U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, DC 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 June 30, 2005
Or
/_/ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from _________ to ____________
Commission File No. 333-93475
CORNERSTONE MINISTRIES INVESTMENTS, INC.
----------------------------------------
(Exact name of small business issuer as specified in its charter)
Georgia 58-2232313
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(State or other jurisdiction (IRS Employer Identification Number)
of incorporation or organization)
2450 Atlanta Highway, Suite 904, Cumming, GA 30040
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(Address of principal executive office) (Zip Code)
Issuer's telephone number, including area code: (678)-455-1100
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Former name, address and former fiscal year, if changed since last report.
Check whether the issuer (1) filed all reports required to be filed by the
Section 13 or 15(d) of the Securities Exchange Act of 1934 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 past 90 days.
Yes X No
--- ---
As of June 30, 2005, there were issued and outstanding 819,799 shares of the
common stock of the issuer.
Transitional Small Business Disclosure Format (Check one): Yes [ ] No [X]
1
Cornerstone Ministries Investments, Inc.
Index
Page
Form 10-QSB Title Page 1
Index 2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Accountant's Review Report F-1
Balance Sheets as of June 30, 2005 and 2004 F-2
Statements of Operations for the three and six months
ended June 30, 2005 and 2004 F-3
Statements of Changes in Shareholders' Equity
for the three months ended June 30, 2005 and 2004 F-4
Statements of Cash Flows for the three months
ended June 30, 2005 and 2004 F-5
Notes to Financial Statements F-6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operation 3
Item 3. Controls and Procedures 8
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 8
Item 2. Changes in Securities and Use of Proceeds 9
Item 3. Defaults on Senior Securities 9
Item 4. Submission of Matters to a Vote of Security Holders 9
Item 5. Other Information 9
Item 6. Exhibits and Reports on Form 8-K 9
Signatures 9
Certifications - Exhibits 31.1 and 31.2 10
2
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operation.
Selected financial data.
Please read the following selected financial data in conjunction with the rest
of this "Management's Discussion and Analysis or Plan of Operation" and with our
financial statements and related notes in this filing.
Six months ended
June 30,
------------------------------
2005 2004
----------- -----------
Revenues $ 7,261,455 $ 5,809,315
----------- -----------
Investor interest expense 5,558,403 4,125,155
Loan loss expense 50,000 30,000
Marketing expenses 539,961 460,714
Management/advisory fees 702,165 629,096
Operating expenses 383,199 390,048
----------- -----------
Total expenses 7,233,728 5,635,013
----------- -----------
Operating income 27,727 174,302
Income tax provision (benefit) (44,271) 11,563
----------- -----------
Net income $ 71,998 $ 162,739
=========== ===========
Overview of operations.
We have always focused on serving faith-based organizations, mostly churches and
senior housing non-profits. We offer specialized programs for church and other
non-profit sponsors of senior housing and affordable/moderate income housing
programs. Nearly all of our earnings prior to 2001 came from financing church
facilities. During the last quarter of 2000, we began to realize revenues from
investment in senior and affordable/moderate income housing projects. During the
last quarter of 2004, we began to make loans to for-profit sponsors of
affordable and low-income housing projects. Less than 2% of our assets are
invested with for-profit sponsors and even though this percentage may increase
in the future, it will remain a small part of our loan portfolio. We generate
revenue from:
o interest on loans
o origination and renewal fees on loans
o loan participation income
o interest on securities
We currently charge a 5% to 10% fee on new loans, based upon expected terms, and
renewal fees of as much as 5% of the outstanding balance of the renewing loan.
Our interest rate on all new loans is currently from 7% to 10%. Some loans are
participating loans, which enable us to receive income from the borrower when
the borrower sells or refinances (with another lender) the property in which we
provided the financing. The participation percentage varies between 25% and 33%
of the borrower's gain.
Participating loans (all related to senior housing facilities) are classified as
real estate joint venture investments if all of the following exist at the
inception of the loan:
o The borrower does not have a substantial equity investment in the
property.
o The Company does not have recourse to substantial tangible, saleable
assets of the borrower other than the underlying collateral of the loan
and there is no irrevocable letter of credit for a substantial amount
of the loan.
o There is no take-out commitment for the full amount of the loan from a
creditworthy, independent third-party.
o The facility does not have lease commitments which will provide
sufficient cash flow to service normal principal and interest loan
amortization.
Comparison of Periods Ended June 30, 2004 and June 30, 2005
General. Assets increased from $116,432,553 at June 30, 2004 to $144,280,245 at
June 30, 2005 for an increase of $27,847,692 or 24%. This increase is a result
of the sale of Investor Certificates and Mortgage Participations, net of
redemptions of $27,688,641. With the additional net cash from these items and
from cash already on hand, we invested in real estate loans and joint venture
investments, net of principal payments received, of $37,147,070. Total revenue
increased for the three and six months ended June 30, 2005 by $544,332 or 18%
and $1,452,140 or 25% to $3,557,394 and $7,261,455, respectively. Net income
(loss) for the three and six months ended June 30, 2005 was ($14,906) and
$71,998 compared to $54,017 and $162,739, respectively for the same periods
ended June 30, 2004.
Total real estate loans and joint venture investments outstanding on June 30,
2005 was $129,581,852 compared to $92,434,782 on June 30, 2004 for an increase
of $37,147,070 or 40%. This increase is due to sales of Investor Certificates
and Mortgage Participation Agreements and the subsequent origination or
refinancing of real estate loans and joint venture investments, as follows:
3
New real estate loan originations $16,301,523
Increase in existing loans, net of principal received 5,943,437
New real estate joint venture investments made 7,936,901
Increase in existing real estate joint venture investments 6,965,209
-----------
$37,147,070
===========
All other assets composed primarily of cash, bond holdings, property and
equipment, and unamortized debt issue costs were $14,698,393 as of June 30,
2005.
Our cash balance decreased $9,775,903 from $15,773,663 on June 30, 2004 to
$5,997,760 on June 30, 2005. In 2004, our Series E certificates became effective
in March and because we had no certificates available for almost 10 months, when
Series E became effective, we sold approximately $19,000,000 in certificates in
the second quarter of 2004. We were unable to reinvest all of these proceeds by
June 30 as it normally takes two to four months to reinvest the cash into real
estate loans. In 2005, we have had certificates available for sale all year,
which makes it easier to manage our cash levels and reinvest proceeds from our
certificate sales.
Principal and interest payable on Investor Certificates and Mortgage
Participation ("MP") Agreements increased $27,688,641 or 25% from $110,475,767
as of June 30, 2004 to $138,164,408 as of June 30, 2005. In 2003, the Company
filed a registration statement with the Securities and Exchange Commission to
sell up to $40,000,000 in additional Investor Certificates and $11,375,000 in
Common Stock. The registration statement was approved on March 26, 2004 which
allowed us to start selling new Investor Certificates in the second quarter of
2004. Also, another registration statement was filed in August 2004 and became
effective in November 2004 which allows us to sell an additional $20,000,000 in
Investor Certificates and $9,750,000 in Common Stock. These registrations have
allowed us to continue the substantial increase in outstanding certificates and
the subsequent investment in new real estate loans and joint venture
investments.
Real estate loan and joint venture interest and fees earned. Interest income and
fees from real estate loans and joint venture investments for the three and six
months ended June 30 is as follows:
2005 2004 Increase %
---------- ---------- ---------- ----
Three months $3,358,169 $2,900,850 $ 457,319 15.8%
Six months $6,591,309 $5,598,347 $ 992,962 17.7%
The increase was due to the following:
Three Months Six Months
----------- -----------
Increase in average outstanding principal $ 880,530 $ 1,615,193
(Three Months: $125,759,429 - 2005; $89,725,937 - 2004)
(Six Months: $120,576,039 - 2005; $87,127,531 - 2004)
Change in weighted average interest rate (27,095) -0-
(Three Months: 9.73% - 2005; 9.85% - 2004)
(Six Months: 9.81% - 2005; 9.81% - 2004)
Change in loan fees recognized (396,116) (622,231)
----------- -----------
$ 457,319 $ 992,962
=========== ===========
The increase in average outstanding principal is due to the addition of 10 new
real estate loans and joint venture investments with outstanding principal of
$24,238,424 and increases in the weighted average principal outstanding on
existing loans of $9,210,084. Loan fees recognized decreased because three large
loans which we originated in the second half of 2003 and early 2004 had their
loan fees fully recognized by early 2005, thus decreasing 2005's revenue as
compared to 2004. Two of our new loans that we originated in early 2005 did not
have loan fees charged so we were not able to replace this revenue in the first
quarter of 2005.
Loan participation and other income. For the three and six months ended June 30,
2005, loan participation and other income increased as follows:
Three Months Six Months
-------------------------------------- --------------------------------------
2005 2004 Change 2005 2004 Change
-------- -------- -------- -------- -------- --------
Investment income $117,025 $104,887 $ 12,138 $264,209 $196,318 $ 67,891
Loan participation & other 82,200 7,325 74,875 405,937 14,650 391,287
-------- -------- -------- -------- -------- --------
Total $199,225 $112,212 $ 87,013 $670,146 $210,968 $459,178
======== ======== ======== ======== ======== ========
The Company's investment income is from the purchase of tax-free bonds used as
permanent financing for projects the Company funded during their development and
initial operations and from interest income on the Company's excess cash. The
increases in investment income are due to an increase in the Company's average
excess cash balance on hand and an increase in short-term interest rates. Each
contributed to approximately 50% of the increase in 2005 versus 2004.
4
For the three months ended June 30, the increase in loan participation and other
income was due to $60,000 in loan guarantee revenue and $15,000 in rent revenue
received from Cornerstone Capital Advisors for their rent of the corporate
office building in Cumming, GA during 2005. For the six months ended June 30,
the increase is due to $257,000 in loan participation revenue received in March,
2005, $104,000 in loan guarantee revenue (see Note 14 of the "Notes to Financial
Statements" for additional disclosures on loan guarantees) and $30,000 in rent
revenue received from Cornerstone Capital Advisors.
