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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
------------ ------------
COMMISSION FILE NUMBER 000-27437
PARAGON FINANCIAL CORPORATION
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 94-322773
(State or Other Jurisdiction of Incorporation (I.R.S. Employer Identification No.)
5000 SAWGRASS VILLAGE CIRCLE, PONTE VEDRA BEACH, FLORIDA 32082
(Address of principal executive offices)
904-285-0000
(Issuer's telephone number)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Exchange Act during
the preceding 12 months (or for such shorter period that the issuer was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
Check whether the registrant filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court.
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 116,396,478 shares as of August
18, 2003.
TABLE OF CONTENTS
Item No. Page Number
--------- -----------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance at June 30, 2003 Sheets (Unaudited) and
December 31, 2002 (Audited) 2
Condensed Consolidated Income Statements for the three and six months ended
June 30, 2003 and 2002 (Unaudited) 3
Condensed Consolidated Statements of Cash Flows for the six months ended
June 30, 2003 and 2002 (Unaudited) 4
Notes to Condensed Consolidated Financial Statements (Unaudited) 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk 21
Item 4. Controls and Procedures 22
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 2. Changes in Securities 23
Item 3. Defaults Upon Senior Securities 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 24
Signature Page 25
Item 1. Financial Statements
PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
JUNE 30, 2003 DECEMBER 31, 2002
(UNAUDITED) *
ASSETS:
Cash and cash equivalents $ 647 $ 91
Fees receivable 440 -
Mortgage loans receivable held for sale, net 14,038 -
Office property and equipment, net of accumulated depreciation 1,234 1
Other notes and mortgages receivable, net 1,014 -
Available for sale securities 953 -
Goodwill and other intangible assets 8,498 -
Prepaid and other assets 201 114
---------------------- ----------------------
TOTAL ASSETS $ 27,025 $ 206
====================== ======================
LIABILITIES AND STOCKHOLDERS' EQUITY:
Warehouse lines of credit $ 13,741 $ -
Notes payable 2,269 -
Notes payable - related party 1,175 -
Convertible debentures payable 38 34
Accounts payable and accrued liabilities 815 177
Accrued expenses related party 59 204
Accrued expense - other 651 -
Derivative liability 280 -
Related party debt subsequently converted to preferred stock - 659
---------------------- ----------------------
TOTAL LIABILITIES 19,028 1,074
STOCKHOLDERS' EQUITY:
Preferred stock: Issuable in series, $0.0001 par value; 5,000,000 shares
authorized: Series E, $1,000 stated value; 2,459 and no shares issued
and outstanding, respectively - -
Common stock: $0.0001 par value; 400,000,000 shares authorized; 116,396,478
and 62,592,744 shares issued and outstanding, respectively 11 6
Additional paid-in capital 11,776 1,693
Retained earnings (3,771) (2,567)
Unearned stock based compensation (115) -
Accumulated other comprehensive income 96 -
---------------------- ----------------------
Total stockholders' equity 7,997 (868)
---------------------- ----------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 27,025 $ 206
====================== ======================
* Condensed from audited financial statements.
See accompanying notes to condensed consolidated financial statements.
2
PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED INCOME STATEMENTS (UNAUDITED)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2003 2002 2003 2002
---- ---- ---- ----
REVENUE:
Gain on sale of loans $ 2,246 $ - $ 2,945 $ -
Loan origination fees 1,670 - 2,546 -
Interest, dividend and other income 398 - 669 -
--------------- -------------- --------------- ----------------
Total revenue 4,314 - 6,160 -
--------------- -------------- --------------- ----------------
EXPENSES:
Salaries, commission, and benefits 2,463 203 4,048 532
Loan production costs 470 - 717 -
General and administrative 1,204 229 1,874 289
Interest 423 - 682 -
Realized loss on derivative 38 63
Unrealized gain on derivative (3) (20)
--------------- -------------- --------------- ----------------
Total expenses 4,595 432 7,364 821
--------------- -------------- --------------- ----------------
Net income $ (281) $ (432) $(1,204) $ (821)
=============== ============== =============== ================
Net income (loss) per common share - basic
and diluted $ (0.00) $ (0.01) $ (0.01) $ (0.02)
=============== ============== =============== ================
Weighted average number of shares
outstanding - basic and diluted 116,146 42,804 106,961 39,106
=============== ============== =============== ================
See accompanying notes to condensed consolidated financial statements.
3
PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2003 JUNE 30, 2002
------------------- --------------------
Operating activities:
Net loss $ (1,204) $ (821)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 125 1
Non-cash stock based compensation 10 261
Non-cash interest expense converted to preferred stock 13 -
Provision for loan repurchases and premium recapture 274 -
Funding of mortgage loans held for sale or as other notes and mortgages (113,405) -
Proceeds from sale of mortgage loans held for sale 123,026 -
Decrease in warehouse lines of credit (9,576) -
Increase in derivative liability 55 -
Increase in net other assets (250) (5)
Increase in net other liabilities 252 376
------------------- --------------------
Net cash used in operating activities (680) (188)
------------------- --------------------
Investing activities:
Purchases of equipment and improvements (322) (2)
Cash acquired in purchases of businesses 205 -
Purchases of marketable equity securities (249) -
Proceeds from the sale of websites 48 -
------------------- --------------------
Net cash used in investing activities (318) (2)
------------------- --------------------
Financing activities:
Proceeds from the sale of common stock - 394
Proceeds from the sale of warrants 13 -
Proceeds from the issuance of debentures 231 -
Borrowings under loans from related parties 1,175
Borrowings under promissory note 135
------------------- --------------------
Net cash provided by financing activities 1,554 394
------------------- --------------------
Net increase in cash and cash equivalents 556 204
Cash and cash equivalents at beginning of period 91 -
------------------- --------------------
Cash and cash equivalents at end of period $ 647 $ 204
=================== ====================
See accompanying notes to condensed consolidated financial statements.
4
PARAGON FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
1. PRINCIPLES OF CONSOLIDATION, BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING
POLICIES
Principles of Consolidation
- ---------------------------
The accompanying condensed consolidated financial statements include
the financial statements of our wholly owned subsidiaries, PNGF Home Lending
Corp. (formerly known as Mortgage Express, Inc. and referred to as "PGNF" in
this Form 10-Q) and Paragon Homefunding, Inc. (referred to as "Paragon Florida"
in this Form 10-Q). All material intercompany balances and transactions are
eliminated in consolidation. The condensed consolidated financial statements
have been prepared in conformity with accounting principles generally accepted
in the United States of America.
Basis of Presentation
- ---------------------
The accompanying condensed consolidated financial statements of Paragon
Financial Corporation and subsidiaries (referred to herein sometimes as "we",
"our" or the "Company") are prepared in accordance with the Securities and
Exchange Commission's rules regarding interim financial statements, and
therefore do not contain all disclosures required by accounting principles
generally accepted in the United States of America for annual financial
statements. Reference is made to the financial statements included in our Annual
Report on Form 10-K for the year ended December 31, 2002. Certain previously
reported amounts have been reclassified to conform to the current period's
presentation. Such reclassifications had no effect on net loss or shareholders'
equity.
