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 September 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
-------------------------------------------- -----
(Address of principal executive office) (Zip Code)
Issuer's telephone number, including area code: (678)-455-1100
------------------
- --------------------------------------------------------------------------------
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 September 30, 2005, there were issued and outstanding 861,940 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 September 30, 2005 and 2004 F-2
Statements of Operations for the three and nine months
ended September 30, 2005 and 2004 F-3
Statements of Changes in Shareholders' Equity
for the nine months ended September 30, 2005 and 2004 F-4
Statements of Cash Flows for the nine months
ended September 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 10
Item 6. Exhibits and Reports on Form 8-K 10
Signatures 10
Certifications - Exhibits 31.1 and 31.2 11
2
To The Board of Directors
Cornerstone Ministries Investments, Inc.
We have reviewed the accompanying balance sheet of Cornerstone Ministries
Investments, Inc. as of September 30, 2005, and the related statements of
operations, changes in shareholder's equity, and cash flows for the three-month
and nine-moth periods ending September 30, 2005. 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.
The balance sheet of Cornerstone Ministries Investments, Inc. as of September
30, 2004 and the related statements of operations, changes in shareholder's
equity, and cash flows for the three-month and nine-month periods ended
September 30, 2004 were reviewed by another accountant, whose report dated
October 27, 2004, stated that they were not aware of any material modifications
that should be made to those statements in order for them to be in conformity
with generally accepted accounting principles.
/s/ Berman Hopkins and Moss, LLP
Winter Park, Florida
November 10, 2005
F-1
CORNERSTONE MINISTRIES INVESTMENTS, INC.
BALANCE SHEETS
As of September 30, 2005 and 2004
9/30/2005 9/30/2004
--------- ---------
ASSETS
Cash and cash equivalents $ 1,303,288 $ 9,257,555
Loans in process 663,344 194,755
Real estate loans, net 76,811,109 50,443,720
Real estate joint venture investments, net 61,591,989 59,470,960
Bond holdings and accrued interest 5,187,112 3,985,667
Property and equipment, net 775,853 828,241
Refundable income taxes 8,228 5,673
Deferred tax asset 56,585 --
Goodwill 450,997 450,997
Unamortized debt issue costs 2,754,780 2,621,638
Real estate held for investment 340,000 340,000
Other assets 98,607 57,957
------------- -------------
TOTAL ASSETS $ 150,041,892 $ 127,657,163
============= =============
LIABILITIES
Investor certificates and accrued interest $ 138,996,526 $ 115,051,868
Mortgage participations and accrued interest 4,952,073 6,212,142
Accounts and other payables 137,049 115,894
Loan guarantee obligation 71,000 104,000
Building mortgages 583,477 608,540
Capital lease obligation 3,013 9,453
Deferred taxes payable -- 150,729
------------- -------------
TOTAL LIABILITIES 144,743,138 122,252,626
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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;
861,940 and 853,123 shares issued and outstanding 8,619 8,531
Paid in capital 5,386,315 5,337,749
Retained earnings (deficit) (96,180) 58,257
------------- -------------
TOTAL SHAREHOLDERS' EQUITY 5,298,754 5,404,537
------------- -------------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 150,041,892 $ 127,657,163
============= =============
SEE ACCOMPANYING NOTES AND ACCOUNTANTS' REVIEW REPORT
F-2
CORNERSTONE MINISTRIES INVESTMENTS, INC.
STATEMENTS OF OPERATIONS
For the three and nine months ended September 30, 2005 and 2004
3 Mo. Ended 3 Mo. Ended 9 Mo. Ended 9 Mo. Ended
9/30/2005 9/30/2004 9/30/2005 9/30/2004
--------- --------- --------- ---------
REVENUES
Real estate loan and joint venture interest and fees $ 3,466,797 $ 3,165,898 $ 10,058,106 $ 8,764,245
Loan participation and other income 162,465 135,706 832,611 346,674
------------ ------------ ------------ ------------
TOTAL REVENUES 3,629,262 3,301,604 10,890,717 9,110,919
------------ ------------ ------------ ------------
EXPENSES
Investor interest expense 2,974,148 2,502,518 8,532,551 6,627,673
Loan loss expense 25,000 20,000 75,000 50,000
Marketing expenses 268,581 274,995 808,542 735,709
Management and advisory fees 332,707 269,575 1,034,872 898,671
Operating expenses 157,485 198,284 540,684 588,332
------------ ------------ ------------ ------------
TOTAL EXPENSES 3,757,921 3,265,372 10,991,649 8,900,385
------------ ------------ ------------ ------------
Income (loss) before income taxes (128,659) 36,232 (100,932) 210,534
Income tax benefit (80,381) (13,123) (124,652) (1,560)
------------ ------------ ------------ ------------
NET INCOME (LOSS) $ (48,278) $ 49,355 $ 23,720 $ 212,094
============ ============ ============ ============
Basic and Diluted Earnings (Loss)
per Common Share $ (0.06) $ 0.06 $ 0.03 $ 0.31
SEE ACCOMPANYING NOTES AND ACCOUNTANTS' REVIEW REPORT
F-3
CORNERSTONE MINISTRIES INVESTMENTS, INC.
