REGENCY
AFFILIATES, INC.
FORM
10-Q
FOR
THE QUARTERLY PERIOD ENDED
SEPTEMBER
30, 2008
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Page
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Part I.
Financial
Information
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|
Item
1. Financial Statements
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|
Consolidated
Balance Sheets September 30, 2008 (Unaudited) and December 31, 2007
(Audited)
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3
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Consolidated
Statements of Operations (Unaudited)
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4
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Consolidated
Statement of Cash Flows (Unaudited)
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5
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Notes
to Consolidated Financial Statements
|
6
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Item 2.
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
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9
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Item 3.
Quantitative
and Qualitative Disclosures About Market
Risk
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13
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Item
4. Controls and Procedures
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13
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Part
II. Other Information
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13
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Item
1. Legal Proceedings
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13
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Item
1A. Risk Factors
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14
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Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds
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15
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Item
3. Defaults Upon Senior Securities
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15
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Item
4. Submission of Matters to a Vote of Security Holders
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15
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Item
5. Other Information
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15
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Item
6. Exhibits
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16
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Signatures
|
18
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Regency
Affiliates, Inc. and Subsidiaries
Condensed
Consolidated Balance Sheet
Assets
|
|
|
|
|
|
|
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September 30,
2008
(Unaudited)
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|
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December 31,
2007
(Audited)
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|
Current
Assets
|
|
|
|
|
|
|
Cash and cash
equivalents
|
|
$
|
3,165,937
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|
|
$
|
253,566
|
|
Marketable
securities
|
|
|
7,198,470
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|
|
|
9,782,234
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Interest receivable,
net of allowance of $644,109
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|
|
-
|
|
|
|
-
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|
Other current
assets
|
|
|
360,636
|
|
|
|
344,539
|
|
|
|
|
|
|
|
|
|
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Total Current
Assets
|
|
|
10,725,043
|
|
|
|
10,380,339
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|
Property,
plant and equipment, net
|
|
|
10,242
|
|
|
|
13,117
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|
|
|
|
|
|
|
|
|
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Investment in
partnerships/LLC
|
|
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10,635,767
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|
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9,563,717
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|
Deferred
tax asset
|
|
|
1,245,500
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|
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1,245,500
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Other
|
|
|
1,300
|
|
|
|
1,300
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|
|
|
|
|
|
|
|
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Total
Assets
|
|
$
|
22,617,852
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|
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$
|
21,203,973
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|
Liabilities
and Stockholders’ Equity
|
|
|
|
|
|
|
|
|
|
|
|
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Current
Liabilities
|
|
|
|
|
|
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Accounts payable and
accrued expenses
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|
$
|
269,172
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|
|
$
|
391,651
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|
Income taxes
payable
|
|
|
16,000
|
|
|
|
-
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|
Total
Liabilities
|
|
|
285,172
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|
|
|
391,651
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|
|
|
|
|
|
|
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|
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|
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Stockholders'
equity
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Serial preferred
stock Series C and D, 234,544 shares outstanding,
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|
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not subject to
mandatory redemption (Maximum liquidation
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|
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preference $21,141,940)
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486,076
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|
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486,076
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|
|
|
|
|
|
|
|
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Common stock, par
value $.01; authorized 8,000,000 shares;
|
|
|
|
|
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|
issued 3,534,812
shares; outstanding 3,468,544 shares
|
|
|
35,349
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|
|
|
35,319
|
|
|
|
|
|
|
|
|
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Additional paid-in
capital
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7,281,219
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|
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7,112,199
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Readjustment
resulting from quasi-reorganization at
December
1987
|
|
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(1,670,596
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)
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(1,670,596
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)
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Retained
earnings
|
|
|
16,609,482
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|
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|
15,258,174
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Note receivable -
sale of stock, net of allowance of $2,440,000
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|
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-
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|
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-
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Treasury stock,
66,268 shares at cost
|
|
|
(408,850
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)
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|
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(408,850
|
)
|
|
|
|
|
|
|
|
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|
Total Stockholders'
Equity
|
|
|
22,332,680
|
|
|
|
20,812,322
|
|
|
|
|
|
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|
|
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Total
Liabilities and Stockholders’ Equity
|
|
$
|
22,617,852
|
|
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$
|
21,203,973
|
|
|
|
|
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The
attached notes are an integral part of these financial
statements.
