As filed with the Securities and Exchange Commission on July 19, 2006
Registration No. 333-_____
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
SHEARSON FINANCIAL NETWORK, INC.
(Name of small business issuer in its charter)
NEVADA 6199 88-0471353
(State or other Jurisdiction (Primary Standard Industrial (I.R.S. Employer
of Incorporation or Classification Code Number) Identification No.)
Organization)
6330 S. Sandhill Rd. Suite 8
Las Vegas, Nevada 89120
(702) 547-7300
(Address and telephone number of principal executive offices
and principal place of business)
Michael A. Barron
Chief Executive Officer
Shearson Financial Network Inc.
6330 S. Sandhill Rd. Suite 8
Las Vegas, Nevada 89120,
(702) 547-7300
(Name, address and telephone number of agent for service)
Copies to:
Gregory Sichenzia, Esq.
David B. Manno, Esq.
Sichenzia Ross Friedman Ference LLP
1065 Avenue of the Americas,
New York, New York 10018
(212) 930-9700
(212) 930-9725 (Fax)
APPROXIMATE DATE OF PROPOSED SALE TO THE PUBLIC:
From time to time after this Registration Statement becomes effective.
If any securities being registered on this Form are to be offered on a delayed
or continuous basis pursuant to Rule 415 under the Securities Act of 1933, other
than securities offered only in connection with dividend or interest
reinvestment plans, check the following box: |X|
If this Form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. |_| ________
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. |_| ________
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. |_| ________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. |_| _____
i
CALCULATION OF REGISTRATION FEE
CALCULATION OF REGISTRATION FEE
----------------------------------------------------------------------------------------------------------------------------
TITLE OF EACH CLASS OF SECURITIES TO BE AMOUNT TO BE PROPOSED PROPOSED MAXIMUM AMOUNT OF
REGISTERED REGISTERED (1) MAXIMUM AGGREGATE REGISTRATION
OFFERING PRICE OFFERING PRICE FEE
PER SHARE (2)
----------------------------------------------------------------------------------------------------------------------------
Common stock, $.001 par value issuable upon $94,043,887(3) $0.025 $2,351,097.18 $ 251.57
conversion of the secured convertible notes
----------------------------------------------------------------------------------------------------------------------------
Total $94,043,887 $2,351,097.18 $ 251.57
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(1) Includes shares of our common stock, par value $0.001 per share, which may
be offered pursuant to this registration statement, which shares are issuable
upon conversion of secured convertible notes held by the selling stockholders.
The number of shares of common stock registered hereunder represents a good
faith estimate by us of the number of shares of common stock issuable upon
conversion of the secured convertible notes.
(2) Estimated solely for purposes of calculating the registration fee in
accordance with Rule 457(c) and Rule 457(g) under the Securities Act of 1933,
using the average of the high and low price as reported on the Over-The-Counter
Bulletin Board on July 17, 2006, which was $0.025 per share.
(3) Includes a good faith estimate (100%) of the shares underlying secured
convertible notes to account for market fluctuations.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE
SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
THE INFORMATION CONTAINED IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED.
WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
ii
PRELIMINARY PROSPECTUS SUBJECT TO COMPLETION, DATED JULY 19, 2006
Shearson Financial Network Inc.
94,043,887 SHARES OF
COMMON STOCK
This prospectus relates to the resale by the selling stockholders of up to
94,043,887 shares of our common stock, of our common stock underlying secured
convertible notes in a principal amount of $1,500,000. The secured convertible
notes are convertible into our common stock at a 50% discount (subject to
adjustment as provided for in the convertible note) to the average of the three
lowest intraday trading prices for the common stock on a principal market for
the 20 trading days before but not including the conversion date. The shares
being registered hereunder do not include shares of common stock that may be
acquired by the selling stockholders upon conversion of amounts due to them
resulting from future accruals of interest pursuant to the convertible notes.
The selling stockholders may sell common stock from time to time in the
principal market on which the stock is traded at the prevailing market price or
in negotiated transactions. The selling stockholders may be deemed underwriters
of the shares of common stock, which they are offering. We will pay the expenses
of registering these shares.
Our common stock is registered under Section 12(g) of the Securities Exchange
Act of 1934 and is listed on the Over-The-Counter Bulletin Board under the
symbol "SFNN". The last reported sales price per share of our common stock as
reported by the Over-The-Counter Bulletin Board on July 11, 2006, was $0.028.
INVESTING IN THESE SECURITIES INVOLVES SIGNIFICANT RISKS.
SEE "RISK FACTORS" BEGINNING ON PAGE 4.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
Prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
The date of this prospectus is July __, 2006.
The information in this Prospectus is not complete and may be changed. This
Prospectus is included in the Registration Statement that was filed by Shearson
Financial Network, Inc. with the Securities and Exchange Commission. The selling
stockholders may not sell these securities until the registration statement
becomes effective. This Prospectus is not an offer to sell these securities and
is not soliciting an offer to buy these securities in any state where the sale
is not permitted.
iii
TABLE OF CONTENTS
Cautionary Note Regarding Forward-Looking Statements .................. 1
Prospectus Summary .................................................... 2
Risk Factors .......................................................... 4
Use Of Proceeds ....................................................... 11
Market For Common Equity And Related Stockholder Matters .............. 11
Management's Discussion And Analysis Of Financial Condition
And Results Of Operations ............................................. 12
Description Of Business ............................................... 17
Description Of Property ............................................... 26
Legal Proceedings ..................................................... 27
Management ............................................................ 27
Executive Compensation ................................................ 29
Certain Relationships And Related Transactions ........................ 30
Security Ownership Of Certain Beneficial Owners And Management ........ 31
Description Of Securities ............................................. 31
Commission's Position On Indemnification For Securities Act Liabilities 32
Plan Of Distribution .................................................. 32
Selling Stockholders .................................................. 35
Legal Matters ......................................................... 38
Experts ............................................................... 38
Available Information ................................................. 38
Index to Consolidated Financial Statements ............................ F-1
iv
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus and any prospectus supplement contain forward-looking
statements. We have based these forward-looking statements on our current
expectations and projections about future events.
In some cases, you can identify forward-looking statements by words such as
"may," "should," "expect," "plan," "could," "anticipate," "intend," "believe,"
"estimate," "predict," "potential," "goal," or "continue" or similar
terminology. These statements are only predictions and involve known and unknown
risks, uncertainties and other factors, including the risks outlined under "Risk
Factors," that may cause our or our industry's actual results, levels of
activity, performance or achievements to be materially different from any future
results, levels of activity, performance or achievements expressed or implied by
such forward-looking statements.
Unless we are required to do so under U.S. federal securities laws or other
applicable laws, we do not intend to update or revise any forward-looking
statements.
1
PROSPECTUS SUMMARY
The following summary highlights selected information contained in this
prospectus. This summary does not contain all the information you should
consider before investing in the securities. Before making an investment
decision, you should read the entire prospectus carefully, including the "risk
factors" section, the financial statements and the notes to the financial
statements.
SHEARSON FINANCIAL NETWORK INC.
OVERVIEW
Shearson Financial Network Inc. SFN was incorporated in Las Vegas, Nevada in
July 2000, and is the parent to two primary operating divisions, Shearson Home
Loans and Real Property Technologies (RPT). Shearson Home Loans (SHL) is a
direct-to-consumer mortgage broker and banker with revenues derived primarily
from origination commissions and resale of whole loans earned on the closing of
first and second mortgages on single-family residences. SHL currently employs
over 500 people which are residential mortgage and/or real estate brokerage
professionals. The Company is a consolidator of mortgage brokerages and
integrates the brokerage companies into the Shearson Home Loans network and then
banks the mortgages through its mortgage banking unit. The Company plans to
continue its growth strategy through the acquisition and affiliation of mortgage
brokerage firms who do not currently bank their own production. By providing
more efficient services to these smaller firms, SHL can accrete loan volume
without having to "organically" grow the business. Banking of the accreted loan
volume generates windfall revenue to the Company. Thus the rate of growth of
SHL's revenue stream is dramatically accelerated. The Company has the
infrastructure, systems, and operational management necessary to properly
integrate these and many more acquisitions in order to establish a countywide
network. The Company's business plan is focused on the integration of over 200
mortgage brokerage offices into the SHEARSON mortgage network.
RPT is a leading real estate information company with headquarters in New York.
RPT reported revenues of approximately $24 million for fiscal year 2005 with pre
tax profits of nearly four million dollars ($4,000,000) and has in excess of 200
employees. RPT operates within the Shearson Financial Network as a separate data
network. RPT provides a steady revenue stream and profitability which the
company looks to mitigate the effects of interest rate fluctuations in the
mortgage lending market. The database has numerous marketing advantages for our
mortgage operations.
..
The Offering
Common stock offered by
selling stockholders ............... Up to 94,043,887 shares, including the
following:
- up to 94,043,887 shares of
common stock underlying secured
convertible notes in the
principal amount of
$1,500,000(includes a good faith
estimate of the shares
underlying secured convertible
notes to account for market
fluctuations and antidilution
protection adjustments,
respectively),
- This number represents 98% of
our current outstanding stock.
Common stock to be
outstanding after the offering ..... Up to 190,241,914 shares
2
Use of proceeds ......................
The proceeds received from the sale of
the secured convertible notes will be
used to support general corporate
purposes and working capital needs.
Over-The-Counter
Bulletin Board Symbol .............. SFNN
The above information regarding common stock to be outstanding after the
offering is based on 96,198,027 shares of common stock outstanding as of June
10, 2006 and assumes the subsequent conversion of our issued secured convertible
notes and exercise of warrants by our selling stockholders, although there can
be no assurances that any warrants will be exercised.
3
JUNE 2006 PURCHASE AGREEMENT
On June 30, 2006, we entered into a Securities Purchase Agreement with AJW
Partners, LLC ("Partners"), AJW Offshore, Ltd. ("Offshore"), AJW Qualified
Partners, LLC ("Qualified") and New Millennium Capital Partners, II, LLC
("Millennium") for the sale of (i) $1,500,000 in secured convertible notes and
(ii) warrants to purchase 30,000,000 shares of the Company's common stock.
Partners, Offshore, Qualified and Millennium are collectively referred to as the
"Purchasers".
The Purchasers are obligated to provide the Company with the funds as follows:
o $500,000 was disbursed at closing;
o $500,000 will be disbursed within five days of filing a registration
statement covering the number of shares of common stock underlying the
secured convertible notes and the warrants; and
o $500,000 will be disbursed within five days of the effectiveness of the
registration statement.
The proceeds of the offering will be used for general corporate purposes and
working capital.
The secured convertible notes bear interest at 6%, unless our common stock is
greater than $0.025 per share for each trading day of a month, in which event no
interest is payable during such month. The secured convertible notes mature
three years from the date of issuance, and are convertible into our common
stock, at the Purchasers' option, at a 50% discount to the average of the three
lowest trading prices of the common stock during the 20 trading day period prior
to conversion.
The full principal amount of the secured convertible notes are due upon a
default under the terms of secured convertible notes. In addition, we granted
the Purchasers a security interest in substantially all of our assets. Pursuant
to an amendment to the registration rights agreement between us and the selling
shareholders, we are required to file a registration statement with the
Securities and Exchange Commission within 30 days of closing, which will include
100% of the common stock underlying the secured convertible notes. If the
registration statement is not declared effective within 165 days from the date
of closing, we are required to pay liquidated damages to the Purchasers. In the
event that we breach any representation or warranty in the Securities Purchase
Agreement, we are required to pay liquidated damages in shares or cash, at our
election, in an amount equal to three percent of the outstanding principal
amount of the secured convertible notes per month plus accrued and unpaid
interest.
The warrants are exercisable until five years from the date of issuance at a
purchase price of $0.02 per share. The Purchasers may exercise the warrants on a
cashless basis if the shares of common stock underlying the warrants are not
then registered pursuant to an effective registration statement. In the event
the Purchasers exercise the warrants on a cashless basis, then we will not
receive any proceeds. In addition, the exercise price of the warrants will be
adjusted in the event we issue common stock at a price below market (a "Dilutive
Issuance"). Upon an issuance of shares of common stock below the market price,
the exercise price of the warrants will be reduced as set forth in Warrant.
In addition, the conversion price of the secured convertible notes and the
exercise price of the warrants may be adjusted in certain circumstances such as
if we pay a stock dividend, subdivides or combines outstanding shares of common
stock into a greater or lesser number of shares, or takes such other actions as
would otherwise result in dilution of the selling stockholder's position.
The Purchasers have agreed to restrict their ability to convert their secured
convertible notes or exercise their warrants and receive shares of our common
stock such that the number of shares of common stock held by them in the
aggregate and their affiliates after such conversion or exercise does not exceed
4.9% of the then issued and outstanding shares of common stock.
We claim an exemption from the registration requirements of the Securities Act
of 1933, as amended (the "Act") for the private placement of these securities
pursuant to Section 4(2) of the Act and/or Regulation D promulgated thereunder
since, among other things, the transaction did not involve a public offering,
the Purchasers were accredited Purchasers and/or qualified institutional buyers,
the Purchasers had access to information about us and their investment, the
Purchasers took the securities for investment and not resale, and we took
appropriate measures to restrict the transfer of the securities.
RISK FACTORS
This investment has a high degree of risk. Before you invest you should
Carefully consider the risks and uncertainties described below and the other
information in this prospectus. If any of the following risks actually occur,
our business, operating results and financial condition could be harmed and the
value of our stock could go down. This means you could lose all or a part of
your investment.
4
RISKS RELATED TO OUR BUSINESS AND INDUSTRY
Some of the more prominent known risks and uncertainties of our business are set
forth below. However, this section does not discuss all possible risks and
uncertainties to which we are subject, nor can it be assumed that there are not
other risks and uncertainties which may be more significant.
o we have suffered recurring losses from operations, has an accumulated
deficit as of December 31, 2005, that raise substantial doubt about the
Company's ability to continue as a going concern;
o we depend on its warehouse lines of credit.
o we need additional funding sources so that our ability to originate and
fund loans is not impaired; and
o our ability to compete with banks and other mortgage lenders that are
significantly larger.
If we are unable to maintain adequate funding sources, our ability to originate
and fund loans will be impaired.
Our ability to originate and purchase mortgage loans depends to a large extent
upon our ability to secure financing upon acceptable terms to fund and hold the
mortgage loans until sold. We currently fund all but a few of the mortgage loans
we purchase and originate through credit facilities with commercial banks and
financial institutions collateralized by loan purchase agreements. On rare
occasions, we fund loans out of cash flow without using our credit facilities.
These agreements are generally terminable at will by either party and must be
renewed each year. Our borrowings are in turn repaid with proceeds received when
mortgage loans are sold. We currently rely on Provident Bank, Warehouse One and
a Private Warehouse line to provide our primary credit facilities for our loan
originations and purchases. Any failure to renew or obtain adequate funding
under our financing facilities or other financing arrangements, or any
substantial reduction in the size of or increase in the cost of such facilities,
could have a material adverse effect on our business, results of operations and
financial condition. To the extent we are not successful in maintaining or
replacing existing financing, we may have to curtail our mortgage loan
origination and purchase activities, which could have a material adverse effect
on our operations and financial condition.
In the event we are required to raise additional equity financing, there can be
no assurance that any such equity financing will be available on acceptable
terms. If such financing is not available on satisfactory terms, we may be
unable to expand or continue our business as desired and operating results may
be adversely affected. Any equity financing could result in dilution to existing
stockholders.
General economic conditions may adversely affect our business.
Economic conditions affect the overall level of activity in the mortgage
business. The decision to buy, sell or refinance a residence is affected by such
economic conditions as the overall growth or decline of the economy, the level
of consumer confidence, real estate values, interest rates and investment
returns expected by the financial community. These conditions can affect the
number and size of mortgage loans of the types we typically originate and make
these mortgage loans less attractive to borrowers or to investors in the
mortgages. In addition, a decline in real estate values will have an adverse
effect on the loan-to-value ratios for the related mortgage loans, weakening the
collateral coverage and resulting in greater exposure in the event of a default.
This greater exposure to default could make it more difficult for us to obtain
interim financing for mortgage loans we originate or purchase or decrease the
availability of purchasers of such mortgage loans.
We are likely to originate and sell fewer mortgage loans if interest rates rise.
In periods of rising interest rates, historically the demand for mortgage loans
has declined which could result in lower revenues for us. The refinancing
segment of the mortgage business is usually the first segment affected. The
reason is that as interest rates rise, the costs of refinancing outweigh any
interest rate saving eliminating those who are refinancing solely to reduce
their interest rate. For the year ended December 31, 2005, refinance loans made
up approximately 56.8% in total dollar volume of our loans. Rising interest
rates also affect the purchase segment of the mortgage business. As interest
rates increase, payment amounts rise decreasing the number of potential
borrowers who feel they can afford the payments and who qualify for the
mortgages.
Interest rate fluctuations can affect the profitability of our mortgage loans.
5
Changes in interest rates can affect the volume, net interest income and sale of
mortgage loans originated and purchased by us. When we purchase or originate a
loan, we usually have a commitment from a third party to purchase that loan.
Generally, we fund the loan using borrowings from our lines of credit that are
limited to specific uses and are known as warehouse lines of credit. The
warehouse line of credit is repaid upon the sale of the warehoused loans. Before
we sell the mortgage loan, we are entitled to receive interest income on the
loan from the borrower and we simultaneously pay interest expense to the
institution providing the warehouse line of credit. The interest rate we receive
during this period and the interest rate we pay are usually different. The
profitability of the loan is affected by this difference and fluctuations in
interest rates before the mortgage loan is sold. Although we generally have a
commitment to sell the mortgage loan before we commit to fund the mortgage loan,
there are situations in which we bear a risk of changes in interest rates prior
to the mortgage loan being sold. In particular, if interest rates increase
during the time before we sell an uncommitted mortgage loan but after we have
funded the mortgage loan, we could be required to sell the principal of the
mortgage loan for less than we funded, thereby decreasing the mortgage loan's
profitability or incurring a loss on the mortgage loan's sale.
Payments for mortgage loan servicing rights may be less in times of stable or
declining interest rates.
The prices we receive upon the sale of mortgage loans and servicing rights
depend upon a number of factors, including the general supply of and demand for
mortgage servicing rights, as well as prepayment and delinquency rates on the
portfolios of mortgage servicing rights being sold. Interest rate changes can
also affect the profitability of the sale of mortgage loan servicing rights to a
third party. Purchasers of mortgage loan servicing rights analyze a variety of
factors to determine the purchase price they are willing to pay, including the
prepayment sensitivity of servicing rights. Because of the increased likelihood
of prepayment of loans in periods of declining interest rates, the price of
mortgage loan servicing rights related to higher rate mortgage loans may be less
than in times of stable or increasing interest rates, which could adversely
affect our operations and financial condition.
We must depend on brokers to be accurate in their representations regarding
compliance and loan quality and may incur losses if representations are
inaccurate.
In addition to depending on brokers to generate mortgage loans, we depend on
brokers to be accurate in their representations and warranties regarding
compliance with regulations and the quality of the loans to be funded.
We depend on programs that purchase and guarantee loans.
Generally, the institutional investors that purchase mortgage loans that we
originate generate funds by selling mortgage-backed securities. This funding
mechanism is largely dependent upon the continuation of programs administered by
national government-sponsored mortgage entities, such as Freddie Mac, Fannie Mae
and Ginnie Mae, which provide the context for, and facilitate the issuance of,
such securities. We also sell a small portion of our loans, less than 1%
directly to Fannie Mae. Although we are not aware of any proposed changes in
these programs, the discontinuation of, or a significant reduction in, the
operations of such programs could have a material adverse effect on our
operations. In addition, the sponsor may change the mortgage loan products
eligible for these programs from time to time. Changes could affect the
profitability of specific types of mortgage loan products by changing the
administrative costs of purchasing or originating the mortgage loans or other
aspects of the programs.
Our competitors in the mortgage banking industry are often larger making it more
difficult for us to compete successfully.
We face strong competition in originating, purchasing and selling mortgage loans
and related mortgage servicing rights. Our competition is principally from
savings and loan associations, other mortgage companies, and commercial banks
and, to a lesser degree, credit unions and insurance companies, depending upon
the type of mortgage loan product offered. We compete with these entities by
striving to provide timely service to mortgage brokers and borrowers and develop
competitive products. Many of these institutions have greater financial
resources than we do and maintain a significant number of branch offices in the
areas in which we conduct operations. Increased competition for mortgage loans
from other lenders may result in a decrease in the volume of mortgage loans that
we are able to originate and purchase. If we are unable to compete effectively,
our operations and financial condition could be materially and adversely
affected.
Real property with environmental problems securing our loans may cause us to
incur liability.
In the course of our business, we sometimes acquire residential real estate that
served as collateral for loans that are in default. It is possible that
hazardous substances or waste, contaminants or pollutants could be present on
such properties and not discovered until after we have taken possession. In such
event, we might be required to remove such substances from the affected
properties at our expense. The cost of such removal could substantially exceed
the value of the affected properties or the loans secured by such properties.
There can be no assurance that we would have adequate remedies against the prior
owners or other responsible parties, or that we would not find it difficult or
impossible to sell the affected real properties either prior to or following
such removal. These costs could have a material adverse effect on our operations
and financial condition.
6
Most of our assets are pledged to secure debt leaving few if any assets that
might be distributed to shareholders in liquidation.
Due to our financing needs, with the occasional exception of loans funded by us,
all of our mortgage assets will be used to secure purchase agreements, bank
borrowings or other credit arrangements for at least the near future. We hope to
be able to fund more loans ourselves at some point in the future, but may never
be able to do on a significant scale. At most times, our debt under the line of
credit is approximately equal to the value of our mortgage loan assets.
Therefore, such mortgage assets would not be distributed to stockholders in the
event of liquidation, except to the extent that the market value of the assets
exceeds amounts due our creditors. The market value of the mortgage assets will
fluctuate as a result of market factors such as interest rates and prepayment
rates as well as the supply of, and demand for, such mortgage assets. In the
event of the bankruptcy of a counter-party with whom we have an agreement, we
might experience difficulty recovering our pledged mortgage assets, which may
adversely affect our operations and financial condition.
We could be required to sell mortgage assets under adverse market conditions.
If we are not able to renew or replace credit facilities as they come up for
renewal, we could be required to sell mortgage assets under adverse market
conditions and, as a result, could incur permanent capital losses. A sharp rise
in interest rates or increasing market concern about the value or liquidity of
mortgage assets in which we have a significant investment will reduce the market
value of the mortgage assets, which would likely cause lenders to require
additional collateral. A number of such factors in combination may cause
difficulties for us including a possible liquidation of a major portion of our
mortgage assets at disadvantageous prices with consequent losses, which would
have a material adverse effect on our financial status and could render us
insolvent. Additionally, although we intend generally to sell our mortgage
assets within ninety days or less of generation or purchase because such assets
will be pledged under financing agreements, our ability to sell mortgage assets
to obtain cash will be greatly limited. Our inability to sell such assets could
have a material adverse effect on our operations and financial condition.
We may need additional equity financing, which may or may not be available, to
expand our business and to reduce our interest costs.
Our primary operating cash requirement is the funding or payment of interest
expense incurred on borrowings. We also must fund general operating and
administrative expenses and from time to time capital expenditures. We currently
fund these cash requirements primarily through our lines of credit and the sale
of loans. Our current plan is to decrease our reliance on the lines of credit
and increase the volume of loan sales. Our ability to implement this business
strategy will depend upon our ability to increase stockholders' equity thereby
establishing a reserve, which may be used to fund loans. There can be no
assurance that we will be able to raise additional equity on favorable terms. We
cannot presently estimate the amount and timing of additional equity financing
requirements because such requirements are tied to, among other things, our
growth. If we were unable to raise such additional capital, our ability to
expand and our results of operations and financial condition could be adversely
affected.
Defaults in mortgage loans or characteristics of property securing the mortgages
may adversely affect our ability to sustain the volume of mortgages.
We fund mortgage loans by drawing on our line of credit, then as soon as
possible and typically within fifteen days, sell the loan in the secondary
market. We use the proceeds of the sale of a loan to repay the amount borrowed
to fund that loan. Thus, the composition of mortgage loans we hold changes from
day to day. There are also loans that for one reason or another we do not sell,
but hold. This is rare, but does happen from time to time. During the time we
hold any mortgage loans, we are subject to increased credit risks, including
risks of borrower defaults and bankruptcies and special hazard losses that are
not covered by standard hazard insurance, such as those occurring from
earthquakes or floods. In the event of a default on any mortgage loan we hold,
we will bear the risk of loss of principal to the extent that the value of the
secured property and any payments from an insurer or guarantor are less than the
amount owed on the mortgage loan and the costs of realizing on the collateral.
Any loans in default will also cease to be eligible collateral for our
borrowings, which means we will have to finance the loan out of other funds
until it is ultimately liquidated. Although we intend to establish reserves in
amounts we believe are adequate to cover these risks, there can be no assurance
that any such reserves will be sufficient to offset losses on mortgage loans in
the future. Even assuming that properties securing mortgage loans we hold
provide adequate security for such mortgage loans, there will likely be delays,
which could be substantial, in prosecuting foreclosures. State and local
statutes and rules may delay or prevent foreclosure on, or sale of, the
mortgaged property and may limit revenues in which case proceeds we receive may
not be sufficient to repay all amounts due on the related mortgage loan. Some
properties that collateralize our mortgage loans may have unique characteristics
or may be subject to seasonal factors that could materially prolong the time
period required to resell the property.
Real estate is illiquid and its value is dependent on conditions beyond our
control.
7
The fair market value of the real property underlying any mortgage we acquire
may decrease. The value is largely dependent on factors beyond our control and
may be affected by adverse changes in national or local economic conditions. The
value may also be affected by the need to comply with environmental laws or the
ongoing need for capital improvements, particularly in older structures.
National disasters could result in unusual loss, as could adverse changes in
zoning laws and other factors that are beyond our control.
We are liable for representations and warranties made to purchasers and
insurers.
In the ordinary course of business, we make representations and warranties to
the purchasers and insurers of mortgage loans and the related mortgage servicing
rights regarding compliance with laws, regulations and program standards. In
broker-generated loans, we generally receive similar representations and
warranties from the brokers from whom we purchase the loans. If any of these
representations and warranties is inaccurate, we may be required to repurchase
the corresponding mortgage loans and/or may be liable for damages. In some
cases, a portion of the costs of a repurchase are covered by our errors and
omissions insurance. Some or all of the costs are also often recovered upon the
sale of the collateral for the loan or by ultimate repayment. There can be no
assurances that we will not experience greater losses in the future.
Mortgage loans are subject to significant government regulation.
Federal, state and local governmental authorities regulate our activities as a
lender. The Truth in Lending Act, and Regulation Z promulgated there under,
mandate that mortgage lenders meet requirements designed to provide consumers
with uniform, understandable information on the terms and conditions of mortgage
loans and credit transactions. The Equal Credit Opportunity Act prohibits
creditors from discriminating against applicants on the basis of race, color,
sex, age or marital status, among other restrictions and requirements. In
instances in which the applicant is denied credit, or the rate or charge for a
mortgage loan increases as a result of information obtained from a consumer
credit agency, the Fair Credit Reporting Act of 1970 requires the lender to
supply the applicant with a name and address of the reporting agency. The Real
Estate Settlement Procedures Act and the Debt Collection Practices Act require
us to file an annual report with HUD. If we fail to comply with any of these
regulations, we could be prohibited from engaging in operations which would have
a material adverse effect on our results of operations and financial condition.
We may issue Preferred Shares which have preferences over common shares.
Our Certificate of Incorporation authorizes the issuance of Preferred Shares
with designations, rights and preferences as determined from time to time by its
Board of Directors. The Board of Directors is empowered, without shareholder
approval, to issue series of Preferred Shares with dividends, liquidation,
conversion, voting or other rights that could adversely affect the rights of the
holders of common shares. The voting rights of any Preferred Shares, however,
are limited by the Certificate of Incorporation and cannot exceed the voting
rights of any common shares. The issuance of preferred shares can be used as a
method of discouraging, delaying or preventing a change of control of the
Company.
We currently do not meet certain corporate governance requirements imposed by
the Sarbanes-Oxley Act and are not eligible to have our shares listed on NASDAQ,
AMEX or the NYSE.
The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act") was signed into law by
President Bush on July 30, 2002 in response to public concerns regarding
corporate accountability in connection with the recent accounting scandals at
Enron and WorldCom. The stated goals of the Sarbanes-Oxley Act are to increase
corporate responsibility, to provide for enhanced penalties for accounting and
auditing improprieties at publicly traded companies and to protect investors by
improving the accuracy and reliability of corporate disclosures pursuant to the
securities laws. The Sarbanes-Oxley Act generally applies to all companies, both
U.S. and non-U.S., that file or are required to file periodic reports with the
Securities and Exchange Commission ("SEC"), under the Securities Exchange Act of
1934 ("Exchange Act"). The Sarbanes-Oxley Act includes very specific additional
disclosure requirements and new corporate governance rules, requires the SEC and
securities exchanges to adopt extensive additional disclosure, corporate
governance and other related rules. Of the new requirements imposed by the
Sarbanes-Oxley Act, among others, we currently have no "independent directors"
on our board of directors, no audit committee, compensation committee nor
nomination committee and we do not have any independent "financial experts" on
our board of directors. As a result, we currently would not be eligible to have
our shares listed on the NASDAQ, AMEX or NYSE, even if we were to meet the other
listing requirements of such self-regulatory organizations. This may have the
effect of depressing the prevailing market price of our common shares on the OTC
Bulletin Board.
