10-Q 1 pacific10q.txt QUARTERLY REPORT PERIOD ENDED APRIL 30, 2003 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, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to _______________ Commission file number 0-6673 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 Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). [ ] Yes [ X ] No 1,080,615 shares of common stock, par value $3.00 per share, were outstanding on June 6, 2003. PACIFIC SECURITY FINANCIAL, INC. FORM 10-Q QUARTERLY REPORT Table of Contents ----------------- PART I. FINANCIAL INFORMATION Item 1. Consolidated Financial Statements (Unaudited) 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 8-11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Financial condition and liquidity 12-13 Results of operations 14-16 Item 3. Quantitative and Qualitative Disclosures About Market Risk 17 Item 4. Controls and Procedures 17 part ii. Other information Item 1. Legal Proceedings 17 Item 2. Changes in Securities and Use of Proceeds 17 Item 3. Defaults Upon Senior Securities 17 Item 4. Submission of Matters to a Vote of Security Holders 17 Item 5. Other Information 18 Item 6. Exhibits and Reports on Form 8-K 18 Signatures 19 Certifications 20-24 PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET --------------------------------------------------------------------------------

~~PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET -------------------------------------------------------------------------------------------------~~ ASSETS April 30, July 31, 2003 2002 ~~2001~~(Unaudited) (Audited) ------------ ------------ ASSETS Cash and cash equivalents ~~Unrestricted~~ $ ~~185~~944,~~229~~793 $ ~~619~~367,~~642~~469 ~~Restricted~~ -- ~~19,480~~ ----------- ----------- ~~185,229 639,122~~ -~~----------~~ ~~-----------~~ Receivables Contracts, mortgages, finance notes, and loans receivable, net Related parties ~~172,137~~-- ~~186~~166,~~846~~182 Unrelated 3012,~~379~~168,~~430~~927 25,~~580~~871,~~270~~569 Less allowance for loan losses (1,054,593) (585,855) ------------ ------------ 3011,~~551~~114,~~567~~334 25,~~767~~451,~~116~~896 Accrued interest ~~213~~55,~~258~~752 ~~282~~208,~~616~~612 Other 49233,~~251~~295 ~~121~~251,~~319~~639 ------------ ------------ 3011,~~814~~403,~~076~~381 2625,~~171~~912,~~051~~147 ------------ ------------ Investment in rental properties, net 1211,~~554~~322,~~691~~650 1712,~~990~~811,~~836~~852 ------------ ------------ Other investments Property held for sale and development 3,~~291~~046,~~027~~066 34,~~635~~399,~~184~~921 ------------ ------------ Other assets Vehicles and equipment, net 7081,~~932~~842 6278,~~732~~553 Prepaid and other, net ~~163~~178,~~610~~285 ~~251~~234,~~053~~410 ~~Taxes~~Federal income tax refund receivable -- 4647,~~681~~273 ------------ ------------ ~~234~~260,~~542~~127 ~~318~~960,~~466~~236 ------------ ------------ TOTAL ASSETS $47 26,~~079~~977,~~565~~017 $48 44,~~754~~451,~~659~~625 ============ =========== ~~1 -------------------------------------------------------------------------------------------------~~=

See accompanying notes. 1 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET --------------------------------------------------------------------------------

