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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
|_| 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: 0-30507
Primecore Mortgage Trust, Inc.
(Exact name of registrant as specified in its charter)
Maryland 94-3324992
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
99 El Camino Real
Menlo Park, CA 94025
(Address of principal offices) (zip code)
(650) 328-3060
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (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 |_|
The number of shares of convertible preferred stock outstanding as of
June 30, 2002 was 22,213,574. The number of shares of common stock
outstanding as of June 30, 2002 was 100.
1
Table of Contents
Part I. Financial Information
Item 1. Financial Statements (unaudited).................................. 3
Balance Sheets as of June 30, 2002 (unaudited) and
December 31, 2001................................................. 4
Statements of Operations for the Three Months and
Six Months Ended June 30, 2002 and 2001 (unaudited)............... 5
Statement of Shareholders' Equity for the Six Months
Ended June 30, 2002 (unaudited)................................... 6
Statements of Cash Flows for the Six Months Ended
June 30, 2002 and 2001 (unaudited)................................ 7
Notes to the Financial Statements (unaudited)..................... 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................. 17
Item 3. Quantitative and Qualitative Disclosures about Market Risk....... 21
Part II. Other Information
Item 1. Legal Proceedings................................................ 23
Item 2. Changes in Securities and Use of Proceeds........................ 23
Item 3. Defaults Upon Senior Securities.................................. 23
Item 4. Submission of Matters to a Vote of Security Holders.............. 23
Item 5. Other Information................................................ 23
Item 6. Exhibits and Reports on Form 8-K................................. 23
(a) Exhibits..................................................... 24
(b) Reports on Form 8-K.......................................... 24
Signatures....................................................... 24
2
Part I. Financial Information
Item 1. Financial Statements
Attached are the following financial statements of Primecore Mortgage
Trust, Inc. (the "Company"):
(1) Balance Sheets as of June 30, 2002 (unaudited), and December 31, 2001
(2) Statements of Operations for the Three Months and Six Months ended
June 30, 2002 and 2001 (unaudited)
(3) Statement of Shareholders' Equity for the Six Months ended June 30,
2002 (unaudited)
(4) Statements of Cash Flows for the Six Months ended June 30, 2002 and
2001 (unaudited)
(5) Notes to Financial Statements (unaudited)
The financial statements referred to above should be read in
conjunction with the Company's audited financial statements for the year ended
December 31, 2001 as filed with the Securities and Exchange Commission in our
Annual Report on Form 10-K filed on March 30, 2002.
3
PRIMECORE MORTGAGE TRUST, INC.
BALANCE SHEETS
As of June 30, 2002 (unaudited) and December 31, 2001
December 31, 2001
June 30, 2002 (as restated)
--------------------- --------------------
ASSETS:
Investments in real estate under development............................ $ 114,474,090 $ 131,759,510
Investments in real estate under development by affiliates.............. 33,600,333 30,769,822
Investments in real estate held for sale................................ 25,688,419 18,952,063
Cash and cash equivalents............................................... 1,325,311 2,706,204
Other assets, net....................................................... 146,324 408,905
--------------------- --------------------
Total assets.................................................... $ 175,234,477 $ 184,596,504
===================== ====================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Notes payable........................................................... $ 13,404,419 $ 17,312,526
Secured line of credit.................................................. 14,999,975 15,000,000
Accrued expenses and other.............................................. 200,147 1,232,022
Preferred stock dividends payable....................................... 1,948,559 1,903,928
Payable to affiliate.................................................... 114,748 31,193
--------------------- --------------------
Total liabilities............................................... 30,667,848 35,479,669
--------------------- --------------------
SHAREHOLDERS' EQUITY:
Preferred stock: par value $0.01, 40,000,000 shares authorized;
22,213,574 and 21,633,864 shares issued and outstanding at
June 30,2002, and December 31, 2001, respectively; entitled to $10
per share in liquidation before any distributions to common.......... 221,955,068 216,157,968
Common stock: par value $0.01, 10,000,000 shares authorized; 100
shares issued and outstanding at June 30, 2002, and December 31,
2001, respectively................................................... 1 1
Retained deficit........................................................ (77,388,440) (67,041,134)
--------------------- --------------------
Total shareholders' equity...................................... 144,566,629 149,116,835
--------------------- --------------------
Total liabilities and shareholders' equity...................... $ 175,234,477 184,596,504
===================== ====================
The accompanying notes are an integral part of these statements.
4
PRIMECORE MORTGAGE TRUST, INC.
STATEMENTS OF OPERATIONS
For the three months ended June 30, 2002 and 2001 and
For the six months ended June 30, 2002 and 2001
(unaudited)
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 2002 June 30, 2001 June 30, 2002 June 30, 2001
----------------- ----------------- ----------------- ------------------
REVENUES:
Income from completed real estate development
(including $500,000, $1,100,000, $0 and $0
from affiliates for the three and six months
ended June 30, 2002 and 2001 respectively)........ $ 6,182,996 $ 2,742,380 $ 7,838,526 $ 6,721,176
Other ............................................. 61,957 -- 61,957 81
----------------- ----------------- ----------------- ------------------
Total revenues............................... 6,244,953 2,742,380 7,900,483 6,721,257
----------------- ----------------- ----------------- ------------------
EXPENSES:
Management fees paid to an affiliate................. 2,450,403 2,989,063 5,108,555 6,111,217
Provision for impairment of investments in real
estate............................................ 1,327,534 -- 1,473,316 --
General, administrative and other.................... 62,852 225,053 168,357 269,711
----------------- ----------------- ----------------- ------------------
Total expenses............................... 3,840,789 3,214,116 6,750,228 6,380,928
----------------- ----------------- ----------------- ------------------
Net income (loss)............................ 2,404,164 (471,736) 1,150,255 340,329
Preferred stock dividends.................... (5,763,743) (6,126,847) (11,497,561) (12,078,306)
----------------- ----------------- ----------------- ------------------
Net loss allocable to common................. $(3,359,579) $ (6,598,583) $(10,347,306) $(11,737,977)
================= ================= ================= ==================
Basic and diluted net loss per common share.......... $ (33,596) $ (65,986) $ (103,473) $ (117,380)
================= ================= ================= =================
Basic and diluted weighted-average shares outstanding. 100 100 100 100
================= ================= ================= =================
The accompanying notes are an integral part of these statements.
5
PRIMECORE MORTGAGE TRUST, INC.
STATEMENT OF SHAREHOLDERS' EQUITY
For the six months ended June 30, 2002
(unaudited)
Retained
Preferred Stock Common Stock Deficit Total
--------------- ------------ -------- -----
Shares Amount Shares Amount
------ ------ ------ ------
Shareholders' equity at
December 31, 2001 (as restated)... 21,633,864 $216,157,968 100 $ 1 $(67,041,134) $149,116,835
Issuance of preferred stock.......... 940,148 9,401,480 -- -- -- 9,401,480
Issuance of preferred stock under
dividend reinvestment plan........ 206,644 2,066,440 -- -- -- 2,066,440
Redemption of preferred stock........ (567,082) (5,670,820) -- -- -- (5,670,820)
Dividends to preferred
shareholders...................... -- -- -- -- (11,497,561) (11,497,561)
Net income........................... -- -- -- 1,150,255 1,150,255
----------------------------------------------------------------------------------
Shareholders' equity at
June 30, 2002..................... 22,213,574 $221,955,068 100 $ 1 $(77,388,440) $144,566,629
==================================================================================
The accompanying notes are an integral part of these statements.
