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Section 1: 10-Q (FORM 10-Q FOR THE PERIOD ENDING 9-30-2006)

Form 10-Q for the period ending 9-30-2006


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2006

or

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from   to  

Commission File Number: 1-12762

MID-AMERICA APARTMENT COMMUNITIES, INC.
(Exact name of registrant as specified in its charter)

TENNESSEE
62-1543819
(State or other jurisdiction of
(I.R.S. Employer Identification No.)
incorporation or organization)
 
 
6584 POPLAR AVENUE, SUITE 300
38138
MEMPHIS, TENNESSEE
(Zip Code) 
(Address of principal executive offices)
 

(901) 682-6600
Registrant's telephone number, including area code
  
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
[X] Yes [ ] No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [X] 
Accelerated filer [ ]
Non-accelerated filer [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
[ ] Yes [X] No

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

 
Number of Shares Outstanding
Class
at October 19, 2006
Common Stock, $.01 par value
24,491,514
 
 



MID-AMERICA APARTMENT COMMUNITIES, INC.
     
TABLE OF CONTENTS
   
Page
 
PART I - FINANCIAL INFORMATION
 
Item 1.
Financial Statements
 
 
Condensed Consolidated Balance Sheets as of September 30, 2006 (Unaudited) and December 31, 2005
2
 
Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2006 and 2005 (Unaudited)
3
 
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2006 and 2005 (Unaudited)
4
 
Notes to Condensed Consolidated Financial Statements (Unaudited)
5
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
16
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
27
Item 4.
Controls and Procedures
27
     
 
PART II - OTHER INFORMATION
 
Item 1.
Legal Proceedings
28
Item 1A.
Risk Factors
28
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
29
Item 3.
Defaults Upon Senior Securities
29
Item 4.
Submission of Matters to a Vote of Security Holders
29
Item 5.
Other Information
29
Item 6.
Exhibits
29
 
Signatures
32


 

Mid-America Apartment Communities, Inc.
Condensed Consolidated Balance Sheets
September 30, 2006 (Unaudited) and December 31, 2005
(Dollars in thousands, except per share data)
           
   
September 30, 2006
 
December 31, 2005
 
Assets:
         
Real estate assets:
         
Land
 
$
204,569
 
$
179,523
 
Buildings and improvements
   
1,888,083
   
1,740,818
 
Furniture, fixtures and equipment
   
50,032
   
46,301
 
Capital improvements in progress
   
10,549
   
4,175
 
     
2,153,233
   
1,970,817
 
Less accumulated depreciation
   
(522,721
)
 
(473,421
)
     
1,630,512
   
1,497,396
 
               
Land held for future development
   
2,360
   
1,366
 
Commercial properties, net
   
6,966
   
7,345
 
Investments in and advances to real estate joint venture
   
3,839
   
4,182
 
Real estate assets, net 
   
1,643,677
   
1,510,289
 
               
Cash and cash equivalents
   
7,689
   
14,064
 
Restricted cash
   
5,186
   
5,534
 
Deferred financing costs, net
   
15,715
   
15,338
 
Other assets
   
38,730
   
20,181
 
Goodwill
   
5,051
   
5,051
 
Assets held for sale
   
7,435
   
-
 
Total assets 
 
$
1,723,483
 
$
1,570,457
 
               
Liabilities and Shareholders' Equity:
             
Liabilities:
             
Notes payable
 
$
1,202,217
 
$
1,140,046
 
Accounts payable
   
678
   
3,278
 
Accrued expenses and other liabilities
   
50,827
   
28,380
 
Security deposits
   
7,498
   
6,429
 
Liabilities associated with assets held for sale
   
213
   
-
 
Total liabilities 
   
1,261,433
   
1,178,133
 
               
Minority interest
   
32,207
   
29,798
 
               
Shareholders' equity:
             
Preferred stock, $.01 par value, 20,000,000 shares authorized,
             
$166,863 or $25 per share liquidation preference:
             
9 1/4% Series F Cumulative Redeemable Preferred Stock, 
             
 3,000,000 shares authorized, 474,500 shares issued and outstanding
   
5
   
5
 
8.30% Series H Cumulative Redeemable Preferred Stock, 
             
 6,200,000 shares authorized, 6,200,000 shares issued and outstanding
   
62
   
62
 
Common stock, $.01 par value per share, 50,000,000 shares authorized;
             
24,489,874 and 22,048,372 shares issued and outstanding at 
             
September 30, 2006, and December 31, 2005, respectively 
   
245
   
220
 
Additional paid-in capital
   
782,249
   
671,885
 
Other
   
-
   
(2,422
)
Accumulated distributions in excess of net income
   
(363,717
)
 
(314,352
)
Accumulated other comprehensive income
   
10,999
   
7,128
 
Total shareholders' equity 
   
429,843
   
362,526
 
Total liabilities and shareholders' equity 
 
$
1,723,483
 
$
1,570,457
 
               
               
See accompanying notes to condensed consolidated financial statements.
 
 

 

Mid-America Apartment Communities, Inc.  
Condensed Consolidated Statements of Operations  
Three and nine months ended September 30, 2006 and 2005  
(Dollars in thousands, except per share data)  
                        
        
Three months ended
 
Nine months ended
 
        
September 30,
 
September 30,
 
   
  
 
2006
 
2005
 
2006
 
2005
 
Operating revenues:
                      
Rental revenues 
       
$
79,132
 
$
72,136
 
$
230,396
 
$
209,463
 
Other property revenues 
         
3,564
   
2,735
   
10,558
   
8,746
 
Total property revenues 
         
82,696
   
74,871
   
240,954
   
218,209
 
Management fee income 
         
53
   
51
   
157
   
272
 
Total operating revenues 
         
82,749
   
74,922
   
241,111
   
218,481
 
Property operating expenses:
                               
Personnel 
         
9,774
   
9,233
   
28,230
   
26,140
 
Building repairs and maintenance 
         
3,354
   
3,195
   
8,737
   
8,107
 
Real estate taxes and insurance 
         
10,653
   
9,347
   
30,158
   
28,205
 
Utilities 
         
5,468
   
4,784
   
14,726
   
12,941
 
Landscaping 
         
2,207
   
2,048
   
6,429
   
5,926
 
Other operating 
         
3,655
   
3,758
   
10,690
   
10,598
 
Depreciation 
         
19,613
   
19,017
   
57,899
   
55,152
 
Total property operating expenses 
         
54,724
   
51,382
   
156,869
   
147,069
 
Property management expenses
         
3,616
   
2,749
   
9,591
   
8,449
 
General and administrative expenses
         
2,665
   
2,329
   
8,708
   
7,148
 
Income from continuing operations before non-operating items
         
21,744
   
18,462
   
65,943
   
55,815
 
Interest and other non-property income
         
162
   
70
   
494
   
357
 
Interest expense
         
(15,505
)
 
(15,251
)
 
(47,039
)
 
(43,324
)
Gain (loss) on debt extinguishment
         
-
   
12
   
(551
)
 
(82
)
Amortization of deferred financing costs
         
(519
)
 
(462
)
 
(1,508
)
 
(1,411
)
Minority interest in operating partnership income
         
(375
)
 
(91
)
 
(1,196
)
 
(1,129
)
(Loss) income from investments in real estate joint ventures
         
(16
)
 
(52
)
 
(135
)
 
73
 
Incentive fee from real estate joint ventures
         
-
   
-
   
-
   
1,723
 
Net (loss) gain on insurance and other settlement proceeds
         
(54
)
 
874
   
171
   
865
 
Gain on sale of non-depreciable assets
         
32
   
-
   
32
   
334
 
Gain on disposition within real estate joint ventures
         
-
   
-
   
-
   
3,034
 
 Income from continuing operations
         
5,469
   
3,562
   
16,211
   
16,255
 
Discontinued operations:
                               
Income from discontinued operations before 
                               
 asset impairment, settlement proceeds and gain on sale
         
161
   
53
   
437
   
147
 
Asset impairment on discontinued operations 
         
-
   
-
   
-
   
(243
)
Net loss on insurance and other settlement proceeds on 
                               
 discontinued operations
         
-
   
-
   
-
   
(25
)
Net income
         
5,630
   
3,615
   
16,648
   
16,134
 
Preferred dividend distribution
         
3,491
   
3,490
   
10,472
   
10,838
 
Net income available for common shareholders
       
$
2,139
 
$
125
 
$
6,176
 
$
5,296
 
                                 
Weighted average shares outstanding (in thousands):
                               