Investor interest expense. Investor interest expense for the three and six
months ended June 30, 2005 was $2,828,984 and $5,558,403, which are increases of
$666,319 (31%) and $1,433,248 (35%), respectively compared to 2004. The
increases are due to:
Three Months Six Months
----------- -----------
Increase in average outstanding certificate principal, including $ 726,333 $ 1,547,387
interest payable subject to compounding
(Three Months: $124,739,706 - 2005; $91,311,352 - 2004)
(Six Months: $122,201,473 - 2005; $86,547,402 - 2004)
Change in weighted average interest percentage (28,756) (63,745)
(Three Months: 8.68% - 2005; 8.80% - 2004)
(Six Months: 8.68% - 2005; 8.82% - 2004)
Decrease in average outstanding Mortgage Participation principal
(Three Months: $4,912,120 - 2005; $6,162,500 - 2004)
(Six Months; $5,148,660 - 2005; $6,156,340 - 2004) (31,258) ($ 50,384)
----------- -----------
$ 666,319 $ 1,433,248
=========== ===========
Loan loss expense and allowance for loan losses. We charged $25,000 and $10,000
for the three months and $50,000 and $30,000 for the six months ended June 30,
2005 and 2004, respectively to loan loss expense. These charges were due to
increases in the family housing development loan portfolio's outstanding
principal.
The total allowance for loan losses increased from $405,000 on June 30, 2004 to
$682,000 on June 30, 2005. This increase is due to: 1) an increase in the family
housing development loan portfolio's outstanding principal ($125,000), and 2)
slower than expected new home sales volumes at three projects and an increase in
the time that it has taken four projects to finish the development phase and
start selling homes ($152,000). These factors have increased the family housing
development loan portfolio's relative credit risk as compared to 2004, thus
necessitating the increase in our allowance for loan loss balance over the last
12 months. The collateral for the family housing loans includes a guarantee from
a non-profit company pledging up to $5,700,000 of net proceeds from the sale of
senior housing communities which are expected to be realized by September 30,
2005.
The allowance for loan loss increases that we made in 2004 and 2005 are
classified as collective loan loss allowances. A collective loan loss allowance
is recognized when the characteristics of a group of loans indicate that it is
probable that a loss exists even though the loss cannot be identified with a
specific loan. The allowance for loan losses is reviewed quarterly and increases
or decreases will be made based on the results of these reviews.
As of June 30, 2005, two church loans with a total carrying amount of $1,909,011
were considered impaired. As of June 30, 2004, one church loan with a carrying
amount of $1,646,353 was considered impaired. No specific impaired loan loss
allowance has been recorded because the carrying amounts of the impaired loans
are less than the loan's collateral or the present value of the loans expected
future cash flows.
As of June 30, 2005, allowance for loan losses as a percent of outstanding loan
principal by loan type:
Loan Loss Outstanding
Allowance Principal %
---------- ------------- ----
Family Housing Development Loans $ 682,000 $ 40,750,848 1.7%
Church Mortgage Loans -0- 9,163,395 0%
Senior Housing Mortgage Loans -0- 13,861,474 0%
Real Estate Joint Venture Investments -0- 59,673,803 0%
---------- ------------- ----
Total $ 682,000 $ 129,449,520 .5%
========== ============= ====
Marketing expenses. Total expenses for the marketing of Investor Certificates
for the three and six months ended June 30, 2005 were $252,392 and $539,961
compared to $256,178 and $460,714 for the same periods in 2004. The changes are
due to:
Three Months Six Months
------------------------------------------ ----------------------------------------
2005 2004 Change 2005 2004 Change
--------- --------- --------- --------- --------- --------
Debt issue cost amortization $ 223,716 $ 203,633 $ 20,083 $ 463,117 $ 366,361 $ 96,756
Other marketing costs 28,676 52,545 (23,869) 76,844 94,353 (17,509)
--------- --------- --------- --------- --------- --------
$ 252,392 $ 256,178 ($ 3,786) $ 539,961 $ 460,714 $ 79,247
========= ========= ========= ========= ========= ========
5
Selling commissions paid to brokers for selling Investor Certificates and
Mortgage Participations and costs incurred to register Investor Certificates are
paid in cash and charged as an expense over the term of the related debt. The
unamortized balance is classified as an asset on the balance sheet as
"Unamortized debt issue costs". The balance was $2,801,718 and $2,328,558 as of
June 30, 2005 and 2004, respectively.
The increase in debt issue cost amortization for the three and six months ended
June 30 are due to an increase in the outstanding Investor Certificates
outstanding at June 30, 2005. Other marketing costs have decreased because we
are not using marketing consultants in 2005 to help us design programs to sell
our Investor Certificates.
Operating and management expenses. Management and advisory expenses for the
three and six months ended June 30 increased $14,675 (5%) and $73,069 (12%) from
$308,876 and $629,096 in 2004 to $323,551 and $702,165 in 2005, respectively.
The increases are due to the Company's growth in revenues in 2005.
Starting in July 2003, the Company contracted with CCA to provide all
administrative and executive personnel services. From July 1, 2003 until July
31, 2004, the agreement obligated us to reimburse actual expenses incurred by
CCA. Also, CCA was eligible to receive incentive compensation of up to 10% of
actual expenses billed to us for the prior 12 months.
Effective August 1, 2004, the original agreement was modified so that we will
pay CCA as follows:
o A monthly management fee equal to 10% of our revenues from all sources
other than loan fees, loan participation revenue, and revenue received from
CCA plus 30% of loan participation revenue.
o A loan origination fee equal to 30% of the total loan fees charged by the
Company to its borrowers. The fee is generally paid from loan proceeds and
reduces deferred loan fees that we will recognize over the life of the
loan.
Please see Note 3 of the "Notes to Financial Statements" for additional
information about our agreement with CCA and for amounts that we have paid to
CCA for the three and six month periods ended June 30, 2005 and 2004.
For the three and six months ended June 30, 2005 and 2004, operating expenses
were as follows:
2005 2004 Change
-------- -------- --------
Three Months Ended $195,237 $231,884 ($36,647)
Six Months Ended $383,199 $390,048 ($ 6,849)
For the three and six months ended June 30, 2005 and 2004 the decreases are due
to:
Three Months Six Months
------------ ----------
Consulting Expenses $ (48,106) $ (63,472)
Legal Expenses 39,537 78,875
Appraisal Costs (25,257) (26,208)
Other (2,821) (3,956)
------------ ----------
$ (36,647) $ (6,849)
============ ==========
Consulting expenses decreased because in 2004, we used consultants to identify
new markets for us in the African-American church community. We have not used
consultants for any material projects in 2005. Legal costs have increased as a
result of the ongoing legal proceedings concerning the Chicago Stock Exchange.
Please see Part II, Item 1 for additional information on this issue. Appraisal
costs decreased because in the second quarter of 2004, we ordered new appraisals
on a number of properties which serve as collateral on senior housing and church
loans. We have not ordered any new appraisals in 2005. Other costs have not
materially changed in 2005 as compared to 2004.
Income tax provision (benefit). The income tax provision (benefit) for the three
and six months ended June 30, 2005 was ($52,864) and ($44,271), respectively
compared to ($10,558) and $11,563, respectively for the same periods ended June
30. 2004. The net decrease in income taxes is due to a decrease in pre-tax
income. The Company's effective tax provision rate was (78.0%) and (24.3%) for
the three months and (159.7%) and 6.6% for the six months ended June 30, 2005
and 2004, respectively. A reconciliation of the Company's effective tax
provision rate to the federal statutory rate is included in the attached "Notes
to Financial Statements" (Note 10).
Dividends. Dividends of $211,143 and $155,066 were declared on June 30, 2005 and
2004 and paid in the following month.
Liquidity and Capital Resources
Cash flows from operations. Net cash provided by the Company's operations for
the six months ended June 30, 2005 and 2004 was $808,093 and $397,339,
respectively. The increase in 2005 was due to an increase in depreciation and
amortization expense, an increase in accrued investor certificate interest
payable, an increase in cash received from loan fees and interest and a decrease
in other assets, partially offset by decreases in net income, accounts and other
payables, and an increase in loans in progress.
6
Investor and mortgage participation interest payable increased $2,362,868 in the
first six months of 2005 due to an increase in outstanding debt and because
approximately 25% to 30% of the Investor Certificate holders who purchased
certificates in 2004 and 2005 have elected to reinvest the interest due to them
each year and not receive the interest in cash until maturity.
Included in the 2005 and 2004 changes in accrued real estate loan and joint
venture interest and deferred loan fee amounts is $768,254 and $782,529 in
interest which was financed as part of loan principal. We receive monthly
interest payments on our loans except when the terms of certain loans allow
borrowers to finance interest payments while the collateralized property is
under development or construction. A summary (by loan type) of the amount of net
financed interest for the six months ended June 30, 2005 and 2004 is as follows:
2005 2004
--------- ---------
Family Housing Development $ 504,582 $ 496,082
Church Construction (3,819) 39,601
Real Estate Joint Venture 267,491 246,846
--------- ---------
$ 768,254 $ 782,529
========= =========
The amount for 2005 represents interest accrued and financed in 2005, net of
payments received in 2005 that were financed in previous years. 2004's amount
represents interest accrued and financed in 2004, net of payments received in
2004 that were financed in previous years.
The increase in the family housing net financed interest in 2005 as compared to
2004 is due to: 1) increased loan balances on six projects which are now in the
development phase and are financing their monthly interest, and 2) one new loan
addition since June 30, 2004 which is in the development phase of construction.
Although the amount of financed interest from these projects will remain fairly
high (currently $80,000 to $90,000 per month), the amount of interest financed
should decline starting in the third or fourth quarter of 2005 because two or
three of these projects should be going into their sales phase and we will begin
to receive interest payments in cash.
The Real Estate Joint Venture financed interest in 2005 is for a loan in
McKinney, TX ($175,558) and for a loan in Chattanooga, TN ($91,933). The
McKinney, TX loan is collateralized by raw land which is being developed for
senior housing. We have been financing the interest on this loan since June,
2003. Our other Real Estate Joint Venture Investment loans are collateralized by
existing facilities that only needed to be remodeled. Therefore, the period in
which the interest is being financed on the McKinney loan is much longer than
the other Real Estate Joint Venture Investment loans. Normally, we finance two
to six months' of interest on senior housing loans. We anticipate, due to the
size of the McKinney project that we will finance interest for another 12 to 24
months. The Chattanooga, TN loan completed its remodeling in 2004 and its
lease-up phase has taken longer than anticipated; therefore, we have capitalized
some of their interest in 2005. We are analyzing and watching this loan closely
to ensure that the stabilized value of the property is greater than the loan
amount and that we do not have any collectibility issues with this loan.
