SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2004
---------------------------------------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 1-13136
------------------------------
HOME PROPERTIES, INC.
---------------------
(Exact name of registrant as specified in its charter)
MARYLAND 16-1455126
-------- ----------
(State or other jurisdiction of (IRS Employer Identification
incorporation or organization) Number)
850 Clinton Square, Rochester, New York 14604
---------------------------------------------
(Address of principal executive offices) (Zip Code)
(585) 546-4900
--------------
(Registrant's telephone number, including area code)
N/A
---
(Former name, former address and former
year, if changed since last report)
Indicate by check mark whether registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO ____
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
YES X NO ____
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Class of Common Stock Outstanding at April 30, 2004
--------------------- -----------------------------
$.01 par value 32,726,138
HOME PROPERTIES, INC.
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets -
March 31, 2004 (Unaudited) and December 31, 2003 3
Consolidated Statements of Operations (Unaudited) -
Three months ended March 31, 2004 and 2003 4
Consolidated Statements of Comprehensive Income (Unaudited) - 5
Three months ended March 31, 2004 and 2003
Consolidated Statements of Cash Flows (Unaudited) - 6
Three months ended March 31, 2004 and 2003
Notes to Consolidated Financial Statements (Unaudited) 7-18
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 19-30
Item 3. Quantitative and Qualitative Disclosures About Market Risk 31
Item 4. Controls and Procedures 32
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 33
Signatures 34
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HOME PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
MARCH 31, 2004 AND DECEMBER 31, 2003
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
2004 2003
---- ----
(Unaudited) (Note1)
ASSETS
Real estate:
Land $ 414,345 $ 387,655
Buildings, improvements and equipment 2,725,734 2,365,337
---------- ----------
3,140,079 2,752,992
Less: accumulated depreciation ( 415,316) ( 330,062)
---------- ----------
Real estate, net 2,724,763 2,422,930
Cash and cash equivalents 7,104 5,103
Cash in escrows 48,295 39,660
Accounts receivable 4,660 4,437
Prepaid expenses 19,427 18,184
Investment in and advances to affiliates 48 5,253
Deferred charges 14,275 9,057
Other assets 7,621 8,693
---------- ----------
Total assets $2,826,193 $2,513,317
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Mortgage notes payable $1,575,406 $1,380,696
Line of credit 71,000 -
Accounts payable 15,598 13,178
Accrued interest payable 9,989 7,013
Accrued expenses and other liabilities 18,945 18,959
Security deposits 24,268 21,664
---------- ----------
Total liabilities 1,715,206 1,441,510
---------- ----------
Commitments and contingencies
Minority interest 357,376 330,544
---------- ----------
Stockholders' equity:
Cumulative redeemable preferred stock, $.01 par value; 3,000,000
shares authorized; 2,400,000 shares issued and outstanding at
March 31, 2004 and December 31, 2003 60,000 60,000
Convertible cumulative preferred stock, $.01 par value; 10,000,000 shares
authorized; 250,000 shares issued and outstanding at March 31, 2004 and
December 31, 2003 25,000 25,000
Common stock, $.01 par value; 80,000,000 shares authorized; 32,688,962 and
31,966,240 shares issued and outstanding at March 31, 2004 and December
31, 2003, respectively 327 320
Excess stock, $.01 par value; 10,000,000 shares authorized; no shares
issued or outstanding - -
Additional paid-in capital 813,290 785,710
Accumulated other comprehensive income (loss) ( 470) ( 542)
Distributions in excess of accumulated earnings ( 144,456) ( 128,910)
Officer and director notes for stock purchases ( 80) ( 315)
---------- ----------
Total stockholders' equity 753,611 741,263
---------- ----------
Total liabilities and stockholders' equity $2,826,193 $2,513,317
========== ==========
The accompanying notes are an integral part of these consolidated financial statements.
HOME PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2004 AND 2003
(UNAUDITED, IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
2004 2003
---- ----
Revenues:
Rental income $108,526 $100,183
Property other income 4,054 3,596
Interest and dividend income 152 155
Other income 465 1,199
---------- ----------
Total Revenues 113,197 105,133
---------- ----------
Expenses:
Operating and maintenance 54,232 48,651
General and administrative 4,725 5,119
Interest 21,332 20,946
Depreciation and amortization 21,711 18,815
Prepayment penalty 196 1,349
Impairment of assets held as General Partner 1,116 427
---------- ----------
Total Expenses 103,312 95,307
---------- ----------
Income from operations 9,885 9,826
Equity in earnings (losses) of unconsolidated affiliates ( 538) ( 740)
---------- ----------
Income before minority interest and discontinued operations 9,347 9,086
Minority interest 2,468 2,052
---------- ----------
Income from continuing operations 6,879 7,034
---------- ----------
Discontinued operations
Income (loss) from operations, net of $55 in 2003 allocated to minority
interest - ( 96)
Gain (loss) on disposition of property, net of $6 in 2004 and $263 in 2003
allocated to minority interest ( 13) 451
---------- ----------
Discontinued operations ( 13) 355
---------- ----------
Income before loss on disposition of property and business and cumulative
effect of change in accounting principle 6,866 7,389
Loss on disposition of property and business, net of $33 in 2004 allocated to
minority interest ( 67) -
---------- ----------
Income before cumulative effect of change in accounting principle 6,799 7,389
Cumulative effect of change in accounting principle, net of $159 allocated to
minority interest ( 321) -
---------- ----------
Net Income 6,478 7,389
Preferred dividends ( 1,898) ( 3,518)
---------- ----------
Net income available to common shareholders $ 4,580 $ 3,871
========== ==========
Basic earnings per share data:
Income from continuing operations $ .15 $ .13
Discontinued operations - .01
Cumulative effect of change in accounting principle ( .01) -
---------- ----------
Net income available to common shareholders $ .14 $ .14
========== ==========
Diluted earnings per share data:
Income from continuing operations $ .15 $ .13
Discontinued operations - .01
Cumulative effect of change in accounting principle ( .01) -
---------- ----------
Net income available to common shareholders $ .14 $ .14
========== ==========
Weighted average number of shares outstanding:
Basic 32,321,929 27,534,484
========== ==========
Diluted 32,874,561 27,731,627
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
HOME PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2004 AND 2003
(UNAUDITED, IN THOUSANDS)
2004 2003
---- ----
Net income $6,478 $7,389
Other comprehensive income (net of minority interest):
Change in fair value of hedge instruments 72 56
------ ------
Comprehensive income $6,550 $7,445
====== ======
The accompanying notes are an integral part of these consolidated financial
statements.
HOME PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2004 AND 2003
(UNAUDITED, IN THOUSANDS)
2004 2003
---- ----
Cash flows from operating activities:
Net income $ 6,478 $ 7,389
-------- ---------
Adjustments to reconcile net income to net cash provided by operating
activities:
Equity in (earnings) losses of unconsolidated affiliates 538 740
Income allocated to minority interest 2,270 2,260
Depreciation and amortization 22,090 19,423
Impairment of assets held as General Partner 1,116 427
Impairment of real property - 423
(Gain) loss on disposition of property and business 119 ( 714)
Loss from early extinguishment of debt 196 1,349
Cumulative effect of change in accounting principle 480 -
Changes in assets and liabilities:
Other assets 1,491 4,416
Accounts payable and accrued liabilities 2,777 ( 2,204)
-------- ---------
Total adjustments 31,077 26,120
-------- ---------
Net cash provided by operating activities 37,555 33,509
-------- ---------
Cash flows used in investing activities:
Purchase of properties and other assets, net of mortgage
notes assumed and UPREIT Units issued ( 64,376) ( 32,173)
Additions to properties ( 19,996) ( 19,724)
Proceeds from sale of properties and business, net - 20,340
Proceeds from sale of affordable properties, net 137
Advances to affiliates ( 795) ( 1,168)
Payments on advances to affiliates 89 1,869
-------- ---------
Net cash used in investing activities ( 84,941) ( 30,857)
-------- ---------
Cash flows from financing activities:
Proceeds from sale of common stock, net 14,509 7,478
Proceeds from mortgage notes payable 15,717 -
Payments of mortgage notes payable ( 19,939) ( 13,820)
Payment of prepayment penalty in connection with the early
extinguishment of debt ( 196) ( 1,349)
Proceeds from line of credit 96,000 60,000
Payments on line of credit ( 25,000) ( 30,000)
Payments of deferred loan costs ( 129) ( 175)
Withdrawals from (additions to) cash escrows, net ( 990) 5,021
Repayment of officer loans 235 99
Dividends and distributions paid ( 31,670) ( 29,890)
-------- ---------
Net cash provided by (used in) financing activities 48,537 ( 2,635)
-------- ---------
Net increase in cash and cash equivalents 1,151 16
Cash and cash equivalents:
Beginning of year 5,103 8,782
Cash assumed in connection with FIN 46 consolidation
850 -
-------- ---------
End of year $ 7,104 $ 8,798
======== =========
Supplemental disclosure of non-cash operating, investing and financing
activities:
Mortgage loans assumed associated with property acquisitions $ 69,782 $ -
Conversion of preferred to common stock - 10,000
Exchange of UPREIT Units/partnership interest for common shares 5,267 3,278
Fair value of hedge instruments 849 1,529
Issuance of UPREIT Units associated with property and other acquisitions 12,105 4,806
Increase in real estate associated with the purchase of UPREIT Units 4,940 -
Compensation cost of stock options issued 248 202
Net real estate assumed in connection with FIN 46 consolidation 152,319 -
Other assets assumed in connection with FIN 46 consolidation 11,916 -
Mortgage debt assumed in connection with FIN 46 consolidation 129,149 -
Other liabilities assumed in connection with FIN 46 consolidation 5,363 -
The accompanying notes are an integral part of these consolidated financial statements.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1. Unaudited Interim Financial Statements
The interim consolidated financial statements of Home Properties, Inc. (the
"Company") have been prepared in accordance with accounting principles
generally accepted in the United States of America for interim financial
information and the applicable rules and regulations of the Securities and
Exchange Commission. Accordingly, certain disclosures accompanying annual
financial statements prepared in accordance with accounting principles
generally accepted in the United States of America are omitted. The
year-end balance sheet data was derived from audited financial statements,
but does not include all disclosures required by accounting principles
generally accepted in the United States of America. In the opinion of
management, all adjustments, consisting solely of normal recurring
adjustments, necessary for the fair presentation of the consolidated
financial statements for the interim periods have been included. The
current period's results of operations are not necessarily indicative of
results which ultimately may be achieved for the year. The interim
consolidated financial statements and notes thereto should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's Form 10-K for the year ended December 31, 2003.
