UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 0-30507
Primecore Mortgage Trust, Inc.
(Exact name of registrant as specified in its charter)
Maryland 94-3324992
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)
99 El Camino Real
Menlo Park, CA 94025
(Address of principal offices) (zip code)
(650) 328-3060
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate by check mark whether the registrant is an accelerated
filer (as defined in Rule 12b-2 of the Act).
Yes [ ] No [ X ]
The number of shares of convertible preferred stock outstanding as of
June 30, 2003 was 22,487,371. The number of shares of common stock outstanding
as of June 30, 2003 was 100.
Table of Contents
Part I. Financial Information
Item 1. Financial Statements (unaudited).................................. 2
Consolidated Balance Sheets as of June 30, 2003 (unaudited) and
December 31, 2002............................................. 3
Consolidated Statements of Operations for the Three and Six
Months Ended June 30, 2003 and 2002 (unaudited)............... 4
Consolidated Statement of Shareholders' Equity for the Six
Months Ended June 30, 2003 and 2002 (unaudited)............... 5
Consolidated Statements of Cash Flows for the Six Months Ended
June 30, 2003 and 2002 (unaudited)............................ 6
Notes to the Consolidated Financial Statements (unaudited)........ 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................ 15
Item 3. Quantitative and Qualitative Disclosures about Market Risk....... 23
Item 4. Controls and Procedures...........................................24
Part II. Other Information
Item 1. Legal Proceedings................................................ 24
Item 2. Changes in Securities and Use of Proceeds........................ 24
Item 3. Defaults Upon Senior Securities.................................. 24
Item 4. Submission of Matters to a Vote of Security Holders.............. 24
Item 5. Other Information................................................ 24
Item 6. Exhibits and Reports on Form 8-K................................. 25
Signatures....................................................... 26
Certifications................................................... 27
1
Part I. Financial Information
Item 1. Financial Statements
Attached are the following unaudited financial statements of Primecore
Mortgage Trust, Inc. (the "Company"):
(1) Balance Sheets as of June 30, 2003 (unaudited), and December 31, 2002
(2) Statements of Operations for the Three and Six Months ended June 30,
2003 and 2002 (unaudited)
(3) Statement of Shareholders' Equity for the Six Months ended June 30,
2003 (unaudited)
(4) Statements of Cash Flows for the Six Months ended June 30, 2003 and
2002 (unaudited)
(5) Notes to Financial Statements (unaudited)
The financial statements referred to above should be read in
conjunction with the Company's audited financial statements for the year ended
December 31, 2002 as filed with the Securities and Exchange Commission in our
Annual Report on Form 10-K filed March 31, 2003.
2
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED BALANCE SHEETS
June 30, 2003
(unaudited) December 31, 2002
--------------------- --------------------
ASSETS:
Investments in real estate under development............................ $ 83,597,820 $ 101,141,515
Investments in real estate held for sale................................ 35,413,161 44,510,168
Loans Receivable........................................................ 4,695,000 4,695,000
Cash and cash equivalents............................................... 1,602,529 4,394,107
Other assets, net....................................................... 319,451 326,245
--------------------- --------------------
Total assets.................................................... $ 125,627,961 $ 155,067,035
===================== ====================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Unsecured notes payable (including $280,000 to a director at June 30,
2003 and $150,000 December 31, 2002)................................. $ 10,785,056 $ 14,276,929
Secured notes payable................................................... 7,693,000 7,693,000
Secured line of credit.................................................. 9,836,191 14,431,132
Accrued expenses and other.............................................. 173,108 256,059
Preferred stock dividends payable....................................... 1,311,764 1,312,417
Payable to manager...................................................... 346,833 669,480
--------------------- --------------------
Total liabilities............................................... 30,145,952 38,639,017
--------------------- --------------------
SHAREHOLDERS' EQUITY:
Preferred stock: par value $0.01, 40,000,000 shares authorized;
22,487,371 and 22,496,804 shares issued and outstanding at
June 30, 2003, and December 31, 2002, respectively.................. 225,985,552 226,079,882
Common stock: par value $0.01, 10,000,000 shares authorized; 100
shares issued and outstanding at June 30, 2003, and December 31,
2002, respectively................................................... 1 1
Accumulated dividends and distributions................................. (87,997,901) (80,132,217)
Accumulated deficit..................................................... (42,505,643) (29,519,648)
--------------------- --------------------
Total shareholders' equity...................................... 95,482,009 116,428,018
--------------------- --------------------
Total liabilities and shareholders' equity...................... $ 125,627,961 $ 155,067,035
===================== ====================
The accompanying notes are an integral part of these statements
3
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Three Months Six Months Six Months
Ended Ended Ended Ended
June 30, 2003 June 30, 2002 June 30, 2003 June 30, 2002
------------------- ---------------- -------------------- ----------------
REVENUES:
Income from completed real estate
development.............................. $ 1,436,429 $ 5,682,996 $ 4,234,100 $ 6,738,526
Other ....................................... 107 61,957 16,264 61,957
------------------- ---------------- -------------------- ----------------
Total revenues.......................... 1,436,536 5,744,953 4,250,364 6,800,483
