UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 1999
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: 0-27552
REALCO, INC.
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(Exact name of registrant as specified in its charter)
New Mexico 85-0316176
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State or other jurisdiction of (I.R.S. Employer
incorporation or other organization Identification No.)
1650 University Boulevard, NE, Suite 5-100
Albuquerque, New Mexico 87102
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (505)242-4561
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
No Par Value Common Stock
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(Title of Class)
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 X No __.
<PAGE>
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The number of shares of the Registrant's common stock outstanding as of December
22, 1999 was 2,887,338. The aggregate market value of the Registrant's common
stock held by non-affiliates as of December 23, 1999 was $4,739,000.
DOCUMENTS INCORPORATED BY REFERENCE
Notice of 2000 Annual Meeting of Stockholders and Proxy Statement (incorporated
into Part III).
<PAGE>
PART I
ITEM 1: BUSINESS.
Realco, Inc., incorporated in 1983 under the laws of the State of New Mexico,
and subsidiaries is hereinafter sometimes referred to as the "Registrant" or the
"Company".
General
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The Company is an integrated real estate services company, which provides a wide
range of real estate related products and services to customers primarily within
the Albuquerque, New Mexico and Phoenix, Arizona metropolitan areas. The
Company's operations are grouped into three principal segments - real estate
brokerage services, construction and land development and financial services.
The Company's principal executive offices are located at 1650 University Blvd.
NE, Suite 5-100, Albuquerque, New Mexico 87102 and its telephone number at that
location is (505) 242-4561.
Real Estate Brokerage Services:
This segment's operations consists of residential and commercial real estate
brokerage services in the Albuquerque and Phoenix metropolitan areas.
Residential brokerage operations are conducted under a franchise agreement with
Prudential Real Estate Affiliates (PREA) by two of the Company's principal
subsidiaries, Hooten/Stahl Realtors, Inc. (d.b.a. Prudential Preferred
Properties, New Mexico) and Mull Realty Company, Inc. (d.b.a. Prudential
Preferred Properties, Arizona). Such operations consist of providing marketing
services to buyers and sellers of residential real estate, providing relocation
services, and to a lesser extent, providing residential property management. The
Company's current franchise agreement with PREA expires in June 2001. PREA has
provided notification to the Company that they would like to renew this
agreement and the Company currently anticipates that renewal terms will be
reached. Terms of such renewal are not expected to differ materially from
existing terms.
Commercial brokerage operations consist primarily of providing marketing
services to buyers, sellers, lessors and lessees of commercial real estate.
These operations also include commercial property management and business
brokerage to a lesser extent. These services are collectively performed by First
Commercial Real Estate Services, Inc., an Albuquerque based subsidiary and Mull
Realty Company, Inc., a Phoenix based subsidiary.
Construction and Land Development:
The Company's construction and land development activities include residential
and commercial operations.
<PAGE>
Residential construction is performed by Charter Building & Development, Corp.
("Charter"), an Albuquerque based subsidiary. Charter's operations can be
described as that of a general contractor, whereby the majority of construction
labor and materials needs associated with any given home are subcontracted to
third-parties. Residential construction is performed in the Albuquerque
metropolitan area at this time, but the Company has identified an individual in
the Phoenix market which is interested in constructing homes under a joint
venture arrangement in fiscal 2000. The Company anticipates participating in the
construction of three homes with this individual in the first half of fiscal
2000. At September 30, 1999, Charter had a backlog of 49 homes under contract
with an indicated value of $8,000,000, as compared to 51 homes under contract
with an indicated value of $9,000,000 in 1998.
The Company is also in the business of acquiring raw land for the purpose of
subdividing and developing into residential homesites. Such activities are
performed by Realco Land Development Division, an unincorporated division of the
Company, in the Albuquerque metropolitan area. The homesites developed by this
division are used internally by Charter as well as sold to third-parties.
Amity, Inc. (d.b.a. Realco Construction), is the Company's Albuquerque based
general contractor specializing in commercial construction. Such commercial
construction consists primarily of ground-up construction of small commercial
buildings, tenant improvements and commercial remodels. With the acquisition of
certain net assets and business operations of TI Construction, Inc. (TI) in
August 1999, the Company now possesses a multi-state presence and expertise in
the construction of veterinary facilities. Prior to this acquisition, operations
were focused primarily in the Albuquerque metropolitan area. It is management's
intent to use the multi-state presence of TI to expand the Company's previously
existing commercial operations to other regions. At September 30, 1999, Amity
had a backlog of commercial construction projects of $2,300,000, as compared to
$1,500,000 in 1998.
Financial Services:
The Company provides financial services through its wholly-owned subsidiaries
Great American Equity Corporation (GAEC) and PHS, Inc. (PHS), as well as through
its equity investment in MI Acquisition Corporation (MI), the parent company of
Miller & Schroeder, Inc.
GAEC's lending activities include residential construction lending and homesite
acquisition and development lending. Construction lending is performed under
participation agreements with two banks in Albuquerque. These participation
agreements generally provide for GAEC to provide the first 25% of all funding
commitments and the banks to provide the remaining 75% of the loan commitment,
as well as administrating these loans. GAEC has also entered into land
acquisition and residential subdivision loan participation agreements with banks
in New Mexico and Arizona. Typically, the Company provides from 25% to 40% of
the funding commitments for this activity through further participation to
certain high net worth private investors, which is subordinate to the bank
position. The Company is generally required to guarantee the entire balance
financed by the banks, while no guarantees are provided to the private
investors. As consideration for the additional risk assumed by the private
investors, they typically receive profit participation payments in addition to
return of principal and interest.
<PAGE>
The operations of PHS include a 50% partnership interest in PHS Mortgage
Company, a full service residential mortgage banker. This partnership has
operations at all New Mexico and Arizona residential brokerage offices operated
by the Company, and typically receives its business through referrals from the
brokerage sales associates.
The Company owns an 11% equity position in MI, which is a financial services
firm specializing in underwriting debt securities. James A. Arias, the Company's
President and Chief Executive Officer serves on the Board of Directors and Audit
Committee of MI and actively participates in certain cross marketing activities
of services and products.
Operating Strategy
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Since the completion of the Company's Initial Public Offering in February 1996,
it has been the Company's intention to cross market services between the primary
business segments. The Company believes that it can capitalize on this operating
strategy and eventually use it for expansion to other geographical areas. For
example, the Company believes that expansion to other markets may be achieved by
its acquisition of either real estate brokerage or building companies. Once such
a business is acquired, the strategy will be to export to its new market the
other services which the Company offers.
On a continuing basis, the Company has been exploring a variety of acquisition
opportunities, consisting of service, product and distribution businesses. The
Company's acquisition strategy complements the plan of internal growth charted
for its existing activities. The ability of the Company to expand its business
in recent years has been due in part to the addition of working capital from the
public securities offering. The Company anticipates that it will require
additional working capital at some future date to continue its ability to expand
current operations.
Financial Information
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Financial information about the Company's business segments can be found in Note
K to the consolidated financial statements presented in Item 8 of this Form 10-K
and is incorporated herein by reference.
Inventory Acquisition and Development
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The construction and land development segment are the Company's only operations
with significant inventory needs. Such inventory needs consist of homesites,
building materials and labor.
<PAGE>
Residential homesites are acquired either by the purchase of developed lots from
third parties or by the purchase of a parcel of undeveloped land which the
Company develops. The Company has also entered into joint venture agreements
with other builders and developers to acquire undeveloped parcels of land for
development into homesites. At September 30, 1999, the Company owned or
controlled through a combination of unencumbered ownership, debt financing and
purchase agreements, over 390 homesites (as compared to 275 in 1998), which are
developed or are currently under development within the Albuquerque, New Mexico
metropolitan area. Such homesites are utilized by Charter's homebuilding
operations and may also be sold to other homebuilders and individuals.
Acquisition of residential homesites is funded through the use of available cash
of the Company or through secured loans with various financing sources.
Financing is typically provided by local branches of financial institutions, on
such terms and conditions which are customary in the marketplace. In some
instances, the Company may also secure subordinate debt on land inventory to
reduce the loan to value position assumed by the financial institutions, without
using internal working capital. Such subordinate debt is typically arranged by
the Company's financial services subsidiary, GAEC, and participated out to high
net worth individuals.
As the Company uses subcontractors to provide skilled labor and materials for
the majority of its operations, construction inventory purchases consist
primarily of payments to such subcontractors. Such inventory purchases are
funded through construction draws from financial institutions under credit
agreements or from progress billings to property owners. The Company's credit
agreements typically provide pre-established lending guidelines which determine
interest rates, available balances and repayment terms. These credit agreements
are provided by local branches of financial institutions on such terms and
conditions which are customary in the marketplace.
Internet Developments
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As part of the Company's focus to maximize opportunities and growth potential,
the Company has identified and is pursuing certain internet related activities.
Specifically, the Company's construction and land development segment has
established a website which provides users with the Company's background and
credentials, the Company's most popular floorplans, information on subdivisions
where the Company is currently building and contact information. The Company's
real estate brokerage services segment has a website which provides Company
background and credentials, information on the local market and contact
information. The Company is currently in the developmental stages of a website
which will provide "Virtual Tours" of certain homes currently listed on the
market. Management believes this significant marketing tool will be operational
by the Company's second quarter of fiscal 2000.
<PAGE>
Competition and Market Factors
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The business in which the Company is engaged is highly competitive. Many of the
Company's competitors have nationwide operations or are affiliated with national
franchising organizations. As such, a number of the Company's competitors have
greater financial resources. It is for that reason that the Company continues to
pursue strategic alliances with other companies.
The real estate industry, and therefore, the Company's operations, can be
cyclical and are affected by consumer confidence levels, prevailing economic
conditions and interest rates. Other factors effecting business include
increases in construction costs, increases in costs associated with home
ownership such as interest rates and property taxes, changes in consumer
preferences and demographic trends. The Company believes that its strategy of
vertical integration will eventually build a dominance in the markets in which
it does business, however, there can be no assurance that this strategy will be
successful.
Work Force
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As of September 30, 1999, the Company's work force totaled approximately 970
people, including 195 employees and 775 real estate sales associates. Management
of the Company believes that its relations with its personnel are satisfactory
and none of its employees are represented by a union.
All of its real estate sales associates are independent contractors. As
independent contractors, such personnel are paid by commission only on the basis
of closed sales transactions. The Company's construction operations normally
hire independent subcontractors to provide the skilled labor needed for
construction projects.
ITEM 2: PROPERTIES.
The Company leases its executive offices on a month to month basis, at $500 per
month. Mr. James A. Arias, the Company's President, is a part owner of the
building in which the executive offices are located. This lease arrangement is
considered a below market lease as to terms and square foot cost when compared
to other leases currently in effect within the building.
The Company leases space for its fifteen real estate brokerage offices in the
Albuquerque, New Mexico and Phoenix, Arizona metropolitan areas. Leases include
space ranging from 1,200 square feet to 37,000 square feet at monthly rental
costs ranging from $1,200 per month to $40,200 per month. Additionally, two
office facilities are leased for residential and commercial construction
operations in Albuquerque. The construction facilities, which consist of office
space and a workshop area, are 10,000 square feet and 3,000 square and monthly
rental costs are $4,500 and $3,000 respectively.
Management believes all facilities are in adequate condition for their intended
use and will not require substantial improvements through Fiscal 2000.
<PAGE>
ITEM 3: LEGAL PROCEEDINGS.
The Company is engaged in various legal proceedings incidental to its normal
business activities. Management of the Company does not believe that the outcome
of each such proceeding or all of them combined will have a material adverse
effect on the Company's operations or financial position.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted during the fourth quarter of the 1999 fiscal year to a
vote of security holders, through the solicitation of proxies or otherwise.
PART II
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
Market Information
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The Company's common stock is traded on the NASDAQ National Market under the
symbol "RLCO". The following table sets forth for the periods indicated, the
high and low sales prices as reported.
Fiscal 1999 Fiscal 1998
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High Low High Low
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First Quarter 2.438 1.125 4.000 2.625
Second Quarter 2.875 1.125 3.250 2.250
Third Quarter 3.250 1.625 2.750 1.875
Fourth Quarter 3.000 1.625 2.750 1.375
Approximate Number of Holders of Common Stock
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As of December 22, 1999, there were approximately 700 holders of record of the
Company's common stock.
Company Dividend Policy Disclosure
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The Company has not paid any dividends on its Common Stock since its initial
public offering in February 1996 and expects that for the foreseeable future it
will follow a policy of retaining earnings in order to finance the continued
development of its business. Payment of dividends is within the discretion of
the Board of Directors and will depend upon the earnings, capital requirements
and operating and financial condition of the Company, among other factors.
<PAGE>
ITEM 6: SELECTED FINANCIAL DATA.
Years ended September 30,
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1999 1998 1997 1996 1995
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(In thousands, except per share amounts)
(a) (b) (c)
Net sales $ 48,328 $ 35,104 $ 28,681 $ 23,298 $ 13,531
Income (loss) from
continuing operations 276 (1,180) 330 132 (50)
Income (loss)from
continuing operations
per common share .10 (.47) .07 .01 (.06)
Total assets 27,812 28,368 26,354 22,608 10,781
Long-term obligations 8,888 10,584 10,296 7,883 2,275
Cash dividends declared
per common share - - - - -
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(a) The 1998 results were affected by the acquisition of Cliff Winn, Inc.