Cash flows from investing activities. For the six months ended June 30, 2005,
the Company used $17,076,823 in cash from investing activities which is an
increase of $9,276,469 from $7,800,354 for the six months ended June 30, 2004.
The increase was due to an increase in real estate and joint venture loans made
in 2005. In the first quarter of 2004 we had no Investor Certificates available
for sale so we were unable to originate loans at the same rate that we have been
able to in 2005.
It is probable that in late September, 2005, that two of our major borrowers
will sell their interests in as many as nine senior housing facilities. If this
happens, approximately $62,000,000 in senior housing real estate loans and real
estate joint venture investments would be received by us as payment on our
existing loans and investments. We are actively seeking alternative loans and
investments in which to invest these proceeds in anticipation of this deal being
finalized.
Cash flows from financing activities. For the six months ended June 30, 2005,
the Company raised $11,398,470 from the sale of Investor Certificates and
Mortgage Participation Agreements. This represents a decrease of $8,325,994 from
new Investor Certificate and Mortgage Participation sales of $19,724,464 for the
six months ended June 30, 2004. When Series E became effective in March, 2004,
we started selling new certificates for the first time in almost 11 months.
Because of this long period of time with no certificates for sale, we
experienced a huge demand in the first few months that Series E was on the
market in 2004, selling over $19,000,000 in Series E certificates in only three
months. Now that we have had certificates on the market for 15 straight months,
the demand has decreased to a steady and more manageable level as compared to
2004.
Investor Certificates redeemed for cash decreased from $1,763,292 for the six
months ended June 30, 2004 to $1,020,285 for the three months ended June 30,
2005. This decrease is due to a larger amount of maturities in 2004 versus 2005.
Also, in the first three months of 2004, we had no new Investor Certificates in
which maturing certificates could be reinvested; therefore, all of 2004's
maturities during the first three months of the year were paid in cash.
7
We have $22,611,060 in Investor Certificates coming due or redeemable upon
demand in the next 12 months. $10,216,014 of this amount is for graduated
certificates, which allow an investor to redeem their certificate each year on
the anniversary date of the purchase. Based on our historical experience, we
expect that less than 20% of the graduated certificates will be redeemed for
cash during the next 12 months. Also, $10,802,768 in five-year bonds will mature
in March, 2006.
We are in the process of filing a new registration statement with the Securities
and Exchange Commission with approximately $60,000,000 in Series G Investor
Certificates available for issuance with terms similar to our Series E and F
certificates. If approved, we will offer these new certificates to investors
with maturing certificates as a way for them to continue their investment with
us. Our historical experience indicates that over 75% of the maturities will be
reinvested into new Investor Certificates, but there is no guarantee that this
will happen or that there will be certificates available to reinvest in. We will
ensure that we have enough cash available to handle these maturities.
Among the measures we take to mitigate any demands for cash are:
o Maintain a minimum cash balance, normally no less than $3,000,000.
o Have readily marketable loans that can be sold for par or a premium.
o Ask investors their intentions at least 30 days before their bonds
mature.
o Have a bank willing to extend credit lines if needed.
o Spread maturity dates throughout the year.
o Limit each investor to not more than $500,000 maturing in any
three-month period.
We believe that cash on hand, cash generated by operations and expected
refinancing and pay-offs of existing loans, will be sufficient to meet our
financing and capital needs for the coming year. The amount and timing of our
future capital requirements will depend on factors such as the origination and
funding of new investments, any opportunities for acquisitions of related
businesses and the overall success of our marketing efforts for certificates,
shares and any other securities.
Item 3. Controls and Procedures
The principal executive officer and the principal financial officer of the small
business issuer, Cornerstone Ministries Investments, Inc., have, as of June 30,
2005, evaluated the small business issuer's disclosure controls and procedures,
as defined by Sections 13a-14(c) and 15d-14(c) of the Securities Exchange Act of
1934. Based on their evaluation, they have concluded that those disclosure
controls and procedures are designed and implemented effectively to ensure that
information required to be disclosed by the small business issuer in the reports
that it files or submits under that Act is recorded, processed, summarized and
reported, within the time periods specified in the Commission's rules and forms.
Part II. Other Information
Item 1. Legal Proceedings
The laws in many states provide an exemption from registration for offerings of
securities approved for listing on the Chicago Stock Exchange (the "Exchange").
Since April 2000, we have considered our securities to have been approved for
listing on the Exchange. Prospectuses for our public offerings of bonds and
common stock, and our publicly-filed reports, have included statements that our
common stock was approved for listing on the Chicago Stock Exchange.
On December 3, 2004, a letter from the Exchange denied our application for
listing and said that it had not previously approved our common stock for
listing. However, on February 4, 2005, a second letter from the Exchange said
that, upon review, the Exchange had apparently approved our common stock for
listing subject to the completion of an offering that would meet the Exchange's
numerical standards for shareowners' equity, number of public shareholders and
publicly held shares. A March 1, 2005 clarification from the Exchange said it
agrees that our status was not inconsistent with its being "approved for listing
upon notice of issuance," the language used in state exemption laws. Our common
stock will not be listed on the Exchange in the future.
Based upon the Exchange's position in its December 3, 2004 letter, securities
regulators for several states each raised the issue of whether we lawfully
offered and sold securities without registration in those states and/or whether
our prospectuses and publicly-filed reports were false and misleading, in their
reference to Exchange approval for listing. Michigan's Commissioner of Financial
and Insurance Services issued Orders of Denial related to our application to
register our Series F offering in that state and initiated an enforcement case
with a Notice of Opportunity to Show Compliance, to which we have responded. We
disagree with the actions taken by Michigan and have administratively appealed
its decisions.
On February 4, 2005, the Texas State Securities Board told us that, by February
11, 2005, either we sign an Agreed Cease and Desist Order and pay a $20,000 fine
or it would obtain an emergency administrative cease and desist order, without
8
our being represented. We chose to sign the order and we paid the fine. The
order is that we "immediately cease and desist from engaging in conduct that is
materially misleading or is otherwise likely to deceive the public in connection
with the offer for sale of any security in Texas." On April 26, 2005, we
consented to entry of a Cease and Desist Order by the Minnesota Commissioner of
Commerce that we cease and desist from offering and selling securities in
Minnesota until we are in compliance with Minnesota statutes and until the
Commissioner's further order. We also agreed to redeem all certificates
purchased by Minnesota residents and to pay an $8,000 civil penalty.
As of August 10, 2005, we are not aware that any other state has instituted any
formal proceedings on this or any other issue related to any of our securities
offerings and we are not a party to any other pending legal proceedings. We are
not aware that any of the properties covered by our mortgage loans is subject to
any pending legal proceedings or that any government authority is contemplating
any legal proceedings involving us or any of those properties, other than
described above.
Item 2. Changes in Securities
Not Applicable
Item 3. Defaults upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of Securities Holders
Not Applicable
Item 5. Other Information
Not Applicable
Item 6. Exhibits and Reports on Form 8-K
(a) (1) Exhibit 32.1, Certifications pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(2) Exhibit 15, Letter on un-audited interim financial information.
(b) No reports on Form 8-K were filed during the quarter for which this report
is filed.
Signatures
In accordance with the requirements of the Securities and Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Dated: August 10, 2005 Cornerstone Ministries Investments, Inc.
(Registrant)
By: S/John T. Ottinger
------------------------------------
John T. Ottinger
Vice President and
Chief Financial Officer
9
To The Board of Directors
Cornerstone Ministries Investments, Inc.
We have reviewed the accompanying balance sheet of Cornerstone Ministries
Investments, Inc. as of June 30, 2005 and 2004, and the related statements of
operations, changes in shareholder's equity, and cash flows for the three-month
and six-moth periods ending June 30, 2005 and 2004. These interim financial
statements are the responsibility of the Company's management.
We conducted our review in accordance with the standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit in accordance with the standards of
the Public Company Accounting Oversight Board, the objective of which is the
expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to the accompanying interim financial statements for them to be in
conformity with U.S. generally accepted accounting principles.
/s/ Robert N. Clemons, CPA, PA
DeLand, Florida
August 8, 2005
F-1
CORNERSTONE MINISTRIES INVESTMENTS, INC.
BALANCE SHEETS
As of June 30, 2005 and 2004
6/30/2005 6/30/2004
------------- -------------
ASSETS
Cash and cash equivalents $ 5,997,760 $ 15,773,663
Loan guarantee receivable -- 60,000
Loans in process 274,019 162,172
Real estate loans, net 69,583,614 47,338,654
Real estate joint venture investments, net 59,998,238 45,096,128
Bond holdings and accrued interest 3,995,883 4,014,667
Property and equipment, net 783,586 847,758
Refundable income taxes 3,778 3,522
Goodwill 450,997 450,997
Unamortized debt issue costs 2,801,718 2,328,558
Real estate held for investment 340,000 340,000
Other assets 50,652 16,434
------------- -------------
TOTAL ASSETS $ 144,280,245 $ 116,432,553
============= =============
LIABILITIES
Investor certificates and accrued interest $ 133,212,335 $ 104,263,625
Mortgage participations and accrued interest 4,952,073 6,212,142
Accounts and other payables 139,750 230,759
Common dividends payable 211,143 155,066
Loan guarantee obligation 71,000 60,000
Building mortgages 589,540 175,442
Capital lease obligation 4,723 10,904
Deferred taxes payable 19,346 161,701
------------- -------------
TOTAL LIABILITIES 139,199,910 111,269,639
------------- -------------
SHAREHOLDERS' EQUITY
Series A Convertible Preferred Stock, no par
value; 235,000 shares authorized, no
shares issued and outstanding -- --
Common Stock, $0.01 par value; 10 million shares authorized;
819,799 and 821,499 shares issued and outstanding 8,198 8,215
Paid in capital 5,120,039 5,145,797
Retained earnings (deficit) (47,902) 8,902
------------- -------------
TOTAL SHAREHOLDERS' EQUITY 5,080,335 5,162,914
------------- -------------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 144,280,245 $ 116,432,553
============= =============
SEE ACCOMPANYING NOTES F-2
CORNERSTONE MINISTRIES INVESTMENTS, INC.