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
For the nine months ended September 30, 2005 and 2004
RETAINED
COMMON STOCK: PAID-IN PREFERRED EARNINGS TREASURY TOTAL
SHARES AMOUNT CAPITAL STOCK (DEFICIT) STOCK EQUITY
BALANCE, DECEMBER 31, 2003 531,532 $ 5,315 $ 3,297,435 $ -- $ 1,229 $ (73,248) $ 3,230,731
Net income 212,094 212,094
Dividend declared (155,066) (155,066)
Common stock issued 321,591 3,216 2,087,125 2,090,341
Common stock issuance costs (46,811) (46,811)
Treasury stock sold (11,269 shares) 73,248 73,248
----------- ----------- ----------- ----------- ----------- --------- -----------
BALANCE, SEPTEMBER 30, 2004 853,123 $ 8,531 $ 5,337,749 $ -- $ 58,257 $ -- $ 5,404,537
=========== =========== =========== =========== =========== ========= ===========
BALANCE, DECEMBER 31, 2004 819,351 $ 8,194 $ 5,118,568 $ -- $ 91,243 $ -- $ 5,218,005
Net income 23,720 23,720
Dividend declared (211,143) (211,143)
Common stock issued 60,812 608 394,670 395,278
Common stock issuance costs (8,657) (8,657)
Common stock redeemed (18,223) (183) (118,266) (118,449)
----------- ----------- ----------- ----------- ----------- --------- -----------
BALANCE, SEPTEMBER 30, 2005 861,940 $ 8,619 $ 5,386,315 $ -- $ (96,180) $ -- $ 5,298,754
=========== =========== =========== =========== =========== ========= ===========
SEE ACCOMPANYING NOTES AND ACCOUNTANTS' REVIEW REPORT
F-4
CORNERSTONE MINISTRIES INVESTMENTS, INC.
STATEMENTS OF CASH FLOWS
For the nine months ended September 30, 2005 and 2004
2005 2004
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 23,720 $ 212,094
Adjustments to reconcile net income to cash
from operations-
Depreciation and amortization 754,166 640,656
Loss on sale of fixed assets -- 2,534
Changes in-
Loans in process (632,471) (76,251)
Accrued bond interest, net 15,704 15,666
Accrued real estate loan/joint venture interest and
deferred loan fees (2,492,041) (3,205,309)
Allowance for loan losses 75,000 50,000
Deferred taxes (126,942) (20,714)
Refundable income taxes (8,228) 36,944
Investor and mortgage participation interest payable 3,712,515 2,726,187
Loan guarantee obligations, net of related receivables (33,000) --
Accounts and other payables (107,572) (47,912)
Other assets 69,513 (42,144)
------------ ------------
NET CASH PROVIDED BY OPERATIONS 1,250,364 291,751
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Real estate loans made (31,435,690) (9,100,510)
Real estate loan principal payments received 9,829,876 7,504,692
Real estate joint venture investments made (3,693,644) (22,443,378)
Real estate joint venture payments received -- 3,325
Bonds purchased (1,219,290) --
Bonds redeemed or sold 30,600 --
Proceeds from sale of fixed assets -- 1,400
Property and equipment purchased (10,917) (9,915)
------------ ------------
NET CASH USED BY INVESTING ACTIVITIES (26,499,065) (24,044,386)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Investor certificates sold 16,416,473 31,100,364
Investor certificates redeemed (1,753,744) (3,336,245)
Mortgage participation agreements sold 150,000 78,250
Mortgage participation agreements redeemed (2,400,000) --
Debt issue costs paid (790,321) (1,438,822)
Building mortgage proceeds -- 440,000
Building mortgage principal payments (18,892) (11,654)
Capital lease principal payments (4,928) (4,179)
Common stock issued, net of issuance costs 386,621 2,043,530
Common stock redeemed (118,449) --
Dividends paid (477,430) (324,153)
Treasury stock sold -- 73,248
------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 11,389,330 28,620,339
------------ ------------
Net change in cash and cash equivalents (13,859,371) 4,867,704
Cash and cash equivalents at beginning of period 15,162,659 4,389,851
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,303,288 $ 9,257,555
============ ============
Supplemental Information-
Interest paid during the period $ 4,854,485 $ 3,916,963
Income taxes paid during the period $ 105,000 $ 62,500
Non-cash transactions-
Investor certificates matured and re-invested $ 151,412 $ 3,309,314
Loan interest financed and included in loan principal $ 966,935 $ 1,186,383
SEE ACCOMPANYING NOTES AND ACCOUNTANTS' REVIEW REPORT
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 real estate 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 real estate 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 real
estate 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.
Real estate 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
residual profits through loan participation agreements, which enable the Company
F-6
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 real estate 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. Discounts or premiums related to the purchase of
bonds are amortized as a yield adjustment over the lives of the related bonds.