8
RISKS RELATING TO OUR CURRENT FINANCING ARRANGEMENT
There are a large number of shares underlying our secured convertible notes and
warrants that may be available for future sale and the sale of these shares may
depress the market price of our common stock.
As of June 10, 2006, we had 96,198,027 shares of common stock issued and
outstanding, $500,000 of secured convertible notes outstanding that may be
converted into an estimated 31,347,962 shares of common stock and outstanding
warrants to purchase 30,000,000 shares of common stock. Additionally, we have an
obligation to sell $1,000,000 of secured convertible notes that may be converted
into an estimated 62,695,924 shares of common stock at current market prices. In
addition, the number of shares of common stock issuable upon conversion of the
outstanding secured convertible notes may increase if the market price of our
stock declines. All of the shares upon conversion of the secured convertible
notes. may be sold without restriction. The sale of these shares may adversely
affect the market price of our common stock.
The continuously adjustable conversion price feature of our secured convertible
notes could require us to issue a substantially greater number of shares which
will cause dilution to our existing stockholders.
Our obligation to issue shares upon conversion of our secured convertible notes
is essentially limitless. The following is an example of the amount of shares of
our common stock that are issuable, upon conversion of $1,500,000 of our secured
convertible notes (excluding accrued interest), based on market prices 25%, 50%
and 75% below the market price, as of July 6, 2006 of .0201:
% BELOW MARKET PRICE PER SHARE DISCOUNT OF 50% NUMBER OF SHARES ISSUABLE
-------------- --------------- --------------- -------------------------
25% $.015075 $.008 187,500,000
50% $.01005 $.005 300,000,000
75% $.0035 $.00175 857,142,857
As illustrated, the number of shares of common stock issuable upon conversion of
our secured convertible notes will increase if the market price of our stock
declines, which will cause dilution to our existing stockholders.
THE CONTINUOUSLY ADJUSTABLE CONVERSION PRICE FEATURE OF OUR SECURED CONVERTIBLE
NOTES MAY HAVE A DEPRESSIVE EFFECT ON THE PRICE OF OUR COMMON STOCK.
The secured convertible notes are convertible into shares of our common stock at
a 50% discount of the trading price of the common stock prior to the conversion.
The significant downward pressure on the price of the common stock as the
selling stockholders convert and sell material amounts of common stock could
have an adverse effect on our stock price. In addition, not only the sale of
shares issued upon conversion or exercise of secured convertible notes and
warrants, but also the mere perception that these sales could occur, may
adversely affect the market price of the common stock.
The issuance of shares upon conversion of the secured convertible notes and
exercise of outstanding warrants may cause immediate and substantial dilution to
our existing shareholders.
The issuance of shares upon conversion of the secured convertible notes and
exercise of warrants may result in substantial dilution to the interests of
bother stockholders since the selling stockholders may ultimately convert and
sell the full amount issuable on conversion. Although AJW Partners, LLC, AJW
Qualified Partners, LLC, AJW Offshore, Ltd., and New Millennium Capital Partners
II, LLC may not convert their secured convertible notes and/or exercise their
warrants if such conversion or exercise would cause them to own more than 4.99%
of our outstanding common stock, this restriction does not prevent AJW Partners,
LLC, AJW Qualified Partners, LLC, AJW Offshore, Ltd., and New Millennium Capital
Partners II, LLC from converting and/or exercising some of their holdings and
then converting the rest of their holdings. In this way, AJW Partners, LLC, AJW
Qualified Partners, LLC, AJW Offshore, Ltd., and New Millennium Capital Partners
II, LLC could sell more than this limit while never holding more than this
limit. There is no upper limit on the number of shares that may be issued which
will have the effect of further diluting the proportionate equity interest and
voting power of holders of our common stock, including investors in this
offering.
In the event that our stock price declines, the shares of common stock allocated
for conversion of the secured convertible notes and registered pursuant to this
prospectus may not be adequate and we may be required to file a subsequent
registration statement covering additional shares and further amend our articles
of incorporation to increase our shares of common stock. If the Shares we have
allocated and are registering herewith are not adequate and we are required to
file an additional registration statement, we may incur substantial costs in
connection therewith.
9
Based on our current market price and the potential decrease in our market price
as a result of the issuance of shares upon conversion of the secured convertible
notes, we have made a good faith estimate as to the amount of shares of common
stock that we are required to register and allocate for conversion of the
secured convertible notes. Accordingly, we have allocated an aggregate of
94,043,887 shares to cover the conversion of the secured convertible notes. In
the event that our stock price decreases, the shares of common stock we have
allocated for conversion of the secured convertible notes and are registering
hereunder may not be adequate. If the shares we intend to allocate to the
registration statement are not adequate and we are required to file an
additional registration statement and further amend our Articles of
Incorporation to increase our authorized shares of common stock, we may incur
substantial costs in connection with the preparation and filing of such
registration statement.
If we are required for any reason to repay our outstanding secured convertible
note, we would be required to deplete our working capital, if available or raise
additional funds. Our failure to repay the secured convertible notes if required
could result in legal action against us, which would require the sale of
substantial assets.
In June 2006, we entered into a Securities Purchase Agreement for the sale of an
aggregate of $1,500,000 principal amount of secured convertible notes. The
secured convertible notes are due and payable, with 6% interest, 3 years from
the date of issuance, unless sooner converted into shares of our common stock.
Although we currently have $500,000 secured convertible notes outstanding, the
investors are obligated to purchase additional secured convertible note in the
principal amount of $1,000,000. In addition, any event of default such as our
failure to repay the principal or interest when due, our failure to issue shares
of common stock upon conversion by the holder, our failure to timely file a
registration statement or have such registration statement declared effective,
breach of any covenant, representation or warranty in the Securities Purchase
Agreement or related convertible note, the assignment or appointment of a
receiver to control a substantial part of our property or business, the filing
of a money judgment, writ or similar process against our company in excess of
$100,000, the commencement of a bankruptcy, insolvency, reorganization or
liquidation proceeding against our company and the delisting of our common stock
could require the early repayment of the secured convertible notes, including a
default interest rate of 15% on the outstanding principal balance of the notes
if the default is not cured with the specified grace period. We anticipate that
the full amount of the secured convertible notes will be converted into shares
of our common stock, in accordance with the terms of the secured convertible
notes. If we were required to repay the secured convertible notes, we would be
required to use our limited working capital and raise additional funds. If we
were unable to repay the notes when required, the note holders could commence
legal action against us and foreclose on all of our assets to recover the
amounts due. Any such action would require us to curtail or cease operations.
If an event of default occurs under the Securities Purchase Agreement, Secured
Convertible Notes, Warrants, or Security Agreement, the investors could
foreclose on our assets.
In connection with the Securities Purchase Agreements we entered into in June
2006, we executed a Security Agreement in favor of the investors granting them a
first priority security interest in all of our goods, inventory, contractual
rights and general intangibles, receivables, documents, instruments, chattel
paper, and intellectual property. The Security Agreements states that if an
event of default occurs under the Securities Purchase Agreement, Secured
Convertible Notes, Warrants or Security Agreements, the Investors have the right
to take possession of the collateral, to operate our business using the
collateral, and have the right to assign, sell, lease or otherwise dispose of
and deliver all or any part of the collateral, at public or private sale or
otherwise to satisfy our obligations under these agreements. If the investors
were to foreclose on our assets, investors may lose all or substantially all of
their investment.
RISKS RELATING TO OUR COMMON STOCK
If we fail to remain current on our reporting requirements, we could be removed
from the OTC Bulletin Board which would limit the ability of broker-dealers to
sell our securities and the ability of stockholder to sell their securities in
the secondary market.
Companies trading on the OTC Bulletin Board, such as us, must be reporting
issuers under Section 12 of the Securities Exchange Act of 1934, as amended, and
must be current in their reports under Section 13, in order to maintain price
quotation privileges on the OTC Bulletin Board. If we fail to remain current on
our reporting requirements, we could be removed from the OTC Bulletin Board. As
a result, the market liquidity for our securities could be severely adversely
affected by limiting the ability of broker-dealers to sell our securities and
the ability of stockholders to sell their securities in the secondary market.
Our common stock is subject to the "penny stock" rules of the SEC and the
trading market in our securities is limited, which makes transactions in our
stock cumbersome and may reduce the value of an investment in our stock.
The Securities and Exchange Commission has adopted Rule 15g-9 which establishes
the definition of a "penny stock," for the purposes relevant to us, as any
equity security that has a market price of less than $5.00 per share or with an
exercise price of less than $5.00 per share, subject to certain exceptions. For
any transaction involving a penny stock, unless exempt, the rules require:
10
o that a broker or dealer approve a person's account for transactions in
penny stocks; and
o the broker or dealer receive from the investor a written agreement to
the transaction, setting forth the identity and quantity of the penny
stock to be purchased.
In order to approve a person's account for transactions in penny stocks, the
broker or dealer must:
o obtain financial information and investment experience objectives of
the person; and
o make a reasonable determination that the transactions in penny stocks
are suitable for that person and the person has sufficient knowledge
and experience in financial matters to be capable of evaluating the
risks of transactions in penny stocks.
The broker or dealer must also deliver, prior to any transaction in a penny
stock, a disclosure schedule prescribed by the Commission relating to the penny
stock market, which, in highlight form:
o sets forth the basis on which the broker or dealer made the suitability
determination; and
o that the broker or dealer received a signed, written agreement from the
investor prior to the transaction.
Generally, brokers may be less willing to execute transactions in securities
subject to the "penny stock" rules. This may make it more difficult for
investors to dispose of our common stock and cause a decline in the market value
of our stock.
Disclosure also has to be made about the risks of investing in penny stocks in
both public offerings and in secondary trading and about the commissions payable
to both the broker-dealer and the registered representative, current quotations
for the securities and the rights and remedies available to an investor in cases
of fraud in penny stock transactions. Finally, monthly statements have to be
sent disclosing recent price information for the penny stock held in the account
and information on the limited market in penny stocks.
OUR CORPORATE CHARTER CONTAINS AUTHORIZED, UNISSUED "BLANK CHECK" PREFERRED
STOCK WHICH CAN BE ISSUED WITHOUT STOCKHOLDER APPROVAL WITH THE EFFECT OF
DILUTING THEN CURRENT STOCKHOLDER INTERESTS.
Our certificate of incorporation currently authorizes the issuance of up
to15,000,000 shares of "blank check" preferred stock with designations, rights
and preferences as may be determined from time to time by our board of
directors. Accordingly, our board of directors is empowered, without stockholder
approval, to issue one or more series of preferred stock with dividend,
liquidation, conversion, voting or other rights which could dilute the interest
of, or impair the voting power of, our common stockholders. The issuance of a
series of preferred stock could be used as a method of discouraging, delaying or
preventing a change in control.
USE OF PROCEEDS
This prospectus relates to shares of our common stock that may be offered and
sold from time to time by the selling stockholders. We will not receive any
proceeds from the sale of shares of common stock in this offering. We have
received gross proceeds $500,000 from the sale of the secured convertible notes
and the investors are obligated to provide us with an additional $500,000,
within five days of the filing of this registration statement and an additional
$500,000 within five days after this registration statement of which this
prospectus forms a part, is declared effective. The proceeds received from the
sale of the secured convertible notes will be used for working capital and
general corporate purposes.
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock has been traded in the over-the-counter bulletin board (OTCBB)
governed by the NASD. Our common stock trades under the symbol "SFNN.OB". The
quotations listed below reflect interim dealer prices without retail mark-up
mark-down or commission and may not represent actual transactions. Trading of
our stock has been minimal with limited or sporadic quotations and therefore we
believe there is no established public market for the common stock.
The following table sets forth the high and low bid quotations per share of the
Company's registered securities for each quarter during the last two fiscal
years, as reported by the OTCBB.
11
Common Shares
High Low
Quarter Ended June 30, 2006 $ .085 $ .0155
- ---------------------------
Quarter Ended March 31, 2006 $ .154 $ .040
- ----------------------------
Year Ended December 31, 2005: High Low
- -----------------------------
Quarter Ended March 31, 2005 $ 0.60 $ 0.22
Quarter Ended June 30, 2005 $ 0.40 $ 0.12
Quarter Ended September 30, 2005 $ 0.17 $ 0.05
Quarter Ended December 31, 2005 $ 0.13 $ 0.04
Year Ended December 31, 2004: High Low
- -----------------------------
Quarter Ended March 31, 2004 $ 5.75 $ 0.19
Quarter Ended June 30, 2004 $ 3.00 $ 1.37
Quarter Ended September 30, 2004 $ 1.55 $ 0.47
Quarter Ended December 31, 2004 $ 0.80 $ 0.20
HOLDERS
As of December 31, 2005, we had approximately 527 holders of our common stock.
The number of record holders was determined from the records of our transfer
agent and does not include beneficial owners of common stock whose shares are
held in the names of various security brokers, dealers, and registered clearing
agencies. The transfer agent of our common stock is Continental Stock transfer
and Trust Company, New York, New York, (212) 509-4000.
We have never declared or paid any cash dividends on our common stock. We do not
anticipate paying any cash dividends to stockholders in the foreseeable future.
In addition, any future determination to pay cash dividends will be at the
discretion of the Board of Directors and will be dependent upon our financial
condition, results of operations, capital requirements, and such other factors
as the Board of Directors deem relevant.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Some of the information in this prospectus contains forward-looking statements
that involve substantial risks and uncertainties. You can identify these
statements by forward-looking words such as "may," "will," "expect,"
"anticipate," "believe," "estimate" and "continue," or similar words. You should
read statements that contain these words carefully because they:
o discuss our future expectations;
o contain projections of our future results of operations or of our
financial condition; and
o state other "forward-looking" information.
We believe it is important to communicate our expectations. However, there may
be events in the future that we are not able to accurately predict or over which
we have no control. Our actual results and the timing of certain events could
differ materially from those anticipated in these forward-looking statements as
a result of certain factors, including those set forth under "Risk Factors,"
"Business" and elsewhere in this prospectus. See "Risk Factors."
CRITICAL ACCOUNTING POLICIES
As set forth in greater detail in the Footnote (1) to our financial
statements "Summary of Significant Accounting Policies", we recognize revenue
upon sale of a loan when the documents are shipped to the independent investors,
and all rights have passed and we become obligated to convey the loan, thereby
isolating the transferred assets from us and fulfilling all criteria of SFAS No.
140. If these criteria were not met, then revenue recognition would be delayed
until the proceeds were subsequently received from the investors, typically
within the following month.
Pursuant to SFAS No. 91,we capitalize our loan origination costs, including an
amount of its payroll and related costs which are directly attributable to the
credit origination process. The measurement of such capitalizable costs requires
the use of some judgments by management, as to the portion of such costs
associated with credit origination and with other activities.
12
Disclosure, pursuant to SFAS No. 107, is required of the fair value of
financial instruments. However, since most of our financial instruments turn
over within a very short time period, management discloses that the net book
value approximates fair value at the balance sheet date.
NEW ACCOUNTING PRONOUNCEMENTS
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment of
ARB No. 43, Chapter 4. SFAS No. 151 amends the guidance in ARB No. 43, Chapter
4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle
facility expense, freight, handing costs, and spoilage. This statement requires
that those items be recognized as current period charges regardless of whether
they meet the criterion of "so abnormal" which was the criterion specified in
ARB No. 43. In addition, this Statement requires that allocation of fixed
production overheads to the cost of production be based on normal capacity of
the production facilities. This pronouncement is effective for the Company
beginning October 1, 2005. We do not believe that adopting this new standard
will have a significant impact to its financial statements.
In December 2004, the FASB issued SFAS No. 123 (revised 2004). Share-Based
Payment, which is a revision of SFAS No. 123, Accounting for Stock-Based
Compensation. SFAS No. 123(R) supersedes APB Opinion No. 25, Accounting for
Stock Issued to Employees and amends SFAS No. 95, Statement of Cash Flows.
Generally, the approach in SFAS No. 123(R) is similar to the approach described
in SFAS No. 123. However, SFAS No. 123(R) requires all share-based payments to
employees, including grants of employee stock options, to be recognized in the
income statement based on their fair values. Pro forma disclosure is no longer
an alternative. The new standard will be effective for us in the first interim
or annual reporting period beginning after December 15, 2005. We expect the
adoption of this standard will have a material impact on our financial
statements assuming employee stock options are granted in the future.
COMPARISON OF THE YEAR ENDED DECEMBER 31, 2005 WITH THE YEAR ENDED DECEMBER 31,
2004
RESULTS OF OPERATIONS
Real estate purchase transactions and therefore the mortgage banking industry
are subject to seasonal trends. These trends generally reflect nationwide home
sale patterns. Such sale typically peaks in the in the spring and summer months
while declining in late fall and winter months. However the refinance segment of
the industry is less seasonal, changing instead as interest rates rise and fall.
During the fiscal year ended December 31, 2005, we made 1,219 loans with an
aggregate dollar value of approximately $223,444,389 compared to 6,229 loans
with an aggregate dollar value of approximately $1,046,168,110 for the year
ended December 31, 2004. This represents a decrease in the number of loans of
5,010 per year or 80% reduction. Most of the loans originated were in principal
amounts averaging $173,875.
Consolidated revenues from origination, sale of loans and fee revenue generated
by contract services decreased 23.7% during the fiscal year ended December 31,
2005 or $2.1million from the year ending December 31, 2004. The decrease is
primarily due to the restructuring of our operating branches, eliminating 18 non
profitable locations
Selling, general and administrative expenses decreased 11.8% or $1.3 million for
the year ended December 31, 2005 as compared to the year ended December 31,
2004. The decrease is primarily due the closure of 18 non profitable locations,
during the quarter ended December 31, 2005 and the sale of Ocean West (discussed
below).
We incurred costs associated with the debt discount amortization related to the
beneficial conversion features on three of its notes in the amount of
$2,904,110, for the year ended December 31, 2005 and $2,490,000, for the year
ended December 31, 2004. This debt discount has been fully amortized as of
December 31, 2005. We wrote off an investment of approximately $353,000 and has
taken a charge to impairment of goodwill for $2.7 million less $1.7 million,
which is attributable to the assets minus liabilities of OWHC as of June 30,
2005, closing balance sheet at time of sale, which nets to the charge of
$732,105.
Depreciation increased 50,909 or 8% for the year ended December 31, 2005 as
compared to the year ended December 31, 2004. Depreciation and amortization
increased 40,874 or 6.9% for the year ended December 31, 2004 as compared to the
year ended December 31, 2003.
Interest expense decreased $1.4 million or 88% to $184,290 for the year ended
December 31, 2005 as compared to 1,588,147 for the year ended December 31, 2004.
The decrease is related to the prior year adjustments of $1.5 million, charged
to interest in 2004.
13
Consumer Direct (discussed below) had loss from operations of $6.8 million for
the year ended December 31, 2005 compared to loss of $7.8 for the year ended
December 31, 2004. We had a net loss of $11.0 million for the year ended
December 31, 2005 , net loss of $11.2 for the year ended December 31, 2004 and a
net loss of $1.9 million for the year ended December 31, 2003. The primary
reason for the loss was the costs associated with the consolidation of our
operations, according to our business plan, and by eliminating non profitable
units and restructuring our base of operations to eliminate certain costs to
outsourcing. We incurred certain costs associated with the debt amortization
discount of one of its notes for approximately $2.9 million in 2005 and $2.5
million in 2004. We incurred a charge of $732,000 relating to its sale of Ocean
West.
Liquidity and Capital Resources
Liquidity is the ability of a company to generate funds to support asset growth,
satisfy disbursement needs, maintain reserve requirements and otherwise operate
on an ongoing basis. If our loan volume increases too rapidly, the increase
could have a severe impact on our liquidity. Our warehouse credit facilities
limit the amount that may be advanced on each loan funded. Therefore, cash must
be used to fund the additional dollars needed to close escrow. The revenue is
not recognized until the loan is sold. Thus, it is crucial that we closely
monitor loan volume.
Since inception through December 31, 2005, we have suffered recurring losses
from operations; we have incurred aggregate net losses of $28,831,673. This
raises substantial doubt about our ability to continue as a going concern, as
described in the explanatory paragraph on our independent auditors' report on
the December 31, 2005 consolidated financial statements, which are included with
this prospectus.
Net cash provided by (used for) operating activities for the year ended December
31, 2005 was $5.9 million compared to net cash used for operating activities for
the year ended December 31, 2004 of $13.8. The primary sources of cash provided
by the year ended December 31, 2005 was from an decrease in loans available for
sale of $10.1 million, an decrease in accounts receivable of $123,391, an
decrease in prepaid expenses of $177,650, an decrease in other assets of $3.7
million, decrease in goodwill of $732,105, decrease due to sale of asset of
$560,417, decrease in goodwill of $732,105, decrease in accounts payable of $2
million, increase in interest payable of $88,111 which is offset by our net loss
of $10.9 million, depreciation of $684,820, write down of capitalized investment
of 352,829 and stock based expenses of $3.0 million. As investors purchase
loans, the amounts advanced for such loans through the warehouse line of credit
are paid. At that time, the receivables are cleared and the cash deposited in
our operating account. These accounts vary significantly depending upon where
the bulk of the loans are in the process of funding and selling. The primary
sources of cash used for the year ended December 31, 2004 was from an increase
in loans available for sale of $7.6 million, an decrease in accounts receivable
of $506,886, an increase in other assets of $1,805,857, cash acquired related to
purchase of Ocean West of $159,505, increase in accounts payable of $93,058
which is offset by the Company's net loss of $11,188,086, depreciation of
633,911, write down on capitalized investments of 360,000 and stock based
expenses of 5,334,903.
Net cash provided by (used in) investing activities during the year ended
December 31, 2005 was $150,769, 12,209 was used to purchase equipment and
$162,978 related to the fixed asset disposition relating to Ocean West. Net cash
used in investing activities during the year ended December 31, 2004 was $1.2
million, which was primarily used to purchase property and equipment and the
acquisition of fixed assets of Ocean West, offset by payments received on notes
receivable of $30,875.
Net cash (used for) provided by financing activities for the year ended December
31, 2005 was $6.2 million, consisting primarily of $8.4 million in advances on
line of credit, proceeds of related notes payable of $617,846, payments of notes
payable of $66,799, payments of long term debt of $493,759, treasury stock
redeemed for services of $271,600, sale of Ocean West $1,966,393 and preferred
dividends of $69,481 paid to former subsidiary. Net cash provided by financing
activities for the year ended December 31, 2004 was $15.2 million, consisting
primarily of $9.1 million in advances on line of credit, proceeds of notes
payable of $1.2 million, proceeds of bridge loans of $5.6 million, purchase of
treasury stock of $556,600, and preferred dividends of $74,559 paid to
subsidiary.
Based on dollar volume, during the year ended December 31, 2005 we funded
approximately 17.3% of our loans through our warehouse credit facilities. Loans
that are closed using our credit facilities are funded through short term
borrowing on our warehouse lines of credit. We pay interest on funds advanced
under the warehouse lines of credit at a pre- negotiated rate. The interest rate
at which we borrow is variable in nature and typically averages between 4.5% and
6.93% per annum. The average time between funding a mortgage and the receipt of
proceeds from the sale of the mortgage was approximately fifteen days during the
year ended December 31, 2005.
Our ability to finance and purchase mortgage loans depends on our ability to
secure warehouse lines of credit with acceptable terms. Currently, we fund loans
through warehouse lines of credit with Bank of Arizona through our subsidiary,
Shearson Home Loans and a Private Line with Club Vista. Shearson Home Loans,
formerly Consumer Direct Lending, entered into a Mortgage Loan and Purchase
Agreement with Bank of Arizona for $10,000,000. The facility is collateralized
by the related mortgage loans receivable. Interest is due monthly at the bank
reference rate plus an established percentage, varying from prime plus 1 to
1.5%. Each loan carries a fee of approximately $100 to $175 per loan. There are
restrictive covenants relating to tangible net worth of not less than $250,000
and a debt to equity ratio no greater than 20:1, we are in compliance with the
covenants as the equity of Shearson Home Loans is approximately $3.4 million. As
of September 30, 2005 the outstanding balance with Bank of Arizona and the
private line was $3.5 million. The lending limit on the line of credit through
Bank of Arizona and the private line is $10 million and $5 million,
respectively.
14
Through our subsidiary, Ocean West Enterprises, we had a line of credit with
Provident Consumer Financial Services ("PCFS") which was $8,000,000 and with
Warehouse One is $5,000,000. As of September 30, 2005, due to the sale on June
6, 2005 of OWHC, the amounts were paid in full and their respective balances
were $0. At December 31, 2004 the interest rate charged on our warehousing lines
of credit with PCFS was approximately 6.93%. As of December 31, 2005 and
December 31, 2004 the outstanding balance with PCFS was $0 and $8,214,512,
respectively. At December 31, 2004 the interest rate charged on the warehouse
line of credit through Warehouse One was approximately 5.5%. As of December 31,
2005 and December 31, 2004 the outstanding balance with Warehouse One was $0 and
$424,634, respectively.
INTEREST RATE RISKS
The uncertainty, which potentially has the single largest effect on the results
of our operations, is interest rate trends. Trends in interest rates are not
only important to the refinance business, but are also very important in the
purchase market as well. As interest rates rise, more individuals are eliminated
as potential borrowers. The reason for this is simple - as interest rates get
higher, so do the mortgage payments. Higher payments mean fewer people have the
ability to qualify for loans. Historically, a rising interest rate market is
more difficult for mortgage bankers like us to deal with than for banks. The
reason for this is that banks tend to have an advantage in an adjustable rate
market, because banks have the ability to hold loans and, therefore, can be more
creative in designing adjustable rate loans to fit the borrower's needs.
Mortgage bankers are limited to loan products that can be sold in the secondary
market or securitized. These programs have become more competitive in recent
years, but banks still retain a competitive advantage.
Inflation has an impact on us because it typically has an impact on interest
rates. As the threat of inflation becomes more of a concern, interest rates tend
to rise. This result is based upon the perception that the Federal Reserve Bank
will revise short-term interest rates to keep inflation in check. This concern
ultimately affects interest rates.
The primary market risks that we face are interest rate risks. Interest rate
movements affect the interest expense on our warehouse lines of credit, the
interest income earned on loans held for sale, the value of mortgages held for
sale and the ultimate gain recognized on mortgage loans which are sold. In a
high interest rate environment, borrower demands for mortgage loans, especially
refinancing of existing mortgages, decline. Higher interest rates may also
adversely affect the volume of mortgage loans. In a low interest rate market,
typically one in which the interest rates have declined sufficiently to make
refinancing for lower rates economical, we may incur early pay-off penalties
when significant number of loans we originate are refinanced within the first
six months of the loan being sold to an investor.
We protect against interest rate risks to the extent we can by pre-selling most
loans to investors prior to funding, locking in rates and returns. The method of
locking in rates and returns varies from investor to investor. Some investors
will commit to rates by telephone while others require written commitments via
facsimile or e-mail. The investor responds with a commitment or trade number
upon confirmation. At that point, the rate and purchase price for that loan are
guaranteed for a definite period of time. We have the option with most investors
to lock in rates for either a best efforts or mandatory delivery. A mandatory
delivery brings the best price, typically 1/4 of 1% higher, but requires us to
deliver the loan within the committed time frame. If we do not meet the
deadline, we may have to pay a penalty, usually ranging from $300 to $1,000. The
lock period that we give to the broker/borrower is typically a minimum of five
days before the loan package needs to be delivered to the investor. The loan
must be in "fundable" form when it is delivered to the investor. This means that
both the credit and the collateral packages must be complete. If this is not the
case, which happens rarely, the investor may re-price the loan. In such event,
if the market has deteriorated, we have some interest rate risk.
We also monitor and work to match the interest rates we charge on our loans to
the interest rates on the warehouse line of credit used to fund the loan. Since
the time period that the financing for any one loan is outstanding is short,
typically ten to fifteen business days, the risk of a negative interest rate gap
continuing for an extended period time is lessened. Upon sale of the loan, the
interest rate risk shifts to the investor. In the past, management has at times
used hedging strategies to lessen the risks arising out of rising and falling
interest rates, but is not currently using hedging strategies due to the
complexities involved in hedging and personnel needed to properly manage it.
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2006 WITH THE THREE MONTHS ENDED
MARCH 31, 2005
Results of Operations
During the quarter ended March 31, 2005, we funded 287 loans with an
aggregate dollar value of approximately $52 million compared to 770 loans with
an aggregate dollar value of approximately $134 million in the quarter ended
March 31, 2004. This decrease was due to a reduction of 47 branch locations and
less favorable market conditions. The average loan size for the quarter ended
March 31, 2005 was approximately $181,000, which was an increase from an average
loan size of $175,000 for the quarter ended March 31, 2004.
