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 March 31, 2003
( ) 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.)
4400 Route 9 South
Freehold, New Jersey 07728
----------------------------------------
(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 _____ (2) 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:
6,753,000 - - May 15, 2003
SURETY HOLDINGS CORP. AND SUBSIDIARIES
INDEX
Page
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Part I - Financial Information
Item 1 - Condensed Consolidated Financial Statements
Balance Sheet as of March 31, 2003 1
Statements of Income for Three Months Ended March 31, 2003
and 2002 2
Statements of Cash Flows for Three Months Ended March 31,
2003 and 2002 3
Notes to the Financial Statements 4-7
Item 2 - Management's Discussion and Analysis or Plan of
Operation 8-16
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 19-21
SURETY HOLDINGS CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
March 31, 2003
(unaudited)
ASSETS
CURRENT ASSETS
Cash $ 11,154,000
Real estate held for sale, current 1,548,000
Other current assets 343,000
Notes receivable, officer, current 13,000
-------------
Total current assets 13,058,000
NOTES RECEIVABLE, less current maturities 1,367,000
NOTES RECEIVABLE, officer, less current maturities 550,000
REAL ESTATE HELD FOR SALE 31,103,000
NOTES RECEIVABLE AND ACCRUED INTEREST,
MARINE FOREST RESORT, INC., net of an approximate
$11 million allowance for loan losses --
REAL ESTATE DEVELOPMENT COSTS 42,588,000
PROPERTY AND EQUIPMENT, net of accumulated depreciation
and amortization of $1,979,000 2,556,000
DEFERRED TAX ASSET 4,557,000
OTHER ASSETS 1,864,000
-------------
$ 97,643,000
=============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Notes payable, current maturity $ 34,000
Accounts payable 429,000
Accrued expenses and other current liabilities 176,000
Income taxes payable 245,000
-------------
Total current liabilities 884,000
-------------
LONG-TERM LIABILITIES
Notes payable, less current maturity 393,000
Obligations pursuant to notes receivable
financing, less current maturity 451,000
-------------
844,000
-------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock, $.001 par value,
200,000,000 shares authorized,
6,753,000 shares issued and
outstanding 7,000
Capital in excess of par value 101,710,000
Accumulated deficit (5,802,000)
-------------
Total stockholders' equity 95,915,000
-------------
$ 97,643,000
=============
SEE ACCOMPANYING NOTES TO CONDENSED FINANCIAL STATEMENTS.
1
SURETY HOLDINGS CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED MARCH 31, 2003 AND 2002
(unaudited)
2003 2002
----------- -----------
REVENUES $ 3,078,000 $ 945,000
COST OF REVENUES 1,167,000 415,000
----------- -----------
GROSS PROFIT 1,911,000 530,000
GENERAL AND ADMINISTRATIVE
EXPENSES 617,000 394,000
----------- -----------
INCOME FROM OPERATIONS 1,294,000 136,000
----------- -----------
OTHER INCOME (EXPENSE)
Interest income 61,000 74,000
Interest expense (7,000) (13,000)
----------- -----------
54,000 61,000
----------- -----------
INCOME BEFORE INCOME TAXES 1,348,000 197,000
INCOME TAXES (513,000) (49,000)
----------- -----------
NET INCOME $ 835,000 $ 148,000
=========== ===========
NET INCOME PER COMMON
SHARE, basic and diluted $ 0.12 $ 0.02
=========== ===========
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING, basic and diluted 6,745,000 6,738,000
=========== ===========
SEE ACCOMPANYING NOTES TO CONDENSED FINANCIAL STATEMENTS.
