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 June 30, 1999
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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 August 6, 1999, there were 3,350,624 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
June 30, 1999 and December 31, 1998 1
Consolidated Statements of Operations and
Comprehensive Income (Loss) for the Three and
Six Months Ended June 30, 1999 and 1998 2
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 1999 and 1998 3
Condensed Notes to Consolidated Financial Statements 4-14
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15-28
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 28
Part II
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Item 1. Legal Proceedings 30
Item 4. Submission of Matters to a Vote of Security Holders 31
Item 6. Exhibits and Reports on Form 8-K 31
Signatures 32
(i)
POINT WEST CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS
June 30, 1999 and December 31, 1998
June 30, December 31,
ASSETS 1999 1998
------------------- --------------------
Cash and cash equivalents $ 10,236,549 $ 6,668,126
Restricted cash 2,264,707 3,153,513
Investment securities-- available-for-sale 25,335,422 2,113,034
Matured policies receivable 279,915 12,000
Loans receivable, net of unearned income of $321,646 and
$117,709, respectively, and net of an allowance for
loan losses of $95,000 and $50,000, respectively 19,075,250 10,187,590
Purchased life insurance policies 32,560,408 33,893,017
Non-marketable securities 3,074,168 5,396,607
Deferred financing costs, net of accumulated amortization
of $1,159,819 and $907,848, respectively 568,614 810,545
Furniture and equipment, net of accumulated depreciation of
$8,145 and $4,469, respectively 24,597 25,365
Other assets 2,482,665 182,964
------------------- --------------------
Total assets $ 95,902,295 $ 62,442,761
=================== ====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued interest expense $ 289,261 $ 263,805
Accounts payable 352,655 192,436
Accrued compensation payable 177,344 222,000
Accrued litigation settlement 3,150,000 --
Revolving certificates 15,300,794 5,400,045
Long term notes payable 38,528,914 38,528,914
Debentures 3,000,000 3,000,000
Deferred income taxes 3,263,992 6,000
------------------- --------------------
Total liabilities 64,062,960 47,613,200
------------------- --------------------
Stockholders' equity:
Common stock, $0.01 par value; 15,000,000 authorized
shares, 4,389,124 and 4,291,824 shares, respectively,
issued, 3,350,624 and 3,253,324 shares, respectively,
outstanding 43,891 42,918
Additional paid-in-capital 30,086,709 29,496,720
Accumulated comprehensive income-- net unrealized
investment gains (losses) 14,972,174 (188,966)
Retained deficit (10,389,407) (11,647,079)
Treasury stock, 1,038,500 shares (2,874,032) (2,874,032)
------------------- --------------------
Total stockholders' equity 31,839,335 14,829,561
------------------- --------------------
Total liabilities and stockholders' equity $ 95,902,295 $ 62,442,761
=================== ====================
<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 Six Months Ended June 30, 1999 and 1998
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
----------------- ---------------- ----------------- -----------------
Income:
Earned discounts on matured policies $ 50,267 $ 49,519 $ 111,001 $ 365,652
Interest income 579,479 347,848 1,070,471 699,155
Gain on assets sold 7,751 11,689 7,751 150,526
Gain on sale of securities 4,791,871 -- 5,760,219 --
Other 228,568 105,403 310,589 168,888
----------------- ---------------- ----------------- -----------------
Total income 5,657,936 514,459 7,260,031 1,384,221
Expenses:
Interest expense 1,164,114 867,922 2,207,147 1,772,042
Compensation and benefits 436,446 345,779 783,780 695,338
Other general and administrative expenses 1,634,514 414,562 2,220,785 847,819
Amortization 128,288 62,656 251,971 125,312
Depreciation 1,878 785 3,676 1,203
Loss on non-marketable securities 535,000 -- 535,000 --
----------------- ---------------- ----------------- -----------------
Total expenses 3,900,240 1,691,704 6,002,359 3,441,714
----------------- ---------------- ----------------- -----------------
Gain (loss) before net loss in wholly owned
financing subsidiary charged to
reserve for equity interest 1,757,696 (1,177,245) 1,257,672 (2,057,493)
Net loss in wholly owned financing subsidiary charged
to reserve for equity interest -- 1,092,037 -- 1,892,713
----------------- ---------------- ----------------- -----------------
Net income (loss) 1,757,696 (85,208) 1,257,672 (164,780)
Comprehensive income -- net unrealized
investment gains (losses) (6,426,831) (483,307) 15,161,140 (80,652)
----------------- ---------------- ----------------- -----------------
Total comprehensive income (loss) $ (4,669,135) $ (568,515) $ 16,418,812 $ (245,432)
================= ================ ================= =================
Basic earnings (loss) per share $ 0.53 (0.03) $ 0.38 $ (0.05)
Diluted earnings (loss) per share 0.48 (0.03) 0.34 (0.05)
Weighted average number of shares of common stock
outstanding 3,341,635 3,253,324 3,307,820 3,253,324
Weighted average number of shares of common stock
and common stock equivalents outstanding 3,657,996 3,253,324 3,680,091 3,253,324
<FN>
See accompanying condensed notes to consolidated financial statements.
</FN>
2
POINT WEST CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended June 30, 1999 and 1998
Six Months Ended
June 30,
1999 1998
------------------ ------------------
Cash flows from operating activities:
Net income (loss) $ 1,257,672 $ (164,780)
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization 255,647 126,515
Gain on assets sold (7,751) (150,526)
Gain on sale of securities (5,760,219) --
Earned discounts on policies (111,001) (365,652)
Collections on matured life insurance policies 1,175,341 2,275,514
Increase in reserve for loans receivable 45,000 --
Increase in other assets (2,319,072) (136,637)
Increase (decrease) in accrued interest expense 25,456 (4,711)
Increase (decrease) in accounts payable 160,219 (37,771)
Decrease in accrued compensation payable (44,656) (93,000)
Decrease in reserve for equity interest in wholly
owned financing subsidiary -- (1,775,769)
Increase in non-marketable securities received (242,164) --
Loss on non-marketable securities 535,000 --
Loss on loan 140,000 --
Increase in accrued litigation settlement 3,150,000 --
------------------ ------------------
Net cash used in operating activities (1,740,528) (326,817)
------------------ ------------------
Cash flows from investing activities:
Proceeds from sale of other assets 27,126 205,696
Purchase of furniture and equipment (2,909) (11,883)
Decrease in restricted cash 888,806 56,566
Purchase of investments and non-marketable securities (3,812,227) (4,723,670)
Sale of investments and non-marketable securities 7,137,420 --
Additions to loans receivable (9,450,703) (2,617,234)
Principal payments on loans receivable 378,043 57,042
------------------ ------------------
Net cash used in investing activities (4,834,444) (7,033,483)
------------------ ------------------
Cash flows from financing activities:
Principal payments on long term notes payable -- (275,193)
Proceeds from revolving certificates 10,040,000 --
Principal payments on revolving certificates (139,251) --
Increase in financing costs (10,040) (50,000)
Proceeds from options exercised 252,686 --
------------------ ------------------
Net cash provided by (used in) financing activities 10,143,395 (325,193)
------------------ ------------------
Net increase (decrease) in cash and cash 3,568,423 (7,685,493)
equivalents
Cash and cash equivalents, beginning of period 6,668,126 10,039,560
------------------ ------------------
Cash and cash equivalents, end of period $ 10,236,549 $ 2,354,067
================== ==================
Supplemental disclosures:
Supplemental disclosure of non-cash activities:
Unrealized gain on securities available for sale $ 15,161,140 $ (80,652)
================== ==================
Receipt of warrants $ 242,164 $ --
================== ==================
Supplemental disclosure of cash flow information:
Taxes paid $ 20,606 $ 8,530
================== ==================
Cash paid for interest $ 2,181,691 $ 1,776,753
================== ==================
<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
June 30, 1999 and for the three and six month periods ended June 30, 1999 and
1998 have been prepared in accordance with generally accepted accounting
principles ("GAAP") 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 six month periods ended June 30, 1999 are not necessarily indicative
of the results that may be expected for the year ending December 31, 1999. The
Consolidated Balance Sheet as of December 31, 1998 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, 1998 (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 I,
LLC ("Allegiance Funding"), Allegiance Capital Trust I ("Allegiance Trust I"),
Allegiance Management Corp. ("Allegiance Management") and Point West Securities,
LLC ("PWS"). References herein to Fourteen Hill include Fourteen Hill Management
and Fourteen Hill Capital. References herein to Allegiance include Allegiance
Capital, Allegiance Funding, Allegiance Trust I and Allegiance Management.
