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EX-32.2 - EXHIBIT 32.2 - IMH Financial Corpa3q1810q-exx322.htm
EX-31.2 - EXHIBIT 31.2 - IMH Financial Corpa3q1810q-exx312.htm
EX-31.1 - EXHIBIT 31.1 - IMH Financial Corpa3q1810q-exx311.htm
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
 
FORM 10-Q
 
(Mark one)
 
x
Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2018
OR
 
¨
Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from: __________to __________

Commission File Number 000-52611
IMH FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
27-1537126
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
7001 N. Scottsdale Rd #2050
Scottsdale, Arizona 85253
(Address of principal executive offices and zip code)

(480) 840-8400
 (Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ   No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to post such files).  Yes þ   No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
¨
 
Accelerated filer
¨
Non-accelerated filer
¨
 
Smaller reporting company
þ
(Do not check if a smaller reporting company)
 
Emerging growth company
¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨ 

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).  Yes ¨   No þ
 
The registrant had 1,576,616 shares of Common Stock, 3,491,758 shares of Class B-1 Common Stock, 3,492,954 shares of Class B-2 Common Stock, 7,159,759 shares of Class B-3 Common Stock, 313,790 shares of Class B-4 Common Stock and 691,733 shares of Class C Common Stock, 2,604,852 shares of Series B-1 Preferred Stock, 5,595,148 shares of Series B-2 Preferred Stock, 2,352,941 shares of B-3 Preferred Stock and 22,000 shares of Series A Preferred Stock. The Series B-1, B-2, and B-3 Preferred Stock are collectively convertible, and when combined with outstanding common stock would convert into 27,279,551 outstanding common shares as of November 14, 2018.



IMH Financial Corporation
September 30, 2018 Form 10-Q Quarterly Report
Index

Item 1.
Financial Statements
 
Unaudited Condensed Consolidated Balance Sheet as of September 30, 2018 and Consolidated Balance Sheet as of December 31, 2017
 
Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2018 and 2017
 
Unaudited Condensed Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2018
 
Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2018 and 2017
 
Notes to Unaudited Condensed Consolidated Financial Statements
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
Item 4.
Controls and Procedures
Item 1.
Legal Proceedings
Item 1A.
Risk Factors
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.
Defaults Upon Senior Securities
Item 4.
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
Signatures
 


2


PART I
 

3


ITEM 1.     FINANCIAL STATEMENTS

4


IMH FINANCIAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data) 
 

September 30,

December 31,
 

2018

2017
Assets

(Unaudited)


Cash and cash equivalents

$
36,196


$
11,789

Funds held by lender and restricted cash

432


143

Mortgage loans, net

22,979


19,668

Real estate held for sale

7,998


5,853

Operating properties, net

25,795


20,484

Other real estate owned

33,707


38,304

Goodwill

15,357


15,380

Other intangibles, net

710


958

Other receivables

769


410

Other assets

1,394


899

Property and equipment, net

422


570

     Total assets

$
145,759


$
114,458






Liabilities



 
Accounts payable and accrued expenses

$
5,932


$
7,904

Accrued property taxes

412


301

Dividends payable

1,077


539

Accrued interest

533


189

Customer deposits and funds held for others

2,826


750

Notes payable, net of discount

35,694


34,105

     Total liabilities

46,474


43,788






Redeemable convertible preferred stock, $.01 par value; 100,000,000 shares authorized; 10,552,941 and 8,200,000 shares outstanding; liquidation preference of $51,170 and $39,570 at September 30, 2018 and December 31, 2017, respectively

44,785


34,859

Perpetual preferred stock, liquidation preference of $22,000

21,738








Commitments and contingencies (Notes 13 and 14)









Stockholders’ Equity

 

 
   Common stock, $.01 par value; 200,000,000 shares authorized; 18,596,774 and 18,079,522 shares issued at September 30, 2018 and December 31, 2017; 16,726,610 and 16,253,426 shares outstanding at September 30, 2018 and December 31, 2017, respectively

186


181

   Less: Treasury stock at cost, 1,870,164 at September 30, 2018 and 1,826,096 at December 31, 2017, respectively

(6,286
)

(6,286
)
   Paid-in Capital

710,572


714,889

   Accumulated Deficit

(686,933
)

(679,535
)
     Total IMH Financial Corporation Stockholders' Equity

17,539


29,249

   Noncontrolling Interests

15,223


6,562

     Total Stockholders' Equity

32,762


35,811

     Total Liabilities and Stockholders’ Equity

$
145,759


$
114,458

The accompanying notes are an integral part of these condensed consolidated financial statements.

5


IMH FINANCIAL CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share data)
 

Three months ended September 30,

Nine months ended September 30,
 

2018

2017

2018

2017
Revenue



 







   Operating property revenue

$
2,085


$


$
5,753


$
1,682

   Mortgage loan income, net

709


350


1,976


402

   Management fees, investment, and other income

32


300


323


808

     Total revenue

2,826


650


8,052


2,892

Operating Expenses

 


 







   Operating property direct expenses (exclusive of interest and depreciation)

2,364


105


6,699


1,544

   Expenses for non-operating real estate owned

151


153


519


485

   Professional fees

1,125


1,059


2,754


3,181

   General and administrative expenses

1,788


1,793


5,376


6,154

   Interest expense

775


449


2,300


1,323

   Depreciation and amortization expense

281


46


925


139

     Total Operating Expenses

6,484


3,605


18,573


12,826

Recovery of Investment and Credit Losses, Gain on Disposal, and Equity Method Loss from Unconsolidated Entities, Net












  Gain on disposal of assets, net

(3,543
)

(321
)

(3,938
)

(2,036
)
  Recovery of investment and credit losses, net



(6,070
)

(175
)

(6,408
)
  Impairment of Real Estate Owned



344




344

  Equity method loss from unconsolidated entities, net



68




239

     Total Recovery of Investment and Credit Losses, Gain on Disposal, and Equity Method Loss from Unconsolidated Entities, Net

(3,543
)

(5,979
)

(4,113
)

(7,861
)
     Total costs and expenses

2,941


(2,374
)

14,460


4,965

Income (loss) from Continuing Operations, Net of Tax

(115
)

3,024


(6,408
)

(2,073
)
  Income (loss) from discontinued operations, net of tax



30




4,766

Net Income (loss)

(115
)

3,054


(6,408
)

2,693

  (Income) loss attributable to noncontrolling interest

(1,105
)

1,224


(990
)

490

  Cash dividend on redeemable convertible preferred stock

(655
)

(539
)

(1,894
)

(1,600
)
  Deemed dividend on redeemable convertible preferred stock

(920
)

(685
)

(2,651
)

(2,016
)
  Cash dividend on perpetual preferred stock

(422
)



(569
)


Net Income (loss) Attributable to Common Shareholders

$
(3,217
)

$
3,054


$
(12,512
)

$
(433
)
Earnings (loss) per common share

 

 




Basic, Continuing Operations

$
(0.19
)

$
0.19


$
(0.75
)

$
(0.32
)
Basic, Discontinued Operations







0.29

Net Basic, Income (Loss) Per Share

$
(0.19
)

$
0.19


$
(0.75
)

$
(0.03
)
Weighted Average Common Shares Outstanding - Basic

16,726,610


16,253,427


16,696,201


16,166,285

Diluted, Continuing Operations

$
(0.19
)

$
0.12


$
(0.75
)

$
(0.32
)
Diluted, Discontinued Operations







0.29

Net Diluted, Income (Loss) Per Share

$
(0.19
)

$
0.12


$
(0.75
)

$
(0.03
)
Diluted Weighted Average Common Shares Outstanding

16,726,610


25,091,821


16,696,201


16,166,285

The accompanying notes are an integral part of these condensed consolidated financial statements.

6


IMH FINANCIAL CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
Nine Months Ended September 30, 2018
(In thousands, except share data) 



Common Stock

Treasury Stock





Total IMH Financial Corporation Stockholders' Equity




 

Shares

Amount

Shares

Amount

Paid-in capital

Accumulated deficit


Non-controlling interest

Total Stockholders' Equity
Balance at December 31, 2017

18,079,522


$
181


1,826,096


$
(6,286
)

$
714,889


$
(679,535
)

$
29,249


$
6,562


$
35,811

Net income (loss)











(7,398
)

(7,398
)

990


(6,408
)
Contributions from Hotel Fund investors















9,815


9,815

Distributions to Hotel Fund investors















(205
)

(205
)
Contribution of Hotel Fund capital costs









(87
)



(87
)



(87
)
Profit participation distribution to non-controlling interests (Note 5)















(1,939
)

(1,939
)
Issuance of common stock warrants, net of cost accretion









581




581




581

Cash dividends on redeemable convertible preferred stock









(1,894
)



(1,894
)



(1,894
)
Deemed dividends on redeemable convertible preferred stock









(2,651
)



(2,651
)



(2,651
)
Cash dividends on perpetual preferred stock









(569
)



(569
)



(569
)
Relinquishment of class C common stock to treasury






44,068













Stock-based compensation

517,252


5






303




308




308

Balance at September 30, 2018

18,596,774


$
186


1,870,164


$
(6,286
)

$
710,572


$
(686,933
)

$
17,539


$
15,223


$
32,762

The accompanying notes are an integral part of these condensed consolidated financial statements.


