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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______________ TO ________________
COMMISSION FILE NUMBER 000-27437
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PARAGON FINANCIAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 94-3227733
(STATE OR OTHER JURISDICTION (I. R. S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
5000 SAWGRASS VILLAGE CIRCLE
PONTE VEDRA BEACH, FL 32082
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (904) 285-0000
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $0.0001 PAR VALUE
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not 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-K or any amendment to this
Form 10-K. [_]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of common stock held by non-affiliates of the
Registrant on June 30, 2003 was approximately $16.9 million based upon the
closing sales price for our common stock on such date of $0.59 as reported on
such date by the Nasdaq Over-The-Counter Bulletin Board. In making this
calculation Registrant has assumed, without admitting for any other purpose,
that all executive officers and directors of the Registrant are affiliates.
As of March 23, 2004, the Registrant had 116,396,478 shares of common
stock outstanding.
PART III incorporates information by reference from the Registrant's
definitive Proxy Statement for its 2004 Annual Meeting of Stockholders to be
filed with the Commission within 120 days of December 31, 2003.
Page
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PART I
Item 1. Business 4
Item 2. Properties 21
Item 3. Legal Proceedings 21
Item 4. Submission of Matters to a Vote of Security Holders 22
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters 23
Item 6. Selected Financial Data 24
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 24
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 35
Item 8. Financial Statements and Supplementary Data 36
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure 36
Item 9A. Controls and Procedures 37
PART III 38
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K 38
SIGNATURES 40
2
PART I
FORWARD LOOKING STATEMENTS
We believe that it is important to communicate our expectations to our
investors. Accordingly, this report contains discussions of events or results
that have not yet occurred or been realized. You can identify this type of
discussion, which is often termed "forward-looking statements", by such words
and phrases as "will","explore", "consider","continue","expects", "anticipates",
"intends", "plans", "believes", "estimates" and "could be". You should read
forward-looking statements carefully because they discuss our future
expectations, contain projections of our future results of operations or of our
financial position, or state other expectations of future performance. There may
be events in the future that we are not able accurately to predict or control.
Any cautionary language in this report provides examples of risks, uncertainties
and events that may cause our actual results to differ from the expectations we
express in our forward-looking statements. You should be aware that the
occurrence of certain of the events described in this report could adversely
affect our business, results of operations and financial position.
These forward looking statements are based on information available to us on the
date hereof, and we assume no obligation to update any such forward looking
statement. It is important to note that our actual results and timing of certain
events could differ materially from those in such forward looking statements due
to a number of factors, including but not limited to, the ability to raise
capital necessary to sustain operations and implement the business plan, the
ability to obtain additional regulatory permits and approvals to operate in the
financial services area, the ability to identify and complete acquisitions and
successfully integrate acquired businesses, if any, the ability to implement the
company's business plan, changes in the real estate market, interest rates or
the general economy of the markets in which the company operates, the ability to
employ and retain qualified management and employees, changes in government
regulations that are applicable to our businesses, the general volatility of the
capital markets and the establishment of a market for the company's shares,
changes in the demand for the company's services, our ability to meet our
projections, the degree and nature of competitors, the ability to generate
sufficient cash to pay creditors, and disruption in the economic and financial
conditions primarily from the impact of past terrorist attacks in the United
States, threats of future attacks, police and military activities overseas and
other disruptive worldwide political events. Other risk factors that could cause
actual results to differ materially are set forth in this item under the heading
"Management Discussion and Analysis of Financial Condition and Results of
Operations - - Overview" on page 24.
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ITEM 1. BUSINESS.
GENERAL
We are a specialty mortgage finance company that provides mortgage products in
the one-to-four family residential mortgage market. We focus primarily on
offering mortgage products to borrowers who generally do not satisfy the credit,
documentation or other underwriting standards prescribed by conventional
mortgage lenders and loan buyers, such as Fannie Mae and Freddie Mac (referred
to as nonconforming or subprime). We originate these loans in accordance with
the underwriting guidelines of our investors. We also broker loans in the
conforming market. We currently conduct business in 24 states and the District
of Columbia. Our executive offices are located in Ponte Vedra Beach, Florida. We
were incorporated in Delaware in August 1999 under the name PRX Holdings, Inc.
Our mortgage operations were first acquired by us in January 2003.
The borrowers in our market typically have impaired or limited credit profiles
or higher debt-to-income ratios than the conforming market permits. Our
borrowers may also have difficulty verifying employment or income, due to
self-employment or other various reasons.
We originate or broker loans through a wholesale division and a retail division.
In 2003, our wholesale division originated 50.9% of our total loan originations,
and our retail division originated 49.1% of our total loan originations. Our
wholesale division originates primarily non-conforming loans through
relationships with over 500 independent brokers.
Our retail division is comprised of 34 loan officers. Depending on the product,
we will either originate the loan ourselves or broker it to a third party
lender. In 2003, we placed 63% of the mortgages we brokered with four particular
lenders to receive the highest level of execution. Since our loan officers are
based in Illinois and Florida, over 89% of our retail loan origination volume
relates to real property located in Illinois and Florida.
In 2003, 69% of the loans that we originated were refinances of existing
mortgages and 31% were for the purchase of residential property. Also in 2003,
98% of our loan originations were first mortgages and 2% were second lien
mortgages. 98% of our loans were secured by owner-occupied properties and 2%
were secured by investment properties in 2003.
We sell all of the loans we originate in bulk to investors in the secondary
market, collecting a premium on thes sale. These whole loan sales enable us to
generate current cash flow which we use to pay down our warehouse credit
facilities and fund future loan originations.
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COMPANY HISTORY
We originally operated as an online healthcare destination under the name
PlanetRX.com. In mid-2001 we began the process of liquidating our online health
store and seeking a merger partner as an alternative to complete liquidation.
On May 31, 2002, the Company merged with Paragon Homefunding, Inc. ("Paragon
Delaware"), a privately held, development stage company based in Ponte Vedra
Beach, Florida, formed for the purpose of entering the financial services market
through acquisitions. Paragon Delaware was incorporated in Delaware on August 3,
2001. For financial reporting purposes, the merger has been accounted for as a
recapitalization of Paragon Delaware with Paragon Delaware viewed as the
accounting acquiror in what is commonly called a reverse acquisition.
Accordingly, the financial statements presented before the merger are those of
Paragon Delaware.
As a result of the merger, a new board of directors was elected and new officers
were appointed. On December 26, 2002, we changed our name to Paragon Financial
Corporation.
On January 31, 2003 and February 4, 2003, we completed our acquisitions of two
mortgage companies, Mortgage Express, Inc. (now known as PGNF Home Lending
Corp.) ("PGNF") and Paragon Homefunding, Inc. ("PHF"), a Florida corporation.
GROWTH AND OPERATING STRATEGIES
We plan to pursue several strategies to increase revenue and profitability.
These strategies include: (i) increasing loan origination volume, (ii)
streamlining business processes through the deployment of technology , (iii)
diversifying product offerings, and (iv) pursuing acquisitions.
The key tactics for pursuing these strategies include:
o Increasing loan origination volume: We intend to increase loan origination
volume through geographic expansion on the East and West Coasts as well as
increasing market penetration in existing markets. We plan to continue to grow
our production volume and market share by growing our network of independent
brokers. We also plan to expand our credit facilities and funding sources so
that we have access to capital that is adequate to fund this increased loan
origination volume.
o Streamlining business processes through the deployment of technology: We
intend to continue our best practices initiative to streamline our business
processes and use technology to drive loan origination and administrative costs
lower and provide better service to our customers.
o Diversifying product offerings: We plan to develop a broad range of products
that are desireable in the markets that we compete. We intend to underwrite
these products to our own underwriting guidelines.
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o Pursuing acqusitions: We intend to pursue an active acquisition strategy of
accretive acquisitions. We will also evaluate other new business opportunities
and relationships in the marketplace.
PRODUCT TYPES
Our products include both fixed-rate loans and adjustable-rate loans, or ARMs.
In addition, our products are available at different interest rates and with
different origination and application points and fees depending on the
particular borrower's risk classification. Borrowers may choose to increase or
decrease their interest rate through the payment of different levels of
origination fees. Our maximum loan amount is generally $500,000 with a
loan-to-value ratio of up to 100%. We do, however, offer larger loans with lower
loan-to-value ratios through a special jumbo program.
Loans originated by us during 2003 had an average loan amount of approximately
$144,700 and an average loan-to-value ratio of 83%. If permitted by applicable
law and agreed to by the borrower, our loans may also include a prepayment
charge that is triggered by the loan's full or substantial prepayment early in
the loan term.
LOAN ORIGINATIONS
WHOLESALE DIVISION
Our wholesale division originates loans through a network of independent
mortgage brokers. Our account executives provide on-site customer service to the
broker to facilitate the funding of the loans.
Our operating subsidiaries were acquired in January 2003. Our wholesale division
originated a total of $295.7 million for the the eleven month period that we
owned it in 2003, or 50.1% of our total production in 2003. At December 31,
2003, our wholesale division was located in a single location in Illinois.
Our wholesale division originates loans through a network of independent
brokers. As of December 31, 2003 we had approved over 500 mortgage brokers to
submit loans to us.
The following table sets forth selected information relating to loan
originations through our wholesale division for the period we owned them during
the year ended December 31, 2003:
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For the interim period ended
----------------------------------------------------
3/31/2003 6/30/03 9/30/03 12/31/03
Principal balance (in thousands) $ 35,281 $ 76,026 $ 99,946 $ 84,470
Average principal balance per loan (in thousands) $ 103 125 125 124
Combined weighted average initial loan-to-
value ratio 89.06% 89.72% 88.43% 87.25%
Percent of first mortgage loans 99.61% 99.21% 98.12% 98.51%
Property securing loans:
Owner occupied 98.64% 98.81% 98.55% 98.51%
Non-owner occupied 1.36% 1.19% 1.45% 1.49%
Weighted average interest rate:
Fixed-rate 8.14 7.41 7.34 7.67
ARMs-initial rate 8.29 7.93 7.72 7.64
ARMs-margin over index 8.22 7.78 7.61 7.39
RETAIL DIVISION
Our retail division originates loans directly to the consumer through our loan
officers located at retail branch offices located in Florida and Illinois. We
also have a central retail telemarketing unit located in Illinois that
originates loans in the states that we are licensed to conduct business. Leads
are generated through radio, direct mail, and the internet.
Our retail division originated a total of $ $285.4 million for the eleven month
period that we owned it in 2003, or 49.9% of our total production in 2003.