~~PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET -------------------------------------------------------------------------------------------------~~ LIABILITIES AND STOCKHOLDERS' EQUITY April 30, July 31, 2003 2002 ~~2001~~(Unaudited) (Audited) ----------- ----------- LIABILITIES Notes payable to banks $22 5,~~215~~550,~~845~~226 $2316,~~487~~438,~~255~~964 Installment contracts, mortgage notes, and notes payable Related parties ~~46,391~~-- 8528,~~898~~158 Unrelated 56,~~265~~410,~~010~~914 58,~~971~~636,~~044~~785 Debenture bonds 108,~~015~~633,~~026~~962 109,~~166~~996,~~644~~954 Accrued expenses and other liabilities Related parties ~~169~~114,~~157~~725 ~~153~~144,~~078~~928 Unrelated ~~728~~600,~~735~~328 ~~782~~896,~~798~~541 ~~Income taxes 319 --~~ Deferred income taxes ~~773~~191,~~456~~191 ~~604~~1,~~870~~096,699 ----------- ----------- 3921,~~213~~501,~~939~~346 4137,~~251~~239,~~587~~029 ----------- ----------- ~~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,~~085~~081,~~092~~027 and 1,~~110~~084,~~385~~289 shares 3,~~255~~243,~~275~~081 3,~~331~~252,~~154~~866 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 2101,~~476,410~~649 21,~~040~~828,~~977~~789 ----------- ----------- Total stockholders' equity 75,~~862~~475,~~626~~671 7,~~503~~212,~~072~~596 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $4726,~~076~~977,~~565~~017 $4844,~~754~~451,~~659~~625 =========== =========== ~~See accompanying notes. 2 -------------------------------------------------------------------------------------------------~~

See accompanying notes. 2 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS --------------------------------------------------------------------------------

PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS ---------------------------------------------------------------------------------------------------------------------- Three Months Ended April 30, Nine Months Ended April 30, ----------------------------~~---~~ ---------------------------~~---~~ 2003 2002 ~~2001~~2003 2002 ~~2001~~ ----------- ----------- ----------- ----------- Income Rental $ ~~307~~354,~~407~~119 $ ~~678~~307,~~438~~407 $ 1,~~234~~062,~~813~~160 $ 21,~~030~~234,~~612~~813 Interest, including loan fees of $60,850 and $140,726 and $~~298~~194,~~017~~967 and $661,777 ~~and $783~~288,~~498~~611 680,397 1,~~070~~213,~~988~~155 2,431,585 ~~2,980,977~~ Gain (loss) on sale of real estate (179,156) (75,238) --(206,126) 1,914,580 ~~(6,793)~~ Other, net 2,905 4,871 622,~~480~~384 16,128 ~~26,398~~ ----------- ----------- ----------- ----------- 466,479 917,437 12,~~755~~091,~~906~~573 5,597,106 ~~5,031,194~~ ----------- ----------- ----------- ----------- Expense Rental operations Depreciation and amortization 115,650 116,273 ~~196~~360,~~082~~053 418,507 ~~585,827~~ Interest 64,377 93,507 ~~137~~236,~~866~~998 331,926 ~~431,182~~ Other 192,016 151,064 ~~264~~524,~~698~~125 554,684 ~~783,451~~ ----------- ----------- ----------- ----------- 372,043 360,844 ~~598~~1,~~646~~121,176 1,305,117 ~~1,800,460~~ Interest, net of amount capitalized 313,654 481,373 ~~716~~1,~~483~~202,388 1,520,539 ~~1,988,897~~ Salaries and commissions 366,656 215,475 ~~243~~895,~~537~~485 838,705 ~~694,082~~ General and administrative 86,634 167,236 ~~119~~581,~~553~~017 480,294 ~~433,753~~ Depreciation and amortization 7,017 11,998 1031,~~950~~448 35,073 32Contract discount 318,~~249~~066 -- 318,066 -- Provision for loan loss -- 351,152 20558,~~000~~872 730,359 ~~20,000~~ ----------- ----------- ----------- ----------- 1,~~588~~464,~~078~~070 1,~~709~~588,~~169~~078 4,~~910~~708,~~087~~452 4,~~969~~910,~~441~~087 ----------- ----------- ----------- ----------- Income (loss) before income tax (benefit) provision (997,591) (670,641) 46(2,~~737~~616,879) 687,019 ~~61,753~~ Income tax (benefit) provision (339,181) (228,345) 15(889,~~890~~739) 233,586 ~~20,996~~ ----------- ----------- ----------- ----------- NET INCOME (LOSS) $(658,410) (442,296) (1,727,140) 453,433 Less preferred stock dividends -- -- (18,000) (18,000) ----------- ----------- ----------- ----------- Income (loss) available to common stockholders $ 30(658,~~847~~410) $ ~~453~~(442,~~433~~296) $(1,745,140) 40$ 435,~~757~~433 =========== =========== =========== =========== Net income (loss) per common share ~~basis~~basic and diluted $ (0.4061) $ (0.0340) $ 0(1.4161) $ 0.0441 =========== =========== =========== =========== Weighted-average common shares outstanding basic and diluted 1,082,216 1,100,791 1,~~125~~083,~~047~~019 1,103,821 ~~1,132,984~~ =========== =========== =========== =========== ~~3 ----------------------------------------------------------------------------------------------------------------------~~

