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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR
15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
--------------------------------------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR
15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-13136
------------------------------
HOME PROPERTIES, INC.
---------------------
(Exact name of registrant as specified in its charter)
MARYLAND 16-1455126
-------- ----------
(State or other jurisdiction of (IRS Employer Identification
incorporation or organization) Number)
850 Clinton Square, Rochester, New York 14604
---------------------------------------------
(Address of principal executive offices) (Zip Code)
(585) 546-4900
--------------
(Registrant's telephone number, including area code)
N/A
---
(Former name, former address and former
year, if changed since last report)
Indicate by check mark whether 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.
YES X NO
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
YES X NO
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Class of Common Stock Outstanding at July 31, 2004
- --------------------- ----------------------------
$.01 par value 33,279,290
HOME PROPERTIES, INC.
TABLE OF CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets -
June 30, 2004 (Unaudited) and December 31, 2003 3
Consolidated Statements of Operations (Unaudited) -
Six months ended June 30, 2004 and 2003 4
Consolidated Statements of Operations (Unaudited) -
Three months ended June 30, 2004 and 2003 5
Consolidated Statements of Comprehensive Income (Unaudited) -
Six months ended June 30, 2004 and 2003 6
Consolidated Statements of Comprehensive Income (Unaudited) - 7
Three months ended June 30, 2004 and 2003
Consolidated Statements of Cash Flows (Unaudited) - 8
Six months ended June 30, 2004 and 2003
Notes to Consolidated Financial Statements (Unaudited) 9-22
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 23-39
Item 3. Quantitative and Qualitative Disclosures About Market Risk 40
Item 4. Controls and Procedures 41
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 42
Signatures 43-47
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HOME PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
JUNE 30, 2004 AND DECEMBER 31, 2003
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
2004 2003
---- ----
(Unaudited) (Note 1)
ASSETS
Real estate:
Land $ 397,159 $ 385,108
Buildings, improvements and equipment 2,527,598 2,347,158
Real estate held for sale, net 181,004 18,365
---------- ----------
3,105,761 2,750,631
Less: accumulated depreciation ( 379,990) ( 327,701)
---------- ----------
Real estate, net 2,725,771 2,422,930
Cash and cash equivalents 6,688 5,103
Cash in escrows 50,643 39,660
Accounts receivable 5,115 4,437
Prepaid expenses 13,320 18,184
Investment in and advances to affiliates 123 5,253
Deferred charges 14,622 9,057
Other assets 10,729 8,693
---------- ----------
Total assets $2,827,011 $2,513,317
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Mortgage notes payable $1,621,795 $1,380,696
Line of credit 26,000 -
Accounts payable 14,642 13,178
Accrued interest payable 10,031 7,013
Accrued expenses and other liabilities 21,963 18,959
Security deposits 24,113 21,664
---------- ----------
Total liabilities 1,718,544 1,441,510
---------- ----------
Commitments and contingencies
Minority interest 347,232 330,544
---------- ----------
Stockholders' equity:
Cumulative redeemable preferred stock, $.01 par value; 2,400,000 shares
issued and outstanding at June 30, 2004 and December 31, 2003 60,000 60,000
Convertible cumulative preferred stock, $.01 par value; 10,000,000 shares
authorized; 250,000 shares issued and outstanding at June 30, 2004 and
Decem31, 2003 25,000 25,000
Common stock, $.01 par value; 80,000,000 shares authorized; 33,270,614 and
31,966,240 shares issued and outstanding at June 30, 2004 and December
31, 2003, respectively 333 320
Excess stock, $.01 par value; 10,000,000 shares authorized; no shares
issued or outstanding - -
Additional paid-in capital 832,125 785,710
Accumulated other comprehensive income ( 319) ( 542)
Distributions in excess of accumulated earnings ( 155,825) ( 128,910)
Officer and director notes for stock purchases ( 79) ( 315)
---------- ----------
Total stockholders' equity 761,235 741,263
---------- ----------
Total liabilities and stockholders' equity $2,827,011 $2,513,317
========== ==========
The accompanying notes are an integral part of these consolidated financial statements.
HOME PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003
(UNAUDITED, IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
2004 2003
---- ----
Revenues:
Rental income $219,833 $200,578
Property other income 8,721 7,511
Interest and dividend income 298 256
Other income 1,163 2,321
---------- ----------
Total revenues 230,015 210,666
---------- ----------
Expenses:
Operating and maintenance 104,598 92,466
General and administrative 9,617 9,701
Interest 45,097 43,263
Depreciation and amortization 44,704 37,516
Impairment of assets held as General Partner 1,116 520
---------- ----------
Total expenses 205,132 183,466
---------- ----------
Income from operations 24,883 27,200
Equity in earnings (losses) of unconsolidated affiliates ( 563) ( 1,184)
---------- ----------
Income before minority interest and discontinued operations 24,320 26,016
Minority interest in affordable limited partnerships 393 -
Minority interest in operating partnership ( 6,847) ( 7,034)
---------- ----------
Income from continuing operations 17,866 18,982
---------- ----------
Discontinued operations
Income (loss) from operations, net of ($419) in 2004 and $135 in 2003
allocated to minority interest ( 870) 231
Gain (loss) on disposition of property, net of $246 in 2004 and $188 in 2003
allocated to minority interest 511 320
---------- ----------
Discontinued operations ( 359) 551
---------- ----------
Income before loss on disposition of property and business and cumulative
effect of change in accounting principle 17,507 19,533
Loss on disposition of property and business, net of $33 in 2004 and $5 in 2003
allocated to minority interest (67) ( 10)
---------- ----------
Income before cumulative effect of change in accounting principle 17,440 19,523
Cumulative effect of change in accounting principle, net of $159 in 2004 and $0
in
2003 allocated to minority interest ( 321) -
---------- ----------
Net income 17,119 19,523
Preferred dividends ( 3,797) ( 6,710)
---------- ----------
Net income available to common shareholders $ 13,322 $12,813
Basic earnings per share data:
Income from continuing operations $ .43 $ .44
Discontinued operations ( .01) .02
Cumulative effect of change in accounting principle ( .01) -
---------- ----------
Net income available to common shareholders $ .41 $ .46
========== ==========
Diluted earnings per share data:
Income from continuing operations $ .42 $ .43
Discontinued operations ( .01) .02
Cumulative effect of change in accounting principle ( .01) -
---------- ----------
Net income available to common shareholders $ .40 $ .45
========== ==========
Weighted average number of shares outstanding:
Basic 32,600,754 27,881,682
========== ==========
Diluted 33,088,059 28,307,215
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
HOME PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED JUNE 30, 2004 AND 2003
(UNAUDITED, IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
2004 2003
---- ----
Revenues:
Rental income $112,440 $101,449
Property other income 4,732 3,990
Interest and dividend income 147 101
Other income 698 1,122
---------- ----------
Total revenues 118,017 106,662
---------- ----------
Expenses:
Operating and maintenance 51,081 44,429
General and administrative 4,892 4,582
Interest 23,689 21,124
Depreciation and amortization 23,270 18,963
Impairment of assets held as General Partner - 93
---------- ----------
Total expenses 102,932 89,191
---------- ----------
Income from operations 15,085 17,471
Equity in earnings (losses) of unconsolidated affiliates ( 25) ( 444)
---------- ----------
Income before minority interest and discontinued operations 15,060 17,027
Minority interest in affordable limited partnerships 393 -
Minority interest in operating partnership ( 4,408) ( 5,019)
---------- ----------
Income from continuing operations 11,045 12,008
---------- ----------
Discontinued operations
Income (loss) from operations, net of ($448) in 2004 and $154 in 2003
allocated to minority interest ( 928) 267
Gain (loss) on disposition of property, net of $252 in 2004 and ($75) in
2003 allocated to minority interest 524 ( 131)
---------- ----------
Discontinued operations ( 404) 136
---------- ----------
Income before loss on disposition of property and business 10,641 12,144
Loss on disposition of property and business, net of $0 in 2004 and $5 in 2003
allocated to minority interest - ( 10)
---------- ----------
Net income 10,641 12,134
Preferred dividends ( 1,899) ( 3,192)
---------- ----------
Net income available to common shareholders $ 8,742 $ 8,942
========== ==========
Basic earnings per share data:
Income from continuing operations $ .28 $ .32
Discontinued operations ( .01) -
---------- ----------
Net income available to common shareholders $ .27 $ .32
========== ==========
Diluted earnings per share data:
Income from continuing operations $ .27 $ .31
Discontinued operations ( .01) -
---------- ----------
Net income available to common shareholders $ .26 $ .31
========== ==========
Weighted average number of shares outstanding:
Basic 32,876,882 28,289,752
========== ==========
Diluted 33,317,967 28,807,558
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
HOME PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003
(UNAUDITED, IN THOUSANDS)
2004 2003
---- ----
Net income $17,119 $19,523
Other comprehensive income (net of minority interest):
Change in fair value of hedge instruments 223 92
------- -------
Comprehensive income $17,342 $19,615
======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
HOME PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED JUNE 30, 2004 AND 2003
(UNAUDITED, IN THOUSANDS)
2004 2003
---- ----
Net income $10,641 $12,134
Other comprehensive income (net of minority interest):
Change in fair value of hedge instruments 151 36
------- -------
Comprehensive income $10,792 $12,170
======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
HOME PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003
(UNAUDITED, IN THOUSANDS)
2004 2003
---- ----
Cash flows from operating activities:
Net income $ 17,119 $ 19,523
Adjustments to reconcile net income to net cash provided by operating
activities:
Equity in (earnings) losses of unconsolidated affiliates 563 1,184
Income allocated to minority interest 6,482 7,354
Depreciation and amortization 48,250 39,279
Impairment of assets held as General Partner 1,116 520
Impairment of real property 1,100 423
Gain on disposition of property and business ( 657) ( 493)
Loss from early extinguishment of debt 102 1,349
Cumulative effect of change in accounting principle 480 -
Changes in assets and liabilities:
Other assets 4,232 9,679
Accounts payable and accrued liabilities 5,019 ( 2,515)
--------- ----------
Total adjustments 66,687 56,780
--------- ----------
Net cash provided by operating activities 83,806 76,303
--------- ----------
Cash flows used in investing activities:
Purchase of properties and other assets, net of mortgage
notes assumed and UPREIT Units issued ( 64,376) ( 32,173)
Additions to properties ( 48,733) ( 47,096)
Proceeds from sale of properties and business, net 8,861 20,266
Proceeds from sale of affordable properties, net 137 -
Advances to affiliates ( 820) ( 1,785)
Payments on advances to affiliates 124 4,081
--------- ----------
Net cash used in investing activities (104,807) ( 56,707)
--------- ----------
Cash flows from financing activities:
Proceeds from sale of common stock, net 20,848 16,675
Proceeds from mortgage notes payable 70,674 50,800
Payments of mortgage notes payable ( 27,510) ( 33,496)
Payment of prepayment penalty in connection with the early
extinguishment of debt ( 102) ( 1,349)
Proceeds from line of credit 129,000 90,000
Payments on line of credit (103,000) ( 86,000)
Payments of deferred loan costs ( 1,346) ( 463)
Withdrawals from (additions to) cash escrows, net ( 3,338) 1,746
Repayment of officer loans 236 202
Dividends and distributions paid ( 63,726) ( 59,783)
--------- ----------
Net cash provided by (used in) financing activities 21,736 ( 21,668)
--------- ----------
Net increase (decrease) in cash and cash equivalents 735 ( 2,072)
Cash and cash equivalents:
Beginning of year 5,103 8,782
Cash assumed in connection with FIN 46R consolidation
850 -
--------- ----------
End of year $ 6,688 $ 6,710
========= ==========
Supplemental disclosure of non-cash operating, investing and financing
activities:
Mortgage loans assumed associated with property acquisitions $69,782 $ -
Conversion of preferred to common stock - 33,680
Exchange of UPREIT Units/partnership interest for common shares 13,843 3,378
Fair value of hedge instruments 682 1,472
Issuance of UPREIT Units associated with property and other acquisitions 12,105 4,806
Increase in real estate associated with the purchase of UPREIT Units 12,470 -
Compensation cost of stock options issued 439 409
Net real estate assumed in connection with FIN 46R consolidation 152,319 -
Other assets assumed in connection with FIN 46R consolidation 11,916 -
Mortgage debt assumed in connection with FIN 46R consolidation 129,149 -
Other liabilities assumed in connection with FIN 46R consolidation 5,363 -
The accompanying notes are an integral part of these consolidated financial
statements.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1. Unaudited Interim Financial Statements
--------------------------------------
The interim consolidated financial statements of Home Properties, Inc. (the
"Company") have been prepared in accordance with accounting principles
generally accepted in the United States of America for interim financial
information and the applicable rules and regulations of the Securities and
Exchange Commission. Accordingly, certain disclosures that would accompany
annual financial statements prepared in accordance with accounting
principles generally accepted in the United States of America are omitted.
The year-end balance sheet data was derived from audited financial
statements, but does not include all disclosures required by accounting
principles generally accepted in the United States of America. In the
opinion of management, all adjustments, consisting solely of normal
recurring adjustments, necessary for the fair presentation of the
consolidated financial statements for the interim periods have been
included. The current period's results of operations are not necessarily
indicative of results which ultimately may be achieved for the year. The
interim consolidated financial statements and notes thereto should be read
in conjunction with the consolidated financial statements and notes thereto
included in the Company's Form 10-K for the year ended December 31, 2003.
2. Organization and Basis of Presentation
--------------------------------------
Organization
The Company is engaged primarily in the ownership, management, acquisition,
and rehabilitation of residential apartment communities in the Northeast,
Mid-Atlantic, Midwest and Southeast Florida. As of June 30, 2004, the
Company operated 199 apartment communities with 49,048 apartments. Of this
total, the Company owned 152 communities, consisting of 42,000 apartments
("Owned Communities"), managed as general partner 4,746 apartments and fee
managed 2,302 apartments for affiliates and third parties.