15
Net revenues from origination and/or sale of loans decreased 86.1% or
$1.2 million, to $191,444 for the quarter ended March 31, 2006 from $1.4 million
for the quarter ended March 31, 2005. The decrease in revenues can be attributed
to the sale of Ocean West.
Total operating expenses decreased $474,154 or 14.5% to $2.8 million for the
quarter ended March 31, 2006 from $3.3 million for the quarter ended March 31,
2005. The decrease is related to expenses relating to Ocean West and an increase
in professional fees.
We had a net loss of $2.9 million for the quarter ended March 31, 2006
compared to net loss of $3.4 million for the same quarter of 2005. The decrease
in the loss for the March 31, 2006 quarter was due the sale of Ocean West and
the Company restructuring its operations by eliminating certain overhead costs.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is the ability of a company to generate funds to support
asset growth, satisfy disbursement needs, maintain reserve requirements and
otherwise operate on an ongoing basis. If our loan volume were to increase too
rapidly, we believe the increase could have a severe impact on our liquidity.
Our warehouse credit facilities limit the amount that may be advanced on each
loan funded. Therefore, cash must be used to fund the additional dollars needed
to close escrow. Thus, it is crucial that we closely monitor our loan volume.
Our ability to finance and purchase mortgage loans depends on our
ability to secure warehouse lines of credit with acceptable terms. Currently, we
fund loans through warehouse lines of credit with Bank of Arizona through our
subsidiary, Shearson Home Loans and a Private Line with Club Vista. Shearson
Home Loans, formerly Consumer Direct Lending, entered into a Mortgage Loan and
Purchase Agreement with Bank of Arizona for $10,000,000. The facility is
collateralized by the related mortgage loans receivable. Interest is due monthly
at the bank reference rate plus an established percentage, varying from prime
plus 1 to 1.5%. Each loan carries a fee of approximately $100 to $175 per loan.
There are restrictive covenants relating to tangible net worth of not less than
$250,000 and a debt to equity ratio no greater than 20:1, we are in compliance
with the covenants as the equity of Shearson Home Loans is approximately $3.1
million. As of March 31, 2006 the outstanding balance with Bank of Arizona and
the private line was $2.7 million. The lending limit on the line of credit
through Bank of Arizona and the private line is $10 million and $5 million,
respectively.
Historically we have funded operations through a combination of
borrowings and issuance of stock. We currently intend to retain our earnings for
the foreseeable future to help increase our liquidity. Management continues to
explore investment alternatives to aid in its liquidity, but there can be no
reliance made on such.
Management currently believes that cash flows from operations should be
sufficient to meet the our current liquidity and capital needs at least through
fiscal 2006 however, if they are not, management will seek equity funding from
the public capital markets , so long as there are no material adverse changes to
the terms or availability of our warehouse lines of credit, we believe we can
meet our liquidity and capital needs at current production levels at least
through fiscal 2006. However we are currently exploring possible liquidity
sources either through additional borrowings or potential capital partners to
enable us to increase our loan production and expansion. Future offerings are
probable in order to fund our acquisition growth. We anticipate raising equity
capital in the amount of $2 million during 2006 in order to fund the integration
of this growth. If such financing is not available on satisfactory terms, we may
be unable to expand or continue our business as desired and operating results
may be adversely affected. Any equity financing could result in dilution to
existing stockholders.
CASH FLOWS
During the first three months of fiscal 2006 and 2005 we had net cash
provided by operating activities of 314,660 and $7.0 million, respectively. The
primary sources of net cash provided by was a decrease in receivables from loan
sold, mortgage loans held for sale, decrease in accounts payable, stock based
expenses of $2.3 million, for the month period ending March 31, 2006. The
primary sources of net cash provided by was a decrease in receivables from loan
sold, mortgage loans held for sale, decrease in other current assets and an
increase in accounts payable and stock based expenses of $188,734, for the month
period ending March 31, 2005 offset by the net loss for the period. As investors
purchase loans, the amounts advanced for such loans through the warehouse lines
of credit are paid. At that time, the receivables are cleared and the cash
deposited in our operating account. These accounts vary significantly depending
upon where the bulk of the loans are in the process of funding and selling.
Net cash used for investing activities during the first three months of
fiscal 2006 and 2005 was $0 and $9,931, which was attributable to the purchase
of property and equipment.
16
Net cash used for financing activities for the three months ended March
31, 2006 was $327,644. This consisted primarily of net payments under the
warehouse lines of credit of $828,857, proceeds of notes payable related party
of $40,550, proceeds of notes payable of $402,010, as well as issuance of common
stock of $58,654. Net cash used for financing activities for the three months
ended March 31, 2005 was $6.8 million. This consisted primarily of net payments
under the warehouse lines of credit of $6.8 million, proceeds of notes payable
related party of $250,000, payments of notes payable of $117,243, as well as
dividends paid of $36,318.
At December 31, 2005, the Company has net operating loss carry forwards
("NOLs") of approximately $10,929,765, expiring in various years through 2017.
REGULATORY TRENDS
The regulatory environments in which we operate have an impact on the
activities in which we may engage, how the activities may be carried out and the
profitability of those activities. Therefore, changes to laws, regulations or
regulatory policies can affect whether and to what extent we are able to operate
profitably. For example, proposed state and federal legislation targeted at
predatory lending could have the unintended consequence of raising the cost or
otherwise reducing the availability of mortgage credit for those potential
borrowers with less than prime-quality credit histories, thereby resulting in a
reduction of otherwise legitimate sub-prime lending opportunities.
BUSINESS
CORPORATE INFORMATION AND HISTORY
Shearson Financial Network, Inc. formerly known as Consumer Direct of America
("CDA") and Blue Star Coffee, Inc. is a Nevada corporation formed in July, 2000
to sell specialty coffee beans, brewed coffee and espresso-based beverages
through company-owned and franchised retail locations. In February 2002, Blue
Star, which was then in the development stage, acquired all of the outstanding
stock of Consumer Capital Holdings, Inc. and Consumer Capital Holdings became a
wholly owned subsidiary of Blue Star. After its acquisition of Consumer Capital
Holdings, Blue Star changed its name to Consumer Direct of America. In June 2006
Consumer Direct of America changed its name to Shearson Financial Network Inc.
Shearson Financial Network Inc. is the parent to two primary operating
divisions, Shearson Home Loans and Real Property Technologies (RPT). Shearson
Home Loans (SHL) is a direct-to-consumer mortgage broker and banker with
revenues derived primarily from origination commissions and resale of whole
loans earned on the closing of first and second mortgages on single-family
residences. SHL currently employs over 500 people which are residential mortgage
and/or real estate brokerage professionals. The Company is a consolidator of
mortgage brokerages and integrates the brokerage companies into the Shearson
Home Loans network and then banks the mortgages through its mortgage banking
unit. The Company plans to continue its growth strategy through the acquisition
and affiliation of mortgage brokerage firms who do not currently bank their own
production. By providing more efficient services to these smaller firms, SHL can
accrete loan volume without having to "organically" grow the business. Banking
of the accreted loan volume generates windfall revenue to the Company. Thus the
rate of growth of SHL's revenue stream is dramatically accelerated. The Company
has the infrastructure, systems, and operational management necessary to
properly integrate these and many more acquisitions in order to establish a
countywide network. The Company's business plan is focused on the integration of
over 200 mortgage brokerage offices into the SHEARSON mortgage network.
RPT is a leading real estate information company with headquarters in New York.
RPT reported revenues of approximately $24 million for fiscal year 2005 with pre
tax profits of nearly four million dollars ($4,000,000) and has in excess of 200
employees. RPT operates within the Shearson Financial Network as a separate data
network. RPT provides a steady revenue stream and profitability which the
company looks to mitigate the effects of interest rate fluctuations in the
mortgage lending market. The database has numerous marketing advantages for our
mortgage operations.
On February 20, 2002 Blue Star Coffee, Inc., a Nevada corporation (the
"Registrant") acquired Consumer Capital Holding, Inc., ("CCHI") a Nevada
corporation through a stock exchange affected pursuant to an Acquisition
Agreement dated February 20, 2002 (the "Agreement"). Pursuant to the Agreement
the stockholders of CCHI transferred to the Registrant all of the issued and
outstanding shares of capital stock of CCHI and the Registrant issued to the
stockholder of CCHI an aggregate of 1,047,900 post split shares of the common,
par value $0.02, per share, of the Registrant. The amount of consideration was
determined by arms length negotiations between the Registrant and the
stockholders of CCHI.
On June 6, 2002, Consumer Direct of America, acquired Lending Servicing
Corporation dba Las Vegas Mortgage ("LSC") a Nevada corporation through a stock
exchange and cash effected pursuant to an Acquisition Agreement dated June 6,
2002 (the "Agreement"). Pursuant to the Agreement, the stockholders of LSC
transferred to the Registrant all of the issued and outstanding shares of
capital stock of LSC and the Registrant issued to the stockholder of LSC an
aggregate of 120,000 post split shares of the common stock par value $0.02, per
share, of the Registrant and $100,000 in cash. The amount of consideration was
determined by arms length negotiations between the Registrant and the
stockholders of LSC.
17
On November 20, 2003, Consumer Direct of America acquired Pro Mortgage Corp.
("PRO" or "Pro Mortgage"), a California corporation through a stock exchange
effected pursuant to an Acquisition Agreement dated November 20, 2003 (the
"Agreement") Pursuant to the Agreement, the two stockholders of PRO transferred
to the Registrant all of the issued and outstanding shares of capital stock of
PRO and the Registrant issued to the two stockholders of PRO an aggregate of
150,000 post split shares of the common stock, par value $0.02, per share, of
the Registrant, PRO has conducted its mortgage brokerage finance business under
the name PRO Mortgage. The amount of the considerations was determined by
arms-length negotiations between the Registrant and the stockholders of PRO.
On October 1, 2004, CDA rescinded its acquisition agreement with Pro Mortgage
Corporation. On November 20, 2003 CDA and Pro Mortgage entered into an
acquisition agreement, whereby Pro Mortgage and CDA agreed to exchange 1,000
shares of Pro Mortgage capital stock, representing 100% of the issued and
outstanding capital stock of Pro Mortgage, in exchange for 3,000,000 shares of
CDA's capital stock, (the "Exchange"). The Exchange was never duly authorized
and approved by the parties thereto, and each of the parties hereto desires to
rescind the exchange. In connection with such rescission CDA transferred and
assigned its shares of the Pro Mortgage capital stock to the Pro Mortgage
shareholders and the Pro Mortgage shareholders transferred back its shares of
the common stock of CDA. We view this rescission as nullification and
accordingly has not included any operating activities related to PRO in our
consolidated financial statements.
On July 15, 2004, we acquired 84.9% of the outstanding common stock of Ocean
West Holding Corporation, ("Ocean West" or "OWHC") through a stock exchange
affected pursuant to a Purchase and Sale of Capital Stock Agreement. Marshall L.
Stewart, Daryl S. Meddings, Enfo Loan Corporation, Kingsley and Nancy Cannon and
Dale and Suzanne Delmege agreed to sell 4,921,930 of their shares of common
stock of Ocean West to us in exchange for 622,381 of our shares (the
"Transfer"). The consideration was based on the average monthly trading prices
of each company's shares for the month of June 2004. The Transfer resulted in
our having majority control and ownership, of Ocean West. Ocean West Holding
Corporation is a holding company, which holds all of the issued and outstanding
stock of Ocean West Enterprises.
On June 6, 2005, InfoByPhone, Inc. a Delaware corporation, consummated an
agreement with OWHC, pursuant to which InfoByPhone, Inc. exchanged all of its
6,000,000 then issued and outstanding shares of common stock for 6,000,000
shares, or approximately 56% of the common stock of OWHC. As a result of the
agreement the transaction was treated for accounting purposes as a
recapitalization by the accounting acquirer (InfoByPhone, Inc.). Prior to the
exchange, OWHC intended to issue a dividend pay out to its shareholders, which
was represented of 100% of the issued and outstanding shares of Ocean West
Enterprises, the wholly owned subsidiary of Ocean West Holding Corporation. This
dividend payout did not occur which resulted in OWHC having 100% interest in
Ocean West Enterprises.
We received cash proceeds in the amount of $400,000 from the sale of the public
holding company, Ocean West Holdings (OTC:BB:OWHC). The sale of OWHC was
directed by the Board of Directors of Ocean West and the payment to us was made
by Ocean West as a reduction against the monies loaned to Ocean West by us.
On February 7, 2006, Consumer Direct of America agreed to sell Shearson Home
Loans, Inc., a Nevada Corporation ("SHL"), and wholly owned subsidiary of
Consumer Direct of America, Inc. ("CDA"), to Paragon Financial Corporation
(PGNF), pursuant to the terms and conditions of a Share Exchange Agreement dated
February 7, 2006 (the "Exchange Agreement") among CDA, SHL and PGNF. Pursuant to
the Exchange Agreement, PGNF acquired all of the common stock of SHL for
149,558,791 shares of PGNF common stock and 79 shares of PGNF Series F Preferred
Stock (convertible into 443,217,018 shares of PGNF Common Stock), valued at
approximately $16,000,000. Each share of the Series F Preferred Stock
automatically converts into 5,610,342 shares of PGNF common stock upon the
filing of an amendment to PGNF articles. Immediately prior to entering into the
Exchange Agreement, PGNF had 119,566,360 shares of PGNF common stock
outstanding. In addition, PGNF had outstanding warrants to purchase 18,531,592
shares of PGNF common stock and outstanding debt convertible into 4,846,000
shares of PGNF common stock arriving at an exchange ratio of 4 to 1.
On May 5, 2006, we rescinded its acquisition agreement with PGNF. On February 7,
2006, we and PGNF entered into an acquisition agreement, whereby we and PGNF
acquired all of the common stock of SHL for 149,558,791 shares of PGNF common
stock and 79 shares of PGNF Series F Preferred Stock (convertible into
443,217,018 shares of PGNF Common Stock), valued at approximately $16,000,000.
Each share of the Series F Preferred Stock automatically converts into 5,610,342
shares of PGNF common stock upon the filing of an amendment to PGNF articles,
(the "Exchange"). The Exchange was never duly authorized and approved by the
parties thereto, and each of the parties hereto desires to rescind the exchange.
In connection with such rescission, we transferred and assigned our shares of
the PGNF capital stock and preferred stock to the PGNF shareholders and the PGNF
shareholders transferred back its shares of our common stock. We view this
rescission as nullification and accordingly have not included any operating
activities related to PGNF in our consolidated financial statements.
18
On June 5, 2006, we agreed to acquire all of the issued and outstanding shares
of common stock of Real Property Technologies ("RPT"), a New York corporation
("RPT"), from its shareholders ("shareholders"), pursuant to the terms and
conditions of a Share Exchange Agreement (the "Exchange Agreement") among
SHAREHOLDERS, RPT and us. Pursuant to the Exchange Agreement, we exchanged
100,000 shares of our Series A-1 Convertible Preferred Stock valued at
approximately $40,000,000. Each share of the Series A-1 Convertible Preferred
Stock has a stated value of four hundred dollars ($400.00). The acquisition of
RPT diversifies our mortgage operations and our mortgage banking capability via
its extensive database of real property information.
RPT is a leading real estate information company with headquarters in New York.
RPT reported revenues of approximately $24 million for fiscal year 2005 with pre
tax profits of nearly four million dollars ($4,000,000) and has in excess of 200
employees. As part of the acquisition, certain key members of RPT's management
will enter into employment agreements providing for a base compensation, plus
bonuses based on future performance of the combined business. We plan to
integrate RPT into Shearson Financial Network and operate RPT as a separate data
network. RPT provides a steady revenue stream and profitability which the
company looks to mitigate the effects of interest rate fluctuations in the
mortgage lending market. The database has numerous marketing advantages for our
mortgage operations.
This transaction is not contingent upon any regulatory approval with the SEC or
any other agency.
The Series A-1 Convertible Preferred Stock issued as part of the consideration
in the Exchange Agreement was a duly authorized series of preferred stock issued
pursuant to authority conferred upon the Board of Directors by our Certificate
of Incorporation. The Board of Directors, by unanimous written consent, adopted
a resolution providing for the issuance of up to one million (1,000,000) shares
of our Series A-1 Convertible Preferred Stock, par value $.0001 per share, which
is designated "Series A-1 Convertible Preferred Shares," which have the
following qualifications, limitations and restrictions of such preferences and
rights:
(i) Stated Value. The stated value per Series A-1 Convertible Preferred Share is
Four Hundred Dollars ($400.00) per share (the "Stated Value").
(ii) Dividends. None.
(iii) Voting Rights. Each share of the Series A-1 Convertible Preferred Shares
shall have 10,000 votes and shall vote upon all matters as a single class with
our common stock.
(iv) Conversion. Upon issuance, the Series A-1 Convertible Preferred Shares are
not convertible until an amendment to the Corporation's Certificate of
Incorporation is filed that increases the authorized shares of common stock.
Upon filing and acceptance of the amendment pursuant to the General Corporation
Law of the State of Nevada each share of Series A-1 Convertible Preferred Shares
shall be converted into 10,000 shares of our common stock.
(v) Liquidation Preference. In the event of our voluntary or involuntary
liquidation, dissolution or winding up, the holders of Series A-1 Convertible
Preferred Shares will be entitled to receive, prior and in preference to any
distribution of our assets or surplus funds to the holders of any shares of
common stock by reason of the ownership thereof, an amount equal to the fixed
sum of the Stated Value per share and any accrued dividends thereof and no more
(the "Preferential Amount"). Neither the merger or consolidation of us, nor the
sale, lease or conveyance of all or part of its assets, shall be deemed to be a
liquidation, dissolution or winding up of our affairs, either voluntarily or
involuntarily, within the meaning of this section.
(vi) Rank. All Series A-1 Convertible Preferred Shares shall rank (A), prior to
our common stock; (B) prior to any class or series of our capital stock
hereafter created, unless such class or series of capital stock specifically, by
its terms, ranks senior to or pari passu with such issuance; and (C) junior to
any class or series of our capital stock of the hereafter created specifically
ranking, by its terms.
On June 6 2006, we agreed to acquire all of the issued and outstanding shares of
common stock of Continental Home Loans Inc. ("CHL"), a New York corporation
("CHL"), from its shareholders ("shareholders"), pursuant to the terms and
conditions of a Share Exchange Agreement (the "Exchange Agreement") among
SHAREHOLDERS, CHL and us. Pursuant to the Exchange Agreement, we exchanged
shares of our Common Stock, valued at approximately $2,560,000 plus cash in the
amount of $640,000 to be deposited into an escrow account on or before July 1,
2006. The acquisition of CHL expands our mortgage operations and our mortgage
banking capability.
CHL is a regional mortgage banker with headquarters in Mellville, New York, and
is licensed to lend in several states including New York and California. The
agreement is subject only to the approval of the New York State Banking
Commission. CHL reported revenues of approximately $1.76 million for fiscal
quarter ending 3/31/ 2005 and has in excess of $ 7 million in total assets on
its balance sheet. As part of the acquisition, certain key members of CHL's
management will enter into employment agreements providing for a base
compensation, plus bonuses based on future performance of the combined business.
We plan to integrate CHL into our previously completed acquisition of Shearson
Homes Loans and use the brand name Shearson Home Loans for all of our mortgage
operations.
This transaction is not contingent upon any regulatory approval with the SEC.
19
On June 9, 2006, we agreed to acquire certain assets and defined liabilities of
eHome CreditCorp. ("EHC"), a New York corporation ("EHC"), from its shareholders
("shareholders"), pursuant to the terms and conditions of an Asset Purchase
Agreement (the "Agreement") among SHAREHOLDERS, EHC and us. Pursuant to the
Agreement, we exchanged 7,500 shares of our Series A-1 Preferred Stock valued at
approximately $3,000,000. Each share of the Series A-1 Preferred Stock has a
stated value of four hundred dollars ($400.00). In addition, the company will
pay $ 1.7 million in cash over a twenty four month period as a structured
reserve. The total value of the transaction is $ 4.7 million. The acquisition of
EHC diversifies our mortgage operations and our mortgage banking capability and
adds an additional $14 million per year in revenue to our mortgage group.
EHC is a leading mortgage banker with headquarters in Garden City, New York, and
is licensed to lend in forty (40) states. EHC reported revenues of approximately
$14 million for fiscal year 2005 and has in excess of 200 employees. As part of
the acquisition, certain key members of EHC's management will enter into
employment agreements providing for a base compensation, plus bonuses based on
future performance of the combined business. We plan to integrate EHC into our
previously completed acquisition of Shearson Homes Loans and use the brand name
Shearson Home Loans for all of our mortgage operations.
This transaction is not contingent upon any regulatory approval with the SEC or
any other agency. Our executive offices are located at 6330 S. Sandhill Road
Suite 8, Las Vegas, Nevada 89120.
COMPETITIVE LEGISLATIVE ADVANTAGE OF CDA
The Acting Secretary of the United States Department of Housing and Urban
Development, "HUD" has submitted revisions to the Real Estate Settlement
Procedures Act (RESPA) to the office of Management and Budget for final
approval. The proposed changes, although the final draft has not been made
public, are expected to have far reaching effects within the Mortgage Industry.
As previously written, the new changes will place a decided advantage in the
hands of mortgage bankers and state and federal banks. Mortgage Brokers will
find themselves at a clear disadvantage in terms of competitive pricing when
compared with banking operations.
If the bill, as last reviewed, passes, the Mortgage Brokers will be forced to
make the transition to banking, become a "net branch" of an existing mortgage
banking operation or be acquired by a company like us. To remain a mortgage
broker in a clearly disadvantaged position will ultimately lead to failure in
the business.
It should be noted that many "net branch" arrangements as currently practiced
are not recognized as legal operations according to HUD. The net branches are
prohibited from originating FHA loans under such an arrangement. Additionally,
as net branch operations, the branch manager receives no equity for his
contributions to the parent banking company. In the case of SFN, there is value
received, as additional compensation can be earned through production and a
viable exit strategy is provided.
This pending legislation will provide additional momentum for large successful
brokerage houses to make the transition to a wholly owned subsidiary of Shearson
Financial Network Inc.
GROWTH STRATEGY
We plan to continue our growth strategy through the acquisition and affiliation
of mortgage brokerage firms who do not currently bank their own production. By
providing more efficient services to these smaller firms, bank products, and
other services not readily available to smaller companies, we can accrete loan
volume without having to "organically" grow the business. Banking of the
accreted loan volume generates windfall revenue to the Company. Thus the rate of
growth of our revenue stream is dramatically accelerated.
Our principal short-term focus is to:
o establish relationships with more of the 200 largest mortgage brokerage
companies;
o increase the number of installations with the our existing mortgage
brokerage branches
o increase the volume of loans originated through the LoanMaker System.
In addition to the residential mortgage origination market, we have identified
three other potential growth opportunities: (i) adding complementary services to
the mortgage lending process such as title search, property appraisals,
relocation services and cash management; (ii) exploiting other financial markets
such as home equity loans, life insurance sales and personal financial planning.
Although we currently have no specific plans in these areas, the we intend to
explore these additional growth opportunities as part of its long-term strategic
growth plan.
20
PRODUCTS
We offer a broad range of mortgage loan products to provide flexibility to
mortgage loan brokers and our retail division. These products vary in
loan-to-value ratio and income requirements as well as other factors. The
following is a list of our primary standard products:
o Conforming Mortgage Products -- Adjustable and fixed rate loan
programs that meet the guidelines for purchase by
government-sponsored entities, such as FNMA and FHLMC which
guarantee mortgage backed securities, and by permanent investors in
mortgage backed securities secured by, or representing ownership in,
such mortgage loans.
o Alt A/Sub Prime Mortgage Products -- Alternative-A/Sub-Prime loans
are adjustable and fixed rate loans that usually do not meet FNMA
and FHLMC guidelines due to various reasons. These loans usually do
not meet this guideline because they require a reduced amount of
income verification and may exceed these agencies maximum
loan-to-value ("LTV") guidelines. These loans are sold to
institutional investors such as Credit Suisse First Boston, Banco
Popular and Saxon Mortgage.
o Second Mortgage Program -- Fixed rate amortizing and fixed rate with
a balloon payment programs that are limited to borrowers we identify
as A+ through B credit, risks, with a maximum combined loan-to-value
ratio equal to 100%.
o JUMBO Loans -- Adjustable and fixed rate loan program for loans that
exceed the loan limits set by the FNMA (Fannie Mae) and the FHLMC
(Freddie Mac). These loans are sold to investors in the secondary
market that specialize in these types of loans and are structured to
meet the guidelines provided by specific investors.
o Non-Conforming Loans -- Fixed- rate first mortgage loans that are
amortized over a fifteen or thirty-year period as well as loans with
a balloon payment in fifteen years and payable during the
fifteen-year period under a thirty-year amortization schedule.
LOAN ORIGINATION
We originate both purchase and refinance mortgage loans. The percentage of
refinance loans as compared to total volume for the year ended December 31, 2005
was 56.8% and 56.4% for the year ending December 31, 2004.
We originate loans primarily through three different channels. The first is
directly through our "corporate" retail division. This division deals directly
with the client. Most of the retail loans are referred to us through real estate
agents or past clients. The remaining clients are generated through various
marketing techniques such as direct mail, telemarketing, or various lead
providers. We have closed this division in the early part of its fiscal year and
has decided to focus its attention on the two remaining channels, as discussed
below. The corporate retail loans comprised 7.7% of our loan volume for the year
ended December 31, 2005 as compared to 24% of our loan volume for the year ended
December 31, 2004.
The second method of origination is through our branch network of retail
branches. A retail branch is where all related branch expenses must be paid for
through branch revenues and the manager of the branch is compensated only
through the branch profits. We have concentrated on developing this area of our
business in recent months because we believe this is one of the most cost
effective and efficient ways to increase loan originations. The net branches
comprised 92.3% of the loan volume in the fiscal year ended December 31, 2005 as
compared to 92% of the loan volume in the fiscal year ended December 31, 2004.
As of December 31, 2005 we had 28 retail branches in 12 states. These branches
are located in areas close to potential borrowers and referral sources. Being
located near these referral sources better enables us in developing referral
business. Our goal is to continue to develop and maintain recurring referral
sources. To supplement branch business, we continue to develop lead programs
through various providers.
UNDERWRITING PROCESS
Loans originated through the corporate retail division or retail branches
require processing. Processing procedures very depending on specific loan
program and investor requirements. Loan applications are reviewed and verified
for accuracy. The verification process includes, but is not limited to: (i)
evaluation of the borrower's credit worthiness by obtaining a formal credit
report through an approved credit agency, (ii) third party verification of the
applicant's income and deposit information, and (iii) obtaining a preliminary
title and appraisal report. Once processing is complete, the file is sent on to
underwriting.
Regardless of how a loan is generated, all loans must be underwritten in
accordance with guidelines set forth by management and the secondary market
investors. Some underwriting criteria include borrower income and credit
worthiness, loan-to-value ratios, property condition and type, insurance
requirements and investor requirements. Our underwriting guidelines also comply
with those guidelines set forth by the FNMA, FHLMC, FHA, Veterans Administration
("VA") and private institutional investors. The underwriting guidelines are
intended to aid in evaluating the credit history of the potential borrower, the
capacity of the borrower to repay the mortgage loan, the value of the real
property, which will secure the loan, and the adequacy of such property as
collateral for the proposed loan. The loan terms, including interest rate and
maximum loan-to-value ratio, are determined based upon the underwriter's review
of the loan application and related data and the application of the underwriting
guidelines.
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We employ only experienced underwriters. Our Underwriting Manager must approve
the hiring of all underwriters, including those who will be located in a
regional or branch office. Our underwriters must have had either substantial
underwriting experience or substantial experience with us in other aspects of
the mortgage finance industry before becoming part of the underwriting
department. All underwriters are required to participate in ongoing training,
including regular supervisory critiques of each underwriter's work. We believe
that our underwriting personnel have the ability to analyze the specific
characteristics of each loan application and make appropriate credit judgments.
The level of income verification varies with program type. The underwriting
guidelines include four levels of documentation requirements for applicants,
which are referred to as the "Full Documentation," "Lite Documentation," "Stated
Income Documentation," and "No Documentation" programs. The purchasers in the
secondary market dictate the level of income documentation required for a
specific loan. Except for the No Documentation programs, where verification of
income is not required, we review:
o the applicant's source of income;
o calculate the amount of income from sources listed on the loan application
or other documentation;
o review the credit history of the applicant;
o calculate the debt service-to-income ratio to determine the applicant's
ability to repay the loan;
o review the type and use of the property being financed; and
o review the property.
Under our Full Documentation programs, applicants are generally required to
submit two written forms of verification of stable income for at least twelve
months. Under our Lite Documentation programs, the applicant may submit
twenty-four months of bank statements in lieu of traditional documentation such
a tax returns and pay-stubs. Our Stated Income Documentation programs may be
accepted based upon the monthly income stated on the mortgage loan application
if other criteria are met. Our No Documentation programs do not give
consideration to income. Instead, more weight is given to the borrowers credit
history and property value. All of the programs require a telephone verification
of the employment of salaried employees. In the case of purchase money loans,
under the Full Documentation program guidelines and, on all purchase loans where
the loan-to-value ratio is greater than 80%, we also verify source of funds to
be deposited by the applicant into escrow.
