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, 2004
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
BellaVista Capital, 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)
Primecore Mortgage Trust, Inc.
99 El Camino Real Menlo Park, CA 94025
(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
August 18, 2004 was 19,850,875. The number of shares of common stock outstanding
as of June 30, 2004 was 100.
Table of Contents
Part I. Financial Information
Item 1. Financial Statements (unaudited).................................. 2
Consolidated Balance Sheets as of June 30, 2004 (unaudited) and
December 31, 2003............................................. 3
Consolidated Statements of Operations for the Three Months and
Six Months Ended June 30, 2004 and 2003 (unaudited)........... 4
Consolidated Statement of Shareholders' Equity for the Three
Months Ended June 30, 2004 (unaudited)........................ 5
Consolidated Statements of Cash Flows for the Three Months Ended
June 30, 2004 and 2003 (unaudited)............................ 6
Notes to the Consolidated Financial Statements (unaudited)........ 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................ 16
Item 3. Quantitative and Qualitative Disclosures about Market Risk....... 21
Item 4. Controls and Procedures.......................................... 21
Part II. Other Information
Item 1. Legal Proceedings................................................ 22
Item 2. Changes in Securities and Use of Proceeds........................ 22
Item 3. Defaults Upon Senior Securities.................................. 22
Item 4. Submission of Matters to a Vote of Security Holders.............. 22
Item 5. Other Information................................................ 22
Item 6. Exhibits and Reports on Form 8-K................................. 22
Signatures....................................................... 23
1
Part I. Financial Information
Item 1. Financial Statements
Attached are the following unaudited financial statements of BellaVista
Capital, Inc., formerly known as Primecore Mortgage Trust, Inc. (the "Company"):
(1) Consolidated Balance Sheets as of June 30, 2004 (unaudited), and
December 31, 2003
(2) Consolidated Statements of Operations for the Three Months and Six
Months ended June 30, 2004 and 2003 (unaudited)
(3) Consolidated Statement of Shareholders' Equity for the Six Months ended
June 30, 2004 (unaudited)
(4) Consolidated Statements of Cash Flows for the Six Months ended June 30,
2004 and 2003 (unaudited)
(5) Notes to Consolidated 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, 2003 as filed with the Securities and Exchange Commission in our
Annual Report on Form 10-K filed April 14, 2004.
2
BELLAVISTA CAPITAL, INC.
CONSOLIDATED BALANCE SHEETS
June 30, 2004
(unaudited) December 31, 2003
----------------- -------------------
ASSETS:
Investments in real estate
under development $ 27,155,355 $ 34,629,956
Investments in real estate
held for sale 41,373,610 44,551,722
Cash and cash equivalents 8,676,471 10,701,188
Fixed assets, net 140,483 --
Other assets, net 140,411 1,504,472
----------------- -------------------
Total assets $ 77,486,330 $ 91,387,338
================= ===================
LIABILITIES AND SHAREHOLDERS'
EQUITY:
Unsecured notes payable
(including $0 and $280,000
to a director at June 30,
2004 and December 31, 2003,
respectively) $ -- $ 4,692,517
Secured notes payable 3,185,000 3,185,000
Accrued expenses and other 659,232 235,551
Payable to manager -- 121,577
----------------- -------------------
Total liabilities 3,844,232 8,234,645
SHAREHOLDERS' EQUITY:
Preferred stock: par value $0.01,
40,000,000 shares authorized;
20,009,011 and 22,229,739 shares
issued and outstanding at June
30, 2004, and December 31, 2003,
respectively 218,924,823 225,142,861
Common stock: par value $0.01,
10,000,000 shares authorized;
100 shares issued and outstanding
at June 30, 2004, and December
31, 2003, respectively 1 1
Accumulated dividends and distributions (90,621,455) (90,621,455)
Accumulated deficit (54,661,271) (51,368,714)
----------------- -------------------
Total shareholders' equity 73,642,098 83,152,693
----------------- -------------------
Total liabilities and
shareholders' equity $ 77,486,330 $ 91,387,338
================== ===================
The accompanying notes are an integral part of these statements
3
BELLAVISTA CAPITAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Three Months Six Months
Ended Ended Six Months Ended
June 30, 2004 June 30, 2003 Ended June 30,
June 30, 2004 2003
------------------ ------------------ ------------------ -----------------
REVENUES:
Income from completed real estate development $ 854,192 $ 1,436,429 $ 2,226,826 $ 4,234,100
Income from legal settlements 159,000 -- 369,000 --
Interest income 28,524 -- 63,629 --
Other 10,015 107 27,787 16,264
------------------ ------------------ ------------------ -----------------
Total revenues 1,051,731 1,436,536 2,687,242 4,250,364
------------------ ------------------ ------------------ -----------------
EXPENSES:
Salaries expense 327,745 -- 349,583 --
Facilities expense 101,563 -- 189,986 --
Legal and accounting expense 218,992 99,629 1,083,920 270,211
Insurance expense 72,155 76,927 144,309 157,922
General, administrative and other expense 70,478 1,318 115,070 83,339
Depreciation expense 8,547 -- 8,547 --
REO expense 80,832 72,676 205,251 131,714
Internalization transition expenses 4,237 -- 433,672 --
Management fees -- 1,096,143 639,698 2,224,076
Provision for impairment of investments in real estate 1,882,283 13,606,038 2,809,763 14,369,097
------------------ ------------------ ------------------ -----------------
Total expenses 2,766,832 14,952,731 5,979,799 17,236,359
------------------ ------------------ ------------------ -----------------
Net (loss) income (1,715,101) (13,516,195) (3,292,557) (12,985,995)
Preferred stock dividends and distributions -- (3,935,292) -- (7,865,684)
------------------ ------------------ ------------------ -----------------
Net loss allocable to common $ (1,715,101) $ (17,451,487) $ (3,292,557) $ (20,851,679)
================== ================== ================== =================
Basic and diluted net loss per common share $ (17,151) $ (174,515) $ (32,926) $ (208,517)
Basic and diluted weighted-average shares outstanding 100 100 100 100
The accompanying notes are an integral part of these statements
4
BELLAVISTA CAPITAL, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
For the three months and six months ended June 30, 2004
(unaudited)
Preferred Stock Common Stock
----------------------------- -----------------
Accumulated
Dividends
and Accumulated
Shares Amount Shares Amount Distributions Deficit Total
------------- --------------- -------- -------- ----------------- ---------------- -----------------
Shareholders' equity at
December 31, 2003 22,229,739 $225,142,861 100 $ 1 $ (90,621,455) $ (51,368,714) $ 83,152,693
Repurchase of Preferred Stock (2,220,728) (6,218,038) -- -- -- -- (6,218,038)
Net loss -- -- -- -- -- (3,292,557) (3,292,557)
