UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the year ended December 31, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 0-24940
PIONEER COMMERCIAL FUNDING CORP.
(Name of small business issuer in its charter)
New York 13-3763437
(State or other jurisdiction of
incorporation or organization) (I.R.S. Employer Identification No.)
21700 Oxnard Street, Woodland Hills, CA 91367
(Address of principal executive offices) (Zip Code)
Issuer's telephone number (818) 346-1921
Securities registered under Section 12(b) of the Exchange Act:
Title of each class Name of each exchange on which
registered
Common Stock NASDAQ
Warrants NASDAQ
Securities registered under Section 12(g) of the Exchange Act:
(Title of Class)
(Title of class)
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Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or
for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the
past 90 days. Yes x No
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B is not contained in this form, and no disclosure will
be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB.
State issuer's revenues for its most recent fiscal year $6,414,161.
As of March 1, 1999, there were 5,542,272 shares of the Registrant's
common stock, $.01 par value, issued and outstanding of which 2,139,090
held by non-affiliates of the Issuer. Based on the closing price for
shares of common stock on that date, the aggregate market value of the
common stock held by non-affiliates of the Issuer was approximately
$1,871,704. For purposes of the foregoing calculation only, all
directors and executive officers of the Issuers have been deemed
affiliates.
(ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE
YEARS)
Check whether the issuer has filed all documents and reports
required to be filed by Section 12, 13 or 15(d) of the Exchange
Act after the distribution of securities under a plan confirmed
by a court. Yes No
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
State the number of shares outstanding of each of the Issuer's classes
of common equity, as of the latest practicable date. As of March 31,
1999 there were 5,542,272 shares of common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The following exhibits are incorporated by reference to the
Registrant's Annual Report on Form 10KSB filed for the year ended
December 31, 1998 or to the Company's Registration Statement on Form
SB-2, Registration No. 33-82838 NY.
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<TABLE>
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<S> <C> <C> <C> <C> <C> <C>
Exhibit
Number Description
3.1 Certificate of Incorporation
3.2 Certificate of Amendment of the Company's Certificate of
Incorporation
3.3 Certificate of Amendment of Certificate of Incorporation of
the Company
3.4 By-Laws of the Company
10.1 Credit Agreement between Bank One, Texas, N.A.
and the Company
10.3 The Company's Non-Qualified Stock Option Plan
</TABLE>
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PART I
Item 1. Description of the Business.
General
Pioneer Commercial Funding Corp. ("Pioneer" or the "Company")
is a mortgage warehouse lender providing short-term (generally 10-90 days with
an average of 33 days per loan) financing to small and medium sized mortgage
bankers who hold ("warehouse") mortgage loans which they originate pending the
nonrecourse sale of such loans to institutional investor agencies in the
secondary mortgage market such as the Government National Mortgage Association
("GNMA"), the Federal National Mortgage Association ("FNMA"), and the Federal
Home Loan Mortgage Corporation ("FHLMC"); each one referred to herein as an
"Agency") and/or accredited financial institutions such as banks, thrifts,
insurance carriers and large mortgage bankers (each one and each Agency referred
to herein as a "Financial Institution").
The Company's Mortgage Lending Operations
The Company provides mortgage warehouse lines of credit for
small and medium sized mortgage bankers who have satisfied the Company's
financial, business and creditworthiness standards. The mortgage loans for which
the Company provides mortgage warehouse lending are primarily used to fund
purchases of owner and non-owner occupied residential Properties (maximum four
units).
In a mortgage warehouse loan transaction, the Company's
mortgage banking customer will first obtain a funding commitment from a
Financial Institution for a fee, which is usually a fraction of a percent of the
commitment amount. The Company's customer will then seek to fill the commitment
through the submission of one or more loans to the Financial Institution which
conform not only to the Financial Institution's established loan criteria, but
also to the commitment's rate and delivery date. These commitments can take
three forms: individual loan, small pool, or standard pool. An individual loan
commitment is an agreement by a Financial Institution, with a usual term of no
longer than two weeks, to purchase a single whole loan of a specified amount on
or before a specified date (the "Commitment Date") at a specified rate. A small
pool commitment is an agreement by a Financial Institution, with a usual term of
no longer than three weeks, to purchase an
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unrestricted number of whole loans of a specified total amount on or before a
specified date at a specified rate. A standard pool commitment is an agreement
by a Financial Institution, with a usual term of no longer than 90 days, to
purchase an unrestricted number of whole loans of a specified total amount of no
less than $1 million on or before a specified date at a specified rate.
Generally, the Company's customers do not possess sufficient capital or bank
lines of credit to fully fund loans they originate during the period of time
that transpires between the date on which a loan is closed and the Commitment
Date. Accordingly, the Company provides its customer with a line of credit that
is collateralized by each loan that the Company funds for its customer, which
enables the customer to hold (warehouse) the loan for the period of
approximately 10 to 90 days that typically occurs from the closing of the loan
until the Commitment Date. During this period, the Company holds the loan
documents (generally, the promissory note and an assignment of the first deed of
trust or mortgage securing the note), and upon its delivery of the loan
documents to the Financial Institution, the Company receives the full amount of
the loan and all other amounts payable to the mortgage banking company. The
Company applies such funds against amounts due from its customer to repay the
principal of the Company's warehouse loan to the customer and then remits any
excess funds to the customer.
The Company derives its revenues from both the
transaction-based fees that it charges its customers in connection with the
loans it funds on their behalf and the interest rate spread between the yield
paid by the Company to its financing sources for its borrowed funds, when
applicable, and the interest rate charged by the Company for mortgage loans that
it funds on behalf of its mortgage banking company customers. During the fiscal
years ended December 31, 1997 and 1998 (the "1997 fiscal year" and "1998 fiscal
year", respectively), such interest rate spread was generally 1.75% and 2.00%,
respectively.
Transaction fees are determined pursuant to a schedule based
upon the length of time between the funding of a loan by the Company and
reimbursement of same by the Financial Institution. During the 1997 and 1998
fiscal years, the Company's customers were charged an initial fee of $80 to $190
upon funding of a loan. If the loan was repaid within 60 days of the funding
date, additional fees were typically not earned by the Company on such loan. If
such loan was not repaid within said period, the customer paid an additional fee
of $300. Performance pricing incentives were also offered in the last quarter of
1998. Under this plan initial
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processing fees were reduced to $75 per loan for loans repaid in 30 days or
less. An additional fee of $75 per loan was charged for loans held for 31 to 60
days. Standard stale loan fees were charged thereafter. In addition, a yearly
facility fee ranges from 25 to 37.5 basis points based on the approved line of
credit to such customer. In the event that the Company disburses funds to a
title company in preparation for closing of a loan which thereafter does not
close, only the initial fee, plus interest for the one to three days that it
normally takes before such funds are returned by the title company to the
Company, are charged by the Company to its customer.
The Company's Bank One, Texas, N.A. Line of Credit.
As of March 31, 1997, the Company entered into a one year
credit agreement (the "Credit Agreement") with Bank One, Texas, N.A. ("Bank
One"). Pursuant to the Credit Agreement, Bank One provided the Company with a
$25,000,000 revolving line of credit (the "Bank One Credit Line") and the
Company paid fees ranging from $17.50 to $12.50 per loan based on monthly loan
volume. In addition, based on the type of the loan, the Company pays interest on
advances made by Bank One at a variable rate ranging from 1/8% below to 1/8%
above Bank One's prime rate of interest (the "Bank One Prime Rate"). The Bank
One Prime Rate is the rate quoted from time to time by the Wall Street Journal
as the base rate on corporate loans at large U.S. money center commercial banks
. As collateral security for its indebtedness to Bank One under the Credit
Agreement, the Company has granted to Bank One a security interest in various
assets including, but not limited to, all promissory notes acquired by the
Company with respect to any loan funded by the Company with proceeds of the Bank
One Credit Line and all mortgages or other forms of collateral securing the
funding of such loans. On August 25,1997, Bank One amended the credit facility
that it provides to the Company to $35,000,000. On September 26,1997 and
December 12, 1997 the facility was increased to $50,000,000 and $60,000,000,
respectively. On February 18, 1999, Bank One extended the Stated Termination
date to April 30, 1999. The Company and Bank One are currently in discussions
for an extension of at least a six month period. It is currently anticipated
that such an extension may be granted. In addition, Bank One amended the total
Principal Debt of Borrowings so that it may never exceed the lesser of either
(a) a $40,000,000 Commitment or (b) the sum of the Borrowing Base plus (i)
through and including February 28, 1999, $15,000,000, (ii) thereafter through
March 31, 1999, $10,000,000, and (iii) thereafter through April 30, 1999,
$5,000,000.
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Prior to the Credit Agreement with Bank One, the Company had a
line of credit with United Mizrahi Bank ("UMB"). The UMB credit line was paid in
full by the Company in February 1997.
The Company's Mortgage Banking Company Customers
During the 1998 fiscal year, the Company funded 3,172 loans
aggregating $172.6 million with the three largest customers, which accounted for
36.7% of its total fundings. The Company funded 893 loans aggregating $76.6
million for one customer, which accounted for 16.3% of the Company's fundings;
813 loans aggregating $53 million for the second customer, which accounted for
11.2% of the Company's fundings; and 1,466 loans aggregating $43 million funded
for the third customer, which accounted for 9.2% of the Company's fundings.
During the nine months ended December 31, 1997, the Company
funded 1,840 loans aggregating $134.5 million with the three largest customers,
which accounted for 43.2% of its total fundings. The Company funded 1,151 loans
aggregating $66.8 million for one customer, which accounted for 21.5% of the
Company's fundings; 487 loans aggregating $45.2 million for the second customer,
which accounted for 14.5% of the Company's fundings; and 202 loans aggregating
$22.5 million funded for the third customer, which accounted for 7.2% of the
Company's fundings.
At December 31, 1998, the Company had 39 mortgage banking
customers. During the year ended December 31, 1998, the Company funded 7,569
mortgage warehouse loans for an aggregate dollar volume of $470 million.
The Mortgage Loan Process
In order to be approved as a customer, a mortgage banking
company must satisfy a set of standards that have been established by the
Company.
All of the Company's customers are Financial
Institution-approved mortgage banks that generally originate three categories of
mortgage loans which are purchased by such Financial Institutions, i.e., (i)
residential mortgage loans which either have been insured by the Federal Housing
Administration, insured by the Farmer's Home Administration or guaranteed by the
Veteran's Administration (collectively, "FHA/VA Loans"); (ii) conventional
residential mortgage loans, i.e., non-FHA/VA Loans which comply
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with the requirements for sale to, or conversion into, mortgage-backed
securities issued by FNMA or FHLMC ("conforming loans"); and (iii)
non-conforming product which includes sub-prime loans.
After a customer has satisfied the Company's application
standards, a credit facility agreement is entered into by the Company and the
customer ("Credit Facility Agreement") which specifies, among other things, the
maximum amount which can be borrowed by the customer under the Credit Facility
Agreement, the maximum percentage of any single mortgage loan that will be
advanced, the interest rate and the terms of repayment. All funds advanced by
the Company under a Credit Facility Agreement are collateralized by a security
interest in the note and mortgage or deed of trust, as well as all instruments
and documents comprising the loan documentation on each loan funded by the
Company and a personal guaranty of the principals of the customer. To insure
completeness, the process of reviewing and determining whether an applicant has
satisfied these standards is fully monitored through the Company's Collateral
Tracking System (the "CTS"), which the Company utilizes to manage the risks
inherent in its business, and prepare, track and confirm the on-time delivery of
all necessary documents to the appropriate Financial Institution.
