Sun Communities - 10-Q quarterly report FY

 

(Exact Name of Registrant as Specified in its Charter)

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 þ No o

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ No o

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

INDEX

The accompanying notes are an integral part of the consolidated financial statements

The accompanying notes are an integral part of the consolidated financial statements

The accompanying notes are an integral part of the consolidated financial statements

The Company accounts for its stock options using the intrinsic value method contained in APB Opinion No. 25. “Accounting for Stock Issued to Employees.” If the Company had accounted for options using the methods contained in FASB Statement No. 123, “Accounting for Stock-Based Compensation”, net income (loss) and earnings (loss) per share would have been presented as follows for the periods ended June 30, 2005 and 2004:

Stock options issued after April 30, 2004 were valued using the Binomial model rather than the Black-Scholes-Merton formula. The difference in valuation between the two methods was not material.

During the second quarter, the Company sold two properties located in Florida comprised of 96 manufactured housing sites and 165 recreational vehicle sites for a combined sales price of $5.7 million. These transactions resulted in a $0.8 million gain.

In accordance with FAS 144, effective for financial statements issued for all fiscal years beginning after December 15, 2001, results of operations and gain/(loss) on sales of real estate for properties with identifiable cash flows sold subsequent to December 31, 2001 are reflected in the Consolidated Statements of Operations as income from discontinued operations for all periods presented. Below is a summary of the results of operations of sold properties through their respective disposition dates (in thousands):

For the periods ended June 30, 2005 and 2004:

The Company also has the following potentially convertible securities which, if converted, may impact dilution:

The following discussion and analysis of the consolidated financial condition and results of operations should be read in conjunction with the consolidated financial statements and the notes thereto. Capitalized terms are used as defined elsewhere in this Form 10-Q.

The Company had identified significant accounting policies that, as a result of the judgments, uncertainties, uniqueness and complexities of the underlying accounting standards and operations involved, could result in material changes to its financial condition or result of operations under different conditions or using different assumptions. Details regarding the Company’s significant accounting policies are described fully in the Company’s 2004 Annual Report filed with the Securities and Exchange Commission on Form 10-K. During the six months ended June 30, 2005, there have been no material changes to the Company’s significant accounting policies that impacted the Company’s financial condition or results of operations.

For the three months ended June 30, 2005, income from operations before minority interest (excluding second quarter 2004 costs associated with the extinguishment of $345 million of unsecured debt of $57.2 million) decreased by $5.8 million from $4.2 million to a loss of $(1.6) million, when compared to the three months ended June 30, 2004. The decrease was due to increased expenses of $7.4 million, offset by increased revenues of $1.5 million and increased equity income from affiliate of $0.1 million as described in more detail below.

Income from rental property increased by $3.5 million from $40.4 million to $43.9 million, or 8.7 percent, due to acquisitions ($1.9 million) and rent increases and other community revenues ($1.6 million).

Revenues from home sales decreased by $1.6 million from $6.0 million to $4.4 million, or 26.7 percent, due primarily to a decline in the number of homes sold.

Ancillary revenues, net increased by $0.2 million from $0.5 million to $0.7 million due primarily to increased lease revenues provided by the Company’s rental program.

Interest income decreased by $0.4 million from $1.5 million to $1.1 million, or 26.7 percent, due primarily to a decrease in interest earning notes and receivables.

Other operating income decreased by $0.2 million from $0.2 million to a loss of less than $0.1 million due primarily to a loss associated with disposition of miscellaneous assets.

Property operating and maintenance expenses increased by $1.5 million from $10.0 million to $11.5 million, or 15.0 percent. The increase was due to increases in utility costs ($0.3 million), payroll expense ($0.4 million), repair and maintenance expense ($0.3 million), seminars and conventions costs related to the Company’s biennial conference for its community managers ($0.2 million), cable TV costs ($0.1 million), and other miscellaneous expenses ($0.2 million).

Cost of home sales decreased by $1.5 million from $5.1 million to $3.6 million, or 29.4 percent, due primarily to a decline in the number of homes sold.

Real estate taxes increased by $0.5 million from $3.3 million to $3.8 million, or 15.2 percent, due primarily to increases in assessments and tax rates.

General and administrative expenses for rental property increased by $1.0 million from $2.6 million to $3.6 million, or 38.5 percent, due to an increase in payroll, benefits, and consulting expenses ($0.7 million), legal costs ($0.2 million), and other miscellaneous expenses ($0.1 million).

Depreciation and amortization increased by $2.7 million from $10.8 million to $ 13.5 million, or 25.0 percent, due primarily to change in estimated useful lives of homes utilized in the Company’s rental program. The change was prospectively adopted during the first quarter of 2005.