7


IMH FINANCIAL CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)



Nine months ended September 30,


2018

2017
OPERATING ACTIVITIES




  Net income (loss)

$
(6,408
)

$
2,693

  Adjustments to reconcile net income (loss) to net cash used in operating activities:



 
    Equity method loss from unconsolidated entities



239

    Stock-based compensation and option amortization

308


591

    Stock-based compensation related to purchase of treasury stock



116

    Gain on disposal assets

(3,938
)

(8,873
)
    Amortization of deferred financing costs

87


447

    Depreciation and amortization expense

925


417

    Accretion of mortgage income

(323
)

(129
)
    Accretion of discount on notes payable

705


610

    Other non-cash recovery of investment an credit losses



(6,298
)
    Impairment of Real Estate Owned



344

    Non-cash interest expense funded by loan draw

811



    Changes in operating assets and liabilities




    Accrued interest receivable

12


(95
)
    Other receivables

(360
)

(1,280
)
    Other assets

78


(2,235
)
    Accrued property taxes

111


(110
)
    Accounts payable and accrued expenses

(2,901
)

(1,686
)
    Customer deposits and funds held for others

137


1,239

    Accrued interest

344


(268
)
    Total adjustments, net

(4,004
)

(16,971
)
        Net cash used in operating activities

(10,412
)

(14,278
)
INVESTING ACTIVITIES



 
  Proceeds from sale of real estate owned, operating properties, and other assets

8,709


98,321

  Purchase of property and equipment

(23
)

(388
)
  Mortgage loan investment and funding

(3,000
)

(7,000
)
  Investment in unconsolidated entities



(1,810
)
  Investment in real estate owned and other operating properties

(7,208
)

(1,383
)
     Net cash provided by (used in) investing activities

(1,522
)

87,740

FINANCING ACTIVITIES

 

 
  Proceeds from issuance of preferred equity

30,000



  Equity issuance costs paid

(405
)


  Purchase of interest rate cap

(548
)


  Repayments of notes payable

(14
)

(50,370
)
  Repayments of capital leases



(2
)
  Dividends paid

(1,926
)

(1,600
)
  Purchase of treasury stock



(338
)
  Contribution of Hotel Fund capital costs

(87
)



8


  Distributions to noncontrolling interests



(9
)
  Contributions from Hotel Fund investors

9,815



  Distributions to Hotel Fund investors

(205
)


     Net cash provided by (used in) financing activities

36,630


(52,319
)





NET INCREASE IN CASH, CASH EQUIVALENTS, AND RESTRICTED CASH

24,696


21,143

CASH, CASH EQUIVALENTS, AND RESTRICTED CASH AT BEGINNING OF PERIOD

11,932


13,689

CASH, CASH EQUIVALENTS, AND RESTRICTED CASH AT END OF PERIOD

36,628


34,832

CASH, CASH EQUIVALENTS, AND RESTRICTED CASH OF DISCONTINUED OPERATIONS



(435
)
CASH, CASH EQUIVALENTS, AND RESTRICTED CASH OF CONTINUING OPERATIONS, END OF PERIOD

$
36,628


$
34,397






SUPPLEMENTAL CASH FLOW INFORMATION




     Cash paid for interest

$
308


$
1,603

     Cash paid for taxes

$


$
5

Non-Cash Investing and Financing Transactions




     Decrease in investment in unconsolidated entities due to consolidation of VIE's

$


$
(4,000
)
     Decrease in mortgage loans due to consolidation of VIE's

$


$
(400
)
     Decrease in other receivables due to consolidation of VIE's

$


$
(2,400
)
     Increase in other real estate owned due to consolidation of VIE's

$


$
17,800

     Increase in other assets due to consolidation of VIE's

$


$
1,100

     Increase in accounts payable due to consolidation of VIE's

$


$
200

     Increase in non-controlling interest due to consolidation of VIE's

$


$
6,509

     Capital expenditures in accounts payables and accrued expenses

$
929


$
438

     Capital lease and other liabilities assumed by buyer in sale of property

$


$
4,292

     Decrease in non-controlling interest through profit participation

$
(1,939
)

$
(1,537
)
The accompanying notes are an integral part of these condensed consolidated financial statements.



9


IMH FINANCIAL CORPORATION
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 1- BUSINESS, BASIS OF PRESENTATION AND LIQUIDITY
 
Our Company
 
IMH Financial Corporation (together with its subsidiaries, the “Company”) is a real estate investment and finance company based in the southwestern United States engaged in various and diverse facets of the real estate lending and investment process, including origination, acquisition, underwriting, servicing, enforcement, development, marketing, and disposition. The Company’s focus is to invest in, manage and dispose of commercial real estate mortgage investments, hospitality assets, or other real estate assets, and to perform all functions reasonably related thereto, including developing, managing and either holding for investment or disposing of real property acquired through acquisition, foreclosure or other means. The Company is seeking to expand
its hospitality footprint through the acquisition or management of other luxury boutique hotels.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for a complete set of financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation of the results for the periods presented have been made. Operating results for the three and nine months ended September 30, 2018 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2018. These condensed consolidated financial statements should be read in conjunction with our consolidated financial statements and notes thereto included in our annual report on Form 10-K for the fiscal year ended December 31, 2017.

The accompanying unaudited condensed consolidated financial statements include the accounts of IMH Financial Corporation, its wholly-owned operating subsidiaries, and variable interest entities in which the Company is determined to be the primary beneficiary. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported and, accordingly, ultimate results could materially differ from those estimates. Additionally, interim results are not necessarily indicative of full year performance. In our opinion, the accompanying condensed consolidated financial statements reflect all adjustments, including normal recurring items, considered necessary for a fair presentation of the interim periods. All significant intercompany accounts and transactions have been eliminated in consolidation.

On January 1, 2018, we adopted the requirements of Accounting Standards Update ("ASU") No. 2014-09 ("ASU 2014-09"), Revenue from Contracts with Customers (“Topic 606”). The adoption of Topic 606 had no impact on the Company’s consolidated financial statements. See “Note 2 - Summary of Significant Accounting Policies” below for additional information.

Liquidity

As of September 30, 2018, our accumulated deficit aggregated $686.9 million primarily as a result of previous provisions for credit losses recorded relating to the decrease in the fair value of the collateral securing our legacy loan portfolio and impairment charges relating to the value of real estate owned (“REO”) assets acquired primarily through foreclosure, as well as ongoing net operating losses resulting from the lack of income-producing assets, and the high cost of our previous debt financing. Beginning in 2008, we experienced significant defaults and foreclosures in our mortgage loan portfolio due primarily to the erosion of the U.S. and global real estate and credit markets during those periods. As a result, since that time we have been focused on enforcing our rights under our loan documents, working to repossess the collateral properties underlying those loans for purposes of disposing of or developing such assets, and pursuing recovery from guarantors under such loans.

In connection with our acquisition of certain hotel and related assets consisting of 64 luxury guest rooms, indoor and outdoor function space, full-service food and beverage outlet and restaurant operations, and spa operations located in Sonoma, California (“MacArthur Place”), the Company entered into a building loan agreement/disbursement schedule and related agreements (the “MacArthur Loan”) with MidFirst Bank in the amount of $32.3 million, of which approximately $19.4 million was utilized for the purchase of MacArthur Place, $10.0 million of which has been set aside to fund planned hotel improvements, and the balance is to fund interest reserves and operating capital. The Company has begun to undertake a significant renovation project of MacArthur Place which is expected to continue until the first or second quarter of 2019.


10

IMH FINANCIAL CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

NOTE 1 – BUSINESS, BASIS OF PRESENTATION AND LIQUIDITY - continued

Our liquidity plan has included obtaining additional debt and equity financing, and selling the majority of our legacy real estate assets. We secured various financings between 2011 and 2018 which, along with proceeds from asset sales, have been our primary sources of working capital. As part of our investment strategy to acquire income-producing assets, we acquired MacArthur Place and made certain mortgage investments during fiscal 2017 and 2018.

The MacArthur Loan required the Company to fund minimum equity of $17.4 million, all of which has been funded. The Company was required to provide a loan repayment guaranty equal to 50% of the MacArthur Loan principal along with a guaranty of interest and operating deficits, as well as other customary non-recourse carve-out matters such as bankruptcy and environmental matters. Under the guarantees, the Company is required to maintain a minimum Tangible Net Worth, as defined, of $50.0 million and minimum liquidity of $5.0 million throughout the term of the MacArthur Loan. The Company was in compliance with such financial covenants as of September 30, 2018. In addition, the MacArthur Loan required MacArthur Place to establish various operating and reserve accounts at MidFirst Bank which are subject to a cash management agreement. In the event of default, MidFirst Bank has the ability to take control of such accounts for the allocation and distribution of proceeds in accordance with the cash management agreement.

While the Company utilized its own equity (along with debt proceeds as described above) to purchase MacArthur Place, the Company formed L’Auberge Fund Manager, LLC, a wholly-owned subsidiary of the Company, which commenced an offering of up to $25.0 million of preferred limited liability company interests (the “Preferred Interests”) in L’Auberge de Sonoma Resort Fund, LLC (the “Hotel Fund”) pursuant to Regulation D and Regulation S promulgated under the Securities Act. The net proceeds of the Offering are being used to (i) reimburse the Company’s initial investment in the Hotel Fund and (ii) fund certain renovations to MacArthur Place. The Company is expected to retain a 10.0% Preferred Interest in the Hotel Fund. The Hotel Fund has sold Preferred Interests to unrelated investors in the aggregate amount of $10.5 million through September 30, 2018. The amount of Preferred Interests raised reduced the Company’s common member interests by a corresponding amount. At September 30, 2018, the Company’s common member interest in the Hotel Fund totaled $14.1 million and it held a preferred interest of $1.2 million. Since the Company is deemed the primary beneficiary of and controls the Hotel Fund, we have consolidated this entity in the accompanying unaudited consolidated financial statements.