Basic 
         
23,990
   
21,548
   
23,099
   
21,278
 
Effect of dilutive stock options 
         
225
   
296
   
226
   
284
 
Diluted 
         
24,215
   
21,844
   
23,325
   
21,562
 
                                 
Net income available for common shareholders
       
$
2,139
 
$
125
 
$
6,176
 
$
5,296
 
Discontinued property operations
         
(161
)
 
(53
)
 
(437
)
 
121
 
Income from continuing operations available for common shareholders
       
$
1,978
 
$
72
 
$
5,739
 
$
5,417
 
                                 
Earnings per share - basic:
                               
Income from continuing operations  
                               
 available for common shareholders 
       
$
0.08
 
$
0.01
 
$
0.25
 
$
0.25
 
Discontinued property operations 
         
0.01
   
-
 
$
0.02
   
-
 
Net income available for common shareholders 
       
$
0.09
 
$
0.01
 
$
0.27
 
$
0.25
 
                                 
Earnings per share - diluted:
                               
Income from continuing operations  
                               
 available for common shareholders 
       
$
0.08
 
$
0.01
 
$
0.24
 
$
0.25
 
Discontinued property operations 
         
0.01
   
-
 
$
0.02
   
-
 
Net income available for common shareholders 
       
$
0.09
 
$
0.01
 
$
0.26
 
$
0.25
 
                                 
Dividends declared per common share (1)
       
$
0.595
 
$
1.180
 
$
2.380
 
$
2.350
 
                                 
(1) The Company declared and paid $1.785 per common share during the nine months ended September 30, 2006.
During this same period the Company also declared an additional $0.595 per common share that will not be paid until October 31, 2006. 
The Company declared and paid $1.755 per common share during the nine months ended September 30, 2005.  
During this same period the Company also declared an additional $0.595 per common share that was not paid until October 31, 2005. 
                                 
See accompanying notes to condensed consolidated financial statements.
 
 

 

Mid-America Apartment Communities, Inc.
Condensed Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2006 and 2005
(Dollars in thousands)
           
   
2006
 
2005
 
Cash flows from operating activities:
         
Net income
 
$
16,648
 
$
16,134
 
Adjustments to reconcile net income to net cash provided by operating activities:
             
Gain from discontinued operations before asset impairment, settlement 
             
  proceeds and gain on sale
   
(437
)
 
(147
)
Depreciation and amortization of deferred financing costs 
   
59,407
   
56,563
 
Stock compensation expense 
   
1,009
   
574
 
Amortization of debt premium 
   
(1,407
)
 
(1,397
)
Loss (income) from investments in real estate joint ventures 
   
135
   
(73
)
Minority interest in operating partnership income 
   
1,196
   
1,129
 
Loss on debt extinguishment 
   
551
   
82
 
Derivative interest (income) expense 
   
(130
)
 
-
 
Gain on sale of non-depreciable assets 
   
(32
)
 
(334
)
Gain on disposition within real estate joint ventures 
   
-
   
(3,034
)
Incentive fee from real estate joint ventures 
   
-
   
(1,723
)
Net loss on insurance and other settlement proceeds on discontinued 
             
 operations
   
-
   
25
 
Asset impairment on discontinued operations 
   
-
   
243
 
Net (gain) loss on insurance and other settlement proceeds 
   
(171
)
 
(865
)
Changes in assets and liabilities: 
             
 Restricted cash
   
89
   
(2,241
)
 Other assets
   
(6,168
)
 
(26
)
 Accounts payable
   
(2,476
)
 
1,825
 
 Accrued expenses and other
   
7,877
   
9,013
 
 Security deposits
   
1,069
   
577
 
Net cash provided by operating activities 
   
77,160
   
76,325
 
Cash flows from investing activities:
             
Purchases of real estate and other assets 
   
(165,723
)
 
(103,592
)
Improvements to existing real estate assets 
   
(30,212
)
 
(18,495
)
Distributions from real estate joint ventures 
   
208
   
14,795
 
Proceeds from disposition of real estate assets 
   
2,039
   
9,790
 
Net cash used in investing activities 
   
(193,688
)
 
(97,502
)
Cash flows from financing activities:
             
Net change in credit lines 
   
63,374
   
28,348
 
Proceeds from notes payable 
   
27,842
   
19,486
 
Principal payments on notes payable 
   
(29,189
)
 
(1,991
)
Payment of deferred financing costs 
   
(2,204
)
 
(789
)
Proceeds from issuances of common shares and units 
   
106,149
   
29,833
 
Distributions to unitholders 
   
(4,412
)
 
(4,579
)
Dividends paid on common shares 
   
(40,935
)
 
(37,333
)
Dividends paid on preferred shares 
   
(10,472
)
 
(10,838
)
Net cash provided by financing activities 
   
110,153
   
22,137
 
Net decrease in cash and cash equivalents 
   
(6,375
)
 
960
 
Cash and cash equivalents, beginning of period
   
14,064
   
9,133
 
Cash and cash equivalents, end of period
 
$
7,689
 
$
10,093
 
               
Supplemental disclosure of cash flow information:
             
   Interest paid
 
$
48,919
 
$
45,333
 
Supplemental disclosure of noncash investing and financing activities:
             
    Conversion of units to common shares
 
$
330
 
$
229
 
    Issuance of restricted common shares
 
$
14
 
$
813
 
    Interest capitalized
 
$
115
 
$
-
 
    Marked-to-market adjustment on derivative instruments
 
$
3,871
 
$
16,029
 
    Fair value adjustment on debt assumed
 
$
1,553
 
$
2,277
 
    Reclass of preferred stock from equity to liabilities
 
$
-
 
$
10,000
 
               
See accompanying notes to condensed consolidated financial statements.
 
 

 

Mid-America Apartment Communities, Inc.
Notes to Condensed Consolidated Financial Statements
September 30, 2006 and 2005 (Unaudited)


1.  BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared by the management of Mid-America Apartment Communities, Inc. (the “Company”) in accordance with generally accepted accounting principles for interim financial information and applicable rules and regulations of the Securities and Exchange Commission and the Company’s accounting policies in effect as of December 31, 2005, as set forth in the Company’s annual consolidated financial statements, as of such date. In the opinion of management, all adjustments necessary for a fair presentation of the condensed consolidated financial statements have been included and all such adjustments were of a normal recurring nature. All significant intercompany accounts and transactions have been eliminated in consolidation. The results of operations for the three and nine month periods ended September 30, 2006, are not necessarily indicative of the results to be expected for the full year. These financial statements should be read in conjunction with the Company’s audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

RECLASSIFICATION

Certain prior period amounts have been reclassified to conform to the 2006 presentation. The reclassifications had no effect on net income available for common shareholders.

2. STOCK BASED COMPENSATION

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement No. 123 (revised December 2004), Share-Based Payment (“Statement 123(R)”). Statement 123(R) replaces FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. Statement 123(R) requires compensation costs related to share-based payment transactions be recognized in the financial statements. With limited exceptions, the amount of compensation cost will be measured based on the grant-date fair value of the equity or the liability instruments issued. In addition, liability awards will be remeasured each reporting period. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. Statement 123(R) is effective as of the beginning of the first annual reporting period that begins after June 15, 2005.

The Company adopted Statement 123(R) effective January 1, 2006 using the “modified prospective” method permitted by Statement 123(R) in which compensation cost is recognized beginning with the effective date (a) based on the requirements of Statement 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of Statement 123 for all awards granted to employees prior to the effective date of Statement 123(R) that remain unvested on the effective date. The effect of adopting Statement 123(R) for the three months ending September 30, 2006 was an increase of approximately $197,800 in net income from continuing operations and in net income, resulting in an increase of approximately $0.01 in both basic and diluted earnings per share. The effect of adopting Statement 123(R) for the nine months ending September 30, 2006 was an increase of approximately $466,200 in net income from continuing operations and in net income, resulting in an increase of approximately $0.02 in both basic and diluted earnings per share. These increases occurred primarily because the fair market values assigned to certain plans at grant date were not impacted by the increase in share price that the Company has experienced over the last two years, resulting in plans generating higher payouts for participants than their fair market value models would have predicted based on then stock price volatility. This series of events resulted in the expense booked to compensation expense in accordance with Statement 123(R) being smaller than the actual number of shares issued times their issue price. The adoption of Statement 123(R) had no impact on cash flow from operations or cash flow from financing activities.


