SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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
---------------------------------
San Francisco, California 94111
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(Address of principal executive offices) (Zip Code)
(415) 394-9467
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(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
At October 31, 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 Financial Information Page #
- ------ ------
Item 1. Consolidated Financial Statements (unaudited):
Consolidated Balance Sheets
September 30, 1999 and December 31, 1998 1
Consolidated Statements of Operations and
Comprehensive Income (Loss) for the Three and
Nine Months Ended September 30, 1999 and 1998 2
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1999 and 1998 3
Condensed Notes to Consolidated Financial Statements 4-15
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16-30
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 31
Part II Other Information
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Item 1. Legal Proceedings 32
Item 5. Other Information 33
Item 6. Exhibits and Reports on Form 8-K 33
Signatures 35
(i)
POINT WEST CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS
September 30, 1999 and December 31, 1998
September 30, December 31,
ASSETS 1999 1998
------------------- --------------------
Cash and cash equivalents $ 8,957,720 $ 6,668,126
Restricted cash 1,688,191 3,153,513
Investment securities
Held-to-maturity 4,479,856 --
Available-for-sale 10,795,110 2,113,034
Matured policies receivable 279,295 12,000
Loans receivable, net of unearned income of $479,073 and
$117,709, respectively, and net of an allowance for
loan losses of $135,000 and $50,000, respectively 29,110,446 10,187,590
Purchased life insurance policies 31,861,707 33,893,017
Non-marketable securities 4,665,126 5,396,607
Deferred financing costs, net of accumulated amortization
of $1,293,858 and $907,848, respectively 717,817 810,545
Furniture and equipment, net of accumulated depreciation of
$10,403 and $4,469, respectively 33,710 25,365
Other assets 2,490,143 182,964
------------------- --------------------
Total assets $ 95,079,121 $ 62,442,761
=================== ====================
LIABILITIES AND STOCKHOLDERS' EQUITY
Accrued interest expense $ 288,981 $ 263,805
Accounts payable 337,720 192,436
Accrued compensation payable 423,164 222,000
Accrued litigation settlement 3,150,000 --
Revolving certificates -- 5,400,045
Term certificates 24,635,000 --
Long term notes payable 38,528,914 38,528,914
Debentures 3,000,000 3,000,000
Deferred income taxes 739,005 6,000
------------------- --------------------
Total 71,102,784 47,613,200
liabilities
------------------- --------------------
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 29,823,503 29,496,720
Accumulated comprehensive income-- net unrealized
investment gains (losses) 3,209,176 (188,966)
Retained deficit (6,226,201) (11,647,079)
Treasury stock, 1,038,500 shares (2,874,032) (2,874,032)
------------------- --------------------
Total stockholders' equity 23,976,337 14,829,561
------------------- --------------------
Total liabilities and stockholders' equity $ 95,079,121 $ 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 Nine Months Ended September 30, 1999 and
1998
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
----------------- ---------------- ----------------- -----------------
Income:
Earned discounts on matured policies $ 76,201 $ 65,167 $ 187,202 $ 430,819
Interest income 1,074,238 350,218 2,144,709 1,049,373
Gain on assets sold -- 14,820 7,751 165,346
Gain on sale of securities 5,946,723 109,691 11,706,942 109,691
Other 41,985 64,299 352,574 233,187
----------------- ---------------- ----------------- -----------------
Total income 7,139,147 604,195 14,399,178 1,988,416
Expenses:
Interest expense 1,313,165 925,545 3,520,312 2,697,587
Compensation and benefits 585,117 414,984 1,368,897 1,110,322
Other general and administrative expenses 394,097 409,101 2,597,382 1,256,920
Amortization 134,039 71,406 386,010 196,718
Depreciation 2,258 1,240 5,934 2,443
Loss on non-marketable securities -- 1,073,494 535,000 1,073,494
----------------- ---------------- ----------------- -----------------
Total expenses 2,428,676 2,895,770 8,413,535 6,337,484
----------------- ---------------- ----------------- -----------------
Gain (loss) before income taxes and net loss
in wholly owned financing subsidiary
charged to reserve for equity interest 4,710,471 (2,291,575) 5,985,643 (4,349,068)
Income tax expense 547,265 -- 564,765 --
Net loss in wholly owned financing subsidiary charged
to reserve for equity interest -- 407,324 -- 2,300,037
----------------- ---------------- ----------------- -----------------
Net income (loss) 4,163,206 (1,884,251) 5,420,878 (2,049,031)
Comprehensive income -- net unrealized
investment gains (losses) (11,762,998) (2,326,692) 3,398,142 (2,407,344)
----------------- ---------------- ----------------- -----------------
Total comprehensive income (loss) $ (7,599,792) $ (4,210,943) $ 8,819,020 $ (4,456,375)
================= ================ ================= =================
Basic earnings (loss) per share $ 1.24 (0.58) $ 1.63 $ (0.63)
Diluted earnings (loss) per share 1.17 (0.58) 1.49 (0.63)
Weighted average number of shares of common stock
outstanding 3,350,624 3,253,324 3,321,888 3,253,324
Weighted average number of shares of common stock
and common stock equivalents outstanding 3,549,536 3,253,324 3,648,029 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 Nine Months Ended September 30, 1999 and 1998
Nine Months Ended
September 30,
1999 1998
----------------- ---------------
Cash flows from operating activities:
Net income (loss) $ 5,420,878 $ (2,049,031)
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation and amortization 391,944 199,161
Gain on assets sold (7,751) (165,346)
Gain on sale of securities (11,706,942) --
Earned discounts on policies (187,202) (430,819)
Collections on matured life insurance policies 1,950,863 3,082,440
Increase in reserve for loans receivable 85,000 --
Increase in other assets (121,265) (1,729)
Increase (decrease) in accrued interest expense 25,176 (8,335)
Increase (decrease) in accounts payable 145,284 (8,208)
Increase (decrease) in accrued compensation payable 201,164 (30,000)
Increase in deferred taxes 516,885 --
Decrease in reserve for equity interest in wholly
owned financing subsidiary -- (2,128,989)
Increase in non-marketable securities received (624,918) --
Loss on non-marketable securities 535,000 1,073,494
Loss on loan 140,000 --
Increase in accrued litigation settlement 945,000 --
----------------- ----------------
Net cash used in operating activities (2,290,884) (467,362)
----------------- ----------------
Cash flows from investing activities:
Proceeds from sale of other assets 27,126 229,067
Purchase of furniture and equipment (14,279) (22,630)
Decrease in restricted cash 1,465,322 323,015
Purchase of investments and non-marketable securities (11,699,821) (6,708,504)
Proceeds from sale of investments and non-marketable
securities 14,755,627 2,028,000
Additions to loans receivable (19,631,409) (3,111,990)
Principal payments on loans receivable 483,553 109,008
----------------- ----------------
Net cash used in investing activities (14,613,881) (7,154,034)
----------------- ----------------
Cash flows from financing activities:
Proceeds from debentures -- 3,000,000
Principal payments on long term notes payable -- (275,193)
Proceeds from revolving certificates 19,708,039 --
Principal payments on revolving certificates (25,108,084) --
Proceeds from term certificates 24,635,000 --
Increase in financing costs (293,282) (187,501)
Proceeds from options exercised 252,686 --
----------------- ----------------
Net cash provided by financing activities 19,194,359 2,537,306
----------------- ----------------
Net increase (decrease) in cash and cash
equivalents 2,289,594 (5,084,090)
Cash and cash equivalents, beginning of period 6,668,126 10,039,560
----------------- ----------------
Cash and cash equivalents, end of period $ 8,957,720 $ 4,955,470
================= ================
Supplemental disclosures:
Supplemental disclosure of non-cash activities:
Unrealized gain (loss) on securities available for sale $ 3,398,142 $ (2,407,344)
Receipt of warrants $ 624,918 $ --
Establishment of receivable from insurance company $ 2,205,000 $ --
Accrued litigation settlement $ 3,150,000 $ --
Supplemental disclosure of cash flow information:
Taxes paid $ 60,736 $ 16,014
Cash paid for interest $ 3,495,136 $ 2,701,359
<FN>
See accompanying condensed notes to consolidated financial statements.
