SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
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 0-27736
POINT WEST CAPITAL CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware 94-3165263
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1700 Montgomery Street, Suite 250
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San Francisco, California 94111
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(Address of principal executive offices) (Zip Code)
(415) 394-9467
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act:
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Common Stock, $0.01 par value
(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the registrant's common stock, $0.01 par value
held by non-affiliates of the registrant as of February 29, 2000 was
approximately $24,421,400.
The number of shares of the registrant's common stock, $0.01 par value
outstanding as of February 29, 2000 was 3,352,624.
Documents Incorporated by Reference:
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The registrant's proxy statement (to be filed) related to its 2000 annual
meeting of stockholders is incorporated by reference in Part III hereof.
POINT WEST CAPITAL CORPORATION
Form 10-K Annual Report
For the Fiscal Year Ended December 31, 1999
Table of Contents
PART I Page
Item 1. Business................................................................ 1
Item 2. Properties.............................................................. 10
Item 3. Legal Proceedings....................................................... 10
Item 4. Submission of Matters to a Vote of Security Holders..................... 11
.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockhloders
Matters ................................................................ 12
Item 6. Selected Financial Data................................................. 13
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................. 15
Item 7A. Quantitative and Qualitative Disclosures About Market Risks............. 32
Item 8. Financial Statements and Supplementary Data............................. 32
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure............................................... 32
PART III
Item 10. Directors and Executive Officers of the Registrant...................... 56
Item 11. Executive Compensation.................................................. 56
Item 12. Security Ownership of Certain Beneficial Owners and Management ......... 56
Item 13. Certain Relationships and Related Transactions.......................... 56
.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K ........ 56
Signatures............................................................................ 61
i
Unless the context otherwise requires, all references to "Point West Capital"
refer to Point West Capital Corporation and all references to the "Company"
refer to Point West Capital Corporation and its consolidated entities.
PART I
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ITEM 1--BUSINESS
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General
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The Company is a specialty financial services company. During 1997, the
Company expanded its financial services business through the operations of Point
West Venture Management, LLC (formerly known as Fourteen Hill Management, LLC)
("Point West Management") and Point West Ventures, L.P. (formerly known as
Fourteen Hill Capital, L.P.) ("Point West Ventures"), which make loans to and
invest in small businesses which are generally highly focused in the areas of
e-commerce, Internet and telecommunications; and Allegiance Capital, LLC
("Allegiance Capital"), Allegiance Funding I, LLC ("Allegiance Funding"),
Allegiance Capital Trust I ("Allegiance Trust I") and Allegiance Management
Corp. ("Allegiance Management"), which lend funds to funeral home and cemetery
owners. During 1998, the Company formed Point West Securities, LLC ("PWS"), a
broker-dealer licensed by the National Association of Securities Dealers, Inc.
("NASD"). References herein to Ventures include Point West Management and Point
West Ventures. References herein to Allegiance include Allegiance Capital,
Allegiance Funding, Allegiance Trust I and Allegiance Management.
The principal business activity of the Company through February 1997
was to provide viatical settlements for terminally ill persons. A viatical
settlement is the payment of cash in return for an ownership interest in, and
right to receive the death benefit (face value) of, a life insurance policy. In
connection with a viatical settlement, the policyholder assigned his or her
policy to the Company, which became the holder, owner or certificate holder of
the policy and the beneficiary thereunder with the right to receive from the
insurance company the face value payable under the policy following the death of
the insured. In the third quarter of 1996, the Company decided to sell all or
substantially all of its assets at that time. See "Asset Sales; Viatical
Settlement Business." In February 1997, Point West Capital's Board of Directors
(the "Board") decided to cease purchasing new policies in connection with the
Company's viatical settlement business. See Note 1 of Notes to Consolidated
Financial Statements. The Company, through its wholly owned special purpose
subsidiary, Dignity Partners Funding Corp. I ("DPFC"), continues to hold
policies which are pledged as security for the Securitized Notes (defined
herein). Point West Capital continues to service the life insurance policies
held by DPFC. For a discussion of a potential default by DPFC under the
Indenture (defined herein), see "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Results of Operations by
Segment -- Viatical Settlements -- Potential Default by DPFC."
The Company operates in four business segments: Ventures (small
business loans and investments); Allegiance (loans to funeral homes and
cemeteries); Viatical Settlements, which is conducted primarily through DPFC;
and Other (other activities of Point West Capital and PWS). Information
regarding the income, contributed net income (loss) and identifiable assets for
each of the Company's business segments is contained in Note 15 of the Company's
consolidated financial statements included herein.
The Company continues to evaluate new business opportunities and to
seek advice from financial advisors to assist it in its strategy of developing
or acquiring new operating businesses. See
1
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Considerations Under the Investment Company Act of 1940."
The Company
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General
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Point West Capital was incorporated in the State of Delaware as Dignity
Partners, Inc. in September 1992 and commenced operations on January 2, 1993.
Effective August 1, 1997, its name was changed to Point West Capital
Corporation. The Company's principal executive offices are located at 1700
Montgomery Street, Suite 250, San Francisco, California 94111, and its telephone
number is (415) 394-9467.
Ventures
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In June 1997, the Company formed Point West Management and Point West
Ventures. Point West Management is a limited liability company wholly owned by
Point West Capital. It was formed solely to serve as the general partner of one
or more small business investment companies ("SBIC"). Point West Ventures is a
limited partnership operating as an SBIC. Point West Management is the sole
general partner and owns 99.981% of Point West Ventures. Point West Capital is
one of the two nominal limited partners of Point West Ventures. Point West
Ventures provides loans, debt and equity capital to small companies as defined
by SBA regulations. Point West Ventures commenced operations in August 1997 and
received its SBIC license from the Small Business Administration ("SBA") in
September 1997.
Allegiance
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Allegiance Capital is a limited liability company formed in September
1997 as a specialty finance company to provide senior secured loans to owners of
funeral homes and cemeteries. Point West Capital has a 65% ownership interest
in, and 95% voting control of, Allegiance Capital and serves as the managing
member. Allegiance Capital's president and its vice president of marketing have
the balance of such interests. Allegiance Capital owns 100% of Allegiance
Funding, which is a special purpose subsidiary formed to acquire and securitize
loans originated by Allegiance Capital. Pursuant to a Trust Agreement dated
August 1, 1998 (the "Allegiance Trust Agreement"), Allegiance Funding formed a
trust, Allegiance Trust I, to consummate a structured financing (the "Allegiance
Financing") which, through December 31, 1999, has provided $28.7 million of debt
to support Allegiance's lending activities. Based upon current loan origination
activities, Allegiance expects to borrow an additional $5 million to $10 million
under the Allegiance Financing prior to its April 15, 2000 expiration date.
However, no assurance can be given that Allegiance will be able to originate
sufficient loans to borrow such amount. Allegiance Capital owns 100% of
Allegiance Management, which is a special purpose subsidiary formed to manage
Allegiance Funding. Allegiance commenced operations in December 1997.
DPFC
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DPFC is a wholly owned subsidiary of Point West Capital formed for the
limited purposes of issuing Senior Viatical Settlement Notes, Series 1995-A,
Stated Maturity March 10, 2005 (the "Securitized Notes"). DPFC purchased life
insurance policies with proceeds of the Securitized Notes. DPFC no longer
purchases policies, but it continues to beneficially own the policies that have
not matured. Those policies are pledged as collateral for the Securitized Notes.
DPFC is a bankruptcy remote entity.
2
PWS
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PWS is a limited liability company formed in July 1998 as a
broker-dealer. PWS is wholly owned by Point West Capital. PWS received its
license from the NASD to become a licensed securities broker-dealer in December
1998. In addition, PWS is registered as a broker-dealer with the Securities and
Exchange Commission ("SEC") and in California, New York and several other
states. PWS commenced operations in December 1998. Operations for PWS in 1999
and 1998 were immaterial.
Asset Sales; Viatical Settlement Business
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Introduction
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In December 1996, the holders of the Company's Common Stock, $0.01 par
value ("Common Stock"), authorized the Board to sell all or substantially all of
the assets of the Company. The Company subsequently sold substantially all of
the Company's life insurance policies other than the policies held by DPFC.
Substantially all of these sales took place during 1997. The sale of policies
held by DPFC, all of which are pledged as security for the Securitized Notes,
requires the consent of the Company and the holders of the Securitized Notes
("Noteholders"). The Company and the Noteholders have not determined whether the
policies will be sold or whether such a sale of policies is feasible. Although
the Company and the Noteholders were previously in discussions that contemplated
a purchase of the policies, and cancellation of the indebtedness, by the
Noteholders, these discussions have ceased. The Company continues to evaluate
its options related to DPFC policies. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations -- Results of Operations by
Segment -- Viatical Settlements" and "-- Description of Securitized Notes." For
a discussion of a potential default by DPFC under the Indenture, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations by Segment -- Viatical Settlements --
Potential Default by DPFC."
Terms of Sale Agreements
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Through December 1997, Point West Capital entered into several
agreements to sell substantial portions of its portfolio of policies. In 1998
and 1999 Point West Capital entered into agreements to sell a small number of
policies. None of the purchasers is affiliated with the Company or any of its
directors or officers. The sale agreements provided for the sale of an aggregate
of 375 life insurance policies. The agreements contained cross indemnity
provisions pursuant to which Point West Capital and the purchaser agreed to
indemnify each other against losses, liabilities or damages arising in
connection with a claim under any policy or with any breach of any
representation or warranty made by the breaching party in the agreement. By
December 31, 1999, Point West Capital had completed the sale of (or otherwise
collected) all but six policies under these sales agreements.
Viatical Business
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As of December 31, 1999, the Company held 463 policies, all but six of
which were held through DPFC. The Company ceased purchasing policies in February
1997. Therefore, the Company's only activities in the viatical settlement
business are monitoring and collection activities. Point West Capital, as
servicer under the Securitized Notes, performs these functions with respect to
DPFC policies. For a discussion of a potential default by DPFC under the
Indenture, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Results of Operations by Segment -- Viatical
Settlements -- Potential Default by DPFC."
3
Monitoring
The insureds are regularly monitored to obtain timely
information concerning their status so that proceeds may be collected
as promptly as possible following the death of the insured. In
addition, the Company monitors the policy to ensure it does not lapse
because of a failure to pay timely premiums. Premiums are paid by the
Company unless a waiver is in place. Some protection against the
failure to pay premiums is provided by statutory or policy provisions
that require insurance companies to provide written notice before
terminating a policy for failure to pay premiums. As owner of record of
the policy, the Company generally receives those notices directly.
Furthermore, the Company monitors the policy to ensure that premium
waivers are renewed and that, when required, the policy is converted
(e.g., from a group term policy to an individual whole life policy) in
a timely manner. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Results of Operations by Segment
-- Viatical Settlements -- Certain Accounting Implications for DPFC."
Collection
Once the Company learns of an insured's death, a request for a
copy of the death certificate is filed in the appropriate governmental
office. The Company then files the death certificate with the insurance
company and requests payment of the policy proceeds. The Company
monitors the collection status until it receives the face value of the
policy.
Consideration of Strategic Options and New Businesses
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In September 1996, in light of the uncertainties facing the Company's
viatical settlement business, the Company engaged an investment bank to assist
the Company in the evaluation of its strategic direction. As a result of the
Company's evaluation, the Company embarked on a strategy to become a more
broadly-based specialty financial services company. The Company continues to
pursue other potential business opportunities and to seek advice from financial
advisors to assist it in its strategy of developing or acquiring new operating
businesses. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Considerations Under the Investment Company Act of
1940."
Ventures (Small Business Loans and Investments)
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Overview
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Point West Ventures is licensed by the SBA as an SBIC. Point West
Ventures focuses on creating a diversified portfolio of loans to and debt and
equity investments in later-stage growth and expansion companies. From time to
time, Point West Ventures invests in early-stage growth companies. To date,
Point West Ventures has focused on businesses in the area of e-commerce,
Internet and telecommunications. Point West Ventures' loans and investments are
structured in a variety of ways, including loans, debt investments such as
subordinated debt with equity participation through warrants or conversion
rights, and investments in preferred and common stock.
Regulation
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As an SBIC, Point West Ventures is required to make loans to or invest
in qualified entities as defined by regulations promulgated by the SBA. These
entities are generally companies with a net worth of less than $18 million and
average net income of less than $6 million for the last two years. Additionally,
at least 20% of Point West Ventures' loans and investments must be made to
entities with a
4
net worth of less than $6 million and average net income of less than $2 million
for the last two years. Point West Ventures holds an SBIC debenture license. As
a result, Ventures pays interest and other fees to the SBA instead of a portion
of its profits.
SBIC's such as Point West Ventures are also limited with respect to the
rates of interest they can charge on their loans and debt investments. The
maximum rate of interest permitted at present for loans is the greater of (i)
19% and (ii) 1100 basis points over the rate for ten year debentures issued by
SBIC's and funded through public certificates bearing the SBA's guarantee (the
"Debenture Rate") or weighted-average cost of capital incurred (including SBA
debt). The maximum rate of interest permitted at present for debt investments is
the greater of (i) 14% and (ii) 600 basis points over the Debenture Rate or
weighted-average cost of capital incurred (including SBA debt).
Point West Ventures is subject to usury and other similar laws in
jurisdictions in which it operates and may in the future become subject to
licensing requirements as a lender in those jurisdictions.
Origination & Investment Selection
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Point West Ventures focuses on later-stage growth companies, but has
also provided capital to early and mezzanine stage companies. Point West
Ventures seeks to lend to or invest in well-managed, growing, public or private
companies that seek capital to finance a variety of activities. These activities
include (1) new product development, (2) expansion into new markets, (3)
increasing production capacity or (4) the acquisition of complementary
businesses. The size of each individual transaction by Point West Ventures has
historically ranged from $100,000 to $3 million, but the average size has been
$800,000. Point West Ventures' investments in small businesses are made with the
intent of having the loans repaid and liquidating the equity portion of the
investments after five years. Although Point West Ventures at the time of any
investment expects to dispose of the investment after five years, situations may
arise in which it may hold equity securities for a different period of time,
especially in the areas of e-commerce and the Internet which frequently undergo
significant and rapid changes.
Point West Ventures considers a number of criteria in making loan and
investment decisions. Although the criteria below may not be applied in every
instance and their importance may vary depending on the relevant circumstances,
the following characteristics generally are sought when evaluating a potential
borrower or investment: (1) highly skilled management with the capability to
organize resources, develop products and exploit market opportunities, (2)
superior growth and the presence of a clearly defined marketing strategy which
addresses the conditions of the market, the needs of the customers and
established competitive practices exhibited in the relevant industry, (3) strong
demonstrable cash flows, historical or projected, or other collateral, (4)
access to additional capital and (5) the existence of a reasonable exit
strategy. Point West Ventures employs third party experts where appropriate to
assess the market opportunity or operational capabilities of the potential
borrower or investment.
Point West Ventures locates potential SBIC investments through contacts
with investment bankers, fund managers, lenders, venture capitalists, leveraged
buyout sponsor groups and other SBIC's. Point West Ventures uses its own
analysts that review informational packages in order to identify potential
investments. After identifying investments that meet Point West Ventures'
investment criteria, the analysts conduct a more thorough investigation and
analysis of the applicant. The process often includes on-site visits, review of
historical and prospective financial information, interviews with management,
employees, customers and vendors of the applicant, background checks and
research on the applicant's product, service or particular industry.
5
Point West Ventures has an Investment Committee that consists of
Bradley N. Rotter, Alan B. Perper and John Ward Rotter, Point West Capital's
executive officers. All loan and investment decisions are presented to the
Investment Committee for their approval prior to commitment.
Monitoring Investments
----------------------
Portfolio loans and investments have a designated employee who is
responsible for periodic contact and all initial troubleshooting. Additionally,
this individual carefully reviews operating results, cash flow, working capital
and financial structure against budgets. Any additional financing, divestiture,
foreclosure or restructuring must be approved by the Investment Committee.
Competition
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Point West Ventures' principal competitors include financial
institutions, venture capital firms and other non-traditional lenders. Many of
these entities have greater financial and managerial resources than Point West
Ventures. The Company believes that many of these entities do not have an
interest in the relatively small size of transactions which Point West Ventures
targets. Additionally, the Company believes that Point West Ventures competes
effectively with those entities primarily on the basis of its quality of
service, reputation and timely decision-making process, and to a significantly
lesser degree on the interest rates or other terms it offers on loans or
investments to those seeking capital.
Allegiance (Loans to Funeral Homes and Cemeteries)
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Overview
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Allegiance provides long-term debt to experienced owners of established
funeral home and cemetery businesses on a senior secured basis at competitive
rates. The funeral home and cemetery businesses comprise what is frequently
called the "death care" industry. Death care historically has been a relatively
stable and mature industry, partly due to the inevitable nature of mortality. In
addition, most areas of the country are already served by one or more funeral
homes and cemetery establishments and opportunities for expansion mostly consist
of consolidation of existing establishments. Though subject to consolidation in
recent years, the death care industry remains highly fragmented. The for-profit
ownership base within the death care industry is split among private entities,
primarily smaller family-owned businesses, and a number of large public
corporations, including Service Corporation International, Loewen Group and
several others. A variety of factors, including turnover among the base of
privately owned death care businesses and the recognition of the substantial
potential value of these businesses, have combined to create demand for capital
within the industry. These capital needs have been underserved by traditional
lending sources.
Allegiance generally seeks to finance funeral home and cemetery
businesses which are well-established by virtue of years of service in the
communities they serve and which are operated by owners with substantial
experience and expertise in operating such businesses. Although some of the
public market participants such as Service Corporation International and Lowen
Group have experienced significant declines in the price of their common stock,
the Company believes that the heritage, reputation and attendant goodwill built
up by privately owned funeral homes and cemeteries provide superior collateral
value.
Marketing & Origination
-----------------------
Allegiance targets family-owned and other private owners of funeral
home and cemetery establishments. Loans are sourced by marketing employees and
independent parties both directly through
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the solicitation of owners of funeral homes and cemetery businesses and
indirectly through contacts with industry associations, professional groups,
business advisors and others. Origination activities are supported through print
advertising in industry trade publications, newsletters and attendance at
industry conferences.
Loans are offered with fixed or adjustable interest rates, generally in
minimum amounts of $500,000. Loan proceeds may be used by the borrower for a
variety of purposes, including acquisitions, debt refinancing and stockholder
buyouts. Allegiance charges a loan arrangement fee payable at closing as well as
a commitment fee, which may be credited against the loan arrangement fee paid at
closing, and may charge other fees from time to time. Contractual repayment
terms require monthly payments sufficient to pay accrued interest and a portion
of principal sufficient to amortize the loan balance over a long-term repayment
schedule, generally 15 to 18 years.
Allegiance obtains a senior, secured position with respect to the
borrowers and business establishments it finances. Security for loans is
generally provided through a mortgage providing a first priority security
interest in the owned or leased real property associated with the borrower's
business establishment(s); a first priority security interest in the related
personal property, intangible assets and intellectual property; a first priority
security interest in the borrower's stock (if a corporation); and personal
guarantees of the borrower's principals.
Underwriting
------------
Loan commitments are made based on an in-depth qualitative and
quantitative underwriting analysis. This analysis focuses on the applicant, its
ownership and management, and the funeral home and/or cemetery establishments it
owns and operates. The process begins with the collection of information
concerning the prospective borrower. Information collected from the borrower
includes detailed information regarding ownership, business locations and
characteristics, personnel, real and personal property used in connection with
the business, the market environment in which the business operates, banking and
trade references and historical financial statements and tax returns.
The management review seeks to assess the quality, sufficiency and
commitment of management, with an emphasis on the borrower's owners or managers
("key principals"). This assessment includes a review of the key principals'
backgrounds, including education, professional experience, other business
experience and other activities such as community involvement. Staffing levels
of licensed and other professionals are reviewed to determine sufficiency given
historic service volume and any projected increases. Allegiance requires that
the funeral home and cemetery establishments financed by it, and the funeral
directors and embalmers associated with such establishments, be fully licensed
in compliance with applicable legal requirements.
The business portion of the underwriting analysis includes a review of
tangible aspects of the business such as property condition and appearance, and
intangible factors affecting business value and economics, such as history,
location and market demographics. Financial statements are analyzed to determine
historic adjusted cash flow in light of the proposed loan amount and debt
service burden. In addition, third-party consultants independently determine
adjusted cash flow and assess business value. Business value of the subject
business is assessed based primarily on its historic financial performance and
secondarily on the real property and other assets of the business. Assessments
of business value are used to determine a loan-to-business value ratio.