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 September 30, property and equipment is composed of:
2005 2004
---- ----
Office Condominiums $797,554 $795,034
Office Computers, Furnishings,
Software & Equipment 127,385 122,037
Vehicles 30,351 30,351
Capital lease - phone system 17,710 17,710
Less: Accumulated Depreciation (197,147) (136,891)
-------- --------
Property and equipment, net $775,853 $828,241
Depreciation exp. - three months $ 16,130 $ 18,558
Depreciation exp. - nine months $ 47,284 $ 50,840
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 $2,460 and $8,363 as of
September 30, 2005 and 2004, respectively. Amortization expense was $1,476 for
the three months and $4,427 for the nine months ended September 30, 2005 and
2004. Interest expense was $172 and $432 for the three months and $721 and
$1,469 for the nine months ended September 30, 2005 and 2004, respectively.
Future minimum lease payments as of September 30, 2005:
Year Amount
- ---- ------
2005 1,883
2006 1,256
------
Total 3,139
Less interest portion (126)
------
Capital lease obligation $3,013
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 $14,502,987 in approved, unused
loan commitments for real estate loans and $5,842,201 for real estate joint
venture investments as of September 30, 2005. The Company also has three new
approved real estate loan commitments totaling $6,900,000 as of September 30,
2005 which the company expects to start funding in the fourth 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 nine months ended September 30, the Company paid CCA as
follows:
Three Months Nine Months
2005 2004 2005 2004
---- ---- ---- ----
Management Fees $332,707 $324,988 $1,034,872 $984,481
Loan Origination Fees 268,500 433,500 333,954 433,500
$601,207 $758,488 $1,368,826 $1,417,981
As of September 30, 2005 and 2004, the Company owed $11,769 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 ended on August 31, 2005, after which the lease converted
to a month-to-month lease. The Company's cost basis in the office building and
office/computer equipment is approximately $634,000. For the three and nine
months ended September 30, 2005, the Company received $15,000 and $45,000,
respectively under the lease agreement.
Cornerstone Direct Public Offerings, LLC
The Company has 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 and the
various state regulatory agencies. Two of the Company's directors serve on the
board of directors of CDPO's majority owner, Foundation for Christian Community
Development, Inc. The base service fee was $75,000 per filing payable in
installments during the filing process. For future filings, the Company intends
to use CDPO only for the state filing portion of its registrations, which will
reduce CDPO's service fee. The new fee schedule has not been finalized as of
September 30, 2005.
During 2003, the Company entered into a service agreement with CDPO for the
filing of a SB-2 Registration Statement (Series E). 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 (Series F). $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 September 30, 2005 and 2004. See Note 12 for additional
disclosures on the Company's registration statements.
NOTE 4 - REAL ESTATE LOANS
At September 30, the Company had Real Estate Loans outstanding as follows:
2005 2004
---- ----
Family housing development loans $48,281,461 $31,648,258
Church mortgage loans 9,221,703 9,481,638
Senior housing mortgage loans 19,861,474 9,286,352
---------- ---------
Total principal 77,364,638 50,416,248
Accrued Interest 818,374 560,959
Unearned Loan Fees (664,903) (108,487)
Allowance for loan losses (707,000) (425,000)
---------- ---------
Total Real Estate Loans $76,811,109 $50,443,720
These loans mature as follow: 2005 - $6,320,591; 2006 - $62,295,695; 2007 -
$5,852,410; 2008 - $0; 2009 - $590,111; beyond 2009 - $2,305,831. 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 nine months ended September 30, the net interest payments
financed were:
2005 2004
---- ----
Current year interest financed $863,570 $868,926
Previous years' financed interest received (270,884) (27,706)
-------- -------
Net financed interest $592,686 $841,220
On September 30, 2005, the Company had significant credit risk concentrations in
the following states:
Georgia - $33,308,269
Florida - $20,106,155
Texas - $11,318,239
So. Carolina - $11,047,431
Impaired loan disclosures for the nine months ended September 30:
2005 2004
---- ----
Number of impaired loans 3 2
Carrying amount $3,157,345 $1,933,751
Weighted average investment - year-to-date $3,075,826 $1,880,867
Impaired loan interest income - current quarter $ 74,254 $ 45,443
Impaired loan interest income - year-to-date $ 220,339 $ 135,118
No allowance for specific impaired loan loss has been recorded because the
carrying amounts of the impaired loans as of September 30, 2005 and 2004 were
less than the present value of the loans expected future cash flows.
Included in family housing development loans on September 30, 2005 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 $1,483,862 made in June,
2005 to purchase land. The Company's maximum loan commitment is $5,500,000. 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 September 30, certain of the Company's mortgage loans on senior housing
facilities and one family housing development loan are classified as real estate
joint venture investments, as follows:
Location 2005 2004
- -------- ---- ----
McKinney, TX $ 5,712,492 $ 3,981,794
St. Petersburg, FL 5,045,334 4,402,891
Lewisville, TX 10,617,954 10,656,804
Garland, TX 6,526,957 6,385,256
Chattanooga, TN 5,700,992 4,883,131
San Antonio, TX 12,671,957 11,551,897
Winter Haven, FL 5,990,625 5,551,751
Edmond, OK 5,481,201 13,098,142
Bryan, TX 3,266,317 -0-
---------- ----------
Total principal outstanding 61,013,829 60,511,666
Accrued interest 697,012 494,783
Unearned loan fees (118,852) (1,535,489)
Allowance for loan losses -0- -0-
---------- ----------
Real estate joint venture investments, net $61,591,989 $59,470,960
These loans mature as follows: 2005 - $4,822,334; 2006 - $56,191,495. 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 September 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 nine months ended September 30, the
net interest payments financed were as follows:
2005 2004
---- ----
Current year interest financed $374,249 $345,163
Previous years' financed interest received -0- -0-
-------- --------
Net financed interest $374,249 $345,163
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 September 30, 2005 and 2004.
