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 March 31, 2005
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 001-15733
SUTTER HOLDING COMPANY, INC.
(Exact name of registrant as specified in its charter)
Delaware 75-3111137
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
220 Montgomery Street, Suite 2100, San Francisco, CA 94104
(Address of principal executive office)
(Zip Code)
(415) 788-1441
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year,
if changed since last report)
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 and (2) has been subject to such filing
requirements for the past 90 days. YES x NO o
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). YES / / NO /X/
Number of shares of common stock outstanding as of April 29, 2005: 1,844,739
TABLE OF CONTENTS
SUTTER HOLDING COMPANY, INC.
FORM 10-Q
Page No.
Part I - Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets --
March 31, 2005 (unaudited) and December 31, 2004 3
Consolidated Statements of Operations --
First Quarter 2005 and 2004 (unaudited) 4
Consolidated Statements of Cash Flows --
First Quarter 2005 and 2004 (unaudited) 5
Notes to Interim Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 16
Item 4. Controls and Procedures 16
Part II - Other Information
Item 2. Unregistered Sales of Equity Securities and Use
of Proceeds 17
Item 5. Other Information 17
Item 6. Exhibits 17
Signature 17
Exhibits
31. Certifications Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32. Certifications Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
2
Part I - Financial Information
Item 1. Financial Statements
SUTTER HOLDING COMPANY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
As of As of
March 31, 2005 December 31, 2004
--------------------- ---------------------
ASSETS (unaudited)
Cash and cash equivalents $ 576,947 $ 193,997
Restricted cash, held in trust 1,064,424 -
Accounts receivable 1,202,311 82,795
Prepaid expenses 134,177 48,142
Mortgages held for sale 3,674,880 2,618,044
Investments, at cost 152,277 237,040
Property and equipment, net 262,226 154,335
Identifiable intangible and other assets 4,890,196 379,535
Goodwill 8,401,912 4,534,193
--------------------- ---------------------
TOTAL ASSETS $ 20,359,350 $ 8,248,081
===================== =====================
LIABILITIES & STOCKHOLDERS' EQUITY
Accounts payable and accrued expenses $ 2,664,399 $ 759,388
Mortgage warehouse line of credit 3,629,528 2,597,235
Interest payable 41,333 34,195
Income taxes payable 87,000 -
Debt to unrelated parties 1,976,951 268,926
Debt to related parties 922,407 1,661,894
--------------------- ---------------------
TOTAL LIABILITIES 9,321,618 5,321,638
--------------------- ---------------------
Commitments and contingencies (see Note 8)
Redeemable convertible preferred stock, $0.0001 par value 125,000
authorized; 1,475 and 175 issued and outstanding at
March 31, 2005 and December 31, 2004, respectively; redeemable
on or after January 26, 2008 at $1,600 per share 1,516,295 -
Stockholders' Equity
Common stock, $0.0001 par value
4,875,000 authorized; 1,844,739 and 634,674 issued and outstanding
at March 31, 2005 and December 31, 2004, respectively 184 63
Additional paid-in capital 14,196,803 7,180,528
Treasury stock (959,622) (959,622)
Accumulated deficit (3,715,928) (3,294,526)
--------------------- ---------------------
Total Stockholders' Equity 9,521,436 2,926,443
--------------------- ---------------------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $ 20,359,350 $ 8,248,081
===================== =====================
See accompanying Notes to Interim Consolidated Financial Statements
3
SUTTER HOLDING COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
For the three months For the three months
ended March 31, ended March 31,
---------------------- ------------------------
2005 2004
---------------------- ------------------------
Revenues:
Insurance commissions, net $ 1,151,166 $ -
Gain on sales of mortgages, net 394,283 412,903
Mortgage commissions on brokered loans 310,933 202,141
Interest income net of interest expense 2,056 13,672
---------------------- ------------------------
Total revenues 1,858,438 628,716
---------------------- ------------------------
Expenses:
General and administrative 1,969,101 643,748
Depreciation and amortization 223,785 29,711
Professional fees and other expenses 98,381 120,584
Other than temporary impairment loss - 32,043
---------------------- ------------------------
Total expenses 2,291,267 826,086
---------------------- ------------------------
Net operating loss (432,829) (197,370)
Other Income (expense)
Extinquishment of debt 100,000 -
Realized gain on sale, other income 48,316 59,921
Interest and dividend income 17,077 32
Other interest expense (146,633) (209,566)
Other expenses (7,333) -
---------------------- ------------------------
Total other income 11,427 (149,613)
---------------------- ------------------------
Loss from continuing operations $ (421,402) $ (346,983)
Provision for income taxes - -
---------------------- ------------------------
Net loss $ (421,402) $ (346,983)
Accretion related to redeemable convertible preferred stock (41,295) -
Accrual of preferred dividends (27,822) -
---------------------- ------------------------
Net loss attributable to common shareholders $ (490,519) $ (346,983)
====================== ========================
Net loss per share -- basic and diluted $ (0.34) $ (0.98)
Weighted Average Shares Outstanding 1,444,559 352,575
See accompanying Notes to Interim Consolidated Financial Statements
4
SUTTER HOLDING COMPANY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the three months ended March 31,
------------------------------------------------
2005 2004
----------------------- ----------------------
OPERATING ACTIVITIES
Net loss $ (421,402) $ (346,983)
Gain on sale of investments (23,245) -
