<PAGE> 1
Filed Pursuant to Rule 424(b)(4)
PROSPECTUS Registration Statement No. 333-46885
3,330,000 COMMON SHARES
ROCK FINANCIAL CORPORATION LOGO
ROCK FINANCIAL CORPORATION
Of the 3,330,000 common shares, par value $.01 per share (the "Common
Shares"), offered hereby (the "Offering") 3,000,000 shares are being offered by
Rock Financial Corporation ("Rock" or the "Company") and 330,000 shares are
being sold by certain option holders of Rock (the "Selling Shareholders"). See
"Principal and Selling Shareholders." Rock will not receive any of the proceeds
from the sale of shares by the Selling Shareholders, but it will receive
approximately $1.5 million of proceeds from the options exercised by the Selling
Shareholders to acquire the shares they are selling. Simultaneously with the
closing of this Offering, Rock will cease to be taxed as an S corporation under
the Internal Revenue Code. In connection with the termination of its S
corporation status, Rock will pay previously-earned and undistributed taxable
income out of the net proceeds of the Offering to Rock's shareholders existing
immediately before the closing of this Offering. Therefore, over half of the
Offering proceeds will go to insiders of Rock. See "Use of Proceeds."
At the request of the Company, the Underwriters have reserved up to 329,670
Common Shares for sale at the initial public offering price to certain
Directors, officers and employees of the Company, their business associates and
related parties (the "Directed Share Program"). The number of Common Shares
available for sale to the general public will be reduced to the extent such
persons purchase such reserved shares. Any reserved shares which are not so
purchased will be offered by the Underwriters to the general public on the same
basis as the other Common Shares offered hereby.
Prior to the Offering, there has been no public market for the Common
Shares. See "Underwriting" for a discussion of factors considered in determining
the initial public offering price. Rock's Common Shares have been approved for
listing on The Nasdaq National Market under the symbol "RCCK."
------------------------------
SEE "RISK FACTORS" BEGINNING ON PAGE 12 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED IN CONNECTION WITH AN INVESTMENT IN THE COMMON SHARES
OFFERED HEREBY.
------------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
====================================================================================================================
PROCEEDS TO
PRICE TO UNDERWRITING PROCEEDS TO SELLING
PUBLIC DISCOUNT(1) COMPANY(2) SHAREHOLDERS
<S> <C> <C> <C> <C>
- --------------------------------------------------------------------------------------------------------------------
Per Share.............. $10.00 $0.70 $9.30 $9.30
- --------------------------------------------------------------------------------------------------------------------
Total(3)............... $33,300,000 $2,331,000 $27,900,000 $3,069,000
====================================================================================================================
</TABLE>
(1) Rock and the Selling Shareholders have agreed to indemnify the Underwriters
against certain liabilities, including liabilities under the Securities Act
of 1933, as amended. See "Underwriting."
(2) Before deducting estimated expenses of $1,300,000, payable by Rock,
including expenses of the Selling Shareholders. See "Principal and Selling
Shareholders."
(3) Rock has granted the Underwriters a 30-day option to purchase up to 499,500
additional Common Shares, on the same terms and conditions as set forth
above, solely to cover over-allotments, if any. If such option is exercised
in full, the total Price to Public will be $38,295,000, Underwriting
Discount will be $2,680,650, Proceeds to Company will be $32,545,350 and
Proceeds to Selling Shareholders will be $3,069,000. See "Underwriting."
------------------------------
The Common Shares are offered subject to prior sale, when, as and if
delivered to and accepted by the Underwriters, and subject to certain other
conditions. The Underwriters reserve the right to withdraw, cancel or modify
said offer and to reject orders in whole or in part. It is expected that
delivery of the Common Shares will be made on or about May 6, 1998 at the
offices of Bear, Stearns & Co. Inc., 245 Park Avenue, New York, New York 10167.
------------------------------
BEAR, STEARNS & CO. INC.
PRUDENTIAL SECURITIES INCORPORATED
RONEY & CO.
MAY 1, 1998
<PAGE> 2
THE ATTORNEY GENERAL OF THE STATE OF NEW YORK HAS NOT PASSED ON OR ENDORSED
THE MERITS OF THIS OFFERING. ANY REPRESENTATION TO THE CONTRARY IS UNLAWFUL.
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE COMMON SHARES,
INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT-COVERING TRANSACTIONS AND THE
IMPOSITION OF PENALTY BIDS. SEE "UNDERWRITING."
NATIONAL SUPPORT CENTER, BINGHAM FARMS, MICHIGAN
GRACIE THE GROUNDHOG
. . . OFFICIAL MASCOT OF FRESH START(TM)
2
<PAGE> 3
STORES AND BRANCHES:
MICHIGAN
Bingham Farms
Canton
Clinton Township
Detroit
Fenton
Flint
Grand Blanc
Grand Rapids
Hartland
Lansing
Rochester
Saginaw
Southgate
Ypsilanti
OHIO
Brook Park
Maple Heights
Toledo
ILLINOIS
Broadview
Hodgkins
Lansing
Skokie
INDIANA
Indianapolis
MISSOURI
Overland
NEVADA
Las Vegas
TEXAS
Bedford
Dallas
ACTIVE STATES:
Florida
Georgia
Illinois
Indiana
Kentucky
Michigan
Missouri
Nevada
Ohio
South Carolina
Texas
Fresh Start(TM) Loan Center, Hodgkins, Illinois
MAP OF UNITED STATES
SHOWING LOCATION OF STORES AND BRANCHES
<PAGE> 4
Rock Financial, Canton, Michigan
(Conventional Mortgage Lending)
Fresh Start(TM) Loan Center, Toledo, Ohio
<PAGE> 5
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by, and should be read
in conjunction with, the more detailed information and financial statements and
notes to financial statements appearing elsewhere in this Prospectus. Unless the
context indicates otherwise, all references in this Prospectus to "Rock" or the
"Company" refer to Rock Financial Corporation. Except as otherwise specified,
all information in this Prospectus (i) assumes no exercise of the Underwriters'
over-allotment option (see "Underwriting"), and (ii) gives effect to a
1,118.31805-for-one stock split effected January 8, 1997.
THE COMPANY
Rock is a specialty finance company marketing conventional and sub-prime
debt consolidation and home financing loans, secured primarily by first or
second mortgages on one- to four-family, owner-occupied residences. The Company
originates loans through 26 stores and branches, one marketing center and one
call center. "Stores" are Fresh Start(TM) division locations and "branches" are
Conventional Mortgage Lending division locations. Founded in 1985 by its current
Chief Executive Officer and Chairman of the Board, Daniel Gilbert, Rock
originates 100% of its loans through its retail operations, marketing its loans
directly to consumers. The Company uses proprietary marketing methods and
technology to increase its market penetration. Rock seeks to provide "world
class" service to its customers, thereby encouraging them to return for future
loans and refer others to Rock for loans. "World Class" service is Rock's
commitment to provide superior customer service, to be responsive to customer
needs and to make applying for and closing each loan as quick, efficient and
convenient for the customer as possible. The Company also focuses on recruiting,
developing and motivating talented people, recruited from inside and outside the
consumer finance industry, to implement its business strategies. Rock believes
it is creating growing brand identities and a retail franchise that will sustain
its loan origination efforts.
As a retail originator of loans, Rock earns a portion of its revenues from
origination points and processing fees charged to its customers. Rock does not
currently securitize its loans. Rather, it sells its loans in large bulk and
whole loan sales for cash premiums in the secondary market. During 1997, Rock
had revenues of $52.1 million, pre-tax income of $11.4 million and pro forma net
income of $7.3 million. During 1997, Rock closed $1.2 billion of loans (12,950
loans). As of March 31, 1998, Rock had 770 employees, including 335 loan
officers.
Rock currently operates through three major divisions. Rock originates
loans to individuals with impaired credit characteristics, high levels of debt
service to income, unfavorable past credit experience, limited credit history,
limited employment history or unverifiable income ("Sub-Prime Home Equity
Loans") through its Fresh Start(TM) division. Rock owns the registered trademark
for the name "Fresh Start Financial Services(R)" and has applied for a
registered service mark for the name "Fresh Start(TM)." Rock originates home
equity second mortgage loans to individuals with good credit histories but
little or no equity in their homes ("High Loan-to-Value Loans" or "High LTV
Loans") through its Specialty Lending division. During 1997, Rock closed $335.3
million of Sub-Prime Home Equity Loans and High LTV Loans (together, "Sub-Prime
Loans") (6,232 loans, representing 49% of the total loans closed). Rock also
originates loans that generally conform to Federal National Mortgage Association
("FNMA") or Federal Home Loan Mortgage Corporation ("Freddie Mac") underwriting
standards, or that generally meet such standards except for maximum loan size
guidelines ("Conventional Loans"), through its Conventional Mortgage Lending
division. During 1997, Rock closed $867.5 million of Conventional Loans (6,513
loans). Although only 28% of the total loan closings (by dollar volume) were
Sub-Prime Loans in 1997, revenues from Sub-Prime Loans equaled 63% of total
revenues due to the higher profit margins and interest rates associated with
Sub-Prime Loans. In addition, Rock began to increase its government-insured
lending operations in 1997, primarily making mortgage loans that meet the
underwriting standards for Federal Housing Administration ("FHA") insurance.
Rock's business in each division is supported by an infrastructure of
sophisticated technology, highly-trained people and specialized marketing,
including multimedia advertising and direct marketing operations. To identify
potential customers, Rock uses internal and external databases of information
regarding past and
3
<PAGE> 6
potential customers and their needs. Rock then develops proprietary customer
profiles which it uses together with information from outside sources to tailor
and direct its marketing efforts for each of its divisions. Rock believes that
its focused marketing approach makes more efficient use of its marketing
resources and leads to a higher marketing success rate than broad indiscriminate
marketing aimed at a wide range of consumers.
FRESH START(TM) DIVISION
Created in 1994, the Fresh Start(TM) division focuses on customers whose
borrowing needs are not served by traditional financial institutions due to
impaired credit profiles or other factors. Sub-Prime Home Equity Loans are used
typically to consolidate debt (such as credit card debt) and to finance home
improvements, home purchases and other consumer needs. By originating loans to
individuals with impaired credit profiles, Rock is able to charge higher
interest rates on its Sub-Prime Home Equity Loans than for its Conventional
Loans.
The Fresh Start(TM) division originates Sub-Prime Home Equity Loans through
its network of retail loan origination stores. The majority of the Fresh
Start(TM) stores are located in retail strip malls or office buildings with
substantial signage. Rock supports its Fresh Start(TM) store network with an
array of marketing, including multimedia advertising campaigns and direct
marketing to build local awareness of the Fresh Start(TM) brand name and to grow
loan volume within each market.
As of March 31, 1998, Rock had 19 Fresh Start(TM) stores, including five
stores opened before 1997, nine stores opened during 1997, and five stores
opened during January 1998. In addition, in November 1997, Rock opened a pilot
marketing center located within a Super Kmart(TM). Rock's Fresh Start(TM)
division is using the "Fresh Start(TM)" name, adopted in 1997, in its
advertising outside of Michigan and plans to convert all eight of its current
Michigan "Boulder Financial" stores to Fresh Start(TM) stores in 1998. Stores
that were open before 1997 closed an average of $9.9 million of Sub-Prime Home
Equity Loans per store during the first quarter of 1998. Rock believes that its
new stores generally mature over a twelve- to eighteen-month time period.
The Fresh Start(TM) division closed $269.3 million of Sub-Prime Home Equity
Loans (4,196 loans) during 1997. Based on information provided in the National
Mortgage News (March 16, 1998), an independent industry publication, Rock
believes it was one of the 20 largest retail originators of Sub-Prime Loans in
the United States in 1997.
SPECIALTY LENDING DIVISION
The Specialty Lending division, which commenced its current operations in
March 1997, originates High LTV Loans secured primarily by second mortgages and
with combined loan-to-value ratios (including the first mortgage balance) of up
to 125% of the estimated value of the underlying property. Because High LTV
Loans have little, if any, equity cushion (unlike Sub-Prime Home Equity Loans),
Rock's underwriting relies principally on the creditworthiness of the customer
for repayment. High LTV Loans are typically used to consolidate debt (such as
credit card debt) and to finance home improvements, education, and other
consumer needs.
The Specialty Lending division markets High LTV Loans to consumers through
its call center located in Bingham Farms, Michigan. During 1997, Rock closed
$66.0 million of High LTV Loans (2,036 loans). As of March 31, 1998, Rock was
soliciting High LTV Loans in eight states and was licensed to do business or
exempt from licensing in eleven others. Rock uses extensive direct-mail
marketing and significant multimedia advertising campaigns to generate inbound
call volume into its call center. At various times, outbound telemarketing
programs also are launched to targeted lists of consumers. The Specialty Lending
division uses a specially trained sales force and relies heavily on technology
and systems designed specifically for Rock. Although the current focus of the
Specialty Lending division is High LTV Loans, the infrastructure of the division
and the call center are designed with the ability to change focus to, or add,
other types of loan products as appropriate.
4
<PAGE> 7
CONVENTIONAL MORTGAGE LENDING DIVISION
Since its inception in 1985, Rock has originated Conventional Loans through
its Conventional Mortgage Lending division. During 1997, Rock originated $867.5
million of Conventional Loans (6,513 loans). Based on a report by Lawyer's Title
Insurance Company (June 1997), Rock believes that it is the largest non-
depositary-affiliated retail lender of one- to four-family residential mortgage
loans in southeast Michigan. The Conventional Mortgage Lending division
originates loans through seven branches, all located in southeast Michigan.
Conventional Loans generally conform to the underwriting guidelines of FNMA or
Freddie Mac, or they generally conform except for maximum loan size, and they
are generally made to finance the purchase of a home or to refinance a home
mortgage.
Over the past 13 years, Rock has used marketing and advertising to create
and enhance brand name recognition for the Rock Financial name. In conjunction
with its multimedia advertising, Rock coordinates extensive direct marketing
campaigns. Rock has developed third-party relationships with real estate
brokers, home builders, attorneys, accountants, and financial planners, which
generate referral business. Rock is also an approved, unsupervised
seller/servicer of FNMA and Freddie Mac Conventional Loans and a Department of
Housing and Urban Development ("HUD")-approved lender.
BUSINESS STRATEGY
Rock's business strategy to sustain its growth in profitability while
continuing to build its consumer lending operations includes: (i) enhancing
consumer recognition of its "Fresh Start(TM)" and "Rock Financial" brand names
in its current markets and establishing brand name recognition in new markets,
(ii) increasing the number of Fresh Start(TM) stores and expanding its call
center operations into additional states, (iii) expanding the cross-selling of
existing products and expanding the products offered through existing
distribution channels, (iv) exploring establishing additional distribution
channels, (v) providing "world class" service, and thereby distinguishing itself
from its competitors, (vi) continuing to invest heavily in technology and
marketing, (vii) maintaining consistent underwriting standards, and thereby
maintaining secondary market interest in Rock's loans, and (viii) seeking
potential acquisition opportunities.
Simultaneously with the closing of this Offering, Rock will cease to be
taxed as an S corporation under Subchapter S (an "S corporation") of the
Internal Revenue Code of 1986, as amended (the "Code"), and will become subject
to federal and state income taxation as a C corporation. In connection with the
termination of its S corporation status, Rock will pay previously-earned and
undistributed taxable income (the "Shareholder Distribution Amount") out of the
net proceeds of the Offering to Rock's shareholders existing immediately before
the closing of this Offering (the "Existing Shareholders") and an accounting
adjustment will be made. See "Termination of S Corporation Status." Rock was
incorporated in the State of Michigan on June 21, 1985. Rock's principal
executive offices are located at 30600 Telegraph Road, Fourth Floor, Bingham
Farms, Michigan 48025. Its telephone number is (248) 540-8000.
5
<PAGE> 8
RECENT DEVELOPMENTS
RECENT FINANCIAL RESULTS.
The following table sets forth certain unaudited financial information
concerning the first quarters of 1997 and 1998.
<TABLE>
<CAPTION>
FOR THE QUARTER ENDED
MARCH 31,
-------------------------
1997 1998
-------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
STATEMENT OF INCOME DATA:
Revenues:
Net interest margin after provision for loan
losses........................................... $ 405 $ 1,247
Loan fees and gains and losses on sale of
mortgages........................................ 7,173 17,663
Net gain on sale of marketable securities........... 685 0
Other income........................................ 50 10
-------- --------
8,313 18,920
-------- --------
Expenses.............................................. 7,192 14,818
-------- --------
Net income.......................................... 1,121 4,102
Pro forma income tax expense(1)....................... 432 1,476
-------- --------
Pro forma net income................................ $ 689 $ 2,626
======== ========
OPERATING DATA:
Principal amount of loan closings:
Fresh Start(TM)..................................... $ 48,212 $ 80,495
Specialty Lending................................... 1,118 23,203
Conventional Mortgage Lending....................... 184,147 370,156
Other............................................... 2,955 9,090
-------- --------
Total....................................... $236,432 $482,944
======== ========
</TABLE>
- -------------------------
(1) Pro forma income taxes reflect adjustments for federal and state income
taxes as if Rock had been taxed as a C corporation rather than an S
corporation.
COMPARISON OF FIRST QUARTERS OF 1997 AND 1998.
During the first quarter of 1998, Rock closed $482.9 million of loans
(5,008 loans), an increase of $246.5 million, or 104.2%, from the $236.4 million
of loans (2,090 loans) closed in the first quarter of 1997. Rock's total
revenues for the first quarter increased to $18.9 million in 1998, an increase
of $10.6 million, or 127.7%, from the first quarter of 1997 and an increase of
$1.1 million, or 6.2%, from the fourth quarter of 1997. The increase in revenues
is primarily due to (i) an increase of $186.0 million, or 101.0%, in the volume
of Conventional Loans closed by Rock in the first quarter of 1998 compared to
the first quarter of 1997, and (ii) an increase of $54.4 million, or 110.2%, in
the volume of Sub-Prime Loans closed by Rock in the first quarter of 1998
compared to the first quarter of 1997.
Total expenses increased from $7.2 million in the first quarter of 1997 to
$14.8 million in the first quarter of 1998, an increase of $7.6 million, or
106.0%, primarily due to increased commissions, increased occupancy costs for
new stores and increases in general and administrative expenses that fluctuate
with increases in volumes of loans closed and numbers of employees.
The 13 stores, one marketing center and two branches that have opened since
July 1, 1997 (including four stores in the fourth quarter of 1997, five stores
in January 1998 and two branches in the second quarter of 1998) contributed
significantly less to Rock's revenues and net income and more to its expenses in
the first quarter of 1998 than stores that had been in operation for at least
twelve months. The stores opened in January
6
<PAGE> 9
1998 and some of the stores opened late in 1997 operated at a net loss
aggregating approximately $1.6 million in the first quarter of 1998. Rock
believes that its new stores generally mature over a twelve- to eighteen-month
time period. During the first quarter of 1998, Rock sold $23.9 million fewer
loans than it closed, including $35.0 million fewer Conventional Loans than it
closed and $11.1 million more Sub-Prime Loans than it closed.
As a result of increased revenues, proportionally lower expenses and lower
bonuses, pre-tax income increased 265.9%, from $1.1 million in the first quarter
of 1997 to $4.1 million in the first quarter of 1998. Rock's pro forma net
income increased from $0.7 million in the first quarter of 1997 to $2.6 million
in the first quarter of 1998, an increase of $1.9 million, or 266.2%. See
"Summary Financial Data."
SEGMENT ANALYSIS OF THE FIRST QUARTER OF 1998.
Although revenues increased in the first quarter of 1998 compared to the
fourth quarter of 1997, the contribution by segment differed from quarter to
quarter. In the first quarter of 1998, the Conventional Mortgage Lending
division contributed $6.7 million, or 35.2%, of revenues, compared to $5.1
million, or 28.4%, in the fourth quarter of 1997. The Fresh Start(TM) division
contributed $9.3 million, or 49.0%, of revenues in the first quarter of 1998,
compared to $9.3 million, or 52.3%, in the fourth quarter of 1997. The Specialty
Lending division contributed $2.8 million, or 14.6%, of revenues in the first
quarter of 1998 compared to $3.4 million, or 19.1%, of revenues in the fourth
quarter of 1997. Rock's pro forma net income increased from $2.5 million in the
fourth quarter of 1997 to $2.6 million in the first quarter of 1998, an increase
of $0.1 million, or 5.0%.
FRESH START(TM) DIVISION. In January 1998, Rock opened an additional five
Fresh Start(TM) stores. Stores that were open before 1997 closed an average of
$9.9 million of Sub-Prime Home Equity Loans during the first quarter of 1998,
compared to $9.6 million in the first quarter of 1997 and $11.4 million in the
fourth quarter of 1997. See the table under the caption "Business -- Operating
Divisions -- Fresh Start(TM) Division."
Management believes that loan closings in the first quarter of 1998 were lower
than fourth quarter of 1997 levels partially because of the seasonality of the
business (see "Business -- Seasonality") and partially because Rock moved some
of its highest producing loan officers into new stores during the first quarter.
Although such personnel relocations result in short-term decreases in loan
production from the more mature stores from which such loan officers were moved,
Rock believes that the presence of its highest producing loan officers in its
new stores will enable such stores to mature and reach full productivity more
quickly than if such stores were staffed solely by new loan officers. The
weighted average loan fees and gains on sales of mortgages (comprising the
aggregate of investor premiums and borrower points) earned by Rock on its
Sub-Prime Home Equity Loans decreased by 6.7% in the first quarter of 1998
compared to the last half of 1997.
SPECIALTY LENDING DIVISION. The Specialty Lending division expanded its
activities into five additional states in the first quarter of 1998, but Rock
shifted part of its Specialty Lending division's sales force from this division
to handle the high demand for Conventional Loans during the first quarter of
1998. Management believes that loan closings in the first quarter of 1998 were
lower than fourth quarter of 1997 levels partially because of the seasonality of
the business (see "Business--Seasonality") and partially because Rock shifted
part of its Specialty Lending division's sales force to handle the high demand
for Conventional Loans during the first quarter of 1998. Rock expects to
continue this practice in the second quarter of 1998. The weighted average loan
fees and gains on sales of mortgages (comprising the aggregate of investor
premiums and borrower points) earned by Rock on its High LTV Loans decreased by
13.2% in the first quarter of 1998 compared to the last half of 1997.
CONVENTIONAL MORTGAGE LENDING DIVISION. Management believes that loan
closings in the first quarter of 1998 were higher than fourth quarter of 1997
levels primarily because of the current interest rate environment which caused a
significant increase in loan refinancings and, to a lesser extent, to additional
loan officers and the implementation of FNMA desktop underwriting technology,
partially offset by the seasonality of the business (see
"Business -- Seasonality").
The table under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Segment Analysis (page 31)"
illustrates the revenues, expenses and related contribution of each of Rock's
divisions for each of the six quarters ended March 31, 1998.
7
<PAGE> 10
RISK FACTORS
Before making an investment decision, prospective investors should
carefully consider all of the information set forth in this Prospectus and, in
particular, should evaluate the factors set forth in "Risk Factors."
THE OFFERING
Common Shares offered by:
Rock........................ 3,000,000 shares
The Selling Shareholders.... 330,000 shares*
Common Shares to be
outstanding after the
Offering.................... 13,330,000 shares*
Use of Proceeds............... To fund a distribution to the Existing
Shareholders in connection with termination
of Rock's status as an S corporation ($17.0
million as of March 31, 1998 after giving
effect to the $5.4 million tax distribution
to existing shareholders on April 10, 1998
and expected to increase by the time of the
distribution) and to repay a portion of the
amounts outstanding under Rock's warehouse
line of credit used to finance, and secured
by, a portion of Rock's inventory of loans
(approximately $9.6 million based on the
March 31, 1998 Shareholder Distribution
Amount, as adjusted for the April 10, 1998
tax distribution). See "Use of Proceeds."
Nasdaq Stock Market Symbol.... "RCCK"
- -------------------------
* Excludes an aggregate of up to 4,500,000 Common Shares reserved for issuance
under Rock's 1996 Stock Option Plan, under which options to acquire 2,447,184
Common Shares were outstanding as of March 31, 1998. The 330,000 Common Shares
being sold by the Selling Shareholders will be acquired by them on the closing
date of this Offering upon exercise of stock options previously granted to
them, and Rock has granted to them, effective as of the closing date of this
Offering, immediately exercisable replacement options to purchase 450,000
Common Shares at the initial public offering price of the Common Shares in
this Offering. At the closing of the Offering, options to purchase 3,005,684
Common Shares will be outstanding.
8
<PAGE> 11
SUMMARY FINANCIAL DATA
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, (1)
--------------------------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Revenue:
Interest income................................... $ 2,724 $ 2,310 $ 3,003 $ 4,267 $ 8,083
Interest expense.................................. 1,819 1,746 3,012 3,669 5,150
-------- -------- -------- ---------- ----------
Net interest margin............................. 905 564 (9) 598 2,933
Provision for credit losses....................... -- -- -- -- (300)
-------- -------- -------- ---------- ----------
Net interest margin after provision for credit
losses........................................ 905 564 (9) 598 2,633
Loan fees and gains and losses on sale of
mortgages....................................... 16,251 10,348 17,788 27,960 47,084
Net gain on sale of mortgage servicing(2)......... -- 2,465 5,728 -- --
Net gain (loss) on sale of marketable securities
(3)............................................. 356 (202) 346 991 2,222
Other income...................................... 677 1,348 399 6 171
-------- -------- -------- ---------- ----------
18,189 14,523 24,252 29,555 52,110
-------- -------- -------- ---------- ----------
Expenses:
Salaries, commissions and employee benefits....... 10,306 9,514 11,272 16,425 24,811
Stock and option holders' bonuses................. 2,026 142 546 2,297 1,592
General and administrative expenses............... 2,761 3,159 3,726 4,646 7,630
Marketing expenses................................ 967 1,465 1,339 2,393 5,370
Depreciation and amortization..................... 390 510 506 663 1,292
-------- -------- -------- ---------- ----------
16,450 14,790 17,388 26,424 40,695
-------- -------- -------- ---------- ----------
Net income (loss)............................... 1,739 (267) 6,863 3,131 11,415
Pro forma income tax expense (benefit) (4).......... 626 (96) 2,471 1,127 4,109
-------- -------- -------- ---------- ----------
Pro forma net income (loss)..................... $ 1,113 $ (171) $ 4,392 $ 2,004 $ 7,306
======== ======== ======== ========== ==========
PER SHARE INFORMATION:
Pro forma net income per share:
Basic........................................... $ 0.55
==========
Diluted......................................... $ 0.51
==========
Weighted average number of shares outstanding:
Basic........................................... 13,330,000
==========
Diluted......................................... 14,282,914
==========
OPERATING DATA:
Principal amount of loan closings:
Fresh Start(TM)................................... $ -- $ 6,787 $ 64,403 $ 147,676 $ 269,275
Specialty Lending................................. -- -- -- -- 66,043
Conventional Mortgage Lending..................... 985,721 679,960 740,408 892,672 867,520
Other............................................. -- -- 15,860 43,042 16,599
-------- -------- -------- ---------- ----------
Total........................................... $985,721 $686,747 $820,671 $1,083,390 $1,219,437
======== ======== ======== ========== ==========
Weighted average interest rate (fixed rate):
Fresh Start(TM)................................... -- 12.58% 12.42% 12.64% 12.69%
Specialty Lending................................. -- -- -- -- 15.22%
Conventional Mortgage Lending..................... 7.36% 7.85% 8.18% 7.86% 7.99%
Other............................................. -- -- 8.03% 8.48% 8.42%
Weighted average interest rate (adjustable rate):
Fresh Start(TM)................................... -- 10.25% 10.91% 10.33% 11.09%
Conventional Mortgage Lending..................... 4.68% 6.27% 6.90% 6.51% 6.83%
Other............................................. -- -- 6.90% 7.07% 7.08%
Total number of employees at year end............... 260 255 266 399 667
Number of branches at year end:(5)
Fresh Start(TM) Stores............................ -- 1 3 5 14
Conventional Mortgage Lending Branches............ 3 8 9 4 5
</TABLE>
9
<PAGE> 12
<TABLE>
<CAPTION>
FOR THE FOR THE
1996 1998
QUARTER QUARTER
ENDED FOR THE 1997 QUARTER ENDED (1) ENDED
----------- ---------------------------------------------------- ----------
DECEMBER 31 MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 MARCH 31
----------- -------- ------- ------------ ----------- --------
<S> <C> <C> <C> <C> <C> <C>
QUARTERLY STATEMENT OF INCOME DATA:
Revenues:
Net interest margin after provision
for credit losses................... $ 306 $ 405 $ 454 $ 829 $ 945 $ 1,247
Loan fees and gains and losses on sale
of mortgages........................ 7,481 7,173 10,895 12,150 16,866 17,663
Net gain (loss) on sale of marketable
securities (3)...................... (945) 685 (18) 1,587 (32) --
Other income.......................... 51 50 52 48 21 10
---------- ---------- ---------- ---------- ---------- ----------
6,893 8,313 11,383 14,614 17,800 18,920
---------- ---------- ---------- ---------- ---------- ----------
Expenses................................ 7,398 7,192 8,162 11,449 13,892 14,818
---------- ---------- ---------- ---------- ---------- ----------
Net income (loss)..................... (505) 1,121 3,221 3,165 3,908 4,102
Pro forma income tax expense (benefit)
(4)................................... (182) 404 1,160 1,139 1,407 1,476
---------- ---------- ---------- ---------- ---------- ----------
Pro forma net income (loss)........... $ (323) $ 717 $ 2,061 $ 2,026 $ 2,501 $ 2,626
========== ========== ========== ========== ========== ==========
PER SHARE INFORMATION:
Pro forma net income per share:
Basic............................... $ (0.02) $ 0.05 $ 0.15 $ 0.15 $ 0.19 $ 0.20
========== ========== ========== ========== ========== ==========
Diluted............................. $ (0.02) $ 0.05 $ 0.14 $ 0.14 $ 0.18 $ 0.18
========== ========== ========== ========== ========== ==========
Weighted average number of shares
outstanding:
Basic............................... 13,330,000 13,330,000 13,330,000 13,330,000 13,330,000 13,330,000
========== ========== ========== ========== ========== ==========
Diluted............................. 14,282,914 14,282,914 14,282,914 14,282,914 14,282,914 14,282,914
========== ========== ========== ========== ========== ==========
OPERATING DATA:
Principal amount of loan closings:
Fresh Start(TM)....................... $ 50,145 $ 48,212 $ 57,499 $ 72,790 $ 90,773 $ 80,495
Specialty Lending..................... -- 1,118 12,575 23,273 29,078 23,203
Conventional Mortgage Lending......... 210,254 184,147 193,629 232,050 257,694 370,156
Other................................. 3,108 2,955 3,938 4,490 5,215 9,090
---------- ---------- ---------- ---------- ---------- ----------
Total............................... $ 263,507 $ 236,432 $ 267,641 $ 332,603 $ 382,760 $ 482,944
========== ========== ========== ========== ========== ==========
Weighted average interest rate (fixed
rate):
Fresh Start(TM)....................... 12.78% 12.62% 12.98% 12.84% 12.40% 11.86%
Specialty Lending..................... --% 15.38% 15.33% 15.19% 15.21% 14.57%
Conventional Mortgage Lending......... 8.20% 8.19% 8.47% 7.94% 7.69% 7.31%
Other................................. 8.90% 8.41% 8.93% 8.40% 8.19% 7.82%
Weighted average interest rate
(adjustable rate):
Fresh Start(TM)....................... 10.50% 10.55% 11.10% 11.21% 11.30% 11.24%
Conventional Mortgage Lending......... 6.63% 6.60% 7.01% 6.87% 6.88% 6.92%
Other................................. 7.22% 7.14% 7.38% 7.02% 6.82% 6.59%
Total number of employees............... 399 423 482 622 667 770
Number of branches at quarter end: (5)
Fresh Start(TM)Stores................. 5 5 6 10 14 19
Conventional Mortgage Lending
Branches............................ 4 4 4 5 5 5
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-------------------------
ACTUAL AS ADJUSTED(6)
------ --------------
<S> <C> <C>
SELECTED BALANCE SHEET DATA:
Cash and cash equivalents................................... $ 11,947 $ 11,947
Mortgage loans held for sale................................ 121,344 121,344
Other assets................................................ 11,138 11,211
Total assets................................................ 144,429 144,502
Warehouse financing facilities.............................. 97,455 85,684
Drafts payable and other liabilities........................ 31,866 31,866
Shareholders' equity........................................ 15,108 26,952
</TABLE>
(footnotes
continued on next page)
10
<PAGE> 13
- -------------------------
(1) Rock commenced operations in its Fresh Start(TM) division in 1994 and
commenced current operations in its Specialty Lending division in 1997. Of
the 14 Fresh Start(TM) stores open at December 31, 1997, nine were opened
during 1997 (eight of which were opened since July 1, 1997).
(2) During 1993 and 1994, Rock elected to retain, rather than sell, the
servicing rights to its loans and received lower sales prices as a result.
In 1994 Rock sold some of its servicing rights, and in 1995 Rock sold all of
its remaining servicing rights and recognized a net gain on the sale of
servicing rights. In 1996 and 1997, Rock sold its loans servicing released.
(3) Before the end of 1997, Rock invested some of its excess cash in marketable
securities. During 1995, 1996 and 1997, Rock sold a portion of its portfolio
of marketable securities and recognized net gains of $346,000, $991,000 and
$2,222,000, respectively.
(4) Pro forma income taxes reflect adjustments for federal and state income
taxes as if Rock had been taxed as a C corporation rather than an S
corporation. See "Termination of S Corporation Status." No pro forma
adjustments have been made for the non-recurring net gains on sales of
marketable securities and stock and option holders' bonuses, or estimated
earnings from the net proceeds received from the Offering.
(5) One is a combined Fresh Start(TM) store and Conventional Mortgage Lending
branch. Does not include one Fresh Start(TM) marketing center opened in
1997.
(6) As adjusted to give effect to (i) a distribution to the Existing
Shareholders of the Shareholder Distribution Amount in the aggregate amount
of approximately $18.0 million (calculated as of December 31, 1997), (ii)
the creation of a deferred tax asset in the amount of $1.7 million
(calculated as of December 31, 1997) arising in connection with Rock's
termination of its S corporation status, (iii) the receipt by Rock of
approximately $1.5 million upon exercise by the Selling Shareholders of
330,000 options at $4.68 a share to acquire the Common Shares they are
selling in the Offering, and (iv) the sale of the Common Shares offered by
Rock by this Prospectus and the application of the estimated net proceeds to
Rock therefrom as described under "Use of Proceeds." In addition, although
he is not required to do so, Daniel Gilbert expects to repay the balance of
his loans from Rock ($1.6 million as of December 31, 1997) with his share of
the Shareholder Distribution Amount, and Rock expects to use that cash to
repay a portion of the amounts outstanding under its warehouse line of
credit. The adjusted amounts give effect to Rock's use of that cash to
reduce its warehouse line of credit. The amounts do not include additional
borrowings or additional S corporation income (which is expected to increase
the Shareholder Distribution Amount) since December 31, 1997. See
"Termination of S Corporation Status," "Use of Proceeds," and
"Capitalization."
11
<PAGE> 14
RISK FACTORS
An investment in the Common Shares of Rock involves certain risks.
Prospective investors should carefully consider the following risk factors, in
addition to the other information contained in this Prospectus, in evaluating an
investment in the Common Shares offered by this Prospectus.
DEPENDENCE ON LOAN SALES
Rock currently expects to sell substantially all of its loans to
independent whole or bulk loan buyers and expects that the gain recognized from
such sales will continue to represent a significant portion of Rock's revenues
and net earnings. Further, Rock is dependent on the cash generated from such
sales to fund its future loan closings and repay borrowings under its warehouse
financing facilities. The price Rock receives for its loans varies from time to
time and may be materially adversely affected by several factors, including,
without limitation, any significant reduction in the number of potential buyers
of Rock's loans, any significant increase in the amount of similar loans
available for sale, general conditions in the loan securitization market, in the
secondary market for loans in general or for Rock's loans in particular, which
make Rock's loans less desirable to potential buyers, and increased prepayments
of, or defaults under, loans in general, the types of loans being sold by Rock
or loans previously sold by Rock. A prolonged, substantial reduction in the size
of the secondary market for loans of the types closed by Rock may adversely
affect Rock's ability to sell loans in the secondary market, with a consequent
adverse impact on Rock's profitability and ability to fund future loan closings.
Any significant decrease in the prices paid to Rock upon sale of its loans could
materially adversely affect its business, operations, financial condition and
results of operations. The weighted average loan fees and gains on sales of
mortgages (comprising the aggregate of investor premiums and borrower's points)
earned by Rock on its Sub-Prime Home Equity Loans and High LTV Loans decreased
by 6.7% and 13.2%, respectively, in the first quarter of 1998 compared to the
last half of 1997. Five loan buyers purchased an aggregate of approximately
91.6% of the Sub-Prime Home Equity Loans sold by Rock in 1997, of which the
largest of such buyers purchased approximately 36.5% of such Sub-Prime Home
Equity Loans. Two loan buyers purchased an aggregate of approximately 93.5% of
the High LTV Loans sold by Rock in 1997. The loss of any of these buyers or any
significant reduction in the prices these buyers are willing to pay for Rock's
loans could have an adverse effect on Rock's business, financial condition and
results of operations.
Rock's ability to complete sales of its loans will depend on a number of
factors, including conditions in the secondary market generally. Adverse changes
in the secondary market could impair Rock's ability to sell its loans on a
favorable or timely basis and could have a material adverse effect upon Rock's
business, financial condition and results of operations. Furthermore, because
Rock's management expects that an important component of Rock's income will be
gain on sale of loans, Rock's quarterly operating results may fluctuate
significantly as a result of the timing and size of loan sales. If such sales do
not close when expected, Rock's results of operations may be materially
adversely affected for that period.
ABILITY TO SUSTAIN AND MANAGE GROWTH
Although Rock has experienced rapid and substantial growth in loan closings
and total revenues in recent years, there can be no assurance that Rock can
sustain these rates of growth or that it will be able to create an
infrastructure or recruit and retain sufficient personnel to keep pace with a
prolonged period of growth. Rock's growth and expansion is expected to place a
significant strain on Rock's management, customer service, operations, human
resources personnel, sales, marketing and administrative personnel and other
resources. In order to serve the needs of its existing and future customers,
Rock has increased and will continue to increase its work force, which requires
Rock to attract, train, motivate and manage qualified employees. Rock's ability
to manage its planned growth depends upon Rock's success in continuing to expand
its operating, management, information, human resources, marketing and financial
systems. If Rock is unable to keep pace in these areas with its rate of growth
in revenues, its business, financial condition and results of operations could
be materially adversely affected.