------------------- ---------------- -------------------- ----------------
EXPENSES:
Management fees ............................. 1,096,143 2,450,403 2,224,076 5,108,555
Provision for impairment of investments in
real estate................................ 1,327,534 14,369,097 1,473,316
13,606,038
General, administrative and other............ 250,550 62,852 643,186 168,357
------------------- ---------------- -------------------- ----------------
Total expenses.......................... 14,952,731 3,840,789 17,236,359 6,750,228
------------------- ---------------- -------------------- ----------------
Net income (loss)......................... (13,516,195) 1,904,164 (12,985,995) 50,255
Preferred stock dividends and
distributions......................... (3,935,292) (5,763,743) (7,865,684) (11,497,561)
------------------- ---------------- -------------------- ----------------
Net loss allocable to common.............. $ (17,451,487) $ (3,859,579) $ (20,851,679) $ (11,447,306)
=================== ================ ==================== ================
Basic and diluted net loss per common
share.................................... $ (174,515) $ (38,596) $ (208,517) $ (114,473)
=================== ================ ==================== ================
Basic and diluted weighted-average shares
outstanding.............................. 100 100 100 100
=================== ================ ==================== ================
The accompanying notes are an integral part of these statements
4
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
For the six months ended June 30, 2003
(unaudited)
Preferred Stock Common Stock
----------------------------- -----------------
Accumulated
Dividends
and Accumulated
Shares Amount Shares Amount Distributions Deficit Total
------------- --------------- -------- -------- ----------------- -------------- ---------------
Shareholders' equity at
December 31, 2002................ 22,496,804 $226,079,882 100 $ 1 $ (80,132,217) $ (29,519,648) $116,428,018
Adjustment for dividend
reinvestment..................... (9,433) (94,330) -- -- -- -- (94,330)
Dividends and distributions to
preferred shareholders........... -- -- -- -- (7,865,684) -- (7,865,684)
Net loss............................ -- (12,985,995) (12,985,995)
-- -- -- --
------------------------------------------------------------------------------------------------
Shareholders' equity at
June 30, 2003.................... 22,487,371 $225,985,552 100 $ 1 $ (87,997,901) $ (42,505,643) $ 95,482,009
================================================================================================
The accompanying notes are an integral part of these statements
5
PRIMECORE MORTGAGE TRUST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Six Months
Ended Ended
June 30, 2003 June 30, 2002
--------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)......................................................... $(12,985,995) $ 50,255
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operations;
Provision for impairment of investments in real estate................. 14,369,097 1,473,316
(Decrease) in accrued expenses and other............................... (82,951) (1,031,875)
Increase (decrease) in payable to manager.............................. (322,647) 83,555
Increase in other assets, net.......................................... 6,794 262,581
----------------- --------------
Net cash provided by operating activities........................ 984,298 837,832
----------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments in real estate under development and property held
for sale............................................................. (12,856,319) (22,392,596)
Investments in real estate under development by affiliates............. -- (6,932,750)
Repayments of investments in real estate under development and
property held for sale............................................... 25,166,942 31,679,492
Repayments of investments in real estate under development by
affiliates........................................................... -- 4,167,610
----------------- --------------
Net cash provided by investing activities........................ 12,310,623 6,521,756
----------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sales of preferred stock, net of offering costs.......... -- 9,401,480
Capital contributions by Manager....................................... -- 1,100,000
Redemptions of preferred stock......................................... (94,330) (5,670,820)
Borrowings under notes payable......................................... 380,000 877,000
Payments under notes payable........................................... (3,910,891) (5,061,626)
Payments on secured line of credit, net................................ (4,594,941) (25)
Payment of preferred stock dividends................................... (7,866,337) (9,386,490)
----------------- --------------
Net cash used in financing activities............................. (16,086,499) (8,740,481)
----------------- --------------
Net increase (decrease) in cash and cash equivalents............ (2,791,578) (1,380,893)
Beginning cash and cash equivalents............................. 4,394,107 2,706,204
----------------- --------------
Ending cash and cash equivalents................................ $ 1,602,529 $ 1,325,311
================= ==============
Cash paid for interest, net of amounts capitalized of $1,163,628 and
$1,359,872, for the six months ended June 30, 2003 and 2002,
respectively........................................................... $ -- $ --
================= ==============
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING
AND FINANCING ACTIVITIES:
Reinvested Preferred Stock dividends...................................... $ -- $ 2,066,440
Interest accrued on unsecured notes payable............................... $ 39,018 $ 276,519
The accompanying notes are an integral part of these statements
6
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
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.
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 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 in our Annual Report on Form 10-K for
the year ending December 31, 2002 filed March 31, 2003..
