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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000 or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________to _________
Commission file number 000-25621
E-LOAN, INC. (Exact name of registrant as specified in its charter)
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5875 Arnold Road, Suite 100
Dublin, California 94568
(Address of principal executive offices including zip code)
(925) 241-2400
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]
As of November 1, 2000, 53,259,878 shares of the Registrant's Common Stock, $0.001 par value per share, were issued and outstanding.
E-LOAN, INC.
QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD ENDED September 30, 2000
TABLE OF CONTENTS
| PART I. FINANCIAL INFORMATION | Page No. |
| Item 1. Interim Financial Statements (unaudited): |
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| Balance Sheets at December 31, 1999 and September 30, 2000 |
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| Statements of Operations for the three and nine months ended September 30, 1999 and September 30,2000 |
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| Statements of Cash Flows for the nine months ended September 30, 1999 and September 30, 2000 |
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| Notes to Unaudited Financial Statements |
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| Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations |
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| Item 3. Quantitative and Qualitative Disclosures About Market Risk |
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| PART II. OTHER INFORMATION |
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| Item 1. Legal Proceedings |
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| Item 2. Changes in Securities and Use of Proceeds |
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| Item 3. Defaults Upon Senior Securities |
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| Item 4. Submission of Matters to a Vote of Security Holders |
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| Item 5. Other Information |
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| Item 6. Exhibits and Reports on Form 8-K |
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| Signature |
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| Index to Exhibits |
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PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
E-LOAN, INC.
BALANCE SHEETS
(In thousands)
December 31, September 30,
1999 2000
------------- -------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents ........................ $37,748 $37,344
Loans held-for-sale .............................. 35,140 14,955
Accounts receivable, prepaids
and other current assets.................... 6,462 10,087
------------- -------------
Total current assets .......................... 79,350 62,386
Fixed assets, net .................................. 4,053 7,784
Deposits and other assets .......................... 1,686 2,054
Goodwill and intangible assets ..................... 67,878 38,078
------------- -------------
Total assets .................................. $152,967 $110,302
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Warehouse lines payable .......................... $33,115 $12,498
Accounts payable, accrued expenses and other...... 12,901 11,296
Capital lease obligation ......................... 252 252
Notes payable .................................... 1,167 1,167
------------- -------------
Total current liabilities ..................... 47,435 25,213
Capital lease obligations .......................... 483 247
Notes payable ...................................... 2,042 1,167
------------- -------------
Total liabilities ............................. 49,960 26,627
------------- -------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, 70,000,000 and 150,000,000 $0.001
par value shares authorized, 41,679,243 and
53,207,921 shares issued and outstanding at
December 31, 1999 and September 30, 2000......... 42 53
Less: subscription receivable ...................... (4) (4)
Marketing services receivable....................... -- (8,956)
Unearned compensation .............................. (21,195) (10,115)
Additional paid in capital ......................... 209,738 259,290
Accumulated deficit ................................ (85,574) (156,593)
------------- -------------
Total stockholders' equity..................... 103,007 83,675
------------- -------------
Total liabilities and stockholders' equity..... $152,967 $110,302
============= =============
The accompanying notes are an integral part of these financial statements.
E-LOAN, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- --------------------
1999 2000 1999 2000
--------- --------- --------- ----------
Revenues .............................. $5,026 $8,966 $14,390 $24,563
Operating expenses:
Operations .......................... 6,470 8,442 15,744 22,448
Sales and marketing ................. 9,362 6,295 20,634 23,026
Technology .......................... 972 1,650 2,250 4,479
General and administrative .......... 1,598 1,548 5,067 5,290
Non-cash marketing
costs ........................... -- 2,985 -- 3,504
Amortization of unearned
compensation .................... 5,599 1,723 17,938 8,109
Amortization of goodwill and intangible
assets .................... 1,656 9,933 1,656 29,800
--------- --------- --------- ----------
Total operating expenses ........... 25,657 32,576 63,289 96,656
--------- --------- --------- ----------
Loss from operations ............... (20,631) (23,610) (48,899) (72,093)
Other income, net .............. 387 486 356 1,075
--------- --------- --------- ----------
Net loss ........................... ($20,244) ($23,124) ($48,543) ($71,018)
========= ========= ========= ==========
Accretion of preferred stock -- -- (1,042) --
--------- --------- --------- ----------
Net loss applicable to common
shareholders..................... ($20,244) ($23,124) ($49,585) ($71,018)
========= ========= ========= ==========
Net loss per share:
Basic and diluted .................. ($0.52) ($0.44) ($2.26) ($1.53)
========= ========= ========= ==========
Weighed-average shares -
Basic and diluted .................. 39,248 52,949 21,924 46,291
========= ========= ========= ==========
The accompanying notes are an integral part of these financial statements.
E-LOAN, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Nine Months Ended
September 30,
----------------------
1999 2000
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ........................................... ($48,543) ($71,018)
Adjustments to reconcile net loss to net cash
used in operating activities:
Amortization of unearned compensation ............ 17,938 8,109
Amortization of goodwill and intangible assets.... 1,656 29,800
Amortization of non-cash marketing costs.......... -- 3,504
Charitable contribution of common stock .......... 900 --
Depreciation ..................................... 826 1,744
Changes in operating assets and liabilities:
Net change in loans held-for-sale ............. 1,607 20,185
Accounts receivable, prepaids, deposits and
other assets................................. (9,979) (3,992)
Accounts payable, accrued expenses and other
payables.................................... 10,831 (1,606)
---------- ----------
Net cash used in operating activities .......... (24,764) (13,274)
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of furniture and equipment ................ (2,496) (5,475)
Net cash received in connection with acquisition
of CarFinance.com................................. 813 --
---------- ----------
Net cash used in investing activities ......... (1,683) (5,475)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of issuance costs related to common stock .. -- --
Proceeds from issuance of common stock, net ........ 62,737 489
Proceeds from private placement, net of offering
costs............................................ -- 39,172
Common Stock issued in connection with Employee
Stock Purchase Plan.............................. -- 412
Proceeds from warehouse lines payable .............. 825,334 649,352
Repayments of warehouse lines payable .............. (827,284) (669,969)
Proceeds from notes payable ........................ 7,859 --
Repayments of notes payable ........................ (5,000) (875)
Payments on obligations under capital lease ........ (160) (236)
Proceeds from issuance of preferred stock, net ..... 849 --
---------- ----------
Net cash provided by
financing activities ..................... 64,335 18,345
---------- ----------
Net (decrease) increase in cash ................... 37,888 (404)
Cash and cash equivalents at beginning of period ... 9,141 37,748
---------- ----------
Cash and cash equivalents at end of period ......... $47,029 $37,344
========== ==========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest ............................. $3,331 $3,590
========== ==========
The accompanying notes are an integral part of these financial statements.
E-LOAN, INC.
1. THE COMPANY
E-LOAN, Inc. (the "Company") or "E-LOAN") was incorporated on August 26, 1996 and began marketing its services in June 1997. Prior to that date, the Company conducted business through a predecessor company, Palo Alto Funding Group ("PAFG") which was established in 1992 as a mortgage broker. The Company is an online lender and is primarily engaged in the brokerage, origination, and sale of mortgage and auto loans. The Company is a provider of first and second mortgage loans, home equity loans, auto loans, small business loans and credit card referrals. The Company operates as a single operating segment.2. BASIS OF PRESENTATION
Interim Financial Information (unaudited)
The accompanying financial statements as of September 30, 2000 and 1999 are unaudited. The unaudited interim financial statements have been prepared on the same basis as the annual financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly the Company's financial position, results of operations and cash flows as of September 30, 2000 and 1999. These financial statements and notes thereto are unaudited and should be read in conjunction with the Company's audited financial statements included in the Company's 10-K for the year ended December 31, 1999. The results for the three months and nine months ended September 30, 2000 are not necessarily indicative of the expected results for the year ending December 31, 2000.
