Form 10-Q for the period ending 6-30-2006

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

FORM 10-Q

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

For the quarterly period ended June 30, 2006

or

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

For the transition period from   to  

Commission File Number: 1-12762

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

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

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

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

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

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

 
Number of Shares Outstanding
Class
at July 19, 2006
Common Stock, $.01 par value
24,044,783
 

MID-AMERICA APARTMENT COMMUNITIES, INC.
     
TABLE OF CONTENTS
   
Page
 
PART I - FINANCIAL INFORMATION
  
Item 1.
Financial Statements
  
 
Condensed Consolidated Balance Sheets as of June 30, 2006 (Unaudited) and December 31, 2005
2
 
Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2006 and 2005 (Unaudited)
3
 
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2006 and 2005 (Unaudited)
4
 
Notes to Condensed Consolidated Financial Statements (Unaudited)
5
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
16
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
26
Item 4.
Controls and Procedures
26
     
 
PART II - OTHER INFORMATION
  
Item 1.
Legal Proceedings
27
Item 1A.
Risk Factors
27
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
28
Item 3.
Defaults Upon Senior Securities
28
Item 4.
Submission of Matters to a Vote of Security Holders
28
Item 5.
Other Information
28
Item 6.
Exhibits
28
 
Signatures
35

 
 

Mid-America Apartment Communities, Inc.
Condensed Consolidated Balance Sheets
June 30, 2006 (Unaudited) and December 31, 2005
(Dollars in thousands, except per share data)
           
   
June 30, 2006
  
December 31, 2005
  
Assets:
              
Real estate assets:
              
Land
  
$
190,862
  
$
179,523
  
Buildings and improvements
    
1,813,395
   
1,740,818
 
Furniture, fixtures and equipment
    
48,115
   
46,301
 
Capital improvements in progress
    
2,981
   
4,175
 
     
2,055,353
   
1,970,817
 
Less accumulated depreciation
    
(503,793
)
  
(473,421
)
     
1,551,560
   
1,497,396
 
               
Land held for future development
    
1,366
   
1,366
 
Commercial properties, net
    
7,156
   
7,345
 
Investments in and advances to real estate joint venture
    
3,926
   
4,182
 
Real estate assets, net 
    
1,564,008
   
1,510,289
 
               
Cash and cash equivalents
    
11,366
   
14,064
 
Restricted cash
    
4,586
   
5,534
 
Deferred financing costs, net
    
15,935
   
15,338
 
Other assets
    
22,645
   
20,181
 
Goodwill
    
5,051
   
5,051
 
Assets held for sale
    
7,328
   
-
 
Total assets 
  
$
1,630,919
  
$
1,570,457
  
               
Liabilities and Shareholders' Equity:
              
Liabilities:
              
Notes payable
  
$
1,125,235
  
$
1,140,046
  
Accounts payable
    
5,986
   
3,278
 
Accrued expenses and other liabilities
    
29,012
   
28,380
 
Security deposits
    
7,209
   
6,429
 
Liabilities associated with assets held for sale
    
290
   
-
 
Total liabilities 
    
1,167,732
   
1,178,133
 
               
Minority interest
    
31,935
   
29,798
 
               
Shareholders' equity:
              
Preferred stock, $.01 par value, 20,000,000 shares authorized,
              
$166,863 or $25 per share liquidation preference:
              
9 1/4% Series F Cumulative Redeemable Preferred Stock, 
              
 3,000,000 shares authorized, 474,500 shares issued and outstanding
   
5
   
5
 
8.30% Series H Cumulative Redeemable Preferred Stock, 
              
 6,200,000 shares authorized, 6,200,000 shares issued and outstanding
    
62
   
62
 
Common stock, $.01 par value per share, 50,000,000 shares authorized;
              
24,025,183 and 22,048,372 shares issued and outstanding at 
              
June 30, 2006, and December 31, 2005, respectively 
    
240
   
220
 
Additional paid-in capital
    
757,581
   
671,885
 
Other
    
-
   
(2,422
)
Accumulated distributions in excess of net income
    
(351,269
)
  
(314,352
)
Accumulated other comprehensive income (loss)
    
24,633
   
7,128
 
Total shareholders' equity 
    
431,252
   
362,526
 
Total liabilities and shareholders' equity 
  
$
1,630,919
  
$
1,570,457
  
               
See accompanying notes to condensed consolidated financial statements.
              

 

Mid-America Apartment Communities, Inc.  
Condensed Consolidated Statements of Operations  
Three and six months ended June 30, 2006 and 2005  
(Dollars in thousands, except per share data)  
                        
        
Three months ended
  
Six months ended
  
        
June 30,
  
June 30,
  
   
  
  
2006
  
2005
  
2006
  
2005
  
Operating revenues:
                                
Rental revenues 
        
$
76,842
  
$
69,290
  
$
151,264
  
$
137,327
  
Other property revenues 
          
3,470
   
3,124
   
6,994
   
6,011
 
Total property revenues 
          
80,312
   
72,414
   
158,258
   
143,338
 
Management fee income 
          
52
   
103
   
104
   
221
 
Total operating revenues 
          
80,364
   
72,517
   
158,362
   
143,559
 
Property operating expenses:
                                
Personnel 
          
9,437
   
8,633
   
18,456
   
16,907
 
Building repairs and maintenance 
          
2,947
   
2,631
   
5,383
   
4,912
 
Real estate taxes and insurance 
          
9,950
   
9,507
   
19,505
   
18,858
 
Utilities 
          
4,573
   
4,038
   
9,258
   
8,157
 
Landscaping 
          
2,132
   
1,950
   
4,222
   
3,878
 
Other operating 
          
3,629
   
3,470
   
7,035
   
6,840
 
Depreciation 
          
19,515
   
18,244
   
38,286
   
36,135
 
Total property operating expenses 
          
52,183
   
48,473
   
102,145
   
95,687
 
Property management expenses
          
3,464
   
2,892
   
5,975
   
5,700
 
General and administrative expenses
          
2,682
   
2,163
   
6,043
   
4,819
 
Income from continuing operations before non-operating items
          
22,035
   
18,989
   
44,199
   
37,353
 
Interest and other non-property income
          
215
   
130
   
332
   
287
 
Interest expense
          
(15,833
)
  