6
PRIMECORE MORTGAGE TRUST, INC.
STATEMENTS OF CASH FLOWS
For the six months ended June 30, 2002 and 2001
(unaudited)
Six Months Six Months
Ended Ended
June 30,2002 June 30,2001
-------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ............................................................ $ 1,150,255 $ 340,329
Adjustments to reconcile net income to net cash (used in) provided by
operations;
Provision for impairment of investments in real estate............ 1,473,316 --
(Decrease) increase in accrued expenses and other................. (1,031,875) (2,801,801)
Increase (decrease) in payable to affiliate...................... 83,555 864,414
Increase (decrease) in other assets, net.......................... 262,581 84,604
------------------------------------------
Net cash provided by (used in) operating activities.......... 1,937,832 (1,512.454)
------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments in real estate under development...................... (22,603,744) (36,955,548)
Investments in real estate under development by affiliates........ (6,998,121) (4,906,156)
Repayment of investments in real estate under development......... 31,679,492 41,380,855
Repayment of investments in real estate under development by
affiliates...................................................... 4,167,610 7,160,352
------------------------------------------
Net cash provided by investing activities.................... 6,245,237 6,679,503
------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sales of preferred stock, net of offering costs..... 9,401,480 18,689,627
Redemptions of preferred stock.................................... (5,670,820) (5,793,780)
Issuance of notes payable......................................... 877,000 16,335,900
Repayment of notes payable........................................ (5,061,626) (28,682,194)
Additions to notes payable from reinvested interest............... 276,519 500,489
(Repayments) borrowings on secured line of credit, net............ (25) 2,290,362
Payments of preferred stock dividends............................. (9,386,490) (8,484,053)
------------------------------------------
Net cash used in financing activities........................... (9,563,962) (5,143,649)
------------------------------------------
Net increase (decrease) in cash and cash equivalents............ (1,380,893) 23,400
Beginning cash and cash equivalents............................. 2,706,204 --
------------------------------------------
Ending cash and cash equivalents................................ $ 1,325,311 $ 23,400
==========================================
Cash paid for interest, net of amounts capitalized of $1,359,872 and
$2,608,296, for the six months ended June 30, 2002, and 2001,
respectively $ -- $ --
==========================================
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING
ACTIVITIES:
Reinvested Preferred Stock dividends $ 2,066,440 $ 3,438,760
The accompanying notes are an integral part of these statements.
7
1. ORGANIZATION AND BUSINESS:
Organization
Primecore Mortgage Trust, Inc., a Maryland corporation, was formed on March 18,
1999 (date of inception) and commenced operations effective May 1, 1999 as a
real estate investment trust (REIT). We are engaged in the business of funding
and holding short-term construction mortgage loans secured by residential real
property, as well as land acquisition and development loans secured by
undeveloped real property, located in the greater San Francisco Bay Area. We are
managed by Primecore Funding Group, Inc., an affiliated California corporation
located in Menlo Park, California. Our manager, or another affiliate, Primecore
Properties, Inc., originates and services the construction mortgage loans we
invest in for a monthly management fee.
Capitalization
We have authorized 50,000,000 shares of capital stock with a $0.01 par value;
40,000,000 shares are designated Class A Convertible Preferred (Preferred
Stock), and 10,000,000 shares are designated as common.
At June 30, 2002, there were 100 shares of common stock outstanding, all held by
William Whitlow, Susan Fox and Michael Rider, who are employees and officers of
our manager. Ms. Fox owns all of the stock of our manager.
The 22,213,574 and 21,633,864 shares of Preferred Stock outstanding as of June
30, 2002 and December 31, 2001, respectively, rank senior to our common stock as
to dividends and liquidation rights. The shares are convertible into, and have
voting rights equal to, the same number of shares of our common stock. We will
not pay any dividends to the holders of the common stock so long as any
Preferred Stock is outstanding.
Preferred Stock dividends are paid monthly in arrears and were $0.26 and $0.53
per share (based on weighted average preferred shares outstanding of 21,957,815
and 21,900,831) for the three and six months ended June 30, 2002, compared with
$0.29 and $0.58 per share (based on weighted average preferred shares
outstanding of 21,304,353 and 21,003,265) for the three and six months ended
June 30, 2001. The terms of our dividend reinvestment plan permit our
shareholders to reinvest dividends in additional shares of Preferred Stock,
currently at $10 per share.
Holders of our Preferred Stock do not have a right to redeem their shares. Our
Board of Directors has adopted a stock redemption policy for Preferred Stock
shareholders who wish to sell their shares to us. The policy may be modified or
terminated at the Board's discretion at any time. Redemption of shares, at a
price determined by the Board of Directors, occurs only when we have cash
available for distribution. Cash available for distribution is determined at the
Board of Director's sole discretion, and is net of current expenses, anticipated
expenses, dividends, debt obligations and reserves for operating funds. We will
not sell or otherwise liquidate any portion of our mortgage loan portfolio or
other assets to fund a Preferred Stock redemption request. We also reserve the
right to limit the number and frequency of stock redemptions by any shareholder.
We sell our stock through private placement and have closed four private
placements since our inception, issuing 25,386,912 shares at $10.00 per share.
Under our current private placement, which opened on April 15, 2002 for
20,000,000 shares of Preferred Stock, we have issued 459,631 shares at $10 per
share as of June 30, 2002. We use the proceeds from issuance of our Preferred
Stock primarily to fund additional loans and also for working capital purposes.
Risk Factors
General Economic Conditions in Lending Areas. Properties securing repayment of
the mortgage loans are located in the San Francisco Bay Area, with the majority
in the counties of Santa Clara and San Mateo. Since the properties secured by
the mortgage loans are located in a limited geographical region, these mortgage
loans may be subject to a greater risk of delinquency or default if the
industries concentrated there suffer adverse economic or business developments.
8
Other. In addition, we are subject to other significant business and financial
risks, including but not limited to liquidity, the prevailing market for
residential real estate, interest rates, dependence on our manager, timely
completion of projects, lack of borrower diversification, and potential
environmental matters relating to properties on which we have made loans. For
additional information see Risk Factors set forth in our Form 10-K dated March
30, 2002.
Retained Deficit
We had a retained deficit as of June 30, 2002 and December 31, 2001 primarily
because we pay dividends to the holders of our Preferred Stock based on our
taxable income in accordance with REIT requirements. Our taxable income differs
from income measured in accordance with generally accepted accounting principles
in the United States due to timing differences in the recognition of income from
our investments in real estate. Refer to Income Taxes in Note 2 below. These
dividend distributions are expected to be matched by revenues from completed
real estate projects in future periods, as described in Note 2 and 3.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Restatement of Previously Reported Financial Condition
The balances presented at December 31, 2001 have been restated to correct the
accounting of an affiliate loan. The loan should have been determined to have
been impaired in November 1999 when the obligor defaulted under the terms of the
loan and the expected estimated future cash flows of the underlying collateral
were less than the then carrying value of the investment. Subsequently, on or
about March 2000, in order to protect the shareholders from loss of capital as a
result of the impairment, Primecore Funding Group, Inc., our affiliate, provided
a guaranty of repayment. Prior filings did not present the impairment. However,
we have now determined that because the guaranty was provided subsequent to the
determination of impairment, in accordance with our accounting policy on
impairments, the loan should have been written down by the amount of the
impairment when the determination was made. Payments made under the guaranty
will be treated as contributions of capital.
