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UNITED STATES SECURITIES
AND EXCHANGE COMMISSION WASHINGTON, D.C.
20549
 FORM 10-Q þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended: March 31, 2005 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period
from toCommission file number: 333-86972 SPECIALTY TRUST, INC. (Formerly Specialty
Mortgage Trust, Inc.)
  Maryland
    
    88-0382463(State or other jurisdiction of
    
    (I.R.S. EmployerIncorporation or organization)
    
    Identification No.)6160 Plumas St.Reno, Nevada
    
    89509(Address of principal executive offices)
    
    (Zip Code)
 (775) 826-0809
(Registrants telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all documents and reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ     No o Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule
12b-2 of the Act) Yes
o     No
þ APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuers classes of stock, as of the
last practicable date. Common Stock ($.01 par value)
    
    8,559,341 as of May 11, 2005




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INDEX PagePART I. FINANCIAL INFORMATIONItem 1
    
    Financial Statements  Specialty Trust, Inc. and Subsidiaries (Unaudited)
    
    
    3Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004
    
    
    3Consolidated Statements of Earnings for the Three Months Ended March 31, 2005 and 2004
    
    
    4Consolidated Statements of Stockholders Equity and Comprehensive Income for the Three Months Ended March 31, 2005 and the Year Ended December 31, 2004
    
    
    5Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2005 and 2004
    
    
    6Notes to Consolidated Financial Statements
    
    
    7Item 2
    
    Managements Discussion and Analysis of Financial Condition And Results of Operations
    
    
    15Item 3
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    25Item 4
    
    Controls and Procedures
    
    
    26PART II. OTHER INFORMATIONItem 1
    
    Legal Proceedings
    
    
    27Item 2
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    27Item 3
    
    Defaults Upon Senior Securities
    
    
    27Item 4
    
    Submission of Matters to a Vote of Security Holders
    
    
    27Item 5
    
    Other Information
    
    
    27Item 6
    
    Exhibits
    
    
    27Signatures
    
    
    28Exhibit 31.1
    
    
    
    
    29Exhibit 31.2
    
    
    
    
    30Exhibit 32.1
    
    
    
    
    31Exhibit 32.2
    
    
    
    
    32EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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PART I. FINANCIAL INFORMATION 
 ITEM I. FINANCIAL STATEMENTS (UNAUDITED) SPECIALTY TRUST, INC. AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS
 (UNAUDITED)March 31, 2005
    
    
    December 31, 2004ASSETSASSETSCash and Cash Equivalents
    
    $
    458,813
    
    
    $
    14,879,417Restricted Cash
    
    
    
    
    
    
    1,001,536Accrued Interest Receivable
    
    
    1,659,061
    
    
    
    1,175,049Accounts Receivable
    
    
    68,307
    
    
    
    68,578Land Held for Residential Development
    
    
    1,951,880
    
    
    
    1,879,432Real Estate Owned (Held for Sale)
    
    
    8,427,397
    
    
    
    9,621,495Mortgage Loans Held for Investment, net of
allowance for loan losses of $1,371,153 and $1,130,138 and
unearned discount of $78,585 and $112,625 at March 31, 2005
and December 31, 2004, respectively
    
    
    109,480,417
    
    
    
    93,350,933Other Assets
    
    
    190,449
    
    
    
    159,628Total Assets
    
    $
    122,236,324
    
    
    $
    122,136,068LIABILITIES AND STOCKHOLDERS EQUITYLIABILITIESDividends Payable
    
    $
    
    
    
    $
    2,274,946Accounts Payable  Related Party
    
    
    207,713
    
    
    
    61,233Accounts Payable and Accrued Expenses
    
    
    128,699
    
    
    
    198,043Accrued Interest Payable
    
    
    54,861
    
    
    
    65,475Deferred Revenue
    
    
    428,371
    
    
    
    Collateralized Notes
    
    
    34,143,066
    
    
    
    41,242,610Lines of Credit
    
    
    5,285,000
    
    
    
    Total Liabilities
    
    $
    40,247,710
    
    
    $
    43,842,307STOCKHOLDERS EQUITYCommon Stock; $0.01 par value; 50,000,000 shares authorized,
8,416,767 and 8,272,529 shares issued and outstanding as of
March 31, 2005 and December 31, 2004, respectively
    
    $
    84,168
    
    
    $
    82,725Additional Paid-in Capital
    
    
    78,939,994
    
    
    
    77,432,753Retained Earnings
    
    
    2,964,452
    
    
    
    778,283Total Stockholders Equity
    
    
    81,988,614
    
    
    
    78,293,761Total Liabilities and Stockholders Equity
    
    $
    122,236,324
    
    
    $
    122,136,068
 See accompanying notes to consolidated financial statements. 3




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SPECIALTY TRUST, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)
 Three Months EndedMarch 31, 2005
    
    
    March 31, 2004RevenueInterest and Dividend Income:Mortgage Loans
    
    $
    3,510,828
    
    
    $
    2,667,263Cash Accounts
    
    
    18,521
    
    
    
    29,500Dividend Income
    
    
    10,108
    
    
    
    3,539,457
    
    
    
    2,696,763Interest Expense:Lines of Credit
    
    
    11,904
    
    
    
    3,513Collateralized Notes
    
    
    541,893
    
    
    
    473,156Total Interest Expense
    
    
    553,797
    

    
    
    476,669Net Interest and Dividend Income
    
    
    2,985,660
    
    
    
    2,220,094Provision for Loan Losses
    
    
    241,015
    
    
    
    23,366Net Interest and Dividend Income
After Provision for Loan Losses
    
    
    2,744,645
    
    
    
    2,196,728Gain/(Loss) on Sale of Real Estate Owned
    
    
    5,873
    
    
    
    (47
    )Other Income
    
    
    
    
    
    
    34,601Net Revenues
    
    
    2,750,518
    
    
    
    2,231,282ExpensesGeneral and Administrative
    
    
    79,616
    
    
    
    166,556Management and Directors Fees
    
    
    348,572
    
    
    
    187,346Other Expenses
    
    
    136,161
    
    
    
    103,687Total Expenses
    
    
    564,349
    
    
    
    457,589NET EARNINGS
    
    $
    2,186,169
    
    
    $
    1,773,693Basic Earnings per Share
    
    $
    0.26
    
    
    $
    0.23Diluted Earning per Share
    
    $
    0.26
    
    
    $
    0.23
 See accompanying notes to consolidated financial statements. 4




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SPECIALTY TRUST, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY AND COMPREHENSIVE INCOME (UNAUDITED)
 Year ended December 31, 2004 and three months ended March 31, 2005
 AdditionalCommon Stock
    
    
    Paid-in
    
    
    RetainedShares
    
    
    Amount
    
    
    Capital
    
    
    Earnings
    
    
    TotalBalance, January 1, 2004
    
    
    7,684,813
    
    
    $
    76,848
    
    
    $
    71,828,838
    
    
    $
    220,805
    
    
    $
    72,126.491Net Earnings and Comprehensive
Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,112,960
    
    
    
    9,112,960Stock Options Exercised
    
    
    33,163
    
    
    
    332
    
    
    
    213,838
    
    
    
    
    
    
    
    214,170Dividends Reinvested on
Common Stock
    
    
    548,553
    
    
    
    5,485
    
    
    
    6,028,605
    
    
    
    
    
    
    
    6,034,090Stock Granted
    
    
    6,000
    
    
    
    60
    
    
    
    65,940
    
    
    
    
    
    
    
    66,000Dividends Declared on
Common Stock
    
    
    
    
    
    
    
    
    
    
    (704,468
    )
    
    
    (8,555,482
    )
    
    
    (9,259,950
    )Balance, December 31, 2004
    
    
    8,272,529
    
    
    $
    82,725
    
    
    $
    77,432,753
    
    
    $
    778,283
    
    
    $
    78,293,761Net Earnings and Comprehensive
Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,186,169
    
    
    
    2,186,169Stock Options Exercised
    
    
    7,375
    
    
    
    74
    
    
    
    3,119
    
    
    
    
    
    
    
    3,193Dividends Reinvested on
Common Stock
    
    
    133,863
    
    
    
    1,339
    
    
    