</FN>
3
POINT WEST CAPITAL CORPORATION
------------------------------
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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1. General Description
- -- -------------------
The unaudited consolidated financial statements of Point West Capital
Corporation ("Point West") and its consolidated entities (the "Company") as of
September 30, 1999 and for the three and nine month periods ended September 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 nine month periods ended September 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"), Point West Venture Management, LLC
(formerly known as Fourteen Hill Management, LLC) ("Point West Management"),
Point West Ventures, L.P. (formerly known as Fourteen Hill Capital, L.P.)
("Point West Ventures"), 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 Ventures include
Point West Management and Point West Ventures. References herein to Allegiance
include Allegiance Capital, Allegiance Funding, Allegiance Trust I and
Allegiance Management.
The principal business activity of the Company through February 1997
was to provide viatical settlements for terminally ill persons. 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 Ventures,
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.
The Company has significant net operating losses (NOLs) for tax
purposes. The NOLs are primarily related to losses incurred by DPFC. The Company
has established valuation allowances which offset completely the deferred tax
assets related to NOLs because the Company and DPFC have been unable to
consistently generate taxable earnings. There has been no reduction made to the
valuation allowance in connection with the gain upon the anticipated retirement
of the Securitized Notes discussed in Note 7 or the unrealized gains on
investment securities discussed in Note 2. The Company will reevaluate the
amount of the valuation allowance in future periods.
4
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 these
pronouncements.
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). Many of the equity securities
classified by the Company as available-for-sale are securities traded in the
NASDAQ SmallCap Market(R) or the NASDAQ OTC Bulletin Board(R). 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. Securities classified as
held-to-maturity included U.S. treasury bills reported at cost with maturities
greater than three months, but less than one year. Cash and cash equivalents
included U.S. treasury bills with maturities less than three months of $8.6
million and $4.9 million at September 30, 1999 and December 31, 1998,
respectively. The Company had no trading securities at September 30, 1999 and no
held-to-maturity or trading securities at 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)."
5
The costs and estimated fair market value of investment securities
(before any minority interest) reflected on the Consolidated Balance Sheets as
of September 30, 1999 and December 31, 1998 are as follows:
September 30, 1999
- ---------------------------------------------------------------------------------------------------------------------
Gross Gross Fair
Cost Unrealized Unrealized Market
Gains Losses Value
Held-to-maturity
U.S. treasury bills.... $ 4,479,856 $ -- $ -- $ 4,479,856
--------------- --------------- --------------- ---------------
Total Held-to-maturity...... $ 4,479,856 $ -- $ -- $ 4,479,856
Available-for-sale
Corporate bond........ $ 350,000 $ -- $ (293,750) $ 56,250
Common stock.......... 6,944,680 5,561,231 (1,857,051) 10,738,860
--------------- --------------- --------------- ---------------
Total available-for-sale... $ 7,294,680 $ 5,561,231 $ (2,150,801) $ 10,795,110
December 31, 1998
- ---------------------------------------------------------------------------------------------------------------------
Gross Gross Fair
Cost Unrealized Unrealized Market
Gains Losses 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 market value and cost) were
$3.5 million and ($189,000) at September 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 nine months ended September 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.
3. Loans Receivable
- -- ----------------
Loans receivable includes loans made to unaffiliated third parties
through Allegiance and Ventures. 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 seventeen loans outstanding at September 30, 1999 in the
aggregate principal amount of $29.4 million, which bear a weighted-average fixed
interest rate per annum of 9.6%. 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
6
fifteen years from the initial loan date. At September 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 long term
financing, subject to certain limitations, with respect to loans Allegiance has
made in the past and may make in the future. See Note 6. Allegiance uses futures
contracts to hedge certain interest rate exposure between the time of
origination of the loans and the expected issuance of term certificates. The
futures contracts are intended to protect the net interest margins earned on the
loans. Any realized gain or loss related to these hedges are deferred and
recognized by Allegiance over the life of the related loan as an adjustment of
interest income. Pursuant to Statement of Financial Accounting 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 September 30, 1999, Allegiance had net realized gains
on its hedging activities of $215,000 which decreased loans receivable in a like
amount. As of September 30, 1999 Allegiance had no open hedging positions.
Ventures had one loan outstanding at September 30, 1999 in the
aggregate principal amount of $614,000, which was originated in January 1998 and
bears interest at a fixed interest rate per annum of 15%. Such loan matures,
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 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 debt
and equity securities through Point West and Ventures. 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, the Company determined that $535,000 of non-
7
marketable securities of one company held by Ventures was impaired at June 30,
1999. Therefore, the Company wrote-off the entire $535,000 carrying value of
such security.
6. Revolving and Term Certificates
- -- -------------------------------
Pursuant to the Allegiance Financing, a consortium of insurance
companies (the "Investors") provided funding through September 20, 1999, with a
balance at that date of $24.9 million, on a non-recourse revolving certificate
basis which was used for the purchase or funding of loans originated by
Allegiance Capital and transferred to Allegiance Funding. On September 21, 1999,
the revolving certificates then outstanding were repaid through the issuance of
the term certificates described below. In addition, the Company and Investors
extended the Allegiance Financing through April 15, 2000. The Investors agreed
to continue to provide revolving debt, subject to certain limitations, through
April 15, 2000, on terms substantially similar to those under the original
revolving certificates under the Allegiance Financing, but with an increased
weighted-average spread of approximately 0.05%. Allegiance has agreed to retain
an unrated revolving certificate related to the extension. In addition, the
Investors agreed to provide up to $30 million of additional term financing,
subject to certain limitations, through April 15, 2000, on terms substantially
similar to those under the original term certificates issued under the
Allegiance Financing, but with an increased weighted-average spread of
approximately 0.5%. Term financings under the extension may be completed in
minimum amounts of $15 million.
