United States
Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the quarterly period ended September 30, 1999
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the transition period from __________ to __________
Commission File Number 000-26787
Mortgage.com, Inc.
------------------
Exact name of registrant as specified in its charter
Florida 65-0435281
------- ----------
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
8751 Broward Boulevard, Fifth Floor, Plantation, FL 33324
---------------------------------------------------------
(Address of principal executive offices)
(954) 452-0000
--------------
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes [X] No _____
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Number of Shares Outstanding
Class On November 3, 1999
----- -------------------
Common Stock, $ .01 par value 42,987,467
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<TABLE>
<CAPTION>
MORTGAGE.COM, INC.
INDEX TO 10-Q
Page
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<S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. Consolidated Balance Sheets as of December 31, 1998 and
September 30, 1999 (Unaudited)..............................................................3
Consolidated Statements of Operations for the three month and
nine month periods ended September 30, 1998 and 1999 (Unaudited)............................4
Consolidated Statements of Cash Flows for the nine month
periods ended September 30, 1998 and 1999 (Unaudited).......................................5
Notes to Consolidated Financial Statements..................................................6
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations...................................................................11
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk..................................23
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings...........................................................................24
ITEM 2. Changes in Securities and Use of Proceeds...................................................24
ITEM 3. Defaults Upon Senior Securities.............................................................24
ITEM 4. Submission of Matters to a Vote of Securities Holders.......................................25
ITEM 5. Other Information...........................................................................25
ITEM 6. Exhibits and Reports on Form 8-K............................................................25
Signatures ............................................................................................25
</TABLE>
2
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<TABLE>
<CAPTION>
PART I - Financial Information
Item 1. Financial Statements
MORTGAGE.COM, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands)
(Unaudited)
December 31, September 30,
1998 1999
---------------- ----------------
<S> <C> <C>
ASSETS:
Cash and cash equivalents ............................................... $ 3,412 $ 1,819
Mortgage loans available for sale, net .................................. 176,373 109,487
Accounts and notes receivable, net ...................................... 1,244 3,499
Accrued interest receivable ............................................. 197 442
Prepaid expenses, deposits and other assets.............................. 1,280 5,354
Property and equipment, net ............................................. 5,266 10,702
Capitalized software development costs .................................. 978 2,207
Goodwill and other intangible assets, net ............................... 4,688 8,841
---------------- ----------------
Total assets ....................................................... $ 193,438 $ 142,351
================ ================
LIABILITIES AND SHAREHOLDERS' EQUITY:
Warehouse and other notes payable ....................................... $ 172,167 $ 86,852
Accounts payable, accrued expenses and other liabilities ................ 5,557 9,462
Capital lease obligations ............................................... 1,566 2,568
Deferred revenue ........................................................ 1,012 --
---------------- ----------------
Total liabilities .................................................. 180,302 98,882
---------------- ----------------
Shareholders' equity:
Common stock, $.01 par value. Authorized 210,000,000 shares; issued
and outstanding 9,398,270 and 42,807,549 shares, respectively ...... 94 428
Preferred stock, $.01 par value. Authorized 15,000,000 shares; issued
and outstanding 3,199,073 and 0 shares, respectively ............... 32 --
Unearned compensation ................................................ (631) (9,394)
Additional paid-in capital ........................................... 31,531 105,519
Accumulated deficit .................................................. (17,890) (53,084)
---------------- ----------------
Total shareholders' equity ......................................... 13,136 43,469
---------------- ----------------
Total liabilities and shareholders' equity ......................... $ 193,438 $ 142,351
================ ================
</TABLE>
See accompanying notes to the consolidated financial statements.
3
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<TABLE>
<CAPTION>
MORTGAGE.COM, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ------------------------------
1998 1999 1998 1999
-------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
Revenue:
Secondary marketing revenue, net .................. $ 7,632 $ 8,622 $ 19,660 $ 27,168
Loan production and processing fees, net .......... 1,329 2,442 3,529 8,143
Management, technology and other fees ............. 539 663 1,734 3,621
Interest income ................................... 2,259 2,846 4,788 8,406
Interest expense on warehouse notes ............... (2,181) (2,277) (4,634) (7,336)
-------------- ------------- ------------- --------------
Net interest income from lending operations ..... 78 569 154 1,070
-------------- ------------- ------------- --------------
Total revenue ........................................ 9,578 12,296 25,077 40,002
-------------- ------------- ------------- --------------
Expenses:
Compensation and employee benefits ................ 6,653 18,385 17,473 40,744
Marketing ......................................... 454 8,623 797 13,203
Research and development .......................... 722 389 1,733 1,759
Depreciation and amortization ..................... 337 1,667 759 3,519
General and administrative ........................ 2,721 5,145 6,603 13,320
Other interest expense ............................ (30) 658 124 1,784
-------------- ------------- ------------- --------------
Total expenses ....................................... 10,857 34,867 27,489 74,329
-------------- ------------- ------------- --------------
Loss before extraordinary item (1,279) (22,571) (2,412) (34,327)
Extraordinary item - loss on early extinguishment of
debt .............................................. -- (436) -- (436)
============== ============= ============= ==============
Net loss ............................................. $ (1,279) $ (23,007) $ (2,412) $ (34,763)
============== ============= ============= ==============
Net loss per share - primary and diluted
Loss before extraordinary item..................... $ (1,279) $ (22,571) $ (2,412) $ (34,327)
Preferred stock dividends
Paid ............................................ (236) (178) (252) (431)
Cumulative unpaid ............................... (698) (549) (1,416) (2,217)
-------------- ------------- ------------- --------------
Loss available to common shareholders ................ (2,213) (23,298) (4,080) (36,975)
Extraordinary item ................................... -- (436) -- (436)
-------------- ------------- ------------- --------------
Net loss available to common shareholders ............ $ (2,213) $ (23,734) $ (4,080) $ (37,411)
============== ============= ============= ==============
Net loss per share - basic and diluted ...............
Loss before extraordinary items ................... $ (0.24) $ (0.83) $ (0.48) $ (2.35)
Extraordinary item ................................ -- (0.02) -- (0.03)
============== ============= ============= ==============
Net loss .......................................... $ (0.24) $ (0.85) $ (0.48) $ (2.38)
============== ============= ============= ==============
Weighted average shares, basic and diluted ........... 9,398 27,919 8,505 15,729
============== ============= ============= ==============
</TABLE>
See accompanying notes to the consolidated financial statements.
