UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
OR
Commission file number 1-10524
United Dominion Realty Trust, Inc.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation of organization)
(I.R.S. Employer
Identification No.)
1745 Shea Center Drive, Suite 200, Highlands Ranch, Colorado 80129
(Address of principal executive offices - zip code)
(720) 283-6120
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
The number of shares of the issuer’s common stock, $1 par value, outstanding as of August 8, 2003 was 116,041,213.
UNITED DOMINION REALTY TRUST, INC.
INDEX
Item 1.
Item 2.
Item 3.
Item 4.
Item 6.
Signatures
2
CONSOLIDATED BALANCE SHEETS
(In thousands, except for share data)
(Unaudited)
ASSETS
Real estate owned:
Real estate held for investment (Note 2)
Less: accumulated depreciation
Real estate under development
Real estate held for disposition (net of accumulated depreciation of $13,022 and $5,857) (Note 3)
Total real estate owned, net of accumulated depreciation
Cash and cash equivalents
Restricted cash
Deferred financing costs, net
Investment in unconsolidated development joint venture (Note 4)
Other assets
Real estate held for disposition assets
Total assets
LIABILITIES AND SHAREHOLDERS’ EQUITY
Secured debt (Note 5)
Unsecured debt (Note 6)
Real estate taxes payable
Accrued interest payable
Security deposits and prepaid rent
Distributions payable
Accounts payable, accrued expenses, and other liabilities
Real estate held for disposition liabilities
Total liabilities
Minority interests
Shareholders’ equity:
Preferred stock, no par value; $25 liquidation preference, 25,000,000 shares authorized;
5,416,009 shares 8.60% Series B Cumulative Redeemable issued and outstanding (5,416,009 in 2002)
6,000,000 shares 7.50% Series D Cumulative Convertible Redeemable issued and outstanding (8,000,000 in 2002)
3,425,217 shares 8.00% Series E Cumulative Convertible issued and outstanding (0 in 2002)
Common stock, $1 par value; 250,000,000 shares authorized 115,885,074 shares issued and outstanding (106,605,259 in 2002)
Additional paid-in capital
Distributions in excess of net income
Deferred compensation—unearned restricted stock awards
Notes receivable from officer-shareholders
Accumulated other comprehensive loss, net (Note 10)
Total shareholders’ equity
Total liabilities and shareholders’ equity
See accompanying notes to consolidated financial statements.
3
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
REVENUES
Rental income
Non-property income
Total revenues
EXPENSES
Rental expenses:
Real estate taxes and insurance
Personnel
Utilities
Repair and maintenance
Administrative and marketing
Property management
Other operating expenses
Real estate depreciation
Interest
Loss/(gain) on early debt retirement
General and administrative
Other depreciation and amortization
Total expenses
Income before minority interests and discontinued operations
Minority interests of outside partnerships
Minority interests of unitholders in operating partnerships
Income before discontinued operations
Income from discontinued operations, net of minority interests (Note 3)
Net income
Distributions to preferred shareholders—Series B
Distributions to preferred shareholders—Series D (Convertible)
Distributions to preferred shareholders—Series E (Convertible)
Premium on preferred share repurchases
Net income available to common shareholders
Earnings per common share—basic and diluted:
Income/(loss) before discontinued operations, net of minority interests
Income from discontinued operations, net of minority interests
Common distributions declared per share
Weighted average number of common shares outstanding—basic
Weighted average number of common shares outstanding—diluted
4
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Operating Activities
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
Gains on sales of land and depreciable property
Premium on preferred stock conversion
(Gain) / loss on early debt retirement
Amortization of deferred financing costs and other
Changes in operating assets and liabilities:
Decrease in operating liabilities
(Increase) / decrease in operating assets
Net cash provided by operating activities
Investing Activities
Proceeds from sales of real estate investments, net
Acquisition of real estate assets, net of liabilities assumed and equity
Development of real estate assets
Capital expenditures and other major improvements—real estate assets, net of escrow reimbursement
Capital expenditures—non-real estate assets
Net cash used in investing activities
Financing Activities
Proceeds from the issuance of secured debt
Scheduled principal payments on secured debt
Non-scheduled principal payments and prepayment penalties on secured debt
Proceeds from the issuance of unsecured debt
Payments and prepayment penalties on unsecured debt
Net proceeds / (repayment) of revolving bank debt
Payment of financing costs
Proceeds from the issuance of common stock
Distributions paid to minority interests
Distributions paid to preferred shareholders
Distributions paid to common shareholders
Repurchase of common stock
Net cash provided by financing activities
Net (decrease)/increase in cash and cash equivalents
Cash and cash equivalents, beginning of period
Cash and cash equivalents, end of period
Supplemental Information:
Interest paid during the period
Issuance of restricted stock awards
Non-cash transactions:
Secured debt assumed with the acquisition of properties
Issuance of preferred stock in connection with acquisitions
Issuance of preferred operating partnership units in connection with acquisitions
Reduction in secured debt from the disposition of properties
Conversion of operating partnership minority interests to common stock (38,423 shares in 2003 and 80,104 shares in 2002)
5
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
(In thousands, excepts share data)
AdditionalPaid-in
Capital
Deferred
Compensation—Unearned Restricted
Stock Awards
Notes Receivablefrom Officer—
Shareholders
AccumulatedOther
ComprehensiveLoss
Balance, December 31, 2002
Comprehensive Income
Other comprehensive income:
Unrealized gain on derivative instruments (Note 7)
Comprehensive income
Issuance of common shares to employees, officers and director-shareholders
Issuance of common shares through dividend reinvestment and stock purchase plan
Issuance of common shares through public offering
Issuance of 8.00% Series E Cumulative Convertible shares
Purchase of common stock
Adjustment for conversion of minority interests of unitholders in operating partnerships
Principal repayments on notes receivable from officer-shareholders
Conversion of 7.50% Series D Cumulative Convertible Redeemable shares
Common stock distributions declared ($0.5700 per share)
Preferred stock distributions declared-Series B ($1.075 per share)
Preferred stock distributions declared-Series D ($1.018 per share)
Preferred stock distributions declared-Series E ($0.3322 per share)
Amortization of deferred compensation
Balance, June 30, 2003
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2003
(UNAUDITED)
1. CONSOLIDATION AND BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of United Dominion Realty Trust, Inc. and its subsidiaries, including United Dominion Realty, L.P. (the “Operating Partnership”), and Heritage Communities L.P. (the “Heritage OP”), (collectively, “United Dominion”). As of June 30, 2003, there were 108,996,263 units in the Operating Partnership outstanding, of which 99,189,107 units, or 91.0%, were owned by United Dominion and 9,807,156 units, or 9.0%, were owned by non-affiliated limited partners. As of June 30, 2003, there were 3,492,889 units in the Heritage OP outstanding, of which 3,116,665 units, or 89.2 %, were owned by United Dominion and 376,224 units, or 10.8%, were owned by non-affiliated limited partners. The consolidated financial statements of United Dominion include the minority interests of the unitholders in the operating partnerships.
The accompanying interim unaudited consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted according to such rules and regulations, although management believes that the disclosures are adequate to make the information presented not misleading. The accompanying consolidated financial statements should be read in conjunction with the audited financial statements and related notes appearing in United Dominion’s Annual Report on Form 10-K for the year ended December 31, 2002, filed with the Securities and Exchange Commission as amended on Form 8-K filed May 14, 2003.
In the opinion of management, the consolidated financial statements reflect all adjustments which are necessary for the fair presentation of financial position at June 30, 2003 and results of operations for the interim periods ended June 30, 2003 and 2002. Such adjustments are normal and recurring in nature. All significant inter-company accounts and transactions have been eliminated in consolidation. The interim results presented are not necessarily indicative of results that can be expected for a full year.
