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 September 30, 2004
-------------------------------------------------
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR
15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-13136
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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 October 31, 2004
--------------------- -------------------------------
$.01 par value 33,500,009
HOME PROPERTIES, INC.
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets -
September 30, 2004 (Unaudited) and December 31, 2003 3
Consolidated Statements of Operations (Unaudited) -
Nine months ended September 30, 2004 and 2003 4
Consolidated Statements of Operations (Unaudited) -
Three months ended September 30, 2004 and 2003 5
Consolidated Statements of Comprehensive Income (Unaudited) -
Nine months ended September 30, 2004 and 2003 6
Consolidated Statements of Comprehensive Income (Unaudited) -
Three months ended September 30, 2004 and 2003 7
Consolidated Statements of Cash Flows (Unaudited) -
Nine months ended September 30, 2004 and 2003 8
Notes to Consolidated Financial Statements (Unaudited) 9-21
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 22-35
Item 3. Quantitative and Qualitative Disclosures About Market Risk 36
Item 4. Controls and Procedures 37
PART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 38
Item 6. Exhibits 38
Signatures 39
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HOME PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2004 AND DECEMBER 31, 2003
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
2004 2003
(Unaudited) (Note 1)
----------- --------
ASSETS
Real estate:
Land $ 407,357 $ 387,655
Buildings, improvements and equipment 2,656,669 2,365,337
Real estate held for sale or disposal, net 79,607 -
---------- ----------
3,143,633 2,752,992
Less: accumulated depreciation ( 390,757) ( 330,062)
---------- ----------
Real estate, net 2,752,876 2,422,930
Cash and cash equivalents 8,267 5,103
Cash in escrows 44,465 39,660
Accounts receivable 5,900 4,437
Prepaid expenses 20,128 18,184
Investment in and advances to affiliates 27 5,253
Deferred charges 13,533 9,057
Other assets 2,944 8,693
---------- ----------
Total assets $2,848,140 $2,513,317
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Mortgage notes payable $1,632,230 $1,380,696
Line of credit 70,500 -
Accounts payable 24,118 13,178
Accrued interest payable 8,869 7,013
Accrued expenses and other liabilities 22,629 18,959
Security deposits 23,683 21,664
---------- ----------
Total liabilities 1,782,029 1,441,510
---------- ----------
Commitments and contingencies
Minority interest 316,294 330,544
---------- ----------
Stockholders' equity:
Cumulative redeemable preferred stock, $.01 par value; 2,400,000 shares issued
and outstanding at September 30, 2004 and December 31, 2003 60,000 60,000
Convertible cumulative preferred stock, $.01 par value; 10,000,000 shares
authorized; 250,000 shares issued and outstanding at September 30, 2004 and
December 31, 2003 25,000 25,000
Common stock, $.01 par value; 80,000,000 shares authorized; 33,485,255 and
31,966,240 shares issued and outstanding at September 30, 2004 and
December 31, 2003, respectively 335 320
Excess stock, $.01 par value; 10,000,000 shares authorized; no shares
issued or outstanding - -
Additional paid-in capital 838,532 785,710
Accumulated other comprehensive income ( 544) ( 542)
Distributions in excess of accumulated earnings ( 173,428) ( 128,910)
Officer notes for stock purchases ( 78) ( 315)
---------- ----------
Total stockholders' equity 749,817 741,263
---------- ----------
Total liabilities and stockholders' equity $2,848,140 $2,513,317
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
HOME PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(UNAUDITED, IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
2004 2003
---- ----
Revenues:
Rental income $331,496 $304,370
Property other income 13,373 11,366
Interest and dividend income 448 351
Other income 1,968 3,349
------- -------
Total revenues 347,285 319,436
------- -------
Expenses:
Operating and maintenance 153,438 138,099
General and administrative 14,496 14,371
Interest 68,060 64,693
Depreciation and amortization 67,377 57,140
Impairment of assets held as General Partner 1,116 2,408
------- -------
Total expenses 304,487 276,711
------- -------
Income from operations 42,798 42,725
Equity in earnings (losses) of unconsolidated affiliates ( 538) ( 1,497)
------- -------
Income before minority interest and discontinued operations 42,260 41,228
Minority interest in operating partnership ( 11,844) ( 11,473)
------- -------
Income from continuing operations 30,416 29,755
------- -------
Discontinued operations
Income (loss) from operations, net of ($805) in 2004 and $567 in 2003
allocated to minority interest ( 1,679) 1,020
Gain (loss) on disposition of property, net of ($2,949) in 2004 and $207 in
2003 allocated to minority interest ( 6,305) 355
------- -------
Discontinued operations ( 7,984) 1,375
------- -------
Income before loss on disposition of property and business and cumulative
effect of change in accounting principle 22,432 31,130
Loss on disposition of property and business, net of $33 in 2004 and
$1 in 2003 allocated to minority interest ( 67) ( 2)
------- -------
Income before cumulative effect of change in accounting principle 22,365 31,128
Cumulative effect of change in accounting principle, net of $159 in 2004 and
$0 in 2003 allocated to minority interest ( 321) -
------- -------
Net income 22,044 31,128
Preferred dividends ( 5,695) ( 9,356)
------- -------
Net income available to common shareholders $16,349 $21,772
======= =======
Basic earnings per share data:
Income from continuing operations $ .75 $ .71
Discontinued operations ( .24) .05
Cumulative effect of change in accounting principle ( .01) -
------ ------
Net income available to common shareholders $ .50 $ .76
====== ======
Diluted earnings per share data:
Income from continuing operations $ .74 $ .71
Discontinued operations ( .24) .04
Cumulative effect of change in accounting principle ( .01) -
------ ------
Net income available to common shareholders $ .49 $ .75
====== ======
Weighted average number of shares outstanding:
- Basic 32,840,672 28,485,398
========== ==========
- Diluted 33,280,680 28,874,160
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
HOME PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(UNAUDITED, IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
2004 2003
---- ----
Revenues:
Rental income $113,237 $103,792
Property other income 4,750 3,855
Interest and dividend income 150 95
Other income 805 1,028
---------- ---------
Total revenues 118,942 108,770
---------- ---------
Expenses:
Operating and maintenance 50,372 45,512
General and administrative 4,879 4,670
Interest 23,496 21,430
Depreciation and amortization 23,445 19,624
Impairment of assets held as General Partner - 1,888
---------- ---------
Total expenses 102,192 93,124
---------- ---------
Income from operations 16,750 15,646
Equity in earnings (losses) of unconsolidated affiliates 25 ( 313)
---------- ---------
Income before minority interest and discontinued operations 16,775 15,333
Minority interest in operating partnership ( 4,746) ( 4,482)
---------- ---------
Income from continuing operations 12,029 10,851
---------- ---------
Discontinued operations
Income (loss) from operations, net of ($135) in 2004 and $389 in 2003
allocated to minority interest ( 288) 710
Gain (loss) on disposition of property, net of ($3,195) in 2004 and $19 in
2003 allocated to minority interest ( 6,816) 35
---------- ---------
Discontinued operations ( 7,104) 745
---------- ---------
Income before gain on disposition of property and business 4,925 11,596
Gain on disposition of property and business, net of $5 allocated to minority
interest - 8
---------- ---------
Net income 4,925 11,604
Preferred dividends ( 1,898) ( 2,646)
---------- ---------
Net income available to common shareholders $ 3,027 $ 8,958
========== =========
Basic earnings per share data:
Income from continuing operations $ .30 $ .28
Discontinued operations ( .21) .02
------ ------
Net income available to common shareholders $ .09 $ .30
====== ======
Diluted earnings per share data:
Income from continuing operations $ .30 $ .27
Discontinued operations ( .21) .03
------ ------
Net income available to common shareholders $ .09 $ .30
====== ======
Weighted average number of shares outstanding:
Basic 33,293,905 29,522,274
========== ==========
Diluted 33,737,974 30,037,671
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
HOME PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(UNAUDITED, IN THOUSANDS)
2004 2003
---- ----
Net income $22,044 $31,128
Other comprehensive income (net of minority interest):
Change in fair value of hedge instruments ( 2) 265
------- -------
Comprehensive income $22,042 $31,393
======= =======
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 SEPTEMBER 30, 2004 AND 2003
(UNAUDITED, IN THOUSANDS)
2004 2003
---- ----
Net income $ 4,925 $11,604
Other comprehensive income (net of minority interest):
Change in fair value of hedge instruments ( 225) 173
--------- -------
Comprehensive income $ 4,700 $11,777
========= =======
The accompanying notes are an integral part of these consolidated financial
statements.
HOME PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
(UNAUDITED, IN THOUSANDS)
2004 2003
---- ----
Cash flows from operating activities:
Net income $ 22,044 $ 31,128
----------- -----------
Adjustments to reconcile net income to net cash provided by operating
activities:
Equity in (earnings) losses of unconsolidated affiliates 538 1,497
Income allocated to minority interest 7,898 12,246
Depreciation and amortization 72,524 59,681
Impairment of assets held as General Partner 1,116 2,408
Impairment of real property 1,100 423
Gain on disposition of property and business ( 562) ( 559)
Loss from early extinguishment of debt 102 1,610
Cumulative effect of change in accounting principle 480 -
Changes in assets and liabilities:
Other assets 2,628 517
Accounts payable and accrued liabilities 15,592 ( 418)
----------- -----------
Total adjustments 101,416 77,405
----------- -----------
Net cash provided by operating activities 123,460 108,533
----------- -----------
Cash flows used in investing activities:
Purchase of properties and other assets, net of mortgage
notes assumed and UPREIT Units issued (153,535) ( 66,760)
Additions to properties ( 74,138) ( 78,658)
Proceeds from sale of properties and business, net 24,927 38,313
Proceeds from sale of affordable properties, net 1,387 -
Advances to affiliates ( 820) ( 2,445)
Payments on advances to affiliates 149 7,411
----------- -----------
Net cash used in investing activities (202,030) (102,139)
----------- -----------
Cash flows from financing activities:
Proceeds from sale of common stock, net 30,249 29,688
Repurchase of treasury stock ( 2,189) -
Proceeds from mortgage notes payable 126,674 77,367
Payments of mortgage notes payable ( 45,251) ( 56,939)
Payment of prepayment penalty in connection with the early
extinguishment of debt ( 102) ( 1,610)
Proceeds from line of credit 201,500 154,000
Payments on line of credit (131,000) (125,000)
Payments of deferred loan costs ( 1,914) ( 822)
Withdrawals from (additions to) cash escrows, net ( 1,371) 4,646
Repayment of officer loans 237 453
Dividends and distributions paid ( 95,949) ( 89,708)
----------- -----------
Net cash provided by (used in) financing activities 80,884 ( 7,925)
----------- -----------
Net increase (decrease) in cash and cash equivalents 2,314 ( 1,531)
Cash and cash equivalents:
Beginning of year 5,103 8,782
Cash assumed in connection with FIN 46R consolidation
850 -
----------- -----------
End of period $ 8,267 $ 7,251
========== ==========
Supplemental disclosure of non-cash operating, investing and financing
activities:
Mortgage loans assumed associated with property acquisitions $ 90,569 $ 25,235
Conversion of preferred to common stock - 73,180
Exchange of UPREIT Units/partnership interest for common shares 14,015 4,686
Fair value of hedge instruments 1,012 1,205
Issuance of UPREIT Units associated with property and other acquisitions 12,105 4,806
Increase in real estate associated with the purchase of UPREIT Units 12,470 3,000
Compensation cost of stock options issued 684 675
Net real estate assumed in connection with FIN 46R consolidation 152,319 -
Other assets assumed in connection with FIN 46R consolidation 11,916 -
Mortgage debt assumed in connection with FIN 46R consolidation 129,149 -
Other liabilities assumed in connection with FIN 46R consolidation 5,363 -
Net real estate disposed in connection with FIN 46R consolidation 69,743 -
Other assets disposed in connection with FIN 46R consolidation 3,054 -
Mortgage debt disposed in connection with FIN 46R consolidation 48,611 -
Other liabilities disposed in connection with FIN 46R consolidation 2,759 -
The accompanying notes are an integral part of these consolidated financial
statements.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1. Unaudited Interim Financial Statements
--------------------------------------
The interim consolidated financial statements of Home Properties, Inc. (the
"Company") have been prepared in accordance with accounting principles
generally accepted in the United States of America for interim financial
information and the applicable rules and regulations of the Securities and
Exchange Commission. Accordingly, certain disclosures that would accompany
annual financial statements prepared in accordance with accounting
principles generally accepted in the United States of America are omitted.