Rock's recent and rapid growth may have a distortive impact on some of
Rock's ratios and financial statistics and may make period-to-period comparisons
difficult. In light of Rock's growth, historical performance of Rock's earnings
may be of little relevance in predicting future performance. Furthermore,
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<PAGE> 15
Rock's financial statistics may not be indicative of Rock's results in future
periods. Any credit or other problems associated with the large number of loans
closed in the recent past may not become apparent until sometime in the future.
CONCENTRATION OF OPERATIONS IN MICHIGAN
During the year ended December 31, 1997, 91.7% of Rock's loan closings (as
measured by the number of loans closed) were secured by properties located in
Michigan. When the properties underlying such loans are located in the same
geographic region, such loans may be subject to a greater risk of delinquency or
default in the event of adverse economic, political or business developments and
natural hazard risks that may affect such region. If the region's real estate
market should experience an overall decline in property values, the rates of
delinquency, foreclosure, bankruptcy and loss on the loans may be expected to
increase substantially, which could negatively impact Rock's ability to
originate loans or sell them in the secondary market. Any impact on Rock's
ability to originate or sell loans could materially adversely affect Rock's
business, financial condition and results of operations.
PREPAYMENT AND RECAPTURE RISK
Decreases in prevailing interest rates or increases in competition could
increase prepayments of Rock's loans as customers refinance their loans with
lower interest rate loans. An increase in prepayments of Rock's loans or of
similar loans in the industry in general could reduce the prices wholesale
purchasers are willing to pay for Rock's loans. Also, an increase in prepayments
could increase Rock's recapture risk, as, in connection with some Sub-Prime Loan
sales, Rock agrees to repay to the purchaser of the loan a portion of the
premium paid for the loan if the loan is prepaid within the first year after
sale. The repayment obligation is generally proportional to the part of the year
that the loan was outstanding. For 1995, 1996 and 1997, the premium recapture
paid by Rock was $3,375, $154,909 and $297,954, respectively. An unexpected
increase in prepayments of such loans could have a material adverse effect on
Rock's business, financial condition and results of operations.
COMPETITION
The consumer lending industry is highly competitive and fragmented. Rock
faces intense competition, primarily from numerous commercial banks, savings and
loan associations, credit unions, insurance companies, mortgage brokers,
mortgage bankers and other consumer finance companies. If Rock expands into
additional geographic markets, it will face competition from consumer lenders
with established positions in such markets. There can be no assurance that Rock
will be able to compete successfully with these consumer lenders.
Competition can take place on various levels, including convenience in
obtaining a loan, service, marketing, pricing (including the interest rates,
closing costs and processing fees offered) and range of products. Many of Rock's
competitors in the consumer lending industry are better established,
substantially larger and have significantly more capital and other resources
than Rock. In addition, FNMA and Freddie Mac are currently developing
technologies and business practices that will expand the scope of mortgage loans
eligible to be purchased by them, including, potentially, Sub-Prime Home Equity
Loans. The effect of these purchases on the consumer lending industry and profit
margins is not presently determinable, but such expanded scope could attract
additional competitors into the market and significantly erode profit margins.
Barriers to entry into the consumer lending industry are low, and the current
level of gains realized by Rock and its existing competitors on the sale of
loans could attract additional competitors into the market. Consequently, there
are many recent market entrants seeking these relatively attractive profit
margins. Increases in the number of companies seeking to originate consumer
loans could lower the rates of interest or reduce the amount of origination
points and fees Rock can charge customers, thereby reducing the potential
profitability of such loans. Competition might also reduce Rock's loan closing
volume. In addition, during periods of declining interest rates, competitors
which have "locked in" low borrowing costs may have a competitive advantage.
There can be no assurance that Rock will be able to compete successfully in this
13
<PAGE> 16
market environment and any failure in this regard could have a material adverse
effect on Rock's business, financial condition and results of operations.
ECONOMIC CONDITIONS
Rock's results of operations will depend on, among other things, the market
value of Rock's loans and the supply of, and demand for, such loans. Prepayment
rates, interest rates, borrowing costs and credit losses depend upon the nature
and terms of the loans, the geographic location of the properties securing the
loans, conditions in financial markets, the fiscal and monetary policies of the
United States government, international economic and financial conditions,
competition and other factors, none of which can be predicted with any
certainty.
Risks associated with Rock's business become more acute in any economic
slowdown or recession. An economic downturn or recession may be accompanied by
decreased home purchases, decreased demand for consumer credit and lower real
estate values and increased loan-to-value ratios on loans previously made,
thereby weakening collateral coverage and increasing the possibility of a loss
in the event of a default. Any material decline in real estate values reduces
the ability of customers to use home equity to support borrowings. Furthermore,
the rates of delinquencies and foreclosures and the frequency and severity of
losses generally increase during economic downturns or recessions. Because Rock
lends to some customers who may be credit-impaired, the actual rates of
delinquencies, foreclosures and losses on such loans could be higher, and the
prices paid by buyers of such loans could be lower, under adverse economic
conditions than those for loans in general.
INTEREST RATES
Rock's profitability may be directly affected by the level of, and
fluctuations in, prevailing interest rates. The market value of a loan generally
declines as interest rates rise, and fixed-rate loans are more sensitive to
changes in market interest rates than adjustable-rate loans. When Rock
establishes an interest rate for a loan before it is committed for sale, a gain
or loss on the sale of such loan may result from changes in interest rates
during the period between the establishment of the interest rate on the loan and
the receipt of a commitment to buy the loan. Rock does not hedge this risk with
respect to Sub-Prime Loans, and any increase in interest rates during the period
between the establishment of the interest rate on a loan and the receipt of a
commitment to buy the loan would adversely affect the value of such loan and the
price at which Rock would be able to sell it. This risk increases the longer
Rock holds these loans before obtaining a commitment to buy them. Rock's
increase in bulk sales of loans, rather than flow sales, increases the period of
time Rock holds these loans before receiving a commitment to buy them. "Flow"
sales are sales of loans underwritten by a third party who commits to purchase
each individual loan its underwriters approve. "Bulk" sales are sales of loans
underwritten to Rock's underwriting standards that are pooled and then sold to
third parties for cash by Rock. In order to hedge this interest rate risk with
respect to its Conventional Loans (which generally have a lower interest
spread), Rock sells (on a forward basis), or obtains forward commitments from
investors to purchase, the estimated amount of Conventional Loans in process for
which an interest rate is established that will ultimately be funded or Rock
periodically purchases treasury-based options based on its estimates of its
exposure and the probable principal amount of Conventional Loans in process for
which an interest rate has been fixed that will ultimately be funded.
When Rock's funding estimates differ from actual experience, the resulting
mismatching of commitments to fund Conventional Loans at certain interest rates
and forward sales or commitments of Conventional Loans with certain interest
rates may have a material adverse effect on Rock's business, financial condition
and results of operations. In addition, when Rock hedges its exposure to
fluctuations in interest rates by purchasing treasury-based options, the
movements in the interest rates on those securities might not match the changes
in pricing of loans in the secondary market, resulting in a potential gain or
loss to Rock. An effective hedging strategy is complex and no hedging strategy
can completely insulate Rock from changes in interest rates. In addition,
hedging strategies involve transaction and other costs, and such costs could
increase as the period covered by the hedging protection increases or in periods
of rising and more greatly fluctuating interest rates.
14
<PAGE> 17
There can be no assurance that profitability of Rock would not be adversely
affected during any period of changes in interest rates.
The profitability of Rock is likely to be adversely affected during any
period of unexpected or rapid changes in prevailing interest rates. The ability
of Rock to close loans, especially in the Conventional Mortgage Lending
division, is directly impacted by increases in prevailing interest rates because
customers might be less willing to borrow money at higher interest rates. In
addition, Rock could experience increasing market pressure to reduce origination
fees, especially for loans closed through Rock's Conventional Mortgage Lending
division. Also, because the interest rates under Rock's warehouse financing
facilities are variable, a rapid or unexpected increase in prevailing interest
rates could increase Rock's interest expense on the borrowings required to fund
its loans before they are sold faster than Rock is able to pass such costs on to
its customers.
DEPENDENCE ON FUNDING SOURCES
Rock funds substantially all of the loans it closes through borrowings
under its warehouse financing facilities and internally generated funds. Rock's
borrowings are in turn repaid with the proceeds received by Rock from loan
sales. Rock is currently, and may in the future continue to be, dependent upon a
few lenders to provide the primary credit facilities for its loans. One of
Rock's current warehouse financing facilities is an uncommitted facility that
may be discontinued at any time and expires in March 1999. The other current
warehouse financing facility expires, with respect to loans committed to be made
by any particular lender, 75 days after that lender demands payment, unless that
lender is replaced. In addition, both of such facilities provide demand loans,
with respect to which the lender may demand repayment at any time. Any demand
for payment, any failure to renew or replace existing financing facilities
before they expire, any failure to obtain adequate funding under these
facilities, any substantial reduction in the size or increase in the cost of
such facilities, or any substantial reduction in the size of, or pricing in, the
market for Rock's loans (which can affect the amounts available for borrowing),
could have a material adverse effect on Rock's business, financial condition and
results of operations. In addition, Rock's ability to increase the volume of
loans it closes is dependent, in part, on Rock's ability to procure, maintain
and manage increasingly larger lines of credit. While Rock believes that the net
proceeds of the Offering, together with the funds available under the warehouse
financing facilities, will be sufficient to fund Rock's operations for the next
twelve months, Rock may need to seek additional financing thereafter if Rock's
future operations are consistent with management's expectations.
Rock has no existing commitments for any such additional financing, and
there can be no assurance that Rock will be able to obtain any such additional
financing on a favorable or timely basis. Rock may not be able to achieve the
degree of leverage it believes to be optimal, which may cause Rock to be less
profitable than it might be otherwise. Also, a default by Rock under its
warehouse financing facilities could also result in a liquidation of the
collateral securing such facilities, including any cross-collateralized assets,
and a resulting loss of the difference between the value of the collateral and
the amount borrowed.
ENVIRONMENTAL LIABILITIES
Certain properties securing loans may be contaminated by hazardous
substances. As a result, the value of such properties may be diminished. In the
event that Rock is forced to foreclose on a defaulted loan secured by a
contaminated property, Rock may be subject to environmental liabilities
regardless of whether Rock was responsible for the contamination. While Rock
intends to exercise due diligence to discover potential environmental
liabilities before acquiring any property through foreclosure, hazardous
substances or wastes, contaminants, pollutants or sources thereof (as defined by
state and federal laws and regulations) may be discovered on properties during
Rock's ownership or after a sale thereof to a third party. If such hazardous
substances are discovered, Rock may be required to remove those substances or
sources and clean up the property at substantial expense. Rock may also be
liable to tenants and users of neighboring properties. In addition, Rock may
find it difficult or impossible to sell the property before or following any
such cleanup. Rock does not conduct or require any environmental testing on the
properties securing its loans.
15
<PAGE> 18
POTENTIAL LOSSES IN CONSUMER LENDING
Although Rock currently sells substantially all of the loans it closes on a
nonrecourse basis, it retains some degree of risk with respect to them. As part
of its desire to increase its net interest income, Rock began in the last half
of 1997 to hold its loans for a period of time pending sale. During this time,
Rock is subject to the various business risks associated with the lending
business, including the risk of customer default, the risk of foreclosure and
interest rate risk.
HIGHER CREDIT RISK OF SUB-PRIME LOANS
Credit risks associated with the loans made by Rock's Fresh Start(TM) and
Specialty Lending divisions are greater than those associated with loans made by
the Conventional Mortgage Lending division. The loans made by the Fresh
Start(TM) and Specialty Lending divisions may differ from the other loans with
respect to loan-to-value ratios, the credit and income history of the customers
(for the Fresh Start(TM) division loans), and the documentation required for
loan approval. As a result of these and other factors, the interest rates
charged on these divisions' loans are often higher than those charged for the
Conventional Mortgage Lending division's loans. The combination of different
underwriting criteria and higher rates of interest may lead to higher
delinquency rates and/or credit losses for these categories of loans as compared
to the loans made by the Conventional Mortgage Lending division, which could
have a material adverse effect on Rock's business, financial condition and
results of operations.
RISKS OF REAL ESTATE COLLATERAL
Many of the risks of consumer home equity lending reflect risks of
investing directly in the real estate securing the loans. If there is a default
on a loan, the ultimate extent of the loss, if any, may only be determined after
a foreclosure of the mortgage and, if the lender takes title to the property,
the liquidation of the underlying property. Factors such as the state of title
to the property or its physical condition (including environmental
considerations) may make a third party unwilling to purchase the property at a
foreclosure sale or to pay a price sufficient to satisfy the related loan
obligations. Foreclosure laws in various states may require a protracted
foreclosure process. In addition, the condition of a property may deteriorate
during the period of foreclosure proceedings. Certain customers may become
subject to bankruptcy proceedings, in which case the amount and timing of loan
payments may be materially adversely affected. In addition, loans closed by
Rock's Specialty Lending division may have combined loan-to-value ratios
(including the first mortgage balance) of up to 125%, making the underlying
property value likely to be significantly less than the loan amount at the time
Rock might have to foreclose on such a loan. Even assuming that the underlying
property provides adequate security for the loan, substantial delays could be
encountered in connection with the liquidation of defaulted loans and a
corresponding delay in the receipt and reinvestment of principal and interest
could occur.
CONTINGENT RISKS
Rock may be required to repurchase or substitute loans that it has sold in
the event of a breach of representations and warranties, including any fraud or
any misrepresentation made during the loan origination process. In connection
with some Sub-Prime Loan sales, Rock may be required to return a portion of the
premium paid for the loan if the loan is prepaid within the first year after
sale. Otherwise, Rock's loan sales are generally on a non-recourse basis. In
addition, potential losses can arise before the sale from many factors, as
summarized in these Risk Factors, and the effects of such factors generally
increase during any economic downturn or recession.
In the ordinary course of its business, Rock is subject to claims made
against it by customers arising from, among other things, losses that are
claimed to have been incurred as a result of alleged breaches of fiduciary
obligations, misrepresentations, errors and omissions of Rock's employees,
officers and agents (including appraisers), incomplete loan documentation and
failures by Rock to comply with various laws and regulations applicable to its
business. Industry participants are frequently named as defendants in litigation
involving alleged violations of federal and state consumer lending laws and
regulations, or other similar laws and
16
<PAGE> 19
regulations, as a result of the consumer-oriented nature of the industry in
which Rock operates and uncertainties with respect to the application of various
laws and regulations in certain circumstances.
RISKS OF REGULATORY ENFORCEMENT AND LAWSUITS
Some sectors of, and participants in, the consumer finance industry have
been adversely affected by regulatory enforcement actions and private
class-action lawsuits regarding various consumer lending practices. These
actions and lawsuits allege violations of the Real Estate Settlement Procedures
Act ("RESPA"), the Truth-In-Lending Act, the Equal Credit Opportunity Act and
various other federal and state lending and consumer protection laws. Some of
the practices which have been the subject of lawsuits against other companies
include, but are not limited to, miscellaneous "add on" fees; truth-in-lending
calculations and disclosures; escrow and adjustable rate mortgage calculations
and collections; private mortgage insurance calculations, disclosures and
cancellation; forced-placed hazard, flood and optional insurance; payoff
statement, release and reconveyance fees; and unfair lending practices. Although
Rock is not currently subject to any regulatory enforcement actions or private
class-action lawsuits, it is subject to the regulations that are the subject
matter of such lawsuits. Rock believes that its liability with respect to any
other currently asserted claims or legal actions is not likely to be material to
its financial condition or results of operations; however, any claims asserted
in the future may result in legal expenses or liabilities which could have a
material adverse effect on Rock's business, financial condition and results of
operations.
RISKS OF SUB-PRIME LOANS IN TEXAS
Texas has newly-enacted laws affecting Sub-Prime Loans. As a result of
these new laws, there are increased risks associated with Rock's loans secured
by property located in Texas, including (i) risks that Rock's Sub-Prime Loans
will not comply with the provisions permitting mortgage liens on Texas real
estate, making Rock's liens invalid, (ii) risks of litigation, including class
action lawsuits, if Rock's loans, including the origination points and
processing fees charged on such loans, are determined to violate Texas law, and
(iii) risks that secondary market loan buyers will not be willing to purchase
loans secured by Texas real estate or will pay lower prices for such loans. Rock
currently sells Sub-Prime Loans originated in Texas on a flow basis and intends
to increase its concentration on originating Conventional Loans in its Fresh
Start(TM) stores in Texas until the new laws are clarified.
DEPENDENCE UPON KEY MANAGEMENT PERSONNEL
Rock's future performance depends in significant part upon the continued
service of its executive officers, including Daniel Gilbert, Chairman of the
Board and Chief Executive Officer, and Steven M. Stone, President, any of whom
would be difficult to replace. The loss of any of these employees or of other
key personnel by Rock could have a material adverse effect on Rock's business,
financial condition and results of operations. In addition, competition for
qualified employees is intense, and an inability to attract, retain and motivate
the additional, highly-skilled employees required for the expansion of Rock's
activities could adversely affect Rock's business, financial condition and
results of operations. There can be no assurance that Rock will be able to
retain its existing personnel or attract the required additional persons on
acceptable terms. Rock has an employment agreement with only one of its
executive officers. Rock maintains $7,650,000 and $2,100,000 of life insurance
on Daniel Gilbert and Lindsay Gross, respectively, in connection with stock
purchase obligations under a former shareholders agreement. Rock expects to sell
these policies for their cash surrender values to Mr. Gilbert and Mr. Gross
after this Offering. Rock does not maintain life insurance on any of its other
executive officers. See "Business -- Employees;" and "Management."
POTENTIAL ORIGINATED MORTGAGE SERVICING RIGHTS RISK
Adverse Effect on Cash Flows. Rock would consider selling its loans with
the servicing rights retained if it believes that the value of the servicing
rights is or may become significantly greater than secondary market buyers are
then willing to pay for them. If Rock sold loans with servicing retained, Rock
would recognize a gain on the sale equal to the difference between the carrying
value of the loan sold on Rock's balance sheet and the sum of (i) the cash
received in such sale, and (ii) the amount of an asset recorded on its balance
sheet
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<PAGE> 20
in an initial amount equal to the present value of the servicing fees it would
expect to collect over the life of the loan (the "Servicing Asset"). If Rock
believes the value of the Servicing Asset in the secondary market becomes high
enough, Rock would consider selling its servicing rights as it did in 1994 and
1995. The Servicing Asset is recognized in the period during which loans are
sold, while cash payments are received by Rock over the life of the loan. Rock,
however, will be required to pay tax on the gain on sale for the year in which
the sale occurs. This difference in the timing of cash flows could cause a cash
shortfall, which may have a material adverse effect on Rock's business,
financial condition and results of operations.
Servicing Asset May Be Overstated. The valuation of any Servicing Asset
would be based on management's estimates relating to the appropriate discount
rate and anticipated average lives of the loans being serviced. To estimate the
anticipated average lives of the loans for which servicing is retained,
management would estimate prepayment and default rates for such loans. If actual
experience varied from management's estimates at the time loans are sold, Rock
would be required to write down the remaining Servicing Asset through a charge
to earnings in the period of adjustment.
Prepayment rates and default rates may be affected by a variety of economic
and other factors, including prevailing interest rates and the availability of
alternative financing, most of which are not within Rock's control. A decrease
in prevailing interest rates could cause prepayments to increase, thereby
requiring a writedown of the Servicing Asset. Even if actual prepayment rates
and default rates are lower than management's original estimates, the Servicing
Asset would not increase. Furthermore, management's estimates of prepayment
rates and default rates are based, in part, on the historical performance of
Rock's loans. A significant portion of Rock's loans was very recently
originated. No assurance can be given that these loans, as with any new loan,
will perform in the future in accordance with Rock's historical experience. In
addition, if Rock introduces new products, it may have little or no experience
on which it can base its estimates, and thus its estimates may be less reliable.
Accordingly, it is possible that Rock may have to write down its Servicing Asset
in the future, and any such writedown could have a material adverse effect on
Rock's business, financial condition and results of operations.
RISKS OF SECURITIZATION
Rock currently does not securitize its loans. If the prices offered in the
secondary market for Rock's loans decrease significantly relative to the value
Rock believes that it could receive by securitizing such loans, Rock's
management would consider securitizing its loans. Securitization is the process
of pooling closed loans and selling them to a trust for a cash purchase price
and an interest in the loans securitized. The cash purchase price is raised
through an offering of securities by the trust. After the securitization, the
purchasers of the securities receive principal and interest on their securities,
and Rock would receive the excess of (i) the principal and interest payments
made on the pool of mortgages, over (ii) the payments to the purchasers of the
securities, servicing and other fees, if required, and an amount equal to the
estimated credit losses related to the loans. The present value of this amount
would be recorded on Rock's balance sheet as an "Excess Spread Receivable." If
Rock began securitizing its loans, it would be subject to the following risks:
Liquidity. If Rock securitizes its loans, its operating cash flow is
expected to decrease as its securitization program grows. Demands on Rock's cash
would increase as a result of (i) reserve accounts, over-collateralization
requirements, fees and expenses incurred in connection with a securitization
program, and (ii) tax payments due on Rock's reported net income, which would
include Rock's non-cash securitization gain on sale, generally equal to the
initial Excess Spread Receivable. The tax would generally be due for the year
the related securitization transaction closes.
Excess Spread Receivable Risk. If Rock were to sell a pool of mortgages in
a securitization transaction, it would recognize a gain on the sale equal to the
difference between the carrying value of the loans sold on Rock's balance sheet
and the sum of (i) the cash received in such sale (which would generally equal
the cash purchase price of the securities sold in the securitization, less any
selling discounts and commissions and expenses of the offering of such
securities), and (ii) the Excess Spread Receivable. This Excess Spread
Receivable would be subject to the same risks described above under the caption
"Potential Originated Mortgage Servicing Rights Risk."
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<PAGE> 21
Securitization Market. Securitization transactions may be affected by a
number of factors, some of which are beyond Rock's control, including, among
other things, conditions in the securities markets in general, conditions in the
asset-backed securitization market and the conformity of loan pools to rating
agency requirements and, when monoline insurance is used, the requirements of
such insurers. Failure to obtain acceptable rating agency ratings or insurance
company credit enhancements, if required, could decrease the efficiency or
affect the timing of any securitizations. In addition, any delay in the sale of
a loan pool would postpone the recognition of gain on such loans until their
sale. Such delays could cause Rock's earnings to fluctuate from quarter to
quarter. If Rock were unable to securitize loans due to changes in the secondary
market or the unavailability of credit enhancements, it might be required to
sell its loans in the secondary market for lower than desired prices or Rock's
growth could be materially impaired and its business, financial conditions and
results of operations could be materially adversely affected. In addition, the
securitization market for many types of assets is relatively undeveloped and may
be more susceptible to market fluctuations or other adverse changes than more
developed capital markets.
GOVERNMENT REGULATION
Rock's business is subject to extensive regulation, supervision and
licensing by federal, state and local governmental authorities and is also
subject to various laws and judicial and administrative decisions imposing
requirements and restrictions on part or all of its operations. Regulated
matters include, without limitation, loan origination, marketing efforts, credit
application and underwriting activities, maximum finance and other charges,
disclosure to customers, certain rights of rescission, loan closing, servicing,
collection and foreclosure procedures, qualification and licensing requirements
for doing business in various jurisdictions and other trade practices. Loan
origination activities are subject to the laws and regulations of each of the
states in which those activities are conducted. Activities as a lender are also
subject to various federal laws. The Truth-in-Lending Act ("TILA") and
Regulation Z promulgated thereunder, as both are amended from time to time,
contain disclosure requirements designed to provide consumers with uniform,
understandable information with respect to the terms and conditions of loans and
credit transactions in order to give them the ability to compare credit terms.
TILA also guarantees consumers a three-day right to cancel certain credit
transactions.
Rock is also required to comply with the Equal Credit Opportunity Act of
1974, as amended ("ECOA"), which prohibits lenders from discriminating against
applicants on the basis of race, color, sex, age or marital status. Regulation B
promulgated under ECOA restricts lenders from obtaining certain types of
information from loan applicants. It also requires certain disclosures by the
lender regarding consumer rights and requires lenders to advise applicants of
the reasons for any credit denial. In instances where the applicant is denied
credit or the rate or charge for a loan increases as a result of information
obtained from a consumer credit agency, the Fair Credit Reporting Act of 1970,
as amended, requires the lender to supply the applicant with a name and address
of the reporting agency. Rock is also subject to RESPA and the Fair Debt
Collection Practices Act and is required to file an annual report with HUD
pursuant to the Home Mortgage Disclosure Act ("HMDA"). Rock is also subject to
the rules and regulations of, and examinations by, HUD, FNMA, Freddie Mac and
state regulatory authorities with respect to originating, processing,
underwriting, selling and servicing loans.
Failure to comply with these requirements can lead to loss of approved
status, termination or suspension of servicing contracts without compensation to
the servicer, demands for indemnification or loan repurchases, certain rights of
rescission, class-action lawsuits and administrative and enforcement actions.
There can be no assurance that Rock will maintain compliance with these
requirements, that maintaining compliance will not result in materially
increased expenses, that more restrictive local, state or federal laws, rules
and regulations will not be adopted or that existing laws and regulations will
not be interpreted in a more restrictive manner, which would make compliance
more difficult and more expensive for Rock. In addition, industry participants
are frequently named as defendants in litigation involving alleged violations of
federal and state consumer lending laws and regulations, or other similar laws
and regulations, as a result of the consumer-oriented nature of the industry in
which Rock operates and uncertainties with respect to the application of various
laws and regulations in certain circumstances. If a significant judgment were
rendered against Rock in connection with
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<PAGE> 22
any litigation, it could have a material adverse effect on Rock's business,
financial condition and results of operations. See "Business -- Government
Regulation."
The laws and regulations described above are subject to legislative,
administrative and judicial interpretation, and certain of these laws and
regulations have been infrequently interpreted or only recently enacted.
Infrequent interpretations of these laws and regulations or an insignificant
number of interpretations of recently-enacted laws and regulations can result in
ambiguity with respect to permitted conduct under these laws and regulations.
Any ambiguity under the laws and regulations to which Rock is subject may lead
to regulatory investigations or enforcement actions and private causes of
action, such as class-action lawsuits, with respect to Rock's compliance with
applicable laws and regulations. Rock may also be subject to regulatory
enforcement actions and private causes of action from time to time with respect
to its compliance with applicable laws and regulations.
POTENTIAL ELIMINATION OF MORTGAGE INTEREST DEDUCTION
Members of Congress and government officials have from time to time
suggested the elimination of the mortgage interest deduction for federal income
tax purposes, either entirely or in part, based on customer income, type of loan
or principal amount. Some of Rock's loans are made to customers for the purpose
of consolidating consumer debt or financing other consumer needs, and the
competitive advantages of tax-deductible interest, when compared with
alternative sources of financing, could be eliminated or seriously impaired by
such government action. In addition, the elimination or substantial reduction in
the home mortgage interest deduction could decrease home buying, which in turn
would decrease the demand for home mortgages. The elimination of, or a
substantial reduction in, the current home mortgage interest tax deduction would
curtail the number of Rock's loan closings, which would have a material adverse
effect on Rock's business, financial condition and results of operations.
ABSENCE OF PUBLIC TRADING MARKET AND POSSIBLE VOLATILITY OF STOCK PRICE
There is currently no trading market for the Common Shares and there can be
no assurance that an active trading market for the Common Shares will develop or
that, if developed, will be sustained. The initial public offering price of the
Common Shares offered by this Prospectus will be determined by negotiations
among Rock and the representative of the Underwriters and may not be indicative
of the price at which the Common Shares will trade after the closing of the
Offering. See "Underwriting" for a discussion of the factors to be considered in
establishing the initial public offering price. If a trading market for the
Common Shares develops, the market price of the Common Shares may experience
fluctuations as a result of such factors as quarter-to-quarter variations in
Rock's results of operations, news announcements, changes in general market or
industry condition or other factors unrelated to the ongoing operating
performance of Rock. In particular, the price of the Common Shares may be
affected by general market price movements as well as developments specifically
related to the consumer lending industry, such as interest rate movements and
credit quality trends. There can be no assurance that the market price for the
Common Shares will not fall below the initial public offering price.
SUBSTANTIAL DILUTION
Purchasers of Common Shares in this Offering will suffer an immediate and
substantial dilution in the pro forma net tangible book value per share of the
Common Shares from the initial public offering price in the amount of $7.98 per
share. See "Dilution."
SHARES ELIGIBLE FOR FUTURE SALE
The 3,330,000 Common Shares sold in the Offering (3,829,500 Common Shares
if the Underwriters' over-allotment option is exercised in full) will be freely
tradable by persons other than "affiliates" of Rock, as that term is defined in
Rule 144 under the Securities Act of 1933, as amended (the "Securities Act"),
without restriction under the Securities Act. Ninety days after the date of this
Prospectus, 10,000,000 Common Shares could become eligible for sale pursuant to
the provisions of Rule 144. However, the holders of these shares and
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<PAGE> 23
certain persons purchasing Common Shares pursuant to the Directed Share Program
have agreed with the Underwriters not to offer such shares for sale, or sell,
pledge or grant an option to purchase such shares, for a period of 180 days from
the date of this Prospectus without the prior written consent of the
representative of the Underwriters. As of March 31, 1998, options to purchase
2,447,184 Common Shares were outstanding under Rock's 1996 Stock Option Plan,
which will vest on various dates extending through 2002. At the closing of the
Offering, options to purchase 3,005,684 Common Shares will be outstanding.
Pursuant to Rule 701 under the Securities Act, beginning 90 days after the
effective date of this Prospectus, shares acquired upon exercise of some of such
options may be resold pursuant to Rule 144 without compliance with the current
public information, holding period, volume limitation or Form 144 filing
requirements. Sales of substantial numbers of such shares in the public market,
or the perception that such sales could occur, could adversely affect the market
price of the Common Shares. However, the holders of some of these options have
agreed with the Underwriters not to offer Common Shares they may acquire upon
exercise of such options for sale, or sell, pledge or grant an option to
purchase such shares, for a period of 180 days from the date of this Prospectus
without the prior written consent of the representative of the Underwriters.
Rock has reserved up to 4,500,000 Common Shares for issuance upon exercise of
options under Rock's 1996 Stock Option Plan. See "Shares Eligible for Future
Sale" and "Underwriting."
CONTROL OF ROCK BY DANIEL GILBERT
Daniel Gilbert will beneficially own 52.9%, and will have voting control
pursuant to a Shareholders Agreement over 75.0%, of the outstanding Common
Shares of Rock after the closing of the Offering (51.0% and 72.3%, respectively,
if the Underwriters' over-allotment option is exercised in full). Accordingly,
Mr. Gilbert will have effective control of Rock, with the ability to approve
fundamental corporate transactions, including mergers, share exchanges and sales
of assets, and to elect the members of the Board of Directors. See "Principal
and Selling Shareholders." In addition, as long as Mr. Gilbert is the
controlling shareholder of Rock, third parties will not be able to gain control
of Rock through purchases of Common Shares not beneficially owned or otherwise
controlled by Mr. Gilbert. Accordingly, the price of the Common Shares will not
reflect any premium which may be attributable to such ability to exercise or
obtain control over Rock.
POTENTIAL ANTI-TAKEOVER EFFECTS OF CHARTER, BYLAW, CONTRACT AND STATUTORY
PROVISIONS
The Board of Directors has the authority, pursuant to Rock's Restated
Articles of Incorporation and without further approval of Rock's shareholders,
to issue preferred shares (the "Preferred Shares") having such rights,
preferences and privileges as the Board of Directors may determine. Any such
issuance of Preferred Shares could, under certain circumstances, have the effect
of delaying or preventing a change in control of Rock and may adversely affect
the rights of holders of Common Shares. In addition, Rock is subject to Michigan
statutes regulating business combinations, takeovers and control share
acquisitions which might also hinder or delay a change in control of Rock.
Anti-takeover provisions that could be included in the Preferred Shares when
issued and the Michigan statutes regulating business combinations, takeovers and
control share acquisitions can have a depressive effect on the market price of
Rock's securities and can limit shareholders' ability to receive a premium on
their shares by discouraging takeover and tender offer bids, even if such events
could be viewed as beneficial by Rock's shareholders. See "Description of
Capital Stock."
The Directors of Rock serve staggered three-year terms, and Directors may
not be removed without cause. The Articles of Incorporation also set the minimum
and maximum number of Directors constituting the entire Board at three and
fifteen, respectively, and require approval of holders of 90% of Rock's voting
shares to amend these provisions. In addition, Rock's bylaws require advance
notice of any nominations for director of Rock, along with information about the
nominee and the shareholder. These provisions could have an anti-takeover effect
by making it more difficult to acquire Rock by means of (i) a tender offer, a
proxy contest or otherwise and (ii) the removal of incumbent officers and
Directors. These provisions could delay, deter or prevent a tender offer or
takeover attempt that a shareholder might consider in his or her best interests,
including those attempts that might result in a premium over the market price
for the shares held by Rock's shareholders.
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In addition, the Company's warehouse line of credit currently requires the
consent of the agent to any change in any material respect in the Company's
executive management, ownership or control of its operations. This provision
could delay, deter or prevent a tender offer or takeover attempt that a
shareholder might consider in his or her best interests, unless the acquiror has
alternative financing or obtains such consent.
YEAR 2000 COMPLIANCE
Rock is engaging a consultant to manage the testing of its equipment and
software to determine whether it is year-2000 compliant and to identify and
resolve any problems discovered. Rock also plans to explore the strategies of
its vendors to discover and resolve any year-2000 problems. Although most of
Rock's hardware and software is less than two years old, because of Rock's
reliance on its technology and systems and the sophistication of its systems,
any significant problems discovered could be expensive, time consuming or both
to fix, and any errors caused by Rock's or its vendors' year-2000 hardware or
software problems could result in liability to Rock. Any of these problems could
have a material adverse effect on Rock's business, financial condition and
results of operations.
RESTRICTIONS ON DIVIDENDS
Under Rock's warehouse line of credit, Rock's ability to pay cash dividends
is limited by requirements that it maintain a minimum tangible effective net
worth, a maximum leverage ratio, a minimum ratio of current assets to current
liabilities, and minimum working capital.
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TERMINATION OF S CORPORATION STATUS
Since March 1, 1992, Rock has elected to be treated for federal income tax
purposes as an S corporation under Subchapter S of the Code and as an S
corporation for certain state corporate income tax purposes under certain
comparable state laws. As a result, Rock's historical earnings since March 1,
1992 have been taxed directly to Rock's shareholders, at their individual
federal and state income tax rates, rather than to Rock (except for certain
state taxes). Upon the issuance of Common Shares at the closing of the Offering,
Rock's S corporation status will terminate, and Rock will become subject to
federal and state income taxation as a C corporation. At that time, Rock will
record a deferred tax asset on its balance sheet, the amount of which will
depend upon timing differences between tax and book accounting relating
principally to marking loans to market for tax purposes. If the S corporation
status had terminated as of March 31, 1998, the amount of the deferred tax asset
would have been approximately $1.8 million. See "Capitalization."
Since March 1, 1992, Rock has made distributions to shareholders of a
portion of Rock's income primarily to permit the shareholders to pay their taxes
on such income. The aggregate amount of distributions to shareholders, however,
has been less than the aggregate amount of taxable income of Rock during this
period. The amount of this previously earned and undistributed taxable income
(including estimated taxable income up to the closing of the Offering, with
provision for adjustment based on the final determination of such taxable
income) will be distributed to the Existing Shareholders out of the net proceeds
of the Offering promptly following the closing of the Offering. The Shareholder
Distribution Amount as of March 31, 1998 after giving effect to the $5.4 million
tax distribution to Existing Shareholders on April 10, 1998 would have been
approximately $17.0 million, and it is expected to increase by the time of the
distribution as a result of additional S corporation income.
Rock and the Existing Shareholders have entered into a Tax Indemnification
Agreement (the "Tax Agreement") relating to their respective income tax
liabilities. Because Rock will be fully subject to corporate income taxation
after termination of Rock's S corporation status, any reallocation of income and
deductions between the period during which Rock was treated as an S corporation
and the period during which Rock will be subject to corporate income taxation
may increase the taxable income of one party while decreasing that of another
party. Accordingly, the Tax Agreement is intended to ensure that taxes are borne
either by Rock or the Existing Shareholders to the extent that such parties
received the related income. The Tax Agreement generally provides that, if an
adjustment is made to the taxable income of Rock for a year in which it was
treated as an S corporation, each party will indemnify the other against any
increase in the indemnified party's income tax liability, including interest and
penalties, with respect to such tax year to the extent such increase results in
a related decrease in the income tax liability, including interest and
penalties, of the indemnifying party (whether with respect to the year of the
adjustment or over future years).
Rock will also indemnify the Existing Shareholders for all taxes imposed
upon them as the result of an indemnification payment under the Tax Agreement.
Rock currently does not believe that there is any amount that it will be
required to indemnify the Existing Shareholders for taxes imposed on them
pursuant to the Tax Agreement. The Tax Indemnification Agreement only requires
indemnification if there is a reallocation of income or deductions between the S
corporation period and the C corporation period. Therefore, indemnification will
only only occur if Rock's determination of income and deductions turns out to be
incorrect, for example, as a result of an audit by the Internal Revenue Service.
Any payment made by Rock to the Existing Shareholders pursuant to the Tax
Agreement may be considered by the Internal Revenue Service or state taxing
authorities to be non-deductible by Rock for income tax purposes. None of the
parties' obligations under the Tax Agreement is secured, and, therefore, there
can be no assurance that the Existing Shareholders or Rock will have funds
available to make any payments which may become due under the Tax Agreement. A
copy of the Tax Agreement has been filed by Rock as an exhibit to the
Registration Statement of which this Prospectus is a part and should be read in
its entirety by prospective investors in this Offering.
