-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WjgbK8vTQHNrkDAemHU268I1X0qWX6CCt82WMfRxmOJvriZcVSIHmhKLq5+BELpx HFBnHLIZzixIFx9ETozAYw== 0001019892-01-500075.txt : 20020410 0001019892-01-500075.hdr.sgml : 20020410 ACCESSION NUMBER: 0001019892-01-500075 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20010930 FILED AS OF DATE: 20011114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HOMEGOLD FINANCIAL INC CENTRAL INDEX KEY: 0000277028 STANDARD INDUSTRIAL CLASSIFICATION: PERSONAL CREDIT INSTITUTIONS [6141] IRS NUMBER: 570513287 STATE OF INCORPORATION: SC FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-08909 FILM NUMBER: 1791684 BUSINESS ADDRESS: STREET 1: 3901 PELHAM ROAD CITY: GREENVILLE STATE: SC ZIP: 29615 BUSINESS PHONE: 8642895400 MAIL ADDRESS: STREET 1: 3901 PELHAM ROAD CITY: GREENVILLE STATE: SC ZIP: 29615 FORMER COMPANY: FORMER CONFORMED NAME: EMERGENT GROUP INC DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: NATIONAL RAILWAY UTILIZATION CORP DATE OF NAME CHANGE: 19840813 FORMER COMPANY: FORMER CONFORMED NAME: NRUC CORP DATE OF NAME CHANGE: 19911002 10-Q 1 form10q-september302001.txt FOR PERIOD ENDED SEPTEMBER 30, 2001 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-Q (Mark One) [ X ] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30, 2001. OR [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from _________ to _________. COMMISSION FILE NUMBER 0-8909 ----------------------- HOMEGOLD FINANCIAL, INC. (Exact name of registrant as specified in its charter) SOUTH CAROLINA 57-0513287 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 113 REED AVENUE LEXINGTON, SOUTH CAROLINA 29072 (Address of Principal Executive Offices) 803-996-2000 (Registrant's Telephone Number, Including Area Code) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No _____ ----- Indicate the number of shares outstanding of each of the issuer's classes of stock, as of the latest practicable date.
Title of each Class: Outstanding at October 31, 2001 - ------------------------------------------------- ----------------------------------- SERIES A NON-CONVERTIBLE PREFERRED STOCK, PAR VALUE $1.00 PER SHARE 10,000,000 COMMON STOCK, PAR VALUE $0.001 PER SHARE 16,897,507
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES FORM 10-Q QUARTER ENDED SEPTEMBER 30, 2001 INDEX PART I. FINANCIAL INFORMATION Page - ------ --------------------- ---- Item 1. Financial Statements for HomeGold Financial, Inc. Consolidated Balance Sheets as of September 30, 2001 and December 31, 2000 3 Consolidated Statements of Operations for the Nine Months Ended September 30, 2001 and 2000 and for the Three Months Ended September 30, 2001 and 2000 4 Consolidated Statements of Shareholder's Equity (Deficit) for the Nine Months Ended September 30, 2001 5 Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2001 6 Notes to Unaudited Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition 20 Item 3. Disclosures about Market Risk 31 PART II. OTHER INFORMATION Item 3. Defaults Upon Senior Securities 33 Item 6. Exhibits and Reports on Form 8-K 33
2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS FOR HOMEGOLD FINANCIAL, INC.
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, DECEMBER 31, 2001 2000 ----------------- ----------------- (In thousands) ASSETS (Unaudited) (Audited) ------ Cash and cash equivalents $ 24,247 $ 3,691 4 Restricted cash 2,578 5,066 Loans receivable 58,979 58,483 Less allowance for credit losses on loans (4,904) (4,652) Less deferred loan fees, net (1,038) (2,132) ----------------- ----------------- Net loans receivable 53,037 51,699 Income taxes receivable 169 318 Accrued interest receivable 1,507 1,817 Other receivables 12,092 11,497 Residual receivable, net 59,102 58,877 Property and equipment, net 20,613 21,430 Real estate and personal property acquired through foreclosure 518 1,281 Excess of cost over net assets of acquired businesses, net of accumulated amortization of 18,575 19,623 $2,760 in 2001 and $1,712 in 2000 Debt origination costs, net 173 221 Deferred income tax asset, net 22,000 22,000 Servicing asset 607 703 Other assets 15,351 3,798 ----------------- ----------------- TOTAL ASSETS $ 230,569 $ 202,021 ================= ================= LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) Liabilities: Revolving warehouse lines of credit $ 30,184 $ 26,951 Other borrowings -- 2,352 Investor savings: Notes payable to investors 186,034 146,087 Subordinated debentures 24,630 19,117 ----------------- ----------------- Total investor savings 210,664 165,204 Senior unsecured debt 11,003 11,214 Other liabilities: Accounts payable and accrued liabilities 3,948 4,637 Remittances payable 1,164 1,201 Income taxes payable 311 347 Accrued interest payable 614 938 ----------------- ----------------- Total other liabilities 6,037 7,123 ----------------- ----------------- Total liabilities 257,888 212,844 Minority interest 1 5 Shareholders' equity (deficit): Preferred stock , par value $1.00 per share- authorized 20,000,000 shares, issued and outstanding 10,000 10,000 10,000,000 shares at September 30, 2001 and December 31, 2000 Common stock, par value $.001 per share at September 30, 2001 and 0.001 at December 31, 2000- authorized 100,000,000 shares, issued and outstanding 16,897,507 17 17 shares at September 30, 2001 and 16,810,149 shares at December 31, 2000 Capital in excess of par value 46,668 46,643 Note receivable from shareholder (5,700) (5,985) + Accumulated deficit (78,305) (61,503) + ----------------- ----------------- Total shareholders' deficit (27,320) (10,828) ----------------- ----------------- TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIT $ 230,569 $ 202,021 ================= ================= See Notes to Unaudited Consolidated Financial Statements, which are an integral part of these statements.
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HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) FOR THE NINE MONTHS ENDED FOR THE THREE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ------------------------------------ ---------------------------------- 2001 2000 2001 2000 --------------- ----------------- ----------------- ------------- (In thousands, except share data) REVENUES: Interest income $ 6,801 $ 9,390 $ 2,468 $ 3,784 Servicing income 3,342 4,479 822 1,893 Gain on sale of loans 8,566 8,498 2,850 3,554 Loan fees, net 22,959 12,977 7,461 4,311 --------------- ----------------- ------------- ---------------- Total revenue from loans and investments 41,668 35,344 13,601 13,542 Other revenues 893 1,512 94 573 --------------- ----------------- ------------- ---------------- Total revenues 42,561 36,856 13,695 14,115 --------------- ----------------- ------------- ---------------- EXPENSES: Interest 15,144 14,564 5,329 5,680 Provision for credit losses 192 2,292 192 650 Costs on real estate owned and defaulted loans 1,266 2,841 71 914 Salaries, wages and employee benefits 25,796 21,337 9,349 8,469 Business development costs 170 6,012 (5,553) 2,136 Restructuring costs 897 (345) Other general and administrative expenses 17,669 2,375 6,270 99 13,950 4,084 --------------- ----------------- ------------- -------------- Total expenses 61,134 63,371 15,313 22,257 --------------- ----------------- ------------- -------------- Loss before income taxes, minority interest, extraordinary item, and cumulative effect (18,573) (26,515) (1,618) (8,142) Provision (benefit)for income taxes 456 (9,485) 127 (9,820) --------------- ----------------- ------------- ------------- Income (Loss) before minority interest, and (19,029) (17,030) (1,745) 1,678 extraordinary item, and cumulative effect Minority interest in (income) loss of subsidiaries (3) (3) (3) (2) --------------- ----------------- ------------- ------------- Income (Loss) before extraordinary item and (19,032) (17,033) (1,748) 1,676 cumulative effect Extraordinary item-gain on extinguishment of debt, net of $0 tax 153 579 -- 261 Cumulative effect of change in accounting principle 2,077 -- 2,077 -- --------------- ----------------- ------------- ------------- NET INCOME (LOSS) $ (16,802) $ (16,454) $ 329 $ 1,937 =============== ================= ============= ============= BASIC AND DILUTED EARNINGS (LOSS) PER SHARE OF COMMON STOCK: Loss before extraordinary item and $ (1.13) $ (1.25) $ (0.11) $ 0.10 cumulative effect on change in accounting principle Extraordinary item, net of taxes 0.01 0.04 0.00 0.02 Cumulative effect of change in accounting 0.12 0.00 0.12 principle --------------- ----------------- ------------- ------------- Net income (loss) $ (1.00) $ (1.21) $ 0.01 $ 0.12 =============== ================= ============= ============= Basic and diluted weighted average shares outstanding 16,875,075 13,651,181 16,897,507 16,805,023 =============== ================= ============= ============= See Notes to Unaudited Consolidated Financial Statements, which are an integral part of these statements.
