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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 September 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
September 30, 2002 was 22,450,280. The number of shares of common stock
outstanding as of September 30, 2002 was 100.
Table of Contents
Part I. Financial Information
Item 1. Financial Statements (unaudited)............................... 3
Balance Sheets as of September 30, 2002 (unaudited) and
December 31, 2001........................................... 4
Statements of Operations for the Three Months and Nine Months
Ended September 30, 2002 and 2001 (unaudited)............... 5
Statement of Shareholders' Equity for the Nine Months Ended
September 30, 2002 (unaudited).............................. 6
Statements of Cash Flows for the Nine Months Ended
September 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................................... 19
Item 3. Quantitative and Qualitative Disclosures about Market Risk..... 23
Item 4. Controls and Procedures........................................ 24
Part II. Other Information
Item 1. Legal Proceedings.............................................. 25
Item 2. Changes in Securities and Use of Proceeds...................... 25
Item 3. Defaults Upon Senior Securities................................ 25
Item 4. Submission of Matters to a Vote of Security Holders............ 25
Item 5. Other Information.............................................. 25
Item 6. Exhibits and Reports on Form 8-K............................... 25
(a) Exhibits................................................... 25
(b) Reports on Form 8-K........................................ 26
Signatures..................................................... 26
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 September 30, 2002 (unaudited), and
December 31, 2001
(2) Statements of Operations for the Three Months and Nine Months ended
September 30, 2002 and 2001 (unaudited)
(3) Statement of Shareholders' Equity for the Nine Months ended
September 30, 2002 (unaudited)
(4) Statements of Cash Flows for the Nine Months ended September 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 September 30, 2002 and December 31, 2001
September 30, 2002 December 31, 2001
(unaudited) (as restated)
--------------------- --------------------
ASSETS:
Investments in real estate under development............................ $ 100,789,348 $ 131,759,510
Investments in real estate under development by affiliates.............. 25,388,374 30,769,822
Investments in real estate held for sale................................ 33,522,877 18,952,063
Loan secured by real estate............................................. 4,695,000 --
Cash and cash equivalents............................................... 1,038,264 2,706,204
Other assets, net....................................................... 240,362 408,905
--------------------- --------------------
Total assets.................................................... $ 165,674,225 $ 184,596,504
===================== ====================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Notes payable........................................................... $ 14,827,448 $ 17,312,526
Secured line of credit.................................................. 15,000,000 15,000,000
Accrued expenses and other liabilities.................................. 241,160 1,232,022
Preferred stock dividends payable....................................... 1,969,553 1,903,928
Payable to affiliate.................................................... 141,319 31,193
--------------------- --------------------
Total liabilities............................................... 32,179,480 35,479,669
--------------------- --------------------
SHAREHOLDERS' EQUITY:
Preferred stock: par value $0.01, 40,000,000 shares authorized;
22,450,280 and 21,633,864 shares issued and outstanding at
September 30, 2002, and December 31, 2001, respectively;
entitled to $10 per share in liquidation before any distributions
to common shareholders............................................... 224,394,158 216,157,968
Common stock: par value $0.01, 10,000,000 shares authorized; 100
shares issued and outstanding at September 30, 2002, and December
31, 2001, respectively............................................... 1 1
Retained deficit........................................................ (90,899,414) (67,041,134)
--------------------- --------------------
Total shareholders' equity...................................... 133,494,745 149,116,835
--------------------- --------------------
Total liabilities and shareholders' equity...................... $ 165,674,225 $ 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 September 30, 2002 and 2001 and
For the nine months ended September 30, 2002 and 2001
(unaudited)
Three Months Three Months Nine Months Nine Months
Ended Ended Ended Ended
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
----------------- ----------------- ----------------- ---------------------
REVENUES:
Income from completed real estate development
(including $1,101,927, $0, $2,201,927
and $0 from affiliates for the three and
nine months ended September 30, 2002 and
2001 respectively).............................. $ 2,908,390 $ 1,430,690 $ 10,746,916 $ 8,151,866
Other ............................................. 141 -- 62,098 81