The following table sets forth selected information relating to loan
originations through our retail division for the period we owned them during the
year ended December 31, 2003:
For the interim period ended
----------------------------------------------------
3/31/03 6/30/03 9/30/03 12/31/03
Principal balance (in thousands) $ 50,582 $ 96,653 $ 96,912 $ 41,221
Average principal balance per loan (in thousands) $ 186 $ 187 $ 176 $ 163
Property securing loans %:
Owner occupied 99.3% 99.2% 98.2% 92.2%
Non-owner occupied 0.7% 0.8% 1.8% 7.8%
Loan Purpose:
Purchase 30.9% 28.7% 31.1% 61.3%
Refinance 69.1% 71.3% 68.9% 38.7%
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FINANCING LOAN ORIGINATIONS, LOANS HELD FOR SALE AND WHOLE LOAN SALES
We finance the funding of the loans we originate through various credit
facilities. We currently use warehouse lines of credit totalling approximately
$35 million provided by Warehouse One, Household Financial, Popular Warehouse
and First Collateral. After we fund the loans and all loan documentation is
complete, we sell the loans through whole loan sales in secondary market
transactions, servicing released, usually within 30 days of origination. We use
the proceeds of these sales to pay down our borrowings under our warehouse lines
of credit. See "--Management's Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity and Capital Resources."
We generally sell all the loans we originate in secondary market transactions
with various institutional investors. The weighted average premiums received on
whole loan sales during 2003 was equal to 4.3% of the original principal balance
of the loans sold, including premiums received for servicing rights.
We seek to maximize our premiums on whole loan sales by closely monitoring the
requirements of institutional purchasers and focusing on originating the types
of loans that meet those requirements and for which institutional purchasers
tend to pay higher premiums. During the year ended December 31, 2003, we sold
$183 million of loans to Popular Bank and $103 million of loans to Wells Fargo,
which represented 33.8% and 18.9%, respectively, of total loans sold. We will
typically concentrate our loan sales with few investors to maximize the premium
and service we receive.
We sell the loans we originate on a non-recourse basis pursuant to purchase
agreements with various investors. We give customary representations and
warranties regarding each loan's characteristics and the origination process in
these agreements. Therefore, we may be required to repurchase or substitute
loans in the event of a breach of these representations and warranties. In
addition, we generally commit to repurchase or substitute a loan if a payment
default occurs within the first month or two following the date the loan is
funded, unless we make other arrangements with the purchaser.
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GEOGRAPHIC DISTRIBUTION
The following table sets forth by state the aggregate dollar amounts (in
thousands) and the percentage of all loans we originated during the year ended
December 31, 2003:
2003 %
- ---------------------------------------------------
$ %
Illinois 273,774 47.1%
Ohio 25,366 4.4%
Michigan 58,392 10.0%
Indiana 22,691 3.9%
Missouri 11,971 2.1%
Minnesota 17,527 3.0%
Florida 98,036 16.9%
Georgia 11,257 1.9%
Tennessee 10,108 1.7%
Kansas 4,662 0.8%
Iowa 4,425 0.8%
Wisconsin 11,064 1.9%
Maryland 4,806 0.8%
All others 27,012 4.7%
$ 581,091 100.0%
INTEREST RATE RISK MANAGEMENT STRATEGIES
We try to mitigate interest rate risk through a variety of strategies. For
instance, the interest rate that will be charged to our borrowers is locked on
the day the loan funds. This generally allows us to price our pipeline of
approved loans with current market rates. In addition, we may elect to use
various derivative financial instruments such as swaps, forwards, options and
futures contracts to mitigate interest rate risk. We may also use forward loan
sale commitments with a predetermined price and delivery date to sell our unsold
loan inventory, which protects us from interest rate increases.
COMPETITION
We continue to face intense competition in the business of originating and
selling mortgage loans. Our competitors include other mortgage banking
companies, consumer finance companies, commercial banks, credit unions, thrift
institutions, credit card issuers and insurance finance companies. Other large
financial institutions have gradually expanded their "non-prime" or "sub-prime"
lending capabilities. Many of these companies have greater access to capital at
a cost lower than our cost of capital under our warehouse facilities. Federally
chartered banks and thrifts can preempt some of the state and local lending laws
to which we are subject, thereby giving them a competitive advantage. In
addition, many of these competitors have considerably greater technical and
marketing resources than we have. Competition among industry participants can
take many forms, including convenience in obtaining a loan, customer service,
marketing and distribution channels, amount and term of the loan, loan
origination fees and interest rates. Additional competition may lower the rates
we can charge borrowers, thereby potentially lowering gain on future loan sales.
In 2003, the most significant form of competition was pricing pressure among
wholesale mortgage originators. Some of our competitors lowered rates and fees
to preserve or expand their market share. Our results of operations, financial
condition and business prospects could be materially adversely affected if
competition intensifies or if any of our
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competitors significantly expands its activities in our markets. Fluctuations in
interest rates and general economic conditions may also affect our competitive
position. During periods of rising rates, competitors that have locked in low
borrowing costs may have a competitive advantage. During periods of declining
rates, competitors may solicit our customers to refinance their loans.
REGULATION
Our business is regulated by federal, state, and local government authorities
and is subject to extensive federal, state and local laws, rules and
regulations. We are also subject to judicial and administrative decisions that
impose requirements and restrictions on our business. At the federal level,
these laws and regulations include the: Equal Credit Opportunity Act; Federal
Truth and Lending Act and Regulation Z; Home Ownership and Equity Protection
Act; Real Estate Settlement Procedures Act; Fair Credit Reporting Act; Fair Debt
Collection Practices Act; Home Mortgage Disclosure Act; Fair Housing Act;
Telephone Consumer Protection Act; Gramm-Leach-Bliley Act; Fair and Accurate
Credit Transactions Act; CAN-SPAM Act; Sarbanes-Oxley Act; and USA PATRIOT Act.
These laws, rules and regulations, among other things: impose licensing
obligations and financial requirements on us; limit the interest rates, finance
charges, and other fees that we may charge; prohibit discrimination; impose
underwriting requirements; mandate disclosures and notices to consumers; mandate
the collection and reporting of statistical data regarding our customers;
regulate our marketing techniques and practices; require us to safeguard
non-public information about our customers; regulate our collection practices;
require us to prevent money-laundering or doing business with suspected
terrorists; and impose corporate governance, internal control and financial
reporting obligations and standards.
Our failure to comply with these laws can lead to: civil and criminal liability;
loss of approved status; demands for indemnification or loan repurchases from
buyers of our loans; class action lawsuits; and administrative enforcement
actions.
COMPLIANCE, QUALITY CONTROL AND QUALITY ASSURANCE
We regularly monitor the laws, rules and regulations that apply to our business
and analyze any changes to them. We also maintain policies and procedures to
help our origination personnel comply with these laws.
Our training programs are designed to teach our personnel about the significant
laws, rules and regulations that affect their job responsibilities. We also
maintain a variety of pre-funding quality control procedures designed to detect
compliance errors prior to funding.
Our loans and practices are also reviewed regularly in connection with the due
diligence that our loan buyers and lenders perform.
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LICENSING
As of December 31, 2003, we were licensed or exempt from licensing requirements
by the relevant state banking or consumer credit agencies to originate first
mortgages in 24 states and the District of Columbia.
ENVIRONMENTAL
In the course of our business, we may acquire properties securing loans that are
in default. There is a risk that hazardous or toxic waste could be found on such
properties. If this occurs, we could be held responsible under applicable law
for the cost of cleaning up or removing the hazardous waste. This cost could
exceed the value of the underlying properties.
EMPLOYEES
The table below presents our employees at December 31, 2003:
FL IL TOTAL
Wholesale Division - 95 95
Retail Division 13 30 43
Administrative and corporate 9 36 45
------- ------- --------
TOTAL 22 161 183
======= ======= ========
AVAILABLE INFORMATION
We make available, free of charge, through our website
(www.paragonfinancialcorp.com) our annual reports on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K, Section 16 reports and any
amendments to those reports as soon as reasonably practicable after such reports
or amendments are electronically filed with or furnished to the Securities and
Exchange Commission.
11
RISK FACTORS
Stockholders and prospective purchasers of our common stock should carefully
consider the risks described below before making a decision to buy our common
stock. If any of the following risks actually occurs, our business could be
harmed. In that case, the trading price of our common stock could decline, and
you may lose all or part of your investment. When determining whether to buy our
common stock, stockholders and prospective purchasers should also refer to the
other information in this Form 10-K, including our financial statements and the
related notes.
RISKS RELATED TO OUR BUSINESS
AN INCREASE IN INTEREST RATES COULD RESULT IN A REDUCTION IN OUR LOAN
ORIGINATION VOLUMES, AN INCREASE IN DELINQUENCY, DEFAULT AND FORECLOSURE RATES
AND A REDUCTION IN THE VALUE OF AND INCOME FROM OUR LOANS.
The following are some of the risks we face related to an increase in interest
rates:
o A substantial and sustained increase in interest rates could harm our
ability to originate loans because refinancing an existing loan would be
less attractive and qualifying for a purchase loan may be more difficult;
and
o If prevailing interest rates increase after we fund a loan, the value that
we receive upon the sale of the loan decreases.
The interest rate under our warehouse lines is based primarily upon the London
Inter-Bank Offered Rate ("LIBOR") or the Prime Rate. The interest rates we
charge on our mortgage loans are based, in part, upon prevailing interest rates
at the time of origination. If LIBOR or the Prime Rate increases after the time
of loan origination, our net interest income, which represents the difference
between the interest received on our mortgage loans pending sale and our cost of
financing such loans, will be reduced. Accordingly, our business, financial
condition, liquidity and results of operations may be significantly harmed as a
result of increased interest rates.
AN INTERRUPTION OR REDUCTION IN THE SECURITIZATION AND WHOLE LOAN MARKETS WOULD
HURT OUR FINANCIAL POSITION.
We are dependent on the securitization market for the sale of our loans because
many of our whole loan buyers purchase our loans with the intention to
securitize. The securitization market is dependent upon a number of factors,
including general economic conditions, conditions in the securities market
generally and conditions in the asset-backed securities market specifically. In
addition, poor performance of our previously securitized loans could harm our
access to the securitization market. Accordingly, a decline in the
securitization market or a change in the market's demand for our loans could
have a material adverse effect on our results of operations, financial condition
and business prospects.
OUR INABILITY TO REALIZE CASH PROCEEDS FROM LOAN SALES IN EXCESS OF THE LOAN
ACQUISITION COST COULD ADVERSELY AFFECT OUR FINANCIAL POSITION.