4
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000 (UNAUDITED) Common Stock Total ------------------------- Note Share- Capital in Receivable holders' Excess of Preferred from Accumulated Equity Par Value Stock Shareholder Deficit (Deficit) Shares Issued Amount ------------- ---------- ------------ ---------- ------------- ----------- ---------- Balance at December 31, 1999 10,149,629 $ 507 $ 39,028 -- -- (31,692) 7,843 Change in par from $0.05 to $0.001 (490) 490 -- -- -- Shares issued: Employee Stock Purchase Plan 46,606 1 35 -- -- -- 36 Officer/Director Compensation 61,540 3 45 -- -- -- 48 Share Cancellation (228,570) (11) -- -- -- -- (11) Shares issued in HomeSense Merger 6,780,944 7 7,045 -- -- -- 7,052 Shares issued in HomeSense Merger -- -- -- 10,000 -- -- 10,000 Note Receivable from Shareholder -- -- -- -- (5,908) -- (5,908) Net loss -- -- -- -- -- (16,454) (16,454) ------------- ---------- ------------ ---------- ------------- ------------- -------- BALANCE AT SEPTEMBER 30, 2000 16,810,149 $ 17 $ 46,643 $ 10,000 $ (5,908) $ (48,146) $ 2,606 ============= ========== ============ ========== ============= ============= ======== Balance at December 31, 2000 16,810,149 17 46,643 10,000 (5,985) (61,503) (10,828) Shares issued: -- Employee Stock Purchase Plan 87,358 -- 25 -- -- -- 25 Collections on Note Receivable from Shareholder -- -- -- -- 285 -- 285 Net loss -- -- -- -- -- (16,802) (16,802) ------------- ---------- ------------- ----------- ------------ ------------ --------- BALANCE AT SEPTEMBER 30, 2001 16,897,507 $ 17 $ 46,668 $ 10,000 $ (5,700) $ (78,305) $(27,320) ============= ========== ============= =========== ============ ============ ========= See Notes to Unaudited Consolidated Financial Statements, which are an integral part of these statements.
5
HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) FOR THE NINE MONTHS ENDED SEPTEMBER 30, ------------------------------------ 2001 2000 ---------------- ---------------- (In thousands) OPERATING ACTIVITIES: Net loss $ (16,802) $ (16,454) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 3,231 2,709 Provision for credit losses on loans 192 2,292 Fair value write-down of REO 126 -- Loss (gain) on sale of property and equipment (9) -- Loss (gain) on sale of REO 372 -- Minority interest in earnings of subsidiary (4) -- Net change in deferred loan fees and deferred (1,093) -- loan costs Gain on retirement of senior unsecured debt (153) (579) Loss on real estate acquired through -- 1,380 foreclosure Fair value write-down of residual receivable -- 2,143 Loans originated with intent to sell (531,571) (441,223) Proceeds from loans sold 441,526 374,971 Proceeds from securitization of loans -- 44,588 Other -- (10,300) Net changes in operating assets and (9,181) (27,015) liabilities ---------------- ---------------- Net cash used in operating activities $ (113,366) $ (67,488) ---------------- ---------------- INVESTING ACTIVITIES: Loans originated or purchased for investment purposes $ -- $ (409) Principal collections on loans not sold 88,720 40,948 Proceeds from sale of real estate and personal property acquired through foreclosure 1,155 9,710 Proceeds from sale of property and equipment 388 45 Purchase of property and equipment (1,708) (147) Loan to/repayment from shareholder 285 (5,908) Other (1,226) (2,867) ---------------- ---------------- Net cash provided by investing activities $ 87,614 $ 41,372 ---------------- ---------------- FINANCING ACTIVITIES: Advances on revolving warehouse lines of credit $ 474,867 $ 557,878 Payments on revolving warehouse lines of credit (473,986) (563,637) Retirement of senior unsecured debt (58) (341) Net increase (decrease) in notes payable to investors 39,947 (7,510) Net increase in subordinated debentures 5,513 23,565 Proceeds from issuance of common stock 25 73 ---------------- ---------------- Net cash provided by financing activities $ 46,308 $ 10,028 ---------------- ---------------- Net increase (decrease) in cash and cash equivalents $ 20,556 $ (16,088) CASH AND CASH EQUIVALENTS: Beginning of period 3,691 26,009 ---------------- ---------------- End of period $ 24,247 $ 9,921 ================ ================ See Notes to Unaudited Consolidated Financial Statements, which are an integral part of these statements.
6 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS NOTE 1--BASIS OF PREPARATION HomeGold Financial, Inc. (referred to herein sometimes as the "Company" and "HGFN") states that the accompanying consolidated financial statements are prepared in accordance with the Securities and Exchange Commission's ("SEC") rules regarding interim financial statements, and therefore do not contain all disclosures required by generally accepted accounting principles for annual financial statements. Reference should be made to the consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2000, including the footnotes thereto. Certain previously reported amounts have been reclassified to conform to current year presentation. Such reclassifications had no effect on net operations or shareholders' equity as reported prior to their adoption. On May 9, 2000, HomeSense Financial Corporation and certain of its affiliated companies ("HomeSense") were merged into HomeGold, Inc., a wholly owned subsidiary of HGFN pursuant to a merger agreement approved by HGFN's shareholders on April 28, 2000. HomeSense was a privately owned specialized mortgage company headquartered in Lexington, South Carolina that originated and sold mortgage loans in the sub-prime mortgage industry. Its principal loan product was a debt consolidation loan, generally collateralized by a first lien on the borrower's home. HomeSense originated its loan volume through a direct retail branch network of eight offices, as well as through centrally-provided telemarketing lead, direct mail, and television advertising. HomeGold, Inc. has continued the business of HomeSense after the merger. In the merger, HGFN issued 6,780,944 shares of its common stock (approximately 40% of post-merger shares outstanding) valued at $1.04 per share plus an additional 10 million shares of Series A Non-convertible Preferred Stock, par value $1 per share, for 100% of the outstanding stock of HomeSense. Most of this merger consideration was issued to HomeSense's primary shareholder Ronald J. Sheppard. Mr. Sheppard is now the chief executive officer and a director of HGFN, and a director of HomeGold, Inc. The merger was accounted for under the purchase method of accounting. The transaction resulted in $19.0 million of goodwill, which is being amortized, on a straight-line basis over 15 years. After the merger was consummated, certain differences arose between the parties to the merger regarding the warranties and representations in the merger agreement. These differences were resolved in February 2001 by an agreement between Mr. Sheppard and HGFN pursuant to which Mr. Sheppard agreed to remain a guarantor with respect to certain indebtedness HomeGold, Inc. assumed from HomeSense in the merger and pursuant to which options for HGFN stock issued to Mr. Sheppard in the merger were cancelled. In addition, a mutual indemnity agreement between HGFN and Mr. Sheppard was cancelled. The consolidated balance sheet as of September 30, 2001, and the consolidated statements of operations for the nine-month and three-month periods ended September 30, 2001 and 2000, and the consolidated statements of cash flows for the nine-month periods ended September 30, 2001 and 2000, are unaudited and in the opinion of management contain all known adjustments, which consist of only normal recurring adjustments necessary to present fairly the financial position, results of operations, and cash flows of the Company. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ from those estimates. These estimates include, among other things, valuation of real estate owned, assumptions used to value residual receivables, determination of the allowance for credit losses, and the valuation of the marketing asset. NOTE 2--PRO FORMA EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE In September 2001, the Company capitalized costs related to the development of its Proprietary Leads Database ("the database"), which was recorded as an intangible asset with an initial life of twenty-four months. Prior to the three months ended September 30, 2001, the Company deferred most marketing expenditures over a six-month deferral period. The implemented capitalized costs of the database represent expenditures incurred over the prior fourteen months. Expenditures totaling approximately $3.3 million which had been expensed during the final five months of 2000 were capitalized and amortized, 7 resulting in a cumulative effect from a change in accounting principle of $2.1 million. The following pro forma information assumes that the change in accounting for the database was implemented on January 1, 2001. The pro forma results are not necessarily indicative of what actually would have happened had the change taken place at the beginning of the year. In addition, they are not intended to be a projection of future results that may be achieved from the Company's operations.
