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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File No. 0-28168
Strategic Capital Resources, Inc.
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 11-3289981
- ------------------------------- ------------------------------------
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
7900 Glades Road, Suite 610, Boca Raton, Florida 33434
------------------------------------------------------
(Address of principal executive office)
(561) 558-0165
----------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding twelve months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
described in Rule 12-b of the Exchange Act)
Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date. The number of shares of common
stock, part value $.001 per share, outstanding as of June 5, 2003 was 77,192.
TABLE OF CONTENTS
Part I FINANCIAL INFORMATION
Item 1. Financial Statements Page Number
Condensed Consolidated Balance Sheets as of 3
March 31, 2003 (unaudited) and June 30, 2002
Condensed Consolidated Statements of Income 4
for the three and nine months ended March 31,
2003 and March 31, 2002 (unaudited)
Condensed Consolidated Statements of Cash 5
Flows for the nine months ended March 31, 2003
and 2002 (unaudited)
Notes to Condensed Consolidated Financial 6-20
Statements (unaudited)
Item 2. Management's Discussion and Analysis of 21-32
Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About 32
Market Risk
Item 4. Controls and Procedures 33
Part II. OTHER INFORMATION
Item 1. Not applicable 33
Item 2. Change in Securities 33-34
Item 3. Not Applicable 34
Item 4. Not Applicable 34
Item 5. Not Applicable 35
Item 6. Exhibits and Reports on Form 8-K 35
SIGNATURES 36
CERTIFICATIONS 37-39
2
STRATEGIC CAPITAL RESOURCES, INC. AND SUBSIDIARIES
PART I. - FINANCIAL INFORMATION
Item 1 - Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS
ASSETS
March 31, June 30,
2003 2002
(Unaudited) (As Restated)
------------ ------------
Revenue producing assets:
Net investment in direct financing arrangements:
Model homes $ 11,659,567 $ 16,140,165
Residential real estate 25,385,410 62,020,542
Multi-family residential property 0 10,010,585
Model homes under operating leases, net of accumulated
depreciation of $43,744 26,112,720 0
------------ ------------
Total revenue producing assets 63,157,697 88,171,292
------------ ------------
Other assets:
Cash and cash equivalents 2,746,228 801,415
Deferred charges 765,016 848,466
Deferred income taxes 17,947 86,967
Deferred operating lease income receivable 44,868 0
Other 794,807 758,923
------------ ------------
Total other assets 4,368,866 2,495,771
------------ ------------
Total assets $ 67,526,563 $ 90,667,063
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Mortgages payable $ 55,288,065 $ 77,592,476
Accounts payable and accrued expenses 1,538,045 1,739,401
Unearned income 57,989 173,038
Income taxes 634,030 852,128
Stockholder loans 770,000 1,909,200
------------ ------------
Total liabilities 58,288,129 82,266,243
------------ ------------
Stockholders' equity:
Common stock, $.001 par value, 25,000,000 shares authorized
87,560 issued, 77,192 outstanding 88 88
Additional paid-in capital 8,847,616 8,847,616
Treasury stock, 10,368 shares at cost (457,999) (457,999)
Retained earnings 848,729 11,115
------------ ------------
Total stockholders' equity 9,238,434 8,400,820
------------ ------------
Total liabilities and stockholders' equity $ 67,526,563 $ 90,667,063
============ ============
See accompanying Notes to Condensed
Consolidated Financial Statements
3
STRATEGIC CAPITAL RESOURCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Nine Months Ended
March 31, March 31,
--------- ---------
2003 2002 2003 2002
(As Restated) (As Restated)
------------ ------------ ------------ ------------
Revenue and other income:
Interest income on direct financing arrangements:
Model homes $ 331,517 $ 632,495 $ 1,171,072 $ 2,283,446
Residential real estate 1,194,082 1,822,504 4,536,909 4,994,628
Multi-family residential property 366,252 230,760 726,760 687,654
Rental income on operating leases 324,002 0 324,002 0
Gain on sale of model home properties under direct
financing arrangements 140,226 86,837 259,088 426,703
Gain on sale of multi-family residential property 281,670 0 281,670 0
Interest and other income 10,314 35,434 27,688 69,522
------------ ------------ ------------ ------------
Total revenue and other income 2,648,063 2,808,030 7,327,189 8,461,953
------------ ------------ ------------ ------------
Cost and operating expenses:
Interest to financial institutions 687,582 1,235,259 2,667,475 3,888,276
Interest to stockholders 349,780 27,112 423,064 82,736
Model home depreciation 43,744 0 43,744 0
Depreciation and amortization 223,984 383,357 995,727 1,108,733
Corporate selling, general and administrative 665,934 659,870 1,825,565 1,520,642
------------ ------------ ------------ ------------
Total cost and operating expenses 1,971,024 2,305,598 5,955,575 6,600,387
------------ ------------ ------------ ------------
Income before income tax expense 677,039 502,432 1,371,614 1,861,566
Income tax expense 182,703 148,000 529,000 580,000
------------ ------------ ------------ ------------
Net income 494,336 354,432 842,614 1,281,566
Preferred stock distributions 0 15,000 5,000 45,000
------------ ------------ ------------ ------------
Income applicable to common stockholders $ 494,336 $ 339,432 $ 837,614 $ 1,236,566
============ ============ ============ ============
Earnings per share, basic and diluted $ 6.40 $ 4.40 $ 10.85 $ 16.02
Weighted average number of shares, basic and diluted 77,192 77,192 77,192 77,192
See accompanying Notes to Condensed
Consolidated Financial Statements
4
STRATEGIC CAPITAL RESOURCES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
March 31,
----------------------------
2003 2002
(As Restated)
------------ ------------
OPERATING ACTIVITIES
Net income $ 842,614 $ 1,281,566
Adjustments to reconcile net income
to net cash provided by operating activities:
Amortization and depreciation expense 1,039,471 1,108,732
Deferred income taxes (149,077) 0
Gain on sale of model home properties under direct financing arrangements (259,088) (426,703)
Gain on sale of multi-family residential property (281,670) 0
Interest expense from issuance of warrants 0 98,668
Deferred operating lease income (44,868) 0
Interest expense from implicit interest on multi-family property 0 75,101
Changes in operating assets and liabilities (294,494) 773,861
------------ ------------
Total adjustments 10,274 1,629,659
------------ ------------
Net cash provided by operating activities 852,888 2,911,225
------------ ------------
INVESTING ACTIVITIES
Investment in properties under direct financing arrangements:
Residential real estate 0 (10,710,909)
Investment in properties under operating lease arrangements:
Model homes (3,780,323) 0
Proceeds from sale of properties under direct financing arrangements 6,503,955 6,479,412
Proceeds from sale of multi-family residential property 902,961 0
Proceeds from debt 369,182 0
------------ ------------
Net cash used in investing activities 3,995,775 (4,231,497)
------------ ------------
FINANCING ACTIVITIES
Principal payments on mortgages payable (803,629) (395,034)
Proceeds from stockholder loans 250,000 375,000
Repayment of stockholder loans (1,389,200) 0
Deferred finance charges (956,021) (1,511,884)
Preferred distributions (5,000) (45,000)
------------ ------------
Net cash provided by (used in) financing activities (2,903,850) (1,576,918)
------------ ------------
NET INCREASE (DECREASE) IN CASH 1,944,813 (2,897,190)
CASH - BEGINNING OF PERIOD 801,415 3,986,639
------------ ------------
CASH - ENDING OF PERIOD $ 2,746,228 $ 1,089,449
============ ============
See accompanying Notes to Condensed
Consolidated Financial Statements
5
STRATEGIC CAPITAL RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2003
(Unaudited)
Note 1. DESCRIPTION OF BUSINESS
Description of Business
- -----------------------
The Company provides specialized financing for major homebuilders and
real estate clients throughout the United States. The arrangements may take
several forms which include direct financing leases, option agreements,
operating leases or management agreements. Such arrangements may represent
off-balance sheet transactions for the Company's clients.