Basis of Presentation
The accompanying consolidated financial statements include the accounts of
the Company and its 68.1% (63.7% at June 30, 2003) partnership interest in
Home Properties, L.P. (the "Operating Partnership"). Such interest has been
calculated as the percentage of outstanding common shares divided by the
total outstanding common shares and Operating Partnership Units ("UPREIT
Units") outstanding. The remaining 31.9% (36.3% at June 30, 2003) is
reflected as Minority Interest in these consolidated financial statements.
The Company owns a 1.0% general partner interest in the Operating
Partnership and the remainder as a limited partner through its wholly owned
subsidiary, Home Properties I, LLC, which owns 100% of the limited partner,
Home Properties Trust. Home Properties Trust was formed in September 1997,
as a Maryland real estate trust and as a qualified REIT subsidiary ("QRS")
and owns the Company's share of the limited partner interests in the
Operating Partnership. For financing purposes, the Company has formed a
limited liability company (the "LLC") and a partnership (the "Financing
Partnership"), which beneficially own certain apartment communities
encumbered by mortgage indebtedness. The LLC is wholly owned by the
Operating Partnership. The Financing Partnership is owned 99.9% by the
Operating Partnership and 0.1% by the QRS.
The accompanying consolidated financial statements include the accounts of
two wholly owned subsidiaries, Home Properties Management, Inc. and Home
Properties Resident Services, Inc. (the "Management Companies"). All
significant inter-company balances and transactions have been eliminated in
these consolidated financial statements.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
2. Organization and Basis of Presentation (continued)
--------------------------------------------------
Through March 30, 2004, the Company accounted for its investment as
managing general partner ("GP") in unconsolidated affordable housing
limited partnerships ("LP") using the equity method of accounting.
Effective March 31, 2004, the Company adopted FASB Interpretation No. 46R,
Consolidation of Variable Interest Entities ("FIN 46R"). This
interpretation addresses consolidation by business enterprises of variable
interest entities in which the equity investment at risk is not sufficient
to permit the entity to finance its activities without additional
subordinated financial support from other parties or in which the equity
investors do not have the characteristics of a controlling financial
interest. This interpretation requires a variable interest entity to be
consolidated by a company if that company is subject to a majority of the
risk of loss from the variable interest entity's activities or entitled to
receive a majority of the entity's residual returns or both. The
interpretation also requires disclosures about variable interest entities
that the company is not required to consolidate but in which it has a
significant variable interest. At this date, the Company is the general
partner in 41 limited partnerships. The Company has made a determination
that all 41 limited partnerships are Variable Interest Entities. The
Company has further determined that it is the primary beneficiary in 34 of
the limited partnerships and therefore consolidated these entities
effective March 31, 2004. Beginning with the second quarter of 2004, the
Company's results of operations for both the three- and six-month periods
ending June 30, 2004, include the results of operations of four of the LPs
("Affordable LPs") for the three-month period ended June 30, 2004. The
results of operations of the remaining 30 consolidated partnerships ("Phase
III") for the same time period are included in discontinued operations.
These properties are classified as held for sale due to the fact that as of
June 30, 2004, the partnerships are under contract for sale, due diligence
has been completed, and the majority of third party approvals have been
received. Home Properties determined that it is not the primary beneficiary
in seven partnerships syndicated under U.S. Department of Housing and Urban
Development subsidy programs. These seven investments will continue to be
accounted for under the equity method. For those seven investments, the
Company will continue to record its allocable share of the respective
partnership's income or loss based on the terms of the agreement. To the
extent it is determined that the LPs cannot absorb their share of the
losses, if any, the GP will record the LPs share of such losses. The
Company will absorb such losses to the extent the Company has outstanding
loans or advances and the limited partner has no remaining capital account.
Reclassifications
Certain reclassifications have been made to the 2003 consolidated financial
statements to conform to the 2004 presentation.
New Accounting Standards
In March 2004, the FASB issued EITF 03-6 "Participating Securities and the
Two-Class Method under FASB Statement 128, Earnings per Share." EITF 03-6
addresses a number of questions regarding the computation of earnings per
share by companies that have issued securities other than common stock that
contractually entitle the holder to participate in dividends and earnings
of the company when, and if, it declares dividends on its common stock.
The issue also provides further guidance in applying the two-class method
of calculating EPS. It clarifies what constitutes a participating
security and how to apply the two-class method of computing EPS once it is
determined that a security is participating, including how to allocate
undistributed earnings to such a security. The EITF is effective for the
first fiscal periods beginning after March 31, 2004. The Company adopted
the provisions of EITF 03-6 effective April 1, 2004 and it had no impact on
the Company's results of operations, financial position, or liquidity.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
2. Organization and Basis of Presentation (continued)
--------------------------------------------------
In May 2003, FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." This
Statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). This
Statement is 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 indefinitely deferred the provisions of paragraphs 9 and 10 of SFAS
No. 150 as they apply to mandatorily redeemable noncontrolling interests.
This deferral applies to minority interest ownerships in limited
partnerships which are mandatorily redeemable upon termination of the
partnership and therefore is potentially applicable to the affordable
portfolio. The Company's investments in the limited partnerships
consolidated under FIN 46R have a mandatory redeemable feature upon
termination of the partnership. However, due to the tax credit restrictions
on the consolidated partnership, if the partnership were terminated prior
to the end of the tax credit compliance period, the partnership would be
liable to fund the tax credits payable to the limited partners.
3. Adoption of New Accounting Policy
---------------------------------
Effective January 1, 2003, the Company adopted the provisions of SFAS 148
"Accounting for Stock Based Compensation - An Amendment of SFAS 123." Under
the transition provisions of this Statement, the Company has elected the
"Modified Prospective Method" for recognizing stock-based compensation
costs. Under this method the Company recognizes stock-based compensation
cost from the beginning of the fiscal year in which the recognition
provisions are first applied as if the fair value based accounting method
in this Statement had been used to account for all employee awards granted,
modified, or settled in fiscal years beginning after December 15, 1994. For
the three and six-months ended June 30, 2004, the Company recognized $491
and $1,001, respectively, in stock compensation costs related to its stock
compensation plans, and $372 and $652, respectively, for the three and
six-months ended June 30, 2003. Of these totals, $191 and $439, for the
three and six-month periods ended June 30, 2004, respectively, related to
the expensing of stock compensation costs associated with stock options
granted by the Company. The remaining $300 and $562, for the three and
six-month periods ended June 30, 2004, respectively, pertains to the stock
compensation costs recognized by the Company relative to its restricted
stock grants. For the three and six months ended June 30, 2003, $207 and
$409, respectively, related to the expensing of stock compensation costs
associated with stock options granted by the Company. The remaining $165
and $243, for the three and six months ended June 30, 2003, respectively,
pertains to the stock compensation costs recognized by the Company relative
to its restricted stock grants.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions used
for grants in 2004 and 2003: dividend yields ranging from 7.81% to 9.40%;
expected volatility ranging from 19.03% to 19.85%; and expected lives of
7.5 years for the options with a lifetime of ten years, and five years for
options with a lifetime of five years. The interest rate used in the
option-pricing model is based on a risk free interest rate ranging from
4.29% to 6.87%.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
4. Earnings Per Common Share
-------------------------
Basic earnings per share ("EPS") is computed as net income available to
common shareholders divided by the weighted average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution
that could occur from common shares issuable through stock-based
compensation including stock options, restricted stock, phantom shares
under the Company's incentive compensation plan, warrants and the
conversion of any cumulative convertible preferred stock. The exchange of
an Operating Partnership Unit for common stock will have no effect on
diluted EPS as Unitholders and stockholders effectively share equally in
the net income of the Operating Partnership. Income from continuing
operations is the same for both the basic and diluted calculation.
The reconciliation of the basic and diluted earnings per share for the six
and three-months ended June 30, 2004 and 2003 is as follows:
Six Months Three Months
---------- ------------
2004 2003 2004 2003
---- ---- ---- ----
Income from continuing operations $17,866 $18,982 $11,045 $12,008
Less: Gain (loss) on disposal of property ( 67) ( 10) - ( 10)
Less: Preferred dividends ( 3,797) ( 6,710) ( 1,899) ( 3,192)
---------- ---------- ---------- ----------
Basic and Diluted - Income from continuing
operations
applicable to common shareholders $14,002 $12,262 $ 9,146 $ 8,806
Less: Cumulative effect of change in accounting
principle ( 321) - - -
Discontinued operations ( 359) 551 ( 404) 136
---------- ---------- ---------- ----------
Net income available to common shareholders $13,322 $12,813 $ 8,742 $ 8,942
Basic weighted average number of shares outstanding 32,600,754 27,881,682 32,876,882 28,289,752
Effect of dilutive stock options 396,361 282,452 353,998 375,253
Effect of phantom and restricted shares 90,944 143,081 87,087 142,553
---------- ---------- ---------- ----------
Diluted weighted average number of shares
outstanding 33,088,059 28,307,215 33,317,967 28,807,558
========== ========== ========== ==========
Basic earnings per share
Income from continuing operations $.43 $.44 $.28 $.32
Discontinued operations (.01) .02 (.01) -
Cumulative effect of change in accounting
principle (.01) - - -
---------- ---------- ---------- ----------
Net Income available to common shareholders $.41 $.46 $.27 $.32
========== ========== ========== ==========
Basic earnings per share
Income from continuing operations $.42 $.43 $.27 $.31
Discontinued operations (.01) .02 (.01) -
Cumulative effect of change in accounting
principle (.01) - - -
---------- ---------- ---------- ----------
Net Income available to common shareholders $.40 $.45 $.26 $.31
========== ========== ========== ==========
Unexercised stock options and warrants to purchase zero and 701,190 shares
the Company's common stock for the six-month periods ended June 30, 2004
and 2003, respectively and zero and 126,000 shares of the Company's common
stock for three-month periods ended June 30, 2004 and 2003, respectively
were not included in the computations of diluted EPS because the options'
exercise prices were greater than the average market price of the Company's
stock during those periods. For the six and three-month periods ended June
30, 2004 the 833,333 common stock equivalents on an as-converted basis of
the Series D Convertible Cumulative Preferred Stock have an antidilutive
effect and are not included in the computation of diluted EPS. In addition,
for the six and three-month periods ended June 30, 2003, the 2,771,593 and
3,016,922, respectively, common stock equivalents on an as-converted basis,
of the Series C, D and E Convertible Cumulative Preferred Stock have an
antidilutive effect and are not included in the computation of diluted EPS.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
5. Other income
------------
Otherincome for the six and three-month periods ended June 30, 2004 and
2003 represents management fee income.
6. Variable interest entities
--------------------------
In the fourth quarter of 2002, the Company decided to sell virtually all of
the assets associated with its general partner interests in the affordable
properties to focus solely on the direct ownership and management of market
rate apartment communities. In April, 2004, the buyer of Phase III, which
consists of the Company`s interest in 38 Upstate New York, Ohio and
Maryland properties, concluded due diligence, which resulted in a $945
reduction in the contracted sales price to $5.8 million. The Company has
recorded an impairment charge in the first quarter of 2004 for this $945 to
reduce the assets in Phase III to estimated fair market value. The Company
is working towards a closing on Phase III by the end of the third quarter.
The assets have been accounted for as "held for sale" as of and for the
three-month period ended June 30, 2004 and reported in discontinued
operations as all significant contingencies surrounding the sale of Phase
III have been resolved. It is possible that certain approvals will not be
granted by this date, pushing the closing into the fourth quarter of 2004
or later.
Effective March 31, 2004, the Company adopted FASB Interpretation No. 46R -
Consolidation of Variable Interest Entities, an interpretation of ARB No.
51 - Consolidated Financial Statements. The interpretation addresses
consolidation by businesses of special purpose entities (variable interest
entities, "VIE"). The Company has made a determination that all 41 of the
remaining limited partnerships are Variable Interest Entities.
The Company determined that it is not the primary beneficiary in seven of
the 41 partnerships syndicated under U.S. Department of Housing and Urban
Development subsidy programs. These seven investments will continue to be
accounted for under the equity method and included in equity in earnings of
unconsolidated affiliates. Included in equity in earnings of unconsolidated
affiliates is the Company share of losses totaling $25 for the three months
ended June 30, 2004. The Company purchased the general partnership
interests in these seven partnerships in January, 1996. The Company is the
general partner and managing agent of these seven partnerships syndicated
under U.S. Department of Housing Development (HUD) subsidy programs. These
partnerships were set up to provide low income housing to residents through
subsidized rents and below market debt governed by HUD. The Company as
general partner and managing agent manages the day-to-day operations of the
partnership for a fee (5% of rents collected). The Company's economic
benefit from these partnerships is the management fee. There is no exposure
to the Company of loss as a result of its involvement with these
partnerships. The management fees earned on these partnerships was $35 and
$73 for the three- and six-month periods ended June 30, 2004. The assets
and liabilities of the seven partnerships total $8,492 and $14,134
respectively at June 30, 2004. Unconsolidated non-recourse debt associated
with the seven partnerships continuing to be accounted for under the equity
method amounted to $13.5 million, of which the Company's proportionate
share, based on its legal ownership, was $787.
