UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2004 Commission file number 001-15733 SUTTER HOLDING COMPANY, INC. (Exact name of Registrant as specified in its charter) Delaware 75-3111137 State or other jurisdiction of (I.R.S. Employer incorporation or organization Identification number) 220 Montgomery Street, Suite 2100, San Francisco, California 94104 (Address of principal executive office) (Zip Code) Registrant's telephone number, including area code (415) 788-1441 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: Title of each class Name of each exchange on which registered Common Stock, $0.0001 par value OTC Bulletin Board Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to the filing requirements for the past 90 days. Yes [X] No [ ] 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. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [ ] No [X] State the aggregate market value of the voting stock held by non-affiliates of the Registrant as of June 30, 2004: $548,832* Indicate number of shares outstanding of each of the Registrant's classes of common stock: March 25, 2005 -- Common Stock, $0.0001 par value 1,844,739 shares DOCUMENTS INCORPORATED BY REFERENCE See Exhibit Index. * This aggregate value is computed at the last sale price of the common stock as of June 30, 2004. It does not include the value of Common Stock held by Directors and Executive Officers of the Registrant and members of their immediate families. TABLE OF CONTENTS Item 1. Business Item 2. Description of Properties Item 3. Legal Proceedings Item 4. Submission of Matters to a Vote of Security Holders Item 5. Market for Registrant's Common Stock and Related Security Holder Matters Item 6. Selected Financial Data Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 7A. Quantitative and Qualitative Disclosures About Market Risk Item 8. Financial Statements and Supplementary Data Report of Independent Certified Public Accountants CONSOLIDATED BALANCE SHEETS CONSOLIDATED STATEMENTS OF OPERATIONS CONSOLIDATED STATEMENTS OF CASH FLOWS CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Item 9A. Controls and Procedures Item 9B. Other Information Item 10. Directors and Executive Officers of the Registrant Item 11. Executive Compensation Item 12. Security Ownership of Certain Beneficial Owners and Management Item 13. Certain Relationships and Related Transactions Item 14. Principal Accountant Fees and Services Item 15. Exhibits, Financial Statement Schedule, and Reports on Form 8-K i PART I Item 1. Business Sutter Holding Company, Inc. ("Sutter", "SHC", "Company" or "Registrant") is a holding company owning subsidiaries engaged primarily in residential mortgage banking. Sutter also has minority investments in other businesses engaged in a variety of activities, as identified herein. Sutter's corporate headquarters are located in San Francisco, California. Operating decisions for the two wholly owned mortgage banking businesses are made by managers of the business units. All major investment and capital allocation decisions are made by Sutter's senior executive officers. Company History under Prior Management The Company was incorporated in Delaware in July 1999 originally under the name Shochet Holdings Corporation. From July 1999 through August 31, 2001, it provided full service, discount brokerage and related non-proprietary financial services and products such as financial planning, insurance and annuities, through its wholly-owned subsidiaries: (1) Shochet Securities, Inc. ("Shochet Securities or "SSI"), (2) Shochet Investment Advisors Corp. and (3) Shochet Mortgage Corporation. SSI previously operated six branch offices in Florida. In March 2000, the Company completed an initial public offering of 1,045,000 shares of its common stock. These securities were listed on the Nasdaq SmallCap Market System under the symbol SHOC from March 2000 until November 2001. Net proceeds raised through this offering amounted to approximately $7,900,000. On August 31, 2001, the Company sold substantially all of its assets comprising its securities brokerage business, including retail and institutional accounts (collectively, the "Brokerage Assets"), to Blue Stone Capital Corp. ("Bluestone") and BlueStone Holding Corp. ("BHC"). On November 7, 2001, the Company, SSI, BlueStone, BHC and Sands Brothers & Co., Ltd. ("Sands") entered into an agreement ("November 2001 Agreement") which served to amend and supplement the August 2001 Agreement, including certain terms of consideration payable to the Company and allowed for the transfer of the Brokerage Assets from BlueStone to Sands. On March 28, 2002, there was a change in control of the Company when its majority shareholder, Firebrand Financial Group, Inc. ("Firebrand") sold 1,213,675 shares or approximately 56.45% of its common stock to Sutter Opportunity Fund 2, LLC ("SOF2"). Company History under Current Management On April 9, 2002, to reflect new management and ownership, the Company changed its name from Shochet Holdings Corporation to Sutter Holding Company, Inc., and its new (current) management completely changed the business plan and direction for the Company. On October 7, 2002, the Company entered into a Stock Purchase and Sale Agreement with Third Half Millennium Company, Inc., an Illinois corporation. The agreement provided for the sale of all of the capital stock of SSI Securities, an inactive wholly owned subsidiary of the Company, to Third Half Millennium. On December 20, 2002, the Company changed its fiscal year end from January 31 to December 31. On January 14, 2003 the Company acquired Easton Mortgage Corporation ("Easton"). As a result, Easton became Sutter's first wholly owned operating subsidiary. Easton is a wholesale mortgage bank located in San Francisco, California and is licensed in California. On December 11, 2003, the Company acquired Progressive Lending LLC ("Progressive"). Progressive is a retail mortgage bank with offices in Arizona, California, Nevada and Washington and is licensed in Arizona, California, Idaho, Illinois, Montana, Nevada, Oregon and Washington. 1 On September 27, 2004, the Company hired Debra Dehn-Hunt as Senior Vice President of Finance and Controller. With over twelve years of finance and accounting experience, she is an important and welcome addition to the Company's accounting and finance staff. On January 26, 2005, the Company acquired FLF, Inc. dba Diversified Risk Insurance Brokers ("Diversified Risk"). Founded in 1977 and headquartered in Emeryville, Diversified Risk is one of the twenty-five largest commercial property and casualty insurance brokers in northern California. Diversifed Risk is licensed in approximately 44 states and, through a consultative approach to brokering, provides insurance services to such industries as agriculture, construction, education, real estate, technology and transportation. As a result of this transaction, Diversified Risk is currently the Company's largest shareholder. Business Description Sutter is a holding company comprised primarily of two operating subsidiaries, Easton and Progressive. Both subsidiaries are mortgage banks that derive a majority of their revenues from originating residential mortgages in the following states: Arizona, California, Nevada and Washington. For the 2004 fiscal year, Sutter, through its wholly owned subsidiaries, engaged in residential mortgage origination which management considers a single business segment. Today, however, due to the recent acquisition of Diversified Risk, Sutter is a more diversified financial services holding company comprised of two distinct business segments: insurance brokerage and mortgage banking. Therefore, in future Company SEC filings, management expects to provide segmented reporting of periodic financial information. In Sutter's primary business of residential mortgage origination, the Company does not hold loans for investment, service loans or take credit risk except in very limited circumstances from the time of funding to the time of sale, which is normally eight to ten business days. Easton Easton is a wholesale mortgage bank that originates and brokers residential mortgages primarily in California through independent mortgage loan brokers and other intermediaries. Occasionally, Easton acts as a broker for small commercial mortgages. During fiscal 2004, Easton originated approximately $48.1 million in banked and brokered conventional and non-conventional mortgages. Easton has two primary warehouse lines of credit in the aggregate amount of $7.0 million, including $3.0 million from Flagstar Bank, FSB ("Flagstar") and $4.0 million from Gateway Bank FSB ("Gateway") respectively, that it uses to fund and warehouse mortgages until such mortgages are bought by investors, which purchases typically occur within eight to ten business days of funding. These loans are pre-sold by the time the Company funds the loan. Easton has a secondary warehouse line of credit in the amount of $250,000, from Flagstar, that it uses to fund and warehouse second mortgages under substantially similar terms and circumstances as exist with the primary line of credit facility. There are minimum capital and tangible net worth requirements imposed separately by Flagstar and Gateway which are checked quarterly and are necessary to maintain the access and use of the warehouse lines. Progressive Progressive is a retail mortgage bank that originates and brokers residential mortgages primarily in Arizona, California, Nevada and Washington through its own sales force of loan officers. Most of Progressive's sales leads come from professional and personal referrals. During fiscal 2004, Progressive originated approximately $153.0 million in banked and brokered conventional and non-conventional mortgages. Progressive has two primary warehouse lines of credit in the aggregate amount of $8.0 million, including $5.0 million from Flagstar and $3.0 million from Provident Funding Services ("Provident"), that it uses to fund and warehouse mortgages until such mortgages are bought by investors, which purchases typically occur within eight to ten business days of funding. These loans are pre-sold by the time the Company funds the loan. There are minimum capital and tangible net worth requirements imposed separately by Flagstar and 2 Provident which are checked quarterly and are necessary to maintain the access and use of the warehouse lines. For fiscal 2004, Progressive received a compliance waiver from Flagstar with respect to a profitability requirement. Types of Loans Easton and Progressive originate mortgage loans that generally fall into one of the following three categories: o Prime Mortgage Loans -- These are prime credit quality first-lien mortgage loans secured by single- (one-to-four) family residences. o Prime Home Equity Loans -- These are prime credit quality second-lien mortgage loans secured by single-(one-to-four) family residences, including home equity lines of credit. o Sub-prime Mortgage Loans -- These are first-and second-lien mortgage loans secured by single- (one-to-four) family residences, made to individuals with credit profiles that do not qualify for a prime loan. The majority of loan production consists of Prime Mortgage Loans. Prime Mortgage Loans include conventional mortgage loans, Federal Housing Administration-insured mortgage loans and Veterans Administration-guaranteed mortgage loans. The majority of the conventional loans qualify for inclusion in guaranteed mortgage securities backed by Fannie Mae or Freddie Mac. Some of the conventional loans we produce either have an original loan amount in excess of the current $359,650 Fannie Mae and Freddie Mac loan limit or otherwise do not meet Fannie Mae or Freddie Mac guidelines. Competition There are numerous mortgage banks of various sizes that compete, locally and nationally, with Easton and Progressive for business on an ongoing basis. In particular, California is a highly competitive market for mortgage loan business given its population and economic significance in the US economy. At any given time, any one of our competitors may be capable of offering products similar to or prices better than those offered by either Easton or Progressive, or any other mortgage bank competitor. However, it is unlikely that this could always be the case since all competitors in the mortgage industry generally have access to the same products and prices. Moreover, in a service industry, what differentiates one mortgage bank from another is the quality of service manifested by customer retention. While Easton and Progressive are not household names, their customer retention is high and the quality of their services is believed to be equal to or better than those provided by their competitors. Regulatory Compliance The mortgage banking business is subject to the rules, regulations or guidelines of, and/or examination by, the following entities with respect to the processing, originating, selling and servicing of mortgage loans: o The Department of Housing and Urban Development ("HUD"); o The Federal Housing Administration (the "FHA"); o The Department of Veteran Affairs; o Fannie Mae, Freddie Mac, Ginnie Mae; o The Federal Home Loan Bank ("FHLB"); and o State regulatory authorities. The rules and regulations of these entities, among other things, impose licensing obligations, establish standards for processing, underwriting and servicing mortgage loans, prohibit discrimination, restrict certain loan features in some cases and fix maximum interest rates and fees. To the extent they apply, Easton and Progressive are subject to all of the rules, regulations and regulatory agencies listed above. Progressive is an FHA lender and is required to submit to the FHA Commissioner, on an annual basis, audited financial statements. Fannie Mae, Freddie Mac, Ginnie Mae and HUD require the maintenance of specified tangible net worth levels (which vary among the entities). 3 Mortgage origination activities are subject to the Equal Credit Opportunity Act, Truth-in-Lending Act, Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act and the Home Ownership Equity Protection Act and the regulations promulgated thereunder, as well as to other federal laws. These laws prohibit discrimination, require the disclosure of certain basic information to mortgagors concerning credit and settlement costs, limit payment for settlement services to the reasonable value of the services rendered and require the maintenance and disclosure of information regarding the disposition of mortgage applications based on race, gender, geographical distribution and income level. There are a number of proposed and recently enacted federal, state and local laws and regulations addressing responsible banking practices with respect to borrowers with blemished credit. In general, these laws and regulations will impose new loan disclosure requirements, restrict or prohibit certain loan terms, fees and charges such as prepayment penalties and will increase penalties for non-compliance. Based on Easton's and Progressive's lending practices, we do not believe that the existence of, or compliance with, these laws and regulations will have a material adverse impact on our business. However, there can be no assurance that more restrictive laws, rules and regulations will not be adopted in the future or that the existing laws, rules and regulations will not be applied in a manner that may adversely impact our business or make compliance more difficult or expensive. Employees Sutter, its subsidiaries and affiliates, had a total of 63 regular employees at December 31, 2004. Additional Information on Sutter Sutter's periodic reports filed with the SEC, which include Form 10-K, Form 10-Q, Form 8-K and amendments thereto, may be accessed by the public free of charge from the SEC. Electronic copies of these reports can be accessed at the SEC's website (http://www.sec.gov). Copies of these reports may also be obtained, free of charge, upon written request to: Sutter Holding Company, Inc., 220 Montgomery Street, Suite 2100, San Francisco, CA 94104, Attn: Corporate Secretary. Also, copies of these reports are available to the public in the SEC's Public Reference Room located at 450 Fifth Street N.W., Washington, D.C. 20549 (1-800-SEC-0330). Item 2. Description of Properties The physical properties used by the Registrant and its subsidiaries are summarized below: Type of Owned/ Approx. Square Business Location Property Leased Footage Sutter San Francisco, CA Corporate Leased 1,800 offices Easton San Francisco, CA Offices Leased 2,400 Progressive Scottsdale, AZ; San Francisco, Offices Leased 11,200 CA; Las Vegas NV and Spokane, WA Item 3. Legal Proceedings During fiscal 2003, the Company received two notices of potential claims in the aggregate amount of approximately $488,000. These potential claims are over four years old and involve parties that have no business relationship or contact with present management or the Company. While current management believes that the ultimate outcome of these claims will not have a material adverse effect on the Company's results of operations, litigation is subject to inherent uncertainties and unfavorable rulings, however unlikely, could occur. Depending on the amount and timing, an unfavorable outcome of one or both of 4 these matters could have a material adverse effect on the Company's business, cash flows, operating results or financial position. An accurate estimate of potential loss from pending claims cannot be made at this time. Item 4. Submission of Matters to a Vote of Security Holders None PART II Item 5. Market for Registrant's Common Stock and Related Security Holder Matters Market Information Sutter's common stock trades on the Over-the-Counter ("OTC") Bulletin Board (symbol: SRHI). The following table sets forth high and low sales prices per share for the Company's common stock during fiscal 2004 and 2003 based on the Company's December 31 fiscal year end, as reported by NASD-OTC. A public trading market for the Company's common stock is not well established. These quotations represent prices between dealers and do not reflect retail mark-ups, mark-downs or commissions. For the Year Ended December 31, 2004 ----------------------------------------------------------- Stock Price Period Ended High Low ---- --- March 31, 2004 $9.00 $9.00 June 30, 2004 $11.00 $5.10 September 30, 2004 $8.95 $3.40 December 31, 2004 $6.00 $3.10 For the Year Ended December 31, 2003 ----------------------------------------------------------- Stock Price Period Ended High Low ---- --- March 31, 2003 $11.20 $11.00 June 30, 2003 $12.00 $11.20 September 30, 2003 $12.00 $7.00 December 31, 2003 $10.50 $7.00 Shareholders Sutter had approximately 40 holders of record of its common stock at March 25, 2005. Dividends Sutter