The year-end balance sheet data was derived from audited financial
statements, but does not include all disclosures required by accounting
principles generally accepted in the United States of America. In the
opinion of management, all adjustments, consisting solely of normal
recurring adjustments, necessary for the fair presentation of the
consolidated financial statements for the interim periods have been
included. The current period's results of operations are not necessarily
indicative of results which ultimately may be achieved for the year. The
interim consolidated financial statements and notes thereto should be read
in conjunction with the consolidated financial statements and notes thereto
included in the Company's Form 10-K for the year ended December 31, 2003.
2. Organization and Basis of Presentation
--------------------------------------
Organization
------------
The Company is engaged primarily in the ownership, management, acquisition,
and rehabilitation of residential apartment communities in the Northeast,
Mid-Atlantic, Midwest and Southeast Florida. As of September 30, 2004, the
Company operated 48,010 apartment communities with 187 apartments. Of this
total, the Company owned 153 communities, consisting of 42,822 apartments
("Owned Communities"), managed as general partner 3,766 apartments and fee
managed 1,422 apartments for affiliates and third parties.
Basis of Presentation
---------------------
The accompanying consolidated financial statements include the accounts of
the Company and its 68.3% (65.5% at September 30, 2003) partnership
interest in Home Properties, L.P. (the "Operating Partnership"). Such
interest has been calculated as the percentage of outstanding common shares
divided by the total outstanding common shares and Operating Partnership
Units ("UPREIT Units") outstanding. The remaining 31.7% (34.5% at September
30, 2003) is reflected as Minority Interest in these consolidated financial
statements. The Company owns a 1.0% general partner interest in the
Operating Partnership and the remainder as a limited partner through its
wholly owned subsidiary, Home Properties I, LLC, which owns 100% of the
limited partner, Home Properties Trust. Home Properties Trust was formed in
September 1997, as a Maryland real estate trust and as a qualified REIT
subsidiary ("QRS") and owns the Company's share of the limited partner
interests in the Operating Partnership. For financing purposes, the Company
has formed a limited liability company (the "LLC") and a partnership (the
"Financing Partnership"), which beneficially own certain apartment
communities encumbered by mortgage indebtedness. The LLC is wholly owned by
the Operating Partnership. The Financing Partnership is owned 99.9% by the
Operating Partnership and 0.1% by the QRS.
The accompanying consolidated financial statements include the accounts of
two wholly owned subsidiaries, Home Properties Management, Inc. and Home
Properties Resident Services, Inc. (the "Management Companies"). All
significant inter-company balances and transactions have been eliminated in
these consolidated financial statements.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
2. Organization and Basis of Presentation (continued)
--------------------------------------------------
Through March 30, 2004, the Company accounted for its investment as
managing general partner ("GP") in unconsolidated affordable housing
limited partnerships ("LP") using the equity method of accounting.
Effective March 31, 2004, the Company adopted FASB Interpretation No. 46R,
Consolidation of Variable Interest Entities ("FIN 46R"). This
interpretation addresses consolidation by business enterprises of variable
interest entities in which the equity investment at risk is not sufficient
to permit the entity to finance its activities without additional
subordinated financial support from other parties or in which the equity
investors do not have the characteristics of a controlling financial
interest. This interpretation requires a variable interest entity to be
consolidated by a company if that company is subject to a majority of the
risk of loss from the variable interest entity's activities or entitled to
receive a majority of the entity's residual returns or both. The
interpretation also requires disclosures about variable interest entities
that the company is not required to consolidate but in which it has a
significant variable interest. As of March 31, 2004, the Company was the
general partner in 41 limited partnerships in Upstate New York,
Pennsylvania, Ohio and Maryland. The Company had made a determination that
all 41 limited partnerships were Variable Interest Entities ("VIEs"). The
Company had further determined that it was the primary beneficiary in 34 of
the VIEs and therefore consolidated these entities effective March 31,
2004. Beginning with the second quarter of 2004, the Company consolidated
the results of operations of the VIEs. The results of operations of the 34
VIE's for both the three and nine-month periods ending September 30, 2004,
are included in discontinued operations. These properties are classified as
held for sale because as of September 30, 2004, 22 of the partnerships had
been sold, the Company is under contract or a letter of intent to sell nine
of the partnerships for which due diligence is in process, one partnership
is being marketed for sale and the remaining two partnerships are being
disposed of through a default on the non-recourse financing. The Company
has met with the federal agency that insured the financing. The agency has
agreed that the Company may continue to manage the property until the
agency can auction off the loan in a note sale. The note sale is expected
to occur in March, 2005, but it may occur later.
Home Properties determined that it is not the primary beneficiary in seven
partnerships syndicated under U.S. Department of Housing and Urban
Development subsidy programs. These seven investments will continue to be
accounted for under the equity method. For those seven investments, the
Company will continue to record its allocable share of the respective
partnership's income or loss based on the terms of the agreement. To the
extent it is determined that the LPs cannot absorb their share of the
losses, if any, the GP will record the LPs share of such losses. The
Company will absorb such losses to the extent the Company has outstanding
loans or advances and the limited partner has no remaining capital account.
Reclassifications
-----------------
Certain reclassifications have been made to the 2003 consolidated financial
statements to conform to the 2004 presentation.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
3. Adoption of New Accounting Policies
-----------------------------------
Effective January 1, 2003, the Company adopted the provisions of SFAS 148
"Accounting for Stock Based Compensation - An Amendment of SFAS 123." Under
the transition provisions of this Statement, the Company has elected the
"Modified Prospective Method" for recognizing stock-based compensation
costs. Under this method the Company recognizes stock-based compensation
cost from the beginning of the fiscal year in which the recognition
provisions are first applied as if the fair value based accounting method
in this Statement had been used to account for all employee awards granted,
modified, or settled in fiscal years beginning after December 15, 1994. For
the three and nine-months ended September 30, 2004, the Company recognized
$549 and $1,550, respectively, in stock compensation costs related to its
stock compensation plans, and $424 and $1,076, respectively, for the three
and nine-months ended September 30, 2003. Of these totals, $245 and $684,
for the three and nine-month periods ended September 30, 2004,
respectively, related to the expensing of stock compensation costs
associated with stock options granted by the Company. The remaining $304
and $866, for the three and nine-month periods ended September 30, 2004,
respectively, pertains to the stock compensation costs recognized by the
Company relative to its restricted stock grants. For the three and
nine-months ended September 30, 2003, $266 and $675, respectively, related
to the expensing of stock compensation costs associated with stock options
granted by the Company. The remaining $158 and $401, for the three and
nine-months ended September 30, 2003, respectively, pertains to the stock
compensation costs recognized by the Company relative to its restricted
stock grants.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following assumptions used
for grants in 2004 and 2003: dividend yields ranging from 6.74% to 8.07%;
expected volatility ranging from 19.00% to 19.79%; 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
3.22% to 4.11%.
Effective April 1, 2004 the Company adopted the provisions of 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 adoption of EITF 03-6 had no impact on the Company's results
of operations, financial position, or liquidity.
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 are
consolidated under FIN 46R and 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.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
4. Earnings Per Common Share
-------------------------
Basic earnings per share ("EPS") is computed as net income available to
common shareholders divided by the weighted average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution
that could occur from common shares issuable through stock-based
compensation including stock options, restricted stock, phantom shares
under the Company's incentive compensation plan, warrants and the
conversion of any cumulative convertible preferred stock. The exchange of
an Operating Partnership Unit for common stock will have no effect on
diluted EPS as Unitholders and stockholders effectively share equally in
the net income of the Operating Partnership. Income from continuing
operations is the same for both the basic and diluted calculation.
The reconciliation of the basic and diluted earnings per share for the nine
and three-months ended September 30, 2004 and 2003 is as follows:
Nine Months Three Months
----------- ------------
2004 2003 2004 2003
---- ---- ---- ----
Income from continuing operations $30,416 $29,755 $12,029 $10,851
Less: Gain (loss) on disposal of property ( 67) ( 2) - 8
Less: Preferred dividends ( 5,695) ( 9,356) ( 1,898) ( 2,646)
---------- ---------- ---------- ----------
Basic and Diluted - Income from continuing
operations applicable to common shareholders 24,654 20,397 10,131 8,213
Less: Cumulative effect of change in accounting
principle ( 321) - - -
Discontinued operations ( 7,984) 1,375 ( 7,104) 745
---------- ---------- ---------- ----------
Net income available to common shareholders $16,349 $21,772 $ 3,027 $ 8,958
========== ========== ========== ==========
Basic weighted average number of shares outstanding 32,840,672 28,485,398 33,293,905 29,522,274
Effect of dilutive stock options 360,045 322,176 371,308 451,260
Effect of phantom and restricted shares 79,963 66,586 72,761 64,137
---------- ---------- ---------- ----------
Diluted weighted average number of shares
outstanding 33,280,680 28,874,160 33,737,974 30,037,671
========== ========== ========== ==========
Basic earnings per share
Income from continuing operations $.75 $.71 $.30 $.28
Discontinued operations (.24) .05 (.21) .02
Cumulative effect of change in accounting
principle (.01) - - -
---- ---- ---- ----
Net Income available to common shareholders $.50 $.76 $.09 $.30
==== ==== ==== ====
Basic earnings per share
Income from continuing operations $.74 $.71 $.30 $.27
Discontinued operations (.24) .04 (.21) .03
Cumulative effect of change in accounting
principle (.01) - - -
---- ---- ---- ----
Net Income available to common shareholders $.49 $.75 $.09 $.30
==== ==== ==== ====
Unexercised stock options and warrants to purchase 733,970 shares the
Company's common stock for the nine-month period ended September 30, 2003
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 this period. For the nine and three-month periods ended
September 30, 2004 the 833,333 common stock equivalents on an as-converted
basis of the Series D Convertible Cumulative Preferred Stock have an
antidilutive effect and are not included in the computation of diluted EPS.
In addition, for the nine- and three-month periods ended September 30,
2003, the 2,657,914 and 1,951,605, respectively, common stock equivalents
on an as-converted basis, of the Series C, D and E Convertible Cumulative
Preferred Stock have an antidilutive effect and are not included in the
computation of diluted EPS.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
5. Other income
------------
Other income for the nine- and three-month periods ended September 30, 2004
and 2003 represents management fee income.
6. Variable interest entities
--------------------------
Effective March 31, 2004, the Company adopted FASB Interpretation No. 46R -
Consolidation of Variable Interest Entities, an interpretation of ARB No.
51 - Consolidated Financial Statements. The interpretation addresses
consolidation by businesses of special purpose entities (variable interest
entities, "VIE"). The Company has made a determination that all 41 of the
remaining limited partnerships are Variable Interest Entities.
The Company determined that it is not the primary beneficiary in seven
partnerships syndicated under U.S. Department of Housing and Urban
Development subsidy programs. The seven partnerships are all either under
contract to be sold or included in a letter of intent to sell as of
September 30, 2004. These seven investments will continue to be accounted
for under the equity method and included in equity in earnings of
unconsolidated affiliates until final sale closing. Included in equity in
earnings of unconsolidated affiliates is the Company's share of income
totaling $25 for the three months ended September 30, 2004. The Company
purchased the general partnership interests in these seven partnerships in
January, 1996. These partnerships were set up to provide low income housing
to residents through subsidized rents and below market debt governed by
HUD. The Company as general partner and managing agent manages the
day-to-day operations of the partnership for a fee (5% of rents collected).
The Company's economic benefit from these partnerships is the management
fee. There is no exposure to the Company of loss as a result of its
involvement with these partnerships. The management fees earned on these
partnerships was $45 and $118 for the three- and nine-month periods ended
September 30, 2004. The assets and liabilities of the seven partnerships
total $8.3 million and $14.1 million at September 30, 2004, respectively.