----------------- ------------------ ----------------- ------------------
Total revenues............................... 2,908,531 1,430,690 10,809,014 8,151,947
----------------- ------------------ ----------------- ------------------
EXPENSES:
Management fees paid to an affiliate................. 2,438,338 2,808,680 7,546,893 8,919,897
Provision for impairment of investments in real
estate............................................ 7,992,171 -- 9,465,487 --
General, administrative and other.................... 117,002 104,651 285,358 374,362
----------------- ------------------ ----------------- ------------------
Total expenses............................... 10,547,511 2,913,331 17,297,738 9,294,259
----------------- ------------------ ----------------- ------------------
Net loss..................................... (7,638,980) (1,482,641) (6,488,724) (1,142,312)
Preferred stock dividends and distributions. (5,871,994) (6,288,698) (17,369,556) (18,367,003)
----------------- ------------------ ----------------- ------------------
Net loss allocable to common shareholders.... $(13,510,974) $(7,771,339) $(23,858,280) $(19,509,315)
================= ================== ================= ==================
Basic and diluted net loss per common share.......... $ (135,110) $ (77,713) $ (238,583) $ (195,093)
================= ================== ================= ==================
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 nine months ended September 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.......... 1,254,964 12,549,640 -- -- -- 12,549,640
Issuance of preferred stock under
dividend reinvestment plan........ 306,820 3,068,200 -- -- -- 3,068,200
Redemption of preferred stock........ (745,368) (7,381,650) -- -- -- (7,381,650)
Dividends and distributions to
preferred shareholders............ -- -- -- -- (17,369,556) (17,369,556)
Net loss -- -- -- -- (6,488,724) (6,488,724)
-------------------------------------------------------------------------------
Shareholders' equity at
September 30, 2002................ 22,450,280 $224,394,158 100 $ 1 $(90,899,414) $133,494,745
===============================================================================
The accompanying notes are an integral part of these statements.
6
PRIMECORE MORTGAGE TRUST, INC.
STATEMENTS OF CASH FLOWS
For the nine months ended September 30, 2002 and 2001
(unaudited)
Nine Months Nine Months
Ended Ended
September 30,2002 September 30,2001
--------------------- --------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................................. $ (6,488,724) $ (1,142,312)
Adjustments to reconcile net loss to net cash (used in) provided by
operations
Provision for impairment of investments in real estate............ 9,465,487 --
(Decrease) increase in accrued expenses and other liabilities..... (990,862) (2,554,895)
Increase (decrease) in payable to affiliate...................... 110,126 (146,467)
(Decrease) increase in other assets, net.......................... 168,543 76,337
--------------------- --------------------
Net cash (used in) provided by operating activities.......... 2,264,570 (3,767,337)
--------------------- --------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments in real estate under development...................... (35,534,271) (49,064,576)
Investments in real estate under development by affiliates........ (5,531,562) (8,519,778)
Repayment of investments in real estate under development......... 42,825,003 57,916,252
Repayment of investments in real estate under development by
affiliates........................................................ 6,218,010 10,203,153
--------------------- --------------------
Net cash provided by investing activities.................... 7,977,180 10,535,051
--------------------- --------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sales of preferred stock, net of offering costs..... 12,549,640 25,595,457
Redemptions of preferred stock.................................... (7,381,650) (8,625,180)
Issuance of notes payable......................................... 3,967,061 17,992,400
Repayment of notes payable........................................ (6,809,010) (34,766,860)
Borrowings on secured line of credit, net......................... -- 6,563,009
Payments of preferred stock dividends and distributions........... (14,235,731) (13,226,540)
--------------------- --------------------
Net cash used in financing activities........................... (11,909,690) (6,467,714)
--------------------- --------------------
Net increase (decrease) in cash and cash equivalents............ (1,667,940) 300,000
Beginning cash and cash equivalents............................. 2,706,204 --
--------------------- --------------------
Ending cash and cash equivalents................................ $ 1,038,264 $ 300,000
===================== ====================
Cash paid for interest, net of amounts capitalized of $1,974,285 and
$3,541,210, for the nine months ended September 30, 2002, and 2001,
respectively........................................................... $ -- $ --
===================== ====================
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Reinvested Preferred Stock dividends and distributions.................... $ 3,068,200 $ 4,918,020
Accrued interest on notes payable......................................... 356,872 750,349
The accompanying notes are an integral part of these statements.