has never paid cash dividends on its common stock and does not intend to do so in the foreseeable future. Payment of dividends will be at the sole discretion of the Company's Board of Directors and will depend upon, among other factors, earnings and future anticipated capital requirements. Securities Authorized for Issuance under Equity Compensation Plans The following is a summary of the Registrant's equity compensation plans under which equity securities are authorized for issuance as of December 31, 2004: 5 Number of securities remaining available for future issuance under Number of securities to Weighted-average equity compensation be issued upon exercise exercise price of plans (excluding of outstanding options outstanding options and securities reflected in Plan Category and warrants (a) warrants (b) column (a)) (c) Plans approved by security holders 100,550 $6.30 99,450 Plans not approved by security holders 273,250 $11.91 101,750 -------------------------- ------------------------- -------------------------- Total 373,800 $10.40 201,200 ========================== ========================= ========================== In the past, the Company's three senior executive officers had been entitled to receive annual awards of stock options as provided for in their employment agreements. Forty thousand options were awarded to two senior executive officers during the 2003 and 2002 fiscal years; these same officers elected not to receive any option award in fiscal 2004. A third senior executive officer was awarded forty thousand options during the 2004 fiscal year. These options vest in equal amounts over three years and expire ten years from their respective dates of issuance. During 2004, the Company's three senior executive officers unanimously elected to waive their entitlements to such option awards in favor of a new proposal, submitted to and unanimously approved by the Board, to award option grants to each of the three senior executive officers whenever an acquisition or merger is consummated. The general terms of any such future option grants under the new proposal are outlined in the senior executive officers' amended and restated employment agreements, copies of which were filed February 1, 2005 on Form 8-K with the SEC, and are incorporated herein by reference. Of the amount in column (a) above, 60,000 represent warrants granted to certain employees of Easton at the time of acquisition, and 1,250 represent warrants granted in 2002 to a former Company independent spokesperson. In addition, 20,000 represent warrants granted to an immediate family member of an officer of the Company in connection with a loan made to the Company; such Company officer expressly disclaims any beneficial interest in these warrants. Issuer Purchases of Equity Securities None Recent Sales of Unregistered Securities; Use of Proceeds from Registered Securities Date Number of Value of Description Securities Shares Sold --------------- ------------- ------------- --------------------------------- 10/1/2004 16,667 $100,000 Shares of common stock issued to certain officers of the Company for cash 12/31/2004 175 175,000 Shares of preferred stock issued ------------- ------------- to qualified investors for cash 16,842 $275,000 ============= ============= The proceeds from the sales of these securities were used for working capital purposes. 6 Item 6. Selected Financial Data Selected Financial Data for the Past Five Years 2004 2003 2002 2001 2000 Revenues: Total revenues(1) $2,714,874 $1,771,748 $0 $25,000 N/A Earnings: Net loss from continuing operations ($1,387,498) ($685,490) ($772,634) ($660,000) N/A Net loss from discontinued operations(2) N/A N/A N/A (5,287,000) (3,075,000) Net loss per share -- basic and diluted(3) ($3.24) ($2.39) ($4.86) ($47.10) ($27.77) Year-end data: Total assets $8,248,081 $9,257,516 $1,965,646 $1,178,000 $9,469,000 Debt and obligations 2,724,403 5,037,338 1,008,376 816,000 751,000 Shareholders' equity 2,926,443 1,401,516 996,639 366,000 6,281,000 ------------------------------------------------------Notes: In 2002, the Company changed its fiscal year end from January 31 to December 31. Therefore, the data presented for fiscal 2002 is for the eleven months ended December 31, 2002. (1) Prior to fiscal 2003, the Company was not engaged in the mortgage business. In 2002, the Company was not engaged in any operating business. Prior to 2002, the Company operated primarily as a broker-dealer under different and unaffiliated management. (2) In 2001, the Company, under a different name and under prior management, took write-downs on certain assets of discontinued businesses. (3) All numbers are split-adjusted to reflect a 1:20 reverse stock split which occurred on June 13, 2002. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations Executive Summary Sutter is a holding company that owns two operating businesses in the mortgage banking industry. Sutter's mortgage subsidiaries, Easton and Progressive, earn revenue by originating, processing, funding and brokering primarily residential mortgages. Sutter also has three non-core, minority investments in one private and two public companies involved in the precious metal mining and technology industries, respectively. These private investments are not considered by management to be an integral part of the future operations or plans of the Company. Presently, management desires and intends to grow Sutter through continued acquisitions in the financial services industry that are most likely to complement its current financial service businesses. Mortgage banking is a cyclical business. Operating performance is subject to fluctuate from quarter to quarter and from year to year based upon numerous market factors, the most significant of which are trends and future anticipated changes in interest rates, and the likely impact such changes could have on borrowers' decisions. During 2004, the mortgage banking sector experienced fairly steady, if somewhat declining, loan volume accompanied by eroding profit margins. Loan volume continued to decline from 2003 levels due to fewer refinancings and steadily rising interest rates driven by six consecutive quarter-point increases by the Federal Reserve of the Federal Funds rate. Profit margins at mortgage banks of all sizes have suffered due to the increased price competition for purchase money mortgages and a largely unchanged supply of qualified borrowers. Consistent with last year, management believes that borrowers generally expect interest rates to rise in the future, or at least not to decline enough for them to consider another refinancing. Competition for purchase money mortgages is likely to intensify in the near term as mortgage banks re-think their strategies and adjust their product offerings to accommodate anticipated market and interest rate trends. Combination loans or "80/20 combo loans" as they are commonly called which consist of a first mortgage for 80% of a property's value and a second mortgage for 20% of a 7 property's value (essentially 100% home mortgage financing), as well as interest-only mortgage loans were the most common loan types in 2004 and are expected to be preferred by borrowers for the foreseeable future given the current interest rate environment. While the Company offers these mortgage products and others competitively, management believes that the Company's operating performance is likely to continue to fluctuate in concert with that of the overall industry. Sutter acquired the mortgage banks of Easton and Progressive at different times in fiscal 2003. The Company had no operating business in fiscal 2002 which makes a direct comparison of operating performance for fiscal years prior to 2003 difficult, if not meaningless. Moreover, Sutter changed its fiscal year end to December 31 from January 31 in 2002 resulting an eleven month fiscal year for 2002 which further complicates any direct fiscal year comparisons prior to 2003. 2004 2003 2002 Total revenues(1) $2,714,874 $1,771,748 $0 Total expenses $3,963,160 $2,137,494 $751,923 Earnings: Net loss from continuing operations(2) ($1,387,498) ($685,490) ($772,634) Net loss per share - basic and diluted(3) ($3.24) ($2.39) ($4.86) ------------------------------------------------------------------ Notes: In 2002, the Company changed its fiscal year end from January 31 to December 31. Therefore, the data presented for fiscal 2002 is for the eleven months ended December 31, 2002. (1) Prior to fiscal 2003, the Company was not engaged in any business. Prior to 2002, the Company operated primarily as a broker-dealer under different and unaffiliated management. (2) Includes: a gain on extinguishment of debt of $656,987 and an other than temporary impairment loss of $232,043 in 2004; and an other than temporary impairment loss of $462,306 in 2003. (3) All numbers are split-adjusted to reflect a 1:20 reverse stock split which occurred on June 13, 2002. Operating results for the twelve months ended December 31, 2004 as compared with the twelve months ended December 31, 2003 Revenues Total revenues for the twelve months ended December 31, 2004 were $2,714,874 versus $1,771,748 for the twelve months ended December 31, 2003. The increase in revenues is due to the addition of Progressive's operations and their impact on revenues for the entire 2004 fiscal year. Progressive's impact on fiscal 2003 revenues was minimal given that the Company had acquired Progressive during the last month of the fiscal year. The Company had interest income related to mortgage operations of $27,588, net of interest expense of $135,528, for the twelve months ended December 31, 2004, and interest income of $26,647, net of interest expense of $133,235, for the twelve months ended December 31, 2003. Expenses Total expenses were $3,963,160 for the twelve months ended December 31, 2004 as compared to $2,137,494 for the twelve months ended December 31, 2003. The increase in total expenses is primarily the result of the addition of Progressive's operations and their impact on expenses for the entire 2004 fiscal year. Professional fees and service also contributed to the overall increase in expenses for the year. Total expenses are comprised primarily of general and administrative expenses and professional fees. 8 Effective May 1, 2004, Sutter relocated its corporate headquarters within San Francisco to new leased office space located at 220 Montgomery Street, Suite 2100, San Francisco, California 94104. Sutter's Easton and Progressive subsidiaries moved to the same location where Progressive will also base its California operations. The consolidation of Sutter's corporate headquarters with Easton's operations and Progressive's California operations under a single seven year lease is expected to reduce that portion of total expenses related to office rent. The Company incurred no bad debt expense for the twelve months ended December 31, 2004 as compared to $100,000 for the twelve months ended December 31, 2003. In 2003, the Company wrote off the $100,000 net carrying value in a note receivable from a non-core investment in Grupo Bufete and recorded a $100,000 bad debt expense for the year due to the uncertainty of collection. Interest Expense The Company had interest expense of $515,205 for the twelve months ended December 31, 2004 as compared to interest expense of $259,671 for the twelve months ended December 31, 2003. The increase in interest expense is primarily the result of funded indebtedness incurred due to acquisitions. Income Tax Expense The Company incurred income tax expense of $850 for the twelve months ended December 31, 2004 as compared to income tax expense of $883 for the twelve months ended December 31, 2003. The Company has federal net operating loss carry-forwards in the amount of $2,010,568 as of December 31, 2004 which may be applied to offset future taxable income. The deferred tax asset from these net operating loss carry-forwards was fully reserved at December 31, 2004. Gain on Extinguishment of Debt The Company realized a gain on the extinguishment of debt in the amount of $656,987 during fiscal 2004 in connection with the early retirement of the RCH note. The RCH note was a seller-financed note originally entered into by the Company in conjunction with the acquisition of Easton in January 2003. The Company was presented with an opportunity by one of the noteholders to prepay the RCH note obligation at a substantial discount to its then outstanding balance plus accrued interest of approximately $1.9 million. Net Losses The Company reported a net loss of ($1,388,348) for the twelve months ended December 31, 2004 as compared to a net loss of ($686,373) for the twelve months ended December 31, 2003. The increase in net loss is primarily the result of poor operating performance at the Company's mortgage subsidiaries. During the fourth quarter, the Company's senior management decided to integrate the operations of its two mortgage subsidiaries in an effort to improve future operating performance and efficiency in our mortgage banking business. The integration process entails a thorough evaluation of all of the Company's current mortgage operations, as well as customer relationships, and is expected to be completed sometime during the second quarter of 2005. Operating results for the twelve months ended December 31, 2003 as compared with the eleven months ended December 31, 2002 Revenues Total revenues for the twelve months ended December 31, 2003 was $1,771,748 versus $0 (zero) for the eleven months ended December 31, 2002. The increase in revenues is the result of the Company's acquisition of Easton in January of 2003. The Company existed essentially as a public shell for the 2002 fiscal year. The Company had interest income related to mortgage operations of $26,647, net of interest expense of $133,235, for the twelve months ended December 31, 2003, and $0 (zero) interest income for the eleven months ended December 31, 2002. 9 Expenses Total expenses were $2,137,494 for the twelve months ended December 31, 2003 as compared to $527,899 for the eleven months ended December 31, 2002. The increase in total expenses is the result of the Company's acquisitions of Easton and Progressive in January and December, respectively, of 2003. Total expenses are comprised primarily of general and administrative expenses, interest expense and professional fees. The Company recorded a bad debt expense of $100,000 for the twelve months ended December 31, 2003 as compared to $0 (zero) for the eleven months ended December 31, 2002. The Company had a note receivable that was originally a $175,000 judgment receivable from Grupo Bufete, secured by an investment interest. In 2002, the Company recorded a $75,000 provision for uncollectibles which resulted in a $100,000 net carrying value for the note receivable during 2003. In 2003, the Company wrote off the remaining $100,000 net carrying value for the note receivable and recorded a $100,000 bad debt expense for the year due to the uncertainty of collection. Interest Expense The Company had interest expense of $259,671 for the twelve months ended December 31, 2003 as compared to interest expense of $21,510 for the eleven months ended December 31, 2002. The increase in interest expense is primarily due to debt obligations incurred in connection with the acquisition of Easton. Income Tax Expense The Company had income tax expense of $883 for the twelve months ended December 31, 2003 as compared to income tax expense of $800 for the eleven months ended December 31, 2002. The Company had federal net operating loss carry-forwards in the amount of $711,000 as of December 31, 2003, which may be applied to offset future taxable income. The deferred tax asset from these net operating loss carry-forwards was fully reserved at December 31, 2003. Net Losses The Company reported a net loss of ($686,373) for the twelve months ended December 31, 2003 as compared to a net loss of ($773,434) for the eleven months ended December 31, 2002. The reduction in net loss is the result of the positive effect on earnings of the acquisitions of Easton and Progressive in January and December of 2003, respectively. Share Repurchases None Impact of Inflation Sutter's management believes that the impact of inflation, although indirect, could be material to its revenue or income from continuing operations in the short term. Historical economic data suggests that interest rates and inflation are highly correlated. Given our disclosure in the Executive Summary section above on the potential impact of changes in interest rates on Sutter's mortgage business, it makes sense that if inflation were to increase significantly in the short term, more likely than not the result will be a significant increase in interest rates in the short term which could materially adversely effect Sutter's mortgage business. However, in the long term, inflation and interest rate changes are likely to have little or no direct effect on revenue or income from continuing operations of Sutter's mortgage business since borrowers' decisions tend to be less influenced by long term changes to inflation and interest rates. Liquidity and Capital Resources Sutter had cash and cash equivalents of $193,997 and $96,971 as of December 31, 2004 and 2003, respectively, and $625,491 as of December 31, 2002. Cash provided by operating activities was $242,458 for the period ended December 31, 2004 as compared to $1,269,452 for the period ended December 31, 2003, and cash used in operating activities of $1,301,653 for the period ended 10 December 31, 2002. The decrease in operating cash flow from fiscal 2003 to fiscal 2004 is primarily the result of a decline in mortgage loan volume. In 2002, the Company had no operating businesses from which to generate cash flow from operations. Cash provided by investing activities was $123,747 for the period ended December 31, 2004 as compared to cash used in investing activities of $1,532,939 and $1,645,787 for the periods ended December 31, 2003 and 2002, respectively. The increase in cash from investing activities is due to the absence of any significant investment purchases, as well as an increase in proceeds from the sale of certain non-core investments during fiscal 2004. Cash used in financing activities was $269,179 for the period ended December 31, 2004 as compared to $265,033 for the period ended December 31, 2003, and cash provided by financing activities of $2,408,949 for the period ended December 31, 2002. Under current management, the Company has made investments in operating and non-operating assets that, depending upon the type of investment, were categorized as investing activities. Management believes there is sufficient cash flow from existing operations to fund any capital expenditures that may arise during the