See accompanying notes. 3 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS) --------------------------------------------------------------------------------

PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS) ----------------------------------------------------------------------------------------------------------------------- Three Months Ended April 30, Nine Months Ended April 30, ----------------------------- ---------------------------~~---~~ 2003 2002 ~~2001~~2003 2002 ~~2001~~ ----------- ----------- ----------- ----------- Net income (loss) $ (658,410) $ (442,296) $ 30(1,~~847~~727,140) $ 453,433 ~~$ 40,757 --------- --------- --------- ---------~~ Other comprehensive income (loss) before income taxes ~~(442,296)~~-- ~~30,847~~-- ~~453,433~~-- ~~40,757~~-- ----------- ----------- ----------- ----------- COMPREHENSIVE INCOME (LOSS) $ (658,410) $ (442,296) $ 30(1,~~847~~727,140) $ 453,433 ~~$ 40,757~~ =========== =========== =========== ========= ~~See accompanying notes. 4 -----------------------------------------------------------------------------------------------------------------------~~==

See accompanying notes. 4 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS --------------------------------------------------------------------------------

~~PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS ---------------------------------------------------------------------------------------------------~~ Nine Months Ended April 30, ----------------------------- 2003 2002 ~~2001~~ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES Cash received from rentals and other $ 1,~~396~~148,~~636~~598 $ 21,~~030~~396,~~501~~636 Interest received 21,~~500~~366,~~942~~015 2,~~941~~500,~~088~~942 Cash paid to suppliers and employees (12,~~799~~629,~~681~~678) (1,~~952~~799,~~331~~681) Interest paid, net of amounts capitalized (1,~~533~~099,~~176~~425) (1,~~934~~533,~~968~~176) Income taxes ~~paid~~refunded (~~60,000~~paid) 631,505 (~~295~~60,000) ------------ ------------ Net cash provided (used) by operating activities (582,985) 504,721 ~~789,290~~ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sales of ~~securities -- 41,724 Proceeds from sales of~~ real estate and fixed assets 3,714,314 1,295,952 ~~61,437~~ Collections on contracts, mortgages, finance notes, and loans receivable 15,289,383 11,818,670 ~~8,640,949~~ Investment in contracts, mortgages, notes, and loans receivable (101,~~652~~740,~~280~~821) (1610,~~953~~652,~~451~~280) Additions to rental properties, property held for sale, property under development, vehicles, and equipment (~~724~~1,~~751~~170,692) (1724,~~568,550~~751) Change in restricted investments ~~and~~-- ~~cash equivalents~~ (19,480) ~~771~~ ------------ ------------ Net cash provided ~~(used)~~ by investing activities 16,092,184 1,718,111 ~~(9,777,120)~~ ------------ ------------ ~~5 ---------------------------------------------------------------------------------------------------~~

See accompanying notes. 5 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS --------------------------------------------------------------------------------

