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 MARCH 31, 2003 [ ] 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 of incorporation or organization) (I.R.S. Employer Identification No.) 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 ( ) Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). 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: 22,282,683 shares of Common Stock as of May 8, 2003.
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 March 31, 2003 (unaudited) and December 31, 2002.........................3 Consolidated Statements of Operations for the quarters ended March 31, 2003 and 2002 (unaudited)...........4 Consolidated Statements of Cash Flows for the quarters ended March 31, 2003 and 2002 (unaudited)...........6 Notes to Consolidated Financial Statements.................................................................7 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........................................................................15 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.........................................23 PART II - OTHER INFORMATION ITEM 1. Legal Proceedings..................................................................................23 ITEM 6. Exhibits and Reports on Form 8-K...................................................................23 2
MANUFACTURED HOME COMMUNITIES, INC. CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 2003 AND DECEMBER 31, 2002 (AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA) MARCH 31, DECEMBER 31, 2003 2002 (UNAUDITED) ----------- ------------ ASSETS Investment in real estate: Land ............................................................. $ 284,219 $ 284,219 Land improvements ................................................ 898,361 893,839 Buildings and other depreciable property ......................... 118,004 117,949 ----------- ----------- 1,300,584 1,296,007 Accumulated depreciation ......................................... (247,241) (238,098) ----------- ----------- Net investment in real estate .................................. 1,053,343 1,057,909 Cash and cash equivalents ........................................... 12,745 7,270 Notes receivable .................................................... 10,732 10,044 Investment in joint ventures ........................................ 19,686 19,634 Rents receivable, net ............................................... 1,730 1,735 Deferred financing costs, net ....................................... 5,267 5,030 Inventory ........................................................... 35,625 33,638 Prepaid expenses and other assets ................................... 28,185 27,590 ----------- ----------- Total assets ..................................................... $ 1,167,313 $ 1,162,850 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Mortgage notes payable ........................................... $ 574,140 $ 575,370 Unsecured term loan .............................................. 100,000 100,000 Unsecured line of credit ......................................... 86,750 84,750 Other notes payable .............................................. 113 113 Accounts payable and accrued expenses ............................ 31,494 31,010 Accrued interest payable ......................................... 6,355 6,415 Rents received in advance and security deposits .................. 8,478 5,966 Distributions payable ............................................ 13,716 13,106 ----------- ----------- Total liabilities .............................................. 821,046 816,730 ----------- ----------- Commitments and contingencies Minority interest -- Common OP Units and other ...................... 43,229 43,501 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; 22,228,183 and 22,093,240 shares issued and outstanding for 2003 and 2002, respectively... 218 218 Paid-in capital .................................................. 258,161 256,394 Deferred compensation ............................................ (2,516) (3,069) Employee notes ................................................... (1,434) (2,713) Distributions in excess of accumulated earnings .................. (72,044) (68,713) Accumulated other comprehensive income (loss) .................... (4,347) (4,498) ----------- ----------- Total stockholders' equity ..................................... 178,038 177,619 ----------- ----------- Total liabilities and stockholders' equity ....................... $ 1,167,313 $ 1,162,850 =========== =========== The accompanying notes are an integral part of the financial statements. 3
MANUFACTURED HOME COMMUNITIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE QUARTERS ENDED MARCH 31, 2003 AND 2002 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED) MARCH 31, MARCH 31, 2003 2002 ---------- ---------- PROPERTY OPERATIONS: Community base rental income ........................ $ 50,167 $ 49,986 Resort base rental income ........................... 4,077 2,437 Utility and other income ............................ 5,338 5,242 -------- -------- Property operating revenues ..................... 59,582 57,665 Property operating and maintenance .................. 16,937 16,057 Real estate taxes ................................... 4,752 4,577 Property management ................................. 2,352 2,407 -------- -------- Property operating expenses ..................... 24,041 23,041 -------- -------- Income from property operations ................. 35,541 34,624 HOME SALES OPERATIONS: Gross revenues from inventory home sales ............ 4,115 4,726 Cost of inventory home sales ........................ (3,470) (3,735) -------- -------- Gross profit from inventory home sales .......... 645 991 Brokered resale revenues, net ....................... 376 431 Home selling expenses ............................... (1,894) (2,118) Ancillary services revenues, net .................... 482 557 -------- -------- Income (loss) from home sales and other ......... (391) (139) OTHER INCOME AND EXPENSES: Interest income ..................................... 261 264 Income from unconsolidated joint ventures ........... 589 375 General and administrative .......................... (1,932) (1,880) Interest and related amortization ................... (12,393) (12,550) Depreciation on corporate assets .................... (310) (326) Depreciation on real estate assets and other costs... (9,033) (8,940) -------- -------- Total other income and expenses ................. (22,818) (23,057) -------- -------- Income before allocation to Minority Interests... 12,332 11,428 MINORITY INTERESTS: (Income) allocated to Common OP Units ............... (1,847) (1,714) (Income) allocated to Perpetual Preferred OP Units... (2,813) (2,813) -------- -------- Income from continuing operations ............... 7,672 6,901 DISCONTINUED OPERATIONS: Income from discontinued operations ............. -- 214 -------- -------- NET INCOME AVAILABLE FOR COMMON SHARES ........ $ 7,672 $ 7,115 ======== ======== The accompanying notes are an integral part of the financial statements. 4