Provision for impairment of investments and notes receivable - 32,043
Depreciation and amortization 223,785 29,711
Amortization of discount on debt 73,587 110,198
Adjustments to reconcile net (loss) income
to net cash (used in) provided by operating activities:
Restricted Cash 272,959 -
Accounts receivable 1,829,817 (14,077)
Prepaid expenses 11,437 8,678
Mortgages held for sale (1,056,836) (2,061,847)
Accounts payable and accrued expenses (2,128,400) 106,986
Interest payable 7,138 54,658
Other assets 122,135 (22,559)
----------------------- ----------------------
Net cash used in operating activities (1,089,025) (2,103,192)
----------------------- ----------------------
INVESTING ACTIVITIES
Capital expenditures (6,958) (29,345)
Proceeds from sales of investments 108,008 191,049
Acquisition of business, net of cash acquired (1,856,319) (2,388)
----------------------- ----------------------
Net cash (used in) provided by investing activities (1,755,269) 159,316
----------------------- ----------------------
FINANCING ACTIVITIES
Proceeds from issuance of preferred stock 1,300,000 -
Proceeds from issuance of common stock - 68,006
Proceeds from subscriptions - 120,000
Proceeds from issuance of debt payable 2,000,000 2,038,638
Increase (decrease) in mortgage warehouse line of credit 1,032,293 (27,867)
Repayment of debt payable (1,105,049) -
----------------------- ----------------------
Net cash provided by financing activities 3,227,244 2,198,777
----------------------- ----------------------
Net change in cash and cash equivalents for the period 382,950 254,901
Cash and cash equivalents, beginning of period 193,997 96,971
----------------------- ----------------------
Cash and cash equivalents, end of period $ 576,947 $ 351,872
======================= ======================
Additional cash flow information:
Cash interest paid $ 25,707 $ 168,151
Supplemental disclosure of non-cash investing and financing activities:
Issuance of shares to wholly owned subsidiary $ - $ 252,500
Forgiveness of related party debt 100,000 -
Accretion related to redeemable convertible preferred stock 41,295 -
Accrual of preferred dividends 27,822 -
Net tangible assets and working capital acquired in Diversified Risk transaction 408,067
See accompanying Notes to Interim Consolidated Financial Statements
5
SUTTER HOLDING COMPANY, INC. AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
1. Basis of Presentation
The accompanying unaudited Consolidated Financial Statements include
the accounts of Sutter Holding Company, Inc. ("Sutter" or "Company")
consolidated with the accounts of all subsidiaries and affiliates that Sutter
controls as of the financial statement date. Reference is made to Sutter's
recently issued annual report on Form 10-K filed with the Securities and
Exchange Commission ("SEC") that includes information necessary or useful to
understanding Sutter's businesses and financial statement presentations. In
particular, Sutter's significant accounting policies and practices were
presented in Note 1 to the Consolidated Financial Statements included in that
annual report, and there have been no changes to such accounting policies and
practices during the quarter. Certain amounts in 2004 have been reclassified to
conform to the current period presentation.
Financial information in this Report reflects any adjustments
(consisting only of normal recurring adjustments) that are, in the opinion of
management, necessary to a fair statement of results for the interim periods in
accordance with generally accepted accounting principles ("GAAP") in the United
States.
Sutter's results, as well as that of its subsidiaries, for interim
periods are not necessarily indicative of results to be expected for the year.
2. Significant Business Acquisitions
As has been previously disclosed in public Company reports on Form 10-K
and Form 8-K, Sutter completed the acquisition of FLF, Inc. dba Diversified Risk
Insurance Brokers ("Diversified Risk") on January 26, 2005. The first quarter of
2005 includes the operations of Diversified Risk, while the first quarter of
2004 does not.
3. Receivables
Trade accounts receivable consist primarily of revenues and fees
receivable from insurance brokerage and mortgage origination activities.
Receivables were comprised of the following at March 31, 2005 and December 31,
2004:.
March 31, December 31,
----------------- ----------------
2005 2004
----------------- ----------------
Insurance segment receivables 1,129,716 0
Mortgage segment receivables 50,166 60,963
Other receivables 22,429 21,832
----------------- ----------------
Total $1,202,311 $82,795
================= ================
4. Investments
Investments are comprised of the following at March 31, 2005 and
December 31, 2004:
March 31, December 31,
------------------- -------------------
2005 2004
------------------- -------------------
Knight Fuller, Inc. $152,277 $237,040
Total $152,277 $237,040
=================== ===================
6
Gross Gross Reduction in Reported Value
Unrealized Unrealized Basis /
March 31, 2005 Cost Gains Losses Disposal
----------------- ---------------- ----------------- ---------------- -----------------
Non-marketable securities held $237,040 $0 $0 $84,763 $152,277
for investment
December 31, 2004
Non-marketable securities held
for investment $469,083 $0 $232,043 $0 $237,040
As of March 31, 2005, the Company owned 73,324 shares of common stock
of Knight Fuller, Inc., which trades under the ticker symbol "KNTF" on the
over-the-counter bulletin board. Management believes these shares represent less
than 5% of the outstanding shares in Knight Fuller. Because Knight Fuller has
had limited operations and revenues, and because its shares are extremely
illiquid, management believes it is prudent to classify these securities as
non-marketable securities held for investment rather than classifying them as
securities available for sale.
