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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM 10-Q


(Mark One)


[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarterly period ending September 30, 2012



[  ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____to_____


Commission file number:  333-103331


Genesis Financial, Inc.

(Exact Name of Registrant as Specified in Its Charter)


Washington

03-0377717

(State of Incorporation)

(IRS Employer Identification No.)

 

 

3773 West Fifth Avenue, Suite 301 Post Falls, ID.

83854

(Address of principal executive offices)

(Zip Code)


Issuer’s telephone number: (208) 457-9442


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


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


Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definitions of “accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):     Large accelerated filer [ ], Accelerated filer [ ], Non-accelerated filer [ ], Smaller reporting company [X]


Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes [  ] No [X]


APPLICABLE ON TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS


Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act subsequent to the distribution of securities under a plan confirmed by the court. Yes [ ] No [ ]


APPLICABLE ONLY TO CORPORATE ISSUERS:


As of October 12, 2012 there were 10,571,608 shares of common stock issued and outstanding.







1






Table of Contents




PART I – FINANCIAL INFORMATION

3

Item 1. Financial Statements and Footnotes

3

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operation

13

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

16

Item 4. Controls and Procedures.

16

PART II - OTHER INFORMATION

17

Item 1.  Legal Proceedings.

17

Item 1A. Risk Factors

17

Item 2.  Unregistered Sale of Equity Securities and Use of Proceeds.

17

Item 3.  Defaults upon Senior Securities.

17

Item 4.  Mine Safety Disclosures.

17

Item 5.  Other Information.

17

Item 6.  Exhibits

17

SIGNATURES

18































2





PART I – FINANCIAL INFORMATION


Item 1. Financial Statements and Footnotes


 

GENESIS FINANCIAL, INC.

 

Balance Sheets

 

 

 

(Unaudited)

 

 

 

 

 

September 30,

 

December 31,

 

 

 

2012

 

2011

ASSETS

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

Cash and cash equivalents

$

52,974

$

22,117

 

Interest and other receivables

 

194,123

 

185,678

 

Related party receivable

 

-

 

9,654

 

Investments in real estate limited liability corporations

 

225,000

 

-

 

Loans held for sale

 

1,387,818

 

598,251

 

Real estate owned

 

883,476

 

1,095,393

 

  Total current assets

 

2,743,391

 

1,911,093

 

 

 

 

 

 

NON-CURRENT ASSETS:

 

 

 

 

 

Long-term investment, at cost

 

1,250,000

 

1,750,000

 

Investment in marketable equity security, at fair value

 

811,848

 

-

 

Office equipment, net of accumulated depreciation of $1,474 and $451

 

6,459

 

7,481

 

  Total non-current assets

 

2,068,307

 

1,757,481

 

 

 

 

 

 

Total assets

$

4,811,698

$

3,668,574

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

Line of credit, affiliated company

$

1,465,000

$

1,510,000

 

Related party payable

 

5,041

 

-

 

Line of credit, bank

 

-

 

187,107

 

Other current liabilities

 

16,122

 

27,120

 

   Total current liabilities

 

1,486,163

 

1,724,227

 

 

 

 

 

 

LONG-TERM LIABILITIES:

 

 

 

 

 

Convertible note payable to officer, net of discount of $14,991 and $62,611, respectively

 

235,009

 

187,389

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY:

 

 

 

 

 

Series B Preferred stock, $1.00 par value: 2,000,000 authorized 1,815,000 and 1,957,500 issued and outstanding, respectively

 

1,815,000

 

1,957,500

 

Common stock, $.001 par value, 100,000,000 authorized, 10,571,608 and 7,863,358 issued and outstanding, respectively

 

10,571

 

7,863

 

Additional paid-in capital

 

5,998,424

 

4,412,451

 

Accumulated deficit

 

(5,045,317)

 

(4,620,856)

 

Accumulated other comprehensive income

 

311,848

 

-

 

  Total stockholders’ equity

 

3,090,526

 

1,756,958

 

 

 

 

 

 

Total liabilities and stockholders' equity

$

4,811,698

$

3,668,574

 

 

 

 

 

 

 

See accompanying notes to financial statements.

 

 

 

 




3






GENESIS FINANCIAL, INC.

 Statements of Operations and Other Comprehensive Income (Loss)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 Three Months Ended September 30,

 

 Nine Months Ended September 30,

 

 

2012

 

2011

 

2012

 

2011

REVENUE:

 

 

 

 

 

 

 

 

  Interest, (net of write-offs),

    processing fee and other income

$

66,107

$

19,102

$

106,750

$

(56,098)

  Net revenues

 

66,107

 

19,102

 

106,750

 

(56,098)

 

 

 

 

 

 

 

 

 

EXPENSES:

 

 

 

 

 

 

 

 

  Fair value adjustment

 

-

 

-

 

215,000

 

(35,191)

  Write-off of receivable

 

18,298

 

-

 

99,898

 

-

  Salaries

 

11,250

 

11,250

 

33,750

 

33,750

  Management fee - affiliate

 

-

 

4,500

 

-

 

13,500

  Interest expense, related party

 

30,887

 

15,874

 

62,633

 

47,620

  Interest expense, other

 

1,170

 

1,984

 

8,247

 

14,267

  Depreciation

 

341

 

-

 

1,023

 

-

  Office occupancy and other

 

54,378

 

17,157

 

110,660

 

61,469

  Total operating expenses

 

116,324

 