The Company is and has been engaged in such arrangements in three
product lines of business, consisting of one reportable segment:
1. Purchase and lease of fully furnished model homes complete with options
and upgrades
2. Residential real estate acquisition and development
3. Multi-family residential property (sold March 2003)
Note 2. BASIS OF PRESENTATION
Interim Presentation
- --------------------
The accompanying condensed consolidated financial statements have been
prepared in conformity with the instructions to Form 10-Q and Article 10, Rule
10-01 of Regulation S-X for interim financial statements. Accordingly, they do
not include all the information and footnote disclosures normally included in
financial statements presented in accordance with accounting principles
generally accepted in the United States have been omitted from the accompanying
condensed consolidated financial statements. The Company's management believes
the disclosures made are adequate to make the information presented not
misleading. The condensed consolidated balance sheet information as of June 30,
2002 was derived from the audited consolidated financial statements included in
the Company's Annual Report Form 10-K. The condensed consolidated financial
statements included as part of this Form 10-Q filing should be read in
conjunction with that report. The accompanying unaudited consolidated financial
statements reflect all adjustments, consisting primarily of normal recurring
items that, in the opinion of the management of the Company, are considered
necessary for a fair presentation of the consolidated financial position,
6
results from operations and cash flows for the periods presented. Results of
operations achieved through March 31, 2003 are not necessarily indicative of
those which may be achieved for the year ending June 30, 2003.
All references in the condensed consolidated financial statements to
common shares, share prices, per share amounts and stock plans have been
retroactively restated for the two hundred-for-one reverse stock split effective
June, 2002
Note 3. SUMMARY OF SIGINIFICANT ACCOUNTING POLICIES
Principles of Consolidation
- ---------------------------
The accompanying condensed consolidated financial statements include
the accounts of Strategic Capital Resources, Inc. and its wholly owned
subsidiaries, which include special purpose subsidiaries. Intercompany
transactions have been eliminated in consolidation.
Special Purpose/Variable Interest Entities
- ------------------------------------------
The Company has several wholly owned special purpose subsidiaries, all
of which are consolidated. They have been formed for the exclusive purpose of
acquiring specific properties and perform no functions other than to manage a
specific project. A special purpose subsidiary is an entity structured in a way
that its sole activity is the specific project.
Special Purpose/Variable Interest Entities/Off Balance Sheet Arrangements
- -------------------------------------------------------------------------
The Company does not have off-balance sheet arrangements with special
purpose entities, variable interest entities or any other entities.
Use of Estimates
- ----------------
The preparation of condensed consolidated financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
condensed consolidated financial statements, and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
7
Fair Value of Financial Instruments
- -----------------------------------
The carrying value of all financial instruments, including cash and
cash equivalent, debt, accounts payable and accrued expenses, approximates their
fair value at the end of the reporting period due to the relatively short term
nature of these instruments.
Revenue Recognition
- -------------------
The Company accounts for some of its model homes and all of its current
residential real estate acquisition and development arrangements as well as
multi-family residential property (sold March 2003) under the direct financing
method of accounting prescribed under SFAS No. 13, Accounting for Leases.
Under the direct finance method of accounting, the assets are recorded
as an investment in direct finance arrangements and represent the minimum net
payments receivable, including third-party guaranteed residuals, plus the
un-guaranteed residual value of the assets, if any, less unearned income.
During the third quarter of fiscal year ended June 30, 2003, the
Company purchased model homes and leased them under operating lease agreements.
The homes are not covered by residual value insurance ("RVI"). All gains or
losses are recorded by the Company when a home is sold. The homes are
depreciated using the straight line method over forty years.
Model homes under operating leases income is recognized when earned in
accordance with the agreements. The contractual lease payment increases
(deferred lease payment) are recognized on a straight line basis over the term
of the lease agreement.
The cumulative difference between lease revenue recognized under this
method and the contractual lease payment terms is recorded as "Deferred
operating lease income receivable" on the Company's condensed consolidated
balance sheet.
We believe that the Company's revenue recognition policies are
appropriate to reflect the substance of the underlying transactions.
Reclassifications
- -----------------
Certain prior year amounts have been reclassified in the condensed
consolidated financial statements and the related notes to conform to the 2003
presentation.
8
Sales of residential real estate sold under direct financing
arrangements and related costs which are typically the same amount are no longer
reported as operating revenue and operating expense. The sales of residential
real estate are now disclosed in management's discussion and analysis.
The multi-family operating expenses (property taxes, insurance and
repairs) have been netted against the multi-family interest income in the
accompanying condensed consolidated statements of income.
The proceeds from the sale of model homes under direct financing
arrangements and the related costs have been reported as a net gain in the
condensed consolidated statements of income.
SEC Consultation/Prior Period Restatements
- ------------------------------------------
The Company has consulted with the Securities and Exchange Commission
and requested guidance with regard to accounting issues relating to the issuance
of warrants in conjunction with stockholder loans in addition to the proper
classification of its assets as well as the recording of certain sales and cost
of sales of the related asset dispositions. These consultations included the
proper timing of revenue and expense recognition versus cash flow recognition
for accounting purposes.
The accompanying condensed consolidated balance sheet as of June 30,
2002 and the condensed consolidated statements of income and cash flows for the
three and nine months ended March 31, 2002 have been restated to correct errors
resulting in the net understatement of interest expense and additional paid-in
capital and the overstatement of interest income and income tax expense.
One of the errors resulted from the Company not recording the effects
of detachable warrants issued with stockholder loans. The effect of the error
was to increase non-cash interest expense and additional paid-in capital and to
decrease net income by $98,668 for the nine months ended March 31, 2002.
The proceeds from the sale of model homes under direct financing
arrangements and the related costs have been reported as a net gain in the
condensed consolidated statements of income.
Revenue and cost of sales have previously been recorded at the time
each home or finished lot was closed and title and possession was transferred to
the buyer as well as the receipt of "good collected funds" by us.
9
Under direct finance accounting arrangements we now only record the
gain or loss on the sale.
Sales of residential real estate sold under direct financing
arrangements and the related costs which are typically the same amount are no
longer reported as operating revenue and operating expense. The sales of
residential real estate are now disclosed in management's discussion and
analysis.
Additionally in May 2003, after consultation with the Securities and
Exchange Commission, the Company's management discovered that it had not
properly accounted for the implicit interest rate in the multi-family
residential property agreement. As a result of the correction, interest income
decreased by $30,132 and $75,101 for the three and nine months ended March 31,
2002 respectively. Income tax expense was reduced by $12,052 and $30,040,
respectively. The adjustment to interest income also resulted in a decrease to
the net investment in the multi-family residential property by $111,399 at June
30, 2002. The net investment is $10,010,585 at June 30, 2002. The deferred tax
asset at June 30, 2002 is $86,967.