4
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<TABLE>
<CAPTION>
MORTGAGE.COM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
Nine Months Ended September 30,
---------------------------------------
1998 1999
----------------- -----------------
<S> <C> <C>
Net cash flows from operating activities:
Net loss ............................................................$ (2,412) $ (34,763)
Adjustments to reconcile net loss to net cash used in
operating activities:
Extraordinary item ................................................. -- 436
Depreciation and amortization ...................................... 759 3,519
Amortization of unearned compensation .............................. -- 7,165
Provision for losses ............................................... 60 1,195
Amortization of discount on subordinated debt ...................... -- 94
(Increase) decrease in mortgage loans available for sale, net ........ (57,132) 66,510
Changes in operating assets and liabilities:
Increase in accounts and notes receivable, net ..................... (744) (3,076)
Increase in accrued interest receivable ............................ (74) (245)
Increase in prepaid expenses, deposits and other assets ............ (174) (4,073)
Increase in accounts payable, accrued expenses and other
liabilities ...................................................... 2,941 3,982
Decrease in deferred revenue ....................................... -- (1,012)
----------------- -----------------
Net cash (used in) provided by operating activities ............ (56,776) 39,732
----------------- -----------------
Cash flows from investing activities:
Additions to capitalized software development costs .................. (428) (1,847)
Additions to property and equipment .................................. (3,197) (6,737)
Purchase of companies, net of cash acquired .......................... (3,254) (617)
Purchase of intangible asset ......................................... -- (3,564)
----------------- -----------------
Net cash used in investing activities .......................... (6,879) (12,765)
----------------- -----------------
Cash flows from financing activities:
Proceeds from (reduction of ) warehouse and other notes
payable .............................................................. 54,708 (85,209)
Proceeds from issuance of subordinated debentures .................... -- 40,500
Repayment of subordinated debentures ................................. (200) (40,500)
Payments of other notes payable ...................................... -- (5)
Proceeds from issuance of common stock ............................... -- 54,426
Proceeds from issuance of preferred stock ............................ 15,144 14,533
Proceeds from exercise of warrants ................................... -- 126
Dividends paid ....................................................... (252) (431)
Redemption of warrants ............................................... -- (12,000)
----------------- -----------------
Net cash provided by (used in) financing activities ............ 69,400 (28,560)
----------------- -----------------
Net increase in cash and cash equivalents ............................... 5,745 (1,593)
Cash and cash equivalents at beginning of period ........................ 1,680 3,412
================= -----------------
Cash and cash equivalents at end of period .............................$ 7,425 $ 1,819
================= =================
Supplemental disclosures of cash flow information:
Cash paid for interest ..............................................$ 5,175 $ 9,071
----------------- -----------------
Cash paid for income taxes ..........................................$ 21 $ 5
================= =================
</TABLE>
See accompanying notes to the consolidated financial statements.
5
<PAGE>
MORTGAGE.COM, INC.
Item 1. Notes To Unaudited Consolidated Financial Statements
1. Description of Business
-----------------------
Mortgage.com, Inc. (formerly known as First Mortgage Network, Inc.)
(the "Company"), is incorporated in Florida and provides online mortgage
services to consumers and to other businesses. The Company has developed
state-of-the-art technology to support its own loan origination, processing,
underwriting, closing and secondary marketing of mortgage loans and is using
this technology as a platform to enable other industry participants to improve
the efficiency and effectiveness of their operations.
The Company commenced operations in 1994 as a wholesale mortgage lender
providing independent mortgage brokers with various support services, including
processing and closing services, as well as a source of funding for their loans.
In 1995, the Company acquired a software system designed to support mortgage
origination, processing, underwriting and closing operations. This system was
enhanced and became known as CLOser, a proprietary platform that supports all of
the services that the Company offers. The Company uses the CLOser software
system to enable financial institutions and non-traditional mortgage originators
such as realtors and homebuilders to originate mortgages as an ancillary
service. The Company also uses the CLOser platform to provide management
processing and back-office services to those customers on an outsourced basis
and also provides funding for the mortgages originated by them.
2. Unaudited Interim Consolidated Financial Statements
---------------------------------------------------
The consolidated financial statements as of September 30, 1998 and 1999
and for the three and nine month periods ended September 30, 1998 and 1999 are
unaudited. The unaudited consolidated financial statements have been prepared on
the same basis as the audited consolidated financial statements and should be
read in conjunction with the Company's audited consolidated financial statements
as of and for the year ended December 31, 1998 as set forth in the Registration
Statement beginning on page F-1. In the opinion of management, all adjustments
of a recurring nature which are necessary to present a fair statement of results
for the interim periods have been made. The unaudited results of operations for
the interim periods are not necessarily indicative of the results for the full
year or any future period. Certain amounts in the financial statements for 1998
and the first two quarters of 1999 have been reclassified to conform to the
third quarter 1999 presentation.
All share and per share amounts, and additional paid-in capital, have
been restated to reflect a seven-for-one common stock split effective August 11,
1999.
6
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3. Use of Estimates
----------------
In preparation of the financial statements, management has considered
all events and/or transactions that are subject to reasonable and normal methods
of estimation, and the financial statements reflect that consideration.
Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets and liabilities and the
disclosure of contingent assets and liabilities to prepare these financial
statements in conformity with generally accepted accounting principles. Actual
results could differ from those estimates.
4. Accounts and Notes Receivable, Net, and Deferred Revenue
--------------------------------------------------------
The Company entered into an agreement in 1996 to sell internally
developed software to an investment firm. As a condition to the agreement, the
Company entered into a ten-year distribution and profit sharing agreement for
the software with the same investment firm. The purchase price of the software
was $10,800,000 of which $1.61 million was received in cash. Due to certain
contract contingencies, the proceeds from the transaction, net of related costs,
were recorded as deferred revenue to be recognized when the contingencies were
satisfied. The related note was included in accounts and notes receivable on the
balance sheet at December 31, 1998 at its discounted net present value and, due
to the contingencies affecting collectibility, was fully reserved for at
December 31, 1998.
On March 31, 1999, this software profit sharing agreement was sold to
an unrelated company as part of a sale of a subsidiary of the Company. The
Company has been relieved of any further obligations. As a result, the $1.01
million in deferred revenue was recorded as management, technology and other
fees income.
5. Intangible Asset
----------------
In January 1999, the Company purchased the Mortgage.com domain name
from an unrelated party for $200,000 in cash, 140,000 shares of common stock
valued at $645,000 and a contingent per loan payment of up to $1.8 million. In
July 1999, the contract was amended and an additional $1.5 million in cash was
paid to release the Company from the contingent portion of the contract. The
asset is being amortized over 10 years.
6. Shareholders' Equity
--------------------
(a) Initial Public Offering
On August 11, 1999, the Company completed an initial public offering in
which 7,062,500 shares of common stock were sold. The principal underwriters
were Credit Suisse First Boston, Deutsche Banc Alex Brown and U.S. Bancorp Piper
Jaffray. Subsequently, the underwriters of the public offering exercised an
option to purchase an additional 379,375 shares of common stock to cover
over-allotments of shares. The gross proceeds from these transactions were $59.5
million, or $55.4 million net of underwriter discounts. A portion of the
proceeds was used to repay the $40.5 million of subordinated debt, and $433,000
was used to redeem certain warrants. Total expenses incurred in the offering
were $1.6 million.