NOTE 6 - ALLOWANCE FOR LOAN LOSSES
For the nine months ended September 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- 50,000 -0- -0- 50,000
Charge-offs -0- -0- -0- -0- -0-
Recoveries -0- -0- -0- -0- -0-
-------- -------- -------- -------- --------
Balance -96/30/04 $ -0- $425,000 $ -0- $ -0- $425,000
-------- --------
Balance - $ -0- $632,000 $ -0- $ -0- $632,000
Loan loss expense -0- 75,000 -0- -0- 75,000
Charge-offs -0- -0- -0- -0- -0-
Recoveries -0- -0- -0- -0- -0-
Balance - 9/30/05 -0- $707,000 -0- -0- $707,000
Components of allowance for loan losses at September 30, 2005 and 2004:
2005 2004
---- ----
Collective loan losses-
Historical experience $ -0- $ -0-
Current credit risk assessment 707,000 425,000
-------- --------
Total collective loan losses 707,000 425,000
Specific impaired loan losses -0- -0-
-------- --------
Total allowance for loan losses $707,000 $425,000
Loan loss allowance increases for the three and nine months ended September 30,
2005 and 2004 were due to an increase in the family housing loan portfolio's
outstanding principal balance.
From July 1, 2004 through December 31, 2004, the Company charged $207,000 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 December 31, 2004 and 2003, 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 September 30, 2005, unamortized debt issue costs
consist of:
Costs incurred to register debt securities $ 780,966
Commissions paid on the sale of debt securities 4,556,423
Less: Accumulated Amortization (2,582,609)
----------
$2,754,780
Amortization expense was $242,933 and $223,454 for the three months and $706,881
and $589,815 for the nine months ended September 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:
10/2005 - 9/2006 - $916,993 10/2008 - 9/2009 - $376,233
10/2006 - 9/2007 - $805,361 10/2009 - 9/2010 - $135,295
10/2007 - 9/2008 - $520,898
NOTE 9 - BOND HOLDINGS
Bond holdings at September 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 2,440,000 2,500,000
Undivided interest sold to investors (1,195,600) (1,225,000)
---------- ----------
Net investment in Largo, FL bonds 1,244,400 1,275,000
---------- ----------
Church Bonds 1,219,683 -0-
---------- ----------
Total bond holdings 4,976,583 3,787,500
Accrued interest receivable 210,529 198,167
---------- ----------
Bond holdings & accrued interest $5,187,112 $3,985,667
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 carrying amount. Accordingly, no unrealized holding gains or
losses have been recorded for the three and nine months ended September 30, 2005
and 2004.
Net proceeds from the partial maturity of bonds were $30,600 and $0 for the nine
months ended September, 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 $95,213 and $82,500 for the three months and
$259,270 and $248,056 for the nine months ended September 30, 2005 and 2004,
respectively.
NOTE 10 - INCOME TAXES
The net deferred tax asset (liability) in the accompanying balance sheets
includes the following components as of September 30:
2005 2004
---- ----
Deferred tax assets $407,188 $217,033
Deferred tax liabilities (350,603) (367,762)
-------- --------
Net deferred tax asset (liability) $ 56,585 ($150,729)
F-14
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
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 September 30, 2005 and
2004.
Components of the Company's income tax provision (benefit) for the three and
nine months ended September 30:
Three Months Nine Months
2005 2004 2005 2004
-------- -------- --------- --------
Current: Federal $ -0- $ (4,689) $ -0- $ 8,987
State (4,450) 2,538 2,290 10,167
Deferred: Federal ( 74,113) (9,911) (121,816) (18,741)
State (1,818) (1,061) (5,126) (1,973)
-------- -------- --------- --------
$(80,381) $(13,123) $(124,652) $ (1,560)
Reconciliation of the Company's income tax provision (benefit) rate to statutory
federal rates for the three and nine months ended September 30:
Three Months Nine 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 (25.9%) (77.4%) (87.3%) (40.0%)
Other, net 1.1% 3.5% 1.5% 1.6%
----- ----- ------ ----
Effective tax provision (benefit) rate (62.5%) (36.2%) (123.5%) (0.7%)
NOTE 11 - CASH CONCENTRATION RISK
A cash concentration risk arises when the Company has more cash in a financial
institution than is covered by federal deposit insurance. At September 30, 2005,
the Company had cash in excess of insured limits totaling $1,142,849.
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%.
