Contents 2. Directors and Officers 3. Letter to Shareholders 4. Selected Financial Data 5. Business 7. Selected Quarterly Financial Data 8. Management’s Discussion and Analysis of Financial Condition and Results of Operations 22. Financial Statements ALICO, INC. 640 South Main Street Post Office Box 338 La Belle, Florida 33975 Tel: (863) 675-2966 Fax: (863) 675-6928 www.alicoinc.com ANNUAL MEETING Friday, February 11, 2005, 10:00 a.m. Alico Arena Florida Gulf Coast University Fort Myers, Florida STOCK TRANSFER AGENT SunTrust Bank, Atlanta P.O. Box 4625 Atlanta, GA 30302-4625 – 1 – Directors John R. Alexander Chairman of the Board Alico, Inc. President, Chief Executive Officer and Director Atlantic Blue Trust, Inc. Lake Wales, Florida Member Executive Committee Richard C. Ackert Former President and CEO (retired December 2004) SouthTrust Bank, N.A. Fort Myers, Florida Member Audit, Compensation, Investment and Nominating Committees J.D. Alexander Senator District 17, Florida Senate Director Atlantic Blue Trust, Inc. Partner Scenic Highland Groves Lake Wales, Florida Member Executive and Investment Committees William L. Barton, P.E. President Mitigation Land Partners Inc. Naples, Florida Member Audit, Compensation, Investment and Nominating Committees Larry Carter, CPA Former President and Chief Operating Officer Conagra Foods - Food Ingredients Group Omaha, Nebraska Member Audit, Compensation, Investment and Nominating Committees W. Bernard Lester President and Chief Executive Officer Alico, Inc. LaBelle, Florida Member Executive Committee Stephen M. Mulready Former President and Chief Executive Officer USA Operations of Royal and Sunalliance Farmington, Connecticut Member Audit, Compensation, Investment and Nominating Commottees Thomas E. Oakley Vice-chairman of the Board Alico, Inc. President Oakley Transport Inc. Lake Wales, Florida Member Executive, Audit, Compensation, Investment and Nominating Committees Baxter G. Troutman Representative District 66, Florida House of Representatives Director Atlantic Blue Trust, Inc. CEO Florida Labor Solutions, Inc. Frostproof, Florida Member Executive Committee Officers W. Bernard Lester, President and Chief Executive Officer L. Craig Simmons, Vice President and Chief Financial Officer Steven M. Smith, Vice President, Citrus Division B. Wade Grigsby, Vice President, Ranch Division Robert P. Miley, Vice President, Heavy Equipment Division Denise Plair, Corporate Secretary – 2 – Letter to Shareholders January 21, 2005 To Our Stockholders: On February 26, 2004, beneficial ownership of the shares of Alico, Inc. previously controlled by Ben Hill Griffin, III as Trustee of the Ben Hill Griffin Jr. Irrevocable Trust, transferred to Atlantic Blue Trust, Inc., a corporation owned by his sisters and their lineal descendants. Upon the transfer of the beneficial ownership of these shares, Ben Hill Griffin III, resigned as Chairman of the Board, Chief Executive Officer and as a director, and Walker E. Blount, Jr., Monterey Campbell III, Amy Gravina and K.E. Hartsaw resigned as directors and were replaced by five new directors. The five new directors are John R. Alexander, president and CEO and a director of Atlantic Blue Trust, Inc.; Senator J.D. Alexander, District 17, Florida Senate, director of Atlantic Blue Trust, Inc. and partner, Scenic Highland Groves, Lake Wales, Florida; Larry Carter, CPA, and former president and COO of Conagra Foods - Food Ingredients Group, Omaha, Nebraska; Stephen M. Mulready, former president and CEO, USA Operations of Royal and Sunalliance, Farmington Connecticut; and Representative Baxter G. Troutman, District 66, Florida House of Representatives, director of Atlantic Blue Trust, Inc. and CEO of Florida Labor Solutions, Inc., Frostproof, Florida. Our corporate philosophy encompasses a love of land and an understanding and commitment to Florida agriculture while managing Alico’s operations and real estate to maximize their value for the long term. We are working with the Alico staff to enhance shareholder value and commit to working diligently for the benefit of all of the shareholders. We plan to continue the company’s involvement in the Central and Southwest Florida regions and its close association with Florida Gulf Coast University. Net income for the year ended August 31, 2004 was $17.8 million or $2.47 per share, compared to $12.7 million or $1.78 per share last year. Income from operations was higher in fiscal 2004 than fiscal 2003 ($6.7 million in fiscal 2004 vs. $4.7 million in fiscal 2003). The increase in income was primarily due to increased royalty income from rock and sand products mined from the Company’s Lee County property. Mining activity has increased due to continued development around Southwest Florida. With the enhanced effort of our associates, together with the support of our suppliers, customers and stockholders, we are confident that Alico will grow and produce even better results in the future. We appreciate your continuing support. Sincerely, John R. Alexander Chairman of the Board – 3 – Selected financial data 2004 Years Ended August 31 (in thousands except per share amounts) 2002 2001 2003 2000 Operating revenue Operating expenses Income (loss) from continuing operations Income (loss) from continuing operations per weighted average common share Total Revenue Total Costs and Expenses Income Taxes Net Income Average Number of Shares Outstanding Net Income Per Share Cash Dividend Declared Per Share Current Assets Total Assets Current Liabilities Ratio-Current Assets to Current Liabilities Working Capital Long-Term Obligations Total Liabilities Stockholders’ Equity $ 52,057 45,390 6,667 $ 48,285 43,582 4,703 $ 49,185 50,313 (1,128) $ 51,533 45,083 6,450 $ 45,207 38,258 6,949 0.92 87,779 59,979 9,987 17,813 7,219 2.47 0.60 125,925 238,242 10,136 12.42:1 115,789 82,908 93,044 145,198 0.66 66,532 47,448 6,425 12,659 7,106 1.78 0.35 90,204 216,545 10,124 8.91:1 80,080 80,239 90,363 126,182 (0.16) 63,545 53,752 2,258 7,535 7,070 1.07 1.00 66,267 191,910 9,543 6.94:1 56,724 69,149 78,692 113,218 0.92 69,710 49,598 4,046 16,066 7,033 2.29 1.00 61,345 179,134 7,691 7.98:1 53,654 58,818 66,509 112,625 0.99 62,540 41,965 6,464 14,111 7,028 2.01 0.30 56,578 176,876 12,346 4.58:1 44,232 60,985 73,331 103,545 Common stock prices and other stockholder information The common stock of Alico, Inc. is traded over the counter on the NASDAQ National Market System under the symbol ALCO. The high and low prices, by fiscal quarter, during the years ended August 31, 2004 and 2003 are below: First Quarter ......................... Second Quarter ..................... Third Quarter ........................ Fourth Quarter ...................... 2004 2003 High 35.99 39.75 38.99 46.20 Low 26.18 32.79 30.50 34.02 High 28.80 28.04 27.30 28.70 Low 22.25 21.15 21.00 22.72 The Company has 553 registered holders of record, but believes there are many more beneficial owners. Dividend information Only year end dividends have been paid and during the last three fiscal years were as follows: Record Date October 11, 2002 October 17, 2003 Payment Date October 25, 2002 October 31, 2003 Amount Paid Per Share $.35 $.60 The Company’s Board of Directors, at its meeting on October 8, 2004, voted to defer its annual dividend until a special committee of the board which has been formed has completed its consideration of any restructuring proposal from Atlantic Blue Trust, Inc., a Florida corporation which in February of 2004 acquired ownership of 3,493,777 shares (the "Shares") of the Company’s common stock from Ben Hill Griffin III, as Trustee of the Ben Hill Griffin, Jr. Irrevocable Trust. Dividends are paid at the discretion of the Company's Board of Directors. The Company foresees no change in its ability to pay annual dividends in the immediate future; nevertheless, there is no assurance that dividends will be paid in the future since they are dependent upon earnings, the financial condition of the Company, and other factors. – 4 – Business Alico, Inc. is an agribusiness company, primarily engaged in the production of citrus, cattle, sugarcane, sod and forest products. Agricultural operations have combined to produce from 90 to 95 percent of annual operating revenues during the past five years. Revenues from mining rock, sand and other road building and construction materials, by independent operators on Company lands, is another important source of income producing from 3 to 7 percent of annual operating revenues during the last five years. The Company also engages in land rentals for farming, cattle grazing, recreation, oil exploration and miscellaneous uses. Gross revenue from these activities during the past five years has ranged from 5 to 9 percent of annual operating revenue. While the Company is not in the retail land development and sales business except through its wholly owned subsidiary, Saddlebag Lake Resorts, Inc., it does from time to time sell land which, in the opinion of management, is surplus to the Company’s primary operations. Additionally, the Company’s wholly owned subsidiary, Alico-Agri, Ltd., engages in bulk land sales in connection with the generation of underwriting capital. Subsidiary Operations The Company has three wholly owned subsidiaries. Saddlebag Lake Resorts, Inc. is engaged exclusively in retail land sales and development. A small acreage subdivision, Blue Jordan Forest, covering approximately 1,100 acres and divided into 299 lots near Frostproof, Florida, has been developed with sales commencing in the fall of 1986. Two other projects, Saddlebag Lake Recreational Campground and Tiger Creek Forest (a small acreage subdivision), both of which have been sold out, were also developed by the subsidiary. Agri-Insurance Company, Ltd., (“Agri”) newly formed during fiscal 2000, was created to write crop insurance against catastrophic losses due to weather and/or disease. During fiscal 2002 and 2003, the subsidiary wrote a limited amount of coverage for Ben Hill Griffin, Inc., and for all of the Alico, Inc. citrus groves. During fiscal 2004, Agri began providing coverage for Tri County, LLC, a subsidiary of Atlantic Blue Trust, Inc., the holder of approximately 47.7% of the Company’s common stock. Alico-Agri, Ltd. was formed in fiscal 2003 to manage the real estate holdings of Agri. The financial results of the operations of these subsidiaries are consolidated with those of the parent Company. Properties From the inception of the Company's initial development program in 1948, the goal has been to develop its lands for the most profitable use. Prior to implementation of the development program, detailed studies were made of the properties focusing on soil capabilities, topography, transportation, availability of markets and the climatic characteristics of each of the tracts. Based on these and later studies, the use of each tract was determined. It is the opinion of Management that the lands are suitable for agricultural, residential and commercial uses. However, since the Company is primarily engaged in agricultural activities, some of the lands are considered surplus to its needs for this purpose and sales of such surplus real property are made from time to time. Management believes that each of the major operating segments are adequately supported by agricultural equipment, buildings, fences, irrigation systems and other amenities required for the operation of the projects. – 5 – At August 31, 2004, the Company owned a total of 141,067 acres of land located in four counties in Florida. Acreage in each county and the primary classification with respect to present use of these properties is shown in the following table: Alico, Inc. & Subsidiaries Land Use Summary Lee Hendry Polk Collier Total Citrus Producing acres Support and nonproductive* Total Citrus Sugarcane Producing acres Support and nonproductive* Total Sugarcane Ranch Improved pasture Semi-improved pasture Native pasture Support and nonproductive* Total Ranch Farming Leased acres Support and nonproductive* Total farming Sod Producing acres Support and nonproductive* Total sod Rock and Sand Mining Commercial & Residential – – – – – – – – – – – 130 21 151 – – – 5,573 8 3,765 1,890 5,655 13,083 10,796 23,879 22,627 20,038 11,846 23,302 77,813 2,802 1,008 3,810 500 335 835 – 4 3,253 650 3,903 4,129 3,197 7,326 – – – 295 602 5,949 1,540 8,386 – – – – – – – 214 – – – – 1,112 1,718 680 3,510 – – – – – – – – 11,147 5,737 16,884 13,083 10,796 23,879 22,922 