 

The modified prospective method of Statement 123(R) does not require prior periods to be restated to reflect the amount of compensation cost that would have been reflected in the financial statements. The following table reflects the effect on net income if Statement 123(R) had been used by the Company along with the applicable assumptions utilized in the Black-Scholes option pricing model calculation for those periods in which option grants were issued (dollars and shares in thousands, except per share data):
 

               
       
September 30, 2005
 
       
Three
 
Nine
 
       
Months
 
Months
 
       
Ended
 
Ended
 
Net income
       
$
3,615
 
$
16,134
 
Preferred dividend distribution
         
3,490
   
10,838
 
Net income available for
                   
common shareholders
         
125
   
5,296
 
Add: Stock-based employee
                   
compensation expense included
                   
in reported net income
         
-
   
-
 
Less: Stock-based employee
                   
compensation expense from
                   
employee stock purchase plan discount
         
9
   
23
 
Less: Stock-based employee
                   
compensation expense determined
                   
under fair value method of accounting
         
26
   
82
 
Pro forma net income available for
                   
common shareholders
       
$
90
 
$
5,191
 
                     
Average common shares outstanding - Basic
         
21,548
   
21,278
 
Average common shares outstanding - Diluted
         
21,844
   
21,562
 
                     
Net income available per common share:
                   
Basic as reported
       
$
0.01
 
$
0.25
 
Basic pro forma
       
$
0.00
 
$
0.24
 
Diluted as reported
       
$
0.01
 
$
0.25
 
Diluted pro forma
       
$
0.00
 
$
0.24
 
                     
Assumptions:(1)
                   
Risk free interest rate
         
N/A
   
N/A
 
Expected life - Years
         
N/A
   
N/A
 
Expected volatility
         
N/A
   
N/A
 
Expected dividends
         
N/A
   
N/A
 
                     
(1) No grants were issued in the periods shown.
 

Employee Stock Purchase Plan

The Mid-America Apartment Communities, Inc. Employee Stock Purchase Plan (the “ESPP”) provides a means for employees to purchase common stock of the Company. The Board of Directors has authorized the issuance of 150,000 shares for the plan. The ESPP is administered by the Compensation Committee of the Board of Directors who may annually grant options to employees to purchase annually up to an aggregate of 15,000 shares of common
stock at a price equal to 85% of the market price of the common stock. Shares are purchased semi-annually on June 30 and December 31. No shares were purchased during the three months ended September 30, 2006 and 2005. Because it is not possible to reasonably estimate fair value at the grant date, the Company estimates the compensation costs based on intrinsic values updated until the date of the settlement. Compensation cost recognized for the three and nine months ending September 30, 2006 were approximately $12,300 and $36,900, respectively.
 


Incentive Plans Overview and Summary

The Company’s stock compensation plans consist of the ESPP and a number of incentives provided to attract and retain independent directors, executive officers and key employees. Incentives are currently granted under the 2004 Stock Plan which was approved at the May 24, 2004 Annual Meeting of Shareholders. This plan replaced the 1994 Restricted Stock and Stock Option Plan (collectively, the “Plans”) under which no further awards may be granted as of January 31, 2004. The 1994 Restricted Stock and Stock Option Plan allowed for the grant of restricted stock and stock options up to a total of 2.4 million shares. The 2004 Stock Plan allows for the grant of restricted stock and stock options up to a total of 500,000 shares. The Company believes that such awards better align the interests of its employees with those of its shareholders. Total compensation cost under the Plans was approximately $245,100 and $147,800 for the three months ended September 30, 2006 and 2005, respectively, and approximately $615,400 and $347,700 for the nine months ended September 30, 2006 and 2005, respectively. As of September 30, 2006, the total unrecognized compensation cost related to the Plans was approximately $3.0 million. This cost is expected to be recognized over the weighted average period of 4.4 years. Information concerning specific grants under the Plans is listed below.

Options

All option awards made under the Plans have been granted with the exercise price equal to the market price on the day of grant. The options vest over five years of continuous service at a rate of 10%, 10%, 20%, 30% and 30%, and expire 10 years from grant date. Dividends are not paid on unexercised options.

The fair value of each option award is estimated on the grant date using the Black-Scholes method, which utilizes the assumptions noted in the following table. Volatility is based on the historical volatility of the Company’s common stock. Expected life of the option is estimated using historical data to estimate option exercise and employee termination. The Company uses a U.S. constant-maturity Treasury close to the same expected life of the option to represent the risk-free rate. Turnover is based on the historical rate at which options are exercised. The Company uses its current dividend yield at the time of grant to estimate the dividend yield over the life of the option. No options were granted during the periods presented in the following table; therefore, no fair value was calculated.


   
Three months ended September 30,
 
Nine months ended September 30,
 
   
2006
 
2005
 
2006
 
2005
 
Volatility
   
N/A
   
N/A
   
N/A
   
N/A
 
Expected life
   
N/A
   
N/A
   
N/A
   
N/A
 
Risk-free rate
   
N/A
   
N/A
   
N/A
   
N/A
 
Dividend yield
   
N/A
   
N/A
   
N/A
   
N/A
 
 
 

 

A summary of option activity under the Plans as of September 30, 2006, and the changes during the nine months then ended follows:
 

           
Weighted-
     
       
Weighted-
 
Average
     
       
Average
 
Remaining
 
Aggregate
 
       
Exercise
 
Contractual
 
Intrinsic
 
Options
 
Shares
 
Price
 
Life
 
Value
 
Outstanding at January 1, 2006
   
398,052
 
$
24.83
             
Granted
   
-
   
-
             
Exercised
   
(123,360
)
 
24.09
             
Forfeited or expired
   
(7,350
)
 
26.03
             
Outstanding at March 31, 2006
   
267,342
 
$
25.14
   
3.8
 
$
7,916,799
 
Granted
   
-
   
-
             
Exercised
   
(6,570
)
 
23.82
             
Forfeited or expired
   
(13,820
)
 
25.52
             
Outstanding at June 30, 2006
   
246,952
 
$
25.12
   
3.7
 
$
7,563,212
 
Granted
   
-
   
-
             
Exercised
   
(14,500
)
 
25.61
             
Forfeited or expired
   
-
   
-
             
Outstanding at September 30, 2006
   
232,452
 
$
25.09
   
3.5
 
$
5,832,955
 
Exercisable at September 30, 2006
   
160,347
 
$
24.90
   
2.6
 
$
3,992,835
 
 

The total intrinsic value of options exercised during the three months ended September 30, 2006 and 2005, was approximately $461,500 and $332,100, respectively. The total intrinsic value of options exercised during the nine months ended September 30, 2006 and 2005, was approximately $4.4 million and $3.6 million, respectively. Cash received from the exercise of options for the three and nine months ended September 30, 2006, was approximately $371,400 and $3.5 million, respectively.

Executive 2000 Restricted Stock
 
In 2000, the Company issued 10,750 restricted shares of common stock to executive officers with a grant date fair value of $22.1875 per share. The grant date fair value was determined by the closing trading price of the Company’s shares on the day prior to the date of the grant. These shares vest 10% each over ten years through 2010. The executive officers have the option to accelerate the vesting in lieu of bonuses. As of September 30, 2006, no shares have been vested early. Recipients receive dividend payments on the shares of restricted stock prior to vesting.


 

A summary of the status of the Executive 2000 Restricted Stock nonvested shares as of September 30, 2006, and the changes for the nine months ended September 30, 2006, is presented below:
 

       
Weighted
 
       
Average
 
       
Grant-Date
 
Nonvested Shares
 
Shares
 
Fair Value
 
Nonvested at January 1, 2006
   
5,375
 
$
22.19
 
Granted
   
-
       
Vested
   
(1,075
)
$
22.19
 
Forfeited
   
-
       
Nonvested at March 31, 2006
   
4,300
 
$
22.19
 
Granted
   
-
       
Vested
   
-
       
Forfeited
   
-
       
Nonvested at June 30, 2006
   
4,300
 
$
22.19
 
Granted
   
-
       
Vested
   
-
       
Forfeited
   
-
       
Nonvested at September 30, 2006
   
4,300
 
$
22.19
 

For the three and nine months ended September 30, 2006, compensation costs related to the nonvested shares granted was approximately $6,000 and $17,900, respectively. As of September 30, 2006 there was approximately $81,500 of total unrecognized compensation cost related to nonvested shares granted. This cost is expected to be recognized over the weighted average period of 3.4 years. No shares vested during the three months ended September 30, 2006.