~~PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS ----------------------------------------------------------------------------------------------------~~ Nine Months Ended April 30, ----------------------------- 2003 2002 ~~2001~~ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Net borrowings under line of credit agreements $(110,~~271~~888,~~410~~738) $ 9(1,~~048~~271,~~590~~410) Proceeds from installment contracts, mortgage notes, and notes payable -- 200,000 ~~1,277,214~~ Payments on installment contracts, mortgage notes, and notes payable (~~947~~2,~~475~~254,030) (~~955~~947,~~206~~475) Proceeds from sales of debenture bonds -- 31,009 ~~190,470~~ Redemption of debenture bonds (~~594~~1,~~970~~761,322) (~~430~~594,~~204~~970) Purchase and retirement of common stock (759,~~879~~785) (3975,~~457~~879) Payment of dividends on preferred stock (18,000) (18,000) ------------ ------------ Net cash ~~provided (~~used) by financing activities (14,931,875) (2,676,725) ~~9,073,407~~ ------------ ------------ NET CHANGE IN CASH AND CASH EQUIVALENTS 577,324 (453,893) ~~85,577~~ Cash and cash equivalents, beginning of year 367,469 639,122 ~~442,208~~ ------------ ------------ Cash and cash equivalents, end of period $ ~~185~~944,~~229~~793 $ ~~527~~185,~~785~~229 ~~------------~~============ ~~------------ See accompanying notes. 6 ----------------------------------------------------------------------------------------------------~~============

See accompanying notes. 6 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, INC. NOTES TO UNAUDITED FINANCIAL STATEMENTS --------------------------------------------------------------------------------

~~PACIFIC SECURITY FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS ---------------------------------------------------------------------------------------------------~~ Nine Months Ended April 30, --------------------------- 2003 2002 ~~2001~~ ----------- ----------- RECONCILIATION OF NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES Net income $ ~~453~~(1,~~433~~727,140) $ 40453,~~757~~433 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 391,501 434,830 ~~618,076~~ Deferred income tax (benefit) ~~168,586~~expense (41905,~~700~~508) ~~Deferred financing income realized -- (9~~168,~~933)~~586 Interest accrued on debenture bonds 398,330 412,343 ~~396,897~~ (Gain) loss on sales of real estate 206,126 (1,914,581) ~~6,793~~ Provision for loan loss 468,738 730,359 ~~20,000~~ Change in assets and liabilities: Accrued interest receivable 152,860 69,357 ~~(29,956)~~ Prepaid expenses 56,125 87,443 ~~6,772~~ Accrued expense (289,634) (19,051) ~~47,803~~ Income taxes (receivable) ~~payable~~647,273 5,000 ~~(232,304)~~ Other, net 18,344 77,002 ~~(33,915)~~ ----------- ----------- NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES $ ~~504~~(582,~~721~~985) $ ~~789~~504,~~290~~721 =========== =========== SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES Company financed sale of property $ 929,739 $ 6,679,280 ~~$ --~~ =========== =========== Property held for sale and development acquired in satisfaction for defaulted loan receivable $ 581,~~080~~250,000 $ 158,~~065,804~~080 =========== =========== Impairment of real estate owned against provision for loan loss $ -- $ 60,000 ~~$ --~~ =========== =========== ~~See accompanying notes. 7 --------------------------------------------------------------------------------------------------~~

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, 2002, filed with the Securities and Exchange Commission. The results of operations for the nine months ended April 30, 2003, 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. 8 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, INC. NOTES TO UNAUDITED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 1 - BASIS OF PRESENTATION (CONTINUED) 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 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. 9 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, INC. NOTES TO UNAUDITED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- NOTE 2 - BUSINESS SEGMENT REPORTING Information about the Company's separate continuing business segments as of and for the nine months ended April 30, 2003 and 2002, is as follows:

Real Estate, Commercial Rental, and Lending Receivables Operations Operations Total ------------ ------------- ------------ ~~2002~~2003 Revenue $ 2598,~~007,034~~701 $ 31,~~590~~492,~~072~~872 $ 52,~~597~~091,~~106~~573 ~~Income~~Loss from operations, 44before tax (benefit) (1,~~114~~095,552) ~~642~~(1,~~905~~521,327) ~~687~~(2,~~019~~616,879) Identifiable assets, net 228,~~433~~348,~~863~~880 2418,~~645~~628,~~702~~137 4726,~~079~~977,~~565~~017 Depreciation and amortization 3,~~727~~664 ~~328~~387,~~199~~837 ~~331~~391,~~926~~501 Capital expenditures 402,~~414~~382 ~~684~~1,~~337~~168,310 ~~724~~1,~~751~~170,692 ~~2001~~2002 Revenue $ 2,~~697~~007,~~467~~034 $ 23,~~333~~590,~~727~~072 $ 5,~~031~~597,~~194~~106 Income ~~(loss)~~ from operations, before ~~taxes~~tax ~~823~~44,~~104~~114 ~~(761~~642,~~351)~~905 61687,~~753~~019 Identifiable assets, net 2422,~~220~~433,~~718~~863 2524,~~480~~645,~~537~~702 4947,~~701~~079,~~255~~565 Depreciation and amortization 23,~~467~~727 ~~615~~449,~~609~~853 ~~618~~453,~~076~~580 Capital expenditures 2040,~~449~~414 1684,~~548,101~~337 1724,~~568,550~~751