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<PAGE> 26
USE OF PROCEEDS
The net proceeds to Rock from the sale of the 3,000,000 Common Shares
offered by Rock by this Prospectus are estimated to be $26,600,000 ($31,245,350
if the Underwriters' over-allotment option is exercised in full), after
deducting the underwriting discount and estimated Offering expenses payable by
Rock, at the initial public offering price of $10.00 per Common Share. Rock will
not receive any proceeds from the sale of Common Shares by the Selling
Shareholders, but it will receive approximately $1.5 million of proceeds from
the options exercised by the Selling Shareholders to acquire the shares they are
selling.
The net proceeds of the Offering will be used (i) to pay the Shareholder
Distribution Amount ($17.0 million calculated as of March 31, 1998 after giving
effect to the $5.4 million tax distribution to Existing Shareholders on April
10, 1998) to the Existing Shareholders in connection with termination of Rock's
status as an S corporation (see "Termination of S Corporation Status"), and (ii)
to repay a portion of the amounts outstanding under Rock's warehouse line of
credit used to finance, and secured by, a portion of Rock's inventory of loans
(approximately $9.6 million based on the March 31, 1998 Shareholder Distribution
Amount, as adjusted for the April 10, 1998 tax distribution). The Shareholder
Distribution Amount is expected to increase by the distribution date as a result
of additional S corporation income, and, therefore, the proceeds used to repay a
portion of the warehouse line of credit are expected to decrease. Although not
required to do so, Daniel Gilbert expects to repay the balance of his loans from
Rock ($1.6 million as of March 31, 1998) with his share of the Shareholder
Distribution Amount, and Rock expects to use that cash to repay a portion of the
amounts outstanding under its warehouse line of credit.
Rock's warehouse line of credit currently provides for up to $150 million
principal amount of demand loans. The loans bear interest at rates that vary,
depending on the type of underlying loan, from the bank's prime rate to 1.5% to
2.5% over the federal funds rate (resulting in a weighted average interest rate
of 6.94% during 1997). The warehouse line of credit expires, with respect to
loans committed to be made by any particular lender, 75 days after that lender
demands payment, unless that lender is replaced. Borrowings under the warehouse
line of credit are used to fund loans closed by Rock. As of March 31, 1998, Rock
had borrowed $68.8 million under this facility.
Rock might use some of the net proceeds of the Offering or other cash for
possible acquisitions of other businesses engaged in retail origination of
consumer loans. Although the Company regularly reviews potential acquisition
opportunities, it has not entered into a letter of intent or definitive
agreement with any acquisition candidates and there can be no assurance that
Rock will enter into any such agreements or acquire any acquisition candidates.
See "Business -- Business Strategy."
Pending their ultimate application, the net proceeds to Rock from the
Offering will be invested in short-term, investment grade, interest-bearing
securities, deposit accounts or both.
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CAPITALIZATION
The following table sets forth, as of December 31, 1997, (i) the actual
capitalization of Rock, and (ii) the pro forma capitalization of Rock as
adjusted to give effect to the conversion of Rock from an S corporation to a C
corporation, to the receipt by Rock of approximately $1.5 million upon exercise
by the Selling Shareholders of 330,000 options at $4.68 a share to acquire the
Common Shares they are selling in the Offering, to the sale of the Common Shares
offered by Rock by this Prospectus at the initial public offering price of
$10.00 per share, and to the application of the estimated net proceeds to Rock
therefrom. This table should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Financial Statements and Notes to Financial Statements included elsewhere in
this Prospectus. See "Termination of S Corporation Status" and "Use of
Proceeds."
<TABLE>
<CAPTION>
DECEMBER 31, 1997
--------------------------
ACTUAL AS ADJUSTED(1)
------ --------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
SHORT-TERM DEBT:
Warehouse line of credit.................................... $ 79,294 $ 67,523
Reverse repurchase agreement................................ 18,161 18,161
Notes payable............................................... 1,945 1,945
Drafts payable.............................................. 21,875 21,875
-------- --------
Total short-term debt.................................. $121,275 $109,504
======== ========
SHAREHOLDERS' EQUITY:
Preferred shares, authorized, 1,000,000 shares of $.01 par
value; no shares issued or outstanding.................... -- --
Common Shares; authorized, 50,000,000 shares of $.01 par
value; issued and outstanding, 10,000,000 shares at
December 31, 1997 (13,330,000 shares, as adjusted)........ 100 133
Additional paid-in capital.................................. 1,424 29,535
Retained earnings (deficit)................................. 13,584 (2,716)
-------- --------
Total shareholders' equity and total capitalization.... $ 15,108 $ 26,952
======== ========
</TABLE>
- -------------------------
(1) Assumes that the estimated net proceeds of this Offering are applied as
described in "Use of Proceeds" and "Termination of S Corporation Status."
Also reflects (i) the creation of a deferred tax asset in the amount of $1.7
million (calculated as of December 31, 1997) arising in connection with the
termination of Rock's S corporation status, and (ii) the receipt by Rock of
approximately $1.5 million upon exercise by the Selling Shareholders of
330,000 options at $4.68 a share to acquire the Common Shares they are
selling in the Offering. In addition, although not required to do so, Daniel
Gilbert expects to repay the balance of his loans from Rock ($1.6 million as
of December 31, 1997) with his share of the Shareholder Distribution Amount,
and Rock expects to use that cash to repay a portion of the amounts
outstanding under its warehouse line of credit. The adjustments include the
reduction in the amounts outstanding under the warehouse line of credit as a
result of such use of cash. See "Termination of S Corporation Status," "Use
of Proceeds" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
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DIVIDEND POLICY
Rock expects that it will pay a quarterly dividend of $.02 per share
beginning in the second quarter of 1998. Even if Rock begins paying such a
dividend, it may discontinue it at any time or it may change the amount of the
dividend at any time. Any determination to pay dividends at all or to change the
amount of any dividend will depend on Rock's financial condition, capital
requirements, results of operations, contractual limitations and any other
factors deemed relevant by the Board of Directors. Under Rock's warehouse line
of credit, Rock's ability to pay cash dividends is limited by requirements that
it maintain a minimum tangible effective net worth, a maximum leverage ratio, a
minimum ratio of current assets to current liabilities, and minimum working
capital.
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DILUTION
Purchasers of the Common Shares offered hereby will experience an immediate
and substantial dilution in the net tangible book value of the Common Shares
from the initial public offering price. The net tangible book value of Rock as
of December 31, 1997 was approximately $15,108,136, or $1.51 per Common Share
based on 10,000,000 Common Shares outstanding. The net tangible book value per
share represents the amount of total assets less liabilities, excluding
intangible assets, divided by the number of Common Shares outstanding. After
giving effect to (i) the sale by Rock of 3,000,000 Common Shares offered in the
Offering at the initial public offering price of $10.00 per share, after
deducting the underwriting discount and estimated Offering expenses, (ii) the
receipt by Rock of approximately $1.5 million upon exercise by the Selling
Shareholders of 330,000 options at $4.68 a share to acquire the Common Shares
they are selling in the Offering, (iii) the Shareholder Distribution Amount of
an aggregate of $18.0 million (calculated as of December 31, 1997 and expected
to increase by the distribution date), (iv) the creation of a deferred tax asset
in the amount of $1.7 million (calculated as of December 31, 1997) arising in
connection with the termination of Rock's S corporation status, and (v) the
application of the rest of the estimated net proceeds as described under "Use of
Proceeds," the pro forma net tangible book value of Rock as of December 31, 1997
would have been approximately $26,952,536, or $2.02 per share. This represents
an immediate increase in pro forma net tangible book value of $0.51 per share to
existing shareholders of Rock and an immediate and substantial dilution of $7.98
per share to new investors purchasing shares in the Offering. The following
table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price............................... $10.00
Net tangible book value as of December 31, 1997........... $ 1.51
Decrease due to payment of Shareholder Distribution
Amount................................................. (1.80)
Increase due to deferred tax asset........................ 0.17
Increase due to option exercise........................... 0.15
Increase attributable to new investors.................... 1.99
------
Pro forma net tangible book value after Offering............ 2.02
------
Dilution to new investors................................... $ 7.98
======
</TABLE>
The following table sets forth on a pro forma basis as of December 31, 1997
the difference between existing shareholders and the purchasers of shares in the
Offering with respect to the number of shares issued by Rock and owned by them,
the total consideration received by Rock for those shares and the average price
paid per share:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
-------------------- --------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
------ ------- ------ ------- ---------
<S> <C> <C> <C> <C> <C>
Existing shareholders.................... 10,000,000 75.0% $ 1,523,750 4.6% $ 0.15
Option holders........................... 330,000 2.5% 1,544,400 4.7% $ 4.68
New public investors..................... 3,000,000 22.5% 30,000,000 90.7% $10.00
---------- ----- ----------- -----
Total.................................. 13,330,000 100.0% $33,068,150 100.0%
========== ===== =========== =====
</TABLE>
The information and tables above exclude the effect of (i) 2,497,184 Common
Shares subject to options outstanding at a weighted average exercise price of
$4.86 per share as of December 31, 1997, and (ii) options to purchase up to an
additional 2,007,816 Common Shares available for issuance under Rock's 1996
Stock Option Plan. To the extent outstanding options are exercised, there may be
further dilution to new investors. The 330,000 Common Shares being sold by the
Selling Shareholders will be acquired by them on the closing date of this
Offering upon exercise of stock options previously granted to them, and Rock has
granted to them, effective as of the closing date of this Offering, immediately
exercisable replacement options to purchase 450,000 Common Shares at the initial
public offering price of the Common Shares in this Offering. See
"Capitalization." Rock will receive approximately $1.5 million of proceeds from
the options exercised by the Selling Shareholders to acquire the shares they are
selling.
27
<PAGE> 30
SELECTED FINANCIAL DATA
The following table sets forth selected financial information of Rock as of
December 31, 1993, 1994, 1995, 1996 and 1997, and for each of the five years in
the period ended December 31, 1997. The historical income statement and balance
sheet data are derived from the audited financial statements of Rock, certain of
which appear elsewhere in this Prospectus together with the report of KPMG Peat
Marwick LLP, independent auditors, covering the years 1995, 1996 and 1997. The
historical income statement and balance sheet data for 1993 and 1994 were
audited by Rock's former auditors. The selected financial data should be read in
conjunction with the financial statements and notes thereto and with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this Prospectus.
SUMMARY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,(1)
------------------------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Revenue:
Interest income..................................... $ 2,724 $ 2,310 $ 3,003 $ 4,267 $ 8,083
Interest expense.................................... 1,819 1,746 3,012 3,669 5,150
------- ------- ------- ------- ----------
Net interest margin............................... 905 564 (9) 598 2,933
Provision for credit losses......................... -- -- -- -- (300)
------- ------- ------- ------- ----------
Net interest margin after provision for credit
losses.......................................... 905 564 (9) 598 2,633
Loan fees and gains and losses on sale of
mortgages......................................... 16,251 10,348 17,788 27,960 47,084
Net gain on sale of mortgage servicing(2)........... -- 2,465 5,728 -- --
Net gain (loss) on sale of marketable
securities(3)..................................... 356 (202) 346 991 2,222
Other income........................................ 677 1,348 399 6 171
------- ------- ------- ------- ----------
18,189 14,523 24,252 29,555 52,110
------- ------- ------- ------- ----------
Expenses:
Salaries, commissions and employee benefits......... 10,306 9,514 11,272 16,425 24,811
Stock and option holders' bonuses................... 2,026 142 546 2,297 1,592
General and administrative expenses................. 2,761 3,159 3,726 4,646 7,630
Marketing expenses.................................. 967 1,465 1,339 2,393 5,370
Depreciation and amortization....................... 390 510 506 663 1,292
------- ------- ------- ------- ----------
16,450 14,790 17,388 26,424 40,695
------- ------- ------- ------- ----------
Net income (loss)................................. 1,739 (267) 6,863 3,131 11,415
Pro forma income tax expense (benefit)(4)............. 626 (96) 2,471 1,127 4,109
------- ------- ------- ------- ----------
Pro forma net income (loss)....................... $ 1,113 $ (171) $ 4,392 $ 2,004 $ 7,306
======= ======= ======= ======= ==========
PER SHARE INFORMATION:
Pro forma net income per share:
Basic............................................. $0.55
==========
Diluted........................................... $0.51
==========
Weighted average number of shares outstanding:
Basic............................................. 13,330,000
==========
Diluted........................................... 14,282,914
==========
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,(1)
------------------------------------------------------
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
SELECTED BALANCE SHEET DATA:
Cash and cash equivalents............................. $ 1,254 $ -- $ 686 $ 3,289 $ 11,947
Mortgage loans held for sale.......................... 77,456 26,717 73,996 85,009 121,344
Other assets.......................................... 5,440 8,173 19,613 12,062 11,138
Total assets.......................................... 84,150 34,890 94,295 100,360 144,429
Warehouse financing facilities........................ 47,206 15,732 64,107 67,621 97,455
Drafts payable and other liabilities.................. 31,805 12,885 13,661 20,393 31,866
Shareholders' equity.................................. 5,859 6,273 16,527 12,346 15,108
</TABLE>
(footnotes continued on next page)
28
<PAGE> 31
- -------------------------
(1) Rock commenced operations in its Fresh Start(TM) division in 1994 and
commenced current operations in its Specialty Lending division in 1997. Of
the 14 Fresh Start(TM) stores open at December 31, 1997, nine were opened
during 1997 (eight of which were opened since July 1, 1997).
(2) During 1993 and 1994, Rock elected to retain, rather than sell, the
servicing rights to its loans and received lower sales prices as a result.
In 1994 Rock sold some of its servicing rights, and in 1995 Rock sold all of
its remaining servicing rights and recognized a net gain on the sale of
servicing rights. In 1996 and 1997, Rock sold its loans servicing released.
(3) Before the end of 1997, Rock invested some of its excess cash in marketable
securities. During 1995, 1996 and 1997, Rock sold a portion of its portfolio
of marketable securities and recognized net gains of $346,000, $991,000 and
$2,222,000, respectively.
(4) Pro forma income taxes reflect adjustments for federal and state income
taxes as if Rock had been taxed as a C corporation rather than an S
corporation. See "Termination of S Corporation Status." No pro forma
adjustments have been made for the non-recurring net gains on sales of
marketable securities and stock and option holders' bonuses, or estimated
earnings from the net proceeds received from the Offering.
29
<PAGE> 32
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following analysis of the financial condition and results of operations
of Rock should be read in conjunction with the preceding "Selected Financial
Data." Additionally, Rock's financial statements and notes thereto, as well as
other data included in this Prospectus, should be read and analyzed in
combination with the analysis below. With the exception of historical
information, certain of the matters discussed in this Prospectus are
forward-looking statements that involve risks and uncertainties and actual
results could differ materially from those discussed. The words and phrases
"should be," "will be," "predicted," "believe," "expect," "anticipate" and
similar expressions identify forward-looking statements. These forward-looking
statements reflect Rock's current views in respect of future events in financial
performance, but are subject to many uncertainties and factors relating to
Rock's operations and business environment which may cause its actual results to
differ materially from any future results expressed or implied by such
forward-looking statements.
GENERAL
Rock is a specialty finance company marketing conventional and sub-prime
debt consolidation and home financing loans, secured primarily by first or
second mortgages on one- to four-family, owner-occupied residences. The Company
originates loans through 26 stores and branches, one marketing center and one
call center. Founded in 1985 by its current Chief Executive Officer and Chairman
of the Board, Daniel Gilbert, Rock originates 100% of its loans through its
retail operations, marketing its loans directly to consumers. The Company uses
proprietary marketing methods and technology to increase its market penetration.
Rock seeks to provide "world class" service to its customers, thereby
encouraging them to return for future loans and refer others to Rock for loans.
The Company also focuses on recruiting, developing and motivating talented
people, recruited from inside and outside the consumer finance industry, to
implement its business strategies. Rock believes it is creating growing brand
identities and a retail franchise that will sustain its loan origination
efforts.
Rock currently operates through three major divisions. Rock originates
Sub-Prime Home Equity Loans to individuals with impaired credit characteristics,
high levels of debt service to income, unfavorable past credit experience,
limited credit history, limited employment history or unverifiable income
through its Fresh Start(TM) division, created in 1994. Rock originates home
equity second mortgage loans to individuals with good credit histories but
little or no equity in their homes through its Specialty Lending division, which
commenced its current operations in March 1997. Since its inception in 1985,
Rock has originated Conventional Loans that generally conform to FNMA or Freddie
Mac underwriting standards, or that generally meet such standards except for
maximum loan size guidelines, through its Conventional Mortgage Lending
division. In addition, Rock began to increase its government-insured lending
operations in 1997, primarily making mortgage loans that meet the underwriting
standards for FHA insurance.
SEGMENT ANALYSIS
Rock's recent and rapid growth may have a distortive impact on some of
Rock's ratios and financial statistics and may make period-to-period comparisons
difficult. In light of Rock's growth, historical performance of Rock's earnings
may be of little relevance in predicting future performance. Furthermore, Rock's
financial statistics may not be indicative of Rock's results in future periods.
During 1997, Rock's growth and expansion of its Fresh Start(TM) store
network, the timing difference between loan closings and loan sales and the
seasonality of Rock's business caused its quarterly results to vary
significantly. The timing difference between loan closings and loan sales was
more significant in the third and fourth quarters of 1997, with larger bulk
sales of Fresh Start(TM) loans. The store openings created operating expenses
that were absorbed by the earnings of the then existing store network. A new
store opening requires Rock to incur monthly expenses in excess of revenues
generated by the new store until enough loans are closed for the store to reach
break-even. For a description of the average closings per store during 1997, see
"Business -- Operating Divisions -- Fresh Start(TM) Division -- Fresh Start(TM)
Stores."
30
<PAGE> 33
The following table shows the contribution to revenues and expenses of each
of Rock's divisions for the fourth quarter of fiscal 1996, for each quarter of
fiscal 1997 and for the first quarter of fiscal 1998:
<TABLE>
<CAPTION>
QUARTER QUARTER
ENDED YEAR ENDED DECEMBER 31, 1997 ENDED
DECEMBER 31, ---------------------------------------------------------- MARCH 31,
1996 1ST QTR. 2ND QTR. 3RD QTR. 4TH QTR. TOTAL 1998
------------ -------- -------- -------- -------- ----- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
FRESH START(TM):
Revenue................... $ 3,938.8 $ 3,570.8 $ 6,365.9 $ 6,677.5 $ 9,323.9 $ 25,938.1 $ 9,275.6
Expenses.................. (2,782.3) (2,479.4) (3,033.3) (4,520.6) (5,865.4) (15,898.7) (5,856.3)
--------- --------- --------- --------- --------- ---------- ---------
Division contribution... 1,156.5 1,091.4 3,332.6 2,156.9 3,458.5 10,039.4 3,419.3
--------- --------- --------- --------- --------- ---------- ---------
SPECIALTY LENDING:
Revenue................... -- 79.5 1,267.1 2,293.9 3,405.3 7,045.8 2,753.8
Expenses.................. -- (188.5) (593.9) (1,221.3) (1,751.0) (3,754.7) (1,841.1)
--------- --------- --------- --------- --------- ---------- ---------
Division contribution... -- (109.0) 673.2 1,072.6 1,654.3 3,291.1 912.7
--------- --------- --------- --------- --------- ---------- ---------
CONVENTIONAL MORTGAGE
LENDING:
Revenue................... 3,761.2 3,796.5 3,548.4 3,938.0 5,050.7 16,333.6 6,663.1
Expenses.................. (2,754.3) (2,261.0) (2,128.5) (2,869.3) (3,099.3) (10,358.1) (3,807.2)
--------- --------- --------- --------- --------- ---------- ---------
Division contribution... 1,006.9 1,535.5 1,419.9 1,068.7 1,951.4 5,975.5 2,855.9
--------- --------- --------- --------- --------- ---------- ---------
Other revenue (loss)...... (806.4) 867.5 200.5 1,703.9 20.6 2,792.7 228.3
Other expenses............ (1,861.4) (2,263.9) (2,405.5) (2,837.8) (3,175.9) (10,683.1) (3,313.9)
--------- --------- --------- --------- --------- ---------- ---------
Pre-tax income (loss)... $ (504.4) $ 1,121.5 $ 3,220.7 $ 3,164.3 $ 3,908.9 $ 11,415.4 $ 4,102.3
========= ========= ========= ========= ========= ========== =========
</TABLE>
See "Prospectus Summary -- Recent Developments" for a discussion of the
contribution to revenues and expenses of each of Rock's divisions for the first
quarter of fiscal 1998.
The Fresh Start(TM) division began to sell loans by bulk sales in the
second quarter of 1997. Bulk sales generate higher premiums than sales of
individual loans. In addition, the principal amount of loan sales in the second
quarter increased 71% over the first quarter. There can be no assurance that the
rate of growth in originations and sales of Sub-Prime Home Equity Loans or the
premiums received on sales of such loans in 1997 will continue at the same
levels in 1998. See "Risk Factors -- Dependence on Loan Sales." The nine stores
opened during 1997 incurred approximately $1.8 million of expenses in excess of
revenues in the third and fourth quarters of 1997. In addition, the Fresh
Start(TM) division opened five more stores in the first quarter of 1998. The
direct costs for these new stores started late in the fourth quarter of 1997.
During the fourth quarter, the principal amount of loan sales increased by 44%
over the third quarter. The 1997 revenues were reduced by the provision for
premium recapture of approximately $600,000 for the estimated amount of premium
recapture associated with loans that prepay within the first year after sale.
For a description of risks involving the Fresh Start(TM) division's Texas
stores, see "Risk Factors -- Risks of Sub-Prime Loans in Texas."
Because 13 stores, one marketing center and two branches have opened since
July 1, 1997 (including four stores in the fourth quarter of 1997, five stores
in January 1998 and two branches in the second quarter of 1998), Rock expects
these stores and branches to contribute significantly less to its revenues and
net income and more to its expenses in the first and possibly the second and
third quarters of 1998 than stores that have been in operation for at least
twelve months. The stores opened in January 1998 and some of the stores opened
late in 1997 operated at a net loss aggregating approximately $1.6 million in
the first quarter of 1998. "Stores" are Fresh Start(TM) division locations and
"branches" are Conventional Mortgage Lending division locations.
The Specialty Lending division commenced its current operations in the
first quarter of 1997. The staffing and expenses of the start-up were incurred
in the first quarter of 1997 with minimal contribution to revenues. The
subsequent quarters demonstrated a consistent contribution as a percent of
revenues. There can be no assurance that the rate of growth in originations and
sales of High LTV Loans or the premiums received on sales of such loans in 1997
will continue at the same levels in 1998. See "Risk Factors -- Dependence on
Loan Sales."
31
<PAGE> 34
The Conventional Mortgage Lending division increased its loan officers from
the first quarter to the third quarter of 1997. Additionally, a branch was
opened in Michigan during the fourth quarter and two branches were opened in the
second quarter of 1998. The impact of some of these costs to expand this
division are reflected in the third and fourth quarter expenses of the
Conventional Mortgage Lending division. Rock's Conventional Mortgage Lending
division's revenues and division contribution increased in the fourth quarter
due to increased production resulting, in part, from the favorable interest rate
environment.
Other revenue includes the net contribution from sales of marketable
securities and government insured lending. Most of the $2.8 million of other
revenue consisted of non-recurring gains on the sale of marketable securities
held for sale, all of which were sold by December 31, 1997.
Other expenses include expenses not directly allocable to a particular
division, such as the costs associated with Rock's legal, marketing, facilities,
information services, executive, human resources, secondary marketing and
general and administrative support teams. Included in other expenses was
approximately $1.6 million of bonuses to Rock's shareholders and option holders;
Rock does not intend to pay aggregate bonuses of that magnitude to these persons
for 1998. Other expenses in the third and fourth quarters also include increases
in costs of recruiting management members, costs of temporary employees, and
increased depreciation and travel expenses as compared to the first half of
1997.
TERMINATION OF S CORPORATION STATUS AND INCOME TAXES
Simultaneously with the closing of the Offering, Rock will cease to be
taxed as an S corporation under the Code. In connection with the termination of
its S corporation status, Rock will pay the Shareholder Distribution Amount out
of the net proceeds of this Offering to the Existing Shareholders. The
Shareholder Distribution Amount would have been $17.0 million calculated as of
March 31, 1998 after giving effect to the $5.4 million tax distribution to
Existing Shareholders on April 10, 1998. The Shareholder Distribution Amount is
expected to increase by the distribution date as a result of additional S
corporation income. See "Use of Proceeds" and "Termination of S Corporation
Status."
As an S corporation, Rock's income, whether or not distributed, was taxed
at the shareholder level for federal and state tax purposes. Upon termination of
its S corporation status, Rock will be subject to federal and state income
taxation and will record a deferred tax asset on its balance sheet. The amount
of the deferred tax asset to be recorded as of the date of termination of the S
corporation status will depend upon timing differences between tax and book
accounting relating principally to marking loans to market for tax purposes. If
the S corporation status had been terminated as of March 31, 1998, the amount of
the deferred tax asset would have been approximately $1.8 million. The pro forma
provision for income taxes in the selected consolidated financial data shows
results as if Rock had been subject to federal and state taxation at the tax
rates effective for the periods presented.
RESULTS OF OPERATIONS
FISCAL YEAR ENDED DECEMBER 31, 1997 VERSUS FISCAL YEAR ENDED DECEMBER 31, 1996
The following table sets forth the revenues and expenses and pre-tax income
for Rock for the years ended December 31, 1996 and 1997:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1996 1997
---- ----
(IN THOUSANDS)
<S> <C> <C>
Total revenue before gains on sale of marketable
securities................................................ $ 28,564 $ 49,888
Net gain on sale of marketable securities................... 991 2,222
-------- --------
Total revenue............................................... 29,555 52,110
Total expenses.............................................. (26,424) (40,695)
-------- --------
Pre-tax income.............................................. 3,131 11,415
Add back stock and option holders' bonuses.................. 2,297 1,592
-------- --------
Pre-tax income before stock and option holders' bonuses..... $ 5,428 $ 13,007
======== ========
</TABLE>
32
<PAGE> 35
Rock's total revenues increased to $52.1 million in 1997 from $29.6 million
in 1996, an increase of $22.5 million, or 76.3%, which included a net increase
of $1.2 million in gains on sales of marketable securities over 1996. Excluding
gains on sales of marketable securities, Rock's total revenues increased to
$49.9 million in 1997 from $28.6 million in 1996, an increase of $21.3 million,
or 74.7%. The increase in revenues is primarily due to (i) an increased portion
of the loans closed by Rock consisting of Sub-Prime Loans (27.5% of the total
dollar volume of loans closed in 1997, compared to 13.7% in 1996), which have
higher origination fees and with respect to which Rock receives a higher premium
on sale than Rock's Conventional Loans, (ii) an increase of $121.6 million, or
82.3%, in the volume of Sub-Prime Home Equity Loans closed by Rock in 1997, and
(iii) an increase in bulk sales of loans (which generally resulted in higher
premiums than sales of individual loans). In 1997, the Fresh Start(TM)
division's revenues as a percentage of total revenue increased to 49.8%,
compared to 40% in 1996.
Total expenses increased from $26.4 million in 1996 to $40.7 million in
1997, an increase of $14.3 million, or 54.0%, primarily due to increased
commissions, increased occupancy costs for store openings and increases in
general and administrative expenses that fluctuate with increases in volumes of
loans closed. As a result of the increased revenues, proportionally lower
expenses and lower bonuses, pre-tax income before stock and option holders'
bonuses increased 139.6%, from $5.4 million in 1996 to $13.0 million in 1997.
Because 13 stores, one marketing center and two branches have opened since
July 1, 1997 (including four stores in the fourth quarter of 1997, five in the
first quarter of 1998 and two branches in the second quarter of 1998), Rock
expects these stores and branches to contribute significantly less to its
revenues and net income and more to its expenses in the first and possibly the
second and third quarters of 1998 than stores that have been in operation for at
least twelve months. The stores opened in January 1998 and some of the stores
opened late in 1997 operated at a net loss aggregating approximately $1.6
million in the first quarter of 1998. Also, management believes that in part
because of the seasonality of its business, the trend in its quarterly revenue
and income growth during the four quarters of 1997 did not continue at the same
level in the first quarter of 1998. See "Business -- Seasonality."
Stock and option holders' bonuses decreased from $2.3 million in 1996 to
$1.6 million in 1997, a decrease of $0.7 million, or 30.7%. During 1996 and
1997, Rock paid bonuses to option holders in accordance with their employment
agreements. The agreements do not require these bonuses after December 31, 1997.
In addition, Rock paid bonuses to all three of its shareholders in 1996 and one
of its shareholders in 1997, partially in recognition of cumulative past
services. Rock does not intend to pay aggregate bonuses of this magnitude to
these persons for 1998.
The following table sets forth information regarding the components of
Rock's revenues for the years ended December 31, 1996 and 1997:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
--------------------
1996 1997
---- ----
(IN THOUSANDS)
<S> <C> <C>
Interest income............................................. $ 4,267 $ 8,083
Interest expense............................................ (3,669) (5,150)
------- -------
Net interest margin....................................... 598 2,933
Provision for credit losses................................. -- (300)
------- -------
Net interest margin after provision for credit losses..... 598 2,633
Loan fees and gains and losses on sale of mortgages......... 27,960 47,084
Net gain on sale of marketable securities................... 991 2,222
Other income................................................ 6 171
------- -------
Total revenue............................................. $29,555 $52,110
======= =======
</TABLE>
Net interest margin increased to $2.9 million in 1997 from $0.6 million in
1996, an increase of $2.3 million, or 390.0%. The increase was primarily due to
(i) the increase in the dollar volume of loans closed by
33
<PAGE> 36
Rock, and (ii) a change in the manner of selling loans from "flow" sales to
"bulk" sales and assignment of trade sales, resulting in an increase in the
length of time loans were held before sale, which allowed Rock to take advantage
of the positive net interest margin. "Flow" sales are sales of loans
underwritten by a third party who commits to purchase each individual loan its
underwriters approve. "Bulk" sales are sales of loans underwritten to Rock's
underwriting standards that are pooled and then sold to third parties for cash
by Rock. Assignment of trade sales are sales of Conventional Loans to a third
party who exchanges them with FNMA or Freddie Mac for their securities. The
increase in net interest margin is also due to (i) higher weighted average
interest rates charged on the loans as a result of the increased proportion of
Sub-Prime Loans, which generally have higher interest rates, (ii) a decrease in
the weighted average interest rates charged on Rock's borrowing facilities (from
7.26% in 1996 to 7.03% in 1997), and (iii) Rock's increased use of internally-
generated cash to fund its loans. Rock has employed, and expects to continue to
employ, strategies to attempt to increase its net interest margin, including
holding its loans longer before it sells them, closing a higher volume of loans,
closing a higher proportion of Sub-Prime Loans, which generally have higher
interest rates, negotiating lower borrowing rates and using available cash to
fund loans without borrowing additional money. Although this strategy enhances
Rock's net interest margin, it exposes Rock to a greater risk of delinquencies.
Loans that become delinquent generally cannot be sold to third parties,
increasing the likelihood of foreclosures and charge-offs.
Rock may be required to repurchase or substitute loans in the event of a
breach of representations and warranties, including any fraud or any
misrepresentation made during the loan origination process. Rock recorded a
provision for credit losses of $300,000 in 1997 for future repurchase or
substitution requirements relating to loans sold before December 31, 1997 and
credit risk for loans held for sale and investment. During 1997, two loans were
reclassified as real estate owned, resulting in a $30,000 charge against the
reserve.
Loan fees and gains and losses on sale of mortgages increased to $47.1
million in 1997 from $28.0 million in 1996, an increase of $19.1 million, or
68.4%. This increase is primarily due to an increased portion of the loans
closed by Rock consisting of Sub-Prime Loans, with respect to which Rock
receives higher loan fees and a higher premium on sale, and the introduction of
Specialty Lending in 1997, resulting in $66.0 million of High LTV Loans closed
in 1997 for which Rock also receives relatively higher loan fees and premiums on
sale, and the higher volume of loans closed in 1997. The dollar volume of
Sub-Prime Loans increased in 1997 compared to 1996 primarily as a result of an
increase in Fresh Start(TM) stores, loan officers, and marketing and the
beginning of Rock's Specialty Lending division in 1997. The average premium
received by Rock on all loans sold during 1997 also increased, primarily due to
changes in the way Rock sold its loans in 1997 and favorable market conditions.
Rock sold a majority of its Sub-Prime Loans through bulk sales, rather than on a
flow basis. In addition, Rock began selling its Conventional Loans pursuant to
assignments of trade, rather than on a flow basis.
The increase in loan fees and gains and losses on sale of mortgages was
partially offset by an increase in Rock's recapture reserve in 1997. Some
Sub-Prime Loan sales require Rock to return a portion of the premium received by
Rock on the sale of the loan if the loan is prepaid by the customer within the
first year after sale. Rock records a provision for this risk based on its
evaluation of the terms of its sale contracts and its assumptions concerning
prepayments. Rock increased its reserve, and decreased its loan fees and gains
and losses on sale of mortgages, by $603,000 for this risk in 1997, compared to
an increase of $317,000 in 1996. In addition, by increasing net interest margin
by holding loans for longer periods of time, Rock is subject to a higher risk of
delinquencies and resulting foreclosure losses.
Rock currently does not securitize its loans. Rock sells its loans in large
bulk and whole loan sales for cash premiums in the secondary market. If the
prices offered in the secondary market for Rock's loans decrease significantly
relative to the value Rock believes that it could receive by securitizing such
loans, Rock's management would consider securitizing its loans. If Rock began to
securitize its loans, it would be subject to the risks described in "Risk
Factors -- Risks of Securitization."
Rock currently services the loans it closes between the date of closing and
the date of sale of the loan and the related servicing. Through 1997, Rock sold
all of its loans servicing released (i.e., without retaining the right to
service the loan) or sells the loan servicing rights separately. Rock would
consider selling its loans with
34
<PAGE> 37
the servicing rights retained if it believes that the value of the servicing
rights is or may become significantly greater than secondary market buyers are
then willing to pay for them. If Rock sold loans with servicing retained, Rock
would recognize a gain on the sale equal to the difference between the carrying
value of the loan sold on Rock's balance sheet and the sum of (i) the cash
received in such sale, and (ii) the amount of an asset recorded on its balance
sheet in an initial amount equal to the present value of the servicing fees it
would expect to collect over the life of the loan (the "Servicing Asset"). If
Rock believes the value of the Servicing Asset in the secondary market becomes
high enough, Rock would consider selling its servicing rights as it did in 1994
and 1995. If Rock began to sell its loans with servicing retained, it would be
subject to the risks described in "Risk Factors -- Potential Originated Mortgage
Servicing Rights Risk."
Net gain on sale of marketable securities increased to $2.2 million in 1997
from $1.0 million in 1996, an increase of $1.2 million, or 124.2%. Before the
end of 1997, Rock had invested some of its excess cash in marketable securities.
During 1996 and 1997, Rock sold a portion of its portfolio of marketable
securities held for sale. No such marketable securities were held by Rock at
December 31, 1997, and, therefore, the gains on sales will not continue in the
future.
The following table sets forth information regarding the components of
Rock's expenses for the years ended December 31, 1996 and 1997:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1996 1997
---- ----
(IN THOUSANDS)
<S> <C> <C>
Salaries, commissions and employee benefits................. $16,425 $24,811
Stock and option holders' bonuses........................... 2,297 1,592
General and administrative expenses......................... 4,646 7,630
Marketing expenses.......................................... 2,393 5,370
Depreciation and amortization............................... 663 1,292
------- -------
Total expenses............................................ $26,424 $40,695
======= =======
</TABLE>
Salaries, commissions and employee benefits increased from $16.4 million in
1996 to $24.8 million in 1997, an increase of $8.4 million, or 51.1%. The
increase was primarily attributable to Rock hiring additional personnel in order
to generate increased levels of loan closings, increased compensation for new
management team members hired during 1997, and increased commissions due to
increased closings. Rock employed 399 persons as of December 31, 1996, compared
to 667 persons as of December 31, 1997, a 72.5% increase. These expenses are
expected to increase in 1998 as a result of additional employees hired in 1997
and expected to be hired in 1998 in connection with new stores and branches and
expansion of existing operations.
Stock and option holders' bonuses decreased from $2.3 million in 1996 to
$1.6 million in 1997, a decrease of $0.7 million, or 30.7%. During 1996 and
1997, Rock paid bonuses to option holders in accordance with their employment
agreements. The agreements do not require these bonuses after December 31, 1997.
In addition, Rock paid bonuses to all three of its shareholders in 1996 and one
of its shareholders in 1997, partially in recognition of cumulative past
services. Rock does not intend to pay aggregate bonuses of this magnitude to
these persons for 1998.
General and administrative expenses consist primarily of occupancy costs,
professional services, office expenses, automobile and delivery expenses and
other expenses, many of which vary with the volume of loan closings. General and
administrative expenses increased from $4.6 million in 1996 to $7.6 million in
1997, an increase of $3.0 million, or 64.2%. The increase was primarily
attributable to an increase in occupancy expenses as a result of opening nine
new Fresh Start(TM) stores and one marketing center in 1997 and one new
Conventional Mortgage Lending branch during 1997 and to significantly expanded
Specialty Lending activities in 1997. In addition, recruiting expenses increased
in 1997 primarily due to the opening of the new Fresh Start(TM) stores and the
hiring of new management team members. These expenses are expected to increase
in 1998 as a result of new stores and branches and expansion of existing
operations. Also, legal expenses increased in 1997 as a result of a
reorganization of some of Rock's employment and share ownership relationships in
1997.
35
<PAGE> 38
Marketing expenses increased from $2.4 million in 1996 to $5.4 million in
1997, an increase of $3.0 million, or 124.4%. Marketing expenses for the Fresh
Start(TM) and Specialty Lending divisions in 1997 increased $1.7 million, or
120.0%, and $1.2 million, or 100.0%, respectively, over 1996. The increase was
primarily attributable to Rock's greater marketing, both in existing markets and
in new markets to generate higher levels of loan closings, as well as the
marketing costs associated with the introduction of Rock's High LTV Loans. This
increase is primarily the result of Rock's increased focus on its Sub-Prime Loan
business, which required greater marketing related to new store openings, and
ongoing marketing. These expenses are expected to increase in 1998 in connection
with new stores and branches and expansion of existing operations into new
geographic markets.