------------- --------------- -------- -------- ----------------- ---------------- -----------------
Shareholders' equity at
June 30, 2004 20,009,011 $218,924,823 100 $ 1 $ (90,621,455) $ (54,661,271) $ 73,642,098
============= =============== ======== ======== ================= ================ =================
The accompanying notes are an integral part of these statements
5
BELLAVISTA CAPITAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Six Months
Ended Ended
June 30, 2004 June 30, 2003
------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $ (3,292,557) $ (12,985,995)
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operations;
Depreciation expense 8,547 --
Provision for impairment of investments in real estate 2,809,763 14,369,097
Increase in accrued expenses and other 423,681 (82,951)
Decrease in payable to manager (121,577) (322,647)
-------------------- ---------------------
Net cash (used in) provided by operating activities (172,143) 977,504
-------------------- ---------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of fixed assets (149,030) --
Decrease in other assets, net 1,364,061 6,794
Proceeds from investments in real estate under development and
property held for sale 18,210,326 25,166,942
Investments in real estate under development and property held for
sale (10,363,112) (12,856,319)
-------------------- ---------------------
Net cash provided by investing activities 9,062,245 12,317,417
-------------------- ---------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repurchase of Preferred Stock (6,218,038) --
Adjustment for dividend reinvestment -- (94,330)
Issuance of unsecured notes payable -- 380,000
Repayment of unsecured notes payable (4,696,781) (3,910,891)
Payments on secured line of credit, net -- (4,594,941)
Payment of preferred stock dividends -- (7,866,337)
-------------------- ---------------------
Net cash used in financing activities (10,914,819) (16,086,499)
-------------------- ---------------------
Net decrease in cash and cash equivalents (2,024,717) (2,791,578)
Beginning cash and cash equivalents 10,701,188 4,394,107
-------------------- ---------------------
Ending cash and cash equivalents $ 8,676,471 $ 1,602,529
==================== =====================
Cash paid for interest, net of amounts capitalized of $49,988 and
$1,163,628, for the six months ended June 30, 2004 and 2003,
respectively $ -- $ --
Interest accrued on unsecured notes payable $ 4,264 $ 39,018
==================== =====================
The accompanying notes are an integral part of these statements
6
BELLAVISTACAPITAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. ORGANIZATION AND BUSINESS:
Organization
The Company, formerly known as 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). On October 7, 2003 our Board
of Directors voted to withdraw our REIT election effective for the tax year
beginning January 1, 2004. The Company changed its name to BellaVista Capital,
Inc. on April 28, 2004. We are engaged in the business of investing in
residential real estate development. We are organized in a single operating
segment for purposes of making operating decisions and assessing performance.
Prior to December 31, 2003, we were managed by Primecore Funding Group, Inc., at
the time an affiliated California corporation located in Menlo Park, California.
Consolidated Entities
The Company is the sole member of the following limited liability companies
whose operations are consolidated with these financial statements:
99 Investors, LLC - This entity owns real property in Atherton,
California which is being developed into a single family home.
Sands Drive San Jose, LLC - This entity owns real property in San Jose,
California which is being developed into 72 condominiums .
Risk Factors
General Economic Conditions in Lending Areas. All but one of the properties
securing repayment of our 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 and the collateral securing our 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 investments in
real estate held for sale. In the event that 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, 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 with unfavorable terms. 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, timely completion of projects, lack of
borrower diversification, and potential environmental matters relating to
properties on which we have made loans. Detailed risk factors are set forth in
the Company's Annual Report on Form 10-K filed April 14, 2004.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Use of Estimates
These financial statements have been prepared in accordance with accounting
principles generally accepted in the United States of America. The preparation
7
BELLAVISTACAPITAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
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. Valuations of investments in real estate include management's
best estimates of the amounts expected to be realized on the sale of its
investments. The estimates are based on an analysis of the properties, including
certain inherent assumptions and estimates that are involved in preparing such
valuations. The amounts the Company will ultimately realize could differ
materially in the near term from these estimates.
Investments in Real Estate under Development
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.
Because our loans contain many of the characteristics of ADC Loans they 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. Investments in real
estate under development 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 includes capitalized interest costs but 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 properties are termed
real estate owned (REO) and 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.
8
BELLAVISTACAPITAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Consolidation Policy
The consolidated financial statements include the accounts of the Company and
its wholly owned subsidiaries. All intercompany accounts and transactions have
been eliminated in consolidation.
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
We recognize income from our ADC loans and REO properties 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
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.
As of December 31, 2003 we had generated a net operating loss of approximately
$45 million from the disposition of impaired assets in our portfolio. The
ability to use this net operating loss to offset future taxable income may
result in tax savings to the company. The Company has established a full
valuation allowance against these net operating loss carry forwards and future
tax deductions because of the possibility that the carry forwards may expire
unused and that future tax deductions may not be realized through future
operations.
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 to preferred shareholders and net income is
decreased by declared dividends 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
quarters ended June 30, 2004 and 2003 are the same and are 100 shares.