Under the Allegiance Financing various classes of revolving and term
certificates through Allegiance Trust I have been issued. With the extension,
the amount issued under different classes may increase, and increases may be
disproportionate to the current proportions of term certificates outstanding.
The original revolving certificates were issued in August 1998 in four classes,
consisting of Class A-R, Class B-R, Class C-R and Class D-R. The Class D-R
certificate, which represents the right to receive all excess cash flow from
Allegiance Trust I, was unrated while the other revolving certificates received
ratings from Duff & Phelps Credit Rating Co. ("Duff & Phelps") ranging from A to
BB. At September 20, 1999, the following principal amounts of Class A-R, Class
B-R, Class C-R and Class D-R certificates were outstanding, respectively: $19.5
million, $3.2 million, $2.2 million and $2.4 million. At September 21, 1999 such
revolving certificates were repaid through the issuance in the following amounts
of Class A, Class B, Class C, Class D, Class E and Class F term certificates:
$17.8 million, $1.8 million, $2.0 million, $1.8 million, $1.3 million and $2.6
million. The Class F term certificate, which was retained by Allegiance, was
unrated while the other term certificates received ratings from Duff & Phelps
ranging from AA to B.
Because of Allegiance's right to redeem the term certificates if 15% or
less in principal amount of certificates is 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.
In connection with the Allegiance Financing, Allegiance Capital paid a
$175,000 commitment fee when funds were initially borrowed. Of such commitment
fee, $58,000 has been amortized over the expected life of the revolving
certificates (10 months) and $117,000 will be amortized over the expected life
of the term certificates (15 years). In connection with the extension,
Allegiance paid a $125,000 commitment fee. Of such fee, $42,000 will be
amortized over the expected life of the revolving certificates (8 months) and
$83,000 will be amortized over the expected life of the term certificates (15
years). These allocations were based on an estimate of the portion of the
commitment fee attributable to the revolving certificates and the term
certificates.
8
In connection with the extension of 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
outstanding balance of the Class A-R certificate. At present the outstanding
balance of the Class A-R certificate is zero.
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 forgiveness). For the first nine months of 1999, the loss
associated with DPFC was approximately $3.1 million. At September 30, 1999,
DPFC's accumulated deficit was $4.8 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
- -- ----------
Point West Ventures 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, Point West Ventures
paid to the SBA a $105,000 fee (3.5% of the total borrowings) to borrow such
money. The debenture is subject to a prepayment penalty if paid prior to
September 1, 2003.
9
9. Stockholders' Equity
- -- ---------------------
Changes in stockholders' equity during the first nine 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 326,783
Accumulated comprehensive income -- net unrealized
investment gains 3,398,142
Net income 5,420,878
-----------
Stockholders' equity, end of period $23,976,337
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 nine months ended September 30, 1999, the Company's total comprehensive
income includes net unrealized investment gains, net of applicable taxes of
$291,000, 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 $(3.3) million and $2.4 million for the three and
nine months ended September 30, 1998, respectively, in its Form 10-Q for the
period ended September 30, 1998. Of these unrealized gains (losses), $(1.0)
million and $4.8 million in the three and nine months ended September 30, 1998,
respectively, related to unrealized gains (losses) 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 $(2.3) million and $(2.4) million. 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 September 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.
11. Earnings per Share
- -- ------------------
Earnings per share ("EPS") is calculated in accordance with Statement
of Financial Accounting Standard No.128 ("SFAS 128"). 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 Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
Weighted-average number of shares of common
stock outstanding......................... 3,350,624 3,253,324 3,321,888 3,253,324
Additional common stock equivalents........ 198,912 -- 326,141 --
--------- --------- --------- ----------
Weighted-average number of shares of common
stock and common stock equivalents
outstanding............................... 3,549,536 3,253,324 3,648,029 3,253,324
10
Diluted EPS for the three and nine months ended September 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 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. In August 1999, the Ninth Circuit reversed the
United States District Court's ruling in regard to the Section 11 claims. The
plaintiffs and defendants have executed a memorandum of understanding providing
for a settlement pursuant to which all claims against all defendants would be
dismissed. The memorandum of understanding provides for the payment of $3.15
million to the plaintiffs. Under the terms of the Company's D&O insurance
policy, the Company's insurer is obligated to pay 70% of the settlement amount.
The settlement is subject to negotiation and execution of further documentation
and 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 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 are covered by the memorandum of understanding described
above and will also be dismissed pursuant to 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. The remaining
amount of $945,000 was expensed in the second quarter of 1999 in the
Consolidated Statements of Operations and Comprehensive Income (Loss).
11
13. Segment Reporting
- -- -----------------
Statement of 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.
The Company's reportable operating segments include Viatical
Settlements, Ventures 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.
12
The following tables represent the Company's results from segments for
the three months ended September 30, 1999 and 1998.
Three Months Ended September 30, 1999
-----------------------------------------------------------------------------------------
Viatical
Settlements (1) Ventures Allegiance Other Total
--------------- -------- ---------- ----- -----
Interest income...... $ 19,488 $ 475,996 $ 517,361 $ 61,393 $ 1,074,238
Gain on sale of
securities......... -- 3,499,686 -- 2,447,037 5,946,723
Other revenue........ 99,052 -- 10,000 9,134 118,186
Interest expense...... 879,651 52,478 381,036 -- 1,313,165
Depreciation &
Amortization...... 58,720 7,500 67,819 2,258 136,297
Income tax expense. -- -- 30,380 516,885 547,265
Contributed income
(loss) (2)............ (884,027) 3,912,443 (156,166) 1,290,956 4,163,206
Comprehensive
Income (loss)...... -- (11,761,748) -- (1,250) (11,762,998)
Segment assets...... 33,962,584 20,791,042 29,915,252 10,410,243 95,079,121
Three Months Ended September 30, 1998
-----------------------------------------------------------------------------------------
Viatical
Settlements (1) Ventures Allegiance Other Total
--------------- -------- ---------- ----- -----
Interest income...... $ 50,569 $ 32,213 $ 139,934 $ 127,502 $ 350,218
Gain on sale of
securities......... -- 24,691 -- 85,000 109,691
Other revenue........ 156,825 -- (12,539) -- 144,286
Interest expense...... 879,651 45,894 -- -- 925,545
Depreciation &
Amortization...... 58,720 10,759 1,927 1,240 72,646
Income tax expense. -- -- -- -- --
Contributed income
(loss) (2)............ (439,139) (1,019,650) 2,319 (427,781) (1,884,251)
Comprehensive
Income (loss)...... -- (2,326,692) -- -- (2,326,692)
Segment assets...... 38,195,121 7,330,338(3) 6,275,716 7,089,930 58,891,105(3)
13
The following tables represent the Company's results from segments for
the nine months ended September 30, 1999 and 1998.