In most cases, our underwriters determine the applicant's ability to repay the
loan using: (a) a qualifying rate that is equal to the stated interest rate on
fixed-rate loans, (b) the initial interest rate on loans which provide for three
years of fixed interest rate and payments before the initial interest rate
adjustment, or (c) 2% above the initial interest rate on other adjustable-rate
loans. The underwriting guidelines require that mortgage loans be underwritten
following a standard procedure that complies with applicable federal and state
laws and regulations. It also requires our underwriters to be satisfied of the
value of the property to be mortgaged based upon a review of the appraisal. In
general, the maximum principal amount of loans originated under our conventional
program is $650,000; however, management may approve and make larger loans on a
case-by-case basis. Larger loans also require approval by the intended purchaser
of the loan.
Automated underwriting systems are rapidly becoming the industry standard when
underwriting conventional loans. These systems can be used for underwriting loan
programs such as FHA and VA; and at times specific investors require their use.
The two primary systems are the FNMA's Desktop Underwriter and the FHLMC's Loan
Prospector. Over the past few years, the trend has moved toward the exclusive
use of these systems. We currently underwrite over half of the loans originated
using these systems. We are also in the process of developing it own proprietary
underwriting system to aid in the process of underwriting those loan programs
that can not be underwritten by the Desktop Underwriter or Loan Prospector.
Management evaluates the underwriting guidelines on an ongoing basis and
periodically modifies them to reflect current assessments of various issues
relating to underwriting analysis. In addition, as new loan products are
developed, we adopt underwriting guidelines that we believe are appropriate for
the new products. All loans are underwritten to the standards of the intended
purchasers of the loans. We make certain representations and warranties
customary in the industry relating to, among other things, accurate information,
program standards, and compliance with laws and regulations. If we are found to
have breached such a representation or warranty, we could be required to
repurchase the loan.
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QUALITY CONTROL
We have implemented a loan quality control process to help enforce sound lending
practices and compliance with our policies and procedures as well the compliance
requirements of agencies such as HUD, Fannie Mae and the requirements of other
purchasers of mortgages. While we are not currently a HUD approved lender it
does however comply with its standards. Prior to funding a loan, we perform a
"pre-funding quality control audit" in which our staff re-verifies the
borrower's credit history and employment, using automated services as well as
verbal verifications. In addition, an independent appraiser appraises properties
that will potentially secure the mortgage loans. A qualified licensed
independent appraiser must conduct all appraisals and the appraisal must conform
to the Uniform Standards of Professional Appraisal Practice adopted by the
Appraisal Standards Board of the Appraisal Foundation. Our personnel also review
every appraisal to confirm the adequacy of the property as collateral prior to
funding.
In addition, our quality assurance department audits a percentage of all loans
that are funded. The department reviews the documentation, including appraisals
and verifications, for compliance with established underwriting guidelines and
lending procedures. The department also reexamines the funding documents for
accuracy, completeness and adherence to corporate, state and federal
requirements. As part of the audit process, any deficiencies discovered are
reported to senior management to determine trends and any need for additional
training of personnel.
LOAN FUNDING
Loans that are closed using our own credit facilities are funded through short
term borrowing on our warehouse lines of credit. We pay interest on funds
advanced under the warehouse line of credit at a pre-negotiated rate. The rate
at which we borrows is variable in nature and typically averages between 4.5%
and 5.5%. We currently have approval for $20,000,000 in warehouse capability. We
have our primary warehouse line of $10 million with Warehouse One and a total of
$10 million with several other warehouse lenders. The facilities are secured by
the mortgage loans financed through the line, related mortgage servicing
agreements, of which we repay the outstanding balance under the warehouse line
with the proceeds from the sale of mortgage loans. The additional proceeds
earned from loan sales also replenish working capital.
SALE OF LOANS
The percentage of originated loans that were funded using our warehouse lines of
credit was 17.3% of the total dollar volume for the year ended December 31,
2005. We generally sell substantially all of the loans originated. Once we have
funded a loan through a credit facility, the next objective is to sell the loan
as quickly as possible, which typically happens in ten to fifteen business days.
In some instances we hold the loan for sale and may be unable to sell the loan.
As of December 31, 2005, there were 5 loans that had not been sold. A
reconciliation package is prepared for our accounting department. The file then
moves on to the shipping department where it is copied and stacked to specific
investor guidelines. After we receive the final closing statement, usually two
to three days after funding, the file is sent to the appropriate investor and
revenue is recognized. We typically make general representations and warranties
to purchasers of the mortgages relating to borrower disclosures, closing
procedures, credit documentation, follow-up documentation and accuracy of
representations. In many cases, purchasers of the mortgages will require
language in the documentation mandating that we return all or a portion of the
premium and any premium paid for servicing rights for loans that are paid off
early, typically prior to the end of the first six months. In most cases, we are
only liable for premium recapture if the loan is being prepaid as a result of a
refinancing through us or one of our affiliates.
Purchasers of loans vary from time to time as the purchasers get in and out of
the market. For the year ended December 31, 2005 1 buyer purchased in excess of
10% of our production funded on our warehouse lines of credit: Countrywide
purchased 90%. For the year ended December 31, 2004, four buyers purchased in
excess of 10% of our production funded on our warehouse lines of credit: Union
Federal purchased 23%, Credit Suisse First Boston purchased 25%, Banco Popular
purchased 20%, and The Winter Group purchased 10%. Our secondary marketing
department chooses the purchaser for a particular loan. Commitments to purchase
loans are made on a loan-by-loan basis. We are not required to provide a certain
number of loans to any purchaser.
MORTGAGE LOAN SERVICING RIGHTS
We currently sell the servicing rights on essentially all the loans we fund. At
the time the loan is sold, the purchaser of the loan typically pays us a premium
for the release of the servicing rights. The premium is paid for the right to
collect the servicing fees for the period the loan remains on the investor's
books. A typical spread for an "A" grade loan is 1/4 of 1% annually. In the
past, we occasionally retained servicing rights, but no longer do so on a
regular basis. Since we are not currently set up to service loans in-house, we
contract with a third party to sub-service any loans for which we have servicing
rights. The sub-servicer is responsible for accepting and posting all payments,
maintaining escrow accounts and reporting to the end investors, such as Fannie
Mae. For this service, we typically pay the sub-servicer a monthly fee averaging
$6 to $7 per loan.
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LENDER RELATIONS
Today's mortgage lenders are seeking bigger shares of the market at less cost to
them. As of December 31, 2005, the following lenders were represented on the
LoanMaker System; Countrywide Funding Corporation , BNC Mortgage Corporation of
America, IMPAC Funding Corporation and Aegis.
REGULATION
The consumer finance industry is highly regulated; therefore we are is subject
to extensive and complex rules and regulations of, and examinations by, various
federal, state and local government authorities. These rules impose obligations
and restrictions on our loan origination, credit activities and secured
transactions. In addition, these rules limit the interest rates, finance charges
and other fees that we may assess, mandate extensive disclosure to borrowers,
prohibit discrimination, and impose multiple qualifications and licensing
obligations. Failure to comply with these requirements may result in, among
other things, loss of HUD approved status, demands by purchasers of mortgages
for indemnification or mortgage loan repurchases, exercise of rights of
rescission of mortgage loans by borrowers, class action lawsuits by borrowers,
administrative enforcement actions, and civil and criminal liability. Currently
the Company is not an approved HUD lender. We use our quality assurance program
to monitor compliance and, based upon assessments of our compliance staff,
believe that we are in compliance with applicable rules and regulations in all
material respects.
Our loan origination activities are subject to the laws and regulations in each
state in which we conduct lending activities. For example, state usury laws
limit the interest rates that we can charge on our loans. In connection with
plans to expand our geographic reach, we have investigated requirements in
additional states. We currently hold licenses or exemption certificates in
thirteen states. We do not have operations or significant loan activity in all
of these states at this time. Our current operations and loan activity is
primarily in California. California originations made up 44.9% of our total
volume based on units. Other states that we originated were Nevada (13.7%),
Kansas (2.1%), Georgia (4.8%), Ohio (7.4%), Florida (2.8%), Missouri (1.7%),
Connecticut (3.7%), Washington (3%), Arizona (9.3%), South Carolina (2.53%),
Tennessee (1.01%), and Oregon (1.2%).
Our lending activities are also subject to various federal laws, including the
Truth-in-Lending Act, the Equal Credit Opportunity Act, the Fair Credit
Reporting Act, the Real Estate Settlement Procedures Act and the Home Mortgage
Disclosure Act. We are not currently making loans subject to the Homeownership
and Equity Protection Act of 1994. More specifically, we are subject to
disclosure requirements under the Truth-in-Lending Act and Regulation Z
promulgated thereunder. The Truth-in-Lending Act is designed to provide
consumers with uniform, understandable information relating to specify terms and
conditions of loan and credit transactions and, by standardizing the form of
information provided, facilitate comparisons among available credit options. The
act also gives consumers the right to change their minds about a credit
transaction by guaranteeing consumers a three-day right to cancel some credit
transactions, such as loans of the type we originate. In addition, the
Truth-in-Lending Act gives consumers the right to rescind the loan transaction
if the lender fails to provide the required disclosures to the consumer. We are
also required to comply with the Equal Credit Opportunity Act of 1994 and
Regulation B promulgated thereunder, the Fair Credit Reporting Act, the Real
Estate Settlement Procedures Act of 1975 and the Home Mortgage Disclosure Act of
1975. The Equal Credit Opportunity Act prohibits lenders from discriminating
against an applicant for a loan on the basis of race, color, sex, age, religion,
national origin or marital status. Regulation B prohibits lenders from
requesting some types of information from loan applicants. The Fair Credit
Reporting Act requires lenders to supply applicants with information relating to
the denial of any loan application. Beginning with loans originated in 1997, the
Home Mortgage Disclosure Act requires that we file annual reports with HUD for
collection and reporting of statistical data in loan transactions. The Real
Estate Settlement Procedures Act mandates disclosures concerning settlement fees
and charges and mortgage servicing transfer practices. It also prohibits the
payment or receipt of kickbacks or referral fees in connection with the
performance of settlement services.
The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act") was signed into law by
President Bush on July 30, 2002 in response to public concerns regarding
corporate accountability in connection with the recent accounting scandals at
Enron and WorldCom. The stated goals of the Sarbanes-Oxley Act are to increase
corporate responsibility, to provide for enhanced penalties for accounting and
auditing improprieties at publicly traded companies and to protect investors by
improving the accuracy and reliability of corporate disclosures pursuant to the
securities laws. The Sarbanes-Oxley Act is the most far-reaching U.S. securities
legislation enacted in some time. The Sarbanes-Oxley Act generally applies to
all companies, both U.S. and non-U.S., that file or are required to file
periodic reports with the Securities and Exchange Commission ("SEC"), under the
Securities Exchange Act of 1934 ("Exchange Act"). The Sarbanes-Oxley Act
includes very specific additional disclosure requirements and new corporate
governance rules, requires the SEC and securities exchanges to adopt extensive
additional disclosure, corporate governance and other related rules and mandates
further studies of certain issues by the SEC and the Comptroller General. The
Sarbanes-Oxley Act represents significant federal involvement in matters
traditionally left to state regulatory systems, such as the regulation of the
accounting profession, and to state corporate law, such as the relationship
between a board of directors and management and between a board of directors and
its committees. Of the new requirements imposed by the Sarbanes-Oxley Act, among
others, we currently have no "independent directors" on our board of directors,
no audit committee, compensation committee nor nomination committee and we do
not have any independent "financial experts" on our board of directors. As a
result, we currently would not be eligible to have our shares listed on the
NASDAQ, AMEX or NYSE, even if we were to meet the other listing requirements of
such self-regulatory organizations.
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The laws and regulations under which we operate are subject to change at any
time. In addition, new laws or regulations may be added at any time. There can
be no assurance that any change or addition of laws will not make compliance
more difficult or more extensive, restrict ability to originate, broker,
purchase or sell loans, further limit the amount of commissions, interest or
other charges which may be earned, or otherwise adversely affect our business or
prospects.
COMPETITION
The mortgage market is intensely competitive and rapidly evolving, and
competition is expected to intensify even more in the future. We compete mainly
on the selection of mortgage products we offer and on customer service. Barriers
to entry are minimal, and competition is likely to increase significantly as new
companies enter the market and current competitors expand their services.
Further, there can be no assurance that our competitors and potential
competitors will not develop services and products that are equal or superior to
those of Consumer Direct of America or that achieve greater market acceptance
than our products and services. We currently compete with traditional mortgage
companies and Internet companies offering mortgage and real estate related
services, including, but not limited to:
o various online mortgage brokers, including E-LOAN, Inc. and
Lendingtree.com;
o mortgage banking companies, commercial banks, savings associations, credit
unions and other financial institutions which originate mortgage loans;
o Real estate agents; and
o Mortgage brokers.
Many of our mortgage banking and mortgage brokerage competitors have competitive
advantages including the following:
o Longer operating histories;
o Greater name recognition and more extensive customer bases; and
o Substantially greater financial, marketing, technical and other resources.
As previously stated, our business depends primarily on providing direct person
- - to - person mortgage services to a diversified client base consisting of
consumers. To remain competitive, we must increase the volume of mortgage loan
transactions that we effect and maintain sustainable margins on such mortgage
transactions.
Also, we will need to maintain strategic relationships with a critical mass of
lenders and mortgage brokers to fulfill consumer demand. This will take
significant time and resources, and will require that we provide our lending and
brokerage partners with compelling reasons to partner with us, as many of these
partners are also current or potential competitors of ours.
Finally, we will need to continue developing our technology to facilitate
transactions for both consumers and lenders, as well as to permit lenders and
any strategic partners to integrate their services easily and seamlessly with
our services.
LICENSING AND REGULATION OF MORTGAGE BROKERAGE LOAN BUSINESS
We are licensed as a mortgage banker and broker, and are otherwise authorized to
originate mortgage loans in thirty states. Our mortgage brokerage operations are
subject to extensive regulation by federal and state authorities. The United
States Department of Housing and Urban Development ("HUD") regulates certain
aspects of the mortgage lending business. The Real Estate Settlement Procedures
Act of 1974 ("RESPA"), a Federal statute, requires that certain disclosures,
such as a Truth-in-Lending Statement, be made to borrowers and that certain
information, such as the HUD Settlement Costs booklet, be provided to borrowers.
The Fair Housing Act prohibits among other practices, discrimination, unfair and
deceptive trade practices, and requires disclosure of certain basic information
to mortgagors concerning illicit terms. If we fail to comply with such
regulations, possible consequences could include loss of approved status,
demands for indemnification, class action lawsuits, and administrative
enforcement actions.
RESPA contains certain prohibitions regarding the giving or taking of a fee,
anything of value for the referral of business to any mortgage broker however,
there is no prohibition regarding the payment of reasonable fees for the
provision of goods, services and facilities. From time to time in its debate
over tax reform, Congress has discussed eliminating deductibility of mortgage
interest. Should this occur, it would reduce the number of those who can afford
homeownership, which would reduce potential demand for the our products and
services. Additionally several large law firms have promoted class action claims
alleging that certain industry fee practices violate RESPA. While the mortgage
broker industry has responded vigorously to these activities, no assurances can
be given as to their outcome and the impact on the industry.
In California, regulation and licensing of mortgage brokers falls under the
California Department of Real Estate (DRE). Other than banking industry
employees, who are exempt from DRE licensing requirements, individuals engaged
directly in the origination of loans or the dissemination of certain information
are required to be licensed by the DRE. Accordingly, Consumer Direct of America
and some of its affiliates will be required to be licensed in accordance with
the differing requirements of the various states in which offices and operations
are established. Failure by Consumer Direct of America to comply with the
multitude of government regulations and licensing requirements to which we are
subject could have a material adverse effect on our business, financial
condition and results of operations.
25
INTELLECTUAL PROPERTY
Trademarks and other proprietary rights are important to our success and our
competitive position. Although we seek to protect our trademarks and other
proprietary rights through a variety of means, we may not have taken adequate
steps to protect these rights. We may also license content from third parties in
the future and it is possible that it could be subjected to infringement actions
based upon the content licensed from these third parties. Any claims brought
against us, regardless of their merit, could result in costly litigation and the
diversion of our financial resources and technical and management personnel.
Further, if any claims are proved valid, through litigation or otherwise, we may
be required to change our trademarks and pay financial damages, which could
adversely, affect our business.
We typically enter into confidentiality agreements with our employees and
consultants and generally control access to and distribution of our
technologies, documentation and other proprietary information. Despite our
efforts to protect our proprietary rights from unauthorized use or disclosure,
parties may attempt to disclose, obtain or use our rights. The steps we have
taken may not prevent misappropriation of our proprietary rights, particularly
in foreign countries where laws or law enforcement practices may not protect our
proprietary rights as fully as in the United States.
EMPLOYEES
As of December 31, 2005, we had 102 full-time employees, of whom 17
were in administrative and 85 were at the branch locations. We believe that
relations with our employees are good.
DESCRIPTION OF PROPERTY
We lease approximately 17,580 square feet of general office space in premises
located at 6330 S. Sandhill Road, Las Vegas, Nevada and 15991 Redhill Avenue,
Tustin, California. Our lease for these spaces expires in July 2007 and November
2007, respectively.
The Sandhill lease provides for monthly payments of $10,333 with additional
monthly expense of $1,728 incurred for such building expenses as maintenance.
The square footage of this space is 10,580.
We evaluate on a continuing basis the suitability and adequacy of all of its
branch office locations, and has active programs of relocating or closing any as
necessary to maintain efficient and attractive facilities. We believe that our
present facilities are adequate for its operating purposes.
Our branch offices are located at:
Name Address
- ---- -------
A.N.S. Home Loans Diamond Bar, CA
Magellan's All-In-One Lending Salem, OR
Ocean West Funding Concord, OH
Pacific Loan Company Oakhurst, CA
Ocean West Funding North Fork, CA
Ocean West Funding Palm Springs, CA
Rhodes Mortgage Westport, CT
American Mtg and Investment Myrtle Beach, SC
Cedarbrook Funding Painesville, OH
Ocean West Funding Monroe, CT
Ocean West Funding Memphis, TN
Haldeman Huskey Mortgage Merriam, KS
All Fund Amarillo TX
Ocean West Funding Tustin, CA
Harbor Mortgage Corp Beachwood, OH
Ocean West Funding Waterbury, CT
Ocean West Funding Pensacola, FL
Ocean West Funding Moreno Valley, CA
Perfect Mortgage Castro Valley, CA
At Your Service Mtg Cedartown, GA
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Name Address
- ---- -------
Ocean West Funding Indianapolis, IN
Ocean West Funding Suwanee, GA
Ocean West Funding Fullerton, CA
LAMAX Los Angeles, CA
AKC Mortgage Tustin, CA
Shearson Home Loans Lakewood, CA
Interfaith Capital Bridgeport, CT
Shearson Home Loans Las Vegas, NV
LEGAL PROCEEDINGS
We are party to claims from time to time, not required to be disclosed in
accordance with Item 103 of Regulation S-B. While management currently believes
that the ultimate outcome of these proceedings, individually and in the
aggregate, will not have a material adverse effect on our financial position or
results of operations, litigation is subject to inherent uncertainties.
On April 14, 2004, we commenced an action against Consulting Services LLC. On
April 19, 2004, Consulting Services LLC instituted a counterclaim against us.
Both claims are contented by the parties to be of a breach of contract nature
from a certain Asset Acquisition Agreement that we claim we never consummated
therfore services are not liable under the agreement. The counterclaims of a
similar nature which we are claiming no liability and Consulting Services LLC is
asking for the amount of stock agreed to be given for services per the
acquisition agreement of approximately 2.7 million shares of our stock valued at
the time to be approximately $1.8 million and $655,321 for certain liabilities
we were to assume per the agreement upon closing. We are is asserting its
position of no liability and asking for approximately $712,859 of which was
advanced to Consulting Services prior to the knowledge that the transaction was
not to close. Were an unfavorable ruling to occur, there exists the possibility
of a material adverse impact on our results of operations of the period in which
the ruling occurs. The estimate of the potential impact on our financial
position or overall results of operations for the above legal proceedings could
change in the future.
MANAGEMENT
EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES
As of July 1, 2006, our directors and executive officers, their ages, positions
held, and duration of such, are as follows:
Michael A. Barron 55 Chairman, Chief Executive Officer and Director
Lee Shorey 61 Chief Financial Officer Secretary and Director
Joseph Cosio-Barron 57 President
Directors hold office for a period of one year from their election at the annual
meeting of stockholders and until their successors are duly elected and
qualified. Officers are elected by, and serve at the discretion of, the Board of
Directors. None of the above individuals has any family relationship with any
other. We currently do not compensate our directors for attending Board
meetings, but we do reimburse them for out-of-pocket expenses.
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Business Experience
The following is a brief account of the education and business experience during
at least the past five years of each director, executive officer and key
employee, indicating the principal occupation during that period, and the name
and principal business of the organization in which such occupation and
employment were carried out.
MICHAEL A. BARRON - CHAIRMAN & CEO, founded CONSUMER DIRECT of AMERICA in May
2001. From September 1998 to April 2001, Mr. Barron was semi-retired and a
consultant to various mortgage companies. From March 1995-1998, Mr. Barron
pioneered the first nationwide commercially deployed video conference mortgage
financing platform for Intel Corporation which as a licensed mortgage banker and
broker in 20 states funded over $1 billion in closed loans. In November 1988, he
founded and served as President, until 1992, of Finet Holdings Corporation
(NASDAQ:FNCM), a publicly traded mortgage broker and banking business
specializing in e-mortgage financing on site in real estate offices and remote
loan origination via the Internet (www.finet.com). In June 1979, TRW hired Mr.
Barron to develop its real estate information services division (TRW/REIS) that
acquired 11 companies in the field and eventually became the world's largest
repository of real estate property information - Experian. Mr. Barron was a
founder of Citidata, the first electronic provider of computerized real estate
multiple listing services (MLS) in the nation from 1975 to 1979. Mr. Barron was
the Senior Planner for the City of Monterey where he was the HUD liaison for the
City's downtown redevelopment project. He master planned the city's
redevelopment of famous Cannery Row, Fisherman's Wharf, and was Secretary of the
Architectural Review Committee. Mr. Barron holds a B.S. degree from California
Polytechnic University and has completed courses in the MBA program at UCLA.
LEE SHOREY - CFO, SECRETARY AND TREASURER, has over 30 years experience in
finance, mortgage brokerages and real estate services companies. Mr. Shorey
holds a BS Degree in Accounting. Mr. Shorey held the position of VP
Administration/HR for Virtual Mortgage Network. In that capacity Mr. Shorey
managed the general accounting, statistical reporting, document preparation and
research for preparation of business plan, reporting on regional activity,
tracking sales and production, handling payroll and HR activities for the
company. Prior to that assignment, Mr. Shorey functioned as the Controller for
Finet Corporation, a San Francisco area computerized loan origination company.
Mr. Shorey held the position of VP Operations for American Financial Network
located in Dallas, TX., one of the first computerized loan origination networks.
In addition to the above, Mr. Shorey has had several years of experience in
training, procedures and marketing with Associates Corporation during his 18
years with that Company.
JOSEPH A. COSIO-BARRON - PRESIDENT. Prior to joining the company from 1996-2002
Mr. Cosio-Barron served as the Managing Partner and President of CBS
Consultants, Inc. a California Corporation. CBS Consultants, Inc. a financial
firm offered highly specialized services in Securities compliance and lending
for hotels, resorts, and casinos and their development and construction. Mr.
Barron received a BA of Business Management, San Francisco State College, JD,
and a Law Degree from Golden Gate University and is a Member of the State Bar
Association in California.
Committees of the Board
We do not have an audit, committee, compensation committee or nomination
committee.
Involvement in Certain Legal Proceedings
None of our directors, executive officers, promoters or control persons have
been involved in any of the following events during the past five years:
1. any bankruptcy petition filed by or against any
business of which such person was a general partner or
executive officer either at the time of the bankruptcy
or within two years prior to that time;
2. any conviction in a criminal proceeding or being
subject to a pending criminal proceeding (excluding
traffic violations and other minor offences);
3. being subject to any order, judgment, or decree,
not subsequently reversed, suspended or vacated, of
any court of competent jurisdiction, permanently or
temporarily enjoining, barring, suspending or
otherwise limiting his involvement in any type of
business, securities or banking activities; or
4. being found by a court of competent jurisdiction
(in a civil action), the Commission or the Commodity
Futures Trading Commission to have violated a federal
or state securities or commodities law, and the
judgment has not been reversed, suspended, or vacated.
28
We believe that Mr. Barron is capable of analyzing and evaluating our financial
statements and understanding internal controls and procedures for financial
reporting. In addition, we believe that retaining an independent director who
would qualify as an "audit committee financial expert" would be overly costly
and burdensome and is not warranted in our circumstances given the financial
condition of our company.
Section 16(a) Beneficial Ownership Compliance
Section 16(a) of the Securities Exchange Act requires our executive officers and
directors, and persons who own more than 10% of our common stock, to file
reports regarding ownership of, and transactions in, our securities with the
Securities and Exchange Commission and to provide us with copies of those
filings. Based solely on our review of the copies of such forms received by us,
or written representations from certain reporting persons, we believe that
during fiscal year ended December 31, 2005, all filing requirements applicable
to its officers, directors and greater than 10% beneficial owners were complied
with.
We have not yet adopted a Code of Ethics but expect to in the near future.
EXECUTIVE COMPENSATION
The following table summarizes the compensation of our executive officers during
the three years ended December 31, 2005, 2004 and 2003. No other officers or
directors received annual compensation in excess of $100,000 during the last
three fiscal years.
SUMMARY COMPENSATION TABLE
LONG TERM PAYOUTS
OMPENSATION
ANNUAL COMPENSATION AWARDS
------------------- ------ -------
SECURITIES
NAME AND RESTRICTED UNDERLYING LTIP
PRINCIPAL OTHER ANNUAL STOCK OPTIONS SARS PAY-OUTS ALL OTHER
POSITION SALARY BONUS COMPENSATION AWARDS ($) (#) ($) COMPENSATION
-------- ------ ----- ------------ ---------- --- --- ------------
Michael A. Barron, 2003 $180,000
President and Chief 2004 $180,000 $-- $-- $160,000 --
Executive Officer 2005 $180,000
- ----------------------------------------------------------------------------------------------------------------------------------
Wayne Bailey, Chief 2003 $180,000
Operating Officer and 2004 $180,000 $-- $-- $-- --
Director, resigned 2005 $135,000
10/01/2005.
- ----------------------------------------------------------------------------------------------------------------------------------
Lee Shorey, Chief
Operating Officer and
Director 2005 $84,000 $-- $-- $-- --
- ----------------------------------------------------------------------------------------------------------------------------------
Joseph Cosio-Barron, - 2003 $120,000
- -President 2004 $120,000 $-- $-- $160,000 --
2005 $180,000
- ----------------------------------------------------------------------------------------------------------------------------------
OPTION GRANTS IN THE LAST FISCAL YEAR
Our Board of Directors has adopted a stock option plan and reserved an aggregate
of 500,000 shares of common stock for grants of restricted stock and stock
options under the plan. The purpose of the plan is to enhance the long-term
stockholder value of the Company by offering opportunities to our officers,
directors, employees and consultants to participate in our growth and success,
and to encourage them to remain in our service and acquire and maintain stock
ownership in us.
As of June 30, 2003, options to purchase 900,000 shares of common stock were
outstanding under the option plan at an exercise price of $1.00 per share,
options to purchase 20,000 shares were available for grants and no options had
been exercised.
29
The plan is currently administered by our Board of Directors, which has the
authority to select individuals who are to receive grants under the plan and to
specify the terms and conditions of each restricted stock grant and each option
to be granted, the vesting provisions, the option term and the exercise price.
Unless otherwise provided by the Board of Directors, an option granted under the
plan expires 10 years from the date of grant (5 years in the case of an
incentive option granted to a holder of 10% or more of the shares of our
outstanding common stock) or, if earlier, three months after the optionee's
termination of employment or service. Options granted under the plan are not
generally transferable by the optionee except by will or the laws of descent and
distribution and generally are exercisable during the lifetime of the optionee
only by such optionee. The plan is subject to the approval of the stockholders
within 12 months after the date of its adoption.
The plan will remain in effect for 10 years after the date of its adoption by
our Board of Directors. The plan may be amended by the Board of Directors
without the consent of our stockholders, except that any amendment, although
effective when made, will be subject to stockholder approval if required by any
Federal or state law or regulation or by the rules of any stock exchange or any
automated quotation system on which our common stock may then be listed or
quoted. The number of shares received under the plan and the number of shares
subject to outstanding options are subject to adjustment in the event of stock
splits, stock dividends and other extraordinary corporate events.
