ST JOE Co - Quarter Report: 2007 September (Form 10-Q)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-Q

 

 

Commission file number 1-10466

 

The St. Joe Company

(Exact name of registrant as specified in its charter)

 

 

(904) 301-4200

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ     NO o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer þ     Accelerated Filer o     Non-Accelerated Filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o     NO þ

 

APPLICABLE ONLY TO CORPORATE ISSUERS:

 

As of October 31, 2007, there were 104,765,458 shares of common stock, no par value, issued and 74,612,500 outstanding, with 30,152,958 shares of treasury stock.

 

 

THE ST. JOE COMPANY

INDEX

 

 

PART I. FINANCIAL INFORMATION

 

 

THE ST. JOE COMPANY

 

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

 

 

See notes to consolidated financial statements.

THE ST. JOE COMPANY

CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Dollars in thousands except per share amounts)

 

 

See notes to consolidated financial statements.

THE ST. JOE COMPANY

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
(Unaudited)
(Dollars in thousands, except per share amounts)

 

 

See notes to consolidated financial statements.

THE ST. JOE COMPANY

 

CONSOLIDATED STATEMENTS OF CASH FLOW

(Unaudited)

(Dollars in thousands)

 

 

See notes to consolidated financial statements.

THE ST. JOE COMPANY

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

The accompanying unaudited interim financial statements have been prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain information and footnotes required by U.S. generally accepted accounting principles for complete financial statements are not included herein. The interim statements should be read in conjunction with the financial statements and notes thereto included in the Company’s latest Annual Report on Form 10-K. In the opinion of the Company, the accompanying unaudited consolidated financial statements contain all normal recurring adjustments necessary to present fairly the financial position as of September 30, 2007 and the results of operations for the three and nine month periods ended September 30, 2007 and 2006 and cash flows for the nine month periods ended September 30, 2007 and 2006. The results of operations for the three and nine month periods ended September 30, 2007 and cash flows for the nine month period ended September 30, 2007 are not necessarily indicative of the results that may be expected for the full year. The December 31, 2006 balance sheet amounts have been derived from our December 31, 2006 audited financial statements.

 

During 2006, the Company adopted the recognition and disclosure provisions of Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Pension and Other Postretirement Plans — An Amendment of SFAS Statements No. 87, 88, 106 and 132R (“SFAS 158”). The adoption of SFAS 158 at December 31, 2006 resulted in the Company recording a $(1.0) million transition adjustment to comprehensive income in its Consolidated Statements of Changes in Stockholders’ Equity. The transition adjustment should have impacted the balance of accumulated other comprehensive income but instead was presented as a reduction to comprehensive income. The Company will revise and remove the transition adjustment from comprehensive income on the Consolidated Statements of Changes in Stockholders’ Equity for 2006 in the Company’s Form 10-K for the year ended December 31, 2007.

 

 

Stock-Based Compensation

 

During the first quarter of 2006, the Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards No. 123 — revised 2004, Share-Based Payment (“SFAS 123R”), which replaced Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS 123”), and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”). Under the fair value recognition provisions of SFAS 123R, stock-based compensation cost is measured at the grant date based on the fair value of the award and is typically recognized as expense on a straight-line basis over the requisite service period, which is the vesting period. The Company elected the modified-prospective method of adoption, under which prior periods are not revised for comparative purposes. The valuation provisions of SFAS 123R apply to new grants that were outstanding as of the effective date and are subsequently modified. Estimated compensation for the unvested portion of grants that were outstanding as of the effective dates is being recognized over the remaining service period using the compensation cost estimated for the SFAS 123 pro forma disclosures. Additionally, the 15% discount at which employees may purchase the Company’s common stock through payroll deductions is being recognized as compensation expense. Upon exercise of stock options or granting of non-vested stock, the Company will issue new common stock.

 

Stock Options and Non-Vested Restricted Stock

 

The Company has four stock incentive plans (the 1997 Stock Incentive Plan, the 1998 Stock Incentive Plan, the 1999 Stock Incentive Plan and the 2001 Stock Incentive Plan), whereby awards may be granted to certain employees and non-employee directors of the Company in the form of restricted shares of Company common stock or options to purchase Company common stock. Awards are discretionary and are determined by the Compensation Committee of the Board of Directors. Awards vest based upon service conditions. Option and share awards provide

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

for accelerated vesting if there is a change in control (as defined in the award agreements). The total amount of restricted shares and options originally available for grant under each of the Company’s four plans was 8.5 million shares, 1.4 million shares, 2.0 million shares, and 3.0 million shares, respectively. Non-vested restricted shares generally vest over requisite service periods of three-year or four-year periods, beginning on the date of each grant, but are considered outstanding under the treasury stock method. Stock option awards are granted with an exercise price equal to market price of the Company’s stock at the date of grant. The options vest over requisite service periods and are exercisable in equal installments on the first through fourth or fifth anniversaries, as applicable, of the date of grant and generally expire 7-10 years after the date of grant.

