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GYRO > SEC Filings for GYRO > Form 10-Q on 12-Nov-2013All Recent SEC Filings

Show all filings for GYRODYNE CO OF AMERICA INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for GYRODYNE CO OF AMERICA INC


12-Nov-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

When we use the terms "Gyrodyne," the "Company," "we," "us," and "our," we mean Gyrodyne Company of America, Inc. and all entities owned by us, including non-consolidated entities, except where it is clear that the term means only the parent company. References herein to our Quarterly Report are to this Quarterly Report on Form 10-Q for the three and nine-months ended September 30, 2013.

Cautionary Statement Concerning Forward- Looking Information. This Quarterly Report and the documents incorporated by reference into this Quarterly Report contain forward-looking statements about the Company within the meaning of
Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and
Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Statements containing the words "believes," "anticipates," "estimates," "expects," "intends," "plans," "seeks," "will," "may," "should," "would," "projects," "continues" and similar expressions or the negative of these terms constitutes forward-looking statements that involve risks and uncertainties. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and they are included in this Quarterly Report for the purpose of invoking these safe harbor provisions. Such statements are based on current expectations and are subject to risks, uncertainties and changes in condition, significance, value and effect. In September 2013, the Board of Directors approved a plan of liquidation intended to qualify as a tax liquidation, which included a plan of merger and other related transactions. The risks, uncertainties and changes in condition, significance, value and effect that could cause the Company's actual results to differ materially from anticipated results include risks and uncertainties relating to the process of exploring strategic alternatives, risks associated with the Company's ability to implement the tax liquidation, plan of liquidation or the plan of merger, the risk that the proceeds from the sale of our assets may not be sufficient to satisfy our obligations to our current and future creditors, the risk of shareholder litigation relating to the tax liquidation, the plan of liquidation or the plan of merger and other unforeseeable expenses related to the proposed liquidation, the tax treatment of condemnation proceeds, 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 to develop the Company's existing real estate and other risks detailed from time to time in the Company's SEC filings. Except as may be required under federal law, we undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur.

Overview

We are a self-managed and self-administered real estate investment trust formed under the laws of the State of New York. We operate primarily in one segment. The Company's primary business is the investment in and the acquisition, ownership and management of a geographically diverse portfolio of medical office and industrial properties and development of industrial and residential properties. Substantially all of our rental properties are subject to net leases in which the tenant must reimburse Gyrodyne for a portion of or all or substantially all of the costs and /or cost increases for utilities, insurance, repairs and maintenance, and real estate taxes.

As of September 30, 2013, the Company has 100% ownership in two medical office parks comprising 91,796 rentable square feet, ten of 14 buildings in another medical office park comprising 39,329 rentable square feet and a multitenant industrial park comprising 128,586 rentable square feet. Inclusive of the industrial park, the Company has approximately 68 acres of property in St. James, New York. In addition, the Company has an estimated 9.32% limited partnership interest in Callery Judge Grove, L.P. (the "Grove"), a limited partnership, which in September 2013 sold its only asset, an undeveloped Florida property, the "Grove Property". Gyrodyne did not receive any distribution in connection with the sale. Under the agreement with the purchaser, the Grove may receive certain additional payments if certain development benchmarks are achieved by the purchaser, which could enable future distributions to Gyrodyne. Gyrodyne cannot predict whether these benchmarks will be achieved or as to the timing or amount of any further distributions by Grove. Gyrodyne does anticipate it will be required to recognize its deferred tax liability during 2014.

With the exception of the receipt of the condemnation proceeds, our revenues and cash flows are generated predominantly from property rent receipts. Growth in revenues and cash flows had been and remains directly correlated to our ability to re-lease suites that are vacant or may become vacant at favorable rates and our strategic plan.

Our properties are located in New York State and Northern Virginia. We compete with a large number of real estate property owners and developers, some of which may be willing to accept lower returns on their investments. The principal factors of competition are rents charged, attractiveness of location, the quality of the property and breadth and quality of services provided. Our success depends upon, among other factors, trends of the national, regional and local economies, financial condition and operating results of current and prospective tenants and customers, availability and cost of capital, construction and renovation costs, taxes, governmental regulations, legislation and population trends. See "Part I" in our Annual Report on Form 10-K for the year ended December 31, 2012 for additional information regarding these factors.