2. Organization and Basis of Presentation
Organization
------------
The Company is engaged primarily in the ownership, management, acquisition,
and rehabilitation of residential apartment communities in the
Northeastern, Mid-Atlantic and Midwestern United States. As of March 31,
2004, the Company operated 201 apartment communities with 49,272
apartments. Of this total, the Company owned 154 communities, consisting of
42,224 apartments, managed as general partner 4,746 apartments and fee
managed 2,302 apartments for affiliates and third parties.
Basis of Presentation
---------------------
The accompanying consolidated financial statements include the accounts of
the Company and its 67.1% (63.3% at March 31, 2003) partnership interest in
the Operating Partnership. Such interest has been calculated as the
percentage of outstanding common shares divided by the total outstanding
common shares and Operating Partnership Units ("UPREIT Units") outstanding.
The remaining 32.9% (36.7% at March 31, 2003) is reflected as Minority
Interest in these consolidated financial statements. The Company owns a
1.0% general partner interest in the Operating Partnership and the
remainder as a limited partner through its wholly owned subsidiary, Home
Properties I, LLC, which owns 100% of the limited partner, Home Properties
Trust. Home Properties Trust was formed in September 1997, as a Maryland
real estate trust and as a qualified REIT subsidiary ("QRS") and owns the
Company's share of the limited partner interests in the Operating
Partnership. For financing purposes, the Company has formed a limited
liability company (the "LLC") and a partnership (the "Financing
Partnership"), which beneficially own certain apartment communities
encumbered by mortgage indebtedness. The LLC is wholly owned by the
Operating Partnership. The Financing Partnership is owned 99.9% by the
Operating Partnership and 0.1% by the QRS.
The accompanying consolidated financial statements include the accounts of
two wholly owned subsidiaries, Home Properties Management, Inc. and Home
Properties Resident Services, Inc. (the "Management Companies"). All
significant inter-company balances and transactions have been eliminated in
these consolidated financial statements.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
2. Organization and Basis of Presentation (continued)
Through March 30, 2004, the Company accounted for its investment as
managing general partner ("GP") in unconsolidated affordable housing
limited partnerships ("LP") using the equity method of accounting.
Effective March 31, 2004, the Company adopted FASB Interpretation No. 46R,
Consolidation of Variable Interest Entities ("FIN 46R"). This
interpretation addresses consolidation by business enterprises of variable
interest entities in which the equity investment at risk is not sufficient
to permit the entity to finance its activities without additional
subordinated financial support from other parties or in which the equity
investors do not have the characteristics of a controlling financial
interest. This interpretation requires a variable interest entity to be
consolidated by a company if that company is subject to a majority of the
risk of loss from the variable interest entity's activities or entitled to
receive a majority of the entity's residual returns or both. The
interpretation also requires disclosures about variable interest entities
that the company is not required to consolidate but in which it has a
significant variable interest. At this date, the Company is the general
partner in 41 limited partnerships. The Company has made a determination
that all 41 limited partnerships are Variable Interest Entities. The
Company has further determined that it is the primary beneficiary in 34 of
the limited partnerships and therefore consolidated these entities
effective March 31, 2004. Home Properties determined that it is not the
primary beneficiary in seven partnerships syndicated under U.S. Department
of Housing and Urban Development subsidy programs. These seven investments
will continue to be accounted for under the equity method. For those seven
investments, the Company will continue to record its allocable share of the
respective partnership's income or loss based on the terms of the
agreement. To the extent it is determined that the LPs cannot absorb their
share of the losses, if any, the GP will record the LPs share of such
losses. The Company will absorb such losses to the extent the Company has
outstanding loans or advances and the limited partner has no remaining
capital account. The Company has no loans to the seven partnerships as of
March 31, 2004 and therefore did not absorb an LP share of losses.
Reclassifications
-----------------
Certain reclassifications have been made to the 2003 consolidated financial
statements to conform to the 2004 presentation.
New Accounting Standards
------------------------
In March 2004, the FASB issued EITF 03-6 "Participating Securities and the
Two-Class Method under FASB Statement 128, Earnings per Share." EITF 03-6
addresses a number of questions regarding the computation of earnings per
share by companies that have issued securities other than common stock that
contractually entitle the holder to participate in dividends and earnings
of the company when, and if, it declares dividends on its common stock.
The issue also provides further guidance in applying the two-class method
of calculating EPS. It clarifies what constitutes a participating
security and how to apply the two-class method of computing EPS once it is
determined that a security is participating, including how to allocate
undistributed earnings to such a security. The EITF is effective for the
first fiscal periods beginning after March 31, 2004. The Company preferred
shares are non-participating as defined under the provisions of EITF 03-06.
The provisions of EITF 03-6 are not expected to have a material impact on
the Company's financial statements.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
2. Organization and Basis of Presentation (continued)
In May 2003, FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." This
Statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). This
Statement is effective for financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003. On October 29, 2003 the
FASB indefinitely deferred the provisions of paragraphs 9 and 10 of SFAS
No. 150 as they apply to mandatorily redeemable noncontrolling interests.
This deferral applies to minority interest ownerships in limited
partnerships which are mandatorily redeemable upon termination of the
partnership and therefore is potentially applicable to the affordable
portfolio. The Company's investments in the limited partnerships
consolidated under FIN 46R have a mandatory redeemable feature upon
termination of the partnership. However, due to the tax credit restrictions
on the consolidated partnership, if the partnership were terminated prior
to the end of the tax credit compliance period, the partnership would be
liable to fund the tax credits payable to the limited partners.
3. Adoption of New Accounting Policy
Effective January 1, 2003, the Company adopted the provisions of SFAS 148
"Accounting for Stock Based Compensation - An Amendment of SFAS 123." Under
the transition provisions of this Statement, the Company has elected the
"Modified Prospective Method" for recognizing stock-based compensation
costs for the three-month periods ended March 31, 2004 and 2003. Under this
method the Company recognizes stock-based compensation cost from the
beginning of the fiscal year in which the recognition provisions are first
applied as if the fair value based accounting method in this Statement had
been used to account for all employee awards granted, modified, or settled
in fiscal years beginning after December 15, 1994. For the three-month
periods ended March 31, 2004 and 2003, the Company recognized $511 and
$280, respectively, in stock compensation costs related to its stock
compensation plans. Of this total, $248 and $202, for the three-month
periods ended March 31, 2004 and 2003, respectively, related to the
expensing of stock compensation costs associated with stock options granted
by the Company. The remaining $263 and $72, for the three-month periods
ended March 31, 2004 and 2003, respectively, pertains to the stock
compensation costs recognized by the Company relative to its restricted
stock grants.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions used
for grants in 2004: dividend yields ranging from 7.81% to 9.40%; expected
volatility of 19.85%; and expected lives of 7.5 years for the options with
a lifetime of ten years, and five years for options with a lifetime of five
years. The interest rate used in the option-pricing model is based on a
risk free interest rate ranging from 4.29% to 6.87%.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
4. Earnings Per Common Share
Basic earnings per share ("EPS") is computed as net income available to
common shareholders divided by the weighted average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution
that could occur from common shares issuable through stock-based
compensation including stock options, restricted stock, phantom shares
under the Company's incentive compensation plan, warrants and the
conversion of any cumulative convertible preferred stock. The exchange of
an Operating Partnership Unit for common stock will have no effect on
diluted EPS as Unitholders and stockholders effectively share equally in
the net income of the Operating Partnership. Income from continuing
operations is the same for both the basic and diluted calculation.