Use of Estimates in the Preparation of Financial Statements
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 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.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Software Development Costs
The Company expenses computer software costs as they are incurred in the preliminary project stage in accordance with SOP 98-1 "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use". Once the capitalization criteria of the SOP have been met, external direct costs of materials and services consumed in developing or obtaining internal-use computer software and payroll and payroll related costs for employees who are directly associated with and who devote time to the internal-use computer software are capitalized. Capitalized costs are amortized over one to three years on a straight-line basis. For the nine months ended September 30, 2000, the Company had capitalized approximately $2.1 million in software development costs.
Net Income (Loss) Per Share
The Company computes net loss per share in accordance with SFAS No. 128, Earnings per Share. Under the provisions of SFAS No. 128 basic net loss per share is computed by dividing the net loss available to common stockholders for the period by the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed by dividing the net loss available to common stockholders for the period by the weighted average number of common and common equivalent shares outstanding during the period, to the extent such common equivalent shares are dilutive. Common equivalent shares are composed of incremental common shares issuable upon the exercise of stock options and warrants and upon conversion of Series A, B, C and Series D convertible preferred stock.
Pro forma net loss per share has been computed by dividing net loss applicable to common shareholders by the pro forma weighted average number of shares outstanding. Pro forma weighted average shares assume the conversion of all preferred stock (which were ultimately converted to common stock in conjunction with the initial public offering, as if the conversion occurred at the beginning of the period or at date of issuance, if later.)
The following table sets forth the computation of basic and diluted net loss per share for the periods indicated ($000's except per share amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- ---------------------
1999 2000 1999 2000
----------- ----------- ---------- ----------
Numerator:
Net loss..................... ($20,244) ($23,124) ($48,543) ($71,018)
Accretion of Series C and D
manditorily redeemable
convertible preferred
stock to redemption value.. -- -- (1,042) --
Net loss applicable to common ----------- ----------- ---------- ----------
shareholders............... ($20,244) ($23,124) ($49,585) ($71,018)
=========== =========== ========== ==========
Denominator:
Weighted average common shares -
Basic and diluted........... 39,248 52,949 21,924 46,291
Net loss per share:
Basic and diluted............ ($0.52) ($0.44) ($2.26) ($1.53)
=========== =========== ========== ==========
4. WAREHOUSE LINES PAYABLE
As of September 30, 2000, the Company had a warehouse line of credit for borrowings of up to $30 million for interim financing of mortgage loans. The interest rate charged on borrowings against these funds is variable based on the commercial paper rate of the lender plus various percentage rates. Borrowings are collateralized by the mortgage loans held-for-sale. The committed line of credit expires on December 31, 2000. Upon expiration, management believes it will either renew its existing line or obtain sufficient additional lines. At September 30, 1999 and 2000, approximately $29.7 million and $8.5 million was outstanding under this line, respectively. This line of credit agreement generally requires the Company to comply with various financial and non-financial covenants. The Company was in compliance with these covenants at September 30, 2000.
The Company has an agreement to finance up to $200 million of mortgage loan inventory pending sale of these loans to the ultimate mortgage loan investors. Of this amount, $100 million is available in committed funds. This loan inventory financing is secured by the related mortgage loans. The interest rate charged on these funds is 75 basis points (.75%) over LIBOR. The line expires April 9, 2001. At September 30, 2000, there were no outstanding amounts. This line of credit agreement generally requires the Company to comply with various financial and non-financial covenants. At September 30, 2000, the Company was not in compliance with a covenant that requires the Company to have an additional line of credit of at least $50 million and has obtained a waiver from its lender. The Company believes its combined warehouse facilities are sufficient to fund its current operations and believes that additional capacity is available if required.
5. REVENUES AND OTHER INCOME, NET
The following table provides the components of revenues ($000s):
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- ---------------------
1999 2000 1999 2000
----------- ----------- ---------- ----------
Gain on sale of loans and
brokerage fee .............. $2,532 $4,209 $10,086 $11,538
Interest income on loans...... 1,616 1,562 3,426 3,366
Auto revenues................. 458 2,999 458 9,106
Credit card and other......... 420 196 420 553
----------- ----------- ---------- ----------
Total Revenues................ $5,026 $8,966 $14,390 $24,563
=========== =========== ========== ==========
The following table provides the components of other income, net ($000s):
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- ---------------------
1999 2000 1999 2000
----------- ----------- ---------- ----------
Interest on short-term
investments................... $550 $583 $635 $1,410
Interest expense on
non-warehouse facility
borrowings.................... (66) (73) (142) (245)
Equity investment income (loss) (38) (36) (53) (97)
Other......................... (59) 12 (84) 7
----------- ----------- ---------- ----------
$387 $486 $356 $1,075
=========== =========== ========== ==========
6. OPERATING EXPENSES
The following table provides detail of the Company's operating expenses classified by the following categories ($000s):
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- ---------------------
1999 2000 1999 2000
----------- ----------- ---------- ----------
Compensation and benefits...... $4,555 $4,883 $12,439 $16,237
Processing costs............... 916 1,406 1,555 3,921
Advertising and marketing...... 8,541 5,625 18,182 20,385
Professional services.......... 1,053 1,963 2,770 4,653
Occupancy costs................ 781 1,091 1,956 2,795
Computer and internet.......... 205 222 478 641
General and administrative..... 686 1,205 2,614 3,266
Interest expense on warehouse
borrowings................... 1,665 1,540 3,701 3,345
Non-cash marketing costs....... -- 2,985 -- 3,504
Amortization of unearned
compensation................. 5,599 1,723 17,938 8,109
Amortization of goodwill and
intangible assets............ 1,656 9,933 1,656 29,800
----------- ----------- ---------- ----------
Total Operating Expenses....... $25,657 $32,576 $63,289 $96,656
=========== =========== ========== ==========
7. COMMITMENTS AND CONTINGENCIES
FINANCIAL INSTRUMENT CONTINGENCIES
E-LOAN originates mortgage loans and manages the market risk related to these loans through various hedging programs.
Loan Commitments and Sell forward Commitments
Upon receiving a locked commitment from a borrower ("rate lock"), the Company simultaneously enters into either a mandatory sell forward agreement with a counterparty (Fannie Mae) or a non-mandatory forward sale agreement with the ultimate investor. At September 30, 2000, the Company was a party to commitments to fund loans at interest rates previously agreed (locked) by both the Company and the borrower for specified periods of time. Rate locks with the borrowers are on a best effort basis, borrowers are not obligated to enter into the loan agreement. A rate lock which does not result in a funded loan is referred to as fallout. As the Company is exposed to movements in interest rates after entering into a rate lock, the Company must estimate fallout if interest rate risk is to be hedged with a mandatory sell forward agreement. At September 30, 2000, the Company had provided locks to originate loans amounting to approximately $71.1 million (the "locked pipeline").
Hedging Activities
The Company originates mortgage loans and sells them primarily through whole loan sales. The market values of mortgage loans are sensitive to changes in market interest rates. If interest rates rise between the time the Company enters into a rate lock with the borrower the subsequent funding of the loan and the time the mortgage loans are committed for sale, there may be a decline in the market value of the mortgage loans. To protect against such possible declines, the Company has adopted a hedging strategy.
