ITEM 1. DESCRIPTION OF BUSINESS
FINET.COM, INC.
This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Readers are cautioned that actual results could differ materially from those indicated in such statements as a result of certain factors, including those set forth under "Management's Discussion and Analysis of Financial Condition and Results of Operations--Factors That May Affect Future Results" and elsewhere in, or incorporated by reference into, this report.
CORPORATE HISTORY AND NEW MANAGEMENT
CORPORATE HISTORY
We were incorporated in 1989 to pursue a line of business unrelated to our current business. We acquired Finet Corporation, a private technology-oriented mortgage broker and discontinued our unrelated lines of business in 1990. In December 1996, we acquired Monument Mortgage, a technology-oriented private mortgage banking company, and since then, have made several additional acquisitions to expand our technology and broaden our services. In April 1998, we acquired Coastal Federal Mortgage Company, a sub-prime mortgage banker with lending offices in New Jersey, Pennsylvania and Florida, and, in May 1998, we acquired Mical Mortgage, a mortgage banker with offices in San Diego and Las Vegas that specialized in the origination of FHA and VA loans. As a result of operational and loan underwriting problems discovered after these acquisitions, we discontinued our Coastal and Mical business units in April 1999. We may incur additional losses from the discontinued businesses of Coastal Federal Mortgage and Mical Mortgage. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Factors That May Affect Future Performance".
We currently operate our mortgage businesses through our wholly-owned subsidiary, Monument Mortgage. On August 20, 1999, FiNet acquired certain operations and assets of Lowestrate.com, Inc. ("Lowestrate"). The assets included the trademark "Lowestrate.com" and the related website and certain equipment and software. The acquired assets and operations will be used in our consumer-direct segment.
NEW MANAGEMENT
Since December 1999, we have significantly reshaped our management team. On February 1, 2000, we appointed Rick Cossano as our President and Chief Executive Officer. In addition, other executive and management positions have been replaced with people experienced in business-to-business mortgage sales and secondary marketing. Our new management team is focused on improving profits by significantly growing revenues and streamlining costs. We intend to grow revenues by expanding our sales force nationwide and by offering products with higher margins than our current products.
BUSINESS
FINET.COM
FiNet.com is a full service, on-line mortgage banker that offers an easy-to-use, one-stop mortgage source for consumers and mortgage brokers. We provide on-line and e-commerce technologies and loan process management tools to mortgage broker businesses to enable them to compete more effectively with on-line and other national lenders and to brokers, to help their customers make better informed borrowing decisions. We also operate one of the first sites on the Internet that enables the consumer to apply for and receive credit approval on-line, and to electronically search, analyze and select from a wide variety of mortgage loan products and rates offered by us and other lenders. We make the mortgage process easier
and more understandable, while maintaining quality service by controlling the consumer's entire mortgage lending experience.
We generate revenues by providing services to two primary customer groups: mortgage broker businesses and consumers.
We intend to increase our brand awareness with mortgage broker businesses by:
- building a strong sales force that will market our services by personal contact and assist mortgage brokers in adopting on-line technologies;
- introducing new Internet-oriented services, and
- employing traditional marketing strategies, including participation in trade shows and conferences, advertising in industry publications, flyers and broker loyalty programs.
We offer mortgage broker businesses the opportunity to use the on-line technology and automated underwriting systems of our full service mortgage banking operation to expand and improve service to their local customers and compete with on-line mortgage originators, while maintaining the flexibility to control their own businesses. As a full service mortgage banker, we fund loans originated by mortgage brokers, which we then sell to institutional investors in the secondary mortgage market. We refer to these services to mortgage brokers as our business-to-business channel.
We provide our customers with a fast and easy to use on-line method to get their loans approved through our award-winning iQualify technology. Mortgage brokers and consumers can use our FiNet.com website to search, analyze and select from a wide variety of mortgage loan products and rates offered by our Monument Mortgage subsidiary. We allow each consumer to choose between automated service and personalized assistance at any time in the loan process. Consumers are assisted by our mortgage professionals throughout the loan application process. We refer to these services to consumers as our consumer direct channel.
During the eight months ended December 31, 1999, we originated and/or funded $519.0 million in mortgage loans directly or through our mortgage broker customers. We primarily earn revenues from the sale of loans and related servicing rights in the secondary mortgage market and from interest on mortgage loans held pending sale.
We offer a full range of loan products, including fixed and adjustable rate first mortgage loans with a variety of maturities, conforming loans (loans that meet the purchase standards of Fannie Mae or Freddie Mac), jumbo loans (loans that meet those standards except they exceed the maximum loan amount), home equity lines of credit, second mortgages and loans to borrowers who do not meet one or more of the other credit or documentation standards of the government-sponsored mortgage programs.
THE UNITED STATES MORTGAGE MARKET
The United States residential mortgage market is a substantial and growing part of the U.S. economy. According to the Mortgage Bankers Association, loan origination volume in the U.S. reached $1.3 trillion in 1999, slightly down from $1.5 trillion in 1998. The residential mortgage market is fragmented, with the largest mortgage lender, Norwest, accounting for only 7.7% of funded loans in 1999.
Consumers generally seek mortgage loans to finance a home purchase or to refinance existing mortgage debt. In some cases, a borrower may refinance for more than the existing mortgage amount and use the cash generated for other purposes. Mortgage loans are originated through two primary lending channels, frequently referred to as retail and wholesale. These terms correspond to our consumer-direct and business-to-business channels. Traditional retail originators generate loans through direct contact with the consumer. Retail originators work through local branch offices or telemarketing centers. Wholesale
originators pay loan origination fees to mortgage brokers or purchase closed loans from other lenders, who, in either case, work directly with consumers from local offices.
Typically, the traditional mortgage loan process involves the following steps:
- meeting with lender or broker to complete the lengthy paper application;
- gathering extensive supporting documentation for the application;
- entering the application information/data into the broker's or lender's processing system;
- ordering appraisals, title and credit reports and verifying deposit and other factual matters;
- submitting the paper loan file to an underwriter to determine loan eligibility;
- receiving conditions to approval of loan by the underwriter;
- collecting additional information and complying with the conditions;
- resubmitting the revised paper file for approval;
- preparing loan documents and closing instructions;
- reviewing and approving the loan for funding; and
- closing of the transaction.
This paper intensive process generally takes at least three weeks to complete.
CONSUMERS
The traditional mortgage loan application and closing process described above is complex, time-consuming, paper-intensive and costly. We believe that this process causes many consumers to feel:
- uncertain that lenders and brokers are providing unbiased advice and recommending the most suitable mortgage products;
- skeptical that rates initially quoted will ultimately be available;
- intimidated by the number and variety of mortgage products available;
- pressured to commit to a particular mortgage product before they have researched and compared alternative products to their satisfaction;
- aggravated by the amount and types of loan fees they are required to pay; and
- frustrated by the substantial time and effort that it takes to complete a mortgage loan.
MORTGAGE BROKER BUSINESSES
In 1998 approximately 70% of all mortgages in the United States were originated through mortgage brokers. The mortgage broker industry is highly fragmented with approximately 36,000 mortgage broker businesses operating in the United States according to Wholesale Access. Mortgage broker businesses are typically small, local enterprises that increasingly lack the financial resources and technological capability to compete with financially stronger and better-organized mortgage lenders, including on-line mortgage originators. In particular, they generally lack access to the technology necessary to determine borrower eligibility quickly and to search and analyze available mortgage products to find the best match for their customers. Because local practices and customs in the mortgage industry vary significantly from jurisdiction to jurisdiction, and many consumers will continue to prefer face-to-face local contact, we believe that nationwide lenders will not be able to meet the needs of local mortgage consumers. Mortgage brokers will thus continue to be an integral and important part of the mortgage lending process for the foreseeable
future. However, as technological advances make it easier for consumers to deal directly with lenders, we believe that mortgage brokers will need to find new ways to compete more effectively for the consumers' business.
ON-LINE MORTGAGE ORIGINATION
With the advent of on-line and e-commerce technologies, loan originations can be made electronically, resulting in cost and time savings to consumers and the mortgage brokers who assist those consumers. Although the on-line mortgage industry is still relatively new, it is expected to grow rapidly. According to Forrester Research, the market for on-line mortgage originations is expected to grow from an estimated $18.7 billion in 1999 to over $91.2 billion in 2003, representing an increase in on-line mortgage originations from 1.5% of the existing market in 1999 to 9.6% of the projected market in 2003.
THE FINET.COM SOLUTION
We are a pioneer in offering on-line mortgage services to consumers and mortgage broker businesses. The FiNet.com solution focuses on both consumers and the mortgage brokers who assist many consumers in the mortgage loan process. We believe that by using on-line and e-commerce technologies to streamline and automate the process of making residential mortgage loans, we can help consumers and mortgage broker businesses save time and money, and improve access to mortgage credit. We also believe that we can help mortgage brokers expand their business and withstand the competitive threat posed by on-line lenders.
The FiNet.com solution provides the following key advantages in our business-to-business channel:
- EMPOWERING BROKERS WITH TECHNOLOGY. We help mortgage brokers reduce the cost of their mortgage originations by supplying them with on-line and e-commerce technologies and loan processing management tools. We believe that on-line and e-commerce technologies can enable traditional mortgage brokers to compete more effectively in their local markets with new on-line mortgage originators and large retail loan originators. We enable our business-to-business channel customers to provide the benefits of automated, on-line mortgage services to their local customers while maintaining personal contact with and controlling the customer relationship.
- OFFERING BROKERS CHOICE AND ASSISTANCE. As a full service mortgage banker, we provide our business-to-business channel customers the ability to place a loan with us either electronically or in the traditional paper format. We believe that our on-line underwriting services provide exceptional value to our business-to-business channel customers by greatly reducing the time it takes to determine customer loan eligibility. Our business-to-business channel customers have access to numerous leading on-line underwriting software solutions.
The FiNet.com solution provides the following key advantages in our business-to-consumer channel:
- CONVENIENCE AND SERVICE. We provide our consumers with a fast and easy-to-use on-line method to get a mortgage loan approved using our award-winning iQualify technology. By clicking on our FiNet.com website, consumers can easily and efficiently search, analyze and compare mortgage products and rates, and make loan decisions based on their personal financial situation and needs. In addition, our customers are able to choose either an automated process to complete their mortgage transaction or, at any point, choose to receive the personalized assistance of a mortgage professional. We aim to make our fees and costs competitive with other on-line mortgage originators, who typically charge .625% for conforming loan products.
- UNBIASED ADVICE WITH NO SALES PRESSURE. Because our mortgage lending process is automated, the consumer will not feel pressured to commit to any particular mortgage product. In addition, by having the ability to search, compare and analyze different mortgage products and rates without having to consult with a mortgage broker or lender, the consumer will not be susceptible to
receiving biased advice from the mortgage broker or lender. We also give the consumer the ability to lock in an interest rate when the application is approved, assuring the consumer that the rate initially quoted will be available at closing.
- WIDE CHOICE OF MORTGAGE LOANS. Through FiNet.com we provide consumers with a wide choice of mortgage products and rates offered by Monument Mortgage. We continuously review the mortgage products and rates offered by other lenders in order to select new mortgage products to provide our on-line consumers.
PRODUCTS AND SERVICES
We intend to implement our business strategy by offering fully-automated on-line mortgage services to consumers through FiNet.com and to mortgage broker businesses through Monument Mortgage. We believe that our on-line mortgage services offer distinct advantages over the traditional loan process which is paper intensive, slow and cumbersome.
FINET.COM
Through our FiNet.com website, consumers can fill out an on-line loan application and request an automated underwriting analysis of their application. The FiNet.com process requires the borrower to complete an application which consists of only 32 fields, in contrast to the extensive, multi-page traditional paper mortgage application. Our iQualify technology electronically obtains a credit report on the borrower, combines and reformats the credit and application information and submits the information through Monument Mortgage to an automated underwriting system for a comprehensive credit analysis. If the system returns an "approved" status, the consumer can be confident that a lender will make the consumer a mortgage loan on the terms submitted, subject to verification of the information provided by the customer. We have utilized Fannie Mae's Desktop Underwriter system extensively in our mortgage lending activities.
We have developed interfaces from FiNet.com to other automated underwriting systems from Freddie Mac (Loan Prospector), GMAC/RFC (AssetWise) and GE Capital Mortgage (Good Decisions) to increase the number and type of loans processed by us that receive an automated approval, including jumbo loans which have loan amounts greater than the $252,700 Fannie Mae/Freddie Mac limit, and so-called Alternative A mortgage loans and sub-prime loans, which are loans to borrowers with credit histories unacceptable for one or more reasons to Fannie Mae and Freddie Mac. We believe that approximately 80% of consumers seeking loans are eligible to get their applications approved in our fully automated process.
After receiving automated underwriting approval, the consumer will be able to select from and compare multiple loan options offered by Monument Mortgage.
FiNet.com also offers consumers the option to exit the fully automated process and continue to complete the loan process with the personal assistance of our mortgage professionals. In many cases, the mortgage professionals use our on-line tools to assist those consumers whose applications fall outside the parameters of the fully-automated process. These consumers include borrowers who are self-employed or have credit problems, or who are purchasing investment property. In addition, if the automated underwriting system is unable to approve an application, the consumer is provided with a detailed and understandable list of the reasons why the mortgage application was not approved, which is intended to facilitate re-application.
MONUMENT MORTGAGE
Although a mortgage broker is generally more familiar with the mortgage lending process, the broker must still contend with many time consuming and paper intensive tasks involved in the mortgage lending
process. To assist the mortgage broker, we provide the mortgage broker with access to our automated, on-line mortgage approval process. A mortgage broker can access our services either through the submission of traditional paper files to our loan processors or electronically through automated underwriting software. In either case, we use our automated technology to process the mortgage broker's loan application quickly and efficiently. We are developing an on-line monitoring system that will enable the mortgage broker to monitor in real time the status of loans submitted to us.
TECHNOLOGY
We are building our technology systems by combining our own proprietary technologies with the commercially licensed Internet technologies such as:
- GHR Systems' PremierWare software components for pricing, product searches and analysis;
- Tuttle & Co.'s LockPoint Xtra for interest rate risk management; and
- GMAC/RFC's RFConnects for warehouse line management.
SOFTWARE AND SYSTEMS
Through our proprietary iQualify technology, we are directly linked to the underwriting systems of the investors who will eventually purchase the closed loans from us. Therefore, any loan which is approved through iQualify is also approved by the investor who will ultimately purchase it from us. iQualify also tracks mortgage rates and e-mails consumers when their target rate has been reached.
We are configuring our commercially licensed software to:
- search qualifying product information from more than 50 lenders following approval;
- provide the correct pricing for the combination of mortgage features selected;
- perform a variety of mortgage-related computations, such as maximum affordable sale price, minimum required cash, specified cash investment and specified monthly payment computations;
- complete a "checklist document" based on the requirements of specific transactions;
- access an independently maintained, comprehensive closing cost database of fees for all 50 states on a county-by-county basis;
- provide automated tracking status of a loan, or loans in the case of our mortgage broker business customers, through the lending process; and
- allow a mortgage broker or consumer to directly "lock-in" a rate and points on loans in process.
SERVER HOSTING AND BACK-UP
Our website's hardware systems are housed at our facilities in San Ramon, California, where we have redundant power back-up and redundant communications lines. Our routers are configured for load balancing and fault tolerance. We have a strict maintenance schedule for our hardware and are not required to take our website off-line to perform scheduled maintenance.
SECURITY
Through a Linux firewall we are able to maintain the integrity of our system by blocking unauthorized traffic. The firewall is accessible only via the console which is housed in a secure cage at our facility. In addition, all sensitive transmissions between the client and server are encrypted.
MARKETING
We intend to selectively pursue business partnerships in order to leverage our current market position, increase our on-line visibility, and accelerate distribution of our services. We intend to operate primarily in the business-to-business channel by providing increased services to mortgage broker businesses. We incurred large general advertising expenditures to promote our brand name during the eight months ended December 31, 1999. Due to our shift in focus to the business-to-business channel, we expect to significantly decrease advertising costs for brand name promotion, which are associated with the consumer direct channel. However, we may incur additional other costs of expanding our sales force consistent with supporting a business-to-business infrastructure.
BUSINESS-TO-BUSINESS CHANNEL
We intend to increase our brand awareness with mortgage broker businesses by:
- building a strong sales force that will market our services by personal contact and assist mortgage brokers in adopting on-line technologies;
- introducing new Internet-oriented services; and
- employing traditional marketing strategies, including participation in trade shows and conferences, advertising in industry publications, flyers and broker loyalty programs.
We believe that rapid expansion of our national sales force and the resulting increase in revenues attributed them is critical to our success.
CONSUMER DIRECT CHANNEL
We recently changed our consumer direct channel strategy by significantly narrowing our target group of consumers. During the eight months ended December 31, 1999, our primary marketing strategy included affiliations and business alliances with general interest websites as well as websites catering to homebuyers and real estate agents. We entered into a number of marketing arrangements with websites such as XOOM, AskJeeeves, Homeseekers.com, CoxInteractive Media and others. We incurred $6.2 million of marketing expense in pursuit of this strategy. However, these marketing programs did not result in the volume increases we expected and the resulting customer acquisition costs per loan were prohibitive. Therefore, we discontinued the majority of these programs and affiliations late in the period ended December 31, 1999, and will be winding them down in the first quarter of calendar 2000.
Our new strategy includes selectively marketing our services through affinity arrangements and private label arrangements that target specific consumer groups. In private label arrangements, we will create websites to prominently display our partners' names and logos with a unique appearance and operate the websites.
MORTGAGE OPERATIONS
While we currently make loans primarily in California, we are licensed to originate and fund mortgages in 49 states and the District of Columbia. We expect that the proportion of loans we make outside of California will increase as a result of the expansion of our nationwide sales force.
LOAN PRODUCT TYPES
FiNet.com offers consumers a variety of new and traditional mortgage products through its nationwide network of lenders, which includes our Monument Mortgage subsidiary. Monument Mortgage offers consumers and mortgage broker businesses a wide array of first mortgage products, including 15 and 30-year fixed rate loans, balloon loans and adjustable rate loans. Monument Mortgage also offers second
mortgages and home equity lines of credit. The following is a description of the types of mortgage loans currently offered by Monument Mortgage.
CONFORMING MORTGAGE LOANS
Conforming mortgage loans are mortgage loans that conform to the underwriting standards established by one of the government-sponsored mortgage entities, Fannie Mae or Freddie Mac, and are originated and generally sold by us directly to Fannie Mae or Freddie Mac.
JUMBO MORTGAGE LOANS
Jumbo mortgage loans do not satisfy the criteria to be conforming loans solely because they exceed the maximum loan size, currently $252,700 for single-family homes. We sell all the jumbo mortgage loans we originate to institutional investors such as Bank of America or privately sponsored mortgage conduits such as GE Capital Mortgage and GMAC/RFC, among others.
ALTERNATIVE A MORTGAGE LOANS
Alternative A mortgage loans fail to satisfy one or more elements of the jumbo or Fannie Mae/ Freddie Mac loan underwriting criteria, such as those relating to documentation, employment history, income verification, loan-to-value ratios, credit history, qualifying ratios or borrower net worth. We originate mortgage loans that do not satisfy one or more of the underwriting criteria but which, in our estimation, based primarily on the borrower's credit score and loan-to-value ratios for the property, present a risk profile comparable to conforming loans. We generally sell these loans to GMAC/RFC and IndyMac.
