SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-13136
HOME PROPERTIES, INC.
(Exact name of registrant as specified in its charter)
MARYLAND 16-1455126
(State or other jurisdiction of (IRS Employer Identification
incorporation or organization) Number)
850 Clinton Square, Rochester, New York 14604
(Address of principal executive offices) (Zip Code)
(585) 546-4900
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former
year, if changed since last report)
Indicate by check mark whether registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
----- -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
YES X NO
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Class of Common Stock Outstanding at April 30, 2005
$.01 par value 31,504,438
HOME PROPERTIES, INC.
TABLE OF CONTENTS
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets -
March 31, 2005 (Unaudited) and December 31, 2004 3
Consolidated Statements of Operations (Unaudited) -
Three months ended March 31, 2005 and 2004 4
Consolidated Statements of Comprehensive Income (Unaudited) -
Three months ended March 31, 2005 and 2004 5
Consolidated Statements of Cash Flows (Unaudited) -
Three months ended March 31, 2005 and 2004 6
Notes to Consolidated Financial Statements (Unaudited) 7-18
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 19-32
Item 3. Quantitative and Qualitative Disclosures About Market Risk 33
Item 4. Controls and Procedures 34
ART II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 35
Signatures 36
Item 6. Exhibits
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HOME PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
MARCH 31, 2005 AND DECEMBER 31, 2004
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
2005 2004
---- ----
(Unaudited) (Note 1)
ASSETS
Real estate:
Land $ 408,186 $402,620
Buildings, improvements and equipment 2,695,288 2,642,570
Real estate held for sale or disposal, net 40,636 78,711
---------- ----------
3,144,110 3,123,901
Less: accumulated depreciation ( 429,886) ( 405,919)
---------- ----------
Real estate, net 2,714,224 2,717,982
Cash and cash equivalents 9,895 7,925
Cash in escrows 39,735 43,883
Accounts receivable 4,872 6,664
Prepaid expenses 18,292 18,224
Deferred charges 12,512 13,778
Other assets 9,301 8,340
---------- ----------
Total assets $2,808,831 $2,816,796
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Mortgage notes payable $1,688,986 $1,644,722
Line of credit 92,000 58,000
Accounts payable 18,140 24,600
Accrued interest payable 8,493 8,876
Accrued expenses and other liabilities 21,256 26,750
Security deposits 22,838 22,651
---------- ----------
Total liabilities 1,851,713 1,785,599
---------- ----------
Commitments and contingencies
Minority interest 294,886 310,775
---------- ----------
Stockholders' equity:
Cumulative redeemable preferred stock, $.01 par value; 2,400,000 shares issued
and outstanding at March 31, 2005 and December 31, 2004 60,000 60,000
Convertible cumulative preferred stock, $.01 par value; 10,000,000 shares
authorized; 250,000 shares issued and outstanding at March 31, 2005 and
December 31, 2004 25,000 25,000
Common stock, $.01 par value; 80,000,000 shares authorized; 31,442,679 and
32,625,413 shares issued and outstanding at March 31, 2005 and
December 31, 2004, respectively 314 326
Excess stock, $.01 par value; 10,000,000 shares authorized; no shares issued or outstanding - -
Additional paid-in capital 770,014 807,212
Accumulated other comprehensive income ( 9) ( 362)
Distributions in excess of accumulated earnings ( 193,087) ( 171,754)
---------- ----------
Total stockholders' equity 662,232 720,422
---------- ----------
Total liabilities and stockholders' equity $2,808,831 $2,816,796
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
HOME PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004
(UNAUDITED, IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
2005 2004
---- ----
Revenues:
Rental income $112,958 $105,061
Property other income 5,173 4,593
Interest and dividend income 68 152
Other income 588 465
---------- --------
Total revenues 118,787 110,271
---------- --------
Expenses:
Operating and maintenance 57,511 53,110
General and administrative 5,405 4,725
Interest 24,943 20,925
Depreciation and amortization 24,196 21,050
Impairment of assets held as General Partner - 1,116
---------- --------
Total expenses 112,055 100,926
---------- --------
Income from operations 6,732 9,345
Equity in earnings (losses) of unconsolidated affiliates - ( 538)
---------- --------
Income before minority interest and discontinued operations 6,732 8,807
Minority interest in operating partnership ( 1,598) ( 2,289)
---------- --------
Income from continuing operations 5,134 6,518
---------- --------
Discontinued operations
Income (loss) from operations, net of ($2,521) in 2005 and $179 in 2004
allocated to minority interest ( 5,106) 361
Gain (loss) on disposition of property, net of ($6) in 2004 allocated to minority interest - ( 13)
---------- --------
Discontinued operations ( 5,106) 348
---------- --------
Income before loss on disposition of property and business and cumulative effect of
change in accounting principle 28 6,866
Loss on disposition of property and business, net of $33 in 2004 allocated to minority
interest - ( 67)
---------- --------
Income before cumulative effect of change in accounting principle 28 6,799
Cumulative effect of change in accounting principle, net of $159 in 2004 allocated to
minority interest - ( 321)
---------- --------
Net income 28 6,478
Preferred dividends ( 1,898) ( 1,898)
---------- --------
Net income (loss) available to common shareholders ($ 1,870) $ 4,580
Basic earnings per share data:
Income from continuing operations $.10 $.14
Discontinued operations ( .16) .01
Cumulative effect of change in accounting principle - ( .01)
---------- --------
Net income (loss) available to common shareholders ($ .06) $.14
Diluted earnings per share data:
Income from continuing operations $.10 $.14
Discontinued operations ( .16) .01
Cumulative effect of change in accounting principle - ( .01)
---------- --------
Net income (loss) available to common shareholders ($ .06) $.14
Weighted average number of shares outstanding:
- Basic 31,785,440 32,321,929
========== ==========
- Diluted 32,227,972 32,874,561
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
HOME PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004
(UNAUDITED, IN THOUSANDS)
2005 2004
---- ----
Net income $ 28 $ 6,478
Other comprehensive income (net of minority interest):
Change in fair value of hedge instruments 353 72
------ -------
Comprehensive income $ 381 $ 6,550
====== =======
The accompanying notes are an integral part of these consolidated financial
statements.