2
SURETY HOLDINGS CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 2003 AND 2002
(unaudited)
2003 2002
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 835,000 $ 148,000
Adjustments to reconcile net income
to net cash used in operating activities:
Depreciation and amortization 36,000 38,000
Deferred income taxes 8,000 45,000
Gain on sales of property (2,109,000) (675,000)
Loss on sale of notes receivable 79,000
Stock compensation charge 32,000
Increase (decrease) in cash
attributable to changes in operating
assets and liabilities:
Other current assets 123,000 (34,000)
Other assets (115,000) (122,000)
Accounts payable (269,000) (185,000)
Accrued expenses and other
current liabilities 58,000 16,000
Income taxes payable 245,000
------------ ------------
NET CASH USED IN OPERATING ACTIVITIES (1,156,000) (690,000)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (10,000) (27,000)
Proceeds from sales of property 2,868,000 710,000
Real estate development expenditures (294,000) (265,000)
Proceeds from repayments of notes receivable 4,000 838,000
------------ ------------
NET CASH PROVIDED BY INVESTING ACTIVITIES 2,568,000 1,256,000
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on notes payable (8,000) (7,000)
Proceeds from repayments of notes receivable, officer 4,000
Repayments of notes payable, president (155,000)
------------ ------------
NET CASH USED IN FINANCING ACTIVITIES (4,000) (162,000)
------------ ------------
NET INCREASE IN CASH 1,408,000 404,000
CASH
Beginning of period 9,746,000 9,908,000
------------ ------------
End of period $ 11,154,000 $ 10,312,000
============ ============
SEE ACCOMPANYING NOTES TO CONDENSED FINANCIAL STATEMENTS.
3
SURETY HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS
Surety Holdings Corp. ("Surety") and its wholly-owned subsidiaries
(collectively, the "Company") are 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
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.
The current operations of the Company include the sale of its non-Kohala
Preserve development project real estate and other ancillary activities, all of
which are not deemed to be the future of the Company's business.
In January 2003, the Company acquired the assets of Millennium International
Sports & Entertainment, LLC ("Millennium"), which consisted of sports and
entertainment memorabilia (see Item 7, CONSOLIDATED FINANCIAL STATEMENTS - NOTE
13, in the Company's Annual Report on Form 10-KSB for the year ended December
31, 2002 for further detail). However, since revenues related to the sales of
the memorabilia were below certain thresholds specified in the Asset Purchase
Agreement, the Company notified Millennium of its election to rescind the Asset
Purchase Agreement, pursuant to the terms of agreement.
2. UNAUDITED STATEMENTS, INCOME PER COMMON SHARE AND NEW ACCOUNTING
PRONOUNCEMENTS
UNAUDITED STATEMENTS
The accompanying condensed consolidated financial statements of Surety Holdings
Corp. and Subsidiaries as of March 31, 2003 and for the three months ended March
31, 2003 and 2002 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, 2002. The results of operations for the three months
ended March 31, 2003 are not necessarily indicative of the results that may
occur for the year ending December 31, 2003.
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 three months ended
March 31, 2003 and 2002 were the same.
4
SURETY HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
2. UNAUDITED STATEMENTS, INCOME PER COMMON SHARE AND NEW ACCOUNTING
PRONOUNCEMENTS (CONTINUED)
NEW ACCOUNTING PRONOUNCEMENTS
In 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 146,
"Accounting for Costs Associated with Exit of Disposal Activities" and No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure". SFAS No.
146, which is effective beginning with fiscal year ending December 31, 2003,
addresses financial accounting and reporting for costs associated with exit or
disposal activities. The adoption of SFAS No. 146 did not have a significant
impact on its consolidated financial position, results of operations and cash
flows. The adoption of SFAS No. 148, which was effective for fiscal years
beginning after December 15, 2002, addresses stock-based compensation. This
pronouncement did not have a material impact on the Company's consolidated
financial position, result of operations and cash flows.
3. REAL ESTATE DEVELOPMENT COSTS
At March 31, 2003, real estate development costs, attributed to the Company's
Kohala Preserve development project, consist of the following:
Land and land acquisition costs $28,975,000
Planning and studies 2,490,000
Engineering and architectural 565,000
Infrastructure 6,404,000
Professional and consulting fees 2,575,000
Other 1,579,000
-----------
$42,588,000
===========
4. STOCKHOLDERS' EQUITY
In January 2003, the Company issued 15,000 shares of its common stock valued at
$32,000 pursuant to employment contracts.
