SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Fiscal Year Ended December 31, 2002
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)
(650) 328-3060
(Registrant's telephone number, including area code)
Securities registered under Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Class A Convertible Preferred Stock, par value $0.01 per share
(Title of class)
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[ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of the voting and non-voting common equity
held by non-affiliates of the registrant is $0. Indicate the number of shares
outstanding of each of the registrant's classes of common stock as of the
latest practicable date: 100 Shares of Common Stock
PART I
ITEM 1. BUSINESS
The Company and Affiliates
We are a real estate investment trust (REIT) incorporated in Maryland on
March 18, 1999. We began operations May 1, 1999. We make and fund short-term
construction mortgage loans that are made to developers of for-sale,
single-family and multi-unit residential real estate. All loans are secured by
recorded deeds of trust on the property being developed, and title insurance
protecting the position of the deeds of trust is always a condition to making a
loan. Most loans are secured by first deeds of trust on the property being
developed, although, under proper circumstances and where the loan meets our
requirements, we may accept a junior deed of trust. To date, we have made loans
only in Northern California, however, there is no restriction on our ability to
make or fund loans in other areas. We do not engage in any foreign operations or
derive any revenue from foreign operations.
Primecore Funding Group, Inc., an affiliate, pursuant to an amended and
restated management agreement dated October 17, 2002, manages all of our
affairs. We have no employees. Our manager, or an affiliate of our manager,
originates and services all of the mortgage loans that we make and the
properties we own through foreclosure or deed in lieu of foreclosure. Our
manager bears all operating expenses connected with originating and managing our
mortgage loan portfolio and receives a monthly management fee. At December 31,
2002, our manager serviced our portfolio of mortgage loans with an aggregate
balance of $192.6 million.
Susan Fox, one of our founders, is the President and sole shareholder of
Primecore Funding Group, Inc. Primecore Funding Group, Inc. holds a restricted
real estate broker license issued by the California Department of Real Estate.
We have affiliates with whom we share common officers and some common directors,
but which have their own, independent business purposes. Our affiliates include
Primecore Properties, Inc., Eprime, Inc., and 99 El Camino Partners LLC. 99
Investors, LLC is a California limited liability company of which the Company is
the sole member. We have issued four classes of securities: (1) common stock;
(2) Class A Convertible Preferred stock; (3) Series A notes; and (4) Series B
notes.
Business Strategies
Our investment objective is to make construction loans on projects that we
believe are likely to ultimately sell for an amount in excess of the loan
principal, plus interest at the agreed upon rate, and contractual loan fees. We
conduct, through our manager, centralized loan underwriting and pricing, project
evaluation, loan funding and loan servicing to maintain control of the risks of
operating a construction mortgage lending operation and managing a portfolio of
short-term construction mortgage loans. All of our loans are secured by recorded
deeds of trust, and are supported by loan documents that have been designed to
protect our investments. Our manager manages the loans with the goal of assuring
that disbursements are proper and that projects are built, to the maximum extent
possible, in accordance with stated budgets and timelines.
We serve a niche that is different from institutional new-home construction
lenders. Nevertheless, we face competition in the business of originating and
servicing construction mortgage loans from banks, thrifts and other independent
mortgage lenders. While many of these entities have significantly greater
resources, we compete effectively due to: (1) our tax advantaged status as a
REIT; (2) our concentration in construction lending, (3) freedom from
bureaucracy that allows more flexibility in meeting borrower needs; and (4)
freedom from regulatory-related administrative costs and requirements, which
requirements can result in increased costs to the borrower due to delays in loan
approval, construction or funding of loans.
Dividend Policy and Distributions
In order to maintain our status as a REIT, we are required to distribute at
least 90% of our annual taxable income. We currently make dividend distributions
monthly, although this is subject to change at the discretion of our Board of
Directors. So long as shares of preferred stock remain outstanding, only holders
of our preferred stock will receive dividends; and there will be no cash
dividends declared or paid on our common stock.
We pay dividends monthly to shareholders of record based on the number of
weighted average shares owned during the preceding calendar month. Since we
began operations on May 1, 1999, we have paid dividends totaling $3.97 per
weighted average share.
Our Board of Directors determines the amount of dividends. On October 17,
2002, our Board of Directors voted unanimously to adjust our monthly dividend
distribution to shareholders from $0.0875 per share to $0.0583 per share
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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 weakness in the San
Francisco Bay Area real estate market 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.
Mortgage Lending
General Business Model. Our business plan is to make and hold to maturity a
portfolio of construction mortgage loans for investment that generates a net
interest margin over time and allows us to take full advantage of our REIT
status. The loans are made to developers of for-sale, single-family and
multi-unit residential real estate. Our loans often include funding for both
land acquisition and development. Most loans are written with maturity dates of
up to 18 months, which dates may be extended by our manager when deemed to be in
the Company's best interests, especially, during periods of economic slowdown.
Loan interest rates are fixed and have ranged from 11% to 18%. In the past, loan
origination fees, typically 4% of the loan commitment amount, have been charged
to borrowers. On a going forward basis, such origination fees may be reflected
in the interest rate charged to a borrower. All loans are secured by recorded
deeds of trust on the property being developed, and title insurance protecting
the position of our deeds of trust is always a condition to making a loan. To
date, we have made loans only in Northern California, however, there is no
restriction on our ability to make or fund loans in other areas.
All approved loans are subject to detailed loan documentation that has been
formulated by legal counsel for our specific purposes. Our manager monitors all
loans to ensure that they are being properly administered and that loan proceeds
are properly disbursed. All loans provide for monthly payments of interest only
and a payment of principal in full at the end of the loan term. In accordance
with our loan documents, we generally advance the monthly interest payments out
of available loan proceeds, although our loan documents provide us with a right
not to advance or to cease such payments should our manager determine that
conditions require such actions. Loan fees, if charged, are typically advanced
out of the loan proceeds with the initial loan advance. Generally, our loans
require the borrower to make a "balloon payment" equal to the principal amount,
advanced interest and fees upon maturity of the loan. The loan maturity date is
the date of sale of the underlying real estate or the date stated in the loan
documents. Although we do not limit the amount of our investment in any single
construction loan, we generally lend up to 75% of the estimated completed value
of the real estate.
Management of the Company and Its Loan Portfolio. Primecore Funding Group,
Inc., our affiliate, manages all of our business, subject to direction from our
Board of Directors. Our manager bears all operating expenses connected with
originating and managing our mortgage loan portfolio, and receives a monthly
management fee that is established by a written management agreement that we
entered into with our manager. Our manager's responsibilities, which may be
satisfied by subcontracts with affiliates or others, include:
Representing the Company in connection with arranging loans;
In accordance with the directions of the Company's Board of Directors,
investing or reinvesting any money of the Company;Furnishing reports and
statistical and economic research to the Company regarding the Company's real
estate loan activities and the performance of its portfolio of loans;
Administering the day-to-day operations of the Company and performing
administrative functions necessary in the management of the Company, including
the collection of revenues, the payment of the Company's expenses, debts and
obligations and the maintenance of appropriate computer services to perform such
administrative functions;
Counseling the Company in connection with policy decisions to be made by
the Board of Directors;
Overseeing the servicing of the Company's loans;Establishing underwriting,
appraisal and quality control procedures for the loans made by the Company;
Providing the Company with data processing, legal and administrative
services to the extent required to implement the business strategy of the
Company;
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Providing all actions necessary for compliance by the Company with all
federal, state and local regulatory requirements applicable to the Company in
respect of its business activities, including maintaining books and records and
preparing or causing to be prepared all financial statements required under
applicable regulations and contractual undertakings;
Providing all actions necessary to enable the Company to make required
federal, state and local tax filings and reports and generally enable the
Company to maintain its status as a REIT, including, but not limited to,
soliciting stockholders for required information to the extent required by the
REIT provisions of the Code;
Communicating on behalf of the Company with the stockholders of the Company
as required to satisfy any reporting requirements and to maintain effective
relations with such stockholders;
and Performing such other services as may be required from time to time for
management and other activities relating to the assets and growth of the Company
as the Board of Directors shall reasonably request or the Manager shall deem
appropriate under the particular circumstances.
Our manager is contractually obligated to bear the following expenses on our
behalf:
1. Employment expenses of the personnel employed by the Manager, including, but
not limited to, salaries, wages, payroll taxes, and the cost of employee benefit
plans;
2. Rent, telephone, utilities, office furniture, equipment and machinery
(including computers, to the extent utilized) and other office expenses (such as
asset/liability software, modeling software and other software and hardware) of
the Manager needed in order to perform its duties as set forth herein;
3. Bookkeeping fees and expenses including any costs of computer services, other
than in connection with communications to security holders of the Company;
4. Miscellaneous administrative expenses incurred in supervising and monitoring
the Company's investments or any subsidiary's investments or relating to
performance by the Manager of its functions;
5. Fees and expenses paid to advisors under agreements with the Manager;
6. Expenses connected with the acquisition of the Company's assets and mortgage
loans;
7. Expenses related to the servicing of the Company's mortgage loans; and
8. Travel and related expenses of personnel of the Manager when attending
meetings or performing other business activities which relate to the Company or
any subsidiary of the Company.
Our headquarters are the offices of our manager. We currently do not pay
any rent for our headquarters, as these expenses are borne by our manager. The
headquarters consist of 6,828 square feet of office space at 99 El Camino Real,
Menlo Park, California 94025 leased by our manager from 99 El Camino Partners.
The lease expires on May 31, 2009, but includes two 5 year options expiring on
May 31, 2019. We believe our present facilities are adequate to meet our current
business requirements and those of our manager, and that suitable facilities for
expansion will be available if and when necessary.
Loan Origination. Our manager evaluates prospective construction loans on
our behalf. Our manager, at times with Primecore Properties, Inc., its real
estate brokerage affiliate, arranges and services all loans on our behalf. Our
manager employs persons skilled in loan underwriting, disbursement and
monitoring, and the various business and legal issues that may be involved with
real estate lending. Mortgage loan originations are generally generated from new
loans made to existing developer relationships, referrals from real estate and
mortgage loan brokers and contacts from prospective borrowers. Proposed loans
are evaluated by our manager to determine whether the loan is of a type
typically made by us, if the security for the loan and the loan to value ratio
meets our investment standards, and whether the loan can be priced in a manner
to meet our investment criteria and objectives. In the past, our manager has
generally relied on analysis by its representatives and not on third party
appraisals in determining whether to originate a particular construction loan.
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In January 2003, we commissioned third party appraisals for all our existing
loans and properties we owned. We will also seek third party appraisals for
loans made in the future and for modified loans.
Collateral valuation. Collateral valuation receives special attention in
the underwriting of our construction loans. Our manager utilizes the experience
of its employees, brokers in its real estate brokerage affiliate, third party
appraisals and other information deemed useful to make assessments of a proposed
project's viability and projected value, and to determine if a proposed loan
meets our criteria. In the loan evaluation process, primary emphasis is placed
on the ability of the underlying collateral to protect against losses in the
event of default by the borrower. The evaluation is based on the projected
market value of the proposed project, using various tools, including comparable
sales of similar properties and projections of market appeal and demand at
completion. The goal of the underwriting process is to achieve a comfort level
that the projected completion value of the property will support full repayment
of the outstanding loan balance.
Loan Servicing. Our manager has overall servicing responsibility for all
construction loans that we make, with the goal being protection of loan funds
and collateral for loans. Servicing involves taking all steps necessary to
administer the loan and collect loan payments, including monitoring the
propriety of loan draw requests, monitoring progress of a project, accounting
for principal and interest, addressing loan delinquencies, arranging loan
workouts or extensions where appropriate, and supervising foreclosures and
property dispositions. Our manager may, where appropriate, employ at the
borrower's expense, an outside agent to oversee construction progress and draw
requests. Loan proceeds are disbursed as construction progresses, and only after
our manager has received satisfactory documentation and evidence. Using its
experience in construction lending and its knowledge of real estate development,
our manager monitors the progress of all development projects securing our
loans, and takes steps to ensure that the development projects are being built
in a timely manner, within an agreed budget. Before making disbursements of loan
proceeds, borrower disbursement requests are verified by invoices from the
developer or its subcontractors, and by periodic site inspections of progress.
In addition, our manager generally requires the submission of signed labor and
material lien releases by the builder in connection with each completed phase of
the project before making any periodic disbursements for a loan.
Sales of construction mortgage loans. We plan to hold mortgage loans to
maturity, and have not embarked on selling loans in any secondary market. Nor
are we aware that a secondary market exists for the loans we hold. We may,
however, decide to sell assets from time to time for a number of reasons,
including, without limitation: (1) to dispose of an asset for which credit risk
concerns have arisen; (2) to reduce interest rate risk; (3) or to re-structure
our balance sheet when our management deems it advisable. We will select any
mortgage loans to be sold according to the particular purpose the sale is
intended to serve. Our Board of Directors has not adopted a policy that would
restrict management's authority to determine the timing of sales or the
selection of mortgage loans to be sold.
Other REIT qualified investments. As part of the acquisition of a
particular loan, or through a foreclosure we may acquire an equity interest in
the real property securing the loan in the form of a shared appreciation
interest or other equity participation. We also may invest our funds directly in
real property, if in the opinion of our Board of Directors it is in our best
interest. We may also purchase the stock of other mortgage REITs or similar
companies if we believe that they will yield attractive returns on capital and
otherwise not violate any requirements for maintaining our status as a REIT.
ITEM 2. PROPERTIES.
We do not own any property for investment purposes. We own certain real
property that we have acquired through foreclosure or deed in lieu of
foreclosure. Our policy is to attempt to maximize the value of the property
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prior to liquidation. In some cases this may involve completing construction,
sometimes through a subsidiary or affiliate, and then marketing the property for
sale. The following is a list of real estate owned by us as of December 31,
2002:
Estimated
Number Carrying Realizable
Property Type Construction Status of units Amount Value
- ------------------------------------------------------------------------------------------------------
Per unit market value estimated at less than $2.5 million
Land development Completed for sale 4 $1,676,642 $ 1,584,241
Condominium Framing 2 1,542,395 1,788,641
Single family detached Demolition/Grading 4 1,235,039 1,654,059
Drywall 1 134,000 134,000
Cabinets/Countertops 2 3,420,626 3,626,737
Completed for sale 6 8,098,752 8,098,752
---------------------------------------
19 16,107,454 16,886,430
Per unit market value estimated at $2.5 million or higher
Single family detached Entitlement/Permit 2 1,698,708 1,698,708
Demolition/Grading 1 1,168,069 1,640,124
Framing 1 1,690,291 1,690,292
Drywall 1 3,573,246 3,573,246
Cabinets/Countertops 3 9,538,400 10,142,979
Completed for sale 1 3,041,000 3,041,000
9 20,709,714 21,786,349
---------------------------------------
28 36,817,168 38,672,779
=======================================
ITEM 3. 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 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of our stockholders during the fourth
quarter of the year ended December 31, 2002.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
There is currently no public trading market for our Class A Convertible
Preferred stock or our common stock. We are authorized to issue up to 50,000,000
shares of stock, of which 40,000,000 shares are designated as Class A
Convertible Preferred Stock and 10,000,000 are designated as Common Stock. At
December 31, 2002, there were issued and outstanding 22,496,804 shares of Class
A Convertible Preferred stock and 100 shares of common stock, issued and
outstanding. The number of outstanding shares is subject to change because of
newly issued shares, shareholder redemptions and dividend reinvestments. We have
also offered and sold Series A and B promissory notes of varying amounts and
maturities.
All sales of stock and issuances of notes to date have been made under exemption
from the registration requirements of the Securities Act of 1933 pursuant to
Regulation D, Rule 506. All sales of stock and notes are made only to accredited
investors, as defined in Regulation D, Rule 501 (a)(4), (5) or (6) under the
1933 Securities Act. Appropriate legends were placed on each stock certificate
and promissory note. No underwriters were involved and no underwriting
commissions were paid in any of the transactions.
We have not paid any cash dividends to holders of our common stock.
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The preferred stock has the rights and privileges and is subject to the
conditions set forth in our supplementary articles of incorporation, filed with
the State of Maryland Department of Assessments and Taxation. Subject to the
limitations set forth in the terms of the preferred stock, we may issue
additional preferred stock from time to time in one or more classes or series,
with such distinctive designations, rights and preferences as shall be
determined by the Board of Directors. Additional series of preferred stock would
be available for possible future financings, or acquisitions by us, and for
general corporate purposes without any legal requirement that further
shareholder authorization for issuance be obtained. Our issuance of additional
series of preferred stock could have the effect of making an attempt to gain
control of our company more difficult by means of a merger, tender offer, proxy
contest or otherwise.
The following summary of the rights of the preferred stock and the common
stock is qualified in its entirety by reference to our charter and related
supplementary articles.