The condensed consolidated balance sheet as of June 30, 2003 and the
condensed consolidated statements of operations and cash flows for the three and
six month periods ended June 30, 2003 and 2002 are unaudited and include all
adjustments (consisting only of normal recurring accruals) which management
considers necessary for a fair presentation of our financial position as of June
30, 2003 and our operating results and cash flows for the three and six month
periods ended June 30, 2003 and 2002. The results of operations for the three
and six months ended June 30, 2003 and 2002 are not necessarily indicative of
the results to be expected for the full year.
The results of operations for the three and six months ended June 30,
2002 have been restated to include an adjustment of professional fees in the
three months ended June 30, 2002. For information on our restated quarterly
results of operations for the year ended December 31, 2002, please refer to
footnote 8 to the financial statements included in our Annual Report on Form
10-K for the year ended December 31, 2002.
Due to our recent acquisitions, we are no longer considered a
development stage enterprise.
Significant Accounting Policies
- -------------------------------
Use Of Estimates. In preparing financial statements in conformity with generally
accepted accounting principles, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements and revenues and expenses during the reporting period. Actual results
could differ from those estimates.
5
Financial Statement Presentation. We prepare our financial statements using an
unclassified balance sheet presentation as is customary in the mortgage banking
industry. We operate under two business segments: wholesale and retail.
Cash and Cash Equivalents. For purposes of the statements of cash flows, we
consider all highly-liquid debt instruments with maturities when purchased of
three months or less to be cash equivalents. Cash equivalents consist of cash on
hand and cash due from banks.
Mortgage Loans Receivable Held for Sale. Mortgage loans receivable held for sale
are stated at the lower of amortized cost or fair value as determined by
outstanding commitments from investors or current investor-yield requirements,
calculated on an aggregate basis. Interest on loans receivable held for sale is
credited to income as earned. Interest is accrued only if deemed collectible.
Gain on Sales of Loans. Gains or losses resulting from sales of mortgage loans
are recognized at the date of settlement and are based on the difference between
the selling price of the mortgage loans sold and the carrying value of the
related loans sold. Nonrefundable fees and direct costs associated with the
origination of mortgage loans are deferred and recognized when the loans are
sold. Loan sales are accounted for as sales when control of the loans is
surrendered.
Origination Fees. Origination fees are comprised of points and other fees
charged on mortgage loans originated by our retail channel. Retail points and
fees are primarily a function of the volume of mortgage loans originated by our
retail channel. Origination fees on loans originated by our retail channel which
are subsequently sold are deferred and recognized as part of the gain on sale of
loans.
Derivatives. As a result of our merger with PGNF, we have a derivative
instrument. SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, obligates us to record all derivatives at fair value and permits us
to designate derivative instruments as being used to hedge changes in fair value
or changes in cash flows. Changes in the fair value of derivatives that offset
changes in cash flows of hedged items are recorded initially in other
comprehensive income. Amounts recorded in other comprehensive income are
subsequently reclassified into earnings during the same period in which the
hedged item affects earnings. If a derivative qualifies as a fair value hedge,
then changes in fair value of the hedging derivative are recorded in earnings
and are offset by changes in fair value attributable to the hedged risk of the
hedged item. Any portion of the change in the fair value of derivatives
designated as hedge that is deemed ineffective is recorded in earnings along
with changes in the fair value of derivatives with no hedge designation.
Allowance for loan repurchases and premium recapture. The allowance for loan
repurchases and premium recapture relates primarily to the potential repurchase
of loans or indemnification of losses based on alleged violations of
representations and warranties which are customary to the mortgage banking
industry. We purchase fraud insurance on the loans originated by our wholesale
segment to mitigate this risk. The allowance represents our estimate of the
total uninsured losses expected to occur and is considered to be adequate.
Provisions for losses are charged to gain on sale of loans and credited to
mortgage loans receivable held for sale.
Office Property and Equipment. Property and equipment are carried at cost less
accumulated depreciation. Upon disposal of property and equipment, the
appropriate accounts are reduced by the related cost and accumulated
6
depreciation. The resulting gains and losses are reflected in consolidated
earnings. Depreciation is computed using the straight-line method over the
estimated lives of the related assets.
Advertising. Our advertising costs are expensed as incurred.
Available-for-sale securities. Available-for-sale securities consist of
securities not classified as trading or held-to-maturity. Unrealized holding
gains and losses, net of tax, on available-for-sale securities are reported as a
net amount in a separate component of shareholders' equity until realized.
Realized gains and losses on the sale of available-for-sale securities are
determined using the specified identification method. Declines in the fair value
of individual held-to-maturity and available-for-sale securities below cost or
amortized cost that are other than temporary result in write downs of the
individual securities to their fair value as a new cost basis. The related
write-downs are included in earnings as realized losses. Premiums and discounts
are recognized in interest income using the interest method over the period to
maturity.
Stock Based Compensation.
Stock-Based Compensation. We have elected to follow Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25"), and
related interpretations, in accounting for employee stock options rather than
the alternative fair value accounting allowed by FASB Statement No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123"). APB 25 provides that
compensation expense relative to our employee stock options is recorded on the
date of grant only if the current market price of the underlying stock exceeds
the exercise price. Under SFAS 123, the fair value of stock options at the date
of grant is recognized in earnings over the vesting period of the options. In
December 2002, FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure" ("SFAS 148"), which amends SFAS 123 to
provide alternative methods of transition for a voluntary change to the fair
value method of accounting for stock-based employee compensation. In addition,
SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent
disclosures in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the method on
reported results. We will continue to report stock based compensation under
APB25 but have adopted the interim reporting requirements of SFAS 148.
As of June 30, 2003, there were stock options outstanding for the
purchase of 38,442,900 shares of our common stock. There were options to
purchase 15,009,900 shares of our common stock granted during the quarter ended
June 30, 2003. We also rescinded options to purchase 5,000,000 shares of our
common stock during the quarter ended June 30, 2003. The following table shows
the pro forma net loss as if the fair value method of SFAS No. 123 had been used
to account for stock-based compensation expense (dollars in thousands, except
per share amounts):
SIX MONTHS ENDED
------------------------------
JUNE 30, JUNE 30,
2003 2002
------------- -------------
Net loss, as reported $ (1,204) $ (821)
Stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax effects 315 -
------------- -------------
7
------------- -------------
Pro forma net loss $(1,519) $(821)
Net loss per share:
Basic and diluted, as reported $ (0.00) $ (0.02)
Pro forma basic and diluted $ (0.01) $ (0.02)
On May 12, 2003, we issued a total of 250,000 restricted shares of our
common stock valued at $125,000 to a consulting firm and its owner. The
restricted shares vest over a two year period, and we incur a non-cash charge of
$5,208 per month as a result of the issuance of these restricted shares.
On May 14, 2003, we issued 1,000,000 options to purchase shares of our
common stock at an exercise price of $0.60 per share to a consultant. The fair
value of these options on the date of grant using the Black-Scholes model was
$160,509, and we incur a non-cash charge of $6,688 per month as a result of the
issuance of these options.
2. ACQUISITIONS AND GOODWILL
On January 31, 2003, we completed our merger with PGNF, and as a result
of the merger, PGNF became a wholly owned subsidiary of ours. PGNF has been in
the business of originating residential mortgage loans since 1998. Subject to
the terms of the merger agreement, at closing, all of the outstanding shares of
PGNF's common stock converted into 52,329,735 shares of our common stock valued
at $6.4 million (or approximately $0.122 per share), or approximately 45.5% of
the then outstanding common stock after the consummation of the merger.