 

The Company currently uses the Black-Scholes option pricing model to determine the fair value of stock options. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by the stock price as well as assumptions regarding a number of other variables. These variables include expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors (term of option), risk-free interest rate and expected dividends.

 

The Company estimates the expected term of options granted by incorporating the contractual term of the options and analyzing employees’ actual and expected exercise behaviors. The Company estimates the volatility of its common stock by using historical volatility in market price over a period consistent with the expected term and other factors. The Company bases the risk-free interest rate that it uses in the option valuation model on U.S. Treasuries with remaining terms similar to the expected term on the options. The Company uses an estimated dividend yield in the option valuation model when dividends are anticipated.

 

Presented below are the per share weighted-average fair value of stock options granted during the nine months ended September 30, 2007 and 2006, using the Black Scholes option-pricing model, along with the assumptions used.

 

 

Total stock-based compensation recognized on the consolidated statements of income for the three month and nine month periods ended September 30, 2007 and 2006 is as follows (in thousands):

 

 

The total income tax benefit recognized on the consolidated statements of income for stock-based compensation arrangements was $0.8 million and $2.7 million for the three and nine month periods ended September 30, 2007, respectively, and $0.9 million and $4.4 million for the three and nine month periods ended September 30, 2006, respectively.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The following table sets forth the summary of option activity under the stock option program for the nine months ended September 30, 2007:

 

 

The total intrinsic value of options exercised was $0.2 million and $3.3 million during the three and nine month periods ended September 30, 2007, respectively, and $4.3 million and $6.2 million during the three and nine month periods ended September 30, 2006, respectively. The intrinsic value is calculated as the difference between the market value as of exercise date and the exercise price of the shares.

 

The following table presents information regarding all options outstanding at September 30, 2007:

 

 

The following table presents information regarding options exercisable at September 30, 2007:

 

 

The aggregate intrinsic value of options outstanding and options exercisable as of September 30, 2007 was $2.6 million and $2.6 million, respectively. In computing compensation expense from share-based payments as of September 30, 2007, the Company has estimated that 135,645 options of the 171,703 unvested options outstanding are expected to vest. The aggregate intrinsic value of such options expected to vest was zero at September 30, 2007. The intrinsic value is calculated as the difference between the market value as of September 30, 2007 and the grant date fair value. The closing price as of September 30, 2007 was $33.61 per share as reported by the New York Stock Exchange.

 

Cash received for strike prices from options exercised under share-based payment arrangements for the nine month periods ended September 30, 2007 and 2006 was $4.1 million and $6.5 million, respectively. The actual tax benefit realized for the tax deductions from options exercised under stock-based arrangements totaled $1.3 million and $2.3 million for the nine month periods ended September 30, 2007 and 2006, respectively.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The following table sets forth the summary of non-vested restricted stock activity for the nine months ended September 30, 2007:

 

 

The fair value of restricted stock is determined based upon the fair value of the Company’s common stock on the date of grant.

 

The total fair value of restricted stock that vested was $4.7 million and $6.4 million for the three and nine month periods ended September 30, 2007, respectively, and $9.1 million and $11.0 million for the three and nine month periods ended September 30, 2006, respectively.

 

Prior to the adoption of SFAS 123R, the Company recognized the estimated compensation cost of non-vested restricted stock over the vesting term. The estimated compensation cost is based on the fair value of the Company’s common stock on the date of grant. The Company will continue to recognize the compensation cost over the requisite service period.

 

As of September 30, 2007, there was $11.9 million of unrecognized compensation cost, adjusted for estimated forfeitures, related to non-vested stock-based compensation arrangements. This cost includes $3.1 million related to stock option grants and $8.8 million of non-vested restricted stock which will be recognized over a weighted average period of four years.