Strategic Process

In July 2012, the Company received an additional $167,530,657 from the State of New York in payment of the judgments in the Company's favor in the Company's condemnation litigation with the State, which consisted of $98,685,000 in additional damages (the "2012 Proceeds"), $1,474,941 in costs, disbursements and expenses, and $67,370,716 in interest. Subsequent to receiving the payment the Company was notified by the State of a $29,000 overpayment, which the Company returned, due to an error in the interest calculation by the State of New York.

In August 2012, the Company announced that it was undertaking a strategic review, which was designed to maximize shareholder value through one or more potential cash distributions and/or through a potential sale, merger or other strategic combination, consistent with the Company's stated goal of providing one or more tax efficient liquidity event to its shareholders. In August 2012, the Company retained Rothschild, Inc., as financial advisor, and Skadden, Arps, Slate, Meagher & Flom LLP, as legal advisor, and authorized a committee of its Board (the "Strategic Alternatives Committee"), to lead the strategic review process. Commencing in October 2012, the Company solicited interest in proposals to acquire the Company from over 260 entities, and, in March 2013, an information memorandum was circulated to over 30 entities who had executed nondisclosure agreements. In the several months thereafter, members of its Board and management met with several bidders, permitted such bidders to conduct due diligence and indicative bids were received from a number of parties. Some of such indicative bids were for the whole Company and others contemplated the sale of a partial interest to a bidder who would assume control, but none of such bids were fully developed or contained value parameters and other terms acceptable to its Board.

Following a change in tax law in January 2013 reducing the recognition period applicable for the 2012 taxable year to five years, the Company applied for a private letter ruling from the IRS in March 2013 and ultimately received a favorable ruling on August 28, 2013 (the "PLR"). The PLR concludes that the Company's receipt of the 2012 Proceeds occurred outside of the applicable recognition period for 2012, and therefore permits the Company to distribute, by means of a dividend such as the Special Dividend described below, the gains realized from its receipt of the 2012 Proceeds, subject to a 4% excise tax but without incurring the built-in gains tax.

Further to the Company's previously stated goal of providing one or more tax efficient liquidity events to its shareholders and taking into account, among other factors, the Company's receipt of the PLR, the Board concluded that it is in the best interests of Gyrodyne and its shareholders to liquidate the Company for federal income tax purposes. On September 12, 2013, the Board adopted a plan of liquidation, pursuant to which the Company intends to dispose of its remaining assets in an orderly manner designed to obtain the best reasonably available value for such assets and to complete a tax liquidation, including pursuant to a merger into a new wholly owned limited liability company within a two year period from the adoption of the plan of liquidation.

On September 13, 2013, the Board declared a special dividend in the amount of $98,685,000, or $66.56 per share, of which approximately $68,000,000, or $45.86 per share, will be paid in cash. The balance of the Special Dividend will be payable in the form of cash proceeds from any further asset dispositions effected prior to payment of the dividend, Dividend Notes, interests in a limited liability company to which the Company may transfer its remaining assets (or into which it may merge), or a combination of such forms at the discretion of the Board. The form of the balance of the special dividend, if other than cash, is referred to as the non-cash portion of the special dividend.

In a meeting held on October 9, 2013, the Board determined that in order to most clearly and directly accomplish its goal of distribution of the $98.7 million as a return of capital to shareholders, and in light of relevant consideration of issues of business continuity, shareholder liquidity and timeliness of execution, the Company would pursue the tax liquidation by means of a merger of the Company into Gyrodyne, LLC, a New York limited liability company and direct and wholly-owned subsidiary of the Company. At such meeting the Board also determined that, if the merger into Gyrodyne, LLC is not completed by December 31, 2013, the most likely in-kind distribution in the special dividend would be of nontransferable interests in Gyrodyne Special Distribution, LLC, another newly formed wholly-owned subsidiary of the Company. In order to achieve the full benefits of the special dividend, the Company must make a distribution of in-kind assets with a value of at least $30,685,000 in the aggregate.