7
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO FINANCIAL STATEMENTS
For the nine months ended September 30, 2002
(unaudited)
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., (the "Manager") 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 September 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 22,450,280 and 21,633,864 shares of Preferred Stock outstanding as of
September 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 and distributions are paid monthly in arrears and were
$0.26 and $0.79 per share (based on weighted average preferred shares
outstanding of 22,369,856 and 22,058,891) for the three and nine months ended
September 30, 2002, compared with $0.29 and $0.86 per share (based on weighted
average preferred shares outstanding of 21,874,159 and 21,296,753) for the three
and nine months ended September 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
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.
Because of the slowdown in our loan repayments, and the amount and timing of
other contractual obligations, we presently do not anticipate making any
redemption payments through the end of the calendar year.
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 774,447 shares at $10 per
share as of September 30, 2002. We use the proceeds from issuance of our
Preferred Stock primarily to fund additional loans and also for working capital
purposes.
8
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO FINANCIAL STATEMENTS
For the nine months ended September 30, 2002
(unaudited)
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.
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 September 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 of America due to timing differences in the
recognition of income from our investments in real estate. Refer to Income Taxes
in Note 2 below.
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, the Manager 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.
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
Basis of Presentation
The accompanying unaudited financial statements present the financial position
of the Company as of September 30, 2002, and December 31, 2001, as restated, and
the results of operations and cash flows of the Company for the three months and
nine months ended September 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 September 30, 2002 and 2001 and for
the periods then ended.
9
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO FINANCIAL STATEMENTS
For the nine months ended September 30, 2002
(unaudited)
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 of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
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
Most 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 (Notes 3 and 4). 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 and include amounts funded under the loan agreements and capitalized
interest expense. If our loans qualified as loans under US GAAP, interest and
points would be recognized in income as earned instead of at the time of sale of
the underlying property.
Such investments 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. 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 operations.
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 accrued interest and points on those loans at the contracted
interest 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 financed property is sold or
10
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO FINANCIAL STATEMENTS
For the nine months ended September 30, 2002
(unaudited)
refinanced. We compute income as the difference between cash received from the
sale or refinancing of the property and the carrying value of the investments at
the date of repayment.
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 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 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 nine months ended September 30, 2002 and 2001 is
computed as follows:
Nine Months Nine Months
Ended Ended
September 30, 2002 September 30, 2001
-------------------- --------------------
Revenues - interest income and points $ 25,031,353 $ 29,686,207
Operating expenses (9,612,588) (12,769,249)
Loan losses (1,467,529) --
-------------------- --------------------
Taxable income before dividends 13,951,236 16,916,958
Dividends and distributions (17,369,556) (18,367,003)
-------------------- --------------------
Distributions in excess of
taxable income $ (3,418,320) $ (1,450,045)
==================== ====================
Our taxable income differs from income measured in accordance with generally
accepted accounting principles in the United States of America due to timing
differences in the recognition of income from our investments in real estate.
For tax purposes, interest and points are accrued as income according to the
terms of our loan contracts, but not recognized under generally accepted
accounting principles in the United States of America until the contract has
been paid through sale or refinancing of the secured property. 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. Dividend distributions 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. Subsequent to September 30,
2002 we decreased our distribution rate to shareholders. Refer to Note 11 -
Subsequent Events for a discussion.
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 nine months
ended September 30, 2002 and 2001, are the same and are 100 shares.
11
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO FINANCIAL STATEMENTS
For the nine months ended September 30, 2002
(unaudited)
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 in
real estate under development. 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 to a third party or refinancing of a property by another lender.
The income that we ultimately realize is based upon the terms of the
construction mortgage loan. During the nine months ended September 30, 2002,
fixed interest rates on loans outstanding ranged from 11 percent to 16 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 nine months ended September 30, 2002. Collection of the
charged interest and points is dependent on the value of the property financed.