Realtors on February 1, 1998.
(b) The 1997 results were affected by the acquisition of Mull Realty Company,
Inc. on January 1, 1997 and the acquisition of First Commercial Real Estate
Services, Inc. on May 1, 1997.
(c) The 1996 results were affected by the acquisition of Amity, Inc. on July 1,
1996 and the issuance of debt and equity securities in connection with the
Company's initial public offering on February 7, 1996.
<PAGE>
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
Overview of Operations
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Net earnings increased $1,456,000 in 1999 to $276,000 from a 1998 net loss of
$1,180,000. The increase in earnings is primarily attributable to construction
and land development operations. Specifically, gross profit from residential
construction sales increased $1,359,000 and the Company received developed
homesites with a value of $550,000 in connection with the settlement of a
lawsuit. Such items are offset by a $669,000 increase in operating expenses
associated with such operations. These items as well as other items affecting
results of operations for all segments are discussed in more detail below.
Business Combinations
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The Company's growth has been achieved primarily through acquisitions,
subsequent to its public offering in 1996. Following is a brief description of
such acquisitions and terms.
In fiscal 1996, the Company acquired the outstanding stock of Amity, Inc., an
Albuquerque based commercial construction contractor for 24,297 shares of Series
D Preferred Stock of the Company. Additionally, the Company acquired a 50%
partnership interest for $63,000 in PHS Mortgage Company, which originates and
sells residential mortgages in the Albuquerque market. The operations of PHS
were expanded to Phoenix during 1998.
In fiscal 1997, the Company acquired the outstanding common stock of Mull Realty
Company (a Phoenix based residential and commercial real estate brokerage
company, d.b.a. Prudential Preferred Properties, Arizona) for a cash payment of
$359,000, the issuance of a $800,000 note payable and future contingent payments
of up to $1,175,000. The Company also purchased the net assets and business of
First Commercial Real Estate Services, Inc. (an Albuquerque based commercial
real estate brokerage company) for a cash payment of $265,000 in 1997.
Additionally, the Company purchased an 11% equity interest in MI Acquisition
Corporation, the parent company of Miller & Schroeder, Inc. for $1,000,000. MI
is a financial services firm located in Minneapolis which specializes in debt
securities.
In fiscal 1998, the Company acquired the outstanding common stock of Cliff Winn,
Inc. Realtors (a Phoenix based residential real estate brokerage company) for a
cash payment of $426,000 and future contingent payments of up to $963,000.
In fiscal 1999, the Company acquired certain net assets and the business of TI
Construction, Inc. The acquisition of this commercial contractor which
specializes in veterinary clinics was made through the issuance of 67,000 shares
of Company common stock held in treasury.
<PAGE>
Results of Operations
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Based upon the various lines of business in which the Company is engaged, it has
defined thefollowing operating segments for purposes of financial accounting and
reporting: Real Estate Brokerage Segment, Construction and Land Development
Segment, and Financial Services Segment.
The Company currently operates within the Albuquerque, New Mexico and Phoenix,
Arizona metropolitan areas. Since inception, management has planned on expanding
operations and business concepts to other geographical areas, preferably to
areas within the southwest United States having similar demographics.
Real Estate Brokerage Segment:
The real estate brokerage segment consists of Prudential Preferred Properties,
New Mexico (PPP-NM), Prudential Preferred Properties, Arizona (PPP-AZ), and
First Commercial Real Estate Services, Inc. (First Commercial).
Market conditions in residential resale activity continues to be brisk in
Albuquerque and Phoenix. While the Phoenix market continues to experience strong
growth, the Albuquerque market stabilized in the current year. There are a
record number of homes listed in Albuquerque, however, the average number of
days a home stays on the market has increased. Competition in Albuquerque
continues to be strong, especially in attracting and retaining quality sales
associates. This competition has been increased by past consolidations and
mergers and fewer new agents entering the workplace. Such conditions in the
Albuquerque market have led to continued losses from such operations.
Management continues to attempt to implement changes in the Albuquerque market
to increase market share, reduce agent commission splits and reduce operating
expenses. In 1998, management committed to a plan to consolidate four sales
offices in the Albuquerque market into a single, newly constructed, modern
facility. As a result of this plan, a restructuring charge of $273,000
associated with lease abandonment expenses was accrued in fiscal 1998. Of the
$273,000 initial restructuring charge, $235,000 remains as an accrued liability
at September 30, 1999 for expected tenant improvements, vacancies and shortfalls
on sublease revenues on the abandoned properties.
The new facility was initially expected to be available for relocation in March
1999. As a result of delays encountered in the construction process, operations
were not relocated until August 1999. While the new facility has had an
immediate impact on the marketplace and recruiting abilities, the later than
expected occupancy date did not permit management to carry out many of its
recruiting and cost control initiatives in fiscal 1999. Accordingly, no
significant improvement in operations of this segment occurred during the
current year.
<PAGE>
Fiscal 1999 vs. 1998
Total brokerage commissions and fees for this segment increased $3,274,000
or 15%, to $25,625,000 in 1999. This increase is primarily attributable to
additional revenues of $2,722,000 generated by PPP-AZ and $494,000 generated by
First Commercial. PPP-AZ generated these additional revenues through $820,000 of
internal growth and $1,902,000 as a result of Winn Realtors contributing twelve
months of operations in 1999, as opposed to eight months in 1998; while First
Commercial's increase was attributable entirely to internal growth. This segment
experienced a pre-tax loss of $495,000 for 1999 as compared to a $530,000 loss
in 1998. The decrease in the loss is the result of several factors discussed in
more detail below.
PPP-NM experienced a pre-tax loss of $1,097,000 in 1999, as compared to a
$1,250,000 loss in 1998. This decrease of $153,000 is primarily attributable to
$273,000 of lease abandonment costs accrued in the prior year, as offset by
nominal changes in recurring operating expenses and gross profit on brokerage
fees (typically referred to as company dollar). Management remains optimistic
that the aforementioned plans will improve the operations of this subsidiary in
fiscal 2000.
While PPP-AZ did increase its brokerage revenues by 22% in 1999 to
$15,131,000, and increase its company dollar to 27%, as compared to 25% in 1998,
operating expenses increased $1,137,000, or 48% to $3,530,000 in 1999. As a
result, of these factors, pre-tax earnings only increased 38% to $663,00 in
1999. This increase in operating expenses is attributable to the higher sales
volume, as well as higher facility costs associated with this subsidiary's
expansion throughout the Phoenix metropolitan area. The increase in facility
costs currently being experienced is expected to eventually result in growth in
revenues and profitability for these operations.
First Commercial recognized pre-tax earnings of $11,000 for the 1999
period, as compared to a pre-tax loss of $101,000 in 1998. This improvement in
operations is the result of an increase in company dollar of $215,000 or 47%
over 1999, which is attributable to a 45% increase in revenues. The increase in
company dollar was offset by a $103,000 or 19% increase in operating expenses.
Fiscal 1998 vs. 1997
Total revenues from brokerage commissions and fees increased $7,496,000 to
$21,983,000 in 1998, an increase of 52% over 1997. Such increase was almost
entirely in the Phoenix marketplace where revenues increased $7,292,000 or 143%
to $12,409,000 in 1998. The February 1998 acquisition of Scottsdale based Winn
Realtors contributed $4,362,000 to this increase.
PPP-NM recognized a pre-tax loss of $1,250,000 in 1998, as compared to a
pre-tax loss of $749,000 in 1997. The additional loss recognized is the result
of a decrease in company dollar of $303,000 or 11% from 1997, and the
recognition of $273,000 of charges associated with the aforementioned plan of
management to relocate sales offices into a new facility.
<PAGE>
The Phoenix operations contributed pre-tax earnings of $799,000 in 1998 as
compared to $478,000 in 1997. This increase is attributable to the
aforementioned acquisition of Winn Realtors, which contributed $301,000 in
pre-tax earnings in 1998. An increase in the average splits paid to agents of
previously existing operations from 69% to 75% in 1998 offset the expected
profitability from the aforementioned increase in revenues. Operating expenses
remained relatively constant as a percentage of total revenues for the period.
The Albuquerque commercial brokerage operations resulted in a pre-tax loss
of $101,000 in 1998 as compared to a pre-tax loss of $35,000 in 1997. This
increase is primarily attributable to an increase in operating expenses. This
increase was incurred in an effort to expand operations through sales associate
recruitment and establishing property management operations. These cost
increases are expected to result in growth in revenues and therefore
profitability in future periods.
Construction and Land Development Segment:
The construction and land development segment operates in the Albuquerque, Rio
Rancho and Los Lunas, New Mexico metropolitan areas. Construction is comprised
of the residential and commercial operations of Charter and Realco Construction,
respectively. This segment also includes development activities consisting of
the acquisition of raw land for development into residential homesites, which
are sold to Charter or to other builders. Such land development projects are
performed under joint venture agreements with other developers or entirely by
the Company.
Fiscal 1999 vs. 1998
Revenues for this segment increased $9,583,000 or 73% over 1998. This
increase in revenues contributed to a $2,049,000 or 330% increase in gross
profit over 1998. As a result of this increase and other income of $550,000
received in a lawsuit settlement relating to the operations of the land
development division, this segment recognized a pre-tax profit of $820,000 in
1999 compared to a pre-tax loss of $1,034,000 in 1998.
Charter's residential construction revenues for the period increased
$7,028,000 or 69% over 1998. As previously discussed, this increase is
attributable to the line of value engineered houses being received well by the
marketplace upon its introduction in the fourth quarter of 1998. This product
line also contributed an increase in gross profit margin from 5% to 10% in 1999.
The increases in sales volume and gross profit contributed to a decrease in the
1998 period's pre-tax loss of $1,293,000 resulting in a pre- tax profit of
$77,000 for 1999. While management is pleased with the improvement in operating
results of this subsidiary, there is still improvement which needs to be made in
reducing job costs and operating expenses and improving marketing efforts in
order to return this subsidiary to its previous levels of profitability.
<PAGE>
Revenues from Realco Construction's commercial construction operations
totaled $3,188,000 in 1999, an increase of $1,464,000 or 85% over 1998. Despite
this increase in revenues, a decrease in gross profit margins and a $197,000 or
75% increase in general and administrative expenses resulted in a pre-tax loss
of $103,000 for 1999, as compared to a pre-tax loss of $66,000 in 1998. The
increase in general and administrative expenses for the 1999 period was incurred
as a result of expanding operations. This increased level of operating costs are
expected to continue, however higher future production is expected to sustain
such costs.
As previously mentioned, effective August 1, 1999, the Company acquired
certain net assets and the business operations of TI, an Albuquerque based
commercial contractor which specializes in veterinary clinics. This acquisition
is expected to further increase the revenue base, as well as result in a
reduction in combined operating expenses through economies of scale of these
entities in the future.
The Company's land development activities experienced an increase in
revenues and pre-tax earnings of $1,414,000 and $463,000, respectively over
1998. The increase in revenues primarily consists of $983,000 of additional lot
sales to Charter and other builders, and $550,000 received in connection with a
lawsuit. Specifically, an agreement reached on December 30, 1998 provided for
the Company to receive certain residential homesites valued at approximately
$550,000 in consideration for its 50% interest in a joint venture, which
received an award of $1,633,000 in a lawsuit. As this award is expected to go
through an extensive future appeal process, management determined this exchange
was in the best interest of the Company after considering risk and future legal
costs. The overall level of profitability of this division decreased as a result
of increased carrying costs on lot inventory and a reduction in equity earnings
of investees, as a profitable joint venture concluded its development
operations.
In August 1999, the Company entered into an agreement which provides for
the Company to purchase eight lots and have the option to purchase an additional
eighty-nine lots subject to certain takedown requirements. Construction in this
desirably located subdivision will be performed under a joint venture agreement
whereby Charter and another Albuquerque based builder will market its homes in
this subdivision. Charter will serve as the construction manager to each
builder's homes to be constructed in this subdivision.
Fiscal 1998 vs. 1997
Total revenues for this segment decreased 8% to $13,338,000, while total
expenses were comparable between the periods. These factors resulted in a
pre-tax loss of $1,034,000 in 1998 as compared to pre-tax earnings of $93,000 in
1997. Included in total expenses for 1998 is a $281,000 impairment recognized on
land and construction inventories to reduce these assets to net realizable
value.
<PAGE>
Revenues from residential construction by Charter decreased $1,167,000 to
$10,124,000 in 1998, a decrease of 10% from 1997. Costs of construction sales
and operating costs were 95% and 8% of construction revenues in 1998 compared to
94% and 7% respectively for 1997. Included in these amounts is an inventory
impairment of $270,000. These factors collectively resulted in a pre-tax loss of
$1,216,000 in 1998 as compared to a pre-tax loss of $591,000 in 1997.
Revenues from commercial construction decreased $26,000 to $1,724,000 in
1998, a decrease of 1% from 1997. Despite the nominal decline in revenues, gross
profits from commercial construction decreased $165,000 or 44% from 1997. This
decrease in gross profit and a $47,000 increase in operating expenses to
$285,000 resulted in a pre-tax loss of $66,000 compared to pre- tax earnings of
$142,000 in 1997. The expansion of Amity's offices and the addition of
personnel, have contributed to increased operating costs, as well increasing job
costs. It is expected, management will ultimately manage this growth period and
return to profitability.