The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the dates of the financial statements and the amounts of revenues and expenses during the reporting periods. Actual amounts realized or paid could differ from those estimates. Certain previously reported amounts have been reclassified to conform to the current financial statement presentation.
2. REAL ESTATE HELD FOR INVESTMENT
At June 30, 2003, there are 257 communities with 73,791 apartment homes classified as real estate held for investment. The following table summarizes the components of real estate held for investment at June 30,(dollars in thousands):
June 30,
2003
Land and land improvements
Buildings and improvements
Furniture, fixtures, and equipment
Real estate held for investment
Accumulated depreciation
Real estate held for investment, net
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3. INCOME FROM DISCONTINUED OPERATIONS
During 2002, United Dominion sold 25 communities with a total of 6,990 apartment homes, one parcel of land, and one commercial property with 143,000 square feet. For the six months ended June 30, 2003, United Dominion sold one community with a total of 220 apartment homes and one commercial property with 104,000 square feet. At June 30, 2003, United Dominion had seven communities with 2,063 apartment homes and a net book value of $75.7 million and two parcels of land with a net book value of $5.6 million included in real estate held for disposition. The results of operations for these properties and the interest expense associated with the secured debt on these properties are classified on the Consolidated Statements of Operations in the line item entitled “Income from discontinued operations, net of minority interests.”
The following is a summary of income from discontinued operations for the three and six months ended June 30, 2003 and 2002 (dollars in thousands):
Three Months Ended
Six Months Ended
Rental expenses
Loss on early debt retirement
Impairment loss on real estate and investments
Other expenses
Income before (loss)/gains on sales of investments, and minority interests
(Loss)/gains on sales of depreciable property
Income before minority interests
Minority interests on income from discontinued operations
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4. INVESTMENT IN UNCONSOLIDATED DEVELOPMENT JOINT VENTURE
On September 10, 2002, United Dominion signed a development joint venture agreement with AEGON USA Realty Advisors, Inc. in which United Dominion is serving as the managing member. The venture is expected to develop approximately eight to ten garden style apartment communities over the next three years, with a total development cost of up to $210 million. The venture will obtain bank construction financing for 65% to 80% of total costs and will provide equity contributions for the balance of the costs with AEGON providing 80% and United Dominion providing 20%. United Dominion is serving as the developer, general contractor and property manager for the venture and has guaranteed those project development costs, excluding financing costs (including fees and interest), which exceed the defined project cost budgeted amounts. In June 2003, United Dominion contributed land with a carrying value of $3.8 million to the joint venture.
The following is a summary of the financial position of the joint venture as of June 30, 2003 (dollars in thousands):
Assets
Deferred financing costs
Liabilities and Partners’ Capital
Accounts payable and other accrued liabilities
Partners’ capital
Total liabilities and partners’ capital
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5. SECURED DEBT
Secured debt on continuing and discontinued operations, which encumbers $1.6 billion or 37.7% of United Dominion’s real estate owned ($2.6 billion or 62.3% of United Dominion’s real estate owned is unencumbered) consists of the following at June 30, 2003 (dollars in thousands):
December 31,
2002
Fixed Rate Debt
Mortgage notes payable (a)
Tax-exempt secured notes payable
Fannie Mae credit facilities
Fannie Mae credit facilities—swapped
Total fixed rate secured debt
Variable Rate Debt
Mortgage notes payable
Freddie Mac credit facility
Total variable rate secured debt
Total Secured Debt
Approximate principal payments due during each of the next five calendar years and thereafter, as of June 30, 2003, are as follows (dollars in thousands):
Year
2004
2005
2006
2007
Thereafter
For the six months ended June 30, 2002, United Dominion recognized $16.8 million ($0.16 per diluted share) of expense as a result of prepayment penalties incurred from the refinancing of certain secured loans, using proceeds from the Fannie Mae and Freddie Mac credit facilities, and the early payoff of loans on the sale of properties.
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6. UNSECURED DEBT
A summary of unsecured debt at June 30, 2003 and December 31, 2002 is as follows (dollars in thousands):
Commercial Banks
Borrowings outstanding under an unsecured credit facility due March 2007 (a)
Borrowings outstanding under an unsecured credit facility due August 2003(a)
Borrowings outstanding under an unsecured term loan due May 2004–2005 (a)
Senior Unsecured Notes—Other
7.65% Medium-Term Notes due January 2003
7.22% Medium-Term Notes due February 2003
8.63% Notes due March 2003
7.98% Notes due March 2002–2003
5.05% City of Portland, OR Bonds due October 2003
7.67% Medium-Term Notes due January 2004
7.73% Medium-Term Notes due April 2005
7.02% Medium-Term Notes due November 2005
7.95% Medium-Term Notes due July 2006
7.07% Medium-Term Notes due November 2006
7.25% Notes due January 2007
4.50% Medium-Term Notes due March 2008 (b)
ABAG Tax-Exempt Bonds due August 2008
8.50% Monthly Income Notes due November 2008
6.50% Notes due June 2009
8.50% Debentures due September 2024 (c)
Other (d)
Total Unsecured Debt
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7. FINANCIAL INSTRUMENTS
United Dominion accounts for its derivative instruments in accordance with Statements of Financial Accounting Standards No. 133 and 138, “Accounting for Certain Derivative Instruments and Hedging Activities.” At June 30, 2003, all of United Dominion’s derivative financial instruments are interest rate swap agreements that are designated as cash flow hedges of debt with variable interest rate features, and are qualifying hedges for financial reporting purposes. For derivative instruments that qualify as cash flow hedges, the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings during the same period or periods during which the hedged transaction affects earnings. The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of future cash flows of the hedged item, if any, is recognized in current earnings during the period of change.
The fair value of United Dominion’s derivative instruments is reported on the balance sheet at their current fair value. Estimated fair values for interest rate swaps rely on prevailing market interest rates. These fair value amounts should not be viewed in isolation, but rather in relation to the values of the underlying hedged transactions and investments and to the overall reduction in exposure to adverse fluctuations in interest rates. Each interest rate swap agreement is designated with all or a portion of the principal balance and term of a specific debt obligation. The interest rate swaps involve the periodic exchange of payments over the life of the related agreements. Amounts received or paid on the interest rate swaps are recorded on an accrual basis as an adjustment to the related interest expense of the outstanding debt based on the accrual method of accounting. The related amounts payable to and receivable from counterparties are included in other liabilities and other assets, respectively.
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The following table presents the fair values of United Dominion’s derivative financial instruments outstanding, based on external market quotations, as of June 30, 2003 (dollars in thousands):
Notional
Amount
$
10,000
7,000
17,000
Unsecured Debt:
Bank Credit Facility
25,000
23,500
23,000
5,000
151,500
168,500
During the quarter ended June 30, 2003, United Dominion recognized $2.3 million of unrealized gains in comprehensive income and $0.3 million of gain was recorded to net income for what would be the ineffective portion of our hedging instruments. In addition, United Dominion has recognized $4.3 million of derivative financial instrument liabilities on the Consolidated Balance Sheet.
As of June 30, 2003, United Dominion expects to reclassify $4.3 million of net losses on derivative instruments from accumulated other comprehensive loss to earnings (interest expense which, combined with the interest paid on the underlying debt, results in interest expense at the fixed rates shown above) during the next twelve months on the related hedged transactions.
8. EARNINGS PER SHARE
Basic earnings per common share is computed based upon the weighted average number of common shares outstanding during the period. Diluted earnings per common share is computed based upon common shares outstanding plus the effect of dilutive stock options and other potentially dilutive common stock equivalents. The dilutive effect of stock options and other potentially dilutive common stock equivalents is determined using the treasury stock method based on United Dominion’s average stock price.
