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, 2003March 31, 2004
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 001-13106
Essex Property Trust, Inc.
(Exact name of Registrant as Specified in its Charter)
925 East Meadow Drive
Palo Alto, California 94303
(Address of Principal Executive Offices including Zip Code)
(650) 494-3700
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file reports), and (2) has been subject to such 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 Securities Exchange Act of 1934). 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:
22,788,64222,884,242 shares of Common Stock as of November 1, 2003April 30, 2004
ESSEX PROPERTY TRUST, INC.
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION | Page No. |
Item 1. Financial Statements (Unaudited): | |
Consolidated Balance Sheets as of | |
Consolidated Statements of Operations for the three months ended | |
Consolidated Statements of Stockholders' Equity for the ended | |
Condensed Consolidated Statements of Cash Flows for the | |
Notes to Consolidated Financial Statements | |
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations | |
Item 3. Quantitative and Qualitative Disclosures About Market Risk | |
Item 4. Controls and Prodedures | |
PART II. OTHER INFORMATION | |
Item 2. Changes in Securities and Use of Proceeds | |
Item 6. Exhibits and Reports on Form 8-K | |
Signature |
2
Explanatory Note: This Filing is the subject of a previously filed Form 12b-25.
Part I -- Financial Information
Item 1. Financial Statements (Unaudited)
"Essex" or the "Company" means Essex Property Trust, Inc., a real estate investment trust incorporated in the State of Maryland, or where the context otherwise requires, Essex Portfolio, L.P., a limited partnership (the "Operating Partnership") in which Essex Property Trust, Inc. is the sole general partner.
The information furnished in the accompanying consolidated unaudited balance sheets, statements of operations, stockholders' equity and cash flows of the Company reflects all adjustments which are, in the opinion of management, necessary for a fair presentation of the aforementioned consolidated financial statements for the interim periods.
The accompanying unaudited consolidated financial statements should be read in conjunction with the notes to such consolidated financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations. Additionally, these unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's annual report on Form 10-K for the year ended December 31, 2003.
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ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Unaudited)
(Dollars in thousands, except per share amounts)
September 30,March 31, December 31, 2004 20032002(1) ------------ ------------ Assets Real estate: Rental properties: Land and land improvements $392,156496,130 $368,712469,347 Buildings and improvements1,212,194 1,147,2441,654,365 1,514,775 ------------ ------------1,604,350 1,515,9562,150,495 1,984,122 Less accumulated depreciation(227,300) (191,821)(284,203) (265,763) ------------ ------------1,377,050 1,324,1351,866,292 1,718,359 Investments88,831 61,21283,125 79,567 Real estate under development96,203 143,75662,942 55,183 ------------ ------------1,562,084 1,529,1032,012,359 1,853,109 Cash and cash equivalents-unrestricted10,400 8,56217,709 14,768 Cash and cash equivalents-restricted10,072 9,265 Notes receivable from investees and related parties 18,620 24,08117,313 11,175 Notes and other receivables34,873 31,318from related parties 5,338 5,738 Notes and other receivables 6,105 6,021 Prepaid expenses and other assets17,584 11,13321,215 17,426 Deferred charges, net5,448 6,2729,757 8,574 ------------ ------------ $1,659,0812,089,796 $1,619,7341,916,811 ============ ============ Liabilities and Stockholders' Equity Mortgage notes payable $664,596967,392 $677,563891,798 Lines of credit162,700 126,500199,100 93,100 Accounts payable and accrued liabilities32,792 35,79129,938 24,981 Dividends payable20,527 17,87922,955 22,379 Other liabilities8,535 8,15710,871 10,011 ------------ ------------ Total liabilities889,150 865,8901,230,256 1,042,269 Minority interests263,683 262,530289,346 293,143 Stockholders' equity: Common stock, $.0001 par value, 655,682,178 and 656,682,178 authorized,21,186,94222,880,642 and20,983,19322,825,942 issued and outstanding 2 2 Cumulative redeemable preferred stock; $.0001 par value: No shares issued and outstanding: 7.875% Series B 2,000,000 shares authorized -- -- 9.125% Series C 500,000 shares authorized -- -- 9.30% Series D 2,000,000 shares authorized -- -- 9.25% Series E 2,200,000 shares authorized -- -- 7.8125% Series F 1,000,000 and no shares authorized, 1,000,000 and no shares issued and outstanding, liquidation value 25,000--25,000 Excess stock, $.0001 par value, 330,000,000 shares authorized and no shares issued and outstanding -- -- Additional paid-in capital544,252 535,125643,552 642,643 Distributions in excess of accumulated earnings(63,006) (43,813)(98,360) (86,246) ------------ ------------ Total stockholders' equity506,248 491,314570,194 581,399 ------------ ------------ Commitments and contingencies $1,659,0812,089,796 $1,619,7341,916,811 ============ ============
(1) The December 31, 2003 consolidated balance sheet has been restated for the retroactive adoption of the provisions of FIN 46 Revised and SFAS 123 as discussed in Note 1.
See accompanying notes to the consolidated unaudited financial statements.
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ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(Unaudited)
(Dollars in thousands, except per share amounts)
Three Months EndedNine Months Ended September 30, September 30,March 31, ------------------------------------------------2004 20032002 2003 2002 ----------- -----------(1) ----------- ----------- Revenues: $ 64,229 $ 61,955 Rental$ 53,431 $ 42,337 $ 161,131 $ 126,2232,102 2,064 Other property1,824 1,292 5,301 4,004----------- ---------------------- -----------66,331 64,019 Total property55,255 43,629 166,432 130,2273,475 2,266 Interest and other2,982 5,166 9,247 18,961----------- ---------------------- -----------69,806 66,285 Total revenues58,237 48,795 175,679 149,188 ----------- ---------------------- ----------- Expenses: Property operating expenses: 4,383 4,399 Maintenance and repairs4,540 2,965 12,476 8,1315,544 4,829 Real estate taxes4,407 3,158 13,144 9,4263,014 2,902 Utilities3,303 2,050 9,015 6,3336,916 6,841 Administrative4,377 3,403 14,950 10,075840 963 Advertising1,016 658 2,878 2,0111,144 856 Insurance883 604 2,464 1,43618,432 13,302 Depreciation and amortization12,308 9,129 35,473 27,229----------- ---------------------- ----------- 30,834 21,967 90,400 64,64140,273 34,092 14,310 13,207 Interest10,528 8,621 31,858 26,062273 220 Amortization of deferred financing costs333 147 825 4422,930 2,309 General and administrative1,678 1,482 5,208 4,747----------- ---------------------- -----------57,786 49,828 Total expenses43,373 32,217 128,291 95,892 ----------- ---------------------- ----------- Incomefrom continuing operationsbefore minority interestsand discontinued operations 14,864 16,578 47,388 53,29612,020 16,457 Minority interests(5,604) (5,964) (17,247) (18,313) ----------- ----------- ----------- ----------- Income from continuing operations 9,260 10,614 30,141 34,983 Discontinued operations (net of minority interests): Income from real estate sold -- -- -- 225 Gain on sale of real estate -- -- -- 8,061 ----------- -----------(5,570) (6,812) ----------- ----------- Net income 6,450 9,645 Dividends to preferred stockholders - Series F (488) -- ----------- ----------- Net income available to common stockholders $9,2605,962 $10,614 $ 30,141 $ 43,269 =========== ===========9,645 =========== =========== Per common share data: Basic:Income from continuing operations $ 0.44 $ 0.58 $ 1.43 $ 1.89 Income from discontinued operations -- -- -- 0.45 ----------- ----------- ----------- -----------Net income available to common stockholders $0.440.26 $0.58 $ 1.43 $ 2.34 =========== ===========0.46 =========== =========== Weighted average number of common shares outstanding during the period21,126,229 18,345,664 21,053,215 18,481,300 =========== ===========22,843,258 20,995,908 =========== =========== Diluted:Income from continuing operations $ 0.43 $ 0.57 $ 1.42 $ 1.88 Income from discontinued operations -- -- -- 0.44 ----------- ----------- ----------- -----------Net income available to common stockholders $0.430.26 $0.57 $ 1.42 $ 2.32 =========== ===========0.45 =========== =========== Weighted average number of common shares outstanding during the period21,377,735 18,508,907 21,265,073 18,640,602 =========== ===========23,104,929 21,208,098 =========== =========== Dividend per common share $0.780.79 $0.77 $ 2.34 $ 2.310.78 =========== ====================== ===========
(1) The consolidated statement of operations for the three months ended March 31, 2003 has been restated for the retroactive adoption of FIN 46 Revised and SFAS 123 as discussed in Note 1.
See accompanying notes to the consolidated unaudited financial statements.
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ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
for the ninethree months ended September 30, 2003March 31, 2004 and the
year ended December 31, 20022003
(Unaudited)
(Dollars and shares in thousands)
Series F Distributions Preferred stock Common stock Additional in excess of -------------------- -------------------- paid-in accumulated Shares Amount Shares Amount capital earnings Total --------- --------- --------- --------- --------- ------------- --------- Balances at December 31,20012002 (1) -- $ --18,42820,983 $ 2 $421,592538,731 $(39,920)(53,042) $381,674 Shares purchased by Operating Partnership -- -- (411) -- (19,715) -- (19,715)485,691 Issuance of common stock under stock-based compensation plans (1) -- --246207 --3,3767,501 --3,3767,501 Issuance of common stock -- --2,7201,636 --136,80999,202 --136,80999,202 Issuance of preferred stock 1,000 25,000 -- -- (924) -- 24,076 Reallocation of minority interest -- -- -- --(6,937)(2,203) --(6,937) Net income(2,203) Write off of Series C preferred units offering costs, previously classified within minority interest -- -- -- -- --52,874 52,874(625) (625) Amortization of discount on Series F Preferred stock -- -- -- -- 336 (336) -- Net income (1) -- -- -- -- -- 35,090 35,090 Dividends declared -- -- -- -- --(56,767) (56,767)(67,333) (67,333) --------- --------- --------- --------- --------- ------------- --------- Balances at December 31,2002 -- -- 20,9832003 (1) 1,000 25,000 22,826 2535,125 (43,813) 491,314642,643 (86,246) 581,399 Issuance of common stock under stock-based compensation plans -- --16855 --5,4782,547 --5,478 Issuance of common stock -- -- 36 -- 2,170 -- 2,170 Issuance of preferred stock 1,000 25,000 -- -- (588) -- 24,4122,547 Reallocation of minority interest -- -- -- --2,067(1,638) --2,067(1,638) Net income -- -- -- -- --30,141 30,141 Dividends declared6,450 6,450 Common and preferred stock dividends decl -- -- -- -- --(49,334) (49,334)(18,564) (18,564) --------- --------- --------- --------- --------- ------------- --------- Balances atSeptember 30, 2003March 31, 2004 1,000 $ 25,00021,18722,881 $ 2 $544,252643,552 $(63,006)(98,360) $506,248570,194 ========= ========= ========= ========= ========= ============= =========
(1) The stockholders' equity balances as of and for the year ended December 31, 2003 and certain balances as of December 31, 2002 have been restated for the retroactive adoption of FIN 46 Revised and SFAS 123 as discussed in Note 1.
See accompanying notes to the consolidated unaudited financial statements.
6
ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(Dollars in thousands)
NineThree Months EndedSeptember 30,March 31, -------------------- 2004 20032002(1) --------- --------- Net cash provided by operating activities $73,74835,956 $67,89230,055 --------- --------- Cash flows from investing activities: Additions to real estate: Acquisitions (83,071) --(8,864)Improvements to recent acquisitions(6,336) (794)(3,039) (997) Redevelopment(1,508) (6,486)(1,446) (181) Revenue generating capital expenditures(144) (664) Non-revenue generating(18) (80) Other capital expenditures(5,102) (4,130)(2,041) (2,197) Increase/(decrease) in restricted cash(807) 8,674(6,138) (923) Additions to notes receivable frominvestees, otherrelated parties and other receivables(8,337) (4,109)(97) (739) Repayment of notes receivable frominvestees, otherrelated parties and other receivables8,093 4,624330 258 Additions to real estate under development(20,119) (41,935)(7,600) (6,742) Net distributions from (contributions to) investments incorporations andlimited partnerships(24,293) 16,469(2,746) (821) --------- --------- Net cash used in investing activities(58,553) (37,215)(105,866) (12,422) --------- --------- Cash flows from financing activities: Proceeds from mortgageand othernotes payable and lines of credit89,851 98,500124,425 27,447 Repayment of mortgageand othernotes payable and lines of credit(66,618) (55,301)(26,011) (19,922) Additions to deferred charges(159) (1,041)(1,779) (166) Net proceeds from stock options exercised5,020 3,307 Issuance of preferred stock 24,664 --and shares issued through dividend reinvestment 1,662 409 Contributions from minority interest partners 47 --(14)Distributions to minority interest partners(15,389) (18,851) Shares purchased by Operating Partnership -- (19,715)(6,673) (6,523) Redemption ofOperating Partnershipminority interest units (494) (542)(309) DividendsCommon and preferred stock dividends paid(50,184) (41,546)(18,326) (15,336) --------- --------- Net cashused inprovided by (used in) financing activities(13,357) (34,970)72,851 (14,633) --------- --------- Net increase in cash and cash equivalents1,838 (4,293)2,941 3,000 Cash and cash equivalents at beginning of period8,562 6,44014,768 12,076 --------- --------- Cash and cash equivalents at end of period $10,40017,709 $2,14715,076 ========= ========= Supplemental disclosure of cash flow information: Cash paid for interest, net of$3,108$916 and$4,906$902 capitalized in20032004 and2002,2003, respectively $28,86711,798 $21,7649,155 ========= =========Supplemental disclosureAccrued redemption ofnon-cash investing and financing activities: Receipt of note receivable from third party in exchange for the following: Note receivable from investeeminority interest units $ 3,472 $ --$ 34,000 Accrued interest on note receivable from investee -- 2,393 Investments -- 8,990 Other receivables from investee -- 117 Less cash received from investee -- (5,500) --------- $ -- $ 40,000========= =========Proceeds from dispositionAssumption of mortgage loan payable in conjunction with the purchase of real estateheld by exchange facilitator and classified as other asset$ 83,179 $ --$ 19,477========= =========Additional investment in limited partnership: InvestmentsCommon stock issued pursuant to phantom stock plan $--798 $3,681 Accounts payable -- (3,681) --------- --------- $ -- $ --458 ========= ========= Issuance of Operating Partnership Units in connection with the purchase of real estate $5,7681,729 $--5,768 ========= ========= Real estate under development transferred to rental property $72,711-- $--72,711 ========= =========Common stock issued pursuant to phantom stock plan $ 458 $ -- ========= ========= Issuance
(1) The statement of common stockcash flows for the three months ended March 31, 2003 has been restated for the retroactive adoption of FIN 46 Revised and SFAS 123 as discussed in connection with the Sachs merger $ 2,170 $ --
========= =========
Note 1.