The following schedule sets forth the restated amounts:
As previously Amount of
December 31, 2001 reported change As Restated
----------------- ---------------- ----------------
Investments in real estate
under development by affiliates $ 40,237,961 $ (9,468,139) $ 30,769,822
Total assets 194,064,643 (9,468,139) 184,596,504
Retained Deficit (57,572,995) (9,468,139) (67,041,134)
Total liabilities and shareholders'
equity $194,064,643 $ (9,468,139) $184,596,504
As a result of this restatement we will file an amended Form 10-K for the year
ended December 31, 2001 and an amended form 10-Q for the three months ended
March 31, 2002.
Basis of Presentation
The accompanying unaudited financial statements present the financial position
of the Company as of June 30, 2002, and December 31, 2001, as restated, and the
results of operations and cash flows of the Company for the three months and six
months ended June 30, 2002 and 2001. In the opinion of management, the
accompanying unaudited financial statements contain all adjustments (consisting
of only normal accruals) necessary to present fairly the financial position and
results of operations of the Company as of June 30, 2002 and 2001 and for the
periods then ended.
9
Use of Estimates
These financial statements have been prepared in accordance with accounting
principles generally accepted in the United States using the accrual method of
accounting. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States 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. Actual results could differ from those
estimates.
Investments in Real Estate under Development
and Investments in Real Estate under Development by Affiliates
All of our loans are initially classified for financial reporting purposes as
investments in real estate under development or investments in real estate under
development by affiliates (Notes 3 and 4). Such investments include capitalized
interest and are stated at the lower of cost or net realizable value. Management
conducts a review for impairment on an investment-by-investment basis whenever
events or changes in circumstances indicate that the carrying amount of an
investment may not be recoverable. An impairment is recognized when estimated
expected future cash flows (undiscounted and without interest charges),
typically from the sale of a completed property, are less than the carrying
amount of the investment, which does not include accrued interest and points.
The estimation of expected future net cash flows is inherently uncertain and
relies to a considerable extent on assumptions regarding current and future
economic and market conditions. If, in future periods, there are changes in the
estimates or assumptions incorporated into the impairment review analysis, the
changes could result in an adjustment to the carrying amount of the investments.
To the extent an impairment has occurred, the excess of the carrying amount of
the investment over its estimated fair value, less estimated selling costs, will
be charged to income.
Investments in Real Estate Held for Sale
We may take title to property through foreclosure or by deed in lieu of
foreclosure when a borrower defaults on our loan. Such arrangements are
accounted for in a manner similar to our investments in real estate under
development and real estate under development by affiliates. Interest income for
tax purposes is not accrued on investments in real estate held for sale.
Cash and Cash Equivalents
Cash and cash equivalents include cash held in financial institutions and other
highly liquid short-term investments with original maturities of three months or
less.
Income from Completed Real Estate Development
Our investment objective is to make construction mortgage loans on projects we
believe are likely to ultimately sell for an amount sufficient to repay the
principal plus interest and points on those loans at the contracted rate. We do
not intend to own or develop property and do not participate in the profit
realized by the borrower, including affiliated borrowers, upon sale of the
property.
We recognize income from our investments in real estate under development upon
the sale or refinancing of the completed real estate to or by a third party. No
interest income or points are recognized until the property is sold or
refinanced. We compute income as cash received (which includes amounts funded,
accrued interest and points) less the carrying value of the investments at the
date of repayment (which includes amounts funded and capitalized interest
costs).
Income Taxes
To continue to qualify as a REIT, we must distribute at least 90 percent of our
taxable income each year. As a REIT, we generally will not be subject to
corporate-level federal income tax on net income we distribute to our
shareholders. As such, no provision for federal income taxes is included in our
financial statements. Such taxes are the responsibility of the individual
Preferred Stock shareholders. If we fail to qualify as a REIT in any taxable
year, we will be subject to federal income taxes at regular corporate rates
(including any applicable alternative minimum tax) and may not be able to
10
qualify as a REIT for four subsequent taxable years. Even if we qualify for
taxation as a REIT, we may be subject to certain state and local taxes on our
income and property and to federal income and excise taxes on our undistributed
taxable income.
Our taxable income for the six months ended June 30, 2002 and 2001 is computed
as follows:
Six Months Six Months
Ended Ended
June 30, 2002 June 30, 2001
------------------------------------------
Revenues - Interest income $ 17,181,033 $ 20,504,661
Operating expenses (6,496,510) (9,000,984)
Loan losses (912,935) --
------------------------------------------
Income before dividends 9,771,588 11,503,677
Dividend expense (11,497,561) (12,078,306)
------------------------------------------
Taxable loss...................... $ (1,725,973) $ (574,629)
==========================================
Our taxable income differs from income measured in accordance with generally
accepted accounting principles in the United States due to timing differences in
the recognition of income from our investments in real estate. We distribute
Preferred Stock dividends at a level sufficient to satisfy specified return
targets for our investors. As a result, actual dividends may be in excess of
taxable income during some periods. Rates of return are subject to adjustment by
our Board of Directors based upon prevailing market and company specific
conditions. Timely payment of Preferred Stock dividends could be adversely
effected if we experience a slow down in the repayment of our loans. Dividends
could be significantly reduced upon determination of a decline in the value of
our loan portfolio or to adjust for expected loan losses.
Net Loss Per Share of Common Stock
Per share amounts for our common stock are computed using the weighted average
common shares outstanding during the period. Net loss used in the calculation is
increased by declared dividends owed to preferred shareholders. The diluted
weighted average common shares outstanding include the dilutive effect of stock
options and other common stock equivalents. There are currently no stock options
or other dilutive common stock equivalents, and as a result, the basic and
diluted weighted average common shares outstanding for the three and six months
ended June 30, 2002 and 2001, are the same and are 100 shares.
New Accounting Pronouncement
In August 2001, the Financial Accounting Standards Board (FASB) issued SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which is
effective for fiscal years beginning after December 15, 2001. SFAS No. 144
addresses financial accounting and reporting for the impairment or disposal of
long-lived assets and supersedes SFAS No. 121,"Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets To Be Disposed Of" among other
existing authoritative literature. We are required to and have adopted SFAS No.
144 in the first quarter of fiscal 2002, which did not have a significant effect
on our financial position, results of operations and cash flows in the current
period.
3. INVESTMENTS IN REAL ESTATE UNDER DEVELOPMENT:
We make loans with maturity dates generally ranging from 12 to 18 months. The
term of a loan may be extended, when management deems it appropriate to do so.
For financial reporting purposes, we account for our loans as investments.
Investments in real estate under development represent funds advanced in cash
plus capitalized interest on arrangements in effect at any particular time.
Since real estate under development generates no operating income, we do not
accrue any income for financial reporting purposes until the sale or refinancing
of a property. The income that we ultimately realize is based upon the terms of
the construction mortgage loan. During the six months ended June 30, 2002, fixed
11
interest rates on loans outstanding ranged from 11 percent to 13 percent. In the
case of loans on which the borrower defaulted, the interest rate charged during
the period of default was an additional 5 percent over the note rate. In
addition, we charged points, which were typically 4 percent of the borrowed
amount during the six months ended June 30, 2002.
