ITEM 1.
BUSINESS
General
We are a self-administered and self-managed real estate investment trust, or REIT. We own, operate, and develop manufactured housing communities concentrated in the midwestern and southeastern United States. We are a fully integrated real estate company which, together with our affiliates and predecessors, have been in the business of acquiring, operating and expanding manufactured housing communities since 1975. As of December 31, 2007, we owned and operated a portfolio of 136 properties located in eighteen states (the “Properties” or “Property”), including 124 manufactured housing communities, four recreational vehicle communities, and eight properties containing both manufactured housing and recreational vehicle sites. As of December 31, 2007, the Properties contained an aggregate of 47,607 developed sites comprised of 42,266 developed manufactured home sites and 5,341 recreational vehicle sites and an additional 6,588 manufactured home sites suitable for development. In order to enhance property performance and cash flow, the Company, through Sun Home Services, Inc., a Michigan corporation (“SHS”), actively markets, sells and leases new and pre-owned manufactured homes for placement in the Properties.
Our executive and principal property management office is located at 27777 Franklin Road, Suite 200, Southfield, Michigan 48034 and our telephone number is (248) 208-2500. We have regional property management offices located in Austin, Texas; Dayton, Ohio; Grand Rapids, Michigan; Elkhart, Indiana; and Orlando, Florida, and we employed an aggregate of 646 people as of December 31, 2007.
Our website address is www.suncommunities.com and we make available, free of charge, on or through our website all of our periodic reports, including our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, as soon as reasonably practicable after we file such reports with the Securities and Exchange Commission.
Recent Developments
Change in Date of Annual Meeting. In the past, the Company has typically held its annual meeting of shareholders (the “Annual Meeting”) during the third week of May. This year the Company will hold its Annual Meeting on July 18. In future years, the Company intends to hold the Annual Meeting during the month of July. The Company intends to file its proxy statement for the 2008 Annual Meeting on or about April 30, 2008. Due to the timing of the filing of the proxy statement, the deadline for submitting shareholder proposal for consideration at the 2008 Annual Meeting will not be extended.
Change in Management. As announced on February 6, 2008, the Company appointed Karen J. Dearing, who has served as the Company’s Corporate Controller since 2002, as the Company’s Chief Financial Officer, and John B. McLaren, previously Senior Vice President of Home Sales and Leasing, as Chief Operating Officer. Ms. Dearing and Mr. McLaren succeed Jeffrey P. Jorissen, former Chief Financial Officer, and Brian W. Fannon, former Chief Operating Officer, who remain with the Company as Senior Advisor to Senior Management and President, respectively.
Investment in Affiliate. The Company recognized a $1.9 million impairment to the carrying value of its investment in Origen Financial, Inc. (“Origen”) at December 31, 2007. Also, included in equity loss from affiliate in 2007 is an $8.0 million loss attributable to the Company’s portion of Origen’s goodwill and investment impairment charges of $32.3 million and $9.2 million, respectively. On March 13, 2008, Origen announced that recent and current conditions in the credit markets have adversely impacted Origen’s business and financial condition to the extent that it has determined to suspend loan originations for its own account and has taken steps to right-size its work force. Origen also announced that: (a) its warehouse facility expires on March 14, 2008, and Origen expects to sell its loans that collateralize this facility and use most of the proceeds to pay off the warehouse line; (b) approximately $50.0 million under its supplemental facility, which expires March 14, 2008, has been extended to June 13, 2008, subject to certain conditions; and (c) its Board of Directors is assessing possible courses of action, including continuation of a pared down business, possible sale of certain assets or possible sale of the entire company.
Share-based Compensation. As of December 30, 2007, the Company modified certain terms of performance-based restricted stock and phantom performance-based liability awards to key executives which were to be earned based on compounded annual growth in FFO per diluted share/OP unit over a five year period. In March 2008, the awards were cancelled.
Debt. In January of 2007, the Company completed financings of $17.5 million and $20.0 million at interest rates of 5.842 percent and 5.825 percent, respectively. The loans are secured by two properties and have interest only payments for a term of 10 years. The proceeds from both financings were used to pay down the Company’s revolving line of credit.
In April of 2007, the Company extended $15.8 million of debt with an original maturity date of April 1, 2007. The transaction extended the maturity date of the debt until April 1, 2012, and reduced the spread over LIBOR by 0.25 percent. As part of the transaction the Company paid down the principal balance of the debt by $1.0 million. The transaction was accounted for as a modification of debt.
Mortgage Note Receivable. On March 1, 2007, a $13.5 million mortgage note receivable was repaid by the borrower.
Structure of the Company
Structured as an umbrella partnership REIT, or UPREIT, Sun Communities Operating Limited Partnership, a Michigan limited partnership (the “Operating Partnership”), is the entity through which we conduct substantially all of our operations, and which owns, either directly or indirectly through subsidiaries, all of our assets (the subsidiaries, collectively with the Operating Partnership, the “Subsidiaries”). This UPREIT structure enables us to comply with certain complex requirements under the Federal tax rules and regulations applicable to REITs, and to acquire manufactured housing communities in transactions that defer some or all of the sellers’ tax consequences. We are the sole general partner of, and, as of December 31, 2007, held approximately 88.8% of the interests (not including preferred limited partnership interests) in, the Operating Partnership. The Subsidiaries also include SHS, which provides manufactured home sales and other services to current and prospective tenants of the Properties.
The Manufactured Housing Community Industry
A manufactured housing community is a residential subdivision designed and improved with sites for the placement of manufactured homes and related improvements and amenities. Manufactured homes are detached, single-family homes which are produced off-site by manufacturers and installed on sites within the community. Manufactured homes are available in a wide array of designs, providing owners with a level of customization generally unavailable in other forms of multifamily housing.
Modern manufactured housing communities, such as the Properties, contain improvements similar to other garden-style residential developments, including centralized entrances, paved streets, curbs and gutters, and parkways. In addition, these communities also often provide a number of amenities, such as a clubhouse, a swimming pool, shuffleboard courts, tennis courts, laundry facilities and cable television service.
The owner of each home on our Properties leases the site on which the home is located. We own the underlying land, utility connections, streets, lighting, driveways, common area amenities and other capital improvements and are responsible for enforcement of community guidelines and maintenance. Some of the Properties provide water and sewer service through public or private utilities, while others provide these services to residents from on-site facilities. Each owner within our Properties is responsible for the maintenance of the home and leased site. As a result, capital expenditure needs tend to be less significant, relative to multi-family rental apartment complexes.
Property Management
Our property management strategy emphasizes intensive, hands-on management by dedicated, on-site district and community managers. We believe that this on-site focus enables us to continually monitor and address tenant concerns, the performance of competitive properties and local market conditions. Of the 646 Company employees, approximately 537 are located on-site as property managers, support staff, or maintenance personnel.
Throughout 2007, our community managers were overseen by Brian W. Fannon, Chief Operating Officer, who has 38 years of property management experience, three Senior Vice Presidents of Operations and thirteen Regional Vice Presidents. In addition, the Regional Vice Presidents are responsible for semi-annual market surveys of competitive communities, interaction with local manufactured home dealers and regular property inspections. In February 2008, Mr. Fannon was named President of the Company and was succeeded as Chief Operating Officer by John B. McLaren.
Each district or community manager performs regular inspections in order to continually monitor the Property’s physical condition and provides managers with the opportunity to understand and effectively address tenant concerns. In addition to a district or community manager, each district or property has an on-site maintenance personnel and management support staff. We hold periodic training sessions for all property management personnel to ensure that management policies are implemented effectively and professionally.
Home Sales and Leasing
SHS is in the manufactured home market offering manufactured home sales and leasing services to tenants and prospective tenants of our communities. Since tenants often purchase a home already on-site within a community, such services enhance occupancy and property performance. Additionally, because many of the homes on the Properties are sold through SHS, better control of home quality in our communities can be maintained than if sales services were conducted solely through third-party brokers. In recent years SHS also began leasing homes to prospective tenants. At December 31, 2007, SHS had 5,328 occupied leased homes in its portfolio. Homes for this rental program are purchased at discounted rates from finance companies that hold repossessed homes within the Company’s communities. New homes are purchased as necessary to supplement these repossessed home purchases. Leases associated with the rental program are, in general, one year leases. This program requires intensive management of costs associated with repair and refurbishment of these homes as the tenants vacate and the homes are re-leased, similar to apartment rentals. The Company has added Repair and Service Supervisors in areas with high concentrations of rental homes to aggressively pursue cost containment programs. The program is a strategic response to capture the value inherent in the purchase of substantially discounted repossessed homes in the Company’s communities. The growth of the leasing program has slowed as new repossessions appear to have peaked. Additional reductions in the leasing program may occur as rental homes are sold.
Regulations and Insurance
General. Manufactured housing community properties are subject to various laws, ordinances and regulations, including regulations relating to recreational facilities such as swimming pools, clubhouses and other common areas. We believe that each Property has the necessary operating permits and approvals.
Insurance. Our management believes that the Properties are covered by adequate fire, flood, property and business interruption insurance provided by reputable companies with commercially reasonable deductibles and limits. We maintain a blanket policy that covers all of our Properties. We have obtained title insurance insuring fee title to the Properties in an aggregate amount which we believe to be adequate.
Corporate Governance
We have implemented the following corporate governance initiatives to address certain legal requirements promulgated under the Sarbanes-Oxley Act of 2002, as well as the New York Stock Exchange corporate governance listing standards:
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Our Board of Directors has determined that each member of the Audit Committee (Clunet R. Lewis, Robert H. Naftaly and Stephanie W. Bergeron), qualify as “audit committee financial experts” as such term is defined under Item 401 of Regulation S-K. Mr. Lewis, Mr. Naftaly and Ms. Bergeron are “independent” as that term is used in Item 7(d)(3)(iv) of Schedule 14A under the Exchange Act.
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Our Audit Committee adopted our Audit and Non-Audit Services Pre-Approval Policy, which sets forth the procedures and the conditions pursuant to which permissible services to be performed by our independent public accountants may be pre-approved.
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Our Board of Directors adopted a Financial Code of Ethics for Senior Financial Officers, which governs the conduct of our senior financial officers. A copy of this code is available on our website at www.suncommunities.com under the heading “Investor Relations”, “Officers and Directors” and subheading “Governance Documents” and is also available in print to any stockholder upon written request addressed to Investor Relations, Sun Communities, Inc., 27777 Franklin Road, Suite 200, Southfield, Michigan 48034.
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Our Board of Directors established and adopted charters for each of its Audit, Compensation and Nominating and Corporate Governance Committees. Each committee is comprised of three (3) independent directors. A copy of each of these charters is available on our website at www.suncommunities.com under the heading “Investor Relations”, “Officers and Directors” and subheading “Governance Documents” and is also available in print to any stockholder upon written request addressed to Investor Relations, Sun Communities, Inc., 27777 Franklin Road, Suite 200, Southfield, Michigan 48034.
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Our Board of Directors adopted a Code of Business Conduct and Ethics, which governs business decisions made and actions taken by our directors, officers and employees. A copy of this code is available on our website at www.suncommunities.com under the heading “Investor Relations”, “Officers and Directors” and subheading “Governance Documents” and is also available in print to any stockholder upon written request addressed to Investor Relations, Sun Communities, Inc., 27777 Franklin Road, Suite 200, Southfield, Michigan 48034.
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Our Board of Directors adopted Corporate Governance Guidelines, a copy of which is available on our website at www.suncommunities.com under the heading “Investor Relations”, “Officers and Directors” and subheading “Governance Documents” and is also available in print to any stockholder upon written request addressed to Investor Relations, Sun Communities, Inc., 27777 Franklin Road, Suite 200, Southfield, Michigan 48034.
ITEM 1A.
ITEM 1A.
RISK FACTORS
Risk Factors
Our prospects are subject to certain uncertainties and risks. Our future results could differ materially from current results, and our actual results could differ materially from those projected in forward-looking statements as a result of certain risk factors. These risk factors include, but are not limited to, those set forth below, other one-time events, and important factors disclosed previously and from time to time in other Company filings with the Securities and Exchange Commission. This report contains certain forward-looking statements.
Real Estate Risks
General economic conditions and the concentration of our properties in Michigan, Florida, and Indiana may affect our ability to generate sufficient revenue.
The market and economic conditions in our current markets generally, and specifically in metropolitan areas of our current markets, may significantly affect manufactured home occupancy or rental rates. Occupancy and rental rates, in turn, may significantly affect our revenues, and if our communities do not generate revenues sufficient to meet our operating expenses, including debt service and capital expenditures, our cash flow and ability to pay or refinance our debt obligations could be adversely affected. We derived significant amounts of rental income for the period ended December 31, 2007 from properties located in Michigan, Florida, and Indiana. As of December 31, 2007, 47 of our 136 Properties, or approximately 30% of developed sites, are located in Michigan, 19 Properties, or approximately 21% of developed sites, are located in Florida, and 18 Properties, or approximately 14% of developed sites, are located in Indiana. As a result of the geographic concentration of our Properties in Michigan, Florida, and Indiana, we are exposed to the risks of downturns in the local economy or other local real estate market conditions which could adversely affect occupancy rates, rental rates and property values of properties in these markets.
The following factors, among others, may adversely affect the revenues generated by our communities:
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the national and local economic climate which may be adversely impacted by, among other factors, plant closings and industry slowdowns;
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local real estate market conditions such as the oversupply of manufactured housing sites or a reduction in demand for manufactured housing sites in an area;
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the number of repossessed homes in a particular market;
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the lack of an established dealer network;
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the rental market which may limit the extent to which rents may be increased to meet increased expenses without decreasing occupancy rates;
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the perceptions by prospective tenants of the safety, convenience and attractiveness of the Properties and the neighborhoods where they are located;
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zoning or other regulatory restrictions;
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competition from other available manufactured housing sites and alternative forms of housing (such as apartment buildings and site-built single-family homes);
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our ability to provide adequate management, maintenance and insurance;
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increased operating costs, including insurance premiums, real estate taxes and utilities; or
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the enactment of rent control laws or laws taxing the owners of manufactured homes.
Our income would also be adversely affected if tenants were unable to pay rent or if sites were unable to be rented on favorable terms. If we were unable to promptly relet or renew the leases for a significant number of the sites, or if the rental rates upon such renewal or reletting were significantly lower than expected rates, then our business and results of operations could be adversely affected. In addition, certain expenditures associated with each equity investment (such as real estate taxes and maintenance costs) generally are not reduced when circumstances cause a reduction in income from the investment. Furthermore, real estate investments are relatively illiquid and, therefore, will tend to limit our ability to vary our portfolio promptly in response to changes in economic or other conditions.
Competition affects occupancy levels and rents which could adversely affect our revenues.
All of our Properties are located in developed areas that include other manufactured housing community properties. The number of competitive manufactured housing community properties in a particular area could have a material adverse effect on our ability to lease sites and increase rents charged at our Properties or at any newly acquired properties. We may be competing with others with greater resources and whose officers and directors have more experience than our officers and directors. In addition, other forms of multi-family residential properties, such as private and federally funded or assisted multi-family housing projects and single-family housing, provide housing alternatives to potential tenants of manufactured housing communities.
Our ability to sell or lease manufactured homes may be affected by various factors, which may in turn adversely affect our profitability.
SHS is in the manufactured home market offering manufactured home sales and leasing services to tenants and prospective tenants of our communities. The market for the sale and lease of manufactured homes may be adversely affected by the following factors:
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downturns in economic conditions which adversely impact the housing market;
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an oversupply of, or a reduced demand for, manufactured homes;
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the difficulty facing potential purchasers in obtaining affordable financing as a result of heightened lending criteria; and
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an increase or decrease in the rate of manufactured home repossessions which provide aggressively priced competition to new manufactured home sales.
Any of the above listed factors could adversely impact our rate of manufactured home sales and leases, which would result in a decrease in profitability.
Increases in taxes and regulatory compliance costs may reduce our revenue.
Costs resulting from changes in real estate laws, income taxes, service or other taxes, generally are not passed through to tenants under leases and may adversely affect our funds from operations and our ability to pay or refinance our debt. Similarly, changes in laws increasing the potential liability for environmental conditions existing on properties or increasing the restrictions on discharges or other conditions may result in significant unanticipated expenditures, which would adversely affect our business and results of operations.
We may not be able to integrate or finance our development activities.
From time to time, we engage in the construction and development of new communities, and may continue to engage in the development and construction business in the future. Our development and construction business may be exposed to the following risks which are in addition to those risks associated with the ownership and operation of established manufactured housing communities:
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we may not be able to obtain financing with favorable terms for community development which may make us unable to proceed with the development;
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we may be unable to obtain, or face delays in obtaining, necessary zoning, building and other governmental permits and authorizations, which could result in increased costs and delays, and even require us to abandon development of the community entirely if we are unable to obtain such permits or authorizations;
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we may abandon development opportunities that we have already begun to explore and as a result we may not recover expenses already incurred in connection with exploring such development opportunities;
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we may be unable to complete construction and lease-up of a community on schedule resulting in increased debt service expense and construction costs;
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we may incur construction and development costs for a community which exceed our original estimates due to increased materials, labor or other costs, which could make completion of the community uneconomical and we may not be able to increase rents to compensate for the increase in development costs which may impact our profitability;
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we may be unable to secure long-term financing on completion of development resulting in increased debt service and lower profitability; and
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occupancy rates and rents at a newly developed community may fluctuate depending on several factors, including market and economic conditions, which may result in the community not being profitable.
If any of the above occurred, our business and results of operations could be adversely affected.
We may not be able to integrate or finance our acquisitions and our acquisitions may not perform as expected.
We acquire and intend to continue to acquire manufactured housing communities on a select basis. Our acquisition activities and their success are subject to the following risks:
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we may be unable to acquire a desired property because of competition from other well capitalized real estate investors, including both publicly traded real estate investment trusts and institutional investment funds;
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even if we enter into an acquisition agreement for a property, it is usually subject to customary conditions to closing, including completion of due diligence investigations to our satisfaction, which may not be satisfied;
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even if we are able to acquire a desired property, competition from other real estate investors may significantly increase the purchase price;
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we may be unable to finance acquisitions on favorable terms;
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acquired properties may fail to perform as expected;
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acquired properties may be located in new markets where we face risks associated with a lack of market knowledge or understanding of the local economy, lack of business relationships in the area and unfamiliarity with local governmental and permitting procedures; and
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we may be unable to quickly and efficiently integrate new acquisitions, particularly acquisitions of portfolios of properties, into our existing operations.
If any of the above occurred, our business and results of operations could be adversely affected.
In addition, we may acquire properties subject to liabilities and without any recourse, or with only limited recourse, with respect to unknown liabilities. As a result, if a liability were to be asserted against us based upon ownership of those properties, we might have to pay substantial sums to settle it, which could adversely affect our cash flow.
Rent control legislation may harm our ability to increase rents.
State and local rent control laws in certain jurisdictions may limit our ability to increase rents and to recover increases in operating expenses and the costs of capital improvements. Enactment of such laws has been considered from time to time in other jurisdictions. Certain Properties are located, and we may purchase additional properties, in markets that are either subject to rent control or in which rent-limiting legislation exists or may be enacted.
We may be subject to environmental liability.
Under various federal, state and local laws, ordinances and regulations, an owner or operator of real estate is liable for the costs of removal or remediation of certain hazardous substances at, on, under or in such property. Such laws often impose such liability without regard to whether the owner knew of, or was responsible for, the presence of such hazardous substances. The presence of such substances, or the failure to properly remediate such substances, may adversely affect the owner’s ability to sell or rent such property, to borrow using such property as collateral or to develop such property. Persons who arrange for the disposal or treatment of hazardous substances also may be liable for the costs of removal or remediation of such substances at a disposal or treatment facility owned or operated by another person. In addition, certain environmental laws impose liability for the management and disposal of asbestos-containing materials and for the release of such materials into the air. These laws may provide for third parties to seek recovery from owners or operators of real properties for personal injury associated with asbestos-containing materials. In connection with the ownership, operation, management, and development of real properties, we may be considered an owner or operator of such properties and, therefore, are potentially liable for removal or remediation costs, and also may be liable for governmental fines and injuries to persons and property. When we arrange for the treatment or disposal of hazardous substances at landfills or other facilities owned by other persons, we may be liable for the removal or remediation costs at such facilities.
All of the Properties have been subject to a Phase I or similar environmental audit (which involves general inspections without soil sampling or ground water analysis) completed by independent environmental consultants. These environmental audits have not revealed any significant environmental liability that would have a material adverse effect on our business. These audits cannot reflect conditions arising after the studies were completed, and no assurances can be given that existing environmental studies reveal all environmental liabilities, that any prior owner or operator of a property or neighboring owner or operator did not create any material environmental condition not known to us, or that a material environmental condition does not otherwise exist as to any one or more Properties.
Losses in excess of our insurance coverage or uninsured losses could adversely affect our cash flow.
We maintain comprehensive liability, fire, flood (where appropriate), extended coverage, and rental loss insurance on the Properties with policy specifications, limits, and deductibles which are customarily carried for similar properties. As a result of market conditions in the insurance industry, we carry a $250,000 deductible on our liability insurance. Certain types of losses, however, may be either uninsurable or not economically insurable, such as losses due to earthquakes, riots, or acts of war. In the event an uninsured loss occurs, we could lose both our investment in and anticipated profits and cash flow from the affected property. Any loss would adversely affect our ability to repay our debt.
Financing and Investment Risks
Our significant amount of debt could limit our operational flexibility or otherwise adversely affect our financial condition.
We have a significant amount of debt. As of December 31, 2007, we had approximately $1.2 billion of total debt outstanding, consisting of approximately $1.1 billion in debt that is collateralized by mortgage liens on 103 of the Properties (the “Mortgage Debt”), and approximately $135.2 million in unsecured debt. If we fail to meet our obligations under the Mortgage Debt, the lender would be entitled to foreclose on all or some of the Properties securing such debt which could have a material adverse effect on us and our ability to make expected distributions, and could threaten our continued viability.
We are subject to the risks normally associated with debt financing, including the following risks:
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our cash flow may be insufficient to meet required payments of principal and interest, or require us to dedicate a substantial portion of our cash flow to pay our debt and the interest associated with our debt rather than to other areas of our business;
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our existing indebtedness may limit our operating flexibility due to financial and other restrictive covenants, including restrictions on incurring additional debt;
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it may be more difficult for us to obtain additional financing in the future for our operations, working capital requirements, capital expenditures, debt service or other general requirements;
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we may be more vulnerable in the event of adverse economic and industry conditions or a downturn in our business;
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we may be placed at a competitive disadvantage compared to our competitors that have less debt; and
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we may not be able to re-finance at all or on favorable terms, as our debt matures.
If any of the above risks occurred, our financial condition and results of operations could be materially adversely affected.
We may be able to incur substantially more debt which would increase the risks associated with our substantial leverage.
Despite our current indebtedness levels, we may still be able to incur substantially more debt in the future. If new debt is added to our current debt levels, an even greater portion of our cash flow will be needed to satisfy our debt service obligations. As a result, the related risks that we now face could intensify and increase the risk of a default on our indebtedness.
Our equity investment in Origen Financial, Inc., may subject us to certain risks.
In October 2003, we purchased 5,000,000 shares of common stock of Origen Financial Inc, (“Origen”), (representing approximately 19% of the issued and outstanding shares of common stock as of December 31, 2007) for $50 million. Origen is a publicly traded real estate investment trust in the business of originating and servicing manufactured home loans. Our equity investment in Origen is subject to all of the risks associated with Origen’s business, including the availability of credit to fund new loans and for the periodic securitization of pools of loans that were previously originated. On March 13, 2008, Origen announced that the deterioration of the credit markets has adversely impacted Origen’s business and financial condition to the extent that it cannot continue to operate in the manner that it has previously conducted itself, which may have a material adverse effect on the value of our investment in Origen.. The Company recorded an impairment to the carrying value in its investment in Origen of $1.9 million and $18.0 million at December 31, 2007 and 2006, respectively. Additional information is included under “Recent Developments-Investment in Affiliate” and in Footnote 1.g. to our consolidated financial statements included herein.
The financial condition and solvency of our borrowers and the market value of our properties may adversely affect our investments in real estate, installment and other loans.
As of December 31, 2007, we had outstanding approximately $30.6 million in installment loans to owners of manufactured homes. These installment loans are collateralized by the manufactured homes. We may invest in additional mortgages and installment loans in the future. By virtue of our investment in the mortgages and the loans, we are subject to the following risks of such investment:
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the borrowers may not be able to make debt service payments or pay principal when due;
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the value of property securing the mortgages and loans may be less than the amounts owed; and
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interest rates payable on the mortgages and loans may be lower than our cost of funds.
If any of the above occurred, our business and results of operations could be adversely affected.
Tax Risks
We may suffer adverse tax consequences and be unable to attract capital if we fail to qualify as a REIT.
We believe that since our taxable year ended December 31, 1994, we have been organized and operated, and intend to continue to operate, so as to qualify for taxation as a REIT under the Internal Revenue Code (“Code”). Although we believe that we have been and will continue to be organized and have operated and will continue to operate so as to qualify for taxation as a REIT, we cannot assure you that we have been or will continue to be organized or operated in a manner to so qualify or remain so qualified. Qualification as a REIT involves the satisfaction of numerous requirements (some on an annual and quarterly basis) established under highly technical and complex Code provisions for which there are only limited judicial or administrative interpretations, and involves the determination of various factual matters and circumstances not entirely within our control. In addition, frequent changes occur in the area of REIT taxation, which require the Company continually to monitor its tax status.
If we fail to qualify as a REIT in any taxable year, we would be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates. Moreover, unless entitled to relief under certain statutory provisions, we also would be disqualified from treatment as a REIT for the four taxable years following the year during which qualification was lost. This treatment would reduce our net earnings available for investment or distribution to stockholders because of the additional tax liability to us for the years involved. In addition, distributions to stockholders would no longer be required to be made. Even if we qualify for and maintain our REIT status, we will be subject to certain federal, state and local taxes on our property and certain of our operations.
We intend for the Operating Partnership to qualify as a partnership, but we cannot guarantee that it will qualify.
We believe that the Operating Partnership has been organized as a partnership and will qualify for treatment as such under the Code. However, if the Operating Partnership is deemed to be a “publicly traded partnership,” it will be treated as a corporation instead of a partnership for federal income tax purposes unless at least 90% of its income is qualifying income as defined in the Code. The income requirements applicable to REITs and the definition of “qualifying income” for purposes of this 90% test are similar in most respects. Qualifying income for the 90% test generally includes passive income, such as specified types of real property rents, dividends and interest. We believe that the Operating Partnership would meet this 90% test, but we cannot guarantee that it would. If the Operating Partnership were to be taxed as a corporation, it would incur substantial tax liabilities, we would fail to qualify as a REIT for federal income tax purposes, and our ability to raise additional capital could be significantly impaired.
Our ability to accumulate cash is restricted due to certain REIT distribution requirements.
In order to qualify as a REIT, we must distribute to our stockholders at least 90% of our REIT taxable income (calculated without any deduction for dividends paid and excluding net capital gain) and to avoid federal income taxation, our distributions must not be less than 100% of our REIT taxable income, including capital gains. As a result of the distribution requirements, we do not expect to accumulate significant amounts of cash. Accordingly, these distributions could significantly reduce the cash available to us in subsequent periods to fund our operations and future growth.
Business Risks
Some of our directors and officers may have conflicts of interest with respect to certain related party transactions and other business interests.
Ownership of Origen. In October, 2003, the Company purchased 5,000,000 shares of Origen common stock for $50 million and Shiffman Origen LLC (which is owned by the Milton M. Shiffman Spouse’s Marital Trust, Gary A. Shiffman (the Company’s Chief Executive Officer), and members of Mr. Shiffman’s family) purchased 1,025,000 shares of Origen common stock for $10.25 million. Gary A. Shiffman is a member of the board of directors of Origen and Arthur A. Weiss, a director of the Company, is a trustee of the Milton M. Shiffman Spouse’s Marital Trust.
Accordingly, in all transactions involving Origen, Mr. Shiffman and/or Mr. Weiss may have a conflict of interest with respect to their respective obligations as an officer and/or director of the Company. The following are the current transactions and agreements involving Origen which may present a conflict of interest for Mr. Shiffman or Mr. Weiss:
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Origen Servicing Inc., a wholly owned subsidiary of Origen, services approximately $30.6 million of manufactured home loans for the Company as of December 31, 2007, for an annual servicing fee of 100 to 150 basis points of the outstanding principal balance of the loans pursuant to a Loan Servicing Agreement.
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Origen has agreed to fund loans that meet the Company’s underwriting guidelines and then transfer those loans at par to the Company pursuant to a Loan Origination, Sale and Purchase Agreement. During 2007 and 2006, the Company purchased $13.3 million and $7.9 million of these loans, respectively.
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The Company purchases certain repossessed manufactured houses owned by Origen located in its manufactured housing communities. The Company purchased approximately $1.1 million and $1.2 million of repossessed homes from Origen during 2007 and 2006. This program allows the Company to retain homes for resale and rent in its communities.
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As noted above, Origen services manufactured home loans for the Company under a Loan Servicing Agreement. Certain loans may, from time to time, be sold to Origen. For loans that are made below published rates, the Company will pay Origen the interest differential between market rates and the rate paid by the borrower for any such loans sold to Origen. In 2006, the Company sold a portfolio of installment loans on manufactured homes totaling approximately $4.1 million to a wholly-owned subsidiary of Origen Financial, Inc. for 100.5 percent of the principal balance for loans that were 89 days or less delinquent and 100 percent of the principal balance for loans that were 90 days or more delinquent. The Company recognized a gain on the sale of these notes of $0.02 million.
Tax Consequences Upon Sale of Properties. Gary A. Shiffman holds limited partnership interests in the Operating Partnership which were received in connection with the contribution of 24 properties (four of which have been sold) from partnerships previously affiliated with him (the “Sun Partnerships”). Prior to any redemption of these limited partnership interests for our common stock, Mr. Shiffman will have tax consequences different from those of us and our public stockholders on the sale of any of the Sun Partnerships. Therefore, Mr. Shiffman and the Company may have different objectives regarding the appropriate pricing and timing of any sale of those properties.
Lease of Executive Offices. Gary A. Shiffman, together with certain family members, indirectly owns approximately a 21 percent equity interest in American Center LLC, the entity from which we lease office space for our principal executive offices. Arthur A. Weiss owns a 0.75 percent indirect interest in American Center LLC. This lease was for an initial term of five years, beginning May 1, 2003, with the right to extend the lease for an additional five year term. On July 30, 2007 the Company exercised its option to extend its lease for its executive offices. The extension is for a period of five years commencing on May 1, 2008. The base rent for the option term will continue to be the same as the rent payable at the end of the current term. The current annual base rent under the current lease is $21.50 per square foot (gross). Mr. Shiffman and Mr. Weiss may have a conflict of interest with respect to their obligations as an officer and/or director of the Company and their ownership interest in American Center LLC.
We rely on key management.
We are dependent on the efforts of our executive officers, particularly Gary A. Shiffman, Brian W. Fannon, John B. McLaren, Karen J. Dearing and Jonathan M. Colman (together, the “Senior Officers”). As disclosed under “Legal Proceedings,” the SEC has initiated civil action against three of our employees, including Mr. Shiffman, with respect to our accounting of the SunChamp LLC, (“SunChamp”), investment during 2000, 2001 and 2002. The defense of this civil action may divert the time and attention of these employees, be costly to the Company and/or result in the loss of services, or change in duties, of one or more of these employees. The loss of services of one or more of our executive officers could have a temporary adverse effect on our operations. We do not currently maintain or contemplate obtaining any “key-man” life insurance on the Senior Officers.
Certain provisions in our governing documents may make it difficult for a third-party to acquire us.
9.8% Ownership Limit. In order to qualify and maintain our qualification as a REIT, not more than 50% of the outstanding shares of our capital stock may be owned, directly or indirectly, by five or fewer individuals. Thus, ownership of more than 9.8% of our outstanding shares of common stock by any single stockholder has been restricted, with certain exceptions, for the purpose of maintaining our qualification as a REIT under the Code. Such restrictions in our charter do not apply to Gary Shiffman, the Milton M. Shiffman Spouse’s Marital Trust and the Estate of Robert B. Bayer.
The 9.8% ownership limit, as well as our ability to issue additional shares of common stock or shares of other stock (which may have rights and preferences over the common stock), may discourage a change of control of the Company and may also: (1) deter tender offers for the common stock, which offers may be advantageous to stockholders; and (2) limit the opportunity for stockholders to receive a premium for their common stock that might otherwise exist if an investor were attempting to assemble a block of common stock in excess of 9.8% of the outstanding shares of the Company or otherwise effect a change of control of the Company.
Staggered Board. Our Board of Directors has been divided into three classes of directors. The term of one class will expire each year. Directors for each class will be chosen for a three-year term upon the expiration of such class’s term, and the directors in the other two classes will continue in office. The staggered terms for directors may affect the stockholders’ ability to change control of the Company even if a change in control were in the stockholders’ interest.
Preferred Stock. Our charter authorizes the Board of Directors to issue up to 10,000,000 shares of preferred stock and to establish the preferences and rights (including the right to vote and the right to convert into shares of common stock) of any shares issued. The power to issue preferred stock could have the effect of delaying or preventing a change in control of the Company even if a change in control were in the stockholders’ interest.
Rights Plan. We adopted a stockholders’ rights plan in 1998 that provides our stockholders (other than a stockholder attempting to acquire a 15% or greater interest in the Company) with the right to purchase stock in the Company at a discount in the event any person attempts to acquire a 15% or greater interest in the Company. Because this plan could make it more expensive for a person to acquire a controlling interest in the Company, it could have the effect of delaying or preventing a change in control of the Company even if a change in control were in the stockholders’ interest. The rights will expire at the close of business on June 8, 2008, unless earlier redeemed or exchanged by the Company.
Changes in our investment and financing policies may be made without stockholder approval.
Our investment and financing policies, and our policies with respect to certain other activities, including our growth, debt, capitalization, distributions, REIT status, and operating policies, are determined by our Board of Directors. Although the Board of Directors has no present intention to do so, these policies may be amended or revised from time to time at the discretion of the Board of Directors without notice to or a vote of our stockholders. Accordingly, stockholders may not have control over changes in our policies and changes in our policies may not fully serve the interests of all stockholders.
Substantial sales of our common stock could cause our stock price to fall.
Sales of a substantial number of shares of our common stock, or the perception that such sales could occur, could adversely affect prevailing market prices for shares. As of December 31, 2007, up to approximately 2,828,000 shares of our common stock may be issued in the future to the limited partners of the Operating Partnership in exchange for their Common or Convertible Preferred OP Units. The Preferred OP Units are convertible at $68. The limited partners may sell such shares pursuant to registration rights or an available exemption from registration. In 2008 and 2009, Water Oak, Ltd., a former owner of one of the Properties, may be issued Common OP Units with a value of approximately $1,250,000. In addition, as of December 31, 2007, options to purchase 286,137 shares of our common stock were outstanding under our 1993 Employee Stock Option Plan, our 1993 Non-Employee Director Stock Option Plan and our Long-Term Incentive Plan (the “Plans”). No prediction can be made regarding the effect that future sales of shares of our common stock will have on the market price of shares.
An increase in interest rates may have an adverse effect on the price of our common stock.
One of the factors that may influence the price of our common stock in the public market will be the annual distributions to stockholders relative to the prevailing market price of the common stock. An increase in market interest rates may tend to make the common stock less attractive relative to other investments, which could adversely affect the market price of our common stock.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
On July 13, 2006, the Company received a comment letter from the SEC with respect to its Form 10-Q for the quarter ended March 31, 2006. The Company has responded to the comments and has not received any further communication from the SEC on this matter. The Company believes it has appropriately addressed all of the issues raised by the SEC in the comment letter and considers the matter resolved.
ITEM 2.
ITEM 2.
PROPERTIES
General. As of December 31, 2007, the Properties consisted of 124 manufactured housing communities, four recreational vehicle communities, and eight properties containing both manufactured housing and recreational vehicle sites located in eighteen states concentrated in the midwestern and southeastern United States. As of December 31, 2007, the Properties contained 47,607 developed sites comprised of 42,266 developed manufactured home sites, 5,341 recreational vehicle sites and an additional 6,588 manufactured home sites suitable for development. Most of the Properties include amenities oriented toward family and retirement living. Of the 136 Properties, 69 have more than 300 developed manufactured home sites, with the largest having 979 developed manufactured home sites.
As of December 31, 2007, the Properties had an occupancy rate of 84 percent in stabilized communities and 71 percent in development communities and the aggregate occupancy rate was 82 percent excluding recreational vehicle sites. Since January 1, 2007, the Properties have averaged an aggregate annual turnover of homes (where the home is moved out of the community) of approximately 3.2 percent and an average annual turnover of residents (where the resident-owned home is sold and remains within the community, typically without interruption of rental income) of approximately 6.5 percent. The average renewal rate for residents in the Company’s rental program was approximately 50 percent for the year ended December 31, 2007.
We believe that our Properties’ high amenity levels contribute to low turnover and generally high occupancy rates. All of the Properties provide residents with attractive amenities with most offering a clubhouse, a swimming pool, laundry facilities and cable television service. Many Properties offer additional amenities such as sauna/whirlpool spas, tennis, shuffleboard and basketball courts and/or exercise rooms.
We have concentrated our communities within certain geographic areas in order to achieve economies of scale in management and operation. The Properties are principally concentrated in the midwestern and southeastern United States. We believe that geographic diversification helps to insulate the portfolio from regional economic influences.
The following table sets forth certain information relating to the properties owned or financed as of December 31, 2007:
Developed
Occupancy
Occupancy
Occupancy
Sites as of
as of
as of
as of
Property and Location
12/31/2007
12/31/07(1)
12/31/06(1)
12/31/05(1)
MIDWEST
Michigan
Academy/West Pointe
91%
94%
98%
Canton, MI
Allendale Meadows Mobile Village
78%
81%
84%
Allendale, MI
Alpine Meadows Mobile Village
85%
87%
94%
Grand Rapids, MI
Bedford Hills Mobile Village
78%
79%
85%
Battle Creek, MI
Brentwood Mobile Village
92%
95%
92%
Kentwood, MI
Byron Center Mobile Village
88%
91%
96%
Byron Center, MI
Candlewick Court
85%
87%
89%
Owosso, MI
College Park Estates
74%
74%
77%
Canton, MI
Continental Estates
43%
49%
54%
Davison, MI
Continental North
54%
58%
59%
Davison, MI
Country Acres Mobile Village
90%
88%
91%
Cadillac, MI
Country Meadows Mobile Village
89%
91%
92%
Flat Rock, MI
Countryside Village
80%
81%
89%
Perry, MI
Creekwood Meadows
64%
63%
67%
Burton, MI
Cutler Estates Mobile Village
84%
83%
91%
Grand Rapids, MI
Davison East
52%
63%
67%
Davison, MI
Falcon Pointe(6)
18%(6)
19%(6)
19%(6)
East Lansing, MI
Fisherman’s Cove
83%
80%
86%
Flint, MI
Grand Mobile Estates
77%
79%
85%
Grand Rapids, MI
Hamlin(3)
75%(3)
75%(3)
78%(3)
Webberville, MI
Holly Village/Hawaiian Gardens
97%
97%
99%
Holly, MI
Hunters Glen(6)
46%(6)
43%(6)
46%(6)
Wayland, MI
Kensington Meadows
80%
81%
88%
Lansing, MI
Kings Court Mobile Village
97%
97%
98%
Traverse City, MI
Developed
Occupancy
Occupancy
Occupancy
Sites as of
as of
as of
as of
Property and Location
12/31/2007
12/31/07(1)
12/31/06(1)
12/31/05(1)
Knollwood Estates
88%
91%
88%
Allendale, MI
Lafayette Place
68%
77%
85%
Metro Detroit, MI
Lakeview
91%
91%
91%
Ypsilanti, MI
Lincoln Estates
94%
96%
99%
Holland, MI
Meadow Lake Estates
87%
88%
91%
White Lake, MI
Meadowbrook Estates
94%
93%
93%
Monroe, MI
Presidential Estates Mobile Village
83%
85%
87%
Hudsonville, MI
Richmond Place
84%
95%
97%
Metro Detroit, MI
River Haven Village
63%
66%
68%
Grand Haven, MI
Scio Farms Estates
93%
95%
96%
Ann Arbor, MI
Sheffield Estates
99%
97%
n/a(2)
Auburn Hills, MI
Sherman Oaks
77%
78%
83%
Jackson, MI
St. Clair Place
80%
88%
94%
Metro Detroit, MI
Sunset Ridge(6)
87%(6)
82%(6)
75%(6)
Portland Township, MI
Timberline Estates
80%
80%
87%
Grand Rapids, MI
Town & Country Mobile Village
99%
100%
98%
Traverse City, MI
Village Trails(3)
76%(3)
73%(3)
72%(3)
Howard City, MI
White Lake Mobile Home Village
95%
96%
97%
White Lake, MI
White Oak Estates
74%
78%
81%
Mt. Morris, MI
Windham Hills Estates(3)
69%(3)
69%(3)
72%(3)
Jackson, MI
Woodhaven Place
95%
94%
96%
Metro Detroit, MI
Michigan Total
14,333
80%
82%
84%
Indiana
Brookside Mobile Home Village
66%
67%
73%
Goshen, IN
Carrington Pointe(3)
72%(3)
71%(3)
72%(3)
Ft. Wayne, IN
Leases. The typical lease we enter into with a tenant for the rental of a site is month-to-month or year-to-year, renewable upon the consent of both parties, or, in some instances, as provided by statute. In some cases, leases are for one-year terms, with up to ten renewal options exercisable by the tenant, with rent adjusted for increases in the consumer price index. These leases are cancelable for non-payment of rent, violation of community rules and regulations or other specified defaults. During the past five years, on average 3.4 percent of the homes in our communities have been removed by their owners and 7.6 percent of the homes have been sold by their owners to a new owner who then assumes rental obligations as a community resident. The small percentage of homes removed from our communities is impacted by the $4,000 to $10,000 cost to move a home. The above experience can be summarized as follows: the average resident remains in our communities for approximately thirteen years, while the average home, which gives rise to the rental stream, remains in our communities for approximately twenty nine years. See “Regulations and Insurance.”
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
On April 9, 2003, T.J. Holdings, LLC (“TJ Holdings”), a member of Sun/Forest, LLC (“Sun/Forest”) (which, in turn, owns an equity interest in SunChamp LLC), (“SunChamp”), filed a complaint against the Company, SunChamp, certain other affiliates of the Company and two directors of Sun Communities, Inc. in the Superior Court of Guilford County, North Carolina. The complaint alleges that the defendants wrongfully deprived the plaintiff of economic opportunities that they took for themselves in contravention of duties allegedly owed to the plaintiff and purports to claim damages of $13.0 million plus an unspecified amount for punitive damages. The Company believes the complaint and the claims threatened therein have no merit and will defend it vigorously. These proceedings were stayed by the Superior Court of Guilford County, North Carolina in 2004 pending final determination by the Circuit Court of Oakland County, Michigan as to whether the dispute should be submitted to arbitration and the conclusion of all appeals therefrom. On March 13, 2007, the Michigan Court of Appeals issued an order compelling arbitration of all claims brought in the North Carolina case. TJ Holdings has filed an application for review in the Michigan Supreme Court which has been denied and, accordingly, the North Carolina case is permanently stayed. TJ Holdings has now filed an arbitration demand in Southfield, Michigan based on the same claims. The Company intends to vigorously defend against the allegations.
As announced on February 27, 2006, the U.S. Securities and Exchange Commission (the “SEC”) completed its inquiry regarding the Company’s accounting for its SunChamp investment during 2000, 2001 and 2002, and the Company and the SEC entered into an agreed-upon Administrative Order (the “Order”). The Order required that the Company cease and desist from violations of certain non intent-based provisions of the federal securities laws, without admitting or denying any such violations.
On February 27, 2006, the SEC filed a civil action against the Company’s Chief Executive Officer, its then (and now former as of February 2008) Chief Financial Officer and a former controller in the United States District Court for the Eastern District of Michigan alleging various claims generally consistent with the SEC’s findings set forth in the Order. The discovery stage of this action has closed, and the parties are awaiting decisions on dispositive motions. The Company continues to indemnify such employees for all costs and expenses incurred in connection with such civil action.
The Company is involved in various other legal proceedings arising in the ordinary course of business. All such proceedings, taken together, are not expected to have a material adverse impact on our results of operations or financial condition.
ITEM 4.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS
Not applicable
PART II
ITEM 5.
ITEM 5.
MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock has been listed on the New York Stock Exchange (“NYSE”) since December 8, 1993, under the symbol “SUI.” On February 29, 2008, the closing sales price of the common stock was $20.38 and the common stock was held by 305 holders of record. The following table sets forth the high and low closing sales prices per share for the common stock for the periods indicated as reported by the NYSE and the distributions per share paid by the Company with respect to each period.
Set forth below is a line graph comparing the yearly percentage change in the cumulative total shareholder return on the Common Stock against the cumulative total return of a broad market index composed of all issuers listed on the New York Stock Exchange and an industry index comprised of twenty publicly traded residential real estate investment trusts, for the five year period ending on December 31, 2007. This line graph assumes a $100 investment on December 31, 2002, a reinvestment of dividends and actual increase of the market value of the Company’s Common Stock relative to an initial investment of $100. The comparisons in this table are required by the SEC and are not intended to forecast or be indicative of possible future performance of the Company’s Common Stock.
Recent Sales of Unregistered Securities
On March 31, 2007, the Operating Partnership issued and immediately redeemed 30,898 Common Operating Partnership Units, (“OP Units”), from Water Oak, Ltd. for an aggregate purchase price of $961,540.
All of the above partnership units and shares of common stock were issued in private placements in reliance on Section 4(2) of the Securities Act of 1933, as amended, including Regulation D promulgated there under. No underwriters were used in connection with any of such issuances.
Equity Compensation Plan Information
The following table reflects information about the securities authorized for issuance under the Company’s equity compensation plans as of December 31, 2007.
(1)
On May 29, 1997, the Company established a Long Term Incentive Plan (the “LTIP”) pursuant to which all full-time salaried and full-time commission only employees of the Company, excluding the Company’s officers, were entitled to receive options to purchase shares of the Company’s common stock at $32.75 per share (i.e., the average of the highest and lowest selling prices for the common stock on May 29, 1997), on January 31, 2002. In accordance with the terms of the LTIP, (a) the Company granted the eligible participants options to purchase 167,918 shares of common stock; and (b) each eligible participant received an option to purchase a number of shares of common stock equal to the product of 167,918 and the quotient derived by dividing such participant’s total compensation during the period beginning on January 1, 1997 and ending on December 31, 2001 (the “Award Period”) by the aggregate compensation of all of the eligible participants during the Award Period.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
(a) Operating data for the years ended December 31, 2004 and 2003, have been restated to reflect the reclassifications required under SFAS No. 144 for the properties sold in 2005.
(b) See Note (2) following Same Property Information on page 38.
(c) See Other, pages 44-46.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
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 notes thereto elsewhere herein.
The Company is a fully integrated, self-administered and self-managed REIT which owns, operates, develops and finances manufactured housing communities concentrated in the midwestern and southeastern United States. As of December 31, 2007, the Company owned and operated a portfolio of 136 developed properties located in eighteen states, including 124 manufactured housing communities, four recreational vehicle communities, and eight properties containing both manufactured housing and recreational vehicle sites.
In recent years the operations of manufactured homebuilders, dealers, and the companies that finance the purchase of the homes have experienced severe losses and substantial volatility. New home shipments have declined from approximately 373,000 in 1998 to less than 100,000 in 2007. The decline was largely due to the turmoil in the financing side of the industry as lenders experienced substantial losses arising from defaults on poorly underwritten loans in the mid to late 1990s and beyond. As a result of the losses, the lenders experienced liquidity constraints and significantly tightened underwriting standards thus reducing the demand for new homes.
These trends may be abating as the volume of repossessed homes in the market place appears to be declining. Newly repossessed homes are also declining as the reinforcing effects of tightened underwriting standards and reduced new home financing volumes impact the industry.
The effect of these trends on the Company has been to reduce occupancies in our portfolio as the demand of tenants for sites in our communities has declined for the above-stated reasons. The rate of leasing in our new community developments has likewise slowed. Despite these trends, the Company’s same property portfolio has consistently reflected growth in net operating income evidencing the revenue and operating stability long associated with the business of owning and operating manufactured housing communities.
While the problems which directly impacted the manufacturers, dealers, and lenders appear to be bottoming, the Company does not expect a rapid or strong recovery in its operations. The Company expects a gradually improving leasing environment in its portfolio.
As a result of these industry conditions, a large quantity of homes repossessed by lenders have become available for purchase at discounts of up to 50% and more from original cost or loan amount. The Company has made every effort to acquire these value-priced homes especially as the alternative would likely be the removal of the homes from the community. Such removal would create total dependence on the sale of a new home to fill the site. As new home shipments have declined by nearly three quarters from their peak in 1998 to current levels, such dependence would leave the Company vulnerable to a recovery in new home shipments as its primary method to improve occupancy.
The Company intends to sell these value-priced homes to residents over time. In the meantime it is most economical to lease the homes to residents. At December 31, 2007, the Company had 5,328 homes rented in its communities which comprise over 47,000 sites. All renters are subject to underwriting criteria. The Company expects to continue to acquire homes from lenders as long as the pricing of the homes remains compelling. The Company is actively developing programs for its renters and others to acquire these homes.
Critical Accounting Policies and Estimates
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses the Company’s consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. In preparing these financial statements, management has made its best estimates and judgment of certain amounts included in the financial statements. Nevertheless, actual results may differ from these estimates under different assumptions or conditions.
Management believes the following significant accounting policies, among others, affect its more significant judgments and estimates used in the preparation of its consolidated financial statements:
Impairment of Long-Lived Assets and Investment in Affiliates. Rental property is recorded at cost, less accumulated depreciation. The Company measures the recoverability of its assets in accordance with Statement of Financial Accounting Standards No. 144 (“SFAS 144”), “Accounting for the Impairment or Disposal of Long Lived Assets.” If such assets were deemed to be impaired as a result of this measurement evaluation, the impairment that would be recognized is the amount by which the carrying amount of the asset exceeds fair value as determined on a discounted net cash flow basis. Assets are tested for impairment every three years or more frequently whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. Circumstances that may prompt a test of recoverability may include a significant decrease in anticipated market price, an adverse change to the extent or manner in which an asset may be used or in its physical condition or other such events that may significantly change the value of the long-lived asset.
The Company owns an approximate 19 percent investment in an affiliate that is reported under the equity method of accounting. Management performs an analysis to determine if the investment has experienced an other than temporary decline in value. Numerous factors are evaluated in accordance with published GAAP and SEC staff guidance. Changes in the facts and circumstances evaluated, future adverse changes in market conditions or operating results of the affiliate may affect management’s analysis.
Notes and Accounts Receivable. The Company evaluates the recoverability of its receivables whenever events occur or there are changes in circumstances such that management believes it is probable that it will be unable to collect all amounts due according to the contractual terms of the loan and lease agreements. Receivables related to community rents are reserved when the Company believes that collection is less than probable, which is generally after a resident balance reaches 60 to 90 days past due. The Company reserves for estimated repairs to homes which collateralize its installment notes receivable based upon an estimate of annual foreclosures and historical costs of repair.
Depreciation. Depreciation is computed on a straight-line basis over the estimated useful lives of the assets. Useful lives are 30 years for land improvements and buildings, 10 years for rental homes, 7 to 15 years for furniture, fixtures and equipment, and 7 years for intangible assets.
Revenue Recognition. Rental income attributable to site and home leases is recorded on a straight-line basis when earned from tenants. Leases entered into by tenants generally range from month-to-month to two years and are renewable by mutual agreement of the Company and the resident or, in some cases, as provided by state statute. Revenue from the sale of manufactured homes is recognized upon transfer of title at the closing of the sales transaction.
Capitalized Costs. The Company capitalizes certain costs (including interest and other costs) incurred in connection with the development, redevelopment, capital enhancement and leasing of its properties. Management is required to use professional judgment in determining whether such costs meet the criteria for immediate expense or capitalization. The amounts are dependent on the volume and timing of such activities and the costs associated with such activities. Maintenance, repairs and minor improvements to properties are expensed when incurred. Renovations and improvements to properties are capitalized and depreciated over their estimated useful lives and construction costs related to the development of new community or expansion sites are capitalized until the property is substantially complete. Costs incurred to renovate repossessed homes for the Company’s rental program are capitalized and costs incurred to refurbish the homes at turnover and repair the homes while occupied are expensed. Certain expenditures to dealers and residents related to obtaining lessees in our communities are capitalized and amortized over a seven year period based on the anticipated term of occupancy of a resident. Costs associated with implementing the Company’s computer systems are capitalized and amortized over the estimated useful lives of the related software and hardware.
Derivative Instruments and Hedging Activities. The Company currently has two interest rate swaps and an interest rate cap agreement to offset interest rate risk. The Company does not enter into derivative transactions for speculative purposes. The Company adjusts its balance sheet on an ongoing quarterly basis to reflect current fair market value of its derivatives. Changes in the fair value of derivatives are recorded each period in earnings or comprehensive income, as appropriate. The ineffective portion of the hedge is immediately recognized in earnings to the extent that the change in value of a derivative does not perfectly offset the change in value of the instrument being hedged. The unrealized gains and losses held in accumulated other comprehensive income will be reclassified to earnings over time and occurs when the hedged items are also recognized in earnings. The Company uses standard market conventions to determine the fair values of derivative instruments, including the quoted market prices or quotes from brokers or dealers for the same or similar instruments. All methods of assessing fair value result in a general approximation of value and such value may never actually be realized.
Income Taxes. The Company has elected to be taxed as a REIT as defined under Section 856(c) of the Internal Revenue Code of 1986, as amended. In order for the Company to qualify as a REIT, at least ninety-five percent (95%) of the Company’s gross income in any year must be derived from qualifying sources. As a REIT, the Company generally will not be subject to U.S. federal income taxes at the corporate level if it distributes at least ninety percent (90%) of its REIT ordinary taxable income to its stockholders, which it fully intends to do. If the Company fails to qualify as a REIT in any taxable year, the Company will be subject to Federal income tax (including any applicable alternative minimum tax) on its taxable income at regular corporate rates. The Company remains subject to certain state and local taxes on its income and property as well as Federal income and excise taxes on its undistributed income.
The Company is subject to certain state taxes that are considered income taxes and has certain subsidiaries that are taxed as regular corporations. Deferred tax assets or liabilities are recognized for temporary differences between the tax bases of assets and liabilities and their carrying amounts in the financial statements and net operating loss carry forwards. Deferred tax assets and liabilities are measured using currently enacted tax rates. A valuation allowance is established if based on available evidence it is more likely than not that some portion or all of the deferred tax assets will not be realized.
Results of Operations
Comparison of year ended December 31, 2007, to year ended December 31,
For the year ended December 31, 2007, loss from operations decreased by $9.7 million, from a loss of $28.5 million in 2006 to a loss of $18.8 million in 2007. The decrease in loss was due to increased revenues of $8.2 million and a decrease in loss from affiliate of $8.6 million, offset by increased expenses of $7.1 million, as described in more detail below.
Income from real property increased by $3.9 million, from $187.5 million to $191.4 million, or 2.0 percent, due to rent increases ($3.1 million) and other community revenues ($0.8 million).
Revenue from home sales increased by $2.7 million, from $20.2 million to $22.9 million, or 13.4 percent. The Company sold 712 manufactured homes during the year ended December 31, 2007 as compared to 492 sales during 2006. Additional revenue resulted from the substantial increase in the number of homes sold but was partially offset by a 21.8 percent decrease in average sales price as higher priced Florida home sales lagged and consumer demand shifted to pre-owned homes.
Rental home revenue increased by $4.0 million, from $14.8 million to $18.8 million, or 27.0 percent. The number of tenants in the Company’s rental program increased from 4,576 at December 31, 2006 to 5,328 at December 31, 2007, resulting in additional revenue of approximately $2.9 million. The remainder of the increase resulted from an increase in the average rental rate per home from $686 per month at December 31, 2006 to $718 per month at December 31, 2007.
Ancillary revenues, net, increased by $0.1 million, from $0.4 million to $0.5 million, due to an increase in commissions from the brokerage of insurance policies.
Interest income decreased by $0.8 million, from $3.7 million to $2.9 million, or 21.6 percent, primarily due to the repayment of a $13.5 million mortgage note receivable by the borrower on March 1, 2007.
Other income decreased by $1.6 million, from income of $1.0 million to loss of $0.6 million, due to a decrease in brokerage commissions of $0.4 million, an increase in loss realized on the disposal of assets and land of $0.6 million, a decrease in proceeds from the settlement of a lawsuit which is included in 2006 Other Income of $0.4 million, and a decrease in other miscellaneous operating income $0.2 million.
Property operating and maintenance expenses increased by $0.8 million, from $48.1 million to $48.9 million, or 1.7 percent. The increase was due to the cost of the Company’s biennial convention ($0.2 million), an increase in legal expenses ($0.2 million), an increase in property and casualty insurance costs ($0.2 million), an increase in utility expenses ($0.3 million), and an increase in cable expense ($0.1 million) offset by a decrease in supply and repair costs ($0.2 million).
Real estate taxes increased by $0.5 million, from $15.9 million to $16.4 million, or 3.1 percent, due to increases in assessments and tax rates.
Cost of home sales increased by $2.5 million, from $15.7 million to $18.2 million, or 15.9 percent due primarily to the increase in the number of homes sold. The Company sold 712 manufactured homes during the year ended December 31, 2007 as compared to 492 sales during 2006. Gross profit margins decreased from 22.4 percent in 2006 to 20.6 percent in 2007 due primarily to a decrease in profit margin on sales of new homes.
Rental home operating and maintenance increased by $2.9 million, from $10.9 million to $13.8 million, due primarily to an increase in the number of tenants in the Company’s rental program. Additional information regarding the Company’s rental program is contained in the table below.
General and administrative expenses for real property decreased by $1.8 million, from $16.4 million to $14.6 million, due to a reduction of deferred compensation expenses of $2.1 million and a reduction in consulting fees of $0.3 million offset by an increase in salary, wage and incentive costs of $0.6 million. The reduction in deferred compensation expense includes the $1.4 million effect of the reversal in 2007 of $0.7 million of expenses recognized in 2006 related to performance-based restricted and phantom stock awards, because the Company determined that it was improbable that the performance criteria would be achieved.
General and administrative expenses for home sales and rentals decreased by $0.4 million, from $6.5 million to $6.1 million, or 6.2 percent due primarily to an decrease in payroll and benefits.
Depreciation and amortization increased by $2.2 million, from $60.3 million to $62.5 million, or 3.6 percent, due primarily to an increase in the total rental home portfolio.
Debt extinguishment expenses in 2006 of $0.5 million include defeasance fees and other costs associated with extinguishing $45.0 million of secured notes. Deferred financing costs of $0.2 million related to this debt were expensed in 2006.
Interest expense, including interest on mandatorily redeemable debt, increased by $0.4 million, from $65.1 million to $65.5 million, or 0.6 percent.
Provision for state income tax is discussed in detail in Footnote 10, Income Taxes.
Included in Equity loss from affiliate is an impairment to the carrying value of Origen of $1.9 million and $18.0 million in 2007 and 2006, respectively. Also, included in equity loss from affiliate in 2007 is an $8.0 million loss attributable to the Company’s portion of Origen’s goodwill and investment impairment charges of $32.3 million and $9.2 million, respectively.
Comparison of year ended December 31, 2006, to year ended December 31,
For the year ended December 31, 2006, loss from operations increased by $22.4 million from a loss of $6.1 million in 2005 to a loss of $28.5 million in 2006. The increase in loss was due to increased expenses of $22.5 million and increased loss from affiliate of $15.7 million, offset by increased revenues of $15.8 million as described in more detail below.
Income from real property increased by $7.4 million, from $180.1 million to $187.5 million, or 4.1 percent, due to property acquisitions ($1.6 million), rent increases ($5.0 million) and other community revenues ($0.8 million).
Revenue from home sales increased by $1.8 million, from $18.4 million to $20.2 million, or 9.8 percent. The Company sold 492 manufactured homes during the year ended December 31, 2006 as compared to 425 sales during 2005. Additional revenue resulted from the increase in the number of homes sold and was partially offset by a 4.9 percent decrease in average sales price as consumer demand shifted to pre-owned homes.
Rental home revenue increased by $5.8 million, from $9.1 million to $14.9 million, or 63.7 percent. The number of tenants in the Company’s rental program increased from 3,711 at December 31, 2005 to 4,576 at December 31, 2006, resulting in additional revenue of approximately $4.2 million. The remainder of the increase resulted from an increase in the average rental rate per home from $643 per month at December 31, 2005 to $686 per month at December 31, 2006.
Ancillary revenues, net, decreased by $0.3 million, from $0.7 million to $0.4 million, due to a non-refundable option payment received in 2005 ($0.2 million) and increased golf course management fees ($0.2 million) offset by an increase in other miscellaneous ancillary revenues ($0.1 million).
Interest income decreased by $0.6 million, from $4.3 million to $3.7 million, or 14.0 percent, due primarily to a decrease in interest earned on the Company’s short-term investments which were sold during 2006.
Other income increased by $1.7 million, from a loss of $(0.7) million to income of $1.0 million, due to an increase in brokerage commissions ($0.1 million), a decrease in unsuccessful acquisition expenses ($0.5 million), proceeds from a lawsuit settlement ($0.4 million) and an increase in other miscellaneous operating income ($0.7 million).
Property operating and maintenance expenses increased by $1.9 million, from $46.2 million to $48.1 million, or 4.1 percent. The increase was due to acquisitions ($0.5 million), increases in utility costs ($1.5 million) and payroll and health insurance costs ($0.5 million), partially offset by decreases in repair and maintenance ($0.3 million) and miscellaneous other expenses ($0.3 million).
Real estate taxes increased by $0.7 million, from $15.2 million to $15.9 million, or 4.6 percent, due to acquisitions ($0.2 million) and increases in assessments and tax rates ($0.5 million).
Cost of home sales increased by $1.8 million, from $13.9 million to $15.7 million, or 12.9 percent due primarily to the increase in the number of homes sold. The Company sold 492 manufactured homes during the year ended December 31, 2006 as compared to 425 sales during 2005. Gross profit margins decreased from 24.6 percent in 2005 to 22.4 percent in 2006 due to increased sales of pre-owned homes at lower margins.
Rental home operating and maintenance increased by $3.6 million, from $7.3 million to $10.9 million, due primarily to an increase in the number of tenants in the Company’s rental program. Additional information regarding the Company’s rental program is contained in the table below.
General and administrative expenses for real property increased by $1.9 million, from $14.5 million to $16.4 million, due to an increase in payroll and benefits ($1.8 million), state and local taxes ($0.2 million), directors fee ($0.1 million) and audit and accounting fees ($0.2 million). The payroll and benefit increase includes the accrual of annual performance based bonus incentives ($0.5 million) and recognition of expense related to performance-based restricted and phantom stock awards ($0.7 million). These increases were offset by a decrease in legal fees of $0.4 million.
General and administrative expenses for home sales and rentals increased by $0.2 million, from $6.3 million to $6.5 million, or 3.2 percent due primarily to an increase in payroll and benefits.
Depreciation and amortization increased by $6.0 million, from $54.3 million to $60.3 million, or 11.0 percent, due primarily to an increase in the total rental home portfolio.
Debt extinguishment expense of $0.5 million includes defeasance fees and other costs associated with extinguishing $45.0 million of secured notes. Deferred financing costs of $0.2 million related to this debt were expensed.
Interest expense, including interest on mandatorily redeemable debt, increased by $5.1 million, from $60.0 million to $65.1 million, or 8.5 percent. Average debt increased by 4.0 percent and the remainder of the increase is due to higher variable rates.
Included in Equity loss from affiliate in 2006 is an $18.0 million impairment to the carrying value of Origen.
Same Property Information
The following table reflects the Same Property financial information for the periods ended December 31, 2007 and 2006. The “Same Property” data represents information regarding the operation of communities owned as of January 1, 2006, and December 31, 2007.
Same property occupancy, site, and rent information at December 31, 2007 and 2006:
(1) Amounts are reported net of recovery of water and sewer utility expenses.
(2) Investors in and analysts following the real estate industry utilize net operating income (“NOI”) as a supplemental performance measure. NOI is derived from revenues (determined in accordance with GAAP) minus property operating expenses and real estate taxes (determined in accordance with GAAP). NOI does not represent cash generated from operating activities in accordance with GAAP and should not be considered to be an alternative to net income (determined in accordance with GAAP) as an indication of the Company’s financial performance or to be an alternative to cash flow from operating activities (determined in accordance with GAAP) as a measure of the Company’s liquidity; nor is it indicative of funds available for the Company’s cash needs, including its ability to make cash distributions. The Company believes that net income is the most directly comparable GAAP measurement to net operating income. Net income includes interest and depreciation and amortization which often have no effect on the market value of a property and therefore limit its use as a performance measure. In addition, such expenses are often incurred at a parent company level and therefore are not necessarily linked to the performance of a real estate asset. The Company believes that net operating income is helpful to investors as a measure of operating performance because it is an indicator of the return on property investment, and provides a method of comparing property performance over time. The Company uses NOI as a key management tool when evaluating performance and growth of particular properties and/or groups of properties. The principal limitation of NOI is that it excludes depreciation, amortization and non-property specific expenses such as general and administrative expenses, all of which are significant costs, and therefore, NOI is a measure of the operating performance of the properties of the Company rather than of the Company overall.
(3) Occupied sites include manufactured housing and permanent recreational vehicle sites, and exclude seasonal recreational vehicle sites.
(4)
Occupancy % and weighted average rent relates to manufactured housing sites, excluding both permanent and seasonal recreational vehicle sites.
On a same property basis, real property net operating income increased by $2.6 million from $126.6 million for the year ended December 31, 2006, to $129.2 million for the year ended December 31, 2007, or 2.1 percent. Income from real property increased by $3.5 million from $179.3 million to $182.8 million, or 1.9 percent, due primarily to increases in rents including water and property tax pass through. Property operating expenses increased by $0.8 million from $52.8 million to $53.6 million, or 1.6 percent, due to increases in real estate taxes ($0.5 million), and other expenses ($0.3 million).
Rental Program
The following table reflects additional information regarding the Company’s rental program for the years ended December 31, 2007, 2006 and 2005:
(1) See Note (2) following Same Property Information on page 38.
Net operating income from the rental program increased $4.0 million from $22.7 million in 2006 to $26.7 million in 2007 as a result of a $6.9 million increase in revenue offset by a $2.9 million increase in expenses. Revenues increased due to an increase in the weighted average monthly rental rate and an increase in the number of leased rental homes. Expenses were also impacted by the increase in the number of leased rental homes. A comparison of the year ended 2006 to the year ended 2005 results in similar increases in net operating income, revenue and expenses for the same reasons as noted in the comparison of the year ended 2007 to the year ended 2006.
Liquidity and Capital Resources
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, capital improvements of properties, the purchase of new and pre-owned homes, property acquisitions, development and expansion of properties, and debt repayment.
The Company expects to meet its short-term liquidity requirements through its working capital provided by operating activities and through its $155.0 million lines 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 continuously seeks acquisition opportunities that meet the Company’s criteria for acquisition. Should such investment opportunities arise in 2008, the Company will finance the acquisitions though the temporary use of its lines of credit until permanent secured financing can be arranged, through the assumption of existing debt on the properties or the issuance of certain equity securities.
The Company has also invested approximately $24.2 million during 2007 in the acquisition of homes primarily intended for its rental program. Expenditures for 2008 will be dependent upon the condition of the markets for repossessions and new home sales as well as rental homes.
Cash and cash equivalents increased by $2.2 million to $5.4 million at December 31, 2007, compared to $3.2 million at December 31, 2006. Net cash provided by operating activities increased by $3.3 million to $49.6 million for the year ended December 31, 2007, compared to $46.3 million for the year ended December 31, 2006.
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 markets generally, and specifically in metropolitan areas of the Company’s current markets; (b) lower occupancy rates of 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 or rentals of manufactured homes. See “Risk Factors.”
The Company has an unsecured line of credit facility with a maximum borrowing amount of $115 million, subject to certain borrowing base calculations, which bears interest at LIBOR + 1.65 percent (6.55 percent at December 31, 2007) and matures on October 1, 2010, with a one-year optional extension. The outstanding balance on the line of credit at December 31, 2007, was $85.4 million. In addition, $3.4 million of availability was used to back standby letters of credit leaving a maximum of $26.2 million available to be drawn under the facility based on the December 31, 2007, calculation of borrowing base. The line of credit facility contains various leverage, debt service coverage, net worth maintenance and other customary covenants all of which the Company was in compliance with at December 31, 2007.
The sub-prime credit crisis and ensuing decline in credit availability have caused turmoil in US and foreign markets. Many industries with no direct involvement with sub-prime lending, securitizations, home building or mortgages have suffered share price declines as economic uncertainty has derailed investor confidence. While many of the fundamentals of the Company, and manufactured housing industry, have been improving over recent years, the Company’s share price has suffered in the turbulent stock market of the past six months. For the Company, the most relevant consequence of this financial turmoil is the uncertainty of the availability of credit. With minimal debt maturities of $4.3 million and $16.0 million in 2008 and 2009, respectively, the Company believes this risk is significantly mitigated.
The Company’s primary long-term liquidity needs are principal payments on outstanding indebtedness. At December 31, 2007, the Company’s outstanding contractual obligations were as follows:
Interest expense is a material cash requirement of the Company and is expected to be in excess of $66.1 million for 2008, $64.8 million for 2009, $63.1 million for 2010, $60.3 million for 2011 and $55.7 million for 2012, based on the current debt levels, rates and maturities.
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 its Properties. The Company currently has 33 unencumbered Properties with an estimated market value of $222.0 million, some of which support the borrowing base for the Company’s $115.0 million unsecured line of credit which has $88.8 million outstanding at December 31, 2007. From time to time, the Company may also issue shares of its capital stock or preferred 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. If it were to become necessary for the Company to approach the credit markets, the current volatility in the credit markets could make borrowing more expensive. See “Risk Factors”. If the Company is unable to obtain additional debt or equity financing on acceptable terms, the Company’s business, results of operations and financial condition will be adversely impacted.
At December 31, 2007, the Company’s debt to total capitalization approximated 73.1 percent (assuming conversion of all Common OP Units to shares of common stock). The debt has a weighted average maturity of approximately 6.4 years and a weighted average interest rate of 5.4 percent.
Capital expenditures for the years ended December 31, 2007 and 2006 included recurring capital expenditures of $7.3 million and $6.9 million, respectively.
Net cash used in investing activities was $20.8 million for the year ended December 31, 2007, compared to $38.0 million in the prior year. The difference is due to increased repayments of notes receivables and officer’s notes, net, of $13.2 million and decreased investment in rental properties of $8.2 million, offset by decreased proceeds from loans sold to Origen of $4.2 million.
Net cash used in financing activities was $26.6 million for the year ended December 31, 2007, compared to $11.0 million in the prior year. The difference is primarily due to a decrease in payments to redeem common stock and OP units of $1.1 million , a decrease in payments to retire preferred operating partnership units of $3.7 million, a decrease in payments for deferred financing costs of $0.5 million, and a decrease in distributions of $2.7 million offset by a decrease in borrowings on the line of credit of $13.8 million, a decrease in net proceeds from notes payable and other debt of $7.4 million and a decrease in net proceeds from option exercises of $2.4 million.
Inflation
Most of the leases allow for periodic rent increases which provide the Company with the opportunity to achieve increases in rental income as each lease expires. Such types of leases generally minimize the risk of inflation to the Company.
Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS No. 157). SFAS No. 157 establishes a common definition for fair value to be applied to US GAAP guidance requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. SFAS No. 157 was originally effective for fiscal years beginning after November 15, 2007, however in February, 2008, the FASB agreed to (a) defer the effective date in Statement 157 for one year for certain nonfinancial assets and non financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), and (b) remove certain leasing transactions form the scope of Statement 157. The Company does not believe SFAS 157 will have a material impact on its financial position and results of operations.
Recent Accounting Pronouncements, continued:
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115” (SFAS 159). This statement permits, but does not require, entities to measure certain financial instruments and other assets and liabilities at fair value on an instrument-by-instrument basis. Unrealized gains and losses on items for which the fair value option has been elected should be recognized in earnings at each subsequent reporting date. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company did not elect the fair value option on January 1, 2008 and does not believe SFAS 159 will have an impact on its results from operations or financial position.
In December 2007, the FASB issued Statement No. 141R (revised 2007), “Business Combinations” (“SFAS 141R”). SFAS 141R will significantly change the accounting for business combinations. Under SFAS 141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. Statement 141R will change the accounting treatment for certain specific acquisition related items and also includes a substantial number of new disclosure requirements. The Company will apply SFAS 141R prospectively to business combinations for which the acquisition date is on or after January 1, 2009.
In December 2007, the FASB issued Statement No. 160, “Noncontrolling Interests in Consolidated Financial Statements-An Amendment of ARB No. 51” (“SFAS 160”). SFAS 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary (minority interest) is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements and separately from the parent company’s equity. This statement also requires consolidated net income to be reported at amounts that include the amounts attributable to the parent and the noncontrolling interest and requires disclosure, on the face of the consolidated statement of operations, the amounts of consolidated net income attributable to the parent and the noncontrolling interest. SFAS 160 is effective for business combinations for which the acquisition date is on or after the first annual reporting period beginning on or after December 15, 2008. The Company does not believe SFAS 160 will have a material impact on its consolidated financial statements.
Other:
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 loss to FFO and calculates FFO data for both basic and diluted purposes for the years ended December 31, 2007, 2006, 2005 (in thousands):
SUN COMMUNITIES, INC.
RECONCILIATION OF NET LOSS TO FUNDS FROM OPERATIONS
(Amounts in thousands, except for per share/OP unit amounts)
(1) Net loss for the years ended December 31, 2007 and 2006 includes a $1.9 million and $18.0 million reduction in the carrying value of the Company’s investment in affiliate (Origen), respectively. Also, included in equity loss from affiliate in 2007 is an $8.0 million loss attributable to the Company’s portion of Origen’s goodwill and investment impairment charges of $32.3 million and $9.2 million, respectively. The table below is adjusted to exclude the above mentioned amounts:
Other, continued:
(2) The Company currently has two interest rate swaps and an interest rate cap agreement. The valuation adjustment reflects the theoretical noncash profit and loss were those hedging transactions terminated at the balance sheet date. As the Company has no expectation of terminating the transactions prior to maturity, the net of these noncash valuation adjustments will be zero at the various maturities. As any imperfection related to hedging correlation in these swaps is reflected currently in cash as interest, the valuation adjustments reflect volatility that would distort the comparative measurement of FFO and on a net basis approximate zero. Accordingly, the valuation adjustments are excluded from FFO. The valuation adjustment is included in interest expense.
(3) This tax provision represents potential future taxes payable on sale of company assets. It does not impact Funds From Operations and would be payable from prospective proceeds of such sales.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
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 entered into three separate interest rate swap agreements and an interest rate cap agreement. One of the swap agreements fixes $25 million of variable rate borrowings at 4.84 percent through July 2009, another of the swap agreements fixes $25 million of variable rate borrowings at 5.28 percent through July 2012 and the third swap agreement, which matured in July 2007, had a notional amount of $25 million and an effective fixed rate of 3.88 percent. The interest rate cap agreement has a cap rate of 9.99 percent, a notional amount of $152.4 million and a termination date of April 28, 2009. Each of the Company’s derivative contracts is based upon 90-day LIBOR.
The Company’s remaining variable rate debt totals $209.6 million and $184.1 million as of December 31, 2007 and 2006, respectively, which bears interest at Prime, various LIBOR or Fannie Mae Discounted Mortgage Backed Securities (“DMBS”) rates. If Prime, LIBOR, or DMBS increased or decreased by 1.0 percent during the years ended December 31, 2007 and 2006, the Company believes its interest expense would have increased or decreased by approximately $1.7 million and $1.9 million, respectively, based on the $173.8 million and $192.4 million average balance outstanding under the Company’s variable rate debt facilities for the year ended December 31, 2007 and 2006, respectively.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial statements and supplementary data are filed herewith under Item 15.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The Company’s management is responsible for establishing and maintaining disclosure controls and procedures as defined in the rules promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer, Gary A. Shiffman, and Chief Financial Officer, Karen J. Dearing, the Company evaluated the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of December 31, 2007. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2007, to ensure that information the Company is required to disclose in its filings with the Securities and Exchange Commission under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms, and to ensure that information required to be disclosed by the Company in the reports that it files under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
Design and Evaluation of Internal Control Over Financial Reporting
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, the Company has included a report of management’s assessment of the design and effectiveness of its internal controls as part of this Annual Report on Form 10-K for the fiscal year ended December 31, 2007. The Company’s independent registered public accounting firm also attested to, and reported on, the effectiveness of internal control over financial reporting. Management’s report and the independent registered public accounting firm’s attestation report are included in the Company’s 2007 financial statements under the captions entitled “Management’s Report on Internal Control Over Financial Reporting” and “Report of Independent Registered Public Accounting Firm” and are incorporated herein by reference.
Changes in Internal Control Over Financial Reporting
There have been no changes in the Company’s internal control over financial reporting during the quarterly period ended December 31, 2007 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
Not applicable
PART III
The information required by Items 10, 11, 12, 13, and 14 will be included in the Company’s proxy statement for its 2007 Annual Meeting of Shareholders, and is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(1) A list of the financial statements required to be filed as a part of this Form 10-K is shown in the “Index to the Consolidated Financial Statements and Financial Statement Schedule” filed herewith.
(2) A list of the financial statement schedules required to be filed as a part of this Form 10-K is shown in the “Index to the Consolidated Financial Statements and Financial Statement Schedule” filed herewith.
(3) A list of the exhibits required by Item 601 of Regulation S-K to be filed as a part of this Form 10-K is shown on the “Exhibit Index” filed herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Date: March 17, 2008
SUN COMMUNITIES, INC., a
Maryland corporation
By: /s/ Gary A. Shiffman
Gary A. Shiffman, Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Name
Title
Date
/s/ Gary A. Shiffman
Chief Executive Officer, President and
Chairman of the Board of Directors
March 17, 2008
Gary A. Shiffman
/s/ Karen J. Dearing
Executive Vice President, Chief Financial
Officer, Treasurer, Secretary and Principal
Accounting Officer
March 17, 2008
Karen J. Dearing
/s/ Paul D. Lapides
Director
March 17, 2008
Paul D. Lapides
/s/ Ted J. Simon
Director
March 17, 2008
Ted J. Simon
/s/ Clunet R. Lewis
Director
March 17, 2008
Clunet R. Lewis
/s/ Ronald L. Piasecki
Director
March 17, 2008
Ronald L. Piasecki
/s/ Arthur A. Weiss
Director
March 17, 2008
Arthur A. Weiss
/s/ Robert H. Naftaly
Director
March 17, 2008
Robert H. Naftaly
/s/ Stephanie W. Bergeron
Director
March 17, 2008
Stephanie W. Bergeron
EXHIBIT INDEX
Exhibit
Number
Description
Method of
Filing
2.1
Form of Sun Communities, Inc.’s Common Stock Certificate
(1)
3.1
Amended and Restated Articles of Incorporation of Sun Communities, Inc
(1)
3.2
Bylaws of Sun Communities, Inc.
(2)
3.3
Articles Supplementary, dated October 16, 2006
(20)
3.4
Amendment to Bylaws, dated October 16, 2006
(20)
3.5
Amendment to Bylaws, dated October 29, 2007
(25)
4.1
Articles Supplementary of Board of Directors of Sun Communities, Inc. Designating a Series of Preferred Stock and Fixing Distribution and other Rights in such Series
(9)
4.2
Articles Supplementary of Board of Directors of Sun Communities, Inc. Designating a Series of Preferred Stock
(11)
10.1
Second Amended and Restated Agreement of Limited Partnership of Sun Communities Operating Limited Partnership
(6)
10.2
Second Amended and Restated 1993 Stock Option Plan
(10)
10.3
Amended and Restated 1993 Non-Employee Director Stock Option Plan
(6)
10.4
Form of Stock Option Agreement between Sun Communities, Inc. and certain directors, officers and other individuals#
(1)
10.5
Form of Non-Employee Director Stock Option Agreement between Sun Communities, Inc. and certain directors#
(4)
10.6
2004 Non-Employee Director Stock Option Plan#
(26)
10.7
Form of Restricted Stock Award Agreement#
(19)
10.8
Stock Pledge Agreement between Gary A. Shiffman and the Operating Partnership for 94,570 shares of Common Stock
(5)
10.9
Stock Pledge Agreement between Gary A. Shiffman and the Operating Partnership for 305,430 shares of Common Stock
(5)
10.10
Stock Pledge Agreement between Gary A. Shiffman and the Operating Partnership with respect to 80,000 shares of Common Stock
(7)
10.11
Employment Agreement between Sun Communities, Inc. and Gary A. Shiffman, dated as of January 1, 2005#
(17)
10.12
Employment Agreement between Sun Communities, Inc. and Jeffrey P. Jorissen, dated as of January 1, 2005#
(17)
10.13
Employment Agreement by and between Brian W. Fannon and Sun Communities, Inc., dated as of January 1, 2005#
(17)
10.14
First Amendment to Employment Agreement by and between Brian W. Fannon and Sun Communities, Inc. dated December 30, 2007
(27)
10.15
Long Term Incentive Plan
(7)
10.16
Sun Communities, Inc. 1998 Stock Purchase Plan#
(9)
10.17
Rights Agreement between Sun Communities, Inc. and State Street Bank and Trust Company, dated April 24, 1998
(8)
10.18
One Hundred Third Amendment to Second Amended and Restated Limited Partnership Agreement of the Operating Partnership
(11)
10.19
One Hundred Eleventh Amendment to Second Amended and Restated Limited Partnership Agreement of the Operating Partnership
(12)
10.20
One Hundred Thirty-Sixth Amendment to Second Amended and Restated Limited Partnership Agreement of the Operating Partnership
(12)
10.21
One Hundred Forty-Fifth Amendment to Second Amended and Restated Limited Partnership Agreement of the Operating Partnership
(12)
10.22
One Hundred Seventy-Second Amendment to Second Amended and Restated Limited Partnership Agreement of the Operating Partnership
(19)
10.23
Restricted Stock Award Agreement between Sun Communities, Inc. and Gary A. Shiffman, dated May 10, 2004#
(19)
10.24
First Amendment to Restricted Stock Award Agreement between Sun Communities, Inc., and Gary A. Shiffman#
(19)
10.25
Second Amendment to Restricted Stock Award Agreement between Sun Communities, Inc. and Gary A. Shiffman
(27)
10.26
Restricted Stock Award Agreement between Sun Communities, Inc. and Jeffrey P. Jorissen, dated May 10, 2004#
(19)
10.27
First Amendment to Restricted Stock Award Agreement between Sun Communities, Inc. and Jeffrey P. Jorissen#
(19)
10.28
Second Amendment to Restricted Stock Award Agreement between Sun Communities, Inc. and Jeffrey P. Jorissen
(27)
10.29
Form of Loan Agreement dated June 9, 2004 by and among Sun Candlewick LLC, Sun Silver Star LLC and Aspen-Holland Estates, LLC, as Borrowers, and Bank of America, N.A., as Lender
(15)
10.30
Schedule identifying substantially identical agreements to Exhibit 10.29
(15)
10.31
Form of Loan Agreement dated June 9, 2004 by and between Sun Pool 8 LLC, as Borrower, and Bank of America, N.A., as Lender
(15)
10.32
Schedule identifying substantially identical agreements to Exhibit 10.31
(15)
10.33
Form of Loan Agreement dated June 9, 2004 by and between Sun Continental Estates LLC as Borrower, and Bank of America, N.A., as Lender
(15)
10.34
Schedule identifying substantially identical agreements to Exhibit 10.33
(15)
10.35
Form of Loan Agreement dated June 9, 2004 by and between Sun Indian Creek LLC, as Borrower, and Bank of America, N.A., as Lender
(15)
10.36
Schedule identifying substantially identical agreements to Exhibit 10.35
(15)
10.37
Amended And Restated Master Credit Facility Agreement dated April 28, 2004 by and among Sun Secured Financing LLC, Aspen Ft. Collins Limited Partnership, Sun Secured Financing Houston Limited Partnership, Sun Communities Finance, LLC, Sun Holly Forest LLC, Sun Saddle Oak LLC, as Borrowers, and Arcs Commercial Mortgage Co., L.P., as Lender
(15)
10.38
Appendix I (definitions) to Amended And Restated Master Credit Facility Agreement dated April 28, 2004 by and among Sun Secured Financing LLC, Aspen Ft. Collins Limited Partnership, Sun Secured Financing Houston Limited Partnership, Sun Communities Finance, LLC, Sun Holly Forest LLC, Sun Saddle Oak LLC, as Borrowers, and Arcs Commercial Mortgage Co., L.P., as Lender
(15)
10.39
Fixed Facility Note dated April 5, 2004 made by Sun Secured Financing LLC, Aspen - Ft. Collins Limited Partnership and Sun Secured Financing Houston Limited Partnership, in favor of Arcs Commercial Mortgage Co., L.P., in the original principal amount of $77,362,500
(15)
10.40
Fixed Facility Note dated April 28, 2004 made by Sun Secured Financing LLC, Sun Secured Financing Houston Limited Partnership, Aspen - Ft. Collins Limited Partnership, Sun Communities Finance LLC, Sun Holly Forest LLC and Sun Saddle Oak LLC, in favor of Arcs Commercial Mortgage Co., L.P., in the original principal amount of $100,000,000
(15)
10.41
Variable Facility Note dated April 28, 2004 made by Sun Secured Financing LLC, Sun Secured Financing Houston Limited Partnership, Aspen - Ft. Collins Limited Partnership, Sun Communities Finance LLC, Sun Holly Forest LLC and Sun Saddle Oak LLC, in favor of Arcs Commercial Mortgage Co., L.P., in the original principal amount of $60,275,000
(15)
10.42
Fourth Amended and Restated Variable Facility Note dated April 28, 2004 made by Sun Secured Financing LLC, Sun Secured Financing Houston Limited Partnership, Aspen - Ft. Collins Limited Partnership, Sun Communities Finance LLC, Sun Holly Forest LLC and Sun Saddle Oak LLC, in favor of Arcs Commercial Mortgage Co., L.P., in the original principal amount of $152,362,500
(15)
10.43
Credit Agreement, dated September 30, 2004, among the Company, the Operating Partnership, Standard Federal Bank National Association, LaSalle Bank National Association and other lenders
(16)
10.44
Second Amended and Restated Promissory Note (Secured), dated as of July 15, 2002, made by Gary A. Shiffman in favor of the Operating Partnership
(13)
10.45
First Amended and Restated Promissory Note (Unsecured), dated as of July 15, 2002, made by Gary A. Shiffman in favor of the Operating Partnership
(13)
10.46
First Amended and Restated Promissory Note (Secured), dated as of July 15, 2002, made by Gary A. Shiffman in favor of the Operating Partnership
(13)
10.47
Second Amended and Restated Promissory Note (Unsecured), dated as of July 15, 2002, made by Gary A. Shiffman in favor of the Operating Partnership
(13)
10.48
Second Amended and Restated Promissory Note (Secured), dated as of July 15, 2002, made by Gary A. Shiffman in favor of the Operating Partnership
(13)
10.49
Lease, dated November 1, 2002, by and between the Operating Partnership as Tenant and American Center LLC as Landlord
(14)
10.50
Concurrent Private Placement Agreement dated October 8, 2003 among Sun OFI, Inc., Origen Financial, Inc., and the Purchasers (as defined therein)
(18)
10.51
Registration Rights Agreement dated as of October 8, 2003 among Sun OFI, Inc., Origen Financial, Inc., Lehman Brothers Inc., on behalf of itself and as agent for the investors listed on Schedule A thereto and those persons listed on Schedule B thereto
(18)
10.52
Agreement for Wholesale Financing, dated March 1, 2006, by and between Sun Home Services, Inc. and Textron Financial Corporation
(21)
10.53
Promissory Note dated July 10, 2006 made by Sun Villa MHC LLC in favor of ARCS Commercial Mortgage Co., L.P., in the original principal amount of $18,300,000
(22)
10.54
Promissory Note dated July 10, 2006 made by Sun Countryside Atlanta LLC in favor of ARCS Commercial Mortgage Co., L.P., in the original principal amount of $12,950,000
(22)
10.55
Deed of Trust, Assignment of Rents, Security Agreement and Fixture Filing, dated July 10, 2006, made by Sun Villa MHC LLC in favor of ARCS Commercial Mortgage Co., L.P.
(22)
10.56
Deed to Secure Debt and Security Agreement dated July 10, 2006 made by Sun Countryside Atlanta LLC in favor of ARCS Commercial Mortgage Co., L.P.
(22)
10.57
Promissory Note dated August 1, 2006 made by Sun Countryside Lake Lanier LLC in favor of ARCS Commercial Mortgage Co., L.P., in the original principal amount of $16,850,000
(23)
10.58
Deed to Secured Debt and Security Agreement dated August 1, 2006 made by Sun Countryside Lake Lanier LLC in favor of ARCS Commercial Mortgage Co., L.P.
(23)
10.59
Future Advance, Renewal and Consolidation Promissory Note dated November 15, 2006 made by Miami Lakes Venture Associates in favor of Lehman Brothers Bank, FSB in the original principal amount of $54,000,000
(23)
10.60
Notice of Future Advance, Mortgage Modification, Extension and Spreader Agreement and Security Agreement dated November 15, 2006 made by Miami Lakes Venture Associates in favor of Lehman Brothers Bank, FSB
(23)
10.61
Promissory Note dated January 4, 2007 made by High Point Associates, L.P., in favor of Lehman Brothers Bank, FSB in the original principal amount of $17,500,000
(23)
10.62
Mortgage and Security Agreement dated January 4, 2007 made by High Point Associates, L.P., in favor of Lehman Brothers Bank, FSB
(23)
10.63
Promissory Note dated January 5, 2007 made by Sea Breeze Limited Partnership in favor of Lehman Brothers Bank, FSB in the original principal amount of $20,000,000
(23)
10.64
Mortgage and Security Agreement dated January 5, 2007 made by Sea Breeze Limited Partnership in favor of Lehman Brothers Bank, FSB
(23)
10.65
First Amendment to Amended and Restated Master Credit Facility Agreement dated May 31, 2007 by and among (i) Sun Secured Financing LLC, Aspen-Ft. Collins Limited Partnership, Sun Secured Financing Houston Limited Partnership, Sun Communities Finance, LLC, Sun Holly Forest LLC and Sun Saddle Oak LLC, and (ii) ARCS Commercial Mortgage Co., L.P.
(24)
10.66
Fourth Amendment to Credit Agreement dated June 1, 2007 by and among Sun Communities Operating Limited Partnership, Sun Communities, Inc., LaSalle Bank Midwest National Association, the Huntington National Bank, KeyBank National Association, National City Bank of the Midwest and Sovereign Bank
(24)
21.1
List of Subsidiaries of Sun Communities, Inc.
(28)
23.1
Consent of Grant Thornton LLP
(28)
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(28)
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(28)
32.1
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of
(28)
(1)
Incorporated by reference to Sun Communities, Inc.’s Registration Statement No. 33-69340.
(2)
Incorporated by reference to Sun Communities, Inc.’s Annual Report on Form 10-K for the year ended December 31, 1995.
(3)
Incorporated by reference to Sun Communities, Inc.’s Current Report on Form 8-K dated April 24, 1996.
(4)
Incorporated by reference to Sun Communities, Inc.’s Registration Statement No. 33-80972.
(5)
Incorporated by reference to Sun Communities, Inc.’s Quarterly Report on Form 10-K for the quarter ended September 30, 1995.
(6)
Incorporated by reference to Sun Communities, Inc.’s Annual Report on Form 10-K for the year ended December 31, 1996.
(7)
Incorporated by reference to Sun Communities, Inc.’s Annual Report on Form 10-K for the year ended December 31, 1997.
(8)
Incorporated by reference to Sun Communities, Inc.’s Current Report on Form 8-A dated May 27, 1998.
(9)
Incorporated by reference to Sun Communities, Inc.’s Annual Report on Form 10-K for the year ended December 31, 1998.
(10)
Incorporated by reference to Sun Communities, Inc.’s Proxy Statement, dated April 20, 1999
(11)
Incorporated by reference to Sun Communities, Inc.’s Current Report on Form 8-K dated October 14, 1999.
(12)
Incorporated by reference to Sun Communities, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2001.
(13)
Incorporated by reference to Sun Communities, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2002.
(14)
Incorporated by reference to Sun Communities, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2002, as amended.
(15)
Incorporated by reference to Sun Communities, Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2004.
(16)
Incorporated by reference to Sun Communities, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004.
(17)
Incorporated by reference to Sun Communities, Inc.’s Current Report on Form 8-K dated February 23, 2005.
(18)
Incorporated by reference to Origen Financial, Inc.’s Registration Statement on Form S-11, No. 333-112516
(19)
Incorporated by reference to Sun Communities, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2004.
(20)
Incorporated by reference to Sun Communities, Inc.’s Current Report on Form 8-K dated October 19, 2006
(21)
Incorporated by reference to Sun Communities, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31,
(22)
Incorporated by reference to Sun Communities, Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30,
(23)
Incorporated by reference to Sun Communities, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31,
(24)
Incorporated by reference to Sun Communities, Inc.’s Quarterly Report on Form 10-Q for the quarter ended June 30,
(25)
Incorporated by reference to Sun Communities, Inc.’s Current Report on Form 8-K dated October 30, 2007
(26)
Incorporated by reference to Sun Communities, Inc.’s Proxy Statement dated April 20, 2004
(27)
Incorporated by reference to Sun Communities, Inc.’s Current Report on Form 8-K dated January 4, 2008
#
Management contract or compensatory plan or arrangement.
SUN COMMUNITIES, INC.
INDEX TO THE CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL
STATEMENT SCHEDULE
Page
Management’s Report on Internal Control Over Financial Reporting
Reports of Independent Registered Public Accounting Firm
-
Financial Statements:
Consolidated Balance Sheets as of December 31, 2007 and
Consolidated Statements of Operations
for the Years Ended December 31, 2007, 2006 and
Consolidated Statements of Comprehensive Loss
for the Years Ended December 31, 2007, 2006 and
Consolidated Statements of Stockholders’ Equity
for the Years Ended December 31, 2007, 2006 and
Consolidated Statements of Cash Flows
for the Years Ended December 31, 2007, 2006 and
Notes to Consolidated Financial Statements
-
Schedule III - Real Estate and Accumulated Depreciation
-
Management’s Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) and 15d-15(f) promulgated under the Securities Exchange Act of 1934, as amended. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
•
pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;
•
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles;
•
provide reasonable assurance that receipts and expenditures of the Company are being made only in accordance with authorization of management and directors of the Company; and
•
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material adverse effect on the financial statements.
All internal control systems, no matter how well designed, have inherent limitations and can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. Even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007. In making this assessment, management used the criteria for effective internal control over financial reporting set forth in “Internal Control - Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management determined that, as of December 31, 2007, the Company’s internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Grant Thornton LLP, an independent registered public accounting firm, has issued an attestation report on the Company’s internal control over financial reporting as of December 31, 2007, and their report is included herein.
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Sun Communities, Inc.
We have audited Sun Communities, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Sun Communities, Inc. and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on Sun Communities, Inc. and subsidiaries’ internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Sun Communities, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Sun Communities, Inc. and subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007 and our report dated March 17, 2008 expressed an unqualified opinion on those financial statements.
/s/ GRANT THORNTON LLP
Southfield, Michigan
March 17,
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Sun Communities, Inc.
We have audited the accompanying consolidated balance sheets of Sun Communities, Inc. and subsidiaries as of December 31, 2007 and 2006, and the related statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007. Our audits of the basic financial statements included the financial statement schedule listed in the accompanying index. These financial statements and the financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Sun Communities, Inc. and subsidiaries as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
As discussed in Note 6 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standard No. 123(R), “Share-Based Payments”, effective January 1, 2006.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Sun Communities Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated March 17, 2008 expressed an unqualified opinion.
/s/ GRANT THORNTON LLP
Southfield, Michigan
March 17, 2008
SUN COMMUNITIES, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2007 AND 2006
(amounts in thousands)
The accompanying notes are an integral part of the consolidated financial statements
SUN COMMUNITIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005
(amounts in thousands except for per share data)
The accompanying notes are an integral part of the consolidated financial statements
SUN COMMUNITIES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
FOR THE YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005
(amounts in thousands)
SUN COMMUNITIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005
(amounts in thousands except for per share data)
The accompanying notes are an integral part of the consolidated financial statements
SUN COMMUNITIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005
(amounts in thousands)
The accompanying notes are an integral part of the consolidated financial statements
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
a.
Business: Sun Communities, Inc. (the “Company”) is a real estate investment trust (“REIT”) which owns and operates 136 manufactured housing communities at December 31, 2007, located in eighteen states concentrated principally in the Midwest and Southeast comprising 47,607 developed sites and 6,588 sites suitable for development.
The preparation of financial statements in conformity with generally accepted accounting principles 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 dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
b.
Principles of Consolidation: The accompanying financial statements include the accounts of the Company and all majority-owned and controlled subsidiaries including Sun Communities Operating Limited Partnership (the “Operating Partnership”) SunChamp LLC (“SunChamp”), and Sun Home Services, Inc. (“SHS”). SHS is a wholly owned subsidiary that actively markets, sells and leases new and pre-owned manufactured homes for placement in the Company’s properties.
The minority interests include 2.3 million Common Operating Partnership Units (“OP Units”) which are convertible into an equivalent number of shares of the Company’s common stock. Such conversion would have no effect on earnings per share since the allocation of earnings to an OP Unit is equivalent to earnings allocated to a share of common stock. The minority interests are adjusted to their relative ownership interest whenever OP Units or common stock are issued, converted or retired by reclassification to/from paid-in capital.
Preferred OP Units (“POP Units”) of $49.4 million and $53.9 million, which are mandatorily redeemable, are included in debt at December 31, 2007 and 2006, respectively, pursuant to the adoption of Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liability and Equity”. These POP Units pay priority returns at rates ranging from 7.1 percent to 7.6 percent and mature between 2009 and 2014. Of these POP Units, $35.8 million are convertible into shares of the Company’s common stock or OP Units at conversion price $68 per unit. The maximum amount that the Company is required to pay to redeem its POP Units is $49.4 million and, if converted, approximately 526,000 shares of the Company’s capital stock or OP Units would be issued.
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued:
c.
Investment Property: Rental property is recorded at cost, less accumulated depreciation. The Company measures the recoverability of its assets in accordance with Statement of Financial Accounting Standards No. 144 (“SFAS 144”), “Accounting for the Impairment or Disposal of Long Lived Assets.” If such assets were deemed to be impaired as a result of this measurement evaluation, the impairment that would be recognized is the amount by which the carrying amount of the asset exceeds fair value as determined on a discounted net cash flow basis. Assets are tested for impairment every three years or more frequently whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. Circumstances that may prompt a test of recoverability may include a significant decrease in anticipated market price, an adverse change to the extent or manner in which an asset may be used or in its physical condition or other such events that may significantly change the value of the long-lived asset.
The Company periodically receives offers from interested parties to purchase certain of its properties. These offers may be the result of an active program initiated by the Company to sell the property, or from an unsolicited offer to purchase the property. The typical sale process involves a significant negotiation and due diligence period between the Company and the potential purchaser. As the intent of this process is to determine if there are items that would cause the purchaser to be unwilling to purchase or the Company unwilling to sell, it is not unusual for such potential offers of sale/purchase to be withdrawn as such issues arise. The Company classifies assets as “held for sale” when it is probable, in its opinion, that a sale transaction will be completed within one year. This typically occurs when all significant contingencies surrounding the closing have been resolved, which often corresponds with the closing date.
The Company allocates the purchase price of properties to net tangible and identified intangible assets acquired based on their fair values in accordance with the provisions of SFAS No. 141, “Business Combinations”. In making estimates of fair values for purposes of allocating purchase price, the Company utilizes a number of sources, including analysis of recently acquired and existing comparable properties in our portfolio, other market data and independent appraisals if obtained in connection with the acquisition or financing of the respective property. The Company also considers information obtained about each property as a result of its pre-acquisition due diligence, marketing and leasing activities in estimating the fair value of the tangible and intangible assets (including in-place leases) acquired.
Depreciation is computed on a straight-line basis over the estimated useful lives of the assets. Useful lives are 30 years for land improvements and buildings, 10 years for rental homes, 7 to 15 years for furniture, fixtures and equipment, and 7 years for intangible assets.
d.
Cash and Cash Equivalents: The Company considers all highly liquid investments with a maturity at date of purchase of three months or less to be cash and cash equivalents.
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued:
e.
Notes and Accounts Receivable: Notes and accounts receivable are stated at their outstanding balance reduced by allowance for uncollectible accounts. The Company evaluates the recoverability of its receivables whenever events occur or there are changes in circumstances such that management believes it is probable that it will be unable to collect all amounts due according to the contractual terms of the loan and lease agreements. The ability to collect the loans is measured based on current information and events; it is probable that the Company will not be able to collect all amounts due according to the contractual terms of the loan agreement. When making this evaluation numerous factors are considered, including delinquency level, estimated costs to lease or sell, and the Company’s repossession history. For receivables relating to community rents the Company reserves for receivables when it believes collection is less than probable, which is generally after a resident balance reaches 60 to 90 days past due. The Company reserves for estimated repairs to homes which collateralize its installment notes receivable based upon an estimate of annual foreclosures and historical costs of repair.
f.
Share-Based Compensation: The Company adopted SFAS 123(R), “Share-Based Payment” effective January 1, 2006 using the “modified prospective” method permitted by SFAS 123(R) in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of Statement 123 for all awards granted to employees prior to the effective date of SFAS 123(R) that remain unvested on the effective date. Prior to the adoption of SFAS 123(R), the company accounted for its stock options using the intrinsic value method contained in APB Opinion No. 25, “Accounting for Stock Issued to Employees.”
g.
Investments in and Advances to Affiliates: Origen Financial, Inc. (“Origen”), is a publicly-traded real estate investment trust in the business of originating, acquiring and servicing manufactured home loans. In October 2003, the Company purchased 5,000,000 shares of common stock of Origen for $50.0 million. As of December 31, 2007, the Company’s 5,000,000 shares of Origen common stock represented approximately 19% of the issued and outstanding shares of the capital stock of Origen. The investment is accounted for using the equity method of accounting. At December 31, 2007, the Company’s investment in Origen had a market value of $20.0 million. The Company received dividends from Origen of $1.4 and $0.5 million during 2007 and 2006, respectively.
The Company has considered the provisions of Accounting Principles Bulletin No. 18, “The Equity Method of Accounting for Investments in Common Stock”, and has concluded that a recognition of an other than temporary impairment was required as of December 31, 2007 and 2006. The Company considered numerous factors, including:
•
The length of the time and the extent to which the market value has been less than cost,
•
The financial condition and near-term prospects of Origen,
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued:
•
The intent and ability of the Company to retain its investment in Origen for a period of time sufficient to allow for any anticipated recovery in market value,
•
The condition and trend of the economic cycle,
•
Origen’s financial performance and projections
•
Trends in the general market,
•
Origen’s capital strength and liquidity, and
•
Origen’s dividend payment record.
The Company also considered various indicators of fair value, including multiples of book value, multiples of EBITDA, book value, tangible book value, and market price. As a result of its analysis, the Company recognized a $1.9 million and $18.0 million impairment of the carrying value of its equity investment in Origen for the years ended December 31, 2007 and 2006, respectively, which is included in equity loss from affiliate. Also included in equity loss from affiliate in 2007 is an $8.0 million loss attributable to the Company’s portion of Origen’s goodwill and investment impairment charges of $32.3 million and $9.2 million, respectively.
Summarized consolidated financial information of Origen at December 31, 2007, 2006 and 2005 is presented below before elimination of inter-company transactions (amounts in thousands):
See Footnote 16 Subsequent Events for additional information regarding this investment.
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued:
h. Revenue Recognition: Rental income attributable to site and home leases is recorded on a straight-line basis when earned from tenants. Leases entered into by tenants generally range from month-to-month to two years and are renewable by mutual agreement of the Company and resident or, in some cases, as provided by state statute. Revenue from the sale of manufactured homes is recognized upon transfer of title at the closing of the sales transaction. Interest income on notes receivable is recorded on a level yield basis over the life of the notes.
i. Other Capitalized Costs: The Company capitalizes certain costs (including interest and other costs) incurred in connection with the development, redevelopment, capital enhancement and leasing of its properties. Management is required to use professional judgment in determining whether such costs meet the criteria for immediate expense or capitalization. The amounts are dependent on the volume and timing of such activities and the costs associated with such activities. Maintenance, repairs and minor improvements to properties are expensed when incurred. Renovations and improvements to properties are capitalized and depreciated over their estimated useful lives and construction costs related to the development of new community or expansion sites are capitalized until the property is substantially complete. Certain expenditures to dealers and residents related to obtaining lessees in our communities are capitalized, as intangible assets, and are amortized over a seven year period based on the anticipated term of occupancy of a resident. Costs associated with implementing the Company’s new computer systems are capitalized and amortized over the estimated useful lives of the related software and hardware.
j. Fair Value of Financial Instruments: The carrying values of cash and cash equivalents, escrows, receivables, accounts payable, accrued expenses and other assets and liabilities are reasonable estimates of their fair values because of the shorter maturities of these instruments. The fair value of the Company’s long-term indebtedness, which is based on the estimates of management and on rates currently quoted and rates currently prevailing for comparable loans and instruments of comparable maturities, is greater than the carrying value by approximately $44.4 million and $24.7 million at December 31, 2007 and 2006, respectively. Potential expenses that would be incurred in an actual sale or settlement are not taken into consideration.
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued:
k.
Derivative Instruments and Hedging Activities: The Company currently has three derivative contracts consisting of two interest rate swap agreements and an interest rate cap agreement. 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 and to cap the maximum interest rate on its variable rate borrowings. The Company does not enter into derivative instruments for speculative purposes.
The swap agreements were effective April 2003, and have the effect of fixing interest rates relative to a collateralized term loan due to Fannie Mae. One swap fixes $25 million of variable rate borrowings at 4.84 percent through July 2009. The second swap matures in July 2012, with an effective fixed rate of 5.28 percent and a notional amount of $25 million. The interest rate cap agreement has a cap rate of 9.99 percent, a notional amount of $152.4 million and a termination date of April 28, 2009. Each of the Company’s derivative contracts is based upon 90-day LIBOR.
The Company has designated the two swaps and the interest rate cap as cash flow hedges for accounting purposes. The changes in the value of these hedges are reflected in accumulated other comprehensive income (loss) on the balance sheet. These three hedges were highly effective and had minimal effect on income. An additional swap matured in July 2007 and did not qualify as a hedge for accounting purposes and, accordingly, the entire change in valuation, whether positive or negative, was reflected as a component of interest expense. The valuation adjustment decreased interest expense by $0.3 million for the year ended December 31, 2007, decreased interest expense by $0.3 million for the year ended December 31, 2006, and increased interest expense by $0.4 million for the year ended December 31, 2005.
In accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” which requires all derivative instruments to be carried at fair value on the balance sheet, the Company has recorded a liability of $0.9 million and an asset of $0.6 million as of December 31, 2007 and 2006, respectively.
These valuation adjustments will only be realized if the Company terminates the swaps prior to maturity. This is not the intent of the Company and, therefore, the net of valuation adjustments through the various maturity dates will approximate zero.
From time to time, the Company is required to provide cash collateral for its swaps. At December 31, 2007 and 2006, the Company had collateral deposits recorded in other assets of $1.4 million and $0.6 million , respectively.
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued:
l.
Deferred Tax Assets: The Company is subject to certain state taxes that are considered income taxes and has certain subsidiaries that are taxed as regular corporations. Deferred tax assets or liabilities are recognized for temporary differences between the tax bases of assets and liabilities and their carrying amounts in the financial statements and net operating loss carry forwards. Deferred tax assets and liabilities are measured using currently enacted tax rates. A valuation allowance is established if, based on the available evidence, it is considered more likely than not that some portion or all of the deferred tax assets will not be realized.
m. Inventory: Inventory of manufactured homes is stated at lower of specific cost or market.
n. Advertising Costs: Advertising costs are expensed as incurred.
o.
Reclassifications: Certain 2005 and 2006 amounts have been reclassified to conform to the 2007 financial statement presentation. Such reclassifications had no effect on results of operations as originally presented.
p. Use of Estimates: The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes including the depreciable lives and recoverability of real estate assets and other capitalized costs, and the assumption of interest rates for present value calculations. These estimates involve judgments with respect to, among other things, future economic factors that are difficult to predict and are often beyond management’s control. As a result, actual amounts may differ from these estimates.
2. INVESTMENT PROPERTY (amounts in thousands):
Land improvements and buildings consist primarily of infrastructure, roads, landscaping, clubhouses, maintenance buildings and amenities.
During 2006, the Company acquired a manufactured home community located in Oakland County, Michigan with occupancy of approximately 95 percent for a total purchase price of $7.8 million. The transaction included the assumption of $4.5 million of debt.
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
3. DISPOSITION OF PROPERTIES:
In accordance with FAS 144, results of operations and gain/(loss) on sales of real estate for properties with identifiable cash flows 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):
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
4. NOTES AND OTHER RECEIVABLES:
The following table sets forth certain information regarding notes and other receivables (amounts in thousands):
The mortgage note receivable of $13.5 million at December 31, 2006, was repaid on March 1, 2007.
The installment loans of $30.4 million and $20.5 million at December 31, 2007 and 2006, respectively, are collateralized by manufactured homes and are presented net of allowance for losses of $0.2 million for each period. The loans represent financing provided by the Company to purchasers of manufactured homes located in its communities.
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
4. NOTES AND OTHER RECEIVABLES, continued:
Officer’s notes, presented as a reduction to stockholders’ equity in the balance sheet, are 10 year, LIBOR + 1.75% notes, with a minimum and maximum interest rate of 6% and 9%, respectively. The notes become due in three equal installments on each of December 31, 2008, 2009 and 2010. The following table sets forth certain information regarding officer’s notes as of December 31, 2007 and 2006 (in thousands except for shares and units):
The officer’s personal liability on the secured promissory notes is limited to all accrued interest on such notes plus fifty percent (50%) of the deficiency, if any, after application of the proceeds from the sale of the secured shares and/or the secured units to the then outstanding principal balance of the promissory notes. The unsecured notes are fully recourse to the officer.
The reduction in the aggregate principal balance of these notes was $0.3 million and $0.3 million for the years 2007 and 2006, respectively. Total interest was $0.6 million, $1.0 million and $0.6 million for the years ended December 31, 2007, 2006 and 2005, respectively.
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
5. DEBT AND LINE OF CREDIT:
The following table sets forth certain information regarding debt (amounts in thousands):
The collateralized term loans totaling $867.7 million at December 31, 2007, are secured by 87 properties comprising approximately 31,094 sites representing approximately $578.4 million of net book value. The mortgage notes totaling $184.9 million at December 31, 2007, are collateralized by 16 communities comprising approximately 5,862 sites representing approximately $172.9 million of net book value.
The Company has an unsecured revolving line of credit facility with a maximum borrowing capacity of $115 million, subject to certain borrowing base calculations. The outstanding balance on the line of credit at December 31, 2007 and 2006, was $85.4 million and $86.4 million, respectively. In addition, $3.4 million of availability was used to back standby letters of credit at December 31, 2007 and 2006. Borrowings under the line of credit bear an interest rate of LIBOR plus 1.65% (6.55% at December 31, 2007) and mature October 1, 2010. A one year extension is available at the Company’s option. At December 31, 2007 and 2006, $26.2 million and $25.2 million, respectively, were available to be drawn under the facility based on the calculation of the borrowing base at each year end.
In March of 2006, the Company closed on a $40.0 million floor plan facility that allows for draws on new and pre-owned home purchases and on the Company’s portfolio of rental homes. At December 31, 2007, the outstanding balance on the floor plan was $0.3 million and there was no outstanding balance at December 31, 2006. The facility bears interest at 7.25 percent and matures on March 1, 2009.
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
5. DEBT AND LINE OF CREDIT, continued:
In January of 2007, the Company completed financings of $17.5 million and $20.0 million at interest rates of 5.842 percent and 5.825 percent, respectively. The loans are secured by two properties and have interest only payments for a term of 10 years. The proceeds from both financings were used to pay down the Company’s revolving line of credit.
In February of 2007, the Company redeemed $4.5 million of Preferred OP units.
In April of 2007, the Company extended $15.8 million of debt with an original maturity date of April 1, 2007. The transaction extended the maturity date of the debt to April 1, 2012, and reduced the spread over LIBOR by 0.25 percent, to LIBOR + 1.5 percent. As part of the transaction, the Company paid down the principal balance of the debt by $1.0 million. The transaction was accounted for as a modification of debt.
At December 31, 2007, the total of maturities and amortization of debt during the next five years are as follows (amounts in thousands):
The most restrictive of these debt agreements place limitations on secured and unsecured borrowings and contain minimum debt service coverage, leverage, distribution and net worth requirements. At December 31, 2007 and 2006, all covenants were met.
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
6. SHARE-BASED COMPENSATION:
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement No. 123 (revised December 2004), Share-Based Payment (“SFAS 123(R)”). SFAS 123(R) replaces FASB Statement No. 123 (“Statement 123”), Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25 (“APB 25”), Accounting for Stock Issued to Employees. SFAS 123(R) requires compensation costs related to share-based payment transactions be recognized in the financial statements. With limited exceptions, the amount of compensation cost will be measured based on the grant-date fair value of the equity or the liability instruments issued. In addition, liability awards will be remeasured each reporting period.
The Company adopted SFAS 123(R) effective January 1, 2006, using the “modified prospective” method permitted by SFAS 123(R) in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of Statement 123 for all awards granted to employees prior to the effective date of SFAS 123(R) that remain unvested on the effective date. Prior to the adoption of SFAS 123(R), forfeitures were recognized as they occurred. Upon adopting SFAS 123(R), an estimate of future forfeitures is incorporated into the determination of compensation cost for restricted stock grants and stock options. The effect of this estimate of future forfeitures was the reversal of previously recorded compensation expense on restricted stock grants that were not vested at January 1, 2006, and are now expected to be forfeited. Accordingly, the cumulative effect of adopting SFAS 123(R) in 2006 was an increase in loss from operations of $0.06 million, an increase in loss from continuing operations of $0.05 million, a decrease in net loss of $0.2 million and an increase of $0.01 in both basic and diluted earnings per share in 2006.
The modified prospective method of SFAS 123(R) does not require prior periods to be restated to reflect the amount of compensation cost that would have been reflected in the financial statements. The effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement 123 to stock-based compensation for the year ended December 31, 2005, is as follows (amounts in thousands except for per share data):
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
6. SHARE-BASED COMPENSATION, continued:
Total compensation cost recorded for share-based compensation for the years ended December 31, 2007, 2006 and 2005, was $1.1 million, $3.2 million (excluding the cumulative effect of change in accounting principle adjustment) and $1.8 million, respectively.
The Company awards restricted stock and options to its employees under its Second Amended and Restated Stock Option Plan (the “Plan”). The Plan provides for the issuance of options, stock appreciation rights, restricted stock and other stock based awards. The Company believes that the awards better align the interests of its employees with those of its shareholders and has provided these incentives to attract and retain executive officers and key employees.
Restricted Stock
The Company’s primary share-based compensation is restricted stock. The following table summarizes the Company’s restricted stock activity for the year ended December 31, 2007:
The remaining compensation expense to be recognized associated with the 281,711 restricted shares outstanding at December 31, 2007 is approximately $5.2 million. That expense is expected to be recognized $1.3 million in 2008, $2.3 million in 2009, $1.4 million in 2010 and $0.2 million thereafter. For the years ended December 31, 2007 and 2006, the Company recognized $1.8 million and $2.1 million of compensation expense, respectively, related to its outstanding restricted stock. Recipients receive dividend payments on the unvested shares of restricted stock. The total fair value of shares vested during the years ended December 31, 2007, 2006 and 2005, was $2.1 million, $2.3 million and $1.7 million, respectively.
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
6. SHARE-BASED COMPENSATION, continued:
Performance-Based Restricted Stock
At December 31, 2006, the Company had 93,750 shares performance-based restricted stock which was to be awarded based on the compounded annual growth rate of the Company’s per share funds from operations (“FFO”) as determined by comparing the per share FFO for the year ended December 31, 2009, with the per share FFO for the year ended December 31, 2005. The Company needed to achieve compounded annual growth of at least 5 percent for the recipients to receive any amount of the award and at least 9 percent to receive the entire share award. For the twelve months ended December 31, 2006, the Company expensed $0.6 million of compensation related to these shares based on an estimated award of 43,753 shares on March 1, 2010.
During the fourth quarter of 2007, the Company determined that the performance targets were not probable of being achieved and therefore, reversed total compensation expense recognized through September 30, 2007 of $0.8 million. On December 30, 2007, the Company modified the performance based restricted stock award altering certain provisions including required performance targets and, potentially, the named recipients of the awards. Subsequent to year end these performance-based restricted stock awards were cancelled.
Options
At December 31, 2007, the Company had 210,137 options outstanding and exercisable under the Plan. For the year ended December 31, 2006, the Company recognized $0.03 million of compensation expense related to its outstanding options. No awards were granted in any of the past three years.
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
6.
SHARE-BASED COMPENSATION continued:
The Company issues new shares at the time of share option exercise (or share unit conversion). The following table summarizes the Company’s option activity during 2007:
The aggregate intrinsic value of options exercised during the years ended December 31, 2007 and 2006, was $0.02 million and $0.8 million, respectively.
Phantom Awards
At December 31, 2007, the Company had 20,417 unvested phantom liability awards with an aggregate fair value of $0.4 million. The phantom awards pay cash bonuses per share equal to the amount of dividend paid per share of common stock. The awards vest (cash bonus is paid) in varying amounts until 2014. The remaining unrecognized expense related to these phantom liability awards is $0.3 million. For the year ended December 31,2007 and 2006, the Company recognized $0.1 million and $0.1 million of compensation expense, related to these phantom awards, respectively. The value of the awards is remeasured at each reporting date. The following table summarizes the phantom liability award activity for the year ended December 31, 2007:
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
6.
SHARE-BASED COMPENSATION continued:
At December 31, 2006, the Company had 18,750 unvested phantom performance-based liability awards which were to be awarded based on the compounded annual growth rate of the Company’s per share funds from operations (“FFO”) as determined by comparing the per share FFO for the year ended December 31, 2009, with the per share FFO for the year ended December 31, 2005. The Company needed to achieve compounded annual growth of at least 5 percent for the recipient to receive any amount of the award and at least 9 percent to receive the entire share award. The phantom performance-based awards pay cash bonuses per vested share equal to the average of the highest and lowest selling price on March 1, 2010. For the twelve months ended December 31, 2006, the Company expensed $0.1 million of compensation related to these shares based on an estimated award of 8,750 shares on March 1, 2010.
During the fourth quarter of 2007, the Company determined that the performance targets were not probable of being achieved and therefore, reversed total compensation expense recognized through September 30, 2007 of $0.1 million. On December 30, 2007, the Company modified the phantom performance based liability award altering certain provisions including required performance targets and, potentially, the named recipients of the awards. Subsequent to year end these performance-based restricted stock awards were cancelled.
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
Director Option Awards
The Company has a 1993 and a 2004 Non-Employee Director Option Plan (“Director Plans”) which each authorize the issuance of 100,000 options to non-employee directors. There remains 86,500 options available to be awarded under these two plans. At December 31, 2007, the Company had 76,000 options outstanding under the Director Plan, of which 18,000 were unvested. The unvested options of 8,500, 6,000, and 3,500, will vest in 2008, 2009 and 2010, respectively. The remaining unrecognized expense related to these options is $0.03 million which will be recognized over the weighted average remaining vesting period of 1.1 years. For the year ended December 31, 2007 and 2006, the Company recognized $0.03 million and $0.03 million of compensation expense related to these director options, respectively. The fair value of the options issued is estimated on the date of grant using the Binomial (lattice) option pricing model, with the following assumptions used for the grants for the period indicated:
The following table summarizes the Director option activity for the year ended December 31, 2007:
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
7.
STOCKHOLDERS’ EQUITY:
In April 1998, the Company declared a dividend of one Preferred Stock Purchase Right (“Right”) for each outstanding share of common stock. The Rights are not presently exercisable. Each Right entitles the holder, upon the occurrence of certain specified events, including a material change in the ownership of the Company, to purchase preferred stock and common stock, from the Company and/or from another person into which the Company is merged or which acquires control of the Company.
The Rights may be generally redeemed by the Company at a price of $0.01 per Right or approximately $0.2 million in total. The Rights expire on June 8, 2008.
In November 2004, the Company was authorized to repurchase up to 1,000,000 shares of its common stock by its Board of Directors. Repurchases of 600,000 shares were made during 2005. No repurchases were made during the years ended December 31, 2007 or 2006.
In October 1996, as last amended in March 2002, the Securities and Exchange Commission declared effective the Company’s shelf registration statement on Form S-3 for the proposed offering, from time to time, of up to $300 million of our common stock, preferred stock and debt securities. In addition to such debt securities, preferred stock and other common stock the Company may sell under the registration statement, the Company has registered for sale 1,600,000 shares of its common stock pursuant to a sales agreement that was entered into with Brinson Patrick Securities Corporation. Sales under the agreement commenced on October 21, 2001 and 967,642 shares and 33,549 shares were sold prior to 2007 and in 2007, respectively. The Company sold shares of common stock under the sales agreement with Brinson Patrick Securities Corporation during 2007 at the price of the Company’s common stock prevailing at the time of each sale. The Company received net proceeds of approximately $1.0 million, for the twelve months ended December 31, 2007 as a result of these sales.
The components of other income are as follows for the years ended December 31, 2007, 2006 and 2005:
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
9.
SEGMENT REPORTING (amounts in thousands):
The consolidated operations of the Company can be segmented into home sales and home rentals, and real property operations segments. Following is a presentation of financial information for the years ended December 31, 2007, 2006 and 2005.
