================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) (X) QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005 ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NUMBER: 1-13136 ------------------------------- -------------------------------------------------------------------------------- HOME PROPERTIES, INC. --------------------- (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) MARYLAND 16-1455126 -------- ---------- (State of incorporation) (I.R.S. Employer Identification No.) -------------------------------------------------------------------------------- 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 fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for at least 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 Exchange Act). Yes X No ----- ----- Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No X ----- -----APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d)of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes No ----- ----- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class of Common Stock Outstanding at October 31, 2005 --------------------- ------------------------------- $.01 par value 31,816,027 ================================================================================ HOME PROPERTIES, INC. TABLE OF CONTENTS PAGE PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets - September 30, 2005 (Unaudited) and December 31, 2004 4 Consolidated Statements of Operations (Unaudited) - Nine months ended September 30, 2005 and 2004 5 Consolidated Statements of Operations (Unaudited) - Three months ended September 30, 2005 and 2004 6 Consolidated Statements of Comprehensive Income (Unaudited) - Nine months ended September 30, 2005 and 2004 7 Consolidated Statements of Comprehensive Income (Unaudited) - Three months ended September 30, 2005 and 2004 8 Consolidated Statements of Cash Flows (Unaudited) - Nine months ended September 30, 2005 and 2004 9 Notes to Consolidated Financial Statements (Unaudited) 10-22 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 23-37 Item 3. Quantitative and Qualitative Disclosures About Market Risk 38 Item 4. Controls and Procedures 39 PART II. OTHER INFORMATION Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 40 Item 6. Exhibits 40 Signatures 41 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS HOME PROPERTIES, INC. CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2005 AND DECEMBER 31, 2004 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 2005 2004 ---- ---- (Unaudited) (Note 1) ASSETS Real estate: Land 416,538 $ 402,620 Construction in progress 1,738 1,627 Buildings, improvements and equipment 2,817,939 2,640,943 Real estate held for sale or disposal, net 21,173 78,711 ---------- ---------- 3,257,388 3,123,901 Less: accumulated depreciation (478,645) (405,919) ---------- ---------- Real estate, net 2,778,743 2,717,982 Cash and cash equivalents 5,264 7,925 Cash in escrows 37,587 43,883 Accounts receivable 6,009 6,664 Prepaid expenses 21,550 18,224 Deferred charges 11,060 13,778 Other assets 8,591 8,340 ---------- ---------- Total assets $2,868,804 $2,816,796 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Mortgage notes payable $1,768,554 $1,644,722 Line of credit 94,000 58,000 Accounts payable 18,718 24,600 Accrued interest payable 8,738 8,876 Accrued expenses and other liabilities 22,830 26,750 Security deposits 23,447 22,651 ---------- ---------- Total liabilities 1,936,287 1,785,599 ---------- ---------- Commitments and contingencies Minority interest 287,170 310,775 ---------- ---------- Stockholders' equity: Cumulative redeemable preferred stock, $.01 par value; 2,400,000 shares issued and outstanding at September 30, 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 December 31, 2004 - 25,000 Common stock, $.01 par value; 80,000,000 shares authorized; 32,391,306 and 32,625,413 shares issued and outstanding at September 30, 2005 and December 31, 2004, respectively 324 326 Excess stock, $.01 par value; 10,000,000 shares authorized; no shares issued or outstanding - - Additional paid-in capital 795,522 807,212 Accumulated other comprehensive income (loss) 126 (362) Distributions in excess of accumulated earnings (210,625) (171,754) ---------- ---------- Total stockholders' equity 645,347 720,422 ---------- ---------- Total liabilities and stockholders' equity $2,868,804 $2,816,796 ========== ========== The accompanying notes are an integral part of these consolidated financial statements. HOME PROPERTIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 (UNAUDITED, IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 2005 2004 ---- ---- Revenues: Rental income $345,149 $323,922 Property other income 18,871 15,357 Interest income 233 449 Other income 1,503 1,968 -------- -------- Total revenues 365,756 341,696 -------- -------- Expenses: Operating and maintenance 165,065 152,267 General and administrative 14,443 14,496 Interest 77,175 66,615 Depreciation and amortization 74,263 66,073 Impairment of assets held as general partner - 1,116 -------- -------- Total expenses 330,946 300,567 -------- -------- Income from operations 34,810 41,129 Equity in losses of unconsolidated affiliates - (538) -------- -------- Income before minority interest and discontinued operations 34,810 40,591 Minority interest (9,842) (11,240) -------- -------- Income from continuing operations 24,968 29,351 -------- -------- Discontinued operations: Loss from operations, net of ($2,379) in 2005 and ($201) in 2004 allocated to minority interest (4,808) (614) Gain (loss) on disposition of property, net of $3,041 in 2005 and ($2,949) in 2004 allocated to minority interest 6,290 (6,305) -------- -------- Discontinued operations 1,482 (6,919) -------- -------- Income before loss on disposition of property and business and cumulative effect of change in accounting principle 26,450 22,432 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 26,450 22,365 Cumulative effect of change in accounting principle, net of ($159) in 2004 allocated to minority interest - (321) -------- -------- Net income 26,450 22,044 Preferred dividends (4,929) (5,695) -------- -------- Net income available to common shareholders $ 21,521 $ 16,349 ======== ======== Basic earnings per share data: Income from continuing operations $ .62 $ .72 Discontinued operations .05 ( .21) Cumulative effect of change in accounting principle - ( .01) ------ ------ Net income available to common shareholders $ .67 $ .50 ====== ====== Diluted earnings per share data: Income from continuing operations $ .62 $ .71 Discontinued operations .04 ( .21) Cumulative effect of change in accounting principle - ( .01) ------ ------ Net income available to common shareholders $ .66 $ .49 ====== ====== Weighted average number of shares outstanding: Basic 32,072,307 32,840,672 ========== ========== Diluted 32,481,218 33,280,680 ========== ========== The accompanying notes are an integral part of these consolidated financial statements. HOME PROPERTIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 (UNAUDITED, IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 2005 2004 ---- ---- Revenues: Rental income $117,581 $110,731 Property other income 7,626 5,484 Interest and dividend income 92 150 Other income 476 805 -------- -------- Total revenues 125,775 117,170 -------- -------- Expenses: Operating and maintenance 54,161 50,102 General and administrative 4,894 4,879 Interest 27,059 23,016 Depreciation and amortization 25,639 22,999 -------- -------- Total expenses 111,753 100,996 -------- -------- Income from operations 14,022 16,174 Equity in earnings (losses) of unconsolidated affiliates - 25 -------- -------- Income before minority interest and discontinued operations 14,022 16,199 Minority interest in operating partnership (4,133) (4,562) -------- -------- Income from continuing operations 9,889 11,637 -------- -------- Discontinued operations: Income from operations, net of $216 in 2005 and $49 in 2004 allocated to minority interest 447 104 Gain (loss) on disposition of property, net of $3,081 in 2005 and ($3,195) in 2004 allocated to minority interest 6,367 (6,816) -------- -------- Discontinued operations 6,814 (6,712) -------- -------- Net income 16,703 4,925 Preferred dividends (1,350) (1,898) -------- -------- Net income available to common shareholders $ 15,353 $ 3,027 ======== ======== Basic earnings per share data: Income from continuing operations $ .26 $ .29 Discontinued operations .21 ( .20) ------ ------ Net income available to common shareholders $ .47 $ .09 ====== ====== Diluted earnings per share data: Income from continuing operations $ .26 $ .29 Discontinued operations .21 ( .20) ------ ------ Net income available to common shareholders $ .47 $ .09 ====== ====== Weighted average number of shares outstanding: Basic 32,518,949 33,293,905 ========== ========== Diluted 32,950,121 33,737,974 ========== ========== The accompanying notes are an integral part of these consolidated financial statements. HOME PROPERTIES, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 (UNAUDITED, IN THOUSANDS) 2005 2004 ---- ---- Net income $26,450 $22,044 Other comprehensive income (net of minority interest): Change in fair value of hedge instruments 488 (2) ------- ------- Comprehensive income $26,938 $22,042 ======= ======= The accompanying notes are an integral part of these consolidated financial statements. HOME PROPERTIES, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 (UNAUDITED, IN THOUSANDS) 2005 2004 ---- ---- Net income $16,703 $4,925 Other comprehensive income (net of minority interest): Change in fair value of hedge instruments 216 (225) ------- ------ Comprehensive income $16,919 $4,700 ======= ====== The accompanying notes are an integral part of these consolidated financial statements. HOME PROPERTIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004 (UNAUDITED, IN THOUSANDS) 2005 2004 ---- ---- Cash flows from operating activities: Net income $ 26,450 $ 22,044 -------- -------- Adjustments to reconcile net income to net cash provided by operating activities: Equity in losses of unconsolidated affiliates - 538 Income allocated to minority interest 10,504 7,898 Depreciation and amortization 75,781 72,524 Impairment of assets held as General Partner 400 1,116 Impairment of real property 7,325 1,100 Gain on disposition of property and business (10,302) (562) Loss from early extinguishment of debt - 102 Issuance of restricted stock, compensation cost of stock options and deferred compensation 1,982 1,908 Cumulative effect of change in accounting principle - 480 Changes in assets and liabilities: Other assets (3,003) 2,628 Accounts payable and accrued liabilities (8,518) 15,592 -------- -------- Total adjustments 74,169 103,324 -------- -------- Net cash provided by operating activities 100,619 125,368 -------- -------- Cash flows from investing activities: Purchase of properties and other assets, net of mortgage notes assumed and UPREIT Units issued (99,139) (153,535) Additions to properties (72,980) (74,138) Proceeds from sale of properties and business, net 5,574 24,927 Proceeds from sale of affordable properties, net - 1,387 Advances to affiliates - (820) Payments on advances to affiliates - 149 -------- -------- Net cash used in investing activities (166,545) (202,030) -------- -------- Cash flows from financing activities: Proceeds from sale of common stock, net 6,117 28,341 Repurchase of common stock (61,330) (2,189) Proceeds from mortgage notes payable 237,952 126,674 Payments of mortgage notes payable (61,209) (45,251) Payment of prepayment penalty in connection with the early extinguishment of debt - (102) Proceeds from line of credit 258,200 201,500 Payments on line of credit (222,200) (131,000) Payments of deferred loan costs (2,530) (1,914) Withdrawals from (additions to) cash escrows, net 2,634 (1,371) Repayment of officer loans - 237 Dividends and distributions paid (94,369) (95,949) -------- -------- Net cash provided by financing activities 63,265 78,976 -------- -------- Net (decrease) increase in cash and cash equivalents (2,661) 2,314 Cash and cash equivalents: Beginning of year 7,925 5,103 Cash assumed in connection with FIN 46R consolidation - 850 -------- -------- End of year $ 5,264 $ 8,267 ========= ========= Supplemental disclosure of non-cash operating, investing and financing activities: ---------------------------------------------------------------------------------- Mortgage loans assumed associated with property acquisitions $ 7,916 $ 90,569 Exchange of UPREIT Units/partnership interest for common shares 3,442 14,015 Fair value of hedge instruments (67) 1,012 Issuance of UPREIT Units associated with property and other acquisitions 12,611 12,105 Increase in real estate associated with the purchase of UPREIT Units 2,856 12,470 Compensation cost of stock options issued 646 684 Net real estate disposed in connection with FIN 46R consolidation (50,467) (69,743) Other assets disposed in connection with FIN 46R consolidation (6,940) (3,054) Mortgage debt disposed in connection with FIN 46R consolidation (59,339) (48,611) Other liabilities disposed in connection with FIN 46R consolidation (1,187) (2,759) 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 (UNAUDITED, 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 September 30, 2005, the Company operated 159 apartment communities with 46,316 apartment units. Of this total, the Company owned 154 communities, consisting of 42,747 apartment units ("Owned Communities"), managed as general partner 868 apartment units and fee managed 2,701 apartments for affiliates and third parties. Basis of Presentation --------------------- The accompanying consolidated financial statements include the accounts of the Company and its 67.4% (68.3% at September 30, 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 32.6% (31.7% at September 30, 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 (UNAUDITED, 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 and 2005, the Company sold most of these consolidated VIEs with only one partnership remaining as of September 30, 2005. The results of operations for the VIEs owned during the three- and nine-month periods ending September 30, 2005 are included in discontinued operations. The one remaining property is classified as held for sale. As of September 30, 2005, the Company intends to sell the property. As of March 31, 2004, 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, none of which remained as of September 30, 2005. These investments were accounted for under the equity method through their sale. The Company recorded its allocable share of the respective partnership's income or loss based on the terms of the agreements. To the extent it was determined that the LPs could not absorb their share of the losses, if any, the GP recorded the LPs share of such losses. The Company absorbed such losses to the extent the Company had outstanding loans or advances and the limited partner had no remaining capital account. All seven partnerships have been sold as of September 30, 2005. 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 (UNAUDITED, 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 year 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 application of SFAS No. 123R beginning January 1, 2006 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 (UNAUDITED, 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 UPREIT Unit for common stock will have no effect on diluted EPS as Unitholders and stockholders effectively share equally in the net income of the Operating Partnership. Income from continuing operations is the same for both the basic and diluted calculation. The reconciliation of the basic and diluted earnings per share for the nine and three months ended September 30, 2005 and 2004 is as follows: Nine Months Three Months ----------- ------------ 2005 2004 2005 2004 ---- ---- ---- ---- Income from continuing operations $24,968 $29,351 $9,889 $11,637 Add: Loss on disposal of property - (67) - - Less: Preferred dividends (4,929) (5,695) (1,350) (1,898) ------- ------- ------- ------ Basic and Diluted - Income from continuing operations applicable to common shareholders 20,039 23,589 8,539 9,739 Less: Cumulative effect of change in accounting principle - (321) - - Discontinued operations 1,482 (6,919) 6,814 (6,712) ------- ------- ------- ------ Net income available to common shareholders $21,521 $16,349 $15,353 $3,027 ======= ======= ======= ====== Basic weighted average number of shares outstanding 32,072,307 32,840,672 32,518,949 33,293,905 Effect of dilutive stock options 351,765 360,045 381,652 371,308 Effect of restricted shares 57,146 79,963 49,520 72,761 ---------- ---------- ---------- ---------- Diluted weighted average number of shares outstanding 32,481,218 33,280,680 32,950,121 33,737,974 ========== ========== ========== ========== Basic earnings per share Income from continuing operations $.62 $.72 $.26 $.29 Discontinued operations .05 (.21) .21 (.20) Cumulative effect of change in accounting principle - (.01) - - ---- ---- ---- ---- Net Income available to common shareholders $.67 $.50 $.47 $.09 ==== ==== ==== ==== Diluted earnings per share Income from continuing operations $.62 $.71 $.26 $.29 Discontinued operations .04 (.21) .21 (.20) Cumulative effect of change in accounting principle - (.01) - - ---- ---- ---- ---- Net Income available to common shareholders $.66 $.49 $.47 $.09 ==== ==== ==== ==== Unexercised stock options to purchase 542,800 shares of the Company's common stock for the nine-month period ended September 30, 2005 were not included in the computation of diluted EPS because the options' exercise prices were greater than the average market price of the Company's stock during this period. For the three-month period ended September 30, 2005 and the nine- and three-month periods ended September 30, 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. HOME PROPERTIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 4. Earnings Per Common Share (continued) -- ------------------------------------- For the nine-month period ended September 30, 2005 and the nine- and three-month periods ended September 30, 2004 the 833,333 common stock equivalents on an as-converted basis of the Series D Convertible Cumulative Preferred Stock have an antidilutive effect and are not included in the computation of diluted EPS to the extent they were not converted. On May 26, 2005, the Series D Convertible Cumulative Preferred Stock were converted and the common shares issued upon such conversion were included in outstanding common shares from the date of conversion. 5. Other income -- ------------ Other income for the nine- and three-month periods ended September 30, 2005 and 2004 includes 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 VIEs. 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, all of which have been sold as of September 30, 2005. 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 managed the day-to-day operations of the partnerships for a fee (5% of rents collected). The Company's economic benefit from these partnerships was the management fee. There was 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- and nine-month periods ended September 30, 2005. The management fees earned on these partnerships were $45 and $118 for the three- and nine-month periods ended September 30, 2004. The assets and liabilities of the seven partnerships totaled $8,300 and $14,100 at September 30, 2004, respectively. 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 three of the original 34 VIEs for the three- and nine-month periods ending September 30, 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 flows reach certain levels. The effect on the consolidated balance sheet as of September 30, 2005 is an increase in "Total assets" of $21,900, an increase in "Total liabilities" of $17,900, and an increase in "Minority interest" of $3,900. Of the $17,900 increase in "Total liabilities," $17,000 represents non-recourse mortgage debt. 