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 March 31, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 0-30507
Primecore Mortgage Trust, Inc.
(Exact name of registrant as specified in its charter)
Maryland 94-3324992
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
99 El Camino Real
Menlo Park, CA 94025
(Address of principal offices) (zip code)
(650) 328-3060
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
The number of shares of convertible preferred stock outstanding as of March
31, 2002 was 22,082,460. The number of shares of common stock outstanding as of
March 31, 2002 was 100.
2
Table of Contents
Part I. Financial Information
Item 1. Financial Statements (unaudited)..................................... 4
Balance Sheets as of March 31, 2002 (unaudited)
and December 31, 2001................................ 5
Statements of Operations for the Three Months
Ended March 31, 2002 and 2001 (unaudited)............ 6
Statement of Shareholders' Equity for the
Three Months Ended March 31, 2002 (unaudited)........ 7
Statements of Cash Flows for the Three
Months Ended March 31, 2002 and 2001 (unaudited)..... 8
Notes to the Financial Statements (unaudited)........................ 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................. 17
Item 3. Quantitative and Qualitative Disclosures about Market Risk.......... 21
Part II. Other Information
Item 1. Legal Proceedings................................................... 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.................................... 23
(a) Exhibits........................................................ 22
(b) Reports on Form 8-K............................................. 23
Signatures.......................................................... 23
3
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 March 31, 2002, and December 31, 2001 (unaudited)
(2) Statements of Operations for the Three Months ended March 31, 2002
and 2001 (unaudited)
(3) Statement of Shareholders' Equity for the Three Months ended
March 31, 2002 (unaudited)
(4) Statements of Cash Flows for the Three Months ended March 31, 2002
and 2001 (unaudited)
(5) Notes to Financial Statements (unaudited)
The financial statements referred to above should be read in conjunction
with the Company's audited financial statements for the year ended December 31,
2001 as filed with the Securities and Exchange Commission in our Annual Report
on Form 10-K filed March 30, 2002.
4
PRIMECORE MORTGAGE TRUST, INC.
BALANCE SHEETS
As of March 31, 2002 and December 31, 2001
(unaudited)
March 31, 2002 December 31, 2001
--------------------- --------------------
ASSETS:
Investments in real estate under development............................ $ 120,857,218 $ 131,759,510
Investments in real estate under development by affiliates.............. 40,829,324 40,237,961
Investments in real estate held for sale................................ 24,904,451 18,952,063
Cash and cash equivalents............................................... 1,748 2,706,204
Other assets, net....................................................... 218,600 408,905
--------------------- --------------------
Total assets....................................................... $ 186,808,341 $ 194,064,643
===================== ====================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Notes payable........................................................... $ 14,948,388 $ 17,312,526
Secured line of credit.................................................. 14,862,249 15,000,000
Accrued expenses and other.............................................. 194,623 1,232,022
Preferred stock dividends payable....................................... 1,921,679 1,903,928
Payable to affiliate.................................................... 24,345 31,193
--------------------- --------------------
Total liabilities.................................................. 31,951,284 35,479,669
--------------------- --------------------
SHAREHOLDERS' EQUITY:
Preferred stock: par value $0.01, 40,000,000 shares authorized;
21,959,845 and 21,633,864 shares issued and outstanding at
March 31,2002, and December 31, 2001, respectively; entitled to $10
per share in liquidation before any distributions to common
liquidation before any distributions to common....................... 219,417,778 216,157,968
Common stock: par value $0.01, 10,000,000 shares authorized; 100
shares issued and outstanding at March 31, 2002, and December 31,
2001, respectively 1 1
Retained deficit........................................................ (64,560,722) (57,572,995)
--------------------- --------------------
Total shareholders' equity......................................... 154,857,057 158,584,974
--------------------- --------------------
Total liabilities and shareholders' equity......................... $ 186,808,341 $ 194,064,643
===================== ====================
The accompanying notes are an integral part of these statements.
5
PRIMECORE MORTGAGE TRUST, INC.
BALANCE SHEETS
As of March 31, 2002 and December 31, 2001
(unaudited)
Three Months Three Months
Ended Ended
March 31,2002 March 31,2001
----------------- -------------------
REVENUES:
Income from completed real estate development (including $600,000
and $0 from affiliates for the three months ended March 31, 2002
and 2001, respectively............................. $ 1,655,530 $ 3,978,796
Other .............................................. -- 81
----------------- -----------------
Total revenues................................... 1,655,530 3,978,877
----------------- -----------------
EXPENSES:
Management fees paid to an affiliate.................. 2,658,152 3,122,154
Provision for impairment of investments in real
estate........................................... 145,782 --
General, administrative and other..................... 105,505 44,658
----------------- -----------------
Total expenses................................... 2,909,439 3,166,812
----------------- -----------------
Net income (loss)................................ (1,253,909) 812,065
Preferred stock dividends........................ (5,733,818) (5,951,458)
----------------- -----------------
Net loss allocable to common..................... $ (6,987,727) $ (5,139,393)
================= =================
Basic and diluted net loss per common share........... $ (69,877) $ (51,394)
================= =================
Basic and diluted weighted-average shares outstanding. 100 100
================= =================
The accompanying notes are an integral part of these statements.
6
PRIMECORE MORTGAGE TRUST, INC.
BALANCE SHEETS
As of March 31, 2002 and December 31, 2001
(unaudited)
Retained
Preferred Stock Common Stock Deficit Total
--------------- ------------ -------- -----
Shares Amount Shares Amount
------ ------ ------ ------
Shareholders' equity at
December 31, 2001................. 21,633,864 $216,157,968 100 $ 1 $(57,572,995) $158,584,974
Issuance of preferred stock.......... 448,596 4,485,960 -- -- -- 4,485,960
Issuance of preferred stock under
dividend reinvestment plan........ 105,914 1,059,140 -- -- -- 1,059,140
Redemption of preferred stock........ (228,529) (2,285,290) -- -- -- (2,285,290)
Dividends to preferred
shareholders...................... -- -- -- -- (5,733,818) (5,733,818)
Net loss............................. -- -- -- -- (1,253,909) (1,253,909)
-----------------------------------------------------------------------------
Shareholders' equity at
March 31, 2002.................... 21,959,845 $219,417,778 100 $ 1 $(64,560,722) $154,857,057
=============================================================================
The accompanying notes are an integral part of these statements.