HOME PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004
(UNAUDITED, IN THOUSANDS)
2005 2004
---- ----
Cash flows from operating activities:
Net income $ 28 $ 6,478
------ -------
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in losses of unconsolidated affiliates - 538
Income (loss) allocated to minority interest ( 923) 2,270
Depreciation and amortization 24,756 22,090
Impairment of assets held as General Partner 7,725 1,116
Gain on disposition of property and business - 119
Cumulative effect of change in accounting principle - 480
Changes in assets and liabilities:
Other assets 165 1,491
Accounts payable and accrued liabilities (10,661) 2,777
------ -------
Total adjustments 21,062 30,881
------ -------
Net cash provided by operating activities 21,090 37,359
------ -------
Cash flows used in investing activities:
Purchase of properties and other assets, net of mortgage
notes assumed and UPREIT Units issued (19,553) ( 64,376)
Additions to properties (18,215) ( 19,996)
Proceeds from sale of affordable properties, net - 137
Advances to affiliates - ( 795)
Payments on advances to affiliates - 89
------ -------
Net cash used in investing activities (37,768) ( 84,941)
------ -------
Cash flows from financing activities:
Proceeds from sale of common stock, net 3,271 14,509
Repurchase of common stock (54,265) -
Proceeds from mortgage notes payable 82,040 15,717
Payments of mortgage notes payable (12,626) ( 19,939)
Proceeds from line of credit 99,200 96,000
Payments on line of credit (65,200) ( 25,000)
Payments of deferred loan costs (506) ( 129)
Additions to cash escrows, net (1,761) ( 990)
Repayment of officer loans - 235
Dividends and distributions paid (31,505) ( 31,670)
------ -------
Net cash provided by financing activities 18,648 48,733
------ -------
Net increase in cash and cash equivalents 1,970 1,151
Cash and cash equivalents:
Beginning of year 7,925 5,103
Cash assumed in connection with FIN 46R consolidation - 850
------ -------
End of period $9,895 $ 7,104
====== =======
Supplemental disclosure of non-cash operating, investing and financing activities:
Mortgage loans assumed associated with property acquisitions $7,916 $ 69,782
Exchange of UPREIT Units/partnership interest for common shares 156 5,267
Fair value of hedge instruments 131 849
Issuance of UPREIT Units associated with property and other acquisitions 12,611 12,105
Compensation cost of stock options issued 171 248
Net real estate disposed in connection with FIN 46R consolidation (30,651) -
Other assets disposed in connection with FIN 46R consolidation (4,403) -
Mortgage debt disposed in connection with FIN 46R consolidation (30,021) -
Other liabilities disposed in connection with FIN 46R consolidation (827) -
Increase in real estate associated with the purchase of UPREIT Units - 4,940
Net real estate assumed in connection with FIN 46R consolidation - 152,319
Other assets assumed in connection with FIN 46R consolidation - 11,916
Mortgage debt assumed in connection with FIN 46R consolidation - 129,149
Other liabilities assumed in connection with FIN 46R consolidation - 5,363
The accompanying notes are an integral part of these consolidated financial
statements.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1. Unaudited Interim Financial Statements
-- --------------------------------------
The interim consolidated financial statements of Home Properties, Inc. (the
"Company") have been prepared in accordance with accounting principles
generally accepted in the United States of America for interim financial
information and the applicable rules and regulations of the Securities and
Exchange Commission. Accordingly, certain disclosures that would accompany
annual financial statements prepared in accordance with accounting
principles generally accepted in the United States of America are omitted.
The year-end balance sheet data was derived from audited financial
statements, but does not include all disclosures required by accounting
principles generally accepted in the United States of America. In the
opinion of management, all adjustments, consisting solely of normal
recurring adjustments, necessary for the fair presentation of the
consolidated financial statements for the interim periods have been
included. The current period's results of operations are not necessarily
indicative of results which ultimately may be achieved for the year. The
interim consolidated financial statements and notes thereto should be read
in conjunction with the consolidated financial statements and notes thereto
included in the Company's Form 10-K for the year ended December 31, 2004.
2. Organization and Basis of Presentation
-- --------------------------------------
Organization
------------
The Company is engaged primarily in the ownership, management, acquisition,
and rehabilitation of residential apartment communities in the
Northeastern, Mid-Atlantic, Midwestern and Southeast Florida regions of the
United States. As of March 31, 2005, the Company operated 163 apartment
communities with 47,186 apartment units. Of this total, the Company owned
153 communities, consisting of 42,326 apartment units ("Owned
Communities"), managed as general partner 2,051 apartment units and fee
managed 2,809 apartments for affiliates and third parties.
Basis of Presentation
---------------------
The accompanying consolidated financial statements include the accounts of
the Company and its 66.5% (67.1% at March 31, 2004) 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 33.5% (32.9% at March 31, 2004) 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. During 2004, the Company sold most of these consolidated VIEs
such that three partnerships (two properties) remain as of March 31, 2005.
The results of operations for 5 VIEs for the three month period ending
March 31, 2005, are included in discontinued operations (two VIEs were sold
in March 2005). These properties are classified as held for sale because as
of March 31, 2005, the Company is under a letter of intent to sell one of
the partnerships for which due diligence is in process and the remaining
two partnerships are being disposed of through a default on the
non-recourse financing. During March 2005, the mortgage notes were sold by
HUD. The Company is currently discussing transferring title to the property
to either the new mortgage holder or other interested buyers.
As of March 31, 2004, Home Properties determined that it was not the
primary beneficiary in seven partnerships syndicated under U.S. Department
of Housing and Urban Development subsidy programs, two of which remained as
of March 31, 2005. These two investments will continue to be accounted for
under the equity method. The Company will continue to record its allocable
share of the respective partnership's income or loss based on the terms of
the agreements. 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 2004 consolidated financial
statements to conform to the 2005 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
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 123R Share Based Payment (SFAS No. 123R). The statement is a
revision of SFAS No. 123 Accounting for Stock-Based Compensation. SFAS No
123R supersedes APB Opinion No. 25 Accounting for Stock Issued to
Employees, and its related implementation guidance. SFAS 123R, requires
that entities recognize the cost of employee services received in exchange
for awards of equity instruments (i.e. stock options) based on the
grant-date fair value of those awards. The Statement is effective for the
first fiscal periods beginning after June 15, 2005. On January 1, 2003, the
Company adopted the provisions of SFAS No. 148 Accounting for Stock-Based
Compensation - Transition and Disclosure, an Amendment to SFAS No. 123.
Effective on that date, the Company began recognizing compensation cost
related to stock option grants. Based upon the Company's adoption of SFAS
No. 148, the Company does not expect the issuance of SFAS No. 123R to have
a material impact on the Company's results of operations, financial
position or liquidity.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
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
three-months ended March 31, 2005 and 2004 is as follows:
Three Months
2005 2004
---- ----
Income from continuing operations $5,134 $ 6,518
Add: Gain (loss) on disposal of property - ( 67)
Less: Preferred dividends ( 1,898) ( 1,898)
---------- ----------
Basic and Diluted - Income from continuing operations
applicable to common shareholders 3,236 4,553
Less: Cumulative effect of change in accounting principle - ( 321)
Discontinued operations ( 5,106) 348
---------- ----------
Net income available to common shareholders ($ 1,870) $4,580
========== ==========
Basic weighted average number of shares outstanding 31,785,440 32,321,929
Effect of dilutive stock options 357,856 448,698
Effect of phantom and restricted shares 84,676 103,934
---------- ----------
Diluted weighted average number of shares outstanding 32,227,972 32,874,561
========== ==========
Basic earnings per share
Income from continuing operations $.10 $.14
Discontinued operations (.16) .01
Cumulative effect of change in accounting principle - (.01)
---------- ----------
Net Income available to common shareholders ($.06) $.14
========== ==========
Basic earnings per share
Income from continuing operations $.10 $.14
Discontinued operations (.16) .01
Cumulative effect of change in accounting principle - (.01)
---------- ----------
Net Income available to common shareholders ($.06) $.14
========== ==========
For the three-month periods ended March 31, 2005 and 2004, no unexercised
stock options to purchase shares of the Company's common stock were
excluded in the computations of diluted EPS as the options' exercise prices
were less than the average market price of the Company's stock during each
period. For the three-month periods ended March 31, 2005 and 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. To the extent the preferred
stock was converted, the common shares would be included in outstanding
shares from the date of conversion.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
5. Other income
------------
Other income for the three-month periods ended March 31, 2005 and 2004 is
management and other real-estate service fees.