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The following table sets forth the computation of basic and diluted earnings per share (dollars in thousands, except per share data):
Numerator for basic and diluted earnings per share—Net income available to common shareholders
Denominator:
Denominator for basic earnings per share—Weighted average common shares outstanding
Non-vested restricted stock awards
Effect of dilutive securities:
Employee stock options and non-vested restricted stock awards
Denominator for diluted earnings per share
Basic and diluted earnings per share
The effect of the conversion of the operating partnership units and convertible preferred stock is not dilutive and is therefore not included in the above calculations. If the operating partnership units were converted to common stock, the additional shares of common stock outstanding for the three and six months ended June 30, 2003 would be 7,286,193 and 7,124,753 and 7,003,884 and 7,029,393 for the three and six months ended June 30,2002. If the convertible preferred stock was converted to common stock, the additional shares of common stock outstanding for the three and six months ended June 30, 2003 would be 11,632,713 and 11,968,318 weighted average common shares and 12,307,692 weighted average common shares for the three and six months ended June 30, 2002.
9. STOCK-BASED COMPENSATION
United Dominion has elected to follow the intrinsic value method under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) in accounting for its employee stock options because the alternative fair value accounting provided for under Statement 123, “Accounting for Stock Based Compensation” (“SFAS 123”), requires the use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of United Dominion’s employee stock options equals the market price of the underlying stock on the date of grant, no compensation cost has been recognized.
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The following table sets forth United Dominion’s earnings and earnings per share had United Dominion’s stock-based compensation expense been determined based upon the fair value method at the date of grant, consistent with the provisions of SFAS 123 (in thousands, except per share data):
Reported net income available to common shareholders
Stock-based employee compensation cost included in net income
Stock-based employee compensation cost that would have been included in net income under the fair value method
Adjusted net income available to common shareholders
Earnings per common share—basic and diluted
As reported
Pro forma
10. COMPREHENSIVE INCOME
Total comprehensive income for the three and six months ended June 30, 2003 and 2002 was $17.8 million and $34.3 million for 2003 and $26.1 million and $27.6 million for 2002, respectively. The difference between net income and total comprehensive income is primarily due to the fair value accounting for interest rate swaps.
11. COMMITMENTS AND CONTINGENCIES
Commitments
United Dominion is committed to completing its real estate currently under development, which has an estimated cost to complete of $53.1 million at June 30, 2003.
Contingencies
Series A Out-Performance Program
In May 2001, the shareholders of United Dominion approved the Series A Out-Performance Program (the “Series A Program”) pursuant to which executives and other key officers of United Dominion (the “participants”) were given the opportunity to invest indirectly in United Dominion by purchasing interests in a limited liability company (the “Series A LLC”), the only assets of which are a special class of partnership units of the Operating Partnership (“Series A Out-Performance Partnership Shares” or “Series A OPPSs”), for an initial investment of $1.27 million (the full market value of the Series A OPPSs at inception, as determined by an independent investment banking firm). The Series A Program measured United Dominion’s performance over a 28-month period beginning February 2001 and ending on May 31, 2003.
The Series A Program was designed to provide participants with the possibility of substantial returns on their investment if United Dominion’s total return, as measured by the cumulative amount of dividends paid plus share price appreciation on its common stock during the measurement period, exceeded the greater of (a) industry average (defined as the total cumulative return of the Morgan Stanley REIT Index over the same period) or (b) a 30% total return (12% annualized).
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At the conclusion of the measurement period on May 31, 2003, United Dominion’s total return satisfied these criteria. As a result, the Series A LLC as holder of the Series A OPPSs will receive distributions and allocations of income and loss from the Operating Partnership equal to the distributions and allocations that would be received on 1,853,204 interests in the Operating Partnership (“OP Units”), which distributions and allocations will be distributed to the participants on a pro rata basis based on ownership of the Series A LLC.
Series B Out-Performance Program
In May 2003, the shareholders of United Dominion approved the Series B Out-Performance Program (the “Series B Program”) pursuant to which executives of United Dominion (the “participants”) were given the opportunity to invest indirectly in United Dominion by purchasing interests in a limited liability company (the “Series B LLC”), the only assets of which are a special class of partnership units of the Operating Partnership (“Series B Out-Performance Partnership Shares” or “Series B OPPSs”), for an initial investment of $1.0 million (the full market value of the Series B OPPSs at inception, as determined by an independent investment banking firm). The Series B Program will measure United Dominion’s performance over a 24-month period beginning June 2003.
The Series B Program is designed to provide participants with the possibility of substantial returns on their investment if United Dominion’s total return, as measured by the cumulative amount of dividends paid plus share price appreciation, on its common stock during the measurement period, exceeds the greater of (a) industry average (defined as the total cumulative return of the Morgan Stanley REIT Index over the same period) or (b) a 22% total return (11% annualized) (the “minimum return”).
At the conclusion of the measurement period, if United Dominion’s total return satisfies these criteria, the Series B LLC as holder of the Series B OPPSs will receive (for the indirect benefit of the participants as holders of interests in the Series B LLC) distributions and allocations of income and loss from the Operating Partnership equal to the distributions and allocations that would be received on the number of OP Units obtained by:
If, on the valuation date, the cumulative total return of United Dominion’s common stock does not meet the minimum return or the total return of the peer group and there is no excess return, then the participants will forfeit their entire initial investment of $1.0 million. It is this feature, combined with the fact that management paid market value for the indirect interest in the Series B OPPSs, that we believe makes this program better than previous programs, such as stock options, that were likewise designed to motivate and retain executives and key management, by ensuring that management’s goals are perpetually aligned with the shareholders.
12. RELATED PARTY TRANSACTIONS
As of June 30, 2003, United Dominion has $2.3 million of notes receivable from certain officers and directors of United Dominion (original principal balances of $2.7 million), at an interest rate of 7.0% that mature between December 2003 and October 2005. The purpose of the loans was for the borrowers to purchase shares of United Dominion’s common stock pursuant to United
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Dominion’s 1991 Stock Purchase and Loan Plan. The loans are evidenced by promissory notes between the borrowers and United Dominion and are secured by a pledge of the shares of common stock (218,000 shares with a market value of $3.8 million at June 30, 2003). The notes require that dividends received on the shares be applied towards payment of the notes.
In addition, United Dominion entered into a Servicing and Purchase Agreement (the “ Servicing Agreement”) with SunTrust Bank (the “Bank”) whereby United Dominion has agreed to act as servicing agent for and to purchase certain loans made by the Bank to officers and directors of United Dominion (the “Borrowers”) to finance the purchase of shares of United Dominion’s common stock. The loans are evidenced by promissory notes (“Notes”) between each Borrower and the Bank. The Servicing Agreement provides that the Bank can require United Dominion to purchase the Notes upon an event of default by the Borrower or United Dominion under the Servicing Agreement and at certain other times during the term of the Servicing Agreement. The aggregate outstanding principal balance of the Notes as of June 30, 2003 was $9.0 million (original principal balance was $10.3 million), and all of the Notes mature during 2004. Because certain of the Borrowers elected floating rate loans and others elected fixed rate loans, the interest rates on these loans as of June 30, 2003 ranged from 2.08% to 7.68%. Each Borrower entered into a Participation Agreement with United Dominion that requires that all cash dividends received on the shares (870,113 shares at June 30, 2003 with a closing market value of $15.0 million) be applied towards payment of the Notes. Based upon the fact that 100% of all cash dividend payments are paid to amortize the Notes and that the Notes are recourse to the Borrowers, United Dominion believes that its exposure to liability under the Notes is remote.
13. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In January 2003, the FASB issued Interpretation 46, “Consolidation of Variable Interest Entities.” This statement refines the identification process of variable interest entities and how an entity assesses its interests in a variable interest entity to decide whether to consolidate that entity. United Dominion, from time to time, enters into partnership and joint venture arrangements, which may be required to be consolidated under this statement. As of June 30, 2003, none of United Dominion’s joint venture investments require consolidation. The provisions of Interpretation 46 are applicable to joint ventures created before January 1, 2003 for the first reporting period which begins after June 15, 2003. United Dominion is currently assessing the impact that this interpretation will have on its consolidated financial position and results of operations.