The aggregate net effect of the correction of the errors was to reduce
previously reported earnings of $372,564 and $1,425,325 for the three and nine
months ended March 31, 2002 to earnings of $354,432 and $1,281,566,
respectively. The aggregate net effect of the correction of the errors on income
per share was to reduce previously reported earnings per share of $4.63 and
$17.88 for the three and nine months ended March 31, 2002 to income per share of
$4.40 and $16.02, respectively.
The retained earnings, additional paid-in capital, the net investment
in multi family residential property and the deferred tax asset in the June 30,
2002 condensed consolidated balance sheet, and the net income, interest income
and income tax expense in the condensed consolidated statements of operations
and cash flows for the three and nine months ended March 31, 2002 have been
restated for the effect of the adjustments resulting from the correction of the
errors.
The conclusions reached with the Securities and Exchange Commission
have been incorporated into this filing. Additionally as a result of the
conclusions reached, the Company will be amending its annual report on Form 10-K
for its fiscal year ended June 30, 2002 as well as its Form 10-Q for the quarter
ended September 30, 2002 and its Form 10-Q for the quarter and the six months
ended December 31, 2002.
10
The Company has been advised by the Securities and Exchange Commission
that it will be performing a "cover to cover" review of its amended Form 10-K
for the fiscal year ended June 30, 2002. The Securities and Exchange Commission
may have additional comments that require additional amendments to our filings.
We have not been advised when the "cover to cover" review will be completed.
New Accounting Pronouncements
- -----------------------------
In December 2002, the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 148, "Accounting for Stock-Based Compensation - Transition
and Disclosure," an amendment of FASB Statement No. 123. This statement provides
alternative transition methods for a voluntary change to the fair value basis of
accounting for stock-based employee compensation. However this statement does
not permit the use of the original SFAS No. 123 prospective method of transition
for changes to the fair value based method made in fiscal years beginning after
December 15, 2003. In addition, this Statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock-based
employee compensation, description of transition method utilized and the effect
of the method used on reported results. The Company does not believe the
adoption of this standard will have a material impact on the condensed
consolidated financial statements.
In January 2003, the Financial Accounting Standards Board ("FASB")
issued FASB Interpretation (Interpretation) No. 46, "Consolidation of Variable
Interest Entities", an interpretation of Accounting Research Bulletin ("ARB")
No. 51, "Consolidated Financial Statements". Interpretation No. 46 addresses
consolidation by business enterprises of variable interest entities, which have
one or both of the following characteristics: (i) the equity investment at risk
is not sufficient to permit the entity to finance its activities without
additional subordinated support from other parties, which is provided through
other interests that will absorb some or all of the expected losses of the
entity; (ii) the equity investors lack one or more of the following essential
characteristics of a controlling financial interest: the direct or indirect
ability to make decisions about the entities activities through voting rights or
similar rights; or the obligation to absorb the expected losses of the entity if
they occur, which makes it possible for the entity to finance its activities;
the right to receive the expected residual returns of the entity if they occur,
which is the compensation for the risk of absorbing the expected losses.
Interpretation No. 46 also requires expanded disclosures by the primary
beneficiary (as defined) of a variable interest entity and by an enterprise that
holds a significant variable interest in a variable interest entity but is not
11
the primary beneficiary. Interpretation No. 46 applies immediately to variable
interest entities created after January 31, 2003, and to variable interest
entities in which an enterprise obtains an interest after that date. It applies
in the first fiscal year or interim period beginning after June 15, 2003, to
variable interest entities in which an enterprise holds a variable interest that
it acquired before February 1, 2003. Interpretation No. 46 may be applied
prospectively with a cumulative-effect adjustment as of the date on which it is
first applied or by restating previously issued financial statements for one or
more years with a cumulative-effect adjustment as of the beginning of the first
year restated. As Interpretation No. 46 has just been issued, we have not
completed our evaluation as to the potential impact on our consolidated
financial statements. However, based on preliminary review, management does not
believe that the adoption of Interpretation No. 46 will have a significant
effect on our consolidated financial statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement
133 on Derivative Instruments and Hedging Activities". SFAS No. 149 amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities". The
changes in SFAS No. 149 improve financial reporting by requiring that contracts
with comparable characteristics be accounted for similarly. This statement is
effective for contracts entered into or modified after June 30, 2003 and all of
its provisions should be applied prospectively. The adoption of SFAS No. 149 is
not expected to have a material impact on our financial condition or results of
operations.
Note 4. NET INVESTMENT IN DIRECT FINANCING ARRANGEMENTS
The components of the net investment in direct financing arrangements
at March 31, 2003 and June 30, 2002 are as follows:
March 31, June 30,
2003 2002
(As Restated)
------------ ------------
Total minimum payments receivable $ 37,044,977 $ 88,171,292
Less: Unearned income 57,989 173,038
------------ ------------
Net investment in direct financing arrangements $ 36,986,988 $ 87,998,254
============ ============
12
Note 5. NEW FINANCIAL STATEMENT ITEMS
a. Model homes under operating leases - balance sheet
b. Rental income on operating leases - income statement
c. Model home depreciation - income statement
During the quarter ended March 31, 2003, the Company acquired 76 model
homes located in Florida, Texas, Colorado and Arizona. The purchase price of
$26,156,464 was financed utilizing existing and new credit facilities, as well
as Company funds.
The Company accounts for these model home transactions under the
provisions of SFAS No. 13, Accounting for Leases. Since the Company did not
obtain residual value insurance for these model homes they are accounted for as
operating leases. The homes are depreciated over 40 years. The client, a public
home builder, has entered into a triple net lease on the homes with terms
ranging from two to four years which includes a one year extension option.
We entered into a sale/leaseback agreement on the model homes with the
client. The lease terms range from one to three years per home (excluding
extensions). The client has the right to extend the lease terms for six months
and we have the right to extend the term for one year. The lease is triple net
whereby the lessee is responsible for all operating costs and provides for a
deferred lease payment payable at the end of the lease. The client is
responsible for the costs associated with the resale of the homes and has an
exclusive sales contract with us. If the homes are sold for a profit we retain
100% of the profit and if they are sold for a loss we bear the loss.
Model homes under operating leases income is recognized when earned in
accordance with the agreement. The contractual lease payment increases (deferred
lease payment) are recognized using the straight line method over the term of
the lease.
The cumulative difference between lease revenue recognized under the
agreement and the revenue recognized when straight lining the deferred lease
payment is recorded as "Deferred operating lease income receivable" on the
Company's condensed consolidated balance sheet.
We believe that the Company's revenue recognition policies are
appropriate to reflect the substance of the underlying transactions.
13
Note 6. COMMITMENTS AND CONTINGENCIES
Financing Activities
- --------------------
At March 31, 2003, the Company had approximately $38 million available
under its revolving loan agreement, which may be utilized to acquire real estate
assets in accordance with the terms of those agreements. The Company is
currently in negotiations to renew its $60,000,000 revolving secured credit
facility which matures August 2003. As part of the renewal negotiation, we
extended the maturity date on the current outstanding balance of approximately
$20,000,000 for one (1) year while we finalize a new facility that is more
favorable to the Company. The renewal fee paid will be applied to the renewal
fee on the $60,000,000 revolving secured credit facility.
We anticipate finalization of the renewal this fiscal year, but there
is no assurance that we will consummate the facility renewal.
The Company received a commitment from a new bank for approximately
$7,000,000. The loan will bear interest at LIBOR plus a premium and has a three
year term.
