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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 SEPTEMBER 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 94-3227733
- -------------------------------------------------------------- ------------------------------------
(State or Other Jurisdiction of Incorporation or organization) (I.R.S. Employer Identification No.)
5000 SAWGRASS VILLAGE CIRCLE, PONTE VEDRA BEACH, FLORIDA 32082
- -------------------------------------------------------------- ------------------------------------
(Address of principal executive offices) (Zip Code)
904-285-0000
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(Issuer's telephone number)
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
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]
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 November 14, 2003.
TABLE OF CONTENTS
ITEM NO. Page Number
- -------- -----------
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at September 30, 2003 (Unaudited)
and December 31, 2002 (Audited) 3
Condensed Consolidated Income Statements for the three and nine months
ended September 30, 2003 and 2002 (Unaudited) 4
Condensed Consolidated Statements of Cash Flows for the nine months ended
September 30, 2003 and 2002 (Unaudited) 5
Notes to Condensed Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk 25
Item 4. Controls and Procedures 26
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 2. Changes in Securities 26
Item 3. Defaults Upon Senior Securities 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 5. Other Information 26
Item 6. Exhibits and Reports on Form 8-K 26
2
Item 1. Financial Statements
PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30, 2003 DECEMBER 31, 2002
(UNAUDITED) *
ASSETS:
Cash and cash equivalents $ 723 $ 91
Fees receivable 240 -
Mortgage loans receivable held-for-sale, net 24,312 -
Office property and equipment, net of accumulated depreciation 1,209 1
Other notes and mortgages receivable, net 595 -
Available-for-sale securities 829 -
Goodwill and other intangible assets 8,431 -
Prepaid and other assets 407 114
---------------------- ----------------------
TOTAL ASSETS $ 36,746 $ 206
====================== ======================
LIABILITIES AND STOCKHOLDERS' EQUITY:
Warehouse lines of credit $ 23,508 $ -
Notes payable 2,088 -
Notes payable - related party 1,109 -
Convertible debentures payable 38 34
Accounts payable and accrued liabilities 820 177
Accrued expenses - related party 59 204
Accrued expense - other 903 -
Derivative liability 240 -
Related party debt subsequently converted to preferred stock - 659
---------------------- ----------------------
TOTAL LIABILITIES 28,765 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, $0.001 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 11,778 1,693
Retained earnings (3,854) (2,567)
Unearned stock-based compensation (83) -
Accumulated other comprehensive income 129 -
---------------------- ----------------------
Total stockholders' equity 7,981 (868)
---------------------- ----------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 36,746 $ 206
====================== ======================
* Condensed from audited financial statements.
See accompanying notes to condensed consolidated financial statements.
3
PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED INCOME STATEMENTS (UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30 SEPTEMBER 30
------------------ ------------------
2003 2002 2003 2002
---- ---- ---- ----
REVENUE:
Gain on sale of loans $ 2,155 $ - $ 5,100 $ -
Loan origination fees 1,577 - 4,123 -
Interest, dividends, and other income 455 - 1,124 -
--------------- -------------- --------------- ----------------
Total revenue 4,187 - 10,347 -
--------------- -------------- --------------- ----------------
EXPENSES:
Salaries, commissions, and benefits 2,350 572 6,398 1,104
Loan production costs 397 - 1,114 -
General and administrative 1,087 85 2,961 374
Interest 435 1 1,117 1
Realized loss on derivative 40 - 103 -
Unrealized gain on derivative (39) - (59) -
--------------- -------------- --------------- ----------------
Total expenses 4,270 658 11,634 1,479
--------------- -------------- --------------- ----------------
Net loss $ (83) $ (658) $(1,287) $ (1,479)
=============== ============== =============== ================
Net loss per common share - basic $ (0.00) $ (0.01) $ (0.01) $ (0.03)
=============== ============== =============== ================
Weighted average number of shares
outstanding - basic and diluted 116,167 62,143 110,066 53,087
=============== ============== =============== ================
See accompanying notes to condensed consolidated financial statements.
