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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 1998
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Commission File Number: 0-18108
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FINET HOLDINGS CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE
(State or jurisdiction of
incorporation or organization)
505 Sansome Street, #1420
SAN FRANCSICSO, CA 94111
(Address of principal executive office)
94-3115180
(IRS Employer Identification Number)
(415) 263-5400
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant has (1) filed all reports
required to be filed by Section 13 or 15(d) of the Securities Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
filing requirements within the past 90 days.
Yes _X_ No __
The number of shares outstanding of each of the issuer's classes of common
stock was 36,405,386 shares of common stock, par value $.01, as of December
15, 1998.
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FINET HOLDINGS CORPORATION
INDEX
Item Description
Page
- ---- -------------------------------------------------------------------
- ----
PART I - FINANCIAL INFORMATION
1. Financial Statements
Unaudited Balance Sheet
October 31, 1998 ................................................
3
Unaudited Statements of Operations
Three Months Ended October 31, 1998 and 1997.....................
4
Six Months Ended October 31, 1998 and 1997.......................
5
Unaudited Statements of Cash Flow
Six Months Ended October 31, 1998 and 1997.......................
6
Notes to Unaudited Financial Statements............................
8
2. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................
13
PART II - OTHER INFORMATION
1. Legal Proceedings..................................................
18
2. Changes in Securities..............................................
18
4. Submission of Matters to a Vote of Security Holders................
19
5. Other Information..................................................
19
6. Exhibits and Reports on Form 8-K...................................
19
Signatures.........................................................
20
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FINET HOLDINGS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(Dollars in thousands, except shares and per share amounts)
October 31,
1998
--------------
ASSETS
Cash and cash equivalents $ 137
Accounts receivable from sales of mortgage loans and servicing rights15,822
Mortgage loan servicing advances and other receivables 3,303
Mortgages held for sale, net of allowances of $1,132 103,771
Mortgage servicing rights (Note 3) 4,460
Furniture, fixtures and equipment, net of accumulated depreciation 2,323
of $3,361
Goodwill 4,593
Other assets 3,591
-------
Total assets $ 138,000
=======
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Warehouse and revolving lines of credit (Note 4) 116,156
Notes payable and capitalized leases (Note 4) 2,904
3% Convertible subordinated debentures (Note 4) 7,000
Accounts payable, accrued expenses and other liabilities10,713
-------
Total liabilities 136,773
- -------
Commitments and contingencies (Note 5)
Stockholders' equity: (Note 6)
Preferred stock, $.01 par value, (100,000 shares authorized, 250 issued
and outstanding) 2,500
Common stock, $.01 par value, (150,000,000 shares authorized, 33,905,000
shares outstanding at October 31, 1998) 400
Paid-in capital 16,343
Accumulated deficit (18,016)
----------
Total stockholders' equity 1,227
----------
Total liabilities and stockholders' equity $138,000
==========
The accompanying notes are an integral part of the consolidated financial
statements.
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FINET HOLDINGS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(Dollars in thousands - except shares and per share amounts)
Three months ended
October 31,
---------------------
- --
1998 1997
--------- -------
- --
REVENUE
Gain on sale of mortgage loans and servicing rights, net of
loan origination costs $ 2,747 $ 1,413
Interest income 2,154 882
Loan servicing fees 283 125
Retail broker fees 907 45
Other 102 58
--------- -------
- --
Total revenue 6,193 2,523
--------- -------
- --
EXPENSES
Compensation and related expenses 4,071 1,475
Occupancy and other office expenses 1,887 1,261
Interest expense 3,547 678
Marketing expenses 511 236
Depreciation and amortization 359 163
Other operating expenses 649 521
--------- -------
- --
Total expenses 11,024 4,334
--------- -------
- --
Loss before income taxes (4,831) (1,811)
Income tax expense - (42)
--------- -------
- --
NET LOSS $ (4,831) $ (1,853)
=========
=========
Basic and diluted net loss per common share (Note 1)$ (.15)$
(.06)
=========
=========
Shares used in computing basic and diluted share data32,983 28,812
=========
=========
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE> 5
FINET HOLDINGS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(Dollars in thousands - except per share amounts)
Six months ended
October 31,
---------------------
- --
1998 1997
--------- -------
- --
REVENUE
Gain on sale of mortgage loans and servicing rights, net of
loan origination costs $ 6,817 $ 4,011
Interest income 3,957 1,756
Loan servicing fees 961 253
Retail broker fees 1,430 75
Other 196 163
--------- -------
- --
Total revenue 13,361 6,258
--------- -------
- --
EXPENSES
Compensation and related expenses 7,990 4,115
Occupancy and other office expenses 3,718 2,194
Interest expense 6,339 1,420
Marketing expenses 1,011 501
Depreciation and amortization 679 296
Other operating expenses 1,003 643
--------- -------
- --
Total expenses 20,740 9,169
--------- -------
- --
Loss before income taxes
Income taxes and extraordinary gain, net of tax (7,379) (2,911)
Income tax expense - (45)
Extraordinary gain, net of tax - 3
--------- -------
- --
NET LOSS $ (7,379) $ (2,953)
=========
=========
Basic and diluted net loss per common share (Note 1)$ (.23)$
(.10)
=========
=========
Shares used in computing basic and diluted share data32,728 28,642
=========
=========
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE> 6
FINET HOLDINGS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, Dollars in thousands)
Six months ended
October 31,
1998
1997
-------- ------
- --
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (7,389) $ (2,953)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 1,216 296
Amortization of mortgage servicing rights 903 -
Amortization of imputed interest on convertible debt1,383 -
Write down of other assets and provision for losses(126) 423
Gain on sale of mortgage servicing rights (466) (47)
Deferred tax benefit (83) (114)
Changes in operating assets and liabilities:
(Increase) decrease in receivables from sales of mortgage loans and
