SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
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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)
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 [ ]
At October 31, 1998, there were 3,253,324 shares of the registrant's Common
Stock outstanding.
POINT WEST CAPITAL CORPORATION
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INDEX
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Part I Page #
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Item 1. Consolidated Financial Statements:
Consolidated Balance Sheets
September 30, 1998 and December 31, 1997 1
Consolidated Statements of Operations
and Comprehensive Income (Loss) for the
Three and Nine Months Ended September 30, 1998 and 1997 2
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1998 and 1997 3
Condensed Notes to Consolidated Financial Statements 4-10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11-20
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 21
Part II
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Item 1. Legal Proceedings 22
Item 5. Other Information 23
Item 6. Exhibits and Reports on Form 8-K 24
Signatures 25
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(i)
POINT WEST CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS
September 30, 1998 and December 31, 1997
September 30, December 31,
ASSETS 1998 1997
------------------- ------------------
Cash and cash equivalents $ 4,955,470 $ 10,039,560
Restricted cash 3,433,699 3,756,714
Investment securities (note 2)
Held-to-maturity 1,235,010 2,220,000
Available-for-sale 8,593,662 3,597,343
Matured policies receivable 75,000 305,435
Loans receivable, net of unearned income of $(127,106) and
$59,884, respectively (note 3) 7,018,698 4,015,716
Assets held for sale (note 4) 66,470 129,334
Purchased life insurance policies (note 5) 33,993,697 36,586,788
Non-marketable securities (note 6) 3,658,478 1,658,478
Deferred financing and organizational costs, net of
accumulated amortization of $818,602 and
$621,884, respectively 516,216 525,433
Furniture and equipment, net of accumulated depreciation of
$2,784 and $341, respectively 27,049 6,862
Other assets 129,316 127,590
------------------- ------------------
Total assets $ 63,702,765 $ 62,969,253
=================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued expenses $ 174,815 $ 183,150
Accounts payable 208,643 216,851
Accrued compensation payable 163,000 193,000
Reserve for equity interest in wholly owned financing
subsidiary (note 5) -- 2,300,037
Long term notes payable (note 7) 38,528,914 38,804,107
Debentures payable to Small Business Administration (note 8) 3,000,000 --
Deferred income taxes 6,000 6,000
------------------- ------------------
Total liabilities 42,081,372 41,703,145
------------------- ------------------
Stockholders' equity:
Common stock, $0.01 par value; 15,000,000 authorized shares,
4,291,824 shares issued
3,253,324 shares outstanding 42,918 42,918
Additional paid-in-capital 29,496,720 29,496,720
Comprehensive income-- net unrealized
investment gains (note 2 and 9) 5,001,555 2,597,239
Retained deficit (10,045,768) (7,996,737)
Treasury stock, 1,038,500 shares (2,874,032) (2,874,032)
------------------- ------------------
Total stockholders' equity 21,621,393 21,266,108
------------------- ------------------
Total liabilities and stockholders' equity $ 63,702,765 $ 62,969,253
=================== ==================
<FN>
See accompanying condensed notes to consolidated financial statements
</FN>
1
POINT WEST CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
For the Three and Nine Months Ended September 30, 1998 and 1997
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
-------------- -------------- -------------- -----------------
Income:
Earned discounts on matured policies (note 10) $ 65,167 $ 91,473 $ 430,819 $ 377,450
Interest income 350,218 338,191 1,049,373 883,401
Gain (loss) on sale of convertible
preferred shares -- (20,000) -- 679,665
Gain on assets sold (note 4) 14,820 98,128 165,346 1,460,986
Other 173,990 18,168 342,878 88,043
-------------- -------------- -------------- -----------------
Total income 604,195 525,960 1,988,416 3,489,545
Expenses:
Interest expense 925,545 896,771 2,697,587 2,721,030
Compensation and benefits 414,984 289,244 1,110,322 843,352
Other general and administrative expenses 409,101 12,123 1,256,920 1,037,236
Amortization 71,406 60,392 196,718 177,538
Depreciation 1,240 -- 2,443 --
Provision for loss on assets held for sale (note 4 ) -- 328,236 -- 328,236
Loss on non-marketable securities (note 6) 1,073,494 -- 1,073,494 --
-------------- -------------- -------------- -----------------
Total expenses 2,895,770 1,586,766 6,337,484 5,107,392
-------------- -------------- -------------- -----------------
Loss before net loss in wholly owned
financing subsidiary charged
to reserve for equity interest (2,291,575) (1,060,806) (4,349,068) (1,617,847)
Net loss in wholly owned financing subsidiary charged
to reserve for equity interest (note 5) 407,324 942,943 2,300,037 2,827,594
-------------- -------------- -------------- -----------------
Net income (loss) $ (1,884,251) $ (117,863) $ (2,049,031) $ 1,209,747
============== ============== ============== =================
Comprehensive income (loss) -- net unrealized
investment gains (losses) (note 9) (3,274,708) 356,421 2,404,316 356,421
Total comprehensive income (loss) (note 9) (5,158,959) 238,558 355,285 1,566,168
Basic earnings (loss) per share (note 11) (0.58) (0.04) (0.63) 0.33
Diluted earnings (loss) per share (note 11) (0.58) (0.04) (0.63) 0.33
Weighted average number of shares of common stock
outstanding (note 11) 3,253,324 3,253,324 3,253,324 3,612,190
Weighted average number of shares of common stock
and common stock equivalents outstanding (note 11) 3,253,324 3,253,324 3,253,324 3,692,572
<FN>
See accompanying condensed notes to consolidated financial statements
</FN>
2
POINT WEST CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 1998 and 1997
Nine Months Ended
September 30,
1998 1997
------------------- -------------------
Cash flows for operating activities:
Net income (loss) $ (2,049,031) $ 1,209,747
Adjustments to reconcile net income (loss) to net cash
(used in) provided by operating activities:
Depreciation and amortization 199,161 177,538
Gain on sale of assets (165,346) (1,460,986)
Gain on sale of convertible preferred shares -- (679,665)
Provisions for loss on sale of assets -- 328,236
Earned discounts on policies (430,819) (377,450)
Purchase of life insurance policies -- (966,275)
Collections on matured life insurance policies 3,082,440 5,317,170
Increase in other assets (1,729) (37,192)
(Decrease) increase in accrued expenses (8,335) 3,383
(Decrease) increase in accounts payable (8,208) 149,648
Decrease in accrued compensation payable (30,000) (52,390)
Decrease in reserve for equity interest in wholly
owned financing subsidiary (2,128,989) (2,827,594)
Loss on non-marketable securities 1,073,494 --
------------------- -------------------
Net cash (used in) provided by operating activities (467,362) 784,170
------------------- -------------------
Cash flows from investing activities:
Proceeds from sale of assets held for sale 229,067 12,686,192
Purchase of furniture and equipment (22,630) --
Return of restricted cash 323,015 504,816
Purchase of investment and non-marketable securities (6,708,504) (3,477,500)
Sale of investment and non-marketable securities 2,028,000 2,021,187
Additions to loans receivable (3,111,990) --
Principal payments on loans receivable 109,008 --
------------------- -------------------
Net cash (used in) provided by investing activities (7,154,034) 11,734,695
------------------- -------------------
Cash flows from financing activities:
Proceeds from debentures payable to the Small Business Administration 3,000,000 --
Principal payments on long term notes payable (275,193) (2,414,098)
Purchase of treasury stock -- (2,484,032)
Increase in financing costs (187,501) (80,592)
------------------- -------------------
Net cash provided by (used in) financing activities 2,537,306 (4,978,722)
------------------- -------------------
Net (decrease) increase in cash and cash equivalents (5,084,090) 7,540,143
Cash and cash equivalents, beginning of period 10,039,560 6,586,447
------------------- -------------------
Cash and cash equivalents, end of period $ 4,955,470 $ 14,126,590
=================== ===================
Supplemental disclosures:
Supplemental disclosure of non-cash activities:
Unrealized gain on securities available for sale $ 5,001,555 $ 356,421
=================== ===================
Supplemental disclosure of cash flow information:
State taxes paid $ 16,014 $ 35,823
=================== ===================
Cash paid for interest $ 2,701,359 $ 2,717,647
=================== ===================
<FN>
See accompanying condensed notes to consolidated financial statements
</FN>
3
POINT WEST CAPITAL CORPORATION
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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
----------------------------------------------------
1. General Description
- -- -------------------
The unaudited consolidated financial statements of Point West Capital
Corporation ("Point West") and its consolidated entities (the "Company") as of
September 30, 1998 and for the three and nine month periods ended September 30,
1998 have been prepared in accordance with generally accepted accounting
principles for interim financial information, in accordance with Rule 10-01 of
Regulation S-X. Accordingly, such statements do not include all of the
information and notes thereto that are included in the annual consolidated
financial statements. In the opinion of management, all adjustments considered
necessary for a fair presentation have been included. Operating results for the
three and nine month periods ended September 30, 1998 are not necessarily
indicative of the results that may be expected for the year ending December 31,
1998. The balance sheet as of December 31, 1997 has been derived from the
audited consolidated financial statements of the Company. The statements and
notes thereto included herein should be read in conjunction with the audited
consolidated financial statements and notes thereto included in the Company's
Annual Report on Form 10-K for the year ended December 31, 1997 (the "Form
10-K").