Within one day of the CTS's confirmation that all required
documentation has been received and reviewed by the Company's staff, the Company
will wire between 98% to 100% of the proceeds of the loan to the appropriate
escrow agent or title company with instructions to disburse the funds only upon
consummation of the loan closing, or otherwise return the funds to the Company.
At the time of closing, the mortgage banking company funds the balance of the
loan.
On or shortly before expiration of the Commitment Date, the
Company delivers all promissory notes and mortgage instruments comprising the
loans to be purchased pursuant to the Financial Institution's commitment to such
Financial Institution. Upon receipt of such funds from the Financial Institution
or the paying agent, the Company applies such funds against amounts due from the
customer to repay the principal of the Company's warehouse loan to the customer
and then remits the excess funds to the customer. By limiting the mortgage loans
funded to those that conform to Financial Institution criteria, which define the
prevalent standards for the entire secondary mortgage market, the Company
reduces its overall financing risk to those mortgages which are the most liquid
and readily acceptable by secondary mortgage market
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lenders.
Furthermore, the Company will have all of the data and
documentation necessary to sell the loan to another Financial Institution if,
for any reason, a Financial Institution refuses to accept and pay for a loan
subsequent to the closing thereof.
The Collateral Tracking System
The Company manages the risks inherent in its business and
prepares, tracks and confirms the on-time delivery of all necessary documents to
the appropriate Financial Institution with the CTS, a proprietary set of
computer-based operating software. The CTS, which was developed principally by
the Company for its business and not for resale to other mortgage financing
companies, provides the operating data controls that are used by the Company's
staff to run the business on a day-to-day basis. The CTS programs assist the
Company in its efforts to avoid problems caused by, and the monetary losses that
can result from, frequent short-term processing deadlines, the high volume of
loan transactions and the complex document structures of mortgage loan financing
transactions which are integral parts of the mortgage loan warehouse financing
business.
The CTS keeps track of all amounts funded under its customer's
line of credit, automatically determines whether a sufficient balance remains
thereunder to fund a particular loan and updates the available balance
information upon transfer of funds. The CTS generates all documentation
pertaining to the transfer of funds to the title company closing a loan, the
transmittal and release of loan documents to a Financial Institution, the
receipt of funds in payment of loans purchased by a Financial Institution, and
the distribution of funds due to the mortgage banking company.
The CTS programs, which include all phases of the Company's
mortgage financing operations, have been modified and altered over time so that
they meet the Company's evolving business requirements. CTS was first developed
in 1987 by principals of the Predecessor. In the year ended December 31, 1998
and the nine months ended December 31, 1997, the Company invested approximately
$15,469 and $52,235, respectively, for development and modification of the CTS
to meet the Company's needs.
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The Year 2000 Issue.
The Year 2000 ("Y2K") issue is the result of computer programs using a two-digit
format, as opposed to four digits, to indicate the year. Such computer systems
will be unable to interpret dates beyond the year 1999, which could cause a
system failure or other computer errors, leading to disruptions in operations.
The Company has two basic computer functions, accounting and collateral
tracking. Date sensitive calculations such as fees and interest charges and due
dates on loans comprising the Company's warehouse loans receivable and payable
would be negatively effected if the accounting and collateral tracking systems
were not compliant after the end of 1999. The Company, with the assistance of
outside software contractors, is in the process of changing its accounting and
collateral tracking computer systems from non-compliant systems run on AS400
hardware to a compliant system run on a Windows NT network. Final implementation
of fully tested and operationally Y2K compliant systems is projected to be
complete by the end of the second quarter of 1999. Cost incurred to date for
computer system enhancement, which includes work flow technology and collateral
document scanning for electronic storage as well as Y2K compliance, is
approximately $350,000 which is included in equipment and software fixed assets.
Additional costs to complete the project are expected to be less than $100,000.
The Company's banks and lender have communicated that they will be Y2K compliant
by the end of 1999. No other third party Y2K compliance is expected to have a
material impact on the operations of the Company.
Strategy.
The Company has embarked on strategies to meet competitive
forces in the mortgage market. These strategies include focusing on customers
with a broader product base such as non-conforming loans (loans which are not
sold to the Agencies) and home equity loans.
The Company is seeking acquisitions of complementary
businesses such as mortgage companies and companies that provide specialty
financial services within the mortgage industry.
Mortgage Banking Operations
On April 16, 1997, the Company entered into a joint venture
agreement with Maryland Financial Corporation ("MFC") to form Pioneer Home
Funding, LLC, a California limited liability company ("PHF"). The Company
accounts for this investment on the equity method. The agreement provides that
the Company and MFC would maintain a 80 percent and a 20 percent ownership
interest, respectively. An amendment to the agreement was made on October 31,
1997. This amendment provides that the Company would contribute $40,000 for a 20
percent interest in PHF. In addition, the Company may from time to time make
loans to PHF as needed. Under this agreement the Company has the option to
convert loans made to PHF into an 80 percent interest in PHF. For the nine
months ended December 31, 1997 and the year ended December 31,1998 the Company
has made advances to PHF and is reflecting a receivable (included
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in other assets on the balance sheet) totaling $224,476 and
$275,344, respectively. At December 31, 1998, the Company has
recorded a reserve aggregating $110,000 against this receivable due
to the financial condition of PHF.
Competition.
The business of originating and financing the origination of
residential mortgage loans is highly competitive. In order to obtain qualified
residential mortgage loans from small to medium sized originating mortgage
bankers, the Company competes with national, regional and local commercial banks
and mortgage banking companies who engage in mortgage loan warehouse lending
that have longer operating histories and significantly greater resources than
those of the Company in providing multi-state, computer-based bridge financing
of residential mortgage loans. In recent years, a declining interest rate
environment favorable to mortgage loan originations has existed. During the
period 1997-1998, larger, established mortgage banking companies have formed
mortgage warehouse divisions. The Company believes that as an independent
warehouse lender, it can effectively compete by adjusting to an ever-changing
mortgage market while providing a high-quality service through experienced
management and information provided to the Company's customers through the CTS.
Seasonality.
The mortgage banking industry is generally subject to seasonal
trends. These trends reflect a national pattern of sales and resales of
homes, although refinancing tends to be less seasonal and more closely
related to changes in interest rates. Sales and resales of homes
typically peak during the spring and summer and decline to lower levels
from December through March.
Regulation - Mortgage Warehouse Lending.
Mortgage loan warehousing is not presently subject to federal
regulation. At the state level, the California Finance Lenders Law went into
effect July 1, 1995. This law imposes licensing obligations on the Company,
requires the filing of annual and periodic reports, establishes maximum interest
rates and repayment terms in certain cases, and provides for fines and
imprisonment for violation of the law. Other participants in the mortgage
warehouse financing process, such as title companies and appraisers, are
regulated by the states in which they reside and such regulations
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often determine the scope and approach of the Company's collateral control
monitoring program. Furthermore, mortgage banking is a highly regulated
industry. The Company's mortgage banking customers are subject to the rules and
regulations of, and examinations by, the Federal Housing Administration ("FHA"),
the Veterans Administration ("VA"), GNMA, FNMA, FHLMC and state regulatory
authorities with respect to originating, processing, underwriting, selling,
securitizing and servicing residential mortgage loans. In addition, there are
other federal and state statutes and regulations affecting such activities.
Employees
At December 31, 1998 the Company employed 18 full-time employees. None
of the employees of the Company is represented by a labor union or is subject to
a collective bargaining agreement. The Company believes that its relations with
its employees are good.
Item 2. Property
On October 17,1997, the Company entered into a ten year lease
to rent 6,846 square feet on the sixteenth floor of an office building at 21700
Oxnard Street, Woodland Hills, California. The monthly base rent during year one
through five is $13,692 and for
years six through ten is $15,745.
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Item 3. Legal Proceedings.
During October 1997 the Company warehoused $1.7 million in
mortgages for a customer who used a third party conduit, American Financial
Mortgage Corporation, to sell its loans to an investor, Norwest Funding, Inc.
The Company provided instructions to the third party conduit that the funds were
to be wired by the investor to the Company's bank. The investor mis-wired the
funds to the conduit's bank, Corestates Bank, N.A. the conduit's bank has
refused to return the funds. The Company commenced legal action, to collect the
funds from the conduit, the conduit's guarantor, the investor and the conduit's
bank. The Company's lender, Bank One Texas, N.A. ("Bank One"), has joined the
litigation as a co-plaintiff in support of the Company's position. In addition
the company has a $5 million personal guarantee from the third party conduit's
primary shareholder and an additional $2 million guarantee from the customer's
primary shareholder. Although it is impossible to determine the ultimate outcome
of this matter, management believes that it will recover the funds.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
PART II
Item 5. Market for Common Stock and Related Stockholder Matters.
The Common Stock issued by the Company in connection with the
IPO has been listed on the Nasdaq SmallCap Market since August 14, 1996 under
the symbol "PCFC". The following table sets forth below the high and low sale
prices for the Common Stock for the periods indicated:
Quarter Ended High Low
------------- ---- ---
March 31, 1997 $ 3.00 $ 0.78
June 30, 1997 $ 2.50 $ 1.25
September 30, 1997 $ 2.8125 $ 1.875
December 31, 1997 $ 2.875 $ 1.50
March 31, 1998 $ 2.6875 $ 1.75
June 30, 1998 $ 3.25 $ 1.875
September 30, 1998 $ 2.4375 $ 1.25
December 31, 1998 $ 2.25 $ .25
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As of December 31, 1998, there were 23 record holders of the Common
Stock.
Dividend Policy and Restrictions on Payment of Dividends.
The Company has never paid cash dividends on its Common Stock.
Furthermore, the provisions of the plan of reorganization (the "POR") pertaining
to the Predecessor's emergence from bankruptcy prohibit the Company from paying
any dividends to its common shareholders until the sum of $1,350,000 shall have
been paid to the Predecessor's pre-bankruptcy unsecured creditors. As of
December 31, 1998, no payment to the unsecured creditors has been made. Further,
in accordance with the POR, the Predecessor became obligated to pay certain
portions of its net income in satisfaction of said payment obligation to its
pre-bankruptcy creditors. Upon consummation of the Merger, the Company became
obligated, by operation of law, to comply with such payment obligation and
dividend payment prohibition, among other operating restrictions. The Company
does not anticipate paying cash dividends on the Common Stock in the foreseeable
future as it intends to retain future earnings to finance the growth of the
business. The payment of future cash dividends on the Common Stock will depend
on such factors as earnings levels, anticipated capital requirements, the
operating and financial condition of the Company and other factors deemed
relevant by the Board of Directors.
Item 6. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Certain matters addressed in this Annual Report may constitute
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of
1934, as amended. Such forward-looking statements are subject to a variety of
risks and uncertainties that could cause actual results to differ materially
from those anticipated by the Company's management. The Private Securities
Litigation Reform Act of 1995 (the "Act") provides certain "safe harbor"
provisions for forward-looking statements. All forward-looking statements made
in this Annual Report are made pursuant to the Act.
General
The Company commenced active operations on June 14, 1993
following its emergence from Chapter 11 bankruptcy proceedings.
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The Company did not engage in any substantial mortgage warehouse lending
activities from the time it emerged from bankruptcy through March 31, 1997.
During the nine months ended December 31, 1997 the Company significantly
increased its financing facility and began the process of evaluating many new
customer relationships. On March 31, 1997 the Company entered into a credit
agreement with Bank One. On August 25, 1997, Bank One amended the credit
facility that it provided to the Company to $35,000,000. On September 26, 1997
and December 12, 1997 the facility increased to $50,000,000 and $60,000,000,
respectively. The line of credit was reduced to $50,000,000 on October 1, 1998
and $40,000,000 on October 30, 1998.