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 September 30:
F-15
Years to Maturity 2005 2004
- ----------------- ------------ ------------
On demand & 1 year $ 22,656,748 $ 12,102,147
2 26,447,434 10,803,667
3 26,364,802 27,329,873
4 30,532,001 26,425,074
5+ 20,636,387 30,983,200
------------ ------------
Total Principal $126,637,372 $107,643,961
At September 30, 2005 and 2004, accrued interest payable was $12,359,154 and
$7,407,907, respectively.
Interest rates for certificates outstanding at September 30, 2005 are:
4.00% - $1,528,670 8.00% - $ 2,925,651 9.00% - $63,609,340
6.25% - $1,551,434 8.25% - $51,168,388
6.75% - $2,726,560 8.50% - $ 3,127,329
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 nine
months ended September 30, 2005, the Company sold $16,362,535 in Series F
Investor Certificates and $395,278 in Common Stock (60,812 shares at $6.50 per
share).
The Company expects to file a new registration statement with the Securities and
Exchange Commission during the 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
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
$122,812 and $154,063 for the three months and $380,246 and $461,880 for the
nine months ended September 30, 2005 and 2004, respectively.
F-16
MP Agreement principal and interest outstanding and related collateral as of
September 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 $6,039,863
Garland, TX senior housing loan; matures 4/1/06
with a one year extension at the Company's option 3,396,500 $6,564,510
----------
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
September 30, 2005, all loans which had a guarantee were current based on their
loan terms. Loan guarantees as of September 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 related
loan guarantees was credited to earnings in 2005.
NOTE 15 - BUILDING MORTGAGES
Building mortgages outstanding at September 30: 2005 2004
------- -------
Fidelity Bank - collateralized by rental office building $163,073 $173,073
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 420,404 435,467
------- -------
Interest rate equal to "prime + 1.5%", currently 8.0%; monthly
principal & interest payment of $4,196; matures Sept. 1, 2009,
at which time a balloon payment of $340,543 is due.
Total principal outstanding $583,477 $608,540
Interest expense for the three months ended September 30 $11,441 $ 6,191
Interest expense for the nine months ended September 30 $32,482 $ 13,847
Total carrying value of the mortgage's collateral $731,575 $743,167
Estimated annual principal payments: 2005 - $7,754; 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
F-17
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 nine months ended September 30 have
been calculated as follows:
Three Months Nine Months
------------ -----------
2004 Net Income $ 49,355 $212,094
- ---- Average Common Shares Outstanding 846,114 678,455
Earnings per Common Share $ 0.06 $ 0.31
2005 Net Income (Loss) $(48,278) $ 23,720
- ---- Average Common Shares Outstanding 844,269 826,794
Earnings (Loss) per Common Share $ (0.06) $ 0.03
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.
NOTE 19 - MAJOR CUSTOMERS
The Company recorded more than 10% of its total revenue for the nine months
ended September 30, 2005 from the following customers:
Amount % Description of Revenue Received
------ --- -------------------------------
Senior Housing Services, Inc. $4,634,911 42.5% Interest and fees from real estate joint
venture investments
Wellstone Housing, LLC 2,167,498 19.9% Interest and fees from family housing
development loans
Sage Living Centers, Inc. 1,247,734 11.5% Interest and fees from real estate joint
---------- ----- venture investments
$8,050,143 73.9%
F-18
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 nine months ended September
30, 2005 was $6,802,409 or 62.4% 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 September
30, 2005 are:
Carrying Amount Fair Value
--------------- ----------
Financial assets:
Cash and cash equivalents $ 1,303,288 $ 1,303,288
Bond holdings $ 4,976,583 $ 4,976,583
Financial liabilities:
Investor certificates $126,637,372 $126,637,372
Mortgage participations $ 4,912,500 $ 4,912,500
Building mortgages $ 583,477 $ 583,477
Capital lease obligation $ 3,013 $ 3,103
Loan guarantee obligations $ 71,000 $ 71,000
F-19
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.
Nine months ended
September 30,
2005 2004
---------- ---------
Revenues $10,890,717 $9,110,919
---------- ---------
Investor interest expense 8,532,551 6,627,673
Loan loss expense 75,000 50,000
Marketing expenses 808,542 735,709
Management/advisory fees 1,034,872 898,671
Operating expenses 540,684 588,332
---------- ---------
Total expenses 10,991,649 8,900,385
---------- ---------
Operating income (100,932) 210,534
Income tax benefit (124,652) (1,560)
---------- ---------
Net income $ 23,720 $ 212,094
Overview of operations.
We have always focused on serving faith-based organizations, mostly churches and
senior housing non-profit organizations. 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. Approximately
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 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 September 30, 2004 and September 30, 2005
General. Assets increased from $127,657,163 at September 30, 2004 to
$150,041,892 at September 30, 2005 for an increase of $22,384,729 or 18%. This
increase is a result of the sale of Investor Certificates and Mortgage
Participations, net of redemptions of $22,684,589. 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
$28,488,418. Total revenue increased for the three and nine months ended
September 30, 2005 by $327,658 or 10% and $1,779,798 or 19% to $3,629,262 and
$10,890,717, respectively. Net income (loss) for the three and nine months ended
September 30, 2005 was ($48,278) and $23,720 compared to $49,355 and $212,094,
respectively for the same periods ended September 30, 2004.