7
PRIMECORE MORTGAGE TRUST, INC.
BALANCE SHEETS
As of March 31, 2002 and December 31, 2001
(unaudited)
Three Months Three Months
Ended Ended
March 31,2002 March 31,2001
-------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)......................................................... $(1,253,909) $ 812,065
Adjustments to reconcile net income (loss) to net cash (used in) provided
by operations;
Provision for impairment of investments in real estate 145,782
(Decrease) increase in accrued expenses, bank overdraft and other.... (1,037,399) (1,377,268)
(Decrease) increase in payable to affiliate.......................... (6,848) 2,197,475
Decrease (increase) in other assets, net............................. 190,305 52,784
------------------------------------------
Net cash (used in) provided by operating activities............. (1,962,069) 1,685,056
------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investments in real estate under development...................... (6,289,797) (24,407,892)
Investments in real estate under development by affiliates........ (3,546,747) (2,313,483)
Return of investments in real estate under development............ 11,096,919 20,110,477
Return of investments in real estate under development by
affiliates................................................. 2,955,384 4,887,993
------------------------------------------
Net cash provided by (used in) investing activities............. 4,215,759 (1,722,905)
------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sales of preferred stock, net of offering costs..... 4,485,960 11,241,520
Redemptions of preferred stock.................................... (2,285,290) (2,037,080)
Issuance of notes payable......................................... 662,000 5,564,700
Repayment of notes payable........................................ (3,177,800) (12,754,219)
Additions to notes payable from reinvested interest............... 151,661 278,237
(Payments) borrowings on secured line of credit................... (137,751) 1,947,845
Payment of preferred stock dividends.............................. (4,656,927) (4,129,934)
------------------------------------------
Net cash (used in) provided by financing activities.............. (4,958,146) 111,069
------------------------------------------
Net increase (decrease) in cash and cash equivalents.............. (2,704,456) 73,220
Beginning cash and cash equivalents............................... 2,706,204 --
------------------------------------------
Ending cash and cash equivalents.................................. $ 1,748 $73,220
==========================================
Cash paid for interest, net of amounts capitalized of $741,880 and
$1,278,450, for the three months ended March 31, 2002, and 2001,
respectively $ -- $ --
==========================================
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING
AND FINANCING ACTIVITIES:
Reinvested Preferred Stock dividends 1,059,140 1,708,300
The accompanying notes are an integral part of these statements.
8
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO THE FINANCIAL STATEMENTS
For the three months ended March 31, 2002
(unaudited)
1. ORGANIZATION AND BUSINESS:
Organization
Primecore Mortgage Trust, Inc., a Maryland corporation, was formed on March 18,
1999 (inception) and commenced operations effective May 1, 1999 as a real estate
investment trust (REIT). We are engaged in the business of funding and holding
short-term construction mortgage loans secured by residential real property, as
well as land acquisition and development loans secured by undeveloped real
property, located in the greater San Francisco Bay Area. We are managed by
Primecore Funding Group, Inc., a California corporation located in Menlo Park,
California. Our manager, or its affiliate, Primecore Properties, Inc.,
originates and services the construction mortgage loans we invest in for a
monthly management fee.
Capitalization
We have authorized 50,000,000 shares of capital stock with a $0.01 par value;
40,000,000 shares are designated Class A Convertible Preferred (Preferred
Stock), and 10,000,000 shares are designated as common.
At March 31, 2002, there were 100 shares of common stock outstanding, all held
by William Whitlow, Susan Fox and Michael Rider, who are employees and officers
of our manager. Ms. Fox owns all of the stock of our manager.
The 21,959,845 and 21,633,864 shares of Preferred Stock outstanding as of March
31, 2002 and December 31, 2001, respectively rank senior to our common stock as
to dividends and liquidation rights. The shares are convertible into, and have
voting rights equal to, the same number of shares of our common stock. We will
not pay any dividends to the holders of the common stock so long as any
Preferred Stock is outstanding.
Preferred stock dividends are paid monthly in arrears and were $0.26 per share
(based on weighted average preferred shares outstanding of 21,843,214) for the
three months ended March 31, 2002, compared with $0.29 per share (based on
weighted average preferred shares outstanding of 20,698,831) for the three
months ended March 31, 2001. The terms of our dividend reinvestment plan permit
our shareholders to reinvest dividends in additional shares of Preferred Stock,
currently at $10 per share.
Holders of our Preferred Stock do not have a right to redeem their shares. Our
Board of Directors, however, currently has a stock redemption policy for
shareholders who wish to sell their shares to us. The policy may be modified or
terminated at the Board's discretion at any time. Currently, we will repurchase
shares at $10.00 per share if we have cash available for distribution. Cash
available for distribution is determined at the Board of Director's sole
discretion, and is net of current expenses, anticipated expenses, dividends,
debt obligations and reserves for operating funds. We will not sell or otherwise
liquidate any portion of our mortgage loan portfolio or other assets to fund a
redemption request. We also reserve the right to limit the number and frequency
of stock redemptions by any shareholder.
We sell our stock through private placement and have closed three private
placements since our inception issuing 24,466,291 shares at $10.00 per share.
Under our current private placement for 20,000,000 shares of Preferred Stock we
have issued 888,700 shares at $10 per share as of March 31, 2002. We use the
proceeds from issuance of our Preferred Stock primarily to fund additional loans
and also for working capital purposes.
9
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO THE FINANCIAL STATEMENTS
For the three months ended March 31, 2002
(unaudited)
Risk Factors
General Economic Conditions in Lending Areas. Properties securing repayment of
the mortgage loans are located in the San Francisco Bay Area, with the majority
in the counties of Santa Clara and San Mateo. Since the properties secured by
the mortgage loans are located in a limited geographical region, these mortgage
loans may be subject to a greater risk of delinquency or default if the
industries concentrated there suffer adverse economic or business developments.
Other. In addition, we are subject to other significant business and financial
risks, including but not limited to liquidity, the prevailing market for
residential real estate, interest rates, dependence on our manager, timely
completion of projects, lack of borrower diversification, and potential
environmental matters relating to properties on which we have made loans. For
additional information see Risk Factors set forth in our Form 10-K dated March
30, 2002.