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Basis of Presentation
The accompanying unaudited financial statements present the financial position
of the Company as of June 30, 2003 (unaudited), and December 31, 2002, and the
results of operations and cash flows of the Company for the three months and six
months ended June 30, 2003 and 2002. In the opinion of management, the
accompanying unaudited financial statements contain all adjustments (consisting
of only normal accruals) necessary to present fairly the financial position and
results of operations of the Company as of June 30, 2003 and for the periods
then ended.
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
7
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
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
We have originated loans to acquire, develop and construct 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 (Note 3). Revenue from interest and
points is recognized as cash is received from the sale or refinancing of such
properties. 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 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.
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 at the contracted interest rate and points on those ADC loans. We do
not intend to own or develop property and do not participate in the profit
realized by the borrower 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
8
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
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
any applicable alternative minimum tax) and may not be able to qualify as a REIT
for four subsequent taxable years. Even if we qualify for taxation as a REIT, we
may be subject to certain state and local taxes on our income and property and
to federal income and excise taxes on our undistributed taxable income.
Our taxable income 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 have distributed Preferred Stock
dividends monthly 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. Currently our monthly
dividend rate is $0.0583 per share. On July 17, 2003 our Board of Directors
voted to suspend payment of dividends effective after payment of our August
declaration.
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
three and six month period ended June 30, 2003 and 2002, 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.
Reclassifications
Certain prior period amounts have been reclassified to conform to current year
presentation.
3. INVESTMENTS IN REAL ESTATE UNDER DEVELOPMENT:
We make ADC loans with maturity dates generally up 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 three
months ended June 30, 2003 fixed interest rates on ADC loans outstanding ranged
from 11 percent to 17 percent. In the case of ADC loans on which the borrower
9
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
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 June 30, 2003:
Commitment Carrying
Location - County Maturity Dates Amount Amount
- ---------------------------- ----------------- ------------- ------------
Alameda 12/02-04/03 $ 3,954,000 1,277,592
Marin 08/01-11/03 42,635,000 19,455,765
Monterey 12/02-12/03 25,025,000 14,431,745
San Francisco 03/02-06/03 16,100,000 5,204,945
San Mateo 07/02-12/03 47,174,485 26,480,699
Santa Clara 05/02-06/03 23,300,000 15,313,746
Santa Cruz 06/01-06/01 6,750,000 1,433,328
------------- ------------
$164,938,485 $83,597,820
============= ============
During the three months and six months ended June 30, 2003, we capitalized
$451,067 and $897,126 of interest costs to investments in real estate under
development compared with $560,068 and $1,111,017 during the three months and
six months ended June 30, 2002.
We will fund commitments on existing ADC loans from the repayment of other ADC
loans, proceeds from sales of REO properties, issuance of unsecured notes
payable or issuance of additional preferred stock. As of June 30, 2003 our
unfunded commitment was $16,040,336, exclusive of interest and points compared
with $23,835,015 at December 31, 2002. We believe we will have adequate sources
of capital to fund these commitments when and as they become due.
As of June 30, 2003, we had loans with a carrying amount of $1,094,344, which
had not been paid by their stated maturity dates and which we do not intend to
extend compared with $10,293,731 at December 31, 2002. These ADC loans accrue
interest at the default rate, which is 500 basis points above the note rate. We
may choose not to extend these contracts for a variety of reasons.
Additionally, at June 30, 2003, we had recorded notices of default on loans with
a carrying amount of $42,496,499 compared with $18,886,100 at December 31, 2002.
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 three months and six months ended June 30, 2003, we charged
$6,069,241 and $6,146,861 to operations for ADC loans we believe are impaired
compared with $1,327,534 and $1,473,316 during the three months and six months
ended June 30, 2002.
4. INVESTMENT IN REAL ESTATE HELD FOR SALE:
As of June 30, 2003, we held title to 16 properties received through foreclosure
or by deed in lieu of foreclosure.
10
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
The following table summarizes investments in real estate held for sale at June
30, 2003:
Carrying
County Number Amount
- ------------------------------------------- ----------- ------------------
Alameda 3 $ 1,758,646
Marin 2 5,143,577
San Francisco 2 2,146,050
San Mateo 3 11,638,886
Santa Clara 6 14,726,002
----------- ------------------
Total 16 $ 35,413,161
==================
We report these properties at the lower of their existing carrying amount or net
realizable value and they are in various stages of construction. The properties
will be sold in the manner which we believe maximizes their value to us. During
the three months and six months ended June 30, 2003, we capitalized $121,161 and
$234,115 of interest costs to investments in real estate held for sale that were
still under construction compared with $92,810 and $178,739 during the three
months and six months ended June 30, 2002.
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 ADC loans,
proceeds from the sale of REO properties, issuance of unsecured notes payable or
issuance of additional preferred stock. As of June 30, 2003, our estimated costs
to complete these investments was $11,645,414 compared with $15,320,528 at
December 31, 2002.
During the three months and six months ended June 30, 2003, we charged
$7,536,797 and $8,222,237 to operations for impairments on Investments in Real
Estate Held For Sale compared with none during the three months and six months
ended June 30, 2002.