 

Employee Stock Purchase Plan

 

In November 1999, the Company implemented an employee stock purchase plan whereby all employees may purchase the Company’s common stock through monthly payroll deductions at a 15% discount from the fair market value of its common stock at each month end, with an annual limit of $25,000 in purchases per employee.

 

Earnings (Loss) Per Share

 

Basic earnings (loss) per share is calculated by dividing net income (loss) by average number of common shares outstanding for the period. Diluted earnings per share is calculated by dividing net income by the average number of common shares outstanding for the period including all potentially dilutive shares issuable under outstanding stock options and non-vested restricted stock, using the treasury stock method. Stock options and non-vested restricted stock are not considered in the diluted earnings (loss) per share calculation when the Company has a loss from continuing operations. The anti-dilutive stock options and non-vested restricted stock excluded from the computation of diluted earnings (loss) per share totaled 146,384 and 267,361, respectively, for the three months ended September 30, 2007.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The following table presents a reconciliation of average shares outstanding:

 

 

Through September 30, 2007, the Board of Directors had authorized a total of $950.0 million for the repurchase from time to time of outstanding common stock from shareholders (the “Stock Repurchase Program”). A total of approximately $846.2 million had been expended in the Stock Repurchase Program from its inception through September 30, 2007. There is no expiration date on the Stock Repurchase Program.

 

From the inception of the Stock Repurchase Program to September 30, 2007, the Company repurchased from shareholders 27,945,611 shares and executives surrendered a total of 2,304,717 shares as payment for strike prices and taxes due on exercised stock options and vested restricted stock, for a total of 30,250,328 acquired shares. During the nine month period ended September 30, 2007, the Company did not repurchase shares from shareholders. During the nine month period ended September 30, 2006, the Company repurchased 948,200 shares from shareholders. During the nine month periods ended September 30, 2007 and 2006, executives surrendered a total of 51,158 and 74,601 shares, respectively, as payment for strike prices and taxes due on exercised stock options and vested restricted stock.

 

Shares of Company stock issued upon the exercise of stock options for the nine month periods ended September 30, 2007 and 2006 were 139,431 and 226,501 shares, respectively.

 

Supplemental Cash Flow Information

 

Supplemental cash flow information for the nine months ended September 30 is as follows (in millions):

 

 

The Company’s non-cash investing and financing activities for the nine months ended September 30 are as follows (in millions):

 

 

Cash flows related to assets ultimately planned to be sold, including residential real estate development and related amenities, sales of rural land by the rural land sales segment, the Company’s timberland operations and land developed by the commercial real estate segment are included in operating activities on the statement of cash flows. The Company’s buildings developed for commercial rental purposes and assets purchased with tax-deferred

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

proceeds are intended to be held for investment purposes and related cash flows from acquisitions and dispositions of those assets are included in investing activities on the statements of cash flows. Cash flows from investing activities also include related cash flows from assets not held for sale. Distributions of income from unconsolidated affiliates are included in cash flows from operating activities; distributions of capital from unconsolidated affiliates are included in cash flows from investing activities.

 

Derivative Financial Instruments

 

The Company accounts for derivative financial instruments in accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended (“SFAS 133”). SFAS 133 requires that an entity recognize all derivatives, as defined, as either assets or liabilities at fair value. If the derivative is designated as a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will either be offset against the change in fair value of the hedged assets, liabilities or firm commitments through earnings or recognized as a component of comprehensive income until the hedged item is recognized in earnings. The ineffective portion of the derivative’s change in fair value will be immediately recognized in earnings. The Company uses derivative instruments to manage its exposure to market risks from changes in interest rates and does not hold or issue derivative instruments for speculative or trading purposes

 

On September 27, 2007, the Company entered into a 45 — day forward starting interest rate swap contract with Wachovia Bank to minimize the risk that the interest rate component relating to a notional principal amount of a then-forecasted issuance of $25.6 million of notes may be adversely affected by interest rate fluctuations (see note 3). This derivative instrument is not designated as a hedge and changes in the fair value of this derivative instrument are recognized in earnings as gain (loss) on derivative contracts.

 

 

On May 3, 2007, we sold our mid-Atlantic homebuilding operations, primarily operating under the name Saussy Burbank. The sales price was $76.3 million, consisting of $36.0 million in cash and approximately $40.3 million in seller financing. The remaining balance outstanding on the seller financing at September 30, 2007 was $33.8 million.