Depreciation and amortization expenses increased from $0.7 million in 1996
to $1.3 million in 1997, an increase of $0.6 million, or 94.9%. The increase was
primarily attributable to Rock's purchase of a front-end origination computer
system in early 1997 and purchases of additional equipment and leasehold
improvements during 1997 for new stores. These expenses are expected to increase
in 1998 as a result of new stores and branches and expansion of existing
operations.
Upon completion of this Offering, Rock's tax status will change from that
of an S corporation to that of a C corporation. As a C corporation, Rock will be
subject to federal and state income taxation. As an S corporation, Rock's
taxable income is included in the individual returns of the shareholders.
FISCAL YEAR ENDED DECEMBER 31, 1996 VERSUS FISCAL YEAR ENDED DECEMBER 31, 1995
The following table sets forth the revenues and expenses and pre-tax income
for Rock for the years ended December 31, 1995 and 1996:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1995 1996
---- ----
(IN THOUSANDS)
<S> <C> <C>
Total revenue before gains on sale of mortgage
servicing and marketable securities....................... $18,178 $28,564
Net gain on sale of mortgage servicing...................... 5,728 --
Net gain on sale of marketable securities................... 346 991
------- -------
Total revenue............................................... 24,252 29,555
Total expenses.............................................. (17,389) (26,424)
------- -------
Pre-tax income.............................................. 6,863 3,131
Add back stock and option holders' bonuses.................. 546 2,297
------- -------
Pre-tax income before stock and option holders' bonuses..... $ 7,409 $ 5,428
======= =======
</TABLE>
Rock's total revenues increased to $29.6 million in 1996 from $24.3 million
in 1995, an increase of $5.3 million, or 21.9%, which included a net increase of
$0.6 million in gains on sales of marketable securities over 1995 and a gain on
the sale of servicing rights of $5.7 million in 1995. Excluding gains on sales
of marketable securities and the gain on the sale of servicing rights, Rock's
total revenues increased to $28.6 million in 1996 from $18.2 million in 1995, an
increase of $10.4 million, or 57.1%. The increase in revenues is primarily due
to (i) an increased portion of the loans closed by Rock consisting of Sub-Prime
Loans (13.7% of the total dollar volume of loans closed in 1996, compared to
7.9% in 1995), which have higher origination fees and with respect to which Rock
receives a higher premium on sale than Conventional Loans, and (ii) a 132.0%
increase in the volume of Sub-Prime Loans closed by Rock. In 1996, the Fresh
Start(TM) division's revenues as a percentage of total revenue increased to 40%,
compared to 14% in 1995.
Total expenses increased from $17.4 million in 1995 to $26.4 million in
1996, an increase of $9.0 million, or 52.0%, primarily due to increased
commissions, increased occupancy costs for a branch opening, increased stock and
option holders' bonuses and increases in general and administrative expenses
that fluctuate with increases in volumes of loans closed. Included in total
revenues for 1995 is a $5.7 million gain on the sale of mortgage servicing
rights and a $346,000 gain on the sale of marketable securities, and included in
total
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<PAGE> 39
revenues for 1996 is a $991,000 gain on the sale of marketable securities. As a
result of the gain on sale of mortgage servicing rights in 1995 and
proportionately higher expenses, partially offset by the lower gain on the sale
of marketable securities in 1995, pre-tax income before stock and option
holders' bonuses decreased 26.7%, from $7.4 million in 1995 to $5.4 million in
1996.
The following table sets forth information regarding the components of
Rock's revenues for the years ended December 31, 1995 and 1996:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1995 1996
---- ----
(IN THOUSANDS)
<S> <C> <C>
Interest income............................................. $ 3,003 $ 4,267
Interest expense............................................ (3,012) (3,669)
------- -------
Net interest margin....................................... (9) 598
Loan fees and gains and losses on sale of mortgages......... 17,788 27,960
Net gain on sale of mortgage servicing...................... 5,728 --
Net gain on sale of marketable securities................... 346 991
Other income................................................ 399 6
------- -------
Total revenue............................................. $24,252 $29,555
======= =======
</TABLE>
Net interest margin increased to $598,000 in 1996 from a loss of $9,000 in
1995, an increase of $607,000. The increase was primarily due to (i) higher
weighted average interest rates charged on the loans as a result of the
increased proportion of Sub-Prime Loans, which generally have higher interest
rates, (ii) the increase in the dollar volume of loans closed by Rock, and (iii)
Rock's increased use of internally-generated cash to fund its loans.
Loan fees and gains and losses on sale of mortgages increased to $28.0
million in 1996 from $17.8 million in 1995, an increase of $10.2 million, or
57.2%. This increase is primarily due to an increased portion of the loans
closed by Rock consisting of Sub-Prime Loans, with respect to which Rock
receives higher loan fees and a higher premium on sale, and an increase of 20.5%
in the dollar volume of loans closed. The dollar volume of Sub-Prime Loans
increased in 1996 compared to 1995 primarily because of an increase in Fresh
Start(TM) stores, loan officers and marketing.
The increase in the loan fees and gains and losses on sale of mortgages was
partially offset by an increase in Rock's recapture reserve in 1996. Some
Sub-Prime Loan sales require Rock to return a portion of the premium received by
Rock on the sale of the loan if the loan is prepaid by the customer within the
first year after sale. Rock records a provision for this risk based on its
evaluation of the terms of its sale contracts and its assumptions concerning
prepayments. Rock increased its reserve, and decreased its loan fees and gains
and losses on sale of mortgages, by $317,000 for this risk in 1996, compared to
an increase of $205,000 in 1995.
Rock recognized a $5.7 million net gain on the sale of mortgage servicing
in 1995. Rock retained the servicing rights to loans it sold in 1993 and 1994
(and received lower sales prices as a result). In 1995, Rock sold all of its
remaining servicing rights. In 1996, Rock sold all of its loans servicing
released. Other income in 1995 also includes approximately $280,000 of loan
servicing fees for the period during which Rock retained servicing rights in
1995.
Net gain on sale of marketable securities increased to $991,000 in 1996
from $346,000 in 1995, an increase of $645,000, or 186.7%. During 1995 and 1996,
Rock invested some of its excess cash in marketable securities. During 1995 and
1996, Rock sold a portion of its portfolio of marketable securities held for
sale and recognized gains on those sales. The net gain in 1995 included
recognition of an $850,000 loss due to a significant decrease in the value of a
marketable equity security that was subsequently sold.
37
<PAGE> 40
The following table sets forth information regarding the components of
Rock's expenses for the years ended December 31, 1995 and 1996:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1995 1996
---- ----
(IN THOUSANDS)
<S> <C> <C>
Salaries, commissions and employee benefits................. $11,272 $16,425
Stock and option holders' bonuses........................... 545 2,297
General and administrative.................................. 3,726 4,646
Marketing expenses.......................................... 1,339 2,393
Depreciation and amortization............................... 507 663
------- -------
Total expenses......................................... $17,389 $26,424
======= =======
</TABLE>
Salaries, commissions and employee benefits increased from $11.3 million in
1995 to $16.4 million in 1996, an increase of $5.1 million, or 45.7%. The
increase was primarily attributable to Rock hiring additional personnel in order
to generate increased levels of loan closings, and increased commissions due to
increased closings. Rock employed 266 persons as of December 31, 1995, compared
to 399 persons as of December 31, 1996, a 50% increase.
Stock and option holders' bonuses increased from $0.5 million in 1995 to
$2.3 million in 1996, an increase of $1.8 million. During 1996, Rock paid
bonuses to option holders in accordance with their employment agreements. The
agreements do not require these bonuses after December 31, 1997. In addition,
Rock paid bonuses to all of its shareholders in 1996, partially in recognition
of cumulative past services. Rock does not intend to pay bonuses of this
magnitude to these persons for 1998.
General and administrative expenses consist primarily of occupancy costs,
professional services, office expenses, automobile and delivery expenses and
other expenses, many of which vary with the volume of loan closings. General and
administrative expenses increased from $3.7 million in 1995 to $4.6 million in
1996, an increase of $0.9 million, or 24.7%. The increase was primarily
attributable to increased occupancy expenses as a result of opening two new
Fresh Start(TM) stores in 1996 and increased expenses required to accommodate
the significantly expanded loan closing volumes experienced by Rock in 1996.
Marketing expenses increased from $1.3 million in 1995 to $2.4 million in
1996, an increase of $1.1 million, or 78.7%. The increase was primarily
attributable to Rock's greater marketing expenses, both in existing markets and
in new markets to generate higher levels of loan closings. This increase is
primarily the result of Rock's increased focus on its Sub-Prime Loan business,
which required greater marketing related to each loan closed and new store
openings, and ongoing marketing.
Depreciation and amortization expenses increased from $0.5 million in 1995
to $0.7 million in 1996, an increase of $0.2 million, or 30.8%. The increase was
primarily attributable to Rock's purchases of additional equipment and leasehold
improvements during 1996 for new stores and expansion of Rock's national support
center.
38
<PAGE> 41
LIQUIDITY AND CAPITAL RESOURCES
The following table sets forth information concerning Rock's financial
condition as of December 31, 1996 and 1997:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------
1996 1997
---- ----
(IN THOUSANDS)
<S> <C> <C>
Cash and cash equivalents................................... $ 3,289 $ 11,947
Marketable securities....................................... 5,954 --
Mortgage loans held for sale................................ 85,009 121,344
Property and equipment, net................................. 2,681 7,011
Other assets................................................ 3,427 4,127
-------- --------
Total assets.............................................. $100,360 $144,429
======== ========
Warehouse borrowings........................................ $ 67,621 $ 97,455
Drafts payable.............................................. 14,897 21,875
Other liabilities........................................... 5,596 9,991
Shareholders' equity........................................ 12,346 15,108
-------- --------
Total liabilities and shareholders' equity................ $100,360 $144,429
======== ========
</TABLE>
Cash and cash equivalents increased in 1997 primarily due to the cash
generated from operations along with the sale of the remaining marketable equity
securities. Mortgage loans held for sale increased due to higher volume of
originations in 1997 by the Fresh Start(TM) division, which Rock holds for
longer periods of time to accumulate for bulk sales and to increase interest
income. See "Results of Operations." Property and equipment increased due to new
Fresh Start(TM) store openings and the acquisition of a new front-end
origination technology in 1997. Other assets at December 31, 1997 include loans
to a shareholder of approximately $1.6 million, which are expected to be repaid
out of the Shareholder Distribution Amount, approximately $0.8 million of loans
held for investment, net of approximately $0.3 million of allowances for losses
on these loans, approximately $0.2 million of real estate owned as a result of
foreclosures, and approximately $1.5 million of miscellaneous assets.
Warehouse borrowings and drafts payable increased due to the increase in
volumes of originations and holding loans for longer periods of time. See
"Results of Operations." The increase in other liabilities is due to increased
trade payables relating to increases in the volume of loans closed and financing
for equipment acquisitions. Shareholders' equity reflects the increase due to
pre-tax income less distributions to shareholders to pay tax liabilities they
incur as a result of Rock's status as an S corporation and a special, one-time
distribution to shareholders of approximately $4.8 million in 1997.
Net cash provided by operating activities during 1997 before increases or
decreases in loans held for sale was approximately $19.7 million, compared to
approximately $9.2 million in 1996. Cash was provided primarily by (i) Rock's
pre-tax income for 1997 (approximately $10.8 million before depreciation and
amortization, provision for credit losses and net gain on sales of marketable
securities in 1997, compared to approximately $2.8 million in 1996), (ii) an
increase in drafts payable, which represent funds advanced for loan closings
that have not yet been drawn against the warehouse line of credit (approximately
$7.0 million in 1997, compared to approximately $7.5 million in 1996), and (iii)
an increase in accounts payable and accrued expenses and other liabilities,
primarily as a result of the increase in loan closings and the number of stores
opened during 1997 (approximately $2.6 million in 1997, compared to a reduction
of approximately $0.8 million in 1996).
These sources of cash were more than offset primarily by cash used to fund
the increase in loans held for sale resulting from the increased volume of
closings in 1997 (approximately $36.3 million in 1997, compared to approximately
$11.0 million in 1996). Cash was also used during 1997 (i) to purchase
equipment, both for new stores and a marketing center and to upgrade Rock's
computer and telephone systems (approximately $5.6 million in 1997, compared to
approximately $2.1 million in 1996), (ii) to fund distributions to
39
<PAGE> 42
shareholders both to pay their taxes on Rock's income taxed to them as a result
of Rock's S corporation status and to distribute a portion of the additional
earnings previously taxed to them (approximately $7.2 million in 1997, compared
to approximately $3.5 million in 1996), and (iii) to fund loans to shareholders
(approximately $0.9 million in 1997, compared to payments received on such loans
of approximately $2.0 million in 1996). These uses of cash were financed
primarily by cash generated by operations, proceeds from the sales of marketable
securities and a $2 million loan secured by computer equipment purchased with
the loan proceeds. Increased borrowings under Rock's warehouse financing
facilities (approximately $29.8 million in 1997, compared to approximately $3.5
million in 1996) were used to finance, in part, the higher amount of loans held
for sale.
Rock's operations require continued access to financing sources. Rock's
primary operating cash requirements include the funding of (i) loan closings,
(ii) capital expenditures in connection with the expansion of its stores and
branches, (iii) beginning after this Offering, income tax payments due on Rock's
net income, (iv) ongoing administrative and other operating expenses, including
compensation of additional employees expected to be hired in 1998, and (v)
repayments of borrowings and related interest.
Adequate credit facilities and other sources of funding, which permit Rock
to fund the loans it closes, are essential to the continuation of Rock's ability
to close loans. After using available working capital, Rock borrows money to
fund its loan closings and repays these borrowings as the loans are sold. Loan
origination fees are sometimes included in the principal balance of the loan
closed, although Rock may receive these fees either at the closing of the loan
or at the time of a warehouse line of credit borrowing or reverse repurchase
sale of the loan. Upon the sale of loans and the subsequent repayment of the
borrowings, Rock's working capital and credit facilities then become available
to fund additional loan closings.
Rock has $250 million ($350 million after completion of the Offering) of
warehouse financing facilities. Rock's warehouse line of credit currently
provides for up to $150 million principal amount of demand loans secured by
loans held for sale and other assets of Rock. Loans under the warehouse line of
credit bear interest at rates that vary depending on the type of underlying
loan, and the loans are subject to sublimits, advance rates and warehouse terms
that vary depending on the type of underlying loan. Interest rates vary from the
bank's prime rate to 1.5% to 2.5% over the federal funds rate (resulting in a
weighted average interest rate of 6.94% during 1997). The warehouse line of
credit requires Rock to maintain a minimum tangible effective net worth, a
maximum leverage ratio, a minimum current ratio and minimum working capital. The
warehouse line of credit expires, with respect to loans committed to be made by
any particular lender, 75 days after that lender demands payment, unless that
lender is replaced. Borrowings under the warehouse line of credit are used to
fund loans closed by Rock. As of March 31, 1998, Rock had borrowed $68.7 million
under this facility and had a maximum of $81.3 million available for additional
borrowings thereunder and was in compliance with all associated financial
covenants.
In addition to the $150 million warehouse line of credit, Rock's reverse
repurchase arrangement provides that the lender, an affiliate of one of the
Representatives of the Underwriters in this Offering, will purchase from Rock at
par, subject to Rock's agreement to repurchase on a daily basis, up to $100
million ($200 million after completion of the Offering) of fully-amortizing,
first or junior lien residential mortgage loans and home equity loans that
comply with Rock's origination guidelines and conform to whole and bulk loan
sale requirements. This agreement is not a committed facility and the lender may
elect to discontinue the repurchase agreement at any time. The term of any
financing under the repurchase agreement matures and may be renewed on a daily
basis. In any event, the arrangement terminates in March 1999. The effective
weighted average interest rate to Rock of this arrangement in 1997 was 6.88%.
Rock uses this facility as a supplemental borrowing facility to fund loans
closed by Rock until they are sold. As of March 31, 1998, Rock had financed $4.7
million of loans under this facility and an additional $95.3 million was
available for future financings.
The net proceeds of the Offering, together with cash flows from operations,
are expected to be sufficient to fund the payment to the Existing Shareholders
of the Shareholder Distribution Amount and Rock's liquidity requirements for the
next 12 months, if Rock's future operations are consistent with management's
expectations. See "Termination of S Corporation Status" and "Use of Proceeds."
Rock, however, expects to
40
<PAGE> 43
continue its expansion and expects that eventually it will need to arrange for
additional sources of capital through the issuance of debt, equity or additional
bank borrowings. Rock has no commitments for any such additional financings, and
there can be no assurance that Rock will be able to obtain any such additional
financing at the times required and on terms and conditions acceptable to Rock.
In such event, Rock's growth and operations could be curtailed.
If Rock begins to securitize its assets or significantly increases its
retained mortgage servicing rights, Rock's liquidity could be materially
adversely affected. See "Risk Factors -- Risks of Securitization" and "--
Potential Originated Mortgage Servicing Rights Risk."
HEDGING
Rock closes loans and subsequently sells them for cash to unaffiliated
wholesale purchasers. If prevailing interest rates rise between the time Rock
closes loans or fixes the interest rates on such loans and the time such loans
are priced for sale, the spread between the amount loaned and the amount the
wholesale purchaser is willing to pay for the loan narrows, resulting in a loss
in value of the loan. To protect against such losses in respect of its
Conventional Loans (where the interest spread is lower), Rock currently enters
into forward sales commitments for future delivery of FNMA and Freddie Mac
securities to fix the sales price of the conventional loans expected to be
closed or hedges the value of those loans through periodic purchases of
short-duration treasury-based options. Rock had $82,535,000 of such forward
sales commitments as of December 31, 1997 with various investment bankers. Rock
generally assigns these commitments to third parties along with Conventional
Loans necessary to obtain the FNMA and Freddie Mac securities deliverable
pursuant to those commitments. Before entering into forward commitments or
hedging, Rock performs an analysis of its Conventional Loans and Conventional
Loan applications with committed interest rates taking into account such factors
as the estimated portion of loan applications that will ultimately be funded,
interest rates, inventories of loans and applications and other factors to
determine the type and amount of forward commitment and hedging transactions.
Rock attempts to make forward commitments for or hedge substantially all of its
estimated interest rate risk on its Conventional Loans. Rock does not believe
that hedging its interest rate risk with respect to its Sub-Prime Loans is cost
effective as a result of their generally higher interest spreads combined with
their relative lack of sensitivity to changes in market interest rates and
considering the period during which Rock currently intends to accumulate such
loans for sale. See "Risk Factors -- Economic Conditions -- Interest Rates."
IMPACT OF INFLATION
Inflation has not had a material effect on Rock's results of operations.
Increases in the inflation rate generally result in increased interest rates.
Because Rock borrows money at variable rates, increased interest rates will
increase the borrowing costs of Rock. Inflation will also increase the operating
costs of Rock. Rock may not be able to pass on the effects of inflation and the
accompanying higher interest rates to its customers due to usury or other
regulatory restrictions or competitive pressures. Profitability may also be
affected by the level of and fluctuation in interest rates, which affect Rock's
ability to earn a spread between interest received on its loans and the costs of
its borrowings. The profitability of Rock is likely to be adversely affected
during any period of unexpected or rapid changes in interest rates. A
substantial and sustained increase in interest rates could adversely affect the
ability of Rock to close loans. Fluctuating interest rates also may affect the
net interest income earned by Rock resulting from the difference between the
yield to Rock on loans held pending sales and the interest paid by Rock for
funds borrowed under Rock's warehouse financing facilities. See "Risk Factors --
Economic Conditions -- Interest Rates."
YEAR 2000 COMPLIANCE
Rock does not expect the cost of making its computer systems year-2000
compliant will be material. Because most of Rock's computer hardware and
software is less than two years old, it believes that its exposure to
year-2000-related hardware and software problems is lower than if it used older
equipment or software. Nonetheless, Rock is engaging a consultant to manage the
testing of its equipment and software and the identification and resolution of
any problems discovered. Rock also plans to explore the strategies of its
41
<PAGE> 44
vendors to discover and resolve any year-2000 problems. Rock is already
participating with its loan servicing vendor in its year-2000 evaluation
process. Rock expects to complete this process during 1998. See "Risk Factors --
Year 2000 Compliance."
NEW ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per
Share." This Statement specifies the computation, presentation, and disclosure
requirements for earnings per share for entities with publicly-held common stock
or potential common stock. This Statement is effective for financial statements
for both interim and annual periods ending after December 15, 1997 and will be
implemented in Rock's financial statements upon completion of the Offering. The
pro forma earnings per share information presented in this Prospectus is
computed in accordance with SFAS No. 128.
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income." This Statement establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains and losses)
in a full set of general-purpose financial statements. This Statement is
effective for fiscal years beginning after December 15, 1997. Reclassification
of financial statements for earlier periods provided for comparative purposes is
required. At this time Rock has determined that this Statement will have no
significant impact on its financial position or results of operations for 1998.
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of
an Enterprise and Related Information." This Statement establishes standards for
the way public business enterprises report information about their operating
segments and requires them to report selected information about operating
segments, products and services, activities in different geographic areas, and
its reliance on major customers. SFAS No. 131 requires a "management approach"
for identifying reportable segments based on the way that management organizes
the segments within the enterprise for making operating decisions and assessing
performance. SFAS No. 131 is effective for financial statements for periods
beginning after December 15, 1997, and will be adopted by Rock in 1998 as
required. Rock has presented the required disclosures of financial information
for its three divisions, Fresh Start(TM), Specialty Lending and Conventional
Mortgage Lending in this "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
42
<PAGE> 45
BUSINESS
OVERVIEW
Rock is a specialty finance company marketing conventional and sub-prime
debt consolidation and home financing loans, secured primarily by first or
second mortgages on one- to four-family, owner-occupied residences. The Company
originates loans through 26 stores and branches, one marketing center and one
call center. Founded in 1985 by its current Chief Executive Officer and Chairman
of the Board, Daniel Gilbert, Rock originates 100% of its loans through its
retail operations, marketing its loans directly to consumers. The Company uses
proprietary marketing methods and technology to increase its market penetration.
Rock seeks to provide "world class" service to its customers, thereby
encouraging them to return for future loans and refer others to Rock for loans.
The Company also focuses on recruiting, developing and motivating talented
people, recruited from inside and outside the consumer finance industry, to
implement its business strategies. Rock believes it is creating growing brand
identities and a retail franchise that will sustain its loan origination
efforts.
As a retail originator of loans, Rock earns a portion of its revenues from
origination points and processing fees charged to its customers. Rock currently
does not securitize its loans. Rather, it sells its loans in large bulk and
whole loan sales for cash premiums in the secondary market. During 1997, Rock
had revenues of $52.1 million, pre-tax income of $11.4 million and pro forma net
income of $7.3 million. During 1997, Rock closed $1.2 billion of loans (12,950
loans). As of March 31, 1998, Rock had 770 employees, including 335 loan
officers.
Rock currently operates through three major divisions. Rock originates
Sub-Prime Home Equity Loans to individuals with impaired credit characteristics,
high levels of debt service to income, unfavorable past credit experience,
limited credit history, limited employment history or unverifiable income
through its Fresh Start(TM) division. Rock owns the registered trademark for the
name "Fresh Start Financial Services(R)" and has applied for a registered
service mark for the name "Fresh Start(TM)." Rock originates home equity second
mortgage loans to individuals with good credit histories but little or no equity
in their homes through its Specialty Lending division. During 1997, Rock closed
$335.3 million of Sub-Prime Home Equity Loans and High LTV Loans (6,232 loans,
representing 49% of the total loans closed). Rock also originates Conventional
Loans that generally conform to FNMA or Freddie Mac underwriting standards, or
that generally meet such standards except for maximum loan size guidelines,
through its Conventional Mortgage Lending division. During 1997, Rock closed
$867.5 million of Conventional Loans (6,513 loans). Although only 28% of the
total loan closings (by dollar volume) were Sub-Prime Loans in 1997, revenues
from Sub-Prime Loans equaled 63% of total revenues due to the higher profit
margins and interest rates associated with Sub-Prime Loans. In addition, Rock
began to increase its government-insured lending operations in 1997, primarily
making mortgage loans that meet the underwriting standards for FHA insurance.
Rock's business in each division is supported by an infrastructure of
sophisticated technology, highly-trained people and specialized marketing,
including multimedia advertising and direct marketing operations. To identify
potential customers, Rock uses internal and external databases of information
regarding past and potential customers and their needs. Rock then develops
proprietary customer profiles which it uses together with information from
outside sources to tailor and direct its marketing efforts for each of its
divisions. Rock believes that its focused marketing approach makes more
efficient use of its marketing resources and leads to a higher marketing success
rate than broad indiscriminate marketing aimed at a wide range of consumers.
BUSINESS STRATEGY
Rock's business strategy to sustain its growth in profitability while
continuing to build its consumer lending operations includes: (i) enhancing
consumer recognition of its "Fresh Start(TM)" and "Rock Financial" brand names
in its current markets and establishing brand name recognition in new markets,
(ii) increasing the number of Fresh Start(TM) stores and expanding its call
center operations into additional states, (iii) expanding the cross-selling of
existing products and expanding the products offered through existing
distribution channels, (iv) exploring establishing additional distribution
channels, (v) providing "world class" service, and thereby distinguishing itself
from its competitors, (vi) continuing to invest heavily in technology
43
<PAGE> 46
and marketing, (vii) maintaining consistent underwriting standards, and thereby
maintaining secondary market interest in Rock's loans, and (viii) seeking
potential acquisition opportunities.
Enhance Consumer Recognition of the "Fresh Start(TM)" and "Rock Financial"
Brand Names. Rock uses advertising and marketing to enhance consumer recognition
of its "Fresh Start(TM)" and "Rock Financial" brand names in each of the current
markets it serves and to establish brand name recognition in new markets it
enters. Rock believes that it can differentiate itself from its competitors
through strong brand names and increase the likelihood that potential customers
will use Rock to meet their financial needs.
Increase the Number of Fresh Start(TM) Stores and Expand Call Center
Operations. Rock plans to increase the number of its Fresh Start(TM) stores and
expand its call center operations into additional states, thereby increasing
loan production and diversifying its operations geographically. Rock believes
that Sub-Prime Loans are less dependent on prevailing interest rates and home
purchases and have higher origination fees and margins than Conventional Loans.
Rock opened nine Fresh Start(TM) stores and one marketing center during
1997 and opened an additional five Fresh Start(TM) stores in January 1998 and an
additional two Conventional Mortgage Lending branches in April 1998. Rock plans
to open additional stores in 1998. As of March 31, 1998, Rock was soliciting
High LTV Loans in eight states and was licensed to do business or exempt from
licensing in eleven others. Rock is analyzing the requirements to do business
and originate Sub-Prime Loans in other states.
Expand the Cross-Selling of Existing Products and Expand the Products
Offered Through Existing Distribution Channels. Rock plans to place loan
officers from each of Rock's other divisions in each Fresh Start(TM) store,
thereby enabling Rock to make available a greater variety of products to its
customers at these stores and to allow each of Rock's divisions to benefit from
cross-selling opportunities. Rock also plans to continue to explore new products
which it can cost-effectively originate through each of its existing
distribution channels. As part of this strategy, Rock began to increase its
government-insured lending operations through its existing distribution channels
in 1997.
Explore Establishing Additional Distribution Channels. Rock has developed a
marketing and technology infrastructure that management believes will allow Rock
to establish new distribution channels to market financial products directly to
the consumer. Rock will explore creating new channels to market such financial
products.
Provide "World Class" Service. Rock trains its employees in what it calls
its "world class" service philosophy, which is Rock's commitment to provide
superior customer service, to be responsive to customer needs and to make
applying for and closing each loan as quick, efficient and convenient for the
customer as possible. Rock believes that "world class" service is necessary to
distinguish Rock from its competitors. Rock also believes that referral and
repeat business are its most important sources of business, and that satisfied
customers who received "world class" service are more likely to refer others to
Rock for loans and to return to Rock for their future financing needs.
Continue to Invest Heavily in Technology and Marketing. Rock has invested
heavily in its technology and marketing to create an infrastructure of
sophisticated technology, highly-trained people and specialized marketing and to
create and enhance brand name recognition for the Rock Financial and Fresh
Start(TM) brand names. During 1997, the Company invested approximately $3.9
million in technology equipment that was capitalized, spent approximately $2.3
million to employ technology employees and spent approximately $5.4 million on
marketing. Rock plans to continue to make a similar investment in its technology
and marketing in 1998 to maintain and enhance that infrastructure.
Maintain Consistent Underwriting Standards. Rock desires to maintain
consistent underwriting standards while it increases the volume of loans closed.
Rock believes that maintaining consistent underwriting standards is important to
develop and maintain its reputation and to maintain secondary market interest in
Rock's loans. Also, Rock seeks to maximize its premium on whole and bulk loan
sales by closely monitoring secondary market buyers' requirements.
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<PAGE> 47
Seek Potential Acquisition Opportunities. Rock seeks potential acquisition
opportunities. It intends to review selective new acquisition opportunities, as
they arise, as a means of expanding its retail operations. In evaluating an
acquisition candidate, Rock intends to analyze several strategic
characteristics, including the candidate's geographic locations, the types of
loans it originates, the presence and strength of local competition, the
regulations applicable in the candidate's geographic locations and the structure
of the transaction. The purchase consideration for any such acquisitions may be
cash, equity or debt securities or a combination of the foregoing. Rock
currently is not a party to a letter of intent or definitive agreement with any
acquisition candidates. There can be no assurance that Rock will enter into any
such agreements or acquire any acquisition candidates.
KEY COMPONENTS OF ROCK'S RETAIL FRANCHISE
Rock originates 100% of its loans through its retail operations, marketing
its loans directly to consumers. The Company uses proprietary marketing methods
and technology to increase its market penetration. Rock seeks to provide "world
class" service to its customers, thereby encouraging them to return for future
loans and refer others to Rock for loans. The Company also focuses on
recruiting, developing and motivating talented people, recruited from inside and
outside the consumer finance industry, to implement its business strategies.
Through the use of these key components, Rock believes it is creating growing
brand identities and a retail franchise that will sustain its loan origination
efforts.
Marketing and Advertising. Rock makes extensive use of multimedia
advertising campaigns, including television, radio, yellow pages and print
advertising, and direct marketing efforts to support its loan officers' sales
efforts. Rock uses its proprietary customer profiles to focus its advertising
and direct marketing efforts in order to reach its target customer
cost-effectively and generate loan inquiries. Rock also uses advertising to
increase brand name recognition for its Rock Financial and Fresh Start(TM) brand
names. Rock's Fresh Start(TM) division is using the "Fresh Start(TM)" name,
adopted in 1997, in its advertising outside of Michigan and plans to convert all
eight of its current Michigan "Boulder Financial" stores to Fresh Start(TM)
stores in 1998. By creating brand name recognition, Rock believes that it is
more likely that consumers will use the Company to meet their financial needs.
Rock has an in-house marketing staff with a marketing product manager
dedicated to each division. Rock's marketing team, together with an outside
advertising agency, produces Rock's graphic art, places virtually all of Rock's
print, radio and television advertising, manages Rock's marketing data base and
acquires lists used for call center and direct marketing efforts.
Rock has also developed and trademarked a proprietary direct mail product
called "Mortgage in a Box(R)." After a customer has paid a loan application or
processing fee, Rock mails the customer a colorful Mortgage in a Box(R) package
that contains application forms and instructions. Rock believes its Mortgage in
a Box(R) package simplifies the loan application process and helps customers
return complete information necessary for Rock to make underwriting decisions
regarding the potential loan. Rock characterizes this product as "the world's
most user-friendly loan application kit." Rock has also established a web site
at http://www.Rockfin.com. The site provides product information about the loans
offered by Rock.
Using Technology and Information Systems for Marketing. Rock believes that
its focused marketing approach makes more efficient use of its marketing
resources and leads to a higher marketing success rate than broad indiscriminate
marketing aimed at a wide range of consumers. To identify potential customers,
Rock uses internal and external data bases of information regarding past and
potential customers and their needs. Rock then develops proprietary customer
profiles which it uses to tailor and direct its marketing efforts for each of
its divisions. Rock uses its profiles to attempt to identify homeowners and
potential homeowners believed by management to be likely to have a need for a
Rock product and who are likely to satisfy its underwriting guidelines. Rock
uses these profiles and demographic information to determine where to locate its
stores and branches and how to target its multimedia advertising. Rock also
monitors the effectiveness of its marketing programs and adjusts them based on
their performance.
Call center loan officers make outbound calls using Rock's predictive
dialer systems. Rock's telephone system also routes inbound calls to available
call center loan representatives. The telephone system can also
45
<PAGE> 48
track where calls originate, who handles the call, the time a customer spends
waiting on the phone and other information about Rock's phone calls. Rock also
uses a customized loan origination system that allows Rock to process loans
quickly and efficiently. The system provides real-time access to the information
used by each team in operations as well as the secondary marketing and financial
teams. Rock also uses these systems to develop computer-generated forms for each
of its various loans in each jurisdiction to make the processing of approved
loans faster and more efficient.
As of March 31, 1998, Rock employed a staff of 39 in its technology team to
allow it to analyze better its information regarding past customers, develop
customer profiles, create and obtain lists of potential customers and track loan
applications, closings and sales. In addition, Rock's software systems help call
center and other loan officers make and keep track of calls and assist them with
their sales presentations and in gathering the information necessary to
determine if a potential customer qualifies for a Rock loan.
High Level of Service and Relationship Selling. Rock seeks to provide
"world class" service to its customers, thereby encouraging them to return for
future loans and to refer others to Rock for loans. Rock strives to recruit and
hire employees who share Rock's commitment to provide "world class" service to
its customers and who have the attitude and the skills Rock considers necessary
to be successful. Through its training programs, Rock seeks to instill in all of
its employees Rock's commitment to provide superior customer service and to be
responsive to customer needs. Rock strives to make applying for and closing each
loan as quick, efficient and convenient for the customer as possible.
Rock believes that "world class" service is necessary to distinguish Rock
from its competitors. The loan products offered by Rock are generally
standardized products offered by many competitors, so potential customers
generally can choose among competitors on the basis of price, convenience and
service. In addition, Rock believes that referrals and repeat business from
satisfied customers are its largest sources of business and that satisfied
customers who received "world class" service are more likely to refer others to
Rock for loans and to return to Rock for their future financing needs. Rock
attempts to measure customers' satisfaction with its service through customer
service ratings and compensates its employees based, in part, on those ratings.
In addition, Rock attempts to establish third-party relationships with
persons from whom potential customers might seek advice about the types of loans
offered by Rock, such as real estate brokers, home builders and professionals in
order to generate referral business.
Training. Rock focuses on recruiting, developing and motivating talented
people from within and outside the consumer finance industry to implement its
business strategies. Rock is committed to its human resources team and its
efforts to train Rock's employees in Rock's marketing and "world class" service
philosophies. Through its training programs, Rock seeks to instill in all of its
employees Rock's commitment to provide superior customer service and to be
responsive to customer needs. All new employees are required to undergo a
training program. New sales persons are required to take a two- to four-week
training class to provide them with knowledge of Rock's products and to provide
them with extensive training in sales and marketing techniques, including
telephone sales techniques, and customer relations. Sales persons are also
provided with periodic ongoing training to keep their skills and product
knowledge up to date. Rock uses its technology and information systems to
provide employees with more standardized training, realistic practice of their
skills and quick feedback. Management also uses its technology and information
systems to monitor employee performance both in training classes and on the job,
which in turn helps Rock assess the ongoing training needs of its employees and
develop more effective training programs.
Ongoing telephone skill training is provided to all loan officers. The
training includes classroom as well as individual training sessions. Employees
are trained to return all calls promptly. Employees, especially call center
employees, are evaluated and compensated based on, among other things, the
number of closed loans, the speed and accuracy of their loan closings, the
percentage of proposed loans submitted that receive underwriting approval and
the customer's evaluation of the service received.
Rock recruits employees who have the attitude and skills Rock considers
necessary to be successful. Rock has established a web site for its recruiting
efforts at http://www.rockcareers.com. It then strives to develop its loan
officers and to promote its most qualified loan officers. Rock monitors the
performance of its loan officers
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<PAGE> 49
on a daily, weekly, monthly and yearly basis. Rock also measures the customer
service ratings of each of its loan officers and of its internal staff based on
customer feedback at loan closing. Individual compensation is adjusted based in
part on the results of these ratings.
OPERATING DIVISIONS
Rock currently operates through three major divisions. Rock originates
Sub-Prime Home Equity Loans to individuals with impaired credit characteristics,
high levels of debt service to income, unfavorable past credit experience,
limited credit history, limited employment history or unverifiable income
through its Fresh Start(TM) division. Rock owns the registered trademark for the
name "Fresh Start Financial Services(R)" and has applied for a registered
service mark for the name "Fresh Start(TM)." Rock originates High LTV Loans to
individuals with good credit histories but little or no equity in their homes
through its Specialty Lending division. Rock also originates Conventional Loans
that generally conform to FNMA or Freddie Mac underwriting standards, or that
generally meet such standards except for maximum loan size guidelines, through
its Conventional Mortgage Lending division. In addition, Rock began to increase
its government-insured lending operations in 1997, primarily making mortgage
loans that meet the underwriting standards for FHA insurance.
FRESH START(TM) DIVISION
Rock's Fresh Start(TM) division, which was created in 1994, originates
Sub-Prime Home Equity Loans secured primarily by first liens on one- to
four-family, owner-occupied residences. The Fresh Start(TM) division focuses on
customers whose borrowing needs are not served by traditional financial
institutions due to impaired credit profiles or other factors. The Fresh
Start(TM) division originates Sub-Prime Home Equity Loans through its network of
retail loan origination stores. Rock supports its Fresh Start(TM) store network
with an array of marketing, including multimedia advertising campaigns and
direct marketing to build local awareness of the Fresh Start(TM) brand name and
to grow loan volume within each market. Rock's Fresh Start(TM) division is using
the "Fresh Start(TM)" name, adopted in 1997, in its advertising outside of
Michigan and plans to convert all eight of its current Michigan "Boulder
Financial" stores to Fresh Start(TM) stores in 1998. In 1997, this division
closed $269.3 million of Sub-Prime Home Equity Loans (4,196 loans), compared to
$147.7 million of Sub-Prime Home Equity Loans (2,272 loans) in 1996. Based on
information provided in the National Mortgage News (March 16, 1998), an
independent industry publication, Rock believes it was one of the 20 largest
retail originators of Sub-Prime Loans in the United States in 1997.