loan servicing rights 9,715 (9,738)
(Increase) decrease in mortgage loans held for sale(19,572) (7,381)
(Increase) decrease in originated mortgage servicing rights, net(289)
277
Increase (decrease) in mortgage loan servicing advances and other
receivables 627 (78)
Net increase (decrease) in other assets 568 12
Net increase (decrease) in other liabilities (2,082) 456
------- -----
- --
Net cash used by operating activities (15,595) (18,847)
------- -----
- --
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of mortgage servicing rights - (165)
Proceeds from sale of mortgage servicing rights 1,597 75
Principal payments on mortgage loans held for investment- (11)
Purchase of furniture, fixtures and equipment (171) (189)
Acquisition of purchased technology and intangibles - (204)
Pre-acquisition advances to affiliates - (270)
Proceeds from sale of fixed assets 12 -
Acquisition of business, net of cash acquired (1,718) -
------- -----
- --
Net cash provided (used) by investing activities (280) (764)
------- -----
- --
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 2 3,885
Proceeds from issuance of convertible debt 1,384 -
Proceeds from issuance of preferred stock 2,286 -
Proceeds from warrant exercise 197
- -
Net increase (decrease) in warehouse borrowings (31,411) 16,470
Decrease in mortgage loans funded on behalf of Mical42,360 -
Proceeds from advances on note payable and line of credit(764) (45)
Repayment of note payable, capitalized leases and line of credit
(220) 119
------- -------
Net cash provided (used) by financing activities 13,834 20,429
------- -----
- --
Net increase (decrease) in cash (2,041) 818
Cash at beginning of period 2,178 1,148
------- -----
- --
Cash at end of period $ 137 $ 1,966
=======
=======
Supplemental cash flow information (Note 7)
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE> 7
FINET HOLDINGS CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Finet Holdings Corporation ("Finet" or the "Company") is an electronic
commerce firm operating in one business segment, homeownership services.
Finet is primarily engaged in wholesale and retail mortgage lending (as
both a mortgage banker and a mortgage broker) and the delivery of related
real estate sales and financing transaction settlement services. The
majority of its revenues, including those related to mortgage lending, is
derived from increasingly automated electronic business processes,
including those conducted over the Internet.
The operations of the Company's principal lending subsidiaries, Monument
Mortgage, Inc. ("MMI"), a California mortgage banker specializing in
conforming prime loans, Coastal Federal Mortgage Company ("Coastal"), a New
Jersey sub-prime mortgage banker, and Mical Mortgage, Inc. ("Mical"), a
California mortgage banker specializing in FHA and VA loans, are in the
process of being consolidated and integrated. The Company's business
activity is carried out throughout the 40 states in which the Company is
currently licensed. (See Note 8.)
The acquisition of Coastal on April 30, 1998 was accounted for as a pooling
of interests. Accordingly, the Company's results for the quarter and the
six months ended October 31, 1997 have been restated to include Coastal's
results of operations for that period.
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-QSB and
Regulation S-B. Accordingly, they do not include all the information and
footnotes required by generally accepted accounting principles for complete
financial statement presentation. In the opinion of management, all
adjustments, consisting of normal recurring accruals, considered necessary
for a fair presentation of the results for the interim period have been
included. Operating results for the six months ended October 31, 1998 are
not necessarily indicative of the results that may be expected for the
fiscal year ending April 30, 1999. This report should be read in
conjunction with the consolidated financial statements and footnotes
included in the annual report on Form 10-KSB for the fiscal year ended
April 30, 1998 of Finet Holdings Corporation.
The consolidated financial statements of the Company include the accounts
of all active wholly owned subsidiaries. All significant inter-company
balances and transactions have been eliminated in consolidation.
PER SHARE AMOUNTS
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128, Earnings per Share. SFAS No. 128 simplifies the standards for
computing earnings per share ("EPS") and makes them comparable to
international standards. SFAS No. 128 was effective for financial
statements issued for periods ending after December 15, 1997, with earlier
application not permitted. Upon adoption, all prior EPS data was restated.
Basic EPS is determined by dividing net loss by the weighted average shares
outstanding during the period. Since the fully diluted loss per share for
the quarters ended October 31, 1998 and 1997, respectively, was anti-
dilutive, basic and diluted earnings per share are the same. The effects of
common stock equivalents have not been included because they would have
been anti-dilutive during the periods reported.
NOTE 2. ACQUISITIONS
On May 19, 1998 the Company acquired all the issued and outstanding shares
of Mical, a non-public mortgage banker with principal offices in San Diego,
California, in exchange for 552,000 shares (including 120,000 contingent
shares) of the Company's common stock. Due to the financial requirements of
Mical, certain transactions and advances were made in
<PAGE> 8
anticipation of the acquisition. The acquisition has been accounted for as
a purchase and its operations included in the Company's financial
statements since that date. The excess of the purchase price over the fair
market value of the acquired net assets ($4.6 million at October 31, 1998)
was recorded as goodwill and is being amortized over 20 years. The
following condensed pro forma statements of operations of the Company for
the six months ended October 31, 1998 and 1997 give effect to the
acquisition of Mical as though the transaction had occurred at the
beginning of the periods:
(In thousands) PRO FORMA
6 Months Ending October 31,
1998 1997
----------- -----------
[S] [C] [C]
Revenue $ 13,866 $ 16,861
Expenses 22,264 17,789
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Net loss $ (8,398) $ (928)
=========== ===========
Loss per share $ (.26) (.03)
============ ============
On June 23, 1998 the Company acquired, from an individual, certain assets
which include an internet site, "interloan.com", in exchange for 100,000
shares of the Company's common stock. The Company also entered into a
binding term sheet agreement that will result in a three-year employment
agreement with that individual.