Retained Deficit
We had a retained deficit as of March 31, 2002 and December 31, 2001 because we
pay dividends to the holders of our Preferred Stock based on our taxable income,
in accordance with REIT requirements. Our taxable income differs from income
measured in accordance with generally accepted accounting principles in the
United States due to timing differences in the recognition of income from our
investments in real estate. See Income Taxes in Note 2 below. These dividend
distributions are expected to be matched by revenues from completed real estate
projects in future periods, as described in Note 2 and 3.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Basis of Presentation
The accompanying unaudited financial statements present the financial position
of the Company as of March 31, 2002, and December 31, 2001, and the results of
operations and cash flows of the Company for the three months ended March 31,
2002 and 2001. In the opinion of management, the accompanying unaudited
financial statements contain all adjustments (consisting of only normal
accruals) necessary to present fairly the financial position and results of
operations of the Company as of March 31, 2002 and for the period then ended.
Use of Estimates
These financial statements have been prepared in accordance with accounting
principles generally accepted in the United States using the accrual method of
accounting. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Investments in Real Estate under Development
and Investments in Real Estate under Development by Affiliates
All of our loans are initially classified for financial reporting purposes as
investments in real estate under development or investments in real estate under
development by affiliates (Notes 3 and 4). Such investments include capitalized
interest and are stated at the lower of cost or net realizable value. Management
conducts a review for impairment on an investment-by-investment basis whenever
events or changes in circumstances indicate that the carrying amount of an
investment may not be recoverable. An impairment is recognized when estimated
expected future cash flows (undiscounted and without interest charges),
typically from the sale of a completed property, are less than the carrying
amount of the investment, which does not include accrued interest and points.
10
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO THE FINANCIAL STATEMENTS
For the three months ended March 31, 2002
(unaudited)
The estimation of expected future net cash flows is inherently uncertain and
relies to a considerable extent on assumptions regarding current and future
economic and market conditions. If, in future periods, there are changes in the
estimates or assumptions incorporated into the impairment review analysis, the
changes could result in an adjustment to the carrying amount of the investments.
To the extent an impairment has occurred, the excess of the carrying amount of
the investment over its estimated fair value, less estimated selling costs, will
be charged to income. During the three months ended March 31, 2002, we charged
$145,782 to income for investments we believe are impaired compared with none
during the three months ended March 31, 2001.
Investments in Real Estate Held for Sale
We may take title to property through foreclosure or be deed in lieu of
foreclosure when a borrower defaults on his loan. Such arrangements cease to be
loans but are accounted for in a manner similar to our investments in real
estate under development and real estate under development by affiliates.
Interest income for tax purposes is not accrued on investments in real estate
held for sale.
Cash and Cash Equivalents
Cash and cash equivalents include cash held in financial institutions and other
highly liquid short-term investments with original maturities of three months or
less.
Income from Completed Real Estate Development
Our investment objective is to make construction mortgage loans on projects we
believe are likely to ultimately sell for an amount sufficient to repay the
principal plus interest of those loans at the agreed upon rate. We do not intend
to own or develop property and do not participate in the profit realized by the
borrower, including affiliated borrowers, upon sale of the property.
We recognize income from our investments in real estate under development upon
the sale or refinancing of the completed real estate to or by a third party. No
income or points are recognized until the property is sold or refinanced. We
compute income as cash received (which includes amounts funded, accrued interest
and points) less the carrying value of the investments at the date of repayment
(which includes amounts funded and capitalized interest costs).
Income Taxes
To continue to qualify as a REIT, we must currently distribute at least 90
percent of our taxable income. 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
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.
11
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO THE FINANCIAL STATEMENTS
For the three months ended March 31, 2002
(unaudited)
Our taxable income is computed as follows:
Three Months Ended Three Months Ended
March 31, 2002 March 31, 2001
------------------------------------------
Revenues - Interest income $ 8,862,713 10,497,133
Operating expenses (3,398,718) (4,417,283)
Loan losses (179,593) --
------------------------------------------
------------------------------------------
Income before dividends 5,284,402 6,079,850
Dividend expense (5,733,818) (5,951,458)
------------------------------------------
Taxable (loss) income........ $ (449,417) $ 128,392
==========================================
Our taxable income differs from income measured in accordance with generally
accepted accounting principles in the United States due to timing differences in
the recognition of income from our investments in real estate. We distribute
preferred stock dividends at a level sufficient to satisfy specified return
targets for our investors. As a result, actual dividends may be in excess of
taxable income. Rates of return are subject to adjustment by our Board of
Directors based upon prevailing market and company specific conditions. Timely
payment of preferred stock dividends could be adversely effected if we
experience a slow down in the repayment of our loans. It is possible that
dividends could be significantly reduced if there was a decline in the value of
our loan portfolio.
Net Income (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 income (loss) used in the
calculation is reduced by dividends owed to preferred shareholders. The diluted
weighted average common shares outstanding include the dilutive effect of stock
options and other common stock equivalents. There are currently no stock options
or other dilutive common stock equivalents, and as a result, the basic and
diluted weighted average common shares outstanding for the three months ended
March 31, 2002 and 2001, are the same and are 100 shares.
New Accounting Pronouncement
In August 2001, the Financial Accounting Standards Board (FASB) issued SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets," which is
effective for fiscal years beginning after December 15, 2001. SFAS No. 144
addresses financial accounting and reporting for the impairment or disposal of
long-lived assets and supersedes SFAS No. 121,"Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets To Be Disposed Of" among other
existing authoritative literature. We are required to and have adopted SFAS No.
144 in the first quarter of fiscal 2002 which did not have a significant effect
on our financial position, results of operations and cash flows in the current
period.
3. INVESTMENTS IN REAL ESTATE UNDER DEVELOPMENT:
We make loans with maturity dates generally ranging from 12 to 18 months. For
financial reporting purposes, we account for our loans as investments.
Investments in real estate under development represent funds advanced in cash
plus capitalized interest on arrangements in effect at any particular time.
Since real estate under development generates no operating income, we do not
accrue any income for financial reporting purposes until the sale or refinancing
of a property. The income that we ultimately realize is based upon the terms of
12
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO THE FINANCIAL STATEMENTS
For the three months ended March 31, 2002
(unaudited)
the construction mortgage loan. During the three months ended March 31, 2002,
fixed interest rates on loans outstanding ranged from 11 percent to 13 percent.