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 had made a determination that all 41 of the
remaining limited partnerships as of that date were Variable Interest
Entities.
The Company determined that it was not the primary beneficiary in seven
partnerships syndicated under U.S. Department of Housing and Urban
Development subsidy programs of which five have been sold as of March 31,
2005. The two remaining partnerships are under contract to be sold as of
March 31, 2005. These two investments will continue to be accounted for
under the equity method and included in equity in earnings of
unconsolidated affiliates until final sale closing. The Company purchased
the general partnership interests in these 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. No management fees were recognized on these partnerships
during the three month period ended March 31, 2005. The assets and
liabilities of the two partnerships totaled $2.9 million and $4.9 million
at March 31, 2005, respectively. Unconsolidated non-recourse debt
associated with the two partnerships continuing to be accounted for under
the equity method amounted to $4.6 million, of which the Company's
proportionate share, based on its legal ownership, was $179.
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 remaining five of the original 34 VIEs for the three
month period ending March 31, 2005 are included in discontinued operations
as all of the VIEs are held for sale as described below.
The Company was 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 managed 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 (as discussed in Note 11). The Company is responsible to fund
operating deficits to the extent there are any and can receive operating
incentive awards when cash flow reach certain levels. The effect on the
consolidated balance sheet as of March 31, 2005 is an increase in Total
assets of $44 million, an increase in Total liabilities of $48 million, an
increase in Minority interest of $1 million, and a decrease in
Stockholders' equity of $4.9 million. In connection with the adoption of
FIN 46R, the Company recorded a $321 charge, net of minority interest, for
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 $48
million increase in total liabilities, $46.5 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 March 31, 2005, the Company has closed on the sale of all but
five of the 41 VIEs. In addition, the Company is under contract or letter
of intent for the sale of three of the remaining five VIEs. Based on the
offer received in the first quarter on one of these three VIEs, the Company
has recorded an impairment charge of $400 for the three month period ended
March 31, 2005. The remaining two VIEs (not under contract for sale) are
being disposed of through a default on the non-recourse financing. The
Company repurchased 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 performed a valuation analysis on the
underlying real estate, and as a result, recorded a $7.3 million impairment
of real estate to adjust the net book value of the property to the
Company's estimate of fair market value. The mortgage note was sold in
March, 2005. The Company is currently discussing transferring title of the
property to either the new mortgage holder or other interested buyers. A
transfer is expected to occur later in the year. At that time, the Company
would be relieved of its obligation on the non-recourse financing and would
record an offsetting $7.3 million gain from debt forgiveness in excess of
the new reduced basis on the real estate that would in essence zero out the
$7.3 million impairment charge recorded.
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 were 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, 2004. Non-core properties consist of
apartment communities acquired during 2004 and 2005, 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 or non-cash real estate
impairment charge, minority interest in the Operating Partnership,
extraordinary items, plus real estate depreciation, less dividends from
non-convertible preferred shares. FFO is not a measure of operating results
or cash flows from operating activities as measured by generally accepted
accounting principles and it is not indicative of cash available to fund
cash needs and should not be considered an alternative to cash flows as a
measure of liquidity. Other companies may calculate similarly titled
performance measures in a different manner.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
7. Segment Reporting (continued)
-----------------------------
The revenues, profit (loss), and assets for each of the reportable segments
are summarized as of and for the three-month periods ended March 31, 2005,
and 2004 as follows.
Three Months
------------
2005 2004
---- ----
Revenues
Apartments owned
Core properties $ 109,704 $ 107,964
Non-core properties 8,427 1,690
Reconciling items 656 617
---------- ----------
Total Revenue $ 118,787 $ 110,271
========== ==========
Profit (loss)
Funds from operations:
Apartments owned
Core properties $ 56,049 $ 55,518
Non-core properties 4,571 1,026
Reconciling items 656 617
---------- ----------
Segment contribution to FFO 61,276 57,161
General and administrative expenses ( 5,405) ( 4,725)
Interest expense ( 24,943) ( 20,925)
Prepayment penalty on sale included in interest - -
Depreciation of unconsolidated affiliates - 543
Non-real estate depreciation/amortization ( 813) ( 742)
FAS 141 acquisition rent / intangibles 219 182
Equity in earnings (losses) of unconsolidated affiliates - ( 538)
Impairment of assets held as General Partner - ( 1,116)
Impairment of affordable assets not in FFO - 945
Loss on sale of business - ( 17)
Income from discontinued operations before minority interest and
depreciation ( 7,627) 1,201
Redeemable preferred dividend (Series F) ( 1,350) ( 1,350)
---------- ----------
Funds from Operations 21,357 30,619
Depreciation - apartments owned ( 23,383) ( 20,969)
Depreciation of unconsolidated affiliates - ( 543)
FAS 141 acquisition rent/intangibles ( 219) ( 182)
Redeemable preferred dividend 1,350 1,350
Impairment of affordable assets not in FFO - ( 945)
(Income) loss from discontinued operations before minority
interest and loss on disposition of property 7,627 ( 523)
Minority interest - in operating partnership ( 1,598) ( 2,289)
---------- ----------
Income from continuing operations $ 5,134 $ 6,518
========== ==========
Assets - As of March 31, 2005 and December 31, 2004
Apartments owned:
- Core $2,362,479 $2,368,949
- Non-core 351,745 349,033
Reconciling items 94,607 98,814
---------- ----------
Total Assets $2,808,831 $2,816,796
========== ==========
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 three apartment communities ("2005 Acquired
Communities") with a combined 550 apartment units in three unrelated
transactions during the three-month period ended March 31, 2005. The total
combined purchase price (including closing costs) of $40.2 million equates
to approximately $73 per unit. Consideration for the communities was funded
through the assumption or placement of new debt of $7.9 million,
$19.7 million from the Company's line of credit and $12.6 million of UPREIT
Units.
The following proforma information was prepared as if the 2005 transactions
related to the acquisition of the 2005 Acquired Communities had occurred on
January 1, 2004. 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 on January 1, 2004, nor does it
purport to represent the results of operations for future periods.
Adjustments to the proforma condensed combined statement of operations for
the three-month periods ended March 31, 2005 and 2004, consist principally
of providing net operating activity and recording interest, depreciation
and amortization from January 1, 2004 to the acquisition date as
appropriate.