5. 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 June 30, 2003 payments were current
on the loan.
6. UNSECURED NOTES PAYABLE:
We had unsecured borrowings of $10,740,745 at June 30, 2003 compared with
$14,095,017 at December 31, 2002 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 6.50 and 12.00
percent with interest payable monthly in arrears. We may repay these notes,
without penalty, at our option before their stated maturity. As of June 30,
2003, we estimate that the carrying amounts of our notes payable approximate
their fair value based on current borrowing rates available to us.
Included in our unsecured notes payable is $280,000 owed to one of our directors
at June 30, 2003 compared with $150,000 at December 31, 2002. One note for
$150,000, bears interest at 10%, was issued for a two-year term and matures on
June 28, 2004. The second note for $130,000, bears interest at 8.50% was issued
for a three-year term and matures on May 29, 2006.
Additionally, at June 30, 2003, we had $44,312 due on notes payable to financial
institutions to finance the cost of our insurance policies compared with
$181,912 at December 31, 2002. The note bears interest at 7.462% and requires
monthly payments $14,955.
11
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
The following table summarizes the maturities of our notes payable at June 30,
2003:
Year Amount
--------------- ----------------
2003 $ 7,523,665
2004 2,881,391
2005 250,000
2006 130,000
----------------
Total $ 10,785,056
================
7. SECURED NOTES PAYABLE:
At June 30, 2003 and December 31, 2002 we owed $7,693,000 under notes payable to
financial institutions secured by real property we own. The notes require
monthly payments of interest only. All notes have a due on sale clause which
provides that the note will become due and payable upon transfer of title of the
securing real estate. The following table sets forth salient data:
Securing property Rate Due Date Note Amount
- ---------------------- ---------------- ------------------ ------------------
2 single family homes 6.00% 8/25/2003 $ 2,508,000
1 single family home 4.75% 5/1/2030 3,185,000
1 single family home 5.25% 1/1/2004 2,000,000
------------------
Total $ 7,693,000
==================
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 June 30, 2003, was $9,836,191, compared with
$14,431,132 at December 31, 2002. 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 (5.50 percent at June 30, 2003) and matured on May 11,
2003.
We have negotiated a forbearance agreement of this facility with our lender and
are exploring other financing options. Our present projections indicate we will
have the liquidity necessary to fully repay this loan by the forbearance date.
If we do not pay the loan when due our lender will have various remedies that
could severely affect our cash flow and our ability to fund commitments, and
which will require that we take immediate steps to address our cash flow needs.
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 were
fully amortized on the effective interest method over the life of the facility.
At June 30, 2003 we were negotiating a credit facility with several lenders in
order to replace our current facility.
12
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
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 June 30, 2003, there were 100 shares of common stock outstanding.
The 22,487,371 and 22,496,804 shares of Preferred Stock outstanding as of June
30, 2003 and December 31, 2002, 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
$0.17 and $0.35 per share (based on weighted average preferred shares
outstanding of 22,487,371) for the three months and six months ended June 30,
2003 compared with $0.26 and $0.53 per share (based on weighted average
preferred shares outstanding of 21,957,815 and 21,900,831) for the three months
and six months ended June 30, 2002. On July 16, our Board of Directors voted to
suspend payment of return of capital dividends after the payment of August
dividends, which will be made on or about September 7, 2003.
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 ran
from January 1, 2003 through March 31, 2003. Redemption of shares is always
subject to availability of funds for redemption purposes. No redemptions were
made for the first Repurchase Period due to restrictions imposed as a condition
for forbearance of payment on our line of credit facility. 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 June 30, 2003
we had an active private placement, but had not sold any shares in connection
therewith.
10. TRANSACTIONS WITH AFFILIATES:
Management Fees
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.
13
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Payable to Manager
We owed $346,833 to our Manager at June 30, 2003 for fees earned in June 2003
compared with $669,480 payable December 31, 2002. The amounts payable to our
Manager are typically paid during the following month.
Real Estate Sales Commissions
We paid real estate sales commissions of $41,000 and $235,600 during the three
months and six months ended June 30, 2003 to Primecore Properties, Inc., an
affiliate, compared with $48,300 during the three months and six months ended
June 30, 2002. 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.
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 $4,283,042
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 and investments in real under development by
affiliates.
General Uninsured Losses
We require that our borrowers carry comprehensive liability, fire, flood,
extended coverage, and rental loss insurance with policy specifications, limits,
and deductibles customarily carried for similar properties. We also carry
insurance to cover losses in case a borrower's policy lapses. 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. 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.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
General
Our material financial transactions have been purchasing and holding a portfolio
of construction 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-Q, which are not historical facts,
may be forward-looking statements. Such statements are subject to risks and
uncertainties that could cause actual results to differ materially from those
projected. Investors are cautioned not to attribute undue certainty to these
forward-looking statements, which speak only as of the date of this Form 10-Q.