HOME EQUITY AND SECOND MORTGAGE LOANS
Home equity and second mortgage loans are secured by second liens on the related property. Home equity mortgage loans take the form of a line of credit while second mortgage loans are "closed-end" loans. Both types of loans are designed primarily for high credit quality borrowers and are underwritten according to the standards of the investor to which the loans will be sold. Home equity lines generally provide for either a 5-year or 15-year draw period, during which the borrower may make cash withdrawals, and a 10-year repayment period during which the amount outstanding at the end of the draw period is amortized. Only interest payments are made during the draw period. Second mortgage loans are "closed-end," that is they are fixed in amount at the time of origination and typically amortize over the term of the loan or have a balloon payment feature. Home equity lines generally bear adjustable interest rates while second mortgage loans typically bear fixed interest rates. Both types of loans are frequently originated in conjunction with our origination of a first-lien mortgage loan on the related property. We generally sell these loans to Homecomings, a GMAC/RFC subsidiary.
SUB-PRIME MORTGAGE LOANS
This category consists of mortgage loans for borrowers who have impaired or limited credit profiles or higher debt-to-income ratios than would be acceptable for sale of such loans to one of the agencies or private-sponsored mortgage conduits. Such mortgage loans may also fail to satisfy the underwriting criteria of the government-sponsored entities in other ways. We categorize these mortgage loans based on the borrower's credit profile as "A-" or "B" or loans which are generally considered "non-prime" mortgage loans in the secondary mortgage market. We do not originate mortgage loans that our automated underwriting system would categorize as "C" or "D" loans. We currently sell the "A-" or "B" loans we originate to investors such as GMAC/RFC.
LOAN ORIGINATION
The following table summarizes our originations for the categories of mortgage loans by type in the periods indicated for our ongoing businesses.
- ------------------------
* Less than one percent
The following table summarizes originations for the categories of mortgage loans by type in the periods indicated for our discontinued businesses.
The following table summarizes our originations of mortgage loans by purpose in the periods indicated for our ongoing businesses.
The following table summarizes our originations of mortgage loans by purpose in the periods indicated for our discontinued businesses.
- ------------------------
* Less than one percent
The following table summarizes our originations of mortgage loans by channel in the periods indicated for our ongoing businesses.
The following table summarizes our originations of mortgage loans by channel in the periods indicated for our discontinued businesses.
GEOGRAPHIC CONCENTRATION
The following table summarizes our loan originations by state in the periods indicated for our ongoing businesses.
- ------------------------
* Less than one percent
The following table summarizes our originations of mortgage loans by state in the periods indicated for our discontinued businesses.
UNDERWRITING
If Monument Mortgage chooses to have a loan funded and closed by another lender, that lender is responsible for underwriting the loan and may choose to re-underwrite the loan. If Monument Mortgage funds a loan direclty, we use the streamlined underwriting process by accepting the consumer's automated underwriting results. Because we do not hold mortgage loans for investment, we underwrite each mortgage loan to criteria provided by the investor we expect to purchase the loan. By using automated underwriting systems accepted by our investors, we reduce the risk of an investor rejecting the loan for underwriting reasons.
Mortgage investors' underwriting criteria generally include such items as the borrower's mortgage, installment loan payments and credit history, employment history, capacity to pay, outstanding judgments, charge-offs and repossessions involving the borrower, and involvement in bankruptcies by the borrower and foreclosures. Since loans are secured by a mortgage lien, an appraisal of the property securing the loan is also required.
To maintain the integrity of the underwriting process, we do not permit our loan production personnel, including loan originators and Internet service representatives, to underwrite the mortgage
loans which they originate. All underwriting reviews and decisions for loans underwritten by us are conducted by separate underwriters who have no other involvement with the loans.
COMPLIANCE/QUALITY CONTROL
COMPLIANCE
Our legal/compliance team is responsible for compliance and licensing. This centralized compliance function allows us to control and supervise regulatory compliance and offer consistency to our customers. Additionally, the compliance group develops loan documents for new products and maintains lending and broker licenses.
QUALITY ASSURANCE
Prior to funding a loan, we perform a pre-closing audit to ensure the loan meets investor requirements. The pre-closing audit includes the following items:
- a new credit report is obtained;
- a cross reference check is performed to determine if the borrower or property has been previously submitted for a loan;
- a verbal verification of current employment is completed; and
- for most self-employed borrowers, the IRS is contacted to confirm annual income.
QUALITY CONTROL
Our quality control personnel continuously sample closed loans to verify their compliance with legal documentation requirements and for accuracy and potential fraud. These quality control reviews enable us to monitor, evaluate and improve the overall quality of loan production and to identify and communicate to the legal/compliance team and management existing and potential underwriting problems.
We currently utilize the services of an independent quality control provider. Each month our quality control provider reviews a random 10% sample of loans funded by us. The review includes:
- a credit underwriting review;
- a complete loan package re-verification;
- a loan program compliance review; and
- a federal regulatory compliance review.
Every loan selected for review undergoes a complete re-verification of employment, deposit, mortgage and rental history. A new residential mortgage credit report is ordered on 10% of the selected loans, while a new review appraisal is ordered on another 10% of the selected loans. This review also includes procedures intended to detect evidence of fraudulent documentation and/or imprudent activity during the processing, funding, servicing or selling of the mortgage loan. Verification of occupancy and applicable information is made by regular mail. Over each 12-month period, our quality control provider is required to include loans of all product types, all states of operation and all loans with high-risk characteristics. Its quality control reports include individual loan overviews, loan group overviews and key trends or patterns summarized on a monthly and year-to-date basis. We evaluate our provider's quality control reports on a regular basis and address any deficiencies specified in the reports. To date, these quality control reviews have not uncovered any material deficiencies.
REPURCHASES
Our agreements to sell loans to institutional lenders generally require us to repurchase any loan if the representations made in the agreement are materially inaccurate. Such representations are customary in sales agreements and generally relate to the qualification of the borrower. See "Risk Factors--If we have to repurchase loans originated for or sold to lenders, our operating results could be materially adversely affected."
FINANCING AND SALE OF LOANS AND SERVICING RIGHTS
WAREHOUSE FINANCING
We use our secured $75 million revolving credit facility as well as a $15 million purchase repurchase credit facility to fund loan originations and finance originated loans until they are sold. During the eight month period ending December 31, 1999, 42% of our loans funded by Monument Mortgage were sold to Fannie Mae. We are required to comply with various operating and financial covenants including covenants relating to:
- net worth;
- maximum debt limits;
- debt to equity ratio;
- rate of liability growth
- changes in our executive management; and
- continued quotation on Nasdaq.
At December 31, 1999, our liability growth rate exceeded the permitted amount in our primary warehouse lending agreement. Subsequent to December 31, 1999, the lender waived the default. This facility expires on May 31, 2000. At December 31, 1999, the outstanding balance under our facilities was $80.5 million. We are in the process of obtaining additional funding facilities.
INTEREST RATE RISK MANAGEMENT
Prior to the sale of originated mortgage loans, we bear the market risk on the value of the loans. If market interest rates rise between the time we commit to originate a loan at a specific rate and the time such loans are priced for sale, the market price of the loan declines, resulting in a loss on the sale of the loan. To protect against such losses, we attempt to manage our interest rate risk exposure through hedging transactions using a combination of forward sales of mortgage-backed securities and forward whole-loan sales to fix the sales price of loans we expect to close. Forward sales means sales of loans with settlement dates more than five days in the future. Before entering into forward sales, forward commitments or hedging, we perform an analysis of our loans with committed interest rates, taking into account such factors as the estimated portion of such loans that will ultimately be funded, note rate, interest rates, inventories of loans and applications and other factors to determine the type and amount of forward commitment and hedging transactions. We attempt to make forward commitments for or hedge substantially all of our estimated interest rate risk on our loans. We do not believe that hedging our interest rate risk with respect to our non-prime loans is cost effective because these loans generally have higher interest spreads and generally lack sensitivity to interest rate changes due to their credit characteristics and the short period of time we hold them. We believe that we have implemented a cost-effective hedging program to provide a level of protection against changes in the market value of our fixed-rate mortgage loans held for sale. We utilize the services of a nationally known risk management consultant, Tuttle & Co., to assist us. An effective hedging strategy is complex, and no hedging strategy can completely insulate us against interest rate changes.
LOAN SALES
We customarily sell all loans we fund to a number of investors, including: the government-sponsored mortgage entities, institutional investors, and national privately-sponsored mortgage conduits. A primary component of our business strategy is to seek the most efficient method of selling our mortgage loans. We evaluate the sale of each mortgage loan type and compare prices available for each alternative method of sale, given current market conditions at the time and the risk characteristics of the mortgage loan type to determine which method of sale to utilize.
We currently sell our conforming loans through concurrent transactions or assignments of trade or whole-loan sales. Concurrent transactions involve a sale of the underlying mortgage loan directly to Fannie Mae or Freddie Mac with a concurrent sale of the servicing rights to an independent servicer. Assignment of trade sales are sales of conforming loans to a third party along with an assignment of the associated mortgage backed security commitment/trade. The third party then exchanges the loans with Fannie Mae or Freddie Mac for mortgage backed securities issued by them, which are then delivered against the assigned trade. In a whole-loan sale, individual loans are underwritten to the standards of and sold to a specific buyer on a forward commitment or over-the-counter basis. Jumbo and Alternative Mortgage loans are currently sold in whole-loan sales on a forward commitment basis. We sell our non-prime loans, home equity lines and closed-end second mortgage loans through whole-loan sales.
The sale of mortgage loans may generate a cash and an accounting gain or loss. Gains or losses result primarily from two factors. First, we may originate a loan at a price that may be higher or lower than we would receive if we immediately sold the loan in the secondary market. These pricing differences occur principally as a result of competitive pricing conditions in the primary loan origination market. Second, gains or losses may result from changes in interest rates that cause changes in the market value of the loans from the time the price commitment is given to the customer until the time that the loan is sold to the investor. We apply interest rate risk management techniques to reduce the net effect of interest rate changes on the gain or loss on loan sales.
We sell some of our loans on a forward commitment or other deferred delivery and payment basis and have credit risk exposure to the extent purchasers are unable to meet the terms of their forward purchase contracts. As is customary in the marketplace, none of the forward payment obligations of any of our counterparties is currently secured or subject to margin requirements, although we attempt to limit our credit exposure on forward sales arrangements by entering into forward sales contracts exclusively with institutions that we believe are sound credit risks, and by limiting our exposure to any single counterparty.
SALES OF SERVICING RIGHTS
When a loan is originated, a corresponding right to service the loan is created. Although in fiscal 1999 and 1998 we had a small loan servicing portfolio, our current strategy is to realize the value of this right by selling our loans without retaining the right to service the loan or by selling the servicing rights separately from the loan. As a result, we minimize risk associated with defaults and early prepayments of those loans. However, we service the loans we close between the date of funding the loan and the date we sell the loan and the related servicing in the secondary market. We sold our loan servicing portfolio in August 1999, and we have no plans for retaining servicing rights on loans we underwrite, fund and close.
RECOURSE
By selling all the loans we close, we reduce our exposure to default risk (other than first-payment defaults by customers) and most of the prepayment risk normally inherent in the mortgage lending business. However, in connection with whole-loan sales and exchanges, we make representations and warranties to the buyers of the loans relating to, among other things, compliance with laws, regulations and program standards and accuracy of information. In the event of a breach of these representations and warranties, we may be required to repurchase these mortgage loans and indemnify the investors for
damages caused by the breach. If a repurchase request is made, we would either attempt to remedy the deficiency and have the investors rescind the rejection of the mortgage loan or refinance or sell the mortgage loan, sometimes at a loss. In addition, in connection with some non-prime loan sales, we may be required to return a portion of the premium received upon the sale of the loan if the loan is prepaid by the borrower within the first year after sale. We have been able to minimize the risks of loan rejection and repurchase of loans made by Monument Mortgage by using automated underwriting systems and by implementing a stringent quality assurance program that monitors the most important stages of the mortgage loan closing process. We may be obligated, however, to repurchase loans made by some of the companies we acquired. See "Risk Factors--If we have to repurchase loans originated for or sold to lenders, our operating results could be materially adversely affected."
MORTGAGE BANKING REGULATION
Our operations are subject to extensive regulation by federal and state authorities. For example, the United States Department of Housing and Urban Development, or HUD, regulates certain aspects of the mortgage lending business, as do the Federal Reserve Board and the Federal Trade Commission. The Real Estate Settlement Procedures Act of 1974, or RESPA, and the Truth in Lending Act, Federal statutes, require that certain disclosures, such as good faith estimates of settlement charges, a Truth-in-Lending Statement and a HUD-1 settlement statement be provided to borrowers and that certain information, such as the HUD Settlement Costs booklet, also be provided to borrowers. The Federal Fair Housing Act and the Equal Credit Opportunity Act prohibit discrimination and various state statutes prohibit unfair and deceptive trade practices, and impose disclosure and other requirements in connection with the mortgage loan origination process. If we fail to comply with such regulations, possible consequences could include loss of approved status, demands for indemnification, class action lawsuits and administrative enforcement actions.
Additionally, RESPA contains certain prohibitions regarding the giving or taking of a fee, kickback, or anything of value for the referral of business to any specific person or organization. However, the payment of reasonable compensation for the provision of goods, services and facilities is generally not prohibited.
In California, regulation and licensing of mortgage brokers and lenders falls under the California Department of Real Estate or the California Department of Corporations. Other than banking industry employees and other persons who are exempt from the licensing requirements of the California Department of Real Estate and California Department of Corporations, individuals engaged directly in the origination of loans or the dissemination of certain information are required to be licensed by the California Department of Real Estate or the California Department of Corporations. We and some of our subsidiaries are also required to be licensed in other states in which we have offices or operate. Although we have the licenses required in California and 48 other states and believe that we will be able to obtain licenses required in the remaining state, we cannot be sure that we will successfully comply with the many government regulations and licensing requirements to which we are subject. If we fail to comply with these legal requirements, it could have a material adverse effect on our business, financial condition and results of operations.
COMPETITION
The e-mortgage market is new, rapidly evolving and intensely competitive. Because the barriers to entry are minimal, we expect competition to intensify in the future. We believe we compete based on service and price.
In addition, the residential mortgage loans business is highly competitive. We currently compete with a variety of other companies offering mortgage services, including:
- various on-line mortgage brokers, including E-LOAN Inc., iOwn.com, Mortgage.com, Quicken Mortgage and Keystroke Financial;
- mortgage companies that offer products through on-line search engines, such as Yahoo! and Microsoft Corporation's Home Advisor website;
- mortgage banking companies, commercial banks, savings associations, credit unions and other financial institutions which still originate the vast majority of mortgage loans; and
- mortgage brokers.
Many of our mortgage banking and mortgage brokerage competitors have longer operating histories or significantly greater financial, technical, marketing and other resources than we do. Some of our on line competitors are spending substantial funds on mass marketing and branding their mortgage services. In addition, some of our competitors offer a wider range of services and financial products to customers and have the ability to respond more quickly to new or changing opportunities. As a result, many have greater name recognition and more extensive customer bases and can offer more attractive terms to customers, including more aggressive loan pricing policies.
INTELLECTUAL PROPERTY
Trademarks and other proprietary rights are important to our success and our competitive position. We currently hold a number of trademarks, service marks, patents and copyrights. Although we seek to protect our trademarks and other proprietary rights through a variety of means, we may not have taken adequate steps to protect these rights. We will continue to license content from third parties in the future and it is possible that we could be subjected to infringement actions based upon the content licensed from these third parties. Any claims brought against us, regardless of their merit, could result in costly litigation and the diversion of our financial resources and technical and management personnel. Further, if such claims are proved valid, through litigation or otherwise, we may be required to change our trademarks or other proprietary marks and pay financial damages, which could adversely affect our business.
We currently enter into confidentiality or license agreements with our new employees, consultants and corporate partners to control access to and distribution of our technologies, documentation and other proprietary information. Despite our efforts to protect our proprietary rights from unauthorized use or disclosure, parties may attempt to disclose, obtain or use our proprietary rights. The steps we have taken may not prevent misappropriation of our proprietary rights, particularly in foreign countries where laws or law enforcement practices may not protect our proprietary rights as fully as in the United States.
EMPLOYEES
As of February 29, 2000, we had 126 full-time and 7 part-time employees. 28 employees comprise the consumer direct division and 53 employees comprise the business-to-business division. Fify-two employees comprise marketing, technology, administration and support areas. None of our employees is represented by a union. Management believes that its relations with employees are good.
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth certain information regarding FiNet.com's executive officers and directors as of March 1, 2000.
- ------------------------
(1) Member of the Audit Committee
(2) Member of the Compensation Committee
RICK COSSANO has served as President, Chief Executive Officer and a member of the Board of Directors since February 2000. Prior to joining FiNet.com, Mr. Cossano was the President and Chief Operating Officer of LandSafe Title, Inc. from 1996 to 2000 and the Executive Vice President of the Wholesale Lending Division and Consumer Markets Division for Countrywide Home Loans from 1993 to 1996.
L. DANIEL RAWITCH has served as Vice Chairman of the Board since May 1999. He also served us in various other positions, including as President of FiNet.com from October 1998 to May 1999 and as its Chief Executive Officer from May 1995 to October 1998. Prior to joining FiNet.com, he served as Chief Executive Officer of Residential Pacific Mortgage, Inc., from 1989 until it was acquired by FiNet.com in August 1994.
W. ROBERT SNOW has served as FiNet.com's Executive Vice President-Business-to-Business since February 2000. Prior to joining FiNet.com, he was Regional Vice President for Countrywide Home Loans from March 1996 to December 1999. From 1992 to 1996, Mr. Snow served as Wholesale Operations Manager for First Franklin Financial Corporation.
GARY A. PALMER has served as FiNet.com's Executive Vice President--Chief Financial Officer since December 1998. Prior to joining FiNet.com, he was an independent financial consultant from January 1997 to December 1998. From October 1995 to December 1997, he served as Executive Vice President, Chief Financial Officer and Secretary of Southern Pacific Funding Corporation. Prior to that, Mr. Palmer served as Senior Vice President and Treasurer of Gentra Capital Corporation. Mr. Palmer received his B.S. degree in Business Administration from the University of Vermont and his M.B.A. degree from the University of North Carolina at Chapel Hill.
S. LEWIS MEYER has served as a director since January 1997. Since June 1993, Dr. Meyer has served as President and Chief Executive Officer of Imatron Inc., a company engaged in designing, manufacturing and marketing a high performance tomography scanner. From April 1991 until joining Imatron, Dr. Meyer was Vice President, Operations of Otsuka Electronics (U.S.A.), Inc. From August 1990 to April 1991, he was a founding partner of Medical Capital Management, a company engaged in providing consulting services to medical equipment manufacturers, imaging services providers and related medical professionals. Before that, he was Founder, President and Chief Executive Officer of American Health Services Corp. (now Insight Health Services), a developer and operator of diagnostic imaging and treatment centers. Dr. Meyer is also a director of BSD Medical Corporation. Dr. Meyer received his B.S. degree in
Physics from the University of the Pacific and his M.S. and Ph.D. degrees in Physics from Purdue University.