Point West is a specialty financial services company. The Company's
financial statements consolidate the assets, liabilities and operations of
Dignity Partners Funding Corp. I ("DPFC"), Fourteen Hill Management, LLC
("Fourteen Hill Management"), Fourteen Hill Capital, L.P. ("Fourteen Hill
Capital"), Allegiance Capital, LLC ("Allegiance Capital"), Allegiance Funding
Corp. I ("Allegiance Funding") and Allegiance Capital Trust I ("Allegiance Trust
I"). References herein to Allegiance include Allegiance Capital, Allegiance
Funding and Allegiance Trust I.
Until February 1997, the Company provided viatical settlements for
terminally ill persons. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Overview." Subsequently, the Company has
become a more broadly-based specialty financial services company by expanding
its financial services business through the formation of Fourteen Hill
Management and Fourteen Hill Capital, which invest in small businesses, and
Allegiance which lends funds to funeral home and cemetery owners. The Company
continues to service the life insurance policies held by its wholly owned
special purpose subsidiary, DPFC, and to evaluate other strategic business
opportunities. Fourteen Hill Capital and Allegiance may or may not be indicative
of the types of business opportunities the Company intends to continue to
pursue. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Fourteen Hill Management and Fourteen Hill Capital" and
"-- Allegiance."
During 1997, the Financial Accounting Standard Board ("FASB") issued
Statement of Financial Accounting Standard No. 131 ("SFAS 131"), Disclosure
About Segments of An Enterprise and Related Information. SFAS 131 is effective
with the year-end 1998 financial statements. During 1998, FASB issued Statement
of Financial Accounting Standard No. 133 ("SFAS 133"), Accounting for Derivative
Instruments and Hedging Activities. SFAS 133 is effective for all fiscal
quarters of fiscal years beginning after June 15, 1999. The Company will comply
with the disclosure requirements of SFAS 131 and SFAS 133 when required.
4
2. Investment Securities
- -- ---------------------
Statement of Financial Accounting Standards No. 115 ("SFAS 115"),
Accounting for Certain Instruments in Debt and Equity Securities, requires
marketable debt and equity securities to be classified into held-to-maturity,
available-for-sale and trading categories. Securities classified as
held-to-maturity are reported at amortized cost and available-for-sale
securities are reported at fair market value with unrealized gains and losses as
a separate component of stockholders' equity. Many of the equity securities
classified by the Company as available-for-sale are securities (or are
convertible into securities) traded in the over-the-counter ("OTC") market. Fair
market value is estimated by the Company based on the average closing bid of the
securities for the last three trading days of the reporting period and is
adjusted to reflect management's estimate of liquidity constraints. The Company
had no trading securities at September 30, 1998 or December 31, 1997. Any
unrealized gains and losses, declines in value of securities judged to be
other-than-temporary and accrued interest and dividends on all securities will
be reported on an appropriate line item above "Net Income (Loss)" on the
consolidated statements of operations and comprehensive income (loss) when
realized.
The amortized costs and estimated fair value of investment securities
(before any minority interest) as of September 30, 1998 and December 31, 1997
are as follows:
December 31, 1997
- -------------------------------------------------------------------------------------------------------
Gross Unrealized Gross Unrealized
Amortized Cost Gains Loss
Fair Value
Held-to-maturity
Corporate bonds $ 1,235,010 $ -- $ (150,010) $ 1,085,000
-------------- --------------- ----------------- --------------
Total held-to-maturity $ 1,235,010 $ -- $ (150,010) $ 1,085,000
Available-for-sale
Common stock $ 3,592,000 $ 5,001,662 $ -- $ 8,593,662
Warrants $ 0 $ -- $ -- $ --
------------------ ----------------- ------------------ ------------------
Total available-for-sale $ 3,592,000 $ 5,001,662 $ -- $ 8,593,662
December 31, 1997
- -------------------------------------------------------------------------------------------------------
Gross Unrealized Gross Unrealized
Amortized Cost Gains Loss
Fair Value
Held-to-maturity
Corporate bonds $ 2,220,000 $ 75,000 $ (5,000) $ 2,290,000
-------------- ---------------- ----------------- --------------
Total held-to-maturity $ 2,220,000 $ 75,000 $ (5,000) $ 2,290,000
Available-for-sale
Common stock $ 903,181 $ 1,355,153 $ -- $ 2,258,334
Warrants $ 96,819 $ 1,242,190 $ -- $ 1,339,009
-------------- ----------------- --------------- --------------
Total available-for-sale $ 1,000,000 $ 2,597,343 $ -- $ 3,597,343
5
The Company classifies debt securities for which it has the positive
intent and ability to hold to maturity as held-to-maturity. All investments in
debt securities classified as held-to-maturity at September 30, 1998 and
December 31, 1997 have maturity dates ranging from one to six years. Warrants
classified as available-for-sale have expiration dates ranging from one to five
years. Certain warrants outstanding at December 31, 1997 were exercised during
the first quarter of 1998 and the securities purchased upon such conversion are
reflected at September 30, 1998 as available-for-sale.
Unrealized gains on available-for-sale securities (representing
differences between estimated fair value and cost) of $5.0 million and $2.6
million at September 30, 1998 and December 31, 1997, respectively, were credited
to a separate component of stockholders' equity called "Comprehensive Income --
Net Unrealized Investment Gains."
3. Loans Receivable
- -- -----------------
Loans receivable includes loans made to unaffiliated third parties
through Allegiance and Fourteen Hill Capital. Such loans are reported at
amortized cost, and interest is accrued as earned. All loans at September 30,
1998 and December 31, 1997 were current, and no reserves were considered
necessary as of either date.
