apartment community consisted of the following at December 31, 1998 (dollars in thousands):
18. REAL ESTATE AND ACCUMULATED DEPRECIATION -- (Continued)
- --------- (1) The aggregate cost for federal income tax purposes at December 31, 1998 is $ 944.9 million.
(2) Encumbered by fixed rate mortgages of $146.7 million.
(3) Encumbered by fixed rate mortgage of $8.5 million.
(4) Collateral for $52.9 million of letters of credit which serve as collateral for $51.8 million in tax exempt bonds.
(5) Property purchased by Company. Date reflects date construction completed.
(6) Includes furniture, fixtures and equipment.
A summary of activity for real estate assets and accumulated depreciation is as follows:
(1) Includes only apartment communities and does not include fixed assets used in property development, construction and management of apartment communities.
19. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Quarterly financial information for the years 1998 and 1997 are as follows (in thousands except per share data):