10-Q 1 pacificsecurity-10q.txt QUARTERLY REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------------- FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended April 30, 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 0-6673 PACIFIC SECURITY FINANCIAL, INC. -------------------------------- (Exact name of registrant as specified in its charter) Washington 91-0669906 ------------------------------- ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 10 North Post Street 325 Peyton Building Spokane, Washington 99201 (509) 444-7700 -------------------------------------- ------------------------------ (Address of principal executive offices) (Registrant's telephone number, including area code) 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. [X] Yes [ ] No PACIFIC SECURITY FINANCIAL, INC. FORM 10-Q QUARTERLY REPORT Table of Contents ---------------------- CONSOLIDATED FINANCIAL STATEMENTS Consolidated balance sheet 1-2 Consolidated statement of operations 3 Consolidated statement of comprehensive income (loss) 4 Consolidated statement of cash flows 5-7 Notes to unaudited financial statements 8-9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Financial condition and liquidity 10 Results of operations 12-13 ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK 14 ITEM 5. OTHER INFORMATION 14 SIGNATURES 15

~~January~~PACIFIC 31SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET ------------------------------------------------------------------------------------------------- ASSETS April 30, July 31, 2002 2001 ----------- ----------- ASSETS Cash and cash equivalents Unrestricted $ ~~255~~185,~~522~~229 $ 619,642 Restricted -- 19,480 ----------- ----------- ~~255~~185,~~522~~229 639,122 ----------- ----------- Receivables Contracts, mortgages, finance notes, and loans receivable, net Related parties ~~178~~172,~~007~~137 186,846 Unrelated 3130,~~182~~379,~~665~~430 25,580,270 ----------- ----------- 3130,~~360~~551,~~672~~567 25,767,116 Accrued interest ~~245~~213,~~008~~258 282,616 Other 4349,~~602~~251 121,319 ----------- ----------- 3130,~~649~~814,~~282~~076 26,171,051 ----------- ----------- Investment in rental properties, net 1312,~~165~~554,~~536~~691 17,990,836 ----------- ----------- Other investments Property held for sale and development 3,~~305~~291,~~656~~027 3,635,184 ----------- ----------- Other assets Vehicles and equipment, net 7570,~~437~~932 62,732 Prepaid and other, net ~~186~~163,~~766~~610 251,053 Taxes -- 4,681 ----------- ----------- ~~262~~234,~~203~~542 318,466 ----------- ----------- TOTAL ASSETS $4847,~~638~~079,~~199~~565 $48,754,659 =========== =========== 1 -------------------------------------------------------------------------------------------------

~~January~~PACIFIC 31SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET ------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY April 30, July 31, 2002 2001 ----------- ----------- LIABILITIES Notes payable to banks $22,~~448~~215,~~318~~845 $23,487,255 Installment contracts, mortgage notes, and notes payable Related parties 6446,~~205~~391 85,898 Unrelated 65,~~016~~265,~~498~~010 5,971,044 Debenture bonds 910,~~947~~015,~~726~~026 10,166,644 Accrued expenses and other liabilities Related parties ~~131~~169,~~124~~157 153,078 Unrelated ~~646~~728,~~674~~735 782,798 Income taxes 319 -- Deferred income taxes 1773,~~021,801~~456 604,870 ----------- ----------- 4039,~~276~~213,~~665~~939 41,251,587 ----------- ----------- COMMITMENTS AND CONTINGENCIES (Note 2) STOCKHOLDERS' EQUITY Preferred stock Class A preferred stock, $100 par value, authorized 20,000 shares; issued and outstanding 3,000 shares 300,000 300,000 Preferred stock, authorized 10,000,000 no par value shares; no shares issued and outstanding -- -- Common stock Original class, authorized 2,500,000 no par value shares; $3 stated value; issued and outstanding, 1,~~104~~085,~~116~~092 and 1,110,385 shares 3,~~311~~255,~~886~~275 3,331,154 Class B, authorized 30,000 no par value shares; no shares issued and outstanding -- -- Additional paid-in capital 1,830,941 1,830,941 Retained earnings 2,~~918~~476,~~707~~410 2,040,977 ----------- ----------- Total stockholders' equity 87,~~361~~862,~~534~~626 7,503,072 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $4847,~~638~~076,~~199~~565 $48,754,659 =========== =========== See accompanying notes. 2 -------------------------------------------------------------------------------------------------

PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS ---------------------------------------------------------------------------------------------------------------------- Three Months Ended ~~January~~April 3130, ~~Six~~Nine Months Ended ~~January~~April 3130, ------------------------------- ------------------------------ 2002 2001 2002 2001 ----------- -----------~~------~~ ----------- -----------~~-----~~ Income Rental $ ~~334~~307,~~941~~407 $ ~~661~~678,~~259~~438 $ ~~927~~1,~~406~~234,813 $ 12,~~352~~030,~~174~~612 Interest, including loan fees of $~~244~~140,~~777~~726 and $~~277~~298,~~285~~017 and $~~521~~661,~~051~~777 and $~~485~~783,~~481~~498 ~~814~~680,~~993~~397 1,~~073~~070,~~726~~988 12,~~751~~431,~~188~~585 12,~~909~~980,~~989~~977 Gain (loss) on sale of real estate (~~155~~75,~~769~~238) ~~(6,793)~~-- 1,~~989~~914,~~818~~580 (6,793) Other, net 24,~~259~~871 106,~~506~~480 1116,~~257~~128 1926,~~918~~398 ----------- ----------- ----------- ----------- ~~996~~917,~~424~~437 1,~~738~~755,~~698~~906 45,~~679~~597,~~669~~106 35,~~275~~031,~~288~~194 ----------- ----------- ----------- ----------- Expense Rental operations Depreciation and amortization ~~127~~116,~~823~~273 ~~194~~196,~~968~~082 ~~302~~418,~~234~~507 ~~389~~585,~~745~~827 Interest ~~117~~93,~~753~~507 ~~143~~137,~~234~~866 ~~238~~331,~~419~~926 ~~293~~431,~~316~~182 Other ~~168~~151,~~127~~064 ~~259~~264,~~696~~698 ~~403~~554,~~620~~684 ~~518~~783,~~753~~451 ----------- ----------- ----------- ----------- ~~413~~360,~~703~~844 ~~597~~598,~~898~~646 ~~944~~1,~~273~~305,117 1,~~201~~800,~~814~~460 Interest, net of amount capitalized ~~496~~481,~~809~~373 ~~695~~716,~~141~~483 1,~~039~~520,~~166~~539 1,~~272~~988,~~414~~897 Salaries and commissions ~~225~~215,~~306~~475 ~~236~~243,~~781~~537 ~~623~~838,~~230~~705 ~~450~~694,~~545~~082 General and administrative ~~137~~167,~~427~~236 ~~131~~119,~~668~~553 ~~313~~480,~~058~~294 ~~314~~433,~~200~~753 Depreciation and amortization 11,~~473~~998 10,~~774~~950 2335,~~075~~073 2132,~~299~~249 Provision for loan loss 82351,~~207~~152 --20,000 ~~379~~730,~~207~~359 --20,000 ----------- ----------- ----------- ----------- 1,~~366~~588,~~925~~078 1,~~672~~709,~~262~~169 34,~~322~~910,~~009~~087 34,~~260~~969,~~272~~441 ----------- ----------- ----------- ----------- Income (loss) before income tax (benefit) provision (~~370~~670,~~501~~641) 6646,~~436~~737 1687,~~357,660~~019 1561,~~016~~753 Income tax (benefit) provision (~~125~~228,~~644~~345) 2215,~~589~~890 ~~461~~233,~~931~~586 520,~~106~~996 ----------- ----------- ----------- ----------- NET INCOME (LOSS) $ (~~244~~442,~~857~~296) $ 4330,847 $ ~~895~~453,~~729~~433 $ 940,~~910~~757 =========== =========== =========== =========== Net income per common share basis and diluted $ (0.2240) $ 0.0403 $ 0.8141 $ 0.0104 =========== =========== =========== =========== Weighted-average common shares outstanding basic and diluted 1,~~104~~100,~~096~~791 1,~~135~~125,~~812~~047 1,~~105~~103,~~336~~821 1,~~136~~132,~~953~~984 =========== =========== =========== =========== 3 ----------------------------------------------------------------------------------------------------------------------