Sub-Prime Home Equity Loans. Sub-Prime Home Equity Loans do not generally
meet the underwriting standards for sale to FNMA or Freddie Mac for any of a
variety of reasons, such as impaired credit characteristics, high levels of debt
service to income, unfavorable past credit experience, limited credit history,
employment history or unverifiable income. These loans are used typically to
consolidate debt (such as credit card debt) and to finance home improvements,
home purchases and other consumer needs. By originating loans to individuals
with impaired credit profiles, Rock is able to charge higher interest rates on
its Sub-Prime Home Equity Loans than for its Conventional Loans.
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<PAGE> 50
The following table shows, for 1995, 1996 and 1997, various information
concerning the aggregate of the loans closed by Rock's Fresh Start(TM) division:
<TABLE>
<CAPTION>
1995 1996 1997
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Principal amount of loans closed............................ $64,403 $147,676 $269,275
Number of loans closed...................................... 899 2,272 4,196
Average initial loan balance................................ $ 72 $ 65 $ 64
Fixed rate loans:
Percentage of loans closed (dollars)...................... 41.7% 22.7% 33.5%
Weighted average interest rate............................ 12.4% 12.6% 12.7%
Weighted average initial combined LTV..................... 86.8% 81.4% 78.1%
Adjustable rate loans:
Percentage of loans closed (dollars)...................... 58.3% 77.3% 66.5%
Weighted average initial interest rate.................... 10.9% 10.3% 11.1%
Weighted average initial combined LTV..................... 77.1% 77.2% 79.0%
Lien position:
Percentage first mortgages................................ 96.8% 95.2% 80.7%
Percentage second mortgages............................... 3.2% 4.8% 19.3%
</TABLE>
Fresh Start(TM) Stores. The majority of the Fresh Start(TM) stores are
located in retail strip malls or office buildings with substantial signage.
These stores range in size from approximately 1,400 to 5,400 square feet in
size. In addition, Rock is experimenting with one pilot marketing center, opened
in November 1997, that has 638 square feet of space and is located inside a
Super Kmart(TM). In the future, Rock may use a smaller office building store in
a new geographic area to test a new market because such stores are generally
less expensive to establish and the leases have shorter terms. If the business
is successful in such a test location, Rock may try to relocate into a 2,500 to
5,000 square foot store in a retail strip mall.
Each store is headed by a store manager, who is responsible for overseeing
all loans originated from that store and is compensated, in part, based on loan
closing volume in his or her store. The loan officers in the store also earn the
majority of their compensation through commissions. Fresh Start(TM) store
managers report to district managers who are responsible for overseeing loan
originations for the entire district and are compensated, in part, based on the
volume of loans closed in that district.
As of December 31, 1997, Rock had 14 Fresh Start(TM) stores (eight in
Michigan, three in Illinois and three in Ohio) and one pilot marketing center in
Illinois. In addition, Rock opened five new Fresh Start(TM) stores in January
1998, one each in Nevada, Missouri and Indiana and two in Texas. Rock plans to
open additional stores in 1998. In addition, Rock plans to place loan officers
from each of Rock's other divisions in each Fresh Start(TM) store, allowing Rock
to provide a greater variety of products to its customers and to use leads
generated by one division to make loans through other divisions, as appropriate.
During 1995, 1996 and 1997, Rock closed 92.5%, 100.0% and 89.9%, respectively,
of the dollar volume of its Sub-Prime Home Equity Loans secured by property
located in Michigan.
Establishing stores in new states requires Rock to familiarize itself
thoroughly with that state's regulatory requirements and to tailor its loan
products and practices to comply with such requirements. Rock must also identify
and train store managers and loan officers through its in-house training
programs for each new office. Rock attempts to locate stores in neighborhoods
where there is a high concentration of likely customers. For a description of
how the Company determines which neighborhoods have a high concentration of
likely customers, see "Key Components of Rock's Retail Franchise -- Using
Technology and Information Systems for Marketing."
The Fresh Start(TM) division also makes extensive use of telephone call
center marketing and direct mail campaigns. Rock focuses its direct marketing
efforts on its profiled customers and those responding to its advertising,
generally in the communities around its stores. The customer profiles, combined
with information from other sources, are used to create mailing and call lists.
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<PAGE> 51
The following two tables show, for the fourth quarter of fiscal 1996, for
each calendar quarter of fiscal 1997 and for the first quarter of fiscal 1998,
(i) the total quarterly loan origination volume for Fresh Start(TM) stores
grouped by when they were opened, and (ii) the average quarterly loan
origination volume per store for Fresh Start(TM) stores grouped by when they
were opened, in order to show the historical change in loan closings as new
stores mature. Rock believes that its new stores generally mature over a twelve-
to eighteen-month time period.
TOTAL LOAN CLOSINGS
<TABLE>
<CAPTION>
NUMBER OF 1996 1997 1998
NEW ----------- ----------------------------------------------------- -----------
WHEN STORES OPENED STORES OPENED 4TH QUARTER 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER 1ST QUARTER
------------------ ------------- ----------- ----------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Before 12/31/96......... 5 $50,144 $48,212 $54,067 $58,936 $56,999 $49,353
1997 -- 2nd Quarter..... 1 -- -- $ 3,432 $ 7,004 $ 8,827 $ 9,246
1997 -- 3rd Quarter..... 4 -- -- -- $ 6,658 $17,486 $ 9,961
1997 -- 4th Quarter..... 4 -- -- -- -- $ 7,653 $ 9,100
1998 -- 1st Quarter..... 5 -- -- -- -- -- $ 2,834
-- ------- ------- ------- ------- ------- -------
19 $50,144 $48,212 $57,499 $72,598 $90,965 $80,494
== ======= ======= ======= ======= ======= =======
</TABLE>
AVERAGE LOAN CLOSINGS PER INDIVIDUAL STORE
<TABLE>
<CAPTION>
1996 1997 1998
----------- ----------------------------------------------------- -----------
WHEN STORES OPENED 4TH QUARTER 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER 1ST QUARTER
------------------ ----------- ----------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Before 12/31/96.............. $10,028 $9,642 $10,813 $11,787 $11,400 $9,870
1997 -- 2nd Quarter.......... -- -- $ 3,432 $ 7,004 $ 8,827 $9,246
1997 -- 3rd Quarter.......... -- -- -- $ 1,665 $ 4,372 $2,490
1997 -- 4th Quarter.......... -- -- -- -- $ 1,913 $2,275
1998 -- 1st Quarter.......... -- -- -- -- -- $ 567
</TABLE>
Underwriting. Rock has developed its own underwriting guidelines for some
of the loans originated through its Fresh Start(TM) division and adjusts these
guidelines to the general standards required by secondary market buyers of such
loans. Rock continually monitors its guidelines and adjusts them to changing
market conditions. Some of the loans originated through the Fresh Start(TM)
division are underwritten by third parties that purchase such loans on a flow
basis pursuant to contracts with the Company. During 1997, approximately 18.1%
of the loans originated through the Fresh Start(TM) division were underwritten
by third parties that purchase such loans on a flow basis. For the loans
underwritten by Rock's underwriters, Rock is dependent on such underwriters and
its quality control team to maintain the quality of its loans. See "Compliance
and Quality Control."
When underwriting its Fresh Start(TM) division loans, Rock relies
principally on the underlying collateral, and to a lesser extent on the
creditworthiness of the customer. Rock classifies such customers as "A" through
"D" credits for purposes of underwriting and pricing its Sub-Prime Home Equity
Loans. The criteria include the customer's mortgage, installment loan and
revolving debt payment history, employment history, capacity to pay, outstanding
judgments, charge-offs and repossessions, involvement in bankruptcies and
foreclosures. Lower credit-rated customers generally must meet higher
underwriting standards to obtain a loan, such as lower LTV and lower maximum
loan amounts, and generally must pay higher interest rates on their loans.
Underwriting reviews and decisions for loans underwritten by Rock are made
by separate Rock underwriters at the national support center. Rock has
guidelines to assist its underwriters in the credit decision process. Although
each loan is secured by a mortgage lien, it is essential that care and
consideration be given to the appraisal of the property securing the loan. Rock
also evaluates the applicant's creditworthiness through the use of a consumer
credit report, verification of employment and a review of the debt-to-income
ratio of the customer. After completion of the documentation necessary for
underwriting review of a loan, Rock's goal is to
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<PAGE> 52
make underwriting decisions within 24 to 48 hours. On a case-by-case basis,
Rock's underwriters may determine that a prospective customer warrants an
exception from Rock's underwriting guidelines due to compensating factors.
SPECIALTY LENDING DIVISION
Rock's Specialty Lending division, which commenced its current operations
in March 1997, originates High LTV Loans secured primarily by second mortgages
and with combined loan-to-value ratios (including the first mortgage balance) of
up to 125% of the estimated value of the underlying property. The Specialty
Lending division markets High LTV Loans to consumers through its call center,
located at Rock's national support center in Bingham Farms, Michigan. As of
March 31, 1998, Rock was soliciting High LTV Loans in eight states and was
licensed to do business or exempt from licensing in eleven others. Rock uses
extensive direct-mail marketing and significant multimedia advertising campaigns
to generate inbound call volume into its call center. At various times, outbound
telemarketing programs also are launched to targeted lists of consumers. The
Specialty Lending division uses a specially trained sales force and relies
heavily on technology and systems designed specifically for Rock. During 1997,
Rock closed $66.0 million of High LTV Loans (2,036 loans).
High LTV Loans. The Specialty Lending division's current product focus is
on High LTV Loans (up to 125%, including the first mortgage balance). Rock's
High LTV Loans are typically used to consolidate debt (such as credit card debt)
and to finance home improvements, education and other consumer needs for
customers with good credit histories and high credit scores, generally only
customers Rock rates as "A+", "A" or "B" credits. Specialty Lending division
loans are limited to $100,000 and require the customer to have a total
debt-to-income ratio of no more than 50%. Although the current focus of the
Specialty Lending division is High LTV Loans, the infrastructure of the division
and the call center are designed with the ability to change focus to, or add,
other types of loan products as appropriate.
The following table shows various information concerning the aggregate of
the loans closed by Rock's Specialty Lending division for each calendar quarter
of 1997. During 1997, Rock's High LTV Loans had an average interest rate of
15.3% and a weighted average combined loan-to-value ratio of 107%. The Specialty
Lending division commenced its current operations in March 1997.
<TABLE>
<CAPTION>
1997
--------------------------------------------------------
1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER
----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Principal amount of loans closed.................. $1,118 $12,574 $23,273 $29,078
Number of loans closed............................ 41 396 716 883
Average initial loan balance...................... $ 27 $ 32 $ 33 $ 33
Weighted average FICO score....................... 675 675 678 673
Weighted average interest rate.................... 15.4% 15.3% 15.2% 15.2%
Weighted average initial LTV...................... 91.0% 93.4% 110.4% 109.9%
</TABLE>
During 1997, Rock closed 87.7% and 12.3% of the dollar volume of its High
LTV Loans secured by property located in Michigan and Illinois, respectively.
Underwriting. Rock has developed its own underwriting guidelines for some
of the loans originated through its Specialty Lending division and adjusts these
guidelines to represent the general standards required by secondary market
buyers of such loans. Rock continually monitors its guidelines and adjusts them
to changing market conditions. Some of the loans originated through the
Specialty Lending division are underwritten by third parties that purchase such
loans on a flow basis.
Because High LTV Loans have little, if any, equity cushion (unlike
Sub-Prime Home Equity Loans), Rock's underwriting relies principally on the
creditworthiness of the customer for repayment, and to a lesser extent on the
underlying collateral. Rock classifies such customers as "A+", "A" or "B"
credits for purposes of underwriting and pricing its High LTV Loans. The
criteria for such classifications and the evaluation of a customer's
creditworthiness include, as a significant component, the credit evaluation
scoring methodology
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<PAGE> 53
A FRESH
PERSPECTIVE
LOGO
FRESH START(TM) LOAN CENTER, TOLEDO, OHIO
GRACIE THE GROUNDHOG
...OFFICIAL MASCOT OF
FRESH START(TM)
<PAGE> 54
BUILDING A BRAND
Rock has invested heavily
in its technology and
marketing to create an
infrastructure of
sophisticated technology,
highly trained people and
specialized marketing to
create and enhance brand
name recognition for the
Rock Financial and Fresh
Start(TM) brand names.
Rock Financial believes
that it can differentiate
itself from its competitors
through strong brand names.
By creating brand name
recognition, Rock believes
that it is more likely that
consumers will use the
Company to meet their
financial needs.
-----------------------------------------
-----------------------------------------
Fresh Start(TM) Loan Center, Hodgkins,
Illinois
-----------------------------------------
-----------------------------------------
The Fresh Start(TM) Sun, Fresh Start(TM)
Loan Center, Toledo, Ohio
-----------------------------------------
-----------------------------------------
Children's Play Area, Fresh Start(TM)
Loan Center, Toledo, Ohio
<PAGE> 55
Mortgage in a Box(R) Application Kit
Conference Room, Fresh Start(TM) Loan Center, Toledo, Ohio
Customer Lobby, Fresh Start(TM) Loan Center, Toledo, Ohio
Rock has also developed and
trademarked a proprietary
direct mail product called
'Mortgage in a Box(R)." The
colorful Mortgage in a Box(R)
package contains application
forms and instructions. Rock
believes its Mortgage in a Box(R)
package simplifies the loan
application process. Rock
characterizes this product as
"the world's most user-friendly
loan application kit."
GRACIE THE
GROUNDHOG
...OFFICIAL
MASCOT OF
FRESH START(TM)
<PAGE> 56
"MR. HOME" . . .
OFFICIAL MASCOT OF
MORTGAGE IN A BOX(R)
MORTGAGE IN A BOX(R) APPLICATION KIT
<PAGE> 57
developed by Fair, Isaac and Company ("FICO"), a consulting firm specializing in
creating default-predictive models through credit scoring mechanisms. The
criteria include the customer's mortgage and revolving debt payment history,
employment history, capacity to pay, outstanding judgments, involvement in
bankruptcies and foreclosures. During 1997, the average FICO score for a High
LTV Loan was 675.
Underwriting reviews and decisions are made by separate Rock underwriters
at the national support center. Rock has guidelines to assist its underwriters
in the credit decision process. Rock generally evaluates the applicant's
creditworthiness through the use of a FICO score, a consumer credit report,
verification of employment and a review of the debt-to-income ratio of the
customer. After completion of the documentation necessary for underwriting
review of a loan, Rock's goal is to make underwriting decisions within 24 to 48
hours. On a case-by-case basis, Rock's underwriters may determine that a
prospective customer warrants an exception from Rock's underwriting guidelines
when compensating factors are present.
CONVENTIONAL MORTGAGE LENDING DIVISION
Since its inception in 1985, Rock has originated Conventional Loans through
its Conventional Mortgage Lending division. The Conventional Mortgage Lending
division originates loans through seven branches, all located in southeast
Michigan. Over the past 13 years, Rock has used marketing and advertising to
create and enhance brand name recognition for the Rock Financial name. In
conjunction with its multimedia advertising, Rock coordinates extensive direct
marketing campaigns. Rock has developed third-party relationships with real
estate brokers, home builders, attorneys, accountants, and financial planners,
which generate referral business. Conventional Loans generally conform to the
underwriting guidelines of FNMA or Freddie Mac, or they generally conform except
for maximum loan size, and they are generally made to finance the purchase of a
home or to refinance a home mortgage. Rock is also an approved, unsupervised
seller/servicer of FNMA and Freddie Mac Conventional Loans and a HUD-approved
lender. During 1997, Rock originated $867.5 million of Conventional Loans (6,513
loans). Based on a report by Lawyer's Title Insurance Company (June 1997), Rock
believes that it is the largest non-depositary-affiliated retail lender of one-
to four-family residential mortgage loans in southeast Michigan.
Conventional Mortgage Lending Branches. As of April 6, 1998, the
Conventional Mortgage Lending division had seven southeastern Michigan branches.
Two branches are located in retail strip malls, two are in office buildings and
three are located near residential real estate brokers' offices. The branches,
other than the national support center, range in size from 256 to 6,360 square
feet. Each branch is headed by a branch manager, who is responsible for
overseeing all loans originated from that branch and is compensated, in part,
based on loan closing volume in his or her branch. The loan officers in the
branch also earn the majority of their compensation through commissions.
The Conventional Mortgage Lending division also makes extensive use of
telephone call center marketing and direct mail campaigns. Over the past 13
years, Rock has used marketing and advertising to create and enhance brand name
recognition for the Rock Financial name. In conjunction with its multimedia
advertising, Rock coordinates extensive direct marketing campaigns. Rock focuses
its direct marketing efforts on its profiled customers and those responding to
its advertising, generally in the communities around its branch offices. The
customer profiles, combined with information from other sources, are used to
create mailing and call lists.
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Conventional Loans. The following table shows, for 1995, 1996 and 1997,
various information concerning the aggregate of the loans closed by Rock's
Conventional Mortgage Lending division:
<TABLE>
<CAPTION>
1995 1996 1997
---- ---- ----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Principal amount of loans closed............................ $740,408 $892,672 $867,520
Number of loans closed...................................... 5,640 6,940 6,513
Average initial loan balance................................ $ 131 $ 129 $ 133
Fixed rate loans:
Percentage of loans closed (dollars)...................... 38.7% 37.2% 45.9%
Weighted average interest rate............................ 8.2% 7.9% 8.0%
Weighted average initial LTV.............................. 75.3% 72.0% 70.1%
Adjustable rate loans:
Percentage of loans closed (dollars)...................... 61.3% 62.8% 54.1%
Weighted average initial interest rate.................... 6.9% 6.5% 6.8%
Weighted average initial LTV.............................. 75.7% 72.9% 71.9%
</TABLE>
Substantially all of the Conventional Mortgage Lending division's loans are
currently originated in the State of Michigan.
Underwriting. Loans originated through Rock's Conventional Mortgage Lending
division must generally meet the underwriting standards for sale to FNMA or
Freddie Mac or must generally meet such standards except for maximum loan size.
These standards include the customer's mortgage, installment loan and revolving
debt payment history, employment history, capacity to pay, outstanding
judgments, charge offs and repossessions, involvement in bankruptcies and
foreclosures.
Underwriting reviews and decisions are made by separate Rock underwriters
located at each branch. Although loans are secured by a mortgage lien, it is
essential that care and consideration be given to the appraisal of the property
securing the loan. Also, Rock generally evaluates the applicant's
creditworthiness through the use of a consumer credit report, verification of
employment and a review of the debt-to-income ratio of the customer. After
completion of the documentation necessary for underwriting review of a loan,
Rock's goal is to make underwriting decisions within 24 to 48 hours. On a
case-by-case basis, Rock's underwriters may determine that a prospective
customer warrants an exception from Rock's underwriting guidelines if
compensating factors exist. Also, in January 1998, Rock introduced FNMA's
automated underwriting systems to its Conventional Mortgage Lending division.
OTHER OPERATIONS
Rock began to increase its government-insured lending operations in 1997,
primarily making mortgage loans that meet the underwriting standards for FHA
insurance. Rock's FHA loans are generally made to finance or refinance home
purchases. Rock currently originates these loans from three branches in Michigan
that house operations of other divisions. Rock is considering organizing its
government-insured lending business as a separate division in 1998. For the year
ended December 31, 1997, Rock closed $16.6 million of FHA loans, representing
approximately 1.6% of Rock's total loans, with an average principal amount of
$81,000 and a weighted average interest rate of 7.7%.
COMPLIANCE AND QUALITY CONTROL
Rock's legal/compliance team is responsible for compliance and quality
control. This centralized compliance function allows Rock to control and
supervise regulatory compliance and offer consistency to its customers. The
legal/compliance team also assists in developing underwriting and asset quality
requirements for its loans and in applying those standards in making
underwriting decisions. The legal/compliance team also helps the servicing team
handle delinquencies and foreclosures that occur before a loan is sold.
The quality control personnel review loans that have already been made (i)
to monitor, evaluate and improve the overall quality of loan production, and
(ii) to identify and communicate to the legal/compliance
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<PAGE> 59
team and management existing and potential underwriting and loan file problems
or areas of concern. After loans close, the quality control personnel select a
percentage of the closed loans to check them for documentation, accuracy,
compliance with law and potential fraud. The sample is selected so that each
loan officer, branch, store and production employee is checked periodically. The
quality control team also does statistical analyses of closed loans to determine
if there are any patterns or problems. Any problems found are called to the
attention of the legal/compliance team and senior management.
LOAN SERVICING
Rock currently services the loans it closes between the date of making the
loan and the date it sells the loan and the related servicing. Rock employs
Alltel Information Services, Inc. for providing its loan servicing computing
services. Before April 1995, Rock retained the rights to service the
Conventional Loans it sold, and, as a result, had a servicing portfolio of
$640.1 million as of July 28, 1994. Rock, however, sold its servicing rights in
April 1995 and through 1997 sold all of its loans servicing released (i.e.,
without retaining the right to service the loan) or sells the servicing rights
separately. Rock's technology and personnel, however, are capable of servicing a
substantially larger portfolio of loans without significantly increasing costs.
Rock would consider selling its loans with the servicing rights retained if it
believes that the value of the servicing rights is or may become significantly
greater than secondary market buyers are then willing to pay for them. If Rock
sold loans with servicing retained, Rock would recognize a gain on the sale
equal to the difference between the carrying value of the loan sold on Rock's
balance sheet and the sum of (i) the cash received in such sale, and (ii) the
amount of an asset recorded on its balance sheet in an initial amount equal to
the present value of the servicing fees it would expect to collect over the life
of the loan (the "Servicing Asset"). If Rock believes the value of the Servicing
Asset in the secondary market becomes high enough, Rock would consider selling
its servicing rights as it did in 1994 and 1995. If Rock began to sell its loans
with servicing retained, it would be subject to the risks described in "Risk
Factors -- Potential Originated Mortgage Servicing Rights Risk."
Loan servicing includes collecting payments from customers, accounting for
loan principal and interest, holding custodial funds for payment of
mortgage-related expenses, such as taxes and insurance, inspecting the mortgaged
premises as required, contacting delinquent customers, supervising foreclosures
and property disposition in the event of unremedied defaults, and otherwise
administering the loan.
SALE OF LOANS
Rock closes all of its loans with the intent of selling such loans in the
secondary market. Rock attempts to originate loans with characteristics which
will be sought by unaffiliated purchasers of loans, including banks and parties
seeking loans for securitization pools, at attractive premiums. Sales of
Sub-Prime Loans and Conventional Loans are conducted by Rock's secondary
marketing team.
When Rock sells the loans it closes, Rock also reduces its exposure to
default risk (other than some first-payment defaults by customers) and most of
the prepayment risk normally inherent in the consumer lending business. Rock may
be required to repurchase or substitute loans in the event of a breach of
representations and warranties, including representations regarding compliance
with laws, regulations and program standards, accuracy of information, and lack
of fraud or any misrepresentation made during the loan origination process. In
addition, in connection with some Sub-Prime Loan sales, Rock may be required to
return a portion of the premium received upon the sale of the loan if the loan
is prepaid by the customer within the first year after sale. Otherwise, Rock's
loan sales are generally on a non-recourse basis. For the year ended December
31, 1997, Rock accrued $603,000 with respect to future premium recapture, and
during the year made $298,000 of recapture payments. The amount remaining as a
reserve with respect to future premium recapture at December 31, 1997 was
$694,000. In addition, Rock recorded a provision for credit losses of $300,000
in 1997 for potential repurchase obligations and the credit risk associated with
holding loans longer before sale. During 1997, two loans were foreclosed and
transferred to real estate owned, resulting in a $30,000 charge to the
allowance.
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<PAGE> 60
SUB-PRIME LOANS
Rock sells its Sub-Prime Loans either through "bulk" sales or "flow" sales.
"Bulk" sales are sales of loans underwritten to Rock's underwriting standards
that are pooled and then sold to third parties for cash by Rock. "Flow" sales
are sales of loans underwritten by a third party who commits to purchase each
individual loan its underwriters approve.
Rock currently does not securitize its loans. If the prices offered in the
secondary market for Rock's loans decrease significantly relative to the value
Rock believes that it could receive by securitizing such loans, Rock's
management would consider securitizing its loans. If Rock began to securitize
its loans, it would be subject to the risks described in "Risk Factors -- Risks
of Securitization."
Five loan buyers purchased an aggregate of approximately 91.6% of the
Sub-Prime Home Equity Loans sold by Rock in 1997, of which the largest of such
buyers purchased approximately 36.5% of such Sub-Prime Home Equity Loans. Two
loan buyers purchased approximately 93.5% of the High LTV Loans sold by Rock in
1997. The loss of any of these buyers or any significant reduction in the prices
these buyers are willing to pay for Rock's loans could have an adverse effect on
Rock's business, financial condition and results of operations.
CONVENTIONAL LOANS
Rock sells its Conventional Loans either through assignments of trade or
whole loan sales. Currently, Rock's fixed-rate Conventional Loans meeting FNMA
or Freddie Mac guidelines are sold through assignments of trade. Assignment of
trade sales are sales of Conventional Loans to a third party who exchanges them
with FNMA or Freddie Mac for their securities. Loans not meeting FNMA or Freddie
Mac guidelines are sold in whole loan sales. In a whole loan sale, individual
loans are underwritten and sold to a specific buyer on a committed basis.
INTEREST RATE RISK MANAGEMENT
Rock closes loans and subsequently sells them for cash to unaffiliated
wholesale purchasers. If prevailing interest rates rise between the time Rock
closes loans or fixes the interest rates on such loans and the time such loans
are priced for sale, the spread between the amount loaned and the amount the
wholesale purchaser is willing to pay for the loan narrows, resulting in a loss
in value of the loan. To protect against such losses in respect of its
Conventional Loans (where the interest spread is lower), Rock currently enters
into forward sales commitments to fix the sales price of the Conventional Loans
expected to be closed or hedges the value of those loans through periodic
purchases of short-duration treasury-based options. Before entering into forward
commitments or hedging, Rock performs an analysis of its Conventional Loans and
Conventional Loan applications with committed interest rates taking into account
such factors as the estimated portion of such loan applications that will
ultimately be funded, interest rates, inventories of loans and applications and
other factors to determine the type and amount of forward commitment and hedging
transactions. Rock attempts to make forward commitments for or hedge
substantially all of its estimated interest rate risk on its Conventional Loans.
Rock does not believe that hedging its interest rate risk with respect to its
Sub-Prime Loans is cost effective as a result of their generally higher interest
spreads combined with their relative lack of sensitivity to changes in market
interest rates and considering the period during which Rock intends to
accumulate such loans for sale. See "Risk Factors -- Economic Conditions --
Interest Rates."
COMPETITION
The consumer lending industry is highly competitive and fragmented. Rock
faces intense competition, primarily from numerous commercial banks, savings and
loan associations, credit unions, insurance companies, mortgage brokers,
mortgage bankers and other consumer finance companies. If Rock expands into
additional geographic markets, it will face competition from consumer lenders
with established positions in such markets. There can be no assurance that Rock
will be able to compete successfully with these consumer lenders.
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<PAGE> 61
Competition can take place on various levels, including convenience in
obtaining a loan, service, marketing, pricing (including the interest rates,
closing costs and processing fees offered) and range of products. Rock believes
that pricing, service and convenience are the most important competitive factors
affecting its business. Many of Rock's competitors in the consumer lending
industry are better established, substantially larger and have significantly
more capital and other resources than Rock. In addition, FNMA and Freddie Mac
are currently developing technologies and business practices that will expand
the scope of mortgage loans eligible to be purchased by them, including
Sub-Prime Home Equity Loans. The effect of these purchases on the consumer
lending industry and profit margins is not presently determinable, but such
expanded scope could attract additional competitors into the market and
significantly erode profit margins. Barriers to entry into the consumer lending
industry are low, and the current level of gains realized by Rock and its
existing competitors on the sale of loans could attract additional competitors
into the market. Consequently, there are many recent market entrants seeking
these relatively attractive profit margins. Increases in the number of
competitors seeking to originate consumer loans could lower the rates of
interest or reduce the amount of origination points and fees Rock can charge
customers, thereby reducing the potential profitability of such loans.
Competition might also reduce Rock's loan closing volume. In addition, during
periods of declining interest rates, competitors which have "locked in" low
borrowing costs may have a competitive advantage. There can be no assurance that
Rock will be able to compete successfully in this market environment and any
failure in this regard could have a material adverse effect on Rock's business,
financial condition and results of operations.
SYSTEMS
Rock is committed to maintaining and enhancing its technology and systems.
As of March 31, 1998, Rock employed a staff of 39 in its technology team to
allow it better to analyze its information regarding past customers, develop
customer profiles, create and obtain lists of potential customers and track loan
applications, closings and sales. Rock's offering of a broad range of loan
products requires the timely delivery of such loan products and careful
monitoring and tracking of loans from their origination through their ultimate
sale. Rock uses a loan origination and administration system that allows Rock to
process loans quickly and efficiently. The system provides real-time access to
the information used by each team in operations as well as the secondary
marketing and financial teams. The system provides loan officers with
information concerning the status of each loan application and reminds them of
the documents and steps needed to close the loan. Rock also uses these systems
to develop computer-generated forms for each of its various loans in each
jurisdiction to make the processing of approved loans faster and more efficient.
Also, in January 1998, Rock introduced FNMA's automated underwriting systems to
its Conventional Mortgage Lending division. Because a loan officer's
compensation is based, in part, on the number of loans closed each month, this
information also provides employees with information about the status of their
compensation for the month and gives them an incentive to be more productive.
Call center loan officers handle both inbound and outbound calls. Most
inbound calls are from homeowners responding to Rock's advertising and direct
mail campaigns. Outbound calls use Rock's computerized predictive dialers with
scripted, interactive sales presentations to solicit homeowners and current
customers. A predictive dialing system is a telecommunications device which
initiates phone calls to pre-selected and randomly-selected numbers, predicts
when sales agents are available to receive calls and automatically forwards
calls to an available sales agent. It also routes inbound calls to available
call center loan representatives. The telephone system can track where calls
originate, who handles the call, the time a customer spends waiting on the phone
and other information about Rock's phone calls.
Rock does not expect the cost of making its computer systems year-2000
compliant will be material. Because most of Rock's computer hardware and
software is less than two years old, it believes that its exposure to year
2000-related hardware and software problems is lower than if it used older
equipment or software. Nonetheless, Rock is engaging a consultant to manage the
testing of its equipment and software and the identification and resolution of
any problems discovered. Rock also plans to explore the strategies of its
vendors to discover and resolve any year-2000 problems. Rock is already
participating with its loan servicing
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<PAGE> 62
vendor in its year-2000 evaluation process. Rock expects to complete this
process during 1998. See "Risk Factors -- Year 2000 Compliance."
SEASONALITY
Rock is affected by consumer demand for home loans, which is partially
influenced by regional trends, economic conditions and personal preferences.
Rock's business is generally subject to seasonal trends with loan activity
generally decreasing during the winter months, especially loans relating to home
purchases. Rock's lowest revenue and net income levels during the year have
historically been in the first quarter. In addition, Rock believes that new
stores typically require twelve to eighteen months of operations before their
revenues and expenses are at levels comparable to older stores, and that during
their first two to three quarters of operations their expenses might exceed
their contribution to income. Because 13 stores, one marketing center and two
branches have opened since July 1, 1997 (including four stores in the fourth
quarter of 1997, five stores in January 1998 and two branches in the second
quarter of 1998), Rock expects these stores and branches to contribute
significantly less to its revenues and net income and more to its expenses in
the first and possibly the second and third quarters of 1998 than stores and
branches that have been in operation for at least twelve months. The stores
opened in January 1998 and some of the stores opened late in 1997 operated at a
net loss aggregating approximately $1.6 million in the first quarter of 1998.
GOVERNMENT REGULATION
Rock's business is subject to extensive regulation, supervision and
licensing by federal, state and local governmental authorities and will be
subject to various laws and judicial and administrative decisions imposing
requirements and restrictions on part or all of its operations. Regulated
matters include, without limitation, loan origination, marketing efforts, credit
application and underwriting activities, maximum finance and other charges,
disclosure to customers, certain rights of rescission, closing and servicing
loans, collection and foreclosure procedures, qualification and licensing
requirements for doing business in various jurisdictions and other trade
practices.
Loan origination activities are subject to the laws and regulations in each
of the states in which those activities are conducted. Activities as a lender
are also subject to various federal laws. The Truth-in-Lending Act ("TILA") and
Regulation Z promulgated thereunder, as both are amended from time to time,
contain disclosure requirements designed to provide consumers with uniform,
understandable information with respect to the terms and conditions of loans and
credit transactions in order to give them the ability to compare credit terms.
TILA also guarantees consumers a three-day right to cancel certain credit
transactions. If Rock is found not to be in compliance with TILA, aggrieved
customers could have the right to rescind their loan transactions with Rock and
to demand the return of finance charges paid to Rock.
In September 1994, the Riegle Community Development and Regulatory
Improvement Act of 1994 (the "Riegle Act") was enacted. Among other things, the
Riegle Act makes certain amendments to TILA. The TILA amendments, which became
effective in October 1995, generally apply to mortgage loans (other than
mortgage loans to finance the acquisition or initial construction of a dwelling)
("covered loans") with (i) total points and fees upon origination in excess of
the greater of eight percent of the loan amount or $400, or (ii) an annual
percentage rate of more than 10 percentage points higher than comparably
maturing United States Treasury securities.
The TILA amendments impose additional disclosure requirements on lenders
originating covered loans and prohibit lenders from originating covered loans
that are underwritten solely on the basis of the customer's home equity without
regard to the customer's ability to repay the loan. Rock applies to all covered
loans underwriting criteria that take into consideration the customer's ability
to repay. The TILA amendments also prohibit lenders from including prepayment
fee clauses in covered loans to customers with a debt-to-income ratio in excess
of 50% or in covered loans used to refinance existing loans originated by the
same lender. Rock did not report any prepayment fee revenue in the years ended
December 31, 1995, 1996 and 1997. The TILA amendments impose other restrictions
on covered loans, including restrictions on balloon payments and negative
amortization features, which Rock does not believe will have a material effect
on its operations.
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Rock is also required to comply with the Equal Credit Opportunity Act of
1974, as amended ("ECOA"), which prohibits lenders from discriminating against
applicants on the basis of race, color, sex, age or marital status. Regulation B
promulgated under ECOA restricts lenders from obtaining certain types of
information from loan applicants. It also requires certain disclosures by the
lender regarding consumer rights and requires lenders to advise applicants of
the reasons for any credit denial. In instances where the applicant is denied
credit or the rate or charge for a loan increases as a result of information
obtained from a consumer credit agency, the Fair Credit Reporting Act of 1970,
as amended ("FCRA"), requires the lender to supply the applicant with a name and
address of the reporting agency. Rock is also subject to the Real Estate
Settlement Procedures Act ("RESPA") and the Fair Debt Collection Practices Act
and is required to file an annual report with HUD pursuant to the Home Mortgage
Disclosure Act ("HMDA"). Rock is also subject to the rules and regulations of,
and examinations by, HUD, FNMA, Freddie Mac and state regulatory authorities
with respect to originating, processing, underwriting, selling and servicing
mortgage loans and to various other federal and state laws, rules and
regulations governing among other things, the licensing of, and procedures that
must be followed by, consumer lenders and servicers, and disclosures that must
be made to consumer customers.
Texas has newly-enacted laws affecting Sub-Prime Loans. As a result of
these new laws there are increased risks associated with Rock's loans secured by
property located in Texas, including (i) risks that Rock's Sub-Prime Loans will
not comply with the provisions permitting mortgage liens on Texas real estate,
making Rock's liens invalid, (ii) risks of litigation, including class action
lawsuits, if Rock's loans, including the origination points and processing fees
charged on such loans, are determined to violate Texas law, and (iii) risks that
secondary market loan buyers will not be willing to purchase loans secured by
Texas real estate or will pay lower prices for such loans. Rock currently sells
Sub-Prime Loans originated in Texas on a flow basis and intends to increase its
concentration on originating Conventional Loans in its Fresh Start(TM) stores in
Texas until the new laws are clarified.
Failure to comply with these requirements can lead to civil or criminal
liability, loss of approved status, termination or suspension of servicing
contracts without compensation to the servicer, demands for indemnification or
loan repurchases, certain rights of rescission for mortgage loans, class action
lawsuits and administrative and enforcement actions. There can be no assurance
that Rock will maintain compliance with these requirements in the future without
additional expenses, or that more restrictive local, state or federal laws,
rules and regulations will not be adopted or that existing laws and regulations
will not be interpreted in a more restrictive manner, which would make
compliance more difficult and more expensive for Rock.
In addition, industry participants are frequently named as defendants in
litigation involving alleged violations of federal and state consumer-lending
laws and regulations, or other similar laws and regulations, as a result of the
consumer-oriented nature of the industry in which Rock operates and
uncertainties with respect to the application of various laws and regulations in
certain circumstances. Some sectors of, and participants in, the
consumer-finance industry have been adversely affected by regulatory enforcement
actions and private class-action lawsuits regarding various consumer-lending
practices. These actions and lawsuits allege violations of the Real Estate
Settlement Procedures Act, the Truth-in-Lending Act, the Equal Credit
Opportunity Act and various other federal and state lending and
consumer-protection laws. Some of the practices which have been the subject of
lawsuits against other companies include, but are not limited to, miscellaneous
"add-on" fees; truth-in-lending calculations and disclosures; escrow and
adjustable-rate mortgage calculations and collections; private mortgage
insurance calculations, disclosures and cancellation; forced-placed hazard,
flood and optional insurance; payoff statement, release and reconveyance fees;
and unfair lending practices. If a significant judgment were rendered against
Rock in connection with any litigation, it could have a material adverse effect
on Rock's business, financial condition and results of operations.
Further, during the course of its business, Rock may acquire properties
securing loans that are in default. To date, Rock has not been required to
perform any environmental investigation or remediation activities, nor has it
been subject to any environmental claims. Rock, however, might be required to
perform such investigations or activities, or become subject to environmental
claims, in the future. There is a risk that hazardous or toxic waste could be
found on properties acquired by Rock. In such event, Rock could be held
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responsible for the cost of remediating or removing such waste, and such cost
could exceed the value of the underlying properties.
The laws and regulations described above are subject to legislative,
administrative and judicial interpretation, and certain of these laws and
regulations have been infrequently interpreted or only recently enacted.