Unconsolidated non-recourse debt associated with the seven partnerships
continuing to be accounted for under the equity method amounted to $13.5
million, of which the Company's proportionate share, based on its legal
ownership, was $785.
The Company has further determined that it is the primary beneficiary in 34
of the VIEs and therefore consolidated these entities effective March 31,
2004. Beginning with the second quarter of 2004, the Company consolidated
the results of operations of the VIEs. The results of operations of the 34
VIEs for both the three- and six-month periods ending September 30, 2004
are included in discontinued operations as all of the VIE's are held for
sale as described below.
The Company is the general partner in these 34 VIEs syndicated using low
income housing tax credits under Section 42 of the Internal Revenue Code.
As general partner, the Company manages the day-to-day operations of these
partnerships for a management fee. In addition, the Company has certain
operating deficit guarantees and tax credit guarantees to its limited
partners. The Company is responsible to fund operating deficits to the
extent there are any and can receive operating incentive awards when cash
flow reaches certain levels. The effect on the consolidated balance sheet
as of September 30, 2004 is an increase in Total assets of $88.4 million,
an increase in Total liabilities of $81.8 million, an increase in Minority
interest of $7 million, and a decrease in Stockholders' equity of $321. In
connection with the adoption of FIN 46R, the Company recorded a $321 charge
of a cumulative effect of a change in accounting principle during the first
quarter of 2004. This charge was a result of the negative capital accounts
of minority interest partners that were absorbed by the Company. Of the
$81.8 million increase in total liabilities, $77.8 million represented
non-recourse mortgage debt.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
6. Variable interest entities (continued)
--------------------------------------
Effective September 30, 2004, the Company has closed on the sale of 22 of
the 41 VIE's and is under contract with the same buyer for the sale of an
additional eight VIEs pending lender approval. Based upon the final
contract price established during final negotiations with the buyer for
these 30 partnerships, an additional $3.6 million loss was recorded during
the third quarter of 2004. The Company has received an offer to sell eight
of its remaining 11 limited partnerships and is working towards a closing
on these properties by the end of the fourth quarter of 2004. Based on the
offer received on these eight VIE's, the Company has recorded an impairment
charge of $500 for the three month period ended September 30, 2004.
Additionally, the Company is marketing for sale one partnership as to
which, based upon the Company's estimate of fair market value, an $800
impairment charge was recorded in the three month period ended September
30, 2004. During the third quarter of 2004, the Company began an exit
strategy with one additional property (two partnerships) with 1,058 units.
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. Although the Company does not anticipate that occupancy
levels or other aspects of the operational outlook will improve in the
foreseeable future, it does not anticipate future cash shortfalls since the
debt service is not being paid. The Company has met with the federal agency
that insured repayment of the loan. That agency has agreed the Company may
continue to manage the property until the agency can sell the mortgage
note. The note sale is expected to occur in March, 2005, but it may occur
later. In addition, the Company has agreed to repurchase the limited
partner's interests in satisfaction of any tax credit guarantees or other
obligations to that partner in January, 2005 for $5.7 million. The Company
has therefore recorded a $5.7 million liability to the limited partner
resulting in a loss on disposition of property of $5.0 million as of and
for the three month period ended September 30, 2004.
In addition, during the first quarter of 2004, the Company recorded an
impairment charge of $1.6 million to reduce the value of the assets
associated with the VIEs 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 to reduce the assets to estimated fair market value. Of the total
impairment charge recorded of $1.6 million 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 primarily market
rate apartment communities. Each apartment community is considered a
separate operating segment. Each segment on a stand alone basis is less
than 10% of the revenues, profit or loss, and assets of the combined
reported operating segments and meets the majority of the aggregation
criteria under SFAS No. 131. The operating segments are aggregated and
segregated as Core and Non-core properties.
Non-segment revenue to reconcile to total revenue consists of interest and
dividend income and other income. Non-segment assets to reconcile to total
assets include cash and cash equivalents, cash in escrows, accounts
receivable, prepaid expenses, investments in and advances to affiliates,
deferred charges and other assets.
Core properties consist of all apartment communities which have been owned
more than one full calendar year. Therefore, the Core Properties represent
communities owned as of January 1, 2003. Non-core properties consist of
apartment communities acquired during 2003 and 2004, such that full year
comparable operating results are not available.
The accounting policies of the segments are the same as those described in
Notes 1 and 2 of the Company's Form 10-K.
The Company assesses and measures segment operating results based on a
performance measure referred to as Funds from Operations ("FFO"). FFO is
defined as net income (computed in accordance with GAAP) excluding gains or
losses from the sales of property and business, minority interest in the
Operating Partnership, extraordinary items, plus real estate depreciation,
less dividends from non-convertible preferred shares. FFO is not a measure
of operating results or cash flows from operating activities as measured by
generally accepted accounting principles and it is not indicative of cash
available to fund cash needs and should not be considered an alternative to
cash flows as a measure of liquidity. Other companies may calculate
similarly titled performance measures in a different manner.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
7. Segment Reporting (continued)
-----------------------------
The revenues, profit (loss), and assets for each of the reportable segments
are summarized as of and for the nine- and three-month periods ended
September 30, 2004, and 2003 as follows.
Nine Months Three Months
----------- ------------
2004 2003 2004 2003
---- ---- ---- ----
Revenues
Apartments owned
Core properties $325,699 $312,840 $109,297 $106,277
Non-core properties 19,170 2,896 8,690 1,370
Reconciling items 2,416 3,700 955 1,123
-------- -------- -------- --------
Total Revenue $347,285 $319,436 $118,942 $108,770
======== ======== ======== ========
Profit (loss)
Funds from operations:
Apartments owned
Core properties $179,530 $175,609 $62,274 $61,115
Non-core properties 11,901 2,028 5,341 1,020
Reconciling items 2,416 3,700 955 1,123
-------- -------- -------- --------
Segment contribution to FFO 193,847 181,337 68,570 63,258
General and administrative expenses ( 14,496) ( 14,371) ( 4,879) ( 4,670)
Interest expense ( 68,060) ( 64,693) ( 23,496) ( 21,430)
Prepayment penalty on sale included in interest - 1,610 - 261
Depreciation of unconsolidated affiliates 1,837 725
556 -
Non-real estate depreciation/amortization ( 2,606) ( 1,687) ( 928) ( 540)
FAS 141 acquisition rent / intangibles 835 - 325 -
Equity in earnings (losses) of unconsolidated ( 538) ( 1,497) 25 ( 313)
affiliates
Impairment of assets held as General Partner ( 1,116) ( 2,408) - ( 1,888)
Impairment of affordable assets not in FFO 945 1,862 - 1,862
Loss on disposition of discontinued operations,
before minority interest ( 9,917) - ( 9,917) -
Income from discontinued operations before minority ( (
interest and depreciation 541) 3,446 40) 1,527
Redeemable preferred dividend (Series F) ( 4,050) ( 4,050) ( 1,350) ( 1,350)
-------- -------- -------- --------
Funds from Operations 94,859 101,386 28,310 37,442
Depreciation - apartments owned ( 65,289) ( 56,889) ( 22,517) ( 19,512)
Depreciation of unconsolidated affiliates ( 1,998) ( 1,837) ( 383) ( 725)
FAS 141 acquisition rent/intangibles ( 835) - ( 325) -
Redeemable preferred dividend 4,050 4,050 1,350 1,350
Loss from early extinguishment of debt in connection
with sale of real estate - ( 1,610) - ( 261)
Impairment of real property - ( 423) - -
Impairment of affordable assets not in FFO ( 945) ( 1,862) ( 1,862)
-
(Income) loss from discontinued operations before
minority
interest 2,501 ( 1,587) 423 ( 1,099)
Loss on disposition of discontinued operations,
before minority interest 9,917 - 9,917 -
Minority interest - in operating partnership ( 11,844) ( 11,473) ( 4,746) ( 4,482)
-------- -------- -------- --------
Income from continuing operations $30,416 $29,755 $12,029 $10,851
======== ======== ======== ========
Assets - As of September 30, 2004 and December 31, 2003
-------------------------------------------------------
Apartments owned:
- Core $2,369,058 $1,924,763
- Non-core 352,956 543,698
Reconciling items 126,126 44,856
---------- ----------
Total Assets $2,848,140 $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 ten apartment communities ("2004 Acquired
Communities") with a combined 2,486 units in six unrelated transactions
during the nine-month period ended September 30, 2004. The total combined
purchase price (including closing costs) of $257.4 million equates to
approximately $104 per unit. Consideration for the communities was funded
through the assumption or placement of new debt of $146.6 million of debt,
$98.7 million from the Company's line of credit and $12.1 million of UPREIT
Units.
In addition, the Company disposed of two apartment communities ("2004
Disposed Properties") with 620 units during the nine-month period ended
September 30, 2004. The total combined selling price (including closing
costs) of $26.8 million resulted in a $477 gain on sale of real estate, net
of minority interest.
The following proforma information was prepared as if (i) the 2004
transactions related to the acquisition of the 2004 Acquired Communities
had occurred on January 1, 2003, (ii) the 2003 transactions related to the
acquisition of two apartment communities in two separate transactions had
occurred on January 1, 2003, (iii) the disposition of the 2004 Disposed
Properties had occurred on January 1, 2003, (iv) the 2003 transactions
related to the disposition of seven apartment communities in seven separate
transactions had occurred on January 1, 2003. The proforma financial
information is based upon the historical consolidated financial statements
and is not necessarily indicative of the consolidated results which
actually would have occurred if the transactions had been consummated at
the beginning of 2003, nor does it purport to represent the results of
operations for future periods. Adjustments to the proforma condensed
combined statement of operations for the nine- and three-month periods
ended September 30, 2004 and 2003, consist principally of providing net
operating activity and recording interest, depreciation and amortization
from January 1, 2003 to the earlier of September 30, 2004 or 2003, as
applicable, or the acquisition date.
For the Nine-months For the Three-months
Ended September 30 Ended September 30
------------------ ------------------
2004 2003 2004 2003
---- ---- ---- ----
Total revenues $356,693 $343,925 $119,976 $117,273
Net income available to common shareholders 24,904 21,191 10,079 8,651
before cumulative effect of change in accounting
principle
Net income available to common shareholders 24,583 21,191 10,079 8,651
Per common share data:
Net income available to common shareholders
before cumulative effect of change in accounting
principle
Basic $0.76 $0.74 $0.30 $0.29
Diluted $0.75 $0.73 $0.30 $0.29
Net income available to common shareholders
Basic $0.75 $0.74 $0.30 $0.29
Diluted $0.74 $0.73 $0.30 $0.29
Weighted average numbers of shares outstanding:
Basic 32,840,672 28,495,398 33,293,905 29,522,274
Diluted 33,280,680 28,874,160 33,737,974 30,037,671
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
9. Derivative Financial Instruments
--------------------------------
The Company has four interest rate swaps that effectively convert variable
rate debt to fixed rate debt. As of September 30, 2004, the aggregate fair
value of the Company's interest rate swaps was $1,012 prior to the
allocation of minority interest and is included in accrued expenses and
other liabilities in the consolidated balance sheets. For the nine-months
ending September 30, 2004, as the critical terms of the interest rate swaps
and the hedged items are the same, no ineffectiveness was recorded in the
consolidated statements of operations. All components of the interest rate
swaps were included in the assessment of hedge effectiveness. The fair
value of the interest rate swaps is based upon the estimate of amounts the
Company would receive or pay to terminate the contract at the reporting
date and is estimated using interest rate market pricing models.
10. Disposition of Property and Discontinued Operation
--------------------------------------------------
Included in discontinued operations are the operating results, net of
minority interest, of nine apartment community dispositions (two sold in
2004 and seven sold in 2003), for the three and nine months ended September
30, 2003. Included in discontinued operations for the three- and nine-month
periods ended September 30, 2004 are two properties sold in 2004. In
addition, discontinued operations includes the operating results, net of
minority interest, of the VIEs sold or held for sale for the three and six
months ended September 30, 2004. For purposes of the discontinued
operations presentation, the Company only includes interest expense
associated with specific mortgage indebtedness of the properties that are
sold or classified as held for sale.