MANUFACTURED HOME COMMUNITIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED) FOR THE QUARTERS ENDED MARCH 31, 2003 AND 2002 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED) MARCH 31, MARCH 31, 2003 2002 ------------ ------------ EARNINGS PER COMMON SHARE - BASIC: Income from continuing operations ............................ $ .35 $ .32 Income from discontinued operations .......................... -- .01 ------------ ------------ Net income available for Common Shares ....................... $ .35 $ .33 ============ ============ EARNINGS PER COMMON SHARE - FULLY DILUTED: Income from continuing operations ............................ $ .34 $ .31 Income from discontinued operations .......................... -- .01 ------------ ------------ Net income available for Common Shares ....................... $ .34 $ .32 ============ ============ ============ ============ Distributions declared per Common Share outstanding .......... $ .495 $ .475 ============ ============ Weighted average Common Shares outstanding -- basic .......... 21,918 21,433 ============ ============ Weighted average Common Shares outstanding -- fully diluted... 27,740 27,508 ============ ============ The accompanying notes are an integral part of the financial statements. 5
MANUFACTURED HOME COMMUNITIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE QUARTERS ENDED MARCH 31, 2003 AND 2002 (AMOUNTS IN THOUSANDS) (UNAUDITED) MARCH 31, MARCH 31, 2003 2002 ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income ........................................................ $ 7,672 $ 7,115 Adjustments to reconcile net income to cash provided by operating activities: Income allocated to Minority Interests ........................ 4,660 4,580 Depreciation and amortization expense ......................... 9,567 9,247 Equity in income of unconsolidated joint ventures ............. (584) (353) Amortization of deferred compensation and other ............... 1,271 741 Decrease in provision for uncollectible rents receivable ...... 157 154 Changes in assets and liabilities: Increase in rents receivable .................................. (152) (385) Increase in inventory ......................................... (1,987) (462) (Increase) decrease in prepaid expenses and other assets ...... (595) 1,585 Increase in accounts payable and accrued expenses ............. 575 246 Increase in rents received in advance and security deposits.... 2,512 3,733 -------- -------- Net cash provided by operating activities ......................... 23,096 26,201 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of rental properties .................................. -- (7,325) Distributions from joint ventures ................................. 341 167 Purchase of RSI ................................................... -- (674) Cash received in acquisition of RSI ............................... -- 2,374 Funding of notes receivable ....................................... (688) (855) Improvements: Improvements -- corporate ..................................... (78) (222) Improvements -- rental properties ............................. (3,017) (2,376) Site development costs ........................................ (1,491) (4,339) -------- -------- Net cash used in investing activities ............................. (4,933) (13,250) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds from stock options and employee stock purchase plan... 1,620 1,948 Distributions to Common Stockholders, Common OP Unitholders and Perpetual Preferred OP Unitholders ............................ (15,896) (14,851) Collection of principal payments on employee notes ................ 1,279 60 Line of credit: Proceeds ...................................................... 15,000 11,000 Repayments .................................................... (13,000) (2,000) Principal payments ................................................ (1,230) (3,043) Debt issuance costs ............................................... (461) (438) -------- -------- Net cash used in financing activities ............................. (12,688) (7,324) -------- -------- Net increase in cash and cash equivalents .............................. 5,475 5,627 Cash and cash equivalents, beginning of period ......................... 7,270 1,354 -------- -------- Cash and cash equivalents, end of period ............................... $ 12,745 $ 6,981 ======== ======== SUPPLEMENTAL INFORMATION: Cash paid during the period for interest ............................... $ 12,275 $ 11,928 ======== ======== The accompanying notes are an integral part of the financial statements. 6
MANUFACTURED HOME COMMUNITIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DEFINITION OF TERMS: Manufactured Home Communities, Inc., together with MHC Operating Limited Partnership (the "Operating Partnership") and other consolidated subsidiaries ("Subsidiaries"), are referred to herein as the "Company", "MHC", "we", "us", and "our". Capitalized terms used but not defined herein are as defined in the Company's Annual Report on Form 10-K (the "2002 Form 10-K") for the year ended December 31, 2002. PRESENTATION: These unaudited Consolidated Financial Statements of MHC, a Maryland corporation, 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 2002 Form 10-K. The following Notes to Consolidated Financial Statements highlight significant changes to the Notes included in the 2002 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. (a) Basis of Consolidation The Company consolidates its majority owed subsidiaries in which it has the ability to control the operations of the subsidiaries. The Company does not consolidate entities it does not have sole control of the major decisions. All inter-company transactions have been eliminated in consolidation. The Company's acquisitions were all accounted for as purchases in accordance with Accounting Principles Board Opinion No. 16 "Business Combinations" for those transactions initiated before June 30, 2001 and in accordance with Statement of Financial Accounting Standards No. 141 "Business Combinations" for those transactions completed after June 30, 2001. In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities. The 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 consolidation requirements of Interpretation 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. The Company will adopt FIN 46 in the third quarter of 2003. We have not yet determined the effect the adoption of the Interpretation will have on the Company. (b) Segments We manage all our 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. The distribution of the Properties throughout the United States reflects our belief that geographic diversification helps insulate the portfolio from regional economic influences. We intend to target new acquisitions in or near markets where the Properties are located and will also consider acquisitions of properties outside such markets. 7
MANUFACTURED HOME COMMUNITIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) (c) Inventory Inventory consists of new and used manufactured homes, is stated at the lower of cost or market and is net of a valuation allowance calculated after consideration of the NADA (National Automobile Dealers Association) Manufactured Housing Appraisal Guide. Inventory sales revenues and resale revenues are recognized when the home sale is closed. Resale revenues are stated net of commissions paid to employees of $56,000 for the quarter ended March 31, 2003. (d) Notes Receivable Notes receivable generally are stated at their outstanding unpaid principal balances net of any deferred fees or costs on originated loans, or unamortized discounts or premiums net of a valuation allowance. Interest income is accrued on the unpaid principal balance. Discounts or premiums are amortized to income using the interest method. In certain cases we finance the sale of homes to our residents (referred to as "Chattel Loans") which are secured by the homes. The valuation allowance for the Chattel Loans is calculated based a comparison of the outstanding principal balance of