Additionally, we issued a promissory note in the amount of $1.8 million to an
entity wholly owned by the sole shareholder of PGNF. The promissory note accrued
interest at 4.92% and was payable on July 31, 2004. Our payment obligations
under the promissory note were secured by a security interest in the PGNF shares
of common stock that we own. On March 26, 2003, the holder of this note agreed
to convert the note into 1,800 shares of our Series E preferred stock with a
face value of $1,000 per share, and a 4% stated dividend payable in cash or
shares of common stock, at the Company's option. This series of preferred stock
does not provide for redemption and is non-voting.
On February 2, 2003 we completed our merger with Paragon Florida.
Subject to the terms of the merger agreement, at closing, all of the outstanding
shares of Paragon Florida's common stock converted into 1,224,000 of shares of
our common stock valued at $836,000 (approximately $0.6833 per share).
Additionally, we issued promissory notes to the shareholders of Paragon Florida
in the aggregate principal amount of $25,000. The promissory notes accrue
interest at 4.92% and are payable on February 2, 2004. Paragon Florida has been
in the business of originating residential mortgage loans since 1998.
Both of these mergers were accounted for as acquisitions pursuant to
SFAS No. 141, Accounting for Business Combinations ("SFAS 141"). Accordingly,
our results of operations include the operating results of these companies from
the effective date of these mergers, February 1, 2003. As a result of these
mergers, we had initially recorded goodwill and other specifically identified
intangible assets of $8.1 million which represented the excess of the purchase
price over the initial estimated fair values of the tangible, financial and
intangible assets acquired and liabilities assumed at date of acquisition.
Subsequently, we have recorded $339,000 of additional goodwill related to our
acquisition of PGNF due to loan repurchases and premium recapture on loans sold
prior to our acquisition of PGNF. We continue to evaluate the estimates of the
fair values of the assets acquired and liabilities assumed. The final fair
values allocated to the assets acquired,
8
including specifically indentifiable intangibles other than goodwill,
liabilities assumed and goodwill may differ materially from our current
estimate. SFAS No. 142, Accounting for Goodwill and Intangible Assets,
eliminated the requirement to amortize goodwill through a periodic charge to
earnings. We will evaluate goodwill and any other specifically identified
intangible assets on an periodic basis for impairment based upon the estimated
fair value as of the balance sheet date.
Our unaudited consolidated results of operations on a pro forma basis
as if we had consummated the mergers with PGNF and Paragon Florida on January 1,
2002 are as follows:
SIX MONTHS ENDING
--------------------------------------
JUNE 30, 2003 JUNE 30, 2002
----------------- -----------------
Revenues $8,429 $5,995
Net income (loss) $ (37) $ (83)
Diluted earnings (loss) per share $ (0.00) $ (0.00)
Weighted average shares - diluted 125,353 96,358
3. GOING CONCERN
We have sustained operating losses since inception. At June 30, 2003, our
shareholders' equity was $8.0 million due primarily to the issuance of equity
securities as a result of our acquisitions of PGNF and Paragon Florida which
resulted in recognition of $8.5 million in goodwill. We incurred a net loss of
$1.2 million and used $680,000 of cash in operations during the six months ended
June 30, 2003. These factors raise substantial doubt about our ability to
continue as a going concern. The accompanying financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
Management believes that, with the mergers with PGNF and Paragon Florida, it has
taken the steps necessary to reverse the negative trend. Our continued existence
depends on a number of factors, including but not limited to, our ability to
secure adequate sources of capital and locate and fund acquisitions of suitable
companies. However, there can be no assurance we will be able to continue as a
going concern.
4. COMPREHENSIVE INCOME (LOSS)
The components of comprehensive income (loss) for the three and six
months ended June 30, 2003 are listed below (dollars in thousands):
THREE MONTHS SIX MONTHS
JUNE 30, 2003 JUNE 30, 2003
Net loss as reported $ (281) $ (1,204)
Other Comprehensive Income (Loss):
Unrealized gain on available for sale
Securities 97 96
----------------- -----------------
Total Comprehensive Loss $ (184) $ (1,108)
================= =================
9
5. CONCENTRATIONS OF RISK
Our ability to continue to originate loans is dependent, in part, upon
our ability to sell loans in the secondary market in order to generate cash
proceeds for new originations. The value of and market for our loans is
dependent upon a number of factors, including general economic conditions,
interest rates and governmental regulations. Adverse changes in such factors may
affect our ability to sell loans for acceptable prices within reasonable periods
of time.
6. MORTGAGE LOANS RECEIVABLE HELD FOR SALE
Mortgage loans receivable held for sale includes certain employee costs
and loan production costs which, pursuant to SFAS No. 91, have been deferred and
added to the basis of mortgage loans receivable held for sale. These capitalized
costs are offset against net gains on mortgage loan sales and fees when the
loans are sold or amortized as yield adjustment in the case of loans held for
investment. A summary of mortgage loans receivable held for sale, at the lower
of cost or market at June 30, 2003 follows (dollars in thousands):
Mortgage loans receivable held for sale $13,945
Allowance for loan repurchases and premium
Recapture (234)
Net deferred origination costs 327
----------------
$14,038
================
7. DEBENTURES AND WARRANTS
On March 6, 2003, we completed a private offering of 379 units
consisting of (i) a $1,000 convertible promissory note due December 31, 2003
with interest payable quarterly at a stated interest rate of 15% per annum and
(ii) a warrant to purchase shares of common stock, exercisable at $0.25 per
share, for each $5.00 in principal of the promissory note issued in the unit.
The holder has the right to convert the outstanding principal amount of the
convertible promissory note (or any portion thereof), together with accrued
interest thereon, into shares of our common stock at a conversion price of $0.25
per share, subject to standard anti-dilution adjustments as specified in the
note.
Over the course of the offering, our common stock was trading above the
conversion price. This difference has resulted in the recognition of a
beneficial conversion feature and, accordingly, a portion of the proceeds from
each convertible note has been credited to additional paid-in capital.
Cumulatively, we raised $354,000 in cash and paid $25,000 in legal
services to our company counsel. We allocated $20,000, $321,000 $38,000 of the
proceeds to the warrants, beneficial conversion feature and debenture values,
respectively. Based upon these allocations, the overall effective interest rate
on this offering is approximately 1016%.
8. WAREHOUSE LINES OF CREDIT
Our subsidiary, PGNF, has mortgage warehouse facilities with commercial
banks aggregating $50 million. These credit facilities are used to fund mortgage
loans and are collateralized by the mortgage loans
10
funded. These warehouse facilities do require compensating balances totaling
$10,000. Warehouse lines of credit consist of the following at June 30, 2003
(dollars in thousands):
$5 million mortgage warehouse credit facility at a commercial bank; interest at
Prime plus 2%. This credit facility expires on June 30, 2004. $ 1,221
$20 million mortgage warehouse credit facility with a $15 million sublimit for
non-bank approved product at a commercial bank; interest at Prime plus 1.5%.