21,752 19,513 25,522 89,709 2,932 1,029 3,961 500 335 835 5,573 226 Totals 5,732 111,996 12,503 10,836 141,067 * Includes buildings, roads, water management systems and wetlands. JACKSONVILLE OCALA DAYTONA BEACH Total Acreage 141,067 ac. ORLANDO TAMPA LAKELAND Polk County 12,503 ac. Lee County 5,732 ac. Collier County 10,836 ac. FORT MYERS LA BELLE WEST PALM BEACH Hendry County 111,996 ac. NAPLES MIAMI – 6 – Selected quarterly financial data (Unaudited) Summarized quarterly financial data (in thousands except for per share amounts) for the years ended August 31, 2004 and August 31, 2003, is as follows: Quarters Ended November 30 2003 2002 Feb. 29 2004 Feb. 28 2003 May 31 August 31 2004 2003 2004 2003 Revenue Citrus Sugarcane Ranch Property sales Interest $ 1,354 $ 1,621 $ 8,539 $ 9,774 $ 9,686 $ 9,247 $ 4,970 $ 3,465 2,591 3.344 14 450 2,748 2,118 535 276 957 5,615 1,080 32,175 804 1,470 5,212 1,146 134 245 942 3,459 4,650 1,002 748 1,290 4,977 3,086 178 229 703 733 604 290 517 436 825 16,143 451 1,179 1,084 Other revenue 1,215 Total revenue 8,968 8,255 49,683 17,453 20,835 18,420 8,293 22,404 Costs and expenses Citrus Sugarcane Ranch Interest Other Total costs 2,254 2,107 2,620 488 1,580 2,224 2,214 541 8,033 4,436 991 491 9,405 4,062 1,025 483 8,081 2,932 4,045 406 7,385 3,476 2,658 518 2,447 1,736 198 522 440 426 893 539 1,425 1,347 15,321 1,398 1,392 1,436 1,350 4,102 and expenses 8.894 7,906 29,272 16,373 16,856 15,473 4,957 7,696 Income before income taxes Provision for income taxes 74 349 20,411 1,080 3,979 2,947 3,336 14,708 25 91 7,667 290 1,639 882 656 5,162 Net income $ 49 $ 258 $12,744 $ 790 $ 2,340 $ 2,065 $ 2,680 $ 9,546 Basic earnings per share Weighted-average $ .01 $ .04 $ 1.77 $ .11 $ .32 $ .29 $ .37 $ 1.34 shares outstanding 7,140 7,097 7,180 7,108 7,263 7,110 7,288 7,111 – 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations. Cautionary Statement Some of the statements in this document include statements about future expectations. Statements that are not historical facts are “forward-looking statements” for the purpose of the safe harbor provided by Section 21E of the Exchange Act and Section 27A of the Securities Act. These forward-looking statements, which include references to one or more potential transactions, and strategic alternatives under consideration, are predictive in nature or depend upon or refer to future events or conditions and are subject to known as well as unknown risks and uncertainties that may cause actual results to differ materially from our expectations. There can be no assurance that any future transac- tions will occur or be structured in the manner suggested or that any such transaction will be completed. The Company undertakes no obligation to update publicly any forward-looking statements, whether as a result of future events, new information or otherwise. When used in this document, or in the documents incorporated by reference herein, the words “anticipate”, “believe”, “estimate”, “may”, “intend”, “expect” and other words of similar meaning, are likely to address the Company’s growth strategy, financial results and/or product development programs. Actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements contained herein. The considerations listed herein represent certain important factors the Company believes could cause such results to differ. These considerations are not intended to represent a complete list of the general or specific risks that may affect the Company. It should be recognized that other risks, including general economic factors and expansion strategies, may be significant, presently or in the future, and the risks set forth herein may affect the Company to a greater extent than indicated. The following discussion focuses on the results of operations and the financial condition of the Company. This section should be read in conjunction with the consolidated financial statements and notes. Liquidity and Capital Resources The Company had cash and marketable securities of $79.9 million at August 31, 2004, compared with $55.2 million at August 31, 2003. Working capital was $115.8 million and $80.1 million at August 31, 2004 and August 31, 2003 respectively. Cash outlay for land, equipment, buildings, and other improvements totaled $7.3 million during fiscal 2004, com- pared to $7.3 million during fiscal 2003 and $9.3 million during fiscal 2002, respectively. Land preparation for citrus re-development and capital maintenance continued, as did expenditures for replacement equipment and raising of breeding cattle. The Company, through Agri, supplies catastrophic business interruption coverage for Tri-County Grove, LLC a subsidiary of Atlantic Blue Trust, Inc., the holder of approximately 47.7% of the Company’s common stock. Total coverage under the policy is $2.7 million. This represents the only underwriting exposure at August 31, 2004. In August and Septem- ber 2004, a series of three hurricanes struck southwest Florida. The current estimate of the State’s crop loss is approximately 27%. Due to the extensive damages incurred throughout the state, a final assessment of damages has not yet been completed. The Company does expect a claim to be filed; however, the amount of the claim is not yet determinable. Total potential exposure under the policy for this claim is $900 thousand. – 8 – Management believes that the Company will be able to meet its working capital requirements for the foreseeable future with internally generated funds. The sale of a Lee County parcel is expected to close by August 2005. If the contract should close as written, it would provide approximately $13.8 million cash due at closing. The contracts were filed as attachments to the Company’s quarterly report on Form 10-Q/A for the nine months ended May 31, 2004. Also in connection with real estate transactions, the Company received a $10.0 million mortgage note in December 2003. The note matured in December 2004 and was paid in full. Management also expects continued profitability from the Company’s agricultural operations in fiscal 2005. Total earnings from agricultural operations in fiscal 2005 should approximate fiscal 2004. The outlook is for gross profits from citrus operations to potentially increase in fiscal 2005 when compared to fiscal 2004. Florida’s citrus production is expected to decline as a result of crop damages sustained during a series of hurricanes that hit Florida in August and September of 2004. The reduction in the supply of citrus is expected to result in improved market prices. The damage to the Company’s groves was limited to approximately $400 thousand. Provided there are no other catastrophic or unfavorable weather events, citrus earnings could improve. Management expects gross profits from sugarcane operations to decline in fiscal 2005, due to government imposed quotas that will limit the amount of raw cane the Company can deliver to processors. Gross profits from the Company’s cattle operations in fiscal 2005 are expected to remain similar to the fiscal 2004 results. Management expects royalties from rock and sand products to approximate or exceed fiscal 2004 levels in 2005, due to continued increases in production caused by development in Southwest Florida. However, mining royalties will cease upon the final disposition of the Lee County land. The final sale is expected to close within the next two fiscal years. In August 2004 Atlantic Blue Trust, Inc., the Company’s largest stockholder, requested that the Company consider a restructuring of the Company. While Atlantic Blue Trust did not propose the specific terms of a transaction, Atlantic Blue Trust discussed with the Company’s Board of Directors the advisability of combining Atlantic Blue Trust’s cattle ranch, citrus operations and other acreage with Alico’s business in an effort to both lower costs and improve joint operations with Alico remaining a public company. To facilitate such a possible restructuring, Atlantic Blue Trust urged consideration of (a) paying a special cash dividend to all Alico stockholders; and (b) merging Atlantic Blue Trust with Alico or one of its subsidiaries with shareholders of Atlantic Blue Trust receiving shares of Alico common stock in the merger. The Company has established a special committee comprised of all of the independent directors to analyze the possible restructuring. The special committee has retained outside financial and legal advisors to assist with this analysis. Alico directors affiliated with Atlantic Blue Trust or employed by Alico have not participated and will not participate in the evaluation of a possible restructuring. As of this date no formal proposal has been made by Atlantic Blue Trust. The Company has credit commitments that provide for revolving credit of up to $54.0 million, of which $10.8 million was available for the Company’s general use at August 31, 2004 (see Note 6 of Notes to consolidated financial statements). – 9 – Results of Operations Summary of results (in thousands) Operating revenue Gross profit General & administrative expenses Income (loss) from operations Profit on sale of real estate Interest and investment income Interest expense Other income Provision for income taxes Effective income tax rate Net income Operating Revenue Operating revenues for fiscal 2004 increased $60,000 compared to fiscal 2003. Increases in $50,000 revenues from rock and sand royalties and from agricultural activities were the most significant factors in the increase. Operating revenues for fiscal 2003 decreased compared to fiscal 2002. A decrease in revenues from agricultural activities was the most significant factor in the decline. ) s d n a s u o h t n i ( s r a l l o D $40,000 $30,000 $20,000 $10,000 0 Years Ended August 31 2004 2003 2002 $52,057 $48,285 $49,185 13,138 11,022 6,471 6,667 6,319 4,703 20,311 14,994 2,519 1,825 128 9,987 1,201 2,081 267 6,425 9,678 10,806 (1,128) 11,641 1,471 2,421 230 2,258 35.9 % 33.7 % 23.1 % $17,813 $12,659 $7,535 Operating Revenue 2004 2003 2002 Fiscal Year (ended August 31) Income (loss) from Operations Income from operations was higher in fiscal 2004 than fiscal 2003 ($6,667 in fiscal 2004 vs. $4,703 in fiscal 2003). The increase in income was primarily due to increased royalty income from rock and sand products mined from the Company’s Lee County property. Mining activity has increased due to continued development around southwest Florida. Income (loss) from operations increased significantly during fiscal 2003 when compared to the prior year ($4,703 in fiscal 2003 vs. ($1,128) in fiscal 2002). The improvement in income from operations was largely impacted by the Company’s fiscal 2002 commitment to donate $5.0 million to Florida Gulf Coast University (the University) in December 2001. The entire donation was accrued and included in general and administrative expenses during fiscal 2002. The remaining increase in income from operations in fiscal 2003 compared to fiscal 2002 was due to an increase in earnings from agricultural activities. – 10 – Interest & Investment Income vs. Expense Interest and Investment Income Interest and investment income is generated principally from investments in marketable equity securities, corporate and municipal bonds, mutual funds, U.S. Treasury securities and mortgages held on real estate sold on the installment basis. Realized investment earn- ings were reinvested throughout fiscal 2004, $4,000 $3,000 $2,000 $1,000 ) s d n a s u o h t n i ( s r a l l o D Interest & Investment Income Interest Expense 2003 and 2002, increasing investment levels $0 2004 2003 2002 Fiscal Year (ended August 31) during each year. Interest and investment income increased in fiscal 2004 when compared to fiscal 2003 ($2.5 million vs. $1.2 million in fiscal 2004 and 2003, respectively). The increase was caused by an increase in investment level in fiscal 2004 when compared to fiscal 2003 ($55.6 million at August 31, 2004 vs. $38.8 million at August 31, 2003), coupled with improved conditions in the financial markets. The investment levels increased due to the reinvestment of realized investment earnings, together with additional invested capital provided by proceeds from the sale of bulk excess real estate in December of 2003. The decrease in fiscal 2003 and 2002 interest and investment income resulted from unfavorable conditions in the financial markets. Interest Expense Interest expense declined during fiscal 2004 when compared to fiscal 2003. The