 

On June 1, 2007, St. Joe Timberland Company, a wholly owned subsidiary, sold 33,035 acres of timberlands located primarily in Stewart County, Georgia for a sales price of $46.4 million. The entire sales price was paid in the form of two notes receivable maturing on June 1, 2022 and bearing interest at 5.668% payable semi-annually. The notes are fully supported by irrevocable letters of credit from Wachovia Bank. On July 11, 2007, the installment notes and irrevocable letters of credit were transferred to a qualifying special purpose entity (“QSPE”) as a capital contribution. On July 11, 2007 the QSPE issued in a private placement notes payable in the amount of $41.8 million bearing interest at 5.9% due and maturing in 2022. The QSPE used the proceeds of such issuance to pay $41.8 million to St. Joe Timberland Company as a return of capital.

 

Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“SFAS 140”) defines the criteria for QSPEs and their treatment within consolidated financial statements. Accordingly, the assets and debt of the QSPE are not required to be and have not been consolidated on the Company’s balance sheet at September 30, 2007.

 

The Company recorded a loss of $1.2 million on the monetization of the notes receivable through the QSPE. The amount of loss is determined based on the original carrying value of the notes, allocated between the assets monetized and the retained interest based on their relative fair value at the date of monetization. The Company’s retained interest consists principally of net excess cash flows (the difference between the interest received on the notes receivable and the interest paid on the debt issued to third parties) and a cash reserve account. Fair value of the retained interest is estimated based on the present value of future excess cash flows to be received over the life of the notes, using management’s best estimate of key assumptions, including credit risk and discount rates. The balance of the retained interest is reflected in other assets at September 30, 2007.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

On September 27, 2007, St. Joe Timberland Company sold 19,989 acres of timberlands located primarily in Wakulla and Jefferson counties, Florida for a sales price of $28.5 million. The entire sales price was paid in the form of a note receivable maturing on September 27, 2022 and bearing interest at 5.622% payable semi-annually. The note is fully supported by an irrevocable letter of credit from Wachovia Bank. In November 2007, the Company plans to transfer the installment note and irrevocable letter of credit to a QSPE as a capital contribution. The QSPE is expected to issue in a private placement a note payable in the amount of $25.6 million bearing interest at 6.044% and maturing in 2023. The QSPE will use the proceeds of such issuance to pay approximately $25.6 million to St. Joe Timberland Company as a return of capital.

 

 

On August 7, 2007, the Company closed the sale of one of the remaining two buildings in its office building portfolio. Approximately $29.3 million of mortgage debt was defeased in connection with the sale. The defeasance transaction resulted in the establishment of a defeasance trust and deposit of proceeds of $31.1 million which will be used to pay down the related mortgage debt (see note 12). The proceeds were invested in government backed securities which were pledged to provide principal and interest payments for the mortgage debt previously collateralized by the commercial building. These amounts have been included in the Company’s consolidated balance sheet at September 30, 2007. The Company has classified the defeasance trust investment as held-to-maturity because the Company has both the positive intent and the ability to hold the securities to maturity. Accordingly, the Company has recorded the investment at cost, adjusted for the amortization of a premium which approximates market value.

 

 

During late 2006 and early 2007, the Company implemented certain corporate organizational changes designed to position the Company for the years ahead. The Company announced that it was exiting the Florida homebuilding business to focus on maximizing the value of its landholdings through place making. The Company also eliminated certain redundancies among its field and corporate operations, and put in place a regional management structure to oversee its various product lines. The charges associated with the restructuring and reorganization program (“program”) by segment that are included in the restructuring charge for the nine months ended September 30, 2007 were as follows (in millions):

 

 

Capitalized homebuilding costs are comprised of architectural fees and overhead costs. Termination benefits are comprised of severance-related payments for all employees terminated in connection with the program.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Cumulative charges related to the program as of September 30, 2007 were as follows:

 

 

The Company does not expect to incur any additional charges related to the program.

 

At September 30, 2007, the accrued liability associated with the program consisted of the following:

 

 

On October 8, 2007, the Company announced a restructuring of its business to enhance and accelerate the Company’s value creation process. The plan includes the divestiture of non-core assets, a significant reduction in capital expenditures, a leaner operating structure and an increased focus on the use of strategic business partners. As a result, the Company expects to take a charge to earnings of approximately $7.0 million. Approximately one-half of the total charges are expected to be incurred in the fourth quarter of 2007, with substantially all of the remaining charges to be recognized in 2008. The charges to be incurred will be primarily termination benefits to employees.

