Back to GetFilings.com

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

————————

FORM 10-Q

(Mark One)

ý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended April 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 0-6673

PACIFIC SECURITY COMPANIES, INC.

(Exact name of registrant as specified in its charter)

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.

ý Yes                                 ¨ No

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes   ý No

1,078,279 shares of common stock, par value $3.00 per share, were outstanding on June 10, 2004.

PACIFIC SECURITY COMPANIES, INC.

FORM 10-Q QUARTERLY REPORT

Table of Contents

———————

PACIFIC SECURITY COMPANIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET

See accompanying notes.                                                                                                                 1

PACIFIC SECURITY COMPANIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET

See accompanying notes.                                                                                                                 2

PACIFIC SECURITY COMPANIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF OPERATIONS

See accompanying notes.                                                                                                                 3

PACIFIC SECURITY COMPANIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS

See accompanying notes.                                                                                                                 4

PACIFIC SECURITY COMPANIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS

See accompanying notes.                                                                                                                 5

PACIFIC SECURITY COMPANIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED FINANCIAL STATEMENTS

Note 1 - Basis of Presentation

The consolidated financial statements include the accounts of Pacific Security Companies, Inc. and its subsidiaries (the Company). In the opinion of the Company, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the Company’s financial position, results of operations, and cash flows for the periods presented.

These consolidated financial statements should be read in conjunction with the consolidated financial statements and the related disclosures contained in the Company’s annual report on Form 10-K for the year ended July 31, 2003, filed with the Securities and Exchange Commission.

The results of operations for the nine months ended April 30, 2004, are not necessarily indicative of the results to be expected for the full year.

Contracts, mortgages, finance notes, and loans receivable:

The Company’s contracts, finance notes, and loans receivable consist primarily of short-term construction and real estate development loans. Contracts, mortgages, finance notes, and loans receivable are stated at the unpaid principal balance, plus accrued interest, less acquisition discounts, unearned loan fees, and an allowance for estimated uncollectible amounts, as necessary. Management evaluates receivables which may not be fully collectible to determine if a provision for loss is necessary based on the present value of expected future cash flows from the receivables in the ordinary course of business or from amounts recoverable through foreclosures and the subsequent resale of the collateral.

Contracts, mortgages, finance notes, and loans receivable are placed on nonaccrual status when collection of principal or interest is considered doubtful. Interest income previously accrued on these loans, but not yet received, is reversed in the current period to the extent that it is considered uncollectible. Interest subsequently recovered is credited to income in the period collected.

Allowance for loan losses:

The allowance for loan losses is based on management’s evaluation of each specific loan. A loan is considered impaired when, based on current information such as adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, current economic conditions, and independent appraisals, it is probable that the Company will be unable to collect, on a timely basis, all principal and interest according to the contractual terms of the loan’s original agreement. The amount of the impairment is measured using cash flows discounted at the loan’s effective interest rate, except when it is determined that the sole source of repayment for the loan is the operation or liquidation of the underlying collateral. In such cases, the current value of the collateral, reduced by anticipated selling costs, is used in place of discounted cash flows. Generally, when a loan is deemed impaired, current period interest previously accrued but not collected is reversed against current period interest income. Income on such impaired loans is then recognized only to the extent that cash in excess of any amounts charged off to the allowance for loan losses is received and where the future collection of principal is probable. Interest accruals are resumed on such loans only when they are brought

6

PACIFIC SECURITY COMPANIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED FINANCIAL STATEMENTS

Note 1 - Basis of Presentation (Continued)

fully current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest.

Contracts, mortgages, finance notes, and loans receivable are charged off when management believes there has been permanent impairment of their carrying values.

Sales of real estate:

Profit on sale of real estate is recognized when the buyers’ initial and continuing investment is adequate to demonstrate (1) a commitment to fulfill the terms of the transaction, (2) that collectibility of the remaining sales price due is reasonably assured, and (3) the Company maintains no continuing involvement or obligation in relation to the property sold and has transferred all the risk and rewards of ownership to the buyer.

Receipts on sales of real estate investments are accounted for as customer deposits until the principal payments received on the sales contracts exceed the minimum guidelines for gain recognition. Losses arising from sales of real estate are recognized immediately upon sale.

Reclassifications:

Certain reclassifications have been made in the prior period’s financial statements in order to conform with the current period financials. The reclassifications had no effect on previously reported net income (loss) or equity.