~~Three~~PACIFIC ~~Months~~SECURITY ~~Ended~~FINANCIAL, ~~January~~INC. ~~31,~~AND ~~Six~~SUBSIDIARIES ~~Months~~CONSOLIDATED ~~Ended~~STATEMENT ~~January~~OF ~~31,~~COMPREHENSIVE INCOME (LOSS) ---------------------------- ------------------------------------------------------------------------------------------- ~~2002~~Three ~~2001~~Months ~~2002~~Ended ~~2001~~April 30, Nine Months Ended April 30, ----------------------------- ------------------------------ 2002 2001 2002 2001 --------- --------- --------- --------- Net income (loss) $ (~~244~~442,~~857~~296) $ 4330,847 $ ~~895~~453,~~729~~433 $ 940,~~910~~757 ----------- ----------- ----------- ----------- Other comprehensive income (loss) before income taxes (~~244~~442,~~857~~296) 4330,847 ~~895~~453,~~729~~433 940,~~910~~757 ----------- ----------- ----------- ----------- COMPREHENSIVE INCOME (LOSS) $ (~~244~~442,~~857~~296) $ 4330,847 $ ~~895~~453,~~729~~433 $ 940,~~910~~757 =========== =========== =========== =========== See accompanying notes. 4 -----------------------------------------------------------------------------------------------------------------------

~~Six~~PACIFIC ~~Months~~SECURITY ~~Ended~~FINANCIAL, ~~January~~INC. ~~31,~~AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS --------------------------------------------------------------------------------------------------- ~~2002~~Nine ~~2001~~Months Ended April 30, ---------------------------- 2002 2001 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES Cash received from rentals and other $ 1,~~079~~396,~~101~~636 $ 12,~~330~~030,~~765~~501 Interest received 12,~~788~~500,~~796~~942 12,~~837~~941,~~353~~088 Cash paid to suppliers and employees (1,~~395~~799,~~701~~681) (1,~~311~~952,~~716~~331) Interest paid, net of amounts capitalized (1,~~065~~533,~~574~~176) (1,~~224~~934,~~029~~968) Income taxes paid (4060,000) (~~270~~295,000) ------------ ------------ Net cash provided ~~(used)~~ by operating activities ~~366~~504,~~622~~721 ~~362~~789,~~373~~290 ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sales of securities -- 41,724 Proceeds from sales of real estate and fixed assets ~~520~~1,~~216~~295,952 61,437 Collections on contracts, mortgages, finance notes, and loans receivable 811,~~784~~818,~~851~~670 48,~~792~~640,~~010~~949 Investment in contracts, mortgages, notes, and loans receivable (810,~~018~~652,~~334~~280) (1116,~~979~~953,~~423~~451) Additions to rental properties, property held for sale, property under development, vehicles, and equipment (~~439~~724,~~816~~751) (~~997~~1,~~970~~568,550) Change in restricted investments and cash equivalents (19,480) ~~(369)~~771 ------------ ------------ Net cash provided (used) by investing activities ~~827~~1,~~437~~718,111 (89,~~082~~777,~~591~~120) ------------ ------------ 5 ---------------------------------------------------------------------------------------------------