The Company retains the services of Tuttle & Co., an unaffiliated advisory firm specializing in mortgage loan pipeline management, to assist the Company in minimizing the interest rate risk associated with the time lag between when loans are rate-locked and when they are committed for sale or exchanged in the secondary market. Individual mortgage loan risks are aggregated by note rate, mortgage loan type and stage in the pipeline, and are then matched, based on duration, with the appropriate hedging instrument, thus mitigating basis risk until closing and delivery. The Company currently hedges its mortgage pipeline through mandatory forward sales of Fannie Mae mortgage- backed securities and non-mandatory forward sales agreements with the ultimate investor. The Company determines which alternative provides the best execution in the secondary market. As a managed account of Tuttle & Co., the Company is able to take advantage of Tuttle's reporting services, including pipeline, mark-to-market, commitment and position reporting.
The Company believes that it has implemented a cost-effective hedging program to provide a level of protection against changes in the market value of its fixed-rate mortgage loans held for sale. However, an effective strategy is complex and no hedging strategy can completely insulate the Company against such changes.
At September 30, 2000, the Company had entered into mandatory forward loan sale agreements with Fannie Mae amounting to approximately $26.0 million. Tuttle & Company adjusts the amount of forward sale agreements entered into by expected locked pipeline fallout.
At September 30, 2000, the Company had entered into non- mandatory forward loan sale agreements amounting to approximately $39.4 million. These forward loan sale agreements do not subject the Company to mandatory delivery and there is no penalty if the Company does not deliver into the commitment. The Company is exposed to the risk that these counterparties may be unable to meet the terms of these sale agreements. The investors are well- established U.S. financial institutions; the Company does not require collateral to support these commitments, and there has been no failure on the part of the counterparties to meet the terms of these agreements to date.
At September 30, 2000, the Company had uncommitted funded loans of $4.7 million.
Future Commitments
The Company has future payment commitments for leases and marketing services agreements aggregating $5.5 million, $7.0 million, $9.9 million, $14.6 million, and $1.5 million for the years 2000 through 2004, respectively. The Company has contractual commitments with cancellation clauses, which if exercised would significantly reduce these future obligations. The Company's option to cancel the most significant commitment expires on December 31, 2000. If the Company were to exercise the cancellation option, the majority of these future commitments would be removed.
8. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133, as amended, establishes accounting and reporting standards for derivative instruments and hedging activities. It requires an entity to recognize all derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair value. We are currently in the process of evaluating the initial adoption of SFAS 133 and its impact on the Company. Presently, we do not expect this standard to have a material effect on our operations or financial position. However, the adoption of SFAS 133 will require substantive financial statement disclosure. We are required to adopt SFAS 133 in the first quarter of fiscal year 2001.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the Financial Statements and the related Notes thereto included elsewhere in this Form 10-Q. This discussion contains, in addition to historical information, forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from the results discussed in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below, as well as those discussed below under "Factors Affecting Future Operating Results." The Company disclaims any obligation to update information contained in any forward- looking statement. See "Forward-Looking Statements."
OVERVIEW
E-LOAN is a leading online lender whose revenues are derived primarily from the commissions and fees earned from both brokered mortgage and auto loans and mortgage and auto loans that it underwrites, funds and sells on the secondary market.
Mortgage Revenues
E-LOAN's mortgage revenues are derived from the origination and sale of self-funded loans and, to a lesser extent, from the brokering of loans. Brokered loans are funded through lending partners and E-LOAN never takes title to the mortgage. Brokerage revenues are comprised of the mark-up to the lending partner's loan price, and processing and credit reporting fees. These revenues are recognized at the time a loan is closed. Self-funded loans are funded through E-LOAN's own warehouse lines of credit and sold to mortgage loan purchasers. Self-funded loan revenues consist of proceeds in excess of the carrying value of the loan, origination fees less certain direct origination costs, other processing fees and interest paid by borrowers on loans that E-LOAN holds for sale. These revenues are recognized at the time the loan is sold or, for interest income, as earned during the period from funding to sale. E-LOAN earns additional revenue from its self-funded loans as compared to brokered loans because the sale of loans includes a service release premium.
Auto Revenues
E-LOAN's auto revenues are derived from the origination and sale of self-funded loans and from the brokering of auto loans. Auto brokerage revenues are primarily comprised of the mark-up to the lending partner's loan price or a set origination fee. These revenues are recognized at the time a loan is closed. Self-funded loans are currently funded using E-LOAN's balance sheet and sold to auto loan purchasers. Self-funded loan revenues also consist of the mark-up to the lending partners loan price or a set origination fee. These revenues are recognized at the time a loan is sold.
General
In generating revenues, E-LOAN relies on a number of strategic Internet distribution partners to direct a significant number of prospective customers to its website. E-LOAN considers its distribution partnerships with Schwab, Yahoo!, Wingspanbank.com, AutoTrader.com, Kelley Blue Book and bankrate.com to be the most critical to its ability to generate revenues. Schwab and Yahoo! have made equity investments in E-LOAN.
RESULTS OF OPERATIONS
The following table sets forth certain items from the Company's statements of operations as a percentage of total revenues for the periods indicated:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- --------------------
1999 2000 1999 2000
--------- --------- --------- ----------
Revenues .............................. 100% 100% 100% 100%
Operating expenses:
Operations .......................... 129 94 109 91
Sales and marketing ................. 186 70 143 94
Technology .......................... 19 18 16 18
General and administrative .......... 32 17 35 22
Non-cash marketing
costs ........................... -- 33 -- 14
Amortization of unearned
compensation .................... 111 19 125 33
Amortization of goodwill and intangible
assets .................... 33 111 12 122
--------- --------- --------- ----------
Total operating expenses ........... 510 363 440 394
--------- --------- --------- ----------
Loss from operations ............... (410) (263) (340) (294)
Other income, net .............. 8 5 2 5
--------- --------- --------- ----------
Net loss ........................... -402% -258% -338% -289%
========= ========= ========= ==========
PRO FORMA NET LOSS (SUPPLEMENTAL)
Pro forma net loss for the third quarter of 2000 was $8.5 million, with a pro forma net loss per share of $0.16 on 52.9 million shares. This compares to a pro forma net loss of $13 million in the third quarter of 1999, with a pro forma net loss per share of $0.33 on 39.2 million shares. Pro forma results exclude the effects of non-cash charges related to a compensation charge associated with the Company's stock option plan, amortization of goodwill on the acquisition of CarFinance.com, a one-time charitable contribution, and amortization of non-cash marketing costs related to the issuance of warrants to purchase the Company's common stock
Revenues
Revenues increased to $9.0 million for the three months ended September 30, 2000 from $5.0 million for the three months ended September 30, 1999 and increased to $24.6 million in the nine months ended September 30, 2000 from $14.4 million in the nine months ended September 30, 1999. Revenues for the three months ended September 30, 2000 reflect the increased diversity of our revenue streams with mortgage loans and auto loans contributing $5.8 million and $3.0 million, respectively. As a result, E-LOAN continues to be less reliant on mortgage refinance loans, which are more sensitive to changes in interest rates. Refinance mortgages for the quarter ended September 30, 2000 accounted for 20% of total revenues compared to 35% of total revenues for the quarter ended September 30, 1999.
Operating Expenses
Total Operating Expenses. Total operating expenses increased $6.9 million to $32.6 million for the three months ended September 30, 2000 from $25.7 million for the three months ended September 30, 1999 and increased to $96.7 million in the nine months ended September 30, 2000 from $63.3 million in the nine months ended September 30, 1999. The increase was primarily due to the amortization of goodwill, amortization of non-cash marketing costs related to the issuance of warrants to purchase the Company's stock, processing costs due to increased volumes, employee compensation, and advertising costs.