5. Property and Equipment, Net
Property and equipment consist of the following at March 31, 2005 and
December 31, 2004:
March 31, December 31,
------------------- -------------------
2005 2004
------------------- -------------------
Furniture, equipment and
leasehold improvements $468,293 $328,546
Accumulated depreciation (206,067) (174,211)
------------------- -------------------
Furniture, equipment and
leasehold improvements, net $262,226 $154,335
=================== ===================
6. Identifiable Intangible Assets, Net
Identifiable intangible assets consist of the following at March 31,
2005 and December 31, 2004:
March 31, December 31,
----------------- -----------------
2005 2004
----------------- -----------------
Mortgage Banking Customer Relationships,
net of accumulated amortization of $67,796
and $54,796 at March 31, 2005 and
December 31, 2004, respectively $192,204 $205,204
Non-compete agreement, net of accumulated
amortization of $39,113 and $31,613 at
March 31, 2005 and December 31, 2004,
respectively 20,888 28,388
Insurance Customer Relationships, net of
accumulated amortization of $171,429 at
March 31, 2005 4,628,571 0
Other assets 48,533 145,943
----------------- -----------------
Total identifiable intangible and other
assets, net $4,890,196 $379,535
================= =================
7. Goodwill
Goodwill increased by $3,867,719 to a total balance of $8,401,912 as of
March 31, 2005 due to the acquisition of Diversified Risk during the quarter.
7
8. Commitments and Contingencies
The Company's mortgage subsidiaries have certain covenants in
connection with their warehouse lines of credit. In each case, the covenants
include a requirement that the subsidiary maintain a minimum tangible net worth
of $250,000, and a current ratio greater than one. The Company and its
subsidiaries were in compliance with all covenants at March 31, 2005, except
Progressive received a waiver for March 31, 2005 with respect to a profitability
requirement.
9. Debt to Unrelated and Related Parties
Debt to unrelated and related parties of Sutter and its subsidiaries
consisted of the following as of March 31, 2005 and December 31, 2004:
March 31, December 31,
-------------------- --------------------
2005 2004
-------------------- --------------------
Debt to unrelated parties:
8.00% note due 2010 $1,976,951 0
15.00% note due 2005 0 25,000
8.00% note due 2006,
net of unamortized
discount of $56,074
at December 31, 2004 0 243,926
-------------------- --------------------
Total $1,976,951 $268,926
==================== ====================
Debt to related parties:
10.00% note due 2005 $0 57,000
10.00% note due 2005 37,000 37,000
12.50% note due 2005,
net of unamortized
discount of $14,593
at March 31, 2005 and
$32,106 at December 31, 2004,
respectively 385,407 617,894
6.00% note due 2007 500,000 500,000
6.00% note due 2007 0 450,000
-------------------- --------------------
Total $922,407 $1,661,894
==================== ====================
On January 26, 2005, the Company's insurance subsidiary, Diversified
Risk, borrowed $2 million in the form of a term loan from the Bank of Alameda.
Proceeds from the loan were used to finance a portion of the acquisition of
Diversified Risk by the Company. The loan bears interest at 8.00% annually,
amortizes over ten years and is due in 2010.
On January 31, 2005, all unrelated party notes, except for the Bank of
Alameda loan, were repaid. Specifically, the Company repaid in full the 8.00%
convertible note due in 2006 that had an outstanding principal balance of
$300,000. The Company also repaid in full the 15.00% note due in 2005 that had
an outstanding principal balance of $25,000.
On February 2, 2005, the Company repaid in full the following related
party notes: (1) the 10.00% note due in 2005 that had an outstanding principal
balance of $57,000; and (2) the 6.00% note due in 2007 that had an original
outstanding principal balance due at maturity of $450,000. Since the Company
prepaid this last note prior to maturity, the cash payment in full satisfaction
of the note amounted to only $350,000, and the $100,000 favorable difference was
recorded as a gain on the extinguishment of debt for the period. The Company
also repaid a portion, or $250,000, of the original $650,000 outstanding
principal balance on the 12.50% note due in 2005.
8
10. Preferred Stock
On January 26, 2005, the Company raised $1,300,000 in cash from an
institutional investor by issuing 1,300 shares of Series A Redeemable
Convertible Preferred Stock (the "Redeemable Preferred Shares"). The Preferred
Shares have a redemption feature that provides the institutional investor the
right to force the Company to repurchase and retire all (and not less than all)
1,300 Preferred Shares for a maximum price of $1,600 per share, the settlement
of which can be accomplished through either the payment of cash or, at the
election of the holder, the conversion of the Preferred Shares into common stock
in an amount determined by the conversion price. Such conversion can be
initiated at any time either (a) by the holder, or (b) by the Company upon the
successful filing of a registration statement with the SEC. This redemption
right is neither transferable nor assignable. In the event the institutional
investor sells any or all of its Redeemable Preferred Shares, prior to the third
anniversary of the date of issuance, the redemption right is automatically
revoked.