This credit facility expired on July 31, 2003 and subsequently renewed to July 31, 2004. 11,742
$10 million mortgage warehouse credit facility at a commercial bank; interest at
Prime plus 1.5%. This credit facility expires on June 30, 2004. 309
$10 million mortgage warehouse credit facility at a commercial bank; interest at
Libor plus 2.25%. This credit facility was terminated on July 18, 2003. 469
$5 million mortgage warehouse credit facility at a commercial bank; interest at
Prime plus 1%. This credit facility expires December 31, 2003. -
-----------------------
$13,741
=======================
All of the PGNF's warehouse lines contain provisions whereby the
lender can terminate their agreement without cause with certain notice
requirements. The Company's management believes the warehouse relationships will
remain in place until maturity; however, there is no assurance that one or more
of the lenders will not terminate their agreements prior to maturity, or that
additional lines will be negotiated when existing lines terminate. Either
occurrence would adversely affect our ability to originate loans.
9. SEGMENT DATA
We provide a broad range of mortgage products through our wholesale and
retail segments. Management measures the revenue streams of each of our lending
segments separately. The table below provides revenue and expense data by
business segment for the six months ended June 30, 2003 (dollars in thousands).
WHOLESALE RETAIL CORPORATE TOTAL
------------- ------------ ------------ --------------
Mortgage loans closed $111,307 $147,235 $ - $ 258,542
============= ============ ============ ==============
Revenues:
Gain on sale of loans $ 2,546 $ 399 $ - $ 2,945
Loan origination fees - 2,546 - 2,546
Interest, dividend and other income 630 39 - 669
------------- ------------ ------------ --------------
Total revenues 3,176 2,984 - 6,160
------------- ------------ ------------ --------------
Expenses:
Salaries and benefits 1,644 1,974 430 4,048
Loan production costs 206 511 - 717
General and administrative expenses 910 448 517 1,875
Interest expense and other expenses 473 42 209 724
------------- ------------ ------------ --------------
Total expenses 3,233 2,975 1,156 7,364
------------- ------------ ------------ --------------
Net income (loss) $ (57) $ 9 $ (1,156) $(1,204)
============= ============ ============ ==============
11
10. PREFERRED STOCK
On March 26, 2003, our board of directors authorized the issuance of Series E
preferred stock. Our Series E preferred stock has a stated value of $1,000 per
share and provides for a mandatory dividend equal to 4% of the stated value per
annum. The Series E preferred stock is non-voting, is not redeemable and has no
conversion rights.
On March 26, 2003, the holder of the $1.8 million note issued as part of the
consideration for the PGNF acquisition converted this note, including $14,000 in
accrued interest, into 1,800 shares of Series E preferred stock. On March 26,
2003, our executive officers converted $659,000 due them for deferred salaries,
benefits and other items into 659 shares of Series E preferred stock. At June
30, 2003, the cumulative dividend due on this Series E preferred stock was
$25,870.
11. COMMITMENTS AND CONTINGENCIES
Minimum Operating Lease Commitments
- -----------------------------------
The Company is party to real estate leases for its corporate headquarters and
operations locations in Westmont, IL and Olrando, FL.
Employment Agreements
- ---------------------
At June 30, 2003, the Company is party to several employment contracts with
certain members of management. These contracts are for varying periods and
include standard provisions for restrictions on competition after termination.
These agreements provide for salaries, bonuses and other benefits and also
specify and delineate the granting of various stock options.
Litigation
- ----------
In March, April and May 2001, the Company, and its former directors David M.
Beirne, Michael Mortiz, William J. Razzouk and Christos M. Cotsakos and its
former Chief Financial Officer, Steve Valenzuela were named as defendants in
class action complaints alleging violations of the federal securities laws in
the United States District Court for the Southern District of New York. The
complaints against the Company have been consolidated into a single action and a
Consolidated Amended Complaint, which is now the operative complaint, was filed
on April 19, 2002.
The purported class action alleges violation of Sections 11 and 15 of the
Securities Acts of 1933 and Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934 and Rule 10b-5 promulgated thereunder. The essence of the complaint
is that the defendants issued and sold the Company's common stock pursuant to a
registration statement for its October 7, 1999 initial public offering ("IPO")
without disclosing to investors that certain underwriters in the offering had
solicited and received excessive and undisclosed commissions from certain
investors. The complaint also alleges that the registration statement failed to
disclose that the underwriters allocated Company shares in the IPO to customers
in exchange for the customers' promises to purchase additional shares in the
aftermarket at pre-determined prices above the IPO price, thereby maintaining,
distorting and/or inflating the market price for the shares in the aftermarket.
The action seeks damages in an
12
unspecified amount.
The action is being coordinated with approximately three hundred other nearly
identical actions filed against other companies. On July 15, 2002, the Company
moved to dismiss all claims against it and the individual defendants. On
February 19, 2003, the Court denied the motion to dismiss the complaint against
the Company. The Court dismissed the Section 10(b) claim against the individual
defendants, but denied the motion to dismiss the Section 11 claim and the
Section 15 and 20(a) control person claims against the individual defendants.
The Company has approved a Memorandum of Understanding ("MOU") and related
agreements which set forth the terms of a settlement between the Company and the
plaintiff class. Thus far, 289 of the companies sued in nearly identical actions
have also approved the MOU and related agreements. The MOU and related
agreements are subject to a number of contingencies, including the negotiation
of a settlement agreement and approval by the Court. We cannot opine as to
whether or when a settlement will occur or be finalized. Whether or not the
settlement is ultimately approved, we believe the resolution of this matter will
not have a material adverse effect on the Company.
On June 19, 2001, vTraction, Inc. filed a complaint for breach of contract in
the Chancery Court of Tennessee for the Thirtieth Judicial District at Memphis
alleging that the Company entered into an oral agreement with vTraction to sell
certain equipment and later reneged, and claiming damages in an amount
including, but not limited to, the difference between the price agreed to in the
alleged oral contract and the market price of the equipment. The Company has
filed an answer asserting the affirmative defenses of failure of consideration
and statute of frauds and denying the existence of an oral contract. At this
time, the Company does not believe this matter will have a material impact on
its financial position, operations or liquidity.
12. NEW ACCOUNTING PRONOUNCEMENTS
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)" (EITF 94-3). The
principal difference between SFAS No. 146 and EITF 94-3 relates to SFAS No.
146's requirements for recognition of a liability for a cost associated with an
exit or disposal activity. SFAS No. 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when the liability is
incurred. Under EITF 94-3, a liability for an exit cost as generally defined in
EITF 94-3 was recognized at the date of an entity's commitment to an exit plan.
We adopted the new standard effective January 1, 2003. The adoption of SFAS No.
146 did not have a material impact on our results of operations, financial
position or cash flows.
In November 2002, the FASB issued FASB Interpretation No. 45,
"Guarantor's Accounting Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others". The interpretation elaborates on
the disclosures to be made by a guarantor in its financial statements under
certain guarantees that is has issued. It also clarifies that a guarantor is
required to recognize, at the inception of a guarantee, a liability for the fair
value of the obligation undertaken in issuing the guarantee. We adopted the
disclosure requirements of the Interpretation as of December 31, 2002, the date
upon which they became effective. These provisions of the Interpretation require
disclosure of the nature of the guarantee, the maximum potential amount of
future payments that the guarantor could be required to make under the
guarantee, and the current amount of the liability, if any, for the guarantor's
obligations under the guarantee. The recognition requirements of the
13
Interpretation were effective January 1, 2003. The implementation of the
recognition requirements of the Interpretation did not have a material impact on
our results of operations, financial position or cash flows.
