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, 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
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(Address of Principal Executive Offices)
Registrant's telephone number including area code 732-409-0113
------------
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 - - November 11, 2003
SURETY HOLDINGS CORP. AND SUBSIDIARIES
INDEX
Page
----
Part I - Financial Information
Item 1 - Condensed Consolidated Financial Statements
Balance Sheet as of September 30, 2003 2
Statements of Income for the nine and three months
ended September 30, 2003 and 2002 3
Statements of Cash Flows for nine months ended September 30, 2003 and 2002 4-5
Notes to the Financial Statements 6-11
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations 12-21
Item 3 - Evaluation of Disclosure Controls and Procedures 22
Part II - Other Information
Item 1 - Legal Proceedings 22
Item 2 - Change in Securities 22
Item 3 - Defaults Upon Senior Securities 22
Item 4 - Submission of Matters to a Vote of Security Holders 22
Item 5 - Other Information 22
Item 6 - Exhibits and Reports on Form 8-K 22
SIGNATURE 23
EXHIBIT INDEX 24
SURETY HOLDINGS CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 2003
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash $ 11,049,000
Real estate held for sale, current 3,161,000
Other current assets 620,000
Notes receivable, officer, current 13,000
-------------
Total current assets 14,843,000
NOTES RECEIVABLE, less current maturities 2,871,000
NOTE RECEIVABLE, officer, less current maturity 544,000
REAL ESTATE HELD FOR SALE 28,548,000
NOTES RECEIVABLE AND ACCRUED INTEREST,
MARINE FOREST RESORT, INC., net of an approximate
$11 million allowance for loan losses --
REAL ESTATE DEVELOPMENT COSTS 42,933,000
PROPERTY AND EQUIPMENT, net of accumulated depreciation
and amortization of approximately $2 million 2,493,000
DEFERRED TAX ASSET 4,559,000
OTHER ASSETS 2,084,000
-------------
$ 98,875,000
=============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Notes payable, current maturity $ 36,000
Accounts payable 325,000
Accrued expenses and other current liabilities 172,000
-------------
Total current liabilities 533,000
-------------
LONG-TERM LIABILITIES
Notes payable, less current maturity 373,000
Obligations pursuant to notes receivable
financing, less current maturity 451,000
-------------
Total long-term liabilities 824,000
-------------
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 101,709,000
Accumulated deficit (4,198,000)
-------------
Total stockholders' equity 97,518,000
-------------
$ 98,875,000
=============
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
2
SURETY HOLDINGS CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
NINE AND THREE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, THREE MONTHS ENDED SEPTEMBER 30,
2003 2002 2003 2002
----------- ----------- ----------- -----------
REVENUES $ 8,641,000 $ 3,386,000 $ 1,671,000 $ 1,593,000
COST OF REVENUES 2,976,000 1,254,000 589,000 605,000
----------- ----------- ----------- -----------
GROSS PROFIT 5,665,000 2,132,000 1,082,000 988,000
GENERAL AND ADMINISTRATIVE
EXPENSES 1,892,000 1,215,000 754,000 440,000
----------- ----------- ----------- -----------
INCOME FROM OPERATIONS 3,773,000 917,000 328,000 548,000
----------- ----------- ----------- -----------
OTHER INCOME (EXPENSE)
Interest income 206,000 240,000 97,000 103,000
Interest expense (18,000) (106,000) (5,000) (8,000)
----------- ----------- ----------- -----------
188,000 134,000 92,000 95,000
----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES 3,961,000 1,051,000 420,000 643,000
INCOME TAXES (1,522,000) (411,000) (204,000) (246,000)
----------- ----------- ----------- -----------
NET INCOME $ 2,439,000 $ 640,000 $ 216,000 $ 397,000
=========== =========== =========== ===========
NET INCOME PER COMMON
SHARE, basic and diluted $ 0.36 $ 0.09 $ 0.03 $ 0.06
=========== =========== =========== ===========
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING, basic and diluted 6,750,000 6,738,000 6,753,000 6,738,000
=========== =========== =========== ===========
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
3
SURETY HOLDINGS CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(UNAUDITED)
2003 2002
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 2,439,000 $ 640,000
Adjustments to reconcile net income
to net cash used in operating activities:
Depreciation and amortization 107,000 112,000
Deferred income taxes 6,000 8,000
Gain on sales of property (6,288,000) (2,148,000)
Loss on disposition of property 12,000