50,765

 

531,211

 

135,415

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

NET INCOME (LOSS)

 

(50,217)

 

(31,663)

 

(424,461)

 

(191,513)

 

 

 

 

 

 

 

 

 

OTHER COMPREHENSIVE INCOME:

 

 

 

 

 

 

 

 

  Unrealized gain on marketable

    equity security

 

311,848

 

-

 

311,848

 

-

 

 

 

 

 

 

 

 

 

OTHER COMPREHENSIVE INCOME (LOSS)

$

261,631

$

(31,663)

$

(112,613)

$

(191,513)

 

 

 

 

 

 

 

 

 

BASIC AND DILUTED EARNINGS  (LOSS) PER SHARE

$

(0.01)

$

0

$

(0.05)

$

(0.02)

 

 

 

 

 

 

 

 

 

WEIGHTED AVERAGE SHARE  OUTSTANDING BASIC AND DILUTED

 

9,729,619

 

7,757,108

 

8,727,988

 

7,757,108

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 See accompanying notes to financial statements.









4








GENESIS FINANCIAL, INC.

Statement of Cash Flows

(Unaudited)

 

 

 

 

 

Nine Months Ended September 30,

 

 

2012

 

2011

CASH FLOWS FROM OPERATING ACTIVITIES

$

165,393

$

(68,480)

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

  Purchase of long-term investment

 

-

 

(300,000)

 

 

 

 

 

  Acquisition of cash from purchase of GHI and GHII (See Note 4)

 

97,571

 

-

  Net cash provided (used) by investing activities

 

97,571

 

(300,000)

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

  Sales of preferred stock in private placement

 

-

 

1,149,500

  Borrowings (repayment) line of credit with affiliate, net

 

(45,000)

 

(210,845)

  Borrowings (repayment) from line of credit from bank, net

 

(187,107)

 

(94,157)

  Payment on Note payable, Flyback Energy, Inc.

 

 -

 

(560,000)

  Net cash provided (used) by financing activities

 

(232,107)

 

284,498

 

 

 

 

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENT

 

26,973

 

(83,982)

 

 

 

 

 

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD

 

22,117

 

117,455

 

 

 

 

 

CASH AND CASH EQUIVALENTS AT END OF PERIOD

$

52,974

$

33,473

 

 

 

 

 

NONCASH TRANSACTIONS:

 

 

 

 

  Purchase of loans held for sale with common stock

$

958,944

$

-

  Purchase of Investments in LLC’s with common stock

$

225,000

$

-

  Purchase of real estate owned with common stock

$

129,685

$

-

  Preferred stock converted to common stock

$

142,500

$

15,000

 

 

 

 

 

See accompanying notes to financial statements.



 



5



Genesis Financial, Inc.

Notes to Financial Statements

September 30, 2012

(Unaudited)




NOTE 1 — ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:


Organization:


Genesis Financial, Inc. (“the Company” or “Genesis”) was incorporated in Washington State on January 24, 2002.  The Company is primarily engaged in the business of purchasing and selling real estate receivable loans and periodically providing bridge capital funding.  Loans consist of real estate loans and mortgage notes collateralized by primarily first position liens on residential and commercial real estate.  The loans collateralized by real estate are typically non-conventional either because they are originated as a result of seller financing, or the underlying property is non-conventional.


The Company invests in loans using investor funds, equity funds and funds generated from external borrowings including a line of credit facility from an affiliated stockholder.


The unaudited financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America for interim financial information, as well as the instructions to Form 10-Q.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  In the opinion of the Company’s management, all adjustments (consisting of only normal recurring accruals) considered necessary for a fair presentation of the interim financial statements have been included.  Operating results for the nine months period ended September 30, 2012 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2012.  


For further information refer to the financial statements and footnotes thereto in the Company’s Annual Report on Form 10-K for year ended December 31, 2011.


The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period.  Significant estimates used herein include those relating to management’s estimate of fair value of loans held for sales, real estate owned, and long-term investments.  It is reasonably possible that actual results could differ from those and other estimates used in preparing these financial statements and such differences could be material.


Summary of Significant Accounting Policies:


Fair value measurements - The following information for each class of assets and liabilities that are measured at fair value is disclosed:


1.

the fair value measurement;


2.

the level within the fair value hierarchy in which the fair value measurements in their entirety fall, segregating fair value measurements using quoted prices in active markets for identical assets or liabilities (Level 1), significant other observable inputs (Level 2), and significant unobservable inputs (Level 3);


3.

for fair value measurements using significant unobservable inputs (Level 3), a reconciliation of the beginning and ending balances, separately presenting changes during the period attributable to the following:


a.

total gains or losses for the period (realized and unrealized), segregating those gains or losses included in earnings, and a description of where those gains or losses included in earnings  are reported in the statement of operations;

b.

the amount of these gains or losses attributable to the change in unrealized gains or losses relating to those assets or liabilities still held at the reporting period date and a description of where those unrealized gains or losses are reported;

c.

purchases, sales, issuances, and settlements (net); and

d.

transfers into and/or out of Level 3;



6



Genesis Financial, Inc.

Notes to Financial Statements

September 30, 2012

(Unaudited)




4.

the amount of the total gains or losses for the period in (3)(a) included in earnings that are attributable to the change in unrealized gains or losses relating to those assets and liabilities still held at the reporting date and a description of where those unrealized gains or losses are reported in the statement of operations; and

5.

in annual periods only, the valuation technique(s) used to measure fair value and a discussion of changes in valuation techniques, if any, during the period.