STATEMENTS OF OPERATIONS
For the three and six months ended June 30, 2005 and 2004
3 Mo. Ended 3 Mo. Ended 6 Mo. Ended 6 Mo. Ended
6/30/2005 6/30/2004 6/30/2005 6/30/2004
----------- ----------- ----------- -----------
REVENUES
Real estate loan and joint venture interest and fees $ 3,358,169 $ 2,900,850 $ 6,591,309 $ 5,598,347
Loan participation and other income 199,225 112,212 670,146 210,968
----------- ----------- ----------- -----------
TOTAL REVENUES 3,557,394 3,013,062 7,261,455 5,809,315
----------- ----------- ----------- -----------
EXPENSES
Investor interest expense 2,828,984 2,162,665 5,558,403 4,125,155
Loan loss expense 25,000 10,000 50,000 30,000
Marketing expenses 252,392 256,178 539,961 460,714
Management and advisory fees 323,551 308,876 702,165 629,096
Operating expenses 195,237 231,884 383,199 390,048
----------- ----------- ----------- -----------
TOTAL EXPENSES 3,625,164 2,969,603 7,233,728 5,635,013
----------- ----------- ----------- -----------
Income (loss) before provision for income taxes (67,770) 43,459 27,727 174,302
Income tax (benefit) provision (52,864) (10,558) (44,271) 11,563
----------- ----------- ----------- -----------
NET INCOME (LOSS) $ (14,906) $ 54,017 $ 71,998 $ 162,739
=========== =========== =========== ===========
Basic and Diluted Earnings
per Common Share $ (0.02) $ 0.07 $ 0.09 $ 0.27
SEE ACCOMPANYING NOTES AND ACCOUNTANT'S REVIEW REPORT F-3
CORNERSTONE MINISTRIES INVESTMENTS, INC.
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the six months ended June 30, 2005 and 2004
RETAINED
COMMON STOCK: PAID-IN PREFERRED EARNINGS TREASURY TOTAL
SHARES AMOUNT CAPITAL STOCK (DEFICIT) STOCK EQUITY
----------- ----------- ----------- ------ ----------- --------- -----------
BALANCE, DECEMBER 31, 2003 531,528 $ 5,315 $ 3,297,435 $ -- $ 1,229 $ (73,248) $ 3,230,731
Net income -- -- -- -- 162,739 -- 162,739
Dividend declared -- -- -- -- (155,066) -- (155,066)
Common stock issued 289,971 2,900 1,881,911 -- -- -- 1,884,811
Common stock issuance costs -- -- (33,549) -- -- -- (33,549)
Treasury stock sold (11,269 shares) -- -- -- -- -- 73,248 73,248
----------- ----------- ----------- ------ ----------- --------- -----------
BALANCE, JUNE 30, 2004 821,499 $ 8,215 $ 5,145,797 $ -- $ 8,902 $ -- $ 5,162,914
=========== =========== =========== ====== =========== ========= ===========
BALANCE, DECEMBER 31, 2004 819,351 $ 8,194 $ 5,118,568 $ -- $ 91,243 $ -- $ 5,218,005
Net income -- -- -- -- 71,998 -- 71,998
Dividend declared -- -- -- -- (211,143) -- (211,143)
Common stock issued 17,864 179 115,937 -- -- -- 116,116
Common stock issuance costs -- -- (1,440) -- -- -- (1,440)
Common stock redeemed (17,416) (175) (113,026) -- -- -- (113,201)
----------- ----------- ----------- ------ ----------- --------- -----------
BALANCE, JUNE 30, 2005 819,799 $ 8,198 $ 5,120,039 $ -- $ (47,902) $ -- $ 5,080,335
=========== =========== =========== ====== =========== ========= ===========
SEE ACCOMPANYING NOTES F-4
CORNERSTONE MINISTRIES INVESTMENTS, INC.
STATEMENTS OF CASH FLOWS
For the six months ended June 30, 2005 and 2004
2005 2004
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 71,998 $ 162,739
Adjustments to reconcile net income to cash
from operations-
Depreciation and amortization 494,272 398,644
Changes in-
Loans in process (243,146) (43,668)
Accrued bond interest, net -- (13,334)
Accrued real estate loan/joint venture interest and deferred loan fees (1,853,100) (1,947,868)
Allowance for loan losses 50,000 30,000
Deferred taxes (51,011) (9,742)
Refundable income taxes (3,778) 39,095
Investor and mortgage participation interest payable 2,362,868 1,819,141
Loan guarantee obligations, net of related receivables (33,000) --
Accounts and other payables (104,871) (37,047)
Other assets 117,861 (621)
------------ ------------
NET CASH PROVIDED BY OPERATIONS 808,093 397,339
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Real estate loans made (20,288,673) (4,496,366)
Real estate loan principal payments received 5,656,896 5,509,656
Real estate joint venture investments made (2,460,376) (8,806,704)
Bonds redeemed or sold 17,850 --
Property and equipment purchased (2,520) (6,940)
------------ ------------
NET CASH USED BY INVESTING ACTIVITIES (17,076,823) (7,800,354)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Investor certificates sold 11,248,470 19,646,214
Investor certificates redeemed (1,020,285) (1,763,292)
Mortgage participation agreements sold 150,000 78,250
Mortgage participation agreements redeemed (2,400,000) --
Debt issue costs paid (593,495) (922,288)
Building mortgage principal payments (12,829) (4,752)
Capital lease principal payments (3,218) (2,728)
Common stock issued, net of issuance costs 114,676 1,851,262
Common stock redeemed (113,201) --
Dividends paid (266,287) (169,087)
Treasury stock sold -- 73,248
------------ ------------
NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES 7,103,831 18,786,827
------------ ------------
Net change in cash and cash equivalents (9,164,899) 11,383,812
Cash and cash equivalents at beginning of period 15,162,659 4,389,851
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 5,997,760 $ 15,773,663
============ ============
Supplemental Information-
Interest paid during the period $ 3,217,955 $ 2,314,706
Income taxes paid during the period $ 105,000 $ 62,500
Non-cash transactions-
Investor certificates matured and re-invested $ 151,412 $ --
Loan interest financed and included in loan principal $ 768,254 $ 782,529
SEE ACCOMPANYING NOTES F-5
CORNERSTONE MINISTRIES INVESTMENTS, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying financial statements include the accounts of Cornerstone
Ministries Investments, Inc. ("the Company"). Previously, the Company's
financial statements included the accounts of two wholly-owned subsidiaries,
Wellstone Communities, Inc. and Wellstone Financial Group, LLC. In June, 2004,
the Company dissolved both subsidiaries. See Note 17 for additional disclosures.
The Company originates and purchases mortgage loans, substantially all of which
are made to faith-based organizations. The Company offers specialized loan
programs for churches, non-profit sponsors of senior housing facilities and
either non-profit or for-profit sponsors of affordable and low income housing
projects. The Company also invests in other real estate projects for the purpose
of selling at a profit, or leasing. Substantially all of the Company's loans and
investments are in projects located in the Southeastern United States.
Cash and cash equivalents include checking accounts and short-term certificates
with original maturities of 90 days or less.
Real estate loans and senior housing loans classified as real estate joint
venture investments include unpaid principal and accrued interest balances net
of deferred loan fees and unearned discounts, less an allowance for loan losses.
Interest income is recognized monthly on the accrual basis in accordance with
loan terms. Interest income is recognized on the cash basis for loans with a
recorded impairment loss (other than restructured loans) and the possibility of
future loss considered remote. If the possibility of future loss is not remote,
then interest income is not recognized and interest payments are credited to
outstanding loan principal. Loan origination fees are deferred and amortized as
a yield adjustment over the lives of the related loans using the interest
method. Amortization of deferred loan fees is discontinued when a loan is placed
on non-accrual status. Interest income and loan fees recognized from real estate
loans and senior housing loans classified as real estate joint venture
investments are reported as "Real estate loan and joint venture interest and
fees" in the accompanying Statements of Operations.
The Company receives monthly interest payments on its real estate loans and
senior housing loans (classified as real estate joint venture investments)
except when the terms of a loan allow a borrower to finance interest payments.
Interest is financed in the following circumstances:
o Family housing loans may finance interest while the project is in the
development and pre-sales phase, which normally lasts 12 to 36 months
depending on the size of the project. The Company receives the financed
interest as the borrower sells homes in the development.
o Church construction loans may finance interest while the church building
is under construction. This takes three to nine months, depending on the
size of the building. When the building is operational, the financed
interest from the construction phase is included in the loan's principal
amount and the Company begins receiving monthly interest payments from the
borrower.
o Senior housing loans may finance interest during the construction,
renovation and lease-up stages of the borrower's operations. This takes
two to six months if there is an existing building and 12 to 24 months if
the financed property is raw land and a new building is being constructed.
When the facility is operational, the financed interest is included in the
loan's principal amount and the Company begins receiving monthly interest
payments from the borrower.
Senior housing loans are classified as real estate joint venture investments if
the Company participates in a property's residual profits and all of the
following exist at the inception of the loan:
o The borrower has title but not a substantial equity investment in the
property.
o The Company does not have recourse to substantial tangible, saleable
assets of the borrower other than the underlying collateral of the loan
and there is no irrevocable letter of credit for a substantial amount of
the loan.
o There is no take-out commitment for the full amount of the loan from a
creditworthy, independent third-party.
o The facility does not have lease commitments which will provide sufficient
cash flow to service normal principal and interest loan amortization.
The Company normally provides all or substantially all of the funding (directly
or through loan guarantees) for the acquisition and development of these
facilities, which are owned by non-profit entities. The Company participates in
F-6
residual profits through loan participation agreements, which enable the Company
to receive income from the borrower when the property in which the Company
provided financing is sold or refinanced with another lender. The participation
is between 25% and 33% of the borrower's gain. Loan participation income is
recognized when the borrower's sale or refinancing is completed and the Company
receives cash from the borrower.
Loans in process are amounts advanced or expended on behalf of borrowers prior
to completion of the loan documentation. Interest is not accrued on these
amounts until the loan documentation is complete and the borrower acknowledges
the debt and associated interest. Substantially all of these expenditures are
converted to loans within one year or less.
Unamortized debt issue costs include the costs and commissions associated with
issuing Investor Certificates and Mortgage Participation Agreements. These costs
are being amortized on a straight-line basis over the term of the associated
debt, principally five years.