(14,404
)
  
(31,534
)
  
(28,073
)
Loss on debt extinguishment
          
(1
)
  
(90
)
  
(551
)
  
(94
)
Amortization of deferred financing costs
          
(504
)
  
(489
)
  
(989
)
  
(949
)
Minority interest in operating partnership income
          
(408
)
  
(778
)
  
(821
)
  
(1,038
)
(Loss) income from investments in real estate joint ventures
          
(35
)
  
(193
)
  
(119
)
  
125
 
Incentive fee from real estate joint ventures
          
-
   
1,723
   
-
   
1,723
 
Net gain (loss) on insurance and other settlement proceeds
          
225
   
(16
)
  
225
   
(9
)
Gain on sale of non-depreciable assets
          
-
   
334
   
-
   
334
 
Gain on disposition within real estate joint ventures
          
-
   
3,034
   
-
   
3,034
 
Income from continuing operations
          
5,694
   
8,240
   
10,742
   
12,693
 
Discontinued operations:
                                
Gain from discontinued operations before 
                                
 asset impairment, settlement proceeds and gain on sale
          
198
   
102
   
276
   
94
 
Asset impairment on discontinued operations 
          
-
   
(149
)
  
-
   
(243
)
Net loss on insurance and other settlement proceeds on 
                                
 discontinued operations
          
-
   
-
   
-
   
(25
)
Net income
          
5,892
   
8,193
   
11,018
   
12,519
 
Preferred dividend distribution
          
3,491
   
3,635
   
6,981
   
7,348
 
Net income available for common shareholders
        
$
2,401
  
$
4,558
  
$
4,037
  
$
5,171
  
                                 
Weighted average shares outstanding (in thousands):
                                
Basic 
          
23,152
   
21,351
   
22,645
   
21,140
 
Effect of dilutive stock options 
          
222
   
274
   
228
   
279
 
Diluted 
          
23,374
   
21,625
   
22,873
   
21,419
 
                                 
Net income available for common shareholders
        
$
2,401
  
$
4,558
  
$
4,037
  
$
5,171
  
Discontinued property operations
          
(198
)
  
47
   
(276
)
  
174
 
Income from continuing operations available for common shareholders
        
$
2,203
  
$
4,605
  
$
3,761
  
$
5,345
  
                                 
Earnings per share - basic:
                                
Income from continuing operations  
                                
available for common shareholders 
        
$
0.09
  
$
0.22
  
$
0.17
  
$
0.25
  
Discontinued property operations 
          
0.01
   
(0.01
)
  
0.01
   
(0.01
)
Net income available for common shareholders 
        
$
0.10
  
$
0.21
  
$
0.18
  
$
0.24
  
                                 
Earnings per share - diluted:
                                
Income from continuing operations  
                                
available for common shareholders 
        
$
0.09
  
$
0.21
  
$
0.17
  
$
0.25
  
Discontinued property operations 
          
0.01
   
-
   
0.01
   
(0.01
)
Net income available for common shareholders 
        
$
0.10
  
$
0.21
  
$
0.18
  
$
0.24
  
                                 
Dividends declared per common share (1)
        
$
0.595
  
$
0.585
  
$
1.785
  
$
1.170
  
                                 
(1) The Company declared and paid $1.19 per common share during the six months ended June 30, 2006.
During this same period the Company also declared an additional $0.595 per common share that will not be paid until July 31, 2006. 
                                 
See accompanying notes to condensed consolidated financial statements.
 
 

Mid-America Apartment Communities, Inc.
Condensed Consolidated Statements of Cash Flows
Six Months Ended June 30, 2006 and 2005
(Dollars in thousands)
           
   
2006
  
2005
  
Cash flows from operating activities:
          
Net income
 
$
11,018
  
$
12,519
  
Adjustments to reconcile net income to net cash provided by operating activities:
              
Gain from discontinued operations before asset impairment, settlement 
              
     proceeds and gain on sale
    
(276
)
  
(94
)
Depreciation and amortization of deferred financing costs 
    
39,275
   
37,084
 
Stock compensation expense 
    
646
   
392
 
Amortization of debt premium 
    
(930
)
  
(932
)
Loss (income) from investments in real estate joint ventures 
    
119
   
(125
)
Minority interest in operating partnership income 
    
821
   
1,038
 
Loss on debt extinguishment 
    
551
   
94
 
Derivative interest (income) expense 
    
(120
)
  
-
 
Gain on sale of non-depreciable assets 
    
-
   
(334
)
Gain on disposition within real estate joint ventures 
    
-
   
(3,034
)
Incentive fee from real estate joint ventures 
    
-
   
(1,723
)
Net loss on insurance and other settlement proceeds on discontinued 
              
     operations
    
-
   
25
 
Asset impairment on discontinued operations 
    
-
   
243
 
Net (gain) loss on insurance and other settlement proceeds 
    
(225
)
  
9
 
Changes in assets and liabilities: 
              
     Restricted cash
    
689
   
(1,225
)
     Other assets
    
2,741
   
5,555
 
     Accounts payable
    
2,874
   
1,672
 
     Accrued expenses and other
    
2,574
   
3,367
 
     Security deposits
    
780
   
453
 
Net cash provided by operating activities 
    
60,537
   
54,984
 
Cash flows from investing activities:
              
Purchases of real estate and other assets 
    
(82,213
)
  
(47,314
)
Improvements to existing real estate assets 
    
(17,802
)
  