In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148 “Accounting for Stock-Based Compensation, Transition and Disclosure” (“SFAS 148”). SFAS 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS 148 also requires that disclosures of the pro forma effect of using the fair value method of accounting for stock-based compensation be displayed more prominently and in a tabular format. Additionally, SFAS 148 requires disclosure of the pro forma effect in interim financial statements. The transition disclosure requirements of SFAS 148 are effective for the fiscal year 2003. The interim and annual disclosure requirements are effective for the third quarter of 2003. As of January 1, 2003, United Dominion elected to adopt the disclosure requirements of SFAS 148.
In November 2002, the FASB issued Interpretation 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” This statement requires that a liability for the fair value of a guarantee be recognized at the time the obligation is undertaken. The statement also requires that the liability be measured over the term of the related guarantee. This statement is effective for all guarantees entered into subsequent to December 31, 2002. For all guarantees entered into prior to December 31, 2002, there is to be no change in accounting; however, disclosure of management’s estimate of its future obligation under the guarantee is to be made. As of June 30, 2003, management estimates that its likelihood of funding its guarantor obligations is remote and that the impact to United Dominion would be immaterial.
In April 2002, the FASB issued Statement 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Correction” (“SFAS No. 145”). Statement 4, “Reporting Gains and Losses from Extinguishment of
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Debt” (“SFAS No. 4”), required that gains and losses from the extinguishment of debt that were included in the determination of net income be aggregated and, if material, classified as an extraordinary item. As of March 31, 2003, United Dominion has recorded current period items and reclassified prior period items that do not meet the extraordinary classification into continuing operations in accordance with the provisions of SFAS No. 145.
14. SUBSEQUENT EVENTS
On July 31, 2003, United Dominion completed the sale of $50 million of 4.50% senior unsecured notes due in March 2008 under its existing shelf registration. The net proceeds from the issuance of approximately $49.9 million are anticipated to be used to repay amounts outstanding on United Dominion’s $500 million unsecured revolving credit facility.
Forward-Looking Statements
This quarterly report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such forward-looking statements include, without limitation, statements concerning property acquisitions and dispositions, development activity and capital expenditures, capital raising activities, rent growth, occupancy, and rental expense growth. Words such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “seeks”, “estimates,” and variations of such words and similar expressions are intended to identify such forward-looking statements. Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance or achievements of United Dominion Realty Trust, Inc. to be materially different from the results of operations or plans expressed or implied by such forward-looking statements. Such factors include, among other things, unanticipated adverse business developments affecting United Dominion, or its properties, adverse changes in the real estate markets and general and local economies and business conditions. Although United Dominion believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore such statements included in this report may not prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by United Dominion or any other person that the results or conditions described in such statements or the objectives and plans of United Dominion will be achieved.
Business Overview
United Dominion is a real estate investment trust, or REIT, that owns, acquires, renovates, develops, and manages middle-market apartment communities nationwide. We were formed in 1972 as a Virginia corporation and our subsidiaries include two operating partnerships, United Dominion Realty, L.P. and Heritage Communities, L.P. In June 2003, United Dominion changed its state of incorporation from Virginia to Maryland. Unless the context otherwise requires, all references in this report to “we,” “us,” “our,” or “United Dominion” refer collectively to United Dominion Realty Trust, Inc. and its subsidiaries.
We believe that we must distinguish ourselves within the industry to maintain a leadership position over the long-term. We believe an increased focus on being an excellent operator of apartment homes, in markets where we have a significant share and long-term rent growth prospects are greatest, will be a compelling and successful business model to differentiate United Dominion in the eyes of residents, associates, and investors. With this strategy, we believe that we can become the best in the multifamily industry based upon the following key principles:
OPERATIONAL EXCELLENCE—Operational excellence is a way of conducting business with consistent, disciplined, and efficient systems and business processes throughout our organization, to provide residents, suppliers, and associates with predictable,
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positive experiences, regardless of location. Through operational excellence, we believe that we can enhance the performance of our existing portfolio and new properties we seek to acquire, deliver superior service to our residents, and provide greater returns to our investors.
MIDDLE-MARKET—United Dominion will focus efforts on owning and managing apartments that provide housing for residents who cannot typically afford an entry-level home, or residents who choose apartment living over other alternatives. We will primarily serve the price-sensitive, value-for-money customers, in the broad middle-market segments of the population.
PORTFOLIO MANAGEMENT—We intend to continue to own and operate middle-market apartment homes across a geographically diverse platform. We believe that enhancing our presence in 25 to 30 core markets will enable us to capitalize on operating efficiencies while maintaining sufficient geographic diversification. As local market cycles create opportunities, we intend to exit current markets where long-term growth is below the national average (the “non-core markets”), and redeploy capital within our core markets.
We believe that over the long-term, the fundamental principles of operational excellence, middle-market focus, and proactive portfolio management will better position United Dominion to serve its residents, increase profitability, provide rewarding careers to our associates, and capitalize on changes in the marketplace.
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At June 30, 2003, United Dominion’s portfolio included 264 communities with 75,854 apartment homes nationwide. The following table summarizes United Dominion’s market information by major geographic markets (includes real estate held for disposition, real estate under development, and land, but excludes commercial properties):
June 30, 2003
Southern California
Dallas, TX
Houston, TX
Phoenix, AZ
Orlando, FL
Raleigh, NC
Tampa, FL
Metropolitan DC
Arlington, TX
Columbus, OH
Monterey Peninsula, CA
San Francisco, CA
Charlotte, NC
Nashville, TN
Greensboro, NC
Richmond, VA
Wilmington, NC
Baltimore, MD
Atlanta, GA
Columbia, SC
Jacksonville, FL
Norfolk, VA
Lansing, MI
Seattle, WA
Other Western
Other Pacific
Other Southwestern
Other Florida
Other Midwestern
Other North Carolina
Other Southeastern
Other Mid-Atlantic
Other Northeastern
Real Estate Under Development
Land
Total
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Liquidity and Capital Resources
Liquidity is the ability to meet present and future financial obligations either through the sale or maturity of existing assets or by the acquisition of additional funds through capital management. Both the coordination of asset and liability maturities and effective capital management are important to the maintenance of liquidity. United Dominion’s primary source of liquidity is its cash flow from operations as determined by rental rates, occupancy levels, and operating expenses related to its portfolio of apartment homes. United Dominion routinely uses its unsecured bank credit facility to temporarily fund certain investing and financing activities prior to arranging for longer-term financing. During the past several years, proceeds from the sale of real estate have been used for both investing and financing activities.
United Dominion expects to meet its short-term liquidity requirements generally through its net cash provided by operations and borrowings under credit arrangements. We expect to meet certain long-term liquidity requirements such as scheduled debt maturities, the repayment of financing on development activities, and potential property acquisitions, through long-term secured and unsecured borrowings, the disposition of properties, and the issuance of additional debt or equity securities of United Dominion. We believe that our net cash provided by operations will continue to be adequate to meet both operating requirements and the payment of dividends by United Dominion in accordance with REIT requirements in both the short- and long-term. Likewise, the budgeted expenditures for improvements and renovations of certain properties are expected to be funded from property operations.