The allowance for loan losses for real estate loans and senior housing loans
classified as real estate joint venture investments is maintained at a level
which, in management's judgment, is adequate to absorb credit losses inherent in
the loan portfolio. The amount of the allowance is determined in accordance with
SFAS No. 5 (collective loan losses) and SFAS No. 114 (specific impaired loan
losses). A collective loan loss is recognized when the characteristics of a
group of loans indicate that it is probable that a loss exists even though the
loss cannot be identified with a specific loan. The collective loan loss
allowance amount is based on observable data that management believes is
reflective of the underlying credit losses inherent in the portfolio. The
components of this evaluation include trends in the Company's historical loss
experience, changes in credit risk and credit quality, credit concentrations,
economic conditions, collateral values, and other risks inherent in the
portfolio. Specific impaired loan loss allowances are made when it is determined
that a loan is impaired and the loan's carrying amount exceeds the present value
of estimated future cash flows, or, if the loan is considered collateral
dependant, the loan's collateral value. A loan is considered impaired if it is
probable that the Company will be unable to collect all amounts due according to
the contractual terms of the loan agreement. Although management uses available
information to recognize losses on loans, because of uncertainties associated
with local economic conditions, collateral values, and future cash flows on
impaired loans, it is reasonably possible that a material change could occur in
the allowance for loan losses in the near term. However, the amount of the
change that is reasonably possible cannot be estimated. The allowance is
increased by a provision for loan loss and reduced by charge-offs, net of
recoveries. Changes in the allowance relating to specific impaired loans are
charged or credited to loan loss expense. Loans are charged-off to the extent
the loan's carrying amount exceeds the net realizable value of the collateral,
with the charge-off occurring when it is likely that the loan is uncollectible
and foreclosure will occur.
Bond holdings consist of tax-free local government securities and church bonds.
The Company accounts for these investments using SFAS No. 115, "Accounting for
Certain Investments in Debt and Equity Securities", and classifies the bonds as
"available for sale" securities. The bonds are recorded at cost and adjusted for
unrealized holding gains and losses. Temporary unrealized holding gains and
losses are reported, net of deferred taxes, as a separate component of
shareholder's equity until realized. If an unrealized holding loss is judged to
be other than temporary, the cost basis of the security is written down to fair
value and included in earnings.
Property and equipment are valued at cost when purchased. Depreciation is
provided on the straight-line method over the estimated useful lives of the
assets, which are three to five years for furnishings and equipment, and 40
years for office buildings.
Real estate held for investment includes land which the Company owns and intends
to hold as an investment for more than one year. The assets are carried at the
lesser of cost or fair value as required by SFAS No. 144, "Accounting for
Impairment or Disposal of Long-Lived Assets". Impairment losses are recognized
when the carrying amount of a long-lived asset is determined not to be
recoverable and the carrying amount exceeds fair value. Profit from real estate
sales is recognized when the collectibility of the sales price is reasonably
assured and the Company is not obligated to perform significant activities after
the sale to earn the profit. If either of these conditions exists, all or part
of the profit is deferred and recognized using the installment sale method or
cost recovery method as prescribed by SFAS No. 66, "Accounting for Sales of Real
Estate".
F-7
Interest on Investor Certificates is accrued from the date of issuance.
Certificate holders choose, at the time of purchase, to have interest paid
semi-annually or upon redemption. Investors holding five year certificates in
multiples of $10,000 may receive interest monthly. Unpaid interest is compounded
semi-annually. Interest on Mortgage Participation Agreements is accrued from the
date of issuance and is paid monthly.
Mortgage Participation Agreements are accounted for as secured borrowings with
pledges of collateral because the agreements do not meet the definition of a
sale of a financial asset under SFAS No. 140, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities".
The Company is guarantor on certain loans secured by senior housing facilities
which are owned by non-profit entities. Loan guarantees that originated prior to
January 1, 2003 have no obligation recognized in the financial statements. For
loan guarantees that were originated or modified on or after January 1, 2003, a
loan guarantee obligation is recognized based on the loan guarantees estimated
fair value. The Company charges the loan guarantee's fair value to the
respective borrower as compensation for the Company's risk and payment is
expected within 30 days of the loan guarantee's origination or modification
date. Unpaid amounts are classified as "Loan guarantee receivables" in the
accompanying balance sheets. Loan guarantee obligations are analyzed at the end
of each quarter and if the fair value of the loan guarantee has declined, the
carrying amount of the obligation is reduced and credited to earnings.
Income taxes are provided for the tax effects of transactions reported in the
financial statements and consist of taxes currently due plus deferred taxes
related primarily to the difference between the methods of accounting for
depreciation, amortization, start-up costs, allowance for loan losses, and
installment sales for financial and tax-reporting purposes. The deferred taxes
represent the estimated future tax consequences of those differences, which will
be either taxable or deductible when the assets and liabilities are recovered or
settled. Accelerated depreciation methods and shorter asset lives are used for
tax reporting, and straight-line depreciation is used for financial statement
reporting. The Company calculates deferred taxes under the provisions of SFAS
No. 109 which provides for deferred tax assets and liabilities to be carried on
the balance sheet at current tax rates.
Management uses estimates and assumptions in preparing these financial
statements in accordance with generally accepted accounting principles. The
estimates and assumptions affect the reported amounts of assets and liabilities,
the disclosure of contingent assets and liabilities, and reported revenues and
expenses. Actual amounts may vary from the estimates that are used.
Basic earnings per common share are calculated by dividing net income by the
weighted average number of common shares outstanding during the year. Diluted
earnings per common share are calculated by adjusting weighted average
outstanding shares, assuming conversion of all potentially dilutive shares of
Series A Convertible Preferred Stock.
New Accounting Pronouncements:
In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment (SFAS
123R). This standard amends SFAS No. 123, Accounting for Stock-Based
Compensation, and supercedes APB Opinion No. 25, Accounting for Stock Issued to
Employees, and its related implementation guidance. SFAS 123R establishes the
accounting for grants of stock options and other transactions in which an entity
exchanges its equity instruments for goods or services. SFAS 123R requires that
companies use a fair value method to value stock options and recognize the
related compensation expense in net earnings. The provisions of SFAS 123R are
effective for the first reporting period beginning after June 15, 2005, although
earlier application is encouraged. The Company does not have any share-based
payment obligations and does not expect this pronouncement to have a material
effect on our financial position or results of operations.
In March 2004, the FASB's Emerging Issues Task Force (EITF) finalized Issue No.
03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments (EITF 03-1). The FASB has delayed the implementation of EITF
03-1 and has begun a new project to address the issues associated with
other-than-temporary impairment of debt and equity securities. The outcome of
this new project and its impact on the Company's financial position or results
of operations cannot be determined at this time.
F-8
In January 2003, the FASB issued Interpretation No. 46 (FIN 46), Consolidation
of Variable Interest Entities (VIEs), an interpretation of ARB (Accounting
Research Bulletin) No. 51. In December 2003, the FASB issued a revised version
of FIN 46 (FIN 46R), which delayed the effective date of FIN 46 for all VIEs
until March 2004. This interpretation requires the consolidation of entities in
which an enterprise absorbs a majority of the entity's expected losses, receives
a majority of the expected residual gains, or both, as a result of ownership,
contractual or other financial interests in the entity. FIN 46R and its various
interpretations have not materially impacted the Company's financial position or
results of operations.
Recently, the FASB has been very active, issuing a number of accounting
pronouncements with various effective dates. These pronouncements, which were
not discussed above, do not have a material effect on our financial statements.
NOTE 2 - PROPERTY AND EQUIPMENT
At June 30, property and equipment is composed of:
2005 2004
--------- ---------
Office Condominiums $ 797,554 $ 792,659
Office Computers, Furnishings,
Software & Equipment 122,037 121,437
Vehicles 30,351 37,730
Capital lease - phone system 17,710 17,710
Less: Accumulated Depreciation (184,066) (121,778)
--------- ---------
Property and equipment, net $ 783,586 $ 847,758
Depreciation exp. - three months $ 15,496 $ 16,262
Depreciation exp. - six months $ 31,154 $ 32,282
NOTE 3 - COMMITMENTS AND RELATED PARTY TRANSACTIONS
Leases:
During 2003, the Company entered into a capital lease for a new telephone system
at the Company's headquarters. The lease was recorded at the asset's fair value
and is being amortized over three years using the straight-line method. Interest
expense is calculated based on the implied interest rate in the lease. The lease
payment, including principal, interest and sales tax, is $672 per month. The
carrying value of the capitalized lease asset was $3,936 and $9,839 as of June
30, 2005 and 2004, respectively. Amortization expense was $1,476 for the three
months and $2,952 for the six months ended June 30, 2005 and 2004, respectively.
Interest expense was $241 and $491 for the three months and $549 and $1,037 for
the six months ended June 30, 2005 and 2004. Future minimum lease payments as of
June 30, 2005:
Year Amount
- ---- ------
2005 3,766
2006 1,256
------
Total 5,022
Less interest portion (299)
------
Capital lease obligation $4,723
======
Loan Commitments:
The Company makes loan commitments in connection with certain real estate loans
and joint venture investments that include funding for project development,
building construction, renovations, lease-up operations, financed interest and
other amounts that the borrower may draw upon in accordance with the loan
agreement. For existing loans, the Company has $7,013,143 in approved, unused
loan commitments for real estate loans and $6,804,054 for real estate joint
venture investments as of June 30, 2005. The Company also has one new approved
real estate loan commitment for $790,000 as of June 30, 2005 which the company
expects to fund in the third quarter.
F-9
Related Party Transactions:
Cornerstone Capital Advisors, Inc. - Management and Advisory Service Agreement
Effective July 1, 2003, the Company entered into a Management and Advisory
Services Agreement with Cornerstone Capital Advisors, Inc. ("CCA") to provide
loan management, administration, and accounting; investor relations; marketing;
computer and management information systems administration; record maintenance;
executive management; and bookkeeping and accounting after June 30, 2003. The
agreement is for renewable one year terms and it may be terminated by either
party upon 60 days' written notice. The Company does not have any employees of
its own and CCA is subject to the supervision of the Company's board of
directors. Two of the Company's directors serve on the CCA board of directors.
From July 1, 2003 until July 31, 2004, the agreement obligated the Company to
reimburse actual expenses incurred by CCA. Also, CCA was eligible to earn
incentive compensation of up to 10% of the actual expenses billed to the Company
for the prior 12 months. The base for the incentive compensation included being
current on all bond interest and other obligations, and that the common stock
shareholders have received dividends equal to an annual rate of at least 10% on
the price paid in a public offering for all the time the shares were
outstanding. Factors above the base and the exact amount of incentive
compensation were determined by the board of director's judgment on the extent
to which CCA's services contributed to the results.
