CTO Realty Growth - 10-Q quarterly report FY

See Accompanying Notes to Consolidated Financial Statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)

On January 1, 2008 the Company adopted Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - including an amendment of FASB Statement No. 115 (Statement 159).”  Statement 159 gives the Company the irrevocable option to carry most financial assets and liabilities at fair value  that are not currently required to be measured at fair value.  If the fair value option is elected, changes in fair value would be recorded in earnings at each subsequent reporting date.  The adoption of Statement 159 had no impact on the Company’s financial condition, results of operations or cash flows, as the fair value option was not elected by the Company.

On January 1, 2008 the Company also adopted Statement No. 157, “Fair Value Measurement” (Statement 157).  Statement 157 defines fair value, establishes a framework for the measurement of fair value, and enhances disclosures about fair value measurements.  The statement does not require any new fair value measures. The adoption of Statement 157 had no impact on the financial condition, results of operations or cash flows of the Company.  Delayed application of this Statement is permitted for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until fiscal years begining after November 15, 2008, and interim periods within those fiscal years.  The Company has elected to defer the implementation of Statement 157 related to nonfinancial assets and nonfinancial liabilities.  The Company is evaluating the impact of implementation.

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. 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.

Sales and development activity on and around Company owned lands have been strong in the last several years. These activities included the sale of 120 acres of land to Florida Hospital for the construction of a new facility which is anticipated to open mid-year 2009, 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 60-acre Interstate Commerce Park both adjacent to Interstate 95, and the sale of approximately 100 acres of land on which a private high school is under development and anticipated to open in August 2008.  Construction is underway on the future site of the City of Daytona Beach police headquarters.  The building, which is located adjacent to Gateway Commerce Park, is anticipated to be completed and occupied this year.  In early 2008, development also commenced on a 288-unit apartment complex on lands sold by the Company during 2007.

In addition to the above mentioned development activities performed by third parties, the Company has two self-developed projects in process.  The first project is a two building 30,000 square-foot flex office space complex located within Gateway Commerce Park.  Construction of these buildings, which are to be held in the Company’s portfolio of income properties, is scheduled to be completed in the second quarter of 2008.  Leases are currently in negotiation on this project.   Also under development by the Company is a 12 acre, 4 lot commercial complex, located at the corner of LPGA and Williamson Boulevards.  Site work, building plans and permitting are complete.  The parcel will include a 23,000 square-foot “Class A” office building.  Construction of the building is scheduled to begin in the second quarter with a significant portion of the building under lease to a credit-rated tenant.

These commercial and residential development activities tend to create additional buyer interest and sales opportunities. The residential real estate market continues to be depressed from its peak in mid-to-late 2005, with the commercial market showing signs of the beginning of a downturn.  The Company currently has a reasonably strong backlog of contracts in place for closing in 2008.

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.  At March 31, 2008, the Company had invested approximately $110 million in twenty-five income properties through this process, with an additional $9.5 million held by a qualified intermediary for future investment in additional properties.   With a closing on April 17, 2008, the Company utilized the funds held by the intermediary for the purchase of a Harris Teeter supermarket  in Charlotte, North Carolina.

After the Harris Teeter Supermarket purchase, the Company now has an investment base of approximately $120 million in income properties. Lease revenue of approximately $9.2 million is projected to be generated annually on this investment base.  This income, along with income from additional net-lease income property investments, will continue to decrease earnings volatility in future years and add to overall financial performance.  This strategy has enabled the Company to enter into the business of building, leasing, and holding in its portfolio select income properties that are strategically located on Company lands.

Golf operations consist of the operation of two 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 Champions course was designed by Rees Jones and the Legends course was designed by Arthur Hills.

The Company’s agricultural operations consist of growing, managing, and sale of timber and hay products on approximately 11,000 acres of Company lands on the west side of Daytona Beach, Florida.

During the first quarter of 2008, the Company posted a profit of $156,124, equivalent to $.03 per share.  These profits were earned during the first quarter, on strong results from income properties and decreased general and administrative expenses, despite no land sales closings in the first quarter. A loss of $583,812, equivalent to $.10 per share, was recorded during 2007’s first quarter.

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.

EBDDT totaled $348,037 for the quarter ended March 31, 2008, in line with the $333,210 EBDDT recorded in the first quarter of 2007. During 2008 the add-back for deferred taxes was negative as income taxes previously deferred on gains from real estate transactions became currently due when the Company received funds held by the intermediary.  The like-kind exchange process utilizing these funds was not completed, as reinvestment property which met the Company’s criteria could not be identified within the time constraints.