NOTE 3. MORTGAGE SERVICING RIGHTS
During the six months ended October 31, 1998, the activity in mortgage loan
servicing rights was as follows:
October 31,
(Dollar amounts in thousands) 1998
- ------------------------------ ---------
Mortgage Servicing Rights
Beginning balance $ 5,478
Additions 1,193
Sales (1,330)
Amortization/Payoff (881)
---------
Ending balance $ 4,460
=========
Servicing rights to mortgage loans with an unpaid principal balance of
approximately $515 million were pledged as collateral to lenders as of
October 31, 1998.
NOTE 4. DEBT
The following table and comments present summary information regarding the
Company's debt as of October 31, 1998:
<PAGE> 9
(In thousands)
Interest
Expires or
Facility Balance Rate Due
- ---------------------------------- -------------- -------------- ------
- -------------
REVOLVING
Warehouse lines of credit:
$35 million committed $ 44,085 LIBOR +
variable spread December 31,
1998
$24 million 8,362 Libor +2.5%
December 31, 1998
$60 million 62,709 NY Prime May 1,
1999
Revolving line of credit:
$ 1 million committed 1,000 Prime + 0.625%
Requires payment to
zero 5
days per qtr
---------
116,156
OTHER DEBT AND CAPITAL LEASES:
Servicing acquisition loan
$1,870 committed 1,800 Prime + 0.625%
November 15, 1998
Various notes 901 Various Due in
2000
Capitalized leases 203 3.5% to 11.5% Varies
to 2002
---------
$ 2,904
3% SUBORDINATED CONVERTIBLE DEBT: $ 7,000
The Company issued the third traunch of its 3% Subordinated Convertible
Debentures in May 1998 in the amount of $1,500,000, bringing the total
issue of 3% Subordinated Convertible Debentures to $7,000,000. The
debentures and accrued interest are convertible into the Company's common
stock at the lesser of $5.00 per share or 78% of the determined market
price prior to conversion. In connection with this issue the Company
recorded additional paid-in capital of $1,551,000 for the discount related
to imputed interest represented by the market discount conversion factor.
This discount is being amortized to interest expense over the period from
the date of issue to the date the debentures first become convertible.
Through October 31, 1998, the Company has amortized the entire discount to
interest expense. In addition, the company recorded $563,000 of expense
related to debt issuance costs. (See Note 8.)
COLLATERAL
Collateral for the debt obligations is a combination of mortgage loans held
for sale, receivables from sales of mortgage loans, servicing assets, other
assets of the Company, and Finet's corporate guarantee.
The collateral for the capitalized leases is the equipment thereby
financed.
DEBT COVENANTS
The Borrowing Agreements (Agreements) for the warehouse lines of credit,
the revolving line of credit and the note payable contain various financial
covenants including net worth computed in accordance with generally
accepted accounting principles, current ratio and tangible net worth
leverage ratio requirements. Should an event of default occur, as defined
in the Agreements, outstanding principal and interest on the Company's
credit facilities are due on demand.
On August 25, 1998, Residential Funding Corporation ("RFC") notified the
Company that it was in default of its lending agreements. The Company did
not satisfy its July interest payment of $119,254, and the Company did not
meet its debt service obligation on August 31, 1998 on its long-term note
of $1.8 million. The Company was also in violation of certain financial
covenants. RFC is entitled to exercise certain rights and remedies under
the loan agreement, including the right to cease making advances to the
Company, to accelerate obligations and to sue on the notes and guarantees.
RFC has not granted a waiver of these events of default. However, RFC has
agreed to forbear from enforcing its remedies in anticipation of additional
equity investments the Company will receive. (See Note 8.) All unpaid
interest, fees and principal balances are currently due.
<PAGE> 10
In October RFC increased the interest rates on the Company's borrowings to
4% in excess of the rate otherwise applicable. RFC also reduced the total
committed lines from $79 million to $59 million.
Notwithstanding its rights to remedies, RFC at its sole discretion has
continued to make advances to the Company, uninterrupted. RFC has also
allowed the warehouse line advances to exceed the committed amount. The
Company anticipates that it will cure its defaults with respect to its
borrowings when it receives additional equity investments in December 1998.
Equity contributions will be used to service debt, fund operations and to
make operating capital expenditures. (See Note 8.)
There can be no assurance that the Company will cure its warehouse credit
relationship. The inability to cure its borrowing relationship or obtain
alternative warehouse financing sources and working capital arrangements
could result in a major disruption and the Company's business relationships
with its brokers, investors and borrowers could be seriously damaged.
Ultimately there could be a material adverse impact on results from
operations and financial condition if the Company's borrowing relationship
is not cured or if additional capital resources are not received.
NOTE 5. COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS
On January 14, 1998, prior to the acquisition of Mical, a lawsuit was filed
against Mical in the United States District Court for the Middle District
of Georgia (the "Action"). The complaint alleges, among other things, that
in connection with residential mortgage loan closings, Mical made certain
payments to mortgage brokers in violation of the Real Estate Settlement
Procedures Act and induced mortgage brokers to breach their alleged
fiduciary duties to their customers. The plaintiffs seek unspecified
compensatory and punitive damages as to certain claims.
Management believes that its compensation programs to mortgage brokers
comply with applicable laws and with long standing industry practices, and
that it has meritorious defenses to the Action. Management has been advised
by counsel, that the facts of the underlying transaction are not supportive
of a court order granting class certification. The Company intends to
defend vigorously against the Action and believes that the ultimate
resolution will not have a material adverse effect on the Company's results
of operations or consolidated financial position.