See accompanying notes to the consolidated unaudited financial statements.
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ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Notes to Consolidated Financial StatementsSeptember 30,March 31, 2004 and 2003 and 2002
(Unaudited)(Dollars in thousands, except per share and per unit amounts)
(1)Organization and Basis of Presentation
The unaudited consolidated financial statements of the Company are prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and in accordance with the instructions to Form 10-Q. In the opinion of management, all adjustments necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented have been included and are normal and recurring in nature. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's annual report on Form 10-K for the year ended December 31, 2002.2003.
All significant intercompany balances and transactions have been eliminated in the consolidated financial statements.
The unaudited consolidated financial statements for the three and nine months ended September 30,March 31, 2004 and 2003 and 2002 include the accounts of the Company and Essex Portfolio, L.P. (the "Operating Partnership", which holds the operating assets of the Company). See "Accounting Changes" section below for a description of entities retroactively consolidated by the Operating Partnership for all periods presented pursuant to its adoption of FIN 46 Revised. The Company is the sole general partner in the Operating Partnership, with a 90.1%90.5%, 90.0%90.8% and 88.7%89.9% general partnership interest as of September 30, 2003,March 31, 2004, December 31, 20022003 and September 30, 2002,March 31, 2003, respectively.
As of September 30, 2003,March 31, 2004, the Company operates and has ownership interests in 117125 multifamily properties (containing 25,09526,991 units), five recreational vehicle parks (comprising 1,717 spaces), fourfive office buildings (with approximately 63,540173,540 square feet) and two manufactured housing communities (containing 607 sites), (collectively, the "Properties"). The Properties are located in Southern California (Los Angeles, Ventura, Orange and San Diego counties), Northern California (the San Francisco Bay Area), the Pacific Northwest (the Seattle, Washington and Portland, Oregon metropolitan areas) and other areas (Houston, Texas, Las Vegas, Nevada and Hemet, California).
Essex Apartment Value Fund, L.P. (the "Fund"("Fund I"), is an investment fund organized by the Company in 2001 to add value through rental growth and asset appreciation, utilizing the Company's development, redevelopment and asset management capabilities. Currently, the Fund I is considered fully invested based on its acquisitions to date and anticipated development and redevelopment expenditures. An affiliate of the Company, Essex VFGP, L.P. ("VFGP"), is a 1% general partner and is a 20.4% limited partner. The Operating Partnership owns a 99% limited partnership interest in VFGP. The Fund I now expects to utilize leverage of approximately 61% of the valueestimated costs, of the underlying real estate portfolio.portfolio, including estimated completion costs of development projects. The Company is committed to invest 21.4% of the aggregate capital committed to the Fund. In addition, Essex will be compensated by the Fund I for its asset management, property management, development and redevelopment services and may receive incentive payments if the Fund I exceeds certain financial return benchmarks. The Company's remaining unfunded capital commitment as of March 31, 2004 is $9,614,000.
The Company investsCompany's equity in joint ventures, which generally involve multifamily property acquisitions. For joint ventures entered into afterincome from investments accounted for using the equity method was $910,000 and $651,000 for the three months ended March 31, 2004 and 2003, respectively, and is classified as a component of "Revenue- Interest and other income" in the accompanying consolidated statement of operations.
Accounting Changes
In January 31, 2003, the Company follows the guidance provided byFinancial Accounting Standards Board (FASB) issued FASB Interpretation NoNo. 46 (FIN 46), "Consolidation of Variable Interest Entities.Entities, an Interpretation of ARB No. 51." The Company didFIN 46 established new measurement techniques to evaluate whether entities should be consolidated in accordance with Accounting Research Bulletin (ARB) No. 51, "Consolidated Financial Statements." FIN 46 defined variable interest entities (VIEs), in which equity investors lack an essential characteristic of a controlling financial interest or do not enter into any new joint ventures duringhave sufficient equity investment at risk to permit the nine months ended September 30, 2003. For joint ventures entered into priorentity to January 31,finance its activities without additional subordinated financial support from other parties. In December 2003, the Company accounts for these investments under the equity or consolidation methodsFASB completed deliberations of accountingproposed modifications to FIN 46 (FIN 46 Revised) resulting in multiple effective dates based on the voting control it exercises through its ownership interests in these affiliates. Undernature and the equity methodtiming of accounting, the investment is carried at the costformation of assets contributed or distributed, plus the Company's equity in undistributed earnings or losses since its initial investment. The individual assets, liabilities, revenues and expenses of the joint venture are not recorded in the Company's consolidated financial statements.
8
Beginning on December 31, 2003, the Company is required to apply the provisions of FIN 46 to all investments (including joint ventures) and all other arrangements which were entered into prior to January 31, 2003 to evaluate whether such arrangements represents involvement with a variable interest entities ("VIE"). Further evaluation is required to determine whether the Company should continue using its historical accounting method or consolidate the VIE. FIN 46 Revised must be applied no later than the Company's first quarter of 2004. Special Purpose Entities (SPEs) created prior to February 1, 2003 may be accounted for under FIN 46 or FIN 46 Revised but no later than the Company's quarter ended December 31, 2003. The Company has not formed nor is it a party to any SPEs. FIN 46 Revised may be applied prospectively with a cumulative- effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative- effect adjustment as of the beginning of the first year restated. The disclosure requirements
As of January 1, 2004, the Company adopted the provisions of FIN 46 are effectiveRevised using the retroactive restatement approach, and amounts have been restated for all financial statements initially issued afterprior periods presented to reflect the adoption of FIN 46 Revised. The Company applied FIN 46 Revised to all of the Company's arrangements which were entered into prior to January 31, 2003. It is reasonably possible2003 and evaluated whether such arrangements represent involvement with a VIE and whether the Company qualifies as the primary beneficiary and should therefore consolidate the VIE. Subsequent to January 31, 2003, the Company has not entered into any arrangements that certainare deemed VIEs.
Certain of the entities through which and with which the Company conductswe conduct business including those described in Notes 3(b) and 5 of the Company's December 31, 2002 consolidated financial statements will behave been deemed to be VIEs under the provisions of FIN 46.46 Revised. Based on its preliminary evaluationour analysis of FIN 46 Revised, the Company consolidated Essex Management Corporation (EMC), Essex Fidelity I Corporation (EFC), 17 Down REIT limited partnerships (comprising ten properties), an office building that is subject to loans made by the Company, and the multifamily improvements owned by a third party in which the Company owns the land underlying these improvements and from which the Company receives fees, including land lease, subordination and property management fees. The Company consolidated these entities considered reasonably possible to be VIEs,because it is deemed the primary beneficiary. The Company's increase in total assets and liabilities netrelated to the consolidation of intercompany balances of suchthese VIEs were approximately $192,000,000 and $157,000,000, respectively, at March 31, 2004.
The Down REIT entities were estimated at $77,775 and $55,603 at September 30, 2003. The Company's estimated maximum exposure to loss would be equal to its investments in these arrangements, which totaled $22,850, as of September 30, 2003. The disclosures provided reflect management's understanding and analysis of FIN 46 based upon information currently available. The evaluation of the impact of FIN 46 on the Company's consolidated financial statements is ongoing and is subject to change in the event additional interpretive guidance is provided by the Financial Accounting Standards Board or others.
Included in the Company's investments accounted for under the equity method are limited partnership interests in 17 partnerships (Down REIT entities), whichthat collectively own ten multifamily properties comprised of 1,831 units. These(1,831 units) were investments were made under arrangements whereby Essex Management Corporation (EMC) became the general partner, the Operating Partnership became a special limited partner, and the other limited partners were granted rights of redemption for their interests. Such limited partners can request to be redeemed and the Company can elect to redeem their rights for cash or by issuing shares of its common stock on a one share per unit basis. Conversion values will be based on the market value of the Company's common stock at the time of redemption multiplied by the number of units stipulated under the above arrangements. The other limited partners receive distributions based on the Company's current dividend rate times the number of units held. At September 30, 2003,March 31, 2004, the maximum number of shares that could be issued to meet redemption of these Down REIT entities is 1,467,198. The equity in income or loss reported by1,443,668. As of March 31, 2004 and December 31, 2003, the Company under the equity methodcarrying value of accounting for these down REIT entities is the net income of these down REIT entities as reduced by the income allocated to the other limited partners whichpartners' interests is equal to the distributions they received.
All significant intercompany balances and transactions have been eliminated in the consolidated financial statements.
The Company's equity in income from investments accounted for using the equity method was $1,848 and $1,835 for the three months ended September 30, 2003 and 2002, respectively, and $5,458 and $7,135 for the nine months ended September 30, 2003 and 2002, respectively,presented at their historical cost and is classified as "Interest and other income"within minority interests in the accompanying consolidated statementbalance sheets.
Interest holders in VIEs consolidated by the Company are allocated a priority of operations.
Certain prior year balances have been reclassified to conformnet income equal to the current year presentation.
9
Stock-based CompensationProperties consolidated in accordance with FIN 46 Revised were encumbered by third party, non-recourse loans totaling $152,341,000 and $152,669,000 as of March 31, 2004 and December 31, 2003, respectively.
There is one VIE as to which the Company is not deemed to be the primary beneficiary of such VIE. Total assets and liabilities of this entity as of March 31, 2004 were $14,591,000 and $14,703,000, respectively. The Company applies APB Opinion No. 25 (APB 25) and related interpretations inis not exposed to a material loss from this entity.
As of January 1, 2004, the Company adopted the fair value method of accounting for its stock-based compensation plans granted to employees and directors.using the retroactive restatement method as provided by Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation." Under APB 25, nothe fair value method, stock-based compensation cost has been recognized for stock options granted to employees and directors since all such stock options were granted with an exercise price equal tois measured at the fair market value of the underlying common stock. For the Company's long-term incentive plan and phantom stock plan, no compensation expense was recognized during the three months ended September 30, 2003 and 2002 and $408 and $911 was recognized for the nine months ended September 30, 2003 and 2002, respectively. Had compensation cost for these stock options and the Company's other plans been determinedgrant date based on the fair value atof the grant dates consistent withaward and is expensed over the vesting period. For the three months ended March 31, 2004 and 2003, stock-based compensation expense under the fair value method pursuant to FAS 123, the Company's net income applicable to common stockholderswas $136,000 and $221,000, respectively. The Company did not grant stock options for the three and nine months ended September 30, 2003 and 2002 would have been reduced to the pro forma amounts indicated below:March 31, '2004.
Three Months Ended Nine Months Ended September 30, September 30, -------------------- -------------------- 2003 2002 2003 2002 --------- --------- --------- --------- Net income available to common stockholders: As reported $ 9,260 $ 10,614 $ 30,141 $ 43,269 Pro forma 9,133 10,488 29,760 42,890 Basic earnings per common share: As reported $ 0.44 $ 0.58 $ 1.43 $ 2.34 Pro forma 0.43 0.57 1.41 2.32 Diluted earnings per common share: As reported $ 0.43 $ 0.57 $ 1.42 $ 2.32 Pro forma 0.43 0.57 1.40 2.30 Weighted-average fair value of stock options granted during the periods presented $ 3.90 $ 4.69 $ 3.90 $ 4.69
The fair value of stock options granted each period was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants:
Three Months EndedNine Months Ended September 30, September 30,March 31, -----------------------------------------------2004 20032002 2003 2002(1) ---------------------- ----------------------- Risk-free interest rates2.63% 3.08%-4.62%n/a 2.17%-2.78% 3.08%-4.62%Expected lives6 years 6 years 6 yearsn/a 6 years Volatility19.18% 18.92% 17.89%-19.18% 18.92%n/a 17.91% Dividend yield5.73% 6.30% 5.73%-6.12% 6.30%n/a 6.12%
The accounting effect of adopting FIN 46 Revised and SFAS 123 on net income previously reported for the quarter ended Match 31, 2003 is as follows (dollars in thousands, except per share amounts):
Net income previously reported $ 10,231 Adjustment for effect of adopting FAS 123 (99) Adjustment for effect of adopting FIN 46 Revised (487) Net income as reported $ 9,645 Per diluted share previously reported $ 0.48 Adjustment for effect of adopting FAS 123 (0.01) Adjustment for effect of adopting FIN 46 Revised (0.02) Per diluted share as reported $ 0.45
10
Additional Distribution paid-in in excess of capital accumulated earnings ----------- ------------------ Statement of Stockholders' Equity: Balance at January 1, 2003, as previously reported $ 535,125 $ (43,813) Adjustments for cumulative effect on prior years of retroactively applying SFAS 123 3,606 (2,696) Adjustments for cumulative effect on prior years of retroactively applying FIN 46 Revised -- (6,533) Balance at January 1, 2003, as adjusted $ 538,731 $ (53,042)
Beginning in 2003, the Company implemented an upgrade to its subsidiary ledger for accounting for fixed assets. The Company completed this system upgrade in the first quarter of 2004. In conjunction with this system upgrade, the Company has determined that cumulative depreciation expense generated by consolidated or equity method rental properties was understated by approximately $2.1 million through December 31, 2003 and this amount was recorded during the quarter ended March 31, 2004. Had the correction been made in 2003, depreciation expense would have increased by approximately $640,000, $1.3 million, and $1.0 million in the first, second and third quarters of 2003, respectively. In the fourth quarter 2003, depreciation expense would have decreased by approximately $1.4 million. The Company does not believe that the correction is material to the previously reported financial statements and is not material to any consolidated earnings trends.
(2)Significant Transactions for the Quarter ended September 30, 2003
On January 28, 2004, the Company purchased Mountain View Apartments, a 106- unit multifamily community located in Camarillo, California for a contract price of approximately $14.3 million. The property is unencumbered.
On February 27, 2004, the Company purchased Fountain Park Apartments, a 705- unit multifamily community located in Playa Vista, California, for a contract price of approximately $124.5 million. In connection with the transaction the Company assumed tax-exempt variable rate bond obligations totaling $83.2 million that mature in 2033. Financing and other agreements require 53% of the apartment homes in Fountain Park to be subject to various rent restrictions based on resident income criteria.
