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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION  
 FORM 10-Q (Mark one) x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the Quarterly Period Ended September 30, 2004 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the Transition Period From  to   Commission File Number 333-111643 DESERT CAPITAL REIT, INC.  Maryland
    
    20-0495883(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)
 2357 Renaissance Drive, Suite A, Las Vegas, Nevada 89119
(Address of principal executive office)
(Zip Code) Registrants telephone number, including area code: (800) 419-2855 Check whether the issuer (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 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  o The number of shares of the registrants common stock, par value $0.01 per
share, outstanding as of November 5, 2004 was 964,701.




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DESERT CAPITAL REIT, INC. FORM 10-QFor the Quarter Ended September 30, 2004 INDEX Part I. Financial InformationItem 1. Financial Statements (Unaudited)
    
    2a) Balance Sheets: September 30, 2004 (Unaudited) and December 31, 2003
    
    2b) Income Statement
(Unaudited) for the three and nine months ended September 30, 2004
    
    3c) Statement of Cash
Flows (Unaudited) for the three and nine months ended September 30,
2004
    
    4d) Statement of
Stockholders Equity (Unaudited) for the nine months ended September 30, 2004
    
    5e) Notes to Condensed Consolidated Financial Statements
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    9Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    15Item 4. Controls and Procedures
    
    16Part II Other InformationItem 1. Legal Proceedings
    
    16Item 2. Changes in Securities and Small Business Issuer Purchases of Equity
Securities
    
    16Item 5. Other Information
    
    17Item 6. Exhibit and Reports on Form 8-K
    
    17Signatures
    
    
    
    18Revolving Loan and Security AgreementPromissory NoteCertification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO and CFO Pursuant to Section 906




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Part I. Financial Information 
 Item 1. Financial Statements (Unaudited) DESERT CAPITAL REIT, INC. 
 BALANCE SHEETS September 30, 2004
    
    December 31, 2003(Unaudited)
    
    (Audited)ASSETS:Cash in bank
    
    $
    324,128
    
    
    $
    182,202Interest receivable
    
    
    30,955
    
    
    
    Prepaid insurance
    
    
    68,333
    
    
    
    Deferred offering costs
    
    
    
    
    
    
    415,778Mortgage notes receivable (net)
    
    
    8,280,296
    
    
    
    TOTAL ASSETS
    
    $
    8,703,713
    
    
    $
    597,980LIABILITIES AND STOCKHOLDERS EQUITYAccounts payable
    
    $
    27,855
    
    
    $
    3,980Sales commissions payable
    
    
    278,223
    
    
    
    Interest payable
    
    
    12,228
    
    
    
    Dividends payable
    
    
    30,906
    
    
    
    Notes payable
    
    
    4,054,655
    
    
    
    400,000TOTAL LIABILITIES
    
    
    4,403,867
    
    
    
    403,980Preferred stock, $0.01 par value: 15,000,000 shares
authorized, none outstandingCommon stock, $0.01 par value: 100,000,000 shares authorized;
631,512, and 20,000 shares issued and outstanding
at September 30, 2004 and December 31 2003, respectively
    
    
    6,315
    
    
    
    200Additional paid in capital
    
    
    4,467,271
    
    
    
    199,800Accumulated deficit
    
    
    (173,740
    )
    
    
    (6,000
    )TOTAL STOCKHOLDERS EQUITY
    
    
    4,299,847
    
    
    
    194,000TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    8,703,713
    
    
    $
    597,980
 The accompanying notes are an integral part of these condensed financial statements 2




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DESERT CAPITAL REIT, INC. 
 Income Statement
 For the Three Months Ended
    
    For the Nine Months EndedSeptember 30, 2004
    
    September 30, 2004(Unaudited)
    
    (Unaudited)REVENUEInterest income
    
    $
    64,557
    
    
    $
    64,557TOTAL REVENUE
    
    
    64,557
    
    
    
    64,557EXPENSESInterest expense
    
    
    13,401
    
    
    
    13,401Management fee
    
    
    5,606
    
    
    
    5,606Compensation expense
    
    
    43,993
    
    
    
    91,993Insurance expense
    
    
    51,000
    
    
    
    51,000Travel expense
    
    
    6,341
    
    
    
    17,924Provision for loan losses
    
    
    4,589
    
    
    
    4,589General and administrative
    
    
    11,606
    
    
    
    16,880TOTAL EXPENSES
    
    
    136,536
    
    
    
    201,392NET INCOME (LOSS)
    
    $
    (71,979
    )
    
    $
    (136,834
    )BASIC EARNINGS PER COMMON SHARE
    
    $
    (0.18
    )
    
    $
    (0.34
    )
 The accompanying notes are an integral part of these condensed financial statements 3




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DESERT CAPITAL REIT, INC. 
 Statement of Cash Flows
 For the Three Months
Ended
    
    For the Nine Months EndedSeptember 30,
2004
    
    September 30, 2004(Unaudited)
    
    (Unaudited)OPERATING ACTIVITIESNet income (loss)
    
    $
    (71,979
    )
    
    $
    (136,834
    )Stock based compensation
    
    
    5,556
    
    
    
    5,556Provision for loan losses
    
    
    4,589
    
    
    
    4,589Interest receivable
    
    
    (30,955
    )
    
    
    (30,955
    )Prepaid insurance
    
    
    (68,333
    )
    
    
    (68,333
    )Accounts payable
    
    
    27,855
    
    
    
    27,855Interest payable
    
    
    12,228
    
    
    
    12,228Net cash used by operating activities
    
    
    (121,039
    )
    
    
    (185,895
    )INVESTING ACTIVITIESPurchase of mortgage notes receivable
    
    
    (8,284,885
    )
    
    
    (8,284,885
    )Net cash used by investing activities
    
    
    (8,284,885
    )
    
    
    (8,284,885
    )FINANCING ACTIVITIESProceeds from notes payable
    
    
    3,436,117
    
    
    
    3,650,675Issuance of common stock
    
    
    5,915,116
    
    
    