The net cash proceeds received from loan sales consist of the premiums we
receive on sales of loans in excess of the outstanding principal balance, minus
the discounts on loans that we have to sell for less than the outstanding
principal balance. If we are unable to originate loans at a cost lower than the
cash proceeds realized from loan sales, our results of operations, financial
condition and business prospects could be materially adversely affected.
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OUR BUSINESS MAY BE SIGNIFICANTLY HARMED BY A SLOWDOWN IN THE ECONOMY OF THE
MIDWEST, WHERE WE CONDUCT A SIGNIFICANT AMOUNT OF BUSINESS.
Since inception of our subsidiary PGNF Home Lending Corp. (formerly known as
Mortgage Express), a significant portion of the mortgage loans we have
originated or brokered have been secured by property in the Midwest with a
concentration in Illinois. A decline in the economy or the residential real
estate market in the Midwest could restrict our ability to originate, sell, or
broker loans, and significantly harm our business, financial condition,
liquidity and results of operations.
WE FACE INTENSE COMPETITION THAT COULD ADVERSELY IMPACT OUR MARKET SHARE AND OUR
REVENUE.
We face intense competition from other financial and mortgage banking companies,
Internet-based lending companies where entry barriers are relatively low, and
from traditional bank and thrift lenders to the mortgage industry. As we seek to
expand our business further, we will face a significant number of additional
competitors, many of whom will be well-established in the markets we seek to
penetrate. Some of our competitors are much larger, have better name
recognition, and have far greater financial and other resources than we do.
The government-sponsored entities Fannie Mae and Freddie Mac are also expanding
their participation in the mortgage industry. These government-sponsored
entities have a size and cost-of-funds advantage that allows them to purchase
loans with lower rates or fees than we are willing to offer. While the
government-sponsored entities presently do not have the legal authority to
originate mortgage loans, they do have the authority to buy loans. A material
expansion of their involvement in the market to purchase loans could change the
dynamics of the industry by virtue of their sheer size, pricing power and the
inherent advantages of a government charter. In addition, if as a result of
their purchasing practices, these government-sponsored entities experience
significantly higher-than-expected losses, such experience could adversely
affect the overall investor perception of the mortgage industry.
The intense competition in the mortgage industry has also led to rapid
technological developments, evolving industry standards and frequent releases of
new products and enhancements. As mortgage products are offered more widely
through alternative distribution channels, such as the Internet, we may be
required to make significant changes to our current retail and wholesale
structure and information systems to compete effectively. Our inability to
continue enhancing our current capabilities, or to adapt to other technological
changes in the industry, could significantly harm our business, financial
condition, liquidity and results of operations.
Competition in the industry can take many forms, including interest rates and
costs of a loan, less stringent underwriting standards, convenience in obtaining
a loan, customer service, amount and term of a loan and marketing and
distribution channels. The need to maintain mortgage loan volume in this
competitive environment creates a risk of price competition in the mortgage
industry. Price competition could cause us to lower the interest rates that we
offer borrowers, which could lower the value of our loans. If our competitors
adopt less stringent underwriting standards we will be pressured to do so as
well, which would result in greater loan risk without compensating pricing. If
we do not relax underwriting standards in response to our competitors, we may
lose market share. Any increase in these pricing and underwriting pressures
could
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reduce the volume of our loan originations and sales and significantly harm our
business, financial condition, liquidity and results of operations.
OUR ABILITY TO MAINTAIN AND INCREASE OUR CREDIT FACILITIES ON ATTRACTIVE TERMS
WILL BE CRITICAL TO OUR GROWTH AND PROFITABILITY.
We require substantial cash to fund our loan originations. Our primary source
for this cash is our warehouse credit facilities. Our warehouse credit
facilities contain extensive restrictions and covenants that, among other
things, require us to satisfy specified financial, asset quality and loan
performance tests. If we fail to meet or satisfy any of these covenants, we
would be in default under these agreements and our lenders could elect to
declare all amounts outstanding under the agreements to be immediately due and
payable, enforce their interests against collateral pledged under such
agreements and restrict our ability to make additional borrowings. These
agreements also contain cross-default provisions, so that if a default occurs
under any one agreement, the lenders under our other agreements could also
declare a default. These agreements also contain provisions that may restrict
how we conduct our business.
Each of these credit facilities is cancelable by the lender. Because these are
short-term commitments of capital, the lenders may respond to market conditions
that may favor an alternative investment strategy for them, making it more
difficult for us to secure continued financing. If we are not able to maintain
any of these warehouse credit facilities or arrange for new financing on terms
acceptable to us, or if we default on our covenants or are otherwise unable to
access funds under any of these facilities, we will have to curtail or stop our
loan origination activities. This would result in decreased revenues and profits
for us. The loss of our warehouse lines would result in the cessation of our
wholesale business and require the immediate repayment of our borrowings under
these lines which would require us to sell our loans immediately which could
result in a reduction in profitability.
OUR ABILITY TO PROFITABLY SELL OUR LOANS WOULD BE REDUCED WITH THE LOSS OF KEY
PURCHASERS OF OUR LOANS OR WITH A REDUCTION IN THE PRICES PAID FOR OUR LOANS.
We currently sell substantially all of the loans we originate to independent
whole loan or bulk loan buyers in the secondary market. The premium earned by
these sales generates substantially all of our revenue and profits in our
mortgage banking business. We also depend upon the sale of these loans to repay
borrowings under our warehouse lines of credit in order to have credit available
to fund future loan closings and fund our other obligations. We currently
originate loans to the specifications and guidelines set by the investors who
purchase our loans. The loss of any of these investors would require us to find
another purchaser for these loans who may have different guidelines and may not
be willing to pay us as much for these loans. Our inability to sell our loans
would result in the inability to repay our warehouse lines, which in turn would
not be available to fund future loans and therefore have an adverse effect on
our revenue.
An active secondary market is critical for the profitable sale of our loans and
a reduction in the size of the secondary market for our types of loans may
adversely affect our ability to sell our loans and therefore adversely affect
our profitability. The timing of our loan dispositions (which are periodic) is
not always matched to the timing of our expenses (which are continuous). This
requires us to maintain certain levels of cash to maintain acceptable levels of
liquidity. Further,
14
any decrease in demand in the whole loan market such that we are unable to
timely and profitably sell our loans could inhibit our ability to meet our
liquidity demands.
DEFECTIVE LOANS MAY HARM OUR BUSINESS.
In connection with the sale of our loans to our investors in the secondary
market, we are required to make a variety of customary representations and
warranties regarding our company and the loans we originate. We are subject to
many of these representations and warranties for the life of the loan. These
representations and warranties relate to, among other things, compliance with
laws; regulations and underwriting standards; the accuracy of information in the
loan documents and loan file; and the characteristics and enforceability of the
loan.
A loan that does not comply with these representations and warranties may be
unsaleable or saleable only at a discount. If such a loan is sold before an
inaccuracy or other non-compliance is detected, we may be obligated to
repurchase the loan and bear any associated loss directly, or we may be
obligated to indemnify the purchaser against any such losses. Repurchase
obligations are typically triggered in loan sale transactions if a loan becomes
more than 30 days delinquent for up to the first four payments due on the loan,
or in any sale if the loan materially breaches our representations or
warranties. We believe that we have qualified personnel at all levels and have
established controls to ensure that all loans are originated to the market's
requirements, but we cannot assure you that we will not make mistakes, or that
certain employees will not deliberately violate our lending policies. We seek to
minimize losses from defective loans by correcting flaws, if possible, and
selling or re-selling such loans. We also create allowances to provide for
defective loans in our financial statements. We cannot assure you, however, that
losses associated with defective loans will not harm our results of operations
or financial condition.
In our mortgage banking business we currently originate and sell mostly subprime
mortgage loans. Subprime mortgage loans generally have higher delinquency and
default rates than prime mortgage loans. Delinquency interrupts the flow of
projected interest income from a mortgage loan, and default can ultimately lead
to a loss if the net realizable value of the real property securing the mortgage
loan is insufficient to cover the principal and interest due on the loan. Also,
our cost of financing a delinquent or defaulted loan is generally higher than
for a performing loan. We reacquire the risks of delinquency and default for
loans that we are obligated to repurchase.
We attempt to manage these risks with risk-based mortgage loan pricing and
appropriate underwriting policies. However, if such policies and methods are
insufficient to control our delinquency and default risks and do not result in
appropriate loan pricing; and if we are required to repurchase a significant
amount of the loans we originate, our business, financial condition, liquidity
and results of operations could be significantly harmed.
WE ARE SUBJECT TO LOSSES DUE TO FRAUDULENT AND NEGLIGENT ACTS ON THE PART OF
LOAN APPLICANTS, MORTGAGE BROKERS, OTHER VENDORS AND OUR EMPLOYEES.
When we originate mortgage loans, we rely heavily upon information supplied by
third parties including the information contained in the loan application
regarding employment and income
15
history, property appraisal and title information. If any of this information is
intentionally or negligently misrepresented and such misrepresentation is not
detected prior to loan funding, the value of the loan may be significantly lower
than expected. Whether a misrepresentation is made by the loan applicant, the
mortgage broker, another third party or one of our own employees, we often bear
the risk of loss associated with the misrepresentation. A loan containing a
material misrepresentation is typically unsaleable or subject to repurchase if
it is sold prior to detection of the misrepresentation. Even though we may have
rights against persons and entities who made or knew about the
misrepresentation, such persons and entities are often difficult to locate and
it is often difficult to collect any monetary losses that we have suffered from
them.
Although we have controls and processes in place that are designed to identify
misrepresented information in our loan origination operations, we cannot assure
you that we have detected or will detect all misrepresented information in our
loan originations. If we experience a significant number of such fraudulent or
negligent acts, our business, financial condition, liquidity and results of
operations could be significantly harmed.
IF THE PREPAYMENT RATES FOR OUR MORTGAGE LOANS ARE HIGHER THAN EXPECTED, OUR
RESULTS OF OPERATIONS MAY BE SIGNIFICANTLY HARMED.
Prepayment losses generally occur after we sell our loans and the extent of our
losses depends on when the prepayment occurs. If the prepayment occurs within 12
to 18 months following the sale, we may have to reimburse the purchaser for all
or a portion of the premium paid by the purchaser for the loan, resulting in a
loss of our profit on the loan.
Prepayment rates on mortgage loans vary from time to time and tend to increase
during periods of declining interest rates. We seek to minimize our prepayment
risk through a variety of means, including originating a significant portion of
loans with prepayment penalties with terms of two to five years. No strategy,
however, can completely insulate us from prepayment risks, whether arising from
the effects of interest rate changes or otherwise.
THE INABILITY TO ATTRACT AND RETAIN QUALIFIED EMPLOYEES COULD SIGNIFICANTLY HARM
OUR BUSINESS.