Prior to closing, any real property to be pledged as collateral
undergoes an environmental review. The Company uses third-party environmental
service providers for the environmental review. In addition
7
to providing assurance as to the quality of the real property collateral, the
review generally meets standards for due diligence developed to avoid lender
liability.
All loan decisions are presented to Allegiance's Investment Committee
for its approval prior to commitment. The committee is comprised of two of Point
West Capital's executive officers and the President of Allegiance. Allegiance
relies on outside legal counsel to prepare loan documents and to facilitate loan
closings.
Allegiance may, from time to time in the future, purchase from other
lenders in the death care industry portfolios of existing loans held by such
lenders. In such case, the underwriting procedures followed by such lenders in
connection with loan originations and by Allegiance in connection with such
purchase may be different from those described above. However, Allegiance
intends, to the extent reasonable, to undertake underwriting and due diligence
procedures that are prudent in the circumstances and that are established by
Allegiance's Investment Committee.
Servicing
---------
Point West Capital performs certain basic loan servicing functions
related to loans made by Allegiance. These functions include (1) sending monthly
billing statements and other notices, (2) tracking and posting loan payments,
(3) directing the transfer of loan payments to the appropriate accounts and (4)
maintaining loan files.
In addition to the functions performed by Point West Capital,
Allegiance performs loan portfolio surveillance functions in order to monitor
credit quality. Borrowers provide certain information periodically, including
quarterly and annual financial statements as well as supplemental business
activity information. Allegiance uses this information to monitor periodically
covenant compliance and the credit quality of the borrowers' underlying
businesses. As a senior secured lender, in the event of default, Allegiance is
in a relatively strong position to control any disposition of the businesses it
finances. However, the monitoring process is intended to help borrowers identify
and address problems to avoid defaults. To date, Allegiance has had only one
non-performing loan. This loan is in the foreclosure process. See "Item 3--Legal
Proceedings."
Competition
-----------
Allegiance faces competition from alternative providers of capital,
including primarily financial institutions, the financial services industry and
to a lesser extent other companies in the death care industry. The financial
services industry is highly competitive. Allegiance competes with both
traditional lenders such as commercial banks, thrifts and finance companies as
well as specialized lenders such as Provident Services, Inc. (a subsidiary of
Service Corporation International) and Franchise Mortgage Acceptance Co. The
Company believes that Allegiance's focus on and knowledge of the death care
industry, its ability to offer loans on terms which meet the needs of owners and
acquirers of death care businesses, and its attractiveness to borrowers as a
non-industry lender, provide it with the ability to compete effectively.
Regulation
----------
In October 1998, Allegiance Capital received its finance lenders
license from the State of California. Allegiance makes filings or obtains
licenses as counsel deems appropriate to meet individual state lending
requirements. It is also subject to usury and other similar laws in such
jurisdictions.
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Broker-Dealer Activities
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Overview
--------
PWS is a broker-dealer licensed by the NASD and registered with the
SEC. PWS is also licensed as a broker-dealer in California, New York and several
other states. PWS intends to offer investment banking services targeting
e-commerce, telecommunications, Internet and other growth companies. PWS
commenced operations in December 1998. The full scope of services to be provided
by PWS has not yet been determined. To date, PWS' operations have not been
material.
Competition
-----------
PWS encounters intense competition in its business and competes
directly with numerous securities firms, virtually all of which have
substantially greater capital and other resources. PWS also faces competition
from banks, insurance companies and financial institutions. The companies in the
industries to which PWS targets its investment banking services are relatively
small. PWS believes that its larger competitors will not target those companies.
The Company hopes that PWS will be able to compete effectively with those
competitors primarily on the basis of the quality of its service, product
selection and price. However, because of the uncertainty regarding the scope of
the services to be provided by PWS, the Company cannot predict the competition
PWS will encounter or its ability to compete.
Regulation
----------
The securities industry in the United States is subject to extensive
regulation under federal and state laws. The SEC is the federal agency
responsible for the administration of the federal securities laws. However, much
of the regulation of broker-dealers has been delegated to self-regulatory
organizations, principally the NASD and the New York Stock Exchange. These
self-regulatory organizations adopt rules (which are subject to approval by the
SEC) for governing the industry and conduct periodic examinations of member
broker-dealers. Securities firms are also subject to regulation by state
securities commissions in the states in which they are registered.
The regulations to which broker-dealers are subject cover all aspects
of the securities business, including sales methods, trading practices, capital
structure, record keeping and the conduct of directors, officers and employees.
Additional legislation, changes in rules promulgated by the SEC and by
self-regulatory organizations or changes in the interpretation or enforcement of
existing laws and rules often directly affect the method of operation and
profitability of broker-dealers. The SEC and the self-regulatory organizations
may conduct administrative proceedings that can result in censure, fine,
suspension or expulsion of a broker-dealer, its officers or employees. The
principal purpose of regulation and discipline of broker-dealers is the
protection of clients and the securities markets rather than protection of
creditors and shareholders of broker-dealers.
Other Investments
- -----------------
From time to time, Point West Capital invests in companies directly and
not through Ventures. These activities include loans and equity investments.
Employees
- ---------
As of December 31, 1999, the Company employed 19 individuals, three of
whom (in addition to Point West Capital's executive officers) also perform
services on behalf of The Echelon Group of
9
Companies, LLC ("Echelon"), a financial services company. Echelon is owned by
Point West Capital's executive officers. None of the Company's employees is a
member of a labor union. The Company believes that it maintains good relations
with its employees.
ITEM 2--PROPERTIES
- ------------------
The Company currently leases approximately 6,150 square feet of office
space in San Francisco which it shares with Echelon. Point West Capital, which
is the lessee under the lease, charges Echelon for 20% of the rent of the entire
office space. See "Certain Relationships and Related Transactions." The Company
believes that its current office space will be adequate for its current
operations through the expiration of the lease in May 2004. However, if the
Company is successful in expanding into new businesses, it might require
additional office space.
ITEM 3--LEGAL PROCEEDINGS
- -------------------------
From time to time, the Company is involved in routine legal proceedings
incidental to its business, including litigation in connection with (i) loans
and investments made by Point West Ventures and Allegiance, and (ii) the
collection of amounts owed under life insurance policies by insurance company
obligors. The Company does not expect that these proceedings, individually or in
the aggregate, will have a material adverse effect on the Company's financial
position, liquidity or results of operations.
On December 19, 1996, a complaint was filed in the United States
District Court, Northern District of California (the "Court") (Docket No.
C96-4558) against Dignity Partners, Inc. (now Point West Capital Corporation)
and each of its directors by three individuals purporting to act on behalf of
themselves and an alleged class consisting of all purchasers of the Company's
common stock during the period February 14, 1996 to July 16, 1996. The complaint
alleges that the defendants violated Section 10(b) of the Securities Exchange
Act of 1934 and Rule 10b-5 thereunder and Section 11 of the Securities Act of
1933 and seeks, among other things, compensatory damages, interest, fees and
costs. The allegations were based on alleged misrepresentations in and omissions
from the Company's registration statement and prospectus related to its initial
public offering and certain documents filed by the Company under the Exchange
Act. In the second quarter of 1999, a settlement in principle was reached and on
February 25, 2000, the Court approved a settlement agreement pursuant to which
all claims against all defendants will be dismissed and $3.15 million will be
paid to the plaintiffs. Under the terms of the Company's D&O insurance policy,
the Company's insurer paid 70% of the settlement amount. As a result, during the
second quarter of 1999, the Company recorded an accrued litigation settlement
liability of $3.15 million, an expense of $945,000, and an accounts receivable
from its insurance company of $2.2 million (which is included in other assets in
the Consolidated Balance Sheet and was paid into an escrow account in January
2000).
On February 13, 1997, a complaint was filed in the Superior Court of
California, City and County of San Francisco (Docket No. 984643) against Dignity
Partners, Inc., and each of its executive officers and Echelon by an individual
purporting to act on behalf of himself and an alleged class consisting of all
purchasers of the Company's common stock during the period February 14, 1996 to
July 16, 1996. The complaint alleges that the defendants violated section 25400
of the California Corporate Code and seeks to recover damages. The allegations
are based on alleged misstatements, concealment and/or misrepresentations and
omissions of allegedly material information in connection with the Company's
initial public offering and subsequent disclosures. The case has been stayed
since its inception by agreement of the parties. However, the claims in this
case are covered by the settlement agreement described above and will also be
dismissed pursuant to the settlement agreement described above
10
In October 1999, Allegiance brought an action in the District Court of
Webb County, Texas seeking to collect on a defaulted loan with an outstanding
principal balance of $2.1 million. In response to the lawsuit, on October 29,
1999, the defendants filed a counterclaim against Allegiance and a third-party
petition against an individual who is an officer of Allegiance. The counterclaim
and the third-party petition allege that Allegiance and the Allegiance officer
committed fraud, conversion, deceptive trade practices, negligence, breach of
fiduciary duty, negligent misrepresentation, conspiracy and other wrongful acts,
and seeks, among other things, compensatory and punitive damages (or
cancellation of indebtedness), interest, fees and costs. The defendants retained
a consulting firm owned by the Allegiance officer to consult in the acquisition
of a funeral home and to assist in financing such acquisition. The defendants'
allegations and the third-party petition are based on (i) allegedly erroneous
advice provided by the Allegiance officer, (ii) an alleged failure by the
Allegiance officer to disclose his relationship with Allegiance and (iii) the
allegedly wrongful exercise by Allegiance of its rights in the collateral
securing the defaulted loan. The Company believes that the counterclaim is
without merit and intends to prosecute the original action, and defend the
counterclaim, vigorously.
ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- -----------------------------------------------------------
No matters were submitted to a vote of the Company's stockholders
during the fourth quarter of 1999.
11
PART II
-------
ITEM 5--MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
- -------------------------------------------------------------
STOCKHOLDERS MATTERS
--------------------
Point West Capital's Common Stock trades on the National Market System
of The Nasdaq Stock Market(R) under the symbol "PWCC." As of February 7, 2000,
there were 118 holders of record of Common Stock, including banks, brokerage
firms and other nominees. A substantial portion of the publicly-held shares of
Common Stock are held in book-entry form. As of February 7, 2000, the Company
estimates that there were more than 500 beneficial owners of Common Stock
including more than 500 round lot holders. The following table sets forth, for
the fiscal quarters indicated, the high and low sales prices for the Common
Stock on The Nasdaq Stock Market(R).
1999 High Low
---- ----- ---
First Quarter ...................... $ 23 7/8 $ 4 5/8
Second Quarter...................... 29 3/4 7
Third Quarter....................... 11 1/8 4 11/16
Fourth Quarter...................... 19 6/7 4 3/8
1998 High Low
---- ---- ---
First Quarter ...................... $ 6 $ 3 3/4
Second Quarter...................... 7 1/8 4 3/4
Third Quarter....................... 6 4
Fourth Quarter...................... 7 2 1/4
The Company has never declared or paid any cash dividends on its
capital stock. The indenture pursuant to which the Securitized Notes were issued
(the "Indenture") limits the Company's ability to pay dividends by restricting,
prior to repayment in full of the Securitized Notes, the Company's access to
cash generated through the collection of pledged policies. The Company currently
intends to retain its future earnings, if any, to finance its existing
businesses and any new businesses. Therefore, the Company does not anticipate
paying cash dividends on the Common Stock for the foreseeable future.
12
ITEM 6--SELECTED FINANCIAL DATA
- -------------------------------
The data presented below should be read in conjunction with the
consolidated financial statements and notes thereto and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" included
elsewhere herein. Because the Company changed its accounting policy with respect
to the viatical settlement business effective for all periods beginning after
June 30, 1996 and ceased the viatical settlement business in February 1997,
information for 1996 and 1995 and as of December 31, 1996 and 1995 is not
comparable to later periods or as of subsequent year ends. In addition, two
businesses started in the second half of 1997 generated substantially more
activity in 1999 compared to 1998 and 1997
Years Ended December 31,
------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(Dollars in thousands, except per share amounts)
----------------------------------------------------
Statements of Operations Data:
- -----------------------------
Earned discounts on life insurance policies (1). $ -- $ -- $ -- $ 3,697 $ 6,933
Earned discounts on prior maturities and
matured policies (1)........................ 204 439 489 1,782 --
Interest income.................................. 3,314 1,494 1,184 783 267
Net gain (loss) on securities.................... 15,785 (999) 680 -- --
Gain (loss) on assets sold....................... 8 165 1,463 (180) --
Total income..................................... 19,718 1,334 3,918 6,405 7,389
Interest expense................................. 4,963 3,680 3,599 3,984 3,352
Provision for loss on assets held for sale....... -- -- 328 3,140 --
Loss on investment in wholly owned financing
subsidiary.................................. -- -- -- 6,940 --
Total expenses................................... 10,476 7,279 6,795 17,118 5,394
Income (loss) before income taxes, minority
interest and net loss in wholly owned
financing subsidiary charged to reserve for
equity interest............................ 9,242 (5,945) (2,877) (10,713) 1,996
Income tax benefit (expense)..................... 590 (6) (4) 526 (625)
Net loss in wholly owned financing subsidiary
charged to reserve for equity interest...... -- 2,300 3,891 488 --
Net income (loss) (2)............................ 9,832 (3,650) 1,011 (9,699) 803
Basic earnings (loss) per share (3).............. $ 2.95 $(1.12) $ 0.29 $(2.46) $ 0.51
Diluted earnings (loss) per share (3)............ $ 2.70 $(1.12) $ 0.28 $(2.46) $ 0.42
Balance Sheet Data (at December 31):
- ------------------------------------
Cash and cash equivalents........................ $ 12,836 $ 6,668 $ 10,040 $ 6,586 $ 1,057
Investment securities............................ 9,024 2,113 5,817 -- --
Loans receivable................................. 35,467 10,188 4,016 -- --
Purchased life insurance policies................ 31,728 33,893 36,587 41,246 48,938
Non-marketable securities........................ 5,933 5,397 1,658 3,000 --
Total assets..................................... 101,526 62,443 62,969 68,944 58,226
Accrued litigation settlement.................... 2,205 -- -- -- --
Reserve for equity interest in wholly owned
financing subsidiary........................ -- -- 2,300 6,453 --
Total revolving certificates..................... 4,200 5,400 -- -- --
Total long-term debt (4)......................... 66,028 41,529 38,804 41,218 40,549
13
Years Ended December 31,
------------------------
1999 1998 1997 1996 1995
---- ---- ---- ---- ----
(Dollars in thousands, except per share amounts)
----------------------------------------------------
Total liabilities................................ 73,983 47,613 41,703 48,802 46,680
Total stockholders' equity (2)................... 27,543 14,830 21,266 20,142 4,866
Operating Data
- --------------
Ventures
- --------
Number of loans and investments originated
during the year.............................. 16 6 2 -- --
Number of loans and investments outstanding,
end of year.................................. 15 6 2 -- --
Aggregate amount of loans and investments
originated during year at cost............... $ 11,204 $ 6,695 $ 1,250 -- --
Aggregate amount of loans and investments
outstanding, end of year at cost............ $ 9,285 $ 6,456 $ 1,250 -- --
Allegiance
- ----------
Number of loans originated during year........... 16 4 1 -- --
Number of loans outstanding, end of year......... 21 5 1 -- --
Aggregate principal amount of loans originated
during year $ 25,075 $ 5,425 $ 3,826 -- --
Aggregate principal amount of loans
outstanding, end of year.................... $ 33,778 $ 9,103 $ 3,826 -- --
Interest accrued during year (5)................. $ 1,729 $ 582 $ 12 -- --
Weighted-average interest rate on loans
originated during year (6).................. 9.9% 9.2% 9.4% -- --
Weighted-average interest rate on loans
outstanding, end of year (6)................ 9.8% 9.3% 9.4% -- --
Weighted-average cost of funds on debt
outstanding, end of year (7)................ 8.4% 8.2% -- -- --
<FN>
--
(1) See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Results of Operations by Segment - Viatical
Settlements - Method of Accounting for Viatical Settlements."
(2) Includes minority interest of $568 in 1995 on the statements of operations
data and minority interest of $6,680 in 1995 on the balance sheet data. The
minority interest was eliminated in 1996.
(3) Reflects the following transactions as if such transaction had occurred at
the beginning of 1995 and 1996: (a) On September 30, 1995, Point West
Capital and its then sole stockholder, The Echelon Group Inc. ("Old
Echelon"), which was owned entirely by Point West Capital's executive
officers, entered into a series of transactions (collectively, the
"Reorganization") to separate the business of Point West Capital from Old
Echelon's other business interests; (b) On January 12, 1996, Point West
Capital effected a reverse stock split pursuant to which each outstanding
share of Common Stock was converted into .7175 of a share of Common Stock;
(c) In February 1996, all outstanding shares of Point West Capital's
Cumulative Pay-in-Kind Preferred Stock were converted into 321,144 shares
of Common Stock. The Reorganization included a sale of assets by Old
Echelon to Echelon, which was also owned entirely by Point West Capital's
executive officers, and a merger of Old Echelon into Point West Capital.
Point West Capital's initial public offering occurred in February 1996.
(4) Includes term certificates, securitized notes payable, debentures payable
and other long term liabilities.
(5) Includes origination fees recognized over the life of the related loans
using the level yield method. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Results of Operations by
Segment - Allegiance - Method of Accounting for Loans."
(6) Includes one loan currently in default; excludes origination fees.
(7) Reflects cost of term certificates and revolving certificates.
</FN>
14
ITEM 7--MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
- -------------------------------------------------------------------
AND RESULTS OF OPERATIONS
-------------------------
The following is a discussion and analysis of the consolidated
financial condition of the Company at December 31, 1999 and results of
operations for the Company for the three years ended December 31, 1999, and of
certain factors that may affect the Company's prospective financial condition
and results of operations. The following should be read in conjunction with the
consolidated financial statements and related notes appearing elsewhere herein.
In addition, two businesses started in the second half of 1997 generated
substantially more activity in 1999 compared to 1998 and 1997.
Overview
- --------
The Company is a specialty financial services company. The Company's
financial statements consolidate the assets, liabilities and operations of DPFC,
Ventures, Allegiance and PWS. The principal business activity of the Company
through February 1997 was to provide viatical settlements for terminally ill
persons. See "Cessation of Viatical Settlement Business; Sale of Assets."
Subsequent to February 1997, the Company has become a more broadly-based
specialty financial services company. To that end, the Company has expanded its
financial services business through Ventures, Allegiance and PWS. The Company
continues to evaluate new business opportunities. Ventures, Allegiance and PWS,
whose business activities are described under "Item 1--Business," may or may not
be indicative of the types of business opportunities the Company will continue
to pursue. See "Method of Consolidation" and "Considerations Under the
Investment Company Act of 1940" below. No assurance can be given that the
Company will be successful in identifying any new business opportunities or that
any such enterprise will be successful.
Cessation of Viatical Settlement Business; Sale of Assets
- ---------------------------------------------------------
The principal business activity of the Company through February 1997
was to provide viatical settlements for terminally ill persons. A viatical
settlement is the payment of cash in return for an ownership interest in, and
right to receive the death benefit (face value) of, a life insurance policy. In
the third quarter of 1996, the Company decided to sell all or substantially all
of its assets at that time. In February 1997, Point West Capital's Board decided
to cease the Company's viatical settlement business. See Note 1 of Notes to
Consolidated Financial Statements. Through December 31, 1999, the Company had
entered into agreements to sell 375 policies with an aggregate sale price of
$19.5 million, representing $29.3 million in aggregate face value. By December
31, 1999, the Company had completed the sale of (or otherwise collected) all but
six policies (having an aggregate face value of $358,000) under these sales
agreements. Substantially all of the sales took place during 1997. Point West
Capital continues to service the life insurance policies held by DPFC which at
December 31, 1999 totaled 457 policies with a face value of $36.6 million and a
carrying value of $31.7 million. See "Item 1--Business -- Asset Sales; Viatical
Settlement Business -- Viatical Business."
As a result of the decision in the third quarter of 1996 to sell all or
substantially all of the Company's assets, the Company reclassified all of its
assets at that time (other than the policies held by DPFC) to a "held-for-sale"
category during the third quarter of 1996. Accordingly, these assets are
accounted for at the lower of carrying value or fair value less cost to sell.
Method of Consolidation
- -----------------------
The Company's financial statements consolidate the assets, liabilities and
operations of DPFC, Ventures, Allegiance and PWS. See "Item 1--Business--The
Company" and Note 1 of Notes to
15
Consolidated Financial Statements. Operations for PWS in 1999 and 1998 were
immaterial. With the exception of Allegiance, Point West Capital directly or
indirectly owns virtually all of the equity interests in its consolidated
entities.