In the case of loans on which the borrower defaulted, the interest rate charged
during the period of default was an additional 5 percent over the note rate. In
addition, we charged points, which were typically 4 percent of the borrowed
amount during that same period.
13
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO THE FINANCIAL STATEMENTS
For the three months ended March 31, 2002
(unaudited)
The following table summarizes our portfolio of investments in real estate under
development at March 31, 2002:
Maturity Commitment Carrying Deferred
Location - County Dates Amount Amount Income
- ------------------- ------------ -------------- -------------- -------------
Alameda 12/02-04/03 $ 6,894,000 $ 1,482,824 $ 894,668
Contra Costa 05/02-05/02 5,610,000 4,668,141 1,058,204
Marin 06/01-01/03 30,340,000 19,234,657 6,265,172
Monterey 05/02-12/03 19,500,000 10,584,630 2,923,122
Napa 08/02 4,750,000 2,424,147 876,224
San Francisco 01/02-10/02 26,935,000 16,189,220 6,006,637
San Mateo 02/02-10/02 52,761,140 28,563,384 8,312,530
Santa Clara 06/01-08/02 60,840,000 30,868,155 13,713,547
Santa Cruz 06/01 6,750,000 5,008,490 1,946,263
Sonoma 09/01 6,585,000 1,833,570 1,285,882
-------------- -------------- -------------
$220,965,140 $ 120,857,218 $43,282,249
============== ============== =============
Earned but unrecognized interest and points on loans outstanding at March 31,
2002 totaled $43,282,249 compared with $39,667,545 at December 31, 2001. These
amounts will be recognized as income from completed real estate development upon
the sale or refinancing of the underlying property. During the three months
ended March 31, 2002, we capitalized $550,513 of interest expense to investments
in real estate under development.
We will fund unfunded commitments on existing loans from the repayment of other
loans, borrowings on our line of credit (Note 7), issuance of short-term notes
payable or issuance of additional preferred stock. We believe we will have
adequate sources of capital to fund these commitments when and as they become
due.
As of March 31, 2002, we had loans with a carrying amount of $11,552,595, which
had not been paid by their stated maturity dates and which we do not intend to
extend compared with $19,218,517 at December 31, 2001. These loans are accruing
interest at the default rate, which is 5 percent higher than the note rate.
Additionally, at March 31, 2002, we had recorded notices of default on loans
with a carrying amount of $16,653,807 compared with $14,293,382 at December 31,
2001. Recording a notice of default begins the process of foreclosure. In many
cases we expect the borrower will have sufficient time to either sell or
refinance the property before the foreclosure period expires. All loans for
which a notice of default has been recorded are charged interest at the default
rate.
4. INVESTMENTS IN REAL ESTATE UNDER DEVELOPMENT BY AFFILIATES:
We have also made loans to affiliates of our manager acting as the developer.
These arrangements are accounted for in a manner identical to that described in
Note 3 above. The following table summarizes our portfolio of investments in
real estate under development by affiliates at March 31, 2002:
Maturity Commitment Carrying Deferred
Location - County Dates Amount Amount Income
- ------------------- ------------ -------------- -------------- -------------
San Mateo 01/03-04/03 $ 14,200,000 $ 8,852,234 $ 2,586,812
Santa Clara 12/01-03/03 56,125,000 31,977,090 13,475,636
-------------- -------------- -------------
$ 70,325,000 $ 40,829,324 $ 16,062,448
============== ============== =============
14
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO THE FINANCIAL STATEMENTS
For the three months ended March 31, 2002
(unaudited)
Earned but unrecognized interest and points on loans outstanding at March 31,
2002 totaled $16,062,448 compared with $14,863,787 at December 31, 2001. Such
amounts will be recognized as income from completed real estate development upon
the sale or refinancing of the underlying property. During the three months
ended March 31, 2002, we capitalized $140,799 of interest expense to investments
in real estate under development by affiliates.
5. INVESTMENT IN REAL ESTATE HELD FOR SALE:
As of March 31, 2002, we held title to twelve properties received through
foreclosure or by deed in lieu of foreclosure. The following table summarizes
investments in real estate held for sale at December 31, 2001:
Commitment Carrying Deferred
County Number Amount Amount Income
- ------------------- ------------ -------------- -------------- -------------
Alameda 2 $ 14,365,000 $ 4,794,385 $ 1,534,602
Marin 5 14,666,000 8,664,909 3,731,551
San Mateo 2 3,375,000 2,579,307 588,152
Santa Clara 3 11,235,000 8,862,851 2,368,822
------------ -------------- -------------- -------------
Total 12 $ 43,641,000 $ 24,901,452 $ 8,223,127
============== ============== =============
These properties were initially recorded at their existing carrying amount and
are in various stages of construction and some are complete. During the three
months ended March 31, 2002, we capitalized $85,929 of interest expense to
investments in real estate under development. They will be sold in the manner
which we believe maximizes their value to us.
During the three months ended March 31, 2002, we sold one property with the
following results:
Net sales proceeds $ 920,955
Carrying amount 843,258
---------------
---------------
Total income reported $ 77,697
===============
6. NOTES PAYABLE:
We had unsecured borrowings of $14,948,387 at March 31, 2002 compared with
$17,312,526 at December 31, 2001 on notes issued to accredited investors through
private placements. These notes have varying maturities of up to two years from
the date of issuance and bear interest at fixed rates between 9 and 12.5 percent
15
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO THE FINANCIAL STATEMENTS
For the three months ended March 31, 2002
(unaudited)
with interest payable monthly in arrears. We may call these notes at our option
before their stated maturity. As of March 31, 2002, we estimate that the
carrying amounts of our notes payable approximate their fair value based on
current borrowing rates available to us. The following table summarizes the
maturities of our notes payable at March 31, 2002:
Year Amount
------------------------------ -----------------
------------------------------ -----------------
2002 $ 11,364,855
2003 3,363,533
2004 220,000
16
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO THE FINANCIAL STATEMENTS
For the three months ended March 31, 2002
(unaudited)
7. LINE OF CREDIT:
We have a $15,000,000 line of credit with a commercial bank. The amount borrowed
under the line of credit at March 31, 2002, was $14,862,249, compared with
$15,000,000 at December 31, 2001. The line of credit is secured by our assets
and guaranteed by our manager and another affiliate, carries interest at prime
plus 1.50 percent (6.25 percent at March 31, 2002) and matures in May 2003. The
terms of the line of credit require, among other provisions, that we maintain
total equity of no less than $150,000,000, a debt to equity ratio of less than
1.5 to 1.0 and quarterly taxable income from operations of at least $500,000. We
were in compliance with all covenants at March 31, 2002. We incurred loan fees
and other costs of $235,169 in connection with this loan, which are included in
other assets in the accompanying balance sheets and are being amortized on the
effective interest method over the life of the facility. Accumulated
amortization of loan fees amounted to $67,285 at March 31, 2002.