Allegiance had two loans outstanding at September 30, 1998 in the
aggregate principal amount of $5.8 million, one of which was originated in
December 1997 and bears interest at a fixed interest rate per annum of 9.4% and
the other of which was originated in January 1998 and bears interest at a fixed
interest rate per annum of 9.8%. 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. 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 ("SFAS 91"), Accounting for Nonrefundable
Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct
Costs of Leases.
On August 19, 1998, Allegiance put in place a structured financing
which provides short term financing and may provide long term financing, subject
to certain limitations, with respect to loans Allegiance has made in the past
and may make in the future. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Allegiance." It is anticipated
that this transaction will provide interim floating rate financing and
ultimately permanent fixed and floating rate financing for loans originated by
Allegiance, including the two loans held by Allegiance at September 30, 1998.
The interest rate at which it is anticipated that term certificates will be
issued will be set in the future when approximately $30 million of loans have
been originated. Allegiance utilizes futures contracts to hedge certain interest
rate exposure between the time of origination of the loans and the issuance of
term certificates. Any realized gain or loss related to these hedges are
deferred and recognized by the Company over the life of the related loan as an
adjustment of interest income. Pursuant to Statement of Financial Accounting
Standards No. 80 ("SFAS 80"), Accounting for Futures Contracts, all such
deferred amounts are reflected on the balance sheet 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 September 30, 1998, the Company had net
realized losses on its hedging activities of $211,000 which increased loans
receivable in a like amount. In addition, the Company had unrealized net losses
from open hedging positions of $123,000 as of September 30, 1998. The Company
had no hedging activities at December 31, 1997.
Fourteen Hill Capital had two loans outstanding at September 30, 1998
in the aggregate principal amount of $1,045,000, 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 September 1998 and bears interest at a
6
fixed interest rate per annum of 14%. Such loans mature, subject to permitted
prepayments, in approximately 5 years.
4. Assets Held for Sale
- -- --------------------
As a result of the Company's decision in 1996 to sell all or
substantially all of its assets, it reclassified all assets owned as of such
date, other than the assets of DPFC, to a "held-for-sale" category. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Overview." Accordingly, such assets are recorded on the balance
sheet as of September 30, 1998 and December 31, 1997 at the lower of carrying
value or fair value less estimated cost to sell. In connection with the decision
to sell assets, the Company established a reserve for loss on sale of assets in
1996 and reevaluates such reserve each quarter. Assets held for sale consisted
of:
September 30 , 1998 December 31, 1997
------------------- -----------------
Capitalized costs $ 232,447 $ 525,697
Earned discounts on life insurance policies 731 2,482
Reserve for loss on sale (166,708) (398,845)
------------------ ----------------
Assets held for sale $ 66,470 $ 129,334
================= ==================
The reserve for loss on sale was calculated based on the life
expectancy of the insured under each life insurance policy in relation to prices
obtained by the Company in connection with other sales, management's estimate of
the saleability of such policy, the type of policy (e.g., term or whole life),
the age of the insured and premiums on such policy. Any gain or loss due to the
difference between actual proceeds (less any back end sourcing fees) and the
carrying value after giving effect to the reserve for loss on sale of assets is
reported as a realized gain or loss on assets sold at the time any sale proceeds
are received.
"Assets held for sale" at September 30, 1998 consisted of 7 life
insurance policies which were the subject of prior sales agreements between the
Company and unaffiliated third parties. The Company experienced delays and
difficulties in transferring to the purchasers under such agreements the
ownership of these 7 policies and, thus, the sale of these 7 policies was not
consummated under such sales agreements. However, the Company continues to
pursue other alternatives for the sale of these policies.
5. Purchased Life Insurance Policies
- -- ---------------------------------
Effective July 1996, 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 7),
requires the consent of the Company and the Noteholders. The Company has
discussed potential sales of DPFC policies with the Noteholders; however, the
Company has not determined whether it will decide to sell such policies and
cannot determine whether the Noteholders will consent to such a sale or whether
such a sale is feasible. A reserve was recorded in 1996 in the amount of $6.9
million to reflect the estimated loss of Point West'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 consolidated statement of operations and comprehensive income (loss)
in the appropriate period. See Note 7.
7
6. Non-Marketable Securities
- -- -------------------------
Non-marketable securities include investments in non-marketable debt
and equity securities through Point West and Fourteen Hill Capital. The Company
accounts for such non-marketable securities using the cost method.
In 1996, Point West purchased convertible preferred shares in American
Information Company, Inc. ("American Information"). As of September 30, 1998,
the carrying value of such non-marketable preferred shares was $1.7 million. See
the Form 10-K for further information regarding the Company's investment in
American Information.
In 1998, Fourteen Hill Capital invested $2 million in the convertible
preferred shares (convertible into common shares) of one unaffiliated small
business entity and invested $1 million in the debt securities (which are
convertible into preferred shares, which in turn are convertible into common
shares) of another unaffiliated small business entity. The investment in the
convertible debt yields a fixed interest rate per annum of 6.4%.
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
review, the Company determined that $1.1 million of non-marketable securities of
one company was impaired at September 30, 1998, and therefore wrote-off its
entire $1.1 million carrying value of such security.
7. Long Term 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, which are
reported on the balance sheet as long term notes payable, 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. The assets of DPFC are the beneficial ownership
interests in the life insurance policies and funds which secure the Securitized
Notes. Since 1996, losses associated with DPFC have been charged against the
reserve which was originally established in 1996 for the estimated loss of Point
West's equity interest in DPFC. See Note 5. 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
consolidated statement of operations and comprehensive 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. At September 30, 1998, DPFC's accumulated deficit was
$562,000. In the third quarter of 1998, the total loss realized by DPFC was
$969,000, $407,000 of which was charged against the reserve for equity interest
in wholly owned financing subsidiary, and $562,000 of which was otherwise
reflected in the Company's consolidated statements of operations and
comprehensive income (loss).
Point West is the servicer of the policies pledged under the indenture
pursuant to which the Securitized Notes were issued and incurs servicing
expenses (which are reimbursed, subject to certain priority payments) in
connection therewith.
8
8. Debentures payable to Small Business Administration
- -- ---------------------------------------------------
As of September 30, 1998, Fourteen Hill Capital had issued one
debenture in the principal amount of $3 million payable to the Small Business
Administration ("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, Fourteen Hill Capital 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 paid prior to September 1, 2003.
9. Stockholders' Equity
- -- --------------------
Changes in stockholders' equity during the first nine months of 1998
reflected the following:
Stockholders' equity, beginning of period $ 21,266,108
Comprehensive income -- net unrealized investment gains 2,404,316
Net loss (2,049,031)
-----------------
Stockholders' equity, end of period $ 21,621,393
During 1997, FASB issued Statement of Financial Accounting Standard
No.130 ("SFAS 130"), Reporting Comprehensive Income. SFAS 130 is effective for
interim and annual periods beginning after December 15, 1997. At September 30,
1998, the Company's total comprehensive income (loss) includes net unrealized
investment gains which represents the increase in the Company's investment
securities classified as available-for-sale.
10. Earned Discounts on Matured Policies
- -- ------------------------------------
With the decision to sell all or substantially all of the Company's
assets, any income on matured policies since the third quarter of 1996 has been
recorded as earned discounts on matured policies and recorded upon the
notification of death of the insured. Such income is equal to the difference
between the proceeds the Company received on the policies (less any back end
sourcing fees) and the carrying value of such policies after giving effect to
any reserve for loss on sale of such policies.