Point West has a 65% ownership interest in and 95% voting control of
Allegiance Capital. Allegiance Capital owns 100% of both Allegiance Funding and
Allegiance Management. Allegiance Funding owns approximately 15% of Allegiance
Trust I. The Allegiance Financing does not qualify for sale treatment under
Statement of Financial Accounting Standards No. 125, Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities ("SFAS
125") because the terms of the Allegiance Financing entitle Allegiance Funding
to repurchase loans prior to the point at which the cost of servicing them
becomes burdensome. Accordingly, the Allegiance Financing will not receive gain
on sale treatment under SFAS 125. The loans and borrowings under the Allegiance
Financing are reflected in the Consolidated Balance Sheets.
Point West formed Allegiance Capital in September 1997, and made the
only capital contribution to Allegiance Capital. During 1998, Point West Capital
was allocated 99.5% of the interest on loans through November 20, 1998, which
was the initial funding date for the Allegiance Financing. Point West Capital is
allocated a preferred return (based on the weighted-average interest rate of all
loans outstanding) to the extent that Point West Capital's capital investment in
Allegiance exceeds $3.0 million. In addition, net profits of Allegiance Capital
for each calendar year are allocated to Point West Capital in an amount equal to
a return of 10% per annum, compounded monthly, on the amount of its capital
contribution, but not in excess of such net profits. Any shortfall is carried
forward indefinitely to the next calendar year or years in which net profits are
sufficient to make such allocation. An additional 5% return for each calendar
year will be allocated first to Point West Capital to the extent that in each
year sufficient profits are available with no carry forward provided.
Share Repurchase Program
- ------------------------
In October 1996, the Board approved a share repurchase program pursuant
to which the Company was authorized to purchase from time to time up to 1
million shares of Common Stock at prevailing market prices. In June 1997, such
authority was increased to 1.04 million shares of Common Stock. In June 1997,
the Company completed the share repurchase program, having repurchased an
aggregate of 1.04 million shares at a weighted-average price of $2.77 per share.
Results of Operations for the Company
- -------------------------------------
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
---------------------------------------------------------------------
Total Income. Total income increased $18.4 million to $19.7 million in
1999 from $1.3 million in 1998 primarily due to $13.0 million of net gain on
securities recognized by Ventures. Also contributing to the increase was (i)
$2.8 million of net gain on securities sold by Point West Capital and (ii) an
increase in interest income primarily related to an increase in loans held by
Allegiance and Ventures. Offsetting the increase in 1999 compared to 1998 was an
aggregate decrease of $393,000 in income related to the Viatical Settlement
segment. See "Results of Operations by Segment -- Viatical Settlements -- Year
Ended December 31, 1999 Compared to Year Ended December 31, 1998 and Year Ended
December 31, 1998 Compared to Year Ended December 31, 1997 -- Earned Discounts
on Matured Policies" and " -- Gain on Assets Sold."
Total Expenses. Total expenses increased 43.8% to $10.5 million in 1999
from $7.3 million in 1998. This increase was primarily due to a $1.3 million
increase in interest expense related to borrowings
16
by Allegiance. Also contributing to the increase were (i) $945,000 of litigation
expense recorded in 1999 reflecting the net amount of the settlement agreement
related to the pending federal class action and state alleged class action
lawsuits not covered by insurance, (ii) an increase in compensation and benefits
for employees in 1999, (iii) an increase in legal and professional expenses
related to Allegiance, and (iv) a write-off of a loan. See "Results of
Operations by Segment -- Other -- Other General and Administrative Expenses."
The settlement agreement is subject to Court approval.
Income Taxes. The income tax benefit of $590,000 recorded in 1999 is
primarily related to the elimination of the valuation allowance and the
utilization of the net operating losses (NOLs) to offset net gain on securities
recognized by Ventures. See "Income Taxes." In 1998, the Company recorded $5,600
for minimum state income taxes. See Note 8 of Notes to Consolidated Financial
Statements.
Net Loss in Wholly Owned Financing Subsidiary Charged to Reserve for
Equity Interest. The DPFC net loss of $4.2 million for 1999 and $1.7 million for
1998 was included in the Company's net income (loss). During 1998, an additional
$2.3 million of DPFC loss was charged against the reserve for equity interest in
wholly owned financing subsidiary. Prior to the depletion of the reserve during
the third quarter of 1998, losses were charged against the reserve for equity
interest in wholly owned financing subsidiary. After the reserve was fully
depleted during the third quarter of 1998, DPFC's losses have been reflected in
the Company's net income (loss). All additional losses of DPFC will be reflected
in the Company's net income (loss) during the periods in which such losses
occur.
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
---------------------------------------------------------------------
Total Income. Total income decreased 66.7% to $1.3 million in 1998 from
$3.9 million in 1997 due primarily to a $1.0 million loss on securities
recognized by Ventures in 1998. Total income for 1997 included a $680,000 gain
on securities sold by Point West Capital. Also contributing to the decrease was
a $1.3 million decrease in the gain on life insurance policies sold. Offsetting
this decrease was an increase of $310,000 for 1998 in interest income related to
the activities of Allegiance and Ventures.
Total Expenses. Total expenses increased 7.4% to $7.3 million in 1998
from $6.8 million in 1997. Contributing to the increase were: (i) a $363,000
increase in compensation and benefits resulting from the hiring of employees to
support Allegiance's and PWS' activities and an increase in salaries and other
benefits for other employees for 1998; and (ii) a $253,000 increase in other
general and administrative expenses due to increased premium expenses incurred
in connection with life insurance policies held by DPFC. The 1997 expenses
include a $328,000 provision for loss on assets held for sale.
Income Tax Expense. In 1998, the Company recorded $5,600 for minimum
state income taxes versus $4,000 in 1997. See Note 8 of Notes to Consolidated
Financial Statements.
Net Loss in Wholly Owned Financing Subsidiary Charged to Reserve for
Equity Interest. The DPFC net loss of $2.3 million and $3.9 million recorded in
1998 and 1997, respectively, were included in the Company's loss before income
taxes and net loss in wholly owned financing subsidiary charged to reserve for
equity interest.
Results of Operations by Segment
- --------------------------------
Viatical Settlements
--------------------
The Viatical Settlements segment includes results of operations in
connection with viatical settlements for DPFC and Point West Capital.
17
Method of Accounting for Viatical Settlements
Through June 30, 1996, the Company used the level yield method to
recognize income on life insurance policies. See the Company's 1998 Form 10-K
for a further description thereof. As a result of the Company's decision in 1996
to sell all or substantially all of its assets, the Company established a
reserve for loss on sale of assets during 1996. This reserve is reevaluated
quarterly. The reserve for loss on sale of assets was $132,000 and $167,000 as
of December 31, 1999 and 1998, respectively. In 1996, the Company also
established a reserve for loss of Point West Capital's equity interest in DPFC.
By the end of the third quarter of 1998, the reserve was fully depleted. See
"Certain Accounting Implications for DPFC."
During 1999, 1998 and 1997, the Company recognized income with respect
to its viatical settlement business upon receipt of proceeds on policies (either
pursuant to sale of the policy or the death of the insured). The income is equal
to the difference between the policy proceeds (less any back-end sourcing fees)
and the carrying value of the policies after giving effect to any reserve for
loss on the sale of such policies. The Company also no longer includes, in the
carrying value of policies in the Consolidated Balance Sheet, premiums incurred
after June 30, 1996, but began expensing these costs in the Consolidated
Statement of Operations.
Certain Accounting Implications for DPFC
Although the Securitized Notes have a stated maturity of March 10,
2005, the Securitized Notes were originally expected to be repaid by the fourth
quarter of 1997. However, at December 31, 1999, $38.5 million remained
outstanding under the Securitized Notes. As a result of the substantially
delayed collection of DPFC policies, DPFC had a deficit of approximately $5.9
million at December 31, 1999.
If the collection experience for the DPFC policies continues to be
substantially delayed, DPFC's deficit will increase for one or more of the
following reasons. First, a decision to discontinue paying premiums on some
policies may be made because the present value of the expected death benefit on
some policies may be less than expected future premiums to be paid on such
policies. Second, the face value of certain policies (especially group term) may
begin to decrease as the people whose lives are insured thereunder reach
specified age levels (often 65). Finally, policies for which the insurance was
continued under a disability provision may be uneconomical to convert given the
insured's age and life expectancy if such insured person is no longer considered
disabled. The Company cannot determine at present the extent to which policies
held by DPFC will be so affected.
In 1999, the total loss realized by DPFC was $4.2 million, which was
reflected in the Company's net income. In 1998, the total loss realized by DPFC
was $4.0 million, $2.3 million of which was charged against the reserve for
equity interest in wholly owned financing subsidiary, and $1.7 million of which
was reflected in the Company's net loss. The average historical quarterly losses
in DPFC have been approximately $1 million per quarter over the past four
quarters. Upon the retirement of the Securitized Notes, the Company will
recognize a gain in an amount approximately equal to any accumulated deficit of
DPFC net of any tax effect.
The Securitized Notes represent the obligations solely of DPFC. Point
West Capital did not guarantee repayment of the Securitized Notes and is not
required to fund any principal or interest deficiencies thereunder.
18
Potential Default by DPFC
The Company and the Noteholders were previously in discussions
regarding ongoing responsibilities for the Securitized Notes and the potential
liquidation of DPFC. However, these discussions have ceased. If the Company and
the Noteholders do not modify existing obligations and responsibilities for the
Securitized Notes, it appears likely that sometime between March and June 2000
there will be insufficient funds available to pay interest on, and other costs
associated with, the Securitized Notes. Such other costs consist primarily of
Point West Capital's monthly servicing fee of $36,000 and the reimbursement to
Point West Capital for premiums paid (which during 1998 and 1999 averaged
$23,000 per month). The exact point in time that there will be insufficient
funds cannot be determined because it is dependent on life insurance policy
collections. Based on the liquidity account balance as of February 29, 2000 and
on policies collected during February 2000, sufficient funds are available to
pay interest on, and a portion of other costs associated with, the Securitized
Notes through February 2000. A failure to pay interest under the Securitized
Notes would constitute an event of default under the Indenture. In addition, a
failure to pay other costs associated with the Securitized Notes would, if not
cured within 30 days, constitute an event of default under the Indenture. An
event of default would give the Noteholders the right to accelerate the payment
of the Securitized Notes, foreclose on the policies and dismiss Point West
Capital as the servicer. In addition, when DPFC is liquidated or the Securitized
Notes are otherwise retired, the Company will have income tax liability
associated with the gain from debt forgiveness. The Company may be able to
utilize the carryforward losses from DPFC to offset such liability, unless the
carryforward losses have been previously utilized. The Company does not
currently know what actions might be taken or claims might be made by either the
Noteholders or the Company with respect to an event of default or any
insufficiency of funds to pay costs associated with the Securitized Notes.
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
and Year Ended December 31, 1998 Compared to Year Ended December 31,
1997
Earned Discounts. Earned discounts on matured polices decreased 53.5%
to $204,000 in 1999 from $439,000 in 1998, and decreased 10.2% in 1998 from
$489,000 in 1997. The decreases are due primarily to fewer deaths of insureds
and secondarily to a decrease in the size of the Company's portfolio of life
insurance policies. During 1999, earned discounts on matured policies were
recognized on 38 policies with a face value of $2.4 million, compared to 46 and
77 policies with a face value of $2.9 million and $4.9 million in 1998 and 1997,
respectively. See "Method of Accounting for Viatical Settlements." As of
December 31, 1999, the Company held 463 policies with an aggregate carrying
value of $31.8 million (comprised of "purchased life insurance policies" and a
portion of "other assets") and an aggregate face value of $36.9 million. All of
the "purchased life insurance policies" are pledged as security for the
Securitized Notes.
Interest Income. Interest income decreased 60.5% to $79,000 in 1999
from $200,000 in 1998, and 13.8% in 1998 from $232,000 in 1997, as a result of
lower cash balances attributable to DPFC and to lower yields on such cash
balances. DPFC's cash balances are affected by the amount and timing of any
policy collections and by the amount and timing of expenses (such as interest,
trustee fees, premium costs and servicing fees) related to its portfolio. The
cash generated by DPFC policy collections is restricted under the Indenture.
Gain on Assets Sold. The gain on assets sold decreased 95.2% to $8,000
in 1999 from $165,000 in 1998 and 89.0% in 1998 from $1.5 million in 1997. The
Company collected sale proceeds on one policy in 1999 compared to seven and 246
policies in 1998 and 1997, respectively. The realized gain was calculated based
on the difference between the sale proceeds and the carrying value after giving
effect to the provision for loss on sale of assets. See "Cessation of Viatical
Settlement Business; Sale of Assets."
19
The Company collected a large portion of the sale proceeds from life insurance
policies in 1997. Therefore, there have been and will be minimal (if any) gains
or losses on any policies sold in future periods pursuant to existing
agreements.
Other Income. Components of other income include collections on
policies of dividends, interest and paid-up cash values, increases in face value
of matured policies and refunds of premiums on matured policies. Other income
decreased 55.5% to $77,000 in 1999 from $173,000 in 1998. This decrease was due
to the face value increase described below and to the decrease in the number and
amount of matured policies. Other income increased $106,000 in 1998 from $67,000
in 1997 due to a $65,000 increase in face value on one policy in 1998 and an
aggregate of $43,000 in paid-up cash values on two policies in 1998.
Interest Expense. Interest expense remained relatively constant at $3.5
million in 1999 and $3.6 million in 1998 and 1997. Average borrowings under the
Securitized Notes changed less than $1.0 million over the past three years.
Other General and Administrative Expenses. Other general and
administrative expenses decreased 44.1% to $356,000 in 1999 from $637,000 in
1998. During 1998 the Company recorded a historically high premium expense. The
Company believes that if the life insurance policies continue to mature slowly,
life insurance premium costs are likely to increase in future periods
notwithstanding the decrease in 1999. See "Certain Accounting Implications for
DPFC." Other general and administrative expenses increased $402,000 in 1998 from
$235,000 in 1997. This increase was due primarily to an increase in life
insurance policy premium costs. However, because such premium costs were largely
charged against the reserve for equity interest in wholly owned financing
subsidiary until it was depleted in the third quarter of 1998, the increase had
a marginal effect on the Company's 1998 net income (loss) relative to 1997.
Provision for Loss on Assets Held for Sale. The Company recorded in
1996 a provision for loss on sale of assets totaling $3.1 million. In 1997, the
Company recorded an additional provision in the amount of $328,000 in connection
with the remaining policies not yet sold, based on management's revised best
estimate of proceeds from the sale of such policies. No further provision was
considered necessary in 1999 or 1998 because management believed that the
existing provision was adequate.
Ventures
--------
Method of Accounting for Loans and Debt and Equity Securities
Statement of Financial Accounting Standards No. 115, Accounting for
Certain Investments in Debt and Equity Securities ("SFAS 115"), requires
marketable debt and equity securities to be classified into held-to-maturity,
available-for-sale and trading categories. Securities classified as
available-for-sale are reported in the Consolidated Balance Sheets at fair value
with any cumulative unrealized gains and losses as a separate component of
stockholders' equity. The Company uses the cost method to account for
non-marketable securities. The Company reviews on a quarterly basis all
non-marketable securities and attempts to ascertain whether the value is
impaired. For further information regarding accounting for securities classified
as available-for-sale, see Note 2 of Notes to Consolidated Financial Statements.
Any realized gains and losses, interest and dividend and unrealized losses on
securities judged to be other-than-temporary are reported in the Consolidated
Statements of Operations on an appropriate line.
The Company accounts for loans at the principal amount outstanding, and
accruing interest on outstanding balances. At December 31, 1999 and 1998, the
Company evaluated each of Ventures' outstanding loans and determined that an
allowance for loan losses was not necessary. As Ventures' loan
20
portfolio grows or upon subsequent evaluation, the Company will provide for
allowances for loan losses to the extent considered necessary. See Note 3 of the
Notes to Consolidated Financial Statements.
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
and Year Ended December 31, 1998 Compared to Year Ended December 31,
1997
Interest Income. Interest income increased to $1.2 million in 1999 from
$300,000 in 1998. This increase was primarily due to $625,000 of interest income
recognized in 1999 as a result of warrants (valued using the Black-Scholes
option-pricing model) received in connection with one of Ventures' loans. Also
contributing to the increase was a $284,000 original issue discount recognized
in connection with a debt security that was repaid in December 1999. Interest
income increased $167,000 in 1998 from $133,000 in 1997. This increase was due
primarily to $98,000 of interest income recognized in 1998 as a result of a
warrant received in connection with the loan described above. Also contributing
to the increase was an increase in the number of loans made by Ventures. See
"Method of Accounting for Loans and Debt and Equity Securities."
Net Gain (Loss) on Securities. Ventures recognized a net gain on
securities of $13.0 million in 1999 primarily in connection with the sale of two
of its investments. See "Income Tax." Ventures reviews on a quarterly basis all
non-marketable securities and attempts to ascertain whether the value is
impaired. As a result of such review, Ventures determined that $535,000 of
non-marketable equity securities held of one company was impaired at June 30,
1999 and $500,000 of non-marketable equity securities held of another company
was impaired at December 31, 1999. Therefore, Ventures wrote-off the entire
$1,035,000 carrying value of such securities in 1999, which is included in the
net gain on securities. This write-off partially offset Venture's gain on
securities during 1999. Ventures recognized a net loss on securities of $979,000
in 1998 primarily because it determined that $1,004,000 of non-marketable
securities held of one company was impaired at September 30, 1998, and therefore
wrote-off the entire $1,004,000 carrying value of such security in 1998. This
write-off completely offset Venture's $25,000 gain on securities during 1998.
Ventures did not recognize any net gain (loss) on securities in 1997.
Other Income. In 1999, Ventures recognized other income of $64,000 in
connection with a partial recovery of a $1.0 million investment that was
completely written-off in 1998 and a fee related to one of Ventures' loans.
Ventures recognized no other income in 1998 and minimal other income in 1997.
Interest Expense. Interest expense increased to $208,000 in 1999 from
$98,000 in 1998 due to a full year of interest owed on funds borrowed from the
SBA in July 1998. The fixed interest rate (including a 1% annual fee) is 6.9%.
Prior to July 1998, Ventures had no debt.
Amortization. Amortization costs decreased 51.6% to $30,000 in 1999
from $62,000 in 1998. The 1998 period reflects organizational costs which are
currently required to be expensed as incurred and were written-off at the end of
1998. Amortization costs increased $58,000 in 1998 from $4,000 in 1997 because
of the financing costs associated with the funds borrowed in July 1998 and
because organizational costs were expensed in 1998.
Allegiance
----------
Method of Accounting for Loans
The Company accounts for loans advanced by Allegiance by carrying them
at the principal amount outstanding, and accruing interest on outstanding
balances. At December 31, 1999 and 1998 the allowance for loan losses was
$155,000 and $50,000, respectively. The allowance for loan losses is
21
estimated by management based on a review of the loans and factors which in
management's judgement indicate impairment is inherent in the portfolio on the
balance sheet date. Management believes that the allowance for loan losses is
adequate. Although management uses available information to recognize losses on
loans, future additions to the allowance may be necessary based on changes in
economic conditions. At December 31, 1999, one loan was in default and on
non-accrual status. This loan is not included in the collateral securing the
Allegiance Financing.
Loan origination fees and direct loan origination costs are capitalized
and recognized over the life of the related loan as an adjustment of yield
(interest income) in accordance with Statement of Financial Accounting Standards
No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating
or Acquiring Loans and Initial Direct Costs of Leases ("SFAS 91").
The Allegiance Financing provides for long-term fixed and short-term
fixed and floating rate debt. See "Description of Revolving and Term
Certificates." Allegiance, from time to time, uses futures contracts to hedge
certain interest rate exposure between the time of origination of the loans and
the expected issuance of term certificates. The futures contracts are intended
to protect a portion of the net interest margins earned on the loans. Any
realized gain or loss related to these hedges are deferred and recognized by
Allegiance over the life of the related loan as an adjustment of interest
income. Pursuant to Statement of Financial Accounting Standards No. 80,
Accounting for Futures Contracts ("SFAS 80"), all such deferred amounts are
reflected in the Consolidated Balance Sheets as an increase (in the case of a
hedging loss) or decrease (in the case of a hedging gain), in the carrying value
of loans receivable. As of December 31, 1999, Allegiance had net realized gains
on its hedging activities of $215,000 which decreased loans receivable in a like
amount. As of December 31, 1999, Allegiance had no open hedges. As of December
31, 1998, Allegiance had net realized losses on its hedging activities of
$261,000 which increased loans receivable in a like amount.
