1 FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 COMMISSION FILE NUMBER: 1-11718 MANUFACTURED HOME COMMUNITIES, INC. (Exact name of registrant as specified in its Charter) MARYLAND 36-3857664 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) TWO NORTH RIVERSIDE PLAZA, SUITE 800, CHICAGO, ILLINOIS 60606 (Address of principal executive offices) (Zip Code) (312) 279-1400 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes (X) No ( ) APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 21,309,001 shares of Common Stock as of July 31, 2001.
2 MANUFACTURED HOME COMMUNITIES, INC. TABLE OF CONTENTS PART I - FINANCIAL STATEMENTS ITEM 1. FINANCIAL STATEMENTS INDEX TO FINANCIAL STATEMENTS Page Consolidated Balance Sheets as of June 30, 2001 (unaudited) and December 31, 2000.................................................... 3 Consolidated Statements of Operations for the quarters and six months ended June 30, 2001 and 2000 (unaudited)....................................... 4 Consolidated Statements of Cash Flows for the six months ended June 30, 2001 and 2000 (unaudited)................................................ 5 Notes to Consolidated Financial Statements............................... 6 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................. 15 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk........... 22 PART II - OTHER INFORMATION ITEM 1. Legal Proceedings.................................................... 23 ITEM 6. Exhibits and Reports on Form 8-K..................................... 23 2
3 MANUFACTURED HOME COMMUNITIES, INC. CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 2001 AND DECEMBER 31, 2000 (AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA) JUNE 30, DECEMBER 31, 2001 2000 (UNAUDITED) ----------- ------------ ASSETS Investment in real estate: Land .......................................................................... $ 273,559 $ 271,822 Land improvements ............................................................. 848,770 839,725 Buildings and other depreciable property ...................................... 108,853 106,629 ----------- ----------- 1,231,182 1,218,176 Accumulated depreciation ...................................................... (194,915) (181,580) ----------- ----------- Net investment in real estate ............................................... 1,036,267 1,036,596 Cash and cash equivalents ........................................................ 3,417 2,847 Notes receivable ................................................................. 3,834 4,984 Investment in and advances to affiliates ......................................... 23,469 21,215 Investment in joint ventures ..................................................... 13,506 13,267 Rents receivable ................................................................. 1,479 1,440 Deferred financing costs, net .................................................... 5,802 6,344 Prepaid expenses and other assets ................................................ 18,186 17,611 ----------- ----------- Total assets .................................................................. $ 1,105,960 $ 1,104,304 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Mortgage notes payable ........................................................ $ 554,548 $ 556,578 Unsecured term loan ........................................................... 100,000 100,000 Unsecured line of credit ...................................................... 55,100 59,900 Other notes payable ........................................................... 3,206 3,206 Accounts payable and accrued expenses ......................................... 25,134 23,822 Accrued interest payable ...................................................... 4,896 5,116 Rents received in advance and security deposits ............................... 6,194 5,184 Distributions payable ......................................................... 11,992 11,100 Due to affiliates ............................................................. 32 32 ----------- ----------- Total liabilities ........................................................... 761,102 764,938 ----------- ----------- Commitments and contingencies Minority interest - Common OP Units and other .................................... 46,515 46,271 Minority interest - Perpetual Preferred OP Units ................................. 125,000 125,000 Stockholders' equity: Preferred stock, $.01 par value 10,000,000 shares authorized; none issued ................................... -- -- Common stock, $.01 par value 50,000,000 shares authorized; 21,294,747 and 21,064,785 shares issued and outstanding for 2001 and 2000, respectively ............... 212 210 Paid-in capital ............................................................... 239,714 235,681 Deferred compensation ......................................................... (4,919) (5,969) Employee notes ................................................................ (3,940) (4,205) Distributions in excess of accumulated earnings ............................... (57,724) (57,622) ----------- ----------- Total stockholders' equity .................................................. 173,343 168,095 ----------- ----------- Total liabilities and stockholders' equity .................................... $ 1,105,960 $ 1,104,304 =========== =========== The accompanying notes are an integral part of the financial statements. 3
4 MANUFACTURED HOME COMMUNITIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE QUARTERS AND SIX MONTHS ENDED JUNE 30, 2001 AND 2000 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED) QUARTERS ENDED SIX MONTHS ENDED ------------------------------- ------------------------------- JUNE 30, JUNE 30, JUNE 30, JUNE 30, 2001 2000 2001 2000 ------------- -------------- ------------- -------------- REVENUES Base rental income..................................... $ 48,770 $ 47,249 $ 97,783 $ 94,558 RV base rental income.................................. 633 1,176 2,483 4,875 Utility and other income............................... 5,987 5,031 12,419 10,729 Equity in income of affiliates......................... 654 642 677 792 Interest income........................................ 174 173 388 464 ------------- -------------- ------------- -------------- Total revenues.................................... 56,218 54,271 113,750 111,418 ------------- -------------- ------------- -------------- EXPENSES Property operating and maintenance..................... 15,351 14,411 31,344 29,818 Real estate taxes ..................................... 4,429 4,363 9,031 8,687 Property management.................................... 2,267 2,171 4,514 4,560 General and administrative............................. 1,857 1,834 3,513 3,660 Interest and related amortization...................... 12,905 13,154 26,311 26,485 Depreciation on corporate assets....................... 310 277 614 548 Depreciation on real estate assets and other costs..... 8,587 8,567 17,266 17,424 ------------- -------------- ------------- -------------- Total expenses.................................... 45,706 44,777 92,593 91,182 ------------- -------------- ------------- -------------- Income from operations........................... 10,512 9,494 21,157 20,236 Gain on sale of Properties and other................... --- 12,053 8,093 12,053 ------------- -------------- ------------- -------------- Income before allocation to Minority Interests and extraordinary loss........................ 10,512 21,547 29,250 32,289 (Income) allocated to Common OP Units.................. (1,564) (3,772) (4,846) (5,371) (Income) allocated to Perpetual Preferred OP Units..... (2,813) (2,813) (5,626) (5,626) ------------- -------------- ------------- -------------- Income before extraordinary loss on early extinguishment of debt........................ 6,135 14,962 18,778 21,292 Extraordinary loss on early extinguishment of debt (net of $264 allocated to minority interests)..... --- 1,041 --- 1,041 ------------- -------------- ------------- -------------- NET INCOME....................................... $ 6,135 $ 13,921 $ 18,778 $ 20,251 ============= ============== ============= ============== Income per share before extraordinary loss - basic..... $ .29 $ .68 $ .90 $ .96 ============= ============== ============= ============== Income per share before extraordinary loss - diluted... $ .29 $ .67 $ .88 $ .95 ============= ============== ============= ============== Net income per Common Share - basic.................... $ .29 $ .64 $ .90 $ .92 ============= ============== ============= ============== Net income per Common Share - diluted.................. $ .29 $ .63 $ .88 $ .90 ============= ============== ============= ============== Distributions declared per Common Share................ $ .445 $ .415 $ .89 $ .83 ============= ============== ============= ============== Weighted average Common Shares outstanding - basic.......................... 20,969 21,871 20,881 22,082 ============= ============== ============= ============== Weighted average Common Shares outstanding - diluted (see Note 2)........... 26,898 27,809 26,835 28,024 ============= ============== ============= ============== The accompanying notes are an integral part of the financial statements. 4