In connection with the Special Dividend, the company incurred costs of $3.4 million for the 4% excise tax, $1.6 million for transaction costs, and approximately $5.1 million for Incentive Compensation Plan payments.

On October 21, 2013, the Company filed a preliminary proxy statement/prospectus with the SEC. The foregoing description of the Company's strategic process is qualified in its entirety by the more in-depth description contained in such preliminary proxy statement/prospectus, which description is incorporated by reference into this Quarterly Report.

Economic Conditions

Recession and Recovery: The economic recession and illiquidity and volatility in the financial and capital markets from 2008 to present has continued to negatively affect substantially all businesses, including ours. Although signs of an economic recovery beginning in 2010 through mid to late 2013 have emerged, it is not possible for us to quantify the timing and impact of the recovery on our future financial results. The length and depth of the economic recession combined with the slow economic recovery has continued to negatively impact the real estate industry. Additionally, the Company stated in its 2010 through 2012 periodic filings that it believes the full impact of the economic downturn has not yet been fully absorbed by the real estate market, partially attributable to the Company's belief that lease commitments, by their very nature, expire over time resulting in the vacancy impact of an economic slowdown occurring over a similar period of time as tenants cannot reduce their space demands until their leases expire. The continuation of negative absorption rates in many regions across the country, including Long Island, continues to confirm the impact of the economic volatility.


Fiscal Cliff: The Company's business could also be adversely impacted by the recent automatic cuts in Federal spending. The American Taxpayer Relief Act (ATRA) of 2012, referred to generally as the fiscal cliff deal, delayed until March 1, 2013, the automatic spending cuts of nearly $1 trillion over the next 10 years (commonly known as "sequestration") that were included under the Budget Control Act of 2011. These spending cuts include a 2% cut to Medicare providers and suppliers. Medicaid is exempt from these cuts. Cuts to Medicare reimbursement could have an adverse effect on our healthcare tenants' results of operations and financial condition. The Company owns a medical building in Fairfax Virginia which may be adversely affected by any sharp reduction in government spending and employment in the Washington DC area. The short term and long term economic impact of sequestration will not be known until the actual spending cuts are implemented and the economic impact of the changes in the budget and taxes are known. Similar to the healthcare legislation discussed in our Annual Report on Form 10-K for the year ended December 31, 2012, it will take an extended number of years to understand the impact of any changes brought about from the sequester.

Global Credit and Financial Crisis: The continued concerns about the impact of a widespread and long term global credit and financial crisis have contributed to market volatility and diminishing expectations for the real estate industry, including the potential downward pressure on our common stock price. As a result, our business continues to be impacted by factors including (1) increased challenges in re-leasing space, and (2) potential risks stemming from late rental receipts, tenant defaults and tenant bankruptcies.

Healthcare Legislation: The Federal health care legislation enacted in 2010 will potentially affect medical office real estate due to the direct impact on its tenant base. While the impact is not expected to be immediate due to the multi-year phase in period of the legislation, medical professionals are reviewing their real estate options which include remaining status quo, increasing tenant space to address a higher volume of patients as well as combining practices with other professionals. As a result, our business could be impacted by factors including (1) difficulty transitioning doctors to longer term leases, (2) difficulty raising rates and (3) increased challenges in re-leasing space.

As of September 30, 2013, the average effective rental revenue per square foot adjusted for tenant improvements was $18.77 which was the same as the year ended December 31, 2012. The Company defines the effective revenue per square foot as the annual rate per square foot stated in the lease reduced by the average annual tenant improvement allowance provided for in such leases.

Business Strategy

We focus our business strategy on maximizing the intrinsic value per share through aligning our operating and investment strategy with our goal of executing on a tax efficient liquidity event or series of tax efficient liquidity events. This strategy involves a balance between preserving capital and improving the market value of our real estate portfolio. Our objectives are as follows:

? managing the plan of liquidation to dispose of the Company's remaining assets in an orderly manner designed to obtain the best reasonably available value and to complete the liquidation for federal income tax purposes within a two year period from the adoption of the plan of liquidation;

? managing the tax exposure related to the condemnation proceeds and the sale of the remaining properties;

? managing our portfolio to improve our operating cash flow while simultaneously increasing the market values of the underlying operating properties;

? focusing use of capital to that which preserves or improves the market value of our real estate portfolio;

? maximizing funds from operations ("FFO") and company adjusted FFO ("AFFO"); and

? continuing to pursue the re-zoning effort of the Flowerfield property to maximize its value;

We believe these objectives help us achieve our strategic plan in the long term and strengthen our business and enhance value of our underlying real estate portfolio in the short term.