Unrealized net losses from open hedges as of December 31, 1998 were $800.
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
and Year Ended December 31, 1998 Compared to Year Ended December 31,
1997
Interest Income. Interest income increased to $1.8 million in 1999 from
$589,000 in 1998 and $14,000 in 1997. This increase was due to increased lending
activity by Allegiance. However, offsetting this increase was $132,000 of
interest in 1999 that was not accrued on one delinquent loan. Allegiance had 21
loans outstanding in the aggregate amount of $33.8 million at December 31, 1999
as compared to five loans and one loan outstanding in the aggregate amount of
$9.1 million and $3.8 million at December 31, 1998 and December 31, 1997,
respectively. The weighted-average interest rate on the loans outstanding during
1999 was 8.9% compared to 9.4% during 1998 and 1997. The weighted-average
interest rate is calculated based on the total interest earned for the
appropriate period, excluding one loan on non-accrual status, divided by the
weighted-average principal balance outstanding during the appropriate period.
The weighted-average interest rate for the 1999 period decreased because one
loan in the amount of $2.1 million was delinquent and on non-accrual status.
Allegiance cannot predict at this time whether the loan will remain on
non-accrual status. However, to the extent that the loan does remain on
non-accrual status, Allegiance does not anticipate receiving interest income
(approximately $16,000 per month) from such loan. Allegiance has declared an
event of default on the delinquent loan and is in the process of taking actions
to foreclose on assets securing the loan. Based on a preliminary assessment of
the business and operations of the defaulted borrower, Allegiance believes it
will not incur any loss in connection with such loan. See "Item 3--Legal
Proceedings."
Interest Expense. Interest expense increased to $1.2 million in 1999
from $31,000 in 1998 as a result of the interest paid under the Allegiance
Financing. During 1999 the weighted-average interest rate under the Allegiance
Financing was 7.9% and the weighted-average borrowings were $15.4 million
22
compared to a weighted-average interest rate of 9.2% and weighted-average
borrowings of $299,000 for 1998. Prior to November 1998, Allegiance had no debt.
Compensation and Benefits. Compensation and benefits increased 55.4% to
$286,000 in 1999 from $184,000 in 1998 and increased $137,000 in 1998 from
$47,000 in 1997. These increases resulted from the hiring of additional
employees to support Allegiance's lending activities.
Other General and Administrative Expenses. Other general and
administrative expenses increased $344,000 to $522,000 in 1999 from $178,000 in
1998. This increase was due primarily to a $152,000 increase in general legal
expense, a $55,000 increase in allowance for loan losses, a $64,000 increase in
professional fees related to the one delinquent loan, and a $49,000 increase in
expenses related to the Allegiance Financing. Other general and administrative
expenses increased $145,000 in 1998 from $33,000 in 1997. This increase was
primarily due to an increase in Allegiance's activities and the allowance for
loan losses that was recorded in 1998. See "Method of Accounting for Loans."
Amortization. Amortization costs increased $167,000 to $223,000 in 1999
from $56,000 in 1998 and $55,000 in 1998 from $1,000 in 1997. The 1999 period
reflects a full year of financing costs associated with the Allegiance Financing
which was completed in August 1998. The 1998 period reflects financing costs
associated with the Allegiance Financing and organizational costs which are
currently required to be expensed as incurred and were written-off at the end of
1998. The 1997 period reflects organizational costs.
Other
-----
The Other segment includes operating results for Point West Capital and
PWS. Except for compensation and benefit expenses clearly attributable to
Allegiance, corporate overhead is included in the Other segment and has not been
allocated to other segments. Activities for PWS were immaterial in 1999 and
1998.
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
and Year Ended December 31, 1998 Compared to Year Ended December 31,
1997
Interest Income. Interest income declined 43.1% to $231,000 in 1999
from $406,000 in 1998. Interest income declined because a larger portion of cash
balances have been invested in lower yielding instruments (primarily government
securities) in 1999 compared to higher yielding instruments (primarily
commercial paper and corporate bonds) in 1998. See "Considerations Under the
Investment Company Act of 1940." Interest income decreased 49.5% in 1998 from
$804,000 in 1997. This decrease in 1998 compared to 1997 is due to lower cash
balances. In 1998, the Company used a portion of proceeds from the sale of
policies in the first half of 1997 to grow other businesses. In 1997, such
proceeds were invested in short term securities and marketable securities.
Net Gain (Loss) on Securities. Net gain on securities increased to $2.8
million in 1999 from ($20,000) in 1998. This increase was primarily the result
of a $2.4 million gain in connection with the partial sale by Point West of one
of its investments. Also contributing to the increase was a gain in connection
with hedging activities of Internet related stocks of $312,000. Under generally
accepted accounting principles such hedging activities do not constitute hedges
under SFAS 80. Therefore, such hedging activities are reflected in the Company's
Consolidated Statement of Operations. At December 31, 1999 no such hedges were
in place. See "Item 7A -- Quantitative and Qualitative Disclosures About Market
Risks." Net gain on securities decreased in 1998 from $680,000 in 1997 because
Point West Capital recognized a $680,000 gain in 1997 in connection with another
partial sale of the investment described above.
23
Other Income. Other income increased to $252,000 in 1999 from $70,000
in 1998. This increase was due to (i) an increase of $140,000 in fees received
by PWS for investment banking services and (ii) $42,000 in trading commissions
generated by PWS in 1999. The amount and timing of these services in future
periods cannot be predicted because of the limited operating history of PWS and
the uncertainty regarding the scope of services to be provided by PWS. Other
income increased $44,000 in 1998 from $26,000 in 1997. This increase was
primarily a result of a $70,000 placement fee received by Point West Capital in
connection with an investment made by co-investors of Point West Ventures in an
unaffiliated small business entity. The placement fee received was in the form
of preferred shares. These preferred shares were written off in 1998 as part of
the $1.1 million write off of non-marketable securities. See Note 4 of Notes to
Consolidated Financial Statements.
Compensation and Benefits. Compensation and benefits increased 30.8% to
$1.7 million in 1999 from $1.3 million in 1998 and 18.2% in 1998 from $1.1
million in 1997. These increases were due primarily to an increase in
compensation and benefits for employees.
Other General and Administrative Expenses. Other general and
administrative expenses increased $1.3 million to $2.2 million in 1999 from
$882,000 in 1998. This increase was primarily due to $945,000 of litigation
expense recorded in 1999 reflecting the net amount of the settlement agreement
related to the pending federal class action and state alleged class action
lawsuits not covered by insurance. On February 25, 2000, the Court approved a
proposed settlement of the lawsuits. As a result, the Company expects legal
expenses to decrease substantially in 2000 relative to 1999 and 1998. See "Item
3--Legal Proceedings." Also contributing to the increase were a $140,000 loan
write-off, a $101,000 increase in legal expenses incurred in connection with the
federal and state alleged class action lawsuits, a $65,000 increase in rent
expense and a $55,000 increase in accounting expense. During the second quarter
of 1999, the Company renewed the lease on its current space. The Company's
monthly rent increased from $5,240 per month to approximately $15,000 per month.
Other general and administrative expenses decreased 26.5% in 1998 from $1.2
million in 1997. This decrease was due primarily to a decrease in legal expenses
in 1998 in the amount of $228,000 incurred in connection with the federal and
state alleged class action lawsuits. This decrease was largely a result of Point
West Capital's directors and officers insurance policy retention limit being
satisfied, requiring the insurance carrier to fund the majority of the
continuing costs of such litigation.
Liquidity and Capital Resources
- -------------------------------
Point West Capital and PWS
At present, neither Point West Capital nor PWS has an external funding
source from which to fund its working capital and general corporate needs.
During 1999, the Company supported the operations of Point West Capital and PWS
primarily from existing cash balances and sale proceeds of investment
securities. In prior periods, the Company generated cash primarily from sales
proceeds of life insurance policies and investment securities. The Company
invested the cash in the growth of its businesses. At December 31, 1999, Point
West Capital and PWS' cash and cash equivalents were $767,000. At December 31,
1999, Point West Capital and PWS' investment securities classified as
held-to-maturity were $2.5 million, which consisted of government securities.
The Company continues to analyze its current and future needs for financing,
which will be dependent on its ability to develop the businesses of Ventures,
Allegiance and PWS and any other business opportunities the Company pursues. See
"Considerations Under the Investment Company Act of 1940." There can be no
assurance that Point West Capital or PWS will be successful in obtaining
external financing on satisfactory terms assuming the Company determines
additional funds are needed. The Company at present anticipates having
sufficient liquidity to meet the working capital and operational needs of Point
West Capital and PWS through 2000, using current cash and cash equivalents.
24
DPFC
DPFC operations are in run-off. Point West Capital, as servicer under
the Securitized Notes, performs monitoring and collection activities for DPFC
and incurs administrative costs associated with these activities. Point West
Capital is reimbursed for these costs subject to priority provisions contained
in the Indenture. As of December 31, 1999, the outstanding principal amount of
the Securitized Notes was $38.5 million. As of the same date, DPFC had
restricted cash of $1.0 million, which cannot be accessed by Point West Capital
except for reimbursement of costs incurred in connection with its activities as
servicer under the Indenture. Principal and interest payments on the Securitized
Notes are payable solely from collections on policies pledged to secure the
payment thereof and do not require Point West Capital to expend cash or obtain
financing to satisfy such principal and interest obligations. For a discussion
of the adverse effects of a potential default by DPFC on the Company, see
"Results of Operations by Segment -- Viatical Settlements -- Potential Default
by DPFC."
Ventures
Ventures' activities have generally been supported by capital
contributions from Point West Capital, by the sale of investments, by loans from
the SBA and the repayment by obligors of loans. During 1997, 1998 and 1999 Point
West Capital contributed to Ventures $2.5 million, $2.5 million and $800,000,
respectively. During 1999, Ventures generated $21.3 million of cash proceeds
(net of commissions) from the sale of securities and repayment of loans. At
December 31, 1999, Ventures' cash and cash equivalents were $11.5 million.
Point West Ventures has an SBA debenture license and, therefore, may be
permitted, based on capital contributions by Point West Capital and realized
gains on the sale of securities, to borrow up to $16.6 million from the SBA. Any
borrowings bear interest at the Debenture Rate. Interest is payable
semi-annually. In addition, there is a leverage and underwriting fee of 3.5% and
a fee of 1% per annum on the outstanding amount of debt. Among other
requirements, an SBIC with an SBIC debenture license must maintain proper
diversification of its portfolio. This requirement generally means that in order
to borrow funds from the SBA, no single investment may exceed 20% of the SBIC's
regulatory capital plus its net unrealized investment gains. The net unrealized
investment gains may be used in this calculation only if the SBIC has positive
retained earnings. Additionally, the portfolio must consist of a proper mix of
debt and equity investments. In July 1998, Point West Ventures borrowed $3.0
million from the SBA.
Ventures may not have sufficient liquidity, at least in the short term,
to grow its business. In addition, because of substantial appreciation in
investments, the Company may be required to restrict Ventures' growth in order
to avoid registration under the Investment Company Act of 1940 at some time in
the future. See "Considerations Under the Investment Company Act of 1940."
Allegiance
As of December 31, 1999, Point West Capital had invested $7.5 million
in Allegiance Capital. In August 1998, Allegiance put in place the Allegiance
Financing. See "Description of Revolving and Term Certificates." The Company
expects that the Allegiance Financing will provide sufficient funds to support
Allegiance's current level of lending activities through April 15, 2000.
Allegiance is attempting to arrange additional financing for its loan
origination activities after April 15, 2000, but no assurance can be given that
such financing will be obtained or obtained on terms acceptable to Allegiance.
See Note 5 of Notes to Consolidated Financial Statements.
25
Description of Revolving and Term Certificates
- ----------------------------------------------
Pursuant to the Allegiance Financing, a consortium of insurance
companies (the "Investors") provided funding through September 20, 1999, with a
balance at that date of $24.9 million, on a non-recourse revolving certificate
basis which was used for the purchase or funding of loans originated by
Allegiance Capital and transferred, through Allegiance Funding, to Allegiance
Trust I. On September 21, 1999, the revolving certificates then outstanding were
repaid through the issuance of the term certificates described below.
Under the Allegiance Financing, various classes of revolving and term
certificates of Allegiance Trust I have been issued. The original revolving
certificates were issued in August 1998 in four classes, consisting of Class
A-R, Class B-R, Class C-R and Class D-R. The Class D-R certificate, which
represents the right to receive all excess cash flow from Allegiance Trust I,
was unrated while the other revolving certificates received ratings from Duff &
Phelps Credit Rating Co. ("Duff & Phelps") ranging from A to BB. At September
20, 1999, the following principal amounts of Class A-R, Class B-R, Class C-R and
Class D-R revolving certificates were outstanding, respectively: $19.5 million,
$3.2 million, $2.2 million and $2.4 million. At September 21, 1999 such
revolving certificates were repaid through the issuance in the following amounts
of Class A, Class B, Class C, Class D, Class E and Class F term certificates:
$17.8 million, $1.8 million, $2.0 million, $1.8 million, $1.3 million and $2.6
million. The Class F term certificate, which was retained by Allegiance, was
unrated while the other term certificates received ratings from Duff & Phelps
ranging from AA to B. The weighted-average fixed interest rate of the term
certificates held by third parties is 8.1%.
The Company and Investors executed amendments which extended the
Allegiance Financing through April 15, 2000. The Investors agreed to continue to
provide revolving debt, subject to certain limitations, through April 15, 2000,
on terms similar to those under the original revolving certificates under the
Allegiance Financing, but with the addition of another class of revolving
certificates as described below. Allegiance has agreed to retain an unrated
revolving certificate related to the extension. In addition, the Investors
agreed to provide up to $20.2 million of additional term financing, subject to
certain limitations, through April 15, 2000, on terms similar to those under the
original term certificates issued under the Allegiance Financing. The fixed
interest rate on the additional term certificates will be based on the ten-year
U.S. Treasury yield plus a spread ranging from 2.0% to 8.5%. As of December 31,
1999, Allegiance has borrowed $4.2 million under the revolving certificates.
Allegiance anticipates converting to term debt any outstanding revolving debt
under the Allegiance Financing as of April 15, 2000.
Pursuant to the extension, as additional funds are utilized going
forward, the amount issued under the various classes of term certificates will
increase, and such increases may be disproportionate to the current proportions
of term certificates outstanding. In December 1999, Allegiance Trust I reissued
the Class C-R revolving certificate as two classes, Class C1-R and Class C2-R,
and funded the Class B-R, Class C1-R, Class C2-R and Class D-R revolving
certificates. The Class C1-R certificates were funded in the principal amount of
$1.4 million and the Class C2-R certificates were funded in the principal amount
of $1.1 million. The Class B-R certificates were funded in the principal amount
of $1.7 million. Such certificates bear interest at a fixed rate based on the
one-year U.S. Treasury yield plus a weighted-average spread of 4.7%. The
weighted-average interest rate of the revolving certificates held by third
parties at December 31, 1999 was 10.4%. Allegiance funded and retained the
unrated Class D-R revolving certificate in the amount of $2,197,000.
The Allegiance Financing does not qualify for sale treatment under SFAS
125 because it entitles Allegiance Funding to repurchase loans prior to the
point at which the cost of servicing them becomes burdensome. Accordingly, the
Allegiance Financing will not receive gain on sale treatment under SFAS
26
125. The loans and borrowings under the Allegiance Financing are reflected in
the Consolidated Balance Sheets.
In connection with the Allegiance Financing, Allegiance Capital paid a
$175,000 commitment fee when funds were initially borrowed. Of such commitment
fee, $58,000 has been amortized over the expected life of the revolving
certificates (10 months) and $117,000 are being amortized over the expected life
of the term certificates (15 years). In connection with the extension,
Allegiance paid a $125,000 commitment fee. Of such fee, $42,000 will be
amortized over the expected life of the revolving certificates (8 months) and
$83,000 will be amortized over the expected life of the term certificates (15
years). These allocations were based on an estimate of the portion of the
commitment fee attributable to the revolving certificates and the term
certificates.
Allegiance's ability to borrow under the Allegiance Financing is based
on the delivery of loans meeting certain eligibility criteria relating to
loan-level and pool-level credit criteria, form of security and appropriate
legal documentation. The loan-level credit criteria and security and
documentation requirements generally follow Allegiance's basic lending
guidelines. The pool-level criteria create requirements with respect to a
variety of parameters intended to achieve certain overall levels of credit
quality and credit diversification. The ability to borrow is also subject to the
non-occurrence of certain events of default, some of which are curable and some
of which result in permanent loss of borrowing rights. Permanent loss of funding
will result from, among other things, the following: (i) non-payment of interest
on the revolving certificates (ii) any event of default by the servicer, Point
West Capital, or special servicer, Allegiance Capital (as described below), not
cured or waived within 30 days; (iii) the occurrence of certain events of
bankruptcy, insolvency or reorganization with respect to Allegiance Funding; and
(iv) the occurrence of certain specified levels of delinquent or defaulted loans
or loan losses. Temporary loss of funding will result from exceeding certain
specified levels of delinquent or defaulted loans or loan losses, or from
non-compliance with required liquidity account levels (as described below).
Under the Allegiance Financing, a liquidity account (the "Reserve
Account") is required to be maintained, generally at 1% of the aggregate balance
of loans underlying the revolving and term certificates, subject to a minimum of
$250,000. The required amount can increase by a formula amount upon the
incurrence of, and based on a fraction of the dollar amount of, any delinquent,
defaulted or underperforming loans.
Point West Capital acts as servicer and Allegiance Capital acts as
special servicer pursuant to a Servicing Agreement (the "Allegiance Servicing
Agreement"). As servicer, Point West Capital is required to provide monthly
reports to the trustee regarding loan collections, to maintain the loan payment
records and to provide related monitoring services. Point West Capital receives
a fee of 0.20% per annum on the outstanding balance of the loan pool, underlying
the revolving and term certificates and bears all expenses related to its
duties, as well as the trustee fee. As special servicer, Allegiance Capital
provides quarterly reports to the trustee regarding loan collateral performance
and is responsible for managing any delinquencies, defaults or liquidations. An
unaffiliated third party provides additional services with respect to loan
collateral monitoring as servicing advisor. Allegiance Capital receives a fee of
0.20% per annum on the outstanding balance of the loan pool underlying the
revolving and term certificates, and bears all expenses related to its duties,
as well as the servicing advisor's fees. Point West Capital, Allegiance Capital
and the servicing advisor are entitled to receive reimbursement from loan
collections for certain expenses which may be incurred with respect to loan
defaults, work-outs or dispositions. All amounts owed to Point West Capital and
Allegiance Capital are subject to availability of cash after payment of certain
other priority amounts pursuant to the Allegiance Trust Agreement. An event of
default under the Allegiance Servicing Agreement will occur upon, among other
things, (i) failure by the servicer, special servicer or servicing advisor to
remit any loan collections received by them; (ii) failure by the servicer,
special servicer or servicing advisor to deliver the reports required to be
delivered by
27
them; or (iii) the occurrence of certain events of bankruptcy, insolvency or
reorganization with respect to the servicer, special servicer or servicing
advisor. If an event of default occurs and is not remedied, the offending party,
servicer, special servicer, or servicing advisor, may be replaced at the request
of the Investors and replaced by a nominee of Allegiance Funding, subject to the
approval of the Investors.
Description of Securitized Notes
- --------------------------------
The Securitized Notes bear interest at a fixed annual rate of 9.17%.
The principal amount of the Securitized Notes to be repaid in any month is equal
to proceeds of policies collected during the preceding month less certain
required monthly payments (such as interest and servicing and trustee fees) to
be paid on such date.
The ownership interest in policies purchased by DPFC is nominally held
by an unaffiliated third party trustee under the Indenture but the policies are
beneficially owned by DPFC. The Company accounts for this securitization as a
debt financing and not as a sale of assets, which is in accordance with the
accounting literature in effect for bankruptcy remote entities with non-recourse
debt. The assets, liabilities and operations of DPFC are consolidated in the
Company's consolidated financial statements.
The Indenture contains certain covenants restricting the activities of
DPFC. DPFC is required to maintain in an account under the Indenture (the
"Liquidity Account") a balance of 10% of the outstanding principal balance of
the Securitized Notes. Subject to certain restrictions, funds in the Liquidity
Account may be used to pay, among other things, servicing and trustee fees,
principal and interest and taxes. Events of default under the Indenture include
(i) a default in payment of principal or interest on the Securitized Notes when
due, (ii) a default by DPFC in the performance of any material covenant or a
material breach of a representation or warranty of DPFC which is not cured
within 30 days, and (iii) certain events of bankruptcy, insolvency and
reorganization involving DPFC.