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities". This interpretation provides
guidance with respect to the identification of variable interest entities and
when assets, liabilities, noncontrolling interests, and the results of
operations of a variable interest entity need to be included in a company's
consolidated financial statements. The Interpretation requires consolidation by
business enterprises of variable interest entities in cases where the equity
investment at risk is not sufficient to permit the entity to finance its
activities without additional subordinated financial support from other parties,
which is provided through other interests that will absorb some or all of the
expected losses of the entity, or in cases where the equity investors lack one
or more of the essential characteristics of a controlling financial interest,
which include the ability to make decisions about the entity's activities
through voting rights, the obligation to absorb the expected losses of the
entity if they occur, or the right to receive the expected residual returns of
the entity if they occur. The Interpretation applies immediately to variable
interest entities created after January 31, 2003, and to variable interest
entities in which an enterprise obtains an interest after that date. We are
currently assessing the impact that the Interpretation will have on our
consolidated financial position and consolidated results of operations and do
not believe this Interpretation will have a material impact on our results of
operations, financial position or cash flows.
13. SUPPLEMENTAL CASH FLOW INFORMATION
FOR THE SIX MONTHS ENDED
------------------------------------------------
JUNE 30, 2003 JUNE 30, 2002
---------------------- --------------------
Cash interest paid $ 511 $ -
Non-cash investing and financing activities:
Consideration for purchases of businesses $9,028 $ -
Non-cash effect of merger, assumption of certain
liabilities $ - $61
14. INCOME TAXES
We utilize an asset and liability approach in our accounting for income
taxes. This approach requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of temporary differences
between the financial statement and tax basis carrying amounts of assets and
liabilities. Our results of operations do not recognize a tax benefit on the net
operating losses incurred in the three month periods ended June 30, 2003 and
2002.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Special Note Regarding Forward-Looking Information
- --------------------------------------------------
Certain information contained in this Report may include
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995, and is subject to the safe harbor created by that
act. We caution readers that certain important factors may affect our actual
results and could cause such results to differ materially from any
forward-looking statements which may be deemed to have been made in this Report
or which are otherwise made by or on behalf of us. For this purpose, any
statements contained in this Report that are not statements of historical fact
may be deemed to be forward-looking statements. Without limiting the generality
of the foregoing, words such as "may," "will," "expect," "believe," "explore,"
"consider," "anticipate," "intend," "could," "estimate," "annualized," "plan,"
or "continue" or the negative variations of those words or comparable
terminology are intended to identify forward-looking statements. Factors that
may affect our results include, but are not limited to the risks and
uncertainties associated with:
- our ability to raise capital necessary to sustain our operations and
to implement our business plan,
- our ability to obtain regulatory permits and approvals to continue
operating in the financial services area,
- our ability to identify and complete acquisitions and successfully
integrate the businesses we acquire, if any,
- changes in the real estate market, interest rates or the general
economy of the markets in which we operate,
- our ability to employ and retain qualified management and employees,
- changes in government regulations that are applicable to our
businesses,
- general volatility of the capital markets and the maintenance of a
market for our shares,
- changes in the demand for our services,
- the degree and nature of our competition,
- our ability to generate sufficient cash to pay our creditors, and
- disruption in the economic and financial conditions primarily from
the impact of past terrorist attacks in the United States, threats of
future attacks, police and military activities overseas and other
disruptive worldwide political events.
We are also subject to other risks detailed from time to time in our
Securities and Exchange Commission filings. Any one or more of these
uncertainties, risks and other influences could materially affect our results of
operations and whether forward-looking statements made by us ultimately prove to
be accurate. Our actual results, performance and achievements could differ
materially from those expressed or implied in these
15
forward-looking statements. We undertake no obligation to publicly update or
revise any forward-looking statements, whether from new information, future
events or otherwise.
GENERAL
We are headquartered in Ponte Vedra Beach, Florida and were
incorporated in Delaware in August 1999. We are a mortgage banker and mortgage
broker in the one-to-four family residential mortgage market. We conduct
business in 24 states and the District of Columbia.
We originate loans through our wholesale and retail divisions.
Wholesale loans are originated through independent mortgage brokers by the
Wholesale Division of our subsidiary, PGNF. After originating we then sell those
loans.
Our retail division originates loans direct to the consumer at our
locations in Illinois and Florida. By creating a direct relationship with the
borrower, retail lending provides a more sustainable loan origination franchise
and greater control over the lending process. The loan origination fees
contribute to profitability and cash flow and offset the higher costs of retail
lending.
MARKET CONDITIONS
The financial services industry, including the markets in which we
operate, is highly competitive. Competition is based on the type of loan,
interest rates, and service. Traditional competitors in the financial services
industry include commercial banks, credit unions, thrift institutions, credit
card issuers, consumer and commercial finance companies, and leasing companies.
While we face significant competition in connection with our mortgage loan
products, we believe that we compete effectively in our markets by providing
competitive rates and efficient, complete services.
SEASONALITY
The mortgage banking industry is generally subject to seasonal trends.
These trends reflect the general national pattern of sales and resales of homes,
although refinancings tend to be less seasonal and more closely related to
changes in mortgage interest rates. Sales and resales of homes typically peak
during the spring and summer seasons and decline to lower levels from
mid-November through February. In addition, mortgage delinquency rates typically
rise temporarily in the winter months.
CRITICAL ACCOUNTING POLICIES
We have established various accounting policies which govern the
application of accounting principles generally accepted in the United States of
America in the preparation of our financial statements. Our significant
accounting policies are described in Footnote 1 to the Condensed Consolidated
Financial Statements, beginning on page 5. Certain accounting policies require
us to make significant estimates and assumptions that may have a material impact
on certain assets and liabilities, as well as our operating results, and we
consider these to be critical accounting policies. The estimates and assumptions
we use are based on historical experience and other factors which we believe to
be reasonable under the circumstances. Actual results could differ materially
from these estimates and assumptions, which could have a material impact on the
carrying value of assets and liabilities and our results of operations.
16
We believe the following are critical accounting policies that require
the most significant estimates and assumptions that are subject to significant
change in the preparation of our consolidated financial statements:
- Provision for loan repurchases and premium recapture.
- Gain on sale of loans.
- Income taxes.
RESULTS OF OPERATIONS - THREE MONTHS ENDED JUNE 30, 2003 AND MARCH 31, 2003
The discussion below should be read in conjunction with the Paragon
Financial Corporation and Subsidiaries (the "Company", "we", "our" or "us")
Unaudited Condensed Consolidated Financial Statements and Notes appearing
elsewhere in this report. The results of operations for PGNF and Paragon Florida
are included since February 1, 2003, the effective date of our mergers with
them.
For the three and six months ended June 30, 2002, we were a development
stage company and reported no revenues. As a result, an analysis of the three
and six months ended June 30, 2003 to the three and six months ended June 30,
2002, is not releveant, and we have elected to discuss the results of operations
and analysis of financial condition below for the three months ended June 30,
2003 compared to the three months ended March 31, 2003. The table below sets
forth information regarding the components of the Company's revenue and expenses
for the three months ended June 30, 2003 and March 31, 2003.