    5,915,116Offering costs paid
    
    
    (671,903
    )
    
    
    (953,084
    )Net cash provided by financing activities
    
    
    8,679,330
    
    
    
    8,612,707Net increase in cash
    
    
    273,406
    
    
    
    141,926Cash at beginning of period
    
    
    50,772
    
    
    
    182,202Cash at end of period
    
    $
    324,128
    
    
    $
    324,128Cash paid for interest
    
    $
    1,174
    
    
    $
    1,174Supplemental schedule of non-cash investing and financing:Common stock
dividends declared but not paid:
    
    $
    30,906
    
    
    $
    30,906Sales commissions incurred but not paid:
    
    $
    278,223
    
    
    $
    278,223
 The accompanying notes are an integral part of these condensed financial statements 4




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DESERT CAPITAL REIT,
INC. 
 Statement of Stockholders Equity
 For the Nine Months Ended
September 30, 2004
(Unaudited) Common
    
    CommonStock
    
    Stock Par
    
    Additional Paid -
    
    AccumulatedShares
    
    Value
    
    in Capital
    
    Deficit
    
    TotalBalance at
January 1, 2004
    
    
    20,000
    
    
    $
    200
    
    
    $
    199,800
    
    
    $
    (6,000
    )
    
    $
    194,000Issuance of
common stock
    
    
    591,512
    
    
    
    5,915
    
    
    
    5,909,201
    
    
    
    
    
    
    
    5,915,116Stock based
compensation
    
    
    20,000
    
    
    
    200
    
    
    
    5,356
    
    
    
    
    
    
    
    5,556Distributions
common stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (30,906
    )
    
    
    (30,906
    )Offering costs
    
    
    
    
    
    
    
    
    
    
    (1,647,085
    )
    
    
    
    
    
    
    (1,647,085
    )Net income (loss)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (136,834
    )
    
    
    (136,834
    )Balance - September 30, 2004
    
    
    631,512
    
    
    $
    6,315
    
    
    $
    4,467,271
    
    
    $
    (173,740
    )
    
    $
    4,299,847
 The accompanying notes are an integral part of these condensed financial statements 5




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Desert Capital REIT,
INC. 
 Notes to Financial Statements
September 30, 2004 (UNAUDITED)
 Note 1  Description of Business and Basis of Presentation Desert Capital REIT, Inc. (the Company), was organized and incorporated
under the laws of the state of Maryland in December 2003. The
Securities and Exchange Commission, ("SEC"), declared the
Companys
Registration Statement on Form S-11 effective on July 16, 2004. The
Company incurred organizational costs prior to the effectiveness of
the Registration Statement, but
principal business activity did not begin until July 16, 2004. The principal
business activity is the financing of and investment in mortgage loans,
including acquisition and development loans, construction loans, commercial
property loans, and residential loans. The financing will be provided through
equity capital and leverage. The accompanying unaudited interim financial statements have been prepared
in accordance with accounting principles generally accepted in the United
States for interim financial information and with 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 for
complete financial statements, although management believes that the
disclosures presented herein are adequate to make the information presented not
misleading. In the opinion of management, all adjustments (consisting only of
normal recurring accruals) considered necessary for a fair presentation have
been included. The SEC declared the Companys Registration Statement
on Form S-11 effective on July 16, 2004. The Company incurred organizational costs
prior to the effectiveness of
the Registration Statement, but principal business activity did not begin until July 16, 2004. The results of operations from inception (July 16, 2004) to
September 30, 2004 are not necessarily indicative of results that may be
expected for the entire year ending December 31, 2004. Note 2  Summary of Significant Accounting Policies Use of Estimates 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 amounts reported
in the financial statements and accompanying notes. Actual results could
differ from those estimates. Cash The Company places its temporary excess cash with high quality financial
institutions. Such deposits may exceed the FDIC insurance limits. Revenue Recognition Interest will be accrued monthly on outstanding principal balances unless
our Advisor considers the collection of interest to be uncertain. The Company
generally considers the collection of interest to be uncertain when loans are
contractually past due three months or more. Income Taxes The Company intends at all times to qualify as a real estate investment
trust (REIT) for federal income tax purposes, under Sections 856 through 860
of the Internal Revenue Code of 1986, as amended and applicable Treasury
Regulations. Therefore, the Company generally will not be subject to federal
corporate income taxes if the Company distributes at least 90% of its taxable
income to its stockholders. To qualify as a REIT, the Company must elect to be
so treated and must meet on a continuing basis certain requirements relating to
the Companys organization, sources of income, nature of assets, and
distribution of income to stockholders. The Company must also maintain certain
records and request certain information from its stockholders designed to
disclose actual ownership of its stock in order to maintain REIT status. In addition, the Company must satisfy certain gross income requirements
annually and certain asset tests at the close of each quarter of its taxable
year. If the trust fails to qualify for taxation as a REIT in any taxable
year, and the relief provisions do not apply, the Company will be subject to
tax on its taxable income at regular corporate rates. Distributions to
stockholders in any year in which the Company fails to qualify will not be
deductible by the Company nor will they be required to be made. Unless
entitled to relief under specific statutory provisions, the Company will also
be disqualified from taxation as a REIT for the four taxable years following
the year during which qualification was lost. 6