The reconciliation of the basic weighted average shares outstanding and
diluted weighted average shares outstanding for the three-months ended
March 31, 2004 and 2003 is as follows:
Three Months
------------
2004 2003
---- ----
Income from continuing operations $ 6,879 $ 7,034
Add (Less): Gain (loss) on disposal of property ( 67) -
Less: Preferred dividends ( 1,898) ( 3,518)
---------- ----------
Basic and Diluted - Income from continuing operations
applicable to common shareholders $ 4,914 $ 3,516
Discontinued operations ( 13) 355
Cumulative effect of change in accounting principle ( 321) -
---------- ----------
Net income available to common shareholders $ 4,580 $ 3,871
========== ==========
Basic weighted average number of shares outstanding 32,321,929 27,534,484
Effect of dilutive stock options 448,698 97,143
Effect of restricted shares 103,934 -
---------- ----------
Diluted weighted average number of shares
outstanding 32,874,561 27,731,627
========== ==========
Basic earnings per share
Income from continuing operations $.15 $.13
Discontinued operations - .01
Cumulative effect of change in accounting
principle (.01) -
---------- ----------
Net Income available to common shareholders $.14 $.14
========== ==========
Diluted earnings per share
Income from continuing operations $.15 $.13
Discontinued operations - .01
Cumulative effect of change in accounting
principle (.01) -
---------- ----------
Net Income available to common shareholders $.14 $.14
========== ==========
Unexercised stock options to purchase zero and 648,090 shares of the
Company's common stock were not included in the computations of diluted EPS
because the options' exercise prices were greater than the average market
price of the Company's stock during the three-month periods ended March 31,
2004 and 2003, respectively. For the three-month period ended March 31,
2004, the 833,333 common stock equivalents on an as-converted basis of the
Series D Convertible Cumulative Preferred Stock has an antidilutive effect
and is not included in the computation of diluted EPS. For the three-month
period ended March 31, 2003, the 3,264,978 common stock equivalents on an
as-converted basis of the Series C, D and E Convertible Cumulative
Preferred Stock has an antidilutive effect and is not included in the
computation of diluted EPS. To the extent the preferred stock was
converted, the common shares would be included in outstanding shares from
the date of conversion.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
5. Other income
Otherincome for the three-month periods ended March 31, 2004 and 2003 is
summarized as follows:
Three-months
2004 2003
---- ----
Management fees $ 459 $1,171
Other 6 28
----- ------
$ 465 $1,199
===== ======
6. Equity in earnings (losses) of unconsolidated affiliates
Effective March 31, 2004, the Company adopted FASB Interpretation No. 46R -
Consolidation of Variable Interest Entities, an interpretation of ARB No.
51 - Consolidated Financial Statements. The interpretation addresses
consolidation by businesses of special purpose entities (variable interest
entities, "VIE"). The Company has made a determination that all 41 of the
remaining limited partnerships are Variable Interest Entities. The Company
has further determined that it is the primary beneficiary in 34 of the
limited partnerships and therefore consolidated these entities effective
March 31, 2004. Home Properties determined that it is not the primary
beneficiary in seven partnerships syndicated under U.S. Department of
Housing and Urban Development subsidy programs. The assets and liabilities
of the seven partnerships total $7,454 and $11,717, respectively. These
seven investments will continue to be accounted for under the equity
method.
These affordable limited partnerships are funded with non-recourse
financing. In connection with FIN 46, the Company was required to
consolidate the assets and liabilities in 34 out of the 41 remaining
limited partnerships. The effect on the consolidated balance sheet is an
increase in Total assets of $164.2 million, an increase in Total
liabilities of $134.5 million, an increase in Minority interest of $30.0
million, and a decrease in Stockholders' equity of $321. In connection with
the adoption of FIN 46, the Company recorded a $321 charge of a cumulative
effect of a change in accounting principle. This charge was a result of the
negative capital accounts of minority interest partners that were absorbed
by the Company. Of the $134.5 million increase in total liabilities, $129.1
million represented mortgage debt. Unconsolidated debt associated with the
seven partnerships continuing to be accounted for under the equity method
amounted to $11.2 million, of which the Company's proportionate share,
based on its legal ownership, was $765.
In the fourth quarter of 2002, the Company decided to sell virtually all of
the assets associated with its general partner interests in the affordable
properties to focus solely on the direct ownership and management of market
rate apartment communities. At that time, the Company announced its
intention to sell the assets, which include principally loans, advances and
management contracts, in three phases. The sales of Phase I and Phase II
were completed in 2003. In April, 2004, the buyer of Phase III, which
consists of the Company`s interest in 38 Upstate New York, Ohio and
Maryland properties, concluded due diligence, which resulted in a $945
reduction in the contracted sales price to $5.8 million. The Company has
recorded an impairment charge in the first quarter of 2004 for this $945 to
reduce the assets in Phase III to estimated fair market value. The Company
is working towards a closing on Phase III by June 30, 2004. The assets are
not accounted for as "held for sale" as the execution of the sale is
subject to limited partner, lender and agency approvals. It is possible
that certain approvals will not be granted by this date, pushing the
closing into the third quarter of 2004 or later.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
6. Equity in earnings (losses) of unconsolidated affiliates (continued)
During 2004, the Company plans to pursue the sale of its general partner
interests in one additional property (two partnerships) with 1,072 units.
It does not currently have a contract for this sale but anticipates that if
a sale is the chosen course of action, a closing will not be likely to
occur before the end of 2004. If a sale is the chosen course of action,
although the Company cannot accurately estimate a price at this time, it is
likely that the Company will have to pay a third party to purchase its
interest in this asset. The Company has guarantees to the partnerships to
reimburse limited partners for any lost tax credits (which could total
approximately $5.6 million) and to fund operating deficits. The property is
currently experiencing high vacancy. The regulatory agreement between the
entity which owns the property and the State Housing Authority requires a
percentage of residents to meet certain income qualifications. The Company
has had difficulty renting the units subject to those requirements to
persons it believes are economically qualified to rent the units. The
Company does not anticipate that occupancy levels or other aspects of the
operational outlook will improve in the foreseeable future under the
regulation restrictions. The Company has funded operating deficits of $475
during the first quarter of 2004 and expects to continue to fund a similar
level each quarter for the remainder of the year or until the property is
sold. The prior operating advances are not an indicator of future cash
requirements. In accordance with GAAP, the Company will consolidate future
operating expenses and will record its share of partnership operations
subject to the operating deficit funding required.
In the first quarter of 2004, the Company recorded an impairment charge of
$1,600 to adjust the assets associated with the affordable properties to
management's estimate of fair market value. The impairment charge is
classified in the financial statements as "Impairment of assets held as
general partner" of $1,116 and "Equity in earnings (losses) of
unconsolidated affiliates" of $484. A portion of the total $1,116 charge,
or $171, represents monies loaned to certain affordable properties during
the first quarter of 2004 to fund operating shortfalls, which are not
anticipated to be recovered from projected sale proceeds. The remaining
balance of $945 pertains to an additional net impairment charge taken on
Phase III to reduce the assets to estimated fair market value. Of the total
impairment charge recorded for the three-month period ended March 31, 2004,
$655 relates to cash advances to fund operating shortfalls.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
7. Segment Reporting
The Company is engaged in the ownership and management of market rate
apartment communities. Each apartment community is considered a separate
operating segment. Each segment on a stand alone basis is less than 10% of
the revenues, profit or loss, and assets of the combined reported operating
segments and meets the majority of the aggregation criteria under SFAS No.
131. The operating segments are aggregated and segregated as Core and
Non-core properties.
Non-segment revenue to reconcile to total revenue consists of interest and
dividend income and other income. Non-segment assets to reconcile to total
assets include cash and cash equivalents, cash in escrows, accounts
receivable, prepaid expenses, investments in and advances to affiliates,
deferred charges and other assets.
Core properties consist of all apartment communities which have been owned
more than one full calendar year. Therefore, the Core Properties represent
communities owned as of January 1, 2003. Non-core properties consist of
apartment communities acquired during 2003 and 2004, such that full year
comparable operating results are not available.
The accounting policies of the segments are the same as those described in
Notes 1 and 2 of the Company's Form 10-K.
The Company assesses and measures segment operating results based on a
performance measure referred to as Funds from Operations ("FFO"). FFO is
defined as net income (computed in accordance with GAAP) excluding gains or
losses from the sales of property and business (including loss associated
with early extinguishment of debt in connection with the sale) or non-cash
real estate impairment charge, minority interest in the Operating
Partnership, extraordinary items, plus real estate depreciation, less
dividends from non-convertible preferred shares. FFO is not a measure of
operating results or cash flows from operating activities as measured by
generally accepted accounting principles and it is not indicative of cash
available to fund cash needs and should not be considered an alternative to
cash flows as a measure of liquidity. Other companies may calculate
similarly titled performance measures in a different manner.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
7. Segment Reporting (continued)
The revenues, profit (loss), and assets for each of the reportable segments
are summarized as follows as of and for the three-month periods ended March
31, 2004, and 2003.
Three Months
2004 2003
Revenues
Apartments owned
Core properties $ 108,475 $ 102,951
Non-core properties 4,105 828
Reconciling items 617 1,354
---------- ----------
Total Revenue $ 113,197 $ 105,133
========== ==========
Profit (loss)
Funds from operations:
Apartments owned
Core properties $ 55,757 $ 54,363
Non-core properties 2,591 765
Reconciling items 617 1,354
---------- ----------
Segment contribution to FFO 58,965 56,482
General & administrative expenses ( 4,725) ( 5,119)
Interest expense ( 21,332) ( 20,946)
Depreciation of unconsolidated affiliates 543 549
Non-real estate depreciation/amortization ( 742) ( 609)
Prepayment penalty ( 196) -
FAS 141 acquisition rent / intangibles 182 -
Equity in earnings (losses) of unconsolidated affiliates ( 538) ( 740)
Impairment of assets held as General Partner ( 1,116) ( 427)
Impairment of affordable assets not in FFO 945 -
Loss on sale of business ( 17) -
Income from discontinued operations before minority interest, depreciation and
loss on disposition of property - 510
Redeemable preferred dividend (Series F) ( 1,350) ( 1,350)
Funds from Operations 30,619 28,350
Depreciation - apartments owned ( 20,969) ( 18,444)
Depreciation of unconsolidated affiliates ( 543) ( 549)
FAS 141 acquisition rent/intangibles ( 182) -
Redeemable preferred dividend 1,350 1,350
---------- ----------
Loss from early extinguishment of debt in connection with sale of real - ( 1,349)
estate
Impairment of real property - ( 423)
Impairment of affordable assets not in FFO ( 945) -
(Income) loss from discontinued operations before minority interest and
loss on disposition of property 17 151
Minority interest ( 2,468) ( 2,052)
---------- ----------
Income from continuing operations $ 6,879 $ 7,034
========== ==========
Assets - As of March 31, 2004 and December 31, 2003
Apartments owned:
- Core 2,374,804 $1,924,763
- Non-core 241,278 543,698
Reconciling items 210,111 44,856
---------- ----------
Total Assets $2,826,193 $2,513,317
========== ==========
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
8. Pro Forma Condensed Financial Information
The Company acquired seven apartment communities ("2004 Acquired
Communities") with a combined 1,278 units in four unrelated transactions
during the three-month period ended March 31, 2004. The total combined
purchase price (including closing costs) of $149.3 million equates to
approximately $117 per unit. Consideration for the communities was funded
through the assumption of $69.8 million of debt, $67.4 million from the
Company's line of credit and $12.1 million of UPREIT Units.