11. Earnings per Share
- -- ------------------
Statement of Financial Accounting Standards No.128 ("SFAS 128"),
Earnings per Share, was issued in February 1997 and is effective for years
ending after December 15, 1997. Under SFAS 128, earnings per share ("EPS") is
reported as two separate calculations: Basic EPS, similar to the previous
primary EPS excluding stock equivalents; and, Diluted EPS, similar to the
previous fully diluted EPS.
The weighted average number of common stock shares and additional
common stock equivalent shares used in computing EPS are set forth below for the
periods indicated.
For the three months For the six months
ended September 30, ended September 30,
=================== ==================
1998 1997 1998 1997
Weighted average number of shares of common
Stock outstanding....................................... 3,253,324 3,253,324 3,253,324 3,612,190
Additional common stock equivalents .............. -- -- -- 80,382
--------- --------- --------- ---------
Weighted average number of shares of common stock
and common stock equivalents outstanding ........ 3,253,324 3,253,324 3,253,324 3,692,572
========= ========= ========= =========
9
Diluted EPS for the three and nine months ended September 30, 1998 and
the three months ended September 30, 1997 do not include any common stock
equivalents due to their anti-dilutive effect. Common Stock equivalents for the
nine months ended September 30, 1997 include, to the extent they do not have an
anti-dilutive effect, employee stock options, non-employee director stock
options and warrants issued to Jefferies & Company, Inc., the investment banking
firm which previously advised the Company in connection with strategic options.
12. Litigation
- -- ----------
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
alleged 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. On April 24, 1998, the Court granted the Company's and other defendants'
motion to dismiss as it related to the Section 11 claims with prejudice but
denied the motion to dismiss the claims under Section 10(b) and Rule 10b-5 as to
all defendants other than Mr. Bow, one of Point West's directors. Thereafter,
plaintiffs filed a motion for class certification which the remaining defendants
have opposed. The Company has not received a ruling on the motion for class
certification. The case is currently in discovery. The Company and each of the
remaining defendants intend to continue to defend the action vigorously.
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 New Echelon LLC 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. Although
the case has been stayed since its inception, the plaintiff recently filed a
motion (which the defendants have opposed) to have the stay lifted. The Company
and each of the defendants intend to defend the action vigorously.
10
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 as of September 30, 1998, and of the results
of operations for the Company for the three and nine months ended September 30,
1998 and 1997, 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 unaudited consolidated financial statements and related
notes appearing elsewhere herein. For the reasons set forth below (including the
sale of a substantial portion of the Company's life insurance policies during
the first half of 1997 and the inception of two new businesses in the second
half of 1997) the Company's results of operations and cash flows for the three
and nine months ended September 30, 1998 are not comparable to those for the
three and nine months ended September 30, 1997.
Overview
- --------
The Company is a specialty financial services company. The Company's
financial statements consolidate the assets, liabilities and operations of DPFC,
Fourteen Hill Management, Fourteen Hill Capital and Allegiance. See the Form
10-K and Condensed Notes to Consolidated Financial Statements (contained herein)
for further information regarding these entities.
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'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. Through December 31, 1997, the Company
had entered into agreements to sell 373 policies with an aggregate face value of
$29.2 million and had consummated the sale of (or otherwise collected) all but 7
of such policies (having an aggregate face value of $436,000) at September 30,
1998. See "Results of Operations -- Three and Nine Months Ended September 30,
1998 Compared to Three and Nine Months Ended September 30, 1997 -- Gain on
Assets Sold" and Note 4 of the Condensed Notes to Consolidated Financial
Statements (contained herein) for further information regarding assets held for
sale.
Subsequent to February 1997, the Company has become a more
broadly-based specialty financial services company by expanding its financial
services business through the formation of Fourteen Hill Management and Fourteen
Hill Capital, which invest in small businesses, and Allegiance which lends funds
to funeral home and cemetery owners. The Company continues to service the life
insurance policies held by its wholly owned special purpose subsidiary, DPFC,
and to evaluate other strategic business opportunities. Fourteen Hill Capital
and Allegiance, whose business activities are described below, may or may not be
indicative of the types of business opportunities the Company intends to
continue to pursue.
11
Fourteen Hill Management and Fourteen Hill Capital
- --------------------------------------------------
On June 3, 1997, the Company formed Fourteen Hill Management and
Fourteen Hill Capital. Fourteen Hill Management is a wholly owned limited
liability company of Point West formed solely for the purpose of serving as the
general partner of one or more small business investment companies ("SBIC").
Fourteen Hill Capital is a limited partnership formed solely for the purpose of
operating as an SBIC. Fourteen Hill Capital received its SBIC license from the
SBA effective September 26, 1997. Fourteen Hill Management is the sole general
partner of Fourteen Hill Capital, and owns 99.978% of the partnership interests.
Point West is one of the two limited partners of Fourteen Hill Capital and owns
0.02% of the partnership interests. The remaining 0.002% of the partnership
interest is owned by one unaffiliated limited partner. Point West capitalized
Fourteen Hill Management with $5.0 million.
Fourteen Hill Capital provides loans, debt and equity capital to small
companies (i.e., generally companies with a net worth less than $l8 million and
average net income less than $6 million for the last two years). Fourteen Hill
Capital commenced operations in August 1997. At September 30, 1998, Fourteen
Hill Capital had two loans outstanding in the aggregate principal amount of
$1,045,000 and non-marketable securities consisting of one convertible debt
instrument and one convertible preferred equity instrument for which it
originally provided funds in the aggregate amount of $3 million. See Notes 3 and
6 of the Condensed Notes to Consolidated Financial Statements (contained herein)
and "Method of Accounting." In addition, Fourteen Hill Capital has investments
in marketable securities consisting of three equity investments outstanding for
which it had originally provided funds in the aggregate amount of $3.6 million.
At September 30, 1998, such investments in marketable securities were carried on
the balance sheet at $8.6 million. The difference between such carrying value
and the original funds provided is reflected as "Comprehensive Income -- Net
Unrealized Investment Gains" in stockholders' equity. Many of the marketable
equity securities, which are held by Fourteen Hill Capital and which are
classified as available-for-sale, are securities traded in the OTC Market. Fair
market value is estimated by the Company based on the average closing bid of the
securities for the last three trading days of the reporting period and is
adjusted to reflect management's estimate of liquidity constraints.
On July 16, 1998, Fourteen Hill Capital borrowed $3 million from the
SBA. At present, Fourteen Hill Capital is unable to borrow additional funds from
the SBA because two investments each represents an amount greater than 20% of
its regulatory capital plus its net unrealized investment gains. The Company
cannot determine when, if ever, it will be able to borrow additional funds from
the SBA. In addition, if Fourteen Hill Capital does not liquidate a portion of
its investment portfolio or obtain additional capital, the SBA may accelerate
the repayment of the debenture. See "Liquidity and Capital Resources." See the
Form 10-K and Notes 2, 3 and 6 of the Condensed Notes to Consolidated Financial
Statements (contained herein) for further information regarding Fourteen Hill
Management and Fourteen Hill Capital.