We undertake no obligation to publicly release any revisions to these
forward-looking statements to reflect events or circumstances after the date of
this Form 10-Q or to reflect the occurrence of unanticipated events, other than
as required by law.
Overview
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. Several
characteristics of this target customer base and residential housing market have
been vital to Primecore's business model:
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:
15
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 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.
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 beginning in
2001. 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, and the slowdown in
real estate activity, experienced in the United States and Europe following
terrorist attacks in the fall of 2001 and the war in Iraq 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 and during 2000, we made a
significant number of ADC loans for the development of such housing units. As of
January 1, 2003, 66% of the estimated collections from our investments were
invested in properties with estimated sale prices greater than $2.5 million per
unit. These properties have been selling slower than anticipated, and in a
number of cases have been sold at substantially lower prices than contemplated
when the ADC loans were made. During 2003, additional under performing ADC loans
and foreclosed properties that we now own ("REO") must be liquidated. We expect
continued negative 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
Income from Real Estate Investments
We charge interest on the money we lend to developers. Our business model
targets a 16% gross rate of return on these funds. Although we charge our
borrowers for the use of our money, we typically 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 usually rely on the value of the securing
property to support repayment of our loan plus accrued interest. We calculate
the gross internal rate of return for our closed investments based on the
discounted present value of the investment cash flows on an
investment-by-investment basis. Our target yield is 16%. The chart below depicts
the two year average yield on our investments. We use a two year average because
it fairly closely corresponds with the average term of our investments.
[CHART OMITTED]
The chart shows the effects the economic downturn has had on the yield of our
investments. The two year average yield from our investments during the three
and six months ended June 30, 2003 was 9.88% and 10.62% compared with 15.38% and
15.11% during the three and six months ended June 30, 2002. The decrease
resulted mainly from our inability to collect the amounts we had estimated on
the loans we made in 1999 and 2000. As we continue to close ADC loans and REO
properties in our portfolio that were made in 1999 and 2000, we expect the two
year average yield will continue to decrease. This will happen because our
current estimated values do not support full repayment of amounts invested. As
16
we use the proceeds from these investments to make new loans the average yield
should begin to move upward again and toward our target yield however, because
the yield reflects data from closed investments and our investment cycle is
typically two years, we do not expect to observe this upward trend for at least
two years.
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
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 (NRV) of our investments.
June 30,2003 December 31, 2002
--------------- -------------------
Investments in real estate under
construction $ 83,597,820 $ 101,141,515
Investments in real estate held for sale 35,413,161 44,510,168
--------------- -------------------
Total investments in real estate per US
GAAP 119,010,981 145,651,683
Add: GAAP impairments 26,425,575 18,753,706
Accrued interest and points 59,129,258 64,337,376
Less: Capitalized interest (6,343,892) (6,566,481)
--------------- -------------------
Balance owed on real estate investments 198,221,922 222,176,284
Amount estimated uncollectible (62,914,068) (43,875,448)
--------------- -------------------
Estimated realizable value of investments
in real estate (NRV) $ 135,307,854 $ 178,300,836
=============== ===================
NRV 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.
Stock Redemption Price
Our Preferred Stock does not trade on any secondary market. Accordingly, we have
established a repurchase policy to provide liquidity to our shareholders. The
Board has determined that the repurchase price of the stock should be determined
with reference to the NRV of our assets. The following calculation established
17
the repurchase price of our stock at June 30, 2003 and December 31, 2002 for
purposes of the Primecore Mortgage Trust, Inc. Redemption Policy:
June 30, 2003 December 31, 2002
--------------- -------------------
Cash $ 1,602,529 $ 4,394,107
NRV of investments in real estate 135,307,854 178,300,836
Loans secured by real estate 4,695,000 4,695,000
--------------- -------------------
Total realizable assets 141,605,383 187,389,943
Total liabilities (30,145,954) (38,639,018)
--------------- -------------------
Net realizable assets 111,459,429 148,750,925
Preferred shares outstanding 22,487,371 22,496,804
--------------- -------------------
Preferred Stock repurchase price $ 4.96 $ 6.61
=============== ===================
The Preferred Stock repurchase price is determined for the sole purpose of
satisfying the provisions of the Primecore Mortgage Trust, Inc. Redemption
Policy and is not meant to establish the fair market value of our Preferred
Stock. The fair market value of our stock can only be determined through a free
market of buyers and sellers. The repurchase price is also not meant to
represent the amount which would be obtained for a share of Preferred Stock upon
liquidation of the company. The repurchase price uses estimates of future
completed values which cannot be assured; does not discount for the period it
would take to complete our ADC Loans and REO properties; and does not factor in
administrative costs or potential future revenues collectible.