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Based on the Companys belief that it has operated in a manner so as to
allow it to be taxed as a REIT since inception, no provision for federal income
taxes has been made in the financial statements. Organization Expenses Organization expenses are expensed as incurred. Offering Costs Costs attributable to the securities offering are charged against the
proceeds of the offering as a reduction to equity capital. These costs include
legal and accounting fees to prepare the securities filing as well as the fees
incurred in selling the securities, such as underwriting commissions. Loans The Company generally grants 9 to 12 month mortgage loans to customers. A
substantial portion of the loan portfolio is represented by mortgage loans
throughout southern Nevada. The ability of the Companys borrowers to honor
their contracts is dependent upon the real estate and general economic
conditions in this area. Loans are stated at unpaid principal balances, less the allowance for loan
losses. The accrual of interest on mortgage loans is generally discontinued at the
time the loan is 90 days past due. Past due status is based on contractual
terms of the loan. In all cases, loans are place on nonaccrual or charged off
at an earlier date if collection of principal or interest is considered
doubtful. All interest accrued but not collected for loans that are placed on
nonaccrual or charged off is reversed against interest income. The interest on
these loans is accounted for on the cash-basis or cost-recovery method, until
qualifying for return to accrual. Loans are returned to accrual status when
all the principal and interest amounts contractually due are brought current
and future payments are reasonably assured. Allowance for Loan Losses The Company provides a loan allowance related to certain of our mortgage
loans. Management monitors the delinquencies and defaults on the underlying
mortgages and, if an impairment of the related mortgage security is deemed to
be other than temporary, we will reduce the carrying value of the related
mortgage security to fair value. Our loan loss provision will be based on our
assessment of numerous factors affecting our portfolio of mortgage assets
including, but not limited to, current and projected economic conditions,
delinquency status, credit losses to date on underlying mortgages and any
remaining credit protection. Loan loss provision estimates are reviewed
periodically and adjustments are reported in earnings when they become known. Impairment Policy The Company has adopted Statement of Financial Accounting Standards No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS No.
144). Impairment is measured on a loan-by-loan basis on the fair value of the
related collateral since all loans subject to this measurement are collateral
dependent. There were no impairment losses recognized for the nine months ended September 30, 2004. Stock Compensation The Company accounts for stock-based compensation issued to non-employees
using the fair value recognition provisions of SFAS Statement No. 148
Accounting for Stock-Based Compensation  Transition and Disclosure  An
Amendment to FASB Statement No. 123 (FAS 148). The total value of the
restricted stock is determined on the grant date, and this amount is expensed
over the vesting period using the straight-line method. Note 3  Mortgage Notes Receivable Mortgage notes receivable represent acquisition and development,
construction, commercial property, and residential loans. The Company is
subject to the risks inherent in finance lending, including the risk of
borrower default and bankruptcy. The Company also invests in subordinated or
second lien, mortgage loans. As of September 30, 2004, approximately 16% of
the mortgage notes outstanding balance were second lien mortgages. Mortgage notes receivable are stated at the principal outstanding, less the allowance for loan losses.
Mortgage notes receivable are generally single-pay notes with interest due
monthly, and have an average term of 9 to 12 months. Acquisition & development loans
    
    $
    4,362,800Construction loans
    
    
    3,422,085Commercial property loans
    
    
    500,000Allowance for loan loss
    
    
    (4,589
    )Mortgage notes receivable (net)
    
    $
    8,280,296
 Note 4  Allowance for Loan Loses Management reviews its allowance for losses provision periodically and the
Company maintains an allowance for losses on mortgage notes receivable at an
amount that management believes is sufficient to protect 7




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against potential losses inherent in the loan portfolio. The Companys
actual losses may differ from the estimate. As of September 30, 2004 the
Company does not have any past due loans or loans in default. A reconciliation of the Companys allowance for losses follows: Balance, beginning of period
    
    $
    Provision for loan loss
    
    
    4,589Balance, end of period
    
    $
    4,589
 Note 5  Stock Based Compensation The Board of Directors have adopted the 2004 Stock Incentive Plan of
Desert Capital REIT, Inc. (the Plan). Directors, officers of the Company or
any affiliate of the Company, and individual consultants or advisors are
eligible for stock based compensation under the Plan. The Company has
authorized 1 million shares of common stock under the Plan. As of September
30, 2004, the Company has granted 20,000 restricted share awards under the
Plan. The restricted share awards were granted on September 1, 2004, and there
was no stock compensation awarded prior to this date. The fair value of the
shares on the grant date were $10 per share, and the shares vest in three equal
annual installments. As of September 30, 2004, $5,556 has been expensed due to
stock based compensation. Note 6  Basic Earnings Per Common Share Earnings per share is computed in accordance with SFAS No. 128, Earnings
Per Share. Basic earnings per share is calculated by dividing net income by
the weighted average number of shares of common stock outstanding during each
period inclusive of unvested restricted stock which participates fully in
dividends. For the ThreeMonths
EndedSeptember 30, 2004
    
    For the NineMonths
EndedSeptember 30, 2004Net income
(loss)
    
    $
    (71,979
    )
    
    $
    (136,834
    )Weighted average number of common shares outstanding
    
    
    404,854
    
    
    
    404,854Basic earnings per common share
    
    $
    (0.18
    )
    
    $
    (0.34
    )
 Note 7  Dividends On September 1, 2004, the Company declared dividends of $0.075 per share
of common stock, payable to stockholders of record at the close of business on
September 30, 2004. These dividends were paid on October 15, 2004. Note 8  Notes Payable As of September 30, 2004, the Company has borrowed $2,880,000, from
Beresford Bancorporation, Inc., a related party, under a line of credit term
facility, up to a maximum of $5,000,000 with notes receivable pledged as
collateral against advances. The interest rate is the 10 year treasury yield
on the last day of the month, rounded to the nearest 0.125%, plus 3.00% and is
payable monthly. The note matures February 1, 2005. The interest rate applicable for the month of September was
7.125%. Interest expense accrued and payable as of September 30, 2004, was
$7,308. As of September 30, 2004, the Company has also borrowed $1,175,655 from
its advisor, Burton Management Company, Ltd., (Burton), a related party. The
interest rate on this note is equal to the 10 year treasury yield on the last
day of the month. The interest rate applicable for the month of September was
4.119%. Interest expense accrued and payable as of September 30, 2004, was
$4,919. 8