The Company and certain subsidiaries are defendants in various legal
proceedings involving matters generally incidental to their business.
Although it is difficult to predict the outcome of such cases, after
reviewing with counsel all such proceedings, management does not expect the
aggregate liability or loss, if any, resulting therefrom will have a
material adverse effect on the consolidated financial position or results
of operations of the Company and its subsidiaries.
MORTGAGE LOAN APPLICATIONS IN PROCESS
The Company has open short-term commitments to fund mortgage loan
applications in process subject to credit approval. Commitments to fund
loans are agreements to lend to a customer as long as there is no violation
of any condition established in the contract. Interest rate risk is
mitigated by the use of forward contracts to sell loans to investors.
LOAN SALE COMMITMENTS
The Company has entered into optional and mandatory forward commitments to
deliver mortgage loans of $61 million as of October 31, 1998.
NOTE 6. STOCKHOLDERS' EQUITY
In May 1998, the Company issued 432,000 shares of common stock, valued at
$1,400,000, as consideration for the acquisition of Mical (See Note 2).
Upon resolution of specified contingencies, 120,000 additional common
shares may be issued. As a result of the acquisition, 33,000 common shares
were issued as a finders fee and 73,000 shares were issued under a keep-
well agreement with an existing shareholder.
<PAGE> 11
In June 1998, the Company issued 25,000 common shares with the execution of
a binding term sheet agreement for the acquisition of Interloan (See Note
2). An additional 75,000 common shares remain to be issued under the
provisions of the term sheet.
In September 1998, the Company issued 250 shares of its $2.5 million Series
A Convertible Preferred Stock in a private placement generating $2.3
million of proceeds, net of expenses. The preferred shareholders are not
entitled to vote or to receive dividends. Upon any liquidation,
dissolution or winding up, the holders of the Preferred A are entitled to
receive a cash liquidated value (representing $10,000 per share plus 6%
interest), to the extent there are funds sufficient to pay, in preference
to all Common shareholders
In connection with the Company's offering of the Series A Preferred
Shares, the Company issued Warrants to investors to purchase 250,000 shares
of the Company`s Common Stock at $1.00 per share. In November, an agreement
was reached to redeem all of the outstanding $2.5 million of Series A
Convertible Preferred Stock. (See Note 8)
In October 1998, the Company received $196,711 as the result of an exercise
of 262,281 warrants at seventy-five cents per share. The Company had
reduced the exercise price from $1.50 per share to seventy-five cents per
share.
In October 1998, the Company entered into an agreement with a private
investor to issue 2.5 million shares of common stock at eighty cents per
share for proceeds of $2.0 million. In connection with the issuance, the
Company agreed to reduce the exercise price of 1,000,000 Common Stock
Purchase Warrants owned by the investor from $5.00 to $1.00 per share.
The Company received an additional equity infusion in December. (See Note
8).
NOTE 7. SUPPLEMENTAL CASH FLOW INFORMATION
The following table presents supplemental investing and financing
activities for the six month periods ended October 31, 1998 and 1997:
(Dollars in thousands) 1998 1997
------ ------
Cash paid during the period for:
Interest on line of credit and other borrowings $ 294 $ 294
Income taxes - -
Common stock issued during the period for:
Creditor settlements - 22
Purchase of intangible assets - 808
In connection with the acquisition of all of the common stock of MICAL
Mortgage, Inc. for $1.4 million of Finet common stock, the company acquired
assets with a fair value of $93.5 million and assumed liabilities of $92.1
million.
NOTE 8. SUBSEQUENT EVENTS
In November 1998, the Company received $2.0 million from the issuance of
2.5 million shares of common stock at eighty cents per share (see Note 6).
In November 1998, the Company reached agreement with its debenture holders
to convert $1.1 million of its total $7.0 million, 3% Convertible
Subordinated Debentures into 2.2 million common shares at a conversion
price of fifty cents per share, to convert an additional $4.4 million of
debentures into 7,333,333 common shares at a conversion price of sixty
cents per share and to redeem, effective with the closing of the private
placement described below, the remaining $1.5 million of debentures at 100
percent of face value. The agreement also establishes that the Company
will redeem all of the outstanding $2.5 million of Series A Convertible
Preferred Stock at 100 percent of face value. $2.0 million will be paid
following the closing of the private placement and the balance will be paid
within 60 days of the closing. The Company also agreed to issue 840,000, 5-
year warrants, exercisable at $1.50 per share to the Series A Convertible
Preferred shareholders.
<PAGE> 12
The Company is reviewing operations and quality and compliance procedures
of Mical Mortgage, Inc., acquired in May, 1998 to determine how best to
maximize shareholder value. The Company is consulting with lenders,
governmental regulatory agencies and loan investors, and has retained
outside consultants to assist in this review. In connection with this
review, the Company is assessing the future economic value of the goodwill
recorded in the purchase transaction along with the other assets of Mical.
On December 15, 1998, the Company's Board of Directors approved a
preliminary plan to restructure the operations of Mical. The Company is
determining the provision necessary to recognize costs associated with the
impairment of tangible and intangible assets, to restructure operations,
and to provide for potential liabilities associated with the plan. The
Company anticipates that the charges will total approximately $7 to $8
million. This charge will be recognized in the third quarter when the plan
is finalized. Beyond this charge, management does not expect a further
continuing effect of this action on the Company's business, financial
position, or results of operations.