Long term investments – Investments not readily marketable are recorded at cost when purchased. The investments in equity securities of privately held companies in which the Company holds less than 20% voting interest and on which the Company does not have the ability to exercise significant influence are accounted for using the cost method. Under the cost method, these investments are carried at the lower of cost or fair value, determined using Level 3 inputs. The Company recognizes an impairment charge when a decline in the fair value of its investments below the cost basis is judged to be other-than-temporary. In making this determination, the Company reviews several factors to determine whether the losses are other-than-temporary, including but not limited to: (i) the length of time the investment was in an unrealized loss position, (ii) the extent to which fair value was less than cost, (iii) the financial condition and near term prospects of the issuer and (iv) the Company's intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in fair value.


Investment in marketable equity securities – Marketable equity securities are classified as available for sale and are valued at fair value, which is the market price. Realized gains and losses on the sale of securities are recognized on a specific identification basis. Unrealized gains and losses are included as a component of accumulated other comprehensive income (loss), unless an other than temporary impairment in value has occurred, which would then be charged to current period net income (loss).


Loans held for sale

Loans held for sale are initially recorded at the lower of cost or fair value.  Loans held for sale are measured at fair value on a recurring basis.  Fair value for these loans is determined by assessing the probability of borrower default using historical payment performance and available cash flows to the borrower, then projecting the amount and timing of cash flows, including collateral liquidation if repayment weaknesses exist.  The Company considers any valuation inputs related to loans held for sale to be Level 3 inputs.


Interest on loans held for sale is included in interest income during the period held for sale.  Until the loan is sold, origination fees received from borrowers are deferred and amortized into income over the established average life of related loan under a method which approximates the effective interest rate method.


Typically, the Company attempts to sell loans three to twelve months after acquisition. It is the policy of the Company not to hold any loans for investment purposes.  


Real estate owned

Real estate owned (“REO”) (acquired through a loan default) is recorded at fair value on a non-recurring basis.  Upon transfer of a loan held for sale to REO, properties are recorded at amounts which are equal to fair value of the properties based on the following inputs: (1) appraisal provided by a certified appraiser, (2) BPO (Broker’s Pricing Opinion) provided by a qualified real estate broker, (3) site inspection by qualified management of the Company, or (4) a combination of all of the above.  Periodically, non-recurring fair value adjustments to REO are recorded to reflect partial write-downs based on the same inputs.  The Company considers any valuation inputs related to REO to be Level 3 inputs.  The individual carrying values of these assets are reviewed for impairment at least annually and any additional impairment charges are expensed to operations.


Earnings per share – Basic earnings per common share have been computed on the basis of the weighted-average number of common shares outstanding during the period presented.  Diluted earnings per common share are computed on the basis of the number of shares that are currently outstanding plus the number of shares that would be issued pursuant to outstanding warrants, stock options and common stock issuable on conversion of preferred stock unless such shares are deemed to be anti-dilutive.  The dilutive effect of convertible debt and outstanding securities, in periods of future income, would be as follows as of September 30, 2012 and September 30, 2011:







7



Genesis Financial, Inc.

Notes to Financial Statements

September 30, 2012

(Unaudited)




 

September 30,

 

2012

2011

Stock options

1,261,000

1,000,000

Convertible preferred stock

4,537,500

4,962,500

Convertible debt

625,000

625,000

Total possible dilution

6,423,500

6,587,500


NOTE 2 — LOANS HELD FOR SALE:


The Company's fair value of loans held for sale consisted of the following:


 

 

September 30,

2012

 

December 31, 2011

Residential

$

531,180

$

116,931

Land

 

92,367

 

93,715

Commercial

 

734,271

 

331,302

Other

 

30,000

 

56,303

Total

$

1,387,818

$

598,251


The following table presents a reconciliation of assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the quarter ended September 30, 2012:


 

 

September 30,

2012

Beginning Balance

$

598,251

New loans

 

30,000

Purchased from Genesis Holdings & Genesis Holdings II

 

958,944

Principal payments

 

(165,760)

Fair value adjustments

 

-

Sales of loans

 

(33,617)

Ending Balance

$

1,387,818



NOTE 3- REAL ESTATE OWNED:


The Company's fair value of REO consisted of the following:


 

 

September 30,

 2012

 

December 31, 2011

Residential

$

-

$

81,956

Land

 

558,212

 

763,437

Commercial

 

325,264

 

250,000

Total

$

883,476

$

1,095,393




8



Genesis Financial, Inc.

Notes to Financial Statements

September 30, 2012

(Unaudited)




The following table presents the change in balance sheet carrying values associated with REO for the quarter ended September 30, 2012:


 

 

September 30,

2012

Beginning Balance

$

1,095,393

Purchased from Genesis Holding and Genesis Holdings II

 

129,686

Proceeds from sales of REO

 

(92,548)

Fair value adjustment

 

(215,000)

Net change in holding costs

 

(34,055)

Ending Balance

$

883,476


Genesis Holdings, Inc. and Genesis Holdings II, Inc.


 On July 19, 2012, the Company acquired cash, investments in real estate limited liability corporations, loans held for sale and real estate owned that was previously owned by Genesis Holding, Inc and Genesis II, Inc.   The consideration paid by the Company was 2,352,000 shares of common stock with a fair value of $0.60 per share on the date of the transaction for a total consideration of $1,411,200   A majority of the shareholders of both Genesis Holdings, Inc. and Genesis Holdings II, Inc. approved the asset sales.   