As of December 31, 1997, the Company had 46 customers and
during the nine months then ended had funded 4,824 loans with an aggregate value
of $311 million.
As of December 31, 1998, the Company had 39 customers and had
funded 7,569 loans with an aggregate value of $470 million.
Results of Operation for Year Ended December 31, 1998 Compared to
the Nine Month Period Ended December 31, 1997.
Revenues: The Company's revenues increased to $6,414,161 for
the year ended December 31, 1998 from $3,115,750 for the nine month period ended
December 31, 1997. This increase is attributable to the additional three months
in the 1998 period, a continued increase in the volume of loans and an increase
in the amount of borrowings outstanding during the period. The aggregate loan
volume for the year ended December 31, 1998 was $470 million on 7,569 loans
compared to $311 million on 4,824 loans for the nine month period ended December
31, 1997. During the year ended December 31, 1998, the average loan size was
$62,095 with an average duration of 33 days compared to an average loan size of
$64,879 with an average loan duration of 26 days for the nine month period ended
December 31, 1997. Processing fees for the year ended December 31, 1998
increased to $1,752,390 from $842,654 for the nine month period ended December
31, 1997. Attending this increase in loan volume is the interest component of
revenues (interest charged customers). Interest revenue increased to $4,424,386
for the year ended December 31, 1998 from $2,163,182 for the nine month period
ended December 31, 1997.
Interest and Fee Costs: The Company's direct costs consist of
interest and other charges that it pays to its revolving credit line provider.
The Company's interest and fee charge for the year ended December 31, 1998 was
$3,991,137 as compared to $1,737,215 for the nine months ended December 31,
1997. This increase is attributable to the increase in loan funding volume and
the additional three months in the year ended December 31, 1998. The Company
funded 7,397 loans for a total amount of $462
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million through bank borrowings for the year ended December 31, 1998 compared to
4,448 loans for the nine month period ended December 31, 1997 with a total loan
amount of $287 million.
The increase in average loan duration is primarily due to the
shortage of liquid funds supplying the secondary market for subprime and high
loan to value residential mortgage loans which occurred in the third and fourth
quarters of 1998. Several major mortgage investors withdrew from the market.
Others refused to honor their commitments at contracted prices and terms. This
situation adversely affected several of the Company's customers as they were
unable to sell loans under previously contracted terms. Accordingly, the
Company's customers had to resell these loans to new investors who, as a result
of the tight money supply, dramatically tightened their loan specification
requirements and dropped their prices resulting in a significant slow down in
loan turnover. This was especially true with high loan to value loans which
comprised a large percentage of the Company's loan base. As a result of the
above described tightening of the mortgage money supply, five of the Company's
clients have downsized their operations in anticipation of exiting the mortgage
origination business and in so doing have reduced resources available to perform
the tasks required to effectively and timely resell their loans to new
investors, further adding to the length of time such loans stay on the Company's
line of credit.
Loan Loss Provision: The $1,016,450 loan loss provision for the year ended
December 31, 1998 is due to the recognition of a discount on the sale of loans
during the year and the accrual of a reserve for estimated losses on the future
disposition of loans held for sale, mortgage warehouse loans and for
uncollectible interest and fees receivable. The Company sold 32 of the 37 loans
held for resale with an original loan value of $3,806,115 at a discount of
$72,070. Management estimates that the remaining five loans held for resale may
also sell at a loss. In addition, management estimates that certain other
uncommitted mortgage warehouse loans belonging to customers described above may
be sold at discounts significant enough that those customers may be unable to
cover the shortage and pay all of the accrued interest and fees thereon.
Accordingly, an estimate for these future losses has been reserved. No such
provision was made in the nine month period ended December 31, 1997.
Other Operating Expenses: Other operating expenses increased
16
<PAGE>
to $2,597,223 in the year ended December 31, 1998 from $919,005 in the nine
month period ended December 31, 1997. Compensation and benefits increased to
$1,055,972 in the year ended December 31, 1998 from $370,077 in the nine month
period ended December 31, 1997 due to the additional three months included in
the year ended December 31, 1998 and the increase in employee strength required
to process the additional volume of loans. The amount of time to process each
loan from funding to repayment increased in 1998 due to the additional efforts
required to insure loans met the more rigorous specifications of investors as a
result of the tight money supply in the secondary market for high loan to value
residential mortgages and to assist customers in their efforts to resell loans
with unhonored commitments.
Depreciation expense increased to $202,530 in the year ended
December 31, 1998 from $36,421 in the nine month period ended December 31, 1997.
The fixed asset base upon which depreciation is determined increased from highly
depreciated furniture, equipment and software in service in the nine month
period ended December 31, 1997 while the Company resided in the Reseda location
to a fixed asset base of virtually all new furniture, leasehold improvements,
computer equipment and additional scanning software in the year ended December
31, 1998. Fixed assets increased to $1,374,179 from $682,382 and net fixed
assets increased to $732,796 from $233,529 at December 31, 1998 from December
31, 1997.
Professional fees, which include accounting and legal fees,
increased to $322,075 for the year ended December 31, 1998 from $127,136 for the
nine month period ended December 31, 1997 primarily due to the additional costs
attendant to the lawsuit, more fully described in Item 3, against Corestates
Bank, N.A., American Financial Mortgage Corporation and Norwest Funding, Inc.
Rent expense increased to $210,591 for the year ended December
31, 1998 from $37,072 for the nine month period ended December 31, 1997 due to
the move at the beginning of 1998 from the Reseda location with a base monthly
rent of $2,178 per month to the Woodland Hills office with a $13,692 base
monthly rent. During 1998 the Company was obligated on leases for both
locations. The Reseda office was sublet to three lessees beginning in the last
quarter of 1998.
17
<PAGE>
Net Loss Versus Net Income:
The Company incurred a net loss of $1,158,753 including a loan
loss provision of $1,016,450, for the year ended December 31, 1998 compared to
net income of $529,743 for the nine month period ended December 31, 1997.
Depreciation and rent expense increases associated with the move from Reseda to
Woodland Hills, which management considered necessary for the planned growth of
the Company, had a negative effect on 1998 earnings. The investor tightening of
loan specification requirements further increased the required processing time
per loan in the second half of 1998 and the Company's reduction of processing
fees in the last quarter of 1998 also had a negative effect on 1998 earnings.
Cash Flows:
Operating Activities: In spite of a $1,158,753 loss for the
year ended December 31, 1998, the Company generated $15 million from
operating activities as a result of a reduction in warehouse mortgages
receivable of $13 million and the sale of $4 million in loans held for
resale. In the nine month period ended December 31, 1997 the Company
utilized $50 million due to increases of $45 million of mortgage
warehouse loans, $4.5 million of loans held for resale and $1.7 million
of receivables for loans shipped.
Investing Activities: In 1998, $380,537 was invested in fixed
assets and $199,625 was advanced to Pioneer Home Funding. In the nine month
period ended December 31, 1997, $413,592 was invested in fixed assets, $264,476
was invested in Pioneer Home Funding and $225,000 was invested in Fidelity First
Mortgage Corp.
Financing Activities: In 1998, $16.7 million was used to
reduce short term borrowings on the Company's line of credit compared to a $50
million net increase in cash provided by short term line of credit borrowing in
the nine month period ended December 31, 1997. In 1998, $726,000 and $241,000
was generated by the issuance of subordinated debt and common stock compared to
$1,000,000 and $9,000 for the nine month period ended December 31, 1997.
Liquidity and Capital Resources:
Bank One has continued to make available to the Company a
revolving line of credit of $40 million. The Company's primary
18
<PAGE>
sources of capital which it employs in its warehouse lending operations are
borrowings under its Bank One line of credit and its net equity capital funds of
approximately $5.2 million and $1.7 million in subordinated debt. The Company
and Bank One are currently in discussions for an extension of at least a six
month period. It is currently anticipated that such an extension may be granted.
Item 7. Financial Statements
See pages F-1 to F-25
Item 8. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.
On November 11, 1998 the Registrant appointed Lazar Levine &
Felix LLP as the new auditors for the Registrant. The change in auditors was
approved by Registrant's Board of Directors. The reason for the change was that
Grant Thornton LLP, the present auditor, indicated that they would not renew
their engagement for the year ended December 31, 1998. There were no
disagreements with Grant Thornton LLP on any matter of accounting principles or
practices, financial statement disclosure or audit scope or procedure which if
not resolved to the satisfaction of the former accountants would have caused
them to make reference to the subject matter in their report. None of the events
listed in paragraphs (B) through (D) of Regulation S-B Item 304 (a) (1) (iv)
occurred.
PART III
Item 9. Directors, Executive Officers and Control Persons.
Executive Officers and Directors
The executive officers and directors of the Company are as follows:
Name Age Position
Boaz Harel......... 35 Chairman of the Board,
Director
19
<PAGE>
M. Albert Nissim... 65 President, Director
John O'Brien. . . . 51 Vice President,
Chief Financial Officer
David W. Sass...... 63 Secretary
Richard Fried...... 52 Director
Tamar Lieber....... 56 Director
Lynda Davey........ 44 Director
Joseph Samuels..... 68 Director
Boaz Harel was appointed to the Board in November 1996 and
elected as Chairman of the Board on July 2, 1997. From 1991 to 1993, Mr. Harel
was the founder and managing director of Mashik Business and Development Ltd.,
an engineering consulting company. Since 1993, Mr. Harel has been the Managing
Director of Leedan Business Enterprise Ltd. ("Leedan"), a publicly-held Israeli
company which is the beneficial owner of 58% of the Company's Common Stock.
Since January 1994, Mr. Harel has served as a member of the Supervisory Board of
ICTS International N.V. and since September 1996, Mr. Harel has served as the
Chairman of ICTS USA (1994), Inc., an indirect subsidiary of Leedan. Since 1997
Mr. Harel has been Co-Managing Director of Leedan International Holdings B.V., a
principal shareholder of the Company and an indirect wholly-owned subsidiary of
Leedan.
M. Albert Nissim was appointed as the President of the Company
in January 1997 and was elected to the Board on September 25, 1997. He has
served as Secretary of ICTS International N.V. since January 1996. Mr. Nissim
has also served as President of ICTS USA (1994), Inc. since January 1994. From
1994 to 1995, he served as Managing Director of ICTS International B.V. Mr.
Nissim served as the President of Harel & Partners from 1991 to 1994. From 1990
to the present, he has been the Vice President and a director of Tuffy
Associates Corp., an automotive repair franchise company affiliated with Mr.
Ezra Harel, the brother of Boaz Harel. Mr. Nissim is also a Co-Managing Director
of Leedan International Holdings B.V., a principal shareholder of the Company.
In April 1997, Mr. Nissim was appointed as one of the Company's designees on the
Board of Directors of Pioneer Home
20
<PAGE>
Funding, L.L.C., a subsidiary of the Company.
John O'Brien was appointed Vice President and Chief Financial
Officer on April 28, 1998. Mr. O'Brien is a California Certified Public
Accountant and has previously served as the Chief Financial Officer of Paramount
Citrus Association, Sun Pacific and ABBA Pure and Natural Hair Care Products.
Prior to that Mr. O'Brien was an audit manager with Ernst & Young. Mr. O'Brien
earned a BS degree in Business Administration (Accounting) from California State
University at Northridge in 1973.
David W. Sass has been a Director since April, 1998 and has
been a practicing attorney in New York City for the past 38 years and is
currently a senior partner in the law firm of McLaughlin & Stern, LLP,
securities counsel to the Company. Mr. Sass is also a director of Pallet
Management Systems, Inc., a company engaged in the manufacture and repair of
wooden pallets and other packaging services and a director of The Harmat
Organization, Inc., a New York based construction company and a member and Vice
Chairman of the Board of Trustees of Ithaca College. Mr. Sass earned a B.A. from
Ithaca College, a J.D. from Temple University School of Law and an L.L.M. (in
taxation) from New York University School of Law.