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 was absorbed by the Company. HOME PROPERTIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 6. Variable interest entities (continued) -- -------------------------------------- During the first quarter of 2004, the Company recorded an impairment charge of $1,600 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 $1,600 for the three-month period ended March 31, 2004, $655 related to cash advances to fund operating shortfalls. In addition, on September 30, 2005, two VIEs were disposed of through a transfer of deed in lieu of foreclosure. The Company had repurchased the limited partner's interests in satisfaction of any tax credit guarantees or other obligations to that partner in January, 2005 for $5,700. In connection with the Company's decision to dispose of the property, the Company performed a valuation analysis on the underlying real estate, and as a result, recorded a $7,300 impairment of real estate during the first quarter of 2005 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. Finally, on September, 30, 2005, the deed was transferred to the mortgage holder in lieu of foreclosure resulting in a gain on sale of real estate of $7,700. Effective September 30, 2005, the Company has closed on the sale of all but one of the 41 VIEs. The Company is actively seeking buyers for the one remaining VIE. The Company performed a valuation analysis on the underlying real estate of the one remaining VIE, and as a result, recorded an impairment charge of $400 for the three month period ended March 31, 2005 to adjust the net book value of the property to the Company's estimate of fair market value. HOME PROPERTIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED, 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 for the year ended December 31, 2004. 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 (UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 7. Segment Reporting (continued) -- ----------------------------- The revenues, profit (loss), and assets for each of the reportable segments are summarized as of and for the nine- and three-month periods ended September 30, 2005, and 2004 as follows: Nine Months Three Months ----------- ------------ 2005 2004 2005 2004 ---- ---- ---- ---- Revenues -------- Apartments owned Core properties $335,500 $327,284 $114,316 $109,904 Non-core properties 28,520 11,992 10,891 6,311 Reconciling items 1,736 2,420 568 955 -------- -------- -------- -------- Total Revenue $365,756 $341,696 $125,775 $117,170 ======== ======== ======== ======== Profit (loss) ------------- Funds from operations: Apartments owned Core properties $183,141 $179,900 $65,025 $62,339 Non-core properties 15,814 7,109 6,021 3,774 Reconciling items 1,736 2,420 568 955 -------- -------- -------- -------- Segment contribution to FFO 200,691 189,429 71,614 67,068 General and administrative expenses (14,443) (14,496) (4,894) (4,879) Interest expense (77,175) (66,615) (27,059) (23,016) Depreciation of unconsolidated affiliates - 556 - - Non-real estate depreciation/amortization (2,436) (2,606) (841) (928) FAS 141 acquisition rent / intangibles 605 835 199 325 Equity in earnings (losses) of unconsolidated affiliates - (538) - 25 Impairment of assets held as General Partner - (1,116) - - Impairment of affordable assets not in FFO - 945 - - Loss on sale of business - (17) - - Gain (loss) on disposition of discontinued operations, before minority interest 7,325 (9,917) 7,325 ( 9,917) Income (loss) from discontinued operations before minority interest and depreciation (7,094) 2,449 663 982 Redeemable preferred dividend - Series F (4,050) (4,050) (1,350) (1,350) -------- -------- -------- -------- Funds from Operations - Diluted 103,423 94,859 45,657 28,310 Depreciation - apartments owned (71,919) (66,731) (24,798) (22,900) Depreciation of unconsolidated affiliates - (556) - - FAS 141 acquisition rent/intangibles (605) (835) (199) (325) Redeemable preferred dividend 4,050 4,050 1,350 1,350 Impairment of affordable assets not in FFO - (945) - - Loss (income) from discontinued operations before minority interest and loss on disposition of property 7,186 832 (663) (153) Gain (loss) on disposition of discontinued operations, before minority interest (7,325) 9,917 (7,325) 9,917 Minority interest in operating partnership (9,842) (11,240) (4,133) (4,562) -------- -------- -------- -------- Income from continuing operations $ 24,968 $ 29,351 $ 9,889 $ 11,637 ======== ======== ======== ======== Assets - As of September 30, 2005 and December 31, 2004 ------------------------------------------------------- Apartments owned: - Core $2,362,557 $2,368,691 - Non-core 416,186 349,291 Reconciling items 90,061 98,814 ---------- ---------- Total Assets $2,868,804 $2,816,796 ========== ========== HOME PROPERTIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 8. Pro Forma Condensed Financial Information -- ----------------------------------------- The Company acquired five apartment communities ("2005 Acquired Communities") with a combined 1,038 apartment units in five unrelated transactions during the nine-month period ended September 30, 2005. The total combined purchase price (including closing costs) of $119,900 equates to approximately $115 per unit. Consideration for the communities was funded through the assumption or placement of new debt of $51,500, $55,800 from the Company's line of credit and $12,600 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 nine- and three-month periods ended September 30, 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 Nine Months For the Three Months Ended September 30, Ended September 30, ------------------- ------------------- 2005 2004 2005 2004 ---- ---- ---- ---- Total revenues $370,382 $360,347 $126,204 $121,287 Net income available to common shareholders before cumulative effect of change in accounting principle 20,316 22,452 8,591 9,859 Net income available to common shareholders 20,316 22,131 8,591 9,859 Per common share data: Net income available to common shareholders before cumulative effect of change in accounting principle Basic $0.63 $0.68 $0.26 $0.30 Diluted $0.63 $0.67 $0.26 $0.29 Net income available to common shareholders Basic $0.63 $0.67 $0.26 $0.30 Diluted $0.63 $0.66 $0.26 $0.29 Weighted average numbers of shares outstanding: Basic 32,072,307 32,840,672 32,518,949 33,293,905 Diluted 32,481,218 33,280,680 32,950,121 33,737,974 HOME PROPERTIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 9. Derivative Financial Instruments -- -------------------------------- The Company enters into financial derivative instruments only for the purpose of minimizing risk and, thereby, protecting income. Derivative instruments utilized as part of the Company's risk management strategy may include interest rate swaps and caps. All derivatives are recognized on the balance sheet at fair value. The Company does not employ leveraged derivative instruments, nor does it enter into derivative instruments for trading or speculative purposes. The Company has four interest rate swaps and one interest rate cap that effectively convert variable rate debt to fixed rate debt. As of September 30, 2005, the aggregate fair value of the Company's interest rate swaps was $67 prior to the allocation of minority interest and is included in accrued expenses and other liabilities in the consolidated balance sheets. For the three-and nine-months ending September 30, 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 Operations --- --------------------------------------------------- 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 six apartment community dispositions (one sold in 2005 and five sold in 2004), for the three- and nine-months ended September 30, 2004. Included in discontinued operations for the three- and nine-months ended September 30, 2005 is one property sold in 2005. In addition, discontinued operations includes the operating results, net of minority interest, of three VIEs for the three-months ended September 30, 2005 and five VIEs for the nine-months ended September 30, 2005. One remaining VIE is held for sale as of September 30, 2005. Assets and liabilities for the one VIE of approximately $21,900 and $17,900, 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 $17,000 related to the one VIE. 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 as follows: For the Nine Months For the Three Months September 30, September 30, ------------- ------------- 2005 2004 2005 2004 ---- ---- ---- ---- Revenues Rental income $ 6,618 $22,146 $1,982 $8,763 Property other income 267 1,031 76 608 Other income (loss) (165) (259) (52) (259) ------- ------- ----- ----- Total revenues 6,720 22,918 2,006 9,112 ------- ------- ----- ----- Expenses Operating and maintenance 5,385 13,860 961 5,647 Interest expense 682 5,046 382 2,084 Depreciation and amortization 92 5,151 - 837 Impairment of real property 7,725 1,100 - - ------- ------- ----- ----- Total expenses 13,884 25,157 1,343 8,568 ------- ------- ----- ----- Income (loss) from discontinued operations before minority interest and gain (loss) on disposition of property (7,164) (2,239) 663 544 Minority interest in limited partnership (23) 1,424 - (391) Minority interest in operating partnership 2,379 201 (216) (49) ------- ------- ----- ----- Income (loss) from discontinued operations $(4,808) $ (614) $ 447 $ 104 ======= ======= ===== ===== HOME PROPERTIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED, 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 had 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 $1,300. At the time, the Company believed the assessment and the state's underlying position were neither 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 Company filed a protest with the Pennsylvania State Commonwealth Court concerning the 1999 tax year. Settlement discussions have occurred during the third quarter of 2005 for the open years 1999-2001. Based on these discussions, the Company believes that the likelihood of settling all three open years has increased, and has accrued $160. 