Operations. Operations expense is comprised of both fixed and variable expenses, including employee compensation and expenses associated with the production and sale of loans and interest expense paid by E- LOAN under the warehouse facilities it uses to fund mortgage loans held for sale. Operations expense increased to $8.4 million for the three months ended September 30, 2000 from $6.5 million for the three months ended September 30, 1999 and increased to $22.4 million in the nine months ended September 30, 2000 from $15.7 million in the nine months ended September 30, 1999. Operations expense decreased as a percentage of revenue from 129% to 94% for the three months ended September 30, 1999 and 2000, respectively, and decreased as a percentage of revenue from 109% to 91% in the nine months ended September 30, 1999 and 2000, respectively. The increase in absolute dollars is primarily due to greater loan volume and interest expense related to a higher percentage of self-funded loans. E-LOAN expects operations expenses to trend lower as a percentage of revenues going forward as it further streamlines the loan process and leverages its fixed costs over growing loan volume.
Sales and Marketing. Sales and marketing expense is primarily comprised of expenses (excluding non-cash marketing costs) related to advertising, promotion and distribution partnerships and employee compensation and other expenses related to personnel. Sales and marketing expense decreased to $6.3 million for the three months ended September 30, 2000 from $9.4 million for the three months ended September 30, 1999 and increased to $23.0 million in the nine months ended September 30, 2000 from $20.6 million in the nine months ended September 30, 1999. Sales and marketing expense decreased as a percentage of revenue from 186% to 70% for the three months ended September 30, 1999 and 2000, respectively, and decreased as a percentage of revenue from 143% to 94% in the nine months ended September 30, 1999 and 2000, respectively. E-LOAN intends to decrease absolute dollar spending in sales and marketing activities while increasing its focus on improving the conversion of site visitors to applicants and closed loans.
Technology. Technology expense includes employee compensation, the introduction of new technologies and the support of E-LOAN's existing technological infrastructure. Technology expense increased to $1.7 million for the three months ended September 30, 2000 from $1.0 million for the three months ended September 30, 1999 and increased to $4.5 million in the nine months ended September 30, 2000 from $2.3 million in the nine months ended September 30, 1999. Technology expense decreased as a percentage of revenue from 19% to 18% for the three months ended September 30, 1999 and 2000, respectively, and increased as a percentage of revenue from 16% to 18% in the nine months ended September 30, 1999 and 2000, respectively. The increase in absolute dollars was primarily the result of the growth in engineering and management information systems personnel to support the expansion of online operations. E-LOAN intends to increase absolute dollar spending on technology in an effort to further improve the online loan origination process and implement new features and services to its website. For the nine months ended September 30, 2000, the Company had capitalized approximately $2.1 million in software development costs.
General and Administrative. General and administrative expense is primarily comprised of employee compensation and professional services. General and administrative expense decreased to $1.5 million for the three months ended September 30, 2000 from $1.6 million to the three months ended September 30, 1999, and slightly increased to $5.3 million in the nine months ended September 30, 2000 from $5.1 million in the nine months ended September 30, 1999. General and administrative expense decreased as a percentage of revenue from 32% to 17% for the three months ended September 30, 1999 and 2000, respectively, and decreased as a percentage of revenue from 35% to 22% in the nine months ended September 30, 1999 and 2000, respectively. General and administrative expenses are expected to stay relatively constant in the upcoming quarters.
Non-Cash Marketing Costs. On June 15, 2000, E-LOAN issued a total of 13.1 million warrants to purchase common stock in two tranches to Charles Schwab & Co., Inc. pursuant to the Marketing Services Agreement. The first tranche of 6.5 million warrants have a three-year term and are exercisable at $3.75 per share. The second tranche consists of 6.6 million warrants with a three and a quarter year term and are exercisable at $15.00 per share. E-LOAN recorded the $12.5 million value of the warrants as marketing services receivable as a contra-equity account. This amount is being amortized on a straight-line basis over a one-year period. For the nine months ended September 30, 2000, E-LOAN incurred a $3.5 million non-cash charge related to the amortization of the marketing services receivable.
Amortization of Unearned Compensation. As of December 31, 1999, E-LOAN had an unamortized unearned compensation balance of $21.2 million in connection with certain stock issuances and option grants, which were considered to be compensatory. E-LOAN amortized $1.7 million and $8.1 million for the three and nine months ended September 30, 2000, respectively, compared to $5.6 million and $17.9 million for the three and nine months ended September 30, 1999, respectively. The amortization of the unearned compensation charge will continue to decrease in absolute dollars as E-LOAN is amortizing the related expense on an accelerated basis as well as cancellation of options related to employee turnover.
Amortization of Goodwill. Amortization of goodwill was $9.9 million and $29.8 million for the three and nine months ended September 30, 2000, respectively, compared to $1.7 million for the three and nine months ended September 30, 1999. E-LOAN is amortizing the goodwill and acquired intangible assets related to the acquisition of Carfinance.com on September 17, 1999, on a straight-line basis over two years.
Other Income, net
Other income, net, increased from $0.4 million for the three months ended September 30, 1999 to $0.5 million for the three months ended September 30, 2000 and increased from $0.4 million for the nine months ended September 30, 1999 to $1.1 million for the nine months ended September 30, 2000. The increase is primarily attributable to the increase of interest income on investments.
Liquidity and Capital Resources
E-LOAN's sources of cash flow include cash from the gain on sale of self-funded mortgage and auto loans, borrowings under warehouse lines of credit and other credit facilities, brokerage fees, interest income, credit card referrals and the sale of equity securities in both private and public transactions. E-LOAN's uses of cash include the funding of mortgage and auto loans, repayment of amounts borrowed under warehouse lines of credit, operating expenses, payment of interest, and capital expenditures primarily comprised of furniture, fixtures, computer equipment, software and leasehold improvements.
Net cash used in operating activities was ($24.8) million and ($13.3) million for the nine months ended September 30, 1999 and 2000, respectively. Net cash used in operating activities during the nine months ended September 30, 2000, was primarily due to an increase in net losses, offset by a reduction in loans held for sale. Net cash used in operating activities during the nine months ended September 30, 1999, was primarily due to an increase in net losses.
Net cash used in investing activities was ($1.7) million and ($5.5) million for the nine months ended September 30, 1999 and 2000, respectively. Net cash used in investing activities during these periods was primarily for the purchase of software, furniture and equipment and leasehold improvements.
Net cash provided by financing activities was $64.3 million and $18.3 million for the nine months ended September 30, 1999 and 2000, respectively. Net cash provided by financing activities during the nine months ended September 30, 2000 was primarily from proceeds of the issuance of common stock in conjunction with the Private Placement offset by repayments on E-LOAN'S warehouse lines of credit. Net cash provided by financing activities during the nine months ended September 30, 1999 was primarily from the net proceeds from the Company's initial public offering on July 2, 1999, proceeds from notes payable offset by net repayments under E-LOAN's warehouse lines of credit.
As of September 30, 2000, the Company had cash and cash equivalents of $37.3 million which E-LOAN believes is sufficient to fund operations through profitability. The Company presently uses its own cash to fund auto loans that are not underwritten and funded by Bank of America. The Company is currently working on obtaining a line of credit as a source of funding these auto loans.