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Note 9  Commitments and Related Parties The Company has contracted with Burton to serve as Advisor for the
Company. Burton oversees the day-to-day operations including asset, liability
and capital management. Burton is compensated based upon the advisory agreement
that entitles Burton to a base management fee, incentive compensation and
reimbursement of expenses. The president and owner of Burton is also the
president and chief executive officer of the Company. The annual base
management compensation is 1% of the first $200,000,000 of average invested
assets plus 0.8% of the average invested assets in excess of $200,000,000, to
be paid quarterly. The base management fee payable to the Advisor as of
September 30, 2004, is $5,606. The incentive compensation is a tiered
percentage of the amount of our net income (taxable income) excluding capital
losses, before deducting incentive compensation less a threshold return, which
is the net income that would produce an annualized return on our average
invested assets equal to the 10 year U.S. Treasury rate plus 1.0%. The tiered
percentage is the weighted average of 20% of the first $200,000,000 of average
invested assets and 10% of the excess over $200,000,000 of average invested
assets. The incentive compensation will be calculated quarterly and any
positive quarterly incentive amount shall be paid by the Company, along with
the base management compensation, within 15 days of receipt of the
computations. At the end of the fiscal year, the incentive compensation shall
be calculated based upon the net income for the year. If the quarterly payments
are less than the annual incentive amount, the Company shall pay Burton the
difference. If the quarterly payments were to exceed the annual incentive
compensation, Burton will refund the excess to the Company, which will reduce
the previously recorded incentive fee expense. Should the Company not have
sufficient cash available to pay the quarterly or annual amounts, the Company
would either borrow sufficient funds or sell assets to meet these contracted
obligations. The Company has entered into a three year agreement with Consolidated Mortgage,
Inc., which will provide for the right of first offer to purchase all
residential mortgage and commercial bridge loans originated by Consolidated
Mortgage. The officers of the Company were formerly officers with Consolidated
Mortgage. The dealer-manager, CMC Financial Services, Inc., directs and oversees the
sale of the Companys equity securities. CMC Financial receives a sales
commission and other fees based on the sale of these securities. The
dealer-manager is an affiliate of both the Company and Burton, as the president
and owner of CMC Financial Services, Inc. is also the president and chief
executive officer of the Company. Note 10  Subsequent Event The Company entered into an agreement to acquire Consolidated Mortgage
Corporation on November 10, 2004. The transaction is structured as an
installment sale pursuant to which the Company will acquire the outstanding
equity securities of Consolidated Mortgage over time so as to comply with
applicable Internal Revenue Code provisions. The initial closing of 25% of the
outstanding equity of Consolidated Mortgage is expected to occur within the
next 30 days, following the receipt by the Company of certain regulatory
approvals from the State of Nevada. The Company expects to acquire all of the
outstanding equity securities of Consolidated Mortgage by the end of the third
quarter 2005. The purchase price to be paid by the Company for Consolidated
Mortgage consists of $9 million in cash and 450,000 shares of the Companys
common stock. 
 Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations The following discussion of our financial condition and results of
operations should be read in conjunction with the financial statements and
notes to those statements included elsewhere in this document. This discussion
may contain certain forward-looking statements. Forwarding-looking statements
are those that are not historical in nature. They can often be identified by
their inclusion of words such as will, anticipate, estimate, should,
expect, believe, intend and similar expressions. Any projection of
revenues, earnings or losses, capital expenditures, distributions, capital
structure or other financial terms is a forward-looking statement. Our forward-looking statements are based upon our managements beliefs,
assumptions and expectations of our future operations and economic performance,
taking into account the information currently available to us. Forward-looking
statements involve risks and uncertainties, some of which are not currently
known to us, that might cause our actual results, performance or financial
condition to be materially different from the expectations of future results,
performance or financial condition we express or imply in any forward-looking
statements. Some of the important factors that could cause our actual results,
performance or financial condition to differ materially from expectations are:  
    
    Our limited operating history and the lack of
experience of our Advisor, Burton Management Company, Ltd., in
managing a REIT;
    
    Changes in interest rates;
    
    Potential impacts of our leveraging policies and
strategies without notice to you or stockholder approval; 9




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
    
    Our Advisors motivation to recommend riskier
investments in an effort to maximize its incentive compensation
under the advisory agreement; and
    
    Although we believe our proposed method of operations
will be in conformity with the requirements for qualification as
a REIT, we cannot assure you that we will qualify as a REIT or,
if so qualified, will continue to qualify as a REIT. Our failure
to qualify or remain qualified as a REIT could have material
adverse effect on our performance and your investment. We undertake no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. In light of these risks, uncertainties and assumptions,
the events described by our forward-looking events might not occur. We qualify
any and all of our forward-looking statements by these cautionary factors. In
addition, you should carefully review the risk factors describe in other
documents we file from time to time with the Securities and Exchange
Commission. General Desert Capital REIT, Inc. is a REIT headquartered in Las Vegas, Nevada. We
are externally managed and were formed in December 2003 to invest in mortgage
loans. We expect to derive our revenues primarily from the receipt of interest
and principal payments under loans acquired with our equity capital and
borrowed funds. Our principal business objective is to generate net income for
distribution to our stockholders from the spread between interest income on our
mortgage assets and the costs of financing the acquisition of these assets. We
expect that this spread, net of operating expenses, will provide both operating
capital and distributable income. Our business will depend on our access to
external sources of financing at a cost we can absorb while still generating an
attractive risk-adjusted return on the loans we acquire using the proceeds of
our financings. Our business will also depend on our ability to locate
suitable investments to keep our capital fully deployed at favorable rates. We intend to elect to be taxed as a REIT for U.S. federal income tax
purposes commencing with our taxable year ending December 31, 2004, thereby
generally avoiding U.S. federal income taxes on our taxable income that we
distribute currently to our stockholders. Risk Factors Investment in our common stock involves a high degree of risk. The risk
factors that should be considered when making an investment in our common stock
include, but are not limited to, those described in the following paragraphs
and more fully described in our Registration Statement. There
are a number of risks associated with ownership of our common stock, including, but
not limited to, reliance on our Advisor, potential conflicts of interest and
investment in a development stage enterprise. We are
totally reliant on our Advisor, which is an affiliate of several of our
officers and directors, to manage our business and assets. Certain of our
officers and directors will be subject to substantial conflicts of interest.
We may incur substantial debt, which could hinder our ability to pay dividends
to our stockholders. We may not be able to invest in a diverse portfolio of loans and the
value of our shares would then fluctuate with the performance of specific loans. We are evaluating the market of available loans and will acquire or fund
loans that meet our investment criteria. Each of the types of loans we expect
to acquire are subject to risks: balloon loan payments are risky because
repayment depends on the borrowers ability to refinance the loan or sell the
property, commercial loans are risky partly due to the fact that they generally
have higher loan balances than our other categories of loans, and subordinated
loans are subject to a greater risk of loss than loans secured by first liens.
If we cannot fund loan acquisitions on favorable terms to meet financial
expectations, our earnings could be adversely affected. 10