THREE MONTHS ENDED
-----------------------------------------
JUNE 30, 2003 MARCH 31, 2003
-----------------------------------------
(DOLLARS IN THOUSANDS)
LOAN ORIGINATION VOLUME:
Wholesale $ 76,026 $35,281
Retail 96,152 51,083
------------------ -------------------
TOTAL LOAN ORIGINATION VOLUME $ 172,178 $86,364
================== ===================
LOAN SALES $ 72,040 $41,671
================== ===================
REVENUES:
Gain on sale of loans $ 2,246 $ 699
Origination fees 1,670 876
Interest, dividend and other income 398 271
------------------ -------------------
Total revenue 4,314 1,846
------------------ -------------------
EXPENSES:
Salaries, commission, and benefits 2,463 1,585
Loan production costs 470 247
General and administrative 1,204 670
Interest 423 259
Realized loss on derivative 38 25
Unrealized gain on derivative (3) (17)
------------------ -------------------
Total expenses 4,595 2,769
------------------ -------------------
NET INCOME $ (281) $ (923)
================== ===================
Total Loan Originations. Total loan originations increased $85.8 million, or
99.4%, to $177.2 million for the
17
three months ended June 30, 2003 compared to $86.4 million for the three months
ended March 31, 2003. Of this increase, $38.0 million, or 44.3% of the increase,
relates to loan production volume for the month of January 2003 which occurred
prior to our acquisition of PGNF and Paragon Florida, both effective February 1,
2003, and is not included in the amounts in the table above, and $47.8 million
of the increase, or 55.7%, relates to internal growth in our loan originations.
Wholesale Loan Originations. Wholesale loan origination increased $40.7 million,
or 115.5%, to $76.0 million for the three months ended June 30, 2003 compared to
$35.3 million for the three months ended March 31, 2003. Of this increase, $19.0
million, or 46.7%, relates to wholesale loan origination for the month of
January 2003 which occurred prior to our acquisition of PGNF and Paragon
Florida, both effective February 1, 2003, and is not included in the amounts
above, and $21.7 million, or 53.3%, relates to internal growth in our wholesale
loan originations.
Retail Loan Originations. Retail loan origination increased $45.1 million, or
88.2%, to $96.2 million for the three months ended June 30, 2003 compared to
$51.1 million for the three months ended March 31, 2003. Of this increase, $19.0
million, or 42.1%, relates to retail loan origination for the month of January
2003 which occurred prior to our acquisition of PGNF and Paragon Florida, both
effective February 1, 2003, and is not included in the amounts above, and $26.1
million, or 57.9%, relates to internal grwoth in our retail loan originations.
Loan Sales. As a fundamental part of our business and financing strategy, we
sell mortgage loans to third party investors in the secondary markets as market
conditions allow. Generally, we seek to dispose of all of our loan production
within 30 days. We apply the net proceeds of the loan sales to pay down our
warehouse facilities in order to make capacity available for future funding of
mortgage loans.
Loan sales increased $30.4 million, or 72.9%, to $72.0 million for the three
months ended June 30, 2003 compared to $41.7 million for the three months ended
March 31, 2003. Of this increase, $27.3 million, or 90%, relates to loan sales
completed in January 2003 which occurred prior to our acquisitions of PGNF and
Paragon Florida, and is not included in the amounts above, and $3.1 million, or
10%, relates to internal growth in our loan sales.
REVENUE
Gain on Sale of Loans. Gain on sale of loans increased $1.55 million, or
221.3%, to $2.25 million for the three months ended June 30, 2003 compared to
$699,000 for the three months ended March 31, 2003. Of this increase $685,000,
or 44.3%, of the increase was due to internal growth in the volume of loans sold
in the three months ended June 30, 2003 compared to the three months ended March
31, 2003, while $861,000, or 55.7%, relates to loans sold in January 2003 which
ocurred prior to our acquisitions of PGNF and Paragon Florida and were not
included in our operating results for the three months ended March 31, 2003.
The gain on sale of loans is net of a provision for loan losses,
repurchases and premium recapture of $245,000 for the three months ended June
30, 2003 compared to a provision of $37,000 for the three months ended March 31,
2003. The increase in the provision is due to the increased volume of loan sales
in the three months ended June 30, 2003 as compared to the three months ended
March 31, 2003.
Origination Fees. Origination fees increased $794,000, or 90.6% to $1.67 million
in the three months ended June 30, 2003 compared to $876,000 in the three months
ended March 31, 2003. This increase was due to higher retail loan origination
volume in the three months ended June 30, 2003 as compared to the three months
ended March 31, 2003. $414,000, or 52.1%, of the increase was due to fees earned
in January 2003 which ocurred prior to our acquisitions of PGNF and Paragon
Florida and were not included in our operating results for the three months
ended March 31, 2003. $380,000, or 47.9%, relates to internal growth in
origination volume in the three months ended June 30, 2003 compared to the three
months ended March 31, 2003. Expressed as a percentage of retail loan
origination volume, origination fees were 1.74% of retail loan originations in
the three months ended June 30, 2003 compared to 1.71% in the three months ended
March 31, 2003.
Interest, dividend and other income. Interest, dividend and other income
increased $127,000, or 46.9%, to $398,000 for the three months ended June 30,
2003 compared to $271,000 for the three months ended March 31, 2003. The
interest, dividend and other income relates to the income earned at our
subsidiaries PGNF and Paragon Florida. The increase is due to there being three
months interest, dividend and other income in for the
18
period ended June 30, 2003 and only two months of interest, dividend and other
income in the period ended March 31, 2003 due to the effective dates of our
acquisitons of PGNF and Paragon Florida.
EXPENSES
Salaries, commissions and benefits. Salaries, commissions and benefits increased
$879,000, or 55.4%, to $2.46 million for the three months ended June 30, 2003
compared to $1.59 million for the three months ended March 31, 2003. The
increase is due primarily to there being three months' salaries, commission and
benefits for PGNF and Paragon Florida in the period ended June 30, 2003 and only
two months of salaries, commission and benefits for the period ended June 30,
2003 in the period ended March 31, 2003 due to the February 1, 2003 effective
dates of our mergers with PGNF and Paragon Florida as well as additions to our
corporate management team that occurred in the three months ended June 30, 2003.
As a percentage of revenue, salaries, commission and benefits decreased to 57.1%
for the three month period ended June 30, 2003 from 85.9%. This decrease was due
primarily to the salaries, commission and benefits for the month of January 2003
which were not included in the amounts reported for the three months ended March
31, 2003.
Loan production costs. Loan production costs increased $223,000, or 90.3%, to
$470,000 for the three months ended June 30, 2003 compared to $247,000 for the
three months ended March 31, 2003. The increase is due primarily to the increase
in the volume of retail loan originations as well as there being three months'
loan production costs for PGNF and Paragon Florida in the period ended June 30,
2003 and only two months of loan production costs in the period ended March 31,
2003 due to the effective dates of our mergers with PGNF and Paragon Florida. As
a percentage of revenue, loan production costs were 28.1% for the three month
period ended June 30, 2003 compared to 28.3% in the three months ended March 31,
2003.