STEPHEN J. SOGIN has served as a director since March 1990. Dr. Sogin is a venture capitalist. From December 1984 until January 1995, he was a general partner of Montgomery Medical Ventures. In July 1997, Dr. Sogin consented to a cease and desist order issued by the SEC involving his late filing of Forms 3, 4 and 5 which he was required to file in his capacity as a general partner of Montgomery Medical Ventures II. None of the SEC's findings involve charges that Dr. Sogin received improper gains or personal benefits as a result of these violations. Dr. Sogin has advised FiNet.com that the trades in question were conducted by the partnership (Montgomery Medical Ventures II) and none of these trades were executed by him personally. Dr. Sogin is also a director of Osteotech, Inc. Dr. Sogin received his B.S., M.S. and Ph.D. degrees in microbiology from the University of Illinois.
RICHARD E. WILKES has served as a director since November 1998. Since April 1999 he has been President and Chief Executive Officer of IMX, Inc., a company engaged in the business of electronic trading of mortgages. Prior to that he was a principal in Mortgage Outsource Services, a provider of pre- and post-closing services to the residential mortgage industry. In October 1995, Mr. Wilkes founded Group Millennium, a consulting company specializing in mergers and acquisitions and strategic planning for the mortgage banking industry. From 1989 to 1995, Mr. Wilkes was employed by MacAndrews and Forbes Holdings, Inc.
ANTONIO P. FALCAO has served as a director since February 1999. Since 1994, Mr. Falcao has been the Chief Financial Officer for several companies of the A. Amorim Group, a business group based in Portugal that owns Banco Nacional de Credito Imobiliario, a Portuguese real estate bank. The A. Amorim Group, which is affiliated with Americo Ferreira Amorim, one of our largest stockholders, also has interests in the cork, textile, hotel, oil, finance and telecommunications industries. Mr. Falcao received his degree in Finance and Economics from the University of Oporto.
FINANCIAL INFORMATION ABOUT BUSINESS SEGMENTS
See the Notes to our Consolidated Financial Statements for financial information of the two business segments or channels we operate in: the business-to-business channel and the consumer direct channel.
BUSINESS RISKS
See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations."
ITEM 2.
ITEM 2. DESCRIPTION OF PROPERTY
We relocated our headquarters and operations to in San Ramon, California, from Walnut Creek, California, where our current facility occupies approximately 39,335 square feet of space. In addition to housing the administrative offices, this facility houses operations of both our business-to-business and our consumer-direct segments. The lease for this facility expires in April 2004.
We have an east coast facility located in East Norriton, Pennsylvania which occupies approximately 3,705 square feet of space. This facility houses operations for the consumer-direct segment. The leases for this facility expire in November 2000 and June 2002.
We believe that our facilities are adequate to support anticipated operations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
On January 14, 1998, prior to our acquisition of Mical, a lawsuit was filed against Mical in the United States District Court for the Middle District of Georgia. The complaint alleges, among other things, that in
connection with residential mortgage loan closings, Mical made certain payments to mortgage brokers in violation of the RESPA and induced mortgage brokers to breach their alleged fiduciary duties to their customers. The plaintiffs seek unspecified compensatory and punitive damages as to certain claims. We believe that our compensation programs for mortgage brokers comply with applicable laws and with long standing industry practices. We intend to defend vigorously against this action and believe that the ultimate resolution will not have a material adverse effect on our business, results of operations and financial condition.
On April 16, 1999, a lawsuit was filed in the Superior Court of the State of California, County of San Francisco by a former director and officer of FiNet.com against FiNet.com and one of its then current and now former directors. The complaint alleges, among other things, that the plaintiff and our then current director entered into an oral contract, wherein they agreed to share all profits from bonus shares that were issued to either party under certain specific circumstances. It is further alleged that we issued to our current director 1,800,000 shares of stock and that our then current director failed to provide the plaintiff one-half of the stock, or 900,000 shares. The plaintiff seeks to recover 900,000 shares of our common stock and punitive damages as to certain of the claims. FiNet.com and our then current director have each filed a general denial of all claims. We intend to defend vigorously against the action and believe that the ultimate resolution will not have a material adverse effect on our business, results of operations or financial condition.
On December 16, 1999, a lawsuit was filed in the Judicial District Court of Dallas County, Texas, by FC Capital Corp. d/b/a FirstCity Capital Corporation. The complaint alleges breach of contract by Coastal for failure to repurchase loans in accordance with the terms and condition of a Purchase Agreement entered into by First City and Coastal in March 1998. The plaintiff has named Finet as a defendant alleging that Finet assumed all of Coastal's debts and obligations when Finet acquired Coastal in April 1998. The plaintiff seeks to recover actual damages in the amount of $1.7 million and premium rebates in the approximate amount of $26,000. The action was removed to the United State District Court, Northern District of Texas, Dallas Division on January 18, 2000, and we have since filed procedural motions. We intend to defend vigorously against the action and believe that the ultimate resolution will not have a material adverse effect on our business, results of operations or financial condition.
FiNet.com and certain subsidiaries are defendants in various legal proceedings involving matters generally incidental to their business. We do not expect that the aggregate liability or loss, if any, resulting therefrom or from the matters described above will have a material adverse effect on our business, results of operations or financial condition.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
Our common stock has traded on the Nasdaq SmallCap Market since June 1, 1999 under the symbol "FNCM". Prior to that, our common stock traded on the Nasdaq SmallCap Market under the symbol "FNHC." The following table sets forth the high and low sale prices of our common stock on Nasdaq for the periods indicated.
As of March 15, 2000, there were approximately 492 holders of record of our common stock. On March 15, 2000, the last reported sale price of our common stock on the Nasdaq Market was $1.84.
DIVIDENDS
We have not paid, and we do not currently intend to pay, cash dividends on our common stock. The current policy of our Board of Directors is to retain earnings, if any, to provide funds for operation and expansion of our business. The payment of cash dividends in the future will be at the discretion of the Board of Directors and will depend upon, among other things, our earnings, capital requirements and financial position. In addition, our ability to pay dividends may be limited under future loan agreements which restrict or prohibit the payment of dividends.
RECENT SALES OF UNREGISTERED SECURITIES
During the past three years, we have issued the securities set forth below which were not registered under the Securities Act of 1933.
Except for sales pursuant to Regulation S, which were made in compliance with Regulation S, the sales of the following securities were made in reliance upon the exemption from the registration provisions of the Securities Act under Section 4(2) thereof or Regulation D promulgated thereunder, as transactions by an issuer not involving a public offering. The purchasers of the securities described below made representations that they acquired the securities for their own account and not with a view toward distribution thereof to the public. The certificates evidencing the securities bear legends stating that the shares may not be offered, sold or otherwise transferred other than pursuant to an effective registration statement under the Securities Act, or an exemption from such registration requirements.
In March 1997, we issued 1,000,000 shares of common stock and a warrant to purchase 600,000 shares of common stock to an accredited investor in a private placement for an aggregate purchase price of $600,000. In addition, we issued a warrant to purchase 50,000 shares of common stock to the placement agent for the transaction.
In April 1997, we issued 3,991,250 shares of common stock and warrants to purchase 743,125 shares of common stock in a private placement to accredited investors for an aggregate purchase price of $3,991,250. In addition, we issued a warrant to purchase 399,125 shares of common stock to the placement agent for the transaction.
In October 1997, we issued 1,300,000 shares of common stock and warrants to purchase 1,300,000 shares of common stock for an aggregate purchase price of $3,500,000 in a private placement.
In March and May of 1998, we issued $7,000,000 principal amount of the registrant's 3% Subordinated Convertible Debentures and warrants to purchase 175,000 shares of common stock to accredited investors in a private placement. In a restructuring of this transaction in January 1999, the debentures were converted into 9,533,333 shares of common stock and warrants to purchase 840,000 shares of common stock.
In September 1998, we issued 250 shares of our Series A Convertible Preferred Stock and warrants to purchase 250,000 shares of common stock at an exercise price of $1.00 per share to accredited investors in a private placement for an aggregate purchase price of $2,500,000. The Series A Convertible Preferred Stock was redeemed in January 1999 and February 1999.
In November 1998, we issued 2,500,000 shares of common stock in a private placement to an accredited investor for an aggregate purchase price of $2,000,000.
In January 1999, we issued 1,000,000 shares of common stock to an existing stockholder pursuant to an indemnity agreement.
During the third quarter of our 1999 fiscal year, we issued 22,740,000 shares of common stock and warrants to purchase 122,675 shares of common stock to accredited investors in a series of private placements for an aggregate purchase price of $12,431,000. In addition, we issued warrants to purchase 2,449,867 shares of common stock to the placement agents for such transactions. One such placement agent received placement agent fees of $812,358 in connection with the transactions.
In May and June 1999, we issued 3,347,039 shares of common stock in a private placement to accredited investors for an aggregate purchase price of $13,020,000.
In June 1999, we issued 7,712,081 shares of common stock in a private placement to accredited investors for an aggregate purchase price of $30,000,000.
In August 1999, we purchased certain assets and operations of Lowestrate.com, for a total purchase price of 1,400,000 shares of FiNet.com common shares. 560,000 of these shares were issued to the seller at the closing. The remaining 840,000 shares were placed in escrow subject to release to Lowestrate if the contingencies are resolved.
In October 1999, we issued 600,000 shares of FiNet common stock in connection with our purchase of the remaining 50% interest of a limited liability corporation.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and notes to our consolidated financial statements and with "Management's Discussion and Analysis of Financial Condition and Results of Operations," which appear elsewhere in this Annual Report on Form 10-K. The following table provides selected historical consolidated financial information of FiNet.com. We prepared this information using the consolidated financial statements of
FiNet.com as of the dates indicated and for the eight months ended December 31, 1999, and each of the fiscal years in the five year period ended April 30, 1999. We derived the consolidated statement of operations and balance sheet data as of the eight months ended December 31, 1999, and for each of the fiscal years in the five year period ended April 30, 1999 from FiNet.com's financial statements audited by Ernst & Young, LLP (1999), Reuben E. Price (1998, 1997), Deloitte & Touche (1996, 1995), independent public accountants for FiNet.com.
- ------------------------
(1) See Note 2 to the consolidated financial statements for an explanation of the determination of the number of shares used in computing per share data.
(2) Selected financial data for the fiscal years ended April 30, 1996 and 1995 do not include data for our Coastal subsidiary which was acquired in a pooling transaction on April 30, 1998, because its inclusion is not meaningful in assessing trends of FiNet.com and its business was discontinued in fiscal 1999.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
WE HAVE MADE FORWARD-LOOKING STATEMENTS IN THIS ANNUAL REPORT ON FORM 10-K THAT ARE SUBJECT TO RISKS AND UNCERTAINTIES. FORWARD-LOOKING STATEMENTS INCLUDE INFORMATION CONCERNING OUR POSSIBLE OR ASSUMED FUTURE RESULTS OF OPERATIONS. ALSO, WHEN WE USE SUCH WORDS AS "BELIEVE," "EXPECT," "ANTICIPATE," "PLAN," "COULD," "INTEND" OR SIMILAR EXPRESSIONS, WE ARE MAKING FORWARD-LOOKING STATEMENTS. YOU SHOULD NOTE THAT AN INVESTMENT IN OUR SECURITIES INVOLVES CERTAIN RISKS AND UNCERTAINTIES THAT COULD AFFECT OUR FUTURE FINANCIAL RESULTS. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN
FACTORS, INCLUDING THOSE SET FORTH IN "FACTORS THAT MAY AFFECT FUTURE PERFORMANCE" AND ELSEWHERE IN THIS ANNUAL REPORT ON FORM 10-K.
THE FOLLOWING DISCUSSION AND ANALYSIS OF OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS SHOULD BE READ IN CONJUNCTION WITH OUR CONSOLIDATED FINANCIAL STATEMENTS.
OVERVIEW
FiNet.com is a full service, on-line mortgage banker that offers an easy-to-use, one stop mortgage source for consumers and mortgage brokers. We operate one of the first sites on the Internet that enables the consumer to apply for and receive credit approval on-line, and to electronically search, analyze and select from a wide variety of mortgage loan products and rates offered by us and other lenders. We make the mortgage process easier and more understandable, while maintaining quality service by controlling the consumer's entire mortgage lending experience. We also provide on-line and e-commerce technologies and loan process management tools to mortgage broker businesses to enable them to compete more effectively with on-line and other national lenders and brokers, and help their customers make better informed borrowing decisions.
We earn revenues through both the origination and sale of mortgage loans. As a retail originator of loans, we generate loan origination income and loan-related fees through loans funded and brokered by us. Our loan origination income consists of origination points paid to us by borrowers or discount points paid to us by wholesale lenders. Our loan-related fees consist of application, documentation and processing fees paid by borrowers.
On the loans that we sell, we generate revenues from net premium income and interest income. Net premium income consists of the net gain on the sale of mortgage loans and mortgage servicing rights. This net gain is recognized based upon the difference between the combined selling price of the loans and their related servicing rights, on the one hand, and the carrying value of the mortgage loans and servicing rights sold, on the other. Interest income consists of the interest we receive on our mortgage loans held for sale.
Our costs and expenses consist largely of:
- interest paid under our warehouse credit facilities;
- loan-related expenses, consisting of fees paid to third parties for appraisal and credit report services and reserves for potential loan repurchase and premium recapture obligations;
- salaries, commissions and benefits paid to employees;
- general and administrative expenses such as occupancy costs, office expenses and professional services; and
- depreciation and amortization expense related principally to our facilities, computers and goodwill associated with our acquisitions.
Seasonality affects the mortgage industry because loan originations are typically at their lowest levels during the first and fourth calendar quarters due to a reduced level of home buying activity during the winter months. Loan originations generally increase during the warmer months beginning in March and continuing through October. As a result, we may report earnings in these calendar quarters that are generally lower than that of the second and third calendar quarters. However, due to significant refinance activity during 1997 and 1998, which was generally affected more by changes in interest rates than by seasons, the expected seasonal patterns are not evident in our historical financial statements. In the future, our expenses are also likely to vary quarter-to-quarter based upon fluctuations in the volume of loans we originate due to seasonality and other factors.
Economic and interest rate cycles also affect the mortgage industry, as loan originations typically fall in rising interest rate environments. During such periods, refinancing originations decrease as higher
interest rates provide reduced economic incentives for borrowers to refinance their existing mortgages. Due to stable and decreasing interest rate environments in prior years, our historical performance during those periods may not be indicative of results in rising interest rate environments such as 1999. In addition, our recent growth may distort some of our ratios and financial statistics and may make period-to-period comparisons difficult. In light of this growth, our historical earnings performance may be of little relevance in predicting future performance. Furthermore, our financial statistics may not be indicative of our results in future periods.
On April 30, 1998, we acquired Coastal Federal Mortgage in a transaction accounted for as a pooling of interests. Our results of operations and financial position for the fiscal years ended April 30, 1998 and 1997 have been restated to include Coastal's results. Coastal's results for years prior to fiscal 1997 have not been included in our consolidated results, as they are not meaningful in assessing our historical trends. On May 19, 1998, we acquired Mical in a transaction accounted for as a purchase. Mical's results of operations are included in our financial statements since the date of acquisition. Due to significant operating problems and losses at Coastal and Mical, our new management elected to close both units during fiscal 1999.
IMPACT OF OUR DISCONTINUED UNITS--MICAL, COASTAL AND OUR SERVICING BUSINESS
We incurred significant losses at both our Mical and Coastal subsidiaries during fiscal 1999. New management elected to discontinue the businesses of both of these subsidiaries in the last half of fiscal 1999. In addition, management determined that servicing loans would not be a part of on-going operations and began preparing our servicing portfolios for sale. The following table summarizes the impact these discontinued business units had on our consolidated operating results for the last three fiscal years ended April 30, and for the eight months ended December 31, 1999:
RESULTS OF OPERATIONS
EIGHT MONTHS ENDED DECEMBER 31, 1999 COMPARED TO EIGHT MONTHS ENDED DECEMBER 31,
REVENUES AND VOLUMES
Total loan volume for FiNet's production units is summarized below.
Loan volume decreased $154.8 million, or 23%, to $519.0 million for the eight months ended December 31, 1999 from $673.8 million for the eight months ended December 31, 1998. Revenues decreased $10.8 million, or 64%, to $6.1 million for the eight months ended December 31, 1999 from $16.9 million for the eight months ended December 31, 1998. The volume decrease was attributable primarily to the volume of the discontinued business units that were no longer operating in the eight months ended December 31, 1999. Additionally, business-to-business segment volumes decreased in our continuing units. Mortgage lending rates have increased in the current fiscal year relative to the prior fiscal year, slowing mortgage industry originations. In addition, price decreases negatively impacted revenues since they were not offset by volume increases. We expect to increase revenues through the planned expansion of our sales force and increased emphasis on the business-to-business segment. However, there can be no assurance that increased revenues will be achieved.
COST OF REVENUES AND GROSS PROFIT
Cost of revenues decreased $6.3 million, or 43%, to $8.4 million for the eight months ended December 31, 1999 from $14.7 million for the eight months ended December 31, 1998. However, as a percentage of revenues, cost of revenues increased, decreasing our gross profit to (39)% of revenues. Production personnel costs, the primary component of cost of revenues in our continuing businesses, were not decreased proportionately with volume decreases resulting in a negative impact on margins.
Gross profit was also negatively affected by an increase in loan loss provisions of $807,000 to $1.5 million from $693,000 for the for the eight months ended December 31, 1998. The increase is due to additional reserves provided at both our discontinued subsidiaries and our on-going businesses. Our discontinued subsidiaries continue to incur losses related to loans previously sold (off-balance sheet risk). Our on-going business required increased reserves due to increased volumes and slower sales of mortgages originated. We also recorded $433,000 of expense related to the sale of our servicing portfolio which was completed during the eight months ended December 31, 1999.
The Company records provisions for losses to reflect market valuation allowances on mortgages held for sale and mortgage loans previously sold (off-balance sheet risk) and provisions for doubtful accounts receivable. The Company evaluates the collectibility of its accounts receivable primarily on a receivable by receivable basis, as accounts receivable is composed of amounts that do not necessarily carry similar risk characteristics, such as amounts heldback by purchasers on sales of mortgage loans and amounts heldback on sales of servicing rights. Additionally, the Company maintains communications with such purchasers and others from whom receivables are due and in certain circumstances, determines the allowance necessary based on agreed upon amounts.
The Company determines its market valuation allowance relating to mortgages held for sale and mortgages that have been sold primarily on a loan by loan basis. The allowance is based on factors such as market values, bids received, industry loss experience and the Company's prior loss experience, if any, as well as risk characteristics of the loan portfolio.
Warehouse interest expense decreased $4.3 million or 81% to $1.0 million for the eight months ended December 31, 1999 from $5.3 million for the eight months ended December 31, 1998 primarily due to the volume decrease. In addition, we employed our excess cash to fund our mortgage inventory during a portion of the eight month period, whereas for the period ended December 31, 1998, we financed over 95% of our mortgage inventory. Also, in fiscal 1999, our primary warehouse lender allowed certain excess cash balance accounts to be offset against amounts due on warehouse borrowings, thereby further reducing our warehouse interest expense for the current fiscal period compared to the comparable period of the prior year. The decrease in inventory financing in the period ended December 1999 compared to the 1998 period resulted in lower warehouse facility borrowings, contributing to the decrease in interest expense.