On December 31, 2004, the Company had 175 shares of Series A
Convertible Preferred Stock (the "Preferred Shares") already issued and
outstanding to a small group of qualified individual investors, but these
Preferred Shares were not redeemable. However, the initial subscription
agreements entered into with the qualified individual investors stated that the
individual investors were to receive the same rights and preferences as those
about to be received by the institutional investor with which the Company was
negotiating during the first quarter of 2005. The Company is currently in the
process of distributing and finalizing agreements that extend the same
redemption right, effective retroactively to January 26, 2005, to each of the
qualified individual investors of the Preferred Shares. As a result, the 175
Preferred Shares issued to individual investors, and originally classified
within the shareholders' equity section of the Company's balance sheet as
Preferred Shares, will now be classified as Redeemable Preferred Shares.
All of the holders of preferred shares receive a 10% annual cash
dividend that is paid quarterly.
11. Common Stock
Changes in issued and outstanding Sutter common stock for the quarter
ended March 31, 2005 are shown in the table below.
Common Stock, $0.0001 Par Value
(4,875,000 shares authorized)
Shares issued and outstanding
-------------------------------
Balance at December 31, 2004 634,674
Issuances during the quarter 1,210,065
-------------
Balance at March 31, 2005 1,844,739
The only issuances during the quarter were in the form of consideration
given in exchange for the capital stock of Diversified Risk. No Sutter shares
were issued for cash during the quarter.
12. Certain Relationships and Related Party Transactions
Between January 31 and February 2, 2005, the Company paid the following
related party debts: (1) the 10.00% note due 2005 that had an original principal
balance due at maturity of $57,000; (2) $250,000 of the 12.50% note due 2005
that had an original principal balance due at maturity of $650,000; and (3) the
6.00% note due 2007 that had an original outstanding principal balance due at
maturity of $450,000.
In conjunction with the term loan to Diversified Risk from the Bank of
Alameda, Messrs. Collins, Dixon and Knuff each personally guaranteed the loan
for as long as it remains outstanding. For making these personal guarantees,
Messrs. Collins, Dixon and Knuff are each entitled to receive fees in the amount
of $13,333 per annum. As of the date of this filing, these fees have not been
paid.
9
13. Recent Accounting Pronouncements
The Company's management has reviewed the FASB Emerging Issues Task
Force's recent pronouncements with respect to Issue No. 04-1, "Accounting for
Pre-existing Relationships between the Parties to a Business Combination" and
Issue No. 03-13, "Applying the Conditions in Paragraph 42 of FASB Statement No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets, in
Determining Whether to Report Discontinued Operations", as well as reviewed the
AICPA's recent pronouncement in Statement of Position (SOP) 03-3, "Accounting
for Certain Loans or Debt Securities Acquired in a Transfer". It is the opinion
of Sutter management that these recent pronouncements will not have a material
effect on the financial statements or position of the Company.
14. Business Segment Information
Beginning in 2005, as a result of the addition of Diversified Risk, the
Company now consists of two reportable business segments: insurance brokerage
and mortgage banking. The insurance segment is comprised of Diversified Risk,
and the mortgage banking segment is comprised of Easton and Progressive.
Diversified Risk brokers commercial property and casualty insurance for
hundreds of clients located primarily in California, although it has a number of
clients located throughout the United States. Diversified Risk emphasizes a
"total cost of risk" or "TCOR" consultative approach to providing its services,
which include all of those listed in the table located in the Results of
Operations section on page 11 of this report. Diversified Risk maintains
long-standing relationships with major insurance carriers such as AIG, Chubb,
Fireman's Fund, and St. Paul/Travelers, among others.
Easton and Progressive each originate residential mortgage loans in
several states. Easton also brokers small commercial mortgage loans. While
Easton has traditionally been a wholesale mortgage originator and Progressive
has traditionally been a retail mortgage originator, both subsidiaries are
currently being integrated into a single operation that will continue providing
both wholesale and retail services. The integration of the two businesses is
expected to be completed sometime during the Company's second fiscal quarter.
In addition to these business segments, the Company has a corporate
management and administration group. Corporate expenses for this group are
allocated to each business segment and are included in the business segment
results reported below. In other words, the numbers presented below are "fully
burdened" with Sutter's corporate overhead and expenses.
The "Acquisition-related expenses" category includes
acquisition-related costs incurred during the quarter, including amortization
and any impairments of acquisition-related intangibles and goodwill. As reported
in the Company's consolidated financial statements, these expense items are
included in general and administrative expenses, and depreciation and
amortization expenses, as appropriate. We break out these acquisition-related
expenses here and provide results on an adjusted net operating income basis to
more clearly represent how the individual business segments actually performed,
albeit fully burdened, for the periods shown.