In January 2003, coinciding with our inclusion in the S&P MidCap 400 Index, United Dominion sold 2.0 million shares of common stock at a public offering price of $15.71 per share under its $1.0 billion shelf registration statement. We received net proceeds from this offering, after an underwriting discount, of $31.2 million, which were used to repay debt and for general corporate purposes. In February 2003, United Dominion sold $150 million aggregate principal amount of 4.50% medium-term notes due in March 2008 under a new $300 million medium-term note program. The net proceeds from this issuance of approximately $149.3 million were used to repay amounts outstanding on United Dominion’s unsecured revolving credit facility. In April 2003, United Dominion sold 3.0 million shares of common stock under its $1.0 billion shelf registration statement at a public offering price of $16.97 per share. We received net proceeds from this offering of $49.2 million that were used to acquire additional apartment communities. In May 2003, the underwriters exercised their right to purchase 100,000 shares of common stock through their over-allotment received with the April 2003 offering, and the net proceeds of $1.6 million were used for general corporate purposes. As of June 30, 2003, approximately $766 million of equity and debt securities remain available for use under the shelf registration. Access to capital markets is dependent on market conditions at the time of issuance.
Future Capital Needs
Future development expenditures are expected to be funded primarily through joint ventures, with proceeds from the sale of property, with construction loans and, to a lesser extent, with cash flows provided by operating activities. Acquisition activity in strategic markets is expected to be largely financed through the issuance of equity and debt securities, the issuance of operating partnership units, the assumption or placement of secured debt, and by the reinvestment of proceeds from the sale of property in non-strategic markets.
During the remainder of 2003, United Dominion has approximately $15.8 million of secured debt and $7.6 million of unsecured debt maturing that we anticipate repaying using proceeds from borrowings under our secured or unsecured credit facilities, or the issuance of new unsecured debt securities.
Critical Accounting Policies and Estimates
Our critical accounting policies are those having the most impact on the reporting of our financial condition and results and those requiring significant judgments and estimates. These policies include those related to (1) capital expenditures, (2) impairment of long-lived assets, and (3) derivatives and hedging activities. Our critical accounting policies are described in more detail in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2002. There have been no significant changes in our critical accounting policies from those reported in our 2002 Annual Report on Form 10-K. With respect to these critical accounting policies, management believes that the application of judgments and assessments is consistently applied and produces financial information that fairly depicts the results of operations for all periods presented.
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Statements of Cash Flow
The following discussion explains the changes in net cash provided by operating activities and net cash used in investing and financing activities that are presented in United Dominion’s Consolidated Statements of Cash Flows.
For the six months ended June 30, 2003, United Dominion’s cash flow provided by operating activities was $107.1 million compared to $116.9 million for the same period in 2002. The decrease in cash flow provided by operating activities resulted primarily from a decrease in property operating income provided by our same communities and a decrease in the overall size of United Dominion’s apartment community portfolio (see discussion under “Apartment Community Operations”). These decreases in cash flows were partially offset by a decrease in interest and general and administrative expenses.
For the six months ended June 30, 2003, net cash used in investing activities was $157.4 million compared to $117.7 million for the same period in 2002. Changes in the level of investing activities from period to period reflect United Dominion’s strategy as it relates to its acquisition, capital expenditure, development, and disposition programs, as well as the impact of the capital market environment on these activities.
Acquisitions
During the six months ended June 30, 2003, United Dominion acquired four apartment communities in Orange County, California totaling 1,068 homes, the remaining 47% joint venture partners’ ownership interest in nine communities totaling 1,706 homes in Salinas and Pacific Grove, California, one apartment community with 464 apartment homes in St. Petersburg, Florida, and one parcel of land in Irving, Texas for an aggregate consideration of approximately $247 million. Consistent with our long-term strategic plan to achieve greater operating efficiencies by investing in fewer, more concentrated markets, United Dominion, over the last two years, has been expanding its interests in the fast growing Southern California market. Throughout the remainder of 2003, we plan to continue to channel new investments to those markets that are projected to provide the best investment returns for us over the next ten years. Markets will be targeted based upon defined criteria including past performance, expected job growth, current and anticipated housing supply and demand, and the ability to attract and support household formation.
Capital Expenditures
In conformity with accounting principles generally accepted in the United States, United Dominion capitalizes those expenditures related to acquiring new assets, materially enhancing the value of an existing asset, or substantially extending the useful life of an existing asset. Expenditures necessary to maintain an existing property in ordinary operating condition are expensed as incurred.
During the first six months of 2003, $23.5 million or $321 per home was spent on capital expenditures for all of United Dominion’s communities excluding development and commercial properties. These capital improvements included turnover related expenditures for floor coverings and appliances, other recurring capital expenditures such as HVAC equipment, roofs, landscaping, siding, parking lots, and other non-revenue enhancing capital expenditures, which aggregated $17.5 million or $238 per home. In addition, revenue enhancing capital expenditures, including water sub-metering, the initial installation of microwaves or washer-dryers, and extensive interior upgrades totaled $4.2 million or $58 per home and major renovations totaled $1.8 million or $25 per home for the six months ended June 30, 2003.
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The following table outlines capital expenditures and repair and maintenance costs for United Dominion’s total portfolio, excluding real estate under development and commercial properties for the periods presented (dollars in thousands):
June 30, (per unit)
Turnover capital expenditures
Other recurring capital expenditures
Total recurring capital expenditures
Revenue enhancing improvements
Major renovations
Total capital improvements
Total expenditures
Total capital improvements increased $2.0 million or $41 per home in the first half of 2003 compared to the same period in 2002. United Dominion will continue to selectively add revenue enhancing improvements which we believe will provide a return on investment substantially in excess of United Dominion’s cost of capital. Recurring capital expenditures during 2003 are currently expected to be approximately $435 per home.
Development activity is focused in core markets that have strong operations in place. For the six months ended June 30, 2003, United Dominion invested approximately $9.7 million in development projects, up $2.3 million from $7.4 million for the same period in 2002.
The following projects were under development at June 30, 2003:
Location
The Mandolin II
2000 Post III
Rancho Cucamonga
In addition, United Dominion owns seven parcels of land that it continues to hold for future development that had a carrying value at June 30, 2003 of $11.4 million. Five of the seven parcels represent additional phases to existing communities as United Dominion plans to add apartment homes adjacent to currently owned communities that are in improving markets.
Development Joint Venture
In September 2002, United Dominion signed a development joint venture agreement with AEGON USA Realty Advisors, Inc. in which United Dominion serves as the managing member. The joint venture is expected to develop approximately eight to ten garden style apartment communities over the next three to five years, with a total development cost of up to $210 million. The joint venture will obtain bank construction financing for 65% to 80% of total costs. The joint venture will provide equity contributions for the balance of the costs with AEGON providing 80% and United Dominion providing 20%. United Dominion will serve as the developer, general contractor, and property manager for the joint venture, and will guarantee those project development costs, excluding
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financing costs (including fees and interest), which exceed the defined project cost budgeted amounts for each respective project, as they come to fruition.
The following joint venture project was under development at June 30, 2003:
Villa Tuscana
Disposition of Investments
For the six months ended June 30, 2003, United Dominion sold one community with 220 apartment homes and one commercial property for an aggregate sales price of approximately $12.2 million and recognized gains for financial reporting purposes of $0.9 million. Proceeds from the sales were used primarily to reduce debt.
During 2003, United Dominion plans to continue to pursue its strategy of exiting markets where long-term growth prospects are limited and redeploying capital into markets that would enhance future growth rates and economies of scale. We intend to use proceeds from 2003 dispositions to acquire communities, fund development activity, and reduce debt.
Net cash provided by financing activities during the six months ended June 30, 2003 was $48.8 million compared to net cash provided by financing activities of $1.7 million for the six months ended June 30, 2002. As part of the plan to improve United Dominion’s balance sheet position, we utilized proceeds from dispositions, equity and debt offerings, and refinancings to extend maturities, pay down existing debt, and purchase new properties.
The following is a summary of our financing activities for the six months ended June 30, 2003:
Issued $56.9 million of a new convertible preferred stock, the “Series E” preferred stock, and 1,617,815 net Preferred Operating Partnership Units totaling $26.9 million in June 2003 as partial consideration for the purchase of four communities in Southern California. Each were priced at $16.61 per share and dividends on the Series E preferred stock and Preferred Operating Partnership Units carry a fixed coupon of 8.0% until such time as the common share dividend is equal to or exceeds this amount
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for four consecutive calendar quarters, at which time the Series E preferred stock will be entitled to receive the common share dividend on an as converted basis (initially one for one) for all future periods.
