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GYRO > SEC Filings for GYRO > Form 10-K on 18-Mar-2013All Recent SEC Filings

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Form 10-K for GYRODYNE CO OF AMERICA INC


18-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

Cautionary Statements Concerning Forward-Looking Statements

The statements made in this Form 10-K, other materials the Company has filed or may file with the Securities and Exchange Commission, in each case that are not historical facts, contain "forward-looking information" within the meaning of the Private Securities Litigation Reform Act of 1995, and Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, both as amended, which can be identified by the use of forward-looking terminology such as "may," "will," "anticipates," "expects," "projects," "estimates," "believes," "seeks," "could," "should," or "continue," the negative thereof, and other variations or comparable terminology as well as statements regarding the evaluation of strategic alternatives. These forward-looking statements are based on the current plans and expectations of management, and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those reflected in such forward-looking statements. Such risks and uncertainties include, but are not limited to, risks and uncertainties relating to the process of exploring strategic alternatives, the effect of economic and business conditions, risks inherent in the real estate markets of Suffolk and Westchester Counties in New York, Palm Beach County in Florida and Fairfax County in Virginia, the ability to obtain additional capital in order to maintain and or develop the existing real estate, uncertainties associated with the Company's reinvestment of the condemnation proceeds under Section 1033 and other risks detailed from time to time in the Company's SEC reports. These and other matters the Company discusses in this Report, or in the documents it incorporates by reference into this Report, may cause actual results to differ from those the Company describes. The Company assumes no obligation to update or revise any forward-looking information, whether as a result of new information, future events or otherwise.

Overview

As used herein, the terms "we," "us," "our" or the "Company" refer to Gyrodyne Company of America, Inc., a New York corporation. We operate as a fully integrated, self-administered and self-managed real estate investment trust ("REIT") focused on acquiring, developing, owning, leasing and managing medical, commercial and industrial real estate. Our tenants include unrelated diversified entities with a recent emphasis on medical office parks and properties. Our properties are generally located in markets with well established reputations, including Suffolk and Westchester counties in New York and Fairfax, Virginia in the metro-Washington D.C area.

As of December 31, 2012, our portfolio consisted of four developed properties, consisting of 22 buildings with an aggregate of 259,711 rentable square feet. We also own undeveloped land parcels adjacent to existing properties for which plans are currently being formulated.

Factors Which May Influence Future Operations

Our operating focus is on acquiring, developing, owning, leasing and managing medical, residential, commercial and industrial space. As of December 31, 2012, our operating portfolio was 82% leased to 103 tenants. As of December 31, 2011, our operating portfolio was 86% leased to 106 tenants. The year over year decrease in the gross portfolio occupancy percentage was primarily the result of lease terminations in the Cortlandt Medical Center due to the completion of the Hudson Valley Hospital Center $100 million expansion and renovation. Our continued focus on overcoming the challenges of negative absorption in the real estate industry through 2012 has resulted in increasing the Flowerfield occupancy rate from 83% to 85%.


The Company's strategy of repositioning its assets involves purchasing medical space where the Company believes it could increase the occupancy and / or rental rates of the targeted acquisition. As a result, a material acquisition where the acquired asset's occupancy rate is below the Company average will result in temporarily decreasing the overall occupancy rate.

Our leasing strategy for 2013 includes negotiating longer term leases, and focuses on leasing vacant space, negotiating early renewals for leases scheduled to expire during the year, and identifying new tenants or existing tenants seeking additional space.