Richard Fried was appointed to the Predecessor's Board in
February 1994 and served as Vice-President of the Predecessor. Upon consummation
of the Merger in November 1994, he became a director of the Company. Since June
1991 Mr. Fried has served as President of Medical Systems, Inc., an application
software development company, of which he has been a principal shareholder. From
February 1993, he has served as President of Montgomery Associates, Inc., a
corporation wholly-owned by him, which is engaged in business as an
importer-exporter. Since April 1993, Mr. Fried has been a principal shareholder,
and has served as President, of Sea Change Systems, Inc., a software tools
development company. From April 1993 to May 1994, he was a Branch Manager of LPL
Financial Services, a stock brokerage firm, which is an NASD member firm. Since
November 1994, Mr. Fried has been a controlling shareholder and has served as
President of SMARTpay, Inc., a collection service. From April 1995 he has served
as President of Centennial Systems, Inc., a software distribution, sales and
service firm of which he is a principal
21
<PAGE>
shareholder. Since October 1996, Mr. Fried has been a controlling shareholder,
and has served as President, of Leeward Software, Inc., an application software
developer. From October 1996 he has also served as President of Windward
Software, Inc., a materials management software intellectual property company of
which he is also a principal shareholder. From December 1996 he has served as
President of Strategic Reporting Systems, Inc., a database report generation
software development and distribution firm of which he is a principal
shareholder. From April 1997, he has served as managing director of HYCOM USA,
Inc., an international software development and distribution company, of which
he is a principal shareholder.
Tamar Lieber was appointed to the Board in June 1995. Ms.
Lieber has been engaged in practice as a senior psychotherapist at the Center
for Preventive Psychiatry in White Plains, New York, a non-for profit community
mental health clinic, for more than the past five years.
Lynda Davey was elected to the Board on September 25, 1997. Ms. Davey has served
as the President of Avalon Group, Ltd. And Chairman of Avalon Securities, Ltd.,
private investment banking firms, since April, 1992. From April, 1988 throughout
1991 Ms. Davey was Managing Director and head of investment banking at Tribeca
Corporation, a New York merchant bank. Prior to 1988, Ms. Davey was
Vice-President of the Merchandise and Retail Group in the corporate finance
department of Salomon Brothers Inc. Ms. Davey also serves as a director of Tuffy
Associates Corp. And the Center for Design Innovation of the Fashion Institute
of Technology. Ms. Davey is a registered architect.
Joseph Samuels has served as a president and is the sole
shareholder of Fulton Properties of Calif. Inc., an investment corporation
engaged in acquisition, development and management of real estate for more than
the past five years. Mr. Samuels has also served as President and is the sole
shareholder of Goldsboro Properties Inc., a real estate holding corporation, for
more than the past five years.
Item 10. Executive Compensation.
The following table sets forth compensation awarded to, earned
by or paid to executives of the Company. No executive officer of the Company
earned a salary and bonus of more than $100,000 during the 1997 fiscal year.
During such fiscal year, the Company did not grant
22
<PAGE>
any restricted stock awards or stock appreciation rights to any of its
executives.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Annual Compensation Awards
Name and
Principal Position Fiscal Year Salary($) Bonus($) Other Annual Securities
Compensation ($) Underlying
Option
Boaz Harel* 1998(1) $100,000 $15,000 100,000
Chairman of the Board 1997(2) $25,000 15,000
M. Albert Nissim** 1998(1) $118,654 $12,000 50,000
President 1997(2) $54,000 90,000
John O'Brien*** 1998(1) $58,513
Chief Financial Officer
David W. Sass**** 1998(1) $ 0
Secretary
</TABLE>
* Commenced as Chairman on July 2, 1997.
** Commenced service as President of the Company in the fourth quarter of the
1996 fiscal year. *** Commenced service as Chief Financial Officer in the second
quarter of the 1998 fiscal year. **** Commenced service as Secretary in the
second quarter of the 1998 fiscal year.
(1) For the Year Ending December 31, 1998
(2) Nine Months ended December 31, 1997
(3) For Fiscal Year Ending March 31, 1997
Compensation of Directors.
The Directors of the Company received cash compensation of
$300 per meeting in his or her capacity as a director.
Options Issued to Executives.
In consideration of the services rendered by Messrs. Goldberg
and Housman, in lieu of payment of salaries, between June 1995 and the closing
of the IPO, the Company issued five year options to each of them to purchase
75,758 shares of Common Stock at an exercise price of $5.00 per share. Such
options were not issued pursuant to the Company's Incentive Stock Option Plan.
The table below sets forth information
23
<PAGE>
regarding option grants to executive officers and Directors of
the Company.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Number of Exercise Price
Name Options Granted Per Share Expiration Date
M. Albert Nissim(1) 50,000 $5.00 October, 2000
90,000 $2.50 February, 2000
Arthur Goldberg* 75,758 $5.00 August, 2001
Elie Housman* 75,758 $5.00 August, 2001
Boaz Harel(1) 100,000 $2.375 October, 2000
15,000 $1.125 January, 2000
Richard Fried(1) 24,000 $2.125 October, 2000
15,000 $1.125 January, 2000
Tamar Lieber(1) 24,000 $2.125 October, 2000
15,000 $1.125 January, 2000
Lynda Davey(1) 24,000 $2.125 October, 2000
15,000 $1.125 January, 2000
Joseph Samuels(1) 24,000 $2.125 October, 2000
15,000 $1.125 January, 2000
*Former officer and director.
</TABLE>
(1) Options vested at the rate of 1/3rd each year.
Executive Compensation.
On May 12, 1998, Albert Nissim's compensation was increased to
$9,500 per month effective April 1, 1998 in consideration of his contributions
to the Company. In addition, Mr. Nissim was awarded a $12,000 bonus payable in
the second quarter in consideration of the Company's performance.
On May 12, 1998 Boaz Harel was awarded a $15,000 bonus,
payable in the second quarter in consideration of the Company's performance.
24
<PAGE>
Employment Agreements.
In July 1997, the Company extended the Employment Agreement
with M. Albert Nissim as President for an indefinite period, on a part-time
basis, at a salary of $6,000 (amended to $9,500) per month. The Agreement may be
terminated by either party on not less than 90 days prior notice.
Boaz and Leedan Agreement
The Company has approved a compensation plan for Mr. Boaz
Harel and/or Leedan Business Enterprises, Ltd. ("Leedan"), the company which
provides management services to the Company by making Mr. Harel available to the
Company. Leedan is also a principal shareholder of the Company. The plan
provides aggregate renumeration to Mr. Harel and/or Leedan of $100,000 per annum
plus 5% of the Company's net income pre-tax above $1,000,000 annually. Leedan
and Mr. Harel will determine how such compensation will be divided between them.
Item 11. Security Ownership of Certain Beneficial Owners and
Management
The following table sets forth the holdings of the Common
Stock as of March 1, 1999 by each person or entity known to the Company to be
the beneficial owner of more than five percent (5%) of the outstanding shares of
Common Stock and by (1) each director and named executive officer; and (2) all
directors and executive officers as a group.
25
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Number of Shares Percent
Name Title of Common Stock of Class
ICTS International N.V. 300,000 5.4%
Vertrekpassage 226
1118 AV Schiphol Airport
Holland
Lancer Partners L.P. 345,000 6.2%
200 Park Avenue, Ste 3900
New York, NY 10166
Leedan Business
Enterprise Ltd. 2,376,136(1) 42.9%
("Leedan Business")
8 Shaul Hamelech Blvd.
Tel-Aviv 64733, Israel
Rogosin International B.V. 530,000(3) 9.5%
One Rockefeller Plaza,
Ste. 2412
New York, NY 10020
Boaz Harel Director 2,376,136(1)(2) 42.9%
1 Rockfeller Plaza
Suite 2412
New York, New York
10020
M. Albert Nissim President and 140,0004 *
One Rockefeller Plaza Director
Suite 2412
New York, NY
Tamar Lieber Director 339,000(5) 5.8%
160 W. 66th Street
Apt. 49B
New York, NY 10023
Richard Fried Director 51,046(5) *
33 Marian Road
Marblehead, MA 01945
Lynda Davey Director 24,000(5) *
1375 Broadway 15,000
5th Floor
New York, NY 10018
Joseph Samuels Director 24,000(5) *
321 24th Street 15,000
Santa Monica, CA 90402
Directors and
Executive
Officers as a
group (6 persons) 2,984,182 53.8%
* Less than 1%
</TABLE>
26
<PAGE>
(1) Leedan International Holdings B.V., which together with Leedan Systems &
Properties Promotion (1003) Ltd. Holds 48.2% of the issued and outstanding
Common Stock of the Company, is an indirect wholly-owned subsidiary of Leedan
Business. Certain members of the family of Mr. Boaz Harel, a director of the
Company, collectively, own approximately 57.5% of the outstanding shares of
Leedan Business. Mr. Harel, owns approximately 17% of the outstanding shares of
Leedan Business and disclaims beneficial ownership of any stock of Leedan
Business held by an other member of the Harel family.
(2) Does not include three year option for 100,000, vesting 1/3rd each year,
exercisable at $2.375 per share nor a three year option for 15,000 shares
exercisable at $1.125 per share, vesting 1/3rd each year.
(3) An affiliate to Leedan Business Enterprises Ltd. Shares were purchased in a
private transaction.
(4) Includes 90,000 shares of Common Stock exercisable at $2.50 per share which
Mr. Nissim has the right to acquire within 60 days from the date hereof upon
exercise of an option held by him and 50,000 option exercisable at $5.00 per
share at the rate of 1/3rd per year for three years.
(5) Includes 24,000 shares as part of a 3 year option, exercisable at $2.125 per
share, vesting at the rate of 1/3rd per year for three years as well as 15,000
shares as part of a three year option exercisable at $1.125 per share, vesting
at the rate of 1/3rd per year.
(6) Does not include any options referred to in notes (2), (3), (4) and (5)
hereof.
Item 12. Certain Relationships and Related Transactions
Certain Transactions.
On November 18, 1998 a settlement was reached with a guarantor
of a mortgage banking customer's defaulted line of credit. The guarantor was
also a company stockholder. Pursuant to the settlement, an entity which is an
affiliate of Leedan accepted $530,000 of the guarantor's recognized debt to the
Company in exchange for the guarantor's shares in the Company. This entity paid
the Company $176,667 and issued two installment notes of $176,667 each with
maturity dates of August 23, 1999 and May 23, 2000, respectively. These notes
bear interest at a rate of 8.25% per annum and are payable quarterly commencing
three months from the date of issuance which was November 23, 1998.
On November 18, 1998, a settlement was reached with a
guarantor of a mortgage banking customer's defaulted line of credit. The
guarantor was also a Company stockholder. Pursuant to the settlement, Rogosin
Business Enterprises Ltd., accepted $530,000 of the guarantor's recognized debt
to the Company in trade for the guarantor's shares in the Company. Furthermore,
pursuant to the settlement, the guarantor issued two additional notes in the
amount of $735,102 to the Company.
27
<PAGE>
Pursuant to the settlement as stated above, the guarantor
issued to the Company two installment notes in the amounts of $265,103 and
$470,000, respectively. These notes bear interest at a rate of 8.25% per annum
and are payable quarterly commencing three months from November 18, 1998, the
date of issuance of the notes. Both notes mature November 18, 2000.