FORWARD LOOKING STATEMENTS
The statements contained in this Report that are not historical facts are "forward-looking statements" (as such term is defined in Section 27A of the Securities Act of 1933 and section 21E of the Securities Exchange Act of 1934), which can be identified by the use of forward-looking terminology such as "estimated," "projects," "anticipated," "expects," "intends," "believes," or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy that involve risks and uncertainties. These forward-looking statements, such as the Company's plans to increase the number of purchase loans, the relative importance of loans E-LOAN originates and sells and growth in the number of applications received, statements regarding development of E-LOAN's business, future operating results, anticipated capital expenditures, the expectations as to the use of the capital resource and the availability of additional financing, and other statements contain in this Report regarding matters that are not historical facts, are only estimates or predictions and cannot be relied upon. No assurance can be given that future results will be achieved; actual events or results may differ materially as a result of risks facing the company or actual results differing from the assumption underlying such statements. Such risks and assumptions include, but are not limited to, E-LOAN's ability to successfully promote and market its brand to current and new customers, generate customer demand for its products in regions of the country other than California, access additional debt or equity financing in the future, achieve acceptable pricing for its services, respond to increasing competition, manage growth of E-LOAN's operations, as well as regulatory, legislative, and judicial developments that could cause actual results to vary materially from the future results indicated, expressed or implied in such forward-looking statements. All written and oral forward-looking statements made in connection with this Report which are attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by the "Factors Affecting Future Operating Results" and other cautionary statements included herein. The Company disclaims any obligation to update information contained in any forward-looking statement.
FACTORS AFFECTING FUTURE OPERATING RESULTS
The following important factors, among others, could cause actual results to differ materially from those contained in forward- looking statements made in this report or presented elsewhere by management from time to time.
WE HAVE A HISTORY OF LOSSES, WE EXPECT LOSSES TO CONTINUE AND WE MAY NOT ACHIEVE OR MAINTAIN PROFITABILITY.
We have not achieved profitability and expect to continue to incur operating losses for the foreseeable future. We incurred net losses of $48.5 million and $71.0 million for the nine months ended September 30, 1999 and 2000, respectively. As of September 30, 2000, our accumulated deficit was $156.6 million. Because we expect our operating costs will increase to accommodate expected growth in loan applications, we will need to generate significant revenues to achieve and maintain profitability. Even if we achieve profitability, we may not sustain or increase profitability on a quarterly or annual basis in the future. If revenues grow slower than we anticipate, or if operating expenses exceed our expectations or cannot be adjusted accordingly, our business, results of operations and financial condition will be adversely affected.
WE HAVE A LIMITED OPERATING HISTORY AND CONSEQUENTLY FACE SIGNIFICANT RISKS AND CHALLENGES IN BUILDING OUR BUSINESS.
We were incorporated in August 1996, initiated our online mortgage operations in June 1997 and acquired our online auto operations in September 1999. Since we began our online mortgage operations, we have operated during only one downturn in the mortgage business, which commenced in 1999 and is continuing. We cannot assure you that we will be able to operate successfully if the current downturn continues further or becomes more extensive. As a result of our limited operating history, our recent growth and our reporting responsibilities as a public company, we may need to expand operational, financial and administrative systems and control procedures to enable us to further train and manage our employees and coordinate the efforts of our underwriting, accounting, finance, marketing, and operations departments.
OUR QUARTERLY FINANCIAL RESULTS ARE VULNERABLE TO SIGNIFICANT FLUCTUATIONS AND SEASONALITY, WHICH COULD ADVERSELY AFFECT OUR STOCK PRICE.
Our revenues and operating results may vary significantly from quarter to quarter due to a number of factors. Certain months or quarters have historically experienced a greater volume of purchase money mortgage and auto loan applications and funded loans. As a result, we believe that quarter- to-quarter comparisons of our operating results are not a good indication of our future performance. It is possible that in some future periods our operating results may be below the expectations of public market analysts and investors. In this event, the price of our common stock may fall.
INTEREST RATE FLUCTUATIONS COULD ADVERSELY AFFECT OUR BUSINESS IN SEVERAL WAYS, INCLUDING CONSUMERS' INCENTIVE TO REFINANCE EXISTING MORTGAGE LOANS.
A significant percentage of our mortgage customers use our services to refinance existing mortgages and they are motivated to do so primarily when interest rates fall below the rates of their existing mortgages. In the event interest rates significantly increase, consumers' incentive to refinance will be greatly reduced and the number of loans that we originate could significantly decline.
OUR ABILITY TO ENGAGE IN PROFITABLE SECONDARY SALES OF LOANS MAY ALSO BE ADVERSELY AFFECTED BY INCREASES IN INTEREST RATES.
The mortgage loan purchase commitments we obtain are contingent upon our delivery of the relevant loans to the purchasers within specified periods. To the extent that we are unable to deliver the loans within the specified periods and interest rates increase during those periods, we may experience no gain or even a loss on the sale of these loans. In addition, any increase in interest rates will increase the cost of maintaining our warehouse and repurchase lines of credit on which we depend to fund the loans we originate. We have recently implemented a hedging program to manage the risk of loss due to fluctuations in interest rates, but our hedging efforts may not be successful, and no hedging strategy can completely eliminate interest rate risk. A sharp decrease in interest rates over a short period may cause customers who have interest rates on mortgages committed through E-Loan to either delay closing their loans or refinance with another lender. If this occurs in significant numbers, it may have an adverse effect on our business or quarterly results of operations.
OUR HEDGING STRATEGY MAY NOT SUCCEED IN REDUCING OUR EXPOSURE TO LOSSES CAUSED BY FLUCTUATIONS IN INTEREST RATES.
We attempt to manage our interest rate risk exposure through hedging transactions using a combination of forward sales of mortgage- backed securities and forward whole-loan sales to fix the sales price of loans we expect to fund. An effective hedging strategy is complex, and we have limited experience administering a hedging program. A successful hedging program depends in part on our ability to properly estimate the number of loans that will actually close and is subject to fluctuations in the prices of mortgage-backed securities, which do not necessarily move in tandem with the prices of loans we originate and 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.
UNCERTAINTY WITH RESPECT TO THE TIME IT TAKES TO CLOSE MORTGAGE LOANS CAN LEAD TO UNPREDICTABLE REVENUE AND PROFITABILITY.
The time between the date an application for a mortgage loan is received from a customer on our website and the date the loan closes can be lengthy and unpredictable. The loan application and approval process is often delayed due to factors over which we have little or no control, including the timing of the customer's decision to commit to an available interest rate, the close of escrow date for purchase loans, the timeliness of appraisals and the adequacy of the customer's own disclosure documentation. Purchase mortgage loans generally take longer to close than refinance loans as they are tied to the close of the property sale escrow date. This uncertain timetable can have a direct impact on our revenue and profitability for any given period. We may expend substantial funds and management resources supporting the loan completion process and never generate revenue from closed loans. Therefore, our results of operations for a particular period may be adversely affected if the mortgage loans applied for during that period do not close in a timely manner or at all.
WE HAVE RECENTLY EXPERIENCED SIGNIFICANT GROWTH IN OUR BUSINESS, AND IF WE ARE UNABLE TO MANAGE THIS GROWTH, OUR BUSINESS WILL BE ADVERSELY AFFECTED.
Over the past two years we have experienced significant growth, which has placed a strain on our resources and will continue to do so in the future. Our failure to manage this growth effectively could adversely affect our business. We may not be successful in managing or expanding our operations or maintaining adequate management, financial and operating systems and controls. Our headcount has grown substantially. At September 30, 1999 and 2000, we had 283 and 342 full-time employees, respectively.