During 2004, the Company sold two properties referred to above with a total
of 620 units for total consideration of $26.8 million, or an average of $43
per unit. During 2003, the Company sold seven properties referred to above
with a total of 1,568 units for total consideration of $59.3 million, or an
average of $38 per unit.
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.
The operating results of the components of discontinued operations are
summarized for the nine- and three-month periods ended September 30, 2004
and 2003 as follows:
Nine months Three months
----------- ------------
2004 2003 2004 2003
---- ---- ---- ----
Revenues
Rental Income $ 14,572 $8,784 $6,257 $2,938
Property other income 1,044 451 484 148
Interest and dividend income ( 162) 50 ( 78) 7
Other income ( 457) - ( 181) -
-------- ------- ------- -------
Total Revenues 14,997 9,285 6,482 3,093
-------- ------- ------- -------
Expenses
Operating and Maintenance 10,357 4,383 4,519 1,163
Interest expense 3,601 1,456 1,604 403
Depreciation and amortization 3,847 1,436 391 428
Impairment of real property 1,100 423 - -
-------- ------- ------- -------
Total Expenses 18,905 7,698 6,514 1,994
-------- ------- ------- -------
Income (loss) from discontinued operations before
minority interest and gain (loss) on
disposition of property ( 3,908) 1,587 ( 32) 1,099
Minority interest ( 2,229) ( 567) ( 256) ( 389)
-------- ------- ------- -------
Income (loss) from discontinued operations ( $1,679) $ 1,020 ($ 288) $ 710
======== ======= ======= =======
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
10. Disposition of Property and Discontinued Operations (continued)
---------------------------------------------------------------
The table below provides a more detailed presentation of the components of
discontinued operations for the nine- and three-month periods ended
September 30, 2004.
Nine Months 2004 Three Months 2004
---------------- -----------------
Owned Owned
Communities VIEs Total Communities VIEs Total
----------- ---- ----- ----------- ---- -----
Revenues
Rental Income $2,342 $12,230 $ 14,572 $ 212 $6,045 $6,257
Property other income 173 871 1,044 29 455 484
Interest and dividend income 1 ( 163) ( 162) - ( 78) ( 78)
Other income - ( 457) ( 457) - ( 181) ( 181)
------ ------- -------- ------ ------ ------
Total Revenues 2,516 12,481 14,997 241 6,241 6,482
------ ------- -------- ------ ------ ------
Expenses
Operating and Maintenance 1,399 8,958 10,357 275 4,244 4,519
Interest expense 281 3,320 3,601 40 1,564 1,604
Depreciation and amortization 518 3,329 3,847 - 391 391
Impairment of real property 1,100 - 1,100 - - -
------ ------- -------- ------ ------ ------
Total Expenses 3,298 15,607 18,905 315 6,199 6,514
------ ------- -------- ------ ------ ------
Income (loss) from discontinued
operations before minority
interest and gain (loss) on
disposition of property ( 782) ( 3,126) ( 3,908) ( 74) 42 ( 32)
Minority interest 254 1,975 2,229 24 ( 280) ( 256)
------ ------- -------- ------ ------ ------
Income (loss) from discontinued
operations ($ 528) ($1,151) ($1,679) ($ 50) ($ 238) ($ 288)
====== ======= ======== ====== ====== ======
The results of discontinued operations in the table above have been
presented for the nine- and three-month periods ended September 30, 2004
only, as the discontinued operations for 2003 solely represents the results
from owned communities.
11. Commitments and Contingencies
-----------------------------
Contingencies
-------------
In 2001, the Company underwent a state capital stock tax audit. The state
has assessed taxes of $469 for the 1998 and 1999 tax years under audit. If
the state's position is applied to all tax years through December 31, 2001,
the assessment would be $1.3 million. At the time, the Company believed the
assessment and the state's underlying position were not supportable by the
law nor consistent with previously provided interpretative guidance from
the office of the State Secretary of Revenue. After two subsequent
enactments by the state legislation during 2002 affecting the pertinent tax
statute, the Company was advised by outside tax counsel that its filing
position for 1998-2001 should prevail. During December 2003, the state's
governor signed legislation which included the REIT tax provisions. Based
upon this, Company's tax counsel expects that the outstanding litigation
should now be able to be resolved. Effective January 1, 2003, the Company
reorganized the ownership of Home Properties Trust, which should subject
the Company to a much lower level of tax going forward. In September 2004,
the Company settled the 1998 year under audit for a total of $39,000,
including interest. The 1999-2001 tax years will take time to resolve,
however, the Company's outside counsel still maintains that the Company
should not have any additional liability.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
11. Commitments and Contingencies (continued)
-----------------------------------------
During April, 2004, the Company finalized negotiations with New York State
settling a sales and use tax audit covering the period June 1, 1999 through
May 31, 2002. The total cost to the Company as a result of the audit
amounted to $861. This was included in the first quarter results and
allocated $448 to expense and $413 capitalized to real estate assets for
improvements.
As a result of this audit, during the second quarter the Company examined
its sales and use tax compliance in the other states in which the Company
operates. Based upon its internal analysis, the Company estimated its
liability as of June 30, 2004 in those states where it found non-compliance
and recorded at June 30, 2004 a liability of $1,712. This was included in
the second quarter results and allocated $761 to expense and $951
capitalized to real estate assets for improvements. The liability recorded
relates to the period beginning on the later of: (i) the date the Company
first purchased property in the applicable state; or (ii) January 1, 1997
and ending on June 30, 2004. In addition, the Company increased the
liability for sales tax exposure by $30K for the three-month period ended
September 30, 2004. The Company recognizes that the liability recorded is
an estimate and that the actual tax liability that will be paid in the
future may be less than or greater than this estimate. The Company has
determined that the likely range is between $1,325 and $2,300.
The Company and the Operating Partnership, along with Home Leasing
Corporation, the predecessor of the Company that is owned by Nelson and
Norman Leenhouts, are defendants in a lawsuit. The essence of the complaint
is that the entity in which plaintiffs were investors was wrongfully
excluded from the Company's initial organization as a real estate
investment trust and the investors therefore did not obtain the benefits
from exchanging their equity interests in that entity for equity in the
Operating Partnership. In their original complaint, plaintiffs sought
damages in the amount of $3 million. In the subsequent discovery process,
plaintiffs increased the damages sought to $11 million. The Company and the
Operating Partnership have responded to the lawsuit by denying all material
allegations and asserting various defenses. The only remaining cause of
action against the Company and the Operating Partnership is a claim of
breach of fiduciary duty. It is not possible to estimate the possible loss
or range of loss at this time and the Company has therefore not accrued any
liability to date. Management and its counsel believe that applicable legal
precedents support a conclusion that neither the Company nor the Operating
Partnership should be found to have any liability to the plaintiffs and
that, in the event any liability is found, recoverable damages should be
limited to an immaterial amount.
Guarantees
----------
As of September 30, 2004, the Company, through its general partnership
interests in certain affordable property limited partnerships, had
guaranteed the Low Income Housing Tax Credits to limited partners in 14
partnerships totaling approximately $31 million. As of September 30, 2004,
there were no known conditions that would make such payments necessary
relating to these guarantees. In addition, the Company, acting as general
partner in certain partnerships, is obligated to advance funds to meet
partnership operating deficits.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
12. 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 $41.4 has been
received during the nine months ended September 30, 2004. The current gain
recorded on the sale of these assets as of September 30, 2004 amounts to
$10.6. If the management of this property is retained for the entire three
years the Company expects to receive an additional $124.2 for the period
October 1, 2004 through January 1, 2007. The gain on sale would then be
approximately $134.8.
13. Subsequent Events
-----------------
On November 2, 2004 the Board of Directors approved a dividend of $.63 per
share for the quarter ended September 30, 2004. This is the equivalent of
an annual distribution of $2.52 per share. The dividend is payable November
26, 2004 to shareholders of record on November 16, 2004.
On November 2, 2004 the Company also declared a regular dividend of $.5625
per share on its Series F Cumulative Redeemable Preferred Stock, for the
quarter ending November 30, 2004. The dividend on the preferred shares is
payable on November 30, 2004 to shareholders of record on November 16,
2004. This dividend is equivalent to an annualized rate of $2.25 per share.
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 September 30, 2004, the Company had an unsecured line of credit from M & T
Bank of $115 million. The Company's outstanding balance as of September 30,
2004, was $70.5 million. Borrowings under the line of credit bear interest at
1.05% over the one-month LIBOR rate. Accordingly, increases in interest rates
will increase the Company's interest expense and as a result will affect the
Company's results of operations and financial condition. The line of credit
expires on September 1, 2005.
To the extent that the Company does not satisfy its long-term liquidity
requirements through net cash flows provided by operating activities and its
credit facility, it intends to satisfy such requirements through additional long
term secured or unsecured indebtedness, proceeds from the sale of properties,
the issuance of UPREIT Units, proceeds from the Dividend Reinvestment Plan
("DRIP"), or the issuance of additional equity securities. As of September 30,
2004, the Company owned 24 properties with 3,477 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 September 30, 2004 was $144.4 million.
In May and June 2000, the Company completed the sale of $60 million of Series C
Preferred Stock in a private transaction with affiliates of Prudential Real
Estate Investors ("Prudential"), Teachers Insurance and Annuity Association of
America ("Teachers"), affiliates of AEW Capital Management and Pacific Life
Insurance Company. The Series C Preferred Stock carried an annual dividend rate
equal to the greater of 8.75% or the actual dividend paid on the Company's
common shares into which the preferred shares could be converted. The stock had
a conversion price of $30.25 per share and a five-year, non-call provision. As
part of the Series C Preferred Stock transaction, the Company also issued
240,000 warrants to purchase common shares at a price of $30.25 per share,
expiring in five years. On January 9, 2003, holders of 100,000 shares of Series
C Preferred Shares elected to convert those shares for 330,579 shares of common
stock. On May 8, 2003, 200,000 shares of Series C Preferred Shares were
converted into 661,157 shares of common stock. On August 26, 2003, 200,000
shares of Series C Preferred Shares were converted into 661,157 of common stock.
On November 5, 2003, holders of the remaining 100,000 shares of Series C
Preferred Shares elected to convert those shares for 330,579 shares of common
stock. On September 9, 2003, 17,780 warrants were exercised, resulting in the
issuance of 17,780 shares of common stock. During the fourth quarter of 2003,
the remaining 222,220 common stock warrants were exercised, resulting in the
issuance of 222,220 shares of common stock. Neither the conversions nor the
warrant exercise had an effect on the reported results of operations.
In June 2000, the Company issued $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 issued $30 million of Series E Preferred Stock in
a private transaction, again with affiliates of Prudential and Teachers. The
Series E Preferred Stock carried an annual dividend rate equal to the greater of
8.55% or the actual dividend paid on the Company's common shares into which the
preferred shares could be converted. The stock had a conversion price of $31.60
per share and a five-year, non-call provision. In addition, as part of the
Series E Preferred Stock transaction, the Company issued warrants to purchase
285,000 common shares at a price of $31.60 per share, expiring in five years. On
August 20, 2002, 63,200 of the Series E Convertible Preferred Shares were
converted into 200,000 shares of common stock. On May 6, 2003, 36,800 shares of
Series E Preferred Shares were converted into 116,456 shares of common stock. On
August 26, 2003 the remaining 200,000 shares of Series E Preferred Shares were
converted into 632,911 of common stock. On September 9, 2003, 17,100 warrants
were exercised, resulting in the issuance of 17,100 shares of common stock.
During the fourth quarter of 2003, the remaining 267,900 common stock warrants
were exercised, resulting in the issuance of 267,900 shares of common stock.
Neither the conversions nor the warrant exercise had an effect on the reported
results of operations.
In March 2002, the Company issued 2,400,000 shares of its 9.00% Series F
Cumulative Redeemable Preferred Stock ("Series F Preferred Shares"), with a
$25.00 liquidation preference per share. This offering generated net proceeds of
approximately $58 million. The net proceeds were used to fund the Series B
preferred stock repurchase, property acquisitions, and property upgrades. The
Series F Preferred Shares are redeemable by the Company at anytime on or after
March 25, 2007 at a redemption price of $25.00 per share, plus any accumulated,
accrued and unpaid dividends. Each Series F Preferred share will receive an
annual dividend equal to 9.00% of the liquidation preference per share
(equivalent to a fixed annual amount of $2.25 per share).