Loss on sale of notes receivable 75,000
Stock compensation charge 31,000
Increase (decrease) in cash attributable
to changes in operating assets and liabilities:
Other current assets (263,000) (22,000)
Other assets (335,000) (1,190,000)
Accounts payable (373,000) (19,000)
Accrued expenses and other
current liabilities 54,000 416,000
------------ ------------
NET CASH USED IN OPERATING ACTIVITIES (4,622,000) (2,116,000)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (18,000) (105,000)
Proceeds from sales of property 6,331,000 2,686,000
Real estate development expenditures (639,000) (754,000)
Proceeds from repayments of notes receivable 267,000 819,000
Proceeds from repayments of note receivable, officer 10,000 5,000
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NET CASH PROVIDED BY INVESTING ACTIVITIES 5,951,000 2,651,000
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on notes payable (26,000) (22,000)
Repayments of notes payable, president (375,000)
------------ ------------
NET CASH USED IN FINANCING ACTIVITIES (26,000) (397,000)
------------ ------------
NET INCREASE IN CASH 1,303,000 138,000
CASH
Beginning of period 9,746,000 9,908,000
------------ ------------
End of period $ 11,049,000 $ 10,046,000
============ ============
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
4
SURETY HOLDINGS CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
(UNAUDITED)
2003 2002
------------ ------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION,
cash paid during the period for:
Interest $ 18,000 $ 24,000
============ ============
Income taxes $ 1,713,000 $ --
============ ============
SUPPLEMENTAL DISCLOSURES OF NONCASH
INVESTING AND FINANCING ACTIVITIES:
Issuance of note receivable to officer upon sale of property
and improvements $ -- $ 575,000
============ ============
Issuance of notes receivable upon sale of property $ 1,658,000 $ --
============ ============
SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
5
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 September 30, 2003 and for the nine and three-month
periods ended September 30, 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 nine and
three-month periods ended September 30, 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 nine and
three-month periods ended September 30, 2003 and 2002 were the same.
6
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 January 2003, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46").
FIN 46 requires certain variable interest entities to be consolidated by the
primary beneficiary of the entity if the equity investors in the equity do not
have the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. FIN 46 is
effective immediately for all new variable interest entities created or acquired
after January 15, 2003. The Company has no arrangements that would be subject to
this interpretation.
In April 2003, the FASB issued SFAS No.149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies the accounting for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities
under SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities." SFAS No. 149 is generally effective for contracts entered into or
modified after June 30, 2003 and for hedging relationships designated after June
30, 2003. The adoption of SFAS No. 149 on July 1, 2003, as required, had no
impact on the Company's condensed consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity". SFAS No. 150
establishes standards for classifying and measuring as liabilities, certain
financial instruments that embody obligations of the issuer and have
characteristics of both liabilities and equity. The adoption of SFAS No. 150,
effective for all financial instruments entered into or modified after May 31,
2003, will not have a material effect on the Company's condensed consolidated
financial statements.
3. REAL ESTATE DEVELOPMENT COSTS
At September 30, 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 2,572,000
Engineering and architectural 565,000
Infrastructure 6,711,000
Professional and consulting fees 2,490,000
Other 1,620,000
------------
$ 42,933,000
============
4. STOCKHOLDERS' EQUITY
In January 2003, the Company issued 15,000 shares of its common stock valued at
$31,000 pursuant to employment contracts.
7
SURETY HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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
7. RELATED PARTY TRANSACTIONS
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 September 30, 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 September 30, 2003, the
balance on this note receivable was approximately $557,000.