The following table summarizes our portfolio of investments in real estate under
development at September 30, 2002:
Maturity Commitment Carrying
Location - County Dates Amount Amount
- ------------------------------------------------------------------------------
Alameda 12/02-04/03 $ 6,894,000 $ 1,959,629
Marin 06/01-09/03 35,740,000 20,530,655
Monterey 12/02-12/03 29,825,000 10,961,702
Napa 11/02-11/02 4,750,000 3,243,833
San Francisco 03/02-06/03 25,675,000 11,973,691
San Mateo 06/02-12/03 53,274,485 32,163,482
Santa Clara 03/02-05/03 24,020,000 14,904,861
Santa Cruz 06/01/06/01 6,750,000 5,051,495
-------------------- -------------------
$ 186,928,485 $ 100,789,348
==================== ===================
During the three and nine months ended September 30, 2002, we capitalized
$394,892 and $1,407,169 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. As of September 30, 2002 our
unfunded commitment was $38,758,295, exclusive of interest and points. We
believe we will have adequate sources of capital to fund these commitments when
and as they become due.
As of September 30, 2002, we had loans with a carrying amount of $16,655,562,
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 September 30, 2002, we had recorded notices of default on
loans with a carrying amount of $9,550,305 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 nine months ended September 30, 2002, we charged $550,984
and $1,945,042, respectively to operations for investments we believe are
impaired compared with none during the three and nine months ended September 30,
2001.
12
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO FINANCIAL STATEMENTS
For the nine months ended September 30, 2002
(unaudited)
4. INVESTMENTS IN REAL ESTATE UNDER DEVELOPMENT BY AFFILIATES:
We have also made loans to affiliates of the Manager acting as the developer.
These arrangements are accounted for in a manner identical to that described in
Note 3 above.
The following table summarizes our portfolio of investments in real estate under
development by affiliates at September 30, 2002:
Maturity Commitment Amount Carrying
Location - County Dates Amount
- -------------------- -------------- --------------------- -------------------
San Mateo 01/03-04/03 $ 14,200,000 $ 8,965,920
Santa Clara 12/01-03/03 52,425,000 16,422,454
--------------------- -------------------
$ 66,625,000 $ 25,388,374
===================== ===================
During the three and nine months ended September 30, 2002, we capitalized
$113,432 and $334,513 of interest expense from our secured line of credit and
our unsecured notes payable to investments in real estate under development by
affiliates.
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. As of September 30, 2002 our
unfunded commitment was $5,366,135, exclusive of interest and points. We believe
we will have adequate sources of capital to fund these commitments when and as
they become due.
We charged $4,923,858 to operations for impairments on Investments in Real
Estate by Affiliates during the three and nine months ended September 30, 2002,
respectively compared with none for the three and nine months ended September
30, 2001. See Note 11 - Subsequent Events for a discussion of impairments
related to Investments in Real Estate by Affiliates.
5. INVESTMENT IN REAL ESTATE HELD FOR SALE:
As of September 30, 2002, we held title to twenty properties received through
foreclosure or by deed in lieu of foreclosure. The following table summarizes
investments in real estate held for sale at September 30, 2002:
Commitment Carrying
County Number Amount Amount
- ------------------------ -------- ----------------------- ----------------
Alameda 2 $ 14,365,000 $ 4,941,467
Marin 3 9,075,000 7,399,084
San Francisco 1 2,500,000 1,488,601
San Mateo 3 7,025,000 4,933,751
Santa Clara 11 24,600,000 14,759,974
----------------------- ----------------
Total 20 $ 57,565,000 $ 33,522,877
======================= ================
We report these properties at the lower of their existing carrying amount or net
realizable value 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
nine months ended September 30, 2002, we capitalized $108,665 and $207,404 of
interest expense to investments in real estate held for sale that are still
under construction.
13
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO FINANCIAL STATEMENTS
For the nine months ended September 30, 2002
(unaudited)
Additional funds will be required to complete the investments in real estate
held for sale. We will fund these costs 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. As of September 30, 2002 our
estimated costs to complete these investments was $12,030,334.
We charged $2,517,329 and $2,596,587 to operations for impairments on
Investments in Real Estate Held For Sale during the three and nine months ended
September 30, 2002 compared with none for the three and nine months ended
September 30, 2001.