4
PARAGON FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002
------------------- --------------------
Operating activities:
Net loss $ (1,287) $ (1,479)
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization 203 1
Non-cash stocked based compensation 42 794
Non-cash interest expense converted to preferred stock 13 -
Provision for loan repurchases and premium recapture 184 -
Origination of mortgage loans held for sale (228,387) -
Proceeds from sale of mortgage loans held-for-sale 228,117 -
Increase in warehouse lines of credit 191 -
Decrease in derivative liability (81) -
Increase in net other assets (132) (15)
Increase in net other liabilities 512 403
------------------- --------------------
Net cash provided by (used in) operating activities (625) (296)
------------------- --------------------
Investing activities:
Purchases of equipment and improvements (374) (2)
Cash acquired in purchases of businesses 272 -
Proceeds from sale of websites 48 -
Purchases of marketable equity securities 4 -
------------------- --------------------
Net cash used in investing activities (50) (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 1,109 -
Borrowings under promissory notes 317 -
Repayments of debt (363) -
------------------- --------------------
Net cash provided by financing activities 1,307 394
------------------- --------------------
Net increase in cash and cash equivalents 632 96
Cash and cash equivalents at beginning of period 91 -
------------------- --------------------
Cash and cash equivalents at end of period $ 723 $ 96
=================== ====================
See accompanying notes to condensed consolidated financial statements.
5
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, PGNF 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 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 (sometimes referred to herein 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 stockholders'
equity.
The condensed consolidated balance sheet as of September 30, 2003 and the
condensed consolidated statements of operations and cash flows for the three and
nine month periods ended September 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
September 30, 2003 and our operating results and cash flows for the three and
nine month periods ended September 30, 2003 and 2002. The results of operations
for the three and nine months ended September 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 nine months ended September 30, 2002
were restated to include an adjustment of professional fees in the three months
ended September 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.
6
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.
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, to the extent that consideration other than beneficial interests in
the loans transferred is received in the exchange.
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 a fair value hedge
7
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
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 stockholders' 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. 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 APB
25 but have adopted the interim reporting requirements of SFAS 148.
8
As of September 30, 2003, there were stock options outstanding for the purchase
of 38,161,500 shares of our common stock. There were no stock options granted
and 181,250 forfeited during the quarter ended September 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):
NINE MONTHS ENDED
---------------------------------------
SEPTEMBER 30, 2003 SEPTEMBER 30, 2002
------------------ ------------------
Net loss, as reported $ (1,287) $ (1,479)
Stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax effects 869 4
------------- -------------
Pro forma net loss $(2,156) $(1,483)
============= =============
Net loss per share:
Basic and diluted, as reported $ (0.01) $ (0.03)
Pro forma basic and diluted $ (0.02) $ (0.03)
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 incurred a non-cash charge of $14,000
and $18,000 for the three and nine month periods ended September 30, 2003 as a
result of the issuance of these restricted shares. This amount is included in
Salaries, commissions, and benefits on the Condensed Consolidated Income
Statements.
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 incurred a non-cash charge of $17,000 and $24,000 for the three and nine
month periods ended September 30, 2003 as a result of the issuance of these
options. This amount is included in Salaries, commissions, and benefits on the
Condensed Consolidated Income Statements.
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. 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. Paragon
Florida 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 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
9
Florida in the aggregate principal amount of $25,000. The promissory notes
accrue interest at 4.92% and are payable on February 2, 2004.
