CTO Realty Growth - 10-Q quarterly report FY

Net income of $2,102,564, equivalent to $.37 per share, was posted for the quarter ended September 30, 2007.  This net income represents a 12% reduction from 2006’s third quarter profits of $2,384,018, equivalent to $.42 per share.  The decreased earnings were primarily attributable to lower earnings from real estate sales.  Lower income taxes in 2006 also contributed to the decline, as charitable contributions of land were made during the third quarter of 2006 to lower the effective tax rate to 25% during the period.

During the first nine months of 2007, net income totaled $2,634,692, equivalent to $.46 per share, a significant downturn from profits of $8,251,984, equivalent to $1.45 per share, recorded for the same period one year earlier.  Lower profits from land sales were the major cause of this downturn, with higher stock option expense also a contributing factor.

The third quarter and first nine 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 $3,165,382 and $5,119,297 for the third quarter and first nine months of 2007, respectively, was significantly lower than 2006’s third quarter and first nine months EBDDT amounting to $4,343,522 and $13,268,186, respectively.  The lower profits from land sales transactions and the resulting reduced deferral of the gains for income tax purposes were the primary cause of the unfavorable results.  The reversal of deferred taxes on gains from year-end 2006 transactions for which the like-kind exchange process was not completed also contributed to the reduced EBDDT in the first nine-months of 2007, as the Company was unable to identify investment property which met established criteria.

Earnings from real estate sales totaled $2,367,558 during the third quarter of 2007.  These earnings were realized on the sale of 11 acres of property, which produced revenues amounting to $2,994,820.  Revenues amounting to $5,095,658 and profits of $3,601,109 were realized from real estate sales during the third quarter of 2006.  These revenues and profits were earned on the sale of 100 acres of property.  Included in property sales during 2006’s third quarter were profits of $577,000 realized on transactions that had been deferred in previous periods, due to post-closing obligations.  During the third quarter of 2006, the Company made a charitable contribution of 11 acres of land, which had a fair market value of $950,000.  This transaction was recorded as a sale of real estate with an offsetting charge to real estate costs and expenses.

During the first nine months of 2007, the sale of 104 acres of land, including a charitable contribution of 25 acres of land valued at $1,500,000, produced revenues and profits from land sales totaling $8,860,680 and $4,027,242, 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 $11,622,501were realized on the sale of 143 acres of property, which generated revenues of $14,620,160, during 2006’s first nine-month period.  Also included in earnings for the first nine months of 2006 was the recognition of profits totaling $4,733,000, that had previously been deferred in 2005 due to post-closing obligations.  An additional $1,084,000 of profit was deferred at September 30, 2006, on two transactions which closed in 2006, as post-closing obligations had not been completed.

Income properties produced revenues and profits of $2,207,308 and $1,687,198, respectively, during the third quarter of 2007.  These revenues represented a modest 1% increase over 2006’s same period revenues of $2,183,626, while profits declined 5% over prior year profits totaling $1,775,929.  Operating expenses rose during the period on higher real estate taxes and other operating costs associated with properties purchased in 2006.

The addition of two properties in June 2006 accounted for revenue and profit gains of 9% and 5%, respectively, for the first nine months of 2007 when compared to 2006’s same period.  Revenues totaling $6,537,982 produced profits from income properties of $5,164,790 in 2007’s nine month period, with 2006’s same period resulting in revenues and profits of $5,997,775 and $4,928,206, respectively.  Income properties costs and expenses increased 28% during the period to $1,373,192 with depreciation and operating expenses associated with the two new properties for the full nine-month period.

Revenues from golf operations decreased 9% during the third quarter of 2007 resulting in a 19% increase in losses posted from the operation.  The revenue decline, to $930,164, was the result of decreases in both golf and food and beverage activities.  The number of golf rounds played fell 9% during the three-month period and average rate per round played declined 3%.  Weather was a factor in the lower numbers with a greater number of rain days experienced during the current period compared to the abnormally dry period experienced in 2006.  Losses during 2007’s third quarter amounted to $647,559.  Revenues and losses during the third quarter of 2006 totaled $1,027,067 and $541,920, respectively.  Golf operations costs and expense were in line with prior year results.

Losses from golf operations rose 28% to $1,329,516 for the first nine months of 2007 when compared to losses of $1,036,988 posted in 2006’s same period.  Revenues of $3,907,346 were in line with 2006’s revenues totaling $3,909,816 but were offset by a 6% increase in golf operations costs and expenses.  Stable revenues were achieved despite a 2% decrease in revenues from golf activities as food and beverage activities produced a 4% increase in revenue.  Golf rounds played during the nine-month period rose 1%, but were offset by a 4% fall in the average rate per round.  The higher costs and expenses recorded during the period in 2007 were primarily attributed to higher food and beverage cost of sales and payroll costs, along with increased course maintenance costs.

Results from the third quarter and first nine 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 $816,235 and $1,400,979 for the third quarter and first nine months of 2007, respectively.  These profits were realized on the release of subsurface entry rights on 645 acres of which 394 were released in the third quarter.  During the first nine months of 2006, profits on the release of subsurface interests totaled $668,420 of which $212,550 was earned in the third quarter.   Releases were granted on 610 acres and 49 acres for the nine months and third quarter of 2006, respectively.

Interest and other income increased to $149,627 in the third quarter of 2007 from $38,831 recorded in 2006’s third quarter.  Higher interest on investment securities, mortgage notes receivable, and funds held for reinvestment through the like-kind exchange process all contributed to the rise.  For the nine-month period interest and other income decreased 7% to $450,420 compared to $484,516 in the prior year.  The decline was primarily the result of lower interest earned on funds held for reinvestment through the like-kind exchange process, offset by higher earnings from investment securities and mortgage notes receivable.

Lower stock options expense for the quarter resulted in a 45% decrease in general and administrative expenses during the period.  Stock option expenses were reduced approximately $880,000 when compared to the prior year’s third quarter when the price of the Company’s stock rose significantly.  General and administrative expenses totaled $1,044,337 and $1,911,250 for the third quarter of 2007 and 2006, respectively.

General and administrative expenses of $5,525,328 for the first nine months of 2007 represented a 22% increase over 2006 general and administrative expenses of $4,541,745.  For the nine- month period stock option expense increased approximately $665,000 over the prior year.  Also contributing to the increased general and administrative expenses were higher legal fees and pension and other post-retirement benefit costs.

During the first nine months of 2006, the Company made charitable contributions of land to qualified organizations.  These contributions, which the Company determined with reasonable assurance could be utilized over the five year carryforward period, resulted in an approximate $690,000 positive adjustment to the income tax provision in the first nine months of 2006.  This positive adjustment resulted in an effective tax rate approximating 32% for the nine-month period and 25% for the third quarter of 2006. 

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  $240,476 was posted in 2006’s nine months ended September 30, 2006.

 

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 $14,279,475 at September 30, 2007, of which $1,524,347 was being held by a qualified intermediary for reinvestment through the like-kind exchange process.  These funds increased $575,044 since December 31, 2006.  The primary increase in these funds was from operating activities offset by  $3,789,860 for the acquisition of property, plant, and equipment, $4,840,721 for land development and road construction, and $1,598,389 for the payment of dividends equivalent to $.28 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.   At the time of the original contract in 2004 (at which point the price of the repurchase was set) and the Company’s exercise of its right to repurchase in 2007, William H. Davison, Chairman, President, and Chief Executive Officer of SunTrust Bank of East Central Florida, was not a member of the Company’s Board of Directors.  The land, which was originally sold in 2004 to SunTrust Bank, was repurchased at its original sales price pursuant to the terms of the contract, as it could not meet the build provision in the contract due to an overall change in direction of the Bank's real estate ownership strategy.  The Bank had previously announced the sale of its real estate portfolio and curtailment of new construction.

The Company's Board of Directors and management periodically review the allocation of any excess capital with a goal of providing the highest return for all shareholders over the long term.  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 October 24, 2007 meeting the Board declared a quarterly dividend of $0.10 per share and reaffirmed its support for investment of raw land sales proceeds through the tax deferred like-kind exchange process and self-development of income properties on Company-owned lands.

Capital expenditures for the remainder of 2007 are expected to approximate $2 million.  These expenditures include approximately $500,000 for land clearing and planting in the hay operation, $300,000 for road development, and $750,000 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 $6,872,781 at September 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 September 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 September 30, 2007 and September 30, 2006.  A liability in the amount of $374,823 at September 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 $230,235 at September 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 current Plan 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.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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 ($6,872,781 outstanding at September 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 third 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.