5 MANUFACTURED HOME COMMUNITIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE SIX MONTHS ENDED JUNE 30, 2001 AND 2000 (AMOUNTS IN THOUSANDS) (UNAUDITED) JUNE 30, JUNE 30, 2001 2000 ----------------- ---------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income............................................................ $ 18,778 $ 20,251 Adjustments to reconcile net income to Cash provided by operating activities: Income allocated to Minority Interests............................ 10,472 10,733 Gain on sale of Properties and other.............................. (8,093) (12,053) Depreciation and amortization expense............................. 18,426 17,475 Equity in income of affiliates and joint ventures................. (1,401) (792) Amortization of deferred compensation and other................... 1,050 1,193 (Increase) decrease in rents receivable........................... (39) 196 (Increase) in prepaid expenses and other assets................... (575) (2,042) Increase in accounts payable and accrued expenses................. 1,092 5,160 Increase (decrease) in rents received in advance and security deposits 1,010 (586) ----------------- ---------------- Net cash provided by operating activities............................. 40,720 39,535 ----------------- ---------------- CASH FLOWS FROM INVESTING ACTIVITIES: Contributions to affiliates........................................... (1,643) (3,787) Collection of notes receivable........................................ 1,150 1,040 Investment in joint ventures net of distributions received............ 134 (133) Proceeds from disposition of rental Properties and other assets....... 16,864 44,329 Collection of escrow proceeds, net.................................... --- 10,500 Acquisition of rental Properties...................................... (16,879) (3,474) Improvements: Improvements - corporate.......................................... (514) (204) Improvements - rental properties.................................. (4,286) (2,896) Site development costs............................................ (4,230) (1,909) ----------------- ---------------- Net cash (used in) provided by investing activities................... (9,404) 43,466 ----------------- ---------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from stock options and employee stock purchase plan...... 4,383 1,932 Distributions to Common Stockholders, Common OP Unitholders and Perpetual Preferred OP Unitholders................................ (28,564) (28,173) Repurchase of Common Stock and OP Units............................... --- (22,431) Collection of principal payments on employee notes.................... 265 278 Line of credit: Proceeds.......................................................... 23,000 37,000 Repayments........................................................ (27,800) (119,700) Refinancing - net proceeds............................................ --- 67,352 Principal payments.................................................... (2,030) (2,815) Debt issuance costs................................................... --- (1,222) ----------------- ---------------- Net cash used in financing activities................................. (30,746) (67,779) ----------------- ---------------- Net increase in cash and cash equivalents.................................. 570 15,222 Cash and cash equivalents, beginning of period............................. 2,847 6,676 ----------------- ---------------- Cash and cash equivalents, end of period................................... $ 3,417 $ 21,898 ================= ================ SUPPLEMENTAL INFORMATION: Cash paid during the period for interest................................... $ 26,637 $ 27,602 ================= ================ The accompanying notes are an integral part of the financial statements. 5
6 MANUFACTURED HOME COMMUNITIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DEFINITION OF TERMS: Capitalized terms used but not defined herein are as defined in the Company's Annual Report on Form 10-K (the "2000 Form 10-K") for the year ended December 31, 2000. PRESENTATION: These unaudited Consolidated Financial Statements of Manufactured Home Communities, Inc., a Maryland corporation, and its subsidiaries (collectively, the "Company"), have been prepared pursuant to the Securities and Exchange Commission ("SEC") rules and regulations and should be read in conjunction with the financial statements and notes thereto included in the 2000 Form 10-K. The following Notes to Consolidated Financial Statements highlight significant changes to the Notes included in the 2000 Form 10-K and present interim disclosures as required by the SEC. The accompanying Consolidated Financial Statements reflect, in the opinion of management, all adjustments necessary for a fair presentation of the interim financial statements. All such adjustments are of a normal and recurring nature. Certain reclassifications have been made to the prior periods' financial statements in order to conform with current period presentation. NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS No. 131") requires certain disclosures of selected information about operating segments in the annual financial statements and related disclosures about products and services, geographic areas, and major customers. The adoption of SFAS No. 131 did not affect the results of operations or financial position of the Company. The Company manages operations on a property by property basis. Since each property has similar economic and operational characteristics, the Company has one reportable segment, which is the operation of manufactured home communities. NOTE 2 - EARNINGS PER COMMON SHARE Earnings per common share are based on the weighted average number of common shares outstanding during each period. Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS No. 128") defines the calculation of basic and fully diluted earnings per share. Basic and fully diluted earnings per share are based on the weighted average shares outstanding during each period and basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. The conversion of OP Units has been excluded from the basic earnings per share calculation. The conversion of an OP Unit to a share of common stock has no material effect on earnings per common share. 6
7 MANUFACTURED HOME COMMUNITIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 2 - EARNINGS PER COMMON SHARE (CONTINUED) The following table sets forth the computation of basic and diluted earnings per share for the quarters and six months ended June 30, 2001 and 2000 (amounts in thousands): QUARTERS ENDED SIX MONTHS ENDED -------------------------- -------------------------- JUNE 30, JUNE 30, JUNE 30, JUNE 30, 2001 2000 2001 2000 ----------- ----------- ----------- ----------- NUMERATOR: Numerator for basic earnings per share - Net income.......................................... $ 6,135 $ 13,921 $ 18,778 $ 20,251 Effect of dilutive securities: Income allocated to Common OP Units (net of extraordinary loss of $264 in 2000)........ 1,564 3,508 4,846 5,107 ----------- ----------- ----------- ----------- Numerator for diluted earnings per share- income available to common shareholders after assumed conversions.......................... $ 7,699 $ 17,429 $ 23,624 $ 25,358 =========== =========== =========== =========== DENOMINATOR: Denominator for basic earnings per share - Weighted average Common Stock outstanding........... 20,969 21,871 20,881 22,082 Effect of dilutive securities: Weighted average Common OP Units.................... 5,481 5,598 5,494 5,618 Employee stock options.............................. 