In the first quarter of 2004, the Company recorded an impairment charge of
$1,600 to adjust the assets associated with the affordable properties to
management's estimate of fair market value. The impairment charge is
classified in the financial statements as "Impairment of assets held as
general partner" of $1,116 and "Equity in earnings (losses) of
unconsolidated affiliates" of $484. A portion of the total $1,116 charge,
or $171, represents monies loaned to certain affordable properties during
the first quarter of 2004 to fund operating shortfalls, which are not
anticipated to be recovered from projected sale proceeds. The remaining
balance of $945 pertains to an additional net impairment charge taken on
Phase III to reduce the assets to estimated fair market value (as described
above). Of the total impairment charge recorded of $1,600 for the
three-month period ended March 31, 2004, $655 relates to cash advances to
fund operating shortfalls.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
6. Variable interest entities (continued)
--------------------------------------
The Company has further determined that it is the primary beneficiary in 34
of the limited partnerships and therefore consolidated these entities
effective March 31, 2004. Beginning with the second quarter of 2004, the
Company's results of operations for both the three- and six-month periods
ending June 30, 2004, include the results of operations of four of the
Affordable LPs for the three-month period ended June 30, 2004. The results
of operations of the remaining 30 consolidated partnerships for the same
time period are included in the results of discontinued operations. These
properties are classified as held for sale due to the fact that as of June
30, 2004, the partnerships are under contract for sale, due diligence has
been completed, and the majority of third party approvals have been
received. The Company is the general partner in these 34 partnerships
syndicated using low income housing tax credits under Section 42 of the
Internal Revenue Code. As general partner, the Company manages the
day-to-day operations of these partnerships for a management fee. In
addition, the Company has certain operating deficit guarantees and tax
credit guarantees to its limited partners. The Company is responsible to
fund operating deficits to the extent there are any and can receive
operating incentive awards when cash flow reaches certain levels. The
effect on the consolidated balance sheet as of June 30, 2004 is an increase
in Total assets of $162.4 million, an increase in Total liabilities of
$132.3 million, an increase in Minority interest of $30.4 million, and a
decrease in Stockholders' equity of $321. In connection with the adoption
of FIN 46R, the Company recorded a $321 charge of a cumulative effect of a
change in accounting principle during the first quarter. This charge was a
result of the negative capital accounts of minority interest partners that
were absorbed by the Company. Of the $132.3 million increase in total
liabilities, $126.7 million represented non-recourse mortgage debt.
During 2004, the Company plans to pursue the disposition of its general
partner interests in one additional property (two partnerships) with 1,058
units. The Company anticipates that if a sale is the chosen course of
action, a closing will not be likely to occur before the end of 2004; and,
although the Company cannot accurately estimate a price at this time, it is
likely that the Company will have to pay a third party to purchase its
interest in this asset. The Company has guarantees to the partnerships to,
upon the occurrence of certain events, repay limited partners their paid in
capital contributions (which could total approximately $5.6 million) and to
fund operating deficits. The property is currently experiencing high
vacancy. The regulatory agreement between the entity which owns the
property and the State Housing Authority requires a percentage of residents
to meet certain income qualifications. The Company has had difficulty
renting the units subject to those requirements to persons it believes are
economically qualified to rent the units. The Company does not anticipate
that occupancy levels or other aspects of the operational outlook will
improve in the foreseeable future under the regulatory restrictions. The
Company has funded operating deficits of $475 during the first quarter of
2004. Effective April 1, 2004 and in accordance with GAAP, the Company
consolidated the results of operations and recorded its share of
partnership operations.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
7. Segment Reporting
-----------------
The Company is engaged in the ownership and management of primarily market
rate apartment communities. Each apartment community is considered a
separate operating segment. Each segment on a stand alone basis is less
than 10% of the revenues, profit or loss, and assets of the combined
reported operating segments and meets the majority of the aggregation
criteria under SFAS No. 131. The operating segments are aggregated and
segregated as Core and Non-core properties.
Non-segment revenue to reconcile to total revenue consists of interest and
dividend income and other income. Non-segment assets to reconcile to total
assets include cash and cash equivalents, cash in escrows, accounts
receivable, prepaid expenses, investments in and advances to affiliates,
deferred charges and other assets.
Core properties consist of all apartment communities which have been owned
more than one full calendar year. Therefore, the Core Properties represent
communities owned as of January 1, 2003. Non-core properties consist of
apartment communities acquired during 2003 and 2004, such that full year
comparable operating results are not available.
The accounting policies of the segments are the same as those described in
Notes 1 and 2 of the Company's Form 10-K.
The Company assesses and measures segment operating results based on a
performance measure referred to as Funds from Operations ("FFO"). FFO is
defined as net income (computed in accordance with GAAP) excluding gains or
losses from the sales of property and business (minority interest in the
Operating Partnership, extraordinary items, plus real estate depreciation,
less dividends from non-convertible preferred shares. FFO is not a measure
of operating results or cash flows from operating activities as measured by
generally accepted accounting principles and it is not indicative of cash
available to fund cash needs and should not be considered an alternative to
cash flows as a measure of liquidity. Other companies may calculate
similarly titled performance measures in a different manner.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
7. Segment Reporting (continued)
-----------------------------
The revenues, profit (loss), and assets for each of the reportable segments
are summarized as follows as of and for the six and three-month periods
ended June 30, 2004, and 2003.
Six Months Three Months
---------- ------------
2004 2003 2004 2003
---- ---- ---- ----
Revenues
Apartments owned
Core properties $217,903 $208,081 $109,877 $105,530
Core properties included in discontinued operations ( 1,502) ( 1,518) ( 752) ( 789)
Non-core properties 12,153 1,526 8,047 698
Reconciling items 1,461 2,577 845 1,223
-------- -------- ---------- ----------
Total Revenue $230,015 $210,666 $118,017 $106,662
======== ======== ========== ==========
Profit (loss)
Funds from operations:
Apartments owned
Core properties $118,008 $115,268 $ 62,449 $ 61,033
Core properties included in discontinued operations ( 755) ( 775) ( 453) ( 392)
Non-core properties 6,703 1,130 4,095 369
Reconciling items 1,461 2,577 845 1,223
-------- -------- ---------- ----------
Segment contribution to FFO 125,417 118,200 66,936 62,233
General and administrative expenses ( 9,617) ( 9,701) ( 4,892) ( 4,582)
Interest expense ( 45,097) ( 41,914) ( 23,689) ( 21,124)
Depreciation of unconsolidated affiliates 556 1,113 13 564
Non-real estate depreciation/amortization ( 1,678) ( 1,147) ( 936) ( 538)
FAS 141 acquisition rent / intangibles 510 - 328 -
Equity in earnings (losses) of unconsolidated ( 563) ( 1,184) ( 25) ( 444)
affiliates
Impairment of assets held as General Partner ( 1,116) ( 520) - ( 93)
Impairment of affordable assets not in FFO 945 - - -
Loss on sale of business ( 17) - - -
Income from discontinued operations before minority
interest,
depreciation and gain (loss) on disposition of
property ( 91) 1,799 ( 455) 930
Redeemable preferred dividend (Series F) ( 2,700) ( 2,700) ( 1,350) ( 1,350)
-------- -------- ---------- ----------
Funds from Operations 66,549 63,946 35,930 35,596
Depreciation - apartments owned ( 42,772) ( 37,377) ( 21,803) ( 18,933)
Depreciation of unconsolidated affiliates ( 1,615) ( 1,113) ( 1,072) ( 564)
FAS 141 acquisition rent/intangibles ( 510) - ( 328) -
Redeemable preferred dividend 2,700 2,700 1,350 1,350
Loss from early extinguishment of debt in connection
with sale of real estate - ( 1,349) - -
Impairment of affordable assets not in FFO ( 945) - - -
(Income) loss from discontinued operations before
minority interest and loss on disposition of property 1,306 ( 791) 1,376 ( 422)
Minority interest - in operating partnership ( 6,847) ( 7,034) ( 4,408) ( 5,019)
-------- -------- ---------- ----------
Income from continuing operations $17,866 $18,982 $11,045 $12,008
======== ======== ========== ==========
Assets - As of June 30, 2004 and December 31, 2003
Apartments owned:
- Core $2,370,434 $1,924,763
- Non-core 404,455 543,698
Reconciling items 52,122 44,856
---------- ----------
Total Assets $2,827,011 $2,513,317
========== ==========
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
8. Pro Forma Condensed Financial Information
-----------------------------------------
The Company acquired seven apartment communities ("2004 Acquired
Communities") with a combined 1,278 units in four unrelated transactions
during the six-month period ended June 30, 2004. The total combined
purchase price (including closing costs) of $149.3 million equates to
approximately $117 per unit. Consideration for the communities was funded
through the assumption of $69.8 million of debt, $67.4 million from the
Company's line of credit and $12.1 million of UPREIT Units.
In addition, the Company disposed of one apartment community ("2004
Disposed Properties") with 224 units during the second quarter of 2004. The
total selling price (including closing costs) of $9 million resulted in a
$557 gain on sale of real estate, net of minority interest. During the
first six months of 2004, the Company reported a $46 loss, net of minority
interest, relating to additional expenses incurred in the same period for
sales which took place during 2003. These costs represent a change in
estimate from those accrued at the time of sale.
The following proforma information was prepared as if (i) the 2004
transactions related to the acquisition of the 2004 Acquired Communities
had occurred on January 1, 2003, (ii) the 2003 transactions related to the
acquisition of two apartment communities in two separate transactions had
occurred on January 1, 2003, (iii) the disposition of the 2004 Disposed
Properties had occurred on January 1, 2003, (iv) the 2003 transactions
related to the disposition of seven apartment communities in seven separate
transactions had occurred on January 1, 2003. The proforma financial
information is based upon the historical consolidated financial statements
and is not necessarily indicative of the consolidated results which
actually would have occurred if the transactions had been consummated at
the beginning of 2003, nor does it purport to represent the results of
operations for future periods. Adjustments to the proforma condensed
combined statement of operations for the six and three-month periods ended
June 30, 2004 and 2003, consist principally of providing net operating
activity and recording interest, depreciation and amortization from January
1, 2003 to the earlier of June 30, 2004 or 2003, as applicable, or the
acquisition date.
For the Six-months Ended For the Three-months Ended
June 30 June 30
------------------------ --------------------------
2004 2003 2004 2003
---- ---- ---- ----
Total revenues $232,313 $222,024 $118,017 $112,127
Net income available to common shareholders 14,155 14,329 9,274 9,061
before
cumulative effect of change in accounting
principle
Net income available to common shareholders 13,834 14,329 9,274 9,061
Per common share data:
Net income available to common shareholders
before
cumulative effect of change in accounting
principle
Basic $0.43 $0.51 $0.28 $0.32
Diluted $0.43 $0.51 $0.28 $0.31
Net income available to common shareholders
Basic $0.42 $0.51 $0.28 $0.32
Diluted $0.42 $0.51 $0.28 $0.31
Weighted average numbers of shares outstanding:
Basic 32,600,754 27,881,682 32,876,882 28,289,752
Diluted 33,088,059 28,307,215 33,317,967 28,807,558
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
9. Derivative Financial Instruments
--------------------------------
The Company has four interest rate swaps that effectively convert variable
rate debt to fixed rate debt. As of June 30, 2004, the aggregate fair value
of the Company's interest rate swaps was $682 prior to the allocation of
minority interest and is included in accrued expenses and other liabilities
in the consolidated balance sheets. For the six-months ending June 30,
2004, as the critical terms of the interest rate swaps and the hedged items
are the same, no ineffectiveness was recorded in the consolidated
statements of operations. All components of the interest rate swaps were
included in the assessment of hedge effectiveness. The fair value of the
interest rate swaps is based upon the estimate of amounts the Company would
receive or pay to terminate the contract at the reporting date and is
estimated using interest rate market pricing models.
10. Disposition of Property and Discontinued Operations
---------------------------------------------------
Included in discontinued operations are the operating results, net of
minority interest, of eight apartment community dispositions (one sold in
2004 and seven sold in 2003) and one held for sale in 2004, discussed
below, for the three and six-months ended June 30, 2003. Included in
discontinued operations for the three- and six-month periods ended June 30,
2004 are one property sold in 2004 and one property considered held for
sale. In addition, discontinued operations includes the operating results,
net of minority interest, of the Phase III consolidated partnerships held
for sale for the three-months ended June 30, 2004. For purposes of the
discontinued operations presentation, the Company only includes interest
expense associated with specific mortgage indebtedness of the properties
that are sold or classified as held for sale.
During 2004, the Company sold one property referred to above with a total
of 224 units for total consideration of $9.3 million, or an average of
$41.6 per unit. During 2003, the Company sold seven properties referred to
above with a total of 1,568 units for total consideration of $59.3 million,
or an average of $38 per unit. During the six months ended June 30, 2004,
the Company reported a combined $46 loss, net of minority interest,
relating to additional expenses incurred in the same period for sales which
took place during 2003. These costs represent a change in estimate from
those accrued at the time of sale.
In connection with the Company's strategic asset disposition program,
management is constantly reevaluating the performance of its portfolio on a
property-by-property basis. The Company from time to time determines that
it is in the best interest of the Company to dispose of assets that have
reached their potential or are less efficient to operate due to their size
or remote location and reinvest such proceeds in higher performing assets
located in targeted geographic markets. It is possible that the Company
will sell such properties at a loss. In addition, it is possible that for
assets held for use, certain holding period assumptions made by the Company
may change which could result in the Company's recording of an impairment
charge.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
10. Disposition of Property and Discontinued Operations (continued)
---------------------------------------------------------------
During the second quarter of 2004, a third party completed its due
diligence on a 396-unit property located in Indiana which resulted in a
reduction in price to the sale contract. As a result of this reduction in
price and in accordance with SFAS No. 144, it was determined that the book
value of this property was in excess of the undiscounted cash flows.
Therefore, an impairment of real property of $1.1 million was recorded for
the six and three-month periods ended June 30, 2004. This property was
considered held for sale and has been reflected in discontinued operations
as of June 30, 2004 as all significant contingencies surrounding the sale
had been resolved.
The operating results of the components of discontinued operations are
summarized as follows for the six and three-month periods ended June 30,
2004 and 2003.
Six months Three months
---------- ------------
2004 2003 2004 2003
---- ---- ---- ----
Revenues
Rental Income $ 6,741 $5,846 $5,608 $2,870
Property other income 102 346 36 181
-------- ------- -------- -------
Total Revenues 6,843 6,192 5,644 3,051
-------- ------- -------- -------
Expenses
Operating and Maintenance 4,306 3,342 3,591 1,612
Interest expense 1,464 1,051 1,344 509
Depreciation and amortization 2,684 1,010 2,407 509
Impairment of real property 1,100 423 1,100 -
-------- ------- -------- -------
Total Expenses 9,554 5,826 8,442 2,630
-------- ------- -------- -------
Income (loss) from discontinued operations before
minority interest and gain (loss) on
disposition of property (2,711) 366 ( 2,798) 421
Minority interest 1,841 ( 135) 1,870 ( 154)
-------- ------- -------- -------
Income from discontinued operations ($ 870) $ 231 ($ 928) $ 267
======== ======= ======== =======
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
10. Disposition of Property and Discontinued Operations (continued)
---------------------------------------------------------------
The table below provides a more detailed presentation of the components of
discontinued operations for the six- and three-month periods ended June 30,
2004.