(10,521
)
Distributions from real estate joint ventures 
    
137
   
14,755
 
Proceeds from disposition of real estate assets 
    
1,089
   
8,432
 
Net cash used in investing activities 
    
(98,789
)
  
(34,648
)
Cash flows from financing activities:
              
Net change in credit lines 
    
1,659
   
(26,337
)
Proceeds from notes payable 
    
13,235
   
19,486
 
Principal payments on notes payable 
    
(28,737
)
  
(1,320
)
Payment of deferred financing costs 
    
(1,905
)
  
(493
)
Proceeds from issuances of common shares and units 
    
87,892
   
20,951
 
Distributions to unitholders 
    
(2,990
)
  
(3,067
)
Dividends paid on common shares 
    
(26,619
)
  
(24,725
)
Dividends paid on preferred shares 
    
(6,981
)
  
(7,348
)
Net cash provided by financing activities 
    
35,554
   
(22,853
)
Net decrease in cash and cash equivalents 
    
(2,698
)
  
(2,517
)
Cash and cash equivalents, beginning of period
    
14,064
   
9,133
 
Cash and cash equivalents, end of period
  
$
11,366
  
$
6,616
  
               
Supplemental disclosure of cash flow information:
              
Interest paid
  
$
32,989
  
$
29,344
  
Supplemental disclosure of noncash investing and financing activities:
              
    Conversion of units to common shares
  
$
136
  
$
20
  
    Issuance of restricted common shares
  
$
39
  
$
813
  
    Marked-to-market adjustment on derivative instruments
  
$
17,505
  
$
2,308
  
    Fair value adjustment on debt assumed
  
$
-
  
$
2,277
  
    Reclass of preferred stock from equity to liabilities
  
$
-
  
$
10,000
  
               
See accompanying notes to condensed consolidated financial statements.
 
 

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


1.  BASIS OF PRESENTATION

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

RECLASSIFICATION

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

2. STOCK BASED COMPENSATION

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

The Company adopted Statement 123(R) effective January 1, 2006 using the “modified prospective” method permitted by Statement 123(R) in which compensation cost is recognized beginning with the effective date (a) based on the requirements of Statement 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of Statement 123 for all awards granted to employees prior to the effective date of Statement 123(R) that remain unvested on the effective date. The effect of adopting Statement 123(R) for the three months ending June 30, 2006 was an increase of approximately $81,500 in net income from continuing operations and in net income with no increase to either basic or diluted earnings per share. The effect of adopting Statement 123(R) for the six months ending June 30, 2006 was an increase of approximately $268,400 in net income from continuing operations and in net income with an increase of approximately $0.01 to both basic and diluted earnings per share. The adoption of Statement 123(R) had no impact on cash flow from operations or cash flow from financing activities.




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


               
       
Three
  
Six
  
       
Months
  
Months
  
       
Ended
  
Ended
  
       
June 30, 2005
  
June 30, 2005
  
Net income
        
$
8,193
  
$
12,519
  
Preferred dividend distribution
          
3,635
   
7,348
 
Net income available for
                   
common shareholders
          
4,558
   
5,171
 
Add: Stock-based employee
                    
compensation expense included
                    
in reported net income
          
-
   
-
 
Less: Stock-based employee
                   
compensation expense from
                    
employee stock purchase plan discount
          
7
   
14
 
Less: Stock-based employee
                   
compensation expense determined
                    
under fair value method of accounting
          
26
   
56
 
Pro forma net income available for
                    
common shareholders
        
$
4,525
  
$
5,101
  
                     
Average common shares outstanding - Basic
          
21,351
   
21,140
 
Average common shares outstanding - Diluted
          
21,625
   
21,419
 
                     
Net income available per common share:
                    
Basic as reported
        
$
0.21
  
$
0.24
  
Basic pro forma
        
$
0.21
  
$
0.24
  
Diluted as reported
        
$
0.21
  
$
0.24
  
Diluted pro forma
        
$
0.21
  
$
0.24
  
                     
Assumptions:(1)
                    
Risk free interest rate
          
N/A
    
N/A
  
Expected life - Years
          
N/A
    
N/A
  
Expected volatility
          
N/A
    
N/A
  
Expected dividends
          
N/A
    
N/A
  
                     
(1)No grants were issued in the periods shown.
              

Employee Stock Purchase Plan

The Mid-America Apartment Communities, Inc. Employee Stock Purchase Plan (the “ESPP”) provides a means for employees to purchase common stock of the Company. The Board of Directors has authorized the issuance of 150,000 shares for the plan. The ESPP is administered by the Compensation Committee of the Board of Directors who may annually grant options to employees to purchase annually up to an aggregate of 15,000 shares of common stock at a price equal to 85% of the market price of the common stock. Shares are purchased semi-annually on June 30 and December 31. During the three months ended June 30, 2006 and 2005, 2,235 and 2,349 shares, respectively,

were purchased through the ESPP. Because it is not possible to reasonably estimate fair value at the grant date, the Company estimates the compensation costs based on intrinsic values updated until the date of the settlement. Compensation cost recognized for the three and six months ending June 30, 2006 were approximately $8,600 and $24,600, respectively.

Incentive Plans Overview and Summary

The Company’s stock compensation plans consist of the ESPP and a number of incentives provided to attract and retain independent directors, executive officers and key employees. Incentives are currently granted under the 2004 Stock Plan which was approved at the May 24, 2004 Annual Meeting of Shareholders. This plan replaced the 1994 Restricted Stock and Stock Option Plan (collectively, the “Plans”) under which no further awards may be granted as of January 31, 2004. The 1994 Restricted Stock and Stock Option Plan allowed for the grant of restricted stock and stock options up to a total of 2.4 million shares. The 2004 Stock Plan allows for the grant of restricted stock and stock options up to a total of 500,000 shares. The Company believes that such awards better align the interests of its employees with those of its shareholders. Total compensation cost under the Plans was approximately $248,400 and $124,400 for the three months ended June 30, 2006 and 2005, respectively, and approximately $370,400 and $200,000 for the six months ended June 30, 2006 and 2005, respectively. As of June 30, 2006, the total unrecognized compensation cost related to the Plans was approximately $3.3 million. This cost is expected to be recognized over the weighted average period of 4.5 years. Information concerning specific grants under the Plans is listed below.