The Company and private investors have agreed to placement of approximately
22 million shares of the Company's common stock at sixty cents per share,
totaling $13.6 million. The Company received $1.3 million and expects to
receive the balance of the capital contribution in December, 1998. This
equity contribution will be used to retire debt and other obligations, to
fund operations and to make capital expenditures as necessary in the
Company's operations.
<PAGE> 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
The following information should be read in conjunction with the condensed
consolidated financial statements and notes included in Item 1 of this
Quarterly Report, the financial statements and the notes thereto, and
Management's Discussion and Analysis of Financial Condition and Results of
Operations included in the Company's Annual Report on Form
10-KSB for the fiscal year ended April 30, 1998.
The Private Securities Litigation Reform Act of 1995 provides a "safe
harbor" for certain forward-looking statements. This Quarterly Report on
Form 10-QSB may contain forward-looking statements which reflect the
Company's current views with respect to future events and financial
performance. These forward-looking statements are subject to certain risks
and uncertainties, including those identified below, which could cause
actual results to differ materially from historical results or those
anticipated. The words "believe," "expect," "anticipate," "intend,"
"estimate," "should" and other expressions which indicate future events and
trends identify forward-looking statements. Readers are cautioned not to
place undue reliance on these forward-looking statements, which speak only
as of their dates. The Company undertakes no obligation to publicly update
or revise any forward-looking statements, whether as a result of new
information, future events or otherwise. The following factors could cause
actual results to differ materially from historical results or those
anticipated: (1) the level of demand for homeownership services, including
mortgage credit, which is affected by such external factors as the level of
interest rates, the strength of the various segments of the economy and
demographics of the Company's markets; (2) the direction of interest rates;
(3) the relationship between mortgage interest rates and the cost of funds;
(4) federal and state regulation of the Company's operations; (5) the rate
of acceptance and growth of demand for on-line homeownership transactions
compared to traditional manual business processes; and (6) competition
within the residential real estate services industry.
RESULTS OF OPERATIONS
The Company has a growing base of electronic commerce revenues, including:
(a) from mortgage financing and settlement services provided directly to
consumers by the Company's retail activities (including both loans funded
by the Company's lending unit as well as loans funded by other lenders);
(b) from loans funded for mortgage brokers by the Company's wholesale
lending activities; (c) from loan servicing fees; (d) from the sale of
customer leads to other real estate service providers; and (e) from
providing Internet products and services to realtors, loan brokers and
consumers.
COMPARISON OF QUARTERS ENDED OCTOBER 31, 1998 AND 1997
The Company is currently expanding the scope of its electronic commerce
mortgage financing transaction services. The 1998 period includes costs
related to this plan. Revenues for the three months ended October 31, 1998
include the operations of Mical and Interloan, which were both acquired in
purchase accounting transactions in the first quarter of 1998. Both
periods include the results of the Company's Coastal unit, as it was
acquired in the prior fiscal year in a pooling transaction.
Revenues for the quarter ended October 31, 1998 increased $3.7 million,
from $2.5 million to $6.2 million over the 1997 quarter. $3.1 million of
the increase was attributable to the incremental revenues of the Company's
Mical unit. Excluding the incremental effect of Mical, revenues increased
$592,000 or 23%. Increased interest income and increased retail broker fee
income also contributed to the total increase of $3.7 million over the
prior year. However, revenue increases were offset by significant
increases in operating expenses, including compensation, occupancy,
interest, and certain non-recurring expenses related to the acquisitions of
Coastal and Mical. The Company incurred a net loss for the quarter of $4.8
million compared to a $1.9 million loss for the quarter ended October 31,
1997. Mical accounts for $766,000 of this increased loss.
<PAGE> 14
Gain on sale of mortgage loans and servicing rights, net of loan
origination costs, increased primarily due to the gains recorded by Mical.
Gain on sale of mortgage loans also include loan origination fee income. In
general, these fees are affected by numerous factors including the volume
and mix of loans produced and sold, loan pricing decisions, interest rate
volatility and the direction of interest rates.
Loan servicing fee income increased $158,000 over the prior year, as the
Company's loan servicing portfolio has a higher balance for the 1998 period
as a result of assets purchased in December of 1997. However, the
Company's loan servicing portfolio balance is decreasing (the second
quarter of 1998 as compared to the first quarter of 1998) as borrowers
refinance to take advantage of decreasing borrowing rates. The Company
expects loan servicing fee income to continue to decrease for the balance
of the fiscal year.
Total loan volume in the Company's production units is summarized below.
(Dollar amounts in thousands) Three Months Ended October 31,
- ---------------------------------- ---------------------------
1998 1997
----------- ------------
Retail $ 87,287 $ 922
Wholesale Prime 308,350 71,467
Wholesale Sub-Prime 22,231 51,575
--------- ---------
Total Loan Volume $417,868 $123,964
======== =========
The factors which affect the relative volume of production among the
Company's units include the price competitiveness of each unit's product
offerings, the level of mortgage lending activity in each unit's market,
the success of each unit's sales and marketing efforts and the operational
level of loan processing efficiency achieved. The incremental volume of the
Company's Mical unit since its acquisition in the current fiscal year
contributed Several factors contributed to the increase in volume.
(Complete) The Company intends to increase its loan production volumes
except in it's government (VA/FHA) offerings where it plans to decrease
those volumes in the short term while reviewing operations related to those
offerings. (??)
Interest income increased $1.3 million to $2.2 million for the quarter
ended October 31, 1998 due to the incremental interest earned at Mical. The
Company earns interest on, and incurs interest expense to carry, mortgage
loans held in inventory. Although the Company expects interest rates to
remain stable, interest income is expected to decrease as it decreases the
time loans are carried in inventory. While interest income may decline,
the proceeds from the sale of the loan will be received more timely and can
be used to service debt and reduce interest expense.