    1,471,152
    
    
    
    
    
    
    
    1,472,491Stock Granted
    
    
    3,000
    
    
    
    30
    
    
    
    32,970
    
    
    
    
    
    
    
    33,000Balance, March 31, 2005
    
    
    8,416,767
    
    
    $
    84,168
    
    
    $
    78,939,994
    
    
    $
    2,964,452
    
    
    $
    81,988,614
 See accompanying notes to consolidated financial statements. 5




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SPECIALTY TRUST, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
 Three Months EndedMarch 31, 2005
    
    
    March 31, 2004Cash flows from operating activities:Net Earnings
    
    $
    2,186,169
    
    
    $
    1,773,693Adjustment to Reconcile Net Earnings to Net Cash
Provided by Operating Activities:Amortization
    
    
    
    
    
    
    16,940Provision for Loan Losses
    
    
    241,015
    
    
    
    23,366Amortization of Loan Fees on Mortgage Loans
    
    
    (34,040
    )
    
    
    (23,740
    )(Gain)/Loss on Sale of Real Estate Owned
    
    
    (5,873
    )
    
    
    47Non-cash Stock Compensation
    
    
    33,000
    
    
    
    16,500Changes in Assets and Liabilities:Accrued Interest Receivable
    
    
    (484,012
    )
    
    
    (101,647
    )Accounts Receivable
    
    
    271
    
    
    
    56,656Other Assets
    
    
    (30,821
    )
    
    
    Accounts Payable (including Related Party) and Accrued Interest Payable
    
    
    66,522
    
    
    
    (99,882
    )Net Cash Provided by Operating activities
    
    
    1,972,231
    
    
    
    1,661,933Cash flows from investing activities:Investment in Real Estate Owned
    
    
    (219,433
    )
    
    
    (138,882
    )Proceeds from Sale of Real Estate Owned
    
    
    33,386
    
    
    
    372,368Investment in Land Held for Residential Development
    
    
    (166,873
    )
    
    
    (43,001
    )Proceeds from Sale of Land Held for Residential Development
    
    
    94,425
    
    
    
    323,198Purchase of Mortgage Loans Held for Investment
    
    
    (39,571,614
    )
    
    
    (13,475,538
    )Principal Repayments of Mortgage Loans Held for Investment
    
    
    25,049,544
    
    
    
    22,359,166Net Cash (Used In)/Provided by Investing Activities
    
    
    (14,780,565
    )
    
    
    9,397,311Cash flows from financing activities:Proceeds from Common Stock Options Exercised
    
    
    3,193
    
    
    
    129,975Cash Dividends Paid
    
    
    (802,455
    )
    
    
    (784,056
    )Proceeds from Lines of Credit
    
    
    5,285,000
    
    
    
    Proceeds from Collateralized Notes
    
    
    
    
    
    
    10,023,000Interest Reinvested on Collateralized Notes
    
    
    404,047
    
    
    
    363,960Principal Payments on Collateralized Notes
    
    
    (7,503,591
    )
    
    
    (8,177,885
    )Change in Restricted Cash
    
    
    1,001,536
    
    
    
    Net Cash (Used In)/Provided by Financing Activities
    
    
    (1,612,270
    )
    
    
    1,554,994NET (DECREASE)/INCREASE IN CASH AND CASH EQUIVALENTS
    
    
    (14,420,604
    )
    
    
    12,614,238Cash and Cash Equivalents at Beginning of Period
    
    
    14,879,417
    
    
    
    2,593,407Cash and Cash Equivalents at End of Period
    
    $
    458,813
    
    
    $
    15,207,645Supplemental Cash Flow Information:Cash Paid for Interest
    
    $
    564,411
    
    
    $
    477,592Supplemental Disclosure of Non-Cash Investing and Financing Activities:Collateralized Notes Refinanced at Maturity
    
    $
    
    
    
    $
    1,845,115Mortgage Loans received upon sale of Real Estate Owned including reduction to Real Estate Owned of $1,413,531 and increase to Deferred
Revenue of $428,371
    
    $
    1,814,389
    
    
    $
    Dividends Reinvested for Common Stock
    
    $
    1,472,491
    
    
    $
    1,521,388Common Stock Grants
    
    $
    33,000
    
    
    $
    33,000
 See accompanying notes to consolidated financial statements. 6




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SPECIALTY TRUST, INC. AND SUBSIDIARIES 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2005
(Unaudited)
 NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION Specialty Trust, Inc. and Subsidiaries (the Company) is a Maryland corporation, which acquires
and holds interests in mortgage loans secured by property located in Nevada, Arizona, Colorado,
California, and Utah. The Companys strategy is to acquire land loans, construction loans,
commercial building loans and nonconforming single-family and small multifamily residential loans.
The Company has elected to be treated as a real estate investment trust (REIT) under the Internal
Revenue Code of 1986, as amended. The mortgage loans are originated and serviced by Specialty
Financial (the Manager), a private mortgage finance company operating in Nevada, wholly owned by
Nello Gonfiantini III, the Companys President and Chairman of its Board of Directors. The Company
was incorporated on October 21, 1997 and began operations on January 31, 1998. The unaudited consolidated financial statements of the Company are prepared in accordance with U.S.
generally accepted accounting principles for interim financial information and in accordance with
the instructions to Form 10Q. In the opinion of the management of the Company, all adjustments
necessary for a fair presentation of the financial position, results of operations and cash flows
for the periods presented have been included and are normal and recurring in nature. The results
for the three months ended March 31, 2005 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2005 or for any other period. These unaudited
consolidated financial statements should be read in conjunction with the audited consolidated
financial statements included in the Companys annual report on Form 10-K for the year ended
December 31, 2004. The unaudited consolidated financial statements for the three months ended March 31, 2005 include
the accounts of the Company and its wholly owned subsidiaries, Specialty Acquisition Corporation
(SAC), a taxable REIT subsidiary and Specialty Acquisition Corp. II (SAC II), a qualified REIT
subsidiary. SAC was formed on May 2, 2002 to enable the Company to perform development activities
to land it had foreclosed upon (Note 4), and to maintain the Companys qualified REIT status. SAC
II was formed on January 17, 2003 to enable the Company to hold property (Note 6). All
inter-company accounts and transactions have been eliminated upon consolidation. Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with U.S generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during the reporting period.
On an on-going basis, the Company evaluates its estimates, including those related to the adequacy
of the allowance for loan losses and contingencies. The Company bases its estimates on historical
experience and on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions. The one accounting estimate
that materially affects the financial statements is the allowance for loan losses. Land Held for Residential Development Land Held for Residential Development consists of real estate acquired through foreclosure and is
carried at the lower of cost or the propertys estimated fair value, less estimated costs to sell. 7




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Real Estate Owned Real Estate Owned consists of real estate acquired through foreclosure and is carried at the lower
of cost or the propertys estimated fair value, less estimated costs to sell. Stock Options The Company accounts for stock based compensation under the Financial Accounting Standards Boards
(FASB) Statement of Financial Accounting Standard (SFAS) 123, Accounting for Stock-Based
Compensation,which requires the measurement of stock compensation expense using the fair value
method of accounting. Mortgage Loans The Company has both the intent and the ability to hold mortgage loans until maturity. Therefore,
mortgage loans are classified and accounted for as held for investment and are carried at cost. The mortgage loans are originated by the Manager, in the name of the Manager, and simultaneously
sold, in whole or in part, to the Company. Loan servicing is retained by the Manager. The Company follows SFAS 114, Accounting by Creditors for Impairment of a Loan, and SFAS 118,
"Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosure. Under SFAS
114, a loan is impaired when, based on current information and events, it is probable that a
creditor will be unable to collect the contractual interest and principal payments of a loan
according to the contractual terms of the loan agreement. SFAS 114 requires that impaired loans be
measured at the present value of expected future cash flows discounted at the loans effective
interest rate or, as a practical expedient, at the loans observable market price or the fair value
of the collateral, if the loan is collateral dependent. The Company generally obtains a third party
appraisal on the underlying collateral for impaired loans to determine the amount of impairment, if
any. SFAS 118 clarifies interest income recognition and the disclosure requirements of SFAS 114. The Company does not recognize interest income on loans once they are determined to be impaired
until the interest is collected in cash. Cash receipts are allocated to interest income, except
when such payments are specifically designated as principal reduction or when the Company does not
believe the Companys investment in the loan is fully recoverable. Revenue Recognition Revenue is recognized on performing loans when interest has been earned according to the terms of
the loan. However, revenue ceases to be recognized when the loan becomes 90 days delinquent, when
foreclosure proceedings have been initiated, or when the Loan-to-Value ratio exceeds 100%,
whichever event occurs first. Mortgage loan origination fees in excess of 2.5% charged to a borrower for and upon the
origination, extension or refinancing of a mortgage loan are paid to the Company, effectively
discounting the purchase price of the loan and are amortized by the effective interest method over
the contractual life of the loan. These amounts are classified as unearned discounts. Mortgage
loan origination fees up to 2.5% are earned by the Manager prior to the purchase of the mortgage
loans by the Company. Earnings per Share Basic Earnings Per Share (EPS) is computed by dividing net earnings by the weighted average number
of shares of common stock outstanding during the period. Diluted EPS is computed by dividing net
earnings by the weighted-average common shares and potentially dilutive securities outstanding
during the period. For the diluted EPS calculation, the weighted average common shares and
potentially dilutive securities outstanding 8