The Company defines development communities as new apartment properties that are being constructed or are newly constructed, andwhich are in a phase of lease-up and have not yet reached stabilized operations. At September 30, 2003,March 31, 2004, the Company (including the Fund's development communities) had ownership interests in sixtwo development communities with an aggregate(excluding the investments of 1,368Fund I described below), aggregating 444 multifamily units andwith an estimated total cost of $229,700 of which approximately $74,800 remains$74.9 million with $12.0 million remaining to be expended and of which approximately $36,400 is the Company's commitment.expended.
During the third quarter,Although the Company completed construction and neared completion on the lease-up at The San Marcos (phase I), a 312-unit apartment community locateddoes not anticipate starting any new development projects in Richmond, California. This property reached stabilized operations in October 2003 and2004, it will be reclassified from real estate undercontinue to evaluate, if deemed appropriate, potential development projects of multifamily properties with significant consideration given to rental properties on the Company's balance sheet in the fourth quarter of 2003.current market conditions.
During the quarter, the Company continued construction at the San Marcos project of an additional 120 units (phase II), which are located directly adjacent to the first phase. It is anticipated that construction of these additional units will be completed in the second quarter of 2004 and is expected to reach stabilized operations in the fourth quarter of 2004.
Construction continued during the quarter at Hidden Valley, a 324-unit apartment community located in Simi Valley, California. The Company expects initial occupancy to take place in the fourth quarter of 2003 and to reach stabilized operations in the third quarter of 2004. The Company has a 75 percent ownership interest in this development project.
The Company defines redevelopment communities as existing properties owned or recently acquired, which have been targeted for investment by the Company with the expectation of increased financial returns through property improvement. Redevelopment communities typically have apartment units that are not available for rent and, as a result, may have less than stabilized operations. At September 30, 2003,March 31, 2004, the Company (including the Fund's redevelopment communities) hashad ownership interests in two redevelopment communities which contain an aggregate(excluding the investments of 782Fund I described below), aggregating 804 multifamily units andwith an estimated total cost specifically related to the redevelopment costs of $7,000$9.4 million, of which approximately $4,400$7.1 million remains to be expended andexpended.
On February 20, 2004 the Company prepaid an $8.7 million non-recourse mortgage with an interest rate of which approximately $3,000 is7.8% that was to mature in January 2007. In conjunction with this transaction, the Company's commitment.Company paid a $175,000 prepayment fee.
On July 30, 2003, in connection with the Company's acquisition, by merger, of John M. Sachs, Inc. ("Sachs") on December 17, 2002, and under terms of the merger agreement, a final analysis was prepared, which indicated that the actual net liabilities of Sachs were less than the net liabilities of Sachs estimated to be outstanding as of the merger date. Based on this final analysis and as a post-closing adjustment payment pursuant to the merger agreement,In January 2004, the Company made a final payment of $1,766 in cash andrestructured its previously issued an additional 35,860 shares of common stock to certain of the pre-merger shareholders of Sachs.
On September 23, 2003, the Company issued 1,000,000 shares of its$50.0 million, 9.30% Series FD Cumulative Redeemable Preferred Stock at a fixed price of $24.664 per share, a discount from the $25.00 per share liquidation value of the shares. The shares do not begin to accrue a dividend until November 25, 2003Units ("Series D Units"), and following that date, will pay quarterly distributions at an annualized rate of 7.8125% per year of the liquidation value and will be redeemable by the Company on or after September 23, 2008. The Company will amortize the original discount in connection with the issuance of these shares in the fourth quarter of 2003, resulting in a charge of approximately $336.
During the quarter the Company expanded its existing $165,000 unsecured revolving credit facility to $185,000. No other material terms of this facility were revised.
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In August 2000 an affiliate of the Company sold a vacant 110,000 square foot office building located in Irvine, California to a third party for $15,000. The Company loaned the buyer $15,000 as a secured first mortgage on the property. In addition, after the buyer expended $500 for such items as tenant improvements, leasing commissions, and carrying costs, the Company agreed to lend an additional $4,500 to the buyer for these related items, under a mezzanine loan, which is secured by a second deed of trust on the property (the Mezzanine Loan). The current balance of the Mezzanine Loan is approximately $3,800, of which the principal shareholder of the buyer guarantees $1,700. The Company has evaluated the realization potential of the first and mezzanine loan and effective June 2002, ceased accruing interest income on these notes until the timing of the borrower's cash flow from the office building is more predictable. The loan matured in March 2003 and is default. Management is currently evaluating its potential courses of action.
On October 6, 2003, the Company sold 1.6previously issued $80.0 million, newly issued shares of common stock receiving offering proceeds (before expenses) of $60.67 per share, representing a 3.25% discount to the common stock's closing price on September 30, 2003, the date of the underwriting agreement between the Company and the underwriter, pursuant to which the shares were sold. The net proceeds of the offering of approximately $96,772 is expected to be used for the acquisition of multifamily communities located in the Company's targeted West Coast markets and may also be used for general corporate purposes, including the repayment of debt and the funding of development activities.
On October 9, 2003, the Company acquired two multifamily communities comprising 442 apartment homes in the Seattle, Washington metropolitan area for an aggregate purchase price of $41,700. One property is Canyon Pointe, a 250- unit multifamily property located in Bothell, Washington and the other is Forest View, a 192-unit multifamily property located in Renton, Washington. Neither property was encumbered with debt.
On October 23, 2003, the Company acquired Walnut Heights Apartments, a 163- unit multifamily community located in the City of Walnut, California, for a contract price of approximately $24,300. This property was not encumbered with debt.
On October 14, 2003, the Company issued a notice of redemption to the holders of its 9.125%7.875% Series CB Cumulative Redeemable Preferred Units. Pursuant to the provisionsUnits ("Series B Units"). The existing distribution rate of 9.30% of the Amended and Restated AgreementSeries D Units will continue until July 27, 2004 - the end of Limited Partnership of Essex Portfolio, L.P.,the current non-call period. On July 28, 2004, the distribution rate on the Series D Units is to be reduced to 7.875%. The date that the Series D Units can first be redeemed at the Company's option was extended by six years to July 28, 2010. The date that the Series B Units can first be redeemed at the Company's option was extended from February 6, 2003 to December 31, 2009.
Acquisition Activities of theThe Essex Apartment Value Fund (the "Fund")
On July 11, 2003, the ("Fund I")
Fund I has acquired an ownership interest in Coronado North and South, located in Newport Beach, California, for approximately $33,700 from an unrelated co-investment partner.
Disposition Activities of the Fund
On July 24, 2003, the Fund sold a 30 unit apartment community, which was acquired on May 1, 2003 in conjunction with the purchase of threecommitted to develop multifamily properties with an aggregate cost at approximately $640 million, (including the estimated total cost of development and redevelopment projects), and is now considered fully invested. The portfolio is concentrated in Southern California, and is comprised of 28815 multifamily communities aggregating 4,396 apartment homes all located in San Dimas, California, for $4,175 in cash to an unrelated third party. This property was not encumbered by a mortgage. No gain or loss was realized on this transaction.and three development communities totaling 612 apartment homes.
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Development Communities of the
At September 30, 2003 the Fund has three I owned two development communities with an aggregate of 612480 multifamily units and an estimated total cost of $107,500$101.7 million, of which $48,800$25.9 million remains to be expended and approximately $10,400$5.5 million is expected to be funded by the Company's commitment. The total cost estimated does not include costs related to the construction ofCompany through its 132-unit Kelvin Avenue projectcapital commitments. Fund I also owns a land parcel in Irvine, California. The Kelvin Avenue project is still in the process of obtaining entitlements.
Redevelopment Communities of the Fund
At September 30, 2003 theMarch 31, 2004, Fund has one redevelopment community,I was redeveloping a 174 unit174-unit apartment community with an estimated total cost specifically(specifically related to the redevelopment project) of $3,500$3.5 million. As of which $1,700March 31, 2004, $1.4 million remains to be expended, andof which approximately $400$302,000 is the Company's commitment.
Debt Transactions of the Fund
On July 28, 2003, the
The Company is in the amountprocess of $9,600, withforming the second Essex Apartment Value Fund ("Fund II"), which is expected to be similar to Fund I in size and structure. Essex anticipates an initial closing of Fund II during the second quarter of 2004, and anticipates its capital commitment by a 5.03% fixed interest rate for a 8-year term, which matures in July 2011, with an option to extend the maturity for one year thereafter at a floating rate of 2.5% over Freddie Mac's Reference Bill. During the extension period, the loan may be paid in full with no prepayment penalty.
Completion of Real Estate Investments by the Fund
Currently the Fund is considered fully invested based on its acquisitions to date and anticipated development and redevelopment expenditures.
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(3)Related Party Transactions
All general and administrative expenses of the Company and Essex Management Corporation, an unconsolidated preferred stock subsidiary of the Company ("EMC"), are initially borne byto be approximately $50 million.
(3)Investments
As of January 1, 2004, the Company withadopted the provisions of FIN 46 Revised using the retroactive restatement approach, and amounts have been restated for all prior periods presented to reflect the adoption of FIN 46 Revised (See Note 1). The following table details the Company's investments accounted for under the equity method of accounting (dollars in thousands):
March 31, December 31 2004 2003 --------- --------- Investments in joint ventures: Direct and indirect LLC member interests of approximately 49.9% in Newport Beach North, LLC and Newport Beach South, LLC $ 15,200 $ 13,020 Limited partnership interest of 20.4% and general partner interest of 1% in Essex Apartment Value Fund, L.P 51,131 51,110 Limited partnership interest of 20% in AEW joint venture 4,288 4,406 Class A member interest of 45% in Park Hill LLC 5,673 5,731 Preferred limited partnership interests in Mountain Vista Apartments 6,806 5,276 Other investments 27 24 --------- --------- Total investments 83,125 79,567
The combined summarized financial information of investments, which are accounted for under the equity method, are as follows:
March 31, December 31, 2004 2003 Balance sheets: --------- --------- Real estate and real estate under development $ 701,365 $ 667,538 Other assets 15,430 11,277 --------- --------- Total assets $ 716,795 $ 678,815 ========= ========= Mortgage notes payable $ 448,636 $ 442,419 Other liabilities 21,442 13,943 Partners' equity 246,717 222,453 --------- --------- Total liabilities and partners' equity $ 716,795 $ 678,815 ========= ========= Company's share of equity $ 83,125 $ 79,567 ========= ========= March 31, March 31, 2004 2003 --------- --------- Statements of operations: Total revenue $ 17,357 $ 12,812 Total expenses 15,415 11,668 --------- --------- Total net income $ 1,942 $ 1,144 ========= ========= Company's share of net income $ 910 $ 651 ========= =========
For a portion subsequently allocated to EMC. Expenses allocated to EMCfurther discussion regarding these investments, see the Company's annual report on Form 10-K for the three monthsyear ended September 30,December 31, 2003, Notes to Consolidated Financial Statements, Note. 3, "Real Estate."
(4)Related Party Transactions
As of January 1, 2004, the Company adopted the provisions of FIN 46 Revised using the retroactive restatement approach, and 2002 totaled $615 and $532, respectively, and $1,907 and $2,010amounts have been restated for all prior periods presented to reflect the nine months ended September 30, 2003 and 2002, respectively. The allocation is reflected as a reduction in general and administrative expenses in the accompanying consolidated statementsadoption of operations.FIN 46 Revised (see Note 1).
Interest and other income includes interest income earned on notes receivable from investees of $79 and $377 for the three months ended September 30, 2003 and 2002, respectively, and $235 and $2,535 for the nine months ended September 30, 2003 and 2002, respectively. Other income also includes management fee income and investment income from the Company's investees of $2,761$1,805,000 and $2,058$1,572,000 for the three months ended September 30,March 31, 2004 and 2003, and 2002, respectively, and $8,538 and $7,647 for the nine months ended September 30, 2003 and 2002, respectively.
Notes receivable from investees and other receivables from related party receivablesparties as of September 30, 2003March 31, 2004 and December 31, 20022003 consist of the following:following (dollars in thousands):
September 30,March 31, December 31, 2004 20032002------------ ------------ Notesreceivableand other receivables fromjoint venture investees:related parties: Note receivablefromto Highridge Apartments (Down REIT) from The Marcus & Millichap Company, secured, bearing interest at10%12.75%, dueon demandOctober 1, 2004 $2,9503,000 $2,950 Notes receivable from Essex Fidelity I Corp ("EFC"), secured, bearing interest at LIBOR + 2.5%, due 2004 7,065 14,979 Note receivable from EFC, unsecured, bearing interest at 7.5%, due 2011 390 7263,000 Receivable from Newport Beach North, LLC and Newport Beach South, LLC, unsecured, non interest bearing, due on demand1,967 376 Other related party receivables:-- 200 Loans to officers made prior to July 31, 2002, secured, bearing interest at 8%, due beginning April 2006 633 633 Other related party receivables, substantially due on demand5,615 4,4171,705 1,905 ------------ ------------ $18,6205,338 $24,0815,738 ============ ============
The Company's officers and directors do not have substantial economic interest in these joint venture investees.
Other related party receivables consist primarily of accrued interest income on notes receivable from joint venture investees and loans to officers, and advances and accrued management fees from joint venture investees, and unreimbursed expenses due from EMC.
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(4)New Accounting Pronouncements Adopted During the Quarter
In May 2003, the FASB issued Statement of Financial Accounting Standard No. 150 ("FAS 150"), "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." FAS 150 requires issuers to classify as liabilities (or assets in some circumstances) three classes of freestanding financial instruments that embody obligations for the issuer. Previously, many such instruments had been classified as equity. A freestanding financial instrument is an instrument that is entered into separately and apart from any of the entity's other financial instruments or equity transactions, or that is entered into in conjunction with some other transaction and is legally detachable and separately exercisable, such as certain put and call options. These provisions are effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. On October 29, 2003, the FASB deferred indefinitely the provision within FAS 150 which required non-controlling interests in consolidated finite life entities to be presented as a liability. The adoption of FAS 150 on July 1, 2003 did not have any impact on our consolidated financial statements.
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investees.
(5)Segment Information
The Company defines its reportable operating segments as the three geographical regions in which its properties are located: Southern California, Northern California and the Pacific Northwest. Excluded from segment revenues are properties outside of these regions and interest and other income. Non- segment revenues and net operating income included in the following schedule also consists of revenue generated from the commercial properties, recreational vehicle parks, and manufactured housing communities. Other non-segment assets include investments, real estate under development, cash, notes receivables, other assets and deferred charges. The revenues, net operating income, and assets for each of the reportable operating segments are summarized as follows for the periods presented.presented (dollars in thousands).