Genesis Holdings, Inc. & Genesis Holdings II, Inc. Purchases

Cash

$

97,571

Loans held for sale

 

958,944

Real estate owned

 

129,685

LLC membership

 

225,000

 

$

1,411,200


The management members of Genesis Holdings, Inc., Genesis Holdings II, Inc. and the Company are the same individuals.   John Coghlan is the President and Chairman of the Board of Directors of Genesis Holdings, Inc.; Virginia Walters is the Treasurer; and Mike Kirk is the Secretary and member of the board of directors. The management of Genesis Holdings, Inc. participates in the management of Genesis Financial, Inc.   Coghlan Family Corporation is a shareholder of Genesis Holdings, Inc.   Mike Kirk is the President and Chairman of the Board of Genesis Holdings II, Inc. and John Coghlan is the Secretary and Treasurer.   See Note 9 for further disclosure regarding associations amongst these entities.


NOTE 4 — INVESTMENTS:


Long term investment:


Flyback Energy, Inc.:


On November 23, 2010, the Company closed the purchase of an equity interest in Flyback Energy, Inc., for $1,200,000.  The purchase was for $1,200,000 of Series “B” Preferred Stock and Common Stock Purchase Warrants from Flyback Energy, Inc., a closely held Washington corporation payable on an installment basis.  At November 23, 2010, the purchase represented a ten percent equity interest in Flyback Energy, Inc. assuming the warrants were exercised and Series "B" Preferred Shares converted into 2,666,666 shares of common stock. At September 30, 2012 and December 31, 2011, the purchases represented an eight percent equity interest in Flyback Energy Inc.


The Company paid $500,000 down with the balance of $700,000 payable on a promissory note at $140,000 monthly commencing December 23, 2010.  The $700,000 note was paid in full during the second quarter of 2011.  On April 25, 2011, the Company purchased $50,000 of Series “C” Preferred Stock that is convertible at $.60 per share or 83,333 shares of common stock and bears a 5% dividend rate.




9



Genesis Financial, Inc.

Notes to Financial Statements

September 30, 2012

(Unaudited)



The Flyback Series "B" Preferred shares are convertible into Flyback common shares at on a one for one (1:1) basis and the conversion pricing is subject to adjustments for certain diluting issues of common stock, subdivisions or combinations of common stock, reclassifications, exchanges and, or substitutions of stock.


Flyback Energy, Inc. is a privately-held company that has developed a unique and proprietary electronic switch design that offers control over electrical power and magnetic fields.


Marketable Equity Security:


AWG International Water Corporation:


The Company purchased 109,906 shares of the AWG International Water Corporation (“AWGI”) common stock for $500,000 ($250,000 each in 2010 and 2011).  In July 2012, AWGI was merged with MIP Solutions, Inc.  In connection with this merger, the Company’s 109,906 shares of AWGI common stock were converted into 7,380,433 shares of the resulting company.  The resulting company changed its name to AWG International Water Corporation and is traded on OTCM. Prior to the merger, the Company accounted for its investment in AWGI as a long term investment because AWGI was not traded on a listed exchange.    Once the merger occurred and the shares were tradable, the Company changed the method of accounting for this investment to an investment in a marketable equity security.   Under this accounting, the investment is presented at fair value on the balance sheet and the resulting unrealized gain or loss is recognized as other comprehensive income.   


At September 30, 2012 the quoted market value of AWGI was $.11 per share or $811,848 resulting in an unrealized gain of $311,848.   The investment is measured using Level 1 fair value inputs.


AWG International Water Corporation is a company that designs and builds proprietary systems Air-to-Water machines for residential and commercial applications.  


Limited Liability Corporations:


As part of the asset acquisition of Genesis Holding, Inc. the Company acquired a 9.145% interest in Wenatchee Riverview, LLC for $150,000 and 21.0% interest in 21 Bay Street, LLC for $75,000.  The LLC’s are passive investments which each hold an individual real estate investment REO for sale.


NOTE 5 — LINES OF CREDIT:


On June 27, 2012, Genesis entered into a $250,000 line of credit with RiverBank, bearing indexed interest rate as published by the Wall Street Journal or 5% whichever is greater. At the time of the loan the indexed rate was 3.25%.  At September 30, 2012, the balance owing is $ - 0 -. The line has a term of 12 months, and an origination fee of 1/2%, or $1,250. The payments are due monthly on the 1st on all accrued unpaid interest. The Riverbank line of credit is senior to the CFC line of credit, and is collateralized by the assets of Genesis.  The Riverbank line requires that the CFC line may not be paid down lower than the amount owing to Riverbank at any time during the term of the loan.  The line is payable on demand and is personally guaranteed by John R. and Wendy Coghlan, related parties of the Company.


The Company has a $2,500,000 Line of Credit Agreement with the Coghlan Family Corporation, Inc. (“CFC”), with a balance owing of $1,465,000 at September 30, 2012 and $1,510,000 at December 31, 2011. CFC is an affiliated company controlled by a John R. Coghlan. If the Company defaults on the agreement, the default interest rate will be 12%.  Interest is payable monthly. The line has a term of 12 months and an origination fee of 1/2% or $12,500. The credit line is collateralized by all of Genesis’ assets and is subordinate to the Riverbank line of credit. The line of credit agreement requires that the Company maintain a debt to equity ratio of no greater than 3.0. Borrowings under the line are personally guaranteed by Michael A. Kirk, the Secretary of the Company. Because of the economic conditions, CFC has agreed to waive the interest starting October 1, 2010 and has also agreed to waive the 3.0 debt to equity ratio requirement as well as the 12% default rate.