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include the average number of shares of common stock outstanding, adjusted for the dilutive effect
of unexercised stock options using the treasury stock method. Allowance for Loan Losses The Company maintains an allowance for loan losses on mortgage loans. Additions to the allowance
are based on an assessment of certain factors including, but not limited to, a review of collateral
values, borrower payment ability and general economic conditions. Additions to the allowance are
provided through a charge to current earnings. Actual losses on loans are recorded as a charge-off
or a reduction to the loan loss allowance. Subsequent recoveries of amounts previously charged off
are added back to the provision for loan losses. Evaluation of the adequacy of the allowance for loan losses is based primarily on the Companys
periodic assessment and grading of the loan portfolio. Additional factors considered by the Company
include the consideration of past loan loss experience, trends in past due and nonperforming loans,
risk characteristics of the various classifications of loans, current economic conditions, the fair
value of underlying collateral and other regulatory or legal issues that could affect loan losses.
While the Company uses available information to recognize losses on loans, future adjustments to
the allowance for loan losses may be necessary based on changes in economic conditions and the
impact of such changes on the Companys borrowers. Income Taxes The Companys financial results generally do not reflect provisions for current or deferred income
taxes. Management believes that the Company has and intends to continue to operate in a manner
that will allow the Company to be taxed as a REIT and as a result, does not anticipate the payment
of substantial corporate level taxes. Many of these requirements, however, are highly technical
and complex. If the Company were to fail to meet any of these requirements, it would be subject to
federal income tax. SAC, the Companys wholly owned taxable REIT subsidiary, is generally subject to corporate level
income tax on its income and will generally be able to distribute only its net after tax earnings
to the Company as dividends. Management believes that the deferred tax assets related to net
operating losses will most likely not be recovered. SAC II, the Companys qualified REIT subsidiary, is a corporation and the REIT owns 100% of the
stock. As a qualified REIT Subsidiary, SAC II is not treated as a separate corporation from the
REIT for tax purposes. Therefore, its activities are treated as activities of the REIT and subject
to the REIT qualification tests and prohibitive transaction limits. All of its assets, liabilities
and items of income, deduction and credit are included in the Federal income tax return in the
related tax line items for the REIT. NOTE 2. MORTGAGE LOANS HELD FOR INVESTMENT Mortgage Loan Products The Company has four mortgage loan products consisting of land, construction, commercial building
and nonconforming. The mortgage loan products have stated interest rates ranging from 9.0% to
18.0%. Due to the nature of the effective interest rates among the four loan products, the Company
does not compile or report revenues by product type. Pursuant to existing loan agreements, the Company is committed to fund additional loan advances
totaling $41,000 as of March 31, 2005. Allowance for Loan Losses The Company sets aside an allowance for loan losses through periodic charges to earnings. The
Company believes sufficient reserves have been provided in the allowance to absorb probable losses
in the loan portfolio at 9




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March 31, 2005 and December 31, 2004. The following table presents a roll forward of the allowance for loan losses: Three Months Ended March 31,2005
    
    
    2004Balance at beginning of period
    
    $
    1,130,138
    
    
    $
    1,424,256Provision for Loan Losses
    
    
    241,015
    
    
    
    23,366Charge Offs
    
    
    
    
    
    
    Balance at end of period
    
    $
    1,371,153
    
    
    $
    1,447,622
 NOTE 3. DELINQUENT LOANS At March 31, 2005, the Company had no loans that were delinquent for principal or interest. At December 31, 2004, the Company had two loans that were 30 days past due totaling approximately
$5.5 million in principal and accrued interest. In accordance with its revenue recognition policy,
Management has accrued the delinquent interest on these loans. NOTE 4. LAND HELD FOR RESIDENTIAL DEVELOPMENT In February 2001, the Company foreclosed on a mortgage loan in default and obtained ownership of
the residential land development project (the Project) securing the loan. The Companys recorded
investment in the loan at the time of foreclosure was approximately $2.7 million. The Company
obtained a third-party appraisal of the Project at the time of the foreclosure, which was used by
management to value the Project at approximately $2.5 million, net of estimated costs to sell. A
loss of $225,000 was recorded upon recording the initial carrying value of the Project upon
foreclosure. The three phases comprising the Project, which totaled 117 lots, were in various
stages of completion. The appraisal provided an allocation of the fair value as follows: (i) phase
Is 15 lots at $30,000 each, (ii) phase IIs 61 lots at approximately $15,000 each, and (iii) phase
IIIs 41 lots at approximately $15,000 each. The appraisal was based on the current condition of
the lots and did not consider costs, which the Company or its assignee would incur to prepare these
lots for the commencement of homebuilding. The Company subsequently contributed the Project to
SAC, its wholly owned taxable REIT subsidiary. In June 2002, SAC entered into an agreement with a third-party homebuilder to transfer title of the
lots to the homebuilder in exchange for an upfront payment, in cash, equal to a portion of the
original appraised value of the uncompleted lots. Additionally, the homebuilder is responsible to
pay SAC the difference between the agreed value per lot and the cash previously received, upon sale
of the homes to third parties. SAC is also entitled to 50% of the profits, if any, realized by the
homebuilder upon closing of the sale of each home, as well as repayment of infrastructure costs
borne by the Company prior to the agreement. SAC receives a security interest in each lot transferred to the homebuilder, subordinate to the
senior interest held by the homebuilders construction lender. SAC is not obligated for any future
costs of the Project once a completed lot is delivered to the homebuilder. This arrangement is
accounted for as a real estate investment by which cash received upfront upon delivery of the
completed lots reduces SACs investment in the land held for residential development. Upon the
sale of completed homes by the homebuilder to an independent third-party, SAC records proceeds as a
reduction to land held for residential development as Phases I and II of the development are
expected to result in minimal profit. After the investment has been fully recovered, SAC will
recognize profit equal to its share of the profits realized and received from home sales and may
record a provision for income taxes if SAC is anticipated to generate taxable income for the year. All 76 lots in phases I and II were transferred to the homebuilder in 2002 upon payment to SAC of
$565,943. In 10




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##### Table of Contents



order to complete the lots, SAC incurred site mapping and other engineering costs, real estate
taxes and insurance costs all of which were capitalized. Three homes were sold during the quarter
ended March 31, 2005 leaving fifteen homes to sell in Phases I and II as well as the Phase III
land. The following table provides a roll-forward of this account: Balance at December 31, 2004
    