IF ONLINE LENDING AND OUR SERVICE OFFERINGS DO NOT ACHIEVE WIDESPREAD CONSUMER ACCEPTANCE, OUR BUSINESS WILL BE ADVERSELY AFFECTED.
Our success will depend in large part on widespread consumer acceptance of obtaining mortgage and auto loans online. The development of an online market for mortgage and auto loans has only recently begun, is rapidly evolving and likely will be characterized by an increasing number of market entrants. Our future growth, if any, will depend on the following critical factors:
We cannot assure you that the market for our services will develop, that our services will be adopted or that consumers will significantly increase their use of the Internet for obtaining mortgage or auto loans. If the online market for mortgage and auto loans fails to develop, or develops more slowly than expected, or if our services do not achieve widespread market acceptance, our business, results of operations and financial condition would be adversely affected.
THE LOSS OF ONE OR MORE OF OUR SIGNIFICANT DISTRIBUTION PARTNERS WOULD ADVERSELY AFFECT OUR BUSINESS.
We rely on Internet distribution partners to direct a significant number of prospective customers to our website. If we lose any of our significant distribution partners, we will likely fail to meet our growth objectives, both in terms of additional borrowers and increased brand awareness. Approximately 43% and 60% of our mortgage and auto loan applications, respectively, were derived from the websites of our distribution partners during the quarter ended September 30, 2000. Our agreements with our distribution partners are typically short-term, from one to four years in length, and many can be terminated for any reason upon 30 to 60 days prior written notice. We cannot assure you that any or all of these agreements will not be terminated or will be renewed or extended past their current expiration dates. If any of these agreements were to be terminated or were to lapse without extension, we could lose a considerable number of loan applications and our business would be adversely affected.
THE TERMINATION OF ONE OR MORE OF OUR MORTGAGE LOAN FUNDING SOURCES WOULD ADVERSELY AFFECT OUR BUSINESS.
We depend on GE Capital Mortgage Services, Inc. ("GE Capital") to finance our self-funded mortgage loan activities through the warehouse credit facility they provide. We also depend on Greenwich Capital Financial Products, Inc. ("Greenwich Capital") to finance portions of our mortgage loan inventory pending ultimate sale to mortgage loan purchasers. If either of these warehouse credit facilities becomes unavailable, our business would be adversely affected. Under our agreements with each of these lenders, we make extensive representations, warranties and various operating and financial covenants. A material breach of these representations, warranties or covenants could result in the termination of our agreements and an obligation to repay all amounts outstanding at the time of termination. In the past, we have had to obtain waivers from Greenwich Capital and GE Capital as a result of our failure to comply with covenants regarding the issuance of capital stock, excess asset purchases and the breach of financial ratios. Our agreement with Greenwich Capital expires in May 2001 and our agreement with GE Capital expires in December 2000.
WE ARE DEPENDENT ON ONE LENDING SOURCE FOR THE MAJORITY OF OUR AUTO LOAN BUSINESS.
Currently, the majority of our auto loans are funded through Bank of America pursuant to a Transition Services Agreement entered into in connection with our acquisition of Electronic Vehicle Remarketing, Inc. We currently rely on Bank of America's underwriting system for the processing of the majority of our auto loans. If Bank of America is unable to underwrite or fund our auto loans, we may experience delays in processing loans or an inability to accept or process auto loan applications until we are able to secure new sources of funding. Sufficient additional sources of funding for our auto loans may not be available on favorable terms or at all.
IF WE ARE UNABLE TO SECURE NEW SOURCES OF FUNDING FOR OUR AUTO LOANS, WE MAY NOT BE ABLE TO GROW OUR AUTO LOAN BUSINESS.
We currently use our own cash to fund auto loans that are not underwritten and funded by Bank of America. We are currently attempting to obtain a line of credit as a source of funding for our self-funded auto loans. If we are unable to secure alternative sources of funding, our own funds may be insufficient to grow our business. Sufficient additional sources of funding for our auto loans may not be available on favorable terms or at all.
IF WE DO NOT INCREASE THE NUMBER OF AUTO LOAN LENDERS WHO FUND THROUGH OUR SITE OUR AUTO LOAN BUSINESS WILL NOT GROW.
To grow our auto loan business, we must broaden our offering of auto loans to a wide range of credit profiles. Currently, the majority of our auto loans are funded through Bank of America, and the underwriting criteria that Bank of America requires allows us to fund auto loans only for those applicants with high credit profiles. In order to fund auto loans for more of the applicants, we must increase the number of lenders who make their loan products available through our site. We cannot assure you that we will be able to enter into arrangements with sufficient other auto loan lenders on favorable terms or at all.
WE DEPEND ON THE TIMELY AND COMPETENT SERVICES OF VARIOUS COMPANIES INVOLVED IN THE MORTGAGE PROCESS; IF THESE COMPANIES FAIL TO TIMELY AND COMPETENTLY DELIVER THESE SERVICES, OUR BUSINESS AND REPUTATION WILL BE DIRECTLY AND ADVERSELY AFFECTED.
We rely on other companies to perform services related to the loan underwriting process, including appraisals, credit reporting and title searches. Any interruptions or delays in the provision of these services may cause delays in the processing and closing of loans for our customers. If we are unsuccessful in managing the timely delivery of these services we will likely experience increased customer dissatisfaction and our business and reputation could be adversely affected.
WE DEPEND ON OUR AGREEMENTS WITH THIRD PARTIES TO FUND MORTGAGE LOANS OR FULFILL LOAN TRANSACTION PROCESSING IN TWO STATES; IF THESE AGREEMENTS ARE TERMINATED, OUR BUSINESS COULD BE ADVERSELY AFFECTED.
We license our mortgage loan origination systems and proprietary marks to NetB@nk to enable NetB@nk to fund mortgage loans under the E- LOAN brand in two states. Our agreement with NetB@ank may be terminated by either party upon 30 days prior written notice. The termination of the agreement with respect to any or all of the two states could have a material adverse effect on our business.
THE LOSS OF OUR RELATIONSHIP WITH ANY SIGNIFICANT PROVIDER OF AUTOMATED UNDERWRITING WOULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS.
We depend on automated underwriting and other services offered by government sponsored and other mortgage investors, including Fannie Mae and Freddie Mac ("Agencies"), to help ensure that our mortgage services can be offered efficiently and on a timely basis. We currently have an agreement with the Agencies that authorizes our use of their automated underwriting services and enables us to sell qualified first mortgages to these Agencies. We cannot assure you that we will remain in good standing with the Agencies or that the Agencies will not terminate our relationship. We expect to continue to process a significant portion of our conforming mortgage loans using the Agencies' systems until we are able to obtain automated underwriting services from other providers. Our agreement with the Agencies can be terminated by either party. The termination of our agreements with the Agencies would adversely affect our business by reducing our ability to streamline the mortgage origination process.
WE MAY INCUR LOSSES ON LOANS IF WE BREAH REPRESENTATIONS OR WARRANTIES TO MORTGAGE LOAN PURCHASERS.