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. During 1997,
the Company expanded its financial services business through the operations of
Fourteen Hill, which invests in small businesses, and Allegiance, which lends
funds to funeral home and cemetery owners. During 1998, the Company formed PWS,
a broker-dealer licensed by the National Association of Securities Dealers, Inc.
The Company continues to service the life insurance policies held by its wholly
owned special purpose subsidiary, DPFC. The Company continues to evaluate new
business opportunities.
In June 1999, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard No. 137 ("SFAS 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
defers the effective date of Statement of Financial Accounting Standard No. 133
("SFAS 133"), Accounting for Derivative Instruments and Hedging Activities. 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.
4
2. Investment Securities
- -- ---------------------
Statement of Financial Accounting Standard No. 115 ("SFAS 115"),
Accounting for Certain Investments 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
available-for-sale are reported on the Consolidated Balance Sheets at fair
market value with any cumulative unrealized gains and losses as a separate
component of stockholders' equity and any unrealized gains and losses for the
respective period as a separate line item on the Consolidated Statements of
Operations and Comprehensive Income (Loss). Several of the equity securities
classified by the Company as available-for-sale are 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 held-to-maturity or trading securities
at June 30, 1999 or December 31, 1998. Any realized gains and losses, accrued
interest and dividends and unrealized losses on securities judged to be
other-than-temporary are reported on the Consolidated Statements of Operations
and Comprehensive Income (Loss) on an appropriate line item above "Net Income
(Loss)".
The costs and estimated fair value of investment securities (before any
minority interest) reflected on the Consolidated Balance Sheets as of June 30,
1999 and December 31, 1998 are as follows:
June 30, 1999
- ---------------------------------------------------------------------------------------------------------------------
Gross Gross
Cost Unrealized Gains Unrealized
Losses Fair Value
Available-for-sale
Corporate bond $ 350,000 $ -- $ (292,500) $ 57,500
Common stock 6,416,630 19,965,496 (1,104,204) 25,277,922
--------------- --------------- --------------- ---------------
Total available-for-sale $ 6,766,630 $ 19,965,496 $ (1,396,704) $ 25,335,422
December 31, 1998
- ---------------------------------------------------------------------------------------------------------------------
Gross Gross
Cost Unrealized Gains Unrealized
Losses Fair Value
Available-for-sale
Corporate bond $ 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 $18.6
million and ($189,000) at June 30, 1999 and December 31, 1998, respectively. A
separate balance sheet component of stockholders' equity called "Accumulated
Comprehensive Income -- Net Unrealized Investment Gains (Losses)" reflects such
cumulative gains (losses), net of applicable taxes. For the three and six months
ended June 30, 1999 and 1998, the Company's total comprehensive income (loss) in
its Consolidated Statements of Operations and Comprehensive Income (Loss)
includes unrealized investment gains (losses), net of applicable taxes, only for
the respective period. See Note 10.
5
3. Loans Receivable
- -- ----------------
Loans receivable includes loans made to unaffiliated third parties
through Allegiance and Fourteen Hill. Such loans are reported at amortized cost
net of an allowance for loan losses for the Allegiance loans, and interest is
accrued as earned.
Allegiance had twelve loans outstanding at June 30, 1999 in the
aggregate principal amount of $18.9 million, which bear a weighted-average fixed
interest rate per annum of 9.5%. Allegiance had five loans outstanding at
December 31, 1998 in the aggregate principal amount of $9.1 million, which bear
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 June
30, 1999, one loan was delinquent 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 Standard No. 91 ("SFAS 91"),
Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases.
In August 1998, Allegiance put in place a structured financing (the
"Allegiance 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. It is anticipated that this
transaction will provide interim fixed and floating rate financing and
ultimately permanent fixed and floating rate financing for loans originated. See
Note 6. Allegiance uses futures contracts to hedge certain interest rate
exposure between the time of origination of the loans and the establishment of
permanent fixed rate financing. The futures contracts are to protect the 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
Standard No. 80 ("SFAS 80"), Accounting for Futures Contracts, all such deferred
amounts are reflected on 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 June 30, 1999, Allegiance had net
realized gains on its hedging activities of $35,000 which reduced the amount of
loans receivable in a like amount. In addition, Allegiance had net unrealized
gains from open hedging positions of $103,000 as of June 30, 1999.
Fourteen Hill had two loans outstanding at June 30, 1999 in the
aggregate principal amount of $619,000, 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 fixed interest
rate per annum of 14%. Such loans mature, subject to permitted prepayments,
approximately 5 years from the initial loan date.
4. Purchased Life Insurance Policies
- -- ---------------------------------
Purchased life insurance policies consist 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. Although the Company and the Noteholders have not
determined whether the policies will be sold or whether such a sale of policies
is feasible, the Company and the Noteholders are in discussions that contemplate
a purchase of the policies and cancellation of the indebtedness by the
Noteholders. The discussions also contemplate that the Company would continue to
act as servicer through June 30, 2002. No assurance can be given that any
agreement will be ultimately reached with the Noteholders or, if reached, will
contain such terms and conditions contemplated by current discussions. 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
6
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.
5. Non-Marketable Securities
- -- -------------------------
Non-marketable securities include investments in non-marketable equity
securities through Point West and Fourteen Hill. At June 30, 1999 (after giving
effect to the write-off as described below) the Company had one investment in
preferred shares, one investment in convertible preferred shares and one
investment in common stock carried at an aggregate cost of $2.6 million and four
investments in warrants carried at an aggregate cost of $453,000. At December
31, 1998 the Company had four investments in convertible preferred shares
carried at an aggregate cost of $5.3 million and 1 investment in warrants
carried at a cost of $98,000. The Company accounts for such non-marketable
securities using the cost method. See the Form 10-K.
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, Fourteen Hill determined that $535,000 of non-marketable securities of
one company was impaired at June 30, 1999. Therefore, Fourteen Hill wrote-off
the entire $535,000 carrying value of such security.
6. Revolving Certificates
- -- ----------------------
Pursuant to the Allegiance Financing, a consortium of insurance
companies (the "Investors") will make available funding up to 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. In addition, the Allegiance
Financing provides a commitment, subject to certain limitations, to provide up
to an additional $30 million of permanent funding through September 15, 1999
through the issuance of term certificates. In the event that term certificates
are not issued by September 15, 1999, Allegiance will be required to refinance
from other sources any revolving certificates outstanding under the Allegiance
Financing.
The Allegiance Financing contemplates the issuance of various classes
of revolving and term certificates through Allegiance Trust I. The Investors
purchased rated revolving certificates, while Allegiance Funding retained an
unrated certificate. The 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 is unrated, while the other revolving certificates
received ratings from Duff & Phelps Credit Rating Co. ("Duff & Phelps") ranging
from A to BB. It is also anticipated that the term certificates, when and if
issued, will receive ratings from Duff & Phelps. The Class A-R certificate,
rated A, was partially drawn in the first half of 1999 in the principal amount
of $10.0 million. Such certificate bears interest at a variable rate based on
the one-month LIBOR plus a spread of 2.0%. The Class B-R certificate, rated BBB,
was fully drawn in December 1998 in the principal amount of $3.3 million and
bears interest at a fixed rate of 7.1%. The Class C-R certificate, rated BB, was
fully drawn in November 1998 in the principal amount of $2.1 million and bears
interest at a fixed rate of 9.8%. Any future borrowings under the revolving
certificates will be through increases in the principal amount of the Class A-R
certificate. The weighted-average interest rate of the certificates at June 30,
1999 was 7.4%. Allegiance initially retained the unrated Class D-R certificate
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 the revolving certificates. Because of Allegiance's right to
redeem the certificates if 15% or less in principal amount of certificates is
7
outstanding, the Allegiance Financing does not qualify for sale treatment under
Statement of Financial Accounting Standard No. 125 ("SFAS 125"), Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.