Three Months EndedSeptember 30,March 31, ------------------------ 2004 20032002(1) ----------- ----------- Revenues: Southern California $27,18437,052 $18,56033,079 Northern California15,099 14,39915,818 16,216 Pacific Northwest10,032 10,53412,199 11,156 Other non-segment areas2,940 1361,262 3,568 ----------- -----------55,255 43,62966,331 64,019 Interest and other income2,982 5,1663,475 2,266 ----------- ----------- Total revenues $58,23769,806 $48,79566,285 =========== =========== Net operating income: Southern California $18,58725,262 $13,19222,855 Northern California10,200 10,46710,741 11,362 Pacific Northwest6,773 7,0607,955 7,307 Other non-segment areas1,169 72532 1,705 ----------- ----------- Total net operating income36,729 30,79144,490 43,229 Interest and other income2,982 5,1663,475 2,266 Depreciation and amortization: Southern California(5,058) (3,522)(10,326) (6,537) Northern California(3,511) (2,752)(5,501) (3,315) Pacific Northwest(2,633) (2,790)(1,185) (2,965) Other non-segment areas(1,106) (65)(1,420) (485) ----------- -----------(12,308) (9,129)(18,432) (13,302) Interest: Southern California(3,439) (1,839)(6,228) (5,476) Northern California(2,807) (2,839)(3,051) (3,081) Pacific Northwest(1,001) (1,519)(1,705) (1,175) Other non-segment areas(3,281) (2,424)(3,326) (3,475) ----------- -----------(10,528) (8,621)(14,310) (13,207) Amortization of deferred financing costs(333) (147)(273) (220) General and administrative(1,678) (1,482)(2,930) (2,309) ----------- ----------- Incomefrom continuing operationsbefore minority interestsand discontinued operations$14,86412,020 $16,57816,457 =========== ===========
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(5)Segment Information (continued)
Nine Months Ended September 30, ------------ ----------- 2003 2002 ----------- ----------- Revenues: Southern California $ 80,259 $ 53,996 Northern California 46,206 44,073 Pacific Northwest 30,567 31,747 Other non-segment areas 9,400 411 ----------- ----------- Total segment revenues 166,432 130,227 Interest and other income 9,247 18,961 ----------- ----------- Total revenues $ 175,679 $ 149,188 =========== =========== Net operating income: Southern California $ 55,293 $ 38,183 Northern California 31,900 32,946 Pacific Northwest 19,999 21,461 Other non-segment areas 4,313 225 ----------- ----------- Total segment net operating income 111,505 92,815 Interest and other income 9,247 18,961 Depreciation and amortization: Southern California (15,361) (10,375) Northern California (9,724) (8,263) Pacific Northwest (8,044) (8,381) Other non-segment areas (2,344) (210) ----------- ----------- (35,473) (27,229) Interest: Southern California (10,328) (5,533) Northern California (8,397) (8,480) Pacific Northwest (3,082) (4,566) Other non-segment areas (10,051) (7,483) ----------- ----------- (31,858) (26,062) Amortization of deferred financing costs (825) (442) General and administrative (5,208) (4,747) ----------- ----------- Income from continuing operations before minority interests and discontinued operations $ 47,388 $ 53,296 =========== ===========
September 30,March 31, December 31, 2004 20032002(1) ----------- ----------- Assets: Net real estate assets: Southern California $692,2551,034,553 $700,877886,980 Northern California364,561 293,541438,373 435,041 Pacific Northwest245,698 251,252310,342 312,628 Other non-segment areas74,536 78,46583,024 83,710 ----------- ----------- Total net real estate assets1,377,050 1,324,1351,866,292 1,718,359 Other non-segment assets282,031 295,599223,504 198,452 ----------- ----------- Total assets $1,659,0812,089,796 $1,619,7341,916,811 =========== ===========
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(1) Amounts have been restated for the retroactive adoption of FIN 46 Revised and SFAS 123 as discussed in Note 1.
(6)Net Income Per Common Share
(Amounts in thousands, except per share data)
Three Months Ended Three Months EndedSeptember 30,March 31, 2004 March 31, 2003September 30, 2002-------------------------------- -------------------------------- Weighted Per Weighted Per Average Common Average Common Common Share Common Share Income Shares Amount Income Shares Amount --------- ----------- -------- --------- ----------- -------- Basic - Net income available to common stockholders $9,260 21,126,2295,962 22,843 0.26 $0.44 $ 10,614 18,345,664 $ 0.58 ======== ========9,645 20,996 0.46 Effect of Dilutive Securities: Convertible limited partnershipUnits(1)Units (1) -- -- -- -- Stock options (2) --195,506172 --163,243156 Vested series Z incentive units --56,00090 ----56 --------- ----------- --------- ----------- --251,506262 --163,243212 --------- ----------- --------- ----------- Diluted - Net income available to common stockholders $9,260 21,377,7355,962 23,105 $0.430.26 $10,614 18,508,9079,645 21,208 $0.57 ========= ======== ========= ======== Nine Months Ended Nine Months Ended September 30, 2003 September 30, 2002 -------------------------------- -------------------------------- Weighted Per Weighted Per Average Common Average Common Common Share Common Share Income Shares Amount Income Shares Amount --------- ----------- -------- --------- ----------- -------- Basic: Income from continuing operations $ 30,141 21,053,215 $ 1.43 $ 34,983 18,481,300 $ 1.89 Income from discontinued operations -- 21,053,215 -- 8,286 18,481,3000.45--------- -------- --------- -------- 30,141 $ 1.43 43,269 $ 2.34 ======== ======== Effect of Dilutive Securities: Convertible limited partnership Units(1) -- -- -- -- Stock options (2) -- 155,975 -- 159,302 Vested series Z incentive units -- 55,883 -- -- --------- ----------- --------- ----------- -- 211,858 -- 159,302 --------- ----------- --------- ----------- Diluted: Income from continuing operations 30,141 21,265,073 $ 1.42 34,983 18,640,602 $ 1.88 Income from discontinued operations -- 21,265,073 -- 8,286 18,640,602 0.44 --------- -------- --------- -------- $ 30,141 $ 1.42 $ 43,269 $ 2.32========= ======== ========= ========
(1) ConvertibleWeighted average convertible limited partnership units of 2,269,4902,265,248 and 2,280,3042,285,953 for the three months ended September 30,March 31, 2004 and 2003, and 2002, respectively, and 2,270,087 and 2,282,369 for the nine months ended September 30, 2003 and 2002, respectively, were not included in the determination of diluted EPS because they were anti- dilutive.anti-dilutive. The DownREIT limited partnership units have historically been redeemed for cash. The Company has never exercised its right to issue common stock to fund any redemption requests. As such, the Company does not consider these to be common stock equivalents.
(2) The following stock options are not included in the diluted earnings per share calculation because the exercise price of the option was greater than the average market price of the common share for the quarter and, therefore, would be anti-dilutive:
Three Months EndedNine Months Ended September 30, September 30,March 31, -----------------------------------------------2004 20032002 2003 2002 ----------- ---------------------- ----------- Number of options --75,750 -- 75,75072,000 Range of exercise prices n/a$50.88-54.25 n/$51.01-54.25
(7) Subsequent Event
On April 30, 2004, the Company renewed its $185 million unsecured line of credit facility for a $50.88-54.2
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Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion is based primarily on the consolidated unaudited financial statements of Essex Property Trust, Inc. ("Essex" or the "Company") for the three and nine months ended September 30, 2003March 31, 2004 and 2002.2003. This information should be read in conjunction with the accompanying consolidated unaudited financial statements and notes thereto. These consolidated financial statements include all adjustments which are, in the opinion of management, necessary to reflect a fair statement of the results and all such adjustments are of a normal recurring nature.
Substantially all of the assets of the Company are held by, and substantially all operations are conducted through, Essex Portfolio, L.P. (the "Operating Partnership"). Effective January 1, 2004, the Operating Partnership consolidated the entities discussed below pursuant to its adoption of FIN 46 Revised. The Company is the sole general partner of the Operating Partnership and, as of September 30, 2003,March 31, 2004, December 31, 20022003 and September 30, 2002, withMarch 31, 2003, held a 90.1%90.5%, 90.0%90.8% and 88.7 %89.9% general partnership interest in the Operating Partnership, respectively. The Company has elected to be treated as a real estate investment trust ("REIT") for federal income tax purposes.
Accounting Changes
Variable Interest Entities
In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51." FIN 46 established new measurement techniques to evaluate whether entities should be consolidated in accordance with Accounting Research Bulletin (ARB) No. 51, "Consolidated Financial Statements." FIN 46 defined variable interest entities (VIEs), in which equity investors lack an essential characteristic of a controlling financial interest or do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support from other parties. In December 2003, the FASB completed deliberations of proposed modifications to FIN 46 (FIN 46 Revised) resulting in multiple effective dates based on the nature and the timing of formation of the VIE. FIN 46 Revised must be applied no later than the Company's first quarter of 2004. Special Purpose Entities (SPEs) created prior to February 1, 2003 may be accounted for under FIN 46 or FIN 46 Revised but no later than the Company's quarter ended December 31, 2003. The Company has not formed nor is it a party to any SPEs. FIN 46 Revised may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated.
As of January 1, 2004, the Company adopted the provisions of FIN 46 Revised using the retroactive restatement approach, and amounts have been restated for all prior periods presented to reflect the adoption of FIN 46 Revised. The Company applied FIN 46 Revised to all of the Company's arrangements which were entered into prior to January 31, 2003 and evaluated whether such arrangements represent involvement with a VIE and whether the Company qualifies as the primary beneficiary and should therefore consolidate the VIE. Subsequent to January 31, 2003, the Company has not entered into any arrangements that are deemed VIEs.
Certain of the entities through which and with which we conduct business have been deemed to be VIEs under the provisions of FIN 46 Revised. Based on our analysis of FIN 46 Revised, the Company consolidated Essex Management Corporation (EMC), Essex Fidelity I Corporation (EFC), 17 Down REIT limited partnerships (comprising ten properties), an office building that is subject to loans made by the Company, and the multifamily improvements owned by a third party in which the Company owns the land underlying these improvements and from which the Company receives fees, including land lease, subordination and property management fees. The Company consolidated these entities because it is deemed the primary beneficiary. The Company's increase in total assets and liabilities related to the consolidation of these VIEs were approximately $192,000,000 and $157,000,000, respectively, at March 31, 2004.
The Down REIT entities that collectively own ten multifamily properties (1,831 units) were investments made under arrangements whereby Essex Management Corporation (EMC) became the general partner, the Operating Partnership became a special limited partner, and the other limited partners were granted rights of redemption for their interests. Such limited partners can request to be redeemed and the Company can elect to redeem their rights for cash or by issuing shares of its common stock on a one share per unit basis. Conversion values will be based on the market value of the Company's common stock at the time of redemption multiplied by the number of units stipulated under the above arrangements. The other limited partners receive distributions based on the Company's current dividend rate times the number of units held. At March 31, 2004, the maximum number of shares that could be issued to meet redemption of these Down REIT entities is 1,443,668. As of March 31, 2004 and December 31, 2003, the carrying value of the other limited partners' interests is presented at their historical cost and is classified within minority interests in the accompanying consolidated balance sheets.
Interest holders in VIEs consolidated by the Company are allocated a priority of net income equal to the cash payments made to those interest holders for services rendered or distributions from cash flow. The remaining results of operations are generally allocated to the Company.
Properties consolidated in accordance with FIN 46 Revised were encumbered by third party, non-recourse loans totaling $152,341,000 and $152,669,000 as of March 31, 2004 and December 31, 2003, respectively.
There is one VIE as to which the Company is not deemed to be the primary beneficiary of such VIE. Total assets and liabilities of this entity as of March 31, 2004 were $14,591,000 and $14,703,000, respectively. The Company is not exposed to a material loss from this entity.
Stock-Based Compensation
As of January 1, 2004, the Company adopted the fair value method of accounting for its stock-based compensation plans using the retroactive restatement method as provided by Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation." Under the fair value method, stock-based compensation cost is measured at the grant date based on the fair value of the award and is expensed over the vesting period. For the three months ended March 31, 2004 and 2003, stock-based compensation expense under the fair value method was $136,000 and $221,000, respectively.The Company did not grant stock options for the three months ended March 31, 2004.
The fair value of stock options granted was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants:
Three Months Ended March 31, ----------------------- 2004 2003 (1) ----------- ----------- Risk-free interest rates n/a 2.17% Expected lives n/a 6 years Volatility n/a 17.91% Dividend yield n/a 6.12%
Reconciliation to previously reported amounts
The accounting effect of adopting FIN 46 Revised and SFAS 123 on net income previously reported for the quarter ended March 31, 2003 is as follows (dollars in thousands, except per share amounts):
Net income previously reported $ 10,231 Adjustment for effect of adopting FAS 123 (99) Adjustment for effect of adopting FIN 46 Revised (487) Net income as reported $ 9,645 Per diluted share previously reported $ 0.48 Adjustment for effect of adopting FAS 123 (0.01) Adjustment for effect of adopting FIN 46 Revised (0.02) Per diluted share as reported $ 0.45
The accounting effect of adopting FIN 46 Revised and SFAS 123 on stockholders' equity at January 1, 2003 for previously reported amounts is as follows (dollars in thousands):
Additional Distribution paid-in in excess of capital accumulated earnings ----------- ------------------ Statement of Stockholders' Equity: Balance at January 1, 2003, as previously reported $ 535,125 $ (43,813) Adjustments for cumulative effect on prior years of retroactively applying SFAS 123 3,606 (2,696) Adjustments for cumulative effect on prior years of retroactively applying FIN 46 Revised -- (6,533) Balance at January 1, 2003, as adjusted $ 538,731 $ (53,042)
Beginning in 2003, the Company implemented an upgrade to its subsidiary ledger for accounting for fixed assets. The Company completed this system upgrade in the first quarter of 2004. In conjunction with this system upgrade, the Company has determined that cumulative depreciation expense generated by consolidated or equity method rental properties was understated by approximately $2.1 million through December 31, 2003 and this amount was recorded during the quarter ended March 31, 2004. Had the correction been made in 2003, depreciation expense would have increased by approximately $640,000, $1.3 million, and $1.0 million in the first, second and third quarters of 2003, respectively. In the fourth quarter 2003, depreciation expense would have decreased by approximately $1.4 million. The Company does not believe that the correction is material to the previously reported financial statements and is not material to any consolidated any consolidated earnings trends.