each note compared to the N.A.D.A. value of the underlying manufactured home collateral. (e) Real Estate Real estate is recorded at cost less accumulated depreciation. Depreciation is computed on the straight-line basis over the estimated useful lives of the assets. We use a 30-year estimated life for buildings acquired and structural and land improvements, a ten-to-fifteen-year estimated life for building upgrades and a three-to-seven-year estimated life for furniture, fixtures and equipment. Expenditures for ordinary maintenance and repairs are expensed to operations as incurred and significant renovations and improvements that improve the asset and extend the useful life of the asset are capitalized and then expensed over their estimated useful life. Our estimates of useful lives, salvage value, and depreciation method used are proscribed by various generally accepted accounting principles ("GAAP") literature. In addition, the Financial Accounting Standards Board ("FASB") is currently reviewing the methods of depreciation and cost capitalization for all industries and in June 2001 issued FASB Exposure Draft, "Accounting in Interim and Annual Financial Statements for Certain Costs and Activities Related to Property, Plant and Equipment", the implementation of which, if issued, could also have a material effect on the Company's results of operations. Certain costs, primarily legal costs, relative to our efforts to effectively change the use and operations of several Properties subject to rent control (see Note 9) are currently classified 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. For the three months ended March 31, 2003, we have capitalized $785,000 of these costs. To the extent these efforts are not successful, these costs will be expensed. In addition, we capitalize certain costs, primarily legal costs, related to entering into lease agreements which govern the terms under which we may enter into leases with individual tenants and which are expensed over the term of the lease agreement. 8
MANUFACTURED HOME COMMUNITIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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. The following table sets forth the computation of basic and diluted earnings per share for the quarters ended March 31, 2003 and 2002 (amounts in thousands): MARCH 31, MARCH 31, 2003 2002 ------------ ------------ NUMERATORS: NET INCOME FROM OPERATIONS: Net income from operations -- basic............................... $ 7,672 $ 6,901 Amounts allocated to dilutive securities.......................... 1,847 1,714 ------------ ------------ Net income from operations -- fully diluted....................... $ 9,519 $ 8,615 ============ ============ NET INCOME FROM DISCONTINUED OPERATIONS: Net income from discontinued operations -- basic.................. $ --- $ 214 Amounts allocated to dilutive securities.......................... --- 53 ------------ ------------ Net income from discontinued operations -- fully diluted.......... $ --- $ 267 ============ ============ EARNINGS PER COMMON SHARE- FULLY DILUTED: Net income available for Common Shares -- basic................... $ 7,672 $ 7,115 Amounts allocated to dilutive securities.......................... 1,847 1,714 ------------ ------------ Net income available for Common Shares -- fully diluted........... $ 9,519 $ 8,829 ============ ============ DENOMINATOR: Weighted average Common Shares outstanding -- basic................... 21,918 21,433 Effect of dilutive securities: Weighted average Common OP Units.................................. 5,358 5,423 Employee stock options............................................ 464 652 ------------ ------------ Weighted average Common Shares outstanding -- fully diluted........... 27,740 27,508 ============ ============ NOTE 3 - COMMON STOCK AND RELATED TRANSACTIONS On April 11, 2003, the Company paid a $.495 per share distribution for the quarter ended March 31, 2003 to stockholders of record on March 28, 2003. NOTE 4 - INVESTMENT IN REAL ESTATE 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. 9
MANUFACTURED HOME COMMUNITIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 - NOTES RECEIVABLE As of March 31, 2003 and December 31, 2002, the Company had approximately $10.7 million and $10.0 million in notes receivable, respectively. The Company has approximately $1.6 million in notes which bear interest at a per annum 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 certain joint ventures. The Company has approximately $9.1 million in Chattel Loans receivable, which yield interest at a per annum average rate of approximately 9.0%, have an average term and amortization of 5 to 15 years, require monthly principal and interest payments and are collateralized by manufactured homes at certain of the Properties. NOTE 6 - INVESTMENT IN JOINT VENTURES The Company recorded approximately $584,000 and $353,000 of net income from joint ventures in the quarters ended March 31, 2003 and 2002, respectively, and received approximately $341,000 and $167,000 in distributions for the quarters ended March 31, 2003 and 2002, respectively. Due to the Company's inability to control the joint ventures, the Company accounts for its investment in the joint ventures using the equity method of accounting. The following table summarizes the Company's investments in unconsolidated joint ventures: NUMBER OF ECONOMIC INVESTMENT AS OF PROPERTY LOCATION SITES INTEREST (a) MAR 31, 2003 DEC 31, 2002 - ------------------------ ------------------ ------------- --------------- ----------------------------------------- (in thousands) Trails West Tucson, AZ 503 50% $ 1,927 $ 1,917 Plantation Calimesa, CA 385 50% 2,859 2,861 Manatee Bradenton, FL 290 90% 600 631 Home Hallandale, FL 136 90% 1,065 1,092 Villa del Sol Sarasota, FL 207 90% 712 726 Voyager RV Resort Tucson, AZ --- 25% 4,579 4,463 Preferred Interests in College Heights --- 17% 7,944 7,944 ------------- ------------------ ---------------- 1,521 $ 19,686 $ 19,634 ================== ================ (a) The percentages shown approximate the Company's economic interest. The Company's legal interest may differ. NOTE 7 - LONG-TERM BORROWINGS As of March 31, 2003 and December 31, 2002, the Company had outstanding mortgage indebtedness of approximately $574.1 million and $575.4 million, respectively, encumbering 66 of the Company's Properties. As of March 31, 2003 and December 31, 2002, the carrying value of such Properties was approximately $720 million and $720 million, respectively. The outstanding mortgage indebtedness consists of: o A $265.0 million mortgage note (the "$265 Million Mortgage") collateralized by 28 Properties beneficially owned by MHC Financing Limited Partnership. The $265 Million Mortgage has a maturity date of January 2, 2028 and pays 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 (net of accumulated amortization of $2.7 million which is being amortized into interest expense over the life of the loan. 10