OPERATING EXPENSES
GENERAL AND ADMINISTRATIVE
Personnel costs and other general and administrative costs of our continuing businesses increased $3.8 million, or 37%, to $14.0 million in the eight months ended December 31, 1999 from $10.2 million in the eight months ended December 31, 1998. Decreases attributable to the discontinued units were offset by significant increases in personnel costs as well as professional fees at the continuing units. Personnel costs have increased as FiNet increased its management team and hired additional sales and production employees in anticipation of increased volumes. In addition, general and administrative expenses have increased significantly as the result of our spending associated with becoming Year 2000 compliant.
MARKETING AND ADVERTISING
We initiated a number of marketing relationships in the eight months ended December 31, 1999 designed to attract prospective customers to our website. As a result, marketing and advertising increased $5.4 million to $6.2 million for the eight months ended December 31, 1999 from $755,000 in the eight months ended December 31, 1998. FiNet intends to significantly decrease its spending on branding over the subsequent twelve months relative to spending incurred in the current eight month period.
SPECIAL CHARGES.
Special charges of $1.4 million and $4.9 million were established in the eight month period ended December 31, 1999 and fiscal 1999. The special charges include $3.8 million of goodwill write off and restructuring charges associated with the discontinuance of the business of Mical for fiscal 1999, $690,000 writedown of purchased software for fiscal 1999 and $405,000 to liquidate certain assets and liabilities in connection with the discontinuance of the business of Coastal for fiscal 1999. During the eight months ended December 31, 1999, the Company expensed $1.4 million net book value of fixed assets as a result of a relocation of the corporate headquarters and primary operations.
DEPRECIATION AND AMORTIZATION.
Depreciation and amortization expenses for the eight months ended December 31, 1999 increased by $180,000 or 30%, to $777,000 from $597,000 is fiscal 1999. The increase was due primarily to the amortization of the goodwill associated with the purchase of certain assets and operations of Lowestrate, and increased depreciation associated with our purchases of property, plant and equipment.
OTHER INTEREST EXPENSE
Other interest expense decreased $2.7 million to zero for the eight months ended December 31, 1999 from $2.7 million for the eight months ended December 31, 1998. During the eight months ended December 31, 1998, we incurred other interest expense as we amortized our 3% subordinated convertible debt discount. We also incurred interest expense related to certain notes payable, a working capital line of credit, and borrowings for the previous purchase of servicing assets. These obligations were reduced to zero during the eight months ended December 31, 1999; therefore, we did not incur material interest expense other than warehouse interest expense during the eight months ended December 31, 1999.
INCOME TAXES
As of December 31, 1999, we had approximately $75 million of federal and state net operating loss carryforwards for tax reporting purposes available to offset future taxable income. Our federal net operating loss carryforwards begin to expire in 2004. A valuation allowance has been recorded for the entire deferred tax asset at December 31, 1999 as a result of uncertainties regarding the realization of the asset due to the lack of our earnings history.
NET LOSS
Net loss for the eight months ended December 31, 1999 increased by $12.8 million, or 102%, to $25.3 million from $12.5 million for the eight months ended December 31, 1998, due to investments in technology, marketing and expenses associated with the relocation of our corporate headquarters.
FISCAL 1999 COMPARED TO FISCAL 1998
REVENUES AND VOLUMES
Loan volume increased by $718 million, or 118%, to $1,328 million in fiscal 1999 from $610 million in fiscal 1998 as a result of a significant increase in the number of loans funded through our mortgage banking subsidiaries, volume attributable to acquired operations, and significant refinancing activity stimulated by relatively low interest rates. Refinancings accounted for 69% of our loan volume in fiscal 1999, compared to 65% in fiscal 1998.
Revenues for fiscal 1999 increased by $7.2 million, or 47%, to $22.4 million from $15.2 million in fiscal 1998. This increase resulted primarily from the incremental volume of funded loans from Mical and increased volumes of originated loans generated by our Interloan.com website, both of which were purchased in the first quarter of fiscal 1999. Loans originated by mortgage brokers and funded by us accounted for $4.4 million in additional revenues, or 61% of the increase for the year. Loans we originated, most of which were funded by other lenders, accounted for $2.5 million in additional revenues, or 34% of the increase for the year.
COST OF REVENUES AND GROSS PROFIT
Cost of revenues for fiscal 1999 increased by $20.4 million, or 139%, to $35.1 million from $14.7 million in fiscal 1998. This increase resulted primarily from an increase in direct costs associated with increased volumes of funded loans from the purchase of Mical, increased indirect production expenses from the purchases of the Interloan.com website and Mical, and provisions for losses on mortgages held for sale and receivables. Increased volumes of funded loans accounted for $7.7 million in additional costs, or 38% of the increase for the year. Indirect production expenses accounted for $5.9 million in additional costs, or 29% of the increase for the year.
Provisions for losses increased by $5.8 million to $6.5 million in fiscal 1999 from $718,000 in fiscal 1998. We record provisions for losses to reflect market valuation allowances on mortgages held for sale and mortgage loans previously sold (off-balance sheet risk) and provisions for doubtful accounts receivable. We
evaluate the collectibility of its accounts receivable primarily on a receivable by receivable basis, as accounts receivable is composed of amounts that do not necessarily carry similar risk characteristics, such as amounts heldback by purchasers on sales of mortgage loans and amounts heldback on sales of servicing rights. Additionally, we maintain communications with such purchasers and others from whom receivables are due and in certain circumstances, determines the allowance necessary based on agreed upon amounts.
We determine our market valuation allowance relating to mortgages held for sale and mortgages that have been sold primarily on a loan by loan basis. The allowance is based on factors such as market values, bids received, industry loss experience and our prior loss experience, if any, as well as risk characteristics of the loan portfolio.
The increase in provision for losses of $2.2 million, or 38%, was attributable to the provision for doubtful accounts recorded at our Mical Mortgage subsidiary. We acquired Mical in a business combination accounted for as a purchase in May 1998. Accordingly, the provision for doubtful accounts of Mical is included in our results of operations only subsequent to the acquisition date--only for fiscal 1999, and accounts for the entire increase. The remaining increase in the provision for losses relates to increased provisions for losses on mortgages held for sale and mortgages previously sold (off-balance sheet risk). This increase was attributable primarily to our Mical Mortgage subsidiary but additionally to provisions for loan losses recorded by our Coastal Federal Mortgage subsidiary. Loans originated at Mical and at Coastal, acquired in May and April 1998, had risk characteristics and loss recourse provisions that were dissimilar from our risk characteristics and sale recourse provisions prior to these acquisitions.
Gross profit for fiscal 1999 decreased by $13.1 million to a loss of $12.7 million from a profit of $442,000 in fiscal 1998 as a result of the increase in our cost of revenues.
OPERATING EXPENSES
GENERAL AND ADMINISTRATIVE. General and administrative expenses for fiscal 1999 increased by $5.8 million, or 98%, to $11.7 million from $5.9 million in fiscal 1998. This increase resulted primarily from the acquisition of Mical and increased expenses.
MARKETING AND ADVERTISING. Marketing and advertising expenses for fiscal 1999 increased by $1.3 million, or 141%, to $2.2 million from $921,000 in fiscal 1998. This increase resulted primarily from Internet advertising expenses.
SPECIAL CHARGES. Special charges of $4.9 million were established in fiscal 1999 and include $3.8 million of goodwill writeoff and restructuring charges associated with the discontinuance of the business of Mical, a $690,000 writedown of purchased software and $405,000 to liquidate certain assets and liabilities in connection with the discontinuance of the business of Coastal.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses for fiscal 1999 increased by $164,000, or 34%, to $646,000 from $482,000 in fiscal 1998. The increase was due primarily to the increase in assets acquired with the purchase of Mical.
OTHER. Other operating expense for fiscal 1999 increased by $625,000, or 71%, to $1.5 million from $875,000 in fiscal 1998. This increase resulted primarily from charges recorded to value warrants issued when our 3% Convertible Debentures were converted to common stock.
OTHER INTEREST EXPENSE
Other interest expense for fiscal 1999 increased by $2.6 million, or 619%, to $3.0 million from $420,000 for fiscal 1998. The increase was primarily the result of amortization of the imputed interest and debt issuance costs on our 3% Convertible Subordinated Debentures, which were issued in March and May 1998. The debt was redeemed in January 1999 and the discount has been fully amortized.
INCOME TAXES
As of April 30, 1999, we had approximately $49 million of federal and state net operating loss carryforwards for tax reporting purposes available to offset future taxable income. Our federal net operating loss carryforwards begin to expire in 2004. A valuation allowance has been recorded for the entire deferred tax asset at April 30, 1999 as a result of uncertainties regarding the realization of the asset due to the lack of our earnings history.
NET LOSS
Net loss for fiscal 1999 increased by $27.1 million, or 288%, to $36.5 million from $9.4 million for fiscal 1998, primarily due to the purchases of Mical and Coastal, increased marketing expenses associated with the purchase of Interloan.com, and expenses associated with financing transactions.
FISCAL 1998 COMPARED TO FISCAL 1997
REVENUES AND VOLUMES
Loan volume increased by $222 million, or 53%, to $610 million in fiscal 1998 from $388 million in fiscal 1997 as a result of a significant increase in the number of loans funded through our mortgage banking subsidiaries and significant refinancing activity stimulated by relatively low interest rates. Refinancings accounted for 65% of our origination volume in fiscal 1998 compared to 48% in fiscal 1997.
Revenues for fiscal 1998 increased by $2.9 million, or 24%, to $15.2 million from $12.3 million in fiscal 1997. This increase resulted primarily from increased volumes of funded loans. Loans originated by mortgage brokers and funded by us accounted for $2.0 million in additional revenues, or 69% of the increase for the year. The volume of loans we originated and funded accounted for $200,000 in additional revenues, or 7% of the increase for the year.
COST OF REVENUES AND GROSS PROFIT
Cost of revenues for fiscal 1998 increased by $5.4 million, or 58%, to $14.7 million from $9.3 million in fiscal 1997. This increase resulted primarily from an increase in direct and indirect costs due to increased volumes of funded loans. Funded loans accounted for $1.3 million in additional costs, or 24% of the increase for the year. Indirect production expenses accounted for $3.6 million in additional costs, or 67% of the increase for the year.
Gross profit for fiscal 1998 decreased by $2.6 million to $442,000 from $3.0 million in fiscal 1997 as a result of an increase in our cost of revenues.
OPERATING EXPENSES
GENERAL AND ADMINISTRATIVE. General and administrative expenses for fiscal 1998 increased by $1.4 million, or 31%, to $5.9 million from $4.5 million in fiscal 1997. This increase resulted primarily from the addition of new employees in our technology and customer service departments.
MARKETING AND ADVERTISING. Marketing and advertising expenses for fiscal 1998 increased by $254,000, or 38%, to $921,000 from $667,000 in fiscal 1997. This increase resulted primarily from increased advertising expenses associated with the increased level of loan fundings and the introduction of new products.
SPECIAL CHARGES. In fiscal 1998, we recorded special charges of $1.0 million to writeoff intangible assets that we determined would no longer be employed in future operations.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses for fiscal 1998 increased by $377,000 to $482,000 from $105,000, in fiscal 1997. The increase was primarily due to depreciation of fixed assets acquired to support increased business activity and staff expansion.
OTHER. Other operating expense for fiscal 1998 increased by $323,000, or 59%, to $875,000 from $552,000 in fiscal 1997. This increase resulted primarily from expenses related to the acquisition of Mical and Coastal.
OTHER INTEREST EXPENSE
Other interest expense for fiscal 1998 increased by $302,000, or 256%, to $420,000 from $118,000 in fiscal 1997. This increase was the result of amortization of the imputed interest and debt issuance costs on our 3% Convertible Subordinated Debentures, which were issued in March 1998.
INCOME TAXES
As of April 30, 1998, we had approximately $31 million of federal and state net operating loss carryforwards for tax reporting purposes available to offset future taxable income. Our federal net operating loss carryforwards begin to expire in 2004. A valuation allowance has been recorded for the entire deferred tax asset at April 30, 1998 as a result of uncertainties regarding the realization of the asset due to the lack of our earnings history.
NET LOSS
Net loss for fiscal 1998 increased by $6.6 million, or 236%, to $9.4 million from $2.8 million for fiscal 1997, primarily due to an increase in the number of employees and office space in anticipation of growing the business, consulting expenses related to the acquisition of Monument in the prior fiscal year, expenses in anticipation of the Mical and Coastal acquisitions, and intangible asset write downs.
FINANCIAL CONDITION
DECEMBER 31, 1999 COMPARED TO APRIL 30, 1999
Historically we have experienced operating losses and have relied on external sources of debt and equity financing to fund operations, to service debt and to complete acquisitions and to make capital investments. Equity increases, primarily from private placements of common stock and warrant exercises, partially offset by operating losses have increased stockholders' equity to $30.4 million at December 31, 1999 from $6.7 million at April 30, 1999.
Our cash increased by $14.4 million to $18.6 million at December 31, 1999 from $4.2 million at April 30, 1999, primarily as the result of cash received from private placements, partially offset by our use of cash to fund some of our mortgage origination activities and to make capital investments. In addition, we recorded $10.4 million of restricted cash, relating primarily to receipts from sales of mortgage loans, which could only be used to reduce warehouse borrowings.
Mortgages held for sale increased by $45.3 million, or 136%, to $78.7 million at December 31, 1999 from $33.4 million at April 30, 1999. This increase was due to an increase in the volume of originations late in the period and slower than expected settlements.
Mortgage servicing rights decreased from $2.7 million at April 30, 1999 to zero at December 31, 1999. The servicing portfolio was sold during in the eight months ended December 31, 1999. We received cash of $2.0 million; we recorded $433,000 of additional expense in "Cost of Revenues", and the balance due is recorded in "Accounts receivable" on our Consolidated Balance Sheet at December 31, 1999. We expect to collect substantially all of the balance due on this sale during the six months ended June 30, 2000.
Warehouse borrowings increased $47.5 million, or 144%, from $33.0 million at April 30, 1999 to $80.5 million at December 31, 1999 as our loan originations increased late in the period ended December 31, 1999.
Accrued expenses increased as we increased our spending on professional services relating to the implementation of computer systems and related infrastructure.
Improvement in our financial condition is dependent on our ability to significantly grow our loan origination volumes, to achieve highly efficient operating processes and procedures, and to manage warehouse interest expense and operating expenses given the level of volumes. Our financial condition is further dependent on economic conditions such as the general health of the economy and demand for mortgage loans. There can be no assurance that we will be able to improve our financial condition through profitable operations.
LIQUIDITY AND CAPITAL RESOURCES
The nature of the mortgage lending business requires us to advance cash on a daily basis to fund newly originated loans to our borrowers. The majority of these funds are provided through conventional mortgage warehouse lines of credit, "purchase-repurchase" agreements, and our cash balances. Additional cash resources, obtained primarily through private placements of our common stock and other debt and equity offerings are used to fund ongoing expenses such as administration and marketing, to invest in product development and geographic expansion, and to satisfy debt and other obligations as they come due. Currently, cash generated by operations is not sufficient to meet our operating requirements.
Adequate credit facilities and other sources of funding, which permit us to fund mortgage loans, are essential to our ability to close loans through our mortgage banking subsidiaries. We borrow money to fund our loan closings and repay these borrowings as the loans and the accompanying servicing rights are sold. Upon the sale of loans and servicing rights and the subsequent repayment of the borrowings, our credit facilities become available to fund additional loan closings.
On August 9, 1999 we entered into a new, $75 million committed warehouse borrowing agreement with GMAC/RFC which expires on May 31, 2000. The new agreement replaced the existing $35 million extended agreement. The new facility may be used for the origination or the acquisition of mortgage loans and is secured by mortgages loans that have been funded using the facility. Borrowings under this agreement bear interest at LIBOR plus 1.75%. As of December 31, 1999, $73.2 million was outstanding on this facility. The agreement contains a number of operating and financial covenants that, among other things, require us to maintain a minimum current ratio, a minimum ratio of total liabilities to tangible net worth and maintain a minimum level of tangible net worth. The agreement also contains covenants that limit our ability to:
- change executive management;
- transfer or sell assets;
- rapidly grow liabilities;
- pay dividends;
- enter into transactions with our affiliates; or
- enter into a merger, consolidate or sell substantially all of our assets.
The events of default contained in our revolving warehouse facility are typical of facilities of its type. At December 31, 1999, we were in default of our primary warehouse lending agreement, as were in violation of the liability growth covenant. Subsequent to December 31, 1999, the lender waived the default.
Our available credit lines also include Fannie Mae's "As Soon as Pooled/Early Purchase Option" (the "ASAP Plus" program). Under the ASAP Plus program, Fannie Mae funds us on the loans we deliver to them upon receipt of appropriate mortgage collateral. Fannie Mae subsequently purchases the mortgage loans for cash upon receipt of complete and accurate mortgage pool and other documentation. At December 31, 1999, $7.3 million was outstanding on this facility.
During the eight months ended December 31, 1999, operating activities, including daily operating expenditures, repayment of warehouse borrowings and funding new originations, used $27.9 million in cash compared to cash used by operations of $12.9 million during the same period of the prior year.
Investing activities used cash of $1.5 million during the eight months ended December 31, 1999, consisting primarily of investments in property, plant and equipment partially offset by proceeds from the sale of our servicing portfolio and proceeds from the sale of marketable equity securities. We do not intend to purchase additional mortgage servicing rights. We expect our level of capital spending for calendar 2000 to decrease somewhat as we will not incur infrastructure upgrades required for Year 2000 compliance.
Cash provided by financing activities was $43.8 million for the eight months ended December 31, 1999, attributable mainly to private placements of our common stock.
We expect that cash flow from the sale of mortgage loans will increase as we intend to increase both fundings and sales through additional marketing and sales efforts in our business-to-business segment.
If we continue to maintain at least our current level of working capital borrowing resources, we believe that our existing cash balances and funds available under our revolving warehouse facilities and Fannie Mae ASAP Program will be sufficient to meet our liquidity requirements for the next 12 months. We do, however, expect that in the future we will need to arrange for additional sources of capital through the issuance of debt or equity or additional warehouse facilities. We have no commitments for any additional financings, and we cannot be sure that we will be able to obtain any such additional financing at the times required and on terms and conditions acceptable to us. In such event, our growth could slow and operations could be adversely affected. See also Note 6 to the consolidated financial statements.
FACTORS THAT MAY AFFECT FUTURE PERFORMANCE
The risks described below could materially adversely affect our business, results of operations and financial condition, which, in turn, could cause the price of our shares to decline, resulting in a loss of all or part of your investment. We cannot predict which, if any, of these risks may actually occur, or the extent to which any occurrence, circumstance or event will actually affect our business, results of operations or financial condition, and the trading price of our shares.
BECAUSE WE EXPECT CONTINUED LOSSES IN THE FUTURE, OUR BUSINESS, FINANCIAL CONDITION AND GROWTH PROSPECTS COULD BE MATERIALLY ADVERSELY AFFECTED.
We have incurred net losses of $9.4 million, $36.5 million and $25.3 million for fiscal 1998 and 1999 and the eight months ended December 31, 1999, respectively, and, at December 31, 1999, we had an accumulated deficit of approximately $73.2 million. Although we cannot predict future results of operations with any degree of certainty, we expect to continue to incur losses because of the current state of the mortgage market and our plans to continue to invest in information technology, marketing and geographic expansion of our business. While we do not believe these losses will exhaust our credit lines or available capital resources in the year ending December 31, 2000, we may not be able to implement our business plans, and our business, results of operations financial condition and growth prospects could be materially adversely affected.