As of September 30, 2018, we had cash and cash equivalents of $36.2 million, REO assets held for sale with a carrying value of $8.0 million, and other REO assets with a carrying value of $33.7 million that we seek to dispose of within the next 12 months. We continue to evaluate potential disposition strategies for our remaining REO assets and to seek additional sources of debt and equity for investment and working capital purposes.

As further described in Note 11, on February 9, 2018, the Company entered into a Series B-3 Cumulative Convertible Preferred Stock Subscription Agreement with its largest shareholder, JPMorgan Chase Funding Inc. (“Chase Funding”), pursuant to which Chase Funding agreed to purchase 2,352,941 shares of Series B-3 Cumulative Convertible Preferred Stock, $0.01 par value per share, of the Company (the “Series B-3 Preferred Stock”), at a purchase price of $3.40 per share, for a total purchase price of $8.0 million. The Company uses the proceeds from the sale of these shares for general corporate purposes. Dividends on the Series B-3 Preferred Stock accrue at the rate of 5.65% of the issue price per year, and are payable quarterly in arrears. In connection with this transaction, the Company issued a warrant to Chase Funding to acquire an additional 600,000 shares of our common stock that is exercisable at any time on or after February 9, 2021 for a two (2) year period at an exercise price of $2.25 per share.

In addition, on May 31, 2018, the Company entered into a Series A Senior Perpetual Preferred Stock Subscription Agreement with Chase Funding, pursuant to which Chase Funding agreed to purchase 22,000 shares of our Series A Senior Perpetual Preferred Stock, (the “Series A Preferred Stock”), at a purchase price of $1,000 per share, for a total purchase price of $22.0 million. The Company uses the proceeds from the sale of these shares for general corporate purposes and to pursue its investment strategy. Dividends on the Series A Preferred Stock are cumulative and accrue from the issue date at the rate of 7.5% of the issue price per year, payable quarterly in arrears on or before the last day of each calendar quarter. The Series A Preferred Stock shall, with respect to dividend and redemption rights and rights upon liquidation, dissolution or winding up of the Corporation, rank senior to all other classes or series of shares of the Company’s preferred and common stock and to all other equity securities issued by the Company from time to time. See Note 11 for additional information relating to the Series B-3 Preferred Stock and Series A Perpetual Preferred Stock.

We require liquidity and capital resources for our general working capital needs, including maintenance, development costs and capital expenditures for our operating properties and non-operating REO assets, professional fees, general and administrative operating costs, loan enforcement costs, financing costs, debt service payments, including the $10.2 million Exchange Notes debt

11

IMH FINANCIAL CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

NOTE 1 – BUSINESS, BASIS OF PRESENTATION AND LIQUIDITY - continued

maturing in April 2019 (see Note 9 for additional information), dividends to our preferred shareholders, as well as to acquire our target assets. We expect our primary sources of liquidity over the next twelve months to consist of our current cash, mezzanine and mortgage loan interest income, revenues from ownership or management of hotels, proceeds from borrowings and equity issuances, and proceeds from the disposition of our existing REO assets held for sale. We believe that our cash and cash equivalents coupled with our operating and investing revenues, as well as proceeds that we anticipate receiving from the disposition of our real estate held for sale, and debt and equity financing will be sufficient to allow us to fund our operations for a period of one year from the date these consolidated financial statements are issued.

While we have been successful in securing financing through September 30, 2018 to provide adequate funding for working capital purposes, which has been supplemented by proceeds from the sale of certain REO assets, and receipts of principal and interest on mortgage and related investments, there is no assurance that we will be successful in selling our remaining REO assets in a timely manner or in obtaining additional or replacement financing, if needed, to sufficiently fund future operations, repay existing debt, or to implement our investment strategy. Our failure to generate sustainable earning assets and to successfully liquidate a sufficient number of our loans and REO assets may have a material adverse effect on our business, results of operations and financial position.


12

IMH FINANCIAL CORPORATION
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2 — SIGNIFICANT ACCOUNTING POLICIES

Our significant accounting policies are detailed in “Note 2 - Summary of Significant Accounting Policies" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017.

Redeemable Convertible Preferred Stock
 
During the nine months ended September 30, 2018, the Company issued an additional 2,352,941 shares of redeemable convertible preferred stock. The preferred stock is convertible into common stock on a one-to-one basis, and is redeemable five years from the issuance date at the option of the holder for a redemption price of the greater of 145% of the original purchase price of the preferred stock or tangible net book value per share at redemption. The preferred stock is reported in the mezzanine equity section of the accompanying consolidated balance sheet.  Since the preferred stock does not have a mandatory redemption date (rather it is at the option of the holder), under applicable accounting guidance, the Company elected to amortize the redemption premium over the five year redemption period using the effective interest method and recording this as a deemed dividend, rather than recording the entire accretion of the redemption premium as a deemed dividend upon issuance of the preferred stock. The Company is required to assess whether the preferred stock is redeemable at each reporting period.

Perpetual Preferred Stock

As described in Note 11, the Company issued 22,000 shares of Series A perpetual preferred stock to Chase Funding during the nine months ended September 30, 2018. While the Series A Preferred Stock ranks senior to all other classes or series of shares of preferred or common stock, is does not have voting rights, is not convertible to common stock and has no stated redemption date. After five years, the holder of these shares has call rights to require the Company to redeem all of the shares at the redemption price. However, since the Series A Preferred Stock maintains characteristics of both debt and equity as of the reporting date, ithas been presented in the mezzanine equity section of the accompanying condensed consolidated balance sheets in accordance with GAAP.

Derivative Instruments and Hedging

We occasionally use interest rate derivatives to mitigate our risks against rising variable interest rate debts. Our interest rate derivatives currently consist of one interest rate cap which is not designated as a hedge. As such, this derivative is recorded at fair value in accordance with the applicable authoritative accounting guidance. Interest rate derivatives are reported as other assets in the accompanying condensed consolidated balance sheets. Changes in the fair value of interest rate derivatives are recognized in earnings as unrealized gain (loss) on derivatives in the accompanying condensed consolidated statements of operations.

Revenue Recognition

In the first quarter of 2018, the Company implemented ASU 2014-09. Revenue is measured based on consideration specified in a contract with a customer. The Company recognizes revenue when it satisfies a performance obligation by transferring control over a product or service to a customer. ASU 2014-09 defines a five-step process to achieve this core principle.

Mortgage Investment Revenue Recognition

Interest on mortgage loans is recognized as revenue when earned using the interest method based on a 360 or 365 day year, in accordance with the related mortgage loan terms. We do not recognize interest income on loans once they are deemed to be impaired and placed in non-accrual status. Generally, a loan is placed in non-accrual status when (i) it is past its scheduled maturity by more than 90 days; (ii) it becomes delinquent as to interest due by more than 90 days; or (iii) the related fair value of the collateral is less than the total principal, accrued interest and related costs. We may determine that a loan, while delinquent in payment status, should not be placed in non-accrual status in instances where the fair value of the loan collateral significantly exceeds the principal and the accrued interest, as we expect that income recognized in such cases is probable of collection. Unless and until we have determined that the value of underlying collateral is insufficient to recover the total contractual amounts due under the loan term, generally our policy is to continue to accrue interest until the loan is more than 90 days delinquent with respect to accrued, uncollected interest or more than 90 days past scheduled maturity, whichever comes first.


13

IMH FINANCIAL CORPORATION
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

NOTE 2 — SIGNIFICANT ACCOUNTING POLICIES – continued

We defer fees for loan originations, processing and modifications, net of direct origination costs, at origination and amortize such fees as an adjustment to interest income using the effective interest method. Revenue for non-refundable commitment fees is recognized over the remaining life of the loan as an adjustment to the interest income yield.

We defer premiums or discounts arising from acquired loans at acquisition and amortize such premiums or discounts as an adjustment to interest income over the contractual term of the related loan using the effective interest method. We include the unamortized portion of the premium or discount as a part of the net carrying value of the loan in the condensed consolidated balance sheets. Costs not directly paid to the seller of the loan are expensed as incurred and not amortized, except for any fees paid directly to the seller.

The significant accounting policies that have changed as a result of the adoption of ASU 2014-09 are set forth below.

Hotel Revenues

We identified the following performance obligations in connection with our hotel revenues, for which revenue is recognized as the respective performance obligations are satisfied, which results in recognizing the amount we expect to be entitled to for providing the goods or services:

• Cancellable room reservations or ancillary services are typically satisfied as the good or service is transferred to the hotel guest, which is generally when the room stay occurs.

• Noncancellable room reservations and banquet or conference reservations represent a series of distinct goods or services provided over time satisfied as each distinct good or service is provided, which is reflected by the duration of the room reservation.

• Material rights for free or discounted goods or services are satisfied at the earlier point in time when the material right expires or the underlying free or discounted good or service is provided to the hotel guest.
 
• Other ancillary goods and services purchased independently of the room reservation at standalone selling prices are considered separate performance obligations, which are satisfied when the related good or service is provided to the hotel guest.

• Components of package reservations for which each component could be sold separately to other hotel guests are considered separate performance obligations and are satisfied as set forth above.

Hotel revenues primarily consist of hotel room rentals, food and beverage sales, and other ancillary goods and services. Revenue is recognized when rooms are occupied or goods and services have been delivered or rendered, respectively. Payment terms typically align with when the goods and services are provided.