The following table summarizes our portfolio of investments in real estate under
development at June 30, 2002:
Maturity Commitment Carrying
Location - County Dates Amount Amount
- -------------------------- ------------- --------------- ---------------
Alameda 12/02-04/03 $ 6,894,000 $ 1,678,734
Contra Costa 08/02-08/02 5,610,000 943,527
Marin 06/01-09/03 34,940,000 19,539,614
Monterey 05/02-12/03 24,475,000 10,673,493
Napa 08/02-08/02 4,750,000 2,740,079
San Francisco 03/02-12/02 27,885,000 16,722,978
San Mateo 03/02-02/03 57,611,140 34,612,075
Santa Clara 09/01-05/03 49,865,000 22,533,711
Santa Cruz 06/01-06/01 6,750,000 5,029,879
--------------- ---------------
$218,780,140 $114,474,090
=============== ===============
Earned but unrecognized interest and points on loans outstanding at June 30,
2002 totaled $43,164,764 compared with $39,667,545 at December 31, 2001. To the
extent that there are sufficient proceeds, these amounts will be recognized as
income from completed real estate development upon the sale or refinancing of
the underlying property. During the three and six months ended June 30, 2002, we
capitalized $560,068 and $1,111,017 of interest expense from our secured line of
credit and our unsecured notes payable to investments in real estate under
development.
We will fund unfunded commitments on existing loans from the repayment of other
loans, borrowings on our line of credit (Note 7), issuance of short-term notes
payable or issuance of additional preferred stock. We believe we will have
adequate sources of capital to fund these commitments when and as they become
due.
As of June 30, 2002, we had loans with a carrying amount of $18,602,682, which
had not been paid by their stated maturity dates and which we do not intend to
extend compared with $19,218,517 at December 31, 2001. These loans are accruing
interest at the default rate, which is 500 basis points above the note rate.
Additionally, at June 30, 2002, we had recorded notices of default on loans with
a carrying amount of $24,757,789 compared with $14,293,382 at December 31, 2001.
Recording a notice of default begins the process of foreclosure. In many cases
we expect the borrower will have sufficient time to either sell or refinance the
property before the foreclosure period expires. All loans for which a notice of
default has been recorded are charged interest at the default rate which
interest will be collected upon repayment of the loan assuming there are
sufficient proceeds.
During the three and six months ended June 30, 2002, we charged $1,327,534 and
$1,473,316, respectively to income for investments we believe are impaired
compared with none during the three and six months ended June 30, 2001.
4. INVESTMENTS IN REAL ESTATE UNDER DEVELOPMENT BY AFFILIATES:
We have also made loans to affiliates of our manager acting as the developer.
These arrangements are accounted for in a manner identical to that described in
Note 3 above.
12
The following table summarizes our portfolio of investments in real estate under
development by affiliates at June 30, 2002:
Maturity Commitment Carrying
Location - County Dates Amount Amount
- ----------------------------------------- -------------------- -----------------
San Mateo 01/03-04/03 $ 14,200,000 $ 9,740,259
Santa Clara 12/01-03/03 56,125,000 23,860,074
-------------------- -----------------
$ 70,325,000 $ 33,600,333
==================== =================
Earned but unrecognized interest and points on loans outstanding at June 30,
2002 totaled $12,299,730 compared with $10,942,275 at December 31, 2001. To the
extent that there are sufficient proceeds these amounts will be recognized as
income from completed real estate development upon the sale or refinancing of
the underlying property. During the three and six months ended June 30, 2002, we
capitalized $80,718 and $221,081 of interest expense from our secured line of
credit and our unsecured notes payable to investments in real estate under
development by affiliates.
5. INVESTMENT IN REAL ESTATE HELD FOR SALE:
As of June 30, 2002, we held title to twelve properties received through
foreclosure or by deed in lieu of foreclosure. The following table summarizes
investments in real estate held for sale at June 30, 2002:
Commitment Carrying
County Number Amount Amount
- ----------------------------------------- -------------------- -----------------
Alameda 2 $ 14,365,000 $ 4,999,820
Marin 3 9,075,000 7,705,210
San Mateo 2 3,375,000 2,957,830
Santa Clara 5 13,040,000 10,025,559
------------- -------------------- -----------------
Total 12 $ 39,855,000 $ 25,688,419
==================== =================
We report these properties at their existing carrying amount and are in various
stages of construction. They will be sold in the manner which we believe
maximizes their value to us. During the three and six months ended June 30,
2002, we capitalized $92,810 and $178,739 of interest expense to investments in
real estate held for sale.
6. NOTES PAYABLE:
We had unsecured borrowings of $13,404,419 at June 30, 2002 compared with
$17,312,526 at December 31, 2001 on notes issued to accredited investors through
private placements. These notes have varying maturities of up to two years from
the date of issuance and bear interest at fixed rates between 9 and 12.5 percent
with interest payable monthly in arrears. We may repay these notes, without
penalty, at our option before their stated maturity. As of June 30, 2002, we
estimate that the carrying amounts of our notes payable approximate their fair
value based on current borrowing rates available to us.
13
The following table summarizes the maturities of our notes payable at June 30,
2002:
Year Amount
------------------------------ -----------------
2002 $8,425,521
2003 4,608,898
2004 370,000
-----------------
Total $ 13,404,419
=================
7. LINE OF CREDIT:
We have a $15,000,000 line of credit with a commercial bank. The amount borrowed
under the line of credit at June 30, 2002, was $14,999,975, compared with
$15,000,000 at December 31, 2001. The line of credit is collateralized by our
assets and guaranteed by our manager and another affiliate, carries interest at
prime plus 1.50 percent (6.25 percent at June 30, 2002) and matures in May 2003.
In order for us to request advances on our line of credit, the terms of the line
of credit require, among other provisions, that we maintain total equity of no
less than $150,000,000, a debt to equity ratio of less than 1.5 to 1.0 and
quarterly taxable income from operations of at least $500,000. Since our total
equity at June 30, 2002 was less than $150 million, we will be unable to request
additional advances until we either obtain a waiver of the requirement or
increase our equity to at least $150 million. We incurred loan fees and other
costs of $235,169 in connection with this loan, which are included in other
assets in the accompanying balance sheets and are being amortized on the
effective interest method over the life of the facility. Accumulated
amortization of loan fees amounted to $104,965 at June 30, 2002.
8. TRANSACTIONS WITH AFFILIATES:
Management Fees
A management agreement dated March 30, 1999, as amended, between us and our
manager provides for a monthly fee payable in arrears equal to 0.25 percent of
the total commitment amount of the loans in our investments in real estate under
development, in our investments in real estate under development by affiliates,
and in our investments in real estate held for sale. For the three and six
months ended June 30, 2002, the portfolio management fees earned by our manager
were $2,450,403 and $5,108,555 compared with $2,989,063 and $6,111,217 for the
three and six months ended June 30, 2001.
In January 2002, the Board of Directors approved an amendment to the management
agreement which clarified that the commitment amount of loans which had been
foreclosed upon by us would be included in the calculation of the management
fee. The clarification was retroactive and all previously uncharged fees
totalling $160,728 were then charged in February 2002.
Payable to Affiliate
The $114,748 and $31,193 payable to affiliate at June 30, 2002 and December 31,
2001, respectively, represents short-term advances to us by our manager to
facilitate our cash management.