6. LOAN SECURED BY REAL ESTATE:
We had a loan secured by real property which we received as payment for one of
our Investments in Real Estate by Affiliates. The loan bears fixed interest at
7%, with interest payments of $27,388 payable monthly and matures on August 1,
2003. The loan is secured by three parcels of real property and is subject to
certain collateral release provisions.
7. NOTES PAYABLE:
We had unsecured borrowings of $14,827,448 at September 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 September 30, 2002,
we estimate that the carrying amounts of our notes payable approximate their
fair value based on current borrowing rates available to us. Additionally, at
September 30, 2002, we had $70,649 compared with $0 at December 31, 2001 due on
notes payable to financial institutions to finance the cost of our insurance
policy. The note bears interest at 11.274% and requires monthly payments of
$10,476.
The following table summarizes the maturities of our notes payable at September
30, 2002:
Year Amount
------------------------------ -----------------
2002 $ 7,127,910
2003 7,229,538
2004 470,000
-----------------
Total $ 14,827,448
=================
8. 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 September 30, 2002, was $15,000,000, 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 September 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 September 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 $142,645 at September 30,
2002.
14
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO FINANCIAL STATEMENTS
For the nine months ended September 30, 2002
(unaudited)
9. 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 nine
months ended September 30, 2002, the portfolio management fees earned by our
manager were $2,438,338 and $7,546,893 compared with $2,808,680 and $8,919,897
for the three and nine months ended September 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
totaling $160,728 were then charged in February 2002.
Subsequent to September 30, 2002 we restructured our agreement with the Manager.
Refer to Note 11 - Subsequent Events for a discussion.
Real Estate Sales Commissions
We paid real estate sales commissions of $40,200 and $125,865 for the three and
nine months ended September 30, 2002 to Primecore Properties, Inc., an
affiliate. The commissions were paid for services provided by Primecore
Properties under listing agreements to sell property acquired by us through
foreclosure or deed in lieu of foreclosure.
Payable to Affiliate
The $141,319 and $31,193 payable to affiliate at September 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
investments. As of September 30, 2002, loans assumed by or made to our
affiliates represented 21% of our loan commitments and 16% 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
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 broker. Except as disclosed above,
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
15
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO FINANCIAL STATEMENTS
For the nine months ended September 30, 2002
(unaudited)
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 September
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 $ --
Loan 2447 Affiliate properties 13,500,000 --
Loan 2512 Affiliate properties 7,000,000 --
---------------- ---------------
Total Primecore
Funding Group, Inc. loans $ 24,325,000 $ --
================ ===============
99 Investors, LLC
Loan 2404 7 Lots, Los Altos Nursery $ 18,100,000 $ 9,889,000
Loan 2428 Quarry Estates - Lot 15 5,000,000 3,450,000
Loan 2429 Quarry Estates - Lot 16 5,000,000 3,083,454
Loan 2455 91 Fleur Place 7,100,000 3,538,286
Loan 2469 37 Euclid 7,100,000 5,427,634
---------------- ---------------
Total 99 Investors $ 42,300,000 $ 25,388,374
================ ===============
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
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
16
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO FINANCIAL STATEMENTS
For the nine months ended September 30, 2002
(unaudited)
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.
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,
three homes were complete and on the market for sale.
Loan nos. 2428-29 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 September 30, 2002, one of the homes was complete and
on the market. The final home is scheduled to complete in November 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.
Subsequent to September 30, 2002 we restructured our affiliate loans. Refer to
Note 11 - Subsequent Events for discussion.
10. 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.
Construction Contracts
In connection with our development of investments in real estate held for sale,
we have entered into contracts with construction companies totaling $851,572 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.
17
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO FINANCIAL STATEMENTS
For the nine months ended September 30, 2002
(unaudited)
11. SUBSEQUENT EVENTS:
On October 17, 2002, our Board of Directors met to decide on a means of
addressing a number of matters, including the impact of the economic downturn
over the past year on the Company. The meeting followed several prior meetings
of the Board during which the Board considered alternatives for addressing the
issues related to our investments resulting from the economic downturn. At the
meeting, the following matters were resolved by the Board:
The Board voted unanimously to adjust our monthly cash distribution to
shareholders from $0.0875 per share to $0.0583 per share beginning with
distributions declared in October 2002 and paid in November 2002. In adjusting
the distribution, the Board considered the following factors: the economy over
the past year; prospects for a quick turnaround in the economy; the economic
uncertainties arising from world events; and the San Francisco Bay Area real
estate market conditions and its actual and potential impact on our loan
portfolio. The Board also considered the needs of shareholders when setting the
distribution rate, recognizing the desires of shareholders to receive monthly
distributions and also recognizing that distributions at the specified rate will
result in a return of capital to shareholders since the distributions will
exceed income. The Board will continue to review and reassess the distribution
policy as new information becomes available.