On May 21, 2004, the we filed a Form S-8 to register 750,000 shares of our
common stock at an offering price of $2.20 per share. Currently, all of the
shares under this plan, 2004 Stock Compensation Plan, have been issued.
On June 13, 2005, we filed a Form S-8 to register 5,000,000 shares of our common
stock at an offering price of $0.30 per share. Currently, all of the shares
under this plan have been issued. No options were granted during the year ended
December 31, 2005.
On January 3, 2006, the we filed a Form S-8 to register 10,000,000 shares of its
common stock at an offering price of $0.08 per share. Currently, all of the
shares under this plan have been issued.
EMPLOYMENT AGREEMENTS
Our employment agreement with Michael Barron requires him to perform the duties
of Chairman of the Board and Chief Executive Officer at an annual salary of
$300,000. He received 160,000 shares of restrictive stock which vests ratably on
a monthly basis during the first two years of the term of the agreement. In
addition, Mr. Barron is entitled to receive a performance bonus if our actual
annual revenues and net income equals or exceeds projected annual revenues and
net income approved by our Board. His performance bonus will be equal to the
percentage of his annual salary equal to 50% plus the percentage by which actual
income exceeds projected income. He is entitled to the same benefits afforded to
other executives. He is also entitled to a car allowance of $1,000 per month.
His employment agreement provides that if we terminate him without cause, he is
entitled to receive a lump sum payment equal to twice his annual salary plus the
present value of a performance bonus computed on the basis that we achieve all
of our performance targets. Mr. Barron's employment agreement commenced as of
June 15, 2006 and terminates on June 14, 2009.
Our employment agreement with Joseph Cosio-Barron requires him to perform the
duties of -President at an annual salary of $300,000. He received 160,000 shares
of restrictive stock which vests ratably on a monthly basis during the first two
years of the term of the agreement. In addition, Mr. Cosio-Barron is entitled to
receive a performance bonus if our actual annual revenues and net income equals
or exceeds projected annual revenues and net income approved by our Board. His
performance bonus will be equal to the percentage of his annual salary equal to
50% plus the percentage by which actual income exceeds projected income. He is
entitled to the same benefits afforded to other executives. He is also entitled
to a car allowance of $1,000 per month. His employment agreement provides that
if we terminate him without cause, he is entitled to receive a lump sum payment
equal to twice his annual salary plus the present value of a performance bonus
computed on the basis that we achieve all of our performance targets. Mr.
Cosio-Barron's employment agreement commenced as of June 15, 2006 and terminates
on June 14, 2009.
DIRECTOR COMPENSATION
We currently do not compensate our directors for attending Board meetings, but
we do reimburse them for out-of-pocket expenses.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On January 21, 2005, the we borrowed $125,000 from our Chief Financial Officer,
Wayne Bailey. On October 14, 2004 we borrowed $150,000 from our Chief Executive
Officer, Michael Barron. On January 21, 2005, we borrowed $125,000 from our
Chief Executive Officer, Michael Barron. A Note Payable from the company in the
amount of $125,000 has been personally guaranteed by Michael Barron.
30
During the month of December 2005, we entered in to financing agreement with
Eclipse Holding Company, which is 50% owned by our Chief Executive Officer,
Michael Barron. We entered into an agreement to borrow a total of $750,000 in
the form of a note payable, with an interest of 10% per annum. At December 31,
2005, the outstanding balance on this note was $642,846. The agreement calls for
the issuance of common stock warrants. As of December 31, 2005 the we issued
7,500,000 shares.
On July 15, 2004, Marshall L. Stewart and Daryl S. Meddings, officers of Ocean
West Holding Corporation agreed to sell 4,106,776 of their shares of common
stock of Ocean West to CDA in exchange for 519,310 shares of CDA for an
approximate value of $983,573, based on the average trading prices of the
respective stocks for the month of June 2005. Mr. Stewart and Mr. Meddings
currently own combined 7% of the shares of the Company and are currently on the
board of Ocean West as well as officers.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information with respect to beneficial
ownership of the Common Stock as of April 5, 2006 by (i) each person known by us
to be the beneficial owner of more than five percent of our Common Stock, (ii)
each of our executive officers and directors, and (iii) all of our executive
officers and directors as a group. See "Management."
PERCENT OF COMMON
NUMBER OF SHARES STOCK BENEFICIALLY
NAME AND ADDRESS OF BENEFICIAL OWNER (1) BENEFICIALLY OWNED (2) OWNED (3)
===================================================================================================================================
Michael A. Barron (President, Chief Executive Officer and Director) 7,714,918(4) 8%
Lee Shorey (Chief Financial Officer and Director) 67,000 0.1%
Joseph Cosio-Barron (-President 12,488,618(5) 12.9%
Crusader Capital Partners 15,361,462(6) 16.0%
Eclipse Holding Corporation 22,469,999(7) 23.4%
All Officers and Directors as a group (4 persons) 20,203,536(8) 20.9%
(1) The address of each of the beneficial owners is 6330 S. Sandhill,
Suite 8, Las Vegas, Nevada 89120. Except as indicated.
(2) In computing the number of shares beneficially owned by a person and
the percentage ownership of that person, shares of common stock
subject to options held by that person that are currently
exercisable, or become exercisable within 60 days after February 16,
2006 are deemed outstanding. However, such shares are not deemed
outstanding for purposes of computing the percentage ownership of
any other person.
(3) Based on 96,198,027 shares outstanding as of April 5, 2006, plus the
number of shares, which the beneficial owner has the right to
acquire within 60 days, if any, as indicated in footnote (2) above.
(4) Includes 64,000 shares issuable upon exercise of an option and
160,000 shares issuable upon exercise of a warrant held by Mr.
Barron.
(5) Includes 48,000 shares issuable upon exercise of an option and
160,000 shares issuable upon exercise of a warrant held by Mr.
Cosio-Barron.
(6) The address is 230 Park Avenue, Suite 1000, New York, NY 10169.
(7) The address is c/o Jeffrey Helfer CPA, 21800 Oxnard St., #850,
Woodland Hills, CA 91367
(8) Includes 112,000 shares issuable upon exercise of options and
320,000 shares issuable upon exercise of warrants.
DESCRIPTION OF SECURITIES
Our authorized capital stock consists of 500,000,000 shares of stock, of which
500,000,000 shares are designated common stock, par value $.001 per share, and
1,000,000 shares of Series A preferred stock, par value $.01 per share. As of
June 10, 2006, there were 96,198,027 shares of common stock, and 107,500 shares
of preferred stock issued or outstanding.
The following summary of the material provisions of our common stock, series A
preferred stock, series B preferred stock, warrants, certificate of
incorporation and by-laws is qualified by reference to the provisions of our
certificate of incorporation and by-laws and the forms of warrants included as
exhibits to the registration statement of which this prospectus is a part.
31
COMMON STOCK
The holders of common stock do not have cumulative voting rights and are
entitled to one vote per share on all matters to be voted upon by the
stockholders. Our common stock is not entitled to preemptive rights and is not
subject to redemption (including sinking fund provisions) or conversion. Upon
our liquidation, dissolution or winding-up, the assets (if any) legally
available for distribution to stockholders are distributable ratably among the
holders of our common stock after payment of all classes or series of our
preferred stock. All outstanding shares of our common stock are validly issued,
fully-paid and nonassessable. The rights, preferences and privileges of holders
of our common stock are subject to the preferential rights of all classes or
series of preferred stock that we may issue in the future.
PREFERRED STOCK
Our articles of incorporation authorize up to 15,000,000 shares of $0.01 par
value preferred stock. Shares of preferred stock may be issued in one or more
classes or series at such time and in such quantities the board of directors may
determine. All shares of any one series shall be equal in rank and identical in
all respects. Preferred stockholders have liquidation preference up to the
amount of the original equity investment. Each share of preferred stock is
convertible into one share of common stock. As of December 31, 2005, there were
no preferred shares issued.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our common stock is Continental Stock
transfer and Trust Company, New York, New York, (212) 509-4000.
MARKET INFORMATION
Our common stock is quoted on the OTC Bulletin Board under the symbol "SFNN
..OB." The market for our common stock is characterized generally by low volume.
COMMISSION'S POSITION ON INDEMNIFICATION FOR SECURITIES ACT LIABILITIES
Our Articles of Incorporation, provides that our directors or officers shall not
be personally liable to us or our shareholders for damages for breach of such
director's or officer's fiduciary duty as a director or officer, except for (i)
acts or omissions which involve intentional misconduct, fraud or a knowing
violation of the law or (ii) the unlawful payment of dividends. The effect of
this provision of our Articles of Incorporation, is to eliminate our rights and
our shareholders' rights (through shareholders' derivative suits on behalf of
our company) to recover damages against a director or officer for breach of the
fiduciary duty of care as a director or officer, except under certain situations
detailed in our Articles of Incorporation. We believe that the indemnification
provisions in our Articles of Incorporation, as amended, are necessary to
attract and retain qualified persons as directors and officers.
Our Articles of Incorporation also provides that every person who was or is a
party to, or is threatened to be made a party to, or is involved in any such
action, suit or proceeding, whether civil, criminal, administrative or
investigative, by the reason of the fact that he or she, or a person with whom
he or she is a legal representative, is or was a director of the corporation, or
who is serving at the request of the corporation as a director or officer of
another corporation, or is a representative in a partnership, joint venture,
trust or other enterprise, shall be indemnified and held harmless to the fullest
extent legally permissible under the laws of the State of Nevada from time to
time against all expenses, liability and loss (including attorneys' fees,
judgments, fines, and amounts paid or to be paid in a settlement) reasonably
incurred or suffered by him or her in connection therewith. Such right of
indemnification shall be a contract right which may be enforced in any manner
desired by such person. The expenses of officers and directors incurred in
defending a civil suit or proceeding must be paid by the corporation as incurred
and in advance of the final disposition of the action, suit, or proceeding,
under receipt of an undertaking by or on behalf of the director or officer to
repay the amount if it is ultimately determined by a court of competent
jurisdiction that he or she is not entitled to be indemnified by the
corporation. Such right of indemnification shall not be exclusive of any other
right of such directors, officers or representatives may have or hereafter
acquire, and, without limiting the generality of such statement, they shall be
entitled to their respective rights of indemnification under any bylaw,
agreement, vote of stockholders, provision of law, or otherwise, as well as
their rights under this article.
Insofar as indemnification for liabilities arising under the Securities Act of
1933 may be permitted to directors, officers or persons controlling us pursuant
to the foregoing provisions, or otherwise, we have been advised that in the
opinion of the Securities and Exchange Commission, such indemnification is
against public policy as expressed in the Securities Act of 1933 and is,
therefore, unenforceable.
PLAN OF DISTRIBUTION
The selling stockholders and any of their respective pledgees, donees, assignees
and other successors-in-interest may, from time to time, sell any or all of
their shares of common stock on any stock exchange, market or trading facility
on which the shares are traded or in private transactions. These sales may be at
fixed or negotiated prices. The selling stockholders may use any one or more of
the following methods when selling shares:
32
o ordinary brokerage transactions and transactions in which the
broker-dealer solicits the purchaser;
o block trades in which the broker-dealer will attempt to sell the shares
as agent but may position and resell a portion of the block as
principal to facilitate the transaction;
o purchases by a broker-dealer as principal and resale by the
broker-dealer for its account;
o an exchange distribution in accordance with the rules of the applicable
exchange;
o privately-negotiated transactions;
o broker-dealers may agree with the selling stockholders to sell a
specified number of such shares at a stipulated price per share;
o a combination of any such methods of sale; and
o any other method permitted pursuant to applicable law.
The selling stockholders may also sell shares under Rule 144 under the
Securities Act, if available, or Regulation S, rather than under this
prospectus. The selling stockholders shall have the sole and absolute discretion
not to accept any purchase offer or make any sale of shares if they deem the
purchase price to be unsatisfactory at any particular time.
The selling stockholders or their respective pledgees, donees, transferees or
other successors in interest, may also sell the shares directly to market makers
acting as principals and/or broker-dealers acting as agents for themselves or
their customers. Such broker-dealers may receive compensation in the form of
discounts, concessions or commissions from the selling stockholders and/or the
purchasers of shares for whom such broker-dealers may act as agents or to whom
they sell as principal or both, which compensation as to a particular
broker-dealer might be in excess of customary commissions. Market makers and
block purchasers purchasing the shares will do so for their own account and at
their own risk. It is possible that a selling stockholder will attempt to sell
shares of common stock in block transactions to market makers or other
purchasers at a price per share which may be below the then market price. The
selling stockholders cannot assure that all or any of the shares offered in this
prospectus will be issued to, or sold by, the selling stockholders. The selling
stockholders and any brokers, dealers or agents, upon effecting the sale of any
of the shares offered in this prospectus, may be deemed to be "underwriters" as
that term is defined under the Securities Act of 1933, as amended, or the
Securities Exchange Act of 1934, as amended, or the rules and regulations under
such acts. In such event, any commissions received by such broker-dealers or
agents and any profit on the resale of the shares purchased by them may be
deemed to be underwriting commissions or discounts under the Securities Act.
We are required to pay all fees and expenses incident to the registration of the
shares, including fees and disbursements of counsel to the selling stockholders,
but excluding brokerage commissions or underwriter discounts.
The selling stockholders, alternatively, may sell all or any part of the shares
offered in this prospectus through an underwriter. No selling stockholder has
entered into any agreement with a prospective underwriter and there is no
assurance that any such agreement will be entered into.
The selling stockholders may pledge their shares to their brokers under the
margin provisions of customer agreements. If a selling stockholders defaults on
a margin loan, the broker may, from time to time, offer and sell the pledged
shares. The selling stockholders and any other persons participating in the sale
or distribution of the shares will be subject to applicable provisions of the
Securities Exchange Act of 1934, as amended, and the rules and regulations under
such act, including, without limitation, Regulation M. These provisions may
restrict certain activities of, and limit the timing of purchases and sales of
any of the shares by, the selling stockholders or any other such person. In the
event that the selling stockholders are deemed affiliated purchasers or
distribution participants within the meaning of Regulation M, then the selling
stockholders will not be permitted to engage in short sales of common stock.
Furthermore, under Regulation M, persons engaged in a distribution of securities
are prohibited from simultaneously engaging in market making and certain other
activities with respect to such securities for a specified period of time prior
to the commencement of such distributions, subject to specified exceptions or
exemptions.
We have agreed to indemnify the selling stockholders, or their transferees or
assignees, against certain liabilities, including liabilities under the
Securities Act of 1933, as amended, or to contribute to payments the selling
stockholders or their respective pledgees, donees, transferees or other
successors in interest, may be required to make in respect of such liabilities.
If the selling stockholders notify us that they have a material arrangement with
a broker-dealer for the resale of the common stock, then we would be required to
amend the registration statement of which this prospectus is a part, and file a
prospectus supplement to describe the agreements between the selling
stockholders and the broker-dealer.
33
PENNY STOCK
The Securities and Exchange Commission has adopted Rule 15g-9 which establishes
the definition of a "penny stock," for the purposes relevant to us, as any
equity security that has a market price of less than $5.00 per share or with an
exercise price of less than $5.00 per share, subject to certain exceptions. For
any transaction involving a penny stock, unless exempt, the rules require:
o that a broker or dealer approve a person's account for transactions in
penny stocks; and
o the broker or dealer receive from the investor a written agreement to
the transaction, setting forth the identity and quantity of the penny
stock to be purchased.
In order to approve a person's account for transactions in penny stocks, the
broker or dealer must:
o obtain financial information and investment experience objectives of
the person; and
o make a reasonable determination that the transactions in penny stocks
are suitable for that person and the person has sufficient knowledge
and experience in financial matters to be capable of evaluating the
risks of transactions in penny stocks.
The broker or dealer must also deliver, prior to any transaction in a penny
stock, a disclosure schedule prescribed by the Commission relating to the penny
stock market, which, in highlight form:
o sets forth the basis on which the broker or dealer made the suitability
determination; and
o that the broker or dealer received a signed, written agreement from the
investor prior to the transaction.
Generally, brokers may be less willing to execute transactions in
securities subject to the "penny stock" rules. This may make it more difficult
for investors to dispose of our common stock and cause a decline in the market
value of our stock.
Disclosure also has to be made about the risks of investing in penny
stocks in both public offerings and in secondary trading and about the
commissions payable to both the broker-dealer and the registered representative,
current quotations for the securities and the rights and remedies available to
an investor in cases of fraud in penny stock transactions. Finally, monthly
statements have to be sent disclosing recent price information for the penny
stock held in the account and information on the limited market in penny stocks.
34
SELLING STOCKHOLDERS
The table below sets forth information concerning the resale of the shares of
common stock by the selling stockholders. We will not receive any proceeds from
the resale of the common stock by the selling stockholders. We will receive
proceeds from the exercise of the warrants. Assuming all the shares registered
below are sold by the selling stockholders, none of the selling stockholders
will continue to own any shares of our common stock.
The following table also sets forth the name of each person who is offering the
resale of shares of common stock by this prospectus, the number of shares of
common stock beneficially owned by each person, the number of shares of common
stock that may be sold in this offering and the number of shares of common stock
each person will own after the offering, assuming they sell all of the shares
offered.
-----------------------------------------------------------------------------------------------------------------------------------
Total
Total Shares of Percentage Percentage
Common Stock of Common Shares of Beneficial of Common
Issuable Upon Stock, Common Stock Beneficial Percentage of Ownership Stock Owned
Conversion of Assuming Included in Ownership Common Stock After the After
Name Notes Full Prospectus Before the Owned Before Offering Offering
and/or Warrants Conversion (1) Offering* Offering* (7) (7)
-----------------------------------------------------------------------------------------------------------------------------------
AJW Offshore, Ltd. (2) 75,666,771(3) 78.65% Up to 4,800,281 4.99% 4,800,281 4.99%
57,366,771
shares of
common stock
-----------------------------------------------------------------------------------------------------------------------------------
AJW Qualified 34,608,245(4) 36% Up to 4,800,281 4.99% 4,800,281 4.99%
Partners, LLC (2) 26,238,245
shares of
common stock
-----------------------------------------------------------------------------------------------------------------------------------
AJW Partners, LLC (2) 12,156,301(5) 13% Up to 4,800,281 4.99% 2,940,000 3.06%
9,216,301
shares of
common stock
-----------------------------------------------------------------------------------------------------------------------------------
New Millennium Capital 1,612,571(6) 1.68% Up to 1,612,571 1.67% 390,000 **
Partners II, LLC (2) 1,222,571
shares of
common stock
===================================================================================================================================
* These columns represent the aggregate maximum number and percentage of shares
that the selling stockholders can own at one time (and therefore, offer for
resale at any one time) due to their 4.99% limitation.
** Less than 1%
The number and percentage of shares beneficially owned is determined in
accordance with Rule 13d-3 of the Securities Exchange Act of 1934, and the
information is not necessarily indicative of beneficial ownership for any other
purpose. Under such rule, beneficial ownership includes any shares as to which
the selling stockholders has sole or shared voting power or investment power and
also any shares, which the selling stockholders has the right to acquire within
60 days. The actual number of shares of common stock issuable upon the
conversion of the secured convertible notes is subject to adjustment depending
on, among other factors, the future market price of the common stock, and could
be materially less or more than the number estimated in the table.
(1) Includes a good faith estimate of the shares issuable upon conversion of the
secured convertible notes, based on current market prices. Because the number of
shares of common stock issuable upon conversion of the secured convertible notes
is dependent in part upon the market price of our common stock prior to a
conversion, the actual number of shares of common stock that will be issued upon
conversion will fluctuate daily and cannot be determined at this time. The
selling stockholders have contractually agreed to restrict their ability to
convert their secured convertible notes or exercise their warrants and receive
shares of our common stock such that the number of shares of common stock held
by them in the aggregate and their affiliates after such conversion or exercise
does not exceed 4.99% of the then issued and outstanding shares of common stock
as determined in accordance with Section 13(d) of the Exchange Act. Accordingly,
the number of shares of common stock set forth in the table for the selling
stockholders exceeds the number of shares of common stock that the selling
stockholders could own beneficially at any given time through their ownership of
the secured convertible notes and the warrants. In that regard, the beneficial
ownership of the common stock by the selling stockholder set forth in the table
is not determined in accordance with Rule 13d-3 under the Securities Exchange
Act of 1934, as amended.
35
The shares being registered hereunder do not include shares of common stock that
may be acquired by the selling stockholders upon conversion of amounts due to
them resulting from future accruals of interest pursuant to the convertible
notes.
(2) The selling stockholders are affiliates of each other because they are under
common control. AJW Partners, LLC is a private investment fund that is owned by
its investors and managed by SMS Group, LLC. SMS Group, LLC, of which Mr. Corey
S. Ribotsky is the fund manager, has voting and investment control over the
shares listed below owned by AJW Partners, LLC. AJW Offshore, Ltd., formerly
known as AJW/New Millennium Offshore, Ltd., is a private investment fund that is
owned by its investors and managed by First Street Manager II, LLC. First Street
Manager II, LLC, of which Corey S. Ribotsky is the fund manager, has voting and
investment control over the shares owned by AJW Offshore, Ltd. AJW Qualified
Partners, LLC, formerly known as Pegasus Capital Partners, LLC, is a private
investment fund that is owned by its investors and managed by AJW Manager, LLC,
of which Corey S. Ribotsky and Lloyd A. Groveman are the fund managers, have
voting and investment control over the shares listed below owned by AJW
Qualified Partners, LLC. New Millennium Capital Partners II, LLC, is a private
investment fund that is owned by its investors and managed by First Street
Manager II, LLC. First Street Manager II, LLC, of which Corey S. Ribotsky is the
fund manager, has voting and investment control over the shares owned by New
Millennium Capital Partners II, LLC. We have been notified by the selling
stockholders that they are not broker-dealers or affiliates of broker-dealers
and that they believe they are not required to be broker-dealers.
(3) Includes (i) 57,366,771 shares of common stock issuable upon conversion of
secured convertible notes, and (ii) 18,300,000 shares of common stock issuable
upon exercise of common stock purchase warrants.
(4) Includes (i) 26,238,245 shares of common stock issuable upon conversion of
secured convertible notes, and (ii) 8,370,000 shares of common stock issuable
upon exercise of common stock purchase warrants.
(5) Includes (i) 9,216,300 shares of common stock issuable upon conversion of
secured convertible notes, and (ii) 2,940,000 shares of common stock issuable
upon exercise of common stock purchase warrants.
(6) Includes (i) 1,22,570 shares of common stock issuable upon conversion of
secured convertible notes, and (ii) 390.000 shares of common stock issuable upon
exercise of common stock purchase warrants.
(7) Assumes that all securities registered will be sold.
TERMS OF SECURED CONVERTIBLE NOTES AND THE WARRANTS
To obtain funding for our ongoing operations, we entered into a Securities
Purchase Agreement with four accredited investors on June 30, 2006 for the sale
of (i) $1,500,000 in secured convertible notes and (ii) warrants to buy
30,000,000 shares of our common stock.
The investors are obligated to provide us with the funds (gross proceeds) as
follows:
o $5000,000 was disbursed at the closing;
o $500,000 will be disbursed within five days of filing a registration
statement covering the number of shares of common stock underlying the
secured convertible notes and the warrants, and
o $500,000 will be disbursed within five days of the effectiveness of
this prospectus.
The secured convertible notes bear interest at 6%, unless our common stock is
greater than $0.025 per share for each trading day of a month, in which event no
interest is payable during such month. The secured convertible notes mature
three years from the date of issuance, and are convertible into our common
stock, at the Purchasers' option, at a 50% discount (subject to adjustment as
provided for in the note) to the average of the three lowest trading prices of
the common stock during the 20 trading day period prior to conversion.
The full principal amount of the secured convertible notes are due upon a
default under the terms of secured convertible notes. In addition, we granted
the Purchasers a security interest in substantially all of its assets. Pursuant
to an amendment to the registration rights agreement between us and the selling
shareholders, we are required to file a registration statement with the
Securities and Exchange Commission within 30 days of closing, which will include
100% of the common stock underlying the secured convertible notes. If the
registration statement is not declared effective within 165 days from the date
of closing, we are required to pay liquidated damages to the Purchasers. In the
event that we breach any representation or warranty in the Securities Purchase
Agreement, the we are required to pay liquidated damages in shares or cash, at
our election, in an amount equal to three percent of the outstanding principal
amount of the secured convertible notes per month plus accrued and unpaid
interest.
The warrants are exercisable until five years from the date of issuance at a
purchase price of $0.02 per share. The Purchasers may exercise the warrants on a
cashless basis if the shares of common stock underlying the warrants are not
then registered pursuant to an effective registration statement. In the event
the Purchasers exercise the warrants on a cashless basis, then we will not
receive any proceeds. In addition, the exercise price of the warrants will be
adjusted in the event the Company issues common stock at a price below market (a
"Dilutive Issuance"). Upon an issuance of shares of common stock below the
market price, the exercise price of the warrants will be reduced as set forth in
Warrant.
36
In addition, the conversion price of the secured convertible notes and the
exercise price of the warrants may be adjusted in certain circumstances such as
if we pay a stock dividend, subdivides or combines outstanding shares of common
stock into a greater or lesser number of shares, or takes such other actions as
would otherwise result in dilution of the selling stockholder's position.
The Purchasers have agreed to restrict their ability to convert their secured
convertible notes or exercise their warrants and receive shares of the our
common stock such that the number of shares of common stock held by them in the
aggregate and their affiliates after such conversion or exercise does not exceed
4.9% of the then issued and outstanding shares of common stock.
In connection with the Securities Purchase Agreement, we executed a Security
Agreement in favor of the investors granting them a continuing security interest
in, a continuing first lien upon all of our goods, inventory, contractual rights
and general intangibles, receivables, documents, instruments, chattel paper.
Under the Security Agreement, events of default occur upon:
o The occurrence of an event of default (as defined in the secured
convertible notes) under the secured convertible notes;
o Any representation or warranty we made in the Security Agreement shall
prove to have been incorrect in any material respect when made;
o The failure by us to observe or perform any of our obligations under
the Security Agreement or in the Intellectual Property Security
Agreement for ten (10) days after receipt of notice of such failure
from the investors; and
o Any breach of, or default under, the Warrants.
An event of default under the secured convertible notes occurs if we:
o Fail to pay the principal or interest when due;
o Do not issue shares of common stock upon receipt of a conversion
notice;
o Fail to file a registration statement within 45 days after June 30,
2006 or fail to have the registration statement effective by within 120
days after June 30, 2006;
o Breach any material covenant or other material term or condition in the
secured convertible notes or the Securities Purchase Agreement;
o Breach any representation or warranty made in the Securities Purchase
Agreement or other document executed in connection therewith;
o Apply for or consent to the appointment of a receiver or trustee for us
or any of our subsidiaries or for a substantial part of our of our
subsidiaries' property or business, or such a receiver or trustee shall
otherwise be appointed;
o Have any money judgment, writ or similar process shall be entered or
filed against us or any of our subsidiaries or any of our property or
other assets for more than $100,000, and shall remain unvacated,
unbonded or unstayed for a period of thirty (30) days unless otherwise
consented to by the investors;
o Institute or have instituted against us or any of our subsidiaries any
bankruptcy, insolvency, reorganization or liquidation proceedings or
other proceedings for relief under any bankruptcy law or any law for
the relief of debtors;
o Fail to maintain the listing of our common stock on one of the OTCBB or
an equivalent replacement exchange, the Nasdaq National Market, the
Nasdaq SmallCap Market, the New York Stock Exchange, or the American
Stock Exchange; or
o Default under any other secured convertible note issued pursuant to the
Securities Purchase Agreement.
Upon occurrence of any event of default under either the Security Agreement, the
investors shall have the right to exercise all of the remedies conferred under
the Security Agreement and under the secured convertible notes, and the
investors shall have all the rights and remedies of a secured party under the
Uniform Commercial Code and/or any other applicable law (including the Uniform
Commercial Code of any jurisdiction in which any collateral is then located).
37
The investors shall have the following rights and powers:
o Taking possession of all of our assets, including, but not limited to,
our inventory, receivables, equipment, contract rights and other
general intangibles, as well as our intellectual property; and
o Operating our business using the collateral as set forth above with the
right to assign, sell, lease or otherwise dispose of and deliver all or
any part of the collateral, at public or private sale or otherwise, for
cash or on credit.
A complete copy of the Securities Purchase Agreements and related documents are
incorporated by reference as exhibits to our Form SB-2 registration statement
relating to this prospectus.
SAMPLE CONVERSION CALCULATION
The number of shares of common stock issuable upon conversion of the secured
convertible notes is determined by dividing that portion of the principal of the
notes to be converted and interest, if any, by the conversion price. For
example, assuming conversion of the $1,50,000 of secured convertible notes on
July 6, 2006, at a conversion price of $.0201 number of shares issuable upon
conversion would be:
$1,500,000/$0.0201 = 74,626,8655 shares
The following is an example of the amount of shares of our common stock that are
issuable, upon conversion of the principal amount of our secured convertible
notes, based on market prices 25%, 50% and 75% below the market price as of July
6, 2006 of $0.0201.