    $
    1,879,432Capitalized Costs
    
    
    166,873Net proceeds from sale of homes
    
    
    (94,425
    )Balance at March 31, 2005
    
    $
    1,951,880
 On June 30, 2003, the homebuilder neglected to exercise his option to purchase Phase III of the
Project. The Company has subsequently listed the property for sale and has received offers on the
land subsequent to March 31, 2005, such offers are in excess of the book value of the Phase III
land. NOTE 5. REAL ESTATE OWNED (HELD FOR SALE) As of March 31, 2005 and December 31, 2004, real estate owned totaled $8.4 million and $9.6 million
respectively. The properties acquired were as follows:  
    A personal residence in Telluride, Colorado acquired in September of 2003 with a loan
balance of approximately $1.7 million. The Company has incurred approximately $1.6 million
in costs to prepare the personal residence for sale, all of which was capitalized to real
estate owned.  
    Two parcels of raw land in Mesquite, Nevada acquired in August of 2003 with loan
balances of approximately $2.6 million and $2.5 million. Portions of land were sold on
various dates in 2004 and 2005.  
    A personal residence in Castle Rock, Colorado acquired in July of 2004 with a loan
balance of $2.3 million. During the quarter ended March 31, 2005, the Company sold two portions of the raw land located in
Mesquite, Nevada. The Company carried back mortgages on these sales totaling approximately $1.8
million resulting in a deferred gain of approximately $428,000. The deferred gain will be
recognized as principal payments are received on the underlying mortgages based on the installment
method of accounting. NOTE 6. QUALIFIED REIT SUBSIDIARY As of January 17, 2003, the Company formed SAC II, a qualified REIT subsidiary. A qualified
REIT subsidiary is a corporation in which a REIT owns 100% of the stock and which is not a taxable
REIT subsidiary. As a qualified REIT Subsidiary, SAC II is not treated as a separate corporation
from the REIT for tax purposes. Therefore, its activities are treated as activities of the REIT
and subject to the REIT qualification tests and prohibitive transaction limits. All of its assets,
liabilities and items of income, deduction and credit are included in the related tax line items
for the REIT. As of and for the three months ended March 31, 2005, there was no activity recorded in SAC II. NOTE 7. COLLATERALIZED NOTES On August 16, 2004, Post Effective Amendment No. 2 to the Companys registration statement was
declared effective by the Securities and Exchange Commission (SEC) changing the amount of
collateralized notes available for sale to $189,521,000 (including amounts remaining unsold under
the prior registration) from the original $250,000,000, which had been declared effective by the
SEC on January 18, 2001. The collateralized 11




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##### Table of Contents



notes are secured by mortgage loans at least one and one-half times the aggregate principal amount
outstanding on the collateralized notes. If there are not sufficient, qualifying mortgage loans in
the loan portfolio to attain the required collateral levels, the Company is required to pledge
restricted cash to the trustee of the notes in order to collateralize the notes at the required
level. The outstanding collateralized notes have maturities ranging from three months to five years from
the date of issue and bear a fixed rate of interest ranging from 3.25% to 7.50% at March 31, 2005
and December 31, 2004. The effective yield of collateralized notes outstanding at March 31, 2005
and December 31, 2004 was 5.90% and 5.77%, respectively. At March 31, 2005 and December 31, 2004,
the collateralized notes were secured by $58.6 million and $42.5 million respectively, of mortgage
loans pledged as collateral. In November 2004, the Companys Board of Directors determined that continuing the Companys
publicly offered collateralized note program would subject the Company to significant costs and
expenses, including costs of complying with the Sarbanes-Oxley Act of 2002 that would exceed the
benefits derived from the public issuance of the notes. As a result, the Board directed that the
public collateralized note program be terminated. On December 15, 2004, Post Effective Amendment
No. 3 to the Companys registration statement was declared effective by the Securities and Exchange
Commission (SEC) thereby deregistering $165,915,000 collateralized notes which represented all of
the remaining registered but unsold collateralized notes. The Company expects to be able to begin
offering collateralized notes on a private basis in June 2005. NOTE 8. RELATED PARTY On October 23, 1997, the Company entered into a Management Agreement with the Manager. The
Agreement was subsequently updated through the Second Amended and Restated Management Agreement
dated January 1, 2004. The Manager is responsible for the day-to-day operations of the Company and
performs such services and activities relating to the assets and operations of the Company as are
provided for in the Agreement. The Manager originates the mortgage loans in the name of the
Manager, and sells the loans, in whole or in part, to the Company. The Manager retains the
servicing of the mortgage loans. The Manager receives mortgage placement fees or points, usually charged to the borrower for and
upon origination, extension or refinancing of loans, up to 2.5% of the loan balance, with any
additional fees or points paid to the Company. The Manager receives a fee for loan servicing equal
to one-half of one percent per annum of all loans serviced. These fees are earned directly by the
Manager and are deducted from the interest or late payments paid to the Company to cover the
Managers costs to manage the portfolio, effectively reducing the yield to the Company. Under the Amended Agreement dated January 1, 2004, the Manager receives a monthly base management
fee equal to one-half of one percent of the Mortgage Asset Portfolio at the end of the preceding
quarter which includes Mortgage Loans net of allowances and unearned discounts, Real Estate Owned
and Land Held for Residential Development. In addition, the Manager receives, as incentive
compensation for each fiscal quarter, an amount equal to 50% of the tax  based net income before
the dividend deduction of the Company, in excess of a threshold return determined annually by the
Board of Directors. The Board of Directors determined the threshold return to be 11% for the year
ending December 31, 2005. If the Companys tax-based net income does not exceed the threshold
return on an annualized basis, the Manager does not receive incentive compensation for that year.
The Manager earned $187,620 of such incentive fee during the quarter ended March 31, 2005. 12




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##### Table of Contents



Fees earned by the Manager for the three months ended March 31, 2005 and 2004, are as follows: Three Months EndedMarch 31,2005
    
    
    2004Loan Origination and Extension Fees
    
    $
    598,925
    
    
    $
    556,500Loan Servicing Fees
    
    
    123,157
    
    
    
    110,557Late Payment Charges
    
    
    44,876
    
    
    
    7,324Subtotal
    
    $
    766,958
    
    
    
    674,381Base Management Fee
    
    
    131,065
    
    
    
    130,467Incentive Compensation Bonus
    
    
    187,620
    
    
    
    Total Compensation
    
    $
    1,085,643
    
    
    $
    804,848
 The loan origination fees are received by the Manager as part of the initial funding of the loan.
Loan servicing fees reduce the amount of interest income recognized by the Company as the Manager
withholds the servicing fee from interest payments received from borrowers. Late payment charges
are received directly by the Manager from the borrower. The Base Management Fee is paid monthly to
the Manager by the Company, and the Managers incentive compensation is calculated in accordance
with the Agreement. Both the Base Management Fee and the incentive compensation are recorded in
the line item, Management and Directors Fees, in the Companys financial statements. In addition, SAC currently has an agreement with a realtor related to the development of the land
held for residential development discussed in Note 4. SAC will pay a realtor finders fee of $300
per lot and a 3.5% sales commission for each home sold. The realtor is an employee of a real
estate company, which is owned by an independent director and member of the Companys Audit
Committee. As of March 31, 2005 and December 31, 2004, SAC did not have any outstanding payables
to the realtor related to the finders fee. Total fees paid to the real estate company for the
three months ended March 31, 2005 and 2004 were approximately $32,639 and $67,481 respectively. 13




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##### Table of Contents



NOTE 9. EARNINGS PER SHARE The following is a reconciliation of earnings per share (in thousands, except per share amounts): Three Months EndedMarch 31,2005
    
    
    2004Basic:Net earnings applicable to common stock
    
    $
    2,186
    
    
    $
    1,774Weighted average number of shares  basic
    
    
    8,417
    
    
    
    7,822Earnings per share  basic
    
    $
    0.26
    
    
    $
    0.23Diluted:Net earnings applicable to diluted earnings per share
    
    $
    2,186
    
    
    $
    1,774Weighted average number of shares  basic
    
    
    8,417
    
    
    
    7,822Weighted average shares of dilutive stock
options using average period stock price
under the treasury stock method
    
    
    2
    
    
    
    14Weighted average number of shares  diluted
    
    
    8,419
    
    
    