Although the transaction prices of room rentals, goods and other services are generally fixed and based on the respective room reservation or other agreement, an estimate to reduce the transaction price is required if a discount is expected to be provided to the customer. For corporate customers, the hotel offers discounts on goods and services sold in package reservations, and the corresponding transaction price is allocated to the performance obligations within the package based on the estimated standalone selling prices of each component. On occasion, the hotel may also provide the customer with a material right to a free or discounted good or service in conjunction with a room reservation or banquet contract. These material rights are considered separate performance obligations to which a portion of the transaction price is allocated based on the estimated standalone selling prices of the good or service, adjusted for the likelihood the hotel guest will exercise the right.


14

IMH FINANCIAL CORPORATION
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

NOTE 2 — SIGNIFICANT ACCOUNTING POLICIES – continued

Funds Held by Lender and Restricted Cash

Funds held by lender and restricted cash includes amounts maintained in escrow or other restricted accounts deposited into reserve accounts held by lenders for contractually specified purposes, which includes property taxes and insurance. The following table provides a reconciliation of cash, cash equivalents, and funds held by lender and restricted cash reported within the condensed consolidated balance sheet that sum to the total of the same such amounts shown in the condensed consolidated statement of cash flows as of September 30, 2018 and December 31, 2017 (in thousands):


September 30,

December 31,


2018

2017
Cash and cash equivalents

$
36,196


$
11,789

Funds held by lender and restricted cash

432

143
 Total cash, cash equivalents, and restricted cash

$
36,628


$
11,932


Recent Accounting Pronouncements

Adopted Accounting Standards

In May 2014, the FASB issued ASU 2014-09. This ASU supersedes the revenue recognition requirements in Revenue Recognition (Topic 605) and requires entities to recognize revenue when a customer obtains control of promised goods or services and in an amount that reflects the consideration the entity expects to receive in exchange for those goods or services. Subsequent to ASU 2014-09, the FASB issued several related ASUs to clarify the application of the new revenue recognition standard, collectively referred to herein as ASU 2014-09. We adopted this standard effective January 1, 2018, under the modified retrospective method, and the adoption of this standard did not have a material impact on our consolidated financial statements. See related disclosures in Note 3.

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (Subtopic 825-10), which requires all equity investments to be measured at fair value with changes in the fair value recognized through net income (other than those accounted for under equity method of accounting or those that result in consolidation of the investee). The amendments in this update also require an entity to present separately in other comprehensive income, the portion of the total change in the fair value of a liability resulting from a change in the instrument­ specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. In addition, the amendments in this update require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. We adopted this standard effective January 1, 2018. The adoption of this standard did not have a material impact on our consolidated financial statements and related disclosures.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”), which is intended to address diversity in practice related to how certain cash receipts and cash payments are presented and classifi

ed in the statement of cash flows. The amendments in ASU 2016-15 address eight specific cash flow issues as well as application of the predominance principle (dependence on predominant source or use of receipt or payment) and are effective for public business entities for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years with early adoption permitted. ASU 2016-15 requires retrospective adoption unless it is impracticable to apply, in which case it is to be applied prospectively as of the earliest date practicable. We adopted the requirements of ASU 2016-15 which had no significant impact on the consolidated financial statements.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”), which provides guidance on the presentation of restricted cash and restricted cash equivalents in the statement of cash flows. In accordance with ASU 2016-18, restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning­ of­ period and end­ of­ period amounts shown on the statements of cash flows. The amendments of ASU 2016-18 are effective for reporting periods beginning after December 15, 2017, with early adoption permitted. We adopted

15

IMH FINANCIAL CORPORATION
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

NOTE 2 — SIGNIFICANT ACCOUNTING POLICIES – continued

the requirements of ASU 2016-18 which resulted in a change in the presentation of the statement of cash flows. The Company’s statement of cash flows for the nine months ended September 30, 2017 has been retroactively restated for the effect of adopting this ASU, adding approximately $2.2 million of cash, cash equivalents, and restricted cash at the beginning of the period and approximately $0.3 million of cash, cash equivalents, and restricted cash to the end of the period. The reclassification resulted in a decrease to cash, cash equivalents, and restricted cash used in operating activities by $1.4 million and a decrease to cash, cash equivalents, and restricted cash provided by investing activities by $0.4 million. The preceding table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the condensed consolidated balance sheets that sum to the total of the same such amounts shown on the condensed consolidated statement of cash flows.

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business (“ASU 2017-01”), which clarifies the definition of a business by adding guidance to assist entities in evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. For public companies, ASU 2017-01 is effective for fiscal years beginning after December 15, 2017, including interim periods within those periods. We adopted this standard effective January 1, 2018. Under the new standard, certain future acquisitions may be considered asset acquisitions rather than business combinations, which would affect capitalization of acquisitions costs (such costs are expensed for business combinations and capitalized for asset acquisitions).

In February 2017, the FASB issued ASU 2017-05, Other Income-Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets (ASU “2017-05”), which clarifies the scope of ASC Subtopic 610-20, Other Income-Gains and Losses from the Derecognition of Nonfinancial Assets and adds guidance for partial sales of nonfinancial assets. ASU 2017-05 is effective for fiscal years beginning after December 15, 2017. Early adoption is permitted. An entity may elect to apply ASU 2017-05 under a retrospective or modified retrospective method. We adopted this standard effective January 1, 2018, under the modified retrospective method. The adoption of this standard did not have a material impact on our consolidated financial statements and related disclosures.

In May 2017, the FASB issued ASU 2017-09, Compensation-Stock Compensation (Topic 718). The ASU provides clarification on when modification accounting should be used for changes to the terms or conditions of a share-based payment award. ASU 2017-09 does not change the accounting for modifications but clarifies that modification accounting guidance should only be applied if there is a change to the value, vesting conditions or award classification and would not be required if the changes are considered non-substantive. The amendments of this ASU are effective for reporting periods beginning after December 15, 2017, with early adoption permitted. We adopted this standard effective January 1, 2018. The adoption of this standard did not have a material impact on our consolidated financial statements and related disclosures.

In March 2018, the FASB issued ASU 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118.  This ASU codifies existing SEC guidance contained in SEC Staff Accounting Bulletin No. 118 (SAB 118), which expresses the view of the staff regarding application of existing guidance for the accounting for income taxes as it relates to the enactment of the Tax Cuts and Jobs Act (the “Tax Act”) which was signed into law in the fourth quarter of 2017. In accordance with ASU 2018-05, the Company has recorded provisional estimates for the accounting impacts of the Tax Act, including the transition tax, deferred tax remeasurements, and other items, due to the uncertainty regarding how these provisions are to be implemented and additional anticipated forthcoming guidance. Management has completed the analysis of the impacts of the Tax Act and we adopted ASU 2018-05, which had no impact to the consolidated financial statements during 2018.

In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480) and Derivatives and Hedging (Topic 815): I. Accounting for Certain Financial Instruments with Down Round Features; II. Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception, (“ASU 2017-11”). Part I of this update addresses the complexity of accounting for certain financial instruments with down round features. Down round features are features of certain equity-linked instruments (or embedded features) that result in the strike price being reduced on the basis of the pricing of future equity offerings. Current accounting guidance creates cost and complexity for entities that issue financial instruments (such as warrants and convertible instruments) with down round features that require fair value measurement of the entire instrument or conversion option. Part II of this update addresses the difficulty of navigating Topic 480, Distinguishing Liabilities from Equity, because of the existence of extensive pending content in the FASB Accounting Standards Codification. This pending content is the result of the indefinite deferral of accounting requirements about mandatorily redeemable financial instruments of certain nonpublic entities and certain mandatorily redeemable noncontrolling interests. The amendments in Part II of this update do not have an accounting effect. This ASU is effective for fiscal years, and interim periods within those years, beginning after December

16

IMH FINANCIAL CORPORATION
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

NOTE 2 — SIGNIFICANT ACCOUNTING POLICIES – continued

15, 2018. We adopted this standard effective January 1, 2018. The adoption of this standard did not have a material impact on our consolidated financial statements and related disclosures.

Accounting Standards Not Yet Adopted

In February 2016, the FASB issued ASU 2016-02, Leases. This new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. In July 2018, the FASB issued ASU No. 2018-11 which provides an alternative transition method that allows entities to apply the new leases standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The Company plans to adopt the requirements of ASU 2016-02 effective January 1, 2019, the first day of fiscal year 2019, and will use the cumulative-effect transition method. The Company anticipates taking advantage of the practical expedient options, which allows an entity not to reassess whether any existing or expired contracts contain leases, and lease classifications for existing or expired leases, and initial direct costs for existing leases, and the Company is further evaluating other optional practical expedients. Based upon a preliminary assessment, the Company expects that substantially all of the operations lease commitments will be subject to the new guidance. We are currently performing an assessment of the revised standard and assessing our existing lease portfolio in order to determine the impact to our accounting systems, processes and internal control over financial reporting.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses. The ASU requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. Additionally, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. For public companies, this update will be effective for interim and annual periods beginning after December 15, 2019. We have not yet determined the impact the adoption of ASU 2016-13 will have on the Company’s consolidated financial statements and related disclosures.

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment (“ASU 2017-04”), which simplifies the current two-step goodwill impairment test by eliminating Step 2 of the test. The guidance requires a one-step impairment test in which an entity compares the fair value of a reporting unit with its carrying amount and recognizes an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, if any. This guidance is effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years, and should be applied on a prospective basis. Early adoption is permitted for the interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently evaluating the impact of the adoption of this guidance on its financial statements and related disclosures.

In June 2018, the FASB issued ASU 2018-07, Stock Compensation - Improvements to Nonemployee Share-Based Payment Accounting (“ASU 2018-07”), which intended to simplify nonemployee share-based payment accounting. This new guidance will more closely align the accounting for share-based payment awards issued to employees and nonemployees. This guidance is effective for fiscal years beginning after December 15, 2018 and for interim periods within those fiscal years, with early adoption
permitted. The Company is currently evaluating the impact of the adoption of this guidance on its financial statements and related disclosures.