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Public Offering of Equity Securities/Use of Proceeds Pursuant to a Registration Statement on Form S-11 under the Securities Act
of 1933, as amended (the Registration Statement), we offered for sale to the
public on a best efforts basis a minimum of 250,000 and a maximum of
20,000,000 shares of our common stock at a price of $10 per share (the
Offering) and up to 2,000,000 additional shares pursuant to a dividend
reinvestment plan under which our stockholders may elect to have dividends
reinvested in additional shares at $10 per share. The Registration Statement
was declared effective by the SEC on July 16, 2004. As of September 30, 2004, we had sold approximately 611,512 shares of our
common stock (Shares) for aggregate gross proceeds before Offering costs and
selling commissions of approximately $6,115,120. Of these amounts, 20,000
shares or $200,000 of our common stock were sold to our Advisor. In
connection with the Offering, we incurred approximately $950,126 of
costs related to the issuance and distribution of the Shares through the
quarter ended September 30, 2004. We will continue to incur similar costs in
the future as additional shares are sold. Critical Accounting Policies and Management Estimates Our financial statements are prepared in accordance with GAAP. The
application of these accounting policies will require our management to make
certain judgments and estimates that directly affect our financial reporting
results. We consider the policies discussed below to be critical to an
understanding of our financial statements. Specific risks for these critical
accounting policies are described in the following paragraphs. In regard to
these policies, we caution you that we have no operating history and future
events rarely develop exactly as forecasted, and the best estimates of our
management will likely require adjustment. See Note 2
 Summary of Significant Accounting Policies to our
financial statements for a more
complete description of these policies. Basis of Accounting and Presentation.The preparation of financial
statements in conformity with GAAP 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 period.
Management believes that the estimates and assumptions utilized in preparing
our financial statements and accompanying notes are reasonable and prudent.
Actual results could differ from those estimates. Accounting for Stock Compensation.As of September 30, 2004, we had
20,000 shares of restricted stock outstanding. We intend to issue additional
shares of restricted stock in the future. We expect to continue to issue
stock-based compensation to our directors. We account for stock-based
compensation issued to non-employees using the fair value recognition
provisions of SFAS Statement No. 148 Accounting for Stock-Based Compensation -
Transition and Disclosure  An Amendment to FASB Statement No. 123 (FAS 148).
The total value of the restricted stock is determined on the grant date, and
this amount is expensed over the vesting period using the straight-line method. Interest on Loans.Interest will be accrued monthly on outstanding
principal balances unless our Advisor considers the collection of interest to
be uncertain. We generally consider the collection of interest to be uncertain
when loans are contractually past due three months or more. Organization Expenses.Organization expenses are expensed as incurred. Offering Costs.Costs attributable to the securities offering are charged
against the proceeds of the offering as a reduction to equity capital. These
costs include legal and accounting fees to prepare the securities filing as
well as the fees incurred in selling the securities, such as underwriting
commissions. Income Taxes.For our taxable year ending December 31, 2004, we intend to
elect to be taxed as a REIT under Sections 856 through 860 of the Internal
Revenue Code and, upon the election being made, we will be taxed as such
beginning with our taxable year ending December 31, 2004. To qualify as a
REIT, we must meet certain organizational and operational requirements,
including a requirement to currently distribute at least 90% of our 11




