U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(X) QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended September 30, 2002
( ) TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from to
Commission File No. 0-32331
SURETY HOLDINGS CORP.
-----------------------------------------------------------
(Name of Small Business Issuer in its Charter)
Delaware 52-2229054
---------------------------------- -----------------------------
State of other jurisdiction of (IRS Employer
incorporation or organization Identification No.)
850 Fort Plains Road
Howell, New Jersey 07731
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(Address of Principal Executive Offices)
Registrant's telephone number including area code 732-886-0706
------------
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15 (d) of the Exchange Act during the past 12 months (or for
such shorter period that the Registrant was required to file such reports,
and (2) has been subject to such filing requirements for the past 90 days.
(1) YES X NO (1) YES X NO
---- ---- ---- ----
State the number of shares outstanding of each of the Registrant's classes
of common equity, as of the latest applicable date:
6,738,000 - - November 14, 2002
SURETY HOLDINGS CORP. AND SUBSIDIARY
INDEX
PAGE
----
Part I - Financial Information
Item 1 - Condensed Consolidated Financial Statements (unaudited)
Balance Sheet as of September 30, 2002 1
Statements of Income for the nine and three months
ended September 30, 2002 and 2001 2
Statements of Cash Flows for the nine months ended September
30, 2002 and 2001 3
Notes to Financial Statements 4-8
Item 2 - Management's Discussion and Analysis or Plan of Operation 9-16
Item 3 - Evaluation of Disclosure Controls and Procedures 17
Part II - Other Information
Item 1 - Legal Proceedings 17
Item 2 - Change in Securities 17
Item 3 - Defaults Upon Senior Securities 17
Item 4 - Submission of Matters to a Vote of Security Holders 17
Item 5 - Other Information 17
Item 6 - Exhibits and Reports on Form 8-K 17
SIGNATURE 18
CERTIFICATIONS 19-22
SURETY HOLDINGS CORP. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 2002
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash $ 10,046,000
Real estate held for sale, current 2,950,000
Other current assets 164,000
--------------
Total current assets 13,160,000
NOTES RECEIVABLE, less current maturities 1,487,000
NOTE RECEIVABLE, officer 570,000
REAL ESTATE HELD FOR SALE 35,768,000
NOTES RECEIVABLE AND ACCRUED INTEREST,
MARINE FOREST RESORT, INC., net of a $7.2
million allowance for loan losses 3,814,000
REAL ESTATE DEVELOPMENT COSTS 37,721,000
PROPERTY AND EQUIPMENT, net of accumulated depreciation
and amortization of $1,908,000 2,612,000
DEFERRED TAX ASSET 3,512,000
--------------
$ 98,644,000
==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Notes payable, current maturity $ 30,000
Notes payable, president 7,000
Accounts payable 419,000
Accrued expenses and other current liabilities 140,000
Income taxes payable 400,000
--------------
Total current liabilities 996,000
--------------
LONG-TERM LIABILITIES,
Notes payable, less current maturity 413,000
--------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock, $.001 par value,
200,000,000 shares authorized,
6,738,000 shares issued and
outstanding 7,000
Capital in excess of par value 101,678,000
Accumulated deficit (4,450,000)
--------------
Total stockholders' equity 97,235,000
--------------
$ 98,644,000
==============
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
1
SURETY HOLDINGS CORP. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
NINE AND THREE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, THREE MONTHS ENDED SEPTEMBER 30,
2002 2001 2002 2001
----------- ----------- ----------- -----------
REVENUES $ 3,386,000 $ 2,470,000 $ 1,593,000 $ 1,131,000
COST OF REVENUES 1,254,000 986,000 605,000 438,000
----------- ----------- ----------- -----------
GROSS PROFIT 2,132,000 1,484,000 988,000 693,000
GENERAL AND ADMINISTRATIVE
EXPENSES 1,215,000 997,000 440,000 256,000
----------- ----------- ----------- -----------
INCOME FROM OPERATIONS 917,000 487,000 548,000 437,000
----------- ----------- ----------- -----------
OTHER INCOME (EXPENSE)
Interest income 240,000 979,000 103,000 325,000
Interest expense (106,000) (47,000) (8,000) (19,000)
----------- ----------- ----------- -----------
134,000 932,000 95,000 306,000
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES 1,051,000 1,419,000 643,000 743,000
INCOME TAXES (411,000) (562,000) (246,000) (168,000)
----------- ----------- ----------- -----------
NET INCOME $ 640,000 $ 857,000 $ 397,000 $ 575,000
=========== =========== =========== ===========
NET INCOME PER COMMON
SHARE, basic and diluted $ 0.09 $ 0.13 $ 0.06 $ 0.09
=========== =========== =========== ===========
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING, basic and diluted 6,738,000 6,738,000 6,738,000 6,738,000
=========== =========== =========== ===========
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
2
SURETY HOLDINGS CORP. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
(UNAUDITED)
2002 2001
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 640,000 $ 857,000
Adjustments to reconcile net income
to net cash used in operating activities:
Depreciation and amortization 112,000 121,000
Deferred income taxes 8,000 540,000
Accrued interest receivable, Marine Forest Resorts, Inc. (730,000)
Gain on sales of property (2,148,000) (1,403,000)
Loss (gain) on disposition of property 12,000 (7,000)
Loss on sale of notes receivable 75,000
Increase (decrease) in cash
attributable to changes in operating
assets and liabilities:
Other current assets (22,000) (188,000)