Key Managers 2002 Restricted Stock

In 2002, the Company issued 97,881 restricted shares of common stock to key managers with a grant date fair value of $25.65 per share. The grant date fair value was determined by the closing trading price of the Company’s shares on the day prior to the date of the grant. As a result of three managers leaving the employment of the Company, as of September 30, 2006, only 81,916 shares remain issued. These shares will vest 20% a year for five consecutive years beginning in 2007. Recipients receive dividend payments on the shares of restricted stock prior to vesting.
 
 

 

A summary of the status of the Key Management 2002 Restricted Stock nonvested shares as of September 30, 2006, and the changes for the nine months ended September 30, 2006, is presented below:
 

       
Weighted
 
       
Average
 
       
Grant-Date
 
Nonvested Shares
 
Shares
 
Fair Value
 
Nonvested at January 1, 2006
   
86,477
 
$
25.65
 
Granted
   
-
       
Vested
   
-
       
Forfeited
   
-
       
Nonvested at March 31, 2006
   
86,477
 
$
25.65
 
Granted
   
-
       
Vested
   
-
       
Forfeited
   
(4,561
)
$
25.65
 
Nonvested at June 30, 2006
   
81,916
 
$
25.65
 
Granted
   
-
       
Vested
   
-
       
Forfeited
   
-
       
Nonvested at September 30, 2006
   
81,916
 
$
25.65
 
 

For the three and nine months ended September 30, 2006, compensation costs related to the nonvested shares granted was approximately $55,000 and $164,900, respectively. As of September 30, 2006, there was approximately $1.2 million of total unrecognized compensation cost related to nonvested shares granted. This cost is expected to be recognized over the weighted average period of 5.3 years. No shares vested during the three months ended September 30, 2006.

Executive 2005 Restricted Stock

In 2005, the Company issued 8,852 restricted shares of common stock to executive management under the 2004 Stock Plan with a grant date fair value of $38.50 per share. These shares will vest in two equal amounts in 2006 and 2007. Recipients will receive dividend payments on the shares of restricted stock prior to vesting.

A summary of the status of the Executive 2005 Restricted Stock nonvested shares as of September 30, 2006, and the changes for the nine months ended September 30, 2006, is presented below:
 

       
Weighted
 
       
Average
 
       
Grant-Date
 
Nonvested Shares
 
Shares
 
Fair Value
 
Nonvested at January 1, 2006
   
8,852
 
$
38.50
 
Granted
   
-
       
Vested
   
(4,426
)
$
38.50
 
Forfeited
   
-
       
Nonvested at March 31, 2006
   
4,426
 
$
38.50
 
Granted
   
-
       
Vested
   
-
       
Forfeited
   
-
       
Nonvested at June 30, 2006
   
4,426
 
$
38.50
 
Granted
   
-
       
Vested
   
-
       
Forfeited
   
-
       
Nonvested at September 30, 2006
   
4,426
 
$
38.50
 
 
 

 

For the three and nine months ended September 30, 2006, compensation costs related to the nonvested shares granted was approximately $42,600 and $127,800, respectively. As of September 30, 2006, there was approximately $71,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted. This cost is expected to be recognized over the weighted average period of 0.4 years. No shares vested during the three months ended September 30, 2006.

Director 2005 Restricted Stock Plan

Beginning with the 2005 Annual Meeting of Shareholders, non-employee directors elected to the Board of Directors receive a grant of $75,000 worth of restricted shares of common stock. The shares vest in three equal installments over the director’s three-year term. To begin the program, non-employee directors not sitting for re-election at the 2005 Annual Meeting of Shareholders received a pro-rata grant representing the number of years left in their term. In 2005, 8,596 shares of restricted stock were granted to non-employee directors with a grant date fair value of $40.71 per share. The grant date fair value is determined by the closing trading price of the Company’s shares on the day prior to the date of the grant.

A summary of the status of the Director Restricted Stock nonvested shares as of September 30, 2006, and the changes for the nine months ended September 30, 2006, is presented below:

       
Weighted
 
       
Average
 
       
Grant-Date
 
Nonvested Shares
 
Shares
 
Fair Value
 
Nonvested at January 1, 2006
   
8,596
 
$
40.71
 
Granted
   
73
 
$
56.60
 
Vested
   
-
       
Forfeited
   
(1,228
)
$
40.71
 
Nonvested at March 31, 2006
   
7,441
 
$
40.87
 
Granted
   
-
       
Vested
   
(3,757
)
$
41.02
 
Forfeited
   
-
       
Nonvested at June 30, 2006
   
3,684
 
$
40.71
 
Granted
   
-
       
Vested
   
-
       
Forfeited
   
-
       
Nonvested at September 30, 2006
   
3,684
 
$
40.71
 
 

For the three and nine months ended September 30, 2006, compensation costs related to the nonvested shares granted was approximately $25,000 and $82,900, respectively. As of September 30, 2006, there was approximately $113,400 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted. This cost is expected to be recognized over the weighted average period of 0.6 years. No shares vested during the three months ended September 30, 2006.

Director 2006 Restricted Stock Plan

At the 2006 Annual Meeting of Shareholders 4,774 shares of restricted stock were granted to non-employee directors with a grant date fair value of $52.34 per share. The grant date fair value is determined by the closing trading price of the Company’s shares on the day prior to the date of the grant.
 

 

A summary of the status of the Director Restricted Stock nonvested shares as of September 30, 2006, and the changes for the nine months ended September 30, 2006, is presented below:
 

       
Weighted
 
       
Average
 
       
Grant-Date
 
Nonvested Shares
 
Shares
 
Fair Value
 
Nonvested at January 1, 2006
   
-
       
Granted
   
-
       
Vested
   
-
       
Forfeited
   
-
       
Nonvested at March 31, 2006
   
-
       
Granted
   
4,774
 
$
52.34
 
Vested
   
-
       
Forfeited
   
-
       
Nonvested at June 30, 2006
   
4,774
 
$
52.34
 
Granted
   
-
       
Vested
   
-
       
Forfeited
   
-
       
Nonvested at September 30, 2006
   
4,774
 
$
52.34
 
 

For the three and nine months ended September 30, 2006, compensation costs related to the nonvested shares granted was approximately $18,800 and $28,300, respectively. As of September 30, 2006, there was approximately $221,600 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted. This cost is expected to be recognized over the weighted average period of 1.5 years. No shares vested during the three months ended September 30, 2006.

Key Managers 2005 Restricted Stock

In 2005, the Board of Directors adopted the 2005 Key Management Restricted Stock Plan (the “2005 Plan”), a long-term incentive program for key managers and executive officers. The 2005 Plan grants shares of restricted stock based on a sliding scale of total shareholder return over three 12-month periods ending in 2006, 2007 and 2008. Any restricted stock earned will vest 100% three years after the date of the restricted stock issuance. Recipients will receive dividend payments on the shares of restricted stock during the restriction periods. There is no automatic vesting of the shares. Based on the Company’s performance from July 1, 2005, through June 30, 2006, 25,034 restricted shares of common stock were issued to key managers and executive officers on June 30, 2006.

The fair value of the stock award was estimated on the grant date using a Monte Carlo simulation with the assumptions noted in the following table. Volatility is based on the historical volatility of the Company’s common stock. The expected term of the 2005 Plan is based on the criteria for the plan and the expected life of the awards. The Company uses a U.S. constant-maturity Treasury with the same term as the expected term of the 2005 Plan to represent the risk-free rate. Turnover is based on the historical experience for the key managers and executive officers. The Company uses its current dividend yield at the time of grant to estimate the dividend yield over the life of the plan.