Nine Months Ended September 30, 1999
-----------------------------------------------------------------------------------------
Viatical
Settlements (1) Ventures Allegiance Other Total
--------------- --------- ---------- ----- -----
Interest income...... $ 65,178 $ 795,579 $ 1,109,725 $ 174,227 $ 2,144,709
Gain on sale of
securities......... -- 8,942,455 -- 2,764,487 11,706,942
Other revenue........ 262,578 46,458 10,000 228,491 547,527
Interest expense...... 2,634,131 155,722 730,459 -- 3,520,312
Depreciation &
amortization....... 176,160 22,500 187,350 5,934 391,944
Income tax expense . 800 800 43,880 519,285 564,765
Contributed income
(loss) (2)............ (2,765,830) 9,061,763 (346,432) (528,623) 5,420,878
Comprehensive
income (loss)........ -- 3,501,892 -- (103,750) 3,398,142
Segment assets...... 33,962,584 20,791,042 29,915,252 10,410,243 95,079,121
Nine Months Ended September 30, 1998
-----------------------------------------------------------------------------------------
Viatical
Settlements (1) Ventures Allegiance Other Total
--------------- --------- ---------- ----- -----
Interest income...... $ 157,783 $ 150,891 $ 424,168 $ 316,531 $ 1,049,373
Gain on sale of
securities......... -- 24,691 -- 85,000 109,691
Other revenue........ 768,815 -- (9,088) 69,625 829,352
Interest expense...... 2,651,693 45,894 -- -- 2,697,587
Depreciation &
amortization....... 176,160 15,775 4,783 2,443 199,161
Income tax expense . -- -- -- -- --
Contributed income
(loss) (2).............. (115,513) (937,199) 213,193 (1,209,512) (2,049,031)
Comprehensive
income (loss) (3)... -- (2,407,344) -- -- (2,407,344)
Segment assets....... 38,195,121 7,330,338(3) 6,275,716 7,089,930 58,891,105(3)
<FN>
- --
(1) The Viatical Settlements segment includes results of operations in
connection with viatical settlements for DPFC and Point West.
(2) Corporate overhead and income tax expense are not generally allocated
between segments and are included in the Other segment.
(3) Reflects a reclassification of convertible preferred shares held by
Ventures from available-for-sale to non-marketable securities, which are
carried at cost. See Note 10.
</FN>
14
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
------------------
September 30, 1999 September 30, 1998
Income
------
Interest income $ 1,074,238 $ 350,218
Gain on sale of securities 5,946,723 109,691
Other revenue 118,186 144,286
--------------- ---------------
Total income $ 7,139,147 $ 604,195
Nine Months Ended
------------------
September 30, 1999 September 30, 1998
Income
------
Interest income $ 2,144,709 $ 1,049,373
Gain on sale of securities 11,706,942 109,691
Other revenue 547,527 829,352
--------------- ---------------
Total income $ 14,399,178 $ 1,988,416
14. Events Subsequent to the Balance Sheet Date
- -- -------------------------------------------
Ventures has invested a total of $2.9 million in four new small
business entities through November 10, 1999.
15
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
-------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
The following is a discussion and analysis of the consolidated
financial condition of the Company as of September 30, 1999, and of the results
of operations for the Company for the three and nine months ended September 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 nine months of 1999 compared to the
first nine months of 1998) the Company's results of operations and cash flows
for the three and nine months ended September 30, 1999 are not comparable to
those for the three and nine months ended September 30, 1998.
Overview
- --------
Point West is a specialty financial services company. The Company's
financial statements consolidate the assets, liabilities and operations of DPFC,
Ventures, 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 Ventures, 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 new business opportunities. Ventures,
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 Nine Months Ended September 30, 1999 Compared to the Three and
---------------------------------------------------------------------------
Nine Months Ended September 30, 1998
------------------------------------
Total Income. Total income increased $6.5 million to $7.1 million in
the third quarter of 1999 from $604,000 in the third quarter of 1998. This
increase was due primarily to $3.5 million and $2.4 million of gain on sale of
securities by Ventures and Point West, respectively, during the third quarter of
1999. The increase was also due to a $724,000 increase in interest income
primarily related to loans held
16
by Allegiance and Ventures. Total income increased $12.4 million to $14.4
million in the first nine months of 1999 from $2.0 million in the first nine
months of 1998. This increase was due primarily to $8.9 million of gain on sale
of securities by Ventures during the first nine months of 1999. Also
contributing to the increase was (i) $2.8 million of gain on sale of securities
by Point West, (ii) a $1.1 million increase in interest income primarily related
to loans held by Allegiance and Ventures and (iii) a $119,000 increase in other
income primarily related to a fee received by PWS for investment banking
services. Offsetting the increase in the first nine months of 1999 compared to
the first nine months of 1998 was an aggregate decrease of $401,000 in income
related to the Viatical Settlement segment. See "Results of Operations by
Segment -- Viatical Settlements -- Three and Nine Months Ended September 30,
1999 Compared to the Three and Nine Months Ended September 30, 1998 -- Earned
Discounts on Matured Policies" and " -- Gain on Assets Sold."
Total Expenses. Total expenses decreased 17.2% to $2.4 million in the
third quarter of 1999 from $2.9 million in the third quarter of 1998. This
decrease was primarily due to a $1.1 million loss on non-marketable securities
recorded in the third quarter of 1998. Offsetting this decrease were (i) a
$388,000 increase in interest expense related to borrowings by Allegiance, (ii)
a $170,000 increase in compensation and benefits expense primarily related to an
increase in salaries paid to employees and (iii) a $63,000 increase in
amortization costs related to the Allegiance Financing.
Total expenses increased 33.3% to $8.4 million in the first nine months
of 1999 from $6.3 million in the first nine months 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 $823,000 increase in interest expense related to borrowings by Allegiance,
(ii) a $259,000 increase in compensation and benefits expense primarily related
to an increase in salaries paid to employees, (iii) a $189,000 increase in
amortization costs related to the Allegiance Financing, (iv) a $133,000 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 and (v)
a $140,000 write-off of a loan recognized by Point West. See "Results of
Operations by Segment -- Other -- Other General and Administrative Expenses."
The Company wrote-off $535,000 of non-marketable securities during the first
nine months of 1999. This compares to a $1.1 million write-off during the
comparable 1998 period, thereby offsetting the increase in total expenses in the
first nine months of 1999 compared to the first nine months of 1998.
Income Tax Expense. The income tax expense of $547,000 and $565,000
recorded in the three and nine months ended September 30, 1999, respectively, is
primarily related to the state tax expense for gain on sale of securities
recognized by Point West and Ventures. See "Income Taxes."
Net Loss in Wholly Owned Financing Subsidiary Charged to Reserve for
Equity Interest. The DPFC net loss of $407,000 and $2.3 million recorded in the
three and nine months ended September 30, 1998, respectively, 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.