Allegiance
- ----------
Allegiance Capital is a limited liability company formed on September
5, 1997 as a specialty finance company to provide senior secured loans to
funeral home and cemetery owners. Through September 30, 1998, Allegiance Capital
had funded two loans in the aggregate principal amount of $5.9 million. Point
West provided the capital to Allegiance Capital for such loans. Point West has a
65% ownership interest and 95% voting control in Allegiance Capital and serves
as the managing member of Allegiance Capital. Allegiance Capital's president and
its vice president of marketing, each of whom was hired in September 1997, have
the balance of such interests and have an option to acquire from Point West 5%
of the equity interests (but not the voting power) if certain events occur.
Allegiance Capital owns 100% of Allegiance Funding, which is a special purpose
subsidiary formed to acquire and securitize loans originated by Allegiance
Capital. Net profits of Allegiance Capital for each calendar year will be
12
allocated first to Point West 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 will be 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 to the extent that in each year sufficient profits are
available with no carry forward provided.
On August 19, 1998, Allegiance Funding formed a trust, Allegiance Trust
I, to consummate a structured financing which may provide approximately $56.4
million to support Allegiance's lending activities (the "Financing"). At
September 30, 1998, no funds had been borrowed under the Financing.
Pursuant to the Financing, a consortium of insurance companies (the
"Investors") will provide funding of approximately $26.4 million through August
31, 1999 on a non recourse revolving certificate basis to be used for the
purchase or funding of loans originated by Allegiance Capital and transferred to
Allegiance Funding. The interest rate on such revolving facility depends on the
amount outstanding and varies with prevailing interest rates, but if the entire
revolving facility were utilized, the weighted-average interest rate at
September 30, 1998 would have been approximately 7.5%. Such interest rate
represents a spread of 2.0% over the one-month LIBOR (London InterBank Offered
Rate) on such date for a portion of the certificates and the weighted-average
spread of 3.9% over the one-year U.S. Treasury rate for the remaining interest
bearing certificates. Upon the earlier of the incurrence of $26.4 million of
revolving certificates or August 31, 1999, such revolving certificates will be
repaid through the issuance of term certificates with an approximate 15-year
maturity. In addition, the Financing provides a commitment to provide up to an
additional $30 million of funding through August 31, 1999 through 15-year term
loans. In the event that term certificates are not issued by August 31, 1999,
Allegiance will be required to refinance any revolving certificates outstanding
under the Financing. See "Liquidity and Capital Resources."
The Financing contemplates the issuance of various classes of revolving
and term certificates through Allegiance Trust I. Certificates receiving ratings
are to be purchased by the Investors, while Allegiance Funding will retain
unrated certificates. The revolving certificates received ratings from Duff &
Phelps Credit Rating Co. ranging from A to BB and it is anticipated that the
term certificates, when and if issued, will also receive ratings from Duff &
Phelps. Allegiance initially retained an unrated revolving certificate
(currently with an aggregate principal amount of $0) with a maximum aggregate
principal amount of $3,650,000. This certificate represents the right to receive
all excess cash flow from Allegiance Trust I. Allegiance also anticipates
retaining unrated term certificates following retirement of revolving
certificates. Because of Allegiance's right to redeem the certificates if 15% or
less in principal amount of certificates is outstanding, the Financing does not
qualify for sale treatment under Statement of Financial Accounting Standards No.
125 ("SFAS 125"), Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities. Accordingly, the Financing will not receive gain
on sale treatment under SFAS 125 and any borrowings under the Financing will be
reflected on the consolidated balance sheet.
In connection with the Financing, Allegiance will pay a $175,000
commitment fee when funds are initially borrowed under the Financing. Such
commitment fee will be amortized over the expected life of the Financing (15
years). See Note 3 of the Condensed Notes to Consolidated Financial Statements
(contained herein) and "Liquidity and Capital Resources" for further information
regarding Allegiance and the Financing.
Method of Accounting
- --------------------
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 and reevaluates this reserve
13
quarterly. The Company also established a reserve for loss of Point West's
equity interest in DPFC during 1996 because of the uncertainties created by the
data presented at the AIDS Conference and subsequent reports of the efficacy of
new treatments for AIDS/HIV. The reserve for loss on sale of assets was $167,000
and $399,000 as of September 30, 1998 and December 31, 1997, respectively. The
reserve for loss of Point West's equity interest in DPFC was fully depleted as
of September 30, 1998 and was $2.3 million as of December 31, 1997,
respectively. See "Certain Accounting Implications for DPFC." In addition,
beginning in 1996, the Company began recognizing 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). Such income is
equal to the difference between such proceeds (less any back-end sourcing fees)
and the carrying value of such policies after giving effect to any reserve for
loss on the sale of such policies. See the Form 10-K and Notes 4 and 5 of the
Condensed Notes to Consolidated Financial Statements (contained herein) for
further information regarding the reserve for loss on sale of assets and the
reserve for loss of Point West's equity interest in DPFC.
SFAS 115 requires marketable debt and equity securities (including
those held by Fourteen Hill Capital) to be classified into held-to-maturity,
available-for-sale and trading categories. Securities classified as
held-to-maturity are reported at amortized cost and available-for-sale
securities are reported at fair market value with unrealized gains and losses as
a separate component of stockholders' equity. The Company had no trading
securities at September 30, 1998 or December 31, 1997. Any unrealized gains and
losses, declines in value of securities judged to be other-than-temporary and
accrued interest and dividends on all securities will be reported on an
appropriate line item above "Net Income (Loss)" on the consolidated statements
of operations and comprehensive income (loss) when realized. See Note 2 of the
Condensed Notes to Consolidated Financial Statements (contained herein).
The Company accounts for loans advanced by Fourteen Hill Capital and
Allegiance by accruing interest on outstanding balances. At December 31, 1997
and September 30, 1998, the Company evaluated each of the outstanding loans and
determined that a reserve for the loans was not necessary. As the Company's loan
portfolio grows or upon subsequent evaluation, reserves for loans will be added
to the extent considered necessary. 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 SFAS 91. See
Note 3 of the Condensed Notes to Consolidated Financial Statements (contained
herein).
The interest rate at which Allegiance anticipates issuing term
certificates will be set in the future when approximately $30 million of loans
have been originated. Allegiance utilizes futures contracts to hedge certain
interest rate exposure between the time of origination of the loans and the
issuance of term certificates. Any realized gain or loss related to these hedges
are deferred and recognized by the Company over the life of the related loan as
an adjustment of interest income. Pursuant to SFAS 80, all such deferred amounts
are reflected on the balance sheet 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 September 30, 1998, the Company had net realized losses
on its hedging activities of $211,000 which increased loans receivable in a like
amount. In addition, the Company had unrealized net losses from open hedging
positions of $123,000 as of September 30, 1998. The Company had no hedging
activities at December 31, 1997.
Point West is the counter party to a swap agreement pursuant to which
Point West has assumed certain variable rate interest exposure of Allegiance
between the time of origination of loans and the issuance of term certificates.
Point West plans to utilize futures contracts to hedge such exposure. Any
realized gain or loss related to these hedges will be deferred and recognized by
the Company over the life of the term certificates as an adjustment of interest
expense.
14
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. As a result
of such review, the Company determined that $1.1 million of non-marketable
securities of one company was impaired at September 30, 1998, and therefore
wrote-off its entire $1.1 million carrying value of such security. See "Results
of Operations -- Three and Nine Months Ended September 30, 1998 Compared to
Three and Nine Months Ended September 30, 1997 -- Loss on Non-Marketable
Securities"
Certain Accounting Implications for DPFC
- ----------------------------------------
Although the Securitized Notes had an expected life of 2.1 years in
September 1995, the Securitized Notes were not retired through collections by
October 1997. At September 30, 1998, $38.5 million was outstanding under the
Securitized Notes. As a result of the substantially delayed collection of DPFC
policies, DPFC had a deficit at September 30, 1998.