In August 2018, the SEC adopted the final rule under SEC Release No. 33-10532, “Disclosure Update and Simplification”, amending certain disclosure requirements that were redundant, duplicative, overlapping, outdated or superseded. In addition, the amendments expanded the disclosure requirements on the analysis of stockholders' equity for interim financial statements. Under the amendments, an analysis of changes in each caption of stockholders' equity presented in the balance sheet must be provided in a note or separate statement. The analysis should present a reconciliation of the beginning balance to the ending balance of each period for which a statement of comprehensive income is required to be filed. The Company anticipates its first presentation of changes in shareholders' equity will be included in its Form 10-Q for the first quarter of fiscal year 2019.

17

IMH FINANCIAL CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3 — REVENUE

On January 1, 2018, we adopted Topic 606 using the modified retrospective method. The adoption of this standard did not have a material impact on our consolidated financial statements, thus no adjustments to opening retained earnings were made as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under ASC Topic 605-Revenue Recognition.

The Company derives hotel revenues from our hotel in Sonoma, California. Rooms revenue represents revenue from the occupancy of our hotel rooms and is driven by the occupancy and average daily rate charged. Rooms revenue includes revenue for guest no-shows, day use, and early/late departure fees. The contracts for room stays with customers are generally short in duration and revenues are recognized as services are provided over the course of the hotel stay.

Food & Beverage (“F&B”) revenue consists of revenue from the restaurants and lounges at our hotel properties, In-room dining and mini-bar revenue, and banquet/catering revenue from group and social functions. Other F&B revenue may include revenue from audio-visual equipment/services, rental of function rooms, and other F&B related revenue. Revenue is recognized as the services or products are provided. Our hotel properties may employ third parties to provide certain services at the property, for example, audio visual services. We evaluate each of these contracts to determine if the hotel is the principal or the agent in the transaction, and record the revenue as appropriate (i.e., gross vs. net).

Other revenue consists of ancillary revenue at the property, including attrition and cancellation fees, resort fees, spa and other guest services. Attrition and cancellation fees are recognized for non-cancellable deposits when the customer provides notification of cancellation within established management policy time frames. Taxes collected from customers and submitted to taxing authorities are not recorded in revenue. Interest income is recognized when earned.


Following is a breakdown of revenue by source (in thousands):
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Operating property revenue
 
 
 
 
 
 
 
 
  Rooms
 
$
1,311

 
$

 
$
3,207

 
$

  Golf range fees
 

 

 

 
820

  Banquet
 
175

 

 
333

 
114

  Food and beverage
 
314

 

 
1,440

 
352

  Spa and fitness center
 
194

 

 
522

 
240

  Other
 
91

 

 
251

 
156

    Total operating property revenue
 
2,085

 

 
5,753

 
1,682

Mortgage loan income, net
 
709

 
350

 
1,976

 
402

Management fees, investment and other income
 
32

 
300

 
323

 
808

  Total revenue
 
$
2,826

 
$
650

 
$
8,052

 
$
2,892




18

IMH FINANCIAL CORPORATION
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 4 — MORTGAGE LOANS, NET

As of September 30, 2018, the Company had six loans with an outstanding balance of $23.0 million, three of which were performing loans bearing a weighted-average interest rate of 8.84% as of September 30, 2018. As of December 31, 2017, the Company had four loans with an outstanding balance of $19.7 million, two of which were performing loans bearing a weighted-average interest rate of 9.69%. During the nine months ended September 30, 2018 and 2017, we recorded mortgage interest income of $2.0 million and $0.4 million, respectively.

During the three months ended September 30, 2018, one of our loans with an outstanding balance of $7.6 million entered default status upon its maturity, although it was not considered impaired since the fair value of the underlying collateral was deemed to exceed the carrying value of the loan. As of September 30, 2018, the Company had three non-performing loans, two of which have been fully reserved and have a zero carrying value and the remaining non-performing loan has a carrying value of $7.63 million. As of December 31, 2017, the Company had two non-performing loans, respectively, which have been fully reserved and have a zero carrying value. As of September 30, 2018 and December 31, 2017, the valuation allowance was $13.1 million and 12.7 million, respectively.

During the nine months ended September 30, 2018 ,the Company originated two new loans. The first loan is a $13.1 million construction loan bearing annual interest at 8.5% plus one-month LIBOR, with an original maturity date of July 18, 2020 and a six-month extension option. As of September 30, 2018, the Company had not yet advanced any loan funds pending the borrower’s obligation to meet certain minimum equity requirements. The loan is collateralized by a first lien security interest in certain real and personal property and related improvements thereon located in Phoenix, Arizona. The second loan origination was a mortgage loan for $3.0 million bearing annual interest rate of 6% plus one-month LIBOR (subject to an 8% interest rate floor), and an exit fee equal to 1% of the principal balance. The loan is collateralized by a first lien security interest in a residential unit located in New York, NY. The loan provides for interest only payments payable monthly during the initial 12 month term with a balloon payment due upon maturity. The borrower has an option to extend the loan by six months. We did not originate or sell any mortgage loans during the nine months ended September 30, 2017. During the nine months ended September 30, 2017, the Company purchased one new mezzanine loan from a related party (as described in Note 14) at a discount for $7.0 million, with a face value of $7.6 million and incurred and expensed costs related to underwriting the loan of $0.2 million.

19

IMH FINANCIAL CORPORATION
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 5 — REAL ESTATE HELD FOR SALE, OTHER REAL ESTATE OWNED, AND OPERATING PROPERTIES

As of September 30, 2018, we held total REO assets of $67.5 million, of which $8.0 million were classified as held for sale, $25.8 million were held as operating properties, and $33.7 million were classified as other real estate owned. At December 31, 2017, we held total REO assets of $64.6 million, of which $5.9 million were classified as held for sale, $20.5 million were held as operating properties, and $38.3 million were classified as other real estate owned.

During the nine months ended September 30, 2018, we sold three REO assets (or portions thereof) for $8.7 million (net of transaction costs and other adjustments) resulting in a total net gain on sale of $3.9 million, less allocated gains to non-controlling interests of $1.9 million. During the nine months ended September 30, 2017, the Company sold REO from seven projects (in whole or portions thereof), for $98.3 million (net of transaction costs and other non-cash adjustments) resulting in a total net gain on sale of $8.9 million, of which $6.8 million is included as a component of discontinued operations in the condensed consolidated statement of operations.

REO Planned Development and Operations

Costs and expenses related to operating, holding and maintaining our operating properties and REO assets are expensed as incurred and included in operating property direct expenses, and expenses for non-operating real estate owned in the accompanying condensed consolidated statements of operations. For the three months ended September 30, 2018 and 2017, these costs and expenses were $2.5 million and $0.3 million ($16.0 thousand of which is included in income from discontinued operations), respectively. For the nine months ended September 30, 2018 and 2017, these costs and expenses were $7.2 million and $6.0 million ($4.0 million of which is included in loss from discontinued operations), respectively. Costs related to the development or improvements of the Company’s real estate assets are generally capitalized and costs relating to holding the assets are generally charged to expense. Cash outlays for capitalized development costs totaled $7.2 million and $1.4 million for the nine months ended September 30, 2018 and 2017, respectively.

20

IMH FINANCIAL CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6 - VARIABLE INTEREST ENTITIES
As of September 30, 2018 and December 31, 2017, we consolidated multiple variable interest entities (“VIE’s”) relating to three projects: two are comprised of real estate holdings and one is an operating hotel property. We are deemed to be the primary beneficiaries of these consolidated VIE’s as we have the power to direct the activities that most significantly affect their economic performance and we have the obligation to absorb their losses and the right to receive benefits that could be significant to them. The assets of our consolidated VIE’s are only available to settle the obligations of the respective entities. Our condensed consolidated balance sheets included the assets and liabilities of these VIE’s. Our condensed consolidated statement of operations includes net loss for the nine months ended September 30, 2018 and year ended December 31, 2017. These are primarily comprised of the following (in thousands):
Assets, Liabilities, and Losses of Consolidated VIE's
 
September 30, 2018
 
* 12/31/2017
Total assets
 
$
81,950

 
$
69,480

Total liabilities
 
34,960

 
30,240

Net loss
 
(70
)
 
(1,480
)
* As Restated

During the nine months ended September 30, 2018, the Hotel Fund raised $9.8 million in Preferred Interests and made distributions of earnings to holders of those Preferred Interests of $0.2 million.


21

IMH FINANCIAL CORPORATION
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 7 - DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

Interest Rate Derivative

We are exposed to risks arising from rising interest rates on our variable rate debt instruments.  To manage these risks, we primarily use interest rate derivatives, which currently consist of one interest rate cap.  To mitigate the nonperformance risk, we routinely use a third party’s analysis of the creditworthiness of the counterparties, which supports our belief that the counterparties’ nonperformance risk is limited. All derivatives are recorded at fair value.

During the nine months ended September 30, 2018, we entered into an interest rate cap with a notional amount of $36.0 million and a rate cap of 2.2%. The interest rate cap had an effective date of March 21, 2018 and terminates on March 1, 2021. This instrument was not designated as a cash flow hedge. During the three and nine months ended September 30, 2018, there was no adjustment of the fair value on the interest rate cap. The estimated fair value of the interest rate cap at September 30, 2018 approximated $0.5 million.