17
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 Ventures' investments,
FlashNet Communications Inc. ("FlashNet"), completed an initial public offering.
As a result of the offering, the FlashNet securities held by Ventures were
recharacterized from non-marketable securities to marketable securities.
Primarily as a result of the recharacterization of FlashNet shares and other
non-marketable securities to marketable securities, comprehensive income -- net
unrealized investment gains (losses) for the nine months ended September 30,
1999 was $3.4 million versus $(2.4) million for the comparable 1998 period. The
increase was also impacted, both positively and negatively, by the amount of
marketable securities held and changes in the value of those securities.
Comprehensive income -- net unrealized investment losses for the third quarter
of 1999 was $(11.8) million, primarily reflecting the decrease in the market
value of the FlashNet securities between June 30, 1999 and September 30, 1999
and the sale of shares of FlashNet securities in September 1999.
The Company originally reported "Comprehensive Income -- Net Unrealized
Investment Gains (Losses)" of $(3.3) million and $2.4 million for the three and
nine months ended September 30, 1998, respectively, in its Form 10-Q for the
period ended September 30, 1998. Of these unrealized gains (losses), $(1.0)
million and $4.8 million in the three and nine months ended September 30, 1998,
respectively, related to unrealized gains (losses) 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 $(2.3) million and $(2.4) million. 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 of the Condensed Notes to Consolidated
Financial Statements. In both periods, such securities were convertible into
marketable securities but nonetheless should have been reflected at September
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 --
Ventures" 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 September 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
18
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 September 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 $4.8 million at
September 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 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 nine months of 1999, the total loss realized by DPFC was
$3.1 million, which was reflected in the Company's net income. The loss for the
first nine months of 1999 decreased basic EPS by $0.93. 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 Nine Months Ended September 30, 1999 Compared to the Three
and Nine Months Ended September 30, 1998
Earned Discounts on Matured Policies. Earned discounts on matured
policies increased 16.9% to $76,000 in the third quarter of 1999 from $65,000 in
the third quarter of 1998 due to an increase in the number and face amount of
matured policies. During the third quarter of 1999, earned discounts on matured
policies were recognized on 11 policies with a face value of $783,000, compared
to 6 policies with a face value of $542,000 in the third quarter of 1998. Earned
discounts on matured policies decreased 56.6% to $187,000 in the first nine
months of 1999 from $431,000 in the first nine months 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 first
nine months of 1999, earned discounts on matured policies were recognized on 35
policies with a face value of $2.2 million, compared to 44 policies with a face
value of $2.9 million in the first nine months of 1998. See "Method of
Accounting for Viatical Settlements." As of September 30, 1999, the Company held
471 policies with an aggregate carrying value of $32.2 million (comprised of
"matured policies receivable," "purchased life insurance policies" and a portion
of "other assets") and an aggregate face value of $37.4 million. All of the
"purchased life insurance policies" and "matured policies receivable" are
pledged as security for the Securitized Notes.
19
Interest Income. Interest income decreased 62.7% to $19,000 in the
third quarter of 1999 from $51,000 in the third quarter of 1998 and 58.9% to
$65,000 in the first nine months of 1999 from $158,000 in the first nine months
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 Company did not collect any proceeds on
policies sold during the third quarter of 1999. The Company collected the sale
proceeds on 1 policy resulting in a realized gain of $15,000 in the third
quarter of 1998. The gain on assets sold decreased to $8,000 in the first nine
months of 1999 from $165,000 in the first nine months of 1998. The Company
collected the sale proceeds on one policy in the first nine months of 1999,
compared to seven policies in the first nine months 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 policies. Other income
decreased 70.1% to $23,000 in the third quarter of 1999 from $77,000 in the
third quarter of 1998. This decrease is due to a $65,000 increase in face value
on one policy realized during the third quarter of 1998. Other income decreased
60.7% to $68,000 in the first nine months of 1999 from $173,000 in the first
nine months of 1998. This decrease was due to the face value increase described
above and to the decrease in the number and amount of matured policies.
Interest Expense. Interest expense was $880,000 for both the third
quarter of 1999 and the third quarter of 1998. Interest expense decreased
nominally to $2,634,131 in the first nine months of 1999 from $2,651,693 in the
first nine months of 1998 as a result of modest principal repayments of $275,000
under the Securitized Notes during the second quarter of 1998.
Other General and Administrative Expenses. Other general and
administrative expenses decreased 44.3% to $64,000 in the third quarter of 1999
from $115,000 in the third quarter of 1998 and 44.9% to $283,000 in the first
nine months of 1999 from $514,000 in the first nine months 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."
Ventures
--------
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). Securities classified
as held-to-maturity included U.S. treasury bills reported at cost with
maturities greater than three months, but less than one year. The Company had no
trading securities at September 30, 1999 and no held-to-maturity or trading
securities at December 31, 1998. The Company uses the cost
20
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 Nine Months Ended September 30, 1999 Compared to the Three
and Nine Months Ended September 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 the Consolidated Statements of Operations
and Comprehensive Income (Loss) on an appropriate line item above "Net 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 Ventures' 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 September 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."
The Company accounts for loans by accruing interest on outstanding
balances. At September 30, 1999 and December 31, 1998, the Company evaluated
each of Ventures' outstanding loans and determined that an allowance for loan
losses was not necessary. As Ventures' 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 Nine Months Ended September 30, 1999 Compared to the Three
and Nine Months Ended September 30, 1998
Interest Income. Interest income increased $444,000 to $476,000 in the
third quarter of 1999 from $32,000 in the third quarter of 1998 and $645,000 to
$796,000 in the first nine months of 1999 from $151,000 in the first nine months
of 1998. This increase was primarily due to $383,000 and $625,000 of interest
income recognized in the three and nine months ended September 30, 1999,
respectively, as a result of a warrant (valued using the Black-Scholes
option-pricing model) received in connection with one of Ventures' loans.
Gain on Sale of Securities. Ventures recognized a net gain of $3.5
million and $8.9 million in the three and nine months ended September 30, 1999,
respectively, primarily in connection with the sale of two of its investments,
including FlashNet. For federal tax purposes, the gain on sale of securities was
offset by the Company's NOL's. However, the gain generated a state tax
liability. See "Income Tax." Ventures recognized a net gain of $25,000 in the
three and nine months ended September 30, 1998.
Other Income. Ventures 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 increased to $52,000 in the third
quarter of 1999 from $46,000 in the third quarter of 1998 and to $156,000 in the
first nine months of 1999 from $46,000 in the first nine months of 1998 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, Ventures had no debt.
Amortization. Amortization costs decreased 27.3% to $8,000 in the third
quarter of 1999 from $11,000 in the third quarter of 1998. The 1998 period
reflects organizational costs which are currently
21
required to be expensed as incurred and were written-off at the end of 1998.
Amortization costs increased 43.8% to $23,000 in the first nine months of 1999
from $16,000 in the first nine months of 1998. This increase was due to the
financing costs associated with the funds borrowed in July 1998.