% BELOW MARKET PRICE PER SHARE DISCOUNT OF 50% NUMBER OF SHARES ISSUABLE
-------------- --------------- --------------- -------------------------
25% $.015075 $.008 187,500,000
50% $.01005 $.005 300,000,000
75% $.0035 $.00175 857,142,857
LEGAL MATTERS
Sichenzia Ross Friedman Ference LLP, New York, New York will issue an opinion
with respect to the validity of the shares of common stock being offered hereby.
EXPERTS
Our consolidated financial statements for the year ended December 31, 2005
included in this prospectus have been audited by Pollard-Kelley Auditing
Services Inc. independent registered public accounting firm, as stated in their
report, appearing in this prospectus and have been so included in reliance upon
the report of such firm given upon their authority as experts in accounting and
auditing. Our consolidated financial statements for they year ended December 31,
2004, included in this prospectus have been audited by De Joya & Company
independent registered public accounting firm, as stated in their report,
appearing in this prospectus and have been so included in reliance upon the
report of such firm given upon their authority as experts in accounting and
auditing.
AVAILABLE INFORMATION
We have filed a registration statement on Form SB-2 under the Securities Act of
1933, as amended, relating to the shares of common stock being offered by this
prospectus, and reference is made to such registration statement. This
prospectus constitutes the prospectus of SHEARSON FINANCIAL NETWORK, INC..,
filed as part of the registration statement, and it does not contain all
information in the registration statement, as certain portions have been omitted
in accordance with the rules and regulations of the Securities and Exchange
Commission.
We are subject to the informational requirements of the Securities Exchange Act
of 1934 which requires us to file reports, proxy statements and other
information with the Securities and Exchange Commission. Such reports, proxy
statements and other information may be inspected at public reference facilities
of the SEC at 100 F Street N.E. Washington, D.C. 20549. Copies of such material
can be obtained from the Public Reference Section of the SEC at 100 F Street
N.E. Washington, D.C. 20549 at prescribed rates. Because we file documents
electronically with the SEC, you may also obtain this information by visiting
the SEC's Internet website at http://www.sec.gov.
38
INDEX TO FINANCIAL STATEMENTS
SHEARSON FINANCIAL NETWORK, INC.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ............................ F-2
CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2005 ................................ F-3
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004 F-4
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2005 AND
2004 ............................................................................... F-5
STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)......................................... F-6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ......................................... F-7 - F-21
CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 2006 (UNAUDITED) AND DECEMBER 31, 2005 . F-22
CONSOLIDATED STATEMENT OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2006
AND 2005 (UNAUDITED) ............................................................... F-23
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 2006
AND 2005 (UNAUDITED) ............................................................... F-24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ......................................... F-25 - F-26
F-1
Report of Independent Registered Public Accounting Firm
Board of Directors
Consumer Direct of America
We have audited the accompanying balance sheets of Consumer Direct of America
and Subsidiaries as of December 31, 2005, and the related statements of income,
changes in stockholders' equity, and cash flows for the one year period ended
December 31, 2005. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conduct our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
The Company has not generated significant revenues or profits to date. This
factor among others may indicate the Company will be unable to continue as a
going concern. The Company's continuation as a going concern depends upon its
ability to generate sufficient cash flow to conduct its operations and its
ability to obtain additional sources of capital and financing. The accompanying
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of the Company at December 31,
2005 and the results of its operations and it cash flows for one year period
ended December 31, 2005, in conformity with U.S. generally accepted accounting
standards.
Pollard-Kelley Auditing Services, Inc.
/S/ Pollard-Kelley Auditing Services, Inc.
Fairlawn, Ohio
May 21, 2006
- --------------------------------------------------------------------------------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Consumer Direct ofAmerica
Las Vegas, Nevada
We have audited the consolidated balance sheet of Consumer Direct of America and
Subsidiary (the "Company") as of December 31, 2004 and the related consolidated
statements of operations, stockholders' deficit and cash flows for the year
ended December 31, 2004. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosure in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statement referred to above presently
fairly, in all material respects, the financial position of Consumer Direct of
America and Subsidiary as of December 31, 2004 and the results of their
operations and their cash flows for the year ended December 31, 2004, in
conformity with accounting principles generally accepted in the United States.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses from operations
and has an accumulated deficit as of December 31, 2004, which raises substantial
doubt about the Company's ability to continue as a going concern. Management's
plans in regard to these matters are also described in Note 1. The consolidated
financial statements do not include any adjustments that might result from the
outcome of these uncertainties.
/s/ De Joya & Company
De Joya and Company.
Henderson, Nevada
May 6, 2005
F-2
CONSUMER DIRECT OF AMERICA
CONSOLIDATED BALANCE SHEET
December 31,
2005
------------------
Assets
Current assets:
Cash and cash equivalents $ 21,401
Mortgage loans held for sale 831,200
Accounts receivable and receivables from loans sold, net 107,321
Prepaid and other current assets 433,281
------------------
Total current assets 1,393,203
------------------
Property and equipment, net 1,664,571
------------------
Other assets:
Notes receivable --
Goodwill 1,372,916
Total other assets 1,372,916
------------------
Total assets $ 4,430,690
==================
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable and accrued expenses $ 1,690,101
Bridge notes payable 5,869,682
Interest payable 140,794
Notes payable 333,173
Notes payable - related party 767,846
Line of Credit 3,497,073
------------------
Total current liabilities 12,298,669
Long-term liabilities:
Long term debt, net of current portion --
------------------
Total long- term liabilities --
------------------
Total liabilities 12,298,669
------------------
Stockholders' deficit:
Preferred stock, $0.01 par value, 15,000,000 shares authorized 0 issued and outstanding at December 31, 2005 --
Common stock, $0.001 par value, 100,000,000, 37,544,108 shares issued and outstanding December 31, 2005 37,544
Additional paid-in capital 20,926,149
Treasury stock, cost method --
Accumulated deficit (28,831,673)
------------------
Total stockholders' (deficit) (7,867,979)
------------------
Total liabilities and stockholders' (deficit) $ 4,430,690
==================
See accompanying notes to consolidated financial statements.
F-3
CONSUMER DIRECT OF AMERICA
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
2005 2004
---------------- ----------------
Revenues
Loan origination and sale of mortgage loans $ 6,483,748 $ 8,430,137
Marketing revenues and commissions 335,536 506,801
Rental income 6,905 3,685
---------------- ----------------
Total revenue 6,826,190 8,940,623
Cost of sales 2,786,367 4,711,668
---------------- ----------------
Gross Profit 4,039,822 4,228,955
Expenses
Selling, general and administrative 10,111,434 11,458,276
Depreciation expense 684,820 633,911
---------------- ----------------
Total expenses 10,976,254 14,429,327
Loss from operations (6,756,432) (7,863,233)
---------------- ----------------
Other (expense) income
Interest income -- --
Interest expense (184,290) (1,588,147)
Debt discount expense (2,904,110) (2,489,916)
Impairment of goodwill (732,105) --
Write down of investment (352,829) --
Other income -- 490,483
---------------- ----------------
Total other (expense) income (4,173,333) (3,587,580)
Loss before minority shareholder interest (10,929,765) (11,450,813)
---------------- ----------------
Loss applicable to minority shareholder interest -- 262,727
---------------- ----------------
Net loss (10,929,765) (11,188,086)
Dividends on preferred shares (69,481) (74,559)
Net loss applicable to common shareholders $ (10,999,246) $ (11,262,645)
================ ================
Net loss per share, basic and diluted $ (0.50) $ (2.09)
================ ================
Net loss per common share, applicable to common shareholders, basic and diluted $ (0.50) $ (2.11)
================ ================
Weighted average number of common shares outstanding, basic and diluted 21,942,476 5,349,423
See accompanying notes to consolidated financial statements.
F-4
CONSUMER DIRECT OF AMERICA
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
2005 2004
---------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) $ (10,929,765) $ (11,188,086)
ADJUSTMENTS TO RECONCILE NET LOSS FROM OPERATIONS TO NET CASH USED IN OPERATIONS:
Depreciation 684,820 633,911
Write down on capitalized investments 352,829 360,000
Stock based expenses 2,972,838 5,334,903
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable 123,391 506,886
(Increase) decrease in mortgage loans held for sale 10,074,577 (7,626,394)
(Increase) decrease in prepaid expenses 177,650 267,069
(Increase) decrease in goodwill 732,105 --
(Increase) decrease related to sale of asset (560,417) 159,505
(Increase) decrease in other assets 3,698,578 (1,805,857)
Increase (decrease) in accounts payable and accrued expenses (2,072,271) 93,058
Increase (decrease) in interest payable 88,111 36,269
(Increase) decrease in minority shareholder interest 532,595 (532,595)
---------------- ----------------
Net cash used in operating activities 5,875,041 (13,761,331)
---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of fixed assets (12,209) (1,261,260)
Disposition of fixed assets 162,978 --
Payment received on notes receivable -- 30,875
---------------- ----------------
Net cash provided by (used in) investing activities 150,769 (1,230,385)
---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Advances (payments)on lines of credit (8,428,350) 9,070,414
Proceeds from related notes payable 617,846 15,000
Proceeds from bridge loans -- 5,574,082
Payments of notes payable (66,799) --
Payments of long term debt (493,759) --
Redemption (purchase) of treasury stock 271,600 (556,600)
Dividends paid on preferred shares of subsidiary (69,481) (74,559)
---------------- ----------------
Net cash provided by financing activities (6,202,551) 15,187,268
---------------- ----------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (176,740) 195,552
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 198,141 2,589
---------------- ----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 21,401 $ 198,141
================ ================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid $ 251,199 $ 115,310 -
---------------- ----------------
See accompanying notes to consolidated financial statements.
F-5
CONSUMER DIRECT OF AMERICA
STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
Additional Total
Common Stock Treasury Paid in Accumulated Stockholders'
Shares Amount Stock Capital Deficit Equity
(Deficit)
------------ -------- --------- ------------- ------------ -------------------
BALANCE DECEMBER 31, 2003 (RESTATED) 3,392,171 $ 3,392 $ 9,036,568 $ (6,569,782) $ 2,470,178
Issuance of stock 737,000 737 1,397,801 1,398,538
Treasury stock purchased (556,600) (556,600)
Stock issued for debt conversion 1,228,292 1,228 508,505 509,733
Treasury stock issued for services 285,000 285,000
Stock issued for services 901,402 901 259,629 260,530
Stock issued for debt 19,666 20 39,312 39,332
Stock issued for warrant 255,763 256 256
Stock issued for acquisition 622,381 622 1,178,167 1,178,789
Stock issued as collateral 300,000 300 -- 300
Pro Mortgage rescission (150,000) (150) (761,060 (761,060)
Warrants 900,363 900,363
Debt discount related to beneficial conversion feature 5,394,026 5,394,026
Dividends paid to preferred shares of subsidiary (74,559) (74,559)
Net loss -- -- -- -- (11,188,086) (11,188,086)
------------ -------- --------- ------------- ------------ -------------------
BALANCE DECEMBER 31, 2004 7,306,675 $ 7,306 $(271,600) $ 17,953,311 $(17,832,428) $ (143,411)
============ ======== ========= ============= ============ ===================
Stock issued for services 2,595,221 2,595 722,825 722,825
Stock issued for debt 1,909,000 1,909 320,301 322,210
Stock issued for warrant 902,675 903 903
Stock issued for acquisition 480,930 481 98,938 99,419
Stock issued for equity services 23,656,470 23,656 1,529,196 1,552,852
Stock issued for AP settlement 194,320 194 182,345 182,539
Stock issued for deferred compensation 416,667 417 37,083 37,500
Stock subscription payable 82,150 82 82,150 82,232
Treasury stock redeemed for services 271,600 271,600
Dividends paid to preferred shares of subsidiary (69,481) (69,481)
Net loss -- -- -- -- (10,929,765) (10,929,765)
------------ -------- --------- ------------- ------------ -------------------
BALANCE DECEMBER 31, 2005 37,544,108 $ 37,544 $ -- $ 20,926,149 $(28,831,673) $(7,867,979)
============ ======== ========= ============= ============ ===================
See accompanying notes to consolidated financial statements.
F-6
CONSUMER DIRECT OF AMERICA
STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF PRESENTATION:
Consumer Direct of America ("CDA") formerly known as Blue Star Coffee,
Inc. is a Nevada corporation formed in July, 2000 to sell specialty
coffee beans, brewed coffee and espresso-based beverages through
company-owned and franchised retail locations. In February 2002, Blue
Star, which was then in the development stage, acquired all of the
outstanding stock of Consumer Capital Holdings, Inc. and Consumer
Capital Holdings became a wholly owned subsidiary of Blue Star. After
its acquisition of Consumer Capital Holdings, Blue Star changed its
name to Consumer Direct of America. Consumer Direct of America (The
"Company") is a direct-to-consumer mortgage broker and banker with
revenues derived primarily from origination commissions earned on the
closing of first and second mortgages on single-family residences
("mortgage loans" and "home equity loans"). Shearson Home Loans,
("SHL"), formerly known as Consumer Direct Lending Inc. ("CDL") is a
Nevada corporation formed in October 2001 to originate retail mortgages
and to provide mortgage banking services. The board of directors of CDL
approved to change the name of the Company from Consumer Direct
Lending, Inc. to Shearson Home Loans on June 22, 2005. Shearson Home
Loans establishes banking and correspondent relationships with major
lenders and banks.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. The Company
has suffered recurring losses from operations and has an accumulated
deficit of $28,831,673 as of December 31, 2005, which raises
substantial doubt about the Company's ability to continue as a going
concern.
Management currently believes that cash flows from operations should be
sufficient to meet the Company's current liquidity and capital needs at
least through fiscal 2006 however, if they are not, management will
seek equity funding from the public capital markets , so long as there
are no material adverse changes to the terms or availability of our
warehouse lines of credit, we believe we can meet our liquidity and
capital needs at current production levels at least through fiscal
2006. However we are currently exploring possible liquidity sources
either through additional borrowings or potential capital partners to
enable us to increase our loan production and expansion. Future
offerings are probable in order to fund the acquisition growth by the
Company.
GOING CONCERN:
The accompanying financial statements have been prepared assuming that
the Company will continue as a going concern. As shown in the
accompanying financial statements, the Company incurred a net ordinary
loss before minority interest of $10,999,246 during the year ended
December 31, 2005. Although a substantial portion of the Company's
cumulative net loss is attributable to non-cash operating expenses,
management believes that it will need additional equity or debt
financing to be able to sustain its operations until it can achieve
profitability, if ever. These matters raise substantial doubt about the
Company's ability to continue as a going concern.
Management is attempting to raise additional equity and debt financing
to sustain operations until it can market its services, expands its
customer base, and achieves profitability. The successful outcome of
future activities cannot be determined at this time and there are no
assurances that if achieved, the Company will have sufficient funds to
execute its intended business plan or generate positive operating
results.
The accompanying financial statements do not include any adjustments
related to the recoverability and classification of assets or the
amounts and classification of liabilities that might be necessary
should the Company be unable to continue as a going concern.
F-7
NATURE OF BUSINESS:
The Company is a direct-to-consumer mortgage broker and banker with
revenues derived primarily from origination commissions earned on the
closing of first and second mortgages on single-family residences
("mortgage loans" and "home equity loans").
PRINCIPLES OF CONSOLIDATION:
The consolidated financial statements include the accounts of Consumer
Direct and the accounts of Shearson Home Loans and Ocean West
Enterprises, its Subsidiary which was sold on June 6, 2005. All
significant inter-company accounts and transactions have been
eliminated.
RISKS AND UNCERTAINTIES:
The Company operates in a highly competitive industry that is subject
to intense competition and potential government regulations.
Significant changes in interest rates or the underlying economic
condition of the United States or any specific region of the United
States real estate market could have a materially adverse impact on the
Company's operations.
USE OF ESTIMATES:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements, and the reported amounts of revenues
and expenses during the reported periods. Significant estimates made by
the Company's management include, but are not limited to, the
realizability of mortgage loans held for sale, mortgage servicing
rights and property held for sale, the collectibility of notes
receivable, and the recoverability of property and equipment through
future operating profits. Actual results could materially differ from
those estimates.
CONCENTRATION OF CREDIT RISK:
The Company maintains, at times, cash balances at certain financial
institutions in excess of amounts insured by federal agencies. For the
year ended December 31, 2005; 1 buyer purchased 90% and the year ended
December 31, 2004; 4 buyers purchased 25%, 23%, 20% and 10% (December
31, 2004), of the Company's mortgages.
CASH AND CASH EQUIVALENTS:
For the purpose of the statement of cash flows, the Company considers
all highly liquid holdings with maturities of three months or less at
the time of purchase to be cash equivalents.
F-8
MORTGAGE LOANS HELD FOR SALE:
Mortgage loans held for sale to investors are stated at the lower of
cost or market value computed on the aggregate method by residential
loan type (unrealized losses are offset by unrealized gains) and are
evaluated at the end of each year, and are determined by outstanding
commitments from investors or current investor yield requirements. The
amount by which cost exceeds market value is accounted for as a
valuation allowance and any changes in the valuation allowance are
included in the determination of net income. As of December 31, 2005
and December 31, 2004, there was no valuation allowance required as
cost was estimated not to exceed market value. A substantial portion of
loans was sold to investors within 30 days subsequent to December 31,
2005 and December 31, 2004.
MORTGAGE SERVICING:
The Company recognizes as separate assets or liabilities the obligation
to service mortgage loans for others, through loan origination, by
allocating total costs incurred between the loan and the servicing
rights retained based on their relative fair values. Amortization of
mortgage service assets or rights ("MSRs") is based on the ratio of net
servicing income received in the current period to total net servicing
income projected to be realized from the MSRs. Amortization of mortgage
service liabilities ("MSLs") is based on the ratio of net servicing
costs paid in the current period to total net servicing costs projected
to be paid from the MSL. Projected net servicing income is in turn
determined by the estimated future balance of the underlying mortgage
loan portfolio, which declines over time from prepayments and scheduled
loan amortization. The Company estimates future prepayment rates based
on current interest rate levels, other economic conditions and market
forecasts, as well as relevant characteristics of the servicing
portfolio, such as loan types, interest rate stratification and recent
prepayment experience. MSRs are periodically evaluated for impairment,
which is recognized in the statement of operations during the
applicable period through additions to an impairment reserve. For
purposes of performing its impairment evaluation, the Company
stratifies its servicing portfolio on the basis of certain risk
characteristics including loan type and interest rate. The Company has
determined that no impairment allowance is needed as of December 31,
2005 and December 31, 2004. For the year ended December 31, 2005 and
December 31, 2004, no mortgage servicing rights were capitalized.
Amortization expense related to mortgage servicing rights for the years
ended December 31, 2005 and December 31, 2004, was $6,532 and $6,576,
respectively.
PROPERTY AND EQUIPMENT:
Property and equipment are stated at cost, less accumulated
depreciation. Depreciation is recorded using the straight-line method
over the estimated useful lives of the related assets, ranging from
three to thirty years. Depreciation expense related to property and
equipment was $684,820 and $633,911 for the year ended December 31,
2005 and the year ended December 31, 2004. Maintenance and repairs are
charged to operations when incurred. Major betterments and renewals are
capitalized. Gains or losses are recognized upon sale or disposition of
assets.
LONG-LIVED ASSETS:
The Company accounts for its long-lived assets in accordance with SFAS
No. 144, "Accounting For The Impairment or Disposal of Long-Lived
Assets" which requires that long-lived assets and certain identifiable
intangibles to be held and used by any entity be reviewed for
impairment whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable. Pursuant to
SFAS 144, management of the Company assesses the recoverability of
property and equipment by determining whether the depreciation of such
assets over their remaining lives can be recovered through projected
undiscounted cash flows. The amount of impairment, if any, is measured
based on fair value (projected discounted cash flows) and is charged to
operations in the period in which such impairment is determined by
management. To date, management has not identified any impairment of
property and equipment. There can be no assurance, however, that market
conditions or demands for the Company's services will not change which
could result in future long-lived asset impairment.
F-9
INTANGIBLE ASSETS
The Company has adopted FASB 142. Under guidance of SFAS 142, net
assets of companies acquired in purchase transactions are recorded at
fair value at the date of acquisition, as such, the historical cost
basis of individual assets and liabilities are adjusted to reflect
their fair value. Identified intangibles are amortized on an
accelerated or straight-line basis over the period benefited. Goodwill
is not amortized, but is reviewed for potential impairment on an annual
basis at the reporting unit level. The impairment test is performed in
two phases. The first step of the goodwill impairment test, used to
identify potential impairment, compares the fair value of the reporting
unit with its carrying amount, including goodwill. Of the fair value of
the reporting unit exceeds its carrying amount, goodwill of the
reporting unit is considered not impaired; however, if the carrying
amount of the reporting unit exceeds its fair value, an additional
procedure must be performed. That additional procedure compares the
implied fair value of the reporting units' goodwill (as defined in SFAS
142) with the carrying amount of that goodwill. An impairment loss is
recorded to the extent that the carrying amount of goodwill exceeds its
implied fair value.
After reviewing the requirements of FASB 142, the Company has decided
to write off all of the goodwill on the books except for the goodwill
associated with Las Vegas Mortgage. The Company does not feel there has
been any impairment of the Goodwill for this acquisition as shown on
the financial statements, due to; increase in revenues for the company,
decreases in expenses for the company and decreases in overhead for the
company.
REVENUE AND COST RECOGNITION:
Revenue from the sale of loans is recognized at the time the loans are
sold or when the Company has shipped the loan file to independent
investors consistent with the criteria established in SFAS No. 140,
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities." At this point, all of the services
required to be performed for such revenues have been completed. Loan
origination costs and incremental direct costs are deferred and
recognized over the term of the loan as an adjustment of the loan yield
until the loan is sold. Incremental direct costs include credit
reports, appraisal fees, document preparation fees, wire fees, tax and
filing fees, funding fees and commissions. When the loan is sold and
service is released, the unamortized loan origination costs and
incremental direct selling costs are netted against the revenue and
recorded to the statement of operations. Revenue from the servicing of
loans is recognized as earned.
BASIC AND DILUTED LOSS PER SHARE:
In accordance with SFAS No. 128, "Earnings Per Share," the basic loss
per common share is computed by dividing net loss available to common
stockholders after reducing net income by preferred stock dividend, by
the weighted average common shares outstanding during the period.
Diluted earnings per share reflect per share amounts that would have
resulted if diluted potential common stock had been converted to common
stock. Common stock equivalents have not been included in the earnings
per share computation for the years ended December 31, 2005 and 2004 as
the amounts are anti-dilutive.
ADVERTISING:
The Company expenses advertising costs as incurred. The advertising
costs for the year ended December 31, 2005 and the year ended December
31, 2004 were $600,882 and $541,025, respectively.
INCOME TAXES:
The Company accounts for income taxes under SFAS No. 109, "Accounting
for Income Taxes." Under the asset and liability method of SFAS No.
109, deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered
or settled. Under SFAS No. 109, the effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the
period the enactment occurs. A valuation allowance is provided for
certain deferred tax assets if it is more likely than not that the
Company will not realize tax assets through future operations.
F-10
STOCK ISSUED FOR SERVICES:
The Company accounts for equity instruments issued to non-employees in
accordance with the provisions of SFAS No. 123 and Emerging Issues Task
Force ("EITF") Issue No. 96-18, "Accounting for Equity Instruments That
Are Issued to Other Than Employees for Acquiring, or in Conjunction
with Selling, Goods or Services". All transactions in which goods or
services are the consideration received for the issuance of equity
instruments are accounted for based on the fair value of the
consideration received or the fair value of the equity instrument
issued whichever is more reliably measurable. The measurement date of
the fair value of the equity instrument issued is the earlier of the
date on which the counter party's performance is complete or the date
on which it is probable that performance will occur.
The amounts that have been charged against income for those services
were approximately $2,972,838 and $1,684,000 for 2005, and 2004,
respectively.
FAIR VALUE OF FINANCIAL INSTRUMENTS:
The Company has adopted SFAS No. 107, "Disclosures About Fair Value of
Financial Instruments." SFAS No. 107 requires disclosure of fair value
information about financial instruments when it is practicable to
estimate that value. For certain of the Company's financial instruments
including cash, receivables, and accounts payable and accrued expenses,
the carrying amounts approximate fair value due to their short
maturities. The amounts shown for notes payable also approximate fair
value because current interest rates and terms offered to the Company
for similar debt are substantially the same.
NEW ACCOUNTING PRONOUNCEMENTS:
In November 2004, the FASB issued SFAS No. 151, Inventory Costs, an
amendment of ARB No. 43, Chapter 4. SFAS No. 151 amends the guidance in
ARB No. 43, Chapter 4, Inventory Pricing, to clarify the accounting for
abnormal amounts of idle facility expense, freight, handing costs, and
spoilage. This statement requires that those items be recognized as
current period charges regardless of whether they meet the criterion of
"so abnormal" which was the criterion specified in ARB No. 43. In
addition, this Statement requires that allocation of fixed production
overheads to the cost of production be based on normal capacity of the
production facilities. This pronouncement is effective for the Company
beginning October 1, 2005. The Company does not believe adopting this
new standard will have a significant impact to its financial
statements.
In December 2004, the FASB issued SFAS No. 123 (revised 2004).
Share-Based Payment, which is a revision of SFAS No. 123, Accounting
for Stock-Based Compensation. SFAS No. 123(R) supersedes APB Opinion
No. 25, Accounting for Stock Issued to Employees and amends SFAS No.
95, Statement of Cash Flows. Generally, the approach in SFAS No. 123(R)
is similar to the approach described in SFAS No. 123. However, SFAS No.
123(R) requires all share-based payments to employees, including grants
of employee stock options, to be recognized in the income statement
based on their fair values. Pro forma disclosure is no longer an
alternative. The new standard will be effective for the Company in the
first interim or annual reporting period beginning after December 15,
2005. The Company expects the adoption of this standard will have a
material impact on its financial statements assuming employee stock
options are granted in the future.
RECLASSIFICATIONS:
Certain prior year balances have been reclassified to conform to
current year presentation. Such classifications had no effect on net
income.
(2) PROPERTY AND EQUIPMENT:
December 31,
A summary is as follows: 2005
----------------
Furniture fixtures, and equipment $ 733,288
Computer equipment 1,389,230
Software 820,325
Leasehold improvements 109,477
----------------
3,052,321
Less accumulated depreciation and amortization (1,387,750)
----------------
$ 1,664,571
================
F-11
(3) GOODWILL
The origin of Goodwill is from two transactions:
Purchase of Las Vegas Mortgage $ 1,372,916
The Las Vegas Mortgage purchase took place in June of 2002.
The goodwill arose out of the difference between the purchase price and
the fair market value of assets received.
In June of 2002, the Company acquired all of the outstanding stock of
Las Vegas Mortgage in exchange for $100,000 in cash and $1,361,726 of
the Company's stock. The purpose of the transaction was to expand its
interests in the Las Vegas market. Las Vegas Mortgage had branches and
relationships in the Las Vegas Area. The Company had a call center in
Las Vegas and wanted to get into the Mortgage Business in Las Vegas.
This acquisition allowed the Company to have an immediate large
position in Las Vegas. The Company is now one of the largest take out
lenders in the Western United States and it is all based from the Las
Vegas operations. With the acquisition of Las Vegas Mortgage the
Company was able to move its corporate headquarters to Las Vegas and
expand its network. The acquisition of Las Vegas Mortgage was key in
the expansion and growth of the Company from a small mortgage company
in California to a major mortgage broker in the Western States.
In July of 2004, the Company purchased 84.9% stock interest in Ocean
West. The purpose of the transaction was to acquire a mortgage branch
network with licenses in 36 states and a mortgage bank. The Company
sold its interest in Ocean West on June 6, 2005, and recorded a charge
of impairment of $2,698,498 offset by the assets net of liabilities at
the time of sale of $1,966,393 or $732,105.
The Company has adopted FASB 142. Under guidance of SFAS 142, net
assets of companies acquired in purchase transactions are recorded at
fair value at the date of acquisition, as such, the historical cost
basis of individual assets and liabilities are adjusted to reflect
their fair value. Identified intangibles are amortized on an
accelerated or straight-line basis over the period benefited. Goodwill
is not amortized, but is reviewed for potential impairment on an annual
basis at the reporting unit level. The impairment test is performed in
two phases. The first step of the goodwill impairment test, used to
identify potential impairment, compares the fair value of the reporting
unit with its carrying amount, including goodwill. Of the fair value of
the reporting unit exceeds its carrying amount, goodwill of the
reporting unit is considered not impaired; however, if the carrying
amount of the reporting unit exceeds its fair value, an additional
procedure must be performed. That additional procedure compares the
implied fair value of the reporting units' goodwill (as defined in SFAS
142) with the carrying amount of that goodwill. An impairment loss is
recorded to the extent that the carrying amount of goodwill exceeds its
implied fair value.
Other intangible assets are evaluated for impairment if events and
circumstances indicate a possible impairment. Such evaluation of other
intangible assets is based on undiscounted cash flow projections.