Dividends. Holders of our Class A Convertible Preferred stock are entitled
to dividends declared and payable at such times and in such amounts as the Board
of Directors may from time to time determine from amounts legally available for
such distribution. For so long as shares of preferred stock shall remain
outstanding, there shall be no dividends declared or paid nor any distributions
made on the common stock, nor, without the written consent of holders of 66 2/3%
of the outstanding preferred stock, shall any shares of common stock be
purchased or redeemed for a price in excess of their par value.
Redemption Policy. Holders of our Class A Convertible Preferred stock do
not have a vested right to redeem their shares. Our Board of Directors, however,
currently has a stock redemption policy, effective as of February 12, 2003, for
shareholders who wish to sell their shares to us. The policy may be modified or
terminated at the Board's discretion at any time. Currently, we will repurchase
shares, at fair market value, as determined by our Board of Directors, utilizing
25% of "free cash flow" for such purposes. "Free cash flow" means the total of
all proceeds from repayments of loans and all net proceeds from the sale of
real-estate-owned properties in the Company's portfolio during a Repurchase
Period, and then subtracting from such total amounts due during the same period
for (i) existing loan commitments, (ii) debt payments to third parties, (iii)
dividend or other distributions to shareholders, and (iv) operating expenses.
The periods between October 1 and March 31 of the following year, and April 1
and September 30 are each a "Repurchase Period" for the purposes of calculating
"free cash flow," except that the first Repurchase Period under the policy runs
from January 1, 2003 through March 31, 2003. Redemption of shares is always
subject to availability of funds for redemption purposes. All redemption
requests will be determined and acted upon in accordance with the best interests
of the Company. We will not sell or otherwise liquidate any portion of our
mortgage loan portfolio or other assets to fund a redemption request. We also
reserve the right to limit the number and frequency of stock redemptions by
shareholders.
Conversion. Our Articles Supplementary, as filed, provide that shares of
common stock will convert to common stock upon: (1) the closing of a firm
commitment underwritten initial public offering of the common stock resulting in
aggregate gross proceeds to us of at least $50 million at a share price of at
least $10.00, or for such lesser amount of proceeds or lower price, or both, as
is approved by at least two-thirds of the voting power of the preferred stock;
or (2) five years after the last closing of the initial offering. This provision
was included at the time that the Articles Supplementary were filed in
connection with certain agreements that existed at the time of filing, but which
were subsequently rescinded. Since these agreements are no longer of any effect,
and because the Board of Directors has no present plans to seek any public
market for the Company's stock, it is expected that the preferred stock will
convert to common stock on September 1, 2004. Since only 100 shares of common
stock are outstanding and we have no plans to sell or issue any additional
shares of common stock prior to that date, the conversion should not have any
material impact on the rights of the preferred shareholders.
Liquidation. Upon the liquidation, dissolution or winding up of our
company, either voluntary or involuntary, the holders of our Class A Convertible
Preferred stock will be entitled to receive out of our assets available for
distribution to our shareholders, an amount per share of up to the original
purchase price per share, plus any declared but unpaid dividends, before any
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distribution to the holders of our common shares. Thereafter, to the extent any
assets remain in our company, such assets shall be distributed in equal amounts
per share to the holders of common shares and preferred shares on an "as
converted" basis, that is, as if the preferred shares had converted into shares
of common shares. Neither a consolidation or merger with or into another
corporation, nor a merger of any other corporation with us, nor the sale of all
or substantially all of our property or business, other than in connection with
a winding up of our business, will be considered a liquidation, dissolution or
winding up for these purposes.
Merger. In the event of a change in control, a merger, consolidation or
other combination by our company, or transfer of all or substantially all of our
assets, each holder of the preferred shares will have the option to elect to
receive either: (1) what the common shares would have received if conversion had
occurred before the record date, or (2) 100% of the liquidation preference of
the preferred shares as provided under "Liquidation" above.
Voting. Except as provided by law or our charter, the holders of our Class
A Convertible Preferred shares and common shares shall vote together as a class
for the election of directors and on all other matters to be voted on by our
shareholders. Each holder of preferred stock shall be entitled to one vote for
each share of common stock that would be issuable to such holder upon the
conversion of all the shares of preferred stock so held, and each holder of
common stock shall be entitled to one vote per share. Despite these provisions,
(a) the holders of common stock and the holders of preferred stock will be
entitled to vote as separate classes (1) for any proposed merger, consolidation
or sale of the assets of our company as an entirety, but only if at the time of
such proposal, one person or group of persons is the "beneficial owner", as
determined under the rules of Regulation 13D-6 under the Exchange Act, of more
than 66 2/3% of the preferred stock, and (2) for any stock splits, reverse stock
splits, or other amendments to our charter which in any way adversely affects
the preferences, qualifications, special or relative rights or privileges of the
common stock, and (b) the holders of preferred stock will be entitled to vote
separately as a class on the matters described under "Restrictions" below. Our
charter does not provide for cumulative voting and, accordingly, the holders of
a majority of the outstanding shares of capital stock have the power to elect
all directors to be elected each year.
Our founding shareholders held our first annual meeting of shareholders in
1999. Our first general meeting of preferred shareholders was held on May 25,
2000. Subsequent general meetings of shareholders were held on May 31, 2001 and
May 30, 2002. Special meetings of preferred shareholders may be called at any
time by the President, by the Chairman of the Board of Directors, by a majority
of the Board of Directors, or by the written request of shareholders entitled to
cast a majority of the votes which all shareholders are entitled to cast at the
particular meeting, addressed to the Secretary and then the Secretary shall
proceed to call a special meeting only as may be required by law. Our charter
and bylaws may be amended in accordance with Maryland law.
Restrictions. Unless a greater percentage vote is required by law or our
charter, and in addition to any other vote required by law, without the prior
consent of holders of 66 2/3% of the outstanding preferred stock voting as a
separate class: (1) we will not create or issue any additional class or series
of capital stock unless such class or series ranks junior to the preferred stock
in respect of dividends and liquidation preference or increase the authorized
amount of preferred stock; and (2) we will not amend the terms of the preferred
stock in any way or our charter in a way which adversely affects the
preferences, qualifications, special or relative rights or privileges of the
preferred stock.
Repurchase of Shares and Restrictions on Transfer. Two of the requirements
of qualification for the tax benefits accorded by the REIT provisions of the
Internal Revenue Code are that (1) during the last half of each taxable year not
more than 50% in value of the outstanding shares may be owned directly or
indirectly by five or fewer individuals, the "50%/5 stockholder test", and (2)
there must be at least 100 stockholders on at least 335 days of each taxable
year of 12 months.
To meet these requirements at all times, our charter prohibits any person,
without the prior consent of the Board of Directors, from acquiring or holding,
directly or indirectly, shares of capital stock in excess of 9.8%, by vote or
value, of the aggregate of the outstanding shares of capital stock or in excess
of 9.8%, by value or number of shares, whichever is more restrictive, of the
aggregate of the outstanding shares of our common stock. For this purpose, the
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term "ownership" is defined in accordance with the REIT provisions of the Code
and the constructive ownership provisions of Section 544 of the Code, as
modified by Section 856(h)(1)(B) of the Code.
For purposes of the 50%/5 stockholder test, the constructive ownership
provisions applicable under Section 544 of the Code attribute ownership of
securities owned by a corporation, partnership, estate or trust proportionately
to its stockholders, partners or beneficiaries. These Code provisions also
attribute ownership of securities owned by family members to other members of
the same family and treat securities with respect to which a person has an
option to purchase as actually owned by that person in each case only if to do
so would cause a violation of the 50%/5 test. Further, these Code provisions set
forth rules as to when securities constructively owned by a person are
considered to be actually owned for the further application of such attribution
provisions, referred to as "reattribution". Thus, for purposes of determining
whether a person holds shares of capital stock in violation of the ownership
limitations set forth in our charter, many persons may be deemed to own directly
more than the 9.8% limit because an entities' shares are attributed to its
individual investors. A person will be treated as owning not only shares of
capital stock actually or beneficially owned, but also any shares of capital
stock attributed to such person under the attribution rules described above.
Accordingly, under some circumstances, shares of capital stock owned by a person
who individually owns less than 9.8% of the shares outstanding may nevertheless
be in violation of the ownership limitations set forth in our charter. Ownership
of shares of our capital stock through such attribution is generally referred to
as constructive ownership. Actual, and not constructive, ownership determines
the 100 stockholder test.
Our charter provides that if any transfer of shares of capital stock occurs
which, if effective, would result in any person beneficially or constructively
owning shares of capital stock in excess or in violation of the above transfer
or ownership limitations, then that number of shares of capital stock the
beneficial or constructive ownership of which otherwise would cause such person
to violate such limitations, rounded to the nearest whole shares, shall be
automatically transferred to a trustee, as trustee of a trust, for the exclusive
benefit of one or more charitable beneficiaries, and the intended transferee
shall not acquire any rights in such shares. Shares held by the trustee shall be
issued and outstanding shares of capital stock. The intended transferee shall
not benefit economically from ownership of any shares held in the trust, shall
have no rights to dividends, and shall not possess any rights to vote or other
rights attributable to the shares held in the trust. The trustee shall have all
voting rights and rights to dividends or other distributions with respect to
shares held in the Trust, which rights shall be exercised for the exclusive
benefit of the charitable beneficiary. Any dividend or other distribution paid
to the intended transferee before our discovery that shares of common stock have
been transferred to the trustee shall be paid with respect to such shares to the
trustee by the intended transferee upon demand and any dividend or other
distribution authorized but unpaid shall be paid when due to the trustee. Our
Board of Directors may, in their discretion, waive these requirements on owning
shares in excess of the ownership limitations.
Within 20 days of receiving notice from us that shares of capital stock
have been transferred to the trust, the trustee shall sell the shares held in
the trust to a person, designated by the trustee, whose ownership of the shares
will not violate the ownership limitations set forth in our charter. Upon such
sale, the interest of the charitable beneficiary in the shares sold shall end
and the trustee shall distribute the net proceeds of the sale to the intended
transferee and to the charitable beneficiary as follows. The intended transferee
shall receive the lesser of (1) the price paid by the intended transferee for
the shares or, if the intended transferee did not give value for the shares in
connection with the event causing the shares to be held in the trust, for
example, in the case of a gift, devise or other such transaction, the market
price, as defined below, of the shares on the day of the event causing the
shares to be held in the trust and (2) the price per share received by the
trustee from the sale or other disposition of the shares held in the trust. Any
net sales proceeds in excess of the amount payable to the intended transferee
shall be immediately paid to the charitable beneficiary. In addition, shares of
capital stock transferred to the trustee shall be deemed to have been offered
for sale to us, or our designee, at a price per share equal to the lesser of (1)
the price per share in the transaction that resulted in such transfer to the
trust, or, in the case of a devise or gift, the market price at the time of such
devise or gift, and (2) the market price on the date we, or our designee,
accepts such offer. We shall have the right to accept such offer until the
trustee has sold shares held in the trust. Upon such a sale to us, the interest
of the charitable beneficiary in the shares sold shall end and the trustee shall
distribute the net proceeds of the sale to the intended transferee.
9
The term "market price" on any date shall mean, with respect to any class
or series of our outstanding shares of stock, the closing price, as defined
below, for such shares on such date. The "closing price" on any date shall mean
the last sale price for such shares, regular way, or, in case no such sale takes
place on such day, the average of the closing bid and asked prices, regular way,
for such shares, in either case as reported in the principal consolidated
transaction reporting system with respect to securities listed or admitted to
trading on the NYSE or, if such shares are not listed or admitted to trading on
the NYSE, as reported on the principal consolidated transaction reporting system
with respect to securities listed on the principal national securities exchange
on which such shares are listed or admitted to trading or, if such shares are
not listed or admitted to trading on any national securities exchange, the last
quoted price, or, if not so quoted, the average of the high bid and low asked
prices in the over-the-counter market, as reported by the National Association
of Securities Dealers, Inc. Automated Quotation System of, if such system is no
longer in use, the principal other automated quotation system that may then be
in use or, if such shares are not quoted by any such organization, the average
of the closing bid and asked prices as furnished by a professional market maker
making a market in such shares selected by the Board of Directors or, if no
trading price is available for such shares, the fair market value of the shares,
as determined in good faith by the Board of Directors.
Every owner of more than 5%, or such lower percentage as required by the
Code or the regulations promulgated thereunder, of all classes or series of our
stock, within 30 days after the end of each taxable year, is required to give
written notice to us stating the name and address of such owner, the number of
shares of each class and series of our stock beneficially owned and a
description of the manner in which such shares are held. Each such owner shall
provide to us with such additional information as we may request to determine
the effect, if any, of such beneficial ownership on our status as a REIT and to
ensure compliance with the ownership limitations.
Subject to limitations, the Board of Directors may increase or decrease the
ownership limitations. In addition, to the extent consistent with the REIT
provisions of the Code, the Board of Directors may waive the ownership
limitations for and at the request of purchasers in this private placement or
subsequent purchasers.
The provisions described above may inhibit market activity and the
resulting opportunity for the holders of our capital stock to receive a premium
for their shares that might otherwise exist in the absence of such provisions.
Such provisions also may make us an unsuitable investment vehicle for any person
seeking to obtain ownership of more than 9.8% of the outstanding shares of
capital stock.
Before the listing of our stock for trading on a national exchange, we will
not permit a qualified plan, for this purpose only, the term "qualified plan"
also includes IRAs, entities whose assets include plan assets by reason of a
plan's investment in such entity, and other employee benefit plans described in
Section 3(3) of ERISA, whether or not subject to Title I of ERISA, to acquire
our stock, either directly from us or by transfer from an existing shareholder,
if such proposed transfer would cause the ownership of any class of our stock by
qualified plans in the aggregate to equal or exceed 25%. As a result, we retain
the right not to approve of the purchase of stock by or on behalf of a qualified
plan transferee or purchaser of shares. This restriction could adversely affect
the ability of a shareholder to sell his or her stock.
ITEM 6. SELECTED FINANCIAL INFORMATION.
You should read the following financial and operating data together with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our audited financial statements included elsewhere in this Form
10-K.
10
Capitalization
Our capitalization, as of December 31, 2002, was as follows:
Borrowings:
Unsecured notes payable $ 14,276,929
Secured line of credit
($15,000,000 facility) 14,431,132
------------------
Total borrowings 28,708,061
------------------
Capital Stock
Class A Convertible preferred stock
- 22,496,804 shares outstanding 226,079,882
Common stock - 100 shares outstanding (1) 1
Accumulated dividends and distributions (80,132,217)
------------------
Total borrowings and capital stock $ 174,655,727
==================
(1) Our founders have purchased a total of 100 shares of common stock at $.01
per share.
The selected financial data set forth below has been derived from our audited
financial statements included elsewhere in this Form 10-K.
11
December 31, 2001 December 31, 2000 December 31, 1999
December 31, 2002 (as restated) (as restated) (as restated)
------------------- ------------------ -------------------- -------------------
(in thousands, except per share amounts)
Total assets................................ $ 147,374 $ 184,597 $ 207,077 $ 176,756
Total debt.................................. 28,708 32,313 45,432 9,039
Convertible preferred stock................. 226,080 216,158 199,286 189,851
Accumulated deficit......................... (29,520) (8,215) (8,882) (12,455)
Inception
Year Ended Year Ended Year Ended (March 18, 1999) to
December 31, 2002 December 31, 2001 December 31, 2000 December 31, 1999
------------------- ------------------ -------------------- -------------------
Operating Results under Generally Accepted
Accounting Principles in the United States:
Revenues................................ 10,018 12,588 15,140 2,583
Net Income (loss)....................... (21,305) 667 3,572 (12,455)
(Loss) Income allocable to a Preferred Share:
Basic and Diluted....................... $ (0.96) $ 0.03 $ 0.19 (0.72)
Preferred stock dividends and distributions
per share............................... $ 0.96 $ 1.12 $ 1.14 $ 0.75
Loss allocable to each common share:
Basic and Diluted....................... (426,107) (234,510) (180,375) (124,547)
Cash flows from (used by):
Operating activities.................... (322) (2,156) 6,076 (1,434)
Investing activities.................... 17,991 26,400 ( 28,139) (26,887)
Financing activities.................... (15,982) (21,538) 21,387 28,997
Item 7. 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 mortgage loans. Statements contained in this Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and elsewhere in this Form 10-K, 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-K.
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-K or to reflect the occurrence of unanticipated events, other than
as required by law.
Overview
Primecore is engaged in the business of providing secured loans for the
development of residential real estate. The business has been active in its
current REIT form since 1999 and related business activities that preceded the
formation of the REIT began in 1996. Officers and employees of Primecore have
substantial experience in real estate and real estate lending matters.
Primecore's strategy has been specifically designed to serve the needs of small
and medium-sized developers who are actively building single-family and smaller
multi-family housing units in high demand residential areas.