Six Months 2004 Three Months 2004
--------------- -----------------
Owned Owned
Communities Phase III Total Communities Phase III Total
----------- --------- ----- ----------- --------- -----
Revenues
Rental Income $2,130 $4,611 $6,741 $ 997 $4,611 $5,608
Property other income 145 ( 43) 102 79 ( 43) 36
-------- -------- ------- ------- -------- -------
Total Revenues 2,275 4,568 6,843 1,076 4,568 5,644
-------- -------- ------- ------- -------- -------
Expenses
Operating and Maintenance 1,124 3,182 4,306 409 3,182 3,591
Interest expense 241 1,223 1,464 121 1,223 1,344
Depreciation and amortization 518 2,166 2,684 241 2,166 2,407
Impairment of real property 1,100 - 1,100 1,100 - 1,100
-------- -------- ------- ------- -------- -------
Total Expenses 2,983 6,571 9,554 1,871 6,571 8,442
-------- -------- ------- ------- -------- -------
Income (loss) from discontinued
operations before minority
interest and gain (loss) on
disposition of property ( 708) ( 2,003) (2,711) ( 795) (2,003) (2,798)
419 1,422 1,841 448 1,422 1,870
-------- -------- ------- ------- -------- -------
Minority interest
Income from discontinued
operations ($ 289) ($ 581) ($ 870) ($ 347) ($ 581) ($ 928)
======== ======== ======= ======= ======== =======
The results of discontinued operations in the table above have been
presented for the six- and three-month periods ended June 30, 2004 only, as
the discontinued operations for 2003 solely represents the results from
owned communities.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
11. Commitments and Contingencies
-----------------------------
Contingencies
In 2001, the Company underwent a state capital stock tax audit. The state
has assessed taxes of $469 for the 1998 and 1999 tax years under audit. If
the state's position is applied to all tax years through December 31, 2001,
the assessment would be $1.3 million. At the time, the Company believed the
assessment and the state's underlying position were not supportable by the
law nor consistent with previously provided interpretative guidance from
the office of the State Secretary of Revenue. After two subsequent
enactments by the state legislation during 2002 affecting the pertinent tax
statute, the Company was advised by outside tax counsel that its filing
position for 1998-2001 should prevail. During December 2003, the state's
governor signed legislation which included the REIT tax provisions. Based
upon this, Company's tax counsel expects that the outstanding litigation
should now be able to be resolved. Effective January 1, 2003, the Company
reorganized the ownership of Home Properties Trust, which should subject
the Company to a much lower level of tax going forward.
During April, 2004, the Company finalized negotiations with New York State
settling a sales and use tax audit covering the period June 1, 1999 through
May 31, 2002. The total cost to the Company as a result of the audit
amounted to $861. This was included in the first quarter results.
As a result of this audit, during the second quarter the Company examined
its sales and use tax compliance in the other states in which the Company
operates. Based upon its internal analysis, the Company has estimated its
liability as of June 30, 2004 in those states where it found non-compliance
and has recorded at June 30, 2004 a liability of $1,712. The liability
recorded relates to the period beginning on the later of: (i) the date the
company first purchased property in the applicable state; or (ii) January
1, 1997 and ending on June 30, 2004. The Company recognizes that the
liability recorded is an estimate and that the actual tax liability that
will be paid in the future may be less than or greater than this estimate.
The Company has determined that the likely range is between $1,325 and
$2,300.
The Company and the Operating Partnership, along with Home Leasing
Corporation, the predecessor of the Company that is owned by Nelson and
Norman Leenhouts, are defendants in a lawsuit. The essence of the complaint
is that the entity in which plaintiffs were investors was wrongfully
excluded from the Company's initial organization as a real estate
investment trust and the investors therefore did not obtain the benefits
from exchanging their equity interests in that entity for equity in the
Operating Partnership. In their original complaint, plaintiffs sought
damages in the amount of $3 million. In the subsequent discovery process,
plaintiffs increased the damages sought to $10 million. The Company and the
Operating Partnership have responded to the lawsuit by denying all material
allegations and asserting various defenses. The only remaining cause of
action against the Company and the Operating Partnership is a claim of
breach of fiduciary duty. On a procedural basis, plaintiffs were recently
permitted to change their election from a judge to a jury trial. It is not
possible to estimate the possible loss or range of loss at this time and
the Company has therefore not accrued any liability for the second quarter.
Management and its counsel believe that applicable legal precedents support
a conclusion that neither the Company nor the Operating Partnership should
be found to have any liability to the plaintiffs.
Guarantees
The Company, through its general partnership interests in certain
affordable property limited partnerships, has guaranteed the Low Income
Housing Tax Credits to limited partners in 23 partnerships totaling
approximately $48 million. As of June 30, 2004, there were no known
conditions that would make such payments necessary, and no amounts have
been recorded. In addition, the Company, acting as general partner in
certain partnerships, is obligated to advance funds to meet partnership
operating deficits.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
12. Impairment of real property
---------------------------
During the second quarter of 2004, a third party completed its due
diligence on a 396-unit property located in Indiana which resulted in a
reduction in price to the sale contract. As a result of this reduction in
price and in accordance with SFAS No. 144, it was determined that the book
value of this property was in excess of the undiscounted cash flows.
Therefore, an impairment of real property of $1.1 million was recorded for
the six and three-month periods ended June 30, 2004. This property was
considered held for sale and has been reflected in discontinued operations
as of June 30, 2004 as all significant contingencies surrounding the sale
had been resolved.
13. Related Party Transactions
--------------------------
On January 1, 2004, the Company sold certain assets of its commercial
property management division to Home Leasing LLC, which is owned by Nelson
and Norman Leenhouts. This division managed approximately 2.2 million
square feet of gross leasable area, as well as certain planned communities.
The initial amount paid was $82. In addition, the Company is entitled to
receive a percentage of the management fee received by Home Leasing in
connection with the management of one of the commercial properties for a
period not to exceed 36 months. The expected monthly fee as outlined in the
contract is approximately $4.6 or $55.2 per year. If Home Leasing continues
to manage the property for three years, the Company is expected to receive
total additional deferred purchase price of $165.6 of which $27.6 has been
received during the six-months ended June 30, 2004. The current loss
recorded on the sale of these assets as of June 30, 2004 amounts to $3.2.
If the management of this property is retained for the entire three years
the Company expects to receive an additional $138 for the period July 1,
2004 through January 1, 2007. The gain on sale would then be approximately
$134.5.
14. Subsequent Events
-----------------
On July 8, 2004, the Company acquired its first property in Florida. The
Hamptons is an 836-unit apartment community in North Lauderdale. The total
purchase price of $70.4 million, including closing costs, equates to
approximately $84.2 per unit. Consideration included $56.0 million in a
variable rate Fannie Mae Discount Mortgage Backed Security (DMBS) financed
through Prudential Mortgage Capital Company and $14.4 million from the
Company's line of credit. The initial interest rate on the DMBS is 2.4%,
inclusive of the rate cap, and adjusts every 90 days. The property is
currently 93.7% occupied, based on economic occupancy, with monthly rents
averaging $807.
On July 30, 2004 the Company sold Maple Lane Apartments, a 396 unit
community located in South Bend, Indiana. The total sales price of $17.5
million equates to $44 per apartment unit. An impairment charge of $1.1
million was recorded in the second quarter to adjust this asset to
management's estimate of fair market value.
HOME PROPERTIES, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The following discussion should be read in conjunction with the accompanying
consolidated financial statements and notes thereto.
Forward-Looking Statements
- --------------------------
This discussion contains forward-looking statements. Although the Company
believes expectations reflected in such forward-looking statements are based on
reasonable assumptions, it can give no assurance that its expectations will be
achieved. Factors that may cause actual results to differ include general
economic and local real estate conditions, the weather and other conditions that
might affect operating expenses, the timely completion of repositioning
activities within anticipated budgets, the actual pace of future acquisitions
and sales, including the sale of the general partner interests in affordable
properties, and continued access to capital to fund growth.
Liquidity and Capital Resources
- -------------------------------
The Company's principal liquidity demands are expected to be distributions to
the common and preferred stockholders and Operating Partnership Unitholders,
capital improvements and repairs and maintenance for the properties, acquisition
of additional properties, property development and debt repayments.
The Company intends to meet its short-term liquidity requirements through net
cash flows provided by operating activities and its unsecured line of credit.
The Company considers its ability to generate cash to be adequate to meet all
operating requirements and make distributions to its stockholders in accordance
with the provisions of the Internal Revenue Code, as amended, applicable to
REITs.
As of June 30, 2004, the Company had an unsecured line of credit from M & T Bank
of $115 million. The Company's outstanding balance as of June 30, 2004, was $26
million. Borrowings under the line of credit bear interest at 1.05% over the
one-month LIBOR rate. Accordingly, increases in interest rates will increase the
Company's interest expense and as a result will affect the Company's results of
operations and financial condition. The line of credit expires on September 1,
2005.
To the extent that the Company does not satisfy its long-term liquidity
requirements through net cash flows provided by operating activities and its
credit facility, it intends to satisfy such requirements through the issuance of
UPREIT Units, proceeds from the Dividend Reinvestment Plan ("DRIP"), proceeds
from the sale of properties, additional long term secured or unsecured
indebtedness, or the issuance of additional equity securities. As of June 30,
2004, the Company owned 25 properties with 3,895 apartment units, which were
unencumbered by debt.
In May 1998, the Company's Form S-3 Registration Statement was declared
effective relating to the issuance of up to $400 million of common stock,
preferred stock or other securities. The available balance on the shelf
registration statement at June 30, 2004 was $144.4 million.
In May and June 2000, the Company completed the sale of $60 million of Series C
Preferred Stock in a private transaction with affiliates of Prudential Real
Estate Investors ("Prudential"), Teachers Insurance and Annuity Association of
America ("Teachers"), affiliates of AEW Capital Management and Pacific Life
Insurance Company. The Series C Preferred Stock carried an annual dividend rate
equal to the greater of 8.75% or the actual dividend paid on the Company's
common shares into which the preferred shares could be converted. The stock had
a conversion price of $30.25 per share and a five-year, non-call provision. As
part of the Series C Preferred Stock transaction, the Company also issued
240,000 warrants to purchase common shares at a price of $30.25 per share,
expiring in five years. On January 9, 2003, holders of 100,000 shares of Series
C Preferred Shares elected to convert those shares for 330,579 shares of common
stock. On May 8, 2003, 200,000 shares of Series C Preferred Shares were
converted into 661,157 shares of common stock. On August 26, 2003, 200,000
shares of Series C Preferred Shares were converted into 661,157 of common stock.
On November 5, 2003, holders of the remaining 100,000 shares of Series C
Preferred Shares elected to convert those shares for 330,579 shares of common
stock. On September 9, 2003, 17,780 warrants were exercised, resulting in the
issuance of 17,780 shares of common stock. During the fourth quarter of 2003,
the remaining 222,220 common stock warrants were exercised, resulting in the
issuance of 222,220 shares of common stock. Neither the conversions nor the
warrant exercise had an effect on the reported results of operations.
In June 2000, the Company completed the sale of $25 million of Series D
Preferred Stock in a private transaction with The Equitable Life Assurance
Society of the United States. The Series D Preferred Stock carries an annual
dividend rate equal to the greater of 8.775% or the actual dividend paid on the
Company's common shares into which the preferred shares can be converted. The
stock has a conversion price of $30 per share and a five-year, non-call
provision.
In December 2000, the Company completed the sale of $30 million of Series E
Preferred Stock in a private transaction, again with affiliates of Prudential
and Teachers. The Series E Preferred Stock carried an annual dividend rate equal
to the greater of 8.55% or the actual dividend paid on the Company's common
shares into which the preferred shares could be converted. The stock had a
conversion price of $31.60 per share and a five-year, non-call provision. In
addition, as part of the Series E Preferred Stock transaction, the Company
issued warrants to purchase 285,000 common shares at a price of $31.60 per
share, expiring in five years. On August 20, 2002, 63,200 of the Series E
Convertible Preferred Shares were converted into 200,000 shares of common stock.
On May 6, 2003, 36,800 shares of Series E Preferred Shares were converted into
116,456 shares of common stock. On August 26, 2003 the remaining 200,000 shares
of Series E Preferred Shares were converted into 632,911 of common stock. On
September 9, 2003, 17,100 warrants were exercised, resulting in the issuance of
17,100 shares of common stock. During the fourth quarter of 2003, the remaining
267,900 common stock warrants were exercised, resulting in the issuance of
267,900 shares of common stock. Neither the conversions nor the warrant exercise
had an effect on the reported results of operations.
In March 2002, the Company issued 2,400,000 shares of its 9.00% Series F
Cumulative Redeemable Preferred Stock ("Series F Preferred Shares"), with a
$25.00 liquidation preference per share. This offering generated net proceeds of
approximately $58 million. The net proceeds were used to fund the Series B
preferred stock repurchase, property acquisitions, and property upgrades. The
Series F Preferred Shares are redeemable by the Company at anytime on or after
March 25, 2007 at a redemption price of $25.00 per share, plus any accumulated,
accrued and unpaid dividends. Each Series F Preferred share will receive an
annual dividend equal to 9.00% of the liquidation preference per share
(equivalent to a fixed annual amount of $2.25 per share).