The issuance of UPREIT Units for property acquisitions continues to be a source
of capital for the Company. During the first quarter of 2004, the Company
acquired four communities with 534 units for a total purchase price of $64.2
million. The Company issued UPREIT Units valued at approximately $12.1 million
as part of the consideration for two of the properties, with the balance funded
by the assumption of debt and cash. During 2003, the Company exercised an option
to acquire approximately 10 acres of land adjacent to one of its existing
properties for $2.8 million. In connection with this transaction, the Company
issued UPREIT Units valued at approximately $2.8 million. In addition, $2
million of UPREIT Units were issued to satisfy an existing liability.
During 2003, $30.3 million of common stock was issued under the Company's DRIP.
An additional $17.5 million has been raised through the DRIP program during the
first nine 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 nine months of 2004. Effective December 10, 2004, the discount on
reinvested dividends and optional cash purchases will be reduced from 2% to 0%.
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 three months ended
September 30, 2004, 57,500 shares were repurchased by the Company. At September
30, 2004 the Company had authorization to repurchase 3,078,300 shares of common
stock and UPREIT Units under the stock repurchase program. Historically, the
Company repurchased shares when their price was more than 10% below the midpoint
of Company published NAVs. Effective November 2, 2004, the Board modified
certain price restrictions which substantially enhances the Company's ability to
repurchase shares.
As of September 30, 2004, excluding the effect of the FIN 46R consolidations,
the weighted average rate of interest on mortgage debt is 6.0% and the weighted
average maturity is approximately eight years. Approximately 88% 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.
Effective September 30, 2004, the Company closed on the sale of its general
partner interests in 22 of its 41 Upstate New York, Ohio, and Maryland
properties with a total of 1,718 units. The Company has under contract with the
same buyer of these 22 partnerships an additional eight partnerships, pending
lender approval, with a total of 490 units. In addition to this sale, the
company has received a letter of intent to sell general partnership interests in
eight other properties with a total of 612 units.
Of the remaining two properties (three partnerships), with a total of 1,940
units, the Company will retain its ownership interest and will continue to
manage one of them while it pursues various disposition options. The other
property (two partnerships) is being disposed of through a default on the
non-recourse financing. The Company has met with the federal agency which
insured the repayment of that financing. That agency has agreed that the Company
may continue to manage the property until the agency can auction or sell the
loan in a note sale. The note sale is expected to occur in March, 2005, but it
may occur later. The Company has agreed to repurchase in January 2005 the
limited partner's 99.99% interests in accordance with the partnership
agreements. The Company has recorded the liability to repurchase these limited
partnership interests and the resulting loss on disposition of property of $5.0
million. The Company has no further obligation to fund operating deficits and
will only participate in the cash flow of the property by receiving a fee for
managing the property until the note sale.
Due to the sale, contract, and letter of intent referenced above, the results of
operations of the 34 limited partnerships for the three and nine-month periods
ended September 30, 2004 have been consolidated herein and reported as
discontinued operations. The balance sheet consolidates the accounts of the
remaining twelve of the original 34 properties classified as held for sale as of
September 30, 2004. The tables on the following pages show the effects of the
VIEs being consolidated.
Home Properties determined that it is not the primary beneficiary in seven
partnerships syndicated under U.S. Department of Housing and Urban Development
subsidy programs. These seven investments will continue to be accounted for
under the equity method. For those seven investments, the Company will continue
to record its allocable share of the respective partnership's income or loss
based on the terms of the agreement. To the extent it is determined that the LPs
cannot absorb their share of the losses, if any, the GP will record the LPs
share of such losses. The Company will absorb such losses to the extent the
Company has outstanding loans or advances and the limited partner has no
remaining capital account.
The Company, through its general partnership interest in certain affordable
property limited partnerships, has guaranteed the low income housing tax credits
to the limited partners for a period of either five or ten years in 14
partnerships totaling approximately $31 million. Such guarantee requires the
Company to operate the properties in compliance with Internal Revenue Code
Section 42 for 15 years. The weighted average number of compliance years
remaining is approximately 10 years. In addition, acting as the general partner
in certain partnerships, the Company is obligated to advance funds to meet
partnership operating deficits. If operating deficits continue to occur, the
Company would determine on an individual partnership basis if it is in the best
interest of the Company to continue to fund these deficits.
The Company believes the properties' operations conform to the applicable
requirements as set forth above. In addition, the Company has required the buyer
of its general partner interests in the limited partnerships to secure releases
of the Company's guarantees from the limited partners.
As indicated above, the Company is working towards a complete disposition of its
general partner interests in affordable properties. The following table below
summarizes the effect of the consolidation requirements of FIN 46R on the
balance sheet as of September 30, 2004.
Consolidation Summary of the Balance Sheet as of September, 2004
(in thousands)
September 30, 2004 Effect of FIN 46R September 30, 2004
(before FIN 46R) Consolidation (as reported)
---------------- ------------- -------------
ASSETS
Real estate:
Land $ 407,357 $ - $ 407,357
Buildings, improvements and equipment 2,656,669 - 2,656,669
---------- --------- ----------
Real estate held for sale or disposal, net - 79,607 79,607
3,064,026 79,607 3,143,633
Less: accumulated depreciation ( 390,757) - ( 390,757)
---------- --------- ----------
Real estate, net 2,673,269 79,607 2,752,876
Cash and cash equivalents 7,823 444 8,267
Cash in escrows 39,917 4,548 44,465
Accounts receivable 5,125 775 5,900
Prepaid expenses 20,322 ( 194) 20,128
Investment in and advances to affiliates 663 ( 636) 27
Deferred charges 9,647 3,886 13,533
Other assets 2,926 18 2,944
---------- --------- ----------
Total assets $2,759,692 $ 88,448 $2,848,140
========== ========= ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Mortgage notes payable $1,554,452 $ 77,778 $1,632,230
Line of credit 70,500 - 70,500
Accounts payable 22,638 1,480 24,118
Accrued interest payable 7,532 1,337 8,869
Accrued expenses and other liabilities 22,020 609 22,629
Security deposits 23,121 562 23,683
---------- --------- ----------
Total liabilities 1,700,263 81,766 1,782,029
---------- --------- ----------
Minority interest 309,291 7,003 316,294
---------- --------- ----------
Stockholders' equity 750,138 ( 321) 749,817
Total liabilities and stockholders' equity $2,759,692 $ 88,448 $2,848,140
========== ========= ==========
Acquisitions and Dispositions
-----------------------------
During the first nine months of 2004, the Company acquired ten apartment
communities in six 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, one apartment
community in Massachusetts with a total of 276 units, two apartment communities
in Florida with a total of 836 units and one additional apartment community in
New Jersey with a total of 372 units. The total purchase price of $247.5
million, including closing costs, equated to an average of $99.6 per apartment.
Consideration included $136.9 million of assumed or new debt (fair market value
of $146.6 million), $98.7 million in cash or line of credit, and $11.9 million
of UPREIT Units (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 6.7%.
Capitalization rate ("cap rate") is defined as the rate of interest used to
convert the first year expected net operating income ("NOI") less a 3.0%
management fee into a single present value. NOI is defined by the Company as
rental income and property other income less operating and maintenance expenses.
Management generally considers NOI to be an appropriate measure of operating
performance because it helps investors to understand the operations of a
community. In addition, the apartment communities are valued and sold in the
market by using a multiple of NOI.
During the first nine months of 2004, the Company disposed of two wholly owned
communities with a total of 620 units located in upstate New York and Indiana.
The total sales price of $26.8 million equated to approximately $43.3 per unit.
The Company recorded a net gain on sale, before allocation of minority interest,
of approximately $707 related to these sales. The weighted average expected
first year cap rate for these communities is 8.0%.
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 $70.5 million outstanding at September 30, 2004. The
$1.6 billion in mortgage notes payable from the Company's wholly owned
properties, before the effect of FIN 46R, have varying maturities ranging from 1
to 37 years. The weighted average interest rate of the Company's fixed rate
notes was 6.36% and 6.47% at September 30, 2004 and December 31, 2003,
respectively. The weighted average interest rate of the Company's variable rate
notes and credit facility was 2.65% and 2.32% at September 30, 2004 and
December 31, 2003, respectively.
The Company has a non-cancelable operating ground lease for one of its
properties. The lease expires May 1, 2020, with options to extend the term of
the lease for two successive terms of twenty-five years each. The lease provides
for contingent rental payments based on certain variable factors. At September
30, 2004, future minimum rental payments required under the lease are $70 per
year until the lease expires.
The Company leases its corporate office space from an entity affiliated with
Nelson and Norman Leenhouts, and the office space for its regional offices from
third parties. The corporate office space requires an annual base rent plus a
pro-rata portion of property improvements, real estate taxes, and common area
maintenance. The regional office leases require an annual base rent plus a
pro-rata portion of real estate taxes.
Capital Improvements
--------------------
The Company's policy is to capitalize costs related to the acquisition,
development, rehabilitation, construction and improvement of properties. Capital
improvements are costs that increase the value and extend the useful life of an
asset. Ordinary repair and maintenance costs that do not extend the useful life
of the asset are expensed as incurred. Costs incurred on a lease turnover due to
normal wear and tear by the resident are expensed on the turn. Recurring capital
improvements typically include: appliances, carpeting and flooring, HVAC
equipment, kitchen/ bath cabinets, new roofs, site improvements and various
exterior building improvements. Non- recurring, revenue generating capital
improvements include, among other items: community centers, new windows, and
kitchen/ bath apartment upgrades. Revenue generating capital improvements will
directly result in rental earnings or expense savings. The Company capitalizes
interest and certain internal personnel costs related to the communities under
rehabilitation and construction.
The Company estimates that on an annual basis $525 per unit is spent on
recurring capital expenditures. During the three- and nine-month periods ended
September 30, 2004 approximately $131 and $393 per unit was estimated to be
spent on recurring capital expenditures. The table below summarizes the actual
total capital improvements, (before the effects of FIN 46R) incurred by major
categories for the three- and nine-month periods ended September 30, 2004 and
2003 and an estimate of the breakdown the three- and nine-month periods ended
September 30, 2004 as follows: of total capital improvements by major categories
between recurring and non-recurring, revenue generating capital improvements for
the three- and nine-month periods ended September 30, 2004 as follows: the
three- and nine-month periods ended September 30, 2004 as follows:
For the three-month period ended September 30,
(in thousands, except per unit data)
2004 2003
-------------------------------------------------------------- ------------------------
Non-
Recurring Per Recurring Per Total Capital Per Total Capital Per
Cap Ex Unit (a) Cap Ex Unit Improvements Unit(a) Improvements Unit (a)
------ -------- ------ ---- ------------ ------- ------------ --------
New Buildings $ - $ - $ 951 $22 $ 951 $22 $ 530 $13
Major building improvements 965 23 4,549 107 5,514 130 5,806 145
Roof replacements 369 9 716 17 1,085 26 1,920 48
Site improvements 353 8 2,621 62 2,974 70 3,017 75
Apartment upgrades 696 16 7,327 173 8,023 189 9,762 244
Appliances 578 14 648 15 1,226 29 1,341 34
Carpeting/Flooring 1,815 43 1,533 36 3,348 79 3,711 93
HVAC/Mechanicals 535 12 3,767 89 4,302 101 4,468 112
Miscellaneous 238 6 450 11 688 17 764 20
------ ---- ------- ---- ------- ---- ------- ----
Totals $5,549 $131 $22,562 $532 $28,111 $663 $31,319 $784
====== ==== ======= ==== ======= ==== ======= ====
(a) Calculated using the weighted average number of units outstanding,
including 39,586 core units, 2003 acquisition units of 730 and 2004
weighted average acquisition units of 2,089 for the three-month period
ended September 30, 2004 and 39,586 core units and 2003 weighted average
acquisition units of 385 for the three-month period ended September 30,
2003.