coming year and which are necessary to achieve the Company's operating goals. As of December 31, 2004, Sutter had funded debt of $2,019,000 at a weighted average annual interest rate of approximately 9.3%. These long-term borrowings were incurred predominantly as a result of Sutter's two acquisitions during 2003. Management believes that the Company's cost of borrowing is reasonable given the Company's small size and current market capitalization. Sutter's two mortgage subsidiaries each have their own warehouse lines of credit provided to them by financial institutions. Easton has two primary warehouse lines for an aggregate of $7.0 million, and a secondary warehouse line for $250,000. Progressive has two primary warehouse lines for an aggregate of $8.0 million. These warehouse lines of credit are used for the temporary funding of mortgage loans until they are purchased by investors. The warehouse lines of credit may be cancelled by their issuing financial institutions at any time upon thirty days notice to the Company or its subsidiaries. The Company's subsidiaries have certain covenants in connection with these warehouse lines of credit. In each case, the covenants include a requirement that the subsidiary maintain a minimum tangible net worth of $250,000, and a current ratio greater than one. The Company and its subsidiaries were in compliance with all covenants at December 31, 2004, except Progressive received a waiver for fiscal 2004 with respect to a profitability requirement. Management believes operating cash flow is reasonably likely to be sufficient to cover operating expenses in the coming fiscal year. However, overall liquidity could be adversely affected if there is a short-term decrease in demand for our subsidiaries' mortgage products. Management believes the Company has short-term resources available to sufficiently cover such market volatility typical of the mortgage business, as well as current commitments. Moreover, management expects to be able to raise additional cash in the short-term from the sale of certain non-core investments. Management expects to grow the Company through further acquisitions of complementary financial service businesses in the future where the consideration given will be predominantly common stock of Sutter. For example, the consideration given in the Company's acquisition of Diversified Risk Insurance Brokers, completed on January 26, 2005, was comprised of 80% common stock and 20% cash. However, management anticipates that the Company may have to raise capital for working capital purposes and future acquisitions in the next twelve months. In the event cash is necessary to consummate a future acquisition, the Company has sufficient external cash resources. Provided Sutter can achieve the necessary growth in revenue, cash flow and operations in the short term, management anticipates being able to raise additional long-term capital. The Company's overall capital needs are continually reviewed to ensure that its capital base can support current business needs and future estimated business needs. Based upon these reviews, the Company believes that its capital structure is adequate for current operations and any reasonably foreseeable future needs. Management anticipates making small capital expenditures to implement a new accounting platform, as well as incurring additional expenses in the second half of fiscal 2005 associated with the implementation and compliance of Section 404 of the Sarbanes-Oxley Act. Certain elements of the Sarbanes-Oxley Act have already been implemented. Management believes that the Company currently maintains sufficient liquidity to cover these and other existing requirements, and provide for contingent liquidity. 11 Off-Balance Sheet Arrangements In the normal course of business, the commitment, funding and closing of brokered mortgage loans occurs on the same day. Therefore, the Company has no such related off-balance sheet arrangements, risks or guarantees. Contractual Obligations Sutter and its subsidiaries have contractual obligations associated with ongoing business and financing activities, which will result in cash payments in future periods. Certain of those obligations, such as notes payable and other borrowings and related interest payments, are reflected in the Consolidated Financial Statements. A summary of contractual obligations follows. Payments due by period ------------------------------------------------------------------------------------------------------- Contractual Obligations Total 2005 2006 2007 2008 2009 2010 or later ----- ---- ---- ---- ---- ---- ------------- Debt obligations $2,019,000 $881,500 $412,500 $725,000 $0 $0 $0 Lease obligations 1,507,953 411,319 346,752 198,329 162,688 166,656 222,208 Total $3,526,953 $1,292,819 $759,252 $923,329 $162,688 $166,656 $222,208 The data above does not reflect reductions in long-term debt which are the result of separate agreements entered into by the Company and/or its subsidiaries subsequent to the fiscal year end. Critical Accounting Policies Revenue Recognition When the Company funds a loan to a borrower through its warehouse line of credit but prior to selling the loan, it records the principal amount of the loan as mortgages held for sale. Once the loan is purchased by an investor, usually within ten business days of funding, the principal amount of the loan is deducted from the Company's outstanding balance on its warehouse line of credit. It then recognizes mortgage sales along with origination and related fees. The costs and fees associated with originating and processing loans funded on our warehouse lines of credit are included in cost of sales at the time the loan is sold. Commission revenue on brokered loans is recognized at the time commission revenue on brokered loans is received. The Company does not record an allowance for loan losses because the loans are typically sold to investors within ten business days of funding. This short-term risk is mitigated by the fact that any losses that may occur due to the loss of a loan are simply adjustments to revenue for the period since all revenues are related to the successful origination, processing and funding of a loan. Investments Marketable equity securities are classified as securities available for sale and reported at estimated fair value. Unrealized gains and losses, after applicable taxes, are reported in cumulative other comprehensive income. We use current quotations, where available, to estimate the fair value of these securities. Where current quotations are not available, we estimate fair value based on the present value of future cash flows, adjusted for the quality rating of the securities, prepayment assumptions and other factors. We reduce the asset value when we consider the declines in the value of marketable equity securities to be other-than-temporary and record the estimated loss in "realized gains or losses" in the statement of operations. The initial indicator of impairment for equity securities is a sustained decline in market price below the amount recorded for that investment. We consider the length of time and the extent to which market value has been less than cost and any recent events specific to the issuer and economic conditions of its industry. At December 31, 2004, Sutter does not have any marketable equity securities. 12 Non-marketable equity securities include securities that are not publicly traded. We review these assets at least quarterly for possible other-than-temporary impairment. Our review typically includes an analysis of the facts and circumstances of each investment, the expectations for the investment's cash flows and capital needs, the viability of its business model and our exit strategy. These securities generally are accounted for at cost. We reduce the asset value when we consider declines in value to be other-than-temporary. Realized investment gains and losses are also recognized when investments are sold or disposed. Realized investment gains may fluctuate significantly from period to period, resulting in a meaningful effect on reported net earnings. The Company realized an investment gain of $24,122 in 2004, and investment losses of $61,801 and $224,024 in 2003 and 2002, respectively. The Company had other than temporary impairment losses of $232,043 in 2004, $462,306 (exclusive of $100,000 in bad debt expense) in 2003, and none in 2002. These assets are non-core assets that were acquired prior to the acquisitions of our operating businesses, and therefore are not likely to have any impact on future operations. Purchase Price Allocation and Intangible Assets A significant amount of judgment is required in performing goodwill and identifiable intangible asset impairment tests. Such tests include periodically determining or reviewing the estimated fair value of Sutter's reporting units. Under SFAS No. 142, fair value refers to the amount for which the entire reporting unit may be bought or sold. There are several methods of estimating reporting unit values, including market quotations, asset and liability fair values and other valuation techniques, such as discounted cash flows and multiples of earnings or revenues. If the carrying amount of a reporting unit, including goodwill, exceeds the estimated fair value, then individual assets, including identifiable intangible assets and liabilities of the reporting unit are estimated at fair value. The excess of the estimated fair value of the reporting unit over the estimated fair value of net assets would establish the implied value of goodwill. The excess of the recorded amount of goodwill over its implied value is then charged to earnings as an impairment loss. Sutter's consolidated financial position reflects certain investments in non-core public and private businesses. All investments in non-core private businesses have been fully reserved. All investments in non-core public businesses are carried at the lower of cost or fair value. In the case of investments carried at fair value, considerable judgment is required in determining the assumptions used in arriving at fair value and to what extent, if any, such investments are impaired. Significant changes in these assumptions can have a significant effect on carrying values. Recent Accounting Pronouncements On December 16, 2004, the Financial Accounting Standards Board ("FASB") issued its Statement of Financial Accounting Standards No. 123, as revised in 2004, Share-Based Payment ("Statement 123R"), which addresses the accounting for employee stock options. Statement 123R requires that the cost of all employee stock options, as well as other equity-based compensation arrangements, be measured and reflected in the financial statements based on the estimated fair value of the awards. The Company's management intends to adopt and implement the rules and guidelines as set forth in Statement 123R during fiscal 2005 according to deadlines established by FASB. The Company believes the adoption of Statement 123R is likely to have a significant adverse impact on its future consolidated statements of operations and earnings per share. Forward-Looking Statements Investors are cautioned that certain statements contained in this document, as well as some statements by the Company in periodic press releases and some oral statements of Company officials during presentations about the Company, are "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Act"). Forward-looking statements include statements which are predictive in nature, which depend upon or refer to future events or conditions, which include words such as "expects," "anticipates," "intends," "plans," "believes," "estimates," or similar expressions. In addition, any statements concerning future financial performance (including future revenues, earnings or growth rates), ongoing business strategies or prospects, and possible future Company actions, which may be provided by management, are also forward-looking statements as defined by the 13 Act. Forward-looking statements are based on current expectations and projections about future events and are subject to risks, uncertainties, and assumptions about the Company, economic and market factors and the industries in which the Company does business, among other things. These statements are not guaranties of future performance and the Company has no specific intention to update these statements. Actual events and results may differ materially from those expressed or forecasted in forward-looking statements due to a number of factors. The principal important risk factors that could cause the Company's actual performance and future events and actions to differ materially from such forward-looking statements, include, but are not limited to, changes in applicable Federal or State laws or regulations, changes in Federal income tax laws, and changes in general economic and market factors that affect the prices of securities or the industries in which Sutter and its affiliates do business, especially those affecting the mortgage banking industry. Item 7A. Quantitative and Qualitative Disclosures About Market Risk In addition to other risks described in sections of this report (see "Competition", "Inflation", and "Liquidity and Capital Resources"), the Company is generally subject to the following risk factors. The Company is subject to potential interest rate risk in primarily three ways. First, there is interest rate risk arising from the timing difference between the time a loan is funded and the time it is purchased by an investor from the Company's warehouse line of credit. This type of interest rate risk is mitigated by the fact that a funded loan spends between eight and ten business days on the Company's warehouse line prior to purchase, and that the Company will not fund a loan until the borrower has locked in a borrowing rate at which the Company knows it can sell a loan to an investor. Second, the Company is subject to general fluctuations in market interest rates for debt instruments, particularly rising interest rates. To the extent that changes in such rates influence borrowers' decisions to postpone entering into mortgage loans today in favor of doing so in the future or not at all, the Company's business and profitability may be adversely affected in the short-term. Third, to the extent market interest rates for corporate debt increase in the future, the Company's cost of debt capital may increase which could result in increased interest payments. This increase in interest payments may adversely affect the Company's cash flow and profitability. Currently, the interest rates charged on all of the Company's debt are fixed, and so an increase in market interest rates will not have any effect on the Company's existing interest payments. Occasionally, circumstances arise whereby a loan funded on one of our warehouse lines of credit takes longer than eight to ten business days to be purchased by an investor. Such occurrences are infrequent, but may be considered to give rise to potential interest rate risk as long as the funded loan remains on our balance sheet. This potential risk is mitigated by the fact that the rate we are charged for funded loans on our warehouse line is tied to the Prime Rate, and adjusts to changes in the Prime Rate. Therefore, the Company is not subject to additional risk due to short-term changes in interest rates that may occur while a loan remains outstanding on one of its warehouse lines of credit. The Company's mortgage businesses are potentially subject to regulatory risks given the various regulatory requirements (previously disclosed in this report) with which Sutter's subsidiaries must comply. Currently, there are a number of proposed and recently enacted federal, state and local laws and regulations addressing responsible banking practices with respect to borrowers with blemished credit. In general, these laws and regulations will impose new loan disclosure requirements, restrict or prohibit certain loan terms, fees and charges such as prepayment penalties and will increase penalties for non-compliance. Based on Easton's and Progressive's lending practices, we do not believe that the existence of, or compliance with, these laws and regulations will have a material adverse impact on our business. However, there can be no assurance that more restrictive laws, rules and regulations will not be adopted in the future or that the existing laws, rules and regulations will not be applied in a manner that may adversely impact our business or make compliance more difficult or expensive. The Company relies on certain key personnel to manage the business and generate revenue on an ongoing basis. If one or more of those key personnel were to quit, leave or retire, the Company's revenues, profitability and short-term future growth prospects may be adversely affected. The Company has employment agreements with most of its key personnel and has implemented an employee stock option plan during fiscal 2004. 