In connection with the sale of mortgage and auto loans, we make customary representations and warranties to loan purchasers relating to, among other things, compliance with laws and origination practices. In the event we breach any of these representations and warranties, we may be required to repurchase or substitute these loans and bear any subsequent losses on the repurchased loans. We may also be required to indemnify mortgage and auto loan purchasers for these losses and claims with respect to loans for which there was a breach of representations and warranties. In addition, many of our agreements with mortgage and auto loan purchasers prohibit our solicitation of borrowers with respect to the refinancing of loans we originate and sell. The loan purchasers under our mortgage loan purchase agreements may construe our continuing mortgage monitoring service as violating these non-solicitation provisions, in which case they may elect to terminate their agreements with us or may seek recovery from us for damages sustained by them. Many of our agreements with mortgage and auto loan purchasers prohibit us from refinancing mortgage and auto loans for specified time periods, unless we pay penalties to the loan purchasers or obtain their consent. Many of these agreements also require us to return any premiums paid by a mortgage or auto loan purchaser if the loans purchased are prepaid in full during periods of up to 12 months following the date the loan is purchased.
THE CONSUMER LENDING INDUSTRY IS INTENSELY COMPETITIVE, AND IF WE FAIL TO SUCCESSFULLY COMPETE IN THIS INDUSTRY, OUR MARKET SHARE AND BUSINESS WILL BE ADVERSELY AFFECTED.
To compete successfully, we must respond promptly and effectively to the challenges of technological change, evolving standards and our competitors' innovations by continuing to enhance and expand our services, as well as our sales and marketing channels. Increased competition, particularly online competition, could result in price reductions, reduced margins or loss of market share, any of which could adversely affect our business. We may not be able to compete successfully in our market environment and our failure to do so could have an adverse effect on our business, results of operations and financial condition.
IF WE FAIL TO COMPLY WITH THE NUMEROUS LAWS AND REGULATIONS THAT GOVERN OUR INDUSTRY, OUR BUSINESS COULD BE ADVERSELY AFFECTED.
Our business must comply with all applicable state and federal laws, and with extensive and complex rules and regulations of, and licensing and examination by, various federal, state and local government authorities. These rules impose obligations and restrictions on our mortgage and auto loan brokering and lending activities. In particular, these rules limit the broker fees, interest rates, finance charges and other fees we may assess, require extensive disclosure to our customers, prohibit discrimination and impose on us multiple qualification and licensing obligations. We may not always have been and may not always be in compliance with these requirements. Failure to comply with these requirements may result in, among other things, revocation of required licenses or registrations, loss of approved status, voiding of loan contracts or security interests, indemnification liability or the obligation to repurchase loans sold to loan purchasers, rescission of mortgage loans, class action lawsuits, administrative enforcement actions and civil and criminal liability.
ANY ACQUISITIONS THAT WE UNDERTAKE COULD BE DIFFICULT TO INTEGRATE AND COULD DISRUPT OUR BUSINESS, DILUTE STOCKHOLDER VALUE AND ADVERSELY AFFECT OUR OPERATING RESULTS.
In September 1999, we acquired Electronic Vehicle Remarketing, Inc., and we may acquire or make investments in other complementary businesses, technologies, services or products in the future. These acquisitions and investments could disrupt our ongoing business, distract our management and employees and increase our expenses. In the past, we have had discussions with companies regarding our acquiring, or investing in, their businesses, products, services, or technologies, and we expect to have additional discussions in the future. If we acquire a company, we could have difficulty in assimilating that company's personnel, operations, technology, and software. In addition, the key personnel of the acquired company may decide not to work for us. We could also have difficulty in integrating the acquired products, services or technologies into our operations, and we may incur indebtedness or issue equity securities to pay for any future acquisitions. The issuance of equity securities could be dilutive to our existing stockholders.
THE LOSS OF ANY OF OUR EXECUTIVE OFFICERS OR KEY PERSONNEL WOULD LIKELY HAVE AN ADVERSE EFFECT ON OUR BUSINESS.
Our future success depends to a significant extent on the continued services of our senior management and other key personnel, particularly co-founders Chris Larsen, Chief Executive Officer, and Janina Pawlowski, Chairman of the Board of Directors, as well as Joseph Kennedy, President and Chief Operating Officer. Ms. Pawlowski, a licensed real estate broker, is responsible for all of our mortgage activities in California and two other states. If Ms. Pawlowski were to terminate her relationship with us for any reason, we would not be able to conduct mortgage business in these states until a replacement is found. The loss of the services of Mr. Larsen, Ms. Pawlowski, Mr. Kennedy or other key employees, would also likely have an adverse effect on our business, results of operations and financial condition. We have not entered into employment agreements with any of our executives, except Mr. Kennedy, and we do not maintain "key person" life insurance for any of our personnel.
WE MAY NOT BE ABLE TO RECRUIT AND RETAIN THE PERSONNEL WE NEED TO SUCCEED.
Competition for personnel throughout our industry is intense. We may be unable to retain our key employees or attract, assimilate or retain other highly qualified employees in the future. Our future success depends on our continuing to attract, retain and motivate highly skilled employees, particularly with respect to our loan processing functions. We have in the past experienced, and we expect to continue to experience in the future, difficulty in hiring and retaining employees with appropriate qualifications. If we do not succeed in attracting new personnel or retaining and motivating our current personnel, our business will be adversely affected.
OUR BUSINESS WILL BE IMPAIRED IF CONSUMERS DO NOT CONTINUE TO USE THE INTERNET.
Our business will be adversely affected if Internet usage does not continue to grow, particularly by home and auto buyers. A number of factors may inhibit Internet usage by consumers, including inadequate network infrastructure, security concerns, inconsistent quality of service, and lack of availability of cost-effective, high-speed service. If Internet usage grows, the Internet infrastructure may not be able to support the demands placed on it by this growth and its performance and reliability may decline. In addition, many websites have experienced service interruptions as a result of outages and other delays occurring throughout the Internet infrastructure. If these outages or delays frequently occur in the future, Internet usage, as well as the usage of our website, could grow more slowly or decline.
OUR BUSINESS WILL SUFFER IF WE ARE UNABLE TO EXPAND AND PROMOTE OUR BRAND RECOGNITION.
Establishing and maintaining our brand is critical to attracting and expanding our customer base, solidifying our business relationships and successfully implementing our business strategy. We cannot ensure that our brand will be positively accepted by the market or that our reputation will be strong. Promotion and enhancement of our brand will also depend, in part, on our success in providing a high-quality customer experience. We cannot ensure that we will be successful in achieving this goal. To date, we have received customer complaints regarding the quality of our service. If these complaints persist, they may significantly damage our reputation and offset the efforts we make in promoting and enhancing our brand and could have an adverse effect on our business, results of operations and financial condition. If visitors to our website do not perceive our existing services to be of high quality or if we alter or modify our brand image, introduce new services or enter into new business ventures that are not favorably received, the value of our brand could be diluted, thereby decreasing the attractiveness of our service to potential customers.
OUR BUSINESS WILL SUFFER IF WE ARE UNABLE TO ADAPT TO THE RAPID TECHNOLOGICAL CHANGE THAT CHARACTERIZES OUR INDUSTRY.
Our future success will depend on our ability to adapt to rapidly changing technologies by continually improving the performance features and reliability of our services. We rely on third party software products and services, including software related to automated underwriting functions, which will enable us to realize processing efficiencies that are central to our operations. If we are unable to integrate this software in a fully functional manner, we may experience difficulties that could delay or prevent the successful development, introduction or marketing of new products and services. In addition, enhancements of our products and services must meet the requirements of our current and prospective customers and must achieve significant market acceptance. We could also incur substantial costs if we need to modify our services or infrastructure to adapt to these changes.
ANY OUTAGES, DELAYS OR OTHER DIFFICULITIES EXPERIENCED BY THE INTERNET SERVICE PROVIDERS, ONLINE SERVICE PROVIDERS OR OTHER WEBSITE OPERATORS ON WHICH OUR USERS DEPEND COULD ADVERSELY AFFECT OUR BUSINESS.