Accounts payable (19,000) 101,000
Accrued expenses and other
current liabilities 16,000 (161,000)
Income taxes payable 400,000 28,000
------------ ------------
NET CASH USED IN OPERATING ACTIVITIES (926,000) (842,000)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (105,000) (219,000)
Proceeds from sales of property 2,686,000 1,144,000
Real estate development expenditures (1,944,000) (2,160,000)
Proceeds from repayments of notes receivable 819,000 963,000
Proceeds from repayments of note receivable, officer 5,000
Advances to Marine Forest Resort, Inc. (1,950,000)
------------ ------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 1,461,000 (2,222,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on notes payable (22,000) (509,000)
Proceeds from bank line of credit 1,000,000
Proceeds from notes payable, president 165,000
Repayments of notes payable, president (375,000)
------------ ------------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (397,000) 656,000
------------ ------------
NET INCREASE (DECREASE) IN CASH 138,000 (2,408,000)
CASH
Beginning of period 9,908,000 10,147,000
------------ ------------
End of period $ 10,046,000 $ 7,739,000
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND
FINANCING ACTIVITY, issuance of notes receivable to officer
upon sale of property and leasehold improvements $ 575,000 $ --
============ ============
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
3
SURETY HOLDINGS CORP. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS
Surety Holdings Corp. ("Surety") and its wholly-owned subsidiary, Surety Kohala
Corporation ("Kohala") (collectively, the "Company") is primarily engaged in the
development of a property on 642 acres of land in the North Kohala district of
Hawaii Island in the state of Hawaii. This development, referred to as the
Kohala Preserve (f/n/a Mahukona development project) (see Note 3), was initially
slated to be a hotel, 18-hole golf course and resort homes. However, the Company
is exploring other avenues of development for the 642 acres most notably, an
all-inclusive fractional interest club community.
The current operations of the Company include the sale of its non-Kohala
Preserve project real estate and other ancillary activities, all of which are
not deemed to be the future of the Company's business.
2. UNAUDITED STATEMENTS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
UNAUDITED STATEMENTS
The accompanying condensed consolidated financial statements of Surety Holdings
Corp. and Subsidiary as of September 30, 2002 and for the nine and three-month
periods ended September 30, 2002 and 2001 are unaudited and reflect all
adjustments of a normal and recurring nature to present fairly the consolidated
financial position, results of operations and cash flows for the interim
periods. These unaudited condensed consolidated financial statements have been
prepared by the Company pursuant to instructions to Form 10-QSB. Pursuant to
such instructions, certain financial information and footnote disclosures
normally included in such financial statements have been omitted.
These unaudited condensed consolidated financial statements should be read in
conjunction with the consolidated audited financial statements and notes
thereto, together with management's discussion and analysis or plan of
operations, contained in the Company's Annual Report on the Form 10-KSB for the
year ended December 31, 2001. The results of operations for the nine and
three-month periods ended September 30, 2002 are not necessarily indicative of
the results that may occur for the year ending December 31, 2002.
INCOME PER COMMON SHARE
The Company complies with Statement of Financial Accounting Standards ("SFAS")
No. 128, "Earnings Per Share" which requires dual presentation of basic and
diluted earnings per share. Basic earnings per share excludes dilution and is
computed by dividing income available to common stockholders by the
weighted-average common shares outstanding for the year. Diluted earnings per
share reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock or
resulted in the issuance of common stock that then shared in the earnings of the
entity. Since the Company has no securities or other contracts to issue common
stock, basic and diluted net income per common share for the nine and
three-month periods ended September 30, 2002 and 2001 were the same.
PRINCIPLES OF CONSOLIDATION
The condensed consolidated financial statements include the accounts of Surety
and Kohala. All significant intercompany transactions and balances have been
eliminated in consolidation.
4
SURETY HOLDINGS CORP. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
3. REAL ESTATE DEVELOPMENT COSTS
At September 30, 2002, real estate development costs, attributed primarily to
the Company's Kohala Preserve, consist of the following:
Land and land acquisition costs $ 23,896,000
Planning and studies 2,670,000
Engineering and architectural 564,000
Infrastructure 6,473,000
Professional and consulting fees 2,610,000
Other 1,508,000
------------
$ 37,721,000
============
4. STOCKHOLDERS' EQUITY
In February 2002, the Company's board of directors authorized a three-for-one
stock split effected in the form of a 200 percent stock dividend which was
distributed on February 15, 2002 to stockholders of record on February 4, 2002.
Stockholders' equity has been restated to give retroactive recognition to the
stock split for all periods presented by reclassifying from capital in excess of
par value to common stock the par value of the additional shares arising from
the split. In addition, all references in the condensed consolidated financial
statements to number of shares and per share amounts have been restated.