3. INVESTMENTS IN REAL ESTATE UNDER DEVELOPMENT:
We have made ADC loans with maturity dates generally ranging from 12 to 18
months. As of June 30, 2004 we had eight ADC loans outstanding which are
described below.
9
BELLAVISTACAPITAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Final Face Amount Funded Carrying
Interest Maturity Amount (net of Capitalized Recognized Amount of
Description Rate Date of Mortgages payments) Interest Costs Impairment Mortgages
- ------------------------ ------------- ----------------- ---------------- ----------------- ----------------- ----------------
Loan 2423 16.50% 12/1/03 $ 7,300,000 $ 5,583,014 $ 262,555 $ 159,436 $ 5,686,134
Loan 2468 16.50% 12/31/03 3,775,000 2,440,475 97,569 -- 2,538,045
Loan 2503 11.50% 12/1/04 7,725,000 5,372,606 134,522 1,582,725 3,924,403
Loan 2504 11.50% 12/1/04 8,765,000 6,039,449 160,684 1,373,894 4,826,240
Loan 2517 21.00% 8/4/05 4,135,000 2,159,866 113,833 -- 2,273,698
Loan 2518 11.50% 11/1/03 9,400,000 3,430,904 213,163 1,048,399 2,595,668
Loan 2523 8.00% 8/4/05 11,000,000 4,296,736 14,277 -- 4,311,014
Loan 2524 10.00% 11/12/06 1,300,000 1,000,000 153 -- 1,000,153
----------------- ---------------- ----------------- ----------------- ----------------
Total $ 53,400,000 $30,323,050 $ 996,756 $ 4,164454 $ 27,155,355
================= ================ ================= ================= ================
Loan 2423 - This $7,300,000 loan bears interest at 16.50%, was due on December
1, 2003 and is secured by an approximately 4,200 square foot home in Belvedere,
California. In addition, the principals of the borrower have executed limited
personal guarantees of repayment. The home is complete and on the market for
sale and we have no further obligation to fund additional amounts toward the
loan. We filed Notice of Default on May 28, 2004, which begins the foreclosure
process.
Loan 2468 - This $3,775,000 loan bears interest at 16.50%, was due on December
31, 2003 and is secured by an approximately 4,000 square foot home in Tiburon,
California. On May 28, 2004 we recorded a Notice of Default against the
property, which begins the process of foreclosure. As long as the default is not
cured, we have no obligation to fund the remaining obligation of $365,207
remaining on the non-interest portion of our commitment. In response to our
Notice of Default, the borrower halted construction in June 2004. We do not
expect construction to resume until we obtain title to the property through
foreclosure.
Loan 2503 - This loan is secured by an approximately 8,300 square foot home in
Carmel, California. The $7,075,000 loan matured on June 1, 2004 and was extended
to December 1, 2004. The amount of the loan was also increased by $650,000 to
$7,725,000. The entire amount of increase provided for interest reserve with no
additional funds available to the borrower. As of June 30, 2004 we had $182,394
remaining to fund on our commitment for the non interest portion of the loan.
The home is complete and on the market for sale.
Loan 2504 - This loan is secured by an approximately 7,900 square foot home in
Carmel, California. The $7,950,000 loan matured on June 1, 2004 and was extended
to December 1, 2004. The amount of the loan was also increased by $815,000 to
$8,765,000. The entire amount of increase provided for interest reserve with no
additional funds available to the borrower. As of June 30, 2004, we had $215,551
remaining to fund on the non interest portion of our commitment. Construction
is nearly complete and we currently expect the home to be ready for sale in
August 2004.
Loan 2517 - This $4,135,000 loan is secured by a second deed of trust on 17
condominiums totaling approximately 31,500 square feet in San Mateo, California.
Our deed of trust is subordinate to our $11.0 million construction deed of
trust, Loan 2523. This note was issued on May 24, 2002, the proceeds of which
were used to acquire the property and provide funds for obtaining development
approvals, and was modified on August 3, 2003 as part of the agreement to
provide funds needed to construct the condominiums. The note bears interest at
21%, which is accrued and payable August 4, 2005, the loan's maturity date. We
have fully funded the non-interest portion of our commitment.
Loan 2518 - This $9,400,000 loan is secured by a deed of trust on an
approximately 6,400 square foot home in Tiburon, California. This note was
issued on July 29, 2002, the proceeds of which were used to acquire the property
and provide funds for construction, bears interest at 11.5% and matured on
November 1, 2003. Because the estimated completed value of the property is not
sufficient to fully repay the loan, we are not currently accruing interest on
10
BELLAVISTACAPITAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
the loan. On May 28, 2004 we recorded a Notice of Default against the property,
which begins the process of foreclosure. As long as the default is not cured, we
have no obligation to fund the $3,420,332 remaining on the non interest portion
of our commitment. Construction on the property was halted after framing and
there is no construction activity currently associated with the property.
Loan 2523 - This $11,000,000 loan is secured by a first deed of trust on 17
condominiums totaling approximately 31,500 square feet in San Mateo, California.
The note was issued on August 4, 2003, the proceeds of which will be used for
construction of the condominiums. The note bears interest at 8.00%, which is
accrued and payable August 4, 2005, the loan's maturity date. As of June 30,
2004 we had $5,403,263 remaining to fund on the non interest portion of our loan
commitment.
Loan 2524 - This $1,300,000 loan is secured by a third deed of trust on a 10.3
acre parcel in Colorado Springs, Colorado which will comprise 148 condominium
units. The loan is junior to a deed of trust in the amount of $2,392,000 and a
revolving deed of trust totaling $4,000,000, both in favor of Ohio Savings Bank.
The note was issued on May 12, 2004, bears interest at 10%, which is accrued and
payable at the loan's maturity date, November 12, 2006. The note provides for
additional interest equal to 3% of the gross sales price of each completed
condominium unit. As of June 30, 2004 we had no additional funding requirement
on the non interest portion of our commitment.