Interest expense increased by $3.4 million from $11.2 million to $14.6 million, or 30.4 percent, primarily due to increased debt levels somewhat offset by lower interest rates.

The settlement of the Company’s insurance claim relating to the Florida hurricanes of 2004 justified a reduction of $0.1 million in the Company’s previously recorded reserve for loss.

For the six months ended June 30, 2005, income from operations before minority interest decreased by $11.3 million from $11.3 million to a loss of less than $(0.1) million, when compared to the six months ended June 30, 2004 (excluding $57.2 million of costs incurred in 2004 and associated with the extinguishment of $345 million of unsecured debt). The decrease was due to increased expenses of $14.6 million, decreased equity income from affiliate of $0.2 million, offset by increased revenues of $3.5 million as described in more detail below.

Income from rental property increased by $6.4 million from $83.0 million to $89.4 million, or 7.7 percent, due to acquisitions ($3.8 million) and rent increases and other community revenues ($2.6 million).

Revenues from home sales decreased by $1.8 million from $9.9 million to $8.1 million, or 18.2 percent, due primarily to a decline in the number of homes sold.

Ancillary revenues, net, increased by $0.1 million from $1.1 million to $1.2 million due primarily to increased lease revenues provided by the Company’s rental program.

Interest income decreased by $0.5 million from $3.2 million to $2.7 million, or 15.6 percent, due primarily to a decrease in interest earning notes and receivables.

Other operating income decreased by $0.7 million from $0.5 million to a loss of $(0.2) million due primarily to a loss associated with disposition of miscellaneous assets ($0.4 million) and an increase in expenditures on unsuccessful acquisitions ($0.3 million).

Property operating and maintenance expenses increased by $2.3 million from $20.1 million to $22.4 million, or 11.4 percent. The increase was due to increases in utility costs ($0.7 million), payroll expense ($0.5 million), repair and maintenance expenses ($0.4 million), seminars and conventions costs related to the Company’s biennial conference for its community managers ($0.2 million), cable TV costs ($0.2 million), and other miscellaneous expenses ($0.3 million).

Cost of home sales decreased by $2.2 million from $8.2 million to $6.0 million, or 26.8 percent, due primarily to a decline in the number of homes sold.

Real estate taxes increased by $1.1 million from $6.5 million to $7.6 million, or 16.9 percent, due primarily to increases in assessments and tax rates.

General and administrative expenses for rental property increased by $1.7 million from $5.4 million to $7.1 million, or 31.5 percent, due to an increase in payroll, benefits, and consulting expenses ($1.1 million), legal costs ($0.5 million), and other miscellaneous expenses ($0.1 million).

Depreciation and amortization increased by $4.5 million from $22.0 million to $26.5 million, or 20.5 percent, due primarily to change in estimated useful lives of homes utilized in the Company’s rental program. The change was prospectively adopted during the first quarter of 2005.

Interest expense increased by $7.8 million from $21.5 million to $29.3 million, or 36.3 percent, primarily due to increased debt levels somewhat offset by lower interest rates.

The settlement of the Company’s insurance claim relating to the Florida hurricanes of 2004 justified a reduction of $0.6 million in the Company’s previously recorded reserve for loss.

The following table reflects property-level financial information as of and for the three months ended June 30, 2005 and 2004. The “Same Property” data represents information regarding the operation of communities owned as of January 1, 2004 and June 30, 2005. Site, occupancy, and rent data for those communities is presented as of the last day of each period presented. The “Total Portfolio” column differs from the “Same Property” column by including financial and statistical information for new development and acquisition communities.

On a same property basis, property net operating income increased by $1.1 million from $55.7 million to $56.8 million, or 2.0 percent. Income from rental property increased by $2.0 million from $77.5 million to $79.5 million, or 2.6 percent, due primarily to increases in rents including water and property tax pass through. Property operating expenses increased by $1.0 million from $21.7 million to $22.7 million, or 4.6 percent, due primarily to increases in real estate taxes and utility expenses.

The Company’s principal liquidity demands have historically been, and are expected to continue to be, distributions to the Company’s stockholders and the unitholders of the Operating Partnership, property acquisitions, development and expansion of properties, capital improvements of properties, the purchase of new and pre-owned homes and debt repayment.

The Company expects to meet its short-term liquidity requirements through its working capital provided by operating activities and through its $115.0 million line of credit. The Company considers these resources to be adequate to meet all operating requirements, including recurring capital improvements, routinely amortizing debt and other normally recurring expenditures of a capital nature, pay dividends to its stockholders to maintain qualification as a REIT in accordance with the Internal Revenue Code and make distributions to the Operating Partnership’s unitholders.