22

IMH FINANCIAL CORPORATION
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 8 — FAIR VALUE
 
Valuation Allowance and Fair Value Measurement of Loans and Real Estate Held for Sale
 
Our valuation analysis process and procedures are disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017. We perform a valuation analysis of our loans, REO held for sale, other REO, and derivative instruments on a quarterly basis. We consider all relevant, material circumstances to determine if, and the extent to which, a valuation allowance is required.

Impairment for collateral dependent loans is measured at the balance sheet date based on the then fair value of the collateral in relation to contractual amounts due under the terms of the applicable loan if foreclosure is probable. Substantially all of our loans in default are deemed to be collateral dependent.
 
REO assets that are classified as held for sale and other REO are measured at the lower of carrying amount or fair value, less estimated cost to sell. If an asset is considered impaired, an impairment loss is recognized for the difference between the asset’s carrying amount and its fair value, less estimated cost to sell. If we elect to change the disposition strategy for our other REO, and such assets were deemed to be held for sale, we may record additional impairment charges, and the amounts could be significant.
 
Selection of Single Best Estimate of Value
 
The results of our valuation efforts generally provide a range of values for the collateral valued or REO assets rather than a single point estimate because of variances in the potential value indicated from the available sources of market participant information. The selection of a value from within a range of values depends upon general overall market conditions as well as specific market conditions for each property valued and its stage of entitlement or development. In selecting the single best estimate of value, we consider the information in the valuation reports, credible purchase offers received and agreements executed, as well as multiple observable and unobservable inputs.

Fair Value Measurements of Derivative Instrument

As described in Note 7, during the nine months ended September 30, 2018, we purchased an interest rate cap in order to mitigate our risk on variable debt against rising interest rates. In order to estimate the fair value of this derivative instrument, we use valuation reports from third party broker who issued the derivative instrument. The report contemplates fair value by using inputs, including market-observable data such as U.S dollar and foreign-denominated interest rate curves, foreign exchange rates, volatilities, and information derived from or corroborated by that market-observable data which are classified as Level 2 inputs in the fair value hierarchy. The fair value method does not contemplate credit valuation adjustments (“CVA”) which would be a Level 3 input as the CVA uses credit spreads which are generally unobservable to the market. The fair value used in these financial statements approximate fair value without the CVA. As of September 30, 2018, the fair value of the interest rate cap was $0.5 million and there were no gains or losses on the instrument during the three or nine months ended September 30, 2018.

Fair Value Measurements of Equity Securities

As described elsewhere in this Form 10-Q, during the nine months ended September 30, 2018, we issued 2,352,941 shares of Series B-3 Preferred Stock and a detachable common stock warrant to purchase 600,000 shares. We also issued 22,000 shares of Series A Preferred Stock. In order to estimate the fair value of the securities issued in these transactions pursuant to applicable accounting guidance, we engaged a third party valuation firm to assist us in our fair value assessment as our securities are not traded on an open exchange. In estimating fair value, the valuation firm considered the negotiated terms of these transactions, utilized certain current and prospective financial and operational data provided by management, obtained financial and other data from various public, financial and industry sources, and evaluated applicable economic and industry conditions as of the valuation date and their effects on the Company. Based on this valuation assessment, management estimated the fair value of the equity securities issued or granted in connection with the transaction completed February 9, 2018 for the Series B-3 Preferred Stock and May 31, 2018 for the Series A Preferred Stock as follows:

23

IMH FINANCIAL CORPORATION
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


NOTE 8 — FAIR VALUE – continued

Subject securities
 
Estimated Fair Value per Share
Series B-3
 
$
4.12

Series A Preferred Stock
 
$
1,000

JPM Warrants
 
$
1.52


We accounted for the issuance of the Series B-3 Preferred Stock and common stock warrants in accordance with applicable accounting guidance, under which we allocated the $8.0 million investment amount in proportion to the relative fair value of the the Series B-3 Preferred Stock and common stock warrants. As described below, the fair value of the common stock warrants was estimated at $0.9 million at date of issuance however, the allocated relative fair value of the warrants of $0.7 million was recorded as additional paid-in capital with an offsetting discount to the Series B-3 Preferred Stock during the nine months ended September 30, 2018. The common stock warrants have an exercise price of $2.25, a contractual term of 2 years and are not exercisable until February 9, 2021.

The fair value of the common stock warrants was estimated at $0.9 million on the date of issuance using the Black-Scholes valuation model based on the exercise price of the award and other assumptions relating to expected dividend yield, expected stock price volatility, risk-free interest rate, and expected life of options granted. Expected volatility is based on the historical volatility of our peer companies’ stock for the length of time corresponding to the expected term of the warrants. The expected dividend yield is based on our historical and projected dividend payments. The risk-free interest rate is based on the U.S. treasury yield curve on the grant date for the expected term of the option or warrant. A summary of these applicable factors used in the valuation follows:
Expected stock price volatility
 
40
%
Risk-free interest rate
 
2
%
Expected life of warrants (in years)
 
3

Expected dividend yield
 

Common Stock value discount for lack of marketability
 
25
%

Valuation Conclusions

Based on the results of our evaluation and analysis, we recorded no non-cash provision for credit losses on our loan portfolio during the three and nine months ended September 30, 2018 and 2017, respectively. We recorded net recoveries of investment and credit losses of $0 and $0.2 million during the three and nine months ended September 30, 2018, respectively. We recorded net recoveries of $6.1 million and $6.4 million in net recoveries of investment and credit losses for the three and nine months ended September 30, 2017, respectively. These recoveries resulted from the collection of cash and/or other assets recovered from certain guarantors on certain legacy loans and insurance recoveries received during the respective period. We recorded no impairment losses during the three and nine months ended September 30, 2018 and $0.3 million during the three and nine months ended September 30, 2017.

As of September 30, 2018 and December 31, 2017, the valuation allowance totaled $13.1 million, representing 37.1% and 39.2%, respectively, of the total outstanding loan principal and accrued interest balances. With the existing valuation allowance recorded as of September 30, 2018, we believe that, as of that date, the fair value of our loans, REO assets held for sale, and other REO is adequate in relation to the net carrying value of the related assets and that no additional valuation allowance or impairment is considered necessary. While the above results reflect management’s assessment of estimated fair value as of September 30, 2018 based on currently available data, we will continue to evaluate our loans and REO assets to determine the appropriateness of the carrying value of such assets. Depending on market conditions, such updates may yield materially different values and potentially increase or decrease the valuation allowance for loans or impairment charges for REO assets.

24

IMH FINANCIAL CORPORATION
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 9 — NOTES PAYABLE AND SPECIAL ASSESSMENT OBLIGATIONS
 
As of September 30, 2018 and December 31, 2017, our debt, notes payable and special assessment obligations consisted of the following (in thousands): 
 
 
September 30,
 
December 31,
 
 
2018
 
2017
Note Payables, Net
 
 
 
 
$32.3 million note payable to MidFirst Bank secured by a first lien on an operating hotel property, interest-only payments due monthly at the 30-day Libor (2.26% and 1.56% at September 30, 2018 and December 31, 2017, respectively) plus 3.25% to 3.75% depending on compensating balances and meeting certain financial thresholds and terms (5.41% and 5.31% effective rate at September 30, 2018 and December 31, 2017, respectively) , matures October 1, 2020 with possibility of two one-year extensions, with construction completion and repayment guarantee provide by the Company
 
$
20,368

 
$
19,557

$5.9 million note payable secured by real estate in New Mexico, annual interest only payments based on annual interest rates of prime plus 2.0% through December 31, 2017, and prime plus 3.0% thereafter (8.25% and 5.75% at September 30, 2018 and December 31, 2017, respectively), matures December 31, 2019
 
5,940

 
5,940

Unsecured note payable under class action settlement, face amount of $10.2 million, net discount of $0.8 million and $1.2 million at September 30, 2018 and December 31, 2017, respectively, 4% annual coupon interest rate (14.6% effective yield), interest payable quarterly, matures April 28, 2019
 
9,643

 
8,938

$2.3 million special assessment bonds dated between 2002 and 2007, secured by the residential land located in Dakota County, Minnesota, annual interest rate ranging from 6%-7.5%, maturing various dates through 2022 (classified as held for sale as of March 31, 2018)
 
103

 
116

Total notes payable
 
36,054

 
34,551

Less: deferred financing costs of notes payable
 
(360
)
 
(446
)
Total notes payable, net
 
$
35,694

 
$
34,105

 
Interest expense for the three months ended September 30, 2018 and 2017 was $0.8 million and $0.4 million, respectively. Interest expense for the nine months ended September 30, 2018 and 2017 was $2.3 million and $2.4 million, respectively. Interest expense for the nine months ended September 30, 2017 includes $1.1 million which is included in income from discontinued operations in the accompanying condensed consolidated statements of operations.

Senior Indebtedness

MacArthur Place

In October 2017, we borrowed $32.3 million from MidFirst Bank in connection with our purchase of MacArthur Place, of which $19.4 million was utilized for the purchase of MacArthur Place, approximately $10.0 million of which was being set aside to fund planned hotel improvements, and the balance is to fund interest reserves and operating capital. The MacArthur Loan bears floating interest equal to the 30-day LIBOR rate (2.26% and 1.56% at September 30, 2018 and December 31, 2017, respectively) plus 3.75%, which may be reduced by up to 0.50% if certain conditions are met. During the three and nine months ended September 30, 2018, the Company made interest draws totaling $0.3 million and $0.8 million, respectively against the loan. The Company incurred deferred financing fees of $0.5 million which are being amortized over the term of the loan using the effective interest method.