Pro Forma for the Three Months Ended 31-Mar-01 30-Jun-01 30-Sep-01 --------- --------- --------- Revenue $ 11,385 $ 17,481 $ 13,696 Expenses (21,382) (24,767) (15,444) Extraordinary item-gain on extinguishment of debt -- 52 101 Cumulative effect-change in accounting principle -- -- 2,077 --------------- --------------- ---------------- Net Income (Loss) $ $ (7,185) $ (1,748) (7,868) =============== =============== ================ Basic and diluted earnings (loss) per share of common stock: Loss before extraordinary item and cumulative effect $ (0.59) $ (0.43) $ (0.10) on change of accounting principle Extraordinary item, net of taxes -- 0.00 0.01 Cumulative effect on change of accounting principle -- 0.12 0.00 --------------- --------------- ---------------- Net Income (Loss) $ (0.47) $ (0.42) $ (0.10) =============== =============== ================ Basic and diluted weighted average shares outstanding 16,848,359 16,878,784 16,897,507 =============== =============== ================
NOTE 3--ACCOUNTING CONSIDERATIONS In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" which is effective for all fiscal quarters of fiscal years beginning after June 15, 2000, as amended by SFAS 137. This SFAS statement establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. Since the Company has no significant hedging positions outstanding, the implementation of this standard had no material impact on its financial statements. In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities--a replacement of FASB No. 125." It revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures but carries over most of FASB No. 125's provisions without reconsideration. SFAS No. 140 is effective for all transfers and servicing of financial assets and extinguishment of liabilities occurring after March 31, 2001. Retroactive and early adoption is prohibited. This statement is effective for disclosures related to securitization transactions and collateral for fiscal years ending after December 15, 2000. The adoption of provisions of SFAS No. 140 was not material to the Company. In the November 2000 meeting, the Emerging Issues Task Force (EITF) reached a consensus on EITF 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets." The issue deals with how interest income and impairment should be recognized for retained interests in securitizations. If upon evaluation, the holder determines that it is probable that there is a change in estimated cash flows (in both timing and estimates of projected cash flows) , the amount of accretable yield should be recalculated and if that change in estimated cash flows is an adverse change, an other-than-temporary impairment should be considered to have occurred. The effective date of this EITF is March 15, 2001. The Company does not believe any permanent impairment has occurred in its securitized assets as of September 30, 2001. In June 2001, the FASB issued SFAS No. 141 - Business Combinations. This FASB addresses accounting and reporting for all business combinations and defines the purchase method as the only acceptable method. During 2001, the Company has not participated in any business combinations. 8 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS In June 2001, the FASB issued SFAS No. 142 - Goodwill and Other Intangible Assets. This SFAS addresses how goodwill and other intangible assets should be accounted for at their acquisition (except for those acquired in a business combination) and after they have been initially recognized in the financial statements. The statement is effective for all fiscal years beginning after December 15, 2001. The Company has not completed its evaluation of the effect this statement will have on the financial position of the Company. In July 2001, the SEC issued Staff Accounting Bulletin (SAB) No. 102 - Selected Loan Loss Allowance Methodology and Documentation Issues. This staff accounting bulletin clearly defines the required development, documentation, and application of a systematic methodology for determining allowances for loan and lease losses in accordance with generally accepted accounting principles. The Company believes that it is in compliance with SAB 102 as of September 30, 2001. In September 2001, the Company capitalized costs related to the development of its Proprietary Leads Database ("the database"), which was recorded as an intangible asset with an initial life of twenty-four months. Prior to the three months ended September 30, 2001, the Company deferred most marketing expenditures over a six-month deferral period. The implemented capitalized costs of the database represent expenditures incurred over the prior fourteen months. Expenditures totaling approximately $3.3 million which had been expensed during the final five months of 2000 were capitalized and amortized, resulting in a cumulative effect from a change in accounting principle of $2.1 million. Additional accounting standards that have been issued or proposed by the FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption. NOTE 4--CASH FLOW INFORMATION For the nine-month periods ended September 30, 2001 and 2000, the Company paid interest of $15.1 million and $14.5 million, respectively. For the nine-month periods ended September 30, 2001 and 2000, the Company paid income taxes of $582,000 and $515,000, respectively. For the nine-month periods ended September 30, 2001 and 2000, the Company foreclosed on property in the amount of $1.3 million and $2.8 million, respectively. During the nine months ended September 30, 2000 in connection with the HomeSense merger the following non cash items were recorded: (In thousands) Loans receivable $ 29,244 Property and equipment, net 5,800 Goodwill 19,020 Revolving warehouse lines of credit 29,244 Notes payable 127,859 Other liabilities 8,692 Preferred stock 10,000 Common stock 7 Capital in excess of par value 7,045 NOTE 5--CASH, CASH EQUIVALENTS, AND RESTRICTED CASH The Company maintains its primary checking accounts with one principal bank and makes overnight investments in reverse repurchase agreements with that bank. The amounts maintained in the checking accounts are insured by the Federal Deposit Insurance Corporation ("FDIC") up to $100,000. At September 30, 2001, the amounts maintained in overnight investments in reverse repurchase agreements and other short-term investments, which are not insured by the FDIC, totaled approximately $24.2 million. The investments were secured by U.S. Government securities pledged by the banks. 9 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. The Company has assigned certificates of deposit totaling $2.6 million to its warehouse lenders to secure its borrowings under revolving warehouse credit agreements. The certificates of deposit are shown as restricted cash in the financial statements. NOTE 6--RESIDUAL RECEIVABLES AND SALES AND SECURITIZATIONS OF LOANS In 1997, the Company began securitizing mortgage loans, whereby it sells the loans that it originates or purchases to a trust for cash, and records certain assets and income based upon the difference between all principal and interest received from the loans sold and (i) all principal and interest required to be passed through to the asset-backed bond investors, (ii) all excess contractual servicing fees, (iii) other recurring fees and (iv) an estimate of losses on the loans (collectively, the "Excess Cash Flow"). At the time of the securitization, the Company estimates these amounts based upon a declining principal balance of the underlying loans, adjusted by an estimated prepayment and loss rate, and capitalizes these amounts using a discount rate that market participants would use for similar financial instruments. These capitalized assets are recorded as a residual receivable. The Company believes the assumptions it has used to value the residual receivable are appropriate and reasonable. At each reporting period, the Company assesses the fair value of these residual assets based on the present value of future cash flows expected under management's current best estimates of the key assumptions-credit losses, prepayment speed, forward yield curves, and discount rates commensurate with the risks involved and adjusts the recorded amounts to their estimated fair value. The Company believes, based on market conditions and market factors, that it will continue to securitize, in 2001. The Company makes securitization decisions based on a number of factors including conditions in the secondary market, the aggregate size and weighted average coupon of loans available to sell, fixed costs associated with securitization transactions, and liquidity needs. The Company completed servicing released securitizations in the third quarter of 2000 for $41.6 million. This transaction also resulted in a $12.1 million residual certificate. These subordinate residual securities totaled $60.1 million and $58.9 million, net of allowances, at September 30, 2001 and December 31, 2000, respectively. The Company also sells on a whole loan basis (servicing released) a significant portion of its loans, including substantially all of its mortgage loans secured by second mortgage liens, principally to secure the additional cash flow associated with the premiums paid in connection with such sales and to eliminate the credit risk associated with the second lien mortgage loans. The Company believes, based on market conditions and business factors, that it will continue to sell loans on a whole loan basis for the remainder of 2001. NOTE 7--WAREHOUSE LINES OF CREDIT AND OTHER BORROWINGS The Company renewed its revolving warehouse line of credit with Household Commercial Financial Services, Inc. ("Household"), effective as of June 11, 2001, which bears interest at the Prime rate plus .25%, advances funds at 97% of the loan amount, and is collateralized by the mortgage loans funded. Household also holds a first mortgage on the Company's Pelham Road facilities in Greenville, South Carolina. The agreement requires, among other matters, positive net income in the Company's subsidiary, HomeGold, Inc., for the three months ending June 30, 2001 and for each month thereafter. The Company is currently in default under this covenant. On August 29, 2001, as a result of this Event of Default, Household executed an amendment to the June 11 warehouse line of credit in which Household agreed to (i) forebear through December 31, 2001 from accelerating the Loans or exercising any rights and remedies to which it is entitled and to (ii) continue to extend Loans to the Company's subsidiary in accordance with the June 11 agreement. The amendment reduced the maximum commitment to $20 million at September 30, 2001. The amendment further reduced the maximum commitment to $10 million on October 31, 2001. The amendment calls for a cessation of lending as of November 30, 2001, and requires all loans to be paid off the line by December 31, 2001. The Company has reached an oral agreement with Household to continue lending indefinitely at a level not to exceed $20 million. Availability under the credit agreement is expected to be determined based on eligible collateral as defined under the agreement, for which the Company has forwarded to the bank the required loan files and documentation. Based on the outstanding borrowings under the line of credit of $10.4 million, the Company had $9.6 million of immediate availability under this agreement at September 30, 2001. 10 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company has a $15 million revolving warehouse line of credit with The Provident Bank ("Provident"). Interest on the line varies on a loan by loan basis and ranges from the prime rate plus 1.5% to the prime rate plus 3.5%, depending on the grade and age of the mortgage funded. The agreement allows for a rate reduction from the base rates if certain monthly funded volume targets are met. For the month of September, 2001, the Company achieved the targeted funded volume for the second stage rate reduction of 0.25% from the initial base rates. Provident holds a first mortgage on the Company's Reed Avenue property in Lexington, South Carolina. The agreement contains no covenants related to the financial condition or results of operations of the Company; and the Company has not violated any other provisions of the agreement. All advances to the Company under the Provident warehouse were at Provident's sole discretion. The agreement allows Provident to retain the servicing rights to any loans funded on the line of credit. Availability under the credit agreement is determined based on eligible collateral as defined in the agreement, for which the Company has forwarded to the bank the required loan files and documentation. The line of credit terminates on October 31, 2002. At September 30, 2001, the balance of funded loans on the line was $7.3 million, and these loans were all sub-serviced by Provident. The Company has a $15 million warehouse line of credit with Impac Mortgage Acceptance Corp. ("Impac"). The facility bears interest at the prime rate plus 1.50%, requires a $1 million collateral deposit, and may be terminated by Impac without notice. Advance rates on fundings range from 96% to 100% of the principal amount, depending on the type and source of the mortgage. The maximum commitment for this line of credit is $15 million. At September 30, 2001, the balance of funded loans on the line was $11.7 million. All of the Company's warehouse lines contain provisions whereby the lender can terminate their agreement without cause with certain notice requirements. The Company's management believes all current warehouse relationships will remain in place until maturity; however, there is no assurance that one or more of the lenders will not terminate their agreements prior to maturity, or that additional lines will be negotiated at maturity. Either occurrence would adversely affect the Company's ability to originate loans. NOTE 8--SENIOR UNSECURED DEBT AND SUBSIDIARY GUARANTORS In September 1997, the Company sold $125.0 million in aggregate principal amount of Senior Notes due 2004 ("Senior Notes"). The Senior Notes constitute unsecured indebtedness of the Company. The Senior Notes mature on September 15, 2004, with interest payable semi-annually at 10.75%. The Senior Notes will be redeemable at the option of the Company, in whole or in part, on or after September 15, 2001, at predetermined redemption prices plus accrued and unpaid interest to the date of redemption. Prior to 2000, the Company purchased $112.9 million in aggregate principal amount of its Senior Notes for a combined purchase price of $63.9 million or 56.6% of face value. In 2000, the company purchased $920,000 in aggregate principal amount of the Senior Notes in open market transactions for a purchase price of $341,000. During 2001, the Company has purchased $211,000 in aggregate principal balance of the Senior Notes in open market transactions for a purchase price of $58,000, and may, from time to time, purchase more of its Senior Notes depending on its cash needs, market conditions, and other factors. As of September 30, 2001, the indenture pertaining to the Senior Notes contained various restrictive covenants including limitations on, among other things, incurring certain types of additional indebtedness, the payment of dividends and certain other payments, the ability of the Company's subsidiaries to incur further limitations on their ability to pay dividends or make other payments to the Company, liens, asset sales, the issuance of preferred stock by the Company's subsidiaries, and transactions with affiliates. At September 30, 2001, management believes the Company was in compliance with such restrictive covenants. In October 2001, the Company purchased $4.8 million in principal amount of its outstanding senior notes for a purchase price of $2.6 million, or 55% of face value. In conjunction with the purchase, the Company received the consent of a majority of holders of a majority of the principal amount of the oustanding senior notes to eliminate the restrictive covenants summarized above. The Senior Notes are fully and unconditionally guaranteed (the "Subsidiary Guarantees") jointly and severally on an unsecured basis (each, a "Guarantee") by certain of the Company's subsidiaries. With the exception of the Guarantee by the Company's subsidiary CII, the Subsidiary Guarantees rank on par with the right of payment with all existing and future unsubordinated indebtedness of the Subsidiary Guarantors and senior in right of payment to all existing and future subordinated indebtedness of such Guarantors. All existing debt of all subsidiaries other than CII are currently considered to be subordinated to the Senior Notes. The Guarantee by CII is equal in priority to CII's notes payable to investors and is senior to CII's subordinated debentures. The Senior Notes outstanding at September 30, 2001 and 2000 were $11.0 million and $11.2 million, respectively. 11 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company has included consolidating condensed financial data of the combined subsidiaries of the Company in these financial statements. The Company believes that providing the condensed consolidating information is of material interest to investors in the Senior Notes and has not presented separate financial statements for each of the wholly-owned Subsidiary Guarantors, because it was deemed that such financial statements would not provide investors with any material additional information. At both September 30, 2001 and December 31, 2000, all of the Subsidiary Guarantors were wholly-owned by the Company. The Subsidiary Guarantors of the Company's Senior Notes at September 30, 2001 consist of the following wholly-owned subsidiaries of the Company: HomeGold, Inc. Emergent Mortgage Corp. of Tennessee Carolina Investors, Inc. Emergent Insurance Agency Corp. Emergent Business Capital Asset Based Lending, Inc. Investments in subsidiaries are accounted for by the parent company and Subsidiary Guarantors on the equity method for the purposes of the consolidating financial data. Earnings of subsidiaries are therefore reflected in the parent's and Subsidiary Guarantor's investment accounts and earnings. The principal elimination entries eliminate investments in subsidiaries and intercompany balances and transactions. As of September 30, 2001 and December 31, 2000, the Subsidiary Guarantors conduct all of the Company's operations, other than the investment of certain residual receivables through its special purpose securitization subsidiaries. 12