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. 10 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, INC. NOTES TO UNAUDITED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- 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 have a material effect on its financial position or results of operations. NOTE 4 - SUBSEQUENT EVENT Subsequent to April 30, 2003, the Company sold a rental property located in Boise, Idaho, for approximately $1,024,000, resulting in a loss of approximately $218,000. The net book value of this commercial building was approximately $1,204,000. 11 -------------------------------------------------------------------------------- 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, 2003, the Company had total stockholders' equity of approximately $5,476,000 and a total liabilities to equity ratio of 3.93 to 1, which decreased from 5.16 to 1 at July 31, 2002. During the fiscal year-to-date, the Company's primary sources of funds were approximately $15,289,000 in real estate contract and loan collections and $3,714,000 in net proceeds from the sales of real estate. The primary uses of funds were approximately $14,904,000 for net debt reduction, approximately $1,741,000 for investments in contracts and loans receivable, $1,171,000 for property improvements, and $583,000 for operating activities. The Company's sources of liquidity traditionally 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 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 approximately $2,145,000 at April 30, 2003, and $3,495,000 at July 31, 2002. At April 30, 2003, the Company's outstanding banking agreements totaled approximately $5,550,000 with an additional $6,411,000 due for installment contracts, mortgage notes, and notes payable. During the quarter ended April 30, 2003, the Company induced a borrower with a discount of $318,000 (10%) on a contract of approximately $3,181,000 to pay off and provide funds to pay off the Company's bank line on March 3, 2003. The bank continues to work with the Company on a loan that was paid down to $880,000 on March 3, 2003, and that is collateralized by a Company loan to a borrower who filed for bankruptcy. The bank has agreed to extend the loan for a period of six months to September 3, 2003, with interest only paid monthly. After six months the loan will be evaluated based on market and other business conditions. Another financial institution the Company has relied upon as a source of funding for its commercial real estate loans has indicated they are terminating (nationally) all or nearly all, commercial warehouse lines of credit. This financial institution agreed to work with the Company to allow a current loan totaling approximately $1,858,000 to pay off as it matured. The final payoff occurred in May 2003 subsequent to the quarter ended April 30, 2003. Management does not believe that this line of credit can be quickly replaced by another lender. This will materially impact the Company's liquidity and profitability. 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. 12 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- FINANCIAL CONDITION AND LIQUIDITY (CONTINUED): 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 has begun to implement strategies for restructuring, which include liquidating a majority of the Company's assets over the course of the next year. The Company has reduced personnel during the 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 will continue to own and invest in commercial real 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. No additional provision for loan loss was made during the quarter ending April 30, 2003. The allowance for loan loss includes a 100% allowance on a Bellevue, Washington, loan of approximately $669,000. The Bellevue loan borrower filed for bankruptcy protection on June 6, 2002. A judgment has been sought for the balance owed. 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 that was acquired through a trustee's sale after the bankruptcy stay was lifted in December 2002. The Company was stayed in foreclosure proceedings on three Eagle, Idaho loans when the borrower filed for bankruptcy protection on December 19, 2002. A total allowance for loan loss of $269,000 has been provided against loans receivable totaling approximately $2,460,000. A trustee's sale has been scheduled for June 12, 2003, and the Company is negotiating with the borrower and other interested parties. On a Kirkland, Washington, loan of approximately $140,000, the allowance for loan loss is $100,000. 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 is currently assessing its potential for recovery. The borrower on two loans totaling approximately $995,000 filed for bankruptcy in March 2003. The loans are collateralized by eight lots, including one partially finished house and eleven acres of land in Oakland Hills, California. The Company is currently assessing its potential for recovery and has made no provision for loan loss on these loans. 13 -------------------------------------------------------------------------------- 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, 2003, was approximately $658,000 compared with a net loss of approximately $442,000 for the quarter ended April 30, 2002. The change was primarily attributable to a reduction of $224,000 in net interest income, an increase of $318,000 in contract discount expense, an increase of $151,000 in salaries and commission, and a $104,000 increase in pre-tax loss on sales of real estate offset by a decrease of $351,000 in the provision for loan losses, a decrease of $81,000 in general and administrative expense, an increase of $36,000 in net rental income, and an increase of $111,000 in income tax benefit in the quarter ended April 30, 2003, compared with the similar period in 2002. Rental revenue increased by approximately $47,000 (15%) to approximately $354,000 in the quarter ended April 30, 2003, from approximately $307,000 in 2002. This increase primarily resulted from increased rents from new tenants in the Peyton and Pier 1 Buildings offsetting reduced rents from properties sold during the prior year. Rental property expenses were approximately $11,000 (3%) higher in 2003 than for the comparable three months in 2002. This increase was due to increased operating expense of $41,000 (27%) primarily due to new parking garage charges that more than offset decreased interest expense of $29,000 (31%) and decreased depreciation of $1,000 (1%). Salaries and commissions were approximately $151,000 (70%) higher for the quarter ended April 30, 2003, than the comparable three months in 2002 due to one-time payments of approximately $231,000, made under employment contracts to employees as part of restructuring charges. These one-time charges, a portion of which was previously accrued as restructuring charges in general and administrative expense, more than offset the costs saved by reducing personnel during the quarter. Interest income, including loan fees, decreased approximately $392,000 (58%) for the three months ended April 30, 2003, compared with the similar period in 2002 as the variable interest rate on contracts and loans receivable decreased during the period and the total amount of receivables declined. Loan fees declined approximately $80,000 (57%) to $61,000 from $141,000 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 $168,000 (35%) in the third quarter of 2003 compared with the same 2002 period primarily due to a reduction in interest-bearing debt. General and administrative expense decreased approximately $81,000 (48%) for the three months ended April 30, 2003, compared with the same period in 2002, primarily because some previously accrued restructuring charges were reversed and paid as salaries and commissions. The contract discount of $318,000 was provided to a borrower to induce the payoff of a $3,181,000 contract receivable. 