If the collection experience for the DPFC policies continues to be
substantially delayed, the deficit of DPFC 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.
Since 1996, losses associated with DPFC have been charged against the
reserve which was originally established in 1996 for the estimated loss of Point
West's equity interest in DPFC. 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 consolidated statement
of operations and comprehensive 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. At September
30, 1998, DPFC's accumulated deficit was $562,000. In the third quarter of 1998,
the total loss realized by DPFC was $969,000, $407,000 of which was charged
against the reserve for equity interest in wholly owned financing subsidiary,
and $562,000 of which was otherwise reflected in the Company's consolidated
statement of operations and comprehensive income (loss). The loss of $562,000
for the third quarter of 1998 decreased basic EPS by $0.17 for the three and
nine months ended September 30, 1998. The average historical quarterly losses in
DPFC have been approximately $938,000 per quarter over the past eight quarters.
The Securitized Notes represent the obligations solely of DPFC. The Company did
not guarantee repayment of the Securitized Notes and is not required to fund any
principal or interest deficiencies thereunder.
Results of Operation
- --------------------
Three and Nine Months Ended September 30, 1998 Compared to the Three and Nine
- -----------------------------------------------------------------------------
Months Ended September 30, 1997
- -------------------------------
Earned Discounts on Matured Policies. Earned discounts on matured
polices decreased 28.8% in the third quarter of 1998 compared to the third
quarter of 1997 due to the decrease in the number and face amount of matured
policies. During the third quarter of 1998, the Company had earned discounts on
6 policies with a face value of $542,000, compared to 9 policies with a face
value of $605,000 in the third quarter of 1997. Earned discounts on matured
polices increased 14.1% in the first nine months of 1998
15
compared to the first nine months of 1997. During the first nine months of 1998,
the Company had earned discounts on 44 policies with a face value of $2.9
million, compared to 63 policies with a face value of $4.1 million during the
first nine months of 1997. Although the Company had earned discounts on fewer
policies during the first nine months of 1998 compared to the first nine months
of 1997, the earned discounts increased for the 1998 period due primarily to the
collection in the first quarter of 1998 of two policies with above-average face
values and relatively low carrying values. See "Method of Accounting."
Interest Income. Interest income increased 3.6% in the third quarter of
1998 compared to the third quarter of 1997 and 18.8% in the first nine months of
1998 over the first nine months of 1997. This increase is due primarily to the
interest earned on loans made by Fourteen Hill Capital (which was formed in June
1997) and Allegiance (which was formed in September 1997). See "Method of
Accounting." Partially offsetting this increase is the decrease in interest
earned on the proceeds from the sale of policies in the first half of 1997 which
were invested in short term securities and marketable securities.
Gain on Sale of Convertible Preferred Shares. In the first quarter of
1997 the Company recognized a $700,000 gain on the sale of a portion of Point
West's investment in American Information. In addition, the Company had an
option that expired on October 26, 1997 to purchase for approximately $1.1
million, 8.2 million additional shares of common stock of American Information.
Since the Company did not exercise this option, a $20,000 pre-tax loss was
recognized in the third quarter of 1997. See the Form 10-K. The Company accounts
for this investment using the cost method.
Gain on Assets Sold. The gain on assets sold decreased 84.9% in the
third quarter of 1998 compared to the third quarter of 1997 and 88.7% in the
first nine months of 1998 compared to the first nine months of 1997 because a
large portion of the sale proceeds from life insurance policies was collected
during the first half of 1997. The Company collected the sale proceeds on 1
policy resulting in a realized gain of $15,000 in the third quarter of 1998,
compared to 6 policies resulting in a realized gain of $98,000 in the third
quarter of 1997. The Company collected the sale proceeds on 7 policies resulting
in a realized gain of $165,000 in the first nine months of 1998, compared to 245
policies resulting in a realized gain of $1.5 million in the first nine months
of 1997. The realized gain was calculated based on the difference between the
sale proceeds and the carrying value of such policies after giving effect to the
reserve for loss on sale of assets. See Note 4 of the Condensed Notes to
Consolidated Financial Statements (contained herein).
Other Income. Components of other income include a placement fee,
collections on policies of dividends, interest and paid-up cash values,
increases in face value of matured policies, refunds of premiums on matured
policies and realized capital gains on investments securities. Other income
increased $156,000 during the third quarter of 1998 compared to the third
quarter of 1997 and $255,000 during the first nine months of 1998 compared to
the first nine months of 1997. This increase is primarily a result of $110,000
in capital gains from the sale of investment securities and a $65,000 increase
in face value on one policy, both realized during the third quarter of 1998. The
nine-month increase is also due to a $70,000 placement fee received in the
second quarter of 1998 by Point West in the form of convertible preferred shares
in connection with an investment made by co-investors of Fourteen Hill Capital
in an unaffiliated small business entity.
Interest Expense. Interest expense increased 3.2% in the third quarter
of 1998 compared to the third quarter of 1997. Such increase was due to the
interest paid on the $3 million borrowed from the SBA on July 16, 1998. The
interest rate (including the 1% annual fee) on the SBA Debentures was 6.9%.
Interest expense decreased 0.9% in the first nine months of 1998 compared to the
first nine months of 1997. Such decrease was due to the decrease in interest
expense for the Securitized Notes. Average borrowings under the Securitized
Notes were $38.7 million in the first nine months of 1998 compared to
16
$39.3 million in the first nine months of 1997. The interest rate on the
Securitized Notes was 9.17% in both periods.
Compensation and Benefits. Compensation and benefits increased 43.5% in
the third quarter of 1998 compared to the third quarter of 1997 and 31.7% in the
first nine months of 1998 compared to the first nine months of 1997. This
increase was due to two new employees hired in September 1997 to support
Allegiance's lending activities, four new employees hired in the third quarter
of 1998 to support Point West's activities and an increase in compensation and
benefits for other employees (including executive officers) for 1998.
Other General and Administrative Expenses. Other general and
administrative expenses increased $397,000 in the third quarter of 1998 compared
to the third quarter of 1997. The third quarter of 1997 included a one-time
reduction of professional fees in the amount of $75,000 due to the expiration of
a consulting contract and a reduction of estimated general legal expenses in the
amount of $100,000. In addition, such increase is also due to an increase of
$115,000 in life insurance policy premium costs during 1998 and an increase in
legal expenses of $49,000 incurred in connection with federal and state alleged
class action lawsuits filed against the Company and its officers and directors.
Other general and administrative expenses increased $220,000 in the
first nine months of 1998 compared to the first nine months of 1997. The
increase was due to an increase in life insurance policy premium costs of
$389,000 in the first nine months of 1998. Prior to the third quarter of 1998
and the depletion of the reserve for equity interest in wholly owned financing
subsidiary, premium costs were reflected in the reduction of such reserve. As a
result, such increased premium costs did not impact net income in any period
prior to the third quarter of 1998. Partially offsetting this increase was a
decrease in legal expenses in the first nine months of 1998 in the amount of
$241,000 incurred in connection with federal and state alleged class action
lawsuits filed against the Company and its officers and directors. This decrease
was largely a result of the retention limit being satisfied, requiring the
insurance carrier to fund the majority of the continuing costs of such
litigation.