Overview
The Company believes that its operating results have largely been a result of its business strategy of investing in submarkets that provide the greatest potential for rental growth at the lowest relative risk. Essex believes that its market research process, which includes an analysis of both metropolitan statistical areas (MSA's) and submarkets, provides it with a distinct competitive advantage. Essex researches markets by reviewing data from private and government sources as well as information developed or verified by its field personnel. Essex then utilizes its proprietary research model to project market rent trends, allowing the Company to allocate capital to the markets with the best risk-adjusted return potential.
Essex's research process begins with a macro-economic analysis of various MSA's, followed by an evaluation of the submarkets within that MSA. The objective of the economic research department is to estimate the amount of new demand for housing, comparing it to the number of single family and multifamily homes being constructed within a submarket. Historically, markets with demand for multifamily housing that is greater than supply generate increasing occupancy levels and growth in rents.
Key components of Essex's analysis are as follows:
Job Growth: The Company believes that quality job growth will lead to demand for multifamily and for-sale housing. Based on a variety of considerations, the Company estimates how the total demand for housing will be allocated between rental and for-sale housing.
Housing Supply: Limited housing supply, both rental and for-sale, is a very important factor in maintaining high occupancy levels, particularly in periods of recession or slow economic growth. The Company seeks to identify markets in which there is a low level of housing construction, measured as a percentage of existing housing stock.
Cost of for-sale housing: The Company prefers areas with relatively expensive for-sale housing, which is usually caused by an insufficient amount of single-family housing construction. The Company seeks to identify areas where the cost of rent is low relative to both median income levels and the cost of homeownership.
Demographic trends: The Company evaluates areas with long-term positive immigration and demographic trends, and areas that provide an attractive quality of life.
Based on its evaluation of multifamily housing supply and demand factors, the Company forecasts the occupancy and rent trends for its targeted submarkets, and actively seeks to expand its multifamily portfolio in the submarkets with the greatest risk-adjusted return.
By region, the Company's operating results and investment strategy are as follows:
Southern California Region: At the time of the Company's 1994 initial public offering (IPO), the Company had ownership interests representing 17% of its multifamily units in this region. Following the IPO, the Company, using its research process, determined that various markets in the Southern California region were attractive for multifamily property investment and, the Company, accordingly increased its ownership in such markets. As of March 31, 2004, we have ownership interests representing 59% of our multifamily units in this region. During the three months ended March 31, 2004, the region continued to perform well, with same store property revenues increasing 4.4% versus the comparable period in 2003. Same store property revenues remained flat versus the immediately preceding quarter. The Company expects this region to continue generating positive operating results in the near term.
Northern California Region: As of March 31, 2004, the Company had ownership interests representing 17% of its multifamily units in this region. Several years of job losses have resulted in declining rents. In the three months ended March 31, 2004, same store property revenues decreased 8.2% versus the comparable period in 2003 and decreased 0.7% versus the immediately preceding quarter. The Company expects market rents to remain flat in fiscal year 2004, which would result in same store property revenues to decline. The Company expects positive multifamily fundamentals in this region after 2004. As a result, the Company will begin to increase its investment focus in this region.
Pacific Northwest Region: As of March 31, 2004, the Company had ownership interests representing 22% of its multifamily units in the region. This region also lost jobs in 2003, but at a lower rate compared to the Company's Northern California region. In the three months ended March 31, 2004, same store property revenues decreased 0.1% versus the comparable period in 2003 and increased 1.5% versus the immediately preceding quarter. The Company expects job growth in this region in fiscal year 2004, and believes this region will generate a slight increase in same property revenue versus 2003. The Company expects positive multifamily fundamentals in this region after 2004, and the Company will begin to increase it investment focus in this region.
Critical Accounting Policies
See Item 7 of the Company's Annual Report on Form 10-K for the year ended December 31, 2003 for a discussion of the Company's critical accounting policies. As a result of the implementation of FIN 46 Revised, discussed in Note 1 to the condensed consolidated financial statements, the Company has identified an additional critical accounting policy regarding consolidation of VIEs.
The Company assesses each entity in which it has an investment or contractual relationship which may be deemed to be a VIE. If such an entity is a VIE, then the Company analyzes the expected losses and expected residual returns to determine who is the primary beneficiary. If the Company is the primary beneficiary, then the entity is consolidated. The analysis required to identify VIEs and primary beneficiaries is complex and judgmental and must be applied to various types of entities and structures.
General Background
The Company's property revenues are generated primarily from multifamily property operations, which accounted for greater than 96% of its property revenues for the three and nine months ended September 30, 2003March 31, 2004 and 2002.2003. The Company's multifamily properties (the "Properties"("the Properties") are located in Southern California (Los Angeles, Ventura, Orange and San Diego counties), Northern California (the San Francisco Bay Area), the Pacific Northwest (the(The Seattle, Washington and Portland, Oregon metropolitan areas), and other areas (Houston, Texas,(Hemet, California, Las Vegas, Nevada, and Hemet, California)Houston, Texas).
Essex Apartment Value Fund, L.P. (the "Fund"("Fund I"), is an investment fund organized by the Company in 2001 to add value through rental growth and asset appreciation, utilizing the Company's development, redevelopment and asset management capabilities. Currently, the Fund I is considered fully invested based on its acquisitions to date and anticipated development and redevelopment expenditures. An affiliate of the Company, Essex VFGP, L.P. ("VFGP"), is a 1% general partner and is a 20.4% limited partner. The Operating Partnership owns a 99% limited partnership interest in VFGP. Fund I now expects to utilize leverage of approximately 61% of the valueestimated costs, of the underlying real estate portfolio.portfolio, including estimated completion costs of development projects. The Company is committed to invest 21.4% of the aggregate capital committed to the Fund. In addition, the CompanyEssex will be compensated by the Fund I for its asset management, property management, development and redevelopment services and may receive incentive payments if the Fund I exceeds certain financial return benchmarks. The Company's remaining unfunded capital commitment as of March 31, 2004 is $9,614,000.
The Company is in the process of forming the second Essex Apartment Value Fund ("Fund II"), which is expected to be similar to Fund I in size and structure. Essex anticipates an initial closing of Fund II during the second quarter of 2004, and anticipates its capital commitment by a subsidiary of the Company to be approximately $50 million.
Since its formation, the Fund I has acquired ownership interests in 17 multifamily residential properties, representing 4,926 apartment units with an aggregate purchase pricecost of approximately $500$640 million excluding(including the estimated total cost of development and redevelopment expenses,projects), and disposed of two multifamily residential property,properties, consisting of 530 apartment units at a gross sales price of approximately $73$73.2 million resulting in a net realized gain of approximately $5.7 million. In addition, threetwo development land parcels, where approximately 612480 apartment units are planned for construction, have been purchased by the Fund I with a total estimated cost for the projects of approximately $107.5$101.7 million. As of September 30, 2003,March 31, 2004, the remaining commitments to fund these development projects is approximately $48.8$25.9 million of which approximately $10.4$5.5 million is the Company's commitment. The 132- unit Kelvin Avenue development projectFund I also owns a land parcel in Irvine, California is still in the process of obtaining entitlements and its estimated total costs have not yet been finalized and is not included in the numbers above.California.
The Company has elected to be treated as a REITreal estate investment trust ("REIT") for federal income tax purposes commencing with the year ended December 31,since 1994. The Company provides a majoritysome of its fee based asset management and disposition services as well as third-party property management and leasing services through Essex Management Corporation ("EMC"), in order to maintain compliance with REIT tax rules. The Company owns 100% of EMC's 19,000 shares of nonvoting preferred stock. Executives ofEMC was retroactively consolidated by the Company own 100%as of EMC's 1,000 shares of Common Stock.
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SinceJanuary 1, 2004 for all periods presented in accordance with the Company's initial public offering (the "IPO") in June 1994, the Company has acquired ownership interests in 105 multifamily residential properties, its headquarters building, three Southern California office buildings, five recreational vehicle parks, and two manufactured housing communities. With respect to the multifamily residential properties that the Company acquired, 14 are located in Northern California, 69 are located in Southern California, 15 are located in the Seattle Metropolitan Area, five are located in the Portland Metropolitan Area and two are located in other areas. In total, these acquisitions consistadoption of 21,536 units with total capitalized acquisition costs of approximately $2,005.2 million. Additionally, since its IPO, the Company has developed and has ownership interests in ten multifamily properties that have reached stabilized operations. These development properties consist of 2,406 units with total capitalized development costs of $309.5 million. As part of its active portfolio management strategy, the Company has disposed of, since its IPO, twelve multifamily residential properties (six in Northern California, five in Southern California and one in the Pacific Northwest) consisting of a total of 2,014 units, six retail shopping centers in the Portland, Oregon metropolitan area and its former headquarters building located in Northern California at an aggregate gross sales price of approximately $259.5 million resulting in a net realized gain of approximately $53.8 million.FIN 46 Revised.
The Company (excluding the Fund'sFund I's development communities) has ownership interests in and is developing threetwo multifamily residential communities, with an aggregate of 756444 multifamily units. In connection with these development projects, the Company has directly, or in some cases through its joint venture partners, entered into contractual construction related commitments with unrelated third parties and the total projected estimated cost for these projects is approximately $122.2$74.9 million. As of September 30, 2003,March 31, 2004, the remaining commitment to fund these projects is approximately $26.0$12.0 million.
Results of Operations
Comparison of the Three Months Ended September 30, 2003March 31, 2004 to the Three Months Ended September 30, 2002March 31, 2003
Average financial occupancy rates of the Company's multifamily Quarterly Same Store Properties (stabilized properties consolidated by the Company for each of the three months ended September 30, 2003March 31, 2004 and 2002)2003) was 96.0% and 96.1%95.2%, for the three months ended September 30,March 31, 2004 and 2003, and 2002, respectively. "Financial occupancy" is defined as the percentage resulting from dividing actual rental revenue by total possible rental revenue. Actual rental revenue represents contractual rental revenue pursuant to leases without considering delinquency and concessions. Total possible rental revenue represents the value of all apartment units, with occupied units valued at contractual rental rates pursuant to leases and vacant units valued at estimated market rents. We believe that financial occupancy is a meaningful measure of occupancy because it considers the value of each vacant unit at its estimated market rate. Financial occupancy rates disclosed by other REITs may not be comparable to our calculation of financial occupancy.
The regional breakdown of average financial occupancy for the multifamily Quarterly Same Store Properties for the three months ended September 30,March 31, 2004 and 2003 and 2002 are as follows:
Three months endedSeptember 30,March 31, ---------------------- 2004 20032002--------- ----------- Southern California97.0% 96.3%96.2% 95.2% Northern California95.6% 96.8%95.8% 95.9% Pacific Northwest94.8% 94.8%95.9% 94.5%
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Total Revenues increased by $9,442,000$3,521,000 or 19.4%5.3% to $58,237,000$69,806,000 in the thirdfirst quarter of 20032004 from $48,795,000$66,285,000 in the thirdfirst quarter of 2002.2003. The following table sets forth a breakdown of these revenue amounts, including the revenues attributable to the Quarterly Same Store Properties.
Three Months EndedSeptember 30,March 31, Number of -------------------- Dollar Percentage Properties 2004 20032002Change Change ----------- --------- --------- --------- ----------- Revenues: (Dollars in thousands) Property revenues - quarterly Quarterly Same Store Properties Southern California2242 $17,91424,604 $17,26323,567 $651 3.81,037 4.4 % Northern California16 12,189 13,589 (1,400) (10.3)17 12,593 13,725 (1,132) (8.2) Pacific Northwest 2310,032 10,534 (502) (4.8)10,311 10,321 (10) (0.1) ----------- --------- --------- --------- ----------- Properties61 40,135 41,386 (1,251) (3.0)82 47,508 47,613 (105) (0.2) Property revenues - properties acquired or consolidated subsequent toJune 30,December 31, 2002 (1)15,120 2,243 12,877 574.118,823 16,406 2,417 14.7 --------- --------- --------- ----------- Total property revenues55,255 43,629 11,626 26.666,331 64,019 2,312 3.6 Interest and other income2,982 5,166 (2,184) (42.3)3,475 2,266 1,209 53.4 --------- --------- --------- ----------- Total revenues $58,23769,806 $48,79566,285 $9,442 19.43,521 5.3 % ========= ========= ========= ===========
(1) Also includes fourfive office buildings (one consolidated in accordance with FIN 46R), five recreational vehicle parks, two manufactured housing communities, redevelopment communities, development communities, and development communities.12 multifamily properties consolidated as of January 1, 2004 in accordance with FIN 46 Revised.
As set forth in the above table, the $9,442,000$3,521,000 net increase in total revenues was mainlyprimarily attributable to an increase of $12,877,000 attributable$2,417,000 due to acquisition of thirteen multifamily properties acquired(the "Quarterly Acquisition Properties") subsequent to June 30,December 31, 2002 four office buildings, five recreational vehicle parks, two manufactured housing communities, redevelopment communities and development communities, which was offset in part by a decreasethe increase in interest and other income of $2,184,000 and a decrease in revenues from the Quarterly Same Store Properties of $1,251,000. Subsequent to June 30, 2002, the Company acquired interests in 21 multifamily properties, two office buildings, five recreational vehicle parks, two manufactured housing communities and achieved stabilized operations in three redevelopment communities and one development community (the "Quarterly Acquisitions Properties").$1,209,000.
Interest and other income decreasedincreased by $2,184,000$1,209,000 or 42.3%53.4% to $2,982,000$3,475,000 in the thirdfirst quarter of 20032004 from $5,166,000$2,266,000 in the thirdfirst quarter of 2002.2003. The decreaseincrease primarily relates to the repayment of notes receivable which resultedan increase in a decreaseequity income in interest income on notes receivablesco-investments and the sale of co- investment assets resulting in the decrease in income earned on the Company's co-investments.leasing income.