Infrequent interpretations of these laws and regulations or an insignificant
number of interpretations of recently enacted laws and regulations can result in
ambiguity with respect to permitted conduct under these laws and regulations.
Any ambiguity under the laws and regulations to which Rock is subject may lead
to regulatory investigations or enforcement actions and private causes of
action, such as class action lawsuits, with respect to Rock's compliance with
applicable laws and regulations. Rock may also be subject to regulatory
enforcement actions and private causes of action from time to time with respect
to its compliance with applicable laws and regulations.
In addition, because Rock's business is highly regulated, the laws, rules
and regulations applicable to Rock are subject to modification and change. Any
changes in such laws, rules and regulations could make compliance much more
difficult or expensive, restrict Rock's ability to originate or sell loans,
limit or restrict the amount of interest and other charges earned on loans
closed or sold by Rock, or otherwise adversely affect the business or prospects
of Rock.
EMPLOYEES
As of March 31, 1998, Rock employed 770 full-time individuals, including
335 in its sales force. Rock believes that its future success is dependent, in
large part, on its ability to attract and retain highly-qualified sales,
management, marketing, technical and administrative personnel. Rock's employees
are not represented by a union or subject to a collective bargaining agreement.
Rock believes that its relations with its current employees are good.
PROPERTIES
Rock's executive and administrative offices are located in leased premises
at 30600 Telegraph Road, Fourth Floor, Bingham Farms, Michigan 48025 and consist
of approximately 53,560 square feet. Rock expects to amend its lease to add
additional space to its call center and additional office space. Rock has
options to lease these premises through October 31, 2001, and the current base
monthly rental is approximately $58,600.
As of April 6, 1998, Rock had 19 Fresh Start(TM) stores and one marketing
center (eight in Michigan, four in Illinois, three in Ohio, two in Texas and one
each in Nevada, Missouri and Indiana), and seven Conventional Lending branches
(all in southeast Michigan). The Fresh Start(TM) division's stores are generally
located in retail strip malls or office buildings. Two Conventional Lending
branches are located in retail strip malls, three are in office buildings and
two are located near residential real estate brokers' offices. Rock leases all
of its Fresh Start(TM) stores, marketing center and Conventional Lending branch
locations pursuant to leases that expire at varying times from one month after
notice from the landlord to July 2002. See "Operating Divisions -- Fresh
Start(TM) Division -- Fresh Start(TM) Stores" and "Operating Divisions --
Conventional Mortgage Lending Division -- Conventional Mortgage Lending
Branches."
Rock believes that its facilities are adequate for its current needs and
that additional space is available for future expansion. For a description of
Rock's store expansion strategy, see "Business Strategy."
SERVICE MARKS
Rock has registered the names "Fresh Start Financial Services(R),"
"Mortgage in a Box(R)" and "Mortgage First(R)" as service marks with the United
States Patent and Trademark Office. and has filed applications for the names
"Fresh Start(TM)," "Fresh Start Loan Center," "Lender for Life" and "PMI
Buster." The registrations of these service marks are renewable indefinitely.
Rock is not aware of any adverse claims concerning its marks.
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LEGAL PROCEEDINGS
Rock is involved from time to time in routine litigation incidental to its
business. Although the amount of any liability that could arise with respect to
these actions cannot accurately be predicted, in the opinion of Rock, any such
liability will not have a material adverse effect on Rock's financial position.
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<PAGE> 66
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The Board of Directors of Rock is divided into three classes: Class I,
Class II and Class III. After his initial term, each Director will serve for a
term ending following the third annual meeting following the annual meeting at
which such Director is elected and until his successor is elected and qualified,
or until his earlier death, resignation or removal. Rock's Restated Articles of
Incorporation provide that Directors may only be removed for cause. The initial
terms of office of Directors in Class I, Class II and Class III end after the
annual meetings of shareholders of Rock in 1999, 2000 and 2001, respectively.
All officers are appointed by and serve at the discretion of the Board of
Directors. The following table sets forth certain information regarding the
current directors and executive officers of Rock as of April 10, 1998:
<TABLE>
<CAPTION>
NAME AGE POSITION CLASS
---- --- -------- -----
<S> <C> <C> <C>
Daniel Gilbert......... 36 Chairman of the Board of Directors and Chief Executive III
Officer
Steven M. Stone........ 38 President and Director II
David Carroll.......... 35 Chief Operations Officer N/A
Lindsay Gross.......... 35 Executive Vice President, Conventional Lending N/A
Frank E. Plenskofski... 39 Treasurer and Chief Financial Officer N/A
Gary L. Gilbert........ 33 Director I
David A. Brandon*...... 45 Director III
David Katzman*......... 38 Director II
Robert V. Schechter.... 60 Director I
</TABLE>
- -------------------------
* Member of the Compensation Committee and Member of the Audit Committee.
Daniel Gilbert. Mr. Gilbert founded Rock in June 1985 and has served as its
Chief Executive Officer since its inception in June 1985 and as its Chairman of
the Board since December 1992. From February 1986 until February 1998 he served
as Rock's President. Mr. Gilbert has been a Director of Rock since its inception
in June 1985. Gary L. Gilbert and Daniel Gilbert are brothers. David Katzman and
Daniel Gilbert are first cousins.
Steven M. Stone. Mr. Stone has served as President of Rock since January
1998. He previously served as the President of Rock's Fresh Start(TM) division
from January 1996 until February 1998 and as its Director of Alternative Lending
from June 1994 until January 1996. Before that he served as President, Home
Lending, of Worldwide Mortgage Corporation, a company engaged in originating
sub-prime mortgage loans, from April 1992 until April 1994. Mr. Stone has been a
Director of Rock since December 1996. Mr. Stone is a party to an employment
agreement with Rock pursuant to which he is required, during the term thereof,
to be elected to the office with Rock he currently holds.
David Carroll. Mr. Carroll has served as Chief Operations Officer of Rock
since September 1994. From July 1992 until September 1994 he served as Rock's
Operation's Manager. From April 1992 until July 1992 he served as Rock's
Director of Wholesale Lending. Mr. Carroll was a Director of Rock from September
1994 until February 1998.
Lindsay Gross. Mr. Gross has served as Executive Vice President,
Conventional Lending of Rock since December 1992. He also served as Rock's
Secretary from March 1987 until September 1994. Mr. Gross was a Director of Rock
from March 1987 until February 1998.
Frank E. Plenskofski. Mr. Plenskofski is a certified public accountant and
a member of both the American Institute of Certified Public Accountants and of
the Pennsylvania Institute of Certified Public Accountants. He has served as
Rock's Treasurer and Chief Financial Officer since December 1996. From April
1996 until December 1996 he served as Rock's Chief Financial Officer. From
October 1992 until April 1996 he served as Senior Vice President of Secondary
Marketing of Com Net Mortgage Services, Inc., a mortgage banking company and a
subsidiary of Common Wealth Savings Bank.
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<PAGE> 67
Gary L. Gilbert. Mr. Gilbert has served as the President and Chief
Executive Officer of Option Home Lending, Inc., a company he founded, since
February 1997. From December 1992 until January 1997 he served as Rock's
Executive Vice President. From March 1987 until December 1992 he served as
Rock's Vice President. Gary L. Gilbert was an employee of Rock from June 1985
until March 1987. Mr. Gilbert has been a Director of Rock since March 1987.
Pursuant to a Stock Purchase Agreement, dated as of January 17, 1997, between
Gary L. Gilbert and Daniel Gilbert, Daniel Gilbert has agreed to vote his Common
Shares to elect Gary L. Gilbert as a director of Rock until the closing of this
Offering. Gary L. Gilbert and Daniel Gilbert are brothers.
David A. Brandon. Mr. Brandon is Chief Executive Officer, President and
Chairman of the Board of Directors of Valassis Communications, Inc., a publisher
of advertising inserts. Mr. Brandon was elected President and director of
Valassis Communications, Inc. in October 1991 and has served as a Director since
that time. He was appointed Chairman of the Board of Directors in July 1997. He
served as Executive Vice President and Chief Operating Officer of Valassis
Inserts, Inc. from 1986 through July 1989 and President and Chief Executive
Officer of Valassis Inserts from July 1989 until its merger into Valassis
Communications, Inc. He has served as a director of Rock since April 1998.
David Katzman. Mr. Katzman has served as President of National Blinds &
Wallpaper, Inc., a subsidiary of The Home Depot, a home building supplies
retailer, since November 1997. From October 1987 until November 1997 he served
as President of Deekay Enterprises, Inc., a home building supplies retailer. He
has served as a Director of Rock since April 1998. Daniel Gilbert and David
Katzman are first cousins.
Robert V. Schechter. Mr. Schechter has been President and the sole
shareholder of Benefit Programs, Inc., an insurance agency, since it was founded
in 1971. He has been a Director of Rock since April 1998.
The Company intends to add another Director who is not an officer or
employee of the Company.
COMMITTEES OF THE BOARD OF DIRECTORS
The Board of Directors has an Audit Committee which consists of two
Directors. David A. Brandon and David Katzman are the current members of this
committee. The Audit Committee (i) recommends to the Board the conditions,
compensation and term of appointment of independent certified public accountants
for the audit of Rock's financial statements, (ii) reviews examination reports
of Rock prepared by regulatory authorities, and (iii) provides the Board with
such assistance as is necessary with respect to Rock's corporate and reporting
practices. The Audit Committee may also from time to time confer with the
auditors to exchange views relating to the scope and results of the audit. The
Audit Committee was formed in April 1998.
The Board of Directors also has a Compensation Committee which consists of
two Directors. David A. Brandon and David Katzman are the current members of
this committee. The Compensation Committee makes recommendations to the Board of
Directors with respect to compensation arrangements and plans for senior
management, officers and directors of Rock and administers Rock's 1996 Stock
Option Plan. The Compensation Committee was formed in April 1998.
Rock does not have a nominating committee.
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<PAGE> 68
COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth information for the year ended December 31,
1997 concerning compensation of (i) Rock's Chief Executive Officer, and (ii)
Rock's four most highly-compensated other executive officers who were serving as
executive officers of Rock as of December 31, 1997 and whose total annual salary
and bonus exceeded $100,000 in 1997:
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
------------
AWARDS
------------
ANNUAL COMPENSATION SECURITIES ALL OTHER
NAME AND ---------------------- UNDERLYING COMPENSATION
PRINCIPAL POSITION YEAR SALARY($) BONUS($) OPTIONS(#) ($)(1)
------------------ ---- --------- -------- ---------- ------------
<S> <C> <C> <C> <C> <C>
Daniel Gilbert,.......................... 1997 225,000 620,000(2) -0- 1,900
Chairman of the Board 1996 150,000 1,245,000 -0- 1,385
and Chief Executive Officer 1995 150,000 377,000 -0- 1,289
Steven M. Stone,......................... 1997 160,000 540,000(2) -0-(3) 849
President 1996 125,000 578,000 1,001,454 -0-
1995 75,385 68,480 -0- -0-
David Carroll,........................... 1997 130,000 40,000 50,000 1,900
Chief Operations Officer 1996 120,000 30,000 -0- 1,125
1995 100,000 20,000 -0- 1,000
Lindsay Gross,........................... 1997 175,000 167,030 -0- 1,900
Executive Vice President, 1996 180,000 69,000 -0- 286
Conventional Lending 1995 199,500 50,000 -0- 77
Frank E. Plenskofski,.................... 1997 120,000 40,000 50,000 62,877
Chief Financial Officer(4) 1996 86,796 30,000 -0- 11,000
</TABLE>
- -------------------------
(1) Includes $1,900, $849, $1,900, $1,900 and $877 contributed by Rock to
Messrs. Gilbert, Stone, Carroll, Gross and Plenskofski, respectively,
pursuant to the matching contribution provisions of Rock's 401(k) Savings
Plan for the year ended December 31, 1997. Also includes $62,000 paid to Mr.
Plenskofski in 1997 to reimburse him for relocation expenses.
(2) Rock does not intend to pay bonuses of this magnitude to Messrs. Gilbert and
Stone for 1998.
(3) In connection with an amendment to his employment agreement, effective as of
the closing date of this Offering, Rock granted Mr. Stone an immediately
exercisable option to purchase 292,500 Common Shares with an exercise price
equal to the initial public offering price set forth on the cover page of
this Prospectus. See "Employment Contracts and Termination of Employment and
Change-in-Control Arrangements."
(4) Mr. Plenskofski became an executive officer of Rock in December 1996.
COMPENSATION OF DIRECTORS
Following completion of this Offering, Rock intends to pay each Director
who is not an officer, employee or 10% shareholder of Rock ("Outside Directors")
a fee of $1,000 for each Board meeting attended in person, $750 for each
telephonic Board meeting attended, and $500 for each Board committee meeting
attended on a date other than the date of a Board meeting. Rock will also
reimburse Outside Directors for their reasonable expenses of attending Board and
Board committee meetings. Rock also intends to grant options to purchase 15,000
Common Shares to each of the Outside Directors effective as of the closing date
of this Offering at an exercise price equal to the initial public offering price
of the Common Shares.
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<PAGE> 69
OPTION GRANTS TABLE
The following table sets forth information concerning individual grants of
stock options made during the year ended December 31, 1997 to each of the
executive officers of Rock named in the Summary Compensation Table above:
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
- ----------------------------------------------------------------------------------------- POTENTIAL
% OF REALIZABLE VALUE AT
TOTAL ASSUMED ANNUAL
NUMBER OF OPTIONS RATES OF STOCK PRICE
SECURITIES GRANTED TO APPRECIATION
UNDERLYING EMPLOYEES EXERCISE FOR OPTION TERM
OPTIONS IN FISCAL PRICE EXPIRATION --------------------
NAME GRANTED(#) YEAR ($/SH) DATE 5%($) 10%($)
---- ---------- ---------- -------- ---------- ----- ------
<S> <C> <C> <C> <C> <C> <C>
Daniel Gilbert..................... -0- 0.0 N/A N/A N/A N/A
Steven M. Stone.................... -0-(1) 0.0 N/A N/A N/A N/A
David Carroll...................... 50,000(2) 4.7 $4.68 12/31/06 147,161 372,936
Lindsay Gross...................... -0- 0.0 N/A N/A N/A N/A
Frank E. Plenskofski............... 50,000(2) 4.7 $4.68 12/31/06 147,161 372,936
</TABLE>
- -------------------------
(1) Mr. Stone received an option to purchase 1,001,454 Common Shares in December
1996, representing approximately 65% of the options granted in 1996. The
option is immediately exercisable in full at $4.68 a share through December
28, 2006. The value of such option assuming 5% and 10% stock price
appreciation from the exercise price over the term of the option would be
$2,947,506 and $7,469,560, respectively. The option will continue to be
exercisable for three years after termination of Mr. Stone's employment
without cause and one year after he ceases to be an employee of Rock because
of his death or disability, but in no event after the termination date of
the option. In connection with an amendment to his employment agreement,
effective as of the closing date of this Offering, Rock granted Mr. Stone an
immediately exercisable option to purchase 292,500 Common Shares with an
exercise price equal to the initial public offering price set forth on the
cover page of this Prospectus. See "Employment Contracts and Termination of
Employment and Change-in-Control Arrangements."
(2) These options are exercisable in one-fifth cumulative annual installments
beginning December 31, 1997.
(3) With respect to each of the options described above, if upon exercise of
these options Rock must pay any amount for income tax withholding, in the
Compensation Committee's or the Board of Directors' sole discretion, either
the optionee will pay such amount to Rock or the number of Common Shares
delivered by Rock to the optionee will be appropriately reduced to reimburse
Rock for such payment. The Compensation Committee or the Board of Directors
may also permit the optionee to choose to have such shares withheld or to
tender Common Shares the optionee already owns. The Compensation Committee
or the Board may also make such other arrangements with respect to income
tax withholding as the Compensation Committee shall determine. In addition,
each of the options described above contains provisions requiring forfeiture
of the gain realized upon exercise of the option if the employee leaves Rock
within one year after exercise or engages in certain activities inimical,
contrary or harmful to the interests of Rock.
Effective as of the closing date of this Offering, Rock intends to grant
ten-year options under its 1996 Stock Option Plan to purchase an aggregate of
approximately 438,500 Common Shares to approximately 124 Directors and employees
of the Company at an exercise price equal to the initial public offering price
of the Common Shares. Such grants of options are expected to include 10,000,
10,000, 15,000, 15,000 and 15,000 options granted to David Carroll, Frank
Plenskofski, David Brandon, David Katzman and Robert Schechter, respectively.
These options are in addition to the options to purchase 450,000 Common Shares
to be granted to the Selling Shareholders and described in Note 5 to the table
under the caption "Principal and Selling Shareholders."
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<PAGE> 70
AGGREGATED OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUE TABLE
The following table sets forth information concerning each exercise of
stock options during the year ended December 31, 1997 by each of the executive
officers named in the Summary Compensation Table above and the value of
unexercised options held by such persons as of December 31, 1997 (at an assumed
market value equal to the initial public offering price of $10.00):
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF
SECURITIES VALUE OF
UNDERLYING UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS AT OPTIONS AT
SHARES FY-END(#) FY-END($)
ACQUIRED ON VALUE EXERCISABLE/ EXERCISABLE/
NAME EXERCISE(#) REALIZED($) UNEXERCISABLE UNEXERCISABLE
---- ----------- ----------- ------------- -------------
<S> <C> <C> <C> <C>
Daniel Gilbert........................ -0- -0- -0-/-0- -0-/-0-
Steven M. Stone....................... -0- -0- 1,001,454/-0- 5,327,735/-0-
David Carroll......................... -0- -0- 10,000/40,000 53,200/212,800
Lindsay Gross......................... -0- -0- -0-/-0- -0-/-0-
Frank E. Plenskofski.................. -0- -0- 10,000/40,000 53,200/212,800
</TABLE>
EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE-IN-CONTROL
ARRANGEMENTS
Daniel Gilbert. As of April 10, 1998, Rock entered into a letter agreement
with Daniel Gilbert. Pursuant to the letter agreement, Daniel Gilbert agreed
that his bonus with respect to 1998 from Rock will not exceed $300,000. The
letter agreement also provides that Daniel Gilbert will not compete with Rock in
the business of originating loans in the states in which Rock is active until
the earliest of (i) one year after his termination of employment by Rock for
cause, (ii) one year after termination of employment by Daniel Gilbert without
good reason, except as a result of his death or disability, and (iii) the date
of termination of his employment for any other reason.
Steven M. Stone. As of June 27, 1994, Rock entered into an employment
agreement with Steven M. Stone, which agreement was amended as of December 28,
1996 and as of February 18, 1998. Pursuant to such agreement, he is employed as
President of Rock. Such agreement may be terminated by Mr. Stone or Rock at any
time. Mr. Stone is entitled to a salary and a discretionary bonus determined by
Rock's Chief Executive Officer. Such employment agreement provided for the
payment of special bonuses in the amounts of $540,000 by December 31, 1996,
$180,000 by July 1, 1997 and $360,000 by December 31, 1997, the grant of a stock
option on December 28, 1996 to purchase 1,001,454 Common Shares at $4.68 per
share, and the grant of an immediately exercisable stock option on the closing
date of this Offering to purchase 292,500 Common Shares at an exercise price
equal to the initial public offering price set forth on the cover page of this
Prospectus (the "New Option"). Before the February 18, 1998 amendment, Mr. Stone
had the right under the agreement to receive a "Distribution Bonus" while
employed by Rock until the closing of this Offering. The "Distribution Bonus"
was generally equal to the per share amount of any dividend or other
distribution payable to Rock's shareholders multiplied by the number of shares
subject to Mr. Stone's December 28, 1996 option. In exchange for cancellation of
Mr. Stone's right to receive the Distribution Bonus, Rock (i) agreed to permit
Mr. Stone to be one of the Selling Shareholders in this Offering (see "Principal
and Selling Shareholders"), and (ii) agreed to grant to Mr. Stone the New
Option.
Mr. Stone is entitled to various fringe benefits under the agreement as
determined by Rock's Chief Executive Officer. If Mr. Stone terminates his
employment with Rock upon a minimum of 30 days prior written notice and if Mr.
Stone is not then in breach of any provision of the agreement (as determined by
Rock's Chief Executive Officer), Rock will continue to pay Mr. Stone's salary
for four weeks after the date of termination, if Mr. Stone fully cooperates with
Rock during the transition period. Mr. Stone has agreed not to compete with Rock
during his employment and during specified periods following the termination of
his
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<PAGE> 71
employment, with some exceptions in the event of a Change in Ownership of Rock
(as defined in the agreement).
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
During the year ended December 31, 1997, Rock's Board of Directors did not
have a Compensation Committee or any other committee performing similar
functions. Decisions concerning executive compensation for 1997 were made by the
Board of Directors, including Daniel Gilbert, Steven M. Stone, David Carroll,
Lindsay Gross and Gary L. Gilbert. All of the Directors were, and (except for
Gary L. Gilbert, who resigned as an officer of Rock effective January 17, 1997)
continue to be, officers and employees of Rock. None of the executive officers
of Rock currently serves on the compensation committee of another entity or any
other committee of the board of directors of another entity performing similar
functions. The Directors of Rock have the relationships with Rock described
below:
Indebtedness of Daniel Gilbert, Lindsay Gross and Gary L. Gilbert. From
time to time, Rock has made loans to Daniel Gilbert, Lindsay Gross and Gary L.
Gilbert for personal purposes. The interest charged on such loans is 3% per
year. Gary L. Gilbert repaid his loans in full on February 26, 1997, and Lindsay
Gross repaid his loans in full on February 28, 1997. For the years ended
December 31, 1995, 1996 and 1997 the largest amounts of such loans outstanding
for Daniel Gilbert were $2,338,000, $2,689,000 and $6,109,000, respectively. For
the years ended December 31, 1995, 1996 and 1997 the largest amounts of such
loans outstanding for Gary L. Gilbert were $400,000, $745,000 and $970,000,
respectively. For the years ended December 31, 1995, 1996 and 1997 the largest
amounts of such loans outstanding for Lindsay Gross were $62,000, $99,000 and
$680,000, respectively. As of March 31, 1998, no amounts were owed by Gary L.
Gilbert or Lindsay Gross, and $1,633,000 of principal and accrued interest were
owed by Daniel Gilbert to Rock. Although not required to do so, Daniel Gilbert
expects to repay the balance of his loans with his share of the Shareholder
Distribution Amount.
Transactions with Title Source, Inc. Title Source, Inc. is a title
insurance agency owned 51.60% by Daniel Gilbert, 10.13% by Steven M. Stone,
9.60% by Gary L. Gilbert, 6.00% by Lindsay Gross, and 3.60% by David Carroll.
Title Source, Inc. was formed to acquire the assets of an existing title
insurance agency, which acquisition occurred as of October 1, 1997. Rock expects
to recommend Title Source, Inc. for substantially all of the title insurance
policies required in connection with its mortgage loans. For the year ended
December 31, 1997, Rock collected $39,000 in fees on behalf of Title Source,
Inc. for its closing services. In addition, customers of Rock paid $147,300 in
premiums for title insurance placed through Title Source, Inc. in connection
with loans closed by Rock. Rock cannot predict with certainty the amount of
business proposed to be done with Title Source, Inc. in 1998. Rock made a
working capital loan to Title Source, Inc. during 1997 bearing interest at an
annual rate of 8.25%. The maximum amount of such loan outstanding during 1997
was $300,000. This loan was repaid in full before December 31, 1997.
Transactions with Rock Construction Company, Inc. d/b/a Rock Homes
Construction. Daniel Gilbert, Gary L. Gilbert and Lindsay Gross were 25%, 12.5%
and 12.5% shareholders of Rock Construction, Inc. d/b/a Rock Homes Construction,
a home building contractor, until November 11, 1996, and Daniel Gilbert was a
Vice President and the Secretary of Rock Construction Company, Inc. until
January 2, 1997. In addition, Gary L. Gilbert was a Vice President and Lindsay
Gross was the Treasurer of Rock Construction Company, Inc. until April 1998.
Rock made working capital loans to Rock Construction Company, Inc. from time to
time during 1995, 1996 and 1997 bearing interest at an annual rate of 8.25%. The
maximum amounts of such loans outstanding during 1995, 1996 and 1997 were
$354,000, $50,000 and $100,000, respectively. All of these loans were repaid in
full before December 31, 1997.
Severance Arrangements with Gary L. Gilbert. Gary L. Gilbert resigned as an
officer of Rock effective January 17, 1997 and has started a consumer finance
business operating in the Chicago, Illinois area. In connection with his
resignation, Daniel Gilbert agreed, pursuant to a Stock Purchase Agreement
between Daniel Gilbert and Gary L. Gilbert, to cause Rock to (i) continue Gary
L. Gilbert's salary and commissions through February 28, 1997 ($130,000 a year),
(ii) pay Gary L. Gilbert a $200,000 bonus in 1996, (iii) continue Gary L.
Gilbert's medical and dental insurance for as long as he remains a Director of
Rock,
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<PAGE> 72
unless he becomes employed by another entity providing him with such insurance,
(iv) transfer assets valued at $3,500 to Gary L. Gilbert, (v) declare a dividend
(declared on September 1, 1997) that would result in a distribution to Gary L.
Gilbert of at least $1,000,000, and (vi) allow Gary L. Gilbert to consult with
Rock employees concerning areas of Rock's business and operations that are
similar to the business or operations of any mortgage business formed or
acquired by Gary L. Gilbert. Daniel Gilbert also agreed pursuant to the Stock
Purchase Agreement to vote his Common Shares to elect Gary L. Gilbert as a
Director of Rock until the closing of this Offering.
STOCK OPTION PLAN
In December 1996, the Board of Directors and shareholders of Rock adopted
the Rock Financial Corporation 1996 Stock Option Plan (the "Plan"). The purpose
of the Plan is to provide key employees (including officers), Directors,
consultants and advisors of Rock with an increased incentive to make significant
and extraordinary contributions to the long-term performance and growth of Rock,
to join the interests of key employees, directors, consultants and advisors with
the interests of the shareholders of Rock, and to facilitate attracting and
retaining key employees, Directors, consultants and advisors of exceptional
ability. The Plan authorizes the granting of incentive stock options ("Incentive
Options") and nonqualified stock options ("Nonqualified Options") to purchase
Common Shares to eligible persons. A total of 4,500,000 Common Shares are
authorized for sale upon exercise of options granted under the Plan. The Plan is
currently administered by the Compensation Committee of the Board of Directors
(the "Committee"), which consists of two of the non-employee Directors of Rock.
The Plan provides for adjustments to the number of shares and to the exercise
price of outstanding options in the event of stock dividends, stock splits,
recapitalizations, mergers, statutory share exchanges or reorganizations of or
by Rock.
Key employees (including officers), Directors, consultants and advisors of
or to Rock are eligible to participate in the Plan, and as of March 31, 1998, 89
employees held options to purchase an aggregate of 2,447,184 Common Shares
pursuant to the Plan. Options to purchase an aggregate of 1,540,684 Common
Shares were granted in December 1996 at an exercise price of $4.68 per share,
including grants of 1,001,454 Nonqualified Options to Steven M. Stone. Such
options were immediately exercisable in full. Options to purchase an aggregate
of 780,000 Common Shares were granted in January 1997 (as adjusted in March
1997) at an exercise price of $4.68 per share, including grants of Nonqualified
Options to executive officers as follows: David Carroll (50,000) and Frank E.
Plenskofski (45,000). Such options vest in one-fifth cumulative annual
installments beginning December 31, 1997. Options to purchase an aggregate of
90,000 Common Shares were granted in April 1997 at an exercise price of $4.68
per share, including a grant of Nonqualified Options to Frank E. Plenskofski
(5,000). Such options vest in one-fifth cumulative annual installments beginning
December 31, 1997. Options to purchase an aggregate of 189,000 Common Shares
were granted in July 1997 (as adjusted in March 1998) at an exercise price of
$7.00 per share. Such options vest in one-fifth cumulative annual installments
beginning December 31, 1998. In connection with amendments to employment
agreements with three key employees, effective as of the closing date of this
Offering, Rock granted such employees immediately exercisable options to
purchase 450,000 Common Shares with an exercise price equal to the initial
public offering price set forth on the cover page of this Prospectus. Effective
as of the closing date of this Offering, Rock intends to grant ten-year options
under its 1996 Stock Option Plan to purchase an aggregate of approximately
438,500 Common Shares to approximately 124 Directors and employees of the
Company at an exercise price equal to the initial public offering price of the
Common Shares. Such grants of options are expected to include 10,000, 10,000,
15,000, 15,000 and 15,000 options granted to David Carroll, Frank Plenskofski,
David Brandon, David Katzman and Robert Schechter, respectively. These options
are in addition to the options to purchase 450,000 Common Shares to be granted
to the Selling Shareholders and described in Note 5 to the table under the
caption "Principal and Selling Shareholders."
No Incentive Option may be granted with an exercise price per share less
than the fair market value of the Common Shares at the date of grant. The
Nonqualified Options may be granted with any exercise price determined by the
Committee administering the Plan. The exercise price of an option may be paid in
cash, or, with the consent of the Committee, (i) in Common Shares, (ii) by
delivery of a promissory note payable to the order of Rock which is acceptable
to the Committee, (iii) by a cash down payment and delivery of a
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<PAGE> 73
promissory note in the amount of the unpaid exercise price, (iv) by Rock
retaining from the shares to be delivered upon exercise of the stock option that
number of shares having a fair market value on the date of exercise equal to the
option price of the number of shares with respect to which the participant
exercises the option, (v) by delivery to Rock of written notice of the exercise
in such form as the Committee may prescribe, accompanied by irrevocable
instructions to a stock broker to promptly deliver to Rock full payment for the
shares with respect to which the option is exercised from the proceeds of the
stock broker's sale of or loan against some or all of the shares, or (vi) in
such other manner as the Committee determines is appropriate.
An employee may receive more than one Incentive Option, but the maximum
aggregate fair market value of the Common Shares (determined when the Incentive
Option is granted) with respect to which Incentive Options are first exercisable
by such employee in any calendar year cannot exceed $100,000. In addition, no
Incentive Option may be granted to an employee owning directly or indirectly
stock possessing more than 10% of the total combined voting power of all classes
of stock of Rock, unless the exercise price is set at not less than 110% of the
fair market value of the shares subject to such Incentive Option on the date of
grant and such Incentive Option expires not later than five years from the date
of grant. Awards of Nonqualified Options are not subject to these special
limitations.
To the extent required for Incentive Options or to the extent determined by
the Committee, no option granted under the Plan is transferable otherwise than
by will, or by the laws of descent and distribution, or, with respect to
Nonqualified Options, pursuant to a qualified domestic relations order, and such
option is exercisable, during the lifetime of the participant, only by the
participant. The Committee may, however, authorize all or a portion of any
option granted to be on terms which permit transfer by such optionee to, and the
exercise of such option by, (i) the spouse, children or grandchildren of the
optionee ("Immediate Family Members"), (ii) a trust or trusts for the exclusive
benefit of such Immediate Family Members, (iii) a partnership in which such
Immediate Family Members are the only partners, or (iv) such other persons or
entities as determined by the Committee, on such terms and conditions as the
Committee may determine; provided that (x) the stock option agreement pursuant
to which such options are granted must be approved by the Committee and must
expressly provide for transferability in a manner consistent with the Plan, and
(y) subsequent transfers of transferred options are prohibited except for
transfers the original optionee would be permitted to make.
Subject to the terms of the Plan, each option granted under the Plan is
exercisable at the time or times or in such installments as may be determined by
the Committee. Except as described below, options may be exercised only while
the participant is an employee, director, consultant or advisor of Rock. Subject
to the requirements of Incentive Options that are intended to remain Incentive
Options, in connection with a participant ceasing to be an employee of Rock for
any reason, the stock option agreement may provide for the acceleration of, or
the Committee may accelerate, in whole or in part, the time or times or
installments with respect to which any option shall be exercisable in connection
with termination of a participant's employment with Rock, subject to any
restrictions, terms and conditions fixed by the Committee.
In connection with a business combination involving Rock, the dissolution
or liquidation of Rock or a capital reorganization or reclassification such that
holders of Common Shares shall be entitled to receive stock, securities, cash or
other assets with respect to or in exchange for the Common Shares (a
"Transaction"), and effective as of a date selected by the Committee, the
Committee may (a) accelerate the time at which stock options then outstanding
may be exercised so that such stock options may be exercised in full for a
limited period of time on or before a specified date fixed by the Committee
after which specified date all unexercised stock options and all rights of
participants thereunder shall terminate; (b) accelerate the time at which stock
options then outstanding may be exercised so that such stock options may be
exercised in full for their then remaining term; or (c) require the mandatory
surrender to Rock of outstanding stock options held by such participants
(irrespective of whether such stock options are then exercisable) as of a date,
before or not later than sixty days after such Transaction, specified by the
Committee, and in such event Rock shall thereupon cancel such stock options and
shall pay to each participant an amount of cash equal to the excess of the fair
market value of the aggregate Common Shares subject to such stock option,
determined as of the date such Transaction is effective, over the aggregate
option price of such shares; provided, however, the Committee shall not select
an alternative (unless consented to by the participant) such that, if a
participant
67
<PAGE> 74
exercised his or her accelerated stock option pursuant to alternative (a) or (b)
and participated in the Transaction or received cash pursuant to alternative
(c), the alternative would result in the participant's owing any money by virtue
of the operation of Section 16(b) of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). If all such alternatives have such a result, the
Committee shall take such action to put such participants in as close to the
same position as such participant would have been in had alternative (a), (b) or
(c) been selected but without resulting in any payment by such participant
pursuant to Section 16(b) of the Exchange Act.
Subject to the other provisions of the Plan, all rights to exercise options
terminate when a participant ceases to be an employee, director, consultant or
advisor of or to Rock for any cause, except that the Committee may permit the
exercise of all or any portion of the options granted to such participant (i)
for a period not to exceed three months following such termination with respect
to Incentive Options that are intended to remain Incentive Options if such
termination is not due to death or permanent disability of the participant, (ii)
for a period not to exceed one year following termination of employment with
respect to Incentive Options that are intended to remain Incentive Options if
termination of employment is due to the death or permanent disability of the
participant, and (iii) for a period not to extend beyond the expiration date
with respect to Nonqualified Options or Incentive Options that are not intended
to remain Incentive Options, all subject to any restrictions, terms and
conditions fixed by the Committee. In no event, however, shall an option be
exercisable after its expiration date, and, unless the Committee determines
otherwise, an option may only be exercised after termination of a participant's
employment, consultation or other service by or to Rock to the extent
exercisable on the date of such termination or to the extent exercisable as a
result of the reason for such termination. If not sooner terminated, each stock
option granted under the Plan shall expire not more than 10 years from the date
of grant.
401(K) SAVINGS PLAN
Effective in March 1987, Rock established Rock's 401(k) Savings Plan (the
"401(k) Plan"), which is intended to comply with Sections 401(a) and 401(k) of
the Internal Revenue Code of 1986, as amended, and the applicable provisions of
the Employee Retirement Income Security Act of 1974, as amended. Amounts
contributed to the 401(k) Plan are held under a trust intended to be exempt from
income tax pursuant to Section 501(a) of the Internal Revenue Code. All
full-time and part-time employees of Rock that have completed at least six
months of service and are at least 21 years of age are eligible to participate
in the 401(k) Plan. Participating employees will be entitled to make pre-tax
contributions to their accounts in amounts equal to not less than 1% and not
more than 15% of their compensation each year, subject to certain maximum annual
limits imposed by law (approximately $9,500 in 1997). Rock matches 20% of
employee contributions in amounts of employee contributions up to 5% of their
compensation. Rock also has the right to make certain additional matching
contributions in amounts not to exceed 15% of employee compensation. Matching
contributions made by Rock vest in participating employees over a three-year
period after the date of contribution. Distributions generally are payable in a
lump sum after retirement or death and, in certain circumstances, upon
termination of employment with Rock for other reasons.
CERTAIN TRANSACTIONS
Since its inception, Rock has had business relationships and engaged in
certain transactions with affiliated companies and parties as described below.
TRANSACTIONS WITH DIRECTORS
See "Compensation -- Compensation Committee Interlocks and Insider
Participation" for a description of (i) indebtedness of Daniel Gilbert, Lindsay
Gross and Gary L. Gilbert to Rock, (ii) transactions between Rock and Title
Source, Inc., a company a majority of the shares of which are owned by officers
and employees of Rock, (iii) transactions between Rock and Rock Construction
Company, Inc., a company half of the shares of which were formerly owned by
officers and directors of Rock and of which certain directors and an officer of
Rock formerly were officers, and (iv) various severance arrangements with Gary
L. Gilbert.
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<PAGE> 75
Transactions with Rock Insurance Corporation. Rock Insurance Corporation is
a property, casualty and life insurance agency owned 60% by Robert V. Schechter,
a director of Rock since April 1998, and 40% by his family. For the years ended
December 31, 1995, 1996 and 1997, Rock Insurance Corporation received $84,362,
$134,147 and $233,746, respectively, in commissions from homeowners and
auto-owners insurance placed to applicants for Rock loans. These revenues
represented substantially all of Rock Insurance Corporation's revenues in 1995,
1996 and 1997. Rock cannot predict with certainty the amount of business
proposed to be done with Rock Insurance Corporation in 1998. In addition, Rock
Insurance Corporation subleased approximately 2,000 square feet of space from
Rock pursuant to an oral month-to-month sublease. The rent pursuant to such
sublease for 1995, 1996 and 1997, was $10,098, $10,638 and $10,082,
respectively.
Transactions with Benefit Programs, Inc. Robert V. Schechter, a director of
Rock, is a life and health insurance agent through Benefit Programs, Inc. d/b/a
Robert Schechter & Associates. Mr. Schechter is the President and sole
shareholder of Benefit Programs, Inc. Rock placed some of its life, health and
dental insurance through Benefit Programs, Inc. in 1995, 1996 and 1997, and
Benefit Programs, Inc. received $17,754, $14,916 and $492 in commissions in
connection with such insurance in 1995, 1996 and 1997, respectively. In
addition, Rock obtained life insurance on the lives of Daniel Gilbert, Lindsay
Gross and Gary Gilbert through Benefit Programs, Inc., and Benefit Programs,
Inc. received $43,721, $3,593, and $3,019 in commissions in connection with such
insurance in 1995, 1996 and 1997, respectively. Benefit Programs, Inc. also
received commissions of $4,934 and $2,493 for insurance products furnished to
Rock's 401(k) Plan in 1995 and 1996, respectively.