Loss on Non-Marketable Securities. Ventures reviews on a quarterly
basis all non-marketable securities and attempts to ascertain whether the value
is impaired. As a result of such review, Ventures determined that $535,000 of
non-marketable equity securities of one company was impaired at June 30, 1999.
Therefore, Ventures wrote-off the entire $535,000 carrying value of such
security. In addition, Ventures determined that $1.0 million of non-marketable
securities of one company was impaired at September 30, 1998, and therefore
wrote-off its entire $1.0 million carrying value of such security.
Allegiance
----------
Method of Accounting for Loans
The Company accounts for loans advanced by Allegiance by accruing
interest on outstanding balances. At September 30, 1999 and December 31, 1998
the allowance for loan losses was $135,000 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 September 30, 1999, one loan was in default
and on non-accrual status. This loan was not included in the collateral securing
the Allegiance Financing.
Loan origination fees and direct loan origination costs are capitalized
and recognized over the life of the related loan as an adjustment of yield
(interest income) in accordance with SFAS 91.
The Allegiance Financing provides for long term fixed and short term
fixed and floating rate debt. On September 21, 1999, the revolving certificates
then outstanding were repaid through the issuance of term certificates. In
addition, the Company and Investors extended the Allegiance Financing through
April 15, 2000. The investors agreed to continue to provide revolving debt,
subject to certain limitations, through April 15, 2000, on terms substantially
similar to those under the original revolving certificates under the Allegiance
Financing, but with an increased weighted-average spread of approximately 0.05%.
Allegiance has agreed to retain an unrated revolving certificate related to the
extension. In addition, the Investors agreed to provide up to $30 million of
additional term financing, subject to certain limitations, through April 15,
2000, on terms substantially similar to those under the original term
certificates issued under the Allegiance Financing, but with an increased
weighted-average spread of approximately 0.5%. Term financing under the
extension may be completed in minimum amounts of $15 million.
Because of Allegiance's right to redeem the term certificates if 15% or
less in principal amount of certificates is 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 Sheets.
Allegiance uses futures contracts to hedge certain interest rate
exposure between the time of origination of the loans and the expected issuance
of term certificates. The futures contracts are intended to protect the net
interest margins earned on the loans. Any realized gain or loss related to these
hedges are deferred and recognized by Allegiance over the life of the related
loan as an adjustment of interest income. Pursuant to SFAS 80, 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 September 30, 1999, Allegiance had net
realized gains on its
22
hedging activities of $215,000 which decreased loans receivable in a like
amount. As of September 30, 1999 Allegiance had no open hedging positions.
Three and Nine Months Ended September 30, 1999 Compared to the Three
and Nine Months Ended September 30, 1998
Interest Income. Interest income increased $377,000 to $517,000 in the
third quarter of 1999 from $140,000 in the third quarter of 1998 and $676,000 to
$1.1 million in the first nine months of 1999 from $424,000 in the first nine
months of 1998. This increase was due to increased lending activity by
Allegiance. However, offsetting this increase was $49,000 and $83,000 of
interest for the third quarter of 1999 and the first nine months of 1999,
respectively, that was not accrued on one delinquent loan. Allegiance had
seventeen loans outstanding in the aggregate amount of $29.4 million at
September 30, 1999 as compared to two loans outstanding in the amount of $5.8
million at September 30, 1998. The weighted-average interest rate on the loans
outstanding during the three and nine months ended September 30, 1999 was 8.9%
compared to 9.5% during the three and nine months ended September 30, 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 has declared an
event of default and is in the process of taking actions to foreclose on assets
securing the loan. Allegiance does not believe it will incur any loss in
connection with such loan.
Interest Expense. Interest expense for Allegiance was $381,000 and
$730,000 in the three and nine months ended September 30, 1999, respectively, as
a result of the interest paid under the Allegiance Financing. During the three
and nine months ended September 30, 1999, the weighted-average interest rate
under the Allegiance Financing was 7.6% and the weighted-average borrowings were
$16.5 million and $11.5 million, respectively. Prior to November 1998,
Allegiance had no debt.
Compensation and Benefits. Compensation and benefits increased 10.0% to
$66,000 in the third quarter of 1999 from $60,000 in the third quarter of 1998
and 35.1% to $181,000 in the first nine months of 1999 from $134,000 in the
first nine months of 1998. This increase resulted from the hiring of additional
employees in 1999 to support Allegiance's lending activities.
Other General and Administrative Expenses. Other general and
administrative expenses were $138,000 in the third quarter of 1999. This was due
primarily to a $41,000 increase in general legal expense, a $40,000 provision
for loan losses, $17,000 in expenses related to the Allegiance Financing, a
$13,000 increase in accounting expense and a $6,000 increase in marketing
expense. There were no other general and administrative expenses for the third
quarter of 1998 because expenses related to loans which were expensed in
previous periods were required to be capitalized in accordance with SFAS 91. See
"Method of Accounting for Loans." Other general and administrative expenses
increased $262,000 to $323,000 in the first nine months of 1999 from $61,000 in
the first nine months of 1998. This increase was due primarily to a $91,000
increase in general legal expense, a $85,000 increase in allowance for loan
losses, $40,000 in expenses related to the Allegiance Financing and a $24,000
increase in marketing expense. In addition, the increase was due to an increase
in Allegiance's activities.
Amortization. Amortization costs increased to $68,000 in the third
quarter of 1999 from $2,000 in the third quarter 1998 and to $187,000 in the
first nine months of 1999 from $5,000 in the first nine months 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.
23
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 nine months of 1999 and 1998.
Three and Nine Months Ended September 30, 1999 Compared to the Three
and Nine Months Ended September 30, 1998
Interest Income. Interest income declined 52.3% to $61,000 in the third
quarter of 1999 from $128,000 in the third quarter of 1998 and 45.1% to $174,000
in the first nine months of 1999 from $317,000 in the first nine months of 1998.
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 $2.4 million gain
in the third quarter of 1999 in connection with the sale of one of its
investments. In addition, 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." Point West recognized a $85,000 gain in the third quarter of 1998 in
connection with the sale of a debt security.
Other Income. Other income was $9,000 in the third quarter of 1999 due
to trading commissions generated by PWS. Other income increased to $228,000 in
the first nine months of 1999 from $70,000 in the first nine months of 1998.
This increase was due to (i) an increase of $121,000 in fees received by PWS for
investment banking services and (ii) $37,000 in trading commissions generated by
PWS in the first nine months of 1999. The increase in other income was primarily
due to transaction based investment banking services. The amount and timing of
these services in future periods cannot be predicted because of the limited
operating history of PWS.
Compensation and Benefits. Compensation and benefits increased 46.2% to
$519,000 in the third quarter of 1999 from $355,000 in the third quarter of 1998
and 22.8% to $1.2 million in the first nine months of 1999 from $977,000 in the
first nine months of 1998. This increase was due primarily to an increase in
compensation and benefits for employees in 1999.