5. COMMITMENTS AND CONTINGENCIES
The prior approvals obtained for the Kohala Preserve development 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. Generally, these agreements are
on a project by project basis requiring payments as services are performed.
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 consolidated financial
position, results of operations or cash flows of the Company.
5
SURETY HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
6. RELATED PARTY TRANSACTIONS
PRESIDENT
From time to time, the Company's President advances the Company monies pursuant
to one-year 5% promissory notes. At March 31, 2003, the amount owed to the
Company's President pursuant to such notes was approximately $nil. Related
interest expense for the three months ended March 31, 2003 and 2002 is
approximately $nil and $4,000, respectively
MARINE FOREST RESORT, INC. ("MARINE FOREST")
Pursuant to uncollateralized promissory notes, the Company advanced Marine
Forest, a related Japanese corporation that controls 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 six months after date of issuance. However, the notes were
extended an additional six months and subsequently extended to December 31,
2002, as a concession to Marine Forest to advance Marine Forest's development
projects. Marine Forest's current development plans are based upon a recently
completed study prepared by a consultant for the Kohala Preserve development
plan. The Company believes that Marine Forest may sell its development projects
based on the aforementioned study and repay the notes and interest thereafter.
As of March 31, 2003, the notes remain outstanding. Further, since issuance of
the notes, no interest has been paid to the Company. Accordingly, during the
years ended December 31, 2002 and 2001, in light of the speculative nature of
Marine Forest's 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 $3.8 million and $7.2 million, respectively,
including approximately $1.3 million of aggregate accrued interest receivable.
During the year ended December 31, 2002, the Company discontinued accruing
interest income on the notes in light of its impairment charge.
NOTE RECEIVABLE, OFFICER
In April 2002, an officer of the Company purchased property and improvements
thereon for $575,000. The officer entered into a 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%. At March 31, 2003, the balance
on this note receivable was $563,000.
OTHER
During the three months ended March 31, 2003 and 2002, the Company rented
properties to related individuals for aggregate annual rentals of approximately
$nil and $10,000, respectively.
7. SEGMENT REPORTING
As discussed in Note 1, the Company's primary business focus is the Kohala
Preserve development 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 three months ended March 31, 2003 and
2002 are as follows (in thousands):
6
SURETY HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
7. SEGMENT REPORTING (CONTINUED)
THREE MONTHS ENDED MARCH 31, 2003
Real Estate Rental Cattle
Sales Activity Sales Other Corporate Total
------------------------------------------------------------------------------------
Total revenues $ 2,868 $ 83 $ 72 $ 55 $ -- $ 3,078
Total cost of revenues 1,020 31 60 56 1,167
------------------------------------------------------------------------------------
Gross profit (loss) 1,848 52 12 (1) 1,911
General and administrative expenses (617) (617)
Interest income, net 54 54
Income taxes (513) (513)
------------------------------------------------------------------------------------
Net income (loss) $ 1,848 $ 52 $ 12 $ (1) $ (1,076) $ 835
====================================================================================
Total assets $ 36,571 $ 61 $ 99 $ 563 $ 60,349 $ 97,643
====================================================================================
Capital expenditures $ -- $ -- $ 6 $ -- $ 298 $ 304
====================================================================================
Depreciation and amortization $ -- $ 1 $ 4 $ 15 $ 16 $ 36
====================================================================================
THREE MONTHS ENDED MARCH 31, 2002
Real Estate Rental Cattle
Sales Activity Sales Other Corporate Total
------------------------------------------------------------------------------------
Total revenues $ 710 $ 99 $ 81 $ 55 $ -- $ 945
Total cost of revenues 270 28 48 69 415
------------------------------------------------------------------------------------
Gross profit (loss) 440 71 33 (14) 530
General and administrative expenses (394) (394)
Interest income, net 61 61
Income taxes (49) (49)
------------------------------------------------------------------------------------
Net income (loss) $ 440 $ 71 $ 33 $ (14) $ (382) $ 148
====================================================================================
Total assets $ 40,679 $ 53 $ 106 $ 1,039 $ 55,944 $ 97,821
====================================================================================
Capital expenditures $ -- $ -- $ -- $ 27 $ 265 $ 292
====================================================================================
Depreciation and amortization $ -- $ 1 $ 4 $ 18 $ 15 $ 38
====================================================================================
7
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
NOTE ON FORWARD LOOKING INFORMATION
This Form 10-QSB contains 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", "anticipate",
"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"), 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
development project (formerly known as the 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 DEVELOPMENT in Liquidity and Capital Resources).