448 340 460 324 ----------- ----------- ----------- ----------- Denominator for diluted earnings per share- adjusted weighted average shares and assumed conversions................................ 26,898 27,809 26,835 28,024 =========== =========== =========== =========== NOTE 3 - COMMON STOCK AND RELATED TRANSACTIONS On April 16, 2001 and July 13, 2001, the Company paid a $.445 per share distribution for the quarter ended March 31, 2001 and June 30, 2001 to stockholders of record on March 30, 2001 and June 29, 2001, respectively. NOTE 4 - REAL ESTATE On January 3, 2001, the Company acquired two Florida communities, totaling 730 sites, for an aggregate purchase price of approximately $16.3 million. Golden Lakes is a 422-site community in Plant City, near Tampa, Florida and includes approximately 23 acres for expansion. Chain O' Lakes is a 308-site community in Grand Island, near Orlando, Florida, and includes a marina with 50 boat docks. The acquisition was funded with a borrowing under the Company's line of credit. On February 13, 2001, the Company completed the disposition of the following seven communities, totaling 1,281 sites, in Kansas, Missouri and Oklahoma for a total sale price of approximately $19.1 million. Dellwood Estates.........136 sites Briarwood................166 sites Bonner Springs...........211 sites Carriage Park............143 sites North Star...............219 sites Quivira Hills............142 sites Rockwood.................264 sites 7
8 MANUFACTURED HOME COMMUNITIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 4 - REAL ESTATE (CONTINUED) Included in the sales price are proceeds from the sale by Realty Systems, Inc., an affiliate of the Company, of inventory and notes receivable totaling $1.7 million. The Company recorded a gain of $8.1 million on the sale of these Properties. Proceeds from the sale were used to reduce the amounts outstanding on the Company's line of credit. Certain costs, including legal costs, relative to efforts by the Company to effectively change the use and operations of several Properties are currently recorded in other assets. These costs, to the extent these efforts are successful, are capitalized to the extent of the established value of the revised project and included in the net investment in real estate for the appropriate Properties. To the extent these efforts are not successful, these costs will be expensed. The Company is actively seeking to acquire additional manufactured home communities and currently is engaged in negotiations relating to the possible acquisition of a number of Properties. At any time these negotiations are at varying stages which may include contracts outstanding to acquire certain manufactured home communities which are subject to satisfactory completion of the Company's due diligence review. NOTE 5 - NOTES RECEIVABLE As of June 30, 2001 and December 31, 2000, the Company had approximately $3.8 million and $5.0 million in notes receivable, respectively. The Company has approximately $2.1 million in loans maturing on June 1, 2003, which bear interest at the rate of approximately 8.4%, and are collateralized by the property known as Trails West. The Company has approximately $1.7 million in notes which bear interest at a rate of prime plus 0.5% and mature on December 31, 2011. The notes are collateralized with a combination of Common OP Units and partnership interests in Voyager and other joint ventures. NOTE 6 - LONG-TERM BORROWINGS As of June 30, 2001 and December 31, 2000, the Company had outstanding mortgage indebtedness of approximately $554.5 million and $556.6 million, respectively, encumbering 73 of the Company's Properties. As of June 30, 2001 and December 31, 2000, the carrying value of such Properties was approximately $635 million and $631 million, respectively. The outstanding mortgage indebtedness consists of: - - A $265.0 million mortgage note (the "$265 Million Mortgage") collateralized by 29 Properties beneficially owned by MHC Financing Limited Partnership. The $265 Million Mortgage has a maturity date of January 2, 2028 and bears interest at a rate of 7.015% per annum. There is no principal amortization until February 1, 2008, after which principal and interest are to be paid from available cash flow and the interest rate will be reset at a rate equal to the then 10-year U.S. Treasury obligations plus 2.0%. The $265 Million Mortgage is recorded net of a hedge of $3.0 million which is being amortized into interest expense over the life of the loan. - - A $66.2 million mortgage note (the "College Heights Mortgage") collateralized by 18 Properties owned in a joint venture formed by the Company and Wolverine Investors, LLC. The College Heights Mortgage bears interest at a rate of 7.19% per annum, amortizes beginning July 1, 1999 over 30 years and matures July 1, 2008. - - A $93.4 million mortgage note (the "DeAnza Mortgage") collateralized by 6 Properties beneficially owned by MHC-DeAnza Financing Limited Partnership. The DeAnza Mortgage bears interest at a rate of 7.82% per annum, amortizes beginning August 1, 2000 over 30 years and matures July 1, 2010. 8
9 MANUFACTURED HOME COMMUNITIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 6 - LONG-TERM BORROWINGS (CONTINUED) - - A $22.7 million mortgage note (the "Bay Indies Mortgage") collateralized by one Property beneficially owned by MHC-Bay Indies Financing Limited Partnership. The Bay Indies Mortgage bears interest at a rate of 7.48% per annum, amortizes beginning August 1, 1994 over 27.5 years and matures July 1, 2004. - - A $15.6 million mortgage note (the "Date Palm Mortgage") collateralized by one Property beneficially owned by MHC Date Palm, L.L.C. The Date Palm Mortgage bears interest at a rate of 7.96%, amortizes beginning August 1, 2000 over 30 years and matures July 1, 2010. - - Approximately $92.1 million of mortgage debt on 18 other various Properties, which was recorded at fair market value with the related discount or premium being amortized over the life of the loan using the effective interest rate. Scheduled maturities for the outstanding indebtedness are at various dates through November 30, 2020, and fixed interest rates range from 7.21% to 8.87%. In addition, the Company has a $2.4 million loan recorded to account for a direct financing lease entered into in May 1997. The Company has a $150 million unsecured line of credit with a group of banks (the "Credit Agreement") bearing interest at the London Interbank Offered Rate ("LIBOR") plus 1.125%, maturing on August 9, 2003. The Company pays a quarterly fee on the average unused amount of such credit equal to 0.15% of such amount. As of June 30, 2001 and December 31, 2000, the Company had $55.1 million and $59.9 million, respectively, outstanding under the Credit Agreement. The Company has a $100 million unsecured term loan (the "Term Loan") with a group of banks with interest only payable monthly at a rate of LIBOR plus 1.0%. The Term Loan matures on April 3, 2002. The Company has approximately $3.2 million of installment notes payable, secured by a letter of credit, each with an interest rate of 6.5%, maturing September 1, 2002. Approximately $1.9 million of the notes pay principal annually and interest quarterly and the remaining $1.3 million of the notes pay interest only quarterly. NOTE 7 - STOCK OPTIONS Pursuant to the Stock Option Plan as discussed in Note 14 to the 2000 Form 10-K, certain officers, directors, employees and consultants have been offered the opportunity to acquire shares of common stock of the Company through stock options ("Options"). During the six months ended June 30, 2001, Options for 158,896 shares of common stock were exercised. NOTE 8 - COMMITMENTS AND CONTINGENCIES The residents of DeAnza Santa Cruz Mobile Estates, a Property located in Santa Cruz, California (the "City") previously brought several actions opposing certain fees and charges in connection with water service at the Property. The trial of the ongoing utility charge dispute with the residents of this Property concluded on January 22, 1999. This summary provides the history and reasoning underlying the Company's defense of the residents' claims and explains the Company's decision to continue to defend its position, which the Company believes is fair and accurate. DeAnza Santa Cruz Mobile Estates is a 198-site community overlooking the Pacific Ocean. It is subject to the City's rent control ordinance which limits annual rent increases to 75% of CPI. The Company purchased this Property in August 1994 from certain unaffiliated DeAnza entities ("DeAnza"). Prior to the Company's purchase in 1994, DeAnza made the decision to submeter and separately bill tenants at the Property for both water and sewer in 1993 in the face of the City's rapidly rising utility costs. 9