The following table details the changes to net realizable assets per share for
the six months ended June 30, 2003:
Six months
ended
June 30, 2003 Per share
----------------- ---------------
Estimated collectible income $ (25,443,237)
Operating expenses
Management fee expense 2,224,076
Interest expense 1,131,241
General and administrative expense 643,186
----------------- ---------------
Total operating expenses 3,998,503 0.18
----------------- ---------------
Operating loss (29,441,740) (1.30)
Dividends and distributions (7,865,684) (0.35)
----------------- ---------------
Total change $ (37,307,424) $ (1.65)
================= ===============
The decrease in net realizable assets of $1.65 per share results from the
distribution of $0.35 per share in Preferred Stock dividends and $1.30 per share
resulting from operations. During the three months ended June 30, 2003 we closed
two ADC loans priced in the high end market. The sale prices achieved for these
properties was considerably less than the values we, and the independent
appraisers we retained, had estimated in January 2003, indicating a much softer
market in the high end sector than expected. As a result of these, and other
recent high end sales, we conducted another analysis of the estimated value of
every property in our portfolio and adjusted estimated values where we thought
appropriate. In our analysis we studied local market sale comparables which we
track; we discussed pricing with real estate brokers in their specialty
submarkets; we performed an analytical review of our appraisal information; and
we used information from more recent third party appraisals of our investments.
The analysis resulted in an additional decrease in the expected NRV of our
investments.
We believe that the lack of sales in high end market during the second half of
2002 masked the extent of the decline in values in the high end sector when the
estimates of portfolio values were made in January 2003. With more sales in this
sector during the three months ended June 30, 2003 we have obtained a clearer
picture of this market sector and believe the revised values are reasonable.
However, as always, predictions are subject to variation, and factors beyond our
expectation or control could result in future decreases or increases in the
value estimates, which can only be based on information available at any given
time.
18
Management fees
During the three and six months ended June 30, 2003 our management fee expense
was $1,096,143 and $2,224,076 compared with $2,450,043 and $5,108,555 during the
three and six months ended June 30, 2002. The decrease is due to the restatement
of the management agreement which became effective January 1, 2003. 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 Prior to January 1, 2003, we paid management fees
based on the amount of loan commitments outstanding at the end of each month.
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 $4.2 million in 2003.
Interest costs
Since December 31, 1999, all interest costs have been capitalized as a cost of
our investments. Interest cost associated with our borrowings was $572,228 and
$1,131,241 during the three and six months ended June 30, 2003, compared with
$640,786 and $1,332,098 during the three and six months ended June 30, 2002. The
decrease is due to a combination of a lower average cost of debt, 8.16% and
8.54% during the three and six months ended June 30, 2003, compared with 9.08%
and 9.24% during the three and six months ended June 30, 2002; and a lower
amount of debt on our balance sheet, an average of $25.2 million and 23.5
million during the three and six months ended June 30, 2003 compared with an
average of $27.1 million and $28.2 million during the three and six months ended
June 30, 2002. We are seeking to maintain our debt at existing levels, and will
endeavor to negotiate extensions of existing notes or seek new sources to enable
us to lower the cost of our debt.
General and administrative expenses
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 $250,550 and $643,186 during the
three and six months ended June 30, 2003, compared with $62,852 and $168,357
during the three and six months ended June 30, 2002. The increased costs result
from a number of factors. During 2003 we commissioned appraisals of the
portfolio to help us determine value. Additionally, we incurred costs associated
with our ownership of the properties we have taken in foreclosure or deed in
lieu of foreclosure. Our insurance costs have increased as the insurance market
has become more expensive and restricted. Finally, the cost of our annual audit
increased due to additional procedures performed by our new auditors necessary
to comply with new regulatory requirements.
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 and sales of preferred stock.
Sources of cash
Investment repayments
Our 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 66% of the estimated proceeds from our
19
investments were invested in properties expected to sell at prices over $2.5
million. During the three and six months ended June 30, 2003, we received loan
repayments, including income, of $11,369,688 and $29,236,718, respectively. Of
the $29,236,718 received in proceeds during that period, only $7,403,656
represented proceeds from properties which sold at prices over $2.5 million. As
a result, at June 30, 2003 the balance increased so that approximately 71% of
the estimated proceeds from our investments were invested in properties expected
to sell for prices at $2.5 million and above.
Sales of properties in the $2.5 million and over sector were very slow in 2002
and during the six months ended June 30, 2003 as the few buyers who are able to
afford these properties have been very deliberate about their purchase
decisions. We did receive repayment from two ADC loans whose properties sold
over $2.5 million and we have had more market activity in other properties we
have financed or own in this sector since May 2003. However, in order to obtain
these sales, we were forced to accept proceeds substantially less than the
amount we estimated for those ADC loans. The chart below depicts the amount of
proceeds we expect to collect from our existing investments once they have sold
or refinanced. The bars of the graph categorize the proceeds by the price sector
of the underlying property.
[CHART OMITTED]
The chart shows that we estimate we will collect $45.4 million in proceeds from
ADC loans and REO properties which were complete and on the market as of June
30, 2003. Of that approximately $17.4 million represented ADC loans and REO
properties valued at less than $2.5 million per unit. We expect an additional
$4.0 million in estimated proceeds from ADC loans and REO properties valued at
less than $2.5 million to complete construction within the next three months.