14 Item 8. Financial Statements and Supplementary Data REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Stockholders Sutter Holding Company, Inc. and Subsidiaries We have audited the accompanying consolidated balance sheet of Sutter Holding Company, Inc. and Subsidiaries as of December 31, 2004, and the related statements of operations, stockholders' equity, and cash flows the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2004, and the results of its operations and its cash flows for the year then ended, in conformity with U. S. generally accepted accounting principles. /s/ Burr, Pilger & Mayer LLP San Francisco, California March 25, 2005 15 Report of Independent Registered Public Accounting Firm Board of Directors and Stockholders Sutter Holding Company, Inc. and Subsidiaries San Francisco, California We have audited the accompanying consolidated balance sheet of Sutter Holding Company, Inc. and Subsidiaries as of December 31, 2003 and the related consolidated statements of operations, stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides 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 Sutter Holding Company, Inc. and Subsidiaries at December 31, 2003, and the results of its operations and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. /s/ BDO Seidman, LLP March 26, 2004 San Francisco, California INDEPENDENT AUDITORS' REPORT The Board of Directors Sutter Holding Company, Inc. We have audited the accompanying balance sheet of Sutter Holding Company, Inc. as of December 31, 2002 and the related statements of income and comprehensive income, stockholders' equity, and cash flows for the period of February 1, 2002 through December 31, 2002. These financial statements are the responsibility of Sutter Holding Company, Inc. management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits 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 audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Sutter Holding Company, Inc. as of December 31, 2002 and the results of its operations and its cash flows for the period February 1, 2002 through December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. /s/ REGALIA & ASSOCIATES Danville, California March 6, 2003 16 Item 8. Financial Statements and Supplementary Data SUTTER HOLDING COMPANY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS As of As of December 31, 2004 December 31, 2003 -------------------- --------------------- ASSETS Cash and cash equivalents $ 193,997 $ 96,971 Accounts receivable 82,795 37,212 Prepaid expenses 48,142 44,290 Mortgages held for sale 2,618,044 3,020,753 Non-marketable investments, at cost 237,040 985,053 Property and equipment, net 154,335 258,706 Identifiable intangible and other assets 379,535 330,785 Goodwill 4,534,193 4,483,746 -------------------- --------------------- TOTAL ASSETS $ 8,248,081 $ 9,257,516 ==================== ===================== LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable and accrued expenses $ 759,388 $ 318,344 Mortgage warehouse line of credit 2,597,235 2,986,485 Interest payable 34,195 8,885 Debt to unrelated parties 268,926 588,551 Debt to related parties 1,661,894 3,953,735 -------------------- --------------------- Total Liabilities 5,321,638 7,856,000 -------------------- --------------------- Commitments and contingencies (Notes 8 and 16) Stockholders' Equity Preferred stock, $0.0001 par value 125,000 authorized; 175 issued and outstanding - - Common stock, $0.0001 par value 1,875,000 authorized; 634,674 and 351,942 issued and outstanding at December 31, 2004 and December 31, 2003, respectively 63 35 Additional paid-in capital 7,180,528 4,669,164 Treasury stock (959,622) (604,665) Accumulated deficit (3,294,526) (2,663,018) -------------------- --------------------- Total Stockholders' Equity 2,926,443 1,401,516 -------------------- --------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 8,248,081 $ 9,257,516 ==================== ===================== See accompanying Notes to Consolidated Financial Statements 17 Item 8. Financial Statements and Supplementary Data SUTTER HOLDING COMPANY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS For the eleven For the twelve months ended months ended December 31, December 31, ----------------------------------- ---------------- 2004 2003 2002 --------------- --------------- ---------------- Revenues: Net gain on sales of mortgages $ 1,239,907 $ 502,056 $ - Mortgage commissions on brokered loans 1,447,379 1,243,045 - Interest income net of interest expense of $135,528, $133,235 and $0, respectively 27,588 26,647 - --------------- --------------- ---------------- Total revenues 2,714,874 1,771,748 - --------------- --------------- ---------------- Expenses: General and administrative 2,969,326 1,294,868 433,955 Depreciation and amortization 252,269 46,758 748 Professional fees and other expenses 491,745 304,129 93,196 Other than temporary impairment loss 232,043 462,306 - Other expenses 17,777 29,433 - --------------- --------------- ---------------- Total expenses 3,963,160 2,137,494 527,899 --------------- --------------- ---------------- Net operating loss (1,248,286) (365,746) (527,899) --------------- --------------- ---------------- Other Income Realized gain (loss) on sale 24,122 (61,801) (224,024) Interest and dividend income 38,396 1,728 799 Other interest expense (515,205) (259,671) (21,510) Inducement to convert debt to equity (343,512) - - Realized gain on extinguishment of debt 656,987 - - --------------- --------------- ---------------- Total other income (139,212) (319,744) (244,735) --------------- --------------- ---------------- Loss from continuing operations (1,387,498) (685,490) (772,634) Provision for income taxes 850 883 800 --------------- --------------- ---------------- Net loss $ (1,388,348) $ (686,373) $ (773,434) =============== =============== ================ Net income (loss) per share -- basic and diluted $ (3.24) $ (2.39) $ (4.86) Weighted Average Shares Outstanding 428,341 287,584 158,996 See accompanying Notes to Consolidated Financial Statements 18 Item 8. Financial Statements and Supplementary Data SUTTER HOLDING COMPANY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the eleven For the twelve months ended months ended December 31, December 31, ----------------------------------- ---------------- 2004 2003 2002 --------------- --------------- ---------------- OPERATING ACTIVITIES Net loss $ (1,388,348) $ (686,373) $ (773,434) Realized (gain) loss on the sales of investments, net (24,122) 61,801 230,724 Inducement to convert debt to equity 343,512 - - Depreciation and amortization 252,269 46,758 748 Other than temporary impairment loss 232,043 562,306 - Amortization of discount on debt 138,226 33,507 - Unrealized loss on investment - - (62,500) Adjustments to reconcile net loss to net cash (used in) provided by operating activities: Accounts receivable (45,583) 34,080 (8,528) Prepaid expenses (3,852) (15,204) (1,836) Mortgages held for sale 402,709 1,175,747 - Accounts payable and accrued expenses 441,044 83,793 (715,859) Income taxes payable - (6,367) 800 Interest payable 25,310 (19,347) 28,232 Other assets (130,750) (1,249) - --------------- --------------- ---------------- Net cash provided by operating activities 242,458 1,269,452 (1,301,653) --------------- --------------- ---------------- INVESTING ACTIVITIES Capital expenditures (65,898) (6,126) (1,994) Proceeds from sales of investments 240,092 70,944 - Purchases of subsidiaries, net of cash (50,447) (1,507,469) (1,545,269) Purchases of other investments - (90,288) (98,542) --------------- --------------- ---------------- Net cash provided by (used in) investing activities 123,747 (1,532,939) (1,645,805) --------------- --------------- ---------------- FINANCING ACTIVITIES Proceeds from issuance of common stock 168,000 50,000 1,458,970 Proceeds from issuance of preferred stock 175,000 - - Proceeds from issuance of warrants - - 103,030 Proceeds from issuance of notes payable 731,216 2,121,000 1,008,376 Decrease in mortgage warehouse line of credit (389,250) (1,155,073) - Repayment of notes payable (954,145) (1,207,222) (66,000) Purchases of stock for treasury - (73,738) (95,427) --------------- --------------- ---------------- Net cash used in financing activities (269,179) (265,033) 2,408,949 --------------- --------------- ---------------- Net change in cash and cash equivalents for the period 97,026 (528,520) (538,509) Cash and cash equivalents, beginning of period 96,971 625,491 1,164,000 --------------- --------------- ---------------- Cash and cash equivalents, end of period $ 193,997 $ 96,971 $ 625,491 =============== =============== ================ Additional cash flow information: Cash interest paid $ 135,271 $ 168,151 $ 53,910 Cash paid for income taxes 850 833 800 Supplemental disclosure of non-cash investing and financing activities: Beneficial conversion of unrelated party note to equity $ 107,500 $ - $ - Issuance of shares to wholly owned subsidiary 354,957 252,500 - Issuance of shares for Progressive acquisition - 500,000 - Issuance of shares to acquire other equity securities - 1,030,000 - Issuance of shares to related parties for granting loans - 40,000 - Issuance of shares to related parties on conversion of debt - 100,000 - Return and retirement of shares upon disposal of an investment - 800,000 - Forgiveness of unrelated party debt 656,987 - - Reclass of related party note to unrelated party note 1,337,735 - - Non cash acquisition of shares through dividend 2,084,230 - - Assumption of unrelated party note by independent third party in conjunction with the sale of an investment 300,000 - - Non-cash acquisition of shares through dividend 756,840 - - Acquisition of shares for treasury - 18,738 - Fair value of warrants issued with debt 35,025 - - See accompanying Notes to Consolidated Financial Statements 19 Item 8. Financial Statements and Supplementary Data SUTTER HOLDING COMPANY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY Sutter Holding Company, Inc. Consolidated Statement of Stockholders' Equity Additional Other Total Preferred Common Paid-In Treasury Accumulated Subscriptions Comprehensive Stockholders' Shares Stock Shares Stock Capital Stock Deficit Receivable Income Equity --------- ------ ------ ---------- -------- ------------ ------------- ------------- ------------- Balances, January 31, 2002(1) - $ - 2,245,000 $ - $10,196,000 $(238,000) $(9,574,000) $ (18,000) $ - $ 366,000 Repayment of loans to officers(2) - - - - - - - 18,000 - 18,000 Repurchase of shares(2) - - (95,000) - - (95,427) - - - (95,427) Reverse stock split (1:20) - - (2,042,500) - - - - - - Issuance of common stock - - 136,536 904,869 - - - - 904,869 Reclass par value of common stock - - - 24 (24) - - - - - Issuance of options/warrants - - - - 166,422 - (103,030) - - 63,392 Sale of subsidiary - - - - (7,898,080) - 8,473,819 - - 575,739 Net loss - - - - - - (773,434) - - (773,434) Unrealized losses on investments - - - - - - - - (62,500) (62,500) ------------------------------------------------------------------------------------------------------------- Balances, December 31, 2002 - $ - 244,036 $ 24 $ 3,369,187 $(333,427) $(1,976,645) $ - $ (62,500) $ 996,639 Issuance of common stock - - 185,402 19 1,972,481 - - - - 1,972,500 Repurchase of shares - - (77,496) (8) (854,992) (271,238) - - - (1,126,238) Issuance of options/warrants - - - 182,488 - - - - 182,488 Net loss - - - - - (686,373) - - (686,373) Reclassification of realized gain (loss) - - - - - - - - 62,500 62,500 -------------------------------------------------------------------------------------------------------------- Balances, December 31, 2003 - $ - 351,942 $ 35 $ 4,669,164 $(604,665) $(2,663,018) $ - $ - $ 1,401,516 Issuance of common stock - - 24,223 2 167,998 - - - 168,000 Issuance of preferred stock 175 0 - - 175,000 - - - 175,000 Beneficial note conversion feature - - - - 107,500 - - - - 107,500 Issuance of shares to wholly owned subsidiary - - 37,276 4 354,953 (354,957) - - - - Non-cash acquisition of shares in conjunction with extingishment of debt - - (126,140) (13) (756,827) - 756,840 - - - Inducement to convert debt to equity - - - - 343,512 - - - - 343,512 Issuance of common stock in conjunction with Extinguishment of dept - - 347,373 35 2,084,203 - - - - 2,084,238 Issuance of warrants - - - 35,025 - - - - 35,025 Net loss - - - - - - (1,388,348) - 1,388,348) ------------------------------------------------------------------------------------------------------------- Balances, December 31, 2004 175 $ 0 634,674 $ 63 $ 7,180,528 $(959,622) $(3,294,526) $ - $ - $ 2,926,443 -------------------------------Notes: (1) During the 2002 calendar year, the Company's fiscal year end was changed from January 31 to December 31. (2) Former officers of the Company effected this transaction prior to entering into the Stock Purchase Agreement dated March 28, 2002, which resulted in the sale of a controlling interest in the Company. See accompanying Notes to Consolidated Financial Statements 20 Item 8. Financial Statements and Supplementary Data SUTTER HOLDING COMPANY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2004 1. Significant Accounting Policies and Practices (a) Organization and Basis of Consolidation Sutter Holding Company, Inc. ("Sutter" or "Company") is a holding company owning subsidiaries engaged primarily in residential mortgage banking. Sutter also has minority investments in other businesses engaged in a variety of activities, as identified herein. The Company has determined that its residential mortgage banking operations constitute a single business segment. The accompanying Consolidated Financial Statements include the accounts of Sutter consolidated with the accounts of all of its subsidiaries and affiliates in which Sutter holds a controlling financial interest as of the financial statement date. Subsidiaries' operations are included from the respective dates of acquisition (see Note 2). Normally, control reflects ownership of a majority of the voting interests. Other factors considered in determining whether control is held include whether Sutter provides significant financial support as a result of its authority to purchase or sell assets or make other operating decisions that significantly affect the entity's results of operations, and whether Sutter bears a majority of the financial risks. All inter-company accounts and transactions have been eliminated. Certain amounts in 2003 and 2002 have been reclassified to conform with the current year presentation. The integration of our two mortgage banking subsidiaries into one operating unit and the addition of the insurance broker, Diversified Risk, in January 2005, are each expected to contribute positively to the future stability and growth of operating cash flow, performance and liquidity. However, liquidity could be adversely affected if there is a short-term decrease in demand for either of Easton's or Progressive's mortgage products. Management believes the Company has short-term resources available to sufficiently cover such events typical of the mortgage business as well as current commitments. 21 (b) Use of Estimates in Preparation of Financial Statements The preparation of the Consolidated Financial Statements in conformity with generally accepted accounting principles ("GAAP") requires management to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the period. In addition, estimates and assumptions associated with the determination of fair value of invested assets and related impairments, and the determination of goodwill impairments require considerable judgment by management. Actual results may differ from the estimates and assumptions used in preparing the Consolidated Financial Statements. (c) Cash Equivalents Cash equivalents consist of funds invested in money market accounts and other investments with maturities of three months or less when purchased. (d) Mortgages Held for Sale Loans held for sale represent originated mortgage loans held for sale to permanent investors. The loans are initially recorded at cost based on the principal amount outstanding net of deferred direct origination costs and fees. The loans are subsequently carried at the lower of cost or market value. Market value is determined by examining outstanding commitments from investors or current investor yield requirements calculated on the aggregate loan basis. The Company had no significant commitments classified as derivatives under Statement of Financial Accounting Standards No. 133 ("SFAS 133") at December 31, 2004 and 2003. Specifically, the Company does not enter into fixed interest rate lock commitments and the Company's forward sales commitments under its bank warehouse lines of credit are for only very short periods of time and result in no valuable derivatives contracts. (e) Investments Marketable equity securities are classified as securities available for sale and reported at estimated fair value. Unrealized gains and losses, after applicable taxes, are reported in cumulative other comprehensive income. We use current quotations, where available, to estimate the fair value of these securities. Where current quotations are not available, we estimate fair value based on the present value of future cash flows, adjusted for the quality rating of the securities, prepayment assumptions and other factors. We reduce the asset value when we consider the declines in the value of marketable equity securities to be other-than-temporary and record the estimated loss in "realized gains or losses" in the statement of operations. The initial indicator of impairment for equity securities is a sustained decline in market price below the amount recorded for that investment. We consider the length of time and the extent to which market value has been less than cost and any recent events specific to the issuer and economic conditions of its industry. At December 31, 2004, Sutter does not have any marketable equity securities. Non-marketable equity securities include securities that are not publicly traded. We review these assets at least quarterly for possible other-than-temporary impairment. Our review typically includes an analysis of the facts and circumstances of each investment, the expectations for the investment's cash flows and capital needs, the viability of its business model and our exit strategy. These securities generally are accounted for at cost. We reduce the asset value when we consider declines in value to be other-than-temporary. We recognize the estimated loss from equity investments in provision for impairment. Realized investment gains and losses are recognized when investments are sold or disposed. Realized investment gains may fluctuate significantly from period to period, resulting in a meaningful effect on reported net earnings. The Company realized an investment gain of $24,122 in 2004, and investment losses of $61,801 and $224,024 in 2003 and 2002, respectively. The Company had other than temporary impairment losses of $232,043 in 2004, $462,306 (exclusive of $100,000 in bad debt expense) in 2003, and none in 2002. These assets are non-core assets that were acquired prior to the acquisitions of our operating businesses, and therefore are not likely to have any impact on future operations. 