Note 2 - Business Segment Reporting

Information about the Company’s separate continuing business segments as of and for the nine months ended April 30, 2004 and 2003, is as follows:

7

PACIFIC SECURITY COMPANIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED FINANCIAL STATEMENTS

Note 2 - Business Segment Reporting (Continued)

The Company has determined that its reportable business segments are those that are based on its method of disaggregated internal reporting. The Company’s reportable business segments are its commercial loan origination business and its rental and receivable operations. Its commercial loan origination business, operated as Cornerstone Realty Advisors, Inc., originates commercial construction loans throughout the western United States. The rental and receivable operations represent the selling and leasing of real properties and the financing of contracts and loans collateralized by real estate. Some unallocated general corporate expense items are part of the rental and receivable segment reporting.

Management decided to dissolve its 100% owned subsidiary, Cornerstone Realty Advisors, Inc., as of its corporation license expiration date of March 31, 2002. Commercial lending activities are now being conducted through the parent company.

Note 3 - New Accounting Pronouncements

In May 2003, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company does not expect SFAS No. 150 to hav e a material effect on its financial position or results of operations.

Note 4 - Subsequent Events

On June 1, 2004, the Company completed the $1,370,000 sale of Cornerstone Office Building #2.

On June 8, 2004, the Company completed the $5,775,000 sale of the Peyton Building.

On June 9, 2004, the Company completed the $822,000 sale of approximately half of the Park City, Utah, property acquired in December 2002.

The proceeds from the sales of the properties were used to pay off approximately $4.5 million of debt collateralized by the properties and to provide liquidity to the Company for general corporate purposes, including the retirement of debenture obligations.

8

PACIFIC SECURITY COMPANIES, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Financial condition and liquidity:

At April 30, 2004, the Company had total stockholders’ equity of approximately $2,584,000 and a total liabilities to equity ratio of 6.11 to 1, which increased from 4.22 at July 31, 2003. During the nine months ended January 31, 2004, the Company’s primary sources of funds were approximately $4,478,000 from the sales of real estate, and $365,000 in real estate contract and loan collections. The primary uses of funds were approximately $3,288,000 for net debt reduction, and $1,075,000 for property improvements.

The Company’s sources of liquidity historically have included the issuance of debentures under the auspices of the Washington State Securities Division of the Department of Financial Institutions and borrowings from various bank lenders. These sources of liquidity are limited either by the Washington State Securities Division, which has capped the amount of debentures the Company may sell or by the individual banks through restrictive covenants included in the loan agreements. The state of Washington has mandated as a condition for issuance of a permit that the Company reduce total debentures outstanding by $500,000 to $7,965,000 by August 29, 2004. The requirement to do so has materially impacted the Company’s liquidity.

An additional source of liquidity is the issuance of participation interests in certain loans and contracts originated by the Company. The total of these nonrecourse repurchasable participations was approximately $475,000 at April 30, 2004, and July 31, 2003.

At April 30, 2004, the Company’s outstanding banking agreements totaled approximately $2,812,500 (which was paid off on June 8, 2004) with an additional $4,760,858 due for installment contracts, mortgage notes, and notes payable. The Company obtained a six month extension to July 1, 2004, on a $1,650,000 loan with undisbursed funds at April 30, 2004, of approximately $110,000 to be used to complete the construction of Cornerstone Office Building #2. The Company has negotiated a term loan of approximately $500,000 collateralized by Cornerstone Office Building #1 after paying off approximately $1,150,000 of the construction loan for Cornerstone Office Building #2 in June 2004. The Company does not have a line of credit from a lender. This will materially impact the Company’s liquidity and profitability. The Company has pla ns to begin making new loans but has concentrated on collection efforts to pay down outstanding debt. These collection efforts include foreclosure proceedings on loans.

The Company anticipates, but there can be no assurance, that cash flows from operations along with real estate and receivable sales will be sufficient to provide for the retirement of maturing debentures and mortgage obligations.

The Company continues to implement strategies for restructuring, which include liquidating a majority of the Company’s assets over the course of the next year. The Company reduced personnel during the prior year, incurring restructuring charges exceeding $300,000 for severance payments and employment contracts for seven employees. Six employees have continued to work for the Company after the April 30, 2003, employment contract ending date. It is management’s intention that the Company may continue to own and invest in commercial real

9

PACIFIC SECURITY COMPANIES, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Financial condition and liquidity (continued):

estate upon completion of the restructuring, at which time management intends to evaluate the opportunities to continue financing commercial real estate in light of market conditions and available capital.