The Company maintains an investment in Marine Forest Resort, Inc. ("Marine
Forest"), a related Japanese corporation that controls approximately 400 acres
of land in Okinawa, Japan (see MARINE FOREST in Liquidity and Capital Resources
for discussion of Impairment Charge).
The current operations of the Company (discussed in Results of Operations on the
following pages) include the sale of its non-Kohala Preserve development project
real estate and other ancillary activities, many of which are not deemed to be
the future of the Company's business.
In January 2003, the Company acquired the assets of Millennium International
Sports & Entertainment, LLC, which consisted of sports and entertainment
memorabilia. Subsequently, the Company has notified Millennium of its election
to rescind on the Asset Purchase Agreement as a result of revenues relating to
the memorabilia being below certain specified thresholds in the agreement.(see
MILLENNIUM in Liquidity and Capital Resources).
8
CRITICAL ACCOUNTING POLICIES
The Company has identified the following critical accounting policies which
effect the Company's consolidated financial statements as of March 31, 2003 and
for the two quarters ended March 31, 2003 and 2002:
REAL ESTATE HELD FOR SALE AND DEVELOPMENT COSTS (INCLUDING IMPAIRMENT)
Real estate held for sale is stated at the lower of cost or market. All direct
and indirect costs relating to the Company's development project are capitalized
in accordance with Statement of Financial Accounting Standards ("SFAS") No. 67
"Accounting for Costs and Initial Rental Operations of Real Estate Projects".
Such standard requires costs associated with the acquisition, development and
construction of real estate and real estate-related projects to be capitalized
as part of that project. The realization of these costs is predicated on the
ability of the Company to successfully open and operate the development
property.
The Company reviews its real estate held for sale, real estate development costs
and long-lived assets for impairment whenever events or changes in circumstances
indicate that the carrying amount of the assets may not be fully recoverable. To
determine the recoverability of these assets, the Company employs various
methods to assess fair value including, but not limited to, analysis of
undiscounted cash flows, third party appraisals or valuations and contractual
sales value of similar properties. Impairment is the amount by which the
carrying value of the asset exceeds its fair value.
The Company has obtained an "Opinion of Market Value", dated February 3, 2003,
for a majority of its property from Economics Research Associates, an
experienced and reputable advisor for developers and others.
MARINE FOREST - "ACCOUNTING BY CREDITORS FOR IMPAIRMENT OF A LOAN"
The Company accounts for the notes receivable from Marine Forest under the
provisions of SFAS No. 114, "Accounting by Creditors for Impairment of a Loan".
Under SFAS No. 114, a loan is impaired when, based on current information and
events, it is probable that a creditor will be unable to collect all a mounts
due according to the contractual terms of the loan agreement. SFAS No. 114
requires lenders to measure impaired loans based on: (i) the present value of
expected future cash flows discounted at the loans' effective interest rate;
(ii) the loans' observable market price or (iii) the fair value of the
collateral if the loan is collateral-dependent. An allowance for loan losses is
maintained if the measure of an impaired loan is less than its recorded
investment. Adjustments to the allowance are made through corresponding charges
or credits to the provision for loan losses.