    7,836Earnings per share  diluted
    
    $
    0.26
    
    
    $
    0.23
 14




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Financial Statements and Notes. Safe Harbor Statement Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995: Statements in
this discussion regarding Specialty Trust, Inc., and the business, which are not historical facts,
are forward-looking statements that involve risks and uncertainties. For a discussion of such
risks and uncertainties, which could cause actual results to differ from those contained in the
forward-looking statements, please refer to Risk Factors commencing on Page 12 of our Prospectus
included in the Registration Statement on Form S-11 (File No. 333-86972) relating to our
Collateralized Notes Program. Company Overview The Company is a mortgage finance company specializing in acquiring nonconforming residential and
commercial real estate mortgage loans for the purpose of holding the loans in its portfolio. The
Company funds its loans chiefly through equity and to a lesser degree with short-term debt. This
short-term debt consists of secured bank lines of credit and the Collateralized Note Program. The Companys business objective and strategy is to build and hold a portfolio of mortgage loans
for investment that generates net income for distribution to stockholders. Loans are made
principally to borrowers in the States of Nevada, Arizona, Colorado, California and Utah whose
needs are generally not being served by traditional financial institutions. The Companys strategy
is to focus on land loans, construction loans, commercial building loans and nonconforming
single-family and small multi-family residential loans. Management generally limits the amount of
investment in any single mortgage loan or in mortgage loans to one borrower to 10% of the total
assets (approximately $12 million), although the Board of Directors may approve exceptions. Most
loans will have terms of one to three years. The mortgage loans may be secured by unimproved as
well as improved real property and non-income producing property as well as income-producing real
property. Some mortgage loans may be secured by a borrowers leasehold interest in real property.
The loans generally produce higher yields than those obtained on traditional single-family
residential mortgage loans, but are subject to higher risks of default and loss. The Company is structured as a real estate investment trust (REIT), thereby generally eliminating
federal taxes at the corporate level on income that is distributed to stockholders. Because the
Company is not structured as a traditional lender that accepts deposits, it is subject to
substantially less regulatory oversight and incurs lower compliance expenses as compared to banks,
thrift institutions and many other holders of mortgage loans. Specialty Financial serves as the Companys manager and is responsible for loan originations, loan
servicing, and day-to-day operations, subject to the supervision of the Companys Board of
Directors. Significant Aspects of First Quarter 2005 and Year End 2004 At March 31, 2005, the Company owned approximately $110.9 million of mortgage loans,
approximately
$10.4 million of land held for residential development and foreclosure property. Total assets were
approximately $122.2 million. These assets are financed with approximately $34.1 million of
collateralized notes, $5.3 million of lines of credit, and approximately $82.0 million of equity. As of March 31, 2005, the Companys equity-to-assets ratio was 67.1%, the debt-to-equity ratio was
48.1% and the annualized return on equity for the three months ended March 31, 2005 was 11.1%. 15




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##### Table of Contents



At December 31, 2004, the Company owned approximately $94.6 million of mortgage loans,
approximately
$11.5 million of land held for residential development and foreclosure property. The Companys
total assets were approximately $122.1 million. The assets were financed with approximately $41.2
million of collateralized notes, and approximately $78.3 million of equity. As of December 31, 2004, the Companys equity-to-assets ratio was 64.1%, the debt-to-equity ratio
was 52.7%, and the average return on equity for the year ended December 31, 2004 was 12.1%. Critical Accounting Policies The Companys management is responsible to insure that its policies and methodologies are in
accordance with U.S. generally accepted accounting principles. During the first quarter of 2005,
management reviewed and evaluated the Companys critical accounting policies and believes them to
be appropriate. The Companys consolidated financial statements include the accounts of the Company and its wholly
owned subsidiaries, SAC and SAC II. The preparation of consolidated financial statements in
accordance with U.S. generally accepted accounting principles requires management to make estimates
and assumptions in certain circumstances that affect amounts reported in the accompanying
consolidated financial statements. These estimates are based, in part, on managements judgment
and assumptions regarding various economic conditions believed to be reasonable based on facts and
circumstances existing at the time of reporting. In preparing these consolidated financial
statements, management has used their best estimates and judgments of certain amounts included in
the consolidated financial statements, giving due consideration to materiality. The Company does
not believe that there is a great likelihood that materially different amounts would be reported
related to accounting policies described below. However, application of these accounting policies
involves the exercise of judgment and use of assumptions as to future uncertainties and, as a
result, actual results could differ from those estimates. The following summarizes the components of the Companys consolidated financial statements where
understanding accounting policies is critical to understanding and evaluating reported financial
results, especially given the significant estimates used in applying the policies. The discussion
is intended to demonstrate the significance of estimates to the financial statements and the
related accounting policies. Detailed accounting policies are described in Note 1 to the Companys
consolidated financial statements. Revenue Recognition Revenue is recognized on performing loans when interest has been earned according to the terms of
the loan. However, revenue is no longer recognized when the loan has become delinquent for 90
days, when foreclosure proceedings have been initiated, or when the loan-to-value ratio exceeds
100%, whichever event occurs first. Management believes the Companys revenue recognition policies
are appropriate to reflect the substance of the underlying transactions. Allowance for Loan Loss The Company maintains an allowance for loan losses on its mortgage loans. Additions to the
allowance are based on an assessment of certain factors including, but not limited to, a review of
collateral values, borrower payment ability and general economic conditions. Management believes
that the Companys policies and methodology are appropriate to reflect the potential loss on the
current loan portfolio. Impairment of Long-Lived Assets Real estate investments held represent long-lived assets for accounting purposes. The Company
periodically reviews long-lived assets for impairment in value whenever an event or changes in
circumstances indicate that the carrying amount of the assets may not be recoverable. In
managements opinion, and based on their estimates, real estate owned and land held for development
are considered to be held for sale and are not carried at amounts in excess of their estimated fair
value. Land held for residential development is carried at the lower of cost or fair value less
estimated costs to sell. Fair value is derived using estimates and assumptions relating to
eventual sales prices and estimates for costs to complete. Management believes the assumptions
used in determining fair value 16




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##### Table of Contents



are based on the best information available at the time of analysis. Income Taxes The Companys financial results generally do not reflect provisions for current or deferred income
taxes. Management believes that the Company has and intends to continue to operate in a manner that
will allow the Company to be taxed as a REIT and as a result, does not anticipate the payment of
substantial corporate level taxes. Many of these requirements, however, are highly technical and
complex. If the Company were to fail to meet any of these requirements, it would be subject to
federal income tax. On May 2, 2002, the Company formed Specialty Acquisition Corp. (SAC) a wholly owned taxable REIT
subsidiary effective January 1, 2003. A taxable REIT subsidiary is generally subject to corporate
level income tax on its income and will generally be able to distribute only its net after tax
earnings to the Company as dividends. Management believes that the deferred tax assets related to
net operating losses will most likely not be recovered. As of January 17, 2003, the Company formed Specialty Acquisition Corp. II (SAC II) a qualified REIT
subsidiary. A qualified REIT subsidiary is a corporation in which a REIT owns 100% of the stock
and which is not a taxable REIT subsidiary. As a qualified REIT Subsidiary, SAC II is not treated
as a separate corporation from the REIT for tax purposes. Therefore, its activities are treated as
activities of the REIT and subject to the REIT qualification tests and prohibitive transaction
limits. All of its assets, liabilities and items of income, deduction and credit are included in
the federal income tax return for the REIT. Changes in Financial Condition Assets Cash and Cash Equivalents and Restricted Cash Cash and cash equivalents and restricted cash decreased by approximately $15.4 million (97%) as of
March 31, 2005, compared to December 31, 2004. The timing of loan fundings and the timing of debt
or equity issues generally determine the amount of cash held by the Company. The Companys goal is
to keep cash invested in loans or other financial instruments and therefore to keep cash balances
low whenever possible. Accrued Interest Receivable Accrued interest receivable increased by approximately $484,000 (41%) as of March 31, 2005 compared
to December 31, 2004 primarily as the result of an overall increase in the loan portfolio and the
Companys investment in loans with a deferred interest component as of March 31, 2005. Under these
loans, borrowers pay a reduced rate of interest during the loan term while interest accrues at a
substantially higher rate. The deferred interest is due upon maturity of the loan. Land Held for Residential Development Land held for residential development increased by approximately $72,000 (4%) as of March 31, 2005
compared to December 31, 2004 as a result of costs incurred related to Phase III of the Project
classified as land held for residential development. Land held for residential development
consists of three phases of undeveloped lots (the Project), which were obtained by the Company
through foreclosure in February 2001. This Project originally included 117 lots, which were in
various stages of completion at the time of foreclosure. An appraisal was obtained at the time of
foreclosure which provided an allocation of the fair value as follows: (i) phase Is 15 lots at
$30,000 each, (ii) phase IIs 61 lots at approximately $15,000 each and (iii) phase IIIs 41 lots
at approximately $15,000 each. The appraisal was based on the current condition of the lots and
did not consider costs, which the Company or its assignee would incur to prepare these lots for the
commencement of homebuilding. The Company subsequently contributed the Project to Specialty
Acquisition Corp. (SAC), its wholly owned taxable REIT subsidiary formed in May 2002. In June 2002, SAC entered into an agreement with a third-party homebuilder to transfer title to the
lots on a phased basis to the homebuilder in exchange for an upfront cash payment equal to a
portion of the original 17