 

 

On April 30, 2007, the Company entered into a Purchase and Sale Agreement for the sale of the Company’s office building portfolio, consisting of 17 buildings. On June 20, 2007, the Company closed on the sale of 15 of the 17 properties in the office building portfolio for a cash price of $277.5 million. In the aggregate, the transaction resulted in a pre-tax gain of $48.6 million, of which the Company realized $45.3 million, net of a deferred gain of $3.3 million on a sale leaseback arrangement with three of the properties. Income from and the gain associated with these three properties have been included in continuing operations due to the Company’s continuing involvement as a lessee. The Company expects to incur continuing cash out flows related to these three properties over the next five years. The sale of the remaining two office buildings closed on August 7, 2007 for a sale price and pre-tax gain of $56.0 million and $6.5 million, respectively, and September 19, 2007, for a sale price and pre-tax gain of $44.0 million and $3.7 million, respectively. The income/loss from and gain on the remaining 14 buildings of the office building portfolio are reflected in discontinued operations below.

 

Building sales included in discontinued operations for 2006 also include the operating results of Nextel II sold on December 20, 2006, One Crescent Ridge sold on September 29, 2006, and Prestige Place One & Two sold on June 28, 2006. The sales of Crescent Ridge and Prestige Place One & Two resulted in a pre-tax gain of $10.6 million and $4.4 million, respectively.

 

On May 3, 2007, the Company sold its mid-Atlantic homebuilding operations, primarily operating under the name Saussy Burbank, to an investor group based in Charlotte, North Carolina. The sales price was $76.3 million, consisting of $36.0 million in cash and approximately $40.3 million in seller financing, the majority of which is

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

secured by home inventory and is payable over eighteen months. Included in 2007 pre-tax income is a $2.2 million impairment charge to approximate fair value, less costs to sell, related to the sale of Saussy Burbank.

 

Discontinued operations presented on the Consolidated Statements of Income included the following (in thousands):

 

 

 

In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity (“SFAS 150”). SFAS 150 requires companies having consolidated entities with specified termination dates to treat minority owner’s interests in such entities as liabilities in an amount based on the fair value of entities. Although SFAS 150 was originally effective July 1, 2003, the FASB has indefinitely deferred certain provisions related to the classification and measurement requirements for mandatorily redeemable financial instruments that become subject to SFAS 150 solely as a result of consolidation, including minority interests of entities with specific termination dates. The Company has one consolidated entity with a specified termination date: Artisan Park, L.L.C. (“Artisan Park”). At September 30, 2007, the carrying amount of the minority interest in Artisan Park was $6.7 million, which approximated fair market value. The Company has no other material financial instruments that are affected by SFAS 150.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

Real estate by segment includes the following (in thousands):

 

 

Included in operating property are Company-owned amenities related to residential real estate, the Company’s timberlands and land and buildings developed by the Company and used for commercial rental purposes. Development property consists of residential real estate land and inventory currently under development to be sold. Investment property primarily includes the Company’s land held for future use.

 

Depreciation expense from continuing operations reported on real estate was approximately $7.8 million and $8.1 million in the nine months ended September 30, 2007 and 2006, respectively.

 

 

On August 16, 2007, the Company purchased the Greg Norman-designed Shark’s Tooth Golf Club, 28 fully-developed home-sites, additional land parcels and beach and tennis club facilities in the Wild Heron community near Panama City Beach, Florida for approximately $30.0 million. The acquisition is being accounted for under the purchase method of accounting and as such, the results of operations are included in the consolidated financial statements from the date of acquisition, in the residential real estate segment. The acquisition was recorded by allocating the cost of the assets acquired, including liabilities assumed, based on their estimated fair values at the

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

acquisition date. The valuation of assets and liabilities assumed has been determined and the purchase price has been allocated as follows:

 

 

 

The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Homes and home-sites substantially completed and ready for sale are measured at lower of carrying value or fair value less costs to sell. For projects under development, an estimate of future cash flows on an undiscounted basis is performed using estimated future expenditures necessary to maintain the existing service potential of the project and using management’s best estimates about future sales prices and holding periods. The overall decrease in demand and market prices for residential real estate indicates that certain carrying amounts within our residential real estate segment may not be recoverable. As a result of the third quarter 2007 impairment analysis, the Company recorded an impairment charge of $13.0 million in the residential real estate segment.