IF OUR NEW MANAGEMENT IS NOT ABLE TO EXPAND AND IMPROVE OUR OPERATIONS, OUR BUSINESS WOULD SUFFER.
Since December 1999, we have replaced most of our management team. Our new officers have not previously worked together, and we cannot be sure that they will be able to work together to improve and expand our operations. On February 1, 2000, Rick Cossano became our President and Chief Executive Officer replacing Mark Korell, who retired effective January 15, 2000. Robert Snow, became our Executive Vice President, Business to Business, on January 31, 2000, replacing Kevin Gillespie, Executive Vice President, Sales and Marketing, who resigned effective December 20, 1999. Michael Quinn will become our Senior Vice President, Director of Capital Markets on April 1, 2000, replacing Michael Conway, who was terminated as Executive Vice President, Capital Markets, effective January 31, 2000. In addition, Christos Skeadas, Executive Vice President--Chief Technology Officer, and Thomas Porter, Executive Vice President--Administration have recently resigned. If the new management team is not able to work together and improve and expand our operations, our financial condition, profitability and growth prospects would be materially adversely affected.
THE LOSS OF ANY OF OUR KEY PERSONNEL WOULD LIKELY HAVE AN ADVERSE EFFECT OUR BUSINESS.
We believe that our future success will depend to a significant extent on the continued services of our new senior management and other key personnel. The loss of the services of key employees or delay in recruiting candidates to fill our currently vacant management positions or any other key position which may become vacant could have a material adverse effect on our business, results of operations and financial condition.
IF WE ARE UNABLE TO MANAGE GROWTH IN OUR BUSINESS, OUR RESULTS OF OPERATIONS MAY NOT IMPROVE.
We anticipate that we will need to expand our employee base, facilities and infrastructure in order to be able to compete successfully and take advantage of market opportunities. If we are unable to manage the expansion of our business effectively, our business, results of operations and financial condition may not improve and could deteriorate. We expect this expansion to place significant strain on our management, operational and financial resources. Our current personnel, systems, procedures and controls are not adequate to support anticipated growth of our operations. To manage this expected growth, we will need to improve our mortgage processing, operational and financial systems, information processing capacity,
procedures and controls. We may be unable to hire, train, retain or manage necessary personnel, or to identify and take advantage of existing and potential strategic relationships and market opportunities.
IF THERE IS A FURTHER DECREASE IN DEMAND FOR MORTGAGES, OUR BUSINESS COULD SUFFER.
Demand for mortgages is typically adversely affected by periods of economic slowdown or recession, rising interest rates, declining demand for consumer credit, declining home sales, declining real estate values and decreased ability of borrowers to make loan payments. These factors tend to decrease demand for mortgage loans of the types we originate and could increase the rates of delinquencies and foreclosures on loans we hold. These changes would likely have a material adverse affect on our business, results of operations and financial condition.
IF WE ARE UNABLE TO DIFFERENTIATE OURSELVES FROM OUR COMPETITION IN OUR INDUSTRY, OUR BUSINESS PROSPECTS COULD BE HARMED.
The e-mortgage market is new, rapidly evolving and intensely competitive. Because the barriers to entry are minimal, we expect competition to intensify in the future. In addition, the residential mortgage loan business is highly competitive. We currently compete with a variety of other companies offering mortgage services, including:
- various on-line mortgage brokers, including E-LOAN Inc., iOwn.com, Mortgage.com, Quicken Mortgage and Keystroke Financial;
- mortgage companies that offer products through on-line search engines, such as Yahoo! and Microsoft Corporation's Home Advisor website;
- mortgage banking companies, commercial banks, savings associations, credit unions and other financial institutions which still originate the vast majority of mortgage loans; and
- mortgage brokers.
Many of our mortgage banking and mortgage brokerage competitors have longer operating histories or significantly greater financial, technical, marketing and other resources than we do. Some of our on-line competitors are spending substantial funds on mass marketing and branding their mortgage services. In addition, some of our competitors offer a wider range of services and financial products to customers and have the ability to respond more quickly to new or changing opportunities. As a result, many have greater name recognition and more extensive customer bases and can offer more attractive terms to customers, including more aggressive loan pricing policies. We cannot be sure that we will be able to compete successfully against current and future competitors. If we are unable to do so it will have a material adverse effect on our business, results of operations and financial condition.
IF INTEREST RATES CONTINUE TO RISE, OUR RESULTS OF OPERATIONS COULD BE MATERIALLY ADVERSELY AFFECTED.
Rising interest rates generally discourage refinancing of residential mortgages and reduce the number of new home sales. Any further increase in interest rates or an adverse change in the residential real estate market or general economic conditions, both of which are outside our control, could have a material adverse effect on our business, results of operations and financial condition.
The effect of interest rate changes tends to be greater on the market for refinancing loans than it is on the market for purchase loans, since refinancing a mortgage loan is voluntary and motivated primarily by a homeowner's desire to lower financing costs, whereas new home purchasers are motivated by a need or desire for a new home. Accordingly, the annual volume of new mortgage refinance loans is quite volatile. Approximately 44% of the loans we originated and/or funded during the eight months ended December 31, 1999 were loans to refinance mortgage debt, compared to 69% during the eight months ended
December 31, 1998. We cannot predict future interest rate trends, their impact on our business, or our ability to manage this business mix.
The value of the loans we make is based, in part, on market interest rates, and our business, results of operations and financial condition may be materially adversely affected if interest rates change rapidly or unexpectedly. If interest rates rise after we fix a price for a loan but before we sell the loan into the secondary market, the value of that loan will decrease. If we delay in selling our loans into the secondary market, our interest rate exposure increases and we could incur a loss on the sale. While we use various hedging strategies to provide some protection against interest rate risks, no hedging strategy can protect us completely. The nature and timing of hedging transactions influences the effectiveness of hedging strategies and poorly designed strategies or improperly executed transactions may increase rather than decrease risk. In addition, hedging strategies involve transaction and other costs. There is a risk that our hedging strategy and the hedges that we make will not adequately offset the risks of interest rate volatility and that our hedges will result in losses.
IF WE FAIL TO MAINTAIN CREDIT FACILITIES TO FINANCE OUR MORTGAGE LENDING ACTIVITIES, OUR GROWTH PROSPECTS COULD BE SEVERELY LIMITED.
To the extent that we are unable to access adequate capital to fund loans, we may have to curtail or cease our loan funding activities entirely. This would have a material adverse effect on our business, results of operations and financial condition. Because we are not a bank, we are dependent upon specialized mortgage credit facilities from other lenders to finance our mortgage lending activities. In August 1999, we entered into a $75 million committed warehouse borrowing agreement with GMAC/RFC which replaced an existing $35 million agreement with GMAC/RFC. In the agreement, which expires on May 31, 2000, we make numerous representations, warranties and operating and financial covenants. A material breach by FiNet.com of any of these representations, warranties or covenants could result in the termination of the agreement and an obligation to repay the entire amount outstanding under the agreement. In the past, we have had to obtain waivers from GMAC/RFC's for defaults under the agreement. At December 31, 1999, we were in default of our primarily warehouse lending agreement, as we were in violation of certain financial and other covenants. Subsequent to December 31, 1999, the lender waived the defaults. During January 2000, the defaults were cured. However, we cannot assure you that we will be able obtain a waiver of from GMAC/RFC of any future defaults, should they occur, or that financing will continue to be available on favorable terms or at all.
IF WE ARE UNABLE TO RESPOND TO RAPID TECHNOLOGICAL CHANGE IN E-COMMERCE AND IMPROVE OUR PRODUCTS AND SERVICES, OUR BUSINESS COULD BE MATERIALLY ADVERSELY AFFECTED.
The Internet and e-commerce are characterized by rapid technological change, changes in user and customer requirements and preferences, frequent new product and service introductions embodying new technologies, and the emergence of new industry standards and practices that could render existing technology and systems obsolete. There can be no assurance that we will successfully use new technologies effectively or adapt our websites, technology and transaction-processing systems to customer requirements or emerging industry standards. If we are unable to license and internally develop leading technologies useful in our business, enhance our existing services, develop new services and technology that address the increasingly sophisticated and varied needs of our customers, and respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis, we will not remain competitive and our business, our results of operations and financial condition could be materially adversely affected.
IF WE ARE UNABLE TO ATTRACT QUALIFIED PERSONNEL, OUR BUSINESS COULD SUFFER.
Our ability to grow and our future success depends on our ability to identify, attract, hire, train, retain and motivate other highly skilled technical, managerial, sales and marketing, customer service and
professional personnel. Competition for such employees is intense, especially in the e-commerce sector, and there is a risk that we will not be able to successfully attract, assimilate or retain sufficiently qualified personnel. If we fail to retain and attract the necessary technical, managerial, sales and marketing, customer service personnel and experienced professionals, our business, results of operations and financial condition could be materially adversely affected.
IF CONSUMERS AND MORTGAGE BROKER BUSINESSES DO NOT EMBRACE ON-LINE MORTGAGE FINANCING AND SALES, OUR BUSINESS WOULD BE MATERIALLY ADVERSELY AFFECTED.
Our success depends upon the acceptance of on-line mortgage financing by consumers, mortgage brokers and other real estate service providers. If the market for on-line mortgage financing fails to develop, or develops more slowly than expected, our business, results of operations and financial condition would be materially adversely affected. In addition, if there are insufficient communications services to support the Internet, it could result in slower response times which would adversely affect usage of the Internet. Even if use of the Internet for on-line financing gains acceptance, we may be unable, for technical or other reasons, to develop and introduce new products and services or enhancements in a timely manner, and such products and services and enhancements may not gain widespread market acceptance. Any of these factors could have a material adverse effect on our business, results of operations and financial condition.
IF THERE IS A RECESSION, NATURAL DISASTER OR OTHER DISRUPTION IN THE CALIFORNIA ECONOMY, OUR BUSINESS COULD BE MATERIALLY ADVERSELY AFFECTED.
We are particularly vulnerable to recessions and conditions affecting the California economy. Of the loans we originated and/or funded in the eight months ended December 31, 1999, 83% were for properties located in California. No other state represented more than 3% of our closed loans during such period. While we expect to expand our business in other states, a concentration of loans in California is likely to continue for the foreseeable future.
There have been times in the past, most recently in 1991 and 1992, when the California economy suffered a recession more severe than the rest of the country. If such a recession were to occur again, our business, results of operations and financial condition would be materially adversely affected. In addition, California historically has been vulnerable to natural disasters, such as earthquakes and mudslides, which are not typically covered by standard hazard insurance policies. These natural disasters often result in increased loan delinquencies or defaults which could adversely effect on our business, results of operations and financial condition.
IF WE HAVE TO REPURCHASE LOANS ORIGINATED FOR OR SOLD TO LENDERS, OUR RESULTS COULD BE MATERIALLY ADVERSELY AFFECTED.
There is a risk that we will not have sufficient funds to repurchase loans upon demand or that such repurchases will have a material adverse effect on our business, results of operations and financial condition. Under agreements with some of our lenders, they may require us to repurchase loans that we originate for them, or they purchase from us, in the event of material misrepresentations by us or inaccuracies in the borrowers' loan documents. In the eight months ended December 31, 1999, our Coastal Federal Mortgage, Mical Mortgage and Monument Mortgage subsidiaries were required to repurchase approximately $0, $6.5 million and $465,000 principal amount of loans, respectively. It is possible that future demands will be made to purchase loans originated and sold by these subsidiaries. As of December 31, 1999, we held approximately $220,000 aggregate principal amount of loan in foreclosure. As a result of repurchases, we occasionally are required to hold foreclosed residential real estate in inventory until it can be resold. Future foreclosures could have a material adverse effect on our business, results of operations and financial condition. If interest rates rise and the economy declines, the rate of mortgage
loan foreclosures may rise. Depending on the circumstances of the transaction, we may or may not be able to sell the property for more than the outstanding loan balance.
PROBLEMS AND RISKS RELATED TO POTENTIAL ACQUISITIONS AND ALLIANCES MAY HARM OUR BUSINESS.
To implement our growth strategy we may acquire or enter into alliances with companies with complementary services, technologies and businesses. In connection with any such acquisition, we may fail to successfully integrate the operations of the acquired company. For example, as described more completely below under "We may incur additional losses from the discontinued operations of Coastal Federal Mortgage and Mical Mortgage," we incurred significant losses following our acquisitions of Mical Mortgage and Coastal Federal Mortgage, and they have discontinued their operations. Any future alliances we pursue may not be successful. Also, acquisitions or alliances could divert our management's attention from other business matters, or we could lose key employees of acquired companies or alliance businesses.
THE DISCONTINUATION OF FEDERAL PROGRAMS THAT PURCHASE LOANS OR ANY CHANGE IN OUR ELIGIBILITY TO PARTICIPATE IN SUCH PROGRAMS WOULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
If the mortgage programs administered by Fannie Mae, Freddie Mac and Ginnie Mae or our eligibility to participate in them were terminated or significantly curtailed, our business, results of operations and financial condition would be materially adversely affected. We fund our mortgage loan operations in part by selling the mortgage loans that we fund to these mortgage programs which pool the loans into mortgage-backed securities. Our ability to sell mortgage loans depends upon the continuation of programs administered by these entities, as well as our continued eligibility to participate in these programs.
We also depend upon private mortgage investors, such as GMAC/RFC, GE Capital Mortgage and IndyMac, to purchase mortgage loans that we originate which do not qualify for inclusion in the federal programs described above. If private investors reduce their purchases of these mortgage loans, the market and price for such mortgage loans will be adversely affected, which would have a material adverse effect on our business, results of operations and financial condition.
We depend on automated underwriting and other services offered by government sponsored and other mortgage investors, including Fannie Mae's Desktop Underwriter, Freddie Mac's Loan Prospector, GMAC/RFC's AssetWise and GE Capital Mortgage's Good Decisions. These services help ensure that our mortgage services can be offered efficiently and timely. We currently have an agreement with Fannie Mae that allows us to use their automated underwriting services and enables us to sell them qualified first mortgages. We expect to continue to process a significant portion of our conforming loans using the Fannie Mae system. However, our agreements with Fannie Mae and other mortgage investors can be terminated by either party at any time. There is a risk that we will not remain in good standing with Fannie Mae and other mortgage investors or that Fannie Mae and other mortgage investors will terminate our relationship. The termination of our agreement with Fannie Mae would materially adversely impact our ability to originate loans.
WE MAY INCUR ADDITIONAL LOSSES FROM THE DISCONTINUED BUSINESS OF COASTAL FEDERAL MORTGAGE AND MICAL MORTGAGE.
In April 1998, we acquired Coastal Federal Mortgage, and in May 1998, we acquired Mical Mortgage Inc. Our results of operations include net losses from the acquisitions of both of these units and from their operating activities. Although these business units were discontinued in April 1999, they may incur additional losses, which would be included in our consolidated results. We reported net losses associated with Coastal and Mical during fiscal 1999 and for the eight months ended December 31, 1999 of $16.9 million and $2.9 million, respectively.
IF OUR QUARTERLY REVENUES AND OPERATING RESULTS FLUCTUATE SIGNIFICANTLY, THE PRICE OF OUR COMMON STOCK IS LIKELY TO BE VOLATILE.
Our quarterly revenues and operating results are likely to continue to vary substantially from quarter to quarter due to a number of factors, including the following:
- fluctuations in interest rates;
- seasonal or other economic factors affecting demand for mortgages;
- changes in our pricing policies or our competitors' pricing policies for mortgage origination and processing fees;
- the introduction of new products and services by us or our competitors;
- the level of consumer interest and confidence in the Internet as a means of accessing financial products and services;
- any termination or restructuring of agreements with key service providers; and
- technical difficulties or service interruptions affecting our Internet websites or operational data processing systems.
Fluctuation in our quarterly results may cause the price of our common stock to be volatile.
We anticipate that as the on-line mortgage origination industry matures, our business will also be increasingly susceptible to the same seasonal and cyclical factors that affect the mortgage industry as a whole. Accordingly, we believe period-to-period comparisons of our operating results are not meaningful and our results for any period should not be relied upon as an indication of future performance. Our operating results may fail to meet our expectations or those of analysts who follow us. Any such failure could cause our stock price to decline substantially.
OUR STOCK PRICE COULD BE HIGHLY VOLATILE.
The trading prices of Internet and e-commerce stocks have recently experienced extreme price and volume fluctuations. These fluctuations often appear to be unrelated or disproportionate to the operating performance of Internet and e-commerce companies. The valuations of many Internet and e-commerce stocks are extraordinarily high based on conventional valuation standards such as price-to-earnings and price-to-sales ratios. These trading prices and valuations may not be sustained. Any negative change in the public's perception of the prospects of Internet or e-commerce companies could further depress our stock price regardless of our future results. In the past, securities class action litigation often has been brought against companies following declines in the market price of their securities. If litigation of this type were brought against us, it could be very costly and could divert management's attention and resources from our business.
IF THERE ARE INTERRUPTIONS OR DELAY IN OBTAINING APPRAISAL, CREDIT REPORTING, TITLE SEARCHES AND OTHER UNDERWRITING SERVICES FROM THIRD PARTIES, WE MAY EXPERIENCE CUSTOMER DISSATISFACTION AND DIFFICULTIES CLOSING LOANS.
If we are unsuccessful in securing the timely delivery of ancillary services such as appraisals, credit reporting and title searches, we will likely experience increased customer dissatisfaction, and our business, results of operations and financial condition could be materially adversely affected. We rely on other companies to perform certain aspects of the loan underwriting process, including appraisals, credit reporting and title searches. If the provision of these ancillary services were interrupted or delayed, it could cause delays in the processing and closing of loans for our customers. The value of the service we offer and the ultimate success of our business are dependent on our ability to secure the timely provision of these ancillary services by the third parties with whom we have business relationships.
IF WE FAIL TO COMPLY WITH EXTENSIVE FEDERAL AND STATE LAWS REGULATING OUR INDUSTRY, WE COULD BE SUBJECT TO PENALTIES, DISQUALIFICATIONS, LAWSUITS OR ENFORCEMENT ACTIONS THAT COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
Our operations are subject to extensive regulation by federal and state authorities. If we fail to comply with such regulations, possible consequences could include loss of approved status, demands for indemnification, class action lawsuits, administrative enforcement actions and other civil and criminal sanctions, and could have a material adverse effect on our business, results of operations and financial condition. See "Business--Mortgage Banking Regulation," at page 19 of our Annual Report on Form 10-K for the year ended April 30, 1999.
IF OUR COMPUTER SYSTEMS FAIL, OUR BUSINESS WOULD BE MATERIALLY ADVERSELY AFFECTED.
Any interruption in the availability of our websites, transaction-processing systems or network infrastructure could materially adversely affect our business, results of operations and financial condition. Such interruptions could result from events such as fires, floods, earthquakes, power losses, telecommunications failures, computer viruses and electronic breaches. Our insurance policies may not adequately compensate us for losses that may occur in the event of a failure of our computer systems or other interruptions in our business.
Our websites must accommodate a high volume of traffic and deliver frequently updated information, the accuracy and timeliness of which is critical to our business. In the past, we have experienced periodic system interruptions, which we believe will continue to occur from time to time. Any substantial increase in the volume of traffic on our websites will require us to expand and upgrade further our technology, transaction-processing systems and network infrastructure. We cannot be sure that we will be able to accurately project the rate or timing of increases, if any, in the use of our websites or expand and upgrade our systems and infrastructure to accommodate such increases in a timely manner. In addition, our users depend on Internet service providers, on-line service providers and other website operators for access to our websites. Many of them have experienced significant outages in the past, and could experience outage delays and other difficulties due to system failures unrelated to our systems. Moreover, the Internet infrastructure may not be able to support continued growth in its use. Any of these problems would materially adversely affect our business, results of operations and financial condition.