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REIT taxable income to stockholders. As a REIT, we generally will not be
subject to U.S. federal income tax on taxable income that we distribute to our
stockholders. If we fail to qualify as a REIT in any taxable year, we will
then be subject to U.S. federal income taxes on our taxable income at regular
corporate rates starting with that year and will not be permitted to qualify
for treatment as a REIT for U.S. federal income tax purpose for four years
following the year during which qualification is lost unless the IRS were to
grant us relief under certain statutory provisions. Such an event could have a
material adverse effect on our net income and net cash available for
distribution to stockholders. However, we believe that we will be organized
and operate in such a manner as to qualify for treatment as a REIT and we
intend to operate in the foreseeable future in such a manner so that we will
qualify as a REIT for U.S. federal income tax purposes. Impairment Policy.We have adopted Statement of Financial Accounting
Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets (SFAS No. 144). Impairment is measured on a loan-by-loan basis on the
fair value of the related collateral since all loans subject to this
measurement are collateral dependent. There was no impairment losses recognized
for the nine months ended September 30, 2004. Loans. The Company generally grants 9 to 12 month mortgage loans to
customers. A substantial portion of the loan portfolio is represented by
mortgage loans throughout southern Nevada. The ability of the Companys
borrowers to honor their contracts is dependent upon the real estate and
general economic conditions in this area. Loans are stated at unpaid principal balances, less the allowance for loan
losses. The accrual of interest on mortgage loans is generally discontinued at the
time the loan is 90 days past due. Past due status is based on contractual
terms of the loan. In all cases, loans are place on nonaccrual or charged off
at an earlier date if collection of principal or interest is considered
doubtful. All interest accrued but not collected for loans that are placed on
nonaccrual or charged off is reversed against interest income. The interest on
these loans is accounted for on the cash-basis or cost-recovery method, until
qualifying for return to accrual. Loans are returned to accrual status when
all the principal and interest amounts contractually due are brought current
and future payments are reasonably assured. Allowance for Loan Losses.We will provide a loan allowance related to
certain of our mortgage loans. We will monitor the delinquencies and defaults
on the underlying mortgages and, if an impairment of the related mortgage
security is deemed to be other than temporary, we will reduce the carrying
value of the related mortgage security to fair value. Our loan loss provision
will be based on our assessment of numerous factors affecting our portfolio of
mortgage assets including, but not limited to, current and projected economic
conditions, delinquency status, credit losses to date on underlying mortgages
and any remaining credit protection. Loan loss provision estimates are
reviewed periodically and adjustments are reported in earnings when they become
known. Recent Accounting Developments In June 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. The statement specifies the
accounting for certain employee termination benefits, contract termination
costs and costs to consolidate facilities or relocate employees and is
effective for exit and disposal activities initiated after December 31, 2002.
We do not expect the statement to have a material effect on our financial
condition or results of operations. In November 2002, the FASB issued FASB Interpretation (FIN) No. 45
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others. FIN No. 45 specifies the
disclosures to be made about obligations under certain issued guarantees and
requires a liability to be recognized for the fair value of a guarantee
obligation. The recognition and measurement provisions of the interpretation
apply prospectively to guarantees issued after September 30, 2002. We do not
expect the recognition and measurement provisions to have a material effect on
our financial condition or results of operations. In January 2003, the FASB issued FASB Interpretation (FIN) No. 46
Consolidation of Variable Interest Entities. FIN No. 46 requires a company
to consolidate a variable interest entity (VIE) if the company has variable
interests that give it a majority of the expected losses or a majority of the
expected residual returns of the entity. Prior to FIN No. 46, VIEs were
commonly referred to as SPEs. FIN No. 46 is effective immediately for VIEs
created after January 31, 2003. We do not expect the interpretation to have a
material effect on our financial condition or results of operations. In May 2003, the FASB issued SFAS No. 150, Accounting for certain
Financial Instruments with Characteristics of both Liabilities and Equity.
SFAS No. 150, which is effective at the beginning of the first interim period
beginning after June 15, 2003, must be implemented by reporting the cumulative
effect of a change in accounting principle for financial instruments created
before the issuance date of the statement and still existing at the beginning
of the interim period of adoption. The statement requires that a financial
instrument which falls within the scope of the statement to be classified and
measured as a liability. The following financial instruments are required to
be classified as liabilities: (1) shares that are mandatorily redeemable, (2)
an obligation to repurchase the issuers equity shares or one indexed to such
an obligation and that requires or may require settlement by transferring
assets and (3) the embodiment of an unconditional obligation that the issuer
may or may not settle by issuing a variable number of equity shares if, at
inception, the monetary value of the obligation is based on certain 12




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measurements defined in the statement. We do not expect the statement to
have a material effect on our financial condition or results of operations. Results of Operations For
the three months ended September 30, 2004, net (loss) was
$(71,979) or
$(0.18) per weighted average share outstanding (basic and diluted). For the
same period, interest income was approximately $64,557, and was primarily
earned from investments in loans secured by real estate. Interest expense on
short-term borrowings was $13,401. On July 16, 2004, we commenced a public
offering of 20,000,000 shares of common stock. Because we continue to raise
equity through our ongoing offering, operating results for the nine months ended
September 30, 2004 are not indicative of future operating results. Operating
expenses for the three months ended September 30, 2004, were
$136,536. Base advisory fees to the Advisor under the advisory agreement, which were
$5,606 for the three months ended September 30, 2004, are based on a percentage of
our average invested assets. Average invested assets, for these purposes,
are calculated monthly and are the average of the aggregate book value of our
assets invested, directly or indirectly, in equity interests and in loans
secured by real estate, before certain reserves. Other
expenses for the three months ended September 30, 2004, included
$43,993
in compensation expense related to the compensation of our board of directors,
$51,000 of insurance expense, consisting of directors and officers
indemnification insurance premiums, and a $4,589 provision for losses to
protect against potential losses inherent in our loan portfolio. Because the Company did not commence operations until the third quarter of
2004, the only comparative financial data presented is the balance sheet as of
December 31, 2003. REIT taxable net income is calculated according to the requirements of the
Internal Revenue Code, rather than GAAP. The following table reconciles GAAP
net income to REIT taxable net income for the nine months ended September 30, 2004
(in thousands): GAAP net
income (loss)
    
    $
    (136,834
    )Adjustments to GAAP net income:
    
    
    4,589REIT taxable
net income (loss)
    
    $
    (132,245
    )
 We believe that the presentation of our REIT taxable net income is useful
to investors because it is directly related to the distributions we are
required to make in order to retain our REIT status. There are limitations
associated with REIT taxable net income. For example, this measure does not
reflect net capital losses during the period and, thus, by itself is an
incomplete measure of our financial performance over any period. As a result,
our REIT taxable net income should be considered in addition to, and not as a
substitute for, our GAAP-based net income as a measure of our financial
performance. Contractual Obligations and Commitments As of September 30, 2004, we had entered into an advisory agreement with
our Advisor. See Note 9 to the financial statements for significant terms of
the advisory agreement. Off-Balance Sheet Arrangements Since inception, we have not maintained any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, established for
the purpose of facilitating off-balance sheet arrangements or other
contractually narrow or limited purposes. Further, 13