Equity earnings from investees in land development joint ventures decreased
$295,000 to $163,000 in 1998, a decrease of 64% over 1997. This decrease is
primarily the result of the Company acquiring its partner's interests in two
joint ventures which are now accounted for as wholly-owned subsidiaries. The
Company is not currently a joint venture partner in any development projects
with significant inventory. Most of the lot inventory held by the Company is
wholly owned, therefore, gains on sale of lots to Charter are not recognized
until sales are closed. As the backlog of homes are closed, gains on sale of
Company owned lots are recognized.
During 1998, the Company acquired an undeveloped land parcel and completed
development of 96 home building lots in Los Lunas, New Mexico, a community,
approximately 15 miles south of Albuquerque. This development is not subject to
a joint venture agreement, and all building lots are currently reserved for
Charter. This subdivision is targeted for entry level housing with prices
ranging from $90,000 to $120,000.
Financial Services Segment:
The financial services segment consists of operations of the parent company,
Great American Equity Corporation (GAEC) and PHS, Inc.
In addition to financial services performed directly by the Company, operations
also include the Company's share of earnings from various equity method
investees who perform financial services. Such investees include a 50% equity
interest in PHS Mortgage Company and an approximately 11% interest in MI
Acquisition Corporation.
<PAGE>
Fiscal 1999 vs. 1998
The financial services segment, which includes certain unallocated
operating expenses of the parent company, realized a pre-tax profit of $111,000
in 1999 as compared to a pre-tax profit of $205,000 in 1998. The decrease is
primarily attributable to the $334,000 gain recognized on the sale of First
American Title, an equity method investee, in the 1998 period for which there
was no comparable activity in 1999, as offset by a $198,000 reduction in
operating expenses in 1999. Other significant items affecting operating results
are as follows.
Net equity earnings recognized by PHS, Inc. from its interest in PHS
Mortgage Company totaled $353,000 for the 1999 period, as compared to $317,000
in 1998. This increase is the result of continued growth in the operations of
this venture within the Albuquerque market as well as its recent expansion into
the Phoenix market.
The Company recognized equity earnings of $140,000 for the 1999 period as
compared to $13,000 in 1998 for its investment in MI Acquisition Corporation.
This increase in earnings of $127,000 is primarily attributable to the closing
of more investment banking deals in 1999.
Earnings from GAEC were comparable between the periods, $34,000 in 1999 as
compared to $46,000 in 1998. While earnings were comparable, revenues decreased
by $115,000 and expenses decreased $104,000. These decreases are the result of a
reduction in financing activities performed by this subsidiary as a result of an
increase in working capital being utilized by the real estate brokerage and
construction operations. Management does not anticipate any significant increase
in the amount of financing activities performed by this subsidiary in the near
term.
Fiscal 1998 vs. 1997
This segment generated pre-tax earnings of $205,000 in 1998 as compared to
$772,000 in 1997. This decrease in earnings is the result of a decrease in total
revenues of $225,000 to $1,693,000 in 1998 and an increase in unallocated
general and administrative expenses of $299,000. Depreciation and interest
expense incurred in this segment were comparable between the periods.
Equity earnings from investees consisted primarily of $317,000 from PHS
Mortgage Company, as compared to $249,000 in 1997. This increase is the result
of expanding operations to the Arizona market. The Company's investment in MI
provided $13,000 in equity earnings in 1998, as compared to $30,000 in 1997.
This segment experienced a gain of $334,000 in 1998 on the sale of First
American Title Company of New Mexico, a publicly held corporation which the
Company sold its 20% equity interest for $500,000 in November 1997.
Interest and loan fees generated by GAEC decreased $357,000 to $172,000 in
1998. Increased capital requirements to support the Company's residential
brokerage and home building activities restricted the capital availability
required to maintain the GAEC lending program, therefore revenue and operating
profits experienced a sharp decline.
<PAGE>
Liquidity and Capital Resources
- -------------------------------
The Company's liquidity consists primarily of cash, trade accounts receivable,
inventories and construction advances collateralized by inventory. Future cash
needs will be financed primarily by cash flows from operations, future advances
under construction loans and if needed, other financing arrangements, which may
be available to the Company. The Company does not have any material commitments
for capital expenditures for fiscal 2000.
The Company's current projection of future cash requirements, may be affected in
the future by numerous factors, including changes in customer receipts, consumer
industry trends, sales volume, operating cost fluctuations, acquisitions of
existing businesses and unplanned capital spending. Management believes that
cash flow from operations, current reserves of cash and cash equivalents and
credit facilities in place will sustain the Company's operations and anticipated
growth for the ensuing twelve months.
Year 2000 Issues
- ----------------
The Company has been notified by its principal vendors of its operating computer
programs, that they are deemed Year 2000 compliant. The Company has completed
its systematic program of testing its computer hardware and related software
programs to detect and correct any Year 2000 deficiencies.
The Company's key business relationships include suppliers and subcontractors
for building and land development, realtor clearing associations, and financial
institutions and mortgage companies which not only process the Company's cash
receipts and disbursements but also provide deposit and lending services for the
Company and its customers. The Company has limited assurance from most of these
key parties that they are Year 2000 compliant.
While some of the Company's business relations have provided assurance they are
addressing Year 2000 issues, the Company cannot guarantee such businesses will
address and resolve these issues in a timely manner.
The Company does not believe there will be any significant future costs incurred
with respect to its own computer software and hardware since its vendors have
deemed them Year 2000 compliant. As a result of the Company primarily using
internal information technology personnel to carry out its Year 2000 readiness
plan, total costs incurred to address this issue, including personnel and
equipment costs, were limited to less than $35,000.
Impact of Inflation
- -------------------
The Company's business is significantly affected by general economic conditions,
particularly by inflation and its generally associated adverse effect on
interest rates. Although inflation rates have been low in recent years, any rise
in inflation would likely affect the Company's revenues and earnings power by
reducing demand for new and resale homes as a result of correspondingly higher
interest rates.
<PAGE>
Forward Looking Statements
- --------------------------
Investors are cautioned that certain statements contained in this document are
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 (the "Act"). Statements which are predictive in
nature, which depend upon or refer to future events or conditions constitute
forward-looking statements. In addition, any statements concerning future
financial performance, 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, assumptions, and economic and market conditions
in the real estate industry, among other things.
Actual events and results may differ materially from those expressed or
forecasted in the forward-looking statements made by the Company or Company
management due to a number of factors. Important factors that could cause such
differences include but are not limited to, changes in general economic
conditions either nationally or in regions in where the Company operates or may
commence operations, employment growth or unemployment rates, availability and
costs of land and homebuilding materials, labor costs, interest rates,
prevailing rates for sales associate commission structures, industry
competition, regulatory developments, and the success of the Company and its
suppliers in identifying and addressing operating systems and programs that are
not year 2000 ready.
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The Company has no material market risk associated with interest rates, foreign
currency exchange rates or commodity prices.
<PAGE>
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Report of Independent Certified Public Accountants
Shareholders
Realco, Inc.
We have audited the accompanying consolidated balance sheets of Realco, Inc. and
Subsidiaries, as of September 30, 1999 and 1998, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended September 30, 1999. Our audits also included the
financial statement schedule listed in the index at Item 14(a). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Realco, Inc. and
Subsidiaries, as of September 30, 1999 and 1998, and the consolidated results of
their operations and their consolidated cash flows for each of the three years
in the period ended September 30, 1999, in conformity with generally accepted
accounting principles. Also, in our opinion, the related financial statement
schedule, when considered in relation to the financial statements taken as a
whole, presents fairly in all material respects the information set forth
therein.
GRANT THORNTON LLP
Oklahoma City, Oklahoma
November 12, 1999
<PAGE>
REALCO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30,
(Dollars in thousands)
1999 1998
-------- --------
ASSETS
Cash and cash equivalents $ 3,688 $ 3,788
Restricted cash 367 170
Accounts and notes receivable, net 1,899 2,278
Cost and estimated earnings in excess of
billings on uncompleted contracts 482 -
Inventories 14,932 16,760
Property and equipment, net 1,935 928
Investments - equity method 1,744 1,807
Deferred income taxes 117 301
Costs in excess of net assets acquired, net 1,605 1,276
Other assets 1,043 1,060
-------- --------
$ 27,812 $ 28,368
======== ========
LIABILITIES
Notes payable $ 5,214 $ 6,472
Lease obligations 743 77
Construction advances and notes payable,
collateralized by inventories 6,797 9,094
Accounts payable and accrued liabilities 4,293 2,584
Escrow funds held for others 367 170
-------- --------
Total liabilities 17,414 18,397
STOCKHOLDERS' EQUITY
Preferred stock - authorized, 500,000 shares Series A - issued and
outstanding, 79,969
and 82,569 shares in 1999 and 1998,
respectively, stated at liquidation value 799 826
Series B - issued and outstanding, 212,859
shares, stated at liquidation value 2,129 2,129
Series D - issued and outstanding, 23,919
shares in 1998, stated at liquidation value - 239
Common stock - no par value; authorized,
6,000,000 shares; issued, 2,894,038 and
2,845,000 shares in 1999 and 1998, respectively 7,909 7,712
Retained deficit (408) (684)
Accumulated other comprehensive income - (27)
------- -------
10,429 10,195
Less 11,000 and 78,000 shares common
stock held in treasury in 1999 and
1998, respectively - at cost 31 224
-------- --------
10,398 9,971
-------- --------
$ 27,812 $ 28,368
======== ========
See accompanying notes.
<PAGE>
REALCO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended September 30,
(Dollars in thousands, except per share amounts)
1999 1998 1997
-------- -------- --------
REVENUES
Brokerage commissions and fees $ 25,625 $ 21,984 $ 14,487
Construction sales 20,340 11,848 13,041
Sales of developed lots 2,363 1,272 1,154
Equity in net earnings of investees 545 506 789
Interest and other 911 785 1,080
-------- -------- --------
49,784 36,395 30,551
COSTS AND EXPENSES
Cost of brokerage revenue 18,615 16,254 10,275
Cost of construction sales 18,287 10,953 11,608
Cost of developed lots sold 1,746 1,345 1,073
Selling, general, administrative,
and other 9,101 8,126 5,880
Depreciation and amortization 601 522 502
Interest 998 711 684
-------- -------- --------
49,348 37,911 30,022
-------- -------- --------
Earnings (loss) before income taxes 436 (1,516) 529
INCOME TAX EXPENSE (BENEFIT) 160 (336) 199
-------- -------- --------
NET EARNINGS (LOSS) 276 (1,180) 330
PREFERRED STOCK DIVIDEND REQUIREMENT (4) 120 121
-------- -------- --------
NET EARNINGS (LOSS) APPLICABLE
TO COMMON SHARES $ 280 $ (1,300) $ 209
======== ======== ========
BASIC AND DILUTED EARNINGS (LOSS)
PER COMMON SHARE
Net earnings (loss) per common
share before preferred stock
dividend requirement $ .10 $ (.42) $ .12
======== ======== ========
Net earnings (loss) per common
share after preferred stock
dividend requirement $ .10 $ (.47) $ .07
======== ======== ========
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING 2,774,609 2,777,452 2,829,837
========= ========= =========
See accompanying notes.
<PAGE>
REALCO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Years ended September 30, 1999, 1998 AND 1997
(Dollars in thousands)
Series A Series B Series D preferred preferred
preferred stock 6 % stock 3% stock 3% Common
cumulative cumulative cumulative stock
---------- ---------- ---------- --------
Balance at October 1, 1996 $ 826 $ 2,179 $ 243 $ 7,712
Retirement of Series B
preferred stock - (50) - -
Retirement of Series D
preferred stock - - (4) -
Purchase of common stock
for treasury - - - -
Comprehensive income
Net earnings - - - -
Other comprehensive
income (loss)
Unrealized gain (loss)
on investments, net - - - -
Comprehensive income - - - -
---------- ---------- ---------- --------
Balance at September 30, 1997 826 2,129 239 7,712
Purchase of common stock
for treasury - - - -
Comprehensive loss
Net loss - - - -
Other comprehensive
income (loss)
Unrealized gain (loss)
on investments, net - - - -
Comprehensive income - - - -
---------- ---------- ---------- --------
Balance at September 30, 1998 826 2,129 239 7,712
Redemption of Series A
preferred stock (27) - - -
Conversion of Series D
preferred stock - - (239) 239
Issuance of treasury stock
in acquisition - - - (42)
Comprehensive income
Net earnings - - - -
Other comprehensive
income (loss)
Unrealized gain (loss)
on investments, net - - - -
Comprehensive income - - - -
---------- ---------- ---------- --------
Balance at September 30, 1999 $ 799 $ 2,129 $ - $ 7,909
========== ========== ========== ========
<PAGE>
REALCO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY - CONTINUED
Years ended September 30, 1999, 1998 AND 1997
(Dollars in thousands)
Accumulated
Retained Other
earnings Treasury Comprehensive
(deficit) stock Income (Loss) Total
---------- --------- ------------- --------
Balance at October 1, 1996 $ 166 $ - $ 7 $ 11,133
Retirement of Series B
preferred stock - - - (50)
Retirement of Series D
preferred stock - - - (4)
Purchase of common stock
for treasury
Comprehensive income - (93) - (93)
Net earnings 330 - - 330
Other comprehensive
income (loss)
Unrealized gain (loss)
on investments, net - - 11 11
--------
Comprehensive income 341
-------- -------- ------------- --------
Balance at September 30, 1997 496 (93) 18 11,327
Purchase of common stock
for treasury - (131) - (131)
Comprehensive loss
Net loss (1,180) - - (1,180)
Other comprehensive
income (loss)
Unrealized gain (loss)
on investments, net - - (45) (45)
--------
Comprehensive loss (1,225)
-------- --------- ------------- --------
Balance at September 30, 1998 (684) (224) (27) 9,971
Redemption of Series A
preferred stock - - - (27)
Conversion of Series D
preferred stock - - - -
Issuance of treasury stock
in acquisition - 193 - 151
Comprehensive income
Net earnings 276 - - 276
Other comprehensive
income (loss)
Unrealized gain (loss)
on investments, net - - 27 27
--------
Comprehensive Income - - - 303
---------- --------- ------------- --------
Balance at September 30, 1999 $ (408) $ (31) $ - $ 10,398
========== ========= ============= ========
See accompanying notes.