Volatility
   
17.10
%
Expected life in years
   
3
 
Risk-free rate
   
3.77
%
Dividend yield
   
5.20
%
 
 

 

A summary of the status of the 2005 Plan nonvested shares as of September 30, 2006, and the changes for the nine months ended September 30, 2006, is presented below:
 

       
Weighted
 
       
Average
 
       
Grant-Date
 
Nonvested Shares
   
Shares
   
Fair Value
 
Nonvested at January 1, 2006
   
36,691
 
$
45.42
 
Granted
   
-
       
Vested
   
-
       
Forfeited
   
-
       
Nonvested at March 31, 2006
   
36,691
 
$
45.42
 
Granted
   
-
       
Vested
   
-
       
Forfeited
   
-
       
Nonvested at June 30, 2006
   
36,691
 
$
45.42
 
Granted
   
-
       
Vested
   
-
       
Forfeited
   
-
       
Nonvested at September 30, 2006
   
36,691
 
$
45.42
 

For the three and nine months ended September 30, 2006, compensation costs related to the nonvested shares granted was approximately $62,100 and $185,000, respectively. As of September 30, 2006, there was approximately $1.2 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted. The Company’s policy is to recognize compensation cost on a straight-line basis over the requisite service period for an entire award (rather than each portion of an award). Accordingly, the $1.2 million unrecognized cost will be recognized over the weighted average period of 4.8 years. No shares vested during the three months ended September 30, 2006.

Long-Term Performance Based Incentive Plan for Executive Officers

The Compensation Committee by authorization of the Board of Directors of the Company submitted the Long-Term Performance Based Incentive Plan for Executive Officers (the "Long-Term Plan"), which was approved by shareholders on June 2, 2003. The Long-Term Plan allows executive management to earn performance units that convert into shares of restricted stock based on achieving defined total shareholder investment performance levels. Based on the Company’s performance from January 1, 2003, through December 31, 2005, 74,894 restricted shares of common stock were issued to executive management on March 14, 2006. While these shares of restricted stock will be entitled to dividend payments, they will not be transferable or have voting privileges until they vest. Dependent upon the executive officer’s continued employment with the Company, these shares of restricted stock will vest 20% annually from 2006 through 2010.

The fair value of the stock award was estimated on the grant date using a Monte Carlo simulation with the assumptions noted in the following table. Volatility is based on the historical volatility of the Company’s common stock. The expected term of the Long-Term Plan is based on the criteria for the plan and the expected life of the awards. The Company uses a U.S. constant-maturity Treasury for the same term as the expected term of the Long-Term Plan to represent the risk-free rate. Turnover is based on the historical experience for the key managers and executive officers. The Company uses its current dividend yield at the time of grant to estimate the dividend yield over the life of the plan.
 

Volatility
   
6.38
%
Expected life in years
   
3
 
Risk-free rate
   
1.99
%
Dividend yield
   
9.60
%
 
 

 

A summary of the status of the Long-Term Plan nonvested shares as of September 30, 2006, and the changes for the nine months ended September 30, 2006, is presented below:

       
Weighted
 
       
Average
 
       
Grant-Date
 
Nonvested Shares
 
Shares
 
Fair Value
 
Nonvested at January 1, 2006
   
75,895
 
$
34.72
 
Granted
   
-
       
Vested
   
-
       
Forfeited
   
-
       
Nonvested at March 31, 2006
   
75,895
 
$
34.72
 
Granted
   
-
       
Vested
   
-
       
Forfeited
   
-
       
Nonvested at June 30, 2006
   
75,895
 
$
34.72
 
Granted
   
-
       
Vested
   
-
       
Forfeited
   
-
       
Nonvested at September 30, 2006
   
75,895
 
$
34.72
 

For the three and nine months ended September 30, 2006, compensation costs related to the nonvested shares granted was approximately $10,300 and $31,000, respectively. As of September 30, 2006, there was approximately $176,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted. This unrecognized cost will be recognized over the weighted average period of 4.3 years. No shares vested during the three months ended September 30, 2006.

3. COMPREHENSIVE INCOME

Total comprehensive income and its components for the three and nine month periods ended September 30, 2006 and 2005, were as follows (dollars in thousands):
 

   
Three months
 
Nine months
 
   
ended September 30,
 
ended September 30,
 
   
2006
 
2005
 
2006
 
2005
 
                   
Net income
 
$
5,630
 
$
3,615
 
$
16,648
 
$
16,134
 
Marked-to-market adjustment
                         
on derivative instruments
   
(13,634
)
 
13,721
   
3,871
   
16,029
 
Total comprehensive income
 
$
(8,004
)
$
17,336
 
$
20,519
 
$
32,163
 
 

The marked-to-market adjustment on derivative instruments is based upon the change of interest rates available for derivative instruments with similar terms and remaining maturities existing at each balance sheet date.
 
4. DERIVATIVE FINANCIAL INSTRUMENTS

In the normal course of business, the Company uses certain derivative financial instruments to manage, or hedge, the interest rate risk associated with the Company’s variable rate debt or as hedges in anticipation of future debt transactions to manage well-defined interest rate risk associated with the transaction.

The Company does not use derivative financial instruments for speculative or trading purposes. Further, the Company has a policy of entering into contracts with major financial institutions based upon their credit rating and other factors. When viewed in conjunction with the underlying and offsetting exposure that the derivatives are designated to hedge, the Company has not sustained any material loss from those instruments nor does it anticipate any material adverse effect on its net income or financial position in the future from the use of derivatives.

The Company requires that derivative financial instruments designated as cash flow hedges be effective in reducing the interest rate risk exposure that they are designated to hedge. This effectiveness is essential for qualifying for hedge accounting. Instruments that meet the hedging criteria are formally designated as hedging instruments at the inception of the derivative contract. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking the hedge transaction. This process includes linking all derivatives that are designated as fair value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the inception of the hedging relationship and on an ongoing basis, whether the derivatives used are highly effective in offsetting changes in fair values or cash flows of hedged items. When it is determined that a derivative has ceased to be a highly effective hedge, the Company discontinues hedge accounting prospectively.

All of the Company’s derivative financial instruments are reported at fair value and represented on the balance sheet, and are characterized as cash flow hedges. These transactions hedge the future cash flows of debt transactions through interest rate swaps that convert variable payments to fixed payments and interest rate caps that limit the exposure to rising interest rates. The unrealized gains/losses in the fair value of these hedging instruments are reported on the balance sheet with a corresponding adjustment to accumulated other comprehensive income, with any ineffective portion of the hedging transactions reclassified to earnings. During the three and nine month periods ended September 30, 2006 and 2005, the ineffective portion of the hedging transactions was not significant.
 
 

 

5. SHARE AND UNIT INFORMATION

At September 30, 2006, 24,489,874 common shares and 2,493,325 operating partnership units were outstanding, representing a total of 26,983,199 shares and units. Additionally, the Company had outstanding options for 232,452 shares of common stock at September 30, 2006, of which 99,743 were anti-dilutive. At September 30, 2005, 21,748,081 common shares and 2,615,419 operating partnership units were outstanding, representing a total of 24,363,500 shares and units. Additionally, the Company had outstanding options for 404,918 shares of common stock at September 30, 2005, of which 217,782 were anti-dilutive.

6. REAL ESTATE ACQUISITIONS  

On September 6, 2006, the Company acquired the Reserve at Woodwind Lakes apartments, a 328-unit community located in Houston, Texas.

On September 29, 2006, the Company acquired the Talus Ranch and Sansol apartments, representing a total of 480 units in Phoenix, Arizona. The Company plans to operate the two properties as one community.

7. DISCONTINUED OPERATIONS

As part of the Company’s disposition strategy to selectively dispose of mature assets that no longer meet the Company’s investment criteria and long-term strategic objectives, as of March 31, 2005, the Company was in negotiations to sell the Eastview apartments, a 432-unit community located in Memphis, Tennessee. In accordance with Statement No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets, (“Statement 144”) the community was considered held for sale in the accompanying condensed consolidated financial statements. The sale of the Eastview apartments was subsequently completed on April 1, 2005.

In April 2006, the Company entered into an agreement to list the 184-unit Gleneagles apartments and the 200-unit Hickory Farm apartments both located in Memphis, Tennessee, for sale. In accordance with Statement 144 these communities were considered held for sale in the accompanying condensed consolidated financial statements.