Accordingly, the Allegiance Financing will not receive gain on sale treatment
under SFAS 125. The loans and borrowings under the Allegiance Financing are
reflected on the Consolidated Balance Sheets.
The Company and Investors have reached an agreement in principle to
extend the Allegiance Financing through April 15, 2000. Although no assurance
can be given that such extension will ultimately be put in place, if the
extension is consummated Allegiance would be permitted to borrow up to $30
million on a revolving basis through March 31, 2000 on terms substantially
similar to those of the current revolving certificates under the Allegiance
Financing. In addition, the Investors would agree to provide up to $60 million
of permanent financing (less any permanent financing provided under the current
arrangement) through April 15, 2000, on terms substantially similar to the
current term certificates under the Allegiance Financing, but with an increased
weighted-average spread of approximately 0.5%. Upon completion of an initial $30
million term financing, whether under the current arrangement or the extension,
subsequent term financings under the extension could be completed in a minimum
amount of $15 million.
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 will be amortized over the expected life of the revolving
certificates (10 months) and $117,000 will be amortized over the expected life
of the Allegiance Financing (15 years). In connection with the extension,
Allegiance would pay a $125,000 commitment fee. Of such fee, $42,000 would be
amortized over the expected life of the revolving certificates (8 months) and
$83,000 would be amortized over the expected life of the Allegiance Financing
(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.
In connection with the Allegiance Financing, Point West agreed to
provide additional cash to Allegiance Trust I in the event that monthly LIBOR
interest rates exceed 6.16%. The amount of cash will be a function of several
variables including the monthly LIBOR interest rate and the amount of revolving
Class A-R certificate outstanding under Allegiance Trust I.
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 Consolidated Balance Sheets 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. 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's equity interest in DPFC. See Note 4. Since
the third quarter of 1998, losses associated with DPFC after depletion of the
reserve have been 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 (less any tax
effect for debt
8
forgiveness). For the first half of 1999, the loss associated with DPFC was
approximately $2.1 million. At June 30, 1999, DPFC's accumulated deficit was
$3.8 million.
Point West is the servicer of the policies pledged under the Indenture
pursuant to which the Securitized Notes were issued (the "Indenture") and incurs
servicing expenses (which are reimbursed, subject to certain priority payments)
in connection therewith.
The Company is in discussions with the Noteholders regarding the
possible purchase of policies and cancellation of indebtedness by the
Noteholders. See Note 4.
8. Debentures
- -- ----------
Fourteen Hill Capital has 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 six months of 1999
reflected the following:
Stockholders' equity, beginning of period $14,829,561
Common stock -- options exercised 973
Additional paid-in-capital -- options exercised 589,989
Accumulated comprehensive income -- net unrealized
investment gains 15,161,140
Net income 1,257,672
-----------
Stockholders' equity, end of period $31,839,335
10. Comprehensive Income -- Net Unrealized Investment Gains (Losses)
- -- ----------------------------------------------------------------
Statement of Financial Accounting Standard No. 130 ("SFAS 130"),
Reporting Comprehensive Income, requires the reporting of comprehensive income.
For the six months ended June 30, 1999, the Company's total comprehensive income
includes net unrealized investment gains, net of applicable taxes of $3.6
million which represents the increase in the Company's investment securities
classified as available-for-sale.
The Company originally reported "Comprehensive Income -- Net Unrealized
Investment Gains (Losses)" of $2.5 million and $5.7 million for the three and
six months ended June 30, 1998, respectively, in its Form 10-Q for the period
ended June 30, 1998. Of these unrealized gains, $3.0 million and $5.8 million in
the three and six months ended June 30, 1998, respectively, related to
unrealized gains on certain convertible preferred shares originally classified
as available-for-sale. In this Form 10-Q, the Company has reported
"Comprehensive Income -- Net Unrealized Investment Gains (Losses)" for the same
periods of $(483,000) and $(81,000). The difference in numbers reported is due
to a reclassification of those convertible preferred shares from
available-for-sale to non-marketable securities, which are carried at cost. See
Notes 2 and 5. In both periods, such securities were convertible into marketable
securities but nonetheless should have been reflected at June 30, 1998 as
non-marketable securities under GAAP and carried at cost with corresponding
footnote disclosure regarding any significant appreciation
9
or permanent impairment. During the first half of 1999, such securities were
converted into common shares and sold.
11. Earnings per Share
- -- ------------------
Statement of Financial Accounting Standard No.128 ("SFAS 128"),
Earnings per Share, requires earnings per share ("EPS") to be reported as two
separate calculations: Basic EPS, similar to the previous primary EPS excluding
common 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.
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
Weighted average number of shares of common
stock outstanding......................... 3,341,635 3,253,324 3,307,820 3,253,324
Additional common stock equivalents........ 316,361 -- 372,271 --
Weighted average number of shares of common
stock and common stock equivalents
outstanding............................... 3,657,996 3,253,324 3,680,091 3,253,324
Diluted EPS for the three and six months ended June 30, 1998 do not
include any common stock equivalents due to their anti-dilutive effect.
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
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. 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 outside directors.
Plaintiffs have appealed this dismissal to the United States Circuit Court for
the Ninth Circuit. On November 13, 1998, the Court granted plaintiff's motion
for class certification. On March 11, 1999, defendants filed a motion for
summary judgement which was denied. The case is currently in discovery. A trial
date has been set for January 20, 2000. However, the plaintiffs and defendants
have reached an agreement in principle providing for a settlement pursuant to
which all claims against all defendants would be dismissed. The agreement
provides for the payment of $3.15 million. Under the terms of the Company's D&O
insurance policy, the Company's insurer is obligated to pay 70% of the
settlement amount. Any settlement would be subject to court approval. No
assurance can be given that a definitive settlement agreement will be reached,
or, if reached, will be approved by the Court. In the event a settlement is not
effected, the Company and each of the remaining defendants intend to continue to
defend the action vigorously.
10
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. The case
has been stayed since its inception by agreement of the parties. However, the
claims in this case will also be resolved by the settlement arrangement
described above if it becomes effective. In the event a settlement is not
effected, the Company and each of the defendants intend to defend the action
vigorously.
As a result of having reached a settlement agreement in principle, the
Company recorded an accrued litigation settlement liability of $3.15 million
and an accounts receivable from the insurance company of $2.2 million, and the
remaining amount of $945,000 was expensed in the second quarter of 1999 in the
Consolidated Statements of Operations and Comprehensive Income (Loss).
13. Segment Reporting
- -- -----------------
Financial Accounting Standard No. 131 ("SFAS 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. The Company's chief operating
decision making group is comprised of the Chairman of the Board, the President
and the Chief Financial Officer of Point West.
11
The Company's reportable operating segments include viatical
settlements, Fourteen Hill and Allegiance. The Other Segment includes Point West
and PWS. The accounting policies of the operating segments are the same as those
described in the summary of significant accounting policies in the Form 10-K.
The following tables represent the Company's results from segments for the three
months ended June 30, 1999 and 1998.