Provision for Loss on Assets Held for Sale. The Company recorded in
1996 a provision for loss on sale of assets totaling $3.3 million. For the
quarter ended September 30, 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 adjustment to the provision has been made during 1998.
Loss on Non-Marketable Securities. 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 review, the Company determined that $1.1
million of non-marketable securities of one company was impaired at September
30, 1998, and therefore wrote-off its entire $1.1 million carrying value of such
security.
Net Loss in Wholly Owned Financing Subsidiary Charged to Reserve for
Equity Interest. The DPFC net loss of $407,000 and $2.3 million recorded in the
three and nine months ended September 30, 1998, respectively, and $943,000 and
$2.8 million recorded in the three and nine months ended September 30, 1997,
respectively, were included in the Company's net loss before net loss in wholly
owned financing subsidiary charged to reserve for equity interest. 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 consolidated statement of operations
and comprehensive income (loss). All additional losses of DPFC will be reflected
in the Company's consolidated statement of operations and comprehensive income
(loss) for the periods in which such losses occur.
17
Liquidity and Capital Resources
- --------------------------------
On July 16, 1998, Fourteen Hill Capital borrowed $3 million from the
SBA. At present, Fourteen Hill Capital is unable to borrow additional funds from
the SBA because two investments each represents an amount greater than 20% of
its regulatory capital plus its net unrealized investment gains. The Company
cannot determine when, if ever, it will be able to borrow additional funds from
the SBA. In addition, if Fourteen Hill Capital does not liquidate a portion of
its investment portfolio or obtain additional capital, the SBA may accelerate
the repayment of the debenture. The Securitized Notes do not provide funds with
which to fund operations. On August 19, 1998, Allegiance put in place the
Financing which may provide up to $56.4 million solely to support any future
lending activities of Allegiance. It is anticipated that the Financing will
provide interim floating rate financing through August 31, 1999 and ultimately
15 year fixed and floating rate financing for loans originated by Allegiance.
However, if Allegiance does not originate $30 million in loans by August 31,
1999, the term certificates may not be issued and Allegiance would be
responsible for finding an alternative financing source. See "Allegiance." At
present, the Company does not have an external funding source from which to fund
its working capital and general corporate needs.
At September 30, 1998, cash and cash equivalents was $5.0 million. The
Company continues to analyze its current and future needs for financing, which
will be dependent on its ability to develop the businesses of Fourteen Hill
Capital and Allegiance and any other business opportunities the Company pursues.
There can be no assurance that the Company will be successful in obtaining
external financing on satisfactory terms assuming it determines it needs
additional funds. Point West at present anticipates having sufficient liquidity
to meet its working capital and operational needs through 1999, using current
cash and cash equivalents. However, the Company may not have sufficient
liquidity to grow the business of Fourteen Hill Capital.
As of September 30, 1998, the outstanding principal amount of the
Securitized Notes was $38.5 million. 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 the Company to expend cash or
obtain financing to satisfy such principal and interest obligations. See Note 7
of the Condensed Notes to Consolidated Financial Statements (contained herein).
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,
holding or trading in securities within the meaning of the 1940 Act, whether or
not those companies intend to be engaged primarily in such business). There are
various percentage of assets and income tests under the 1940 Act (the
"Percentage Tests") that are relevant in considering whether a company is deemed
to be an investment company. Companies that are subject to the 1940 Act must
register with the Securities and Exchange Commission (the "Commission") as
investment companies and upon registration become subject to extensive
regulation.
The Company does not believe it is engaged primarily in the business of
investing, reinvesting, holding or trading in securities within the meaning of
the 1940 Act and the rules of the Commission promulgated thereunder and does not
believe that it should be deemed to be an investment company under the
Percentage Tests. It is possible, however, that the Company could, in the
future, be deemed to be an investment company under the Percentage Tests or
otherwise and, thus, be required to register and be regulated under the 1940
Act, which could significantly and adversely affect the Company's business and
the market price of its Common Stock.
18
In particular, through Fourteen Hill Capital, the Company holds
investments in securities. These investments have been made primarily since
January 1998. The value of these and certain of the Company's other investments
have increased substantially since originally being purchased, increasing the
likelihood that the Company will, in the future, exceed one or more of the
Percentage Tests, unless the Company's other businesses grow more rapidly than
currently anticipated.
Although the Company intends to conduct its business so as to not
become subject to regulation under the 1940 Act, the Company's ability to
continue not being subject to registration and regulation under the 1940 Act
will be subject to many factors, some of which may be outside the Company's
control. Such factors include, among others, the successful and timely
implementation of the Company's business plan, the relative values of the
various assets which are held by the Company and the sources of the Company's
income which, in turn, will be significantly affected by increases or decreases
in the market value of assets held by Fourteen Hill Capital. In view of the
foregoing, no assurance can be given that the Company may not, in the future, be
required to register as an investment company under the 1940 Act or take steps
to avoid being required to register. Such steps may include (i) disposing of
certain assets at a time or in a manner which would not maximize potential
returns, (ii) restricting additional investments by Fourteen Hill Capital (or
otherwise) even if the capital to make additional investments is available, and
(iii) initiating other businesses which may be different from the Company's
other business activities.
Other
- -----
The "Year 2000 issue" refers to a wide variety of potential computer
program processing and functionality issues that may arise from the inability of
computer programs to properly process date-sensitive information relating to the
Year 2000, years thereafter and to a lesser degree the Year 1999. Any of the
Company's computers, computer programs and administration equipment or products
that have date-sensitive software may recognize a date using "00" as the year
1900 rather than the year 2000. If any of the Company's systems or equipment
that have date-sensitive software use only two digits, system failures or
miscalculations may result causing disruptions of operations, including, among
other things, a temporary inability to process transactions or send and receive
electronic data with third parties or engage in similar normal business
activities.
The Company expects to spend approximately $50,000 to $100,000 in the
aggregate during 1998 and 1999 to modify its computer information systems
enabling proper processing of transactions relating to the year 2000 and beyond
("Year 2000 Compliant"). During 1998, the Company made an assessment of Year
2000 Compliant issues and determined that it needed to modify or replace certain
third party computer hardware and software. As the Company has implemented
solutions to the Year 2000 Compliant issues, in some circumstances it has
determined that replacing existing systems, hardware, or equipment may be more
efficient and also provide additional functionality. The Company has completed
such modifications and replacements. Through September 30, 1998, the Company had
incurred Year 2000 Compliant costs of approximately $24,000, of which $19,000
has been capitalized. The Company does not believe the amounts expected to be
expensed over the next two years will have a material effect on its financial
position or results of operations. However, there can be no assurance that
actual costs (i) will not materially exceed expected costs and (ii) will not
have a material adverse effect on the Company's financial condition and results
of operation. The Company is currently assessing its electronic office equipment
such as the phone system, copiers, fax machines, printers, and the like to
determine if such equipment is date sensitive and will require upgrades. The
Company is also assessing the readiness of its business-critical spreadsheets
and customized databases and plans to make modifications of those systems as
necessary. The Company expects to have completed all of its remediation efforts
by the end of 1998, allowing time in 1999 for testing and system refinements
that may be needed.