Our website has in the past and may in the future experience slower response times or decreased traffic for a variety of reasons. In addition, our users depend on Internet service providers, online service providers and other website operators for access to our websites. Many of them have experienced significant outages in the past, and could experience outages, delays and other difficulties due to system failures unrelated to our systems. Additionally, the Internet infrastructure may not be able to support continued growth in its use. Any of these problems could adversely affect our business.
OUR BUSINESS WILL BE ADVERSELY AFFECTED IF WE ARE UNABLE TO SAFEGUARD THE SECURITY AND PRIVACY OF OUR CUSTOMERS' FINANCIAL DATA.
Internet usage could decline if any well-publicized compromise of security occurred. We may incur significant costs to protect against the threat of security breaches or to alleviate problems caused by any breaches that occur. We also retain on our premises personal financial documents that we receive from prospective borrowers in connection with their loan applications. These documents are highly sensitive and if a third party were to misappropriate our customers' personal information, customers could possibly bring legal claims against us. We cannot assure you that our privacy policy will be deemed sufficient by our prospective customers or any federal or state laws governing privacy, which may be adopted in the future.
OUR BUSINESS WILL BE ADVERSELY AFFECTED IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS FROM THIRD PARTY CHALLENGES OR IF WE ARE INVOLVED IN LITIGATION.
Trademarks and other proprietary rights are important to our success and our competitive position. Although we seek to protect our trademarks and other proprietary rights through a variety of means, we cannot assure you that the actions we have taken are adequate to protect these rights. We may also license content from third parties in the future, and it is possible that we could face infringement actions based upon the content licensed from these third parties. Trademark or propriety rights claims against us, regardless of their merit, could result in costly litigation and the diversion of our financial resources and technical and management personnel. Further, if any of these claims are proved valid, through litigation or otherwise, we may be required to change our trademarks and pay financial damages, which could adversely affect our business.
ITEM 4. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Interest rate movements significantly impact E-LOAN's volume of closed loans and represent the primary component of market risk to E-LOAN. In a higher interest rate environment, consumer demand for mortgage and auto loans, particularly refinancing of existing mortgages, declines. Interest rate movements affect the interest income earned on loans held for sale, interest expense on the warehouse lines payable, the value of mortgage loans held for sale and ultimately the gain on sale of mortgage and auto loans. In addition, in an increasing interest rate environment, E-LOAN's mortgage and auto loan brokerage volume is adversely affected.
E-LOAN originates mortgage loans and manages the market risk related to these loans through various hedging programs.
Loan Commitments and Sell forward Commitments
Upon receiving a locked commitment from a borrower ("rate lock"), the Company simultaneously enters into either a mandatory sell forward agreement with a counterparty (Fannie Mae) or a non- mandatory forward sale agreement with the ultimate investor. At September 30, 2000, the Company was a party to commitments to fund loans at interest rates previously agreed (locked) by both the Company and the borrower for specified periods of time. Rate locks with the borrowers are on a best effort basis, borrowers are not obligated to enter into the loan agreement. A rate lock, which does not result in a funded loan, is referred to as fallout. As the Company is exposed to movements in interest rates after entering into a rate locks, the Company must estimate fallout if interest rate risk is to be hedged with a mandatory sell forward agreement.
Hedging Activities
The Company originates mortgage loans and sells them primarily through whole loan sales. The market values of mortgage loans are sensitive to changes in market interest rates. If interest rates rise between the time the Company enters into a rate lock with the borrower the subsequent funding of the loan and the time the mortgage loans are committed for sale, there may be a decline in the market value of the mortgage loans. To protect against such possible declines, the Company has adopted a hedging strategy.
The Company retains the services of Tuttle & Co., an unaffiliated advisory firm specializing in mortgage loan pipeline management to assist the Company in minimizing the interest rate risk associated with the time lag between when loans are rate-locked and when they are committed for sale or exchanged in the secondary market. Individual mortgage loan risks are aggregated by note rate, mortgage loan type and stage in the pipeline, and are then matched, based on duration, with the appropriate hedging instrument, thus mitigating basis risk until closing and delivery. The Company currently hedges its mortgage pipeline through mandatory forward sales of Fannie Mae mortgage- backed securities and non-mandatory forward sales agreements with the ultimate investor. The Company determines which alternative provides the best execution in the secondary market. As a managed account of Tuttle & Co., the Company is able to take advantage of Tuttle's reporting services, including pipeline, mark-to-market, commitment and position reporting.
The Company believes that it has implemented a cost-effective hedging program to provide a level of protection against changes in the market value of its fixed-rate mortgage loans held for sale. However, an effective strategy is complex and no hedging strategy can completely insulate the Company against such changes.
PART II OTHER INFORMATION
ITEM 1. Legal Proceedings
Reference is made to Part I, Item 3, Legal Proceedings in our Annual Report on Form 10-K and Form 10-K/A for the year ended December 31, 1999 and Part II, Item I, Legal Proceedings in our Form 10-Q for the quarters ended March 31, 2000 and June 30, 2000 for descriptions of legal proceedings.
The Company is subject to various other legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these claims cannot be predicted with certainty, management does not believe that the outcome of any of these legal matters will have a material adverse effect on the Company's results of operations or financial position.
Item 2. Changes in Securities and Use of Proceeds
(c) Recent Sales of Unregistered Securities.
During the three months ended September 30, 2000, the Company did not sell any unregistered securities.
(d) Use of Proceeds from Registered Securities.
On July 2, 1999 the Company completed an initial public offering in which it sold 4,020,000 shares of its common stock and 5,000 shares were sold by a selling stockholder. The managing underwriters of the offering were Goldman, Sachs & Co., Donaldson, Lufkin & Jenrette Securities Corporation, Hambrecht & Quist LLC, DLJdirect Inc. and E*Trade Securities Inc. The shares of common stock sold in the offering were registered under the Securities Act of 1933, as amended, on a Registration Statement on Form S-1 (the "Registration Statement") (Reg. No. 333-74945) that was declared effective by the Securities and Exchange Commission on June 28, 1999. All 4,025,000 shares of common stock registered under the Registration Statement were sold at a price of $14.00 per share for gross proceeds to E-LOAN of $56.2 million and gross proceeds to the selling stockholder of $70,000. Offering proceeds to E-LOAN, net of underwriter discounts, were approximately $52.3 million.
From June 28, 1999, the effective date of the Registration Statement, to September 30, 2000, the Company has used the $52.3 million of initial public offering proceeds in its entirety for working capital purposes, including expenses associated with advertising campaigns, brand-name promotions and other marketing efforts and capital expenditures. All amounts represent estimates of direct or indirect payments of amounts to third parties. No amounts were paid directly or indirectly for the above purposes to directors or officers of the Company, to persons owning ten percent or more of any class of equity securities of the Company, or to affiliates of the Company. The use of proceeds described above does not represent a material change in the use of proceeds described in the offering prospectus.
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
10.68+ Systems and Marketing Agreement between H&R Block Mortgage Corporation and the Company, dated July 1, 2000.
27.1 Financial Data Schedule
There were no reports on Form 8-K filed during the three months ended September 30, 2000.
+ Confidential treatment requested
E-LOAN, INC.
SIGNATURES
Pursuant to the requirement of the Security Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| E-LOAN, INC. |
Dated: November 14, 2000
| By: | /s/ Frank Siskowski |
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| Frank Siskowski | |
| Chief Financial Officer | |
| (Principal Financial and Accounting Officer and Duly Authorized Officer) |
Exhibit Index
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