Third Quarter 2013 Transaction Summary

The following summarizes our significant transactions and other activity during the three months ended September 30, 2013.

Investments - The Company received principal payments during the three months ended September 30, 2013 of approximately $210,000 from its prior year investment in conforming agency fixed rate mortgage pass through securities with either AA or AAA ratings fully guaranteed by US government agencies (the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation). The portfolio is currently generating a yield of approximately 2%.

Leasing - During the three months ended September 30, 2013, the Company executed 9 lease renewals encompassing approximately 10,000 square feet, and approximately $154,000 in annual revenue. In addition, the Company entered into 2 new leases encompassing approximately 3,000 square feet and $74,000 in annual revenue. Partially offsetting the new leases and renewals were 5 terminations during the three month period ending September 30, 2013, comprising approximately 9,000 square feet and approximately $137,000 in annual revenue. The Company realized a decrease in net deferred revenue of approximately $28,500. Included in the renewals were two tenants who expanded 3,570 square feet which relates to an additional $26,460 in annual rent.

The new leases and lease extensions signed during the third quarter included tenant allowances which the Company estimates at a cost of approximately $69,000, and rent abatements of approximately $37,000. There were lease commissions incurred by the Company during the third quarter of approximately $75,000 affiliated with total lease commitment revenues over the term of the respected leases of approximately $696,000 plus tenant reimbursements.

Subsequent to quarter end, the Company signed one new lease encompassing 2,100 square feet and approximately $23,000 in annual revenue. Offsetting the new lease were 2 terminations aggregating approximately 1,200 square feet and $17,000 in annual revenue.

The continued economic volatility for small businesses and medical practices has impacted property management firms, including the Company's ability to renew leases at comparable rates if at all, without providing either rent abatements or comparable other lease incentives. During 2012 through September 2013, medical office parks and industrial parks continued to face challenges to maintain both rental rates and occupancy. Rental revenues were $1,156,360 and $1,104,502 for the three months ended September 30, 2013, and June 30, 2013, respectively, a quarter over quarter increase of $51,858. Although the Company successfully avoided portfolio wide rental revenue degradation, the company sees continuing challenges to maintain both rental rates and occupancy during the slow economic recovery. The below table reflects the Company's rental revenue at its industrial park vs. the combined rental revenue of its medical parks and the related occupancy rate and effective rental rate of each.

                                                    Third Quarter Ended    Second Quarter Ended
                                                     September 30, 2013       June 30, 2013
Industrial Park Rental Revenue                      $     469,154          $     423,958
Combined Medical Park Rental Revenue                $     687,206          $     680,544

Occupancy Rate Industrial Park                                 83 %                   86 %
Occupancy Rate Combined Medical Parks                          82 %                   81 %
Total Occupancy Rate                                           82 %                   83 %
Average Effective Rental rate per square foot -
Industrial Park                                     $       13.89          $       13.99
Effective Rental Rate per square foot- Medical
Parks                                               $       23.69          $       23.85
Average Total Effective rental rate per square
foot                                                $       18.77          $       18.72

Our leasing activity has resulted in total lease commitments as of September 30, 2013 and June 30, 2013 of $16,017,000 and $16,252,000, respectively. There were two new leases and 2 expansions during the quarter, with the resulting annual revenue commitment partially offset by 5 terminations during the quarter. The Company has launched aggressive leasing strategies at each of its medical parks. In addition, the Company negotiated settlement and termination agreements with two tenants in default in the industrial park and one tenant in the medical parks, all of which exited the occupied space prior to September 30, 2013. During the third quarter the Company estimates approximately $106,000 of tenant incentives were provided to attract new tenants. However, the economy continues to be challenging and, to compete effectively with other local landlords, the Company may offer aggressive tenant improvements in exchange for signing medium and long term lease commitments.