TRANSACTIONS WITH SHAREHOLDERS
See "Termination of S Corporation Status" for a description of a Tax
Indemnification Agreement between Rock and the Existing Shareholders.
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<PAGE> 76
PRINCIPAL AND SELLING SHAREHOLDERS
The following table sets forth information regarding the beneficial
ownership of the Common Shares as of March 31, 1998, and as adjusted to reflect
the sale of the Common Shares offered by this Prospectus, by (i) each person
known by Rock to own more than 5% of Rock's Common Shares, (ii) each of the
Selling Shareholders, (iii) each Director of Rock, (iv) each executive officer
of Rock named in the Summary Compensation Table above, and (v) all Directors and
executive officers of Rock as a group. The address of each person listed below
is 30600 Telegraph Road, Fourth Floor, Bingham Farms, Michigan 48025, unless
otherwise indicated.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED BEFORE OWNED AFTER
THE OFFERING(1) THE OFFERING(1)
---------------------- SHARES ----------------------
PERCENT BEING PERCENT
NUMBER OF CLASS OFFERED NUMBER OF CLASS
------ -------- ------- ------ --------
<S> <C> <C> <C> <C> <C>
Daniel Gilbert(2)........................... 10,000,000 100.0 -0- 10,000,000 75.0
Gary L. Gilbert(2)(3)....................... 2,077,298 20.8 -0- 2,077,298 15.6
Steven M. Stone(2)(4)....................... 1,001,454 9.1 214,500(5) 1,079,454 7.5
Lindsay Gross(2)............................ 865,601 8.7 -0- 865,601 6.5
Adam Schoener(2)(6)......................... 269,615 2.6 57,750(5) 290,615 2.1
Ross Niskar(2)(7)........................... 269,615 2.6 57,750(5) 290,615 2.1
David Carroll(8)............................ 10,000 * -0- 10,000 *
Frank E. Plenskofski(9)..................... 10,000 * -0- 10,000 *
David A. Brandon............................ -0- * -0- -0- *
David Katzman............................... -0- * -0- -0- *
Robert V. Schechter......................... -0- * -0- -0- *
All directors and executive officers as a
group (9 persons)(10)..................... 11,021,454 100.0 330,000 11,099,454 76.9
</TABLE>
- -------------------------
* Represents less than 1% of outstanding Common Shares.
(1) Based on 10,000,000 Common Shares outstanding as of March 31, 1998, before
the Offering, and 13,330,000 Common Shares outstanding after the Offering.
Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission (the "Commission") and generally
includes voting or investment power with respect to securities. Except as
indicated in the footnotes to this table, the persons named in the table
have sole investment power with respect to all Common Shares beneficially
owned.
(2) Pursuant to a Shareholders Agreement, expected to be executed as of the
closing date of this Offering, among Rock, Daniel Gilbert, Gary L. Gilbert,
Lindsay Gross, Steven M. Stone, Ross Niskar and Adam Schoener, each of the
shareholder parties to the agreement (other than Daniel Gilbert) is
expected to give Daniel Gilbert all voting power over all shares currently
owned or later acquired by them for ten years. As of March 31, 1998, Mr.
Daniel Gilbert owned 7,057,101 Common Shares of record, or approximately
70.6% of the outstanding Common Shares before the Offering and
approximately 52.9% of the outstanding Common Shares after this Offering.
(3) Gary L. Gilbert's address is 640 N. LaSalle St., Suite 330, Chicago,
Illinois 60610.
(4) Includes 1,001,454 Common Shares before the Offering, and 1,079,454 Common
Shares after the Offering, that Mr. Stone has the right to acquire pursuant
to stock options exercisable within 60 days of March 31, 1998.
(5) At the closing of this Offering, each of Messrs. Stone, Schoener and Niskar
will exercise options they currently own to purchase Common Shares at $4.68
a share in an amount equal to the number of shares they are selling in this
Offering. Rock will receive approximately $1.5 million of proceeds from the
options exercised by these Selling Shareholders to acquire the shares they
are selling. Pursuant to their amended employment agreements, Rock has
granted them immediately exercisable replacement options effective on the
closing date of this Offering to purchase 450,000 Common Shares at an
exercise
70
<PAGE> 77
price equal to the initial public offering price set forth on the cover page of
this Prospectus (the "New Options"). Each of Messrs. Stone, Schoener and Niskar
cancelled their rights to receive "Distribution Bonuses" previously required by
their employment agreements with Rock in exchange for Rock's agreement (i)
to permit them to be Selling Shareholders in this Offering, and (ii) to
grant them the New Options. For a description of the former "Distribution
Bonus," see the description of Mr. Stone's employment agreement under the
caption "Management -- Executive Compensation -- Employment Contracts and
Termination of Employment and Change-in-Control Arrangements -- Steven M.
Stone."
(6) Includes 269,615 Common Shares before the Offering, and 290,615 Common
Shares after the Offering, that Mr. Schoener has the right to acquire
pursuant to stock options exercisable within 60 days of March 31, 1998.
(7) Includes 269,615 Common Shares before the Offering, and 290,615 Common
Shares after the Offering, that Mr. Niskar has the right to acquire
pursuant to stock options exercisable within 60 days of March 31, 1998.
(8) Includes 10,000 Common Shares that Mr. Carroll has the right to acquire
pursuant to stock options exercisable within 60 days of March 31, 1998.
(9) Includes 10,000 Common Shares that Mr. Plenskofski has the right to acquire
pursuant to stock options exercisable within 60 days of March 31, 1998.
(10) Includes 1,021,454 Common Shares before the Offering, and 1,099,454 Common
Shares after the Offering, that all Directors and executive officers as a
group have the right to acquire pursuant to stock options exercisable
within 60 days of March 31, 1998.
Effective as of the closing date of this Offering, Rock intends to grant
ten-year options under its 1996 Stock Option Plan to purchase an aggregate of
approximately 438,500 Common Shares to approximately 124 Directors and employees
of the Company at an exercise price equal to the initial public offering price
of the Common Shares. Such grants of options are expected to include 10,000,
10,000, 15,000, 15,000 and 15,000 options granted to David Carroll, Frank
Plenskofski, David Brandon, David Katzman and Robert Schechter, respectively.
These options are in addition to the options to purchase 450,000 Common Shares
to be granted to the Selling Shareholders and described in Note 5 above."
Directors, officers and employees of Rock intend to purchase an aggregate
of 220,000 Common Shares in the Offering as part of the Directed Share Program,
including approximately 1,000, 1,500, 5,000, 5,000 and 5,000 Common Shares
expected to be purchased by David Carroll, Frank Plenskofski, David A. Brandon,
David Katzman and Robert Schechter. These shares have not been included in the
beneficial ownership tables above.
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<PAGE> 78
DESCRIPTION OF CAPITAL STOCK
GENERAL
The authorized capital shares of Rock consist of an aggregate of 50,000,000
Common Shares, par value $0.01 per share, and 1,000,000 Preferred Shares, par
value $0.01 per share. 10,000,000 Common Shares and no Preferred Shares are
outstanding as of March 31, 1998. All of the shares being offered in this
Offering are Common Shares.
COMMON SHARES
Holders of Common Shares have one vote per share on each matter submitted
to a vote of the shareholders and the right to participate ratably in the net
assets of Rock upon liquidation. Holders of Common Shares participate ratably in
dividends and distributions as may be declared by the Board of Directors from
funds legally available for that purpose (see "Dividend Policy"), have no
conversion rights, are not redeemable and are not entitled to any preemptive or
subscription rights. The Common Shares currently outstanding are, and the Common
Shares to be issued in connection with this Offering will be, duly authorized,
validly issued, fully paid and non-assessable. Holders of Common Shares have no
cumulative voting rights, and accordingly, holders of a majority of the
outstanding Common Shares are able to elect all of Rock's Directors.
The Board of Directors is divided into three classes. After his or her
initial term, each Director will serve for a term ending at the third Annual
Meeting of Shareholders following the meeting at which such Director is elected
and until his or her successor is elected and qualified, or until his or her
earlier death, resignation or removal. Initially, the Class I Directors, Gary L.
Gilbert and Robert V. Schechter, will hold office until the Annual Meeting of
Shareholders to be held in 1999, the Class II Directors, Steven M. Stone and
David Katzman, will hold office until the Annual Meeting of Shareholders to be
held in 2000, and the Class III Directors, Daniel Gilbert and David A. Brandon,
will hold office until the Annual Meeting of Shareholders to be held in 2001,
and until their successors are elected and qualified, or until their earlier
death, resignation or removal. Directors may not be removed without cause.
Rock's Restated Articles of Incorporation also set the minimum and maximum
number of Directors constituting the entire Board at three and fifteen,
respectively, and require approval of holders of 90% of Rock's voting shares to
amend this provision. In addition, Rock's bylaws require advance notice of any
nominations for director of Rock, along with information about the nominee and
the shareholder.
PREFERRED SHARES
Rock has also authorized the issuance of up to 1,000,000 Preferred Shares,
$0.01 par value per share, none of which is outstanding as of the date of this
Prospectus. The Preferred Shares may be issued from time to time in one or more
series. The Board of Directors is authorized to determine the rights,
preferences, privileges and restrictions granted to, and imposed upon, each
series of Preferred Shares and to fix the number of shares of any series of
Preferred Shares and the designation of any such series. The issuance of
Preferred Shares could be used, under certain circumstances, as a method of
preventing a change in control of Rock and could permit the Board of Directors,
without any action of the holders of the Common Shares, to issue Preferred
Shares which could have a detrimental effect on the rights of holders of the
Common Shares, including loss of voting control. Anti-takeover provisions that
could be included in the Preferred Shares when issued may have a depressive
effect on the market price of Rock's securities and may limit shareholders'
ability to receive a premium on their shares by discouraging takeover and tender
offer bids. Rock has no present plans to issue any Preferred Shares.
CHARTER AND BYLAW PROVISIONS
Various provisions in Rock's Restated Articles of Incorporation and bylaws
could have the effect of delaying, deferring or preventing changes in control of
Rock. See "Risk Factors -- Potential Anti-Takeover Effects of Charter, Bylaw,
Contract and Statutory Provisions."
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<PAGE> 79
BUSINESS COMBINATION PROVISIONS OF MICHIGAN LAW
Chapters 7A and 7B of the Michigan Business Corporation Act may affect
attempts to acquire control of Rock. In general, under Chapter 7A, "business
combinations" (defined to include, among other transactions, certain mergers,
dispositions of assets or shares and recapitalizations) between covered Michigan
business corporations or their subsidiaries and an "interested shareholder"
(defined as the direct or indirect beneficial owner of at least 10% of the
voting power of a covered corporation's outstanding shares) can only be
consummated if approved by at least 90% of the votes of each class of the
corporation's shares entitled to vote and by at least two-thirds of such voting
shares not held by the interested shareholder or affiliates, unless five years
have elapsed after the person involved became an "interested shareholder" and
unless certain price and other conditions are satisfied. The Board of Directors
has the power to elect to be subject to Chapter 7A as to specifically identified
or unidentified interested shareholders.
In general, under Chapter 7B, an entity that acquires "Control Shares" of
Rock may vote the Control Shares on any matter only if a majority of all shares,
and of all non-"Interested Shares", of each class of shares entitled to vote as
a class, approve such voting rights. Interested Shares are shares owned by
officers of Rock, employee-directors of Rock and the entity making the Control
Share Acquisition. Control Shares are shares that when added to shares already
owned by an entity, would give the entity voting power in the election of
directors over any of the three thresholds: one-fifth, one-third and a majority.
The effect of the statute is to condition the acquisition of voting control of a
corporation on the approval of a majority of the pre-existing disinterested
shareholders. The Board of Directors may amend the bylaws before a Control Share
Acquisition occurs to provide that Chapter 7B does not apply to Rock. In
addition, certain provisions in Rock's bylaws could have the effect of delaying,
deferring or preventing changes in control of Rock. See "Risk Factors --
Potential Anti-Takeover Effects of Charter, Bylaw, Contract and Statutory
Provisions."
INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Michigan Business Corporation Act permits Michigan corporations to
limit the personal liability of directors for breaches of their fiduciary
duties. The Restated Articles of Incorporation of Rock so limit the liability of
directors. Rock's bylaws also provide for indemnification of directors and
officers. Rock believes that such indemnification will assist Rock in continuing
to attract and retain talented directors and officers in light of the risk of
litigation directed against directors and officers of publicly-held
corporations.
The Restated Articles of Incorporation limit director liability to the
maximum extent permitted by Michigan law. Michigan law allows the articles of
incorporation of a Michigan corporation to contain a provision eliminating or
limiting a director's liability to the corporation or its shareholders for money
damages for any action taken or any failure to take any action as a director,
except for liability for specified acts. As a result of the inclusion of such a
provision, shareholders of Rock may be unable to recover monetary damages
against directors for actions taken by them which constitute negligence or gross
negligence or which are in violation of their fiduciary duties, although it may
be possible to obtain injunctive or other equitable relief with respect to such
actions. If equitable remedies are found not to be available to shareholders in
any particular case, shareholders may not have any effective remedy against the
challenged conduct. These provisions, however, do not affect liability under the
Securities Act.
The Michigan Business Corporation Act authorizes a corporation under
specified circumstances to indemnify its directors and officers (including
reimbursement for expenses incurred). The provisions of Rock's bylaws relating
to indemnification of directors and executive officers generally provide that
directors and executive officers will be indemnified to the fullest extent
permissible under Michigan law. The provision also provides for the advancement
of litigation expenses at the request of a director or executive officer. These
obligations are broad enough to permit indemnification with respect to
liabilities arising under the Securities Act or the Michigan Uniform Securities
Act.
In addition, Rock has obtained Directors' and Officers' liability
insurance. The policy provides for $5,000,000 in coverage, including liabilities
under the Securities Act in connection with this Offering.
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<PAGE> 80
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to Directors, officers or persons controlling Rock pursuant to
the foregoing provisions, Rock has been informed that in the opinion of the
Securities and Exchange Commission such indemnification is against public policy
as expressed in the Securities Act and is therefore unenforceable.
TRANSFER AGENT AND REGISTRAR
National City Bank, Cleveland, Ohio, is expected to serve as transfer agent
and registrar for the Common Shares. As of March 31, 1998 there were three
holders of record of Rock's Common Shares.
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<PAGE> 81
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the Offering, Rock will have outstanding 13,330,000
Common Shares (13,829,500 Common Shares if the Underwriters' over-allotment
option is exercised in full). The 3,330,000 Common Shares to be sold in the
Offering, and any of the 499,500 Common Shares that may be sold upon exercise of
the Underwriters' over-allotment option, will be freely tradable by persons
other than "affiliates" of Rock, as that term is defined in Rule 144 under the
Securities Act, without restriction or registration under the Securities Act.
The remaining 10,000,000 shares (all such shares being referred to as the
"Restricted Shares") will be held by Rock's current shareholders. The Restricted
Shares may not be sold unless they are registered under the Securities Act or
sold pursuant to an applicable exemption from registration, including an
exemption pursuant to Rule 144 under the Securities Act.
As currently in effect, Rule 144 generally permits the public sale in
ordinary brokers' transactions of "restricted securities" and of securities
owned by "affiliates" beginning 90 days after the date of this Prospectus if the
other restrictions enumerated in Rule 144 are met. Restricted securities are
securities, such as the Restricted Shares, acquired directly or indirectly from
an issuer or an affiliate of the issuer in a transaction not involving a public
offering. In general, under Rule 144, if a period of at least one year has
elapsed since the later of the date the Restricted Shares were acquired from
Rock or an affiliate, as applicable, then the holder of such Restricted Shares
(including an affiliate) is entitled, subject to specified conditions, to sell
within any three-month period a number of shares not exceeding the greater of
(i) 1% of Rock's then outstanding Common Shares, or (ii) the average weekly
trading volume of the shares during the four calendar weeks preceding the filing
of a Form 144 with respect to such sale. Sales under Rule 144 are also subject
to specified manner-of-sale provisions and requirements as to notice and the
availability of current public information about Rock.
Affiliates may sell Common Shares not constituting Restricted Shares in
accordance with the foregoing limitations and requirements but without regard to
the one-year period. However, a person who is not and has not been an affiliate
of Rock at any time during the 90 days preceding the sale of the Restricted
Shares, and who has beneficially owned the Restricted Shares for at least two
years, is entitled to sell such Restricted Shares under Rule 144 without regard
to the volume limitations, manner-of-sale requirements or notice and public
information requirements of Rule 144. Because management believes that all
outstanding shares have been held by the current shareholders for more than one
year, all of such Restricted Shares will become eligible for sale pursuant to
Rule 144 beginning 90 days after the date of this Prospectus. However, the
holders of such shares have agreed during the 180-day period immediately
following the date of this Prospectus not to sell or otherwise dispose of any
securities of Rock without the consent of the representatives of the
Underwriters, subject to specified exceptions. See "Risk Factors -- Shares
Eligible for Future Sale" and "Underwriting."
Rock has reserved 4,500,000 Common Shares for issuance under the Plan, of
which options to purchase 2,447,184 Common Shares were outstanding at March 31,
1998. At the closing of the Offering, options to purchase 3,005,684 Common
Shares will be outstanding. The 330,000 Common Shares being sold by the Selling
Shareholders will be acquired by them on the closing date of this Offering upon
exercise of stock options previously granted to them, and Rock has granted to
them, effective as of the closing date of this Offering, immediately exercisable
replacement options to purchase 450,000 Common Shares at the initial public
offering price of the Common Shares in this Offering. All of the Common Shares
issued as a result of any grants under this Plan will be restricted securities
unless Rock files a registration statement under the Securities Act relating to
the issuance of the shares. Rock currently intends to register the Common Shares
reserved under the Plan. Subject to compliance with Rule 144 by affiliates of
Rock, any shares issued upon exercise of options granted under such employee
benefit plans will become freely tradable at the effective date of the
Registration Statement for the shares reserved under such plans. In addition,
pursuant to Rule 701 under the Securities Act, 90 days after the date of this
Prospectus, Common Shares issued upon exercise of options granted under the Plan
in reliance on Rule 701 may be resold by persons other than affiliates in
reliance on Rule 144, without compliance with the current public information,
holding period, volume or notice requirements of Rule 144, and by affiliates
without compliance with the holding period requirements of Rule 144. In
connection with the Offering, Rock's Directors and executive officers, owning in
the aggregate all
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<PAGE> 82
of the outstanding Common Shares, the Selling Shareholders and certain other
persons purchasing Common Shares pursuant to the Directed Share Program have
agreed that they will not sell, contract to sell or otherwise dispose of any
shares of capital stock of Rock for a period of 180 days after the date of this
Prospectus without the prior written consent of the Representatives, except for
the transfers of shares contemplated by this Prospectus, subject to specified
limited exceptions.
Prior to the Offering, there has been no public market for the Common
Shares, and no prediction can be made as to the effect, if any, that sales of
Common Shares or the availability of Common Shares for sale will have on the
market price prevailing from time to time. Nevertheless, sales of substantial
amounts of Common Shares in the public market could adversely affect prevailing
market prices.
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<PAGE> 83
UNDERWRITING
The Underwriters of the Offering of the Common Shares (the "Underwriters"),
for whom Bear, Stearns & Co. Inc., Prudential Securities Incorporated and Roney
& Co. L.L.C. are acting as representatives (the "Representatives"), have
severally agreed, subject to the terms and conditions of the Underwriting
Agreement (the form of which is filed as an exhibit to the Registration
Statement of which this Prospectus is a part, the "Underwriting Agreement"), to
purchase from Rock and the Selling Shareholders the aggregate number of Common
Shares set forth opposite their names below:
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITERS COMMON SHARES
------------ -------------
<S> <C>
Bear, Stearns & Co. Inc..................................... 1,067,000
Prudential Securities Incorporated.......................... 1,067,000
Roney & Co. L.L.C........................................... 239,000
CIBC Oppenheimer Corp. ..................................... 66,000
Credit Suisse First Boston Corporation...................... 66,000
Furman Selz LLC............................................. 66,000
Lehman Brothers Inc. ....................................... 66,000
Merrill Lynch, Pierce, Fenner & Smith
Incorporated........................................ 66,000
NationsBanc Montgomery Securities LLC....................... 66,000
PaineWebber Incorporated.................................... 66,000
Smith Barney Inc. .......................................... 66,000
Keefe, Bruyette & Woods, Inc. .............................. 66,000
Aegis Capital Corp.......................................... 33,000
Ferris, Baker Watts, Incorporated........................... 33,000
First of Michigan Corporation............................... 33,000
Friedman, Billings, Ramsey & Co., Inc. ..................... 33,000
Jefferies & Company......................................... 33,000
J.W. Charles Securities, Inc. .............................. 33,000
Northeast Securities Inc. .................................. 33,000
Piper Jaffray Inc. ......................................... 33,000
Dain Rauscher Incorporated.................................. 33,000
Sutro & Co. Incorporated.................................... 33,000
Wheat First Securities, Inc. ............................... 33,000
---------
Total..................................................... 3,330,000
=========
</TABLE>
The Underwriting Agreement provides that the obligations of the
Underwriters are subject to certain conditions precedent and that, if any of the
foregoing Common Shares are purchased by the Underwriters pursuant to the
Underwriting Agreement, all such shares must be so purchased. Rock and the
Selling Shareholders have agreed to indemnify the Underwriters against certain
liabilities, including liabilities under the Securities Act, or to contribute to
payments that the Underwriters may be required to make in respect thereof.
Rock has been advised that the Underwriters propose to offer the Common
Shares to the public initially at the initial public offering price set forth on
the cover page of this Prospectus and to certain selected dealers (which may
include the Underwriters) at such initial public offering price less a
concession not to exceed $0.42 per share. The selected dealers may reallow a
concession to certain other dealers not to exceed $0.10 per share. After the
initial Offering to the public, the initial public offering price, the
concession to selected dealers and the reallowance to other dealers may be
changed by the Representatives.
Bear Stearns Home Equity Trust, an affiliate of Bear, Stearns & Co. Inc.,
currently provides Rock with an uncommitted $100 million reverse repurchase
arrangement pursuant to which Bear Stearns Home Equity Trust will purchase from
Rock, subject to Rock's agreement to repurchase on a daily basis, up to $100
million ($200 million after completion of the Offering) of fully-amortizing,
first or junior lien residential mortgage
77
<PAGE> 84
loans and home equity loans that comply with Rock's origination guidelines and
conform to whole and bulk loan sale requirements. This agreement is not a
committed facility and Bear Stearns Home Equity Trust may elect to discontinue
the repurchase agreement at any time. The term of any financing under the
repurchase agreement matures and may be renewed on a daily basis. In any event,
the arrangement terminates in March 1999. Rock uses this facility as a
supplemental borrowing facility to fund loans closed by Rock until they are
sold. As of March 31, 1998, Rock had financed $4.7 million of loans under this
facility and an additional $95.3 million was available for future financings.
Bear, Stearns & Co. Inc. provided Rock with financial advisory services
during 1996 in connection with a reorganization of Rock. Bear, Stearns & Co.
Inc. received a fee of $50,000 from Rock for these financial advisory services.
Rock has granted to the Underwriters an option to purchase up to 499,500
additional Common Shares at the initial public offering price less the
underwriting discount set forth on the cover page of this Prospectus, solely to
cover over-allotments, if any. Such option may be exercised at any time until 30
days after the date of this Prospectus. To the extent that the Underwriters
exercise such option, each of the Underwriters will be committed, subject to
certain conditions, to purchase a number of additional shares proportionate to
such Underwriter's initial commitment as indicated in the preceding table.
Prior to the Offering there has been no public market for any of Rock's
securities. The initial public offering price set forth on the cover page of
this Prospectus has been determined by negotiations among Rock, the Selling
Shareholders and the Representatives. In determining such price, consideration
was given to various factors including (i) the market valuation of comparable
companies, (ii) market conditions for initial public offerings, (iii) the
history of and prospects for Rock's business, (iv) Rock's past and present
operations and earnings, (v) Rock's current financial position, (vi) an
assessment of Rock's management, (vii) the position of Rock in its industry, and
(viii) the market value of Rock's assets. Consideration also was given to the
general condition of the securities markets, the demand for similar securities
of comparable companies and other market factors.
At the request of the Company, the Underwriters have reserved up to 329,670
Common Shares for sale at the initial public offering price to certain
Directors, officers and employees of the Company, their business associates and
related parties. The number of Common Shares available for sale to the general
public will be reduced to the extent such persons purchase such reserved shares.
Any reserved shares which are not so purchased will be offered by the
Underwriters to the general public on the same basis as the other Common Shares
offered hereby.
In connection with the Offering, Rock's Directors and executive officers,
owning in the aggregate all of the outstanding Common Shares, the Selling
Shareholders and certain other persons participating in the Directed Share
Program have agreed that they will not sell, contract to sell or otherwise
dispose of any shares of capital stock of Rock for a period of 180 days after
the date of this Prospectus without the prior written consent of the
Representatives, except for the transfers of shares contemplated by this
Prospectus, subject to specified limited exceptions. See "Shares Eligible For
Future Sale." Also in connection with the Offering, Rock has agreed that it will
not sell, contract to sell or otherwise dispose of any shares of capital stock
of Rock for a period of 180 days after the date of this Prospectus without the
prior written consent of the Representatives, except for Common Shares offered
by this Prospectus and except for issuances or sales by Rock under the terms of
the 1996 Stock Option Plan.
The Representatives have informed Rock that the Underwriters do not expect
to make sales to accounts over which they exercise discretionary authority in
excess of 5% of the number of Common Shares offered by this Prospectus.
In order to facilitate the Offering, certain persons participating in the
Offering may engage in transactions that stabilize, maintain or otherwise affect
the price of the Common Shares during and after the Offering. Specifically, the
Underwriters may over-allot or otherwise create a short position in the Common
Shares for their own account by selling more Common Shares than have been sold
to them by Rock. The Underwriters may elect to cover any such short position by
purchasing Common Shares in the open market or by exercising the over-allotment
option granted to the Underwriters. In addition, such persons may stabilize or
maintain the price of the Common Shares by bidding for or purchasing Common
Shares in the open market and may
78
<PAGE> 85
impose penalty bids, under which selling concessions allowed to syndicate
members or other broker-dealers participating in the Offering are reclaimed if
Common Shares previously distributed in the Offering are repurchased in
connection with stabilization transactions or otherwise. The effect of these
transactions may be to stabilize or maintain the market price of the Common
Shares at a level above that which might otherwise prevail in the open market.
The imposition of a penalty bid may also affect the price of the Common Shares
to the extent that it discourages resales thereof. No representation is made as
to the magnitude or effect of any such stabilization or other transactions. Such
transactions may be effected on The Nasdaq National Market or otherwise and, if
commenced, may be discontinued at any time.
LEGAL MATTERS
The validity of the Common Shares to be offered by this Prospectus will be
passed upon for Rock and the Selling Shareholders by Honigman Miller Schwartz
and Cohn, Detroit, Michigan. Certain legal matters in connection with the
Offering will be passed upon for the Underwriters by Berick, Pearlman & Mills
Co., L.P.A., Cleveland, Ohio.
EXPERTS
The financial statements of Rock Financial Corporation as of December 31,
1996 and 1997, and for each of the years in the three-year period ended December
31, 1997, included in this Prospectus and elsewhere in the Registration
Statement have been included in this Prospectus and in the Registration
Statement in reliance upon the report of KPMG Peat Marwick LLP, independent
auditors, appearing elsewhere in this Prospectus, and upon the authority of such
firm as experts in accounting and auditing.
CHANGE IN ACCOUNTANTS
Rock engaged KPMG Peat Marwick LLP as its independent accountants after it
terminated its relationship with Coopers & Lybrand LLP in August 1997. In
connection with its audits for 1996 and 1995 and during the interim period
preceding such termination, there were no disagreements between Rock and Coopers
& Lybrand LLP on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedure, which disagreements, if
not resolved to the satisfaction of Coopers & Lybrand LLP, would have caused
them to make reference thereto in their report on the financial statements. No
report issued by Coopers & Lybrand LLP with respect to Rock's financial
statements contained any adverse opinion or disclaimer of opinion, or was
qualified or modified as to uncertainty, audit scope or accounting principles.
The decision to change accountants was made by management of Rock.
ADDITIONAL INFORMATION
Rock has filed with the Securities and Exchange Commission a Registration
Statement on Form S-1 under the Securities Act, of which this Prospectus forms a
part, with respect to the Common Shares offered by this Prospectus. This
Prospectus omits certain information contained in the Registration Statement,
and reference is made to the Registration Statement for further information with
respect to Rock and the Common Shares offered by this Prospectus. Statements
contained in this Prospectus concerning the provisions of documents are
necessarily summaries of such documents and when any such document is an exhibit
to the Registration Statement, each such statement is qualified in its entirety
by reference to the copy of such document filed with the Commission. Copies of
the Registration Statement may be acquired upon payment of the prescribed fees
or examined without charge at the public reference facilities of the Commission
at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at
1-800-SEC-0330 for further information on the operation of the public reference
rooms. In addition, the Registration Statement may be accessed electronically at
the Commission's site on the World Wide Web at http://www.sec.gov.
Upon completion of the Offering, Rock will be subject to the informational
requirements of the Securities Exchange Act of 1934, as amended, and, in
accordance therewith, will file reports, proxy and information statements with
the Commission. Such reports, proxy and information statements and other
information can be inspected and copied at the address and web site set forth
above.
79
<PAGE> 86
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report -- KPMG Peat Marwick LLP....... F-2
Balance Sheets as of December 31, 1996 and 1997............. F-3
Statements of Income for the years ended December 31, 1995,
1996 and 1997............................................. F-4
Statements of Shareholders' Equity for the years ended
December 31, 1995, 1996 and 1997.......................... F-5
Statements of Cash Flows for the years ended December 31,
1995, 1996 and 1997....................................... F-6
Notes to Financial Statements............................... F-7
</TABLE>
F-1
<PAGE> 87
INDEPENDENT AUDITORS' REPORT
The Shareholders and Board of Directors of
Rock Financial Corporation:
We have audited the accompanying balance sheets of Rock Financial
Corporation (the "Corporation") as of December 31, 1996 and 1997, and the
related statements of income, shareholders' equity, and cash flows for each of
the years in the three-year period ended December 31, 1997. These financial
statements are the responsibility of the Corporation's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of the Corporation as of
December 31, 1996 and 1997, and the results of its operations and its cash flows
for each of the years in the three-year period ended December 31, 1997, in
conformity with generally accepted accounting principles.
/s/ KPMG Peat Marwick LLP
Detroit, Michigan
February 18, 1998
F-2
<PAGE> 88
ROCK FINANCIAL CORPORATION
BALANCE SHEETS
DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
PRO FORMA
1997
1996 1997 (NOTE 18)
---- ---- ---------
(AUDITED) (UNAUDITED)
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents.......................... $ 3,288,751 $ 11,946,992 $ 11,946,992
Marketable securities available for sale........... 5,953,862 -- --
Mortgage loans held for sale....................... 85,009,395 121,343,814 121,343,814
Mortgage loans held for investment (net of
allowance for losses of $270,000 in 1997)........ -- 810,293 810,293
Real estate owned.................................. -- 158,271 158,271
Shareholders' advances............................. 2,519,342 1,626,519 --
Property and equipment, net........................ 2,681,314 7,010,537 7,010,537
Deferred income taxes.............................. -- -- 1,700,000
Other assets....................................... 906,846 1,532,471 1,532,471
------------ ------------ ------------
Total assets.................................. $100,359,510 $144,428,897 $144,502,378
============ ============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Warehouse line of credit......................... $ 67,621,266 $ 79,293,856 $ 67,522,937
Reverse repurchase agreement..................... -- 18,161,423 18,161,423
Notes payable.................................... -- 1,944,445 1,944,445
Drafts payable................................... 14,896,675 21,875,184 21,875,184
Accounts payable................................. 1,998,939 3,255,503 3,255,503
Accrued expenses and other liabilities........... 3,496,491 4,790,350 4,790,350
------------ ------------ ------------
Total liabilities............................. 88,013,371 129,320,761 117,549,842
------------ ------------ ------------
Shareholders' equity:
Common shares, $.01 par value. Authorized
50,000,000 shares; issued and outstanding
10,000,000 shares............................. 100,000 100,000 133,300
Additional paid-in capital....................... 1,423,750 1,423,750 29,534,850
Retained earnings (deficit)...................... 9,386,020 13,584,386 (2,715,614)
Unrealized gain on marketable securities......... 1,436,369 -- --
------------ ------------ ------------
Total shareholders' equity.................... 12,346,139 15,108,136 26,952,536
------------ ------------ ------------
Total liabilities and shareholders' equity.... $100,359,910 $144,428,897 $144,502,378
============ ============ ============
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-3
<PAGE> 89
ROCK FINANCIAL CORPORATION
STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
<CAPTION>
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Revenue:
Interest income..................................... $ 3,002,750 $ 4,267,824 $ 8,082,448
Interest expense.................................... 3,012,033 3,669,393 5,149,881
----------- ----------- -----------
Net interest margin.............................. (9,283) 598,431 2,932,567
Provision for credit losses......................... -- -- 300,000
----------- ----------- -----------
Net interest margin after provision for credit
losses......................................... (9,283) 598,431 2,632,567
Loan fees and gains and losses on sale of
mortgages........................................ 17,788,279 27,959,437 47,084,309
Net gain on sale of mortgage servicing.............. 5,728,411 -- --
Net gain on sale of marketable securities........... 345,716 991,219 2,221,905
Other income........................................ 398,555 6,489 171,085
----------- ----------- -----------
24,251,678 29,555,576 52,109,866
----------- ----------- -----------
Expenses:
Salaries, commissions and employee benefits......... 11,271,770 16,424,971 24,810,597
Stock and option holders' bonuses................... 545,480 2,297,625 1,592,030
General and administrative expenses................. 3,725,601 4,645,820 7,629,889
Marketing expenses.................................. 1,338,752 2,392,994 5,369,515
Depreciation and amortization....................... 506,634 663,428 1,292,479
----------- ----------- -----------
17,388,237 26,424,838 40,694,510
----------- ----------- -----------
Net income....................................... $ 6,863,441 $ 3,130,738 $11,415,356
=========== =========== ===========
Unaudited pro forma information (note 18):
Provision for pro forma income taxes................ 4,109,528
-----------
Pro forma net income................................ $ 7,305,828
===========
Pro forma earnings per share:
Basic............................................... $ 0.55
===========
Diluted............................................. $ 0.51
===========
Pro forma weighted average number of shares
outstanding:
Basic............................................... 13,330,000
===========
Diluted............................................. 14,282,914
===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-4
<PAGE> 90
ROCK FINANCIAL CORPORATION
STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
<CAPTION>
UNREALIZED
ADDITIONAL GAIN ON TOTAL
COMMON PAID-IN RETAINED MARKETABLE SHAREHOLDERS'
SHARES CAPITAL EARNINGS SECURITIES EQUITY
------ ---------- -------- ---------- -------------
<S> <C> <C> <C> <C> <C>
Balance December 31, 1994........ $100,000 $1,423,750 $ 2,957,767 $ 1,792,046 $ 6,273,563
Year ended December 31, 1995 Net
income......................... 6,863,441 6,863,441
Shareholder distributions...... (67,359) (67,359)
Change in unrealized gain on
marketable securities....... 3,457,339 3,457,339
-------- ---------- ----------- ----------- -----------
Balance December 31, 1995........ 100,000 1,423,750 9,753,849 5,249,385 16,526,984
Year ended December 31, 1996 Net
income......................... 3,130,738 3,130,738
Shareholder distributions...... (3,498,567) (3,498,567)
Change in unrealized gain on
marketable securities....... (3,813,016) (3,813,016)
-------- ---------- ----------- ----------- -----------
Balance December 31, 1996........ 100,000 1,423,750 9,386,020 1,436,369 12,346,139
Year ended December 31, 1997 Net
income......................... 11,415,356 11,415,356
Shareholder distributions...... (7,216,990) (7,216,990)
Change in unrealized gain on
marketable securities....... (1,436,369) (1,436,369)
-------- ---------- ----------- ----------- -----------
Balance December 31, 1997........ $100,000 $1,423,750 $13,584,386 $ -- $15,108,136
======== ========== =========== =========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-5
<PAGE> 91
ROCK FINANCIAL CORPORATION
STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
<CAPTION>
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Net income................................. $ 6,863,441 $ 3,130,738 $ 11,415,356
------------- --------------- ---------------
Adjustments to reconcile net income to net
cash used in operating activities:
Depreciation and amortization........... 506,634 663,428 1,292,479
Provision for credit losses............. -- -- 300,000
Net gain on sale of mortgage
servicing............................. (5,728,411) -- --
Net gain on sales of marketable
securities............................ (345,716) (991,219) (2,221,905)
Change in assets and liabilities:
Mortgage loans held for sale -
originations....................... (821,916,358) (1,080,765,776) (1,203,722,723)
Mortgage loans held for sale -
sales.............................. 774,638,605 1,069,751,958 1,167,388,304
Other assets.......................... 40,942 (314,122) (625,625)
Drafts payable........................ (3,484,721) 7,513,046 6,978,509
Accounts payable...................... 304,475 1,215,113 1,256,564
Accrued expenses and other
liabilities........................ 1,048,546 1,357,558 1,293,858
Accounts payable, broker.............. 3,354,526 (3,354,526) --
------------- --------------- ---------------
Total adjustments.................. (51,581,478) (4,924,540) (28,060,539)
------------- --------------- ---------------
Net cash used in operating
activities....................... (44,718,037) (1,793,802) (16,645,183)
------------- --------------- ---------------
Cash flows from investing activities:
Proceeds from sale of marketable
securities.............................. 64,201,835 26,056,131 10,846,241
Purchase of marketable securities.......... (71,564,768) (17,613,113) (4,106,842)
Net increase in real estate owned and loans
held for investment..................... -- -- (1,268,564)
Purchase of equipment...................... (407,975) (2,084,296) (5,621,702)
Proceeds from sale of mortgage servicing... 5,755,610 -- --
Shareholder (advances) repayments.......... (441,743) (1,978,492) 892,823
------------- --------------- ---------------
Net cash provided by (used in)
investing activities............... (2,457,041) 4,380,230 741,956
------------- --------------- ---------------
Cash flows from financing activities:
Net borrowings under warehouse line of
credit.................................. 48,374,896 3,514,047 11,672,590
Net borrowings under reverse repurchase
agreement............................... -- -- 18,161,423
Net (payments) borrowing under notes
payable................................. (445,616) -- 1,944,445
Shareholder distributions.................. (67,359) (3,498,567) (7,216,990)
------------- --------------- ---------------
Net cash from financing activities.... 47,861,921 15,480 24,561,468
------------- --------------- ---------------
Net increase in cash and cash equivalents.... 686,843 2,601,908 8,658,241
Cash and cash equivalents, beginning of
year....................................... -- 686,843 3,288,751
------------- --------------- ---------------
Cash and cash equivalents, end of year....... $ 686,843 $ 3,288,751 $ 11,946,992
============= =============== ===============
Supplemental disclosure of cash flow
information:
Cash paid during the year for interest..... $ 3,078,220 $ 3,915,704 $ 4,994,752
============= =============== ===============
Transfers of loans from held for sale to
held for investment..................... $ -- $ -- $ 1,095,293
============= =============== ===============
Transfers of loans from held for investment
to real estate owned.................... $ -- $ -- $ 173,271
============= =============== ===============
Write-down of marketable securities for
other than temporary impairment......... $ 846,500 $ -- $ --
============= =============== ===============
</TABLE>
The accompanying notes are an integral part of the financial statements.