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 have 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 $288,000 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, including specifically identifiable 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 a 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 (in thousands except per share data):
NINE MONTHS ENDING
--------------------------------------
SEPTEMBER 30, SEPTEMBER 30,
2003 2002
----------------- -----------------
Revenues $ 12,763 $ 10,318
Net loss $ (120) $ (1,094)
Diluted loss per share $ (0.00) $ (0.01)
Weighted average shares - diluted 122,257 106,641
3. GOING CONCERN
We have sustained operating losses since inception. At September 30, 2003, our
stockholders' 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 $8.4 million in goodwill. We incurred a net loss of
$1.3 million and used $623,000 of cash in operations during the nine months
ended September 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
10
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 nine months
ended September 30, 2003 are listed below (dollars in thousands):
THREE MONTHS NINE MONTHS
SEPTEMBER 30, 2003 SEPTEMBER 30, 2003
Net loss as reported $ (83) $ (1,287)
Other Comprehensive Income:
Unrealized gain on available-for-sale
securities 33 129
------------------------ ------------------------
Total Comprehensive Loss $ (50) $ (1,158)
======================== ========================
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 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 September 30,
2003 follows (dollars in thousands):
Mortgage loans receivable held-for-sale $24,101
Allowance for loan repurchases and premium
recapture (307)
Net deferred origination costs 518
----------------
$24,312
================
11
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, and $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
of $40 million in the aggregate. These warehouse credit facilities are used to
fund mortgage loans, are collateralized by the mortgage loans funded, and do not
require material compensating balances. Warehouse lines of credit consist of the
following at September 30, 2003 (dollars in thousands):
$5 million mortgage warehouse credit facility at a commercial bank; interest at greater of
LIBOR and Fed Funds plus 4%. This credit facility expires on June 30, 2004. $ 5,058
$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 expires on July 31, 2004. 12,785
$10 million mortgage warehouse credit facility at a commercial bank; interest at
Prime plus 1.5%. This credit facility expires on June 30, 2004. 518
$5 million mortgage warehouse credit facility at a commercial bank; interest at
Prime plus 1%. This credit facility expires December 31, 2003. 5,147
--------------
$23,508
==============
PGNF's warehouse lines contain provisions whereby the lender can terminate their
agreement without cause with certain notice requirements and have certain
covenants requirements. PGNF was in compliance with these covenants at September
30, 2003. Certain of PGNF's lenders allowed overfunding of the warehouse
facilities during the quarter. These overfundings are allowed on a case by case
basis with no assurances they will be allowed. We believe 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 the Company's
wholesale operations.
12
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 nine months ended September 30, 2003 (dollars in
thousands):
WHOLESALE RETAIL CORPORATE TOTAL
------------- ------------ ------------ --------------
Mortgage loans closed $ 211,253 $244,147 - $455,400
Sold loans $201,696 $19,615 - $221,311
Revenues:
Gain on sale of loans $4,359 $741 - $5,100
Loan origination fees - 4,123 - 4,123
Interest, dividend and other income 1,048 76 1,124
------------- ------------ ------------ --------------
Total revenues 5,407 4,940 - 10,347
Expenses:
Salaries and benefits 2,161 3,247 990 6,398
Loan production costs 348 766 - 1,114
General and administrative expenses 1,568 738 655 2,961
Interest expense and other expenses 772 76 313 1,161
------------- ------------ ------------ --------------
Total expenses 4,849 4,827 1,958 11,634
------------- ------------ ------------ --------------
Net income (loss) $558 $113 $(1,958) $(1,287)
============= ============ ============ ==============
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 payable in cash or stock at our direction. 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
September 30, 2003, the cumulative dividend due on this Series E preferred stock
was $50,662.
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 Orlando, FL.
13
Employment Agreements
At September 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 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
14
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 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
15
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 NINE MONTHS ENDED
----------------------- -- -------------------------
SEPTEMBER 30, 2003 SEPTEMBER 30, 2002
----------------------- -------------------------
Cash interest paid $ 878 $ -
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 and nine month periods ended September 30, 2003 and
2002.
15. NET LOSS PER SHARE
Basic net loss per share is computed by dividing the net loss for the period by
the weighted average number of shares of common stock outstanding during the
period. Diluted net loss per share is computed using the weighted average number
of common shares and common equivalent shares if dilutive. Common equivalent
shares consist of the incremental common shares issuable upon the exercise of
stock options and warrants (using the treasury stock method), and the common
shares outstanding subject to repurchase. The periods presented below exclude
common equivalent shares, as the effect of such shares on a weighted average
basis is anti-dilutive.
16
The following table sets forth the computation of basic and diluted net loss per
share for the periods indicated (in thousands, except per share amounts):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2003 SEPTEMBER 30, 2003
------------------ ------------------
2003 2002 2003 2002
---- ---- ---- ----
Numerator: Net loss $ (83) $ (658) $(1,287) $ (1,479)
Denominator: Weighted average common shares 116,167 62,143 110,066 53,087
Basic and diluted net loss per share $ (0.00) $ (0.01) $ (0.01) $ (0.03)
17
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
18
- 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 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.
19
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 6. Certain accounting policies require us to make significant
estimates and assumptions that may have a material impact on certain assets and
liabilities, as well as our operating results, and we consider these to be
critical accounting policies. The estimates and assumptions we use are based on
historical experience and other factors which we believe to be reasonable under
the circumstances. Actual results could differ materially from these estimates
and assumptions, which could have a material impact on the carrying value of
assets and liabilities and our results of operations.