The following proforma information was prepared as if (i) the 2004
transaction related to the acquisition of the 2004 Acquired Communities had
occurred on January 1, 2003, (ii) the 2003 transactions related to the
acquisition of two apartment communities in two separate transactions had
occurred on January 1, 2003, and (iii) the 2003 transactions related to the
disposition of seven apartment communities in seven separate transactions
had occurred on January 1, 2003. The proforma financial information is
based upon the historical consolidated financial statements and is not
necessarily indicative of the consolidated results which actually would
have occurred if the transactions had been consummated at the beginning of
2003, nor does it purport to represent the results of operations for future
periods. Adjustments to the proforma condensed combined statement of
operations for the three-months ended March 31, 2004 and 2003, consist
principally of providing net operating activity and recording interest,
depreciation and amortization from January 1, 2003 to the earlier of March
31, 2004 or 2003, as applicable, or the acquisition date.
For the Three-months Ended
March 31
2004 2003
---- ----
Total revenues $115,495 $111,025
Net income available to common shareholders before
cumulative effect of change in accounting principle 4,817 4,344
Net income available to common shareholders 4,496 4,344
Per common share data:
Net income available to common shareholders before
cumulative effect of change in accounting principle
Basic $0.15 $0.16
========== ==========
Diluted $0.15 $0.16
========== ==========
Net income available to common shareholders
Basic $0.14 $0.16
========== ==========
Diluted $0.14 $0.16
========== ==========
Weighted average numbers of shares outstanding:
Basic 32,321,929 27,534,484
========== ==========
Diluted 32,874,561 27,731,627
========== ==========
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
9. Derivative Financial Instruments
The Company has three interest rate swaps that effectively convert variable
rate debt to fixed rate debt. As of March 31, 2004, the aggregate fair
value of the Company's interest rate swaps was $849 prior to the allocation
of minority interest and is included in accrued expenses and other
liabilities in the consolidated balance sheets. For the three-months ending
March 31, 2004, as the critical terms of the interest rate swaps and the
hedged items are the same, no ineffectiveness was recorded in the
consolidated statements of operations. All components of the interest rate
swaps were included in the assessment of hedge effectiveness. The fair
value of the interest rate swaps is based upon the estimate of amounts the
Company would receive or pay to terminate the contract at the reporting
date and is estimated using interest rate market pricing models.
10. Disposition of Property and Discontinued Operations
Included in discontinued operations for the three-months ended March 31,
2003 are the operating results, net of minority interest, of seven
apartment community dispositions sold in 2003. For purposes of the
discontinued operations presentation, the Company only includes interest
expense associated with specific mortgage indebtedness of the properties
that are sold or classified as held for sale.
As part of its strategic disposition program, during 2003, the Company sold
seven properties referred to above with a total of 1,568 units for total
consideration of $59.3 million, or an average of $38 per unit. During the
first quarter of 2004, the Company reported a combined $13 loss, net of
minority interest, relating to additional expenses incurred in the same
quarter for sales which took place during 2003. These costs represent a
change in estimate from those accrued at the time of sale.
In connection with the Company's strategic asset disposition program,
management is constantly reevaluating the performance of its portfolio on a
property-by-property basis. The Company from time to time determines that
it is in the best interest of the Company to dispose of assets that have
reached their potential or are less efficient to operate due to their size
or remote location and reinvest such proceeds in higher performing assets
located in targeted geographic markets. It is possible that the Company
will sell such properties at a loss. In addition, it is possible that for
assets held for use, certain holding period assumptions made by the Company
may change which could result in the Company's recording of an impairment
charge.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
10. Disposition of Property and Discontinued Operations (continued)
The operating results of the components of discontinued operations are
summarized as follows for the three-month periods ended March 31, 2004 and
2003.
Three months
2004 2003
---- ----
Revenues:
Rental Income $ - $1,922
Property other income - 90
------- -------
Total Revenues - 2,012
------- -------
Operating and Maintenance - 1,115
Interest expense - 387
Depreciation and amortization - 238
Impairment of real property - 423
------- -------
Total Expenses - 2,163
------- -------
Income (loss) from discontinued operations before minority interest and
gain (loss) on disposition of property - ( 151)
Minority interest - ( 55)
------- -------
Income from discontinued operations $ - ($ 96)
======= =======
11. Commitments and Contingencies
Contingencies
-------------
In 2001, the Company underwent a state tax audit. The state has assessed
taxes of $469 for the 1998 and 1999 tax years under audit. If the state's
position is applied to all tax years through December 31, 2001, the
assessment would be $1.3 million. At the time, the Company believed the
assessment and the state's underlying position were not supportable by the
law nor consistent with previously provided interpretative guidance from
the office of the State Secretary of Revenue. After two subsequent
enactments by the state legislation during 2002 affecting the pertinent tax
statute, the Company was advised by outside tax counsel that its filing
position for 1998-2001 should prevail. During December 2003, the state's
governor signed legislation which included the REIT tax provisions. Based
upon this, Company's tax counsel expects that the outstanding litigation
should now be able to be resolved. Effective January 1, 2003, the Company
reorganized the ownership of Home Properties Trust, which should subject
the Company to a much lower level of tax going forward.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
11. Commitments and Contingencies (continued)
Guarantees
----------
The Company, through its general partnership interests in certain
affordable property limited partnerships, has guaranteed the Low Income
Housing Tax Credits to limited partners in 23 partnerships totaling
approximately $48 million. As of March 31, 2004, there were no known
conditions that would make such payments necessary, and no amounts have
been recorded. In addition, the Company, acting as general partner in
certain partnerships, is obligated to advance funds to meet partnership
operating deficits.
12. Related Party Transactions
On January 1, 2004, the Company sold certain assets of its commercial
property management division to Home Leasing LLC, which is owned by Nelson
and Norman Leenhouts. This division managed approximately 2.2 million
square feet of gross leasable area, as well as certain planned communities.
The initial amount paid was $82. In addition, the Company is entitled to
receive a percentage of the management fee received by Home Leasing in
connection with the management of one of the commercial properties for a
period not to exceed 36 months. The expected monthly fee as outlined in the
contract is approximately $4.6 or $55.2 per year. If Home Leasing continues
to manage the property for three years, the Company is expected to receive
total additional deferred purchase price of $165.6 of which $13.8 has been
received during the three months ended March 31, 2004. The current loss
recorded on the sale of these assets as of March 31, 2004 amounts to $17.
If the management of this property is retained for the entire three years
the Company expects to receive an additional $151.8 for the period April 1,
2004 through January 1, 2007. The gain on sale would then be approximately
$134.5.
HOME PROPERTIES, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The following discussion should be read in conjunction with the accompanying
consolidated financial statements and notes thereto.
Forward-Looking Statements
--------------------------
This discussion contains forward-looking statements. Although the Company
believes expectations reflected in such forward-looking statements are based on
reasonable assumptions, it can give no assurance that its expectations will be
achieved. Factors that may cause actual results to differ include general
economic and local real estate conditions, the weather and other conditions that
might affect operating expenses, the timely completion of repositioning
activities within anticipated budgets, the actual pace of future acquisitions
and sales, including the sale of the general partner interests in affordable
properties, and continued access to capital to fund growth.
Liquidity and Capital Resources
-------------------------------
The Company's principal liquidity demands are expected to be distributions to
the common and preferred stockholders and Operating Partnership Unitholders,
capital improvements and repairs and maintenance for the properties, acquisition
of additional properties, property development and debt repayments.
The Company intends to meet its short-term liquidity requirements through net
cash flows provided by operating activities and its unsecured line of credit.
The Company considers its ability to generate cash to be adequate to meet all
operating requirements and make distributions to its stockholders in accordance
with the provisions of the Internal Revenue Code, as amended, applicable to
REITs.
As of March 31, 2004, the Company had an unsecured line of credit from M & T
Bank of $115 million. The Company's outstanding balance as of March 31, 2004,
was $71 million. Borrowings under the line of credit bear interest at 1.15% over
the one-month LIBOR rate. Accordingly, increases in interest rates will increase
the Company's interest expense and as a result will affect the Company's results
of operations and financial condition. The Company renegotiated certain terms of
the line of credit effective April 1, 2004, including a ten basis point drop in
the interest rate and easing of certain covenant restrictions. The line of
credit expires on September 1, 2005.
To the extent that the Company does not satisfy its long-term liquidity
requirements through net cash flows provided by operating activities and its
credit facility, it intends to satisfy such requirements through the issuance of
UPREIT Units, proceeds from the Dividend Reinvestment Plan ("DRIP"), proceeds
from the sale of properties, additional long term secured or unsecured
indebtedness, or the issuance of additional equity securities. As of March 31,
2004, the Company owned 27 properties with 4,199 apartment units, which were
unencumbered by debt.