F-6
<PAGE> 92
ROCK FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1995, 1996 AND 1997
1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES:
Rock Financial Corporation (the "Corporation") is a specialty finance
company marketing conventional and sub-prime debt consolidation and home
financing loans, secured primarily by first or second mortgages on one- to
four-family, owner-occupied residences. The Corporation markets its loans
directly to consumers. The Corporation's current loan products include
"Sub-Prime Home Equity Loans" and "High LTV Loans" (together, "Sub-Prime Loans")
and "Conventional Loans."
The Corporation currently operates through three major divisions. Rock
originates Sub-Prime Home Equity Loans to individuals with impaired credit
characteristics, high levels of debt service to income, unfavorable past credit
experience, limited credit history, limited employment history or unverifiable
income through its Fresh Start(TM) division. Rock originates High LTV Loans to
individuals with good credit histories but little or no equity in their homes
through its Specialty Lending division. Rock also originates Conventional Loans
through its Conventional Mortgage Lending division. In 1997, the Corporation
originated its production from 19 branch locations operating in Michigan,
Illinois and Ohio.
a. CASH EQUIVALENTS
The Corporation considers all highly liquid investments purchased with
a maturity of three months or less to be cash equivalents. Included in cash
was $222,752 and $257,730 of restricted cash for mortgagor escrows at
December 31, 1996 and 1997, respectively.
b. MARKETABLE SECURITIES
The Corporation accounts for marketable securities in accordance with
Statement of Financial Accounting Standards No. 115, Accounting for Certain
Debt and Equity Securities ("SFAS 115"). All marketable securities are
classified as available-for-sale and are carried at market value.
Unrealized gains and losses are included as a separate component of
shareholders' equity. Dividends on equity securities are recognized on the
ex-dividend date.
The Corporation continuously evaluates its marketable investment
securities for other-than-temporary or permanent impairment, which is
defined as being greater than 20 percent impaired for greater than six
consecutive months. When an investment security is determined to have
other-than-temporary or permanent impairment, the loss is recognized
through a charge against income.
c. MORTGAGE LOANS HELD FOR SALE
Mortgage loans held for sale are valued at the lower of cost or
market, determined on an aggregate basis, based upon commitments from
investors to purchase such loans or upon prevailing market rates. Loans
determined to be non-salable are transferred to loans held for investment
at their estimated fair value at the date of transfer.
d. MORTGAGE LOANS HELD FOR INVESTMENT
Mortgage loans held for investment are stated at their principal
amount outstanding, net of an allowance for loan losses. Interest on loans
is accrued daily based on the outstanding principal balance. Loans are
generally placed on a non-accrual basis when principal or interest is past
due 90 days or more and when, in the opinion of management, full collection
of principal and interest is unlikely. At the time a loan is placed on
non-accrual status, interest previously accrued but not yet collected is
charged against current income. Income on such loans is then recognized
only to the extent that cash is received and where future collection of
principal is probable. Loan origination fees and certain direct loan
origination costs are deferred and recognized over the lives of the related
loans as an adjustment of the yield.
F-7
<PAGE> 93
ROCK FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
DECEMBER 31, 1995, 1996 AND 1997
e. ALLOWANCE FOR LOSSES
The allowance for losses is based on management's periodic evaluation
of the potential loss exposure associated with the portfolio of mortgage
loans held for investment and costs to be incurred due to the repurchase of
mortgage loans or indemnification of losses based on alleged violations of
representations and warranties customary to the mortgage banking industry,
and reflects an amount that, in management's opinion, is adequate to absorb
such estimated losses. In evaluating the potential exposure, management
takes into consideration numerous factors, including current economic
conditions, prior loss experience, the provisions of loan sale agreements,
the composition of the portfolio of mortgage loans held for investment, and
management's evaluation of the collectibility of specific mortgage loans
held for investment.
f. REAL ESTATE OWNED
Real estate owned is recorded at the lower of the cost of acquisition
or the asset's fair value, net of disposal cost at the time of foreclosure,
which becomes the property's new basis. Any write-downs at date of
acquisition are charged to the allowance for losses. Expenses incurred in
maintaining assets and subsequent write-downs to reflect declines in value
are charged to general and administrative expenses.
g. INVESTOR RESERVES
Investor reserves represent reserves for the estimated repayment,
where applicable, of a portion of the premium received from investors on
sales of certain sub-prime loans if such loans are repaid in their entirety
within a specified time period after the sale of the loans (generally one
year). Provisions for premium recapture are determined based on
management's estimates of potential repayments, considering factors such as
historical premium recapture experience, projected prepayments on loans
sales, existence of prepayment penalties to be paid by the borrower, and
general economic conditions. Actual premium recapture experience may vary
from management's estimates.
h. PROPERTY AND EQUIPMENT
Property and equipment are stated at cost, less accumulated
depreciation. Depreciation of property and equipment is generally computed
on a straight line basis over the estimated useful lives of the assets.
Upon retirement or sale, the cost of assets disposed of and the related
accumulated depreciation are removed from the accounts; any resulting gain
or loss is credited or charged to operations. Costs of maintenance and
repairs are charged to expense when incurred.
i. REVENUE RECOGNITION
Loan origination revenue and associated incremental direct costs on
loans held for sale are deferred until the related loan is sold. Gains and
losses on loans are recognized at the time of sale and are based upon the
difference between the selling price and the carrying value of the related
loans sold. Loan servicing revenue is earned as the related principal is
collected. Interest on mortgage loans held for sale and mortgage loans held
for investment is credited to income as earned, and interest expense on
related borrowings is expensed as incurred.
The Corporation adopted the provisions of Statement of Financial
Accounting Standards No. 125, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, as of January 1, 1997.
The impact of the adoption of this standard was not material to the
Corporation's financial position or results of operations.
F-8
<PAGE> 94
ROCK FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
DECEMBER 31, 1995, 1996 AND 1997
j. DERIVATIVE FINANCIAL INSTRUMENTS
The Corporation utilizes derivative financial instruments as part of
an overall interest rate risk and mortgage pipeline management strategy.
Derivative financial instruments utilized by the Corporation include
treasury-based options. The Corporation is an end-user of derivative
financial instruments and does not conduct trading activities for
derivatives. These derivative financial instruments involve, to varying
degrees, elements of credit and market risk which are not recognized on the
balance sheet.
Credit risk is defined as the possibility that a loss may occur from
the failure of another party to perform in accordance with the terms of the
contract which exceeds the value of existing collateral, if any. Market
risk is the possibility that future changes in market conditions may make
the derivative financial instrument less valuable. The Corporation
evaluates the risks associated with derivatives in much the same way as the
risks with on-balance-sheet financial instruments. The derivative's risk of
credit loss is generally a small fraction of the notional value of the
instrument and is represented by the fair value of the derivative
instrument. The Corporation attempts to limit its credit risk by dealing
with creditworthy counterparties and obtaining collateral where
appropriate.
The Corporation uses treasury-based options in hedging its interest
rate risk exposure. Utilization of treasury-based options involves some
degree of basis risk. Basis risk is defined as the risk that the hedge
instrument's price does not move as expected relative to the increase or
decrease in the market price of the hedged financial instrument. The
Corporation calculates an expected hedge ratio to attempt to mitigate a
portion of this risk.
The Corporation accounts for its options utilizing "Split Accounting."
The option's value is categorized into "intrinsic" and "time value"
components. The intrinsic value is the amount that the option is "in the
money." The time value is the amount by which its price exceeds its
intrinsic value. Split Accounting results in accounting for time value and
intrinsic value separately. The time value is amortized over the option's
exercise period. The intrinsic value is recognized as a component of the
gain or loss on settlement of the option.
k. INCOME TAXES
Effective March 1, 1992, the Corporation elected to have its income
taxed directly to the individual shareholders, in accordance with the S
corporation provisions of the Internal Revenue Code. Accordingly, no
provision for income taxes has been reflected in the financial statements
(see note 18 for a description of pro forma basic and diluted earnings per
share).
l. ADVERTISING COSTS
Advertising costs are incurred for non-direct response advertising.
Accordingly, the costs of producing the advertising are expensed as
incurred, while the costs of communicating the advertising are expensed
when the advertising space or airtime is first used.
m. EARNINGS PER SHARE
Basic earnings per share is computed based on the weighted average
number of common shares outstanding during the year. Diluted earnings per
share is computed based on the weighted average number of common shares and
common share equivalents during the year (see note 18 for a description of
pro forma basic and diluted earnings per share).
n. MANAGEMENT ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and
F-9
<PAGE> 95
ROCK FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
DECEMBER 31, 1995, 1996 AND 1997
liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
o. RECLASSIFICATIONS
Certain amounts from the prior year have been reclassified to conform
with current year presentation.
2. MARKETABLE SECURITIES:
The marketable securities held by the Corporation at December 31, 1996,
which were all equity securities, had an aggregate cost of $4,517,491 and an
aggregate fair value of $5,953,860, resulting in a net unrealized gain of
$1,436,369, including gross unrealized gains of $1,704,872 and gross unrealized
losses of $268,503.
Realized gains and losses on marketable securities are computed based on
the specific identification method. Realized gains of $4,633,620, $4,511,466,
and $3,156,783 and realized losses of $4,287,904, $3,520,247 and $646,895 on the
sale of marketable securities for the years ended December 31, 1995, 1996 and
1997, respectively, are included in the determination of net income. Included in
realized losses for the year ended December 31, 1995, was a write-down of
approximately $846,500 on a marketable security for other than temporary
impairment.
3. MORTGAGE LOANS HELD FOR SALE AND HELD FOR INVESTMENT:
The following summarizes mortgage loans held for sale by type at December
31, 1996 and 1997:
<TABLE>
<CAPTION>
1996 1997
---- ----
<S> <C> <C>
Conventional prime loans held for sale...................... $68,972,367 $ 74,049,209
Sub-prime loans held for sale............................... 15,459,184 38,372,558
High LTV loans held for sale................................ 323,400 9,194,343
----------- ------------
84,754,951 121,616,110
Net deferred loan origination costs (fees).................. 254,444 (272,296)
----------- ------------
Mortgage loans held for sale.............................. $85,009,395 $121,343,814
=========== ============
</TABLE>
Included in mortgage loans held for investment at December 31, 1997 was an
allowance for credit losses of $270,000, which was established in 1997 through a
provision of $300,000 offset by charge-offs of $30,000.
As of December 31, 1996, one loan classified as held for sale with an
outstanding balance of approximately $45,000 was greater than 90 days past due.
As of December 31, 1997, there were no loans held for sale that were greater
than 90 days past due. As of December 31, 1997, there were approximately $72,000
of loans held for investment that were greater than 90 days past due (none in
1996), $25,000 of which was classified as nonaccrual at December 31, 1997.
F-10
<PAGE> 96
ROCK FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
DECEMBER 31, 1995, 1996 AND 1997
4. PROPERTY AND EQUIPMENT:
Property and equipment are depreciated over lives ranging from five to
seven years for office furniture, equipment and leasehold improvements. Property
and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1997
------------ ------------
<S> <C> <C>
Office furniture and equipment.............................. $4,133,940 $ 9,779,846
Leasehold improvements...................................... 195,252 600,958
Projects in process......................................... 489,600 59,595
---------- -----------
Total cost................................................ 4,818,792 10,440,399
Accumulated depreciation.................................... 2,137,478 3,429,862
---------- -----------
Net....................................................... $2,681,314 $ 7,010,537
========== ===========
</TABLE>
5. BORROWINGS:
Advances under the Corporation's warehouse line of credit are based on a
formula computation, with interest due monthly, are due on demand, and are
collateralized by residential first and second mortgages. Advances may be drawn
for working capital and sub-prime, high LTV, and conventional prime mortgage
loans. Interest rates are variable and are based on the federal funds rate and
prime rate, depending on the type of advance. Interest rates ranged from 7.16
percent to 8.75 percent at December 31, 1996 and 6.69 percent to 7.69 percent at
December 31, 1997, with weighted average interest rates of 7.29 percent and 6.94
percent at December 31, 1996 and 1997, respectively.
The maximum outstanding balance permitted under the line was $90,000,000
(with certain sublimits for working capital, non-conforming and second mortgage
loans) at December 31, 1996 and 1997. The Corporation is required to maintain a
minimum tangible net worth and other financial covenants, as defined in the
agreement. The Corporation was in compliance with the requirements as of
December 31, 1996 and 1997.
The Corporation's reverse repurchase agreement entered into in 1997
provides that the lender will purchase from the Corporation, subject to the
Corporation's agreement to repurchase on a daily basis, up to $100 million of
conventional prime and sub-prime mortgage loans at par. Loans subject to
purchase are fixed and adjustable rate, fully-amortizing, first or junior lien
residential mortgage loans and home equity loans that comply with the
Corporation's origination guidelines and conform to whole and bulk loan sale
requirements. This agreement is not a committed facility and the lender may
elect to discontinue the repurchase agreement at any time. The term of any
financing under the repurchase agreement matures and may be renewed on a daily
basis. In any event, the arrangement terminates in March 1999. Interest rates
are variable and are based on the London Interbank Offered Rate, depending on
the type of advance. The interest rate in effect at December 31, 1997 was 8.25
percent, while the weighted average interest rate during 1997 was 6.88 percent.
In February 1997, the Corporation borrowed $2,000,000 for the purchase of
computer equipment and software. The note matures in three years, payments are
based on equal monthly installments plus interest at 75 basis points over prime,
and the loan is collateralized by the Corporation's equipment. The interest rate
in effect at December 31, 1997 was 9.25 percent.
Drafts payable represent funds advanced for mortgages closed which have not
yet been drawn against the warehouse line of credit.
F-11
<PAGE> 97
ROCK FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
DECEMBER 31, 1995, 1996 AND 1997
6. INVESTOR RESERVES:
The following presents the activity in the investor reserves, which are
included in accrued expenses and other liabilities, for the periods indicated:
<TABLE>
<CAPTION>
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Beginning balance........................................... $ 25,249 $ 226,809 $ 389,162
Provision for premium recapture............................. 204,935 317,262 602,632
Premium recapture paid...................................... (3,375) (154,909) (297,954)
-------- --------- ---------
Ending balance.............................................. $226,809 $ 389,162 $ 693,840
======== ========= =========
</TABLE>
7. RELATED PARTY TRANSACTIONS:
During the years ended December 31, 1996 and 1997, the Corporation made
short-term advances to certain shareholders that bear interest at 3 percent per
year. The highest amounts outstanding during the period to any shareholder
totaled approximately $2,700,000 and $6,100,000 in 1996 and 1997, respectively.
Interest income relating to such advances totaled approximately $62,000, $98,000
and $148,000 for the years ended December 31, 1995, 1996 and 1997, respectively.
In addition, the Corporation made short-term loans to certain affiliates
during 1996 and 1997. The maximum amounts outstanding during 1996 and 1997 were
$50,000 and $400,000, respectively. No balance was remaining outstanding at
either December 31, 1996 or 1997. Interest income relating to such loans totaled
approximately $13,000, $300, and $10,000 for the years ended December 31, 1995,
1996 and 1997, respectively.
8. OPERATING LEASES:
The following is a schedule of future minimum lease payments (for leases
with initial or remaining terms in excess of one year) as of December 31, 1997:
<TABLE>
<S> <C>
1998........................................................ $2,500,000
1999........................................................ 1,700,000
2000........................................................ 1,200,000
2001........................................................ 600,000
2002 and thereafter......................................... 300,000
----------
Total..................................................... $6,300,000
Less sublease payments to be received....................... 100,000
----------
Net future minimum lease payments......................... $6,200,000
==========
</TABLE>
Total rental expense incurred during the years ended December 31, 1995,
1996 and 1997, was $980,000, $990,000 and $1,580,000, respectively.
9. EMPLOYEE BENEFIT PLAN:
The Corporation maintains a defined contribution 401(k) Savings Plan
covering substantially all full-time employees. Employees can make elective
contributions to the plan. The plan requires the Corporation to contribute 20
percent of employee contributions to the plan up to a maximum of one percent of
the employee's gross pay. The Corporation's contributions to the plan for the
years ended December 31, 1995, 1996 and 1997 amounted to $42,000, $43,000 and
$83,000, respectively.
F-12
<PAGE> 98
ROCK FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
DECEMBER 31, 1995, 1996 AND 1997
10. STOCK PURCHASE AGREEMENT:
The Corporation is a party to a Shareholders Agreement with its three
shareholders. The terms of the agreement restrict the sale and pledging of the
shareholders' stock in the Corporation. The agreement also gives the Corporation
the option to purchase the stock of two of the shareholders upon death. The
purchase price is based upon an appraisal of the Corporation and is partially
insured by life insurance policies carried on the lives of the shareholders (see
note 17).
11. STOCK OPTION PLAN AND EMPLOYMENT AGREEMENTS:
On December 27, 1996, the Corporation approved a stock option plan in which
3,578,617 common shares have been reserved for issuance (see note 17). Under the
plan, the exercise price of any incentive stock option will not be less than the
fair market value of the common shares on the date of grant. The exercise price
of any nonqualified option and the dates on which the options are first
exercisable are determined by the Stock Option Committee or the Board of
Directors. The term of any option may not exceed ten years from the date of
grant. On December 28, 1996, 1,540,684 immediately exercisable options were
granted at $4.68 per share. On January 31, 1997 (as adjusted in March 1997),
780,000 options were granted, vesting in one-fifth cumulative annual
installments beginning December 31, 1997, at $4.68 per share. On April 30, 1997,
90,000 options were granted, vesting in one-fifth cumulative annual installments
beginning December 31, 1997, at $4.68 per share. On July 30, 1997, 196,500
options were granted, vesting in one-fifth cumulative annual installments
beginning December 31, 1998, at $7.00 per share. At December 31, 1997, 1,086,433
common shares were reserved for issuance under the plan.
Option activity since the plan was adopted in 1996 was as follows:
<TABLE>
<CAPTION>
NUMBER WEIGHTED AVERAGE
OF SHARES EXERCISE PRICE
--------- ----------------
<S> <C> <C>
Options outstanding at December 31, 1995.................... -- N/A
Activity during 1996:
Granted................................................... 1,540,684 $4.68
Expired................................................... -- N/A
--------- -----
Options outstanding at December 31, 1996 (all
exercisable).............................................. 1,540,684 $4.68
Activity during 1997:
Granted................................................... 1,066,500 $5.11
Expired................................................... -- --
Forfeited................................................. 110,000 $4.68
--------- -----
Options outstanding at December 31, 1997 (including
exercisable options for 1,692,684 shares)................. 2,497,184 $4.86
========= =====
</TABLE>
In accordance with SFAS No. 123, Accounting for Stock-Based Compensation,
the Corporation applied the intrinsic value method of accounting, as described
in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, to its stock-based compensation. Accordingly, no compensation expense
has been charged against income for stock option grants. Had compensation
expense been determined based on the fair value at the 1996 and 1997 grant
dates, consistent with the fair value methodology of SFAS No. 123, the
Corporation's net income (loss) would have been ($369,262) and $11,065,356 in
1996 and 1997, respectively.
The weighted average fair value of options granted in 1996 and 1997
totalled $2.30 and $2.50 per share, respectively. The fair value of each option
grant is estimated on the date of grant using the Black-Scholes option pricing
model. The weighted average assumptions used in valuing the option grants for
the years ended
F-13
<PAGE> 99
ROCK FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
DECEMBER 31, 1995, 1996 AND 1997
December 31, 1996 and 1997, respectively, were expected life, five years for
both years; interest rate 5.40% and 5.30%; and volatility (the measure by which
the stock price has fluctuated or will be expected to fluctuate during the
period), 66% for both years.
At December 31, 1997, 2,497,184 of the outstanding options have exercise
prices that range between $4.68 and $7.00, with a weighted average exercise
price of $4.86. Of these options, 1,692,684 options are exercisable, with a
weighted average exercise price of $4.68 and a weighted average contractual
maturity of 8.8 years. The remaining 804,500 outstanding options have exercise
prices that range between $4.68 and $7.00, with a weighted average exercise
price of $5.25, and a weighted average contractual maturity of 8.8 years.
Certain option holders who are officers of the Corporation entered into
employment agreements which stipulate a "Distribution Bonus" is entitled to be
paid upon certain conditions. The agreements require the Corporation to pay the
"Distribution Bonus" at the same time as shareholders receive distributions in
respect of their common shares, except for "Excluded Payments", as long as the
officers are employed by the Corporation. The amount of the "Distribution Bonus"
is determined by the number of common shares of the Corporation that these
officers have the right to acquire multiplied by the per share distributions
paid to shareholders. "Excluded Payments" mean all the following (1) any
distribution that is not cash or property, (2) any distribution of securities
issued by the Corporation, (3) salaries, bonuses or other compensation that one
or more shareholders may receive as consideration for services rendered, (4)
distributions to shareholders to cover their income tax liabilities for the S
corporation status, and (5) distributions of up to $5 million paid to
shareholders by September 1, 1997.
No distributions were made to shareholders in 1995, 1996 or 1997 that
resulted in the required payment of the Distribution Bonus. The Corporation's
shareholders do not intend to receive distributions in the normal course of
business in the foreseeable future in excess of the Excluded Payments.
Therefore, the Distribution Bonuses, which would have been approximately $70,000
in 1995, $600,000 in 1996, and $1.1 million in 1997, have not been accrued for
or recognized as compensation expense in the accompanying financial statements.
Such accrual and corresponding compensation expense will be recognized when such
shareholder distributions are declared.
In February 1998, the option holders who were entitled to these
Distribution Bonuses entered into an agreement whereby their rights to the
Distribution Bonuses will be eliminated if the Offering (see note 17) is
consummated (if the Offering is not consummated, the prior provisions with
respect to the Distribution Bonuses will be reinstated). These rights were
replaced with the rights to exercise existing options representing approximately
330,000 of the Corporation's common shares and simultaneously sell the shares as
part of a proposed initial public offering of the Corporation's stock. In
addition, the option holders were granted additional options for 450,000 common
shares at an exercise price equal to the initial public offering price. As the
existing options expected to be exercised were granted at the fair value of the
stock at the date of grant, and the additional options for 450,000 common shares
expected to be granted are being granted at the fair value at the date of grant,
the Corporation has recognized no compensation expense associated with such
options.
12. FAIR VALUE OF FINANCIAL INSTRUMENTS:
SFAS No. 107, Disclosures About Fair Value of Financial Instruments,
requires disclosures of the fair value of certain financial instruments for
which it is practical to estimate the value. In cases where quoted market prices
are not available, fair values are based on estimates using present value or
other valuation techniques.
F-14
<PAGE> 100
ROCK FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
DECEMBER 31, 1995, 1996 AND 1997
The following tables present the carrying amounts and fair value of
financial instruments at December 31, 1996 and 1997:
<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1997
-------------------------- --------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- ----- -------- -----
<S> <C> <C> <C> <C>
Cash and cash equivalents................. $ 3,288,751 $ 3,290,000 $11,949,992 $11,950,000
Marketable securities..................... 5,956,471 5,960,000 -- --
Mortgage loans held for sale--
Conventional prime...................... 69,343,512 70,300,000 74,475,694 75,500,000
Sub-prime home equity................... 15,277,512 16,000,000 37,896,640 39,900,000
High LTV second mortgages............... 388,371 400,000 8,971,480 9,700,000
Mortgage loans held for investment........ -- -- 810,293 900,000
Warehouse line of credit.................. 67,621,266 67,600,000 79,293,856 79,300,000
Reverse repurchase agreement.............. -- -- 18,161,423 18,200,000
Notes payable............................. -- -- 1,944,445 1,900,000
Calls on U.S. Treasury securities......... -- -- 17,000 14,000
</TABLE>
Fair value methods and assumptions for the Corporation's financial
instruments are as follows:
Cash and Cash Equivalents
The carrying amounts reported in the balance sheet for cash and cash
equivalents reasonably approximate those assets' fair values.
Marketable Securities Available for Sale
Fair values for marketable securities available for sale are based on
quoted market prices.
Loans Held for Sale and Loans Held for Investment
For mortgage loans held for sale and investment, fair value is estimated
using quoted market prices for similar loans, adjusted for differences in loan
characteristics, including credit quality. The carrying amount of accrued
interest receivable approximates the assets' fair value.
Borrowings
For borrowings, fair value is estimated based on the discounted value of
contractual cash flows using interest rates currently in effect for similar
maturities and collateral requirements. As all of the borrowings have variable
interest rates that approximate current market interest rates for similar types
of liens of credit and are due upon demand, the carrying amount of these
borrowings approximates their estimated fair values.
Off-Balance-Sheet Instruments
The fair value of the calls on U.S. Treasury securities is based on quoted
market prices for similar instruments.
The fair value of commitments to extend credit is estimated using the fees
currently charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the present creditworthiness of the
customers. For fixed-rate loan commitments, fair value also considers the
difference between current levels of interest rates and the committed rates. The
fair value of commitments to extend credit approximated the book values at both
December 31, 1996 and 1997.
F-15
<PAGE> 101
ROCK FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
DECEMBER 31, 1995, 1996 AND 1997
The Corporation had mandatory forward sales commitments for future delivery
of FNMA and Freddie Mac securities of $82,535,000 as of December 31, 1997. The
Corporation's exposure to credit loss in the event of non-performance by other
parties to the mandatory sales commitments represents the difference between the
contractual amount and the fair value of those agreements based on quoted market
prices. The fair value of those agreements approximated the contractual amount
as of December 31, 1997.
13. LOAN SERVICING PORTFOLIO:
In April 1995, the Corporation sold its entire remaining loan servicing
portfolio. As a result of the sale, the Corporation recognized a gain of
$5,728,411, net of the related capitalized purchase mortgage servicing rights.
14. STOCK SPLIT:
On January 8, 1997, the Corporation effected a stock split of the
Corporation's common shares on the basis of 1,118.31805 common shares for each
common share formerly issued and outstanding. The financial statements and
related disclosures have been retroactively adjusted to reflect this split.
15. LOAN FEES AND GAINS AND LOSSES ON THE SALE OF MORTGAGES:
Loan fees and gains and losses on the sale of mortgages for the years ended
December 31, 1995, 1996 and 1997 were comprised of the following components:
<TABLE>
<CAPTION>
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Gain on loan sales.................................... $17,016,142 $25,613,600 $37,728,135
Net loan origination fees............................. 977,072 2,663,099 9,958,806
Provision for premium recapture....................... (204,935) (317,262) (602,632)
----------- ----------- -----------
$17,788,279 $27,959,437 $47,084,309
=========== =========== ===========
</TABLE>
16. COMMITMENTS AND CONTINGENCIES:
The Corporation is a party to financial instruments with off-balance-sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments are loan commitments to extend credit and
treasury-based options. These instruments involve, to varying degrees, elements
of credit risk in excess of the amounts recognized in the balance sheets.
The Corporation's exposure to credit loss in the event of the
non-performance by the other party to the financial instruments for loan
commitments to extend credit is represented by the contractual amounts of these
instruments, while the risk of credit loss associated with the Corporation's
treasury-based options is a small fraction of the notional amount of the
instrument and is represented by the fair value of such instruments. The
Corporation uses the same credit policies in making credit commitments as it
does for on-balance-sheet loans.
F-16
<PAGE> 102
ROCK FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
DECEMBER 31, 1995, 1996 AND 1997
Financial instruments for loan commitments to extend credit whose contract
amounts represent credit risk at December 31, 1996 and 1997, are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1996 DECEMBER 31, 1997
--------------------------- ---------------------------
FIXED-RATE VARIABLE-RATE FIXED-RATE VARIABLE-RATE
---------- ------------- ---------- -------------
<S> <C> <C> <C> <C>
Conventional prime loans.................. $59,600,000 $43,600,000 $58,500,000 $17,600,000
Sub-prime loans........................... 300,000 500,000 4,600,000 3,600,000
High LTV loans............................ -- -- 12,300,000 --
----------- ----------- ----------- -----------
$59,900,000 $44,100,000 $75,400,000 $21,200,000
=========== =========== =========== ===========
</TABLE>
Loan commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. The Corporation evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained is
based on management's credit evaluation of the customer. Market risk may arise
if interest rates move adversely subsequent to the extension of loan
commitments.
The treasury-based options held by the Corporation at December 31, 1997
were calls on U.S. Treasury securities in the notional amount of $2 million, to
mitigate its interest rate risk on its conventional mortgage loan pipeline.
The Corporation is subject to various claims and legal proceedings arising
out of the normal course of business, none of which, in the opinion of
management, is expected to have a material effect on the Corporation's financial
position.
17. SUBSEQUENT EVENTS:
The Corporation is contemplating an initial public offering of common
shares (the "Offering"). In connection with the proposed Offering, the
Corporation's Board of Directors approved an amendment and restatement of the
Corporation's Restated Articles of Incorporation to (i) increase the authorized
common shares from 20,000,000 to 50,000,000, and (ii) reorganize the Board of
Directors into three classes with staggered terms ending on the first, second or
third succeeding Annual Meeting of Shareholders of the Corporation and providing
that Directors may be removed only for cause. The Corporation's shareholders
approved such amendment and restatement on February 18, 1998. In connection with
the proposed Offering, the Corporation has capitalized approximately $55,000 of
costs directly associated with the Offering.
Also on February 18, 1998, the Corporation's Board of Directors (i)
declared a dividend to the Corporation's then existing shareholders, subject to,
and effective immediately before, the closing of the Offering and payable out of
the proceeds of the Offering, equal to the entire amount of the Corporation's
income taxed or taxable to the existing shareholders while the Corporation was
an S corporation, but not yet distributed to them (the "Shareholder Distribution
Amount"), and (ii) approved a Tax Indemnification Agreement among the
Corporation and its then existing shareholders. The Tax Indemnification
Agreement is intended to ensure that, if there is any reallocation of taxable
income or deductions between the period during which the Corporation was taxed
as an S corporation and the period after the closing of the Offering during
which it is taxed as a C corporation, income taxes are borne either by the
Corporation or the existing shareholders to the extent that such parties
received the related income.
In addition, on February 18, 1998, the Corporation's Board of Directors
approved a Shareholders Agreement among the Corporation and its existing
shareholders. The terms of the agreement provide that two of the minority
shareholders will vote their common shares in the manner directed by the
majority shareholder.
F-17
<PAGE> 103
ROCK FINANCIAL CORPORATION
NOTES TO FINANCIAL STATEMENTS -- CONTINUED
DECEMBER 31, 1995, 1996 AND 1997
In addition, on February 18, 1998, the Corporation's Board of Directors and
shareholders amended and restated the Corporation's 1996 Stock Option Plan to
increase the number of shares reserved for issuance under the plan from
3,578,617 Common Shares to 4,500,000 Common Shares.
18. UNAUDITED PRO FORMA FINANCIAL INFORMATION:
The pro forma financial information has been presented to show what the
significant effects on the historical financial position might have been had the
distribution of the Shareholder Distribution Amount, the termination of the
Corporation's S corporation status, the exercise of options by the Selling
Shareholders in connection with the Offering, and the sale of the Common Shares
offered by the Company in the Offering occurred as of December 31, 1997, in
connection with the proposed Offering described in note 17 and to show what the
significant effects on the historical results of operations might have been had
the Corporation not been treated as an S corporation for income tax purposes as
of the beginning of the earliest year presented.
Pro Forma Balance Sheet -- The Corporation's December 31, 1997 balance
sheet is adjusted for the following pro forma adjustments: (1) the distribution
from retained earnings of the Shareholder Distribution Amount of $18 million,
(2) the establishment of a deferred tax asset of $1.7 million in connection with
the proposed termination of the Corporation's S corporation status as of
December 31, 1997, with an offsetting increase in retained earnings, (3)
although he is not required to do so, the expected repayment by one of the
Company's shareholders of the entire outstanding balance of shareholder advances
(approximately $1.6 million as of December 31, 1997) with his share of the
Shareholder Distribution Amount, and the Corporation's expected use of that cash
to repay a portion of the amounts outstanding under its warehouse line of
credit, (4) the receipt by the Company of approximately $1.5 million upon
exercise by certain of the Company's option holders of 330,000 options at $4.68
a share to acquire the Common Shares they are selling in the Offering and the
Corporation's application of the estimated net proceeds therefrom to repay a
portion of the amounts outstanding under its warehouse line of credit, and (5)
the sale of the Common Shares offered by the Company in the Offering and the
application of the estimated net proceeds therefrom to fund the Shareholder
Distribution Amount and repay a portion of the amounts outstanding under its
warehouse line of credit. The Company does not expect to have any undistributed
"S" corporation earnings. The principal components of the Corporation's pro
forma deferred tax asset related to the temporary differences between tax and
book accounting for recognition of gains on sales of mortgage loans. The amount
of the deferred tax asset to be recorded will be dependent upon the extent of
such temporary differences at the date of revocation of the Corporation's S
corporation status.
Pro Forma Net Income -- The presentation of pro forma net income represents
the historical results of operations adjusted to recognize federal and state
income taxes as if the Corporation had been taxed as a C corporation rather than
an S corporation for all of the periods presented, using a pro forma combined
federal and state income tax rate of approximately 36.0%.
Pro forma basic earnings per share has been computed by dividing pro forma
net income by the 13,330,000 average shares assumed to be outstanding including
the 3,000,000 shares to be sold by the Corporation in the proposed Offering and
the 330,000 shares to be sold by certain existing shareholders in the proposed
Offering (after exercising options to purchase those shares from the
Corporation). Pro forma diluted earnings per share has been computed by dividing
pro forma net income by the 14,282,914 average shares assumed to be outstanding,
including the 3,000,000 shares to be sold by the Corporation in the proposed
Offering and the 330,000 shares to be sold by certain existing shareholders in
the proposed Offering (after exercising options to purchase those shares from
the Corporation) as well as the number of common stock equivalent shares assumed
to be outstanding upon exercise of the Corporation's stock options existing as
of December 31, 1997, using the treasury stock method and the initial public
offering price of $10.00 per share.
F-18
<PAGE> 104
A HIGHLY VISIBLE RETAIL PRESENCE
Rock originates loans through twenty-six stores
and branches, one marketing center and one call
center. Rock originates 100% of its loans through
its retail operations, marketing its loans
directly to consumers.
The majority of the Fresh Start(TM) stores are
located in retail strip malls or office buildings
with substantial signage. Rock opened nine Fresh
Start(TM) stores and a pilot marketing center
located within a Super Kmart(TM) during 1997.
Fresh Start(TM) Loan Center, Super Kmart(TM), Broadview, Illinois
Fresh Start(TM) Loan Center, Toledo, Ohio
Fresh Start(TM) Loan Center, Toledo, Ohio
<PAGE> 105
Fresh Start(TM) Loan Center, Super Kmart(TM), Broadview, Illinois
Rock Financial, Canton, Michigan
(Conventional Mortgage Lending)
Fresh Start(TM) Loan Center, Hodgkins, Illinois
In January 1998, Rock opened an additional five
Fresh Start(TM) stores.
Rock plans to increase the number of its Fresh
Start(TM) stores, thereby increasing loan
production and diversifying its operations
geographically.
Rock believes it is creating growing brand
identities and a retail franchise that will
sustain its loan origination efforts.
Gracie the Groundhog...official mascot of Fresh
Start(TM)
<PAGE> 106
THE
RETAIL
FRANCHISE
Fresh Start(TM) Loan Center, Hodgkins, Illinois
<PAGE> 107
===========================================================
UNTIL MAY 26, 1998 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS
EFFECTING TRANSACTIONS IN THE COMMON SHARES, WHETHER OR NOT PARTICIPATING IN
THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION
TO THE OBLIGATIONS OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS
UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
-------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary..................... 3
Risk Factors........................... 12
Termination of S Corporation
Status............................... 23
Use of Proceeds........................ 24
Capitalization......................... 25
Dividend Policy........................ 26
Dilution............................... 27
Selected Financial Data................ 28
Management's Discussion and Analysis of
Financial Condition and Results of
Operations........................... 30
Business............................... 43
Management............................. 60
Certain Transactions................... 68
Principal and Selling Shareholders..... 70
Description of Capital Stock........... 72
Shares Eligible for Future Sale........ 75
Underwriting........................... 77
Legal Matters.......................... 79
Experts................................ 79
Change in Accountants.................. 79
Additional Information................. 79
Index to Financial Statements.......... F-1
</TABLE>
NO DEALER, SALES REPRESENTATIVE, OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO
GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS
OFFERING OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE,
SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN
AUTHORIZED BY ROCK, THE SELLING SHAREHOLDERS OR ANY OF THE UNDERWRITERS. THIS
PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO
BUY ANY SECURITIES OTHER THAN THE COMMON SHARES TO WHICH IT RELATES OR AN OFFER
TO, OR A SOLICITATION OF, ANY PERSON IN ANY JURISDICTION WHERE SUCH AN OFFER OR
SOLICITATION WOULD BE UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY
SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN IMPLICATION THAT
THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY OR THAT INFORMATION
CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF.
===========================================================
===========================================================
3,330,000
ROCK FINANCIAL LOGO
COMMON SHARES
---------------------
PROSPECTUS
---------------------
BEAR, STEARNS & CO. INC.
PRUDENTIAL SECURITIES INCORPORATED
RONEY & CO.
MAY 1, 1998
===========================================================