4. INVESTMENT IN REAL ESTATE HELD FOR SALE:
As of June 30, 2004, we or our wholly-owned subsidiaries held title to 12
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
properties are described below:
Carrying Estimated
Amount Funded Capitalized Recognized Amount of Costs to
Description (net of payments) Interest Costs Impairment Property Complete
- --------------------- ------------------ ------------------ ------------------ ------------------ ------------------
Property 2216 $ 10,493,894 $ 559,082 $ 2,145,617 $ 9,089,393 $ 24,800,000
Property 2345 4,313,509 189,228 -- 4,502,737 16,756
Property 2368 2,106,321 77,040 -- 2,183,361 860,616
Property 2396 2,369,558 99,696 813,805 1,655,448 486,113
Property 2407 2,226,598 69,015 -- 2,295,613 --
Property 2442 4,940,372 242,264 275,952 4,906,684 --
Property 2443 685,683 34,890 -- 720,573 --
Property 2455 11,101,075 382,842 5,417,299 6,066,618 701,288
Property 2462 7,311,703 292,503 4,536,487 3,067,718 128,282
Property 2465 208,423 13,076 -- 221,499 --
Property 2492 3,459,213 104,592 665,388 2,898,417 45,820
Property 2506 4,268,403 45,382 548,236 3,765,549 731,194
------------------ ------------------ ------------------ ------------------ ------------------
Total $ 53,484,752 $ 2,109,610 $ 14,402,784 $ 41,373,610 $ 27,770,069
================== ================== ================== ================== ==================
Property 2216 - This is an approximately 8 acre parcel which has been approved
for development of 72 townhomes and condominiums totaling approximately 123,372
square feet in San Jose, California. We have contracted with an outside party to
provide development and construction management services for this property. As
of June 30, 2004 we were still in process of securing our grading permit in
order to begin work on the project. We currently anticipate breaking ground in
August 2004.
11
BELLAVISTACAPITAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Property 2345 - This is an approximately 7,000 square foot home in the Pacific
Heights neighborhood of San Francisco, California. Construction is complete and
the property is under contract for sale with escrow expected to close in late
July or early August 2004.
Property 2368 - This is an 8 unit condominium project totaling approximately
6,100 square feet in the South of Market area of San Francisco, California. The
units are loft style condominiums which are popular in that area of the city.
The project is currently under construction and is expected to be complete and
on the market in September 2004.
Property 2396 - This is a 2 unit condominium project totaling approximately
4,450 square feet on Russian Hill in San Francisco, California. The project is
currently under construction and is expected to be complete and on the market in
August 2004.
Property 2407 - This property consists of 6 subdivided and improved lots in San
Rafael, California. The lots are approved, subject to design review, for 6
single-family homes. The property is under contract to sell with escrow
scheduled to close in August 2004.
Property 2442 - This property is an approximately 10,000 square foot home in
Atherton, California. As of June 30, 2004 the property was complete and listed
for sale.
Property 2443 - This project consists of 3 lots for the construction of
single-family homes averaging approximately 4,000 square feet each. Two of the
homes had started foundation work before construction was halted while we
pursued our foreclosure action. No work had commenced on the third home prior to
beginning our foreclosure action. As of June 30, 2004 two of the three lots were
under contract to sell with escrow expected to close in late July or early
August 2004. The remaining lot is listed for sale.
Property 2455 - This project is an approximately 8,850 square foot home in
Atherton, California. The project is under construction and we currently
estimate it will be complete and ready for sale in October 2004.
Property 2462 - This project is an approximately 7,000 square foot home in
Saratoga, California. The project has completed construction and is listed for
sale.
Property 2465 - This project is an approximately 8,900 square foot lot in
Oakland, California. Construction had not started prior to our foreclosure
action. We currently plan to sell the property in its existing condition and
have listed it for sale.
Property 2492 - This is an approximately 4,500 square foot home in Portola
Valley, California. The property is complete and was listed for sale in April
2004.
Property 2506 - This project is an approximately 6,400 square foot home in
Hillsborough, California. The property is currently under construction and we
expect the home to be complete and ready for sale in October 2004.
5. 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, 2004 and December 31, 2003, there were 100 shares of common stock
outstanding.
The 20,009,011and 22,229,739 shares of Preferred Stock outstanding as of June
30, 2004 and December 31, 2003, 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.
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
12
BELLAVISTACAPITAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
terminated at the Board's discretion at any time. 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". 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. In May 2004 the
Board of Directors authorized funds for the repurchase of shares. On May 27,
2004 we repurchased 2,220,728 shares of Preferred Stock at $2.80 per share.
We sold our stock through private placements and have closed five private
placements since our inception, issuing 26,161,438 shares at $10.00 per share.
We used the proceeds from issuance of our Preferred Stock primarily to fund
additional ADC loans and also for working capital purposes. As of June 30, 2004
we did not have an active private placement.
7. TRANSACTIONS WITH AFFILIATES:
Prior to March 19, 2004, we had the following affiliates all of which were owned
by Susan Fox, who, prior to such date was the President, CEO and a Director of
the Company: Primecore Funding Group, Inc; 99 El Camino Partners, LLC; Primecore
Properties, Inc. During the six months ended June 30, 2004, Primecore Funding
Group, Inc. received management fees from us, and Primecore Properties, Inc.
received real estate commissions in connection with the sale of certain REO
properties in situations where it acted as the listing broker. 99 El Camino
Partners, LLC owns the building, that we began leasing on January 1, 2004.
On December 19, 2003 our Board of Directors voted not to renew the management
agreement with Primecore Funding Group effective December 31, 2003 and
transitioned to internalized management during the first three months of 2004.
On December 23, 2003 we entered into an agreement, effective January 1, 2004
with Primecore Funding Group to provide management services during a transition
period that ended on March 19, 2004.