For the Three-months Ended
March 31,
---------
2005 2004
---- ----
Total revenues $119,363 $111,542
Net income available to common shareholders before
cumulative effect of change in accounting principle 3,269 4,713
Net income available to common shareholders 3,269 4,392
Per common share data:
Net income available to common shareholders before
cumulative effect of change in accounting principle
Basic $0.10 $0.15
Diluted $0.10 $0.14
Net income available to common shareholders
Basic $0.10 $0.14
Diluted $0.10 $0.13
Weighted average numbers of shares outstanding:
Basic 31,785,440 32,321,929
Diluted 32,227,972 32,874,561
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 March 31, 2005, the aggregate fair
value of the Company's interest rate swaps was $131 prior to the allocation
of minority interest and is included in accrued expenses and other
liabilities in the consolidated balance sheets. For the three-months ending
March 31, 2005, 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
--------------------------------------------------
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.
Included in discontinued operations are the operating results, net of
minority interest, of five VIEs for the three months ended March 31, 2005.
Three of the VIEs are held for sale as of March 31, 2005. Assets and
liabilities for these three VIEs of approximately $44.5 million and $48.2
million, respectively, are included in the Consolidated Balance Sheet and
relate primarily to real estate and mortgage notes, respectively. Included
in mortgage notes payable is approximately $46.5 million related to these
three VIEs. 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.
The operating results of the components of discontinued operations are
summarized for the three-month periods ended March 31, 2005 and 2004 as
follows:
Three months
------------
2005 2004
---- ----
Revenues
Rental Income $ 2,201 $3,465
Property other income 74 176
Interest and dividend income - -
Other income ( 59)
------- -------
-
Total Revenues 2,216 3,641
------- -------
Expenses
Operating and Maintenance 2,074 1,837
Interest expense 21 603
Depreciation and amortization - 661
Impairment of real property 7,725
------- -------
-
Total Expenses 9,820 3,101
------- -------
Income (loss) from discontinued operations
before minority interest and gain (loss)
on disposition of property ( 7,604) 540
Minority interest in limited partnership ( 23) -
Minority interest in operating partnership 2,521 ( 179)
------- -------
Income (loss) from discontinued operations ($5,106) $ 361
======= =======
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
11. Commitments and Contingencies
-----------------------------
Contingencies
-------------
The Company is not a party to any legal proceedings which are expected to
have a material adverse effect on the Company's liquidity, financial
position or results of operations. The Company is subject to a variety of
legal actions for personal injury or property damage arising in the
ordinary course of its business, most of which are covered by liability
insurance. While the resolution of these matters cannot be predicted with
certainty, management believes that the final outcome of such legal
proceedings and claims will not have a material adverse effect on the
Company's liquidity, financial position or results of operations.
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, including
interest. During the first quarter of 2005, the 1999 tax year has been
filed with the Pennsylvania State Commonwealth Court. No settlement offer
has been made or discussed related to the 1999 tax year. 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.
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 2004 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 of 2004, 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 $68 for the six-month period ended
December 31, 2004. The Company has filed Voluntary Disclosure Agreements
(VDAs) with the four states where it has financial exposure. During the
first quarter of 2005, the Company has signed VDAs with two of the states
which both have agreed to limit the VDA filing period back to January 1,
2001. For the three month period ended March 31, 2005, the Company has
recorded adjustments to the liability for both the effects of signing the
two VDA's as well as for the results of the Company's additional testing
for the first quarter. The net impact of these adjustments resulted in an
increase in real estate assets of $42, interest expense of $28 and a
decrease in operating expenses of $43 for a net increase to the accrued
liability of $27. 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.
HOME PROPERTIES, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
11. Commitments and Contingencies (Continued)
-----------------------------------------
Guarantees
----------
As of March 31, 2005, 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 8
partnerships totaling approximately $17 million. As of March 31, 2005,
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.
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. No additional deferred
purchase price was recognized during the three months ended March 31, 2005.
The cumulative gain recognized on the sale of these assets through March
31, 2005 amounted to $24.4. If the management of this property is retained
for the entire three years the Company expects to receive an additional
$110.4 for the period April 1, 2005 through January 1, 2007. The gain on
sale would then be approximately $134.8.
13. Subsequent Events
-----------------
On May 6, 2005, the Board of Directors approved a dividend of $.63 per
share for the quarter ended March 31, 2005. This is the equivalent of an
annual distribution of $2.52 per share. The dividend is payable May 27,
2005 to shareholders of record on May 17, 2005.
On May 6, 2005, the Company also declared a regular dividend of $.5625 per
share on its Series F Cumulative Redeemable Preferred Stock, for the
quarter ending May 31, 2005. The dividend on the preferred shares is
payable on May 31, 2005 to shareholders of record on May 17, 2005. 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 March 31, 2005, the Company had an unsecured line of credit from M and T
Bank of $115 million. The Company's outstanding balance as of March 31, 2005,
was $92 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 Company is evaluating alternatives to
replace or extend the line of credit as the existing agreement expires on
September 1, 2005.
On November 23, 2004, the Company signed a supplemental demand note with M and T
Bank. The note has a maximum principal amount of $42 million. Borrowings on the
note bear interest at 1.25% over the one-month LIBOR rate. The demand note was
entered into to fund the Company's stock repurchase program. There was no
balance outstanding as of March 31, 2005 on the supplemental demand note.
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 March 31, 2005,
the Company owned 20 properties with 3,732 apartment units, which were
unencumbered by debt.
In May 1998, the Company's Form S-3 Registration Statement was declared
effective relating to the issuance of up to $400 million of common stock,
preferred stock or other securities. The available balance on the shelf
registration statement at March 31, 2005 was $144.4 million.
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 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 2005, the Company
acquired three communities with 550 units for a total purchase price of $40.2
million. The Company issued UPREIT Units valued at approximately $12.6 million
as part of the consideration for two of the properties, with the balance funded
by the assumption of debt and cash. During 2004, the Company acquired ten
communities with 2,486 units for a total purchase price of $247.5 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 2004, $17.6 million of common stock (net of $6 million share repurchase)
was issued under the Company's DRIP. During the first quarter of 2005, the
Company's additional capital raised under the DRIP netted to zero.
The DRIP was amended, effective December 10, 2004, 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 2% to 0%. The maximum monthly investment
(without receiving approval from the Company) is currently $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. In addition, in the fourth quarter of 2004,
the Company has begun meeting share demand in the program through share
repurchase by the transfer agent in the open market on the Company's behalf
instead of new share issuance. This removes essentially 100% of the dilution
caused by issuing new shares at a price less than the net asset value in an
economic and efficient manner.
On February 16, 2005 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
March 31, 2005, 1,300,700 shares were repurchased by the Company. At March 31,
2005 the Company had authorization to repurchase 2,699,300 shares of common
stock and UPREIT Units under the stock repurchase program. During 2005, the
Company will monitor stock prices, the published net asset value, and
acquisition alternatives to determine the current best use of capital between
the two major uses of capital - stock buyback and acquisitions.
As of March 31, 2005, the weighted average rate of interest on mortgage debt is
5.72% and the weighted average maturity is approximately eight years.
Approximately 87% 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.
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 had made a determination that all 41 of the remaining limited
partnerships as of that date were Variable Interest Entities.