Options

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

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


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



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

           
Weighted-
      
       
Weighted-
 
Average
 
 
 
 
 
 
 
Average
 
Remaining
 
Aggregate
 
 
 
 
 
Exercise
 
Contractual
 
Intrinsic
 
Options
 
Shares
 
Price
 
Life
 
Value
 
Outstanding at January 1, 2006
    
398,052
 
$
24.83
              
Granted
    
-
   
-
             
Exercised
    
(123,360
)
  
24.09
             
Forfeited or expired
    
(7,350
)
  
26.03
             
Outstanding at March 31, 2006
    
267,342
 
$
25.14
    
3.8
 
$
7,916,799
  
Granted
    
-
   
-
             
Exercised
    
(6,570
)
  
23.82
             
Forfeited or expired
    
(13,820
)
  
25.52
             
Outstanding at June 30, 2006
    
246,952
 
$
25.12
    
3.7
 
$
7,563,212
  
Exercisable at June 30, 2006
    
174,847
 
$
24.96
    
2.9
 
$
5,383,478
  

The total intrinsic value of options exercised during the three months ended June 30, 2006 and 2005, was approximately $192,000 and $960,000, respectively. The total intrinsic value of options exercised during the six months ended June 30, 2006 and 2005, was approximately $3.9 million and $3.3 million, respectively. Cash received from the exercise of options for the three and six months ended June 30, 2006, was approximately $156,500 and $3.1 million, respectively.

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

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

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

For the three and six months ended June 30, 2006, compensation costs related to the nonvested shares granted was approximately $6,000 and $11,900, respectively. As of June 30, 2006 there was approximately $87,500 of total unrecognized compensation cost related to nonvested shares granted. This cost is expected to be recognized over the




weighted average period of 3.7 years. No shares vested during the three months ended June 30, 2006.
 
Key Managers 2002 Restricted Stock

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

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

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

For the three and six months ended June 30, 2006, compensation costs related to the nonvested shares granted was approximately $55,000 and $110,000, respectively. As of June 30, 2006, there was approximately $1.2 million of total unrecognized compensation cost related to nonvested shares granted. This cost is expected to be recognized over the weighted average period of 5.5 years. The total fair value of shares forfeited in the three months ended June 30, 2006 is approximately $117,000.

Executive 2005 Restricted Stock

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




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

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

For the three and six months ended June 30, 2006, compensation costs related to the nonvested shares granted was approximately $42,600 and $85,200, respectively. As of June 30, 2006, there was approximately $113,600 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted. This cost is expected to be recognized over the weighted average period of 0.7 years. No shares vested during the three months ended June 30, 2006.

Director 2005 Restricted Stock Plan

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

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

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

For the three and six months ended June 30, 2006, compensation costs related to the nonvested shares granted was approximately $34,800 and $57,900, respectively. As of June 30, 2006, there was approximately $138,400 of total
 

unrecognized compensation cost related to nonvested share-based compensation arrangements granted. This cost is expected to be recognized over the weighted average period of 0.7 years. The total fair value of shares vesting during the three months ended June 30, 2006, was approximately $154,100.

Director 2006 Restricted Stock Plan

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

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

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

For the three and six months ended June 30, 2006, compensation costs related to the nonvested shares granted was approximately $9,500 and $9,500, respectively. As of June 30, 2006, there was approximately $240,400 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted. This cost is expected to be recognized over the weighted average period of 1.6 years. No shares vested during the three months ended June 30, 2006. The fair market value of the shares granted during the three months ended June 30, 2006 is approximately $249,900.

Key Managers 2005 Restricted Stock

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




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


Volatility
  
17.10%
Expected life in years
  
3
Risk-free rate
  
3.77%
Dividend yield
  
5.20%
 
A summary of the status of the 2005 Plan nonvested shares as of June 30, 2006, and the changes for the six months ended June 30, 2006, is presented below:
       
Weighted
  
       
Average
  
       
Grant-Date
  
Nonvested Shares
  
Shares
  
Fair Value
  
Nonvested at January 1, 2006
    
36,691
  
$
45.42
  
Granted
    
-
     
Vested
    
-
        
Forfeited
    
-
      
Nonvested at March 31, 2006
    
36,691
  
$
45.42
  
Granted
    
-
       
Vested
    
-
        
Forfeited
    
-
      
Nonvested at June 30, 2006
    
36,691
 
$
45.42
  

For the three and six months ended June 30, 2006, compensation costs related to the nonvested shares granted was approximately $61,400 and $122,900, respectively. As of June 30, 2006, there was approximately $1.3 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted. The Company’s policy is to recognize compensation cost on a straight-line basis over the requisite service period for an entire award (rather than each portion of an award). Accordingly, the $1.3 million unrecognized cost will be recognized over the weighted average period of 5.0 years. No shares vested during the three months ended June 30, 2006.

Long-Term Performance Based Incentive Plan for Executive Officers

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

The fair value of the stock award was estimated on the grant date using a Monte Carlo simulation with the assumptions noted in the following table. Volatility is based on the historical volatility of the Company’s common stock. The expected term of the Long-Term Plan is based on the criteria for the plan and the expected life of the



awards. The Company uses a U.S. constant-maturity Treasury for the same term as the expected term of the Long-Term Plan to represent the risk-free rate. Turnover is based on the historical experience for the key managers and executive officers. The Company uses its current dividend yield at the time of grant to estimate the dividend yield over the life of the plan.