In connection with mortgage loan servicing activities, the Company
segregates escrow and custodial funds in a separate trust account and
excludes this balance of $12.1 million at October 31, 1998 and $16.0
million at April 30, 1998 from the Company's assets on the accompanying
balance sheet.
Retail broker fee revenue increased significantly, from 45,000 in the
second quarter of 1997 to $907,000 for the second quarter of 1998 quarter.
The increase was generated by the Company's start up retail unit
Interloan.com.
Of the total $6.7 million increase in expenses in 1998 over the 1997
corresponding quarter, interest expense increases accounted for $2.9
million. Of this amount, $1.3 million was incurred at Mical. The remaining
increase of $1.6 million was due primarily to the amortization of debenture
discount and debt issuance expenses, but partly due to interest expense
associated with increased warehouse credit line balances. Although the
debt discount is now fully amortized, the Company's interest rates and
other borrowing terms became less favorable (beginning in October) as a
result of the default interest rate imposed by its warehouse lenders. The
Company expects that interest expense will continue to remain high in the
third quarter of 1998 then return to more favorable terms when its
warehouse relationship and events of default are cured.
<PAGE> 15
Compensation and related employee expenses increased $2.6 million. $1.6
million was incremental expense incurred at Mical and the balance reflects
the Company's strategy of expanding and enhancing its revenue base.
Occupancy and other office expenses increased $626,000 as a result of the
incremental expenses incurred by Mical. In addition, the Company recorded
certain nonrecurring professional fees, most of which were legal,
consulting and accounting expenses related to the acquisitions.
COMPARISON OF SIX MONTHS ENDED OCTOBER 31, 1998 AND 1997
Revenues for the six months ended October 31 increased from $6.3 million in
1997 to $13.4 million in 1998. Of this $7.1 million increase, the
incremental effect of Mical (acquired in May of 1998) accounted for $5.7
million. Excluding Mical, revenue attributable to the remainder of the
businesses increased $1.4 million or 23%. The Company incurred a net loss
for the period of $7.4 million compared to $3.0 million for the comparable
prior year period. Of the $4.4 million change, $1.5 million was the
incremental loss at Mical and the balance of the businesses suffered a $2.9
million or 100% increase in net loss. This increased loss resulted from
$4.4 million of increased expenses, excluding the effect of Mical.
Interest expense increased $2.6 million, occupancy and compensation
increased $1.4 million and marketing expenses increased $.4 million.
Finet's business units, excluding Mical, recorded an increase of $1.4
million in overall revenues. This increase was due primarily to an
increase in retail broker fee income of $1.3 and an increase in loan
servicing fee income of $.7 million, partially offset by a decrease of $.6
million in gain on sale of mortgage loans and servicing rights. Retail
broker fee income increased as a result of the company's start-up
interloan.com unit.
Total loan volume in the Company's production units is summarized below.
(Dollar amounts in thousands) Six Months Ended October 31,
- ---------------------------------- ---------------------------
1998 1997
----------- ------------
Retail $145,791 $ 69,338
Wholesale Prime 618,810 512,350
Wholesale Sub-Prime 54,390 85,260
--------- ---------
Total Loan Volume $818,991 $666,948
======== =========
The loan volume increase was due equally to the added production of Mical
and the Company's other units.
Interest expense, excluding the impact of Mical, increased $2.6 million
over the comparable 1997 period due to the non-cash effect of the
amortization of the Company's debt discount associated with its 3%
Convertible Subordinated Debentures, but also due to higher interest
charges associated with the units that increased their warehouse borrowings
in support of increased loan activity. The Company began incurring
unfavorable default interest rates in October, which has some impact for
the six months, but will increase the Company's year to date interest
expense more significantly in the nine months that will end January 31,
1999. The Company expects to cure its default conditions and return to
normalized interest rates before the fourth quarter of this fiscal year.
Occupancy and compensation expenses (excluding Mical) are up $1.4 million
for the current six month period primarily due to..
<PAGE> 16
BUSINESS DEVELOPMENT ACTIVITIES
The Company's business development activities are focused on diversifying
its mortgage banking of prime conforming loans, and by increasing
electronic commerce revenues, including: (a) the offering of sub-prime and
government subsidized loans; (b) the distribution and use of its
proprietary Agent Connector and iQualify software; (c) the sale of
additional homeowner related products and services; (d) the sale of
business leads to real estate service providers; and (e) the origination of
loans as a mortgage broker.
Over the past several years, some lenders have expanded their mortgage
banking operations through acquisition of formerly independent mortgage
banking companies or through internal growth. The Company has similarly
expanded its mortgage banking operations through acquisitions and internal
growth, but, believing the growth of market acceptance and demand for on-
line homeownership services represents the greatest near term market
opportunity, has also concentrated on expanding its e-commerce origination
and fulfillment capabilities in these areas.
The Company is currently expending cash resources to support these business
development activities, as the revenues they are generating, though
increasing, are currently insufficient to cover start-up and operating
costs. The Company expects, within this business cycle, that all business
units will generate revenues sufficient to cover their respective operating
expenses. During the second quarter and subsequently the Company has
received several equity infusions from private investors. (See Note 6 and
Note 8 to the consolidated financial statements.) Considering the
additional equity financing from private investors that was agreed
subsequent to the second quarter, management believes it has sufficient
cash and short term financing alternatives for the remainder of the fiscal
year.
FINANCIAL CONDITION
Although Finet's revenue is growing, during its limited operating history,
it has experienced operating losses and cash flow deficits. The Company has
relied on external sources of debt and equity financing to fund operations,
to service debt and to complete acquisitions and capital investments. The
Company's operating losses, net of capital contributions, have had an
adverse affect on the Company's financial position, causing stockholders'
equity to decrease from $3.4 million at April 30, 1998 to $1.2 million at
October 31, 1998.