We depend upon our wholesale account executives and retail loan officers to
attract brokers and borrowers, respectively, by, among other things, developing
relationships with financial institutions, other mortgage companies, real estate
agents, borrowers and others. We believe that these relationships lead to repeat
and referral business. The market for skilled executive officers, account
executives and loan officers is highly competitive and historically has
experienced a high rate of turnover. In addition, if a manager leaves our
company there is a likelihood that other members of his or her team will follow.
Competition for qualified account executives and loan officers may lead to
increased hiring and retention costs. Our inability to attract or retain a
sufficient number of skilled account executives and loan officers and other key
employees at manageable costs could harm our business.
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IF WE ARE UNABLE TO MAINTAIN AND EXPAND OUR NETWORK OF INDEPENDENT BROKERS, OUR
LOAN ORIGINATION BUSINESS WILL DECREASE.
All of our wholesale mortgage loan originations are produced through
relationships with independent brokers. These brokers are not contractually
obligated to do business with us. Further, our competitors also have
relationships with these brokers and we all actively compete to retain and
expand our broker networks. Accordingly, we cannot assure you that we will be
successful in maintaining our existing relationships or expanding our broker
networks, the failure of which could significantly harm our business, financial
condition, liquidity and results of operations.
IF WE DO NOT MANAGE OUR GROWTH EFFECTIVELY, OUR FINANCIAL PERFORMANCE COULD BE
HARMED.
We have experienced substantial changes and rapid growth that place certain
pressures on our management, administrative, operational and financial
infrastructure. We expect to continue to experience this rapid growth both
organically and through acquisitions. The increase in the size of our operations
may make it more difficult for us to ensure that we originate quality loans. We
will need to attract and hire additional sales and management personnel in an
intensely competitive hiring environment in order to preserve and increase our
market share. We will also need to effectively integrate our acquisitions. At
the same time, we will need to continue to upgrade and expand our financial,
operational and managerial systems and controls, which could require capital and
human resources beyond what we currently have. We cannot assure you that we will
be able to meet our capital needs; expand our systems effectively; allocate our
human resources optimally; identify and hire qualified employees; or effectively
integrate acquired businesses to achieve growth.
The failure to manage growth or integrate acquisitions effectively would
significantly harm our business, financial condition, liquidity and results of
operations.
AN INTERRUPTION IN OR BREACH OF OUR INFORMATION SYSTEMS MAY RESULT IN LOST
BUSINESS.
We rely heavily upon communications and information systems to conduct our
business. As we implement our growth strategy and increase our volume of loan
production, that reliance will increase. Any failure or interruption or breach
in security of our information systems or the third-party information systems on
which we rely could cause underwriting or other delays and could result in fewer
loan applications being received, slower processing of applications and reduced
efficiency in loan servicing. We cannot assure you that such failures or
interruptions will not occur or if they do occur that they will be adequately
addressed by us or the third parties on which we rely. The occurrence of any
failures or interruptions could significantly harm our business.
THE SUCCESS AND GROWTH OF OUR BUSINESS WILL DEPEND UPON OUR ABILITY TO ADAPT TO
AND IMPLEMENT TECHNOLOGICAL CHANGES.
Our mortgage loan origination business is currently dependent upon our ability
to effectively interface with our brokers, borrowers and other third parties and
to efficiently process loan applications and closings. The origination process
is becoming more dependent upon technological advancement, such as the ability
to process applications over the Internet, accept
17
electronic signatures, provide process status updates instantly and other
customer-expected conveniences that are cost-efficient to our process.
Implementing this new technology and becoming proficient with it may also
require significant capital expenditures. As these requirements increase in the
future, we will have to fully develop these technological capabilities to remain
competitive or our business will be significantly harmed.
OUR FINANCIAL RESULTS FLUCTUATE AS A RESULT OF SEASONALITY AND OTHER TIMING
FACTORS, WHICH MAKES IT DIFFICULT TO PREDICT OUR FUTURE PERFORMANCE.
Our business is generally subject to seasonal trends. These trends reflect the
general pattern of housing sales, which typically peak during the spring and
summer seasons. Our quarterly operating results have fluctuated in the past and
are expected to fluctuate in the future, reflecting the seasonality of the
industry. Further, if the closing of a sale of loans is postponed, the
recognition of gain from the sale is also postponed. If such a delay causes us
to recognize income in the next quarter, our results of operations for the
previous quarter could be significantly depressed.
IN THE FUTURE, OUR HEDGING STRATEGIES MAY NOT BE SUCCESSFUL IN MITIGATING OUR
RISKS ASSOCIATED WITH INTEREST RATES.
Although we do not currently use various derivative financial instruments to
provide a level of protection against interest rate risks, we may elect to do so
in the future. We cannot assure you that our hedging strategy and the
derivatives that we use will adequately offset the risk of interest rate
volatility or that our hedging transactions will not result in losses.
RISKS ASSOCIATED WITH OUR ACQUISITION STRATEGY
THERE ARE RISKS ASSOCIATED WITH OUR ACQUISITION STRATEGY.
We intend to continue to grow through internal expansion and by making selective
acquisitions of small- to medium-sized mortgage brokers and bankers. We cannot
predict whether we will be successful in pursuing these acquisitions or what
would be the consequences of these acquisitions. Consummation of each
acquisition is subject to various conditions, such as securing the approval of
state licensing bodies. Acquisitions may involve a number of specific risks
including adverse short-term effects on our results of operations, dilution from
issuances of our common stock and strain on our financial and administrative
infrastructure.
Our acquisition strategy involves numerous other risks, including risks
associated with:
o Identifying acquisition candidates and negotiating definitive purchase
agreements on satisfactory terms;
o Conducting adequate due diligence;
o Integrating operations, personnel and management information systems;
o Managing a growing and geographically diverse group of employees;
o Diverting management's attention from other business concerns; and
o Competition for attractive acquisition candidates from other acquirors.
18
We cannot be certain that we will be able to successfully integrate our
acquisitions or manage the resulting business effectively, or that any
acquisition will achieve the benefits that we anticipate. In addition, we are
not certain that we will be able to acquire companies at attractive valuations.
Depending upon the nature, size and timing of potential future acquisitions, we
may be required to raise additional financing in order to consummate additional
acquisitions. We cannot assure you that our existing or future financing
agreements will permit the necessary additional financing or that additional
financing will be available to us or, if available, that financing would be on
terms acceptable to our management.
THERE ARE RISKS ASSOCIATED WITH OUR PLAN TO USE OUR COMMON STOCK AS ACQUISITION
CONSIDERATION.
We expect to finance future acquisitions primarily through issuing shares of our
common stock for all or a portion of the consideration to be paid. In the event
that our common stock does not maintain a sufficient market value, or potential
acquisition candidates are otherwise unwilling to accept our common stock as
part of the consideration for the sale of their businesses, our ability to issue
common stock as acquisition consideration may be limited. In addition, currently
our stock is thinly traded on the NASDAQ OTC Bulletin Board. This lack of
liquidity may discourage some acquisition candidates from accepting our common
stock as acquisition consideration.
STATUTORY AND REGULATORY RISKS
THE MULTI-STATE SCOPE OF OUR OPERATIONS EXPOSES US TO RISKS OF NONCOMPLIANCE
WITH AN INCREASING AND INCONSISTENT BODY OF COMPLEX LAWS AND REGULATIONS AT THE
FEDERAL, STATE AND LOCAL LEVELS.
We are currently licensed, or exempt from licensing, in 24 states and the
District of Columbia and must comply with the laws and regulations, as well as
judicial and administrative decisions, of all of these jurisdictions, as well as
an extensive body of federal laws and regulations. The volume of new or modified
laws and regulations has increased in recent years, and, in addition, individual
cities and counties have begun to enact laws that restrict subprime loan
origination activities in those cities and counties. The laws and regulations of
each of these jurisdictions are different, complex and, in some cases, in direct
conflict with each other. As our operations continue to grow to include other
states, it may be more difficult to comprehensively identify, to accurately
interpret and to properly program our technology systems and effectively train
our personnel with respect to all of these laws and regulations, thereby
potentially increasing our exposure to the risks of noncompliance with these
laws and regulations. Increased regulation would result in increased compliance
costs.
Our failure to comply with these laws can lead to civil and criminal liability;
loss of our licenses and right to do business in the various states; demands for
indemnification or loan repurchases from purchasers of our loans; class action
lawsuits; and administrative enforcement actions.
19
Several federal, state and local laws and regulations have been adopted or are
under consideration intended to eliminate so-called "predatory" lending
practices. Many of these laws and regulations impose broad restrictions on
certain commonly accepted lending practices, including some of our practices.
There can be no assurance that these proposed laws, rules and regulations, or
other similar laws, rules or regulations, will not be adopted in the future.
Adoption of these laws and regulations could have a material adverse impact on
our business by substantially increasing the costs of compliance with a variety
of inconsistent federal, state and local rules, or by restricting our ability to
charge rates and fees adequate to compensate us for the risk associated with
certain loans.
The increased governmental scrutiny of Fannie Mae and Freddie Mac may also
result in regulatory changes and oversight which may have an adverse impact on
the industry generally, and in turn have a negative effect on our business.
STOCKHOLDER REFUSAL TO COMPLY WITH REGULATORY REQUIREMENTS MAY INTERFERE WITH
OUR ABILITY TO DO BUSINESS IN CERTAIN STATES.
Some states in which we operate may impose regulatory requirements on our
officers and directors and persons holding certain amounts of our common stock,
usually 10% holders. If any of these persons fails to meet or refuses to comply
with a state's applicable regulatory requirements for licensing, we could lose
our authority to conduct business in that state.
WE MAY BE SUBJECT TO FINES OR OTHER PENALTIES BASED UPON THE CONDUCT OF THE
INDEPENDENT BROKERS IN OUR NETWORK.
The mortgage brokers for which we originate loans have parallel and separate
legal obligations to which they are subject. While these laws may not explicitly
hold the originating lenders responsible for the legal violations of mortgage
brokers, increasingly federal and state agencies have sought to impose such
assignee liability. Recently, for example, the United States Federal Trade
Commission ("FTC") entered into a settlement agreement with a mortgage lender
where the FTC characterized a broker that had placed all of its loan production
with a single lender as the "agent" of the lender; the FTC imposed a fine on the
lender in part because, as "principal," the lender was legally responsible for
the mortgage broker's unfair and deceptive acts and practices. The United States
Justice Department in the past has sought to hold a subprime mortgage lender
responsible for the pricing practices of its mortgage brokers, alleging that the
mortgage lender was directly responsible for the total fees and charges paid by
the borrower under the Fair Housing Act even if the lender neither dictated what
the mortgage broker could charge nor kept the money for its own account.