Regency
Affiliates, Inc. and Subsidiaries
Condensed
Consolidated Statements of Operations
(Unaudited)
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|
Three
Months Ended
September
30,
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Nine
Months Ended
September
30,
|
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|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
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Net
Sales
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|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Costs
and expenses
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|
|
|
|
|
|
|
|
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|
|
|
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General and administrative
expenses
|
|
|
534,355
|
|
|
|
516,482
|
|
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|
1,177,946
|
|
|
|
1,008,978
|
|
|
|
|
534,355
|
|
|
|
516,482
|
|
|
|
1,177,946
|
|
|
|
1,008,978
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Loss
from operations
|
|
|
(534,355
|
)
|
|
|
(516,482
|
)
|
|
|
(1,177,946
|
)
|
|
|
(1,008,978
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Income
from equity investment in partnerships
|
|
|
1,233,922
|
|
|
|
1,017,263
|
|
|
|
2,447,050
|
|
|
|
1,739,247
|
|
Interest
and dividend income
|
|
|
43,309
|
|
|
|
101,211
|
|
|
|
140,693
|
|
|
|
342,670
|
|
Other
income
|
|
|
72
|
|
|
|
1,274
|
|
|
|
72
|
|
|
|
1,847
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
before income taxes
|
|
|
742,948
|
|
|
|
603,266
|
|
|
|
1,409,869
|
|
|
|
1,074,786
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for income taxes
|
|
|
58,560
|
|
|
|
30,275
|
|
|
|
58,560
|
|
|
|
30,275
|
|
Net
income
|
|
$
|
684,388
|
|
|
$
|
572,991
|
|
|
$
|
1,351,309
|
|
|
$
|
1,044,511
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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Net
income per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Basic
|
|
$
|
.19
|
|
|
$
|
.16
|
|
|
$
|
.38
|
|
|
$
|
.30
|
|
Diluted
|
|
$
|
.18
|
|
|
$
|
.15
|
|
|
$
|
.36
|
|
|
$
|
.28
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of common shares
outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
3,534,812
|
|
|
|
3,531,540
|
|
|
|
3,533,032
|
|
|
|
3,457,031
|
|
Diluted
|
|
|
3,741,954
|
|
|
|
3,779,640
|
|
|
|
3,752,528
|
|
|
|
3,705,131
|
|
*2007 net
income per common share – diluted and 2007 weighted average number of common
shares outstanding – diluted have been restated to properly reflect the
computations in
accordance with FAS
128,
“Earnings Per Share, “ which utilizes the treasury stock method for determining
such common stock equivalents.
The
attached notes are an integral part of these financial
statements.
Regency
Affiliates, Inc. and Subsidiaries
Condensed
Consolidated Statements of Cash Flows
(Unaudited)
|
|
Nine
Months Ended
September
30,
|
|
|
|
2008
|
|
|
2007
|
|
Cash
flows from operating activities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
1,351,309
|
|
|
$
|
1,044,511
|
|
Adjustments
to reconcile net income to
|
|
|
|
|
|
|
|
|
net
cash used in operating activities
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
2,875
|
|
|
|
2,517
|
|
(Income)
from equity investment in partnerships
|
|
|
(2,447,050
|
)
|
|
|
(1,739,247
|
)
|
Stock
based compensation
|
|
|
154,200
|
|
|
|
197,750
|
|
Changes
in operating assets and liabilities
|
|
|
|
|
|
|
|
|
Other
current assets
|
|
|
(16,097
|
)
|
|
|
(7,693
|
)
|
Accounts
payable and accrued expenses
|
|
|
(107,629
|
)
|
|
|
(231,641
|
)
|
Income
taxes payable
|
|
|
16,000
|
|
|
|
-
|
|
Net
cash (used in) operating activities
|
|
|
(1,046,392
|
)
|
|
|
(733,803
|
)
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds
received from partnership distributions
|
|
|
1,375,000
|
|
|
|
500,000
|
|
Purchases
of property and equipment
|
|
|
-
|
|
|
|
(12,589
|
)
|
Proceeds
from sales of marketable securities
|
|
|
60,000,000
|
|
|
|
70,400,000
|
|
Purchases
of marketable securities
|
|
|
(57,416,237
|
)
|
|
|
(70,405,065
|
)
|
|
|
|
|
|
|
|
|
|
Net
cash provided by investing activities
|
|
|
3,958,763
|
|
|
|
482,346
|
|
Cash
flows from financing activities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds
from the exercise of stock options
|
|
|
-
|
|
|
|
22,275
|
|
Purchase
of treasury stock
|
|
|
-
|
|
|
|
(88,189
|
)
|
Net
cash provided by (used in) financing activities
|
|
|
-
|
|
|
|
(65,914
|
)
|
|
|
|
|
|
|
|
|
|
Increase
in cash and cash equivalents
|
|
$
|
2,912,371
|
|
|
$
|
(317,371
|
)
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents – beginning
|
|
|
253,566
|
|
|
|
613,253
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents – ending
|
|
$
|
3,165,937
|
|
|
$
|
295,882
|
|
|
|
Nine
Months Ended
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
Supplemental
disclosures of cash flow information:
|
|
|
|
|
|
|
Cash paid during the period
for
|
|
|
|
|
|
|
Interest
|
|
$
|
-
|
|
|
$
|
47,862
|
|
|
|
|
|
|
|
|
|
|
Income taxes
|
|
$
|
103,814
|
|
|
$
|
32,900
|
|
The
attached notes are an integral part of these financial statements.
REGENCY
AFFILIATES, INC.
AND
SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1.
Basis of Presentation
The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q of Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included. Operating results for the
nine-month period ended September 30, 2008 are not necessarily indicative of the
results that may be expected for the year ended December 31,
2008. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's Annual Report on Form
10-KSB for the year ended December 31, 2007.