22 (f) Property, Plant and Equipment Property, plant and equipment are recorded at cost. Depreciation is provided principally on the straight-line method over estimated useful lives as follows: equipment, furniture and fixtures, 3 to 10 years. Leasehold improvements are amortized over the life of the lease or the life of the improvement, whichever is shorter. (g) Intangible Assets As a result of the acquisition of Progressive in 2003, Sutter acquired identifiable intangible assets such as a customer list, valued at $260,000, and a non-compete agreement with a certain key employee, valued at $60,000, in the aggregate amount of $320,000. The customer list is being amortized over a period of five years and the non-compete agreement is being amortized over a period of two years. These intangible assets were valued by an independent valuation firm in accordance with Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets." Sutter also acquired Easton in 2003. However, neither management nor the independent valuation firm identified, and therefore meaningfully quantified, any intangible assets associated with this acquisition. Unlike Progressive, Easton is a wholesale mortgage bank which means that Easton has no retail customers - only non-contractual mortgage broker and realtor relationships. Since there is no contractual obligation between Easton and any California mortgage broker or realtor, and there are thousands of mortgage bankers to which any given mortgage broker or realtor could potentially submit business, it is too difficult and subjective to estimate, based on any acceptable methodology for such purpose (e.g. income approach, expense approach, or comparability analysis), that portion of the purchase price of Easton that could be assigned to a customer list or similarly classified identifiable intangible asset. Thus, no identifiable intangible assets were recorded at the date of acquisition, and the majority of the purchase price was allocated to goodwill. Intangible assets are subject to annual impairment tests. An impairment is deemed to exist if the carrying value of a reporting unit exceeds its estimated fair value. (h) Long-Lived Assets The Company adopted Statement of Financial Accounting Standards No. 144 ("SFAS 144"), "Accounting for the Impairment or Disposal of Long-Lived Assets," on January 1, 2002. Long lived assets, other than goodwill, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets might not be recoverable. The Company does not perform a periodic assessment of assets for impairment in the absence of such information or indicators. Conditions that would necessitate an impairment assessment include a significant decline in the observable market value of an asset, a significant change in the extent or manner in which an asset is used, or a significant adverse change that would indicate that the carrying amount of an asset or group of assets is not recoverable. For long-lived assets to be held and used, the Company recognizes an impairment loss only if its carrying amount is not recoverable through its undiscounted cash flows and measures the impairment loss based on the difference between the carrying amount and fair value. Long-lived assets held for sale are reported at the lower of cost or fair value less costs to sell, if any. (i) Revenue Recognition Gains on Sales of Mortgages: When the Company funds a loan to a borrower through its warehouse line of credit but prior to selling the loan, it records the principal amount of the loan as mortgages held for sale. Once the loan is purchased by an investor, usually within ten business days of funding, the principal amount of the loan is deducted from the Company's outstanding balance on its warehouse line of credit. The Company recognizes gains on sales of loans for the difference between the sales price and the adjusted cost basis of the loans when the title transfers. The adjusted cost basis of the loans includes the original principal amount adjusted for deferrals of origination and commitment fees received, net of direct loan origination costs paid. Loans held for sale represent originated mortgage loans held for sale to permanent investors. The loans are initially recorded at cost based on the principal amount outstanding net of deferred direct origination costs and fees. 23 The loans are subsequently carried at the lower of cost or market value. Market value is determined by examining outstanding commitments from investors or current investor yield requirements calculated on an aggregate loan basis. Loan Origination Fees and Direct Origination Costs: The Company records loan fees, discount points and certain incremental direct origination costs as an adjustment of the cost of the loan and such amounts are included in gain on sales of loans when the loan is sold. During 2004, management elected to change the Company's policy with respect to salaries, compensation and commission costs related to mortgage banking activities to more accurately reflect the direct relationship between such costs and loan origination revenues. During the current year, such salaries, compensation and commission costs have been charged to incremental direct loan origination costs. During fiscal 2003, such salaries, compensation and commission costs were charged to general and administrative expenses. (j) Income Taxes Sutter files consolidated federal and California combined income tax returns with its subsidiaries. The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109 ("SFAS 109"), "Accounting for Income Taxes." SFAS 109 requires that deferred income taxes reflect the tax consequences on future years of differences between the tax bases of assets and liabilities and their financial reporting amounts. (k) Accounting for Stock-Based Compensation At December 31, 2004, as discussed more fully in Note 12, the Company has a formal stock-based compensation plan. The Company accounts for its grants of options under the recognition and measurement principles of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. No stock-based employee compensation cost related to stock options is reflected in net income for the three years ended December 31, 2004, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings (loss) per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123 (as amended by SFAS 148) "Accounting for Stock-Based Compensation" to stock-based employee compensation. Year Ended December 31, --------------------------------------------------------- 2004 2003 2002 ---------------- ----------------- ---------------- Net loss applicable to common stockholders, as reported $ (1,388,348) $ (686,373) $ (773,434) Total stock-based employee compensation expense included in the net loss, net of related tax effects - - - Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects $ (311,835) $ (195,312) $ (55,665) ---------------- ----------------- ---------------- Pro forma net loss applicable to common stockholders $ (1,700,183) $ (881,685) $ (829,099) ---------------- ----------------- ---------------- As reported loss per share $ (3.24) $ (2.39) $ (4.86) ---------------- ----------------- ---------------- Pro forma loss per share $ (3.97) $ (3.07) $ (5.21) ---------------- ----------------- ---------------- 24 The fair value for these options was estimated using the Black-Scholes option pricing model. The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. Option pricing models require the input of highly subjective assumptions, including the expected stock price volatility. Accordingly, option pricing models may not necessarily provide a reliable single measure of the fair value of options. The fair value of options at the date of grant was estimated on the date of grant based on the method prescribed by SFAS No. 123. The following table summarizes the estimated fair value of options and assumptions used in the SFAS No. 123 calculations for stock option plans: 2004 2003 2002 Weighted averages of assumptions: Exercise price of common stock $10.90 $11.50 $11.00 Annual discount rate 4.33% 4.24% 4.06% Annual dividend rate 0.00% 0.00% 0.00% Expected volatility 25.00% 25.00% 25.00% Expected term (years) 7.5 8.8 8.6 (l) Fair Value of Financial Instruments Carrying amounts of certain of the Company's financial instruments, including cash and cash equivalents, accounts receivable, mortgages held for sale, and accounts payable approximate their fair values due to their relative short maturities and based upon comparable market information available at the respective balance sheet dates. Investments at year end represent private equity securities; current book value of these investments represents the best estimate of market value. The Company does not hold or issue financial instruments for trading purposes. The debt to unrelated and related parties has substantially fixed interest rates and remains substantially unchanged at year end. The warehouse lines of credit carry interest rates that are indexed or float with market rates such as the "Prime Rate" and remain substantially unchanged at year end. As a result, the Company estimates that the book value of its debt approximates fair value. (m) Net Loss Per Share Basic net loss per share is computed by dividing the net loss available to common stockholders for the period by the weighted average number of common stock outstanding during the period. Diluted net loss per share is computed based on the weighted average number of common stock and dilutive potential common stock outstanding. The calculation of diluted net loss per share excludes potential common stock if the effect is anti-dilutive. Potential common stock consists of incremental common stock issuable upon the exercise of stock options, shares issuable upon conversion of convertible preferred stock and common stock issuable upon the exercise of common stock warrants. The following table sets forth the computation of basic and diluted net loss per share for the periods presented: Year Ended December 31, --------------------------------------------------- 2004 2003 2002 ---------------- ---------------- ---------------- Numerator: Net loss applicable to common stockholders $ (1,388,348) $ (686,373) $ (773,434) ---------------- ---------------- ---------------- Denominator: Weighted average common stock 428,341 287,584 159,996 ---------------- ---------------- ---------------- Net loss per share: Basic and diluted $ (3.24) $ (2.39) $ (4.86) ---------------- ---------------- ---------------- 25 The following table sets forth potential shares of common stock that are not included in the diluted net loss per share calculation above because to do so would be anti-dilutive for the periods presented: December 31, ---------------------------------------------------- 2004 2003 2002 ---------------- ---------------- ---------------- Common stock options 292,550 168,000 80,000 Common stock warrants 81,250 61,250 0 In April 2004, the Company issued 35,952 shares to Easton to help it meet certain capital requirements. In August 2004, the Company elected to issue 347,373 shares of its common stock to Knight Fuller, Inc. ("KFI") in full satisfaction of its debt obligation to KFI. At the time of issuance, the Company held 126,140 shares of KFI common stock in the form of a non-core investment, and received 126,140 shares of its own common stock for the Company's pro rata share of the issuance. All of the above shares are issued and outstanding, and are reflected as treasury stock on the Company's balance sheet. They do not affect earnings per share. (n) Advertising Costs The Company expenses advertising costs as they are incurred (aired or printed). For the year ended December 31, 2004 and December 31, 2003, the Company expensed $113,771 and $52,861 of advertising costs, respectively. There were no advertising costs incurred during the eleven month period ended December 31, 2002. (o) Recent Accounting Pronouncements On December 16, 2004, the Financial Accounting Standards Board ("FASB") issued its Statement of Financial Accounting Standards No. 123, as revised in 2004, Share-Based Payment ("Statement 123R"), which addresses the accounting for employee stock options. Statement 123R requires that the cost of all employee stock options, as well as other equity-based compensation arrangements, be measured and reflected in the financial statements based on the estimated fair value of the awards. The Company's management intends to adopt and implement the rules and guidelines as set forth in Statement 123R during fiscal 2005 according to deadlines established by FASB. The Company believes the adoption of Statement 123R is likely to have a significant adverse impact on its future consolidated statements of operations and earnings per share. 2. Significant Business Acquisitions On November 23, 2004, the Company signed a definitive agreement with FLF, Inc. d/b/a Diversified Risk Insurance Brokers ("Diversified Risk"), a commercial property and casualty insurance broker based in Emeryville, California. Founded in 1977, Diversified Risk is one of the largest, independently owned commercial insurance agencies in California. The company provides services to a broad range of clients in the transportation, 26 construction, professional, technology, medical, municipal and property industry segments, and maintains long-standing relationships with a number of major insurance carriers. The consideration offered to Diversified Risk's shareholders consisted of 20% cash and 80% in Sutter common stock. All of Diversified Risk's former shareholders have signed employment agreements. On January 26, 2005, this transaction was completed. A summary of the assets acquired and the consideration paid is as follows: Tangible assets acquired, net $414,000 Identifiable intangible assets acquired 4,800,000 Goodwill 3,861,000 --------------- Net assets acquired $9,075,000 =============== Cash consideration $1,815,000 Fair value of stock provided 7,260,000 --------------- Total consideration $9,075,000 =============== The unaudited pro forma results are provided for comparative purposes only and are not necessarily indicative of what actual results would have been had the acquisition been consummated on such dates, nor do they give effect to the synergies, cost savings and other changes expected to result from the acquisitions. Accordingly, the pro forma financial results do not purport to be indicative of results of operations as of the date hereof or for any period ended on the date hereof or for any other future date or period. Had we acquired Diversified Risk at the beginning of the prior period, our results of operations would have been as follows: For the year ended December 31, 2004 Total revenues $ 6,679,254 Net loss (1,680,045) Net loss per basic and diluted common share $ (1.03) The amount of consideration paid in connection with the acquisition was determined by extensive "arms-length" negotiation among the parties. Sutter funded the acquisition of the assets in cash from its working capital plus proceeds from borrowings. There was no material relationship between Diversified Risk and Sutter or any of Sutter's affiliates, directors or officers, or any associate of any such director or officer. Sutter amortizes the intangible assets, separate from goodwill, acquired in the Diversified Risk acquisition to expense over a period of seven years, which is the estimated useful life of such assets. Goodwill from the acquisition of Diversified Risk is amortizable for tax purposes. On December 11, 2003, Sutter completed the acquisition of all of the outstanding membership interests of Progressive Lending, LLC ("Progressive") pursuant to a stock purchase agreement by and among Sutter and William S. (`Steve") Howard, Jr. The operations of Progressive from December 11, 2003 are included in the consolidated financial statements for 2003. This acquisition significantly increases Sutter's mortgage banking operations and is expected to contribute to its growth and geographic presence. The purchase price is subject to reduction if Progressive does not earn at least $500,000 in each of the two years following closing. Progressive's senior management has agreed to stay with the company and intends to grow its operations significantly. On January 14, 2003, Sutter completed the acquisition of all of the outstanding capital stock of Easton Mortgage Corporation ("Easton") pursuant to a stock purchase agreement by and among Sutter, Easton Mortgage Corporation ( "Easton"), RCH LLC ("RCH"), Timothy A. Birch, Stone Williams, L.L.C., Craig R. Bush, Lawrence Anspach, and Diana Mead. This acquisition, which was effective as of January 1, 2003, provides Sutter its first operating business with which 27 Sutter intends facilitate future growth. Operations of Easton from January 1, 2003 are included in the consolidated financial statements for 2003. 3. Receivables Trade accounts receivable consist primarily of revenues and fees receivable from mortgage origination activities. Receivables are comprised of the following at December 31, 2004 and 2003: December 31, ------------------------ 2004 2003 ------------ ----------- Trade receivables $82,795 $37,212 4. Investments Investments are comprised of the following at December 31, 2004 and 2003: December 31, --------------------------------------- 2004 2003 ------------------- ------------------- Niman Ranch Inc. $0 $753,010 Tesoro Gold Co. 0 200,000 Knught Fuller Inc. (KFI) 237,040 0 Other investments 0 32,043 ------------------- ------------------- Total $237,040 $985,053 =================== =================== Gross Gross Unrealized Unrealized Reported Cost Gains Losses Value December 31, 2004 ----------------------------------------------------- Non-marketable securities held for investment $469,083 $0 $232,043 $237,040 December 31, 2003 Non-marketable securities held for investment $1,481,512 $0 $496,459 $985,053 On March 29, 2004, the Company sold its interest in Niman Ranch with a cost of $753,010 to Sutter Opportunity Fund 2, LLC ("SOF2"), a related party, for $1,001,827 (the "Niman Ranch Transaction"). Consideration received by the Company consisted of $191,049 in cash, the assumption of $300,000 in the Company's debt by SOF2, and the assignment by SOF2 to the Company of 126,140 common shares of KFI, another related party, valued at $510,778. At the time of this transaction, the difference between the cost basis and the fair value received for the Niman Ranch interest amounted to $248,817, which was applied to offset or reduce the cost basis in the KFI shares received. Thus, the carrying value of the KFI shares that the Company received in the transaction amounted to $261,961 or approximately $2.08 per KFI share. On July 30, 2004, control of Knight Fuller, Inc. ("KFI"), formerly a related party, was acquired in a sale transaction by an independent third party (the "KFI Change of Control"). In conjunction with the KFI Change of Control, the Company elected to pay in full its debt obligation of $1,992,348 to KFI by issuing approximately 332,058 shares of its common stock to KFI at a value of $6.00 per share. Concurrent with the above transaction, the Company also settled, in full, other subsidiary obligations by issuing an additional 14,553 shares of Sutter common stock to KFI. In total, the Company issued 347,373 shares of common stock to KFI for an aggregate consideration of $2,084,238. 