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. Sales of properties in this price sector have remained fairly stable and
the cash flow we expect from them has been fairly reliable.
At June 30, 2003 we had estimated $28.0 million in proceeds from ADC loans and
REO properties valued at $2.5 million or more, which were complete and on the
market. We expect an additional $22.1 million in estimated proceeds from ADC
loans and REO properties valued at $2.5 million or more to be completed within
the next three months. 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.
These properties have been the most difficult to sell or refinance during the
last 12 months and we currently expect that to continue.
Because a single loan repayment can have a large impact on our repayment
projections, it is difficult to predict repayments with precision, especially as
construction and sales can be delayed due to factors beyond our control, such as
weather, borrower delays, and lengthy foreclosure or borrower bankruptcy
20
proceedings. In the event that our repayments or other cash sources are not
sufficient to timely meet our commitments we will have to take other steps to
meet our commitments, which could include reducing 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.
Stock sales
Our liquidity has been enhanced through sales of our Preferred Stock and
issuance of notes payable to investors. Our Preferred Stock is sold through
private placements. In November 2002 we closed our private placement. Our Board
has authorized the opening of 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.
Issuance of unsecured notes payable
We issue a limited amount of short-term notes payable as an investment
alternative to our Preferred Stock. During the three and six months ended June
30, 2003 we issued $130,000 and $380,000 in unsecured notes payable compared
with $215,000 and $877,000 issued during the three and six months ended June 30,
2002. Our current plan for 2003 and beyond is to maintain our existing notes
payable balances at 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 projected
obligations over the next two years, without taking into account new loans that
may be made in 2003 and 2004:
Total 2003 2004
---------------- ----------------- ----------------
Investment fundings $ 35,300,000 $ 25,100,000 $10,200,000
Line of credit 9,836,191 9,836,191 --
Secured notes payable 7,693,000 4,508,000 3,185,000
Unsecured notes payable 10,405,056 7,523,665 2,881,391
---------------- ----------------- ----------------
Total $ 63,234,247 $ 46,967,856 $ 16,266,391
================ ================= ================
Investment fundings
Investment fundings are the largest use of our cash. At June 30, 2003 we
estimated costs to complete our investments were $35.3 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 June 30, 2003
as we continue to make and fund new loan commitments in 2003 and beyond.
Line of credit
Our line of credit matured on May 11, 2003. We negotiated a forbearance
agreement with our lender that provides us with an additional 90 days to repay
the loan. The agreement provides among other things that 70% of the proceeds
from our ADC loans and REO properties be used to pay down our line of credit. As
of the date of our filing, we had paid the balance down to approximately $1.2
million. We currently expect that we will accomplish full repayment of this
facility by the expiration of our forbearance agreement. If we do not pay the
loan when due, our lender will have various remedies that could severely impact
on our cash flow and our commitments, and which will require that we take
immediate steps to address our cash flow needs, which may include a freeze on
all distributions to shareholders and other steps.
21
At June 30, 2003 we were negotiating a credit facility with several lenders in
order to replace our current facility.
Secured notes payable
Our secured notes payable are loans made to us by financial institutions and
secured by first deeds of trust on properties we own. Monthly interest payments
are required and the maturities of these loans approximate the date we expect
the underlying collateral to sell. Once sold, the secured loan will be repaid.
Unsecured notes payable
At June 30, 2003 we had approximately $10.8 million in unsecured notes payable,
$7.5 million of which will mature in 2003. Our strategy is to extend these
notes, if possible, on terms that are favorable to us.
Stock repurchases
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 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 ran 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. As discussed above, our line of credit expired on May
11, 2003. The terms of our forbearance agreement provide that substantially all
of the proceeds from our ADC loan and REO property repayments be used to pay
down the balance on our line of credit. No redemptions were made for the first
Repurchase Period due to restrictions imposed as a condition for forbearance of
payment on our line of credit facility. Until we have accomplished the repayment
of this loan, we will be unable to fund the allocated repurchase program.
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 of
America. 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,
22
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 and investments in real estate held for sale totaling $13,606,038
and $14,369,097 during the three and six months ended June 30, 2003 compared
with $1,327,534 and $1,473,316 during the three and six months ended June 30,
2002. We believe that all of our investments are carried at realizable values,
however conditions may change and cause our ADC loans and REO properties 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
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. On July 17, 2003 our Board of Directors voted to suspend
payment of dividends effective after payment of our August declaration.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
An investment in our stock involves a high degree of risk. Among other things,
some of the principal risks are: the real estate lending business may be
adversely affected by periods of economic slowdown, which may be accompanied by
declining real estate values on properties securing repayment of loans;
construction mortgage loans involve greater risks of repayment than loans
secured by property that has already been improved since completion market
valuation of a given project can be highly speculative and subject to
unanticipated conditions; there is no public market for our securities, and
liquidity is not assured; under our business model, loan commitments will
generally exceed immediately available cash resources, and failure to obtain
repayment of loans in our portfolio, or a failure to maintain sufficient equity
would affect our ability to fund commitments; since we have no employees, if our
manager refused or became unable to continue to serve us, and a proper
replacement were not found, this would materially impact our business.