Principles
of Consolidation - The consolidated financial statements include the accounts of
Regency Affiliates, Inc. (the "Company"), its wholly owned subsidiaries, Regency
Power, Inc. and Rustic Crafts International, Inc. ("Rustic Crafts"), its 75%
owned subsidiary, Iron Mountain Resources, Inc. ("IMR"), and its 80%
owned subsidiary, National Resource Development Corporation
("NRDC"). All significant intercompany balances and transactions have
been eliminated in consolidation.
Note
2. Related Party Transactions
In
December 2005, the Company’s wholly owned subsidiary, Rustic Crafts, entered
into a stipulation of settlement with RCI Wood Products (“RCI”) regarding
outstanding indebtedness with
RCI
. Under
the terms of this settlement, RCI agreed to pay to Rustic Crafts the sum of
$125,000 with interest at six and one-half percent per annum, payable in
thirty-five (35) monthly installments of $1,088 each, commencing in January
2006. No payments have been received since March 2006. RCI
defaulted on the note in April 2006. The Company had initiated an
action for collection against RCI and personal guarantor of the
note. In June 2008, the Company sold the above mentioned notes to a
collection agency for $1,000 plus 50% of any amounts received, less expenses of
up to $2,500. To date, the Company has received $1,000 from the
collection agency and the collection agency has not received any proceeds on the
notes.
On June
11, 2008, the Company issued 3,000 shares of the Company’s common stock to a
director for payment of director fees for the fiscal year ended December 31,
2006, the fiscal year ended December 31, 2007 and for the first three months of
the fiscal year ending December 31, 2008. The value of the stock amounted to
$14,850.
During
the nine month periods ended September 30, 2008 and 2007, the Company paid
$31,500 in each quarter pursuant to a license agreement entered into with
Royalty Management, Inc. (“Royalty”), an entity wholly owned by Laurence Levy,
the Company’s President and Chief Executive Officer, for office space, office
supplies and services.
During
the nine month periods ended September 30, 2008 and 2007, the Company incurred
directors’ fees of $27,000 and $0, respectively, for services
rendered. As of September 30, 2008 and 2007, $18,000 and $0,
respectively, was included in accrued expenses due to directors for services
rendered.
On August
13, 2008, the Company issued 50,000 options to purchase shares of the Company’s
common stock to an officer of the Company. The stock options are
exercisable at $4.20 per share and expire on August 13, 2018. (see note 4 –
Stock Based Compensation).
REGENCY
AFFILIATES, INC.
AND
SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note
2. Related Party Transactions, continued
On
February 16, 2007, the Company exercised its right to redeem all of the issued
and outstanding Series B Stock (370,747 shares), payable on March 15, 2007. The
aggregate redemption price of 430,473 shares of the Company’s common stock, at
$6.65 per share, amounted to $2,862,645. As this amount is less than the
original debt obligations exchanged with the preferred stockholders, which
represented their investment in 1991 of $3,707,470, no deemed dividend nor
beneficial conversion feature has been recognized by the Company in the current
period. This transaction resulted in the retirement by the Company of all issued
and outstanding Series B Stock.
During
the quarter ended September 30, 2007, the Company issued options to an officer
of the Company to purchase 50,000 shares of its common stock, pursuant to the
Company’s 2003 Stock Incentive Plan, as amended. The stock options expire on
August 14, 2017 and have an exercise price of $5.10 per share. (see note 4 –
Stock Based Compensation).
During
the quarter ended September 30, 2007, two former directors of the Company each
exercised stock options to purchase 1,000 shares of the Company’s
common stock at an exercise price of $1.60 per share.
Note
3. Uncertainties and Contingencies
During
the preparation of the Company's 2004, 2005, 2006, and 2007 Federal corporation
income tax
returns
, a dispute arose between
the Company and Security Land
and Development
Company Limited Partnership (“Security Land”)
regarding the proper amount
of taxable income to be allocated to the Company and reported to the Internal
Revenue Service (the "IRS") on Federal Form K-1. This dispute could not be
resolved and the Company reported a different amount of income on its
corporation income tax return than was reported to the IRS by Security
Land
. The discrepancy may cause the Company's
tax returns to be audited by the IRS. The Company believes that the
outcome of any IRS examination will not affect the financial statements of the
Company as net operating losses are available to offset any additional income
not reported.
In July
2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes” (FIN 48). FIN 48 clarifies the accounting for income taxes by
prescribing a minimum probability threshold that a tax position must meet before
a financial statement benefit is recognized. The minimum threshold is defined in
FIN 48 as a tax position that is more likely than not to be sustained upon
examination by the applicable taxing authority, including resolution of any
related appeals or litigation processes, based on the technical merits of the
position. The tax benefit to be recognized is measured as the largest amount of
benefit that is greater than fifty percent likely of being realized upon
ultimate settlement. FIN 48 must be applied to all existing tax positions upon
initial adoption. The cumulative effect of applying FIN 48 at adoption, if any,
is to be reported as an adjustment to opening retained earnings for the year of
adoption. FIN 48 was effective for the Company’s fiscal year ended December 31,
2007 and no cumulative effects are reported through September 30,
2008.