Accordingly, we may be subject to fines or other penalties based upon the
conduct of our independent mortgage brokers.
WE MAY BE UNABLE TO COMPETE EFFECTIVELY WITH FINANCIAL INSTITUTIONS THAT ARE
EXEMPT FROM CERTAIN STATE RESTRICTIONS.
Certain federally chartered financial institutions are exempt from the state
laws to which we are subject and may operate more effectively under the federal
laws that govern their operations. In addition, beginning July 1, 2003 the
exemption provided to us and other state licensed mortgage
20
bankers under the Alternative Mortgage Transactions Parity Act (the "Parity
Act") and related rules issued in the past by the Office of Thrift Supervision
(the "OTS") was eliminated. The Parity Act was enacted to extend to financial
institutions, other than federally chartered depository institutions, the
federal preemption which federally chartered depository institutions enjoy
regarding state law restrictions and prohibitions on prepayment penalties. The
elimination of this federal preemption will require us to comply with state
restrictions on prepayment penalties. This may place us at a competitive
disadvantage relative to financial institutions that will continue to enjoy
federal preemption of such state restrictions because such institutions will be
able to charge prepayment penalties without regard to state restrictions and
thereby may be able to offer loans with interest rate and loan fee structures
that are more attractive than we are able to offer.
THE INCREASING NUMBER OF FEDERAL, STATE AND LOCAL "ANTI-PREDATORY LENDING" LAWS
MAY RESTRICT OUR ABILITY TO ORIGINATE OR INCREASE OUR RISK OF LIABILITY WITH
RESPECT TO CERTAIN MORTGAGE LOANS AND COULD INCREASE OUR COST OF DOING BUSINESS.
The continued enactment of these laws, rules and regulations may prevent us from
making certain loans and may cause us to reduce the APR or the points and fees
on loans that we do make. In addition, the difficulty of managing the risks
presented by these laws, rules and regulations may decrease the availability of
warehouse financing and the overall demand for subprime loans, making it
difficult to fund or sell any of our loans. If nothing else, the growing number
of these laws, rules and regulations will increase our cost of doing business as
we are required to develop systems and procedures to ensure that we do not
violate any aspect of these new requirements. Any of the foregoing could
significantly harm our business, financial condition, liquidity and results of
operations.
ITEM 2. PROPERTIES
Our executive offices are located at 5000 Sawgrass Village Circle, Ponte Vedra
Beach, Florida. We occupy approximately 4,348 square feet of space at this
location under a lease, which commenced January 1, 2003, and expires December
31, 2006. The annual rent on our executive offices is $95,200, with a 3%
escalator clause.
Our PGNF subsidiary occupies approximately 8,100 square feet in Westmont,
Illinois under a lease expiring August 31, 2010. The annual rent on our offices
in Westmont, Illinois is $360,000. Our PHF subsidiary occupies approximately
2,500 square feet in Maitland, Florida under a lease expiring March 31, 2006.
The annual rent on our office in Maitland, Florida is $50,400, with an escalator
clause based on CPI.
ITEM 3. LEGAL PROCEEDINGS
In mid-2001, the Company, and certain of its former directors and officers were
named as defendants in class action complaints alleging violations of the
federal securities laws in the United States District Court for the Southern
District of New York. In mid-2002, the complaints against the Company were
consolidated into a single action.
21
The essence of the complaint is that in connection with the Company's initial
public offering in October 1999 ("IPO"), the defendants issued and sold the
Company's common stock pursuant to a registration statement which did not
disclose to investors that certain underwriters in the offering had solicited
and received excessive and undisclosed commissions from certain investors
acquiring the Company's common stock in connection with the IPO. The complaint
also alleges that the registration statement failed to disclose that the
underwriters allocated Company shares in the IPO to customers of the
underwriters in exchange for the customers' promises to purchase additional
shares in the aftermarket at pre-determined prices above the IPO price. The
action seeks damages in an unspecified amount.
The action is being coordinated with approximately 300 other nearly identical
actions filed against other companies that had initial public offerings of
securities between 1997 and 2000 same time period.
The Company has approved a Memorandum of Understanding ("MOU") and related
agreements which set forth the terms of a settlement between the Company, the
plaintiff class and the vast majority of the other approximately 300 issuer
defendants. Among other provisions, the settlement contemplated by the MOU
provides for a release of the Company and the individual defendants for the
conduct alleged in the action to be wrongful. The Company would agree to
undertake certain responsibilities, including agreeing to assign away, not
assert, or release certain potential claims the Company may have against its
underwriters.
It is anticipated that any potential financial obligation of the Company to
plaintiffs pursuant to the terms of the MOU and related agreements will be
covered by existing insurance. Therefore, the Company does not expect that the
settlement will involve any payment by the Company. The MOU and related
agreements are subject to a number of contingencies, including the negotiation
of a settlement agreement and its approval by the Court. We cannot opine as to
whether or when a settlement will occur or be finalized. Whether or not the
settlement is ultimately approved, we believe the resolution of this matter will
not have a material adverse effect on the Company.
We are also party to various legal proceedings arising out of the ordinary
course of our business. Management believes that any liability with respect to
these legale actions, individually or in the aggregate, will not have a material
adverse effect on our consolidated financial position and results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our stockholders during the fourth
quarter of 2003.
22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock trades in the over-the-counter market and is quoted on the OTC
Bulletin Board under the symbol PGNF. As of December 31, 2003 and March 23,
2004, we had 116,396,478 shares of common stock issued and outstanding,
respectively.
The following table sets forth, for the periods indicated, the high and low bid
prices per share of our common stock as quoted on the OTC Bulletin Board.
HIGH LOW
2004
1st Quarter through March 23, 2004 $0.35 $0.10
2003
4th Quarter $0.52 $0.15
3rd Quarter $0.62 $0.44
2nd Quarter $0.75 $0.45
1st Quarter $0.80 $0.40
2002
4th Quarter $1.35 $0.08
3rd Quarter $0.17 $0.07
2nd Quarter $0.26 $0.05
1st Quarter $0.07 $0.05
HOLDERS
As of March 23, 2004, we had approximately 324 stockholders of record. Only
record holders of shares held in "nominee" or street names are included in this
number.
DIVIDENDS
We have never declared or paid cash dividends on our common stock. We intend to
retain future earnings, if any, for use in the operations of our business
including working capital, repayment of indebtedness, capital expenditures and
general corporate purposes. We do not anticipate paying any cash dividends on
our common stock in the foreseeable future.
EQUITY COMPENSATION PLAN INFORMATION
Information regarding our equity compensation plans, including both stockholder
approved plans and non-stockholder approved plans, is included in Item 12.
RECENT SALES OF UNREGISTERED SECURITIES
None.
23
ITEM 6. SELECTED FINANCIAL DATA
The table below sets forth a summary of our results of operations and
financial condition as of and for the periods then ended. This information has
been derived from our audited consolidated financial statements contained
elsewhere in this report. Such selected financial data should be read in
conjunction with those financial statements and the notes thereto and with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" also included elsewhere herein.
Inception
(August 3,
2001 to
Twelve month period ended December 31,
December 31 2001
2003 2002 2001
Statement of operations data:
Revenues:
Gain on sale of loans $ 7,230 $ -- $ --
Revenue from loan closings 4,995 --
Interest income 1,680 -- --
-------- -------- --------
Total revenues $ 13,905 $ -- $ --
Total expenses $ 15,857 $ 2,342 $ 225
Loss before taxes $ (1,952) $ (2,342) $ (225)
Net loss $ (1,397) $ 2,342) $ (225)
Basic and diluted earnings per share $ (0.01) $ (0.04) $ (0.01)
As of December 31,
--------------------
2003 2002
-------- --------
Balance sheet data:
Total assets $ 35,662 $ 206
Total liabilities $ 27,686 $ 1,074
Stockholders' equity (deficit) $ 7,976 $ (868)
Tangible net worth $ (660) $ (868)
As mentioned elsewhere, prior to our acquisitions of PGNF and PHF, we were a
development stage enterprise and had no revenues.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our consolidated financial
statements and related notes contained elsewhere herein.
24
GENERAL
We are headquartered in Ponte Vedra Beach, Florida and were incorporated in
Delaware in August 1999. We are a mortgage banker and mortgage broker in the
one-to-four family residential mortgage market. We conduct business in 24 states
and the District of Columbia.
OVERVIEW
Our business relies on our ability to originate mortgage loans at a reasonable
cost, and our ability to sell those loans in the secondary mortgage market at
prices allowing us to earn a gain on sale. We measure the gain on sale as the
sum of the price we receive for our loans, plus the interest we earn for the
period of time we hold the loans, less the cost to originate the loans.
The mortgage banking industry is generally subject to seasonal trends, and loan
origination volumes in our industry have historically fluctuated from year to
year and are affected by such external factors as home values, the level of
consumer debt and the overall condition of the economy. In addition, the
premiums we receive from the secondary market for our loans have also
fluctuated, also influenced by the overall condition of the economy and, more
importantly, the interest rate environment. As a consequence, the business of
originating and selling loans is cyclical.
Gain on Sale of Loans
Gain on sale of loans is affected by the condition of the secondary market for
our loans. This market has been very strong in the past year, partly as a result
of the interest rate environment characterized by low short-term rates relative
to long-term rates, also known as a steep yield curve. The strength of the
secondary market has also been enhanced by an increase in the number of buyers
of our loan products.
Origination Fees
Origination fees are comprised of points and other fees charged on mortgage
loans originated by our retail channel and brokered through other banks and
financial institutions. Retail points and fees are primarily a function of the
volume of mortgage loans originated by our retail channel. Origination fees on
loans originated by our retail channel which are subsequently sold are deferred
and recognized as part of the gain on sale of loans.
Interest Income and Interest Expense
We typically hold our mortgage loans held for sale for a period of 30 to 45 days
before they are sold in the secondary market. During that time, we earn the
coupon rate of interest paid by the borrower, and we pay interest to the lenders
that provide our warehouse credit facilities. During 2003, the difference
between these interest rates was typically in excess of 2%.
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Loan Origination Costs
We also measure and monitor the cost to originate our loans. Such costs include
the points and fees we may pay to brokers, net of fees we receive from
borrowers, plus our operating expenses associated with the origination business.
Loan Originations
As of December 31, 2003, our wholesale division originated loans through our
office in Westmont, Illinois. Our wholesale division originated $295.7 million
during the eleven months ended December 31, 2003. As of December 31, 2003, our
retail division originated loans through our locations in Westmont, Illinois and
Orlando, Florida. Our retail division originated $285.4 million in loans during
the eleven months ended December 31, 2003.