Affiliate Loans
Loans assumed by, or made to, our affiliates represent a material portion of our
investment portfolio. As of June 30, 2002, loans assumed by or made to our
affiliates represented 21% of our loan commitments and 19% of the carrying
amount of those commitments compared with 21% of loan commitments and 17% of the
carrying amount as of December 31, 2001, as restated.
Our affiliates are entities with whom we share common control through
common management. For example, Primecore Funding Group, Inc. is our affiliate
because Susan Fox owns 100% of its stock and is its sole director. She is also
an executive officer of Primecore Funding Group, Inc., as are William Whitlow
14
and Michael Rider. To the extent that Ms. Fox is the director of Primecore
Funding Group, Inc. and is one of our directors, her position in management is
common to both Primecore Funding Group, Inc. and us. Primecore Funding Group,
Inc. is a licensed California real estate broker.
Eprime, Inc. is our affiliate and is a California corporation, incorporated
in 2000. Ms. Fox is the sole shareholder and director. She is the president and
secretary, and Mr. Rider is the chief financial officer. Eprime, Inc. does not
have any employees, does not provide any services to us and does not receive any
compensation from us.
Primecore Properties, Inc. is our affiliate and is a California
corporation, incorporated in 1997. Ms. Fox is its sole shareholder and one of
its directors. Primecore Properties, Inc. is licensed by the California
Department of Real Estate as a real estate corporation. Theresa May Couture is
licensed as an individual real estate broker and is the designated
broker-officer of Primecore Properties, Inc. Primecore Properties, Inc. does not
receive any compensation from us, but does provide services to us for certain
activities that require a California real estate broker license. Those services
are performed for us under the terms of our management agreement with Primecore
Funding Group, Inc. There are currently no arrangements for us to separately
compensate Primecore Properties, Inc. for those services.
99 Investors, LLC, a California Limited Liability Company, is our
affiliate. Ms. Fox is its sole member. It does not have any employees, does not
perform any services for us and does not receive any compensation or benefits
from us.
99 El Camino Partners LLC is our affiliate and a California limited liability
company. Ms. Fox is the sole member. The partnership has no employees, does not
provide any services to us and does not receive any compensation or benefits
from us. 99 El Camino Partners owns the property at 99 El Camino Real, Menlo
Park, California, our principal place of business and that of our affiliates.
The following is a summary of loans assumed by our affiliates as of June 30,
2002, categorized by loan number, project name, affiliate, commitment amount and
carrying amount.
Carrying
Loan Project Name Commitment Amount
- ------------------------------------------------- -------------- --------------
Primecore Funding Group, Inc.
Loan 2376 104 Second Street $ 3,825,000 $ 72,541
Loan 2447 Affiliate properties 13,500,000 --
Loan 2512 Affiliate properties 7,000,000 733,159
-------------- --------------
Total Primecore
Funding Group, Inc. loans $ 24,325,000 $ 805,700
============== ==============
99 Investors, LLC
Loan 2330 Scotia Pines Subdivision $ 4,000,000 $ --
Loan 2404 7 Lots, Los Altos Nursery 12,800,000 12,482,825
Loan 2427 Quarry Estates - Lot 13 5,000,000 3,596,709
Loan 2428 Quarry Estates - Lot 15 5,000,000 3,812,576
Loan 2429 Quarry Estates - Lot 16 5,000,000 3,162,264
Loan 2455 91 Fleur Place 7,100,000 4,929,171
Loan 2469 37 Euclid 7,100,000 4,811,088
-------------- --------------
Total 99 Investors $ 46,000,000 $ 32,794,633
============== ==============
The loans due from Primecore Funding Group were originally assumed by Eprime,
Inc., and are secured by the remaining properties in a series of projects where
Windy Hill Associates, a California corporation, was the original borrower. In
15
November 1999, James Ward, the sole shareholder of Windy Hill Associates, and
Windy Hill Associates defaulted on the obligations under a series of agreements
and started proceedings to dissolve the corporation. Before the dissolution,
Susan Fox was the president of Windy Hill Associates, and was managing its
operations to ensure that the loans were kept current. Upon notice of
dissolution of the corporation, Ms. Fox was replaced as president by Mr. Ward.
We declared the loans in default, and a foreclosure sale was scheduled for March
22, 2000. At the time of the Windy Hill default, which was prior to the pledge
of additional collateral by Primecore Funding Group, the expected future cash
flows from the projects collateralizing the Windy Hill loan were determined to
be insufficient to repay the entire amount of the obligation. In accordance with
our impairment policy, we have written down the balance of the loan (refer to
Note 2 - Restatement of Previously Reported Financial Condition).
Subsequently, on March 22, 2000, Eprime, Inc. purchased the Windy Hill loan with
what is currently designated as our loan no. 2447, for the then existing Windy
Hill loan balance of $11,321,061. A blanket, second deed of trust lien against
several parcels colleralizes the loan. Thereafter, Eprime, Inc. foreclosed on
the Windy Hill deed of trust and took title to all Windy Hill parcels, subject
to existing senior liens. In order to protect the shareholders of Primecore
Mortgage Trust, Inc., against any loss that might be occasioned by the
Ward/Windy Hill defaults, the Eprime, Inc. note purchase and assumption
agreement provided guarantees of repayment and the pledge of additional security
from Primecore Funding Group, Inc., 99 Investors, LLC and the Susan M. Fox 1996
Revocable Trust dated April 26, 1996.
Pursuant to the guaranty arrangement between Primecore Funding Group and
Primecore Mortgage Trust, loan 2447 will be repaid by Primecore Funding Group.
At June 30, 2002, Primecore Funding Group was in the process of formalizing a
repayment plan with terms to present to our Board of Directors. Payments made by
Primecore Funding Group in accordance with this transaction will be treated as
contributions of capital.
Loan no. 2330 was assumed in September 1999 by 99 Investors, LLC, and is secured
by a junior deed of trust on property originally to be developed by Windy Hill
Associates.
Loan no. 2404 was made to 99 Investors, LLC in September 1999. Repayment is
secured by a single junior deed of trust on 7 lots in Los Altos, California. The
loan is for development of 7 single-family residences. As of June 30, 2002, two
homes were complete and on the market for sale.
Loan nos. 2427-29 were made to 99 Investors, LLC in March 2000. Repayment is
secured by junior deeds of trust. The developments are single family residences
in Los Altos Hills. As of March 31, 2002, two of the homes were complete and on
the market. The final home is scheduled to complete in September 2002.
Loan nos. 2455 and 2469 were made to 99 Investors, LLC in April and September
2000, respectively. Repayment is collateralized by junior deeds of trust. The
developments are single family residences in Atherton, California. Construction
is scheduled for completion in October 2002 and January 2003, respectively.
Because of changes in the scope of construction and general cost increases
during development of projects, additional funds are sometimes needed to
complete a project. We will grant an additional extension of credit if our
manager believes repayment of the increased extension of credit is adequately
collateralized. This is our policy, whether the borrower is affiliated or not.
9. COMMITMENTS AND CONTINGENCIES:
Litigation
We are involved in legal actions arising in the normal course of our business.
We are not presently subject to any material litigation nor, to our knowledge,
is any litigation threatened against us which collectively is expected to have a
material adverse effect on our cash flows, financial condition or results of
operations.
16
Construction Contracts
In connection with our development of investments in real estate held for sale,
we have entered into contracts with construction companies totaling $1,538,121
to complete these projects where necessary. We will make payments on these
contracts as construction progresses in much the same manner we do for our
investments in real estate under development and investments in real under
development by affiliates.