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 had significant financial exposure. During the first six months of 2005, the Company signed VDAs with these states which have agreed to limit the VDA filing period back to January 1, 2001, and has satisfied all financial obligations under the VDAs. For the three- and six-month periods ended June 30, 2005, the Company has recorded adjustments to the liability for both the effects of signing the VDAs as well as for the results of the Company's additional testing for the first six months. The net impact of these adjustments resulted in a decrease in real estate assets of $175, interest expense of $115 and operating expenses of $108 for a net decrease to the accrued liability of $398. During the third quarter of 2005, the Company finalized negotiations with New York State settling a sales tax audit covering the period June 1, 2002 through November 30, 2004. The settlement was not materially different from what had been accrued. The result of the recent payments on the VDAs and this New York State audit is that the sales tax accrual which had been over $1,712 (as referenced above) has been reduced to $16 at September 30, 2005. HOME PROPERTIES, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) 11. Commitments and Contingencies (continued) --- ----------------------------------------- Guarantees ---------- As of September 30, 2005, the Company, through its general partnership interest in an affordable property limited partnership, has guaranteed the Low Income Housing Tax Credits to limited partners totaling approximately $3,000. As of September 30, 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 this partnership, 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 $3.4 or $40 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 $135. Additional deferred purchase price of $30 was recognized during the nine months ended September 30, 2005. The cumulative gain recognized on the sale of these assets through September 30, 2005 amounted to $54. If the management of this property is retained for the entire three years the Company expects to receive an additional $50 for the period October 1, 2005 through January 1, 2007. The gain on sale would then be approximately $104. 13. Subsequent Events --- ----------------- On November 4, 2005, the Board of Directors approved a dividend of $.64 per share for the quarter ended September 30, 2005. This is the equivalent of an annual distribution of $2.56 per share. The dividend is payable November 25, 2005 to shareholders of record on November 15, 2005. On November 4, 2005, the Company also declared a regular dividend of $.5625 per share on its Series F Cumulative Redeemable Preferred Stock, for the quarter ending November 30, 2005. The dividend on the preferred shares is payable on November 30, 2005 to shareholders of record on November 15, 2005. This dividend is equivalent to an annualized rate of $2.25 per share. During October 2005, the Company repurchased 423,205 shares of common stock. On November 4, 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. As of November 4, 2005, the Company has authorization to repurchase 3,915,195 shares of common stock and UPREIT Units under the stock repurchase program. The Company owns two properties in Southeast Florida which sustained damages from Hurricane Wilma in late October, 2005. The Company is assessing the damage but does not believe that it will have a material impact on its financial results. The estimated losses from the hurricane will be reported in the results of operations in the fourth quarter of 2005. HOME PROPERTIES, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (UNAUDITED, 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 interest in the remaining affordable property, 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 UPREIT 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. During the third quarter of 2005, the Company's line of credit agreement, which was maturing, was renegotiated for a new three-year term which expires September 1, 2008. The new facility was increased from $115 million to $140 million and contains less restrictive covenants as well as a 30 basis point reduction in the pricing spread over LIBOR. The Company's outstanding balance as of September 30, 2005, was $94 million. Borrowings under the line of credit bear interest at .75% 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. On November 23, 2004, the Company signed a supplemental demand note with M and T Bank. The note had a maximum principal amount of $42 million. The demand note was entered into to fund the Company's stock repurchase program. In connection with the increased borrowing capacity of the line of credit, this supplemental note was terminated during the third quarter of 2005. To the extent that the Company does not satisfy its long-term liquidity requirements through net cash flows provided by operating activities and its credit facility, it intends to satisfy such requirements through additional long-term secured or unsecured indebtedness, proceeds from the sale of properties, the issuance of UPREIT Units, proceeds from the Dividend Reinvestment Plan ("DRIP"), or the issuance of additional equity securities. As of September 30, 2005, the Company owned 23 properties with 4,323 apartment units, which were unencumbered by debt. In May 1998, the Company's Form S-3 Registration Statement was declared effective relating to the issuance of up to $400 million of common stock, preferred stock or other securities. The available balance on the shelf registration statement at September 30, 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 carried 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 had a conversion price of $30 per share and a five-year, non-call provision. On May 26, 2005, all 250,000 shares of the Series D Preferred Stock were converted into 833,333 shares of common stock. The conversion of preferred shares to common shares did not have an effect on the reported results of operations. In March 2002, the Company issued 2,400,000 shares of its 9.00% Series F Cumulative Redeemable Preferred Stock ("Series F Preferred Shares"), with a $25.00 liquidation preference per share. This offering generated net proceeds of approximately $58 million. The net proceeds were used to fund the Series B preferred stock repurchase, property acquisitions, and property upgrades. The Series F Preferred Shares are redeemable by the Company at anytime on or after March 25, 2007 at a redemption price of $25.00 per share, plus any accumulated, accrued and unpaid dividends. Each Series F Preferred share will receive an annual dividend equal to 9.00% of the liquidation preference per share (equivalent to a fixed annual amount of $2.25 per share). The issuance of UPREIT Units for property acquisitions continues to be a source of capital for the Company. During the first nine months of 2005, the Company acquired five communities with 1,038 units for a total purchase price of $119,900. The Company issued UPREIT Units valued at approximately $12,600 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 $247,500. The Company issued UPREIT Units valued at approximately $12,100 as part of the consideration for two of the properties, with the balance funded by the assumption of debt and cash. During 2004, $17,600 of common stock (net of $6,000 share repurchase) was issued under the Company's DRIP. During the first nine months of 2005, the Company's additional capital raised under the DRIP netted to zero after taking into account share repurchases used in lieu of new stock issuance. 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 began 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 for the repurchase of 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 nine months ended September 30, 2005, 1,661,600 shares were repurchased by the Company, with 1,300,700 and 360,900 occurring in the first and third quarters, respectively. At September 30, 2005 the Company had authorization to repurchase 2,338,400 shares of common stock and UPREIT Units under the stock repurchase program. During October 2005, the Company repurchased an additional 423,205 shares of common stock. On November 4, 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. As of November 4, 2005, the Company has authorization to repurchase 3,915,195 shares of common stock and UPREIT Units under the stock repurchase program. The Company will continue to 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 September 30, 2005, the weighted average rate of interest on mortgage debt is 5.9% and the weighted average maturity is approximately seven years. Approximately 90% 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 VIEs. 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 all have been sold as of September 30, 2005. 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 managed the day-to-day operations of the partnership for a fee (5% of rents collected). The Company's economic benefit from these partnerships was 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- and nine-month periods ended September 30, 2005. The management fees earned on these partnerships were $45 and $118 for the three- and nine-month periods ended September 30, 2004. The assets and liabilities of the seven partnerships totaled $8,300 and $14,100 at September 30, 2004, respectively. 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 three of the original 34 VIEs for the three-month period ending September 30, 2005 are included in discontinued operations as 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 flows reach certain levels. The effect on the consolidated balance sheet as of September 30, 2005 is an increase in "Total assets" of $21,900, an increase in "Total liabilities" of $17,900, and an increase in "Minority interest" of $3,900. 