The Company determined that it was not the primary beneficiary in seven
partnerships syndicated under U.S. Department of Housing and Urban Development
subsidy programs of which five have been sold as of March 31, 2005. The two
remaining partnership are under contract to be sold as of March 31, 2005. These
two investments will continue to be accounted for under the equity method and
included in equity in earnings of unconsolidated affiliates until final sale
closing. The Company purchased the general partnership interests in these
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. No management fees were recognized on these partnerships during
the three month period ended March 31, 2005. The assets and liabilities of the
two partnerships totaled $2.9 million and $4.9 million at March 31, 2005,
respectively. Unconsolidated non-recourse debt associated with the two
partnerships continuing to be accounted for under the equity method amounted to
$4.6 million, of which the Company's proportionate share, based on its legal
ownership, was $179.
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 remaining five of
the original 34 VIEs for the three month period ending March 31, 2005 are
included in discontinued operations as all of the VIEs are held for sale as
described below.
The Company was 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 reach certain levels. The
effect on the consolidated balance sheet as of March 31, 2005 is an increase in
Total assets of $44 million, an increase in Total liabilities of $48 million, an
increase in Minority interest of $1 million, and a decrease in Stockholders'
equity of $4.9 million. In connection with the adoption of FIN 46R, the Company
recorded a $321 charge, net of minority interest, for 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 $48 million increase in total liabilities,
$46.5 million represented non-recourse mortgage debt.
Effective March 31, 2005, the Company has closed on the sale of all but five of
the 41 VIEs. In addition, the Company is under contract or letter of intent for
the sale of three of the remaining five VIEs. Based on the offer received on one
of these three VIEs, the Company has recorded an impairment charge of $400 for
the three month period ended March 31, 2005. The remaining two VIEs are being
disposed of through a default on the non-recourse financing. The Company
repurchased 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 performed a valuation analysis on the underlying real
estate, and as a result, recorded a $7.3 million impairment of real estate to
adjust the net book value of the property to the Company's estimate of fair
market value. The mortgage note was sold in March, 2005. The Company is
currently discussing transferring title of the property to either the new
mortgage holder or other interested buyers. A transfer is expected to occur
later in the year. At that time, the Company would be relieved of its obligation
on the non-recourse financing and would record an offsetting $7.3 million gain
from debt forgiveness in excess of the new reduced basis on the real estate that
would in essence zero out the $7.3 million impairment charge recorded.
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 were 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.
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 8
partnerships totaling approximately $17 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 9 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
summarizes the effect of the consolidation requirements of FIN 46R on the
balance sheet as of March 31, 2005.
Consolidation Summary of the Balance Sheet as of March 31, 2005
(in thousands)
March 31, 2005 Effect of FIN 46R March 31, 2005
(before FIN 46R) Consolidation (as reported)
ASSETS
Real estate:
Land $ 408,186 $ - $ 408,186
Buildings, improvements and equipment 2,695,288 - 2,695,288
Real estate held for sale or disposal, net - 40,636 40,636
---------- --------- ----------
3,103,474 40,636 3,144,110
Less: accumulated depreciation ( 429,886) - ( 429,886)
---------- --------- ----------
Real estate, net 2,673,588 40,636 2,714,224
Cash and cash equivalents 9,499 396 9,895
Cash in escrows 38,875 860 39,735
Accounts receivable 4,752 120 4,872
Prepaid expenses 18,327 ( 35) 18,292
Investment in and advances to affiliates 161 ( 161) -
Deferred charges 10,046 2,466 12,512
Other assets 9,094 207 9,301
---------- --------- ----------
Total assets $2,764,342 $ 44,489 $2,808,831
========== ========= ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Mortgage notes payable $1,642,519 $ 46,467 $1,688,986
Line of credit 92,000 - 92,000
Accounts payable 17,731 409 18,140
Accrued interest payable 7,891 602 8,493
Accrued expenses and other liabilities 20,797 459 21,256
Security deposits 22,568 270 22,838
---------- --------- ----------
Total liabilities 1,803,506 48,207 1,851,713
---------- --------- ----------
Minority interest 293,700 1,186 294,886
---------- --------- ----------
Stockholders' equity 667,136 ( 4,904) 662,232
---------- --------- ----------
Total liabilities and stockholders' equity $2,764,342 $ 44,489 $2,808,831
========== ========= ==========
Acquisitions and Dispositions
-----------------------------
During the first three months of 2005, the Company acquired three apartment
communities in three unrelated transactions. The acquisitions consisted of one
apartment community in Maryland with a total of 204 units, and two apartment
communities in New Jersey with a combined 346 units. The total purchase price of
$40.2 million, including closing costs, equated to an average of $73.2 per
apartment. Consideration included $7.9 million of assumed or new debt,
$19.7 million in cash or line of credit, and $12.4 million of UPREIT Units (fair
market value of $12.6 million). The UPREIT Units are exchangeable for shares of
the Company's common stock on a one-for-one basis. For the two acquisitions
involving the issuance of OP units, values of $41.25 and $39.25 per unit were
used for the purpose of determining the number of OP Units issued in each
acquisition. Both values were set when the transactions were negotiated. The
combined weighted average expected first year capitalization rate on these
acquisitions is 6.5%. Capitalization rate ("cap rate") is defined as the rate of
interest used to convert the first year expected net operating income ("NOI")
less a 3.0% management fee into a single present value. NOI is defined by the
Company as rental income and property other income less operating and
maintenance expenses. Management generally considers NOI to be an appropriate
measure of operating performance because it helps investors to understand the
operations of a community. In addition, the apartment communities are valued and
sold in the market by using a multiple of NOI.
Contractual Obligations and Other Commitments
---------------------------------------------
The primary obligations of the Company relate to its borrowings under the line
of credit and mortgage notes payable. The Company's line of credit matures in
September 2005, and had $92 million outstanding at March 31, 2005. No balance
was outstanding at March 31, 2005 on the Company's supplemental demand note. The
$1.7 billion in mortgage notes payable have varying maturities ranging from 1 to
37 years. The weighted average interest rate of the Company's fixed rate notes
was 6.03% and 6.23% at March 31, 2005 and December 31, 2004, respectively. The
weighted average interest rate of the Company's variable rate notes and credit
facility was 3.5% and 2.98% at March 31, 2005 and December 31, 2004,
respectively.
The Company has a non-cancelable operating ground lease for one of its
properties. The lease expires May 1, 2020, with options to extend the term of
the lease for two successive terms of twenty-five years each. The lease provides
for contingent rental payments based on certain variable factors. At March 31,
2005, 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.
On December 1, 2004 the Company entered into a lease agreement with a third
party owner to manage the operations of one of their communities. The lease has
a term of five years, but after two years, (from the 24th month to the 36th
month) the owner may require us to buy the property. From the 36th month to the
end of the lease term, we have the right to require the owner to sell the
property to the Company. It is the Company's expectation that closing on the
acquisition of the property will occur no later than 36 months after the
commencement of the lease. The estimated future acquisition cost is $140
million.