28 Given that the new Loan Agreement entered into between the Company and KFI on June 24, 2004 provided for an exchange of equity for debt at a higher price per share of the Company's common stock than $6.00, the Company had to recognize an expense in the amount of approximately $343,512, an inducement expense, for the difference between the price at which KFI was otherwise entitled to convert its debt into Sutter common stock and the $6.00 at which it was actually converted. Simultaneous with these transactions, KFI declared a stock dividend on its common stock in which shareholders of KFI immediately prior to the KFI Change of Control received one share of the Company's common stock for every share of KFI common stock held by such shareholder. Effective July 30, 2004, Sutter held 126,140 shares or an 18% equity interest in KFI and, due to the resignation of its officers from KFI's board of directors, Sutter no longer had any representation on KFI's board. During the third quarter, Sutter's equity interest in KFI was reduced from approximately 18.0% to approximately 1.0%. As of December 31, 2004, the Company owned approximately 116,140 shares of common stock of KFI. During 2004, these shares were not readily marketable. On January 6, 2005, KFI shares began trading on the OTC Bulletin Board under the symbol KNTF.OB. 5. Property and Equipment Property and equipment consist of the following at December 31, 2004 and 2003: December 31, ---------------------------------------- 2004 2003 -------------------- ------------------- Furniture, equipment & leasehold improvements $328,546 $274,981 Accumulated depreciation (174,211) (16,275) -------------------- ------------------- Furniture, equipment & leasehold improvements, net $154,335 $258,706 ==================== =================== 6. Identifiable Intangibles and Other Assets December 31, ---------------------------------------- 2004 2003 -------------------- ------------------- Customer list, net of accumulated amortization of $54,796 and $2,796 at December 31, 2004 and December 31, 2003 $205,204 $257,204 Non-compete agreement, net of accumulated amortization of $31,613 and $1,613 at June 30, 2004 and December 31, 2003 28,388 58,387 Other assets 145,943 15,194 -------------------- ------------------- Total identifiable intangible and other assets, net $379,535 $330,785 ==================== =================== 7. Goodwill Sutter accounts for goodwill in accordance with Statement of Financial Accounting Standards No. 142 ("SFAS 142") "Goodwill and Other Intangible Assets." SFAS 142 changed the accounting for goodwill from a model that required amortization of goodwill, supplemented by impairment tests, to an accounting model that is based solely upon impairment tests. The carrying amount of goodwill increased during fiscal 2004 due to a final purchase price adjustment provided for in the Stock Purchase Agreement related to the acquisition of Progressive. Goodwill of acquired businesses consisted of the following in 2004 and 2003: 29 December 31, ------------------------------------ 2004 2003 ------------------ ----------------- Balance at the beginning of year $4,483,746 $0 Additions to existing business 50,447 4,483,746 ------------------ ----------------- Balance at the end of year $4,534,193 $4,483,746 ================== ================= 8. Commitments and Contingencies For the first four months of 2004, Sutter rented office space from Sutter Capital Management (a related party) under an operating lease, and Sutter's subsidiaries, Easton and Progressive, rented office space from independent third party lessors under operating leases in three separate locations: San Francisco, CA, Scottsdale, AZ and Spokane, WA. Rent expense was $383,892 and $115,954 for 2004 and 2003, respectively. Minimum future lease payments under all existing leases consist of the following at December 31, 2004: Minimum Minimum Year ending Future Cash Deferred Future Lease December 31, Lease Payments Payments Expense ----------------- ----------------- ---------------------- 2005 411,319 3,401 414,720 2006 346,752 (4,535) 342,217 2007 198,329 (8,503) 189,826 2008 162,688 (16,439) 146,249 2009 166,656 (20,407) 146,249 thereafter 222,208 (27,209) 194,999 ------------------- ---------------- ---------------------- Totals $ 1,507,952 $ (73,692) $ 1,434,260 =================== ================ ====================== In May 2004, the Company entered into a new property lease agreement for approximately 6,000 square feet of office space in downtown San Francisco. The new lease allowed Sutter to consolidate its headquarters office and the office of its Easton subsidiary into one central office. This new location also allowed space for Sutter's Progressive subsidiary to have a retail office presence in northern California. The new lease agreement is for seven years, commences on May 1, 2004 and is expected to meaningfully reduce total office rental costs for the foreseeable future. Sutter's new office address is: 220 Montgomery Street, Suite 2100, San Francisco, CA 94104. In May of 2004, the Progressive subsidiary opened a new office located in Las Vegas, Nevada; this new lease agreement is for 3 years. During fiscal 2003, the Company received two notices of potential claims relating to some of the Company's former businesses under prior management. These potential claims are over four years old and involve parties that have no business relationship or contact with present management or the Company. While current management believes that the ultimate outcome of these claims will not have a material adverse effect on the Company's results of operations, litigation is subject to inherent uncertainties and unfavorable rulings, however unlikely, could occur. Depending on the amount and timing, an unfavorable outcome of one or both of these matters could have a material adverse effect on the Company's business, cash flows, operating results or financial position. An accurate estimate of potential loss from pending claims cannot be made at this time. Easton has two primary warehouse lines of credit in the aggregate amount of $7.0 million, including $3.0 million from Flagstar Bank, FSB ("Flagstar") and $4.0 million from Gateway Bank FSB ("Gateway") respectively, that it uses to fund and warehouse mortgages until such mortgages are bought by investors, which purchases typically occur within eight to ten business days of funding. These loans are pre-sold by the time the Company funds the loan. Easton has a secondary warehouse line of credit in the amount of $250,000, from Flagstar, that it uses to fund and warehouse second mortgages under substantially similar terms and circumstances as exist with the primary line of credit facility. There are minimum capital and tangible net worth requirements 30 imposed separately by Flagstar and Gateway which are checked quarterly and are necessary to maintain the access and use of the warehouse lines. Progressive has two primary warehouse lines of credit in the aggregate amount of $8.0 million, including $5.0 million from Flagstar and $3.0 million from Provident Funding Services ("Provident"), that it uses to fund and warehouse mortgages until such mortgages are bought by investors, which purchases typically occur within eight to ten business days of funding. These loans are pre-sold by the time the Company funds the loan. There are minimum capital and tangible net worth requirements imposed separately by Flagstar and Provident which are checked quarterly and are necessary to maintain the access and use of the warehouse lines. The above facilities are made available to Easton/Progressive on an annual basis. The interest rate charged on borrowings under the above warehouse lines of credit is the prime rate. For the year ended December 31, 2004, the weighted-average interest rate for borrowings under all of the above warehouse lines of credit was approximately 5.32%. Loans Sold to Investors - Generally, the Company is not exposed to significant credit risk on its loans sold to investors. In the normal course of business, the Company is obligated to repurchase loans which are subsequently unable to be sold through its contractual investor channels. Historically, the Company has not had to repurchase any loans sold. If repurchases are required, the loans will then be repackaged and sold to non-traditional investors. Net Worth Requirements - The Company's subsidiaries, Easton and Progressive, are required to maintain certain specified levels of minimum net worth to maintain their approved status with Fannie Mae, Freddie Mac, HUD and other investors. At December 31, 2003, the highest minimum net worth requirement applicable to the Company was $250,000. As discussed earlier, the Company issued shares to its subsidiaries to help them meet their net worth requirements. As of December 31, 2004, the Company's subsidiaries met their respective net worth requirements. 9. Debt to Unrelated and Related Parties Debt to unrelated and related parties of Sutter and its subsidiaries consisted of the following as of December 31, 2004 and 2003: December 31, ---------------------------------------- 2004 2003 -------------------- ------------------- Debt to unrelated parties: 15.00% note due 2005 $25,000 $0 8.00% note due 2006, net of unamortized discount of $56,074 at December 31, 2004, and $78,211 at December 31, 2003 243,926 521,789 10.00% notes due 2007 0 66,762 -------------------- ------------------- Total $268,926 $588,551 ==================== =================== Debt to related parties: 8.00% convertible note due 2005 $0 $1,666,000 10.00% note due 2005 57,000 0 10.00% note due 2005 37,000 1,787,735 12.50% note due 2005, net of unamortized discount of $32,106 at December 31, 2004 617,894 0 6.00% note due 2007 500,000 500,000 6.00% note due 2007 450,000 0 -------------------- ------------------- Total $1,661,894 $3,953,735 ==================== =================== 31 The 8.00% unrelated party note due 2006 in the principal amount of $300,000 is convertible, at the holder's option, into shares of Sutter common stock at the lesser of $15.00 per share or the prevailing market price of Sutter's common stock at the time of conversion, provided however, that in no event shall the conversion result in greater than 4.9% ownership of outstanding Sutter common stock. Included in the convertible debt item is $56,074 of unamortized discount which will be amortized using the effective interest method over the life of the loan. The total beneficial interest conversion feature is approximately $107,500 and is being amortized to interest expense over the life of the loan. Total interest on debt to related parties was $311,997 and $125,777 in 2004 and 2003, respectively. Maturities of the above debt at December 31, 2004 are as follows: Related Non-Related Party Party Year ending December 31, Principal Principal ------------------ ------------------ 2005 $856,500 $25,000 2006 112,500 300,000 2007 725,000 0 2008 0 0 2009 0 0 thereafter 0 0 ------------------ ------------------ $1,694,000 $325,000 ================== ================== The two 6.00% related party notes were issued by subsidiaries and are not guaranteed by Sutter. They were issued in connection with the acquisitions of Easton and Progressive, respectively. The 6.00% related party note with a $500,000 principal balance is due and payable in 2007 subject to an earnout. The 6.00% related party note with a $450,000 principal balance is fully amortizing with interest payable monthly and any outstanding principal balance due in 2007. 10. Income Taxes The Company files consolidated federal and combined state tax returns with its subsidiaries. A rate reconciliation of income taxes at the statutory federal income tax rate to net income taxes included in the accompanying statements of operations is as follows: 2004 2003 2002 ---- ---- ---- Tax at statutory rate 34.0% 34.0% 34.0% State Income Taxes, net of federal benefit 5.8% 5.8% 5.8% Meals and Entertainment -0.7% -0.5% -0.1% Change in Valuation Allowance -36.1% -39.3% -35.7% Other -3.0% -0.1% -4.1% ------------- ------------- ------------ Tax provision recorded 0.0% 0.0% -0.1% ============= ============= ============ As of December 31, 2004, the Company had federal net operating loss carry forwards of approximately $2,010,568. The net operating loss carry forwards will expire at various dates through 2017, if not utilized. 32 Due to the change of control which occurred on March 28, 2002, when present management took over, utilization of the net operating losses may be subject to a substantial annual limitation due to the "change in ownership" provisions of the Internal Revenue Code of 1986, as amended, and similar state provisions. The annual limitation may result in the expiration of net operating losses before utilization. Significant components of the Company's deferred tax assets for federal and state income taxes are as follows: December 31, ---------------------------------- 2004 2003 --------------- --------------- Deferred tax assets: Net operating loss carry forwards $792,000 $283,000 Capital loss carry forwards 0 128,000 Impairment reserve for investments and note receivable 274,000 239,000 Depreciation and amortization 97,000 10,000 Accrued compensation 0 25,000 Other, net 0 1,000 --------------- --------------- Total deferred tax assets 1,163,000 686,000 Valuation allowance (1,163,000) (686,000) --------------- --------------- Net deferred tax assets $0 $0 =============== =============== As of December 31, 2004 and 2003, the Company had deferred tax assets of approximately $1,163,000 and $686,000, respectively. Realization of the deferred tax assets is dependent upon future taxable income, if any, the amount and timing of which are uncertain. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance. The net valuation allowance increased by approximately $477,000, $280,000 and $276,000 during the years ended December 31, 2004, 2003 and 2002, respectively. 11. Common Stock Changes in issued and outstanding Sutter common stock during the three years ended December 31, 2004, December 31, 2003 and December 31, 2002 are shown in the table below. Common Stock, $0.0001 Par Value (1,875,000 shares authorized) Shares issued and outstanding -------------------------------------- Balance at January 31, 2002 2,250,000 ----------------------------------- Reverse split 1:20 112,500 Issuances during the year 131,536 ----------------------------------- Balance at December 31, 2002 244,036 Issuances during the year 185,402 Repurchase during the year (77,496) ----------------------------------- Balance at December 31, 2003 351,942 Issuances during the year 282,732 ----------------------------------- Balance at December 31, 2004 634,674 =================================== 33 12. Stock Options Prior to July 2004 the Company did not have a have a formal stock option plan. Certain members of current management have received non-qualified stock options during the past three years. Stock options activity for 2004, 2003 and 2002 is presented in the following table. 2004 2003 2002 -------------------------- -------------------------- ------------------------ Weighted Weighted Weighted Number Average Number Average Number Average of Exercise of Exercise of Exercise Shares Price Shares Price Shares Price ----------- -------------- ------------ ------------- ------------ ----------- Options outstanding at beginning of year 168,000 $11.43 80,000 $11.00 0 0 Options granted 124,850 $7.31 88,000 $11.83 80,000 $11.00 Options exercised 0 0 0 0 0 0 Options expired or cancelled (300) $5.00 0 0 0 0 ----------- -------------- ------------ ------------- ------------ ----------- Options outstanding at end of year 292,550 $9.67 168,000 $11.43 80,000 $11.00 =========== ============== ============ ============= ============ =========== Options exercisable at end of year 91,000 $10.90 26,666 $11.00 0 0 Options available for future grant 282,150 207,000 295,000 The weighted average fair value of options granted during 2004, 2003 and 2002 is $2.58, $5.02 and $5.16 per option share, respectively. The status of outstanding options as of December 31, 2004 is presented in the following table. Weighted Average Remaining Number of Contractual Exercise Price Shares Life (yrs) ---------------- -------------- Outstanding options: $4.00 1,000 4.1 $5.00 12,600 4.0 $6.00 22,500 4.8 $7.00 44,750 4.2 $9.00 44,000 8.8 $10.10 8,000 4.0 $11.00 80,000 7.6 $12.00 80,000 8.6 Exercisable options: $7.00 8,333 4.0 $10.10 2,667 4.0 $11.00 53,333 7.6 $12.00 26,666 8.6 34 13. Warrants In December 2004, the Company granted 20,000 warrants to purchase common stock to an immediate family member of an officer of the Company in conjunction with the execution of a Stock Purchase and Loan Agreement; the Company officer related to the recipient of the warrants expressly disclaims any beneficial interest in these warrants. These warrants have an exercise price of $6.00 per share and expire in December 2009. The estimated fair value of these warrants at the time of issuance was computed at $35,025 using the Black-Scholes option pricing model with the following assumptions: a risk free interest rate of 3.5%, expected dividend yield of zero percent (0%), term equal to five years, expected volatility of 25.0%, and a common stock price per share of $6.00. All warrants issued and outstanding prior to 2003 have expired. 14. Employee Benefits In 2004, the Company began offering a 401(k) plan managed by Salomon-Smith Barney, a division of Citigroup. The plan covers all of Sutter's and its subsidiaries' employees meeting certain minimum eligibility requirements. Sutter makes matching contributions annually to the plan and matches the first two percent (2%) contributed by each employee. Company contributions to the plan vest in equal percentages over a period of three years. 15. Certain Relationships and Related Party Transactions For fiscal 2004, Mr. Dixon, Mr. Knuff, and Easton president Mr. Birch, each personally guaranteed two warehouse lines of credit on behalf of Easton, in the aggregate amount of $3,250,000. None of the guarantors received any compensation for providing these guarantees. On December 15, 2004, the Company entered into a Stock Purchase and Loan Agreement, with Heather B. Knuff, the spouse of a Company officer, under which Mrs. Knuff loaned $650,000 to the Company. As part of the agreement, Mrs. Knuff received 20,000 warrants to purchase common stock. Subsequently, on January 31, 2005, the Company paid back $200,000 to Mrs. Knuff, reducing the outstanding principal amount of the loan to $450,000. Mr. Knuff expressly disclaims any beneficial interest in this agreement or the related warrants. 16. Other Commitments and Contingencies In November 2002, the FASB issued FIN No. 45 "Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others" -- an interpretation of FASB Statements No. 5, 57 and 107 and rescission of FIN 34." The following is a summary of our agreements that management has determined are within the scope of FIN 45. The Company has agreed to indemnify each of its executive officers and directors for certain events or occurrences arising as a result of the officer or director serving in such capacity. The term of the indemnification period is for the officer's or director's lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited. However, we have a directors' and officers' liability insurance policy that should enable us to recover a portion of future amounts paid. As a result of our insurance policy coverage, we believe the estimated fair value of these indemnification agreements is minimal and have no liabilities recorded for these agreements as of December 31, 2004 and 2003, respectively. 