On March 19, 2004, Susan Fox resigned as President, Chief Executive Officer and
Director of Primecore Mortgage Trust, Inc. Ms. Fox was retained as a consultant
to the Company for a period of 12 months in order to assist with any issues that
occur in connection with the transition of management. For her services she will
be paid $30,000 per month. We have recognized all 12 monthly payments due under
the contract as expense during the six months ended June 30, 2004. We have also
agreed to compensate Ms. Fox for her assistance in recovery of legal actions we
have brought against some of our former borrowers. Our agreement with her
provides that she will receive 5% of any sums we collect from such legal
proceedings. Additionally, we purchased certain furniture, computer equipment
and software from her company, Primecore Funding Group, for $200,000. Finally,
we have entered into a agreement to lease the premises at 99 El Camino Real, a
property owned by 99 El Camino Partners, LLC, a limited liability company in
which Susan Fox is the sole member, through December 31, 2004 at a monthly rate
of $25,000 through June 30, 2004 and then decreasing to $20,000 per month
through December 31, 2004. The agreement also provides that we will pay for real
estate taxes, insurance and maintenance associated with the building.
As of March 19, 2004, none of these entities are affiliates of the Company and,
as of the date of this filing, except as discussed in this Note 7, we have no
business relationships with these entities.
Management Fees
For the three months and six months ended June 30, 2004, the portfolio
management fees earned by our Manager were $0 and $639,698 compared with
$1,096,143 and $2,224,076 for the three months and six months ended June 30,
2003.
13
BELLAVISTACAPITAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Real Estate Sales Commissions
We paid real estate sales commissions of $81,500 and $250,050 during the three
months and six months ended June 30, 2004 to Primecore Properties, Inc.,
compared with $41,000 and $235,600 during the three months and six months ended
June 30, 2003. 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.
8. COMMITMENTS AND CONTINGENCIES:
Leases
We are obligated to make payments under certain office and equipment leases.
During the three months and six months ended June 30, 2004 we recognized $75,000
and $150,000 expense for such leases compared to none during the three months
and six months ended June 30, 2003. As of June 30, 2004 our future minimum
annual lease payments under operating leases was as follows:
Year Amount
- ---- ------
2004 (Remaining six months) 133,174
2005 26,348
2006 22,534
2007 14,039
--------------------
Total 196,095
====================
Litigation
From time to time, we may and have become subject to litigation in connection
with our business. In addition, as of June 30, 2004, we were involved in several
litigation matters that are considered to be out of the ordinary course of
business. The following is a list of non-routine litigation (i.e. suits other
than mechanic's lien lawsuits or similar lawsuits in which the Company becomes
involved from time to time due to its status as a lender) in which the Company
was involved as party, as of June 30, 2004, and in which it was believed at June
30, 2004 that potential liability could each exceed $1 million if the Company is
unsuccessful in its defense, which the Company does not currently believe will
be the case:
1. Baigent, et. al. v. Susan Fox, Primecore Mortgage Trust, Inc., et. al.,
JAMS Arbitration No. 1100041879. Approximately 35 shareholders, holding
approximately 1,260,000 shares of Preferred Stock, approximately 5% of the
Preferred shares of the Company, filed a lawsuit on November 14, 2003. The
lawsuit generally alleges that the Company, its former Manager, and two former
officers failed to disclose the true risks of the investments made by the
plaintiff-shareholders. The Complaint does not specify the amount of damages
being sought. The Company filed a petition to compel mediation and binding
arbitration, which was granted on January 21, 2004. An arbitration hearing is
scheduled for November 15-30, 2004. As of the date of this filing, claimants
holding approximately 76,000 shares of stock have had their stock repurchased by
the Company at a price of $2.80 per share as part of the Company's stock
repurchase program. In addition, claimants holding approximately 73,000 shares
of stock have agreed to settle all of their claims against the Company in return
for repurchase of their shares at prices ranging between $2.20 and $2.70, i.e.
below the $2.80 price the Company paid for repurchased stock on May 28, 2004,
with the settling claimants being solely responsible for paying their own
attorneys' fees and costs of the litigation. The Company believes the claims are
without merit, intends to vigorously defend against the claims, and believes
that it has strong and viable defenses.
2. Showplace Square Lofts Company, LLC v. Primecore, et. al., U.S.
Bankruptcy Court (N.D. Cal) No. 02-3157 DM. On June 25, 2002, a borrower filed a
complaint against the Company in connection with its bankruptcy. Prior to the
time that the bankruptcy case and complaint were filed, the borrower had
14
BELLAVISTACAPITAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
defaulted under its loan and the Company was proceeding to enforce its rights
through foreclosure. The complaint purported to assert claims for avoidance of
fraudulent transfer, breach of contract, intentional fraud, negligent
misrepresentation, negligence declaratory relief, breach of fiduciary duty, and
unfair business practices. The Court has granted summary judgment in favor of
the Company on all claims except the claim for transfer in violation of
Bankruptcy Code Sec. 544. The Company believes that the lawsuit is wholly
without merit. Among other things, the borrower admitted, in a written agreement
signed prior to the filing of the case, that it had no claims against the
Company, and also provided written releases of any possible claims. The Company
intends to vigorously defend against the claims, and believes that it has strong
and viable defenses.
3. Bay Area Luxury Homes/Santa Clara 3, LLC v. Primecore, et. al., Bay Area
Luxury Homes/Alameda VI, LLC v. Primecore, et. al., Bay Area Luxury Homes/Stern
VII, LLC v. Primecore, et. al., U.S. Bankruptcy Court (N.D. Cal.). Three limited
liability companies that are under the control of two individuals, both of whom
are being sued by Primecore for over $5 million under written guarantees that
they signed, filed this series of cases. On or around June 30, 2004, two of the
debtor companies converted their bankruptcies to liquidation bankruptcies under
Chapter 7 of the Bankruptcy Code. Subsequent to June 30, 2004, the Bankruptcy
Court dismissed all of the cases.