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 $17,900 increase in total liabilities, $17,000 represent non-recourse mortgage debt. Effective September 30, 2005, the Company has closed on the sale of all but one of the 41 VIEs. The Company is actively seeking buyers for the one remaining VIE. The Company performed a valuation analysis on the underlying real estate of the one remaining VIE, and as a result, recorded an impairment charge of $400 for the three month period ended March 31, 2005 to adjust the net book value of the property to the Company's estimate of fair market value. In addition, on September 30, 2005 two other VIEs were disposed of through a transfer of deed in lieu of foreclosure. The Company had repurchased the limited partner's interests in satisfaction of any tax credit guarantees or other obligations to that partner in January, 2005 for $5,700. In connection with the Company's decision to dispose of the property, the Company performed a valuation analysis on the underlying real estate, and as a result, recorded a $7,300 impairment of real estate during the first quarter of 2005 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. Finally, on September, 30, 2005, the deed was transferred to the mortgage holder in lieu of foreclosure resulting in a gain on sale of real estate of $7,700. During the first quarter of 2004, the Company recorded an impairment charge of $1,600 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 $1,600 for the three-month period ended March 31, 2004, $655 related to cash advances to fund operating shortfalls. The Company, through its general partnership interest in an affordable property limited partnership, has guaranteed the low income housing tax credits to the limited partners for a period of ten years totaling approximately $3,000. Such guarantee requires the Company to operate the property in compliance with Internal Revenue Code Section 42 for 15 years. In addition, acting as the general partner in this one partnership, the Company is obligated to advance funds to meet partnership operating deficits. The Company believes the property's 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 September 30, 2005. Consolidation Summary of the Balance Sheet as of September 30, 2005 (in thousands) September 30, September 30, 2005 Effect of FIN 46R 2005 (before FIN 46R) Consolidation (as reported) ---------------- ------------- ------------- ASSETS Real estate: Land $ 416,538 $ - $ 416,538 Construction in progress 1,738 - 1,738 Buildings, improvements and equipment 2,817,939 - 2,817,939 Real estate held for sale or disposal, net - 21,173 21,173 ---------- --------- ---------- 3,236,215 21,173 3,257,388 Less: accumulated depreciation (478,645) - (478,645) ---------- --------- ---------- Real estate, net 2,757,570 21,173 2,778,743 Cash and cash equivalents 5,255 9 5,264 Cash in escrows 36,749 838 37,587 Accounts receivable 5,905 104 6,009 Prepaid expenses 21,437 113 21,550 Investment in and advances to affiliates 651 (651) - Deferred charges 10,795 265 11,060 Other assets 8,591 - 8,591 ---------- --------- ---------- Total assets $2,846,953 $ 21,851 $2,868,804 ========== ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Mortgage notes payable $1,751,511 $ 17,043 $1,768,554 Line of credit 94,000 - 94,000 Accounts payable 18,325 393 18,718 Accrued interest payable 8,649 89 8,738 Accrued expenses and other liabilities 22,521 309 22,830 Security deposits 23,349 98 23,447 ---------- --------- ---------- Total liabilities 1,918,355 17,932 1,936,287 ---------- --------- ---------- Minority interest 283,251 3,919 287,170 ---------- --------- ---------- Stockholders' equity 645,347 - 645,347 ---------- --------- ---------- Total liabilities and stockholders' equity $2,846,953 $ 21,851 $2,868,804 ========== ========== ========== Acquisitions and Dispositions ----------------------------- During the first nine months of 2005, the Company acquired five apartment communities in five unrelated transactions. The acquisitions consisted of one apartment community in Maryland with a total of 204 units, two apartment communities in New Jersey with a combined 346 units, one apartment community in Long Island, NY with a total of 342 units, and one apartment community in Pennsylvania with a total of 146 units. The total combined purchase price (including closing costs) of $119,900 equates to approximately $115 per unit. Consideration for the communities was funded through the assumption or placement of new debt of $51,500, $55,800 from the Company's line of credit and $12,400 of UPREIT Units (fair market value of $12,600). 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 UPREIT units, values of $41.25 and $39.25 per unit were used for the purpose of determining the number of UPREIT Units issued in each acquisition. Both per unit values were set based upon equivalent share price when the transactions were negotiated. The combined weighted average expected first year capitalization rate on these acquisitions is 5.8%. Capitalization rate ("cap rate") is defined as the rate of interest used to convert the first year expected net operating income ("NOI") less a 3.0% management fee into a single present value. NOI is defined by the Company as rental income and property other income less operating and maintenance expenses. Management generally considers NOI to be an appropriate measure of operating performance because it helps investors to understand the operations of a community. In addition, the apartment communities are valued and sold in the market by using a multiple of NOI. On July 8, 2005, the Company sold a 110-unit property in Philadelphia, Pennsylvania for $5,900. A gain on sale of approximately $1,800 (before allocation of minority interest) was recorded in the third quarter of 2005 related to this sale. The weighted average first year capitalization rate projected on this disposition is 6.97%. 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 2008 and had $94 million outstanding at September 30, 2005. The $1.8 billion in mortgage notes payable have varying maturities ranging from 1 to 36 years. The weighted average interest rate of the Company's fixed rate notes was 6.11% and 6.23% at September 30, 2005 and December 31, 2004, respectively. The weighted average interest rate of the Company's variable rate notes and credit facility was 4.53% and 2.98% at September 30, 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 September 30, 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, both co-founders and directors of the Company, 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 its 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 the Company to buy the property. From the 36th month to the end of the lease term, the Company has 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 interest in an affordable property limited partnership, has guaranteed the Low Income Housing Tax Credits to limited partners totaling approximately $3,000. With respect to the guarantee of the low income housing tax credits, the Company believes the property's 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 this partnership, 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-and nine-month periods ended September 30, 2005 approximately $131 and $394 per unit was estimated to be spent on recurring capital expenditures. The table below summarizes the actual total capital improvements, (excludes assets held for sale) incurred by major categories for the three-and nine-month periods ended September 30, 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-and nine-month periods ended September 30, 2005 as follows: For the three-month period ended September 30, (in thousands, except per unit data) 2005 2004 ------------------------------------------------------------------------------------ Non- Total Total Recurring Per Recurring Per Capital Per Capital Per Cap Ex Unit(a) Cap Ex Unit(a) Improvements Unit(a) Improvements Unit(a) ------ ------- ------ ------- ------------ ------- ------------ ------- New Buildings $ - $ - $ 1,374 $ 32 $ 1,374 $ 32 $ 950 $ 23 Major building improvements 969 23 5,325 125 6,294 148 5,400 131 Roof replacements 352 8 1,905 45 2,257 53 927 22 Site improvements 352 8 2,381 56 2,733 64 2,963 72 Apartment upgrades 703 16 5,089 120 5,792 136 7,741 188 Appliances 597 14 662 16 1,259 30 1,208 29 Carpeting/Flooring 1,822 43 1,408 33 3,230 76 3,257 79 HVAC/Mechanicals 543 13 3,990 93 4,533 106 4,245 103 Miscellaneous 256 6 582 14 838 20 681 17 ------ ---- ------- ---- ------- ---- ------- ---- Totals $5,594 $131 $22,716 $534 $28,310 $665 $27,372 $664 ====== ==== ======= ==== ======= ==== ======= ==== (a) Calculated using the weighted average number of units outstanding, including 39,175 core units, 2004 acquisition units of 2,486 and 2005 acquisition units of 948 for the three-month period ended September 30, 2005 and 39,175 core units and 2004 acquisition units of 2,089 for the three-month period ended September 30, 2004. For the nine-month period ended September 30, (in thousands, except per unit data) 2005 2004 ------------------------------------------------------------------------------------- Non- Total Total Recurring Per Recurring Per Capital Per Capital Per Cap Ex Unit(a) Cap Ex Unit(a) Improvements Unit(a) Improvements Unit(a) ------ ------- ------ ------- ------------ ------- ------------ ------- New Buildings $ - $ - $ 3,686 $ 87 $ 3,686 $ 87 $ 2,169 $ 54 Major building improvements 2,884 68 10,704 253 13,588 321 14,101 348 Roof replacements 1,046 25 3,167 75 4,213 100 2,278 56 Site improvements 1,046 25 4,609 109 5,655 134 6,923 171 Apartment upgrades 2,092 50 13,503 320 15,595 370 20,583 509 Appliances 1,775 42 1,405 33 3,180 75 3,129 77 Carpeting/Flooring 5,420 128 2,629 62 8,049 190 7,749 191 HVAC/Mechanicals 1,616 38 8,835 209 10,451 247 10,379 256 Miscellaneous 761 18 1,962 46 2,723 64 2,533 63 ------- ---- ------- ------ ------- ------ ------- ------ Totals $16,640 $394 $50,500 $1,194 $67,140 $1,588 $69,844 $1,725 ======= ==== ======= ====== ======= ====== ======= ====== (a) Calculated using the weighted average number of units outstanding, including 39,175 core units, 2004 acquisition units of 2,486 and 2005 acquisition units of 597 for the nine-month period ended September 30, 2005 and 39,175 core units and 2004 acquisition units of 1,295 for the nine-month period ended September 30, 2004. The schedule below summarizes the breakdown of total capital improvements (excludes assets held for sale) between core and non-core as follows: For the three-month period ended September 30, (in thousands, except per unit data) 2005 2004 ------------------------------------------------------------------------------------ Non- Total Total Recurring Per Recurring Per Capital Per Capital Per Cap Ex Unit Caup Ex Unit Improvements Unit Improvements Unit ------ ---- ------- ---- ------------ ---- ------------ ---- Core Communities $5,144 $131 $19,309 $493 $24,453 $624 $26,381 $673 2005 Acquisition Communities 124 131 696 734 820 865 - - 2004 Acquisition Communities 326 131 2,711 1,091 3,037 1,222 991 474 ------ ---- ------- ---- ------- ---- ------- ---- Sub-total 5,594 131 22,716 534 28,310 665 27,372 664 2005 Disposed Communities 1 131 23 2,737 24 2,868 90 818 2004 Disposed Communities - - - - - - 656 568 Corporate office expenditures(1) - - - - 2,420 - 1,092 - ------ ---- ------- ---- ------- ---- ------- ---- $5,595 $131 $22,739 $534 $30,754 $665 $29,210 $661 ====== ==== ======= ==== ======= ==== ======= ==== For the nine-month period ended September 30, (in thousands, except per unit data) 2005 2004 ------------------------------------------------------------------------------------ Non- Total Total Recurring Per Recurring Per Capital Per Capital Per Cap Ex Unit Cap Ex Unit Improvements Unit Improvements Unit ------ ---- ------ ---- ------------ ---- ------------ ---- Core Communities $15,426 $394 $45,266 $1,155 $60,692 $1,549 $67,984 $1,735 2005 Acquisition Communities 235 394 920 1,541 1,155 1,935 - - 2004 Acquisition Communities 979 394 4,314 1,735 5,293 2,129 1,860 1,436 ------- ---- ------- ------ ------- ------ ------- ------ Sub-total 16,640 394 50,500 1,194 67,140 1,588 69,844 1,725 2005 Disposed Communities 30 394 60 794 90 1,188 150 1,364 2004 Disposed Communities - - - - - - 1,986 1,357 Corporate office expenditures(1) - - - - 5,750 - 2,158 - ------- ---- ------- ------ ------- ------ ------- ------ $16,670 $394 $50,560 $1,194 $72,980 $1,588 $74,138 $1,712 ======= ==== ======= ====== ======= ====== ======= ====== (1) No distinction is made between recurring and non-recurring expenditures for corporate office. Corporate office expenditures includes principally computer hardware, software and office furniture and fixtures. Results of Operations --------------------- Summary of Core Properties -------------------------- The Company had 138 apartment communities with 39,175 units which were owned during the nine-month periods being presented (the "Core Properties"). The Company has acquired/developed an additional sixteen apartment communities with 3,572 units during 2005 and 2004 (the "Acquired Communities"). The Company also disposed of six properties with a total of 1,756 units during 2005 and 2004 (the "Disposition Communities"). The Disposition Communities have been classified as discontinued operations. Finally, beginning with the second quarter of 2004, the results of operations for both the three- and nine-month periods ending September 30, 2004, include the results of operations of the affordable limited partnerships ("Affordable LPs") that have been consolidated in accordance with FIN 46R for the first time. The Affordable LPs also have been classified as discontinued operations. The inclusion of the Acquired Communities generally accounted for the significant changes in operating results for the three-and nine-months ended September 30, 2005. A summary of the net operating income from Core Properties is as follows (in thousands): Nine Months Three Months ----------- ------------ 2005 2004 $ Change % Change 2005 2004 $ Change % Chg ---- ---- -------- -------- ---- ---- -------- ----- Rental income $317,674 $312,278 $5,396 1.7% $107,170 $104,576 $2,594 2.5% Property other income 17,826 15,006 2,820 18.8% 7,146 5,328 1,818 34.1% -------- -------- ----- --- ------- ------- ----- --- Total income 335,500 327,284 8,216 2.5% 114,316 109,904 4,412 4.0% Operating and Maintenance (152,359) (147,384) (4,975) ( 3.4%) (49,291) (47,565) ( 1,726) (3.6%) -------- -------- ------ --- ------- ------- ----- --- Net operating income $183,141 $179,900 $3,241 1.8% $65,025 $62,339 $2,686 4.3% ======== ======== ====== === ======= ======= ====== === A summary of the net operating income from continuing operations is as follows (in thousands): Nine Months Three Months ----------- ------------ 2005 2004 $ Change % Change 2005 2004 $ Change % Chg ---- ---- -------- -------- ---- ---- -------- ----- Rental income $345,149 $323,922 $21,227 6.6% $117,581 $110,731 $6,850 6.2% Property other income 18,871 15,357 3,514 22.9% 7,626 5,484 2,142 39.1% -------- -------- ------- --- ------- ------- ------ --- Total income 364,020 339,279 24,741 7.3% 125,207 116,215 8,992 7.7% Operating and Maintenance (165,065) (152,267) ( 12,798) (8.4%) ( 54,161) (50,102) (4,059) (8.1%) -------- -------- ------- --- ------- ------- ------ --- Net operating income $198,955 $187,012 $11,943 6.4% $71,046 $66,113 $4,933 7.5% ======== ======== ======= === ======= ======= ====== === Comparison of nine-months ended September 30, 2005 to the same period in 2004 ----------------------------------------------------------------------------- Of the $21,227 increase in rental income, $15,831 is attributable to the Acquired Communities. The balance of this increase, or $5,396 which is from the Core Properties, was the result of an increase of 2.2% in weighted average rental rates, offset with a decrease in occupancy from 93.4% to 93.0%. Occupancy is defined as total possible rental income, net of vacancy and bad debt expense as a percentage of total possible rental income. Total possible rental income is determined by valuing occupied units at contract rates and vacant units at market rents. Property other income, which consists primarily of income from operation of laundry facilities, late charges, administrative fees, garage and carport charges, net profits from corporate apartments, cable revenue, pet charges, utility recovery charges, and miscellaneous charges to residents increased by $3,514. Of this increase, $694 is attributable to the Acquired Communities and $2,820 represents a 18.8% increase from the Core Properties. Included in the Core increase is $1,533 which represents increased water and sewer recovery charges compared to 2004. Other income decreased $465 due primarily to a decrease in the level of management fee activity as a result of the sale of the affordable limited partnerships. Of the $12,798 increase in operating and maintenance expenses, $7,823 is attributable to the Acquired Communities. The balance, a $4,975 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 insurance expenses. Natural gas heating costs were up $1,710 or 12.7% over 2004. We have seen significant increases in the cost of natural gas per decatherm. Personnel expenses were up $2,034, or 6.0%. Contributing to this was normal operating payroll increases of $1,225, or 3.8% and an increase in site level incentive compensation of $809. Real estate taxes were up $1,999, or 6.1%. Of this, $204, or 0.6% is from a prepaid tax adjustment needed to bring our balance sheet to the proper amount. The balance is a 5.5% increase in normal increases in assessed values and tax rates. The decrease in repairs and maintenance was $1,007 or 4.3% compared to a year ago. The nine-month period in 2004 included an $805 additional tax payment for the NYS sales tax audit. Property insurance decreased $869, or 15.5%, for the period primarily due to a decrease in our property and general liability premiums, and losses to date which have been projected using actuarial assumptions. The cost of supplying heat to our residents will be going up substantially in the fourth quarter of 2005 and into 2006 based on the increase in natural gas costs. The price increase per decatherm was exacerbated by the hurricanes affecting Gulf Coast production in the fall of 2005. In response to this increased cost, the Company has been searching for ways to recover some or all of this marginal increase from our residents by instituting utility recovery programs. The water and sewer recovery program has been under way since March of 2005. The amount of reimbursement has been growing steadily as the program has been rolled out upon lease renewals. The increased income is included in property other income and was discussed above. Starting in September, 2005, the Company is also instituting energy recovery programs to specifically address our higher natural gas costs. This program will start out small, but as we have experienced with the water and sewer program, we expect quick growth over the next few quarters. For the fourth quarter of 2005, our expectation is that increased energy costs (over what was expected just three months ago) will exceed these reimbursements by about three cents per share as measured for Funds from Operations, or FFO. For all of 2006, the income from both recovery programs is expected to exceed the marginal increase in the heating cost line item, although there will be timing differences, as a significant portion of heating costs are incurred in the first quarter, while the reimbursements will grow during the year. General and administrative expense decreased in 2005 by $53. General and administrative expenses as a percentage of total revenues were 3.9% for 2005 as compared to 4.2% for 2004. The decrease is the result of a reduction in the level of corporate incentive compensation accrued in 