As discussed in the section entitled "Variable Interest Entities," the Company,
through its general partnership interests in certain affordable property limited
partnerships, has guaranteed the Low Income Housing Tax Credits to limited
partners in 8 partnerships totaling approximately $17 million. With respect to
the guarantee of the low income housing tax credits, the Company believes the
properties operations conform to the applicable requirements (as set forth above
in the seventh paragraph of the "Variable Interest Entities" section) and does
not anticipate any payment on the guarantees. In addition, the Company, acting
as general partner in certain partnerships, is obligated to advance funds to
meet partnership operating deficits. The Company has required the buyers of its
general partner interests in the limited partnerships to secure releases of the
Company's guarantees from the limited partner and/or to indemnify the Company
against payment on those guarantees.
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-month periods ended March 31,
2005 and 2004, approximately $131 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 -month periods ended March 31, 2005 and 2004 and an
estimate of the breakdown of total capital improvements by major categories
between recurring and non-recurring, revenue generating capital improvements for
the three-month period ended March 31, 2005 as follows:
For the three-month period ended March 31,
(in thousands, except per unit data)
2005 2004
-------------------------------------------------------------- -----------------------
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 $ - $ - $ 1,329 $ 32 $ 1,329 $ 32 $ 553 $14
Major building improvements 957 23 1,317 31 2,274 54 3,395 85
Roof replacements 366 9 605 14 971 23 431 11
Site improvements 351 8 339 8 690 16 1,104 28
Apartment upgrades 691 16 4,034 96 4,725 112 6,334 159
Appliances 574 14 314 7 888 21 936 24
Carpeting/Flooring 1,801 42 404 10 2,205 52 2,233 56
HVAC/Mechanicals 531 13 2,048 49 2,579 62 2,794 70
Miscellaneous 234 6 687 16 921 22 994 25
------- ---- -------- ----- -------- ----- -------- -----
Totals $ 5,505 $131 $ 11,077 $ 263 $ 16,582 $ 394 $ 18,774 $ 472
======= ==== ======== ===== ======== ===== ======== =====
(a) Calculated using the weighted average number of units outstanding,
including 39,290 core units, 2004 acquisition units of 2,486 and 2005
weighted average acquisition units of 293 for the three-month period ended
March 31, 2005 and 39,290 core units and 2004 weighted average acquisition
units of 519 for the three-month period ended March 31, 2004.
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 March 31,
(in thousands, except per unit data)
2005 2004
-------------------------------------------------------------- -----------------------
Non-
Recurring Per Recurring Per Total Capital Per Total Capital Per
Cap Ex Unit Cap Ex Unit Improvements Unit Improvements Unit
------ ---- ------ ---- ------------ ---- ------------ ----
Core Communities $ 5,141 $131 $ 10,255 $ 261 $ 15,396 $ 392 $ 18,654 $ 475
2005 Acquisition
Communities 38 131 3 10 41 141 - -
2004 Acquisition
Communities 326 131 819 330 1,145 461 120 231
------ ---- -------- ----- -------- ----- -------- -----
Sub-total 5,505 131 11,077 263 16,582 394 18,774 472
2005 Disposed Communities - 131 - - - - - -
2004 Disposed Communities - - - - - - 492 299
Corporate office - 1,633 580
expenditures (1) - - - - -
------ ---- -------- ----- -------- ----- -------- -----
$5,505 $131 $ 11,077 $ 263 $ 18,215 $ 394 $ 19,846 $ 465
====== ==== ======== ===== ======== ===== ======== =====
Results of Operations
---------------------
Summary of Core Properties
--------------------------
The Company had 139 apartment communities with 39,290 units which were owned
throughout the three-month period being presented (the "Core Properties"). The
Company has acquired an additional thirteen apartment communities with 3,036
units during 2005 and 2004 (the "Acquired Communities"). The Company also
disposed of five properties with a total of 1,646 units during 2004 (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 month
period ended March 31, 2005.
A summary of the net operating income from Core Properties is as follows (in
thousands):
Three Months
------------
2005 2004 $ Change % Chg
---- ---- -------- -----
Rental income $104,758 $103,441 $1,317 1.3%
Property other income 4,946 4,523 423 9.4%
-------- -------- ------ ---
Total income 109,704 107,964 1,740 1.6%
Operating and Maintenance ( 53,655) ( 52,446) (1,209) (2.3%)
-------- -------- ------ ---
Net operating income $ 56,049 $ 55,518 $ 531 1.0%
======== ========= ====== ===
A summary of the net operating income from continuing operations is as follows
(in thousands):
Three Months
------------
2005 2004 $ Change % Chg
---- ---- -------- -----
Rental income $112,958 $105,061 $7,897 7.5%
Property other income 5,173 4,593 580 12.6%
-------- -------- ------ ---
Total income 118,131 109,654 8,477 7.7%
Operating and Maintenance ( 57,511) ( 53,110) (4,401) (8.3%)
-------- -------- ------ ---
Net operating income $ 60,620 $ 56,544 $4,076 7.2%
======== ========= ====== ===
Comparison of three-months ended March 31, 2005 to the same period in 2004
Of the $7,897 increase in rental income, $6,580 is attributable to the Acquired
Communities. The balance of this increase, or $1,317 which is from the Core
Properties, was the result of an increase of 2.7% in weighted average rental
rates, offset by a decrease in occupancy from 93.6% to 92.3%. 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, corporate apartment revenue, cable revenue, pet charges, and
miscellaneous charges to residents increased by $580. Of this increase, $157 is
attributable to the Acquired Communities, with $423 representing a 9.4% increase
from the Core Properties.
Other income, which reflects management fee income, increased $123 due primarily
to an increase in the level of management activity as compared to the same
period one year ago.
Of the $4,401 increase in operating and maintenance expenses, $3,192 is
attributable to the Acquired Communities. The balance, a $1,209 increase, is
attributable to the Core Properties and is primarily due to increases in natural
gas heating costs, personnel costs and real estate taxes. These increases were
offset in part by savings in repairs and maintenance and property insurance.
Natural gas heating costs were up $610 or 7% over 2004. We have seen significant
increases in the cost of natural gas per decatherm. Last year we had contracts
at $4.52 per decatherm, this year the cost is $6.08. Personnel expenses were up
$859, or 7.9%. Contributing to this is $95 for health insurance (up 14%), $181
or 56% for workers comp from increased incident reports, increase in accrued
payroll from a year ago of $105, and a vacation accrual of $375 of which
approximately $200k represents a catch-up from previous years as we now have the
ability to track this in our HR system. Real estate taxes were up $893, or 8.2%.
Of this, $258, or 2.4% is from a prepaid tax adjustment needed to bring our
balance sheet to the proper amount. The balance is a 5.8% increase in normal
increases in assessed values and tax rates. Repairs and maintenance were down
$387 from a year ago, or 6.1%. Most of this came through the contract repair
line item. The quarter one year ago included $312 from the NYS sales tax audit.
Property insurance decreased for the quarter primarily due to a decrease in our
property and general liability losses to date which have been projected using
actuarial assumptions.
General and administrative expense increased in 2005 by $680, or 14.4%. General
and administrative expenses as a percentage of total revenues were 4.5% for 2005
as compared to 4.1% for 2004. The results are primarily due to the increased
expenses relating to the completion of the 404 compliance and audit work
completed in the first quarter.