 

RESULT OF OPERATIONS

 

An operating loss of $342,934 was recorded during the first quarter of 2008, as the result of no land sales transactions closing during the period.  During the first quarter of 2007, the sale of 83 acres of land, including a charitable contribution of 25 acres valued at $1,500,000, produced revenues and profits from land sales totaling $4,676,566 and $909,550, respectively.  Also included in sales during the first period of 2007 was the sale of approximately $1,900,000 of impact fee credits.  Cost and expenses were substantially higher in 2007’s first quarter with the higher cost basis associated with both the charitable contribution and impact fee credits.

Earnings from income properties totaled $1,744,230 for the quarter ended March 31, 2008.  These earnings were achieved on revenues of $2,173,473.  Both earnings and revenues represented modest increases over revenues and income of $2,160,785 and $1,735,569, respectively, recorded during the first quarter of 2007.

Golf operations posted a loss of $237,417 for the quarter ended March 31, 2008 on revenues totaling $1,379,551.  This loss represented an 18% improvement over the loss of $291,006 in 2007’s same period on revenues of $1,566,207.   Revenues in the first quarter of 2008 represented a decline of 12% when compared to the prior year, with revenues from golf activities decreasing 9% and food and beverage revenues falling 21%.  The average rate per round played increased 3% during the period, but was offset by a 10% decline in the number of rounds played.  Golf operations costs and expenses decreased 13% during the period when compared to the prior year as the result of the reduced activity, lower payroll, and decreased golf course maintenance expenses.

Cash, restricted cash, and investment securities, which totaled $16,266,283 at March 31, 2008, decreased $5,178,187 since December 31, 2007.  The primary uses of these funds were for the payment of income taxes, development and construction activities, and the continued conversion of Company lands to hay.  Income taxes of $2,410,000 were paid in the first quarter of 2008.  Development and construction activity approximated $1,650,000 during the three-month period and included construction of roads on the Company’s core lands adjacent to LPGA Blvd. and the construction of the 30,000 square-foot flex office space complex in Gateway Commerce Center.  Approximately $860,000 was expended on clearing and planting of lands for the hay operation.  Additionally, funds totaling $572,580 were used to pay dividends equivalent to $.10 per share.

Capital expenditures for the remainder of 2008 are projected to approximate $10 million, in addition to the $9.7 million dollars expended for the triple-net lease Harris Teeter supermarket purchased in April. These funds are intended to be used on road construction, conversion of timber lands to hay, and the development and construction of two income properties on Company owned land.  The first property, expected to be completed in the second quarter, is the two building 30,000 square-foot flex office space complex located in Gateway Commerce Park.  The second property will be a 23,000 square-foot office building located on LPGA Boulevard.  This office building will be approximately 40% pre-leased to a credit tenant with the remainder held as speculative space at this time.  These two self-developed projects are expected to be 50% financed upon completion.

Capital to fund the planned expenditures in 2008 is expected to be provided from cash and investment securities (as they mature), operating activities, and financing sources that are currently in place.  The Company also 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.  As additional funds become available through qualified sales, the Company expects to invest in additional real estate opportunities.

The Company’s Board of Directors and management continually review the allocation of any excess capital with the goal of providing the highest return for all shareholders over the long term. The reviews include consideration of various alternatives, including increasing or decreasing regular dividends, declaring special dividends, commencing a stock repurchase program, and retaining funds for reinvestment. The Board of Directors has reaffirmed its support for both the continuation of the 1031 tax deferred exchange strategy for investment of agricultural land sales proceeds and self-development of income properties on Company owned lands.

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 did not provide any offsets, rescission, or buy-back if the improvements were not completed.  During the first quarter of 2007, a portion of the post-closing obligations were competed, and revenues and profits of $140,087 and $73,402, were recognized, respectively on these transactions.  Post-closing obligations still existed at March 31, 2007, on two transactions and in accordance with SFAS No. 66  revenues and profits of $527,164 and $427,628, respectively, were deferred at that time.  All obligations were completed during 2007 and no revenues or profits were deferred at March 31, 2008.

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 real estate 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.  Real estate 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.

At the time the Company’s debt was refinanced in 2002, the Company entered into 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 March 31, 2008 and March 31, 2007.  A liability in the amount of $793,199 at March 31, 2008, has been established on the Company’s balance sheet. The change in fair value, net of applicable taxes, in the cumulative amount of $487,222 at March 31, 2008, has been recorded as accumulated other comprehensive loss, a component of shareholders’ equity.

The Company maintains a stock option 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, with a stock appreciation right granted for each option share granted.

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.

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 ($6,739,375 outstanding at March 31, 2008) long-term mortgage.  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, as required by Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934 (the “Exchange Act”), 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 Exchange Act).  Based on that evaluation, the CEO and CFO have concluded that the design and operation of 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's rules and forms, and to provide reasonable assurance that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company's management, including its CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.  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 first 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.