7
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(b) Common Stock Transactions
During January 1999, the Company issued 140,000 shares of common stock
at a value of $4.61 per share in connection with the acquisition of the internet
domain name www.mortgage.com as described in Note 5.
During April 1999, $100,000 of subordinated debt was converted into
46,667 shares of common stock.
Options to purchase 1,076,960 and 1,081,300 shares of common stock were
exercised during the three and nine-month periods ending September 30, 1999.
(c) Preferred Stock Transactions
During May 1999, the Company issued 250,001 shares of $.01 par value
Series F preferred stock at a price of $60 per share. The Series F preferred
stock converted into 1,875,010 post-split shares of common stock in the initial
public offering in August 1999. All outstanding shares of each series of
preferred stock also converted into common stock in the initial public offering.
(d) Stock Warrant Transactions
During the nine month period ending September 30, 1999, 175,000 common
stock warrants converted to common stock options at $0.71 per share and were
exercised in the initial public offering. In addition, warrants for 175,000
shares of common stock issued in conjunction with subordinated debt were
exercised in the initial public offering.
(e) Unearned Compensation
Unearned compensation resulted when stock options were granted at
prices that were subsequently determined to be less than their estimated fair
value. The Company has recorded an estimate of the excess of fair value over the
issue price as unearned compensation as a separate component of shareholders'
equity.
As of September 30, 1999, the Company has recorded approximately $16.6
million in deferred compensation, and amortized approximately $6.1 million and
$7.2 million to compensation and employee benefits expense in the three and nine
month periods ended September 30, 1999, respectively. During the three months
ended September 30, 1999, certain vesting rights were accelerated resulting in
the acceleration and recognition of approximately $5.4 million of deferred
compensation expense. As the Company's stock option plan has a five-year vesting
requirement, the remaining deferred compensation cost will be amortized on a
straight line basis over the vesting period. Stock-based compensation is a
non-cash expense.
8
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7. Income Taxes
------------
No current or deferred provision for income taxes was recorded for the
three and nine month periods ended September 30, 1999 and 1998 due to the
Company's operating losses in the respective periods.
8. Commitments
-----------
The Company has entered into a 10 year lease for approximately 110,000
square feet in an existing facility in Sunrise, Florida and expects to
consolidate operations that are in three separate facilities early in 2000.
Rental payments will be approximately $100,000 per month.
9. Segment Information
-------------------
The Company operates in two reportable business segments: the Direct to
Consumer reportable Segment, which includes the Mortgage.com internet web site
and retail mortgage brokerage operations, both of which originate mortgage loans
that are subsequently sold in the secondary market; and the Business to Business
reportable Segment, which includes back-office mortgage services for lenders,
realtors, homebuilders and software and internet conduits, technology platform
licenses to mortgage industry participants and the Openclose.com web site that
enables brokers, lenders and insurance companies to conduct their business
through a neutral internet site with selected financial institutions using
automated underwriting capabilities provided by the Federal National Mortgage
Association. The Business to Business reportable Segment generates revenues by
charging fees for these services or by funding and selling loans originated
through a business customer in the secondary market. These segments are
characterized by the nature of their customers and represent components of the
Company about which separate financial information is available that is
evaluated by the chief operating decision maker in deciding how to allocate
resources and in assessing performance. Summarized financial information
concerning the business segments is shown in the following table: (Certain
expenses that are not directly attributable to the business channels have been
reclassified to Overhead in these tables.)
<TABLE>
<CAPTION>
(In Thousands) Direct to Business to
Total Consumer Business
--------------- -------------- --------------
<S> <C> <C> <C>
Three months ended September 30, 1999 Revenue:
Secondary marketing revenue, net .................... $ 8,622 $ 2,539 $ 6,083
Loan production and processing fees, net ............ 2,442 459 1,983
Management, technology and other fees ............... 663 -- 663
Net interest (expenses) income ...................... 569 145 424
--------------- -------------- --------------
Total revenue ......................................... 12,296 3,143 9,153
--------------- -------------- --------------
9
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(In Thousands) Direct to Business to
Total Consumer Business
--------------- -------------- --------------
Expenses
Compensation and employee benefits .................. 11,306 2,674 8,632
Marketing ........................................... 8,622 2,259 6,363
Depreciation and amortization ....................... 1,233 139 1,094
General and administrative .......................... 3,713 754 2,959
--------------- -------------- --------------
Total segment expenses .............................. 24,874 5,826 19,048
-------------- --------------
Segment loss ........................................ $ (2,683) $ (9,895)
-------------- --------------
Research and development not allocated to segments .. 389
Expenses not allocated to segments .................. 9,604
---------------
Total expenses ........................................ 34,867
---------------
Loss before extraordinary item ........................ $ (22,571)
---------------
Three Months ended September 30, 1998
Revenue:
Secondary marketing revenue, net .................... $ 7,632 $ 3,271 $ 4,361
Loan production and processing fees, net ............ 1,329 452 877
Management, technology and other fees ............... 539 -- 539
Net interest (expenses) income ...................... 78 (51) 129
--------------- -------------- --------------
Total revenue ......................................... 9,578 3,672 5,906
--------------- -------------- --------------
Expenses
Compensation and employee benefits .................. 6,153 2,737 3,416
Marketing ........................................... 452 223 229
Depreciation and amortization ....................... 204 63 141
General and administrative .......................... 2,239 638 1,601
--------------- -------------- --------------
Total segment expenses .............................. 9,048 3,661 5,387
-------------- --------------
Segment income ...................................... $ 11 $ 519
-------------- --------------
Research and development not allocated to segments .. 722
Expenses not allocated to segments .................. 1,087
---------------
Total expenses ........................................ 10,857
---------------
Loss before extraordinary item ........................ $ (1,279)
---------------
Nine Months ended September 30, 1999
Revenue:
Secondary marketing revenue, net .................... $ 27,168 $ 7,807 $ 19,361
Loan production and processing fees, net ............ 8,143 1,455 6,688
Management, technology and other fees ............... 3,621 -- 3,621
Net interest (expenses) income ...................... 1,070 94 976
--------------- -------------- --------------
Total revenue ......................................... 40,002 9,356 30,646
--------------- -------------- --------------
10
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(In Thousands) Direct to Business to
Total Consumer Business
--------------- -------------- --------------
Expenses
Compensation and employee benefits .................. 31,224 7,946 23,278
Marketing ........................................... 12,991 3,266 9,725
Depreciation and amortization ....................... 2,617 346 2,271
General and administrative .......................... 10,101 1,889 8,212
--------------- -------------- --------------
Total segment expenses .............................. 56,933 13,447 43,486
-------------- --------------
Segment loss ........................................ $ (4,091) $ (12,840)
-------------- --------------
Research and development not allocated to segments .. 1,759
Expenses not allocated to segments .................. 15,637
---------------
Total expenses ........................................ 74,329
---------------
Loss before extraordinary item ........................ $ 34,327
---------------
Nine Months ended September 30, 1998
Revenue:
Secondary marketing revenue, net .................... $ 19,660 $ 9,379 $ 10,281
Loan production and processing fees, net ............ 3,529 1,307 2,222
Management, technology and other fees ............... 1,734 -- 1,734
Net interest (expenses) income ...................... 154 (139) 293
--------------- -------------- --------------
Total revenue ......................................... 25,077 10,547 14,530
--------------- -------------- --------------
Expenses
Compensation and employee benefits .................. 16,142 7,927 8,215
Marketing ........................................... 789 443 346
Depreciation and amortization ....................... 466 175 291
General and administrative .......................... 5,355 1,681 3,674
--------------- -------------- --------------
Total segment expenses .............................. 22,752 10,226 12,526
-------------- --------------
Segment income ...................................... $ 321 $ 2,004
-------------- --------------
Research and development not allocated to segments .. 1,733
Expenses not allocated to segments .................. 3,004
---------------
Total expenses ........................................ 27,489
---------------
Loss before extraordinary item ........................ $ (2,412)
---------------
Segment assets at September 30, 1999 ..................... $ 109,487 $ 65,509 $ 43,978
-------------- --------------
Other assets not allocated to segments ................... 32,864
---------------
Total assets ............................................. $ 142,351
===============
</TABLE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion of the financial conditions and results of
operations of Mortgage.com, Inc. should be read in conjunction with the
Financial Statements and the related Notes included in this Form 10-Q. This
discussion contains, in addition to historical information, "forward-looking"
statements that reflect our current views with respect to future events and
11
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financial performance. We use words such as "anticipate," "believe," "expect,"
"future," "plan" and "intend," and similar expressions, to identify
forward-looking statements. You should be aware that actual results may differ
materially from our expressed expectations because of risks and uncertainties
inherent in future events, and you should not unduly rely on these forward
looking statements.