12
Several characteristics of this target customer base and residential
housing market have been vital to Primecore's success:
1. These borrowers are generally not well served by institutional lenders
such as commercial banks. There are few lending institutions that are interested
in making construction loans to smaller developers. Traditional lending
institutions often lack the focused local residential real estate development
expertise to evaluate specific projects involving redevelopment of individual
home sites or smaller multifamily complexes. Thus these institutions are
generally slow to respond to developers needs and they propose difficult terms
and conditions on their loans. Developers have been pleased to deal with
Primecore due to its knowledge and responsiveness with respect to such projects.
Furthermore, the developers have been willing to pay interest rates and loan
fees above those charged by commercial banks on other classes of loans.
2. Residential real estate demand in certain well-established locations has
historically been strong throughout the various stages of economic cycles.
Except during exceptional economic downturns, this demand strength has supported
relatively strong and stable valuations for such residential real estate.
Similarly, this demand strength has typically led to high sales volumes of
dwelling units.
3. The greater San Francisco Bay Area and specifically the mid-peninsula
region surrounding Primecore, includes numerous cities, towns and neighborhoods
that exhibit very attractive residential housing characteristics. This region
has a large and diverse economy developed in a geographically constrained area.
Most residential housing locations have been fully developed for decades and yet
a chronic shortage of housing perpetually exists in proximity to employment
opportunities. New housing built in this region on either the few remaining
undeveloped lots or on lots formerly occupied by older housing has historically,
excluding exceptional economic downturns, enjoyed strong demand and relatively
stable high values. Most of the loans we make are classified as Acquisition,
Development and Construction (ADC) loans because they contain most of the
characteristics peculiar to these types of loans. ADC loans have the following
characteristics:
1. The loans are made to acquire, develop and construct real estate.
2. The lender has agreed to provide all or substantially all necessary funds
to acquire, develop or construct the property. The borrower has title to
but little or no cash equity in the project;
3. The lender funds substantially all the interest and fees during the term of
the loan by adding them to the loan balance;
4. Typically, the lender's only security is the project itself. The lender no
recourse to other assets of the borrower, and the borrower does not
guarantee the debt;
5. In order for the lender to recover its investment in the project, the
property must be sold to independent third parties or the borrower must
obtain refinancing from another source.
Primecore's business model contemplates making ADC loans secured by
residential real estate. We have, in the past, sought to accomplish a gross
yield of approximately 16% on our loans. After payment of expenses, the
Primecore model contemplates an annual cash dividend return to Primecore
investors of 9% to 11%.
However, the Bay Area economy has endured an unprecedented slowdown in 2001
and 2002. This was driven first by a reversal of the rapid expansion of the
technology and telecommunications industries in which Silicon Valley companies
play a leading role. Then, the general economic slowdown experienced in the
United States and Europe following terrorist attacks in the fall of 2001 further
exacerbated this economic slowdown.
While some residential real estate in the region has generally continued to
enjoy strong demand despite the economic downturn, projects in the locations and
price ranges we funded were hard hit. In particular, housing with prices in
excess of $2.5 million experienced a significant slow down in sales volume and
unprecedented valuation declines. Prior to 2000, we had made a significant
number of ADC loans for the development of such housing units. As of January
2001, 64% of the ADC loan portfolio consisted of loans greater than $2.5 million
per unit. These projects have been slower to sell than anticipated, and in a
number of cases have been sold at substantially lower prices than contemplated
when the ADC loans were made. As a result, the income we expected in 2002 from
these ADC loans was not realized.
13
During 2003, certain additional under performing ADC loans and foreclosed
properties that we now own must be liquidated. We expect continued impact on our
income from this liquidation. As existing projects are completed and sold, new
ADC loans will be made to balance the portfolio with loans projected to yield
positive rates of return.
Results of Operations
Revenue
We charge interest on the money we lend to developers. Our business model
targeted a 16% gross rate of return on these funds. Although we charge our
borrowers for the use of our money, we do not actually collect principal,
interest or fees until the financed property has sold or been refinanced by a
third party lender. We also do not generally have recourse to other borrower
assets, so we must rely on the value of the securing property to support
repayment of our loan plus accrued interest.
In 2001, the San Francisco Bay Area experienced a quick decline in the
values of homes priced above $5 million. In 2002, this market experienced
further declines in values and fewer homes sold at those price points.
Additionally, in 2002, the decline in the number of sales began to affect what
had been the middle priced sector, those homes priced at between $2 million and
$5 million. The effect essentially merged the middle sector into the high price
sector at a price point above $2.5 million. Therefore, homes now priced above
$2.5 million have roughly the same market characteristics as homes priced above
$5 million: there are few buyers, and the buyers that exist are very selective
and deliberate about making a purchasing decision. The result is that homes
priced above $2.5 million are typically taking longer to sell and selling for
lower prices.
A large percentage of our assets are invested in properties that have been
projected to sell above $2.5 million. As of December 31, 2002, approximately 64%
of our assets were invested in this sector. As a result, we are especially
vulnerable to the continued softening in the high-end market. During the year
ended December 31, 2002, we charged $21.2 million to impairment expense for
properties on which we believe we will not recover the carrying amount of our
investment upon the disposition of the property compared with $73,000 in 2001.
The increase in the impairment charge is a result of two factors: management's
reduction in projected values based on the deterioration of the high-end market,
and increased costs to complete projects which have been acquired through
foreclosure.
During 2002, as prices continued to decline in the high-end sector, many of
our borrowers experience difficulties in completing projects or selling
properties at prices that previously seemed reasonable. In many cases, borrowers
recognized that there would be no profit from the sale of their project. Their
motivation to continue to manage the project had therefore diminished, and in a
number of cases we had to foreclose on projects in order to complete
construction and sell the property. The foreclosure process adds approximately
four months to the time period required to construct a property since frequently
all work ceases during the foreclosure period. In addition, in 2002, several of
our borrowers declared bankruptcy immediately prior to a scheduled foreclosure
sale, thereby delaying further our ability to take control of properties. After
control has been obtained, it is necessary to restart the project and complete
construction. This can sometimes significantly add to the original cost. During
2002 we took title to 23 projects through foreclosure or deed in lieu of
foreclosure compared with 11 and none during the years ended December 31, 2001
and 2000.
14
The following table breaks down the results of our operations from our
investments during 2002:
Number
of loans Repayments Income Yield Impairment
--------- ------------------ ------------------ ------------- ------------------
Paid investments
Foreclosed 14 $ 17,620,481 $ 381,200 (4.73)% $ 2,484,337
ADC loans 19 28,243,279 9,636,989 12.13 --
Active investments
Foreclosed 18 4,756,801 -- -- 16,410,930
ADC loans 39 7,520,458 -- -- 2,342,776
------------------ ------------------ ------------- ------------------
Total 90 $ 58,141,019 $ 10,018,189 8.11% $ 21,238,043
================== ================== ============= ==================
The $16,410,930 impairment reflected as Foreclosed active investments
includes impairment charges of $11,419,566 related to properties formerly owned
by our affiliates. As part of an Affiliate Loan Agreement, our manager is
obligated to repay the amount of these impairments. The repayments will be made
from 70% of any cash flow or rate of return bonuses due to our manager. These
payments will be accounted for as income when received.
We calculate the gross internal rate of return for our investments which
have repaid based on the discounted present value of the cash flows from our
investment activity on an investment by investment basis. In 2002, our average
yield from paid investments was 8.11%. This average yield is approximately one
half of our target yield of 16%. The chart below depicts the yield on our
investments by quarter since the beginning of 2000. The chart shows a fairly
constant yield until the second quarter 2002 when the yield decreased
significantly. The decrease resulted mainly from the sale of foreclosed
properties, many of which stemmed from loans made in 1999 and 2000, when real
estate values were at their peak. We expect continued depressed yields as we
continue to liquidate our existing portfolio of investments and replenish them
with more balanced investments.
[GRAPHIC OMITTED]
Realizable Value of Investments
For financial statement purposes, we do not report as income the amount of
interest and points we charge to borrowers until we collect it. Because we have
a contractual right to receive it, the amount of interest and points we charge
borrowers is added to the balance due on our ADC loans. As the values of the
collateral supporting payment of our ADC loans have declined, the collectibility
of our accrued interest and points has, in many cases, become doubtful.
Management includes the amount of collectible interest and points we are
15
entitled to receive when it sets dividend rates and prices for selling and
redeeming our stock. The information presented below summarizes that analysis
and reconciles the differences between US GAAP and the estimated realizable
value of our investments.
December 31, 2002
-------------------
Investments in real estate under
construction $ 101,141,515
Investments in real estate held for sale 36,817,168
-------------------
Total investments in real estate per US
GAAP 137,958,683
Add: GAAP impairments 18,753,706
Accrued interest and points 64,337,376
Less: Capitalized interest (6,566,481)
-------------------
Balance owed on real estate investments 214,483,284
Amount estimated uncollectible (43,875,448)
-------------------
Realizable value of investments in real
estate $ 170,607,836
===================
The realizable value of our investments represents our current estimate of
the amount of proceeds we expect to receive once our investment is completed and
ready for sale. The estimate relies on a number of assumptions including the
expected value of the investment once completed, less applicable selling costs,
the remaining costs required to complete the project and the length of time
required to complete the project. Many factors, some outside our control, can
cause changes in these estimates and produce different results. We have obtained
independent appraisals for our investments to help us determine expected value
upon completion. However, due to the lack of recent sale comparables for many of
our properties priced in the high-end sector, it is difficult to project with
much certainty the ultimate sale price of many of these properties.
Many of the ADC loans in our portfolio were made in 1999 and 2000, when the
real estate market in the San Francisco Bay area reached its peak. With the
decline in values over the last two years, current values no longer support the
prices paid to acquire the land. The following chart shows the portion of our
portfolio we estimate will not be collectible based on the year the ADC loan was
made:
[GRAPHIC OMITTED]
16
Stock Redemption Price
Subsequent to year-end, the Board of Directors approved a change to our
redemption policy which provided for the disclosure of the fair market value of
our stock. Because our stock does not trade on any secondary market, another
method must be used to determine the fair market value. The Board has determined
that the value of the stock should be determined with reference to the Net
Realizable Value of our assets. Therefore, in accordance with the resolutions of
the Board of Directors, the following calculation determines the fair market
value of our stock at December 31, 2002 for purposes of our redemption policy:
December 31, 2002
-------------------
Cash $ 4,394,107
Realizable value of investments in real estate 170,607,836
Loans secured by real estate 4,695,000
-------------------
Total realizable assets 179,696,943
Total liabilities 30,946,018
-------------------
Net realizable assets 148,750,925
Preferred shares outstanding 22,496,804
-------------------
Net realizable assets per share 6.61
===================
Expense
Prior to January 1, 2003, we paid management fees based on the amount of
loan commitments outstanding at the end of each month. During the year ended
December 31, 2002, our management fee expense was $9,630,071 compared with
$11,345,585 and $10,967,249 in 2001 and 2000 respectively. The decrease in our
management fee expense resulted primarily from the decrease in the amount of our
loan commitments during 2002.
As of October 17, 2002, we entered into an amended and restated management
agreement with our manager, Primecore Funding Group, Inc. The agreement was
included in an 8-K filing on December 20, 2002. The agreement generally provides
that the fees our manager earns will be based on three components: a base fee,
determined monthly, of 3.125% per annum of the total carrying amount of our
investments in real estate, determined according to US GAAP; a cash flow bonus,
determined quarterly, payable only upon achieving certain levels of loan
repayments; and a rate of return bonus, determined quarterly, which is payable
only upon achieving certain income per share returns for holders of Preferred
Stock.
The changes made to the management agreement are intended to provide a
better alignment of interest between our manager and the shareholders given
current economic realities. The base fee is a reduced fee given the current
portfolio since the fee is based on the carrying amount of ADC loans, instead of
loan commitments. To the extent that the manager's actions produce results that
are above base expectations, the manager will be rewarded. Under the
restructured agreement our base management fee expense is expected to be reduced
from $9.6 million in 2002 to approximately $4.5 million in 2003.
Since December 31, 1999, all interest costs have been capitalized as a cost
of our investments. Interest cost associated with our borrowings was $2,578,762
during the year ended December 31, 2002 compared with $4,174,852 and $4,680,818
during the years ended 2001 and 2000. The decrease is due to a combination of a
lower average cost of debt, 9.08% in 2002 compared with 11.01% and 10.96% in
2001 and 2000, respectively; and a lower amount of debt on our balance sheet, an
average of $28.65 million in 2002 compared with averages of $37.22 million and
$42.70 million in 2001 and 2000. We are seeking to maintain our debt at their
existing levels, and intend to negotiate extensions of existing notes or seek
new sources to enable us to lower the cost of our debt.
17
We have no employees, and our general and administrative and other expenses
consist primarily of professional fees, directors' fees and insurance costs.
General administrative and other expenses were $454,900 for the year ended
December 31, 2002, compared with $502,080 and $600,776 for the years ended
December 31, 2001 and 2000.
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 and dividend
distributions 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
By far, the largest source of our liquidity is the repayment of our
investments in real estate. In most cases, we must rely on the sale of the
project before we can collect our investment, which means that our repayment is
largely dependent on the state of the real estate market. As discussed in our
Results of Operations, at December 31, 2002 approximately 64% of our investments
were in properties expected to sell at prices over $2.5 million. Sales of
properties in this sector have been very slow in 2001 and 2002 as the few buyers
who are able to afford these properties have been very deliberate about their
purchase decisions. Our cash flows from loan repayments are therefore a function
of both the construction period and the time it takes for the completed property
to sell. The chart below shows the amount of proceeds we expect to collect from
our existing investments based on the quarter the project is expected to
complete construction and be ready for sale. The bars of the graph categorize
the proceeds by the price sector of the underlying property.
18
[GRAPHIC OMITTED]
Based on existing market conditions, we expect completed properties with
offer prices under $2.5 million to sell in three to six months if the property
is well priced. For properties with offer prices exceeding $2.5 million, we
expect six months to one year for the property to sell if it is well priced.
Because a single loan repayment can have a large impact on our repayment
projections, it is difficult to predict repayments with much precision,
especially as construction and sales can be delayed due to foreclosure or
borrower bankruptcy proceedings. However, due to the large value of properties
that were complete at December 31, 2002 and those expected to complete in the
first quarter of 2003, we believe that we will have sufficient liquidity to meet
our commitments in a timely manner.
In the event that our repayments are not sufficient to timely meet our
commitments we may be forced to reduce prices on properties we control in order
to expedite their repayment. In such cases, amount of proceeds received could be
substantially less than what we would have expected if we allowed a proper
marketing period for the property. This would have a negative impact on the
estimated net realizable value of our assets.
Our liquidity is also enhanced through sales of our Preferred Stock and
issuance of notes payable to investors. Our Preferred Stock is sold through
private placements. For the year ended December 31, 2002 we sold 1.26 million
shares of Preferred Stock for proceeds of $12.6 million compared with 2.79
million shares for proceeds of $27.9 million and 2.84 million shares for $28.2
million during 2001 and 2000, respectively. Sales of our stock decreased during
2002 compared with 2001 and 2000 apparently as a result of general economic
conditions and the performance of our investment portfolio. In November 2002,
the Board of Directors voted to close our private placement. We expect to open a
new private placement in 2003, however we do not expect to generate any
appreciable sales until we have liquidated a substantial part of our existing
investment portfolio and reinvested the proceeds in new projects.
We issue a limited amount of short-term notes payable as an investment
alternative to our Preferred Stock. Originally conceived as a means to fund our
portfolio growth during the period we registered our Preferred Stock, we issued
$4.1 million in notes during the year ended 2002 compared with $19.3 million and
$61.2 million issued during the years 2001 and 2000. For the most part, this was
a planned reduction on our part as we sought to limit the amount of our
short-term indebtedness. Our objective for 2003 and beyond is to maintain our
19
existing notes payable balances at or around current levels through extension of
existing notes and issuance of new notes to replace maturities of existing
notes.
Uses of Cash
The following table sets forth the projected timing and amount of our
obligations over the next two years, without taking into account new loans that
may be made in 2003 and 2004:
Obligation Total 2003 2004
------------------------------- ---------------- ----------------- -----------------
Investment fundings $ 46,250,000 $ 42,500,000 $ 3,750,000
Line of credit 14,431,432 14,431,432 --
Short term notes payable 14,276,929 13,806,929 470,000
Dividend payments 31,494,000 15,747,000 15,747,000
---------------- ----------------- -----------------
Total $106,452,361 $ 86,485,361 $ 19,967,000
================ ================= =================
Investment fundings are our largest use of our cash. At December 31, 2002
we estimated costs to complete our investments were $46.25 million. These
amounts will be funded as construction progresses on our investments. The exact
timing of the 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. Additionally, we expect the amount of actual
investment fundings to be higher than our obligation existing at December 31,
2002 as we continue to make and fund new loan commitments in 2003 and beyond.