HOMEGOLD FINANCIAL, INC. CONSOLIDATING BALANCE SHEETS SEPTEMBER 30, 2001 (Unaudited) (In thousands) Combined Wholly-Owned Combined Parent Guarantor Non-Guarantor Company Subsidiaries Subsidiaries Eliminations Consolidated ---------- ----------- ----------- ------------ ----------- ASSETS Cash and cash equivalents $ 1 24,245 1 -- $ 24,247 Restricted cash 66 2,512 -- -- 2,578 Loans receivable: Loans receivable 1,029 57,950 -- -- 58,979 Notes receivable from other affiliates 6,955 116,500 18,551 (142,006) -- ---------- ----------- ----------- ------------ -- -------- Total loans receivable 7,984 174,450 18,551 (142,006) 58,979 Less allowance for credit losses on loans (250) -- -- (4,904) (4,654) Plus deferred loan costs -- (1,038) -- -- (1,038) ---------- ----------- ----------- ------------ -- -------- Net loans receivable 7,734 168,758 18,551 (142,006) 53,037 Income tax receivable -- 169 -- -- 169 Accrued interest receivable 79 1,428 -- -- 1,507 Other receivables 1,000 11,092 -- -- 12,092 Investment in subsidiaries 81,423 45,790 -- (127,213) -- Residual receivable, net -- 22,540 36,562 -- 59,102 Property and equipment, net -- 20,613 -- -- 20,613 Real estate and personal property acquired -- 518 -- -- 518 through foreclosure Excess of cost over net assets of acquired 34 18,541 -- -- 18,575 businesses, net Deferred income tax asset, net 1,810 20,190 -- -- 22,000 Other assets 178 15,953 -- -- 16,131 ---------- ----------- ----------- ------------ ----------- TOTAL ASSETS $ 92,325 $ 352,349 $ 55,114 $ (269,219) $ 230,569 ========== =========== =========== ============ =========== LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) Liabilities: Revolving warehouse lines of credit and other $ -- $ 30,184 $ -- $ -- $ 30,184 borrowings Investor savings: Notes payable to investors -- 186,034 -- -- 186,034 Subordinated debentures -- 24,630 -- -- 24,630 ---------- ----------- ----------- ------------ ----------- Total investor savings -- 210,664 -- -- 210,664 Senior unsecured debt 11,003 -- -- -- 11,003 Other liabilities: Accounts payable and accrued liabilities 6 3,942 -- -- 3,948 Remittances payable -- 1,164 -- -- 1,164 Income taxes payable -- 311 -- -- 311 Accrued interest payable (30) 644 -- -- 614 Due to (from) affiliates -- 18,619 9,324 (27,943) -- ---------- ----------- ----------- ------------ ----------- Total other liabilities (24) 24,680 9,324 (27,943) 6,037 Subordinated debt to affiliates 108,666 5,399 -- (114,065) -- ---------- ----------- ----------- ------------ ----------- Total liabilities 119,645 270,927 9,324 (142,008) 257,888 Minority interest -- -- -- 1 1 Shareholders' equity (deficit): Preferred stock 10,000 -- -- -- 10,000 Common stock 17 1,000 2 (1,002) 17 Capital in excess of par value 46,668 203,740 48,807 (252,547) 46,668 Note receivable from shareholder (5,700) (5,700) -- 5,700 (5,700) Retained earnings (deficit) (78,305) (117,618) (3,019) 120,637 (78,305) ---------- ----------- ----------- ------------ ----------- Total shareholders' equity (deficit) (27,320) 81,422 45,790 (127,212) (27,320) ---------- ----------- ----------- ------------ ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)$ 92,325 $ 352,349 $ 55,114 $ (269,219) $ 230,569 ========== =========== =========== ============ ===========
13
HOMEGOLD FINANCIAL, INC. CONSOLIDATING BALANCE SHEETS DECEMBER 31, 2000 (Unaudited) (In thousands) Combined Wholly-Owned Combined Parent Guarantor Non-Guarantor Company Subsidiaries Subsidiaries Eliminations Consolidated ---------- ----------- ----------- ------------ ------------ ASSETS Cash and cash equivalents $ 100 $ 3,590 $ 1 $ -- $ 3,691 Restricted cash 66 5,000 -- -- 5,066 Loans receivable: Loans receivable 1,087 57,396 -- -- 58,483 Notes receivable from affiliates 7,847 95,448 14,083 (117,378) -- ---------- ----------- ----------- ------------ ------------ Total loans receivable 8,934 152,844 14,083 (117,378) 58,483 Less allowance for credit losses on loans (250) -- -- (4,402) (4,652) Less deferred loan fees, net -- (2,132) (2,132) ---------- ----------- ----------- ------------ ------------ Net loans receivable 8,684 146,310 14,083 (117,378) 51,699 Other Receivables: Income tax -- 318 -- -- 318 Accrued interest receivable 80 1,737 -- -- 1,817 Other receivables -- 11,497 -- -- 11,497 Investment in subsidiaries 89,558 45,146 -- (134,704) -- Residual receivable, net -- 19,123 39,754 -- 58,877 Property and equipment, net -- 21,430 -- -- 21,430 Real estate and personal property acquired -- 1,281 -- -- 1,281 through foreclosure Excess of cost over net assets of acquired 35 19,588 -- -- 19,623 businesses, net Deferred income tax asset, net 1,810 20,190 -- -- 22,000 Other assets 1,220 3,502 -- -- 4,722 ---------- ----------- ----------- ------------ ------------ TOTAL ASSETS $ 101,554 $ 298,712 $ 53,837 $ (252,082) $ 202,021 ========== =========== =========== ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) Liabilities: Revolving warehouse lines of credit and other $ -- $ 29,303 $ -- $ -- $ 29,303 borrowings Investor savings: Notes payable to investors -- 146,087 -- -- 146,087 Subordinated debentures -- 19,117 -- -- 19,117 ---------- ----------- ----------- ------------ ------------ Total investor savings -- 165,204 -- -- 165,204 Senior unsecured debt 11,214 -- -- -- 11,214 Accounts payable and accrued liabilities -- 4,637 -- -- 4,637 Remittances payable -- 1,201 -- -- 1,201 Income taxes payable -- 347 -- -- 347 Accrued interest payable 328 610 -- -- 938 Due to (from) affiliates 100,840 7,852 8,686 (117,378) -- ---------- ----------- ----------- ------------ ------------ Total other liabilities 101,168 14,647 8,686 (117,378) 7,123 Subordinated debt to affiliates -- -- -- -- -- Total liabilities 112,382 209,154 8,686 (117,378) 212,844 Minority interest -- -- 5 -- 5 Shareholders' equity (deficit): Preferred stock 10,000 -- -- -- 10,000 Common stock 17 1,000 2 (1,002) 17 Capital in excess of par value 46,643 203,739 48,807 (252,546) 46,643 Note receivable from shareholder (5,985) (5,985) -- 5,985 (5,985) Retained earnings (deficit) (61,503) (109,196) (3,663) 112,859 (61,503) ---------- ----------- ----------- ------------ ------------ Total shareholders' equity (deficit) (10,828) (89,558) 45,146 (134,704) (10,828) ---------- ----------- ----------- ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)$ 101,554 $ 298,712 $ 53,837 $ (252,082) $ 202,021 ========== =========== =========== ============ ============
14
HOMEGOLD FINANCIAL, INC. CONSOLIDATING STATEMENTS OF OPERATIONS NINE MONTHS ENDED SEPTEMBER 30, 2001 (Unaudited) (In thousands) Combined Wholly-Owned Combined Parent Guarantor Non-Guarantor Company Subsidiaries Subsidiaries Eliminations Consolidated ----------- ------------- ------------ ------------ ------------ REVENUES: Interest income $ 391 $ 14,593 $ -- $ (8,183) $ 6,801 Servicing income -- 24,434 (21,092) -- 3,342 Gain on sale of loans -- 8,566 -- -- 8,566 Loan fees, net -- 22,959 -- -- 22,959 ----------- ------------- ------------ ----------- ----------- Total revenue from loans and investments 391 70,552 (21,092) (8,183) 41,668 Other revenues 7 1,018 -- (132) 893 ----------- ------------- ------------ ----------- ----------- Total revenues 398 71,570 (21,092) (8,315) 42,561 EXPENSES: Interest 8,730 14,597 -- (8,183) 15,144 Costs on REO and defaulted loans -- 1,266 -- -- 1,266 Fair market write-down of residual receivable -- 23,239 (23,239) -- -- Salaries, wages and employee benefits -- 25,796 -- -- 25,796 Business development costs -- 170 -- -- 170 Restructuring charges -- 897 -- -- 897 Other general and administrative expenses 202 17,791 -- (132) 17,861 ----------- ------------- ------------ ----------- ----------- Total expenses 8,932 83,756 (23,239) (8,315) 61,134 ----------- ------------- ------------ ----------- ----------- Income (loss) before income taxes, minority (8,534) (12,186) 2,147 -- (18,573) interest, and Equity in undistributed earnings (loss) of subsidiaries Earnings (loss) of subsidiaries (8,421) 2,144 -- 6,277 -- ----------- ------------- ------------ ----------- ----------- Income (loss) before income taxes, minority (16,955) (10,042) 2,147 6,277 (18,573) interest and extraordinary item Provision for income taxes -- 456 -- -- 456 ----------- ------------- ------------ ----------- ----------- Income (loss) before minority interest and (16,955) (10,498) 2,147 6,277 (19,029) extraordinary item Minority interest in loss of subsidiaries -- -- (3) -- (3) ----------- ------------- ------------ ----------- ----------- Net income before extraordinary item (16,955) (10,498) 2,144 6,277 (19,032) Extraordianary item - gain on extinquishment of debt 153 -- -- -- 153 Cumulative effect of change in accounting principle -- 2,077 2,077 ----------- ------------- ------------ ----------- ----------- NET INCOME (LOSS) $ (16,802) $ (8,421) $ 2,144 $ 6,277 $ (16,802) =========== ============= ============ =========== =========== NINE MONTHS ENDED SEPTEMBER 30, 2000 (Unaudited) (In thousands) Combined Wholly-Owned Combined Parent Guarantor Non-Guarantor Company Subsidiaries Subsidiaries Eliminations Consolidated ----------- ------------- ------------ ----------- ----------- REVENUES: Interest income $ 866 $ 11,835 $ -- $ (3,311) $ 9,390 Servicing income -- 641 3,838 -- 4,479 Gain on sale of loans -- 8,498 -- -- 8,498 Loan fees, net -- 12,977 -- -- 12,977 ----------- ------------- ------------ ----------- ----------- Total revenue from loans and investments 866 33,951 3,838 (3,311) 35,344 Other revenues -- 1,556 -- (44) 1,512 ----------- ------------- ------------ ----------- ----------- Total revenues 866 35,507 3,838 (3,355) 36,856 EXPENSES: Interest 3,721 14,154 -- (3,311) 14,564 Provision for credit losses -- 2,292 -- -- 2,292 Salaries, wages and employee benefits -- 21,337 -- -- 21,337 Business development costs -- 6,012 -- -- 6,012 Other general and administrative expenses 150 18,936 124 (44) 19,166 ----------- ------------- ------------ ----------- ----------- Total expenses 3,871 62,731 124 (3,355) 63,371 ----------- ------------- ------------ ----------- ----------- Income (loss) before income taxes, minority (3,005) (27,224) 3,714 -- (26,515) interest, and equity in undistributed earnings (loss) of subsidiaries Earnings (loss) of subsidiaries (12,328) 5,842 -- 6,486 -- ----------- ------------- ------------ ----------- -- -------- Income (loss) before income taxes, minority interest and extraordinary item (15,333) (21,382) 3,714 6,486 (26,515) Provision (benefit) for income taxes 1,700 (11,185) -- -- (9,485) -------- ---------- --------- -------- ---------- Income (loss) before minority interest and (17,033) (10,197) 3,714 6,486 (17,030) extraordinary item Minority interest in loss of subsidiaries -- -- (3) -- (3) ----------- ------------- ------------ ----------- ----------- Net income before extraordinary item (17,033) (10,197) 3,711 6,486 (17,033) Extraordianary item - gain on extinquishment of 579 -- -- -- 579 debt ----------- ------------- ------------ ----------- ----------- NET INCOME (LOSS) $ (16,454) $ (10,197) $ 3,711 $ 6,486 $ (16,454) =========== ============= ============ =========== ===========
15
HOMEGOLD FINANCIAL, INC. CONSOLIDATING STATEMENTS OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 2001 (Unaudited) (In thousands) Combined Wholly-Owned Combined Parent Guarantor Non-Guarantor Company Subsidiaries Subsidiaries Eliminations Consolidated ----------- ------------- ------------ ------------ ------------ REVENUES: Interest income $ 132 $ 5,140 $ -- $ (2,804) $ 2,468 Servicing income -- 9,138 (8,316) -- 822 Gain on sale of loans -- 2,850 -- -- 2,850 Loan fees, net -- 7,461 -- -- 7,461 ----------- ------------- ------------ ------------ ------------ Total revenue from loans and investments 132 24,589 (8,316) (2,804) 13,601 Other revenues 1 77 -- 16 94 ----------- ------------- ------------ ------------ ------------ Total revenues 133 24,666 (8,316) (2,788) 13,695 EXPENSES: Interest 2,981 5,151 -- (2,803) 5,329 Cost on REO and defaulted loans -- 71 -- -- 71 Fair market write-down of residual receivable -- 9,433 (9,433) -- -- Salaries, wages and employee benefits -- 9,349 -- -- 9,349 Business development costs -- (5,553) -- -- (5,553) Restructuring charges -- (345) -- -- (345) Other general and administrative expenses 68 6,378 -- 16 6,462 ----------- ------------- ------------ ------------ ------------ Total expenses 3,049 24,484 (9,433) (2,787) 15,313 ----------- ------------- ------------ ------------ ------------ Income (loss) before income taxes, minority (2,916) 182 1,117 (1) (1,618) interest, and equity in undistributed earnings (loss) of subsidiaries Earnings (loss) of subsidiaries 3,245 1,114 -- (4,359) -- ----------- ------------- ------------ ------------ ------------ Income (loss) before income taxes, minority 329 1,296 1,117 (4,360) (1,618) interest and extraordinary item Provision for income taxes -- 127 -- -- 127 ----------- ------------- ------------ ------------ ------------ Income (loss) before minority interest and 329 1,169 1,117 (4,360) (1,745) extraordinary item Minority interest in loss of subsidiaries -- -- (3) -- (3) ----------- ------------- ------------ ------------ ------------ Income before extraordinary item 329 1,169 1,114 (4,360) (1,748) Cumulative effect of change in accounting principle -- 2,077 -- -- 2,077 ----------- ------------- ------------ ------------ ------------ NET INCOME (LOSS) $ 329 $ 3,246 $ 1,114 $ (4,360) $ 329 =========== ============= ============ ============ ============ THREE MONTHS ENDED SEPTEMBER 30, 2000 (Unaudited) (In thousands) Combined Wholly-Owned Combined Parent Guarantor Non-Guarantor Company Subsidiaries Subsidiaries Eliminations Consolidated ----------- ------------- ------------ ------------ ------------ REVENUES: Interest income $ 266 $ 4,489 $ -- $ (971) $ 3,784 Servicing income -- (71) 1,964 -- 1,893 Gain on sale of loans -- 3,554 -- -- 3,554 Loan fees, net -- 4,311 -- -- 4,311 ----------- ------------- ------------ ------------ ------------ Total revenue from loans and investments 266 12,283 1,964 (971) 13,542 Other revenues -- 588 -- (15) 573 ----------- ------------- ------------ ------------ ------------ Total revenues 266 12,871 1,964 (986) 14,115 EXPENSES: Interest 1,082 5,569 -- (971) 5,680 Provision for credit losses -- 650 -- -- 650 Salaries, wages and employee benefits -- 8,469 -- -- 8,469 Business development costs -- 2,361 -- -- 2,361 Other general and administrative expenses 34 6,507 (1,429) (15) 5,097 ----------- ------------- ------------ ------------ ------------ Total expenses 1,116 23,556 (1,429) (986) 22,257 ----------- ------------- ------------ ------------ ------------ Income (loss) before income taxes, minority (850) (10,685) (3,393) -- (8,142) interest, and equity in undistributed earnings (loss) of subsidiaries Earnings (loss) of subsidiaries 4,226 5,842 -- (10,068) -- ----------- ------------- ------------ ------------ ------------ Income (loss) before income taxes, minority interest and extraordinary item 3,376 (4,843) 3,393 (10,068) (8,142) Provision (benefit) for income taxes 1,700 (11,520) -- -- (9,820) ----------- ------------- ------------ --------- ------------ Income (loss) before minority interest and 1,676 6,677 3,393 (10,068) 1,678 extraordinary item Minority interest in loss of subsidiaries -- 1 (3) -- (2) ----------- ------------- ------------ ------------ ------------ Income before extraordinary item 1,676 6,678 3,390 (10,068) 1,676 Extraordinary item - gain on extinquishment of debt 261 -- -- -- 261 ----------- ------------- ------------ ------------ ------------ NET INCOME (LOSS) $ 1,937 $ 6,678 $ 3,390 $ (10,068) $ 1,937 =========== ============= ============ ============ ============
16