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we have not guaranteed any obligations of unconsolidated entities nor do
we have any commitment or intent to provide additional funding to any such
entities. Accordingly, we are not materially exposed to any market, credit,
liquidity or financing risk that could arise if we had engaged in such
relationships. Liquidity and Capital Resources At September 30, 2004, we had $324,128 of cash to meet our immediate
short-term liquidity requirements. We expect that future short-term liquidity
requirements will be financed by net cash flow from operations and existing
working capital. Operating cash flows are expected to increase as additional
loans are added to our portfolio. Cash and cash equivalents increased since
December 31, 2003 principally as a result of the increase in net proceeds from
the Offering. We anticipate that adequate cash will be generated from operations to fund
our operating and administrative expenses, continuing debt service obligations,
and the payment of dividends in the foreseeable future. We paid no dividends for the nine months ended September 30, 2004.
A dividend in the amount of $0.075 per share of our common stock ($30,906 in
the aggregate) was paid on October 15, 2004, to stockholders of record as of
September 30, 2004. We currently expect to pay cash dividends monthly at an
annual rate of 9.00% or $.90 per share. As of September 30, 2004, we had
accrued total distributions of $30,906. Dividends are determined by our board
of directors and are dependent on a number of factors, including the amount of
funds available for distribution, our financial condition, any decision by our
board of directors to reinvest funds rather than to distribute the funds, the
annual distribution required to meet REIT status under the Internal Revenue
Code and other factors our board of directors may deem relevant. Cash Flows used in Operating Activities.Net cash used by operating
activities was $121,039. We expect cash flows from operating activities to
increase due to the acquisition of additional loans. Cash Flows used in Investing Activities.Net cash used in investing
activities amounted to $8,284,885 relating to the acquisition of loans during
the third quarter of 2004. Cash Flows from Financing Activities.Cash provided by financing
activities amounted to $8,679,330 for the three months ended September
30, 2004, consisting of $5,243,213 raised through the Offering (net of offering
costs) during the three-months ended September 30, 2004 and
$3,436,117 in
borrowings under our credit facility. For the three months ended
September 30, 2004, we paid Offering costs, including selling commissions,
investor marketing and due diligence costs and other
offering expenses, totaling $671,903. We will continue to incur similar costs
in the future as additional shares are sold. We currently have a $5 million credit facility that matures in February
2005. Borrowings under our credit facility bear interest at the 10-year
Treasury Rate plus 3%. Depending on market conditions, we may incur debt up to
300% of our net assets. We expect to use borrowings under our credit facility
and any future borrowings under other lines of credit with commercial banks to
fund or acquire loans secured by real estate. The borrowings under our
existing credit facility are, and some or all of our future debt may be,
secured by some or all of our assets. If we default in the payment of interest
or principal on any such debt, breach any representation or warranty in
connection with any borrowing or violate any covenant in any loan document, our
lender may accelerate the maturity of such debt requiring us to immediately
repay all outstanding principal. If we are unable to make such payment, our
lender could foreclose on our assets that are pledged as collateral to that
lender. The lender could also sue us or force us into bankruptcy. Any of
these events would likely have a material adverse effect on the value of an
investment in our common stock. At September 30, 2004, we were in compliance
with all the covenants under our credit facility. In order to qualify as a REIT and to avoid corporate-level tax on the
income we distribute to our stockholders, we are required to distribute at
least 90% of our REIT taxable income on an annual basis. Therefore, one the
net proceeds we receive from this offering are substantially fully invested, we
will need to borrow in order to grow our business and acquire additional
assets. Our sources of funds will primarily be the net proceeds from this
offering, operating cash flows and borrowings. Operating cash flows will
consist of interest received on and maturities of mortgage loans and
investments. Liquidity will also be generated through lines of credit with 14




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commercial banks. We believe that we will be able to obtain financing in
amounts and on terms that are acceptable to us and consistent with our business
strategy prior to the closing of this offering. We believe that these cash
resources will be sufficient to satisfy our immediate liquidity requirements,
and we do not anticipate a need to raise funds from other than these sources
within the next 12 months. Our income calculated for tax purposes may differ from income calculated
in accordance with GAAP. For example, we record a reserve for credit losses
for GAAP purposes whereas only actual credit losses are deducted in calculating
taxable income. The distinction between taxable income and GAAP income is
important to our stockholders because distributions are declared on the basis
of taxable income. While we generally will not be required to pay income taxes
as long as we satisfy the REIT provisions on the Internal Revenue Code, each
year we will be required to complete a U.S. federal income tax return wherein
taxable income is calculated. This taxable income level will determine the
minimum level of distribution we must pay to our stockholders. Our advisory agreement with our Advisor requires us to pay incentive
compensation on a quarterly basis to our Advisor based on the application of
the incentive compensation formula at the end of each quarter. Because we will
be paying out at least 90% of our REIT taxable income to stockholders on a
quarterly basis, we may not have sufficient cash at the end of a particular
quarter to pay the incentive fee, which would require us to borrow under our
credit facility, if any, or sell assets to meet the contractual obligation. In
addition, it is possible that our liquidity may be further impaired if we
generate substantial net income in the first three quarters of a fiscal year
and have a significant drop off in the fourth quarter, but our capital
resources may be limited by the fact that we have overpaid our Advisor for the
year (through the first three quarters) will not be reimbursed for the over
payment until year-end. Nevertheless, our total annual operating expenses,
including the incentive compensation payable to the Advisor, will not exceed
the greater of 2% of average invested assets or 25% of our net income, unless
specifically approved by our independent directors. 
 Item 3. Quantitative and Qualitative Disclosures about Market Risk Market risk refers to the risk of loss from adverse changes in the level of one
or more market prices, rate indices or other market factors. We are exposed to
market risk primarily from changes in interest rates that are very sensitive to
a variety of factors including political, economic and other factors outside of
our control. Interest rate risk arises primarily as a result of our core business activities
of acquiring mortgage loans and funding a portion of the purchases with
borrowings and the associated asset and liability management required to match
maturities of loans to funding sources. The principal objective of our asset
and liability management is to maximize net interest income while operating
within acceptable limits established for interest rate risk and maintaining
adequate levels of liquidity. The primary interest rate exposure to which we are subject relates to our
mortgage loan portfolio. Any change in the general level of interest rates in
the market can affect our net interest income and net income in either a
positive or negative manner. Net interest income is the difference between the
income earned from interest bearing assets less the expense incurred relating
to interest bearing liabilities. Fluctuations in the interest rate environment
can also affect our ability to acquire new loans, the value of our loans for
sale portfolio and our ability to sell the loans held for sale and the related
income associated with a sale. We do not intend to use any derivative instruments to manage our interest rate
exposure. Given the short time horizon of our anticipated investments and our
related borrowings, we do not believe a hedging strategy is necessary. In
addition, our actions are limited by rules with which REITs must comply. 15