9
RESULTS OF OPERATIONS
The following table sets forth the statements of income of the Company for the
three months ended March 31, 2003 and 2002:
2003 2002
Real estate sales $ 2,868,000 $ 710,000
Rentals 83,000 99,000
Cattle sales 72,000 81,000
Other 55,000 55,000
------------- -----------
Total revenues 3,078,000 945,000
------------- -----------
Cost of real estate sales 1,020,000 270,000
Cost of rentals 31,000 28,000
Cost of cattle sales 60,000 48,000
Cost of other 56,000 69,000
------------- -----------
Total cost of revenues 1,167,000 415,000
------------- -----------
Gross profit 1,911,000 530,000
General and administrative expenses 617,000 394,000
------------- -----------
Income from operations 1,294,000 136,000
------------- -----------
Interest income 61,000 74,000
Interest expense (7,000) (13,000)
Income taxes (513,000) (49,000)
------------- -----------
(459,000) 12,000
------------- -----------
Net income $ 835,000 $ 148,000
============= ===========
REAL ESTATE SALES -
For the three months ended March 31, 2003, the Company sold parcels to four
different buyers of properties for proceeds of approximately $2.9 million as
compared to the three months ended March 31, 2002 where the Company sold two
properties for proceeds of approximately $710,000, an approximate $2.2 million
increase. In 2002, the Company had been experiencing closing 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. To address the backlog, the Company switched surveyors on
several projects. Land court and county approval processes (generally three
months or more), which occur subsequent to the surveying, could contribute,
however, to a slowing in the closing process.
10
The Company anticipates closing between 10 to 20 transactions in the second
quarter of 2003 for approximately $4.5 million. As a result of the survey work
becoming quicker, the Company anticipates closing approximately $28 million for
2003. There can be no assurances that the Company will be able to close a
majority of these contracts in 2003.
Real estate sales expense increased in 2003 as a result of the amortization of
the survey costs being much greater in 2003 than previously for the parcels sold
in 2002.
The Company believes that the tourism and second home markets have made
recoveries from the events of September 11, 2001 ("September 11th"), however,
the war in the Middle East may have negative repercussions.
RENTAL REVENUES -
The approximate 16% decrease in rental revenue is primarily attributable to the
sale of real estate formerly leased by the Company. The Sandalwood property, a
new home built on the island during 2001, was rented to Surety Kohala's
President for the last eleven months of 2001. In 2002, the Company sold the
Sandalwood property to Surety Kohala's President for approximately $575,000.
Additionally, during 2002 and 2003, rental revenue was discontinued from certain
properties as these properties were placed in escrow for a pending sale. The
Company expects rental income to continue to decrease in 2003 as long as land
continues to be sold.
CATTLE SALES -
The approximate 11% decrease in cattle sales is attributable to the decrease in
the average price per head of cattle. Specifically, for the three months ended
March 31 2003, the Company sold 281 heads at an average price of approximately
$257 per head versus the same period in 2002, where the Company sold 281 heads
at an average price of approximately $288 per head. The deteriorated cattle
sales margins are attributable to increased costs resulting from the increase in
rent expense caused by the sale and lease back of former pasturelands. Cattle
sales will continue to decrease as the Company continues to sell pasturelands.
OTHER REVENUES -
Other revenues experienced no significant fluctuations. The Company anticipates
other revenues to increase through the remainder of 2003.
GENERAL AND ADMINISTRATIVE EXPENSES -
On an overall basis, general and administrative expenses increased approximately
57% for the three months ended March 31, 2003 as compared to the same period in
2002. The components of general and administrative expenses for the three months
ended March 31, 2003 include salaries and related costs of approximately
$102,000; professional fees (legal, auditing and consulting) of approximately
$289,000; franchise and other taxes of approximately $29,000; depreciation of
approximately $16,000; insurance of approximately $37,000; and other expenses
aggregating approximately $144,000. The components of general and administrative
expenses for the three months ended March 31, 2002 include salaries and related
costs of approximately $108,000; professional fees (legal, auditing and
consulting) of approximately $90,000; franchise and other taxes of
11
approximately $70,000; depreciation of approximately $15,000; insurance of
approximately $36,000; and other expenses aggregating approximately $75,000.