IF OUR ELECTRONIC SECURITY DEVICES ARE BREACHED, OUR BUSINESS WOULD BE MATERIALLY ADVERSELY AFFECTED.
If any compromise in our security devices were to occur, it could have a material adverse effect on our business, results of operations and financial condition. The secure transmission of confidential information through e-commerce is critical to our underwriting process. We rely on certain encryption and authentication technology licensed from third parties to provide secure transmission of confidential information, such as consumers' financial statements. There can be no assurance that advances in computer capabilities, new discoveries in the field of cryptography, or other events or developments will not result in a compromise or breach of the algorithms we use to protect transaction data. We may be required to spend significant capital and other resources to protect against such security breaches or to alleviate problems caused by such breaches. Concerns over the security of transactions conducted on the Internet and the privacy of users may also inhibit the growth of the Internet generally, and e-commerce in particular. To the extent that our activities involve the storage and transmission of proprietary information, such as consumers' financial statements and profile information, security breaches could damage our reputation and expose us to a risk of loss or litigation and possible liability. There can be no assurance that our security measures will prevent security breaches or that a failure to prevent such security breaches will not have a material adverse effect on our business, financial condition and results of operations.
IF OUR SHARES OUR DELISTED, THE LIQUIDITY FOR OUR SHARES COULD BE IMPAIRED.
In December 1998, we received notice from Nasdaq that we had not met required financial ratio criteria for continued listing on the Nasdaq. Nasdaq requested that we maintain a minimum net worth of $2 million and submit to Nasdaq certain periodic financial reporting until July 1999. We have complied with Nasdaq's special reporting request and required ratio criteria.
If we fail to meet the NASD's continued listing requirements, including, among others, net tangible assets or market capitalization, minimum bid price and various corporate governance requirements, our shares could be delisted from the Nasdaq SmallCap Market. In such event, trading, if any, in our common stock would thereafter be conducted in the over-the-counter markets in the so-called "pink sheets" or the NASD's "Electronic Bulletin Board." Consequently, the liquidity of our shares could be impaired, not only in the number of shares which could be bought and sold, but also through delays in the timing of the transactions, reductions in the number and quality of security analysts' and the news media's coverage of the company, and lower prices for our shares than might otherwise be attained.
IF OUR SHARES ARE DELISTED, OUR SHARES COULD BECOME SUBJECT TO THE SEC'S "PENNY STOCK RULE".
If our shares were delisted from Nasdaq, they could become subject to Rule 15g-9 under the Securities Exchange Act of 1934, which imposes additional sales practice requirements on broker-dealers which sell such securities to persons other than established customers and "accredited investors" (generally, individuals with net worth in excess of $1,000,000 or annual incomes exceeding $200,000 or $300,000 together with their spouses). For transactions covered by this rule, a broker-dealer must make a special suitability determination for the purchase and have received the purchaser's written consent to the transaction prior to sale. Consequently, the rule may adversely affect the ability of broker-dealers to sell our shares and may adversely affect the ability of purchasers in this offering to sell any of the securities acquired in the secondary market. If our shares become subject to this rule, market liquidity for our shares could be severely adversely affected.
YEAR 2000 COMPLIANCE
In prior years, the Company discussed the nature and progress of its plans to become Year 2000 ready. In late 1999, the Company completed its remediation and testing of systems. As as result of those planning and implementation efforts, the Company experienced no significant disruptions in mission critical information and technology and non-information technology systems and believes those systems successfully responded to the Year 2000 date change. The Company expensed approximately $597,000 during the eight months ended December 31, 1999 in connection with remediating its systems. The Company is not aware of any material problems resulting from Year 2000 issues, either with its products, its internal systems, or the products and services of third parties. The Company will continue to monitor its mission critical computer applications and those of its suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly.
MATERIAL SUBSEQUENT EVENTS
Effective January 31, 2000, we appointed Robert Snow, Executive Vice President--Business to Business.
Effective January 31, 2000, Michael Conway, our Executive Vice President--Capital Markets, was terminated by the Company. Subsequent to his termination, Mr. Conway initiated arbitration proceedings in which it is alleged that he was wrongfully terminated. A mediation is scheduled to resolve the matter.
Effective February 29, 2000, Thomas Porter, our Executive Vice President--Administration, resigned. Effective March 3, 2000, Christos Skeadas, our Executive Vice President--Chief Technology Officer,
resigned. Effective April 1, 2000, we have appointed Michael Quinn, Senior Vice President, Director of Capital Markets.
As of December 31, 1999, our growth and change in Chief Executive Officers violated certain covenants in our primary warehouse lending agreement. Subsequent to December 31, 1999, the lender waived the defaults.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
FiNet's primary exposure to market risk is interest rate risk. From the time we extend an interest rate commitment to the borrower until the loan is priced for sale to an investor, we are subject interest rate risk. If interest rates rise during that period, the price at which the loan can be sold to an investor declines, resulting in a lower sales price for the loan. We attempt to mitigate such reductions and manage our interest rate risk exposure through hedging transactions using a combination of forward sales of mortgage-backed securities and forward whole-loan sales to fix the sales price of loans we expect to fund. Before entering into hedging transactions, we analyze our loans with committed interest rates (pipeline loans). We consider factors such as the estimated portion of loans that will ultimately be funded, note rates, interest rates, inventory of loans and applications and other factors to determine the type and amount of forward commitment and hedging transactions.
FiNet attempts to make forward commitments for, or hedge substantially, all of its estimated interest rate risk on the loans. We have mandatory and optional forward commitments at December 31, 1999 and April 30, 1999 and 1998 aggregating $110.2 million, $43.8 million and $46.4 million, respectively. These commitments covered the market risk associated with mortgage loans held for sale to investors of $78.7 million, $33.4 million and $63.0 million, respectively, and our pipeline loans for which interest rates were committed at December 31, 1999 and April 30, 1999 and 1998 of $36.5 million, $25.6 million and $87.3 million, respectively. We attempt to limit our credit exposure on forward sales arrangements by entering into forward sales contracts exclusively with institutions that we believe are sound credit risks and by limiting exposure to any single institution.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders FiNet.com, Inc.
We have audited the accompanying consolidated balance sheets of FiNet.com, Inc., and subsidiaries as of December 31, 1999 and April 30, 1999, and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for the eight months ended December 31, 1999 and for the year ended April 30, 1999. These financial statements are the responsibility of FiNet.com, Inc.'s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of FiNet.com, Inc. as of December 31, 1999 and April 30, 1999 and the consolidated results of their operations and their cash flows for the eight months ended December 31, 1999 and the year ended April 30, 1999, in conformity with accounting principles generally accepted in the United States.
/s/ Ernst & Young LLP
San Francisco, California February 22, 2000, except for Note 6 as to which the date is March 30, 2000
REUBEN E. PRICE & CO. PUBLIC ACCOUNTANCY CORPORATION 703 MARKET STREET SAN FRANCISCO, CA 94103
INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders FiNet.com, Inc. Walnut Creek, CA
We have audited the accompanying consolidated balance sheet of FiNet.com, Inc. (formerly Finet Holdings Corporation) and subsidiaries as of April 30, 1998, and the related consolidated statements of operations, stockholders' equity and cash flows for the fiscal years ended April 30, 1998 and 1997. The consolidated financial statements give retroactive effect to the merger of FiNet.com, Inc. and Coastal Federal Mortgage Company on April 30, 1998, which has been accounted for using the pooling of interests method as described in the notes to the consolidated financial statements. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the 1998 and 1997 financial statements of Coastal Federal Mortgage Company, which statements reflect total assets and revenues of approximately 10 percent and 53 percent, respectively, of the related consolidated totals as of April 30, 1998. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to data included for Coastal Federal Mortgage Company, is based solely on the report of the other auditors.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the consolidated statements referred to above present fairly, in all material respects, the financial position of FiNet.com, Inc. and subsidiaries as of April 30, 1998, the consolidated results of their operations and their cash flows for the fiscal years ended April 30, 1998 and 1997 in conformity with generally accepted accounting principles.
/s/ REUBEN E. PRICE & CO.
San Francisco, CA August 12, 1998
INDEPENDENT AUDITORS' REPORT
To the Board of Directors Coastal Federal Mortgage Company
We have audited the balance sheet of Coastal Federal Mortgage Company as of April 30, 1998, and the related statements of income, stockholders' equity and cash flows for each of the years in the two year period then ended (not presented separately herein). These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements enumerated above present fairly, in all material respects, the financial position of Coastal Federal Mortgage Company as of April 30, 1998, and the results of its operations and its cash flows for each of the years in the two year period then ended, in conformity with generally accepted accounting principles.
/s/ Richard A. Eisner & Company, LLP
Florham Park, New Jersey July 9, 1998 With respect to Note C July 31, 1998
REPORT OF MANAGEMENT
To Our Stockholders:
Management of the Company is responsible for the preparation, integrity and objectivity of the consolidated financial statements, and the other financial information presented in the annual report. To meet these responsibilities we maintain a system of internal control that is designed to provide reasonable assurance as to the integrity and reliability of the financial statements, the protection of Company and customer assets from unauthorized use, and the execution and recording of transactions in accordance with management's authorization. The system is augmented by careful selection of our managers, by organizational arrangements that provide an appropriate division of responsibility and by communications programs aimed at assuming that employees adhere to the highest standards of personal and professional integrity. Although no cost-effective internal control system will preclude all errors and irregularities, we believe the Company's system of internal control is adequate to accomplish the objectives set forth above.
The consolidated financial statements have been prepared in conformity with generally accepted accounting principles and necessarily include some amounts that are based on estimates and our best judgments. The financial statements have been audited by the independent accounting firm of Ernst & Young, LLP, who were given unrestricted access to all the Company's financial records and related data. We believe that all representations made to Ernst & Young LLP during their audit were valid and appropriate.
The Board of Directors through its Audit Committee, which is comprised entirely of nonmanagement directors, has an oversight role in the area of financial reporting and internal control. The Audit Committee periodically meets with Ernst & Young LLP, our internal auditors and Company management to discuss accounting, auditing, internal controls over financial reporting and other matters.
FINET.COM, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
See accompanying notes to the consolidated financial statements.
FINET.COM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
See accompanying notes to the consolidated financial statements.
FINET.COM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS)
See accompanying notes to the consolidated financial statements.
FINET.COM, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
See accompanying notes to the consolidated financial statements.
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999
NOTE 1. THE COMPANY
ORGANIZATION
FiNet.com ("FiNet" or "the Company") is a provider of mortgage services to mortgage broker businesses and consumers, including online mortgage services. The Company primarily markets its business to business services through mortgage brokers, and to consumers through marketing agreements with general interest websites and co-branding arrangements with financial services websites. FiNet operates its consumer-direct and business-to-business segments through Monument Mortgage, Inc. ("Monument"), which is licensed to originate and fund mortgage loans in 49 states and the District of Columbia. The majority of Monument's business activity is carried out in California.
Effective June 1, 1999, the Company changed its name from Finet Holdings Corporation to FiNet.com, Inc.
RISKS AND UNCERTAINTIES
The Company has a limited operating history under its current business model, and its prospects are subject to the risks, expenses and uncertainties frequently encountered by companies in the new and rapidly evolving markets for Internet products and services. These risks include the failure to develop and extend the Company's online service brands, the rejection of the Company's services by consumers, vendors and/or advertisers, and the inability of the Company to maintain and increase the levels of traffic on its online services, as well as other risks and uncertainties.
FiNet is substantially dependent on its mortgage finance partners, and the termination of one or more of these relationships would adversely affect FiNet's business. Through Monument Mortgage, Inc., the Company funds and closes mortgage loans. As a non-depository mortgage banker, Monument Mortgage is dependent on specialized mortgage credit facilities to finance its mortgage lending activities. At December 31, 1999, the Company's rapid growth in liabilities violated a covenant with our primary warehouse lender. The lender subsequently waived the default. This facility expires on May 31, 2000. The Company expects to continue its lending relationship with its primary warehouse lender; however, no assurances can be made that this relationship will continue. The inability to obtain warehouse lending would cause a material adverse affect on the Company's results of operations and financial position.
The Company experienced net losses for the eight months ended December 31, 1999 and the years ended April 30, 1999, 1998, and 1997 and had an accumulated deficit at December 31, 1999 of $73,208,000. Net losses are expected for the foreseeable future. Equity capital has been raised to finance operations. The Company's cash on hand at December 31, 1999 was $18,626,000. Future capital requirements depend on many factors including the Company's ability to execute its business plan. The Company may need to raise additional capital through the issuance of debt or equity to execute its business plan. There can be no assurance that the Company will be able to raise additional capital, or that such capital will be available at all on satisfactory terms. Failure to raise additional capital when needed could have a material adverse effect on the Company's business, results of operations and financial condition.
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of FiNet and its wholly-owned subsidiaries. All significant intercompany transactions have been eliminated. Certain reclassifications have been made to prior year financial statements to conform to the presentation for the eight months ended December 31, 1999 .
USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash balances and instruments with maturities of three months or less at the time of purchase. At December 31, 1999 the Company had restricted cash of $10,403,000 relating to amounts received for settlements on sales of mortgage loans that had not yet been applied to reduce the warehouse line of credit. This amount may only be used to pay down the warehouse line and is therefore restricted as to use.
MORTGAGE LOANS HELD FOR SALE
Mortgage loans held for sale, net of related discounts and premiums, are carried at the lower of aggregate cost or market value. Market valuation adjustments of $2,937,000, $3,851,000 and $396,000 at December 31, 1999, April 30, 1999 and 1998, respectively, were required and recorded in a valuation allowance by charges to "Cost of Revenue". Pursuant to the mortgage terms for the loans, the borrowers have pledged the underlying real estate as collateral for the loans.
MORTGAGE SERVICING RIGHTS
Originated loan servicing is recorded based on its relative fair value when separated from the underlying loan and retained by the Company. Purchased loan servicing is recorded at cost, which is not in excess of the future net cash flows related to the servicing profile. Impairment of mortgage servicing rights is determined using the estimated fair value of the servicing rights based on third party appraisals or written bids. The appraisals use a discounted cash flow analysis on a disaggregated portfolio basis stratified by loan type, investor type, and interest rate to determine fair value. Any indicated impairment is recorded using a valuation allowance.
FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment, including furniture and equipment under capital leases, are stated at cost. Depreciation and amortization, which includes the amortization of assets recorded under capital leases, is computed straight-line over their estimated useful lives of three to seven years. The cost of repairs and maintenance of furniture, fixtures and equipment is charged to operating expense.
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) REVENUE RECOGNITION
Lending transaction fees are deferred until the related loan is sold. Upon sale of the loan, deferred transaction fee income is recognized and included in gain on sale of mortgage loans. Discounts and premiums from the origination of mortgage loans held for sale are deferred and recognized as adjustments to gain or loss upon sale.
Loan servicing fees represent fees earned for servicing loans for various investors. The fees are either based on a contractual percentage of the outstanding principal balance or a fixed dollar amount per loan. Fees are credited to income when the related payments are received.
Loan brokerage fees represent fees earned by the Company's consumer-direct segment for processing of mortgage loan applications for third party lenders. The fees for providing these services are recognized at such time as the loans are funded by the lender.
Direct loan origination costs and other production costs attributable to inventory as well as other costs associated with revenues earned during the period are included in "Cost of revenues" in the Company's Consolidated Statement of Operations.
The Company's revenue components are (in thousands):
MARKETING AND ADVERTISING COSTS
All marketing and advertising costs are charged to operating expenses as incurred.
INCOME TAXES
The Company and its subsidiaries file consolidated federal and separate or combined tax returns for certain states. State and local income taxes are filed according to the taxable activities of the Company.
In accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes," the Company uses the liability method of accounting for income taxes. Under the liability method, deferred tax assets and liabilities are recognized for the expected future tax consequences of existing differences between financial reporting and tax reporting bases of assets and
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) liabilities, as well as for operating losses and tax credit carry-forwards, using enacted tax laws and rates. Deferred tax assets are recognized to the extent that management believes, based on available evidence, that it is more likely than not that they will be realized. Deferred tax expense represents the net change in the deferred tax asset or liability balance during the year. This amount, together with income taxes currently payable or refundable for the current year, represents the total income tax expense for the year.
LOSS PER SHARE
The Company computes basic net loss and diluted net loss per share in accordance with SFAS No. 128, "Earnings per Share." Under the provisions of SFAS No. 128, basic net loss per share is computed by dividing the net loss available to common stockholders for the period by the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed by dividing the net loss available to common stockholders for the period by the weighted average number of common and common equivalent shares outstanding during the period, to the extent such common equivalent shares are dilutive. Since the common equivalent shares for all years were antidilutive (,i.e. reduce net loss per share), basic and diluted loss per share are the same.
The Company has excluded all outstanding warrants and options to purchase common stock and shares potentially issuable upon conversion of convertible subordinated debentures existing at December 31, 1999 and April 30, 1999 and 1998 from the calculation of loss per share, because their inclusion would be antidilutive (,i.e. reduce the net loss per share) for all periods presented. The number of options to purchase common stock that were excluded are 11,874,828; 7,512,000; 737,875 and 558,875 for the eight months ended December 31, 1999 and for the fiscal years ended April 30, 1999, 1998 and 1997, respectively. Warrants to purchase common stock of 14,801,000, 16,421,000; 10,596,000 and 6,907,000 for the eight months ended December 31, 1999 and for the fiscal years ended April 30, 1999, 1998 and 1997, respectively, and 2,659,000 shares potentially issuable upon conversion of subordinated debentures at April 30, 1998 were also excluded.
COMPREHENSIVE INCOME (LOSS)
The Company adopted SFAS No. 130, "Reporting Comprehensive Income," at April 30, 1999. The Company is required to display comprehensive income (loss) and its components as part of the financial statements. Other comprehensive income (loss) includes certain changes in equity that are excluded from net income (loss). The Company recorded other comprehensive income related to unrealized gains on the appreciation of Marketable Equity Securities.
STOCK-BASED COMPENSATION
The Company accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principals Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and complies with the disclosure provision of SFAS No. 123, "Accounting for Stock-Based Compensation." Under APB No. 25, compensation expense is based on the excess of the estimated fair value of the Company's stock over the exercise price, if any, on the grant date.
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". However, the effective date for this pronouncement was delayed for one year from the original required date of fiscal years beginning after June 15, 1999. SFAS No. 133 will require the Company to record all derivatives on the balance sheet at fair value. Changes in derivative fair values will either be recognized in earnings as offsets to the changes in fair value of related hedged assets, liabilities and firm commitments or, for forecasted transactions, deferred and recorded as a component of comprehensive income in stockholders' equity until the hedged transactions occur and are recognized in earnings. The ineffective portion of a hedging derivative's change in fair value will be immediately recognized in earnings. In June 1999, the FASB issued SFAS 137, "Accounting for Derivative Instruments and Hedging Activities--Deferral of the Effective Date of FASB Statement No. 133," to defer the effective date of SFAS 133 until fiscal years beginning after June 15, 2000. The Company anticipates engaging in hedging activity in the future, and, therefore, expects to be impacted by the pronouncement. The impact of FAS No. 133 on the Company's consolidated financial statements, however, will depend on a variety of factors, including the level of future hedging activity, the types of hedging instruments used and the effectiveness of such instruments.