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##### Table of Contents



appraised value of the uncompleted lots. Additionally the homebuilder is responsible to pay SAC
the difference between the original appraisal value per lot and the cash previously received, upon
sale of the homes to third parties. SAC is also entitled to 50% of the profits, if any, realized
by the homebuilder upon closing of the sale of each home built, as well as repayment of
infrastructure costs borne by the Company prior to the agreement. SAC receives a security interest
in each lot transferred to the homebuilder, subordinate to the senior interest held by the
homebuilders construction lender. SAC is not obligated for any future costs of the Project once a
completed lot is delivered to the homebuilder. This arrangement is accounted for as a real estate
investment by which cash received upfront upon delivery of the completed lots reduces SACs
investment in the land held for residential development. Upon the sale of lots and completed homes
by the homebuilder to a third-party, SAC will record proceeds as a reduction to the land held for
residential development under the cost recovery method. All 76 lots in phases I and II were transferred to the homebuilder in 2002 upon payment to SAC of
$565,943. In order to complete delivery of the lots, SAC incurred site mapping costs, other
engineering costs, real estate taxes, and insurance costs in 2002, all of which were capitalized.
Three completed homes were sold during the three months ended March 31, 2005. The following table
is a roll-forward of this account: Balance at December 31, 2004
    
    $
    1,879,432Capitalized costs
    
    
    166,873Net proceeds from sale of homes
    
    
    (94,425
    )Balance at March 31, 2005
    
    $
    1,951,880
 On June 30, 2003, the homebuilder neglected to exercise his option to purchase Phase III of the
Project. The Company has subsequently listed the property for sale. Real Estate Owned Real estate owned decreased by approximately $1.2 million (12%) as of March 31, 2005 compared to
December 31, 2004. This decrease was due primarily to the sale of a portion of property located in
Mesquite, Nevada. Mortgage Loans Mortgage loans held for investment net of allowance for loan losses and unearned discounts
increased by approximately $16.1 million (17%) as of March 31, 2005 compared to December 31, 2004
due primarily to the purchase of new mortgage loans during the quarter. The allowance for loan
losses was increased by approximately $241,000 during the quarter ended March 31, 2005 due to an
increase in the overall mortgage loan portfolio as a result of an increase in loan originations in
the current quarter. Other Assets Other assets increased by approximately $31,000 (19%) as of March 31, 2005 compared to December 31,
2004 primarily due to an increase in line of credit fees and other prepaid expenses. Liabilities Dividends Payable Dividends payable decreased
by approximately $2.3 million (100%) as of March 31, 2005
compared to December 31, 2004 due primarily to the dividends declared prior to December 31, 2004 being paid in cash or reinvested during the quarter. Accounts Payable and Accrued Expenses, Accounts Payable  Related Party and Accrued Interest
Payable Accounts payable and accrued expenses and accounts payable related party increased by approximately
$67,000 (20%) as of March 31, 2005 compared to December 31, 2004. This increase was due primarily
to the accrual of management incentive compensation as of March 31, 2005. Deferred Revenue Deferred revenue increased by approximately $428,000 due primarily to the recording of a deferred
gain upon carry-back of a mortgage loan on the sale of real estate owned. 18




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##### Table of Contents



Collateralized Notes Collateralized notes decreased by approximately $7.1 million (17%) as of March 31, 2005 compared to
December 31, 2004 due to the maturity and payout of notes during the quarter. No new
collateralized notes were issued during the period due to the Companys deregistration of the
collateralized note program in 2004. Lines of Credit Lines of credit increased by approximately $5.3 million as of March 31, 2004 compared to December
31, 2004 due to the Company utilizing its lines during the quarter and not utilizing its lines as
of December 31, 2004. The Company relies on its lines of credit, along with other sources, to meet
short term liquidity and funding needs. Results of Operations The rate volume analysis set forth in the following table analyzes changes in net interest income
for the periods indicated by their rate and volume components. Three months EndedMarch 31, 2005Over/UnderMarch 31, 2004NetChange
    
    
    Rate
    
    
    VolumeInterest IncomeMortgage Loans
    
    $
    843,565
    
    
    $
    175,494
    
    
    $
    668,071Cash Accounts
    
    
    (10,979
    )
    
    
    37,364
    
    
    
    (48,343
    )Total
    
    
    832,586
    
    
    
    212,858
    
    
    
    619,728Interest ExpenseLine of Credit
    
    
    8,391
    
    
    
    8,391
    
    
    
    Collateralized Notes
    
    
    68,737
    
    
    
    35,086
    
    
    
    33,651Total
    
    
    77,128
    
    
    
    43,477
    
    
    
    33,651Change in net
interest income
    
    $
    755,458
    
    
    $
    169,381
    
    
    $
    586,077
 The Companys operating results include all of the reported income of its mortgage finance
operation. A comparison of the three months ended March 31, 2005 to the three months ended March
31, 2004 follows: Interest Income, Mortgage Assets Interest income, mortgage assets increased by approximately $844,000 (32%) for the three months
ended March 31, 2005, as compared to the same period in prior year, due primarily to an increase in
the overall loan portfolio. Interest Income Cash Accounts Interest income, cash accounts decreased by approximately $11,000 (37%) for the three months ended
March 31, 2005, respectively, due primarily to the decrease of cash balances on hand as of March
31, 2005 compared to the prior period. Dividend Income Dividend income increased by approximately $10,000 due to the Company earning dividends on balances
that it held in a restricted cash account for a portion of the quarter ended March 31, 2005. Interest Expense  Lines of Credit Interest expense on lines of credit increased by approximately $8,000 (239%) for the three months
ended March 19




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##### Table of Contents



31, 2005, as compared to the same period in prior year, primarily due to the Company utilizing more
of its lines of credit during the three months ended March 31, 2005. Interest Expense  Collateralized Notes Interest expense on collateralized notes increased by approximately $69,000 (15%) for the three
months ended March 31, 2005, as compared to the same period in prior year. The increase was
primarily due to the additional issuance of collateralized notes over those outstanding as of March
31, 2004 offset by a decrease in interest expense due to the deregistration of the Companys
collateralized note program. As a result of the deregistration, the Company cannot issue any
additional collateralized notes for public sale. The Company expects to be able to offer its notes
for private sale starting in June 2005. Provision for Loan Losses Provision for loan losses increased by approximately $218,000 (931%) for the three months ended
March 31, 2005, as compared to the same period in prior year. This increase was primarily due to a
increase in the required allowance for loan losses based on the Companys increased mortgage
portfolio and risk rating process. General and Administrative General and administrative decreased by approximately $87,000 (52%) for the three months ended
March 31, 2005, respectively, as compared to the same period in prior year. This decrease occurred
due to a reduction in professional fees as a result of the Companys deregistration of its
collateralized note program. Management and Directors Fees Management and directors fees increased by approximately $161,000 (86%) for the three months ended
March 31, 2005, as compared to the same period in the prior year. This was primarily due to an
increase in the management incentive fees paid to the manager in the current quarter. Other Expenses Other expenses increased by approximately $32,000 (31%) for the three months ended March 31, 2005,
as compared to the same period in prior year. The increase was primarily due to the Company
incurring costs related to real estate owned properties and land held for residential development. Interest Rate/Market/Credit Risk Management of the Company seeks to manage the interest rate risk, credit risk and market risk of
the Companys portfolio. By originating short-term loans (generally less than three years),
management can significantly reduce the risk of changing interest rates. Additionally, management
continues to monitor the quality of the loans through the consistent application of internal
underwriting guidelines and loss mitigation practices in the Companys servicing procedures. In
this way, management seeks to control credit risk. The majority of the Companys loans are located
in Nevada; however, the Company has also acquired loans in Arizona, Colorado, California and Utah
to help diversify the portfolio and reduce the risk of investing in one market. 20