8. TRANSACTIONS WITH AFFILIATES:
Management Fees
A management agreement dated March 30, 1999 and amended on October 1, 2000
between us and our manager provides for a monthly fee payable in arrears equal
to 0.25 percent of the total commitment amount of the loans in our investments
in real estate under development and in our investments in real estate under
development by affiliates. For the three months ended March 31, 2002, the
portfolio management fees earned by our manager were $2,658,152, compared with
$3,122,154 for the three months ended March 31, 2001.
In January 2002 the Board of Directors approved a clarification to the
management agreement which explicitly provided that the commitment amount of
loans which had been foreclosed upon by us would be included in the calculation
of the management fee. The clarification was retroactive and all previously
uncharged fees totalling $160,728 were then charged in February 2002.
Payable to Affiliate
The $24,345 and $31,193 payable to affiliate at March 31, 2002 and December 31,
2001, respectively, represents short-term advances to us by our manager to
facilitate our cash management.
Affiliate Loans
Loans assumed by, or made to, our affiliates represent a material portion of our
investment portfolio. As of March 31, 2002, loans assumed by or made to our
affiliates represented 21% of our loan commitments and 22% of the funded portion
of those commitments which are the same percentages as at December 31, 2001.
Our affiliates are entities with whom we share common control through
common management. For example, Primecore Funding Group, Inc. is our affiliate
because Susan Fox owns 100% of its stock and is its sole director. She is also
an executive officer of Primecore Funding Group, Inc., as is Mr. Rider. To the
extent that Ms. Fox is the director of Primecore Funding Group, Inc. and is one
of our directors, her position in management is common to both Primecore Funding
Group, Inc. and us.
Eprime, Inc. is our affiliate and is a California corporation, incorporated
March 21, 2000. Ms. Fox is the sole shareholder and director. She is the
president and secretary, and Mr. Rider is the chief financial officer. Eprime,
Inc. does not have any employees, does not provide any services to us and does
not receive any compensation from us.
Primecore Properties, Inc. is our affiliate and is a California
corporation, incorporated in 1997. Ms. Fox is its sole shareholder and one of
its directors. Primecore Properties, Inc. is licensed by the California
Department of Real Estate as a real estate corporation. Theresa May Couture is
17
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO THE FINANCIAL STATEMENTS
For the three months ended March 31, 2002
(unaudited)
licensed as an individual real estate broker and is the designated
broker-officer of Primecore Properties, Inc. Primecore Properties, Inc. does not
receive any compensation from us, but does provide services to us for certain
activities that require a California real estate broker license. Those services
are performed for us under the terms of our management agreement with Primecore
Funding Group, Inc. There are currently no arrangements for us to separately
compensate Primecore Properties, Inc. for those services, although we continue
to pay a management fee to Primecore Funding Group, Inc. See "Management Fees."
99 Investors, LLC, a California Limited Liability Company, is our
affiliate. Ms. Fox is its sole member. It does not have any employees, does not
perform any services for us and does not receive any compensation or benefits
from us.
99 El Camino Partners LLC is our affiliate and a California limited liability
company. Ms. Fox is the sole member. The partnership has no employees, does not
provide any services to us and does not receive any compensation or benefits
from us. 99 El Camino Partners owns the property at 99 El Camino Real, Menlo
Park, California, our principal place of business and that of our affiliates.
The following is a summary of loans assumed by our affiliates as of March 31,
2002, categorized by loan number, project name, affiliate, commitment amount,
funded amount and percentage funded. The funded balance represents the total
amount advanced towards a loan. The funded amount may differ from the loan
balance outstanding as a result of payments received from the sales of property
secured by the loan. Also, included in the funded amount are loan fees and
interest charged to the borrower, which are not reported under generally
accepted accounting principles.
Carrying Deferred
Loan Project Name Commitment Amount Income
- ------------------- ---------------------------------------------- ------------------ ------------------
Eprime, Inc
Loan 2376 104 Second Street 3,825,000 739,804 875,336
Loan 2447 Affiliate properties 13,500,000 9,928,073 4,442,618
Loan 2512 Affiliate properties 7,000,000 721,444 2,272,985
------------------- ------------------ ------------------
Total Eprime loans $ 24,325,000 11,389,321 7,590,939
=================== ================== ==================
99 Investors, LLC
Loan 2330 Scotia Pines Subdivision $ 4,000,000 -- 598,016
Loan 2404 7 Lots, Los Altos Nursery 12,800,000 11,114,951 2,799,513
Loan 2427 Quarry Estates - Lot 13 5,000,000 3,182,075 843,147
Loan 2428 Quarry Estates - Lot 15 5,000,000 3,543,430 842,758
Loan 2429 Quarry Estates - Lot 16 5,000,000 2,747,313 801,263
Loan 2455 91 Fleur Place 7,100,000 4,556,657 1,436,560
Loan 2469 37 Euclid 7,100,000 4,295,577 1,150,252
---------------------------------------------------------
Total 99 Investors $ 46,000,000 29,440,003 8,471,509
=================== ================== ==================
The loans assumed by Eprime, Inc. are secured by the remaining properties in a
series of projects where Windy Hill Associates, a California corporation, was
the original borrower. In November 1999 the sole shareholder of Windy Hill
18
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO THE FINANCIAL STATEMENTS
For the three months ended March 31, 2002
(unaudited)
Associates started proceedings to dissolve the corporation. Before the
dissolution, Susan Fox was the president of Windy Hill Associates, and was
managing its operations to ensure that the loans were kept current. Upon notice
of dissolution of the corporation, Ms. Fox was replaced as president by the sole
shareholder, and the loans went into default. A foreclosure sale was scheduled
for March 22, 2000.