Overview
- --------
We are a provider of mortgage services to consumers and to other
businesses and a leading provider of such services on the internet. We have
developed state-of-the-art technology to support the origination, processing,
underwriting, closing and secondary marketing of mortgage loans. We use this
technology as a platform to provide mortgage financing directly to borrowers and
to enable our clients, such as mortgage brokers, mortgage banks, Realtors and
homebuilders, to improve the efficiency and effectiveness of their operations.
We began operations in April 1994 in Florida as First Mortgage Network,
a wholesale mortgage lender providing independent mortgage brokers with various
support services, including processing, closing and funding services for their
loans. In April 1995, we acquired a software system from Morbank Financial
Systems that was designed to automate mortgage origination, processing,
underwriting and closing functions in traditional mortgage lending operations.
We enhanced this software and named it CLOser, our proprietary technology
platform that supports all of the services we provide. By the end of 1995, we
were using the CLOser software system to enable financial institutions and
non-traditional mortgage originators, such as Realtors and homebuilders, to
originate mortgages as an ancillary service. These "network members" paid
monthly membership fees for the use of the CLOser software system and
transaction fees for our other services.
In the summer of 1996, we expanded our membership network by acquiring
Western American Mortgage, the mortgage affiliate of Mason-McDuffie Real Estate,
a major real estate brokerage company in northern California. Western America
Mortgage originated $37 million in mortgage loans in the first full quarter
after our acquisition. In June 1997, we acquired OnLine Capital, a mortgage
lender also located in northern California, with more than 25 loan counselors at
the point-of-sale of homes, three Realtor business-to-business relationships and
requisite back office personnel. OnLine Capital originated $100 million in
mortgage loans in the quarter before our acquisition. We deployed these acquired
resources to support and expand our member business in California.
In the spring of 1998, we acquired American Finance and Investment
(AFI), a former subsidiary of Virginia First Savings Bank, and moved its
operations to Florida. AFI was one of the first companies to originate mortgages
through the internet. We integrated this acquired internet technology with our
CLOser software system, enabling us to establish various relationships with
other internet-based businesses and to originate mortgage applications online on
a national basis. In January 1999, we acquired the internet web address
12
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www.mortgage.com and changed our corporate name to Mortgage.com, Inc. We believe
this name change more accurately reflects our business of re-engineering the
mortgage process through technology such as the internet.
On October 7, 1999, we terminated our agreement with Intuit Lender
Services, Inc. ("ILSI") for the provision of conforming loan mortgage services
to the Quicken mortgage.com web site. Upon notice of termination, we were
immediately relieved of certain exclusivity restrictions, and minimum loan
obligations specified in the agreement will be reduced by 1/12 per month over a
12-month period. We processed 631 loans from the agreement in the quarter ended
September 30, 1999, and we anticipate the reduced loan volume from this
termination will be replaced by new co-branded internet channels on better
economic terms for the Company. In addition, on November 9, 1999, ILSI
terminated a second agreement concerning the provision for sub-prime mortgage
services. Upon notice of termination, we were immediately relieved of certain
exclusivity restrictions and minimum loan obligations specified in the agreement
will be reduced by 1/9 each month over a period of nine months. We processed 26
loans from this agreement in the quarter ended September 30, 1999 and,
accordingly, do not anticipate that the termination of this agreement will have
a material adverse effect on the Company's sub-prime loan business.
In October 1999, we acquired Capital Savings Co., Inc., PlanMax, Inc.
and the assets of ACM/USA, Inc. and CSC Marketing Services, LLC from CSC
Holdings, LLC for 162,500 shares in common stock. These companies increase our
geographic diversity into several states where we had no physical presence and
also extend our services to home builders, real estate agents and financial
planners in those states as well.
We currently provide origination, processing, underwriting, closing,
funding and post-closing services for mortgages originated directly with
borrowers through our direct-to-consumer channels. We originate mortgages
directly with borrowers through www.mortgage.com and several other web sites and
through loan counselors stationed at the point-of-sale of homes. We also provide
one or more of these services, or the technology to support these services, to
other mortgage industry participants through our business-to-business channels.
We enable these business clients to efficiently conduct the mortgage
process by providing them with:
o private label mortgage services, where we provide mortgage services
that our clients can market under their own brand names;
o co-branded mortgage services, where we provide mortgage services that
we and our clients jointly market under both of our brand names;
o back office services, where we provide the behind-the-scenes
administrative and operational portions of the mortgage process for
our clients; and
o licenses of our proprietary technology, including CLOser and its
internet interface.
We have also developed www.openclose.com, a web site where
participating mortgage lenders, brokers and loan correspondents pay us for the
opportunity to exchange lender product and pricing information, automated
13
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underwriting data, mortgage insurance certificates and borrower application
information in an online environment. The www.openclose.com web site became
available for commercial use in August 1999, and 700 brokers and 20 lenders have
agreed to participate in the program as of October 31, 1999.