 

 

Goodwill represents the excess of the purchase price and related costs over the value assigned to net tangible and identifiable intangible assets of businesses acquired and accounted for under the purchase method of accounting. The Company announced on October 8, 2007 its plan to dispose of Sunshine State Cypress mill and mulch plant as part of its restructuring plan. The Company’s current estimate of fair value based upon market analysis indicates that goodwill would not be recoverable. Accordingly, the Company has recorded an impairment charge of $7.4 million to reduce the goodwill carrying value of Sunshine State Cypress to zero in the forestry segment during the third quarter 2007.

 

 

Debt consists of the following (in thousands):

 

 

On June 20, 2007, the Company closed the sale of 15 of the 17 properties in its office building portfolio. The Company retired approximately $52.9 million of mortgage debt in connection with the sale of these buildings. On August 7, 2007, the Company closed the sale of one of the remaining two buildings in its office building portfolio

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

and approximately $29.3 million of mortgage debt was defeased in connection with the sale. The defeasance transaction resulted in the establishment of a defeasance trust and deposit of proceeds of $31.1 million which will be used to pay down the related mortgage debt (see note 4). The Company purchased treasury securities sufficient to satisfy the scheduled interest and principal payments contractually due under the mortgage debt agreement. The cash flows from these securities have interest and maturity payments that coincide with the scheduled debt service payments of the mortgage note and ultimate payment of principal. The treasury securities were then substituted for the office building that originally served as collateral for the mortgage debt. These securities were placed into a collateral account for the sole purpose of funding the principal and interest payments as they become due. The indebtedness remains on the Company’s consolidated balance sheet at September 30, 2007 since the transaction was not considered to be an extinguishment of debt.

 

On September 19, 2007, the Company closed the sale of the remaining building in its office building portfolio. The purchase price included the assumption of approximately $28.5 million of mortgage debt by the buyer.

 

The aggregate maturities of debt subsequent to September 30, 2007 are as follows (in millions):

 

 

In February 2007, the Company increased the size of its revolving credit facility (the “Credit Facility”) to $500 million. None of the material terms of the Credit Facility were changed in connection with the expansion. Proceeds from the increased Credit Facility have been and will be used for the repayment of debt maturing in 2007, development and construction projects and general corporate purposes.

 

In June 2007, the Company amended its Credit Facility to favorably adjust the financial covenant addressing the fixed charge coverage ratio. In July 2007, the Company also entered into amendments to its 2002 and 2005 senior notes making the same adjustments to their fixed charge covenants.

 

 

A summary of the net periodic pension (credit) expense follows (in thousands):

 

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various states. The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48), on January 1, 2007.

 

The Company had approximately $128.3 million of total unrecognized tax benefits as of January 1, 2007. Of this total, approximately $41.5 million represents the amount of unrecognized tax benefits that, if recognized, would affect the effective income tax rate. In addition, the Company has accrued approximately $11.3 million (net of tax benefit) in interest at January 1, 2007. There were no penalties required to be accrued at January 1, 2007. The Company recognizes interest and/or penalties related to income tax matters in income tax expense.

 

The Internal Revenue Service (IRS) recently examined the federal income tax returns of the Company for the years 2000 through 2004. At the end of March 2007, the Company effectively settled its contested tax positions with the IRS. This settlement resulted in an additional amount owed for 2000 through 2004 tax years of approximately $83.2 million, which had previously been accrued under SFAS 109 and SFAS 5. This amount includes estimated interest of approximately $16.7 million (before tax benefit). This settlement with the IRS resulted in an income tax benefit during the nine months ended September 30, 2007, of approximately $3.1 million to adjust amounts previously accrued to the agreed upon amounts. Since the information about the settlement with the IRS was not available at the implementation date of FIN 48 or at the time of filing of the Company’s Form 10-K for 2006, the effect has been recognized in net income for the nine month period ended September 30, 2007 and was not reflected in a cumulative effect adjustment upon the adoption of FIN 48. Tax years 2005 and 2006 remain subject to examination. The Company does not currently anticipate that the total amount of unrecognized tax benefits will significantly increase or decrease within the next twelve months for any additional items.

 

During the third quarter of 2007, we determined that our effective state tax rate used in determining the tax effect on the gain on discontinued operations recorded in the second quarter should have been higher. The resulting $1.3 million adjustment was recorded in the third quarter income tax expense offset against the gain on sales of discontinued operations and income taxes payable. Neither the origination nor the correction was material to our financial statements.