Property revenues from the Quarterly Same Store Properties decreased by $1,251,000$105,000 or 3.0%0.2% to $40,135,000$47,508,000 in the thirdfirst quarter of 20032004 from $41,386,000$47,613,000 in the thirdfirst quarter of 2002.2003. The majority of thisrelatively minor decrease was attributable to the 1617 Quarterly Same Store Properties located in Northern California andoffset by the 23results of the 42 Quarterly Same Store Properties located in the Pacific Northwest.Southern California. The property revenues of the Quarterly Same Store Properties in Northern California decreased by $1,400,000$1,132,000 or 10.3%8.2% to $12,189,000$12,593,000 in the thirdfirst quarter of 20032004 from $13,589,000$13,725,000 in the thirdfirst quarter of 2002.2003. The decrease in Northern California is primarily attributable to rental rate decreases and a decrease in financial occupancy to 95.6%95.8% in the thirdfirst quarter of 20032004 from 96.8%95.9% in the thirdfirst quarter of 2002.2003. The property revenues of the Quarterly Same Store Properties in the Pacific Northwest decreased slightly by $502,000$10,000 or 4.8%0.1% to $10,032,000$10,311,000 in the thirdfirst quarter of 20032004 from $10,534,000$10,321,000 in the thirdfirst quarter of 2002.2003. The $502,000 decrease in the Pacific Northwest is primarily attributable to rental rate decreases. Financial occupancy remained constant at 94.8% in the third quarter of 2003 as compared to the third quarter of 2002. The 22 42Quarterly Same Store Properties located in Southern California offset the net decrease in total property revenues from the other Quarterly Same Store Properties. The property revenues for these properties increased by $651,000$1,037,000, or 3.8%4.4%, to $17,914,000$24,604,000 in the thirdfirst quarter of 20032004 from $17,263,000$23,567,000 in the thirdfirst quarter of 2002.2003. The $651,000$1,037,000 increase is primarily attributable to rental rate increases and an increase in financial occupancy to 97.0%96.2% in the thirdfirst quarter of 20032004 from 96.3%95.2% in the thirdfirst quarter of 2002.2003.
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Total Expenses increased by $11,156,000$7,958,000 or approximately 34.6%16.0% to $43,373,000$57,786,000 in the thirdfirst quarter of 20032004 from $32,217,000$49,828,000 in the thirdfirst quarter of 2002.2003. This increase was mainly due to an increase in property operating expenses of $8,867,000$6,181,000 or 40.4%18.1% to $30,834,000$40,273,000 in the thirdfirst quarter of 20032004 from $21,967,000$34,092,000 in the thirdfirst quarter of 2002. Of such2003. Such operating expense increase $9,443,000was attributable to an increase in depreciation and amortization of $5,130,000, which was attributable to the Quarterly Acquisition Properties, which was offset byand a small decreasecumulative correction that increased depreciation expense in the amount of approximately $2,100,000 in the first quarter of 2004.All other property operating expense attributable to the Quarterly Same Store Properties.expenses increased $1,051,000. Interest expense increased by $1,907,000$1,103,000 or 22.1%8.4% to $10,528,000$14,310,000 in the thirdfirst quarter of 20032004 from $8,621,000$13,207,000 in the thirdfirst quarter of 2002.2003. The increase in interest expense is due to increases in the mortgage notes payable and line of credit balances and the effect of Quarterly Acquisition Properties.
Minority interests decreased by $360,000$1,242,000 or 6.0%18.2% to $5,604,000$5,570,000 in the thirdfirst quarter of 20032004 from $5,964,000$6,812,000 in the thirdfirst quarter of 2002. This is primarily due to the decrease in net income of the Operating Partnership.
Net incomedecreased by $1,354,000 or 12.8% to $9,260,000 in the third quarter of 2003 from $10,614,000 in the third quarter of 2002. The decrease in net income is mainly attributable to the factors noted above.
Comparison of the Nine Months Ended September 30, 2003 to the Nine Months Ended September 30, 2002
Average financial occupancy rates of the Company's multifamily Same Store Properties (stabilized properties consolidated by the Company for each of the nine months ended September 30, 2003 and 2002) was 95.6% and 94.4%, for the nine months ended September 30, 2003 and 2002, respectively.
The regional breakdown of average financial occupancy for the multifamily Same Store Properties for the nine months ended September 30, 2003 and 2002 are as follows:
Nine Months Ended September 30, ---------------------- 2003 2002 --------- ----------- Southern California 96.0% 94.3% Northern California 95.6% 95.7% Pacific Northwest 94.8% 92.8%
Total Revenues increased by $26,491,000 or 17.8% to $175,679,000 in the nine months ended September 30, 2003 from $149,188,000 in the nine months ended September 30, 2002.
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The following table sets forth a breakdown of these revenue amounts, including the revenues attributable to the Same Store Properties.
Nine Months Ended September 30, Number of -------------------- Dollar Percentage Properties 2003 2002 Change Change ----------- --------- --------- --------- ----------- Revenues: (Dollars in thousands) Property revenues Same Store Properties Southern California 22 $ 52,922 $ 50,413 $ 2,509 5.0 % Northern California 16 38,182 42,165 (3,983) (9.4) Pacific Northwest 23 30,567 31,747 (1,180) (3.7) ----------- --------- --------- --------- ----------- Properties 61 121,671 124,325 (2,654) (2.1) Property revenues - properties acquired subsequent to December 31, 2001 (1) 44,761 5,902 38,859 658.4 --------- --------- --------- ----------- Total property revenues 166,432 130,227 36,205 27.8 Interest and other income 9,247 18,961 (9,714) (51.2) --------- --------- --------- ----------- Total revenues $ 175,679 $ 149,188 $ 26,491 17.8 % ========= ========= ========= ===========
(1) Also includes four office buildings, five recreational vehicle parks, two manufactured housing communities, redevelopment communities, and development communities.
As set forth in the above table, the $26,491,000 net increase in total revenues was mainly attributable to an increase of $38,859,000 attributable to multifamily properties acquired subsequent to December 31, 2001, four office buildings, five recreational vehicle parks, two manufactured housing communities, redevelopment communities and development communities, which was offset in part by a decrease in interest and other income of $9,714,000 and a decrease in revenue from the Same Store Properties of $2,654,000. Subsequent to December 31, 2001, the Company acquired interests in 21 multifamily properties, two office buildings, five recreational vehicle parks, two manufactured housing communities and achieved stabilized operations in three redevelopment communities and one development community (the "Acquisitions Properties").
Interest and other income decreased by $9,714,000 or 51.2% to $9,247,000 in the nine months ended September 30, 2003 from $18,961,000 in the nine months ended September 30, 2002. The decrease primarily relates to the repayment or conversion to non-accrual of notes receivable which resulted in a decrease in interest income on notes receivables and the sale of co-investment assets resulting in the decrease in income earned on the Company's co- investments.
Property revenues from the Same Store Properties decreased by $2,654,000 or 2.1% to $121,671,000 in the nine months ended September 30, 2003 from $124,325,000 in the nine months ended September 30, 2002. The majority of this decrease was attributable to the 16 Same Store Properties located in Northern California and the 23 Same Store Properties located in the Pacific Northwest. The property revenues of the Same Store Properties in Northern California decreased by $3,983,000 or 9.4% to $38,182,000 in the nine months ended September 30, 2003 from $42,165,000 in the nine months ended September 30, 2002. The decrease in Northern California is primarily attributable to rental rate decreases and a slight decrease in financial occupancy to 95.6% in the nine months ended September 30, 2003 from 95.7% in the nine months ended September 30, 2002. The property revenues of the Same Store Properties in the Pacific Northwest decreased by $1,180,000 or 3.7% to $30,567,000 in the nine months ended September 30, 2003 from $31,747,000 in the nine months ended September 30, 2002. The $1,180,000 decrease in the Pacific Northwest is primarily attributable to rental rate decreases offset by an increase in financial occupancy to 94.8% in the nine months ended September 30, 2003 from 92.8% in the nine months ended September 30, 2002. The 22 multifamily residential properties located in Southern California offset the net decrease in total property revenues from the other Same Store Properties. The property revenues for these properties increased by $2,509,000 or 5.0% to $52,922,000 in the nine months ended September 30, 2003 from $50,413,000 in the nine months ended September 30, 2002. The $2,509,000 increase is primarily attributable to rental rate increases and an increase in financial occupancy to 96.0% in the nine months ended September 30, 2003 from 94.3% in the nine months ended September 30, 2002.
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Total Expenses increased by $32,399,000 or approximately 33.8% to $128,291,000 in the nine months ended September 30, 2003 from $95,892,000 in the nine months ended September 30, 2002. This increase was mainly due to an increase in property operating expenses of $25,759,000 or 39.8% to $90,400,000 in the nine months ended September 30, 2003 from $64,641,000 in the nine months ended September 30, 2002. Of such operating expense increase $25,256,000 was attributable to the Acquisition Properties. Interest expense increased by $5,796,000 or 22.2% to $31,858,000 in the nine months ended September 30, 2003 from $26,062,000 in the nine months ended September 30, 2002. The increase in interest expense is due to increases in the line of credit balance.
Minority interests decreased by $1,066,000 or 5.8% to $17,247,000 in the nine months ended September 30, 2003 from $18,313,000 in the nine months ended September 30, 2002.2003. This is primarily due to the decrease in net income of the Operating Partnership.
Discontinued operationsdecreased by $8,286,000 to $0 in the nine months ended September 30, 2003 from $8,286,000 in the nine months ended September 30, 2002. This decrease is due to the reduction of gain on sale of real estate and operating income from Tara Village, a 168-unit apartment community located in Tarzana, California, which was sold on June 18, 2002.
Net incomedecreased by $13,128,000$3,195,000 or 30.3%33.1% to $30,141,000net income of $6,450,000 in the nine months ended September 30, 2003first quarter of 2004 from $43,269,000net income of $9,645,000 in nine months ended September 30, 2002.the first quarter of 2003. The decrease in net income is mainly attributable to the factors noted above.
Liquidity and Capital Resources
At September 30, 2003,March 31, 2004, the Company had $10,400,000$17,709,000 of unrestricted cash and cash equivalents. The Company expects to meet its short-term liquidity requirements by using its working capital, cash generated from operations, and amounts available under lines of credit or other financings. The Company believes that its current net cash flows will be adequate to meet operating requirements and to provide for payment of dividends by the Company in accordance with REIT qualification requirements. The Company expects to meet its long-term liquidity requirements relating to property acquisitions and development (beyond the next 12 months) and balloon debt maturities by using a combination of some or all of the following sources: working capital, amounts available on lines of credit, net proceeds from public and private debt and equity issuances, refinance of maturing loans, and proceeds from the disposition of properties that may be sold from time to time. There can, however, be no assurance that the Company will have access to the debt and equity markets in a timely fashion to meet such future funding requirements or that future working capital and borrowings under the lines of credit will be available, or if available, will be sufficient to meet the Company's requirements or that the Company will be able to dispose of properties in a timely manner and under terms and conditions that the Company deems acceptable.
The Company has two outstanding unsecured lines of credit for an aggregate amount of $215,000,000. The first line, in the amount of $185,000,000, matures in May 2004, with an option to extend it for one year thereafter. Outstanding balances under this line of credit bear interest at a rate, which uses a tiered rate structure tied to the Company's corporate ratings, if any, and leverage rating, which has been priced at LIBOR plus 1.10%. At September 30, 2003 the Company had $132,700,000 outstanding on this line of credit. In July 2003, the Company expanded this line from $165,000,000 to $185,000,000. No other material terms of this facility were revised. A second line of credit in the amount of $30,000,000 matures in December 2003. Outstanding balances, if any, on this second line bear interest based on a tiered rate structure currently at LIBOR plus 1.10%. At September 30, 2003 the Company had $30,000,000 outstanding on this line of credit. The outstanding balance on this line of credit was repaid subsequent to the end of the quarter. At September 30, 2003, these lines of credit bore interest rates of approximately 2.3%. The credit agreements contain debt covenants related to limitations on indebtedness and liabilities, maintenance of minimum levels of consolidated earnings before depreciation, interest and amortization and maintenance of minimum tangible net worth.
In addition, the Fund, the investment fund managed by the Company, has an unsecured line of credit for an aggregate amount of $50,000,000. In August 2003, the Fund reduced this line from $125,000,000 to $50,000,000. This facility is directly tied to the remaining capital commitments of certain investors. As of September 30, 2003, the maximum amount available on this line was approximately $47,568,000. The line bears interest at LIBOR plus 0.875%. As of September 30, 2003, the line had an outstanding balance of $36,572,000. This line matures in December 2003. The Fund plans on using one or more of the following sources to repay the outstanding balance at maturity: working capital, secured mortgage financing, construction financing, calling undrawn equity commitments, and proceeds from the disposition of properties which may be sold from time to time. The line provides for debt covenants relating to limitations on mortgage indebtedness.
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In addition to the Company's unsecured lines of credit, the Company had $664,596,000 of secured indebtedness at September 30, 2003. Such indebtedness consisted of $595,024,000 in fixed rate debt with interest rates varying from 5.5% to 8.2% and maturity dates ranging from 2005 to 2026. The indebtedness also includes $69,572,000 of tax-exempt variable rate demand bonds with interest rates paid during the nine months ended September 30, 2003 which averaged 3.7% and maturity dates ranging from 2020 to 2032. The tax-exempt variable rate demand bonds are capped at interest rates ranging from 7.1% to 7.3%.
The Company's unrestricted cash balance increased by $1,838,000 from $8,562,000 as of December 31,2002 to $10,400,000 as of September 30, 2003. The Company generated $73,748,000 in cash from operating activities, used $58,553,000 cash in investing activities and used $13,357,000 cash in financing activities. The $58,553,000 net cash used in investing activities was primarily a result of $24,293,000 contributed to investments in corporations and limited partnerships, $20,119,000 used to fund real estate under development, $13,090,000 used to upgrade rental properties and $8,337,000 used to fund additions to notes receivables from investees, other related parties and other receivables. The $13,357,000 net cash used in financing activities was primarily a result of $66,618,000 of repayments of mortgages and other notes payable and lines of credit, $50,184,000 of dividends paid, $15,389,000 of distributions to minority interest partners offset by $89,851,000 of proceeds from mortgages and other notes and line of credit and $24,664,000 of net proceeds from the issuance of preferred stock.
Non-revenue generating capital expenditures are improvements and upgrades that extend the useful life of the property and are not related to preparing a multifamily property unit to be rented to a tenant. The Company expects to incur approximately $375$390 per weighted average occupancy unit in non-revenue generating capital expenditures for the year ended December 31, 2003.2004. These expenditures do not include the improvements required in connection with the origination ofas a condition to funding mortgage loans, expenditures for acquisition properties' renovations and improvements, which are expected to generate additional revenue, and renovation expenditures required pursuant to tax-exempt bond financings. The Company expects that cash from operations and/or its lines of credit will fund such expenditures. However, there can be no assurance that the actual expenditures incurred during 20032004 and/or the funding thereof will not be significantly different than the Company's current expectations.