<PAGE>
REALCO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended September 30,
(Dollars in thousands)
1999 1998 1997
-------- -------- --------
Cash flows from operating activities
Net earnings (loss) $ 276 $ (1,180) $ 330
Adjustments to reconcile net earnings
(loss) to net cash provided by
(used in) operating activities
Depreciation and amortization 601 522 502
Accretion of discount on notes
payable 49 55 55
Net distributions in excess of
earnings (earnings in excess of
distributions) from investees 126 (7) (658)
Gain on sale of equity method investment - (334) -
Gain on sale of available for sale
securities (50) (57) (47)
Loss on sale of property and equipment 10 41 -
Provision for deferred income taxes 167 (328) 167
Changes in operating assets and
liabilities (net of businesses
acquired)
(Increase) decrease in restricted
cash (197) 233 86
Decrease (increase) in accounts
receivable 137 242 (384)
Decrease (increase) in inventories 1,828 (3,181) 323
(Increase) decrease in net billings
related to costs and estimated
earnings on uncompleted contracts (406) 128 180
(Increase) decrease in other assets (192) 240 (274)
Increase in accounts payable and
accrued liabilities 1,107 292 340
Increase (decrease) in escrow funds
held for others 197 (233) (86)
-------- -------- --------
Net cash provided by (used in)
operating activities 3,653 (3,567) 534
<PAGE>
Cash flows from investing activities
Purchases of property and equipment (634) (317) (284)
Proceeds from sale of property and
equipment 5 2 -
Payments for businesses acquired (455) (426) (1,424)
Advances on notes receivable (578) (773) (719)
Receipts on notes receivable 1,449 656 1,465
Proceeds from securities available for sale 906 467 195
Purchase of securities available for sale (688) (504) (90)
Purchase of equity method investments (63) - (1,046)
Proceeds from sale of equity method
investment - 500 -
Cash acquired in business acquisitions - 292 252
-------- -------- --------
Net cash used in investing
activities (58) (103) (1,651)
Cash flows from financing activities
Construction advances and notes, net (2,297) 3,955 587
Proceeds from borrowing under revolving
and long-term debt 20 - 500
Payments on revolving, capital lease, and
long-term debt (1,391) (608) (116)
Purchase of treasury stock - (131) (93)
Redemption of preferred stock (27) - -
-------- -------- --------
Net cash provided by (used in)
financing activities (3,695) 3,216 878
-------- -------- --------
NET DECREASE IN CASH AND CASH EQUIVALENTS (100) (454) (239)
Cash and cash equivalents at beginning
of year 3,788 4,242 4,481
-------- -------- --------
Cash and cash equivalents at end of year 3,688 $ 3,788 4,242
======== ======== ========
Cash paid (received) during the year for:
- -----------------------------------------
Income taxes $ - $ (184) $ 88
Interest 1,002 711 684
<PAGE>
Noncash financing and investing activities:
- -------------------------------------------
In 1999, the Company purchased the net assets and business of TI Construction,
Inc. through the issuance of 67,000 shares of Company common stock held in
treasury. In connection with the acquisition, liabilities were assumed as
follows:
Fair value of assets acquired $ 753
Stock issued (151)
--------
Liabilities assumed 602
========
In 1999 and 1998, capital lease obligations of $731 and $47, respectively, were
incurred when the Company entered into leases for office furniture and
equipment.
In 1998, the Company acquired all the common stock of Cliff Winn, Inc. Realtors
for $426. In conjunction with the acquisition, liabilities were assumed as
follows:
Fair value of assets acquired,
including cash of $292 $ 457
Cash paid (426)
--------
Liabilities assumed $ 31
========
<PAGE>
In 1997, the Company acquired all the common stock of Mull Realty Company for
$1,159. In connection with the acquisition, liabilities were assumed as follows:
Fair value of assets acquired,
including cash of $206 $ 1,282
Cash paid (359)
Issuance of note payable (800)
--------
Liabilities assumed $ 123
========
In 1997, the Company purchased the net assets and business of First Commercial
Real Estate Services, Inc. for $265. In conjunction with the acquisition,
liabilities were assumed as follows:
Fair value of assets acquired $ 269
Cash paid (265)
--------
Liabilities assumed $ 4
========
In 1997, the Company purchased the remaining 50% partnership interest in Village
Joint Venture and Stonehenge at High Resort Joint Venture for $800. In
conjunction with the acquisition, liabilities were assumed as follows:
Fair value of assets acquired,
including cash of $46 $ 3,697
Cash paid (800)
Previous equity basis investment (619)
--------
Liabilities assumed $ 2,278
========
In 1997, the Company exchanged a $50 note receivable for 5,000 shares of Series
B preferred stock and $4 of furniture and fixtures for 378 shares of Series D
preferred stock.
See accompanying notes.
<PAGE>
REALCO, INC. AND SIBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999, 1998 and 1997
(Dollars in thousands, except per share amounts)
NOTE A - NATURE OF OPERATIONS AND SUMMARY OF ACCOUNTING POLICIES
Realco, Inc., a New Mexico corporation, and Subsidiaries (the "Company") has
operations which include real estate brokerage sales through a franchise from
Prudential Real Estate Affiliates, Inc.; single-family home construction; land
development; and, to a lesser extent, commercial construction and financial
services. Its operations and customers are primarily in the vicinity of
Albuquerque, New Mexico except for certain real estate brokerage and financial
services operations and customers in Phoenix, Arizona.
The Company's accounting policies reflect industry practices and conform to
generally accepted accounting principles. The more significant policies are
briefly discussed below.
1. Principles of Consolidation
The consolidated financial statements include the accounts of Realco, Inc. and
its wholly owned subsidiaries. All material intercompany accounts and
transactions have been eliminated in consolidation.
2. Revenue Recognition and Provision for Warranty Claims
The Company constructs single-family homes of short building duration for which
minimal deposits are generally required from the buyer. Revenue is recognized
upon closing. Estimated warranty costs are provided at the time of sale.
Revenues from significant commercial construction contracts are recognized on
the percentage-of-completion method; accordingly, income is recognized in the
ratio that costs incurred bear to estimated total costs. The aggregate of costs
incurred and income recognized on uncompleted contracts in excess of related
billings is shown as an asset, and the aggregate billings on uncompleted
contracts in excess of related costs incurred and income recognized is shown as
a liability. Certain short-term smaller commercial construction contracts are
accounted for on the completed-contract method, which does not vary
significantly from the percentage-of-completion basis of accounting. Contract
costs include all direct material, subcontractor, supplies, and labor costs and
those indirect costs relating to contract performance. Provisions for estimated
losses on uncompleted contracts are made in the period in which such losses are
determined. Changes in job performance, job conditions, estimated profitability,
and final contract settlements may result in revisions to cost and income and
are recognized in the period in which the revisions are determined.
Brokerage commissions and fees earned from real estate brokerage services are
recognized at the time of closing on the underlying real estate sales contracts.
<PAGE>
3. Cash, Cash Equivalents, and Restricted Cash
The Company considers money market accounts and all highly liquid debt
instruments purchased with a maturity of three months or less to be cash
equivalents. The Company maintains its cash and cash equivalents in accounts
which may not be federally insured. The Company has not experienced any losses
in such accounts and believes it is not exposed to any significant credit risk.
In the ordinary course of operations, the Company collects and holds in escrow
funds associated with real estate contract deposits, construction sales contract
deposits, and other escrowed funds. These balances are reflected as restricted
cash with a corresponding liability.
4. Accounts and Notes Receivable
The Company reviews accounts and notes receivable for collectibility and
provides reserves on specific accounts based upon whether the Company believes
that the collection of a specific account is questionable.
The Company provides credit to its customers under ordinary trade terms.
Receivables for real estate contracts are generally collateralized by the real
estate.
5. Inventories
Inventories are carried at the lower of cost or estimated net realizable value
and include all acquisition costs, direct labor and benefits, project interest,
materials unique to or installed in the project, subcontractor cost, and a
proportional overhead allocation charge.
6. Property and Equipment
Depreciation is provided in amounts sufficient to relate the cost of depreciable
assets to operations over their estimated service lives of three to ten years
using straight-line and accelerated methods.
Impairment losses are recorded on long-lived assets used in operations when
indicators of impairment are present and the undiscounted cash flows estimated
to be generated by these assets are less than the assets' carrying amount.
Assets acquired under capital leases are recorded at the lower of fair market
value or the present value of future minimum lease payments. These leases are
amortized on the straight-line method over the primary lease term or over
estimated economic lives in the event ownership of the underlying assets
transfers at the end of the lease term.
<PAGE>
7. Income Taxes
Deferred income taxes are provided on temporary differences between the tax
basis of an asset or liability and its reported amount in the consolidated
financial statements that will result in taxable or deductible amounts in future
years. Deferred income tax assets or liabilities are determined by applying the
presently enacted tax rates and laws.
The Company and its subsidiaries file consolidated income tax returns.
8. Earnings (Loss) Per Common Share
Earnings (loss) per common share is calculated based on the weighted average
number of shares outstanding during the year pursuant to Statement of Financial
Accounting Standards ("SFAS") No. 128, Earnings per Share, which was adopted
during the year ended September 30, 1998. Because the conversion prices for
convertible debentures, warrants, and options are greater than the average
market price for the periods presented, the assumed conversion of such
securities are antidilutive. The adoption of this standard did not require
restatement of 1997 net earnings per common share.
9. Investments
Investments in affiliated companies and joint ventures owned 20% to 50% or which
the Company is able to exercise significant influence over operations are
accounted for on the equity method. Accordingly, the consolidated statements of
operations include the Company's share of the affiliated entities' net earnings.
10. Intangible Assets
Costs in excess of net assets of businesses acquired are being amortized using
the straight-line method over fifteen or twenty years. Accumulated amortization
of costs in excess of net assets of businesses acquired was $299 and $177 at
September 30, 1999 and 1998, respectively.
The Company assesses the recoverability of costs in excess of net assets of
businesses acquired by determining whether the amortization of the asset balance
over its remaining life can be recovered through the undiscounted future
operating cash flows of the acquired operation. The amount of the impairment, if
any, is measured based on projected discounted future operating cash flows.
11. Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect certain reported amounts and disclosures; accordingly, actual results
could differ from those estimates.
12. Stock Options
The Company applies APB Opinion 25 and related interpretations in accounting for
its stock options. Accordingly, compensation expense is only recognized for
grants of options which include an exercise price less than the market price of
the stock at the date of the grant.
<PAGE>
13. Advertising Costs
The Company expenses the cost of advertising the first time advertising takes
place. Advertising expense for the fiscal years ended September 30, 1999, 1998
and 1997 was approximately $1,037, $990 and $893, respectively.
14. Other Comprehensive Income
Accumulated other comprehensive income consists solely of net unrealized
investment gains (losses).
Unrealized gain (loss) on investments consists of the following:
1999 1998 1997
-------- -------- --------
Unrealized gain (loss) on investments
arising during the period $ - $ (27) $ 18
Less reclassification adjustment for
gains (losses) included in net
earnings (loss) (27) 18 7
-------- -------- --------
Unrealized gain (loss) on investments,
net $ 27 $ (45) $ 11
======== ======== ========
15. Reclassifications
Certain reclassifications have been made to the 1998 and 1997 consolidated
financial statements to conform to the 1999 presentation.
NOTE B - INVENTORIES
During the years ended September 30, 1999, 1998 and 1997, the Company incurred
and capitalized approximately $363, $285 and $303 respectively, of interest
costs. Capitalized interest costs charged to cost of construction sales were
approximately $332, $333 and $343 for the years ended September 30, 1999, 1998
and 1997, respectively.
Inventories consist of the following as of September 30:
1999 1998
-------- --------
Land and improvements under development $ 8,755 $ 10,885
Construction in progress 5,206 4,878
Model homes 971 997
-------- --------
$ 14,932 $ 16,760
======== ========
Construction in progress includes homes under contract of approximately $3,971
and $3,056 at September 30, 1999 and 1998, respectively.