10 MANUFACTURED HOME COMMUNITIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 8 - COMMITMENTS AND CONTINGENCIES (CONTINUED) Under California Civil Code Section 798.41, DeAnza was required to reduce rent by an amount equal to the average cost of usage over the preceding 12 months. This was done. With respect to water, not looking to submit to jurisdiction of the California Public Utility Commission ("CPUC"), DeAnza relied on California Public Utilities Code Section 2705.5 ("CPUC Section 2705.5") to determine what rates would be charged for water on an ongoing basis without becoming a public utility. DeAnza and the Company interpreted the statute as providing that in a submetered mobile home park, the property owner is not subject to regulation and control of the CPUC so long as the users are charged what they would be charged by the utility company if users received their water directly from the utility company. In Santa Cruz, customers receiving their water directly from the City's water utility were charged a certain lifeline rate for the first 400 ccfs of water and a greater rate for usage over 400 ccfs of water, a readiness to serve charge of $7.80 per month and tax on the total. In reliance on CPUC Section 2705.5, DeAnza implemented its billings on this schedule notwithstanding that it did not receive the discount for the first 400 ccfs of water because it was a commercial and not a residential customer. A dispute with the residents ensued over the readiness to serve charge and tax thereon. The residents argued that California Civil Code Section 798.41 required that the Property owner could only pass through its actual costs of water (and that the excess charges over the amount of the rent rollback were an improper rent increase) and that CPUC Section 2705.5 was not applicable. DeAnza unbundled the utility charges from rent consistent with California Civil Code Section 798.41 and it has generally been undisputed that the rent rollback was accurately calculated. In August 1994, when the Company acquired the Property, the Company reviewed the respective legal positions of the Santa Cruz Homeowners Association ("HOA") and DeAnza and concurred with DeAnza. Their reliance on CPUC Section 2705.5 made both legal and practical sense in that residents paid only what they would pay if they lived in a residential neighborhood within the City and permitted DeAnza to recoup part of the expenses of operating a submetered system through the readiness to serve charge. Over a period of 18 months from 1993 into May of 1995, a series of complaints were filed by the HOA and Herbert Rossman, a resident, against DeAnza, and later, the Company. DeAnza and the Company demurred to each of these complaints on the grounds that the CPUC had exclusive jurisdiction over the setting of water rates and that residents under rent control had to first exhaust their administrative remedies before proceeding in a civil action. At one point, the case was dismissed (with leave to amend) on the basis that jurisdiction was with the CPUC and, at another point, Mr. Rossman was dismissed from the case because he had not exhausted his administrative remedies. On June 29, 1995, a hearing was held before a City rent control officer on billing and submetering issues related to both water and sewer. The Company and DeAnza prevailed on all issues related to sewer and the rent rollback related to water, but the hearing officer determined that the Company could only pass through its actual cost of water, i.e., a prorated readiness to serve charge and tax thereon. The hearing officer did not deal with the subsidy being given to residents through the quantity charge and ordered a rebate in a fixed amount per resident. The Company and DeAnza requested reconsideration on this issue, among others, which reconsideration was denied by the hearing officer. The Company then took a writ of mandate (an appeal from an administrative order) to the Superior Court and, pending this appeal, the residents, the Company and the City agreed to stay the effect of the hearing officer's decision until the Superior Court rendered judgment. In July 1996, the Superior Court affirmed the hearing officer's decision without addressing concerns about the failure to take the subsidy on the quantity charge into account. The Company requested that the City and the HOA agree to a further stay pending appeal to the court of appeal, but they refused and the appeal court denied the Company's request for a stay in late November 1996. Therefore, on January 1, 1997, the Company reduced its water charges at this Property to reflect a pass-through of only the readiness to serve charge and tax at the master meter (approximately $0.73) and to eliminate the subsidy on the water charges. 10
11 MANUFACTURED HOME COMMUNITIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 8 - COMMITMENTS AND CONTINGENCIES (CONTINUED) On their March 1, 1997 rent billings, residents were credited for amounts previously "overcharged" for readiness to serve charge and tax. The amount of the rebate given by the Company and DeAnza was $36,400. In calculating the rebate, the Company and DeAnza took into account the previous subsidy on water usage although this issue had not yet been decided by the court of appeal. The Company and DeAnza felt legally safe in so doing based on language in the hearing officer's decision that actual costs could be passed through. On March 12, 1997, the Company also filed an application with the CPUC to dedicate the water system at this Property to public use and have the CPUC set cost-based rates for water usage. The Company believed it was obligated to take this action because of its consistent reliance on CPUC Section 2705.5 as a safe harbor from CPUC jurisdiction. That is, when the Company could no longer charge for water as the local serving utility would charge, it was no longer exempt from the CPUC's jurisdiction and control under CPUC Section 2705.5. On March 20, 1997, the court of appeal issued the writ of mandate requested by the Company on the grounds that the hearing officer had improperly calculated the amount of the rebate (meaning the Company had correctly calculated the rent credits), but also ruling that the hearing officer was correct when he found that the readiness to serve charge and tax thereon as charged by DeAnza and the Company were an inappropriate rent increase. The court of appeal further agreed with the Company that the City's hearing officer did not have the authority under California Civil Code Section 798.41 to establish rates that could be charged in the future. Following this decision, the CPUC granted the Company its certificate of convenience and necessity on December 17, 1998 and approved cost-based rates and charges for water that exceed what residents were paying under the Company's reliance on CPUC Section 2705.5. Concurrently, the CPUC also issued an Order Instituting Investigation ("OII") confirming its exclusive jurisdiction over the issue of water rates in a submetered system and commencing an investigation into the confusion and turmoil over billings in submetered properties. Specifically, the OII states: "The Commission has exclusive and primary jurisdiction over the establishment of rates for water and sewer services provided by private entities." Specifically, the CPUC ruling regarding the Company's application stated: "The ultimate question of what fees and charges may or may not be assessed, beyond external supplier pass-through charges, for in-park facilities when a mobile home park does not adhere to the provisions of CPUC Section 2705.5, must be decided by the Commission." After the court of appeal decision, the HOA brought all of its members back into the underlying civil action for the purpose of determining damages, including punitive damages, against the Company. The trial was continued from July 1998 to January 1999 to give the CPUC time to act on the Company's application. Notwithstanding the action taken by the CPUC in issuing the OII in December 1998, the trial court denied the Company's motion to dismiss on jurisdictional grounds and trial commenced before a jury on January 11, 1999. Not only did the trial court not consider the Company's motion to dismiss, the trial court refused to allow evidence of the OII or the Company's CPUC approval to go before the jury. Notwithstanding the Company's strenuous objections, the judge also allowed evidence of the Company's and DeAnza's litigation tactics to be used as evidence of bad faith and oppressive actions (including evidence of the application to the CPUC requesting a $22.00 readiness to serve charge). The Company's motion for a mistrial based upon these evidentiary rulings was denied. On January 22, 1999, the jury returned a verdict awarding $6.0 million of punitive damages against the Company and DeAnza. The Company had previously agreed to indemnify DeAnza on the matter. 11