The issuance of UPREIT Units for property acquisitions continues to be a source
of capital for the Company. During the first quarter of 2004, the Company
acquired four communities with 534 units for a total purchase price of $64.2
million. The Company issued UPREIT Units valued at approximately $12.1 million
as part of the consideration for two of the properties, with the balance funded
by the assumption of debt and cash. During 2003, the Company exercised an option
to acquire approximately 10 acres of land adjacent to one of its existing
properties for $2.8 million. In connection with this transaction, the Company
issued UPREIT Units valued at approximately $2.8 million. In addition, $2
million of UPREIT Units were issued to satisfy an existing liability.
During 2003, $30.3 million of common stock was issued under the Company's DRIP.
An additional $12.8 million has been raised through the DRIP program during the
first six months of 2004.
The DRIP was amended, effective April 10, 2001, in order to reduce management's
perceived dilution from issuing new shares at or below the underlying net asset
value. The discount on reinvested dividends and optional cash purchases was
reduced from 3% to 2%. The maximum monthly investment (without receiving
approval from the Company) was reduced from $5 thousand to $1 thousand. As
expected, these changes significantly reduced participation in the plan.
Management will continue to monitor the relationship between the Company's stock
price and estimated net asset value. During times when this difference is small,
management has the flexibility to issue waivers to DRIP participants to provide
for investments in excess of the $1 thousand maximum monthly investment. In
connection with the announcement of the February, 2002 dividend, the Company
announced such waivers will be considered beginning with the March 2002 optional
cash purchase, as management believed the stock was trading at or above its
estimate of net asset value. No such waivers were granted during the 2003 or the
first six months of 2004.
On August 6, 2002 the Board of Directors increased its authorization by
2,000,000 shares to repurchase its common stock or UPREIT Units in connection
with the Company's stock repurchase program. The shares/units may be repurchased
through open market or privately negotiated transactions at the discretion of
Company management. The Board's action does not establish a target stock price
or a specific timetable for share repurchase. During the first three months of
2004, there were no shares or UPREIT Units repurchased by the Company. At June
30, 2004 the Company had authorization to repurchase 3,135,800 shares of common
stock and UPREIT Units under the stock repurchase program.
As of June 30, 2004, excluding the effect of the FIN 46R consolidations, the
weighted average rate of interest on mortgage debt is 6.2% and the weighted
average maturity is approximately eight years. Approximately 93% of the debt is
fixed rate. This limits the exposure to changes in interest rates, minimizing
the effect on results of operations and financial condition.
Off-Balance Sheet Investments
- -----------------------------
Effective March 31, 2004, the Company adopted FASB Interpretation No. 46R -
Consolidation of Variable Interest Entities, an interpretation of ARB No. 51 -
Consolidated Financial Statements. The interpretation addresses consolidation by
businesses of special purpose entities (variable interest entities, "VIE"). The
Company has made a determination that all 41 of the remaining limited
partnerships are Variable Interest Entities. The Company has further determined
that it is the primary beneficiary in 34 of the limited partnerships and
therefore consolidated these entities effective March 31, 2004. Beginning with
the second quarter of 2004, the Company's results of operations for both the
three- and six-month periods ending June 30, 2004, include the results of
operations of four of the Affordable LPs for the three-month period ended June
30, 2004. The tables on the following pages show the effects of the VIEs being
consolidated. The results of operations of the remaining 30 consolidated
partnerships for the same time period are included in the results of
discontinued operations. These properties are classified as held for sale due to
the fact that as of June 30, 2004, the partnerships are under contract for sale,
due diligence has been completed, and the majority of third party approvals have
been received. Home Properties determined that it is not the primary beneficiary
in seven partnerships syndicated under U.S. Department of Housing and Urban
Development subsidy programs. These seven investments will continue to be
accounted for under the equity method. For those seven investments, the Company
will continue to record its allocable share of the respective partnership's
income or loss based on the terms of the agreement. To the extent it is
determined that the LPs cannot absorb their share of the losses, if any, the GP
will record the LPs share of such losses. The Company will absorb such losses to
the extent the Company has outstanding loans or advances and the limited partner
has no remaining capital account.
The Company, through its general partnership interest in certain affordable
property limited partnerships, has guaranteed the low income housing tax credits
to the limited partners for a period of either five or ten years in 23
partnerships totaling approximately $48 million. Such guarantee requires the
Company to operate the properties in compliance with Internal Revenue Code
Section 42 for 15 years. The weighted average number of compliance years
remaining is approximately 10 years. In addition, acting as the general partner
in certain partnerships, the Company is obligated to advance funds to meet
partnership operating deficits. If operating deficits continue to occur, the
Company would determine on an individual partnership basis if it is in the best
interest of the Company to continue to fund these deficits.
The Company believes the properties operations conform to the applicable
requirements as set forth above and do not anticipate any payment on the low
income housing tax credit guarantees described above. In addition, the Company
has required the buyer of its general partner interests in the limited
partnerships to secure releases of the Company's guarantees from the limited
partners or, in the one instance where a release was not granted, the buyer
would indemnify the Company for any liability.
As indicated in Footnote 6, the Company is working towards a closing on Phase
III by the end of the third quarter. If the Company is able to close by this
date, approximately $121 million of assets and $92 million of liabilities will
be removed from the balance sheet in the third quarter. The following tables
below summarizes the effect of the consolidation requirements of FIN 46R on the
balance sheet as of June 30, 2004 as well as the Statements of Operations for
the three- and six-month periods ended June 30, 2004.
Consolidation Summary of the Balance Sheet as of June, 2004
(in thousands)
June 30, 2004 Effect of FIN 46R June 30, 2004
(before FIN 46R) Consolidation (as reported)
---------------- ------------- -------------
ASSETS
Real estate:
Land $ 399,706 $ 14,275 $ 413,981
Buildings, improvements and equipment 2,545,116 199,479 2,744,595
---------- -------- ----------
2,944,822 231,754 3,158,576
Less: accumulated depreciation ( 370,290) ( 62,515 ) ( 432,805)
---------- -------- ----------
Real estate, net 2,574,532 151,239 2,725,771
Cash and cash equivalents 5,751 937 6,688
Cash in escrows 42,770 7,873 50,643
Accounts receivable 4,214 901 5,115
Prepaid expenses 13,140 180 13,320
Investment in and advances to affiliates 4,071 ( 3,948 ) 123
Deferred charges 9,483 5,139 14,622
Other assets 10,654 75 10,729
---------- -------- ----------
Total assets $2,664,615 $162,396 $2,827,011
========== ======== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Mortgage notes payable $1,495,065 $126,730 $1,621,795
Line of credit 26,000 - 26,000
Accounts payable 13,822 820 14,642
Accrued interest payable 7,509 2,522 10,031
Accrued expenses and other liabilities 20,893 1,070 21,963
Security deposits 22,952 1,161 24,113
---------- -------- ----------
Total liabilities 1,586,241 132,303 1,718,544
---------- -------- ----------
Minority interest 316,818 30,414 347,232
---------- -------- ----------
Stockholders' equity 761,556 ( 321 ) 761,235
---------- -------- ----------
Total liabilities and stockholders' equity $2,664,615 $162,396 $2,827,011
========== ======== ==========
Consolidation Summary of the Statement of Operations
for the six-months ended June 30, 2004 (in thousands)
June 30, 2004 Effect of FIN 46R June 30, 2004
(before FIN 46R) Consolidation (as reported)
---------------- ------------- -------------
Revenues:
Rental income $218,259 $ 1,574 $219,833
Property other income 8,623 98 8,721
Interest and dividend income 298 - 298
Other income 1,163 - 1,163
--------- ---------- ---------
Total Revenues 228,343 1,672 230,015
--------- ---------- ---------
Expenses:
Operating and maintenance 103,066 1,532 104,598
General and administrative 9,617 - 9,617
Interest 44,564 533 45,097
Depreciation and amortization 43,932 772 44,704
Impairment of assets held as General Partner 1,352 ( 236) 1,116
--------- ---------- ---------
Total Expenses 202,531 2,601 205,132
--------- ---------- ---------
Income from operations (
25,812 929) 24,883
Equity in earnings (losses) of unconsolidated affiliates ( 1,680) 1,117 ( 563)
--------- ---------- ---------
Income before minority interest and discontinued operations 24,132 188 24,230
Minority interest in affordable limited partnerships - ( 393) ( 393)
Minority interest in operating partnership 6,658 189 6,847
--------- ---------- ---------
Income from continuing operations 17,474 392 17,866
--------- ---------- ---------
Discontinued operations
Income (loss) from operations, net of minority interest ( 478) ( 392) ( 870)
Gain (loss) on disposition of property, net of minority
interest 511 - 511
--------- ---------- ---------
Discontinued operations 33 - ( 359)
--------- ---------- ---------
Income before loss on disposition of property and business
and cumulative effect of change in accounting principle 17,507 - 17,507
Loss on disposition of property and business, net of minority
interest ( 67) - ( 67)
--------- ---------- ---------
Income before cumulative effect of change in accounting
principle 17,440 - 17,440
Cumulative effect of change in accounting principle, net of
minority interest - ( 321) ( 321)
--------- ---------- ---------
Net Income 17,440 ( 321) 17,119
Preferred dividends ( 3,797) - ( 3,797)
--------- ---------- ---------
Net income available to common shareholders $ 13,643 ($ 321) $ 13,322
========= ========== =========
Consolidation Summary of the Statement of Operations
for the three-months ended June 30, 2004 (in thousands)
June 30, 2004 Effect of FIN 46R June 30, 2004
(before FIN 46R) Consolidation (as reported)
---------------- ------------- -------------
Revenues:
Rental income $110,866 $ 1,574 $112,440
Property other income 4,634 98 4,732
Interest and dividend income 147 - 147
Other income 698 - 698
---------- ------------- ----------
Total Revenues 116,345 1,672 118,017
---------- ------------- ----------
Expenses:
Operating and maintenance 49,549 1,532 51,081
General and administrative 4,892 - 4,892
Interest 23,156 533 23,689
Depreciation and amortization 23,498 772 23,270
Impairment of assets held as General Partner 236 ( 236) -
---------- ------------- ----------
Total Expenses 100,331 2,601 102,932
---------- ------------- ----------
Income from operations
16,014 ( 929) 15,085
Equity in earnings (losses) of unconsolidated affiliates ( 1,142) 1,117 ( 25)
---------- ------------- ----------
Income before minority interest and discontinued operations 14,872 188 15,060
Minority interest in affordable limited partnerships - ( 393) ( 393)
Minority interest in operating partnership 4,219 189 4,408
---------- ------------- ----------
Income from continuing operations 10,653 392 11,045
---------- ------------- ----------
Discontinued operations
Income (loss) from operations, net of minority interest ( 536) ( 392) ( 928)
Gain (loss) on disposition of property, net of minority
interest 524 - 524
---------- ------------- ----------
Discontinued operations ( 12) - ( 404)
---------- ------------- ----------
Net Income 10,641 - 10,641
Preferred dividends ( 1,899) - ( 1,899)
---------- ------------- ----------
Net income available to common shareholders $ 8,742 $ 0 $ 8,742
========== ============= ==========
Acquisitions and Dispositions
- -----------------------------
During the first six months of 2004, the Company acquired seven apartment
communities in four unrelated transactions. The acquisitions consisted of a
portfolio of four apartment communities with a total of 534 units in New Jersey,
two apartment communities in Maryland with a total of 468 units and one
apartment community in Massachusetts with a total of 276 units. The total
purchase price of $140.7 million, including closing costs, equated to an average
of $110.0 per apartment. Consideration included $61.4 million of assumed debt
(fair market value of $69.8 million), $67.4 million in cash and $11.9 million of
UPREIT Units in the Company (fair market value of $12.1 million). The UPREIT
Units are exchangeable for shares of the Company's common stock on a one-for-one
basis. For purposes of determining the number of UPREIT Units issued, a value of
$39.00 per unit was set when the transaction was negotiated. The combined
weighted average expected first year capitalization rate on these acquisitions
is 6.8%. Capitalization rate ("cap rate") is defined as the rate of interest
used to convert the first year expected net operating income ("NOI") less a 3.0%
management fee into a single present value. NOI is defined by the Company as
rental income and property other income less operating and maintenance expenses.
Management generally considers NOI to be an appropriate measure of operating
performance because it helps investors to understand the operations of a
community. In addition the apartment communities are valued and sold in the
market by using a multiple of NOI.
During the second quarter the Company disposed of one community with a total of
224 units located in upstate, New York. The total purchase price of $9.3 million
equated to approximately $41.6 per unit. The Company recorded a gain on sale in
the second quarter, before allocation of minority interest, of approximately
$825 related to this sale. The weighted average expected first year cap rate for
this community is 9.0%.
Subsequent to the end of the second quarter of 2004, the Company acquired one
additional community with 836 units for $70.4 million at an expected first year
cap rate of 6.2%. In addition, the Company disposed of a property with 396 units
located in Indiana for a total price of $17.5 million at an expected first year
cap rate of 7.4%.
Contractual Obligations and Other Commitments
- ---------------------------------------------
The primary obligations of the Company relate to its borrowings under the line
of credit and mortgage notes payable. The Company's line of credit matures in
September 2005, and had $26 million outstanding at June 30, 2004. The $1.5
billion in mortgage notes payable from the Company's wholly owned properties,
before the effect of FIN 46R, have varying maturities ranging from 1 to 38
years. The weighted average interest rate of the Company's fixed rate notes was
6.39% and 6.47% at June 30, 2004 and December 31, 2003, respectively. The
weighted average interest rate of the Company's variable rate notes and credit
facility was 2.45% and 2.32% at June 30, 2004 and December 31, 2003,
respectively.
The Company has a non-cancelable operating ground lease for one of its
properties. The lease expires May 1, 2020, with options to extend the term of
the lease for two successive terms of twenty-five years each. The lease provides
for contingent rental payments based on certain variable factors. At June 30,
2004, future minimum rental payments required under the lease are $70 per year
until the lease expires.