4. Amoroso, et. al. v. Primecore Mortgage Trust, et. al, San Mateo Superior
Court. The Complaint, filed by 20 shareholders holding a total of 627,322 shares
of Preferred Stock, approximately 3% of the shares of Preferred Stock of the
Company, is nearly identical to the Baigent lawsuit discussed above. The parties
agreed to mediate and, if necessary, arbitrate all claims made against the
Company. On July 19, 2004, a mediation was held in the matter before the
Honorable Robert Dossee, a retired Justice of the Court of Appeal. As a result,
as of the date of this filing, all claimants, except for one claimant holding
20,000 shares, have accepted settlements under which the Company will repurchase
shares at prices ranging from $2.70 to $2.80, the settling shareholders will
release all claims against the Company or any of its present or former officers
and directors, and the settling shareholders will pay all of their own
attorneys' fees and costs of the litigation. Payments are due from the Company
between August 18 and August 31, 2004. If the one remaining claimant does not
settle or dismiss his claims, and if the matter proceeds, the Company intends to
vigorously defend against the claims, and believes it has strong and viable
defenses to the claims, which the Company believes are without merit.
In addition to the above matters, at June 30, 2004, the Company was
involved in several lawsuits in which it sought recovery from borrowers,
guarantors, and others. The actions included the following:
1. A lawsuit filed in connection with a loan made on a subdivision project
in Marin County. While the Company had written off the loan approximately two
years ago, it was felt that legal avenues existed to seek recovery on the loan.
The Company filed suit and entered into a settlement with the key defendants in
February 2004. Under the settlement, the Company is entitled to receive
$2,300,000 in payments of varying amounts to be made over a 17-month term,
beginning in March 2004. In the event that the payments are not made when due,
the Company has a right to obtain a stipulated judgment. If and when payments
are received, the payments will be reflected in income. The settlement will not
be reflected in the financial statements until payments are received, as
collection is not reasonably assured. The first three payments of $100,000 were
received on March 2, 2004, April 2, 2004, and June 1, 2004. In addition, the
Company obtained a settlement from a co-defendant in the amount of $110,000,
which amount has been paid.
2. A lawsuit to judicially foreclose upon and obtain a deficiency judgment
from a borrower in connection with a loan made on a property in Palo Alto. The
Company obtained the property from the borrower as part of a settlement, and,
subsequent to December 31, 2003, sold the property. In addition, the borrower
stipulated to judgment in the amount of $750,000, which judgment has been
entered. The prospect of collection of the judgment is not reasonably assured,
therefore, if and when payments are received, the payments will be reflected in
income. No potential recovery is currently reflected in the financial
statements.
15
BELLAVISTACAPITAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
3. A lawsuit to collect against two guarantors of indebtedness. The Company
is seeking approximately $7.5 million in damages. The matter is currently set
for trial on September 13, 2004.
4. On May 26, 2004, the Company brought suit against the principals of a
former borrower and their affiliated entities relating to the misappropriation
and diversion of loan funds for improper purposes. The misappropriation and
diversion was first discovered in the course of a bankruptcy proceeding, in
which one of the defendants admitted that he had fraudulently prepared invoices
in the name of third party contractors, and forged endorsements on checks
written by the Company to the third party contractors. The Company seeks to
recover all of the misappropriated funds, and has alleged damages presently
believed to exceed $1,000,000. A case management conference is set for October
2004. The Company has not reflected any potential recovery in its financial
statements.
Construction Contracts
In connection with our development of investments in real estate held for sale,
we have entered into contracts with construction companies totaling $1,945,576
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.
Guarantees
We have issued indemnity agreements to insurance companies in connection with
the sale of certain of our REO properties. The indemnity agreements were
provided in order to induce the insurance companies to issue surety bonds
covering mechanics liens recorded against properties we owned as well as certain
other monetary guarantees of payment. The total amount of the surety bonds
issued with respect to which we have issued indemnity agreement is $1,352,256.
We believe that we have remedies against the mechanics lien claims and that we
will not become liable for their payment as such, no amounts have been accrued
in the financial statements in connection to these liens.
General Uninsured Losses
We require that our borrowers carry comprehensive liability, fire, flood,
extended coverage, and rental loss insurance with policy specifications, limits,
and deductibles customarily carried for similar properties. We also carry
insurance to cover losses in case a borrower's policy lapses. Additionally, we
carry insurance on investments in real estate held for sale. There are, however,
certain types of extraordinary losses that may be either uninsurable or not
economically insurable. Further, all of our investments are located in areas
that are subject to earthquake activity, and we generally do not require our
borrowers to maintain earthquake insurance. Should an investment sustain damage
as a result of an earthquake, we may incur losses due to insurance deductibles,
co-payments on insured losses, or uninsured losses. Should an uninsured loss
occur, we could lose our investment in, and anticipated profits and cash flows
from an investment.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
General Our material financial transactions have been purchasing and holding a
portfolio of construction mortgage loans, and the construction and sale of real
estate acquired through foreclosure or deed in lieu of foreclosure. 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
16
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
After concentrating our efforts on internalizing management during the first
three months of 2004, we turned our attention to developing our new business
during the three months ended June 20, 2004. During this period we searched
property listings, attended industry conferences and contacted real estate
brokers and industry professionals in an effort to make new contacts. With these
new contacts we generated a list of dozens of development projects seeking
financing. We are busy evaluating the projects and negotiating financing terms
with the developers as we seek our target of funding approximately $20 million
of new investments this calendar year.
We also continued the process of completing and liquidating our current non
performing portfolio of assets. As of March 31, 2004 we had 22 investments.
During the three months ended June 30, 2004 we closed three investments totaling
proceeds of approximately $11 million and had three additional properties under
sales contracts totaling approximately $9 million with escrows expected to close
after June 30, 2004.