REGENCY
AFFILIATES, INC.
AND
SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
On January 20, 2004, a
purported derivative and class action lawsuit was filed by two dissident Company
shareholders, Edward E. Gatz and Donald D. Graham, in the New Castle County
Court of Chancery, Delaware (the "Court"), captioned Gatz, et al. v. Ponsoldt,
Sr., et al., (C.A. No. 174-N) naming as defendants certain current and former
directors of the Company, Royalty and certain of its affiliates, Statesman and,
nominally, the Company (the "Delaware Action"). The complaint alleged various
breaches of fiduciary duties by the former directors and Statesman, and that
Royalty and its affiliates knowingly participated in certain of the alleged
breaches. In November 2004 the Court dismissed all but one claim alleged in the
complaint. The Company was not a defendant with respect to the sole surviving
claim, which related to the 2001 sale of a cache of previously quarried and
piled aggregate rock by NRDC to Iron Mountain (the "Aggregate Sale"). On October
16, 2005, the Court dismissed plaintiffs' sole remaining claim for failure to
state a claim for relief. The dismissal was without prejudice and the plaintiffs
were given leave to file an amended complaint attacking the Aggregate
Sale.
On January 30, 2006,
plaintiffs filed an amended complaint challenging the Aggregate Sale and
alleging that the Aggregate Sale negatively impacted the consideration the
Company received in connection with the October 2002 restructuring transactions.
The Company was not a defendant with respect to this claim. Plaintiffs sought
damages in excess of $5,400,000 with respect to the claim related to the
Aggregate Sale. On May 16, 2006, the Court dismissed the sole remaining
complaint alleged in the complaint determining that the sole remaining complaint
was derivative in nature and could therefore not be maintained by the
plaintiffs. On June 14, 2006, the plaintiffs filed a Notice of Appeal appealing
the Court's rulings. In its April 16, 2007 decision, citing an intervening legal
development in the area of direct and derivative claims arising while the appeal
was pending, the Supreme Court of the State of Delaware reversed the Court's
decision and remanded the case to the Court for further
proceedings.
Following the Supreme Court's
remand, the parties began settlement discussions. On April
28, 2008 the parties executed a memorandum of understanding (the "MOU")
reflecting an agreement in principle to settle that class action.
Among other things, the MOU provides that if the settlement is
consummated, the Company will pay $3,000,000 plus interest (as
provided in the MOU) to the plaintiff class. The plaintiff class is defined in
the MOU as all record and beneficial owners of our common stock on October
17, 2002, including any and all of their respective successors in interest,
predecessors, representatives, trustees, executors, administrators, heirs,
immediate and remote, and any person or entity acting for or on behalf of, or
claiming under any of them, and each of them. The plaintiff class does not
include the defendants, members of their families, affiliates of the defendants,
and those individuals or entities who solely held securities convertible into
the
Company’s
common
stock or options to purchase
the Company’s
common stock. The
Company will make that payment pursuant to its obligation to indemnify the
defendants who are former directors of the Company. The MOU provides that the
Company will undertake an appropriate process to determine if
indemnification of its former directors is appropriate under Delaware law.
The MOU expressly provides that the defendants admit no wrongdoing but have
agreed to the MOU to eliminate the uncertainty, distraction, burden and expense
of further litigation. In exchange for the payment, all claims
against the former directors, Statesman, Royalty and the current directors will
be released by the members of the class.
Pursuant to the MOU, the
Company engaged WolfBlock LLP
(“WolfBlock”)
to determine if the former
directors were entitled to indemnification. After reviewing thousands of
pages of documents, testimony from the former directors and the plaintiffs and
interviewing certain former directors, their counsel, plaintiffs and their
counsel, WolfBlock determined that the former directors were entitled to
indemnification from the Company under Delaware law and our
bylaws.
On December 4, 2008, the
parties signed a Stipulation of Settlement which memorialized their agreement,
subject to the approval of the Court, to settle the class action. The
terms of the final settlement are in all material respects identical to the
terms of the MOU. The Court has scheduled a hearing for March 16, 2009, at
which time the Court will consider whether it will approve the Stipulation of
Settlement as fair, reasonable, adequate and in the bests interests of the
class. If the Court approves the settlement, the Company will make the $3
million payment plus interest to the class.
T
he Company's insurance
carrier contends that none of the claims contained in the Delaware Action are
covered by insurance on the basis of the "insured vs. insured" exclusion since
one of the plaintiffs, Donald D. Graham, was previously a director of the
Company.
REGENCY
AFFILIATES, INC.
AND
SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note
4. Stock Based Compensation
On August
13, 2008, the Company’s Board of Directors approved an amendment to the
Company’s 2003 Stock Incentive Plan, as amended, which increased the total
number of authorized shares available under the Plan from 500,000 to 750,000.
All other terms of the Plan remain in full force and effect.