The Company leases its corporate office space from an affiliate and the office
space for its regional offices from third parties. The corporate office space
requires an annual base rent plus a pro-rata portion of property improvements,
real estate taxes, and common area maintenance. The regional office leases
require an annual base rent plus a pro-rata portion of real estate taxes.
Capital Improvements
- --------------------
The Company's policy is to capitalize costs related to the acquisition,
development, rehabilitation, construction and improvement of properties. Capital
improvements are costs that increase the value and extend the useful life of an
asset. Ordinary repair and maintenance costs that do not extend the useful life
of the asset are expensed as incurred. Costs incurred on a lease turnover due to
normal wear and tear by the resident are expensed on the turn. Recurring capital
improvements typically include: appliances, carpeting and flooring, HVAC
equipment, kitchen/ bath cabinets, new roofs, site improvements and various
exterior building improvements. Non- recurring, revenue generating capital
improvements include, among other items: community centers, new windows, and
kitchen/ bath apartment upgrades. Revenue generating capital improvements will
directly result in rental earnings or expense savings. The Company capitalizes
interest and certain internal personnel costs related to the communities under
rehabilitation and construction.
The Company estimates that on an annual basis $525 per unit is spent on
recurring capital expenditures. During the three and six-month period ended June
30, 2004 approximately $131 and $262 per unit was estimated to be spent on
recurring capital expenditures. The table below summarizes the actual total
capital improvements, (before the effects of FIN 46R) incurred by major
categories for the three and six-month periods ended June 30, 2004 and 2003 and
an estimate of the breakdown of total capital improvements by major categories
between recurring and non-recurring, revenue generating capital improvements for
the three and six-month period ended June 30, 2004 as follows:
For the three-month period ended June 30,
(in thousands, except per unit data)
2004 2003
---------------------------------------------------------------------------- ---------------------------
Recurring Non-Recurring Total Capital Total Capital
Cap Ex Per Unit(a) Cap Ex Per Unit(a) Improvements Per Unit(a) Improvements Per Unit(a)
------ ----------- ------ ----------- ------------ ----------- ------------ -----------
New Buildings $ - $ - $ 665 $16 $ 665 $16 $ 496 $12
Major building improvements 956 23 4,389 104 5,345 127 6,422 159
Roof replacements 365 9 711 17 1,076 26 1,028 26
Site improvements 350 8 2,516 60 2,866 68 2,042 51
Apartment upgrades 690 16 6,091 145 6,781 161 8,342 207
Appliances 573 14 428 10 1,001 24 1,219 30
Carpeting/Flooring 1,799 43 539 13 2,338 56 2,974 74
HVAC/Mechanicals 530 12 2,840 68 3,370 80 3,268 81
Miscellaneous 235 6 639 15 874 21 1,131 28
------- ---- ------- ---- ------- ------ ------- ------
Totals $5,498 $131 $18,818 $448 $24,316 $579 $26,922 $668
======= ==== ======= ==== ======= ====== ======= ======
(a) Calculated using the weighted average number of units outstanding,
including 39,992 core units, 2003 acquisition units of 730 and 2004
acquisition units of 1,278 for the three-month period ended June 30, 2004
and 39,992 core units and 2003 acquisition units of 280 for the three-month
period ended June 30, 2003.
For the six-month period ended June 30,
(in thousands, except per unit data)
2004 2003
---------------------------------------------------------------------------- ---------------------------
Recurring Non-Recurring Total Capital Total Capital
Cap Ex Per Unit(a) Cap Ex Per Unit(a) Improvements Per Unit(a) Improvements Per Unit(a)
------ ----------- ------ ----------- ------------ ----------- ------------ -----------
New Buildings $ - $ - $ 1,218 $29 $1,218 $ 29 $ 883 $ 22
Major building improvements 1,894 46 6,886 165 8,780 211 9,832 245
Roof replacements 724 17 793 19 1,517 36 1,303 32
Site improvements 693 17 3,311 79 4,004 96 2,808 70
Apartment upgrades 1,367 33 11,863 285 13,230 318 15,966 397
Appliances 1,135 27 817 20 1,952 47 2,260 56
Carpeting/Flooring 3,564 86 1,068 25 4,632 111 5,230 130
HVAC/Mechanicals 1,050 25 5,143 124 6,193 149 5,503 137
Miscellaneous 466 11 1,413 34 1,879 45 1,966 49
------- ---- ------- ---- ------- ------ ------- ------
Totals $10,893 $262 $32,512 $780 $43,405 $1,042 $45,751 $1,138
======= ==== ======= ==== ======= ====== ======= ======
(a) Calculated using the weighted average number of units outstanding,
including 39,992 core units, 2003 acquisition units of 730 and 2004
acquisition units of 899 for the six-month period ended June 30, 2004 and
39,992 core units and 2003 acquisition units of 215 for the six-month
period ended June 30, 2003.
The schedule below summarizes the breakdown of total capital improvements
(before the effects of FIN 46R) between core and non-core as follows:
For the three-month period ended June 30,
(in thousands, except per unit data)
2004 2003
-------------------------------------------------------------------------- -----------------------
Recurring Non-recurring Total Capital Total Capital
Cap Ex Per Unit Cap Ex Per Unit Improvements Per Unit Improvements Per Unit
------ -------- ------ -------- ------------ -------- ------------ --------
Core Communities $5,234 $131 $18,207 $ 455 $23,441 $ 586 $26,882 $672
2004 Acquisition Communities 168 131 511 400 679 532 - -
2003 Acquisition Communities 96 131 100 137 196 268 40 143
Sub-total 5,498 131 18,818 448 24,316 579 26,922 668
2004 Disposed Communities 23 131 188 1,092 211 1,223 125 559
2003 Disposed Communities - - - - - - 227 224
Corporate office expenditures(1) - - - - 1,760 - 400 -
------- ---- ------- ------ ------- ------ ------- ------
$5,521 $131 $19,006 $ 451 $26,287 $ 582 $27,674 $657
======= ==== ======= ====== ======= ====== ======= ======
For the six-month period ended June 30,
(in thousands, except per unit data)
2004 2003
-------------------------------------------------------------------------- -----------------------
Recurring Non-recurring Total Capital Total Capital
Cap Ex Per Unit Cap Ex Per Unit Improvements Per Unit Improvements Per Unit
------ -------- ------ -------- ------------ -------- ------------ --------
Core Communities $10,466 $262 $31,847 $ 796 $42,313 $1,058 $45,699 $1,143
2004 Acquisition Communities 236 262 514 572 750 834 - -
2003 Acquisition Communities 191 262 151 207 342 469 52 243
Sub-total 10,893 262 32,512 780 43,405 1,042 45,751 1,138
2004 Disposed Communities 52 262 286 1,444 338 1,076 223 995
2003 Disposed Communities - - - - - - 445 419
Corporate office expenditures(1) - - - - 2,390 - 677 -
------- ---- ------- ------ ------- ------ ------- ------
$10,945 $262 $32,798 $ 784 $46,133 $1,046 $47,096 $1,119
======= ==== ======= ====== ======= ====== ======= ======
(1) No distinction is made between recurring and non-recurring expenditures for
corporate office.
Results of Operations
- ---------------------
Summary of Core Properties
The Company had 144 apartment communities with 39,992 units which were owned
during the six-month period being presented (the "Core Properties"). The Company
has acquired an additional nine apartment communities with 2,008 units during
2004 and 2003 (the "Acquired Communities"). The Company also disposed of nine
properties with a total of 2,016 units during 2004 and 2003 (the "Disposition
Communities"). The Disposition Communities have been classified as discontinued
operations. Finally, beginning with the second quarter of 2004, the results of
operations for the both the three- and six-month periods ending June 30, 2004,
include the results of operations of four affordable limited partnerships
("Affordable LPs") that have been consolidated in accordance with FIN 46R for
the first time this quarter. The inclusion of these Affordable LPs and the
Acquired Communities generally accounted for the significant changes in
operating results for the three and six-months ended June 30, 2004.
A summary of the net operating income from Core Properties is as follows (in
thousands):
Six Months Three Month
---------- -----------
2004 2003 $ Change % Change 2004 2003 $ Change % Chg
---- ---- -------- -------- ---- ---- -------- -----
Rental income $209,463 $200,531 $8,932 4.5% $105,348 $101,501 $3,847 3.8%
Property other income 890 11.8% 4,529 500 12.4%
8,440 7,550 4,029
-------- -------- ------ --- ------- ------- ------ ---
Total income 217,903 208,081 9,822 4.7% 109,877 105,530 4,347 4.1%
Operating and
Maintenance ( 99,895) ( 92,813) (7,082) (7.6%) ( 47,428) ( 44,497) (2,931) (6.6%)
-------- -------- ------ --- ------- ------- ------ ---
Net operating income $118,008 $115,268 $2,740 2.4% $62,449 $61,033 $1,416 2.3%
======== ======== ====== === ======= ======= ====== ===
A summary of the net operating income from continuing operations is as follows
(in thousands):
Six Months Three Month
---------- -----------
2004 2003 $ Change % Change 2004 2003 $ Change % Chg
---- ---- -------- -------- ---- ---- -------- -----
Rental income $ 219,833 $ 200,578 $19,255 9.6% $112,440 $ 101,449 $10,991 10.8%
Property other income 1,210 16.1% 742 18.6%
8,721 7,511 4,732 3,990
--------- --------- ------- --- --------- --------- ------- ---
Total income 228,554 208,089 20,465 9.8% 117,172 105,439 11,733 11.1%
Operating and
Maintenance (104,598) ( 92,466) (12,132) (13.1%) ( 51,081) ( 44,429) ( 6,652) (15.0%)
--------- --------- ------- --- --------- --------- ------- ---
Net operating income $ 123,956 $ 115,623 $ 8,333 7.2% $ 66,091 $ 61,010 $ 5,081 8.3%
========= ========= ======= === ========= ========= ======= ===
Comparison of six-months ended June 30, 2004 to the same period in 2003
Of the $19,255 increase in rental income, $8,749 is attributable to the Acquired
Communities and $1,574 is attributable to the addition of the Affordable LPs.
The balance of this increase, or $8,932 which is from the Core Properties, was
the result of an increase of 2.5% in weighted average rental rates, along with
an increase in occupancy from 91.9% to 93.6%. Occupancy is defined as total
possible rental income, net of vacancy and bad debt expense as a percentage of
total possible rental income. Total possible rental income is determined by
valuing occupied units at contract rates and vacant units at market rents.
Property other income, which consists primarily of income from operation of
laundry facilities, late charges, administrative fees, garage and carport
charges, net profits from corporate apartments, cable revenue, pet charges, and
miscellaneous charges to residents increased by $1,210. Of this increase, $222
is attributable to the Acquired Communities, $98 related to the Affordable LPs
and $890 represents a 11.8% increase from the Core Properties.
Other income, which reflects management fee income, decreased $1,158 due
primarily to a decrease in the level of management activity as a result of the
sale of the Phase I and II of the affordable limited partnerships.
During April, 2004, the Company finalized negotiations with New York State
settling a sales and use tax audit covering the period June 1, 1999 through May
31, 2002. As described in the Company's Form 10-Q for the quarter ended March
31, 2004, the total cost to the Company as a result of the audit amounted to
$861 (including $173 of interest expense) for sales tax not charged to the
Company by its vendors. This was included in the first quarter results and
allocated $312 to expense for property repairs, $136 (before minority interest)
to loss on disposition of property, and $413 capitalized to real estate assets
for improvements.
As a result of this audit, during the second quarter the Company examined its
sales and use tax compliance in the other states in which the Company operates.
Based upon its internal analysis, the Company has estimated its liability as of
June 30, 2004 in those states where it found non-compliance and has recorded at
June 30, 2004 a liability of $1,712. This is allocated $493 to expense for
property repairs, $233 to interest expense, $35 (before minority interest) to
loss on disposition of property, and $951 capitalized to real estate assets. The
liability recorded relates to the period beginning on the later of: (i) the date
the company first purchased property in the applicable state; or (ii) January 1,
1997 and ending on June 30, 2004. The Company recognizes that the liability
recorded is an estimate and that the actual tax liability that will be paid in
the future may be less than or greater than this estimate. The Company has
determined that the likely range is between $1,325 and $2,300.
The Company determined that the amount of liability which it failed to record
with respect to sales and use tax did not have a material impact on its results
of operations or reported earnings for the prior periods in which the items
subject to tax were purchased and that the expense recorded in the first and
second quarters of 2004 were one-time adjustments. The Company does not believe
that the additional sales and use tax it will record and pay will have a
material impact on its results of operations in future periods.
As a result of the sales tax audit, the Company initiated procedures during the
second quarter to ensure that sales and use tax on expenditures in New York were
properly collected by its vendors or accrued and paid by the Company. In
addition, the Company has begun to implement procedures and controls designed to
ensure that sales and use taxes are accrued and paid in the other jurisdictions
in which it operates. The Company is also investigating computer software
programs which may provide a technology solution for identifying and calculating
the taxes.
Of the $12,132 increase in operating and maintenance expenses, $3,518 is
attributable to the Acquired Communities and $1,532 is related to the Affordable
LPs. The balance, a $7,082 increase, is attributable to the Core Properties and
is primarily due to increases in repairs and maintenance, personnel costs,
property insurance, and real estate taxes. These increases were offset in part
by savings in snow removal costs. The increase in repairs and maintenance was
18.4% compared to a year ago and is primarily in the areas of contract repair,
painting, and cleaning. Sales tax, as mentioned above, accounts for $805 of this
increase. One of the underlying reasons for the balance of the increase is the
comparative period a year ago. The first quarter of 2003 did not represent a
"typical" first quarter relative to the level of activity usually experienced.
Last year maintenance staff were dealing with snow removal and other effects of
a very severe winter, rather than working on other projects that more typically
would have been done in the first quarter. Personnel expense increased compared
to the same period one year ago due in part to an increase in site level
incentive compensation as a result of improving rent and occupancies. In
addition, increased health insurance and workers compensation costs contributed
significantly to the increase. Property insurance increased for the period
primarily due to an increase in our general liability loss reserve based on
historical losses to date which have been projected using actuarial assumptions.