We believe the following are critical accounting policies that require the most
significant estimates and assumptions that are subject to significant change in
the preparation of our consolidated financial statements:
- Provision for loan repurchases and premium recapture.
- Gain on sale of loans.
- Income taxes.
20
RESULTS OF OPERATIONS - THREE MONTHS ENDED SEPTEMBER 30, 2003 AND JUNE 30, 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 nine months ended September 30, 2002, we were a development
stage company and reported no revenues. As a result, an analysis of the three
and nine months ended September 30, 2003 to the three and nine months ended
September 30, 2002, is not relevant, and we have elected to discuss the results
of operations and analysis of financial condition below for the three months
ended September 30, 2003 compared to the three months ended June 30, 2003. The
table below sets forth information regarding the components of the Company's
revenue and expenses for the three months ended September 30, 2003 and June 30,
2003.
THREE MONTHS ENDED
-----------------------------------------
SEPTEMBER 30, 2003 JUNE 30, 2003
------------------ -------------------
(DOLLARS IN THOUSANDS)
LOAN ORIGINATION VOLUME:
Wholesale $ 99,946 $ 76,026
Retail 96,912 96,152
------------------ -------------------
TOTAL LOAN ORIGINATION VOLUME $ 196,858 $ 172,178
LOAN SALES $ 98,285 $ 79,551
REVENUES:
Gain on sale of loans $ 2,155 $ 2,246
Origination fees 1,577 1,670
Interest, dividend, and other income 455 398
------------------ -------------------
Total revenue 4,187 4,314
------------------ -------------------
EXPENSES:
Salaries, commission, and benefits 2,350 2,463
Loan production costs 397 470
General and administrative 1,087 1,204
Interest 435 423
Realized loss on derivative 40 38
Unrealized gain on derivative (39) (3)
------------------ -------------------
Total expenses 4,270 4,595
------------------ -------------------
NET LOSS $ (83) $ (281)
================== ===================
Total Loan Originations. Total loan originations increased $24.7 million, or
14.3%, to $196.9 million for the three months ended September 30, 2003 compared
to $172.1 million for the three months ended June 30, 2003. This increase
relates to internal growth in our loan originations for the three months ended
September 30, 2003 compared to the three months ended June 30, 2003.
Wholesale Loan Originations. Wholesale loan origination increased $23.9 million,
or 31.5%, to $99.9 million for the three months ended September 30, 2003
compared to $76.0 million for the three months ended June 30, 2003. This
increase relates to internal growth in our wholesale loan originations for the
three months ended September 30, 2003 compared to the three months ended June
30, 2003.
Retail Loan Originations. Retail loan origination increased $0.8 million, or
0.8%, to $96.9 million for the three months ended September 30, 2003 compared to
$96.2 million for the three months ended June 30, 2003. This increase relates to
internal growth in our retail loan originations for the three months ended
September 30, 2003 compared to the three months ended June 30, 2003. Our retail
loan origination volume declined substantially in September 2003 due to
increases in mortgage interest rates in July and August. We expect our retail
loan originations to decline in the three months ending December 31, 2003 as
compared to our retail loan originations in the three months ended September 30,
2003.
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
21
sales to pay down our warehouse facilities in order to make capacity available
for future funding of mortgage loans.
Loan sales increased $18.7 million, or 23.5%, to $98.3 million for the three
months ended September 30, 2003 compared to $79.6 million for the three months
ended June 30, 2003. This increase relates to internal growth in our loan sales
for the three months ended September 30, 2003 compared to the three months ended
June 30, 2003.
REVENUE
Gain on Sale of Loans. Gain on sale of loans decreased $91,000, or 4.1%, to $2.2
million for the three months ended September 30, 2003 compared to $2.2 million
for the three months ended June 30, 2003. This decrease was due primarily to
lower premiums received on loans originated during the month of July resulting
from increases in mortgage interest rates.
The gain on sale of loans is net of a provision for repurchases and premium
recapture of $147,000 for the three months ended September 30, 2003 compared to
a provision of $245,000 for the three months ended June 30, 2003. The decrease
in the provision for repurchases and premium recapture was due to a revision in
our estimated losses as a result of our insuring a portion of our fraud risk
with a third-party. We began insuring against fraud the wholesale loans we
originated in July 2002.