Credit Facilities
United Dominion has four secured revolving credit facilities with Fannie Mae with an aggregate commitment of $860 million and one with Freddie Mac for $72 million. As of June 30, 2003, $676.3 million was outstanding under the Fannie Mae credit facilities leaving $183.7 million of unused capacity. The Fannie Mae credit facilities are for an initial term of ten years, bear interest at floating and fixed rates, and can be extended for an additional five years at United Dominion’s discretion. As of June 30, 2003, $70.7 million had been funded under the Freddie Mac credit facility leaving $1.3 million of unused capacity. The Freddie Mac credit facility is for an initial term of five years with an option by United Dominion to extend for an additional four-year term at the then market rate. As of June 30, 2003, the aggregate borrowings under both the Fannie Mae and Freddie Mac credit facilities was $747.0 million. We have $305.9 million of the funded balance fixed at a weighted average interest rate of 6.4%. The remaining balance on these facilities is currently at a weighted average variable rate of 1.7%.
United Dominion has a $500 million three-year unsecured revolving credit facility that matures in March 2006. The credit facility replaces United Dominion’s $375 million unsecured revolver and $100 million unsecured term loan. If United Dominion receives commitments from additional lenders or if the initial lenders increase their commitments, we will be able to increase the credit facility to $650 million. At United Dominion’s option, the credit facility can be extended one year to March 2007. Based on our current credit ratings, the credit facility bears interest at a rate equal to LIBOR plus 90 basis points. As of June 30, 2003, $254 million was outstanding under the credit facility leaving $246 million of unused capacity.
The Fannie Mae and Freddie Mac credit facilities and the bank revolving credit facility are subject to customary financial covenants and limitations.
Information concerning short-term bank borrowings under United Dominion’s credit facility and unsecured term loan is summarized in the table that follows (dollars in thousands):
Total line of credit
Borrowings outstanding at end of period
Weighted average daily borrowings during the period
Maximum daily borrowings outstanding during the period
Weighted average interest rate during the period
Weighted average interest rate at end of period
Weighted average interest rate at end of period, after giving effect to swap agreements
Derivative Instruments
As part of United Dominion’s overall interest rate risk management strategy, we use derivatives as a means to fix the interest rates of variable rate debt obligations or to hedge anticipated financing transactions. United Dominion’s derivative transactions used for interest rate risk management include various interest rate swaps with indices that relate to the pricing of specific financial instruments of United Dominion. United Dominion believes that it has appropriately controlled its interest rate risk through the use of derivative instruments. During the first half of 2003, the fair value of United Dominion’s derivative instruments has improved from an unfavorable value position of $9.6 million at December 31, 2002 to an unfavorable value position of $4.3 million at June 30, 2003. This decrease is primarily due to the normal progression of the fair market value of derivative instruments to get closer to zero as they near the end of their terms (see Note 7 to the consolidated financial statements).
Funds from Operations
Funds from operations (“FFO”) is defined as net income (computed in accordance with generally accepted accounting principles), excluding gains (losses) from sales of depreciable property, plus real estate depreciation and amortization, and after
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adjustments for unconsolidated partnerships and joint ventures. United Dominion computes FFO for all periods presented in accordance with the recommendations set forth by the National Association of Real Estate Investment Trust’s (“NAREIT”) October 1, 1999 White Paper. Adjusted funds from operations (“AFFO”) is defined as FFO less recurring capital expenditures for our stabilized portfolio of an estimated $435 per home in 2003 and an actual $425 per home in 2002. The 2003 per home charge will be adjusted at year-end to reflect actual expenditures. United Dominion considers FFO and AFFO in evaluating property acquisitions and its operating performance, and believes that FFO and AFFO should be considered along with, but not as an alternative to, net income as a measure of United Dominion’s operating performance and liquidity. FFO does not represent cash generated from operating activities in accordance with generally accepted accounting principles and is not necessarily indicative of cash available to fund cash needs.
Historical cost accounting for real estate assets in accordance with generally accepted accounting principles implicitly assumes that the value of real estate assets diminishes predictably over time. Since real estate values instead have historically risen or fallen with market conditions, many industry investors and analysts have considered presentation of operating results for real estate companies that use historical cost accounting to be insufficient themselves. Thus, NAREIT created FFO as a supplemental measure of REIT operating performance that excludes historical costs depreciation, among other items, from net income based on generally accepted accounting procedures. The use of FFO, combined with the required presentations, has been fundamentally beneficial, improving the understanding of operating results of REITs among the investing public and making comparisons of REIT operating results more meaningful. We generally consider FFO to be a useful measure for reviewing our comparative operating and financial performance (although FFO should be reviewed in conjunction with net income which remains the primary measure of performance) because by excluding gains or losses related to sales of previously depreciated operating real estate assets and excluding real estate asset depreciation and amortization, FFO can help one compare the operating performance of a company’s real estate between periods or as compared to different companies. We believe that FFO and AFFO are the best measures of economic profitability for real estate investment trusts.
The following table outlines United Dominion’s FFO calculation and reconciliation to generally accepted accounting principles pursuant to Regulation G, as adopted by the Securities and Exchange Commission, for the three and six months ended June 30, (dollars in thousands):
Adjustments:
Distributions to preferred shareholders
Real estate depreciation, net of outside partners’ interest
Minority interests of unitholders in operating partnership
Real estate depreciation related to unconsolidated entities
Discontinued Operations:
Impairment loss on real estate
Loss/(gains) on sales of depreciable property
Funds from operations (“FFO”)—basic
Adjustment:
Distribution to preferred shareholders—Series D and E (Convertible)
Funds from operations—diluted
Recurring capital expenditures
Adjusted funds from operations (“AFFO”)—diluted
Weighted average number of common shares and OP Units outstanding—basic
Weighted average number of common shares, OP Units, and common stock equivalents outstanding—diluted
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In the computation of diluted FFO, OP Units, out-performance partnership shares, and the shares of Series D and Series E convertible preferred stock are dilutive; therefore, they are included in the diluted share count.
FFO also does not represent cash generated from operating activities in accordance with generally accepted accounting principles, and therefore should not be considered an alternative to net cash flows from operating activities, as determined by generally accepted accounting principles, as a measure of liquidity. Additionally, it is not necessarily indicative of cash availability to fund cash needs. A presentation of cash flow metrics based on generally accepted accounting principles is as follows (dollars in thousands):
Net cash provided by (used in) financing activities
Results of Operations
The following discussion includes the results of both continuing and discontinued operations for the periods presented.
Net Income Available to Common Shareholders
Net income available to common shareholders was $2.7 million ($0.02 per common share) for the quarter ended June 30, 2003, compared to $20.5 million ($0.19 per common share) for the same period in the prior year. The decrease for the quarter ended June 30, 2003 resulted primarily from a $5.4 million decrease in operating results and a $6.3 million premium recognized by United Dominion to convert 2.0 million shares of our Series D cumulative convertible redeemable preferred stock into common stock during the current period. The premium amount recognized to convert these shares represents the difference between the face value of the preferred stock and the value at which it was recorded at the time of acquisition. In addition, United Dominion recognized $11.9 million less in gains from the sale of depreciable property during the current quarter when compared to the same period in the prior year. These decreases in income were partially offset by a $3.6 million decrease in interest expense for the three month period ended June 30, 2003 when compared to the same period in the prior year.