35 17. Quarterly Data (Unaudited) A summary of revenues and earnings by quarter for each of the last two years is presented in the following table. This information is unaudited. First Second Third Fourth Quarter Quarter Quarter Quarter ------------- ------------- ------------- ------------- 2004 Total revenues $628,716 $727,053 $562,031 $797,074 Net (loss) income ($346,983) ($333,806) ($781,368) $73,809 Net (loss) income per share -- basic and diluted ($0.98) ($1.00) ($1.61) $0.13 2003 Total revenues $696,655 $478,840 $466,494 $202,921 Net income (loss) per share -- basic and diluted $271,092 $24,369 $26,687 ($1,008,521) Net income (loss) per share -- basic and diluted $1.09 $0.10 $0.10 ($3.68) Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure On November 18, 2003, the Company's Board of Directors accepted the resignation of Regalia & Associates ("R&A"), as its principal independent accountants. R&A had approached members of the Board of Directors shortly after R&A had completed performing its annual audit for fiscal 2002 and, at that time, had expressed its desire to cease providing auditing services to the Registrant because R&A claims it is unable to deliver the level of services required by the Sarbanes-Oxley Act. However, R&A had agreed to remain as the Company's independent accountant through the satisfactory review of all of the Company's reports on Form 10-Q for the 2003 fiscal year. As a result of R&A's notification and decision, the Company's Board of Directors undertook a search for a new independent accountant. R&A's report on the Company's financial statements for the year ended December 31, 2002 did not contain an adverse opinion or disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit scope or accounting principles. During the Company's fiscal year ended December 31, 2002, and the subsequent interim periods through September 30, 2003, there were no disagreements with R&A on any matters of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which, if not resolved to the satisfaction of R&A would have caused it to make reference to the subject matter of the disagreement in connection with its report on the financial statements for that period, nor have there been any reportable events as defined under Item 304(a)(1)(v) of Regulation S-K during such period. Effective as of November 18, 2003, the Company's Board of Directors approved and engaged the firm of BDO Seidman, LLP ("BDO"), San Francisco, California, as independent accountants for its fiscal year ending December 31, 2003 and beyond. On October 10, 2004, the Company received the resignation of BDO Seidman, LLP ("BDO") as its principal independent accountants. BDO's report on the Company's financial statements for the year ended December 31, 2003 did not contain an adverse opinion or disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit scope or accounting principles. During the Company's fiscal year ended December 31, 2003, and the subsequent interim periods through October 10, 2004, the date of BDO's resignation, there were no disagreements with BDO on any matters of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which, if not resolved to the satisfaction of BDO would have caused it to make reference to the subject matter of the disagreement in connection with its report on the financial statements for that period, nor have there been any "reportable events" as defined under Item 304(a)(1)(v) of Regulation S-K during such period. Effective as of October 12, 2004, the Company's Board of Directors approved the engagement of, and engaged, the firm of Burr, Pilger & Mayer, LLP ("BPM"), San Francisco, California, as independent accountants for its fiscal year ending December 31, 2004 and beyond. The Company has not, during the two fiscal years ended December 31, 2003, and during the interim period prior to 36 engagement of BPM, consulted BPM regarding (i) either the application of accounting principles to a specified transaction, completed or proposed, or the type of audit opinion that might be rendered on the Company's financial statements, or (ii) any disagreement described under Item 304(a)(1)(iv) of Regulation S-K or any reportable event described under Item 304(a)(1)(v) of Regulation S-K. Item 9A. Controls and Procedures On March 25, 2005, our current independent auditor suggested accounting treatment for a series of transactions that differed from the manner in which we had previously accounted for them. On March 28, 2005, we definitively determined that (1) we had improperly accounted for the carrying value of a non-core investment and the resulting gain on sale from this investment in our 2004 fiscal third quarter, (2) we had improperly taken into revenue a gain on sale of such investment that included the Company taking shares of its common stock back into treasury, and (3) we had not previously accounted for an inducement component of a conversion of outstanding indebtedness of the Company into common stock. As a result of these determinations, we have changed the manner in which these non-cash items are accounted for going forward and we have made adjustments, as necessary, to make past accounting treatment consistent with appropriate accounting treatment with respect to these items. These changes in accounting treatment have had a moderately favorable impact on the Company's balance sheet and a significantly unfavorable impact on the Company's reported loss for the year. However, since these changes are non-cash in nature, they have had no economic impact on the Company or its operations. In an effort to prevent the future potential occurrence of errors with respect to accounting for complex, non-operating transactions such as those that gave rise to the accounting changes above, the Company's senior management has decided to establish a relationship with an independent consulting firm so that it may be provided with an independent expert opinion regarding the proper accounting treatment for any potential future material transaction in advance of recording such transaction. As of the end of the period covered by this Annual Report on Form 10-K, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic SEC filings. Furthermore, the Company's senior management decided to research, identify and seek to implement as soon as practicable a new third-party hosted accounting software solution to better position the Company with respect to future compliance with respect to Section 404 of the Sarbanes-Oxley Act from a financial controls and procedures perspective. As part of this new hosted accounting solution, senior management also decided to add to the Company's accounting staff. These changes are being implemented currently and should be effective sometime in the second quarter. Subsequent to the date of that evaluation, there have been no significant changes in the Company's internal controls over financial reporting or in other factors that could significantly affect internal controls over financial reporting, nor were any corrective actions required with regard to significant deficiencies and material weaknesses. Item 9B. Other Information On November 8, 2004, the Company entered into a Receipt, Settlement and Satisfaction Agreement (the "Satisfaction Agreement"), which amended certain provisions of the Stock Purchase Agreement dated January 14, 2003, by and between the Company and the former owners of Easton. The Satisfaction Agreement grants the Company the right to cancel the existing promissory notes in the sum of $1,854,497 on or before December 17, 2004, in return for a cash payment in the amount of $750,000 by the Company, and amended and restated notes in the amount of $450,000, provided any and all interest due under the promissory notes has been paid. On December 17, 2004, the Company exercised its right with respect to the Satisfaction Agreement and, as a result, significantly and favorably reduced its level of funded indebtedness. 37 Part III Item 10. Directors and Executive Officers of the Registrant As of March 25, 2005, the Company's directors, executive officers and significant employees together with their ages and a brief description of their backgrounds, are as follows: Name Age Position Since ---------------------------------- ------ ------------------------------------------------- ---------- William G. Knuff, III 37 Chairman and Chief Financial Officer 2002 Robert E. Dixon 34 Vice Chairman and Chief Investment Officer 2002 R. Michael Collins 39 President and Chief Executive Officer 2004 Peter F. Seidenberg 36 Director and Audit Committee Chairman 2004 James M. Corroon 65 Director 2005 Karen M. La Monte 50 Secretary 2002 Each director serves, in accordance with the by-laws of the Registrant, until the first meeting of the Board of Directors following the next annual meeting of shareholders and until his respective successor is chosen and qualified or until he sooner dies, resigns, is removed or becomes disqualified. Officers serve at the discretion of the Board of Directors. Each executive officer serves in accordance with his employment agreement, which in the case of each of Messrs. Collins, Dixon and Knuff is for a period of five years from the commencement of their employment agreements. (See Item 11. Executive Compensation) WILLIAM G. KNUFF, III has served as a director since March 2002. He currently serves as Chairman of the Board and Chief Financial Officer. Prior to joining Sutter, Mr. Knuff was a mergers and acquisitions ("M&A") specialist at Robertson Stephens, Inc. where he advised companies on acquisitions in the biotechnology, telecommunications and financial services industries. Mr. Knuff is also a principal of Sutter Capital Management, LLC. Mr. Knuff holds an MBA from Cornell University and a BA from the University of Texas at Austin. ROBERT E. DIXON has served as a director since March 2002. He currently serves as Vice Chairman of the Board and Chief Investment Officer. Mr. Dixon also serves as the managing member of the investment firm of Sutter Capital Management, LLC ("SCM"). SCM is the manager of Sutter Opportunity Fund 2, LLC. Mr. Dixon holds an MBA from Cornell University and a BA from the University of California at Los Angeles. Mr. Dixon is also a Chartered Financial Analyst. R. MICHAEL COLLINS joined the Company on March 22, 2004. Mr. Collins has served as a director since April 2004. He currently serves as President and Chief Executive Officer. Prior to joining Sutter, Mr. Collins spent the last 10 years advising companies and private equity investors on M&A and related transactions. Most recently, he was a director at SG Cowen Securities Corporation, where he served as the head of Consumer M&A. Before SG Cowen, Mr. Collins was an M&A specialist at Robertson Stephens, Inc., and practiced law for several years at the firm of Kirkland & Ellis LLP where he represented leading private equity funds in all aspects of their business. Mr. Collins holds a JD from the Columbia University School of Law and a BA from Stanford University PETER F. SEIDENBERG has served as a director and as Audit Committee Chairman since January 2004. Mr. Seidenberg is currently Chief Financial Officer of Commerce One and a director of Nebraska Heavy Industries. From June 1998 to August 2004, Mr. Seidenberg served as director of finance and corporate controller for Plumtree Software which he helped grow from $2 million to over $80 million in revenue. Mr. Seidenberg holds a BS in Applied Economics and an MBA from Cornell University. JAMES M. CORROON was elected to serve as an independent director on the Company's Board of Directors on January 24, 2005. Mr. Corroon is currently Vice Chairman of Fort Point Insurance Services. He has also served as a director of Insweb since August 1996, and has served as Vice Chairman since May 1999. From July 1999 to December 2000, Mr. Corroon was a full-time employee of Insweb and a member of the senior management team. Prior to his involvement with Fort Point and Insweb, Mr. Corroon was a director of Willis Corroon of California. From 38 October 1966 to December 1995, Mr. Corroon held various management positions with Willis Corroon, and its predecessor entity Corroon & Black Corporation. KAREN M. LA MONTE has served as secretary of the Company since March 2002. Ms. La Monte also serves in various administrative capacities for Sutter Capital Management, LLC and has done so since June 1998. Audit Committee Financial Expert The Company has an independent audit committee of one. Peter Seidenberg, a director of the company and a financial expert serves as the Audit Committee for all purposes relating to communications with the Company's auditors. In his capacity as Audit Committee Chairman, he is also responsible for the oversight of the Company's audit and disclosure process. Mr. Seidenberg is "independent" as that term is used in Item 7(d)(3)(iv) of Schedule 14A under the Securities Exchange Act of 1934. Code of Ethics The Company has and maintains a formal, written Code of Ethics. It was adopted by the Board of Directors in March 2004. Item 11. Executive Compensation The following table sets forth the aggregate compensation paid to the Company's current and former executive officers for services rendered during the past three years: Summary Compensation Table -------------------------------------------------------------------------------- Annual Long Term Compensation Compensation ------------------- ---------------- Securities Underlying Name Salary Options Principal Position(s) Year ($) (#) ----- -------------------------------------------------------------------------- William G. Knuff, III Chairman & Chief Financial Officer 2004 $93,295 (1) - 2003 $71,552 40,000 2002 $8,753 40,000 Robert E. Dixon Vice Chairman & Chief Investment Officer 2004 $93,295 (1) - 2003 $71,552 40,000 2002 $8,753 40,000 R. Michael Collins President & Chief Executive Officer 2004 $75,262 (1) 40,000 Roger N. Gladstone Former Chairman & Chief Executive Officer 2002 (2) $120,000 - David F. Greenberg Former President & Chief Operating Officer 2002 (2) $150,000 - (1) Actual cash compensation paid in 2004 was $43,352 to each of Messrs. Knuff and Dixon, and $25,320 to Mr. Collins. In each case, the differences between reported salary and actual cash paid represent deferred salary. (2) For the period February 1, 2002 thru March 28, 2002. In each case the person resigned his positions as a result of and as a condition to the change of control that occurred on March 28, 2002. 39 Options Option grants in the last fiscal year to Named Executive Officers are as follows: Option Grants in Last Fiscal Year ---------------------------------------------------------------------------------------------------------------------- Number of Securities Percent of Exercise Underlying Total Options Price Grant Date Options Granted to Per Share Expiration Value(1) Name Granted Employees ($) Date ($) ---------------------------------------------------------------------------------------------------------------------- R. Michael Collins 40,000 13.7% $9.00 4/14/2014 $223,600(1) Calculated using the Black-Scholes options pricing model. An approximation of the three-year historical average of the S&P Volatility Index ("VIX") was assumed as a proxy for expected volatility. The rate, as of the grant date, on the 10-year US Treasury bond was assumed for the discount rate. The stock price on the date of grant was $9.00. As of March 18, 2005, none of the above options have vested. The following table sets forth aggregate option exercises in 2004, the number of securities underlying unexercised outstanding options held as of December 31, 2004, and the dollar value of unexercised, in-the-money options for the Named Executive Officers. There were no stock options exercised by any of the Named Executive Officers during 2004. Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values ------------------------------------------------------------------------------------------------------------ Number of Securities Underlying Value of Unexercised Unexercised Options at In-the-Money Options at Fiscal Year-End 2004 Fiscal Year-End 2004(1) ------------------------------------ ------------------------------------ Exercisable Unexercisable Exercisable Unexercisable Name (#) (#) ($) ($) ------------------------------------------------------------------------------------------------------------ R. Michael Collins 0 40,000 $0.00 $0.00 Robert E. Dixon 40,000 80,000 $0.00 $0.00 William G. Knuff, III 40,000 80,000 $0.00 $0.00(1) The value of unexercised in-the-money options is calculated by multiplying the number of securities underlying such options by the difference between (i) the closing price of the common stock on the OTC Bulletin Board on the last trading day of the 2004 fiscal year ($5.00) and (ii) the option exercise price. Compensation of Directors Directors who are also officers of the Company do not receive any compensation for their services as directors or otherwise in their capacities as directors. During fiscal 2004, non-officer, independent directors received $10,000 per year in cash compensation and a certain number of options issued at the discretion of the Board of Directors. For fiscal 2005, non-officer, independent directors will receive $25,000 per year ($6,250 per quarterly meeting attended) in cash compensation. An additional $2,000 per year ($500 per quarterly meeting attended) in cash compensation will be paid to each non-officer, independent director who also serves on a Board committee. At the discretion of the Board, stock options may also be awarded to non-officer, 40 independent directors. Non-officer directors of the Company who do not qualify as "independent", as this term is defined in Item 7(d)(3)(iv) of Schedule 14A under the Securities Exchange Act of 1934, shall not receive any compensation for Board service. Employment Agreements On January 25, 2005, the Company and each of Messrs. Collins, Dixon and Knuff amended certain provisions of their employment agreements to allow for the addition of a termination provision negotiated as a condition of the DRIB transaction, and to provide for an alternate method for the receipt of stock options in lieu of regular, ongoing annual grants. Copies of the employment agreements, as recently amended, were filed on Form 8-K with the SEC and are incorporated herein by reference. Additional Information with Respect to Compensation Committee Interlocks and Insider Participation in Compensation Decisions The Company currently does not have a compensation committee. Messrs. Collins, Dixon, Knuff and Seidenberg participated in deliberations of the Company's Board of Directors concerning executive officer compensation. Sutter's Board of Directors and current management generally believe that executive compensation should be tied to the long term performance of the Company. Evidence of this belief can be seen in the total amount of compensation awarded to the Company's senior executive officers, and in the fact that a significant number of Sutter's employees at Easton and Progressive received greater compensation than each of Sutter's senior executive officers during each of the past three years. Performance Graph [GRAPHIC OMITTED] Item 12. Security Ownership of Certain Beneficial Owners and Management The following table sets forth certain information, as of March 25, 2005, with respect to the number of shares of common stock beneficially owned by (i) each director of the Company, (ii) all directors and officers of the Company 41 as a group and (iii) each shareholder known by us to be a beneficial owner of more than 5% of any class of our voting securities (the "Principal Stockholders"). This table is based on information provided to the Company or filed with the Securities and Exchange Commission (the "SEC") by the Company's directors, officers and Principal Stockholders. Except as otherwise indicated below, the Company believes that the beneficial owners of the common stock, based upon information furnished by such owners, have sole investment and voting power with respect to such shares. Applicable percentages below are based upon 1,844,739 diluted shares outstanding as of March 25, 2005, including any vested, unexercised stock options of the parties listed in the table below. Security Ownership of Certain Beneficial Owners & Management -------------------------------------------------------------------------------- Amount and Nature of Percent Beneficial of Name and Address of Beneficial Owner(1) Ownership Class -------------------------------------------------------------------------------- Michael P. Flynn(2) 452,095 23.4% Charles A. Leone(3) 386,183 20.0% John C. Schreiner(4) 179,129 9.3% Stephen S. Meeker(5) 169,939 8.8% Sutter Opportunity Fund 2, LLC(6), 220 Montgomery Street, Suite 2100, San Francisco, CA 94104 129,531 6.7% William G. Knuff, III(7) 81,764 4.2% William S. Howard, Jr.