As a part of its ongoing business, the Company is in constant
discussion with financial institutions for credit facilities, as well as private
or public placements of its debt or equity securities. The possible offering or
private placement of senior notes with warrants, convertible preferred stock or
similar type of security is constantly being evaluated. It is the Company's
policy not to incur costs from activation of credit facilities unless and until
needed.
We make preliminary commitments to acquire revenue producing assets and
to enter into various types of purchase and leaseback transactions as well as
financing arrangements. We disclose these commitments as part of our routine
reporting. Such preliminary commitments are subject to routine changes in size,
dollar amounts and closing time, prior to finalization. Such changes arise from
a variety of factors, including changes in client needs, economic conditions,
and completion of due diligence and financing agreements.
14
Legal Proceedings and Recent Developments
- -----------------------------------------
Star Insurance Company v. Strategic Capital Resources, Inc., 15th
Judicial Court, Palm Beach County, Florida, Case No. CL 00-433 AD,
The Company resolved the Star Insurance Company action. Based on
mediation, the case was settled for $250,000 in January 2003. This amount was
previously accrued as a corporate expense in the quarter ended September 30,
2002. The lawsuit against the Company was far in excess of $2,500,000. The
Company and its counsel were convinced that our defense was very strong but
decided to settle the suit in order to avoid the uncertainty of a jury verdict
as well as the expenses of the inevitable appeals that would follow. The
mediator pointed out that our cost to defend the lawsuit and appeals would
exceed the $250,000 settlement.
On January 15, 2003, we wire transferred $250,000 to Star Insurance
Company's attorney trust account in full settlement of this litigation. The
receipt of the funds was acknowledged.
We have not received the executed settlement agreement as of April 30,
2003 and demanded the return of our funds by May 1, 2003. Star Insurance Company
faxed back an executed settlement agreement on May 1, 2003. We filed a motion
with the court to have the $250,000 settlement payment returned to us and Star
Insurance Company then made a motion to compel settlement.
A decision is anticipated this calendar year.
Strategic Capital Resources, Inc. vs. Citrin Cooperman& Company, LLP,
Horton & Company, LLP and Edward Horton, United State District Court, Southern
District of Florida, Case No. 03-80249-CIV-HURLEY.
We filed suit against our former auditors. In our Complaint we allege
among other things that the defendants neglected and breached their duty to us
by failing to complete an audit which was necessary for us to file our Form 10-K
for the fiscal year ended June 30, 2002, timely, failed to disclose that its
principal independent accountant (Edward C. Horton) and his former firm (Horton
& Company, LLC) as well as others at Citrin Cooperman & Company, LLP had been
temporarily denied the privilege of appearing or practicing before the
Securities and Exchange Commission as an accountant, failed to obtain
authorization to practice accountancy in the State of Florida as well as other
acts of malpractice and abuse of duty. The litigation is in its early stages and
therefore, an outcome is not predictable at this time.
15
We are not presently involved in any other material litigation other
than previously disclosed nor, to our knowledge, are any other material
litigation threatened against us or any of our properties, other than routine
litigation arising in the ordinary course of business.
Note 7. MORTGAGES AND NOTES PAYABLE
Bank loans are collateralized by first mortgages on specific properties
as well as specific payment, obligations by the client, surety bonds, letters of
credit and/or residual value insurance. Interest is payable monthly in arrears
at interest rates ranging from 3.83% to 7.76% as of March 31, 2003. The maturity
dates ranged from one (1) to three (3) years.
Note 8. SUPPLEMENTAL CASH FLOW INFORMATION
The Company's non-cash investing and financing activities were as
follows:
Nine Months Nine Months
Ended Ended
March 31, March 31,
2003 2002
------------ ------------
Investment in residential real estate $ 0 $ 51,148,057
Bank borrowings 0 (40,437,148)
------------ ------------
Investment in direct financing arrangements $ 0 $ 10,710,909
============ ============
Investment in residential real estate $ 8,162,429 0
Bank borrowings (8,531,611) 0
------------ ------------
Net proceeds in excess of amount invested in
residential real estate ($ 369,182) $ 0
============ ============
Purchase of model homes
under operating leases $ 26,156,464 $ 0
Bank borrowings (22,376,142) 0
------------ ------------
Investment in operating leases $ 3,780,322 $ 0
============ ============
16
During the nine months ended March 31, 2003 and 2002, the Company sold
properties under direct financing arrangements (excluding sale of multi-family
residential property) and paid down the related debt. The sales and related debt
payments are as follows:
Nine Months Nine Months
Ended Ended
March 31, March 31,
Model Home and Residential Real Estate Sales 2003 2002
-------------------------------------------- ------------ ------------
Sales proceeds $ 50,281,975 $ 36,319,005
Debt payments (43,778,020) (29,839,593)
------------ ------------
Net proceeds $ 6,503,955 $ 6,479,412
============ ============
Nine Months Nine Months
Ended Ended
March 31, March 31,
Multi Family Residential Property 2003 2002
--------------------------------- ------------ ------------
Sales proceeds $ 9,895,920 $ 0
Debt payments (8,992,959) 0
------------ ------------
Net proceeds $ 902,961 $ 0
============ ============
Interest paid to financial institutions totaled $2,667,475 and
$3,888,726 for the nine months ended March 31, 2003 and 2002, respectively.
Income taxes paid totaled $540,000 and $610,000 for the nine months ended March
31, 2003 and 2002, respectively.
Note 9. MULTI FAMILY RESIDENTIAL PROPERTY
The asset described below was sold March, 2003.
On July 15, 1999, we purchased a 288 unit multi-family residential
property in Jacksonville, Florida, for a purchase price of $10,227,999. The
purchase price was paid as follows:
Assumption of existing first mortgage $ 4,927,999
New loan 5,300,000
------------
Total Purchase Price $ 10,227,999
============
17
At the time of purchase, the Company entered into a five year
management agreement with a non affiliated independent management company. The
management company was responsible for the operation of the property, retained
all income from the property and was responsible for any losses. The Company
received a monthly fee comprised of the sum of the debt service to cover the
assumed existing first mortgage ($43,365) plus required escrows for real estate
taxes, property insurance and repair reserve, plus a 12% annual return on the
$5,300,000 new loan. The escrow portion was variable based on changes in
estimated expenses. The multi-family operating expenses (property taxes,
insurance and repairs) were netted against the multi-family interest income in
the accompanying condensed consolidated statements of income. The Company's
profit on the transaction arose from the difference between the 12% return and
interest expense paid by the Company on its $5,300,000 loan. The management
company received the benefit of the property appreciation, rent and occupancy
increases. The annual return was 11% for the first two years, 12% for year three
and 13% for years four and five. The average return over the term of the
agreement was 12%.
The management company had an option to purchase the property any time
during the last four years of the agreement at an amount equal to the balance of
the first mortgage plus an interest adjustment of $121,527, representing the
difference between the 11% paid and the 12% due us, bearing interest of 12%
since August 25, 2001, plus $5,300,000. If they failed to exercise the option,
the management company was required to pay a balloon payment of $5,300,000 at
the end of the five years. A performance bond, issued by an insurance company
rated "AAA" by Moody's and Standard & Poors, in the amount of $8,335,000 was
obtained and paid for by the management company to insure the payment and
performance of the management company. The performance bond insured the monthly
payments by the management company and the $5,300,000 balloon payment at the end
of the agreement.