<PAGE>
NOTE C - COSTS AND BILLINGS ON UNCOMPLETED CONTRACTS
The following is a summary of significant commercial construction contracts
accounted for on the percentage-of-completion method as of September 30, 1999.
There were no contracts accounted for on the percentage-of-completion method as
of September 30, 1998.
Costs incurred on uncompleted contracts $ 893
Estimated earnings 162
--------
1,055
Less billings to date 573
--------
Costs and estimated earnings in excess of
billings on uncompleted contracts $ 482
========
NOTE D - INVESTMENTS
The following is a summary of investments carried on the equity method as of
September 30:
1999 1998
-------- --------
MI Acquisition Corporation, 11%
stockholder interest $ 1,245 $ 1,043
PHS Mortgage, 50% stockholder interest 279 219
Success Venture 105 392
Other 115 153
-------- --------
$ 1,744 $ 1,807
======== ========
In November 1997, the Company sold its 20% stockholder interest in First
American Title Company of New Mexico for $500 resulting in a gain of $334.
The Company has participated in certain land development projects under separate
joint venture agreements. The Company's liability is joint and several for such
joint ventures and its 50% share in the operations is reported on the equity
method in the accompanying consolidated financial statements. Effective July 1,
1997, the Company purchased the other 50% interest in Village Joint Venture and
Stonehenge at High Resort Joint Venture for a cash payment of $800. This action
terminated the joint ventures, and the assets, liabilities, and subsequent
results of operations are included in the accompanying consolidated financial
statements.
<PAGE>
Summarized financial information of certain investments carried on the equity
method is as follows:
As of and for the year ended September 30, 1999
-----------------------------------------------
MI
Acquisition PHS Joint
Corporation Mortgage Ventures
----------- ----------- -----------
Cash $ 6,954 $ 78 $ 39
Other assets 62,503 504 171
----------- ----------- -----------
$ 69,457 $ 582 $ 210
=========== =========== ===========
Liabilities $ 58,552 $ 24 $ -
Equity 10,905 558 210
----------- ----------- -----------
$ 69,457 $ 582 $ 210
=========== =========== ===========
Revenue earned $ 34,501 $ 1,599 $ 110
=========== =========== ===========
Net earnings $ 1,223 $ 767 $ 43
=========== =========== ===========
As of and for the year ended September 30, 1998
-----------------------------------------------
MI
Acquisition PHS Joint
Corporation Mortgage Ventures
----------- ----------- -----------
Cash $ 1,734 $ 359 $ 309
Other assets 34,385 543 716
----------- ----------- -----------
$ 36,119 $ 902 $ 1,025
=========== =========== ===========
Liabilities $ 26,844 $ 503 $ 229
Equity 9,275 399 796
----------- ----------- -----------
$ 36,119 $ 902 $ 1,025
=========== =========== ===========
Revenue earned $ 31,779 $ 1,214 $ 893
=========== =========== ===========
Net earnings $ 908 $ 635 $ 290
=========== =========== ===========
<PAGE>
For the year ended September 30, 1997
-------------------------------------
First American MI
Title Company Acquisition PHS Joint
of New Mexico Corporation Mortgage Ventures
-------------- ----------- ----------- -----------
Revenue earned $ 3,921 $ 5,178 $ 919 $ 12,434
============== =========== =========== ===========
Net earnings $ 235 $ 236 $ 498 $ 866
============== =========== =========== ===========
<PAGE>
NOTE E - ACCOUNTS AND NOTES RECEIVABLE
Accounts and notes receivable include the following at September 30:
1999 1998
-------- --------
Residential construction advances to various builders subordinate to the
interest of banks under participation agreements; collateralized by certain
real estate and homes under construction, interest due monthly at the banks'
prime rate plus 1%, principal due as homes are sold, up to a nine-month term
with three-
month renewals considered $ 150 $ 936
Notes receivable from various real estate agents; collateralized by computer
equipment, payable in monthly installments including interest at 10%, with
maturity
dates through November 2000 - 26
Note receivable; collateralized by real estate, interest due monthly at 9%,
principal payable as lots are sold or upon
demand - 118
Brokerage commissions and fees receivable 530 715
Construction sales receivable 909 152
Other advances and receivables 335 356
-------- --------
1,924 2,303
Less allowance for doubtful accounts 25 25
-------- --------
$ 1,899 $ 2,278
======== ========
NOTE F - PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at September 30:
1999 1998
-------- --------
Office equipment, furniture, and fixtures $ 2,564 $ 1,719
Leasehold improvements 577 150
Automobiles and equipment 182 123
-------- --------
3,323 1,992
Less accumulated depreciation and
amortization 1,388 1,064
-------- --------
$ 1,935 $ 928
======== ========
<PAGE>
NOTE G - DEBT
Debt consisted of the following at September 30:
1999 1998
-------- --------
Subordinated sinking fund notes, $5,750 face amount, 9.5% interest payable
annually, principal payable at various dates through December 2003 (less
$121 and $170 unamortized discount at September 30, 1999 and 1998,
respectively,
based on imputed interest rate of 10.5%) (A) $ 4,829 $ 5,580
Construction and development advances;
collateralized by inventories (A)(B) 3,866 4,939
Notes payable; collateralized by
inventories (A)(C) 2,931 4,155
Note payable to Norwest Bank; collateralized by equity investee common stock
owned by the Company, due in semi-annual installments of $35,700 plus
interest at 1% over the bank's prime rate,
through July 2004 (A) 357 429
Noninterest-bearing note payable to selling shareholder of Mull Realty
Company, Inc., collateralized by the common stock of a Company subsidiary,
due in annual installments based upon a factor of earnings with all
outstanding principal due
in April 2001 - 362
Revolving line of credit with Norwest Bank,
interest payable monthly at 1.5% over the
bank's prime rate, matured June 1999 - 100
Other notes payable 28 1
-------- --------
$ 12,011 $ 15,566
======== ========
(A) Subordinated sinking fund notes and certain construction and development
advances and notes payable collateralized by inventory are subject to various
covenants, the most restrictive of which include minimum net worth requirements,
cash flow coverage requirements, limitations on dividends, and limitations on
debt.
<PAGE>
(B) Construction and development advances collateralized by inventories include
amounts advanced under various interim construction lines of credit, other
lending arrangements and buyer financed loans which are payable upon closing.
Each project under lines of credit requires a separate construction loan bearing
interest at the bank's prime rate plus 1% (9.25% and 9.5% at September 30, 1999
and 1998, respectively). Each home to be built under other lending guidelines
requires a separate construction loan at the bank's prime rate plus .5% to 1.5%
(prime rate was 8.25% and 8.5% at September 30, 1999 and 1998, respectively).
(C) Notes payable collateralized by inventories include amounts outstanding on
loan agreements expiring at various dates through April 2000, with variable
interest rates at the banks' prime rates plus .5% to 1.5% (prime rate was 8.25%
and 8.5% at September 30, 1999 and 1998, respectively) and fixed interest rates
of 9% or 10%, with principal payments due as properties are sold.
Aggregate future maturities of debt are as follows at September 30, 1999:
Year ending September 30
2000 $ 7,677
2001 878
2002 875
2003 880
2004 1,822
--------
12,132
Less amount representing discount on debt 121
--------
$ 12,011
========
NOTE H - INCOME TAXES
The provision for income taxes consists of the following for the years ended
September 30:
1999 1998 1997
-------- -------- --------
Current $ (7) $ (8) $ 32
Deferred 167 (328) 167
-------- -------- --------
$ 160 $ (336) $ 199
======== ======== ========
<PAGE>
The Company's effective income tax rate on continuing operations differed from
the federal statutory rate of 34% as follows:
1999 1998 1997
-------- -------- --------
Income taxes at federal statutory
rate $ 148 $ (515) $ 180
Increase (decrease) in valuation
allowance (187) 271 (16)
Nondeductible expenses 41 38 31
State income taxes at statutory rate 26 (91) -
Adjustment of estimated income tax
liability of prior year 127 (49) -
Other 5 10 4
-------- -------- --------
Total tax expense $ 160 $ (336) $ 199
======== ======== ========
Components of deferred taxes are as follows at September 30:
1999 1998
-------- --------
Assets
Inventories $ 72 $ 128
Accrued liabilities 177 147
Property and equipment - 59
Investments 105 123
Tax loss carryforward 32 249
Valuation allowance (108) (295)
-------- --------
$ 278 $ 411
======== ========
Liabilities
Investments $ 134 $ 110
Property and equipment 27 -
-------- --------
$ 161 $ 110
======== ========
The valuation allowance decreased $187 for the year ended September 30, 1999 and
increased $271 for the year ended September 30, 1998.
A valuation allowance for deferred tax assets is required when it is more likely
than not that some portion or all of the deferred tax assets will not be
realized. The ultimate realization of this deferred tax asset depends on the
Company's ability to generate sufficient taxable income in the future.
Management believes it is more likely than not that a portion of the deferred
tax asset will be realized by future operating results. If the Company is unable
to generate sufficient taxable income in the future through operating results or
tax-planning opportunities, an additional valuation allowance will be required
through a charge to expense.
<PAGE>
At September 30, 1999, the Company has net operating loss carryforwards for tax
purposes of approximately $80 which will expire in 2013.
NOTE I - LEASES
The Company leases furniture and equipment under long-term leases with ownership
of the furniture and equipment transferred to the Company at the termination of
the leases. Property and equipment include leased furniture and equipment with a
cost of $778 and $360 and accumulated depreciation of $21 and $237 at September
30, 1999 and 1998, respectively.
Capital lease terms range from three to five years and provide for payments as
follows:
Year ending September 30
2000 $ 291
2001 291
2002 267
2003 6
--------
Total minimum lease payments 855
Amount representing interest 112
--------
Present value of net minimum lease payments $ 743
========
The Company leases certain office facilities and equipment used in its
operations under operating leases expiring at various dates through 2009 and
provide for payments as follows:
Year ending September 30
2000 $ 1,746
2001 1,546
2002 1,491
2003 1,257
2004 924
Thereafter 3,072
--------
$ 10,036
========
Certain facilities are subleased under leases which expire in 2004. Total future
minimum sublease rentals amount to $280 at September 30, 1999.
Rental expense for all operating leases for the years ended September 30 is as
follows:
1999 1998 1997
-------- -------- --------
Minimum rentals $ 1,200 $ 989 $ 601
Sublease rentals (67) (61) -
-------- -------- --------
$ 1,133 $ 928 $ 601
======== ======== ========
<PAGE>
Certain of these leases relating to rental expense of approximately $137, $117
and $127 for the years ended September 30, 1999, 1998 and 1997, respectively,
are with related parties.
NOTE J - BUSINESS COMBINATIONS
The Company acquired TI Construction, Inc. ("TI"), a commercial construction
contractor which specializes in constructing veterinary clinics, effective
August 1, 1999. This acquisition was made through the issuance of 67,000 shares
of Company common stock held in treasury.
The Company acquired Cliff Winn, Inc. Realtors ("Winn Realtors"), a real estate
broker, effective February 1, 1998. The acquisition included a cash payment of
approximately $426 and future contingent payments of up to $963. As of September
30, 1999, contingent payments of $193 have been made, thereby reducing the
future contingent payments to $770. Future contingent payments made, if any, are
based on future earnings levels and will result in additional costs in excess of
net assets acquired to be amortized over the remaining life of the asset.
The Company acquired Mull Realty Company, Inc. ("Mull Realty"), a real estate
broker, effective January 1, 1997. The acquisition included a cash payment of
approximately $359, the issuance of a noninterest-bearing note payable for $800,
and future contingent payments of up to $1,175. As of September 30, 1999,
payments of $800 on the note payable have been made and contingent payments of
$56 have been made, thereby reducing the future contingent payments to $1,119.
The contingent payments made, if any, are based on future earnings levels and
will result in additional costs in excess of the net assets acquired to be
amortized over the remaining life of the asset.
Additionally, the Company acquired First Commercial Real Estate Services, Inc.
("First Commercial"), a commercial real estate broker, effective May 1, 1997,
for a cash payment of $265.
These business combinations have been accounted for using the purchase method of
accounting and the accompanying consolidated financial statements include the
operations of these entities subsequent to the date of acquisition. Initial
costs in excess of the net assets acquired were approximately $1,092.