Point West Capital acts as servicer under the Indenture pursuant to a
Contribution, Sale and Servicing Agreement (the "DPFC Servicing Agreement") and
receives monthly, pursuant and subject to the terms of the Indenture, a fee of
$36,000 until the earlier to occur of collection of the face value of the last
policy in the Pool or payment in full of the Securitized Notes. Point West
Capital is required under the DPFC Servicing Agreement to monitor each policy
and to cause the collection and remittance to the trustee of the face value of
matured policies. Point West Capital pays all expenses related to such
monitoring and collection services, including paying premiums and back-end fees,
and is reimbursed for certain expenses. All amounts owed to Point West Capital
pursuant to the monitoring and collecting activities are subject to availability
of cash after payment of other priority amounts as provided in the Indenture.
For a discussion of a potential default by DPFC under the Indenture, see
"Results of Operations by Segment -- Viatical Settlements -- Potential Default
by DPFC." The DPFC Servicing Agreement contains certain covenants restricting
Point West Capital's activities, including (i) restrictions on mergers, (ii)
provisions related to respecting the separate legal status of DPFC, (iii) a
requirement that no person will own a greater percentage of the aggregate voting
power of equity securities of Point West Capital entitled to vote in the
election of directors than the percentage collectively beneficially owned by the
Point West Capital's executive officers and no person other than Point West
Capital's executive officers will own more than 20% of such aggregate voting
power, (iv) a requirement that Point West Capital's executive officers
constitute a majority of the Board, and (v) a requirement that Point West
Capital employ at least two of Point West Capital's executive officers (or such
other personnel reasonably acceptable to the Noteholders) in their respective
current capacities. An event of default will occur under the DPFC Servicing
Agreement if, among other things, (i) an event of default occurs under the
Indenture, or (ii) certain events of bankruptcy, insolvency or reorganization
occur with respect to Point West Capital. If an event of default occurs under
the DPFC Servicing Agreement, Point West Capital can be replaced as servicer
under the Indenture. The back-up servicer is the trustee under the Indenture.
28
Income Taxes
- ------------
The Company has significant NOLs for tax purposes. The NOLs are
primarily related to losses incurred by DPFC. Prior to December 1999, the
Company established valuation allowances which offset completely the deferred
tax assets related to NOLs because the Company and DPFC were unable to
consistently generate taxable earnings. In 1999, the majority of NOLs were used
to offset the income primarily related to sales of securities by Ventures. The
Company recorded a tax benefit in the amount of $590,000 and the valuation
allowance was eliminated in the fourth quarter of 1999. See "Results of
Operations by Segment -- Viatical Settlements -- Potential Default by DPFC."
Considerations Under the Investment Company Act of 1940
- -------------------------------------------------------
The Investment Company Act of 1940 (the "1940 Act") creates a
comprehensive regulatory framework applicable generally to investment companies
(i.e., companies engaged primarily in the business of investing, reinvesting or
trading in securities within the meaning of the 1940 Act, whether or not those
companies intend to be engaged primarily in such business). Companies that are
subject to the 1940 Act must register with the SEC as investment companies and
upon registration become subject to extensive regulation. The Company believes,
based on its current activities and the nature of its assets, that it should not
be deemed to be an investment company because it is not engaged primarily in the
business of investing, reinvesting or trading in securities within the meaning
of the 1940 Act and the rules of the SEC promulgated thereunder and does not
hold itself out as an investment company.
There are also various percentage of assets and income tests (the
"Percentage Tests") and other subjective tests under the 1940 Act and related
rules that are relevant in considering whether a company is deemed to be an
investment company.
Although the Company believes that it should not be deemed to be an
investment company, it is possible that it could become one in the near future
as a result of the following:
* Allegiance has not grown its commercial lending business as
quickly as the Company had expected;
* The Company has been unable to commence or acquire other
complementary financial services businesses as rapidly as it had
hoped;
* The success of Ventures, which holds a number of investment
securities, has exceeded expectations;
* The success of other investments by the Company has exceeded
expectations; and
* An event of default under the Indenture is expected to occur
sometime between March and June 2000.
The majority of investment securities held by the Company have been
acquired since January 1998. The aggregate value of these investments has
increased substantially since the purchase dates and the Company has realized
substantial gains in connection with the sales of some of these investments.
During 1999, Ventures sold some of its investments in part to address these
issues. The proceeds of these sales have been invested in U.S. government
securities pending final use, which has included further investments by
Ventures.
29
The Company intends to pursue an aggressive strategy to ensure that it
is not deemed to be an investment company. Some elements of this strategy,
however, may at least in the short term materially adversely affect the
Company's financial condition or results of operations, or both. The elements of
this strategy, which are subject to the risks described below involve:
* pursuing the growth of new operating businesses, by acquisition
or internal development;
* continuing to develop Allegiance's commercial lending business;
and
* continuing to dispose of investment securities and/or restricting
the growth of Ventures' business. Although the Company intends to
continue Ventures' investment activities, the Company does not
intend to contribute more capital to Ventures.
Growth of New Operating Businesses
The Company continues to seek advice from financial advisors to assist
it in its strategy of developing or acquiring new operating businesses that do
not involve investment securities. Although the Company intends to pursue
businesses which are complementary to the Company's current businesses, these
businesses may not necessarily involve financial services. These businesses will
be operating entities which do not own, trade or hold any significant amount of
investment securities. The Company may not find any suitable businesses to
acquire or develop on terms acceptable to the Company. In addition, the Company
may not be able to successfully integrate the operations of any new businesses.
Finally, any new businesses may not contribute positively to the Company's
financial condition or results of operations.
Continuing the Growth of Allegiance
The Company will use all reasonable efforts to continue to grow the
commercial lending business of Allegiance. However, the growth of Allegiance is
dependent on the market's acceptance of the product offerings and services of
Allegiance, Allegiance's continued ability to raise financing for its
activities, Allegiance's ability to find suitable creditworthy borrowers and
competitive pressures in the lending industry. At present, Allegiance does not
have an external funding source beyond April 2000.
Disposing of Investment Securities/Limiting Growth of Ventures
The Company may determine that it must dispose of additional investment
securities to avoid being deemed to be an investment company. The dispositions
may occur at times and on terms that would not maximize the value of these
investments. Given the volatile nature of the market, and, in some cases, lack
of a market, for some of these investments, sales could occur at severely
depressed prices. In addition, the dispositions may result in disadvantageous
tax consequences. The Company intends to use any proceeds of any additional sale
to support its working capital (including further investments by Ventures) and
may consider using such proceeds to repay SBA debt. Pending final use, proceeds
of any additional sale will likely be invested in U.S. government securities.
The Company also currently intends to limit the growth of Ventures'
business. Although Ventures intends to continue investing in investment
securities, the Company does not intend to contribute more capital to Ventures.
Limiting Ventures' growth may materially adversely affect the Company's future
financial condition and results of operations.
30
Year 2000 Issue Update
- ----------------------
The Company did not experience any significant malfunctions or errors
in its operating or business systems when the date changed from 1999 to 2000.
Based on operations since January 1, 2000, the Company does not expect any
significant impact to its ongoing business as a result of the "Year 2000 Issue."
However, it is possible that the full impact of the date change, which was of
concern due to computer programs that use two digits instead of four digits to
define years, has not been fully recognized. For example, it is possible that
Year 2000 or similar issues such as leap year-related problems may occur. The
Company believes that any such problems are likely to be minor and correctable.
In addition, the Company could still be negatively affected if its borrowers,
customers or suppliers are adversely affected by the Year 2000 or similar
issues. The Company currently is not aware of any significant Year 2000 or
similar problems that have arisen for its borrowers, customers and suppliers.
The Company incurred Year 2000 compliance costs of approximately
$27,000, of which $19,000 has been capitalized. These efforts included replacing
some outdated, noncompliant hardware and noncompliant software as well as
identifying and remediating Year 2000 problems.
Forward Looking Statements
- --------------------------
This report includes forward looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995. All statements made herein
which are not based on historical facts are forward looking and, accordingly,
involve risks and uncertainties that could cause actual results to differ
materially from those discussed. Such forward looking statements include those
under "Management's Discussion and Analysis of Financial Condition and Results
of Operations" relating to (i) the ability of Allegiance to avail itself of the
benefits of the extension of the Allegiance Financing, (ii) the collection of
interest, no incurrence of any loss and potential foreclosure and liquidation of
one of the loans made by Allegiance, (iii) sufficiency of the Company's
liquidity and capital resources (See "Liquidity and Capital Resources"), (iv)
the Company's ability to continue not being subject to registration and
regulation under the 1940 Act (See "Considerations Under the Investment Company
Act of 1940"), (v) expected future life insurance policy premium costs, (vi) the
potential default under the Indenture and the consequences thereof (including
amount of gain and tax consequences thereof) and (vii) amounts of additional
cash to be contributed to Allegiance Trust I. Such statements are based on
management's belief, judgment and analysis as well as assumptions made by and
information available to management at the date hereof. In addition to any
assumptions and cautionary factors referred to specifically in this report in
connection with such forward looking statements, factors that could cause actual
results to differ materially from those contemplated by the forward looking
statements include (i) Allegiance's ability to originate a sufficient number and
amount of loans that qualify for securitization under the Allegiance Financing,
(ii) the borrower's ability to make future payments on the defaulted Allegiance
loan, Allegiance's ability to foreclose on the collateral at a price at least
equal to the amount of debt (including foreclosure fees and expenses) of such
loan and the outcome of the pending counterclaim filed in connection with the
foreclosure action, (iii) the results of the Company's consideration of
strategic options and any costs associated with a chosen option, (iv)
availability and cost of capital, (v) the factors described under
"Considerations Under the Investment Company Act of 1940," (vi) the maturity
rate of DPFC's portfolio of life insurance policies and actual premium costs
associated with unmatured policies, (vii) Point West Capital's ability to avoid
default under the Indenture, by reaching an agreement with the Noteholders or
other alternatives, (viii) DPFC's ability to generate cash through policy
collections to pay principal, interest, the servicing fees and premiums and the
timing of such collections and (ix) increases in the LIBOR rate and future
amounts outstanding under the Class A-R revolving certificates.
31
ITEM 7A--QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
- ---------------------------------------------------------------------
Market risk refers to the risk that a change in the level of one or
more market prices, interest rates, or other market factors, such as liquidity,
will result in losses for a specified position or portfolio. The Company's
exposure to market risk arises primarily from the Company's investments in the
stock of public and private companies, fixed rate loans and debt investments
made by Allegiance and Ventures and Allegiance's variable rate debt. The
Company's management believes the Company's risk management and hedging
practices result in carefully managed market exposure.
The Company has investment holdings in various companies. Due to the
varying nature of these investments, it is difficult to correlate the effects of
the market to a particular market index. The effects of the market are reviewed
by management on an individual investment-by-investment basis.
During 1999 the Company hedged a position it held in an Internet
service provider and realized a $317,000 gain in connection with such hedging
activity. At December 31, 1999 no such hedges were in place. However, the
Company may hedge certain positions in the future.
The table below represents principal cash flows and weighted-average
interest rates for the Allegiance loans outstanding at December 31, 1999:
2000 2001 2002 2003 2004 Thereafter
---- ---- ---- ---- ---- ----------
Fixed rate loans (1)(2) $ 731,984 $ 857,670 $ 944,994 $1,041,238 $1,147,316 $26,999,732
Average interest
Rates (1) 9.8% 9.8% 9.8% 9.8% 9.8% 9.8%
<FN>
- --
(1) The principal cash flows for fixed rate loans and average interest
rates do not include one delinquent loan.
(2) The Company intends to hedge partially with futures contracts its
interest rate exposure between the time of origination of the loans
and the expected issuance of term certificates under the extension
of the Allegiance Financing.
</FN>
In connection with the extension of the Allegiance Financing, Point
West Capital agreed to provide additional cash to Allegiance Trust I in the
event that monthly LIBOR interest rates exceed 6.16%. To date Point West Capital
has not been required to make any such payments. The amount of cash, if any, to
be provided will be a function of several variables including the monthly LIBOR
interest rate and the outstanding balance of the Class A-R revolving
certificate. At February 23, 2000 the outstanding balance of the Class A-R
revolving certificate was zero.
ITEM 8--FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ---------------------------------------------------
See pages 33 through 55.
ITEM 9--CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
- -------------------------------------------------------------------
AND FINANCIAL DISCLOSURE
------------------------
None other than as previously reported in Point West Capital's Form 8-K
dated September 20, 1999 and filed on September 27, 1999.
32
ERNST & YOUNG LLP Suite 1700 Phone: 415 951 3000
555 California Street
San Francisco, California 94104
Report of Ernst & Young LLP, Independent Auditors
--------------------------------------------------
The Board of Directors and
Stockholders of Point West Capital Corporation
We have audited the accompanying consolidated balance sheet of Point West
Capital Corporation as of December 31, 1999, and the related consolidated
statements of operations, changes in stockholders' equity, and cash flows for
the year then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit. The financial statements of Point West
Capital Corporation for the years ended December 31, 1998 and 1997, were audited
by other auditors whose report dated February 27, 1999 expressed an unqualified
opinion on those statements.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Point West Capital
Corporation as of December 31, 1999 and the results of their operations and
their cash flows for the year then ended, in conformity with accounting
principles generally accepted in the United States.
/s/Ernst & Young LLP
San Francisco, California
February 29, 2000
33
KPMG
Three Embarcadero Center
San Francisco, CA 94111
Independent Auditors' Report
----------------------------
The Board of Directors and Stockholders
Point West Capital Corporation:
We have audited the accompanying consolidated balance sheet of Point West
Capital Corporation as of December 31, 1998, and the related consolidated
statements of operations, stockholders' equity, and cash flows for the two-year
period ended December 31, 1998. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Point West Capital
Corporation as of December 31, 1998, and the results of their operations and
their cash flows for each of the years in the two-year period ended December 31,
1998, in conformity with generally accepted accounting principles.
/s/KPMG LLP
San Francisco, California
February 27, 1999
34
POINT WEST CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31,
ASSETS 1999 1998
------------------- --------------------
Cash and cash equivalents $ 12,836,125 $ 6,668,126
Restricted cash 3,074,057 3,153,513
Investment securities
Held-to-maturity 2,504,610 --
Available-for-sale 6,519,821 2,113,034
Matured policies receivable -- 12,000
Loans receivable, net of unearned income of $540,867 and
$117,709, respectively, and net of an allowance for
loan losses of $155,000 and $50,000, respectively 35,467,079 10,187,590
Purchased life insurance policies 31,727,966 33,893,017
Non-marketable securities 5,933,133 5,396,607
Deferred financing costs, net of accumulated amortization
of $1,378,623 and $907,848, respectively 656,376 810,545
Furniture and equipment, net of accumulated depreciation of
$12,976 and $4,469, respectively 34,917 25,365
Other assets 2,771,767 182,964
------------------- --------------------
Total assets $ 101,525,851 $ 62,442,761
=================== ====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued interest expense $ 346,483 $ 263,805
Accounts payable 238,326 192,436
Accrued compensation payable 543,400 222,000
Accrued litigation settlement 2,205,000 --
Taxes payable 141,100 --
Revolving certificates 4,200,000 5,400,045
Term certificates 24,498,815 --
Securitized notes payable 38,528,914 38,528,914
Debentures payable 3,000,000 3,000,000
Deferred income taxes 281,020 6,000
------------------- --------------------
Total liabilities 73,983,058 47,613,200
------------------- --------------------
Stockholders' equity:
Common stock, $0.01 par value; 15,000,000 authorized shares,
4,390,124 and 4,291,824 shares, respectively, issued
3,351,624 and 3,253,324 shares, respectively, outstanding 43,901 42,918
Additional paid-in-capital 30,088,949 29,496,720
Accumulated comprehensive income (loss) 2,098,960 (188,966)
Retained deficit (1,814,985) (11,647,079)
Treasury stock, 1,038,500 shares (2,874,032) (2,874,032)
------------------- --------------------
Total stockholders' equity 27,542,793 14,829,561
------------------- --------------------
Total liabilities and stockholders' equity $ 101,525,851 $ 62,442,761
=================== ====================
<FN>
See accompanying notes to consolidated financial statements.
</FN>
35
POINT WEST CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31,
1999 1998 1997
------------------- ------------------- -------------------
Income:
Earned discounts on matured policies $ 203,801 $ 438,792 $ 488,563
Interest income 3,314,280 1,494,079 1,183,919
Gain on assets sold 7,751 165,346 1,463,080
Net gain (loss) on securities 15,785,036 (998,813) 679,665
Other 407,439 234,673 102,663
------------------- ------------------- -------------------
Total income 19,718,307 1,334,077 3,917,890
------------------- ------------------- -------------------
Expenses:
Interest expense 4,962,878 3,679,566 3,599,487
Compensation and benefits 1,936,807 1,514,812 1,151,574
Other general and administrative expenses 3,097,131 1,728,169 1,474,916
Amortization 470,775 352,181 240,194
Depreciation 8,507 4,128 341
Provision for loss on assets held for sale -- -- 328,236
------------------- ------------------- -------------------
Total expenses 10,476,098 7,278,856 6,794,748
------------------- ------------------- -------------------
Income (loss) before income taxes and net loss
in wholly owned financing subsidiary
charged to reserve for equity interest 9,242,209 (5,944,779) (2,876,858)
Income tax benefit (expense) 589,885 (5,600) (4,000)
Net loss in wholly owned financing subsidiary charged
to reserve for equity interest -- 2,300,037 3,891,494
------------------- ------------------- -------------------
Net income (loss) $ 9,832,094 $ (3,650,342) $ 1,010,636
=================== =================== ===================
Basic income (loss) per share $ 2.95 $ (1.12) $ 0.29
Diluted income (loss) per share 2.70 (1.12) 0.28
Weighted-average number of shares of common stock
outstanding 3,329,409 3,253,324 3,521,736
Weighted-average number of shares of common stock
and common stock equivalents outstanding 3,641,716 3,253,324 3,605,674
<FN>
See accompanying notes to consolidated financial statements.
</FN>
36
POINT WEST CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the years ended December 31, 1999, 1998 and 1997
Accumulated
Common Stock Additional comprehensive Retained
---------------------
Shares Amount paid-in-capital income (loss) (deficit) Treasury Stock Total
----------- -------- --------------- ------------- ------------- -------------- ------------
Balances at December 31, 1996 4,291,824 $ 42,918 $ 29,496,720 -- (9,007,373) (390,000) 20,142,265
Comprehensive income:
Net income -- -- -- -- 1,010,636 -- 1,010,636
Other comprehensive income:
Unrealized investment gains -- -- -- 2,597,239 -- -- 2,597,239
------------- ------------
Comprehensive income -- -- -- -- -- -- 3,607,875
Purchase of treasury stock -- -- -- -- -- (2,484,032) (2,484,032)
----------- -------- ------------- ------------- ------------- ------------- -------------
Balances at December 31, 1997 4,291,824 42,918 29,496,720 2,597,239 (7,996,737) (2,874,032) 21,266,108
Comprehensive loss:
Net loss -- -- -- -- (3,650,342) -- (3,650,342)
Other comprehensive loss:
Net unrealized investment losses -- -- -- (2,786,205) -- -- (2,786,205)
------------- -------------
Comprehensive loss -- -- -- -- -- -- (6,436,547)
----------- -------- ------------- ------------- ------------- ------------- -------------
Balances at December 31, 1998 4,291,824 42,918 29,496,720 (188,966) (11,647,079) (2,874,032) 14,829,561
Comprehensive income:
Net income -- -- -- -- 9,832,094 -- 9,832,094
Other comprehensive income, net of
income tax:
Net unrealized investment gains,
net of tax of $1.4 million -- -- -- 2,287,926 -- -- 2,287,926
------------- -------------
Comprehensive income -- -- -- -- -- -- 12,120,020
Issuances of common stock
(options exercised, including
tax effect) 98,300 983 592,229 -- -- -- 593,212
----------- -------- ------------- ------------- ------------- ------------- -------------
Balances at December 31, 1999 4,390,124 $ 43,901 $ 30,088,949 $ 2,098,960 $ (1,814,985) $ (2,874,032) $ 27,542,793
=========== ======== ============= ============= ============= ============= =============
<FN>
See accompanying notes to consolidated financial statements.