Company was able to pay down principal on higher interest notes using its existing revolving credit facility, effectively lowering its overall interest rate. Interest expense decreased during fiscal 2003, compared to fiscal 2002. This was due to a decline in interest rates on borrowings. Individual Operating Divisions Gross profits for the individual operating divisions, for fiscal 2004, 2003 and 2002, are presented in the following schedule and are discussed in subsequent sections: Citrus Revenues Sales Cost & expenses Harvesting & marketing Direct production** Allocated cost* Total Gross profit, citrus 2004 Years Ended August 31 2003 2002 $ 24,549 $ 24,107 $ 25,105 9,533 7,677 3,605 20,815 3,734 8,910 7,671 3,525 20,106 4,001 9,364 8,594 3,463 21,421 3,684 – 11 – Sugarcane Revenues Sales Costs and expenses Harvesting and marketing Direct production Allocated cost* Total Gross profit, sugarcane Ranch Revenues Sales Costs and expenses Direct production Allocated cost* Total Gross profit, ranch Total gross profit, agriculture Other operations Revenue Rock products and sand Land rentals and oil lease Forest products Other Total Costs and expenses Allocated cost* General & administrative, all operations Total Gross (loss) income, other operations Total gross profit (loss) Interest & dividends Revenue Expense Interest & dividends, net 2004 Years Ended August 31 2003 2002 12,398 13,373 11,789 2,353 4,164 3,156 9,673 2,725 2,915 3,844 3,429 10,188 3,185 2,239 3,965 3,253 9,457 2,332 9,678 7,175 9,102 5,750 2,428 8,178 1,500 7,959 3,448 1,171 407 128 5,154 1,174 5,297 6,471 (1,317) 6,642 2,519 1,825 694 4,937 1,853 6,790 385 7,571 2,154 973 292 267 3,686 882 5,437 6,319 (2,633) 4,938 1,201 2,081 (880) 6,087 2,428 8,515 587 6,603 1,999 721 355 230 3,305 735 10,071 10,806 (7,501) (898) 1,471 2,421 (950) – 12 – Real estate Revenue Sale of real estate Expenses Cost of sales Other costs Total Gain on sale of real estate 2004 Years Ended August 31 2003 2002 33,481 16,990 12,773 12,987 30 13,017 20,464 1,925 39 1,964 15,026 1,076 56 1,132 11,641 Income before income taxes $ 27,800 $ 19,084 $ 9,793 * Allocated cost includes ad valorem and payroll taxes, depreciation and insurance. ** Excludes capitalized maintenance cost of groves less than five years of age consisting of $2.2 million on 1,276 acres in 2004, $2.3 million on 1,617 acres in 2003, and $2.5 million on 1,326 acres in 2002. Citrus Gross profit was $3.7 million in fiscal 2004, $4.0 million in fiscal 2003, and $3.7 million for fiscal 2002. Revenue from citrus sales increased 2% during fiscal 2004 compared to fiscal 2003 ($24.5 million in fiscal 2004 vs. $24.1 million in fiscal 2003). Total field boxes of citrus harvested increased to 4.6 million in fis- cal 2004 from 4.3 million in fiscal 2003, due to favorable growing conditions, and was the primary cause of the increase. The favorable $10,000 ) s d n a s u o h t n i ( s r a l l o D $8,000 $6,000 $4,000 $2,000 $0 Citrus Division Gross Profit 2004 2003 2002 Fiscal Year (ended August 31) growing conditions also contributed to industry wide production increases, resulting in a record Florida citrus crop. The increased supply caused citrus prices to decrease as a whole, and the Company experienced a 4% decline in fruit prices. Additionally, during August and September of 2004 a series of three hurricanes struck a portion of the Company’s citrus groves in Polk County Florida. The resulting damage compelled the Company to write its crop inventory down $0.4 million. The amount was charged to fiscal 2004 operations. Revenue from citrus sales decreased 4% during fiscal 2003, compared to fiscal 2002 ($24.1 million during fiscal 2003 vs. $25.1 million during fiscal 2002). Pounds of fruit solids per box decreased during fiscal 2003, compared to fiscal 2002, and was the primary cause of the decline in sales revenue. Harvesting and marketing costs increased in fiscal 2004 when compared to fiscal 2003 ($9.5 million in fiscal 2004 vs. $8.9 million in fiscal 2003) due to the increased number of boxes harvested. Direct production and allocated costs were approximately the same for both fiscal 2004 and fiscal 2003 ($11.3 million in fiscal 2004 vs. $11.2 million in fiscal 2003). – 13 – Harvesting and marketing costs decreased in fiscal 2003 when compared to fiscal 2002 due to procedural efficiencies that resulted in a decrease in the per box rate during the year. Direct production and allocated costs decreased 7% in fiscal 2003 when compared to fiscal 2002, due to a decrease in the costs of cultivation and irrigation impacted by improved weather conditions. The final returns from citrus pools are not precisely determinable at year-end. Returns are estimated each year based on the most current information available. Differences between the estimates and the final realization of revenues can be significant, and the differences between estimated and final results can be either positive or negative. Revenues collected in excess of prior year and year end estimates were $728 thousand, $198 thousand, and $568 thousand during fiscal 2004, 2003 and 2002, respectively. Sugarcane Gross profit for fiscal 2004 was $2.7 million, compared to $3.2 million in fiscal 2003 and $2.3 million in fiscal 2002. The 2004, 2003, and 2002 fiscal year crops yielded approxi- mately 465,000, 523,000 and 466,000 standard tons, respectively. Yields per acre were 44.25, 45.51, and 41.37 for the 2004, 2003 and 2002 fiscal years, respectively. Sales revenue from sugarcane decreased to $12.4 million in fiscal 2004 from $13.4 mil- lion in the prior fiscal year. Due to normal crop Sugarcane Division Gross Profit $4,000 $3,000 $2,000 $1,000 ) s d n a s u o h t n i ( s r a l l o D $0 2004 2003 2002 Fiscal Year (ended August 31) rotation and replanting in the current year, fewer acres were harvested (11,131 in fiscal 2004 vs. 11,840 in fiscal 2003). This was the primary cause of the current year decrease in sales revenue. The reduced acres harvested in fiscal 2004 also resulted in lower harvesting and marketing costs than in the prior year ($2.4 million in fiscal 2004 vs. $2.9 million in fiscal 2003). Direct production and allocated costs were a combined $7.3 million for both fiscal 2004 and 2003. Sales revenue from sugarcane increased 13% during fiscal 2003, compared to fiscal 2002 ($13.4 million vs. $11.8 million, respectively). The increase was the result of an improvement in the yield per acre brought about by favorable weather conditions during the growing season. Combined direct production and allocated costs were approximately the same in fiscal 2003 as in fiscal 2002 ($7.3 million vs. $7.2 million, respectively). Ranching The gross profit from ranch operations for fis- cal 2004, 2003 and 2002 was $1.5 million, $0.4 million, and $0.6 million, respectively. Revenues from cattle sales increased by 35% to $9.7 million in fiscal 2004, compared to $7.2 million in the previous fiscal year. The increase was due to an increase in the number of head sold (10,603 in fiscal 2004 vs. 9,062 in fiscal 2003) coupled with increased prices for beef cattle. More animals of the age and size required by meat packers were available Ranch Division Gross Profit $2,000 $1,000 $500 ) s d n a s u o h t n i ( s r a l l o D 0 2004 2003 2002 Fiscal Year (ended August 31) – 14 – for sale in fiscal 2004 than in fiscal 2003 due to the timing of placements into western feedlots. Prices increased as a result of a decrease in the domestic beef supply. As a result of the increase in the number of cattle sold in fiscal 2004, direct and allocated costs increased to $8.2 million in fiscal 2004 from $6.8 million in fiscal 2003. Revenues from cattle sales decreased 21% during fiscal 2003, compared to fiscal 2002 ($7.2 million in fiscal 2003 vs. $9.1 million in fiscal 2002). Direct and allocated production costs decreased by 20% during fiscal 2003, as compared to fiscal 2002 ($6.8 million in fiscal 2003 vs. $8.5 million in fiscal 2002). The decline in revenue and total production costs primarily resulted from a corresponding decrease in the total number of cattle sold during fiscal 2003 when compared to fiscal 2002. Less animals of the age and size required by meat packers were available for sale in fiscal 2003 than in 2002 because of the timing of placements into western feedlots. Total head sold was 9,062 and 12,166 for fiscal 2003 and 2002, respectively. The Company’s cattle marketing activities include retention of calves in western feedlots, contract and auction sales, and risk management contracts. Other Operations Returns from rock products and sand were $3.4 million for fiscal 2004, $2.2 million for 2003 and $2.0 million during 2002. Mining activity has continued to increase due to continued development around southwest Florida. Rock and sand supplies are sufficient to meet current demand, and no major price changes have occurred over the past 3 years. Revenues from land rentals and oil royalties were $1.2 million in fiscal 2004 as compared to $1.0 million in fiscal 2003 and $0.7 million for fiscal 2002. During fiscal 2004, in response to increased demand for Southwest Florida real estate, the Company raised its rental rates for properties. The fiscal 2003 improvement is primarily due to an increase in the amount of land leased for farming. Profits from the sale of sabal palms and other horticultural items, for landscaping purposes, during fiscal 2004 were $0.4 million compared to $0.3 million and $0.4 million for fiscal years 2003 and 2002, respectively. Direct and allocated expenses charged to the “Other” operations category included general and administrative and other costs not charged directly to the citrus, ranching or sugarcane divisions. These expenses totaled $6.5 million during fiscal 2004, compared to $6.3 million during fiscal 2003 and to $10.8 million during fiscal 2002. In Decem- ber 2001, the Company agreed to donate $5.0 million to the Florida Gulf Coast University for a new athletic complex, scholarships and athletic programs. As per the agreement with the University, $1.0 million was paid in fiscal 2002, $800 thousand was paid in fiscal 2003 and fiscal 2004, and $800 thousand will be paid each year over the next three years. The net present value of the total donation was accrued and included in general and administrative expenses in fiscal 2002 and was the primary cause for the increase in general and administrative expenses that year. Profit on Sale of Real Estate Profit from retail land sales, made through Saddlebag, were $153 thousand in fiscal 2004, vs. $32 thousand in fiscal 2003 and breakeven during fiscal 2002. Profit from bulk land sales were $20.3 million in fiscal 2004, $15.0 million in fiscal 2003 and $11.6 million in fiscal 2002. As discussed below, sales contracts are in place for all of the remaining Lee County property with closing dates expected over the next two fiscal years. The total sales price of Gains From Real Estate Sales ) s d n a s u o h t n i ( s r a l l o D $21,000 $18,000 $15,000 $12,000 $9,000 $6,000 $3,000 $0 – 15 – 2004 2003 2002 Fiscal Year (ended August 31) the contracts is $138.4 million. When or if the contracts do close, they are expected to result in gains in excess of $124.0 million. The Board of Directors has not specified how these funds will be used if received. General Corporate The Company is continuing its marketing and permitting activities for its land that surrounds Florida Gulf Coast University in Lee County, Florida. There are sales contracts in place for all this property, totaling $138.4 million. The agreements are at various stages in the due diligence process with closing dates expected over the next two fiscal years. The contracts are subject to various contingencies and there is no assurance that they will close. The Company formed Agri-Insurance Company, Ltd. (Agri) a wholly owned subsidiary, during July of 2000. The insur- ance company was initially capitalized by transferring cash and approximately 3,000 acres of the Lee County property. Through Agri, the Company has been able to underwrite previously uninsurable risk related to catastrophic crop and other losses. The coverages currently underwritten by Agri will indemnify its insureds for the loss of the revenue stream resulting from a catastrophic event. To expedite the creation of the capital liquidity necessary to underwrite the Company’s exposure to catastrophic losses, another 5,600 acres were transferred during fiscal 2001. Agri underwrote