Our line of credit matures in May 2003. We are discussing an extension of
this loan with our current lender and others. We are optimistic that we will be
successful in renewing this commitment or obtaining a new line of credit based
on the amount of collateral we have available to secure the facility. In the
event that we are unsuccessful in renewing this facility we would have to use
more of the proceeds from the repayment of our investments to repay this
facility rather than using the funds to make new loans. We have approximately
$13.8 million in unsecured notes payable that mature in 2003. Our strategy is to
extend these notes on terms that are favorable to us. As of December 31, 2001 we
had approximately $17.3 million in unsecured notes payable which were due to
mature in 2002. During the year we were successful in extending and issuing new
notes to replace the notes we paid while, at the same time, decreasing the
average cost of our borrowings from 11.01% to 9.08%. The net decrease in notes
payable resulting from our efforts was approximately $3 million.
Although dividend payments are not contractual obligations we have included
their impact on our liquidity since the Board of Directors has determined to
maintain a dividend to shareholders even though the dividend is currently, and
for the foreseeable future, paid out of capital and not income. As such, these
dividend payments will not be taxable to shareholders. Dividend payments may be
discontinued at any time, if circumstances warrant and if this can be done
without a risk to our REIT status.
In addition to the above, we expect to pay management fees to our manager
as described under Results of Operations above, and make periodic payments of
interest on our short term notes payable based upon balances outstanding.
We redeemed 0.75 million shares of Preferred Stock with payments of $7.4
million during the year ended December 31, 2002 compared with 1.71 million
shares for $17.1 million and 2.47 million shares for $24.7 million in 2001 and
2000, respectively. We began the year with outstanding redemption requests of
3.8 million shares. By the end of the year, redemption requests were
approximately 6.88 million, with a significant number of such requests being
made following the announcement in October 2002 that the Board would be reducing
dividend payments. Shareholders do not have a vested right to redemption of
their stock, however the Board of Directors maintains a redemption policy that
provides for redemption subject to availability of funds. A moratorium on
redemptions was declared in October 2002. Effective February 12, 2003, the Board
of Directors implemented a new redemption policy for shareholders who wish to
sell their shares to us. The policy may be modified or terminated at the Board's
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discretion at any time. Currently, we will repurchase shares, at fair market
value, as determined by our Board of Directors, utilizing 25% of "free cash
flow" for such purposes. "Free cash flow" means the total of all proceeds from
repayments of loans and all net proceeds from the sale of real-estate-owned
properties in the Company's portfolio during a Repurchase Period, and then
subtracting from such total amounts due during the same period for (i) existing
loan commitments, (ii) debt payments to third parties, (iii) dividend or other
distributions to shareholders, and (iv) operating expenses. The periods between
October 1 and March 31 of the following year, and April 1 and September 30 are
each a "Repurchase Period" for the purposes of calculating "free cash flow,"
except that the first Repurchase Period under the policy runs from January 1,
2003 through March 31, 2003. Redemption of shares is always subject to
availability of funds for redemption purposes, and all redemption requests are
acted upon in accordance with the best interests of the Company. We will not
sell or otherwise liquidate any portion of our mortgage loan portfolio or other
assets to fund a redemption request. The text of the new policy was disclosed in
an 8-K filing on February 18, 2003.
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 ADC 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 ADC 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
fair 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, 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. In accordance with this policy, we
recorded a provision for impairment of investments in real estate under
development totaling $21.2 million during the year ended December 31, 2002
compared with $73,000 and none during the years ended December 31, 2001 and
2000. We believe that all of our investments are carried at realizable values,
however conditions may change and cause our ADC 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 ADC
loans until the sale or refinancing of a property. Revenue from interest and
21
points is recognized as cash is received from the sale or refinancing of such
properties. ADC loans are classified as investments in real estate under
development 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 ADC loans qualified as loans
under GAAP, interest and points would be recognized as income in periods prior
to the sale of the underlying property.
REIT status and taxation. 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 that the Board of Directors deems, at a given time, to be prudent. 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. Payment of preferred stock dividends could be adversely
effected if we experience a further slow down in the repayment of our ADC loans.
ITEM 7A. QUALITATIVE AND QUANTITATIVE 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 ADC 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 ADC 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.
In addition to the foregoing, and other information contained or
incorporated into this Form 10-K, the following is a discussion of risk factors
that we believe are material at this time
General Risks Related to Construction Mortgage Lending
Real estate security. Our securities are subject to risks inherent in real
estate lending. Many of the risks of holding mortgage loans are similar to the
risks of investing directly in the real estate securing the mortgage loans. This
may be especially true in the case of a relatively small or less diverse pool of
mortgage loans. If there is a default on the mortgage loan, the ultimate extent
of our loss, if any, may only be determined after a foreclosure of the mortgage
encumbering the property and, if we take title to the property, upon liquidation
of the property. Factors such as the title to the property or its physical
condition, including environmental considerations and state of construction, may
make a third party unwilling to purchase the property at a foreclosure sale or
for a price sufficient to satisfy the obligations with respect to the related
mortgage loan. Foreclosure laws may protract the foreclosure process. In
addition, the condition of a property may deteriorate during the pendency of
foreclosure proceedings. Some borrowers may become subject to bankruptcy
proceedings, in which case the amount and timing of amounts due may be
materially adversely affected. Even if the real property provides adequate
security for the mortgage loan, substantial delays could be encountered in
connection with the liquidation of a defaulted mortgage loan and a corresponding
delay in the receipt and reinvestment of principal and interest payments could
occur.
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Real estate market conditions. The real estate lending business may be
adversely affected by periods of economic slowdown or recession, which may be
accompanied by declining real estate values. Any material decline in real estate
values reduces the ability of borrowers to use real estate equity to support
borrowings and increases the loan-to-value ratios of mortgage loans previously
made, thereby weakening collateral coverage and increasing the possibility of a
loss in the event of default. In addition, delinquencies, foreclosures and
losses generally increase during economic slowdowns and recessions.
Loans on properties not yet constructed. A mortgage loan made to finance a
property that is not yet constructed will generally involve greater risks than a
mortgage loan on property that has been constructed. In the case of a property
already constructed, market value at the time the loan is made is more readily
ascertainable from current market valuations. In the case of a property not
already constructed, there can be no assurance that the improvements to be
constructed can be accomplished with available funds or in a timely manner. Sale
or refinancing of the completed project generally provides the funds for
repayment of a construction mortgage loan. While analyses are made to predict
the completed market value of the development project, such analyses are subject
to unanticipated changes over which we may have no control. Since market value
cannot be determined until a property is actually sold in the marketplace, the
market valuation of a proposed construction project can be especially
speculative.
Economic conditions. The performance of a mortgage loan portfolio will
depend on, among other things, the level of net interest income generated by the
mortgage loans, the market value of the mortgage loans and the supply of and
demand for construction mortgage loans. Prepayment rates, interest rates,
borrowing costs and credit losses depend upon the nature and terms of the
mortgage loans, the geographic location of the properties securing the mortgage
loans, conditions in financial markets, the fiscal and monetary policies of the
United States government and the Board of Governors of the Federal Reserve
System, international economic and financial conditions, competition and other
factors, none of which can be predicted.
Changes in interest rates. The levels of and fluctuations in interest
rates, which affect the ability to earn a spread between interest received on
loans and the costs of borrowings, may directly affect profitability.
Profitability is likely to be adversely affected during any period of unexpected
or rapid changes in interest rates. For example, a substantial or sustained
increase in interest rates could adversely affect the interest rate differential
between newly originated loans and the cost of borrowing. A significant decline
in interest rates could decrease the size of our loan portfolio by increasing
the level of loan prepayments as our loans carry fixed rates of interest. While
we monitor the interest rate environment, and generally should earn a positive
spread between interest paid on borrowed funds and interest earned on mortgage
loans, there can be no assurance that our profitability, and thus our dividend
rate, would not be adversely affected during any period of changes in interest
rates.
Environmental liabilities. In the event that hazardous substances are found
to have contaminated properties secured by mortgage loans, the value of the real
property may be diminished. If forced to foreclose on a defaulted mortgage loan
on a contaminated property, we might potentially become subject to environmental
liabilities even if we were not responsible for the contamination. While we
intend to exercise due diligence to discover potential environmental liabilities
before the acquisition of any property through foreclosure, hazardous substances
or wastes, contaminants or pollutants may be discovered on properties during our
ownership or after a sale of the property to a third party. If hazardous
substances are discovered on a property, we may be required to remove those
substances or sources and clean up the property. We may also be liable to
tenants and other users of neighboring properties. In addition, we may find it
difficult or impossible to sell the property before or following any clean up.
Legislation and regulation. The mortgage loan and REIT areas are subject to
extensive regulation, supervision and licensing by federal, state and local
governmental authorities and to various laws and judicial and administrative
decisions imposing requirements and restrictions. Laws and regulations may be
subject to legislative, administrative and judicial interpretation, especially
laws and regulations that have been infrequently interpreted or only recently
enacted. Infrequent interpretations of laws and regulations or an insignificant
number of interpretations of recently enacted regulations can result in
23
ambiguity with respect to permitted conduct under these laws and regulations.
Ambiguity under regulations to which our manager or we are subject may lead to
regulatory investigations or enforcement actions and private causes of action.
Failure to comply with regulatory requirements can lead to loss of approved
status, lawsuits and administrative enforcement actions. There can be no
assurance that we or our manager will maintain compliance with these
requirements in the future without additional expenses, or that more restrictive
local, state or federal laws, rules and regulations will not be adopted or that
existing laws and regulations will not be interpreted in a more restrictive
manner, which would make compliance more difficult for us and our manager.
Specific Risks of Investment in Our Securities
Restrictions on transferability and lack of liquidity of shares. Shares of
our Class A Convertible Preferred stock have been privately placed solely with
accredited investors who have acquired them for investment purposes only and not
with a view toward transfer, resale, exchange or distribution. There currently
is no public market for our shares of Preferred stock and transfer is subject to
significant restrictions under federal and state law. Accordingly, the
transferability of such shares of stock is limited. Additionally, the shares may
not be readily accepted as collateral for a loan. Holders of our Class A
Convertible Preferred stock do not have a vested right to redeem their shares,
and therefore may not be able to liquidate their investment in the event of an
emergency or otherwise. Our Board of Directors currently has a stock redemption
policy for shareholders who wish to sell their shares to us. The policy may be
modified or terminated at the Board's discretion at any time, subject to the
exercise of their prudent business judgment. In addition, redemption requests
are only honored where there is cash available for redemption purposes, and
shareholders may therefore not have their redemption requests honored in as
timely a manner as they may wish, especially during economic times when loan
repayments are slowed. Also, a change in the redemption policy, which would be
effected solely for the benefit of the Company, could affect a shareholder's
ability to liquidate their investments.
Loans losses. As noted above, a mortgage loan made to finance a property
that is not yet constructed generally involves greater risks than a mortgage
loan on property that has been constructed since there can be no assurance that
the improvements to be constructed can be accomplished with available funds or
in a timely manner. Furthermore, while analyses are made to predict the
completed market value of the development project, such analyses are subject to
unanticipated changes over which we may have no control, including recessions
and economic downturns. During 2002, we sustained significant losses in our
portfolio, as discussed above, and also were required to acquire a number of
properties through foreclosure, in many cases because their values were
insufficient to repay all of our investment, including accrued interest and
fees. In the near term, we anticipate that there will be additional losses as
loans and real estate owned properties are repaid, foreclosed upon and/or sold.
Dependence on manager. We do not have any employees. All of our day-to-day
operations are conducted on our behalf by our manager and affiliate, Primecore
Funding Group, Inc., which provides services to us pursuant to a written
management agreement. If our manager refused or became unable to perform
services on our behalf, and if a substitute manager could not be found, this
would materially and adversely impact on our ability to continue to do business.
Balloon loans. The loans in our portfolio will typically require the
borrower to make a "balloon payment" on the principal amount upon maturity of
the loan. To the extent that a borrower has an obligation to pay a mortgage loan
in a large lump sum payment, their ability to satisfy this obligation may be
dependent upon their ability to obtain suitable refinancing or otherwise raise a
substantial cash amount. An increase in market interest rates over the mortgage
rates available at the time the loan was originated may have an adverse effect
on the borrower's ability to obtain refinancing or to pay required monthly
payments. As a result, these loans may involve a higher risk of default than
fully amortizing loans.
Lack of geographic diversification. Properties securing repayment of the
mortgage loans are currently located in the San Francisco Bay Region of Northern
California. Since the properties secured by the mortgage loans are located in
the same geographic region, these mortgage loans may be subject to a greater
risk of delinquency, default and potential loss if economic or political
conditions or real property values in the region deteriorated substantially.
24
Also, since borrowers will not be required to purchase earthquake insurance, and
properties are in the San Francisco Bay Area, known for its earthquake activity,
mortgage loans are subject to greater risk of loss than properties located in
more stable geologic areas.
Funding of loan commitments. We use our capital to invest in mortgage loans
with outstanding balances generally less than the outstanding commitment
amounts. This is because disbursements under the commitments occur over time in
conjunction with the construction progress of any particular construction
mortgage loan. We cannot predict with certainty the total amount of our future
capital, however, we expect that proceeds generated from completed real estate
developments and additional equity placements and note issuances, and borrowings
will be sufficient to fund all loan commitments. If, however, for some reason we
were unable to obtain loan payoffs or raise additional capital through the sale
of equity and debt securities or the sale of assets to meet our funding
commitments, and if we were unable to borrow sufficient funds, we might then be
unable to fund all of our existing loan commitments. Borrowers might then be
unable to complete their projects if they could not obtain financing from other
sources, and we conceivably could incur damages. Also, if we became unable to
meet our contractual obligations, our reputation would likely suffer, and we
might be unable to attract new borrowers, resulting in the loss of future
business. This might have a materially adverse effect upon our financial
condition, cash flows and results of operations.
Manager Relationship. Some of our directors and executive officers are also
executive officers, employees and shareholders of our manager. Under a
management agreement, our manager earns a management fee based upon the dollar
amount of our construction mortgage loan portfolio. In evaluating construction
mortgage loans, if our manager were to place an undue emphasis on maximizing
income at the expense of other criteria, such as preservation of capital, to
increase compensation for our manager, this could result in increased exposure
to losses on our mortgage loan portfolio.
Discretion of Board of Directors. Management has established our operating
policies and strategies. These policies and strategies may be modified or waived
by the Board of Directors, without shareholder approval. The ultimate effect of
any such changes may adversely affect our operations.
Competition. As with any business, we may face competition, primarily from
commercial banks, savings and loans, other independent mortgage lenders, and
other mortgage REITs. Also, if we expand into particular geographic markets in
order to increase geographic diversity and take advantage of opportunities in
such markets, we may face competition from lenders with established positions in
these locations. Competition can take place on various levels, including
convenience in obtaining a mortgage loan, service, marketing, origination
channels and pricing. Although we do not know of any particular competitor that
dominates our market, many of our competitors in the financial services business
are substantially larger and have more capital and other resources. There can be
no assurance that we will be able to compete successfully in this market
environment. Any failure in this regard could have a material adverse effect on
our results of operations and financial condition.
Borrowing. We may employ a financing strategy to increase the size of our
mortgage loan portfolio by borrowing a portion of the market value of our
mortgage loans. The costs of those borrowings vary depending upon the lender,
the nature and liquidity of the underlying collateral, the movement of interest
rates, the availability of financing in the market and other factors. If the
returns on the mortgage loans purchased with borrowed funds fail to cover the
cost of the borrowings, we will experience net interest losses and may
experience net losses. In addition, we may not be able to achieve the degree of
leverage we believe to be optimal, which may cause us to be less profitable than
we might be otherwise. We may finance some of the mortgage loans that we hold
through interim financing facilities such as bank credit lines. We will be
dependent upon a few lenders to provide the primary credit facilities for our
mortgage loans. Any failure to renew or obtain adequate funding under these
financings, or any substantial reduction in the size of or pricing in the market
for our mortgage loans, could have a material adverse effect on our operations.
We have not made any agreements under which a lender would be required to enter
into new borrowing agreements during a specified period of time; however, we may
make such agreements if deemed favorable. We will face competition for financing
sources, and the effect of the existence of additional mortgage REITs may be to
deny us access to sufficient funds to carry out our business plan or to increase
25
the cost of funds to us. Our goal is to strike a balance between the
under-utilization of leverage, which reduces potential returns to shareholders,
and the over-utilization of leverage, which could reduce our ability to meet our
obligations during adverse market conditions.