12 MANUFACTURED HOME COMMUNITIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 8 - COMMITMENTS AND CONTINGENCIES (CONTINUED) The Company has bonded the judgment pending appeal in accordance with California procedural rules, which require a bond equal to 150% of the amount of the judgment. Post-judgment interest will accrue at the statutory rate of 10.0% per annum. On April 19, 1999, the trial court denied all of the Company's and DeAnza's post-trial motions for judgement notwithstanding the verdict, new trial and remittitur. The trial court also awarded $700,000 of attorneys' fees to plaintiffs. The Company has appealed the jury verdict and attorneys' fees award (which also accrues interest at the statutory rate of 10.0% per annum) and the appeal has been fully briefed by both parties. The Company is awaiting scheduling of oral argument on the appeal. In two related appeals, the Company had argued that the trial court's ability to enter an award of attorneys' fees in favor of the HOA and to take certain other actions was preempted by the exercise of exclusive jurisdiction by the CPUC over the issue of how to set rates for water in a submetered mobile home park. During 2000, the California court of appeal rejected the Company's preemption argument with respect to these prior rulings in favor of plaintiffs, one of which had awarded plaintiffs approximately $100,000 of attorneys' fees. The California Supreme Court declined to accept the case for review and the Company paid the judgment, including post-judgment interest thereon, and settled the matter for approximately $200,000 late in 2000. The jury verdict appeal also raises a similar jurisdictional argument as well as several other arguments for reversal or reduction of the punitive damage award or for a new trial. An important distinction between the appellate ruling in 2000 and the preemption issue as it is presented on appeal in the jury verdict case is that the preemption argument rejected was "retroactive" while the preemption issue remaining on appeal is prospective. One of the other arguments raised by the Company in the jury verdict appeal is that punitive damages are not available in a case brought under Section 798.41 of the California Mobilehome Residency Law ("MRL") since the MRL contains its own penalty provisions. Although no assurances can be given, the Company believes the appeal will be successful. Subsequently, in December 2000 the HOA and certain individual residents of the Property filed a complaint in the Superior Court of California, County of Santa Cruz (No. CV 139825) against the Company, certain affiliates of the Company and certain employees of the Company. The new lawsuit seeks damages, including punitive damages, for intentional infliction of emotional distress, unfair business practices, and unlawful retaliation purportedly arising from allegedly retaliatory rent increases which were noticed by the Company to certain residents in September 2000. The Company believes that the residents who received rent increase notices with respect to rent increases above those permitted by the local rent control ordinance were not covered by the ordinance either because they did not comply with the provisions of the ordinance or because they are exempted by state law. On December 29, 2000, the Superior Court of California, County of Santa Cruz enjoined such rent increases. The Company intends to vigorously defend the matter, which is scheduled to go to trial in the fall of 2001. Ellenburg Communities The Company and certain other parties entered into a settlement agreement, which was approved by the court in April 2000. The settlement resolved substantially all of the litigation and appeals involving the Ellenburg Properties, and transactions arising out of the settlement closed on May 22, 2000. In connection with the Ellenburg Acquisition, on September 8, 1999, Ellenburg Fund 20 ("Fund 20") filed a cross complaint in the Ellenburg dissolution proceeding against the Company and certain of its affiliates alleging causes of action for fraud and other claims in connection with the Ellenburg acquisition. The Company subsequently successfully had the cross complaint against the Company and its affiliates dismissed with prejudice by the California Superior Court. However, Fund 20 has appealed. This appeal was not resolved by the Settlement. The Company believes Fund 20's allegations are without merit and will vigorously defend itself. 12
13 MANUFACTURED HOME COMMUNITIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 8 - COMMITMENTS AND CONTINGENCIES (CONTINUED) Candlelight Properties, L.L.C In 1996, 1997 and 1998, the Lending Partnership made loans to Candlelight Properties, L.L.C. ("Borrower") in the aggregate principal amount of $8,050,000 (collectively, the "Loan"). The Loan is secured by a mortgage on Candlelight Village ("Candlelight"), a Property in Columbus, Indiana, and is guaranteed by Ronald E. Farren ("Farren"), the 99% owner of Borrower. Candlelight's rental revenues and operating costs are included with the Company's rental revenues and operating costs for financial reporting purposes. Concurrently with the funding of the Loan, Borrower granted the Operating Partnership the option to acquire Candlelight upon the maturity of the Loan. The Operating Partnership notified Borrower that it was exercising its option to acquire Candlelight in March 1999, and the Loan subsequently matured on May 3, 1999. However, Borrower failed to repay the Loan and refused to convey Candlelight to the Operating Partnership. Borrower filed suit in the Circuit Court of Bartholomew County, Indiana ("Trial Court") on May 5, 1999, seeking declaratory judgment on the validity of the exercise of the option. The Lending Partnership filed suit in the Trial Court the next day, seeking to foreclose its mortgage, and the suits were consolidated (collectively, the "State Court Litigation") by the Trial Court. The Trial Court issued an Order on December 1, 1999, finding, among other things, that the Operating Partnership had validly exercised the option. Both parties filed motions to correct errors in the Order, and on May 15, 2000, the Trial Court issued judgments against Borrower and Farren and in favor of the Operating Partnership in the option case and the Lending Partnership in the foreclosure case. Borrower and Farren appealed both judgments, and the Trial Court stayed the judgments pending such appeals. On May 29, 2001, the Indiana Court of Appeals ("Appellate Court") reversed the judgment in the option case, holding that the Trial Court improperly determined that the Operating Partnership validly exercised its option to purchase Candlelight. Also on May 29, 2001, the Appellate Court reversed the Trial Court's judgment in the foreclosure case and remanded the foreclosure case to the Trial Court "for further proceedings to reach an equitable decision consistent with this opinion". On July 16, 2001, the Appellate Court denied a petition for rehearing filed by the Operating Partnership and the Lending Partnership. The Operating Partnership and the Lending Partnership intend to continue vigorously pursuing this matter. On May 3, 2000, Hanover Group, Inc. ("Hanover") and Farren filed suit against the Company and certain executive and senior officers of the Company in the United States District Court for the Southern District of Indiana, Indianapolis Division. The complaint alleges violations of securities laws and fraud arising from the loan transaction being litigated in the State Court Litigation and seeks damages, including treble damages. The Company believes that the complaint is related to rulings made by the Trial Court and is without merit. The Company has filed a motion for judgment on the pleadings (which has been fully briefed), and will continue to vigorously defend itself and the officers of the Company. On May 24, 2000, Hanover and Farren filed suit against the Operating Partnership in the Superior Court of Marion County, Indiana. The complaint seeks declaratory relief and specific performance with respect to the Operating Partnership's alleged obligation to reconvey to Hanover the Operating Partnership's 1% ownership interest in Borrower. The Company believes that the complaint is related to rulings made by the Trial Court and is without merit. The parties have agreed to a stay in this proceeding pending the outcome of the appeals in the State Court Litigation. The Company is involved in various other legal proceedings arising in the ordinary course of business. Management believes that all proceedings herein described or referred to, taken together, are not expected to have a material adverse impact on the Company. 13