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

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

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

For the six and three months ended June 30, 2006, compensation costs related to the nonvested shares granted was approximately $10,300 and $20,700, respectively. As of June 30, 2006, there was approximately $186,200 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted. This unrecognized cost will be recognized over the weighted average period of 4.5 years. No shares vested during the three months ended June 30, 2006.

3. COMPREHENSIVE INCOME

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

   
Three months
  
Six months
  
   
ended June 30,
  
ended June 30,
  
   
2006
  
2005
  
2006
  
2005
  
                   
Net income
  
$
5,892
  
$
8,193
  
$
11,018
  
$
12,519
  
Marked-to-market adjustment
                          
on derivative instruments
    
7,088
   
(8,993
)
  
17,505
   
2,308
 
Total comprehensive income
  
$
12,980
  
$
(800
)
$
28,523
  
$
14,827
  

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



4. DERIVATIVE FINANCIAL INSTRUMENTS

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

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

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

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

5. SHARE AND UNIT INFORMATION

In May 2006, the Company closed on a public offering of 1,150,000 shares of common stock for which it received net proceeds of $59.5 million. The Company used $10 million of the net proceeds to redeem its 8 5/8% Series G Cumulative Redeemable Preferred Stock and the remainder to pay down indebtedness under the Company’s FNMA facilities.

At June 30, 2006, 24,025,183 common shares and 2,508,403 operating partnership units were outstanding, representing a total of 26,533,586 shares and units. Additionally, the Company had outstanding options for 246,952 shares of common stock at June 30, 2006, of which 116,865 were anti-dilutive. At June 30, 2005, 21,518,146 common shares and 2,633,065 operating partnership units were outstanding, representing a total of 24,151,211 shares and units. Additionally, the Company had outstanding options for 425,900 shares of common stock at June 30, 2005, of which 261,063 were anti-dilutive.

6. 8 5/8% SERIES G CUMULATIVE REDEEMABLE PREFERRED STOCK

In 2002, the Company issued 8 5/8% Series G Cumulative Redeemable Preferred Stock (“Series G”) with a $25.00 per share liquidation preference and a preferential cumulative annual distribution of $2.15625 per share, payable monthly. The Company issued 400,000 shares of Series G in a direct placement with private investors (“Investors”) for which it received aggregate proceeds of $10 million. On or after November 15, 2004, the Company or the Investors could give the required one-year notice to redeem or put, respectively, all or part of the Series G shares beginning on or after November 15, 2005, in increments of $1 million. In the event the Investors elect to put all or a part of the Series G to the Company, the Company had the option to redeem all or a portion of the shares of the Series G in shares of common stock of the Company in lieu of cash.



In accordance with EITF D-98: Classification and Measurement of Redeemable Securities, as of March 31, 2005, the Company classified the Series G outside of permanent equity as the Company determined that in the event of a put by the Investors, there were two possible circumstances which were not wholly in control of the Company that could require the Series G to be redeemed by the Company for cash as opposed to common stock, and thus the Series G should be presented outside of permanent equity. These circumstances were the delisting of the Company’s common stock from the New York Stock Exchange and the failure to complete a registration of the Company’s common stock exchanged for the Series G.

On May 26, 2005, the Company gave the required one-year notice to redeem all of the issued and outstanding Series G shares on May 26, 2006. As a result, in accordance with Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (“Statement 150”), the Company classified the Series G as a liability within notes payable as of May 26, 2005, on the accompanying condensed consolidated financial statements. Statement 150 also requires that all subsequent dividend payments be classified as interest expense on the condensed consolidated financial statements.

On May, 26, 2006, the Company redeemed all 400,000 issued and outstanding shares of the Series G.

7. REAL ESTATE ACQUISITIONS  

On April 27, 2006, the Company acquired the Grand Courtyard apartments, a 390-unit community located in Dallas, Texas.

8. DISCONTINUED OPERATIONS

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

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

 

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


   
Three Months Ended
  
Six Months Ended
  
   
June 30,
  
June 30,
  
   
2006
  
2005
  
2006
  
2005
  
                   
Revenues
                          
Rental revenues
  
$
606
  
$
597
  
$
1,229
  
$
1,796
  
Other revenues
    
26
   
(11
)
  
51
   
32
 
Total revenues
    
632
   
586
   
1,280
   
1,828
 
Expenses
                          
Property operating expenses
    
334
   
481
   
802
   
1,602
 
Interest expense
    
100
   
3
   
202
   
132
 
Asset impairment
    
-
   
149
   
-
   
243
 
Total expense
    
434
   
633
   
1,004
   
1,977
 
Gain (loss) from discontinued operations before
                          
gain on sale and settlement proceeds
    
198
   
(47
)
  
276
   
(149
)
Net loss on insurance and other settlement
                          
proceeds
    
-
   
-
   
-
   
(25
)
Gain (loss) from discontinued operations
  
$
198
  
$
(47
)
$
276
  
$
(174
)

9. SEGMENT INFORMATION

At June 30, 2006, the Company owned or had an ownership interest in 135 multifamily apartment communities, including the apartment communities owned by the Company’s joint venture, in 12 different states from which it derives all significant sources of earnings and operating cash flows. The Company’s operational structure is organized on a decentralized basis, with individual property managers having overall responsibility and authority regarding the operations of their respective properties. Each property manager individually monitors local and area trends in rental rates, occupancy percentages, and operating costs. Property managers are given the on-site responsibility and discretion to react to such trends in the best interest of the Company. The Company’s chief operating decision maker evaluates the performance of each individual property based on its contribution to net operating income in order to ensure that the individual property continues to meet the Company’s return criteria and long-term investment goals. The Company defines each of its multifamily communities as an individual operating segment. It has also determined that all of its communities have similar economic characteristics and also meet the other criteria which permit the communities to be aggregated into one reportable segment, which is acquisition and operation of the multifamily communities owned.