Loans that we originate directly from borrowers or through one of our
business clients generate loan origination fees. Loans that we fund, including
loans originated by our business partners and clients, generate gains or losses
when we sell the loans to independent mortgage investors in the secondary
market. When we sell a loan in the secondary market we achieve a net gain or
suffer a net loss equal to the difference between the amount we funded or paid
for the loan and the price at which the loan is sold to the secondary market
investor. Typically, we obtain commitments from investors to buy loans on a
loan-by-loan basis at the same time we lock an interest rate for the borrower.
We have sold, and intend to continue to sell, all loans, together with the
associated servicing rights, in the secondary market. Origination fees, or
"points", and secondary marketing gains or losses are included in "Secondary
marketing revenue, net" in our financial statements.
Other services, including loan underwriting and processing, and
obtaining appraisals and credit reports, generate fees payable by the borrower
at closing. These fees are offset against amounts paid to third parties for the
provision of some of these services and, along with underwriting and closing
fees, are reflected in "Loan production and processing fees, net" in our
financial statements.
Fees for the use of our technology and related support services,
including technology licensing and maintenance fees and fees earned from
creating and maintaining private label web sites, are reflected in "Management,
technical and other fees" in our financial statements.
The cost of funds under our financing arrangements is based on
short-term interest rates, while in today's market the interest rates we charge
borrowers on mortgage loans are based generally on intermediate-term interest
rates. We generate net interest income on mortgage loans if the
intermediate-term interest rate paid by the borrower on the mortgage loan
exceeds the short-term interest rate we are charged under our financing
arrangements. Conversely, we suffer net interest losses if the short-term
interest rate under our financing arrangements exceeds the intermediate-term
interest rate paid by the borrower on the mortgage loan. We try to minimize the
length of time between closing of the loan and delivery of the loan to secondary
market investors, which is especially important when intermediate-term rates
have declined to the levels of short-term rates. The difference between the
interest we earn on the loans we fund and the interest we pay under our
financing arrangements, along with other net interest income or expense, is
recorded as "Net interest (expense) income from lending operations" in our
financial statements.
We have experienced substantial losses since inception and, as of
September 30, 1999, have an accumulated deficit of $53.1 million. These net
losses and the accumulated deficit are a result of investments in our technology
infrastructure and personnel in anticipation of growth in loan volumes from both
our direct-to-consumer and business-to-business channels. We do not expect to be
profitable until at least the latter half of 2002. Our plan to achieve
profitability includes:
14
<PAGE>
o a reduction in our costs per loan through economies of scale we
achieve from higher loan volumes;
o increased automation of the loan process; and
o improved terms of sale on loans we sell in the secondary market.
We will be able to realize improved terms on sales in the secondary
market because our negotiating leverage increases as our loan volumes increase.
We also are working to improve our risk management and are considering hedging
strategies to help manage the risk.
We plan to extend our brand position and use our technology
infrastructure as we scale up loan production volumes. Accordingly, if we are
successful in raising additional funds in the capital markets, we intend to
invest available funds heavily in branding programs, marketing and promotional
campaigns, new partnerships and strategic alliances, our operating
infrastructure and launching www.openclose.com. Our operations have historically
been centered in Florida and California. This is partially due to the state of
our incorporation and the states where we have acquired businesses, and
partially because Florida and California represent two of the largest real
estate markets in the United States. We intend to use the internet to expand our
geographic scope to every potential mortgage borrower in the United States.
We will incur a non-cash expense over the next five years for the
amortization of unearned stock-based compensation resulting from granting stock
options to employees from October 1998 through April 1999. These deferred
compensation costs represent the difference between the exercise price of the
options and the estimated fair market value of the underlying common stock at
the time of grant of the options. Unearned stock-based compensation is amortized
in accordance with the vesting of the underlying options to which it pertains.
Our limited operating history makes it difficult to forecast future
operating results. Although our revenue has grown significantly in recent
quarters, we cannot assure you that we will be able to sustain revenue growth or
achieve and maintain profitability. Even if we were to achieve profitability, we
expect material fluctuations in quarterly revenue and earnings to result from a
number of factors, including:
o changes in interest rates;
o loss of strategic relationships;
o changes in competitive pressures on pricing or quality of service;
o seasonal variations in demand for mortgages;
o general economic conditions;
o system failures or internet down time;
o changes in state or federal government regulations and their
interpretations, especially with respect to the mortgage and internet
industries;
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o our ability to enhance our information technology to keep pace with
changes in the industry; and
o changes in attitudes of consumers doing business over the internet.
As a result, we do not believe that our historical results are
necessarily indicative of results to be expected in any future period.
Results of Operations
- ---------------------
The following table sets forth the percentage of total revenue of
selected line items included in our statement of operations for the periods
indicated:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
(Unaudited) September 30, September 30,
------------------------------ ------------------------------
1998 1999 1998 1999
-------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
Revenue:
Secondary marketing revenue, net .................. 79.7 % 70.1 % 78.4% 67.9 %
Loan production and processing fees, net .......... 13.9 19.9 14.1 20.4
Management, technology and other fees ............. 5.6 5.4 6.9 9.1
Net interest income from lending operations ....... 0.8 4.6 0.6 2.6
-------------- ------------- ------------- --------------
Total revenue ........................................ 100.0 100.0 100.0 100.0
-------------- ------------- ------------- --------------
Expenses:
Compensation and employee benefits ................ 69.5 149.5 69.7 101.9
Marketing ......................................... 4.7 70.1 3.2 33.0
Research and development .......................... 7.5 3.2 6.9 4.4
Depreciation and amortization ..................... 3.5 13.6 3.0 8.8
General and administrative ........................ 28.4 41.8 26.3 33.3
Other interest expense ............................ (0.3) 5.4 0.5 4.4
-------------- ------------- ------------- --------------
Total expenses ....................................... 113.3 283.6 109.6 185.8
-------------- ------------- ------------- --------------
Loss before extraordinary item........................ (13.3) (183.6) (9.6) (85.8)
Loss on early extinguishment of debt -- (3.5) -- (1.1)
-------------- ------------- ------------- --------------
Net loss (13.3)% (187.1)% (9.6% (86.9)%
============== ============= ============= ==============
</TABLE>
Comparison of Three and Nine Months Ended September 30, 1998 and 1999
---------------------------------------------------------------------
Revenue
- -------
Total revenue increased 28% to $12.3 million for the three months ended
September 30, 1999 from $9.6 million in the comparable period in 1998 and
increased 60% to $40.0 million for the nine months ended September 30, 1999 from
$25.1 million in the comparable period in 1998. This growth resulted primarily
from our acquisition of AFI in April 1998, the related loan volume generated by
our web sites and from new strategic alliances with online partners and
Realtors.