MANUFACTURED HOME COMMUNITIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 7 - LONG-TERM BORROWINGS (CONTINUED) o A $92.1 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. o A $49.3 million mortgage note (the "Stagecoach Mortgage") collateralized by 7 Properties beneficially owed by MHC Stagecoach L.L.C. The Stagecoach Mortgage bears interest at a rate of 6.98% per annum, amortizes beginning September 1, 2001 over 10 years and matures September 1, 2011. o A $21.9 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. On April 17, 2003, we entered into an agreement which increased the Bay Indies Mortgage to $45 million. Under the new agreement, the Bay Indies Mortgage bears interest at 5.69% per annum, amortizes over 25 years and matures April 17, 2013. o A $15.4 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% per annum, amortizes beginning August 1, 2000 over 30 years and matures July 1, 2010. o Approximately $130.4 million of mortgage debt on 24 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 6.5% to 9.3% per annum. Included in this debt, the Company has a $2.4 million loan recorded to account for a direct financing lease entered into in May 1997. We have an unsecured line of credit with a group of banks (the "Line of Credit") with a total facility of $150 million, bearing interest at the London Interbank Offered Rate ("LIBOR") plus 1.125%. The Line of Credit matures on August 9, 2003 with two one-year extension options with which we may extend the maturity through August 9, 2005. We pay a quarterly fee on the average unused amount of such credit equal to 0.15% of such amount. As of March 31, 2003, $63.2 million was available under the Line of Credit. We have 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 1.375%. The Term Loan matures on August 9, 2003 with two one-year extension options with which we may extend the maturity through August 9, 2005. On October 29, 2001, we entered into an interest rate swap agreement (the "2001 Swap"), effectively fixing the LIBOR rate on $100 million of our floating rate debt at approximately 3.7% per annum for the period October 2001 through August 2004. The terms of the 2001 Swap require monthly settlements on the same dates interest payments are due on the debt. Effective January 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133") and its amendments, SFAS No. 137 and SFAS No. 138. In accordance with SFAS No. 133, the interest rate swap will be reflected at market value. We believe the 2001 Swap is a perfectly effective cash flow hedge, under SFAS No. 133, and there will be no effect on net income as a result of the mark-to-market adjustment. As of March 31, 2003, the hedge represented a liability of approximately $4.3 million and is recorded in accounts payable and accrued expenses. Mark-to-market changes in the value of the 2001 Swap are included in other comprehensive income. 11
MANUFACTURED HOME COMMUNITIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 8 - STOCK-BASED COMPENSATION Prior to 2003 we had chosen to account for our stock compensation in accordance with APB No. 25, "Accounting for Stock Issued to Employees", based upon the intrinsic value method. This method results in no compensation expense for options issued with an exercise price equal to or exceeding the market value of the Common Shares on the date of grant. Effective January 1, 2003, we elected to account for our stock-based compensation in accordance with SFAS No. 123 and its amendment (SFAS No. 148), "Accounting for Stock Based Compensation", which will result in compensation expense being recorded based on the fair value of the stock option compensation issued. SFAS 148 provides three possible transition methods for changing to the fair value method. We have elected to use the modified-prospective method. This method requires that we recognize stock-based employee compensation cost from the beginning of the fiscal year in which the recognition provisions are first applied as if the fair value method had been used to account for all employee awards granted, or settled in fiscal years beginning after December 15, 1994. The following table illustrates the effect on net income and earnings per share as if the fair value method was applied to all outstanding and unvested awards in each period presented: MARCH 31, MARCH 31, 2003 2002 ------------ ------------ Net income available for Common Shares as reported............................... $ 7,672 $ 7,115 Add: Stock-based compensation expense included in net income as reported..... 476 684 Deduct: Stock-based compensation expense determined under the fair value based method for all awards............ (476) (616) ------------ ------------ Pro forma net income available for Common Shares................................. $ 7,672 $ 7,183 ============ ============ Pro forma net income per Common Share - Basic.................................. $ .35 $ .34 ============ ============ Pro forma net income per Common Share -- Fully Diluted.......................... $ .34 $ .32 ============ ============ Pursuant to the Stock Option Plan as discussed in Note 14 to the 2002 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 quarter ended March 31, 2003, Options for 64,802 shares of common stock were exercised. 12
MANUFACTURED HOME COMMUNITIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 9 - COMMITMENTS AND CONTINGENCIES DEANZA SANTA CRUZ MOBILE ESTATES The residents of DeAnza Santa Cruz Mobile Estates, a property located in Santa Cruz, California, brought several actions opposing fees and charges in connection with water service at the property. As a result of one action, the Company rebated approximately $36,000 to the residents. The DeAnza Santa Cruz Homeowners Association ("HOA") then proceeded to a jury trial alleging these "overcharges" entitled them to an award of punitive damages. In January 1999, a jury awarded the HOA $6.0 million in punitive damages. On December 21, 2001 the California Court of Appeal for the Sixth District reversed the $6.0 million punitive damage award, the related award of attorneys' fees, and, as a result, all post-judgment interest thereon, on the basis that punitive damages are not available as a remedy for a statutory violation of the California Mobilehome Residency Law ("MRL"). The decision of the appellate court left the HOA, the plaintiff in this matter, with the right to seek a new trial in which it must prove its entitlement to either the statutory penalty and attorneys' fees available under the MRL or punitive damages based on causes of action for fraud, misrepresentation or other tort. In order to resolve this matter, the Company accrued for and agreed to pay $201,000 to the HOA. This payment resolves the punitive damage claim. The HOA's attorney has made a motion asking for an award of attorneys' fees and costs in the amount of approximately $1.5 million as a result of this resolution of the litigation. On April 2, 2003 the court awarded attorney's fees to the HOA's attorney in the amount of $593,000 and court costs of approximately $20,000. The Company intends to appeal the award. OTHER CALIFORNIA RENT CONTROL LITIGATION As part of the Company's effort to realize the value of its Properties subject to rent control, the Company has initiated lawsuits against several municipalities in California. The Company's goal is to achieve a level of regulatory fairness in California's rent control jurisdictions, and in particular those jurisdictions that prohibit increasing rents to market upon turnover. This regulatory feature, called vacancy control, allows tenants to sell their homes for a premium representing the value of the future discounted rent-controlled rents. In the Company's view, such regulation results in a transfer of the value of the Company's shareholders' land, which would otherwise be reflected in market rents, to tenants upon the sales of their homes in the form of an inflated purchase price that cannot be attributed to the value of the home being sold. As a result, in the Company's view, the Company loses the value of its asset and the selling tenant leaves the community with a windfall premium. The Company has discovered through the litigation process that certain municipalities considered condemning the Company's communities at values well below the value of the underlying land. In the Company's view, a failure to articulate market rents for sites governed by restrictive rent control would put the Company at risk for condemnation or eminent domain proceedings based on artificially reduced rents. Such a physical taking, should it occur, could represent substantial lost value to shareholders. The Company is cognizant of the need for affordable housing in the jurisdictions, but asserts that restrictive rent regulation with vacancy control does not promote this purpose because the benefits of such regulation are fully capitalized into the prices of the homes sold. The Company estimates that the annual rent subsidy to tenants in these jurisdictions is approximately $15 million. In a more well-balanced regulatory environment, the Company would receive market rents that would eliminate the subsidy and homes would trade at or near their intrinsic value. 13