On March 22, 2000, Eprime, Inc., purchased what is currently designated as
our loan no. 2447, for the then existing loan balance of $11,321,061. A blanket,
second deed of trust lien against several parcels secured the loan. Eprime, Inc.
foreclosed on the second deed of trust and took title to all of those parcels,
subject to existing senior liens. The note purchase and assumption agreement for
all of these loans includes guarantees of repayment and the pledge of additional
security from Primecore Funding Group, Inc., 99 Investors, LLC and the Susan M.
Fox 1996 Revocable Trust dated April 26, 1996. All loans are current, and
construction is on schedule.
Loan no. 2330 was assumed in September 1999 by 99 Investors, LLC is secured by a
junior deed of trust on property originally to be developed by Windy Hill
Associates.
Loan no. 2404 was made to 99 Investors, LLC in September 1999. Repayment is
secured by a single junior deed of trust on 7 lots in Los Altos, California. The
loan is for development of 7 single-family residences. The first homes are
scheduled for completion in April 2002.
Loan nos. 2427-29 were made to 99 Investors, LLC in March 2000. Repayment is
secured by junior deeds of trust. The developments are single family residences
in Los Altos Hills. As of March 31, 2002 two of the homes were complete and on
the market. The final home is scheduled to complete in September 2002.
Loan nos. 2455 and 2469 were made to 99 Investors, LLC in April and September
2000, respectively. Repayment is secured by junior deeds of trust. The
developments are single family residences in Atherton, California. Construction
is scheduled for completion in October 2002, and January 2003, respectively.
Because of changes in the scope of construction and general cost increases
during development of projects, additional funds are sometimes needed to
complete a project. We will grant an additional extension of credit if our
management believes repayment of the increased extension of credit is adequately
secured. This is true of any development we invest in, whether the borrower is
affiliated or not.
9. COMMITMENTS AND CONTINGENCIES:
Litigation
We are involved in legal actions arising in the normal course of our business.
We are not presently subject to any material litigation nor, to our knowledge,
is any litigation threatened against us which collectively is expected to have a
material adverse effect on our cash flows, financial condition or results of
operations.
Construction Contracts
In connection with our development of investments in real estate held for sale,
we have entered into contracts with construction companies totalling $2,946,706
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.
19
PRIMECORE MORTGAGE TRUST, INC.
NOTES TO THE FINANCIAL STATEMENTS
For the three months ended March 31, 2002
(unaudited)
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.
20
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-K,
which are not historical facts, may be forward-looking statements. Such
statements are subject to risks and uncertainties that could cause actual
results to differ materially from those projected. Investors are cautioned not
to attribute undue certainty to these forward-looking statements, which speak
only as of the date of this Form 10-K. We undertake no obligation to publicly
release any revisions to these forward-looking statements to reflect events or
circumstances after the date of this Form 10-K or to reflect the occurrence of
unanticipated events, other than as required by law.
Overview
Subject to the direction and oversight of our Board of Directors, our day-to-day
operations are managed by our manager. We have no employees.
We began operations on May 1, 1999, concurrent with the first interim closing of
a private offering of 14,575,664 shares of our Class A Convertible Preferred
stock at $10 per share primarily in exchange for beneficial interests in trust
deeds on real property securing loans and accrued interest totaling
$145,756,640. Purchasers of our shares were primarily investors in trust deeds
managed by Primecore Funding Group, Inc. who invested in those trust deeds
before our formation and exchanged their interests for our stock at $10 per
share on a dollar for dollar basis. Since that time we have sold our Preferred
Stock through various private placements in order to raise cash to fund our
loans and for working capital purposes.
We currently have an ongoing equity private placement offering of 20,000,000
shares of Preferred Stock at $10.00 per share. This placement was undertaken to
purchase and fund additional and existing construction mortgage loans and for
working capital purposes. The placement is presently scheduled to close on April
15, 2003, however we anticipate extending the closing date until all shares have
been sold, at which point we may announce an additional placement.
We have elected to be taxed as a REIT under the Internal Revenue Code of 1986,
as amended (the "Code"), and as such, are required to distribute at least 90
percent of our taxable income annually, subject to adjustments. Our manager
expects that the cash for such distributions will be generated from our
day-to-day operations, although we may also borrow funds to make distributions.
We may experience high volatility in financial reporting net income from quarter
to quarter and year to year, primarily as a result of fluctuations in timing of
completion of our investments in real estate under development, interest rates,
and general economic conditions in the greater San Francisco Bay Area. Our
operating results will depend, in part, upon our ability to manage our interest
rate and credit risks while maintaining our REIT status.
Results of Operations
We recognize income from our investments only after we receive payment. All
income accrued on our loans, according to our contracts with our borrowers, is
deferred until after we have received payment of all amounts funded as well as
the related accrued income. These payments are usually received by us only after
the associated property has been sold or refinanced. Since our repayment
transactions are typically large in amount yet relatively few in number, our
income is subject to wide variations since the timing of even a single loan
repayment can have a material impact on our revenues. In the first quarter of
2002 our loan repayments totalled $14.0 million compared with $25.0 million in
the first quarter of 2001. Of the $14.0 million collected in loan repayments in
21
the first quarter of 2002, we recorded income of $1.655 million which represents
12% of our payments. The bulk of our loan repayments, $9.25 million, received in
the first quarter of 2002 came from multiple unit developments or partial loan
payments where the payments reflected a return of amounts we had funded rather
than the income we charged our borrowers. As more of the units sell in these
multi-unit developments, we will begin to recognize the income we have accrued
on these investments.
We pay management fees based on the amount of loan commitments outstanding at
the end of each month. Our loan commitments averaged $333 million for the three
months ended March 31, 2002 compared with $416 million for the three months
ended March 31, 2001, a 20% decrease. Our management fees decreased 15% to $2.66
million from $3.12 million The reason that the management fees did not decrease
by the same percentage as the decrease in the average loan commitments was due
to a clarification to the management agreement which was approved by the Board
of Directors in January 2002. The new language explicitly provided that the
commitment amount of loans which had been foreclosed upon by us would be
included in the calculation for the management fee. Because the management
agreement had been silent about this issue, no fees had been charged on
foreclosed loans. The Board of Directors provided that the clarification was
retroactive, and all previously nonchargeable fees were then charged in February
2002.