a limited amount of coverage for Ben Hill Griffin, Inc. during fiscal years 2001 - 2004, and in August 2002, Agri began insuring the Alico, Inc., citrus groves. As Agri gains underwriting experience and increases its liquidity, it will be able to increase its insurance programs. Due to Agri’s limited operating history, it would be difficult to speculate about the impact that Agri could have on the Company’s financial position, results of operations and liquidity in future periods. Since the coverages that have been written, as liquidity has been generated, are primarily for the benefit of Alico, the financial substance of this venture is to insure risk that is inherent in the Company’s existing operations. Agri wrote an insurance policy for Tri-County Grove, LLC, a subsidiary of Atlantic Blue Trust, Inc., the holder of approximately 47.7% of the Company’s common stock in 2004. The coverage term is from August 2004 to July 2005. Total coverage under the policy is $2.7 million and the premium charged was $45 thousand. Premiums for coverages quoted are set by independent actuaries/underwriters hired by Agri in Bermuda based on under- writing considerations established by them. Premiums vary depending upon the size of the property, its age and revenue- producing history as well as the proximity of the insured property to known disease-prone areas or other insured hazards. During the third quarter of fiscal 2003, the Company entered into a limited partnership with Agri to manage Agri’s real estate holdings. Agri transferred all of the Lee County property and associated sales contracts to the limited partner- ship, Alico-Agri, Ltd (Alico-Agri) in return for a 99% partnership interest. Alico, Inc. transferred $1.2 million cash for a 1% interest. The creation of the partnership allows Agri to concentrate solely on insurance matters while utilizing Alico’s knowledge of real estate management. During the second quarter of fiscal 2004, the Company, through Alico-Agri, completed the sale of 244 acres in Lee County, Florida. The sales price was $30.9 million and resulted in a gain of $19.7 million. The sale generated $20.9 million cash with the remaining $10.0 million held in the form of a mortgage receivable due in December 2004. During the fourth quarter of fiscal 2003, the Company sold 358 acres in Hendry County, Florida for $669 thousand. The sale generated a gain of $335 thousand. Additionally, the Company sold 266 acres in Polk County, Florida to the State for $617 thousand, generating a gain of $612 thousand. In the fourth quarter of fiscal 2003, the Company, through Alico-Agri, completed the sale of 313 acres in Lee County, Florida. The sales price was $9.7 million and resulted in a gain of $8.7 million. Additionally, Alico-Agri completed the sale of 40 acres in Lee County, Florida. The sales price of the property was $5.5 million and generated a gain of $4.7 million. – 16 – Recent Events In August 2004 Atlantic Blue Trust, Inc., the Company’s largest stockholder, requested that the Company consider a restructuring of the Company. While Atlantic Blue Trust did not propose the specific terms of a transaction, Atlantic Blue Trust discussed with the Company’s Board of Directors the advisability of combining Atlantic Blue Trust’s cattle ranch, citrus operations and other acreage with Alico’s business in an effort to both lower costs and improve joint operations with Alico remaining a public company. To facilitate such a possible restructuring, Atlantic Blue Trust urged consideration of (a) paying a special cash dividend to all Alico stockholders; and (b) merging Atlantic Blue Trust with Alico or one of its subsidiaries with shareholders of Atlantic Blue Trust receiving shares of Alico common stock in the merger. The Company has established a special committee comprised of all of the independent directors to analyze the possible restructuring. The special committee has retained outside financial and legal advisors to assist with this analysis. Alico directors affiliated with Atlantic Blue Trust or employed by Alico have not participated and will not participate in the evaluation of a possible restructuring. As of this date no formal proposal has been made by Atlantic Blue Trust. The Company received an unsolicited letter from National Land Partners, LLC expressing the desire to discuss a potential acquisition of Alico by National Land. The Company’s Board of Directors referred the National Land letter to the special committee. On December 16, 2004, the special committee along with representatives of Atlantic Blue Trust met with representatives of National Land Partners, LLC. At the conclusion of that meeting, such representatives of Atlantic Blue Trust and its stockholders advised National Land Partners and the Special Committee that neither Atlantic Blue Trust nor any of the holders of Atlantic Blue Trust’s stock would be interested in selling the Alico shares held by Atlantic Blue Trust or supporting a sale transaction at the price offered by National Land Partners or even at a substantially higher price. National Land Partners has acknowledged that it will not proceed with a transaction to acquire Alico without the support of Atlantic Blue Trust and its stockholders. In September 2004, the Company, through Alico-Agri, purchased the assets of La Belle Plant World, Inc. a wholesale grower and shipper of commercial vegetable transplants to commercial farmers. The purchase price was $4.9 million for the land, office building, greenhouses and associated equipment. Alico Plant World, LLC (“Plant World”) was set up as a wholly owned subsidiary of Alico-Agri, Ltd. Plant World was purchased in order to diversify Alico’s agricultural operations and to take advantage of Alico’s existing relationships with the farming community. Due to Plant World’s limited operating history, it would be difficult to speculate about the impact that Plant World could have on the Company’s financial position, results of operations and liquidity in future periods, but it is not expected to be significant in the next fiscal year. Off Balance Sheet Arrangements The Company, through Agri, supplies catastrophic business interruption coverage for Tri-County Grove, LLC a subsidiary of Atlantic Blue Trust, Inc., the holder of approximately 47.7% of the Company’s common stock. The coverage term is from August 2004 to July 2005. Total coverage under the policy is $2.7 million and the premium charged was $45 thousand. In August and September 2004, a series of hurricanes struck southwest Florida. Due to the extensive damages incurred throughout the state, an assessment of damages has not yet been completed. The Company expects a claim to be filed, however, the amount of the claim is not yet determinable. Total potential exposure under the policy for this claim is $900 thousand. Premiums for coverages quoted are set by independent actuaries/underwriters hired by Agri in Bermuda based on under- writing considerations established by them. Premiums vary depending upon the size of the property, its age and revenue- producing history as well as the proximity of the insured property to known disease-prone areas or other insured hazards. – 17 – Disclosure of Contractual Obligations Contractual obligations of the Company are set forth in the table below: Payment due by period (from August 31, 2004) (in thousands) Less than Contractual obligations Total 1 year 1 - 3 years 3 - 5 years 5+ years Long-term debt $ 51,585 $ 3,319 $ 39,875 $ 2,585 $ 5,806 Leases (Operating & capital) Purchase obligations (donation) Other long-term liabilities 0 2,278 33,297 0 764 434 0 1,514 18,718 0 0 0 0 1,764 12,381 Total $ 87,160 $ 4,517 $ 60,107 $ 4,349 $ 18,187 Payment due by period (from August 31, 2003) (in thousands) Less than Contractual obligations Total 1 year 1 - 3 years 3 - 5 years 5+ years Long-term debt $ 57,448 $ 3,321 $ 39,576 $ 4,633 $ 9,918 Leases (Operating & capital) Purchase obligations (donation) Other long-term liabilities 0 2,983 24,142 0 754 350 0 1,459 11,584 0 770 0 0 1,944 10,264 Total $ 84,573 $ 4,425 $ 52,619 $ 7,347 $ 20,182 Critical Accounting Policies and Estimates The preparation of the Company’s financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, management evaluates the estimates and assumptions based upon historical experi- ence and various other factors and circumstances. Management believes that the estimates and assumptions are reasonable in the circumstances; however, actual results may vary from these estimates and assumptions under different future circumstances. The following critical accounting policies have been identified that affect the more significant judgments and estimates used in the preparation of the consolidated financial statements. The Company records inventory at the lower of cost or net realizable value. Management regularly assesses estimated inventory valuations based on current and forecasted usage of the related commodity and any other relevant factors that affect the net realizable value. Based on fruit buyers’ and processors’ advances to growers, stated cash and futures markets combined with experience in the industry, management reviews the reasonableness of the citrus revenue accrual. Adjustments are made through- out the year to these estimates as relevant information regarding the citrus market becomes available. Differences between the estimates and the final realization of revenues can be significant, and the differences between estimated and final results can be either positive or negative. Fluctuation in the market prices for citrus fruit has caused the Company to recognize additional revenue from prior years’ crop totaling $728 thousand, $198 thousand, and $568 thousand during fiscal 2004, 2003, and 2002, respectively. – 18 – In accordance with Statement of Position 85-3 “Accounting by Agricultural Producers and Agricultural Cooperatives”, the cost of growing crops (citrus and sugarcane), are capitalized into inventory until the time of harvest. Once a given crop is harvested, the related inventoried costs are recognized as a cost of sale to provide an appropriate matching of costs incurred with the related revenue earned. Alico formed a wholly owned insurance subsidiary, Agri Insurance Company, Ltd. (Bermuda) (“Agri”) in June of 2000. Agri was formed in response to the lack of insurance availability, both in the traditional commercial insurance markets and governmental sponsored insurance programs, suitable to provide coverages for the increasing number and poten- tial severity of agricultural related events. Such events include citrus canker, crop diseases, livestock related maladies and weather. Alico’s goal included not only prefunding its potential exposures related to the aforementioned events, but also to attempt to attract new underwriting capital if it is successful in profitably underwriting its own potential risks as well as similar risks of its historic business partners. Alico capitalized Agri by contributing real estate located in Lee County, Florida. The real estate was transferred at its historical cost basis. Agri received a determination letter from the Internal Revenue Service (IRS) stating that Agri was exempt from taxation provided that net premium levels, consisting only of premiums with third parties, were below an annual stated level ($350 thousand). Third party premiums have remained below the stated annual level. As the Lee county real estate was sold, substantial gains were generated in Agri, creating permanent book/tax differences. Since receiving the favorable IRS determination letter, certain transactions, entered into by other taxpayers under the same IRS Code Section came under scrutiny and criticism by the news media. In reaction, Management has recorded a contingent liability of $17.0 million for income taxes in the event of an IRS challenge. Management’s decision has been influenced by perceived changes in the regulatory environment. The Company believes that it can successfully defend any such challenge, however, because it is probable that a challenge will be made and possible that it may be successful, Management has provided for the contingency. The IRS is in the process of examining the Company tax returns for the fiscal years ended August 31, 2003, 2002, 2001 and 2000, and Agri tax returns for calendar years 2002, 2001 and 2000. Any adjustments resulting from the examination will be currently due and payable. A Revenue Agent has