NOTE 3. ACQUISITIONS AND DISPOSITIONS
On August 20, 1999, FiNet acquired certain operations and assets of Lowestrate.com, Inc. ("Lowestrate"). The assets included the trademark "Lowestrate.com" and the related website and certain equipment and software. The acquired assets and operations will be used in the Company's consumer-direct segment. As consideration for the purchase, the Company issued 1,400,000 shares of its common stock. Of these shares, 560,000 were issued to the seller at the closing and were valued at approximately $1,820,000. The purchase price of these assets and operations, including expenses was $1,997,000. The entire purchase price was allocated to goodwill and is being amortized over 36 months. Amortization expense recorded for the eight months ended December 31, 1999 was $240,000. The remaining 840,000 shares were placed in escrow subject to release to Lowestrate if the contingencies are resolved. The acquisition was accounted for as a purchase. Certain ancillary agreements were entered into in connection with the acquisition, including a $500,000 non interest-bearing loan due in one year to the seller of Lowestrate, secured by 200,000 of the escrowed shares. The $500,000 note is included in the Company's "Accounts Receivable" on its Consolidated Balance Sheet at December 31, 1999.
Subsequent to the asset and operations purchase date and until appropriate licensing requirements were completed, Monument performed certain processing and marketing services for Lowestrate and recorded fees and expenses related to these services. As licenses were obtained in each state, lending activities in that state were transferred to Monument and FiNet's results of operations include those activities.
On October 28, 1999, the Company acquired its partners' 50% interest in a joint venture. As consideration for the purchase, the Company issued 600,000 shares of its common stock valued at $1,462,000. The only asset of the joint venture was 300,000 common shares of HouseSeekers.com equity securities which became marketable during 1999. The joint venture had no operating activities.
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 3. ACQUISITIONS AND DISPOSITIONS (CONTINUED) The securities are classified as "available for sale" and are valued at market. Of the original 300,000 shares, the Company sold 96,000 shares a in 1999 and recognized a realized gain on the sale of $366,000 which is included in "Revenue" in the Statement of Operations. As of December 31, 1999, the Company held 204,000 shares valued at $2,674,000, which represents the closing bid price of the stock as of December 31, 1999. The Company recognized $1,704,000 of unrealized gains on the marketable equity securities for the eight month period ended December 31, 1999 and this amount has been included in Other Comprehensive Income in the Statement of Changes in Stockholders' Equity.
On May 19, 1998, the Company acquired all of the issued and outstanding shares of Mical Mortgage, Inc. ("Mical"), a non-public mortgage banker with offices in San Diego, California and Las Vegas, Nevada, in exchange for 552,000 shares of FiNet's common stock. At the purchase date, 431,930 of these shares were issued and were valued at $1,674,000. The remaining shares are issuable by FiNet upon the resolution of specified contingencies related to the acquisition and will be recognized as additional purchase price if and when the contingencies are resolved. The acquisition was accounted for as a purchase. Accordingly, the results of Mical's operations have been included in the Company's consolidated financial statements subsequent to the acquisition date. The excess of the purchase price over the fair value of the net assets acquired of $3,332,000, net of purchase accounting adjustments, was recorded as goodwill. The Company discontinued the operations of Mical during fiscal 1999 and expensed the remaining unamortized goodwill relating to this acquisition. (See Note 13.)
On April 30, 1998, FiNet acquired all the issued and outstanding common shares of Coastal Federal Mortgage Company ("Coastal"), a non-public, sub prime mortgage banker with offices in New Jersey, Pennsylvania and Florida, in exchange for 1,250,000 shares of its common stock. This transaction was accounted for as a pooling of interests and, consequently, the consolidated financial statements of FiNet have been restated to include the balance sheet and statements of operations of Coastal for all periods reported. The Company discontinued the operations of Coastal during fiscal 1999 and recorded $405,000 in "Special charges" in the Consolidated Statement of Operations related to liquidating the assets and satisfying the liabilities of Coastal.
On February 9, 1998, the Company acquired all of the issued and outstanding stock of iQualify, Inc., a software developer whose principal asset is the iQualify software currently used by FiNet, for a consideration of 50,000 shares of FiNet common stock valued at $180,000, plus certain future usage-based payments. The acquisition was accounted for as a purchase.
In December 1997, the Company completed the purchase of substantially all of the assets of Real Estate Office Software, Inc. ("REOS"), a Nevada corporation. REOS is a software development and marketing company whose primary product is a proprietary realtor productivity tool called the Real Estate Office. The total purchase price was $1,261,000, consisting of cash of $641,000 and 200,000 shares of FiNet's common stock valued at $620,000. In January 1999, management determined that REOS no longer fit the strategic direction of the Company and that the purchased technology was permanently impaired based on projected future cash flows. Accordingly, the Company expensed the remaining recorded value of REOS of $690,000 in "Special charges" in the Company's Consolidated Statement of Operations.
On December 31, 1996, FiNet acquired all of the outstanding common stock of Monument in exchange for 8.4 million common shares of the Company and a cash payment of $1,000,000. For accounting purposes, the cash payment was deemed a dividend payment to Monument stockholders and
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 3. ACQUISITIONS AND DISPOSITIONS (CONTINUED) the common shares issued in the acquisition have been treated as a recapitalization of Monument, with Monument as the reverse acquisition acquirer. The historical financial statements prior to December 31, 1996 are those of Monument and are deemed to be those of the reporting entity. Since the Company's operations were minimal or dormant during the year ended December 31, 1996, the reverse acquisition was considered a capital transaction rather than a business combination. Following the reverse acquisition, the Company changed its fiscal year end from December 31 to April 30 to conform to the fiscal year end of Monument.
NOTE 4. MORTGAGE SERVICING RIGHTS
Mortgage servicing rights and the related valuation allowance activity was as follows:
In connection with mortgage servicing activities, the Company segregates escrow and custodial funds in a separate trust account and excludes this balance of $571,000, $3.7 million and $16.0 million at December 31, 1999 and April 30, 1999 and 1998, respectively, from its balance sheet.
NOTE 5. FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment consists of the following:
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 5. FURNITURE, FIXTURES AND EQUIPMENT (CONTINUED) During the eight months ended December 31, 1999, the Company recorded $1,385,000 of expense relating to the retirement of fixed assets in connection with a relocation of its corporate headquarters and primary operations. See Note 13, "Special Charges". These assets were used in the business-to-business and consumer-direct segments and for the corporate group.
NOTE 6. BORROWING ARRANGEMENTS
Borrowing arrangements consist of the following:
WAREHOUSE LINES OF CREDIT
In August, 1999, the Company entered into a new lending agreement with its primary warehouse lender, GMAC/RFC. The new agreement provides the Company with a committed $75 million warehouse borrowing facility that carries an interest rate of LIBOR plus 1.75%. The agreement expires on May 31, 2000. For the eight month period ended December 31, 1999, the Company recorded warehouse interest
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 6. BORROWING ARRANGEMENTS (CONTINUED) expense of $1,002,000. For the years ended April 30, 1999, 1998 and 1997, the Company recorded interest expense of $6,587,000, $2,710,000 and $1,874,000, respectively. Borrowings under this warehouse facility are secured by the mortgages held for sale thereby financed. At December 31, 1999, and April 30, 1999 and 1998, LIBOR was 6.49%, 4.90%, and 5.69%, respectively, and the prime rate was 8.5%, 7.75%, and 8.5%, respectively.
The Company's available credit lines also include a $15 million purchase/repurchase agreement with Fannie Mae's "As Soon as Pooled/Early Purchase Option" (the "ASAP Plus" program). Under the ASAP Plus program, Fannie Mae funds the Company on the loans delivered to them upon receipt of appropriate mortgage collateral. Fannie Mae subsequently purchases the mortagage loans for cash upon receipt of complete and accurate mortgage pool and other documentation. At December 31, 1999, the Company had $7.3 million of borrowings outstanding on the ASAP Program.
WAREHOUSE FACILITY COVENANTS
The agreement for the warehouse line of credit contains various financial covenants including minimum net worth, current ratio, tangible net worth, and leverage ratio requirements. Should an event of default occur, as defined in the Agreement, outstanding principal and interest are due on demand. At April 30, 1999, the Company was in default under various financial covenants related to its non-primary warehouse lenders. The Company is negotiating the closure of these warehouse lines. At December 31, 1999, the Company was in default of its primary warehouse lending agreement, as a liability growth rate covenant was violated. Subsequent to December 31, 1999, the lender waived the default. This facility expires on May 31, 2000.
3% SUBORDINATED CONVERTIBLE DEBENTURES
The Company issued $7,000,000 of 3% Subordinated Convertible Debentures in a private placement with interest payable in common stock of FiNet when converted, or in cash at maturity, redemption or retirement. The Company also issued 175,000 detachable warrants for purchase of the Company's common stock in connection with the debenture issuance. These debentures were issued in three separate tranches, with the first two tranches issued in fiscal 1998 totaling $5,500,000, and the third tranch issued in fiscal 1999 totaling $1,500,000. The debentures were convertible into the Company's common stock at the lesser of $5.00 per common share or 78% of the determined market price prior to conversion.
The Company recorded $1,974,000 as additional paid in capital for the discount deemed related to imputed interest for the preferential conversion feature on the debentures. This discount was amortized to interest expense over the period from the date of issue to the date debentures first became convertible. Interest expense of $1,687,000 and $287,000 in fiscal years 1999 and 1998, respectively, was recognized in connection with the discount amortization and is included in other interest expense. Additionally, the Company recorded $269,000 in fiscal 1999 as a discount and additional paid in capital for the deemed fair value of the 175,000 detachable warrants. This discount was fully amortized to interest expense during fiscal 1999.
In January 1999, $1,100,000 of the total $7,000,000 debentures were converted into 2,200,000 common shares at a conversion price of fifty cents per share, and an additional $4,400,000 of debentures were converted into 7,333,333 common shares at a conversion price of sixty cents per share. The remaining
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 6. BORROWING ARRANGEMENTS (CONTINUED) $1,500,000 of debentures were redeemed for cash at 100 percent of face value. In connection with the redemption, the Company also issued 840,000 5-year warrants exercisable at $1.50 per share, to the debenture holders. Expense of $739,000 was recorded for the deemed fair value of these warrants and is included in "Other expense" in the Company's Consolidated Statements of Operations. Additionally, capitalized debt issuance costs of $546,000 were expensed in fiscal 1999 and are included in "Other interest expense" on the Company's Consolidated Statements of Operations.
NOTE 7. LIABILITIES SUBJECT TO COMPROMISE
Prior to the December 31, 1996 reverse acquisition, FiNet had incurred $969,000 of unsecured trade creditor accounts payable. The Company had settled a majority of these claims by April 30, 1997. The creditors agreed to accept, on average, 33.8% of what they were owed. The payments were made in the form of cash and shares of the Company's common stock. The reduction of this liability gave rise to extraordinary gain of $312,000 for the year ended April 30, 1997. The balance of liabilities subject to compromise was $239,000 at December 31, 1999, and $438,000 at April 30, 1999 and April 30, 1998, respectively.
NOTE 8. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases its facilities and certain equipment under non-cancelable operating and capital leases. Future minimum payments consist of the following at December 31, 1999:
Rent expense for the eight months ended December 31, 1999 and for fiscal years 1999, 1998, and 1997, was $1,012,000, $867,000, $601,000 and $514,000, respectively.
LITIGATION
On January 14, 1998, prior to the Company's acquisition of Mical, a lawsuit was filed against Mical in the United States District Court for the Middle District of Georgia. The complaint alleges, among other things, that in connection with residential mortgage loan closings, Mical made certain payments to mortgage brokers in violation of the Real Estate Settlement Procedures Act and induced mortgage brokers
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 8. COMMITMENTS AND CONTINGENCIES (CONTINUED) to breach their alleged fiduciary duties to their customers. The plaintiffs seek unspecified compensatory and punitive damages as to certain claims. Management believes that its compensation programs for mortgage brokers comply with applicable laws and with long standing industry practices. The Company intends to defend vigorously against this action and believes that the ultimate resolution will not have a material adverse effect on its business, results of operations and financial condition.
On April 16, 1999, a lawsuit was filed in the Superior Court of the State of California, County of San Francisco by a former director and officer of FiNet.com against FiNet.com and one of its then current and now former directors. The complaint alleges, among other things, that the plaintiff and the Company's then current director entered into an oral contract, wherein they agreed to share all profits from bonus shares that were issued to either party under certain specific circumstances. It is further alleged that the Company issued to the current director 1,800,000 shares of stock and that the Company's then current director failed to provide the plaintiff one-half of the stock, or 900,000 shares. The plaintiff seeks to recover 900,000 shares of the Company's common stock and punitive damages as to certain of the claims. FiNet.com and the Company's then current director have each filed a general denial of all claims. The Company intends to defend vigorously against the action and believes that the ultimate resolution will not have a material adverse effect on its business, results of operations or financial condition.
On December 16, 1999, a lawsuit was filed in the Judicial District Court of Dallas County, Texas, by FC Capital Corp. d/b/a FirstCity Capital Corporation. The complaint alleges breach of contract by Coastal for failure to repurchase loans in accordance with the terms and condition of a Purchase Agreement entered into by the parties in March 1998. The plaintiff has named Finet as a defendant alleging that Finet assumed all of Coastal's debts and obligations when Finet acquired Coastal in April 1998. The plaintiff seeks to recover actual damages in the amount of $1.7 million and premium rebates in the approximate amount of $26,000. The action was removed to the United State District Court, Northern District of Texas, Dallas Division on January 18, 2000 and the Company has since filed procedural motions. Management intends to defend vigorously against the action and believe that the ultimate resolution will not have a material adverse effect on the Company's business, results of operations or financial condition.
The Company and certain subsidiaries are defendants in various other legal proceedings. Although it is difficult to predict the outcome of such cases, after reviewing with counsel all such proceedings, management does not expect the aggregate liability, if any, resulting therefrom, will have a material adverse effect on the consolidated financial position or results of operations of the Company and its subsidiaries.
NOTE 9. MORTGAGE BANKING ACTIVITIES AND RELATED RISKS
In the normal course of business, companies in the mortgage banking industry encounter certain economic and regulatory risks including: interest rate risk, market risk, credit risk and repurchase risk.
The Company's commitments to extend credit (pipeline loans) for which interest rates were committed to borrowers, subject to loan approval, totaled approximately $36,458,000, $25,604,000 and $87,300,000 as of December 31, 1999 and April 30, 1999 and 1998, respectively. Until a rate commitment is extended by the Company to a borrower, there is no market risk to the Company. If market interest rates rise between the time the Company commits to originate a loan at a specific rate and the time such loans are priced for sale, the market price of the loan declines, resulting in a loss on the sale of the loan.
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 9. MORTGAGE BANKING ACTIVITIES AND RELATED RISKS (CONTINUED) To protect against such losses, the Company attempts to manage its interest rate risk exposure through hedging transactions using a combination of forward sales of mortgage-backed securities and forward whole-loan sales to fix the sales price of loans the Company expects to fund. Forward sales are sales of loans with settlement dates more than five days in the future. Before entering into hedging transactions, the Company performs an analysis of the loans with committed interest rates. This analysis includes taking into account such factors as the estimated portion of such loans that will ultimately be funded, note rate, interest rates, inventory of loans and applications, and other factors to determine the type and amount of forward commitment and hedging transactions. The Company attempts to make forward commitments for, or hedge substantially, all of its estimated interest rate risk on the loans. The Company does not believe that hedging its interest rate risk with respect to the non-prime loans is cost effective because these loans generally have higher interest rate spreads and generally lack sensitivity to interest rate changes due to their credit characteristics and the short period of time held by the Company. The Company had mandatory and optional forward commitments at December 31 and at April 30, 1999 and 1998 aggregating $110,233,000, $43,829,000 and $46,400,000, respectively. These commitments covered the market risk associated with the mortgage loans held for sale to investors of $78,691,000, $33,438,000 and $63,034,000, respectively, and the pipeline loans for which interest rates were committed of $36,458,000, $25,604,000 and $87,300,000, respectively.
As is customary in the marketplace, none of the forward payment obligations of any of the Company's counterparties are currently secured or subject to margin requirements. The Company attempts to limit its credit exposure on forward sales arrangements by entering into forward sales contracts exclusively with institutions that the Company believes are sound credit risks, and by limiting its exposure to any single counterparty.
Fees paid to investors are deferred and subsequently expensed as the loans are delivered to the investor in proportion to the percentage relationship of loans delivered to the total commitment amount. Any remaining fee is recognized as a period expense at the expiration of its commitment period, or earlier if exercise of the commitment is deemed remote.
The Company reduces its exposure to default risk (other than first-payment defaults by customers) and most of the prepayment risk normally inherent in the mortgage lending business by selling all funded loans. However, in connection with loan sales and bulk servicing sales, the Company makes representations and warranties relating to credit information, loan documentation and collateral. To the extent that the Company does not comply with such representations and warranties, or there are early payment defaults, the Company may be required to repurchase the loans or indemnify the purchasers for any losses. For the eight months ended December 31, 1999, and the years ended April 30, 1999, 1998, and 1997, the Company repurchased loans totaling $6,982,820, $10,034,000, $347,000, and zero, respectively, which resulted in losses of $1,572,000, $759,000, $347,000, and zero, respectively.
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 10. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosures of the estimated fair values of financial instruments are made in accordance with the requirements of SFAS No. 107, "Disclosures about Fair Value of Financial Instruments." The estimated fair value amounts have been determined by using available market information and appropriate methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein may not be indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts disclosed in the following paragraph.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate such value:
- Cash, accounts receivable, and warehouse and other lines of credit. The carrying amounts of these assets and liabilities approximate fair value because of the short maturity of those instruments.
- Mortgages held for sale. Fair values for mortgages held for sale are based on management's estimate of the ultimate realizable value.
- Mortgage servicing rights. Fair values for mortgage servicing rights are based on third party appraisals and written bids to purchase the servicing portfolios.
- Notes payable. The carrying value is considered to be a reasonable estimate of fair value based on interest rates of similar financial instruments in the marketplace.
- Loan commitments to fund (i.e. pipeline loans) and loan commitments to sell. The fair value for the pipeline loans, allowing for estimated fallout based on historical experience, and loan commitments to sell, are based on quoted market prices.
The carrying values and the estimated fair values of our financial instruments at December 31, 1999 and April 30, 1999 and 1998 are as follows:
NOTE 11. STOCKHOLDERS' EQUITY
The Company recorded $1,704,000 of "Other comprehensive income" relating to unrealized gains on marketable equity securities held as available for sale at December 31, 1999. (See Note 3)
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 11. STOCKHOLDERS' EQUITY (CONTINUED) As of December 31, 1999, the Company had outstanding warrants as follows:
In September 1998, the Company issued 250 shares of its $2,500 Series A Convertible Preferred Stock ("Preferred") in a private placement generating $2,286,250 of proceeds, net of expenses. In addition, the Company issued Warrants to the Preferred investors to purchase 250,000 shares of the Company's common stock at $1.00 per share. The Company recorded a perferred stock discount of $705,000 upon issuance of the preferred stock. This discount was amortized to the date the preferred stock first became convertible. The entire discount was amortized in fiscal 1999 and is reported as "In-substance preferred dividend" on the Company's 1999 Consolidated Statement of Operations. In the third and fourth quarters of fiscal 1999, the $2,500,000 Series A Convertible Preferred stock was redeemed at face value.