For the three months ended March 31,
------------------------------------------------------------------------------
2005 2004
------------------------------------ --------------------------------------
Insurance Mortgage Insurance Mortgage
(in thousands) Brokerage Banking Total Brokerage Banking Total
------------- ------------- -------- -------------- ------------- ---------
Total revenues $1,151 $707 $1,858 $0 $629 $629
% Contribution 61.9% 38.1% 100.0% 0.0% 100.0% 100.0%
General and administrative expenses 1,053 916 1,969 0 644 644
% Contribution 53.5% 46.5% 100.0% 0.0% 100.0% 100.0%
Depreciation and amortization 184 40 224 0 30 30
% Contribution 82.3% 17.7% 100.0% 0.0% 100.0% 100.0%
Net operating loss (125) (308) (433) 0 (197) (197)
% Contribution 28.8% 71.2% 100.0% 0.0% 100.0% 100.0%
Acquisition-related expenses 364 0 364 0 0 0
% Contribution 100.0% 0.0% 100.0% n/a n/a n/a
Adjusted net operating income (loss) 240 (308) (68) 0 (197) (197)
% Contribution n/m n/m n/m 0.0% 100.0% 100.0%
10
Comparison of the three months ended March 31, 2005 and 2004
------------------------------------------------------------------------------
Dollar Change Percent Change
------------------------------------ --------------------------------------
Insurance Mortgage Insurance Mortgage
(in thousands) Brokerage Banking Total Brokerage Banking Total
------------- ------------- -------- -------------- ------------- ---------
Total revenues $1,151 $79 $1,230 n/a 12.5% 195.6%
General and administrative expenses 1,053 272 1,325 n/a 42.3% 205.9%
Depreciation and amortization 184 10 194 n/a 33.1% 653.2%
Net operating loss (125) (111) (235) n/a 56.2% 119.3%
Acquisition-related expenses 364 0 364 n/a n/a n/a
Adjusted net operating income (loss) 240 (111) 129 n/a 56.2% 65.3%
As we continue to acquire complementary financial services businesses
and/or assets, we anticipate such acquisitions may result in additions to
intangible assets, the amortization of which may adversely impact our net
operating income in the future.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Statements
Investors are cautioned that certain statements contained in this
document, as well as some statements by the Company in periodic press releases
and some oral statements of Company officials during presentations about the
Company, are "forward-looking" statements within the meaning of the Private
Securities Litigation Reform Act of 1995 (the "Act"). Forward-looking statements
include statements which are predictive in nature, which depend upon or refer to
future events or conditions, which include words such as "expects,"
"anticipates," "intends," "plans," "believes," "estimates," or similar
expressions. In addition, any statements concerning future financial performance
(including future revenues, earnings or growth rates), ongoing business
strategies or prospects, and possible future Company actions, which may be
provided by management, are also forward-looking statements as defined by the
Act. Forward-looking statements are based on current expectations and
projections about future events and are subject to risks, uncertainties, and
assumptions about the Company, economic and market factors and the industries in
which the Company does business, among other things. These statements are not
guaranties of future performance and the Company has no specific intention to
update these statements.
Actual events and results may differ materially from those expressed or
forecasted in forward-looking statements due to a number of factors. The
principal important risk factors that could cause the Company's actual
performance and future events and actions to differ materially from such
forward-looking statements, include, but are not limited to, changes in
applicable Federal or State laws or regulations, changes in Federal income tax
laws, and changes in general economic and market factors that affect the prices
of securities or the industries in which Sutter and its affiliates do business,
especially those affecting the mortgage banking industry.
Results of Operations
Executive Summary
Sutter is a holding company that owns subsidiaries with operations in
two distinct business segments: inurance brokerage and mortgage banking.
Sutter's insurance subsidiary, Diversified Risk, earns revenue by
brokering commercial property and casualty insurance. All products and services
are either billed to clients by Diversified Risk or billed directly to the
clients by the insurance carrier. Diversified Risk employs a consultative
approach to selling and advises its clients on the "total cost of risk" for any
given policy or coverage. Diversified Risk maintains long-standing relationships
with major insurance carriers such as AIG, Chubb, Fireman's Fund, and St.
Paul/Travelers, among others.
A portion of Diversified Risk's annual commission revenue,
approximately 7.0%, comes from so-called "contingent" commission arrangements,
which are commissions paid to Diversified Risk by certain insurers depending
upon the quality and volume of underwritten premium business they received from
Diversified Risk for the preceding fiscal year. Since October 2004, the
insurance industry has been under investigation by industry regulators and state
Attorneys General, especially the New York Attorney General, regarding industry
11
practices, including contingent compensation arrangements. While contingent
compensation arrangements are not now (and have never been) illegal, and while
Diversified Risk has neither been subpoenaed nor subject to investigation, a
number of major public insurance brokers are the subject of investigations and
subpoenas concerning both, the historical practice of contingent compensation
arrangements, as well as allegations of unlawful practices such as bid rigging
and tying arrangements. Moreover, while the ultimate outcome of these industry
investigations and their potential impacts on any given broker remain uncertain
at this time, recent developments and separate settlements reached between
regulators and each of Marsh and McLennan Companies, Willis Group Holdings, and
Aon Corporation have caused Sutter management to conclude that contingent
commission arrangements, as currently exist within the industry, may not
continue in their present form. However, it is important to note that most all
of the insurers with which Diversified Risk does business have renewed their
contingent commission agreements for the current fiscal year under similar
arrangements that were in place with Diversified Risk for fiscal 2004, and so
Sutter management fully expects Diversified Risk will receive contingent
commissions in 2005.