For the six months ended June 30, 2003, net income available to common shareholders decreased $2.8 million ($0.03 per common share) compared to the same period in the prior year. The decrease in net income available to common shareholders for the six months ended June 30, 2003 resulted primarily from a $11.2 million decrease in operating results and the $6.3 million premium recognized by United Dominion on the conversion of 2.0 million shares of our Series D cumulative convertible redeemable preferred stock into common stock. In addition, United Dominion recognized $11.8 million less in gains from the sale of depreciable property for the six months ended June 30, 2003 when compared to the same period in the prior year. These decreases in income were partially offset by a $4.5 million decrease in interest expense, and a $1.9 million decrease in general and administrative expenses for the six month period ended June 30, 2003 when compared to the same period in the prior year. Furthermore, United Dominion paid $16.8 million in prepayment penalties in connection with the refinancing of mortgage debt and the early payoff of loans on the sale of properties, and took a $2.3 million impairment charge related to a portfolio in Memphis, Tennessee during the first six months of 2002.
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Apartment Community Operations
United Dominion’s net income is primarily generated from the operation of its apartment communities. The following table summarizes the operating performance of United Dominion’s total apartment portfolio for each of the periods presented (dollars in thousands):
Property rental income
Property operating expense*
Property operating income
Weighted average number of homes
Physical occupancy**
The decrease in property operating income provided by the same communities, development communities, and acquisition communities since June 30, 2002 is primarily due to an overall decrease in same community property operating income and the overall decrease in the size of United Dominion’s apartment community portfolio.
Same Communities
United Dominion’s same communities (those communities acquired, developed, and stabilized prior to January 1, 2002 and held on June 30, 2003, which consisted of 67,560 apartment homes) provided 90% of our property operating income for the six month period ended June 30, 2003.
For the second quarter of 2003, same community property operating income decreased 3.8% or $3.4 million compared to the same period in 2002 as a result of a 1.2% or $1.7 million decrease in revenues from rental and other income and a 3.5% or $1.8 million increase in operating expenses. The decrease in revenues from rental and other income was primarily driven by a 2.4% or $3.6 million decrease in rental rates. This decrease in income was partially offset by a 23.0% or $0.8 million increase in sub-meter, gas, and trash reimbursements, a 9.2% or $0.5 million decrease in concession expense, and a 3.7% or $0.4 million decrease in vacancy loss. Physical occupancy for the quarter increased 0.3% to 93.6% for the quarter. The increase in property operating expenses was primarily driven by a 12.8% or $1.0 million increase in repair and maintenance expense, a 6.2% or $0.5 million increase in utilities expense, a 6.4% or $0.3 million increase in administrative and marketing expense, a 1.9% or $0.2 million increase in personnel costs, and a 1.4% or $0.2 million increase in taxes. These increases were partially offset by a 9.5% or $0.3 million decrease in insurance costs.
As a result of the percentage changes in property rental income and property operating expenses, the operating margin (property operating income divided by property rental income) decreased 1.7% to 62.6%.
For the six months ended June 30, 2003, same community property operating income decreased 4.3% or $7.6 million compared to the same period in 2002 as a result of a 1.7% or $4.8 million decrease in revenues from rental and other income and a 2.8% or $2.8 million increase in operating expenses. The decrease in revenues from rental and other income was primarily driven by a 2.2% or $6.3 million decrease in rental rates and a 21.7% or $0.3 million increase in bad debt expense. These decreases in income were partially offset by a 21.2% or $1.4 million increase in sub-meter, gas, and trash reimbursements, a 1.6% or $0.3 million decrease in vacancy loss, and a 1.6% or $0.1 million decrease in concession expense. Physical occupancy for six months ended June 30, 2003 increased 0.1% to 93.5% compared to the same period in the prior year. The increase in property operating expenses was primarily driven by a 7.1% or $1.1 million increase in repair and maintenance expense, a 4.3% or $0.7 million increase in utilities expense, a 7.6% or $0.7 million increase in administrative and marketing expense, a 2.7% or $0.7 million increase in personnel costs, and a 2.4% or $0.6 million increase in taxes. These increases were partially offset by an 11.1% or $0.7 million decrease in insurance costs and a 41.2% or $0.3 million decrease in incentive compensation.
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As a result of the percentage changes in property rental income and property operating expenses, the operating margin (property operating income divided by property rental income) decreased 1.7% to 62.3%.
Non-Mature Communities
The remaining 10% of United Dominion’s property operating income during the first six months of 2003 was generated from its non-mature communities (those communities acquired or developed during 2002 and 2003, sold properties, and those properties classified as real estate held for disposition). The 15 communities with 4,954 apartment homes acquired by United Dominion during 2002 and 2003 provided $11.6 million of property operating income. In addition, United Dominion’s development communities, which included 854 apartment homes constructed since January 1, 2002, provided $2.4 million of property operating income during 2003, the seven communities with 2,063 apartment homes classified as real estate held for disposition provided $4.3 million of property operating income, and other non-mature communities provided $0.9 million of property operating income for the six months ended June 30, 2003.
Real Estate Depreciation
For the three and six months ended June 30, 2003, real estate depreciation on both continuing and discontinued operations remained relatively constant compared to the same period in 2002 regardless of the decrease in the weighted average number of apartment homes experienced from June 30, 2002 to June 30, 2003, primarily due to the newly acquired properties having a significantly higher per home cost compared to those properties that have been disposed of, and other capital expenditures.
Interest Expense
For the three months ended June 30, 2003, interest expense on both continuing and discontinued operations decreased $3.6 million or 10.8% from the same period in 2002 primarily due to debt refinancings, decreasing interest rates, and an overall decrease in the weighted average level of debt outstanding. For the quarter ended June 30, 2003, the weighted average amount of debt outstanding decreased 5.4% or $115.5 million when compared to the same period in the prior year and the weighted average interest rate decreased from 6.0% to 5.5% in 2003. The weighted average amount of debt employed during 2003 is lower than 2002 primarily due to the high acquisition volume at the beginning of 2002 that was subsequently mitigated by high disposition activity in the second half of 2002. The decrease in the average interest rate during 2003 reflects the ability of United Dominion to take advantage of declining interest rates through refinancing and the utilization of variable rate debt.
For the six months ended June 30, 2003, interest expense on both continuing and discontinued operations decreased $4.5 million or 6.9% from the same period in 2002 primarily due to debt refinancings, decreasing interest rates, and an overall decrease in the weighted average level of debt outstanding. For the six months ended June 30, 2003, the weighted average amount of debt outstanding decreased 0.3% or $5.4 million compared to the same period in the prior year and the weighted average interest rate decreased from 6.2% to 5.6% during the first six months of 2003. The weighted average amount of debt employed during 2003 is lower than 2002 primarily due to the high acquisition volume at the beginning of 2002 that was subsequently mitigated by high disposition activity in the second half of 2002. The decrease in the average interest rate during 2003 reflects the ability of United Dominion to take advantage of declining interest rates through refinancing and the utilization of variable rate debt.
General and Administrative
For the three months ended June 30, 2003, general and administrative expenses increased $0.3 million or 5.3% compared to the same period in 2002. For the six months ended June 30, 2003, general and administrative expenses decreased $1.9 million or 15.3% over the comparable period in 2002. The decrease for the six month period was primarily due to a provision made in the first quarter of 2002 for the pending buyout of certain long-term security monitoring contracts as well as a decrease in incentive compensation expense for the six months ended June 30, 2003.
Gains on Sales of Land and Depreciable Property
For the three and six months ended June 30, 2003, United Dominion recognized gains for financial reporting purposes of $0 and $1 million, respectively, compared to $11.8 million and $12.7 million for the comparable period in 2002. Changes in the level of gains
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recognized from period to period reflect the changing level of United Dominion’s divestiture activity from period to period, as well as the extent of gains related to specific properties sold.
Inflation
United Dominion believes that the direct effects of inflation on our operations have been immaterial. Substantially all of United Dominion’s leases are for a term of one year or less which generally minimizes our risk from the adverse effects of inflation.