NOTE 12. STOCK OPTIONS
1989 STOCK OPTION PLAN (EXPIRED)
The Company's 1989 Stock Option Plan (the "1989 Plan") provided for the grant of options to officers, directors, other key employees and consultants of the Company to purchase up to an aggregate of 1,750,000 shares of common stock. The 1989 Plan was administered by the Company's Board of Directors. The Board of Directors were authorized to determine the terms of options granted under the 1989 Plan, including the number of shares subject to the option, exercise price, term and exercisability. Options granted under the 1989 Plan could be incentive stock options or nonqualified stock options.
The exercise price of incentive stock options could not be less than 100% of the fair market value of the common stock as of the date of grant (110% of the fair market value in the case of an optionee who owns more than 10% of the total combined voting power of all classes of the Company's capital stock). Options could not be exercised more than ten years after the date of grant (five years in the case of 10% stockholders).
Upon termination of employment, the optionee generally has the right to exercise, for 90 days following the termination date, any outstanding option to the extent it was exercisable on the date of termination, after which all unexercised options lapse. In the event of an optionee's death or disability, the optionee could exercise any outstanding option, to the extent it is exercisable, for one year following the termination date.
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 12. STOCK OPTIONS (CONTINUED) 1998 STOCK OPTION PLAN
The Company's 1998 Stock Option Plan (the "1998 Plan") provides for the grant of options to officers, employee directors, other employees and consultants of FiNet.com to purchase up to an aggregate of 10,000,000 shares of common stock. The 1998 Plan is administered by the Company's Board of Directors. The Company's Board of Directors determines the terms of options granted under the 1998 Plan, including the number of shares subject to the option, exercise price, term and exercisability. Options granted under the 1998 Plan may be incentive stock options or nonqualified options. In general, the 1998 Plan has the same terms and conditions as the 1989 Plan. As of December 31, 1999, 4,601,572 options, were available for grant under the 1998 plan.
NON-EMPLOYEE DIRECTORS' STOCK OPTION PLAN
The Company's 1998 Non-Employee Directors' Stock Option Plan (the "Directors' Plan") provides for an automatic grant of an option to purchase 40,000 shares of common stock to non-employee directors upon their election or appointment to the Company's Board of Directors and 60,000 shares for subsequent annual grants. The aggregate number of shares that can be purchased under the Directors' Plan is 1,000,000. The exercise price of the options is 85% of the fair market value of the common stock on the date of grant. The Directors' Plan is administered by the Company's Board of Directors. The initial option grant vests 100% on grant. Subsequent annual grants under the Directors' Plan become exercisable in four equal annual installments, commencing on the first anniversary of the date of grant. To the extent that an option is not exercisable on the date that a director ceases to be a director of the Company, the unexercisable portion lapses. As of December 31, 1999, 760,000 options were available for grant under this plan.
STOCK BONUS INCENTIVE PLAN
The Company's Stock Bonus Incentive Plan (the "Stock Bonus Plan") provides for the grant of bonus shares to any of the Company's employees, directors, officers and to consultants or advisers to the Company. The Company's Board of Directors has authorized up to an aggregate of 875,000 shares of common stock for issuance as bonus awards under the Stock Bonus Plan. The Stock Bonus Plan is currently administered by the Company's Board of Directors. Each grant of bonus shares becomes exercisable according to a schedule to be established by the Company's Board of Directors at the time of grant.
OTHER AGREEMENTS
Pursuant to an employment agreement with a former executive officer, the Company granted options to the executive officer to purchase 720,236 shares of common stock at with prices ranging from $3.313 to $9.1250 which will expire in 2000.
In December 1999, the Company entered into an employment agreement with a new executive officer. Pursuant to the agreement, the Company granted the executive officer 2,250,000 options in addition to 750,000 options granted to him under the 1998 Stock Option Plan. The options are exercisable at $1.03 and will expire in 2009.
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 12. STOCK OPTIONS (CONTINUED) 1999 EMPLOYEE STOCK PURCHASE PLAN
The Company has an Employee Stock Purchase Plan under which 500,000 shares of common stock have been reserved for issuance. Under this plan, FiNet's employees, subject to certain restrictions, may purchase shares of common stock at 85% of the fair market value at either the date of enrollment or the date of purchase, whichever is less. The Company implemented this plan in the first quarter of 2000.
The Company has elected to follow Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations, which require compensation expense for options to be recognized when the market price of the underlying stock exceeds the exercise price on the date of grant. compensation expense recognized in income under APB 25 for the eight months ended December 31, 1999 was $184,000. There was no such expense recognized for the fiscal years ended April 30, 1999, 1998 and 1997.
Statement of Financial Account Standards No. 123 (SFAS 123), "Accounting for Stock Based Compensation," permits companies to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. In management's opinion, the existing stock option valuation models do not necessarily provide a reliable single measure of the fair value of stock-based awards. Therefore, as permitted, the Company will continue to apply the existing account rules under APB No. 25 and provide pro forma net income and pro forma earnings per share (EPS) disclosures for stock-based awards made during the eight months ended December 31, 1999 and fiscal years ended April 30, 1999, 1998 and 1997 as if the fair-value-based method defined in SFAS NO.123 had been applied.
The fair value of options at the date of grant was estimated using the Black-Scholes model with the following assumptions for the eight months ended December 31, 1999 and fiscal years 1999, 1998 and 1997, respectively: risk-free interest rates of 5.38% to 6.52%; 4.78% to 5.53%; 5.5%; and 6.6% to 6.7% volatility of 132.86%; 141%; 50% and 50%; a dividend growth rate of zero was used since the Company does not intend to pay dividends on its common stock; and the expected lives equal to .53 years over the vesting period for the eight months ended December 31, 1999, one year over the vesting period for fiscal 1999, and the remaining option terms for fiscal years 1998 and 1997.
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 12. STOCK OPTIONS (CONTINUED) The weighted-average grant-date fair value and exercise price of options granted during the eight months ended December 31, 1999 and fiscal years 1999, 1998 and 1997 are summarized below:
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 12. STOCK OPTIONS (CONTINUED) The following table summarizes stock option plan activity for the eight months ending December 31, 1999, fiscal years 1999, 1998 and 1997:
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 12. STOCK OPTIONS (CONTINUED) The following table summarizes significant ranges of outstanding and exercisable options at December 31, 1999:
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 13. SPECIAL CHARGES
In connection with the Company's relocation of its headquarters and operating facilities from Walnut Creek, California to San Ramon, California, $1,385,000 of expense was recorded to write-off fixed furniture fixtures and equipment that would no longer be employed in the new location.
In addition, the Company recorded nonrecurring charges associated with discontinued business units during the eight months ended December 31, 1999 and during fiscal year 1999. During the third quarter of fiscal year 1999, the Company's Board of Directors approved a plan to cease Mical's operations and close its facilities. The Company assessed the remaining goodwill balance and determined that the amount was not recoverable from future cash flow. Goodwill of $3,189,000, net of purchase accounting adjustments and recorded amortization, was expensed as part of these special charges in fiscal year 1999. Approximately 130 employees were terminated during fiscal year 1999 as a result of the Mical closure. The Company also recorded a special charge expense of $642,000 during the third quarter of fiscal year 1999 to recognize exit costs primarily for severance and occupancy lease costs net of recovery from subleases. During the eight months ended December 31, 1999, $352,000 was recorded as expense associated with the write off of the remaining furniture fixtures and equipment of Mical.
Except for the items detailed above totaling $352,000 for the eight months ended December 31, 1999 and $642,000 for the fiscal year ended April 30, 1999, all other financial statement effects of winding down Mical are included in results from operations as incurred. At December 31, 1999, the balance of the special charge accrual was $202,000, which represents lease costs of vacated space that the Company expects to incur subsequent to December 31, 1999.
During the year ended April 30, 1999, the Company also recorded nonrecurring expenses of $405,000 to liquidate certain assets and settle certain liabilities in connection with closing Coastal and $690,000 to expense the unamortized balance of its Real Estate Office Software (REOS) technology. Management closed Coastal and expensed the remaining balance of REOS upon determining that the Company would no longer employ these assets in its future strategic direction.
In fiscal year 1998, the Company wrote off $1,010,000 relating to software services and loan leads. Management determined that these assets were permanently impaired, as they did not fit the Company's strategic plans and would no longer be employed in future operations.
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 14. INCOME TAXES
The provisions for income taxes consist of the following:
The reconciliation of the provision for income taxes computed at U.S. statutory income tax rates to pretax income is as follows:
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 14. INCOME TAXES (CONTINUED) The significant components of the Company's deferred tax liabilities and assets as of December 31, 1999, April 30, 1999 and 1998 are as follows:
Deferred tax assets are recognized to the extent that management believes, based on available evidence, that it is more likely than not that they will be realized. Due to the uncertainty surrounding the Company's ability to realize the benefits associated with its net operating losses, a valuation allowance was established against its net deferred tax asset. During the eight months ended December 31, 1999 and during fiscal year 1999, the valuation allowance was increased by $9,842,000 and $8,421,000, respectively. A portion of the valuation allowance relates to deductions from the exercise of stock options. If realized, the benefit from the reduction of that portion of the valuation allowance will be credited to equity.
At December 31, 1999, the Company has federal net operating loss carryforwards (NOLs) of approximately $75 million. The NOLs expire in the years 2004 through 2019. The Company has smaller state tax loss carryforwards. Due to ownership changes, these carryforwards are subject to substantial annual limitations as provided by the Internal Revenue Code of 1986, as amended, and similar state provisions. The annual limitation could result in the expiration of a significant portion of the NOLS before full utilization.
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 15. NON-CASH INVESTING AND FINANCING ACTIVITIES
The following table presents non-cash investing and financing information for the eight months ended December 31, 1999 and for fiscal 1999 and 1998:
NOTE 16. SEGMENT DATA
The Company has adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which requires certain disclosures about operating segments in a manner that is consistent with how management evaluates the performance of the segment. The Company has identified two
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 16. SEGMENT DATA (CONTINUED) reportable business segments: business-to-business and business-to-consumer. Information related to the Company's reportable operating segments is shown below (in thousands):
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 17. RELATED PARTY TRANSACTIONS
MICAL MORTGAGE, INC.
During fiscal year 1998, and in anticipation of the May 19, 1998 acquisition of Mical, FiNet advanced $1.9 million to Mical and utilized the Company's available warehouse lines of credit to fund $42.8 million of loans originated by Mical. Subsequently, these loans were sold and the proceeds used to repay the associated warehouse debt.
IQUALIFY
On February 9, 1998, the Company purchased the outstanding common stock of iQualify, Inc., a software developer, from T. Lee Decker and James Noack, former employees and officers of FiNet, for a consideration of 50,000 shares of the Company's common stock.
CONSULTING AGREEMENTS
The Company entered into a consulting agreement with James Umphryes, a former Monument stockholder. The contract term is three years beginning January 1, 1997 at a monthly fee of $15,000 for a total contract cost of $540,000. For the eight months ended December 31, 1999 and for fiscal year 1999, 1998, and 1997, the Company incurred consulting fee expense relating to this agreement of $120,000, $180,000, $180,000 and $60,000, respectively.
The Company and Dr. Lewis Meyer, a director of the Company, entered into a consulting agreement in June 1998. Pursuant to the agreement, Dr. Meyer received $25,000. In addition, Dr. Meyer paid FiNet $10,000 for warrants to purchase 1,000,000 shares of common stock at an exercise price of $1.25 per share. Twenty percent of the shares became exercisable on the date of grant, and the remaining shares become exercisable in quarterly installments over four years, as long as Dr. Meyer's service with FiNet continues.
LOANS TO OFFICERS
An adjustable rate, second mortgage loan in the amount of $356,000 was made to Michael Conway, a former executive officer of FiNet. The loan carries an initial interest rate of 7.25% and is secured by a second residence. The loan was sold in the secondary market.
A fixed rate, fifteen year second mortgage loan in the amount of $223,000 was made to Christos Skeadas, a former executive of FiNet. The loan carries an interest rate of 10.5% and matures on November 14, 2014.
A fixed rate, third mortgage loan in the amount of $20,000 was made to Christos Skeadas, a former executive of FiNet. The loan carries an interest rate of 7%. The principal amount and all accrued interest are due in a single payment on November 12, 2000.
OTHER
During fiscal year 1999, warrants to purchase 700,000 common shares at $1.25 per share were purchased by two officers for cash consideration of $7,000.
In April 1999, the Company entered into a Lender Subscriber Agreement with IMX, Inc. of which Richard Wilkes, a director of the Company, is president and chief executive officer and of which FiNet's
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 17. RELATED PARTY TRANSACTIONS (CONTINUED) chief executive officer, Mark Korell, is a minority shareholder. Pursuant to the agreement, IMX will provide to the Company certain software and brokerage services.
On February 3, 1999, the Company and Jan C. Hoeffel, a current director and the Company's former president, entered into a letter agreement concerning the termination of his employment as a corporate officer. Pursuant to the agreement, Mr. Hoeffel's employment terminated as of February 28, 1999. In consideration for the issuance to him of 300,000 unregistered shares of common stock, Mr. Hoeffel agreed to forfeit any and all anti-dilution rights previously granted him by the Company, and to surrender to the Company a warrant entitling him to purchase 300,000 shares of common stock.
NOTE 18. VALUATION ALLOWANCES
Valuation allowances consist of the following:
NOTE 19. EMPLOYEE BENEFIT PLAN
The Company has a salary reduction 401(k) retirement savings plan (the "Plan") covering all employees meeting certain eligibility requirements. Employees may contribute up to 15% of their eligible compensation, subject to an annual limit. The Plan provides that, at the Company's discretion, the Company may make employer contributions. There were no employer contributions for the eight months ended December 31, 1999 or during fiscal years 1999, 1998 or 1997.
NOTE 20. YEAR 2000
In prior years, the Company discussed the nature and progress of its plans to become Year 2000 ready. In late 1999, the Company completed its remediation and testing of systems. As a result of those planning and implementation efforts, the Company experienced no significant disruptions in mission critical information technology and non-information technology systems and believes those systems successfully responded to the Year 2000 date change. The Company expensed approximately $597,000 during the eight months ended December 31, 1999 in connection with remediating its systems. The Company is not aware
FINET.COM, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999
NOTE 20. YEAR 2000 (CONTINUED) of any material problems resulting from Year 2000 issues, either with its products, its internal systems, or the products and services of third parties. The Company will continue to monitor its mission critical computer applications and those of its suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly.
ITEM 9.
ITEM 9. CHANGES IN OR DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
On February 12, 1999, FiNet dismissed Reuben E. Price & Co. as its independent accountant and, on February 12, 1999, appointed Ernst & Young LLP to that position.
The reports of Reuben E. Price on FiNet's financial statements for the past two fiscal years contained no adverse opinion or disclaimer, or were qualified as to uncertainty, audit scope, or accounting principles.
The change in accountants was made in light of the recently expanded scope of our operations and the attendant requirement for the accounting services of a larger firm of national scope and stature. The decision to change independent accountants was recommended by management and was approved by FiNet's Audit Committee and Board of Directors.
During the Company's fiscal years ended April 30 1998 and 1997 and the subsequent interim period prior to the change in accountants, there were no disagreements with Reuben E. Price on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item 10 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of the fiscal year.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 is hereby incorporated by reference from our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of the fiscal year.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item 12 is hereby incorporated by reference to our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of the fiscal year.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item 13 is hereby incorporated by reference to our definitive proxy statement, to be filed pursuant to Regulation 14A within 120 days after the end of the fiscal year.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A)1 FINANCIAL STATEMENTS
The information required by this Item appears in Item 8 of this Annual Report on Form 10-K.
(A)2 FINANCIAL STATEMENT SCHEDULES
See the Note 18 to the Company's Consolidated Financial Statements for the required information about Valuation and Qualifying Accounts. All other schedules are omitted because they are not applicable.
(A)3 EXHIBITS
- ------------------------
(1) Incorporated by reference to Exhibit 3.2 of the registrant's Annual Report on Form 10-KSB for the fiscal year ended April 30, 1998, filed on August 13, 1998.
(2) Incorporated by reference to Exhibit 3 of the registrant's Current Report on Form 8-K filed on June 2, 1999.
(3) Incorporated by reference to Exhibit 3 of the registrant's Current Report on Form 8-K filed on November 24, 1999.
(4) Incorporated by reference to the Exhibit of the same number filed with the registrant's Annual Report on Form 10-KSB for the fiscal year ended April 30, 1998, filed on August 13, 1998.
(5) Filed with the registrant's Registration Statement on Form S-1 filed on July 2, 1999.
(6) Incorporated by reference to Exhibit 7.1 of the registrant's Current Report on Form 8-K filed on February 11, 1999.
(7) Incorporated by reference to Exhibit 4.2 of the registrant's Current Report on Form 8-K filed with the SEC on April 6, 1998.
(8) Incorporated by reference to Exhibit 7.2 of the registrant's Current Report on Form 8-K filed on February 11, 1999.
(9) Incorporated by reference to Exhibit 16 of the registrant's Current Report on Form 8-K filed on February 19, 1999.
(10) Incorporated by reference from the registrant's Current Report on Form 8-K filed on August 27, 1999.
(11) Incorporated by reference on Exhibit 4.1 of the registrant's Registration on Form S-3 filed on December 30, 1999.
(B) REPORTS ON FORM 8-K
During the two months ended December 31, 1999, we filed two Current Reports on Form 8-K:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant, FiNet.com, Inc., a corporation organized and existing under the laws of the State of Delaware, has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized, in the City of San Ramon, State of California, on the 30th day of March 2000.
FINET.COM, INC.
By: /s/ RICK COSSANO ----------------------------------------- Rick Cossano PRESIDENT, CHIEF EXECUTIVE OFFICER, AND MEMBER OF THE BOARD OF DIRECTORS
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Rick Cossano and Gary A. Palmer, jointly and severally, his attorney-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Annual Report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virture hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
EXHIBIT INDEX
- ------------------------
(1) Incorporated by reference to Exhibit 3.2 of the registrant's Annual Report on Form 10-KSB for the fiscal year ended April 30, 1998, filed on August 13, 1998.
(2) Incorporated by reference to Exhibit 3 of the registrant's Current Report on Form 8-K filed on June 2, 1999.
(3) Incorporated by reference to Exhibit 3.2 of the registrant's Annual Report on Form 10-KSB for the fiscal year ended December 31, 1993.
(4) Incorporated by reference to the Exhibit of the same number filed with the registrant's Annual Report on Form 10-KSB for the fiscal year ended April 30, 1998, filed on August 13, 1998.
(5) Filed with the registrant's Registration Statement on Form S-1 filed on July 2, 1999.
(6) Incorporated by reference to Exhibit 7.1 of the registrant's Current Report on Form 8-K filed on January 19, 1999.
(7) Incorporated by reference to Exhibit 4.2 of the registrant's Current Report on Form 8-K filed with the SEC on April 6, 1998.
(8) Incorporated by reference to Exhibit 7.2 of the registrant's Current Report on Form 8-K filed on January 19, 1999.
(9) Incorporated by reference to Exhibit 16 of the registrant's Current Report on Form 8-K filed on February 19, 1999.