The Board, acting by the unanimous vote of its directors independent of
management, with all management directors abstaining, voted to concurrently
enter into: (a) an amended and restated Management Agreement with our
Manager,and (b) an agreement regarding loans made to affiliates. The principal
amendments to the Management Agreement are: (a) a change in the method of
determining the management fee, whereby the management fee is more closely tied
to performance of the Company, with the base fee being reduced, and with bonuses
tied to certain cash flow and income per share performance criteria; and (b) a
change in favor of the Company in the fee payable upon termination. The
principal terms of the affiliate loan agreement, which sets forth all
obligations relating to loans previously made to affiliated entities, are: (a)
ownership of all properties secured by "Affiliate Loans" shall be transferred to
the Company; (b) PFG has agreed to pay, and has paid to the Company, the
remaining carrying amount, of loans made to Eprime, Inc., an affiliate; and (c)
PFG has agreed to pay the Company over time any impairment of loans made to 99
Investors, LLC, an affiliate. Such impairment will be determined as the
difference, if any, between the appraised values of the properties transferred,
and our carrying amounts of the contracts owed by 99 Investors, LLC.
The affiliate loan agreement provides that payment of any obligation arising
from the 99 Investors loans will be made from the Manager's performance related
compensation. We have accounted for our estimate of the receivable using the
cost recovery method. Accordingly, we have charged $4,923,858 to operations
during the three months ended September 30, 2002 and will report realization of
this estimated receivable as income when the Manager makes the required
payments.
18
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 construction
("ADC") mortgage loans. In accordance with industry practice, we classify such
mortgage loans as investments in real estate.
Statements contained in this Item 2, "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.
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.
19
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
Revenues
We recognize income only after we receive payment even though our loan 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 relatively large in amount yet few in number, so our income is
subject to wide variations from period to period as the timing of even a single
loan repayment can have a material impact on our revenues as reported under US
GAAP. For the three months and nine months ended September 30, 2002 we
recognized income of $2,908,390 and $10,746,916 compared with $1,430,690 and
$8,151,866 for the same periods in 2001. Our US GAAP income has increased over
the prior year mainly because the loans that repaid have been outstanding for
longer periods and have higher amounts of accrued income than the prior year.
During the same period that we recognized higher US GAAP revenues, the accrued
income we recognized for tax purposes, and which we are entitled to collect if
there are sufficient proceeds from the disposition or refinance of the
properties, decreased to $7.9 million and $25.0 million for the three and nine
months ended 2002 compared with $9.2 million and $29.7 million for the three and
nine months ended 2001. These accruals represent a rate of return of 12.73% and
13.52% for the three and nine months ended September 30, 2002 compared with
14.50% and 15.41% for the three and nine months ended September 30, 2001. The
decrease in the accrued income and the accrual rate of return is largely the
result of the high number and amount of properties we took back in foreclosure.
These properties do not accrue interest after we have taken possession and in
many cases the value of the properties will not be sufficient to provide for
collection of all or part of the income that had been accrued prior to
foreclosure.
Since we do not receive interest payments on our contracts until the underlying
property is sold or refinanced, and we do not generally require our borrowers to
guarantee the contracts, the collection of the income we accrue to our loans is
solely dependent upon the value of the property when it is sold. Approximately
70% of the carrying amount of our portfolio is invested in real estate with
prices expected to sell over $2.5 million. This high end sector of the market
has been subject to the greatest price decreases in the San Francisco Bay Area.
Consequently, our ability to collect the income that has been accruing on our
contracts has become impaired. At September 30, 2002 we were contractually
entitled to approximately $72 million of interest and points accrued on our
contracts. Based on current estimated values of the properties, we anticipate
receiving approximately $45 million of that accrued income if all properties
were sold today.