The following summarized pro forma unaudited information assumes the acquisition
of TI occurred on October 1, 1997 and the acquistions of Winn Realtors, Mull
Realty, and First Commercial had occurred on October 1, 1996:
Years ended September 30,
-------------------------
1999 1998 1997
---------- ---------- ----------
Revenues $ 54,408 $ 42,578 $ 37,232
========== ========== ==========
Net earnings (loss) $ 291 $ (1,078) $ (3)
========== ========== ==========
Earnings (loss) per common share $ .10 $ (.42) $ (.04)
========== ========== ==========
<PAGE>
NOTE K - SEGMENT INFORMATION
The Company operates in the following segments: residential construction, real
estate broker, commercial construction, and financial services. Information
concerning the Company's business segments as of and for the years ended
September 30 is as follows:
1999 1998 1997
-------- -------- --------
Revenues
Residential construction and
and Land Development $19,515 $ 11,396 $ 12,445
Real estate broker
Sales to unaffiliated customers 25,625 21,983 14,487
Intersegment sales - 368 405
Financial services 677 838 877
Commercial construction 3,188 1,724 1,750
Interest and other
Sales to unaffiliated customers 779 453 992
Intersegment sales 646 723 767
Eliminations (646) (1,090) (1,172)
-------- -------- --------
Total $ 49,784 $ 36,395 $ 30,551
======== ======== ========
Operating profit (loss)
Residential construction and
Land Development $ 1,237 $ (348) $ 22
Real estate broker (56) (329) (61)
Financial services 147 325 843
Commercial construction (91) (49) 165
-------- -------- --------
Total $ 1,237 $ (401) $ 969
======== ======== ========
Assets
Residential construction
and land development $ 16,286 $ 17,693 $ 14,857
Real estate broker 4,796 3,920 3,436
Financial services 2,139 3,073 3,166
Commercial construction 1,913 575 767
-------- -------- --------
Identifiable assets 25,134 25,261 22,226
Equity investments 220 544 566
Corporate assets 853 828 969
Other assets 1,605 1,735 2,593
-------- -------- --------
Total $ 27,812 $ 28,368 $ 26,354
======== ======== ========
<PAGE>
Depreciation and amortization
Residential construction and
Land Development $ 127 $ 123 $ 104
Real estate broker 339 256 249
Commercial construction 22 18 23
Other 113 125 126
-------- -------- --------
Total $ 601 $ 522 $ 502
======== ======== ========
Capital expenditures
Residential construction and
Land Development $ 90 $ 147 $ 188
Real estate broker 485 147 80
Commercial construction 17 17 9
Other 42 6 7
-------- -------- --------
Total $ 634 $ 317 $ 284
======== ======== ========
Operating profit consists of total revenues, less costs and expenses including
interest expense allocated to the financial services segment, but does not
include unallocated interest expense, other income, net equity in earnings of
investees, loss on sale of equipment, or income taxes. Identifiable assets are
those assets used in the Company's operations in each area. Other assets include
cash and cash equivalents, investments accounted for under the equity method,
and capitalized debt issuance costs.
NOTE L - COMMITMENTS AND CONTINGENCIES
The Company is engaged in various legal proceedings incidental to its normal
business activities. Management of the Company does not believe that the outcome
of each such proceeding or all of them combined will have a material adverse
effect on the Company or its consolidated financial position or operations.
NOTE M - PREFERRED STOCK AND WARRANTS
Series A voting preferred stock is entitled to dividends when declared and paid
at a 6% cumulative rate payable annually starting January 31, 1996 and payable
each January 31 thereafter. Series B voting preferred stock is entitled to
dividends when declared and paid at a 3% cumulative rate payable annually
starting January 31, 1996 and payable each January 31 thereafter. At September
30, 1999, preferred stock dividends in arrears for Series A were $173 or $2.17
per share ($127 or $1.54 per share for 1998) and Series B were $292 or $1.37 per
share ($228 or $1.07 per share for 1998). Each series of preferred stock have a
liquidation preference of $10 per share, plus all accumulated but unpaid
dividends. Each Series A preferred share is convertible into common shares at $7
per common share on the basis of $10 per preferred share. The Series B preferred
stock is convertible under the same terms; however, the preferred stock value is
$11.11 per share.
<PAGE>
In 1999, 2,600 shares of the outstanding shares of Series A voting preferred
stock were redeemed based upon the $10 per share liquidation value and 23,919
shares of Series D voting preferred stock were converted into 47,838 shares of
common stock. To induce conversion, the Series D preferred stock was converted
at a rate of $5 per common share instead of $7 per common share in the original
conversion terms. The excess carrying value of the Series D preferred stock over
the fair value of the common stock given and the value of additional common
stock issued to induce conversion was approximately $116 which is reflected as a
negative return in the Preferred Stock Dividend Requirement in the Consolidated
Statements of Operations.
During 1997, the Company amended its articles of incorporation to convert the
previously authorized 80,000 shares of Series C preferred stock to a series of
preferred shares which are unclassified as to rights or preferences.
Additionally, this amendment provides for all shares of Series A, Series B, and
Series D preferred shares which are reacquired by the Company to be converted to
a series of preferred stock which is unclassified as to rights or preferences.
As a result of these amendments, the Company has 207,172 preferred shares
authorized which are unclassified as to rights and preferences. Such shares will
be fixed with respect to rights and preferences by the Board of the Company upon
issuance.
As a result of its past public offering of certain debt and equity securities,
690,000 warrants to purchase Company common stock at $8.40 per share were
issued. These warrants became immediately exercisable upon closing of the
offering and expire February 1, 2001. All warrants remain outstanding at
September 30, 1999.
NOTE N - STOCK OPTIONS
The Company adopted an employee incentive stock plan for certain key employees
during the year ended September 30, 1997. Options currently outstanding under
the plan become exercisable one year from the date of the grant and expire five
years after the date of the grant. These options are exercisable at not less
than the market value of the Company's stock on the date of the grant.
Accordingly, no compensation cost has been recognized for these options. Had
compensation cost for these options been determined based on the fair value of
the options at the grant dates consistent with the method of SFAS No. 123,
Accounting for Stock-Based Compensation, the Company's net earnings (loss) and
earnings (loss) per common share would have been the pro forma amounts indicated
below for the years ended September 30:
1999 1998 1997
-------- -------- --------
Net earnings (loss) applicable
to common shares
As reported $ 280 $ (1,300) $ 209
Pro forma 202 (1,386) 193
Earnings (loss) per share
As reported $ .10 $ (.47) $ .07
Pro forma .07 (.50) .07
The fair value of each option grant is estimated on the date of the grant using
the Black-Scholes options-pricing model with the following weighted- average
assumptions used for grants in 1999, 1998 and 1997, respectively: dividend yield
was estimated to remain at zero for all years; expected volatility of 58% for
1999 and 54% for 1998 and 1997; risk-free interest rates of 5.5%, 6% and 5.9%,
respectively; and an expected life of one year for all years.
<PAGE>
The Black-Scholes options valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
A summary of the status of the Company's fixed stock options as of September 30
and changes during the years then ended is presented below:
1999 1998 1997
----------------- ---------------- ----------------
Weighted Weighted Weighted
Number average Number average Number average
of exercise of exercise of exercise
shares price shares price shares price
------- --------- ------- -------- ------- --------
Outstanding at
beginning of year 100,000 $ 3.38 35,000 $ 3.30 - $ -
Granted 105,000 3.06 90,000 3.42 35,000 3.30
Forfeited (10,000) 3.38 (25,000) 3.42 - -
------- -------- -------
Outstanding at
end of year 195,000 $ 3.21 100,000 $ 3.38 35,000 $ 3.30
======= ======== =======
Options exercisable
at year end 120,000 $ 3.27
Weighted-average fair
value of options
granted during the
year $ 1.18 $ 1.09 $ .46
The following information applies to options outstanding at September 30, 1999:
Number outstanding 195,000
Range of exercise prices $2.85 to $3.45
Weighted average exercise price $3.21
Weighted average remaining contractual life 4 years
The Company records proceeds from the exercise of stock options, net of income
tax effects, if any, as additions to common stock.
<PAGE>
NOTE O - FINANCIAL INSTRUMENTS
The following table includes various estimated fair value information as
required by SFAS No. 107, Disclosures About Fair Value of Financial Instruments.
Such information, which pertains to the Company's financial instruments, is
based on the requirements set forth in SFAS No. 107 and does not purport to
represent the aggregate net fair value of the Company. The carrying amounts in
the table below are the amounts at which the financial instruments are reported
in the consolidated financial statements.
All of the Company's financial instruments are held for purposes other than
trading.
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:
1. Cash, Cash Equivalents, and Restricted Cash - The carrying amount
approximates fair value because of the short maturity and highly liquid nature
of those instruments.
2. Fixed Rate Notes Receivable - The discounted amount of future cash flows
using the current rates at which similar loans would be made to borrowers is
used to estimate fair value.
3. Floating Rate Notes Receivable - The carrying amount approximates fair value
because interest rates adjust to market rates.
4. Fixed Rate Debt - The discounted amount of future cash flows using the
Company's current incremental rate of borrowing for similar liabilities is used
to estimate fair value.
5. Floating Rate Debt - The carrying amount approximates fair value because
interest rates adjust to market rates.
The carrying amounts and estimated fair values of the Company's financial
instruments are as follows:
1999 1998
-------------------- --------------------
Carrying Estimated Carrying Estimated
amount fair value amount fair value
-------- ---------- -------- ----------
Financial assets
Cash, cash equivalents, and
restricted cash $ 4,055 $ 4,055 $ 3,958 $ 3,958
Fixed rate notes receivable - - 144 144
Floating rate notes receivable 144 144 936 936
Financial liabilities
Fixed rate debt (5,605) (5,602) (6,776) (6,727)
Floating rate debt (6,407) (6,407) (8,428) (8,428)
Financial liabilities for which
it is not practicable to estimate
fair value
Notes payable - - (362) -
<PAGE>
It was not practicable to estimate the fair value of a noninterest-bearing note
payable which does not have fixed repayment terms.
NOTE P - NON-RECURRING ITEMS
During the fourth quarter of fiscal 1998, the Company committed to close four
real estate brokerage branch offices and re-establish those offices in a single,
strategically located facility. As a result of this commitment, the Company
incurred charges of $273 related to lease abandonments. Additionally, during
this quarter, the Company determined valuation allowances of $505 were required
on certain inventories, receivables, and other assets. The aggregate effect of
these items was to increase the loss for the fourth quarter of fiscal 1998 by
$606 or $.22 per share.
During 1999, the Company's relocation to the new facility was delayed. Of the
$273 initial charge relating to lease abandonments, $235 remains as an accrued
liability at September 30, 1999 which represents the anticipated present value
of future obligations for abandoned facilities.
<PAGE>
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None
PART III
ITEMS 10, 11, 12 and 13:
Information required by Part III (Items 10, 11, 12 and 13) of this Form 10-K is
incorporated by reference from the Registrant's definitive Proxy Statement for
its 2000 Annual Meeting of Stockholders, which will be filed with the Securities
and Exchange Commission, pursuant to Regulation 14A, not later than 120 days
after the end of the fiscal year, all of which information is hereby
incorporated by reference in, and made part of, this Form 10-K.
PART IV
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Documents filed as part of this report:
(1) The financial statements filed as part of this report are included in
Item 8.
(2) The financial statement schedule required to be filed as part of this
report consists of Schedule II Valuation and Qualifying Accounts
appearing at the end of this Item.
(3) The following exhibits are filed as part of this report:
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------- ----------------------
3.1 * Articles of Incorporation dated April 8, 1983.
3.2 * Articles of Amendment to Articles of Incorporation dated March 20,
1995.
3.3 * Articles of Amendment to Articles of Incorporation dated July 28, 1995.
3.4 * Bylaws as amended.
10.1 * The Prudential Real Estate Affiliates, Inc. Franchise Agreement with
the Registrant, as amended.
10.2 1997 Employee Incentive Stock Option Plan, incorporated herein by
reference to the Registrant's Form 10-QSB filed on May 15, 1997.
21 Subsidiares of the Registrant, incorporated herein by reference to the
Registrant's Form 10-KSB filed on January 14, 1999.
27 Financial Data Schedule (filed herewith).
* Filed as an exhibit to the Registrant's Registration Statement under the
Securities Act of 1933, as amended on Form SB-2 (Registration Statement No.
33-98740-D), and incorporated herein by reference.
(b) Reports on Form 8-K:
The Registrant filed reports on Form 8-K and Form 8-K/A, dated August 15,
1999 during the quarter ended September 30, 1999 reporting matters under
Item 5, Other Events.
(c) The exhibits listed under Item 14(a)(3) are filed herewith or incorporated
by reference.
(d) Financial statement schedules:
(1) The financial statements of MI Acquisition Corporation and PHS
Mortgage Company, which are subsidiaries not consolidated and fifty
percent or less owned, are being filed by amendment within ninety days
after the end of such subsidiaries fiscal year end.
(2) The financial statement schedule listed under Item 14(a)(3) is filed
herewith.
Schedule II - Valuation and Qualifying Accounts:
(Dollars in thousands)
Balance at
beginning Charged to Balance at
of year expense Deductions end of year
----------- ----------- ----------- -----------
Year ended September 30,1999
Allowance for doubtful
accounts $ 25 $ 54 $ 54 $ 25
Home construction
warranty reserve 132 166 90 208
Home construction
inventory impairment 270 - 90 180
Reserve for abandonment
of leaseholds 273 - 38 235
Year ended September 30,1998
Allowance for doubtful
accounts $ 76 $ 9 $ 60 $ 25
Home construction
warranty reserve 123 108 99 132
Home construction
inventory impairment - 270 - 270
Reserve for abandonment
of leaseholds - 273 - 273
Year ended September 30,1997
Allowance for doubtful
accounts $ - $ 76 $ - $ 76
Home construction
warranty reserve 133 129 139 123
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
REALCO, INC.