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##### Table of Contents



The following table sets forth the weighted average yield earned on the Companys assets and the
weighted average expense of the Companys liabilities for the periods shown. AnnualizedThree Months EndedMarch 31,2005
    
    
    2004Interest IncomeMortgage Loans
    
    
    12.76
    %
    
    
    12.00
    %Cash Accounts
    
    
    1.64
    %
    
    
    1.08
    %Interest ExpenseLines of Credit
    
    
    5.75
    %
    
    
    4.00
    %Collateralized Notes
    
    
    5.89
    %
    
    
    5.48
    %Net Interest Spread
    
    
    7.19
    %
    
    
    5.26
    %
 Liquidity and Capital Resources Management of the Company manages short-term liquidity (defined as funding needs to cover
commitments and anticipated uses occurring over the next 12 months) in a number of ways. First, the
scheduled interest payments from the mortgage portfolio produce monthly cash flow, which can be
used to originate new loans and to pay dividends to stockholders. This source provided
approximately $3.5 million during the three months ended March 31, 2005 and $11.9 million during
the 12 months ended December 31, 2004, respectively. Secondly, the payoff and the prepayment of loans provide additional liquidity to the portfolio.
Historically, the Company has experienced annual loan payoffs and prepayments of approximately 30%
to 35% of its outstanding portfolio. More recently, the Company has experienced more accelerated
payoffs due to more loans having shorter maturities. The payoff of mortgage loans provided
approximately $25.0 million during the three months ended March 31, 2005. The following table illustrates the scheduled maturities of mortgage loan investments subsequent to
March 31, 2005: Maturity
    
    AmountApril 1, 2005 to December 31, 2005
    
    $
    31,414,2632006
    
    
    54,210,6472007
    
    
    25,305,245$
    110,930,155
 Under existing mortgage loans, the Company is obligated to fund additional loan amounts totaling
$41,000 as of March 31, 2005. Thirdly, the Company had the ability to issue collateralized notes to provide additional liquidity.
Starting May 7, 2002, the Company was permitted to offer collateralized notes with maturities of
up to five years. Management has utilized collateralized notes to meet a portion of the Companys
short-term funding needs in the past. However, on November 24, 2004, the Company filed an
amendment to its registration effectively deregistering the collateralized note program. As a
result, no additional collateralized notes can be publicly offered under the program. The Company
expects to be able to begin offering the collateralized notes on a private basis in June 2005. The following table reflects the maturities of collateralized notes as of March 31, 2005: 21




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Maturity
    
    AmountApril 1, 2005 to December 31, 2005
    
    $
    34,143,066$
    34,143,066
 Lastly, the Company had three committed lines of credit with commercial banks to provide another
level of liquidity as of March 31, 2005. The Company can borrow $5.5 million, $6.5 million and
$7.0 million on three separate lines of credit to provide funding for new mortgage loans, for an
aggregate of $19.0 million in available credit. The $5.5 million is available through May 15,
2006. The $6.5 million is available through June 15, 2005. The $7.0 million line is available
through October 15, 2005. All lines of credit are collateralized by a secured interest in mortgage
loans and require the Company to maintain certain financial covenants. Such covenants include
restrictions on (i) any change in business activities from those the Company is presently engaged
in, and (ii) any change in executive and management personnel that would result in reduced
qualifications and experience compared to present personnel. Such covenants also contain
requirements for (i) minimum tangible net worth, (ii) maximum debt to equity ratio, (iii) fixed
charge coverage ratio, and (iv) a maximum allowable for lines of credit of $20 million. The
Company was in compliance with these covenants as of March 31, 2005. Management believes that the combination of these sources of capital allows them to manage the
short-term liquidity needs of the Company in virtually any business situation and thereby
efficiently use the Companys capital resources. With respect to the Companys long-term liquidity, the Company does not have any commitments that
require funding during periods beyond the next 12 months. There are no commitments for material
capital expenditures or other long-term debt obligations. Management believes the same sources
that are relied upon for short-term liquidity needs will be sufficient to fund long-term needs as
well. Risk Management and the Allowance for Loan Losses The loan portfolio is the Companys primary asset subject to credit risk. To account for this
credit risk, the Company sets aside an allowance or reserve for credit losses through periodic
charges to earnings. These charges are shown in the Companys Statement of Earnings as provision
for loan losses. Credit risk is managed and monitored through the use of prudent lending
standards, a thorough review of potential borrowers, and an on-going review of payment performance.
Asset quality administration, including early identification of problem loans and timely
resolution of problems, further enhances the management of credit risk and the minimization of loan
losses. All specifically identifiable and quantifiable losses are immediately charged off against
the allowance. Charged-off loans are subject to periodic review, and specific efforts are taken to
achieve maximum recovery of principal and interest. Management reviews the adequacy of the allowance for loan losses on a quarterly basis to determine
whether the allowance is adequate to provide for probable losses inherent in the loan portfolio as
of the balance sheet date. Valuation of the adequacy of the allowance for loan losses is based
primarily on managements periodic assessment and grading of the loan portfolio as described below.
Additional factors considered by management include the consideration of past loan loss
experience, trends in past due and nonperforming loans, risk characteristics of the various
classifications of loans, current economic conditions, the fair value of underlying collateral, and
other regulatory or legal issues that could affect loan losses. Loans are initially risk graded prior to loan origination. They are reviewed quarterly and will be
re-graded if the circumstances of the loan have materially changed. Numerous factors are
considered such as renewal, loans to the same borrower, identified facts demonstrating heightened
risk of nonpayment, or if they have become delinquent. The loan review, or grading process
attempts to identify and measure problem and watch list loans. Problem loans are those loans with
higher than average risk with workout and/or legal action probable within one 22




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year. These loans are reported quarterly to the Companys Board of Directors for action. Watch
list loans are those loans considered to have weakness detected in character, capacity to repay or
balance sheet concerns, which prompt management to take corrective action at the earliest
opportunity. Problem and watch list loans generally exhibit one or more of the following
characteristics:  
    Adverse financial trends and conditions
    Decline in the entire industry
    Managerial problems
    Customers failure to provide financial information or other collateral documentation
    Repeated delinquency, overdrafts or renewals The Loan Review Committee of the Board of Directors reviews every significant problem loan and
assessments are performed at least quarterly to confirm the risk rating to that loan, proper
accounting and the adequacy of loan loss reserve assigned. After reviewing the loan portfolio, management will allocate or assign a portion of the allowance
for loan loss to groups of loans and to individual loans to cover managements estimate of probable
loss. Allocation is related to the grade of the loan and includes a component resulting from the
application of the measurement criteria of SFAS 114 Accounting by Creditors for Impairment of a
Loan and SFAS 118 Accounting by Creditors for Impairment of a Loan-Income Recognition and
Disclosures. Management then compares the amounts allocated for probable losses to the current
allowance. To the extent that the current allowance is insufficient to cover estimated probable
losses, management records an additional provision for credit loss. If the allowance is greater
than required at that point in time, the provision is adjusted accordingly. While management uses available information to recognize losses on loans, future adjustments to the
allowance for loan loss may be necessary based on changes in economic conditions and the impact of
such changes on the Companys borrowers. Consistent with US GAAP and with the methodologies used in estimating the unidentified losses in
the loan portfolio, the allowance for loan loss consists of two components as discussed below. First, the allowance includes a component resulting from the application of the measurement
criteria of SFAS 114 and SFAS 118. The second or general component of the allowance for loan loss is intended to absorb inherent
losses that may not be provided for by the first component. The primary reason that the first
component might not be sufficient to absorb the losses present in the portfolio is due to the
inherent limitations to any credit risk grading process. Even for experienced loan reviewers,
grading loans and estimating losses involves a significant degree of judgment regarding the present
situation with respect to individual loans and the portfolio as a whole. In addition, it is
possible that grading and loan review may be performed without the assurance that all relevant
facts are available to the reviewer. For example, troubled borrowers may inadvertently or
deliberately omit important information from correspondence with the reviewer regarding the
borrowers financial condition and the diminished strength of repayment sources. Management believes sufficient amounts have been provided in the allowance for loan loss to absorb
probable losses in the loan portfolio at March 31, 2005. Non-Performing Loans and Potential Problem Loans In accordance with the Companys revenue recognition policy, the accrual of interest income is
discontinued when a loan becomes 90 days past due as to required principal or interest payments.
If collectibility is in doubt, cash receipts on non-accrual loans are used to reduce principal
rather than recorded as interest income. Accrued interest recorded during the 90-day period remains
accrued if management determines that the underlying 23