(8) 49,500 2.6% Robert E. Dixon(7) 48,642 2.5% R. Michael Collins 9,723 0.5% Peter F. Seidenberg 4,000 0.2% James M. Corroon 0 0.0% Karen La Monte 0 0.0% All Officers and Directors as a Group (6 persons)(9) 273,660 14.2% -------------------------------------------------------------------------------- (1) Information for each institutional stockholder listed was derived from statements filed with the Commission pursuant to Section 13(d) or 13(g) of the Securities Exchange Act; the business address of each director or management stockholder listed is c/o the Company at 220 Montgomery Street, Suite 2100,San Francisco, CA 94104. (2) Mr. Flynn is Chairman and CEO of the Company's Diversified Risk insurance subsidiary. These shares are beneficially owned by the Flynn Family Revocable Trust. (3) Mr. Leone is an Executive Vice President of the Company's Diversified Risk insurance subsidiary. These shares are beneficially owned by the Leone Living Family Trust. (4) Mr. Schreiner is an Executive Vice President of the Company's Diversified Risk insurance subsidiary. These shares are beneficially owned by the Schreiner Family Trust. (5) Mr. Meeker is an Executive Vice President of the Company's Diversified Risk insurance subsidiary. These shares are beneficially owned by the Meeker Living Trust. (6) Mr. Dixon is the primcipal owner and manager of Sutter Capital Management, LLC, the manager of Sutter Opportunity Fund 2, LLC. (7) Includes 40,000 options owned by each of Mr. Knuff and Mr. Dixon that are currently vested and exercisable within 90 days of the date of this report on Form 10-K. (8) Mr. Howard is the President of the Company's Progressive mortgage subsidiary. (9) Includes 129,531 shares owned by Sutter Opportunity Fund 2, LLC which is managed by Sutter Capital Management, LLC of which Mr. Dixon is the principal owner and manager, and therefore may be deemed to be a beneficial owner of these shares by virtue of his position. The directors and officers disclaim beneficial ownership of all such shares expressly identified in this footnote. 42 Item 13. Certain Relationships and Related Transactions For fiscal 2004, Mr. Dixon, Mr. Knuff, and Easton president Mr. Birch, each personally guaranteed two warehouse lines of credit on behalf of Easton, in the aggregate amount of $3,250,000. None of the guarantors received any compensation for providing these guarantees. On February 4, 2004, Knight Fuller, Inc. ("KFI") entered into a revolving loan and security agreement with Progressive Lending LLC, a wholly owned subsidiary of the Company. Under the agreement, KFI provided up to $100,000 of revolving credit to Progressive. On February 29, 2004, Progressive entered into a joint venture agreement (the "Joint Venture") with KFI. KFI agreed to contribute $80,000 to the Joint Venture, and Progressive agreed to contribute furniture, computers, other office equipment, and personnel, to open a mortgage banking office in Las Vegas, Nevada. KFI and Progressive each participated in 50% of the profits and losses of the Joint Venture. Subsequent to the KFI Change of Control which occurred on July 30, 2004, Progressive owns 100% of the Las Vegas operation. On March 5, 2004, KFI modified the Promissory Note (the "Note") due from the Company to increase the face value of the Note to $1,757,106.67 and to allow the Company to defer monthly payments for up to one year. In any month in which the Company elects to defer making a cash payment, the interest rate increases to 12% for that month. On March 22, 2004, Michael Collins, a director and officer of Sutter, purchased 5,556 restricted shares of Sutter common stock for $50,000 cash. On March 29, 2004, the Company sold its interest in Niman Ranch with a cost of $753,010 to Sutter Opportunity Fund 2, LLC ("SOF2"), a related party, for $1,001,827 (the "Niman Ranch Transaction"). Consideration received by the Company consisted of $191,049 in cash, the assumption of $300,000 in the Company's debt by SOF2, and the assignment by SOF2 to the Company of 126,140 common shares of KFI, another related party, valued at $510,778. At the time of this transaction, the net gain of $248,817 was deferred as this sale was to a related party that controlled the Company. On March 31, 2004, SOF2 purchased 2,000 restricted shares of Sutter common stock for $18,000 cash. On June 24, 2004, the Company entered into a new Loan Agreement with KFI, pursuant to which (i) the Company borrowed an additional $120,000 from KFI, (ii) KFI was given the option to convert all or a portion of the Company's debt obligations to KFI into common stock of the Company, and (iii) under certain circumstances, the Company was entitled to repay any and all outstanding debt obligations to KFI using the Company's common stock at a price equal to the lesser of (a) $7.25 per share, (b) the lowest price at which the Company sells primary shares after the date of the Loan Agreement and prior to such conversion, if any, or (c) the 10-day weighted average closing price of the Company's common stock on the date of notice to convert. On July 30, 2004, control of Knight Fuller, Inc. ("KFI"), formerly a related party, was acquired in a sale transaction by an independent third party (the "KFI Change of Control"). In conjunction with the KFI Change of Control, the Company elected to pay in full its debt obligation of $1,992,348 to KFI by issuing approximately 332,058 shares of its common stock to KFI at a value of $6.00 per share. Concurrent with those transactions, the Company also settled, in full, other subsidiary obligations by issuing an additional 14,553 shares of Sutter common stock to KFI. In total, the Company issued 347,373 shares of common stock to KFI for an aggregate consideration of $2,084,238. Simultaneous with these transactions, KFI declared a stock dividend on its common stock in which shareholders of KFI immediately prior to the KFI Change of Control received one share of the Company's common stock for every share of KFI common stock held by such shareholder. Effective July 30, 2004, Sutter held 126,140 shares or an 18% equity interest in KFI and, due to the resignation of its officers from KFI's board of directors, Sutter no longer had any representation on KFI's board. During the third quarter, Sutter's equity interest in KFI was reduced to approximately 1.2%, although the number of KFI shares that Sutter owns remained unchanged at September 30, 2004. On December 15, 2004, the Company entered into a Stock Purchase and Loan Agreement, with Heather B. Knuff, the spouse of a Company officer, under which Mrs. Knuff loaned $650,000 to the Company. As part of the agreement, Mrs. Knuff received 20,000 warrants to purchase common stock. Subsequently, on 43 January 31, 2005, the Company paid back $200,000 to Mrs. Knuff, reducing the outstanding principal amount of the loan to $450,000. Mr. Knuff expressly disclaims any beneficial interest in this agreement or the related warrants. Item 14. Principal Accountant Fees and Services Sutter accrues 100% of its budgeted expenses associated with principal accountant fees and services in the year being audited or serviced. The following table presents the expenses accrued by Sutter for such fees and services in 2004 and 2003. Principal Accountant Fees and Services ------------------------------------- 2004 2003 ---------------- -------------- Audit fees $56,000 $80,000 Audit-related fees $0 $0 Tax fees $14,000 $20,000 All other fees $0 $0 ---------------- -------------- Total $70,000 $100,000 ================ ============== Tax fees are comprised of fees related to the preparation and filing of the Company's federal and applicable state tax returns. The Company has an independent director serving as the Audit Committee. This director acts as the liaison between the Board of Directors and the Company's auditor with regard to all communication and responsibility concerning the Company's annual audit and quarterly reviews. All engagements for audit services, audit related services and tax services are approved in advance by the full board of directors of the Company. The Company's Board of Directors has considered whether the provision of the services described above for the fiscal years ended December 31, 2004 and 2003, respectively, is compatible with maintaining the auditor's independence. All audit and non-audit services that may be provided by our principal accountant to the Company shall require pre-approval by the Board. Further, our auditor shall not provide those services to the Company specifically prohibited by the Securities and Exchange Commission, including bookkeeping or other services related to the accounting records or financial statements of the audit client; financial information systems design and implementation; appraisal or valuation services, fairness opinion, or contribution-in-kind reports; actuarial services; internal audit outsourcing services; management functions; human resources; broker-dealer, investment adviser, or investment banking services; legal services and expert services unrelated to the audit; and any other service that the Public Company Accounting Oversight Board determines, by regulation, is impermissible. Part IV Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) 1. Financial Statements The following consolidated financial statements, as well as the Independent Auditors' Report, are included in Part II of this report: Page ---- Independent Auditors' Report 13 Consolidated Balance Sheets at December 31, 2004, and 2003 15 Consolidated Statements of Operations for the years ended 2004, 2003 and 2002 16 Consolidated Statements of Cash Flows for the years ended 2004, 2003 and 2002 17 Consolidated Statements of Changes in Shareholders' Equity for the years ended 2004, 2003 and 2002 18 Notes to Consolidated Financial Statements 19 44 2. Financial Statement Schedules Other schedules are omitted because they are not required, information therein is not applicable, or is reflected in the Consolidated Financial Statements or notes thereto. 3. Exhibits See Exhibit Index on page 40. 3(b). Reports on Form 8-K On October 14, 2004, the Company filed a report on Form 8-K disclosing a change in the Company's certifying accountant. This report on Form 8-K was subsequently amended and re-filed on October 19, 2004, December 3, 2004 and February 7, 2005. On November 4, 2004, the Company filed a report on Form 8-K disclosing the sale of unregistered equity securities. On November 23, 2004, the Company filed a report on Form 8-K disclosing the signing of a definitive agreement between FLF, Inc. dba Diversified Risk Insurance Brokers and the Company. On December 21, 2004, the Company filed a report on Form 8-K disclosing that it entered into an amended material definitive agreement with the RCH Noteholders. 45 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. SUTTER HOLDING COMPANY, INC. Date: April 14, 2005 /s/ R. Michael Collins R. Michael Collins President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. /s/ R. Michael Collins President and Chief Executive April 14, 2005 R. Michael Collins Officer /s/ Robert E. Dixon Vice Chairman and Chief April 14, 2005 Robert E. Dixon Investment Officer /s/ William G. Knuff, III Chairman and Chief Financial April 14, 2005 William G. Knuff, III Officer /s/ Peter F. Seidenberg Director and Audit Committee April 14, 2005 Peter F. Seidenberg Chairman 46 EXHIBIT INDEX No. Exhibit ---------- --------------------------------------------------------------------- 2.1 Stock Purchase Agreement dated December 31, 2002 by and between Sutter and Easton Mortgage Corporation. Incorporated by reference to Form 8-K filed January 17, 2003. 2.1(a) Amended Stock Purchase Agreement dated December 17, 2004 by and between Sutter and Easton Mortgage Corporation. Incorporated by reference to Form 8-K filed December 21, 2004 2.2 Stock Purchase Agreement dated December 11, 2003 by and between Sutter and Progressive Lending, LLC. Incorporated by reference to Form 8-K filed December 15, 2003. 2.3 Agreement and Plan of Merger dated January 26, 2005 by and between Sutter and FLF, Inc. Incorporated by reference to Form 8-K filed February 1, 2005. 3(i) Articles of Incorporation. Incorporated by reference to Form SB-2 filed December 8, 1999. 3.1(i) Amendment to Articles of Incorporation, as corrected. Incorporated by reference to Form 8-K filed February 1, 2005. 3(ii) By-laws Incorporated by reference to Form SB-2 filed December 8, 1999. 3.2(ii) Amended By-laws. Incorporated by reference to Form 8-K filed February 1, 2005. 4.1 Loan and Security Agreement dated December 10, 2003 by and between Sutter and William S. (Steve) Howard, Jr. Incorporated by reference to Form 8-K filed December 15, 2003. 4.2 Loan Agreement dated October 1, 2003 by and between Sutter and Knight Fuller, Inc. Incorporated by reference to Form 10-K filed April 14, 2004. 4.3 Loan and Security Agreement dated September 2, 2002 by and between Sutter and Ira Gaines. Incorporated by reference to Form 10-KSB filed April 7, 2003. 4.4 Voting and Registration Rights Agreement dated July 30, 2004 by and between Sutter and Knight Fuller, Inc. Incorporated by reference to Form 8-K filed August 2, 2004. 4.5 Escrow Agreement dated July 30, 2004 by and between Sutter (as Escrow Agent) and Knight Fuller, Inc. Incorporated by reference to Form 8-K filed August 2, 2004. 4.6 Stock Purchase and Loan Agreement dated December 15, 2004 by and between Sutter and Heather B. Knuff 4.7 Certificate of Designations, Preferences and Rights of Series A Convertible Preferred Stock dated January 26, 2005. Incorporated by reference to Form 8-K filed February 1, 2005. 4.8 Registration Rights Agreement dated January 26, 2005 by and among Sutter, R. Michael Collins, Robert E. Dixon, William G. Knuff, III, and MacKenzie Patterson Fuller, Inc. Incorporated by reference to Form 8-K filed February 1, 2005. 4.9 Put Agreement dated January 26, 2005 by and between Sutter and MacKenzie Patterson Fuller, Inc. Incorporated by reference to Form 8-K filed February 1, 2005. 4.10 Business Loan Agreement dated January 26, 2005 by and between FLF, Inc. and Bank of Alameda. Incorporated by reference to Form 8-K filed February 1, 2005. 4.11 Business Loan Agreement dated January 26, 2005 by and between Sutter and Bank of Alameda. Incorporated by reference to Form 8-K filed February 1, 2005. 10.1 Employment Agreement dated November 22, 2004 by and among Sutter, FLF, Inc. and Michael P. Flynn 10.2 Employment Agreement dated November 22, 2004 by and among Sutter, FLF, Inc. and Charles A. Leone 10.3 Employment Agreement dated November 22, 2004 by and among Sutter, FLF, Inc. and Stephen S. Meeker 10.4 Employment Agreement dated November 22, 2004 by and among Sutter, FLF, Inc. and John C. Schreiner 10.5 Series A Convertible Preferred Stock Purchase Agreement dated January 26, 2005. Incorporated by reference to Form 8-K filed February 1, 2005. 10.6 Amended and Restated Employment Agreement dated January 26, 2005 by and between Sutter and R. Michael Collins. Incorporated by reference to Form 8-K filed February 1, 2005. 10.7 Amended and Restated Employment Agreement dated January 26, 2005 by and between Sutter and Robert E. Dixon. Incorporated by reference to Form 8-K filed February 1, 2005. 10.8 Amended and Restated Employment Agreement dated January 26, 2005 by and between Sutter and William G. Knuff, III. Incorporated by reference to Form 8-K filed February 1, 2005. 10.9 Loan Guaranty dated January 26, 2005 by and between Sutter and R. Michael Collins. Incorporated by reference to Form 8-K filed February 1, 2005. 10.10 Loan Guaranty dated January 26, 2005 by and between Sutter and Robert E. Dixon. Incorporated by reference to Form 8-K filed February 1, 2005. 10.11 Loan Guaranty dated January 26, 2005 by and between Sutter and William G. Knuff, III. Incorporated by reference to Form 8-K filed February 1, 2005. 10.12 Shareholder Covenant Agreement dated January 26, 2005 by and among Sutter and FLF, Inc., Michael P. Flynn, Charles A. Leone, Stephen S. Meeker, and John C. Schreiner. Incorporated by reference to Form 8-K filed February 1, 2005. 14 Code of Ethics. Incorporated by reference to Form 10-K filed April 14, 2004. 16 Letter regarding change in Certifying Accountant. Incorporated by reference to Form 8-K filed February 7, 2005. 21 Subsidiaries of the Registrant 31 Rule 13a-14(a)/15d-14(a) Certifications 32 Section 1350 Certifications 99.1 Press Release. Incorporated by reference to Form 8-K filed November 23, 2004. 99.2 Press Release. Incorporated by reference to Form 8-K filed February 1, 2005.