On September 14, 1998 Joseph Samuels, a Director of the Company and two
affiliates of Leedan Business Enterprises Ltd. loaned to the Company $100,000
and $550,000 and $76,000, respectively. The loan was in connection to the Ninth
Amendment to the Credit Agreement with Bank One to authorize the infusion of an
aggregate of $726,000 in the form of the Company's 11% Subordinated Debenture
for a term until a new lending facility is in place to replace Bank One.
On April 2, 1997 and April 4, 1997, the Company issued unsecured loans
of $400,000 and $600,000, respectively, to Rogosin Converters, Inc., an
affiliate of the Company. Members of the family of Mr. Boaz Harel, a director of
the Company, have an indirect controlling interest in Rogosin Converters, Inc.
The loans were guaranteed by Leedan International B.V., a shareholder of the
Company. The Company earned interest of 12% per annum on the loans, which
interest was paid monthly. The principal and accrued interest on the loans were
paid in full on June 20, 1997.
Item 13. Exhibits & Reports on Form 8-K
(A) The Following financial statements are included in Part II, Item
7:
Independent Auditors' Report by Lazar, Levine & Felix, LLP for year
ended December 31, 1998
Independent Auditors' Report by Grant Thornton LLP for year
ended December 31, 1997
Balance Sheets as of December 31, 1998 and 1997.
Statements of Operations for the year ended December 31, 1998 and
the nine month period ended December 31, 1997.
Statements of Comprehensive Income for the year ended December 31,
1998 and the nine months ended December 31, 1997.
Statements of Stockholders' Equity for the year ended December 31,
1998 and the nine month period ended December 31, 1997.
28
<PAGE>
Statements of Cash Flows for the year ended December 31, 1998 and
the nine month period ended December 31, 1997.
Notes to Financial Statements.
Schedules are omitted for the reason that they are not required, are
not applicable, or the required information is included in the financial
statements or notes thereto.
(B) Reports on Form 8-K Not applicable.
(C) Exhibits. The following exhibits are filed as part of the
Company's report. Where such filing is made by incorporation by reference
(I/B/R) to a previously filed statement or report, such statement or report is
identified in parenthesis.
Official Exhibit
Number Description
[3.1] Certificate of Incorporation of the Company.
[3.2] Certificate of Amendment of the Company's
Certificate of Incorporation.
[3.3] Certificate of Amendment of Certificate of
Incorporation of the Company.
[3.4] By-Laws of the Company.
[10.1] Credit Agreement between Bank One, Texas,
N.A. and the Company, dated March 31, 1997.
11 Earnings Per Share
27 Financial Data Schedule
29
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Pioneer Commercial Funding Corp.
We have audited the accompanying balance sheet of Pioneer Commercial Funding
Corp. (a New York corporation) as of December 31, 1998, and the related
statements of operations, changes in stockholders= equity, and cash flows for
the year then ended. These financial statements are the responsibility of the
Company=s management. Our responsibility is to express an opinion on these
financial statements based on our audit. The financial statements of Pioneer
Commercial Funding Corp. as of and for the nine month period ended December 31,
1997, were audited by other auditors whose report dated March 25, 1998,
expressed an unqualified opinion on those statements.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion the financial statements referred to above present fairly, in all
material respects, the financial position of Pioneer Commercial Funding Corp. as
of December 31, 1998, and the results of its operations and its cash flows for
the year then ended, in conformity with generally accepted accounting
principles.
LAZAR LEVINE & FELIX LLP
New York, New York
April 1, 1999, except as to
Note C which is dated
April 12, 1999
F - 1
<PAGE>
Grant Thornton
Suite 700
1000 Wilshire Blvd.
Los Angeles, CA 90017-2464
(213) 627-1717
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Pioneer Commercial Funding Corp.
We have audited the accompanying balance sheet of Pioneer Commercial Funding
Corporation (a New York corporation) (the "Company") as of December 31, 1997,
and the related statements of operations, comprehensive income, stockholders'
equity, and cash flows for the nine month period then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Pioneer Commercial Funding
Corporation as of December 31, 1997, and the results of its operations and its
cash flows for the nine months then ended, in conformity with generally accepted
accounting principles.
Grant Thornton LLP
Los Angeles, California
March 25, 1998
F-2
<PAGE>
Pioneer Commercial Funding Corp.
BALANCE SHEETS
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
December 31 December 31
1998 1997
------------------ ------------------
ASSETS
Cash and cash equivalents $ 1,503,788 $ 2,972,845
Mortgage warehouse loans receivable, net of allowance for loan losses 33,640,202 47,291,076
Loans held for resale, net of allowance for loan losses 705,479 4,504,231
Receivable for loans shipped 1,716,969 1,716,969
Accrued interest and fee receivable 825,340 930,656
Notes receivable-current portion 176,667 -
Prepaid and other assets 180,503 99,907
------------------ ------------------
Total Current Assets 38,748,948 57,515,684
------------------ ------------------
Fixed Assets
Furniture and equipment 634,376 119,882
Proprietary computer software 551,114 535,645
Leasehold improvements 198,689 26,855
------------------ ------------------
1,384,179 682,382
Less accumulated depreciation and amortization 651,383 448,853
------------------------ ------------------
Net Fixed Assets 732,796 233,529
------------------ ------------------
Investment securities available for sale 318,750 1,032,000
Notes receivable-noncurrent portion 911,770 -
Deposits on furniture and equipment - 321,260
Other assets 475,063 484,130
------------------------ ------------------
Total Assets $ 41,187,327 $ 59,586,603
================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Mortgage warehouse loans payable $ 33,384,925 $ 50,056,160
Accounts payable and accrued expenses 213,646 362,869
Accrued interest and fees 777,798 1,047,132
Due to mortgage banking companies 220,228 629,421
Deferred loan fees 29,000 29,000
Deferred legal fees 65,395 60,683
------------------------ ------------------
Total Current Liabilities 34,690,992 52,185,265
------------------------ ------------------
Subordinated debt 1,726,000 1,000,000
------------------------ ------------------
Total Liabilities 36,416,992 53,185,265
------------------------ ------------------
Commitments and Contingencies
Stockholders' Equity:
Common stock - $.01 par value; authorized 20,000,000 shares; issued and
outstanding - 5,542,272 at December 31, 1998 and
5,442,272 at December 31, 1997 55,423 54,423
Additional paid-in capital 14,556,952 14,316,952
Accumulated deficit (9,935,790) (8,777,037)
Accumulated other comprehensive income 93,750 807,000
------------------------ ------------------
Total Stockholders' Equity 4,770,335 6,401,338
------------------------ ------------------
Total Liabilities and Stockholders' Equity $ 41,187,327 $ 59,586,603
======================== ==================
The accompanying notes are an integral part of these statements.
F-3
<PAGE>
Pioneer Commercial Funding Corp.
STATEMENTS OF OPERATIONS
For the twelve months ended December 31, 1998 and the nine months
ended December 31, 1997
1998 1997
------------------ ------------------
Income:
Interest income $ 4,424,386 $ 2,163,182
Commissions and facility fees 237,385 109,914
Processing fees 1,752,390 842,654
------------------ ------------------
Total Income 6,414,161 3,115,750
------------------ ------------------
Interest and Fee Costs:
Interest expense-warehouse and lines of credit 3,762,591 1,671,389
Bank charges and facility fees 141,042 7,765
Bank processing fees 87,504 58,061
Total Interest and Fee Costs 3,991,137 1,737,215
------------------ ------------------
Net Interest and Fee Income 2,423,024 1,378,535
Loan loss provision 1,016,450 -
1,406,574 1,378,535
------------------ ------------------
Other Operating Expense:
Compensation and benefits 1,055,972 370,077
Depreciation and amortization 202,530 36,421
Professional fees 322,075 127,136
Loan administration charges 198,756 -
Utilities 46,448 25,712
Rent 210,591 37,072
Repairs and maintenance 13,408 10,275
Other 547,443 312,312
Total Other Operating Expenses 2,597,223 919,005
------------------ ------------------
Income (loss) from operations (1,190,649) 459,530
------------------ ------------------
Other Income and Expense:
Interest income - other 77,799 64,668
Interest expense-other (5,099) (3,534)
Miscellaneous income 25 10,228
Equity in loss of affiliate (40,000) -
Total Other Income and Expense 32,725 71,362
------------------ ------------------
Income (Loss) Before Taxes Based on Income (1,157,924) 530,892
Provision for taxes based on income 829 1,149
Net Income (Loss) $ (1,158,753) $ 529,743
================== ==================
Basic and Diluted Income (Loss)
Per Share of Common Stock $ (0.21) $ 0.10
================== ==================
Weighted Average Number of Shares 5,536,519 5,193,545
================== ==================
The accompanying notes are an integral part of these statements.
F-4
<PAGE>
Pioneer Commercial Funding Corp.
STATEMENTS OF COMPREHENSIVE INCOME
For the twelve months ended December 31, 1998 and the nine
months ended December 31, 1997
December 31, December 31,
1998 1997
------------------ ------------------
Net income (loss) $ (1,158,753) $ 529,743
Change in unrealized gain on investment in
securities available for sale (713,250) 807,000
Comprehensive net income (loss) $ (1,872,003) $ 1,336,743
================== ==================
The accompanying notes are an integral part of these statements.
F-5
<PAGE>
Pioneer Commercial Funding Corp.
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the twelve months ended December 31, 1998 and the nine months ended December 31, 1997
Additional Other Total
Common Paid-in Accumulated Comprehensive Stockholders'
Stock Capital Deficit Income (Loss) Equity
------------- ------------ ------------ ------------ ---------------
Balance at March 31, 1997 $ 36,423 12,525,952 $(9,306,789) $ - 3,255,595
Issuance of 1,800,000 common shares
in connection with the conversion of
the convertible note to shares as
of May 9, 1997 18,000 1,782,000 - - 1,800,000
Issuance of options to purchase
100,000 common shares November 1997 9,000 9,000
Unrealized gain on securities
available for sale 807,000 807,000
Net income for the period 529,743 529,743
------------- ------------ ------------ ------------ ---------------
Balance at December 31, 1997 54,423 14,316,952 (8,777,037) 807,000 6,401,338
Issuance of 100,000 shares of
Common Stock on January 21, 1998
converting November 26, 1997 options 1,000 240,000 241,000
Change in unrealized gain on
investment in securities available
for sale (713,250) (713,250)
Net (loss) for period (1,158,753) (1,158,753)
Balance at December 31, 1998 $ 55,423 14,556,952 (9,935,790) $ 93,750 4,770,335
============= ============ ============ ============ ===============
The accompanying notes are an integral part of these statements.
F-6
<PAGE>
Pioneer Commercial Funding Corp.