Three Months Ended June 30, 1999
-----------------------------------------------------------------------------------------
Viatical Fourteen
Settlements (1) Hill Allegiance Other Total
--------------- ----- ---------- ----- -----
Interest income...... $ 18,087 $ 132,183 $ 370,942 $ 58,267 $ 579,479
Gain on sale of
securities......... -- 4,791,871 -- -- 4,791,871
Other revenue........ 93,937 46,458 -- 146,191 286,586
Interest expense...... 871,205 51,907 241,002 -- 1,164,114
Depreciation &
Amortization...... 58,720 7,500 62,068 1,878 130,166
Contributed income
(loss) (2)............ (884,676) 4,369,931 (86,634) (1,640,925) 1,757,696
Comprehensive
Income (loss)...... -- (6,384,331) -- (42,500) (6,426,831)
Segment assets...... 34,955,555 32,012,940 19,529,868 9,403,932 95,902,295
Three Months Ended June 30, 1998
-----------------------------------------------------------------------------------------
Viatical Fourteen
Settlements (1) Hill Allegiance Other Total
--------------- ----- ---------- ----- -----
Interest income...... $ 54,825 $ 74,786 $ 143,804 $ 74,433 $ 347,848
Gain on sale of
securities......... -- -- -- -- --
Other revenue........ 96,986 -- -- 69,625 166,611
Interest expense...... 867,922 -- -- -- 867,922
Depreciation &
Amortization....... 58,720 2,508 1,428 785 63,441
Contributed income
(loss) (2)........... 119,789 46,579 108,919 (360,495) (85,208)
Comprehensive
Income (loss)...... -- (483,307) -- -- (483,307)
Segment assets...... 39,165,137 15,598,039 6,252,402 5,864,532 66,880,110
- --
<FN>
(1) The viatical settlements segment includes results of operations in
connection with viatical settlements for DPFC and Point West.
(2) Corporate overhead is not generally allocated between segments and is
included in the other segment.
</FN>
A reconciliation of the totals reported for the operating segments to
the applicable line items in the consolidated financial statements is as
follows:
Three Months Ended
------------------
June 30, 1999 June 30, 1998
Income
------
Interest income $ 579,479 $ 347,848
Gain on sale of securities 4,791,871 --
Other revenue 286,586 166,611
--------------- ---------------
Total income $ 5,657,936 $ 514,459
12
The following tables represent the Company's results from segments for
the six months ended June 30, 1999 and 1998.
Six Months Ended June 30, 1999
-----------------------------------------------------------------------------------------
Viatical Fourteen
-------- --------
Settlements (1) Hill Allegiance Other Total
--------------- ----- ---------- ----- -----
Interest income....... $ 45,690 $ 319,583 $ 592,364 $ 112,834 $ 1,070,471
Gain on sale of
securities......... -- 5,442,769 -- 317,450 5,760,219
Other revenue......... 163,526 46,458 -- 219,357 429,341
Interest expense...... 1,754,480 103,244 349,423 -- 2,207,147
Depreciation &
Amortization........ 117,440 15,000 119,531 3,676 255,647
Contributed income
(loss) (2)......... (1,881,803) 5,149,320 (190,266) (1,819,579) 1,257,672
Comprehensive
Income (loss)....... -- 15,263,640 -- (102,500) 15,161,140
Segment assets........ 34,955,555 32,012,940 19,529,868 9,403,932 95,902,295
Six Months Ended June 30, 1998
------------------ ------------------ ---------------- ---------------- ------------------
Viatical Fourteen
Settlements (1) Hill Allegiance Other Total
--------------- ----- ---------- ----- -----
Interest income....... $ 107,214 $ 118,678 $ 284,234 $ 189,029 $ 699,155
Gain on sale of
securities......... -- -- -- -- --
Other revenue......... 611,990 -- 3,451 69,625 685,066
Interest expense...... 1,772,042 -- -- -- 1,772,042
Depreciation &
Amortization........ 117,440 5,016 2,856 1,203 126,515
Contributed income
(loss) (2)............ 323,626 82,451 210,874 (781,731) (164,780)
Comprehensive
Income (loss)........ -- (80,652) -- -- (80,652)
Segment assets........ 39,165,137 15,598,039 6,252,402 5,864,532 66,880,110
<FN>
- --
(1) The viatical settlements segment includes results of operations in
connection with viatical settlements for DPFC and Point West.
(2) Corporate overhead is not generally allocated between segments and is
included in the other segment.
</FN>
A reconciliation of the totals reported for the operating segments to
the applicable line items in the consolidated financial statements is as
follows:
Six Months Ended
------------------
June 30, 1999 June 30, 1998
Income
------
Interest income $ 1,070,471 $ 699,155
Gain on sale of securities 5,760,219 --
Other revenue 429,341 685,066
--------------- ---------------
Total income $ 5,657,936 $ 1,384,221
13
14. Events Subsequent to the Balance Sheet Date
- -- --------------------------------------------
On July 16, 1999 Fourteen Hill invested $200,000 in convertible debt of
a small business entity. On July 22, 1999 Fourteen Hill invested $750,000 in
preferred stock of a small business entity. On July 27, 1999, Point West sold
for $3.1 million 43% of its investment in American Information Company, Inc.,
commonly known as Car Club, a privately held company which, among other things,
provides information services to individuals owning or purchasing automobiles.
That portion of Point West's investment that was sold was carried on the
Consolidated Balance Sheets at $719,000 as of June 30, 1999 and December 31,
1998. The remaining preferred shares that Point West held of Car Club were
converted into common shares. On August 4, 1999 Fourteen Hill invested $1.0
million in convertible debt of a small business entity.
14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATION
-----------------------------------
The following is a discussion and analysis of the consolidated
financial condition of the Company as of June 30, 1999, and of the results of
operations for the Company for the three and six months ended June 30, 1999 and
1998, 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 inception of
two new businesses in the second half of 1997 which generated substantially more
activity in the first half of 1999 compared to the first half of 1998) the
Company's results of operations and cash flows for the three and six months
ended June 30, 1999 are not comparable to those for the three and six months
ended June 30, 1998.
Overview
- --------
The Company is a specialty financial services company. The Company's
financial statements consolidate the assets, liabilities and operations of DPFC,
Fourteen Hill, Allegiance and PWS. 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. See the Form
10-K for further information regarding the Company's former principal business
activity. Subsequently, 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 Fourteen Hill, which invests in
small businesses, and Allegiance, which lends funds to funeral home and cemetery
owners. During 1998, the Company formed PWS, a broker-dealer licensed by the
National Association of Securities Dealers, Inc. The Company continues to
service the life insurance policies held by its wholly owned special purpose
subsidiary, DPFC. See Note 4 of the Condensed Notes to Consolidated Financial
Statements (contained herein).
Information regarding the revenues, contributed income (loss) and
identifiable assets for each of the Company's business segments is contained in
Note 13 of the Condensed Notes to Consolidated Financial Statements (contained
herein).
The Company continues to evaluate other business opportunities.
Fourteen Hill, Allegiance and PWS, whose business activities are described
below, may or may not be indicative of the types of business opportunities the
Company will continue to pursue. No assurance can be given that the Company will
be successful in becoming a broad-based specialty financial services company or
that any such enterprise will be successful. The Company is seeking advice from
financial advisors to assist it in its strategy of developing or acquiring new
operating businesses. See "Considerations Under the Investment Company Act of
1940."
Results of Operations for the Company
- -------------------------------------
Three and Six Months Ended June 30, 1999 Compared to the Three and Six
----------------------------------------------------------------------
Months Ended June 30, 1998
--------------------------
Total Income. Total income increased $5.2 million to $5.7 million in
the second quarter of 1999 from $514,000 in the second quarter of 1998. This
increase was due primarily to $4.8 million of gain on sale of securities by
Fourteen Hill during the second quarter of 1999. The increase was also due to
(i) a $232,000 increase in interest income primarily related to the Allegiance
loans and (ii) a $123,000 increase
15
in other income as a result of a fee received by PWS for investment banking
services. Total income increased $5.9 million to $7.3 million in the first half
of 1999 from $1.4 million in the first half of 1998. This increase was due
primarily to $5.4 million of gain on sale of securities by Fourteen Hill during
the first half of 1999. Also contributing to the increase was (i) a $371,000
increase in interest income primarily related to the Allegiance loans, (ii)
$317,000 of gains on sales of securities recognized by Point West in connection
with its hedging activities of internet related stocks and (iii) a $142,000
increase in other income as a result of fees received by PWS for investment
banking services. See "Item 3 -- Quantitative and Qualitative Disclosure About
Market Risk." Offsetting the increase in the first half of 1999 compared to the
first half of 1998 was a $255,000 decrease in earned discounts on matured
policies and a $143,000 decrease in gain on assets sold.