14 MANUFACTURED HOME COMMUNITIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 9 - SUBSEQUENT EVENTS On August 3, 2001, the Company entered into a mortgage financing agreement for $50,000,000. The mortgage bears an interest rate of 6.98% per annum and matures on August 1, 2011. Proceeds from the financing were used to retire mortgages that were maturing and to reduce amounts outstanding on the Company's line of credit. 14
15 MANUFACTURED HOME COMMUNITIES, INC. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The following is a discussion of the interim results of operations, financial condition and liquidity and capital resources of the Company for the quarter and six months ended June 30, 2001 compared to the corresponding periods in 2000. It should be read in conjunction with the Consolidated Financial Statements and Notes thereto included herein and the 2000 Form 10-K. The following discussion may contain certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which reflect management's current views with respect to future events and financial performance. Such forward-looking statements are subject to certain risks and uncertainties, including, but not limited to, the effects of future events on the Company's financial performance, the adverse impact of external factors such as inflation and consumer confidence, and the risks associated with real estate ownership. RESULTS OF OPERATIONS PROPERTY ACQUISITIONS, JOINT VENTURES AND DISPOSITIONS The following chart lists the Properties acquired or sold since January 1, 2000. The Company defines its core manufactured home community portfolio ("Core Portfolio") as manufactured home Properties owned throughout both periods of comparison. Excluded from the Core Portfolio are any Properties acquired or sold during the period and also any recreational vehicle ("RV") Properties which, together, are referred to as the "Non-Core" Properties. PROPERTY TRANSACTION DATE SITES -------- ---------------- ------ TOTAL SITES AS OF JANUARY 1, 2001......................... 54,002 ACQUISITIONS: Golden Lakes.......................................... January 3, 2001 422 Chain O'Lakes......................................... January 3, 2001 308 EXPANSION SITE DEVELOPMENT: Sites added in 2000................................... 108 Sites added in 2001................................... 145 DISPOSITIONS: FFEC-Six (water and wastewater service company)....... February 29, 2000 --- Mesa Regal RV Resort.................................. May 22, 2000 (2,005) Naples Estates........................................ May 22, 2000 (484) Mon Dak............................................... May 22, 2000 (219) Dellwood Estates...................................... February 13, 2001 (136) Briarwood............................................. February 13, 2001 (166) Bonner Springs........................................ February 13, 2001 (211) Carriage Park......................................... February 13, 2001 (143) North Star............................................ February 13, 2001 (219) Quivira Hills......................................... February 13, 2001 (142) Rockwood.............................................. February 13, 2001 (264) ------ TOTAL SITES AS OF JUNE 30, 2001.................................................. 50,996 ====== 15
16 MANUFACTURED HOME COMMUNITIES, INC. RESULTS OF OPERATIONS (CONTINUED) COMPARISON OF THE QUARTER ENDED JUNE 30, 2001 TO THE QUARTER ENDED JUNE 30, 2000 Since December 31, 1999, the gross investment in real estate has decreased from $1,264 million to $1,225 million as of June 30, 2001. The total number of sites owned or controlled has decreased from 54,002 as of December 31, 1999 to 50,996 as of June 30, 2001. The following table summarizes certain financial and statistical data for the Core Portfolio and the Total Portfolio for the quarters ended June 30, 2001 and 2000. CORE PORTFOLIO TOTAL PORTFOLIO ------------------------------------------------ -------------------------------------------- INCREASE/ % INCREASE/ % (dollars in thousands) 2001 2000 (DECREASE) CHANGE 2001 2000 (DECREASE) CHANGE ----------- ----------- ------------ ----------- ----------- ----------- ------------ ------- Base rental income............... $ 48,252 $ 46,088 $ 2,164 4.7% $ 48,770 $ 47,249 $ 1,521 3.2% Utility and other income......... 5,407 4,494 913 20.3% 6,620 6,207 413 6.7% Equity in income of affiliates... --- --- --- --- 654 642 12 1.9% Interest income.................. --- --- --- --- 174 173 1 0.6% ----------- ----------- ------------ ----------- ----------- ----------- ------------ ------- Total revenues.............. 53,659 50,582 3,077 6.1% 56,218 54,271 1,947 3.6% Property operating and maintenance................. 14,455 13,179 1,276 9.7% 15,351 14,411 940 6.5% Real estate taxes................ 4,264 4,208 56 1.3% 4,429 4,363 66 1.5% Property management.............. 2,215 2,064 151 7.3% 2,267 2,171 96 4.4% General and administrative....... --- --- --- --- 1,857 1,834 23 1.3% ----------- ----------- ------------ ----------- ----------- ----------- ------------ ------- Total operating expenses.... 20,934 19,451 1,483 7.6% 23,904 22,779 1,125 4.9% ----------- ----------- ------------ ----------- ----------- ----------- ------------ ------- Income from operations before interest, depreciation and amortization expenses....... 32,725 31,131 1,594 5.1% 32,314 31,492 822 2.6% Interest and related amortization --- --- --- --- 12,905 13,154 (249) (1.9%) Depreciation on corporate assets --- --- --- --- 310 277 33 11.9% Property depreciation and other 7,983 8,017 34 0.4% 8,587 8,567 20 0.2% ----------- ----------- ------------ ----------- ----------- ----------- ------------ ------- Income from operations(1)... 24,742 23,114 1,628 7.0% 10,512 9,494 1,018 10.7% =========== =========== ============ =========== =========== =========== ============ ======= Site and Occupancy Information(2): Average total sites.............. 45,565 45,411 154 0.3% 46,296 47,122 (826) (1.8%) Average occupied sites........... 42,943 42,825 118 0.2% 43,605 44,397 (792) (1.8%) Occupancy %...................... 94.2% 94.3% (0.1%) (0.1%) 94.2% 94.2% 0.0% 0.0% Monthly base rent per site....... $ 374.76 $ 358.73 $ 16.03 4.5% $ 373.03 $ 354.76 $ 18.27 5.1% Total sites as of June 30,.............. 45,596 45,411 185 0.4% 46,296 46,692 (396) (0.8%) Total occupied sites as of June 30,.............. 42,935 42,845 90 0.2% 43,605 44,000 (395) (0.9%) (1) Income from operations for the Core Portfolio does not include an allocation of income from affiliates, interest income, corporate general and administrative expense, interest expense and related amortization or depreciation on corporate assets. (2) Site and occupancy information does not include the five Properties owned through joint ventures or the three RV properties. 16