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

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

The Company believes that the estimates and assumptions that are most important to the portrayal of its financial condition and results of operations, in that they require the most subjective determinations, form the basis of accounting policies deemed to be most critical. These critical accounting policies include revenue recognition,
 

capitalization of expenditures and depreciation of assets, impairment of long-lived assets, including goodwill, and fair value of derivative financial instruments.

Revenue Recognition

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

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

Capitalization of expenditures and depreciation of assets

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

Impairment of long-lived assets, including goodwill

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

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

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

Business Combinations. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill.

Fair value of derivative financial instruments

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

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

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

OVERVIEW OF THE THREE MONTHS ENDED JUNE 30, 2006

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


   
June 30, 2006
  
June 30, 2005
  
Total Portfolio (includes partial ownership in joint ventures)
              
Number of apartment units
    
39,179
   
37,365
 
Number of apartment communities
    
135
   
130
 
               
100% Owned (excludes partial ownership in joint ventures)
              
Number of apartment units
    
38,657
   
36,843
 
Number of apartment communities
    
134
   
129
 
Average monthly rent (excluding joint ventures)
  
$
711
  
$
688
  
Average physical occupancy (excluding joint ventures)
    
95.0
%
  
94.2
%


Increasing operating and administrative expenses offset some of the benefit of the revenue increases. Rising interest rates and an increase in the Company’s owned assets also caused interest expense to rise compared to the same period a year ago. In the first six months of 2006, the Company refinanced approximately $28 million of debt, including the $10 million of the Company’s 8 5/8% Series G Cumulative Redeemable Preferred Stock which had been reclassified as debt, in order to take advantage of lower interest rates. As a result, the company wrote-off deferred finance costs of $551,000.

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

RESULTS OF OPERATIONS

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

Property revenues for the three months ended June 30, 2006, increased by approximately $7,898,000 from the three months ended June 30, 2005, due to (i) a $1,966,000 increase in property revenues from the three properties acquired in 2006 (the “2006 Acquisitions”), (ii) a $1,839,000 increase in property revenues from the two properties acquired after the first quarter of 2005 (the “Two 2005 Acquisitions”), and (iii) $4,093,000 increase in property revenues from all other communities. The increase in property revenues from all other communities was generated primarily by the Company’s same store portfolio and was driven by a 13% reduction in vacancy and a 10% increase in utility reimbursements from the second quarter of 2005 to the second quarter of 2006.

Property operating expenses include costs for property personnel, building repairs and maintenance, real estate taxes and insurance, utilities, landscaping and other property related costs. Property operating expenses for the three months ended June 30, 2006, increased by approximately $2,439,000 from the three months ended June 30, 2005, due primarily to increases of property operating expenses of (i) $884,000 from the 2006 Acquisitions, (ii) $738,000 from the Two 2005 Acquisitions, and (iii) $817,000 from all other communities. The increase in property operating expenses from all other communities consisted primarily of the Company’s same store portfolio and was driven by an increase in maintenance salaries due to higher occupancy levels.

Depreciation expense increased by approximately $1,271,000 primarily due to the increases of depreciation expense of (i) $510,000 from the 2006 Acquisitions, (ii) $441,000 from the Two 2005 Acquisitions, (iii) $105,000 from the addition of the amortization of fair market value of leases of acquired communities and (iv) $215,000 from all other communities. Increases of depreciation expense from all other communities resulted from asset additions made during the normal course of business.

Property management expenses increased by approximately $572,000 from the second quarter of 2005 to the second quarter of 2006 primarily related to an increase in personnel incentives as a result of property performances. General and administrative expenses increased by approximately $519,000 over this same period with a partial increase attributable to a rise in salaries, but no individual items accounting for any significant amount of the increase.

Interest expense increased approximately $1,429,000 in the three months ended June 30, 2006, from the three months ended June 30, 2005, primarily due to the increase in the amount of debt outstanding of $1.09 billion at June 30, 2005, to $1.13 billion at June 30, 2006, and the increase in the Company’s average borrowing cost from 5.2% over the three months ended June 30, 2005, to 5.5% over the three months ended June 30, 2006.

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

Primarily as a result of the foregoing, net income decreased by approximately $2,301,000 in the second three months of 2006 from the second three months of 2005.

COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2006 TO THE SIX MONTHS ENDED JUNE 30, 2005

Property revenues for the six months ended June 30, 2006, increased by approximately $14,920,000 from the six months ended June 30, 2005, due to (i) a $2,573,000 increase in property revenues from the 2006 Acquisitions, (ii) a $4,465,000 increase in property revenues from the three properties acquired in 2005 (the “2005 Acquisitions”), and (iii) $7,882,000 increase in property revenues from all other communities. The increase in property revenues from all other communities was generated primarily by the Company’s same store portfolio and was driven by increased occupancy levels over 2005, increased utility reimbursements and a decrease in net delinquencies.


Property operating expenses include costs for property personnel, building repairs and maintenance, real estate taxes and insurance, utilities, landscaping and other property related costs. Property operating expenses for the six months ended June 30, 2006, increased by approximately $4,307,000 from the six months ended June 30, 2005, due primarily to increases of property operating expenses of (i) $1,108,000 from the 2006 Acquisitions, (ii) $1,706,000 from the 2005 Acquisitions, and (iii) $1,493,000 from all other communities. The increase in property operating expenses from all other communities consisted primarily of the Company’s same store portfolio and was driven by an increase in personnel expense as higher occupancy drove overtime and contract expenses above the levels experienced in the prior year.

Depreciation expense increased by approximately $2,151,000 primarily due to the increases of depreciation expense of (i) $633,000 from the 2006 Acquisitions, (ii) $828,000 from the 2005 Acquisitions, and (iii) $880,000 from all other communities. Increases of depreciation expense from all other communities resulted from asset additions made during the normal course of business. These increases were partially offset by a net decrease in depreciation expense of (i) $190,000 from the expiration of the amortization of fair market value of leases of acquired communities.