19
The Company has begun assessing the readiness of external entities,
such as vendors, suppliers, investments and financial institutions which
interface with the Company and plans to have this assessment complete by June
30, 1999. The Company plans to determine whether those parties have appropriate
plans to remediate Year 2000 issues where their systems interface with the
Company's systems or otherwise impact its operations. The Company plans to
assess the extent to which its operations are vulnerable should those
organizations fail to properly remediate their computer systems. The Company's
Year 2000 team is made up of only one internal staff member, and the loss of the
service of such individual may have a material adverse effect on the Company's
ability to be Year 2000 Compliant. While the Company believes its planning
efforts are adequate to address its Year 2000 concerns, there can be no
guarantee that the systems of other companies on which the Company's systems and
operations rely will be Year 2000 Compliant on a timely basis. Although the
Company believes it is unlikely, there can be no assurance that the failure of
the Company or a third party on which it is dependent to be Year 2000 Compliant
will not have a material adverse effect on the Company's operations, prospects,
financial condition or results of operations.
The Company's contingency plans, if year 2000 modifications do not work
or are not ready by year 2000, relies significantly on manual procedures and
record keeping. All files are expected to be adequately backed up as of December
31, 1999 and to be available to facilitate manual record keeping. Adequate hard
copy reports of balances and transactions as of December 31, 1999 will also be
available to provide a complete manual system of accounting and inventory
control, if required. Subsequent to year 2000, manual systems will continue to
be in place to mitigate the risk of lost information due to any unforeseen
interruptions that may occur as a result of year 2000 issues arising after
January 1, 2000. Nonetheless, there can be no assurance that the Company's
contingency plan will effectively mitigate any Year 2000 failures or that such
contingency plan would not themselves materially adversely effect the Company's
financial condition or results of operations.
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 finance the loans at
the expected rating levels, (ii) sufficiency of the Company's liquidity and
capital resources (See "Liquidity and Capital Resources"), (iii) 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"), and
(iv) expected expenses to make the Company's computer operations Year 2000
Compliant and expectations regarding the Year 2000 Compliance of the Company,
third-parties on which the Company is dependent and the efficacy of contingency
plans related thereto. 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, the
market's acceptance of the asset class consisting of the loans held by
Allegiance and Allegiance's ability to finance the loans on terms acceptable to
the market and Allegiance, (ii) the results of the Company's consideration of
strategic options and any costs associated with a chosen option, (iii)
availability and cost of capital, (iv) the factors described under "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Considerations Under the Investment Company Act of 1940," and (v) the ability of
the Company's suppliers and vendors to become Year 2000 Compliant.
20
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
- ------ -----------------------------------------------------------
Not required.
21
PART II. OTHER INFORMATION
- -------- ------------------
Item 1. Legal Proceedings
- ------- -----------------
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 alleged 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. On April 24, 1998, the Court
granted the Company's and other defendants' motion to dismiss as it
related to the Section 11 claims with prejudice but denied the motion
to dismiss the claims under Section 10(b) and Rule 10b-5 as to all
defendants other than Mr. Bow, one of Point West's directors.
Thereafter, plaintiffs filed a motion for class certification which the
remaining defendants have opposed. The Company has not received a
ruling on the motion for class certification. The case is currently in
discovery. The Company and each of the remaining defendants intend to
continue to defend the action vigorously.
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
New Echelon LLC 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. Although the case has been stayed since its inception, the
plaintiff recently filed a motion (which the defendants have opposed)
to have the stay lifted. The Company and each of the defendants intend
to defend the action vigorously.
22
Item 5. Other Information
- ------ -----------------
(a) The NASDAQ Stock Market SM ("NASDAQ")
On October 19, 1998, the Company received a notice from NASDAQ
which indicated that, because of the recent decline in the
price of the Company's Common Stock, the Company failed to
meet one of the listing requirements of the NASDAQ National
Market(R) ("NMS") to maintain a public float having a market
value equal to at least $5 million. NASDAQ indicated that, if
the Company did not satisfy such requirement by November 13,
1998, NASDAQ would issue a formal notice. The Company does not
believe at November 13, 1998 that it satisfied such request.
In the event that the Company receives a formal notice from
NASDAQ, the Company believes that it will have 90 days to cure
such deficiency. At present, the Company's desire is to
maintain a listing for its Common Stock on the NMS, but it is
possible that, not withstanding such desire, the Company's
Common Stock will be delisted from the NMS. The Company
believes that its Common Stock satisfies the listing
requirements for the NASDAQ SmallCap Market(R) and may pursue
such listing if the Common Stock is delisted from the NMS.
Another alternative is for the Company's Common Stock to be
traded on the NASDAQ OTC Bulletin Board(R) or delisted
entirely.
(b) Annual Stockholders' Meeting
The Company has established May 10, 1999 as the date on which
the Company's 1999 annual stockholders meeting (the "1999
Meeting") will be held. As indicated in the Company's proxy
statement related to its 1998 annual stockholders' meeting,
the Company must receive by December 18, 1998 any proposal of
a stockholder intended to be presented at the 1999 Meeting and
to be included in the Company's proxy, notice of meeting and
proxy statement related to the Meeting pursuant to Rule 14a-8
under the Securities Act of 1934 (the "Exchange Act").
Proposals of stockholders submitted outside the processes of
Rule 14a-8 under the Exchange Act in connection with the 1999
Meeting ("Non-Rule 14a-8 Proposals") must be received by the
Company by March 11, 1999 or such proposals will be considered
untimely under the advance notice provisions of the Company's
Second Amended and Restated Certificate of Incorporation and
Amended and Restated By-Laws (the "Charter Documents"). The
Company's proxy related to the 1999 Meeting will give
discretionary authority to the proxy holders to vote with
respect to all Non-Rule 14a-8 Proposals received by the
Company after March 11, 1999. Any stockholder wishing to
submit a proposal at the 1999 Meeting must also comply with
certain other provisions of the Charter Documents. Notices of
stockholder proposals should be directed to, and any request
for a copy of the Charter Documents (which will be provided at
no charge to any holder of the Company's Common Stock), should
be directed to: Secretary, Point West Capital Corporation,
1700 Montgomery Street, Suite 250, San Francisco, California
94111.
23
Item 6. Exhibits and Reports on Form 8-K
- ------ --------------------------------
(a) Exhibits.
Number Description
------ -----------
# 10.1 Trust Agreement, dated as of August 1, 1998,
among Allegiance Funding Corp. I, Manufacturers
and Traders Trust Company and Point West Capital
Corporation
# 10.2 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
# 10.3 Loan Acquisition Agreement, dated as of August
1, 1998, between Allegiance Capital, LLC and
Allegiance Funding Corp. I
# 10.4 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
10.5 Amended and Restated Limited Liability Company
Agreement of Allegiance Capital, LLC
27 Financial Data Schedule
99.1 Subsidiaries
99.2 Press Release for Fourteen Hill Capital, L.P.
# Certain information omitted pursuant to a request for
confidential treatment filed separately with the Securities
and Exchange Commission.
(b) Reports on Form 8-K.
Date Item Reported Matter Reported
July 24, 1998 5 The Company issued a
press release regarding
its results of
operations for the
second quarter of 1998.
August 19, 1998 5 The Company issued a
press release announcing
the Allegiance
Financing.
24
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized
POINT WEST CAPITAL CORPORATION
DATED: November 13, 1998 /S/ ALAN B. PERPER
--------------------------------
ALAN B. PERPER
President
(Duly Authorized Officer)
DATED: November 13, 1998 /S/ JOHN WARD ROTTER
--------------------------------
JOHN WARD ROTTER
Executive Vice President and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
25