The Company accounted for the multi-family residential property as a
direct financing arrangement, in accordance with the provisions of Statement of
Financial Accounting Standard ("SFAS") 13, Accounting for Leases, because the
agreement contains a bargain purchase option. In May, 2003, after consultation
with the Securities and Exchange Commission, the Company's management discovered
that it had not properly accounted for the implicit interest rate in the
agreement and has accounted for the prior period adjustment as a correction of
error in the accompanying condensed consolidated financial statements (see Note
3).
18
SFAS No. 13 dictates the following accounting treatment for this
transaction: (1) Using the actual purchase price of $10,227,999, the projected
bargain purchase option at the end of five (5) years of $9,630,902 and the
minimum lease payments, an implicit interest rate of 10.295% was derived
utilizing present value tables; (2) the implicit interest rate was then applied
to the purchase price and an interest income stream was generated for the five
(5) years; (3) the calculated amount was compared to the actual cash amount
received (net of executory payments for taxes and insurances); (4) since the
actual interest was greater than the implicit interest the actual interest was
adjusted, resulting in a non-cash interest expense charge in each of the fiscal
years commencing with June 30, 2000. Additionally, the net investment in the
multi-family direct financing arrangement in the consolidated balance sheet was
decreased by the adjustment in (4) above resulting in a net investment in the
multi-family residential property of $10,010,585 at June 30, 2002. The
adjustment also results in an increase in deferred tax asset, since the
adjustment is being recognized for book purposes and not for tax purposes.
The table below reflects the change to the results previously reported.
Actual Interest Deferred Net
Fiscal Interest Implicit Expense Blended Tax Decrease to
Year Income Interest Adjustment Tax Rate Benefit Earnings
---- ---------- ---------- ---------- ---------- ---------- ----------
6/30/2000 $1,103,386 $1,050,539 $ 52,847 40% $ 21,140 $ 31,707
6/30/2001 1,103,386 1,044,834 58,552 40% 23,421 34,131
6/30/2002 1,143,136 1,037,121 106,015 40% 42,406 63,609
---------- ---------- ---------- ---------- ----------
Total $3,349,908 $3,132,494 $ 217,414 $ 89,697 $ 129,447
========== ========== ========== ========== ==========
The effect on the consolidated statement of income for the nine months
ended March 31, 2002 was to reduce interest income by $75,101 (See Note 3 - SEC
Consultation/Prior Period Adjustments). In March 2003, the management company
exercised its option to purchase the property. The sales price of $9,895,920 was
the sum of $5,300,000, the unpaid interest adjustment of $146,896 ($121,527 plus
accrued interest), and the balance of the first mortgage of $4,384,570 plus
closing adjustments of $64,454. The company received cash at closing of $902,961
net of the outstanding balance of the original $5,300,000 loan. Due to the
reduction of the balance sheet value of the asset by the non-cash interest
expense, a gain on the sale of $281,670 was recorded for the three months ended
March 31, 2003.
19
Note 11. SUBSEQUENT EVENTS
Model Home Program
- ------------------
From April 1, 2003 through May 10, 2003, the Company sold two model
homes underlying the direct financing leases at an aggregate sales price of
approximately $686,000. These models were acquired at an aggregate cost of
approximately $528,000.
The Company also has pending contracts to sell five model homes at an
aggregate cost of $1,418,492 and a sales price of $1,903,400.
Residential Real Estate Acquisitions and Development
- ----------------------------------------------------
From April 1, 2003 through the date of the report, the Company had
sales of residential real estate in the amount of $5,498,784.
Stockholder Loan Agreement Amendments
- -------------------------------------
During May 2003 based on a valuation prepared by an independent
valuation company, the Company reached an agreement with its stockholder lenders
to eliminate the obligation to issue additional warrants on each loan renewal
and cancel all warrants previously issued and outstanding. The Company also
agreed to allow participation in new financing pari passu with new mezzanine
lenders at the stockholders sole discretion. The cash consideration of $300,000
was accrued and charged to interest expense for the quarter ended March 31,
2003.
20
Item 2. Management's Discussion and
Analysis of Financial Condition and
Results of Operations
OVERVIEW
We are a Delaware corporation organized in 1995. Our principal
operations consist of the following product lines consisting of one (1) business
segment:
The Company is and has been engaged in such arrangements in three
product lines of business, consisting of one reportable segment:
1. Purchase and lease of fully furnished model homes complete with
options and upgrades.
2. Residential real estate acquisition and development
3. Multi-family residential property (sold March 2003)
The Company derives its income by acquiring revenue producing assets
and entering into agreements for direct financing or operating leases. During
the three months ended March 31, 2003, revenue producing assets totaling
$31,433,096 were sold. A major client accelerated their option to purchase
$10,844,384 of residential real estate. The multi-family residential property
manager exercised their purchase option, reducing the revenue producing assets
by an additional $10,288,000. During the normal course of business, other
revenue producing assets of $10,300,712 were sold. This sales activity
significantly reduced our income. The three and nine months interest income was
reduced by $793,908 and $1,530,987, respectively compared to the prior year.
This was offset by a reduction in interest expense to financial institutions of
$547,677 and $1,220,801 for the three and nine months, respectively compared to
the prior year. In this quarter, the Company acquired additional revenue
producing assets of $26,156,464. These assets generated $324,002 in rental
income for the three months ended March 31, 2003.
For the three months ended March 31, 2003 and 2002, the Company had
sales of residential real estate amounting to $19,865,832 and $11,935,526
respectively. For the nine months ended March 31, 2003 and 2002, the Company
sold $44,797,561 and $21,634,544, respectively.
Sales of residential real estate sold under direct financing
arrangements and the related costs which are typically the same amount are no
longer reported as operating revenue and operating expense. The sales of
residential real estate are now disclosed in Note 3, Revenue Recognition as well
as management's discussion and analysis.
21
RESULTS OF OPERATIONS
Comparison of Three Months Ended March 31, 2003 to Three Months ended
March 31, 2002.
A summary of operating results for the three months ended March 31,
2003 and 2002 are presented below.
Three Months Ended
March 31
---------------------------
2003 2002
(As Restated)
------------ ------------
Revenue and other income $ 2,648,063 $ 2,808,030
------------ ------------
Costs and operating expenses:
Interest 1,037,362 1,262,371
Depreciation and amortization 267,728 383,357
Corporate 665,934 659,870
------------ ------------
1,971,029 2,305,598
------------ ------------
Operating Income 677,039 502,432
Income tax expense 182,703 148,000
------------ ------------
Net income 494,336 354,432
Preferred stock distributions 0 15,000
------------ ------------
Income applicable to common shareholders $ 494,336 $ 339,432
============ ============
Revenue and other income for the three months ended March 31, 2003 had
a net decrease of $159,967 compared to the prior year period. Interest income on
revenue producing assets decreased $793,908 due to the sales of those assets.
Gains on sales of revenue producing assets increased $335,059 primarily due to
the sale of our multi-family residential property which resulted in a gain of
$281,670. The new revenue producing assets, model homes under operating leases
added $324,002 to revenue for the quarter.
Interest and financing costs decreased $225,009 during the three months
ended March 31, 2003 compared to the prior year period. Interest to financial
institutions decreased $547,677 due to reduced borrowing costs on floating rate
loans and lower outstanding loan balances. Interest to stockholders increased
$322,668 (See Stockholder Loan Agreement Amendments, page 19). The settlement of
the warrants related to debt accounted for $300,000 of the increase compared to
the prior year period.
22
Depreciation and amortization for the three months ended March 31, 2003
decreased $159,373 compared to the prior year period. This is due to the reduced
amount of acquisitions of new revenue producing assets and related acquisition
costs, such as loan fees and residual value insurance.