Total real estate loans and joint venture investments outstanding on September
30, 2005 was $138,403,098 compared to $109,914,680 on September 30, 2004 for an
increase of $28,488,418 or 26%. 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 $ 22,213,597
Increase in existing loans, net of principal received 4,153,792
New real estate joint venture investments made 3,266,317
Decrease in existing real estate joint venture investments (1,145,288)
-------------
$ 28,488,418
All other assets composed primarily of cash, bond holdings, property and
equipment, and unamortized debt issue costs were $11,638,794 as of September 30,
2005.
Our cash balance decreased $7,954,267 from $9,257,555 on September 30, 2004 to
$1,303,288 on September 30, 2005. In 2004, our Series E certificates became
effective in March and because we had no certificates available for almost one
year, when Series E became effective, we sold approximately $31,000,000 in
certificates during the second and third quarters of 2004. We were unable to
reinvest all of these proceeds by September 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 $22,684,589 or 19% from $121,264,010
as of September 30, 2004 to $143,948,599 as of September 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 nine
months ended September 30 is as follows:
2005 2004 Increase %
---- ---- -------- ---
Three months $ 3,466,797 $3,165,898 $ 300,899 9.5%
Nine months $10,058,106 $8,764,245 $1,293,861 14.8%
The increase was due to the following:
Three Months Nine Months
------------ -----------
Increase in average outstanding principal $ 728,722 $2,349,701
(Three Months: $131,322,111 - 2005; $101,418,710 - 2004)
(Nine Months: $124,158,063 - 2005; $91,891,257 - 2004)
Change in weighted average interest rate (76,689) (82,475)
(Three Months: 9.61% - 2005; 9.91% - 2004)
(Nine Months: 9.74% - 2005; 9.86% - 2004)
Change in loan fees recognized (351,134) (973,365)
-------- --------
$ 300,899 $1,293,861
The increase in average outstanding principal is due to the addition of nine new
real estate loans and joint venture investments with outstanding principal of
$25,479,914 and increases in the weighted average principal outstanding on
existing loans of $4,423,487. Loan fees recognized decreased because three large
loans which we originated in late 2003 and the first half of 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 all of this revenue during the first
half of 2005. Since late June 2005, we charged over $700,000 in new loan and
renewal fees to our various borrowers which should increase our recognized loan
fees in the fourth quarter and the first half of 2006.
Loan participation and other income. For the three and nine months ended
September 30, 2005, loan participation and other income increased as follows:
Three Months Nine Months
--------------------------------------- ----------------------------------
2005 2004 Change 2005 2004 Change
---- ---- ------ ---- ---- ------
Investment income $140,025 $120,815 $ 19,210 $404,234 $317,071 $ 87,163
Loan participation & other 22,440 14,891 7,549 428,377 29,603 398,774
-------- -------- -------- -------- -------- --------
Total $162,465 $135,706 $ 26,759 $832,611 $346,674 $485,937
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, church bonds and from interest income on the Company's
excess cash.
4
The increase in investment income for the three months ended September 30 is due
to Church bonds purchased during the third quarter of 2005 ($13,155) and an
increase in short-term interest rates ($6,055) during 2005. The increase for the
nine months ended September 30 is due to the church bonds, an increase in
short-term interest rates and an increase in the Company's average excess cash
balance on hand.
For the three months ended September 30, the increase in loan participation and
other income was due to a $5,000 increase in rent revenue received from
Cornerstone Capital Advisors for their rent of the corporate office building in
Cumming, GA and a $2,500 loss from a fixed asset sale in 2004. For the nine
months ended September 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 a $35,000 increase in rent revenue received from Cornerstone
Capital Advisors. See page F-10 for additional information about the rent that
we receive from Cornerstone Capital Advisors.
Investor interest expense. Investor interest expense for the three and nine
months ended September 30, 2005 was $2,974,148 and $8,532,551, which are
increases of $471,630 (19%) and $1,904,878 (29%), respectively compared to 2004.