Date: December 27, 1999 By: /s/ JAMES A. ARIAS
----------------------------------
James A. Arias, President,
Chief Executive Officer, and
Chairman of the Board of Directors
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons in behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
- ------------------------ ---------------------------- -----------------
/s/ JAMES A. ARIAS President, Chief Executive December 27, 1999
- ----------------------- Officer and Chairman
James A. Arias (Principal Executive Officer)
/s/ CHRIS A. BRUEHL Senior Vice President and December 27, 1999
- ----------------------- Chief Financial Officer
Chris A. Bruehl (Principal Financial and
Accounting Officer)
/s/ BILL E. HOOTEN Executive Vice President December 27, 1999
- ----------------------- and Director
Bill E. Hooten
/s/ ARTHUR A. SCHWARTZ Director December 27, 1999
- -----------------------
Arthur A. Schwartz
/s/ MARSHALL BLUMENFELD Director December 27, 1999
- -----------------------
Marshall Blumenfeld
/s/ NOEL ZELLER Director December 27, 1999
- -----------------------
Noel Zeller
/s/ MARTIN S. ORLAND Director December 27, 1999
- -----------------------
Martin S. Orland
<PAGE>
Exhibit 21.1
MI ACQUISITION CORPORATION
AND SUBSIDIARIES
Consolidated Financial Statements
October 31, 1999 and 1998
MI ACQUISITION CORPORATION AND SUBSIDIARIES
Table of Contents
Page
Independent Auditors' Report 1
Consolidated Balance Sheets 2
Consolidated Statements of Income 4
Consolidated Statements of Shareholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 7
<PAGE>
Independent Auditors' Report
The Board of Directors
MI Acquisition Corporation:
We have audited the accompanying consolidated balance sheets of MI Acquisition
Corporation and subsidiaries as of October 31, 1999 and 1998, and the related
consolidated statements of income, shareholders' equity and cash flows for the
years then ended. These consolidated financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of MI Acquisition
Corporation and subsidiaries as of October 31, 1999 and 1998, and the results of
their operations and their cash flows for the years then ended, in conformity
with generally accepted accounting principles.
KPMG LLP
Minneapolis, Minnesota
December 17, 1999
<PAGE>
MI ACQUISITION CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
October 31, 1999 and 1998
Assets 1999 1998
---------- ----------
Cash and cash equivalents $ 1,439,205 2,016,691
Receivables:
Customers 1,390,753 1,114,183
Brokers, dealers and clearing organizations 27,660 68,617
Officers' and employees' notes and advances 130,696 128,944
Notes receivable 1,363,139 1,906,634
Other receivables 1,516,116 2,278,984
---------- ----------
Total receivables 4,428,364 5,497,362
Securities inventory 26,382,956 17,712,874
Loan participation notes held for sale 12,131,039 4,948,907
Office equipment and leasehold improvements,
at cost, less accumulated depreciation and
amortization of $5,140,291 in 1999 and
$4,681,390 in 1998 1,512,254 1,291,618
Deferred taxes 500,000 548,230
Goodwill, net of amortization 4,070,289 4,323,473
Other 862,408 1,061,855
---------- ----------
Total assets $ 51,326,515 37,401,010
========== ==========
See accompanying notes to consolidated financial statements.
2
<PAGE>
MI ACQUISITION CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
October 31, 1999 and 1998
Liabilities and Shareholders' Equity 1999 1998
---------- ----------
Demand notes payable $ 20,347,870 10,463,755
Accounts payable:
Customers 374,262 1,134,376
Brokers, dealers and clearing organizations 161,130 883,543
Operating 1,035,395 1,217,506
Payable to borrowers or participants 6,227,950 1,416,586
---------- ----------
Total accounts payable 7,798,737 4,652,011
Accrued liabilities 4,640,583 4,739,865
Income taxes 285,578 140,548
Securities sold, not yet purchased 302,992 11,501
Term debt 6,916,665 8,006,229
---------- ----------
Total liabilities 40,292,425 28,013,909
---------- ----------
Commitments and contingencies (note 8)
Shareholders' equity:
Common stock, $.01 par value, 90,000,000
shares authorized; 938,950 issued and
outstanding in 1999 and 1998, respectively; 9,390 9,390
preferred stock, $.01 par
value, 10,000,000 shares authorized; none
issued and outstanding
Additional paid-in capital 8,537,053 8,537,053
Retained earnings 2,487,647 1,340,658
Less: Note receivable from
shareholder (note 10) - (500,000)
---------- ----------
Total shareholders' equity 11,034,090 9,387,101
---------- ----------
Total liabilities and shareholders' equity $ 51,326,515 37,401,010
========== ==========
<PAGE>
MI ACQUISITION CORPORATION AND SUBSIDIARIES
Consolidated Statements of Income
Years ended October 31, 1999 and 1998
1999 1998
---------- ----------
Revenues:
Securities underwriting and sales $ 16,617,171 23,821,848
Loan origination fees 13,277,792 7,585,732
Interest income 2,774,697 1,957,519
Other income 3,576,086 2,050,089
---------- ----------
Total revenues 36,245,746 35,415,188
Expenses:
Employee compensation:
Management and underwriting salaries 6,741,204 6,582,929
Sales commissions 5,733,152 5,959,824
Bonuses and incentive compensation 3,178,843 4,003,277
Office, clerical and support salaries 2,381,233 2,307,778
Benefits and other personnel costs 2,515,568 2,129,441
---------- ----------
Total employee compensation 20,550,000 20,983,249
General and administrative 11,516,983 10,409,470
Interest expense 2,093,274 2,021,719
---------- ----------
Total expenses 34,160,257 33,414,438
---------- ----------
Income before income taxes 2,085,489 2,000,750
Income tax expense 938,500 904,400
---------- ----------
Net income $ 1,146,989 1,096,350
========== ==========
See accompanying notes to consolidated financial statements.
4
<PAGE>
MI ACQUISITION CORPORATION AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
Years ended October 31, 1999
Additional
Common paid-in
Shares stock capital
---------- ---------- ----------
Balance, October 31, 1997 875,850 $ 8,759 7,906,684
Stock issued 73,500 735 734,265
Stock redeemed (10,400) (104) (103,896)
Net income - - -
---------- ---------- ----------
Balances, October 31, 1998 938,950 9,390 8,537,053
Note receivable collected - - -
Net income - - -
---------- ---------- ----------
Balances, October 31, 1999 938,950 $ 9,390 8,537,053
========== ========== ==========
Less: Note Total
Retained receivable shareholder's
Earnings (note 10) equity
---------- ---------- -------------
Balance, October 31, 1997 $ 244,308 - 8,159,751
Stock issued - (500,000) 235,000
Stock redeemed - - (104,000)
Net income 1,096,350 - 1,096,350
---------- ---------- -------------
Balances, October 31, 1998 1,340,658 (500,000) 9,387,101
Note receivable collected - 500,000 500,000
Net income 1,146,989 - 1,146,989
---------- ---------- -------------
Balances, October 31, 1999 $ 2,487,647 - 11,034,090
========== ========== =============
See accompanying notes to consolidated financial statements.
5
<PAGE>
MIACQUISITION CORPORATION AND SUBSIDIARIES Consolidated
Statements of Cash Flows Years ended October 31, 1999 and
1998
1999 1998
---------- ----------
Operating activities:
Net income $ 1,146,989 1,096,350
Adjustments to reconcile net income to net
cash provided (used) for operating
activities:
Depreciation 613,872 404,742
Amortization of goodwill 253,184 248,151
Receivables 1,068,998 4,483,748
Securities inventory (8,670,082) 21,581,008
Loan participation notes held for sale (7,182,132) 3,968,234
Deferred taxes 48,230 276,990
Other assets 199,447 96,946
Accounts payable 3,146,726 1,743,063
Accrued liabilities (99,282) 306,206
Income taxes 145,030 140,548
Securities sold, not yet purchased 291,491 -
---------- ----------
Net cash provided (used) for
operating activities (9,037,529) 34,345,986
Investing activities:
Goodwill adjustments (note 1) - 477,283
Purchase of MSAM - (813,331)
Payments for office equipment and leasehold
improvements, net (834,508) (862,805)
---------- ----------
Net cash used for investing activities (834,508) (1,198,853)
Financing activities:
Borrowings (repayments) under demand notes
payable, net 9,884,115 (32,079,245)
Net payments of term debt (1,089,564) (1,713,376)
Proceeds from note receivable to shareholder 500,000 -
Stock issued in connection with purchase
of MSAM - 235,000
Payments for stock redeemed - (104,000)
---------- ----------
Net cash provided (used) by
financing activities 9,294,551 (33,661,621)
---------- ----------
Net decrease in cash (577,486) (514,488)
Cash and cash equivalents, beginning of year 2,016,691 2,531,179
---------- ----------
Cash and cash equivalents, end of year $ 1,439,205 2,016,691
========== ==========
Supplemental disclosures of cash flow information: Cash paid during the year
for:
Interest $ 1,975,727 2,105,641
Income taxes 745,239 702,887
See accompanying notes to consolidated financial statements.
6
<PAGE>
MI ACQUISITION CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
October 31, 1999 and 1998
(1) Summary of Significant Accounting Policies
MI Acquisition Corporation (MIAC) and subsidiaries (the Company) provide
investment banking and advisory services; securities sales, trading, and
underwriting services; and services pertaining to the origination, financing,
and sales of loan participation notes. MIAC is the parent company of Miller and
Schroeder, Inc. (MSI) which in turn is the parent company of: Miller & Schroeder
Financial, Inc. (MSF), Miller & Schroeder Investments Corporation (MSIC), Miller
& Schroeder Small Business Capital Corporation (SBCC), Pooled Loan Marketing
Corporation (PLMC), Miller & Schroeder Capital Corporation (MSCC), Miller &
Schroeder Mortgage Corporation (MSMC), and Miller & Schroeder Asset Management,
Inc. (MSAM).
MSF is a registered broker-dealer in securities under the Securities Exchange
Act of 1934 and underwrites municipal and corporate securities. MSF also markets
and trades fixed income and equity securities. Effective November 8, 1999, MSF's
entire account base was converted to a third party clearing firm on a fully
disclosed basis.
The primary business of MSIC is the origination, financing, and sale of loan
participation notes and lease transactions which are collateralized by real
estate and/or equipment. These transactions are sold through arrangements made
by MSF in the form of nonrecourse loan participation notes. These sales are made
to unaffiliated institutional and other investors. MSIC is also the servicing
agent for loan participation notes of $889 and $639 million at October 31, 1999
and 1998, respectively.
All material intercompany balances and transactions have been eliminated in
consolidation.
In 1997, MIAC was formed and acquired all of the issued and outstanding common
stock of MSI for $13,930,415. The transaction has been accounted for as a
purchase. The cash purchase of outstanding MSI stock was partially financed by
$6,500,000 of term debt and the issuance of $6,729,000 of common stock equity.
The excess of the purchase price over the fair market value of identified net
assets acquired of $4,289,192 was allocated to goodwill. Goodwill is amortized
on a straight-line basis over a period of 20 years. During fiscal 1998, the
Company made purchase accounting adjustments resulting in a net reduction to
goodwill of $477,283.
In February 1998, MIAC acquired all of the issued and outstanding common stock
of MSAM for $813,331 including the assumption of net liabilities of $542,864.
The purchase was partially financed by the issuance of $235,000 of common stock.
The excess of the purchase price over the fair market value of identified net
assets acquired of $813,331 was allocated to goodwill. Goodwill is amortized on
a straight-line basis over a period of 20 years.
The following is a summary of significant accounting policies followed by the
Company:
(a) Cash and Cash Equivalents
For financial reporting purposes, the Company considers all investments
with original maturities of three months or less to be cash equivalents.
Included in cash at October 31, 1998 is $1,200,000 segregated in a special
bank account for the exclusive benefit of customers under Rule 15c3-3 of
the Securities and Exchange Commission. Amounts required to be segregated,
however, at October 31, 1998 was $810,712 and no balance was required at
October 31, 1999.
7
<PAGE>
MI ACQUISITION CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
October 31, 1999 and 1998
(b) Repurchase and Resale Transactions
Transactions involving purchases of securities under agreements to resell
(reverse repurchase agreements) or sales of securities under agreements to
repurchase (repurchase agreements) are accounted for as financing
transactions and are recorded at the contract amount plus accrued interest
at which the securities will be subsequently resold or reacquired.
(c) Securities Transactions and Loan Participation Notes Held for Sale
Securities inventories are carried at estimated current market values. The
difference between cost and market value is included in revenues from
profits on securities trading.
Loan participation notes held for sale are carried at the lower of
aggregate cost or market value. Substantially all of these loan
participation notes were sold subsequent to October 31, 1999 and 1998 at
prices that approximated their carrying values.
Purchases and sales of securities (including sales of loan participations)
are recorded on a settlement date basis. The difference between trade date
basis and settlement date basis accounting did not have a material effect
on the Company's financial position or results of operations.
(d) Office Equipment and Leasehold Improvements
Office equipment and leasehold improvements are stated at net book value.
Equipment is depreciated on a straight-line or accelerated basis over
estimated useful lives of five to seven years. Leasehold improvements are
amortized using the straight-line method over the lesser of the respective
lease term or estimated useful life of the improvements.
(e) Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
(f) Stock-based Compensation
The Company accounts for stock option grants using APB Opinion No. 25
(APB No. 25) and, accordingly, does not recognize compensation expense
related to option grants. The Company, however, applies the disclosure
provisions of Statement of Financial Accounting Standards No. 123 (SFAS
No. 123), Accounting for Stock-based Compensation.