8
SURETY HOLDINGS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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 nine and three months ended September 30,
2003 and 2002 are as follows (in thousands):
NINE MONTHS ENDED SEPTEMBER 30, 2003
Real Estate Rental Cattle
Sales Activity Sales Other Corporate Total
--------------------------------------------------------------------
Revenues $ 7,989 $ 194 $ 248 $ 210 $ -- $ 8,641
Cost of revenues 2,548 91 180 157 2,976
--------------------------------------------------------------------
Segment profit 5,441 103 68 53 5,665
General and administrative expenses (1,892) (1,892)
Interest income, net 188 188
Income taxes (1,522) (1,522)
--------------------------------------------------------------------
Net income (loss) $ 5,441 $ 103 $ 68 $ 53 $ (3,226) $ 2,439
====================================================================
Total assets $ 37,046 $ 126 $ 141 $ 330 $ 61,232 $ 98,875
====================================================================
Capital expenditures $ -- $ -- $ 6 $ -- $ 651 $ 657
====================================================================
Depreciation and amortization $ -- $ 3 $ 13 $ 43 $ 48 $ 107
====================================================================
9
SURETY HOLDINGS CORP. AND SUBSIDIARIES
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
-------------------------------------------------------------------------------
Revenues $ 2,686 $ 221 $ 259 $ 220 $ -- $ 3,386
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 $ 787 $ 859
===============================================================================
Depreciation and amortization $ -- $ 3 $ 13 $ 50 $ 46 $ 112
===============================================================================
THREE MONTHS ENDED SEPTEMBER 30, 2003
Real Estate Rental Cattle
Sales Activity Sales Other Corporate Total
-------------------------------------------------------------------------------
Revenues $ 1,428 $ 53 $ 101 $ 89 $ -- $ 1,671
Cost of revenues 446 30 67 46 589
-------------------------------------------------------------------------------
Segment profit 982 23 34 43 1,082
General and administrative expenses (754) (754)
Interest income, net 92 92
Income taxes (204) (204)
-------------------------------------------------------------------------------
Net income (loss) $ 982 $ 23 $ 34 $ 43 $ (866) $ 216
===============================================================================
Capital expenditures $ -- $ -- $ -- $ -- $ 214 $ 214
===============================================================================
Depreciation and amortization $ -- $ 1 $ 4 $ 14 $ 17 $ 36
===============================================================================
10
SURETY HOLDINGS CORP. AND SUBSIDIARIES
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
-------------------------------------------------------------------------------
Revenues $ 1,368 $ 61 $ 69 $ 95 $ -- $ 1,593
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 $ 639 $ 656
===============================================================================
Depreciation and amortization $ -- $ 1 $ 5 $ 19 $ 14 $ 39
===============================================================================
11
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 pursuing 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 joint venture partners and /or avenues of
development for the 642 acres. (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 is finalizing with Millennium 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).
12
CRITICAL ACCOUNTING POLICIES
The Company has identified the following critical accounting policies which
effect the Company's consolidated financial statements as of September 30, 2003
and for the nine and three months ended September 30, 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 amounts 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.
13
RESULTS OF OPERATIONS
The following table sets forth the statements of income of the Company for the
the nine months ended September 30, 2003 and 2002:
2003 2002
Real estate sales $ 7,989,000 $ 2,686,000
Rentals 194,000 221,000
Cattle sales 248,000 259,000
Other 210,000 220,000
----------- -----------
Total revenues 8,641,000 3,386,000
----------- -----------
Cost of real estate sales 2,548,000 849,000
Cost of rentals 91,000 86,000
Cost of cattle sales 180,000 156,000
Cost of other 157,000 163,000
----------- -----------
Total cost of revenues 2,976,000 1,254,000
----------- -----------
Gross profit 5,665,000 2,132,000
General and administrative expenses 1,892,000 1,215,000
----------- -----------
Income from operations 3,773,000 917,000
----------- -----------
Interest income 206,000 240,000
Interest expense (18,000) (106,000)
Income taxes (1,522,000) (411,000)
----------- -----------
(1,334,000) (277,000)
----------- -----------
Net income $ 2,439,000 $ 640,000
=========== ===========
REAL ESTATE SALES -
For the nine months ended September 30, 2003, the Company sold 32 parcels to 17
different buyers of properties for proceeds of approximately $8,000,000 as
compared to the nine months ended September 30, 2002 where the Company sold
eight properties for proceeds of approximately $2,700,000 an approximate
$5,300,000 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.
The Company anticipates closing between 3 to 5 transactions in the last three
months of 2003 for approximately $4,000,000. As a result of the survey work
becoming quicker, the Company anticipates closing approximately $16,000,000 in
the next twelve months. There can be no assurances that the Company will be able
to close the balance of these contracts in 2004.
14
Real estate sales expense for the nine months ended September 30, 2003 and 2002
was approximately 32% of real estate sales.
RENTAL REVENUES -
Rental revenues for the nine months ended September 30, 2003 are 12% lower than
the rental revenues realized for the nine months ended September 30, 2002. The
Company believes total rental revenues in 2003 could continue to decrease as
compared to total rental revenues realized in 2002 as long as land continues to
be sold.
CATTLE SALES -
The approximate 4% decrease in cattle sales is attributable to the decrease in
the average price per head of cattle and the decrease in the cattle sold.
Specifically, for the nine months ended September 30, 2003, the Company sold 901
heads at an average price of approximately $275 per head versus the same period
in 2002, where the Company sold 930 heads at an average price of approximately
$279 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 remain constant through the remainder of 2003.
GENERAL AND ADMINISTRATIVE EXPENSES -
On an overall basis, general and administrative expenses increased approximately
56% for the nine months ended September 30, 2003 as compared to the same period
in 2002. The components of general and administrative expenses for the nine
months ended September 30, 2003 include salaries and related costs of
approximately $334,000; professional fees (legal, auditing and consulting) of
approximately $740,000; franchise and other taxes of approximately $120,000;
depreciation of approximately $107,000; insurance of approximately $112,000; and
other expenses aggregating approximately $479,000. The components of general and
administrative expenses for the nine months ended September 30, 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 $112,000; insurance of
approximately $89,000; and other expenses aggregating approximately $210,000.
Professional fees more than doubled 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. Insurance expense increased
approximately 26% in 2003. Travel and entertainment by executives increased in
2003 to help progress development plans.
15
OTHER INCOME AND EXPENSE -
Interest expense for the nine months ended September 30, 2002 included
approximately $75,000 of interest charges (a finance cost) incurred from the
loss on sale of mortgage notes.
The following table sets forth the statements of income of the Company for the
three months ended September 30, 2003 and 2002:
2003 2002
Real estate sales $ 1,428,000 $ 1,368,000
Rentals 53,000 61,000
Cattle sales 101,000 69,000
Other 89,000 95,000
----------- -----------
Total revenues 1,671,000 1,593,000
----------- -----------
Cost of real estate sales 446,000 465,000
Cost of rentals 30,000 29,000
Cost of cattle sales 67,000 67,000
Cost of other 46,000 44,000
----------- -----------
Total cost of revenues 589,000 605,000
----------- -----------
Gross profit 1,082,000 988,000
General and administrative expenses 754,000 440,000
----------- -----------
Income from operations 328,000 548,000
----------- -----------
Interest income 97,000 103,000
Interest expense (5,000) (8,000)
Income taxes (204,000) (246,000)
----------- -----------
(112,000) (151,000)
----------- -----------
Net income $ 216,000 $ 397,000
=========== ===========
REAL ESTATE SALES -
During the three months ended September 30, 2003, the Company sold 5 lots for
proceeds of approximately $1,428,000, as compared to the three months ended
September 30, 2002 where the Company sold two parcel of properties for proceeds
of approximately $1,368,000, an approximate $60,000 increase. See management's
discussion and analysis for the nine months ended September 30, 2003 and 2002
for discussion of delays and future expectations.
RENTAL REVENUES -
Rental revenues decreased by approximately $8,000 for the three months ended
September 30, 2003 as compared to the three months ended September 30, 2002.
CATTLE SALES -
Cattle sales increased by approximately $32,000 for the three months ended
September 30, 2003 as 350 heads of cattle were sold compared to 279 heads of
cattle during the same period of the prior year. The Company believes that
cattle sales could decrease for the foreseeable future due to the continuing
sale of pasturelands.
16
OTHER REVENUES -
Other revenues decreased by approximately $6,000 for the three months ended
September 20, 2003 as compared to the three months ended September 30, 2002.
GENERAL AND ADMINISTRATIVE EXPENSES -
On an overall basis, general and administrative expenses increased approximately
71% for the three months ended September 30, 2003 as compared to the same period
in 2002. The components of general and administrative expenses for the three
months ended September 30, 2003 include salaries and related costs of
approximately $129,000; professional fees (legal, auditing and consulting) of
approximately $243,000; franchise and other taxes of approximately $53,000;
depreciation of approximately $17,000; insurance of approximately $37,000; and
other expenses aggregating approximately $275,000. 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; and other expenses aggregating approximately $97,000.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS
For the nine months ended September 30, 2003 and 2002, the Company's net cash
used in operating activities of approximately $4,622,000 and $2,116,000,
respectively, is comprised of the following:
2003 2002
Net income $ 2,439,000 $ 640,000
Depreciation and amortization 107,000 112,000
Deferred income taxes 6,000 8,000
Stock compensation charge 31,000
Net gain on sales and disposition of property
and assets (6,288,000) (2,061,000)
Changes in operating assets
and liabilities (917,000) (815,000)
------------ ------------
$ (4,622,000) $ (2,116,000)
============ ============
17
For the nine months ended September 30, 2003 and 2002, the Company's net cash
provided by investing activities of approximately $5,951,000 and $2,651,000,
respectively, is comprised of the following:
2003 2002
Capital expenditures including
real estate development $ (657,000) $ (859,000)
Proceeds from sales of property 6,331,000 2,686,000
Proceeds from notes receivable 277,000 824,000
----------- -----------
$ 5,951,000 $ 2,651,000
=========== ===========
Approximately $639,000 of the $657,000 of the September 2003 quarter's capital
expenditures and approximately $754,000 of the $859,000 of the September 30,
2002 quarter's capital expenditures was made to progress the Company's Kohala
Preserve development endeavors. These expenditures include approximately
$408,000 and $134,000, in the nine months ended September 30, 2003 and 2002,
respectively, for land clearing, leveling and grading, approximately $15,000 and
$71,000 of professional fees including consulting, approximately $216,000 and
$599,000 in the nine months ended September 30, 2003 and 2002, respectively, for
design, planning, engineering and surveying and other costs.
For the nine months ended September 30, 2003 and 2002, the Company's net cash
used for financing activities of approximately $26,000 and $397,000,
respectively, is comprised of the following:
2003 2002
Repayment of debt (to President) $ -- $ (375,000)
Debt repayments, net (26,000) (22,000)
--------- ----------
$ (26,000) $ (397,000)
========= ==========
As of September 30, 2003, the Company has total current assets of approximately
$14,843,000 and total current liabilities of approximately $533,000 or a working
capital of approximately $14,310,000. 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.
18
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
next six months.
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.
19
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 six months after date of issuance. However, the notes were
extended and 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.
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 September 30, 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 in May of 2003 of its
election to rescind.
20
CONTRACTUAL COMMITMENTS
The Company is obligated under various contractual commitments over the next
several years. Following is a summary of those commitments as of September 30,
2003:
GREATER
1 YEAR 1 -3 YEARS THAN 3 YEARS
Notes payable (a) $ 34,000 $ 46,000 $ 329,000
--------- --------- ---------
$ 34,000 $ 46,000 $ 329,000
========= ========= =========
(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.
21
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 $31,000 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:
(a) Exhibits
Exhibit 31 Rule 13a-14(a)/15d-14(a) Certification -
President and Chief Executive Officer.
Exhibit 32 Section 1350 Certification - President and
Chief Executive Officer.
(b) Reports on Form 8-K.
Form 8-K filed on November 6, 2003 - Other Events.
SIGNATURES
22
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
President, Chief Executive and Chief Financial
Officer
Dated: November 11, 2003
23
EXHIBIT INDEX
Exhibit Number Description
- -------------- -----------
31 Rule 13a-14(a)/15d-14(a) Certification -
President and Chief Executive Officer.
32 Section 1350 Certification - President and
Chief Executive Officer.
24