In response to these operating trends, Finet has installed new leadership,
including a new chairman and chief executive officer. The new team's
charter is to improve operations and to take full advantage of Finet's most
recent acquisitions and technology capabilities, ultimately improving
results from operations and financial position. Improvement in the
Company's financial condition is dependent on its ability to successfully
integrate and consolidate its recent acquisitions, to improve operating
processes and procedures, to cure its warehouse lending defaults, and to
manage interest expense by returning to more favorable borrowing terms.
The Company's financial condition is further dependent on economic
conditions such as the general health of the economy and demand for
homeownership related services. Management is committed to the Company's
future success; however, there can be no assurance that the Company will
attain future profitability.
Total assets increased from $101.4 million at April 30, 1998 to $138.0
million at October 31, 1998. This increase is due primarily to the
purchase accounting acquisition of Mical, partially offset by a decrease in
accounts receivable from sales of mortgage loans and servicing rights due
to increased efforts to sell loans. Liabilities increased from $98.1
million to $136.8 million, as the Company, including Mical, increased its
warehouse borrowings in support of increased loan volumes.
<PAGE> 17
LIQUIDITY AND CAPITAL RESOURCES
The nature of the mortgage lending business requires the Company to advance
cash on a daily basis to fund newly originated loans to its borrowing
customers. The majority of these funds are provided through conventional
mortgage warehouse line of credit from Residential Funding Corporation
("RFC") and from other warehouse lenders. The Company uses cash from its
operating activities to satisfy its obligations to RFC, to fund ongoing
expenses such as administration, to invest in product line and geographic
expansion, and to satisfy debt and other obligations as they come due.
Although new operating revenue sources were developed during 1997 and 1998,
cash generated by operations has been insufficient to meet the Company's on-
going requirements. Therefore, the Company has employed servicing-secured
credit facilities, private placements of debentures and common and
preferred stock issuances as additional resources to meet operating and
investing cash needs.
The Company was unable to make an interest payment of $119,255 in July, and
was unable to make a principal payment of $1.9 million due August 31, 1998
on a term loan. The lender has agreed to forbear from exercising its
rights and remedies of default in anticipation of the completion of a
private placement offering that has been agreed but has not closed. See
discussion under "Warehousing Facility with RFC". (See Notes 6 and 8.)
The proceeds will be used to cure the loan defaults described.
Operating Activities
In the six months ended October 31, 1998, the Company's operating
activities generated used cash of approximately $xxx,000, compared to cash
used by operations of $18.7 million during the comparable 1997 period.
Financing Activities
Cash from financing activities was $XX compared to the first six months of
1997.
In September 1998, the Company issued 250 shares of its $2.5 million Series
A Convertible Preferred Stock in a private placement generating $2.3
million of proceeds, net of expenses. See Note 6 to the Consolidated
Financial Statements.
In October 1998, the Company received $196,711 as the result of an exercise
of 262,281 warrants at seventy-five cents per share. The Company had
reduced the exercise price from $1.50 per share to seventy-five cents per
share.
Investing Activities
Investing activities, consisting primarily of sales of mortgage servicing
rights, provided cash $1.9 million for the six months ended October 31,
1998. The Company does not intend to purchase additional mortgage
servicing rights and is evaluating the sale of its servicing rights
portfolio. A sale, if consummated, would generate cash for servicing debt
and other obligations and for general operating purposes.
The Company's capital expenditures totaled $171,000 for the six months
ended October 31, 1998. The Company expects its level of capital spending
for the rest of the fiscal year to increase somewhat to make information
systems investments in preparation of Y2K compliance.
The Company believes that its cash resources, including unused borrowing
capacity and other sources of liquidity, are sufficient to finance the
Company's operating, investing and financing needs through April 30, 1999.
This assumption is based on additional equity investments the Company
expects to receive in the near term. Although agreements for the private
placement of 22.5 million shares netting proceeds of approximately $13.5
million have been reached, there can be no assurance that the financing
will close and that the cash will be received. Failure to receive such
payment would have a material, adverse affect of the Company's financial
condition and results of operations.
<PAGE> 18
SUBSEQUENT EVENTS
See Note 8 to the Consolidated Financial Statements.
YEAR 2000 COMPLIANCE
The Company has made and will continue to make investments to identify,
modify or replace any computer systems which are not Year 2000 (Y2K)
compliant and to address other issues associated with the change of the
millennium. These costs are expensed by the Company during the period in
which they are incurred. The financial impact to the Company of
implementing the systems changes necessary to become Y2K compliant is not
anticipated to be material to its financial position or results of
operations in any given year. However, the Company's expectations about
future costs associated with the Y2K are subject to uncertainties that
could cause the actual results to differ materially from the Company's
expectations. Factors that could influence the amount and timing of future
costs include the success of the Company in identifying systems and
programs that are not Y2K compliant, the nature and amount of programming
required to upgrade or replace each of the affected programs, the
availability, rate and magnitude of related labor and consulting costs and
the success of the Company's business partners, vendors and clients in
addressing the Y2K issue.
Company's state of readiness:
The Company, together with outside consultants it has engaged, has
formulated its overall plan to address the Y2K issue. The Company plans to
be substantially Y2K compliant by March 31, 1999, with the remaining effort
to be completed by June 30, 1999.
Steps taken to assure readiness by business partner, vendors, clients:
The Company, together with outside consultants it has engaged, has
formulated its overall plan to address the Y2K issue.
The Company:
(a) Has established a senior management steering committee.