STATEMENTS OF CASH FLOWS
For the twelve months ended December 31, 1998 and the nine months ended December 31, 1997
December 31, December 31,
1998 1997
---------------- ----------------
Cash Flows from Operating Activities:
Net income (loss) $ (1,158,753) $ 529,743
Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:
Depreciation and amortization 202,530 36,421
Loan loss reserve 775,136 -
Loss on abandonment of leasehold - 9,178
Equity in loss of affiliate 40,000 -
(Increase) decrease in --
Mortgage warehouse loans receivable 12,070,883 (44,834,922)
Loans held for resale 3,625,170 ( 4,504,231)
Receivable for loans shipped - (1,716,969)
Accrued interest receivable 105,316 (902,832)
Prepaid expenses (80,596) (66,109)
Notes receivable - -
Other assets (50,064) (194,654)
Increase (decrease) in --
Accrued interest payable (269,334) 1,047,132
Due to mortgage banking companies (409,193) 543,875
Accounts payable and accrued expenses (149,223) 160,043
Net Cash Provided by (Used in) Operating Activities 14,701,872 (49,893,325)
---------------- ----------------
Cash Flows from Investing Activities:
Purchase of fixed assets (380,537) (92,332)
Investment in and advances to joint venture (90,869) (264,476)
Deposits on furniture and fixtures - (321,260)
Investment in securities available for sale - (225,000)
Net Cash Used in Investing Activities (471,406) (903,068)
---------------- ----------------
Cash Flows from Financing Activities:
Net increase (decrease) in borrowings used in operations,
net of issuance costs (16,671,235) 50,056,160
Increase in deferred expenses 4,712 -
Increase in subordinated debt 726,000 1,000,000
Net proceeds from issuance of stock 241,000 9,000
Net Cash (Used) Provided by Financing Activities (15,699,523) 51,065,160
---------------- ----------------
Net Increase (Decrease) in cash (1,469,057) 268,767
Cash and Cash Equivalents at the Beginning of the Period 2,972,845 2,704,078
---------------- ----------------
Cash and Cash Equivalents at the End of the Period $ 1,503,788 $ 2,972,845
================ ================
Supplemental Disclosure of Cash Flow Information:
Interest paid $ 4,037,024 $ 642,076
================ ================
Income taxes paid $ 829 1,149
================ ================
Non Cash Financing Activities
Conversion of mortgage loans receivable to notes receivable $ 1,088,437 $ -
================ ================
The accompanying notes are an integral part of these statements.
F-7
</TABLE>
<PAGE>
Pioneer Commercial Funding Corp.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998 and 1997
NOTE A - NATURE OF OPERATIONS
Pioneer Commercial Funding Corp. (the "Company"), formerly known
as PCF Acquisition Corp. ("PCF") is a New York corporation which
merged with Pioneer Commercial Funding Corp. (a New York
corporation) ("Pioneer") on November 23, 1994. PCF was organized
and commenced operations on March 8, 1994 for the express purpose
of raising capital through an initial public offering ("IPO") for
the benefit of Pioneer.
In 1997, the Company changed its year end from March 31 to December 31.
Pioneer's Reorganization
On April 2, 1993, Pioneer emerged from Chapter 11 of the United States
Bankruptcy Code pursuant to a confirmed First Amended Modified Plan of
Reorganization ("POR"). From June 14, 1993, when the Company commenced active
operations following its emergence from Chapter 11 until fiscal year ended March
31, 1997, it operated with limited financing sources and substantially all of
the business conducted by the Company was with one to four mortgage banking
companies.
Operations
The Company is engaged in the business of mortgage warehouse lending which
primarily consists of providing lines of credit, in the form of "warehouse
financing," to mortgage banking companies to enable them to close real estate
loans on single family, owner-occupied dwellings and sell such loans to
investors in the secondary market. The Company obtains its funds to provide such
financing from third-party funding sources with which it has available lines of
credit and from its own sources. The Company's loans receivable from the
mortgage banking companies are secured by an interest in the underlying real
property which are then assigned to the Company's funding sources. Investor
groups who purchase the mortgages (which generally occurs within 10 to 45 days
from the time the Company makes the loan) remit the proceeds directly to the
Company in satisfaction of the loan and interest receivable from the mortgage
banking company. The Company will simultaneously use the funds to pay off its
loan and accrued interest payable to its funding sources. The Company's primary
sources of income from operations are processing fees received from the mortgage
banking company for each loan financed and the interest rate spread (usually
1.75%) between the rate at which the Company borrows from its funding source and
the rate it charges the mortgage banking company.
The Company's customers fund loans throughout the United States.
<PAGE>
Pioneer Commercial Funding Corp.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998 and 1997
NOTE A - NATURE OF OPERATIONS (continued)
Operations (continued)
The Company's operations are subject to certain risks which are inherent to its
industry. Its results of operations depend heavily upon the ability of its
mortgage banking customers to originate mortgage loans. This ability is largely
dependent upon general economic conditions in the geographic areas that the
Company serves. Because these general economic conditions fluctuate, there can
be no assurance that prevailing economic conditions will always favor the
Company's business and operations. In addition, mortgage banking firms have
historically experienced a wide range of financial results, from highly
profitable to highly unprofitable. These financial results are due to many
factors which affect most, if not all, firms in the mortgage banking business at
about the same time. Three of these factors which predominate are: changes in
mortgage interest rates, the availability of affordable credit, and the state of
the domestic economy. These three factors, among others, affect the demand for
new and used housing and thus the demand for financing and refinancing of
mortgages. Lastly, although the Company's mortgage banking customers must have a
commitment for each loan from an approved third-party agency ("Agency") before
the Company will extend mortgage warehouse financing, there is no guarantee that
the Agency will, in fact, accept the mortgage loan when delivered due to certain
deficiencies in the loan or other unanticipated circumstances which may exist.
If for any reason an Agency does not accept the mortgage loan, and the Company's
mortgage banking customer is unable to pay back its obligation to the Company
through other means, the Company could find itself the owner of a long-term loan
of less than market value instead of short-term bridge financing receivable.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The accompanying financial statements, which are prepared in conformity with
generally accepted accounting principles, require the use of estimates made by
management. The most significant estimates with regard to these financial
statements relate to the valuation allowance for estimated losses on the
disposition of stale loans and uncollectable interest and fees, for deferred
income taxes and the estimated obligations due under the POR, as more fully
described in Notes J and O, respectively. Actual results may differ from those
assumed in management's estimates.
Cash and Cash Equivalents
Cash equivalents include time deposits and highly liquid investments with
original maturities of three months or less.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
<PAGE>
Pioneer Commercial Funding Corp.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998 and 1997
Income Taxes
The Company has adopted SFAS 109. "Accounting for Income Taxes" which requires
use of the asset and liability approach of providing for income taxes. This
statement requires recognition of deferred tax liabilities and assets for the
expected future tax consequences of events that have been included in the
financial statements or tax returns. Under this method deferred tax liabilities
and assets are determined based on the differences between the financial
statement and tax basis of assets and liabilities using enacted tax rates in
effect for the year in which the differences are expected to reverse. Under
Statement 109, the effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes the enactment date
(see also Note J).
Revenue Recognition
The Company recognizes revenue at the time a mortgage loan receivable is funded.
Interest income is recorded on the accrual basis in accordance with the terms of
the customer loan and security agreement.
Loan Fees
Loan processing fees are capitalized and recognized as an adjustment of the
yield of the related loan in accordance with SFAS No. 91.
Basic and Diluted Earnings (Loss) Per Share of Common Stock
Net earnings per share is calculated in accordance with Statement of Financial
Standards No. 128, Earnings Per Share ("SFAS 128"), which superseded APB Opinion
No. 15. Basic net earnings per share is based upon the weighted average number
of common shares outstanding. Diluted earnings per share is based on the
assumption that all stock options and warrants were exercised.
For the year ended December 31, 1998, and the nine month period ended December
31, 1997, the exercise price exceeded the average sale price for most options
and warrants, and the impact of conversion of the warrants and options would
have been antidilutive or immaterial. Therefore, the options and warrants were
not considered in the calculation of earnings (loss) per common share.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Concentration of Credit Risk / Fair Value
Financial instruments that potentially subject the Company to concentration of
credit risk consist
<PAGE>
Pioneer Commercial Funding Corp.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998 and 1997
principally of cash investments and mortgage warehouse loans receivable.
The Company maintains, at times, deposits in federally insured financial
institutions in excess of federally insured limits. Management monitors the
soundness of these financial institutions and feels the Company's risk is
negligible.
Management believes that concentrations of credit risk with respect to mortgage
warehouse loans receivable are limited due to the underlying assignment of note
and deed of trust on residential real estate collateral for each loan,
guarantees by mortgage banking customer principals, security deposits
approximating 10% of each customer's line of credit and UCC filings on the
assets of the Company's mortgage banking customers.
As of December 31, 1998 and 1997, the fair value of cash and cash equivalents,
receivables, obligations under accounts payable and debt instruments approximate
the carrying value.
Marketable Securities
At December 31, 1998, marketable securities have been categorized as available
for sale and, as a result, are stated at fair value in accordance with Statement
of Financial Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities". Unrealized gains and losses are included in shareholders'
equity as other comprehensive income (loss).
Fixed Assets
Fixed assets are recorded at cost. Depreciation of fixed assets is provided on a
straight-line basis as follows:
Furniture and equipment 3 - 10 years
Proprietary computer software 5 years
Maintenance and repairs are expensed as incurred. Leasehold improvements are
amortized over the useful life of the asset or the lease, whichever is shorter.
Proprietary computer software consists of a set of computer programs that were
developed internally by the Company for the use in its business and are not for
resale to the other mortgage finance companies.
<PAGE>
Pioneer Commercial Funding Corp.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998 and 1997
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Fixed Assets (continued)
Depreciation and amortization expense for the year ended December 31, 1998 and
the nine month period ended December 31, 1997 aggregate $202,350 and $36,421,
respectively.
Advertising Costs
Advertising costs, which are included in general and administrative expenses,
are expensed as incurred. For the year ended December 31, 1998 and the nine
month period ended December 31, 1997, advertising costs aggregated $45,593 and
$28,205, respectively.
Comprehensive Income
In 1997, the Company adopted Statement of Financing Accounting Standards No.
130, "Reporting Comprehensive Income" (SFAS 130"), which establishes new rules
for the reporting and display of comprehensive income and its components. SFAS
130 requires unrealized gains or losses on the Company's available-for-sale
securities to be included in other comprehensive income.
Segments of an Enterprise and Related Information
In 1998, the Company adopted Financial Accounting Standards Board Statement No.
131, "Disclosures about Segments of an Enterprise and Related Information",
which establishes standards for reporting about operating segments. The Company
has determined that no operating segment outside of its core business met the
quantitative thresholds for separate reporting. Accordingly, no separate
information has been reported.
Reclassifications
Certain reclassifications have been made to conform prior years data to the
current format.
NOTE C - MORTGAGE WAREHOUSE LOANS RECEIVABLE/PAYABLE
Loan receivables are generally due within sixty days from the date funded, with
an average outstanding period of 33 days and interest payable ranging from prime
plus 1.75% to prime plus 2.0%. Similarly, all of the related loans payable are
due within the same time frame. During the fiscal year ended March 31, 1997, the
Company obtained a $25 million revolving line of credit pursuant to a security
agreement between the Company and Bank One, Texas, N.A. ("Bank One"). The
Company pays interest on advances at the "prime rate" of interest, quoted from
time to time by the Wall Street Journal plus or minus one-eighth of a percent.
As collateral security for its
<PAGE>
Pioneer Commercial Funding Corp.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998 and 1997
NOTE C - MORTGAGE WAREHOUSE LOANS RECEIVABLE/PAYABLE (continued)
indebtedness to Bank One the Company granted to Bank One a security interest in
various assets including, but not limited to, all promissory notes acquired by
the Company with respect to any loan funded by it with moneys advanced under its
Bank One credit line and all mortgages or other forms of collateral security
obtained by the Company in connection with the funding of such loans. On August
25, September 26 and December 12, 1997, Bank One amended the credit facility to
provide the Company with $35,000,000, $50,000,000 and $60,000,000, respectively.