In May 1998, the Company's Form S-3 Registration Statement was declared
effective relating to the issuance of up to $400 million of common stock,
preferred stock or other securities. The available balance on the shelf
registration statement at March 31, 2004 was $144.4 million.
In May and June 2000, the Company completed the sale of $60 million of Series C
Preferred Stock in a private transaction with affiliates of Prudential Real
Estate Investors ("Prudential"), Teachers Insurance and Annuity Association of
America ("Teachers"), affiliates of AEW Capital Management and Pacific Life
Insurance Company. The Series C Preferred Stock carried an annual dividend rate
equal to the greater of 8.75% or the actual dividend paid on the Company's
common shares into which the preferred shares could be converted. The stock had
a conversion price of $30.25 per share and a five-year, non-call provision. As
part of the Series C Preferred Stock transaction, the Company also issued
240,000 warrants to purchase common shares at a price of $30.25 per share,
expiring in five years. On January 9, 2003, holders of 100,000 shares of Series
C Preferred Shares elected to convert those shares for 330,579 shares of common
stock. On May 8, 2003, 200,000 shares of Series C Preferred Shares were
converted into 661,157 shares of common stock. On August 26, 2003, 200,000
shares of Series C Preferred Shares were converted into 661,157 of common stock.
On November 5, 2003, holders of the remaining 100,000 shares of Series C
Preferred Shares elected to convert those shares for 330,579 shares of common
stock. On September 9, 2003, 17,780 warrants were exercised, resulting in the
issuance of 17,780 shares of common stock. During the fourth quarter of 2003,
the remaining 222,220 common stock warrants were exercised, resulting in the
issuance of 222,220 shares of common stock. Neither the conversions nor the
warrant exercise had an effect on the reported results of operations.
In June 2000, the Company completed the sale of $25 million of Series D
Preferred Stock in a private transaction with The Equitable Life Assurance
Society of the United States. The Series D Preferred Stock carries an annual
dividend rate equal to the greater of 8.775% or the actual dividend paid on the
Company's common shares into which the preferred shares can be converted. The
stock has a conversion price of $30 per share and a five-year, non-call
provision.
In December 2000, the Company completed the sale of $30 million of Series E
Preferred Stock in a private transaction, again with affiliates of Prudential
and Teachers. The Series E Preferred Stock carried an annual dividend rate equal
to the greater of 8.55% or the actual dividend paid on the Company's common
shares into which the preferred shares could be converted. The stock had a
conversion price of $31.60 per share and a five-year, non-call provision. In
addition, as part of the Series E Preferred Stock transaction, the Company
issued warrants to purchase 285,000 common shares at a price of $31.60 per
share, expiring in five years. On August 20, 2002, 63,200 of the Series E
Convertible Preferred Shares were converted into 200,000 shares of common stock.
On May 6, 2003, 36,800 shares of Series E Preferred Shares were converted into
116,456 shares of common stock. On August 26, 2003 the remaining 200,000 shares
of Series E Preferred Shares were converted into 632,911 of common stock. On
September 9, 2003, 17,100 warrants were exercised, resulting in the issuance of
17,100 shares of common stock. During the fourth quarter of 2003, the remaining
267,900 common stock warrants were exercised, resulting in the issuance of
267,900 shares of common stock. Neither the conversions nor the warrant exercise
had an effect on the reported results of operations.
In March 2002, the Company issued 2,400,000 shares of its 9.00% Series F
Cumulative Redeemable Preferred Stock ("Series F Preferred Shares"), with a
$25.00 liquidation preference per share. This offering generated net proceeds of
approximately $58 million. The net proceeds were used to fund the Series B
preferred stock repurchase, property acquisitions, and property upgrades. The
Series F Preferred Shares are redeemable by the Company at anytime on or after
March 25, 2007 at a redemption price of $25.00 per share, plus any accumulated,
accrued and unpaid dividends. Each Series F Preferred share will receive an
annual dividend equal to 9.00% of the liquidation preference per share
(equivalent to a fixed annual amount of $2.25 per share).
The issuance of UPREIT Units for property acquisitions continues to be a source
of capital for the Company. During the first quarter of 2004, the Company
acquired four communities with 534 units for a total purchase price of $64.2
million. The Company issued UPREIT Units valued at approximately $11.9 million
as part of the consideration for two of the properties, with the balance funded
by the assumption of debt and cash. During 2003, the Company exercised an option
to acquire approximately 10 acres of land adjacent to one of its existing
properties for $2.8 million. In connection with this transaction, the Company
issued UPREIT Units valued at approximately $2.8 million. In addition, $2
million of UPREIT Units were issued to satisfy an existing liability.
During 2003, $30.3 million of common stock was issued under the Company's DRIP.
An additional $7.9 million has been raised through the DRIP program during the
first three months of 2004.
The DRIP was amended, effective April 10, 2001, in order to reduce management's
perceived dilution from issuing new shares at or below the underlying net asset
value. The discount on reinvested dividends and optional cash purchases was
reduced from 3% to 2%. The maximum monthly investment (without receiving
approval from the Company) was reduced from $5 thousand to $1 thousand. As
expected, these changes significantly reduced participation in the plan.
Management will continue to monitor the relationship between the Company's stock
price and estimated net asset value. During times when this difference is small,
management has the flexibility to issue waivers to DRIP participants to provide
for investments in excess of the $1 thousand maximum monthly investment. In
connection with the announcement of the February, 2002 dividend, the Company
announced such waivers will be considered beginning with the March 2002 optional
cash purchase, as management believed the stock was trading at or above its
estimate of net asset value. No such waivers were granted during the 2003 or the
first three months of 2004.
On August 6, 2002 the Board of Directors increased its authorization by
2,000,000 shares to repurchase its common stock or UPREIT Units in connection
with the Company's stock repurchase program. The shares/units may be repurchased
through open market or privately negotiated transactions at the discretion of
Company management. The Board's action does not establish a target stock price
or a specific timetable for share repurchase. During the first three months of
2004, there were no shares or UPREIT Units repurchased by the Company. At March
31, 2004 the Company had authorization to repurchase 3,135,800 shares of common
stock and UPREIT Units under the stock repurchase program.
As of March 31, 2004, excluding the effect of the FIN 46R consolidations, the
weighted average rate of interest on mortgage debt is 6.3% and the weighted
average maturity is approximately 8 years. Approximately 93% of the debt is
fixed rate. This limits the exposure to changes in interest rates, minimizing
the effect on results of operations and financial condition.
Off-Balance Sheet Investments
-----------------------------
Effective March 31, 2004, the Company adopted FASB Interpretation No. 46R -
Consolidation of Variable Interest Entities, an interpretation of ARB No. 51 -
Consolidated Financial Statements. The interpretation addresses consolidation by
businesses of special purpose entities (variable interest entities, "VIE"). The
Company has made a determination that all 41 of the remaining limited
partnerships are Variable Interest Entities. The Company has further determined
that it is the primary beneficiary in 34 of the limited partnerships and
therefore consolidated these entities effective March 31, 2004. Home Properties
determined that it is not the primary beneficiary in seven partnerships
syndicated under U.S. Department of Housing and Urban Development subsidy
programs. These seven investments will continue to be accounted for under the
equity method. For those seven investments, the Company will continue to record
its allocable share of the respective partnership's income or loss based on the
terms of the agreement. To the extent it is determined that the LPs cannot
absorb their share of the losses, if any, the GP will record the LPs share of
such losses. The Company will absorb such losses to the extent the Company has
outstanding loans or advances and the limited partner has no remaining capital
account. The Company has no loans or advances to these seven partnerships as of
March 31, 2004.
As indicated in Footnote 6, the Company is working towards a closing on Phase
III by June 30, 2004. If the Company is able to close by this date,
approximately $122 million of assets and $94 million of liabilities will be
removed from the balance sheet in the second quarter. The following table below
summarizes the effect of the consolidation requirements of FIN 46 on the balance
sheet as of March 31, 2004.
Consolidation Summary of the Balance Sheet as of March 31, 2004
(in thousands)
Effect of
March 31, 2004 FIN 46 March 31, 2004
(before FIN 46) Consolidation (as reported)
--------------- ------------- -------------
ASSETS
Real estate:
Land $ 399,991 $ 14,354 $ 414,345
Buildings, improvements and equipment 2,524,019 201,715 2,725,734
---------- -------- ----------
2,924,010 216,069 3,140,079
Less: accumulated depreciation ( 351,566) ( 63,750) ( 415,316)
---------- -------- ----------
Real estate, net 2,572,444 152,319 2,724,763
Cash and cash equivalents 6,254 850 7,104
Cash in escrows 40,650 7,645 48,295
Accounts receivable 3,412 1,248 4,660
Prepaid expenses 18,419 1,008 19,427
Investment in and advances to affiliates 4,256 ( 4,208) 48
Deferred charges 9,186 5,089 14,275
Other assets 7,337 284 7,621
---------- -------- ----------
Total assets $2,661,958 $164,235 $2,826,193
========== ======== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Mortgage notes payable $1,446,257 $129,149 $1,575,406
Line of credit 71,000 - 71,000
Accounts payable 14,710 888 15,598
Accrued interest payable 7,485 2,504 9,989
Accrued expenses and other liabilities 18,148 797 18,945
Security deposits 23,094 1,174 24,268
---------- -------- ----------
Total liabilities 1,580,694 134,512 1,715,206
---------- -------- ----------
Minority interest 327,332 30,044 357,376
---------- -------- ----------
Stockholders' equity 753,932 ( 321) 753,611
---------- -------- ----------
Total liabilities and stockholders' equity $2,661,958 $164,235 $2,826,193
========== ======== ==========
The Company, through its general partnership interest in certain affordable
property limited partnerships, has guaranteed the low income housing tax credits
to the limited partners for a period of either five or ten years in 23
partnerships totaling approximately $48 million. Such guarantee requires the
Company to operate the properties in compliance with Internal Revenue Code
Section 42 for 15 years. The weighted average number of compliance years
remaining is approximately 10 years. In addition, acting as the general partner
in certain partnerships, the Company is obligated to advance funds to meet
partnership operating deficits. Should operating deficits continue to occur, the
Company would determine on an individual partnership basis if it is in the best
interest of the Company to continue to fund these deficits.