The increases are due to:
Three Months Nine Months
------------ -----------
Increase in average outstanding certificate principal, including
interest payable subject to compounding $ 521,528 $2,070,408
(Three Months: $130,298,477 - 2005; $106,559,739 - 2004)
(Nine Months: $124,900,475 - 2005; $93,218,234 - 2004)
Change in weighted average interest percentage (18,648) (83,896)
(Three Months: 8.75% - 2005; 8.82% - 2004)
(Nine Months: 8.70% - 2005; 8.82% - 2004)
Decrease in average outstanding Mortgage Participation principal
(Three Months: $4,912,500 - 2005; $6,162,500 - 2004)
(Nine Months; $5,069,947 - 2005; $6,158,400 - 2004) (31,250) $ (81,634)
--------- ----------
$ 471,630 $1,904,878
Loan loss expense and allowance for loan losses. We charged $25,000 and $20,000
for the three months and $75,000 and $50,000 for the nine months ended September
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 $425,000 on September 30,
2004 to $707,000 on September 30, 2005. This increase is due to: 1) an increase
in the family housing development loan portfolio's outstanding principal
($130,000), 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 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 September 30, 2005, three church loans with a total carrying amount of
$3,157,345 were considered impaired. As of September 30, 2004, two church loans
with a carrying amount of $1,933,751 were considered impaired. It is likely that
we will foreclose on one of the church loans ($281,591 carrying value) within
the next six months. 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 September 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 $ 707,000 $ 48,281,461 1.5%
Church Mortgage Loans -0- 9,221,703 0%
Senior Housing Mortgage Loans -0- 19,861,474 0%
Real Estate Joint Venture Investments -0- 61,013,829 0%
--------- ------------ ---
Total $ 707,000 $138,378,467 .5%
Marketing expenses. Total expenses for the marketing of Investor Certificates
for the three and nine months ended September 30, 2005 were $268,581 and
$808,542 compared to $274,995 and $735,709 for the same periods in 2004. The
changes are due to:
5
Three Months Nine Months
2005 2004 Change 2005 2004 Change
---- ---- ------ ---- ---- ------
Debt issue cost amortization $242,517 $223,454 $19,063 $705,634 $589,815 $115,819
Other marketing costs 26,064 51,541 (25,477) 102,908 145,894 (42,986)
-------- -------- ------- -------- -------- --------
$268,581 $274,995 $(6,414) $808,542 $735,709 $ 72,833
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 $2,754,780 and $2,621,638 as of
September 30, 2005 and 2004, respectively.
The increases in debt issue cost amortization for the three and nine months
ended September 30 are due to an increase in the outstanding Investor
Certificates outstanding at September 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 nine months ended September 30 increased $63,132 (23%) and $136,201
(15%) from $269,575 and $898,671 in 2004 to $332,707 and $1,034,872 in 2005,
respectively. The increases are due to the Company's growth in revenues in 2005.
Starting in July 2003, the Company contracted with Cornerstone Capital Advisors,
Inc. ("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 nine month periods ended September 30, 2005 and 2004.
For the three and nine months ended September 30, 2005 and 2004, operating
expenses were as follows:
2005 2004 Change
---- ---- ------
Three Months Ended $157,485 $198,284 ($40,799)
Nine Months Ended $540,684 $588,332 ($47,648)
For the three and nine months ended September 30, 2005 and 2004 the decreases
are due to:
Three Months Nine Months
------------ -----------
Consulting Expenses ($45,471) ($98,717)
Legal Expenses 22,373 101,248
Appraisal Costs 2,500 (23,707)
Office expenses 328 (21,424)
Other (20,529) (5,048)
-------- --------
($40,799) ($47,648)
Consulting expenses decreased because in 2004, we used consultants to identify
new markets for us in the African-American church community and in the
low-income apartment housing market. 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 for the nine
months ended September 30 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 ordered only two new appraisals in 2005
both of which were completed in the third quarter and resulted in the $2,500
increase for the three months ended September 30. Office expenses for the nine
months ended September 30 decreased due to the change we made in the CCA
contract on August 1, 2004. When the new contract was put in place, CCA became
responsible for paying the normal office operating costs that we had been paying
prior to that date which reduced our 2005 operating costs. Other costs decreased
due to travel costs decreasing in both periods presented.
6
Income tax provision (benefit). The income tax provision (benefit) for the three
and nine months ended September 30, 2005 was ($80,381) and ($124,652),
respectively compared to ($13,123) and ($1,560), respectively for the same
periods ended September 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
(62.5%) and (36.2%) for the three months and (123.5%) and (0.7%) for the nine
months ended September 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 paid in July 2005 and 2004,
respectively.
Liquidity and Capital Resources
Cash flows from operations. Net cash provided by the Company's operations for
the nine months ended September 30, 2005 and 2004 was $1,250,364 and $291,751,
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, deferred taxes and an increase in loans in progress.
Investor and mortgage participation interest payable increased $3,712,515 in the
first nine months of 2005 due to an increase in outstanding debt (20% of the
increase) and because approximately 25% to 30% of the investors who purchased
certificates in 2004 and 2005 have elected to reinvest the interest due to them
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 $966,935 and $1,186,383 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 nine months ended September 30, 2005 and 2004 is as
follows:
2005 2004
---- ----
Family Housing Development $571,721 $ 802,756
Church Construction 20,965 38,464
Real Estate Joint Venture 374,249 345,163
-------- ----------
$966,935 $1,186,383
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 decrease in the family housing net financed interest in 2005 as compared to
2004 is due to three projects going from their development phase into their sale
phase and thus they are paying interest to us as they sell homes. The net
financed interest will most likely increase from its current level because of
three new loans originated in the third quarter of 2005 which are just starting
the development phase of their operations. These loans total approximately
$8,500,000.
The Real Estate Joint Venture financed interest in 2005 is for a loan in
McKinney, TX ($282,316) and for a loan in Chattanooga, TN ($91,933). The
McKinney, TX loan is collateralized by raw land which is being developed for
family housing. We have been financing the interest on this loan since June,
2003. Our other Real Estate Joint Venture Investment loans are collateralized by
senior housing facilities that were already in place when we originated the
loans and they 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 14 to 18 months.
