01—Abstract
Summary
Summary of the 10-K/A filed May 10, 2007. Cited figures are marked; the original filing is the authoritative source.
AvalonBay Communities (AVB) filed Amendment No. 1 to its FY2006 10-K on May 10, 2007 to restate financial statements for 2004–2006.
The restatement concerns the accounting for long-term land leases: the company now measures aggregate undiscounted fixed-escalation lease payments over the full non-cancelable term (not its expected holding period) for a consolidated asset with a 90-year land lease whose lessor is also the venture partner. This adds roughly $10.5 milliona per year of non-cash operating expense plus incremental depreciation. Net income falls by about $11.9 million in both 2006 and 2005 and about $12.0 million in 2004.
Cash flows are unaffected. Net income available to common stockholders for 2006 is restated to $257.8 millionb (diluted EPS $3.42) versus $269.7 million (diluted EPS $3.57) as originally reported. The restatement also raises minority interest by $13.0 million and reduces equity by about $58.3 million at year-end 2006.
The underlying business remained strong in the restated filing. Established Community rental revenue grew 6.8% in 2006, NOI grew 9.4%, and 2007 guidance calls for 5.0%–6.5% revenue growth and 5.5%–7.5% NOI growth. Total revenue rose 9.9% to $737.3 millionc.
Development is expanding, with 17 communities under construction representing 5,153 apartment homes and $1.3 billiond in total projected capitalized cost, and 2007 development guidance of $1.0–1.3 billion. Leverage is moderate, with debt at 22.3% of total market capitalization and fixed charge coverage of 1.82x on an incurred basis. The company also completed a roughly $594 million equity offering in January 2007 following S&P 500 inclusion.
Investors should weigh the restatement's effect on reported earnings quality and the fact that the company's prior reporting for 2004–2006 should no longer be relied upon. The amendment also flags pending litigation under the Fair Housing and Americans with Disabilities Acts and a wage suit under the Fair Labor Standards Act. Growth in 2006 was driven largely by gains on asset sales and rental rate increases, while 2007 is expected to moderate.
02—Key points
Key Highlights
- Restatement reduces 2006 net income available to common stockholders to $257.8M (diluted EPS $3.42) from $269.7M (EPS $3.57) as originally reported, due to a ~$10.5M annual non-cash land lease expense increase.
- Restatement also cuts equity by about $58.3M at 12/31/06, raises minority interest by $13.0M, and has no effect on operating, investing, or financing cash flows.
- Established Community rental revenue grew 6.8% and NOI grew 9.4% in 2006; Q4 2006 NOI rose 11.3%, the strongest since 2001.
- 2007 guidance: Established Community revenue growth of 5.0%–6.5% and NOI growth of 5.5%–7.5%, with operating expenses projected to rise 3.5%–5.0%.
- Development pipeline of 17 communities (5,153 homes, ~$1.3B projected cost) plus rights to 54 communities (14,185 homes, ~$3.6B); 2007 new development expected at $1.0B–$1.3B.
- Balance sheet: debt-to-total market capitalization of 22.3%, fixed charge coverage of 1.82x (incurred basis), and a $650M unsecured credit facility with $611.9M available at 1/31/07; ~$594M equity raised in January 2007.
- Ongoing litigation includes an ADA/Fair Housing Act accessibility suit covering 100 communities and an FLSA overtime suit; management cannot estimate potential losses.
03—Questions
Frequently Asked Questions
Why did AvalonBay restate its financial statements, and how much did it change reported earnings?
The company changed its accounting for long-term land leases with fixed escalations. It now recognizes rent expense straight-line over the full non-cancelable lease term rather than its expected holding period. This mainly affects one 90-year lease in a consolidated venture. The change adds about $10.5M a year in non-cash expense plus depreciation, reducing net income by roughly $11.9M in 2006 and 2005 and $12.0M in 2004. Cash flows are unchanged.
Does the restatement affect the company's cash flow or dividend capacity?
No. The restatement is non-cash and does not change operating, investing, or financing cash flows. The company's FFO-based dividend coverage is not affected by this non-cash change, although the 2006 FFO figure reported in the filing reflects the restated numbers and the filing itself notes FFO per diluted share of $4.24.
How strong is the underlying apartment business despite the accounting change?
Operating fundamentals were strong. Established Community rental revenue rose 6.8% in 2006 on rate growth of 6.3%, and NOI rose 9.4%. Management expects more moderate growth in 2007 (revenue +5.0%–6.5%, NOI +5.5%–7.5%) as job growth slows and new supply increases modestly.
What are the main risks and pending legal matters investors should monitor?
Key risks include development and construction cost overruns, rising interest rates on variable-rate debt, refinancing needs (about $268M of debt matures within one year), and dependence on capital markets for development and disposition activity. Legal matters include an accessibility lawsuit under the Fair Housing and ADA covering 100 communities and an FLSA overtime suit. Management cannot estimate potential losses from either, and the company also flagged earthquake and uninsured-loss exposure in California.
Should investors continue to rely on AvalonBay's previously reported 2004–2006 financials?
No. The filing states that financial statements and other information for 2004–2006 previously reported should no longer be relied upon and are superseded by this amended 10-K/A and the Q1 2007 10-Q. Prior-year 10-Ks will not be amended, and prior 10-Qs will not be amended.
04—Continue