Real estate taxes were up over the same period a year ago due in part to a
reduction in capital stock taxes in 2003 which we did not experience in the
current year and a significant reassessment on one particular property. Snow
removal costs were down significantly due to a normal winter this year compared
to unusually severe conditions a year ago.
General and administrative expense decreased in 2004 by $84, or 0.9%. General
and administrative expenses as a percentage of total revenues were 4.2% for 2004
as compared to 4.6% for 2003. The decrease is primarily due to the reduced level
of activity in the Management Companies as a result of the sale of the
Commercial Property division on January 1, 2004 and the sale of Phase I and II
during 2003.
Interest expense increased in 2004 by $1,834 as a result of the increased
borrowings in connection with acquisition of the 2004 Acquisition Communities, a
full quarter of interest expense for the 2003 Acquisition Communities and
additional mortgage debt and refinanced mortgage debt incurred during 2003.
Interest expense in the first quarter of 2004 was reduced by $996 when two
mortgage loans were paid off early at amounts less than the amounts carried on
the Company's balance sheet. During 2003, the Company closed on additional
mortgage debt of $80,100 and refinanced $24,000 in existing mortgage debt
resulting in new borrowings of approximately $46,000. A portion of this increase
can also be attributed to the consolidation of the Affordable LPs which added
$533 to this line item. Included in interest expense for 2003 was a $1,349
charge recorded in the first quarter of 2003 related to the prepayment of debt
associated with the sale of Candlewood Apartments in Indiana which occurred
during the same period. Finally, $233 in interest relative to the sales tax
liability recorded and described above is included in 2004.
Depreciation and amortization expense increased $7,188 due to the depreciation
on the Acquisition Communities and the capital additions to the Core Properties
along with the addition of the Affordable LPs which added an additional $772 to
this line item.
In the fourth quarter of 2002, the Company announced its intention to sell
virtually all of the assets associated with its general partner interests in the
affordable properties to focus solely on the direct ownership and management of
market rate apartment communities. The assets included principally loans,
advances and management contracts. During the first six-months of 2004, the
Company recorded impairment charges of $1,116. Of this total, $171 represents
advances made to certain of the affordable property limited partnerships during
the first six months of 2004 which the Company believes will not be repaid upon
the sale of the loans. The remaining $945 pertains to an additional net
impairment charge taken on Phase III to reduce the assets to fair market value.
In connection with FIN 46R, the Company was required to consolidate the majority
of the Affordable LPs results of operations beginning April 1, 2004. The
activity is included in the various line items of income and expense the effects
of which are summarized in the Statement of Operations presented in the Off
Balance Sheet section of Item 2 within this report.
The equity in earnings (losses) of unconsolidated affiliates of $563 is
primarily the result of the general partner recording a greater share of the
underlying investment's losses due to the loans and advances to certain of the
affordable property limited partnerships where the limited partner has no
capital account. This is pursuant to the accounting requirements of EITF 99-10,
"Percentage Used to Determine the Amount of Equity Method Losses." Included and
classified in this account are $509 of advances made during the first six months
of 2004 which the Company believes will not be repaid upon sale. Of the $509 in
advances, $484 represented the activity in the first quarter of 2004 with the
remaining $25 related to advances made in the second quarter of 2004 to one of
the remaining unconsolidated affordable partnerships. In connection with FIN
46R, the Company was required to consolidate the majority of the Affordable LPs
results of operations beginning April 1, 2004. The activity is included in the
various line items of income and expense the effects of which are summarized in
the Statement of Operations presented in the Off Balance Sheet section of Item 2
within this report.
The minority interest in Affordable LPs of $393 represents the limited partners'
share of the losses related to one of the consolidated Affordable LPs where the
limited partner's capital account was positive.
Minority interest in operating partnership decreased $187 due to a general
decrease in income from operations primarily as a result of an overall increase
in depreciation costs.
Included in discontinued operations for the six-month period ended June 30,
2004, are the Disposition Communities and the results of operations of the Phase
III Affordable LPs that in connection with FIN 46R were required to be
consolidated beginning April 1, 2004. As all significant contingencies
surrounding the sale of Phase III have been resolved the Company has considered
these assets held for sale and have reported them in discontinued operations.
Included in the $511 net gain on disposition of property reported for the six
months of 2004 is the sale of an apartment community in Rochester, NY, where the
Company recorded a gain on sale in the second quarter, net of minority interest,
of approximately $557. During the six months ended June 30, 2004, the Company
reported a combined $46 loss, net of minority interest, relating to additional
expenses incurred in the same period for sales which took place during 2003.
These costs represent a change in estimate from those accrued at the time of
sale.
In connection with the adoption of FIN 46R, the Company recorded a $321
cumulative effect charge of a change in accounting principle in the first
quarter of 2004. This charge was the result of negative capital accounts of
minority interest partners that were absorbed by the Company.
Comparison of the three-months ended June 30, 2004 to the same period in 2003
Of the $10,991 increase in rental income, $5,570 is attributable to the Acquired
Communities and $1,574 is attributable to the addition of the Affordable LPs.
The balance of this increase, or $3,847 which is from the Core Properties, was
the result of an increase of 2.5% in weighted average rental rates, along with
an increase in occupancy from 92.6% to 93.7%. Occupancy is defined as total
possible rental income, net of vacancy and bad debt expense as a percentage of
total possible rental income. Total possible rental income is determined by
valuing occupied units at contract rates and vacant units at market rents.
Property other income, which consists primarily of income from operation of
laundry facilities, late charges, administrative fees, garage and carport
charges, net profits from corporate apartments, cable revenue, pet charges, and
miscellaneous charges to residents increased by $742. Of this increase, $144 is
attributable to the Acquired Communities, $98 related to the Affordable LPs and
$500 represents a 12.4% increase from the Core Properties.
Other income, which reflects management fee income, decreased $424 due primarily
to a decrease in the level of management activity as a result of the sale of
Phase I and II of the affordable limited partnerships.
Of the $6,652 increase in operating and maintenance expenses, $2,189 is
attributable to the Acquired Communities and $1,532 is related to the Affordable
LPs. The balance, a $2,931 increase, is attributable to the Core Properties and
is primarily due to increases in repairs and maintenance, personnel costs,
property insurance, and real estate taxes. These increases were offset in part
by a reduction in natural gas heating costs. The increase of $822 in repairs and
maintenance primarily results from the $493 in sales tax recorded here as
described above in the comparison of the six-month results. Personnel expenses
increased $1,005, with $109 resulting from increased site level incentive
compensation going up reflecting improving rent and occupancies compared to a
year ago. In addition, $473 is from increases to workers compensation and health
insurance reserves as a result of recent claim activity. The majority of the
increase in property insurance results from a reduction of $400 to the insurance
reserve in 2003 not repeated in 2004. The 8.7% variance in real estate taxes
results in part from two properties in states where taxes are assessed in
arrears. The results for 2003 include a large reduction in expense for one
property versus a large increase for a different property in 2004. Without these
catch-up adjustments, the net variance would have been 5.4%. Natural gas utility
costs were down $405, or 11.8% due to a comparison a year ago to a cool spring,
which elevated usage in 2003.
General and administrative expense increased in 2004 by $310, or 6.8%. General
and administrative expenses as a percentage of total revenues were 4.1% for 2004
as compared to 4.3% for 2003.
Interest expense increased in 2004 by $2,565 as a result of the increased
borrowings in connection with acquisition of the 2004 Acquisition Communities, a
full quarter of interest expense for the 2003 Acquisition Communities and
additional mortgage debt and refinanced mortgage debt which took place during
2003. During 2003, the Company closed on additional mortgage debt of $80,100 and
refinanced $24,000 in existing mortgage debt resulting in new borrowings of
approximately $46,000. A portion of this increase can also be attributed to the
consolidation of the Affordable LPs which added $533 to this line item. Finally,
$233 in interest relative to the sales tax liability recorded and described
above is included in 2004.
Depreciation and amortization expense increased $4,307 due to the depreciation
on the Acquisition Communities and the capital additions to the Core Properties
along with the addition of the Affordable LPs, which added an additional $772 to
this line item.
In the fourth quarter of 2002, the Company announced its intention to sell
virtually all of the assets associated with its general partner interests in the
affordable properties to focus solely on the direct ownership and management of
market rate apartment communities. The assets include principally loans,
advances and management contracts. In connection with FIN 46R, the Company was
required to consolidate the majority of the affordable limited partnerships
results of operations beginning April 1, 2004. The activity for the second
quarter of 2004 is included in the various line items of income and expense the
effects of which are summarized in the Statement of Operations presented in the
Off Balance Sheet section of Item 2 within this report.
The equity in earnings (losses) of unconsolidated affiliates of $25 is primarily
the result of the general partner recording a greater share of the underlying
investment's losses due to the loans and advances to certain of the affordable
property limited partnerships where the limited partner has no capital account.
This is pursuant to the accounting requirements of EITF 99-10, "Percentage Used
to Determine the Amount of Equity Method Losses." Included and classified in
this account are $25 of advances made in the second quarter of 2004 to one of
the remaining unconsolidated affordable partnerships. In connection with FIN
46R, the Company was required to consolidate the majority of the affordable
limited partnerships results of operations beginning April 1, 2004. The activity
for the second quarter of 2004 is included in the various line items of income
and expense the effects of which are summarized in the Statement of Operations
presented in the Off Balance Sheet section of Item 2 within this report.
The minority interest in affordable limited partnerships of $393 represents the
limited partner's share of the losses related to one of the consolidated
Affordable LPs where the limited partner's capital account was positive.
Minority interest in operating partnership decreased $611 due to a general
decrease in income from operations primarily as a result of an overall increase
in depreciation costs.
Included in discontinued operations for the three-month period ended June 30,
2004, are one apartment community disposition, one apartment community
considered held for sale, and the results of operations of the Phase III limited
partnerships that in connection with FIN 46R were required to be consolidated
beginning April 1, 2004. As all significant contingencies surrounding the sale
of Phase III have been resolved the Company has considered these assets held for
sale and have reported them in discontinued operations.
In connection with the sale of Northgate Apartments in Rochester, NY, the
Company recorded a gain on sale in the second quarter, net of minority interest,
of approximately $557. During the three months ended June 30, 2004, the Company
reported a combined $33 loss, net of minority interest, relating to additional
expenses incurred in the same quarter for sales which took place during 2003.
These costs represent a change in estimate from those accrued at the time of
sale.
Funds From Operations
- ---------------------
Pursuant to the revised definition of Funds From Operations ("FFO") adopted by
the Board of Governors of the National Association of Real Estate Investment
Trusts ("NAREIT"), FFO is defined as net income (computed in accordance with
accounting principles generally accepted in the United States of America
("GAAP")) excluding gains or losses from sales of property, minority interest,
extraordinary items and cumulative effect of change in accounting principle plus
depreciation from real property including adjustments for unconsolidated
partnerships and joint ventures less dividends from non-convertible preferred
shares. NAREIT has recently changed guidance on the interpretation of impairment
charges recorded against the value of real estate. The previous interpretation
was that impairment charges in real estate would be an add back to arrive at
FFO, similar to a loss on sale of real estate. The Company is following this new
interpretation effective April 1, 2004 on a go-forward basis. The change is not
suggested to be retroactive to any prior period reported. Because of the
limitations of the FFO definition as published by NAREIT as set forth above, the
Company has made certain interpretations in applying the definition. The Company
believes all adjustments not specifically provided for are consistent with the
definition.
Management believes that in order to facilitate a clear understanding of the
combined historical operating results of the Company, FFO should be considered
in conjunction with net income as presented in the consolidated financial
statements included elsewhere herein. Management believes that by excluding
gains or losses related to dispositions of property and excluding real estate
depreciation (which can vary among owners of similar assets in similar condition
based on historical cost accounting and useful life estimates), FFO can help one
compare the operating performance of a company's real estate between periods or
as compared to different companies. FFO does not represent cash generated from
operating activities in accordance with generally accepted accounting principles
and is not necessarily indicative of cash available to fund cash needs. FFO does
not include the cost incurred for capital improvements (including capitalized
interest) reflected as an increase to real estate assets. The total capital
improvements include an annual reserve for anticipated recurring, non-revenue
generating capitalized costs of $525 per apartment unit. Please refer to the
Capital Improvement section above in MD&A. Cash provided by operating activities
was $83,806 and $76,303 for the six-month period ended and $46,251 and $42,794
for the three-month period ended June 30, 2004 and 2003, respectively. Cash used
in investing activities was $104,807 and $56,707 for the six-month period ended
and $19,866 and $25,850 for the three-month period ended June 30, 2004 and 2003,
respectively. Cash provided by (used in) financing activities was $21,736 and
($21,668) for the six-month period ended and ($26,801) and ($19,033) for the
three-month period ended June 30, 2004 and 2003, respectively. FFO should not be
considered as an alternative to net income as an indication of the Company's
performance or to cash flow as a measure of liquidity.
The calculation of FFO and reconciliation to GAAP net income available to common
Shareholders for the six and three-months ended June 30, 2004 and 2003 are
presented below (in thousands):
Six Months Three Months
---------- ------------
2004 2003 2004 2003
---- ---- ---- ----
Net income available to common shareholders $13,322 $12,813 $ 8,742 $ 8,942
Convertible preferred dividends 1,097 4,010 549 1,842
Minority interest 6,847 7,034 4,408 5,019
Minority interest - income (loss) from discontinued operations (419) 137 (448) 155
Depreciation and amortization from real property 44,341 37,377 23,190 18,933
Depreciation from real property from unconsolidated entities 556 1,113 13 564
Impairment on General Partner real estate investment 945 - - -
Loss on disposition of property 50 10 - 10
(Gain) loss on disposition of discontinued operations, net of
minority interest (511) (320) (524) 131
Impairment of real property included in income from operations of
disposed properties, before minority interest - 423 - -
Prepayment penalty from early extinguishment of debt in
connection with sale of Candlewood Apartments - 1,349 - -
Cumulative effect of change in accounting principle, net of
minority interest 321 - - -
-------- -------- -------- --------
FFO as defined above $66,549 $63,946 $35,930 $35,596
======== ======== ======== ========
Weighted average common shares/units outstanding(1):
- Basic 48,531.1 44,044.6 48,718.7 44,473.7
======== ======== ======== ========
- Diluted 49,851.7 47,417.2 49,993.1 47,693.2
======== ======== ======== ========
(1) The calculation assumes the conversion of dilutive common stock equivalents
including convertible preferred stock and the conversion of all UPREIT
units to common shares.