2005, mostly offset by increased expenses relating to compliance with the internal controls review and improvements in response to Section 404 of the Sarbanes Oxley Act of 2002 and applicable regulations of the U.S. Securities and Exchange Commission and audit work completed in the first quarter of 2005. Interest expense increased in 2005 by $10,560 as a result of the increased borrowings in connection with acquisition of the 2005 Acquisition Communities, a full nine months of interest expense for the 2004 Acquisition Communities and additional mortgage debt and refinanced mortgage debt incurred during 2004. Interest expense was reduced in the second quarter of 2005 by $393 while 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. Finally, $233 in interest relative to the sales tax liability recorded and described above is included in 2004. Depreciation and amortization expense increased $8,190 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 nine months of 2004, the Company recorded impairment charges of $1,116. Of this total, $171 represented advances made to certain of the Affordable LPs, which the Company believed would not be repaid upon the sale of the loans. The remaining $945 pertains to an additional net impairment charge taken on the remaining properties owned by the Affordable LPs to reduce the assets to fair market value. In connection with FIN 46R, the Company was required to consolidate the majority of the Affordable LPs results of operations beginning April 1, 2004. The results of operations of the Affordable LPs are included in discontinued operations for both the nine-month periods ended September 30, 2005 and 2004. The equity in earnings (losses) of unconsolidated affiliates was a loss of $538 for the nine months ended September 30, 2004 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 had 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 were $484 of advances made during the first three months of 2004 which the Company believes will not be repaid upon sale. Minority interest decreased $1,398 due to a general decrease in income from operations. Included in discontinued operations for the nine-month period ended September 30, 2005, are the results of operations of one apartment community sold and one held for sale that in connection with FIN 46R were required to be consolidated beginning April 1, 2004. As all significant contingencies surrounding the sale of the properties have been resolved, the Company has considered these assets held for sale and has reported them in discontinued operations (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. Comparison of the three-months ended September 30, 2005 to the same period in -------------------------------------------------------------------------------- 2004 ---- Of the $6,850 increase in rental income, $4,256 is attributable to the Acquired Communities. The balance of this increase, or $2,594 which is from the Core Properties, was the result of an increase of 0.8% in weighted average rental rates, plus an increase in occupancy from 92.8% to 93.6%. Occupancy is defined as total possible rental income, net of vacancy and bad debt expense as a percentage of total possible rental income. Total possible rental income is determined by valuing occupied units at contract rates and vacant units at market rents. Property other income, which consists primarily of income from operation of laundry facilities, late charges, administrative fees, garage and carport charges, net profits from corporate apartments, cable revenue, pet charges, utility recovery charges, and miscellaneous charges to residents increased by $2,142. Of this increase, $324 is attributable to the Acquired Communities and $1,818 represents a 34.1% increase from the Core Properties. Included in the Core properties increase is $1,041 which represents increased water and sewer recovery charges compared to 2004. Other income decreased $329 due primarily to a decrease in the level of management fee activity as a result of the sale of the affordable limited partnerships. Of the $4,059 increase in operating and maintenance expenses, $2,333 is attributable to the Acquired Communities. The balance, a $1,726 increase, is attributable to the Core Properties and is primarily due to increases in electricity costs, personnel costs, and real estate taxes. These increases were offset in part by a reduction in property insurance. Electricity costs were up $298, or 13.2% due to a much hotter summer compared to normal which contributed to higher electricity usage. Personnel expenses increased $301, with $378 resulting from increased site level incentive compensation reflecting improving rent and occupancies compared to a year ago. The 4.5% variance in real estate taxes results from normal increases in assessed values and tax rates. Property insurance decreased for the period primarily due to a decrease in our property and general liability premiums, and losses to date which have been projected using actuarial assumptions. General and administrative expense increased in 2005 by $15. General and administrative expenses as a percentage of total revenues were 3.9% for 2005 as compared to 4.2% for 2004. Interest expense increased in 2005 by $4,043 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 which took place during 2004. Depreciation and amortization expense increased $2,640 due to the depreciation on the Acquisition Communities and the capital additions to the Core Properties. Minority interest decreased $429 due to a general decrease in income from operations, offset by the increase in the minority interest percentage from 31.9% to 32.6%. Included in discontinued operations for the three-month period ended September 30, 2005 are the results of operations of one apartment community sold and properties owned by the remaining Affordable LPs that, in connection with FIN 46R, were required to be consolidated beginning April 1, 2004. As all significant contingencies surrounding the sale of the affordable properties have been resolved the Company has considered these assets held for sale and have reported them in discontinued operations. Funds From Operations --------------------- Pursuant to the revised definition of Funds From Operations ("FFO") adopted by the Board of Governors of the National Association of Real Estate Investment Trusts ("NAREIT"), FFO is defined as net income (computed in accordance with accounting principles generally accepted in the United States of America ("GAAP")) excluding gains or losses from sales of property, minority interest, extraordinary items and cumulative effect of change in accounting principle plus depreciation from real property including adjustments for unconsolidated partnerships and joint ventures less dividends from non-convertible preferred shares. NAREIT has recently changed guidance on the interpretation of impairment charges recorded against the value of real estate. The previous interpretation was that impairment charges in real estate would be an add back to arrive at FFO, similar to a loss on sale of real estate. The Company is following this new interpretation effective April 1, 2004 on a go-forward basis. The change is not suggested to be retroactive to any prior period reported. Because of the limitations of the FFO definition as published by NAREIT as set forth above, the Company has made certain interpretations in applying the definition. The Company believes all adjustments not specifically provided for are consistent with the definition. Management believes that in order to facilitate a clear understanding of the combined historical operating results of the Company, FFO should be considered in conjunction with net income as presented in the consolidated financial statements included elsewhere herein. Management believes that by excluding gains or losses related to dispositions of property and excluding real estate depreciation (which can vary among owners of similar assets in similar condition based on historical cost accounting and useful life estimates), FFO can help one compare the operating performance of a company's real estate between periods or as compared to different companies. FFO does not represent cash generated from operating activities in accordance with GAAP 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 Company's 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 $100,619 and $125,368 for the nine-month periods ended and $36,615 and $40,208 for the three-month periods ended September 30, 2005 and 2004, respectively. Cash used in investing activities was $166,545 and $202,030 for the nine-month periods ended and $104,758 and $97,223 for the three-month periods ended September 30, 2005 and 2004, respectively. Cash provided by financing activities was $63,265 and $78,976 for the nine-month periods ended and $63,334 and $58,594 for the three-month periods ended September 30, 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 nine-and three-months ended September 30, 2005 and 2004 are presented below (in thousands): Nine Months Three Months ----------- ------------ 2005 2004 2005 2004 ---- ---- ---- ---- Net income available to common shareholders $ 21,521 $16,349 $15,353 $ 3,027 Minority interest 9,842 11,240 4,133 4,562 Minority interest - income (loss) from discontinued operations (2,379) (201) 216 49 Minority interest - gain (loss) from disposition of discontinued operations 2,389 (3,195) 2,389 (3,195) Depreciation and amortization from real property 72,524 67,566 24,997 23,225 Depreciation from real property from - 556 unconsolidated entities - - Impairment on General Partner real estate - 945 investment - - Loss on disposition of property - 50 - - (Gain) loss on disposition of discontinued operations, net of minority interest (1,353) (417) (1,431) 94 Cumulative effect of change in accounting principle, net of minority interest - 321 - - -------- ------- ------- ------- FFO - Basic $102,544 $93,214 $45,657 $27,762 Convertible preferred dividends 879 - - - -------- ------- ------- ------- FFO - Diluted $103,423 $93,214 $45,657 $27,762 ======== ======= ======= ======= Weighted average common shares/units outstanding(1): - Basic 47,828.7 48,660.3 48,255.2 48,894.6 ======== ======== ======== ======== - Diluted 48,680.2 49,100.3 48,686.3 49,338.6 ======== ======== ======== ======== (1) The calculation assumes the conversion of dilutive common stock equivalents including convertible preferred stock for the nine-month period ended September 30, 2005 and the conversion of all UPREIT units to common shares. The convertible preferred stock had an anti-dilutive effect; therefore, the convertible preferred dividends are not included in FFO diluted for the three and nine months ended September 30, 2004. 