Total Expenses. Total expenses increased 129.4% to $3.9 million in the
second quarter of 1999 from $1.7 million in the second quarter of 1998. This
increase was primarily due to $945,000 of estimated litigation expense recorded
in the second quarter of 1999 reflecting the amount of the proposed settlement
arrangement of the pending federal class action and state alleged class action
lawsuits not covered by insurance. The proposed settlement is subject to a
number of contingencies described in Note 12 of the Condensed Notes to
Consolidated Financial Statements (contained herein). Also contributing to the
increase were (i) a $535,000 loss recognized on securities held by Fourteen
Hill, (ii) a $296,000 increase in interest expense related to borrowings by
Allegiance and Fourteen Hill, (iii) a $140,000 write-off of a loan recognized by
Point West and (iv) a $95,000 increase in legal expenses incurred in connection
with the federal class action and state alleged class action lawsuits filed
against Point West and its directors. Total expenses increased 76.5% to $6.0
million in the first half of 1999 from $3.4 million in the first half of 1998.
This increase was primarily due to the $945,000 estimated litigation expense
described above. Also contributing to the increase were (i) the $535,000 loss on
securities described above, (ii) a $435,000 increase in interest expense related
to borrowings by Allegiance and Fourteen Hill, (iii) the $140,000 loan write-off
described above and (iv) a $205,000 increase in legal expenses incurred in
connection with the federal class action and state alleged class action lawsuits
filed against Point West and its directors. See "Results of Operations by
Segment -- Other -- Other General and Administrative Expenses."
Net Loss in Wholly Owned Financing Subsidiary Charged to Reserve for
Equity Interest. The DPFC net loss of $1.1 million and $1.9 million recorded in
the three and six months ended June 30, 1998, respectively, was included in the
Company's 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 net income (loss). All additional losses of DPFC will be reflected
in the Company's net income (loss) for the periods in which such losses occur.
See the Form 10-K for additional information.
Comprehensive Income -- Net Unrealized Investment Gains (Losses).
Comprehensive income -- net unrealized investment gains (losses) for any period
reflects unrealized gains or losses on marketable securities during that period.
The line item changes as a result of (i) fluctuations in the market value of
marketable securities from period to period, (ii) acquisitions and dispositions
of marketable securities from period to period and (iii) the recharacterizations
of investments from non-marketable securities (which are reflected at the lower
of cost or market value) to marketable securities (which are reflected at fair
market value). During the first quarter of 1999, one of Fourteen Hill's
investments, FlashNet Communications Inc. ("FlashNet"), completed an initial
public offering. As a result of the offering, the FlashNet securities held by
Fourteen Hill were recharacterized from non-marketable securities to marketable
securities. Primarily as a result of this recharacterization, comprehensive
income -- net unrealized investment gains (losses) for the six months ended June
30, 1999 was $15.2 million versus
16
($81,000) for the comparable 1998 period. Comprehensive income -- net unrealized
investment losses for the second quarter of 1999 was $6.4 million, primarily
reflecting the decrease in the market value of the FlashNet securities between
March 31, 1999 and June 30, 1999.
The Company originally reported "Comprehensive Income -- Net Unrealized
Investment Gains (Losses)" of $2.5 million and $5.7 million for the three and
six months ended June 30, 1998, respectively, in its Form 10-Q for the period
ended June 30, 1998. Of these gains, $3.0 million and $5.8 million in the three
and six months ended June 30, 1998, respectively, related to unrealized gains on
certain convertible preferred shares originally classified as
available-for-sale. In this Form 10-Q, the Company has reported "Comprehensive
Income -- Net Unrealized Investment Gains (Losses)" for the same periods of
$(483,000) and $(81,000). The difference in numbers reported is due to a
reclassification of those convertible preferred shares from available-for-sale
to non-marketable securities, which are carried at cost. In both periods, such
securities were convertible into marketable securities but nonetheless should
have been reflected at June 30, 1998 as non-marketable securities under GAAP and
carried at cost with corresponding footnote disclosure regarding any significant
appreciation or permanent impairment. During the first half of 1999, such
securities were converted into common shares and sold. See "Results of
Operations by Segment -- Fourteen Hill" and Note 10 of the Condensed Notes to
Consolidated Financial Statements.
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.
Method of Accounting for Viatical Settlements
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 as of June 30, 1999 and $167,000 as of
December 31, 1998. In 1996, the Company also established a reserve for loss of
Point West's equity interest in DPFC. By the end of the third quarter of 1998,
the equity reserve was fully depleted. See "Certain Accounting Implications for
DPFC." During both 1998 and 1999, 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). 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.
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 June 30, 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 $3.8 million at June 30, 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
17
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 the first half of 1999, the total loss realized by DPFC was $2.1
million, which was reflected in the Company's net income. The loss for the first
half of 1999 decreased basic EPS by $0.64. The average historical quarterly
losses in DPFC have been approximately $1.1 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 (less any tax effect for debt forgiveness).
The Securitized Notes represent the obligations solely of DPFC. Point
West did not guarantee repayment of the Securitized Notes and is not required to
fund any principal or interest deficiencies thereunder.
Three and Six Months Ended June 30, 1999 Compared to the Three and Six
Months Ended June 30, 1998
Earned Discounts on Matured Policies. DPFC recognized earned discounts
on matured polices of $50,000 for both the second quarter of 1999 and 1998.
Earned discounts on matured policies decreased 69.7% to $111,000 in the first
half of 1999 from $366,000 in the first half of 1998. The decrease is 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 the second quarter
of 1999, earned discounts on matured policies were recognized on 12 policies
with a face value of $622,000, compared to 14 policies with a face value of
$590,000 in the second quarter of 1998. During the first half of 1999, earned
discounts on matured policies were recognized on 24 policies with a face value
of $1.5 million, compared to 38 policies with a face value of $2.3 million in
the first half of 1998. See "Method of Accounting for Viatical Settlements." As
of June 30, 1999, the Company held 480 policies with an aggregate carrying value
of $32.9 million (comprised of "matured policies receivable," "purchased life
insurance policies" and a portion of "other assets") and an aggregate face value
of $38.1 million. All of the "purchased life insurance policies" and "matured
policies receivable" are pledged as security for the Securitized Notes.
Interest Income. Interest income decreased 67.3% to $18,000 in the
second quarter of 1999 from $55,000 in the second quarter of 1998 and 57.0% to
$46,000 in the first half of 1999 from $107,000 in the first half of 1998. This
decrease was 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 is restricted under the Indenture.
Gain on Assets Sold. The gain on assets sold decreased to $8,000 in the
second quarter of 1999 from $12,000 in the second quarter of 1998 and to $8,000
in the first half of 1999 from $151,000 in the first half of 1998. The Company
collected the sale proceeds on one policy in the second quarter and first half
of 1999, compared to two policies in the second quarter of 1998 and six policies
in the first half of 1998. 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. The Company collected a large
portion of the sale proceeds from life insurance policies in 1997, therefore
there will be minimal (if any) gains or losses on any assets sold in future
periods.
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
18
policies. Other income was $36,000 in both the second quarter of 1999 and 1998
and decreased 53.1% to $45,000 in the first half of 1999 from $96,000 in the
first half of 1998. This decrease was due to the decrease in the number and
amount of matured policies.
Interest Expense. Interest expense was $871,000 in the second quarter
of 1999, which was consistent with the second quarter of 1998. Interest expense
decreased 1.0% to $1,754,000 in the second half of 1999 from $1,772,000 in the
first half of 1998 as a result of modest principal repayments under the
Securitized Notes. Average borrowings under the Securitized Notes were $38.5
million in the first half of 1999 compared to $38.7 million in the first half of
1998.
Other General and Administrative Expenses. Other general and
administrative expenses decreased 66.2% to $67,000 in the second quarter of 1999
from $198,000 in the second quarter of 1998. This decrease was primarily due to
the timing of various expenses that were paid in the first quarter in 1999 and
the second quarter in 1998. In addition this decrease was due to a decrease in
life insurance policy premium costs. Other general and administrative expenses
decreased 45.1% to $219,000 in the first half of 1999 from $399,000 in the first
half of 1998. This decrease was due primarily to a decrease in life insurance
policy premium costs. Although premium costs decreased in both periods of 1999
as a result of the decrease in size of the Company's portfolio, the Company
believes that if the life insurance policies continue to mature slowly, life
insurance premium costs are likely to increase in future periods. See "Certain
Accounting Implications for DPFC."