Interest expense increased in 2005 by $4,018 as a result of the increased
borrowings in connection with acquisition of the 2005 Acquisition Communities, a
full quarter of interest expense for the 2004 Acquisition Communities and
additional mortgage debt and refinanced mortgage debt incurred during 2004 and
2005. 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 2004, the Company closed on additional
mortgage debt of $76,853 and refinanced $14,338 in existing mortgage debt
resulting in new borrowings of approximately $53,000. During the first quarter
of 2005, the Company closed on additional mortgage debt of $72,880 and
refinanced $5,400 in existing mortgage debt resulting in new borrowings of
approximately $67,480.
Depreciation and amortization expense increased $3,146 due to the depreciation
on the Acquisition Communities and the capital additions to the Core Properties.
The Company has sold 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
three-months of 2004, the Company recorded impairment charges of $1,116. Of this
total, $171 represents advances made to certain of the affordable property
limited partnerships 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 for the
three-months ended March 31, 2004 is primarily the result of the general partner
recording a greater share of the underlying investment's losses due to the loans
and advances to certain of the affordable property limited partnerships where
the limited partner has no capital account. This is pursuant to the accounting
requirements of EITF 99-10, "Percentage Used to Determine the Amount of Equity
Method Losses." Included and classified in this account are $484 of advances
made during the first three months of 2004 which the Company believes will not
be repaid upon sale.
Minority interest decreased $691 due to a general decrease in income from
operations.
Included in discontinued operations for the three-month period ended March 31,
2005, are the results of operations of the five remaining affordable limited
partnerships that in connection with FIN 46R were required to be consolidated
beginning April 1, 2004. (See further detail supplied under "Variable Interest
Entities" section).
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.
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.
FFO falls within the definition of "non-GAAP financial measure" set forth in
Item 10(e) of Regulation S-K and, as a result, the Company is required to
include in this report a statement disclosing the reasons why management
believes that presentation of this measure provides useful information to
investors. 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 and A. Cash provided
by operating activities was $21,090 and $37,359 for the three-month period ended
March 31, 2005 and 2004, respectively. Cash used in investing activities was
$37,768 and $84,941 for the three-month period ended March 31, 2005 and 2004,
respectively. Cash provided by financing activities was $18,648 and $48,733 for
the three-month period ended March 31, 2005 and 2004, respectively. FFO should
not be considered as an alternative to net income as an indication of the
Company's performance or to cash flow as a measure of liquidity.
The calculation of FFO and reconciliation to GAAP net income available to common
Shareholders for the three months ended March 31, 2005 and 2004 are presented
below (in thousands):
Three Months
------------
2005 2004
---- ----
Net income available to common shareholders ($ 1,870) $ 4,580
Convertible preferred dividends 548 548
Minority interest 1,598 2,289
Minority interest - income (loss) from discontinued operations ( 2,521) 179
Depreciation and amortization from real property 23,602 21,151
Depreciation from real property from unconsolidated entities - 543
Impairment on General Partner real estate investment - 945
Loss on disposition of property - 50
(Gain) loss on disposition of discontinued operations, net of minority interest - 13
Cumulative effect of change in accounting principle, net of minority interest - 321
-------- --------
FFO as defined above $ 21,357 $ 30,619
======== ========
Weighted average common shares/units outstanding(1):
- Basic 47,477.1 48,340.8
======== ========
- Diluted 47,919.7 48,893.5
======== ========
(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
------------------
Mar. 31, Dec. 31, Sept. 30, June 30,
2005 2004 2004 2004
---- ---- ---- ----
EBITDA
Total revenues $118,787 $118,357 $118,942 $118,017
Net operating income from discontinued operations 142 2,143 1,364 1,069
Operating and maintenance ( 57,511) (52,227) (50,372) (51,081)
General and administrative ( 5,405) ( 9,482) ( 4,879) ( 4,892)
Equity in earnings (losses) of unconsolidated
affiliates - - 25 ( 25)
-------- ------- -------- --------
$ 56,013 $58,791 $ 65,080 $ 63,088
Fixed Charges
Interest expense $ 24,943 $23,891 $ 23,496 $ 23,783
Interest expense on discontinued operations 21 442 40 476
Preferred dividends 1,898 1,898 1,898 1,899
Capitalized interest 191 191 230 171
-------- ------- -------- --------
$ 27,053 $26,422 $ 25,664 $ 26,329
Times Coverage ratio: 2.07 2.23 2.54 2.40
Line of Credit
--------------
The Credit Agreement relating to the Company's line of credit provides for the
Company to maintain certain financial ratios and measurements. One of these
covenants is that the Company may not pay any distribution to its shareholders
and holders of its UPREIT Units if a distribution, when added to other
distributions paid during the three immediately preceding fiscal quarters,
exceeds the greater of : (i) 90% of funds from operations, and 110% of cash
available for distribution; and (ii) the amount required to maintain the
Company's status as a REIT. During the first quarter of 2005, the funds from
operations payout ratio was 90.3% when measured for the current quarter and the
three immediate preceding fiscal quarters. Due to the non-recurring legal
settlement of $3.8 million in the fourth quarter of 2004, the Company did not
meet the required ratio.. Appropriate waivers have been granted by the
participating banks. 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 the past three years and
continuing into 2005 many regions of the United States have experienced varying
degrees of economic recession and certain recessionary trends, such as the cost
of obtaining sufficient property and liability insurance coverage, short-term
interest rates, and a temporary reduction in occupancy. In light of this, we
will continue to review our business strategy however, we believe that given our
property type and the geographic regions in which we are located, we do not
anticipate any changes in our strategy or material effects in financial
performance.
Declaration of Dividend
-----------------------
On May 6, 2005, the Board of Directors approved a dividend of $.63 per share for
the quarter ended March, 31 2005. This is the equivalent of an annual
distribution of $2.52 per share. The dividend is payable May 27, 2005 to
shareholders of record on May 17, 2005.
On May 6, 2006 the Company also declared a regular dividend of $0.5625 per share
on its Series F Cumulative Redeemable Preferred Stock, for the quarter ending
May 31, 2005. The dividend on the preferred shares is payable on May 31, 2005,
to shareholders of record on May 17, 2005. This dividend is equivalent to an
annualized rate of $2.25 per share.
Contingency
-----------
The Company is not a party to any legal proceedings which are expected to have a
material adverse effect on the Company's liquidity, financial position or
results of operations. The Company is subject to a variety of legal actions for
personal injury or property damage arising in the ordinary course of its
business, most of which are covered by liability insurance. While the resolution
of these matters cannot be predicted with certainty, management believes that
the final outcome of such legal proceedings and claims will not have a material
adverse effect on the Company's liquidity, financial position or results of
operations.
In 2001, the Company underwent a state tax audit. The state has assessed taxes
of $469,000 for the 1998 and 1999 tax years under audit. If the state's position
is applied to all tax years through December 31, 2001, the assessment would be
$1.3 million. At the time, the Company believed the assessment and the state's
underlying position were not supportable by the law nor consistent with
previously provided interpretative guidance from the office of the State
Secretary of Revenue. After two subsequent enactments by the state legislation
during 2002 affecting the pertinent tax statute, the Company has been 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. During the first quarter of 2005, the 1999 tax year
has been filed with the Pennsylvania State Commonwealth Court. No settlement
offer has been made or discussed related to the 1999 tax year. 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.