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 at least 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 following calculation is defined as total revenues from discontinued operations less operating and maintenance expenses. Calculation Presented for Series F Covenants Three-months ended ------------------ Sept. 30, June 30, Mar.31, Dec. 31, 2005 2005 2005 2004 ---- ---- ---- ---- EBITDA ------ Total revenues $125,775 $121,636 $118,787 $118,357 Net operating income (loss) from discontinued operations 1,045 (343) 142 2,143 Operating and maintenance (54,161) (53,623) ( 57,511) (52,227) General and administrative (4,894) (4,144) (5,405) (9,482) Equity in earnings (losses) of unconsolidated affiliates - - - - ------- ------- -------- ------- $67,765 $63,526 $ 56,013 $58,791 Fixed Charges ------------- Interest expense $27,059 $25,173 $ 24,943 $23,891 Interest expense on discontinued operations 382 279 21 442 Preferred dividends 1,350 1,681 1,898 1,898 Capitalized interest 254 339 191 191 ------- ------- -------- ------- $29,045 $27,472 $ 27,053 $26,422 Fixed charge coverage ratio: 2.33 2.31 2.07 2.23 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 was that the Company could 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, exceeded 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. Historically there were certain quarters where the Company did not meet this specific covenant and appropriate waivers were granted by the participating banks. The new credit agreement effective September 1, 2008 has removed this covenant completely. 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 or stock repurchase 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 2001 through 2003, many regions of the United States 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. Starting in 2004 and into 2005, the economy has shown improvement which has benefited multifamily apartments. We continue to review our business strategy and given our property type and the geographic regions in which we are located, we do not anticipate any changes in our strategy or material effects in financial performance. Declaration of Dividend ----------------------- On November 4, 2005, the Board of Directors approved a dividend of $.64 per share for the quarter ended September 30, 2005. This is the equivalent of an annual distribution of $2.56 per share. The dividend is payable November 25, 2005 to shareholders of record on November 15, 2005. On November 4, 2005, the Company also declared a regular dividend of $.5625 per share on its Series F Cumulative Redeemable Preferred Stock, for the quarter ending November 30, 2005. The dividend on the preferred shares is payable on November 30, 2005 to shareholders of record on November 15, 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 capital stock tax audit. The state had 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 $1,300. 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 Company filed a protest with the Pennsylvania State Commonwealth Court concerning the 1999 tax year. Settlement discussions have occurred during the third quarter of 2005 for the open years 1999-2001. Based on these discussions, the Company believes that the likelihood of settling all three open years has increased, and has accrued $160. 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 had significant financial exposure. During the first six months of 2005, the Company signed VDAs with these states which have agreed to limit the VDA filing period back to January 1, 2001, and has satisfied all financial obligations under the VDAs. For the three- and six-month periods ended June 30, 2005, the Company has recorded adjustments to the liability for both the effects of signing the VDAs as well as for the results of the Company's additional testing for the first six months. The net impact of these adjustments resulted in a decrease in real estate assets of $175, interest expense of $115 and operating expenses of $108 for a net decrease to the accrued liability of $398. During the third quarter of 2005, the Company finalized negotiations with New York State settling a sales tax audit covering the period June 1, 2002 through November 30, 2004. The settlement was not materially different from what had been accrued. The result of the recent payments on the VDAs and this New York State audit is that the sales tax accrual which had been over $1,712 (as referenced above) has been reduced to $16 at September 30, 2005. 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 at least 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 year 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 application of SFAS No. 123R beginning January 1, 2006 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 September 30, 2005 and December 31, 2004, approximately 90% and 89%, respectively, of the Company's debt bore interest at fixed rates with a weighted average maturity of approximately 7 and 8 years, respectively, and a weighted average interest rate of approximately 6.11% and 6.23%, respectively, including the $29 million and $34 million, respectively, of debt 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 12 and 8 years, respectively, and a weighted average interest rate of 4.48 % and 2.98%, respectively, at September 30, 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 or stock repurchase with the intention to refinance at a later date. The Company believes, however, that in no event would increases in interest expense as a result of inflation significantly impact the Company's distributable cash flow. At September 30, 2005 and December 31, 2004, the interest rate risk on $29 million and $34 million, respectively, of such variable rate debt has been mitigated through the use of interest rate swap agreements (the "Swaps") with major financial institutions. The Company is exposed to credit risk in the event of non-performance by the counter-parties to the Swaps. The Company believes it mitigates its credit risk by entering into these Swaps with major financial institutions. The Swaps effectively convert the variable rate mortgages to fixed rates of 5.35%, 5.39%, 8.22% and 8.40%. At September 30, 2005 and December 31, 2004, the fair value of the Company's fixed rate debt, including the $29 million and $34 million, respectively, which was swapped to a fixed rate, amounted to a liability of $1.74 billion compared to its carrying amount of $1.66 billion. The Company estimates that a 100 basis point increase in market interest rates at September 30, 2005 would have changed the fair value of the Company's fixed rate debt to a liability of $1.67 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 and/or the issuance of UPREIT Units. Accordingly, the cost of obtaining such interest rate protection agreements in relation to the Company's access to capital markets will continue to be evaluated. The Company has not, and does not plan to, enter into any derivative financial instruments for trading or speculative purposes. As of September 30, 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 September 30, 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 third 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; USE OF PROCEEDS FROM REGISTERED ------------------------------------------------------------------------ SECURITIES ---------- 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 September 30, 2005. Total shares (units) Maximum shares Total shares Average purchased as (units) that may (units) price per part of publicly- yet be purchased Period purchased(1) share (unit) announced Plan under the Plan ------ ------------ ------------ -------------- -------------- Balance June 30, 2005 2,699,300 July 1, 2005 to July 31, 2005 1,199 $45.09 - - August 1, 2005 to August 31, 2005 11,981 $40.84 - - September 1, 2005 to September 30, 2005 208,289 $38.93 205,900 2,493,400 ------- ------ ------- --------- 221,469 $39.07 205,900 2,493,400 ======= ====== ======= ========= (1) During the three months ended September 30, 2005, the Company repurchased 15,569 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"), which are included in this table. ITEM 6. EXHIBITS Exhibit 10.78 Amendment No. Four to Credit Agreement between Home Properties, L.P., certain Lenders, and Manufacturers and Traders Trust Company and Administrative Agent Exhibit 10.79 Agreement, dated September 30, 2005 between General Electric Credit Equities, Inc. and H.P. Knolls I Associates, L.P. Exhibit 10.80 Agreement, dated September 30, 2005, between General Electric Credit Equities, Inc. and H.P. Knolls II Associates, L.P. Exhibit 31.1 Section 302 Certification of Chief Executive Officer Exhibit 31.2 Section 302 Certification of Chief Financial Officer Exhibit 32.1 Section 906 Certification of Chief Executive Officer 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: November 9, 2005 ------------------------------------- By: /s/ Edward J. Pettinella ------------------------------------- Edward J. Pettinella President and Chief Executive Officer Date: November 9, 2005 ------------------------------------- By: /s/ David P. Gardner ------------------------------------- David P. Gardner Executive Vice President and Chief Financial Officer