Our ability to achieve all of our investment objectives may depend not only
on our ability to borrow money in sufficient amounts and on favorable terms but
also on our ability to renew or replace on a continuous basis our maturing
short-term borrowings. In the event we are unable to renew or replace maturing
borrowings, we could be required to sell mortgage loans under adverse market
conditions and could incur losses as a result. A sharp rise in interest rates or
increasing market concern about the value or liquidity of a type or types of
mortgage loans in which our portfolio is concentrated will reduce the market
value of the mortgage loans, which would likely cause lenders to require
additional collateral. A number of those factors in combination may cause
difficulties for us, including a possible liquidation of a major portion of our
mortgage loans portfolio at disadvantageous prices with consequent losses, which
could have a material adverse effect on our solvency.
Future offerings. We may increase our capital resources by making
additional offerings of equity and debt securities, including classes of
preferred stock, common stock, commercial paper, medium-term notes,
mortgage-backed obligations and senior or subordinated debt. All debt securities
will be and some classes of preferred stock could potentially be senior to the
Class A Convertible Preferred stock we are offering under this placement
memorandum in the event of our liquidation. Additional equity offerings may
dilute the equity of our shareholders or reduce the price of shares of our
outstanding securities, or both.
Deficiency upon liquidation of our mortgages. The market value of our
mortgage assets may fluctuate significantly. If we need to sell assets to repay
our outstanding notes or other borrowings or commitments, our mortgage assets
may prove to be illiquid. Even if sold at a discount, the proceeds of sale might
be less than the outstanding principal amount of, and interest payable on, our
notes.
Operating history. The Company was organized in March 1999, and has been
operating since May 1, 1999. Our prior results will not necessarily be
indicative of our future results. Furthermore, although the principals of
Primecore Funding Group, Inc., our manager, have experience in construction
mortgage lending that predates organization of the Company, there can be no
assurance that the past experience of our manager will be indicative of our
future results.
Public market price volatility. We have made a business decision not to
list our securities for trading on any public market in order to avoid the price
volatility to which publicly-traded securities may be subject. It is possible
that future events could result in a determination to change such business
decision. In the event a public market for our securities did develop, the
market price of the securities might increase or decrease for reasons unrelated
to our operating performance. In particular, general market price movements,
interest rate changes and credit quality trends might affect the price of
securities related to the specialty finance and real estate industries market
segments. Also, market prices might be influenced by any variation between the
net yield on our mortgage loan portfolio and prevailing market interest rates
and by the market's perception of our ability to achieve earnings growth. In
addition, if the market price of other REIT stocks declined for any reason, or
if there was a broad-based decline in real estate values or in the value of our
portfolio of mortgage loans, the market price of the securities and
transferability could be adversely affected.
Restrictions on ownership of capital stock. Subject to the limitations set
forth in the articles supplementary creating our preferred stock, our charter
authorizes our Board of Directors to reclassify any of the unissued shares of
authorized capital stock into a class or classes of preferred stock. The
issuance of additional preferred stock could have the effect of making more
difficult any attempt to gain control of us by means of a merger, tender offer,
proxy contest or otherwise. To comply with the requirements for qualification as
a REIT at all times, our charter prohibits any person, absent a waiver from the
Board of Directors, from acquiring or holding, directly or indirectly, shares of
capital stock (including warrants and options), in excess of 9.8% of the vote,
value or aggregate number of the outstanding shares of capital stock or common
stock. See the section "Description of Capital Stock" for a more detailed
description of these limitations on ownership. If a public market were to be
established for our stock, which we presently do not anticipate for reasons set
forth above, these provisions might inhibit market activity and the resulting
26
opportunity for the holders of our capital stock to receive a premium for their
securities that might otherwise exist in the absence of those provisions. Those
provisions also may make us an unsuitable investment vehicle for any person
seeking to obtain ownership of more than 9.8% of the outstanding shares of
capital stock.
In addition, provisions of Maryland law relating to "business combinations"
and a "control share acquisition" and of our charter and bylaws, particularly
the staggered terms for directors, may also have the effect of delaying,
deterring or preventing a takeover attempt or other change in control which
would be beneficial to shareholders and might otherwise result in a premium over
then prevailing market prices.
Every owner of more than 1% (or such lower percentage as required by the
Code or related regulations) of all classes or series of our stock, within 30
days after the end of each taxable year, is required to respond in writing to
our annual request for stock ownership information, or to include such
information on their tax return, including by stating the name and address of
such owner, the number of shares of each class and series of our stock
beneficially owned and a description of the manner in which such shares are
held. Each such owner shall provide to us such additional information as we may
request to determine the effect, if any, of such beneficial ownership on our
status as a REIT and to ensure compliance with the ownership limitations.
Investment by tax-exempt entities. A fiduciary of a pension,
profit-sharing, stock bonus plan or individual retirement account, including a
plan for self-employed individuals and their employees or any other employee
benefit plan subject to the prohibited transaction provisions of the Internal
Revenue Code or the fiduciary responsibility provisions or "prudent man" rule of
the Employee Retirement Income Security Act of 1974, known as "ERISA", should
consider:
(a) whether the ownership of our securities is in accordance with the
documents and instruments governing the employee benefit plan,
(b) whether the ownership of our securities is consistent with the
fiduciary's responsibilities and satisfies the applicable requirements of
ERISA, in particular, the diversification, prudence and liquidity
requirements of section 404 of ERISA,
(c) the prohibitions under ERISA on improper delegation of control
over, or responsibility for "plan assets" and ERISA's imposition of
co-fiduciary liability on a fiduciary who participates in, or permits, by
action or inaction, the occurrence of, or fails to remedy, a known breach
of duty by another fiduciary with respect to plan assets, and
(d) the need to value the assets of the employee benefit plan
annually.
A plan fiduciary should understand the illiquid nature of an investment in
our securities and that no secondary market will exist for them, and should
review both anticipated and unanticipated liquidity needs for the plan and
conclude that an investment in our securities is consistent with the plan's
foreseeable future liquidity needs.
REIT status and taxation. We intend to continue to operate as a REIT for
federal income tax purposes. We elected to be subject to tax as a REIT when we
filed our first federal income tax return for 1999. 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 and the relief provisions of the Code do
not apply, we would be subject to federal income tax as a regular, domestic
corporation, and our shareholders would be subject to tax as shareholders of
such a corporation. Distributions to shareholders in any year in which we fail
to qualify as a REIT would not be deductible in computing our taxable income. As
a result, we could be subject to income tax liability and the cash available for
repayment of our short term notes or distribution to our shareholders would be
significantly reduced or eliminated. Further, we could also be disqualified from
re-electing REIT status for the four taxable years following the year during
which we became disqualified.
27
REIT qualification requirements with respect to (1) our source of income,
the nature of our assets and distribution of dividends may limit operational and
financial opportunities otherwise available to us and (2) shareholder
diversification may limit our access to certain otherwise interested investors.
There is no assurance that future legislation, regulations, administrative
interpretations or court decisions will not significantly change the tax laws
with respect to our qualification as a REIT or with respect to the federal
income tax consequences of that qualification. Any such changes may reduce or
eliminate our competitive advantage over non-REIT competitors.
Investment Company Act exemption. We conduct our business so as not to
become regulated as an investment company under the Investment Company Act. The
Investment Company Act exempts entities that are "primarily engaged in the
business of purchasing or otherwise acquiring mortgages and other liens on and
interests in real estate." If we should fail to qualify for an exemption from
registration as an investment company, our ability to use leverage would be
substantially reduced and we would be unable to conduct our business.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Required financial statements and supplementary data are included in this Form
10-K commencing on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
In July we engaged Grant Thornton LLP as our independent auditors, replacing
Arthur Andersen.
PART III
ITEM 10. DIRECTORS AND OFFICERS OF THE REGISTRANT
Our Board of Directors consists of five directors, two of which were
elected after expansion of our Board on March 1, 2002. Our directors, executive
officers and senior officers and their positions are:
Name Position
---- --------
Susan Fox President and Director
William Whitlow Chairman of the Board of Directors
Michael Rider Treasurer, Chief Financial Officer and Director
Robert Puette Director
James Barrington Director
Ben Hamburg Secretary
The business background and experience of our directors and executive
officers is as follows:
Susan Fox, age 46, is a co-founder, director and President of the Company.
Ms. Fox is also a director, President and sole shareholder of our manager,
Primecore Funding Group, Inc., and other affiliated companies. Ms. Fox has been
involved in real estate development and construction lending for over twenty
years. In 1993, Ms. Fox became a consultant, then employee and President of Jim
Ward & Associates, Inc. Ms. Fox was responsible for dealing with substantial
loan workout situations relating to loans made prior to her retention by Jim
Ward & Associates. Since 1996, Ms. Fox has been the President of Primecore
Funding Group, Inc. Ms. Fox has overall management responsibility and primary
responsibility for loan underwriting and managing the loan portfolio.
28
William Whitlow, age 49, is Chief Executive Officer and Chairman of the
Board of Directors of the Company, and Chief Operating Officer of Primecore
Funding Group, Inc. Mr. Whitlow received a Masters of Management from the J. L.
Kellogg Graduate School of Management at Northwestern University, and a Masters
of Architecture from the University of Illinois. Prior to joining Primecore, Mr.
Whitlow was Managing Director of Arthur Andersen's Western Region Real Estate
Capital Markets Group based in San Francisco. He was responsible for strategic
capital markets consulting, private placements of debt and equity, portfolio and
company sales, and mergers and acquisitions. Prior to joining Arthur Andersen,
Mr. Whitlow was a Director of PricewaterhouseCoopers' Real Estate Capital
Markets Group, operated his own real estate firm, Alliance Management, was a
Vice President at Pacific Gateway Properties, where he directed the strategic
management and repositioning of the company's real estate portfolio, and was
with Aetna Realty Investors, where he held various positions over a 9-year
period, performing loan production, asset management and dispositions services.
Mr. Whitlow is a member of the Urban Land Institute, PREA, and the National
Association of Real Estate Investment Trusts.
Michael Rider, age 40, is a co-founder, director, treasurer and Chief
Financial Officer of the Company. Mr. Rider's term of office as a director
expires in 2003. Mr. Rider is a Certified Public Accountant. Mr. Rider was
controller, then Chief Financial Officer for The Plymouth Group and its
successor, TPG Development Corporation, a San Francisco Bay Area real estate
development company from 1991 until 1998. Since July 1998, he has served as
Chief Financial Officer of Primecore Funding Group, Inc. He is also the Chief
Financial Officer for our affiliates: Eprime, Inc., Primecore Properties, Inc.,
and 99 Investors, LLC.
Robert L. Puette, 61, has been a member of the Board since March 1, 2002.
Prior to such time, Mr. Puette served as an advisory director to the Company. He
is currently a Partner with WK Technology Fund, a venture capital firm. Between
1997 and 2000, Mr. Puette was the President, Chief Executive Officer, and member
of the Board of Directors of Centigram Communications Corporation (NASDAQ), a
communications technology firm. Prior to his position at Centigram, from 1995 to
1997, Mr. Puette served as President, CEO and Chairman of the Board of Directors
at NetFRAME Systems (NASDAQ), a high-availability computer server company, and
from 1990 to 1993, Mr. Puette served as President of Apple USA, Apple
Corporation (NASDAQ). Prior to 1990, Mr. Puette served as a Group General
Manager of Hewlett-Packard Corporation (NYSE). Mr. Puette is also on the Board
of Cupertino Electric Corporation (Private) and the Magis Network Corporation
(Private), and is a former director of Cisco Systems (NASDAQ). Mr. Puette holds
a BSEE degree from Northwestern University and a MSOR degree from Stanford
University.
James Barrington, 61, has been a director since March 2002.From 1965 to
1999, Mr. Barrington was with Arthur Andersen LLP, serving primarily as an audit
and business advisory partner. In his capacity as a partner of Arthur Andersen
LLP, Mr. Barrington did not personally provide any services to the Company. Mr.
Barrington received a B.S. in accounting from San Jose State University and a
M.B.A. from the University of California at Berkeley.
Ben Hamburg, 49, is secretary of the Company, and Executive Vice President
and General Counsel of Primecore Funding Group, Inc. Mr. Hamburg graduated from
the University of California, Los Angeles, and earned his law degree from the
University of California, Berkeley, Boalt Hall School of Law in 1979. Mr.
Hamburg served as a law clerk to the Honorable Ira A. Brown, Jr., Judge of the
San Francisco Superior Court. Prior to joining Primecore Funding Group, Mr.
Hamburg was in private practice, most recently with the San Francisco law firm
of Freeland Cooper & Hamburg, and has specialized in real estate and commercial
matters.
Compensation of Directors
None of the directors of the Company who also serve as executive officers
or employees of our affiliates receives any separate compensation for service on
our Board of Directors or on any Board committee. Although all directors are
entitled to receive reimbursement of reasonable out-of-pocket expenses incurred
in connection with meetings of the Board of Directors, to date, no director has
requested compensation for out of pocket expenses. Messrs. Puette and
Barrington, who are not employed by our affiliates or us, each receive annual
compensation totaling $25,000. Our charter obligates us to indemnify our
29
directors and officers and to pay or reimburse expenses for such individuals in
advance of the final disposition of a proceeding to the maximum extent permitted
from time to time by Maryland law. The Maryland General Corporation Law, the
"Maryland GCL", permits a corporation to indemnify its present and former
directors and officers, among others, against judgments, penalties, fines,
settlements and reasonable expenses actually incurred by them in connection with
any proceeding to which they may be made a party by reason of their service in
those or other capacities, unless it is established that (a) the act or omission
of the director or officer was material to the matter giving rise to the
proceeding and (1) was committed in bad faith, or (2) was a result of active and
deliberate dishonesty, (b) the director or officer actually received an improper
personal benefit in money, property or services, or (c) in the case of any
criminal proceeding, the director or officer had reasonable cause to believe
that the act or omission was unlawful.
Terms of Directors and Officers
Our Board of Directors consists of the number of persons as shall be fixed
by the Board of Directors from time to time by resolution to be divided into
three classes, designated Class I, Class II and Class III, with each class to be
as nearly equal in number of directors as possible. Currently there are five
directors. Ms. Fox is a Class I director and her term expires in 2004. Mr.
Whitlow and Mr. Puette are Class II directors, and their terms expire in 2005.
Mr. Rider and Mr. Barrington are Class III directors, and their terms expire in
2003. At each annual meeting, the successors to the class of directors whose
term expires at that time are to be elected to hold office for a term of three
years, and until their successors are elected and qualified, so that the term of
one class of directors expires at each annual meeting.
For any vacancy on the Board of Directors, including a vacancy created by
an increase in the number of directors, the vacancy may be filled by election of
the Board of Directors or the shareholders, with the director so elected to
serve until the next annual meeting of shareholders, if elected by the Board of
Directors, or for the remainder of the term of the director being replaced, if
elected by the shareholders; any newly-created directorships or decreases in
directorships are to be assigned by the Board of Directors so as to make all
classes as nearly equal in number as possible. Directors may be removed only for
cause and then only by vote of a majority of the combined voting power of
shareholders entitled to vote in the election for directors. Subject to the
voting rights of the holders of the preferred stock, the charter may be amended
by the vote of a majority of the combined voting power of shareholders, provided
that amendments to the article dealing with directors may only be amended if it
is advised by at least two-thirds of the Board of Directors and approved by vote
of at least two-thirds of the combined voting power of shareholders. The effect
of these as well as other provisions of our charter and bylaws may discourage
takeover attempts and make more difficult attempts by shareholders to change
management.
Executive officers are appointed by the Board of Directors, serve at the
Board's pleasure and may be removed from office at any time without cause. There
are no family relationships among any of our directors or executive officers.
Section 16(a) Beneficial Ownership Reporting Compliance
Each of Susan Fox, William Whitlow, Michael Rider, James Barrington, Robert
Puette and Ben Hamburg filed a report on Form 5 reporting beneficial ownership
of common and/or Class A Convertible Preferred Shares. The total number of such
shares held by each of them is set forth under Item 12 below
ITEM 11. EXECUTIVE COMPENSATION.
None of the executive officers of the Company receive compensation from us for
their services. All are paid directly by our manager as part of and not in
addition to the management fee. We do not have a stock option or deferred
compensation plan.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The following table presents information regarding the beneficial ownership
of our capital stock as of December 31, 2002 of: (1) each person known by us to
30
own beneficially five percent or more of our outstanding capital stock; (2) each
of our directors and executive officers; and (3) all of our directors and
executive officers as a group. Unless otherwise indicated in the footnotes to
the table, the beneficial owners named have, to our knowledge, sole voting and
investment power with respect to the shares beneficially owned, subject to
community property laws where applicable.