CRITICAL ACCOUNTING POLICIES
We have established various accounting policies which govern the application of
accounting principles generally accepted in the United States of America in the
preparation of our financial statements. Certain accounting policies require us
to make significant estimates and assumptions that may have a material impact on
certain assets and liabilities, as well as our operating results, and we
consider these to be critical accounting policies. The estimates and assumptions
we use are based on historical experience and other factors which we believe to
be reasonable under the circumstances. Actual results could differ materially
from these estimates and assumptions, which could have a material impact on the
carrying value of assets and liabilities and our results of operations.
We believe the following are critical accounting policies that require the most
significant estimates and assumptions that are subject to significant change in
the preparation of our consolidated financial statements:
PROVISION FOR LOAN REPURCHASES AND PREMIUM RECAPTURE
For mortgage loans sold, we provide for an allowance for loan repurchases and
premium recapture based on our estimate of the potential repurchase of loans or
indemnification of losses based on alleged violations of representations and
warranties which are customary to the mortgage banking industry. We purchase
fraud insurance on the loans originated by our wholesale segment to mitigate
this risk. The allowance represents our estimate of the total uninsured losses
expected to occur and is considered to be adequate. Provisions for losses are
charged to gain on sale of loans and credited to mortgage loans receivable
held-for-sale.
GAIN ON SALE OF LOANS
We recognize gains or losses resulting from sales at the date of settlement
based on the difference between the selling price for sales and the carrying
value of the related loans sold. Such gains and losses may be increased or
decreased by the amount of any servicing-released premiums received. We defer
recognition of non-refundable fees and direct costs associated with the
origination of mortgage loans until the loans are sold.
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INCOME TAXES
We file a consolidated federal income and combined state franchise tax returns.
We utilize the asset and liability method of accounting for income taxes, under
which deferred income taxes are recognized for the future tax consequences
attributable to the differences between the financial statement values of
existing assets and liabilities and their respective tax bases. We measure
deferred tax assets and liabilities using enacted tax rates we expect to apply
to taxable income in the years in which those temporary differences are expected
to be recovered or settled. We recognize the effect on deferred taxes of a
change in tax rates in income in the period that includes the enactment date.
In determining the possible realization of deferred tax assets, we consider
future taxable income from the following sources: (a) the reversal of taxable
temporary differences, (b) future operations exclusive of reversing temporary
differences, and (c) tax planning strategies that, if necessary, would be
implemented to accelerate taxable income into periods in which net operating
losses might otherwise expire.
RESULTS OF OPERATIONS
Until our acquisitions of PGNF and PHF, we were a development stage enterprise
and had no revenues. Therefore, the following table sets forth our results of
operations as a percentage of total revenues only for the eleven months ended
December 31, 2003:
REVENUE:
Gain on sale of loans 52.0%
Loan origination fees 35.9%
Interest income 12.1%
-------------
Total revenue 100.0%
EXPENSES:
Salaries, commissions, and benefits 60.6%
Loan production costs 9.2%
General and administrative expenses 29.5%
Non-recurring charges 2.4%
Interest expense 12.0%
Realized loss on derivative 1.0%
Unrealized gain on derivative -0.7%
-------------
Total expenses 114.0%
LOSS BEFORE TAXES -14.0%
PROVISION FOR TAXES -4.0%
-------------
NET LOSS -10.0%
=============
27
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002
Loan Originations
We originated $581.1 million in loans for the year ended December 31, 2003.
Wholesale loan originations were $295.7 million, or 50.9%, of total originations
for the year ended December 31, 2003. Retail loan originations and purchases
were $285.4 million, or 49.1%, of total originations and purchases for the year
ended December 31, 2003.
Loan Sales
Loan sales were $321.9 million for the year ended December 31, 2003.
REVENUES
Total revenues for the year ended December 31, 2003 were $13.9 million. Our
revenues consist of gain on sale of loans, loan origination fees, and interest
income. Each of these revenue categories is discussed below. In the twelve
months ended December 31, 2002, we were a development stage enterprise and had
no revenues. Therefore, the discussion below is limited to the year ended
December 31, 2003.
Gain on Sale. Gain on sale of loans was $7.2 million for the year ended December
31, 2003. The table below details the calculation of the gain on sale of loans
for the year ended December 31, 2003.
% OF LOAN
(IN THOUSANDS) SALES
------------ ------------
Premiums from loan sale transactions $ 13,908 4.3%
Non-refundable loan fees (1) 1,472 0.4%
Provision for losses (636) (0.2%)
Premiums paid (2) (2,985) (0.9%)
Origination costs (4,529) (1.4%)
------------ ------------
$ 7,230 2.2%
============ ============
(1) Non-refundable loan fees represent points and fees collected from
borrowers.
(2) Premiums paid represent fees paid to independent brokers for wholesale
loan originations.
Loan origination fees. Loan origination fees were $5.0 million for the year
ended December 31, 2003. These fees represent points and other fees charged on
mortgage loans originated by our retail channel. Expressed as a percentage of
retail loan origination volume, origination fees were 1.75% of retail loan
originations for the year ended December 31, 2003.
28
Interest income. Interest income was $1.7 million for the year ended December
31, 2003. The interest income relates primarily to the interest income we earn
on the mortgage loans funded prior to their sale in the secondary market.
OPERATING EXPENSES
Salaries, commissions and benefits. Salaries, commissions and benefits increased
$6.7 million, or 376.9%, to $8.4 million for the year ended December 31, 2003
compared to $1.8 million for the year ended December 31, 2002. Of this increase,
$7.3 million, or 110.1%, relates to salaries, commissions, and benefits of our
subsidiaries PGNF and PHF acquired on January 31, 2003 and February 4, 2003,
respectively. Salaries, commissions, and benefits attributable to our corporate
operations decreased by $673, or 38.1%, in fiscal 2003 compared to fiscal 2002
due primarily to the non-cash compensation expenses incurred in fiscal 2002.
Loan production costs. Loan production costs were $1.3 million for the year
ended December 31, 2003. These loan production costs related entirely to our
subsidiaries PGNF and PHF acquired on January 31, 2003 and February 4, 2003,
respectively.
General and administrative expenses. General and administrative expenses
increased $3.5 million, or 620.7%, to $4.1 million for the year ended December
31, 2003 compared to $569,000 for the year ended December 31, 2002. Of this
increase, $3.2 million, or 90.6%, relates to our subsidiaries PGNF and PHF
acquired on January 31, 2003 and February 4, 2003, respectively. General and
administrative expenses attributable to our corporate operations increased
$331,000, or 58.2%, in fiscal 2003 compared to fiscal 2002 consisting primarily
of increased rent, legal and accounting expenses associated with operating our
businesses.
Non-recurring charges. Non-recurring charges were $333,000 for the year ended
December 31, 2003 and consist of $240,000 in severance for our former CEO and
$93,000 related to investment banking fees and travel related to an unsuccessful
financing effort.
Interest expense. Interest expense increased $1.7 million to $1.7 million for
the year ended December 31, 2003 compared to $5,000 for the year ended December
31, 2002. Of this increase, $1.3 million, or 75.4%, relates to interest expense
at our subsidiary PGNF which was acquired on January 31, 2003. Interest expense
attributable to our corporate operations increased $410,000 due primarily to
interest on our convertible debentures.
Realized loss on derivative. The realized loss on derivative increased $143,000
to $143,000 for the year ended December 31, 2003. The increase is due to
movements of interest rates underlying the derivative financial instrument
assumed as part of our acquisition of PGNF.
Unrealized gain on derivative. The unrealized gain on derivative was $97,000 for
the year ended December 31, 2003. This increase was due to the movements of
interest rates underlying the derivative financial instrument assumed as part of
our acquisition of PGNF.
Total expenses. Total expenses increased $13.5 million, or 577.1%, to $15.9
million for the year ended December 31, 2003 compared to $2.3 million for the
year ended December 31,2002. Of
29
this increase, $13.1 million, or 97.0%, relates to expenses at our subsidiaries
PGNF and PHF acquired on January 31, 2003 and February 4, 2003, respectively.
Total expenses attributable to our corporate operations increased $402,000 due
primarily to factors discussed above.
Income tax benefit. The income tax benefit was $554,000 for the year ended
December 31, 2003. We did not recognize an income tax benefit on our net loss
for the year ended December 31, 2002 since we were a development stage
enterprise and future taxable income was uncertain. Our effective tax rate was
(28.4)%.
Net loss. Net loss for the year ended December 31, 2003 was $1.4 million
compared to $2.3 million for year ended December 31, 2002. The decrease of
$944,000 was due to the factors discussed above.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO THE PERIOD INCEPTION (AUGUST 1, 2001)
TO DECEMBER 31, 2001
Revenue
The Company was a development stage enterprise and had no revenues for the year
ended December 31, 2002 and for the period from inception (August 3, 2001) to
December 31, 2001.
OPERATING EXPENSES
Deferred salaries, related benefits and stock based compensation. Deferred
salaries, related benefits and stock based compensation increased $1,560,000, or
750%, to $1,768,000 for the year ended December 31, 2002 compared to $208,000
for the period from inception (August 3, 2001) to December 31, 2001. This
increase is due to the increase in the number of executives during fiscal 2002
as well as the additional seven months in year ended December 31, 2002 compared
to the period ended December 31, 2001. The deferred salaries, related benefits
and stock based compensation are primarily related to salaries accrued for the
executive officers pursuant to employment agreements. On March 26, 2003 these
executives converted an aggregate of $659,000 of deferred salaries and related
benefits into 659 shares of our Series E preferred stock. Our Series E preferred
stock provides for a stated value of $1,000 per share, an annual dividend of 4%
of the stated value, is non-voting and does not provide for redemption.
General and other administrative expenses. General and other administrative
expenses increased $552,000, or 3,247%, to $569,000 for the year ended December
31, 2002 compared to $17,000 for the period from inception (August 3, 2001) to
December 31, 2001. This increase is primarily due to the additional seven months
in year ended December 31, 2002 compared to the period ended December 31, 2001
as well as the increase in travel to support our acquisition program.
Interest expense. Interest expense was $5,000 and relates to a premium finance
plan on certain of our insurance contracts. There was no interest expense for
the period from inception (August 3, 2001) to December 31, 2001.
30
Net loss. Net loss for the year ended December 31, 2002 was $2,342,000 compared
to $225,000 for the period from inception (August 3, 2001) to December 31, 2001.
The increase of $2,117,000 was due to the factors discussed above.