General Uninsured Losses
We require that our borrowers carry comprehensive liability, fire, flood,
extended coverage, and rental loss insurance with policy specifications, limits,
and deductibles customarily carried for similar properties. We also carry
insurance to cover losses in case a borrower's policy lapses. Additionally, we
carry insurance on investments in real estate held for sale. There are, however,
certain types of extraordinary losses that may be either uninsurable or not
economically insurable. Further, all of our investments are located in areas
that are subject to earthquake activity, and we generally do not require our
borrowers to maintain earthquake insurance. Should an investment sustain damage
as a result of an earthquake, we may incur losses due to insurance deductibles,
co-payments on insured losses, or uninsured losses. Should an uninsured loss
occur, we could lose our investment in, and anticipated profits and cash flows
from an investment.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
General
Our material financial transactions have been purchasing and holding a portfolio
of construction loans determined to be acquisition, development and contruction
("ADC") mortgage loans. Accordingly, we classify such mortgage loans as
investments in real estate.
Statements contained in this Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operations," and elsewhere in this Form 10-Q,
which are not historical facts, may be forward-looking statements. Such
statements are subject to risks and uncertainties that could cause actual
results to differ materially from those projected. Investors are cautioned not
to attribute undue certainty to these forward-looking statements, which speak
only as of the date of this Form 10-Q. We undertake no obligation to publicly
release any revisions to these forward-looking statements to reflect events or
circumstances after the date of this Form 10-Q or to reflect the occurrence of
unanticipated events, other than as required by law.
Overview
Subject to the direction and oversight of our Board of Directors, our day-to-day
operations are managed by our manager. We have no employees.
We began operations on May 1, 1999, concurrent with the first interim closing of
a private offering of 14,575,664 shares of our Class A Convertible Preferred
Stock at $10 per share primarily in exchange for beneficial interests in trust
deeds on real property securing loans and accrued interest totaling
$145,756,640. Purchasers of our shares were primarily investors in trust deeds
managed by Primecore Funding Group, Inc., who invested in those trust deeds
before our formation and exchanged their interests for our stock at $10 per
share on a dollar for dollar basis. Since that time we have sold our Preferred
Stock through various private placements in order to raise cash to fund our
loans and for working capital purposes.
We currently have an ongoing equity private placement offering of 20,000,000
shares of Preferred Stock at $10.00 per share. This placement was undertaken to
purchase and fund additional and existing ADC loans and for working capital
purposes. The placement is presently scheduled to close on April 15, 2003,
however we anticipate extending the closing date until all shares have been
sold, at which point we may announce an additional placement.
We have elected to be taxed as a REIT under the Internal Revenue Code of 1986,
as amended (the "Code"), and as such, are required to distribute at least 90
percent of our taxable income annually, subject to adjustments. Our manager
expects that the cash for such distributions will be generated from our
day-to-day operations, although we may also borrow funds to make distributions.
17
As a REIT, we generally will not be subject to corporate-level federal income
tax on net income that we distribute to our shareholders. As such, no provision
for federal income taxes is included in our financial statements. Such taxes are
the responsibility of the individual shareholders. To maintain our
classification as a REIT, we must satisfy tests concerning the sources of our
income, the nature and type of our assets, the amount of our distributions to
shareholders, and concentration of the ownership of our stock. If we fail to
qualify as a REIT in any taxable year, we will be subject to federal income
taxes at regular corporate rates (including any applicable alternative minimum
tax) and may not be able to qualify as a REIT for four subsequent taxable years.
Even if we qualify for taxation as a REIT, we may be subject to certain state
and local taxes on our income and property and to federal income and excise
taxes on our undistributed taxable income. Regular federal and state income
taxes would be included in our statements of operations if we fail to qualify as
a REIT. We distribute preferred stock dividends at a level sufficient to satisfy
specified return targets for our investors. As a result, actual dividends may be
in excess of taxable income. Rates of return are subject to adjustment by our
Board of Directors based upon prevailing market and company specific conditions.
Timely payment of preferred stock dividends could be adversely effected if we
experience a slow down in the repayment of our loans. It is possible that
dividends could be significantly reduced if there was a decline in the value of
our loan portfolio.
We may experience high volatility in financial reporting net income from quarter
to quarter and year to year, primarily as a result of fluctuations in timing of
completion of our investments in real estate under development, interest rates,
and general economic conditions in the greater San Francisco Bay Area. Our
operating results will depend, in part, upon our ability to manage our interest
rate and credit risks while maintaining our REIT status.
Results of Operations
We recognize income only after we receive payment even though our ADC contracts
accrue interest income and loan fees ("Income") during the term of the contract.
We typically receive these payments at the end of the contract term when the
financed property has been sold or refinanced by third parties. Our repayment
transactions are typically large in amount yet relatively few in number, so our
income is subject to wide variations from period to period since the timing of
even a single loan repayment can have a material impact on our revenues. For the
three months and six months ended June 30, 2002 we recognized income of
$6,182,996 and $7,838,526 compared with $2,742,380 and $6,721,176 for the same
periods in 2001. Our income has increased over the prior year due mainly to the
increased ratio of accrued income to amounts funded in our loan contracts as a
result of an increase in the average age of our loans. As our loans age, the
amount of accrued income we are owed increases as interest accumulates on the
outstanding balance.
We pay management fees based on the amount of commitments on ADC contracts and
foreclosed properties outstanding at the end of each month. During the three
months and six months ended June 30, 2002 our management fee expense was
$2,450,403 and $5,108,555 compared with $2,989,063 and $6,111,217 for the three
and six months ended June 30, 2001. The decrease in management fee expense was
due to the decrease in the balance of commitments on ADC contracts and
foreclosed properties in 2002 over the comparable periods in 2001.
Since December 31, 1999, all interest costs have been capitalized as a cost of
our investments in real estate under development and investments in real estate
under development by affiliates. Interest cost associated with our borrowings
was $640,786 and $1,332,098 for the three and six months ended June 30, 2002,
compared with $1,155,328 and $2,433,778 for the three and six months ended June
30, 2001. The decrease is due to a combination of a lower average cost of debt,
9.08% and 9.24% in the three and six months ended June 30, 2002 compared with
11.40% and 11.51% in the three and six months ended June 30, 2001; and the lower
amount of debt on our balance sheet, an average of $27.1 million and 28.2
million in the three and six months ended June 30, 2002 compared with an average
of $39.4 million and $41.5 million in the three and six months ended June 30,
2001. We expect this trend to continue as we repay higher priced unsecured notes
and replace them with lower priced notes.
Our general administrative and other expenses consist primarily of professional
fees relating to audit and tax return preparation costs, directors' fees and
insurance costs. General administrative and other expenses were $62,852 and
$168,357 for the three and six months ended June 30, 2002, compared with
$225,053 and $269,711 for the three and six months ended June 30, 2001. The
18
decrease for the three months period is a combination of the result of legal
costs saved when our manager hired full time legal counsel to perform tasks that
had been contracted to outside counsel and the timing of audit services
performed in connection with our annual audit. The decrease for the six month
period is due to the decreased legal expenses discussed above.
Liquidity and Capital Resources
Liquidity means the need for, access to and uses of cash. Our principal demands
for liquidity are cash for operations, funds that are required to satisfy
obligations under existing loan commitments, management fees, interest expense
associated with our indebtedness, debt repayments, dividend distributions to
shareholders and redemptions to shareholders. In the near term, our principal
sources of liquidity are the repayments of our real estate investments, funds
received from issuance of unsecured notes payable, our line of credit and sales
of preferred stock.