5. COMMITMENTS AND CONTINGENCIES
The prior approvals obtained for the Kohala Preserve project are conditional;
that is, each approval is subject to various conditions of approval. Certain of
these conditions of approval contain time limits or financial compliance
requirements, which if not met, may ultimately result in legislative and/or
administrative actions to void or revoke the prior approvals. The effect of such
adverse actions would be to return the land entitlements to the former zoning,
or more appropriate zoning as determined by the County of Hawaii. The Company
believes that it has continued to maintain the prior approvals through
compliance with all applicable conditions. In the future, however, the Company
may not be able to maintain compliance with all applicable conditions.
The Company has entered into various consulting agreements for investment
banking, project development and other services.
The Company is involved in certain legal actions that arose in the normal course
of business. In the opinion of the Company's management, the resolution of these
matters will not have a material adverse effect on the condensed consolidated
financial position, results of operations or cash flows of the Company.
6. RELATED PARTY TRANSACTIONS
NOTES PAYABLE, PRESIDENT
From time to time, the Company's President advances the Company monies pursuant
to one-year 5% promissory notes. At September 30, 2002, the amount owed to the
Company's President pursuant to such notes was approximately $7,000. Related
interest expense for the nine months ended September 30, 2002 and 2001 is
approximately $7,000 and $16,000, respectively and $1,000 and $16,000, for the
three months ended September 30, 2002 and 2001, respectively.
5
SURETY HOLDINGS CORP. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
6. RELATED PARTY TRANSACTIONS (CONTINUED)
MARINE FOREST RESORT, INC. ("MARINE FOREST")
Pursuant to uncollateralized promissory notes, the Company advanced Marine
Forest, a related Japanese corporation that owns approximately 400 acres of land
in Okinawa, Japan, $9.75 million. The notes bear interest at the U.S. prime
rate, at date of issuance, plus one percent. Under their original terms, the
notes were due nine months after date of issuance. However, the notes were
extended an additional nine months and subsequently extended to December 31,
2002, as a concession to Marine Forest to advance Marine Forest's development
projects. In connection therewith, the Company continues to discuss the
possibility of a strategic arrangement with Marine Forest, including the Company
acquiring Marine Forest. Current discussions, which are ongoing, are based upon
a recently completed study (Concept Development and Economic Projections Report)
prepared by a consultant for the Kohala Preserve plan. Related interest income
for the nine months ended September 30, 2002 and 2001 is approximately nil and
$730,000, respectively. Related interest income for the three months ended
September 30, 2002 and 2001 is approximately nil and $255,000, respectively. In
2002, the Company discontinued accruing interest income on the promissory notes
in light of its 2001 impairment charge (see next paragraph). Through September
30, 2002, no interest has been paid, however management anticipates that all
accrued interest receivable will be reclassified to principal and settled in
connection with the parties' contemplated strategic arrangement.
At December 31, 2001, in light of the speculative nature of Marine Forest's
contemplated development projects among other reasons and in accordance with its
compliance with the requirements of SFAS No. 114, the Company recorded an
impairment charge of approximately $7.2 million.
NOTE RECEIVABLE, OFFICER
In April 2002, an officer of the Company purchased property and improvements
thereon for $575,000. The officer entered into 30-year note agreement which
requires monthly payments of principal and interest through 2032. The note
receivable bears interest at the rate of 2.66%. The sale of the property and
improvements to the officer resulted in a loss of approximately $15,000.
OTHER
During the nine months ended September 30, 2002 and 2001, the Company rented
properties to related individuals for approximate aggregate rentals of $10,000
and $40,000, respectively. The aggregate rentals to related individuals for the
three months ended September 30, 2002 and 2001 was nil and $10,000,
respectively.
7. SEGMENT REPORTING
As discussed in Note 1, the Company's primary business focus is the Kohala
Preserve project. Nonetheless, the Company complies with SFAS No. 131
"Disclosures about Segments of an Enterprise and Related Information", which
provides information about the Company's current business activities. Management
has divided the Company into the following segments: real estate sales, rental,
cattle sales and other. Transactions between segments are not common and are not
material to the segment information. Some business activities that cannot be
classified in the aforementioned segments are shown under "corporate".