Effective August 1, 2004, the original agreement was modified so that the
Company will pay CCA as follows:
o Management Fee - equal to 10% of the Company's revenues from all sources
other than loan fees, loan participations and revenue received from CCA
plus 30% of loan participation revenue, payable monthly.
o Loan Origination Fee - equal to 30% of the total loan fee charged by the
Company to its borrowers. The fee is generally paid from loan proceeds and
reduces deferred loan fees.
For the three and six months ended June 30, the Company paid CCA as follows:
Three Months Six Months
--------------------- ---------------------
2005 2004 2005 2004
-------- -------- -------- --------
Management Fees $323,551 $335,271 $702,165 $659,493
Loan Origination Fees 65,250 -0- 65,250 -0-
-------- -------- -------- --------
$388,801 $335,271 $767,415 $659,493
======== ======== ======== ========
As of June 30, 2005 and 2004, the Company owed $976 and $0, respectively to CCA
under this agreement.
Cornerstone Capital Advisors, Inc. - Office Lease
Effective August 1, 2004, the Company and CCA entered into a lease agreement
whereby CCA is leasing the Company's corporate office building and
office/computer equipment in Cumming, GA. The lease payment is $5,000 per month.
The initial lease term ends on August 31, 2005, after which time the lease
converts to a month-to-month lease unless CCA notifies the Company of its intent
not to renew within 30 days from the end of the initial lease term. The
Company's cost basis in the office building and office/computer equipment is
approximately $628,000. For the three and six months ended June 30, 2005, the
Company received $15,000 and $30,000, respectively under the lease agreement.
Cornerstone Direct Public Offerings, LLC
Prior to 2005, the Company contracted with Cornerstone Direct Public Offerings,
LLC ("CDPO") to provide legal and administrative services for the filing of SB-2
Registration Statements with the Securities and Exchange Commission. Two of the
Company's directors serve on the board of directors of CDPO's majority owner,
Foundation for Christian Community Development, Inc. The service fee was $75,000
per filing payable in installments during the filing process. The Company does
not intend to use CDPO's services on future filings with the Securities and
Exchange Commission.
During 2003, the Company entered into a service agreement with CDPO for the
filing of a SB-2 Registration Statement. The initial $75,000 fee was paid in
2003. In January, 2004, the Company amended the service agreement and paid an
additional $25,000 to CDPO for cost over-runs related to the length of time
needed for the Company's registration statement to become effective.
F-10
In July, 2004, the Company entered into a service agreement with CDPO for the
filing of a new SB-2 Registration Statement. $75,000 was paid to CDPO in 2004
under this service agreement. In January 2005, the Company amended the agreement
and paid $20,000 to CDPO due to an increase in the time needed to register the
securities with various state securities regulators. No amounts were owed to
CDPO as of June 30, 2005 and 2004. See Note 12 for additional disclosures on the
Company's registration statements.
NOTE 4 - REAL ESTATE LOANS
At June 30, the Company had Real Estate Loans outstanding as follows:
2005 2004
------------ ------------
Family housing development loans $ 40,750,848 $ 27,822,341
Church mortgage loans 9,163,395 10,460,444
Senior housing mortgage loans 19,861,474 9,219,836
------------ ------------
Total principal 69,775,717 47,502,621
Accrued Interest 667,201 390,570
Unearned Loan Fees (177,304) (149,537)
Allowance for loan losses (682,000) (405,000)
------------ ------------
Total Real Estate Loans $ 69,583,614 $ 47,338,654
============ ============
These loans mature as follow: 2005 - $38,460,371; 2006 - $28,410,715; 2007 - $0;
2008 - $0; 2009 - $598,063; beyond 2009 - $2,306,568. Loan maturity may be
accelerated in accordance with loan terms, generally upon certain events of
default such as non-payment of scheduled payments or bankruptcy.
Based on the terms of the loans, the Company allows borrowers with loans related
to certain family housing and church properties to finance interest payments
while the properties are in the development and construction phase of
operations. For the six months ended June 30, the net interest payments financed
were:
2005 2004
--------- ---------
Current year interest financed $ 601,026 $ 543,737
Previous years' financed interest received (100,263) (8,054)
--------- ---------
Net financed interest $ 500,763 $ 535,683
========= =========
On June 30, 2005, the Company had significant credit risk concentrations in the
following states:
Georgia - $27,264,495
Florida - $20,106,155
Texas - $12,001,534
Impaired loan disclosures for the six months ended June 30:
2005 2004
---------- ----------
Number of impaired loans 2 1
Carrying amount $1,909,011 $1,646,353
Weighted average investment - year-to-date $1,871,051 $1,615,304
Impaired loan interest income - current quarter $ 44,756 $ 38,849
Impaired loan interest income - year-to-date $ 89,021 $ 77,697
No allowance for specific impaired loan loss has been recorded because the
carrying amounts of the impaired loans as of June 30, 2005 and 2004 were less
than the present value of the loans expected future cash flows.
Included in family housing development loans is one loan which the Company made
to a borrower which is considered to be a variable interest entity ("VIE"). The
VIE is not consolidated in the Company's financial statements as the Company's
financial interest is not expected to absorb the majority of expected losses nor
receive the majority of expected residual returns. The Company's loan is a first
mortgage loan of $1,114,880 made in June, 2005 to purchase land. The Company's
maximum loan commitment is $1,200,000. The VIE is structured as a limited
partnership and will develop the property into a low income housing tax credit
apartment facility.
F-11
NOTE 5 - REAL ESTATE JOINT VENTURE INVESTMENTS
As of June 30, certain of the Company's mortgage loans on senior housing
facilities are classified as real estate joint venture investments, as follows:
Location 2005 2004
- -------- ------------ ------------
McKinney, TX $ 4,728,599 $ 3,883,476
St. Petersburg, FL 4,910,334 3,943,320
Lewisville, TX 10,617,954 10,533,304
Garland, TX 6,526,957 6,110,256
Chattanooga, TN 5,685,992 4,439,918
San Antonio, TX 12,494,047 10,970,238
Winter Haven, FL 5,962,402 5,505,751
Bryan, TX 3,266,317 -0-
Edmond, OK 5,481,201 -0-
------------ ------------
Total principal outstanding 59,673,803 45,386,263
Accrued interest 591,572 371,123
Unearned loan fees (267,137) (661,258)
Allowance for loan losses -0- -0-
------------ ------------
Real estate joint venture investments, net $ 59,998,238 $ 45,096,128
These loans mature as follows: 2005 - $30,579,764; 2006 - $29,094,039. Loan
maturity may be accelerated in accordance with loan terms, generally upon
certain events of default such as non-payment of scheduled payments or
bankruptcy.
All of the loans, except as noted below, are secured by first or second
mortgages. Three facilities are partially secured by the respective non-profit
borrower's 100% ownership interest in the Limited Liability Companies ("LLC")
which own the properties. The facilities which are owned by the LLC's have a
first mortgage from an outside lender securing the property. The location and
amount of the loans which are secured in this manner as of June 30, 2005 are as
follows:
Lewisville, TX - $ 9,284,620
Bryan, TX - $ 1,932,984
Edmond, OK - $ 3,337,251
-----------
Total $14,554,855
===========
The Company participates in the residual profits of the real estate joint
venture investments through loan participation agreements, which enable the
Company to receive income from a borrower when a property in which the Company
provided financing is sold or refinanced with another lender. The participation
percentage for each property varies between 25% and 33% of the borrower's gain.
In March, 2005, the Company received $257,000 in loan participation income from
a borrower as a result of the borrower's sale of a senior housing facility in
which the Company held a real estate joint venture investment.
All loans accrue interest at 10% per year and except as noted below,
`interest-only' payments are received monthly. The original loan terms are for
one year with two, one year extensions at the Company's option. The Company
charges a 10% loan origination fee which is financed and included in the loan's
principal balance.
In accordance with loan terms, the Company allows certain borrowers to finance
interest payments while their facilities are in the construction or renovation
phase of operations. For the six months ended June 30, the net interest payments
financed were as follows:
2005 2004
-------- --------
Current year interest financed $267,491 $246,846
Previous years' financed interest received -0- -0-
-------- --------
Net financed interest $267,491 $246,846
======== ========
F-12
The Company analyzes the underlying operations and collateral of each facility
in which there is an outstanding loan by requiring independent appraisals every
12 to 24 months, reviewing loan balances and comparing them to the established
loan budgets, and by analyzing income and cash flow statements that are
submitted by the borrowers. If it is determined that it is probable that the
Company will be unable to collect all amounts due according to the contractual
terms of a loan, the loan is considered impaired and a loan loss will be
recognized to the extent the collateral's fair value is less than the current
loan carrying amount. No real estate joint venture investments were considered
impaired as of June 30, 2005 and 2004.
NOTE 6 - ALLOWANCE FOR LOAN LOSSES
For the six months ended June 30, 2005 and 2004, a summary of changes in the
allowance for loan losses by loan type is as follows:
Real Estate
Family Senior Joint Venture
Church Housing Housing Investments Total
---------- ------------ ----------- -------------- -------------
Balance - 12/31/03 $ -0- $375,000 $ -0- $ -0- $375,000
Loan loss expense -0- 30,000 -0- -0- 30,000
Charge-offs -0- -0- -0- -0- -0-
Recoveries -0- -0- -0- -0- -0-
---------- ------------ ----------- -------------- -------------
Balance - 6/30/04 $ -0- $405,000 $ -0- $ -0- $405,000
---------- ------------ ----------- -------------- -------------
Balance - 12/31/04 $ -0- $632,000 $ -0- $ -0- $632,000
Loan loss expense -0- 50,000 -0- -0- 50,000
Charge-offs -0- -0- -0- -0- -0-
Recoveries -0- -0- -0- -0- -0-
---------- ------------ ----------- -------------- -------------
Balance - 6/30/05 -0- $682,000 -0- -0- $682,000
---------- ------------ ----------- -------------- -------------
Components of allowance for loan losses at June 30, 2005 and 2004:
2005 2004
-------- --------
Collective loan losses-
Historical experience $ -0- $ -0-
Current credit risk assessment 682,000 405,000
-------- --------
Total collective loan losses 682,000 405,000
Specific impaired loan losses -0- -0-
-------- --------
Total allowance for loan losses $682,000 $405,000
======== ========
Loan loss allowance increases for the three and six months ended June 30, 2005
and 2004 were due to an increase in the family housing loan portfolio's
outstanding principal balance. Collateral for the family housing loans includes
a guarantee from a non-profit company pledging up to $5,700,000 of net proceeds
from the sale of senior housing communities expected to be realized by September
30, 2005.