Origination Fees. Origination fees decreased $93,000, or 5.6% to $1.6 million in
the three months ended September 30, 2003 compared to $1.7 million in the three
months ended June 30, 2003. This decrease was due to a highly competitive retail
interest rate environment requiring us to reduce our commissions and fees.
Expressed as a percentage of retail loan origination volume, origination fees
were 1.63% of retail loan originations in the three months ended September 30,
2003 compared to 1.74% in the three months ended June 30, 2003.
Interest, dividend and other income. Interest, dividend and other income
increased $57,000, or 14.3%, to $455,000 for the three months ended September
30, 2003 compared to $398,000 for the three months ended June 30, 2003. The
increase is due to increases in interest rates on loans held for sale during the
three month period ended September 30, 2003 compared to the three months ended
June 30, 2003.
EXPENSES
Salaries, commissions, and benefits. Salaries, commissions, and benefits
decreased $113,000, or 4.6%, to $2.4 million for the three months ended
September 30, 2003 compared to $2.5 million for the three months ended June 30,
2003. The decrease was due primarily to reduced headcount
22
in our retail segment corresponding to reductions in the number of mortgage
refinancings in our retail loan segment.
Loan production costs. Loan production costs decreased $73,000, or 15.5%, to
$396,000 for the three months ended September 30, 2003 compared to $470,000 for
the three months ended June 30, 2003. The decrease was due to us closing a
higher percentage of the loans we took applications for, the costs of which are
included in the calculation of gain or loss on sale.
General and administrative expenses. General and administrative expenses
decreased $117,000, or 9.7%, to $1.1 million for the three months ended
September 30, 2003 compared to $1.2 million for the three months ended June 30,
2003. This decrease is due primarily to legal, accounting, printing, and other
non-recurring costs associated with our proxy mailing incurred in the three
months ended June 30, 2003 but not in the three months ended September 30, 2003.
Interest expense. Interest expense increased $13,000, or 3.1%, to $436,000 for
the three months ended September 30, 2003 compared to $423,000 for the three
months ended June 30, 2003. The increase was due to higher average balances on
our warehouse lines of credit during the three months ended September 30, 2003
compared to the three months ended June 30, 2003.
Realized loss on derivative. The realized loss on derivative increased $2,000 to
$40,000 for the three months ended September 30, 2003 compared to $38,000 for
the three months ended June 30, 2003. The increase is due to movements of
interest rates underlying the derivative financial instrument assumed as part of
our acquisition of PGNF.
Unrealized gain on derivative. The unrealized gain on derivative increased
$37,000 to $40,000 for the three months ended September 30, 2003 compared to
$3,000 for the three months ended June 30, 2003. This increase was due to the
movements of interest rates underlying the derivative financial instrument
assumed as part of our acquisition of PGNF.
Net loss. The net loss decreased $198,000 to $83,000 for the three months ended
September 30, 2003 compared to a loss of $281,000 for the three months ended
June 30, 2003 due to the factors above.
LIQUIDITY AND CAPITAL RESOURCES
Our primary sources of liquidity are:
- borrowings under revolving warehouse facilities and other lines of
credit,
- 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,
23
- 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 $723,000 and available-for-
sale securities of $829,000 at September 30, 2003.
Warehouse Facilities. We rely on our revolving warehouse facilities to originate
mortgage loans and hold them prior to sale. At September 30, 2003, we had
committed revolving warehouse facilities in the amount of $40 million.
Generally, our revolving warehouse facilities have 364-day terms and are renewed
on an annual basis. No assurances can be made that we will be successful in our
efforts to continue to renew our warehouse facilities upon their expiration.
Certain of our warehouse facility lenders advance less than 100% of the
principal balance of the mortgage loans, requiring us to use working capital to
fund the remaining portion of the principal balance of the mortgage loans.
All of the our revolving warehouse facilities contain provisions requiring we
meet certain periodic financial covenants, which establish, among other things,
liquidity, stockholders' equity, leverage, and net income levels. If we are
unable to meet these financial covenants going forward, or are unable to obtain
subsequent amendments or waivers, if required, or for any other reason are
unable to maintain existing warehouse lines or renew them when they expire, we
would have to cease our wholesale operations which would jeopardize our ability
to continue to operate as a going concern.