Lease Expirations

The following is a summary of lease expirations and related revenues of leases
in place at December 31, 2012. This table assumes that none of the tenants
exercise renewal options or early termination rights, if any, at or prior to the
scheduled expirations:

                                                                % of Gross Annual
                  Number of       Square          Total          Rental Revenues
                    Leases         Feet          Annual            Represented
Fiscal Year End    Expiring      Expiring         Rent           By Such Leases
     2013                 44        60,000     $ 1,220,950                   28.21 %
     2014                 25        46,000       1,023,105                   23.63 %
     2015                 12        22,000         410,019                    9.47 %
     2016                 10        24,000         521,207                   12.04 %
     2017                  7        12,000         321,708                    7.43 %
  Thereafter              11        39,000         831,853                   19.22 %

The success of our leasing and acquisition strategy will be dependent upon the general economic conditions and more specifically real estate market conditions and trends in the United States and in our target markets of suburban New York, northern Virginia and the eastern portion of the United States. We cannot give any assurance that leases will be renewed or that available space will be re-leased at rental rates equal to or above the current contractual rental rates.

We actively manage the renewal process in conjunction with third party asset management firms. Historically, this has resulted in a very low turnover rate with our tenants. However, industrial properties and medical properties in most of the regions we operate have experienced negative absorption rates meaning that additional space for rent or sale exceeds space sold or leased over the same period. The negative absorption rate is an indicator of the challenges in maintaining or growing average occupancy, rental rates and addressing the demands for tenant incentives / concessions. As a result, the Company continues to actively manage lease termination dates and often approaches tenants up to one year in advance to gauge renewal interest and negotiate related leases. Where a termination is likely, the Company begins marketing the property prior to termination to timely identify the market rent for the specific space, expected vacancy period and market demanded tenant concessions and incentives. During 2012, the Company provided approximately $184,000 in tenant incentives in the form of tenant improvements and lease concessions in the form of rent abatement of approximately $31,000.

The Company may offer tenant concessions in the form of rent abatements rather than tenant improvements to maximize its working capital position. However, tenant improvement incentives may be offered in certain cases where concessions are not effective in meeting the demands of the existing or prospective tenant.

During 2012, the Company incurred approximately $50,500 in leasing fees and commissions in exchange for revenue commitments of approximately $2,522,000 with leases ranging from 1 year to 10 years. The leasing fees reflect a renewal cost rate of approximately 2% of the related revenue commitments. The Company often renews leases without external brokers or other third party costs. The Company has approximately 28% of its annual leasing revenue up for renewal in 2013 as compared to 33% in 2012. General economic conditions, coupled with rental markets in which we operate, will dictate how rental rates on new leases and renewals will compare, favorably or unfavorably, to those leases that were signed in 2012.


Critical Accounting Policies

The preparation of financial statements in conformity with GAAP requires management to use judgment in the application of accounting policies, including making estimates and assumptions. We base our estimates on historical experience and on various other assumptions believed to be reasonable under the circumstances. These judgments affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. If our judgment or interpretation of the facts and circumstances relating to various transactions had been different, it is possible that different accounting policies would have been applied resulting in a different presentation of our financial statements. On an ongoing basis, we evaluate our estimates and assumptions. In the event estimates or assumptions prove to be different from actual results, adjustments are made in subsequent periods to reflect more current information. Below is a discussion of accounting policies that we consider critical in that they address the most material parts of our financial statements, require complex judgment in their application or require estimates about matters that are inherently uncertain.

Investments in Real Estate

Investments in real estate are carried at depreciated cost. Depreciation and amortization are recorded on a straight-line basis over the estimated useful lives of the assets as follows:

Buildings and improvements (years) 5 - 39 Machinery & equipment (years) 3 - 20

Our estimates of useful lives have a direct impact on our net income. If expected useful lives of our investments in real estate were shortened, we would likewise depreciate the assets over a shorter time period, resulting in an increase to depreciation expense and a corresponding decrease to net income on an annual basis.

Management must make significant assumptions in determining the value of assets and liabilities acquired. The use of different assumptions in the allocation of the purchase cost of the acquired properties would affect the timing of recognition of the related revenue and expenses.

Repair and maintenance costs are charged to expense as incurred and significant replacements and betterments are capitalized. Repairs and maintenance costs include all costs that do not extend the useful life of an asset or increase its operating efficiency. Significant replacements and betterments represent costs that extend an asset's useful life or increase its operating efficiency.