Based on our investment strategy, we target a 16% gross internal rate of return
from our contracts. From this return we pay our expenses and distribute
dividends to our shareholders. From the contracts which repaid, we received an
internal rate of return of 13.02% and 12.79% for the three and nine months ended
September 30, 2002. Due to the impaired collectibility of our income discussed
above, we expect our internal rates of return to decrease significantly for
contracts which repay through the end of 2003. As a result, subsequent to
September 30, 2002 our Board decreased the distribution rate paid to
shareholders. We also expect these decreased investment rates of return to
remain below our target rate of 16% until we have liquidated the contracts with
impaired values and reinvested those proceeds into contracts with economics
based on the revised market values. We expect that process to continue
throughout 2003.
Expenses
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 nine months ended September 30, 2002 our management fee expense was
$2,438,338 and $7,546,893 compared with $2,808,680 and $8,919,897 for the three
and nine months ended September 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.
20
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 $616,988 and $1,949,086 for the three and nine months ended September 30,
2002, compared with $963,319 and $3,397,097 for the three and nine months ended
September 30, 2001. The decrease is due to a combination of a lower average cost
of debt, 8.40% and 9.32% in the three and nine months ended September 30, 2002
compared with 11.13% and 11.38% in the three and nine months ended September 30,
2001; and the lower amount of debt on our balance sheet, an average of $28.7
million and $28.4 million in the three and nine months ended September 30, 2002
compared with an average of $31.5 million and $37.2 million in the three and
nine months ended September 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 $117,001 and
$285,358 for the three and nine months ended September 30, 2002, compared with
$104,651 and $374,362 for the three and nine months ended September 30, 2001.
While general, administrative and other expenses were relatively unchanged from
the 3 month period ending September 30, 2002 compared to 2001, the decrease for
the nine months ended September 30, 2002 compared with 2001 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.
Liquidity and Capital Resources
Liquidity means the need for, access to and uses of cash. 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. Our principal demands for liquidity are
funds that are required to satisfy obligations under existing loan commitments,
operating expenses, interest expense associated with our indebtedness, debt
repayments, dividend distributions to shareholders and redemptions to
shareholders.
Sources of Liquidity
Our largest source of liquidity is the repayment of our investment contracts. We
had approximately $244 million which was due under our contracts at September
30, 2002. We rely on the completion and sale of the properties securing our
contracts to collect the investment we have made in our contracts. As such, the
timing of our collection is largely dependent on the borrower's ability to
construct the property and the real estate market conditions at the time the
property is completed and ready for sale. As discussed in the Results of
Operations, approximately 70% of our contracts are dependent upon the sale of
properties expected to sell at prices over $2.5 million. That high end sector of
the San Francisco Bay Area real estate market has suffered the worst during the
economic downturn following the collapse of the dot com economy in 2000. Real
estate inventory has remained high as fewer and fewer individuals compete for a
stock of new housing that was planned during the height of the market and has
become available after the collapse.
We expect these market conditions to continue for the foreseeable future. In
this soft market, we have encouraged our borrowers to aggressively price their
product, and we have done the same with the properties we have acquired through
foreclosure. Although we expect this strategy will result in relatively short
term, and sometimes severe, declines in the rates of return from our contracts,
we believe that the longer term benefits provided by liquidity and through
reinvestment of the proceeds into productive assets will justify the costs. Even
with our aggressive pricing, our repayments have decreased considerably. For the
nine months ended September 30, 2002 repayments from our contracts were
approximately $49 million compared with $68 million for the nine months ended
September 30, 2001. We expect that as we continue the strategy, and as more
properties complete and are ready for sale, the rate of our repayments will
increase.
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 nine
months ended September 30, 2002, we sold 1,254,964 shares of Preferred Stock for
proceeds of approximately $12.5 million compared with 2,559,754 shares for
proceeds of approximately $25.6 for the nine months ended September 30, 2001. We
believe that the decrease in stock sales was due to the slowdown in the US
21
economy in general and the technology sector in particular, where a lot of our
clients have made their money. Additionally, the condition of the local real
estate market and its impact on our portfolio have increased uncertainties about
future dividend rates and stock valuation. Based on these factors we expect
Preferred Stock sales to decrease substantially until and our portfolio position
improves.