The Company plans to invest approximately $5 million in developments consisting of expansions to existing communities and the development of new communities during 2005. The Company expects to finance these investments by using net cash flows provided by operating activities and by drawing upon its line of credit.

Furthermore, the Company may invest substantial amounts in the acquisition of properties during 2005, depending upon a number of factors, including the availability of high-quality properties that meet the Company’s criteria for acquisition. The Company will finance these investments using the proceeds from its secured financing transactions, the temporary use of its line of credit until permanent secured financing can be arranged and through the assumption of existing debt on the properties.

The Company has also invested approximately $35 million in the acquisition of homes primarily intended for its rental program. Expenditures for the reminder of 2005 will be dependent upon the condition of the markets for repossessions and new home sales as well as rental homes.

Cash and cash equivalents decreased by $49.2 million to $3.4 million at June 30, 2005 compared to $52.6 million at December 31, 2004. Net cash provided by operating activities increased by $8.4 million to $30.7 million for the six months ended June 30, 2005 compared to $22.3 million for the six months ended June 30, 2004.

The Company’s net cash flows provided by operating activities may be adversely impacted by, among other things: (a) the market and economic conditions in the Company’s current markets generally, and specifically in metropolitan areas of the Company’s current markets; (b) lower occupancy and rental rates of the Company’s properties (the “Properties”); (c) increased operating costs, including insurance premiums, real estate taxes and utilities, that cannot be passed on to the Company’s tenants; and (d) decreased sales of manufactured homes. See “Factors That May Affect Future Results” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

The Company anticipates meeting its long-term liquidity requirements, such as scheduled debt maturities, large property acquisitions, and Operating Partnership unit redemptions through the collateralization of a significant portion of its properties. From time to time, the Company may also issue shares of its capital stock, issue equity units in the Operating Partnership or sell selected assets. The ability of the Company to finance its long-term liquidity requirements in such manner will be affected by numerous economic factors affecting the manufactured housing community industry at the time, including the availability and cost of mortgage debt, the financial condition of the Company, the operating history of the Properties, the state of the debt and equity markets, and the general national, regional and local economic conditions. See “Factors That May Affect Future Results” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004. If the Company is unable obtain additional debt or equity financing on acceptable terms, the Company’s business, results of operations and financial condition will be adversely impacted.

At June 30, 2005, the Company’s debt to total market capitalization approximated 58.6 percent (assuming conversion of all Common OP Units to shares of common stock). The debt has a weighted average maturity of approximately 8.2 years and a weighted average interest rate of 5.2 percent.

Capital expenditures for the six months ended June 30, 2005 and 2004 included recurring capital expenditures of $3.3 million and $3.0 million, respectively.

Net cash used in investing activities decreased by $114.9 million to $(3.8) million for the six months ended June 30, 2005 compared to $(118.7) million used in investing activities for the six months ended June 30, 2004. This increase was due to a $107.0 million increase in net proceeds from sale of short-term investments, decreased investment in rental property of $36.2 million, a $3.4 million increase in proceeds related to property dispositions and a $0.2 million decrease in distribution from affiliate, offset by a $19.6 decrease in notes receivable and officers’ notes, net, and a $12.3 million decrease in proceeds from sales of installments loans to Origen.

Net cash used in financing activities increased by $192.6 million to $(76.1) million for the six months ended June 30, 2005 when compared to $116.5 million provided by financing activities for the six months ended June 30, 2004. This increase was primarily due to a $143.3 million decrease in net proceeds from notes payable and other debt, inclusive of borrowings on line of credit, payments to retire Perpetual Preferred Operating Partnership Units of $50.0 million, and a $9.6 million decrease of proceeds from issuance of common stock, offset by a $6.8 million decrease in payments for deferred financing costs, a $2.2 million decrease in purchases of Company stock under a one million share buy back authorization, and a $1.3 million decrease in distributions.

     Funds from operations (“FFO”) is defined by the National Association of Real Estate Investment Trusts (“NAREIT”) as net income (computed in accordance with generally accepted accounting principles), excluding gains (or losses) from sales of depreciable operating property, plus real estate-related depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. FFO is a non-GAAP financial measure that management believes is a useful supplemental measure of the Company’s operating performance. Management generally considers FFO to be a useful measure for reviewing comparative operating and financial performance because, by excluding gains and losses related to sales of previously depreciated operating real estate assets and excluding real estate asset depreciation and amortization (which can vary among owners of identical assets in similar condition based on historical cost accounting and useful life estimates), FFO provides a performance measure that, when compared year over year, reflects the impact to operations from trends in occupancy rates, rental rates and operating costs, providing perspective not readily apparent from net income. Management believes that the use of FFO has been beneficial in improving the understanding of operating results of REITs among the investing public and making comparisons of REIT operating results more meaningful.