MANUFACTURED HOME COMMUNITIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 9 - COMMITMENTS AND CONTINGENCIES (CONTINUED) OTHER CALIFORNIA RENT CONTROL LITIGATION (CONTINUED) The Company's efforts to achieve a balanced regulatory environment incentivize tenant groups to file lawsuits against the Company seeking large damage awards. The homeowners association at Contempo Marin ("CMHOA"), a 396 site property in San Rafael, California, sued the Company in December 2000 over a prior settlement agreement on a capital pass-through after the Company sued the City of San Rafael in October 2000 alleging its rent control ordinance is unconstitutional. In the Contempo Marin case, the CMHOA prevailed on a motion for summary judgment on an issue that permits the Company to collect only $3.72 out of a pass-through amount of $7.50 that the Company believes had been agreed to by the CMHOA in a settlement agreement. The Company intends to vigorously defend the matter. The Company believes that such lawsuits will be a consequence of the Company's efforts to change rent control since tenant groups actively desire to preserve the premium value of their homes in addition to the discounted rents provided by rent control. The Company has determined that its efforts to rebalance the regulatory environment despite the risk of litigation from tenant groups are necessary not only because of the $15 million annual subsidy to tenants, but also because of the condemnation risk. ELLENBURG COMMUNITIES The Company and certain other parties entered into a settlement agreement (the "Settlement"), which was approved by the Los Angeles County Superior 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. Only the appeal of one entity remains, the outcome of which is not expected to materially affect the Company. 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 appealed. Although this appeal was one not resolved by the Settlement, the California Court of Appeal dismissed Fund 20's substantive appeals on March 13, 2003 as moot. Fund 20 has petitioned the California Supreme Court to review this decision. In October 2001, Fund 20 sued the Company and certain of its affiliates again, this time in Alameda County, California making substantially the same allegations. The Company obtained an injunction preventing the case from proceeding until the Fund 20 appeal is decided and other related proceedings in Arizona (from which the Company has already been dismissed with prejudice) are concluded. When the March 13, 2003 Court of Appeal dismissal becomes final, the Company will seek to have the Alameda County action dismissed if Fund 20 will not voluntarily dismiss this action. The Company believes Fund 20's allegations are without merit and will vigorously defend itself. COUNTRYSIDE AT VERO BEACH The Company has received letters dated June 17, 2002 and August 26, 2002 from Indian River County ("County"), claiming that the Company currently owes sewer impact fees in the amount of approximately $518,000 with respect to the Property known as Countryside at Vero Beach, located in Vero Beach, Florida, purportedly under the terms of an agreement between the County and a prior owner of the Property. In response, the Company has advised the County that these fees are no longer due and owing as a result of a 1996 settlement agreement between the County and the prior owner of the Property, providing for the payment of $150,000 to the County to discharge any further obligation for the payment of impact or connection fees for sewer service at the Property. The Company paid this settlement amount (with interest) to the County in connection with the Company's acquisition of the Property. Accordingly, the Company believes that the County's claims are without merit. 14
MANUFACTURED HOME COMMUNITIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 9 - COMMITMENTS AND CONTINGENCIES (CONTINUED) DELAWARE DECLARATORY JUDGMENT ACTION In April 2002, the Company entered into a Stipulation and Consent Order to Cease and Desist (the "Consent Order") with the State of Delaware (the "State"). The Consent Order resolved various issues raised by the State concerning the terms of a new lease form used or proposed for use by the Company at certain of its Properties in Delaware. Among other provisions, the Consent Order contemplated that the Company would work with the State to develop and implement a new lease form for use in Delaware. The Consent Order expressly provided that nothing contained therein would preclude the Company from seeking declaratory relief from a court as to the legality or enforceability of any provisions which the Company might wish to incorporate in future leases. Throughout the summer of 2002, the Company's Delaware legal counsel engaged in dialogue with representatives of the State concerning various matters, including the lease provisions to which the State had objected but which the Company wished to incorporate in future leases. Through this process, it became apparent that the parties could not reach agreement as to the legality or enforceability of the proposed lease provisions, and that the Company would need to seek declaratory relief from a court in order to resolve the matter, as contemplated by the Consent Order. Accordingly, on August 29, 2002, the Company filed a Petition for Declaratory Judgment and Other Relief (as amended, the "Petition") in Sussex County, Delaware Superior Court (the "Court"). In response to the filing of the Petition, on October 1, 2002, the State filed its Answer to Petition for Declaratory and Other Relief, and Counterclaims for Civil Enforcement and Contempt (as amended, "Answer and Counterclaim") with the Court. In the Answer and Counterclaim, the State seeks, inter alia, restitution, statutory penalties, investigative costs and attorneys' fees under the Delaware Mobile Home Lots and Leases Act, the Consumer Fraud Act, the Uniform Deceptive Trade Practices Act and the Delaware Consumer Contracts law, and separately seeks a finding of contempt and related contempt penalties for alleged violations of the Consent Order. The Company filed a Motion to Dismiss Respondents' Counterclaims with the Court on October 29, 2002, and the State filed a Motion for Summary Judgment with the Court on November 15, 2002. These motions have been fully briefed. On December 30, 2002, the Company filed a First Amended Petition for Declaratory Judgment and Other Relief with the Court, and on January 31, 2003, the State filed an Amended Answer and Counterclaim with the Court. The Company believes that it has complied, and continues to comply, with the Consent Order, and that the filing of the Petition was expressly contemplated by the Consent Order. The Company believes that the State's allegations in the Answer and Counterclaim are without merit and will vigorously defend itself. OTHER 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. 