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Item 4. Controls and Procedures As of the end of the period covered by this quarterly report, the Company
carried out an evaluation, under the supervision and with the participation of
the Company management, including the Companys Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of
the Companys disclosure controls and procedures pursuant to Securities
Exchange Act Rule 13a-15. Based on that evaluation, the Chief Executive Officer
and the Chief Financial Officer have concluded that these disclosure controls
and procedures are effective as of the end of the period covered by this
report. There has been no change in the Companys internal control over
financial reporting that occurred during the period covered by this report that
has materially affected, or is reasonably likely to materially affect, the
Companys internal control over financial reporting. 
 Part II. Other Information 
 Item 1. Legal Proceedings None. 
 Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities Desert Capital REITs Form S-11 Registration Statement, File No. 333-111643,
registering the sale of up to 22,000,000 shares of Desert Capitals common
stock, was declared effective by the Securities and Exchange Commission on July
16, 2004. The offering commenced on July 16, 2004. The offering is a best
efforts offering, and as of the date of the filing of this Form 10-Q, the
offering is continuing. The dealer-manager for the offering is CMC Financial
Services, Inc. The offering price is $10.00 per share, with discounts and
commissions payable to the dealer-manager equaling $0.90 per share. The
aggregate price of the 22,000,000 shares of common stock registered is
$220,000,000 As of November 5, 2004, Desert Capital has sold 944,701 shares,
with an aggregate offering price of $9,447,009. From July 1, 2004 through September 30, 2004, Desert Capital has incurred
offering expenses of $950,126, consisting of $548,650 in commissions paid to
CMC Financial Services, Inc., the dealer-manager, and $401,476 for legal,
accounting, and filing fees resulting in total expenses of $950,126. Todd B. Parriott, the Chairman of the Board and Chief Executive Officer of Desert
Capital is a director and principal of CMC Financial Services, Inc. The net
offering proceeds to Desert Capital REIT after deducting total offering expenses as of
September 30, 2004 are $4,468,030. Of the $8,598,064 of net proceeds received from sales of Desert Capitals
common stock as of November 5, 2004, $173,708 has been used for working
capital, $812,302 has been invested in temporary investments and $7,612,054 has
been invested in loans secured by real estate. 16




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Item 5. Other Information None. 
 Item 6. Exhibits and Reports on Form 8-K a) Exhibits 3.1 -
    
    Second Amended and Restated Articles of Incorporation
(included as Exhibit 3.1 to Amendment No. 2 to the Registrants
Registration Statement on Form S-11 (File No. 333-111643) (the
Registration Statement) and incorporated herein by reference)3.2 -
    
    Bylaws of the Company (included as Exhibit 3.2 to the
Registration Statement and incorporated herein by reference)4.1 -
    
    Form of Common Stock certificate (included as Exhibit 4.1 to
Amendment No. 2 to the Registration Statement and incorporated herein
by reference)10.1 -
    
    Form of Advisory Agreement (included as Exhibit 10.1 to
Amendment No. 3 to the Registration Statement and incorporated herein
by reference)10.2 -
    
    Form of Strategic Alliance Agreement (included as Exhibit
10.2 to Amendment No. 1 to the Registration Statement and
incorporated herein by reference)10.3 -
    
    Form of Indemnity Agreement (included as Exhibit 10.3 to
Amendment No. 6 to the Registration Statement and incorporated herein
by reference)10.4 -
    
    Form of Escrow Agreement (included as Exhibit 10.4 to
Amendment No. 4 to the Registration Statement and incorporated herein
by reference)10.5 -
    
    Revolving Loan and Security Agreement*10.6 -
    
    Promissory Note*31.1 -
    
    Certification of Chief Executive Officer, Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.31.2 -
    
    Certification of Chief Financial Officer, Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.32.1 -
    
    Certification of Chief Executive Officer and Chief Financial
Officer, Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
   *
    Included herewith b) Reports on Form 8-K No reports on Form 8-K were filed during the period covered by this
report. 17




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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. DESERT CAPITAL REIT, INC.November 15, 2004
    
    /s/ TODD B. PARRIOTTTodd B. Parriott,
Chairman of the Board, Chief Executive Officer,
President and Chief Investment Officer
(Principal Executive Officer)November 15, 2004
    
    /s/ JONATHAN G. ARENSJonathan G. Arens,
Chief Financial Officer
(Principal Accounting Officer)
 18




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EXHIBIT INDEX Exhibit Number
    
    Description3.1 -
    
    Second Amended and Restated Articles of Incorporation (included as
Exhibit 3.1 to Amendment No. 2 to the Registrants Registration Statement
on Form S-11 (File No. 333-111643) (the Registration Statement) and
incorporated herein by reference)3.2 -
    
    Bylaws of the Company (included as Exhibit 3.2 to the Registration
Statement and incorporated herein by reference)4.1 -
    
    Form of Common Stock certificate (included as Exhibit 4.1 to Amendment
No. 2 to the Registration Statement and incorporated herein by reference)10.1 -
    
    Form of Advisory Agreement (included as Exhibit 10.1 to Amendment No. 3
to the Registration Statement and incorporated herein by reference)10.2 -
    
    Form of Strategic Alliance Agreement (included as Exhibit 10.2 to
Amendment No. 1 to the Registration Statement and incorporated herein by
reference)10.3 -
    
    Form of Indemnity Agreement (included as Exhibit 10.3 to Amendment No.
6 to the Registration Statement and incorporated herein by reference)10.4 -
    
    Form of Escrow Agreement (included as Exhibit 10.4 to Amendment No. 4
to the Registration Statement and incorporated herein by reference)10.5 -
    
    Revolving Loan and Security Agreement*10.6 -
    
    Promissory Note*31.1 -
    
    Certification of Chief Executive Officer, Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.31.2 -
    
    Certification of Chief Financial Officer, Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.32.1 -
    
    Certification of Chief Executive Officer and Chief Financial Officer,
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
   *
    Included herewith 19