For the nine-month period ended September 30,
(in thousands, except per unit data)
2004 2003
-------------------------------------------------------------- ------------------------
Non-
Recurring Per Recurring Per Total Capital Per Total Capital Per
Cap Ex Unit(a) Cap Ex Unit(a) Improvements Unit(a) Improvements Unit(a)
------ ------- ------ ------- ------------ ------- ------------ -------
New Buildings $ - $ - $ 2,169 $ 52 $2,169 $ 52 $ 1,413 $ 35
Major building improvements 2,841 68 11,470 276 14,311 344 15,609 392
Roof replacements 1,086 26 1,516 36 2,602 62 3,171 80
Site improvements 1,040 25 5,954 143 6,994 168 5,777 145
Apartment upgrades 2,049 49 19,048 458 21,097 507 25,712 645
Appliances 1,703 41 1,474 35 3,177 76 3,579 90
Carpeting/Flooring 5,344 128 2,641 63 7,985 191 8,905 223
HVAC/Mechanicals 1,574 38 8,927 215 10,501 253 9,965 250
Miscellaneous 698 18 1,871 45 2,569 63 2,726 68
------- ---- ------- ------ ------- ------ ------- ------
Totals $16,335 $393 $55,070 $1,323 $71,405 $1,716 $76,857 $1,928
======= ==== ======= ====== ======= ====== ======= ======
(a) Calculated using the weighted average number of units outstanding,
including 39,586 core units, 2003 acquisition units of 730 and 2004
weighted average acquisition units of 1,295 for the nine-month period ended
September 30, 2004 and 39,586 core units and 2003 weighted average
acquisition units of 272 for the nine-month period ended September 30,
2003.
The schedule below summarizes the breakdown of total capital improvements
(before the effects of FIN 46R) between core and non-core as follows:
For the three-month period ended September 30,
(in thousands, except per unit data)
2004 2003
-------------------------------------------------------------- ------------------------
Non-
Recurring Per Recurring Per Total Capital Per Total Capital Per
Cap Ex Unit Cap Ex Unit Improvements Unit Improvements Unit
------ ---- ------ ---- ------------ ---- ------------ ----
Core Communities $5,180 $131 $21,702 $ 548 $26,882 $ 679 $31,187 $788
2004 Acquisition
Communities 273 131 718 344 991 475 - -
2003 Acquisition
Communities 96 131 142 194 238 325 133 344
------ ---- ------- ------ ------- ----- ------- ----
Sub-total 5,549 131 22,562 532 28,111 663 31,319 784
2004 Disposed Communities 8 131 - - 8 131 203 327
2003 Disposed Communities - - - - - - 274 326
Corporate office
expenditures (1) - - - - 1,091 - 869 -
------ ---- ------- ------ ------- ----- ------- ----
$5,557 $131 $22,562 $ 532 $29,210 $ 661 $32,665 $767
====== ==== ======= ====== ======= ===== ======= ====
For the six--month period ended September 30,
(in thousands, except per unit data)
2004 2003
--------------------------------------------------------------- -----------------------
Non- Total Total
Recurring Per Recurring Per Capital Per Capital Per
Cap Ex Unit Cap Ex Unit Improvements Unit Improvements Unit
------ ---- ------ ---- ------------ ---- ------------ ----
Core Communities $15,540 $393 $53,425 $ 1,350 $68,965 $1,743 $76,672 $1,937
2004 Acquisition
Communities 508 393 1,351 1,044 1,859 1,437 - -
2003 Acquisition
Communities 287 393 294 401 581 794 185 680
------- ---- ------- ------- ------- ------ ------- ------
Sub-total 16,335 393 55,070 1,323 71,405 1,716 76,857 1,928
2004 Disposed Communities 171 393 404 925 576 1,317 640 1,031
2003 Disposed Communities - - - - - - 719 736
Corporate office
expenditures (1) - - - - 2,157 - 1,808 -
------- ---- ------- ------- ------- ------ ------- ------
$16,506 $393 $55,474 $ 1,319 $74,138 $1,712 $80,024 $1,887
======= ==== ======= ======= ======= ====== ======= ======
(1) No distinction is made between recurring and non-recurring expenditures for
corporate office.
Results of Operations
---------------------
Summary of Core Properties
--------------------------
The Company had 141 apartment communities with 39,586 units which were owned
throughout the nine-month period being presented (the "Core Properties"). The
Company has acquired an additional twelve apartment communities with 3,216 units
during 2004 and 2003 (the "Acquired Communities"). The Company also disposed of
nine properties with a total of 2,188 units during 2004 and 2003 (the
"Disposition Communities"). The Disposition Communities have been classified as
discontinued operations. The inclusion of the Acquired Communities generally
accounted for the significant changes in operating results for the three and
nine months ended September 30, 2004.
A summary of the net operating income from Core Properties is as follows (in
thousands):
Nine Months Three Months
----------- ------------
2004 2003 $ Change % Change 2004 2003 $ Change % Chg
---- ---- -------- -------- ---- ---- -------- -----
Rental income $312,836 $301,640 $ 11,196 3.7% $104,763 $102,487 $2,276 2.2%
Property other income 12,863 11,200 1,663 14.8% 4,534 3,790 744 19.6%
-------- -------- ------ --- ------- ------- ------ ---
Total income 325,699 312,840 12,859 4.1% 109,297 106,277 3,020 2.8%
Operating and Maintenance (146,169) (137,231) (8,938) (6.5%) ( 47,023) ( 45,162) (1,861) (4.1%)
-------- -------- ------ --- ------- ------- ------ ---
Net operating income $179,530 $175,609 $3,921 2.2% $62,274 $61,115 $1,159 1.9%
======== ======== ====== === ======= ======= ====== ===
A summary of the net operating income from continuing operations is as follows
(in thousands):
Nine Months Three Months
----------- ------------
2004 2003 $ Change % Change 2004 2003 $ Change % Chg
---- ---- -------- -------- ---- ---- -------- -----
Rental income $ 331,496 $ 304,370 $27,126 8.9% $113,237 $ 103,792 $9,445 9.1%
Property other income 13,373 11,366 2,007 17.7% 4,750 3,855 895 23.2%
--------- --------- ------- --- --------- --------- ------- ---
Total income 344,869 315,736 29,133 9.2% 117,987 107,647 10,340 9.6%
Operating and Maintenance (153,438) ( 138,099) (15,339) (11.1%) ( 50,372) ( 45,512) ( 4,860) (10.7%)
--------- --------- ------- ---- --------- --------- ------- ---
Net operating income $ 191,431 $ 177,637 $13,794 7.8% $ 67,615 $ 62,135 $ 5,480 8.8%
========= ========= ======= ==== ========= ========= ======= ===
Comparison of nine-months ended September 30, 2004 to the same period in 2003
-----------------------------------------------------------------------------
Of the $27,126 increase in rental income, $15,930 is attributable to the
Acquired Communities The balance of this increase, or $11,196 which is from the
Core Properties, was the result of an increase of 2.6% in weighted average
rental rates, along with an increase in occupancy from 92.4% to 93.4%. 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 $2,007. Of this increase, $344
is attributable to the Acquired Communities, with $1,663 representing a 14.8%
increase from the Core Properties.
Other income, which reflects management fee income, decreased $1,381 due
primarily to a decrease in the level of management activity as a result of the
sale of the three Phases of the affordable limited partnerships.
During April, 2004, the Company finalized negotiations with New York State
settling a sales and use tax audit covering the period June 1, 1999 through May
31, 2002. As described in the Company's Form 10-Q for the quarter ended March
31, 2004, the total cost to the Company as a result of the audit amounted to
$861 (including $173 of interest expense) for sales tax not charged to the
Company by its vendors. This was included in the first quarter results and
allocated $312 to expense for property repairs, $136 (before minority interest)
to loss on disposition of property, and $413 capitalized to real estate assets
for improvements.
As a result of this audit, during the second quarter the Company examined its
sales and use tax compliance in the other states in which the Company operates.
Based upon its internal analysis, the Company estimated its liability as of June
30, 2004 in those states where it found non-compliance and has recorded at June
30, 2004 a liability of $1,712. This is allocated $493 to expense for property
repairs, $233 to interest expense, $35 (before minority interest) to loss on
disposition of property, and $951 capitalized to real estate assets. The
liability recorded relates to the period beginning on the later of: (i) the date
the Company first purchased property in the applicable state; or (ii) January 1,
1997 and ending on June 30, 2004. The Company recognizes that the liability
recorded is an estimate and that the actual tax liability that will be paid in
the future may be less than or greater than this estimate. The Company has
determined that the likely range is between $1,325 and $2,300.
The Company determined that the amount of liability which it failed to record
with respect to sales and use tax did not have a material impact on its results
of operations or reported earnings for the prior periods in which the items
subject to tax were purchased and that the expense recorded in the first and
second quarters of 2004 were one-time adjustments. The Company does not believe
that the additional sales and use tax it will record and pay will have a
material impact on its results of operations in future periods.
As a result of the sales tax audit, the Company initiated procedures during the
second quarter to ensure that sales and use tax on expenditures in New York were
properly collected by its vendors or accrued and paid by the Company. In
addition, the Company has begun to implement procedures and controls designed to
ensure that sales and use taxes are accrued and paid in the other jurisdictions
in which it operates. The Company is also investigating computer software
programs which may provide a technology solution for identifying and calculating
the taxes.
Of the $15,339 increase in operating and maintenance expenses, $6,400 is
attributable to the Acquired Communities. The balance, an $8,939 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 and advertising
costs. The increase in repairs and maintenance was $2,741, or 13.1% compared to
a year ago and is primarily in the areas of contract repair, painting, and
cleaning. Sales tax, as mentioned above, accounts for $805 of this increase.
Personnel expense increased $2,732, or 8.8% compared to the same period one year
ago due in part to an increase in site level incentive compensation as a result
of improving rent and occupancies. In addition, increased health insurance and
workers compensation costs contributed significantly to the increase. Property
insurance increased $1,551 or 37.7% for the period primarily due to an increase
in our general liability loss reserve based on historical losses to date which
have been projected using actuarial assumptions. Real estate taxes were up
$1,878 or 6.0% over the same period a year ago. Snow removal costs were down
significantly due to a normal winter this year compared to unusually severe
conditions a year ago. Advertising costs were higher in 2003 in response to
lower than normal occupancy levels.
General and administrative expense increased in 2004 by $125, or 0.9%. General
and administrative expenses as a percentage of total revenues were 4.1% for 2004
as compared to 4.4% for 2003. The results, which are basically flat, are
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 $3,367 as a result of the increased
borrowings in connection with acquisition of the 2004 Acquisition Communities, a
full nine months of interest expense for the 2003 Acquisition Communities and
additional mortgage debt and refinanced mortgage debt incurred during 2003.
Interest expense in the first quarter of 2004 was reduced by $996 when two
mortgage loans were paid off early at amounts less than the amounts carried on
the Company's balance sheet. During 2003, the Company closed on additional
mortgage debt of $80,100 and refinanced $24,000 in existing mortgage debt
resulting in new borrowings of approximately $46,000. Included in interest
expense for 2003 was a $1,349 charge recorded in the first quarter of 2003
related to the prepayment of debt associated with the sale of Candlewood
Apartments in Indiana which occurred during the same period. Finally, $254 in
interest relative to the sales tax liability recorded and described above is
included in 2004.
Depreciation and amortization expense increased $10,237 due to the depreciation
on the Acquisition Communities and the capital additions to the Core Properties.
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 in order to focus solely on the direct ownership and
management of market rate apartment communities. The assets included principally
loans, advances and management contracts. During the first nine-months of 2004,
the Company recorded impairment charges of $1,116 (all in the first quarter). Of
this total, $171 represents advances made to certain of the affordable property
limited partnerships which the Company believes will not be repaid upon the sale
of the loans. The remaining $945 pertains to an additional net impairment charge
taken on Phase III to reduce the assets to fair market value. In connection with
FIN 46R, the Company was required to consolidate the majority of the affordable
limited partnerships results of operations beginning April 1, 2004.