issued a report challenging Agri’s tax exempt status for the years examined, however, the report did not quantify the adjustment proposed. Quantification of the adjustment is expected when the IRS concludes its audits of Alico. No adjustments have been proposed to date for Alico. The Revenue Agent’s findings regarding Alico could occur within the next fiscal year. – 19 – – 20 – Report of Independent Registered Public Accounting Firm To the Stockholders and Board of Directors Alico, Inc.: We have audited the consolidated balance sheet of Alico, Inc. and subsidiaries as of August 31, 2003, and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss), and cash flows for the years ended August 31, 2003 and 2002. In connection with our audits of the related 2003 and 2002 consolidated financial statements, we also have audited the related 2003 and 2002 consolidated financial statement schedules as listed in Item 15(a)(2) herein. These consolidated financial statements and financial statements schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedules based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Alico, Inc. and subsidiaries at August 31, 2003, and the results of their operations and their cash flows for the years ended August 31, 2003 and 2002†in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related 2003 and 2002 consolidated financial statement schedules, when considered in relation to the consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. KPMG, LLP Orlando, Florida October 10, 2003 – 21 – Consolidated balance sheets (in thousands) August 31 2004 2003 Assets Current assets: Cash, including time deposits and other cash investments of $24,171 in 2004 and $16,303 in 2003 $ 24,299 $ 16,352 Marketable securities available for sale, at estimated fair value in 2004 and in 2003 (note 2) Accounts receivable ($6,470 in 2003 due from affiliate) (note 12) Mortgages and notes receivable, current portion (note 3) Land inventories Inventories (note 4) Other current assets 55,570 38,820 9,118 9,983 5,501 9,680 2,534 – 20,772 21,845 682 973 Total current assets 125,925 90,204 Other assets: Land inventories Mortgages and notes receivable, net of current portion (note 3) Investments Cash surrender value of life insurance, restricted (note 10) Total other assets Property, buildings and equipment (note 5) Less accumulated depreciation – 662 1,069 4,900 16,587 234 886 3,797 6,631 21,504 147,756 144,578 (42,070) (39,741) Net property, buildings and equipment 105,686 104,837 Total assets $238,242 $216,545 – 22 – Liabilities and stockholders’ equity Current liabilities: Accounts payable Due to profit sharing plan (note 10) Accrued ad valorem taxes Current portion of notes payable (note 6) Accrued expenses Income taxes payable Deferred income taxes (note 11) Donation payable August 31 2004 2003 $ 1,743 $ 2,110 434 1,678 3,319 1,068 753 376 765 350 1,519 3,321 390 – 1,680 754 Total current liabilities 10,136 10,124 Deferred revenue Notes payable (note 6) Deferred income taxes (note 11) Deferred retirement benefits (note 10) Other noncurrent liabilities (note 8) Donation payable Total liabilities Stockholders’ equity: Preferred stock, no par value. Authorized 1,000,000 shares; issued, none Common stock, $1 par value. Authorized 15,000,000 shares; issued and outstanding 7,309 in 2004 and 7,116 in 2003 Additional Paid in Capital Accumulated other comprehensive income Retained earnings Total stockholders’ equity 266 48,266 11,445 4,464 16,954 1,513 91 54,127 9,668 4,515 9,609 2,229 93,044 90,363 – – 7,309 7,800 1,529 7,116 3,074 961 128,560 115,031 145,198 126,182 Total liabilities and stockholders’ equity $238,242 $216,545 See accompanying notes to consolidated financial statements. – 23 – Consolidated statements of operations (in thousands except per share amounts) Revenue Citrus (including revenues from affiliate (note 12)) Sugarcane Ranch Rock and sand royalties Land rentals and oil lease Forest products Retail land sales Years Ended August 31 2003 2004 2002 $ 24,549 12,398 9,678 3,448 1,171 407 406 $ 24,107 13,373 7,175 2,154 973 292 211 $ 25,105 11,789 9,102 1,999 721 355 114 Operating revenue 52,057 48,285 49,185 Costs of sales Citrus production, harvesting and marketing (including charges from affiliate) (note 12) Sugarcane production, harvesting and hauling Ranch Retail land sales Total costs of sales Gross profit General and administrative expenses Income (loss) from operations Other income (expenses) Profit on sales of real estate: Sales Cost of sales Profit on sales of real estate, net Interest and investment income Interest expense (note 6) Other Total other income, net Income before income taxes Provision for income taxes (note 11) 20,815 9,673 8,178 253 38,919 13,138 6,471 6,667 33,075 12,764 20,311 2,519 (1,825) 128 21,133 27,800 9,987 20,106 10,188 6,790 179 37,263 11,022 6,319 4,703 16,779 1,785 14,994 1,201 (2,081) 267 14,381 19,084 6,425 21,421 9,457 8,515 114 39,507 9,678 10,806 (1,128) 12,659 1,018 11,641 1,471 (2,421) 230 10,921 9,793 2,258 Net Income $ 17,813 $ 12,659 $ 7,535 Weighted-average number of shares outstanding Weighted-average number of dilutive shares outstanding Per share amounts Basic Diluted Dividends 7,219 7,295 $2.47 $2.44 $2.60 7,106 7,256 $1.78 $1.74 $1.35 7,070 7,188 $1.07 $1.05 $1.00 See accompanying Notes to Consolidated Financial Statements. – 24 – Consolidated statements of stockholders’ equity and other comprehensive income (in thousands) Balances, August 31, 2001 Comprehensive income: Net income for the year ended August 31, 2002 Unrealized losses on securities, net of taxes of $(622) and reclassification adjustment Total comprehensive income: Dividends paid Stock options exercised Stock based compensation Balances, August 31, 2002 Comprehensive income: Net income for the year ended August 31, 2003 Unrealized gains on securities, net of taxes of $552 and reclassification adjustment Total comprehensive income: Dividends paid Stock options exercised Stock based compensation Balances, August 31, 2003 Comprehensive income: Net income for the year ended August 31, 2004 Unrealized gains on securities, net of taxes of $234 and reclassification adjustment Total comprehensive income: Dividends paid Stock options exercised Stock based compensation Common Stock Shares Issued Amount Additional Paid-In-Capital Accumulated Other Comprehensive Income (Loss) Retained Earnings Total 7,045 $ 7,045 $ 331 $ 871 $ 104,378 $ 112,625 – – – – 35 – – – – 35 7,080 7,080 – – – – 36 – – – – 36 7,116 7,116 – – – – 193 – – – – 494 891 1,716 519 839 3,074 – – – – – – – – – 193 2,963 1,763 – 7,535 7,535 (1,303) – (1,303) 6,232 (7,059) 529 891 1,393 14,052 (2,482) 555 839 (7,059) – – (2,482) – – (432) 104,854 113,218 12,659 12,659 1,393 – 961 115,031 126,182 17,813 17,813 568 – (4,284) – – 568 18,381 (4,284) 3,156 1,763 – – – – – – – – – – – Balances, August 31, 2004 7,309 $ 7,309 $ 7,800 $ 1,529 $ 128,560 $ 145,198 Disclosure of reclassification amount Unrealized holding gains (losses) arising during the period Less: reclassification adjustment for gains (losses) included in net income Net unrealized gains (losses) on securities See accompanying notes to consolidated financial statements. 2004 2003 2002 787 $ 2,651 $1, (1,774) 219 568 1,258 (471) $ 1,393 $ (1,303) $ $ – 25 – Consolidated statements of cash flows (in thousands) Increase (Decrease) in Cash and Cash Investments Cash flows from operating activities Net Income Adjustments to reconcile net income to cash provided by operating activities: Depreciation (Gain) Loss on breeding herd sales Deferred income tax expense, net Deferred retirement benefits Net (gain) loss on sale of marketable securities (Gain) Loss on disposal of property and equipment Years Ended August 31 2003 2004 2002 $ 17,813 $ 12,659 $ 7,535 6,509 (108) 472 (1,154) (723) – 6,723 (16) 582 1 (691) 606 6,982 (84) 1,263 (31) 381 (150) Gain on real estate sales (20,311) (15,026) (11,758) Stock options granted below fair market value 1,763 839 891 Cash provided by (used for) changes in: Accounts receivable Inventories Other assets Accounts payable and accrued expenses Income taxes payable Deferred revenues 561 474 291 7,194 753 176 (218) (173) 111 5,840 42 (23) 692 1,059 57 2,944 (294) 48 Net cash provided by operating activities 13,710 11,256 9,535 Cash flows from investing activities Increase in land inventories Purchases of property and equipment Proceeds from disposals of property and equipment Proceeds from sale of real estate Purchases of other investments Purchases of marketable securities Proceeds from sales of marketable securities Collection of mortgages and notes receivable (423) (7,280) 738 21,356 (320) (684) (7,325) 431 15,911 – (21,072) (20,257) 5,643 2,586 4,958 2,377 (9,785) (9,270) 1,257 12,789 (126) (8,047) 3,673 2,449 Net cash used for investing activities 1,228 (4,589) (7,060) – 26 – Cash flows from financing activities Proceeds from exercising stock options Proceeds of bank loans Repayment of bank loans Dividends paid Years Ended August 31 2003 2004 2002 3,156 23,922 (29,785) (4,284) 555 33,169 529 43,597 (31,697) (35,627) (2,482) (7,059) Net cash provided by (used for) financing activities (6,991) (455) 1,440 Net increase in cash and cash investments 7,947 6,212 3,915 Cash and cash investments At beginning of year 16,252 10,140 6,225 At end of year $ 24,299 $ 16,352 $ 10,140 Supplemental disclosures of cash flow information Cash paid for interest, net of amount capitalized $ 1,518 $ 1,767 $ 2,124 Cash paid for income taxes, including related interest (note 11) $ 1,370 $ 1,060 $ 943 1,802 $ 1,945 $ (1,925) $ $ 552 $ (622) 700 $ 515 Noncash investing activities Fair value adjustments to securities available for sale Income tax effect related to fair value adjustment $ $ 1,234 Reclassification of breeding herd to property and equipment $ 1,599 See accompanying notes to consolidated financial statements. – 27 – Notes to Consolidated Financial Statements Years Ended August 31, 2004, 2003 and 2002 Note 1. Summary of Significant Accounting Policies Basis of Consolidated Financial Statement Presentation. The consolidated financial statements include the accounts of Alico, Inc. (the Company) and its wholly owned subsidiaries, Saddlebag Lake Resorts, Inc. (Saddlebag), Agri- Insurance Company, Ltd. (Agri), and Alico-Agri, Ltd. after elimination of all significant inter-company balances and transactions. Revenue Recognition. Income from the sale of citrus is recognized at the time the crop is harvested. Based on fruit buyers’ and processors’ advances to growers, stated cash and futures markets combined with experience in the indus- try, management reviews the reasonableness of the citrus revenue accrual. Adjustments are made throughout the year to these estimates as relevant information regarding the citrus market becomes available. Differences between the estimates and the final realization of revenues can be significant, and the differences between estimated and final results can be either positive or negative. Fluctuation in the market prices for citrus fruit has caused the Company to recognize additional revenue from prior years’ crop totaling $728 thousand, $198 thousand, and $568 thousand during fiscal 2004, 2003, and 2002, respectively. Income from sugarcane under a pooled agreement is recognized at the time the crop is harvested. Based on the processor’s advance payment, past sugarcane prices and its experience in the industry, management reviews the reasonableness of the sugarcane revenue accrual. Adjustments are made as additional relevant information regarding the sugar market becomes available. Market price increases to the sugar pool have caused the Company to recognize additional revenue from the prior year’s crop totaling $325 thousand, $356 thousand and $318 thousand during the fiscal year’s 2004, 2003, and 2002, respectively. The Company recognizes revenue from cattle sales at the time the cattle are sold. Real Estate. Real estate sales are recorded under the accrual method of accounting. Residential retail land sales made through Saddlebag are not recognized until the buyer’s initial investment or cumulative payments of principal and interest equal or exceed 10 percent of the contract sales price. Commercial or bulk land sales, made mostly through Alico-Agri, Ltd. are not recognized until payments received for property to be developed within two years after the sale equal 20%, or property to be developed after two years equal 