The Company’s management is continuously evaluating loans for collectibility. Additional provisions for loan losses may be required as the Company analyzes each loan during its efforts to reduce outstanding loans receivable. Litigation may be required in the course of collection. In addition, the Company’s position relative to bankruptcy filings by borrowers must be assessed.

The borrower on a Park City, Utah, loan filed for bankruptcy protection on May 1, 2002. The Company’s principal portion of this loan totaled $1,250,000 and is expected to be recovered through the sale of the foreclosed property, approximately 27 acres of land, that was acquired through a trustee’s sale after the bankruptcy stay was lifted in December 2002. The Company has a sale pending for approximately half of the property expected to close in June 2004 and the remaining balance in 2005.

The Company completed foreclosure proceedings on three Eagle, Idaho, loans totaling approximately $2,460,000 and obtained title to approximately 25 acres of land in June 2003. The Company sold approximately 75% of this property in April 2004 for $1,230,798 at a loss of approximately $246,000 and expects to sell the remaining portion at net cost of approximately $1 million in June 2004.

The Company has provided an allowance for loan loss of $140,000 on a Kirkland, Washington, loan of approximately $140,000. The borrower was forced into involuntary bankruptcy by unsecured creditors. A trustee’s sale of the property scheduled for May 9, 2003, was postponed. The Company assessed its potential for recovery and provided $40,000 to the allowance for loan loss in the quarter ended January 31, 2004.

The borrower on two loans totaling approximately $995,000 filed for bankruptcy in March 2003. The loans were collateralized by a note and second deed of trust on seven lots, including one partially finished house and eleven acres of land in Oakland Hills, California, and a note and first deed of trust on one lot. The Company acquired one lot valued at $400,000 at a Trustees sale on January 28, 2004, and wrote off the remaining $595,000 balance during the quarter ending January 31, 2004. The Company is currently assessing its potential for recovery and made no additional provision for loss in the quarter ended April 30, 2004.

Results of operations (three months):

The Company’s net loss for the quarter ended April 30, 2004, was approximately $1,322,000 compared with a net loss of approximately $658,000 for the quarter ended April 30, 2003. The change was primarily attributable to a provision for impaired assets of $1,438,000, a reduction of $45,000 in net interest income, a $66,000 increase in pre-tax loss on sales of real estate, an increase of $8,000 in general and administrative expense, and a decrease of $15,000 in net rental income, offset by a decrease of $318,000 in contract discount expense, a decrease of $249,000 in salaries and commission, and an increase of $342,000 in income tax benefit in the quarter ended April 30, 2004, compared with the similar period in 2003.

10

PACIFIC SECURITY COMPANIES, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Results of operations (three months) (continued):

Rental revenue decreased by approximately $82,000 (23%) to approximately $272,000 in the quarter ended April 30, 2004, from approximately $354,000 in 2003. This decrease primarily resulted from reduced rents from properties sold during the year.

Rental property expenses were approximately $68,000 (18%) lower in 2004 than for the comparable three months in 2003. This decrease was due to decreased operating expense of $37,000 (19%) decreased interest expense of $4,000 (6%) and decreased depreciation of $26,000 (23%).

Salaries and commissions were approximately $249,000 (68%) lower for the quarter ended April 30, 2004, than the comparable three months in 2003 due to one-time payments of approximately $231,000 in 2003, made under employment contracts to employees as part of restructuring charges.

Interest income, including loan fees, decreased approximately $148,000 (52%) for the three months ended April 30, 2004, compared with the similar period in 2003 as the balance of contracts and loans receivable decreased during the period. Loan fees declined approximately $48,000 (79%) to $13,000 from $61,000 because of a lack of new loan originations.

Interest expense, exclusive of interest on debt associated with rental properties, net of amounts capitalized, decreased approximately $103,000 (33%) in the third quarter of 2004 compared with the same 2003 period primarily due to a reduction in interest-bearing debt.

General and administrative expense increased approximately $8,000 (10%) for the three months ended April 30, 2004, compared with the same period in 2003, primarily because of various costs associated with restructuring.

The contract discount of $318,000 was provided to a borrower to induce the payoff of a $3,181,000 contract receivable in 2003.

A provision for impaired asset losses was provided in 2004 for three rental properties, two of which were expected to be sold in June 2004.

The Company’s effective income tax rate as a percentage of income (loss) before federal income tax was approximately 34% in 2004 and 2003.