17 MANUFACTURED HOME COMMUNITIES, INC. RESULTS OF OPERATIONS (CONTINUED) Revenues The 4.7% increase in base rental income for the Core Portfolio reflects a 4.5% increase in monthly base rent per site coupled with a 0.2% increase in average occupied sites. The 3.2% increase in base rental income for the Total Portfolio reflects the increase for the Core Portfolio and the acquisition and disposition of Non-Core Properties. The increase in utility and other income for the Core Portfolio is due primarily to increases in pass through items such as utilities and real estate taxes - which resulted from higher expenses for these items. The increase in utility and other income for the Total Portfolio reflects the increase for the Core Portfolio and the acquisition and disposition of Non-Core Properties. Interest income increased due to higher weighted average outstanding notes receivable balances and lower weighted average interest rates during the period. Short-term investments had average balances for the quarters ended June 30, 2001 and 2000 of approximately $1.5 million and $858,000, respectively, which earned interest income at an effective rate of 3.8% and 5.6% per annum, respectively. Operating Expenses The increase in property operating and maintenance expense for the Core Portfolio is due primarily to increases in utility expenses generally passed through and included in utility income. Expenses for the Core Portfolio also reflect increases in repairs and maintenance expense, payroll and insurance expenses and other expenses. The increase in Core Portfolio real estate taxes is due to higher property assessments on certain Properties. The increase in Total Portfolio property operating and maintenance expense and real estate taxes is also impacted by acquisition and disposition of Non-Core Properties. The increase in property management expense for the Core Portfolio, which reflects costs of managing the Properties and is estimated based on a percentage of Property revenues, is due primarily to management staffing changes. General and administrative expenses decreased primarily due to the timing of payments for certain public company costs and decreased professional fees. Interest and related amortization decreased due to lower weighted average outstanding debt balances and lower weighted average interest rates during the period. The weighted average outstanding debt balances for the quarters ended June 30, 2001 and 2000 were $716.2 million and $727.0 million, respectively. The effective interest rate was 7.15% and 7.36% per annum for the quarters ended June 30, 2001 and 2000, respectively. Depreciation on corporate assets increased slightly due to fixed asset additions related to information and communication systems. Depreciation on real estate assets and other costs increased due primarily to the acquisition of Non-Core Properties. 17
18 MANUFACTURED HOME COMMUNITIES, INC. COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2001 TO THE SIX MONTHS ENDED JUNE 30, 2000 The following table summarizes certain financial and statistical data for the Core Portfolio and the Total Portfolio for the six months ended June 30, 2001 and 2000. CORE PORTFOLIO TOTAL PORTFOLIO ----------------------------------------------- --------------------------------------------- (dollars in thousands) INCREASE/ % INCREASE/ % 2001 2000 (DECREASE) CHANGE 2001 2000 (DECREASE) CHANGE ----------- ----------- ------------ ---------- ----------- ----------- ------------ ------- Base rental income............... $ 96,380 $ 92,045 $ 4,335 4.7% $ 97,783 $ 94,558 $ 3,225 3.4% Utility and other income......... 10,928 9,186 1,742 19.0% 14,902 15,604 (702) (4.5%) Equity in income of affiliates... --- --- --- --- 677 792 (115) (14.5%) Interest income.................. --- --- --- --- 388 464 (76) (16.4%) ----------- ----------- ------------ ---------- ----------- ----------- ------------ -------- Total revenues.............. 107,308 101,231 6,077 6.0% 113,750 111,418 2,332 2.1% Property operating and maintenance................. 29,350 26,746 2,604 9.7% 31,344 29,818 1,526 5.1% Real estate taxes................ 8,691 8,349 342 4.1% 9,031 8,687 344 4.0% Property management.............. 4,342 4,205 137 3.3% 4,514 4,560 (46) (1.0%) General and administrative....... --- --- --- --- 3,513 3,660 (147) (4.0%) ----------- ----------- ------------ ---------- ----------- ----------- ------------ -------- Total operating expenses.... 42,383 39,300 3,083 7.8% 48,402 46,725 1,677 3.6% ----------- ----------- ------------ ---------- ----------- ----------- ------------ -------- Income from operations before interest, depreciation and amortization expenses....... 64,925 61,931 (2,994) 4.8% 65,348 64,693 655 1.0% Interest and related amortization --- --- --- --- 26,311 26,485 (174) (0.7%) Depreciation on corporate assets --- --- --- --- 614 548 66 12.0% Property depreciation and other 17,270 15,896 1,374 8.6% 17,266 17,424 (158) (0.9%) ----------- ----------- ------------ ---------- ----------- ----------- ------------ -------- Income from operations (1).. 47,655 46,035 1,620 3.5% 21,157 20,236 921 4.6% =========== =========== ============ ========== =========== =========== ============ ======== Site and Occupancy Information (2): Average total sites.............. 45,517 45,387 130 0.3% 46,462 47,206 (744) (1.6%) Average occupied sites........... 43,047 42,819 228 0.5% 43,911 44,496 (585) (1.3%) Occupancy %...................... 94.6% 94.3% 0.3% 0.3% 94.5% 94.3% 0.2% 0.2% Monthly base rent per site....... $ 373.27 $ 358.27 $ 15.00 4.2% $ 371.25 $ 354.19 $ 17.06 4.8% (1) Income from operations for the Core Portfolio does not include an allocation of income from affiliates, interest income, corporate general and administrative expense, interest expense and related amortization or depreciation on corporate assets. (2) Site and occupancy information does not include the five Properties owned through joint ventures or the three RV properties. 18
19 MANUFACTURED HOME COMMUNITIES, INC. RESULTS OF OPERATIONS (CONTINUED) Revenues The 4.7% increase in base rental income for the Core Portfolio reflects a 4.2% increase in monthly base rent per site coupled with a 0.5% increase in average occupied sites. The 3.4% increase in base rental income for the Total Portfolio reflects the increase for the Core Portfolio and the acquisition and disposition of Non-Core Properties. The increase in utility and other income for the Core Portfolio is due primarily to increases in pass through items such as utilities and real estate taxes - which resulted from higher expenses for these items. The decrease in utility and other income for the Total Portfolio reflects the disposition of Non-Core Properties partially offset by the increase for the Core Portfolio. Interest income decreased due to lower notes receivable and short-term investments. Short-term investments had average balances for the six months ended June 30, 2001 and 2000 of approximately $1.9 million and $2.5 million, respectively, which earned interest income at an effective rate of 4.8% and 5.6% per annum, respectively. Operating Expenses The increase in property operating and maintenance expense for the Core Portfolio is due primarily to increases in utility expenses generally passed through and included in utility income. Expenses for the Core Portfolio also reflect increases in repairs and maintenance expense, payroll and insurance expenses and other expenses. The increase in Core Portfolio real estate taxes is due to higher property assessments on certain Properties. The increase in Total Portfolio property operating and maintenance expense and real estate taxes is also impacted by acquisition and disposition of Non-Core Properties. Property management expense for the Core Portfolio, which reflects costs of managing the Properties and is estimated based on a percentage of Property revenues, increased. The increase is due primarily to management payroll. General and administrative expenses decreased primarily due to the timing of payments for certain public company costs and decreased professional fees. Interest and related amortization decreased due to lower weighted average interest rates during the period, slightly offset by higher weighted average outstanding debt balances. The weighted average outstanding debt balances for the six months ended June 30, 2001 and 2000 were $720.6 million and $716.4 million, respectively. The effective interest rate was 7.2% and 7.4% per annum for the six months ended June 30, 2001 and 2000, respectively. Depreciation on corporate assets increased slightly due to fixed asset additions related to information and communication systems. Depreciation on real estate assets and other costs increased due primarily to the acquisition of Non-Core Properties. LIQUIDITY AND CAPITAL RESOURCES LIQUIDITY As of June 30, 2001, the Company had $3.4 million in cash and cash equivalents and $94.9 million available on its line of credit. The Company expects to meet its short-term liquidity requirements, including its distributions, generally through its working capital, net cash provided by operating activities and availability under the existing line of credit. The Company expects to meet certain long-term liquidity requirements such as scheduled debt maturities, property acquisitions and capital improvements by long-term collateralized and uncollateralized borrowings including borrowings under its existing line of credit and the issuance of debt securities or additional equity securities in the Company, in addition to working capital. 19