We make loans at fixed rates of interest. To the extent that prevailing market
interest rates change during the holding period, the value of our loans may be
either adversely or positively affected. When a loan matures, generally within a
12 to 18 month period, it is subject to a new interest rate, determined by us,
based upon current conditions. Since we intend to hold all loans until they are
repaid, we do not believe that changes in market interest rates have a material
impact on the value of the Company.
23
ITEM 4. CONTROLS AND PROCEDURES.
Within the past 90 days we carried out an evaluation, under the supervision of
the Company's Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the Company's disclosure controls and procedures. Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer have each
concluded that those controls and procedures were effective in making known to
them, on a timely basis, the material information needed for the preparation of
this Report on Form 10-Q. There were no significant changes in the Company's
internal controls or in other factors that could significantly affect those
internal controls since the date of their evaluation nor did we find any
significant deficiencies and material weaknesses that would have required
corrective actions to be taken with respect to those controls.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
We are not presently subject to any material litigation nor, to our knowledge,
is any litigation threatened against us which collectively is expected to have a
material adverse effect on our cash flows, financial condition or results of
operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(a) Not Applicable.
(b) Not Applicable.
(c) Sales of Equity Securities.
Between January 1, 2003 and June 30, 2003, we did not sell any shares of
our Class A Convertible Preferred stock.
Purchasers of our Class A Convertible Preferred stock are accredited
investors as defined in Regulation D, Rule 501 (a) (4), (5) or (6) under
the 1933 Securities Act. Each investor signed a subscription agreement
which included representations that the investor had sufficient knowledge
and experience in financial and business matters to be capable of
evaluating the merits and risks of investments generally, and of the
investment in our stock and the investor was able to bear the economic risk
of the investment. Each investor further acknowledged the investor
understood the entire investment could be lost.
The sales of stock were exempt from the registration requirements of the
Securities Act of 1933 pursuant to Regulation D, Rule 506. Appropriate
legends were placed on each stock certificate. No underwriters were
involved and no underwriting commissions were paid in any of the
transactions.
The terms of conversion of the stock have been previously reported.
(d) Not Applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
ITEM 5. OTHER INFORMATION.
Not applicable.
24
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
Exhibits included with this Form 10-Q following the signature page, or those
incorporated by reference to other filings are:
3i.1 Articles of Incorporation of the Company are hereby incorporated herein
by reference from Exhibit 3(i) to the Company's Registration Statement on
Form 10-12G, filed on April 28, 2000
3i.2 Articles Supplementary of the Company are hereby incorporated herein by
reference from Exhibit 99.1 to the Company's Registration Statement on
Form 10-12G, filed on April 28, 2000
3ii.1 Bylaws, Amended March 21, 2000 are hereby incorporated herein by
reference from Exhibit 3(ii) to the Company's Registration Statement on
Form 10-12G, filed on April 28, 2000
3ii.2 Bylaws, Amended March 1, 2001 are hereby incorporated herein by reference
from Exhibit 3ii.2 to the Company's Annual Report on Form 10-K, filed on
March 30, 2001
4.1 Specimen Stock Certificate is hereby incorporated herein by reference
from Exhibit 99.2 to the Company's Registration Statement on Form 10-12G,
filed on April 28, 2000
4.2 Registration Rights Agreement is hereby incorporated herein by reference
from Exhibit 4.1 to the Company's Registration Statement on Form 10-12G,
filed on April 28, 2000
4.3 Founder's Registration Rights Agreement is hereby incorporated herein by
reference from Exhibit 4.2 to the Company's Registration Statement on
Form 10-12G, filed on April 28, 2000
10.1 Management Agreement dated March 30, 1999 is hereby incorporated herein
by reference from Exhibit 10 to the Company's Registration Statement on
Form 10-12G, filed on April 28, 2000
10.2 Management Agreement dated October 1, 2000 is hereby incorporated herein
by reference from Exhibit 10.2 to the Company's Annual Report on Form
10-K, filed on March 30, 2001
11.1 Statement regarding computation of per share earnings
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C Section
1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of
2002
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C Section
1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of
2002
(b) Reports on Form 8-K
Not applicable.
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: August 14, 2003 /s/ SUSAN FOX
--------------------
Susan Fox, President
Dated: August 14, 2003 /s/ MICHAEL RIDER
--------------------
Michael Rider, Chief Financial Officer
26
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Susan Fox, certify that:
1. I have reviewed this Form 10-Q of Primecore Mortgage Trust,
Inc.;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
/s/ SUSAN FOX
--------------------
Susan Fox, President
August 14, 2003
27
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Michael Rider, certify that:
1. I have reviewed this Form 10-Q of Primecore Mortgage Trust,
Inc.;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
/s/ MICHAEL RIDER
--------------------
Michael Rider, Chief Financial Officer
August 14, 2003
28