     Because FFO excludes significant economic components of net income including depreciation and amortization, FFO should be used as an adjunct to net income and not as an alternative to net income. The principal limitation of FFO is that it does not represent cash flow from operations as defined by GAAP and is a supplemental measure of performance that does not replace net income as a measure of performance or net cash provided by operating activities as a measure of liquidity. In addition, FFO is not intended as a measure of a REIT’s ability to meet debt principal repayments and other cash requirements, nor as a measure of working capital. FFO only provides investors with an additional performance measure. Other REITS may use different methods for calculating FFO and, accordingly, the Company’s FFO may not be comparable to other REITs.

The following table reconciles net income to FFO and calculates both basic and diluted FFO per share for the periods ended June 30, 2005 and 2004 (in thousands):

This Form 10-Q contains various “forward-looking statements” within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934, and the Company intends that such forward-looking statements will be subject to the safe harbors created thereby. For this purpose, any statements contained in this filing that relate to prospective events or developments are deemed to be forward-looking statements. Words such as “believes,” “forecasts,” “anticipates,” “intends,” “plans,” “expects,” “may”, “will” and similar expressions are intended to identify forward-looking statements. These forward-looking statements reflect the Company’s current views with respect to future events and financial performance, but involve known and unknown risks and uncertainties, both general and specific to the matters discussed in this filing. These risks and uncertainties may cause the actual results of the Company to be materially different from any future results expressed or implied by such forward looking statements. Such risks and uncertainties include the national, regional and local economic climates, the ability to maintain rental rates and occupancy levels, competitive market forces, changes in market rates of interest, the ability of manufactured home buyers to obtain financing, the level of repossessions by manufactured home lenders and those referenced under the headings entitled “Factors That May Affect Future Results” or “Risk Factors” contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 and the Company’s filings with the Securities and Exchange Commission. The forward-looking statements contained in this Form 10-Q speak only as of the date hereof and the Company expressly disclaims any obligation to provide public updates, revisions or amendments to any forward-looking statements made herein to reflect changes in the Company’s expectations of future events.

The Company’s principal market risk exposure is interest rate risk. The Company mitigates this risk by maintaining prudent amounts of leverage, minimizing capital costs and interest expense while continuously evaluating all available debt and equity resources and following established risk management policies and procedures, which include the periodic use of derivatives. The Company’s primary strategy in entering into derivative contracts is to minimize the variability that changes in interest rates could have on its future cash flows. The Company generally employs derivative instruments that effectively convert a portion of its variable rate debt to fixed rate debt. The Company does not enter into derivative instruments for speculative purposes.

The Company’s variable rate debt totals $124.9 million and $81.2 million as of June 30, 2005 and 2004, respectively, which bears interest at various Prime and LIBOR/DMBS rates. If Prime or LIBOR/DMBS increased or decreased by 1.00 percent during the six months ended June 30, 2005 and 2004, the Company believes its interest expense would have increased or decreased by approximately $1.1 million and $2.5 million based on the $111.5 million and $245.9 million average balance outstanding under the Company’s variable rate debt facilities for the six months ended June 30, 2005 and 2004, respectively.

Additionally, the Company had $14.7 million LIBOR based variable rate mortgage and other notes receivables as of June 30, 2005 and 2004. If LIBOR increased or decreased by 1.0 percent during the six months ended June 30, 2005 and 2004, the Company believes interest income would have increased or decreased by approximately $0.1 million and $0.2 million based on the $14.7 million and $24.0 million average balance outstanding on all variable rate notes receivable for the six months ended June 30, 2005 and 2004, respectively.

The Company has entered into three separate interest rate swap agreements and an interest rate cap agreement. One of these swap agreements fixes $25 million of variable rate borrowings at 4.93 percent for the period April 2003 through July 2009, another of these swap agreements fixes $25 million of variable rate borrowings at 5.37 percent for the period April 2003 through July 2012 and the third swap agreement, which is only effective for so long as 90-day LIBOR is 7 percent or less, fixes $25 million of variable rate borrowings at 3.97 percent for the period April 2003 through July 2007. The interest rate cap agreement has a cap rate of 9.49 percent, a notional amount of $152.4 million and a termination date of April 13, 2006. Each of the Company’s derivative contracts is based upon 90-day LIBOR.

The Board of Directors authorized a program to purchase up to 1,000,000 shares of the Company’s common stock on November 15, 2004. The results of this stock repurchase program for the three months ended June 30, 2005 are as follows:

On May 24, 2005, the Company held its Annual Meeting of Shareholders. The following matters were voted upon at the meeting: