CTO Realty Growth - 10-Q quarterly report FY

 

 

CONSOLIDATED-TOMOKA LAND CO.

 

CONSOLIDATED-TOMOKA LAND CO.

 

 

 

The Management’s Discussion and Analysis of Financial Condition and Results of Operations is designed to be read in conjunction with the financial statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations in the last annual report on Form 10-K.  Readers should also refer to the information set forth in Item 1A of Part II below.

The Company is primarily engaged in real estate land sales and development, reinvestment of land sales proceeds into income properties, and golf course operations.   The Company lands are well located in the growing central Florida Interstate 4 corridor, providing an excellent opportunity for reasonably stable land sales in the near-term future and following years.

With its substantial land holdings in Daytona Beach, the Company has parcels available for the entire spectrum of real estate uses.  Along with land sales, the Company selectively develops parcels primarily for commercial uses.  Sales and development activity on and around Company owned lands have been strong in the last five years.  Although pricing levels and changes by the Company and its immediate competitors can affect sales, the Company generally enjoys a competitive edge due to low costs associated with long-time land ownership and a significant ownership position in the immediate market.

Over the last five years, the Company has had a trend of strong sales and development activities, primarily within the Company’s western Daytona Beach area core land holdings.  These activities include: the sale of 120 acres of land to Florida Hospital in 2005 for the construction of a new facility, which commenced in 2006; the expansion of the Daytona Beach Auto Mall; the opening of a second office building in the Cornerstone Office Park; the continued development within the 250-acre Gateway Commerce Park, and the sale of approximately 100 acres of land on which a private high school is under development. During the first quarter of 2007, development began on the future site of the City of Daytona Beach police station on a parcel sold by the Company, to the City of Daytona Beach in 2006, at a discounted sales price, for which the Company received a charitable contribution deduction.  This site is located adjacent to Gateway Commerce Park. Residential development has also been strong on lands sold by the Company in prior years, including within the LPGA International community, and on other lands both east and west of Interstate 95. These development activities tend to create additional buyer interest and sales opportunities.  While most national homebuilders have experienced significant reductions in new sales contracts from the peak in mid to late 2005, the Company continues to experience a relatively stable Daytona Beach commercial real estate market.  A significant backlog of contracts is in place for closing in the remainder of 2007 and 2008.  Management intends to focus its efforts on closing this backlog while creating additional contracts and value to Company-owned lands.

In 2000, the Company initiated a strategy of investing in income properties utilizing the proceeds of agricultural land sales qualifying for income tax deferral through like-kind exchange treatment for tax purposes.  As of June 30, 2007, the Company had invested approximately $110 million in twenty-five income properties through this process, with an additional $1.3 million held by a qualified intermediary and an additional $8.5 million which was generated through Internal Revenue Code Section 1033, Involuntary Conversion Under Threat of Condemnation, for investment in additional properties. The existing investment base is expected to generate lease revenue of approximately $8.5 million annually.  This income, along with income from additional net-lease income property investments, is expected to decrease earnings volatility in future years and add to overall financial performance.  The Company is now in a position to consider other forms of real estate investment to diversify and enhance potential returns.

Golf operations consist of the operation of the golf courses, a clubhouse facility, and food and beverage activities within the LPGA International mixed-use residential community on the west side of Interstate 95, south and east of LPGA Boulevard.

The Company’s agricultural operations consist of growing, managing, and selling timber and hay products on approximately 11,100 acres of Company lands on the west side of Daytona Beach, Florida.

Net income of $1,115,940, equivalent to $.20 per share, was posted in the quarter ending June 30, 2007.  This net income represents a 70% downturn from 2006’s second quarter profit of $3,739,534, equivalent to $.66 per share.  The unfavorable results were primarily the result of lower land sales volume, offset somewhat by higher earnings from income properties.  Included in the second quarter 2006 profits was $248,454, equivalent to $.04 per share, from discontinued operations. The discontinued operations represented the operation and sale of an auto dealership site located in Daytona Beach, Florida, which was being held as an income property.

For the first six months of 2007 earnings totaled $532,128, equivalent to $.09 per share.  Profits totaling $5,867,966, equivalent to $1.03 per share, were posted in the first six months of 2006.  The lower earnings in 2007 can be attributed to lower profits on land sales, along with higher costs associated with stock-based compensation.  Higher earnings from income properties during the first six months of 2007 were an offset to the lower profits during the period.

The second quarter and first six months of 2006 have been adjusted to reflect the  impact of the adjustment made under Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in the Current Year Financial Statements” (“SAB 108”), in the fourth quarter of 2006.  The adjustment was considered immaterial for each of the periods of 2006.

The Company also uses Earnings before Depreciation, Amortization, and Deferred Taxes (EBDDT) as a performance measure.  The Company’s strategy of investing in income properties through the deferred tax like-kind exchange process produces significant amounts of depreciation and deferred taxes.

The following is the calculation of EBDDT:

EBDDT is calculated by adding depreciation, amortization, and the change in the deferred income tax liability to net income as they represent non-cash charges. EBDDT is not a measure of operating results or cash flows from operating activities as defined by U.S. generally accepted accounting principles.  Further, EBDDT is not necessarily indicative of cash availability to fund cash needs and should not be considered as an alternative to cash flow as a measure of liquidity.  The Company believes, however, that EBDDT provides relevant information about operations and is useful, along with net income, for an understanding of the Company’s operating results.

EBDDT totaling $1,620,705 and $1,953,915 for the second quarter and first six months of 2007, respectively, was significantly lower than 2006’s second quarter and first six months EBDDT amounting to $4,343,522 and $8,162,111, respectively.  The lower profits from land sales transactions and the resulting reduced deferral of the gains for income tax purposes was the primary cause of the unfavorable results.  The net decrease of deferred taxes in the second quarter of 2007 was due to the reversal of deferred taxes on gains from a year-end 2006 transaction for which the like-kind exchange process was not completed as the Company was unable to identify investment property which met established criteria.

Earnings from real estate sales totaled $750,134 during the quarter ended June 30, 2007, on revenues of $1,189,294.  These profits were generated on the sale of 10 acres of property in addition to the realization of $427,628 of profits from 2005 and 2006 transactions which had been deferred.  The sale of 20 acres of land, in addition to the recognition of $2,589,615 of profits from 2005 transactions which had been deferred, produced revenues and profits of $4,912,645 and $4,127,168, respectively, during the second quarter of 2006.

During the first six months of 2007, the sale of 93 acres of land, including a charitable contribution of 25 acres valued at $1,500,000, produced revenues and profits from land sales totaling $5,865,860 and $1,659,684, respectively.  Also included in sales during the period was the sale of approximately $1,900,000 of impact fee credits.  Costs and expenses rose substantially during the period with the higher cost basis associated with both the charitable contribution and the impact fee credits.  Profits of $8,021,392 were realized on the sale of 44 acres of property, which generated revenues of $9,524,502 during 2006’s first six month period.  Also included in earnings for the first six months of 2006 was the recognition of profits totaling $4,310,350, which had previously been deferred in 2005 due to post-closing obligations.  An additional $1,238,263 of profit was deferred at June 30, 2006, on two transactions which closed in 2006, as post-closing obligations had not been completed.

Profits from income properties rose 9% during the second quarter of 2007 when compared to 2006’s same period.  This increase was produced on a 12% gain in revenues, with the addition of two new properties in June 2006.  Revenues and income were $2,169,889 and $1,742,023, respectively for the three month period of 2007.  For the second quarter of 2006 income of $1,594,670 was generated on revenues of $1,934,456.  Income properties costs and expenses increased 26% during the second quarter of 2007 due to higher depreciation and operating expenses associated with the new properties.

During the first six months of 2007 profits from income properties totaling $3,477,592 were realized on revenues of $4,330,674.  These profits and revenues represented increases of 10% and 14%, respectively, over the profits of $3,152,277 recognized in the first six months of 2006 on revenues of $3,814,149.  These gains, also can be attributed to the addition of two new properties in June of 2006.

Revenues from golf operations increased 3% to $1,410,975 during the second quarter of 2007.  This revenue increase, when compared to 2006’s same period, was generated on higher food and beverage volume, as revenue from golf activities declined 1%.  Although the number of rounds played rose 3% over the prior year’s second quarter, the average rate per round played decreased 4%.  A 5% rise in golf costs and expenses more than offset the revenue gain and resulted in a 12% increase in the loss for the quarter to $390,951.  The increase in golf operations costs and expenses were primarily associated with higher food and beverage cost of sales and payroll costs.  Revenues and a loss of $1,373,085 and $349,380, respectively were posted in 2006’s second quarter.

Golf operations recorded a loss of $681,957 during the first six months of 2007.  This loss represented a 38% increase over the loss of $495,068 recognized for the same period of 2006.  Although revenues increased 3% for the period, to $2,977,182, the increase was more than offset by an 8% rise in costs and expenses.  Food and beverage revenues increased 10% during the period with golf revenues increasing 1%.  Total golf rounds played for the six month period rose 6% over the prior year, but was offset by a 6% decline in average rate per round played.  Golf operations revenues totaled $2,882,749 for the first six months of 2006.  The 8% rise in costs and expenses during the period can be traced to higher payroll costs from both golf and food and beverage activities, along with increased cost of food sales.

Results from the second quarter and first six months of 2006 have been adjusted to reflect the quarterly impact of the SAB 108 adjustment made in the fourth quarter of 2006.  The adjustment was related to golf operations' lease expense and related depreciation of property under the lease. The adjustment was considered immaterial for each of the periods of 2006.

Profits on the sale of other real estate interests totaled $550,000 and $584,744 for the second quarter and first six months of 2007, respectively.  These profits were realized on the release of subsurface interests on 215 acres of which 158 were released in the second quarter.  During the first half of 2006, profits on the release of subsurface interests totaled $455,870 of which $311,818 were earned in the second quarter.   Releases were granted on 561 acres and 467 acres for the six months and second quarter of 2006, respectively.

Interest and other income decreased 26% in the second quarter and 33% for the six month period when compared to prior year’s same periods.  The declines to $150,084 for the quarter and $300,793 for the six month period can primarily be attributed to lower interest earned on funds held for reinvestment through the like-kind exchange process.  Interest and other income of $202,233 and $445,685 was earned in the second quarter and first six months of 2006, respectively.

Higher expenses related to stock options for both the second quarter and first six months of 2007 resulted in increases in general and administrative expenses of 38% and 70% for the periods, respectively.  Stock option expense increased $358,744 for the second quarter and $1,544,843 for the six-month period when compared to the same period of 2006.  General and administrative expenses totaled $996,286 for the second quarter of 2007 compared to $721,965 for the same period of 2006.  For the six month period of 2007 general and administrative expenses amounted to $4,480,991 with $2,630,495 expensed in 2006’s first six month period.

In May 2006, the Company sold a former automobile dealership site located in Daytona Beach, Florida, which was being held as an income property.  The financial results of operations have been reported separately as discontinued operations in the financial statements.  Income, net of income taxes, of $248,454 and $240,476 was posted in 2006’s quarter and six months ended June 30, 2006, respectively.

On January 1, 2006, the Company implemented SFAS No. 123R "Share Based Payment." The implementation resulted in the recording of a $216,093, cumulative effect of change in accounting principle during the first quarter, net of income tax.