Number Percent
Title of Class Beneficial Owner of Shares of Class
Class A Convertible Preferred Susan Fox 22,715 *
Michael Rider 5,000 *
Ben Hamburg 5,318 *
Robert Puette 405,241 1.8
------------ ------------
Total 438,274 1.9
============ ============
Common William Whitlow 40 40
Susan Fox 40 40
Michael Rider 20 20
------------ ------------
Total 100 100
============ ============
* Less than one percent of our outstanding capital stock.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Primecore Funding Group, Inc., our affiliate, manages all of our business,
subject to direction from our Board of Directors. Our manager bears all
operating expenses connected with originating and managing our mortgage loan
portfolio, and receives a monthly management fee that is established by a
written management agreement that we entered into with our manager. Primecore
Funding Group, Inc. holds a restricted real estate license issued by the
California Department of Real Estate. Our headquarters are the offices of our
manager. We currently do not pay any rent for our headquarters, as these
expenses are borne by our manager.
We have other affiliates, which are entities with whom we share common
officers and some common directors, but which have their own business purposes.
The following is a list of other affiliates:
Primecore Properties, Inc. 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. Primecore Properties, Inc. provides some services to us
through an agreement with our manager. Primecore Properties, Inc. does not
receive any compensation from us.
Eprime, Inc. 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.
99 Investors, LLC, a California limited liability company, was formed in
1996. The Company is the sole member of 99 Investors, LLC. It does not have any
employees, does not perform any services for us and does not receive any
compensation from us. 99 Investors, LLC, holds title to certain properties on
which we have loans.
99 El Camino Partners, LLC, a California limited liability company, was
formed in 1996. Ms. Fox is its sole member. The partnership has no employees,
does not provide any services to us and does not receive any compensation 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.
31
Because of our prior policy not to take title to real property through
foreclosure or otherwise, we previously relied on our affiliates to assume
defaulted loans. Our prior policy was modified in 2002. We or a wholly-owned
subsidiary will take title to property acquired through foreclosure or
otherwise.
PART IV
ITEM 14. 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-K. 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.
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K
a. Financial Statements. The following financial information is included as
a separate section of this Annual Report on Form 10-K:
1. Report of Independent Public Accountants
2. Balance Sheets As of December 31, 2002 and 2001
3. Statements of Operations for the years ended December 31, 2002, 2001, and
2000
4. Statements of Shareholders' Equity for the years ended December 31, 2002,
2001, and 2000
5. Statements of Cash Flows for the years ended December 31, 2002, 2001, and
2000
6. Notes to Financial Statements December 31, 2002, 2001, and 2000
7. Schedule IV - Investments in real estate at December 31, 2002
b. Exhibits
Exhibits submitted with this Form 10-K, as filed with the Securities and
Exchange Commission, or those incorporated by reference to other filings
are:
Exhibit No. Description of Exhibit
3(i) Articles of Incorporation of the Company is incorporated by
reference to Exhibit 3(i) to the Company's Form 10-12 G/A,
previously filed on April 28, 2000
3(ii) Bylaws, Amended March 30, 2000 is incorporated by reference
to Exhibit 3(ii) to the Company's Form 10-12 G/A, previously
filed on April 28, 2000
3(iii) Articles Supplementary of the Company is incorporated by
reference to Exhibit 99.1 to the Company's Form 10-12 G/A,
previously filed on April 28, 2000
3(iv) Specimen Stock Certificate, is incorporated by reference to
Exhibit 99.2 to the Company's Form 10-12 G/A, previously
filed on April 28, 2000
4.1 Registration Rights Agreement is incorporated by reference
to Exhibit to the Company's Form 10-12 G/A, previously filed
on April 28, 2000
32
4.2 Founder's Registration Rights Agreement is incorporated by
reference to Exhibit to the Company's Form 10-12 G/A,
previously filed on April 28, 2000
4.3 Management Agreement dated March 30, 1999 is incorporated by
reference to Exhibit 10 to the Company's Form 10-12 G/A,
previously filed on April 28, 2000
99.1 Certifications
c. Reports on Form 8-K
The Company filed a report on Form 8-K on October 17, 2002 relating to the
Board of Director's decision to (1) adjust our monthly dividend rate to $0.05833
per share, on Preferred Stock investments, beginning with dividends declared as
of October 31, 2002; (2) enter into an amended and restated management agreement
with Primecore Funding Group, Inc.; and (3) enter into an affiliate loan
agreement with our affiliates.
The Company filed a report on Form 8-K on December 20, 2002 which disclosed
the text of (1) the Amended and Restated Management Agreement with Primecore
Funding Group; and (2) the Affiliate Loan Agreement.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Capacity Date
/s/ Susan Fox President and Director March 31, 2003
- -----------------------
Susan Fox
/s/ William Whitlow Chairman March 31, 2003
- -----------------------
William E. Whitlow
/s/ Michael Rider Chief Financial Officer March 31, 2003
- ----------------------- and Director
Michael Rider
/s/ Robert Puette Director March 31, 2003
- -----------------------
Robert Puette
/s/ James Barrington Director March 31, 2003
- -----------------------
James Barrington
33
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Susan Fox, certify that:
1. I have reviewed this Form 10-K of Primecore Mortgage Trust,
Inc.;
2. Based on my knowledge, this annual 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
annual report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual 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 annual 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 annual 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 annual report (the "Evaluation Date");
and
(c) presented in this annual 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 annual 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
March 31, 2003
34
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Michael Rider, certify that:
1. I have reviewed this Form 10-K of Primecore Mortgage Trust,
Inc.;
2. Based on my knowledge, this annual 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
annual report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual 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 annual 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 annual 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 annual report (the "Evaluation Date");
and
(c) presented in this annual 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 annual 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
March 31, 2003
35
INDEX TO FINANCIAL STATEMENTS AND SCHEDULE
Page No
Report of independent public accountants - Grant Thornton, LLP F-1
Report of independent public accountants - Arthur Andersen F-2
Balance sheets as of December 31, 2002 and 2001 F-3
Statements of operations for the years ended December 31, 2002,
2001, and 2000 F-4
Statements of shareholders' equity for the years ended
December 31, 2002, 2001, and 2000 F-5
Statements of cash flows for the years ended December 31, 2002,
2001, and 2000 F-6
Notes to financial statements F-8
Schedule IV--Investments In Real Estate at December 31, 2002 F-22
36
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of
Primecore Mortgage Trust, Inc.
We have audited the accompanying consolidated balance sheet of Primecore
Mortgage Trust, Inc., as of December 31, 2002 and the related consolidated
statements of operations, shareholders' equity, and cash flows for the year
ended December 31, 2002. These financial statements and the schedule referred to
below are the responsibility of the Company's management. Our responsibility is
to express an opinion on these financial statements and schedule based on our
audit. The financial statements of Primecore Mortgage Trust, Inc. as of December
31, 2001 and for each of the two years in the period then ended were audited by
other auditors who have ceased operations. Those auditors expressed an
unqualified opinion on those financial statements in their report dated February
8, 2002 which included an explanatory paragraph that described a change in the
Company's method of accounting for interest expense effective January 1, 2000
before restatement.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the 2002 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Primecore
Mortgage Trust, Inc. as of December 31, 2002, and the results of its
consolidated operations and its consolidated cash flows for the year ended
December 31, 2002, in conformity with accounting principles generally accepted
in the United States of America.
As discussed above, the financial statements of Primecore Mortgage Trust as of
December 31, 2001, and for each of the two years in the period then ended were
audited by other auditors who have ceased operations. As described in Note 2,
these financial statements have been restated. We audited the adjustments
described in Note 2 that were applied to restate the 2001 and 2000 financial
statements. In our opinion, such adjustments are appropriate and have been
properly applied. However, we were not engaged to audit, review, or apply any
procedures to the 2001 and 2000 financial statements of the Company other than
with respect to such adjustments and, accordingly, we do not express an opinion
or any other form of assurance on the 2001 and 2000 financial statements taken
as a whole.
Our audit was made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The schedule listed in the index of financial
statements and schedule is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not part of the basic
financial statements. This schedule has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
Grant Thornton LLP
San Francisco, California
March 14, 2003
FS-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Primecore Mortgage Trust, Inc.
We have audited the accompanying balance sheets of Primecore Mortgage Trust,
Inc. (a Maryland Corporation), as of December 31, 2001, and 2000, and the
related statements of operations, shareholders' equity, and cash flows for the
years ended December 31, 2001 and 2000, and for the period from inception (March
18, 1999) to December 31, 1999. These financial statements and the schedule
referred to below are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Primecore Mortgage Trust, Inc.
as of December 31, 2001 and 2000, and the results of its operations and its cash
flows for the years ended December 31, 2001and 2000 and for the period from
inception (March 18, 1999) to December 31, 1999, in conformity with accounting
principles generally accepted in the United States.
As further discussed in Note 2 to the accompanying financial statements, the
Company changed its method of accounting for interest expense effective January
1, 2000.
Our audit was made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The schedule listed in the index of financial
statements and schedule is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not part of the basic
financial statements. This schedule has been subjected to the auditing
procedures applied in the audit of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
ARTHUR ANDERSEN
San Francisco, California
February 8, 2002
The report of Arthur Andersen LLP (Andersen) is a copy of a report previously
issued by Andersen on February 8, 2002. The report has not been reissued by
Andersen nor has Andersen consented to its inclusion in this Annual Report on
Form 10-K. The Andersen report refers to the balance sheet as of December 31,
2001, and the statements of operations, shareholders' equity and cash flows for
the two years ended December 31, 2001 and the balance sheet as of December 31,
2000, which is no longer included in the accompanying financial statements.
FS-2
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED BALANCE SHEETS
As of December 31,
2001
2002 (as Restated)
-------------------- --------------------
ASSETS:
Investments in real estate under development ................................. $ 101,141,515 $ 131,759,510
Investments in real estate under development by affiliates.................... -- 30,769,822
Investments in real estate held for sale...................................... 36,817,168 18,952,063
Loans secured by real estate.................................................. 4,695,000 --
Cash and cash equivalents..................................................... 4,394,107 2,706,204
Other assets, net............................................................. 326,245 408,905
-------------------- --------------------
Total assets.......................................................... $ 147,374,035 $ 184,596,504
==================== ====================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Notes payable (including $150,000, and $0 to affiliates at December 31, 2002
and 2001, respectively).................................................... $ 14,276,929 $ 17,312,526
Secured line of credit........................................................ 14,431,132 15,000,000
Accrued expenses and other.................................................... 256,059 1,232,022
Preferred stock dividends payable............................................. 1,312,417 1,903,928
Payable to manager............................................................ 669,480 31,193
-------------------- --------------------
Total liabilities..................................................... 30,946,017 35,479,669
Commitments and contingencies (see note 10)...................................
Convertible Preferred stock: par value $0.01, 40,000,000 shares authorized;
22,496,804 and 21,633,864 shares issued and outstanding at December 31, 2002
and 2001, respectively....................................................
226,079,882 216,157,968
Common stock: par value $0.01, 10,000,000 shares authorized; 100 shares
issued and outstanding at December 31, 2002 and 2001....................... 1 1
Accumulated dividends and distributions....................................... (80,132,217) (58,826,211)
Accumulated deficit........................................................... (29,519,648) (8,214,923)
-------------------- --------------------
Total shareholders' equity............................................ 116,428,018 149,116,835
-------------------- --------------------
Total liabilities and shareholders' equity............................ $147,374,035 $ 184,596,504
==================== ====================
The accompanying notes are an integral part of these statements.
FS-3
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended Year Ended Year Ended
December 31, 2002 December 31, December 31,
2001 2000
-------------------- ----------------- ------------------
REVENUES:
Income from completed real estate development
(including $981,443, $145,468, and $3,040,082 from
affiliates)........................................ $10,018,189 $ 12,519,618 $ 15,103,946
Other................................................. 730 68,510 36,390
-------------------- ----------------- ------------------
Total revenues............................... 10,018,919 12,588,128 15,140,336
EXPENSES:
Management fees paid to Manager....................... 9,630,701 11,345,585 10,967,249
Provision for impairment of investments in real
estate development................................. 21,238,043 73,000 --
General, administrative and other..................... 454,900 502,080 600,776
-------------------- ----------------- ------------------
Total expenses............................... 31,323,644 11, 920,665 11,568,025
-------------------- ----------------- ------------------
Net(loss) income............................. (21,304,725) 667,463 3,572,311
Preferred stock dividends.................... (21,306,006) (24,118,443) (21,609,791)
-------------------- ----------------- ------------------
Net loss allocable to common................. $ (42,610,731) $(23,450,980) $(18,037,481)
==================== ================= ==================
Basic and diluted net loss per common share........... $ (426,107) $ (234,510) $ (180,375)
==================== ================= ==================
Basic and diluted weighted-average common shares
outstanding........................................ 100 100 100
==================== ================= ==================
The accompanying notes are an integral part of these statements.
FS-4
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the years ended December 31, 2002, 2001, and 2000
Preferred Stock Common Stock
------------------------------- ------------------
Accumulated
Dividends and Accumulated
Shares Amount Shares Amount Distributions Deficit Total
--------------- --------------- ------- ---------- -------------- --------------- --------------
Shareholders' equity at January 1,
2000 (as restated)............ 18,985,118 $189,851,180 100 $ 1 $(13,097,977) $(12,454,697) $164,298,507
Issuance of preferred stock, net
of offering costs of $178,589... 2,841,062 28,232,031 -- -- -- -- 28,232,031
Issuance of preferred stock under
dividend reinvestment plan...... 589,684 5,896,840 -- -- -- -- 5,896,840
Redemptions of preferred stock.... (2,469,419) (24,694,190) -- -- -- -- (24,694,190)
Dividends and distributions paid
to preferred shareholders....... -- -- -- -- (21,609,791) -- (21,609,791)
Net income......................... -- -- -- -- -- 3,572,311 3,572,311
--------------- --------------- ------- ---------- -------------- --------------- --------------
Shareholders' equity at
December 31, 2000
(as restated)................... 19,946,445 $199,285,861 100 $ 1 $(34,707,768) $(8,882,386) $155,695,708
Issuance of preferred stock, net
of offering costs of $2,083... 2,797,437 27,972,287 -- -- -- -- 27,972,287
Issuance of preferred stock under
dividend reinvestment plan.... 599,169 5,991,690 -- -- -- -- 5,991,690
Redemptions of preferred stock... (1,709,187) (17,091,870) -- -- -- -- (17,091,870)
Dividends and distributions paid
to preferred shareholders..... -- -- -- -- (24,118,443) -- (24,118,443)
Net income....................... -- -- -- -- -- 667,463 667,463
--------------- --------------- ------- ---------- -------------- --------------- --------------
Shareholders' equity at
December 31, 2001
(as restated)................. 21,633,864 $216,157,968 100 $ 1 $(58,826,211) $(8,214,923) $149,116,835
Issuance of preferred stock...... 1,255,043 12,550,430 -- -- -- -- 12,550,430
Issuance of preferred stock under
dividend reinvestment plan.... 356,559 3,565,590 -- -- -- -- 3,565,590
Redemptions of preferred stock... (748,662) (7,414,590) -- -- -- -- (7,414,590)
Additional paid in capital....... -- 1,220,484 -- -- -- -- 1,220,484
Dividends and distributions paid
to preferred shareholders..... -- -- -- -- (21,306,006) -- (21,306,006)
Net loss........................ -- -- -- -- -- (21,304,725) (21,304,725)
--------------- --------------- ------- ---------- -------------- --------------- --------------
Shareholders' equity at December
31, 2002 ..................... 22,496,804 226,079,882 100 $ 1 $(80,132,217) $(29,519,648) $116,428,018
=============== =============== ======= ========== ============== =============== ==============
The accompanying notes are an integral part of these statements.