We continue to issue notes payable on a limited basis, however they are not a
primary source of our liquidity. During the nine months ended September 30,
2002, we issued approximately $4 million in notes compared with approximately
$18 million for the nine months ended September 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.
Demands for Liquidity
Funding the commitments of our contracts is our largest demand for liquidity.
For the nine months ended September 30, 2002 we funded approximately $41 million
in loan commitments compared with approximately $58 million for the nine months
ended September 30, 2001. We estimate that approximately $56 million will be
needed to fund remaining commitments and complete the properties whose ownership
we control. The exact timing of these payments depends on several factors
including weather, governmental regulation and developer related issues.
Another demand for our liquidity is our line of credit which was extended in
December 2001 to May 2003. 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
September 30, 2002. We have been discussing the matter with our lender and will
attempt to obtain a waiver of the requirement or negotiate an acceptable
alternative.
Unsecured notes payable are also a demand for our liquidity. We have notes of
approximately $7 million maturing by the end of 2002 and another $7 million
maturing in 2003. 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.
Payment of operating expenses constitutes a demand for our liquidity as well.
Our largest operational expense is our management fee expense. This expense is
based on the amount of our commitments to fund contracts. As our commitments
have declined, the management fee has declined correspondingly. Based on our
current commitment level and our restructured management agreement, we expect to
pay management fees of approximately $3 million in the last three months of 2002
and $5.2 million in 2003. See the financial statements Note 11 - Subsequent
Events for a discussion of the changes to our management agreement. Our
remaining operating expenses consist mainly of accounting, legal and certain
insurance expenses. We expect those amounts to remain fairly constant at
approximately $45,000 per month.
Although dividend payments are not contractual obligations, and are therefore
not a strict demand for our liquidity they are a fundamental component of our
business due to our REIT status. 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. We
currently expect our taxable income to be substantially reduced through 2003 and
would therefore have the flexibility to decrease, or even stop, dividend
payments during that period. See the financial statements Note 11 - Subsequent
Events for a discussion regarding changes to our dividend distribution rate.
Because of the slowdown in our loan repayments, and the amount and timing of
other contractual obligations, we presently do not anticipate making any
redemption payments through the end of the calendar year. In the nine months
ended September 30, 2002 we paid approximately $7 million to preferred
stockholders compared with approximately $8.6 million paid in the nine months
ended September 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 4.0
million shares at September 30, 2002.
22
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 to a third party or refinancing to
another lender 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.
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.
23
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.
ITEM 4. CONTROLS AND PROCEDURES.
Within the past 90 days we carried out an evaluation, under the supervision of
the Company's Chief Executive officer and Chief Financial Officer, of the
effectiveness of the Company's disclosure controls and procedures. Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer have each
concluded that those controls and procedures were effective in making known to
them, on a timely basis, the material information needed for the preparation of
this Report on Form 10-Q. There were no significant changes in the Company's
internal controls or in other factors that could significantly affect those
internal controls since the date of their evaluation nor did we find any
significant deficiencies and material weaknesses that would have required
corrective actions to be taken with respect to those controls.
24
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 September 30, 2002, we sold and issued 1,254,964
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.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
25
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
Form 8-K filed 8/6/2002
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: November 14, 2002 /s/ SUSAN FOX
-------------------------
Susan Fox, President
Dated: November 14, 2002 /s/ MICHAEL RIDER
-------------------------
Michael Rider, Chief
Financial Officer
Dated: November 14, 2002 /s/ WILLIAM E. WHITLOW
-------------------------
William E. Whitlow, Chairman
of the Board
26
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Susan Fox, certify that:
1. I have reviewed this Form 10-Q of Primecore Mortgage Trust,
Inc.;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this
quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
(a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
/s/ SUSAN FOX
--------------------------
Susan Fox, President
November 14,2002
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Michael Rider, certify that:
1. I have reviewed this Form 10-Q of Primecore Mortgage Trust,
Inc.;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this
quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
(a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
/s/ MICHAEL RIDER
Michael Rider, Chief Financial Officer
November 14, 2002