Since December 31, 1999 all interest costs have been capitalized as a cost of
our investments in real estate under development and investments in real estate
under development by affiliates. Interest cost associated with our borrowings
was $691,312 for the three months ended March 31, 2002, compared with $1,306,721
for the three months ended March 31, 2001. The decrease is due to a combination
of a lower cost of debt, 9.4% in the first three months of 2002 compared with
11.6% in the first three months of 2001; and a lower amount of debt on our
balance sheet, an average of $29.4 million in the first three months of 2002
compared with an average of $43.5 million in the first three months of 2001.
Our general and administrative and other expenses consist primarily of
professional fees, directors' fees and insurance costs. General administrative
and other expenses were $105,505 for the the three months ended March 31, 2002,
compared with $44,658 for the the three months ended March 31, 2001. The
increase relates primarily to changes in the timing of professional accounting
services provided by our accountants. These changes should provide more
uniformity in expenses throughout the year.
Liquidity and Capital Resources
Liquidity means the need for, access to and uses of cash. Our principal demands
for liquidity are cash for operations, funds that are required to satisfy
obligations under existing loan commitments, management fees, interest expense
associated with our indebtedness, debt repayments and dividend distributions to
shareholders. In the near term, our principal sources of liquidity are the
repayments of our real estate investments, funds received from issuance of
unsecured notes payable, our line of credit and sales of preferred stock.
Sources of cash
By far, our largest source of liquidity is the repayment of our investments in
real estate. As of March 31, 2002 we had $247.7 million, including accrued
income, invested in real estate construction projects. Although our loans
provide for specific maturity dates, in most cases we must rely on the sale of
the project before can collect the amount owed. Therefore repayment is largely
dependent on the health of the real estate market. We therefore keep close track
of the markets where we lend in order to identify trends and make appropriate
adjustments to our forecasts. In doing so, we have identified three price
sectors in the markets where we lend: $2 million and under; $2 million to $5
million and over $5 million.
The market for homes under $2 million has remained strong throughout 2001 and
the first quarter of 2002 with average prices actually increasing over 2000
levels. Although the average number of units sold in this sector decreased in
2001 compared with 2000, we observed an increase in unit sales in the first
quarter of 2002, over average 2001 levels. Due to the scarcity of new housing
opportuinities we see continued strength in this market sector which represents
the expected selling price of about 32% of our investments. The middle sector,
between $2 million and $5 million, weakened in 2001 compared with 2000 with
average days on the market increasing, and the number of units sold decreasing
22
by almost half of 2000 levels. Average prices did fall but by less than 1%. In
the first three months of 2002 we observed an increase in unit sales for this
sector, but average prices declined about 3% over 2001 levels and average days
on the market increased to 165 from 114. We believe that this sector is quite
price sensitive and that the increased number of unit sales in the quarter
results from lower pricing as sellers are starting to adjust to market
realities. About 29% of our investments are expected to sell at prices in this
middle sector. The upper sector, with prices above $5 million had softened the
most compared with the highs recorded in 2000. The first quarter of 2002
continued the trend we saw in 2001 with a very long marketing periods and lower
prices. About 39% of our investments are expected to sell in this sector.
The longer selling periods for our investments means that our cash inflows will
likely be lower than previous periods when homes were selling at a faster rate.
However, due to the maturation of our loan portfolio, we have a larger number of
units currently on the market or close to completion. Taking both these factors
into account, we have projected that our loan repayments should be comparable to
last years' results. In the first quarter our loan repayments were $14.0 million
compared $25.0 million for the first three months of 2001. Most of that
difference results from a small difference in the timing of some rather large
repayments. Because we have a relatively low number of transactions with large
amounts, changes in the timing of a couple of transactions can cause large
variations in period results. We received repayment of three of our investments
in the first week of April, 2002 totalling approximately $8 million which would
have made a big difference in our results had they occurred one week earlier.
For this reason, and the longer transactional periods related to real estate, we
examine trends and results over longer periods of time and are not as concerned
with quarter to quarter performance.
Our liquidity is also enhanced through sales of our Preferred Stock and issuance
of notes payable to investors. Our Preferred Stock is sold through private
placements which are continuous and ongoing. For the three months ended March
31, 2002 we sold 449 thousand shares of Preferred Stock for proceeds of $4.49
million compared with 1.12 million shares for proceeds of $11.2 million for the
three months ended March 31, 2001. Of the stock sold in 2001, approximately 700
thousand shares for proceeds of approximately $7 million were sold in exchange
for Short Term Notes held previously by investors.
We continue to issue notes payable on a limited basis, however they are not a
primary source of our liquidity. During the three months ended March 31, 2002 we
issued $662,000 in notes compared with $5,564,600 for the three months ended
March 31, 2001. Our current plan is to maintain our existing notes payable
balances at their current levels both 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 timing and amount of our obligations through
December 2003:
Remainder
Obligation Total of 2002 2003
-------------------------- -------------- --------------- --------------
Investment fundings $ 37,000,000 $ 20,000,000 $ 17,000,000
Line of credit 15,000,000 -- 15,000,000
Short term notes payable 15,000,000 11,400,000 3,600,000
Dividend payments 40,000,000 15,000,000 20,000,000
-------------- --------------- --------------
Total $107,000,000 $ 46,400,000 $ 55,600,000
============== =============== ==============
Investment fundings are our largest use of our cash. At January 1, 2002 we had
an unfunded loan commitment obligation of approximately $45 million. We funded
approximately $9.7 million of that amount in the first three months of 2002. The
exact timing of the remaining amount of investment fundings is dependent on
several factors including weather, governmental regulation and developer related
issues, so the timing of investment fundings in the above table is an estimate
based on information available to us at this time.
23
Our line of credit was extended in December 2001 to May 2003. We expect to
gradually decrease the outstanding balance of the line to provide us with more
liquidity and more flexibility in finacing our contractual commitments.
As stated above, our plan is to maintain our existing notes payable balances at
their current levels both through extension of existing notes and issuance of
new notes to replace maturities of existing notes. In the first quarter of 2002
we extended approximately $10 million in notes payable, paid approximately $3.2
million and issued $662,000 in new notes. We continue to offer notes to
investors who but at a greatly reduced level. We believe that the market for
notes will continue to exist at a price which affords our shareholders the
benefit of some leverage while allowing us to maintain much desired capital.