Net income for the three months ended March 31, 2003 increased by
$139,904 compared to the three months ended March 31, 2002.
Comparison of Nine Months Ended March 31, 2003 to Nine Months ended
March 31, 2002.
A summary of operating results for the nine months ended March 31, 2003
and 2002 are presented below.
Three Months Ended
March 31
---------------------------
2003 2002
(As Restated)
------------ ------------
Revenue and other income $ 7,327,189 $ 8,461,953
------------ ------------
Costs and operating expenses:
Interest 3,090,539 3,971,012
Depreciation and amortization 1,039,471 1,108,733
Corporate 1,825,565 1,520,642
------------ ------------
5,955,575 6,600,387
------------ ------------
Operating Income 1,371,614 1,861,566
Income tax expense 529,000 580,000
------------ ------------
Net income 842,614 1,281,566
Preferred stock distributions 5,000 45,000
------------ ------------
Income applicable to common shareholders $ 837,614 $ 1,236,566
============ ============
Revenue and other income for the nine months ended March 31, 2003 had a
net decrease of $1,134,764 compared to the prior year period. Interest income on
the revenue producing assets decreased $1,530,987 due to the sales of those
assets. Gains on the sales of revenue producing assets increased $114,055
primarily due to the sale of the multi-family residential property of $281,670,
23
offset by a decrease in gain on sales of model homes of $167,615. The new
revenue producing assets, model homes under operating leases added $324,002 to
revenue for the nine months.
Interest decreased $880,473 during the nine months ended March 31, 2003
compared to the prior year period. Interest to financial institutions decreased
$1,220,801 due to reduced borrowing costs on floating rate loans and lower
outstanding loan balances. Interest to stockholders increased $340,328. The
settlement of the warrants related to debt accounted for $300,000 of the
increase compared to the prior year period (See the Stockholder Loan Agreement
Amendment, page 19).
Depreciation and amortization for the nine months ended March 31, 2003
had a decrease of $69,262 compared to the prior year period. Of the decrease,
$113,006 was due to the reduced amount of acquisitions of new revenue producing
assets and related acquisition costs such as loan fees and residual value
insurance. The new assets, model homes under operating leases, increased the
expense by $43,744.
Corporate selling, general and administrative expenses increased by
$304,923 for the nine months ended March 31, 2003 compared to the nine months
ended March 31, 2002. The Star Insurance settlement accounted for $250,000 of
that increase.
Net income for the nine months ended March 31, 2003 decreased by
$438,952 compared to the nine months ended March 31, 2002.
Model Homes under Direct Financing Arrangements
We purchase and leaseback fully furnished model homes complete with
options and upgrades to major publicly traded homebuilders. The model homes are
leased pursuant to a triple-net lease where the lessee is obligated to pay all
maintenance, taxes, insurance, etc., in addition to the required lease payment.
We try to develop new programs on a continuing basis to satisfy client
needs and changing economic conditions.
From inception to March 31, 2003, we have purchased a total of 539
model homes at an aggregate purchase price in excess of $129,000,000.
24
The following is a breakdown of model home units and costs by state
under direct financing leases:
March 31, 2003 March 31, 2002
-------------- --------------
STATE UNITS AMOUNT UNITS AMOUNT
- ----- ----- ----------- ----- -----------
Arizona 0 $ 0 1 $ 134,650
California 14 4,706,460 32 8,726,315
Florida 0 0 1 472,917
Iowa 6 907,765 10 1,587,935
Minnesota 0 0 3 678,230
Nevada 1 117,990 9 1,145,910
New Jersey 18 4,503,766 20 5,028,087
New York 1 254,000 1 254,000
North Carolina 3 640,586 6 1,497,891
Pennsylvania 1 250,000 2 487,619
Texas 1 279,000 4 1,040,000
----- ----------- ----- -----------
45 $11,659,567 89 $21,053,554
===== =========== ===== ===========
The following is a breakdown of interest income on model homes under
direct financing arrangements by state:
Three Months Ended Nine Months Ended
March 31, March 31,
STATE 2003 2002 2003 2002
----- ----------- ----------- ----------- -----------
Arizona $ 0 $ 0 $ (825) $ 6,917
California 142,860 301,241 536,560 989,722
Florida 0 14,187 0 51,159
Iowa 17,666 40,040 60,715 141,105
Minnesota 2,166 14,231 10,549 77,013
Nevada 0 20,279 0 61,320
New Jersey 122,940 139,159 394,038 518,779
New York 7,620 13,086 22,860 58,644
North Carolina 22,395 44,937 87,921 138,883
Pennsylvania 7,500 14,331 22,499 88,596
Texas 8,370 31,004 36,755 151,308
----------- ----------- ----------- -----------
$ 331,517 $ 632,495 $ 1,171,072 $ 2,283,446
=========== =========== =========== ===========
Residential Real Estate Acquisition and Development
We purchase parcels of residential real estate from non-affiliated
third parties. These parcels are selected by homebuilders with whom we have
established a business relationship. The parcels of land may require additional
government approvals or entitlements and development work or consist of finished
lots. If development work is required, the homebuilder enters into a fixed price
development agreement to develop the parcels of land for us, and in all cases,
is required to provide completion bonds for some or all work by a surety company
25
acceptable to us. The Company enters into these transactions with funding from
banks and these loans are secured by specific assets of the Company. As
development occurs, the Company retains ownership of the developed real estate.
We approve draw requests paid to the developer under the development agreements,
fund them ourselves or have our banks fund. If we fund the draws, the banks
reimburse us upon request. An exclusive option to purchase agreement is entered
into with the homebuilder simultaneously with the land acquisition. The interest
rate relating to the option is negotiated with each client. It is based on the
credit of the client, estimated duration and size of the project and interest
rates in effect at the time. The interest rate on the option is a fixed
percentage, is non-refundable, is payable monthly in advance by the homebuilder
and is fully earned. The interest income is calculated by applying the fixed
percentage to the Company's net investment in the real estate (cost of the land
plus development cost incurred less options exercised by the homebuilder). Our
financing agreements with our lenders may call for a fixed interest rate or
variable rate. These factors are all considered during negotiations to maintain
the Company's profit margins. Each time the homebuilder exercises their option
to purchase the residential real estate there is a formal real estate closing
and title passes to the homebuilder. If the homebuilder fails to exercise their
options to purchase the real estate, the Company has the right to sell the real
estate to another party and there is no refund of the interest received. In
addition, the Company has the right to draw against the developer's letter of
credit or performance bond. Since the option sales price of the real estate to
the homebuilder is equal to the Company's cost of the land plus costs to
develop, there typically is no gain or loss on the sale of the residential real
estate. The terms and conditions of each transaction are project specific
(interest rate on the option, term, takedown schedule, etc.).
We grant our clients an option to acquire finished lots in staged
takedowns. In consideration for the option we receive a deposit in the form of a
performance bond or a letter of credit equal to 20% or less of the total
purchase price as well as an option maintenance fee which is payable monthly in
advance. The option fees are fully earned when paid and non refundable.
The client has the right to terminate their obligations under the
option agreements by forfeiting the deposit, paying for the finished lots
exercised and any other penalties provided for in the agreements. We have legal
title to these assets. If the client terminated the agreements we have the risk
of a decline in the market value of the property. Residual Value Insurance has
been obtained to mitigate this risk however the insurance company provider of
this coverage may be unwilling or unable to pay a claim filed.