We had some delays in our progress toward completing construction of our ADC
Loans and REO properties. Of the 11 investments in our portfolio, which were
under development at March 31, 2004, we completed one and sold another before
completion. Of the remaining nine, we revised seven estimated completion dates
due to construction delays. Although we have had delays, we still expect five
properties to complete construction during the third calendar quarter, two to
complete construction in calendar quarter four and one to complete construction
in the first quarter of 2005. The remaining property under development is our
San Jose project where our development team is in place and working through some
issues associated with our prior borrower which has delayed our planned project
start. We hope to work through these issues and begin construction in August.
In addition to managing our current portfolio of investments, we also made
significant progress in developing our new investment pipeline during the
quarter ended June 30, 2004. By reaching out to developers, brokers and real
estate professionals, we reviewed over two dozen potential investments. We
filtered out a number that did not fit our investment criteria and have been
negotiating terms with several. In May 2004 we funded a new investment of $1
million in Colorado Springs, Colorado. The investment is secured by a second
deed of trust on 148 condominiums and contains a provision for equity
participation.
Results of Operations
Revenue
During the three months and six months ended June 30, 2004 we reported income
from real estate developments of $854,192 and $2,226,826 from our investments
compared with $1,436,429 and $4,234,100 for the three months and six months
ended June 30, 2003, respectively. Our income decreased as a result of the
decrease in the amount of loan repayments during the comparable periods. Income
from real estate developments is a function of the amount of collections we
receive from our investments; during the three months ended June 30, 2004
collections from investments were 54% of the amount received during the three
months ended March 31, 2003.
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. To the extent we
believe we will collect it, the amount of interest and points we charge
borrowers is added to the balance due on our loans for purposes of this
calculation. As the values of the collateral supporting payment of our loans
have declined, the ability to collect our accrued interest and points has, in
many cases, become doubtful. Management includes the amount of collectible
interest and points we estimate we will receive when it sets prices for
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.
17
June 30, 2004 December 31, 2003
--------------- ------------------
Investments in real estate under development $ 27,155,355 $ 34,629,956
Investments in real estate held for sale 41,373,610 44,551,722
--------------- ------------------
Total investments in real estate per US GAAP 68,528,965 79,181,678
Add: GAAP impairments 18,567,238 26,436,565
Accrued interest and points 26,967,040 38,360,634
Less: Capitalized interest (3,106,366) (4,633,962)
--------------- ------------------
Balance owed on real estate investments 110,956,877 139,344,915
Amount estimated uncollectible (34,298,726) (54,162,649)
--------------- ------------------
Realizable value of investments in real estate $ 76,658,151 $ 85,182,266
=============== ==================
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 and sell the project. Many factors outside our control can
cause changes in these estimates and produce different results. Additionally,
many of our properties are custom style homes that appeal to a limited high-end
market with few comparable transactions which makes it difficult to project with
certainty the market value of these properties.
Stock Redemption Price
We have attempted to provide a measure of liquidity to our shareholders through
the repurchase of outstanding shares. Because our Preferred Stock does not trade
in any secondary market, another method must be used to determine the fair
market value in order to set the repurchase price. Under its current repurchase
policy, the Board has concluded 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 June 30, 2004 and
December 31, 2003 for purposes of our redemption policy only:
June 30, 2004 December 31, 2003
--------------- ------------------
Cash $ 8,676,471 $ 10,701,188
Other assets 140,411 1,504,470
Realizable value of investments in real estate 76,658,151 85,182,266
--------------- ------------------
Total realizable assets 85,475,033 97,387,924
Total liabilities (3,844,232) (8,234,645)
--------------- ------------------
Net realizable assets 81,630,801 89,153,279
Preferred shares outstanding 20,009,011 22,229,739
--------------- ------------------
Net realizable assets per share $ 4.08 $ 4.01
=============== ==================
Expenses
In the past, all of our day-to-day operations were performed by Primecore
Funding Group, Inc, operating under a written management agreement. Before
January 1, 2004, we did not have any employees, and substantially all of our
operating costs were paid through our management fee. On December 19, 2003 our
Board of Directors voted not to renew our management agreement with Primecore
Funding Group effective December 31, 2003 and we transitioned to internalized
management during the first three months of 2004.
During the three months ended June 30, 2004, the expense items that had
historically comprised our management fee expenses (salaries, facilities and
general, administrative and other) were $499,786 compared with management fees
of $1,096,143. These expenses during the six months ended June 30, 2004,
including the management fees paid during the first three months ended March 31,
2004 were $1,294,337 compared to $2,224,076 in management fee expenses during
the six months ended June 30, 2003. The decease in the comparable expense items
is due to the downsizing of our staff, reduction in our rent and certain other
cost savings achieved through internalization.
18
Legal and accounting expenses totaled $218,988 and $1,083,916 during the three
months and six months ended June 30, 2004 compared with $99,629 and $270,211
during the three months and six months ended June 30, 2003. Our legal expenses
during the six months ended June 30, 2004 have significantly increased over the
six months ended June 30, 2003 because they include a $640,000 expense for
settlement of a dispute over the amounts due under construction contracts to
build two of our REO properties. During the three months ended June 30, 2004, we
also retained outside counsel to manage our legal activity under a retainer
agreement. The retainer agreement provides for monthly fees which may result in
higher legal expenses during the contracted period than we have reported in
prior periods; however, we believe that the agreement will ultimately provide us
with cost savings over standard legal rates.
We recorded a provision for impairment of $1,882,283 and $2,809,763 during
the three months and six months ended June 30, 2004 compared with $13,606,038
and $14,369,097 during the three months ended March 31, 2003. The impairments
recorded during the three and six months ended June 30, 2004 resulted from the
following factors: the decision to sell one of our REO properties as land rather
than to complete contruction and list the property for sale; unanticipated costs
needed to complete two REO properties; and revised values applied to particular
properties which were deemed impaired due to micro market conditions.