Cash, restricted cash and investment securities amounted to $12,052,563 at June 30, 2007, of which $1,310,560 was being held by a qualified intermediary for reinvestment through the like-kind exchange process.  These funds declined $1,651,868 since December 31, 2006.  The primary uses of these funds were $2,942,376 for the acquisition of property, plant and equipment, $2,983,819 for land development and road construction and $1,026,800 for the payment of dividends equivalent to $.18 per share.  The acquisition of property, plant and equipment included the continued land clearing and planting of Company lands for the hay operation in addition to the repurchase of approximately 4 acres of land on LPGA Blvd., in Daytona Beach, Florida.   The land, which was originally sold in 2004 to SunTrust Bank, was repurchased at its original sales price, per the contract, as they could not meet the build provision in the contract due to an overall change in direction of the institution’s plans.

Offsetting these uses of cash was cash provided from operating activities.  Operating activities provided funds of $3,361,590 during the six month period.  These funds included add-backs to net income of $1,725,103 for non-cash stock option compensation, and $1,231,250 for depreciation and amortization.

The Company's Board of Directors and managment periodically review the allocation of any excess capital with a goal of providing the highest return for all shareholders over the long run.  The reviews include consideration of various alternatives, including increasing regular dividends, declaring special dividends, commencing a stock repurchase program, and retaining funds for reinvestment.  At its July 25, 2007, meeting the Board increased the quarterly dividend from $0.09 to $0.10 per share and reaffirmed its support for investment of raw land sales proceeds and self-development of income properties on Company-owned lands.

Capital expenditures for the remainder of 2007 approximate $4.5 million.  These expenditures include approximately $1.0 million for land clearing and planting in the hay operation, $1.0 million for road development and $2.0 million for site development and construction of a two building 30,000 square-foot flex office space complex and a 23,000 square-foot office building on Company owned lands.  In addition to these requirements, the Company intends to invest in additional real estate opportunities through the like-kind exchange process as properties are identified and qualified funds become available.

Capital to fund planned expenditures is expected to be provided from cash and investment securities, as they mature, operating activities, and existing financing sources.  The Company has the ability to borrow on a non-recourse basis against its existing income properties, which are all free of debt as of the date of this filing.  Outstanding balances on notes payable totaled $6,936,854 at June 30, 2007, with no balance outstanding on the $20 million revolving line of credit.

The profit on sales of real estate is accounted for in accordance with the provisions of SFAS No. 66, “Accounting for Sales of Real Estate.” The Company recognizes revenue from the sale of real estate at the time the sale is consummated unless the property is sold on a deferred payment plan and the initial payment does not meet criteria established under SFAS No. 66, or the Company retains continuing involvement with the property.

During 2005 and 2006, the Company closed transactions for which it had post-closing obligations to provide off-site utilities and/or road improvements.  Full cash payment was received at closing, and warranty deeds were transferred and recorded.  The sales contracts do not provide any offsets, rescission or buy-back if the improvements are not made.  During the first six months of 2007, post-closing obligations were completed, and thus revenues and profits of $667,252 and $563,467 were recognized, respectively, on these transactions.  No post-closing obligations existed at June 30, 2007, and in accordance with SFAS No. 66 no revenues or profits were deferred at that time.

In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company has reviewed the recoverability of long-lived assets, including land and development and property, plant, and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may or may not be recoverable.  Land and development is evaluated for impairment by estimating sales prices less costs to sell.  Impairment on income properties and other property, plant, and equipment is measured using an undiscounted cash flow approach. There has been no material impairment of long-lived assets reflected in the consolidated financial statements.