10



Genesis Financial, Inc.

Notes to Financial Statements

September 30, 2012

(Unaudited)



NOTE 6 — CONVERTIBLE NOTE PAYABLE TO OFFICER


On December 15, 2010, the Company entered into a convertible note agreement with John R. Coghlan, a related party (see Note 8). The note accrues interest at 8% per annum with interest and balance initially due on December 15, 2012.   The note is convertible at any time by Mr. Coghlan into one share of the Company’s Series B Preferred stock for every $1.00 outstanding of the note payable and related accrued interest. In connection with the issuance of this note, the Company recognized a beneficial conversion feature of $128,750 that resulted in a discount to the note payable. The discount is being amortized into earnings over the term of the note. The note is collateralized by 290,000 shares of the Company’s Series B Preferred stock. Subsequent to September 30, 2012, the Company and Coghlan agreed to extend the due date of the note to December 15, 2015.


NOTE 7 — STOCK OPTIONS


On April 10, 2002, the Board of Directors approved the Genesis Financial, Inc. Stock Option Plan (the Plan), and the Plan was subsequently approved by the Shareholders of the Company on May 2, 2002.  The plan allows for issuance of Incentive Stock Options (ISOs) and Non-statutory Stock Options (NSOs).  The maximum number of shares that may be subject to option and exercised under the Plan is 1,300,000 shares (adjusted for the two for one stock split that occurred in 2007).  The ISOs and NSOs expire 30 days after the recipient ceases to be an employee for the Company, or one year after the recipient’s death.   


During the nine month period ended September 30, 2012, the Company authorized the issuance of 65,250 common stock options each to John Coghlan, President of the Company, Michael Kirk, Secretary of the Company, Virginia Walters, Treasurer of the Company, and Wes Sodorff, advisor to the Company. The stock options, representing 261,000 common shares, have an exercise price of $.60 per share and expire five years from the date of the grant.  The options vest at the rate of 20% per year with the first 20% vested upon issuance.  After the granting of these options, no options are available for future grants under the plan.  No options were issued during 2011.   


The fair value of the options granted during the 2012 was estimated on the date of grant using the Black-Scholes option-pricing model with the weighted average assumptions given below:


 

 

 

 

 

Weighted average fair value of options granted

 

 

$0.54

 

Expected stock price volatility

 

 

143.56

%

Risk-free interest rate

 

 

0.74

%

Expected life of options

 

 

5.0 years

 


The Company estimates volatility using historical information.  The risk-free interest rate is based on the implied yield available on U.S. Treasury zero-coupon issues over the equivalent lives of the options. The expected life of the options represents the estimated period of time until exercise giving consideration to the contractual terms.  The Company has not paid dividends on common shares in several years, and no assumption of dividend payment is made in the model.


The aggregate intrinsic value of options outstanding and exercisable as of September 30, 2012 was $400,000 based on our closing stock price of $0.60 per common share at September 30, 2012.  


Transactions concerning stock options pursuant to our stock option plans are summarized as follows:

 

 

 

Shares Subject to

Options

 

Weighted

Average

Exercise Price

Outstanding and exercisable, December 31, 2011

 

1,000,000

 

$0.20

Granted

 

261,000

 

0.60

Exercised

 

-

 

-

Expired

 

-

 

-

Outstanding and exercisable, September 30, 2012

 

1,261,000

 

$0.28


Compensation expense recognized for stock options granted during the period ended September 30, 2012 was $34,981 which is classified as ‘Office occupancy and other’.   Unrecognized compensation related to these options is $104,942 and will be recognized over the next 3.75 years.



11



Genesis Financial, Inc.

Notes to Financial Statements

September 30, 2012

(Unaudited)




NOTE 8— SERIES B PREFERRED STOCK


During the nine month period ending September 30, 2012, holders of 142,500 shares of Series B preferred stock converted their shares into 356,250 share of common stock.


NOTE 9 — RELATED-PARTY TRANSACTIONS:


Affiliates and related parties are defined as Officers, Directors, and/or those Shareholders owning or controlling more than 5% of the common stock of Genesis, or any entities that are owned or controlled by Officers, Directors, and/or those Shareholders owning or controlling more than 5% of the common stock of Genesis.  


Coghlan Family Corporation, Coghlan, LLC and West 3773 Fifth, LLC are controlled by John R. Coghlan, a Company director, President, CFO and majority shareholder. Coghlan Family Corporation is owned 100% by Coghlan, LLC, which is owned by the Coghlan family members.  John R. and Wendy Coghlan (husband and wife) collectively own 35.65% of Coghlan, LLC and are co-managers. West 3773 Fifth, LLC is owned 100% by John and Wendy Coghlan (husband and wife). Genesis Holdings, Inc. is a Washington Corporation, which is managed by John R. Coghlan.  Mr. Coghlan is the President and Director of Genesis Holdings, Inc.  Genesis Holdings II, Inc. is a Washington Corporation, which is managed by Michael Kirk.  Mr. Kirk is the President and Director of Genesis Holdings II, Inc.     Mr. Kirk is Secretary of the Company


In addition to transactions disclosed in notes 2, 3 and 7, Genesis Financial, Inc. had the following related party transactions for the nine months ended September 30, 2012 and 2011.