Property management expenses increased by approximately $275,000 from the first six months of 2005 to the first six months of 2006 primarily related to an increase in personnel incentives and franchise and excise taxes both resulting from improved property operations. General and administrative expenses increased by approximately $1,224,000 over this same period partially related to increased salaries and an increase in cash bonuses earned related to 2005 performance results as determined by the Board of Directors.

Interest expense increased approximately $3,461,000 in the six months ended June 30, 2006, from the six months ended June 30, 2005, primarily due to the increase in the amount of debt outstanding of $1.09 billion at June 30, 2005, to $1.13 billion at June 30, 2006, and the increase in the Company’s average borrowing cost from 5.1% over the six months ended June 30, 2005, to 5.5% over the six months ended June 30, 2006.

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

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

Primarily as a result of the foregoing, net income decreased by approximately $1,501,000 in the first six months of 2006 from the first six months of 2005.

FUNDS FROM OPERATIONS AND NET INCOME

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

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

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

FFO should not be considered as an alternative to net income or any other GAAP measurement of performance, as an indicator of operating performance or as an alternative to cash flow from operating, investing, and financing
 
 

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

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


   
Three months
  
Six months
  
   
ended June 30,
  
ended June 30,
  
   
2006
  
2005
  
2006
  
2005
  
Net income
  
$
5,892
  
$
8,193
  
$
11,018
  
$
12,519
  
Depreciation of real estate assets
    
19,171
   
17,909
   
37,604
   
35,469
 
Net (gain) loss on insurance and other settlement proceeds
    
(225
)
  
16
   
(225
)
  
9
 
Gain on dispositions within real estate joint ventures
    
-
   
(3,034
)
  
-
   
(3,034
)
Net loss on insurance and other settlement proceeds
                          
of discontinued operations
    
-
   
-
   
-
   
25
 
Depreciation of real estate assets of
                          
discontinued operations
    
1
   
160
   
160
   
318
 
Depreciation of real estate assets of
                         
real estate joint ventures
    
121
   
115
   
261
   
247
 
Preferred dividend distribution
    
(3,491
)
  
(3,635
)
  
(6,981
)
  
(7,348
)
Minority interest in operating partnership income
    
408
   
778
   
821
   
1,038
 
Funds from operations
  
$
21,877
  
$
20,502
  
$
42,658
  
$
39,243
  
                           
Weighted average shares and units:
                          
Basic
    
25,662
   
23,984
   
25,160
   
23,774
 
Diluted
    
25,884
   
24,258
   
25,387
   
24,053
 
 
 
Net income for the three and six months ended June 30, 2006, decreased as the gains recorded in 2005 and the increase in interest expense more than offset improved property performance. FFO for the same periods increased as the impact of the 2005 gains is eliminated as well as the impact from increased depreciation expense partially resulting from new acquisitions.

TRENDS

In the second quarter of 2006, property performance continued to show the benefit of improving market conditions, which was strong throughout most of the Company’s markets. Areas that had been weak for several years, especially Atlanta, Dallas, and Austin, continued to show improved demand, and Houston, which recovered in the latter half of 2005, continued to be strong.

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

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

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

LIQUIDITY AND CAPITAL RESOURCES

Net cash flow provided by operating activities increased by approximately $5.5 million from $55.0 million in the first six months of 2005 to $60.5 million in the first six months of 2006 primarily resulting from an increase in cash flows from improved property operations during the first six months of 2006 over the same period in 2005 which were only partially offset by increased interest expenses.

Net cash used in investing activities increased during the first six months of 2006 from the first six months of 2005 to approximately $98.8 million from $34.6 million mainly related to the additional $34.9 million of cash used for acquisitions in the first six months of 2006 over 2005. During the first six months of 2005, the Company received distributions from its real estate joint ventures of $14.8 million which included the Company’s portion from the sale of two properties in one of its joint ventures, a payoff to the Company of a mezzanine loan and an incentive fee. Distributions from real estate joint ventures for the first six months of 2006 totaled only $137,000.

The first six months of 2006 provided net cash from financing activities of $35.6 million while the first six months of 2005 used net cash for financing activities of $22.9 million. This change was driven by a $66.9 million increase in proceeds from issuances of common shares over these periods as the Company raised $59.5 million from a public offering in May 2006. Part of the proceeds were then used to partially pay down outstanding debt under the Company’s credit facilities which accounts for the $28.0 million change from $26.3 million increase in credit lines in the first six months of 2005 to $1.7 million decrease in credit lines over the same period in 2006.

The weighted average interest rate at June 30, 2006, for the $1.13 billion of debt outstanding was 5.6% compared to 5.3% on $1.09 billion of debt outstanding at June 30, 2005. The Company utilizes both conventional and tax exempt debt to help finance its activities. Borrowings are made through individual property mortgages and secured credit facilities. The Company utilizes fixed rate borrowings, interest rate swaps and interest rate caps to manage its current and future interest rate risk. More details on the Company’s borrowings can be found in the schedule presented later in this section.

At June 30, 2006, the Company had secured credit facilities relationships with Prudential Mortgage Capital which are credit enhanced by the Federal National Mortgage Association (“FNMA”), Federal Home Loan Mortgage Corporation (“Freddie MAC”), and a group of banks led by AmSouth Bank. Together, these credit facilities provided a total borrowing capacity and availability to borrow of $1.1 billion at June 30, 2006. The Company had total borrowings outstanding under these credit facilities of $935 million at June 30, 2006.