Although dividend payments are not contractual obligations we have included
their impact on our liquidity since they are a fundamental component of our
business. In order to maintain our REIT status, we must distribute dividends
equal to at least 90% of our taxable income which causes us to distribute
earnings before they are recognized for financial reporting purposes. This
creates a retained deficit which we expect to recover as our loans are paid.
Failure to meet the dividend distribution requirements would jeopardize our REIT
status and could substantially reduce the rate of return we pay to our
shareholders.
In addition to the above, we expect to pay management fees to our manager as
described under Results of Operations above, and make periodic payments of
interest on our short term notes payable based upon balances outstanding.
We continue to redeem Preferred Stock. In the three months ended March 31, 2002
we paid $2.285 million to preferred stockholders representing 228,500 shares
compared with $2.037 million paid representing 203,700 shares in the three
months ended March 31, 2001. We began the year with outstanding redemption
requests of $38.0 and with new requests received, redemption payments made and
redemption cancellations, requests were still approximately $38.0 million. We
have allocated a larger portion of our cash inflows to make redemption payments
and will make these payments as we receive cash from our loan repayments. While
redemptions are not a contractual obligation, we intend to continue to address
redemption requests in accordance with our redemption policy and to continue to
evaluate and determine our redemption policy in the best interests of the
Company and its shareholders.
Critical Accounting Policies and Estimates
Management's Discussion and Analysis of Financial Condition and Results of
Operations covers our financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. On an on-going basis, management evaluates its
estimates and judgments, including those related to the valuation of our assets
and liabilities. Management bases its estimates and judgments on historical
experience and on various other factors that are believed to be reasonable under
the circumstances, the results of which form the basis for making judgments
about the carrying values of assets and liabilities that are not readily
apparent from other sources. Actual results may differ from these estimates
under different assumptions or conditions. Management believes the following
critical accounting policies, among others, affect the more significant
judgments and estimates used in the preparation of its consolidated financial
statements.
Valuation and Realizability of Investments. All of our loans are classified for
financial reporting purposes as investments in real estate under development or
investments in real estate under development by affiliates (see Notes 3 and 4 to
the financial statements). We have foreclosed on some loans that are classified
as investments in real estate held for sale (Note 5). Such investments include
capitalized interest and are stated at the lower of cost or net realizable
value. Management conducts a review for impairment on an
investment-by-investment basis whenever events or changes in circumstances
indicate that the carrying amount of an investment may not be recoverable. An
impairment is recognized when estimated expected future cash flows (undiscounted
and without interest charges), typically from the sale of a completed property,
24
are less than the carrying amount of the investment, plus estimated costs to
complete. The estimation of expected future net cash flows is inherently
uncertain and relies to a considerable extent on assumptions regarding current
and future economics and market conditions. If, in future periods, there are
changes in the estimates or assumptions incorporated into the impairment review
analysis, the changes could result in an adjustment to the carrying amount of
the investments. To the extent an impairment has occurred, the excess of the
carrying amount of the investment over its estimated fair value, less estimated
selling costs, will be charged to income. In accordance with this policy, we
recorded a provision for impairment of investments in real estate under
development totaling $145,782 in the three months ended March 31, 2002. We
believe that all of our investments are carried at realizable values, however
conditions may change and cause our loans to decline in value in a future
period.
Loan Accounting. We have applied the guidance of AICPA Practice Bulletin 1,
Purpose and Scope of AcSEC Practice Bulletins and Procedures for Their Issuance,
Exhibit I in accounting for our investment loans as real estate acquisition,
development, or construction (ADC) arrangements. In accordance with the ADC
accounting rules, we do not accrue income for interest and points on our loans
until the sale or refinancing of a property. Revenue from interest and points is
recognized as cash is received from the sale or refinancing of such properties.
Loans are classified as investments in real estate under development or
investments in real estate under development by affiliates and investments in
real estate held for sale (see Notes 3, 4 and 5 to the financial statements) and
include amounts funded under the loan agreements and capitalized interest
expense. If our loans qualified as loans under GAAP, interest and points would
be recognized in income as earned instead of at the time of sale of the
underlying property.
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 sufficient to satisfy specified return targets for our investors. As a
result, actual dividends may be in excess of taxable income. Rates of return are
subject to adjustment by our Board of Directors based upon prevailing market and
company specific conditions. timely payment of preferred stock dividends could
be adversely effected if we experience a slow down in the repayment of our
loans. It is possible that dividends could be significantly reduced if there was
a decline in the value of our loan portfolio.
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
25
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.
26
PART II.
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
We are not presently subject to any material litigation nor, to our knowledge,
is any litigation threatened against us which collectively is expected to have a
material adverse effect on our cash flows, financial condition or results of
operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
(a) Not Applicable.
(b) Not Applicable.
(c) Sales of Equity Securities.
Between January 1, 2002 and March 31, 2002, we sold and issued 448,596 shares of
our Class A Convertible Preferred stock. Purchasers of such Class A Convertible
Preferred stock paid $10 per share.
Purchasers of our Class A Convertible Preferred stock were accredited investors
as defined in Regulation D, Rule 501 (a) (4), (5) or (6) under the 1933
Securities Act. Each investor signed a subscription agreement which included
representations that the investor had sufficient knowledge and experience in
financial and business matters to be capable of evaluating the merits and risks
of investments generally, and of the investment in our stock and the investor
was able to bear the economic risk of the investment. Each investor further
acknowledged the investor understood the entire investment could be lost.
The sales of stock were exempt from the registration requirements of the
Securities Act of 1933 pursuant to Regulation D, Rule 506. Appropriate legends
were placed on each stock certificate. No underwriters were involved and no
underwriting commissions were paid in any of the transactions.
The terms of conversion of the stock have been previously reported.
(d) Not Applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
ITEM 5. OTHER INFORMATION.
Not applicable.
27
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
(b) Reports on Form 8-K
Not Applicable.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: May 9, 2002 /s/ SUSAN FOX
-------------
Susan Fox, President
Dated: May 9, 2002 /s/ MICHAEL RIDER
-----------------
Michael Rider, Chief Financial Officer
Dated: May 9, 2002 /s/ WILLIAM E. WHITLOW
----------------------
William E. Whitlow, Chairman of the Board
28
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
11.1 Statement regarding computation of per share earnings