After reviewing the requirements of FASB 142, the Company has decided
to write off all of the goodwill on the books except for the goodwill
associated with Las Vegas Mortgage and Ocean West the Company does not
feel there has been any impairment of the Goodwill for these two
acquisitions as shown on the financial statements, due to; increases in
number of contracts for the company, increase in revenues for the
company, decreases in expenses for the company and decreases in
overhead for the company.
(4) CREDIT FACILITIES AND JOINT VENTURE AGREEMENT
On September 21, 2004 the Company entered into a term loan facility
with Club Vista Holdings Inc., ("Club Vista") pursuant to which a
revolving line of credit arrangement for which $5,000,000 can be
borrowed from time to time on a secured basis. Collateral shall be
evidenced by an assignment of Borrowers interest in all mortgage notes
for which funds have been advanced. Interest under the term loan
facility will be determined and imposed in accordance with the
respective cost of funds that Lender may incur. The maturity will be on
a revolving basis for the incurrence of indebtedness for the period of
one year. The funds advanced under this facility will be used
exclusively as follows; to fund home loans and various costs, fees,
expenses and other payments made in connection with the loans made by
the Borrower, to fund any fees relating to warehouse banking lines and
for any such purposes specifically authorized by the Lender in writing.
The net proceeds related to the term loan shall be divided 50/50
between the Company and Club Vista of which the Company shall maintain
at all times a separate accounting for such transactions. As of
December 31, 2005 and December 31, 2004, the Company's balance on this
facility was $5,000,000, respectively. For further information refer to
Note 8 in the Notes to consolidated financials statements as described
herein.
F-12
On September 14, 2004, the Company entered into a joint venture
agreement with Club Vista to offer a product, home equity lines of
credit or HELOC. The proceeds of such will be split 50/50 between both
parties. The credit facility of this joint venture shall be contributed
by Club Vista in the form of a mortgage warehouse credit facility for
$10,000,000 to be collateralized by the Note and Deed of Trust on each
and every loan transaction. Borrowings may only be used for the sole
purpose of warehousing CDA loans. No interest shall be paid on the
initial contributions to the capital of the joint venture. The joint
venture may be dissolved at any time by agreement by both parties. As
of December 31, 2005 and December 31, 2004, the balance of the facility
was $2,668,216 and 3,271,276, respectively.
(5) WAREHOUSE LINES OF CREDIT
We have a warehouse lines of credit with Bank of Arizona through our
subsidiary, Shearson Home Loans. Shearson Home Loans, formerly Consumer
Direct Lending, entered into a Mortgage Loan and Purchase Agreement
with Bank of Arizona for $10,000,000 on March 25, 2005. The facility is
collateralized by the related mortgage loans receivable. Interest is
due monthly at the bank reference rate plus an established percentage,
varying from prime plus 1 to 1.5%. Each loan carries a fee of
approximately $100 to $175 per loan. There are restrictive covenants
relating to tangible net worth of not less than $250,000 and a debt to
equity ratio no greater than 20:1, the Company is in compliance with
the covenants as the equity of Shearson Home Loans is approximately
$3.4 million. As of December 31, 2005, the outstanding balance with
Bank of Arizona was $828,858.
The Company through its former subsidiary, Ocean West Enterprises,
("OWE"), had a line of credit with Provident Consumer Financial
Services ("PCFS") which was $8,000,000 and with Warehouse One is
$5,000,000. As of September 30, 2005, due to the sale on June 6, 2005
of OWHC and its subsidiaries, the amounts were paid in full and their
respective balances were $0. At December 31, 2004 the interest rate
charged on our warehousing lines of credit with PCFS was approximately
6.93%. As of December 31, 2005 and December 31, 2004 the outstanding
balance with PCFS was $0 and $8,214,512, respectively. At December 31,
2004 the interest rate charged on the warehouse line of credit through
Warehouse One was approximately 5.5%. As of December 31, 2005 and
December 31, 2004 the outstanding balance with Warehouse One was $0 and
$424,634, respectively.
The warehouse line of credit has restrictions as to the types of loans
(and the maximum amounts per individual loans) for which said line can
be used. Furthermore, the line can only be used to fund 98% of loan
amounts, as defined; the remaining 2% must be funded by the Company
utilizing its own cash resources.
(6) LONG-TERM DEBT:
A summary of long term debt is as follows:
December 31,
2005
----------------
Convertible secured promissory note payable to BT Venture Fund, bearing interest at 10% per annum or $ 369,682
default interest of 18% compounded daily, payable June 15, 2005. Note has the ability to convert to
the Company's common stock at a conversion price per share equal to the lesser of (a) $1.50 and (b)
70% of the price per share for which shares of common stock, issued by maker to purchasers in equity
financing. See footnote 7. (A)
Convertible secured with substantially all the assets of the Company, promissory note payable to an
individual, bearing interest at 10% per annum, secured by 300,000 shares of the Company's common
stock, payable June 15, 2005. Note has a convertible feature to convert to the Company's common
stock at a exercise price equal to $0.001 per share, number of shares determined by multiplying the
principal amount by 50%and dividing by the stock's closing trading price on the OTCBB on the date
thereof. See footnote 7. (A) This note includes a lien on all of the assets of the Company. 500,000
F-13
Unsecured promissory note payable to an individual, bearing interest at 10% per annum, due on
February 1, 2005. This note has been paid in full. --
Unsecured promissory note payable to an individual, bearing interest at 10% per annum, due on March
5, 2005. This note has been paid in full. --
Unsecured promissory note payable to an individual, bearing interest at 10% per annum, payable upon
demand. This note has been guaranteed by an officer of the company. 125,000
Unsecured promissory note payable to an individual, bearing interest at 10% per annum, payable upon
demand. 58,173
Unsecured promissory note payable to an individual, bearing interest at 10% per annum, payable upon
demand. 150,000
Unsecured promissory note payable to a related party, bearing interest at 10% per annum, payable
upon demand. 125,000
Unsecured promissory note payable to a related party, bearing interest at 10% per annum, payable
upon demand. 642,846
December 31,
2005
----------------
Unsecured note payable to a related party, originally bearing interest at 15% per annum, payable in --
monthly interest installments with all unpaid principal and interest due March 1, 2007. At September
30, 2002, the interest rate was reduced to 12%. This note has been paid in full.
Unsecured note payable to a related party, originally bearing interest at 24% per annum, payable in
monthly interest installments with all unpaid principal and interest due March 1, 2007. At September
30, 2002, the interest rate was reduced to 12%. This note has been paid in full. --
Unsecured note payable to bank bearing interest at 4.5% due November 7, 2003. Secured by certificate
of deposit. This note has been paid in full. --
Unsecured note payable to stockholder, bearing interest at 13% per annum payable in monthly interest
installments with all unpaid principal and interest due June 30, 2008. This note has been paid in
full. --
----------------
1,970,702
Less current maturities (1,970,702)
----------------
$ --
================
(A) These loans are past due their maturities. Management is in the
process of negotiating extended terms.
The following table summarizes the aggregate maturities of long-term
debt:
Years ending
2006 $ 1,970,702
2007 --
2008 --
2009 --
2010 --
Thereafter --
----------------
$ 1,970,702
================
F-14
Interest expense incurred under long term debt obligations amounted to
$184,290 and $1,588,147, for the year ended December 31, 2005 and the
year ended December 31, 2004.
(7) CONVERTIBLE DEBENTURE
During December 31, 2004, the Company entered into three convertible
debentures totaling $5,620,000 of which $5,000,000 was remaining at
December 31, 2005. Additionally, certain debt holders were entitled to
warrants to purchase 116,667 shares of common stock at a weighted
average exercise price of $2.38 per share. In accordance with EITF
00-27, the Company has determined the value of the convertible
debenture and the fair value of the detachable warrants issued in
connection with this debt. The estimated value of the warrants of
$275,750 was determined using the Black-Scholes option pricing model
under the following assumptions: life of 1 year, risk free interest
rate of 3.5%, a dividend yield of 0% and volatility of 142%. The face
amount of these debts of $5,620,000 was proportionately allocated to
the convertible debt and the warrants in the amounts of $5,440,925 and
$179,075, respectively. These notes were then allocated between the
debt and the beneficial conversion feature, which attributed to
$5,000,000 and $440,925, respectively. The combined total discount is
$122,667, which is being amortized over the term of the convertible
debt. For the year ended December 31, 2005 and December 31, 2004, the
Company has amortized a total of $2,904,110 and $2,489,916,
respectively.
(8) COMMITMENTS AND CONTINGENCIES:
Operating Leases
The Company leases its facilities and certain equipment under
noncancellable operating leases that expire through the year 2007.
These agreements generally provide that the Company pay operating costs
such as taxes, insurance, and maintenance.
Future annual minimum payments under operating leases are as follows:
Years ending December 31,
2006 $ 274,932
2007 203,777
Thereafter -
----------------
$ 478,709
================
Rental expense under operating leases for the year ended December 31,
2005 and the year ended December 31, 2004 was $310,072 and $1,079,917,
respectively.
Litigation
In the normal course of business, the Company is involved in various
legal actions. It is the opinion of management that none of these legal
actions will have a material effect on the financial position or
results of operations of the Company.
On April 14, 2004, the Company commenced an action against Consulting
Services LLC. Consulting Services LLC instituted a counterclaim on
April 19, 2004, against the Company. Both claims are contented by the
parties to be of a breach of contract nature from a certain Asset
Acquisition Agreement in which the Company claims never consummated
therfore services are not liable under the agreement. The counterclaims
of a similar nature which CDA is claiming no liability and Consulting
Services LLC is asking for the amount of stock agreed to be given for
services per the acquisition agreement of approximately 2.4 million
shares of the Company's stock valued at the time to be approximately
$1.8 million and $655,321 for certain liabilities the Company were to
assume per the agreement upon closing. The Company is asserting its
position of no liability and asking for approximately $712,859 of which
was advanced to Consulting Services prior to the knowledge that the
transaction was not to close. In April of 2005, the Company filed a
motion for summary judgment. Management of the Company anticipates a
favorable outcome and has determined it is not necessary to impair this
investment.
F-15
Employment Agreements
Our employment agreement with Michael Barron requires him to perform
the duties of Chief Executive Officer at an annual salary of $180,000.
He received 160,000 shares of restrictive stock which vests ratably on
a monthly basis during the first two years of the term of the
agreement. He also received an option to purchase 80,000 shares of
common stock at a price of $5.00 per share. In addition, Mr. Barron is
entitled to receive a performance bonus if our actual annual revenues
and net income equals or exceeds projected annual revenues and net
income approved by our Board. His performance bonus will be equal to
the percentage of his annual salary equal to 50% plus the percentage by
which actual income exceeds projected income. He is entitled to the
same benefits afforded to other executives. He is also entitled to a
car allowance of $1,000 per month. His employment agreement provides
that if we terminate him without cause, he is entitled to receive a
lump sum payment equal to twice his annual salary plus the present
value of a performance bonus computed on the basis that we achieve all
of our performance targets. Mr. Barron's employment agreement commenced
as of June 15, 2002 and terminates on June 14, 2006.
Our employment agreement with Joseph Cosio-Barron requires him to
perform the duties of -President at an annual salary of $120,000. He
received 160,000 shares of restrictive stock which vests ratably on a
monthly basis during the first two years of the term of the agreement.
He also received an option to purchase 80,000 shares of common stock at
a price of $7.40 per share. In addition, Mr. Cosio-Barron is entitled
to receive a performance bonus if our actual annual revenues and net
income equals or exceeds projected annual revenues and net income
approved by our Board. His performance bonus will be equal to the
percentage of his annual salary equal to 50% plus the percentage by
which actual income exceeds projected income. He is entitled to the
same benefits afforded to other executives. He is also entitled to a
car allowance of $1,000 per month. His employment agreement provides
that if we terminate him without cause, he is entitled to receive a
lump sum payment equal to twice his annual salary plus the present
value of a performance bonus computed on the basis that we achieve all
of our performance targets. Mr. Cosio-Barron's employment agreement
commenced as of June 15, 2002 and terminates on June 14, 2006.
No amounts are accrued for the deferred compensation as the Company has
had no pre-tax profits.
(10) PREFERRED STOCK:
The Company's articles of incorporation authorize up to 15,000,000
shares of $0.01 par value preferred stock. Shares of preferred stock
may be issued in one or more classes or series at such time and in such
quantities the board of directors may determine. All shares of any one
series shall be equal in rank and identical in all respects. Preferred
stockholders have liquidation preference up to the amount of the
original equity investment. Each share of preferred stock is
convertible into one share of common stock. As of December 31, 2005,
there were no preferred shares issued.
The Company's former subsidiary, Ocean West Holding Corp., had
preferred stock issued and outstanding at the prior to the sale in
2005. There were $69,481 and $74,559 of dividends paid during the years
December 31, 2005 and December 31, 2004, respectively.
(11) ACQUISITION OR DISPOSITION OF ASSETS
On July 15, 2004, the Company acquired 84.9% of the outstanding common
stock of Ocean West Holding Corporation through a stock exchange
affected pursuant to a Purchase and Sale of Capital Stock Agreement.
Marshall L. Stewart, Daryl S. Meddings, Enfo Loan Corporation, Kingsley
and Nancy Cannon and Dale and Suzanne Delmege agreed to sell 4,921,930
of their shares of common stock of Ocean West Holding Corporation to
CDA in exchange for 622,381 shares of CDA (the "Transfer"). The
consideration was based on the average monthly trading prices of each
company's shares for the month of June 2004. The Transfer results in
CDA having majority control and ownership, of Ocean West Holding
Corporation.
On June 6, 2005, OWHC consummated an agreement with InfoByPhone, Inc. a
Delaware corporation, pursuant to which InfoByPhone, Inc. exchanged all
of its 6,000,000 then issued and outstanding shares of common stock for
6,000,000 shares, or approximately 56% of the common stock of OWHC. As
a result of the agreement the transaction was treated for accounting
purposes as a recapitalization by the accounting acquirer (InfoByPhone,
Inc.). Prior to the exchange, OWHC intended to issue a dividend pay out
to its shareholders, which was represented of 100% of the issued and
outstanding shares of Ocean West Enterprises, its wholly owned
subsidiary of Ocean West Holding Corporation. OWHC remained the sole
owner of 100% of the issued and outstanding shares of OWE.
The Company received cash proceeds in the amount of $400,000 from the
sale of the public holding company, Ocean West Holdings (OTC:BB:OWHC).
The sale of OWHC was directed by the Board of Directors of Ocean West
and the payment to the Company was made by Ocean West as a reduction
against the monies loaned to Ocean West by CDA.
F-16
During January 2004 the Company entered into an agreement to acquire
certain stated assets and to assume certain stated liabilities of
Consulting Services LLC., a Georgia corporation ("CSLLC") through a
stock exchange to be effected pursuant to an Asset Acquisition
Agreement. According to the Agreement, CSLLC should transfer to the
Registrant (the Company) the stated assets and stated liabilities of
CSLLC and the Registrant should issue to the two stockholders of CSLLC
an aggregate of 4,764,427 pre-split or 238,221 shares post-split of the
common stock, par value $0.001, per share, of the Registrant. The
amount of consideration was determined by arms-length negotiations
between the Registrant and the stockholders of CSLLC.
After paying some of the expenses of CSLLC's operations from January
through March 2004, the Company discovered possible violations and
certain undisclosed material issues of the Asset Purchase Agreement by
CSLLC.
On April 21, 2004, the Company filed a lawsuit in the Nevada District
Court against CSLLC alleging breach of contract, breach of covenant of
good faith and fair dealing, tortuous interference with contract, fraud
and misrepresentation, conversion, and unjust enrichment. The Company
seeks rescission of the Agreement and general damages.
In order to secure repayment of approximately $712,829 previously
advanced to the defendant, the Company collateralized various assets.
The Company's management believes to have secured sufficient collateral
in order to recoup $352,829 of the $712,829. As of December 31, 2005,
the $352,829 is included as a part of other assets in the accompanying
consolidated balance sheet (see note 4).
On October 1, 2004, the Company rescinded its acquisition agreement
with Pro Mortgage Corporation ("Pro Mortgage"). On November 20, 2003
the Company and Pro Mortgage entered into an acquisition agreement,
whereby Pro Mortgage and the Company agreed to exchange 1,000 shares of
Pro Mortgage capital stock, representing 100% of the issued and
outstanding capital stock of Pro Mortgage, in exchange for 3,000,000
shares of the Company's capital stock, (the "Exchange"). The Exchange
was never duly authorized and approved by the parties thereto, and each
of the parties hereto desired to rescind the exchange. In connection
with such rescission the Company transferred and assigned its shares of
the Pro Mortgage capital stock to the Pro Mortgage shareholders and the
Pro Mortgage shareholders transferred back its shares of the common
stock of the Company.
The rescission shall have the effect of placing the Company in the
position it was in prior to the Merger. Pursuant to the Rescission
Agreement, the liabilities and assets of Pro Mortgage that existed at
the time of the Merger and as existed as of the closing of the
Recession Agreement, shall remain the liabilities and assets of Pro
Mortgage. The Company views this rescission as nullification and
accordingly has not included any operating activities related to Pro
Mortgage in the accompanying consolidated financial statements.
(12) STOCK OPTION PLANS
The Company has elected to follow Accounting Principles Board Opinion
No. 25 (APB 25), "Accounting for Stock Issued to Employees" and the
related interpretations in accounting for its employee stock options
because, as discussed below, the alternative fair value accounting
provided for under FASB Statement No. 123 (FASB 123), "Accounting for
Stock-Based Compensation," requires the use of option valuation models
that were not developed for use in valuing employee stock options.
Under APB 25, if the exercise price of the Company's employee stock
options is equal to or greater than the market price of the underlying
stock on the date of the grant, no compensation expense is recognized.
The Consumer Direct of America Stock Incentive Plan 2002 (the "Plan")
provides for the grant of 1,950,000 incentive or non-statutory stock
options to purchase common stock. Employees, who share the
responsibility for the management growth or protection of the business
of the Company and certain Non-Employee ("Selected Persons"), are
eligible to receive options which are approved by a committee of the
Board of Directors. These options primarily vest over five years and
are exercisable for a ten-year period from the date of the grant. No
stock options or awards may be granted under this plan after October
15, 2012. On December 31, 2005, the Board of Directors of the Company
elected to cancel the outstanding options; 80,000 to Michael Barron and
80,000 to Joseph Cosio-Barron and terminate the plan.
On March 14, 2002, the Company's Board of Directors granted Michael
Barron the option to purchase 80,000 shares (post-split) of Common
Stock par value $.001 per share of the Company at an option exercise
price of the lower of the two, the fair market value of such shares on
the date of grant of such options, of which the fair market value of a
share of common stock on any date shall be equal to the closing price
of the last preceding day on which shares were traded ($5.00 at March
13, 2002) or $10 per share. The right to exercise such option will vest
in five equal installments over a period of five years beginning on
March 15, 2002. The option expires on March 15, 2012.
F-17
On May 12, 2003, the Company's Board of Directors granted Joseph
Cosio-Barron the option to purchase 80,000 shares (post-split) of
Common Stock par value $.001 per share of the Company at an option
exercise price of the lower of the two, the fair market value of such
shares on the date of grant of such options, of which the fair market
value of a share of common stock on any date shall be equal to the
closing price of the last preceding day on which shares were traded
($7.40 at May 11, 2003) or $10 per share. The right to exercise such
option will vest in five equal installments over a period of five years
beginning on May 13, 2003. The option expires on March 13, 2013.
Additional warrants were granted in 2005 and 2004 to consultants,
bridge loans and investors these warrants totaled $0 and $809,695,
respectively.
On May 14, 2005 the Company adopted a stock compensation plan for 2005.
The purpose of the plan is to provide the Company with a means of
compensating selected key employees (including officers) of, and
consultants and advisors to, the Company and its subsidiaries for their
services with shares of Common Stock of the Company. All shares awarded
or sold under the plan will be newly issued shares of the Company's
Common Stock. The number of shares subject to the plan is 5,000,000.
The Company's Board of Directors will adjust the number and kind of
shares subject to the plan in the event of any recapitalization,
reclassification, reorganization, merger, consolidation, share
exchange, other business combination in which the Company is the
surviving parent corporation, stock split-up, combination of shares, or
dividend or other distribution payable in capital stock or rights to
acquire capital stock.
The Company's Board of Directors administers the plan and selects those
who are to participate in the plan. The Board determines the number of
shares to be awarded or sold to participants, the times of such awards
or sales, the consideration to be paid for the shares, and the
conditions, rights of repurchase, rights of first refusal and transfer
restrictions, if any, that will apply. At the Board's discretion,
shares may be issued in consideration of services fully performed, if
such services are not in connection with the offer or sale of
securities in a capital-raising transaction and do not directly or
indirectly promote or maintain a market for the Company's securities.
Each award or sale of shares under the plan must be evidenced by a
written agreement between the Company and the recipient of the shares.
The Board may make changes in or additions to the plan which it deems
to be proper and in the best interests of the Company and its
stockholders.
The plan became effective on May 14, 2005 and will automatically
terminate on May 13, 2014. The Board may also act to suspend or
terminate the plan at any time, without notice. The plan is not subject
to provisions of the Employee Retirement Income Security Act of 1974.
An "affiliate" of the Company as defined by regulations under the
Securities Act may not offer or sell the shares received under the plan
except pursuant to an effective registration statement under the
Securities Act or an available exemption from registration.
Pro forma information regarding net income and earnings per share is
required by FASB 123, which also requires that the information be
determined as if the Company has accounted for its employee stock
options granted beginning in the fiscal year subsequent to December 31,
1994 under the fair value method of that Statement. The fair value for
these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions
for the year ended December 31, 2005: risk free rate of 3.5%; no
dividend yield; volatility factors of the expected market price of the
Company's common stock of 142%; and weighted-average expected life of
the option of five years. For the year ending December 31, 2004:
risk-free interest rate of 3.5%; no dividend yield; volatility factors
of the expected market price of the Company's common stock of 188%; and
weighted-average expected life of the option of five years. For the
year ending December 31, 2003: risk-free interest rate of 3.5%; no
dividend yield; volatility factors of the expected market price of the
Company's common stock of 304%; and weighted-average expected life of
the option of five years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting
restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions including the
expected stock price volatility. Because the Company's employee stock
options have characteristics significantly different from those of
traded options, and because changes in the subjective input assumptions
can materially affect the fair value estimate, in management's opinion,
the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the option's vesting period.
F-18
The Company's pro forma information follows:
December 31, December 31,
2005 2004
---------------- ----------------
Pro forma net (loss) income applicable to common shareholders $ (11,360,578) $ (11,262,465)
================ ================
Pro forma net (loss) income applicable to common shareholders per
share: Basic and fully diluted $ (0.50) $ (2.11)
================ ================
A summary of the Company's stock option activity follows:
December 31, 2005 December 31, 2004
-------------------------------------------------------------------------
Options Weighted Options Weighted
Average Average
Exercise Exercise
Price Price
---------------- ----------------- ---------------- -----------------
Outstanding - beginning of year 1,200,000 $ 6.60 1,200,000 $ 6.60
Granted -- -- -- --
Exercised -- -- -- --
Cancelled (720,000) $ 2.90 -- --
---------------- ----------------- ---------------- -----------------
Outstanding - end of year 480,000 $ 12.15 1,200,000 $ 6.60
================ ================= ================ =================
Exercisable - end of year 128,000 $ 1.45 -- --
================ ================= ================ =================
(13) STOCK INCENTIVE PLAN:
On May 21, 2004, the Company filed a Form S-8 to register 750,000
shares of its common stock at an offering price of $2.20 per share. All
of the shares have been issued under this plan.
(14) STOCK EQUITY:
Pursuant to a Bridge Loan and Security Agreement (the "Bridge Loan
Agreement") with the Company dated February 26, 2004 and amended May 6,
2004 and April 8, 2005, an individual loaned $500,000 to the Company.
The loan and interest and other payments payable to the individual were
payable on June 15, 2005. The Bridge Loan Agreement provided for the
grant of a security interest to the individual in the form of 300,000
shares of common stock. The 300,000 shares of common stock were
transferred to the individual on April 8, 2005 as payment for certain
amounts owed to the individual pursuant to the Bridge Loan Agreement.
Pursuant to the agreement dated April 8, 2005, the same individual
acquired 850,000 shares of common stock through the exercise of
warrants with a strike price of $.01 on April 20, 2005.
On July 29, 2005, the Company entered into a common stock purchase
agreement with an accredited investor in a private placement (the
"Private Placement") exempt from the registration requirements under
the Securities Act of 1933, as amended (the "Securities Act"). In
connection with the Private Placement, the Company sold (i) 4,166,667
shares at the purchase price of six cents ($.06) for $250,000 (a 30%
discount on the closing bid price for the prior trading day), which
sale closed on July 29, 2005; and (ii) 11,989,796 shares at the price
of four and nine-tenths cents ($.049) for $587,500 (a 30% discount on
the closing bid price for the prior trading day), which sale closed on
August 5, 2005. Pursuant to the Private Placement, the accredited
investor had the option, exercisable until August 28, 2005, to purchase
an additional $662,500 amount of shares of common stock at the per
share price of the lower of (i) $.06 and (ii) 30% below the closing
price of the shares on the OTC bulletin board on the trading day prior
to purchase. The Company intends to use the net proceeds of the Private
Placement primarily for funding working capital acquisitions. and the
spin-off of its subsidiary, Shearson Home Loans.
F-19
The shares of common stock offered and sold in the Private Placement
have not been registered under the Securities Act and were sold in
reliance upon the exemption for the securities registration afforded by
Regulation D of the Securities Act. The investor represented to the
Company that it is an "Accredited Investor," as defined in Rule 501 of
Regulation D, under the Securities Act. In connection with the Private
Placement, the Company entered into a registration rights agreement
with the investor, pursuant to which the Company agreed to promptly
file a registration statement covering re-sales from time-to-time by
the investor of the shares of common stock purchased in the Private
Placement. The Company issued a total of 16,156,462 shares of common
stock for a total value of $1,329,082.
(15) STOCK SUBSCRIPTION AGREEMENT
On or about March 23, 2005, Vertical Capital Partners (a Delaware
corporation) subscribed to acquire 2,000,000 shares of common stock of
the Company at a purchase price of $.001 per share pursuant to an
investment banking agreement between the Company and Vertical Capital
Partners. This subscription agreement has been canceled and on July 11,
2005, Vertical returned the entire 2,000,000 shares of common stock to
the Company and said shares were marked "CANCELLED" and are to be
returned to the Company's treasury. Despite the cancelled subscription
agreement, Vertical remains the beneficial owner 60,000 or less shares
of common stock of the Company. Vertical has sole dispositive and
voting power with respect to 60,000 or less shares of common stock of
the Company.
(16) DEFERRED INCOME TAXES:
Income taxes are generally provided for the tax effects of transactions
reported in the financial statements and consist of taxes currently due
plus deferred taxes related primarily to differences between the basis
of fixed assets for financial and income tax reporting.
As of December 31, 2005, the Company has a net operating loss carry
forward of approximately $22,608,821 for tax purposes, which will be
available to offset future taxable income. If not used, this carry
forward will begin to expire in 2017.
The deferred tax assets relating to the net operating loss carry
forward has been fully reserved as of December 31, 2005.
(17) RELATED-PARTY TRANSACTIONS:
On January 21, 2005, the Company borrowed $125,000 from its Chief
Financial Officer, Wayne Bailey.
During the month of December 2005, the Company entered in to financing
agreement with Eclipse Holding Company, which is 50% owned by the
Company's Chief Executive Officer, Michael Barron. The Company entered
into an agreement to borrow a total of $750,000 in the form of a note
payable, with an interest of 10% per annum. At December 31, 2005, the
outstanding balance on this note was $642,846. The agreement calls for
the issuance of common stock warrants. As of December 31, 2005 the
Company issued 7,500,000 shares.
On July 15, 2004, Marshall L. Stewart and Daryl S. Meddings, officers
of Ocean West Holding Corporation agreed to sell 4,106,776 of their
shares of common stock of the Ocean West to CDA in exchange for 519,310
shares of CDA for an approximate value of $983,573, based on the
average trading prices of the respective stocks for the month of June
2005. Mr. Stewart and Mr. Meddings currently own 7% of the shares of
the Company and are currently on the board of Ocean West as well as
officers.
(18) SUBSEQUENT EVENT:
On February 7, 2006, Consumer Direct of America agreed to sell Shearson
Home Loans, Inc., a Nevada Corporation ("SHL"), and wholly owned
subsidiary of Consumer Direct of America, Inc. ("CDA"), to Paragon
Financial Corporation (PGNF), pursuant to the terms and conditions of a
Share Exchange Agreement dated February 7, 2006 (the "Exchange
Agreement") among CDA, SHL and PGNF. Pursuant to the Exchange
Agreement, PGNF acquired all of the common stock of SHL for 149,558,791
shares of PGNF common stock and 79 shares of PGNF Series F Preferred
Stock (convertible into 443,217,018 shares of PGNF Common Stock),
valued at approximately $16,000,000. Each share of the Series F
Preferred Stock automatically converts into 5,610,342 shares of PGNF
common stock upon the filing of an amendment to PGNF articles.