Other General and Administrative Expenses. Other general and
administrative expenses decreased 12.1% to $188,000 in the third quarter of 1999
from $214,000 in the third quarter of 1998. This decrease was due to a $71,000
decrease in litigation expense. Offsetting this decrease was a $21,000 increase
in rent expense and a $14,000 increase in clearing expenses related to PWS.
During the second quarter of 1999, the Company renewed the lease on its current
space. The Company's monthly rent increased from $5,240 per month to
approximately $15,000 per month. Other general and administrative expenses
increased $1.4 million to $2.0 million in the first nine months of 1999 from
$632,000 in the first nine months 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). Unless a settlement of these actions is effected, Point West
expects legal expenses to increase substantially during the remainder of 1999
relative to 1998. Also contributing to the increase were a $140,000 loan
write-off, a $133,000 increase in legal expenses incurred in connection with the
federal and state alleged class action lawsuits, a $70,000 increase in
accounting expense and $37,000 increase in rent expense.
24
Liquidity and Capital Resources
- -------------------------------
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 nine months of 1999, the Company supported the operations of Point West,
PWS and Ventures 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 September 30, 1999, Point West and PWS' cash and cash equivalents
were $7.0 million, which includes government securities classified as
"Investment Securities -- Held-to-Maturity". The Company continues to analyze
its current and future needs for financing, which will be dependent on its
ability to develop the businesses of Ventures, Allegiance and PWS and any other
business opportunities the Company pursues. See "Considerations Under the
Investment Company Act of 1940." There can be no assurance that Point West or
PWS will be successful in obtaining external financing on satisfactory terms
assuming the Company determines additional funds are needed. The Company at
present anticipates having sufficient liquidity to meet the working capital and
operational needs of Point West 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 September 30, 1999, the outstanding principal amount of the
Securitized Notes was $38.5 million. As of the same date, DPFC had restricted
cash of $1.4 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.
Ventures
Ventures' activities have generally been supported by capital
investments by Point West, by the sale of investments and the repayment by
obligors of loans. During 1997, Point West contributed $2.5 million to Ventures.
During 1998, Point West contributed an additional $2.5 million to Ventures.
During the first quarter of 1999, Point West contributed an additional $800,000
to Ventures. During the first nine months of 1999, Ventures generated $11.2
million of proceeds (net of commissions) from the sale of securities. At
September 30, 1999, Ventures' cash and cash equivalents were $5.5 million
Point West Ventures has an SBA debenture license and, therefore, may be
permitted, based on capital investments by Point West and realized gains on the
sale of securities, to borrow up to $16.6 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, Point West Ventures borrowed $3.0
million from the SBA. Point West Ventures is permitted to borrow an additional
$13.6 million from the SBA.
25
Ventures may not have sufficient liquidity, at least in the short term,
to grow its business. In addition, because of substantial appreciation in
investments, the Company may be required to restrict Ventures' growth in order
to avoid registration under the Investment Company Act of 1940 at some time in
the future. See "Considerations Under the Investment Company Act of 1940."
Allegiance
As of September 30, 1999, Point West has invested $5.3 million in
Allegiance Capital.
On August 19, 1998, Allegiance put in place the Allegiance Financing
which has provided debt on a non-recourse revolving certificate basis to support
lending activities of Allegiance. On September 21, 1999, the revolving
certificates then outstanding were repaid through the issuance of the term
certificates. Such term certificates provide fixed interest rate financing for
the life of the underlying loans. In addition, the Company and Investors
extended the Allegiance Financing through April 15, 2000. The Investors agreed
to continue to provide revolving debt, subject to certain limitations, through
April 15, 2000, on terms substantially similar to those under the original
revolving certificates under the Allegiance Financing, but with an increased
weighted-average spread of approximately 0.05%. Allegiance has agreed to retain
an unrated revolving certificate related to the extension. In addition, the
Investors agreed to provide up to $30 million of additional term financing,
subject to certain limitations, through April 15, 2000, on terms substantially
similar to those under the original term certificates issued under the
Allegiance Financing, but with an increased weighted-average spread of
approximately 0.5%. Term financings under the extension may be completed in
minimum amounts of $15 million.
The Company expects that the Allegiance Financing will provide
sufficient funds to support Allegiance's lending activities through April 15,
2000. See Note 6 of the Condensed Notes to Consolidated Financial Statements.
Income Taxes
- ------------
The Company has significant NOLs for tax purposes. The NOLs are
primarily related to losses incurred by DPFC. The Company has established
valuation allowances which offset completely the deferred tax assets related to
NOLs because the Company and DPFC have been unable to consistently generate
taxable earnings. There has been no reduction made to the valuation allowance in
connection with the gain upon the anticipated retirement of the Securitized
Notes discussed in Note 7 of the Condensed Notes to Consolidated Financial
Statements or the unrealized gains on investment securities discussed in Note 2
of the Condensed Notes to Consolidated Financial Statements. The Company will
reevaluate the amount of the valuation allowance in future periods.
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 and related rules (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.
26
Although the Company believes that it did not exceed the Percentage
Tests at September 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 Ventures, 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, Ventures holds
at November 15, 1999, 497,266 shares of FlashNet common stock that was acquired
for $887,764. During September, October and November 1999, Ventures sold 623,000
shares of FlashNet and has realized $5.1 million of gains in connection with
such sales. At September 30, 1999, the price of FlashNet common stock was $8.00.
On November 8, 1999, Prodigy Communications Corporation announced that it had
executed definitive documentation to acquire FlashNet in a stock-for-stock
merger. The transaction is subject to FlashNet shareholder approval and other
customary conditions.
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.
During 1999, Ventures sold some of its investments (including FlashNet
shares) in part to address these issues. The proceeds of these sales have been
invested in U.S. government securities pending final use, which has included
further investments by Ventures.
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; and
continuing to develop Allegiance's commercial lending business;
and
continuing to dispose of publicly-traded investment securities
and/or restricting the growth of Ventures' business. Although the
Company intends to continue Ventures' investment activities, the
Company does not intend to contribute more capital to Ventures.
Growth of New Operating Businesses
The Company 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
27
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. Allegiance does not have an external funding
source beyond April 2000.
Disposing of Investment Securities/Limiting Growth of Ventures
The Company may determine that it must dispose of additional investment
securities to avoid being deemed to be an investment company. The dispositions
may occur at times and on terms that would not maximize the value of these
investments. In addition, the dispositions may result in disadvantageous tax
consequences. The Company intends to use any proceeds of any additional sale to
support its working capital (including further investments by Ventures) and may
consider using such proceeds to repay SBA debt. Pending final use, proceeds of
any additional sale will be invested in U.S. government securities.
The Company also currently intends to limit the growth of Ventures'
business. Although Ventures intends to continue investing in investment
securities, the Company does not intend to contribute more capital to Ventures.