The Company is currently developing sixtwo multifamily residential projects, with an aggregate of 1,368444 multifamily units. Such projects involve certain risks inherent in real estate development. See "Other Matters/ Risk Factors-- RisksFactors--Risks that Development Activities Will be Delayed or Not Completed and/or Fail to Achieve Expected Results" in Item 1 of the Company's Annual Report on Form 10-K for the year ended December 31, 2002.2003. In connection with these development projects, the Company has directly, or in some cases through its joint venture partners entered into contractual construction related commitments with unrelated third parties and the total projected estimated cost for these projects is approximately $229,700,000.$74,900,000. As of September 30, 2003,March 31, 2004, the remaining commitment to fund these development projects is approximately $74,800,000, of which approximately $36,400,000 is the Company's commitment. The 132-unit Kelvin Avenue development project in Irvine, California is still in the process of obtaining entitlements and its estimated total costs have not yet been finalized and is not included in the numbers above.$12,000,000. The Company expects to fund such commitments by using a combination of some or all of the following sources: its working capital, amounts available on its lines of credit, net proceeds from public and private equity and debt issuances, and proceeds from the disposition of properties, if any.
Although the Company does not anticipate starting any new development projects in 2004, it will continue to evaluate, as appropriate and with due consideration given to current market conditions, potential development projects of multifamily properties.
Essex Apartment Value Fund, L.P. ("Fund I"), is an investment fund organized by the Company in 2001 to add value through rental growth and asset appreciation, utilizing the Company's development, redevelopment and asset management capabilities. Currently, Fund I is considered fully invested based on its acquisitions to date and anticipated development and redevelopment expenditures. An affiliate of the Company, Essex VFGP, L.P. ("VFGP"), is a 1% general partner and is a 20.4% limited partner. The Operating Partnership owns a 99% limited partnership interest in VFGP. Fund I now expects to utilize leverage of approximately 61% of the estimated costs, of the underlying real estate portfolio, including estimated completion costs of development projects. The Company is committed to invest 21.4% of the aggregate capital committed to the Fund. In addition, Essex will be compensated by Fund I for its asset management, property management, development and redevelopment services and may receive incentive payments if Fund I exceeds certain financial return benchmarks. The Company's remaining unfunded capital commitment as of March 31, 2004 is $9,614,000.
The Company is in the process of forming the second Essex Apartment Value Fund ("Fund II"), which is expected to be similar to Fund I in size and structure. Essex anticipates an initial closing of Fund II during the second quarter of 2004, and anticipates its capital commitment by a subsidiary of the Company to be approximately $50 million.
The Company has an outstanding unsecured line of credit for an aggregate amount of $185,000,000. At March 31, 2004, the Company had $118,500,000 outstanding on this line of credit. At March 31, 2004, this line of credit bore an interest rate of approximately 2.2%. On April 30, 2004, the Company renewed this $185 million unsecured line of credit facility for a three-year term, with an option to extend it for one year thereafter. The underlying interest rate on this line is based on a tiered rate structure tied to the Company's corporate ratings and is currently LIBOR plus 1.0%. On December 18, 2003, the Company obtained a 5-year, $90,000,000 credit facility from Freddie Mac, secured by four of Essex's multifamily communities. The aggregate maximum principal amount of the facility is $90,000,000, increasing to $100,000,000 on July 1, 2004. The Company borrowed $80,600,000 under this facility, comprised of two tranches as follows: $41,000,000, locked for 60 days at a base rate of 1.586% (55 basis points over Freddie Mac's Reference Rate) and $39,600,000 locked for 180 days at a base rate of 1.695% (59 basis points over Freddie Mac's Reference Rate).
In addition to the Company's unsecured lines of credit, the Company had $967,392,000 of secured indebtedness at March 31, 2004. Such indebtedness consisted of $786,662,000 in fixed rate debt with interest rates varying from 4.25% to 8.25% and maturity dates ranging from 2005 to 2014. The indebtedness also includes $180,730,000 of tax-exempt variable rate demand bonds with interest rates, including credit enhancements and other fees, paid during the three months ended March 31, 2004 that average 2.60% and maturity dates ranging from 2020 to 2034. The tax-exempt variable rate demand bonds are subject to interest rates caps.
The Company pays quarterly dividends from cash available for distribution. Until it is distributed, cash available for distribution is invested by the Company primarily in short-term investment grade securities or is used by the Company to reduce balances outstanding under its line of credit.
Essex Apartment Value Fund, L.P. (the "Fund"), is an investment fund organized byAs of March 31, 2004, the Company had the capacity pursuant to existing shelf registration statements to issue up to $219,455,250 in 2001equity securities and the Operating Partnership had the capacity pursuant to add value through rental growth and asset appreciation, utilizing the Company's development, redevelopment and asset management capabilities. Currently the Fund is considered fully invested based on its acquisitionssuch registration statements to date and anticipated development and redevelopment expenditures. The Fund now expectsissue up to utilize leverage$250,000,000 of approximately 61% of the value of the underlying real estate portfolio. The Company is committed to invest 21.4% of the aggregate capital committed to the Fund. In addition, the Company will be compensated by the Fund for its asset management, property management, development and redevelopment services and may receive incentive payments if the Fund exceeds certain financial return benchmarks.
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debt securities.
Financing and equity issuances. During the third quarter of 2003 and the early part of the fourth quarter of 2003, the Company undertook the following financing activities and equity issuances.Equity Issuances
On July 30, 2003, in connection with the Company's acquisition, by merger, of John M. Sachs, Inc. ("Sachs") that was completed on December 17, 2002, and under the terms of the merger agreement, a final analysis was prepared, which indicated that the actual net liabilities of Sachs were less than the net liabilities of Sachs estimated to be outstanding as of the merger date. Based on the final analysis and as a post-closing adjustment payment pursuant to the merger agreement, the Company made a final payment of approximately $1,766,000 in cash and issued an additional 35,860 shares of common stock to certain of the pre-merger shareholders of Sachs.
On September 23, 2003, the Company issued 1,000,000 shares of its Series F Cumulative Redeemable Preferred Stock ("Series F Preferred Stock") at a fixed price of $24.664 per share, a discount from the $25.00 per share liquidation value of the shares. The shares dodid not begin to accrue a dividend until November 25, 2003, and, following that date, will pay quarterly distributions at an annualized rate of 7.8125% per year of the liquidation value and will be redeemable by the Company on or after September 23, 2008. The Company will amortizeamortized the original discount in connection with the issuance of these shares in the fourth quarter of 2003, resulting in a charge of approximately $336,000. The shares were issued pursuant to the Company's existing shelf registration statement. The Company intends to useused the net proceeds from this sale of Series F Preferred Stock to redeem all of the 9.125% Series C Cumulative Redeemable Preferred Units (the "Series C Preferred Units") of Essex Portfolio, L.P., of which the Company is the general partner. On October 15, 2003, the Company issued a notice of redemption to the holders of Series C Preferred Stock. The Company expects to redeem all outstanding Series C Preferred Units on November 24, 2003, for a price of $50.00 per unit plus accrued and unpaid dividends.
On October 6, 2003, the Company sold 1.6 million newly issued shares of common stock in a public offering and received offering proceeds (before expenses) of $60.67 per share, representing a 3.25% discount to the common stock's closing price on September 30, 2003, the date of the underwriting agreement between the Company and the underwriter, pursuant to which the shares were sold. The shares were issued pursuant to the Company's existing shelf registration statement. The net proceeds of the offering ofwere approximately $96,772,000 is expected$97,072,000. Subsequent to bethe offering, the net proceeds generated from the offering were used for the acquisition ofto acquire multifamily communities located in the Company's targeted West Coast marketsmarkets.
Using the proceeds of its September 2003 sale of its 7.8125% Series F Cumulative Redeemable Preferred Stock, the Company on November 24, 2003, redeemed all of the outstanding 9.125% Series C Cumulative Redeemable Preferred Units of the Operating Partnership. In connection with this redemption the Company incurred a non-cash charge of $625,000 related to the write-off of the issuance costs.
In January 2004, the Company restructured its previously issued $50 million, 9.30% Series D Cumulative Redeemable Preferred Units ("Series D Units"), and mayits previously issued $80 million, 7.875% Series B Cumulative Redeemable Preferred Units ("Series B Units"). The existing distribution rate of 9.30% of the Series D Units will continue until July 27, 2004 - the end of the current non-call period. On July 28, 2004, the distribution rate on the Series D Units is to be reduced to 7.875%. The date that the Series D Units can first be redeemed at the Company's option was extended by six years to July 28, 2010. The date that the Series B Units can first be redeemed at the Company's option was extended from February 6, 2003 to December 31, 2009.
On June 14, 2000 the Company purchased Waterford Place, a 238-unit apartment community located in San Jose, California for a contract price of $35.0 million and an additional contingent payment. The amount of the contingent payment was disputed and submitted to binding arbitration. As a result of the arbitration, the Company was directed to issue an additional 109,874 units of limited partnership interest ("Units") in the Operating Partnership to the sellers of Waterford Place. On March 31, 2004, the Company completed the issuance of these Units to the sellers. In connection with this issuance, on March 31, 2004, the Company also be usedredeemed for general corporate purposes, includingcash 55,564 Units from these sellers, which included Units from the repayment109,874 issued to them that day as well as Units previously acquired by them.
Company Investments; Off-Balance Sheet Financing
The Company invests in joint ventures, which are accounted for under the equity or consolidation methods of debt andaccounting based on the fundingprovisions of development activities.
AfterFIN 46 Revised or the voting control it exercises through its ownership interests in these affiliates. Under the equity method of accounting, the investment is carried at the cost of assets contributed or distributed, plus the Company's equity issuances,in undistributed earnings or losses since its initial investment. The individual assets, liabilities, revenues and expenses of the joint venture are not recorded in the Company's consolidated financial statements.
There is one VIE as to which the Company hasis not deemed to be the capacity pursuantprimary beneficiary of such VIE. Total assets and liabilities of this entity as of March 31, 2004 were $14,591,000 and $14,703,000, respectively. The Company is not exposed to existing shelf registration statementsa material loss from this entity. At March 31, 2004 and December 31, 2003, the Company did not have any other relationship with unconsolidated entities or financial partnerships, such as entities often referred to issue upas structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, the Company is not materially exposed to $219,455,250any financing, liquidity, market or credit risk that could arise if the Company had engaged in equity securities and the Operating Partnership has the capacity pursuant to such registration statements to issue up to $250,000,000 of debt securities.relationships.
Contractual Obligations and Commercial Commitments
The following table summarizes our contractual obligations and other commitments at September 30, 2003,March 31, 2004, and the effect such obligations could have on our liquidity and cash flow in future periods:
Less Than 2-3 4-5 Over 5 1 Year Years Years Years Total (In thousands) ----------- --------- --------- ------------------ -------------------- Mortgage notes payable $1,68915,154 $48,90465,435 $83,527240,644 $530,476646,159 $664,596967,392 Lines of credit30,000 132,700118,500 (1) -- --162,70080,600 199,100 Developmentcommitments(1) 36,400commitments (2) 17,543 -- -- --36,40017,543 Redevelopmentcommitments(2) 3,000commitments(3) 7,439 -- -- --3,0007,439 Essex Apartment Value Fund, L.P. capital commitment15,2859,614 -- -- --15,2859,614 ----------- --------- --------- ------------------ -------------------- $86,374168,250 $181,60465,435 $83,527240,644 $530,476726,759 $881,9811,201,088 =========== ========= ========= ================== ====================
(1) $35,242__________
(2) $712March 31, 2004.
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New Accounting Pronouncements Not Yet Adopted
In January 2003, the FASB approved for issuance FASB Interpretation No. 46 (FIN 46), "Consolidation of Variable Interest Entities." FIN 46 clarifies the application of Accounting Research Bulletin No. 51, "Consolidated Financial Statements" to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 applies immediately to variable interest entities created after JanuaryMarch 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period ending after December 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. FIN 46 may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. The disclosure requirements of FIN 46 are effective for all financial statements initially issued after January 31, 2003. It is reasonably possible that certain of the entities through which and with which the Company conducts business, including those described in Notes 3(b) and 5 of the Company's December 31, 2002 consolidated financial statements will be deemed to be Variable Interest Entities (VIEs) under the provisions of FIN 46. Based on its preliminary evaluation of the entities considered reasonably possible to be VIEs, the total assets and liabilities net of intercompany balances of such entities were estimated at $77,775,000 and $55,603,000 at September 30, 2003. The Company's estimated maximum exposure to loss would be equal to its investments in these arrangements, which totaled $22,850,000, as of September 30, 2003. The disclosures provided reflect management's understanding and analysis of FIN 46 based upon information currently available. The evaluation of the impact of FIN 46 on the Company's consolidated financial statements is ongoing and is subject to change in the event additional interpretive guidance is provided by the Financial Accounting Standards Board or others.
Forward Looking Statements
Certain statements in this "Management's Discussion and Analysis of Financial Condition and Results of Operations," and elsewhere in this quarterly report on Form 10-Q which are not historical facts may be considered forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended, including statements regarding the Company's expectations, hopes, intentions, beliefs and strategies regarding the future. Forward looking statements include statements regarding the Company's expectations as to the timing of completion of current development projects and the stabilization dates of such projects, expectation as to the total projected costs and rental rates of currentacquisition and development projects, beliefs as to the adequacy of future cash flows to meet operating requirements and to provide for dividend payments in accordance with REIT requirements, expectations as to the amount of capital expenditures, expectations as to the amount of non-revenue generating capital expenditures, future acquisitions and developments, the anticipated performance of the Essex Apartment Value Fund, L.P.("Fund I"), the anticipated initial closing of the second Essex Apartment Value Fund ("Fund II"), the anticipated performance of existing properties, statements regarding the Company's financing activities and the use of proceeds from such activities.