Revenue recognition - Minimum revenues from rental property are recognized on a straight-line basis over the terms of the related leases. The excess of rents recognized over amounts contractually due, if any, are included in deferred rents receivable on the Company's balance sheets. Certain leases also provide for tenant reimbursements of common area maintenance and other operating expenses and real estate taxes. Tenant reimbursements to the Company for expenses where the Company negotiates, manages, contracts and pays the expense on behalf of the tenant are recognized as revenue when they become estimable and collectible. Ancillary and other property related income is recognized in the period earned. The only exception to the straight line basis are for tenants at risk of default. Revenue from tenants where collectability is in question is recognized on a cash basis when the rent is received.

Allowance for doubtful accounts - Management must make estimates of the uncollectability of accounts receivable. Management specifically analyzes accounts receivable, historical bad debts, customer concentrations, customer credit-worthiness, current economic trends, and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts.

A ssets and Liabilities Measured at Fair-Value - Fair Value Measurements, which defines fair-value, establishes a framework for measuring fair-value, and expands disclosures about fair-value measurements. The guidance applies to reported balances that are required or permitted to be measured at fair-value under existing accounting pronouncements; accordingly, the standard does not require any new fair-value measurements of reported balances.

The Fair Value Option for Financial Assets and Financial Liabilities, which permits companies to choose to measure certain financial instruments and other items at fair-value in order to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently. However, we have not elected to measure any additional financial instruments and other items at fair-value (other than those previously required under other GAAP rules or standards) under the provisions of this standard.

The guidance emphasizes that fair-value is a market-based measurement, not an entity-specific measurement. Therefore, a fair-value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair-value measurements, the guidance establishes a fair-value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity
(observable inputs that are classified within Levels 1 and 2 of the hierarchy)
and the reporting entity's own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).


Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access. Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, which is typically based on an entity's own assumptions, as there is little, if any, related market activity. In instances where the determination of the fair-value measurement is based on inputs from different levels of the fair-value hierarchy, the level in the fair-value hierarchy within which the entire fair-value measurement falls is based on the lowest level input that is significant to the fair-value measurement in its entirety. Our assessment of the significance of a particular input to the fair-value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

Newly Issued Accounting Pronouncements

See Notes to Consolidated Financial Statements included elsewhere herein for disclosure and discussion of new accounting standards.

RESULTS OF OPERATIONS

The following is a comparison, for the years ended December 31, 2012 and 2011, of the operating results of Gyrodyne Company of America, Inc.

The Company is reporting net income of $99,048,253 for the twelve months ended December 31, 2012 compared to net loss of $(1,124,665) for the twelve months ended December 31, 2011. Basic and diluted per share income amounted to $66.80 for 2012 compared to per share loss of $(0.84) for the prior year. The additional weighted average shares outstanding in 2012 compared to 2011 diluted the income per share by $7.08 from $73.88 to $66.80. The Company has REIT taxable income in 2012. As a result, the Company declared a special dividend of $38.30 per share payable on December 14, 2012 to shareholders of record on December 1, 2012, which reflects a total distribution for 2012 of $56,786,652. The Company did not have any REIT taxable income for 2011.

The Company is disclosing rental revenue, tenant reimbursements and rental expenses for 2012 and 2011 by property. However, there were no proforma adjustments as there were no acquisitions during the comparative periods.

Rental revenues - Rental revenues are comprised solely of rental income and amounted to $4,448,402 and $4,886,823 for 2012 and 2011, respectively. The (decreases) from 2011 results per property amounted to $(156,204), $(182,847), $(71,499) and $(27,871) for Port Jefferson, Cortlandt, Fairfax and Flowerfield, respectively. The reduction in revenue was mainly due to a reduction in occupancy rates at each of the properties and then further offset by a net decrease in rate per square foot for each property much of which is the byproduct of the negative square footage absorption rates in the real estate industry.