Director Compensation

Effective January 1, 2013, the Board authorized an increase in annual director fees to $42,000 per year and an increase in the Chairman's fee to $36,000. The combined annual fees payable to the Chairman are an aggregate of $78,000 per year. The increase was authorized to compensate the directors, including the Chairman, for the significantly greater role, responsibilities and time commitment of the directors, as well as enhanced potential legal and reputational risks, resulting from the Company's strategic process.


In addition, the cash portion ($45.86 per share) of the Special Dividend announced on September 13, 2013 triggered Incentive Compensation under the Company's Incentive Compensation Plan of $2,850,199 which is payable on the Dividend payment date, December 30, 2013.

Strategic Alternatives

Following the receipt of the condemnation proceeds in July 2012, the Board established a committee to pursue strategic alternatives, including managing the process of selecting legal and financial advisors and making committee recommendations to the Board. As part of the process, in August 2012 the Company retained Rothschild, Inc. as financial advisor, and Skadden, Arps, Slate, Meagher & Flom, LLP, as legal advisor. The Company amended its engagement letter with Rothschild on January 31, 2013 reducing the monthly advisory fees from $100,000 to $50,000 for February 2013 and making a $50,000 payment for March 2013, payable solely at the Company's discretion, with no further monthly retainer fees payable thereafter. Strategic alternative expenses incurred for the quarter ended September 30, 2013 were $2,151,392. During April 2013, the Board authorized the payment of the optional $50,000 March fee which was expensed in the second quarter.

Restructuring

The Company incurred administrative staff restructuring costs of approximately $64,000 in the first quarter of 2013. The restructuring costs were offset by a recurring compensation and benefit savings exceeding $150,000.

Additionally, the Company restructured its maintenance operation through the termination of four employees and outsourced its real estate maintenance to an independent vendor. There were no termination costs payable directly or indirectly to any of the employees.

The restructuring, all of which was completed in the first quarter of 2013, reduced the employee headcount from 11 to 7, net of the hiring of Frederick C Braun III as Prescient and Chief Executive Officer. The Company believes the reduced headcount improves the Company's position to pursue its strategic alternatives and the recently announced merger and related plan of liquidation.

The Grove

The Company has maintained an interest in the Grove, which originally represented a 20% limited partnership interest in the Grove. Based on four subsequent capital raises through 2009, each of which the Company chose not to participate in, the Company's share was diluted to approximately 9.99% as of December 31, 2010, and has since been diluted to 9.32%. On March 18, 2011, the Grove's lender, Prudential Industrial Properties, LLC ("Prudential"), commenced a foreclosure action against the Grove by filing a complaint in the Circuit Court of Palm Beach County to foreclose upon the Grove property, alleging that the Grove has defaulted on its loan from Prudential and that the Grove is indebted to Prudential in the amount of over $37 million in principal and over $8 million in interest and fees. On September 19, 2013, the Grove was sold, the foreclosure lawsuit was dismissed and Grove's debt to Prudential was repaid. The investment is held in a taxable REIT subsidiary of the Company with $0 value and the Company has a $1,315,000 deferred tax liability related to the Grove, which represents taxable losses not yet recorded pursuant to the equity method of accounting. Gyrodyne did not receive any distribution in connection with the sale. Under the agreement with the purchaser, Grove may receive certain additional payments if certain development benchmarks are achieved by the purchaser. Gyrodyne cannot predict whether these benchmarks will be achieved or as to the timing or amount of any further distributions by Grove. Gyrodyne does anticipate it will be required to recognize its deferred tax liability during 2014.

Critical Accounting Policies

Management's discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP. The condensed consolidated financial statements of the Company include accounts of the Company and all majority-owned and controlled subsidiaries. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the Company's condensed consolidated financial statements and related notes. In preparing these financial statements, management has utilized information available including its past history, industry standards and the current economic environment, among other factors, in forming its estimates and judgments of certain amounts included in the condensed consolidated financial statements, giving due consideration to materiality. On a regular basis, we evaluate our assumptions, judgments and estimates. However, application of the critical accounting policies below involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these . . .

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