Fourteen Hill
-------------
Method of Accounting for Loans and 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 on the Consolidated
Balance Sheets at fair market value with any cumulative unrealized gains and
losses as a separate component of stockholders' equity and any unrealized gains
and losses for the respective period as a separate line item on the Consolidated
Statements of Operations and Comprehensive Income (Loss). The Company had no
held-to-maturity or trading securities at June 30, 1999 or December 31, 1998.
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 "Results of
Operations for the Company -- Three and Six Months Ended June 30, 1999 Compared
to the Three and Six Months Ended June 30, 1998 -- Comprehensive Income -- Net
Unrealized Investment Gains (Losses)" and notes 2 and 10 to the Condensed Notes
to Consolidated Financial Statements. Any realized gains and losses, accrued
interest and dividends and unrealized losses on securities judged to be
other-than-temporary are reported on an appropriate line item above "Net Income
(Loss)" on the Consolidated Statements of Operations and Comprehensive Income
(Loss). See Note 2 of the Condensed Notes to Consolidated Financial Statements.
Beginning in 1999, because of the volatility of internet and internet
related stocks, Point West shorted stocks of certain competitors of FlashNet so
as to partially hedge Fourteen Hill's holdings in FlashNet. However, under GAAP
such hedging activities do not constitute hedges under SFAS 80. Therefore, such
hedging activities are reflected in the Company's Consolidated Statement of
Operations and Comprehensive Income (Loss). At June 30, 1999 no such hedges were
in place. The Company recognized a $317,000 gain in connection with such hedging
activities during the first quarter of 1999. See "Item 3 -- Quantitative and
Qualitative Disclosures About Market Risk."
19
The Company accounts for loans by accruing interest on outstanding
balances. At June 30, 1999 and December 31, 1998, the Company evaluated each of
Fourteen Hill's outstanding loans and determined that an allowance for loan
losses was not necessary. As Fourteen Hill's loan portfolio grows or upon
subsequent evaluation, allowances for loan losses will be added to the extent
considered necessary. See Note 3 of the Condensed Notes to Consolidated
Financial Statements.
Three and Six Months Ended June 30, 1999 Compared to the Three and Six
Months Ended June 30, 1998
Interest Income. Interest income increased 76.0% to $132,000 in the
second quarter of 1999 from $75,000 in the second quarter of 1998 and 168.9% to
$320,000 in the first half of 1999 from $119,000 in the first half of 1998. This
increase was due to $93,000 and $242,000 of interest income recognized in the
three and six months ended June 30, 1999, respectively, as a result of a warrant
(valued using the Black-Scholes option-pricing model) received in connection
with one of Fourteen Hill's loans. Offsetting this increase was a decrease in
interest income as a result of lower yields.
Gain on Sale of Securities. Fourteen Hill recognized a net gain of $4.8
million and $5.4 million in the three and six months ended June 30, 1999,
respectively, primarily in connection with the sale of one of its investments.
For tax purposes, the gain on sale of securities was offset by the Company's net
operating loss carryforward.
Other Income. Fourteen Hill recognized other income of $46,000 in the
second quarter of 1999 in connection with the liquidation of a $1.0 million
investment that was written-off in 1998.
Interest Expense. Interest expense was $52,000 and $103,000 in the
three and six months ended June 30, 1999, respectively, due to the interest on
funds borrowed from the SBA in July 1998. The interest rate (including a 1%
annual fee) is 6.9%. Prior to July 1998, Fourteen Hill had no debt.
Amortization. Amortization costs increased $5,000 to $8,000 in the
second quarter of 1999 from $3,000 in the second quarter of 1998 and $10,000 to
$15,000 in the first half of 1999 from $5,000 in the first half of 1998. The
1999 periods reflect the financing costs associated with borrowed funds. The
1998 periods reflect organizational costs which are currently required to be
expensed as incurred and were written-off at the end of 1998.
Loss on Non-Marketable Securities. Fourteen Hill reviews on a quarterly
basis all non-marketable securities and attempts to ascertain whether the value
is impaired. As a result of such review, Fourteen Hill determined that $535,000
of non-marketable equity securities of one company was impaired at June 30,
1999. Therefore, Fourteen Hill wrote-off the entire $535,000 carrying value of
such security.
Allegiance
----------
Method of Accounting for Loans and Debt and Equity Securities
The Company accounts for loans advanced by Allegiance by accruing
interest on outstanding balances. At June 30, 1999 and December 31, 1998 the
allowance for loan losses was $95,000 and $50,000, respectively. The allowance
for loan losses is estimated by management based on a review of the loans and
factors which in management's judgement deserve recognition under current
economic conditions. 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 June 30, 1999, one loan was delinquent and on
non-accrual status.
20
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
The Allegiance Financing provides for short term fixed and floating
rate debt that is expected to become long term fixed rate, and potentially
floating rate, debt. The interest rate at which Allegiance anticipates issuing
long term certificates will be set in the future provided that approximately $30
million of loans have been originated. Because of a provision allowing
Allegiance to redeem outstanding certificates when 15% of the original principal
balance remains outstanding, the Allegiance Financing does not qualify for sale
treatment under SFAS 125. Accordingly, the Allegiance Financing will not receive
gain on sale treatment under SFAS 125. The loans and borrowings under the
Allegiance Financing are reflected on the Consolidated Balance Sheet. Allegiance
utilizes 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 to protect the 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 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 June
30, 1999, Allegiance had net realized gains on its hedging activities of $35,000
which decreased loans receivable in a like amount. In addition, Allegiance had
net unrealized gains from open hedging positions of $103,000 as of June 30
1999. See "Item 3 -- Quantitative and Qualitative Disclosures About Market
Risk."
Three and Six Months Ended June 30, 1999 Compared to the Three and Six
Months Ended June 30, 1998
Interest Income. Interest income increased $227,000 to $371,000 in the
second quarter of 1999 from $144,000 in the second quarter of 1998 and $308,000
to $592,000 in the first half of 1999 from $284,000 in the first half of 1998.
This increase was due to increased lending activity by Allegiance. However,
offsetting this increase was $34,000 of interest for the 1999 periods that was
not paid on one delinquent loan. Allegiance had twelve loans outstanding in the
aggregate amount of $18.9 million at June 30, 1999 as compared to two loans
outstanding in the amount of $5.9 million at June 30, 1998. The weighted-average
interest rate on the loans outstanding during the second quarter of 1999 was
8.6% compared to 9.5% during the second quarter of 1998 and 8.9% during the
first half of 1999 compared to 9.5% during the first half of 1998. The
weighted-average interest rates for the 1999 periods 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 or not 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 may be required to
foreclose on real property and other assets securing the loan and liquidate this
loan in a future period. If it does so, Allegiance does not believe it will
incur any loss in connection with such loan.
Interest Expense. Interest expense for Allegiance was $241,000 and
$349,000 in the three and six months ended June 30, 1999, respectively, as a
result of the interest paid under the Allegiance Financing. During the three and
six months ended June 30, 1999, the weighted-average interest rate under the
Allegiance Financing was 7.5% and 7.7%, respectively. Prior to November 1998,
Allegiance had no debt.
Compensation and Benefits. Compensation and benefits increased 64.9% to
$61,000 in the second quarter of 1999 from $37,000 in the second quarter of 1998
and 55.4% to $115,000 in the first half of 1999 from $74,000 in the first half
of 1998. This increase resulted from the hiring of additional employees in 1999
to support Allegiance's lending activities.
21
Other General and Administrative Expenses. Other general and
administrative expenses increased $80,000 to $94,000 in the second quarter of
1999 from $14,000 in the second quarter of 1998. This increase was due primarily
to a $31,000 increase in general legal expense, a $20,000 provision for loan
losses and a $15,000 increase in marketing expense. Other general and
administrative expenses increased $134,000 to $198,000 in the first half of 1999
from $64,000 in the first half of 1998. This increase was due primarily to a
$50,000 increase in general legal expense, a $45,000 increase in allowance for
loan losses and a $18,000 increase in marketing expense. In addition, the
increase was due to an increase in Allegiance's activities.