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.
24
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, customers may withdraw their mortgage loan
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 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 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 September 30, 2003.
25
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 September 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 September 30, 2003,
that has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.
PART II--OTHER INFORMATION
Item 1. Legal Proceedings
The Company becomes involved, from time to time, 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 - None
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 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
26
PlanetRx.com, Inc. (n/k/a Paragon Financial Corporation), Paragon
Acquisition Corp. II, Paragon Homefunding, Inc., a Florida corporation,
et al. (the "Paragon Homefunding Plan of Merger").***
2.4 Amendment No. 1 to the Paragon Homefunding Florida Plan of Merger.***
3.1 Restated Certificate of Incorporation filed with the Secretary of State
of the State of Delaware on October 6, 1999. ****
3.2 Certificate of Amendment of the Restated Certificate of Incorporation
filed with the Secretary of State of the State of Delaware on October
13, 2000. ****
3.3 Certificate of Amendment to Restated Certificate of Incorporation filed
with the Secretary of State of the State of Delaware on November 30,
2002. ****
3.4 Certificate of Amendment of the Restated Certificate of Incorporation
filed with the Secretary of State of the State of Delaware on December
26, 2002. ****
3.5 Certificate of Designations of Series E Preferred Stock.*****
3.6 Amended and Restated By-laws. ****
4.1 Form of convertible promissory note. ****
10.1 Amended and Restated Employment Agreement, dated as of September 1,
2002 by and between PlanetRx.com, Inc. (now known as Paragon Financial
Corporation) and Paul Danner. ****
10.2 Employment Agreement, dated as of September 4, 2002 by and between
PlanetRx.com, Inc. (now known as Paragon Financial Corporation) and
Steven A. Burleson. ****
10.3 Employment Agreement, dated as of January 31, 2003 by and between
Paragon Financial Corporation and Philip Lagori. ****
10.4 Employment Agreement, dated as of December 30, 2002 by and between
Paragon Financial Corporation and Scott Vining. ****
10.5 Lease dated January 1, 2003 between Ponte Vedra Management Group, Ltd.
and Paragon Financial Corporation. ****
10.6 Lease dated September 1, 2000 between 820 West Lake, LLC and Mortgage
Express, Inc. (n/k/a PGNF Home Lending Corp.). ****
10.7 Employment Agreement, dated October 16, 2003, by and between Paragon
Financial Corporation and George O. Deehan +
10.8 Employment Agreement, dated June 17, 2003, by and between Paragon
Financial Corporation and Joseph P. Bryant, Jr. +
10.9 Employment Agreement, dated May 6, 2003, by and between Paragon
Financial Corporation and Steven L. Barnett. +
31.1 Certification of Chief Executive Officer pursuant to Form of Rule
13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002, dated November 14, 2003 +
31.2 Certification of Chief Financial Officer pursuant to Form of Rule
13a-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002, dated November 14, 2003 +
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, dated November 14, 2003 +
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, dated November 14, 2003 +
- -------------------
* Filed as an exhibit to Paragon's Quarterly Report for the period ended
March 31, 2002
** Filed as an exhibit to Paragon's Quarterly Report for the period ended
September 30, 2002
*** Filed as an exhibit to Paragon's Current Report on Form 8 for an event
dated January 31, 2003
27
**** Filed as an exhibit to Paragon's Annual Report on Form 10-K for the
year ended December 31, 2002
***** Filed as an exhibit to Paragon's Quarterly Report for the period ended
March 31, 2003, as amended.
+ Filed herewith.
(b) Reports on Form 8-K
(1) We filed a Current Report on Form 8-K, as amended, for an event dated
August 26, 2003 announcing the dismissal of independent accountants.
(2) We filed a Current Report on Form 8-K, as amended, for an event dated
October 31, 2003 announcing the engagement of Stevens, Powell &
Company, P.A. as our independent accountants.
28
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
BY:
/s/ GEORGE DEEHAN
- -----------------------------------------------
George Deehan
President, Chief Executive Officer and Director
Dated: November 14, 2003
/s/ SCOTT L. VINING
- -----------------------------------------------
Scott L. Vining
Chief Financial Officer
Dated: November 14, 2003
29