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Secondary marketing revenue, net. Gains and other revenue from the
origination and secondary marketing of mortgage loans increased 13% and 38% to
$8.6 million and $27.2 million for the three month and nine month periods,
respectively, ended September 30, 1999 from $7.6 million and $19.7 million in
the comparable periods in 1998. These increases resulted primarily from the
increases in the total dollar amount of loans we originated, funded and sold.
The total dollar amount of closed loans that we originated increased to $687.3
million and $2.28 billion for the three month and nine month periods,
respectively, ended September 30, 1999 from $512.2 million and $1.34 billion in
the comparable periods in 1998. Of these originations, we funded and sold in the
secondary market $544.1 million and $1.84 billion in loans for the three month
and nine month periods, respectively, as compared to $402.0 million and $950.7
million in the comparable periods last year. Loans that we originated but chose
not to fund were funded by other mortgage lenders. The increase in loan volumes
and related revenue resulted primarily from our introduction of additional
internet origination channels and an increase in Realtor affiliations.
Loan production and processing fees, net. Total loan production and
processing fees, less amounts paid to third parties for processing services,
increased 84% and 131% to $2.4 million and $8.1 million for the three and nine
month periods, respectively, ended September 30, 1999 from $1.3 million and $3.5
million in the comparable periods in 1998. These increases in production and
processing fees resulted from an overall increase in loan volume and from new
strategic alliances that produced fees for processing loans for third parties
and other mortgage lenders. Approximately 20% of these fees came from Intuit
Lender Services during the nine months ended September 30, 1999. Fees from this
source will decline with the phase-out of the Intuit contract.
Management, technology and other fees. Total revenue from management,
technology and other fees increased 23% and 109% to $663,000 and $3.6 million
for the three month and nine month periods, respectively, ended September 30,
1999 from $539,000 and $1.7 million in the comparable periods in 1998. The 1999
nine month amount includes recognition of $1.0 million in previously deferred
revenue from the sale of software that we no longer use in our business. The
remaining increase was primarily attributable to fees earned from business
affiliations for management services and technology.
Net interest income from lending operations. The net interest income
from lending operations increased to $569,000 and $1.1 million for the three
month and nine month periods, respectively, ended September 30, 1999 from
$78,000 and $154,000 in the comparable periods in 1998. These increases were
primarily related to higher net cash positions resulting from equity investments
we received from the initial public offering of stock in August, in the last
three quarters of 1998, and from an improvement in the difference between the
interest revenue we received from borrowers and our cost of funds.
Expenses
- --------
Compensation and employee benefits. Compensation and employee benefits
consist primarily of management and employee salaries, bonuses and commissions
and related costs as well as the cost of personnel from temporary agencies.
Total compensation and benefit costs increased 176% and 133%
17
<PAGE>
to $18.4 million and $40.7 million for the three month and nine month periods,
respectively, ended September 30, 1999 from $6.7 million and $17.5 million in
the comparable periods in 1998. Compensation and benefits represents 101.9% of
revenues in the nine months ended September 30, 1999 and 69.7% of revenues in
the comparable period in 1998. The dollar increase in total compensation and
benefit costs resulted primarily from an increase in personnel from 405 at
September 30, 1998 to 778 at September 30, 1999 to support our new internet
origination volumes and related technical and administrative support services.
The increase was also a result of increased commissions paid to loan originators
commensurate with increased loan volumes. We expect total compensation and
employee benefits to increase in absolute dollars as we continue to expand our
business by hiring additional personnel. Total compensation and benefit costs
increased as a percentage of revenue due to training periods involved in
expanding our call center capacity to meet increasing internet loan demand.
Included in "Compensation and employee benefits" is the amortization of
unearned compensation which resulted when stock options we granted during 1998
and the first and second quarters of 1999 were subsequently deemed to have
exercise prices less than the estimated fair market value of our common stock at
the time of grant. As of September 30, 1999, we have recorded approximately
$16.6 million in deferred compensation, and we amortized approximately $6.1
million and $7.2 million of that amount to expense in the three month and nine
month periods, respectively, ended September 30, 1999. During the three months
ended September 30, 1999, the vesting of certain options was accelerated and
approximately $5.4 million of deferred compensation relating to these options
was recognized in expense. The remaining balance will be amortized on a straight
line basis over the remaining vesting periods of the underlying options.
Stock-based compensation is a non-cash expense.
Marketing. Marketing expenses consist primarily of the cost of a
national advertising campaign to brand the Mortgage.com name with the public and
leads generated through internet marketing and distribution agreements or
co-branding arrangements, as well as the cost of direct advertising and
trade-show participation. Marketing expenses also include fees paid to other web
sites and business partners for lead generation. Marketing expenses increased to
$8.6 million and $13.2 million for the three month and nine month periods,
respectively, ended September 30, 1999, or 70.1% and 33.0% of revenue, from
$454,000 and $797,000 in the respective comparable periods in 1998, or 4.7 % and
3.2% of revenue. These increases were directly related to the branding campaign
and new online distribution agreements and online advertising designed to
increase the exposure of our web site. We believe that marketing expenses will
increase, both in absolute dollars and as a percentage of revenue, as we expand
our strategic partnerships with other web sites to drive more traffic to our web
site and to increase brand awareness. During the three months and nine months
ended September 30, 1999, the branding campaign incurred $6.8 million and $7.3
million, respectively, of approximately $9 million in committed expenses during
1999.
Research and development. Research and development costs consist
primarily of compensation and benefit costs of development personnel, materials,
computer equipment and supplies consumed in software development and related
facility costs. Research and development expenses were $389,000 and $1.8 million
18
<PAGE>
for the three months and nine months ended September 30, 1999, or 3.2% and 4.4%
of revenue, from $722,000 and $1.7 million in the comparable periods in 1998, or
7.5% and 6.9% of revenue. These expenses were primarily due to the addition of
product development personnel to integrate CLOser with newly-acquired internet
technology and third-party software and web platforms. We believe additional
investment in research and development is essential to our success and we expect
these expenses will increase in future periods.
Depreciation and amortization. Depreciation and amortization consists
of depreciation of capital equipment, amortization of goodwill related to
acquisitions, amortization of the Mortgage.com domain name intangible asset and
amortization of capitalized software development costs. Depreciation and
amortization expenses increased to $1.7 million for the three months ended
September 30, 1999, or 13.6% of revenue, from $337,000 in the comparable period
in 1998, or 3.5% of revenue. For the nine months ended September 30, 1999,
depreciation and amortization increased to $3.5 million, or 8.8% of revenues,
from $759,000, or 3.0% of revenues, in the comparable period in 1998. These
increases were a result of increased expenditures for an expansion of our
internet infrastructure, acquisition of capital equipment to support call center
operations, additions to goodwill from the AFI acquisition and payments relating
to the Online Capital and Mortgage.com name acquisitions. During the nine months
ended September 30, 1999, $323,000 was amortized on the intangible asset. These
expenses have increased in absolute dollars as a result of our exercise of an
option to repurchase our CLOser software system from a third party in May 1999
for $3.5 million, an acceleration of $1.5 million in the cost of the domain name
and planned expenditures to maintain state-of-the-art technology in support of
our internet operations.