Sources of cash
Our largest source of liquidity is the repayment of our investments in real
estate. As of June 30, 2002, we had $246 million, including accrued income,
invested in real estate construction projects. Although our loans provide for
specific maturity dates, in most cases we must rely on the sale of the project
before we can collect the amount owed. Repayment is, therefore, largely
dependent on the health of the real estate market. We track sales activity in
the markets where we lend in order to identify trends and help us make
forecasting decisions. In doing so, we have identified three price sectors with
differing characteristics in the markets where we lend: $2 million and under; $2
million to $5 million and over $5 million.
The market for homes under $2 million remained fairly strong throughout 2001 and
the first and second quarter of 2002 with average prices actually increasing
over 2000 levels. Although the average number of units sold in this sector
decreased in 2001 compared with 2000, average unit sales increased in the first
and second quarter of 2002, when compared with average 2001 levels. Average
prices reached all time highs in the second quarter 2002 with prices 10% above
prior year amounts. This market sector represented the expected per unit selling
price of approximately 27% of our investments at June 30, 2002.
The middle sector, between $2 million and $5 million, weakened in 2001 and the
first six months of 2002 compared with 2000. Average days on the market
increased from an average of 89 days in 2000 to 112 in 2001 and 141 in the first
six months of 2002. The number of units sold stabilized in the first six months
of 2002 when compared with 2001, to 164 units sold per quarter compared with an
average of 157 units sold per quarter in 2001. But these amounts are about 40%
below the average 2000 quarterly sales of 269 units. Prices have also fallen
steadily from their 2000 highs. The average price of homes sold in this sector
in 2001 was 2% lower than the average sale price in 2000 and the second quarter
2002 average was 8% below the 2000 high. Approximately 27% of the properties in
our loan portfolio were expected to sell at prices in this middle sector at June
30, 2002.
The third sector, with prices above $5 million has softened the most compared
with the highs recorded in 2000. The first and second quarter of 2002 continued
the 2001 trend of long marketing periods (average days on the market of 154 days
in the second quarter 2002), and lower number of sales with lower prices. In the
second quarter of 2002 the number of units sold in this sector decreased 35%
from the same period in 2001 and 76% from the high in 2000. Average prices
decreased 2% from the previous year and 23% from year 2000 highs. We believe
that this market will remain slow and that prices will continue to remain soft
while the technology industry struggles through the current economic climate.
The decline in the technology stock prices has added to the difficulties of this
sector since purchasers of these homes tend to be technology company executives
who receive a large portion of their compensation from company stock options. At
June 30, 2002 approximately 46% of the investments in our loan portfolio were
expected to sell in this sector.
The longer selling periods for those properties we have financed means that our
cash inflows will likely be lower than previous periods when homes were selling
at a faster rate. In the six months ended June 30, 2002 our loan repayments were
$36 million compared with $49 million in the first six months of 2001. Further,
at June 30, 2002 we had approximately $43 million (including interest and
points) due from loans where the property was complete and on the market for
sale. Of these properties approximately $30 million were expected to sell at
prices above $2 million. In addition to the properties currently on the market,
we expect $62 million of additional product to complete construction before the
end of the calendar year. We have factored the current market conditions into
our impairment analyses and believe that our investments are fairly stated at
June 30, 2002.
19
In addition to loan repayments, our liquidity is enhanced through sales of our
Preferred Stock and issuance of notes payable to investors. Our Preferred Stock
is sold through private placement, which is continuous and ongoing. For the six
months ended June 30, 2002, we sold 940,148 shares of Preferred Stock for
proceeds of $9,401,480 compared with 1,869,171 shares for proceeds of
$18,689,627 for the six months ended June 30, 2001. Of the stock sold in 2001,
approximately 700,000 shares for proceeds of approximately $7 million were sold
in exchange for short term unsecured notes previously held by investors. After
taking into account the exchange of short term unsecured notes for stock, our
Preferred Stock sales decreased approximately 20% from prior period amounts. We
believe that the decrease in stock sales was due mainly to the slowdown in the
US economy in general and the technology sector in particular, where a lot of
our clients have made their money. We expect Preferred Stock sales to remain at
current levels or even decrease somewhat until the economy and the stock markets
improve.
We continue to issue notes payable on a limited basis, however they are not a
primary source of our liquidity. During the six months ended June 30, 2002, we
issued $877,000 in notes compared with $16,335,900 for the six months ended June
30, 2001. Our current plan is to maintain our existing notes payable balances at
levels approximating the current level, both through extension of existing notes
and issuance of new notes to replace maturities.
Uses of Cash
The following table sets forth the timing and amount of our obligations through
December 2003:
Remainder
Obligation Total of 2002 2003
-------------------------- -------------- --------------- ---------------
Investment fundings $ 49,200,319 $ 20,000,000 $ 29,200,319
Line of credit 15,000,000 -- 15,000,000
Short term notes payable 13,404,419 8,425,522 4,978,897
Dividend payments 30,000,000 10,000,000 20,000,000
-------------- --------------- ---------------
Total $107,604,738 $ 38,425,522 $ 69,179,216
============== =============== ===============
Investment fundings are our largest use of our cash. At January 1, 2002 we had
an unfunded loan commitment obligation of approximately $45 million. We funded
approximately $29 million of that amount in the first six months of 2002. The
exact timing of the remaining amount of investment fundings is dependent on
several factors including weather, governmental regulation and developer related
issues, so the timing of investment fundings in the above table is an estimate
based on information available to us at this time.
Our line of credit was extended in December 2001 to May 2003. We expect to
gradually decrease the outstanding balance of the line to provide us with more
liquidity and more flexibility in financing our contractual commitments.
Although our ability to make additional requests for advances on our line of
credit has been suspended until our equity exceeds $150 million, we had already
drawn the maximum amount available on the line as of June 30, 2002. We intend to
discuss the matter with our lender and will attempt to obtain a waiver of the
requirement or negotiate an acceptable alternative.
As stated above, our plan is to maintain our existing notes payable balances
approximating their current levels both through extension of existing notes and
issuance of new notes to replace maturities of existing notes. In the six months
ended June 30, of 2002 we paid $5,061,626 and issued $877,000 in new notes. We
continue to offer notes to investors, but at a greatly reduced level. We believe
that the market for notes will continue to exist at a price which provides a
benefit to our shareholders by providing capital at reasonable rates.
Although dividend payments are not contractual obligations, we have included
their impact on our liquidity since they are a fundamental component of our
business. In order to maintain our REIT status, we must distribute dividends
equal to at least 90% of our taxable income. Failure to meet the dividend
distribution requirements would jeopardize our REIT status and could
substantially reduce the rate of return we pay to our shareholders.
20
In addition to the obligations noted above, we expect to pay management fees to
our manager as described under Results of Operations, and make periodic payments
of interest on our short term notes payable based upon balances outstanding.
Through June 30, 2002 we have continued to redeem Preferred Stock in accordance
with our redemption policy although the slowing loan repayments have had a
direct impact on the amount of cash available for redemption. In the six months
ended June 30, 2002 we paid $5,670,820 to preferred stockholders representing
567,082 shares compared with $5,793,780 paid representing 579,378 shares in the
six months ended June 30, 2001. We began the year with outstanding redemption
requests of approximately 3.8 million shares. With new requests received,
redemption payments made and redemption cancellations, requests stood at
approximately 3.66 million at June 30, 2002. Because of the slowdown in our loan
repayments, we presently do not anticipate making any substantial redemption
payments through the end of the calendar year.