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
9. SEGMENT REPORTING (amounts in thousands), continued:
(1) Investors in and analysts following the real estate industry utilize net operating income (“NOI”) as a supplemental performance measure. NOI is derived from revenues (determined in accordance with GAAP) minus property operating expenses and real estate taxes (determined in accordance with GAAP). NOI does not represent cash generated from operating activities in accordance with GAAP and should not be considered to be an alternative to net income (determined in accordance with GAAP) as an indication of the Company’s financial performance or to be an alternative to cash flow from operating activities (determined in accordance with GAAP) as a measure of the Company’s liquidity; nor is it indicative of funds available for the Company’s cash needs, including its ability to make cash distributions. The Company believes that net income is the most directly comparable GAAP measurement to net operating income. Net income includes interest and depreciation and amortization which often have no effect on the market value of a property and therefore limit its use as a performance measure. In addition, such expenses are often incurred at a parent company level and therefore are not necessarily linked to the performance of a real estate asset. The Company believes that net operating income is helpful to investors as a measure of operating performance because it is an indicator of the return on property investment, and provides a method of comparing property performance over time. The Company uses NOI as a key management tool when evaluating performance and growth of particular properties and/or groups of properties. The principal limitation of NOI is that it excludes depreciation, amortization and non-property specific expenses such as general and administrative expenses, all of which are significant costs, and therefore, NOI is a measure of the operating performance of the properties of the Company rather than of the Company overall.
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
10. INCOME TAXES:
The Company has elected to be taxed as a real estate investment trust (“REIT”) as defined under Section 856(c) of the Internal Revenue Code of 1986, as amended. In order for the Company to qualify as a REIT, at least ninety-five percent (95%) of the Company’s gross income in any year must be derived from qualifying sources. In addition, a REIT must distribute at least ninety percent (90%) of its REIT ordinary taxable income to its stockholders.
Qualification as a REIT involves the satisfaction of numerous requirements (some on an annual and quarterly basis) established under highly technical and complex Code provisions for which there are only limited judicial or administrative interpretations, and involves the determination of various factual matters and circumstances not entirely within the Company’s control. In addition, frequent changes occur in the area of REIT taxation which requires the Company to continually monitor its tax status. The Company analyzed the various REIT tests and confirmed that it continued to qualify as a REIT for the year ended December 31, 2007.
As a REIT, the Company generally will not be subject to U.S. federal income taxes at the corporate level on the ordinary taxable income it distributes to its stockholders as dividends. If the Company fails to qualify as a REIT in any taxable year, its taxable income will be subject to U.S. federal income tax at regular corporate rates (including any applicable alternative minimum tax). Even if the Company qualifies as a REIT, it may be subject to certain state and local income taxes and to U.S. federal income and excise taxes on its undistributed income.
For income tax purposes, distributions paid to common stockholders consist of ordinary income, capital gains, and return of capital. For the years ended December 31, 2007, 2006 and 2005, distributions paid per share were taxable as follows (unaudited):
SHS is subject to U.S. federal income taxes. Deferred taxes reflect the estimated future tax effect of temporary differences between carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The tax effect of temporary differences that give rise to a significant portion of the deferred tax assets at December 31 are as follows (in thousands):
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
10. INCOME TAXES, continued:
SHS has net operating loss carry forwards of approximately $26.3 million at December 31, 2007. The loss carryforwards will begin to expire in 2021 through 2027 if not offset by future taxable income. Management believes its deferred tax asset will be realized but realization is continuously subject to an assessment as to recoverability in the future. Federal income tax expense was $0.1 million for the year ending December 31, 2005, and is included in General and administrative-home sales and rentals in the consolidated statements of operations. No federal tax expense was recognized in 2007 and 2006.
On January 1, 2007, the Company adopted the provisions of Financial Accounting Standards Board (FASB) Interpretation 48, “Accounting for Uncertainty in Income Taxes” (FIN 48). The Company previously had accounted for tax contingencies in accordance with Statement of Financial Accounting Standards 5, “Accounting for Contingencies”. As required by FIN 48, which clarifies FASB Statement No. 109, “Accounting for Income Taxes”, the Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. At the adoption date, the Company applied FIN 48 to all tax positions for which the statute of limitations remained open. As a result of the adoption of FIN 48, the Company did not recognize any increase in the liability for unrecognized tax benefits, which would have been accounted for as a decrease to the January 1, 2007 balance of retained earnings. At January 1, 2007, the Company had no unrecognized tax benefits. There have been no material changes to the unrecognized tax benefits during the year ended December 31, 2007, nor are any expected within the next twelve months.
In July 2007, the State of Michigan signed into law the Michigan Business Tax Act, replacing the Michigan single business tax with a combined business income tax and modified gross receipts tax. These new taxes take effect January 1, 2008 and, for purposes of SFAS 109, “Accounting for Income Taxes”, are properly reflected as an income tax for financial statement reporting purposes as of the enactment date. This represents a change in the reporting of Michigan taxes as the Michigan single business tax was reflected as an administrative expense and not an income tax. In September 2007, the Michigan legislature passed a modification to the Michigan Business Tax Act establishing a deduction against the business income tax component of the tax to the extent that the new tax otherwise results in a net deferred tax liability as of December 31, 2007. In December 2007, another modification was passed by the legislature to add a surcharge that effectively increased the tax rate. The enactment of the Michigan Business Tax Act, in fact, did result in an increase in the Company’s deferred tax liabilities and, as such, are eligible for future deductions against future business income tax liabilities. However, as these deductions are not eligible to offset the gross receipts component of the tax, the Company took a deferred income tax charge for the expected cumulative future effects of this tax in the amount of $585,000. Although the Company does not expect to incur any significant cash tax expense with respect to this tax in the foreseeable future, the provisions under SFAS 109 required recognition in the third quarter, with an adjustment in the fourth quarter, of expected deferred tax implications.
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
10. INCOME TAXES, continued:
The Texas Margin Tax was enacted into law in May, 2006 and became effective in 2007 for calendar year taxpayers. For purposes of SFAS 109, this tax is also properly reflected as an income tax for financial reporting purposes. It was not necessary to record deferred taxes either upon enactment or at December 31, 2007. The Company has recorded a $183,000 liability for the Texas Margin Tax.
Total state income tax expense reported in the financial statements for 2007 is $768,000. On an ongoing basis, the Company will be reflecting the Michigan Business Tax and Texas Margin Tax as income taxes in its financial statements.
As noted, the Company and its subsidiaries are subject to income taxes in the U.S. and various state jurisdictions. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply. With few exceptions, the Company is no longer subject to U.S. Federal, State and Local, examinations by tax authorities before 2003.
The Company’s policy is to report penalties and tax-related interest expense as a component of income tax expense. As of the date of adoption of FIN 48, no interest or penalty associated with any unrecognized tax benefit was accrued, nor was any interest or penalty recognized during the year ended December 31, 2007.
11. EARNINGS (LOSS) PER SHARE:
The Company has outstanding stock options, unvested restricted shares and convertible Preferred OP units which if converted or exercised may impact dilution. Due to the fact that the Company has reported a net loss for each of the years ended December 31, 2007, 2006 and 2005, the calculation of both basic and diluted earnings per share is based upon weighted average shares prior to the inclusion of potentially dilutive securities, as the effect of including these securities in the calculation during these periods would be anti-dilutive.
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
12. QUARTERLY FINANCIAL DATA (unaudited):
The following unaudited quarterly amounts are in thousands, except for per share amounts:
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
13. RECENT ACCOUNTING PRONOUNCEMENTS:
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS No. 157). SFAS No. 157 establishes a common definition for fair value to be applied to US GAAP guidance requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. SFAS No. 157 was originally effective for fiscal years beginning after November 15, 2007, however in February, 2008, the FASB agreed to (a) defer the effective date in Statement 157 for one year for certain nonfinancial assets and non financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), and (b) remove certain leasing transactions form the scope of Statement 157. The Company does not believe SFAS 157 will have a material impact on its financial position and results of operations
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115” (SFAS 159). This statement permits, but does not require, entities to measure certain financial instruments and other assets and liabilities at fair value on an instrument-by-instrument basis. Unrealized gains and losses on items for which the fair value option has been elected should be recognized in earnings at each subsequent reporting date. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company did not elect the fair value option on January 1, 2008 and does not believe SFAS 159 will have an impact on its results from operations or financial position.
In December 2007, the FASB issued Statement No. 141R (revised 2007), “Business Combinations” (“SFAS 141R”). SFAS 141R will significantly change the accounting for business combinations. Under SFAS 141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. Statement 141R will change the accounting treatment for certain specific acquisition related items and also includes a substantial number of new disclosure requirements. The Company will apply SFAS 141R prospectively to business combinations for which the acquisition date is on or after January 1, 2009.
In December 2007, the FASB issued Statement No. 160, “Noncontrolling Interests in Consolidated Financial Statements-An Amendment of ARB No. 51” (“SFAS 160”). SFAS 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling interest in a subsidiary (minority interest) is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements and presented separately from the parent company’s equity. This statement also requires consolidated net income to be reported at amounts that include the amounts attributable to the parent and the noncontrolling interest and requires disclosure, on the face of the consolidated statement of operations, the amounts of consolidated net income attributable to the parent and the noncontrolling interest. SFAS 160 is effective for business combinations for which the acquisition date is on or after the first annual reporting period beginning on or after December 15, 2008. The Company does not believe SFAS 160 will have a material impact on its consolidated financial statements.
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
14. CONTINGENCIES:
On April 9, 2003, T.J. Holdings, LLC (“TJ Holdings”), a member of Sun/Forest, LLC (“Sun/Forest”) (which, in turn, owns an equity interest in SunChamp LLC), (“SunChamp”), filed a complaint against the Company, SunChamp, certain other affiliates of the Company and two directors of Sun Communities, Inc. in the Superior Court of Guilford County, North Carolina. The complaint alleges that the defendants wrongfully deprived the plaintiff of economic opportunities that they took for themselves in contravention of duties allegedly owed to the plaintiff and purports to claim damages of $13.0 million plus an unspecified amount for punitive damages. The Company believes the complaint and the claims threatened therein have no merit and will defend it vigorously. These proceedings were stayed by the Superior Court of Guilford County, North Carolina in 2004 pending final determination by the Circuit Court of Oakland County, Michigan as to whether the dispute should be submitted to arbitration and the conclusion of all appeals therefrom. On March 13, 2007, the Michigan Court of Appeals issued an order compelling arbitration of all claims brought in the North Carolina case. TJ Holdings has filed an application for review in the Michigan Supreme Court which has been denied and, accordingly, the North Carolina case is permanently stayed. TJ Holdings has now filed an arbitration demand in Southfield, Michigan based on the same claims. The Company intends to vigorously defend against the allegations.
As announced on February 27, 2006, the U.S. Securities and Exchange Commission (the “SEC”) completed its inquiry regarding the Company’s accounting for its SunChamp investment during 2000, 2001 and 2002, and the Company and the SEC entered into an agreed-upon Administrative Order (the “Order”). The Order required that the Company cease and desist from violations of certain non intent-based provisions of the federal securities laws, without admitting or denying any such violations.
On February 27, 2006, the SEC filed a civil action against the Company’s Chief Executive Officer, its then (and now former as of February 2008) Chief Financial Officer and a former controller in the United States District Court for the Eastern District of Michigan alleging various claims generally consistent with the SEC’s findings set forth in the Order. The discovery stage of this action has closed, and the parties are awaiting decisions on dispositive motions. The Company continues to indemnify such employees for all costs and expenses incurred in connection with such civil action.
The Company is involved in various other legal proceedings arising in the ordinary course of business. All such proceedings, taken together, are not expected to have a material adverse impact on our results of operations or financial condition.
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
15. RELATED PARTY TRANSACTIONS:
The Company and its affiliates have entered into the following transactions with Origen:
§
Capital Investment in Origen. In 2003, the Company acquired 5,000,000 shares of common stock in Origen in a private placement transaction at $10 per share. In addition, Shiffman Origen LLC (100 percent of which is owned by the Milton M. Shiffman Spouse’s Marital Trust, Gary A. Shiffman and members of his family), acquired 1,025,000 shares of common stock of Origen at $10 per share. Arthur A. Weiss, a director of the Company, is a trustee of the Milton M. Shiffman Spouse’s Marital Trust.
§
Board Membership. Gary A. Shiffman, the Chairman and Chief Executive Officer of the Company, is a board member of Origen.
§
Loan Servicing Agreement. Origen Servicing, Inc., a wholly-owned subsidiary of Origen, serviced approximately $30.6 million and $20.6 million in manufactured home loans for the Company as of December 31, 2007 and 2006, respectively. The Company pays Origen Servicing, Inc. an annual servicing fee of 100 to 150 basis points of the outstanding principal balance of the loans pursuant to a Loan Servicing Agreement which totaled approximately $0.4 million, $0.3 million and $0.3 million during 2007, 2006 and 2005, respectively.
§
Loan Origination, Sale and Purchase Agreement. Origen has agreed to fund loans that meet the Company’s underwriting guidelines and then transfer those loans to the Company pursuant to a Loan Origination, Sale and Purchase Agreement. The Company pays Origen a fee of $550 per loan pursuant to a Loan Origination, Sale and Purchase Agreement which totaled approximately $0.2 million, $0.2 million and $0.1 million during 2007, 2006 and 2005, respectively. During 2007 and 2006, the Company purchased, at par, $13.3 million and $7.9 million of these loans, respectively.
§
Purchase of Repossessed Manufactured Homes. The Company purchases certain repossessed manufactured houses owned by Origen located in its manufactured housing communities. The Company purchased approximately $1.2 million of repossessed homes from Origen during both 2007 and 2006. This program allows the Company to retain houses for resale and rent in its communities.
§
Sale of Installment Loans on Manufactured Homes: As noted above, Origen services manufactured home loans for the Company under a Loan Servicing Agreement. Certain loans may, from time to time, be sold to Origen. For loans that are made below published rates, the Company will pay Origen the interest differential between market rates and the rate paid by the borrower for any such loans sold to Origen. During 2004, the Company sold a portfolio of below published rates loans totaling $1.6 million to Origen. No sales of such loans were made in 2005, 2006 or 2007. The Company paid interest differential of approximately $0.1 million during 2007, 2006 and 2005. In 2006, the Company sold a portfolio of installment loans on manufactured homes totaling approximately $4.1 million to a wholly-owned subsidiary of Origen Financial, Inc. for 100.5 percent of the principal balance for loans that were 89 days or less delinquent and 100 percent of the principal balance for loans that were 90 days or more delinquent. The Company recognized a gain on the sale of these notes of $0.02 million.
SUN COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007, 2006 AND 2005
15. RELATED PARTY TRANSACTIONS, continued:
In addition to the transactions with Origen described above, Mr. Shiffman and his affiliates have entered into the following transactions with the Company:
§
Related Party Lease. Gary A. Shiffman, together with certain family members, indirectly owns approximately a 21 percent equity interest in American Center LLC, the entity from which we lease office space for our principal executive offices. Arthur A. Weiss owns a 0.75 percent indirect interest in American Center LLC. This lease was for an initial term of five years, beginning May 1, 2003, with the right to extend the lease for an additional five year term. On July 30, 2007 the Company exercised its option to extend its lease for its executive offices. The extension is for a period of five years commencing on May 1, 2008. The base rent for the option term will continue to be the same as the rent payable at the end of the current term. The current annual base rent under the current lease is $21.50 per square foot (gross). Mr. Shiffman and Mr. Weiss may have a conflict of interest with respect to their obligations as an officer and/or director of the Company and their ownership interest in American Center LLC.
§
Tax Consequences Upon Sale of Properties. Gary Shiffman holds limited partnership interests in the Operating Partnership which were received in connection with the contribution of 24 properties from partnerships previously affiliated with him (the “Sun Partnerships”). Prior to any redemption of these limited partnership interests for the Company’s common stock, Mr. Shiffman will have tax consequences different from those of the Company and the Company’s public stockholders on the sale of any of the Sun Partnerships. Four of the properties have been sold to date.
16. SUBSEQUENT EVENTS:
On March 13, 2008, Origen announced that recent and current conditions in the credit markets have adversely impacted Origen’s business and financial condition to the extent that it has determined to suspend loan originations for its own account and has taken steps to right-size its work force. Origen also announced that: (a) its warehouse facility expires on March 14, 2008, and Origen expects to sell its loans that collateralize this facility and use most of the proceeds to pay off the warehouse line; (b) approximately $50.0 million under its supplemental facility, which expires March 14, 2008, has been extended to June 13, 2008, subject to certain conditions; and (c) its Board of Directors is assessing possible courses of action, including continuation of a pared down business, possible sale of certain assets or possible sale of the entire company. These events may have a material adverse effect on the value of our investment in Origen. The Company recorded an impairment to the carrying value in its investment in Origen of $1.9 million and $18.0 million at December 31, 2007 and 2006, respectively. Additional information is included in Footnote 1.g.
SUN COMMUNITIES, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION, SCHEDULE III
DECEMBER 31, 2007
(amounts in thousands)
SUN COMMUNITIES, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION, SCHEDULE III
DECEMBER 31, 2007
(amounts in thousands)
SUN COMMUNITIES, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION, SCHEDULE III
DECEMBER 31, 2007
(amounts in thousands)
A These communities collateralize $381.6 million of secured debt.
B These communities collateralize $4.3 million of secured debt.
C These communities collateralize $486.1 million of secured debt.
(1) The initial cost for this property is included in the initial cost reported for Continental Estates.
SUN COMMUNITIES, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION, CONTINUED
DECEMBER 31, 2007
(amounts in thousands)
The change in investment property for the years ended December 31, 2007, 2006, and 2005 is as follows:
The change in accumulated depreciation for the years ended December 31, 2007, 2006, and 2005 is as follows: