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FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 1-11718
MANUFACTURED HOME COMMUNITIES, INC.
(Exact name of registrant as specified in its Charter)
MARYLAND 36-3857664
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
TWO NORTH RIVERSIDE PLAZA, SUITE 800, CHICAGO, ILLINOIS 60606
(Address of principal executive offices) (Zip Code)
(312) 279-1400
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes (X) No ( )
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
21,911,769 shares of Common Stock as of July 19, 2002.
MANUFACTURED HOME COMMUNITIES, INC.
TABLE OF CONTENTS
PART I - FINANCIAL STATEMENTS
ITEM 1. FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
Page
----
Consolidated Balance Sheets
as of June 30, 2002 (unaudited) and December 31, 2001................3
Consolidated Statements of Operations
for the quarters and six months ended June 30, 2002 and 2001
(unaudited)..........................................................4
Consolidated Statements of Cash Flows
for the six months ended June 30, 2002 and 2001 (unaudited)..........5
Notes to Consolidated Financial Statements................................6
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.....................................18
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk........26
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings.................................................27
ITEM 4. Submission of Matters to a Vote of Security Holders...............32
ITEM 6. Exhibits and Reports on Form 8-K..................................32
2
MANUFACTURED HOME COMMUNITIES, INC.
CONSOLIDATED BALANCE SHEETS
AS OF JUNE 30, 2002 AND DECEMBER 31, 2001
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
JUNE 30,
2002 DECEMBER 31,
(UNAUDITED) 2001
----------- -----------
ASSETS Investment in real estate:
Land .......................................................... $ 259,248 $ 256,890
Land improvements ............................................. 813,821 791,903
Buildings and other depreciable property ...................... 112,192 108,804
----------- -----------
1,185,261 1,157,597
Accumulated depreciation ...................................... (221,031) (204,213)
----------- -----------
Net investment in real estate ............................... 964,230 953,384
Cash and cash equivalents ........................................ 10,053 1,926
Notes receivable ................................................. 7,141 1,504
Net assets of discontinued operations ............................ 13,503 12,952
Investment in and advances to affiliates ......................... -- 34,387
Investment in joint ventures ..................................... 11,920 11,853
Rents receivable ................................................. 1,574 1,532
Deferred financing costs, net .................................... 5,477 5,477
Inventory ........................................................ 34,801 --
Prepaid expenses and other assets ................................ 16,809 14,341
----------- -----------
Total assets .................................................. $ 1,065,508 $ 1,037,356
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Mortgage notes payable ........................................ $ 529,413 $ 532,448
Unsecured term loan ........................................... 100,000 100,000
Unsecured line of credit ...................................... 35,250 16,250
Other notes payable ........................................... 11,477 2,236
Accounts payable and accrued expenses ......................... 22,324 19,828
Accrued interest payable ...................................... 4,321 3,879
Rents received in advance and security deposits ............... 5,885 4,324
Distributions payable ......................................... 13,037 12,062
Due to affiliates ............................................. 52 32
----------- -----------
Total liabilities ........................................... 721,759 691,059
----------- -----------
Commitments and contingencies
Minority interest - Common OP Units and other .................... 45,075 46,147
Minority interest - Perpetual Preferred OP Units ................. 125,000 125,000
Stockholders' equity:
Preferred stock, $.01 par value
10,000,000 shares authorized; none issued ................... -- --
Common stock, $.01 par value
50,000,000 shares authorized; 21,890,879 and 21,562,343
shares issued and outstanding for 2002 and 2001, respectively 219 215
Paid-in capital ............................................... 253,107 245,827
Deferred compensation ......................................... (4,428) (4,062)
Employee notes ................................................ (2,847) (3,841)
Distributions in excess of accumulated earnings ............... (70,652) (63,478)
Accumulated other comprehensive income ........................ (1,725) 489
----------- -----------
Total stockholders' equity .................................. 173,674 175,150
----------- -----------
Total liabilities and stockholders' equity .................... $ 1,065,508 $ 1,037,356
=========== ===========
The accompanying notes are an integral part of the financial statements.
3
MANUFACTURED HOME COMMUNITIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE QUARTERS AND SIX MONTHS ENDED JUNE 30, 2002 AND 2001
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
QUARTERS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
------------------------ ------------------------
2002 2001 2002 2001
--------- --------- --------- ---------
PROPERTY OPERATIONS:
Base rental income ............................... $ 47,471 $ 46,012 $ 95,034 $ 92,354
RV base rental income ............................ 1,218 635 3,655 2,485
Utility and other income ......................... 5,065 5,335 10,179 10,920
--------- --------- --------- ---------
Property operating revenues ................ 53,754 51,982 108,868 105,759
Property operating and maintenance ............... 14,911 14,323 29,963 29,224
Real estate taxes ................................ 4,395 4,084 8,684 8,341
Property management .............................. 2,137 2,141 4,423 4,264
--------- --------- --------- ---------
Property operating expenses ................. 21,443 20,548 43,070 41,829
--------- --------- --------- ---------
Income from property operations ............. 32,311 31,434 65,798 63,930
HOME SALES OPERATIONS:
Gross revenues and inventory home sales .......... 7,930 -- 12,659 --
Cost of inventory home sales ..................... (5,920) -- (9,655) --
--------- --------- --------- ---------
Gross profit from inventory home sales ....... 2,010 -- 3,004 --
Brokered resale revenues, net .................... 455 -- 886 --
Home selling expenses ............................ (2,007) -- (4,127) --
Ancillary services revenues, net ................. 112 -- 674 --
--------- --------- --------- ---------
Income from home sales and other ............. 570 -- 437 --
OTHER INCOME AND EXPENSES:
Interest income .................................. 220 174 454 388
Equity in income of affiliates ................... -- 654 -- 677
Other corporate income ........................... 292 461 666 1,138
General and administrative ....................... (2,063) (1,857) (3,943) (3,513)
Interest and related amortization ................ (11,705) (11,818) (23,170) (24,157)
Depreciation on corporate assets ................. (310) (310) (636) (614)
Depreciation on real estate assets and other costs (8,534) (7,974) (16,954) (16,028)
--------- --------- --------- ---------
Total other income and expenses .............. (22,100) (20,670) (43,583) (42,109)
Income from operations ................... 10,781 10,764 22,652 21,821
Income (loss) from discontinued operations ..... 60 (252) (115) (664)
Gain on sale of Properties and other ............. -- -- -- 8,093
--------- --------- --------- ---------
Income before allocation to Minority Interests ... 10,841 10,512 22,537 29,250
(Income) allocated to Common OP Units ............ (1,590) (1,564) (3,357) (4,846)
(Income) allocated to Perpetual Preferred OP Units (2,813) (2,813) (5,626) (5,626)
--------- --------- --------- ---------
NET INCOME ................................. 6,438 6,135 13,554 18,778
========= ========= ========= =========
Net income per Common Share - basic ................... $ .30 $ .29 $ .63 $ .90
========= ========= ========= =========
Net income per Common Share - diluted ................. $ .29 $ .29 $ .61 $ .88
========= ========= ========= =========
Distributions declared per Common Share ............... $ .475 $ .445 $ .95 $ .89
========= ========= ========= =========
Weighted average Common Shares
outstanding - basic ......................... 21,563 20,969 21,498 20,881
========= ========= ========= =========
Weighted average Common Shares
outstanding - diluted (see Note 2) .......... 27,664 26,898 27,587 26,835
========= ========= ========= =========
The accompanying notes are an integral part of the financial statements.
4
MANUFACTURED HOME COMMUNITIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2002 AND 2001
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
JUNE 30, JUNE 30,
2002 2001
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income .................................................................. $ 13,554 $ 18,778
Adjustments to reconcile net income to cash provided by operating activities:
Income allocated to Minority Interests .................................. 8,983 10,472
Gain on sale of Properties and other .................................... -- (8,093)
Depreciation and amortization expense ................................... 18,903 18,426
Equity in income of affiliates and joint ventures ....................... (627) (1,401)
Amortization of deferred compensation and other ......................... 2,560 1,050
Increase in inventory ................................................... 723 --
Increase in rents receivable ............................................ (91) (39)
Increase in prepaid expenses and other assets ........................... (2,672) (575)
Increase in accounts payable and accrued expenses ....................... 457 1,092
Increase in rents received in advance and security deposits ............. 1,602 1,010
-------- --------
Net cash provided by operating activities ................................... 43,392 40,720
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Contributions to affiliates ................................................. -- (1,643)
(Funding) collection of notes receivable .................................... (867) 1,150
Investment in joint ventures net of distributions received .................. 322 134
Proceeds from disposition of rental Properties and other assets ............. -- 16,864
Purchase of Realty Systems, Inc. common stock ............................... (675) --
Cash received with purchase of Realty Systems, Inc. ......................... 844 --
Acquisition of rental Properties ........................................... (9,026) (16,879)
Improvements:
Improvements - corporate ................................................ (324) (514)
Improvements - rental properties ........................................ (6,004) (4,286)
Site development costs .................................................. (5,740) (4,230)
-------- --------
Net cash used in investing activities ....................................... (21,470) (9,404)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from stock options and employee stock purchase plan ............ 5,156 4,383
Distributions to Common Stockholders, Common OP Unitholders and
Perpetual Preferred OP Unitholders ...................................... (30,603) (28,564)
Collection of principal payments on employee notes .......................... 994 265
Line of credit:
Proceeds .............................................................. 26,500 23,000
Repayments .............................................................. (7,500) (27,800)
Refinancing and loan repayments ............................................. (4,733) --
Principal payments .......................................................... (2,197) (2,030)
Debt issuance costs ......................................................... (510) --
-------- --------
Net cash used in financing activities ....................................... (12,893) (30,746)
-------- --------
Net increase in cash and cash equivalents ........................................ 9,029 570
Cash and cash equivalents, beginning of period ................................... 1,354 2,847
-------- --------
Cash and cash equivalents, end of period ......................................... $ 10,383 $ 3,417
======== ========
SUPPLEMENTAL INFORMATION:
Cash paid during the period for interest ......................................... $ 24,477 $ 26,637
======== ========
The accompanying notes are an integral part of the financial statements.
5
MANUFACTURED HOME COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DEFINITION OF TERMS:
Capitalized terms used but not defined herein are as defined in the
Company's Annual Report on Form 10-K for the year ended December 31, 2001.
PRESENTATION:
These unaudited Consolidated Financial Statements of Manufactured Home
Communities, Inc., a Maryland corporation, and its subsidiaries (collectively,
the "Company"), have been prepared pursuant to the Securities and Exchange
Commission ("SEC") rules and regulations and should be read in conjunction with
the financial statements and notes thereto included in the Company's 2001 Annual
Report on Form 10-K (the "2001 Form 10-K"). The following Notes to Consolidated
Financial Statements highlight significant changes to the Notes included in the
2001 Form 10-K and present interim disclosures as required by the SEC. The
accompanying Consolidated Financial Statements reflect, in the opinion of
management, all adjustments necessary for a fair presentation of the interim
financial statements. All such adjustments are of a normal and recurring nature.
Certain reclassifications have been made to the prior periods' financial
statements in order to conform with current period presentation.
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States ("GAAP") requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
(a) Segments
Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information" ("SFAS No. 131") requires
certain disclosures of selected information about operating segments in the
annual financial statements and related disclosures about products and services,
geographic areas, and major customers. The adoption of SFAS No. 131, in June
1998, did not affect the results of operations or financial position of the
Company. The Company manages operations on a property by property basis. Since
each property has similar economic and operational characteristics, the Company
has one reportable segment, which is the operation of manufactured home
communities.
(b) Inventory
Inventory consists of completed new and used homes, is stated at the lower
of cost or market and is net of a valuation allowance calculated after
consideration of the N.A.D.A. (National Automobile Dealers Association)
Manufactured Housing Appraisal Guide and the current market value of the
manufactured home inventory. Inventory sales revenues and resale revenues are
recognized when the home sale is closed. Resale revenues are stated net of
commissions paid to employees of $233,000 and $372,000 for the quarter and six
months ended June 30, 2002, respectively.
(c) Notes Receivable
Notes receivable are stated net of an allowance for doubtful accounts.
6
MANUFACTURED HOME COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(d) Real Estate
Real estate is recorded at cost less accumulated depreciation. Depreciation
is computed on the straight-line basis over the estimated useful lives of the
assets. The Company uses a 30-year estimated life for buildings acquired and
structural and land improvements, a ten-to-fifteen-year estimated life for
building upgrades and a three-to-seven-year estimated life for furniture,
fixtures and equipment. Expenditures for ordinary maintenance and repairs are
expensed to operations as incurred and significant renovations and improvements
that improve the asset and extend the useful life of the asset are capitalized
over their estimated useful life. The determination of useful lives, salvage
value, and depreciation method used are in conformity with GAAP. However, the
useful lives, salvage value, and customary depreciation method used for land
improvements and other significant assets may significantly and materially
overstate the depreciation of the underlying assets and therefore understate the
Net Income of the Company. In addition, the Financial Accounting Standards Board
("FASB") is currently reviewing the methods of depreciation and cost
capitalization for all industries and in June 2001 issued FASB Exposure Draft,
Accounting in Interim and Annual Financial Statements for Certain Costs and
Activities Related to Property, Plant and Equipment the implementation of which,
if issued, could also have a material effect on the Company's results of
operations.
NOTE 2 - EARNINGS PER COMMON SHARE
Earnings per common share are based on the weighted average number of common
shares outstanding during each period. Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" ("SFAS No. 128") defines the calculation
of basic and fully diluted earnings per share. Basic and fully diluted earnings
per share are based on the weighted average shares outstanding during each
period and basic earnings per share excludes any dilutive effects of options,
warrants and convertible securities. The conversion of OP Units has been
excluded from the basic earnings per share calculation. The conversion of an OP
Unit to a share of common stock has no material effect on earnings per common
share.
The following table sets forth the computation of basic and diluted
earnings per share for the quarters and six months ended June 30, 2002 and 2001
(amounts in thousands):
QUARTERS ENDED SIX MONTHS ENDED
------------------- -------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
2002 2001 2002 2001
------- ------- ------- -------
NUMERATOR:
Numerator for basic earnings per share -
Net income .................................. $ 6,438 $ 6,135 $13,554 $18,778
Effect of dilutive securities:
Income allocated to Common OP Units ......... 1,590 1,564 3,357 4,846
------- ------- ------- -------
Numerator for diluted earnings per share-
income available to common shareholders
after assumed conversions ................ $ 8,028 $ 7,699 $16,911 $23,624
======= ======= ======= =======
DENOMINATOR:
Denominator for basic earnings per share -
Weighted average Common Stock outstanding.... 21,563 20,969 21,498 20,881
Effect of dilutive securities:
Weighted average Common OP Units .......... 5,417 5,481 5,421 5,494
Employee stock options ...................... 684 448 668 460
------- ------- ------- -------
Denominator for diluted earnings per share-
adjusted weighted average shares and
assumed conversions ...................... 27,664 26,898 27,587 26,835
======= ======= ======= =======
NOTE 3 - COMMON STOCK AND RELATED TRANSACTIONS
On April 12, 2002 and July 12, 2002, the Company paid a $.475 per share
distribution for the quarters ended March 31, 2002 and June 30, 2002,
respectively, to stockholders of record on March 29, 2002 and June 28, 2002,
respectively.
7
MANUFACTURED HOME COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - ACQUISITION OF REALTY SYSTEMS, INC.
On January 1, 2002, the Company purchased all of the common stock of Realty
Systems, Inc. ("RSI"). The Company previously owned the non-voting preferred
stock of RSI and had notes receivable from RSI which were recorded as an
investment in affiliate. The Company purchased the common stock of RSI from
Equity Group Investments, LLC., controlled by Samuel Zell, chairman of the Board
of Directors for the Company, for approximately $675,000. As a result of this
acquisition, the Company owns and controls RSI and consolidates the financial
results of RSI with those of the Company. Certain costs included in the
acquisition are based on management's estimates and are subject to adjustment
within one year of the closing date of January 1, 2002.
The following table summarizes the estimated fair values of the assets
acquired and liabilities assumed at the date of acquisition:
(amounts in thousands)
ASSETS
Buildings and other depreciable property............ $ 6,656
Cash and cash equivalents........................... 844
Notes receivable.................................... 4,772
Investment in joint ventures........................ 200
Inventory........................................... 35,524
Prepaid expenses and other assets................... 2,719
----------
Total assets acquired............................ 50,715
LIABILITIES
Other notes payable................................. (12,862)
Accounts payable and accrued expenses............... (2,718)
Accrued interest payable............................ (73)
----------
Total liabilities assumed........................ (15,653)
Conversion of previous investment................... (34,387)
Cash paid for common equity interest................ (675)
==========
8
MANUFACTURED HOME COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - DISCONTINUED OPERATIONS
Statement of Financial Accounting Standards No. 144, "Accounting for the
Impairment of Disposal of Long-Lived Assets" (SFAS No. 144") became effective
for fiscal years beginning after December 15, 2001. Adoption of SFAS No. 144, in
January 2002, did not have a material effect on the results of operations or the
financial position of the Company. The adoption of SFAS No. 144 requires the
operations of all assets classified as held-for-sale to be disclosed as
discontinued operations in the period in which certain criteria are met and
prior periods to be reclassified to conform with the current period
presentation. Currently the Company has 17 Properties classified as
held-for-sale, which are part of the Company's College Heights joint venture.
The Company expects to close on a restructuring of the College Heights joint
venture during the third quarter of 2002. This restructuring will eliminate the
Company's voting interest in the joint venture and substantially reduce the
Company's total investment in the joint venture. Accordingly, the Company will
account for the restructuring as a sale.
The net assets from discontinued operations presented on the face of the
balance sheet includes $57.6 million of mortgage notes (the "College Heights
Mortgages") collateralized by the 17 Properties owned in the joint venture. The
College Heights Mortgages bear interest at a rate of 7.19% per annum, amortize
beginning July 1, 1999 over 30 years and mature July 1, 2008.
The following table shows the results of operations for the discontinued
operations:
QUARTERS ENDED SIX MONTHS ENDED
-------------------------- --------------------------
JUNE 30, JUNE 30, JUNE 30, JUNE 30,
(amounts in thousands, except for per share data) 2002 2001 2002 2001
---------- ---------- ---------- ----------
Total revenues........................................ $ 2,905 $ 2,947 $ 5,940 $ 5,789
Total operating expenses.............................. (1,274) (1,498) (2,848) (3,060)
Interest expense and related amortization............. (1,019) (1,088) (2,104) (2,155)
Depreciation expense.................................. (552) (613) (1,103) (1,238)
---------- ---------- ---------- ----------
Income from discontinued operations...............
$ 60 $ (252) $ (115) $ (664)
========== ========== ========== ==========
Net income (loss) per share- basic.................... $ 0.00 $ (0.01) $ 0.01 $ (0.03)
========== ========== ========== ==========
Net income (loss) per share- fully diluted............ $ 0.00 $ (0.01) $ 0.00 $ (0.02)
========== ========== ========== ==========
NOTE 6 - REAL ESTATE
On March 12, 2002, the Company acquired Mt. Hood Village, a recreational
vehicle ("RV") community with a total of 450 sites, for approximately $6.8
million. Mt. Hood Village is located in Welches, Oregon and has land available
for up to 120 expansion sites. The acquisition was funded by a borrowing on the
Company's line of credit.
Third party costs relative to efforts by the Company to effectively change
the use and operations of certain Properties subject to California rent control
laws are currently recorded in land improvements (see Note 10). To the extent
these efforts are successful, such expenditures will be included in the net
investment in real estate for the appropriate Properties. To the extent these
efforts are not successful, such amounts will be expensed at the time such
determination is made.
The Company is actively seeking to acquire additional manufactured home and
RV communities and currently is engaged in negotiations relating to the possible
acquisition of a number of Properties. At any time these negotiations are at
varying stages which may include contracts outstanding to acquire certain
manufactured home and RV communities which are subject to satisfactory
completion of the Company's due diligence review.
9
MANUFACTURED HOME COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - NOTES RECEIVABLE
As of June 30, 2002 and December 31, 2001, the Company had approximately
$7.1 million and $1.5 million in notes receivable, respectively. The Company has
approximately $1.5 million in notes which bear interest at a per annum rate of
prime plus 0.5% and mature on December 31, 2011. The notes are collateralized
with a combination of Common OP Units and partnership interests in certain joint
ventures. The Company has approximately $5.6 million in notes which yield a per
annum rate of approximately 11.3% and are collateralized by manufactured homes
at the Properties.
NOTE 8 - LONG-TERM BORROWINGS
As of June 30, 2002 and December 31, 2001, the Company had outstanding
mortgage indebtedness of approximately $529.4 million and $532.4 million,
respectively, encumbering 60 of the Company's Properties. As of June 30, 2002
and December 31, 2001, the carrying value of such Properties was approximately
$618.3 million and $612.0 million, respectively.
The outstanding mortgage indebtedness consists of:
- - A $265.0 million mortgage note (the "$265 Million Mortgage") collateralized
by 29 Properties beneficially owned by MHC Financing Limited Partnership.
The $265 Million Mortgage has a maturity date of January 2, 2028 and pays
interest at a rate of 7.015% per annum. There is no principal amortization
until February 1, 2008, after which principal and interest are to be paid
from available cash flow and the interest rate will be reset at a rate
equal to the then 10-year U.S. Treasury obligations plus 2.0%. The $265
Million Mortgage is recorded net of a hedge of $3.0 million (net of
accumulated amortization of $192,000) which is being amortized into
interest expense over the life of the loan.
- - A $92.7 million mortgage note (the "DeAnza Mortgage") collateralized by 6
Properties beneficially owned by MHC-DeAnza Financing Limited Partnership.
The DeAnza Mortgage bears interest at a rate of 7.82% per annum, amortizes
beginning August 1, 2000 over 30 years and matures July 1, 2010.
- - A $22.3 million mortgage note (the "Bay Indies Mortgage") collateralized by
one Property beneficially owned by MHC-Bay Indies Financing Limited
Partnership. The Bay Indies Mortgage bears interest at a rate of 7.48% per
annum, amortizes beginning August 1, 1994 over 27.5 years and matures July
1, 2004.
- - A $15.5 million mortgage note (the "Date Palm Mortgage") collateralized by
one Property beneficially owned by MHC Date Palm, L.L.C. The Date Palm
Mortgage bears interest at a rate of 7.96% per annum, amortizes beginning
August 1, 2000 over 30 years and matures July 1, 2010.
- - A $49.6 million mortgage note (the "Stagecoach Mortgage") collateralized by
7 Properties beneficially owned by MHC Stagecoach, L.L.C. The Stagecoach
Mortgage bears interest at a rate of 6.98% per annum, amortizes beginning
September 1, 2001 over 10 years and matures September 1, 2011.
- - Approximately $87.1 million of mortgage debt on 19 other various
Properties, which was recorded at fair market value with the related
discount or premium being amortized over the life of the loan using the
effective interest rate. Scheduled maturities for the outstanding
indebtedness are at various dates through November 30, 2020, and fixed
interest rates range from 7.15% to 8.92% per annum. In addition, the
Company has a $2.4 million loan recorded to account for a direct financing
lease entered into in May 1997.
The Company has a $150 million unsecured line of credit with a group of
banks (the "Credit Agreement") bearing interest at the London Interbank Offered
Rate ("LIBOR") plus 1.125%, maturing on August 9, 2003. The Company pays a
quarterly fee on the average unused amount of such credit equal to 0.15% of such
amount. As of June 30, 2002 and December 31, 2001, the Company had $35.3 million
and $16.3 million, respectively, outstanding under the Credit Agreement.
The Company has a $100 million unsecured term loan (the "Term Loan") with a
group of banks with interest only payable monthly at a rate of LIBOR plus
1.375%. The Term Loan matures on August 9, 2003.
10
MANUFACTURED HOME COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 - LONG-TERM BORROWINGS (CONTINUED)
On October 29, 2001, the Company entered into an interest rate swap
agreement (the "Swap"), fixing LIBOR on $100 million of the Company's floating
rate debt at approximately 3.7% for the period October 2001 through August 2004.
The terms of the Swap require monthly settlements on the same dates that
interest payments are due on the debt. Effective January 1, 2001, the Company
adopted Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS No. 133") and its
amendments, SFAS No. 137 and SFAS No. 138. In accordance with SFAS No. 133, the
Swap is reflected at market value. The Company believes the Swap is a perfectly
effective cash flow hedge per SFAS No. 133 and there will be no effect on net
income as a result of the mark-to-market adjustment. As of June 30, 2002 the
hedge represented a liability of approximately $1.7 million and is recorded in
accounts payable and accrued expenses. Mark-to-market changes in the value of
the swap are included in other comprehensive income.
The Company has a $9.0 million note payable ("Conseco Financing Note"),
collateralized by manufactured home inventory. The Conseco Financing Note bears
interest at the prime rate and matures at various dates through March 2004 or
when the inventory homes are sold. As of April 1, 2002, the Company stopped
funding inventory purchases with the Conseco Financing Note and all future
purchases of inventory will be funded with the Company's existing line of
credit.
The Company has approximately $2.2 million of installment notes payable,
secured by a letter of credit, each with an interest rate of 6.5% per annum,
maturing September 1, 2002. Approximately $900,000 of the notes pay principal
annually and interest quarterly and the remaining $1.3 million of the notes pay
interest only quarterly.
NOTE 9 - STOCK OPTIONS
Pursuant to the Stock Option Plan as discussed in Note 14 to the 2001 Form
10-K, certain officers, directors, employees and consultants have been offered
the opportunity to acquire shares of common stock of the Company through stock
options ("Options"). During the six months ended June 30, 2002, Options for
262,586 shares of common stock were exercised.
11
MANUFACTURED HOME COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 - COMMITMENTS AND CONTINGENCIES
DEANZA SANTA CRUZ MOBILE ESTATES
The residents of DeAnza Santa Cruz Mobile Estates, a Property located in
Santa Cruz, California (the "City") previously brought several actions opposing
certain fees and charges in connection with water service at the Property. This
summary provides the history and reasoning underlying the Company's defense of
the residents' claims and explains the Company's decision to continue to defend
its position, which the Company believes is fair and accurate.
DeAnza Santa Cruz Mobile Estates is a 198-site community overlooking the
Pacific Ocean. It is subject to the City's rent control ordinance which limits
annual rent increases to 75% of CPI. The Company purchased this Property in
August 1994 from certain unaffiliated DeAnza entities ("DeAnza"). Prior to the
Company's purchase in 1994, DeAnza made the decision to submeter and separately
bill tenants at the Property for both water and sewer in 1993 in the face of the
City's rapidly rising utility costs.
Under California Civil Code Section 798.41, DeAnza was required to reduce
rent by an amount equal to the average cost of usage over the preceding 12
months. This was done. With respect to water charges, because DeAnza did not
want to be regulated by the California Public Utility Commission ("CPUC"),
DeAnza relied on California Public Utilities Code Section 2705.5 ("CPUC Section
2705.5") to determine what rates would be charged for water on an ongoing basis
without becoming a public utility. DeAnza and the Company interpreted the
statute as providing that in a submetered mobile home park, the property owner
is not subject to regulation and control of the CPUC so long as the users are
charged what they would be charged by the utility company if users received
their water directly from the utility company. In Santa Cruz, customers
receiving their water directly from the City's water utility were charged a
certain lifeline rate for the first 400 ccfs of water and a greater rate for
usage over 400 ccfs of water, a readiness to serve charge of $7.80 per month and
tax on the total. In reliance on CPUC Section 2705.5, DeAnza implemented its
billings on this schedule notwithstanding that it did not receive the discount
for the first 400 ccfs of water because it was a commercial and not a
residential customer.
A dispute with the residents ensued over the readiness to serve charge and
tax thereon. The residents argued that California Civil Code Section 798.41
required that the Property owner could only pass through its actual costs of
water (and that the excess charges over the amount of the rent rollback were an
improper rent increase) and that CPUC Section 2705.5 was not applicable. DeAnza
unbundled the utility charges from rent consistent with California Civil Code
Section 798.41 and it has generally been undisputed that the rent rollback was
accurately calculated.
In August 1994, when the Company acquired the Property, the Company
reviewed the respective legal positions of the Santa Cruz Homeowners Association
("HOA") and DeAnza and concurred with DeAnza. DeAnza's reliance on CPUC Section
2705.5 made both legal and practical sense in that residents paid only what they
would pay if they lived in a residential neighborhood within the City and
permitted DeAnza to recoup part of the expenses of operating a submetered system
through the readiness to serve charge.
Over a period of 18 months from 1993 into May of 1995, a series of
complaints were filed by the HOA and Herbert Rossman, a resident, against
DeAnza, and later, the Company. DeAnza and the Company demurred to each of these
complaints on the grounds that the CPUC had exclusive jurisdiction over the
setting of water rates and that residents under rent control had to first
exhaust their administrative remedies before proceeding in a civil action. At
one point, the case was dismissed (with leave to amend) on the basis that
jurisdiction was with the CPUC and, at another point, Mr. Rossman was dismissed
from the case because he had not exhausted his administrative remedies.
12
MANUFACTURED HOME COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
On June 29, 1995, a hearing was held before a City rent control officer on
billing and submetering issues related to both water and sewer. The Company and
DeAnza prevailed on all issues related to sewer and the rent rollback related to
water, but the hearing officer determined that the Company could only pass
through its actual cost of water, i.e., a prorated readiness to serve charge and
tax thereon. The hearing officer did not deal with the subsidy being given to
residents through the quantity charge and ordered a rebate in a fixed amount per
resident. The Company and DeAnza requested reconsideration on this issue, among
others, which reconsideration was denied by the hearing officer.
The Company then took a writ of mandate (an appeal from an administrative
order) to the Superior Court and, pending this appeal, the residents, the
Company and the City agreed to stay the effect of the hearing officer's decision
until the Court rendered judgment.
In July 1996, the Superior Court affirmed the hearing officer's decision
without addressing concerns about the failure to take the subsidy on the
quantity charge into account.
The Company requested that the City and the HOA agree to a further stay
pending appeal to the court of appeal, but they refused and the appeal court
denied the Company's request for a stay in late November 1996. Therefore, on
January 1, 1997, the Company reduced its water charges at this Property to
reflect a pass-through of only the readiness to serve charge and tax at the
master meter (approximately $0.73) and to eliminate the subsidy on the water
charges. On their March 1, 1997 rent billings, residents were credited for
amounts previously "overcharged" for readiness to serve charge and tax. The
amount of the rebate given by the Company and DeAnza was $36,400. In calculating
the rebate, the Company and DeAnza took into account the previous subsidy on
water usage although this issue had not yet been decided by the court of appeal.
The Company and DeAnza felt legally safe in so doing based on language in the
hearing officer's decision that actual costs could be passed through.
On March 12, 1997, the Company also filed an application with the CPUC to
dedicate the water system at this Property to public use and have the CPUC set
cost-based rates for water usage. The Company believed it was obligated to take
this action because of its consistent reliance on CPUC Section 2705.5 as a safe
harbor from CPUC jurisdiction. That is, when the Company could no longer charge
for water as the local serving utility would charge, it was no longer exempt
from the CPUC's jurisdiction and control under CPUC Section 2705.5.
On March 20, 1998, the court of appeal issued the writ of mandate requested
by the Company on the grounds that the hearing officer had improperly calculated
the amount of the rebate (meaning the Company had correctly calculated the rent
credits), but also ruling that the hearing officer was correct when he found
that the readiness to serve charge and tax thereon as charged by DeAnza and the
Company were an inappropriate rent increase. The decision primarily reflected
the court of appeal's view that CPUC Section 2705.5 operated as a ceiling and
that California Civil Code Section 798.41 allowed for a charge based on actual
costs, including costs of administration, operation and maintenance of the
system, but that the Company did not have to provide evidence of such costs. The
court of appeal further agreed with the Company that the City's hearing officer
did not have the authority under California Civil Code Section 798.41 to
establish rates that could be charged in the future.
Following this decision, the CPUC granted the Company its certificate of
convenience and necessity on December 17, 1998 and approved cost-based rates and
charges for water that exceed what residents were paying under the Company's
reliance on CPUC Section 2705.5. Concurrently, the CPUC also issued an Order
Instituting Investigation ("OII") confirming its exclusive jurisdiction over the
issue of water rates in a submetered system and commencing an investigation into
the confusion and turmoil over billings in submetered properties. Specifically,
the OII states: "The Commission has exclusive and primary jurisdiction over the
establishment of rates for water and sewer services provided by private
entities."
13
MANUFACTURED HOME COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
Specifically, the CPUC ruling regarding the Company's application stated:
"The ultimate question of what fees and charges may or may not be assessed,
beyond external supplier pass-through charges, for in-park facilities when a
mobile home park does not adhere to the provisions of CPUC Section 2705.5, must
be decided by the Commission."
After the court of appeal decision, the HOA sought punitive damages against
the Company in a lawsuit that was tried in January 1999 in Santa Cruz County
Superior Court. The trial was continued from July 1998 to January 1999 to give
the CPUC time to act on the Company's application. Notwithstanding the action
taken by the CPUC in issuing the OII in December 1998, the trial court denied
the Company's motion to dismiss on jurisdictional grounds and trial commenced
before a jury on January 11, 1999.
Not only did the trial court not consider the Company's motion to dismiss,
the trial court refused to allow evidence of the OII or the Company's CPUC
approval to go before the jury. Notwithstanding the Company's strenuous
objections, the judge also allowed evidence of the Company's and DeAnza's
litigation tactics to be used as evidence of bad faith and oppressive actions
(including evidence of the application to the CPUC requesting a $22.00 readiness
to serve charge). The Company's motion for a mistrial based upon these
evidentiary rulings was denied. On January 22, 1999, the jury returned a verdict
awarding $6.0 million of punitive damages against the Company and DeAnza. The
Company had previously agreed to indemnify DeAnza on the matter.
On April 19, 1999, the trial court denied all of the Company's and DeAnza's
post-trial motions for judgment notwithstanding the verdict, new trial and
remittitur. The trial court also awarded $700,000 of attorneys' fees to
plaintiffs. The Company appealed the jury verdict and attorneys' fees award
(which also accrues interest at the statutory rate of 10.0% per annum). The
Company bonded the judgment pending appeal in accordance with California
procedural rules, which require a bond equal to 150% of the amount of the
judgment. Post-judgment interest will accrue at the statutory rate of 10.0% per
annum.
On December 21, 2001 the California Court of Appeal for the Sixth District
reversed the $6.0 million punitive damage award, the related award of attorneys'
fees, and, as a result, all post-judgement interest thereon, on the basis that
punitive damages are not available as a remedy for a statutory violation of the
MRL. The decision of the appellate court left the HOA with the right to seek a
new trial in which it must prove its entitlement to either the statutory penalty
and attorneys' fees available under the California Mobilehome Residency Law
("MRL") or punitive damages based on causes of action for fraud,
misrepresentation or other tort. On remand, the HOA has filed two motions in
Santa Cruz Superior Court seeking statutory penalties and attorneys' fees.
Motions in this case are pending. The Company intends to vigorously defend
itself against these claims and has filed motions for summary adjudication of
the statutory penalty issue in favor of the Company and a motion to be declared
the prevailing party in this litigation.
In two related appeals, the Company had argued that the trial court's
ability to enter an award of attorneys' fees in favor of the HOA and to take
certain other actions was preempted by the exercise of exclusive jurisdiction by
the CPUC over the issue of how to set rates for water in a submetered mobile
home park. During 2000, the California court of appeal rejected the Company's
preemption argument with respect to these prior rulings in favor of plaintiffs,
one of which had awarded plaintiffs approximately $100,000 of attorneys' fees.
The California Supreme Court declined to accept the case for review and the
Company paid the judgment, including post-judgment interest thereon, and settled
the matter for approximately $200,000 late in 2000.
14
MANUFACTURED HOME COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
In a separate matter, in December 2000 the HOA and certain individual
residents of the Property filed a complaint in the Superior Court of California,
County of Santa Cruz (No. CV 139825) against the Company, certain affiliates of
the Company and certain employees of the Company (the "2000 Lawsuit"). The 2000
Lawsuit sought damages, including punitive damages, for intentional infliction
of emotional distress, unfair business practices, and unlawful retaliation
purportedly arising from allegedly retaliatory rent increases which were noticed
by the Company to certain residents in September 2000. The Company believes that
the residents who received rent increase notices with respect to rent increases
above those permitted by the local rent control ordinance were not covered by
the ordinance either because they did not comply with the provisions of the
ordinance or because they are exempted by state law. On December 29, 2000, the
Superior Court of California, County of Santa Cruz enjoined such rent increases.
The Company entered into a settlement agreement with the plaintiffs in the
2000 Lawsuit which settlement was approved by the court on July 22, 2002. The
Company believes the settlement agreement is of significant benefit to the
Company. First, pursuant to the settlement agreement all past, present and
future tenants of the Property agree to alternative dispute resolution
procedures which provide that during the next 25 years future disputes will be
resolved through arbitration before a retired judge rather than in court, and
that in such future arbitration proceedings all claims to trial by jury and for
punitive damages are waived.
Second, the settlement agreement provides a process for determining the
rent for 15 sites not subject to rent control, including in certain
circumstances, back rent owing from certain dates in 2001. The settlement
agreement generally gives tenants at these sites three (3) options with respect
to their tenancies. Such tenants may (1) enter into a 34-year lease providing a
rent based on rent control with future escalations based on the consumer price
index, but with the Company retaining the right to charge market rents
determined by the Company upon turnover; (2) enter into a ten (10) year lease
with a monthly rent to be determined by binding arbitration and effective
October 1, 2001; or (3) elect to sell such tenant's home to a third party and
pay back rent owing to the Company (the amount of which will be determined by
arbitration if not agreed to between the tenant and the Company) since January
1, 2001. In certain circumstances the Company will purchase the tenant's home
based upon a mechanism provided in the settlement agreement.
In exchange for the tenants' agreements to the alternative dispute
resolution procedures, the process for resolving back rent owed by tenants not
subject to rent control, and to dismiss the 2000 Lawsuit, the Company agreed to
pay $730,000.
15
MANUFACTURED HOME COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
OTHER CALIFORNIA RENT CONTROL LITIGATION
As part of the Company's effort to realize the value of its Properties
subject to rent control, the Company has initiated lawsuits against several
municipalities in California. The Company's goal is to achieve a level of
regulatory fairness in California's rent control jurisdictions that prohibit
increasing rents to market upon turnover. This regulatory feature, called
vacancy control, allows tenants to sell their homes for a premium representing
the future value of discounted rent-controlled rents. In MHC's view, such
regulation results in a transfer of the value of the Company's shareholders'
land, which would otherwise be reflected in market rents, to tenants upon the
sales of their homes in the form of an inflated purchase price that cannot be
attributed to the value of the home being sold. As a result, in the Company's
view, the Company loses the value of its asset and the selling tenant leaves the
community with a windfall premium. The Company has discovered through the
litigation process that certain municipalities considered condemning the
Company's communities at values well below the value of the underlying land. In
the Company's view, a failure to articulate market rents for sites governed by
restrictive rent control would put the Company at risk for condemnation or
eminent domain proceedings based on artificially reduced rents. Such a physical
taking, should it occur, would represent substantial lost value to shareholders.
The Company is cognizant of the need for affordable housing in the
jurisdictions, but asserts that regulations with vacancy control merely transfer
the value that belongs to the Company's shareholders to tenants in the form of
the premium prices for houses. The Company estimates that the annual rent
subsidy to tenants in these jurisdictions is significant. In a more well
balanced regulatory environment, the Company would receive market rent that
would eliminate the subsidy and homes would trade at or near their intrinsic
value. The Company's efforts to achieve a balanced regulatory environment
incentivizes tenant groups to file lawsuits against the Company seeking large
damage awards. The 2000 Lawsuit described above under Santa Cruz is one example.
The homeowners association at Contempo Marin, a 396 site property in San Rafael,
California sued the Company in December 2000 over a prior settlement agreement
on a capital pass-through after the Company sued the City of San Rafael in
October 2000 alleging its rent control ordinance is unconstitutional. The
Company believes that such lawsuits will be a consequence of the Company's
efforts to change rent control since tenant groups actively desire to preserve
the premium value of their homes in addition to the discounted rents provided by
rent control. The Company has determined that its efforts to rebalance the
regulatory environment despite the risk of litigation from tenant groups is
necessary not only because of the significant annual subsidy to tenants, but
also because of the condemnation risk.
ELLENBURG COMMUNITIES
The Company and certain other parties entered into a settlement agreement
(the "Settlement"), which was approved by the Los Angeles County Superior Court
in April 2000. The Settlement resolved substantially all of the litigation and
appeals involving the Ellenburg Properties, and transactions arising out of the
settlement closed on May 22, 2000. Only the appeal of one entity remains, the
outcome of which is not expected to materially affect the Company.
In connection with the Ellenburg Acquisition, on September 8, 1999,
Ellenburg Fund 20 ("Fund 20") filed a cross complaint in the Ellenburg
dissolution proceeding against the Company and certain of its affiliates
alleging causes of action for fraud and other claims in connection with the
Ellenburg acquisition. The Company subsequently successfully had the cross
complaint against the Company and its affiliates dismissed with prejudice by the
California Superior Court. However, Fund 20 has appealed. This appeal was one
not resolved by the Settlement. The Company believes Fund 20's allegations are
without merit and will vigorously defend itself.
In October 2001, Fund 20 sued the Company and certain of its affiliates
again, this time in Alameda County, California making substantially the same
allegations. The Company obtained an injunction preventing the case from
proceeding until the Fund 20 appeal is decided and other related proceedings in
Arizona (from which the Company has already been dismissed with prejudice) are
concluded.
16
MANUFACTURED HOME COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 - COMMITMENTS AND CONTINGENCIES (CONTINUED)
WESTWINDS
The Operating Partnership is the ground lessee ("Lessee") of certain
property in San Jose, California under ground leases ("Leases") from the
Nicholson Family Trust ("Lessor"). On February 13, 2001, Lessor filed a petition
for arbitration of disputes over whether certain items constitute "gross
revenue" under the Leases, in which petition Lessor seeks damages and
termination of the Leases. Lessee responded on March 12, 2001 disputing Lessor's
contentions. Lessor claims that "gross revenue" for the purpose of calculating
percentage rent owing to Lessor under the Leases includes certain amounts Lessee
has recouped from tenants of the Property (who are protected by rent control)
related to ground rent already paid to Lessor. Lessee has successfully been able
to pass-through to tenants at the Property increases in ground rent under the
Leases. Lessee contends that this pass-through results in reimbursement of lease
expense, not "gross revenue." Lessor also contends that the "net income" of RSI
from the Property should be included in the gross revenue calculation. Lessee
disputes this for many reasons, including, but not limited to, the fact that RSI
is not a lessee under the Leases, the sales activity is not conducted by Lessee,
and RSI is a separate company from Lessee.
Lessor's motion for summary judgment on the pass-through issue was denied
by an arbitration panel on November 2, 2001. Lessor and Lessee agreed to mediate
the dispute and the matter was settled and the lease was amended in early 2002.
Pursuant to the settlement and amendment, Lessee agreed to pay $338,000 related
to prior period rent which was expensed in the first quarter of 2002 and to
prepay rent of $632,000 based on a recalculation of rent in the amended lease.
The rent prepayment and related legal costs will be amortized into ground rent
expense over the remaining life of the lease.
COUNTRYSIDE AT VERO BEACH
The Company has received a letter dated June 17, 2002 from the Indian River
County, Florida Department of Utility Services ("County"), claiming that the
Company currently owes sewer impact fees in the amount of approximately $518,000
with respect to the Property known as Countryside at Vero Beach, located in Vero
Beach, Florida, purportedly under the terms of an agreement between the County
and a prior owner of the Property. In response, the Company has advised the
County that these fees are no longer due and owing as a result of a 1996
settlement agreement between the County and the prior owner of the Property,
providing for the payment of $150,000 to the County to discharge any further
obligation for the payment of impact or connection fees for sewer service at the
Property. The Company paid this settlement amount (with interest) to the County
in connection with the Company's acquisition of the Property. Accordingly, the
Company believes that the County's claims are without merit.
OTHER
The Company is involved in various other legal proceedings arising in the
ordinary course of business. Management believes that all proceedings herein
described or referred to, taken together, are not expected to have a material
adverse impact on the Company.
NOTE 11 - SUBSEQUENT EVENTS
On July 31, 2002, the Company acquired five Properties with a total of
2,424 sites, for approximately $59.7 million. Golden Sun RV Resort is located in
Apache Junction, Arizona and has 330 sites. Countryside RV Resort is located in
Apache Junction, Arizona and has 560 sites. Holiday Village Mobile Home Park is
located in Ormond Beach, Florida and has 301 sites. Breezy Hill RV Resort is
located in Pompano Beach, Florida and has 762 sites. Harbor View Manor is
located in North New Port Richey, Florida and has 471 sites. The acquisition was
funded by a borrowing on the Company's line of credit and the assumption of debt
on four of the properties.
On August 6, 2002, the Company's Board of Directors authorized the repurchase of
up to one million shares of the Company's common stock during 2002. The shares
may be purchased through open market or privately negotiated transactions.
17
MANUFACTURED HOME COMMUNITIES, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The following is a discussion of the interim results of operations,
financial condition and liquidity and capital resources of the Company for the
quarter and six months ended June 30, 2002 compared to the corresponding periods
in 2001. It should be read in conjunction with the Consolidated Financial
Statements and Notes thereto included herein and the 2001 Form 10-K. The
following discussion may contain certain forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995, which reflect
management's current views with respect to future events and financial
performance. Such forward-looking statements are subject to certain risks and
uncertainties, including, but not limited to, the effects of future events on
the Company's financial performance, the adverse impact of external factors such
as inflation and consumer confidence, and the risks associated with real estate
ownership.
RESULTS OF OPERATIONS
PROPERTY ACQUISITIONS, JOINT VENTURES AND DISPOSITIONS
The following chart lists the Properties acquired or sold since January 1,
2001. The Company defines its core manufactured home community portfolio ("Core
Portfolio") as manufactured home Properties owned throughout both periods of
comparison. Excluded from the Core Portfolio are any Properties acquired or sold
during the period and also any recreational vehicle ("RV") Properties which,
together, are referred to as the "Non-Core" Properties.
PROPERTY TRANSACTION DATE SITES
-------- ---------------- -----
TOTAL SITES AS OF JANUARY 1, 2001.......................... 51,387
ACQUISITIONS:
Golden Lakes.......................................... January 3, 2001 422
Chain O'Lakes......................................... January 3, 2001 308
Bulow Resort RV....................................... July 1, 2001 352
Mt. Hood.............................................. March 12, 2002 450
EXPANSION SITE DEVELOPMENT:
Sites added in 2001................................... 143
Sites added in 2002................................... 42
DISPOSITIONS:
Dellwood Estates...................................... February 13, 2001 (136)
Briarwood............................................. February 13, 2001 (166)
Bonner Springs........................................ February 13, 2001 (211)
Carriage Park......................................... February 13, 2001 (143)
North Star............................................ February 13, 2001 (219)
Quivira Hills......................................... February 13, 2001 (142)
Rockwood.............................................. February 13, 2001 (264)
Candlelight........................................... October 5, 2001 (585)
----------
TOTAL SITES AS OF JUNE 30, 2002.................................................. 51,238
----------
Discontinued operations - College Heights Properties (17)................... (3,220)
----------
TOTAL SITES - CONTINUING OPERATIONS AS OF JUNE 30, 2002.......................... 48,018
==========
18
MANUFACTURED HOME COMMUNITIES, INC.
RESULTS OF OPERATIONS (CONTINUED)
COMPARISON OF THE QUARTER ENDED JUNE 30, 2002 TO THE QUARTER ENDED JUNE 30, 2001
Since December 31, 2000, the gross investment in real estate has increased
from $1,218 million to $1,266 million. The total number of sites owned or
controlled has decreased from 51,387 as of December 31, 2000 to 51,238 as of
June 30, 2002.
PROPERTY OPERATIONS:
The following table summarizes certain financial and statistical data for
the Property Operations for the Core Portfolio and the Total Portfolio for the
quarters ended June 30, 2002 and 2001.
CORE PORTFOLIO TOTAL PORTFOLIO
------------------------------------------ --------------------------------------------
(dollars in thousands) INCREASE/ % INCREASE/ %
2002 2001 (DECREASE) CHANGE 2002 2001 (DECREASE) CHANGE
------- ------- ---------- ------ ------- ------- ---------- ------
Base rental income ................ $46,967 $45,136 $ 1,831 4.1% $47,471 $46,012 $ 1,459 3.2%
Utility and other income .......... 4,967 5,212 (245) (4.7%) 6,283 5,970 313 5.2%
------- ------- ------- ------ ------- ------- ------- ------
Property operating revenues .. 51,934 50,348 1,586 3.2% 53,754 51,982 1,772 3.4%
Property operating and
maintenance .................. 13,464 13,338 126 0.9% 14,911 14,323 588 4.1%
Real estate taxes ................. 4,236 3,912 324 8.3% 4,395 4,084 311 7.6%
Property management ............... 2,065 2,074 (9) (0.4%) 2,137 2,141 (4) (0.2%)
------- ------- ------- ------ ------- ------- ------- ------
Property operating expenses .. 19,765 19,324 441 2.3% 21,443 20,548 895 4.4%
------- ------- ------- ------ ------- ------- ------- ------
Income from property operations ... $32,169 $31,024 $ 1,145 3.7% $32,311 $31,434 $ 877 2.8%
Site and Occupancy Information (1):
Average total sites ............... 41,817 41,761 56 0.1% 42,550 43,077 (527) (1.2%)
Average occupied sites ............ 38,988 39,400 (412) (1.0%) 39,612 40,642 (1,030) (2.5%)
Occupancy % ....................... 93.2% 94.3% (1.1%) (1.2%) 93.1% 94.3% (1.2%) (1.3%)
Monthly base rent per site ........ $401.51 $381.87 $ 19.64 5.1% $399.47 $377.38 $ 22.09 5.9%
Total sites
as of June 30, ............... 41,818 41,791 27 0.1% 42,550 43,108 (558) (1.3%)
Total occupied sites
as of June 30, ............... 38,917 39,396 (479) (1.2%) 39,540 40,638 (1,098) (2.7%)
(1) Site and occupancy information does not include the five Properties owned
through joint ventures, the six RV Properties or the 17 Properties held for
sale.
Property Operating Revenues
The 4.1% increase in base rental income for the Core Portfolio reflects a
5.1% increase in monthly base rent per site coupled with a 1.0% decrease in
average occupied sites. The decrease in utility and other income for the Core
Portfolio is due primarily to decreases in utility income, which resulted from
lower expenses for these items.
19
MANUFACTURED HOME COMMUNITIES, INC.
RESULTS OF OPERATIONS (CONTINUED)
Property Operating Expenses
The increase in property operating and maintenance expense for the Core
Portfolio is due primarily to increases in property payroll, insurance and other
expenses and administrative expenses, partially offset by decreased utility
expense. The increase in Core Portfolio real estate taxes is generally due to
higher property assessments on certain Properties. Property management expense
for the Core Portfolio, which reflects costs of managing the Properties and is
estimated based on a percentage of Property revenues, decreased by 0.4% due to
decreased payroll expense.
HOME SALES OPERATIONS:
The following table summarizes certain financial and statistical data for
the Home Sales Operations for the quarters ended June 30, 2002 and 2001.
HOME SALES OPERATIONS
----------------------------------------------------
INCREASE /
(dollars in thousands) 2002 2001 (DECREASE) % CHANGE
------- ------- --------- -------
(Proforma)
Gross revenues from new home sales $ 7,420 $ 7,762 (342) (4.4%)
Cost of new home sales ............ (5,684) (6,076) 392 6.5%
------- ------- ------- -------
Gross profit from new home sales .. 1,736 1,686 50 3.0%
Gross revenues from used home sales 510 977 (467) (47.8%)
Cost of used home sales ........... (236) (689) 453 65.7%
------- ------- ------- -------
Gross profit from used home sales . 274 288 (14) (4.9%)
Brokered resale revenues, net ..... 455 510 (55) (10.8%)
Home selling expenses ............. (2,007) (1,781) (226) (12.7%)
Ancillary services revenues, net .. 112 102 10 9.8%
------- ------- ------- -------
Income from home sales and other .. $ 570 $ 805 (235) (29.2%)
======= ======= ======= =======
HOME SALES VOLUMES:
New home sales .................. 104 119 (15) (12.6%)
Used home sales ................. 41 80 (39) (48.8%)
Brokered home resales ........... 311 326 (15) (4.6%)
The 3.0% increase in gross profits from new home sales reflects an increase
in the gross margin of new home sales and is partially offset by a decrease in
the volume of new home sales. The 4.9% decrease in gross profits from used home
sales reflects a decrease in volume of used home sales. The 10.8% decrease in
brokered resale revenues reflects a decrease in the volume of home resales. The
12.7% increase in home selling expenses reflects an increase in advertising and
administrative expense. The 9.8% increase in ancillary services revenues
reflects an increase in golf course revenues.
The proforma income from home sales and other for 2001 does not include
$128,000 of interest income and $279,000 of interest expense. Interest income
and interest expense were previously included in income from affiliates for 2001
and are now included in other income and expenses. The proforma amounts have no
effect on previously reported net income. The 2001 amounts have been
reclassified to conform to the 2002 financial presentation for comparison
purposes.
20
MANUFACTURED HOME COMMUNITIES, INC.
RESULTS OF OPERATIONS (CONTINUED)
COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2002 TO THE SIX MONTHS ENDED
JUNE 30, 2001
The following table summarizes certain financial and statistical data for the
Property Operations for the Core Portfolio and the Total Portfolio for the six
months ended June 30, 2002 and 2001.
CORE PORTFOLIO TOTAL PORTFOLIO
------------------------------------------- --------------------------------------------
(dollars in thousands) INCREASE/ % INCREASE/ %
2002 2001 (DECREASE) CHANGE 2002 2001 (DECREASE) CHANGE
-------- -------- -------- ------ -------- -------- -------- -------
Base rental income ................ $ 94,003 $ 90,175 $ 3,828 4.2% $ 95,034 $ 92,354 $ 2,680 2.9%
Utility and other income .......... 9,857 10,557 (700) (6.6%) 13,834 13,405 429 3.2%
-------- -------- -------- ------ -------- -------- -------- -------
Property operating revenues .. 103,860 100,732 3,128 3.1% 108,868 105,759 3,109 2.9%
Property operating and
maintenance .................. 27,258 27,076 182 6.7% 29,963 29,224 739 2.5%
Real estate taxes ................. 8,366 7,988 378 4.7% 8,684 8,341 343 4.1%
Property management ............... 4,219 4,061 158 3.9% 4,423 4,264 159 3.7%
-------- -------- -------- ------ -------- -------- -------- -------
Property operating expenses .. 39,843 39,125 718 1.8% 43,070 41,829 1,241 3.0%
-------- -------- -------- ------ -------- -------- -------- -------
Income from property operations ... $ 64,017 $ 61,607 $ 2,410 3.9% $ 65,798 $ 63,930 $ 1,868 2.9%
Site and Occupancy Information (1):
Average total sites ............... 41,800 41,712 88 0.2% 42,493 43,242 (749) (1.7%)
Average occupied sites ............ 39,149 39,498 (349) (0.9%) 39,786 40,941 (1,155) (2.8%)
Occupancy % ....................... 93.7% 94.7% (1.0%) (1.1%) 93.6% 94.7% (1.1%) (1.2%)
Monthly base rent per site ........ $ 400.19 $ 380.78 $ 19.41 5.1% $ 398.10 $ 375.96 $ 22.14 5.9%
Total sites
as of June 30, ............... 41,818 41,791 27 0.1% 42,550 43,108 (558) (1.3%)
Total occupied sites
as of June 30, ............... 38,917 39,396 (479) (1.2%) 39,540 40,638 (1,098) (2.7%)
(1) Site and occupancy information does not include the five Properties owned
through joint ventures, the six RV Properties or the 17 Properties held for
sale.
Property Operating Revenues
The 4.2% increase in base rental income for the Core Portfolio reflects a
5.1% increase in monthly base rent per site coupled with a 0.9% decrease in
average occupied sites. The decrease in utility and other income for the Core
Portfolio is due primarily to decreases in utility income, which resulted from
lower expenses for these items.
Property Operating Expenses
The increase in property operating and maintenance expense for the Core
Portfolio is due primarily to increases in property payroll, insurance and other
expenses and administrative expenses, partially offset by decreased utility
expense. The increase in Core Portfolio real estate taxes is generally due to
higher property assessments on certain Properties. Property management expense
for the Core Portfolio, which reflects costs of managing the Properties and is
estimated based on a percentage of Property revenues, increased by 3.9% due to
increased office expense, rents, and management fees.
21
MANUFACTURED HOME COMMUNITIES, INC.
RESULTS OF OPERATIONS (CONTINUED)
HOME SALES OPERATIONS:
The following table summarizes certain financial and statistical data for
the Home Sales Operations for the six months ended June 30, 2002 and 2001.
HOME SALES OPERATIONS
----------------------------------------------------------
INCREASE /
(dollars in thousands) 2002 2001 (DECREASE) % CHANGE
-------- -------- ---------- --------
(Proforma)
Gross revenues from new home sales $ 11,730 $ 13,027 (1,217) (10.0%)
Cost of new home sales ............ (9,090) (10,147) 1,057 10.4%
-------- -------- -------- -------
Gross profit from new home sales .. 2,640 2,880 (240) (8.3%)
Gross revenues from used home sales 929 1,654 (725) (43.8%)
Cost of used home sales ........... (565) (1,170) 605 51.7%
-------- -------- -------- -------
Gross profit from used home sales . 364 484 (120) (24.8%)
Brokered resale revenues, net ..... 886 899 (13) (1.4%)
Home selling expenses ............. (4,127) (4,057) (70) (1.7%)
Ancillary services revenues, net .. 674 777 (103) (13.3%)
-------- -------- -------- -------
Income from home sales and other .. $ 437 $ 983 (546) (55.5%)
======== ======== ======== =======
HOME SALES VOLUMES:
New home sales .................. 161 197 (36) (18.3%)
Used home sales ................. 78 138 (60) (43.5%)
Brokered home resales ........... 542 596 (54) (9.1%)
The 8.3% decrease in gross profits from new home sales reflects a decrease
in the volume of new home sales. The 24.8% decrease in gross profits from used
home sales reflects a decrease in volume of used home sales. The 1.4% decrease
in brokered resale revenues reflects a decrease in the volume of brokered sales.
This decrease is partially offset by an increase in resale commissions due to
increased resale values for the homes sold. The 1.7% increase in home selling
expenses reflects an increase in payroll, advertising, and administrative
expense. The 13.3% decrease in ancillary services revenues reflects an increase
in expenses for the home rental program.
The proforma income from home sales and other for 2001 does not include
$265,000 of interest income and $572,000 of interest expense. Interest income
and interest expense were previously included in income from affiliates for 2001
and are now included in other income and expenses. The proforma amounts have no
effect on previously reported net income. The 2001 amounts have been
reclassified to conform to the 2002 financial presentation for comparison
purposes.
OTHER INCOME AND EXPENSES:
The increase in other income and expenses reflects an increase in
depreciation expense and general and administrative expense and a decrease in
other corporate income for both the quarter ended and the six months ended June
30, 2002.
22
MANUFACTURED HOME COMMUNITIES, INC.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
As of June 30, 2002, the Company had $10.4 million in cash and cash
equivalents and $114.7 million available on its line of credit. The Company
expects to meet its short-term liquidity requirements, including its
distributions, generally through its working capital, net cash provided by
operating activities and availability under the existing line of credit. The
Company expects to meet certain long-term liquidity requirements such as
scheduled debt maturities, property acquisitions and capital improvements by
long-term collateralized and uncollateralized borrowings including borrowings
under its existing line of credit and the issuance of debt securities or
additional equity securities in the Company, in addition to working capital.
On April 12, 2002 and July 12, 2002, the Company paid a $.475 per share
distribution for the quarters ended March 31, 2002 and June 30, 2002,
respectively, to stockholders of record on March 29, 2002 and June 28, 2002,
respectively. The Operating Partnership paid distributions of 9.0% per annum on
the $125 million of Series D Cumulative Redeemable Perpetual Preferred Units
("Preferred Units"). Distributions on the Preferred Units were paid on March 29,
2002 and June 28, 2002.
MORTGAGES AND CREDIT FACILITIES
Throughout the six months ended June 30, 2002, the Company borrowed $26.5
million on its line of credit and paid down $7.5 million on the line of credit.
The line of credit bears interest at a rate of LIBOR plus 1.125%.
During the six months ended June 30, 2002, the Company paid $2.2 million in
regular principal amortization. The Company paid off a $1.1 million mortgage,
financed with borrowings on the Company's line of credit. Throughout the six
months ended June 30, 2002 the Company made payments of $3.6 million on maturing
debt on the Conseco Financing Note. The Conseco Financing Note payments were
financed with borrowings on the Company's line of credit. As of April 1, 2002,
the Company stopped funding inventory with the Conseco Financing Note and all
future purchases of inventory will be funded with the Company's existing line
of credit.
Certain of the Company's mortgage and credit agreements contain covenants
and restrictions including restrictions as to the ratio of secured or unsecured
debt versus encumbered or unencumbered assets, the ratio of fixed
charges-to-earnings before interest, taxes, depreciation and amortization
("EBITDA"), limitations on certain holdings and other restrictions.
ACQUISITIONS, DISPOSITIONS AND INVESTMENTS
On March 12, 2002, the Company acquired Mt. Hood Village, a recreational
vehicle ("RV") community with a total of 450 sites, for approximately $6.8
million. Mt. Hood Village is located in Welches, Oregon and has land available
for up to 120 expansion sites. The acquisition was funded by a borrowing on the
Company's line of credit.
Throughout the six months ended June 30, 2002, the Company purchased
adjacent land and land improvements for several Properties for $2.2 million.
These acquisitions were funded with borrowings on the Company's line of credit.
On January 1, 2002, the Company purchased all of the common stock of Realty
Systems, Inc. ("RSI"). The Company previously owned the non-voting preferred
stock of RSI and had notes receivable from RSI which were recorded as an
investment in affiliate. The Company purchased the common stock of RSI from
Equity Group Investments, LLC., controlled by Samuel Zell, Chairman of the Board
of Directors for the Company, for approximately $675,000.
23
MANUFACTURED HOME COMMUNITIES, INC.
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
CAPITAL IMPROVEMENTS
Capital expenditures for improvements are identified by the Company as
recurring capital expenditures ("Recurring CapEx"), site development costs and
corporate headquarters costs. Recurring CapEx was approximately $6.0 million for
the six months ended June 30, 2002. Corporate improvements were approximately
$324,000 for the six months ended June 30, 2002. Site development costs were
approximately $5.7 million for the six months ended June 30, 2002, and represent
costs to develop expansion sites at certain of the Company's Properties.
INFLATION
Substantially all of the leases at the Properties allow for monthly or
annual rent increases which provide the Company with the opportunity to achieve
increases, where justified by the market, as each lease matures. Such types of
leases generally minimize the risk of inflation to the Company.
24
MANUFACTURED HOME COMMUNITIES, INC.
LIQUIDITY AND CAPITAL RESOURCES (CONTINUED)
FUNDS FROM OPERATIONS
Funds From Operations ("FFO") was redefined by the National Association of
Real Estate Investment Trusts ("NAREIT") in October 1999, effective January 1,
2000, as net income (computed in accordance with GAAP), before allocation to
minority interests, excluding gains (or losses) from sales of property, plus
real estate depreciation and after adjustments for unconsolidated partnerships
and joint ventures. The Company computes FFO in accordance with the NAREIT
definition, which may differ from the methodology for calculating FFO utilized
by other equity REITs and, accordingly, may not be comparable to such other
REIT's computations. Funds available for distribution ("FAD") is defined as FFO
less non-revenue producing capital expenditures and amortization payments on
mortgage loan principal. The Company believes that FFO and FAD are useful to
investors as a measure of the performance of an equity REIT because, along with
cash flows from operating activities, financing activities and investing
activities, they provide investors an understanding of the ability of the
Company to incur and service debt and to make capital expenditures. FFO and FAD
in and of themselves do not represent cash generated from operating activities
in accordance with GAAP and therefore should not be considered an alternative to
net income as an indication of the Company's performance or to net cash flows
from operating activities as determined by GAAP as a measure of liquidity and
are not necessarily indicative of cash available to fund cash needs.
The following table presents a calculation of FFO and FAD for the quarters
and six months ended June 30, 2002 and 2001 (amounts in thousands):
QUARTERS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- -------------------------
2002 2001 2002 2001
-------- -------- -------- --------
COMPUTATION OF FUNDS FROM OPERATIONS:
Net income ................................................. $ 6,438 $ 6,135 $ 13,554 $ 18,778
Income allocated to common OP Units ........................ 1,590 1,564 3,357 4,846
Depreciation on real estate assets ......................... 8,534 7,974 16,954 16,028
Depreciation on real estate assets held-for-sale ........... 552 613 1,103 1,238
Gain on sale of Properties and other........................ -- -- -- (8,093)
-------- -------- -------- --------
Funds from operations ................................... $ 17,114 $ 16,286 $ 34,968 $ 32,797
======== ======== ======== ========
Weighted average Common Stock outstanding - diluted ........ 27,664 26,898 27,587 26,835
======== ======== ======== ========
COMPUTATION OF FUNDS AVAILABLE FOR DISTRIBUTION:
Funds from operations ...................................... $ 17,114 $ 16,286 $ 34,968 $ 32,797
Non-revenue producing improvements to real estate .......... (1,811) (3,290) (6,004) (4,286)
-------- -------- -------- --------
Funds available for distribution ........................ $ 15,303 $ 12,996 $ 28,964 $ 28,511
======== ======== ======== ========
Weighted average Common Stock outstanding - diluted ........ 27,664 26,898 27,587 26,835
======== ======== ======== ========
25
MANUFACTURED HOME COMMUNITIES, INC.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's earnings are affected by changes in interest rates, as a
portion of the Company's outstanding indebtedness is at variable rates based on
LIBOR. The Company's $150 million line of credit ($35.3 million outstanding at
June 30, 2002) bears interest at LIBOR plus 1.125%, the Company's $100 million
Term Loan bears interest at LIBOR plus 1.375% and the Company's $9.2 million
Conseco Financing Notes bears interest at prime. If LIBOR increased/decreased by
1.0% during the quarter ended June 30, 2002, interest expense would have
increased/decreased by approximately $352,000 based on the combined average
balance outstanding under the Company's line of credit, Term Loan and Conseco
Financing Notes during the period.
On October 29, 2001, the Company entered into an interest rate swap
agreement (the "Swap"), fixing LIBOR on $100 million of the Company's floating
rate debt at approximately 3.7% for the period October 2001 through August 2004.
The terms of the Swap require monthly settlements on the same dates that
interest payments are due on the debt. Effective January 1, 2001, the Company
adopted Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" ("SFAS No. 133) and its
amendments, SFAS No. 137 and SFAS No. 138. In accordance with SFAS No. 133, the
Swap is reflected at market value. The Company believes the Swap is a perfectly
effective cash flow hedge per SFAS No. 133 and there will be no effect on net
income as a result of the mark-to-market adjustment. As of June 30, 2002 the
hedge represented a liability of approximately $1.7 million and is recorded in
accounts payable and accrued expenses. Mark-to-market changes in the value of
the swap are included in other comprehensive income.
26
MANUFACTURED HOME COMMUNITIES, INC.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
DEANZA SANTA CRUZ MOBILE ESTATES
The residents of DeAnza Santa Cruz Mobile Estates, a Property located in
Santa Cruz, California (the "City") previously brought several actions opposing
certain fees and charges in connection with water service at the Property. This
summary provides the history and reasoning underlying the Company's defense of
the residents' claims and explains the Company's decision to continue to defend
its position, which the Company believes is fair and accurate.
DeAnza Santa Cruz Mobile Estates is a 198-site community overlooking the
Pacific Ocean. It is subject to the City's rent control ordinance which limits
annual rent increases to 75% of CPI. The Company purchased this Property in
August 1994 from certain unaffiliated DeAnza entities ("DeAnza"). Prior to the
Company's purchase in 1994, DeAnza made the decision to submeter and separately
bill tenants at the Property for both water and sewer in 1993 in the face of the
City's rapidly rising utility costs.
Under California Civil Code Section 798.41, DeAnza was required to reduce
rent by an amount equal to the average cost of usage over the preceding 12
months. This was done. With respect to water charges, because DeAnza did not
want to be regulated by the California Public Utility Commission ("CPUC"),
DeAnza relied on California Public Utilities Code Section 2705.5 ("CPUC Section
2705.5") to determine what rates would be charged for water on an ongoing basis
without becoming a public utility. DeAnza and the Company interpreted the
statute as providing that in a submetered mobile home park, the property owner
is not subject to regulation and control of the CPUC so long as the users are
charged what they would be charged by the utility company if users received
their water directly from the utility company. In Santa Cruz, customers
receiving their water directly from the City's water utility were charged a
certain lifeline rate for the first 400 ccfs of water and a greater rate for
usage over 400 ccfs of water, a readiness to serve charge of $7.80 per month and
tax on the total. In reliance on CPUC Section 2705.5, DeAnza implemented its
billings on this schedule notwithstanding that it did not receive the discount
for the first 400 ccfs of water because it was a commercial and not a
residential customer.
A dispute with the residents ensued over the readiness to serve charge and
tax thereon. The residents argued that California Civil Code Section 798.41
required that the Property owner could only pass through its actual costs of
water (and that the excess charges over the amount of the rent rollback were an
improper rent increase) and that CPUC Section 2705.5 was not applicable. DeAnza
unbundled the utility charges from rent consistent with California Civil Code
Section 798.41 and it has generally been undisputed that the rent rollback was
accurately calculated.
In August 1994, when the Company acquired the Property, the Company
reviewed the respective legal positions of the Santa Cruz Homeowners Association
("HOA") and DeAnza and concurred with DeAnza. DeAnza's reliance on CPUC Section
2705.5 made both legal and practical sense in that residents paid only what they
would pay if they lived in a residential neighborhood within the City and
permitted DeAnza to recoup part of the expenses of operating a submetered system
through the readiness to serve charge.
Over a period of 18 months from 1993 into May of 1995, a series of
complaints were filed by the HOA and Herbert Rossman, a resident, against
DeAnza, and later, the Company. DeAnza and the Company demurred to each of these
complaints on the grounds that the CPUC had exclusive jurisdiction over the
setting of water rates and that residents under rent control had to first
exhaust their administrative remedies before proceeding in a civil action. At
one point, the case was dismissed (with leave to amend) on the basis that
jurisdiction was with the CPUC and, at another point, Mr. Rossman was dismissed
from the case because he had not exhausted his administrative remedies.
27
On June 29, 1995, a hearing was held before a City rent control officer
on billing and submetering issues related to both water and sewer. The Company
and DeAnza prevailed on all issues related to sewer and the rent rollback
related to water, but the hearing officer determined that the Company could only
pass through its actual cost of water, i.e., a prorated readiness to serve
charge and tax thereon. The hearing officer did not deal with the subsidy being
given to residents through the quantity charge and ordered a rebate in a fixed
amount per resident. The Company and DeAnza requested reconsideration on this
issue, among others, which reconsideration was denied by the hearing officer.
The Company then took a writ of mandate (an appeal from an administrative
order) to the Superior Court and, pending this appeal, the residents, the
Company and the City agreed to stay the effect of the hearing officer's decision
until the Court rendered judgment.
In July 1996, the Superior Court affirmed the hearing officer's decision
without addressing concerns about the failure to take the subsidy on the
quantity charge into account.
The Company requested that the City and the HOA agree to a further stay
pending appeal to the court of appeal, but they refused and the appeal court
denied the Company's request for a stay in late November 1996. Therefore, on
January 1, 1997, the Company reduced its water charges at this Property to
reflect a pass-through of only the readiness to serve charge and tax at the
master meter (approximately $0.73) and to eliminate the subsidy on the water
charges. On their March 1, 1997 rent billings, residents were credited for
amounts previously "overcharged" for readiness to serve charge and tax. The
amount of the rebate given by the Company and DeAnza was $36,400. In calculating
the rebate, the Company and DeAnza took into account the previous subsidy on
water usage although this issue had not yet been decided by the court of appeal.
The Company and DeAnza felt legally safe in so doing based on language in the
hearing officer's decision that actual costs could be passed through.
On March 12, 1997, the Company also filed an application with the CPUC to
dedicate the water system at this Property to public use and have the CPUC set
cost-based rates for water usage. The Company believed it was obligated to take
this action because of its consistent reliance on CPUC Section 2705.5 as a safe
harbor from CPUC jurisdiction. That is, when the Company could no longer charge
for water as the local serving utility would charge, it was no longer exempt
from the CPUC's jurisdiction and control under CPUC Section 2705.5.
On March 20, 1998, the court of appeal issued the writ of mandate requested
by the Company on the grounds that the hearing officer had improperly calculated
the amount of the rebate (meaning the Company had correctly calculated the rent
credits), but also ruling that the hearing officer was correct when he found
that the readiness to serve charge and tax thereon as charged by DeAnza and the
Company were an inappropriate rent increase. The decision primarily reflected
the court of appeal's view that CPUC Section 2705.5 operated as a ceiling and
that California Civil Code Section 798.41 allowed for a charge based on actual
costs, including costs of administration, operation and maintenance of the
system, but that the Company did not have to provide evidence of such costs. The
court of appeal further agreed with the Company that the City's hearing officer
did not have the authority under California Civil Code Section 798.41 to
establish rates that could be charged in the future.
Following this decision, the CPUC granted the Company its certificate of
convenience and necessity on December 17, 1998 and approved cost-based rates and
charges for water that exceed what residents were paying under the Company's
reliance on CPUC Section 2705.5. Concurrently, the CPUC also issued an Order
Instituting Investigation ("OII") confirming its exclusive jurisdiction over the
issue of water rates in a submetered system and commencing an investigation into
the confusion and turmoil over billings in submetered properties. Specifically,
the OII states: "The Commission has exclusive and primary jurisdiction over the
establishment of rates for water and sewer services provided by private
entities."
28
MANUFACTURED HOME COMMUNITIES, INC.
Specifically, the CPUC ruling regarding the Company's application stated:
"The ultimate question of what fees and charges may or may not be assessed,
beyond external supplier pass-through charges, for in-park facilities when a
mobile home park does not adhere to the provisions of CPUC Section 2705.5, must
be decided by the Commission."
After the court of appeal decision, the HOA sought punitive damages against
the Company in a lawsuit that was tried in January 1999 in Santa Cruz County
Superior Court. The trial was continued from July 1998 to January 1999 to give
the CPUC time to act on the Company's application. Notwithstanding the action
taken by the CPUC in issuing the OII in December 1998, the trial court denied
the Company's motion to dismiss on jurisdictional grounds and trial commenced
before a jury on January 11, 1999.
Not only did the trial court not consider the Company's motion to dismiss,
the trial court refused to allow evidence of the OII or the Company's CPUC
approval to go before the jury. Notwithstanding the Company's strenuous
objections, the judge also allowed evidence of the Company's and DeAnza's
litigation tactics to be used as evidence of bad faith and oppressive actions
(including evidence of the application to the CPUC requesting a $22.00 readiness
to serve charge). The Company's motion for a mistrial based upon these
evidentiary rulings was denied. On January 22, 1999, the jury returned a verdict
awarding $6.0 million of punitive damages against the Company and DeAnza. The
Company had previously agreed to indemnify DeAnza on the matter.
On April 19, 1999, the trial court denied all of the Company's and DeAnza's
post-trial motions for judgment notwithstanding the verdict, new trial and
remittitur. The trial court also awarded $700,000 of attorneys' fees to
plaintiffs. The Company appealed the jury verdict and attorneys' fees award
(which also accrues interest at the statutory rate of 10.0% per annum). The
Company bonded the judgment pending appeal in accordance with California
procedural rules, which require a bond equal to 150% of the amount of the
judgment. Post-judgment interest will accrue at the statutory rate of 10.0% per
annum.
On December 21, 2001 the California Court of Appeal for the Sixth District
reversed the $6.0 million punitive damage award, the related award of attorneys'
fees, and, as a result, all post-judgement interest thereon, on the basis that
punitive damages are not available as a remedy for a statutory violation of the
California Mobile Home Residency Law ("MRL"). The decision of the appellate
court left the HOA with the right to seek a new trial in which it must prove its
entitlement to either the statutory penalty and attorneys' fees available under
the MRL or punitive damages based on causes of action for fraud,
misrepresentation or other tort. On remand, the HOA has filed two motions in
Santa Cruz Superior Court seeking statutory penalties and attorneys' fees.
Motions in this case are pending. The Company intends to vigorously defend
itself against these claims and has filed motions for summary adjudication of
the statutory penalty issue in favor of the Company and a motion to be declared
the prevailing party in this litigation.
In two related appeals, the Company had argued that the trial court's
ability to enter an award of attorneys' fees in favor of the HOA and to take
certain other actions was preempted by the exercise of exclusive jurisdiction by
the CPUC over the issue of how to set rates for water in a submetered mobile
home park. During 2000, the California court of appeal rejected the Company's
preemption argument with respect to these prior rulings in favor of plaintiffs,
one of which had awarded plaintiffs approximately $100,000 of attorneys' fees.
The California Supreme Court declined to accept the case for review and the
Company paid the judgment, including post-judgment interest thereon, and settled
the matter for approximately $200,000 late in 2000.
29
MANUFACTURED HOME COMMUNITIES, INC.
In a separate matter, in December 2000 the HOA and certain individual
residents of the Property filed a complaint in the Superior Court of California,
County of Santa Cruz (No. CV 139825) against the Company, certain affiliates of
the Company and certain employees of the Company (the "2000 Lawsuit"). The 2000
Lawsuit sought damages, including punitive damages, for intentional infliction
of emotional distress, unfair business practices, and unlawful retaliation
purportedly arising from allegedly retaliatory rent increases which were noticed
by the Company to certain residents in September 2000. The Company believes that
the residents who received rent increase notices with respect to rent increases
above those permitted by the local rent control ordinance were not covered by
the ordinance either because they did not comply with the provisions of the
ordinance or because they are exempted by state law. On December 29, 2000, the
Superior Court of California, County of Santa Cruz enjoined such rent increases.
The Company entered into a settlement agreement with the plaintiffs in the
2000 Lawsuit which settlement was approved by the court on July 22, 2002. The
Company believes the settlement agreement is of significant benefit to the
Company. First, pursuant to the settlement agreement all past, present and
future tenants of the Property agree to alternative dispute resolution
procedures which provide that during the next 25 years future disputes will be
resolved through arbitration before a retired judge rather than in court, and
that in such future arbitration proceedings all claims to trial by jury and for
punitive damages are waived.
Second, the settlement agreement provides a process for determining the
rent for 15 sites not subject to rent control, including in certain
circumstances, back rent owing from certain dates in 2001. The settlement
agreement generally gives tenants at these sites three (3) options with respect
to their tenancies. Such tenants may (1) enter into a 34-year lease providing a
rent based on rent control with future escalations based on the consumer price
index, but with the Company retaining the right to charge market rents
determined by the Company upon turnover; (2) enter into a ten (10) year lease
with a monthly rent to be determined by binding arbitration and effective
October 1, 2001; or (3) elect to sell such tenant's home to a third party and
pay back rent owing to the Company (the amount of which will be determined by
arbitration if not agreed to between the tenant and the Company) since January
1, 2001. In certain circumstances the Company will purchase the tenant's home
based upon a mechanism provided in the settlement agreement.
In exchange for the tenants' agreements to the alternative dispute
resolution procedures, the process for resolving back rent owed by tenants not
subject to rent control, and to dismiss the 2000 Lawsuit, the Company agreed to
pay $730,000.
Other California Rent Control Litigation
As part of the Company's effort to realize the value of its Properties
subject to rent control, the Company has initiated lawsuits against several
municipalities in California. The Company's goal is to achieve a level of
regulatory fairness in California's rent control jurisdictions that prohibit
increasing rents to market upon turnover. This regulatory feature, called
vacancy control, allows tenants to sell their homes for a premium representing
the future value of discounted rent-controlled rents. In MHC's view, such
regulation results in a transfer of the value of the Company's shareholders'
land, which would otherwise be reflected in market rents, to tenants upon the
sales of their homes in the form of an inflated purchase price that cannot be
attributed to the value of the home being sold. As a result, in the Company's
view, the Company loses the value of its asset and the selling tenant leaves the
community with a windfall premium. The Company has discovered through the
litigation process that certain municipalities considered condemning the
Company's communities at values well below the value of the underlying land. In
the Company's view, a failure to articulate market rents for sites governed by
restrictive rent control would put the Company at risk for condemnation or
eminent domain proceedings based on artificially reduced rents. Such a physical
taking, should it occur, would represent substantial lost value to shareholders.
The Company is cognizant of the need for affordable housing in the
jurisdictions, but asserts that regulations with vacancy control merely transfer
the value that belongs to the Company's shareholders to tenants in the form of
the premium prices for houses. The Company estimates that the annual rent
subsidy to tenants in these jurisdictions is approximately $15,000,000. In a
more well balanced regulatory environment, the Company would receive market rent
that would eliminate the subsidy and homes would trade at or near their
intrinsic value. The Company's efforts to achieve a balanced regulatory
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MANUFACTURED HOME COMMUNITIES, INC.
environment incentivizes tenant groups to file lawsuits against the Company
seeking large damage awards. The 2000 Lawsuit described above under Santa Cruz
is one example. The homeowners association at Contempo Marin, a 396 site
property in San Rafael, California sued the Company in December 2000 over a
prior settlement agreement on a capital pass-through after the Company sued the
City of San Rafael in October 2000 alleging its rent control ordinance is
unconstitutional. The Company believes that such lawsuits will be a consequence
of the Company's efforts to change rent control since tenant groups actively
desire to preserve the premium value of their homes in addition to the
discounted rents provided by rent control. The Company has determined that its
efforts to rebalance the regulatory environment despite the risk of litigation
from tenant groups is necessary not only because of the estimated $15,000,000
annual subsidy to tenants, but also because of the condemnation risk.
Ellenburg Communities
The Company and certain other parties entered into a settlement agreement
(the "Settlement"), which was approved by the Los Angeles County Superior Court
in April 2000. The Settlement resolved substantially all of the litigation and
appeals involving the Ellenburg Properties, and transactions arising out of the
settlement closed on May 22, 2000. Only the appeal of one entity remains, the
outcome of which is not expected to materially affect the Company.
In connection with the Ellenburg Acquisition, on September 8, 1999,
Ellenburg Fund 20 ("Fund 20") filed a cross complaint in the Ellenburg
dissolution proceeding against the Company and certain of its affiliates
alleging causes of action for fraud and other claims in connection with the
Ellenburg acquisition. The Company subsequently successfully had the cross
complaint against the Company and its affiliates dismissed with prejudice by the
California Superior Court. However, Fund 20 has appealed. This appeal was one
not resolved by the Settlement. The Company believes Fund 20's allegations are
without merit and will vigorously defend itself.
In October 2001, Fund 20 sued the Company and certain of its affiliates
again, this time in Alameda County, California making substantially the same
allegations. The Company obtained an injunction preventing the case from
proceeding until the Fund 20 appeal is decided and other related proceedings in
Arizona (from which the Company has already been dismissed with prejudice) are
concluded.
Westwinds
The Operating Partnership is the ground lessee ("Lessee") of certain
property in San Jose, California under ground leases ("Leases") from the
Nicholson Family Trust ("Lessor"). On February 13, 2001, Lessor filed a petition
for arbitration of disputes over whether certain items constitute "gross
revenue" under the Leases, in which petition Lessor seeks damages and
termination of the Leases. Lessee responded on March 12, 2001 disputing Lessor's
contentions. Lessor claims that "gross revenue" for the purpose of calculating
percentage rent owing to Lessor under the Leases includes certain amounts Lessee
has recouped from tenants of the Property (who are protected by rent control)
related to ground rent already paid to Lessor. Lessee has successfully been able
to pass-through to tenants at the Property increases in ground rent under the
Leases. Lessee contends that this pass-through results in reimbursement of lease
expense, not "gross revenue." Lessor also contends that the "net income" of RSI
from the Property should be included in the gross revenue calculation. Lessee
disputes this for many reasons, including, but not limited to, the fact that RSI
is not a lessee under the Leases, the sales activity is not conducted by Lessee,
and RSI is a separate company from Lessee.
Lessor's motion for summary judgment on the pass-through issue was denied
by an arbitration panel on November 2, 2001. Lessor and Lessee agreed to mediate
the dispute and the matter was settled and the lease was amended in early 2002.
Pursuant to the settlement and amendment, Lessee agreed to pay $338,000 related
to prior period rent which was expensed in the first quarter of 2002 and to
prepay rent of $632,000 based on a recalculation of rent in the amended lease.
The rent prepayment and related legal costs will be amortized into ground rent
expense over the remaining life of the lease.
31
MANUFACTURED HOME COMMUNITIES, INC.
COUNTRYSIDE AT VERO BEACH
The Company has received a letter dated June 17, 2002 from the Indian River
County, Florida Department of Utility Services ("County"), claiming that the
Company currently owes sewer impact fees in the amount of approximately $518,000
with respect to the Property known as Countryside at Vero Beach, located in Vero
Beach, Florida, purportedly under the terms of an agreement between the County
and a prior owner of the Property. In response, the Company has advised the
County that these fees are no longer due and owing as a result of a 1996
settlement agreement between the County and the prior owner of the Property,
providing for the payment of $150,000 to the County to discharge any further
obligation for the payment of impact or connection fees for sewer service at the
Property. The Company paid this settlement amount (with interest) to the County
in connection with the Company's acquisition of the Property. Accordingly, the
Company believes that the County's claims are without merit.
OTHER
The Company is involved in various other legal proceedings arising in the
ordinary course of business. Management believes that all proceedings herein
described or referred to, taken together, are not expected to have a material
adverse impact on the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Annual Meeting of Stockholders of the Company, for which proxies were
solicited pursuant to Regulation 14A under the Securities Exchange Act of 1934,
was held on May 8, 2002. At the Annual Meeting, Samuel Zell, David A. Helfand
and Michael A. Torres were each elected to serve as directors of the Company
until the 2005 Annual Meeting of Stockholders.
Votes Cast
--------------------------------------
For Withheld
------------------ ----------------
Samuel Zell 17,515,839 60,873
David A. Helfand 17,515,876 60,836
Michael A. Torres 17,523,492 53,220
There were 4,156,070 broker non-votes.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
Exhibit 99.1 Certifications of the Chief Executive Officer
and the Chief Financial Officer of Manufactured
Home Communities, Inc. as required by Section 906
of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K:
None.
32
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.
MANUFACTURED HOME COMMUNITIES, INC.
BY: /s/ John M. Zoeller
----------------------------------------
John M. Zoeller
Executive Vice President, Treasurer and
Chief Financial Officer
BY: /s/ Mark Howell
----------------------------------------
Mark Howell
Principal Accounting Officer and
Assistant Treasurer
DATE: August 14, 2002
33