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 three months ended March 31, 2003 compared to the corresponding period in 2002. It should be read in conjunction with the Consolidated Financial Statements and Notes thereto included herein and the 2002 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, 2002. 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 resorts ("Resorts") which, together, are referred to as the "Non-Core" Properties. PROPERTY TRANSACTION DATE SITES -------- ---------------- ----- TOTAL SITES AS OF JANUARY 1, 2002.......................... 50,663 ACQUISITIONS: Mt. Hood Village...................................... March 12, 2002 450 Harbor View........................................... July 10, 2002 471 Countryside........................................... July 31, 2002 560 Golden Sun............................................ July 31, 2002 329 Breezy Hill........................................... July 31, 2002 762 Highland Woods........................................ August 14, 2002 148 Holiday Village....................................... July 31, 2002 301 Tropic Winds.......................................... August 7, 2002 531 Silk Oak Lodge........................................ October 1, 2002 180 Hacienda Village...................................... December 18, 2002 519 Glen Ellen............................................ December 31, 2002 117 EXPANSION SITE DEVELOPMENT AND OTHER: Sites added or reconfigured in 2002................... 90 Sites added or reconfigured in 2003................... (45) DISPOSITIONS: College Heights (17 properties)....................... September 1, 2002 (3,220) Camelot Acres......................................... November 13, 2002 (319) ----------- TOTAL SITES AS OF MARCH 31, 2003................................................. 51,537 =========== 16
MANUFACTURED HOME COMMUNITIES, INC. RESULTS OF OPERATIONS (CONTINUED) TRENDS Occupancy in our Properties as well as our ability to increase rental rates directly affect revenues. In 2003, occupancy in our Core Portfolio decreased 1.6%. Also during 2003, average monthly base rental rates for the Core Portfolio increased approximately 5.3%. We project continued growth during the remainder of 2003 in our Core Portfolio performance. Core Portfolio base rental-rate growth is expected to be approximately 5 percent. Assuming current economic conditions continue to impact occupancies, overall revenue growth will be approximately 3 percent. Core Portfolio operating expenses are expected to grow in excess of CPI due to continued increases in insurance, real estate taxes and utility expenses. These projections would result in growth of approximately 2 to 2.5 percent in Core Portfolio income from operations (also referred to as net operating income or "NOI"). CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, which require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosures. We believe that the following critical accounting policies, among others, affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. We periodically evaluate our long-lived assets, including our investments in real estate, for impairment indicators. Our judgments regarding the existence of impairment indicators are based on factors such as operational performance, market conditions and legal factors. Future events could occur which would cause us to conclude that impairment indicators exist and an impairment loss is warranted. The valuation of financial instruments under Statement of Financial Accounting Standards No. 107, "Disclosures About Fair Value of Financial Instruments" ("SFAS No. 107") and Statement of Financial Accounting Standards No. 133 ("SFAS No. 133"), "Accounting for Derivative Instruments and Hedging Activities" requires us to make estimates and judgments that affect the fair value of the instruments. Where possible, we base the fair values of our financial instruments, including our derivative instruments, on listed market prices and third party quotes. Where these are not available, we base our estimates on other factors relevant to the financial instrument. Real estate is recorded at cost less accumulated depreciation. Depreciation is computed on the straight-line basis over the estimated useful lives of the assets. We use a 30-year estimated life for buildings acquired and structural and land improvements, a ten-to-fifteen-year estimated life for building upgrades and a three-to-seven-year estimated life for furniture, fixtures and equipment. Expenditures for ordinary maintenance and repairs are expensed to operations as incurred and significant renovations and improvements that improve the asset and extend the useful life of the asset are capitalized over their estimated useful life. The determination of useful lives, salvage value, and depreciation method used are in conformity with GAAP. However, the useful lives, salvage value, and customary depreciation method used for land improvements and other significant assets may significantly and materially overstate the depreciation of the underlying assets and therefore understate the Net Income of the Company. In addition, the Financial Accounting Standards Board ("FASB") is currently reviewing the methods of depreciation and cost capitalization for all industries and in June 2001 issued FASB Exposure Draft, "Accounting in Interim and Annual Financial Statements for Certain Costs and Activities Related to Property, Plant and Equipment", the implementation of which, if issued, could also have a material effect on the Company's results of operations. 17
MANUFACTURED HOME COMMUNITIES, INC. RESULTS OF OPERATIONS (CONTINUED) CRITICAL ACCOUNTING POLICIES AND ESTIMATES (CONTINUED) Certain costs, primarily legal costs, relative to our efforts to effectively change the use and operations of several Properties subject to rent control are currently classified 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. In addition, we capitalize certain costs, primarily legal costs, related to entering into lease agreements which govern the terms under which we may enter into leases with individual tenants and which are expensed over the term of the lease agreement. In January 2003, the FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"). FIN 46 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 consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. The Company will adopt FIN 46 in the third quarter of 2003. We have not yet determined the effect the adoption of FIN 46 will have on the Company. Prior to 2003 we had chosen to account for our stock compensation in accordance with APB No. 25, "Accounting for Stock Issued to Employees", based upon the intrinsic value method. This method results in no compensation expense for options issued with an exercise price equal to or exceeding the market value of the Common Shares on the date of grant. Effective January 1, 2003, we elected to account for our stock-based compensation in accordance with SFAS No. 123 and its amendment (SFAS No. 148), "Accounting for Stock Based Compensation", which will result in compensation expense being recorded based on the fair value of the stock option compensation issued. SFAS 148 provides three possible transition methods for changing to the fair value method. We have elected to use the modified-prospective method. This method requires that we recognize stock-based employee compensation cost from the beginning of the fiscal year in which the recognition provisions are first applied as if the fair value method had been used to account for all employee awards granted, or settled in fiscal years beginning after December 15, 1994. The following table illustrates the effect on net income and earnings per share as if the fair value method was applied to all outstanding and unvested awards in each period presented: MARCH 31, MARCH 31, 2003 2002 ------------ ------------ Net income available for Common Shares as reported............................ $ 7,672 $ 7,115 Add: Stock-based compensation expense included in net income as reported.. 476 684 Deduct: Stock-based compensation expense determined under the fair value based method for all awards......... (476) (616) ------------ ------------ Pro forma net income available for Common Shares.............................. $ 7,672 $ 7,183 ============ ============ Pro forma net income per Common Share - Basic............................... $ .35 $ .34 ============ ============ Pro forma net income per Common Share -- Fully Diluted....................... $ .34 $ .32 ============ ============ 18
MANUFACTURED HOME COMMUNITIES, INC. RESULTS OF OPERATIONS (CONTINUED) COMPARISON OF THE QUARTER ENDED MARCH 31, 2003 TO THE QUARTER ENDED MARCH 31, 2002 Since December 31, 2001, the gross investment in real estate has increased from $1,238 million to $1,301 million. The total number of sites owned or controlled has increased from 50,663 as of December 31, 2001 to 51,537 as of March 31, 2003. PROPERTY OPERATIONS: The following table summarizes certain financial and statistical data for the Property Operations for the Core Portfolio and the Total Portfolio for the quarters ended March 31, 2003 and 2002. CORE PORTFOLIO TOTAL PORTFOLIO --------------------------------------------- --------------------------------------------- (dollars in thousands) INCREASE/ % INCREASE/ % 2003 2002 (DECREASE) CHANGE 2003 2002 (DECREASE) CHANGE ---------- ---------- ----------- ------ ---------- ---------- ----------- ------ Community base rental income....... $ 48,846 $ 47,165 $ 1,681 3.6% $ 50,167 $ 49,986 $ 181 0.4% Resort base rental income.......... 140 103 37 35.9% 4,077 2,437 1,640 67.3% Utility and other income........... 4,759 4,810 (51) (1.1%) 5,338 5,242 96 1.8% ---------- ---------- ----------- ------ ---------- ---------- ----------- ------ Property operating revenues... 53,745 52,078 1,667 3.2% 59,582 57,665 1,917 3.3% Property operating and maintenance................... 14,484 13,894 590 4.2% 16,937 16,057 880 5.5% Real estate taxes.................. 4,358 4,157 201 4.8% 4,752 4,577 175 3.8% Property management................ 2,122 2,174 (52) (2.4%) 2,352 2,407 (55) (2.3%) ---------- ---------- ----------- ------ ---------- ---------- ----------- ------ Property operating expenses... 20,964 20,225 739 3.7% 24,041 23,041 1,000 4.3% ---------- ---------- ----------- ------ ---------- ---------- ----------- ------ Income from property operations... $ 32,781 $ 31,853 $ 928 2.9% $ 35,541 $ 34,624 $ 917 2.6% ========== ========== =========== ====== ========== ========== =========== ====== Site and Occupancy Information (1): Average total sites............... 42,294 42,276 18 0.0% 43,861 45,496 (1,635) (3.6%) Average occupied sites............ 38,997 39,641 (644) (1.7%) 40,473 42,577 (2,104) (4.9%) Occupancy %....................... 92.2% 93.8% (1.6%) (1.6%) 92.3% 93.6% (1.3%) (1.3%) Monthly base rent per site........ $ 417.51 $ 396.60 $ 20.91 5.3% $ 413.17 $ 393.42 $ 19.75 5.0% Total sites As of March 31,............. 42,294 42,269 25 0.1% 43,861 45,489 (1,628) (3.6%) Total occupied sites As of March 31,............. 38,929 39,577 (648) (1.6%) 40,399 42,513 (2,114) (5.0%) (1) Site and occupancy information excludes Resort sites and Properties owned through joint ventures. 19
MANUFACTURED HOME COMMUNITIES, INC. RESULTS OF OPERATIONS (CONTINUED) Property Operating Revenues The 3.6% increase in Community base rental income for the Core Portfolio reflects a 5.3% increase in monthly base rent per site coupled with a 1.7% decrease in average occupied sites. The decrease in utility and other income for the Core Portfolio is due primarily to decreases in utility income, which resulted from lower expenses for these items. Property Operating Expenses The increase in property operating and maintenance expense for the Core Portfolio is due primarily to increases in property payroll, insurance and other expenses, utility expense, repair and maintenance and administrative expenses. The increase in Core Portfolio real estate taxes is generally due to higher property assessments on certain 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, decreased by 2.4%. HOME SALES OPERATIONS: The following table summarizes certain financial and statistical data for the Home Sales Operations for the quarters ended March 31, 2003 and 2002. HOME SALES OPERATIONS ---------------------------------------------------------------- INCREASE/ 2003 2002 (DECREASE) % CHANGE ------------- ------------- ---------- -------- (dollars in thousands) Gross revenues from new home sales............. $ 3,609 $ 4,309 $ (700) (16.2%) Cost of new home sales......................... (2,975) (3,405) 430 12.6% ------------- ------------- --------- -------- Gross profit from new home sales............... 634 904 (270) (29.9%) Gross revenues from used home sales............ 506 417 89 21.3% Cost of used home sales........................ (495) (330) (165) (50.0%) ------------- ------------- --------- -------- Gross profit from used home sales.............. 11 87 (76) (87.4%) Brokered resale revenues, net.................. 376 431 (55) (12.8%) Home selling expenses.......................... (1,894) (2,118) 224 10.6% Ancillary services revenues, net............... 482 557 (75) (13.5%) ------------- ------------- --------- -------- Loss from home sales and other................. $ (391) $ (139) $ (252) (181.3%) ============= ============= ========= ======== HOME SALES VOLUMES: New home sales............................... 52 57 (5) (8.8%) Used home sales.............................. 35 37 (2) (5.4%) Brokered home resales........................ 260 231 29 12.6% New home sales gross profit reflects an 8.8% decrease in sales volume coupled with a 3.4% decrease in the gross margin. The average selling price of new homes decreased $6,193 or 8.2% compared to 2002. Used home gross profit reflects a decrease in both volume and gross margin on used home sales. Brokered resale revenues reflects decreased commissions. The 10.6% decrease in home selling expenses primarily reflects reductions in payroll and advertising expenses. 20
MANUFACTURED HOME COMMUNITIES, INC. RESULTS OF OPERATIONS (CONTINUED) OTHER INCOME AND EXPENSES: The decrease in other income and expenses reflects increased corporate income and a decrease in interest expense. Interest expense decreased due to a decrease in the weighted average interest rate for outstanding debt. This decrease is partially offset by an increase in general and administrative expenses and depreciation on real estate assets. LIQUIDITY AND CAPITAL RESOURCES LIQUIDITY As of March 31, 2003, the Company had $12.7 million in cash and cash equivalents and $63.3 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. EQUITY TRANSACTIONS On April 11, 2003, the Company paid a $.495 per share distribution for the quarter ended March 31, 2003 to stockholders of record on March 28, 2003. 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 31, 2003. MORTGAGES AND CREDIT FACILITIES Throughout the quarter the Company borrowed $15 million on its line of credit and paid down $13 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 ("EBITDA"), limitations on certain holdings and other restrictions. 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 $3.0 million for the quarter ended March 31, 2003. Site development costs were approximately $1.5 million for the quarter ended March 31, 2003, and represent costs to develop expansion sites at certain of the Company's Properties and costs for improvements to sites when a smaller used home is replaced with a larger new home. 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. 21