FS-5
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended Year Ended Year Ended
December 31, 2002 December 31, 2001 December 31, 2000
------------------- ------------------- ------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income............................................ $ (21,304,725) $ 667,463 $ 3,572,311
Adjustments to reconcile net (loss) income to net cash provided
by (used in) operating activities:
Provision for impairment.................................. 21,238,043 -- --
(Decrease) increase in accrued expenses and other......... (975,963) (2,578,431) 3,595,841
Increase (decrease) in payable to Manager................. 638,287 (205,779) (1,167,718)
Decrease (Increase) in other assets, net.................. 82,661 (39,270) 75,299
------------------- ------------------- ------------------
Net cash provided by (used in) operating activities. (321,697) (2,156,017) 6,075,733
------------------- ------------------- ------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments in real estate under development and held for
sale...................................................... (30,888,569) (63,190,884) (164,372,910)
Investments in real estate under development by affiliates... (9,261,172) (10,869,856) (30,322,772)
Proceeds from investments in real estate under development
and held for sale............................................ 54,124,936 87,597,220 124,348,190
Proceeds from investments in real estate under development
by affiliates................................................ 4,016,083 12,863,389 40,465,714
Decrease (increase) in receivable from affiliate............. -- -- 1,743,081
------------------- ------------------- ------------------
Net cash provided by (used in) investing activities. 17,991,278 26,399,869 (28,138,697)
------------------- ------------------- ------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sales of preferred stock, net of offering costs.. 12,550,430 27,972,287 28,082,031
Redemptions of preferred stock................................. (7,414,590) (17,091,870) (24,694,190)
Proceeds from sales of common stock............................ -- -- --
Issuance of notes payable...................................... 4,098,562 19,345,400 61,199,293
Capital contributions from Manager............................. 1,220,484
Repayment of notes payable..................................... (7,535,769) (41,756,585) (31,898,384)
Net (Repayments) borrowings on secured line of credit.......... (568,868) 8,355,308 4,449,692
Payment of preferred stock dividends........................... (18,331,927) (18,124,688) (15,609,972)
Loan fees paid ................................................ -- (237,500) (141,034)
------------------- ------------------- ------------------
Net cash provided by (used in) financing activities. (15,981,678) (21,537,648) 21,387,436
------------------- ------------------- ------------------
Net increase (decrease) in cash and cash equivalents. 1,687,903 2,706,204 (675,528)
Beginning cash and cash equivalents.................. 2,706,204 -- 675,528
------------------- ------------------- ------------------
Ending cash and cash equivalents..................... $4,394,107 $2,706,204 $ --
=================== =================== ==================
Cash paid for interest, net of amounts capitalized of $2,199,961,
$4,358,952, and $4,680,818 for the periods ending December 31,
2002, 2001 and 2000 respectively............................... $ -- $ -- $ --
=================== =================== ==================
FS-6
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING
ACTIVITIES:
Year Ended Year Ended Year Ended
December 31, 2002 December 31, 2001 December 31, 2000
------------------- ------------------- ------------------
Reinvested Preferred Stock dividends.............................. $ 3,565,590 $ 5,991,690 $ 5,896,840
Interest capitalized on Notes Payable............................. $ 401,610 $ 936,447 $ 1,846,881
Investments in real estate under development received in exchange
for issuance of Preferred Stock................................ -- $ 150,000
Investments in real estate under development by affiliates
received in exchange for issuance of Preferred Stock........... -- -- --
Investments in real estate under development received in exchange
for notes...................................................... -- -- $ 795,000
Investments in real estate under development by affiliates
received in exchange for notes payable......................... -- -- --
The accompanying notes are an integral part of these statements.
FS-7
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND BUSINESS:
Organization
Primecore Mortgage Trust, Inc., a Maryland corporation, was formed on March
18, 1999 and commenced operations effective May 1, 1999 as a real estate
investment trust (REIT). We are engaged in the business of funding and holding
land acquisition, development and construction mortgage loans secured by
residential real property, as well as secured by undeveloped real property,
located in the greater San Francisco Bay Area. Primecore Mortgage Trust, Inc. is
also the sole member of 99 Investors, LLC a California limited liability
company. 99 Investors, LLC owns certain real property in which we have invested.
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.
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.
Realization of Assets. The Company's liquidity and ability to meet its
obligations as they become due are subject to, among other things, its ability
to obtain timely repayments of its ADC loans and sales of its investment in real
estate held for sale. In the event that repayments are not sufficient to timely
meet our commitments and credit facilities are not extended on terms favorable
to us, we will be forced to reduce prices on properties we control in order to
expedite their repayment. In such cases, the amount of proceeds received could
be substantially less than what we would have expected if we allowed a proper
marketing period for the property. This would have a negative impact on the
estimated net realizable value of our assets and would force the Company to
adopt an alternative strategy that may include actions such as seeking
additional capital or further downsizing of the Company. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
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.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Restatement of Previously Reported Financial Statements
The balances presented at December 31, 2001 and 2000 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.
FS-8
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED NOTES TO FINANCIAL STATEMENTS
The following schedule sets forth the restated amounts:
As previously
December 31, 2001 reported Amount of 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
Accumulated earinings (deficit) 1,253,216 (9,468,139) (8,214,923)
Total liabilities and shareholders' equity 194,064,643 (9,468,139) 184,596,504
December 31, 2000
Accumulated earnings (deficit) 585,753 (9,468,139) (8,882,386)
Shareholders' equity 165,163,847 (9,468,139) 155,695,708
January 1, 2000
Accumulated deficit (2,986,558) (9,468,139) (12,454,697)
Shareholders' equity 173,766,646 (9,468,139) 164,298,507
Use of Estimates
These financial statements have been prepared in accordance with accounting
principles generally accepted in the United States of America. 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. The Company's significant estimates include the valuation of
investments in real estate. Actual results could differ from those estimates.
Investments in Real Estate under Development
and Investments in Real Estate under Development by Affiliates
We have originated loans to Acquire, Develop and Construct (ADC)
residential real estate ("ADC loans"). Our loans contain many of the
following characteristics which are identified with ADC loans:
1. The lender has agreed to provide all or substantially all necessary funds
to acquire, develop or construct the property. The borrower has title to
but little or no cash equity in the project;
2. The lender funds substantially all the interest and fees during the term of
the loan by adding them to the loan balance;
3. Typically, the lender's only security is the project itself. The lender has
no recourse to other assets of the borrower, and the borrower does not
guarantee the debt;
4. In order for the lender to recover its investment in the project, the
property must be sold to independent third parties or the borrower must
obtain refinancing from another source.
Therefore, our ADC 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.
FS-9
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED NOTES TO FINANCIAL STATEMENTS
ADC loans are classified as investments in real estate under development or
investments in real estate under development by affiliates and include amounts
funded under the loan agreements and capitalized interest expense. If our ADC
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 fair 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 ADC loan. Such arrangements are
accounted for in a manner similar to our investments in real estate under
development. 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 ADC 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 ADC 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 ADC loans and investments in real estate held
for sale as costs are recovered, generally upon the sale or refinancing of the
underlying completed real estate to or by a third party. No interest income or
points are recognized until the financed property is sold or 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
FS-10
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED NOTES TO FINANCIAL STATEMENTS
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 (loss) income for the years ended December 31, 2002, 2001 and 2000
is computed as follows:
December 31, 2002 December 31, 2001 December 31, 2000
------------------- ------------------- -------------------
Revenues - interest income and points 31,478,965 39,296,945 38,011,681
Operating expenses................................ (12,439,364) (16,284,169) (16,023,843)
Loans charged off................................. (25,553,208) - -
------------------- ------------------- -------------------
Taxable (loss) income before dividends......... (6,513,607) 23,012,776 21,987,838
Dividends and distributions.................... (21,306,006) (24,118,443) (21,609,791)
------------------- ------------------- -------------------
Distributions in excess of taxable (loss)
income...................................... (27,819,613) (1,105,667) 378,047
=================== =================== ===================
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 ADC loans. 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, dividends paid 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. Payment of Preferred
Stock dividends could be adversely effected if we experience a slow down in the
repayment of our ADC loans.
On October 17, 2002, our Board of Directors voted unanimously to adjust our
monthly dividend 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 weakness
in the San Francisco Bay Area real estate market 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. During 2002 we paid
dividends of $21,897,517, all of which in excess of our taxable income. The
Board will continue to review and reassess the distribution policy as new
information becomes available.
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.
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 years ended December 31, 2002, 2001 and 2000, are the same
and are 100 shares.
Consolidation Policy
The consolidated financial statements include the accounts of Primecore
Mortgage Trust and its wholly owned subsidiary, 99 Investors, LLC. All
intercompany accounts and transactions have been eliminated in consolidation.
SFAS 143, Accounting for Asset Retirement Obligations
FASB Statement No. 143, Accounting for Asset Retirement Obligations. The
Statement addresses the financial accounting and reporting for obligations
associated with the retirement of tangible long-lived assets and the associated
asset retirement costs. The Statement requires the Company to record the fair
value of an asset retirement obligation as a liability in the period in which it
incurs a legal obligation associated with the retirement of a tangible
long-lived asset. This Statement was adopted effective June 15, 2002 and
adoption is not expected to have a material impact on the financial condition or
operating results of the Company.
SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets
FASB Statement No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. Statement No. 144 addresses financial accounting and
FS-11
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED NOTES TO FINANCIAL STATEMENTS
reporting for the impairment or disposal of long-lived assets. The provisions of
this Statement were adopted effective January 1, 2002. Adoption did not have a
material impact on the financial condition or operating results of the Company.
SFAS No. 145, Rescissions of FASB Statements No. 4, 44, and 64, Amendment of
FASB Statement No. 13, and Technical Corrections
The provisions of this Statement related to the rescission of Statement 4
are applicable in fiscal years beginning after May 15, 2002. The provisions of
this Statement related to Statement 13 are effective for transactions occurring
after May 15, 2002. All other provisions of this Statement are effective for
financial statements issued on or after May 15, 2002. Adoption of the provisions
applicable to the year ended December 31, 2002 did not have a material impact on
the financial condition or operating results of the Company.
SFAS No. 146, Accounting for Costs Associated with Exit or Disposed Activities
The provisions of this Statement are effective for exit and disposal
activities that are initiated after December 31, 2002. This Statement requires
that a liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred. The Company does not currently have
plans to exit or dispose of activities.
SFAS No. 148, Accounting for Stock-Based Compensation - Transition and
Disclosure
The provisions of this Statement amend FASB Statement No. 123, Accounting
for Stock-Based Compensation, and provide alternative methods of transition for
enterprises that elect to change to the Statement No. 123 fair value method of
accounting for stock-based employee compensation. The Statement also amends the
disclosure requirements of Statement No. 123 to require prominent disclosures
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results.
FASB Interpretation No. 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others (the Interpretation)
This Interpretation addresses the disclosure to be made by a guarantor in
its interim and annual financial statements about its obligations under
guarantees. These disclosure requirements are included in note 13 to the
consolidated financial statement. The Interpretation also requires the
recognition of a liability by a guarantor at the inception of certain
guarantees.
The Interpretation requires the guarantor to recognize a liability for the
noncontingent component of the guarantee, this is the obligation to stand ready
to perform in the event that specified triggering events or conditions occur.
The initial measurement of this liability is the fair value of the guarantee at
inception. The recognition of the liability is required even it is not probable
that payments will be required under the guarantee or if the guarantee was
issued with a premium payment or as part of a transaction with multiple
elements.
As noted above the Company has adopted the disclosure requirement of the
Interpretation (note 13) and will apply the recognition and measurement
provisions for all guarantees entered into or modified after December 31, 2002.
To date the company has not entered into or modified any guarantees and has
recognized no liability pursuant to the provisions of the Interpretation.
FASB Interpretation No. 46, Consolidation of Variable Interest Entities
Interpretation No. 46 addresses consolidation by business enterprises of
variable interest entities, which have one or both of the following
characteristics: 1) the equity investment at risk is not sufficient to permit
the entity to finance its activities without additional financial support from
other parties, or 2) the equity investors lack one or more of the following
essential characteristics of a controlling financial interest: a) the direct or
FS-12
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED NOTES TO FINANCIAL STATEMENTS
indirect ability to make decisions about the entity's activities through voting
or similar rights, b) the obligation to absorb the expected losses of the entity
if they occur, or c) the right to receive the expected residual returns of the
entity if they occur. The Interpretation requires existing variable interest
entities to be consolidated if those entities do not effectively disburse risks
amount parties involved. The Company has determined that they have no
significant ownership in variable interest entities.
3. INVESTMENTS IN REAL ESTATE UNDER DEVELOPMENT:
We make ADC loans with maturity dates generally ranging from 12 to 18
months. The term of an ADC loan may be extended, when management deems it
appropriate to do so. For financial reporting purposes, we account for our ADC
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 (interest and points) that we ultimately
realize is based upon the value of the financed property and terms of the ADC
loan. During the years ended December 31, 2002, 2001 and 2000 fixed interest
rates on ADC loans outstanding ranged from 11 percent to 18 percent. In the case
of ADC loans on which the borrower defaulted under the terms of our lending
contract, the interest rate charged during the period of default was an
additional 5 percent over the note rate. In addition, we charged points on most
ADC loans, which were typically 4 percent of the borrowed amount.
The following table summarizes our portfolio of ADC loans at December 31, 2002:
Commitment Carrying
Location - County Maturity Dates Amount Amount
- ------------------------------------------------------------------------------------------------
Alameda 12/02-04/03 $ 6,894,000 $ 2,501,513
Marin 08/01-11/03 42,140,000 22,368,188
Monterey 12/02-12/03 29,825,000 11,896,192
Napa 11/02-11/02 4,750,000 3,410,477
San Francisco 03/02-06/03 25,675,000 11,495,202
San Mateo 06/02-12/03 53,274,485 32,969,133
Santa Clara 05/02-06/03 23,300,000 15,083,579
Santa Cruz 06/01-06/01 6,750,000 1,417,231
----------------------------------------
$ 192,608,485 $ 101,141,515
========================================
The following table summarizes our portfolio of ADC loans at December 31, 2001:
Commitment Carrying
Location - County Maturity Dates Amount Amount
- ----------------------------------- ------------------ ------------------- -------------------
Alameda 06/01-10/01 $ 5,700,000 $ 1,177,035
Contra Costa 05/02-05/02 5,610,000 4,668,141
Marin 06/01-07/02 29,765,000 19,263,088
Monterey 12/01-12/02 27,160,000 12,051,692
San Francisco 01/02-10/02 26,935,000 15,363,685
San Mateo 09/01-10/02 53,361,140 27,921,345
Santa Clara 06/01-08/02 71,075,000 41,699,251
Other 06/01-09/01 17,665,000 9,615,273
------------------- -------------------
$ 237,271,140 $ 131,759,510
=================== ===================
During the year ended December 31, 2002, we capitalized $1,720,862 of
interest expense from our secured line of credit and our unsecured notes payable
to investments in real estate under development compared with $3,369,004 and
$3,562,236 during the years ended December 31, 2001 and 2000, respectively.
FS-13
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED NOTES TO FINANCIAL STATEMENTS
We will fund unfunded commitments on existing ADC loans from the repayment
of other ADC loans, borrowings on our line of credit (Note 8), issuance of
short-term notes payable or issuance of additional preferred stock. As of
December 31, 2002 our unfunded commitment was $23,835,015, 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 December 31, 2002, we had ADC loans with a carrying amount of
$10,293,731, 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
ADC loans accrue interest at the default rate, which is 500 basis points above
the note rate. We choose not to extend these contracts in order to provide
incentive for the builder to price the property for sale in a short period.
Additionally, at December 31, 2002, we had recorded notices of default on
ADC loans with a carrying amount of $18,886,100 compared with $14,293,382 at
December 31, 2001. Recording a notice of default begins the process of
foreclosure. All ADC 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 ADC loan assuming there are sufficient proceeds. Recording a
Notice of Default is our last resort and usually done only in cases where we
believe that the builder cannot or will not maximize the value of the property.
During the year ended December 31, 2002, we charged $2,342,776, to
operations for ADC loans we believe are impaired compared with none during the
years ended December 31, 2001 and 2000.
4. INVESTMENTS IN REAL ESTATE UNDER DEVELOPMENT BY AFFILIATES:
In the past, we had made ADC loans to affiliates of our Manager on projects
on which the affiliates were acting as the developer. Additionally, after the
default under certain loans made to Windy Hill Associates, an entity whose
principal was one of the original founders of our Manager, and consistent with
our then policy of not taking foreclosed properties in our name, the Windy Hill
ADC loans were transferred to another affiliate, E-Prime, Inc., and foreclosed
upon by E-Prime, Inc. in March 2000. Our Manager guaranteed repayment of these
foreclosed Windy Hill ADC loans. These arrangements are accounted for in a
manner identical to that described in Note 3 above. On October 17, 2002, the
non-management members of the Board of Directors, with management directors
abstaining, resolved to enter into an agreement with our Manager relating to the
E-Prime, Inc. ADC loans and certain ADC loans made to another affiliate, 99
Investors, LLC. Among other things, pursuant to the agreement, all of the
membership interests in 99 Investors, LLC were transferred to us, thereby
effectively transferring ownership of all properties owned by 99 Investors, LLC
to us. The agreement also provided for the release of repayment guarantees from
our Manager and its owner, in exchange for a reduction in the compensation we
pay to our Manager, a decrease in the fee payable upon termination of our
Manager, from 10% of our loan commitments to 4% of our loan commitments, and a
promise to pay certain deficiencies that might result upon liquidation of the
properties securing the loans on the properties. Refer to the discussion of
Management Fees in Note 10 - Transactions with Affiliates. The text of the
Affiliate Loan Agreement was disclosed in an 8-K filing on December 20, 2002.