Limiting Ventures' growth may materially adversely affect the Company's future
financial condition and results of operations.
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
28
such modifications and replacements. Through September 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 has 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.
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, rely significantly on manual procedures and
record keeping. All files are expected to be adequately backed up as of December
31, 1999 and to be available to facilitate manual record keeping. Adequate hard
copy reports of balances and transactions as of December 31, 1999 will also be
available to provide a complete manual system of accounting and inventory
control, if required. Subsequent to Year 2000, manual systems will continue to
be in place to mitigate the risk of lost information due to any unforeseen
interruptions that may occur as a result of Year 2000 issues arising after
January 1, 2000. Nonetheless, there can be no assurance that the Company's
contingency plan will effectively mitigate any Year 2000 failures or that such
contingency plan would not 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 extension of the Allegiance Financing, (ii) the collection of
interest, no incurrence of any loss and potential foreclosure and liquidation of
one of the loans made by Allegiance, (iii) sufficiency of the Company's
liquidity and capital resources (See "Liquidity and Capital Resources"), (iv)
the Company's ability to continue not being subject to registration and
regulation under the 1940 Act (See "Considerations Under the Investment Company
Act of 1940"), (v) 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
29
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, (ii) the borrower's
ability to make future payments on the defaulted Allegiance loan and
Allegiance's ability to foreclose on the collateral at a price at least equal to
the amount of debt (including foreclosure fees and expenses) of such loan, (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.
30
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 Ventures' investments in the stock
of public and private companies, fixed rate loans and debt investments made by
Allegiance and Ventures and Allegiance's variable rate debt. The Company's
management believes the Company's risk management and hedging practices result
in carefully managed market exposure.
The Company has investment holdings in various companies. Due to the
varying nature of these investments, it is difficult to correlate the effects of
the market to a particular market index. The effects of the market are reviewed
by management on an individual investment-by-investment basis.
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 Ventures' holdings in FlashNet. At September 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.
The table below represents principal cash flows and weighted-average
interest rates for the Allegiance loans outstanding at September 30, 1999:
1999 2000 2001 2002 2003 Thereafter
---- ---- ---- ---- ---- ----------
Fixed rate loans(1)(2) $ 124,332 $ 673,624 $ 741,339 $ 815,877 $ 897,930 $24,031,848
Average interest
Rates (1) 9.6% 9.6% 9.6% 9.6% 9.7% 9.7%
- --
<FN>
(1) The principal cash flows for fixed rate loans and average interest rates do
not include one delinquent loan.
(2) The Company intends to hedge its interest rate exposure related to the
future loans made by Allegiance because the interest rate at which
Allegiance anticipates issuing term certificates in connection with the
extension of the Allegiance Financing will be set in the future at some
point. Allegiance intends to utilize futures contracts to hedge certain
interest rate exposure between the time of origination of the loans and the
expected issuance of such term certificates.
</FN>
In connection with the extension of 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
outstanding balance of the Class A-R certificate. At present the outstanding
balance of the Class A-R certificate is zero.
31
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 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. In
August 1999, the Ninth Circuit reversed the United States District
Court's ruling in regard to the Section 11 claims. The plaintiffs and
defendants have executed a memorandum of understanding providing for a
settlement pursuant to which all claims against all defendants would be
dismissed. The memorandum of understanding provides for the payment of
$3.15 million to the plaintiffs. Under the terms of the Company's D&O
insurance policy, the Company's insurer is obligated to pay 70% of the
settlement amount. The settlement is subject to negotiation and
execution of further documentation and 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 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 are covered by the
memorandum of understanding described above and will also be dismissed
pursuant to 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. The remaining amount of $945,000 was expensed in the second
quarter of 1999 in the Consolidated Statements of Operations and
Comprehensive Income (Loss).
32
Item 5. Other Information
- --------------------------
The Company has established May 16, 2000 as the date on which
the Company's 2000 annual stockholders meeting (the "2000
Meeting") will be held. The Company must receive by December
17, 1999 any proposal of a stockholder intended to be
presented at the 2000 Meeting and to be included in the
Company's proxy, notice of meeting and proxy statement related
to the Meeting pursuant to Rule 14a-8 under the Securities Act
of 1934 (the "Exchange Act"). Proposals of stockholders
submitted outside the processes of Rule 14a-8 under the
Exchange Act in connection with the 2000 Meeting ("Non-Rule
14a-8 Proposals") must be received by the Company by March 17,
2000 or such proposals will be considered untimely under the
advance notice provisions of the Company's Second Amended and
Restated Certificate of Incorporation and Amended and Restated
By-Laws (the "Charter Documents"). The Company's proxy related
to the 2000 Meeting will give discretionary authority to the
proxy holders to vote with respect to all Non-Rule 14a-8
Proposals received by the Company after March 17, 2000. Any
stockholder wishing to submit a proposal at the 2000 Meeting
must also comply with certain other provisions of the Charter
Documents. Notices of stockholder proposals should be directed
to, and any request for a copy of the Charter Documents (which
will be provided at no charge to any holder of the Company's
Common Stock), should be directed to: Secretary, Point West
Capital Corporation, 1700 Montgomery Street, Suite 250, San
Francisco, California 94111.
Item 6. Exhibits and Reports on Form 8-K
- ----------------------------------------
(a) Exhibits:
Number Description
------ -----------
10.1** Amended and Restated Supplement to Trust
Agreement for Revolving Series 1998-1, dated as
of September 1, 1999, among Allegiance Funding
I, LLC, Manufacturers and Traders Trust Company
and Point West Capital Corporation.
10.2** Second Amended and Restated Supplement to Trust
Agreement for Revolving Series 1998-1, dated as
of September 15, 1999, among Allegiance Funding
I, LLC, Manufacturers and Traders Trust Company
and Point West Capital Corporation.
10.3** Supplement to Trust Agreement for Term Series
1999-1, dated as of September 15, 1999, among
Allegiance Funding I, LLC, Manufacturers and
Traders Trust Company and Point West Capital
Corporation.
27 Financial Data Schedule
99.1 Press Release for Point West Ventures, L.P.
** Certain information omitted pursuant to a request for
confidential treatment filed with the SEC.
33
(b) Reports on Form 8-K filed during the quarter ended September 30,
1999:
Date Item Reported Matter Reported
---- ------------- ---------------
August 16, 1999 5 The Company issued a press
release regarding its results
of operations for the second
quarter of 1999.
September 20, 1999 4 The Company reported a change
in its independent public
accountants from KPMG LLP to
Ernst & Young LLP.
34
SIGNATURES
==========
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
POINT WEST CAPITAL CORPORATION
Dated: November 15, 1999 /s/ ALAN B. PERPER
--------------------------------
ALAN B. PERPER
President
(Duly Authorized Officer)
Dated: November 15, 1999 /s/ JOHN WARD ROTTER
--------------------------------
JOHN WARD ROTTER
Executive Vice President and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
35