Sutter's mortgage subsidiaries, Easton and Progressive, earn revenue by
originating, processing, funding and brokering primarily conforming and
non-conforming residential mortgages. Easton also brokers small commercial
mortgage loans. Currently, Sutter is in the process of integrating and
consolidating its mortgage subsidiaries into a single mortgage operation. This
process has been underway for several months and is expected to conclude in the
latter part of the second quarter. Once completed, management believes that the
mortgage operations will be well positioned to achieve long-term growth and
profitability.
The following table illustrates the Company's two business segments,
and the services and typical products offered within each segment:
COMMERCIAL INSURANCE BROKERAGE MORTGAGE BANKING
---------------------------------------------------------------- ----------------------------------------------------------------
Services Services
---------------------------------------------------------------- ----------------------------------------------------------------
Risk Management Services & Consulting Residential Commercial
---------------------------------------- --------------------
Workers' Compensation Services & Claims Administration Banked Loans Brokered Loans Brokered Loans
--------------------- ------------------ --------------------
Loss Prevention Services & Program Development
Liability Services Originating Originating Originating
Property Services Processing Processing Processing
Disaster Recovery Planning Funding Sourcing Investors
Selling to Investors
Insurance Products Mortgage Products
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Accounts Receivable Extra Expense Fixed Rate Fixed Rate
Alternate Risk Transfer Fine Arts Adjustable Rate (ARMs) Adj. Rate (ARMs)
Automotive Liability Flexible Spending Accts. Seconds Seconds
Aviation Flood HELOCs HELOCs
Bailee's Coverage Food Spoilage Programs (e.g. 80/20 combos) Option ARMs
Blended Excess Liability Intellectual Property Option ARMs
Boiler & Machinery International Liability
Building Ordinance Key Person Executive Life
Buildings Kidnap/Ransom
Business Property License Bonds
Business Interruption Livestock
Combined Care Loss of Earnings
Computers Loss of Project R&D
Computer Viruses Motor Truck Cargo
Contract Bonds Negligent Hiring
Contractor's Equipment Ocean Cargo
Course of Construction Pension/Profit Sharing
Crime Political Risk
Dental Pollution
Directors & Officers Power Outage
Disability Product Recall
Earthquake Products Liability
Employee Benefit Liability Public Official Bonds
Employment Practices Special Events Liability
Equipment Sprinkler Leakage
Errors & Omissions Stock
Estate Planning Telecommunication Fraud
Executive Compensation Variable Annuities
Extortion Workers' Compensation
12
Sutter also has three non-core minority investments in small companies
(two private, one public) involved in real estate, precious metal mining, and
financial services, respectively. These investments are not considered by
management to be an integral part of the future operations or plans of the
Company. Presently, management desires and intends to grow Sutter through
continued acquisitions in the financial services industry that are most likely
to complement its current financial services businesses.
Operating results for the quarter ended March 31, 2005 as compared with the
quarter ended March 31, 2004
For period comparison purposes, it is important to note that the
Company benefited from the ownership of Diversified Risk, Easton and Progressive
for the quarter ended March 31, 2005, while the Company benefited only from the
ownership of Easton and Progressive for the quarter ended March 31, 2004.
Revenues
Total revenues for the quarter ended March 31, 2005 were $1,858,438
versus $628,716 for the quarter ended March 31, 2004. The increase in revenues
is due primarily to the addition of Diversified Risk's revenues for the quarter.
Comparing the fiscal quarter in 2005 to the same fiscal quarter in 2004, changes
in the significant components of total revenues are as follows: Insurance
commissions increased $1,151,166 from zero; Net gain on sales of mortgages
decreased $161,718 or 39.2% due to weaker volume and due to a reclassification
of certain direct revenue-offsetting expenses; Mortgage commissions on brokered
loans increased $108,792 or 53.8%. In general, the mortgage banking business
segment continues to under-perform, and it is not expected to rebound until
after the integration of our two mortgage subsidiaries is completed.
Expenses
Total expenses were $2,291,267 for the quarter ended March 31, 2005 as
compared to $826,086 for the quarter ended March 31, 2004. The increase in total
expenses is primarily the result of the addition of Diversified Risk in January
2005, as well as acquisition-related costs which are included in general and
administrative expenses, depreciation and amortization, and professional fees.
Comparing the fiscal quarter in 2005 to the same fiscal quarter in 2004, changes
in the significant components of total expenses are as follows: General and
administrative expenses increased $1,182,285 or 183.7% due primarily to the
addition of Diversified Risk; Depreciation and amortization expenses increased
$194,074 or 653.2% due almost entirely to the amortization of intangible assets
acquired in the Diversified Risk transaction; Professional fees and other
expenses decreased $22,203 or 18.4% due primarily to cost savings associated
with changing independent auditors.
Interest Expense
The Company incurred interest expense of $146,633 for the quarter ended
March 31, 2005 as compared to interest expense of $209,566 for the quarter ended
March 31, 2004. The 4.9% reduction in interest expense is due to a significant
overall reduction in the Company's funded debt. As a result, the Company
anticipates additional reductions in interest expense going forward.