General and administrative expenses. General and administrative expenses
increased $534,000, or 79.7%, to $1.2 million for the three months ended June
30, 2003 compared to $670,000 for the three months ended March 31, 2003. This
increase is due primarily to increased legal and accounting costs associated
with the our public reporting responsibilities, consulting costs associated with
recruiting members of our management team, and travel costs associated with our
acquisition program as well as there being three months' general and
administrative expenses for PGNF and Paragon Florida in the period ended June
30, 2003 and only two months of general and administrative expenses in the three
months ended March 31, 2003 due to the effective dates of our mergers with PGNF
and Paragon Florida. As a percentage of revenue, general and administrative
expenses were 27.9% for the three month period ended June 30, 2003 compared to
36.3% in the three months ended March 31, 2003.
Interest expense. Interest expense increased $164,000, or 63.3%, to $423,000 for
the three months ended June 30, 2003 compared to $259,000 for the three months
ended March 31, 2003. The increase is due primarily to there being three months'
interest expense for PGNF and Paragon Florida in the period ended June 30, 2003
and only two months of interest expense in the three months ended March 31, 2003
due to the effective dates of our mergers with PGNF and Paragon Florida.
Realized loss on derivative. The realized loss on derivative increased $13,000
to $38,000 for the three months ended June 30, 2003 compared to $25,000 for the
three months ended March 31, 2003. This increase is due to there being three
months' realized loss on derivative for PGNF in the period ended June 30, 2003
and only two months of realized loss on derivative in the three months ended
March 31, 2003 due to the effective date of our merger with PGNF. The realized
loss on derivative represents the cost of maintaining the derivative financial
19
instrument assumed as part of our acquisition of PGNF.
Unrealized gain on derivative. The unrealized gain on derivative decreased
$14,000 to $3,000 compared to $17,000 for the three months ended March 31, 2003.
This decrease is due to to the movements of interest rates underlying the
derivative financial instrument assumes as part of our acquisition of PGNF.
Net loss. The net loss decreased $642,000 to $281,000 for the three months ended
June 30, 2003 compared to a loss of $923,000 for the three months ended March
31, 2003 due to the factors above.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
Our primary sources of liquidity are:
- fundings under revolving warehouse facilities,
- sale of mortgage loans and related servicing rights, and
- fees earned from originating retail mortgage loans.
Our operations require continued access to short-term and long-term
sources of cash. Our primary operating cash requirements include:
- funding of mortgage loan originations prior to their sale,
- fees and expenses incurred in connection with the sale of loans,
- ongoing administrative, operating, and tax expenses, and
- interest and principal payments under our revolving warehouse facilities
and other existing indebtedness.
We had cash and cash equivalents of approximately $647,000 and
available for sale securities of $953,000 at June 30, 2003 of which $10,000
represents compensating balances under our warehouse credit facilities.
Warehouse Facilities. We rely on our revolving warehouse facilities to originate
mortgage loans and hold them prior to sale. At June 30, 2003, we had committed
revolving warehouse facilities in the amount of $50 million. Of the $50 million
of committed revolving warehouse facilities available to us at June 30, 2003, a
$10.0 million warehouse facility expired on July 18, 2003, and we did not renew
the facility. We subsequently renewed a revolving warehouse facility in the
amount of $20 million with one of our existing lenders. Generally, our revolving
warehouse facilities have 364-day terms and are renewed on an annual basis. No
assurances can be made that we will be successful in our efforts to continue to
renew our warehouse facilities upon their expiration.
Certain of our warehouse facility lenders advance less than 100% of the
principal balance of the mortgage loans, requiring us to use working capital to
fund the remaining portion of the principal balance of the
20
mortgage loans.
All of the our revolving warehouse facilities contain provisions
requiring we meet certain periodic financial covenants, which establish, among
other things, liquidity, stockholders' equity, leverage, and net income levels.
If we are unable to meet these financial covenants going forward, or are unable
to obtain subsequent amendments or waivers, if required, or for any other reason
are unable to maintain existing warehouse lines or renew them when they expire,
we would have to cease our wholesale operations which would jeopardize the our
ability to continue to operate as a going concern.
The Sale of Mortgage Loans. As a fundamental part of our business and financing
strategy, we sell mortgage loans to third party investors in the secondary
markets as market conditions allow. Generally, we seek to dispose of all of our
loan production within 30 days. We apply the net proceeds of the loan sales to
pay down our warehouse facilities in order to make capacity available for future
funding of mortgage loans. Our ability to sell loans in the secondary market on
acceptable terms is essential for the continuation of our wholesale loan
origination operations.
Due to our recent mergers with PGNF and Paragon Florida, we anticipate
that the cash generated from these operations, cash on hand, available for sale
securities and available borrowings under our warehouse facilities will enable
us to meet our existing liquidity requirements during the next 12 months.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Impact Of Inflation
- -------------------
Inflation affects us most significantly in the area of loan
originations and can have a substantial effect on interest rates. Interest rates
normally increase during periods of high inflation and decrease during periods
of low inflation. Profitability may be directly affected by the level and
fluctuation in interest rates that affect our ability to earn a spread between
interest received on its loans and the costs of its borrowings. Our
profitability is likely to be adversely affected during any period of unexpected
or rapid changes in interest rates. A substantial and sustained increase in
interest rates could adversely affect our ability to originate loans and affect
the mix of first and second-lien mortgage loan products. Generally, first-lien
mortgage production increases relative to second-lien mortgage production in
response to low interest rates and second-lien mortgage production increases
relative to first-lien mortgage production during periods of high interest
rates. Fluctuating interest rates may also affect the net interest income earned
by us resulting from the difference between the yield to us on loans held
pending sales and the interest paid by us for funds borrowed under our warehouse
lines of credit.
Market Risk
- -----------
Our market risk is the risk of economic loss resulting from adverse
changes in market prices of mortgage loans and interest rates. We rely heavily
on borrowings under our warehouse credit facilities to conduct our wholesale
origination business. Borrowings under these credit facilities are done at
variable rates that will increase as interest rates rise. Additionally, when
interest rates rise, loans held for sale and any applications in process with
locked-in rates decrease in value. This risk of loss can be reflected in
diminished current market values and/or reduced potential net interest income in
future periods.
When interest rates decline, fallout may occur as a result of customers
withdrawing their applications. In those instances, we may be required to reduce
our interest rates to meet the market demands. Our wholesale segment operates
primarily in the subprime credit market. This market is less sensitive than the
prime credit markets are to the daily fluctuations in mortgage rates.
When interest rates rise, fallout may occur as due to customers that
are not locked into a rate withdrawing their applications, and, as a result, we
may suffer a reduction in the volume of loan originations. We may be required to
reduce our interest rates to entice these customers in order to close their
loans.
We do not maintain a trading account nor are we subject to currency
exchange risk or commodity price
21
risk. Responsibility for monitoring interest rate risk rests with senior
management. Senior management regularly reviews our interest rate risk position
and adopts balance sheet strategies that are intended to optimize operating
earnings while maintaining market risk within acceptable guidelines.
While we monitor interest rates and may, from time to time, employ a
strategy designed to hedge some of the risks associated with changes in interest
rates, no assurance can be given that our results of operations and financial
condition will not be adversely affected during periods of fluctuations in
interest rates. There were no open hedging positions at June 30, 2003.