During
the quarter ended September 30, 2008, an officer of the Company received 50,000
stock options to purchase shares of the Company’s common stock at an exercise
price of $4.20 per share. The fair value of the stock options was estimated
using the Black-Scholes option-pricing model that requires highly subjective
assumptions including the expected stock price volatility. The fair value of the
stock options granted was estimated using the following assumptions: no expected
dividends, risk free interest rate of 3.94%, expected average life of
approximately 7 years, and an expected stock price volatility of
62.08%. The fair value of the stock options granted was $3.08 for
total stock based compensation expense of $154,200 for the quarter ended
September 30, 2008.
During
the quarter ended September 30, 2007, an officer of the Company received 50,000
stock options to purchase shares of the Company’s common stock at an exercise
price of $5.10 per share. The fair value of the stock options was estimated
using the Black-Scholes option-pricing model that requires highly subjective
assumptions including the expected stock price volatility. The fair value of the
stock options granted was estimated using the following assumptions: no expected
dividends, risk free interest rate of 4.73%, expected average life of
approximately 10 years, and an expected stock price volatility of
67%. The fair value of the stock options granted was $3.96 for total
stock based compensation expense of $197,750 for the quarter ended September 30,
2007.
Note
5. Subsequent Events.
On
December 17, 2008, the Company amended 5,000 outstanding stock options to
purchase shares of the Company’s common stock owned by Errol Glasser, a director
of the Company, in order to comply with provisions of Section 409A of the
Internal Revenue Code, as amended. The previous options, which were
cancelled, were exercisable on April 1, 2005, had an expiration date of
April 1, 2013 and an exercise price of $2.40 per share. The
replacement stock options were issued to Mr. Glasser on December 17, 2008 and
have an exercise date of December 17, 2008, an expiration date of December 17,
2018 and an exercise price of $2.60 per share. In addition, the
employment agreements with Laurence Levy, President and Chief Executive Officer
of the Company and Neil Hasson, Chief Financial Officer of the Company, were
also amended on December 17, 2008 in order to comply with provisions of Section
409A of the Internal Revenue Code, as amended.
ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
Forward-Looking
Statements
Certain
statements contained in this Quarterly Report on Form 10-Q, including, but not
limited to those regarding the Company's financial position, business strategy,
acquisition strategy and other plans and objectives for future operations and
any other statements that are not historical facts constitute "forward-looking
statements" within the meaning of federal securities laws and the Private
Securities Litigation Reform Act of 1995. Such forward-looking statements
involve known and unknown risks, uncertainties and other important factors that
could cause the actual results, performance or achievements expressed or implied
by such forward-looking statements to differ materially from any future results,
performance or achievements expressed or implied by such forward-looking
statements. Although the Company believes that the expectations reflected in
these forward-looking statements are reasonable, there can be no assurance that
the actual results or developments anticipated by the Company will be realized
or, even if substantially realized, that they will have the expected effect on
its business or operations. These forward-looking statements are made
based on management's expectations and beliefs concerning future events
impacting the Company and are subject to uncertainties and factors (including,
but not limited to, those specified below) which are difficult to predict and,
in many instances, are beyond the control of the Company.
The
following discussion and analysis of the financial condition and results of
operations of the Company should be read in conjunction with the accompanying
financial statements and related notes included in
Item 1 of
this report.
GENERAL.
We are
committed to enhancing the value of our common stock by seeking opportunities to
monetize certain existing assets and by seeking new business opportunities on an
opportunistic basis.
LIQUIDITY
AND CAPITAL RESOURCES.
On
September 30, 2008, we had current assets of $10,725,043 and stockholders'
equity of $22,332,680. On September 30, 2008, we had $10,364,407 in cash and
marketable securities, total assets of $22,617,852 and total current liabilities
of $285,172.
The most
significant sources of cash are our equity investment in MESC Capital LLC ("MESC
Capital") and interest and dividends earned from existing cash and cash
equivalents. In the event that cash flows from operating activities are not
sufficient, we could liquidate marketable securities as necessary. We believe
our cash flow from operations and existing cash and cash equivalents will be
adequate to satisfy our cash needs for the next twelve months.
The most
significant uses of cash are for employee compensation and professional fees for
legal and accounting services.
Currently,
there are no plans for external financing of current operations or
holdings.
During
the preparation of our 2004, 2005, 2006 and 2007 Federal corporation income tax
returns, a dispute arose between the Company and Security Land regarding
the proper amount of taxable income to be allocated to us and reported to the
Internal Revenue Service (“
IRS
”)
on Federal Form K-1. This dispute could not be
resolved and we reported a different amount of income on our corporation income
tax return than was reported to the IRS by
Security
Land
and
Development Company Limited Partnership (“
Security Land
”)
. The discrepancy may cause our tax returns to
be audited by the IRS. We believe that the outcome of any IRS examination will
not affect our financial statements as net operating losses are available to
offset any additional income not reported.