The Chattanooga, TN loan completed its remodeling in 2004 and its lease-up phase
has taken longer than anticipated; therefore, we capitalized some of their first
quarter 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 nine months ended September 30,
2005, the Company used $26,499,065 in cash from investing activities which is an
increase of $2,454,679 from $24,044,386 for the nine months ended September 30,
2004. The increase was due to an increase in real estate and joint venture loans
made net of principal payments received of $1,263,587 and the purchase of
$1,219,290 in church bonds during 2005. These increases were offset by the
receipt of $30,600 in bond principal payments in 2005 versus no principal
payments received in 2004.
It is possible that in December, 2005, two of our major borrowers will sell
their interests in as many as nine senior housing facilities. If this happens,
approximately $23,000,000 in senior housing real estate loans and real estate
joint venture investment principal 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.
7
Cash flows from financing activities. For the nine months ended September 30,
2005, the Company raised $16,566,473 from the sale of Investor Certificates and
Mortgage Participation Agreements. This represents a decrease of $14,612,141
from new Investor Certificate and Mortgage Participation sales of $31,178,614
for the nine months ended September 30, 2004. When Series E became effective in
March, 2004, we started selling new certificates for the first time in almost
one year. Because of the 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 $31,000,000 in Series E certificates in only six
months. Now that we have had certificates on the market for 18 straight months,
the demand has decreased to a steady and more manageable level as compared to
2004.
Investor Certificates redeemed for cash decreased from $3,336,245 for the nine
months ended September 30, 2004 to $1,753,744 for the nine months ended
September 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.
We have $22,656,748 in Investor Certificates coming due or redeemable upon
demand in the next 12 months. $10,318,973 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, $10,797,105 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 September
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
8
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. While we do not believe that we have
violated any securities laws in connection with our previous reliance on the
Exchange exemption, we have elected to settle any related state regulatory
actions where the cost of such settlements are likely to be significantly less
than the cost of litigation in each state. Previously in the "Legal Proceedings"
section of our 10-QSB dated August 15, 2005, we discussed the final outcomes
relating to the Chicago Exchange exemption issue for the states of Texas,
Michigan, and Minnesota.
On August 25, 2005, at the informal request of Maine's Office of Securities, we
made rescission offers to investors in Maine. In October 2005, at the request of
the Tennessee Department of Commerce and Insurance Securities Division, and
because the Tennessee Securities Division believed four shareholders received
incorrect prospectuses when buying our registered common stock we redeemed eight
shares of our common stock owned by these four Tennessee shareholders.
On August 11, 2005, the Ohio Division of Securities sent us a draft of a Cease
and Desist Order, the terms of which did not require us to pay fines or give
rescission offers. We agreed to the Cease and Desist Order, and on September 12,
2005, the Ohio Division of Securities issued the Cease and Desist Order.
According to the terms of the Order, we are ordered to refrain from offering to
sell unregistered securities in Ohio unless a proper exemption from registration
exists.
On September 20, 2005 we entered into a Consent Agreement with the Indiana
Securities Division, the terms of which required us to give rescission offers to
Indiana investors, pay a $600 investigation expense cost, and refrain from
violating provisions of the Indiana Securities Act in the future.
On March 10, 2005, we attempted to register our Series F Bonds and Common Stock
in New Jersey, by filing a registration statement with the New Jersey Bureau of
Securities. Because our initial prospectus for the Series F Bonds and Common
Stock included the incorrect statement that the Company's common stock was
approved for listing on the Chicago Exchange upon notice of issuance, the New
Jersey Bureau of Securities denied the effectiveness of our registration
statement by issuing a Stop Order on October 5, 2005. According to the Stop
Order we are prohibited from selling Series F Bonds and Common Stock in the
state of New Jersey.
On October 27, 2005, the Colorado Division of Securities sent us a draft of a
Stipulation for Consent and Desist Order, the terms of which would require us to
make rescission offers to certain Colorado investors. We have decided to agree
to the terms of this particular Stipulation for Consent and Desist Order, and
upon the expected execution of the Stipulation for Consent and Desist Order by
both the Colorado Division of Securities and us, we will make the rescission
offers contemplated in the Order.
Since February 2005, we have been discussing our previous offers to sell
securities in Kansas with the Kansas Office of the Securities Commissioner, and
on August 24, 2005, the Kansas Office of the Securities Commissioner requested
that we provide them with additional information relating to these offers to
sell. On September 12, 2005, we provided the Kansas Office of the Securities
Commissioner with the requested additional materials and while we are unsure
whether Kansas plans to issue any formal Order, we have been informed that they
will respond to our September 12, 2005 correspondence by year's end.
As of November 11, 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
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Item 5. Other Information
Not Applicable
Item 6. Exhibits and Reports on Form 8-K
(a) (1) Exhibit 32.1 & 32.2, Certifications pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(2) Exhibit 15, Letter on un-audited 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: November 11, 2005 Cornerstone Ministries Investments, Inc.
(Registrant)
By: S/John T. Ottinger
----------------------
John T. Ottinger
Vice President and
Chief Financial Officer
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