MANUFACTURED HOME COMMUNITIES, INC. LIQUIDITY AND CAPITAL RESOURCES (CONTINUED) FUNDS FROM OPERATIONS Funds From Operations ("FFO"), a non-GAAP financial performance measure, was redefined by the National Association of Real Estate Investment Trusts ("NAREIT") in April 2002, 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 ended March 31, 2003 and 2002 (amounts in thousands): 2003 2002 -------- -------- COMPUTATION OF FUNDS FROM OPERATIONS: Net income available for Common Shares ................. $ 7,672 $ 7,115 Income allocated to Common OP Units .................... 1,847 1,767 Depreciation on real estate assets and other costs ..... 9,033 8,940 Depreciation on discontinued operations ................ -- 31 -------- -------- Funds from operations ............................... $ 18,552 $ 17,853 ======== ======== Weighted average Common Shares outstanding -- diluted... 27,740 27,508 ======== ======== COMPUTATION OF FUNDS AVAILABLE FOR DISTRIBUTION: Funds from operations .................................. $ 18,552 $ 17,853 Non-revenue producing improvements to real estate ...... (3,017) (2,376) -------- -------- Funds available for distribution .................... $ 15,535 $ 15,477 ======== ======== Weighted average Common Shares outstanding -- diluted... 27,740 27,508 ======== ======== 22
MANUFACTURED HOME COMMUNITIES, INC. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Our earnings are affected by changes in interest rates, since a portion of our outstanding indebtedness is at variable rates based on LIBOR. Our Line of Credit ($86.8 million outstanding at March 31, 2003) bears interest at LIBOR plus 1.125%, per annum and our $100 million Term Loan bears interest at LIBOR plus 1.375%. If LIBOR increased/decreased by 1.0% during the quarter ended March 31, 2003, interest expense would have increased/decreased by approximately $1.9 million based on the combined average balance outstanding under the Company's Line of Credit and Term Loan during the period. On October 29, 2001, we entered into an interest rate swap agreement (the "2001 Swap"), effectively fixing the LIBOR rate on $100 million of our floating rate debt at approximately 3.7% per annum for the period October 2001 through August 2004. The terms of the 2001 Swap require monthly settlements on the same dates interest payments are due on the debt. Effective January 1, 2001, the Company adopted Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133") and its amendments, SFAS No. 137 and SFAS No. 138. In accordance with SFAS No. 133, the interest rate swap will be reflected at market value. We believe the 2001 Swap is a perfectly effective cash flow hedge, under SFAS No. 133, and there will be no effect on net income as a result of the mark-to-market adjustment. As of March 31, 2003, the hedge represented a liability of approximately $4.3 million and is recorded in accounts payable and accrued expenses. Mark-to-market changes in the value of the 2001 Swap are included in other comprehensive income. ITEM 4. CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES As of March 31, 2003, an evaluation was performed under the supervision and with the participation of the Company's management, including the CEO and CFO, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on that evaluation, the Company's management, including the CEO and CFO, concluded that the Company's disclosure controls and procedures were effective as of December 31, 2002. CHANGES IN INTERNAL CONTROLS There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to December 31, 2002. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS (see Note 9 of the Consolidated Financial Statements contained herein) ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits: 99.1 Certification of Principal Financial Officer and Chief Executive Officer Pursuant to 18 U.S.C Section 1350 (b) Reports on Form 8-K: Form 8-K dated and filed May 8, 2003, relating to Item 5 -- "Other Events and Regulation FD Disclosure" regarding communications with Chateau Communities, Inc. 23
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 Executive Vice President, Treasurer and Chief Financial Officer BY: /s/ Mark Howell --------------- Mark Howell Principal Accounting Officer and Assistant Treasurer DATE: May 10, 2003 ------------ 24
CERTIFICATIONS I, John M. Zoeller, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Manufactured Home Communities, Inc; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 10, 2003 By: /s/ John M. Zoeller ----------------- ------------------------------------------- John M. Zoeller Executive Vice President and Chief Financial Officer 25
I, Howard Walker, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Manufactured Home Communities, Inc; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 10, 2003 By: /s/ Howard Walker ----------------- ------------------------------------------- Howard Walker Chief Executive Officer 26
EXHIBIT 99.1 CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350 In connection with the accompanying Quarterly Report on Form 10-Q of Manufactured Home Communities, Inc. for the quarter ended March 31, 2003, I, John M. Zoeller, Executive Vice President and Chief Financial Officer of Manufactured Home Communities, Inc., hereby certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, to the best of my knowledge, that: 1. such Quarterly Report on Form 10-Q of Manufactured Home Communities, Inc. for the quarter ended March 31, 2003 fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. the information contained in such Quarterly Report on Form 10-Q of Manufactured Home Communities, Inc. for the quarter ended March 31, 2003 fairly presents, in all material respects, the financial condition and results of operations of Manufactured Home Communities, Inc. Date: May 10, 2003 By: /s/ John M. Zoeller ------------------- ------------------------------------------- John M. Zoeller Executive Vice President and Chief Financial Officer 27
CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350 In connection with the accompanying Quarterly Report on Form 10-Q of Manufactured Home Communities, Inc. for the quarter ended March 31, 2003, I, Howard Walker, Chief Executive Officer of Manufactured Home Communities, Inc., hereby certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, to the best of my knowledge, that: 1. such Quarterly Report on Form 10-Q of Manufactured Home Communities, Inc. for the quarter ended March 31, 2003 fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. the information contained in such Quarterly Report on Form 10-Q of Manufactured Home Communities, Inc. for the quarter ended March 31, 2003 fairly presents, in all material respects, the financial condition and results of operations of Manufactured Home Communities, Inc. Date: May 10, 2003 By: /s/ Howard Walker ------------------ ------------------------------------------- Howard Walker Chief Executive Officer 28