Amortization. Amortization costs increased $61,000 to $62,000 in the
second quarter of 1999 from $1,000 in the second quarter 1998 and $117,000 to
$120,000 in the first half of 1999 from $3,000 in the first half of 1998. The
1999 periods reflect financing costs associated with the Allegiance Financing.
The 1998 periods reflect organizational costs which are currently required to be
expensed as incurred and were written-off at the end of 1998.
Other
-----
The other segment includes operating results for Point West 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.
Activities for PWS were immaterial in the first half of 1998.
Three and Six Months Ended June 30, 1999 Compared to the Three and Six
Months Ended June 30, 1998
Interest Income. Interest income declined 21.6% to $58,000 in the
second quarter of 1999 from $74,000 in the second quarter of 1998 and 40.2% to
$113,000 in the first half of 1999 from $189,000 in the first half of 1998. This
decrease is due to lower cash balances outstanding during the three and six
months ended June 30, 1999 compared to the three and six months ended June 30,
1998. In addition, interest income has declined because a larger portion of cash
balances have been invested in lower yielding instruments in 1999 compared to
1998.
Gain on Sales of Securities. Point West recognized a $317,000 gain in
the first quarter of 1999 in connection with hedging activities of internet
related stocks. See "Item 3 -- Quantitative and Qualitative Disclosures About
Market Risk."
Other Income. Other income increased to $146,000 in the second quarter
of 1999 from $70,000 in the second quarter of 1998. This increase was due to an
increase of $55,000 in fees received by PWS for investment banking services and
$21,000 in trading commissions generated by PWS in the second quarter of 1999.
Other income increased to $219,000 in the first half of 1999 from $70,000 in the
first half of 1998. This increase was due to an increase of $121,000 in fees
received by PWS for investment banking services and $28,000 in trading
commissions generated by PWS in the first half of 1999. The increase in other
income was primarily due to transaction based investment banking services. The
amount and timing of these services cannot be predicted because of the limited
operating history of PWS.
Compensation and Benefits. Compensation and benefits increased 21.7% to
$376,000 in the second quarter of 1999 from $309,000 in the second quarter of
1998 and 7.6% to $668,000 in the first half of 1999 from $621,000 in the first
half of 1998. This increase resulted in the hiring of two new employees in the
third quarter of 1998 to support PWS' activities and an increase in compensation
and benefits for other employees for 1998.
22
Other General and Administrative Expenses. Other general and
administrative expenses increased $1.3 million to $1.5 million in the second
quarter of 1999 from $195,000 in the second quarter of 1998. This increase was
primarily due to $945,000 of estimated litigation expense recorded in the second
quarter of 1999 reflecting the amount of the proposed settlement arrangement of
the pending federal class action and state alleged class action lawsuits not
covered by insurance. The proposed settlement is subject to a number of
contingencies described in Note 12 of the Condensed Notes to Consolidated
Financial Statements (contained herein). Also contributing to the increase were
a $140,000 loan write-off and $95,000 increase in legal expenses incurred in
connection with the federal and state alleged class action lawsuits. Other
general and administrative expenses increased $1.4 million to $1.8 million in
the first half of 1999 from $418,000 in the first half of 1998. This increase
was primarily due to the $945,000 of estimated litigation expense described
above. Also contributing to the increase were a $205,000 increase in legal
expenses incurred in connection with the federal and state alleged class action
lawsuits and the $140,000 loan write-off. Unless a settlement of these actions
is effected, Point West expects legal expenses to increase substantially during
the remainder of 1999 relative to 1998 since one of the lawsuits is currently in
discovery and the trial date is set for January 2000.
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 $14,967 per month.
Liquidity and Capital Resource
- ------------------------------
Point West and PWS
At present, neither Point West nor PWS has an external funding source
from which to fund its working capital and general corporate needs. During the
first half of 1999, the Company supported the operations of Point West, PWS and
Fourteen Hill primarily from cash balances. 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 June 30, 1999, the Company's cash and cash equivalents were $10.2
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, 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 or PWS will be successful in obtaining
external financing on satisfactory terms assuming the Company determines
additional funds are needed. Point West at present anticipates having sufficient
liquidity to meet the working capital and operational needs of Point West and
PWS through 1999, using current cash and cash equivalents.
DPFC
DPFC does not have operations. Point West, as servicer, incurs
administrative costs associated with the Securitized Notes. Point West is
reimbursed for these costs subject to priority provisions contained in the
Indenture. As of June 30, 1999, the outstanding principal amount of the
Securitized Notes was $38.5 million. As of the same date, DPFC had restricted
cash of $2.0 million, which cannot be accessed by Point West 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 to expend cash or obtain financing to
satisfy such principal and interest obligations.
23
Fourteen Hill
Fourteen Hill's activities have generally been supported by capital
investments by Point West, by the sale of certain investments and the repayment
by obligors of loans. During 1997, Point West contributed $2.5 million to
Fourteen Hill. During 1998, Point West contributed an additional $2.5 million to
Fourteen Hill. During the first quarter of 1999, Point West contributed an
additional $800,000 to Fourteen Hill. During the first half of 1999, Fourteen
Hill generated $6.8 million from the sale of securities.
Fourteen Hill Capital has an SBA debenture license and, therefore, may
be permitted to borrow up to $12.5 million from the SBA. Any borrowings bear
interest at the rate for ten year debentures issued by SBIC's and funded through
public sales of certificates bearing the SBA's guarantee ("Debenture Rate").
Interest is payable semi-annually. In addition, there is a leverage fee of 3%
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, Fourteen Hill Capital borrowed $3.0
million from the SBA. Fourteen Hill Capital is permitted to borrow an additional
$9.5 million from the SBA.
Fourteen Hill 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 Fourteen Hill's 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 June 30, 1999, Point West has made the only capital contribution
to Allegiance Capital in the aggregate amount of $4.2 million.
On August 19, 1998, Allegiance put in place the Allegiance Financing
which may provide up to $56.4 million solely to support any lending activities
of Allegiance. The Allegiance Financing provides interim fixed and floating rate
financing through August 31, 1999. The Company anticipates that the Allegiance
Financing will ultimately provide 15 year fixed and floating rate financing for
loans originated by Allegiance. However, if Allegiance does not originate $30
million in loans by September 15, 1999, permanent financing will not be
available under the Allegiance Financing and Allegiance would be responsible for
finding an alternative financing source to repay the interim financing, unless
the Allegiance Financing is extended as discussed below. As of June 30, 1999,
Allegiance had borrowed $15.3 million under the Allegiance Financing.
The Company and Investors have reached an agreement in principle to
extend the Allegiance Financing through April 15, 2000. Although no assurance
can be given that such extension will ultimately be put in place, if the
extension is consummated Allegiance would be permitted to borrow up to $30
million on a revolving basis through March 31, 2000 on terms substantially
similar to those of the current revolving certificates under the Allegiance
Financing. In addition, the Investors would agree to provide up to $60 million
of permanent financing (less any permanent financing provided under the current
arrangement) through April 15, 2000, on terms substantially similar to the
current term certificates under the Allegiance Financing, but with an increased
weighted-average spread of approximately 0.5%. Upon completion of an initial $30
million term financing, whether under the current arrangement or the
24
extension, subsequent term financings under the extension could be completed in
a minimum amount of $15 million.
The Company expects that the Allegiance Financing will provide
sufficient funds to support Allegiance's lending activities through August 1999.
See Note 6 of the Condensed Notes to Consolidated Financial Statements.
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). 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 SEC as investment companies and upon registration become subject to
extensive regulation.
Although the Company believes that it did not exceed the Percentage
Tests at June 30, 1999, it is possible that it may exceed the Percentage Tests
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 Fourteen Hill, which holds a number of
investment securities, has exceeded expectations; and
The success of other investments by the Company has exceeded
expectations.