Michael Kirk and Genesis Finance Corporation


On January 1, 2009, the Company entered into a Management and Servicing Agreement with Genesis Finance Corporation, a Washington Corporation. Mike Kirk, Genesis Financial, Inc.’s secretary is the president of Genesis Finance Corporation. The Company agrees to pay Genesis Finance Corporation a monthly fee of $6,000 per the Management and Servicing Agreement. As of January 1, 2011, the Company had down-sized enough to manage a sizable portion of its own affairs, and renegotiated its outsourcing agreement with Genesis Finance Corporation, lowering the monthly fee to $1,500. As of January 1, 2012 the monthly fee was removed and the outsourcing services were offset by general offices expenses paid by the Company on behalf of Genesis Finance Corporation.  


Coghlan Family Corporation “CFC”


On January 1, 2008, the Company entered into a Line of Credit Agreement Promissory Note Agreement with Coghlan Family Corporation.  (See Note 5)


On February 15, 2011, Coghlan Family Corporation purchased from the Company a $95,000 interest in a contract secured by land.


During the nine months ended September 30, 2011, CFC purchased an additional 219,000 shares of Series B Preferred being offered by the Company.


West 3773 Fifth, LLC


There was no activity for the nine months ended September 30, 2011.


On January 13, 2012, West 3773 Fifth, LLC purchased $25,000 interest in a loan held for sale by the Company.  No gain or loss was recognized on this sale because it was sold at its carrying value.  






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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operation


When used in this Form 10-Q and in our future filings with the Securities and Exchange Commission, the words or phrases will likely result, management expects, or we expect, will continue, is anticipated, estimated or similar expressions are intended to identify forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Readers are cautioned not to place undue reliance on any such forward-looking statements, each of which speaks only as of the date made. These statements are subject to risks and uncertainties, some of which are described below. Actual results may differ materially from historical earnings and those presently anticipated or projected. We have no obligation to publicly release the result of any revisions that may be made to any forward-looking statements to reflect anticipated events or circumstances occurring after the date of such statements.


Background

Genesis Financial, Inc. is engaged in the business of buying and selling seller financed real estate contracts (also referred to as "loans" ,"contracts" or "real estate receivables"), and originating commercial real estate hard money loans.


All contracts and loans are purchased, or originated, to be held for sale, and are carried on the books at cost, or mark-to-market value, whichever is less.  We purchase seller financed real estate receivables from sellers directly or from sellers who are introduced to Genesis by brokers.  When the owner of a real estate receivable wishes to sell the receivable, the owner may contact a broker or Genesis directly.  Seller financed real estate receivables are contracts or loans which are originated by the selling owner of real property.  This is an unconventional form of real estate financing which does not involve banks or mortgage companies.   The loans are considered non-conventional, non-conforming and are viewed by the secondary market as "sub-prime" quality.  Loans which we would originate would be considered "hard money" loans by the secondary markets.


We purchase contracts at a discount and hold them in inventory for a relatively short period to provide seasoning and value appreciation. After the holding period, we sell the contracts. We expect to derive operating revenues from resale’s of contracts at a profit, and from interest income derived from contracts during the holding period. We originate commercial real estate loans and sell the loans, or participations in those loans, to accredited private investors.  From time to time, we also consider other forms of cash flow instruments when warranted.


As of the third quarter of 2008, management felt the real estate and financial markets were going to continue to decline, and made the decision that some major adjustments in the way the Company operated going forward was necessary.  The decision was made to reduce overhead expense by outsourcing the day-to-day operations of the Company, to focus on reducing the Company’s debt through a re-structuring of terms with our credit facilitators, to pursue the sale of Company assets, to continue acquisitions and originations only on deals that have been pre-sold, to focus on salvaging delinquent accounts through increased collection activity and workouts, and to increase the focus on maintenance and resale of repossessions.  This plan was implemented January 1, 2009.


Additional details about our business are set forth in our Annual Report on Form 10-K for the year ending December 31, 2011.  The following discussion should be read in conjunction with the financial information included elsewhere in this Quarterly Report on Form 10-Q.


The purpose of this section is to discuss and analyze our financial condition, liquidity and capital resources and results of operations. You should read this analysis in conjunction with the financial statements and notes that appear elsewhere in this Quarterly Report on Form 10-Q. This section contains certain "forward-looking statements" within the meaning of federal securities laws that involve risks and uncertainties, including statements regarding our plans, objectives, goals, strategies and financial performance. The Company’s actual results could differ materially from the results anticipated in these forward-looking statements as a result of factors set forth under "Disclosure Regarding Forward-Looking Statements" in this Quarterly  Report on Form 10-Q.


PLAN OF OPERATIONS.