 

The following is a summary of discontinued operations for the three and nine months ended September 30, 2006, and 2005, (dollars in thousands):

   
Three Months Ended
 
Nine Months Ended
 
   
September 30,
 
September 30,
 
   
2006
 
2005
 
2006
 
2005
 
                   
Revenues
                 
Rental revenues
 
$
597
 
$
586
 
$
1,826
 
$
2,382
 
Other revenues
   
24
   
24
   
75
   
56
 
Total revenues
   
621
   
610
   
1,901
   
2,438
 
Expenses
                         
Property operating expenses
   
351
   
476
   
1,153
   
2,078
 
Interest expense
   
109
   
81
   
311
   
213
 
Asset impairment
   
-
   
-
   
-
   
243
 
Total expense
   
460
   
557
   
1,464
   
2,534
 
Income (loss) from discontinued operations before
                         
gain on sale and settlement proceeds
   
161
   
53
   
437
   
(96
)
Net loss on insurance and other settlement
                         
proceeds
   
-
   
-
   
-
   
(25
)
Income (loss) from discontinued operations
 
$
161
 
$
53
 
$
437
 
$
(121
)
 

8. SEGMENT INFORMATION

At September 30, 2006, the Company owned or had an ownership interest in 137 multifamily apartment communities, including the apartment communities owned by the Company’s joint venture, in 13 different states from which it derives all significant sources of earnings and operating cash flows. The Company’s operational structure is organized on a decentralized basis, with individual property managers having overall responsibility and authority regarding the operations of their respective properties. Each property manager individually monitors local and area trends in rental rates, occupancy percentages, and operating costs. Property managers are given the on-site responsibility and discretion to react to such trends in the best interest of the Company. The Company’s chief operating decision maker evaluates the performance of each individual property based on its contribution to net operating income in order to ensure that the individual property continues to meet the Company’s return criteria and long-term investment goals. The Company defines each of its multifamily communities as an individual operating segment. It has also determined that all of its communities have similar economic characteristics and also meet the other criteria which permit the communities to be aggregated into one reportable segment, which is acquisition and operation of the multifamily communities owned.

9. SUBSEQUENT EVENTS

On October 12, 2006, the Company acquired the Oaks at Wilmington Island apartments, a 306-unit community located in Savannah, Georgia.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The following discussion and analysis of financial condition and results of operations are based upon the Company’s condensed consolidated financial statements, and the notes thereto, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these condensed consolidated financial statements requires the Company to make a number of estimates and assumptions that affect the reported amounts and disclosures in the condensed consolidated financial statements. On an ongoing basis, the Company evaluates its estimates and assumptions based upon historical experience and various other factors and circumstances. The Company believes that its estimates and assumptions are reasonable in the circumstances; however, actual results may differ from these estimates and assumptions.

The Company believes that the estimates and assumptions that are most important to the portrayal of its financial condition and results of operations, in that they require the most subjective determinations, form the basis of accounting policies deemed to be most critical. These critical accounting policies include revenue recognition, capitalization of expenditures and depreciation of assets, impairment of long-lived assets, including goodwill, and fair value of derivative financial instruments.
 
 

 

Revenue Recognition

The Company leases multifamily residential apartments under operating leases primarily with terms of one year or less. Rent and other property income is recorded when due from residents and is recognized monthly as it is earned. Other property income consists primarily of utility rebillings, other expense reimbursements, and administrative, application and other fees charged to residents. Interest, management fees, and all other sources of income are recognized as earned.

The Company records all gains and losses on real estate in accordance with Statement No. 66 Accounting for Sales of Real Estate.

Capitalization of expenditures and depreciation of assets

The Company carries its real estate assets at their depreciated cost. Depreciation is computed on a straight-line basis over the estimated useful lives of the related assets, which range from 8 to 40 years for land improvements and buildings, 5 years for furniture, fixtures, and equipment, and 3 to 5 years for computers and software, all of which are subjective determinations. Repairs and maintenance costs are expensed as incurred while significant improvements, renovations, and replacements are capitalized. The cost to complete any deferred repairs and maintenance at properties acquired by the Company in order to elevate the condition of the property to the Company’s standards are capitalized as incurred.

Development costs, which are limited to adding new units to three existing properties, are capitalized in accordance with Statement No. 67, Accounting for Costs and Initial Rental Operations of Real Estate Projects.

Impairment of long-lived assets, including goodwill

The Company accounts for long-lived assets in accordance with the provisions of Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“Statement 144”) and evaluates its goodwill for impairment under Statement No. 142, Goodwill and Other Intangible Assets (“Statement 142”). The Company evaluates its goodwill for impairment on an annual basis in the Company’s fiscal fourth quarter, or sooner if a goodwill impairment indicator is identified. The Company periodically evaluates its long-lived assets, including its investments in real estate and goodwill, for indicators that would suggest that the carrying amount of the assets may not be recoverable. The judgments regarding the existence of such indicators are based on factors such as operating performance, market conditions, and legal factors.

In accordance with Statement 144, long-lived assets, such as real estate assets, equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of are separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposed group classified as held for sale are presented separately in the appropriate asset and liability sections of the balance sheet.


 

Goodwill is tested annually for impairment, and is tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. This determination is made at the reporting unit level and consists of two steps. First, the Company determines the fair value of a reporting unit and compares it to its carrying amount. In the apartment industry, the primary method used for determining fair value is to divide annual operating cash flows by an appropriate capitalization rate. The Company determines the appropriate capitalization rate by reviewing the prevailing rates in a property’s market or submarket. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in accordance with Statement No. 141, Business Combinations. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill.

Fair value of derivative financial instruments

The Company utilizes certain derivative financial instruments, primarily interest rate swaps and caps, during the normal course of business to manage, or hedge, the interest rate risk associated with the Company’s variable rate debt or as hedges in anticipation of future debt transactions to manage well-defined interest rate risk associated with the transaction. The valuation of the derivative financial instruments under Statement No. 133 Accounting for Derivative Instruments and Hedging Activities, as amended, requires the Company to make estimates and judgments that affect the fair value of the instruments.

In order for a derivative contract to be designated as a hedging instrument, the relationship between the hedging instrument and the hedged item must be highly effective. While the Company’s calculation of hedge effectiveness contains some subjective determinations, the historical correlation of the cash flows of the hedging instruments and the underlying hedged item are measured by the Company before entering into the hedging relationship and have been found to be highly correlated.

The Company measures ineffectiveness using the change in the variable cash flows method at the inception of the hedge and for each reporting period thereafter, through the term of the hedging instruments. Any amounts determined to be ineffective are recorded in earnings. The change in fair value of the interest rate swaps and caps designated as cash flow hedges are recorded to accumulated other comprehensive income in the statement of shareholders’ equity.

OVERVIEW OF THE THREE MONTHS ENDED SEPTEMBER 30, 2006

The Company’s operating results for the three months ended September 30, 2006, benefited from continued improvement in market conditions, helping the Company grow occupancy from the prior quarter and increase rental rates at the Company’s communities. The Company also benefited from the increase in the number of apartments owned.
 

   
September 30, 2006
 
September 30, 2005
 
Total Portfolio (includes partial ownership in joint ventures)
         
Number of apartment units
   
39,987
   
38,227
 
Number of apartment communities
   
137
   
132
 
               
100% Owned (excludes partial ownership in joint ventures)
             
Number of apartment units
   
39,465
   
37,705
 
Number of apartment communities
   
136
   
131
 
Average monthly rent (excluding joint ventures)
 
$
720
 
$
691
 
Average physical occupancy (excluding joint ventures)
   
95.8
%
 
96.2
%

Increasing operating and administrative expenses offset some of the benefit of the revenue increases.

The following is a discussion of the consolidated financial condition and results of operations of the Company for the three and nine months ended September 30, 2006. This discussion should be read in conjunction with the condensed consolidated financial statements appearing elsewhere in this report. These financial statements include all adjustments, which are, in the opinion of management, necessary to reflect a fair statement of the results for the interim period presented, and all such adjustments are of a normal recurring nature.
 



RESULTS OF OPERATIONS

COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 2006 TO THE THREE MONTHS ENDED SEPTEMBER 30, 2005

Property revenues for the three months ended September 30, 2006, increased by approximately $7,825,000 from the three months ended September 30, 2005, due to (i) a $2,545,000 increase in property revenues from the five properties acquired in 2006 (the “2006 Acquisitions”), (ii) a $285,000 increase in property revenues from the two properties acquired after the first quarter of 2005 (the “Two 2005 Acquisitions”), and (iii) a $4,995,000 increase in property revenues from all other communities. The increase in property revenues from all other communities was generated primarily by the Company’s same store portfolio and was driven by a 3.6% increase in average rent per unit and a reduction of concessions from 4.4% to 3.1% from the third quarter of 2005 to the third quarter of 2006.