</FN>
37
POINT WEST CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
1999 1998 1997
---------------- ----------------- --------------
Cash flows from operating activities:
Net income (loss) $ 9,832,094 $ (3,650,342)$ 1,010,636
Adjustments to reconcile net income (loss) to net cash
(used in) provided by operating activities:
Depreciation and amortization 479,282 356,309 240,535
Loss on loan receivable 140,000 -- --
Gain on assets sold (7,751) (165,346) (1,463,080)
Provision for loans receivable 105,000 50,000 --
Net gain (loss) on securities (15,785,036) 998,813 (679,665)
Interest income received as warrants (624,918) (97,816) --
Provisions for loss on sale of assets -- -- 328,236
Earned discounts on policies (203,801) (438,792) (488,563)
Deferred tax benefit (1,117,141) -- --
Changes in operating assets and liabilities:
Purchase of life insurance policies -- -- (882,848)
Collections on matured life insurance policies 2,377,984 3,209,114 6,051,149
(Increase) decrease in other assets (400,375) 11,600 (25,096)
Increase (decrease) in accrued interest expense 82,678 80,655 (7,744)
Increase (decrease) in accounts payable 45,890 (24,415) (103,726)
Increase in accrued compensation payable 321,400 29,000 6,610
Increase in taxes payable 479,376 -- --
Decrease in reserve for equity interest in wholly
owned financing subsidiary -- (2,084,412) (3,891,494)
---------------- ----------------- --------------
Net cash (used in) provided by operating
activities (4,275,318) (1,725,632) 94,950
---------------- ----------------- --------------
Cash flows from investing activities:
Proceeds from sale of other assets 27,126 229,067 12,692,793
Purchase of furniture and equipment (18,059) (22,630) (7,203)
Decrease in restricted cash 79,456 603,201 868,949
Purchase of held-to-maturity securities (4,479,856) -- --
Proceeds from sale of held-to-maturity securities 1,975,246 -- --
Purchase of investments and non-marketable securities (9,493,806) (6,808,817) (3,220,000)
Proceeds from sale of investments and non-marketable
securities 24,640,599 3,087,691 2,021,187
Additions to loans receivable (26,175,058) (6,549,689) (4,015,716)
Principal payments on loans receivable 650,569 327,815 --
---------------- ----------------- --------------
Net cash (used in) provided by investing
activities (12,793,783) (9,133,362) 8,340,010
---------------- ----------------- --------------
Cash flows from financing activities:
Proceeds from debentures payable -- 3,000,000 --
Principal payments on securitized notes payable -- (275,193) (2,414,098)
Proceeds from revolving certificates 23,908,039 5,400,045 --
Principal payments on revolving certificates (25,108,084) -- --
Proceeds from term certificates 24,635,000 -- --
Principal payments on term certificates (136,185) -- --
Purchase of treasury stock -- -- (2,484,032)
Increase in financing costs (316,606) (637,292) (83,717)
Proceeds from options exercised 254,936 -- --
---------------- ----------------- --------------
Net cash provided by (used in) financing
activities 23,237,100 7,487,560 (4,981,847)
---------------- ----------------- --------------
Net increase (decrease) in cash and cash
equivalents 6,167,999 (3,371,434) 3,453,113
Cash and cash equivalents, beginning of year 6,668,126 10,039,560 6,586,447
---------------- ----------------- --------------
Cash and cash equivalents, end of year $ 12,836,125 $ 6,668,126 $ 10,039,560
================ ================= ==============
Supplemental disclosures:
Supplemental disclosure of non-cash activities:
Unrealized gain (loss) on securities available for sale,
net of tax $ 2,287,926 $ (2,786,205)$ 2,597,239
Receipt of warrants $ 624,918 $ 97,816 $ --
Establishment of receivable from insurance company $ 2,205,000 $ -- $ --
Accrued litigation settlement $ 2,205,000 $ -- $ --
Supplemental disclosure of cash flow information:
Taxes paid $ 64,156 $ 19,680 $ 40,233
Cash paid for interest $ 4,880,200 $ 3,598,911 $ 3,607,231
<FN>
See accompanying notes to consolidated financial statements.
</FN>
38
Point West Capital Corporation
Notes to Consolidated Financial Statements
Years Ended December 31, 1999, 1998 and 1997
1. Summary of Significant Accounting Policies
- -- ------------------------------------------
a. General Description
Point West Capital Corporation ("Point West Capital"), including its
consolidated entities (collectively the "Company"), is a specialty financial
services company.
The principal business activity of the Company through February 1997
was to provide viatical settlements for terminally ill persons. A viatical
settlement is the payment of cash in return for an ownership interest in, and
right to receive the death benefit (face value) of, a life insurance policy. In
February 1997, Point West Capital's Board of Directors (the "Board") decided to
cease the Company's viatical settlement business. The Board's decision resulted
from (i) accounts of research results reported at the International AIDS
Conference held in Vancouver, British Columbia in July 1996 (the "AIDS
Conference"), (ii) the Board's belief regarding increased risks of purchasing
and holding policies insuring the lives of individuals diagnosed with HIV or
AIDS, (iii) accounts of subsequent research results which appeared to confirm
the reports from the AIDS Conference, and (iv) a determination by the Board that
it was not viable for the Company to continue to operate a viatical settlement
business solely for non-AIDS policies. Also as a result of the accounts of
research results reported at the AIDS Conference, the Company decided in the
third quarter of 1996 to sell all or substantially all of its assets at that
time. Through December 31, 1999, the Company had entered into agreements to sell
375 policies with an aggregate sale price of $19.5 million, representing $29.3
million in aggregate face value. By December 31, 1999, Point West Capital had
completed the sale of (or otherwise collected) all but six policies (having an
aggregate face value of $358,000) under these sales agreements. Substantially
all of the sales took place during 1997. Point West Capital continues to service
the life insurance policies held by its wholly owned special purpose subsidiary,
Dignity Partners Funding Corp. I ("DPFC").
Subsequent to February 1997, the Company has become a more
broadly-based specialty financial services company. During 1997, the Company
expanded its financial services business through the operations of Point West
Venture Management, LLC (formerly known as Fourteen Hill Management, LLC)
("Point West Management") and Point West Ventures, L.P. (formerly known as
Fourteen Hill Capital, L.P.) ("Point West Ventures"), which invest in small
businesses; and Allegiance Capital, LLC ("Allegiance Capital"), Allegiance
Funding I, LLC ("Allegiance Funding"), Allegiance Capital Trust I ("Allegiance
Trust I") and Allegiance Management Corp. ("Allegiance Management"), which lend
funds to funeral home and cemetery owners. During 1998, the Company formed Point
West Securities, LLC ("PWS"), a broker-dealer licensed by the National
Association of Securities Dealers, Inc. ("NASD"). References herein to Ventures
include Point West Management and Point West Ventures. References herein to
Allegiance include Allegiance Capital, Allegiance Funding, Allegiance Trust I
and Allegiance Management.
Point West Capital was incorporated in the State of Delaware as Dignity
Partners, Inc. in September 1992 and commenced operations on January 2, 1993.
Effective August 1, 1997, its name was changed to Point West Capital
Corporation.
b. Accounting Principles
The consolidated financial statements are presented in conformity with
accounting principles generally accepted in the United States.
39
Point West Capital Corporation
Notes to Consolidated Financial Statements
c. Principles of Consolidation
The consolidated financial statements include the accounts of Point
West Capital and its majority owned subsidiaries described below. The revenues,
expenses, assets and liabilities of the subsidiaries are included in the
respective line items in the consolidated financial statements after the
elimination of intercompany accounts and transactions.
The Company consolidates the assets, liabilities and operations of its
wholly owned special purpose subsidiary, DPFC.
The Company also consolidates the assets, liabilities and operations of
Point West Management, a wholly owned limited liability company, and Point West
Ventures, a related limited partnership, both formed in June 1997. Point West
Ventures received its small business investment company ("SBIC") license from
the Small Business Administration (the "SBA") effective September 1997. Point
West Management is the sole general partner of Point West Ventures, and owns
99.981% of the partnership interests. Point West Capital is one of the two
limited partners of Point West Ventures and owns 0.017% of the partnership
interests. The remaining 0.002% of the partnership interests is owned by one
unaffiliated limited partner. Point West Ventures provides loans, debt and
equity capital to small companies as defined by the SBA. Point West Ventures
commenced operations in August 1997.
In September 1997, the Company formed Allegiance Capital, a limited
liability company, to provide senior secured loans to owners of funeral homes
and cemeteries. Point West Capital has a 65% ownership interest in, and 95%
voting control of, Allegiance Capital and serves as the managing member.
Allegiance Capital's president and its vice president of marketing have the
balance of such interests. Point West Capital made the only capital contribution
to Allegiance Capital in the amount of $7.5 million. During 1998, Point West
Capital was allocated 99.5% of the interest on loans through November 20, 1998,
which was the initial funding date for the Allegiance Financing (defined
herein). Point West Capital is allocated a preferred return (based on the
weighted-average interest rate of all loans outstanding) to the extent that
Point West Capital's capital investment in Allegiance exceeds $3.0 million. In
addition, net profits of Allegiance Capital for each calendar year are allocated
to Point West Capital in an amount equal to a return of 10% per annum,
compounded monthly, on the amount of its capital contribution, but not in excess
of such net profits. Any shortfall is carried forward indefinitely to the next
calendar year or years in which net profits are sufficient to make such
allocation. An additional 5% return for each calendar year will be allocated
first to Point West Capital to the extent that in each year sufficient profits
are available with no carry forward provided. Allegiance Capital owns 100% of
Allegiance Funding, which is a special purpose subsidiary formed to acquire and
securitize loans originated by Allegiance Capital, and Allegiance Management,
which is a special purpose subsidiary formed to manage Allegiance Funding.
Pursuant to a Trust Agreement dated August 1, 1998 (the "Allegiance Trust
Agreement"), Allegiance Funding formed a trust, Allegiance Trust I, to
consummate a structured financing which has provided $28.7 million of debt and
may provide an additional $16.0 million of debt to support Allegiance's lending
activities (the "Allegiance Financing"). The Company consolidates the assets,
liabilities and operations of Allegiance Capital, Allegiance Funding, Allegiance
Trust I and Allegiance Management. See Note 5.
In addition, the Company consolidates the assets, liabilities and
operations of PWS, a wholly owned limited liability company, formed in July
1998. PWS received its license from the NASD to become a licensed securities
broker-dealer in December 1998. In addition, PWS is registered as a
broker-dealer with the Securities and Exchange Commission and California, New
York and several other states. Point West Capital capitalized PWS with $414,000.
40
Point West Capital Corporation
Notes to Consolidated Financial Statements
d. Loans Receivable and Allowance for Loan Losses
Loans receivable includes loans made to unaffiliated third parties
through Allegiance and Ventures. Such loans are reported at the principal amount
outstanding, net of unearned income, hedging gains and losses and the allowance
for loan losses. Unearned income represents fees paid by borrowers to Allegiance
Capital net of direct expenses. The allowance for loan losses is estimated by
management based on a review of the loans and factors which in management's
judgement indicate impairment inherent in the portfolio on the balance sheet
date. Management believes that the allowance for loan losses is adequate.
Although management uses available information to recognize losses on loans,
future additions to the allowance may be necessary based on changes in economic
conditions. Loans are generally placed on non-accrual status when payment in
full is in doubt or the loan is 90 days or more past due as to principal or
interest. Loans are returned to accrual status once the above noted factors are
no longer present and the loan is current. See Note 3.
e. Purchased Life Insurance Policies
During 1999, 1998 and 1997, the Company recognized income with respect
to its viatical settlement business (i.e. purchased life insurance policies)
upon receipt of proceeds on policies (either pursuant to sale of the policy or
the death of the insured). The income is equal to the difference between the
policy proceeds (less any back-end sourcing fees) and the carrying value of the
policies after giving effect to any reserve for loss on the sale of such
policies. The carrying value for each policy consists of the purchase price,
other capitalized costs and through June 30, 1996, the earned discounts
recognized under the level yield method. Matured policies receivable represents
policies for which the Company has received notification that the insured has
died and for which the Company is awaiting collection of the face value. A
reserve was recorded in 1996 in the amount of $6.9 million to reflect the
estimated loss of Point West Capital's equity interest in DPFC. The reserve
provided for the write-off of the unrealized residual value associated with
DPFC. The losses of DPFC were charged first against the reserve which, during
the third quarter of 1998, was fully depleted. Losses associated with DPFC after
depletion of the reserve during the third quarter of 1998 have been, and all
future losses associated with DPFC will be, reflected in the Company's net
income (loss) for the appropriate period. See Note 6.
Purchased life insurance policies consisted only of those policies held
by DPFC. The sale of policies held by DPFC, all of which are pledged as security
for the Securitized Notes (as defined in Note 6), requires the consent of the
Company and the holders of the Securitized Notes ("Noteholders"). As of February
29, 2000, DPFC's liquidity account had a balance of $281,000. Monthly interest
payments due on the notes are approximately $294,000. Based on the liquidity
account balance as of February 29, 2000 and on policies collected through
February 2000, sufficient funds are available to pay interest on, and a portion
of other costs associated with, the Securitized Notes through February 2000. A
failure to pay interest under the Securitized Notes would constitute an event of
default. In addition, a failure to pay other costs associated with the
Securitized Notes would, if not cured within 30 days, constitute an event of
default. An event of default would give the Noteholders the right to accelerate
the payment of the Securitized Notes, foreclose on the policies and dismiss
Point West Capital as servicer.
f. Deferred Financing Costs
Financing costs are capitalized and amortized using the straight-line
method over the respective expected terms of the financing arrangements.
41
Point West Capital Corporation
Notes to Consolidated Financial Statements
g. Furniture and Equipment
Furniture and equipment are stated at cost net of accumulated
depreciation. Depreciation is provided on a straight-line basis over the
estimated useful lives of the assets, which is generally five years.
h. Income Taxes
The Company accounts for income taxes using the asset and liability
method. Under this method, deferred tax assets and liabilities are recognized
for the estimated future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax basis (temporary differences). Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date of the tax change.
Deferred tax assets are recognized for deductible temporary differences
and operating loss and tax credit carryforwards, and a valuation allowance is
established, if necessary, to reduce the deferred tax asset if it is more likely
than not that the related tax benefits will not be realized in future years. See
Note 8.
i. Cash and Cash Equivalents
The Company considers as cash equivalents all highly liquid investments
with an original maturity of three months or less.
j. Income (Loss) Per Share
Income (loss) per share has been computed according to Statement of
Financial Accounting Standards No. 128, Earnings per Share ("SFAS 128"), which
requires disclosure of basic and diluted earnings per share. Under SFAS 128,
basic income (loss) per common share is calculated by dividing net income (loss)
by the weighted-average number of common shares outstanding during the reporting
period and excludes any dilutive effects of options and warrants. Diluted income
(loss) per common share reflects the potential dilutive effect, determined by
the treasury stock method, of additional common shares that are issuable upon
exercise of outstanding stock options and warrants. See Note 10.
k. Profit Sharing Plan
Point West Capital has a profit sharing plan (the "Plan") for its
employees. Each employee who has been employed for at least one year becomes a
participant in the Plan. The Plan provides for discretionary annual
contributions by Point West Capital for the account of each participant. In any
year in which the Plan is "top-heavy" within the meaning of the Internal Revenue
Code (the "Code"), the Plan requires, consistent with the Code, that a minimum
contribution be made for non-key employees. The contribution is allocated among
participants based on their compensation under an allocation formula integrated
with Social Security. Participants vest 20% in their Plan accounts after two
years of service and an additional 20% after each of the next four years of
service. Upon termination following permanent disability or on retirement at age
65, all amounts credited to a participant's account are distributed, in a lump
sum or in installments, as directed by the participant. Upon death, all amounts
credited to a participant's account become fully vested and are distributed to
the participant's surviving spouse or designated beneficiary. Each year, profit
sharing contributions, if any, are determined by the
42
Point West Capital Corporation
Notes to Consolidated Financial Statements
Compensation Committee of the Board. The Plan contribution expenses which are
included in compensation and benefits during 1999, 1998 and 1997 were $141,000,
$85,000 and $86,000, respectively.
l. Use of Estimates
Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets and liabilities and the
disclosure of contingent assets and liabilities to prepare these financial
statements in conformity with generally accepted accounting principles. Actual
results could differ from those estimates.
m. Stock-Based Compensation
The Company accounts for grants of stock options to employees and
directors according to Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees" and related Interpretations ("ABP No. 25"). Pro
forma net income (loss) information, as required by Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS
123"), is included in Note 14. Options granted to consultants are accounted for
in accordance with Emerging Issues Task Force Consensus No. 96-18, "Accounting
for Equity Investments That Are Issued to Other Than Employees for Acquiring, or
In Conjunction with Selling, Goods or Services," and valued using the
Black-Scholes method prescribed by SFAS 123.
n. Recent Accounting Developments
In June 1999, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 137, Accounting for Derivative
Instruments and Hedging Activities -- Deferral of the Effective Date of FASB
Statement No. 133 -- an Amendment of FASB Statement No. 133 ("SFAS 137"). SFAS
137 defers the effective date of Statement of Financial Accounting Standards No.
133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133").
SFAS 133, as amended, is now effective for all fiscal quarters of fiscal years
beginning after June 15, 2000. Management is still reviewing the impact of this
pronouncement.
o. Reclassifications
Certain prior-year amounts have been reclassified to conform with the
current year's presentation.
2. Investment Securities
- -- ---------------------
Statement of Financial Accounting Standards No. 115, Accounting for
Certain Investments in Debt and Equity Securities ("SFAS 115"), requires
marketable debt and equity securities to be classified into held-to-maturity,
available-for-sale and trading categories. Securities classified as
available-for-sale are reported in the Consolidated Balance Sheets at fair value
with any cumulative unrealized gains and losses included in comprehensive income
and reported as a separate component of stockholders' equity. Fair value is
estimated by management based on the average closing bid of the securities for
the last three trading days of the reporting period, adjusted for liquidity
constraints. Securities classified as held-to-maturity included U.S. treasury
bills reported at cost with original maturities greater than three months, but
less than one year. Cash and cash equivalents included U.S. treasury bills with
maturities less than three months of $8.3 million and $4.9 million at December
31, 1999 and 1998, respectively. Any realized gains and losses, interest and
dividends and unrealized losses on securities judged to be other-than-temporary
are reported in the Consolidated Statements of Operations on an appropriate
line.
43
Point West Capital Corporation
Notes to Consolidated Financial Statements
The costs and estimated fair value of investment securities reflected
in the Consolidated Balance Sheets as of December 31, 1999 and 1998 are as
follows:
December 31, 1999
- ---------------------------------------------------------------------------------------------------------------------
Gross Gross
Unrealized Unrealized Fair
Cost Gains Losses Value
Held-to-maturity
U.S. treasury bills ............ $ 2,504,610 $ -- $ -- $ 2,504,610
------------ ------------ ------------ ------------
Total held-to-maturity $ 2,504,610 $ -- $ -- $ 2,504,610
============ ============ ============ ============
Available-for-sale
Corporate bonds................. $ 350,000 $ -- $ (297,500) $ 52,500
Common stock.................... 2,678,633 4,201,560 (412,872) 6,467,321
------------ ------------ ------------ ------------
Total available-for-sale $ 3,028,633 $ 4,201,560 $ (710,372) $ 6,519,821
============ ============ ============ ============
December 31, 1998
- ---------------------------------------------------------------------------------------------------------------------
Gross Gross
Unrealized Unrealized Fair
Cost Gains Losses Value
Available-for-sale
Corporate bonds................. $ 350,000 $ -- $ (190,000) $ 160,000
Common stock.................... 1,952,000 8,092 (7,058) 1,953,034
------------ ------------ ------------ ------------
Total available-for-sale $ 2,302,000 $ 8,092 $ (197,058) $ 2,113,034
============ ============ ============ ============
Cumulative unrealized gains (losses) on available-for-sale securities
(representing differences between estimated fair value and cost) were $3.5
million and ($189,000) at December 31, 1999 and 1998, respectively. A separate
balance sheet component of stockholders' equity called "Accumulated
Comprehensive Income (Loss)" reflects such cumulative gains (losses), net of
applicable taxes.
3. Loans Receivable
- -- ----------------
Allegiance had 21 loans outstanding at December 31, 1999 in the
aggregate principal amount of $33.8 million, which bear a weighted-average fixed
interest rate per annum of 9.8%. Allegiance had five loans outstanding at
December 31, 1998 in the aggregate principal amount of $9.1 million, which bore
a weighted-average fixed interest rate per annum of 9.3%. Principal payments are
due monthly on such loans, and such loans mature, subject to permitted
prepayments, in approximately fifteen years from the initial loan date. At
December 31, 1999, one loan was in default and on non-accrual status. Loan
origination fees and direct loan origination costs are capitalized and
recognized over the life of the related loan as an adjustment of yield (interest
income) in accordance with Statement of Financial Accounting Standards No. 91,
Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases ("SFAS 91").