8
<PAGE>
MI ACQUISITION CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
October 31, 1999 and 1998
(2) Securities Inventory and Loan Participation Notes Held for Sale
Securities positions, net of securities sold, not yet purchased, at October 31
are summarized as follows:
1999 1998
---------- ----------
Municipal securities $ 19,005,501 16,189,420
U.S. Government and Government
agency securities 255,072 3,021
Other 6,819,391 1,508,932
---------- ----------
Total $ 26,079,964 17,701,373
========== ==========
Loan participation notes held for sale at October 31, 1999 and 1998 totaling
$12,131,039 and $4,948,907, respectively, represent the unsold portions of real
estate mortgage and equipment loan financings with interest rates ranging from
7.25% to 10.00%.
(3) Notes Receivable
Notes receivable at October 31, 1999 and 1998, consist of $25,000 and $102,233,
respectively, of short-term notes and $1,338,139 and $1,804,401 of long-term
notes, respectively. The long-term notes are collateralized by real estate, have
maturity dates ranging from 2001 through 2005 and have interest rates ranging
from 9.41% to 12.43%. The short-term notes relate to temporary advances to
issuers.
(4) Funds Held in Escrow
In connection with MSIC's loan servicing activities, funds for real estate
taxes, insurance, and certain reserve accounts, including amounts for
construction participations, are collected and held in escrow in accordance with
loan documents. Funds held in escrow as of October 31, 1999 and 1998 were
$19,399,129 and $20,231,657, respectively. These funds are not included in the
Company's balance sheets.
(5) Financing Arrangements
(a) Demand Notes Payable
MSF has financing arrangements with several financial institutions and may
borrow up to an aggregate of $51 million. MSF's trading securities and
certain assets are pledged as collateral under these arrangements. Amounts
borrowed under these arrangements fluctuate daily based on the timing of
customer and broker-dealer trades and issues underwritten by MSF. The terms
and expiration dates of these facilities are periodically renegotiated. At
October 31, 1999 and 1998, $11,050,000 and $5,875,000 were outstanding and
$39,950,000 and $45,125,000 were available on these facilities,
respectively. MSF is expected to maintain agreed-upon compensating balances
with the financial institutions. MSF's interest rates on these borrowings
fluctuate with the daily federal funds rate. The rates in effect at October
31, 1999 and 1998, ranged from 6.55% to 6.875% and 6.925% to 7.0%,
respectively.
9
<PAGE>
MI ACQUISITION CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
October 31, 1999 and 1998
MSIC has a $5 million credit facility with a financial institution, and may
draw up to $10 million on MSF's credit facility. At October 31, 1999 and
1998, MSIC had $7,825,000 and $4,500,000 outstanding on these credit
facilities, respectively. MSIC may borrow funds under terms of the demand
note to finance loan participation notes up to predefined amounts, with the
underlying notes pledged as collateral. Interest accrues at the financial
institution's base rate plus 1% (9.25% at October 31, 1999 and 9.0% at
October 31, 1998).
SBCC has a $1 million credit facility with a financial institution which is
secured by notes receivable, and may draw up to $4 million on MSF's credit
facility. At October 31, 1999, there was a balance on these facilities of
$1,284,000 and at October 31, 1998, $0 was outstanding. Interest accrues at
the financial institution's federal funds rate plus 1.5% (6.875% at October
31, 1999).
MSCC has a note payable to a limited partnership of $188,870 at October 31,
1999 that is payable on demand. Interest accrues on this note at 7.25%.
(b) Term Debt
Term debt outstanding as of October 31 consisted of :
1999 1998
---------- ----------
Pollution Control Financing Certificates collateralized by certain notes
receivable guaranteed by the Small Business Administration:
9%, due in annual installments through
October 2001, $ 1,095,000 1,575,000
12.25%, due in March 2005. 182,000 182,000
Notes payable, 8.5%, due in monthly
installments through February 2000,
collateralized by equipment. 3,855 14,789
Notes payable, (8.45% to 9.20% and 10.375% at October 31, 1999 and 1998,
respectively), due in monthly installments through June 2003,
collateralized by certain furniture and
office equipment. 766,566 1,105,192
Notes payable, prime rate plus 1% (9.25% and 9.0% at October 31, 1999 and
1998, respectively), due in monthly installments through October 2001,
collateralized
by note receivable. 399,988 599,992
Note payable to shareholder of the Company,
6.5%, due in annual installments through
January 2003. 289,256 289,256
10
<PAGE>
MI ACQUISITION CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
October 31, 1999 and 1998
1999 1998
---------- ----------
Revolving line of credit, prime rate plus 1% (9.25% and 9.0% at October 31,
1999 and 1998, respectively), due in quarterly
installments through September 2002. 1,680,000 2,240,000
Notes payable, federal funds rate plus 1.5% (6.875% and 7.0% at October 31,
1999 and 1998, respectively), due September 2002 or on demand,
collateralized by marketable
securities. 2,000,000 2,000,000
Note payable to shareholder of the Company,
7% due December 15, 1999. 500,000 -
---------- ----------
$ 6,916,665 8,006,229
========== ==========
The revolving line of credit is collateralized by all assets of the
Company. The Company is required to meet certain operating, capital,
coverage, and debt related covenants under these agreements.
Maturities of term debt outstanding at October 31, 1999 are as follows:
2000 $ 2,170,108
2001 1,512,906
2002 2,660,904
2003 390,747
2004 -
Thereafter 182,000
----------
$ 6,916,665
==========
(6) Income Taxes
The Company files combined state income tax returns, except in certain states
where separate returns are filed, and files a consolidated federal income tax
return.
11
<PAGE>
MI ACQUISITION CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
October 31, 1999 and 1998
The income tax provision reflected in the accompanying consolidated statements
of income consists of:
1999 1998
---------- ----------
Current:
Federal $ 685,000 897,000
State 212,000 32,000
Deferred 41,500 (24,600)
---------- ----------
$ 938,500 904,400
=========== ==========
The Company had net deferred tax assets of $500,000 and $548,230 at October 31,
1999 and 1998, respectively. The temporary differences that give rise to a
significant portion of the deferred tax asset relate primarily to deferred
income and compensation related accruals.
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. Management considers the scheduled reversal of
deferred tax liabilities, projected future taxable income, and tax planning
strategies in making this assessment. In order to fully realize the deferred tax
asset, the Company will need to generate sufficient future taxable income. Based
upon the levels of historical taxable income, projections of future taxable
income, and the ability to carry losses back, management believes it is more
likely than not that the Company will realize the benefits of the deferred tax
asset as of October 31, 1999 and 1998.
The effective tax rate is calculated using the provision for income taxes. The
difference between the U.S. Federal Statutory rate and the effective tax rate is
as follows:
1999 1998
---------- ----------
Statutory tax rate at October 31 34.00% 34.00%
Effect of items on tax rate and provision amounts:
State taxes (net of federal benefit) 6.71% 7.72%
Tax exempt income (8.40%) (5.87%)
Non deductible goodwill 4.13% 4.22%
Meals and Entertainment 3.67% 0.00%
Other 1.16% 5.13%
Additional provision for income taxes 3.73% 0.00%
---------- ----------
Effective tax rate at October 31 45.00% 45.20%
========== ==========
12
<PAGE>
MI ACQUISITION CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
October 31, 1999 and 1998
(7) Net Capital Requirements
As a broker-dealer, MSF is subject to the Securities and Exchange Commission
Uniform Net Capital Rule (Rule 15c3-1), which requires the maintenance of
minimum net capital. MSF has elected to use the alternative method, permitted by
the Rule, which requires that MSF maintain minimum net capital, as defined,
equal to the greater of $250,000 or 2% of aggregate debit balances arising from
customer transactions, as defined. At October 31, 1999, MSF's net capital, as
defined, of $4,743,999 and was 331% of aggregate debit balances and was
$4,493,999 in excess of the minimum net capital required.
(8) Commitments and Contingencies
(a) Underwriting Commitments
In the ordinary course of business, MSF enters into underwriting
commitments. Transactions relating to such underwriting commitments that
were open at October 31, 1999 have subsequently settled and had no material
affect on the financial statements.
(b) Operating Leases
The Company has operating lease commitments expiring at various dates for
its offices and certain equipment. Rental expense was $1,326,800 and
$1,292,821 for fiscal 1999 and 1998, respectively. Future minimum payments
under operating leases are as follows:
Fiscal year:
2000 $ 1,572,764
2001 1,485,585
2002 1,481,509
2003 1,167,656
2004 1,053,599
Thereafter 2,094,904
(c) Employee Benefit Plan
The Company has a 401(k) plan that allows employees to contribute a portion
of their compensation. The expense related to this plan was $308,050 and
$285,990 for the years ended October 31, 1999 and 1998, respectively.
(d) Contingencies
In the normal course of business, the Company, from time to time, becomes
involved in claims and litigation that may ultimately result in a liability
to the Company. It is the opinion of management that facts known at the
present time do not indicate that the ultimate resolution of any such
claims or litigation would have a material effect on the Company's
operations or its financial position.
13
<PAGE>
MI ACQUISITION CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
October 31, 1999 and 1998
(e) Other
As of October 31, 1999 and 1998, MSIC had committed to advance $144,369,047
and $47,440,244, respectively, in construction loans. Concurrent with this
commitment, MSIC has entered into commitments to sell these loans in the
form of nonrecourse loan participation notes.
(9) Financial Instruments with Off-Balance-Sheet Risk
In the ordinary course of business, the Company's securities activities involve
execution, settlement, and financing of various securities transactions as
principal and agent. These activities may expose the Company to credit and
market risks in the event customers, other brokers and dealers, banks,
depositories, or clearing organizations are unable to fulfill contractual
obligations. Such risks may be increased by volatile trading markets.
The Company records customer securities transactions on a settlement date basis.
The Company is therefore exposed to off-balance-sheet risk of loss on unsettled
transactions in the event customers and other counterparties are unable to
fulfill contractual obligations.
The Company also may assume short positions in its inventory. These transactions
result in off-balance-sheet market risk as the Company's ultimate obligation to
satisfy the short sale may exceed the amount recognized in the balance sheets.
The Company also may lend money subject to reverse repurchase agreements. All
positions are collateralized, primarily with U.S. Government or U.S. Government
agency securities. The Company's policy is to take physical possession of
securities purchased under agreements to resell. Such transactions may expose
the Company to risk in the event such borrowers do not repay the loans and the
value of collateral held is less than that of the underlying receivable. These
agreements provide the Company with the right to maintain the relationship
between market value of the collateral and the receivable.
The Company does not believe that it has any significant concentrations of
credit risk.
(10) Stock Option Plans
The Company maintains two fixed stock compensation plans, the MI Acquisition
Corporation Stock Option Plan and the Director Stock Option Plan, which are used
to provide stock incentives to key employees and outside directors of the
Company. Each Plan authorizes the grant of incentive and/or non-qualified
options with an exercise price equal to the fair value of the common stock as of
the grant date. Vesting periods for the options range from immediately to five
years and expire ten years from the date of grant. At October 31, 1999 and 1998,
136,287 and 158,912 shares of common stock, respectively, were available for
grant under the Stock Option Plan and 39,500 and 47,000 shares were available
for grant under the Director Stock Option Plan.
The company granted 50,000 options during the year ended October 31, 1997 to a
director of the company in connection with the MSI acquisition. These options
were exercised effective August 1, 1998 and 50,000 shares were issued at a price
of $10 per share. The Company recorded a loan to the director for this
subscription. The $500,000 outstanding balance of this note receivable was
collected in full during fiscal 1999.
14
<PAGE>
MI ACQUISITION CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
October 31, 1999 and 1998
The Company applies APB No. 25 and related Interpretations in accounting for its
stock option plan. Accordingly, no compensation expense has been recognized in
the consolidated financial statements for stock option grants. Had compensation
expense been determined based on the fair value of the options at grant date
consistent with SFAS No. 123, the Company's consolidated net income of
$1,146,989 and $1,096,350 for the years ended October 31, 1999 and 1998, would
have been $1,093,913 and $985,921, respectively.
The weighted average per-share fair value of options granted during fiscal 1999
and 1998 was $3.54 and $1.87, respectively. The fair value of each option
granted is estimated on the date of grant using the Minimum Value Method with
the following weighted average assumptions used for grants in 1999 and 1998;
dividend yields of 0%; expected volatility of 0%; risk-free interest rate of
5.97% in 1999 and 4.22% in 1998; and expected life of 5 years in 1999 and 5
years in 1998. Pro forma amounts may not be indicative of future results.
The following table summarizes the activity related to the Company's stock
options for the year ended October 31, 1999 and 1998:
1999 1998
----------------- -----------------
Weighted Weighted
average average
exercise exercise
Shares price Shares price
------- -------- ------- --------
Options outstanding at
beginning of year 144,088 $ 10.00 50,000 $ 10.00
Granted 34,000 13.72 144,088 10.00
Exercised - - (50,000) 10.00
Canceled, forfeited or expired (3,875) 10.00 - -
------- -------- ------- --------
Options outstanding at
end of year 174,213 $ 10.73 144,088 $ 10.00
======= ======== ======= ========
The options outstanding at October 31, 1999 and 1998 have a weighted average
remaining contractual life of nine and nine years, respectively.
15
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-END> SEP-30-1999
<CASH> 3688000
<SECURITIES> 0
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