26
Residual Value Insurance
Residual Value Insurance (RVI) indemnifies an insured against a loss
that might occur if the proceeds of the sale of a properly maintained asset are
less than that asset's insured residual value at a specific point in time. It
protects against a decline in the market value of the property.
If we are unwilling or unable to obtain such insurance coverage, our
cost of funds might increase, but our equity in a specific asset will definitely
increase. This will result in a decrease in loan-to-value ratios in our
financings and we assume the risk of loss if the property is sold below our
original acquisition cost.
RVI is obtained to insure 80% to 100% of the acquisition cost of the
model homes as well as 80% to 100% of the fully developed cost of the
residential real estate. In some cases, RVI even covers the cash flow - i.e.
interest income on direct financing of model home arrangements and interest
relating to the options on the residential real estate (this includes related
homebuilder contractual obligations to the Company). The premiums are paid
annually in advance by the Company and are non-refundable and not pro-ratable.
They represent a percentage of the insured value. We understand that the
premiums are based on numerous factors such as - perceived risk, allocation of
statuary capital, availability of similar coverage by other insurance companies
and the feasibility of different financial models.
Insurance companies providing RVI coverage have suffered severe losses
on automobiles, aircraft, aircraft engines and various other assets/properties.
As a result, some insurance companies have ceased providing RVI coverage. This
has adversely affected coverage pricing and availability. The inability to
obtain cost effective RVI insurance on future projects could affect the cost of
funds from the lending institutions we work with as the coverage is considered a
credit enhancement. In addition, the coverage gives the Company added security
in the event a homebuilder does not fulfill its contractual obligations to the
Company.
In the event that any or all of the providers are unwilling to pay a
claim we would have to bear the cost of litigation to collect the claim and not
have the use of the funds for our operations until the litigation and potential
appeals are resolved in our favor. In the event that any or all of the providers
are unable to pay a claim we are subject to that credit risk. We evaluate the
financial condition of the provider prior to our acceptance of the credit
enhancement but can not protect ourselves against downgrades by rating agencies
or future operating losses by the providers.
27
Net Investment in Direct Financing Arrangement - Residential Real Estate
The following is a summary of our residential real estate projects:
Development
Costs Paid Sale of
Date Property Purchase through Finished Balance
Acquired Location Price 3/31/03 Lots 3/31/03
- ---------- ---------- ----------- ----------- ----------- -----------
8/31/2000 California $20,546,010 $ 2,711,758 $19,007,413 $ 4,250,355
11/15/2000 Arizona 1,680,925 1,175,585 2,557,654 298,856
11/22/2000 Utah 3,145,522 1,568,396 4,713,918 0
12/20/2000 Nevada 3,554,591 1,965,374 5,519,965 0
4/30/2001 Nevada 8,620,383 4,070,359 12,690,742 0
4/30/2001 California 5,762,000 1,000,000 6,762,000 0
9/13/2001 New Jersey 11,800,000 3,941,501 8,038,402 7,703,099
1/24/2002 California 11,736,233 1,396,867 0 13,133,100
3/28/2002 California 7,680,468 21,191,246 28,871,714 0
----------- ----------- ----------- -----------
$74,526,132 $39,021,086 $88,161,808 $25,385,410
=========== =========== =========== ===========
The Company had sales of finished lots as follows:
Three Months Three Months Nine Months Nine Months
3/31/2003 3/31/2002 3/31/2003 3/31/2002
- ------------ ------------ ------------ ------------
$ 19,865,832 $ 11.935,526 $ 44,797,561 $ 21,634,543
============ ============ ============ ============
Model Homes under Operating Leases
The following is a breakdown of the model homes and costs by state:
March 31, 2003 March 31, 2002
-------------- --------------
STATE UNITS AMOUNT UNITS AMOUNT
----- ----- ------------ ----- ------------
Arizona 9 $ 2,697,180 0 $ 0
Colorado 21 7,832,000 0 0
Florida 21 7,715,667 0 0
Texas 25 7,911,617 0 0
----- ------------ ----- ------------
76 26,156,464 0 0
----- ------------ ----- ------------
Less accumulated depreciation (43,744) 0
------------ ------------
$ 26,112,720 $ 0
============ ============
28
The rental income on these model homes is as follows:
Deferred Total rental income
Three and Nine operating lease three and nine Three and nine
Months ended receivables at months ended months ended
State March 31, 2003 March 31, 2002 March 31, 2003 March 31, 2002
----- --------------- --------------- --------------- ---------------
Arizona $ 24,724 $ 5,294 $ 30,018 $ 0
Colorado 111,160 13,440 124,600 0
Florida 70,727 13,769 84,496 0
Texas 72,523 12,365 84,888 0
--------------- --------------- --------------- ---------------
$ 279,134 $ 44,868 $ 324,002 $ 0
=============== =============== =============== ===============
Liquidity and Capital Resources
Funding for our operations has been provided by cash flow from
operations secured bank loans as well as loans from our stockholders.
Our uses for cash during the three and nine months ended March 31, 2003
and 2002 were for revenue producing asset acquisitions, interest, and operating
expenses. We provided for our cash requirements from borrowings, the sale of
direct financing leases, sale of the multi-family property during the three
months ended March 31, 2003 and other revenues.
During the three months ended March 31, 2003, a major client
accelerated their option to purchase all the residential real estate covered by
direct financing agreements between them and the Company. The transaction
generated $10,844,384 in revenue, $8,943,864 in debt reduction and $1,900,520 in
cash. The sale of the multi-family residential property reduced revenue
producing assets by $10,288,000 and provided cash of $902,961. These
transactions resulted in the Company having a $21,072,384 reduction in revenue
producing assets under direct financing. Some of the cash proceeds were used to
repay $1,389,200 in stockholder loans and reduce bank debt by $714,000.
We believe that these sources of cash are sufficient to finance our
working capital requirements and other needs for the next twelve (12) months. In
order to acquire larger asset acquisitions, additional capital and/or credit
enhancement may be needed to meet the equity requirements imposed by our
financing sources.
Inflation
Inflation has not had a significant impact on the results of operations
and is not anticipated to have a significant negative impact in the foreseeable
future. Although increases in the rate of inflation may tend to increase
29
interest rates which may increase our cost of borrowed funds, we attempt to pass
the increases through to our customers through increased charges. The potential
adverse impact of inflation on our lease operations is further mitigated by
requiring clients to pay all operating expenses, including but not limited to
real property taxes, insurance and utilities. However, there is no assurance
that inflation will not have a material adverse impact on future results of
operations.
Deflation
Deflation is a persistent fall in the general price level of goods and services.
Deflation is dangerous, however, more so even than inflation, when it reflects a
sharp slump in demand, excess capacity and shrinking money supply. Runaway
deflation of this sort can be much more damaging than runaway inflation, because
it creates a vicious spiral that is hard to escape. The expectation that prices
will be lower tomorrow may encourage consumers to delay purchases, depressing
demand and forcing firms to cut prices by even more. Falling prices also inflate
the real burden of debt (that is, increase real interest rates) causing
bankruptcy and bank failure. This makes deflation particularly dangerous for
economies that have large amounts of corporate debt. Most serious of all,
deflation can make monetary policy ineffective: nominal interest rates cannot be
negative, so real rates can get stuck too high. We can not determine the impact
if any of deflation on our future operations at this time.
Interest Rate Risk
The primary market risk facing us is interest rate risk on our current
and future variable rate mortgage loans which are based on a base rate plus a
negotiated premium.