From July 1, 2004 through December 31, 2004, the Company charged $227,000 to
loan loss expense. This charge was due to an increase in the family housing loan
portfolio's outstanding loan principal, slower than expected new home sales
volumes at three projects, and an increase in the time that it has taken four
projects to finish the development phase and start selling homes. These factors
have increased the family housing loan portfolio's credit risk as compared to
prior years.
The Company has never incurred a loan charge-off; therefore, there is no
collective loan loss allowance related to the Company's historical experience.
NOTE 7 - GOODWILL
The Company adopted SFAS 142 "Goodwill and Other Intangible Assets" effective
January 1, 2002. Goodwill associated with the Company's acquisition of
Presbyterian Investor's Fund, Inc. is carried at $450,997 and is not subject to
further amortization. Goodwill is tested for impairment at the end of each year
using the present value of expected future cash flows to determine its fair
value. At June 30, 2005 and 2004, Goodwill's fair value exceeded its carrying
value; therefore, no provision for impairment loss has been recorded. No
goodwill was acquired or sold in 2004 or 2005.
F-13
NOTE 8 - UNAMORTIZED DEBT ISSUE COSTS
Unamortized debt issue costs consist of legal, accounting, and filing costs
incurred to register the Company's debt securities and commissions paid or
accrued on the sale of debt securities. These costs are amortized on a
straight-line basis over the period the associated securities are outstanding,
generally five years. At June 30, 2005, unamortized debt issue costs consist of:
Costs incurred to register debt securities $ 770,714
Commissions paid on the sale of debt securities 4,370,680
Less: Accumulated Amortization (2,339,676)
-----------
$ 2,801,718
===========
Amortization expense was $224,132 and $203,633 for the three months and $463,948
and $366,361 for the six months ended June 30, 2005 and 2004, respectively, and
is included in marketing expenses in the accompanying Statements of Operations.
Estimated amortization expense for the next five years:
7/2005 - 6/2006 - $910,739 7/2008 - 6/2009 - $396,590
7/2006 - 6/2007 - $798,907 7/2009 - 6/2010 - $142,894
7/2007 - 6/2008 - $552,588
NOTE 9 - BOND HOLDINGS
Bond holdings at June 30 consist of- 2005 2004
----------- -----------
St. Lucie Co., FL Subordinated Revenue Bonds:
Maturity 7/1/2036 $ 2,325,000 $ 2,325,000
Maturity 10/1/2036 2,700,000 2,700,000
Undivided 50% interest sold to investor (2,512,500) (2,512,500)
----------- -----------
Net investment in St.Lucie Co., FL bonds 2,512,500 2,512,500
----------- -----------
Largo, FL Subordinated Revenue bonds:
Matures 10/1/2033 2,465,000 2,500,000
Undivided interest sold to investors (1,207,850) (1,225,000)
----------- -----------
Net investment in Largo, FL bonds 1,257,150 1,275,000
----------- -----------
Cost and fair value of bond holdings 3,769,650 3,787,500
Accrued interest receivable 226,233 227,167
----------- -----------
$ 3,995,883 $ 4,014,667
=========== ===========
The bonds are not traded on an exchange; however, management estimates, based on
discounted expected cash flows, that the fair value of the individual securities
approximates their original cost. Accordingly, no unrealized holding gains or
losses have been recorded for the three and six months ended June 30, 2005 and
2004.
Net proceeds from the partial maturity of bonds were $17,850 and $0 for the six
months ended June, 2005 and 2004, respectively. No realized gains or losses were
recognized. The Company uses the specific identification method to determine
realized gains and losses.
Tax-free interest income was $82,143 and $82,500 for the three months and
$164,057 and $165,556 for the six months ended June 30, 2005 and 2004,
respectively.
NOTE 10 - INCOME TAXES
The net deferred tax (liability) asset in the accompanying balance sheets
includes the following components as of June 30:
2005 2004
--------- ---------
Deferred tax assets $ 338,741 $ 208,753
Deferred tax liabilities (358,087) (370,454)
--------- ---------
Net deferred tax (liability) asset ($ 19,346) ($161,701)
========= =========
The deferred tax liabilities result from the use of accelerated depreciation
methods for property and equipment and from using the installment method for tax
accounting. The deferred tax assets result from tax versus financial reporting
differences in accounting for allowance for loan losses and from differences in
F-14
the amortization of debt issue and start-up costs. The Company estimates that
future taxable income will be sufficient to realize the deferred tax assets;
therefore, no valuation allowance was provided for as of June 30, 2005 and 2004.
Components of the Company's income tax provision (benefit) for the three and six
months ended June 30:
Three Months Six Months
-------------------- --------------------
2005 2004 2005 2004
-------- -------- -------- --------
Current: Federal ($17,550) ($ 8,159) $-0- $ 13.676
State 1,781 2,157 6,740 7,629
Deferred: Federal (35,139) (4,131) (47,703) (8,830)
State (1,956) (425) 3,308) (912)
-------- -------- -------- --------
($52,864) ($10,558) ($44,271) $ 11,563
======== ======== ======== ========
Reconciliation of the Company's income tax provision (benefit) rate to statutory
federal rates for the three and six months ended June 30:
Three Months Six Months
----------------- -----------------
2005 2004 2005 2004
------ ------ ------ ------
Statutory federal rate (35.0%) 35.0% 35.0% 35.0%
Effect of graduated federal rates 1.0% (1.0%) (1.0%) (1.0%)
State taxes, net of federal benefit (3.7%) 3.7% 3.7% 3.7%
Effect of tax-free bond interest income (41.2%) (64.5%) (201.1%) (32.3%)
Other, net .9% 2.5% 3.7% 1.2%
------ ------ ------ ------
Effective tax provision (benefit) rate (78.0%) (24.3%) (159.7%) 6.6%
===== ===== ====== =====
NOTE 11 - CASH CONCENTRATION RISK & RESTRICTED CASH
A cash concentration risk arises when the Company has more cash in a financial
institution than is covered by federal deposit insurance. At June 30, 2005, the
Company had cash in excess of insured limits totaling $5,797,760.
Included in cash and cash equivalents as of June 30, 2005 and 2004 is restricted
cash, as follows:
2005 2004
-------- --------
Investor Certificate trustee agreements $ -0- $257,516
Mortgage loan compensating balance agreement 423,928 -0-
-------- --------
$423,928 $257,516
======== ========
Through May, 2005, Regions Bank was the trustee for certain of the Company's
Investor Certificates. Under the terms of the agreements, the Company agreed to
place cash into an account which could not be used in the Company's operations
as long as the trustee agreements were in place. The trustee agreements were for
renewable one-year terms and the Company could terminate the agreements at any
time. In May, 2005 the Company terminated the agreements and is using a new
trustee for its Investor Certificates who does not require the Company to have
restricted cash on hand as part of the trustee agreements.
In connection with the Company's mortgage loan on its corporate office building,
the lender requires that the Company keep an amount on deposit with the lender
that is at least equal to the amount of principal outstanding on the loan. The
maturity date of the loan is September 1, 2009. Please see Note 15 for
additional disclosures related to the mortgage loan.
The Company has an agreement with a financial institution to invest excess funds
overnight in a Eurodollar account. Investment positions are settled daily and
related interest earnings are included in loan participation and other income in
the Statement of Operations. As the investment meets the Company's definition of
cash and cash equivalents it is carried as such in the accompanying Balance
Sheets.
NOTE 12 - INVESTOR CERTIFICATES
The Company has three types of certificates outstanding:
Access certificates have no stated maturity and are due on demand. The minimum
investment amount is $100. The interest rate is determined by the Board of
Directors each quarter. The directors may change the rate between quarters if
market conditions warrant such a change. The current interest rate is 4%.
F-15
Graduated certificates can be redeemed yearly and have a five year maximum
maturity. The minimum investment amount is $500. The interest rate increases
based on the length of time that the certificate is outstanding. For
certificates sold prior to 2004 the rate starts at 7% and increases .5% for each
year the certificate is outstanding with a 9% maximum rate. Certificates (Series
E and F) sold after 2003 have an initial interest rate of 6.25% and increase .5%
for each year the certificate is outstanding with an 8.25% maximum rate.
Five year certificates have a five year maturity and a $500 minimum investment.
The interest rate is 9% for certificates sold prior to 2004 and 8.25% for
certificates (Series E and F) sold in 2004 and 2005.
The certificates are not collateralized and no sinking fund is required to fund
redemptions at maturity. All of the certificates have been registered with the
Securities and Exchange Commission under the Securities Act of 1933. Five year
schedule of principal maturities for certificates outstanding at June 30:
Years to Maturity 2005 2004
----------------- ------------ ------------
On demand & 1 year $ 22,611,060 $ 15,606,131
2 14,622,299 10,803,667
3 38,356,881 15,415,539
4 16,982,332 38,404,494
5+ 29,630,256 16,882,292
------------ ------------
Total Principal $122,202,828 $ 97,112,123
============ ============
At June 30, 2005 and 2004, accrued interest payable was $11,009,507 and
$7,151,502, respectively.
Interest rates for certificates outstanding at June 30, 2005 are:
4.00% - $1,592,279 8.00% - $ 3,639,996 9.00% - $63,781,947
6.25% - $2,205,765 8.25% - $46,612,587
6.75% - $1,949,332 8.50% - $2,420,922
On April 29, 2003 the Company filed a Form SB-2 Registration Statement under the
Securities Act of 1933 with the Securities and Exchange Commission to sell up to
$40,000,000 of its Series E Investor Certificates along with $11,375,000 of its
Common Stock. The Registration Statement was approved by the Securities and
Exchange Commission on March 26, 2004. From April 2004 through December 2004,
the Company issued $39,931,209 in Series E Investor Certificates and $2,129,341
in Common Stock (327,591 shares at $6.50 per share).
On August 27, 2004, the Company filed a Form SB-2 Registration Statement under
the Securities Act of 1933 with the Securities and Exchange Commission to sell
up to $20,000,000 of its Series F Investor Certificates along with $9,750,000 of
its Common Stock. The Securities and Exchange Commission notified the Company
that it would not complete a full review of the registration statement and the
registration statement became effective on November 1, 2004. The Company started
to sell securities registered in this statement in January, 2005. For the six
months ended June 30, 2005, the Company sold $11,189,532 in Series F Investor
Certificates and $116,116 in Common Stock (17,864 shares at $6.50 per share).