Approximately 72% of the Company’s outstanding obligations at June 30, 2006, were borrowed through facilities with/or credit enhanced by FNMA (the “FNMA Facilities”). The FNMA Facilities have a combined line limit of $950 million, $947 million of which was available to borrow at June 30, 2006. The Company had total borrowings outstanding under the FNMA Facilities of $806 million at June 30, 2006. Various traunches of the facilities mature from 2010 through 2014. The FNMA Facilities provide for both fixed and variable rate borrowings. The interest rate on the majority of the variable portion renews every 90 days and is based on the FNMA Discount Mortgage Backed Security (“DMBS”) rate on the date of renewal, which has typically approximated three-month LIBOR less an average spread of 0.04% over the life of the FNMA Facilities, plus a credit enhancement fee of 0.62% to 0.795%.

Each of the Company’s secured credit facilities is subject to various covenants and conditions on usage, and are subject to periodic re-evaluation of collateral. If the Company were to fail to satisfy a condition to borrowing, the available credit under one or more of the facilities could not be drawn, which could adversely affect the Company’s liquidity. In the event of a reduction in real estate values the amount of available credit could be reduced. Moreover, if the Company were to fail to make a payment or violate a covenant under a credit facility, after applicable cure
 
 

periods one or more of its lenders could declare a default, accelerate the due date for repayment of all amounts outstanding and/or foreclose on properties securing such facilities. Any such event could have a material adverse effect on the Company.

On May 26, 2005, the Company gave the required one year notice to redeem all of the issued and outstanding shares of its 8 5/8% Series G Cumulative Redeemable Preferred Stock (“Series G”), for the total redemption price of $10 million. As a result, in accordance with Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, the Company classified the Series G as a liability within notes payable as of May 26, 2005, on the accompanying condensed consolidated financial statements. On May 26, 2006, the Company completed the redemption of the Series G.

As of June 30, 2006, the Company had interest rate swaps in effect totaling a notional amount of $694 million. To date, these swaps have proven to be highly effective hedges. The Company had also entered into a forward interest rate swap with a notional amount of $10 million that goes into effect on July 7, 2006. As of June 30, 2006, the Company had interest rate cap agreements totaling a notional amount of approximately $42 million.

 

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

           
Outstanding
              
           
Balance/
  
Average
  
Average
  
Average
  
   
Line
  
Line
  
Notional
  
Interest
  
Rate
  
Contract
  
   
Limit
  
Availability
  
Amount
  
Rate
  
Maturity
  
Maturity
  
                           
COMBINED DEBT
                          
Fixed Rate or Swapped
                                      
  Conventional 
              
$
876,062,701
    
5.7
%
  
5/19/2011
    
5/19/2011
  
  Tax Exempt 
                
73,640,000
   
4.3
%
  
1/27/2012
    
1/27/2012
  
      Subtotal Fixed Rate or Swapped
                
949,702,701
   
5.6
%
  
6/7/2011
    
6/7/2011
  
Variable Rate
                                      
  Conventional 
                
122,651,575
   
6.0
%
  
8/25/2006
    
5/9/2012
  
  Tax Exempt 
                
10,855,004
   
4.5
%
  
7/15/2006
    
5/30/2020
  
  Conventional - Capped 
                
17,936,000
   
6.0
%
  
11/13/2009
    
11/13/2009
  
  Tax Exempt - Capped 
                
24,090,000
   
4.3
%
  
11/25/2009
    
11/25/2009
  
       Subtotal Variable Rate
                
175,532,579
   
5.7
%
  
8/17/2006
    
3/11/2013
  
Total Combined Debt Outstanding
              
$
1,125,235,280
    
5.6
%
  
9/6/2010
    
9/15/2011
  
                                       
UNDERLYING DEBT
                                      
Individual Property Mortgages/Bonds
                                      
Conventional Fixed Rate 
              
$
133,062,701
    
4.8
%
  
3/5/2015
    
3/5/2015
  
Tax Exempt Fixed Rate 
                
12,310,000
   
5.2
%
  
12/1/2028
    
12/1/2028
  
Tax Exempt Variable Rate 
                
4,760,004
   
4.7
%
  
7/15/2006
    
6/1/2028
  
FNMA Credit Facilities
                                      
Tax Free Borrowings 
  
$
91,515,000
  
$
91,515,000
    
91,515,000
   
4.3
%
  
7/15/2006
    
3/1/2014
  
Conventional Borrowings 
                                      
 Fixed Rate Borrowings
    
110,000,000
   
110,000,000
   
110,000,000
   
7.2
%
  
1/10/2009
    
1/10/2009
  
 Variable Rate Borrowings
    
748,485,000
   
745,314,000
   
604,318,000
   
6.0
%
  
8/30/2006
    
4/2/2013
  
Subtotal FNMA Facilities
    
950,000,000
   
946,829,000
   
805,833,000
   
5.9
%
  
12/20/2006
    
10/11/2012
  
Freddie Mac Credit Facility I
    
100,000,000
   
96,404,000
   
96,404,000
   
5.9
%
  
9/7/2006
    
7/1/2011
  
Freddie Mac Credit Facility II
    
200,000,000
   
29,825,000
   
29,825,000
   
5.9
%
  
8/1/2006
    
6/2/2014
  
AmSouth Credit Facility
    
40,000,000
   
30,203,438
   
3,040,575
   
7.0
%
  
7/31/2006
    
5/24/2007
  
Union Planters Bank
                
40,000,000
   
6.2
%
  
7/30/2006
    
4/1/2009
  
Total Underlying Debt Outstanding
              
$
1,125,235,280
    
5.7
%
  
2/16/2008
    
2/4/2013
  
                                       
HEDGING INSTRUMENTS
                                      
Interest Rate Swaps
                                      
LIBOR indexed 
              
$
633,000,000
    
4.8
%
  
10/14/2010
        
LIBOR indexed (forward swap) 
                
10,000,000
   
5.7
%
  
3/1/2014
        
BMA indexed 
                
61,330,000
   
3.3
%
  
9/10/2008
        
Total Interest Rate Swaps
              
$
704,330,000
    
4.7
%
  
8/25/2010