The Company has an interest rate swap agreement.  This swap arrangement changes the variable-rate cash flow exposure on the debt obligations to fixed cash flows so that the Company can manage fluctuations in cash flows resulting from interest rate risk.  This swap arrangement essentially creates the equivalent of fixed-rate debt.  The above-referenced transaction is accounted for under SFAS No. 133, “Accounting for Derivative Instruments and Certain Hedging Activities,” and SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities, an Amendment of SFAS No. 133.”  The accounting requires the derivative to be recognized on the balance sheet at its fair value and the changes in fair value to be accounted for as other comprehensive income or loss.  The Company measures the ineffectiveness of the interest rate swap derivative by comparing the present value of the cumulative change in the expected future cash flows on the variable leg of the swap with the present value of the cumulative change in the expected future interest cash flows on the floating rate liability.  This measure resulted in no ineffectiveness for the periods ended June 30, 2007 and June 30, 2006.  A liability in the amount of $216,181 at June 30, 2007, has been established on the Company’s balance sheet. The change in fair value, net of applicable taxes, in the cumulative amount of $132,789 at June 30, 2007, has been recorded as accumulated other comprehensive loss, a component of shareholders’ equity.

The Company maintains the 2001 Stock Option Plan (the "Plan") pursuant to which 500,000 shares of the Company's common stock may be issued.  The Plan in place was approved at the April 25, 2001 shareholders’ meeting. Under the Plan, the option exercise price equals the stock market price on the date of grant.  The options vest over five years and all expire after ten years.  The Plan provides for the grant of (1) incentive stock options, which satisfy the requirements of Internal Revenue Code (IRC) Section 422, and (2) non-qualified options which are not entitled to favorable tax treatment under IRC Section 422.  No optionee may exercise incentive stock options in any calendar year for shares of common stock having a total market value of more than $100,000 on the date of grant (subject to certain carryover provisions).

In connection with the grant of non-qualified options, a stock appreciation right for each share covered by the option may also be granted.  The stock appreciation right will entitle the optionee to receive a supplemental payment, which may be paid in whole or in part in cash or in shares of common stock, equal to a portion of the spread between the exercise price and the fair market value of the underlying shares at the time of exercise.  All options granted to date have been non-qualified options.

On January 1, 2006, the Company adopted SFAS No. 123R by using the modified prospective method of adoption.  SFAS No. 123R requires the classification of share-based payment arrangements as liability or equity instruments.

Both the Company’s stock options and stock appreciation rights are liability classified awards under SFAS No. 123R and are required to be remeasured to fair value at each balance sheet date until the award is settled.  For liability-classified awards, SFAS No. 123R requires an entity to remeasure the liability from its intrinsic value to its fair value on the adoption date, as the cumulative effect of change in accounting principle, net of any related tax effect.  The Company remeasured the value of its stock options and stock appreciation rights as of January 1, 2006, which resulted in a cumulative effect of change in accounting principle, net of tax, totaling $216,093.

The principal market risk (i.e., the risk of loss arising from adverse changes in market rates and prices) to which the Company is exposed is interest rates. The objective of the Company’s asset management activities is to provide an adequate level of liquidity to fund operations and capital expansion, while minimizing market risk. The Company utilizes overnight sweep accounts and short-term investments to minimize the interest rate risk. The Company does not actively invest or trade in equity securities.  The Company does not believe that its interest rate risk related to cash equivalents and short-term investments is material due to the nature of the investments.

The Company manages its debt, considering investment opportunities and risk, tax consequences and overall financial strategies.  The Company is primarily exposed to interest rate risk on its $8,000,000 ($6,936,854 outstanding at June 30, 2007) term loan.  The borrowing bears a variable rate of interest based on market rates.  Management’s objective is to limit the impact of interest rate changes on earnings and cash flows and to lower the overall borrowing costs.  To achieve this objective, the Company entered into an interest rate swap agreement during the second quarter of 2002. A hypothetical change in the interest rate of 100 basis points (i.e., 1%) would not materially affect the Company’s financial position, results of operations or cash flows.

As of the end of the period covered by this report, an evaluation was carried out under the supervision and with the participation of the Company’s management, including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities and Exchange Act of 1934 (the “Exchange Act”)). Based on that evaluation, the CEO and CFO have concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms. There were no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) under the Exchange Act) during the second fiscal quarter covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.