The Company expects to file a new registration statement with the Securities and
Exchange Commission during the third or fourth quarter of 2005 with
approximately $60,000,000 in Series G Investor Certificates available for
issuance. The terms of the Investor Certificates will be similar to the Series E
and F certificates.
NOTE 13 - MORTGAGE PARTICIPATION AGREEMENTS
In 2003, the Company began selling Mortgage Participation ("MP") Agreements. The
MP Agreements have not been registered and therefore, are only available to
accredited investors. The agreements are collateralized by specific senior
housing loans owned by the Company and entitle the investor to a proportionate
share of the interest earned on the collateral. Interest is paid monthly to the
MP investors after the Company receives interest payments on the related
collateralized loans. The agreements have no stated maturity date. Principal
payments are made when the Company receives principal payments on the
collateralized loans. Losses that the Company may incur on the collateralized
loans are shared pro-rata with the MP Agreement holders. The Company has the
F-16
right but not the obligation to redeem the MP Agreements at any time. The MP
Agreement investors do not have the right to sell or repledge their interest in
the underlying collateral. Interest expense related to MP Agreements was
$122,803 and $154,062 for the three months and $257,433 and $307,817 for the six
months ended June 30, 2005 and 2004, respectively.
MP Agreement principal and interest outstanding and related collateral as of
June 30, 2005:
MP Amount Total Collateral
Outstanding Carrying Amount
----------- ---------------
Winter Haven, FL senior housing loan; matures 5/1/06
with a one year extension at the Company's option $1,516,000 $6,011,404
Garland, TX senior housing loan; matures 12/1/05
with a one year extension at the Company's option 3,396,500 $6,535,736
----------
Total principal outstanding 4,912,500
Accrued interest payable 39,573
----------
$4,952,073
==========
The loans which collateralize the MP Agreements are classified as real estate
joint venture investments in the accompanying balance sheets. The total carrying
amount is equal to the loan's outstanding principal, plus accrued interest, less
deferred loan fees.
NOTE 14 - LOAN GUARANTEES
The Company is guarantor on two loans secured by senior housing facilities owned
by unrelated non-profit entities. Certain real estate joint venture investments
and real estate acquisition and development loans in which the borrower chooses
to secure outside financing may require the Company to guarantee the loan as a
condition of the extension of the loan by the financial institution. The
guarantee is solely limited to amounts drawn under credit facilities and only
covers outstanding principal and accrued interest and terminates upon maturity
and principal repayment. Only upon an uncured payment default and upon demand by
the financial institution would the Company be required to perform under its
guarantee obligations. The Company's recourse would be limited to repossession
of the underlying collateral and subsequent resale of the facilities. As of June
30, 2005, all loans which had a guarantee were current based on their loan
terms. Loan guarantees as of June 30, 2005:
Renewal/ Current Loan
Origination Maturity Maximum Principal Guarantee
Location Date Date Guarantee Outstanding Obligation
- -------- ---- ---- --------- ----------- ----------
Palm Bay, FL 12/31/02 12/31/05 13,800,000 12,824,462 -0-
St. Petersburg, FL 12/18/04 12/18/05 7,347,300 7,026,290 71,000
----------- ----------- -------
$21,147,300 $19,850,752 $71,000
=========== =========== =======
In February and April of 2005, the Company originated loans on a facility in
Fort Pierce, FL which paid off two loans with an outside bank in which the
Company had a loan guarantee. The $104,000 estimated fair value of the loan
guarantees was credited to earnings in 2005.
NOTE 15 - BUILDING MORTGAGES
Building mortgages outstanding at June 30: 2005 2004
-------- --------
Fidelity Bank - collateralized by rental office building $165,612 $175,442
Interest rate - 6.25%; monthly principal and interest payment
of $1,723; matures March 1, 2006, at which time a balloon
payment of $159,573 is due
Fidelity Bank - collateralized by corporate office building 423,928 -0-
-------- --------
Interest rate equal to "prime + 1.5%", currently 7.5%; monthly
principal & interest payment of $4,069; matures Sept. 1, 2009,
at which time a balloon payment of $340,543 is due
Total principal outstanding $589,540 $175,442
Interest expense for the three months ended June 30 $ 10,874 $ 3,802
Interest expense for the six months ended June 30 $ 21,041 $ 7,655
Total carrying value of the mortgage's collateral $737,159 $231,355
F-17
Estimated annual principal payments: 2005 - $13,817; 2006 - $179,609; 2007 -
$19,680; 2008 - $21,050; 2009 - $355,384.
NOTE 16 - SERIES A CONVERTIBLE PREFERRED STOCK
In 2001, the Company amended its Articles of Incorporation to provide for the
issuance of up to 235,000 shares of Series A Convertible Preferred Stock. The
shares do not accrue dividends unless such dividends are declared by the Board
of Directors. The shares entitle the preferred shareholder to have one vote per
share, presently equal to the voting rights of Common shareholders. Each share
is convertible, after 3 years, into shares of Common Stock based on an
adjustable formula.
During 2001, as part of the Company's formation and initial capitalization of
Wellstone Financial Group, LLC ("WFG"), 500 preferred shares with a value of
$500,000 were issued to WFG in return for a 100% ownership interest in WFG. In
June 2004, WFG was dissolved and all of the outstanding Series A Convertible
Preferred Stock was redeemed from WFG in exchange for the Company's ownership
interest in WFG. See Note 17 for additional disclosures on this transaction.
NOTE 17 - DISSOLUTION OF SUBSIDIARIES
In June 2004, the Company's board of directors approved an agreement to dissolve
Wellstone Financial Group, LLC ("WFG"), a 100%-owned subsidiary. In exchange for
the Company's ownership interest in WFG, the Company redeemed all of the
Company's Series A Preferred Stock owned by WFG. The fair value of the Preferred
Stock and the Company's ownership interest in WFG were both estimated at
$500,000; therefore, no cash was exchanged. As of June 30, 2004, WFG is no
longer included in the Company's financial statements. The transaction had no
effect on the Company's assets, liabilities, net income and earning per share of
common stock. WFG was dissolved because the Company has been unable to retain
the type of specialized employees necessary to develop WFG's operations into a
long-term profitable venture.
In June 2004, the Company's board of directors approved an agreement to dissolve
Wellstone Communities, Inc. ("WCI"), a 100%-owned subsidiary. The Company
received all of WCI's assets in exchange for its 136,250 shares of WCI Common
Stock. The fair value of this transaction was $1,265,268. WCI's assets included
$1,046,340 in cash and a real estate mortgage loan with a carrying amount of
$218,928. The transaction had no effect on the Company's assets, liabilities,
net income, and earnings per common share. WCI filed a Form SB-2 Registration
Statement in 2003 and planned to issue preferred stock to expand its specialized
loan operations and possibly purchase a bank. WCI was dissolved because the
Company determined that it was not feasible to go forward with the registration
statement given the proposed financial structure.
NOTE 18 - EARNINGS PER SHARE
Basic earnings per share for the three and six months ended June 30 have been
calculated as follows:
Three Months Six Months
------------ ----------
2004 Net Income $ 54,017 $ 162,739
- ----
Average Common Shares Outstanding 709,902 603,085
Earnings per Common Share $ 0.07 $ 0.27
2005 Net Income (Loss) $ (14,906) $ 71,998
- ----
Average Common Shares Outstanding 815,332 815,809
Earnings (Loss) per Common Share $ (0.02) $ 0.09
Diluted earnings per share are the same as basic earnings per share because
there are no shares of Series A Convertible Preferred Stock outstanding. Other
than the Series A Convertible Preferred Stock, there are no other potentially
dilutive securities, stock options or warrants outstanding.
F-18
NOTE 19 - MAJOR CUSTOMERS
The Company recorded more than 10% of its total revenue for the six months ended
June 30, 2005 from the following customers:
Amount % Description of Revenue Received
------ ----- -------------------------------
Senior Housing Services, Inc. $3,162,066 43.5% Interest and fees from real estate joint
venture investments
Wellstone Housing, LLC 1,386,016 19.1% Interest and fees from family housing
development loans
Sage Living Centers, Inc. 907,602 12.5% Interest and fees from real estate joint
---------- ---- venture investments
$5,455,684 75.1%
========== ====
The major customers are not related parties. Neither organization directly or
indirectly controls, is controlled by, or is under common control of the
Company. There is not common ownership interest, officers, or directors and the
Company does not have the power to direct or significantly influence the
management or operating policies of these customers.
On January 1, 2005, Senior Housing Services, Inc formed a single member Limited
Liability Company (Wellstone Housing, LLC) and purchased the assets and assumed
all of Wellstone Housing Corporation's liabilities, which included the Company's
real estate loans. The total combined revenue received from Senior Housing
Services, Inc. and Wellstone Housing, LLC for the six months ended June 30, 2005
was $4,548,082 or 62.6% of the Company's total revenue.
NOTE 20 - FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments:
Cash and cash equivalents - Fair value approximates their carrying amount due to
the initial maturities of the instruments being three months or less.
Bond holdings - These bonds are not traded on an exchange; therefore, fair value
is estimated based on the present value of expected future cash flows, which
approximates their carrying amount.
Investor certificates and mortgage participations - Fair value is estimated
based on the present value of expected future cash flows, which approximates
their carrying amount.
Building mortgages and capital lease obligation - Fair value approximates
carrying value since stated rates are similar to rates currently available to
the Company for debt with similar terms and remaining maturities.
Loan guarantee obligations - Fair value approximates the risk-factored net
present value of possible future cash flows related to the specific loan
guarantee obligation.
The estimated fair values of the Company's financial instruments at June 30,
2005 are:
Carrying Amount Fair Value
--------------- ----------
Financial assets:
Cash and cash equivalents $ 5,997,760 $ 5,997,760
Bond holdings $ 3,769,650 $ 3,769,650
Financial liabilities:
Investor certificates $122,202,858 $122,202,858
Mortgage participations $ 4,912,500 $ 4,912,500
Building mortgages $ 589,540 $ 589,540
Capital lease obligation $ 4,723 $ 4,723
Loan guarantee obligations $ 71,000 $ 71,000
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