 

 

The Company conducts primarily all of its business in four reportable operating segments: residential real estate, commercial real estate, rural land sales and forestry. The residential real estate segment develops and sells home-sites and now to a lesser extent homes, due to the Company’s exit from homebuilding. The commercial real estate segment sells developed and undeveloped land. The rural land sales segment sells parcels of land included in the Company’s holdings of timberlands. The forestry segment produces and sells pine pulpwood, timber and other forest products.

 

The Company uses income from continuing operations before equity in income of unconsolidated affiliates, income taxes and minority interest for purposes of making decisions about allocating resources to each segment and assessing each segment’s performance, which it believes represents current performance measures.

 

The accounting policies of the segments are the same as those described above in the summary of significant accounting policies herein and in our Form 10-K. Total revenues represent sales to unaffiliated customers, as reported in the Company’s consolidated income statements. All intercompany transactions have been eliminated. The segment caption entitled “Other” consists of general and administrative expenses, net of investment income.

 

The Company’s reportable segments are strategic business units that offer different products and services. Decisions about allocations of resources are determined by management based on these strategic business units. Effective August 18, 2006, the implementation of strategy and decisions is deployed through geographic-based managers.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Information by business segment, adjusted as a result of discontinued operations, follows (in thousands).

 

 

 

 

The Company and its affiliates are involved in litigation on a number of matters and are subject to various claims which arise in the normal course of business, none of which, in the opinion of management, is expected to have a material adverse effect on the Company’s consolidated financial position, results of operations or liquidity. The Company has established estimated accruals for its various litigation matters which meet the requirements of Statement of Financial Accounting Standards No. 5, Accounting for Contingencies. However, it is possible that the actual amounts of liabilities resulting from such matters could exceed such accruals by several million dollars.

 

The Company has retained certain self-insurance risks with respect to losses for third party liability, workers’ compensation, property damage, group health insurance provided to employees and other types of insurance.

 

At September 30, 2007 and December 31, 2006, the Company was party to surety bonds of $45.0 million and $64.3 million, respectively, and standby letters of credit in the amounts of $22.7 million and $25.0 million, respectively, which may potentially result in liability to the Company if certain obligations of the Company are not met.

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

At September 30, 2007 and December 31, 2006, the Company was not liable as guarantor on any credit obligations that relate to unconsolidated affiliates or others in accordance with FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirement for Guarantees, Including Indirect Guarantees of Indebtedness of Others.

 

The Company is subject to costs arising out of environmental laws and regulations, which include obligations to remove or limit the effects on the environment of the disposal or release of certain wastes or substances at various sites, including sites which have been previously sold. It is the Company’s policy to accrue and charge against earnings environmental cleanup costs when it is probable that a liability has been incurred and an amount can be reasonably estimated. As assessments and cleanups proceed, these accruals are reviewed and adjusted, if necessary, as additional information becomes available.

 

Pursuant to the terms of various agreements by which the Company disposed of its sugar assets in 1999, the Company is obligated to complete certain defined environmental remediation. Approximately $6.7 million was placed in escrow pending the completion of the remediation. The Company separately funded the costs of remediation, which was substantially completed in 2003. Completion of remediation on one of the subject parcels occurred during the third quarter of 2006, resulting in the release of approximately $2.9 million of the escrowed funds to the Company on August 1, 2006. We expect the remaining balance held in escrow to be released to the Company in 2008. The release of escrow funds will not have any effect on our earnings.

 

The Company’s former paper mill site in Gulf County and certain adjacent property are subject to various Consent Agreements and Brownfield Site Rehabilitation Agreements with the Florida Department of Environmental Protection. The paper mill site has been assessed and has been rehabilitated by Smurfit-Stone Container Corporation in accordance with these agreements. The Company is in the process of rehabilitating the adjacent property in accordance with these agreements. Management does not believe the liability for any remaining required rehabilitation on these properties will be material.

 

Other proceedings involving environmental matters are pending against the Company. It is not possible to quantify future environmental costs because many issues relate to actions by third parties or changes in environmental regulation. However, management believes that the ultimate disposition of currently known matters will not have a material effect on the Company’s consolidated financial position, results of operations or liquidity. Aggregate environmental-related accruals were $3.3 million and $3.4 million as of September 30, 2007 and December 31, 2006, respectively.