Factors Affecting Our Business Prospects
There are many factors that affect our business and the results of our operations, some of which are beyond our control. These factors include:
For a discussion of these and other factors affecting our business and prospects, see “Item 1.—Business—Factors Affecting Our Business and Prospects” in our Annual Report on Form 10-K for the year ended December 31, 2002. In addition, the following factors may affect our business and prospects:
Increases in U.S. state and local taxes could adversely affect our cash available for distribution.
Many U.S. states and localities are considering increases in their income and/or real property tax rates (or increases in the assessments of real property) to cover the revenue shortfalls they are currently facing. We are subject to state and local income and property taxation in various jurisdictions in which we transact business and own property. Increases in income and/or property taxes in those jurisdictions could adversely affect our cash available for distribution to stockholders.
Maryland law may limit the ability of a third party to acquire control of us, which may not be in our stockholders’ best interest.
Maryland business statutes may limit the ability of a third party to acquire control of us. As a Maryland corporation, we are subject to various Maryland laws which may have the effect of discouraging offers to acquire our company and of increasing the difficulty of consummating any such offers, even if our acquisition would be in our stockholders’ best interests. The Maryland General Corporation Law restricts mergers and other business combination transactions between us and any person who acquires beneficial ownership of shares of our stock representing 10% or more of the voting power without our board of directors’ prior approval. Any such business combination transaction could not be completed until five years after the person acquired such voting power, and generally only with the approval of stockholders representing 80% of all votes entitled to be cast and 66 2/3% of the votes entitled to be cast, excluding the interested stockholder, or upon payment of a fair price. Maryland law also provides generally that a person who acquires shares of our equity stock that represent 10% (and certain higher levels) of the voting power in electing directors will have no voting rights unless approved by a vote of two-thirds of the shares eligible to vote.
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Share ownership limitations may prevent takeovers that are beneficial to our stockholders.
Our amended and restated articles of incorporation contain ownership and transfer restrictions relating to our common stock. These restrictions include a provision that generally limits a person from beneficially owning or constructively owning shares of our outstanding equity stock in excess of a 9.9% ownership interest, unless our board of directors exempts the person from such ownership limitation, provided that any such exemption shall not allow the person to exceed 13% of the value of our outstanding equity stock. These provisions may have the effect of delaying, deferring, or preventing someone from taking control of us, even though a change of control might involve a premium price for our stockholders or might otherwise be in our stockholders’ best interests.
United Dominion is exposed to interest rate changes associated with our unsecured credit facility and other variable rate debt as well as refinancing risk on our fixed rate debt. United Dominion’s involvement with derivative financial instruments is limited and we do not expect to use them for trading or other speculative purposes. United Dominion uses derivative instruments solely to manage its exposure to interest rates.
See our Annual Report on Form 10-K for the year ended December 31, 2002 “Item 7A. Quantitative and Qualitative Disclosures About Market Risk” for a more complete discussion of our interest rate sensitive assets and liabilities. As of June 30, 2003, our market risk has not changed materially from the amounts reported on our Annual Report on Form 10-K for the year ended December 31, 2002.
As of June 30, 2003, we carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Our disclosure controls and procedures are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic SEC reports. In addition, our Chief Executive Officer and our Chief Financial Officer concluded that during the quarter ended June 30, 2003, there has been no change in our internal controls over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
PART II
On June 12, 2003, we issued 3,425,217 shares of our Series E Cumulative Convertible Preferred Stock, priced at $16.61 per share, as partial consideration for the acquisition of four apartment communities in Southern California. The Series E preferred shares were issued to the shareholders of Midlands Company, a Delaware corporation, which owned two of the apartment communities acquired in the transaction. We acquired the four apartment communities for approximately $137 million. In addition, we acquired a note receivable with a notional value of $5 million in this transaction. The total consideration paid by us in connection with the transaction included the $58.8 million of Series E preferred shares, 1,617,815 Operating Partnership Units totaling $26.9 million, and cash of approximately $56 million. A total of $37 million in debt will be placed on two of the apartment communities.
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Subject to certain adjustments and conditions, each share of the Series E Cumulative Convertible Preferred Stock is convertible at any time and from time to time at the holder’s option into one share of our common stock. Because the Series E preferred shares were sold in a transaction not involving a public offering, the sale of the shares is exempt from registration under the Securities Act of 1933 in accordance with Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder.
On May 21, 2003, we issued 3,076,923 shares of our common stock to Security Capital Preferred Growth Incorporated at a price or $16.25 per share upon the conversion of 2,000,000 shares of our outstanding Series D Cumulative Convertible Redeemable Preferred Stock held by Security Capital. Because the shares of common stock were sold in a transaction not involving a public offering, the transaction is exempt from registration under the Securities Act of 1933 in accordance with Section 4(2) of the Securities Act.
On May 6, 2003, United Dominion held its Annual Meeting of Shareholders. At the meeting, the shareholders voted on the election of directors, a proposal to change our state of incorporation from Virginia to Maryland, a proposal to approve the Series B Out-Performance Program, and a proposal to ratify the selection of Ernst & Young LLP to serve as our independent auditors for the year ending December 31, 2003.
The following persons were elected directors of United Dominion, to serve as such for the term indicated and under their respective successors are duly elected and qualified or until their earlier resignation or removal, by the indicated vote:
Robert P. Freeman
Jon A. Grove
James D. Klingbeil
Robert C. Larson
John P. McCann
Thomas R. Oliver
Lynne B. Sagalyn
Mark J. Sandler
Robert W. Scharar
Thomas W. Toomey
The shareholders approved the proposal to change our state of incorporation from Virginia to Maryland by the indicated vote:
74,134,384
The shareholders approved the proposal to approve the Series B Out-Performance Program by the indicated vote:
69,144,620
The shareholders approved the proposal to ratify the selection of Ernst & Young LLP to serve as independent auditors for the year ending December 31, 2003, by the indicated vote:
96,477,440
There were 23,172,980 broker non-votes.
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The exhibits filed with this Report are set forth in the Exhibit Index.
We filed or furnished the following Current Reports on Form 8-K during the quarter ended June 30, 2003. The information provided under Item 9. Regulation FD Disclosure (Item 12. Results of Operations and Financial Condition) is not deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934.
Current Report on Form 8-K dated March 14, 2003, filed with the Securities and Exchange Commission on April 3, 2003, under Item 5. Other Events and under Item 7. Financial Statements, Pro Forma Financial Information and Exhibits.
Current Report on Form 8-K dated April 16, 2003, filed with the Securities and Exchange Commission on April 16, 2003, under Item 5. Other Events and under Item 7. Financial Statements, Pro Forma Financial Information and Exhibits.
Current Report on Form 8-K dated April 24, 2003, filed with the Securities and Exchange Commission on April 28, 2003, under Item 5. Other Events and under Item 7. Financial Statements, Pro Forma Financial Information and Exhibits.
Current Report on Form 8-K dated April 28, 2003, furnished to the Securities and Exchange Commission on April 29, 2003, under Item 9. Regulation FD Disclosure (Item 12. Results of Operations and Financial Conditions).
Current Report on Form 8-K dated May 14, 2003, filed with the Securities and Exchange Commission on May 14, 2003, under Item 5. Other Events and under Item 7. Financial Statements, Pro Forma Financial Information and Exhibits.
Current Report on Form 8-K dated June 11, 2003, filed with the Securities and Exchange Commission on June 11, 2003, under Item 5. Other Events and under Item 7. Financial Statements, Pro Forma Financial Information and Exhibits.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
(registrant)
Date: August 13, 2003
/s/ CHRISTOPHERD. GENRY
Executive Vice President and
Chief Financial Officer
/s/ SCOTT A. SHANABERGER
Senior Vice President and
Chief Accounting Officer
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EXHIBIT INDEX
Description