Genesis Financial, Inc. will continue to develop our operations along the lines of our growth since inception, but will also concentrate on reducing overhead expense, and resolving delinquencies and repossession situations. We are not capitalized at a level that allows holding of significant amounts of contracts and loans for investment and as a result, we will continue to work toward short term inventory turnover. We originally anticipated holding most of our contracts and loans between three and nine months, and then selling them in the secondary markets. Through the first nine months of 2003, we were averaging one pool sale every two months.  That trend has declined to the point that, as of the end of 2007, we were not actively pursuing pool sales, due to the slow-down and turmoil in the secondary markets, and that trend continues.  We are either holding these contracts in inventory, or selling them individually as opportunities arise. We expect that the number and dollar volume of all



13





sales will continue to decline over the next twelve months, and longer, especially if financial market conditions continue to deteriorate. Until conditions improve, we will continue to focus our efforts towards developing relationships with investors who are interested in the individual contracts and loans, versus the pools. In order to achieve our targeted growth, we will require additional investors and capital. If additional investors and capital are not available, our growth plans will be delayed further and profitability will continue to be negatively impacted.


Over the past several years, we have seen a dramatic increase in delinquencies, resulting in increased costs of collection and litigation. The increase in delinquencies has also resulted in a dramatic increase in repossessions.  These repossessions tie up capital until the collateral properties can be resold, and require additional capital to maintain the properties during the holding period until a sale can be achieved.  In addition, if property values continue to decline, our ability to recoup our investment through a resale of the property will be adversely affected.  If real estate market values continue to decline, our growth plans will be delayed further and profitability will continue to be negatively impacted.


RESULTS OF OPERATIONS


Quarter ended September 30, 2012 compared to quarter ended September 30, 2011.


Revenues


On July 19, 2012, the Company acquired cash, investments in real estate limited liability corporations, loans held for sale and real estate owned that was previously owned by Genesis Holding, Inc and Genesis Holdings II, Inc.   See Note 3 in the financial statements for further detail.


Total revenues for the quarter ending September 30, 2012 were $66,107 compared to $19,102 for the same quarter ending September 30, 2011.  The majority of the revenue for the quarter ended September 30, 2012 and the quarter ended September 30, 2011 was from interest and broker fee income.  The increase in income for the quarter ended September 30, 2012 was due to the contracts purchased from Genesis Holdings, Inc. and  Genesis Holdings II, Inc.; which, increased revenue by $30,559 for the quarter  ended.


Net income (loss) from operations was $(50,217) and $(31,663), respectively, for the quarters ending September 30, 2012 and 2011.


Of the loans held for sale at September 30, 2012 loans held for sale with carrying value of $763,004 were in payment default.  We believe the defaults and repossessions are directly related to the national real estate market collapse.  


General and Administrative Expenses


General and administrative expenses (“G&A”) for the quarters ended September 30, 2012 and 2011, were $65,628 and $30,907, respectively. G&A primarily consists of management and professional fees for legal and auditing.  The changes for the fiscal quarters ended September 30, 2012 and 2011 were $34,721 and $107 respectively.  The reason for the increase was compensation expenses.


Interest Expense


For the quarters ending September 30, 2012 and 2011, interest expense amounted to $32,057 and $17,858, respectively.


Interest expense was incurred on borrowings under lines of credit with Riverbank, an unaffiliated lender, and the convertible note payable with John R. Coghlan, an affiliated person. The Coghlan Family Corporation, an affiliated company, has waived current interest payments on its line of credit.


We are currently operating under a primary $250,000 line of credit with Riverbank, an unaffiliated lender, with an interest rate 5%.  The line of credit also included a one-half percent origination fee.  The line of credit was renewed to July 1, 2013.


We also are currently operating under a secondary $2,500,000 line of credit with Coghlan Family Corporation, an affiliated company, with a variable interest rate equal to the prime index rate (as published in the Wall Street Journal), plus 1%.  The line of credit also includes a one-half percent origination fee.


We consider the terms of the lines of credit to be acceptable. As of September 30, 2012 and December 31, 2011, the balances on the lines of credit were $1,465,000 and $1,697,107 respectively.  Interest expense on the line of credit will fluctuate in future periods with inventory levels.



14






Nine months ended September 30, 2012 compared to nine months ended September 30, 2011.


Revenues


Total revenues for the nine months ending September 30, 2012 were $106,750 compared to $(56,098) for the same quarter ending September 30, 2011.  The revenue for the nine months ended September 30, 2012 and September 30, 2011 was from interest and broker fee income.  The nine months ended September 30, 2011 included write-offs of previously accrued interest receivable and the nine months ended revenue totaling $30,559 from Genesis Holdings, Inc. and Genesis Holdings II, Inc.


Net income (loss) from operations was $(424,461) and $(191,513), respectively, for the nine months ending September 30, 2012 and 2011. The increase in the loss was due a fair value adjustment of $215,000 and a write-off of a receivable of $81,600 in the second quarter of 2012.


General and Administrative Expenses


General and administrative expenses (“G&A”) for the nine months ended September 30, 2012 and 2011, were $144,410 and $108,719, respectively. G&A primarily consists of management and professional fees for legal and auditing.  The changes for the fiscal quarters ended September 30, 2012 and 2011 were $35,691 and $(55,881) respectively.  The primary reason for the decrease for the quarter ended September 30, 2011 was the decrease in professional fees incurred in bringing the required audits and filings current.


Interest Expense


For the nine months ending September 30, 2012 and 2011, interest expense amounted to $70,880 and $61,887 respectively.


LIQUIDITY AND CAPITAL RESOURCES


The Company’s principal sources of cash are from the collections of principle, interest, payoffs and sales of existing loans held for sale.  Cash flow was increased by $162,992 for the quarter ended September 30, 2012 due to the contracts purchased from Genesis Holdings, Inc. and Genesis Holdings II, Inc.