QUARTERLY RESULTS
Set forth below is certain unaudited quarterly financial data for each of our
last eight quarters. The information has been derived from unaudited financial
statements that, in the opinion of management, include all adjustments
(consisting only of normal recurring adjustments) necessary to fairly present
such quarterly information in accordance with generally accepted accounting
principles. The operating results for any quarter are not necessarily indicative
of the results to be expected for any future period.
In connection with the audit of our financial statements as of and for the year
ended December 31, 2003, we recognized an income tax benefit on our net
operating loss. We had not recognized such a benefit in our previously reported
quarterly information. In the table below, we have allocated this tax benefit to
our previously reported quarterly information.
YEAR ENDED DECEMBER 31, 2003
(IN THOUSANDS, EXCEPT PER SHARE AMOUNT)
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
Revenue $ 1,846 $ 4,314 $ 4,187 $ 3,558
Total operating expenses $ 2,769 $ 4,595 $ 4,270 $ 4,223
Income tax benefit $ (262) $ (80) $ (24) $ (189)
Net loss $ (661) $ (201) $ (59) $ (476)
Basic and diluted loss per
share $ (0.01) $ (0.00) $ (0.00) $ (0.00)
In connection with the audit of our financial statements as of and for the year
ended December 31, 2002, we discovered certain errors in previously reported
quarterly periods during the prior two fiscal years. These errors, some of which
overstated expenses and some of which understated expenses, arose from the
erroneous expensing of offering costs, the non-recognition of a financed
insurance policy as well as non-recording or under-recording of certain costs
and expenses which were paid for by the issuance of Company stock and/or common
stock purchase options, and in one case, certain consulting services that were
donated by a stockholder. These above adjustments have been made to the
previously reported quarterly information. As restated for such adjustments,
unaudited quarterly information for each of the quarters
31
YEAR ENDED DECEMBER 31, 2002
(IN THOUSANDS, EXCEPT PER SHARE AMOUNT)
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
Revenue $ -- $ -- $ -- $ --
Total operating expenses $ 389 $ 432 $ 658 $ 863
Net loss $ (389) $ (432) $ (658) $ (863)
Basic and diluted loss per share $ (0.01) $ (0.01) $ (0.01) $ (0.01)
LIQUIDITY AND CAPITAL RESOURCES
Our primary sources of liquidity are:
o borrowings under revolving warehouse facilities and other lines of credit,
o sale of mortgage loans and related servicing rights, and
o fees earned from originating retail mortgage loans.
Our operations require continued access to short-term and long-term sources of
cash. Our primary operating cash requirements include:
o funding of mortgage loan originations prior to their sale,
o fees and expenses incurred in connection with the sale of loans,
o ongoing administrative, operating, and tax expenses, and
o interest and principal payments under our revolving warehouse facilities
and other existing indebtedness.
We had cash and cash equivalents of approximately $552,000 and
available-for-sale securities of $995,000 at December 31, 2003. At March 23,
2004, we had cash and cash equivalents of approximately $495,000 and no
available-for-sale securities.
Warehouse Credit Facilities. We rely on our revolving warehouse facilities to
originate mortgage loans and hold them prior to sale. At December 31, 2003, we
had committed revolving warehouse facilities in the amount of $35 million
(subject to certain lender restrictions on the aggregate extensions to all
warehouse lenders). Generally, our revolving warehouse facilities have 364-day
terms and are renewed on an annual basis. No assurances can be made that we will
be successful in our efforts to continue to renew our warehouse facilities upon
their expiration.
Certain of our warehouse facility lenders advance less than 100% of the
principal balance of the mortgage loans, requiring us to use working capital to
fund the remaining portion of the principal balance of the mortgage loans. All
of the our revolving warehouse facilities contain provisions requiring we meet
certain periodic financial covenants, which establish, among other things,
liquidity, stockholders' equity, leverage, and net income levels. If we are
unable to meet these financial covenants going forward, or are unable to obtain
subsequent amendments or waivers, if required, or for any other reason are
unable to maintain existing warehouse lines or renew them when they expire, we
would have to cease our wholesale operations which would jeopardize our ability
to continue to operate as a going concern.
Other Credit Facilities. On June 13, 2003, we entered into a revolving line of
credit with a commercial bank in the amount of $250,000. This revolving line of
credit has an interest rate of prime, is secured by a general lien on our
assets, is guaranteed by our subsidiaries, and requires monthly interest
payments. This line of credit is due on demand. Currently, we have drawn
$245,000 on this line of credit.
32
Promissory notes payable: As part of indemnity provisions of the purchase and
sale agreements with purchasers of our loans, we were required to repurchase
certain non-performing loans and repay premiums received on loans that
refinanced within a year of their sale. To satisfy these repurchase obligations,
we issued unsecured promissory notes totaling $1,750,000 with a weighted average
interest rate of 3.93% requiring monthly principal and interest payments of
$65,000. At December 31, 2003, the balance on these promissory notes was $1.4
million.
We have vehicle loans with Ford Motor Credit. These loans were obtained as part
of Ford's 0% interest program. The loans secured by the vehicles purchased
require monthly principal payments of $4,200. At December 31, 2003, the balance
on these vehicle loans was $42,500.
Our PGNF subsidiary has a promissory note with a commercial bank secured by a
general lien on all of its assets. This promissory note bears an interest rate
of 4% (prime) and requires monthly principal and interest payments of $7,400. At
December 31, 2003, PGNF owed $141,100 under this promissory note.
Convertible debentures. On March On March 6, 2003, we completed a private
offering of 379 units consisting of (i) a $1,000 convertible promissory note due
December 31, 2003 with interest payable quarterly at a stated interest rate of
15% per annum and (ii) a warrant to purchase shares of common stock, exercisable
at $0.25 per share, for each $5.00 in principal of the promissory note issued in
the unit. The holder has the right to convert the outstanding principal amount
of the convertible promissory note (or any portion thereof), together with
accrued interest thereon, into shares of our common stock at a conversion price
of $0.25 per share, subject to standard anti-dilution adjustments as specified
in the note. On December 31, 2003, holders of our 15% convertible notes agreed
to amend the maturity date of the convertible notes to December 31, 2004. The
convertible notes require payments of interest on March 31, 2004, June 30, 2004,
September 30, 2004 and December 31, 2004.
The Sale of Mortgage Loans. As a fundamental part of our business and financing
strategy, we sell mortgage loans to third party investors in the secondary
markets as market conditions allow. Generally, we seek to dispose of all of our
loan production within 30 to 45 days. We apply the net proceeds of the loan
sales to pay down our warehouse facilities in order to make capacity available
for future funding of mortgage loans. Our ability to sell loans in the secondary
market on acceptable terms is essential for the continuation of our wholesale
loan origination operations. Due to our recent mergers with PGNF and PHF, we
anticipate that the cash generated from these operations, cash on hand,
available-for-sale securities and available borrowings under our warehouse
facilities will enable us to meet our existing liquidity requirements during the
next 12 months.
NEWLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2003, the FASB issued FASB Interpretation No. 46 (revised December
2003), Consolidation of Variable Interest Entities , which addresses how a
business enterprise should
33
evaluate whether it has a controlling financial interest in an entity through
means other than voting rights and accordingly should consolidate the entity.
FIN 46R replaces FASB Interpretation No. 46, Consolidation of Variable Interest
Entities, which was issued in January 2003. The Company will be required to
apply FIN 46R to all entities subject to this Interpretation no later than the
end of the first reporting period that ends after December 15, 2004. This
interpretation must be applied to those entities that are considered to be
special-purpose entities no later than as of the end of the first reporting
period that ends after December 15, 2003.
For any variable interest entities (VIEs) that must be consolidated under FIN
46R that were created before January 1, 2004, the assets, liabilities and
noncontrolling interests of the VIE initially would be measured at their
carrying amounts with any difference between the net amount added to the balance
sheet and any previously recognized interest being recognized as the cumulative
effect of an accounting change. If determining the carrying amounts is not
practicable, fair value at the date FIN 46R first applies may be used to measure
the assets, liabilities and noncontrolling interest of the VIE. The application
of this Interpretation is not expected to have a material effect on the
Company's financial statements.
In December 2003, the Accounting Standards Executive Committee issued Statement
of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a
Transfer ("SOP 03-3"). SOP 03-3 addresses accounting for differences between
contractual cash flows and cash flows expected to be collected from an
investor's initial investment in loans or debt securities (loans) acquired in a
transfer if those differences are attributable, at least in part, to credit
quality. SOP 03-3 includes loans acquired in purchase business combinations, but
does not apply to loans originated by the entity. SOP 03-3 is effective for
loans acquired in fiscal years beginning after December 15, 2004, although
earlier adoption is encouraged. The adoption of this new statement of position
is not expected to have a material impact on the consolidated financial position
or results of operations of the Company.
In May 2003, the FASB issued FASB Statement No. 150, Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity. This
Statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). Many of
those instruments were previously classified as equity. The provisions of this
Statement are effective for financial instruments entered into or modified after
May 31, 2003, and otherwise are effective at the beginning of the first interim
period beginning after June 15, 2003. The adoption of this new standard is not
expected to have an impact on the consolidated financial position or results of
operations of the Company.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. The Statement amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under
Statement 133. The amendments set forth in Statement 149 improve financial
reporting by requiring that contracts with comparable characteristics be
accounted for similarly. In particular, this Statement clarifies under what
circumstances a contract with an
34
initial net investment meets the characteristic of a derivative as discussed in
Statement 133. In addition, it clarifies when a derivative contains a financing
component that warrants special reporting in the statement of cash flows.
Statement 149 amends certain other existing pronouncements. Those changes will
result in more consistent reporting of contracts that are derivatives in their
entirety or that contain embedded derivatives that warrant separate accounting.
Generally, this Statement is effective for contracts entered into or modified
after June 30, 2003. Since the Company does not currently have any material
derivatives or hedging activities, the adoption of SFAS 149 is not expected to
materially affect the financial statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
GENERAL
We carry interest-sensitive assets on our balance sheet that are financed by
interest-sensitive liabilities. Since these interest-sensitive assets and
liabilities are not necessarily correlated, we are subject to interest-rate
risk. A sudden and sustained increase or decrease in interest rates would impact
our net interest income and gain on sale of loans, as well as the fair value of
our mortgage loans held for sale. We do not hedge against this interest-rate
risk and instead attempt to sell our loans held for sale in a rapid, but orderly
fashion, generally within 30-45 days.
The following table illustrates the timing of the re-pricing of our
interest-sensitive assets and liabilities as of December 31, 2003. We have made
certain assumptions in determining the timing of re-pricing of such assets and
liabilities. One of the more significant assumptions is that all of our mortgage
loans held for sale will be sold in the first six months of 2004.