On
September 30, 2002, our subsidiary, Rustic Crafts International, Inc. ("Rustic
Crafts") sold all of its operating assets subject to the assumption of certain
of its liabilities. Prior to the sale, Rustic Crafts had established a
$1,000,000 line of credit with PNC Bank which was guaranteed by the Company and
expired on May 18, 2002. In conjunction with the Rustic Crafts asset sale,
Rustic Crafts' indebtedness under the line of credit together with its $960,000
mortgage loan from PNC Bank and certain other indebtedness to PNC Bank was
restructured to replace such indebtedness with five notes totaling $2,432,782
and have a ten year amortization schedule. The notes bear interest at the
blended rate of 10.8% per annum. As part of the PNC Bank debt restructuring,
Rustic Crafts was required to pay down the outstanding loan balance with
$200,000 of the purchase price in the Rustic Crafts asset sale, and was required
to make a $540,000 payment in December 2002. A $40,000 payment was made to PNC
Bank in December 2002, but Rustic Crafts and the Company failed to make the
balance of the December 2002 payment. Accordingly, the PNC Bank debt was
subsequently modified to provide for the payment of the remaining $500,000
payment on or before June 30, 2003. On June 30, 2003, we paid all outstanding
principal and interest due to PNC Bank, in satisfaction of the above described
obligations. In December 2005, Rustic Crafts agreed to accept a $125,000 note
from RCI Wood Products, Inc ("RCI") as a restructuring of the above named
obligation. The note bears an interest rate of 6.5% and calls for payments of
$1,088 per month until December 2008 at which time the balance will be due and
payable. Since the quarter ended March 31, 2006, Rustic Crafts has not received
any payments under this obligation. In April 2006, RCI defaulted on the
note. We have initiated an action for collection against RCI and the
personal guarantor of the note. In June 2008, we sold the above
mentioned notes to a collection agency for $1,000 plus 50% of any amounts
received, less expenses of up to $2,500. To date, we have received $1,000 from
the collection agency and the collection agency has not received any proceeds on
the notes.
In
connection with the redemption of our common stock owned by Statesman Inc.
("Statesman"), we acquired from Statesman a three-year option to purchase the
20% stock interest in
National Resource
Development Corporation, our 80% owned subsidiary,
held by Statesman. To
exercise the option, we were required to deliver to Statesman for cancellation a
$2,440,000 note issued to us by Statesman in October 2001. As consideration for
the option, we (i) paid Statesman $250,000, (ii) amended the note and related
pledge agreement to limit our recourse under the note and (iii) transferred to
Statesman certain office furniture and equipment that we owned. This option
expired in October 2005. As part of the redemption, we also entered into an
agreement with Statesman providing for (i) an amendment to the Certificate of
Designations of the Series C Preferred Stock for the Company and (ii) certain
limitations on the ability of Statesman to issue or transfer shares or other
beneficial interests in Statesman or to sell, transfer, purchase or acquire any
capital stock of the Company, in each case without first receiving our written
confirmation that such issuance or transfer would not adversely affect our
ability to utilize our tax loss carryforwards. We paid Statesman an aggregate
amount of $2,730,000 in consideration of the foregoing agreements. As of
September 30, 2008, through the date of this Form 10-Q, we have not collected
the $2,440,000 note and accrued interest of approximately $644,000 due from
Statesman. We have sent demand and default notices to Statesman but we have not
received a response to date. Per the terms of the Agreement, upon event of
default, overdue principal and overdue interest will bear interest, payable upon
demand, at a rate of twelve percent (12%) per annum, and the pledged securities
may be transferred into our name, or sold for proceeds to satisfy the obligation
and collection costs incurred. We have currently reserved the receivable balance
in full while we continue our collection efforts. The reserve adjustment
included a charge to impairment of loans as other expense in the 2006 statement
of operations, and an allowance against the note within equity.
Filing
of Going Private Proxy Statement
On
December 14, 2005, we filed with the SEC a preliminary Schedule 13E-3
Transaction Statement with respect to a going private transaction and a
preliminary Schedule 14A Proxy Statement soliciting stockholders to vote on
amending our certificate of incorporation to provide for a 1-for-100 reverse
stock split (the “Reverse Stock Split”) followed immediately by a 50-for-1
forward stock split of our common stock (the “Forward Stock Split”), which would
result in the reduction of the number of common stockholders of record of the
Company to fewer than 300. This will permit us to discontinue the filing of
annual and periodic reports and other filings with the SEC. Once the
Schedule 13E-3 Transaction Statement and Schedule 14A Proxy Statement are
approved in a definitive form by the SEC, we will mail
copies to
stockholders. We currently intend to effect the Reverse Stock Split and Forward
Stock Split as soon as possible after such distribution.
RESULTS
OF OPERATIONS
2008
Compared to 2007
For
the three months ended September 30, 2008 and September 30, 2007:
No
revenue was generated by the Company in these periods.
General
and administrative expenses increased by $17,873 or 3.5% to $534,355 in 2008
compared to $516,482 in 2007 primarily due to an increase in professional fees
in 2008.
Income
from equity investments in partnerships increased by $216,659 in 2008, 21.3%
higher than in 2007 due to a gain recognized from the sale of assets in MESC
Capital.
Net
income increased by $111,397 in 2008 compared to 2007. The increase was due to
the increase in income from partnerships
of
$
216,659
that was offset primarily
by the increase in general and administrative expenses
of $
17,873
and a reduction in interest and dividend income of
$57,902.
For
the nine months ended September 30, 2008 and September 30, 2007:
No
revenue was generated by the Company in these periods.