General and administrative. General and administrative costs include
telephone and communication costs, rent and other occupancy costs, equipment
leases, loan transfer fees and consulting and professional expenses. General and
administrative expenses increased 89% to $5.1 million for the three months ended
September 30, 1999, or 41.8% of revenue, from $2.7 million in the comparable
period in 1998, or 28.4% of revenue. For the nine months ended September 30,
1999, general and administrative expenses increased 102% to $13.3 million, or
33.3% of revenue, from $6.6 million, or 26.3% of revenue, in the comparable
period of 1998. The increase in general and administrative expenses resulted
from additional rent, communication costs and other expenses related to call
center operations and the addition of administrative personnel in anticipation
of becoming a public company. We expect general and administrative expenses to
increase in absolute dollars as we continue to grow but decrease as a percentage
of revenue as mortgage loan volume increases.
Other interest expense. Other interest expense, which includes interest
on subordinated debt and on capital lease obligations, increased to $658,000 and
$1.8 million in the three month and nine month periods, respectively, ended
September 30, 1999, compared to a negative $30,000, from a correction of a prior
expense, and $124,000 in the comparable periods in 1998. These increases were a
result of the $40.5 million in subordinated debt issued in the February through
May 1999 period and paid off in August 1999.
19
<PAGE>
Liquidity And Capital Resources
- -------------------------------
On August 11, 1999, we completed an initial public offering in which we
sold 7,062,500 shares of common stock. Subsequently, the underwriters of the
public offering exercised an option to purchase an additional 379,375 shares of
common stock to cover over-allotments of shares. The gross proceeds from these
transactions were $59.5 million, or $55.4 million net of underwriter discounts.
A portion of the proceeds was used to repay $40.5 million of subordinated debt
and $433,000 was used to redeem certain warrants.
Since inception, we have funded operations primarily through net cash
proceeds from private issuances of preferred stock of approximately $26.5
million through December 31, 1998. In February and April 1999, we received gross
proceeds from the issuance of subordinated notes totaling $13.0 million. In May
1999, we received an additional $27.5 million from the issuance of a convertible
subordinated note. The subordinated notes and the convertible subordinated notes
were repaid upon completion of the initial public offering. We also received
$15.0 million from the sale of shares of Series F preferred stock in May. All
preferred stock converted into common stock at the date of the public offering
in August.
As of September 30, 1999, we had cash and cash equivalents of $1.8
million and an additional $17 million in cash available through our warehouse
lines of credit which may be used for general corporate purposes. Excess cash
has been temporarily deposited against the warehouse balances to enhance our
return on cash. Subject to market conditions, we intend to raise additional cash
to fund our continuing expansion either through a private placement of stock or
through a secondary offering by the second quarter of 2000.
Our primary need for operating capital is for the funding of mortgage
loans between closing and eventual delivery to secondary market investors. We
fund these loans through warehouse lines of credit and collateralized loan
purchase agreements with banks and other financial institutions. We have a $75.0
million warehouse line of credit with Residential Funding Corporation, a $60.0
million warehouse line of credit with Bank United and a $25.0 million warehouse
line of credit with Cooper River Funding. We also have loan purchase agreements
with Superior Bank FSB and Greenwich Capital. Our aggregate borrowing limits are
currently set at approximately $220.0 million. These financing arrangements
generally provide from 97% to 99% of the principal amounts needed to fund
mortgage loans and are collateralized by the underlying mortgages. The average
time between funding closed mortgages and receipt of loan sale proceeds from
investors was approximately 22 days during the nine months ended September 30,
1999.
We have agreed to terms with our lenders to replace our existing
warehouse lines with a single syndicated line of credit for $90 million and to
increase our loan purchase agreement with Greenwich Capital to $100 million.
Both facilities will be provided on a committed basis. The net effect of this
arrangement should be to provide us with lower financing costs between closing
and ultimate delivery to investors in the secondary market. Although we expect
this financing arrangement to become available in November 1999, we cannot
assure you that it will be available at that time, if at all.
20
<PAGE>
Net cash provided by operating activities for the nine months ended
September 30, 1999 totaled $39.7 million. This cash was generated primarily from
a reduction in mortgage loans available for sale, offset by operating losses.
Net cash used in investing activities for the nine months ended
September 30, 1999 totaled $12.7 million, $8.6 million of which was used for the
purchase of computers, workstations, servers and other equipment to support our
growth in technology support services and call center operations and costs
related to software development. Included in these purchases was the $3.5
million repurchase of our CLOser software system from an unrelated party. The
purchase of the mortgage.com domain name incurred $2.4 million.
Net cash used by financing activities for the nine months ended
September 30, 1999 totaled $28.6 million, as $69.0 million in proceeds from the
issuance of common and preferred stock was used to reduce warehouse and other
notes payable, to redeem warrants and for general corporate purposes.
As of December 31, 1998, we had net operating loss carryforwards of
approximately $15.8 million available to reduce future taxable income, which
carryforwards expire on various dates from 2010 to 2014.
Since inception, we have significantly increased our operating costs
and we anticipate that we will continue to experience significant increases in
our operating costs for the foreseeable future. In addition, we may use cash
resources, including a portion of the remaining net proceeds of our initial
public offering, to fund acquisitions or investments in joint ventures,
businesses, technologies and products or services complementary to our business.
Increased loan volume also requires additional cash to fund the loans. We intend
to raise capital to fund these requirements either through a private placement
of stock or through a secondary offering by the second quarter of 2000. We
believe that the net proceeds of our initial public offering coupled with the
expected increase of our warehouse credit lines and mortgage repurchase
facilities will be sufficient to meet anticipated cash requirements between now
and that date. However, we cannot be sure that we will be able to raise
sufficient funds in the capital markets to adequately support the execution of
its branding program and its plans to expand by acquisitions and investments in
joint ventures and alliances. Moreover, the issuance of additional equity or
convertible debt securities could result in dilution to our existing
stockholders.
Year 2000 Readiness Disclosure Statement
- ----------------------------------------
Many currently installed computer systems and software products are
designed to accept only two digit entries in the date code field. As a result,
they may have problems properly recognizing 1/1/00 as January 1, 2000. In less
than a year, computer systems and software may need to be upgraded to comply
with "Year 2000" requirements. Significant uncertainty exists concerning the
potential effects associated with the Year 2000 issue on business operations.
In early 1998, we began reviewing the Year 2000 compliance status of
our technology platforms licensed to others, the software and systems used in
our internal business processes and other systems and services on which we rely.