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 nine
months of 2004 (all occurred during the first quarter) which the Company
believes will not be repaid upon sale. During the second quarter of 2004, the
Company advanced $25 to one of the remaining unconsolidated affordable
partnerships which was repaid during the third quarter. In connection with FIN
46R, the Company was required to consolidate the majority of the affordable
limited partnerships results of operations beginning April 1, 2004 and is
included in discontinued operations.
Included in discontinued operations for the nine-month period ended September
30, 2004, are the Disposition Communities and the results of operations of the
Phase III affordable limited partnerships that in connection with FIN 46R were
required to be consolidated beginning April 1, 2004. As all significant
contingencies surrounding the sale of Phase III have been resolved the Company
has considered these assets held for sale and have reported them in discontinued
operations. (See further detail supplied under "Off-Balance Sheet Investments"
section).
Included in the $6,305 net loss on disposition of property reported for the nine
months of 2004 is the sale of two apartment communities where the Company has
recorded a combined gain on sale, net of minority interest, of approximately
$477. In addition, the Company recorded a $6,753 loss, net of minority interest
of $3,164, in the third quarter related to the disposal of the Phase III
affordable partnerships. Included in the gross $9.9 million loss reported is a
$5.0 million loss from a property being disposed through a default with the
lender, as more fully explained in the "Off-Balance Sheet Investments" section.
An additional impairment in value of $3.6 million was recorded relating to the
closing of 22 affordable properties and the eight properties under contract for
sale with the same buyer. The Company has recorded a $500 impairment in
connection with a letter of intent to sell general partnership interests in
eight properties with a total of 612 units. Finally, a reduction of $800 to fair
market value has been recorded for the property the Company will continue to
hold for sale. The remaining balance, a $29 loss, net of minority interest,
relates to additional expenses incurred during the nine months ended September
30, 2004 for sales which took place during 2003. These costs represent a change
in estimate from those accrued at the time of sale.
In connection with the adoption of FIN 46R, the Company recorded a $321
cumulative effect charge of a change in accounting principle in the first
quarter of 2004. This charge was the result of negative capital accounts of
minority interest partners that were absorbed by the Company.
Comparison of the three-months ended September 30, 2004 to the same period in
--------------------------------------------------------------------------------
2003
----
Of the $9,445 increase in rental income, $7,169 is attributable to the Acquired
Communities. The balance of this increase, or $2,276 is from the Core
Properties, the result of an increase of 2.9% in weighted average rental rates,
net of a decrease in occupancy from 93.4% to 92.8%. 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 $895. Of this increase, $151 is
attributable to the Acquired Communities and $744 represents a 19.6% increase
from the Core Properties.
Other income, which reflects management fee income, decreased $223 due primarily
to a decrease in the level of management activity as a result of the sale of
Phase I and II of the affordable limited partnerships.
Of the $4,860 increase in operating and maintenance expenses, $2,999 is
attributable to the Acquired Communities. The balance, a $1,861 increase, is
attributable to the Core Properties and is primarily due to increases in repairs
and maintenance, personnel costs, property insurance, and real estate taxes.
These increases were offset in part by a reduction in advertising and office and
telephone expenses. Repairs and maintenance increased $337, or 4.0%, primarily
as a result of increases in painting and cleaning costs offset by savings in
contract repairs and grounds. Personnel expenses increased $726, or 6.8%, with
$84 resulting from increased site level incentive compensation going up
reflecting improving rent compared to a year ago. In addition, $303 is from
increases in health insurance costs. The majority of the increase in property
insurance results from a reduction of $300 to the insurance reserve in 2003 not
repeated in 2004.
General and administrative expense increased in 2004 by $209 or 4.5%. General
and administrative expenses as a percentage of total revenues were 4.1% for 2004
as compared to 4.2% for 2003.
Interest expense increased in 2004 by $2,066 as a result of the increased
borrowings in connection with acquisition of the 2004 Acquisition Communities, a
full quarter of interest expense for the 2003 Acquisition Communities and
additional mortgage debt and refinanced mortgage debt which took place during
2003. During 2003, the Company closed on additional mortgage debt of $80,100 and
refinanced $24,000 in existing mortgage debt resulting in new borrowings of
approximately $46,000.
Depreciation and amortization expense increased $3,821 due to the depreciation
on the Acquisition Communities and the capital additions to the Core Properties.
In the fourth quarter of 2002, the Company announced its intention to sell
virtually all of the assets associated with its general partner interests in the
affordable properties to focus solely on the direct ownership and management of
market rate apartment communities. The assets include principally loans,
advances and management contracts. In connection with FIN 46R, the Company was
required to consolidate the majority of the affordable limited partnerships
results of operations beginning April 1, 2004. The activity for the third
quarter of 2004 is included in discontinued operations as the properties had
either been sold in the third quarter or were classified as held for sale.
The equity in earnings (losses) of unconsolidated affiliates of $25 is an
advance made in the second quarter of 2004 to one of the remaining
unconsolidated affordable partnerships which had been repaid during the third
quarter.
Included in discontinued operations for the three-month period ended September
30, 2004, are two apartment community dispositions, and the results of
operations of the Phase III limited partnerships that in connection with FIN 46R
were required to be consolidated beginning April 1, 2004. As all significant
contingencies surrounding the sale of Phase III have been resolved the Company
has considered these assets held for sale and have reported them in discontinued
operations.
In connection with the sale of Maple Lane Apartments in South Bend, Indiana, the
Company recorded a loss on sale in the third quarter, net of minority interest
of $37, of approximately $78. In addition, the Company recorded a $6,753 loss,
net of minority interest of $3,164, in the third quarter related to the disposal
of the Phase III affordable partnerships. See nine-months comparison for
additional detail. The remaining balance, a $15 gain, net of minority interest,
relates to post closing adjustments incurred in the same quarter for sales which
took place during 2003. These costs represent a change in estimate from those
accrued at the time of sale.
Funds From Operations
---------------------
Pursuant to the revised definition of Funds From Operations ("FFO") adopted by
the Board of Governors of the National Association of Real Estate Investment
Trusts ("NAREIT"), FFO is defined as net income (computed in accordance with
accounting principles generally accepted in the United States of America
("GAAP")) excluding gains or losses from sales of property, minority interest,
extraordinary items and cumulative effect of change in accounting principle plus
depreciation from real property including adjustments for unconsolidated
partnerships and joint ventures less dividends from non-convertible preferred
shares. NAREIT has recently changed guidance on the interpretation of impairment
charges recorded against the value of real estate. The previous interpretation
was that impairment charges in real estate would be an add back to arrive at
FFO, similar to a loss on sale of real estate. The Company is following this new
interpretation effective April 1, 2004 on a go-forward basis. The change is not
suggested to be retroactive to any prior period reported. Because of the
limitations of the FFO definition as published by NAREIT as set forth above, the
Company has made certain interpretations in applying the definition. The Company
believes all adjustments not specifically provided for are consistent with the
definition.
Management believes that in order to facilitate a clear understanding of the
combined historical operating results of the Company, FFO should be considered
in conjunction with net income as presented in the consolidated financial
statements included elsewhere herein. Management believes that by excluding
gains or losses related to dispositions of property and excluding real estate
depreciation (which can vary among owners of similar assets in similar condition
based on historical cost accounting and useful life estimates), FFO can help one
compare the operating performance of a company's real estate between periods or
as compared to different companies. FFO does not represent cash generated from
operating activities in accordance with generally accepted accounting principles
and is not necessarily indicative of cash available to fund cash needs. FFO does
not include the cost incurred for capital improvements (including capitalized
interest) reflected as an increase to real estate assets. The total capital
improvements include an annual reserve for anticipated recurring, non-revenue
generating capitalized costs of $525 per apartment unit. Please refer to the
Capital Improvement section above in MD&A. Cash provided by operating activities
was $123,460 and $108,533 for the nine-month period ended and $39,654 and
$32,230 for the three-month period ended September 30, 2004 and 2003,
respectively. Cash used in investing activities was $202,030 and $102,139 for
the nine-month period ended and $97,223 and $45,432 for the three-month period
ended September 30, 2004 and 2003, respectively. Cash provided by (used in)
financing activities was $80,884 and ($7,925) for the nine-month period ended
and $59,148 and $13,743 for the three-month period ended September 30, 2004 and
2003, respectively. FFO should not be considered as an alternative to net income
as an indication of the Company's performance or to cash flow as a measure of
liquidity.
The calculation of FFO and reconciliation to GAAP net income available to common
Shareholders for the nine and three-months ended September 30, 2004 and 2003 are
presented below (in thousands):
Nine Months Three Months
2004 2003 2004 2003
---- ---- ---- ----
Net income available to common shareholders $16,349 $21,772 $ 3,027 $ 8,958
Convertible preferred dividends 1,645 5,306 548 1,296
Minority interest 11,844 11,473 4,746 4,482
Minority interest - income (loss) from discontinued operations ( 805) 567 ( 135) 389
Minority interest - gain (loss) on disposition of discontinued
operations ( 3,195) - ( 3,195) -
Depreciation and amortization from real property 67,566 56,889 23,225 19,512
Depreciation from real property from unconsolidated entities 556 1,837 - 725
Impairment on General Partner real estate investment 945 1,785 - 1,785
Loss on disposition of property 50 79 - 69
(Gain) loss on disposition of discontinued operations, net of
minority interest ( 417) ( 355) 94 ( 35)
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 - 1,610 - 261
Cumulative effect of change in accounting principle, net of
minority interest 321 - - -
------- -------- ------- -------
FFO as defined above $94,859 $101,386 $28,310 $37,442
======== ======== ======== ========
Weighted average common shares/units outstanding(1):
- Basic 48,660.3 44,577.3 48,894.6 45,611.9
======== ======== ======== ========
- Diluted 49,100.3 47,624.0 49,338.6 48,078.9
======== ======== ======== ========
(1) The calculation assumes the conversion of dilutive common stock equivalents
including convertible preferred stock and the conversion of all UPREIT
units to common shares.
All REITs may not be using the same definition for FFO. Accordingly, the above
presentation may not be comparable to other similarly titled measures of FFO of
other REITs.
Covenants
---------
Series F Preferred Stock
------------------------
In connection with the issuance of the Series F Preferred Stock, the Company is
required to maintain for each fiscal quarterly period a fixed charge coverage
ratio, as defined in the Series F Cumulative Redeemable Preferred Stock Article
Supplementary, of 1.75 to 1.0. The fixed charge coverage ratio and the
components thereof do not represent a measure of cash generated from operating
activities in accordance with generally accepted accounting principles and are
not necessarily indicative of cash available to fund cash needs. Further, this
ratio should not be considered as an alternative measure to net income as an
indication of the Company's performance or of cash flow as a measure of
liquidity. The Company has been in compliance with the covenant since the Series
F Preferred Stock was issued. If the Company fails to be in compliance with this
covenant for six or more consecutive fiscal quarters, the holders of the Series
F Preferred Stock would be entitled to elect two directors to the board of
directors of the Company. The calculation of the fixed charge coverage ratio for
the four most recent quarters since the issuance of the Series F Preferred Stock
is 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
------------------
Sept. 30,2004 June 30,2004 Mar. 31,2004 Dec 31, 2003
------------- ------------ ------------ ------------
Total revenues $118,942 $118,017 $113,197 $111,458
Net operating income from discontinued operations ( 423) ( 276) - 80
Operating and maintenance (50,372) (51,081) ( 54,232) ( 48,698)
General and administrative ( 4,879) ( 4,892) ( 4,725) ( 8,236)
Impairment of assets held as General Partner - - ( 1,116) ( 110)
Equity in earnings (losses) of unconsolidated
affiliates 25 ( 25) ( 538) ( 395)
-------- ------- -------- --------
$ 63,293 $61,743 $ 52,586 $ 54,099
Fixed Charges
Interest expense $ 23,496 $23,783 $ 21,332 $ 21,595
Interest expense on discontinued operations 40 476 - 79
Preferred dividends 1,898 1,899 1,898 1,984
Capitalized interest 230 171 171 230
-------- ------- -------- --------
$ 25,664 $26,329 $ 23,401 $ 23,888
Times Coverage ratio: 2.47 2.35 2.25 2.26
Line of Credit
--------------
The Credit Agreement relating to the Company's line of credit provides for the
Company to maintain certain financial ratios and measurements. One of these
covenants is that the Company may not pay any distribution to its shareholders
and holders of its UPREIT Units if a distribution, when added to other
distributions paid during the three immediately preceding fiscal quarters,
exceeds the greater of : (i) 90% of funds from operations, and 110% of cash
available for distribution; and (ii) the amount required to maintain the
Company's status as a REIT. Due to the granting of restricted stock to the
retiring Co-CEO's in the fourth quarter of 2003 the Company did not meet the 90%
required ratio. Approximate waivers have been granted by the participating banks
to exclude the impact of this charge from future calculations. The Company has
had to obtain waivers for this same covenant for two consecutive years. The line
of credit has not been used for long-term financing but adds a certain amount of
flexibility, especially in meeting the Company's acquisition goals. Many times
it is easier to temporarily finance an acquisition in a short-term nature
through the line of credit, with long term secured financing or other sources of
capital replenishing the line of credit availability.