The MacArthur Loan is secured by a deed of trust on all MacArthur Place real property and improvements, and a security interest in all furniture, fixtures and equipment, licenses and permits, and MacArthur Place related revenues. The Company agreed to provide a construction completion guaranty with respect to the planned improvement project which shall be released upon payment of all project costs and receipt of a certificate of occupancy. In addition, the Company provided a loan repayment guaranty equal to 50% of the loan principal along with a guaranty of interest and operating deficits, as well as other customary carve-out matters such as bankruptcy and environmental matters. Under the guarantees, the Company is required to maintain a minimum tangible

25

IMH FINANCIAL CORPORATION
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

NOTE 9 — NOTES PAYABLE AND SPECIAL ASSESSMENT OBLIGATIONS – continued

net worth, as defined, of $50.0 million and minimum liquidity of $5.0 million throughout the term of the loan. Preferred equity is included as a component of equity with respect to the minimum tangible net worth covenant. The Company was in compliance with these covenants and guarantees at September 30, 2018 and December 31, 2017. In addition, the Company is required to establish various operating and reserve accounts at MidFirst Bank which are subject to a cash management agreement. In the event of default, MidFirst Bank has the ability to take control of such accounts for the allocation and distribution of proceeds in accordance with the cash management agreement.

Exchange Notes

In April 2014, we completed an offering of a five-year, 4%, unsecured notes to certain of our shareholders in exchange for common stock held by such shareholders at an exchange price of $8.02 per share (“Exchange Offering”). Upon completion of the 2014 Exchange Offering, we issued Exchange Offering notes (“EO Notes”) with a face value of $10.2 million, which were recorded by the Company at fair value of $6.4 million based on the fair value and the imputed effective yield of such notes of 14.6% (as compared to the note rate of 4%) resulting in an initial debt discount on the EO Notes of $3.8 million, with a balance of $0.4 million at September 30, 2018. This amount is reflected as a debt discount in the accompanying financial statements and is being amortized as an adjustment to interest expense using the effective interest method over the term of the EO Notes. Interest is payable quarterly in arrears each January, April, July, and October. The EO Notes mature on April 28, 2019, and may be prepaid in whole or in part without penalty at the option of the Company. Had the Company met certain minimum cash and profitability conditions, the Company would have been required to prepay fifty percent (50%) of the outstanding principal balance of the EO Notes on April 29, 2018. Such conditions were not met and no prepayment was required.

As described in Note 15, subsequent to September 30, 2018, the Company commenced an offering to existing noteholders to extend the maturity date of the EO Notes to December 15, 2021 and increase the interest rate from 4% to 7%.

Our notes payable and special assessment obligations have the following scheduled maturities as of September 30, 2018 (in thousands):
Year
 
Amount
2018
 
$
14

2019
 
15,612

2020
 
20,394

2021
 
26

2022
 
8

Less: deferred financing costs of notes payable
 
(360
)
Total
 
$
35,694


26

IMH FINANCIAL CORPORATION
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 10 – SEGMENT INFORMATION

Operating segments are defined as components of an enterprise that engage in business activity from which revenues are earned and expenses incurred for which discrete financial information is available that is evaluated regularly by our chief operating decision makers in deciding how to allocate resources and in assessing performance.
 
The information presented in our reportable segments tables that follow are based in part on internal allocations which involve management judgment. Substantially, all revenues recorded are from external customers. There is no material intersegment activity.

Condensed consolidated financial information for our reportable operating segments as of September 30, 2018 and December 31, 2017 and for the three and nine months ended September 30, 2018 and 2017 is summarized as follows (in thousands):
 
 
September 30,
 
December 31,
Balance Sheet Items
 
2018
 
2017
Total Assets
 
 
 
 
  Mortgage and REO - Legacy portfolio and other options
 
$
67,112

 
$
66,577

  Hospitality and entertainment operations
 
44,877

 
39,337

  Corporate and other
 
33,770

 
8,544

    Consolidated total
 
$
145,759

 
$
114,458

 
 
 
 
 
 
 
 


Nine months ended September 30,
Cash Flow Items

2018

2017
 Expenditures for additions to long-lived assets




  Mortgage and REO - Legacy portfolio and other options

$
2,321


$
733

  Hospitality and entertainment operations

4,887


650

  Corporate and other

23


388

    Consolidated total

$
7,231


$
1,771



27

IMH FINANCIAL CORPORATION
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

NOTE 10 – SEGMENT INFORMATION - continued

 
 
Three months ended September 30, 2018
Income Statement Items
 
Mortgage and REO Legacy Portfolio and Other Operations
 
Hospitality and Entertainment Operations
 
Corporate and Other
 
Consolidated
 
 
 
 
 
 
 
 
 
Revenues
 
 
 
 
 
 
 
 
  Mortgage loan income
 
$
709

 
$

 
$

 
$
709

  Operating property, management fees, and other
 
3

 
2,082

 
32

 
2,117

Total Revenue
 
712

 
2,082

 
32

 
2,826

 
 
 
 
 
 
 
 
 
Total Operating Expenses
 
843

 
3,228

 
2,413

 
6,484

 
 
 
 
 
 
 
 
 
Other (income) expense
 
 
 
 
 
 
 
 
  Gain on disposal of assets, net
 
(3,543
)
 

 

 
(3,543
)
  Recovery of credit losses
 

 

 

 

    Total Other (income)
 
(3,543
)
 

 

 
(3,543
)
 
 
 
 
 
 
 
 
 
Total Costs and expense, net
 
(2,700
)
 
3,228

 
2,413

 
2,941

Net Income (loss)
 
$
3,412

 
$
(1,146
)
 
$
(2,381
)
 
$
(115
)


Three months ended September 30, 2017
Income Statement Items

Mortgage and REO Legacy Portfolio and Other Operations

Hospitality and Entertainment Operations

Corporate and Other

Consolidated









Revenues








  Mortgage loan income

$
350


$


$


$
350

  Operating property, management fees, and other

37


176


87


300

Total Revenue

387


176


87


650










Total Operating Expenses

901


197


2,507


3,605










Other (income) expense








  Gain on disposal of assets, net

(321
)





(321
)
  Recovery of credit losses

(6,070
)





(6,070
)
  Impairment of Real Estate Owned

344






344

  Equity loss from unconsolidated entities, net

68






68

    Total Other (income)

(5,979
)





(5,979
)









Total Costs and expense, net

(5,078
)

197


2,507


(2,374
)
Income (loss) from continuing operations, before income taxes

5,465


(21
)

(2,420
)

3,024

Income (loss) from discontinued operations, net of tax



30




30

Net Income (loss)

$
5,465


$
9


$
(2,420
)

$
3,054



28

IMH FINANCIAL CORPORATION
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

NOTE 10 – SEGMENT INFORMATION - continued



Nine months ended September 30, 2018
Income Statement Items

Mortgage and REO Legacy Portfolio and Other Operations

Hospitality and Entertainment Operations

Corporate and Other

Consolidated









Revenues








  Mortgage loan income

$
1,976


$


$


$
1,976

  Operating property, management fees, and other

2


5,993


81


6,076

Total Revenue

1,978


5,993


81


8,052










Total Operating Expenses

2,256


9,440


6,877


18,573










Other (income) expense








  Gain on disposal of assets, net

(3,938
)





(3,938
)
  Recovery of credit losses

(175
)





(175
)
     Total Other (income)

(4,113
)





(4,113
)









Total Costs and expense, net

(1,857
)

9,440


6,877


14,460

Net Income (loss)

$
3,835


$
(3,447
)

$
(6,796
)

$
(6,408
)
 
 
Nine months ended September 30, 2017
Income Statement Items
 
Mortgage and REO Legacy Portfolio and Other Operations
 
Hospitality and Entertainment Operations
 
Corporate and Other
 
Consolidated
 
 
 
 
 
 
 
 
 
Revenues
 
 
 
 
 
 
 
 
  Mortgage loan income
 
$
402

 
$

 
$

 
$
402

  Operating property, management fees, and other
 
114

 
2,170

 
206

 
2,490

Total Revenue
 
516

 
2,170

 
206

 
2,892

 
 
 
 
 
 
 
 
 
Total Operating Expenses
 
3,302

 
1,700

 
7,824

 
12,826

 
 
 
 
 
 
 
 
 
Other (income) expense
 
 
 
 
 
 
 
 
  Gain on disposal of assets, net
 
(1,867
)
 
(169
)
 

 
(2,036
)
  Recovery of credit losses
 
(6,348
)
 

 
(60
)
 
(6,408
)
  Impairment of Real Estate Owned, Net
 
344

 

 

 
344

  Equity loss from unconsolidated entities, net
 
239

 

 

 
239

     Total Other Income
 
(7,632
)
 
(169
)
 
(60
)
 
(7,861
)
 
 
 
 
 
 
 
 
 
Total Costs and expense, net
 
(4,330
)
 
1,531

 
7,764

 
4,965

Income (loss) from continuing operations, before income taxes
 
4,846

 
639

 
(7,558
)
 
(2,073
)
Income from discontinued operations, net of tax
 

 
4,766

 

 
4,766

Net Income (loss)
 
$
4,846

 
$
5,405

 
$
(7,558
)
 
$
2,693



29

IMH FINANCIAL CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 11 — STOCKHOLDERS’ EQUITY AND EARNINGS PER SHARE
 
Common Stock

Shares of Common Stock, Class B Common Stock, Class C Common Stock, and Class D Common Stock share proportionately in our earnings and losses attributable to common shareholders. During the nine months ended September 30, 2018, a shareholder
voluntarily surrendered and relinquished its entire ownership interest in the Company representing 44,068 shares of Class C common stock. Such shares have been recorded as treasury stock. There are no shares of Class D Common Stock outstanding as of September 30, 2018 or December 31, 2017.