~~Six~~PACIFIC ~~Months~~SECURITY ~~Ended~~FINANCIAL, ~~January~~INC. ~~31,~~AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS ---------------------------------------------------------------------------------------------------- ~~2002~~Nine ~~2001~~Months Ended April 30, -------------------------- 2002 2001 ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Net borrowings under line of credit agreements $(1,~~043~~271,~~870~~410) $ 89,~~040~~048,~~720~~590 Proceeds from installment contracts, mortgage notes, and notes payable 200,000 ~~910~~1,~~013~~277,214 Payments on installment contracts, mortgage notes, and notes payable (~~176~~947,~~239~~475) (~~910~~955,~~422~~206) Proceeds from sales of debenture bonds 2231,~~800~~009 ~~112~~190,~~447~~470 Redemption of debenture bonds (~~543~~594,~~081~~970) (~~330~~430,~~390~~204) Purchase and retirement of common stock (1975,~~269~~879) (2939,~~340~~457) Payment of dividends on preferred stock (18,000) (18,000) ----------- ----------- Net cash provided (used) by financing activities (12,~~577~~676,~~659~~725) 79,~~775~~073,~~028~~407 ----------- ----------- NET CHANGE IN CASH AND CASH EQUIVALENTS (~~383~~453,~~600~~893) 5485,~~810~~577 Cash and cash equivalents, beginning of year 639,122 442,208 ----------- ----------- Cash and cash equivalents, end of ~~year~~period $ ~~255~~185,~~522~~229 $ ~~497~~527,~~018~~785 ~~===========~~------------ ~~===========~~------------ See accompanying notes. 6 ----------------------------------------------------------------------------------------------------

~~Six~~PACIFIC ~~Months~~SECURITY ~~Ended~~FINANCIAL, ~~January~~INC. ~~31,~~AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS --------------------------------------------------------------------------------------------------- ~~2002~~Nine ~~2001~~Months Ended April 30, -------------------------- 2002 2001 ----------- ----------- RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES Net income $ ~~895~~453,~~730~~433 $ 940,~~910~~757 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization ~~325~~434,~~309~~830 ~~411~~618,~~044~~076 Deferred income tax benefit ~~416~~168,~~931~~586 (41,700) Deferred financing income realized -- (69,~~920~~933) Interest accrued on debenture bonds ~~301~~412,~~363~~343 ~~279~~396,~~079~~897 (Gain) loss on sales of real estate (1,~~989~~914,~~818~~581) 6,793 Provision for loan loss ~~379~~730,~~207~~359 --20,000 Change in assets and liabilities: Accrued interest receivable 3769,~~608~~357 (6529,~~715~~956) Prepaid expenses 5787,~~787~~443 (96,~~346)~~772 Accrued expense (~~139~~19,~~145~~051) 3547,~~038~~803 Income taxes (receivable) payable 5,000 (~~223~~232,~~194~~304) Other, net 8277,~~651~~002 (3233,~~616~~915) ----------- ----------- NET CASH PROVIDED BY OPERATING ACTIVITIES $ ~~372~~504,~~623~~721 $ ~~362~~789,~~373~~290 =========== =========== SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES Company financed sale of property $ 6,679,280 $ -- =========== =========== Property held for sale and development acquired in satisfaction for defaulted loan receivable $ --58,080 $ 1,065,804 =========== =========== Impairment of real estate owned against provision for loan loss $ 60,000 $ -- =========== =========== See accompanying notes. 7 --------------------------------------------------------------------------------------------------

PACIFIC SECURITY FINANCIAL, INC. NOTES TO UNAUDITED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- Note 1 - Basis of Presentation The consolidated financial statements include the accounts of Pacific Security Financial, 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, 2001, filed with the Securities and Exchange Commission. The results of operations for the nine months ended April 30, 2002, are not necessarily indicative of the results to be expected for the full year. Note 2 - Business Segment Reporting Information about the Company's separate continuing business segments as of and for the nine months ended April 30, 2002 and 2001, is as follows:

Real Estate, Commercial Rental, and Lending Receivables Operations Operations Total ------------ ------------- ------------~~-----------------------~~ 2002 Revenue $ 12,~~494~~007,~~316~~034 $ 3,~~185~~590,~~353~~072 $ 45,~~679~~597,~~669~~106 Income from operations ~~306~~44,~~390~~114 1642,~~051,270~~905 1687,~~357,660~~019 Identifiable assets, net 22,~~113~~433,~~353~~863 2624,~~524~~645,~~846~~702 4847,~~638~~079,~~199~~565 Depreciation and amortization 23,~~485~~727 ~~322~~328,~~824~~199 ~~325~~331,~~309~~926 Capital expenditures 40,414 ~~399~~684,~~402~~337 ~~439~~724,~~816~~751 2001 Revenue $ 12,~~712~~697,~~934~~467 $ 12,~~562~~333,~~354~~727 $ 35,~~275~~031,~~288~~194 Income (loss) from operations ~~544~~before taxes 823,~~495~~104 (~~529~~761,~~479~~351) 1561,~~016~~753 Identifiable assets, net 2324,~~308~~220,~~591~~718 2425,~~941~~480,~~965~~537 4849,~~250~~701,~~556~~255 Depreciation and amortization 12,~~376~~467 ~~409~~615,~~668~~609 ~~411~~618,~~044~~076 Capital expenditures 1020,~~655~~449 ~~987~~1,~~315~~548,101 ~~997~~1,~~970~~568,550