 

 

Overview

 

The St. Joe Company is one of the largest real estate development companies in Florida. We believe we have one of the largest inventories of private land suitable for development in Florida. The majority of our land is located in Northwest Florida and has a very low cost basis. In order to optimize the value of these core real estate assets, we seek to reposition our substantial timberland holdings for higher and better uses. We increase the value of our raw land assets through the enhancement, entitlement, development and subsequent sale of residential and commercial parcels, home-sites and housing units or through the direct sale of unimproved land.

 

We have four operating segments: residential real estate, commercial real estate, rural land sales and forestry.

 

Our residential real estate segment generates revenues from:

 

 

Our commercial real estate segment generates revenues from the sale of developed and undeveloped land for retail, multi-family, office and industrial uses.

 

Our rural land sales segment generates revenues from:

 

 

Our forestry segment generates revenues from the sale of pulpwood, timber and forest products

 

Our ability to generate revenues, cash flows and profitability is directly related to the real estate market in Florida. Economic, political and weather-related conditions could have adverse effects on consumer buying behavior, construction costs, availability of labor and materials, the cost and availability of insurance, the availability of and changes in prices of fuel and energy, and other factors affecting us and the real estate industry in general and coastal real estate in particular. Additionally, adverse pricing and unavailability of credit could reduce the demand for home-sites we develop, particularly primary home-sites, and commercial properties we develop or sell.

 

Sales of residential real estate slowed significantly beginning in late 2005, and market conditions have continued to deteriorate during 2007. As a result, inventories of resale homes and home-sites have risen dramatically in our markets and have negatively impacted sales of our products. Further, the recent highly publicized problems in the mortgage lending industry have led to higher interest rates and stricter credit standards, which conditions have created additional negative pressure on demand and consumer confidence in housing. At this time, there is little visibility for when the market for residential real estate will improve.

 

On October 8, 2007, the Company announced a restructuring of its business to enhance and accelerate the Company’s value creation process. The plan includes the divestiture of non-core assets, a significant reduction in capital expenditures, the elimination of quarterly dividends, a leaner operating structure and an increased focus on the use of strategic business partners. The new operating structure will consist of a lean corporate center focused on regional planning, land-use entitlements, and business-to-business relationships with strategic partners and customers. We will increase our efforts to stimulate regional economic development and to identify and manage key regional inducers. In connection with this plan, approximately 500 employees in our hospitality, recreational and

golf operations are being transferred to third-party leisure, hospitality and lifestyle companies. Approximately 260 additional positions company-wide, particularly in project development and related support staff, will be either eliminated or transferred to strategic partners and customers by the end of 2008.

 

Forward-Looking Statements

 

We make forward-looking statements in this Report, particularly in the Management’s Discussion and Analysis, pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Any statements in this Report that are not historical facts are forward-looking statements. You can find many of these forward-looking statements by looking for words such as “intend”, “anticipate”, “believe”, “estimate”, “plan”, “should”, “forecast”, or similar expressions. In particular, forward-looking statements include, among others, statements about the following:

 

 

Forward-looking statements are not guarantees of future performance. You are cautioned not to place undue reliance on any of these forward-looking statements. These statements are made as of the date hereof based on current expectations, and we undertake no obligation to update the information contained in this Report. New information, future events or risks may cause the forward-looking events we discuss in this Report not to occur.

 

Forward-looking statements are subject to numerous assumptions, risks and uncertainties. Factors that could cause actual results to differ materially from those contemplated by a forward-looking statement include the risk factors described in our annual report on Form 10-K for the year ended December 31, 2006 and our quarterly reports on Form 10-Q, as well as, among others, the following:

 

 

 

Critical Accounting Estimates

 

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. We base these estimates on historical experience, available current market information and on various

other assumptions that management believes are reasonable under the circumstances. Additionally we evaluate the results of these estimates on an on-going basis. Management’s estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

The critical accounting policies that we believe reflect our more significant judgments and estimates used in the preparation of our consolidated financial statements are set forth in Item 7 of our annual report on Form 10-K for the year ended December 31, 2006. There have been no significant changes in these policies during the first nine months of 2007, except for changes related to the accounting for income taxes, as described below.

 

Recently Issued Accounting Pronouncements

 

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The fair value option established by SFAS 159 permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity shall report unrealized gains and losses, on items for which the fair value option has been elected, in earnings at each subsequent reporting date. SFAS 159 is effective for fiscal years beginning after November 15, 2007. We are currently evaluating the impact of SFAS 159 on our consolidated financial statements.