The Company believes the properties operations conform to the applicable
requirements as set forth above and do not anticipate any payment on the low
income housing tax credit guarantees described above.
Acquisitions and Dispositions
-----------------------------
During the first quarter of 2004, the Company has acquired seven apartment
communities in four unrelated transactions. The acquisitions consisted of a
portfolio of four apartment communities with a total of 534 units in New Jersey,
two apartment communities in Maryland with a total of 468 units and one
apartment community in Massachusetts with a total of 276 units. The total
purchase price of $140.7 million, including closing costs, equated to an average
of $110,000 per apartment. Consideration included $61.4 million of assumed debt
(fair market value of $69.8 million), $67.4 million in cash and $11.9 million of
UPREIT Units in the Company (fair market value of $12.1 million). The UPREIT
Units are exchangeable for shares of the Company's common stock on a one-for-one
basis. For purposes of determining the number of UPREIT Units issued, a value of
$39.00 per unit was set when the transaction was negotiated. The combined
weighted average expected first year capitalization rate on these acquisitions
is 6.8%. Capitalization rate ("cap rate") is defined as the rate of interest
used to convert the first year expected net operating income ("NOI") less a 3.0%
management fee into a single present value. NOI is defined by the Company as
rental income and property other income less operating and maintenance expenses.
Management generally considers NOI to be an appropriate measure of operating
performance because it helps investors to understand the operations of a
community. In addition the apartment communities are valued and sold in the
market by using a multiple of NOI.
Contractual Obligations and Other Commitments
---------------------------------------------
The primary obligations of the Company relate to its borrowings under the line
of credit and mortgage notes payable. The Company's line of credit matures in
September 2005, and had $71 million outstanding at March 31, 2004. The $1.4
billion in mortgage notes payable from the Company's wholly owned properties,
before the effect of FIN 46, have varying maturities ranging from 1 to 38 years.
The weighted average interest rate of the Company's fixed rate notes was 6.41%
and 6.47% at March 31, 2004 and December 31, 2003, respectively. The weighted
average interest rate of the Company's variable rate notes and credit facility
was 2.28% and 2.32% at March 31, 2004 and December 31, 2003, respectively.
The Company has a non-cancelable operating ground lease for one of its
properties. The lease expires May 1, 2020, with options to extend the term of
the lease for two successive terms of twenty-five years each. The lease provides
for contingent rental payments based on certain variable factors. At March 31,
2004, future minimum rental payments required under the lease are $70 per year
until the lease expires.
The Company leases its corporate office space from an affiliate and the office
space for its regional offices from third parties. The corporate office space
requires an annual base rent plus a pro-rata portion of property improvements,
real estate taxes, and common area maintenance. The regional office leases
require an annual base rent plus a pro-rata portion of real estate taxes.
Capital Improvements
--------------------
The Company's policy is to capitalize costs related to the acquisition,
development, rehabilitation, construction and improvement of properties. Capital
improvements are costs that increase the value and extend the useful life of an
asset. Ordinary repair and maintenance costs that do not extend the useful life
of the asset are expensed as incurred. Costs incurred on a lease turnover due to
normal wear and tear by the resident are expensed on the turn. Recurring capital
improvements typically include: appliances, carpeting and flooring, HVAC
equipment, kitchen/ bath cabinets, new roofs, site improvements and various
exterior building improvements. Non- recurring, revenue generating capital
improvements include, among other items: community centers, new windows, and
kitchen/ bath apartment upgrades. Revenue generating capital improvements are
reasonably expected to result in rental earnings or expense savings. The Company
capitalizes interest and certain internal personnel costs related to the
communities under rehabilitation and construction.
The Company estimates that on an annual basis $525 per unit is spent on
recurring capital expenditures. During the three-month period ended March 31,
2004 approximately $131 per unit was estimated to be spent on recurring capital
expenditures. The table below summarizes the actual total capital improvements
incurred by major categories for the three-month periods ended March 31, 2004
and 2003 and an estimate of the breakdown of total capital improvements by major
categories between recurring and non-recurring, revenue generating capital
improvements for the three-month period ended March 31, 2004 as follows:
For the three-month period ended March 31,
(in thousands, except per unit data)
2004 2003
--------------------------------------------------------------------------------- ------------------------
Recurring Non-Recurring Total Capital Total Capital
Cap Ex Per Unit(a) Cap Ex Per Unit(a) Improvements Per Unit(a) Improvements Per Unit(a)
------ ----------- ------ ----------- ------------ ----------- ------------ -----------
New Buildings $ - $ - $ 553 $13 $ 553 $ 13 $ 387 $ 10
Major building improvements 944 23 2,495 60 3,439 83 3,415 85
Roof replacements 361 9 81 2 442 11 293 7
Site improvements 346 8 798 19 1,144 27 774 19
Apartment upgrades 681 16 5,818 140 6,499 156 7,656 190
Appliances 566 14 394 10 960 24 1,043 26
Carpeting/Flooring 1,775 43 526 13 2,301 56 2,266 56
HVAC/Mechanicals 523 13 2,350 57 2,873 70 2,253 56
Miscellaneous 230 5 775 19 1,005 24 840 21
Totals $5,426 $131 $13,790 $333 $19,216 $464 $18,927 $470
(a) Calculated using the weighted average number of units outstanding,
including 40,216 core units, 2003 acquisition units of 730 and 2004
acquisition units of 519 for the three-month period ended March 31, 2004
and 40,216 core units and 2003 acquisition units of 150 for the three-month
period ended March 31, 2003.
The schedule below summarizes the breakdown of total capital improvements
between core and non-core as follows:
For the three-month period ended March 31,
(in thousands, except per unit data)
2004 2003
--------------------------------------------------------------------------------- ------------------------
Recurring Non-recurring Total Capital Total Capital
Cap Ex Per Unit Cap Ex Per Unit Improvements Per Unit Improvements Per Unit
------ -------- ------ -------- ------------ -------- ------------ --------
Core Communities $5,263 $131 $13,737 $342 $19,000 $ 473 $18,915 $470
2004Acquisition Communities 68 131 2 4 70 135 - -
2003Acquisition Communities 95 131 51 70 146 201 12 82
Sub-total 5,426 131 13,790 333 19,216 464 18,927 469
2004 Disposed Communities - - - - - - -
2003 Disposed Communities - - - - - - 218 197
Corporate office expenditures (1) - - - - 630 - 540 -
$5,426 $131 $13,790 $333 $19,846 $ 464 $19,685 $462
(1) No distinction is made between recurring and non-recurring expenditures for
corporate office.
Results of Operations
---------------------
Summary of Core Properties
--------------------------
The Company had 145 apartment communities with 40,216 units which were owned
during both of the three-month periods being presented (the "Core Properties").
The Company has acquired an additional nine apartment communities with 2,008
units during 2004 and 2003 (the "Acquired Communities"). In addition, the
Company also disposed of seven properties with a total of 1,568 units during
2003 (the "Disposition Communities"). These dispositions have been classified as
discontinued operations. The inclusion of the Acquired Communities generally
accounted for the significant changes in operating results for the three-months
ended March 31, 2004.
A summary of the net operating income from Core Properties is as follows (in
thousands):
Three Month
-----------
2004 2003 $ Change % Change
---- ---- -------- --------
Rental income $ 104,547 $ 99,406 $ 5,141 5.2%
Property other income 3,928 3,545 383 10.8%
--------- --------- ------- ---
Total income 108,475 102,951 5,524 5.4%
Operating and Maintenance ( 52,718) ( 48,588) (4,130) (8.5%)
--------- --------- ------- ---
Net operating income $ 55,757 $ 54,363 $ 1,394 2.6%
========= ========= ======= ===
A summary of net operating income from continuing operations is as follows (in thousands):
Three Month
-----------
2004 2003 $ Change % Change
---- ---- -------- --------
Rental income $ 108,526 $ 100,183 $ 8,343 8.3%
Property other income 4,054 3,596 458 (12.7%)
--------- --------- ------- ---
Total income 112,580 103,779 8,801 8.5%
Operating and Maintenance ( 54,232) ( 48,651) (5,581) (11.5%)
--------- --------- ------- ---
Net operating income $ 58,348 $ 55,128 $ 3,220 5.8%
========= ========= ======= ===
Comparison of three-months ended March 31, 2004 to the same period in 2003
--------------------------------------------------------------------------
Of the $8,343 increase in rental income, $3,202 is attributable to the Acquired
Communities. The balance of this increase, or $5,141 which is from the Core
Properties, was the result of an increase of 2.4% in weighted average rental
rates, along with an increase in occupancy from 91.1% to 93.5%. Occupancy is
defined as total possible rental income, net of vacancy and bad debt expense as
a percentage of total possible rental income. Total possible rental income is
determined by valuing occupied units at contract rates and vacant units at
market rents.
Property other income, which consists primarily of income from operation of
laundry facilities, late charges, administrative fees, garage and carport
charges, net profits from corporate apartments, cable revenue, pet charges, and
miscellaneous charges to residents increased by $458. Of this increase, $75 is
attributable to the Acquired Communities and $383 represents a 10.8% increase
from the Core Properties.
Of the $5,581 increase in operating and maintenance expenses, $1,451 is
attributable to the Acquired Communities. The balance, a $4,130 increase, is
attributable to the Core Properties and is primarily due to increases in repairs
and maintenance, personnel costs, property insurance, and real estate taxes.
These increases were offset in part by savings in snow removal costs. The
increase in repairs and maintenance is primarily in the areas of contract
repair, painting, and cleaning. One of the underlying reasons for the increase
is the comparative quarter a year ago. The first quarter of 2003 did not
represent a "typical" first quarter relative to the level of activity usually
experienced. Last year maintenance staff were dealing with snow removal and
other effects of a very severe winter, rather than working on other projects
that more typically would have been done in the first quarter. In addition, as
the result of a sales and use tax audit in New York for the period June 1, 1999
through May 31, 2002, the Company was required to record additional expense of
$312 in contract repairs for sales tax not charged to the Company by its
vendors. The total cost to the Company as a result of the audit amounted to
$861. Of the remaining $549, $413 was capitalized to real estate assets and
$136, before minority interest, to loss on disposition of property. Personnel
expense increased compared to the same period one year ago due in part to an
increase in site level incentive compensation as a result of improving rent and
occupancies. Property insurance increased for the quarter primarily due to an
increase in our general liability loss reserve based on historical losses to
date which have been projected using actuarial assumptions. Real estate taxes
were up over the same quarter a year ago due to a reduction in capital stock
taxes in 2003 which we did not experience in the current year and a significant
reassessment on one particular property. Snow removal costs were down
significantly due to a normal winter this year compared to unusually severe
conditions a year ago.
General and administrative expense decreased in 2004 by $394, or 7.7%. General
and administrative expenses as a percentage of total revenues were 4.2% for 2004
as compared to 4.9% for 2003. The decrease is primarily due to the reduced level
of activity in the Management Companies as a result of the sale of the
Commercial Property division on January 1, 2004 and the sale of Phase I and II
during 2003.
Interest expense increased in 2004 by $386 as a result of the increased
borrowings in connection with acquisition of the 2004 Acquisition Communities, a
full quarter of interest expense for the 2003 Acquisition Communities and
additional mortgage debt and refinanced mortgage debt which took place during
2003. Interest expense in the first quarter of 2004 was reduced by $996 when two
mortgage loans were paid off early at amounts less than the amounts carried on
the Company's balance sheet. During 2003, then existing mortgage debt resulting
in new borrowings of approximately $46,000. Company closed on additional
mortgage debt of $80,100 and refinanced $24,000 in existing mortgage debt
resulting in new borrowings of approximately $46,000.
Depreciation and amortization expense increased $2,896 due to the depreciation
on the Acquisition Communities and the additions to the Core Properties.
Due to paying off two above rate mortgage loans early, prepayment penalties
totaling $196 were incurred during the first quarter of 2004. Due to the
prepayment of debt associated with the sale of Candlewood Apartments in Indiana
during the first quarter of 2003, a $1,349 charge was recorded for the
three-months ended March 31, 2003.
In the fourth quarter of 2002, the Company announced its intention to sell
virtually all of the assets associated with its general partner interests in the
affordable properties to focus solely on the direct ownership and management of
market rate apartment communities. The assets include principally loans,
advances and management contracts. During the first three-months of 2004, the
Company recorded impairment charges of $1,116. Of this total, $171 represents
advances made to certain of the affordable property limited partnerships during
the first three months of 2004 which the Company believes will not be repaid
upon the sale of the loans. The remaining $945 pertains to an additional net
impairment charge taken on Phase III to reduce the assets to fair market value.
The equity in earnings (losses) of unconsolidated affiliates of $538 is
primarily the result of the general partner recording a greater share of the
underlying investment's losses due to the loans and advances to certain of the
affordable property limited partnerships where the limited partner has no
capital account. This is pursuant to the accounting requirements of EITF 99-10,
"Percentage Used to Determine the Amount of Equity Method Losses." Included and
classified in this account are $484 of advances made during the first three
months of 2004 which the Company believes will not be repaid upon sale.
Minority interest increased $416 due to a general increase in income from
operations along with a increase in the Equity in earnings (losses) of
unconsolidated affiliates
In connection with the adoption of FIN 46, the Company recorded a $321
cumulative effect charge of a change in accounting principle in the first
quarter of 2004. This charge was the result of negative capital accounts of
minority interest partners that were absorbed by the Company.
Funds From Operations
---------------------
Pursuant to the revised definition of Funds From Operations ("FFO") adopted by
the Board of Governors of the National Association of Real Estate Investment
Trusts ("NAREIT"), FFO is defined as net income (computed in accordance with
accounting principles generally accepted in the United States of America
("GAAP")) excluding gains or losses from sales of property, minority interest,
extraordinary items and cumulative effect of change in accounting principle plus
depreciation from real property including adjustments for unconsolidated
partnerships and joint ventures less dividends from non-convertible preferred
shares. The Company considers debt extinguishment costs which are incurred as a
result of repaying property specific debt and non-cash real estate impairment
charges, as a component of the gain or loss on sale of the property. Because of
the limitations of the FFO definition as published by NAREIT as set forth above,
the Company has made certain interpretations in applying the definition. The
Company believes all adjustments not specifically provided for are consistent
with the definition.
Management believes that in order to facilitate a clear understanding of the
combined historical operating results of the Company, FFO should be considered
in conjunction with net income as presented in the consolidated financial
statements included elsewhere herein. Management believes that by excluding
gains or losses related to dispositions of property and excluding real estate
depreciation (which can vary among owners of similar assets in similar condition
based on historical cost accounting and useful life estimates), FFO can help one
compare the operating performance of a company's real estate between periods or
as compared to different companies. FFO does not represent cash generated from
operating activities in accordance with generally accepted accounting principles
and is not necessarily indicative of cash available to fund cash needs. Cash
provided by operating activities was $37,555 and $33,509 for the three-month
period ended March 31, 2004 and 2003, respectively. Cash used in investing
activities was $84,941 and $30,857 for three-month period ended March 31, 2004
and 2003, respectively. Cash provided by and (used in) financing activities was
$48,537 and ($2,635) for the three-month period ended March 31, 2004 and 2003,
respectively. FFO should not be considered as an alternative to net income as an
indication of the Company's performance or to cash flow as a measure of
liquidity.
The calculation of FFO and reconciliation to GAAP net income available to common
shareholders for the three-month ended March 31, 2004 and 2003 are presented
below (in thousands):
Three Months
2004 2003
---- ----
Net income available to common shareholders $4,580 $3,871
Convertible preferred dividends 548 2,168
Minority interest 2,468 2,052
Minority interest - income (loss) from discontinued operations - ( 55)
Depreciation and amortization from real property 21,151 18,444
Depreciation from real property from unconsolidated entities 543 549
Impairment on General Partner real estate investment 945 -
Loss on disposition of property 50 -
(Gain) loss on disposition of discontinued operations, net of minority interest 13 ( 451)
Impairment of real property included in income from operations of disposed
properties, before minority interest - 423
Prepayment penalty from early extinguishment of debt in connection with sale of
real estate - 1,349
Cumulative effect of change in accounting principle, net of minority interest 321 -
---------- ----------
FFO $30,619 $28,350
========== ==========
Weighted average common shares/units outstanding:
- Basic 48,340,834 43,606,285
========== ==========
- Diluted 48,893,465 43,803,428
========== ==========
All REITs may not be using the same definition for FFO. Accordingly, the above presentation may not be comparable to other similarly titled measures of FFO
of other REITs.
Covenants
---------
Series F Cumulative Redeemable Preferred Stock
----------------------------------------------
In connection with the issuance of the Series F Preferred Stock, the Company is
required to maintain for each fiscal quarterly period a fixed charge coverage
ratio, as defined in the Series F Cumulative Redeemable Preferred Stock Article
Supplementary, of 1.75 to 1.0. The fixed charge coverage ratio and the
components thereof do not represent a measure of cash generated from operating
activities in accordance with generally accepted accounting principles and are
not necessarily indicative of cash available to fund cash needs. Further, this
ratio should not be considered as an alternative measure to net income as an
indication of the Company's performance or of cash flow as a measure of
liquidity. The calculation of the fixed charge coverage ratio for the four most
recent quarters since the issuance of the Series F Preferred Stock are presented
below (in thousands). Net operating income from discontinued operations in the
calculation below is defined as total revenues from discontinued operations less
operating and maintenance expenses.
Calculation Presented for Series F Covenants
--------------------------------------------
Three-months ended
------------------
Mar. 31 Dec 31 Sept. 30 June 30
2004 2003 2003 2003
---- ---- ---- ----
EBITDA
Total revenues $113,197 $111,458 $111,200 $109,713
Net operating income from discontinued operations - 80 460 -
Operating and maintenance ( 54,232) ( 48,698) ( 46,472) ( 46,040)
General and administrative ( 4,725) ( 8,236) ( 4,670) ( 4,582)
Impairment of assets held as General Partner ( 1,116) ( 110) ( 1,888) ( 93)
Equity in earnings (losses) of unconsolidated
affiliates ( 538) ( 395) ( 313) ( 444)
-------- -------- -------- --------
$ 52,586 $ 54,099 $ 58,317 $ 58,554
Fixed Charges
Interest expense $ 21,332 $ 21,595 $ 21,456 $ 21,634
Interest expense on discontinued operations - 79 116 -
Preferred dividends 1,898 1,984 2,646 3,192
Capitalized interest 171 230 230 230
-------- -------- -------- --------
$ 23,401 $ 23,888 $ 24,448 $ 25,056
Times Coverage ratio: 2.25 2.26 2.39 2.34
Line of Credit
--------------
The Credit Agreement relating to the Company's line of credit provides for the
Company to maintain certain financial ratios and measurements. One of these
covenants is that the Company may not pay any distribution to its shareholders
and holders of its UPREIT Units if a distribution, when added to other
distributions paid during the three immediately preceding fiscal quarters,
exceeds the greater of : (i) 90% of funds from operations, and 110% of cash
available for distribution; and (ii) the amount required to maintain the
Company's status as a REIT. During the first quarter of 2004, the funds from
operations payout ratio was 90.5% when measured for the calendar year. Due to
the granting of restricted stock to the retiring Co-CEO's in the fourth quarter
of 2003 the Company did not meet the required ratio. Waivers have been granted
by the participating banks for the charges incurred in 2003.