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collateral supports recovery of principal and accrued interest. At March 31, 2005, the Company did
not have any loans that had delinquent principal or interest. Land Held for Residential Development and Real Estate Owned (Held for Sale) Land held for residential development and real estate owned (held for sale) consists of real estate
acquired through foreclosure and is carried at the lower of the recorded investment in the loan,
inclusive of any senior indebtedness, or the propertys estimated fair value, less estimated
selling costs. Costs related to the improvements to the property are capitalized. Any other costs
are expensed. Inflation A substantial portion of the Companys assets and liabilities are financial in nature. As a
result, interest rates and other factors drive the Companys performance far more than inflation
does. Changes in interest rates do not necessarily correlate with changes in inflation rates. The
Companys consolidated financial statements are prepared in accordance with U.S. GAAP, while
dividends are based on taxable income. In each case, the Companys Statements of Operations and
Balance Sheets are measured with reference to historical cost or fair value without considering
inflation. Forward Looking Statements When used in this Quarterly Report on Form 10-Q, in future SEC filings, or in other written or oral
communications, the words or phrases will likely result, are expected to, will continue, is
anticipated, estimate, project, or similar expressions are intended to identify
forward-looking statements for purposes of Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the 1934 Act, as amended, and as such may involve known and unknown risks,
uncertainties and assumptions. These forward-looking statements are subject to various risks and uncertainties, including, but not
limited to, risks relating to: increases in prepayment rates on the mortgage loans; changes in
short-term interest rates; the Companys ability to use borrowings to finance its assets; risks
associated with investing in real estate, including changes in business conditions and the general
economy; changes in government regulations affecting the Companys business; and the Companys
ability to maintain its qualification as a REIT for Federal income tax purposes. These risks,
uncertainties, and factors could cause the Companys actual results to differ materially from those
projected in any forward-looking statements it makes. All forward-looking statements speak only as of the date they are made. The Company does not
undertake, and specifically disclaims any obligation to update any forward-looking statements to
reflect events or circumstances after the date of such statements. Readers are cautioned that the
Companys actual results could differ materially from those set forth in such forward-looking
statements. 24




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk includes risks that arise from changes in interest rates, foreign currency exchange
rates, commodity prices, equity prices and other market changes that affect market sensitive
instruments. The Company is a party to various financial instruments that are subject to market
risk. These instruments include commercial mortgage loans, land loans, nonconforming single-family
and small multifamily residential mortgage loans, borrowings under lines of credit and the issuance
of Collateralized Notes. These financial instruments involve elements of interest rate risk. The
loan portfolio is also subject to real estate market risk. Management has not entered into, nor do they intend to enter into, any financial instruments for
trading or speculative purposes. As the Company has no investments outside of the United States, it
is not subject to foreign currency exchange rate risk. Management does not hedge the Companys
exposure to changes in the fair value of loans through the use of derivative instruments. Instead,
Management has managed these exposures through careful underwriting and servicing of the Companys
loans. Further, management targets as potential customers borrowers with relatively significant
equity value in their property. For the most part, the Companys loans provide for either monthly payments of interest only with a
payment of principal in full at the end of the loan term, or monthly payments of interest only with
principal payments upon lot releases and principal in full at the end of the loan term. Because of
the high yield of the Companys loans, management does not believe that a 100-200 basis point
increase or decrease in general interest rates (from those prevailing at March 31, 2005) would have
a significant impact on the fair value of the Companys fixed rate loan portfolio. A significant
increase in interest rates could, however, make it more difficult for the borrowers to sell or
refinance their respective properties. This could have a material adverse effect on the Company,
either through loan defaults or the need to grant extensions of the maturity dates, thereby
delaying repayment. Additionally, a real estate market decline in Nevada, Arizona, Colorado,
California, or Utah could have a material adverse impact on the Company. If real estate values
were to decline, borrowers might find it difficult, if not impossible, to repay some or all of the
principal and accrued interest in connection with a sale or refinancing of the underlying
properties. A number of factors could lead to a real estate market decline including, but not
limited to, a slowdown in the growth of the economy, increasing commercial interest rates and
supply and demand factors. It is not possible for management to quantify the potential loss in
earnings or cash flows that might result from a real estate market decline. Management has attempted to mitigate these risk exposures by carefully underwriting and servicing
the Companys loans. The underwriting decision to provide a loan to an applicant is based primarily
upon the loan-to-value ratio for the underlying collateral. Thereafter, the Manager uses early
intervention, aggressive collection and loss mitigation techniques in the servicing process. While
management has attempted to mitigate these risk exposures, there can be no assurance that these
efforts will be successful. 25




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ITEM 4. CONTROLS AND PROCEDURES  (a)
    Disclosure Controls and ProceduresThe principal executive officer and principal financial officer of
Specialty Trust, Inc. conclude that Specialty Trust, Inc.s disclosure
controls and procedures are effective based on their evaluation of these
controls and procedures required by paragraph (b) of Rule 13a-15 or 15d-15 of
the Securities Exchange Act of 1934, as of the end of the period covered by
this report.(b)
    Changes in Internal Control Over Financial ReportingThere have been no significant changes in Specialty Trust, Inc.s internal
control over financial reporting identified in connection with the evaluation
required by paragraph (d) of Rule 13a-15 or 15d-15 of the Securities Exchange
Act of 1934 that occurred during Specialty Trust, Inc.s last fiscal quarter
that have materially affected, or are reasonably likely to materially affect,
Specialty Trust, Incs internal control over financial reporting. The rest of this page is intentionally left blank 26




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PART II. OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS. At March 31, 2005, other than litigation by the Company in the ordinary course of
business involving foreclosures or other exercise of its rights as a creditor, there
were no material pending proceedings to which the Company was a party or of which any
of its property was subject. 
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS. The Company sold an aggregate of 133,863 shares of common stock to existing
stockholders during the first quarter pursuant to its Dividend Reinvestment Plan.
The price was $11.00 per share. The sales were exempt from the registration
requirements of the Securities Act of 1933 pursuant to Section 4(2) thereof. 
 ITEM 3. DEFAULTS UPON SENIOR SECURITIES. Not applicable 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. None 
 ITEM 5. OTHER INFORMATION. None 
 ITEM 6. EXHIBITS Exhibit No.
    
    Document3.1*
    
    Articles of Incorporation3.3*
    
    Bylaws3.3.1*
    
    Amendment to Bylaws31.1
    
    Certification of the principal executive officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.31.2
    
    Certification of the principal financial officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.32.1
    
    Certification of the Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.32.2
    
    Certification of the Chief Financial Officer pursuant to Section 906 of the
Sarbanes-oxley Act of 2002.
   *
    
    Incorporated by reference to the correspondingly numbered exhibit to the
Registration Statement on Form S-11 (Registration No. 333-44860) filed by Specialty
Trust, Inc. with the Securities and Exchange Commission on August 30, 2000. 27




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SIGNATURES Pursuant to the requirements 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.  SPECIALTY TRUST, INC.Dated: May 13, 2005
    
    By:
    
    /s/ Nello Gonfiantini IIINello Gonfiantini IIIChairman and President(Signed in the capacity of (i) dulyauthorized officer of the registrant )Dated: May 13, 2005
    
    By:
    
    /s/Tanya McCafferyTanya McCafferyInterim Chief Financial Officer(Signed in the capacity of (i) dulyauthorized officer of the registrant and(ii) principal financial officer of theregistrant)
 28