25%, of the contract sales price. Profits from commercial real estate sales are discounted to reflect the market rate of interest where the stated rate is less than the market rate. The recorded valuation discounts are realized as the balances due are collected. Tangible assets that are purchased during the period to aid in the sale of the project as well as costs for services performed to obtain regulatory approval of the sales are capitalized as land and land improvements to the extent they are estimated to be recoverable from the sale of the property. Land and land improvement costs are allocated to individual parcels on a per lot basis using the relative sales value method. The Company has entered into an agreement with a real estate consultant to assist in obtaining the necessary regulatory approvals for the development and marketing of a tract of raw land. The marketing costs under this agreement are being – 28 – expensed as incurred. The costs incurred to obtain the necessary regulatory approvals are capitalized into land costs when paid. These costs will be expensed as cost of sales when the underlying real estate is sold. Marketable Securities Available for Sale. Marketable securities available for sale are carried at their estimated fair value. Net unrealized investment gains and losses are recorded net of related deferred taxes in accumulated other comprehensive income within stockholders’ equity until realized. Fair value for debt and equity investments is based on quoted market prices at the reporting date for those or similar investments. The cost of all marketable securities available for sale is determined on the specific identification method. Inventories. The costs of growing crops are capitalized into inventory until the time of harvest. Once a given crop is harvested, the related inventoried costs are recognized as a cost of sale to provide an appropriate matching of costs incurred with the related revenue earned. Beef cattle inventories are stated at the lower of cost or net realizable value. The cost of the beef cattle inventory is based on the accumulated cost of developing such animals for sale. Unharvested crops are stated at the lower of cost or net realizable value. The cost for unharvested crops is based on accumulated production costs incurred during the eight-month period from January 1 through August 31. Property, Buildings and Equipment. Property, buildings and equipment are stated at cost. Properties acquired from the Company’s predecessor corporation in exchange for common stock issued in 1960, at the inception of the Company, are stated on the basis of cost to the predecessor corporation. Property acquired as part of a land exchange trust, is valued at the carrying value of the property transferred to the trust. All costs related to the development of citrus groves, through planting, are capitalized. Such costs include land clearing, excavation and construction of ditches, dikes, roads, and reservoirs, etc. After the planting, caretaking costs or pre-productive maintenance costs are capitalized for four years. After four years, a grove is considered to have reached maturity and the accumulated costs, except for land excavation become the depreciable basis of a grove and are written off over 25 years. Development costs for sugarcane are capitalized the same as citrus. However, sugarcane matures in one year and the Company is able to harvest an average of 3 crops (1 per year) from one planting. As a result, cultivation/caretaking costs are expensed as the crop is harvested, while the appropriate development and planting costs are depreciated over three years. The breeding herd consists of purchased animals and animals raised on the ranch. Purchased animals are stated at cost. The cost of animals raised on the ranch is based on the accumulated cost of developing such animals for productive use. Depreciation for financial reporting purposes is computed on straight-line or accelerated methods over the estimated useful lives of the various classes of depreciable assets. The Company accounts for long-lived assets in accordance with the provisions of SFAS No. 144, “Accounting for the Impairment or disposal of Long-Lived Assets”. This Statement requires long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets – 29 – exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Land Inventories. Land inventories are carried at cost and consist of property located in Lee County, Florida and owned by Alico-Agri, Ltd., and residential lots in Polk County, Florida and owned by Saddlebag. The Lee County property is held for sale as commercial real estate. Land inventory is considered current if sales contracts are expected to close within one year of the balance sheet date. Other Investments. Other investments are carried at cost. These primarily include stock owned in agricultural coopera- tives. The Company uses cooperatives to process and sell sugarcane and citrus. Cooperatives typically require members to acquire ownership as a term of use of its services. In September 2004, the Company purchased the assets of La Belle Plant World, Inc. a wholesale grower and shipper of commercial fruit and vegetable transplants. Prior to the closing, the Company paid refundable costs in connection with the purchase. These costs have been included in the balance sheet as other investments. Income Taxes. The Company accounts for income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Net Earnings Per Share. Outstanding stock options issued by the Company represent the only dilutive effect reflected in the computation of weighted average shares outstanding assuming dilution. Options do not impact the numerator of the earnings per share computation. There were no stock options issued that could potentially dilute basic earnings per share in the future that were not included in the computation of earnings per share assuming dilution. Cash Flows. For purposes of the cash flows, cash and cash investments include cash on hand and amounts due from financial institutions with an original maturity of less than three months. Use of Estimates. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities. Actual results could differ significantly from those estimates. Although some variability is inherent in these estimates, management believes that the amounts provided are adequate. The valuation of the Company’s inventories and the recognition of citrus and sugarcane rev- enues are two of the more significant estimates made by Management. Financial Instruments and Accruals. The carrying amounts in the consolidated balance sheets for accounts receivable, mortgage and notes receivable, accounts payable and accrued expenses approximate fair value, because of the imme- diate or short term maturity of these items. The carrying amounts reported for the Company’s long-term debts approxi- mate fair value because they are transactions with commercial lenders at interest rates that vary with market conditions and fixed rates that approximate market. Derivative and Hedging Instruments. The Company engages in cattle futures trading activities for the purpose of economically hedging against price fluctuations. The Company records gains and losses related to these cattle hedges in costs of goods sold. At August 31, 2004 and 2003, the Company had no open positions in cattle futures. The – 30 – Company also purchases corn futures in order to lock in the cost of raising feeder cattle over the feeding term. The Company had open positions in 30 corn futures contracts at August 31, 2004. The Company, through its investment portfolio, also may hedge using options or short sales. These transactions are recorded as interest and investment revenue. Accumulated Other Comprehensive Income. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. It includes both net income and other comprehensive income. Items included in other comprehensive income are classified based on their nature. The total of other comprehensive income for a period has been transferred to an equity account and displayed as “accumulated other comprehensive income”. Stock-Based Compensation. The Company applies Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25) for stock options and other stock-based awards while disclosing pro forma net income and net income per share as if the fair value method had been applied in accordance with Statement of Financial Accounting Standards No. 123,” Accounting for Stockbased Compensation” (SFAS 123) and amended by Statement of Financial Accounting Standards No. 148 (SFAS 148) “Accounting for Stock-Based Compensation - Transition and Disclosure”. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based em- ployee compensation: Net income as reported $17,813 $12,659 $ 7,535 Years ended August 31 2003 2002 2004 Add: Total stock-based employee compensation expense determined under the intrinsic value based method for all awards, net of related tax effects Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects Pro forma net income Earnings per share Basic - as reported Basic - pro forma Diluted - as reported Diluted - pro forma 1,100 523 556 (1,063) (529) (484) $17,850 $12,653 $ 7,607 $2.47 $2.47 $2.44 $2.45 $1.78 $1.78 $1.74 $1.74 $1.07 $1.08 $1.05 $1.06 Reportable Segments. The Company has three reportable segments: citrus, sugarcane, and ranch. The citrus segment produces fruit for both the fresh fruit and processed juice markets. The sugarcane segment produces sugarcane for processing. The ranch segment raises beef cattle to be sold in the wholesale market. The Company’s reportable seg- ments are strategic business units that offer different products. They are managed separately because each business requires different operating strategies. Reclassifications. Certain amounts from 2003 and 2002 have been reclassified to conform to the 2004 presentation. – 31 – Major customers. Alico is a producer of agricultural commodities. Due to the limited number of processors of its raw product, geographic limitations and historic success, the Company’s citrus and sugarcane sales are concentrated to a few customers. Details concerning the sales and receivables from these customers are as follows for the years ended August 31: Accounts receivable 2003 2004 2002 2004 Revenues 2003 2002 Citrus fruit marketer $ 5,437 $ 6,470 $ 6,457 $18,385 $17,656 $19,103 Sugar cane processor $ 2,887 $ 2,404 $ 2,083 $12,398 $13,373 $11,789 Note 2. Marketable Securities Available for Sale The Company has classified 100% of its investments in marketable securities as available for sale and, as such, the securities are carried at estimated fair value. Any unrealized gains and losses, net of related deferred taxes, are recorded as a net amount in a separate component of stockholders’ equity until realized. The cost and estimated fair values of marketable securities available for sale at August 31, 2004 and 2003 (in thousands) were as follows: 2004 Gross Gross 2003 Gross Gross Cost Unrealized Unrealized Gains Losses Estimated Fair Value Cost Unrealized Unrealized Gains Losses Estimated Fair Value $ 1,513 $ 6,307 22,418 82 494 2,579 $ (3) $ 1,592 6,266 24,563 (535) (434) $ 2,504 $ 1,893 10,181 85 221 1,801 $ (65) $ 2,524 1,808 11,982 (306) - 30,238 3,155 (972) 32,421 14,578 2,107 (371) 16,314 Equity securities: Preferred stocks Common stocks Mutual funds* Total equity securities Debt securities: 3,225 Municipal bonds 3,628 Mutual funds Fixed maturity funds 2,581 13,726 Corporate bonds 74 81 - 30 (10) (78) (29) (79) 3,289 3,631 2,552 13,677 Total debt securities 23,160 185 (196) 23,149 515 8,435 11,146 2,762 22,858 28 421 - 22 471 - (609) (31) (183) 543 8,247 11,115 2,601 (823) 22,506 Marketable securities available for sale 53,398 3,340 (1,168) 55,570 37,436 2,578 (1,194) 38,820 *Includes shares held by regulated investment companies as well as a limited partnership hedge fund primarily investing in marketable equity securities. – 32 – The aggregate fair value of investments in debt instruments (net of mutual funds of $3,628) as of August 31, 2004, by contractual maturity date, consisted of the following: Due in one year or less Due between one and five years Due between five and ten years Due thereafter Aggregate Fair Values (in thousands) $ 8,100 7,123 1,593 2,716 $19,532 Realized gains and losses on the disposition of securities were as follows: Realized gains Realized losses Net 2004 Years ended August 31 2003 2002 $ 815 $ 834 $ 345 (92) (143) (726) $ 723 $ 691 $ (381) Note 3. Mortgage and Notes Receivable Mortgage and notes receivable arose from real estate sales. The balances (in thousands) are as follows: Mortgage notes receivable on retail land sales Mortgage notes receivable on bulk land sales Other notes receivable Total mortgage and notes receivable Less current portion Non-current portion Maturities of the notes receivable are as follows: Due within 1 year Due between 1 and 2 years Due between 2 and 3 years Due between 3 and 4 years Due between 4 and 5 years Due beyond five years Total Years ended August 31 2003 2004 $ 265 10,290 90 10,645 9,983 $ 235 2,420 113 2,768 2,534 $ 662 $ 234 $ 9,983 87 400 31 31 113 $10,645 In December 2003, Alico-Agri received a non-interest bearing mortgage note in exchange for land sold. The note totaled $10.0 million and is due in full in December 2004. The note was discounted by $244 thousand to reflect the prevailing market rate of interest. The unamortized portion of the discount totaled $81 thousand at August 31, 2004. – 33 – Note 4. Inventories A summary of the Company’s inventories (in thousands) at August 31, 2004 and 2003 is shown below: Unharvested fruit crop on trees Unharvested sugarcane Beef cattle Sod Total inventories 2004 2003 $ 7,712 $ 8,135 5,124 7,172 764 5,159 7,892 659 $ 20,772 $ 21,845 The Company’s unharvested sugarcane and cattle are partially uninsured. During August and September of 2004 a series of three hurricanes struck a portion of the Company’s citrus groves in Polk County Florida. The resulting damage compelled the Company to write its crop inventory down $0.4 million. The amount was charged to fiscal 2004 operations. Note 5. Property, Buildings and Equipment A summary of the Company’s property, building and equipment (in thousands) at August 31, 2004 and 2003 is shown below: Breeding herd Buildings Citrus trees Sugarcane Equipment and other facilities Total depreciable properties Less accumulated depreciation Net depreciable properties Land and land improvements Estimated Useful Lives 5-7 years 5-40 years 22-40 years 4-15 years 3-40 years 2004 2003 $ 13,242 $ 12,711 3,930 33,572 8,371 29,410 88,525 42,070 46,455 59,231 3,875 31,109 8,350 29,526 85,571 39,741 45,830 59,007 Net property, building and equipment $105,686 $104,837 – 34 – Note 6. Indebtedness A summary of the Company’s notes payable is provided in the following table: August 31, 2004 a) Revolving credit line b) Revolving credit line c) Demand note d) Credit line e) Mortgage note payable Other Total August 31, 2003 a) Revolving credit line b) Revolving credit line c) Demand note d) Credit line e) Mortgage note payable Other Total Principal Balance $18,248 15,000 Additional Credit Available Interest Rate* Collateral $7,752 Libor +1% Unsecured – Libor +.8% Unsecured – 3,000 Libor +1% Unsecured 6,000 12,139 198 – – – 5.80% 6.68% 7.00% Unsecured Real estate Real estate $51,585 $10,752 Principal Balance $20,791 15,000 Additional Credit Available Interest Rate* Collateral $5,209 Libor +1% Unsecured – Libor +.8% Unsecured – 3,000 Libor +1% Unsecured 8,000 13,406 251 – – – 5.80% 6.68% 7.00% Unsecured Real estate Secured $57,448 $8,209 a) Line of credit with commercial bank, due in full January 2006. Interest due quarterly. b) Line of credit with commercial lender, renews annually. Subject to review June 2005. Interest due quarterly. c) Working capital loan with commercial bank due on demand. Interest due quarterly. d) 5-year fixed rate term loan with commercial lender. $2 million principal due annually. Interest due quarterly. e) First mortgage on 7,680 acres of cane, citrus, pasture and improvements in Hendry County, Florida with commercial lender. Monthly principal payments of $106 thousand plus accrued interest. Maturities of the Company’s debt is as follows: Due within 1 year Due between 1 and 2 years Due between 2 and 3 years Due between 3 and 4 years Due between 4 and 5 years Due beyond five years Total August 31 2004 $ 3,319 36,560 3,315 1,318 1,267 5,806 2003 $ 3,321 36,264 3,312 3,315 1,318 9,918 $51,585 $57,448 LIBOR was 1.79% and 1.14% at August 31, 2004 and 2003, respectively. The Company’s variable interest rates, based on LIBOR at August 31, 2004 and 2003 was 2.79%, 2.59% and 2.14%, respectively. – 35 – Interest costs expensed and capitalized (in thousands) during the three years ended August 31, 2004, 2003 and 2002 was as follows: Interest expense Interest capitalized Total interest cost 2004 2003 2002 $ 1,825 $ 2,081 $ 2,421 275 267 322 $ 2,100 $ 2,348 $ 2,743 The Company renewed its $26 million line of credit in accordance with the “evergreen” provision in the original loan agreement during November 2004, which extends the due date from January 31, 2005 to January 31, 2006. Accord- ingly, the Company has classified obligations under this agreement as non-current. Since the inception of the original note, Management and the bank, as a matter of routine, have agreed to exercise this provision. Note 7. Commitments and Contingencies The Company is involved in various claims and legal actions arising in the ordinary course of business. Additionally, the Company, through Agri, supplies catastrophic business interruption coverage for Tri-County, LLC a subsidiary of Atlan- tic Blue Trust, Inc., the holder of approximately 47.7% of the Company’s common stock. Total coverage under the policy is $2.7 million. This represents the only underwriting exposure at August 31, 2004. In August and September 2004, a series of three hurricanes struck southwest Florida. The current estimate of the State’s crop loss is approxi- mately 27%. Due to the extensive damages incurred throughout the state, a final assessment of damages has not yet been completed. The Company does expect a claim to be filed; however, the amount of the claim is not yet determin- able. Total potential exposure under the policy for this claim is $900 thousand. Premiums for coverages quoted are set by independent actuaries/underwriters hired by Agri in Bermuda based on underwriting considerations established by them. Premiums vary depending upon the size of the property, its age and revenue-producing history as well as the proximity of the insured property to known disease-prone areas or other insured hazards. Agri is required to maintain liquidity equal to its outside underwriting risk. As of August 31, 2004, Agri’s liquidity was sufficient to cover its underwriting risk. Notwithstanding the undetermined hurricane loss discussed above, in the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company’s consolidated financial position, results of operation or liquidity. Note 8. Other non-current liability Alico formed a wholly owned insurance subsidiary, Agri Insurance Company, Ltd. (Bermuda) (“Agri”) in June of 2000. Agri was formed in response to the lack of insurance availability, both in the traditional commercial insurance markets and governmental sponsored insurance programs, suitable to provide coverages for the increasing number and poten- tial severity of agricultural related events. Such events include citrus canker, crop diseases, livestock related maladies and weather. Alico’s goal included not only prefunding its potential exposures related to the aforementioned events, but also to attempt to attract new underwriting capital if it is successful in profitably underwriting its own potential risks as well as similar risks of its historic business partners. Alico capitalized Agri by contributing real estate located in Lee County, Florida. The real estate was transferred at its historical cost basis. Agri received a determination letter from the Internal Revenue Service (IRS) stating that Agri was exempt from taxation provided that net premium levels, consisting only of premiums with third parties, were below an annual stated level ($350 thousand). Third party premiums have remained below the stated annual level. As the Lee County real estate was sold, substantial gains were generated in Agri, creating permanent book/tax differences. – 36 – Since receiving the favorable IRS determination letter, certain transactions, entered into by other taxpayers under the same IRS Code Section came under scrutiny and criticism by the news media. In reaction, Management has recorded a contingent liability of $17.0 million at August 31, 2004 and $9.6 million at August 31, 2003 for income taxes in the event of an IRS challenge. Management’s decision has been influenced by perceived changes in the regulatory environment. The Company believes that it can successfully defend any such challenge, however, because it is probable that a challenge will be made and possible that it may be successful, Management has provided for the contingency. The IRS is in the process of examining the Company tax returns for the fiscal years ended August 31, 2003, 2002, 2001 and 2000, and Agri tax returns for calendar years 2002, 2001 and 2000. Any adjustments resulting from the examination will be currently due and payable. A Revenue Agent has issued a report challenging Agri’s tax exempt status for the years examined, however, the report did not quantify the adjustment proposed. Quantification of the adjustment is expected when the IRS concludes its audits of Alico. No adjustments have been proposed to date for Alico. The Revenue Agent’s findings regarding Alico could occur within the next fiscal year. Note 9. Stock Option Plan On November 3, 1998, the Company adopted the Alico, Inc., Incentive Equity Plan (The Plan) pursuant to which the Board of Directors of the Company may grant options, stock appreciation rights, and/or restricted stock to certain directors and employees. The Plan authorizes grants of shares or options to purchase up to 650,000 shares of autho- rized but unissued common stock. Stock options granted have a strike price and vesting schedules that are at the discretion of the Board of Directors and determined on the effective date of the grant. The strike price cannot be less than 50% of the market price. The Company applies APB Opinion No. 25 for issuances to directors and employees in accounting for its plan. All stock options have been granted to directors or employees with an exercise price equal to at least 55% of the fair value of the common stock at the date of grant and a vesting period of one year. Balance outstanding, August 31, 2001 Granted Exercised Balance outstanding, August 31, 2002 Granted Exercised Balance outstanding, August 31, 2003 Granted Exercised Balance outstanding, August 31, 2004 Shares under option 84,080 69,598 35,831 117,847 67,280 35,726 149,401 119,462 193,237 75,626 Weighted average exercise price $14.62 15.68 14.76 15.20 15.68 15.53 15.34 18.18 16.33 $17.29 Weighted average remaining contractual life (in years) 7 7 9 9 On August 31, 2004 and 2003, there were 292,844 and 412,356 shares available for grant, respectively. All stock options outstanding were exercisable at August 31, 2004. – 37 – Stock options granted and compensation recognized were as follows: Compensation recognized under APB 25 (thousands) $ 7 18 86 891 839 821 Options Granted Exercise Price Market Price at time of grant Grant date April 6, 1999 September 9, 1999 September 12, 2000 September 11, 2001 September 10, 2002 September 9, 2003 February 3, 2004 34,750 14,992 51,074 69,598 67,280 65,081 54,381 $ 14.62 $ 14.83 14.62 14.62 15.68 15.68 15.68 15.81 16.31 28.48 28.15 28.30 $ 21.17 $ 38.49 $ 942 The fair value of stock options granted was $1.7 million in 2004, $.8 million in 2003 and $.8 million in 2002 on the date of the grant using the Black Scholes option-pricing model with the following weighted average assumptions: Volatility Dividend paid Risk-free interest rate Expected life in years Note 10. Employee Benefit Plans 2004 8.28% 1.87% 2.26% 1 2003 8.39% 2.23% 4.75% 1 2002 8.39% 6.38% 4.75% 1 The Company has a profit sharing plan covering substantially all employees. The plan was established under Internal Revenue Code Section 401(k). Contributions made to the profit sharing plan (in thousands) were $434, $350 and $285 for the years ended August 31, 2004, 2003 and 2002, respectively. Additionally, the Company has a nonqualified defined benefit retirement plan covering the officers and other key management personnel of the Company. Details concerning this plan are as follows: Beginning benefit obligation Service cost Interest cost Benefits paid Actuarial losses Other Ending benefit obligation Changes in plan assets Beginning plan