The comparison of rental revenues for the years ended December 31, 2012 and 2011 are as follows:

    Facility Rental Revenue          December 31, 2012       December 31, 2011
Port Jefferson Professional Park   $           798,180     $           954,384
    Cortlandt Medical Center                   803,913                 986,760
     Fairfax Medical Center                  1,226,484               1,297,983
  Flowerfield Industrial Park                1,619,825               1,647,696
             Total                 $         4,448,402     $         4,886,823

Tenant reimbursements - Tenant reimbursements represent expenses negotiated, managed, and incurred directly by the Company on behalf of or for the benefit of the tenants. Tenant reimbursements were $540,706 and $632,881 for 2012 and 2011, respectively, a decrease of $92,175 or 14%, most of which was attributable to the reduction in occupancy rates supplemented by new leases/renewals containing lower pass through charges resulting from a change in base years.


The comparison of tenant reimbursements for the years ended December 31, 2012 and 2011 are as follows:

  Facility Tenant Reimbursements Rental Revenue        December 31, 2012       December 31, 2011
         Port Jefferson Professional Park            $           100,536     $           167,403
             Cortlandt Medical Center                            136,718                 148,157
              Fairfax Medical Center                              97,011                 111,183
           Flowerfield Industrial Park                           206,441                 206,138
                      Total                          $           540,706     $           632,881

Total expenses excluding condemnation, interest and tax expense - Expenses, excluding condemnation, interest and taxes, amounted to $10,783,084 for 2012 and reflect an increase of $5,667,734 from the 2011 amount of $5,115,350. The net increase was attributable to the distributions under the Incentive Compensation Plan to each member of the Board of Directors and certain employees/former employees totalling $2,380,345 and $1,832,655, respectively, reflecting a total payout of $4,213,000 plus related payroll taxes of approximately $37,000. In addition, the Company incurred $1,013,043 of expenses to pursue strategic alternatives.

Rental operation expenses - Rental expenses for the years ended December 31, 2012 and 2011 were $2,308,036 and $2,347,400, respectively, representing a decrease of $39,364 or 2%. The Company continues to manage the operating expenses of its real estate portfolio to offset escalating insurance and energy costs. While the Company has been successful in controlling costs, the impact of aging buildings will ultimately require additional capital expenditures to further reduce energy consumption and maintenance costs.

The rental expenses for the years ended December 31, 2012 and 2011 are as follows:

    Facility Rental Expense          December 31, 2012       December 31, 2011
Port Jefferson Professional Park   $           396,954     $           414,782
    Cortlandt Medical Center                   479,807                 481,277
     Fairfax Medical Center                    559,540                 549,237
  Flowerfield Industrial Park                  871,735                 902,104
             Total                 $         2,308,036     $         2,347,400

General and administrative expenses - General and administrative expenses for the years ended December 31, 2012 and 2011 were $6,561,910 and $1,862,466, representing an increase of $4,699,444. The net increase was mostly attributable to the distributions under the Incentive Compensation Plan to each member of the Board of Directors, certain current employees and the retired but vested former CEO, Mr. Maroney of $2,380,345, $1,053,250 and $779,405, respectively, reflecting a total payout of $4,213,000 plus related payroll taxes of approximately $37,000. Additionally, the Company incurred approximately $401,000 in costs to prepay the mortgages secured by the Flowerfield Industrial Park, Cortlandt Medical Center and the Fairfax Medical Center. Approximately $250,000 of the costs were non cash write-offs of the balance on the unamortized loan origination fees.

Strategic alternative expenses - Strategic Alternative expenses for the years ended December 31, 2012 and 2011 were $1,013,043 and $29,383, respectively. The Board of Directors established the Strategic Alternatives Committee, comprised of 4 of the 7 members of the Board of Directors. The committee is charged with leading the process of evaluating strategic alternatives which may include one or more tax efficient liquidity events. Over 80% of the fees are related to investment banking and related legal fees to pursue and analyze such alternatives. The expenses do not include any costs associated with full time or part time personnel or overhead costs irrespective of the significant time being allocated to the process. The Company believes such costs are fixed and are appropriately allocated to General and Administrative expenses accordingly.