(b) Is taking inventory of internally used hardware and software
as well as software developed for customers and peripheral
devices and equipment.
(c) Is identifying outside parties with whom the Company
interfaces electronically or operationally, such as business
partners, loan providers, customers, vendors and any others, to
1) confirm that their state of readiness will reduce any
financial or operational risk to the Company, and 2) understand
Finet's responsibility to its business partners.
(d) Is developing an external assessment process in order to
adequately assess the readiness of outside parties.
(e) Has determined the additional human resources necessary to
implement its overall plan.
(f) Has estimated the cost of compliance and determined it to be
reasonable but not material to the financial condition of the
Company or its results of operations.
(g) Is ensuring that new applications are Y2K compliant.
Risks of the company's Y2K issues:
The Company believes that given the hardware and software
replacement/modifications that it foresees, the risk of material financial
loss or operational disruption that might lead to financial loss is low to
medium. However, due to the nature of the mortgage banking industry there
are a significant number of outside third party interfaces that the
Company relies on for conducting business effectively. Their level of
compliance significantly influences the Company's level of risk of
disruption to operations which ultimately impacts the Company's results of
operations and financial condition.
The Company's contingency plans:
Finet is considering various contingency actions including alternative
vendors. The Y2K project planning calls for a fall back to manual
procedures if absolutely necessary, but the Company considers Y2K to be a
critical project and is being addressed it as such.
<PAGE> 20
PART II - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
The Company and certain subsidiaries are defendants in various legal
proceedings. After reviewing with counsel all such proceedings pending
against or involving the Company and its subsidiaries, management does not
expect the aggregate liability or loss, if any, resulting therefrom will
have a material adverse effect on the Company's results of operations or
consolidated financial position.
On May 19, 1998, the Company acquired 100% of the issued and outstanding
stock of Mical from its shareholders. Prior to said acquisition, on January
14, 1998, a lawsuit was filed against Mical in the United States District
Court for the Middle District of Georgia (the "Action"). The complaint
alleges, among other things, that in connection with residential mortgage
loan closings, Mical made certain payments to mortgage brokers in violation
of the Real Estate Settlement Procedures Act and induced mortgage brokers
to breach their alleged fiduciary duties to their customers. The plaintiffs
seek unspecified compensatory and punitive damages as to certain claims.
Mical's management believes that its compensation programs to mortgage
brokers comply with applicable laws and with long standing industry
practices, and that it has meritorious defenses to the Action. Management
has been advised by counsel, that the facts of the underlying transaction
are not supportive of a court order granting class certification. The
Company intends to defend vigorously against the Action and believes that
the ultimate resolution will not have a material adverse effect on the
Company's results of operations or consolidated financial position.
Item 2. CHANGES IN SECURITIES
During the six months ended October 31, 1998, the Company issued a total of
825,000 shares of common stock, as follows: 432,000 shares for the
acquisition of Mical and 33,000 shares as a finders fee, 73,000 shares
under a keep well agreement, and 25,000 shares toward the acquisition of
Interloan. In addition, 263,000 common shares were issued in connection
with warrant exercises and 654,000 shares were issued in connection with
option exercises, employment related issuances and other.
250 shares of Convertible Preferred Stock were issued in a private
placement. (See Note 6.)
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
Item 5. OTHER INFORMATION
On November 24, 1998, the Company's annual meeting of shareholders was held
in San Francisco, California. Including proxies and one shareholder voting
in person, a quorum of 57% of the 33,033,105 shares eligible to vote on the
October 15, 1998 record date were represented at the meeting. All current
Directors were re-elected for an additional one-year term and the following
measures detailed and recommended by the Company's Board of Directors in
the proxy statement were approved by the indicated percentage of shares
voted:
Increase in authorized common shares to 150,000,000 99.3%
Ratification of issuance of Common Stock, Debentures,
Preferred Stock and Warrants: 77.0%
Ratification of the 1998 Stock Option Plan 99.4%
Ratification of the 1998 Stock Bonus Plan 99.5%
Ratification of the 1998 Non-Employee Director Stock Option Plan 99.5%
<PAGE> 21
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBITS
EX-27 Financial Data Schedule
REPORTS ON FORM 8-K
REPORTS ON FORM 8-K
Date Item Description
- -------- ---- -----------------------------------------------------
12/7/98 2 Amendment of an 8-K previously filed, providing the
required financial statements and proforma information
related to the Company's acquisition of 100% of the issued
and
outstanding stock of Mical Mortgage, Inc.
SIGNATURE
In accordance with the requirements of the Securities and Exchange Act, the
Registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FINET HOLDINGS CORPORATION
Date: December 21, 1998 /s/ Mark L. Korell
Mark L. Korell
(CEO and Principal Executive
Officer)
Date December 21, 1998 /s/ George Winkel
George Winkel
(Principal Financial Officer)
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Registrant's unaudited financial reports and is qualified in its entirety
by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> APR-30-1999
<PERIOD-END> OCT-31-1998
<CASH> 137,000
<SECURITIES> 0
<RECEIVABLES> 19,125,000
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 5,684,000
<DEPRECIATION> 3,361,000
<TOTAL-ASSETS> 138,000,000
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
2,500,000
<COMMON> 391,000
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 138,000,000
<SALES> 0
<TOTAL-REVENUES> 13,361,000
<CGS> 0
<TOTAL-COSTS> 20,740,000
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6,339,000
<INCOME-PRETAX> (7,379,000)
<INCOME-TAX> 0
<INCOME-CONTINUING> (7,379,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (7,379,000)
<EPS-PRIMARY> (.23)
<EPS-DILUTED> (.23)
</TABLE>