assets Return on plan assets Employer contributions Plan participant contributions Benefit paid Ending plan assets 2004 2003 $ 4,515 $ 3,785 135 150 (338) – 2 626 234 (132) – 2 4,464 4,515 3,797 126 1,200 115 (338) 4,900 3,666 109 39 115 (132) 3,797 Net pension liability (asset) $ (436) $ 718 – 38 – Components of net pension cost Service cost, net of participant contributions $ Interest cost Expected return on plan assets Prior service cost amortization 2004 Years ended August 31 2003 2002 20 275 (334) 2 $ 511 234 – 2 $ 301 185 – 2 Net pension cost for defined benefit plan $ (37) $ 747 $ 488 The net benefit obligation was computed using a discount rate of 6.25%. Note 11. Income Taxes The provision for income taxes (in thousands) for the years ended August 31, 2004, 2003 and 2002 is summarized as follows: Current: Federal income tax State income tax Deferred: Federal income tax State income tax 2004 2003 2002 $ 8,733 $ 5,872 $ 3,713 933 9,666 290 31 321 628 6,500 (68) (7) (75) 396 4,109 (1,673) (178) (1,851) Total provision for income taxes $ 9,987 $ 6,425 $ 2,258 Following is a reconciliation of the expected income tax expense computed at the U.S. Federal statutory rate of 34% and the actual income tax provision (in thousands) for the years ended August 31, 2004, 2003 and 2002: Expected income tax Increase (decrease) resulting from: State income taxes, net of federal benefit Nontaxable interest and dividends Internal Revenue Service examinations Income from Agri-Insurance Company, Ltd. Stock options exercised Other reconciling items, net 2004 2003 2002 $ 9,452 $ 6,489 $ 3,330 636 (93) 11 – (675) 656 410 (97) 14 (752) 30 331 144 (102) 11 (1,156) 27 4 Total provision for income taxes $ 9,987 $ 6,425 $ 2,258 Some items of revenue and expense included in the statement of operations may not be currently taxable or deductible on the income tax returns. Therefore, income tax assets and liabilities are divided into a current portion, which is the amount attributable to the current year’s tax return, and a deferred portion, which is the amount attributable to another year’s tax return. The revenue and expense items not currently taxable or deductible are called temporary differences. – 39 – The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below (in thousands): Deferred Tax Assets: Contribution carry forward Deferred retirement benefits Prepaid sales commissions Land inventories Stock options appreciation IRS adjustments Other 2004 2003 $ (1,514) $ (1,632) (1,144) (352) (488) (492) (820) (586) (932) (802) (488) (352) (514) (390) Total gross deferred tax assets (5,396) (5,110) Deferred Tax Liabilities: Revenue recognized from citrus and sugarcane Property and equipment (principally due to depreciation and soil and water deductions) Inventories Deferred real estate gains Unrealized security gains Other Total gross deferred tax liabilities Net deferred income tax liabilities 432 607 13,140 1,315 1,625 643 62 12,981 1,205 1,625 – 40 17,217 16,458 $11,821 $11,348 Based on the Company’s history of taxable earnings and its expectations for the future, management has determined that its taxable income will more likely than not be sufficient to fully recognize all deferred tax assets. Agri Insurance Company, Ltd. (Agri), a wholly owned insurance company subsidiary of Alico, is treated as a U.S. taxpayer, pursuant to an election under Internal Revenue Code Section 953 (d), for all purposes except for consolidat- ing an operating loss by virtue of the dual consolidated loss rules. (Dual consolidated losses prevent operating losses (not capital losses) from occurring in insurance companies domiciled outside of the United States from offsetting operating income irrespective of the fact that the insurance company is a member of the consolidated return group.) Agri was established to provide agricultural insurance that falls outside of the Federal Crop Insurance Program, for catastrophic perils. Agri was domiciled in Bermuda because it offers easy access to reinsurance markets. Agri issued its initial policy in August 2000 to a third party. Agri’s ability to underwrite insurance risks has been limited to its operational liquidity, by the Registrar of Companies in Bermuda. Agri will be able to underwrite additional insurance as its liquidity is increased from additional asset sales and as payments are received on prior sales. For Federal income tax purposes, only premiums received by Agri from policies of insurance issued to parties other than its parent, Alico, are considered insurance premiums. The preceding limiting factors resulted in Agri not incurring a tax liability on underwriting profits or investment income. Agri’s tax status resulted in it filing its Federal tax return on a stand alone basis for the calendar year periods ending December 31, 2003, 2002, 2001 and 2000. The IRS is in the process of examining the Company tax returns for the fiscal years ended August 31, 2003, 2002, 2001 and 2000, and Agri tax returns for calendar years 2002, 2001 and 2000. Any adjustments resulting from the – 40 – examination will be currently due and payable. A Revenue Agent has issued a report challenging Agri’s tax exempt status for the years examined, however, the report did not quantify the adjustment proposed. Quantification of the adjustment is expected when the IRS concludes its audits of Alico. No adjustments have been proposed to date for Alico. The Revenue Agent’s findings regarding Alico could occur within the next fiscal year. Note 12. Related Party Transactions Citrus. Citrus revenues of $18.4 million, $17.7 million and $19.1 million were recognized for a portion of citrus crops sold under a marketing agreement with Ben Hill Griffin, Inc. (Griffin) for the years ended August 31, 2004, 2003 and 2002, respectively. Griffin and its subsidiaries was the owner of approximately 49.85 percent of the Company’s common stock prior to February 26, 2004. Accounts receivable, resulting from citrus sales, include amounts due from Griffin totaling $5.4 million at August 31, 2004 and $6.5 million at August 31, 2003. These amounts represent estimated revenues to be received periodically under pooling agreements as sale of pooled products is completed. Harvesting, marketing, and processing costs, related to the citrus sales noted above, totaled $7.2 million, $6.6 million, and $7.1 million for the years ended August 31, 2004, 2003 and 2002, respectively. In addition, Griffin provided the harvesting services for citrus sold to unrelated processors. The aggregate cost of these services was $2.1 million; $2.1 million and $2.0 million for the years ended August 31, 2004, 2003 and 2002, respectively. The accompanying consolidated balance sheets include accounts payable to Griffin for citrus production, harvesting and processing costs in the amount of $498 thousand and $435 thousand at August 31, 2004 and 2003, respectively. Other Transactions. In fiscal 2004, Agri began providing coverage for Tri-County Grove, LLC, a subsidiary of Atlantic Blue Trust, Inc., the holder of approximately 47.7% of the Company’s common stock. The coverage term is from August 2004 to July 2005. Total coverage under the policy is $2.7 million and the premium charged was $45 thousand. Premiums for coverages quoted are set by independent actuaries/underwriters hired by Agri in Bermuda based on underwriting considerations established by them. Premiums vary depending upon the size of the property, its age and revenue-producing history as well as the proximity of the insured property to known disease-prone areas or other insured hazards. The Company purchased fertilizer and other miscellaneous supplies, services, and operating equipment from Griffin, on a competitive bid basis, for use in its cattle, sugarcane, sod and citrus operations. Such purchases totaled $5.3 million; $6.4 million and $6.2 million during the years ended August 31, 2004, 2003 and 2002, respectively. Griffin purchased catastrophic business interruption coverage from Agri during fiscal 2003 and 2002. The total coverage under the policy was $3.5 million and $3.2 million for the fiscal years 2003 and 2002, respectively. The premiums charged under this policy were $138 thousand and $128 thousand for 2003 and 2002, respectively. Note 13. Future Application of Accounting Standards In November 2003, the EITF reached a consensus on Issue No. 03-1, “The Meaning of Other-Than-Temporary Impair- ment and Its Application to Certain Investments.” EITF Issue No. 03-1 provides guidance on other-than-temporary impairment and its application to debt and equity investments. The requirements apply to investments in debt and marketable equity securities that are accounted for under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” The provisions of Issue No. 03-1 are effective for reporting periods beginning after June 15, 2004. To determine whether an investment is other than temporarily impaired, the statement requires the Company to evaluate, among other factors, the duration and extent to which the fair value of an investment is less than its cost; – 41 – the financial health of and business outlook for the investment, including factors such as industry and sector perfor- mance; changes in technology, operational and financing cash flow; the investment’s financial position, including its appraisal and net asset value; market prices; and the Company’s intent and ability to hold the investment. In the opinion of management, the adoption of this statement will not have a significant impact on the Company’s consoli- dated financial statements. Note 14. Reportable Segment Information The Company is primarily engaged in agricultural operations, which are subject to risk, including market prices, weather conditions and environmental concerns. The Company is also engaged in retail land sales and, from time to time, sells real estate considered surplus to its operating needs. Information about the Company’s reportable segments (in thousands) for the years ended August 31, 2004, 2003 and 2002 is summarized as follows: 2004 2003 2002 Revenues Agriculture: Citrus Sugarcane Ranch Total revenues from external customers for reportable segments Other revenues from external customers $ 24,549 $ 24,107 $ 25,105 12,398 9,678 46,625 5,432 13,373 7,175 44,655 3,630 11,789 9,102 45,996 3,189 Total operating revenue $ 52,057 $ 48,285 $ 49,185 Costs of sales Citrus Sugarcane Ranch Total costs of sales for reportable segments Other costs of sales $ 20,815 $ 20,106 $ 21,421 9,673 8,178 38,666 253 10,188 6,790 37,084 179 9,457 8,515 39,393 114 Total consolidated costs of sales $ 38,919 $ 37,263 $ 39,507 Gross profit Agriculture: Citrus Sugarcane Ranch Total profit for reportable segments Other gross profit $ 3,734 $ 4,001 $ 3,684 2,725 1,500 7,959 5,179 3,185 385 7,571 3,451 2,332 587 6,603 3,075 9,678 Consolidated gross profit 13,138 11,022 Unallocated amounts: Profit on sale of bulk real estate Other corporate expense Income before income taxes 20,311 (5,649) 14,994 (6,932) 11,641 (11,526) $ 27,800 $ 19,084 $ 9,793 – 42 – Capital expenditures Agriculture: Citrus Sugarcane Ranch Total agriculture capital expenditures for reportable segments Other capital expenditures Cattle transferred from inventory held for sale into breeding stock 2004 2003 2002 $ 2,872 $ 3,216 $ 4,704 1,804 2,218 6,894 985 1,451 2,245 6,912 1,113 1,293 3,240 9,237 548 (599) (700) (515) Total consolidated capital expenditures $ 7,280 $ 7,325 $ 9,270 Depreciation, depletion and amortization Agriculture: Citrus Sugarcane Ranch Total depreciation, depletion and amortization for reportable segments Other depreciation, depletion, and amortization $ 2,361 $ 2,354 $ 2,394 2,220 1,429 6,010 499 2,414 1,474 6,242 481 2,527 1,573 6,494 488 Total consolidated depreciation, depletion and amortization $ 6,509 $ 6,723 $ 6,982 Assets Agriculture: Citrus Sugarcane Ranch Total assets for reportable segments Other assets Total consolidated assets $ 54,120 $ 54,549 $ 53,876 51,640 22,012 127,772 110,470 52,283 22,430 129,262 87,283 52,015 21,920 127,811 64,099 $ 238,242 $ 216,545 $ 191,910 Identifiable assets represent assets on hand at year-end that are allocable to a particular segment either by their direct use or by allocation when used jointly by two or more segments. Other assets consist principally of cash, temporary investments, mortgage notes receivable, bulk land inventories, and property and equipment used in general corporate business. – 43 – – 44 –