Property operating expenses include costs for property personnel, building repairs and maintenance, real estate taxes and insurance, utilities, landscaping and other property related costs. Property operating expenses for the three months ended September 30, 2006, increased by approximately $2,746,000 from the three months ended September 30, 2005, due primarily to increases of property operating expenses of (i) $1,240,000 from the 2006 Acquisitions, (ii) $173,000 from the Two 2005 Acquisitions, and (iii) $1,333,000 from all other communities. The increase in property operating expenses from all other communities consisted primarily of the Company’s same store portfolio and was driven by an increase in insurance expense of $669,000 over the same quarter last year as a result of higher premiums incurred upon the Company’s policy renewal on July 1, 2006, and a 7.7% increase in utility rates as the Company experienced an increase in electricity, natural gas and water and sewer prices.

Depreciation expense increased by approximately $596,000 primarily due to the increases of depreciation expense of (i) $322,000 from the 2006 Acquisitions, (ii) $70,000 from the Two 2005 Acquisitions, and (iii) $811,000 from all other communities. Increases of depreciation expense from all other communities resulted from asset additions made during the normal course of business. These increases were partially offset by a net decrease in depreciation expense of (i) $607,000 from the expiration of the amortization of fair market value of leases of acquired communities.

Property management expenses increased by approximately $867,000 from the third quarter of 2005 to the third quarter of 2006 primarily related to an increase in personnel incentives and franchise and excise taxes both resulting from improved property operations. General and administrative expenses increased by approximately $336,000 over this same period. No individual items accounted for any significant amount of the increase.

Interest expense increased approximately $254,000 in the three months ended September 30, 2006, from the three months ended September 30, 2005, primarily due to the increase in the amount of debt outstanding of $1.14 billion at September 30, 2005, to $1.20 billion at September 30, 2006, and the increase in the Company’s average borrowing cost by 4 basis points from 5.39% over the three months ended September 30, 2005, to 5.43% over the three months ended September 30, 2006.

In the three months ended September 30, 2005, the Company benefited from a net gain on insurance and other settlement proceeds of approximately $874,000 mainly related to hurricane related claims.

Primarily as a result of the foregoing, net income increased by approximately $2,015,000 in the third quarter of 2006 from the third quarter of 2005.


 

COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2006 TO THE NINE MONTHS ENDED SEPTEMBER 30, 2005

Property revenues for the nine months ended September 30, 2006, increased by approximately $22,745,000 from the nine months ended September 30, 2005, due to (i) a $5,119,000 increase in property revenues from the 2006 Acquisitions, (ii) a $4,966,000 increase in property revenues from the three properties acquired in 2005 (the “2005 Acquisitions”), and (iii) $12,660,000 increase in property revenues from all other communities. The increase in property revenues from all other communities was generated primarily by the Company’s same store portfolio and was driven by increased average rent per unit over 2005.

Property operating expenses include costs for property personnel, building repairs and maintenance, real estate taxes and insurance, utilities, landscaping and other property related costs. Property operating expenses for the nine months ended September 30, 2006, increased by approximately $7,053,000 from the nine months ended September 30, 2005, due primarily to increases of property operating expenses of (i) $2,348,000 from the 2006 Acquisitions, (ii) $1,816,000 from the 2005 Acquisitions, and (iii) $2,889,000 from all other communities. The increase in property operating expenses from all other communities consisted primarily of the Company’s same store portfolio and was driven by an increase in personnel expense as higher occupancy in the first two quarters drove overtime and contract labor expenses above the levels experienced in the prior year and increases in utility rates as the Company experienced an increase in electricity, natural gas and water and sewer prices in the first nine months of 2006.

Depreciation expense increased by approximately $2,747,000 primarily due to the increases of depreciation expense of (i) $955,000 from the 2006 Acquisitions, (ii) $1,249,000 from the 2005 Acquisitions, and (iii) $1,652,000 from all other communities. Increases of depreciation expense from all other communities resulted from asset additions made during the normal course of business. These increases were partially offset by a net decrease in depreciation expense of (i) $1,109,000 from the expiration of the amortization of fair market value of leases of acquired communities.

Property management expenses increased by approximately $1,142,000 from the first nine months of 2005 to the first nine months of 2006 primarily related to an increase in personnel incentives and franchise and excise taxes both resulting from improved property operations. General and administrative expenses increased by approximately $1,560,000 over this same period partially related to increased salaries and an increase in cash bonuses earned related to 2005 performance results as determined by the Board of Directors.

Interest expense increased approximately $3,715,000 in the nine months ended September 30, 2006, from the nine months ended September 30, 2005, primarily due to the increase in the amount of debt outstanding of $1.14 billion at September 30, 2005, to $1.20 billion at September 30, 2006, and the increase in the Company’s average borrowing cost by 20 basis points from 5.21% over the nine months ended September 30, 2005, to 5.41% over the nine months ended September 30, 2006.

In the first nine months of 2006, the Company refinanced the debt on four of its communities primarily to take advantage of the lower interest rate environment. This resulted in a loss on debt extinguishment of approximately $551,000.

In the nine months ended September 30, 2005, the Company benefited from the sale of two properties which it 33.33% owned through a joint venture. The sale of these properties resulted in a gain to the Company of approximately $3,034,000 as well as an incentive fee of $1,723,000. In this same period, the Company recorded a gain of approximately $334,000 from the sale of land.

Primarily as a result of the foregoing, net income increased by approximately $514,000 in the first nine months of 2006 from the first nine months of 2005.

FUNDS FROM OPERATIONS AND NET INCOME

Funds from operations (“FFO”) represents net income (computed in accordance with U.S. generally accepted accounting principles, or “GAAP”) excluding extraordinary items, minority interest in Operating Partnership income, gain on disposition of real estate assets, plus depreciation of real estate, and adjustments for joint ventures to reflect FFO on the same basis. This definition of FFO is in accordance with the National Association of Real Estate Investment Trust’s (“NAREIT”) definition. Disposition of real estate assets includes sales of discontinued operations as well as proceeds received from insurance and other settlements from property damage.



In response to the Securities and Exchange Commission’s Staff Policy Statement relating to EITF Topic D-42 concerning the calculation of earnings per share for the redemption of preferred stock, the Company has included the amount charged to retire preferred stock in excess of carrying values in its FFO calculation.

The Company's policy is to expense the cost of interior painting, vinyl flooring, and blinds as incurred for stabilized properties. During the stabilization period for acquisition properties, these items are capitalized as part of the total repositioning program of newly acquired properties, and, thus are not deducted in calculating FFO.

FFO should not be considered as an alternative to net income or any other GAAP measurement of performance, as an indicator of operating performance or as an alternative to cash flow from operating, investing, and financing activities as a measure of liquidity. The Company believes that FFO is helpful to investors in understanding the Company's operating performance in that such calculation excludes depreciation expense on real estate assets. The Company believes that GAAP historical cost depreciation of real estate assets is generally not correlated with changes in the value of those assets, whose value does not diminish predictably over time, as historical cost depreciation implies. The Company’s calculation of FFO may differ from the methodology for calculating FFO utilized by other REITs and, accordingly, may not be comparable to such other REITs.

The following table is a reconciliation of FFO to net income for the three and nine months ended September 30, 2006, and 2005 (dollars and shares in thousands):
 

   
Three months
 
Nine months
 
   
ended September 30,
 
ended September 30,
 
   
2006
 
2005
 
2006
 
2005
 
Net income
 
$
5,630
 
$
3,615
 
$
16,648
 
$
16,134
 
Depreciation of real estate assets
   
19,286
   
18,682
   
56,890
   
54,151
 
Net loss (gain) on insurance and other settlement proceeds
   
54
   
(874
)
 
(171
)
 
(865
)
Gain on dispositions within real estate joint ventures
   
-
   
-
   
-
   
(3,034
)
Net loss on insurance and other settlement proceeds
                         
of discontinued operations
   
-
   
-
   
-
   
25
 
Depreciation of real estate assets of
                         
discontinued operations
   
-
   
159
   
160
   
477
 
Depreciation of real estate assets of
                         
real estate joint ventures
   
118
   
116
   
379
   
363
 
Preferred dividend distribution
   
(3,491
)
 
(3,490
)
 
(10,472
)
 
(10,838
)
Minority interest in operating partnership income
   
375
   
91
   
1,196
   
1,129
 
Funds from operations
 
$
21,972
 
$
18,299
 
$
64,630
 
$
57,542
 
                           
Weighted average shares and units:
                         
Basic
   
26,491
   
24,168
   
25,609
   
23,907
 
Diluted
   
26,716
   
24,465
   
25,835
   
24,192
 
 

FFO for the three and nine months ended September 30, 2006, increased primarily as the result of improved property performance.

TRENDS

In the third quarter of 2006, property performance continued to show the benefit of improving market conditions, which was strong throughout most of the Company’s markets. Areas that had been weak for several years, especially Atlanta, Dallas, and Austin, continued to show improved demand.

The Company believes that the primary driver of demand by apartment residents is job formation, and this continued to show solid momentum in most of the Company’s larger metro areas. Some of the smaller and mid-size markets in which the Company operates, such as Jackson, MS, Jacksonville, FL, and Columbus, GA remained reasonably strong during the market downturn that preceded this period, and continued to show solid performance. At the same time, the Company has noticed that in some of its markets, supply pressures have been surprisingly muted, and it believes that two factors are at work. In some markets, especially in Florida, some apartment communities have been taken off the rental market and converted to condominiums. Construction and development costs for new apartments also seem to have risen substantially for a variety of reasons, and this has made the economics of building apartments to compete with the Company’s properties less attractive. Rising interest rates have impacted developers’ costs, and this may also have reduced the amount of competition that we face from single-family homes. The cooling of housing markets may also have caused some first time home buyers to delay their purchases.
 


The Company faces cost pressures from increasing operating expenses, especially insurance and real estate tax costs, as well as increasing prices on materials that it uses in maintaining its apartments.

The Company believes that this situation of improved demand, a reduced rate of increase in supply, and reduced competition from single family homes, even while somewhat offset by rising expenses, will continue to contribute to better operating results for the balance of the year. 

LIQUIDITY AND CAPITAL RESOURCES

Net cash flow provided by operating activities increased by approximately $835,000 from $76.3 million in the first nine months of 2005 to $77.2 million in the first nine months of 2006 primarily resulting from an increase in cash flows from improved property operations during the first nine months of 2006 over the same period in 2005.

Net cash used in investing activities increased during the first nine months of 2006 from the first nine months of 2005 to approximately $193.7 million from $97.5 million mainly related to the additional $62.1 million of cash used for acquisitions in the first nine months of 2006 over 2005. During the first nine months of 2005, the Company received distributions from its real estate joint ventures of $14.8 million which included the Company’s portion from the sale of two properties in one of its joint ventures, a payoff to the Company of a mezzanine loan and an incentive fee. Distributions from real estate joint ventures for the first nine months of 2006 totaled only $208,000.

The first nine months of 2006 provided net cash from financing activities of $110.2 million while the first nine months of 2005 provided net cash from financing activities of $22.1 million. This change was driven by a $76.3 million increase in proceeds from issuances of common shares over these periods as the Company raised $59.5 million from a public offering in May 2006. The Company has also issued approximately $53.5 million of common shares through its direct stock purchase program through the first nine months of 2006 compared to $23.0 million in the first nine months of 2005.

The weighted average interest rate at September 30, 2006, for the $1.20 billion of debt outstanding was 5.6% compared to 5.4% on $1.14 billion of debt outstanding at September 30, 2005. The Company utilizes both conventional and tax exempt debt to help finance its activities. Borrowings are made through individual property mortgages and secured credit facilities. The Company utilizes fixed rate borrowings, interest rate swaps and interest rate caps to manage its current and future interest rate risk. More details on the Company’s borrowings can be found in the schedule presented later in this section.

At September 30, 2006, the Company had secured credit facilities relationships with Prudential Mortgage Capital which are credit enhanced by the Federal National Mortgage Association (“FNMA”), Federal Home Loan Mortgage Corporation (“Freddie MAC”), and a group of banks led by AmSouth Bank. Together, these credit facilities provided a total borrowing capacity and availability to borrow of $1.1 billion at September 30, 2006. The Company had total borrowings outstanding under these credit facilities of $997 million at September 30, 2006.

Approximately 71% of the Company’s outstanding obligations at September 30, 2006, were borrowed through facilities with/or credit enhanced by FNMA (the “FNMA Facilities”). The FNMA Facilities have a combined line limit of $950 million, $947 million of which was available to borrow at September 30, 2006. The Company had total borrowings outstanding under the FNMA Facilities of $859 million at September 30, 2006. Various traunches of the facilities mature from 2010 through 2014. The FNMA Facilities provide for both fixed and variable rate borrowings. The interest rate on the majority of the variable portion renews every 90 days and is based on the FNMA Discount Mortgage Backed Security (“DMBS”) rate on the date of renewal, which has typically approximated three-month LIBOR less an average spread of 0.05% over the life of the FNMA Facilities, plus a credit enhancement fee of 0.62% to 0.795%.

Each of the Company’s secured credit facilities is subject to various covenants and conditions on usage, and are subject to periodic re-evaluation of collateral. If the Company were to fail to satisfy a condition to borrowing, the available credit under one or more of the facilities could not be drawn, which could adversely affect the Company’s liquidity. In the event of a reduction in real estate values the amount of available credit could be reduced. Moreover, if the Company were to fail to make a payment or violate a covenant under a credit facility, after applicable cure periods one or more of its lenders could declare a default, accelerate the due date for repayment of all amounts outstanding and/or foreclose on properties securing such facilities. Any such event could have a material adverse effect on the Company.

As of September 30, 2006, the Company had interest rate swaps in effect totaling a notional amount of $679 million. To date, these swaps have proven to be highly effective hedges. The Company also had interest rate cap agreements totaling a notional amount of approximately $42 million.
 
 

 

Summary details of the debt outstanding at September 30, 2006, follow in the table below:
 

           
Outstanding
             
           
Balance/
 
Average
 
Average
 
Average
 
   
Line
 
Line
 
Notional
 
Interest
 
Rate
 
Contract
 
   
Limit
 
Availability
 
Amount
 
Rate
 
Maturity
 
Maturity
 
                           
COMBINED DEBT
                         
Fixed Rate or Swapped
                         
Conventional 
             
$
876,294,192
   
5.6
%
 
8/1/2011
   
8/1/2011
 
Tax Exempt 
               
73,640,000
   
4.3
%
 
1/27/2012
   
1/27/2012
 
 Subtotal Fixed Rate or Swapped
               
949,934,192
   
5.5
%
 
8/14/2011
   
8/14/2011
 
Variable Rate
                                     
Conventional 
               
199,401,963
   
6.0
%
 
10/3/2006
   
8/19/2012
 
Tax Exempt 
               
10,855,004
   
4.5
%
 
10/15/2006
   
5/30/2020
 
Conventional - Capped 
               
17,936,000
   
5.9
%
 
11/13/2009
   
11/13/2009
 
Tax Exempt - Capped 
               
24,090,000
   
4.4
%
 
11/25/2009
   
11/25/2009
 
 Subtotal Variable Rate
               
252,282,967
   
5.8
%
 
10/4/2006
   
3/2/2013
 
Total Combined Debt Outstanding
             
$
1,202,217,159
   
5.6
%
 
8/7/2010
   
12/11/2011
 
                                       
UNDERLYING DEBT
                                     
Individual Property Mortgages/Bonds
                                     
Conventional Fixed Rate 
             
$
148,294,192
   
5.0
%
 
3/24/2015
   
3/24/2015
 
Tax Exempt Fixed Rate 
               
12,310,000
   
5.2
%
 
12/1/2028
   
12/1/2028
 
Tax Exempt Variable Rate 
               
4,760,004
   
4.6
%
 
10/15/2006
   
6/1/2028
 
FNMA Credit Facilities
                                     
Tax Free Borrowings 
 
$
91,515,000
 
$
91,515,000
   
91,515,000
   
4.4
%
 
10/15/2006
   
3/1/2014
 
Conventional Borrowings 
                                     
 Fixed Rate Borrowings
   
110,000,000
   
110,000,000
   
110,000,000