As a result of these agreements, the balance of Investments in Real Estate
Under Development By Affiliates has transferred $19,075,533 to Investments in
Real Estate Held For Sale. Additionally, during the year ended December 31, 2002
we charged $11,419,566 to impairments for these ADC loans compared with none
during the years ended December 31, 2001 and 2000. Under the terms of the
Affiliate Loan Agreement, our Manager is responsible for repaying any difference
between the carrying amount of the properties and the appraised value at the
time we took ownership. Repayments will come from bonuses earned by the Manager
under an amended and restated management agreement, and the entire shortfall
amount shall be paid no later than January 2, 2010. The shortfall amount,
estimated at $11,419,566, the amount of our impairment charge bears simple
interest at the rate of seven percent (7%) per annum until repaid. Because of
the uncertainty in timing and ultimate collection of the Manager's repayment
obligation, we have charged income for the full amount of impairment of the
properties transferred by the Affiliate Loan Agreement. We will account for any
payments by our Manager under this agreement as income when received.
FS-14
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED NOTES TO FINANCIAL STATEMENTS
The following table summarizes our portfolio of investments in real estate under
development by affiliates at December 31, 2001:
Maturity Commitment Amount Carrying
Location - County Dates Amount
- -------------------------------------------------------- ------------------ -------------------
San Mateo 12/01-04/03 $ 14,200,000 $ 8,290,751
Santa Clara 12/01-03/03 56,125,000 22,479,071
------------------ -------------------
$ 70,325,000 $30,769,822
================== ===================
During the year ended December 31, 2002, we capitalized $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 compared with
$805,848 and $1,118,582 during the years ended December 31, 2001 and 2000,
respectively.
5. INVESTMENT IN REAL ESTATE HELD FOR SALE:
As of December 31, 2002, we or our wholly-owned subsidiary, 99 Investors,
LLC, held title to 18 properties which we received through foreclosure, by deed
in lieu of foreclosure, or as a result of an agreement dated October 17, 2002,
pursuant to which all membership interests in 99 Investors, LLC were transferred
to us.
The following table summarizes investments in real estate held for sale at
December 31, 2002:
Carrying
County Number Amount
- --------------------------------------- --------- -------------------
Alameda 1 $ 1,676,642
Marin 2 4,105,484
San Francisco 1 1,542,395
San Mateo 5 8,362,275
Santa Clara 9 21,130,372
--------- -------------------
Total 18 $ 36,817,168
===================
The following table summarizes investments in real estate held for sale at
December 31, 2001:
Carrying
County Number Amount
- --------------------------------------- --------- -------------------
Alameda $ 5,498,629
3
Marin 4 8,438,341
San Mateo 2 2,620,510
Santa Clara 1 2,394,583
--------- -------------------
Total 10 $ 18,952,063
===================
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 year
FS-15
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED NOTES TO FINANCIAL STATEMENTS
ended December 31, 2002, we capitalized $523,387 of interest expense to
investments in real estate held for sale that were still under construction
compared with none during the years ended December 31, 2001 and 2000.
Additional funds will be required to complete certain 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 8), issuance of short-term notes
payable or issuance of additional preferred stock. As of December 31, 2002, our
estimated costs to complete these investments was $15,320,528.
During the year ended December 31, 2002, we charged $7,475,701 to
operations for impairments on Investments in Real Estate Held For Sale compared
with $73,000 and none during the years ended December 31, 2001 and 2000.
6. LOAN SECURED BY REAL ESTATE:
We had a loan secured by real property that 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. As of December 31, 2002 the loan was
current.
7. NOTES PAYABLE:
We had unsecured borrowings of $14,095,017 at December 31, 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 6.00
and 12.0 percent with interest payable monthly in arrears. We may repay these
notes, without penalty, at our option before their stated maturity. As of
December 31, 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 December 31, 2002, we had $181,912 due on notes payable to
financial institutions to finance the cost of our insurance policies compared
with none at December 31, 2001. The notes bear interest at rates between 7.462%
and 11.274% and require monthly payments totaling $25,430.
The following table summarizes the maturities of our notes payable at
December 31, 2002:
Year Amount
--------------------- -----------------
2003 13,806,929
2004 470,000
-----------------
Total $ 14,276,929
=================
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 December 31, 2002, was $14,431,132,
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 (5.75 percent at December
31, 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
FS-16
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED NOTES TO FINANCIAL STATEMENTS
least $500,000. Since our total equity at December 31, 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 $180,325 at December 31, 2002.
9. SHAREHOLDERS' EQUITY
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 December 31, 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 22,496,804 and 21,633,864 shares of Preferred Stock outstanding as of
December 31, 2002 and 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 $0.96, $1.12 and $1.14 per share (based on weighted average preferred
shares outstanding of 22,168,539, 21,450,948 and 18,955,134) for the years ended
2002, 2001 and 2000. Under the terms of our dividend reinvestment plan
shareholders were able to reinvest dividends in additional shares of Preferred
Stock. On November 20, 2002 the Board of Directors voted to close the existing
private placement, thus terminating the dividend reinvestment option until such
time as a new private placement it opened.
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. Effective February 12, 2003,
the Board of Directors implemented a new redemption policy for shareholders who
wish to sell their shares to us. Under this policy we will repurchase shares, at
fair market value, as determined by our Board of Directors, utilizing 25% of
"free cash flow" for such purposes. "Free cash flow" means the total of all
proceeds from repayments of loans and all net proceeds from the sale of
real-estate-owned properties in the Company's portfolio during a Repurchase
Period, and then subtracting from such total amounts due during the same period
for (i) existing loan commitments, (ii) debt payments to third parties, (iii)
dividend or other distributions to shareholders, and (iv) operating expenses.
The periods between October 1 and March 31 of the following year, and April 1
and September 30 are each a "Repurchase Period" for the purposes of calculating
"free cash flow," except that the first Repurchase Period under the policy runs
from January 1, 2003 through March 31, 2003. Redemption of shares is always
subject to availability of funds for redemption purposes. All redemption
requests will be determined and acted upon in accordance with the best interests
of the Company. We will not sell or otherwise liquidate any portion of our
mortgage loan portfolio or other assets to fund a redemption request.
We sell our stock through private placement and have closed five private
placements since our inception, issuing 26,161,438 shares at $10.00 per share.
We use the proceeds from issuance of our Preferred Stock primarily to fund
additional ADC loans and also for working capital purposes. As of December 31,
2002 we did not have an active private placement.
FS-17
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED NOTES TO FINANCIAL STATEMENTS
10. TRANSACTIONS WITH AFFILIATES:
Management Fees
A management agreement dated March 30, 1999, as amended, between us and our
Manager provided for a monthly fee payable in arrears equal to 0.25 percent of
the total commitment amount of the ADC 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 year
ended December 31, 2002, the portfolio management fees earned by our Manager
were $9,630,701 compared with $11,345,585 and $10,967,249 for the years ended
December 31, 2001 and 2000.
As of October 17, 2002, we entered into an amended and restated management
agreement with our Manager, Primecore Funding Group, Inc. The agreement
generally provides that the fees our manager earns will be based on three
components: a base fee, determined monthly, of 3.125% per annum of the total
carrying amount of our investments in real estate, determined according to US
GAAP; a cash flow bonus, determined quarterly, payable only upon achieving
certain levels of loan repayments; and a rate of return bonus, determined
quarterly, which is payable only upon achieving certain income per share returns
for holders of Preferred Stock.
The changes made to the management agreement are intended to provide a
better alignment of interest between our Manager and the shareholders given
current economic realities. The base fee is a reduced fee given the current
portfolio since the fee is based on the carrying amount of ADC loans, instead of
ADC loan commitments. To the extent that the manager's actions produce results
that are above base expectations, the manager will be rewarded with bonuses. The
restructured agreement is expected to reduce our base management fee expense
from $9.6 million in 2002 to approximately $4.5 million in 2003.
Real Estate Sales Commissions
We paid real estate sales commissions of $446,350 during the year ended
December 31, 2002 to Primecore Properties, Inc., an affiliate compared with none
during the years ended December 31, 2001 and 2000. 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
We owed $669,480 to our Manager at December 31, 2002 for fees earned in
December 2002 compared with $31,193 payable December 31, 2001. The amounts
payable are typically paid the following month.
Affiliate Loans
Our affiliates are entities with whom we share common control through
common management. Primecore Funding Group, Inc. is our affiliate and holds a
restricted license as a California real estate broker.
During 2002, as prices for high end homes in the San Francisco Bay Area
continued to decline, we were advised by our manager that proceeds from the
sales of properties securing the affiliate loans would not be sufficient to
fully repay the loans and we would have to rely on the Manager's guarantee for
full repayment. Based on the estimated amount of the payment due from the
Manager, the time period over which the Manager would be able to accomplish the
payments and the ultimate uncertainty of receiving full repayment, our Board of
Directors decided it would be better to restructure the existing management
agreement to better align the Manager's compensation with our shareholders'
interests. On October 17, 2002, our board of directors resolved to enter into an
FS-18
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED NOTES TO FINANCIAL STATEMENTS
Affiliate Loan Agreement with our manager which provided for the transfer of
ownership of the remaining properties securing our affiliate loans and a release
of repayment guarantees from our manager and its owner, in exchange for
restructuring our management agreement with Primecore Funding Group. Refer to
Note 4 - Investments In Real Estate Under Development By Affiliates for a
discussion of the Affiliate Loan Agreement. As a result of this agreement, we no
longer have any affiliate ADC loans. The ownership of 99 Investors, LLC, the
owner of properties securing affiliate ADC loans, has been transferred to
Primecore Mortgage Trust, and its properties are classified as Investments in
Real Estate Held for Sale at December 31, 2002. The following narratives
describe the current status of our affiliate relationships.
Eprime, Inc. is our affiliate and is a California corporation, incorporated
in 2000. Eprime, Inc. was formed for the purpose of acquiring title, completing
and selling the Windy Hill ADC loans which were foreclosed in March 2000. As
part of that transaction, our manager and its owner guaranteed the repayment of
the Windy Hill ADC loans. As of the date of the Affiliate Loan Agreement, all
the properties acquired by Eprime had been completed and sold. At that time, the
carrying amount of the ADC loans due from Eprime was zero as a result of an
impairment charge of $9,468,139 on one of the Eprime ADC loans, completion and
sale of the Eprime properties and payments made under the guarantee agreement by
our Manager. The balance owed under the guarantee agreement, which included
accrued interest, loan fees and the $9,468,139 written down for US GAAP purposes
was $17,846,428. In accordance with the Affiliate Loan Agreement, the guarantees
provided for these ADC loans were released and the balances were written off as
uncollectible.
99 Investors, LLC, a California Limited Liability Company, is an affiliate
which is now wholly-owned by us. 99 Investors, LLC was originally formed for the
purpose of developing and selling residential real estate. As of the date of the
Affiliate Loan Agreement, 99 Investors owned title to eleven homes under
construction which secured five ADC loans held by Primecore Mortgage Trust, Inc.
In accordance with the agreement, ownership of 99 Investors, LLC, and thus all
of its interest in the properties, has been transferred to us as a wholly-owned
subsidiary. We will continue to complete construction and sell the properties.
Our Manager is responsible for the difference, if any, between the carrying
amount of the ADC loans as of the date of our agreement and the appraised values
of the properties at that time. This amount will be paid to us from bonuses that
the Manager receives in accordance with our revised and restated management
agreement, and if the bonuses are insufficient to cover the full amount, the
full amount will be paid in full on or before January 2, 2010, with interest at
seven percent (7%) per annum. Because of the uncertainty in timing and ultimate
collection of our Manager's repayment obligation, we have charged income for the
full amount of impairment of the properties transferred by the Affiliate Loan
Agreement. We will account for payments by our Manager under this agreement as
income when received.
99 El Camino Partners LLC is our affiliate and a California limited
liability company. 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.
Primecore Properties, Inc. is our affiliate and is a California
corporation, incorporated in 1997. 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 our management agreement with Primecore Funding Group, Inc. There
are currently no arrangements for us to separately compensate Primecore
Properties, Inc. for those services.
FS-19
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED NOTES TO FINANCIAL STATEMENTS
11. 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
$9,420,708 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.
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.
12. QUARTERLY STATEMENTS OF OPERATIONS (UNAUDITED):
The following tables contain selected unaudited quarterly financial data for
fiscal years 2002 and 2001:
FS-20
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED NOTES TO FINANCIAL STATEMENTS
Three Months Three Months Three Months Three Months
Ended Ended Ended Ended
March 31, 2002 June 30, 2002 September 30, 2002 December 31, 2002
(as restated) (as restated) (as restated)
---------------- ----------------- --------------------- ------------------
REVENUES:
Income from completed real
estate development
(including $0, $0, $981,443
and $0 from affiliates)
$ 1,055,530 $ 5,682,996 $ 2,787,906 $ 491,757
Other -- 61,957 141 (61,368)
---------------- ----------------- --------------------- ------------------
Total revenues 1,055,530 5,744,953 2,788,047 430,389
EXPENSES:
Management fees paid to
Manager.. 2,658,152 2,450,403 2,438,338 2,083,808
Provision for impairment of
investments in real estate
development................. 145,782 1,327,534 7,992,171 11,772,556
General, administrative and
other....................... 105,505 62,852 117,001 169,542
---------------- ----------------- --------------------- ------------------
Total expenses 2,909,439 3,840,789 10,547,510 14,025,906
---------------- ----------------- --------------------- ------------------
Net income (loss) (1,853,909) 1,904,164 (7,759,463) (13,595,517)
Preferred stock dividends (5,733,818) (5,763,743) (5,871,995) (3,936,450)
---------------- ----------------- --------------------- ------------------
Net loss allocable to
common (7,587,727) (3,859,579) (13,631,458) (17,531,967)
================ ================= ===================== ===================
Basic and diluted net loss per
common share......... (75,877) (38,596) (136,315) (175,320)
================ ================= ===================== ===================
Basic and diluted
weighted-average common 100 100 100 100
shares outstanding
================ ================= ===================== ===================
FS-21
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED NOTES TO FINANCIAL STATEMENTS
Three Months Three Months Three Months Three Months
Ended Ended Ended Ended
March 31, 2001 June 30, 2001 September 30, 2001 December 31, 2001
---------------- ----------------- --------------------- ------------------
REVENUES:
Income from completed real
estate development
(including $0, $0, $0, and
$0 from affiliates) 3,978,796 2,742,380 1,430,690 4,367,752
Other........................ 81 -- -- 68,429
---------------- ----------------- --------------------- ------------------
Total 3,978,877 2,742,380 1,430,690 4,436,181
revenues.....................
EXPENSES:
Management fees paid to
Manager................... 3,122,154 2,989,063 2,808,680 2,425,688
Provision for impairment of
investments in real estate
development............... -- -- -- 73,000
General, administrative and
other..................... 44,658 225,053 104,651 127,718
---------------- ----------------- --------------------- ------------------
Total expenses 3,166,812 3,214,116 2,913,331 2,626,406
---------------- ----------------- --------------------- ------------------
Net income (loss) 812,065 (471,736) (1,482,641) 1,809,775
Preferred stock (5,951,458) (6,126,847) (6,288,698) (5,751,440)
dividends and distributions
---------------- ----------------- --------------------- ------------------
Net loss allocable
to common (5,139,393) (6,598,583) (7,771,339) (3,941,665)
================= ================= ===================== ==================
Basic and diluted net loss
per common share......... (51,394) (65,986) (77,713) (39,417)
================= ================= ===================== ==================
Basic and diluted
weighted-average common
shares 100 100 100 100
================= ================= ===================== ==================
FS-22
SCHEDULE IV
PRIMECORE MORTGAGE TRUST, INC.
MORTGAGE LOANS ON REAL ESTATE
DECEMBER 31, 2002
INVESTMENTS IN REAL ESTATE UNDER DEVELOPMENT:
Final Periodic Face Carrying Carrying
Interest Maturity Payment Amount Amount of Amount
Description Rate Date Terms Prior Liens of Mortgages Mortgages of Defaulted
Loans
- ------------------------- ------------ ---------------- ----------- ------------- ------------------ ---------------- --------------
Land Development 12 - 16% 03/02 - 11/02 Note 1 -- $ 11,460,000 $ 4,932,757 $ 1,417,230
Condominium 11 - 16% 06/01 - 07/03 Note 1 -- 14,225,000 4,165,509 4,165,509
Single Family Detached 11 - 16% 08/01 - 12/03 Note 1 15,307,630 166,923,485 92,043,249 23,597,092
------------------ ---------------- ---------------
$192,608,485 $ 101,141,515 $ 29,179,831
================== ================ ===============
INVESTMENTS IN REAL ESTATE HELD FOR SALE:
Carrying Estimated
Mortgage Amount of Costs to
Description Liens Properties Complete
- -------------------------- ------------------ ---------------- ----------------
Land Development $ -- $ 1,676,642 $ 197,059
Condominium -- 1,542,395 1,455,487
Single Family Detached 13,395,000 33,598,131 13,667,982
------------------ ---------------- ----------------
$ 13,395,000 $ 36,817,168 $15,320,528
================== ================ ================
FS-23