At September 30, 2012 and December 31, 2011, we had cash available of $52,974 and $33,473, respectively, and $250,000 was available under our line bank of credit.  Management considers the capital resources to be adequate to meet the current operating needs of the Company for the next twelve months.


Genesis is currently operating under a primary $250,000 line of credit with Riverbank, an unaffiliated lender, with an interest rate of 5%.  The line of credit also included a one-half percent origination fee.  The line of credit expires July 1, 2013.  The line is payable on demand and is personally guaranteed by John and Wendy Coghlan.  


At September 30, 2012, the Company had a $2,500,000 Line of Credit Agreement with the Coghlan Family Corporation, Inc. (“CFC”) with a balance of $1,465,000. CFC is an affiliated company controlled by a director and principal shareholder of the Company. The interest rate on the line is a variable interest rate equal to the prime rate index (as published in the Wall Street Journal) plus 1%.  The line has a term of 12 months and an origination fee of 1/2% or $12,500. The credit line is collateralized by all of Genesis’ assets but is subordinate to the RiverBank line of credit.  The line of credit agreement requires that the Company maintain a debt to equity ratio of no greater than 3.0. Borrowings under the line are personally guaranteed by an officer of the Company.  Because of the economic conditions, CFC has agreed to waive all interest beginning October 1, 2010 and the 3.0 debt to equity ratio, as well as the 12% default rate, are waived.


Our capital resources are adequate to fund our operations at a reasonable level during the quarter covered by this Quarterly Report.  We have paid close attention to our contract purchases and loans and maintained our funding requirements within our available resources. We receive interest and principal reductions (typically monthly) on contracts and loans which we hold in inventory.  


For the nine months ending September 30, 2012 and 2011, our net cash flows provided (used) by operating activities were $165,393 and $(68,480), respectively.  The reason for the increase for the nine months ended September 30, 2012 was the period ended September 31, 2011 included a write-off of previously accrued interest revenues.


For the nine months ended September 30, 2011 1,149,500 shares of preferred stock were sold with proceeds of $1,149,500.




15





During these periods our net cash provided by (used by) financing activities was $(232,107) and $284,498, respectively.  The reason for the decrease for the period ended September 30, 2012 was the decrease in the Riverbank line of credit while the increase for the period ended September 30, 2011 was the sale of preferred stock in excess of debt-related payments.

Item 3.  Quantitative and Qualitative Disclosures about Market Risk


Not applicable to Smaller Reporting Companies

Item 4. Controls and Procedures.


Evaluation of Disclosure Controls and Procedures


We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) that are designed to be effective in providing reasonable assurance that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (the “ SEC”), and that such information is accumulated and communicated to our management to allow timely decisions regarding required disclosure.


In designing and evaluating disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable, not absolute assurance of achieving the desired objectives. Also, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. The design of any system of controls is based, in part, upon certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.


As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Principal Financial Officer (Chairman of the Board), of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, management concluded that our disclosure controls and procedures are effective as of September 30, 2012 to cause the information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods prescribed by SEC, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Principal Financial Officer (Chairman of the Board), as appropriate, to allow timely decisions regarding required disclosure.


Changes in Internal Control over Financial Reporting


There was no change in our internal controls over financial reporting identified in connection with the requisite evaluation that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


Limitations


Our management, including our Chief Executive Officer and Principal Financial Officer (Chairman of the Board), does not expect that our disclosure controls or internal controls over financial reporting will prevent all errors or all instances of fraud.  A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met.  Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.  Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected.  These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake.  Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and any design may not succeed in achieving its stated goals under all potential future conditions.  Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.  Because of the inherent limitation of a cost-effective control system, misstatements due to error or fraud may occur and not be detected.



16






PART II - OTHER INFORMATION

Item 1.  Legal Proceedings.


We are not a party to any material legal proceedings.

Item 1A. Risk Factors


Not Applicable to Smaller Reporting Companies.

Item 2.  Unregistered Sale of Equity Securities and Use of Proceeds.


None.

Item 3.  Defaults upon Senior Securities.  


None.

Item 4.  Mine Safety Disclosures.


Not Applicable.

Item 5.  Other Information.   


During the quarter ending September 30, 2012 142,500 shares of Series B Preferred stock converted to 356,250 shares of Common stock.

Item 6.  Exhibits


(a) Exhibits


Exhibit No.

Description




Exhibit No.

Description

31.1

CEO Certification pursuant to Section 302 of Sarbanes-Oxley Act of 2002

31.2

CFO Certification pursuant to Section 302 of Sarbanes-Oxley Act of 2002

32.1

CEO Certification pursuant to Section 906 of Sarbanes-Oxley Act of 2002

32.2

CFO Certification pursuant to Section 906 of Sarbanes-Oxley Act of 2002

101*

The following materials from Genesis Financial, Inc.'s Quarterly Report on Form 10-Q for the period ended September 30, 2012 are formatted in XBRL (eXtensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Cash Flow, and (iv) Notes to consolidated Financial Statements tagged as blocks of text.


*   In accordance with Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall not be deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act of 1933, as amended, or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.





17






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.


Dated: November 5, 2012



Genesis Financial, Inc.

(Registrant)


/s/ John R. Coghlan

________________________

By: John R. Coghlan

Title: President, Chief Executive Officer

Chief Financial Officer (Principal Accounting Officer)


/s/ Virginia Walters

________________________

By: Virginia Walters

Title: Treasurer and Director













18