General
and administrative expenses increased by $168,968 or 16.7% to $1,177,946 in 2008
compared to $1,008,978 in 2007 primarily due to an increase in professional fees
of $230,402, and a reduction of stock based compensation of $43,550 and an
increase in directors fees of $27,350.
Income
from equity investment in partnerships increased by $707,803, 40.7% higher than
2007. Our investment in MESC Capital produced income of approximately
$1,148,000 in the nine month period ended September 30, 2008 as compared to
income of approximately $535,000 in the nine month period ended September 30,
2007 due to a reduction in general and administrative expenses
of $
168,968
and a gain from sale of assets in
2008 of
$
600,000
Our investment in
Security Land returned income of approximately $1,299,000 in the nine month
period ended September 30, 2008 as compared to approximately $1,205,000 in the
nine month period ended September 30, 2007 as revenue increased by approximately
$18,000 primarily due to rental income increases related to the consumer price
index and expenses decreased by approximately $76,000 relating to a reduction in
professional fees, maintenance costs and interest
expense.
Net
income increased by $306,798 in 2008 over 2007 or 29.4% primarily due to the
increase in income from equity investment in partnerships.
Our
Stockholders' Equity at September 30, 2008
was $22,332,680 as compared to $20,812,322 at December 31, 2007, an increase of
$1,520,358 which is due to our net income during the nine month period ended
September 30, 2008, stock issuances to one of our directors and stock options
granted to one of our officers.
Impact
of Inflation.
Although
we have not attempted to calculate the effect of inflation, management does not
believe inflation has had a material effect on its results of
operations.
Off-Balance
Sheet Arrangements
We have
not entered into any off-balance sheet arrangements.
Critical
Accounting Estimates
Accounting
estimates and assumptions discussed in this section are those considered most
critical to understanding the financial statements because they involve
significant judgments and uncertainties. For these estimates, we caution that
future events may not develop as forecast, and that the best estimates
often
require adjustment.
Investments
- These assets
are reviewed for impairment based on criteria that include the extension which
cost exceeds market value, the duration of that decline, and
our
ability to hold to recovery. Market research
and analysis is performed to identify potential impairments on a regular
basis.
Note Receivable
- These
assets are reviewed for collectibility on an ongoing basis. Any notes deemed
uncollectible have been offset by an allowance and related accrued interest has
been charged to expense.
Income Taxes
- As stated
above, assumptions have been made that taxable income that may result from a
possible IRS examination will be offset by existing net operating losses
generated by
us
from prior periods. Other
assumptions have been made that these net operating losses will not be limited
or disallowed, which could affect the results of operations in future
periods.
We
have
significant net
operating losses
available to offset future taxable income. The losses have been converted into
deferred tax assets using an estimated 34% tax rate. These deferred tax assets
have been offset with a valuation allowance established to reduce the net
deferred tax asset to the amount that will more likely than not be realized.
This reduction is necessary due to uncertainty of
our
ability to utilize the net operating loss and tax credit carry forwards before
they expire.
ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
N/A
ITEM
4. CONTROLS AND PROCEDURES
Our
management, with the participation of
our
Chief Executive Officer and Chief Financial Officer, has evaluated the
effectiveness of our disclosure controls and procedures (as such term is defined
in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended) as of the end of the period covered by this report. Based on such
evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that, as of the end of such period, our disclosure controls and
procedures are effective.
No change
occurred in our internal controls concerning financial reporting during the
quarter ended September 30, 2008 that has materially affected, or is reasonably
likely to materially affect, our internal controls over financial
reporting.
PART
II - OTHER INFORMATION
ITEM 1.
LEGAL PROCEEDINGS
On January 20, 2004, a
purported derivative and class action lawsuit was filed by two dissident Company
shareholders, Edward E. Gatz and Donald D. Graham, in the New Castle County
Court of Chancery, Delaware (the "Court"), captioned Gatz, et al. v. Ponsoldt,
Sr., et al., (C.A. No. 174-N) naming as defendants certain current and former
directors of the Company, Royalty and certain of its affiliates, Statesman and,
nominally, the Company (the "Delaware Action"). The complaint alleged various
breaches of fiduciary duties by the former directors and Statesman, and that
Royalty and its affiliates knowingly participated in certain of the alleged
breaches. In November 2004 the Court dismissed all but one claim alleged in the
complaint. The Company was not a defendant with respect to the sole surviving
claim, which related to the 2001 sale of a cache of previously quarried and
piled aggregate rock by NRDC to Iron Mountain (the "Aggregate Sale"). On October
16, 2005, the Court dismissed plaintiffs' sole remaining claim for failure to
state a claim for relief. The dismissal was without prejudice and the plaintiffs
were given leave to file an amended complaint attacking the Aggregate
Sale.
On January 30, 2006,
plaintiffs filed an amended complaint challenging the Aggregate Sale and
alleging that the Aggregate Sale negatively impacted the consideration the
Company received in connection with the October 2002 restructuring transactions.