Depreciation expense - Depreciation expense increased by 3% or $23,994, amounting to $900,095 in 2012 compared to $876,101 during the prior year. The increase in depreciation is mainly attributable to the Company's capital investment to improve occupancy and effective rental rates.

Interest income - Interest income not including condemnation related interest, was $86,217 and $1,696 in 2012 and 2011, respectively, an increase of $84,521. The increase is mainly attributable to the purchase of mortgage backed securities during February and March which earned approximately 2% during 2012.


Interest expense - Interest expense in 2012 and 2011 was $965,506 and $1,197,407, respectively, a decrease of $231,901. The decrease was attributable primarily to the expiration of the Interest Rate Swap on the Cortlandt Manor mortgage which locked in the rate at 5.66% through November 2011. Following the expiration of the Interest Rate Swap, the interest rate adjusted down to Libor plus 225 basis points or 2.5%. In addition, the company negotiated the rate on the Port Jefferson Professional Park mortgage effective March 1, 2012, reducing the rate over the next 5 years from 5.75% to 5%. In addition to cutting rates for 2012, late in the fourth quarter, the Company prepaid in full the mortgage loans secured by the Fairfax Medical Center, Cortlandt Medical Center and the Flowerfield Industrial Park, respectively.

The comparison of interest expense for the years ended December 31, 2012 and 2011 as follows:

       Facility Interest Expense            December 31, 2012       December 31, 2011
        Fairfax Medical Center            $           424,936     $           457,200
       Cortlandt Medical Center                       100,598                 239,783
Port Jefferson Professional Park Center               260,447                 297,766
      Flowerfield Industrial Park                     176,772                 199,127
        Other interest expense                          2,753                   3,531
                 Total                    $           965,506     $         1,197,407

As a result of the changes in rental revenue, total operating expenses and other income (expense), the Company is reporting a loss before Condemnation Proceeds and Provision (benefit) for income taxes of $(6,673,265) for 2012 as compared to a loss of $(1,124,665) for 2011.

Income (expense) on Condemnation - Condemnation income (expenses) for the years ended December 31, 2012 and 2011 were $100,028,802 and $(333,308), respectively. The Company successfully concluded its condemnation case during 2012 resulting in an additional $98,685,000 for just compensation for the Property and reimbursement of condemnation costs of $1,474,941. The expenses in 2011 were attributable to legal fees and related expenses associated with the Company's response to New York State's request for appeal. The Company incurred additional condemnation costs in 2012 of $131,138 to conclude pursuing its rights under this litigation.

Interest income on condemnation proceeds of $67,341,716 resulted from the Company's successful conclusion of its condemnation case for just compensation. The interest income was received in 2012.

Income Taxes - The provision for income taxes for the year ended December 31, 2012 was $61,649,000. The Company did not have a tax expense during 2011.


LIQUIDITY AND CAPITAL RESOURCES

The following summary discussion of our cash flows is based on the consolidated statements of cash flows in "Item 8. Financial Statements and Supplementary Data" and is not meant to be an all inclusive discussion of the changes in our cash flows for the periods presented below:

                                                          2012              2011
Net cash provided by (used) in operating activities   $ 161,712,775     $   (477,273 )
       Net cash used in investing activities          $  (5,010,995 )   $   (905,834 )
Net cash (used in) provided by financing activities   $ (72,913,052 )   $  9,617,579
     Ending cash and cash equivalents balance         $  94,164,722     $ 10,375,994


Comparison of the Year Ended December 31, 2012 to the Year Ended December 31, 2011

Net cash provided by (used in) operating activities was $161,712,775 and $(477,273) during the years ended December 31, 2012 and 2011, respectively. The primary factor impacting cashflow provided by operations in 2012 was the conclusion of the condemnation litigation. The Company concluded its condemnation litigation in June 2012 and the state remitted payment in full of $167,530,657. Offsetting the cash provided by condemnation were payments pursuant to the Incentive Compensation Plan to the Board of Directors and certain employees/former employees of $2,380,345 and $1,832,655, . . .

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