Effective June 30, 1998 Leedan Business Enterprise Ltd. ("Leedan"), a 49% owner
of the Company, entered into a Capital Maintenance Agreement with Bank One
wherein Leedan will cause capital contributions or subordinated debt advances,
up to $2 million, to be made to the Company in order to maintain an adjusted
Company net worth of a least $8 million, upon official written request by Bank
One. This agreement will continue in effect until the Company has paid its
obligation to Bank One and Bank One terminates its commitment to supply the
Company credit (See also Note M). On September 1 and September 15, 1998, Bank
One amended the credit facility to decrease the borrowing limit to $55,000,000
and $50,000,000 respectively. The credit facility expired on October 30, 1998,
whereupon Bank One agreed to continue funding the Company's loans until the
facility was renewed or another lender replaced Bank One. On February 18, 1999,
subsequent to the balance sheet date, Bank One renewed the credit facility with
a borrowing limit of $40,000,000 through April 30, 1999. On April 12, 1999, the
Company was notified by the Bank that they believe the Company will be able to
negotiate an extension of the line of credit agreement. In addition, they
indicated that a six month extension, if needed, would most probably be granted.
For the year ended December 31, 1998, and for the nine months ended December 31,
1997 the weighted average interest rate on loans receivable was 10.23% and
10.3%, respectively, and on loans payable was 8.36% and 8.39% respectively.
Loans receivable are collateralized by a security interest in the underlying
real property which the Company then assigns to its funding sources as security
for the loans payable.
NOTE D - LOANS HELD FOR RESALE
In 1997, the Company in accordance with its loan and security agreement took
possession from a customer in the process of liquidating under Chapter 7 of the
Bankruptcy Code 37 loans it funded having an aggregate value of $4.5 million.
The Company has a perfected interest in the loans and sold 32 of the loans at a
net discount of $72,070. The five loans unsold at December 31, 1998 with an
original loan amount of $698,116, together with holdback receivables on sold
loans of $180,945, are held at net realizable value which includes a reserve of
$173,582.
<PAGE>
Pioneer Commercial Funding Corp.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998 and 1997
NOTE E - RECEIVABLE FOR LOANS SHIPPED
During October 1997, the Company warehoused $1.7 million in mortgages for the
same customer as described in Note D above, who used a third party conduit,
American Financial Mortgage Corporation, to sell its loans to an investor,
Norwest Funding, Inc. The Company provided instructions to the third party
conduit that the funds were to be wired by the investor to the Company's bank.
The investor mis-wired the funds to the conduit's bank, Corestates Bank, N.A.
The conduit's bank has refused to return the funds. The Company is taking
actions, including legal action, to collect the funds from the conduit, the
conduit's guarantor, the investor and the conduit's bank. The Company's lender,
Bank One Texas, N.A. ("Bank One"), has joined the litigation as a co-plaintiff
in support of the Company's position. In addition, the Company has a $5 million
personal guarantee from the third party conduit's primary shareholder and an
additional $2 million guarantee from the customer's primary shareholder.
Although it is impossible to assess with accuracy the ultimate outcome of this
matter, management is confident that it will recover the funds.
NOTE F - INVESTMENT SECURITIES AVAILABLE FOR SALE
On July 7, 1997, the Company purchased 300,000 shares at $.75 per share of
Fidelity First Mortgage Corp., NASDAQ (FFIR) for a total investment of $225,000.
FFIR shares closed on December 31, 1998 and 1997 at $1.06 and $3.44 per share,
respectively, resulting in an unrealized gain of $807,000 in 1997 and a
reduction in the unrealized gain of $713,250 in 1998. Fidelity First Mortgage,
which is also a customer of the Company, is based in Columbia, Maryland and
funds conforming and non-conforming single family residential mortgages in
Maryland, Virginia, Delaware, Florida, North and South Carolina. At December 31,
1998 and 1997, mortgage warehouse loans receivable from this customer amounted
to $1,633,457 and $12,309,626, respectively and net accrued interest receivable
amounted to $47,970 and $106,045 for 1998 and 1997 respectively.
<PAGE>
Pioneer Commercial Funding Corp.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998 and 1997
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
NOTE G - NOTES RECEIVABLE:
On November 18, 1998, a settlement was reached with a guarantor of a mortgage
banking customer's defaulted line of credit. The guarantor was also a company
stockholder. Pursuant to the settlement, an entity which is an affiliate of
Leedan (see Note C) accepted $530,000 of the guarantor's recognized debt to the
Company in exchange for the guarantor's shares in the Company. This entity
paid the Company $176,667 and issued two installment notes of $176,667 each
with maturity dates of August 23, 1999 and May 23, 2000, respectively. These
notes bear interest at a rate of 8.25% per annum and are payable quarterly
commencing three months from the date of issuance which was November 23, 1998.
$353,334
Pursuant to the settlement as stated above, the guarantor also issued to the
Company two installment notes in the amounts of $265,103 and $470,000,
respectively. These notes bear interest at a rate of 8.25% per annum and are
payable quarterly commencing three months from November 18, 1998, the date of
issuance of the notes. Both notes mature November 18, 2000.
735,103
1,088,437
Less current portion 176,667
$911,770
</TABLE>
NOTE H - INVESTMENT IN AND ADVANCES TO PIONEER HOME FUNDING
On April 16, 1997, the Company entered into a joint venture agreement with
Maryland Financial Corporation ("MFC") to form Pioneer Home Funding, LLC, a
California Limited Liability Company, ("PHF"). The Company accounts for this
investment on the equity method. The agreement provides that the Company and MFC
would maintain 80% and 20% ownership interests, respectively, in PHF. An
amendment to the agreement was made on October 31, 1997. This amendment provides
that the Company would contribute $40,000 for a 20 percent interest in PHF. In
addition, the Company may from time to time, at its option, make loans to PHF as
needed. Under this agreement the Company has the option to convert loans made to
PHF into an 80% interest in PHF. As of December 31, 1998 and 1997, the Company
has advanced as a loan receivable $275,344 and $224,476, respectively (which is
included in other assets on the balance sheet). At December 31, 1998, the
Company has recorded a reserve aggregating $110,000 against this receivable due
to the financial condition of PHF.
<PAGE>
Pioneer Commercial Funding Corp.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998 and 1997
NOTE I - OTHER ASSETS
The following items are also included in Other Assets (See Note H) on the
Company's financial statements:
1. Effective April 25, 1996, a one year certificate of deposit in the amount of
$25,000 was pledged in order for the Company to receive a California Lender
Bond as a California Financial Lender. The certificate of deposit was
renewed as of April 25,1998 and is renewable annually at the discretion of
the insurance carrier.
2. As a result of the signing of a ten (10) year lease for office space at
21700 Oxnard Street, Suite 1650, Woodland Hills, California, on October 17,
1997, the Company delivered an unconditional, irrevocable and renewable
Letter of Credit (LC), in the amount of $150,000, in favor of the Landlord.
The LC is secured by a $150,000 Certificate of Deposit which is included in
Other Assets on the Company's financial statements.
NOTE J - INCOME TAXES
The components of the provision for income taxes are as follows:
12 Months Ended 9 Months Ended
December 31, 1998 December 31, 1997
Current
Federal $ - $ -
State 1,149 829
------------------
829 1,149
Deferred
Federal - -
State - -
-------------------- -----------------
Provision for Income Taxes $ 829 $ 1,149
================ ================
The Company's reported income tax expense for 1997 varied from the statutory
federal income tax rate due to the effect of net operating loss carryforwards
available.
<PAGE>
Pioneer Commercial Funding Corp.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998 and 1997
NOTE J - INCOME TAXES (continued)
The tax effects of temporary differences that give rise to deferred tax assets
are presented below:
December 31, 1998 December 31, 1997
Deferred Income Tax Assets
Net Operating Losses $680,000 $516,000
Valuation Allowances (680,000) (516,000)
--------- ---------
$ - $ -
=============== ==============
At December 31, 1998, the Company had net operating loss (NOL's) carryforwards
available for income tax purposes of approximately $2.4 million expiring in
varying amounts through 2012. Approximately $1 million of the NOL's are limited
in use pursuant to a change in ownership in November 1994.
NOTE K - DUE TO MORTGAGE BANKING COMPANIES
The Company generally finances up to 100% of the total loan amount closed by the
mortgage banking company. Upon sale of the loan to the investor group, proceeds
for 100% of the loan amount plus premiums or less discounts are remitted to the
Company by the investor. The Company, from time to time, holds such funds until
receipt of amounts due from the mortgage banking company for fees and accrued
interest.
NOTE L - DEFERRED LEGAL FEES
Deferred legal fees are a consequence of the POR (see Note O) and are payable in
four annual installments which began on April 16, 1994. The Company has not paid
the April 1996, 1997 and 1998 installments totaling $65,395 as of December 31,
1998.
<PAGE>
Pioneer Commercial Funding Corp.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998 and 1997
NOTE M - STOCKHOLDERS' EQUITY AND INITIAL PUBLIC OFFERING
Initial Public Offering
In August 1996, the Company consummated its IPO pursuant to which the Company
issued and sold 600,000 shares of its common stock, par value $.01 per share
(the "Common Stock"), and 690,000 warrants (including warrants sold upon
exercise of the underwriters' over-allotment option) to the public at a price of
$5.00 per share and $.10 per warrant, which yielded to the Company net proceeds
of approximately $2 million. The warrants give the owner the right to purchase
an additional share of common stock at a price of $5.50 for a period of four
years commencing after the completion of the IPO (the "Exercise Period"). Such
warrants will be immediately tradable separate from the common stock. Commencing
two years after the completion of the IPO and through the end of the exercise
period, the warrants may be redeemed by the Company upon 30 days written notice
at a price of $.05 per warrant, provided that (1) the closing sale price of the
Company's common stock shall not be less than $7.50 per share for any period 20
days subsequent to the issuance of the written notice, or (2) that the warrant
holders have not exercised their warrants at any time prior to the period 30
days after the issuance of the written notice. In addition, the underwriter was
issued the right for a period of four years commencing one year after the
completion of the IPO to purchase, in tandem, 60,000 shares of common stock of
the Company and 60,000 common stock purchase warrants at a price of $6.12 for
each combined share and warrant. The terms of the warrants acquired by the
managing underwriter were the same as those discussed above except that such
options are nontransferable. The warrants are exercisable into 690,000 shares of
Common Stock at a price of $5.50 per share August 12, 2000.
Private Placement
On February 28, 1997, the Company completed a private placement of securities
(the "Private Placement") with eight investors who invested an aggregate of $4
million in the Company in consideration for 2.2 million shares of Common Stock
and $1.8 million principal amount of convertible promissory notes of the Company
(the "Convertible Notes"). On May 9, 1997, the Company increased its authorized
shares of common stock by 15 million to 20 million shares. With these newly
available shares, the Company immediately converted its outstanding Convertible
Notes into 1.8 million shares of common stock.
Subordinated Debt
On November 26, 1997, the Company issued $1,000,000 in subordinated debt as part
of a $4 million private placement. The private placement provided for a minimum
purchase of $250,000 (1 unit) with each unit obtaining 7,500 Warrants that allow
for the purchase of 7,500 shares. The exercise price of the shares is equal to
the price of the Company's stock as of the date of issue of the subordinated
debt. The Company has 30,000 Warrants outstanding (7,500 per unit for 4 units).
The subordinated debt carries
<PAGE>
Pioneer Commercial Funding Corp.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998 and 1997
NOTE M - STOCKHOLDERS' EQUITY AND INITIAL PUBLIC OFFERING
Subordinated Debt (continued)
an interest rate of 10% per annum and matures on November 25, 2002. The
Company's stock price on November 26, 1997 was $2.875 On September 11, 1998
three subordinated debt advances pursuant to the Leedan Capital Maintenance
Agreement (Note C) were made to the Company totaling $726,000, secured by notes.
The notes are due when a replacement for the Bank One lending facility is in
place, with interest paid quarterly at 11% per annum.