13
Net Losses
The Company reported a net loss of $421,402 for the quarter ended March
31, 2005 as compared to a net loss of $346,983 for the quarter ended March 31,
2004. The decrease in earnings is the result of increased expenses, a
significant portion of which is due to acquisition-related costs and
amortization expense associated with the Diversified Risk transaction that
occurred during the 2005 fiscal quarter, as well as due to weaker than
anticipated performance from our mortgage banking business segment. Excluding
acquisition-related costs and the amortization expense related to the intangible
assets acquired of Diversified Risk, the Company had a net loss of approximately
$68,000 for the quarter ended March 31, 2005.
The Company reported a net loss attributable to common shareholders of
$490,519 for the quarter ended March 31, 2005 as compared to a net loss of
$346,983 for the quarter ended March 31, 2004. Net loss attributable to common
shareholders includes both non-cash and cash expenses related to the accretion
of preferred dividends.
Liquidity and Capital Resources
Sutter had cash and cash equivalents, net of restricted cash, of
$576,947 and $193,997 as of March 31, 2005 and December 31, 2004, respectively.
Through our insurance brokerage business segment, Sutter had $1,064,424 of
restricted or "trust" cash as of March 31, 2005. Our insurance broker
subsidiary, Diversified Risk, collects premiums paid by clients, deducts
commissions and other expenses due Diversified Risk, and holds the remainder in
trust for remittance to the insurance carriers providing coverage to our
clients. Diversified Risk earns interest on these funds during the time between
receipt of the cash and the time the cash is paid to the insurance carriers,
commonly known as "float". The cash held in trust is shown separately on
Sutter's balance sheet as "Restricted Cash". On the statement of cash flows,
changes in restricted cash are included as part of the change in non-cash
working capital in the determination of cash provided by operating activities.
Cash used in operating activities was $1,089,025 as compared to
$2,103,192 for the periods ended March 31, 2005 and 2004, respectively. This
increase in operating cash flow is due primarily to the addition of Diversified
Risk's cash flow from operations. Cash used in investing activities was
$1,755,269 as compared to cash provided by investing activities of $159,316 for
the periods ended March 31, 2005 and 2004, respectively. Cash provided by
financing activities was $3,227,244 and $2,198,777 for the periods ended March
31, 2005 and 2004, respectively. Management believes there is sufficient cash
flow from existing operations to fund any capital expenditures that may arise
during the fiscal year.
As of March 31, 2005, Sutter had funded debt of $2,899,358 at an
average annual interest rate of approximately 8.3%.
Sutter raised $108,008 in cash during the quarter ended March 31, 2005
from the partial sale of shares from one of its non-core investments.
Sutter anticipates that its mortgage banking subsidiaries will continue
to have access to its warehouse lines of credit as necessary to conduct ongoing
mortgage banking activities. Sutter believes that it currently maintains
sufficient liquidity to cover its existing requirements and operations, and
provide for any future contingent liquidity needs.
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Critical Accounting Policies
As presented in detail in the Company's annual report on Form 10-K
filed with the SEC, the most critical accounting policies for the Company are
those involving revenue recognition, investments, and goodwill and intangible
assets.
Revenue Recognition
Insurance Business Segment
Revenues include insurance commissions, certain commissions receivable
from insurance carriers and interest income. The Company takes credit for
commissions in respect of insurance placements at the date when the insured is
billed or at the inception date of the policy, whichever is later. Commissions
on additional premiums and adjustments are recognized as and when advised. In
the case of direct bill by the insurer, the Company takes credit when the
commission is received by the insurer. The Company establishes contract
cancellation reserves where appropriate.
Mortgage Business Segment
When the Company funds a loan to a borrower through its warehouse line
of credit but prior to selling the loan, it records the principal amount of the
loan as mortgages held for sale. Once the loan is purchased by an investor,
usually within ten business days of funding, the principal amount of the loan is
deducted from the Company's outstanding balance on its warehouse line of credit.
It then recognizes mortgage sales along with origination and related fees. The
costs and fees associated with originating and processing loans funded on our
warehouse lines of credit are included in cost of sales at the time the loan is
sold. Commission revenue on brokered loans is recognized at the time commission
revenue on brokered loans is received.
The Company does not record an allowance for loan losses because the
loans are typically sold to investors within ten business days of funding. This
short-term risk is mitigated by the fact that any losses that may occur due to
the loss of a loan are simply adjustments to revenue for the period since all
revenues are related to the successful origination, processing and funding of a
loan.
Investments
Marketable equity securities are classified as securities available for
sale and reported at estimated fair value. Unrealized gains and losses, after
applicable taxes, are reported in cumulative other comprehensive income. We use
current quotations, where available, to estimate the fair value of these
securities. Where current quotations are not available, we estimate fair value
based on the present value of future cash flows, adjusted for the quality rating
of the securities, prepayment assumptions and other factors. We reduce the asset
value when we consider the declines in the value of marketable equity securities
to be other-than-temporary and record the estimated loss in "realized gains or
losses" in the statement of operations. The initial indicator of impairment for
equity securities is a sustained decline in market price below the amount
recorded for that investment. We consider the length of time and the extent to
which market value has been less than cost and any recent events specific to the
issuer and economic conditions of its industry. At March 31, 2005, Sutter does
not have any marketable equity securities.
Non-marketable equity securities include securities that are not
publicly traded. We review these assets at least quarterly for possible
other-than-temporary impairment. Our review typically includes an analysis of
the facts and circumstances of each investment, the expectations for the
investment's cash flows and capital needs, the viability of its business model
and our exit strategy. These securities generally are accounted for at cost. We
reduce the asset value when we consider declines in value to be
other-than-temporary.