8 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, INC. 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. 9 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, 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, 2002, the Company had total stockholders' equity of approximately $7,863,000 and a total liabilities to equity ratio of 4.99 to 1, which decreased from 5.50 to 1 at July 31, 2001. During the nine months ended April 30, 2002, the Company's primary sources of funds were approximately $11,819,000 in real estate contract and loan collections, $96,000 in net proceeds from the sales of real estate, and approximately $505,000 from operating activities. The primary uses of funds were approximately $10,652,000 for investments in contracts and loans receivable, approximately $2,583,000 for net debt reduction, and $725,000 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 who has capped the amount of debentures the Company may sell or by the individual banks through debt to equity ratio covenants included in the lines of credit loan agreements. An additional source of liquidity is the issuance of participation interests in certain loans originated by the Company. The total of these non-recourse participations was $3,268,000 at April 30, 2002, and $6,686,000 at July 31, 2001. At April 30, 2002, the Company's lines of credit and other banking agreements totaled approximately $25,164,000 of which $22,215,845 was outstanding. The remaining unused portions of the lines of credit may not be fully available to the Company to meet operational needs because of a 5 to 1 debt to equity ratio covenant by one of the Company's banks. A second bank has also negotiated a reduction in total line availability from $13.25 million to $11 million effective July 1, 2002. Due to the restrictive banking agreements, the Company has essentially stopped making new loans and has concentrated on collection efforts to pay down outstanding debt. These collection efforts include foreclosure proceedings on several loans. The Company anticipates 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'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 two borrowers subsequent to April 30, 2002, must be assessed. A provision for loan loss of $245,000 was made on a Bellevue, Washington, loan of approximately $700,000. The Bellevue loan borrower filed for bankruptcy protection on June 6, 2002. The Company is currently assessing its potential for recovery. 10 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- 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. Several properties securing commercial loans to a single borrower or entities controlled by that borrower in Boise, Idaho, were in the process of foreclosure on April 30, 2002. Subsequent to that date, the Company obtained title to properties collateralizing or cross-collateralizing the loans. Management has provided for estimated losses on these loans by increasing its loan loss allowance by $106,152 to $392,720 against four loans totaling approximately $2,353,000 in principal balances. Two of the Company's executives made a loan secured by a second mortgage in 2001, behind the first position mortgage of the Company, and ahead of a cross-collateralized third position mortgage held by the Company. The second mortgage was paid off in May 2002, putting the Company in a first and second position. The Company is currently in foreclosure proceedings on its loans. As a result of a slowdown in economic activity since September 11, 2001, the Company anticipates sales of its real estate, including foreclosed properties, may involve delays and possible losses. The $700,000 sale of an office building in February 2002 to the Company's president resulted in a reduction of approximately $697,000 in related debt and a loss on sale of real estate of approximately $61,000. It was management's opinion that the purchase price represented fair market value. Legal counsel was advised prior to the transaction and a favorable opinion was obtained. 11 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- Results of operations (three months): The Company's net loss for the quarter ended April 30, 2002, was approximately $442,000 compared with net income of approximately $31,000 for the quarter ended April 30, 2001. The change was primarily attributable to a $75,000 pre-tax loss on sales of real estate in the quarter ended April 30, 2002, an increase of $331,000 in the provision for loan losses, a reduction of $155,000 in net interest income, and a reduction of $133,000 in net rental income. Rental income decreased by approximately $371,000 (54.7%) to approximately $307,000 in the quarter ended April 30, 2002, from approximately $678,000 in 2001. This decrease primarily resulted from reduced rents from properties sold during the year and increased vacancies. Rental property expenses were approximately $238,000 (39.7%) lower in 2002 than for the comparable three months in 2001. This decrease was due to decreased depreciation expense of $79,809 (40.7%), decreased operating expense of $113,634 (42.9%), and decreased interest of $44,359 (32.2%). Salaries and commissions were approximately $28,000 (11.5%) lower for the quarter ended April 30, 2002, than the comparable three months in 2001 due to lower commissions paid or accrued in 2002. Interest income and amortized discount decreased approximately $391,000 (36.5%) for the three months ended April 30, 2002, compared with the similar period in 2001 as the variable interest rate on contracts and loans receivable decreased during the period and interest on some past due loans went to nonaccrual status. General and administrative expense increased approximately $48,000 (39.9%) for the three months ended April 30, 2002, compared with the same period in 2001, primarily because of legal expense for various matters and loan fee expense increases. Interest expense, exclusive of interest on debt associated with rental properties, net of amounts capitalized, decreased approximately $235,000 (32.8%) in the first quarter of 2002 compared with the same period in 2001 primarily due to the decrease in the rate of interest charged on bank borrowings tied to prime. The Company's effective income tax rate as a percentage of income (loss) before federal income tax was approximately 34% in 2002 and 2001. Results of operations (nine months): The Company's net income for the nine months ended April 30, 2002, was approximately $453,000 compared with net income of approximately $41,000 for the nine months ended April 30, 2001. The increase was primarily attributable to approximately $1,915,000 in gain on sales of real estate in 2002 compared to a loss of $7,000 in 2001, which was partially offset by a decrease of $300,000 in net rental income and increase of $710,000 in the provision for loan losses. 12 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- Rental income decreased approximately $796,000 (39.2%) in the nine months ended April 30, 2002, from 2001. This primarily resulted from decreased rents due to sales of rental properties, including an apartment complex and an office building in October 2001, a commercial building in January 2002, and an office building in February 2002. Rental property expense was approximately $495,000 (27.5%) lower in 2002 than for the comparable nine months in 2001. This resulted from decreased operating expense of $228,767 (29.2%), decreased interest expense of $99,256 (23.0%), and a decrease in depreciation of $167,320 (28.6%). Interest income and amortized discount was approximately $549,000 (18.4%) less for the nine months ended April 30, 2002, compared with the similar period in 2001 as interest earned on the average outstanding balance in contracts and notes receivable decreased during the period, primarily due to lower interest rates and fewer new loans originated by Cornerstone Realty Advisors. Salaries and commissions were approximately $144,000 (20.8%) higher in the nine months ended April 30, 2002, than for the comparable nine months in 2001, primarily because of bonuses paid to Company officers in the current fiscal year. Interest expense, exclusive of interest on debt associated with rental properties, net of amounts capitalized, was approximately $468,000 (23.5%) less in 2002 than in 2001 primarily due to a decrease in interest rates on borrowings tied to bank prime rates. The Company's effective income tax rate as a percentage of income before federal income tax was approximately 34% in 2002 and 2001. 13 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, INC. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK -------------------------------------------------------------------------------- Item 3. Qualitative and Quantitative 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. Part II. Other Information Items 1, 2, 3, 4, and 6 - Not applicable Item 5. Other Information At a special meeting of the Board of Directors on March 7, 2002, David L. Guthrie was elected Chairman of the Board, replacing Wayne E. Guthrie who retained the title Chairman of the Board Emeritus. 14 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, 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 Financial, Inc. /s/ David L. Guthrie ----------------------------------- David L. Guthrie President/Chief Executive Officer June 13, 2002 /s/ Donald J. Migliuri ----------------------------------- Donald J. Migliuri Secretary-Treasurer June 13, 2002 15 --------------------------------------------------------------------------------

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