Such forward-looking statements involve known and unknown risks, uncertainties and other factors including, but not limited to, that the Company will fail to achieve its business objectives, that the actual completion of development projects will be subject to delays, that the stabilization dates of such projects will be delayed, that the total projected costs of current development projects will exceed expectations, that such development projects will not be completed, that development projects and acquisitions will fail to meet expectations, that estimates of future income from an acquired property may prove to be inaccurate, that future cash flows will be inadequate to meet operating requirements and/or will be insufficient to provide for dividend payments in accordance with REIT requirements, that the actual non-revenue generating capital expenditures will exceed the Company's current expectations, that the Essex Apartment Value Fund I will fail to perform as anticipated, that the Company's partners in this Fund fail to fund capital commitments as contractually required, that there may be unexpected delays in the initial closing of Fund II, that there may be a downturn in the markets in which the Company's properties are located, that the terms of any refinancing may not be as favorable as the terms of existing indebtedness, and that the Company will not be able to complete property acquisitions, as anticipated, for which the proceeds from recent equity issuances were intended to be used, as well as those risks, special considerations, and other factors discussed under the caption "Potential Factors Affecting Future Operating Results" below and those discussed under the caption "Other Matters/Risk Factors" in Item 1 of the Company's Annual Report on Form 10-K for the year ended December 31, 2002,2003, and those other risk factors and special considerations set forth in the Company's other filings with the Securities and Exchange Commission (the "SEC") which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements.
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Potential Factors Affecting Future Operating Results
Many factors affect the Company's actual financial performance and may cause the Company's future results to be different from past performance or trends. These factors include those factors discussed under the caption "Other Matters/Risk Factors" in Item 1 of the Company's Annual Report on Form 10-K for the year ended December 31, 20022003 and the following:
Economic Environment and Impact on Operating Results
Both the national economy and the economies of the western states in which the Company owns, manages and develops properties, some of which are concentrated in high-tech sectors, have been and may continue to be in an economic downturn. The impacts of such downturn on operating results can include, and are not limited to, reduction in rental rates, occupancy levels, property valuations and increases in operating costs such as advertising, turnover and repair and maintenance expense.
The Company's property type and diverse geographic locations provide some degree of risk moderation but are not immune to a prolonged down cycle in the real estate markets in which the Company operates. Although the Company believes it is well positioned to meet the challenges ahead, it is possible that further reductions in occupancy and market rental rates will result in reduction of rental revenues, operating income, cash flows, and market value of the Company's shares. Prolonged recession could also affect the Company's ability to obtain financing at acceptable rates of interest and to access funds from the refinance or disposition of properties at acceptable prices.
Development and Redevelopment Activities
The Company pursues multifamily residential properties and development and redevelopment projects from time to time. Development projects generally require various government and other approvals, the receipt of which cannot be assured. The Company's development and redevelopment activities generally entail certain risks, including the following:
These risks may reduce the funds available for distribution to the Company's stockholders. Further, the development and redevelopment of properties is also subject to the general risks associated with real estate investments.
Interest Rate Fluctuations
The Company monitors changes in interest rates and believes that it is well positioned from both a liquidity and interest rate risk perspective. However, current interest rates are at historic lows and potentially could increase rapidly to levels more in line with recent levels. The immediate effect of significant and rapid interest rate increases would result in higher interest expense on the Company's variable interest rate debt. The effect of prolonged interest rate increases could negatively impact the Company's ability to make acquisitions and develop properties at economic returns on investment and the Company's ability to refinance existing borrowings at acceptable rates.
Inflation /Deflation
Substantial inflationary or deflationary pressures would likelycould have a negative effect on rental rates and property operating expenses. The Company believes it effectively manages its property and other expenses but understands that substantial annual rates of inflation or deflation could adversely impact operating results.
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Funds from Operations
Funds from Operations, as defined by the National Association of Real Estate Investment Trusts ("NAREIT") is generally considered by industry analysts as an appropriate measure of performance of an equity REIT. Generally, Funds from Operations adjusts the net income of equity REITs for charges such as depreciation and amortization of rental properties, gains/ lossesgain on sales of real estate, extraordinary items and extraordinary items.cumulative effect of a change in accounting principle. Management considers Funds from Operations to be a useful financial operating performance measurement of an equity REIT because, together with net income and cash flows, Funds from Operations provides investors with an additional basis to evaluate the performance of a REIT. Funds from Operations does not represent net income or cash flows from operations as defined by generally accepted accounting principles (GAAP) and is not intended to indicate whether cash flows will be sufficient to fund cash needs. It should not be considered as an alternative to net income as an indicator of the REIT's operating performance or to cash flows as a measure of liquidity. Funds from Operations also does not represent cash flows generated from operating, investing or financing activities as defined under GAAP. Further, Funds from Operations as disclosed by other REITs may not be comparable to the Company's calculation of Funds from Operations.
The following table sets forth the Company's calculation of Funds from Operations for the three and nine months ended September 30, 2003March 31, 2004 and 2002.2003.
Three Months EndedNine Months Ended September 30, September 30,March 31, ------------------------------------------------------2004 20032002 2003 2002(1) ------------- ------------------------- ------------Incomefrom continuing operationsbefore minorityintrusts and discontinued operationsinterests $14,864,00012,020,000 $16,578,000 $ 47,388,000 $ 53,296,00016,457,000 Adjustments:Gain on sale of co-investment activities -- (19,000) (1,408,000)Depreciation and amortization12,308,000 9,129,000 35,473,000 27,229,00018,432,000 13,302,000 Depreciation and amortization -- unconsolidated co-investments2,663,000 2,170,000 7,071,000 5,892,000and minority interests 834,000 591,000 Minority interests, excluding depreciation(4,612,000) (4,607,000) (13,829,000) (13,816,000) Income from discontinued operations(4,872,000) (5,648,000) Dividends to preferred stockholders - Series F (488,000) ---- -- 225,000 Depreciation - discontinued operations -- -- -- 191,000------------- ------------------------- ------------Funds From Operations $25,223,00025,926,000 $23,251,000 $ 76,103,000 $ 71,609,00024,702,000 ============= ========================= ============Weighted average number shares outstanding diluted(1) 23,647,225 20,829,211 23,535,160 20,962,971(2) 25,370,177 23,494,051 ============= ========================= ============ NineThree Months EndedSeptember 30, --------------------------March 31, ---------------------------- 2004 20032002 ------------ ------------(1) ------------- ------------- Cash flow provided by (used in): Operating activities $73,748,00035,956,000 $67,892,00030,055,000 Investing activities(58,553,000) (37,215,000)(105,866,000) (12,422,000) Financing activities(13,357,000) (34,970,000)72,851,000 (14,633,000)
(1) March 31, 2003 amounts have been restated for the retroactive adoption of FIN 46 Revised and SFAS 123 as discussed in Note 1.
(2) Assumes conversion of all outstanding operating partnership interests in the Operating Partnership. Minority interests have been adjusted to reflect such conversion.
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Item 3: Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to interest rate changes primarily as a result of its line of credit and long-term debt used to maintain liquidity and fund capital expenditures and expansion of the Company's real estate investment portfolio and operations. The Company's interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows and to lower its overall borrowing costs. To achieve its objectives the Company borrows primarily at fixed rates and may enter into derivative financial instruments such as interest rate swaps, caps and treasury locks in order to mitigate its interest rate risk on a related financial instrument. The Company does not enter into derivative or interest rate transactions for speculative purposes.
The Company's interest rate risk is monitored using a variety of techniques. The table below presents the principal amounts and weighted average interest rates by year of expected maturity to evaluate the expected cash flows and sensitivity to interest rate changes.
For the Years Ended20032004 2005 2006 2007 2008 Thereafter Total Fair value -------- -------- --------- -------- -------- ----------- ---------------------------- Fixed rate debt (In thousands) Amount $1,68915,154 $7,90142,583 $41,00322,852 $20,39787,628 $153,016 $63,130465,429 $460,904786,662 $595,024 $ 576,894749,839 Average interest rate6.9% 6.9% 6.9% 6.9% 6.9%6.8% 6.8% 6.8% 6.7% 6.7% 6.8% Variable rate debt (In thousands) Amount$ 30,000 $132,700$118,500 $ -- $ -- $ -- $69,572-- $ 261,330 (1) $232,272379,830 $232,272379,830 Average interest2.7% 2.3%2.2% -- -- --3.7%-- 2.3%
(1) Capped at interest rates ranging from 7.1% to 7.3%.
The table incorporates only those exposures that exist as of September 30, 2003;March 31, 2004; it does not consider those exposures or positions that could arise after that date. As a result, our ultimate realized gain or loss, with respect to interest rate fluctuations, would depend on the exposures that arise during the period, our hedging strategies at the time, and interest rates.
Item 4: Controls and Procedures
As of September 30, 2003,March 31, 2004, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-15 of the Securities Exchange Act of 1934, as amended. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting management to material information relating to the Company that is required to be included in our periodic filings with the Securities and Exchange Commission. ThereCommission.There were no changes in the Company's internal control over financial reporting, that occurred during the quarter ended September 30, 2003,March 31,2004, that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
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Part II -- Other Information
Item 2: Changes in Securities and Use of Proceeds
On September 23, 2003,In January 2004, the Company restructured its previously issued 1,000,000 shares of its$50 million, 9.30% Series FD Cumulative Redeemable Preferred Shares (the "Series FUnits ("Series D Units"), and its previously issued $80 million, 7.875% Series B Cumulative Redeemable Preferred Stock"Units ("Series B Units"). The existing distribution rate of 9.30% of the Series D Units will continue until July 27, 2004 - the end of the current non-call period. On July 28, 2004, the distribution rate on the Series D Units is to be reduced to 7.875%. The date that the Series D Units can first be redeemed at the Company's option was extended by six years to July 28, 2010. The date that the Series B Units can first be redeemed at the Company's option was extended from February 6, 2003 to December 31, 2009.
Unregistered Sales of Securities
On June 14, 2000 the Company purchased Waterford Place, a fixed238- unit apartment community located in San Jose, California for a contract price of $24.664 per share,$35.0 million and an additional contingent payment. The amount of the contingent payment was disputed and submitted to binding arbitration. As a discountresult of the arbitration, the Company was directed to issue an additional 109,874 units of limited partnership interest ("Units") in the Operating Partnership to the sellers of Waterford Place. On March 31, 2004, the Company completed the issuance of these Units to the sellers. In connection with this issuance, on March 31, 2004, the Company also redeemed for cash 55,564 Units from these sellers, which included Units from the $25.00 per share liquidation value109,874 issued to them that day as well as Units previously acquired by them. This private placement of the shares. The shares do not begin to accrue a dividend until November 25, 2003 and following that date, will pay quarterly distributions at an annualized rate of 7.8125% per year of the liquidation value and will be redeemable by the Company on or after September 23, 2008. The shares of Series F Preferred Stock were issued pursuant to the Company's shelf registration statement. With respect to distribution and rights upon voluntary or involuntary liquidation, winding-up or dissolution of the Company, the Series F Preferred Stock ranks senior to the Company's registered common stock and on parity with the Company's Series B Preferred Stock, Series C Preferred Stock, Series D Preferred Stock and Series E Preferred Stock.
Sales of Unregistered Securities. On July 30, 2003, in connection with the Company's acquisition, by merger, of John M. Sachs, Inc. ("Sachs") on December 17, 2002, and under terms of the merger agreement, a final analysis was prepared, which indicated that the actual net liabilities were less than the net liabilities of Sachs estimated to be outstanding as of the merger date. Based on this final analysis, and as a post-closing adjustment payment pursuant to the merger agreement, the Company made a final payment of $1,766,000 in cash and issued an additional 35,860 shares of common stock to certain of the pre- merger shareholders of Sachs. This issuance of common stockUnits was completed pursuant to the exemption from registration contained onin Section 4(2) of the Securities Act of 1933, as amended.
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Item 6: Exhibits and Reports on Form 8-K
3.1 Articles Supplementary relating to the 7.8125% Series F Cumulative Reedemable Preferred Stock, attached as Exhibit 3.1 to the Company's Form 8-K, dated September 19, 2003, and incorporated herein by reference.
10.1 Series F Cumulative Redeemable Preferred Stock Purchase Agreement, dated September 18, 2003, by and between Essex Property Trust, Inc. and Lend Lease Rosen Real Estate Securities, LLC, attached as Exhibit 10.1 to the Company's Form 8-K, dated September 19, 2003 and incorporated herein by reference.
10.2 EighthEleventh Amendment to the First Amended and Restated Agreement of Limited Partnership of Essex Portfolio, L.P., dated September 23, 2003.as of March 29, 2004.
10.3 Amended and Restated Revolving Note Agreements (increasing credit line to $185 million).
10.4 Second Amendment to Second10.2 Third Amended and Restated Revolving Credit Agreement.Agreement, dated April 30, 2004, among Essex Portfolio L.P., Bank of America and other lenders as specified therein.
31.1 Certification of Keith R. Guericke, Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Michael J. Schall, Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Keith R. Guericke, Chief Executive Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Michael J. Schall, Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
On July 30, 2003 the Company filed a Current Report on Form 8-K to file a press release to announce the earnings for the fiscal quarter ended June 30, 2003.
On September 19, 2003January 8, 2004 the Company filed a Current Report on Form 8-K to file a press release to announce that the Company entered into ahad restructured its previously issued $50.0 million, 9.30% Series F Cumulative Preferred Stock Purchase Agreement with Lend Lease Rosen Real Estate Securities, LLC, as agent for its clients, to sell an aggregate of 1,000,000 shares of the Company's 7.8125% Series FD Cumulative Redeemable Preferred Stock (liquidation preference $25.00 per share) $0.0001 par value per share.Units and its previously issued $80.0 million, 7.875% Series B Cumulative Redeemable Preferred Units.
On September 24, 2003January 27, 2004, the Company filed a Current Report on Form 8-K to file a written communication comprised of slides shown during an investor presentation on January 27, 2004.
On February 4, 2004 the Company filed a Current Report on Form 8-K to file a press release to announce fourth quarter and year ended 2003 results.
On March 1, 2004, the completionCompany filed a Current Report on Form 8-K to file a written communication comprised of the sale of 1,000,000 shares of the Company's 7.8125% Series F Cumulative Redeemable Preferred Stock (the "Series F Preferred Stock") to Lend Lease Rosen Real Estate Securities, LLC, as agent for its clients.slides shown during an investor presentation on March 1, 2004.
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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.
ESSEX PROPERTY TRUST, INC. | |
(Registrant) | |
ESSEX PROPERTY TRUST, INC.(Registrant)
November 14, 2003
By: /s/ MARK J. MIKL
Mark J. MiklFirst Vice President, Treasurer and Controller(Authorized Officer and Principal Accounting Officer)Date: May 17, 2004
By: | /S/ MARK J. MIKL | |
Mark J. Mikl | ||
First Vice President, Treasurer and Controller |
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