To date, we have not hedged interest rate risk but continually evaluate
interest rate swaps and other financial instruments to mitigate this risk.
While we have benefited from the overall reduction in interest rates,
there is no assurance that such benefits will continue. If interest rates
increase, it will have a negative impact on margins.
30
Disclosure Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
Discussions containing forward-looking statements may be found in the material
set forth in the section "Management's Discussion and Analysis of Financial
Condition and Results of Operations".
These statements concern expectations, beliefs, projections, future
plans and strategies, anticipated events or trends and similar expressions
concerning matters that are not historical facts. Specifically, this Quarterly
Report contains forward-looking statements regarding:
1. our estimate that we have adequate financial resources to meet
our current working capital needs for the foreseeable future;
2. the impact of inflation/deflation on our future results of
operations; and
3. our ability to pass through to our customers in the form of
increased prices any increases in our costs.
These forward-looking statements reflect our current views about future
events and are subject to risks, uncertainties and assumptions. We wish to
caution readers that certain important factors may have affected and could in
the future affect our actual results and could cause actual results to differ
significantly from those expressed in any forward-looking statement. The most
important factors that could prevent us from achieving our goals, and cause the
assumptions underlying forward-looking statements and the actual results to
differ materially from those expressed in or implied by those forward-looking
statements include, but are not limited to, the following:
1. our significant level of debt;
2. our ability to borrow or otherwise finance our business in the
future;
3. our ability to locate customers in need of our services;
4. economic or other business conditions that affect the desire or
ability of our customers to build new homes in markets in which
we conduct our business;
31
5. a decline in the demand for housing;
6. a decline in the value of the land and model home inventories we
maintain;
7. an increase in interest rates;
8. our ability to successfully dispose of developed properties,
model homes, or undeveloped land or lots at expected prices and
within anticipated time frames;
9. our ability to compete in our existing and future markets; and
10. an increase or change in governmental regulations.
Item 3 -- Quantitative and Qualitative
Disclosures About Market Risk
We are exposed to changes in interest rates primarily as a result of
our floating rate debt arrangements, which include borrowings under lines of
credit. These lines, along with cash flow from operations, are used to maintain
liquidity and fund business operations. The nature and amount of our debt may
vary as a result of business requirements, market conditions and other factors.
It has not been necessary for us to use derivative instruments to adjust our
interest rate risk profile, although we continuously evaluate the need for
interest rate caps, swaps, and other interest rate-related derivative contracts,
to mitigate this risk.
We have attempted to comply with the Sarbanes-Oxley Act of 2002. The
Securities and Exchange Commission implemented Section 302 of the Sarbanes-Oxley
Act of 2002 (the "Act") effective August 29, 2002. Provisions of the Act apply
to all public reporting companies who file reports with the Securities and
Exchange Commission. In addition to certification by the Chief Executive Officer
and Chief Financial Officer as to the accuracy and completeness of financial
statements contained in filed reports, other restrictions and requirements are
part of the Act. The consensus of the AICPA and public filers is that additional
clarification will be needed to fully comply with the Act.
32
Item 4 -- Controls and Procedures
During the 90-day period prior to the filing of this report,
management, including the Company's President & Chief Executive Officer and
Chief Financial Officer evaluated the effectiveness of the design and operation
of the Corporation's disclosure controls and procedures. Based upon, and as of
the date of that evaluation, the President & Chief Executive Officer and Chief
Financial Officer concluded that the disclosure controls and procedures were
effective, in all material respects, to ensure that information required to be
disclosed in the reports the Company files and submits under the Exchange Act is
recorded, processed, summarized and reported as and when required.
There have been no significant changes in the Company's internal
controls or in other factors, which could significantly affect internal controls
subsequent to the date the Company carried out its evaluation. There were no
significant deficiencies or material weaknesses identified in the evaluation
and, therefore, no corrective actions were taken.
PART II - OTHER INFORMATION
Item 1.
Not Applicable
Item 2.
CHANGES IN SECURITIES
Most of our previously outstanding warrants to purchase shares of our
Common Stock had been issued to Mr. Miller, our Chairman, in connection with
loans that had been extended to us by Mr. Miller and other shareholders from
time to time since our inception. The loans represented funds that were
necessary to conclude transactions in the ordinary course of our business, but
were unavailable from other sources. According to the terms of these warrants,
in the event of a transaction that resulted in a reduction of the number of
outstanding shares of our Common Stock, including a reverse stock split, there
would be no proportionate adjustment in the number of shares issuable upon
exercise of the warrants or in the exercise price thereof. The warrants had
exercise prices that ranged from $.13 to $.47. In June 2002, an aggregate of
1,430,000 warrants were exercised for an aggregate exercise price of $236,100
(approximately $.17 per warrant).
In December 2002, the warrant exercise discussed above was rescinded by
the mutual consent of the former warrant holders and our Company. This
rescission was necessary due to wrong advice provided to us by our former
33
independent auditors, who failed to advise us of various negative tax
consequences to the warrant holder, and more importantly, significant negative
impact to our income statement relating to the fact that the applicable warrant
agreement contained the provisions discussed above.
In addition, also in December 2002, pursuant to our Board of Directors
and the warrant holders, the relevant warrant agreements were amended to negate
the provisions specifying that they are not affected by any reverse stock split,
effective as of the date of our reverse stock split. As a result, the 8,797,114
previously outstanding warrants have been reduced to 43,986 pursuant to the
200:1 reverse stock split previously undertaken. The exercise prices have also
been adjusted pursuant to the reverse stock split, resulting in exercise prices
ranging from $24 to $94 per warrant. This amendment was also necessary as a
result of incorrect advice provided by our prior independent auditors. The
outstanding warrants as of March 31, 2003 is 18,205.
At the same time, it was decided by the Board and stock option holders
that it is in the best interest of the Company to cancel the outstanding stock
options and terminate our obligation to issue additional warrants. At June 30,
2002 there were 12,500 outstanding options. The weighted average exercise price
was $46.00. The Board is currently in the discussion stage as to how to
compensate the holders of the cancelled warrants and options.
During May 2003 based on a valuation prepared by an independent
valuation company, the Company reached an agreement with its stockholder lenders
to eliminate the obligation to issue additional warrants on each loan renewal
and cancel all warrants previously issued and outstanding. The Company also
agreed to allow participation in new financing pari passu with new mezzanine
lenders at the stockholders sole discretion. The cash consideration of $300,000,
which was accrued and charged to interest expense for the quarter ended March
31, 2003.
Item 3.
DEFAULTS UPON SENIOR SECURITIES
None.
Item 4.
SUBMISSION OF MATTERS TO A
VOTE OF SECURITY HOLDERS -
None
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Item 5.
OTHER INFORMATION
Not applicable
Item 6.
EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
99.1 CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER
99.2 CERTIFICATION OF THE CHIEF FINANCIAL OFFICER
99.3 Certification of CEO and CFO Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
(b) Reports on Form 8-K.
On February 5, 2003, we filed a Current Report on Form 8-K, which
included a press release, dated February 4, 2003, announcing our earnings for
the first quarter ended September 30, 2002.
On February 12, 2003, we filed a current report on Form 8-K, which
includes a press release date of February 12, 2003, announcing our earnings for
the second quarter ended December 2002.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Strategic Capital Resources, Inc.
(Registrant)
By: /s/ DAVID MILLER
-------------------------------------
David Miller
Chief Executive Officer
Date: June 5, 2003
36