The Company was not a defendant with respect to this claim. Plaintiffs sought
damages in excess of $5,400,000 with respect to the claim related to the
Aggregate Sale. On May 16, 2006, the Court dismissed the sole remaining
complaint alleged in the complaint determining that the sole remaining complaint
was derivative in nature and could therefore not be maintained by the
plaintiffs. On June 14, 2006, the plaintiffs filed a Notice of Appeal appealing
the Court's rulings. In its April 16, 2007 decision, citing an intervening legal
development in the area of direct and derivative claims arising while the appeal
was pending, the Supreme Court of the State of Delaware reversed the Court's
decision and remanded the case to the Court for further
proceedings.
Following the Supreme Court's
remand, the parties began settlement discussions. On April
28, 2008 the parties executed a memorandum of understanding (the "MOU")
reflecting an agreement in principle to settle that class action.
Among other things, the MOU provides that if the settlement is
consummated, the Company will pay $3,000,000 plus interest (as
provided in the MOU) to the plaintiff class. The plaintiff class is defined in
the MOU as all record and beneficial owners of our common stock on October
17, 2002, including any and all of their respective successors in interest,
predecessors, representatives, trustees, executors, administrators, heirs,
immediate and remote, and any person or entity acting for or on behalf of, or
claiming under any of them, and each of them. The plaintiff class does not
include the defendants, members of their families, affiliates of the defendants,
and those individuals or entities who solely held securities convertible into
the
Company’s
common
stock or options to purchase
the Company’s
common stock. The
Company will make that payment pursuant to its obligation to indemnify the
defendants who are former directors of the Company. The MOU provides that the
Company will undertake an appropriate process to determine if
indemnification of its former directors is appropriate under Delaware law.
The MOU expressly provides that the defendants admit no wrongdoing but have
agreed to the MOU to eliminate the uncertainty, distraction, burden and expense
of further litigation. In exchange for the payment, all claims
against the former directors, Statesman, Royalty and the current directors will
be released by the members of the class.
Pursuant to the MOU, the
Company engaged WolfBlock LLP
(“WolfBlock”)
to determine if the former
directors were entitled to indemnification. After reviewing thousands of
pages of documents, testimony from the former directors and the plaintiffs and
interviewing certain former directors, their counsel, plaintiffs and their
counsel, WolfBlock determined that the former directors were entitled to
indemnification from the Company under Delaware law and our
bylaws.
On December 4, 2008, the
parties signed a Stipulation of Settlement which memorialized their agreement,
subject to the approval of the Court, to settle the class action. The
terms of the final settlement are in all material respects identical to the
terms of the MOU. The Court has scheduled a hearing for March 16, 2009, at
which time the Court will consider whether it will approve the Stipulation of
Settlement as fair, reasonable, adequate and in the bests interests of the
class. If the Court approves the settlement, the Company will make the $3
million payment plus interest to the class.
T
he Company's insurance
carrier contends that none of the claims contained in the Delaware Action are
covered by insurance on the basis of the "insured vs. insured" exclusion since
one of the plaintiffs, Donald D. Graham, was previously a director of the
Company.
ITEM
1A. RISK FACTORS
We
believe that the most significant risks to our business are those set forth
below.
·
|
A
default in the lease or sudden catastrophe to the property owned by
Security Land or the operating facilities owned by Mobile Energy Services
Company, LLC ("Mobile Energy") from uninsured acts of God or war could
have a materially adverse impact upon our investment in Security
Land
or Mobile Energy, respectively, and
therefore our financial position and results of
operations;
|
·
|
Our
subsidiaries currently lack the necessary infrastructure at the site of
the Groveland mine in order to permit them to make more than casual sales
of the Aggregate located at the Groveland
mine;
|
·
|
We
have had significant tax loss and credit carryforwards and no assurance
can be provided that the Internal Revenue Service would not attempt to
limit or disallow altogether our use, retroactively and/or prospectively,
of such carryforwards, due to ownership changes or any other reason. The
disallowance of the utilization or our net operating loss would severely
impact or financial position and results of operations due to the
significant amounts of taxable income that has been, and may in the future
be, offset by our net operating loss
carryforwards;
|
·
|
If
we consummate the Reverse Stock Split and Forward Stock Split and become a
privately held company, stockholders will own shares in a private company
and may not have the ability to sell their shares in the public market.
Furthermore, we would not file current, quarterly or annual reports or be
subject to the proxy requirements of the federal securities laws.
Stockholders may therefore find it more difficult to obtain information
about us and our financial
performance;
|
·
|
Royalty
Holdings, LLC
(“Royalty”)
, an
affiliate of our management, beneficially owns approximately 52% of our
common stock. As a result, Royalty has the ability to control the outcome
of all matters requiring stockholder approval, including the election and
removal of directors and any merger, consolidation or sale of all or
substantially all of our assets;
|
·
|
We
do not expect to pay dividends in the foreseeable future;
and
|
·
|
There
are many public and private companies that are also searching for
operating businesses and other business opportunities as potential
acquisition or merger candidates. We will be in direct competition with
these other companies in its search for business opportunities. Many of
these entities have significantly greater financial and personnel
resources than us.
|
ITEM
2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS
None.
ITEM
3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS
None.
ITEM 5.
OTHER INFORMATION
None.