Economic Conditions
-------------------
Substantially all of the leases at the Company's apartment communities are for a
term of one year or less, which enables the Company to seek increased rents upon
renewal of existing leases or commencement of new leases. These short-term
leases minimize the potential adverse effect of inflation on rental income,
although residents may leave without penalty at the end of their lease terms and
may do so if rents are increased significantly.
Historically, real estate has been subject to a wide range of cyclical economic
conditions, which affect various real estate sectors and geographic regions with
differing intensities and at different times. During 2002, 2003 and continuing
into 2004 many regions of the United States have experienced varying degrees of
economic recession and certain recessionary trends, such as the cost of
obtaining sufficient property and liability insurance coverage, short-term
interest rates, and a temporary reduction in occupancy. In light of this, we
will continue to review our business strategy however, we believe that given our
property type and the geographic regions in which we are located, we do not
anticipate any changes in our strategy or material effects in financial
performance.
Declaration of Dividend
-----------------------
On May 5, 2004, the Board of Directors approved a dividend of $.62 per share for
the quarter ended March 31, 2004. This is the equivalent of an annual
distribution of $2.48 per share. The dividend is payable May 28, 2004 to
shareholders of record on May 17, 2004.
On May 5, 2004 the Company also declared a regular dividend of $0.5625 per share
on its Series F Cumulative Redeemable Preferred Stock, for the quarter ending
May 31, 2004. The dividend on the preferred shares is payable on June 1, 2004,
to shareholders of record on May 17, 2004. This dividend is equivalent to an
annualized rate of $2.25 per share.
Contingency
-----------
In 2001, the Company underwent a state tax audit. The state has assessed taxes
of $469,000 for the 1998 and 1999 tax years under audit. If the state's position
is applied to all tax years through December 31, 2001, the assessment would be
$1.3 million. At the time, the Company believed the assessment and the state's
underlying position were not supportable by the law nor consistent with
previously provided interpretative guidance from the office of the State
Secretary of Revenue. After two subsequent enactments by the state legislation
during 2002 affecting the pertinent tax statute, the Company was advised by
outside tax counsel that its filing position for 1998-2001 should prevail.
During December 2003, the state's governor signed legislation which included the
REIT tax provisions. Based upon this, Company's tax counsel expects that the
outstanding litigation should now be able to be resolved. Effective January 1,
2003, the Company reorganized the ownership of Home Properties Trust, which
should subject the Company to a much lower level of tax going forward.
New Accounting Standard
-----------------------
In March 2004, the FASB issued EITF 03-6 "Participating Securities and the
Two-Class Method under FASB Statement 128, Earnings per Share. EITF 03-6
addresses a number of questions regarding the computation of earnings per share
by companies that have issued securities other than common stock that
contractually entitle the holder to participate in dividends and earnings of the
company when, and if, it declares dividends on its common stock. The issue also
provides further guidance in applying the two-class method of calculating EPS.
It clarifies what constitutes a participating security and how to apply the
two-class method of computing EPS once it is determined that a security is
participating, including how to allocate undistributed earnings to such a
security. The EITF is effective for the first fiscal periods beginning after
March 31, 2004. The provisions of EITF 03-6 are not expected to have a material
impact on the Company's financial statements.
In May 2003, FASB issued SFAS 150, "Accounting for Certain Financial Instruments
with Characteristics of Both Liabilities and Equity." This Statement establishes
standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity. It requires
that an issuer classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). This Statement is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. On October 29, 2003 the FASB indefinitely deferred the provisions of
paragraphs 9 and 10 of SFAS 150 as they apply to mandatorily redeemable
noncontrolling interests. This deferral applies to minority interest ownerships
in limited partnerships which are mandatorily redeemable upon termination of the
partnership and therefore is potentially applicable to the affordable portfolio.
The Company's investments in the limited partnerships consolidated under FIN 46R
have a mandatory redeemable feature upon termination of the partnership.
However, due to the tax credit restrictions on the consolidated partnerships, if
the partnerships were terminated prior to the end of the tax credit compliance
periods, the partnership would be liable to fund the tax credits payable to the
limited partners.
HOME PROPERTIES, INC.
ITEM 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
The percentages and loan balances discussed below are prior to FIN 46
consolidations on the balance sheet to provide a better comparison to the
December 31, 2003 balance sheet.
The Company's primary market risk exposure is interest rate risk. At March 31,
2004 and December 31, 2003, approximately 93% and 98%, respectively, of the
Company's debt bore interest at fixed rates with a weighted average maturity of
approximately 8 years and a weighted average interest rate of approximately
6.41% and 6.47%, respectively, including the $25.2 million of debt for both
years which has been swapped to a fixed rate. The remainder of the Company's
debt bears interest at variable rates with a weighted average maturity of
approximately 7 and 2 years, respectively, and a weighted average interest rate
of 2.28% and 2.32%, respectively, at March 31, 2004 and December 31, 2003. The
Company does not intend to utilize a significant amount of permanent variable
rate debt to acquire properties in the future. On occasion, the Company may use
its line of credit in connection with a property acquisition with the intention
to refinance at a later date. The Company believes, however, that in no event
would increases in interest expense as a result of inflation significantly
impact the Company's distributable cash flow.
At March 31, 2004 and December 31, 2003, the interest rate risk on $25.2 million
of such variable rate debt has been mitigated through the use of interest rate
swap agreements (the "Swaps") with major financial institutions. The Company is
exposed to credit risk in the event of non-performance by the counter-parties to
the Swaps. The Company believes it mitigates its credit risk by entering into
these Swaps with major financial institutions. The Swaps effectively convert an
aggregate of $25.2 million in variable rate mortgages to fixed rates of 5.91%,
8.22% and 8.40%.
At March 31, 2004 and December 31, 2003, the fair value of the Company's fixed
rate debt, including the $25.2 million which was swapped to a fixed rate,
amounted to a liability of $1.6 billion compared to its carrying amount of $1.4
billion. The Company estimates that a 100 basis point decrease in market
interest rates at March 31, 2004 would have changed the fair value of the
Company's fixed rate debt to a liability of $1.7 billion.
The Company intends to continuously monitor and actively manage interest costs
on its variable rate debt portfolio and may enter into swap positions based upon
market fluctuations. In addition, the Company believes that it has the ability
to obtain funds through additional equity offerings or the issuance of UPREIT
Units. Accordingly, the cost of obtaining such interest rate protection
agreements in relation to the Company's access to capital markets will continue
to be evaluated. The Company has not, and does not plan to, enter into any
derivative financial instruments for trading or speculative purposes. As of
March 31, 2004, the Company had no other material exposure to market risk.
HOME PROPERTIES, INC.
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in the reports filed or
submitted by the Company under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms, and that such information
is accumulated and communicated to the Company's Chief Executive Officer and
Chief Financial Officer, as appropriate to allow timely decisions regarding
required disclosure. In designing and evaluating the disclosure controls and
procedures, management recognized that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives, and management necessarily was
required to apply its judgment in evaluating the cost-benefit relationship of
possible controls and procedures.
The Chief Executive Officer and Chief Financial Officer as of the end of the
period covered by this report, evaluated the effectiveness of the disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended) and have determined that such
disclosure controls and procedures are effective. There have been no changes in
the internal controls over financial reporting identified in connection with the
evaluation, or that occurred during the first quarter of the year ended December
31, 2004, that has materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting. The Company has
not identified any material weaknesses in its internal controls. Accordingly, no
corrective actions have been taken.
PART II - OTHER INFORMATION
HOME PROPERTIES, INC.
Item 6. Exhibits and Reports or Form 8-K
----------------------------------------
(a) Exhibit 3.11 Articles of Amendment to the Articles of Incorporation
of Home Properties of New York, Inc.
Exhibit 3.12 Amendment Number One to the Home Properties of New
York, Inc. Amended and Restated Bylaws
Exhibit 31.1 Section 302 Certifications of Chief Executive Officer
Exhibit 31.2 Section 302 Certification of Chief Financial Officer
Exhibit 32.1 Section 906 Certifications of Chief Executive Officer
Exhibit 32.2 Section 906 Certification of Chief Financial Officer
(b) Reports on Form 8-K:
- Form 8-K was furnished on April 30, 2004, date of report
April 30, 2004, as amended by Form 8-K/A filed on May 4,
2004, with respect to Items 7 and 12 disclosures regarding
the Registrant's press release announcing its results for
the first quarter of 2004 and the first quarter 2004
investor conference call.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HOME PROPERTIES, INC.
---------------------
(Registrant)
Date: May 10, 2004
-------------------------------------
By: /s/ Edward J. Pettinella
-------------------------------------
Edward J. Pettinella
President and Chief Executive Officer
Date: May 10, 2004
-------------------------------------
By: /s/ David P. Gardner
-------------------------------------
David P. Gardner
Executive Vice President and
Chief Financial Officer