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. In particular, Fourteen Hill
holds 1,120,266 shares of FlashNet common stock that was acquired for $2
million. FlashNet consummated an initial public offering in March 1999. FlashNet
priced at $17 per share, but has traded between $15.63 and $51.50. At June 30,
1999, the price of FlashNet common stock was $29.44.
In any event, the Company does not believe that it should 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.
25
During the second quarter of 1999, Fourteen Hill 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. 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 Fourteen Hill's business.
Growth of New Operating Businesses
The Company is seeking 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 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. As previously discussed although Allegiance
and the Investors are discussing an extension of the Allegiance Financing,
Allegiance does not have an external funding source beyond September 15, 1999.
In addition, unless extended, Allegiance may need to arrange financing to repay
its existing external interim funding source.
Disposing of Investment Securities/Limiting Growth of Fourteen Hill
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. In addition, the dispositions may result in disadvantageous tax
consequences. The Company intends to use any proceeds of any additional sale to
reduce debt and support its working capital. Pending final use, proceeds of any
additional sale will be invested in U.S. government securities.
The Company may also determine that it needs to limit the growth of
Fourteen Hill's business to avoid being an investment company under the 1940
Act. Limiting Fourteen Hill's growth may materially adversely affect the
Company's future financial condition and results of operations.
26
Year 2000 Readiness Disclosure
- ------------------------------
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 following discussion constitutes a Year 2000 Readiness
Disclosure.
The Company expects to spend approximately $30,000 to $50,000 in the
aggregate 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 the majority of such
modifications and replacements. Through June 30, 1999, the Company had incurred
Year 2000 Compliant costs of approximately $27,000, of which $19,000 has been
capitalized. The Company does not believe the amounts expected to be expensed
over the remainder of 1999 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 has assessed 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 performed the required upgrades. The Company has
assessed the readiness of its business-critical spreadsheets and customized
databases and is making modifications of those systems as necessary. During the
remainder of 1999, the Company will test and make any system refinements that
may be needed.
The Company has assessed the readiness of external entities, such as
vendors, suppliers, investments and financial institutions which interface with
the Company. Based on the results of this assessment the risk of business
failure caused by an external party's Year 2000 malfunction is not significant.
The Company's Year 2000 team is made up of three internal staff members. 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
27
Year 2000 failures or that such contingency plan would not itself 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 avail itself of the
benefits of the Allegiance Financing beyond September 1999 or to extend 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) the Company's
ability to enter into a settlement agreement in connection with the federal and
state alleged class action lawsuits filed against the Company and its officers
and directors, (vi) expected expenses (including amounts paid in any settlement)
in connection with the lawsuits described above, (vii) expected future life
insurance policy premium costs, (viii) the potential purchase of policies and
cancellation of indebtedness by the Noteholders, and (ix) 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 and to reach an agreement with the
Investors to extend the Allegiance Financing, (ii) the borrower's ability to
make future payments on the defaulted Allegiance loan and Allegiance's ability
to liquidate the collateral at a price at least equal to the amount of debt
(including foreclosure fees and expenses) of such loan, (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
outcome of the federal and state alleged class action lawsuits filed against the
Company and its officers and directors, (vii) the maturity rate of DPFC's
portfolio of life insurance policies, (viii) Point West's ability to reach an
agreement with the Noteholders and (ix) the ability of the Company's suppliers
and vendors to become Year 2000 Compliant.
ITEM 3--QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- ------------------------------------------------------------------
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 Fourteen Hill's investments in the
stock of public and private companies, fixed rate loans and debt investments
made by Allegiance and Fourteen Hill 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.
28
Beginning in 1999, because of the volatility of internet and internet
related stocks, Point West shorted stocks of certain competitors of FlashNet so
as to partially hedge Fourteen Hill's holdings in FlashNet. At June 30, 1999 no
such hedges were in place. The Company recognized a $317,000 gain in connection
with such hedging activities during the first quarter of 1999.
Allegiance's variable rate debt consist of the Class A-R certificate
totaling $10.0 million which bear interest based on the one-month LIBOR plus a
spread of 2.0%. See Note 6 of the Condensed Notes to Consolidated Financial
Statements.
The table below represents principal cash flows and weighted average
interest rates for the Allegiance loans outstanding at June 30, 1999:
1999 2000 2001 2002 2003 Thereafter
---- ---- ---- ---- ---- ----------
Fixed rate loans (1)(2) $ 158,922 $ 426,734 $ 468,938 $ 515,326 $ 566,315 $14,749,224
Average interest
rates (1) 9.5% 9.5% 9.5% 9.5% 9.5% 9.5%
- --
<FN>
(1) The principal cash flows for fixed rate loans and average interest rates do
not include one delinquent loan.
(2) The Company hedges its interest rate exposure related to the loans made
by Allegiance because the interest rate at which Allegiance anticipates
issuing term certificates will be set in the future at some point.
Allegiance utilizes futures contracts to hedge certain interest rate
exposure between the time of origination of the loans and the expected
issuance of term certificates. The Company sold 10-year Treasury Notes to
hedge such interest rate risk.
</FN>
In connection with the Allegiance Financing, Point West agreed to
provide additional cash to Allegiance Trust I in the event that monthly LIBOR
interest rates exceed 6.16%. The amount of cash will be a function of several
variables including the monthly LIBOR interest rate and the amount of revolving
Class A-R certificate outstanding under Allegiance Trust I.
29
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 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. 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 outside directors.
Plaintiffs have appealed this dismissal to the United States Circuit
Court for the Ninth Circuit. On November 13, 1998, the Court granted
plaintiff's motion for class certification. On March 11, 1999,
defendants filed a motion for summary judgement which was denied. The
case is currently in discovery. A trial date has been set for January
20, 2000. However, the plaintiffs and defendants have reached an
agreement in principle providing for a settlement pursuant to which all
claims against all defendants would be dismissed. The agreement
provides for the payment of $3.15 million. Under the terms of the
Company's D&O insurance policy, the Company's insurer is obligated to
pay 70% of the settlement amount. Any settlement would be subject to
court approval. No assurance can be given that a definitive settlement
agreement will be reached, or, if reached, will be approved by the
Court. In the event a settlement is not effected, 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. The case has been stayed since its inception by agreement
of the parties. However, the claims in this case will also be resolved
by the settlement arrangement described above if it becomes effective.
In the event a settlement is not effected, the Company and each of the
defendants intend to defend the action vigorously.
As a result of having reached a settlement agreement in principle, the
Company recorded an accrued litigation settlement liability of
$3.15 million and an accounts receivable from the insurance company of
$2.2 million, and the remaining amount of $945,000 was expensed in the
second quarter of 1999 in the Consolidated Statements of Operations
and Comprehensive Income (Loss).
30
Item 4. Submission of Matters to a Vote of Security Holders
- -----------------------------------------------------------
On May 10, 1999, the Company held an Annual Meeting of its
stockholders. The election of two directors as set forth in the proxy
statement were presented. Bradley N. Rotter and Stephen T. Bow were
re-elected to the Board of Directors for a term expiring in 2002. The
voting tallies were:
Director Votes For Votes Withheld
-------- --------- --------------
Bradley N. Rotter 3,136,852 23,829
Stephen T. Bow 3,136,852 23,829
The other directors whose term of office continued after the meeting
are: Alan B. Perper (term expiring in 2000), Paul A. Volberding (term
expiring in 2000) and John Ward Rotter (term expiring in 2001).
Item 6. Exhibits and Reports on Form 8-K
- ----------------------------------------
(a) Exhibits:
Number Description
--------- ------------
27 Financial Data Schedule
99.1 Press Release for Fourteen Hill Capital, L.P.
(b) Reports on Form 8-K filed during the quarter ended June 30,
1999:
Date Item Reported Matter Reported
---- ------------- ---------------
April 13, 1999 5 The Company issued a
press release regarding its
results of operations for
the first quarter of 1999.
31
SIGNATURE
---------
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: August 13, 1999 /s/ ALAN B. PERPER
--------------------------------
ALAN B. PERPER
President
(Duly Authorized Officer)
Dated: August 13, 1999 /s/ JOHN WARD ROTTER
--------------------------------
JOHN WARD ROTTER
Executive Vice President and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
32