Dividend Restriction
The holders of the Company's common stock are entitled to one vote for each
share held of record on all matters submitted to a vote of stockholders. The
common stockholders are entitled to receive ratably such dividends as may be
declared by the Board of Directors out of funds legally available. As of
December 31, 1998, in management's opinion, it is not anticipated that dividends
will be paid on common stock in the foreseeable future as certain of the debt
instruments to which the Company is a party to prohibit or restrict the payment
of dividends (see Note O for further discussion of restrictions under the POR).
NOTE N - STOCK OPTION PLANS
The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation." Accordingly, no compensation costs
have been recognized for the Company's Non-Qualified Stock Option Plan (the
"Plan").
The Plan (previously known as PCF Acquisition Corp. Non-qualified Stock Option
Plan) was adopted on August 1, 1994, and provided for the issuance of options to
purchase up to 151,515 shares of the Company's common stock to persons who are
at the time of grant, employees of, or consultants to, the Company. The Plan was
modified on November 4, 1994, in anticipation of the then forthcoming merger,
with and into Pioneer Commercial Funding Corp. The modification provided for a
maximum of 200,000 shares of stock that may be optioned or sold under the Plan.
In 1997, the Company adopted the 1997 Omnibus Stock Incentive Plan under which
it was authorized to issue non-qualified stock options, incentive stock options,
and warrants to key employees, directors and selected advisors to purchase up to
an aggregate of 500,000 shares of the stock of the Company. The options have a
term of five years and generally become fully vested by the end of the third
year.
<PAGE>
Pioneer Commercial Funding Corp.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998 and 1997
NOTE N - STOCK OPTION PLANS (continued)
The Company has issued additional options outside the Plan at the discretion of
its Board of Directors ("BOD").
The following table summarizes information related to shares under option and
shares available for grant under the Plan and separate actions of the BOD.
Weighed Average fair value of options granted during the year as of follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
December 31, 1998 December 31, 1997
----------------- ------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
Options outstanding
beginning 825,045 $3.28 543,045 $3.57
Granted - - 282,000 $2.73
Exercised - - - -
Canceled - - - -
Options outstanding ending 825,045 $3.28 825,045 $3.28
=============== ================ ============== ==============
The following information applies to options outstanding at December 31, 1998
Options Outstanding Options Exercisable
Weighted
Average
Remaining Weighted Weighted
Range of Number Contractual Average Number Average
exercise prices Outstanding Life (Years) Exercise Price Exercisable Exercise Price
$1.00 - $1.50 45,000 3.01 $1.13 - -
$1.51 - $2.25 207,000 3.47 $2.08 119,000 $2.04
$2.26 - $3.40 250,000 3.37 $2.45 83,333 $2.45
$3.41 - $5.00 323,045 1.71 $5.00 289,712 $5.00
825,045 2.28 $3.28 492,045 $3.85
==================== ====================
</TABLE>
NOTE N - STOCK OPTION PLANS (continued)
The fair value of options at date of grant for 1997 was estimated using the
Black-Scholes model with the following weighted average assumptions. No options
were granted in 1998.
12/31/97
Expected Life (years) 3
Risk Free interest rate 5.5%
Volatility 77.7%
Dividend End 0%
Had compensation cost for the plan been determined based on the fair value of
the options at the grant dates consistent with the method of SFAS No. 123, the
Company's net earnings would have been:
12/31/97
Net earnings
As reported $529,743
Pro forma $421,867
Basic earnings per share
As reported $0.10
Pro forma $0.08
Diluted earnings per share
As reported $0.10
Pro forma $0.08
The effects of applying SFAS 123 in this pro forma disclosure are not indicative
of future amounts. SFAS 123 does not apply to awards prior to 1995, and
additional awards in future years are anticipated
<PAGE>
Pioneer Commercial Funding Corp.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998 and 1997
NOTE O - COMMITMENTS AND CONTINGENCIES
Plan of Reorganization
Under the POR, the Company is contingently liable to its pre-Chapter 11
unsecured creditors, for such creditors' pro rata shares of noninterest-bearing
notes (the "Notes") totaling $1,350,000. Commencing with the close of the fiscal
year ending March 31, 1996, and for all succeeding years thereafter, until full
aggregate payment of $1,350,000 is made under the Notes, each Note holder shall
receive a cash distribution equal to such Creditors' pro-rata share of twenty
percent of the Net Income Available for Note Payments, if the Net Income for any
such year exceeds $1,300,000.
In addition to the Notes, approximately $50,000 in professional fees incurred in
connection with the POR were deferred and will only be paid to the extent the
Notes are paid in full.
For the year ended December 31, 1998 and the nine months ended December 31, 1997
the Company had not generated income that resulted in payment on the Notes.
Accordingly, no liability has been reflected in the Company's balance sheet for
the Notes or the professional fees for 1997 or 1998.
As of December 31, 1998, the Company was unable to determine whether it is
probable that it will generate income in future years which would result
in payments on the Notes. As such, no future liability has been reflected
in the Company's balance sheet for the Notes or the professional fees.
In accordance with the POR, certain operating restrictions have been
placed upon the Company until the time that all amounts due on the Notes
have been paid in full. These restrictions include:
- Incurring new debt in excess of $25,000, except for secured lending
required in the ordinary course of the Company's mortgage lending
operations.
- Expending more than $25,000 in the aggregate in a calendar year to
purchase or lease capital assets, except to replace existing assets.
- Expending more than $320,000 annually in the aggregate to the officers
of the Company and placing limitations on salary increases.
- Merging or consolidating with another business.
<PAGE>
Pioneer Commercial Funding Corp.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998 and 1997
NOTE O - COMMITMENTS AND CONTINGENCIES (continued)
Plan of Reorganization (continued)
- Declaring dividends on any class of common stock, except that, if there
should be a public offering of the securities of the Company, and, if
at the option of the Company, fifty percent of the proceeds in excess
of $5,000,000 from such offering are utilized for the payment of the
Notes, then such dividend restriction shall be deemed waived.
In 1997 and 1998 the Company has made expenditures of more than $25,000 to
purchase and lease capital assets in connection with its move to new facilities.
Management believes that these expenditures were necessary to expand the
Company's mortgage operations, and is not aware of any financial impact on the
Company under the restrictions of the POR because of these expenditures.
Lease Obligation
The Company leases 6,846 square feet of office space through October of 2007.
The monthly base rent through September 2002 is $13,692 and for years six
through ten is $15,745.
The Company continues to be obligated under is previous office lease through
October 31, 2001. The current lease calls for monthly rent of $2,178 and CPI
increases with a minimum of 3% and a maximum of 5% annually. The Company sublets
the space at the Reseda location for $1,410 per month subject to three one year
leases.
Rent expenses for the year ended December 31, 1998 and the nine months ended
December 31, 1997 aggregated $210,591 and $37,072, respectively.
At December 31, 1998, future minimum rental are as follows:
Fiscal Year Ended December 31,
1999 $ 190,440
2000 190,440
2001 188,262
2002 164,304
2003 188,950
Thereafter 755,800
--------
$ 1,678,196
<PAGE>
Pioneer Commercial Funding Corp.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998 and 1997
NOTE O - COMMITMENTS AND CONTINGENCIES (continued)
Commitments to Extend Credit Facilities
At December 31, 1998 the Company had made approximately $80 million in
commitments to extend credit facilities to it current customers. These
commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Because many of the commitments will not be
fully drawn upon, the total commitment amounts do not necessarily represent
future cash requirements.
Employment Agreement
In July 1997, the Company extended the Employment Agreement with M. Albert
Nissim as President for an indefinite period, at a salary of $6,000 per month.
Effective April 1, 1998, Mr. Nissim's compensation was increased to $9,500 per
month. In addition, he was awarded a $12,000 bonus. The Agreement may be
terminated by either party on not less than 90 days prior to notice.
Other Agreement
The Company has approved a compensation plan for a director and/or Leedan the
company which provides management services to the Company. Leedan is also a
principal shareholder of the Company. The plan provides aggregate remuneration
to the director and/or Leedan of $100,000 per annum plus 5% of the Company's net
income (pre-tax) above $1,000,000 annually. Leedan and the director will
determine how such compensation will be divided between them.
NOTE P - ECONOMIC DEPENDENCY
During the 1998 fiscal year, the Company funded 893 and 813 loans aggregating
approximately $76.6 million and $53 million, respectively, to two customers. At
December 31, 1998 mortgage warehouses loans receivable from these customers
amounted to $8,393,600 and $3,036,283, respectively.
During the nine months ended December 31,1997, the Company funded 1,151 and 487
loans aggregating approximately $66.8 million and $45.2 million, respectively to
two customers. At December 31, 1997 mortgage warehouse loans receivable from
these customers amounted to $12,309,626 and $2,242,915, respectively.
<PAGE>
Pioneer Commercial Funding Corp.
NOTES TO FINANCIAL STATEMENTS
December 31, 1998 and 1997
NOTE Q - RELATED PARTY TRANSACTIONS
For year ended December 31, 1998 and the nine months ended December 31, 1997
certain family members of a previous executive officer and a member of the BOD
of the Company were engaged to perform various accounting and consulting
services for the Company. Such individuals were compensated during the year
ended December 31, 1998 and the nine months ended December 31, 1997
approximately $16,166 and $15,865, respectively, for these services. (See also
Notes F, G and O for other related party transactions).
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act,
the registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
PIONEER COMMERCIAL FUNDING CORP.
By:
Name: M. Albert Nissim
Title: President
Date: April 15, 1998
In accordance with the Exchange Act, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
By:
Name: M. Albert Nissim
Title: President
Date: April 15, 1998
By:
Name: John O'Brien
Title: Chief Financial Officer
Date: April 15, 1998
By:
Name: Richard Fried
Title: Director
Date: April 15, 1998
By:
Name: Boaz Harel
Title: Director
Date: April 15, 1998
<PAGE>
By:
Name: Tamar Lieber
Title: Director
Date: April 15, 1998
By:
Name: Lynda Davey
Title: Director
Date: April 15, 1998
By:
Name: Joseph Samuels
Title: Director
Date: April 15, 1998
Pioneer Commercial Funding Corp.
Exhibit 11
Computation of Earnings Per Common Share
Year ended Nine months ended
December 31, 1998 December 31, 1997
------------------- -------------------
Net income (loss) $ (1,158,753) 529,743
=================== ===================
Weighted average shares:
Common shares outstanding 5,536,519 5,193,545
------------------- -------------------
Basic and Diluted Earnings (Loss)
Per Common Share $ $(0.21) 0.10
=================== ===================
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the balance
sheet and statements of operations filed as part of the Company's annual report
on Form 10-KSB and is qualified in its entirety by reference to such report.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1998
<CASH> 1,503,788
<SECURITIES> 0
<RECEIVABLES> 36,957,647
<ALLOWANCES> 775,136
<INVENTORY> 0
<CURRENT-ASSETS> 38,748,948
<PP&E> 1,384,179
<DEPRECIATION> 651,383
<TOTAL-ASSETS> 41,187,327
<CURRENT-LIABILITIES> 34,690,992
<BONDS> 0
0
0
<COMMON> 54,423
<OTHER-SE> 14,556,952
<TOTAL-LIABILITY-AND-EQUITY> 41,187,327
<SALES> 0
<TOTAL-REVENUES> 6,414,161
<CGS> 0
<TOTAL-COSTS> 3,991,137
<OTHER-EXPENSES> 2,597,223
<LOSS-PROVISION> 1,016,450
<INTEREST-EXPENSE> 5,099
<INCOME-PRETAX> 1,157,924
<INCOME-TAX> 829
<INCOME-CONTINUING> 1,158,753
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 0
<EPS-PRIMARY> .21
<EPS-DILUTED> .21
</TABLE>