Critical Accounting Policies and Estimates
Management's Discussion and Analysis of Financial Condition and Results of
Operations covers our financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the 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, management evaluates its
estimates and judgments, including those related to the valuation of our assets
and liabilities. Management bases its estimates and judgments on historical
experience and on various other factors 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. Management believes the following
critical accounting policies, among others, affect the more significant
judgments and estimates used in the preparation of its consolidated financial
statements.
Valuation and Realizability of Investments. All of our loans are classified for
financial reporting purposes as investments in real estate under development or
investments in real estate under development by affiliates (see Notes 3 and 4 to
the financial statements). We have foreclosed on some loans that are classified
as investments in real estate held for sale (Note 5). Such investments include
capitalized interest and are stated at the lower of cost or net realizable
value. Management conducts a review for impairment on an
investment-by-investment basis whenever events or changes in circumstances
indicate that the carrying amount of an investment may not be recoverable. An
impairment is recognized when estimated expected future cash flows (undiscounted
and without interest charges), typically from the sale of a completed property,
are less than the carrying amount of the investment, plus estimated costs to
complete. The estimation of expected future net cash flows is inherently
uncertain and relies to a considerable extent on assumptions regarding current
and future economics and market conditions. If, in future periods, there are
changes in the estimates or assumptions incorporated into the impairment review
analysis, the changes could result in an adjustment to the carrying amount of
the investments. To the extent an impairment has occurred, the excess of the
carrying amount of the investment over its estimated fair value, less estimated
selling costs, will be charged to income. We believe that all of our investments
are carried at realizable values, however conditions may change and cause our
loans to decline in value in a future period.
Loan Accounting. We have applied the guidance of AICPA Practice Bulletin 1,
Purpose and Scope of AcSEC Practice Bulletins and Procedures for Their Issuance,
Exhibit I in accounting for our investment loans as real estate acquisition,
development, or construction (ADC) arrangements. In accordance with the ADC
accounting rules, we do not accrue income for interest and points on our loans
until the sale or refinancing of a property. Revenue from interest and points is
recognized as cash is received from the sale or refinancing of such properties.
Loans are classified as investments in real estate under development or
investments in real estate under development by affiliates and investments in
real estate held for sale (see Notes 3, 4 and 5 to the financial statements) and
include amounts funded under the loan agreements and capitalized interest
expense. If our loans qualified as loans under GAAP, interest and points would
be recognized in income as earned instead of at the time of sale of the
underlying property.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
An investment in our stock involves a high degree of risk. Among other things,
some of the principal risks are: the real estate lending business may be
adversely affected by periods of economic slowdown, which may be accompanied by
declining real estate values on properties securing repayment of loans;
construction mortgage loans involve greater risks of repayment than loans
secured by property that has already been improved since completion market
valuation of a given project can be highly speculative and subject to
unanticipated conditions; there is no public market for our securities, and
liquidity is not assured; under our business model, loan commitments will
generally exceed immediately available cash resources, and failure to obtain
repayment of loans in our portfolio, or a failure to maintain sufficient equity
would affect our ability to fund commitments; since we have no employees, if our
manager refused or became unable to continue to serve us, and a proper
replacement were not found, this would materially impact our business.
We make loans at fixed rates of interest. To the extent that prevailing market
interest rates change during the holding period, the value of our loans may be
either adversely or positively affected. When a loan matures, generally within a
12 to 18 month period, it is subject to a new interest rate, determined by us,
based upon current conditions. Since we intend to hold all loans until they are
repaid, we do not believe that changes in market interest rates have a material
impact on the value of the Company.
22
PART II.
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
We are not presently subject to any material litigation nor, to our knowledge,
is any litigation threatened against us which collectively is expected to have a
material adverse effect on our cash flows, financial condition or results of
operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(a) Not Applicable.
(b) Not Applicable.
(c) Sales of Equity Securities.
Between January 1, 2002 and June 30, 2002, we sold and issued 940,148 shares of
our Class A Convertible Preferred stock. Purchasers of such Class A Convertible
Preferred stock paid $10 per share.
Purchasers of our Class A Convertible Preferred stock were accredited investors
as defined in Regulation D, Rule 501 (a) (4), (5) or (6) under the 1933
Securities Act. Each investor signed a subscription agreement which included
representations that the investor had sufficient knowledge and experience in
financial and business matters to be capable of evaluating the merits and risks
of investments generally, and of the investment in our stock and the investor
was able to bear the economic risk of the investment. Each investor further
acknowledged the investor understood the entire investment could be lost.
The sales of stock were exempt from the registration requirements of the
Securities Act of 1933 pursuant to Regulation D, Rule 506. Appropriate legends
were placed on each stock certificate. No underwriters were involved and no
underwriting commissions were paid in any of the transactions.
The terms of conversion of the stock have been previously reported.
(d) Not Applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
ITEM 5. OTHER INFORMATION.
Not applicable.
23
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibits included with this Form 10-Q following the signature page, or those
incorporated by reference to other filings are:
1 Articles of Incorporation of the Company are hereby incorporated herein
by reference from Exhibit 3(i) to the Company's Registration Statement
on Form 10-12G, filed on April 28, 2000
2 Articles Supplementary of the Company are hereby incorporated herein by
reference from Exhibit 99.1 to the Company's Registration Statement on
Form 10-12G, filed on April 28, 2000
3 Bylaws, Amended March 21, 2000 are hereby incorporated herein by
reference from Exhibit 3(ii) to the Company's Registration Statement on
Form 10-12G, filed on April 28, 2000
4 Bylaws, Amended March 1, 2001 are hereby incorporated herein by
reference from Exhibit 3ii.2 to the Company's Annual Report on Form
10-K, filed on March 30, 2001
5 Specimen Stock Certificate is hereby incorporated herein by reference
from Exhibit 99.2 to the Company's Registration Statement on Form
10-12G, filed on April 28, 2000
6 Registration Rights Agreement is hereby incorporated herein by
reference from Exhibit 4.1 to the Company's Registration Statement on
Form 10-12G, filed on April 28, 2000
7 Founder's Registration Rights Agreement is hereby incorporated herein
by reference from Exhibit 4.2 to the Company's Registration Statement
on Form 10-12G, filed on April 28, 2000
8 Management Agreement dated March 30, 1999 is hereby incorporated herein
by reference from Exhibit 10 to the Company's Registration Statement on
Form 10-12G, filed on April 28, 2000
9 Management Agreement dated October 1, 2000 is hereby incorporated
herein by reference from Exhibit 10.2 to the Company's Annual Report on
Form 10-K, filed on March 30, 2001
99.1 Certification by Susan Fox as Chief Executive Officer.
99.2 Certification by Michael Rider as Chief Financial Officer.
(b) Reports on Form 8-K
Not Applicable.
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.
Dated: August 27, 2002 /s/ SUSAN FOX
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Susan Fox, President
Dated: August 27, 2002 /s/ MICHAEL RIDER
-----------------
Michael Rider, Chief Financial Officer
Dated: August 27, 2002 /s/ WILLIAM E. WHITLOW
----------------------
William E. Whitlow, Chairman of the Board