Zero to Six
Description Months
Interest-sensitive assets:
Cash and cash equivalents $ 552
Loans held for sale 23,452
Notes and mortgages 136
Investment in marketable securities 995
--------
Total interest-sensitive assets $ 25,135
========
Interest-sensitive liabilities:
Warehouse loans $ 22,711
Promissory notes 245
--------
Total interest-sensitive liabilities $ 22,956
========
35
IMPACT OF INFLATION
Inflation affects us most significantly in the area of loan originations and can
have a substantial effect on interest rates. Interest rates normally increase
during periods of high inflation and decrease during periods of low inflation.
Profitability may be directly affected by the level and fluctuation in interest
rates that affect our ability to earn a spread between interest received on its
loans and the costs of its borrowings. Our profitability is likely to be
adversely affected during any period of unexpected or rapid changes in interest
rates. A substantial and sustained increase in interest rates could adversely
affect our ability to originate loans and affect the mix of first and
second-lien mortgage loan products. Generally, first-lien mortgage production
increases relative to second-lien mortgage production in response to low
interest rates and second-lien mortgage production increases relative to
first-lien mortgage production during periods of high interest rates.
Fluctuating interest rates may also affect the net interest income earned by us
resulting from the difference between the yield to us on loans held pending
sales and the interest paid by us for funds borrowed under our warehouse lines
of credit.
OFF BALANCE SHEET ARRANGEMENTS
We do not have any significant off balance sheet arrangements.
TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
The following table presents our contractual obligations as of December 31,
2003:
PAYMENT DUE BY PERIOD
-----------------------------------------------------
Total Less than One Year 1 - 3 Years 3 - 5 Years
Warehouse lines of credit $22,711 $22,711 -- --
Promissory notes 1,846 1,126 720 --
Convertible debentures 379 379 -- --
Notes due related parties 801 25 776 --
------- ------- ------- -------
Total $25,737 $24,241 $ 1,496 $ --
======= ======= ======= =======
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is incorporated by reference from our consolidated
financial statements and notes thereto which are included in this report
beginning on page F-1. Certain selected quarterly financial data is included
under Item 7 of this Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On August 26, 2003, our Board of Directors voted to dismiss BP Professional
Group, LLP as our independent accountants.
The report of BP Professional Group, LLP on our financial statements for the
periods ending December 31, 2002 and 2001 contained no adverse opinion or
disclaimer of opinion and was not
36
qualified or modified as to uncertainty, audit scope or accounting principle,
except for doubt about our ability to continue as a going concern.
In connection with its audit for the two most recent fiscal years and through
August 26, 2003, there were no disagreements with BP Professional Group, LLP on
any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or auditing procedure, except as discussed in the
paragraph below, which disagreements, if not resolved to the satisfaction of BP
Professional Group, LLP, would have caused them to make reference thereto in
their report on the financial statements for such years.
During the performance of their review of our financial statements for the
quarter ended March 31, 2003 and through August 26, 2003 , BP Professional
Group, LLP expressed their desire to send a letter to the United States
Securities and Exchange Commission (the "SEC") seeking confirmation of our
application of SFAS No. 141, Accounting for Business Combinations ("SFAS 141"),
to the acquisition of PGNF Home Lending Corp, completed on January 31. 2003. We
did not feel the letter necessary as we maintained we had properly accounted for
the acquisition of PGNF Home Lending Corp. BP Professional Group, LLP decided to
proceed with the preparation and delivery of the letter to the SEC. Upon review
and discussion of BP Professional Group, LLP's communication, the SEC determined
that no action was necessary in regards to our accounting treatment for the
purchase. We have authorized BP Professional Group, LLP to respond fully to the
inquiries of the successor accountant concerning this matter.
On October 31, 2003, we engaged Stevens, Powell & Company, P.A. as our new
independent accountants for the fiscal year ended December 31, 2003. During our
two most recent fiscal years and any subsequent period through October 31, 2003,
we have not consulted with Stevens, Powell & Company, P.A. regarding either (i)
the application of accounting principles to a specified transaction, either
completed or proposed; or the type of audit opinion that might be rendered on
the registrant's financial statements, and either a written report was provided
to us or oral advice was provided that Stevens, Powell & Company, P.A. concluded
was an important factor considered by us in reaching a decision as to the
accounting, auditing or financial reporting issue; or (ii) any matter that was
either the subject of a disagreement (as defined in paragraph 304(a)(1)(iv) and
the related instructions to this item) or a reportable event (as described in
paragraph 304(a)(1)(v)).
ITEM 9A. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures. Our disclosure controls and procedures are designed to provide
reasonable assurance that the information that we must disclose in our reports
filed under the Securities and Exchange Act is communicated and processed in a
timely manner. George Deehan, Chairman and Chief Executive Officer, and Scott
Vining, Chief Financial Officer and Treasurer, participated in this evaluation.
Based on such evaluation, Mr. Deehan and Mr. Vining concluded that, as of the
date of such evaluation, our disclosure controls and procedures were effective.
During the most recent fiscal
37
quarter, there have not been any significant changes in our internal controls or
in other factors that could significantly affect those controls.
PART III
The information called for pursuant to this Part III, Items 10, 11, 12, 13 and
14 is incorporated by reference from our definitive proxy statement, which we
intend to file with the Securities and Exchange Commission no later than April
29, 2004.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following financial statements (which appear sequentially beginning at
page number F-1) are included in this report on Form 10-K. Financial
statement schedules have been omitted since they are either not required,
not applicable, or the information is otherwise included.
Reports of Independent Certified Public Accountants
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statement of Comprehensive Income
Consolidated Statements of Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
(b) Reports on Form 8-K
On November 7, 2003, we filed a report on Form 8-K reporting under Item 4 that
we dismissed our independent auditors.
On November 14, 2003, we filed a report on Form 8-K/A, amending the report filed
on November 7, 2003, reporting under Item 4 that we retained new independent
auditors.
(c) Exhibits
The following Exhibits are hereby filed as part of this Annual Report on
Form 10-K:
EXHIBIT NO. DESCRIPTION
Exhibit
Number
- ------
2.1 Agreement and Plan of Merger dated as of October 14, 2002 among
PlanetRx.com, Inc.
38
(n/k/a Paragon Financial Corporation), Paragon Homefunding, Inc. a
Delaware Corporation and Mortgage Express, Inc. (n/k/a PGNF Home
Lending Corp., et al (the "Mortgage Express Plan of Merger").**
2.2 Amendment No. 1 to the Mortgage Express Plan of Merger.***
2.3 Agreement and Plan of Merger dated December 9, 2002 among
PlanetRx.com, Inc. (n/k/a Paragon Financial Corporation), Paragon
Acquisition Corp. II, Paragon Homefunding, Inc., a Florida
corporation, et al. (the "Paragon Homefunding Plan of Merger").***
2.4 Amendment No. 1 to the Paragon Homefunding Florida Plan of
Merger.***
3.1 Restated Certificate of Incorporation filed with the Secretary of
State of the State of Delaware on October 6, 1999. ****
3.2 Certificate of Amendment of the Restated Certificate of
Incorporation filed with the Secretary of State of the State of
Delaware on October 13, 2000. ****
3.3 Certificate of Amendment to Restated Certificate of Incorporation
filed with the Secretary of State of the State of Delaware on
November 30, 2002. ****
3.4 Certificate of Amendment of the Restated Certificate of
Incorporation filed with the Secretary of State of the State of
Delaware on December 26, 2002. ****
3.5 Certificate of Designations of Series E Preferred Stock.*****
3.6 Amended and Restated By-laws. ****
4.1 Form of convertible promissory note. ****
10.1 Amended and Restated Employment Agreement, dated as of September 1,
2002 by and between PlanetRx.com, Inc. (now known as Paragon
Financial Corporation) and Paul Danner. ****
10.2 Employment Agreement, dated as of September 4, 2002 by and between
PlanetRx.com, Inc. (now known as Paragon Financial Corporation) and
Steven A. Burleson. ****
10.3 Employment Agreement, dated as of January 31, 2003 by and between
Paragon Financial Corporation and Philip Lagori. ****
10.4 Employment Agreement, dated as of December 30, 2002 by and between
Paragon Financial Corporation and Scott Vining. ****
10.5 Lease dated January 1, 2003 between Ponte Vedra Management Group,
Ltd. and Paragon Financial Corporation. ****
10.6 Lease dated September 1, 2000 between 820 West Lake, LLC and
Mortgage Express, Inc. (n/k/a PGNF Home Lending Corp.). ****
10.7 Employment Agreement, dated October 16, 2003, by and between Paragon
Financial Corporation and George O. Deehan *****
10.8 Employment Agreement, dated June 17, 2003, by and between Paragon
Financial Corporation and Joseph P. Bryant, Jr. *****
10.9 Employment Agreement, dated May 6, 2003, by and between Paragon
Financial Corporation and Steven L. Barnett. *****
21.1 Subsidiaries of the Registrant*
31.1 Certification of Chief Executive Officer pursuant to Form of Rule
13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002, dated April 1, 2004 *
31.2 Certification of Chief Financial Officer pursuant to Form of Rule
13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002, dated April 1, 2004 *
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, dated April 1, 2004 *
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, dated April 1, 2004 *
- ----------
* Filed herewith
+ Incorporated herein by reference
@ This Exhibit represents a management contract
** This exhibit represents a compensatory plan
*** Filed as an exhibit to Paragon's Current Report on Form 8 for an event
dated January 31, 2003
**** Filed as an exhibit to Paragon's Annual Report on Form 10-K for the year
ended December 31, 2002
***** Filed as an exhibit to Paragon's Quarterly Reportfor the period ended
March 31, 2003, as amended
39
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of
1934, the Registrant has duly caused this Report to be signed on its behalf by
the undersigned, thereunto duly authorized.
Paragon Financial Corporation
/s/ George O. Deehan
--------------------
George O. Deehan
Chairman and Chief Executive Officer
Dated: April 1, 2004
Each person whose signature appears below hereby constitutes and appoints Scott
L. Vining, as attorney-in-fact to sign on his behalf, individually, and in each
capacity stated below and to file all amendments and/or supplements to the
Annual Report on Form 10-K, with exhibits thereto and the documents in
connection therewith, with the Securities and Exchange Commission, hereby
ratifying and confirming all that said attorney-in-fact, or substitute or
substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ George O. Deehan Chairman of the Board of Directors and April 1, 2004
-------------------- Chief Executive Officer (Principal
George O. Deehan Executive Officer)
/s/ Scott L. Vining Chief Financial Officer & Treasurer April 1, 2004
------------------- (Principal Financial and Accounting
Scott L. Vining Officer)
/s/ Paul K. Danner Director April 1, 2