Liquidity and Capital Resources
Liquidity means the need for, access to and uses of cash. Our principal source
of liquidity is the repayment of our real estate investments. Our principal
demands for liquidity are funds that are required to satisfy obligations under
existing loan commitments, operating expenses, interest expense associated with
our indebtedness and debt repayments.
During the six months ended June 30, 2004 we collected proceeds of approximately
$20.4 million from our investments, including income of approximately $2.2
million. With those proceeds we invested approximately $10.4 million toward
completing our existing investments, used approximately $4.7 million to pay down
our debt and another $6.2 million to repurchase our stock at $2.80 per share. As
of June 30, 2004 we have completely retired our unsecured debt and expect that
our current portfolio of investments will generate approximately $20 million in
cash for new investments during the remaining six months of 2004. These
investible funds will be in excess of the cash we estimate that we will need to
continue to complete our existing portfolio of assets.
Sources of cash
As of June 30, 2004 our primary source of liquidity was the repayment of our
investments in real estate. We have the ability to borrow money from various
financial institutions using our REO properties as collateral if we determine
that we need additional liquidity. We do not currently expect that we will have
such a need during the next 12 months.
In order to receive repayment on our investments, the property securing
repayment typically must be completed and sold to third parties. Accordingly,
our repayments are a function of our developers' ability, or our ability in the
case of REO properties, to complete and sell the properties developed. The
following table summarizes our liquidity expectations for the 20 investments
held at June 30, 2004. The expected proceeds in the table are higher than our
net realizable value estimates because they include our estimated costs to
complete.
Expected Proceeds
-------------------
Investments under contract pending close
of escrow $ 8,554,000
Investments offered for sale 14,716,000
Investments under construction scheduled
to be complete and on the market:
Q3 2004 19,317,000
Q4 2004 11,421,000
Q1 2005 13,761,500
Q4 2005 35,663,000
Q2 2006 1,041,468
Unknown 9,541,000
-------------------
Total $ 114,014,968
===================
19
All work has halted on the properties identified as unknown completion dates due
to our foreclosure action against the borrower. The uncertain timing of the
foreclosure process makes it difficult to predict with accuracy our ability to
complete these projects. It is possible that our repayments may not be
sufficient to timely meet our commitments and we may be forced to reduce prices
on the properties that 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.
Uses of Cash
The following table sets forth the projected timing and amount of our
obligations over the next three years, without taking into account new loans
that may be made in 2004, 2005 and 2006:
Obligation Total 2004 2005
---------------- --------------- -----------------
Investment fundings $ 31,497,731 $ 15,574,867 $ 15,922,864
Secured note payable 3,185,000 3,185,000 --
Total $ 34,682,731 $ 15,578,052 $ 15,922,864
Investment fundings are our largest use of our cash. At June 30, 2004 we
estimated costs to complete investments in our portfolio were approximately
$34.7 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,
2004 as we continue to make and fund new loan commitments in 2004 and beyond.
Our secured note payable is secured by an REO property and is due in 2030,
however it will be repaid upon sale of the property it secures. We currently
expect that property to complete construction and sell during 2004.
We have a 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". Redemption
of shares is always subject to availability of funds 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.
In May 2004 the Board of Directors authorized additional funds for the
repurchase of shares in accordance with our Redemption Policy. On May 27, 2004
we repurchased 2,220,728 shares of Preferred Stock at $2.80 per share.
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
20
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
(see Note 3 to the financial statements). We have foreclosed on some ADC loans
that are classified as investments in real estate held for sale (Note 4). 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. 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
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.
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.. Detailed risk factors are set
forth in the Company's Annual Report on Form 10-K filed April 14, 2004.
ITEM 4. CONTROLS AND PROCEDURES.
Within the past 90 days we carried out an evaluation, under the supervision of
Michael Rider, 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, Mr. Rider has concluded that those
controls and procedures were effective in making known, 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.
Reportable conditions involve matters relating to significant deficiencies in
the design or operation of internal controls that, in an auditor's judgment,
could adversely affect a company's ability to record, process, summarize, and
report financial data consistent with the assertions of management in the
financial statements.
21
Our auditors identified the following two reportable conditions in connection
with their audit of our 2003 Financial Statements: (i) there was a lack of
evidence indicating that journal entries were reviewed and approved by
appropriate finance department personnel as part of the periodic closing
process; and (ii) there were not sufficient personnel in the accounting and
finance department which, the auditors noted, was due in part to the assumption
of additional duties by our CFO after the resignation of our CEO. Our auditors
determined that these significant deficiencies, in the aggregate, do not
constitute material weaknesses in the system of internal controls.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Refer to Financial Statements Note 8 for a discussion of Legal Proceedings
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(a) Not Applicable.
(b) Not Applicable.
(c) Sales of Equity Securities.
Between January 1, 2004 and June 30, 2004, we did not sell any shares of
our Class A Convertible Preferred stock.
(d) Not Applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
ITEM 5. OTHER INFORMATION.
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
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
22
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 Agreement Regarding Affiliate Loans dated November 17, 2002 is hereby
incorporated herein by reference from Exhibit 10.2 on Form 8-K filed on
December 20, 2002
10.2 Amended and Restated Management Agreement dated November 17, 2002 is
hereby incorporated herein by reference from Exhibit 10.1 on Form 8-K,
filed on December, 20, 2002
10.3 Letter agreement with Primecore Funding Group, Inc. and Susan Fox is
hereby incorporated herein by reference from the Company's Annual Report
on Form 10-K filed on April 14, 2004
11.1 Statement regarding computation of per share earnings
31.1 Certification of Chief Executive Officer and Chief Financial Officer
32.1 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
None
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 23, 2004 /s/ MICHAEL RIDER
-----------------
Michael Rider, President and
Chief Financial Officer
23