Results of operations (nine months):

The Company’s net loss for the nine months ended April 30, 2004, was approximately $1,838,000 compared with net loss of approximately $1,727,000 for the nine months ended April 30, 2003. The increase was primarily attributable to a $1,438,000 provision for impaired assets in 2004, and a decrease of approximately $311,000 in net interest income offset by approximately $376,000 in pre-tax increase in gain on sales of real estate in 2004 compared to 2003, a decrease of $318,000 in contract discount expense, a decrease of $193,000 in the provision for loan losses, a decrease of $551,000 in salaries and commissions, and a decrease of $268,000 in general and administrative expenses.

Rental revenue decreased approximately $168,000 (16%) in the nine months ended April 30, 2004, compared to the nine months ended April 30, 2003. This primarily resulted from decreased rents due to sales of rental properties, including an office building in December 2003.

11

PACIFIC SECURITY COMPANIES, INC.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Results of operations (nine months) (continued):

Rental property expense was approximately $48,000 (4%) lower in 2004 than for the comparable nine months in 2002. This resulted from increased operating expense of approximately $27,000 (5%), offset by decreased interest expense of $21,000 (9%), and a decrease in depreciation of $55,000 (15%). The increased operating expense was primarily due to the expensing of approximately $70,000 in prepaid lease fees upon the sale of the Pier 1 building in December 2003.

Interest income, including loan fees, was approximately $823,000 (68%) less for the nine months ended April 30, 2004, compared with the similar period in 2003 as interest earned on the average outstanding balance in contracts and notes receivable decreased during the period. Loan fees declined approximately $176,000 (90%) primarily due to a lack of new loans originated by the Company.

Interest expense, exclusive of interest on debt associated with rental properties, net of amounts capitalized, was approximately $512,000 (43%) less in 2004 than in 2003 primarily due to a reduction in outstanding debt.

Salaries and commissions were approximately $551,000 (62%) lower in the nine months ended April 30, 2004, than for the comparable nine months in 2003, primarily because one-time restructuring expenses for severance payments and employment contracts for certain employees were incurred in 2003 and the costs saved by reducing personnel are reflected in 2004.

General and administrative expense decreased approximately $268,000 (46%) in the nine months ended April 30, 2004, compared with the similar period in 2003 primarily because of decreases in legal fees and real estate taxes.

The contract discount of $318,066 was provided to a borrower to induce the payoff of a $3,181,000 contract receivable in 2003.

The provision for loan loss was approximately $193,000 (35%) less in 2004 than 2003 as the Company continued to pursue legal remedies (including foreclosure actions) to collect outstanding receivables.

The Company’s effective income tax rate as a percentage of income before federal income tax was approximately 34% in 2004 and 2003 resulting in a tax benefit of approximately $947,000 in 2004 compared with a tax benefit of approximately $890,000 in 2003.

12

PACIFIC SECURITY COMPANIES, INC.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET

RISK

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company does not believe that there has been a material change in its market risk since the end of its last fiscal year.

Item 4. Controls and Procedures

(a)

Evaluation of disclosure controls and procedures.

The Company’s principal executive officer and principal financial officer have evaluated the Company’s disclosure controls and procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934) as of a date within 90 days of the filing date of this quarterly report on Form 10-Q. Based on that evaluation, these officers concluded that the design and operation of the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

Part II. Other Information

Item 1. Legal Proceedings

The Company was not engaged in any legal proceeding of a material nature at April 30, 2004. From time to time, the Company is a party to legal proceedings in the ordinary course of business wherein it enforces its security interest in loans.

Item 2. Changes in Securities and Use of Proceeds

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable.

13

PACIFIC SECURITY COMPANIES, INC.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET

RISK

Item 5. Other Information

Not applicable.

Item 6. Exhibits and Reports on Form 8-K

(a)

Exhibits

Exhibit 31.1 CEO Certification required under Section 302 of

Sarbanes-Oxley Act of 2002

Exhibit 31.2 CFO Certification required under Section 302 of

Sarbanes-Oxley Act of 2002

Exhibit 32.1 CEO Certifications required under Section 906 of

Sarbanes-Oxley Act of 2002

Exhibit 32.2 CFO Certifications required under Section 906 of

Sarbanes-Oxley Act of 2002

(b)

Reports on Form 8-K

None

14

PACIFIC SECURITY COMPANIES, INC.

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:

Pacific Security Companies, Inc.

15