HOMEGOLD FINANCIAL, INC. CONSOLIDATING STATEMENT OF CASH FLOWS NINE MONTHS ENDED SEPTEMBER 30, 2001 (Unaudited) (In thousands) Combined Wholly-Owned Combined Parent Guarantor Non-Guarantor Company Subsidiaries Subsidiaries Eliminations Consolidated ----------- ------------- ------------ ------------ ------------ OPERATING ACTIVITIES: Net income (loss) $ (16,802) $ (8,421) $ 2,144 $ 6,277 $ (16,802) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Equity in undistributed earnings of 8,421 (2,144) -- (6,277) -- subsidiaries Depreciation and amortization 1 3,230 -- -- 3,231 Gain on retirement of senior unsecured debt (153) -- -- -- (153) Net decrease in deferred loan fees -- (1,093) -- -- (1,093) Provision for losses on real estate owned -- 192 -- -- 192 Fair value write-down of residual receivable -- 126 -- -- 126 Loss/(gain) on sale of property and equipment -- (9) -- -- (9) Loss / (gain) on sale of REO -- 372 -- -- 372 Loans originated with intent to sell -- (531,571) -- -- (531,571) Proceeds from sold loans -- 441,526 -- -- 441,526 Other -- (7) 3 -- (4) Changes in operating assets and liabilities increasing (decreasing) cash (315) (12,057) 3,191 -- (9,181) ----------- ------------ ----------- ------------ ------------ Net cash provided by (used in) operating activities (8,848) (109,856) 5,338 -- (113,366) ----------- ------------ ----------- ------------ ------------ INVESTING ACTIVITIES: Loans purchased for investment purposes 58 (58) -- -- -- Principal collections on loans not sold -- 88,720 -- -- 88,720 Proceeds from sale of real estate and personal property acquired through foreclosure -- 1,155 -- -- 1,155 Proceeds from sale of property and equipment -- 388 -- -- 388 Purchase of property and equipment -- (1,708) -- -- (1,708) Loans to shareholders -- 285 -- -- 285 Other -- (1,226) -- -- (1,226) ----------- ------------ ----------- ------------ ------------ Net cash provided by in investing activities 58 87,556 -- -- 87,614 ----------- ------------ ----------- ------------ ------------ FINANCING ACTIVITIES: Advances on warehouse lines of credit -- 474,867 -- -- 474,867 Payments on warehouse lines of credit -- (473,986) -- -- (473,986) Retirement of senior unsecured debt (58) -- -- -- (58) Net increase in notes payable to investors -- 39,947 -- -- 39,947 Net increase in subordinated debentures -- 5,513 -- -- 5,513 Advances (to) from subsidiary 8,748 (3,417) (5,331) -- -- Proceeds from issuance of common stock -- 25 -- -- 25 Other -- 7 (7) -- -- ----------- ------------ ----------- ------------ ------------ Net cash provided by (used in) financing 8,690 42,956 (5,338) -- 46,308 activities ----------- ------------ ----------- ------------ ------------ Net increase (decrease) in cash and cash (100) 20,656 -- -- 20,556 equivalents CASH AND CASH EQUIVALENTS: BEGINNING OF PERIOD 101 3,589 1 -- 3,691 ----------- ------------ ----------- ------------ ------------ END OF PERIOD $ 1 $ 24,245 $ 1 $ -- $ 24,247 =========== ============ =========== ============ ============
17
HOMEGOLD FINANCIAL, INC. CONSOLIDATING STATEMENT OF CASH FLOWS NINE MONTHS ENDED SEPTEMBER 30, 2000 (Unaudited) (In thousands) Combined Wholly-Owned Combined Parent Guarantor Non-Guarantor Company Subsidiaries Subsidiaries Eliminations Consolidated ----------- ------------ ----------- ------------ ------------ OPERATING ACTIVITIES: Net income (loss) $ (16,454) (11,845) $ 5,359 $ 6,486 $ (16,454) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Equity in undistributed earnings of subsidiaries 12,328 (5,842) -- (6,486) -- Depreciation and amortization -- 2,709 -- -- 2,709 Provision for credit losses -- 2,292 -- -- 2,292 Gain on retirement of senior unsecured debt 579 (1,158) -- -- (579) Loss on sale of real estate acquired through -- 1,380 -- -- 1,380 foreclosure Fair value write-down of residual receivable -- 2,143 -- -- 2,143 Loans originated with intent to sell -- (441,223) -- -- (441,223) Proceeds from sold loans -- 374,971 -- -- 374,971 Proceeds from securitization of loans -- 44,588 -- -- 44,588 Other -- (10,300) -- -- (10,300) Changes in operating assets and liabilities increasing (decreasing) cash (81) (29,953) 3,019 -- (27,015) ----------- ------------ ----------- ------------ ------------ Net cash provided by (used in) operating (3,628) (72,238) 8,378 -- (67,488) activities ----------- ------------ ----------- ------------ ------------ INVESTING ACTIVITIES: Loans originated for investment purposes -- (220) -- -- (220) Loans purchased for investment purposes -- (189) -- -- (189) Principal collections on loans not sold -- 40,948 -- -- 40,948 Proceeds from sale of real estate and personal property acquired through foreclosure -- 9,710 -- -- 9,710 Proceeds from sale of property and equipment -- 45 -- -- 45 Purchase of property and equipment -- (147) -- -- (147) Loans to shareholders (5,908) -- -- -- (5,908) Other -- (2,867) -- -- (2,867) ----------- ------------ ----------- ------------ ------------ Net cash provided by in investing activities (5,908) 47,280 -- -- 41,372 ----------- ------------ ----------- ------------ ------------ FINANCING ACTIVITIES: Advances on warehouse lines of credit -- 557,878 -- -- 557,878 Payments on warehouse lines of credit -- (563,637) -- -- (563,637) Retirement of senior unsecured debt (341) -- -- -- (341) Net increase in notes payable to investors -- (7,510) -- -- (7,510) Net increase in subordinated debentures -- 23,565 -- -- 23,565 Advances (to) from subsidiary 9,879 (1,508) (8,371) -- -- Proceeds from issuance of additional common stock -- 73 -- -- 73 Other -- 7 (7) -- -- ----------- ------------ ----------- ------------ ------------ Net cash provided by (used in) financing activities 9,538 8,868 (8,378) -- 10,028 ----------- ------------ ----------- ------------ ------------ Net increase (decrease) in cash and cash equivalents 2 (16,090) -- -- (16,088) CASH AND CASH EQUIVALENTS: BEGINNING OF PERIOD 202 25,806 1 -- 26,009 ----------- ------------ ----------- ------------ ------------ END OF PERIOD $ 204 $ 9,716 $ 1 $ -- $ 9,921 =========== ============ =========== ============ ============
18 HOMEGOLD FINANCIAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 9--COMMITMENTS AND CONTINGENCIES On August 20, 1999, Janice Tomlin, Isaiah Tomlin, and Constance Wiggins filed a purported class action lawsuit in New Hanover County, North Carolina Superior Court. That suit has been transferred to North Carolina Business Court. The suit was filed against the Company's subsidiary HomeGold, Inc. and others alleging a variety of statutory and common law claims arising out of mortgage loans they obtained through Chase Mortgage Brokers ("Chase"). On February 22, 2000, Michael and Kimberly Chasten filed a similar action in Duplin County, North Carolina Superior Court. That suit has been removed to the United States District Court for the Eastern District of North Carolina. On April 13, 2000 Reginald Troy filed a similar action in New Hanover County, North Carolina Superior Court. That suit has been removed to the United States District Court for the Eastern District of North Carolina. The plaintiffs in all of these cases are seeking unspecified monetary damages. As to HomeGold, Inc., the complaints in these three cases allege participation by HomeGold, Inc. in an arrangement with Chase under which Chase allegedly charged excessive fees and interest to the consumers, and under which Chase allegedly received undisclosed premiums. There has been no class certified in any of the cases, and HomeGold Inc. has contested and will continue to contest each case vigorously. The Company and its subsidiaries are, from time to time, parties to various legal actions arising in the normal course of business. Other than as described above, management believes that there is no proceeding threatened or pending against the Company or any of its subsidiaries that, if determined adversely, would have a materially adverse effect on the operations, profitability or financial condition of the Company or any of its subsidiaries. HGI, together with certain other subsidiaries of HGFN (collectively, the "Subsidiary Guarantors"), has guaranteed HGFN's performance of its obligations under its 10-3/4% Senior Notes due 2004 (the "Senior Notes") and the indenture related thereto (the "Indenture"). The original aggregate principal amount of the Senior Notes was $125,000,000; however, as of September 30, 2001, HGFN has repurchased $113,997,000 of the Senior Notes leaving $11,003,000 in aggregate principal amount outstanding. In October 2001, HGFN repurchased an additional $4,753,000 of the Senior Notes through a tender offer. HGFN has incurred operating losses of $39.8 million, $35.1 million, and $73.0 million for the years ended December 31, 2000, 1999, and 1998, respectively and has deficit shareholder's equity of $27.3 million at September 30, 2001. The Company incurred operating losses of $9.9 million and $7.2 million in the first and second quarters of 2001 respectively, and income of $0.3 million in the third quarter of 2001. The management of HGFN has implemented plans to reverse these negative trends by implementing operating changes which include, but are not limited to, the following: - Continually offering and reviewing loan products to meet customer demands while also meeting the needs of purchasers of loans originated. - Geographic expansion of loan origination operations. - Maintaining and increasing warehouse lines of credit to fund loan originations. - Reducing non-core operating and general overhead. The Company's management can offer no assurance that all of the operating changes will be implemented, nor can it offer assurance that the negative trends would be reversed were all of these changes implemented successfully. 