All REITs may not be using the same definition for FFO. Accordingly, the above
presentation may not be comparable to other similarly titled measures of FFO of
other REITs.
Covenants
- ---------
Series F Preferred Stock
In connection with the issuance of the Series F Preferred Stock, the Company is
required to maintain for each fiscal quarterly period a fixed charge coverage
ratio, as defined in the Series F Cumulative Redeemable Preferred Stock Article
Supplementary, of 1.75 to 1.0. The fixed charge coverage ratio and the
components thereof do not represent a measure of cash generated from operating
activities in accordance with generally accepted accounting principles and are
not necessarily indicative of cash available to fund cash needs. Further, this
ratio should not be considered as an alternative measure to net income as an
indication of the Company's performance or of cash flow as a measure of
liquidity. The Company has been in compliance with the covenant since the Series
F Preferred Stock was issued. If the Company fails to be in compliance with this
covenant for six or more consecutive fiscal quarters, the holders of the Series
F Preferred Stock would be entitled to elect two directors to the board of
directors of the Company. The calculation of the fixed charge coverage ratio for
the four most recent quarters since the issuance of the Series F Preferred Stock
are presented below (in thousands). Net operating income from discontinued
operations in the calculation below is defined as total revenues from
discontinued operations less operating and maintenance expenses.
Calculation Presented for Series F Covenants
--------------------------------------------
Three-months ended
------------------
June 30, Mar. 31, Dec 31, Sept. 30,
2004 2004 2003 2003
---- ---- ---- ----
EBITDA
------
Total revenues $118,017 $113,197 $111,458 $111,200
Net operating income from discontinued operations ( 276) - 80 460
Operating and maintenance (51,081) (54,232) (48,698) (46,472)
General and administrative ( 4,892) ( 4,725) ( 8,236) ( 4,670)
Impairment of assets held as General Partner - ( 1,116) ( 110) ( 1,888)
Equity in earnings (losses) of unconsolidated
affiliates ( 25) ( 538) ( 395) ( 313)
------- -------- -------- --------
$61,743 $ 52,586 $ 54,099 $ 58,317
Fixed Charges
-------------
Interest expense $23,783 $ 21,332 $ 21,595 $ 21,456
Interest expense on discontinued operations 476 - 79 116
Preferred dividends 1,899 1,898 1,984 2,646
Capitalized interest 171 171 230 230
------- -------- -------- --------
$26,329 $ 23,401 $ 23,888 $ 24,448
Times Coverage ratio: 2.35 2.25 2.26 2.39
Line of Credit
The Credit Agreement relating to the Company's line of credit provides for the
Company to maintain certain financial ratios and measurements. One of these
covenants is that the Company may not pay any distribution to its shareholders
and holders of its UPREIT Units if a distribution, when added to other
distributions paid during the three immediately preceding fiscal quarters,
exceeds the greater of : (i) 90% of funds from operations, and 110% of cash
available for distribution; and (ii) the amount required to maintain the
Company's status as a REIT. Due to the granting of restricted stock to the
retiring Co-CEO's in the fourth quarter of 2003 the Company did not meet the 90%
required ratio. Approximate waivers have been granted by the participating banks
to exclude the impact of this charge from future calculations. The Company has
had to obtain waivers for this same covenant for two consecutive years. The line
of credit has not been used for long-term financing but adds a certain amount of
flexibility, especially in meeting the Company's acquisition goals. Many times
it is easier to temporarily finance an acquisition in a short-term nature
through the line of credit, with long term secured financing or other sources of
capital replenishing the line of credit availability.
Economic Conditions
- -------------------
Substantially all of the leases at the Company's apartment communities are for a
term of one year or less, which enables the Company to seek increased rents upon
renewal of existing leases or commencement of new leases. These short-term
leases minimize the potential adverse effect of inflation on rental income,
although residents may leave without penalty at the end of their lease terms and
may do so if rents are increased significantly.
Historically, real estate has been subject to a wide range of cyclical economic
conditions, which affect various real estate sectors and geographic regions with
differing intensities and at different times. During 2002, 2003 and continuing
into 2004 many regions of the United States have experienced varying degrees of
economic recession and certain recessionary trends, such as the cost of
obtaining sufficient property and liability insurance coverage, short-term
interest rates, and a temporary reduction in occupancy. In light of this, we
will continue to review our business strategy however, we believe that given our
property type and the geographic regions in which we are located, we do not
anticipate any changes in our strategy or material effects in financial
performance.
Declaration of Dividend
- -----------------------
On August 3, 2004, the Board of Directors approved a dividend of $.62 per share
for the quarter ended June 30, 2004. This is the equivalent of an annual
distribution of $2.48 per share. The dividend is payable August 27, 2004 to
shareholders of record on August 16, 2004.
On August 3, 2004 the Company also declared a regular dividend of $0.5625 per
share on its Series F Cumulative Redeemable Preferred Stock, for the quarter
ending August 31, 2004. The dividend on the preferred shares is payable on
August 31, 2004, to shareholders of record on August 16, 2004. This dividend is
equivalent to an annualized rate of $2.25 per share.
Contingency
- -----------
In 2001, the Company underwent a state capital stock tax audit. The state has
assessed taxes of $469 for the 1998 and 1999 tax years under audit. If the
state's position is applied to all tax years through December 31, 2001, the
assessment would be $1.3 million. At the time, the Company believed the
assessment and the state's underlying position were not supportable by the law
nor consistent with previously provided interpretative guidance from the office
of the State Secretary of Revenue. After two subsequent enactments by the state
legislation during 2002 affecting the pertinent tax statute, the Company was
advised by outside tax counsel that its filing position for 1998-2001 should
prevail. During December 2003, the state's governor signed legislation which
included the REIT tax provisions. Based upon this, Company's tax counsel expects
that the outstanding litigation should now be able to be resolved. Effective
January 1, 2003, the Company reorganized the ownership of Home Properties Trust,
which should subject the Company to a much lower level of tax going forward.
The Company and the Operating Partnership, along with Home Leasing Corporation,
the predecessor of the Company that is owned by Nelson and Norman Leenhouts, are
defendants in a lawsuit. The essence of the complaint is that the entity in
which plaintiffs were investors was wrongfully excluded from the Company's
initial organization as a real estate investment trust and the investors
therefore did not obtain the benefits from exchanging their equity interests in
that entity for equity in the Operating Partnership. In their original
complaint, plaintiffs sought damages in the amount of $3 million. In the
subsequent discovery process, plaintiffs increased the damages sought to $10
million. The Company and the Operating Partnership have responded to the lawsuit
by denying all material allegations and asserting various defenses. The only
remaining cause of action against the Company and the Operating Partnership is a
claim of breach of fiduciary duty. On a procedural basis, plaintiffs were
recently permitted to change their election from a judge to a jury trial. It is
not possible to estimate the possible loss or range of loss at this time and the
Company has therefore not accrued any liability for the second quarter.
Management and its counsel believe that applicable legal precedents support a
conclusion that neither the Company nor the Operating Partnership should be
found to have any liability to the plaintiffs.
New Accounting Standard
- -----------------------
In March 2004, the FASB issued EITF 03-6 "Participating Securities and the
Two-Class Method under FASB Statement 128, Earnings per Share. EITF 03-6
addresses a number of questions regarding the computation of earnings per share
by companies that have issued securities other than common stock that
contractually entitle the holder to participate in dividends and earnings of the
company when, and if, it declares dividends on its common stock. The issue also
provides further guidance in applying the two-class method of calculating EPS.
It clarifies what constitutes a participating security and how to apply the
two-class method of computing EPS once it is determined that a security is
participating, including how to allocate undistributed earnings to such a
security. The EITF is effective for the first fiscal periods beginning after
March 31, 2004. The Company adopted the provisions of this EITF effective April
1, 2004, and had no impact on the Company's results of operations, financial
position or liquidity.
In May 2003, FASB issued SFAS 150, "Accounting for Certain Financial Instruments
with Characteristics of Both Liabilities and Equity." This Statement establishes
standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity. It requires
that an issuer classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). This Statement is 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 indefinitely deferred the provisions of
paragraphs 9 and 10 of SFAS 150 as they apply to mandatorily redeemable
noncontrolling interests. This deferral applies to minority interest ownerships
in limited partnerships which are mandatorily redeemable upon termination of the
partnership and therefore is potentially applicable to the affordable portfolio.
The Company's investments in the limited partnerships consolidated under FIN 46R
have a mandatory redeemable feature upon termination of the partnership.
However, due to the tax credit restrictions on the consolidated partnerships, if
the partnerships were terminated prior to the end of the tax credit compliance
periods, the partnership would be liable to fund the tax credits payable to the
limited partners.
HOME PROPERTIES, INC.
ITEM 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
The percentages and loan balances discussed below are prior to FIN 46R
consolidations on the balance sheet. The assets and liabilities of a significant
number of the affordable limited partnerships added to the consolidated balance
sheet as of March 30, 2004 are classified as held for sale on the June 30, 2004
balance sheet. As the non-recourse debt associated with these properties will no
longer affect the balance sheet upon sale of the Company's interests in the
partnerships, the Company believes that comparing pre-FIN 46R financial
information provides the reader of the financial statements with a more
meaningful comparison.
The Company's primary market risk exposure is interest rate risk. At June 30,
2004 and December 31, 2003, approximately 93% and 98%, respectively, of the
Company's debt bore interest at fixed rates with a weighted average maturity of
approximately 8 and 9 years and a weighted average interest rate of
approximately 6.39% and 6.47%, respectively, including the $34.0 million and
$25.2 million of debt, respectively which has been swapped to a fixed rate. The
remainder of the Company's debt bears interest at variable rates with a weighted
average maturity of approximately 11 and 2 years, respectively, and a weighted
average interest rate of 2.45% and 2.32%, respectively, at June 30, 2004 and
December 31, 2003. The Company does not intend to utilize a significant amount
of permanent variable rate debt to acquire properties in the future. On
occasion, the Company may use its line of credit in connection with a property
acquisition with the intention to refinance at a later date. The Company
believes, however, that in no event would increases in interest expense as a
result of inflation significantly impact the Company's distributable cash flow.
At June 30, 2004 and December 31, 2003, the interest rate risk on $34 million
and $25.2 million, respectively of such variable rate debt has been mitigated
through the use of interest rate swap agreements (the "Swaps") with major
financial institutions. The Company is exposed to credit risk in the event of
non-performance by the counter-parties to the Swaps. The Company believes it
mitigates its credit risk by entering into these Swaps with major financial
institutions. The Swaps effectively convert an aggregate of $34 million at June
30, 2004 in variable rate mortgages to fixed rates of 5.35%, 5.39%, 8.22%
and 8.40% and $25.2 million at December 30, 2004 in variable rate mortgages to
fixed rates of 5.91%, 8.22% and 8.40%.
At June 30, 2004 and December 31, 2003, the fair value of the Company's fixed
rate debt, including the $34 million at June 30, 2004 and $25.2 million at
December 31, 2003 which was swapped to a fixed rate, amounted to a liability of
$1.54 billion compared to its carrying amount of $1.47 billion. The Company
estimates that a 100 basis point increase in market interest rates at June 30,
2004 would have changed the fair value of the Company's fixed rate debt to a
liability of $1.47 billion.
The Company intends to continuously monitor and actively manage interest costs
on its variable rate debt portfolio and may enter into swap positions based upon
market fluctuations. In addition, the Company believes that it has the ability
to obtain funds through additional equity offerings or the issuance of UPREIT
Units. Accordingly, the cost of obtaining such interest rate protection
agreements in relation to the Company's access to capital markets will continue
to be evaluated. The Company has not, and does not plan to, enter into any
derivative financial instruments for trading or speculative purposes. As of June
30, 2004, the Company had no other material exposure to market risk.
HOME PROPERTIES, INC.
ITEM 4. INTERNAL CONTROLS
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in the Company's Exchange Act
reports is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms, and that
such information is accumulated and communicated to the Company's Co-Chief
Executive Officers and Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure. In designing and evaluating the
disclosure controls and procedures, management recognized that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and management
necessarily was required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures.
The Co-Chief Executive Officers and Chief Financial Officer have, as of the end
of the period covered by this quarterly report, evaluated the effectiveness of
the disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended) and have
determined that such disclosure controls and procedures are adequate. In
connection with the evaluation, no change in the Company's internal control over
financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the
Securities Exchange Act of 1934, as amended) was identified that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
PART II - OTHER INFORMATION
HOME PROPERTIES, INC.
Item 6. Exhibits and Reports or Form 8-K
(a) Exhibit 31.1 Section 302 Certifications of Chief Executive Officers
Exhibit 31.2 Section 302 Certification of Chief Financial Officer
Exhibit 32.1 Section 906 Certifications of Chief Executive Officers
Exhibit 32.2 Section 906 Certification of Chief Financial Officer
(b) Reports on Form 8-K:
- Form 8-K was furnished on August 6, 2004, date of report August
6, 2004, with respect to Items 7 and 12 disclosures regarding the
Registrant's press release announcing its results for the second
quarter of 2004 and the second quarter 2004 investor conference
call.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HOME PROPERTIES, INC.
(Registrant)
Date: August 9, 2004
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By: /s/ Edward J. Pettinella
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Edward J. Pettinella
President and Chief Executive Officer
Date: August 9, 2004
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By: /s/ David P. Gardner
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David P. Gardner
Executive Vice President and
Chief Financial Officer