Preferred Stock

In 2014, the Company issued a total of 8.2 million shares of the Company’s Series B-1 and B-2 Cumulative Convertible Preferred Stock to certain investor groups in exchange for $26.4 million. Except for certain voting and transfer rights, the rights and obligations of the Series B-1 Preferred Stock and Series B-2 Preferred Stock are substantially the same. On April 11, 2017, Chase Funding, an affiliate of JPMorgan Chase & Co., purchased all of the Company’s outstanding Series B-2 Preferred Shares.

On February 9, 2018, Chase Funding purchased 2,352,941 shares of our Series B Preferred Stock (the “Series B-3 Preferred Stock”), and together with our Series B-1 Cumulative Convertible Preferred Stock, (the “Series B-1 Preferred Stock”) and our Series B-2 Cumulative Convertible Preferred Stock, $0.01 par value per share, of the Company (the “Series B-2 Preferred Stock”), referred to herein as the (“Series B Preferred Stock”), at a purchase price of $3.40 per share, for a total purchase price of $8.0 million. Dividends on the Series B-3 Preferred Stock are cumulative and accrue from the issue date and compound quarterly at the rate of 5.65% of the issue price per year, and are payable quarterly in arrears. Holders of the Series B-3 Preferred Stock are entitled to receive a liquidation preference of 145% of the sum of the original price per share of Series B-3 Preferred Stock plus all accrued and unpaid dividends. The Series B-3 Preferred Stock contains redemption features similar in all material respects to those of all Series B Preferred stock, which are disclosed in IMH’s annual 10-K for the year ended December 31, 2017.

On February 9, 2018, the Company issued to Chase Funding a warrant to acquire up to 600,000 shares of the Company’s common stock (the “JPM Warrant”) . The JPM Warrant is exercisable at any time on or after February 9, 2021 for a two (2) year period, and has an exercise price of $2.25 per share. The JPM Warrant provides for certain adjustments that may be made to the exercise price and the number of shares issuable upon exercise due to customary anti-dilution provisions based on future corporate events. The JPM Warrant is exercisable in cash, and subject to certain conditions may also be exercised on a cashless basis.

Series A Preferred Perpetual Stock Issuance

On May 31, 2018, Chase Funding purchased 22,000 shares of our Series A Preferred Stock at a purchase price of $1,000 per share, for a purchased price of $22.0 million.

The Series A Preferred Stock ranks senior with respect to dividend and redemption rights and rights upon liquidation, dissolution or winding up of the Corporation to all other classes or series of shares of the Company’s preferred and common stock and to all other equity securities issued by the Company from time to time. The Series A Preferred Stock is non-voting stock. Holders of the Series A Preferred Stock are entitled to receive a liquidation preference equal to the sum of the Face Value of the Series A Preferred Stock plus all accrued and unpaid dividends. Dividends on the Series A Preferred Stock are cumulative and accrue from the issue date at the rate of 7.5% of the issue price per year, payable quarterly in arrears on or before the last day of each calendar quarter. The Company has certain call rights with respect to the Series A Preferred Stock and the holders of Series A Preferred Stock have certain put rights which includes an acceleration of the holder’s put right on redemption of any shares of junior securities in the result of a Noncompliance Redemption Demand.

Series B and Series A Preferred stock are classified as mezzanine equity on the balance sheets at September 30, 2018 and December 31, 2017.

Additional Stock Related Issuances

Our First Amended and Restated 2010 IMH Financial Corporation Employee Stock Incentive Plan (“Equity Incentive Plan”) provides for awards /.of stock options, stock appreciation rights, restricted stock units and other performance based awards to our

30

IMH FINANCIAL CORPORATION
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

NOTE 11 — STOCKHOLDERS’ EQUITY AND EARNINGS PER SHARE – continued

officers, employees, directors and certain consultants. The maximum number of shares of common stock available to be issued under such awards was not to exceed 2,700,000 common shares, subject to increase to 3,300,000 shares after an initial public offering.

During the nine months ended September 30, 2018, the Company issued 517,252, shares of common stock pursuant to previous restricted stock awards. We granted 110,979 options to employees pursuant to our Equity Incentive Plan during the nine months ended September 30, 2018. 30,000 of those options have an exercise price of $1.81 per share and have an estimated fair value of $0.73 per option. 80,979 of those options have an exercise price of $2.65 and have an estimated fair value of $1.06 per option and all options vest over a three year term. During the nine months ended September 30, 2018, approximately 64,000 options and approximately 20,000 unvested restricted shares were forfeited as a result of employment terminations.

In addition, during the nine months ended September 30, 2018, the Company issued a total of 74,136 shares of restricted common stock to our non-employee independent directors pursuant to the 2014 Non-Employee Director Compensation Plan for fiscal year 2017. 44,132 of those shares of a fair value of $1.81 and vested on June 29, 2018. 30,004 shares had a fair value on issuance of $2.67 and vest on June 30, 2019.

As of September 30, 2018, there were (i) 1,112,627 stock options outstanding, of which 852,327 shares were fully vested, (ii) 2,600,000 stock warrants outstanding; and (iii) 509,092 shares of unvested restricted stock grants outstanding. Vested restricted stock grants have been issued and are included in outstanding common stock.

Net stock-based compensation expense relating to the stock-based awards was $0.2 million and $0.4 million for the three and nine months ended September 30, 2018, respectively, and $0.2 million and $0.6 million for the three and nine months ended September 30, 2017, respectively. No stock options or warrants were exercised and we did not receive any cash from option or warrant exercises during the nine months ended September 30, 2018 or 2017. As of September 30, 2018, there was $0.6 million of unrecognized compensation cost related to the time-based restricted stock that is expected to be recognized as a charge to earnings over a weighted-average vesting period of 1.33 years.

Net Income (Loss) Per Share
 
The Company has adopted the two-class computation method, and thus includes all participating securities in the computation of basic shares for the periods in which the Company has net income available to common shareholders. A participating security is defined as an unvested share-based payment award containing non-forfeitable rights to dividends regardless of whether or not the awards ultimately vest or expire. Net losses are not allocated to participating securities unless the holder has a contractual obligation to share in the losses.

The following table presents a reconciliation of net loss to net loss attributable to common shareholders used in the basic and diluted earnings per share calculations for the three and nine months ended September 30, 2018 and 2017 (amounts in thousands, except for per share data):

31

IMH FINANCIAL CORPORATION
 
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 

NOTE 11 — STOCKHOLDERS’ EQUITY AND EARNINGS PER SHARE – continued

 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Earnings allocable to common shares:
 
 
 
 
 
 
 
 
Numerator - Loss Attributable to Common Shareholders:
 
 
 
 
 
 
 
 
Net Loss from continuing operations
 
$
(115
)
 
$
3,024

 
$
(6,408
)
 
$
(2,073
)
Loss attributable to noncontrolling interest loss allocation
 
(1,105
)
 
1,224

 
(990
)
 
490

Preferred dividends - cash and deemed
 
(1,997
)
 
(1,224
)
 
(5,114
)
 
(3,616
)
Net Loss from continuing operations attributable to common shareholders
 
(3,217
)
 
3,024

 
(12,512
)
 
(5,199
)
Net Income from discontinued operations attributable to common shareholders
 

 
30

 

 
4,766

Net (Income) Loss attributable to common shareholders
 
$
(3,217
)
 
$
3,054

 
$
(12,512
)
 
$
(433
)
 
 
 
 
 
 
 
 
 
Denominator - Weighted average shares:








Weighted average number of common shares - Basic

16,726,610


16,253,427


16,696,201


16,166,285

Weighted average number of common shares assuming dilution

16,726,610


25,091,821


16,696,201


16,166,285

Basic earnings per common share:








   Net income (loss) per share, Continuing Operations

$
(0.07
)

$
0.26


$
(0.44
)

$
(0.10
)
   Preferred dividends per share

(0.12
)

(0.07
)

(0.31
)

(0.22
)
   Net income (loss) per share, Continuing Operations, net

(0.19
)

0.19


(0.75
)

(0.32
)
   Net income (loss) per share, Discontinued Operations







0.29

   Net income (loss) attributable to common shareholders per share

$
(0.19
)

$
0.19


$
(0.75
)

$
(0.03
)
Diluted earnings per common share:




   Net income (loss) per share, Continuing Operations

$
(0.07
)

$
0.17


$
(0.44
)

$
(0.10
)
   Preferred dividends per share

(0.12
)

(0.05
)

(0.31
)

(0.22
)
   Net income (loss) per share, Continuing Operations, net

(0.19
)

0.12


(0.75
)

(0.32
)
   Net income (loss) per share, Discontinued Operations







0.29

   Net income (loss) attributable to common shareholders per share

$
(0.19
)

$
0.12


$
(0.75
)

$
(0.03
)

The following securities were not included in the computation of diluted net loss per share as their effect would have been anti-dilutive (presented as weighted average balances):


Three months ended September 30,

Nine months ended September 30,


2018

2017

2018

2017
Options to purchase common stock

1,085,497


1,038,988


1,080,442


972,475

Restricted stock

318,390


61,128


362,829


589,835

Warrants to purchase common stock

2,541,286


2,000,000


2,600,000


2,000,000

Convertible preferred stock

10,216,807




10,552,941


8,200,000

   Total

14,161,980


3,100,116


14,596,212


11,762,310




32

IMH FINANCIAL CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 12  — INTANGIBLE ASSETS AND GOODWILL

A summary of our intangible assets and goodwill as of September 30, 2018 and December 31, 2017 is as follows (in thousands):
 
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
 
 
2018
 
2017
 
2018
 
2017
 
2018