Economic Conditions
-------------------
Substantially all of the leases at the Company's apartment communities are for a
term of one year or less, which enables the Company to seek increased rents upon
renewal of existing leases or commencement of new leases. These short-term
leases minimize the potential adverse effect of inflation on rental income,
although residents may leave without penalty at the end of their lease terms and
may do so if rents are increased significantly.
Historically, real estate has been subject to a wide range of cyclical economic
conditions, which affect various real estate sectors and geographic regions with
differing intensities and at different times. During 2002, 2003 and continuing
into 2004 many regions of the United States have experienced varying degrees of
economic recession and certain recessionary trends, such as the cost of
obtaining sufficient property and liability insurance coverage, short-term
interest rates, and a temporary reduction in occupancy. In light of this, we
will continue to review our business strategy however, we believe that given our
property type and the geographic regions in which we are located, we do not
anticipate any changes in our strategy or material effects in financial
performance.
Declaration of Dividend
-----------------------
On November 2, 2004, the Board of Directors approved a dividend of $.63 per
share for the quarter ended September 30, 2004. This is the equivalent of an
annual distribution of $2.52 per share. The dividend is payable November 26,
2004 to shareholders of record on November 16, 2004.
On November 2, 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 November 30, 2004. The dividend on the preferred shares is payable on
November 30, 2004, to shareholders of record on November 16, 2004. This dividend
is equivalent to an annualized rate of $2.25 per share.
Contingency
-----------
In 2001, the Company underwent a state capital stock tax audit. The state has
assessed taxes of $469 for the 1998 and 1999 tax years under audit. If the
state's position is applied to all tax years through December 31, 2001, the
assessment would be $1.3 million. At the time, the Company believed the
assessment and the state's underlying position were not supportable by the law
nor consistent with previously provided interpretative guidance from the office
of the State Secretary of Revenue. After two subsequent enactments by the state
legislation during 2002 affecting the pertinent tax statute, the Company was
advised by outside tax counsel that its filing position for 1998-2001 should
prevail. During December 2003, the state's governor signed legislation which
included the REIT tax provisions. Based upon this, Company's tax counsel expects
that the outstanding litigation should now be able to be resolved. Effective
January 1, 2003, the Company reorganized the ownership of Home Properties Trust,
which should subject the Company to a much lower level of tax going forward.
During the third quarter, the Company offered to settle the 1998 tax year for
$29 of the $194 assessment, which was accepted by the State's Attorney General.
For the remaining years, 1999-2001 or $1.1 million in exposure, the Company is
still dealing with the State Department of Revenue, pursuing 100% relief as
supported by interpretation of tax law by outside counsel.
The Company and the Operating Partnership, along with Home Leasing Corporation,
the predecessor of the Company that is owned by Nelson and Norman Leenhouts, are
defendants in a lawsuit. The essence of the complaint is that the entity in
which plaintiffs were investors was wrongfully excluded from the Company's
initial organization as a real estate investment trust and the investors,
therefore, did not obtain the benefits from exchanging their equity interests in
that entity for equity in the Operating Partnership. In their original
complaint, plaintiffs sought damages in the amount of $3 million. In the
subsequent discovery process, plaintiffs increased the damages sought to $11
million. The Company and the Operating Partnership have responded to the lawsuit
by denying all material allegations and asserting various defenses. The only
remaining cause of action against the Company and the Operating Partnership is a
claim of breach of fiduciary duty. It is not possible to estimate the possible
loss or range of loss at this time and the Company has therefore not accrued any
liability for the third quarter. Management and its counsel believe that
applicable legal precedents support a conclusion that neither the Company nor
the Operating Partnership should be found to have any liability to the
plaintiffs, and that, in the event any liability is found, recoverable damages
should be limited to an immaterial amount.
New Accounting Standards
------------------------
In March 2004, the FASB issued EITF 03-6 "Participating Securities and the
Two-Class Method under FASB Statement 128, Earnings per Share. EITF 03-6
addresses a number of questions regarding the computation of earnings per share
by companies that have issued securities other than common stock that
contractually entitle the holder to participate in dividends and earnings of the
company when, and if, it declares dividends on its common stock. The issue also
provides further guidance in applying the two-class method of calculating EPS.
It clarifies what constitutes a participating security and how to apply the
two-class method of computing EPS once it is determined that a security is
participating, including how to allocate undistributed earnings to such a
security. The EITF is effective for the first fiscal periods beginning after
March 31, 2004. The Company adopted the provisions of this EITF effective April
1, 2004, and had no impact on the Company's results of operations, financial
position or liquidity.
In May 2003, FASB issued SFAS 150, "Accounting for Certain Financial Instruments
with Characteristics of Both Liabilities and Equity." This Statement establishes
standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity. It requires
that an issuer classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). This Statement is effective for
financial instruments entered into or modified after May 31, 2003, and otherwise
is effective at the beginning of the first interim period beginning after June
15, 2003. On October 29, 2003 the FASB indefinitely deferred the provisions of
paragraphs 9 and 10 of SFAS 150 as they apply to mandatorily redeemable
noncontrolling interests. This deferral applies to minority interest ownerships
in limited partnerships which are mandatorily redeemable upon termination of the
partnership and therefore is potentially applicable to the affordable portfolio.
The Company's investments in the limited partnerships consolidated under FIN 46R
have a mandatory redeemable feature upon termination of the partnership.
However, due to the tax credit restrictions on the consolidated partnerships, if
the partnerships were terminated prior to the end of the tax credit compliance
periods, the partnership would be liable to fund the tax credits payable to the
limited partners.
HOME PROPERTIES, INC.
ITEM 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
The percentages and loan balances discussed below are prior to FIN 46R
consolidations on the balance sheet. The assets and liabilities of a certain of
the affordable limited partnerships added to the consolidated balance sheet as
of March 30, 2004 remain and are classified as held for sale on the September
30, 2004 balance sheet. As the non-recourse debt associated with these
properties will no longer affect the balance sheet upon sale of the Company's
interests in the partnerships, the Company believes that comparing pre-FIN 46R
financial information provides the reader of the financial statements with a
more meaningful comparison.
The Company's primary market risk exposure is interest rate risk. At September
30, 2004 and December 31, 2003, approximately 88% and 98%, respectively, of the
Company's debt bore interest at fixed rates with a weighted average maturity of
approximately 7 and 9 years and a weighted average interest rate of
approximately 6.36% and 6.47%, respectively, including the $34.0 million and
$25.2 million of debt, respectively which has been swapped to a fixed rate. The
remainder of the Company's debt bears interest at variable rates with a weighted
average maturity of approximately 8 and 2 years, respectively, and a weighted
average interest rate of 2.65% and 2.32%, respectively, at September 30, 2004
and December 31, 2003. The Company does not intend to utilize a significant
amount of permanent variable rate debt to acquire properties in the future. On
occasion, the Company may use its line of credit in connection with a property
acquisition with the intention to refinance at a later date. The Company
believes, however, that in no event would increases in interest expense as a
result of inflation significantly impact the Company's distributable cash flow.
At September 30, 2004 and December 31, 2003, the interest rate risk on $34
million and $25.2 million, respectively of such variable rate debt has been
mitigated through the use of interest rate swap agreements (the "Swaps") with
major financial institutions. The Company is exposed to credit risk in the event
of non-performance by the counter-parties to the Swaps. The Company believes it
mitigates its credit risk by entering into these Swaps with major financial
institutions. The Swaps effectively convert an aggregate of $34 million at
September 30, 2004 in variable rate mortgages to fixed rates of 5.35%, 5.39%,
8.22% and 8.40% and $25.2 million at December 31, 2003 in variable rate
mortgages to fixed rates of 5.91%, 8.22% and 8.40%.
At September 30, 2004 and December 31, 2003, the fair value of the Company's
fixed rate debt, including the $34 million at September 30, 2004 and $25.2
million at December 31, 2003 which was swapped to a fixed rate, amounted to a
liability of $1.63 billion compared to its carrying amount of $1.53 billion. The
Company estimates that a 100 basis point increase in market interest rates at
September 30, 2004 would have changed the fair value of the Company's fixed rate
debt to a liability of $1.55 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
September 30, 2004, the Company had no other material exposure to market risk.
HOME PROPERTIES, INC.
ITEM 4. INTERNAL CONTROLS
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in the Company's Exchange Act
reports is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms, and that
such information is accumulated and communicated to the Company's Co-Chief
Executive Officers and Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure. In designing and evaluating the
disclosure controls and procedures, management recognized that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and management
necessarily was required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures.
The Co-Chief Executive Officers and Chief Financial Officer have, as of the end
of the period covered by this quarterly report, evaluated the effectiveness of
the disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended) and have
determined that such disclosure controls and procedures are adequate. In
connection with the evaluation, no change in the Company's internal control over
financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the
Securities Exchange Act of 1934, as amended) was identified that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
PART II - OTHER INFORMATION
HOME PROPERTIES, INC.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
------- -----------------------------------------------------------
In 1997, the Company's Board of Directors approved a stock repurchase program
under which the Company may repurchase shares of its outstanding common stock
and UPREIT Units. 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 specific target stock price or a specific
timetable for share repurchase. Recently, the Company's Board of Directors
removed certain price restrictions, which substantially enhances the Company's
ability to repurchase shares. At December 31, 2003 the Company had authorization
to repurchase 3,135,800 shares of common stock and UPREIT Units under the stock
repurchase program. No shares were repurchased during the first two quarters of
2004. In addition, participants in the Company's Stock Benefit Plan can use
common stock of the Company that they already own to pay all or a portion of the
exercise payable to the Company upon the exercise of an option. In such event,
the common stock used to pay the exercise price is returned to authorized but
unissued status, and for purposes of this table is deemed to have been
repurchased by the Company. The following table summarizes the total number of
shares (units) repurchased by the Company during the three month period ending
September 30, 2004.
Maximum shares
Total shares (units)
Total shares Average (units) purchased available under
(units) price per under Company the Company
Period purchased(1) share (unit) Program Program
------ --------- ------------ ------- -------
Balance June 30, 2004: - - - 3,135,800
------ ------- ------ ---------
July 1, 2004 to
July 31, 2004 - - - 3,135,800
August 1, 2004 to
August 31, 2004 57,500 $ 38.07 57,500 3,078,300
September 1, 2004 to
September 30, 2004 5,698 $ 39.41 - 3,078,300
------ ------- ------ ---------
Balance September 30, 2004: 63,198 $ 38.15 57,500 3,078,300
====== ======= ====== =========
(1) During September, 2004, 5,698 shares of common stock were used in
satisfaction of the Company's obligation upon the exercise of stock
options issued.
Item 6. Exhibits
------- --------
Exhibit 31.1 Section 302 Certifications of Chief Executive Officers
Exhibit 31.2 Section 302 Certification of Chief Financial Officer
Exhibit 32.1 Section 906 Certifications of Chief Executive Officers
Exhibit 32.2 Section 906 Certification of Chief Financial Officer
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.
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(Registrant)
Date: November 9, 2004
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By: /s/ Edward J. Pettinella
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Edward J. Pettinella
President and Chief Executive Officer
Date: November 9, 2004
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By: /s/ David P. Gardner
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David P. Gardner
Executive Vice President and
Chief Financial Officer