14 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- RESULTS OF OPERATIONS (THREE MONTHS) (CONTINUED): No provision for loan loss was made in the quarter ended April 30, 2003, compared with $351,000 provided in the same period in 2002 as management determined the existing allowance was adequate. The Company's effective income tax rate as a percentage of income (loss) before federal income tax was approximately 34.0% in 2003 and 2002. RESULTS OF OPERATIONS (NINE MONTHS): The Company's net loss for the nine months ended April 30, 2003, was approximately $1,727,000 compared with net income of approximately $453,000 for the nine months ended April 30, 2002. The decrease was primarily attributable to approximately $2,121,000 in pre-tax reduction in gain on sales of real estate in 2003 compared to 2002, a decrease of $900,000 in net interest income, an increase of $318,000 in contract discount expense, an increase of $101,000 in general and administrative expenses offset by a decrease of $171,000 in the provision for loan losses. Rental revenue decreased approximately $173,000 (14%) in the nine months ended April 30, 2003, compared to the nine months ended April 30, 2002. This primarily resulted from decreased rents due to sales of rental properties, including an apartment complex and an office building in October 2001. Rental property expense was approximately $184,000 (14%) lower in 2003 than for the comparable nine months in 2002. This resulted from decreased operating expense of approximately $31,000 (6%), decreased interest expense of $95,000 (29%), and a decrease in depreciation of $58,000 (14%). Interest income, including loan fees, was approximately $1,218,000 (50%) less for the nine months ended April 30, 2003, compared with the similar period in 2002 as interest earned on the average outstanding balance in contracts and notes receivable decreased during the period. Loan fees declined approximately $467,000 (70%) 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 $318,000 (21%) less in 2003 than in 2002 primarily due to a reduction in outstanding debt and a decrease in interest rates on borrowings tied to bank prime rates. Salaries and commissions were approximately $57,000 (7%) higher in the nine months ended April 30, 2003, than for the comparable nine months in 2002, primarily because one-time restructuring expenses for severance payments and employment contracts for certain employees were incurred in 2003 and more than offset the costs saved by reducing personnel. 15 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -------------------------------------------------------------------------------- RESULTS OF OPERATIONS (NINE MONTHS) (CONTINUED): General and administrative expense increased approximately $101,000 (21%) in the nine months ended April 30, 2003, compared with the similar period in 2002 primarily because of increases in legal fees and real estate taxes. The contract discount of $318,000 was provided to a borrower to induce the payoff of a $3,181,000 contract receivable. The provision for loan loss was approximately $171,000 (23%) less in 2003 than 2002 as the Company continued to aggressively 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 34.0% in 2003 and 2002 resulting in a tax benefit of approximately $890,000 in 2003 compared with an expense of approximately $234,000 in 2002. 16 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, 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, 2003. 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 Two Directors, Constance Guthrie and Jack Bury (replacing Wayne Guthrie), were elected to the Board of Directors and Moss Adams LLP was approved as the Company's outside independent auditor by a vote of the stockholders at the annual meeting of stockholders on April 29, 2003. 17 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, 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 99.1 -- Certification Pursuant to 18 U.S. C. ss. 1350 (b) Reports on Form 8-K None 18 -------------------------------------------------------------------------------- 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 11, 2003 /s/ Donald J. Migliuri -------------------------------------------------------------------------------- Donald J. Migliuri Secretary-Treasurer June 11, 2003 19 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, INC. CERTIFICATIONS -------------------------------------------------------------------------------- I, David L. Guthrie, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Pacific Security Financial, Inc. (the Company); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this report (the Evaluation Date); and (c) presented in this report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the registrant's Board of Directors: (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize, and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 20 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, INC. CERTIFICATIONS -------------------------------------------------------------------------------- 6. The registrant's other certifying officer and I have indicated in this quarter report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Dated: June 11, 2003 /s/ David L. Guthrie --------------------------- David L. Guthrie, President 21 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, INC. CERTIFICATIONS -------------------------------------------------------------------------------- I, Donald J. Migliuri, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Pacific Security Financial, Inc. (the Company); 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: (a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this report (the Evaluation Date); and (c) presented in this report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the registrant's Board of Directors: (a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize, and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 22 -------------------------------------------------------------------------------- PACIFIC SECURITY FINANCIAL, INC. CERTIFICATIONS -------------------------------------------------------------------------------- 6. The registrant's other certifying officer and I have indicated in this quarter report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Dated: June 11, 2003 /s/ Donald J. Migliuri ----------------------------- Donald J. Migliuri, Treasurer 23 --------------------------------------------------------------------------------

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