In August 1998, Allegiance put in place the Allegiance Financing which
provides short-term financing and long-term financing with respect to loans
Allegiance has made in the past and may make in the future. See Note 5.
Allegiance uses futures contracts to hedge certain interest rate exposure
between
44
Point West Capital Corporation
Notes to Consolidated Financial Statements
the time of origination of the loans and the expected issuance of term
certificates. The futures contracts are intended to protect a portion of the net
interest margins earned on the loans. Any realized gain or loss related to these
hedges are deferred and recognized by Allegiance over the life of the related
loan as an adjustment of interest income. Pursuant to Statement of Financial
Accounting Standards No. 80, Accounting for Futures Contracts ("SFAS 80"), all
such deferred amounts are reflected in the Consolidated Balance Sheets as an
increase (in the case of a hedging loss) or decrease (in the case of a hedging
gain) in the carrying value of loans receivable. As of December 31, 1999,
Allegiance had cumulative net realized gains on its hedging activities of
$215,000 which decreased loans receivable in a like amount. As of December 31,
1999 Allegiance had no open hedges. As of December 31, 1998, Allegiance had net
realized losses on its hedging activities of $261,000 which increased loans
receivable in a like amount. Unrealized net losses from open hedges as of
December 31, 1998 were $800.
Ventures had two loans outstanding at December 31, 1999 in the
aggregate principal amount of $2.6 million, one of which was originated in
January 1998 and bears interest at a fixed interest rate per annum of 15% and
the other of which was originated in November 1999 and bears interest at a
variable rate based on the prime rate plus 4% (at December 31, 1999 the prime
rate was 8.5%). The loan originated in January 1998 matures, subject to
permitted prepayments, approximately 5 years from the initial loan date and the
loan originated in November 1999 matures, subject to permitted prepayments, on
April 30, 2000. Ventures had two loans outstanding at December 31, 1998 in the
aggregate principal amount of $864,000, one of which is described above and the
other of which was originated in September 1998 and bore interest at a fixed
interest rate per annum of 14%, but was repaid in 1999.
4. Non-Marketable Securities
- -- -------------------------
Non-marketable securities include investments in non-marketable debt
and equity securities through Point West Capital and Ventures. The Company
accounts for such non-marketable securities using the cost method.
The Company reviews on a quarterly basis all non-marketable securities
and attempts to ascertain whether the value is impaired. As a result of such
reviews, Ventures determined that $535,000 of non-marketable equity securities
held of one company was impaired at June 30, 1999 and $500,000 of non-marketable
equity securities held of another company was impaired at December 31, 1999.
Therefore, the Company wrote-off the entire $1,035,000 carrying value of such
securities in 1999. In addition, the Company determined that $1.1 million of
non-marketable securities held of one company was impaired at September 30,
1998, and therefore wrote-off the entire $1.1 million carrying value of such
security in 1998. These write-offs are included in net gain (loss) on securities
in the Consolidated Statements of Operations.
5. Revolving and Term Certificates
- -- -------------------------------
Pursuant to the Allegiance Financing, a consortium of insurance
companies (the "Investors") provided funding through September 20, 1999, with a
balance at that date of $24.9 million, on a non-recourse revolving certificate
basis which was used for the purchase or funding of loans originated by
Allegiance Capital and transferred, through Allegiance Funding, to Allegiance
Trust I. On September 21, 1999, the revolving certificates then outstanding were
repaid through the issuance of the term certificates described below.
Under the Allegiance Financing various classes of revolving and term
certificates of Allegiance Trust I have been issued. The original revolving
certificates were issued in August 1998 in four classes, consisting of Class
A-R, Class B-R, Class C-R and Class D-R. The Class D-R certificate, which
45
Point West Capital Corporation
Notes to Consolidated Financial Statements
represents the right to receive all excess cash flow from Allegiance Trust I,
was unrated while the other revolving certificates received ratings from Duff &
Phelps Credit Rating Co. ranging from A to BB. At September 20, 1999, the
following principal amounts of Class A-R, Class B-R, Class C-R and Class D-R
revolving certificates were outstanding, respectively: $19.5 million, $3.2
million, $2.2 million and $2.4 million. At September 21, 1999 such revolving
certificates were repaid through the issuance in the following amounts of Class
A, Class B, Class C, Class D, Class E and Class F term certificates: $17.8
million, $1.8 million, $2.0 million, $1.8 million, $1.3 million and $2.6
million. The Class F term certificate, which was retained by Allegiance, was
unrated while the other term certificates received ratings from Duff & Phelps
ranging from AA to B. The weighted-average fixed interest rate of the term
certificates held by third parties is 8.1%.
The Company and Investors executed amendments which extended the
Allegiance Financing through April 15, 2000. The Investors agreed to continue to
provide revolving debt, subject to certain limitations, through April 15, 2000,
on terms similar to those under the original revolving certificates under the
Allegiance Financing, but with the addition of another class of revolving
certificates as described below. Allegiance has agreed to retain an unrated
revolving certificate related to the extension. In addition, the Investors
agreed to provide up to $20.2 million of additional term financing, subject to
certain limitations, through April 15, 2000, on terms similar to those under the
original term certificates issued under the Allegiance Financing. The fixed
interest on the additional term certificates will be based on the ten-year U.S.
Treasury yield plus a spread ranging from 2.0% to 8.5%. As of December 31, 1999,
Allegiance has borrowed $4.2 million under the revolving certificates.
Pursuant to the extension, as additional funds are utilized going
forward, the amount issued under the various classes of term certificates will
increase, and such increases may be disproportionate to the current proportions
of term certificates outstanding. In December 1999, Allegiance Trust I reissued
the Class C-R revolving certificate as two classes, Class C1-R and Class C2-R,
and funded the Class B-R, Class C1-R, Class C2-R and Class D-R revolving
certificates. The Class C1-R certificates were funded in the principal amount of
$1.4 million and the Class C2-R certificates were funded in the principal amount
of $1.1 million. The Class B-R certificates were funded in the principal amount
of $1.7 million. Such certificates bear interest at a fixed rate based on the
one-year U.S. Treasury yield plus a weighted-average spread of 4.7%. The
weighted-average interest rate of the revolving certificates held by third
parties at December 31, 1999 was 10.4%. Allegiance funded and retained the
unrated Class D-R revolving certificate in the amount of $2,197,000.
The Allegiance Financing does not qualify for sale treatment under SFAS
125 because its terms entitle Allegiance Funding to repurchase loans prior to
the point at which the cost of servicing them becomes burdensome. Accordingly,
the Allegiance Financing will not receive gain on sale treatment under SFAS 125.
The loans and borrowings under the Allegiance Financing are reflected in the
Consolidated Balance Sheets.
In connection with the Allegiance Financing, Allegiance Capital paid a
$175,000 commitment fee when funds were initially borrowed. Of such commitment
fee, $58,000 has been amortized over the expected life of the revolving
certificates (10 months) and $117,000 are being amortized over the expected life
of the term certificates (15 years). In connection with the extension,
Allegiance paid a $125,000 commitment fee. Of such fee, $42,000 will be
amortized over the expected life of the revolving certificates (8 months) and
$83,000 will be amortized over the expected life of the term certificates (15
years). These allocations were based on an estimate of the portion of the
commitment fee attributable to the revolving certificates and the term
certificates.
46
Point West Capital Corporation
Notes to Consolidated Financial Statements
In connection with the extension of the Allegiance Financing, Point
West Capital agreed to provide additional cash to Allegiance Trust I in the
event that monthly LIBOR interest rates exceed 6.16%. To date Point West Capital
has not been required to make any such payments. The amount of cash, if any, to
be provided will be a function of several variables including the monthly LIBOR
interest rate and the outstanding balance of the Class A-R revolving
certificate. At February 23, 2000, the outstanding balance of the Class A-R
revolving certificate was zero.
6. Securitized Notes Payable
- -- -------------------------
The Senior Viatical Settlement Notes, Series 1995-A, Stated Maturity
March 10, 2005 (the "Securitized Notes") were issued by DPFC. Principal and
interest payments on the Securitized Notes are payable solely from collections
on pledged policies and deposited funds. The Securitized Notes bear a fixed
interest rate of 9.17% per annum.
The Securitized Notes represent the obligations solely of DPFC. The
Company's consolidated financial statements include the assets, liabilities and
operations of DPFC; however, the assets of DPFC are not available to pay
creditors of Point West Capital. The assets of DPFC are the beneficial ownership
interests in the life insurance policies and funds which secure the Securitized
Notes. From 1996 through the third quarter of 1998, losses associated with DPFC
were charged against the reserve which was originally established in 1996 for
the estimated loss of Point West Capital's equity interest in DPFC. See Note 1e.
Since the third quarter of 1998, losses associated with DPFC after depletion of
the reserve have been reflected in the Company's net income (loss) in the
appropriate period. Upon the retirement of the Securitized Notes, the Company
will recognize a gain in an amount approximately equal to any accumulated
deficit reflected net of any tax effect. For 1999, the loss associated with DPFC
was approximately $4.2 million. At December 31, 1999, DPFC's accumulated deficit
was approximately $5.9 million.
Point West Capital is the servicer of the policies pledged under the
Indenture pursuant to which the Securitized Notes were issued and incurs
servicing expenses and receives servicing income, subject to certain priority
payments, in connection therewith.
7. Debenture Payable
- -- -----------------
Point West Ventures has issued one debenture in the principal amount of
$3 million payable to the SBA with semi-annual interest only payments at a fixed
rate of 5.9% (plus a 1% annual fee) and a scheduled maturity date of September
1, 2008. In addition, Point West Ventures paid to the SBA a $105,000 fee (3.5%
of the total borrowings) to borrow such money. The debenture is subject to a
prepayment penalty if repaid prior to September 1, 2003.
47
Point West Capital Corporation
Notes to Consolidated Financial Statements
8. Income Taxes
- -- ------------
Point West Capital and its subsidiaries file a consolidated tax return.
The components of the provision for income tax included in the statements of
operations for the years ended December 31, are as follows:
1999 1998 1997
---- ---- ----
Federal:
Current expense.................... $ (26,112) $ -- $ --
Deferred benefit................... 985,583 -- --
State:
Current expense.................... (501,144) (5,600) (4,000)
Deferred benefit .................... 131,558 -- --
--------------- --------------- ---------------
Income tax benefit (expense)........ $ 589,885 $ (5,600) $ (4,000)
=============== ================ ================
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities as of December
31, are presented below.
1999 1998
---- ----
Deferred tax assets:
Revenue and expenses recognized on the cash
basis for tax purposes.................................... $ 100,374 $ 270,173
Depreciation, amortization and other........................... 4,052 6,961
Allowance for assets held for sale............................. -- 66,407
Allowance for loss on non-marketable securities................ 199,172 427,620
Allowance for loan losses...................................... 61,743 19,917
Unrealized loss on securities available for sale............... -- 75,265
Net operating loss carryforwards............................... 2,009,039 5,773,727
------------------ -----------------
2,374,380 6,640,070
Valuation allowance............................................ -- (4,296,383)
------------------ -----------------
Deferred tax assets net of valuation allowance................. 2,374,380 2,343,687
Deferred tax liabilities:
Unrealized gain on securities available for sale.............. 1,392,161 --
Accretion recognized on a cash basis for tax purposes......... 1,263,239 2,349,687
------------------ -----------------
2,655,400 2,349,687
------------------ -----------------
Net deferred tax liability......................................... $(281,020) $ (6,000)
================== =================
48
Point West Capital Corporation
Notes to Consolidated Financial Statements
A reconciliation of the difference between the amount of income tax
benefit (expense) recorded and the amount calculated using the federal rate of
34% is as follows:
1999 1998 1997
---- ---- ----
Tax benefit (expense) at statutory rate
(34%).................................. $ (3,142,351) $ 1,239,212 $ (344,976)
State taxes, net of federal benefits..... (243,927) 76,409 (189,173)
Change in valuation allowance (1)........ 4,221,118 (1,319,532) 530,149
Other.................................... (244,955) (1,689) --
------------------ ------------------ ------------------=
Income tax benefit (expense) ... $ 589,885 $ (5,600) $ (4,000)
================== =================== ==================
<FN>
- --
(1) $75,265 of the change in tax valuation allowance has been reflected in
the statement of changes in stockholders' equity in connection with the
unrealized loss on securities available-for-sale.
</FN>
At December 31, 1999, the Company has an estimated federal tax net
operating loss carryforward of $5,278,409 expiring in the years 2012 and 2018,
and a California tax net operating loss carryforward of approximately $3,764,417
expiring in the year 2003.
9. Common Stock
- -- ------------
In October 1996, the Board approved a share repurchase program pursuant
to which the Company was authorized to purchase from time to time up to 1
million shares of common stock at prevailing market prices. In June 1997, such
authority was increased to 1.04 million shares of common stock. In June 1997,
the Company completed the share repurchase program, having repurchased an
aggregate of 1.04 million shares at a weighted-average price of $2.77 per share.
10. Income (Loss) Per Share
- -- -----------------------
The weighted-average number of common stock shares and additional
common stock equivalent shares used in computing income (loss) per share for the
years ended December 31, 1999, 1998 and 1997 are set forth below. The following
is a reconciliation of the numerator and denominator of basic and diluted net
income (loss) per share:
1999 1998 1997
---- ---- ----
Numerator:
Net income (loss)................................. $9,832,094 $ (3,650,342) $1,010,636
============= ============= =============
Denominator:
Weighted-average shares.......................... 3,329,409 3,253,324 3,521,736
------------- ------------- -------------
Denominator for basic calculation............... 3,329,409 3,253,324 3,521,736
Weighted-average effect of dilutive securities:
Employee stock options..................... 201,249 -- 83,938
Warrants................................... 111,058 -- --
------------- ------------- -------------
Denominator for diluted calculation............. 3,641,716 3,253,324 3,605,674
============= ============= =============
Income (loss) per share:
Basic........................................... $ 2.95 $ (1.12) $ 0.29
========= ========= ========
Diluted......................................... $ 2.70 $ (1.12) $ 0.28
========= ========== ========
49
Point West Capital Corporation
Notes to Consolidated Financial Statements
Options outstanding during the year ended December 31, 1999 to purchase
approximately 40,000 shares of common stock were not included in the computation
of diluted income per share because the options' exercise price was greater than
the average market price of the common stock during the year and, therefore,
would be anti-dilutive. Options outstanding during the year ended December 31,
1998 are not included in the computation of diluted income per share because of
the anti-dilutive effect. Options and warrants outstanding during the year ended
December 31, 1997 to purchase approximately 340,000 shares of common stock were
not included in the computation of diluted income per share because the options'
exercise price was greater than the average market price of the common stock
during the year and, therefore, would be anti-dilutive.
11. Commitments
- --- -----------
The Company has a lease obligation for its California office space,
which expires on May 31, 2004. The Company shares the monthly rent expense with
The Echelon Group of Companies, LLC ("Echelon") under a cost sharing agreement.
Echelon is owned by Point West Capital's executive officers. The monthly rent
through May 31, 2001 is $18,963, of which (under the current terms of the cost
sharing agreement) the Company pays $15,170 and Echelon pays $3,793. The monthly
rent from June 1, 2001 through May 31, 2002 is $19,475, of which (under the
current terms of the cost sharing agreement) the Company will pay $15,580 and
Echelon will pay $3,895. The monthly rent from June 1, 2002 through May 31, 2004
is $19,988, of which (under the current terms of the cost sharing agreement) the
Company will pay $15,990 and Echelon will pay $3,998.
Future minimum rental payments (less amounts to be paid by Echelon
under the current terms of the cost sharing agreement) at December 31, 1999,
under operating leases with an initial term of one year or more, are as follows:
Year ending December 31,
2000.......... $ 182,040
2001.......... 184,910
2002.......... 189,830
2003.......... 191,880
2004.......... 79,950
---------
Total......... $ 828,610
=========
12. Litigation
- --- ----------
From time to time, the Company is involved in routine legal proceedings
incidental to its business, including litigation in connection with (i) loans
and investments made by Point West Ventures and Allegiance, and (ii) the
collection of amounts owed under life insurance policies by insurance company
obligors. The Company does not expect that these proceedings, individually or in
the aggregate, will have a material adverse effect on the Company's financial
position, liquidity or results of operations.
On December 19, 1996, a complaint was filed in the United States
District Court, Northern District of California (the "Court") (Docket No.
C96-4558) against Dignity Partners, Inc. (now Point West Capital Corporation)
and each of its directors by three individuals purporting to act on behalf of
themselves and an alleged class consisting of all purchasers of the Company's
common stock during the period February 14, 1996 to July 16, 1996. The complaint
alleges that the defendants violated Section 10(b) of the Securities Exchange
Act of 1934 and Rule 10b-5 thereunder and Section 11 of the Securities Act of
1933 and seeks, among other things, compensatory damages, interest, fees and
costs. The allegations were based on alleged misrepresentations in and omissions
from the Company's registration
50
Point West Capital Corporation
Notes to Consolidated Financial Statements
statement and prospectus related to its initial public offering and certain
documents filed by the Company under the Exchange Act. In the second quarter of
1999, a settlement in principle was reached and on February 25, 2000, the Court
approved a settlement agreement pursuant to which all claims against all
defendants will be dismissed and $3.15 million will be paid to the plaintiffs.
Under the terms of the Company's D&O insurance policy, the Company's insurer
paid 70% of the settlement amount. As a result, during the second quarter of
1999, the Company recorded an accrued litigation settlement liability of $3.15
million, an expense of $945,000 and an accounts receivable from its insurance
company of $2.2 million (which is included in other assets in the Consolidated
Balance Sheet and was paid into an escrow account in January 2000).
On February 13, 1997, a complaint was filed in the Superior Court of
California, City and County of San Francisco (Docket No. 984643) against Dignity
Partners, Inc., and each of its executive officers and Echelon by an individual
purporting to act on behalf of himself and an alleged class consisting of all
purchasers of the Company's common stock during the period February 14, 1996 to
July 16, 1996. The complaint alleges that the defendants violated section 25400
of the California Corporate Code and seeks to recover damages. The allegations
are based on alleged misstatements, concealment and/or misrepresentations and
omissions of allegedly material information in connection with the Company's
initial public offering and subsequent disclosures. The case has been stayed
since its inception by agreement of the parties. However, the claims in this
case are covered by the settlement agreement described above and will also be
dismissed pursuant to the settlement agreement described above.
In October 1999, Allegiance brought an action in the District Court of
Webb County, Texas seeking to collect on a defaulted loan with an outstanding
principal balance of $2.1 million. In response to the lawsuit, on October 29,
1999, the defendants filed a counterclaim against Allegiance and a third-party
petition against an individual who is an officer of Allegiance. The counterclaim
and the third-party petition allege that Allegiance and the Allegiance officer
committed fraud, conversion, deceptive trade practices, negligence, breach of
fiduciary duty, negligent misrepresentation, conspiracy and other wrongful acts,
and seeks, among other things, compensatory and punitive damages (or
cancellation of indebtedness), interest, fees and costs. The defendants retained
a consulting firm owned by the Allegiance officer to consult in the acquisition
of a funeral home and to assist in financing such acquisition. The defendants'
allegations and the third-party petition are based on (i) allegedly erroneous
advice provided by the Allegiance officer, (ii) an alleged failure by the
Allegiance officer to disclose his relationship with Allegiance and (iii) the
allegedly wrongful exercise by Allegiance of its rights in the collateral
securing the defaulted loan. The Company believes that the counterclaim is
without merit and intends to prosecute the original action, and defend the
counterclaim, vigorously.
13. Fair Value of Financial Instruments
- --- -----------------------------------
The following methods and assumptions were used to estimate the fair
value of each class of financial instruments:
Cash and cash equivalents, restricted cash and matured policies
receivable are stated at approximate fair value because of the short maturity of
these instruments. All balances have maturities within 60 days of the balance
sheet date.
Investment securities are stated at fair value based on quoted market
prices with adjustments for liquidity constraints.
Loans receivable are stated at cost which approximates fair value, as
underlying rates approximate current market rates.
51
Point West Capital Corporation
Notes to Consolidated Financial Statements
The portfolio of purchased life insurance policies is stated at cost
plus accretion through June 1996. Fair value is not readily determinable.