15
Realized investment gains and losses are also recognized when
investments are sold or disposed. Realized investment gains may fluctuate
significantly from period to period, resulting in a meaningful effect on
reported net earnings. The Company realized an investment gain of $23,245 for
the quarter ended March 31, 2005.
Goodwill, Purchase Price Allocation and Intangible Assets
A significant amount of judgment is required in performing goodwill and
identifiable intangible asset impairment tests. Such tests include periodically
determining or reviewing the estimated fair value of Sutter's reporting units.
Under SFAS No. 142, fair value refers to the amount for which the entire
reporting unit may be bought or sold. There are several methods of estimating
reporting unit values, including market quotations, asset and liability fair
values and other valuation techniques, such as discounted cash flows and
multiples of earnings or revenues. If the carrying amount of a reporting unit,
including goodwill, exceeds the estimated fair value, then individual assets,
including identifiable intangible assets and liabilities of the reporting unit
are estimated at fair value. The excess of the estimated fair value of the
reporting unit over the estimated fair value of net assets would establish the
implied value of goodwill. The excess of the recorded amount of goodwill over
its implied value is then charged to earnings as an impairment loss.
Sutter's consolidated financial position reflects certain investments
in non-core public and private businesses. All investments in non-core private
businesses have been fully reserved. All investments in non-core public
businesses are carried at the lower of cost or fair value. In the case of
investments carried at fair value, considerable judgment is required in
determining the assumptions used in arriving at fair value and to what extent,
if any, such investments are impaired. Significant changes in these assumptions
can have a significant effect on carrying values.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Reference is made to Sutter's recently issued report on Form 10-K filed
with the SEC and in particular the "Market Risk Disclosures" included in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." As of March 31, 2005, there have been no material changes in the
market risks as described in Sutter's recently issued report on Form 10-K.
Item 4. Controls and Procedures
As of the end of the period covered by this Quarterly Report on Form
10-Q, the Corporation carried out an evaluation, under the supervision and with
the participation of the Corporation's management, including the Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the design and
operation of the Corporation's disclosure controls and procedures pursuant to
Exchange Act Rule 13a-14. Based upon that evaluation, the Chief Executive
Officer and the Chief Financial Officer concluded that the Corporation's
disclosure controls and procedures are effective in timely alerting them to
material information relating to the Corporation (including its consolidated
subsidiaries) required to be included in the Corporation's periodic Securities
and Exchange Commission ("SEC") filings. Subsequent to the date of that
evaluation, there have been no significant changes in the Corporation's internal
controls over financial reporting or in other factors that could significantly
affect internal controls over financial reporting, nor were any corrective
actions required with regard to significant deficiencies and material
weaknesses.
16
Part II Other Information
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On January 26, 2005, the Company issued 1,210,065 shares of its common
stock to the former owners of FLF, Inc. dba Diversified Risk Insurance Brokers.
The Company did not receive any cash as a result of this issuance.
All of the shares issued above are unregistered and restricted shares
as defined by the Securities Act of 1933, as amended and promulgated by the
Securities and Exchange Commission.
Item 5. Other Information
At a regularly scheduled board meeting which occurred on May 10, 2005,
the Company elected three new members to its board of directors and thereby
increased the size of its board from five to eight members. As has been
previously disclosed on Form 8-K, the former owners of Diversified Risk were
entitled to nominate two members to Sutter's board of directors in connection
with the Diversified Risk transaction. As a result, Messrs. Michael P. Flynn and
James F. Wells were each nominated and unanimously elected to the Sutter board.
Mr. Flynn is also Chairman and Chief Executive Officer of Diversified Risk. Mr.
Wells is an independent insurance consultant and former managing director of
Acordia's western US regional business. Additionally, in conjunction with a
significant investment in Sutter made by MacKenzie Patterson Fuller, Inc.
("MPF") in the form of Series A Redeemable Convertible Preferred Stock, MPF was
entitled to nominate one member to Sutter's board of directors. As a result,
Charles E. Patterson was nominated and unanimously elected to the Sutter board.
Of the three new Sutter board members, only Mr. Wells qualifies as
"independent" as that term is defined by Section 404 of Sarbanes-Oxley. Mr.
Wells will join Messrs. Corroon and Seidenberg on the Company's Audit Committee,
as well as on the Company's newly formed Compensation Committee.
Mr. Flynn, a Sutter board member and executive officer of Sutter's
wholly owned Diversified Risk subsidiary, is the 50% owner of a limited
liability company which owns and leases office space in which Diversified Risk
operates. Annual lease payments made by Diversified Risk amount to approximately
$350,000.
Item 6. Exhibits
a. Exhibits
31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(Chief Executive Officer)
31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(Chief Financial Officer)
32.1 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(Chief Executive Officer)
32.2 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(Chief Financial Officer)
SIGNATURE
Pursuant to the requirement of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
SUTTER HOLDING COMPANY, INC.
(Registrant)
Date: May 16, 2005 /s/ William G. Knuff, III
-----------------------------------
(Signature)
William G. Knuff, III
Chief Financial Officer
17