Salaries and related costs remained relatively unchanged from the first quarter
2003 compared to the first quarter of 2002. Professional fees more than tripled
in 2003 as a result of (i) higher legal costs in connection with hiring legal
counsel to negotiate and address the development cost activities and (ii) an
increase in consulting fees paid to the Company's President and Chief Executive
Officer. Depreciation and insurance expense remained flat in 2003. Other
expenses increased by approximately $69,000 primarily as a result of increased
travel and entertainment by executives to progress development plans and to
complete the Millennium transaction, (ii) increased rent attributable to
temporary accommodations in San Francisco for the Company's President and (iii)
stock compensation charge incurred pursuant to employment contracts.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS
For the three months ended March 31, 2003 and 2002, the Company's net cash used
in operating activities of approximately $1,156,000 and $690,000, respectively,
is comprised of the following:
2003 2002
Net income $ 835,000 $ 148,000
Depreciation and amortization 36,000 38,000
Deferred income taxes 8,000 45,000
Stock compensation charge 32,000
Net gain on sales and disposition of property
and assets (2,109,000) (596,000)
Changes in operating assets
and liabilities 42,000 (325,000)
------------ ----------
$ (1,156,000) $ (690,000)
============ ==========
12
For the three months ended March 31, 2003 and 2002, the Company's net cash
provided by investing activities of approximately $2,568,000 and $1,256,000,
respectively, is comprised of the following:
2003 2002
Capital expenditures including
real estate development $ (304,000) $ (292,000)
Proceeds from sales of property 2,868,000 710,000
Proceeds from notes receivable 4,000 838,000
------------- ------------
$2,568,000 $1,256,000
============= ============
Approximately $294,000 of the $304,000 of the March 2003 quarter's capital
expenditures and approximately $265,000 of the $292,000 of the March 2002
quarter's capital expenditures was made to progress the Company's Kohala
Preserve development endeavors. These expenditures include approximately
$114,000 and $76,000, in the March 31, 2003 and 2002 quarters, respectively, for
land clearing, leveling and grading and approximately $180,000 and $78,000 in
the March 31, 2003 and 2002 quarters, respectively, for design, planning,
engineering and surveying and other costs.
For the three months ended March 31, 2003 and 2002, the Company's net cash used
for financing activities of approximately $4,000 and $162,000, respectively, is
comprised of the following:
2003 2002
Proceeds from repayment of officer's note $ 4,000 $ --
Repayment of debt (to President) (155,000)
Debt repayments, net (8,000) (7,000)
---------- ------------
$ (4,000) $ (162,000)
========== ============
As of March 31, 2002, the Company has total current assets of approximately
$13.1 million and total current liabilities of approximately $.9 million or a
working capital of approximately $12.2 million. As previously discussed, the
Company anticipates 2003 revenue levels to be higher than levels experienced
during 2002. However, given the Company's anticipated cash requirements to
complete the revised Kohala Preserve development project (discussed below),
future capital raising or debt financing activities may be required.
13
KOHALA PRESERVE (FORMERLY MAHUKONA) DEVELOPMENT
The Company continues to strategize its development plans relative to its 642
acres of land in the North Kohala district of Hawaii Island in the state of
Hawaii (known as the Kohala Preserve development project). The original plan for
this valuable parcel of land was the development of a hotel, 18-hole golf course
and resort homes. However, during 2001, the Company hired several consultants,
with extensive experience in high-end resort development and marketing, to
reassess its development strategy with respect to Kohala Preserve 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
present 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.
The revised Kohala Preserve development project is subject to further Company
and consultant review and analysis that is expected to be completed during the
second quarter of 2003.
Based on the present assessment of its consultants, the Kohala Preserve
development project cost (excluding ongoing costs and maintenance) would be
approximately $213.7 million and completed substantially (approximately 80%)
over a three-year period. Based on information provided by its consultants, the
Company anticipates the timing and details of the $213.7 million to be as
follows (in thousands):
YEAR 1 YEAR 2 YEAR 3 BEYOND
Infrastructure and amenities $ 21,062 $ 31,762 $ 13,280 $ 15,586
3-Bedroom fractionals 15,080 15,998
2-Bedroom fractionals 8,918 3,546
Hales 4,262 4,389
3-Bedroom condos 11,310
2-Bedroom condos 5,016
Lots 822 2,471
Hotel 16,243 43,949
---------- ---------- ---------- ----------
$ 37,305 $ 76,533 $ 57,866 $ 41,990
========== ========== ========== ==========
The Company recognizes that its current operations will not be sufficient to
fund the cost of Kohala Preserve's development 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.
14
MARINE FOREST
Pursuant to uncollateralized promissory notes, the Company advanced Marine
Forest, a related Japanese corporation that controls approximately 400 acres of
land in Okinawa, Japan, $9.75 million. The notes bear interest at the U.S. prime
rate, at the 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 and additional nine months and subsequently extended to December 31,
2002, as a concession to Marine Forest to advance Marine Forest's development
projects. Marine Forest's current development plans are based upon a recently
completed study prepared by a consultant for the Kohala Preserve development
plan. The Company believes that Marine Forest may sell its development projects
based on the aforementioned study and repay the notes and interest thereafter.
However, this action has not been initiated at this point and when (and if)
initiated, it would take at least a year, if not longer, to consummate such a
transaction.
As of March 31, 2003 and through the date hereof, the notes remain outstanding.
Further, since issuance of the notes and through the date hereof, no interest
has been paid to the Company. Accordingly, during the years ended December 31,
2002 and 2001, in light of the speculative nature of Marine Forest's development
projects among other reasons and in accordance with its compliance with the
requirements of SFAS No. 114 (see previous discussion of Critical Accounting
Policies), the Company recorded an impairment charge of approximately $3.8
million and $7.2 million, respectively, including approximately $1.3 million of
aggregate accrued interest receivable. During the year ended December 31, 2002,
the Company discontinued accruing interest income on the notes in light of its
impairment charge.
MILLENNIUM
In January 2003, pursuant to an Asset Purchase Agreement, the Company acquired
the assets of Millennium International Sports & Entertainment, LLC
("Millennium"), which consisted of sports and entertainment memorabilia. In
consideration for the assets received, the Company will issue shares of its
common stock if certain revenue levels related to the sales of the memorabilia
are attained by certain dates. If revenues related to the sales of the
memorabilia equal or exceed $8 million by December 31, 2003, an aggregate of
350,000 shares of the Company's common stock would be issued to the former
members of Millenium, all of whom executed employment agreements with the
Company in connection with the January 2003 transaction. Since the Company's
acquisition of Millennium and through May 15, 2003, there has been little to no
revenues related to the sales of the memorabilia. Pursuant to the terms of the
Asset Purchase Agreement, the Company notified Millennium of its election to
rescind.
15
CONTRACTUAL COMMITMENTS
The Company is obligated under various contractual commitments over the next
several years. Following is a summary of those commitments as of December 31,
2002:
GREATER
1 YEAR 1-3 YEARS THAN 3 YEARS
Notes payable (a) $ 34,000 $ 46,000 $ 355,000
---------- ---------- -----------
$ 34,000 $ 46,000 $ 355,000
========== ========== ===========
(a) Excludes obligation pursuant to notes receivable financing whereby a cash
outlay is only required if the financial institution requires the Company
to repurchase a defaulted note.
16
SURETY HOLDINGS CORP. AND SUBSIDIARIES
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, 2002.
Item 2. Change in Securities:
In January 2003, the Company issued 15,000 shares of its common stock
valued at $32,000 pursuant to employment contracts.
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:
Form 8-K filed on January 16, 2003 - other events.
17
SURETY HOLDINGS CORP. AND SUBSIDIARIES
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: May 15, 2003
18
SURETY HOLDINGS CORP. AND SUBSIDIARIES
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: May 15. 2003
By: /s/ Yoshihiro Kamon
-------------------------
Yoshihiro Kamon
President and sole Director of Surety
19
SURETY HOLDINGS CORP. AND SUBSIDIARIES
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: May 15, 2003
By: /s/ Howard R. Knapp
-------------------------------
Howard R. Knapp
Chief Financial Officer of Surety
20