The Company does not believe that it is practical to estimate the fair
value for its investments in non-marketable securities.
The revolving and term certificates, securitized notes payable and
debenture payable are all stated at cost which approximates fair value, as
underlying rates described below approximate current market rates. The revolving
certificates outstanding at December 31, 1999 bear a fixed interest rate of the
weighted-average spread of 4.7% over the one-year U.S. Treasury yield. The term
certificates bear a fixed weighted-average interest rate of 8.1%. The
securitized notes payable bear a fixed interest rate of 9.2%. The debentures
bear a fixed interest rate of 6.9%.
14. Stock-Based Compensation
- --- ------------------------
The Company has two stock option plans. Under the Amended and Restated
1995 Stock Option Plan ("1995 Plan"), Point West Capital may grant options to
employees, consultants and directors of Point West Capital and its subsidiaries
for up to 450,000 shares of common stock. Point West Capital has increased the
number of shares that may be issued under the 1995 Plan to 950,000 subject to
stockholder approval. Options in excess of 450,000 shares under the 1995 Plan
have been granted subject to receipt of stockholder approval. Under the Stock
Option Plan For Non-Employee Directors ("Director Plan"), options for up to
75,000 shares of common stock are granted automatically to non-employee
directors of Point West Capital. Point West has increased the number of shares
that may be issued under the Director Plan to 150,000, subject to stockholder
approval. The exercise price of each granted option generally equals the market
price of the Common Stock on the date of grant. Each option generally expires
ten years after the date of grant. Under the 1995 Plan, each granted option
generally vests 20% per year over five years. Some incentive stock options
granted to executive officers under the 1995 Plan have different terms than
generally described above. These options have an exercise price equal to 110% of
market value on the date of grant, vest 25% per year over 4 years and expire 5
years after the date of grant. Under the Director Plan, initially, each new
non-employee director, when joining the board, is granted 10,000 options that
vest 34%, 33% and 33% at the next three annual meetings following the grant
date. At each annual meeting, each non-employee director is granted 5,000
options that vest at the next annual meeting.
52
Point West Capital Corporation
Notes to Consolidated Financial Statements
A summary of the Company's stock option activity during 1999, 1998 and
1997 follows:
1999 1998 1997
------------------------- -------------------------- ---------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Price Per Price Per Price Per
Options Option Options Option Options Option
------- ------ -------- ------ ------- ------
Outstanding at
Beginning of year 385,500 $ 3.45 273,000 $ 3.40 181,000 $ 3.33
Granted 362,500 $ 6.61 125,500 $ 3.41 96,000 $ 3.44
Exercised (98,300) $ 2.59 -- -- -- --
Forfeited (44,000) $ 2.47 (13,000) $ 1.85 (4,000) $ 1.38
Canceled (27,000) $ 10.88 -- -- -- --
------------ ------------- -------------
Outstanding at end
of year 578,700 $ 5.31 385,500 $ 3.45 273,000 $ 3.40
============ ============= =============
Options exercisable
at year-end 101,950 $ 5.80 111,400 $ 5.03 53,733 $ 6.47
============ ============= =============
The weighted-average fair value of options granted during 1999, 1998
and 1997 were $3.99, $2.20 and $2.38, respectively.
The following table summarizes information about stock options
outstanding at December 31, 1999:
Options Outstanding Options Exercisable
------------------------------------------------------ ---------------------------------
Weighted-
Range of Number Average Weighted- Number Weighted-
Exercisable Outstanding Remaining Average Exercisable Average
Prices at 12/31/99 Contractual Life Exercise Price at 12/31/99 Exercise Price
------ ----------- ----------------- -------------- ----------- ---------------
$1.38 - $1.38 50,800 6.55 $ 1.38 12,000 $ 1.38
$2.25 - $2.75 77,500 6.66 $ 2.42 17,250 $ 2.42
$3.44 - $3.44 71,900 7.82 $ 3.44 31,100 $ 3.44
$5.00 - $6.88 338,500 9.72 $ 6.04 11,600 $ 6.29
$10.81 - $13.50 40,000 7.05 $12.55 30,000 $13.13
--------------- ------- ---- ------ ------
$1.38 - $13.50 578,700 8.61 $ 5.31 101,950 $ 5.80
The Company has elected to follow APB No. 25 in accounting for its
employee and director stock options because, as discussed below, the alternative
fair value accounting provided for under SFAS 123 requires use of option
valuation models that were not developed for use in valuing employee stock
options. Under APB No. 25, the Company does not recognize compensation expense
with respect to awards if the exercise price equals or exceeds the fair value of
the underlying security on the date of grant and other terms are fixed.
Pro forma income per share information is required by SFAS 123, which
also requires that the information be determined as if the Company had accounted
for its employee stock options under the fair value method. This method was
developed for use in estimating the fair value of traded options that have no
vesting restrictions and are fully transferable. In addition, option valuation
method models require the input of highly selective assumptions, including the
expected life of the options. Because the Company's
53
Point West Capital Corporation
Notes to Consolidated Financial Statements
stock-based awards have characteristics significantly different from those
traded options and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure of the fair value of
its stock-based awards.
Had compensation cost for the Company's two stock-based compensation
plans been determined consistent with SFAS 123, the Company's pro forma net
income (loss) and income (loss) per share would have been as follows:
1999 1998 1997
----------------- ----------------- ---------------
Net income (loss) As reported $ 9,832,094 $ (3,650,342) $ 1,010,636
Pro forma $ 9,493,373 $ (3,878,265) $ 799,444
Basic earnings (loss) per share As reported $2.95 $ (1.12) $0.29
Pro forma $2.85 $ (1.19) $0.23
Diluted earnings (loss) per share As reported $2.70 $ (1.12) $0.28
Pro forma $2.61 $ (1.19) $0.22
For purposes of the Company's pro forma disclosure, the fair value of
each option is estimated on the date of grant using the Black-Scholes
option-pricing model. The following weighted-average assumptions were used for
grants:
1999 1998 1997
---- ---- ----
Expected volatility 75% 75% 75%
1995 Plan:
Risk-free interest rate 6.5% 5.0% 5.8%
Expected life 6 years 6 years 7 years
Director Plan:
Risk-free interest rate 6.2% 4.6% 5.6%
Expected life 2 years 2 years 2 years
In addition to the above mentioned stock option plans, on September 16,
1996 Point West Capital granted 300,000 warrants at a purchase price of $6.00
per share to an investment banking firm. These warrants were exercisable
immediately and expire on September 16, 2001. The expense for these warrants was
determined consistent with SFAS 123. The fair value of each warrant was
estimated on the date of grant using the Black-Scholes option-pricing model with
the following weighted-average assumptions: expected volatility of 20%;
risk-free interest rate of 6.2%; and expected life of 5 years.
15. Segment Reporting
- --- ------------------
Statement of Financial Accounting Standards No. 131, Disclosures about
Segments of an Enterprise and Related Information, establishes standards for
reporting information about operating segments in annual financial statements
and requires selected information about operating segments in interim financial
reports. Operating segments are defined as components of an enterprise about
which separate financial information is available that is evaluated regularly by
the chief operating decision maker, or decision making group, in deciding how to
allocate resources and in assessing performance. Point West Capital's chief
operating decision making group is comprised of the Chairman of the Board, the
President and the Chief Financial Officer.
54
Point West Capital Corporation
Notes to Consolidated Financial Statements
The Company's reportable operating segments include Viatical
Settlements, Ventures and Allegiance. The activities of each operating segment
are described in Note 1c. The Other segment includes Point West Capital and PWS.
The accounting policies of the operating segments are the same as those
described in the summary of significant accounting policies. The following
tables represent the Company's results from segments for 1999 and 1998. Segment
reporting for 1997 has not been included since the operations of Ventures and
Allegiance were insignificant as of such date.
1999
----------------------------------------------------------------------------------------
Viatical
Settlements (1) Ventures Allegiance Other Total
--------------- --------- ---------- ----- -----
Interest income...... $ 79,459 $ 1,205,203 $1,798,477 $ 231,141 $ 3,314,280
Net gain on
securities ......... -- 13,020,549 -- 2,764,487 15,785,036
Other income ......... 288,336 63,657 15,000 251,998 618,991
--------------- --------------- -------------- --------------- ---------------
Total income ......... 367,795 14,289,409 1,813,477 3,247,626 19,718,307
Interest expense...... 3,533,101 208,200 1,221,577 -- 4,962,878
Depreciation &
amortization....... 217,444 30,000 223,331 8,507 479,282
Income tax benefit
(expense) (2)...... (800) (800) (43,880) 635,365 589,885
Contributed net income
(loss) (2)......... (3,739,141) 14,041,159 (483,123) 13,199 9,832,094
Identifiable assets... 32,901,015 25,718,616 35,993,686 6,912,534 101,525,851
1998
----------------------------------------------------------------------------------------
Viatical
Settlements (1) Ventures Allegiance Other Total
--------------- -------- ---------- ----- -----
Interest income...... $ 199,782 $ 299,842 $ 588,639 $ 405,816 $1,494,079
Net loss on
securities......... -- (979,179) -- (19,634) (998,813)
Other income........ 776,797 -- (8,050) 70,064 838,811
--------------- --------------- -------------- --------------- --------------
Total income ......... 976,579 (679,337) 580,589 456,246 1,334,077
Interest expense...... 3,550,664 98,372 30,530 -- 3,679,566
Depreciation &
amortization....... 234,880 61,733 55,568 4,128 356,309
Income tax benefit
(expense) (2)........ (800) (800) (1,600) (2,400) (5,600)
Contributed net income
(loss) (2).... (1,145,463) (874,293) 129,611 (1,760,197) (3,650,342)
Identifiable assets... 37,078,882 7,140,917 10,162,182 8,060,780 62,442,761
<FN>
- --
(1) The Viatical Settlements segment includes results of operations in
connection with viatical settlements for DPFC and Point West.
(2) Corporate overhead and income tax expense are not generally allocated
between segments and are included in the Other segment.
</FN>
55
PART III
--------
ITEM 10--DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- -----------------------------------------------------------
Information regarding directors of the Company and the executive
officers of the Company (each of whom is a director) will be set forth under the
caption "Directors and Executive Officers" in the Company's proxy statement
related to its 2000 annual meeting of stockholders (the "Proxy Statement") and
is incorporated herein by reference. Information required by Item 405 of
Regulation S-K will be set forth under the caption "Section 16(a) Beneficial
Ownership Reporting Compliance" in the Proxy Statement and is incorporated
herein by reference.
ITEM 11--EXECUTIVE COMPENSATION
- -------------------------------
Information required by this item will be set forth under the caption
"Executive Compensation" in the Proxy Statement and, except for the information
under the captions "Executive Compensation -- Report of the Compensation
Committee on Executive Compensation" and "Executive Compensation -- Performance
Graph," is incorporated herein by reference.
ITEM 12--SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- -----------------------------------------------------------------------
Information required by this item will be set forth under the caption
"Security Ownership of Certain Beneficial Owners and Management" in the Proxy
Statement and is incorporated herein by reference.
ITEM 13--CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
Information regarding certain relationships and related transactions of
directors and executive officers will be set forth under the caption "Certain
Relationships and Related Transactions" in the Proxy Statement and is
incorporated herein by reference.
PART IV
--------
ITEM 14--EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
- ---------------------------------------------------------------
FORM 8-K
---------
(a) 1. The following designated financial statements and
the auditors' reports thereon are included herein at
pages 33 through 55:
Ernst & Young LLP's Independent Auditors'
Report.
KPMG LLP's Independent Auditors' Report.
Consolidated Balance Sheets as of December
31, 1999 and 1998.
Consolidated Statements of Operations for
the years ended December 31, 1999, 1998 and
1997.
56
Consolidated Statements of Stockholders'
Equity for the years ended December 31,
1999, 1998 and 1997.
Consolidated Statements of Cash Flows for
the years ended December 31, 1999, 1998 and
1997.
Notes to Consolidated Financial Statements.
2. All schedules are omitted because the required
information is not present or is not present in
amounts sufficient to require submission of the
schedule, or because the required information is
included in the consolidated financial statements or
notes thereto listed in Item 14(a)(1).
3. Exhibits:
Exhibit
Number Description of Document
------- -----------------------
3.1 Composite of Second Amended and Restated Certificate
of Incorporation, as amended through August 1, 1997
(Incorporated by reference to Exhibit 3 of the
Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1997).
3.2 Amended and Restated Bylaws of the Company
(Incorporated by reference to Exhibit 3.2 of the
Company's Registration Statement on Form S-1
(Registration No.33-98708) (the "Registration
Statement")).
4.1 Indenture, dated as of February 1, 1995 (the
"Indenture") among the Company, as Servicer, DPFC, as
Issuer, and Bankers Trust Company, as Indenture
Trustee ("Bankers Trust") (Incorporated by reference
to Exhibit 10.12 of the Registration Statement).
4.2 Amendment No. 1 to the Indenture (Incorporated by
reference to Exhibit 10.13 of the Registration
Statement).
4.3 Amendment No.2 to the Indenture, dated as of August
5, 1996. (Incorporated by reference to Exhibit 4.3 of
the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1997).
4.4 Amendment No.3 to the Indenture, dated as of July 2,
1997 (Incorporated by reference to Exhibit 10 of the
Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1997).
4.5 Amendment No.4 to the Indenture, dated as of November
4, 1997 (Incorporated by reference to Exhibit 4.5 of
the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1997).
10.1* Point West Capital Corporation Amended and Restated
1995 Stock Option Plan (Incorporated by reference to
Exhibit 10 of the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1998).
57
10.2* Stock Option Plan for Non-Employee Directors
(Incorporated by reference to Exhibit 10.2 of the
Registration Statement).
10.3* Form of option agreement dated November 17, 1997
granted to each of Bradley N. Rotter, Alan B. Perper
and John Ward Rotter. (Incorporated by reference to
Exhibit 10.4 of the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1997).
10.4* Form of option agreement dated November 25, 1998
granted to each of Bradley N. Rotter, Alan B. Perper
and John Ward Rotter. (Incorporated by reference to
Exhibit 10.4 of the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1998).
10.5* Form of option agreement dated November 11, 1999
granted to each of Bradley N. Rotter, Alan B. Perper
and John Ward Rotter.
10.6 Agreement between the Company and Echelon regarding
allocation of costs (Incorporated by reference to
Exhibit 10.4 of the Registration Statement).
10.7 Amendment No. 1 to the Agreement between the Company
and Echelon regarding allocation of costs.
10.8* Profit Sharing Plan (Incorporated by reference to
Exhibit 10.5 of the Registration Statement).
10.9 Contribution, Sale and Servicing Agreement
("Servicing Agreement") dated as of February 1, 1995
among the Company, DPFC and Bankers Trust
(Incorporated by reference to Exhibit 10.14 of the
Registration Statement).
10.10 Amendment No.1 to Servicing Agreement (Incorporated
by reference to Exhibit 10.15 of the Registration
Statement).
10.11 Amendment No.2 to the Servicing Agreement
(Incorporated by reference to Exhibit 10.10 of the
Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1995).
10.12 Master Agreement for Purchase of Life Insurance
Policies dated September 27, 1996 (Incorporated by
reference to Exhibit 10 of the Company's Quarterly
Report on Form 10-Q for the quarter ended September
30, 1996).
10.13 Amendment dated as of November 13, 1996 to Master
Agreement for Purchase of Insurance Policies dated as
of September 27, 1996 (Incorporated by reference to
Exhibit 10.11 of the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1996).
10.14 Purchase and Sale Agreement dated as of January 16,
1997 (Incorporated by reference to Exhibit 10.12 of
the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1996).
58
10.15 Second Master Agreement for Purchase of Insurance
Policies dated as of February 10, 1997 (Incorporated
by reference to Exhibit 10.13 of the Company's Annual
Report on Form 10-K for the fiscal year ended
December 31, 1996).
10.16 Third Master Agreement for Purchase of Insurance
Policies dated as of March 24, 1997 (Incorporated by
reference to Exhibit 10.14 of the Company's Annual
Report on Form 10-K for the fiscal year ended
December 31, 1996).
10.17 Indemnification Agreement, dated September 30, 1995,
between the Company (as successor to Old Echelon) and
Echelon (Incorporated by reference to Exhibit 10.18
of the Registration Statement).
10.18 Amended and Restated Limited Liability Company
Agreement of Allegiance Capital, LLC (Incorporated by
reference to Exhibit 10.5 of the Company's Quarterly
Report on Form 10-Q for the quarter ended September
30, 1998).
10.19 Fourteen Hill Capital, L.P. Agreement of Limited
Partnership (Incorporated by reference to Exhibit
10.2 of the Company's Quarterly Report on Form I-Q
for the quarter ended September 30, 1997).
10.20 Fourteen Hill Management, LLC Operating Agreement by
Point West Capital and Fourteen Hill Management, LLC
as of June 9, 1997 (Incorporated by reference to
Exhibit 10.3 of the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1997).
10.21** Trust Agreement, dated as of August 1, 1998, among
Allegiance Funding Corp. I, Manufacturers and Traders
Trust Company and Point West Capital Corporation
(Incorporated by reference to Exhibit 10.1 of the
Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998).
10.22** Supplement to Trust Agreement for Revolving Series
1998-1, dated as of August 1, 1998 among Allegiance
Funding Corp. I, Manufacturers and Traders Trust
Company and Point West Capital Corporation
(Incorporated by reference to Exhibit 10.2 of the
Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998).
10.23** Loan Acquisition Agreement, dated as of August 1,
1998, between Allegiance Capital, LLC and Allegiance
Funding Corp. I (Incorporated by reference to Exhibit
10.3 of the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1998).
10.24** Servicing Agreement, dated as of August 1, 1998,
among Point West Capital Corporation, Allegiance
Capital, LLC, Allegiance Funding Corp. I,
Manufacturers and Traders Trust Company and other
party thereto (Incorporated by reference to Exhibit
10.4 of the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1998).
10.25 Point West Securities LLC Operating Agreement by
Point West Capital Corporation and Point West
Securities, LLC as of July 8, 1998 (Incorporated by
reference to Exhibit 10.26 of the Company's Annual
Report on Form 10-K for the fiscal year ended
December 31, 1998).
59
10.26** Amended and Restated Supplement to Trust Agreement
for Revolving Series 1998-1, dated as of September 1,
1999, among Allegiance Funding I, LLC, Manufacturers
and Traders Trust Company and Point West Capital
Corporation. (Incorporated by reference to Exhibit
10.1 of the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1999).
10.27** Second Amended and Restated Supplement to Trust
Agreement for Revolving Series 1998-1, dated as of
September 15, 1999, among Allegiance Funding I, LLC,
Manufacturers and Traders Trust Company and Point
West Capital Corporation. (Incorporated by reference
to Exhibit 10.2 of the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1999).
10.28** Supplement to Trust Agreement for Term Series 1999-1,
dated as of September 15, 1999, among Allegiance
Funding I, LLC, Manufacturers and Traders Trust
Company and Point West Capital Corporation.
(Incorporated by reference to Exhibit 10.3 of the
Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1999).
21.1 Subsidiaries of the Company.
23.1 Consent of Ernst & Young LLP.
23.2 Consent of KPMG LLP.
24.1 Powers of Attorney.
27 Financial Data Schedule.
99.1 Press Release for Point West Ventures, L.P.
* Management contract or compensation plan or arrangement.
** Certain information omitted pursuant to an order for confidential
treatment granted by the SEC.
(b) Reports on Form 8-K filed during the fourth quarter of 1999:
Date Item Reported Matter Reported
---- ------------- ---------------
November 12, 1999 5 The Company issue
a press release
regarding its results
of operations for
the third quarter of
1999.
60
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.
Dated March 3, 2000 POINT WEST CAPITAL CORPORATION
/s/Alan B. Perper
-----------------------------
Alan B. Perper
President
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on March 3,2000:
/s/ Alan B. Perper *
- ----------------------------- -----------------------------
Alan B. Perper John Ward Rotter
President and Director Executive Vice President,
(Principal Executive Officer) Chief Financial Officer
and Director
(Principal Financial and
Accounting Officer)
* *
- ----------------------------- -----------------------------
Bradley N. Rotter Stephen T. Bow
Chairman of the Board and Director Director
*
- -----------------------------
Paul A. Volberding, M.D.
Director
* The undersigned by signing his name hereunto has hereby signed this
report on behalf of the above-named directors, on March 3, 2000
pursuant to a power of attorney executed on behalf of each such director
and filed with the Securities and Exchange Commission as Exhibit 24.1 to
this report.
By: /s/ Alan B. Perper
---------------------
Alan B. Perper
61