ITEM 4. CONTROLS AND PROCEDURES
Our Chief Executive Officer and Chief Financial Officer conducted an
evaluation of the effectiveness of our disclosure controls and procedures. Based
on this evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that our disclosure controls and procedures were effective as of June
30, 2003 in alerting them in a timely manner to material information required to
be included in our SEC reports. In addition, no change in our internal control
over financial reporting occurred during the fiscal quarter ended June 30, 2003
that has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.
22
PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In March, April and May 2001, the Company, and its former directors
David M. Beirne, Michael Mortiz, William J. Razzouk and Christos M. Cotsakos and
its former Chief Financial Officer, Steve Valenzuela were named as defendants in
class action complaints alleging violations of the federal securities laws in
the United States District Court for the Southern District of New York. The
complaints against the Company have been consolidated into a single action and a
Consolidated Amended Complaint, which is now the operative complaint, was filed
on April 19, 2002.
The purported class action alleges violation of Sections 11 and 15 of the
Securities Acts of 1933 and Sections 10(b) and 20(a) of the Securities Exchange
Act of 1934 and Rule 10b-5 promulgated thereunder. The essence of the complaint
is that the defendants issued and sold the Company's common stock pursuant to a
registration statement for its October 7, 1999 initial public offering ("IPO")
without disclosing to investors that certain underwriters in the offering had
solicited and received excessive and undisclosed commissions from certain
investors. The complaint also alleges that the registration statement failed to
disclose that the underwriters allocated Company shares in the IPO to customers
in exchange for the customers' promises to purchase additional shares in the
aftermarket at pre-determined prices above the IPO price, thereby maintaining,
distorting and/or inflating the market price for the shares in the aftermarket.
The action seeks damages in an unspecified amount.
The action is being coordinated with approximately three hundred other nearly
identical actions filed against other companies. On July 15, 2002, the Company
moved to dismiss all claims against it and the individual defendants. On
February 19, 2003, the Court denied the motion to dismiss the complaint against
the Company. The Court dismissed the Section 10(b) claim against the individual
defendants, but denied the motion to dismiss the Section 11 claim and the
Section 15 and 20(a) control person claims against the individual defendants.
The Company has approved a Memorandum of Understanding ("MOU") and related
agreements which set forth the terms of a settlement between the Company and the
plaintiff class. Thus far, 289 of the companies sued in nearly identical actions
have also approved the MOU and related agreements. The MOU and related
agreements are subject to a number of contingencies, including the negotiation
of a settlement agreement and approval by the Court. We cannot opine as to
whether or when a settlement will occur or be finalized. Whether or not the
settlement is ultimately approved, we believe the resolution of this matter will
not have a material adverse effect on the Company.
On June 19, 2001, vTraction, Inc. filed a complaint for breach of contract in
the Chancery Court of Tennessee for the Thirtieth Judicial District at Memphis
alleging that the Company entered into an oral agreement with vTraction to sell
certain equipment and later reneged, and claiming damages in an amount
including, but not limited to, the difference between the price agreed to in the
alleged oral contract and the market price of the equipment. The Company has
filed an answer asserting the affirmative defenses of failure of consideration
and statute of frauds and denying the existence of an oral contract. At this
time, the Company does not believe this matter will have a material impact on
its financial position, operations or liquidity.
In addition to the above, the Company from time to time becomes
involved in a variety of mortgage lending related claims and other matters
incidental to its business in addition to the matters described above. In the
opinion of the Company, the resolution of any of these matters is not expected
to have a material adverse effect on its consolidated financial position and
results of operations.
ITEM 2. CHANGES IN SECURITIES - NONE
ITEM 3. DEFAULTS UPON SENIOR SECURITIES - NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) We held our annual meeting of stockholders on June 24, 2003. Of the
116,146,479 shares of common stock entitled to vote at the meeting, 101,016,302
shares of common stock were present in person or by proxy and entitled to vote.
Such number of shares represented approximately 86.97% of the our outstanding
shares of common stock.
At the meeting, the stockholders approved the election of Steven A. Burleson,
Paul K. Danner, Philip Lagori and Harold Lazarus to our Board of Directors. In
connection with such election, the stockholders voted as follows:
Nominees: For Withheld
- -------- --- --------
Steven A. Burleson 101,011,180 5,122
Paul K. Danner 101,011,180 5,122
Philip Lagori 101,010,962 5,340
Harold Lazarus, Ph.D. 101,011,174 5,128
23
ITEM 5. OTHER INFORMATION - NONE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
The following exhibits are hereby filed as part of this Quarterly
Report on Form 10-Q.
Exhibit
Number Description
2.1.1 Agreement and Plan of Merger dated as of October 14, 2002 among
PlanetRx.com, Inc. (n/k/a Paragon Financial Corporation), Paragon
Homefunding, Inc. a Delaware Corporation and Mortgage Express, Inc.
(n/k/a PGNF Home Lending Corp., et al (the "Mortgage Express Plan of
Merger") *
2.2 Amendment No. 1 to the Mortgage Express Plan of Merger **
2.3 Agreement and Plan of Merger dated December 9, 2002 among PlanetRx.com,
Inc. (n/k/a Paragon Financial Corporation), Paragon Acquisition Corp.
II, Paragon Homefunding, Inc., a Florida corporation, et al. (the
"Paragon Homefunding Plan of Merger") **
2.4 Amendment No. 1 to the Paragon Homefunding Florida Plan of Merger **
3.1 Restated Certificate of Incorporation filed with the Secretary of State
of the State of Delaware on October 6, 1999 ***
3.2 Certificate of Amendment of the Restated Certificate of Incorporation
filed with the Secretary of State of the State of Delaware on October
13, 2000 ***
3.3 Certificate of Amendment to Restated Certificate of Incorporation filed
with the Secretary of State of the State of Delaware on November 30,
2002 ***
3.4 Certificate of Amendment of the Restated Certificate of Incorporation
filed with the Secretary of State of the State of Delaware on December
26, 2002 ***
3.5 Certificate of Designations of Series E Preferred Stock ***
3.6 Amended and Restated By-laws ***
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a)/15(d)-14(a) Certificate of Chief Financial Officer
32.1 Section 1350 Certification of Chief Executive Officer
32.2 Section 1350 Certification of Chief Financial Officer
- -----------------------
* Filed as an exhibit to Paragon's Quarterly Report on Form 10-Q for the
period ended September 30, 2002 and incorported herein by reference
thereto
** Filed as an exhibit to Paragon's Current Report on Form 8-K for an
event dated January 31, 2003 and incorported herein by reference
thereto
*** Filed as an exhibit to Paragon's Quarterly Report on Form 10-Q/A for
the period ended March 31, 2003 and incorported herein by reference
thereto
(b) Current Report on Form 8-K for an Event Dated May 28, 2003 filed on May
28, 2003 relating to our earnings release for the three month period
ended March 31, 2003.
24
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
PARAGON FINANCIAL CORPORATION
/s/ STEVEN A. BURLESON
----------------------------------
Steven A. Burleson
President, Chief Executive Officer and Director
Dated: August 18, 2003
/s/ SCOTT L. VINING
-------------------------------------
Scott L. Vining
Chief Financial Officer
Dated: August 18, 2003
25