20 MANUFACTURED HOME COMMUNITIES, INC. LIQUIDITY AND CAPITAL RESOURCES (CONTINUED) On April 16, 2001 and July 13, 2001, the Company paid a $.445 per share distribution for the quarters ended March 30, 2001 and June 30, 2001, to stockholders of record on March 30, 2001 and June 29, 2001, respectively. The Operating Partnership paid distributions of 9.0% per annum on the $125 million of Series D Cumulative Redeemable Perpetual Preferred Units ("Preferred Units"). Distributions on the Preferred Units were paid on March 30, 2001 and June 29, 2001. MORTGAGES AND CREDIT FACILITIES During the six months ended June 30, 2001 the Company borrowed $23.0 million on its line of credit and paid down $27.8 million on the line of credit. The line of credit bears interest at a rate of LIBOR plus 1.125%. Certain of the Company's mortgage and credit agreements contain covenants and restrictions including restrictions as to the ratio of secured or unsecured debt versus encumbered or unencumbered assets, the ratio of fixed charges-to-earnings before interest, taxes, depreciation and amortization, limitations on certain holdings and other restrictions. ACQUISITIONS, DISPOSITIONS AND INVESTMENTS On January 3, 2001, the Company acquired two Florida communities, totaling 730 sites, for an aggregate purchase price of approximately $16.3 million. Golden Lakes is a 422-site community in Plant City, near Tampa, Florida and includes approximately 23 acres for expansion. Chain O' Lakes is a 308-site community in Grand Island, near Orlando, Florida, and includes a marina with 50 boat docks. The acquisition was funded with a borrowing under the Company's line of credit. On February 13, 2001, the Company completed the disposition of seven communities, totaling 1,281 sites, in Kansas, Missouri and Oklahoma for a total sale price of approximately $19.1 million. A gain of $8.1 million was recorded in other income on the accompanying consolidated statements of operations. Included in the sales price are proceeds from the sale by Realty Systems, Inc., an affiliate of the Company, of inventory and notes receivable totaling $1.7 million. Proceeds from the sale were used to reduce the amount outstanding on the Company's line of credit. CAPITAL IMPROVEMENTS Capital expenditures for improvements are identified by the Company as recurring capital expenditures ("Recurring CapEx"), site development costs and corporate headquarters costs. Recurring CapEx was approximately $4.3 million for the six months ended June 30, 2001. Site development costs were approximately $4.2 million for the six months ended June 30, 2001, and represent costs to develop expansion sites at certain of the Company's Properties. INFLATION Substantially all of the leases at the Properties allow for monthly or annual rent increases which provide the Company with the opportunity to achieve increases, where justified by the market, as each lease matures. Such types of leases generally minimize the risk of inflation to the Company. 20
21 MANUFACTURED HOME COMMUNITIES, INC. LIQUIDITY AND CAPITAL RESOURCES (CONTINUED) FUNDS FROM OPERATIONS Funds From Operations ("FFO") was redefined by the National Association of Real Estate Investment Trusts ("NAREIT") in October 1999, effective January 1, 2000, as net income (computed in accordance with GAAP), before allocation to minority interests, excluding gains (or losses) from sales of property, plus real estate depreciation and after adjustments for unconsolidated partnerships and joint ventures. The Company computes FFO in accordance with the NAREIT definition, which may differ from the methodology for calculating FFO utilized by other equity REITs and, accordingly, may not be comparable to such other REIT's computations. Funds available for distribution ("FAD") is defined as FFO less non-revenue producing capital expenditures and amortization payments on mortgage loan principal. The Company believes that FFO and FAD are useful to investors as a measure of the performance of an equity REIT because, along with cash flows from operating activities, financing activities and investing activities, they provide investors an understanding of the ability of the Company to incur and service debt and to make capital expenditures. FFO and FAD in and of themselves do not represent cash generated from operating activities in accordance with GAAP and therefore should not be considered an alternative to net income as an indication of the Company's performance or to net cash flows from operating activities as determined by GAAP as a measure of liquidity and are not necessarily indicative of cash available to fund cash needs. The following table presents a calculation of FFO and FAD for the quarters and six months ended June 30, 2001 and 2000 (amounts in thousands): QUARTERS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------ ------------------- 2001 2000 2001 2000 ------- -------- -------- ------- COMPUTATION OF FUNDS FROM OPERATIONS: Income before extraordinary loss on early extinguishment of debt .............................. $ 6,135 $ 14,962 $ 18,778 $ 21,292 Income allocated to Common OP Units ................. 1,564 3,772 4,846 5,371 Depreciation on real estate assets and other costs .. 8,587 8,567 17,266 17,424 Gain on sale of property and other .................. -- (12,053) (8,093) (12,053) -------- -------- -------- -------- Funds from operations ............................ $ 16,286 $ 15,248 $ 32,797 $ 32,034 ======== ======== ======== ======== Weighted average Common Stock outstanding - diluted . 26,898 27,809 26,835 28,024 ======== ======== ======== ======== COMPUTATION OF FUNDS AVAILABLE FOR DISTRIBUTION: Funds from operations ............................... $ 16,286 $ 15,248 $ 32,798 $ 32,034 Non-revenue producing improvements to real estate ... (3,290) (2,031) (4,286) (2,732) -------- -------- -------- -------- Funds available for distribution ................. $ 12,996 $ 13,217 $ 28,512 $ 29,302 ======== ======== ======== ======== Weighted average Common Stock outstanding - diluted . 26,898 27,809 26,835 28,024 ======== ======== ======== ======== 21
22 MANUFACTURED HOME COMMUNITIES, INC. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's earnings are affected by changes in interest rates, as a portion of the Company's outstanding indebtedness is at variable rates based on LIBOR. The Company's $150 million line of credit ($55.1 million outstanding at June 30, 2001) bears interest at LIBOR plus 1.125% and the Company's $100 million Term Loan bears interest at LIBOR plus 1.0%. If LIBOR increased/decreased by 1.0% during the quarter ended June 30, 2001, interest expense for the quarter would have increased/decreased by approximately $394,000 based on the combined average balance outstanding under the Company's line of credit and Term Loan during the period. In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement No. 133 ("SFAS No. 133"), "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133 permits early adoption as of the beginning of any fiscal quarter after its issuance. In June 1999, the FASB issued Statement No. 137 which deferred the effective date of SFAS No. 133 to all fiscal quarters for fiscal years beginning after June 15, 2000. The Company adopted SFAS No. 133 on January 1, 2001. SFAS No. 133 requires the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The Company has determined that SFAS No. 133 currently has no significant effect on the earnings and financial position of the Company. 22
23 MANUFACTURED HOME COMMUNITIES, INC. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS (see Note 8 of the Consolidated Financial Statements contained herein) ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits: None. (b) Reports on Form 8-K: None. 23
24 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. MANUFACTURED HOME COMMUNITIES, INC. BY: /s/ John M. Zoeller ------------------------------------- John M. Zoeller Vice President, Treasurer and Chief Financial Officer BY: /s/ Mark Howell ------------------------------------- Mark Howell Principal Accounting Officer and Assistant Treasurer DATE: August 10, 2001 24