21
<PAGE>
We have completed this program and have implemented strategies and developed
contingency plans for potential third party Year 2000 compliance problems that
we deem critical to our business continuity. We cannot assure you that the
program has anticipated or identified all potential Year 2000 effects on our
business or that our contingency plans will be effective.
We have fully integrated Year 2000 testing into the development of our
own software. We believe that the entire technology platform on which we operate
and which we provide to clients is Year 2000 compliant. Accordingly, the use or
occurrence of dates on or after January 1, 2000 and the occurrence of leap years
will not affect the performance of our systems with respect to their ability to
correctly create, store, process and output information related to such data.
We have contacted all of our major customers and suppliers of critical
components, equipment and services to determine whether products and services we
obtain from them are Year 2000 compliant. We have been satisfied with their
responses and believe that all critical suppliers and customers comply with Year
2000 requirements. In addition, we have tested critical systems provided by
these suppliers and the systems used by our major clients to provide us with
additional assurance about their Year 2000 readiness. These tests have not
revealed any significant Year 2000 problems.
The Company's contingency plan is substantially completed. However, we
believe that our critical suppliers and major customers are Year 2000 compliant.
Our contingency plans will focus on disruption of third party services which are
key to our operations, particularly telecommunications and electric utility
services. We have inquired of the providers of these services about their Year
2000 readiness and have been satisfied with their responses. Nevertheless, if a
critical supplier or major customer turns out not to be Year 2000 compliant, we
could incur substantial costs and experience a disruption of our business, which
potentially would have a negative effect on our results of operations.
We sometimes warrant to customers that the use or occurrence of dates
on or after January 1, 2000 will not adversely affect the performance of our
systems with respect to the ability to create, store, process and output
information related to such data. If any of these customers experience Year 2000
problems in connection with use of our systems, they could assert claims for
damages against us.
We have budgeted $600,000 for investigating and remedying issues
related to Year 2000 compliance, including the cost of developing contingency
plans. To date, we have spent substantially all of the budget. To the extent we
have not adequately assessed our Year 2000 compliance deficiencies, additional
and possibly significant resources may be spent on investigating and remedying
Year 2000 issues. The expenditure of such resources may have a material adverse
effect on our business, financial condition and results of operations.
22
<PAGE>
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest rate movements significantly impact our volume of closed
loans. Interest rate movements represent the primary component of market risk to
us. In a higher interest rate environment, borrower demand for mortgage loans,
particularly refinancing of existing mortgages, declines. Interest rate
movements affect the interest income earned on loans we hold for sale in the
secondary market, interest expense on our warehouse lines, the value of mortgage
loans we hold for sale in the secondary market and ultimately the gain on the
sale of those mortgage loans. In addition, in an increasing interest rate
environment, the volume of mortgage loans that our clients originate declines.
We originate mortgage loans and manage the market risk related to these
loans by pre-selling them on a best efforts basis to the anticipated secondary
market investors at the same time that we establish the borrowers' interest
rates. If we can deliver mortgage loans within the time frames established by
the secondary market investors, we have no interest rate risk exposure on those
loans. However, if the loan closes but we cannot deliver the loan within those
time frames, and if interest rates increase, we may experience a reduced gain or
may even incur a loss on the sale of the loan.
Management is currently evaluating hedging strategies to protect us
against the risk we incur with sales of mortgage loans in the secondary market
when interest rates rise and fall. We have retained Tuttle & Co., an
unaffiliated advisory firm, to help us manage our interest rate risks. We are
considering engaging Tuttle to also assist us with a hedging strategy. Hedging
strategies involve buying and selling mortgage-backed securities so that if
interest rates increase or decrease sharply and we expect to suffer a loss on
the sale of those loans, our buying and selling of mortgage-backed securities
will offset the loss. We would analyze the probability that a group of loans we
have originated will not close, and try to match our purchases and sales of
mortgage-backed securities to the amount we expect will close.
An effective hedging strategy is complex and no hedging strategy can
completely eliminate our risk. Part of this is because the prices of
mortgage-backed securities do not necessarily move in tandem with the prices of
loans we originate and close. To the extent the two prices do not move in
tandem, our hedging strategy may not work, and we may experience losses on our
sales of mortgage loans in the secondary market. The other key factor is whether
our probability analysis properly estimates the number of loans that will
actually close. To the extent that we implement a hedging strategy but are
unable to effectively match our purchases and sales of mortgage-backed
securities with the sale of the closed loans we have originated, our gains on
sales of mortgage loans will be reduced, or we will experience a net loss on
those sales.
We currently sell more than 90% of the loans we sell through best
efforts commitments, which means we do not suffer a penalty if the loans do not
close. We sell some loans, including sub-prime loans, on a mandatory delivery
basis. Selling on a mandatory delivery basis means we are required to sell the
loans to a secondary market investor at a price we agree upon, regardless of
whether the loans close. This potentially generates greater revenue for us
because secondary market investors are willing to pay more for a mandatory
delivery commitment from us. However, it also exposes us to greater losses if
the loans do not close.
23
<PAGE>
Management is considering selling a greater number of loans on a
mandatory delivery basis so that we can generate greater gains on the sales of
loans. Our hedging strategy of buying and selling mortgage-backed securities
would help us manage the additional risk we would incur when more loans are sold
on a mandatory delivery basis. However, because hedging strategies are not
perfect, our hedging strategy may not completely offset the additional risk, and
we may suffer losses on loans sold on a mandatory delivery basis.
We also do not currently maintain a trading portfolio. As a result, we
are not exposed to market risk as it relates to trading activities. Our entire
loan portfolio is held for sale. Accordingly, we must perform market valuations
of our pipeline, our mortgage portfolio held for sale and the related sale
commitments in order to properly record the portfolio and the pipeline at the
lower of cost or market. Therefore, we measure the interest rates of our loan
portfolio against prevailing interest rates in the market.
Because we pre-sell our mortgage loan commitments, we believe that a 1%
increase or decrease in long-term interest rates would not have a significant
adverse effect on our earnings from interest rate sensitive assets. We pay off
warehouse lines when the loans are sold in the secondary market. Because the
loans are held in the warehouse lines for a short period of time, we do not
expect to incur significant losses from an increase in interest rates on the
warehouse lines. However, since a significant percentage of our closed loan
volume is from refinancing mortgage loans, our future operating results may be
more sensitive to interest rate movements.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Not applicable.
Item 2. Changes in Securities and Use of Proceeds
See Note 6(a) to the Consolidated Financial Statements in
Part I, Item. 1 hereof.
Item 3. Defaults Upon Senior Securities
Not applicable.
24
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Item 4. Submission of Matters to a Vote of Securities Holders
Not applicable
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27 Financial Data Schedule
(b) Reports on Form 8-K
None
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
MORTGAGE.COM, INC.
Registrant
Dated: November 12, 1999
/s/ Edwin D. Johnson
---------------------
Edwin D. Johnson, its duly authorized officer,
Senior Vice President & Chief Financial Officer
25
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