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
$861,000. This was included in the first quarter 2004 results and allocated
$448,000 to expense and $413,000 capitalized to real estate assets for
improvements.
As a result of this audit, during the second quarter of 2004 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 December 31, 2004 in those states where it found non-compliance
and recorded at December 31, 2004 a liability of $1,780,000. This was included
in the year end results and allocated $805,000 to expense and $975,000
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 December 31, 2004. The Company has filed Voluntary Disclosure Agreements
(VDAs) with the four states where it has financial exposure. During the first
quarter of 2005, the Company has signed VDAs with two of the states which both
have agreed to limit the VDA filing period back to January 1, 2001. For the
three month period ended March 31, 2005, the Company has recorded adjustments to
the liability for both the effects of signing the two VDA's as well as for the
results of the Company's additional testing for the first quarter. The net
impact of these adjustments resulted in an increase in real estate assets of
$42,000, interest expense of $28,000 and a decrease in operating expenses of
$43,000 for a net increase to the accrued liability of $27,000. 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 $1,325,000
and $2,300,000.
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 Articles
Supplementary to the Company's Articles of Incorporation, 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.
New Accounting Standards
------------------------
In December 2004, the FASB issued Statement of Financial Accounting Standards
No. 123R Share Based Payment (SFAS No. 123R). The statement is a revision of
SFAS No. 123 Accounting for Stock-Based Compensation. SFAS No 123R supersedes
APB Opinion No. 25 Accounting for Stock Issued to Employees, and its related
implementation guidance. SFAS 123R, requires that entities recognize the cost of
employee services received in exchange for awards of equity instruments (i.e.
stock options) based on the grant-date fair value of those awards. The Statement
is effective for the first fiscal periods beginning after December 15, 2005. On
January 1, 2003, the Company adopted the provisions of SFAS No. 148 Accounting
for Stock-Based Compensation - Transition and Disclosure, an Amendment to SFAS
No. 123. Effective on that date, the Company began recognizing compensation cost
related to stock option grants. Based upon the Company's adoption of SFAS No.
148, the Company does not expect the issuance of SFAS No. 123R to have a
material impact on the Company's results of operations, financial position or
liquidity.
HOME PROPERTIES, INC.
ITEM 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
The Company's primary market risk exposure is interest rate risk. At March 31,
2005 and December 31, 2004, approximately 87% and 89%, respectively, of the
Company's debt bore interest at fixed rates with a weighted average maturity of
approximately 8 years and a weighted average interest rate of approximately
6.03% and 6.23%, respectively, including the $34.0 million of debt for both
years which has been swapped to a fixed rate. The remainder of the Company's
debt bears interest at variable rates with a weighted average maturity of
approximately 7 and 8 years, respectively, and a weighted average interest rate
of 3.52% and 2.98%, respectively, at March 31, 2005 and December 31, 2004. The
Company does not intend to utilize a significant amount of permanent variable
rate debt to acquire properties in the future. On occasion, the Company may use
its line of credit in connection with a property acquisition with the intention
to refinance at a later date. The Company believes, however, that in no event
would increases in interest expense as a result of inflation significantly
impact the Company's distributable cash flow.
At March 31, 2005 and December 31, 2004, the interest rate risk on $34 million
of such variable rate debt has been mitigated through the use of interest rate
swap agreements (the "Swaps") with major financial institutions. The Company is
exposed to credit risk in the event of non-performance by the counter-parties to
the Swaps. The Company believes it mitigates its credit risk by entering into
these Swaps with major financial institutions. The Swaps effectively convert an
aggregate of $34 million in variable rate mortgages to fixed rates of 5.35%,
5.39%, 8.22% and 8.40%.
At March 31, 2005 and December 31, 2004, the fair value of the Company's fixed
rate debt, including the $34 million which was swapped to a fixed rate, amounted
to a liability of $1.72 billion compared to its carrying amount of $1.69
billion. The Company estimates that a 100 basis point increase in market
interest rates at March 31, 2005 would have changed the fair value of the
Company's fixed rate debt to a liability of $1.65 billion.
The Company intends to continuously monitor and actively manage interest costs
on its variable rate debt portfolio and may enter into swap positions based upon
market fluctuations. In addition, the Company believes that it has the ability
to obtain funds through additional equity offerings or the issuance of UPREIT
Units. Accordingly, the cost of obtaining such interest rate protection
agreements in relation to the Company's access to capital markets will continue
to be evaluated. The Company has not, and does not plan to, enter into any
derivative financial instruments for trading or speculative purposes. As of
March 31, 2005, the Company had no other material exposure to market risk.
HOME PROPERTIES, INC.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
------------------------------------------------
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in the reports filed or
submitted by the Company under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms, and that such information
is accumulated and communicated to the officers who certify the Company's
financial reports and to the other members of senior management and the Board of
Directors.
The principal executive officer and principal financial officer evaluated, as of
March 31, 2005, the effectiveness of the disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15-d-15(e) under the Securities Exchange Act of
1934, as amended (the "Exchange Act") and have determined that such disclosure
controls and procedures are effective.
There have been no changes in the internal controls over financial reporting
identified in connection with that evaluation, or that occurred during the first
quarter of the year ended December 31, 2005 that has materially affected, or is
reasonably likely to materially affect, the Company's internal control over
financial reporting. The Company has not identified any material weaknesses in
its internal controls.
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, 2004, the Company had
authorization to repurchase 2,000,000 shares of common stock and UPREIT Units
under the stock repurchase program. On February 16, 2005, the Board of Directors
approved a 2,000,000 share increase in the stock repurchase program. 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 March 31, 2005.
Maximum shares
Total shares Average Total shares (units) (units) available
(units) price per purchased under under the
Period purchased (1) share (unit) Company Program Company Program
------ ------------- ------------ --------------- ---------------
Balance December 31, 2004: 2,000,000
January 1, 2005 to
January 31, 2005 717,792 $40.85 716,000 1,284,000
February 1, 2005 to
February 28, 2005 599,975 $41.06 584,700 699,300
Board approved increase
February 16, 2005 2,000,000
March 1, 2005 to
March 31, 2005 1,796 $40.38 - -
--------- ------ --------- ---------
Balance March 31, 2005: 1,319,563 $40.95 1,300,700 2,699,300
(1) During the three months ended March 31, 2005, the Company repurchased
18,863 shares of common stock through share repurchase by the transfer
agent in the open market in connection with the Company's Dividend
Reinvestment Plan (DRIP).
Item 6. Exhibits
Exhibit 31.1 Section 302 Certifications of Chief Executive Officer
Exhibit 31.2 Section 302 Certification of Chief Financial Officer
Exhibit 32.1 Section 906 Certifications of Chief Executive 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.
(Registrant)
Date: May 10, 2005
By: /s/ Edward J. Pettinella
-------------------------------------
Edward J. Pettinella
President and Chief Executive Officer
Date: May 10, 2005
By: /s/ David P. Gardner
-------------------------------------
David P. Gardner
Executive Vice President and
Chief Financial Officer