Operating results, by segment, for the nine and three months ended September 30,
2002 and 2001 are as follows (in thousands):
6
SURETY HOLDINGS CORP. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
7. Segment reporting (continued)
NINE MONTHS ENDED SEPTEMBER 30, 2002
Real Estate Rental Cattle
Sales Activity Sales Other Corporate Total
--------------------------------------------------------------------------------------
Total revenues $ 2,686 $ 221 $ 259 $ 220 $ -- $ 3,386
Total cost of revenues 849 86 156 163 1,254
--------------------------------------------------------------------------------------
Segment profit 1,837 135 103 57 2,132
General and administrative expenses (1,215) (1,215)
Interest income, net 134 134
Income taxes (411) (411)
--------------------------------------------------------------------------------------
Net income (loss) $ 1,837 $ 135 $ 103 $ 57 $ (1,492) $ 640
======================================================================================
Total assets $ 40,219 $ 63 $ 101 $ 585 $ 57,676 $ 98,644
======================================================================================
Capital expenditures $ -- $ -- $ 9 $ 63 $ 1,977 $ 2,049
======================================================================================
Depreciation and amortization $ -- $ 3 $ 13 $ 50 $ 46 $ 112
======================================================================================
NINE MONTHS ENDED SEPTEMBER 30, 2001
Real Estate Rental Cattle
Sales Activity Sales Other Corporate Total
------------------------------------------------------------------------------------
Total revenues $ 1,683 $ 273 $ 309 $ 205 $ -- $ 2,470
Total cost of revenues 531 103 181 171 986
--------------------------------------------------------------------------------------
Segment profit 1,152 170 128 34 1,484
General and administrative expenses (997) (997)
Interest income, net 932 932
Income taxes (562) (562)
--------------------------------------------------------------------------------------
Net income (loss) $ 1,152 $ 170 $ 128 $ 34 $ (627) $ 857
======================================================================================
Total assets $ 42,225 $ 2,006 $ 37 $ 138 $ 57,200 $ 101,606
======================================================================================
Capital expenditures $ -- $ 7 $ 87 $ 120 $ 2,165 $ 2,379
======================================================================================
Depreciation and amortization $ -- $ 5 $ 10 $ 51 $ 55 $ 121
======================================================================================
7
SURETY HOLDINGS CORP. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
7. SEGMENT REPORTING (CONTINUED)
THREE MONTHS ENDED SEPTEMBER 30, 2002
Real Estate Rental Cattle
Sales Activity Sales Other Corporate Total
---------------------------------------------------------------------------
Total revenues $ 1,368 $ 61 $ 69 $ 95 $ -- $ 1,593
Total cost of revenues 465 29 67 44 605
---------------------------------------------------------------------------
Segment profit 903 32 2 51 988
General and administrative expenses (440) (440)
Interest income, net 95 95
Income taxes (246) (246)
---------------------------------------------------------------------------
Net income (loss) $ 903 $ 32 $ 2 $ 51 $ (591) $ 397
===========================================================================
Capital expenditures $ -- $ -- $ 5 $ 12 $ 982 $ 999
===========================================================================
Depreciation and amortization $ -- $ 1 $ 5 $ 19 $ 14 $ 39
===========================================================================
THREE MONTHS ENDED SEPTEMBER 30, 2001
Real Estate Rental Cattle
Sales Activity Sales Other Corporate Total
---------------------------------------------------------------------------
Total revenues $ 894 $ 71 $ 75 $ 91 $ -- $ 1,131
Total cost of revenues 273 26 75 64 438
---------------------------------------------------------------------------
Segment profit 621 45 -- 27 693
General and administrative expenses (256) (256)
Interest income, net 306 306
Income taxes (168) (168)
---------------------------------------------------------------------------
Net income (loss) $ 621 $ 45 $ -- $ 27 $ (118) $ 575
===========================================================================
Capital expenditures $ -- $ -- $ 11 $ 46 $ 763 $ 820
===========================================================================
Depreciation and amortization $ -- $ 1 $ 4 $ 18 $ 25 $ 48
===========================================================================
8
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
NOTE ON FORWARD-LOOKING INFORMATION
This Form 10-QSB contains certain forward-looking statements. For this purpose,
any statements contained in this Form 10-QSB that are not statements of
historical fact may be deemed to be forward-looking statements. Without limiting
the foregoing, words such as "may," "will," "expect," "believe," "anticipates,"
"estimates," or "continue" or comparable terminology or the negative thereof are
intended to identify certain forward-looking statements. These statements by
their nature involve substantial risks and uncertainties, both known and
unknown, and actual results may differ materially from any future results
expressed or implied by such forward-looking statements. The Company undertakes
no obligation to publicly update or revise any forward-looking statements
whether as a result of new information, future events or otherwise.
OVERVIEW
Surety Holdings Corp. (the "Company"), through its wholly-owned subsidiary,
Surety Kohala Corporation ("Surety Kohala") (formerly Chalon International of
Hawaii, Inc.), is engaged in the development of a property on 642 acres of land
in the North Kohala district of Hawaii Island in the state of Hawaii. This
development, referred to as the Kohala Preserve project (f/n/a Mahukona
development project), was initially slated to be a hotel, 18-hole golf course
and resort homes. However, the Company is exploring other avenues of development
for the 642 acres most notably, an all-inclusive fractional interest club
community (see KOHALA PRESERVE in Liquidity and Capital Resources).
The current operations of the Company (discussed below) include the sale of its
non-Kohala Preserve project real estate and other ancillary activities, many of
which are not deemed to be the future of the Company's business.
9
RESULTS OF OPERATIONS
The following table sets forth the statements of income of the Company for the
nine months ended September 30, 2002 and 2001:
2002 2001
------------- --------------
Real estate sales $ 2,686,000 $ 1,683,000
Rentals 221,000 273,000
Cattle sales 259,000 309,000
Other 220,000 205,000
------------- --------------
Total revenues 3,386,000 2,470,000
------------- --------------
Cost of real estate sales 849,000 531,000
Cost of rentals 86,000 103,000
Cost of cattle sales 156,000 181,000
Cost of other 163,000 171,000
------------- --------------
Total cost of revenues 1,254,000 986,000
------------- --------------
Gross profit 2,132,000 1,484,000
General and administrative expenses 1,215,000 997,000
------------- --------------
Income from operations 917,000 487,000
------------- --------------
Interest income 240,000 979,000
Interest expense (106,000) (47,000)
Income taxes (411,000) (562,000)
------------- --------------
(277,000) 370,000
------------- --------------
Net income $ 640,000 $ 857,000
============= ==============
REAL ESTATE SALES -
During the nine months ended September 30, 2002, the Company sold eight parcels
for proceeds of $2,686,000. During the same period of the prior year, there were
sales of only four parcels due to survey delays. Real estate sales for both
periods have been impacted due to delays caused by the Company's survey company,
the largest survey company on the Big Island of Hawaii and probably the only
survey company large enough to handle the Company's PCRS (Parcel Consolidation
Re-Subdivision) parcels and subdivisions, being backlogged with work. This
surveying backlog is a result of increasing demand of the Company's North Kohala
property in a favorable economic time. Further, many of the properties the
Company is selling have never been surveyed and the topography and terrain are
very difficult for surveyors. To address the backlog, the Company recently
switched surveyors on several projects and survey work is beginning to be
completed in a timely manner. The Company is expecting between 10 and 20
closings in the fourth quarter of 2002, which will bring additional proceeds of
approximately $10 million. However, in light of the aforementioned among other
unanticipated circumstances, no assurances can be made that the Company will
meet its expectations in this regard.
10
Real estate sales margin remained consistent when compared to the prior period.
Included in 2002 real estate costs is a $15,000 loss brought about as the result
of the sale of the Sandalwood house and property to Surety Kohala's president.
RENTAL REVENUES -
The approximate 19% decrease in rental revenue is primarily attributable to the
sale of real estate formerly leased by the Company. The Company expects this
trend to continue in the fourth quarter of 2002 and into 2003.
CATTLE SALES -
The approximate 16% decrease in cattle sales is attributable to a
difficult-to-predict beef market. The Company experienced an increase of 64
heads in the sale of cattle from the same period of the prior year but this was
offset by a 11% decrease in the price per head. During the nine months ended
September 30, 2002, cattle expenditures decreased approximately 14%, as a result
of the sale of land previously used for pastures. The Company anticipates that
future cattle revenues and costs will continue to decrease as the Company
continues its sale of pasture lands.
OTHER REVENUES -
Other revenues increased approximately 7% during the first nine months of 2002
as Eco-tourism activity rebounded strongly from the September 11th induced
downturn. Margins also increased in 2002 as stronger Eco-tourism revenues offset
an increase in repairs and maintenance of buildings and grounds. The Company
anticipates that other revenues will continue to increase over the next year.
GENERAL AND ADMINISTRATIVE EXPENSES -
General and administrative expenses for the nine months ended September 30, 2002
increased approximately 22% as compared with the same period of 2001. The
components of general and administrative expenses for 2002 include salaries and
related costs of approximately $373,000; professional fees (legal, auditing and
consulting) of approximately $289,000; franchise and other taxes of
approximately $142,000; depreciation of approximately $47,000; insurance of
approximately $89,000; rent expense of approximately $69,000; travel, meals and
entertainment of approximately $122,000 and other expenses aggregating
approximately $84,000. The components of general and administrative expenses for
the same period of 2001 include salaries and related costs of approximately
$409,000; professional fees (legal, auditing and consulting) of approximately
$199,000; franchise and other taxes of approximately $158,000; depreciation of
approximately $45,000 insurance of approximately $40,000; rent expense of
approximately $31,000; travel, meals and entertainment of approximately $13,000
and other expenses aggregating approximately $102,000.
OTHER INCOME AND EXPENSE -
Decreased interest income during the nine months ended September 30, 2002 is
directly attributable to the Company discontinuing its accrual of interest
income on the Marine Forest notes in light of its 2001 impairment charge and
compliance with the requirements of Statements of Financial Accounting Standards
("SFAS") No 114. Included in interest expense for the nine months ended
September 30, 2002 is an approximate $75,000 loss (a finance cost) resulting
from the sale of 5 mortgage notes to financial institutions at a discount which
provided cash of approximately $759,000.
11
RESULTS OF OPERATIONS
The following table sets forth the statements of income of the Company for the
three months ended September 30, 2002 and 2001:
2002 2001
Real estate sales $ 1,368,000 $ 894,000
Rentals 61,000 71,000
Cattle sales 69,000 75,000
Other 95,000 91,000
------------ ------------
Total revenues 1,593,000 1,131,000
------------ ------------
Cost of real estate sales 465,000 273,000
Cost of rentals 29,000 26,000
Cost of cattle sales 67,000 75,000
Cost of other 44,000 64,000
------------ ------------
Total cost of revenues 605,000 438,000
------------ ------------
Gross profit 988,000 693,000
General and administrative expenses 440,000 256,000
------------ ------------
Income from operations 548,000 437,000
------------ ------------
Interest income 103,000 325,000
Interest expense (8,000) (19,000)
Income taxes (246,000) (168,000)
------------ ------------
(151,000) 138,000
------------ ------------
Net income $ 397,000 $ 575,000
============ ============
REAL ESTATE SALES -
During the three months ended September 30, 2002, the Company sold two parcels
for proceeds of $1,368,000. During the same period of the prior year, there were
also two sales of parcels for proceeds of $894,000. See management's discussion
and analysis for the nine months ended September 30, 2002 and 2001 for
discussion of delays and future expectations.
RENTAL REVENUES -
As previously discussed, the decrease in rental revenue and related margins is
attributable to the sale of real estate formerly leased by the Company. The
Company expects this trend to continue in the fourth quarter of 2002 and into
2003.
CATTLE SALES -
Cattle sales declined approximately 8% for the three months ended September 30,
2002, as compared to the same period in the prior year, as the average price per
head of cattle decreased 10% from the same period of the prior year. The Company
believes that cattle sales will continue to decrease for the foreseeable future
due to the continuing sale of pasture lands.
12
OTHER REVENUES -
Other revenues remained relatively unchanged during the three months ended
September 30, 2002 as compared to the same period of the prior year.
GENERAL AND ADMINISTRATIVE EXPENSES -
General and administrative expenses for the three months ended September 30,
2002 increased 72% with the same period of 2001. The components of general and
administrative expenses for the three months ended September 30, 2002 include
salaries and related costs of approximately $111,000; professional fees (legal,
auditing and consulting) of approximately $147,000; franchise and other taxes of
approximately $40,000; depreciation of approximately $16,000; insurance of
approximately $29,000; rent expense of approximately $21,000; travel, meals and
entertainment of approximately $50,000 and other expenses aggregating
approximately $26,000. The components of general and administrative expenses for
the same period of the prior year include salaries and related costs of
approximately $101,000; professional fees (legal, auditing and consulting) of
approximately $38,000; franchise and other taxes of approximately $44,000;
depreciation of approximately $13,000; insurance of approximately $12,000; rent
expense of approximately $10,000; travel, meals and entertainment of
approximately $3,000 and other expenses aggregating approximately $35,000.
OTHER INCOME AND EXPENSE -
Decreased interest income during the three months ended September 30, 2002 is
directly attributable to the Company discontinuing its accrual of interest
income on the Marine Forest note in light of its 2001 impairment charge and
compliance with the requirements of SFAS No. 114.
LIQUIDITY AND CAPITAL RESOURCES
Cash flows
For the nine months ended September 30, 2002 and 2001, the Company's net cash
used in operating activities of approximately $926,000 and $842,000,
respectively, is comprised of the following:
2002 2001
Net income $ 640,000 $ 857,000
Depreciation and amortization 112,000 121,000
Deferred income taxes 8,000 540,000
Net gain on sales of property
and notes receivable (2,061,000) (1,410,000)
Changes in operating assets
and liabilities 375,000 (950,000)
------------- -------------
$ (926,000) $ (842,000)
============= =============
13
For the nine months ended September 30, 2002 and 2001, the Company's net cash
provided by (used in) investing activities of approximately $1,461,000 and
($2,222,000), respectively, is comprised of the following:
2002 2001
Capital expenditures including
real estate development $ (2,049,000) $ (2,379,000)
Proceeds from sales of property 2,686,000 1,144,000
Proceeds from notes receivable 819,000 963,000
Proceeds from note receivable, officer 5,000
Advances to Marine Forest (1,950,000)
------------- -------------
$ 1,461,000 $ (2,222,000)
============= =============
Approximately $956,000 of the $2,049,000 2002 capital expenditures was made to
progress the Company's Kohala Preserve endeavors. These expenditures include
approximately $134,000 for land-clearing, leveling and grading, approximately
$71,000 of professional fees including consulting, approximately $679,000 for
design, engineering and surveying and $72,000 for other. As previously
discussed, in 2002, the Company sold eight properties for total proceeds of
$2,686,000, whereas in 2001 there were only four sales of real estate for total
proceeds of $1,682,000. During the nine months ended September 30, 2001, the
Company advanced Marine Forest monies pursuant to short-term promissory notes.
No monies were advanced to Marine Forest during the nine months ended September
30, 2002 (see separate liquidity discussion on page 16).
For the nine months ended September 30, 2002 and 2001, the Company's net cash
provided by (used in) financing activities of approximately ($397,000) and
$656,000, respectively, is comprised of the following:
2002 2001
Debt proceeds (from President) $ -- $ 165,000
Proceeds from notes and bank line of credit 1,000,000
Repayment of debt (to President) (375,000)
Debt repayments (22,000) (509,000)
------------- -------------
$ (397,000) $ 656,000
============= =============
14
As of September 30, 2002, the Company has total current assets of approximately
$13.2 million and total current liabilities of approximately $1 million or a
working capital of approximately $12.2 million. As previously discussed, the
Company anticipates 2002 revenue levels to be higher than levels experienced
during 2001. However, given the Company's anticipated cash requirements to
complete the revised Kohala Preserve project and plans to execute a strategic
arrangement with Marine Forest (both discussed below), future capital raising or
debt financing activities may be required.
In an effort to increase the marketability of the Company's common stock, among
other reasons, in February 2002, the Company's board of directors authorized a
three-for-one stock split effected in the form of a two hundred percent stock
dividend.
KOHALA PRESERVE (F/N/A MAHUKONA DEVELOPMENT)
As previously discussed, the events of September 11th had an impact on tourism
and hence, temporarily curtailed the Company's development activities. However,
the Company believes that the tourist market and the high-end second home market
are gradually recovering. In this regard, the Company has resumed its
development strategies however it has focused on a revised plan for the 642
acres of land in the North Kohala district of Hawaii Island in the state of
Hawaii (known as the Kohala Preserve project). As previously reported, the plan
for this valuable parcel of land was the development of a hotel, 18-hole golf
course and resort homes. However, the Company recently hired several
consultants, with extensive experience in high-end resort development and
marketing, to reassess its development strategy with respect to Mahukona
property, the goal of which is to provide the Company guidance in determining an
effective development strategy that will optimize the property's economic
potential.
The preliminary assessment of the consultants for the Kohala Preserve property
is the development of an all-inclusive fractional interest club community
structured as an undivided interest ("UDI"). A UDI would allow the prospective
buyer to use the Kohala Preserve facility plus the eco-ranch lands and would
provide an ownership interest in both. A UDI would not allow the prospective
buyer to own a specific parcel of land, but only a fraction of each square foot
of property. During the quarter ended June 30, 2002, the consultants completed
their review and analysis of the Kohala Preserve property and issued a Concept
Development and Economic Projections Report. The "theme book" (a large,
multi-page book, which incorporates representative images of the components of
the project incorporating the written positioning statement) has been completed
by InterCommunications, Inc., a marketing consulting firm, for purposes of
presentations to prospective development partners, government agencies and
research groups; the Company is in the process of choosing a project logo. The
final site plan and development program is underway by EDSA, a consulting firm
hired by the Company to perform a master plan audit, which will convey
recommendations with regards to the modification of the existing master plan.
The Company is continuing discussions with its consultants and hopeful
formalized plans will be completed before the end of the year.
Based on the preliminary assessment of its consultants, the revised Kohala
Preserve project cost (excluding ongoing costs and maintenance) would be
approximately $93 million and completed substantially over a three-year period.
Based on information provided by its consultants, the Company anticipates the
timing and details of the $93 million to be as follows (in thousands):
15
YEAR 1 YEAR 2 YEAR 3
INITIAL INFRASTRUCTURE AND DEVELOPMENT COSTS
Infrastructure (roads, water, sewer, etc.) $ 10,000 $ 10,000 $ 10,000
Golf course, range, clubhouse, etc. 10,000 10,000
Tennis complex 1,000
Central lodge facility (lobby, restaurants, etc.) 10,500
Beach club 10,000
Recreational trails/improvements 500 500
Ranch Improvements/amenities 500 2,000 1,000
Club boats / marina improvements 1,500 1,000
Other amenities/improvements 2,000
Entrance/gatehouse 500
Design, permits, engineering
contingency 3,075 7,200 2,012
----------- ----------- -----------
$ 23,575 $ 55,200 $ 14,512
=========== =========== ===========
The Company recognizes that its current operations will not be sufficient to
fund the cost of Kohala Preserve project and it may not be successful in future
capital raising or debt financing activities. Accordingly, the Company is
exploring other financing strategies including, but not limited to, a 50% joint
venture with development partners, including, but not limited to, another
property development company, a fractional facility management company or
private investors. No assurances can be made that the Company will be able to
finance or complete the Kohala Preserve as outlined above.
MARINE FOREST
As disclosed in the Company's prior public filings, the Company has advanced
funds to Marine Forest, a related Japanese corporation that owns approximately
400 acres of land in Okinawa, Japan, in which it is developing pursuant to a
"golf resort" theme. Funding of $9.75 million was used by Marine Forest
primarily in the construction of a golf course and related amenities. The
Company anticipated interest payments to commence on or about December 31, 2001.
However, such interest payments were contingent upon Marine Forest's ability to
start the sales of its golf memberships. These sales were postponed and
development (construction) activity was temporarily suspended as a result of the
events of September 11th.
The Company continues to discuss the possibility of a strategic arrangement with
Marine Forest including, but not limited to, the Company acquiring Marine
Forest, which Marine Forest has orally agreed to. Current discussions, which are
ongoing, are based upon a completed study (Concept Development and Economic
Projections Report) prepared by a consultant for the Kohala Preserve plan.
Through September 30, 2002, no interest has been paid to the Company, however
management anticipates that all accrued interest receivable will be reclassified
to principal and settled in connection with the parties' contemplated strategic
arrangement previously discussed.
At December 31, 2001, in light of the speculative nature of Marine Forest's
contemplated development projects among other reasons and in accordance with its
compliance with the requirements of SFAS No. 114, the Company has recorded an
impairment charge of approximately $7.2 million. The Company will continue to
review impairment by applying the procedures set forth in SFAS No. 114. If
there's a significant change in the amount or timing of the impaired loan's
expected future cash flow, the Company will adjust (upward or downward) the
valuation allowance.
16
Item 3. Evaluation of Disclosure Controls and Procedures
(a) Evaluation of disclosure controls and procedures. Our president and chief
financial officer, after evaluating the effectiveness of the Company's
"disclosure controls and procedures" (as defined in the Securities Exchange Act
of 1934 Rules 13a-14(c) and 15-d-14(c)) as of a date (the "Evaluation Date")
within 90 days before the filing date of this quarterly report, have concluded
that as of the Evaluation Date, our disclosure controls and procedures were
adequate and designed to ensure that material information relating to us and our
consolidated subsidiaries would be made known to them by others within those
entities.
(b) Changes in internal controls. There were no significant changes in our
internal controls or to our knowledge, in other factors that could significantly
affect our disclosure controls and procedures subsequent to the Evaluation Date.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings:
There have been no material changes in legal proceedings as required to be
reported on Form 10-QSB from as previously reported in the Company's 10-KSB for
the fiscal year ended December 31, 2001.
Item 2. Change in Securities:
In February 2002, the Company's board of directors authorized a three-for-one
stock split effected in the form of a 200 percent stock dividend which was
distributed on February 15, 2002 to stockholders of record on February 4, 2002.
Item 3. Defaults Upon Senior Securities:
None
Item 4. Submission of Matters to a Vote of Security Holders:
None
Item 5. Other information:
None
Item 6. Exhibits and Reports on Form 8-K:
None
17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SURETY HOLDINGS CORP.
(Registrant)
By: /s/ Howard R. Knapp
-----------------------
Howard R. Knapp
Chief Financial Officer
Dated: November 14, 2002
18
CERTIFICATIONS
I, Yoshihiro Kamon, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Surety Holdings
Corp. and Subsidiary;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the periods covered by
this quarterly report;
3. Based on my knowledge, the condensed consolidated financial statements, and
other financial information included in this quarterly report, fairly
present in all material respects the consolidated financial condition,
results of operations and cash flows of the registrant as of, and for, the
periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiary, is made known to us by others within those
entities, particularly during the periods in which this quarterly
report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors:
(a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Dated: November 14, 2002
By: /s/ Yoshihiro Kamon
--------------------------------------
Yoshihiro Kamon
President and sole Director of Surety
19
CERTIFICATIONS
I, Howard R. Knapp, certify that:
1. I have reviewed this quarterly report on Form 10-QSB of Surety Holdings
Corp. and Subsidiary;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the periods covered by
this quarterly report;
3. Based on my knowledge, the condensed consolidated financial statements, and
other financial information included in this quarterly report, fairly
present in all material respects the consolidated financial condition,
results of operations and cash flows of the registrant as of, and for, the
periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiary, is made known to us by others within those
entities, particularly during the periods in which this quarterly
report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors:
(a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Dated: November 14, 2002
By: /s/ Howard R. Knapp
---------------------------------
Howard R. Knapp
Chief Financial Officer of Surety
20
CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. 1350
In connection with the accompanying Quarterly Report on Form 10-QSB of
Surety Holdings Corp. and Subsidiary for the quarter ended September 30, 2002,
the undersigned hereby certifies pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, to the best of my
knowledge and belief, that:
(1) such Quarterly Report on Form 10-QSB for the quarter ended September
30, 2002 fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) the information contained in such Quarterly Report on Form 10-QSB for
the quarter ended September 30, 2002 fairly presents, in all material
respects, the financial condition and results of operations of Surety
Holdings Corp. and Subsidiary.
Nov. 14, 2002 /s/ Yoshihiro Kamon
-------------------
Name: Yoshihiro Kamon
Title: President and Sole Director of Surety
21
CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. 1350
In connection with the accompanying Quarterly Report on Form 10-QSB of Surety
Holdings Corp. and Subsidiary for the quarter ended September 30, 2002, the
undersigned hereby certifies pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, to the best of my
knowledge and belief, that:
(1) such Quarterly Report on Form 10-QSB for the quarter ended September
30, 2002 fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) the information contained in such Quarterly Report on Form 10-QSB for
the quarter ended September 30, 2002 fairly presents, in all material
respects, the financial condition and results of operations of Surety
Holdings Corp. and Subsidiary.
Nov. 14, 2002 /s/ Howard R. Knapp
-------------------
Name: Howard R. Knapp
Title: Chief Financial Officer of Surety
22