Immediately prior to entering into the Exchange Agreement, PGNF had
119,566,360 shares of PGNF common stock outstanding. In addition, PGNF
had outstanding warrants to purchase 18,531,592 shares of PGNF common
stock and outstanding debt convertible into 4,846,000 shares of PGNF
common stock arriving at an exchange ratio of 4 to 1.
F-20
On May 5, 2006, the Company rescinded its acquisition agreement with
PGNF. On February 7, 2006 the Company and PGNF entered into an
acquisition agreement, whereby PGNF and the Company acquired all of the
common stock of SHL for 149,558,791 shares of PGNF common stock and 79
shares of PGNF Series F Preferred Stock (convertible into 443,217,018
shares of PGNF Common Stock), valued at approximately $16,000,000. Each
share of the Series F Preferred Stock automatically converts into
5,610,342 shares of PGNF common stock upon the filing of an amendment
to PGNF articles, (the "Exchange"). The Exchange was never duly
authorized and approved by the parties thereto, and each of the parties
hereto desires to rescind the exchange. In connection with such
rescission the Company transferred and assigned its shares of the PGNF
capital stock and preferred stock to the PGNF shareholders and the PGNF
shareholders transferred back its shares of the common stock of the
Company. The Company views this rescission as nullification and
accordingly has not included any operating activities related to PGNF
in the Company's consolidated financial statements.
On April 14, 2006, the Company filed Form PRE 14A, requesting a vote of
its shareholders, to increase the authorized shares of the Company to
200,000,000 from 100,000,000.
F-21
CONSUMER DIRECT OF AMERICA
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2006 2006
(unaudited) (audited)
---------------- ----------------
Assets
Current assets:
Cash and cash equivalents $ 8,417 $ 21,401
Loans available for sale -- 831,200
Accounts receivable and receivables from loans sold, net 120,175 107,321
Prepaid and other current assets 108,495 433,281
---------------- ----------------
Total current assets 237,086 1,393,203
---------------- ----------------
Property and equipment, net 1,510,895 1,664,571
---------------- ----------------
Other assets:
Goodwill 1,372,916 1,372,916
Other assets, net -- --
---------------- ----------------
Total other assets 1,372,916 1,372,916
---------------- ----------------
Total assets $ 3,120,897 $ 4,430,690
================ ================
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable and accrued expenses $ 1,269,052 $ 1,690,101
Bridge notes payable 5,869,682 5,869,682
Interest payable 130,352 140,794
Notes payable 735,183 333,173
Notes payable - related party 808,396 767,846
Line of credit 2,668,216 3,497,073
---------------- ----------------
Total current liabilities 11,480,880 12,298,669
---------------- ----------------
Long-term liabilities:
Notes payable - stockholders, less current maturities -- --
---------------- ----------------
Total long- term liabilities -- --
---------------- ----------------
Total liabilities 11,480,880 12,298,669
---------------- ----------------
Stockholders' equity (deficit):
Common stock, $0.001 par value, 100,000,000 shares authorized, 96,198,027 and 37,544,108 96,198 37,544
shares issued and outstanding at March 31, 2006 and December 31, 2005, respectively
Preferred Stock, $0.01 par value, 15,000,000 shares authorized, -0- shares issued and -- --
outstanding at March 31, 2005 and December 30, 2004, respectively
Additional paid-in capital - Common stock 23,233,440 20,926,149
Treasury stock -- --
Accumulated deficit (31,689,622) (28,831,673)
---------------- ----------------
Total stockholders' (deficit) (8,359,983) (7,867,979)
---------------- ----------------
Total liabilities and stockholders' (deficit) $ 3,120,897 $ 4,430,690
================ ================
The accompanying notes are an integral part of these financial statements
F-22
CONSUMER DIRECT OF AMERICA
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
March 31, March 31,
2006 2005
---------------- ----------------
Revenues
Loan origination and sale of mortgage loans $ 191,444 $ 1,208,549
Marketing revenues and commissions -- 165,540
Rental income -- 3,395
---------------- ----------------
Total revenue 191,444 1,377,483
Expenses
Selling, general and administrative 2,869,341 3,266,035
Depreciation expense 153,676 188,734
---------------- ----------------
Total expenses 3,023,017 3,454,769
Loss from operations (2,831,573) (2,077,286)
---------------- ----------------
Other (expense) income
Interest expense (26,375) (25,293)
Debt discount expense -- (1,244,616)
Other income -- --
---------------- ----------------
Total other (expense) income (26,375) (1,269,909)
Loss before minority shareholder interest (2,857,948) (3,308,160)
---------------- ----------------
Loss applicable to minority shareholder interest -- (39,034)
---------------- ----------------
Net loss (2,857,948) (3,347,194)
Dividends on preferred shares -- (36,318)
Net loss applicable to common shareholders $ (2,857,948) $ (3,383,512)
================ ================
Net loss per share, basic and diluted $ (0.13) $ (0.36)
================ ================
Net loss per common share, applicable to common shareholders, basic and diluted $ (0.13) $ (0.36)
================ ================
Weighted average number of common shares outstanding, basic and diluted 49,373,033 9,410,000
The accompanying notes are an integral part of these financial statements
F-23
CONSUMER DIRECT OF AMERICA
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005
THREE MONTHS THREE MONTHS
ENDED ENDED
MARCH 31, MARCH 31,
2006 2005
---------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) $ (2,857,948) $ (3,308,160)
ADJUSTMENTS TO RECONCILE NET LOSS FROM OPERATIONS TO NET CASH USED IN OPERATIONS:
Depreciation 153,676 188,734
Stock based expenses 2,307,290 676,519
CHANGES IN OPERATING ASSETS AND LIABILITIES:
(Increase) decrease in accounts receivable (12,854) 96,782
(Increase) decrease in mortgage loans held for sale 831,200 7,865,635
(Increase) decrease in prepaid expenses 324,786 69,573
(Increase) decrease in other assets -- 1,246,224
Increase (decrease) in accounts payable and accrued expenses (431,491) 213,557
(Increase) decrease in minority shareholder interest -- (39,031)
---------------- ----------------
Net cash provided by operating activities 314,660 7,009,833
---------------- ----------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of fixed assets -- (9,931)
---------------- ----------------
Net cash used in investing activities -- (9,931)
---------------- ----------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net repayments on lines of credit (828,857) (6,852,893)
Proceeds from related notes payable 40,550 250,000
Proceeds from notes payable 402,010 --
Payments of notes payable (117,243) (117,243)
Issuance of common stock 58,654 --
Dividends paid on preferred shares of subsidiary -- (36,318)
---------------- ----------------
Net cash used for financing activities (327,644) (6,756,454)
---------------- ----------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (12,984) 243,448
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 21,401 198,141
---------------- ----------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 8,417 $ 441,589
================ ================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid $ -- $ 67,930
================
The accompanying notes are an integral part of these financial statements
F-24
CONSUMER DIRECT OF AMERICA
NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
MARCH 31, 2006
(1) BASIS OF PRESENTATION:
The unaudited financial statements as of March 31, 2006 included herein have
been prepared without audit pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with United
States generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included. It is suggested that these financial
statements be read in conjunction with the December 31, 2005 audited financial
statements and notes thereto.
Since inception through March 31, 2006, the Company has suffered recurring
losses from operations of approximately $31,689,622. Although a substantial
portion of the Company's cumulative net loss is attributable to non-cash
operating expenses, management believes that it will need additional equity or
debt financing to be able to sustain its operations until it can achieve
profitability, if ever. These matters raise substantial doubt about the
Company's ability to continue as a going concern.
(2) PRINCIPLES OF CONSOLIDATION:
The consolidated financial statements include the accounts of Consumer Direct
and its subsidiary Shearson Home Loans. All significant inter-company accounts
and transactions have been eliminated.
(3) INTERIM PERIOD:
These financial statements have been prepared by the Company, without audit,
pursuant to the rules and regulations of the Securities and Exchange Commission.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been omitted. Operating results for the
three months ended March 31, 2006 are not necessarily indicative of the results
that may be expected for the full year ending December 31, 2006.
The unaudited interim consolidated financial statements should be read in
conjunction with the Company's audited financial statements and notes thereto
for the past fiscal year ended December 31, 2005, included in the Company's
Annual Report on Form 10-KSB/A.
Earnings per share have been calculated based upon the weighted average number
of common shares outstanding during both reporting periods.
(4) STOCK ISSUED FOR SERVICES:
The Company accounts for equity instruments issued to non-employees in
accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force
("EITF") Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to
Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services". All transactions in which goods or services are the consideration
received for the issuance of equity instruments are accounted for based on the
fair value of the consideration received or the fair value of the equity
instrument issued whichever is more reliably measurable. The measurement date of
the fair value of the equity instrument issued is the earlier of the date on
which the counter party's performance is complete or the date on which it is
probable that performance will occur. For the quarter ended March 31, 2006, the
amounts that have been charged against income for those services were
approximately $2,307,290.
(5) RELATED-PARTY TRANSACTIONS:
On January 21, 2005, the Company borrowed $125,000 from its Chief Financial
Officer, Wayne Bailey.
F-25
CONSUMER DIRECT OF AMERICA
NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
MARCH 31, 2006
During the month of December 2005, the Company entered in to financing agreement
with Eclipse Holding Company, which is 50% owned by the Company's Chief
Executive Officer, Michael Barron. The Company entered into an agreement to
borrow a total of $750,000 in the form of a note payable, with an interest of
10% per annum. At December 31, 2005, the outstanding balance on this note was
$683,396. The agreement calls for the issuance of common stock warrants. As of
March 31, 2006 the Company issued 22,469,999 shares.
(6) SUBSEQUENT EVENT:
On February 7, 2006, Consumer Direct of America agreed to sell Shearson Home
Loans, Inc., a Nevada Corporation ("SHL"), and wholly owned subsidiary of
Consumer Direct of America, Inc. ("CDA"), to Paragon Financial Corporation
(PGNF), pursuant to the terms and conditions of a Share Exchange Agreement dated
February 7, 2006 (the "Exchange Agreement") among CDA, SHL and PGNF. Pursuant to
the Exchange Agreement, PGNF acquired all of the common stock of SHL for
149,558,791 shares of PGNF common stock and 79 shares of PGNF Series F Preferred
Stock (convertible into 443,217,018 shares of PGNF Common Stock), valued at
approximately $16,000,000. Each share of the Series F Preferred Stock
automatically converts into 5,610,342 shares of PGNF common stock upon the
filing of an amendment to PGNF articles. Immediately prior to entering into the
Exchange Agreement, PGNF had 119,566,360 shares of PGNF common stock
outstanding. In addition, PGNF had outstanding warrants to purchase 18,531,592
shares of PGNF common stock and outstanding debt convertible into 4,846,000
shares of PGNF common stock arriving at an exchange ratio of 4 to 1.
On April 14, 2006, the Company filed Form PRE 14A, requesting a vote of its
shareholders, to increase the authorized shares of the Company to 200,000,000
from 100,000,000.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
On October 11, 2005, De Joya and Company the independent accountant previously
engaged as the principal accountant to audit our financial statements, was
dismissed. Our board of directors approved the resignation of De Joya and
Company and approved the decision to change accountants. During our last fiscal
year and any subsequent interim period preceding the resignation of De Joya and
Company, there have been no disagreements with De Joya and Company on any
matters of accounting principles or practices, financial statement disclosure,
or audit scope and procedure, which disagreements, if not resolved to the
satisfaction of De Joya and Company, would have caused De Joya and Company make
reference to the subject matter of the disagreements in connection with its
report on the financial statement for such year.
On October 11, 2005, we engaged Chavez and Koch, CPA's, (Chavez and Koch"), to
act as the principal accountant to audit our financial statements. CDA did not
consult with Chavez and Koch, CPA's on the application of accounting principles
to a specified transaction, or the type of audit opinion that might be rendered
on our financial statements or any disagreements or a reportable event, during
our last two fiscal years and any subsequent interim period preceding the
dismissal of De Joya and Company.
On May 5, 2006, Chavez and Koch resigned. Our board of directors CDA approved
the resignation of Chavez and Koch and approved the decision to change
accountants.
On May 8, 2006, we engaged Pollard-Kelley Auditing Services Inc. to act as the
principal accountant to audit our financial statements. We did not consult with
Pollard-Kelley Auditing Services Inc. on the application of accounting
principles to a specified transaction, or the type of audit opinion that might
be rendered on our financial statements or any disagreements or a reportable
event, during our last two fiscal years and any subsequent interim period
preceding the resignation of Chavez and Koch . Pollard-Kelley audited our
balance sheets and those of our subsidiaries and the related statements of
income, changes in stockholders' equity, cash flows for the one year period
ended December 31, 2005.
F-26
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Our Articles of Incorporation, as amended and restated, provide to the fullest
extent permitted by Section 145 of the General Corporation Law of the State of
Delaware, that our directors or officers shall not be personally liable to us or
our shareholders for damages for breach of such director's or officer's
fiduciary duty. The effect of this provision of our Articles of Incorporation,
as amended and restated, is to eliminate our rights and our shareholders
(through shareholders' derivative suits on behalf of our company) to recover
damages against a director or officer for breach of the fiduciary duty of care
as a director or officer (including breaches resulting from negligent or grossly
negligent behavior), except under certain situations defined by statute. We
believe that the indemnification provisions in our Articles of Incorporation, as
amended, are necessary to attract and retain qualified persons as directors and
officers.
Our By Laws also provide that the Board of Directors may also authorize us to
indemnify our employees or agents, and to advance the reasonable expenses of
such persons, to the same extent, following the same determinations and upon the
same conditions as are required for the indemnification of and advancement of
expenses to our directors and officers. As of the date of this Registration
Statement, the Board of Directors has not extended indemnification rights to
persons other than directors and officers.
Insofar as indemnification for liabilities arising under the Securities Act of
1933 may be permitted to directors, officers or persons controlling us pursuant
to the foregoing provisions, or otherwise, we have been advised that in the
opinion of the Securities and Exchange Commission, such indemnification is
against public policy as expressed in the Securities Act of 1933 and is,
therefore, unenforceable.
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth an itemization of all estimated expenses, all of
which we will pay, in connection with the issuance and distribution of the
securities being registered:
NATURE OF EXPENSE AMOUNT
SEC Registration fee $ 251.57
Accounting fees and expenses 10,000*
Legal fees and expenses 40,000*
Miscellaneous 1,000*
------------
TOTAL $ 51,251.57*
============
o Estimated.
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES.
On June 30, 2006, we entered into a Securities Purchase Agreement with AJW
Partners, LLC ("Partners"), AJW Offshore, Ltd. ("Offshore"), AJW Qualified
Partners, LLC ("Qualified") and New Millennium Capital Partners, II, LLC
("Millennium") for the sale of (i) $1,500,000 in secured convertible notes and
(ii) warrants to purchase 30,000,000 shares of the Company's common stock.
Partners, Offshore, Qualified and Millennium are collectively referred to as the
"Purchasers".
The Purchasers are obligated to provide the Company with the funds as follows:
o $500,000 was disbursed at closing;
o $500,000 will be disbursed within five days of filing a registration
statement covering the number of shares of common stock underlying the
secured convertible notes and the warrants; and
o $500,000 will be disbursed within five days of the effectiveness of the
registration statement.
II-1
The secured convertible notes bear interest at 6%, unless our common stock is
greater than $0.025 per share for each trading day of a month, in which event no
interest is payable during such month. The secured convertible notes mature
three years from the date of issuance, and are convertible into our common
stock, at the Purchasers' option, at a 50% discount to the average of the three
lowest trading prices of the common stock during the 20 trading day period prior
to conversion. The Notes and Warrants described were offered and sold to the
Investors in a private placement transaction made in reliance upon exemptions
from registration pursuant to Section 4(2) under the Securities Act of 1933 and
Rule 506 promulgated there under. Each of the Investors is an accredited
investor as defined in Rule 501 of Regulation D promulgated under the Securities
Act of 1933.
During the year ended December 31, 2005, the Company issued shares of its common
stock for the following:
o 2,595,221 shares issued for services with a value of $722,825.
o 1,909,000 shares issued for settlement of debt for a value of $320,301.
o 902,675 shares issued for a warrant.
o 480,930 shares issued for acquisition for a value of $98,938.
o 23,656,470 shares issued for equity services for a value of $1,529,196.
o 194,320 shares issued for settlement of accounts payable for a value of
$182,345.
o 416,667 shares issued for deferred compensation for a value of $37,083.
o 82,150 shares for stock subscription for a value of $82,150.
The above-referenced sales of our securities were made in reliance upon
exemptions from registration pursuant to Section 4(2) of the Securities Act of
1933.
During the year ended December 31, 2004, the Company issued shares of its common
stock for the following:
o 737,000 shares for a value of $1,397,801
o 1,228,292 shares for conversion of debt for a value of $508,505
o 901,402 shares issued for services for a value of $259,629
o 19,666 shares issued for settlement of debt for a value of $ $39,312
o 255,763 shares issued for a warrant
o 622,381 shares issued for the acquisition of Ocean West Holding
Corporation for a value of $1,178,167
o 300,000 shares issued for collateral for debt
o 150,000 shares returned to the Company for the rescission of the Pro
Mortgage acquisition, with a value of $761,060
The above-referenced sales of our
securities were made in reliance upon exemptions from registration pursuant to
Section 4(2) of the Securities Act of 1933.
II-2
During the year ended December 31, 2003, the Company issued shares of its common
stock for the following:
o 1,164,150 shares issued for the conversion of debt for a value of
$942,984.
o 25,000 shares issued for assets for a value of $149,475.
o 1,250 shares issued for cash for a value of $2,499.
o 26,050 shares issued for conversion of debt for a value of $81,723.
o 150,000 shares issued for Pro Mortgage acquisition for a value of
$761,060.
o 303,461 shares issued for interest on debt for a value of $1,517,896.
The above-referenced sales of our securities were made in reliance upon
exemptions from registration pursuant to Section 4(2) of the Securities Act of
1933.
ITEM 27. EXHIBITS.
The following exhibits are included as part of this Form SB-2.
EXHIBIT NO. TITLE
- --------------------------------------------------------------------------------
2.1 Share Exchange Agreement by Paragon Financial Corporation and
Shearson Home Loans, dated February 13, 2006 (14)
2.3 Purchase of Common Stock Agreement between the Registrant and
Crusader Capital Partners, LLC, dated August 1, 2005. (16)
3.1 Articles of Incorporation of the Registrant (1)
3.2 Amendment to Articles of Incorporation of the Registrant *
3.3 Amendment to Articles of Incorporation of the Registrant *
3.4 Amendment to Articles of Incorporation of the Registrant
2.3 Purchase and Sale of Capital Stock Agreement between the
Registrant and Ocean West Holding Corporation, dated July 15,
2004. (4)
3.4 Bylaws of the Registrant (1)
4.3 Stock Subscription Agreement between the Registrant and Ocean
West Corporation, dated July 1, 2004. (5)
4.4 Stock Subscription Agreement between the Registrant and Ocean
West Corporation, dated August 1, 2004. (6)
4.5 Stock Subscription Agreement between the Registrant and Ocean
West Corporation, dated September 1, 2004. (7)
4.6 Stock Subscription Cancellation Agreement between Registrant on
Ocean West Holding Corporation, dated September 28, 2004, (12)
4.7 Stock Subscription Agreement between the Registrant and Ocean
West Enterprise, dated September 28, 2004, (12)
4.8 Convertible Promissory Note between the Registrant and Club Vista
Holdings Inc., dated July 31, 2004. (8)
4.9 Credit Facility Agreement Note between the Registrant and Club
Vista Holdings Inc., dated September 21, 2004. (9)
II-3
5.2 Joint Venture Agreement between the Registrant and Club Vista
Holdings Inc., dated September 14, 2004. (10)
5.3 Opinion of counsel for 2006 Compensation Plan, dated January 3,
2006 (15)
5.4 Opinion of Sichenzia Ross Friedman Ference LLP
10.1 Common Stock Purchase Agreement dated February 20, 2002 between
the Registrant and Consumer Capital Holdings, Inc. (2)
10.2 Consulting Agreement between the Company and Caitlin Enterprises
dated April 21, 2003. *
10.3 Employment Agreement between the Registrant and Michael A. Barron
dated June 15, 2002.*
10.4 Employment Agreement between the Registrant and Paul Grady dated
June 15, 2002*
10.5 Employment Agreement between the Registrant and Joseph A.
Cosio-Barron dated June 15, 2002.*
10.6 Employment Agreement between the Registrant and Michael F.
Accardi dated June 15, 2002.*
10.7 Employment Agreement between the Registrant and Terry Vickery
dated June 15, 2002.*
10.8 Employment Agreement between the Registrant and Wayne Bailey
dated November 1, 2002.*
10.9 The Registrant's 2002 Stock Incentive Plan (3)
EXHIBIT NO. TITLE
- --------------------------------------------------------------------------------
10.10 Form of Series A Common Stock Purchase Warrant.*
10.11 Form of Series B Common Stock Purchase Warrant.*
10.12 Form of Series C Common Stock Purchase Warrant.*
10.13 Form of Series D Common Stock Purchase Warrant.*
10.14 Lease Agreement between the Registrant and Sandpost LLC dated
July 1, 2002.*
10.15 Sublease Agreement between Consumer Direct, Inc. and TKV
Investments dated April 15, 2001.*
10.16 Office space sublease between the Registrant and Keane, Inc.
dated August 5, 2002.*
10.17 Rescission and Settlement Agreement dated October 1, 2004, (13)
10.18 Promissory Note dated October 25, 2004, (13)
10.19 2006 Stock Compensation Plan, dated January 3, 2006 (15)
10.20 2005 Stock Compensation Plan, dated June 13, 2005. (17)
10.21 Securities Purchase Agreement, dated June 30, 2006, by and among
Shearson Financial Network, Inc. and AJW Offshore, Ltd, AJW
Qualified Partners, LLC, AJW Partners, LLC and New Millennium
Capital Partners II, LLC. (18)
10.22 Callable Secured Convertible Note issued to AJW Offshore, Ltd.,
dated June 30, 2006 (18)
10.23 Callable Secured Convertible Note issued to AJW Qualified
Partners, LLC, dated June 30, 2006. (18)
10.24 Callable Secured Convertible Note issued to AJW Partners, LLC,
dated June 30, 2006. (18)
10.25 Callable Secured Convertible Note issued to New Millennium
Capital Partners II, LLC, dated December 16, 2005. (18)
10.26 Stock Purchase Warrant issued to AJW Offshore, Ltd., dated June
30, 2006. (18)
10.27 Stock Purchase Warrant issued to AJW Qualified Partners, LLC,
dated June 30, 2006. (18)
10.28 Stock Purchase Warrant issued to AJW Partners, LLC, dated June
30, 2006. (18)
10.29 Stock Purchase Warrant issued to New Millennium Capital Partners
II, LLC, dated June 30, 2006 (18)
10.30 Registration Rights Agreement, dated as of June 30, 2006, by and
among Shearson Financial Network, Inc., AJW Offshore, Ltd., AJW
Qualified Partners, LLC, AJW Partners, LLC and New Millennium
Capital Partners II, LLC.(18)
10.31 Security Agreement, dated as of June 30, 2006, by and among
Shearson Financial Network, Inc., AJW Offshore, Ltd., AJW
Qualified Partners, LLC, AJW Partners, LLC and New Millennium
Capital Partners II, LLC. (18)
10.32 Form of Amendment to the Registration Rights Agreement dated June
30, 2006
16.2 Letter from Chavez and Koch, CPA's, dated February 8, 2005 (11)
21.1 Subsidiaries of Registrant
23.1 Consent of Pollard-Kelley Auditing Services, Inc.
23.2 Consent of Dejoyu & Company.
23.3 Consent of Sichenzia Ross Friedman Ference LLP (see exhibit 5.4)
* To be filed by amendment
II-4
(1) Incorporated by reference to the exhibits to the Registrant's
Registration Statement on Form 10-SB dated May 8, 2001 and filed with
the SEC on May 11, 2001.
(2) Incorporated by reference to the exhibits to Registrant's Report on
Form 8-K dated March 4, 2002 and filed with the SEC on March 6, 2002.
(3) Incorporated by reference to the exhibit to the Registrant's
Registration Statement on Form S-8 dated November 22, 2002 and filed
with the SEC on November 23, 2001
(4) Previously filed as an exhibit to Form 8-K, dated August 3, 2004
(5-10) Previously filed as an exhibit to Form 10QSB for the period ended
September 30, 2004.
(11) Previously filed as an exhibit to Form 8-K, dated February 8, 2005.
(12) Previously filed as an exhibit to Form 10QSB, for the period ended
September 30, 2004
(13) Previously filed as an exhibit to Form 10KSB, for the period ended
December 31, 2004, dated April 15, 2005.
(14) Previously filed as an exhibit to Form 8-K, dated February 13, 2006.
(15) Previously filed as an exhibit to Form S-8, dated January 3, 2006.
(16) Previously filed as an exhibit to Form 8-K, dated August 1, 2005.
(17) Previously filed as an exhibit to Form S-8, dated June 13, 2005.
(18) Incorporated by reference to the exhibits to the Registrant's Form 8-K
filed with the SEC on July 10, 2006
ITEM 28. UNDERTAKINGS.
The undersigned registrant hereby undertakes to:
(1) File, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement to:
(i) Include any prospectus required by Section 10(a)(3) of the Securities Act of
1933, as amended (the "Securities Act");
(ii) Reflect in the prospectus any facts or events which, individually or
together, represent a fundamental change in the information in the registration
statement. Notwithstanding the foregoing, any increase or decrease in volume of
securities offered (if the total dollar value of the securities offered would
not exceed that which was registered) and any deviation from the low or high end
of the estimated maximum offering range may be reflected in the form of a
prospectus filed with the Commission pursuant to Rule 424(b) under the
Securities Act if, in the aggregate, the changes in volume and price represent
no more than a 20% change in the maximum aggregate offering price set forth in
the "Calculation of Registration Fee" table in the effective registration
statement, and (iii) Include any additional or changed material information on
the plan of distribution.
(2) For determining liability under the Securities Act, treat each
post-effective amendment as a new registration statement of the securities
offered, and the offering of the securities at that time to be the initial bona
fide offering.
(3) File a post-effective amendment to remove from registration any of the
securities that remain unsold at the end of the offering.
(4) For determining liability of the undersigned small business issuer under the
Securities Act to any purchaser in the initial distribution of the securities,
the undersigned undertakes that in a primary offering of securities of the
undersigned small business issuer pursuant to this registration statement,
regardless of the underwriting method used to sell the securities to the
purchaser, if the securities are offered or sold to such purchaser by means of
any of the following communications, the undersigned small business issuer will
be a seller to the purchaser and will be considered to offer or sell such
securities to such purchaser:
II-5
(i) Any preliminary prospectus or prospectus of the undersigned small business
issuer relating to the offering required to be filed pursuant to Rule 424;
(ii) Any free writing prospectus relating to the offering prepared by or on
behalf of the undersigned small business issuer or used or referred to by the
undersigned small business issuer;
(iii) The portion of any other free writing prospectus relating to the offering
containing material information about the undersigned small business issuer or
its securities provided by or on behalf of the undersigned small business
issuer; and
(iv) Any other communication that is an offer in the offering made by the
undersigned small business issuer to the purchaser.
Insofar as indemnification for liabilities arising under the Securities Act may
be permitted to directors, officers and controlling persons of the registrant
pursuant to the foregoing provisions, or otherwise, the registrant has been
advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Securities Act and
is, therefore, unenforceable.
In the event that a claim for indemnification against such liabilities (other
than the payment by the registrant of expenses incurred or paid by a director,
officer or controlling person of the registrant in the successful defense of any
action, suit or proceeding) is asserted by such director, officer or controlling
person in connection with the securities being registered, the registrant will,
unless in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements for filing on Form SB-2 and authorized this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in Las Vegas, Nevada 89120, on July 19, 2006.
Shearson Financial Network Inc.
By: /s/ Michael A. Barron
-----------------------------------------
Michael A. Barron, Chief Executive Officer, Director
(Principal Executive Officer)
By: /s/ Lee Shorey
-----------------------------------------
Lee Shorey, Chief Financial Officer, Director
(Principal Financial Officer)
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints Michael A. Barron his true and lawful attorney-in-fact
and agent, with full power of substitution and resubstitution for him and in his
name, place and stead, in any and all capacities, to sign any and all amendments
(including post-effective amendments) to this Registration Statement, and any
subsequent registration statements pursuant to Rule 462 of the Securities Act of
1933 and to file the same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
said attorney-in-fact and agent full power and authority to do and perform each
and every act and thing requisite and necessary to be done in and about the
premises, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that attorney-in-fact or his
substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this registration
statement has been signed by the following persons in the capacities and on the
dates indicated.
Signature Title Date
/s/ Michael A. Barron President, Chief Executive Officer July 19, 2006
- -------------------------------- (Principal Executive Officer) and
Michael A. Barron Director
/s/ Lee Shorey Chief Financial Officer, Director July 19, 2006
- -------------------------------- (Principal Financial Officer)
Lee Shorey