19 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The discussion should be read in conjunction with the HomeGold Financial, Inc. and Subsidiaries (the "Company") Unaudited Consolidated Financial Statements and Notes appearing elsewhere in this report. FORWARD - LOOKING INFORMATION From time to time, the Company makes oral and written statements that may constitute "forward-looking statements" (rather than historical facts) as defined in the Private Securities Litigation Reform Act of 1995 (the "Act") or by the SEC in its rules, regulations and releases, including Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. This report contains such statements. The Company desires to take advantage of the "safe harbor" provisions in the Act for forward-looking statements made from time to time, including, but not limited to, the forward-looking statements made in this Form 10-Q, as well as those made in other filings with the SEC, and other financial discussion and analysis by management that reflect projections or future financial or economic performance of the Company. The words "expect," "estimate," "anticipate," "predict," "believe," and similar expressions and variations thereof are intended to identify forward-looking statements. Such statements appear in a number of places in this filing and include statements regarding the intent, belief, or current expectations of the Company, its directors, or officers with respect to management's current plans and expectations and are subject to risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Such risks and uncertainties include, but are not limited to: lower origination volume due to market conditions, inability to achieve desired efficiency levels, higher losses due to economic downturn or lower real estate values, loss of key employees, negative cash flows and capital needs, delinquencies and losses in securitization trusts, right to terminate mortgage servicing and related negative impact on cash flow, adverse consequences of changes in the interest rate environment, deterioration of creditworthiness of borrowers and risk of default, general economic conditions in the Company's markets, including inflation, recession, interest rates and other economic factors, loss of funding sources, loss of ability to sell loans, general lending risks, impact of competition, regulation of lending activities, changes in the regulatory environment, lower than anticipated premiums on loan sales, lower than anticipated origination fees, adverse impact of lawsuits, faster than anticipated prepayments on loans, losses due to breach of representation or warranties under previous agreements and other detrimental developments. The preceding list of risks and uncertainties, however, is not intended to be exhaustive. Because actual results may differ materially from those projected in this Report for the reasons, among others, listed above, the stockholders and bondholders of the Company are cautioned not to put undue reliance on such forward-looking statements. The Company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof. Readers should carefully review the factors referred to above and the other documents the Company files from time to time with the Securities and Exchange Commission, including the quarterly reports on Form 10-Q filed by the Company during fiscal 2001 and any current reports on Form 8-K filed by the Company. GENERAL The Company is headquartered in Lexington, South Carolina, and primarily engages in the business of originating, selling, securitizing, and servicing non-conforming and conforming mortgage loan products. The Company began originating conforming loans in January 2001. As of September 30, 2001, approximately $86 million (17.4%) of the Company's origination production arose from conforming loan products. The Company plans to continue to expand its conforming loan origination efforts in the remainder of 2001. The Company commenced its lending operations in 1991 through the acquisition of CII, a small mortgage lending company, which had been in operation since 1963. During the corporate restructuring beginning in May 2001, the Company moved its corporate headquarters from Greenville, SC, and implemented certain management and departmental-reporting changes. MARKET CONDITIONS The financial services industry, including the markets in which the Company operates, is highly competitive. Competition is based on the types of loans offered, interest rates, and service. Traditional competitors in the financial services industry include commercial banks, credit unions, thrift institutions, credit card issuers, consumer and commercial finance companies, and leasing companies. The Company's management believes its focus on customer service, interest rates, and ease of obtaining a loan place it advantageously among its competitors; however, such advantages are often short-lived in a growing market. 20 MERGER WITH HOMESENSE FINANCIAL CORP. On May 9, 2000, HomeSense Financial Corporation and certain of its affiliated companies ("HomeSense") were merged into HomeGold, Inc., a wholly owned subsidiary of HGFN pursuant to a merger agreement approved by HGFN's shareholders on April 28, 2000. HomeSense was a privately owned specialized mortgage company headquartered in Lexington, South Carolina that originated and sold mortgage loans in the sub-prime mortgage industry. Its principal loan product was a debt consolidation loan, generally collateralized by a first lien on the borrower's home. HomeSense originated its loan volume through a direct retail branch network of eight offices, as well as through centrally-provided telemarketing lead, direct mail, and television advertising. HomeGold, Inc. has continued the business of HomeSense after the merger. In the merger, HGFN issued 6,780,944 shares of its common stock (approximately 40% of post-merger shares outstanding) valued at $1.04 per share plus an additional 10 million shares of Series A Non-convertible Preferred Stock, par value $1 per share, for 100% of the outstanding stock of HomeSense. Most of this merger consideration was issued to HomeSense's primary shareholder Ronald J. Sheppard. Mr. Sheppard is now the chief executive officer and a director of HGFN, and a director of HomeGold, Inc. The merger was accounted for under the purchase method of accounting. The transaction resulted in $19.0 million of goodwill, which is being amortized on a straight-line basis over 15 years. After the merger was consummated, certain differences arose between the parties to the merger regarding the warranties and representations in the merger agreement. These differences were resolved in February 2001 by an agreement between Mr. Sheppard and HGFN pursuant to which Mr. Sheppard agreed to remain a guarantor with respect to certain indebtedness HomeGold, Inc. had assumed from HomeSense in the merger and pursuant to which options for HGFN stock issued to Mr. Sheppard in the merger were cancelled. In addition, a mutual indemnity agreement between HGFN and Mr. Sheppard was cancelled. RESULTS OF OPERATIONS Nine months ended September 30, 2001, compared to nine months ended September 30, 2000 Because the merger of HomeGold, Inc. and HomeSense Financial Corp. occurred in May 2000, the results of operations for the nine months ended September 30, 2000 include the results of four pre-merger months, causing comparative increases in revenues and costs from the nine months ended September 30, 2000 to the nine months ended September 30, 2001. The Company recognized a net loss of $16.8 million for the nine months ended September 30, 2001 as compared to a net loss of $16.5 million for the nine months ended September 30, 2000. Included in the 2001 net loss was a $2.1 million cumulative effect gain resulting from a change in accounting principle. Included in the 2000 net loss was a $10.0 million tax benefit resulting from the recognition of a deferred tax asset. Total revenues for the nine months ended September 30, 2001 increased $5.7 million (10.5%) compared to the nine months ended September 30, 2000. The increase in total revenues resulted primarily from a $9.9 million (76.9%) increase in net loan fees, partially offset by a $2.6 million (27.6%) decrease in interest income, a $1.1 million (25.4%) decrease in servicing fee income, and a $0.6 million (39.6%) decrease in other revenues. The increase in net loan fees is due to a $ 90.3 million increase in production--partially attributable to the merger, but also attributable to improved production efficiencies and an increase in production personnel--and an increase in average loan origination fees charged, to 3.96% from 2.56%. The increase in average loan origination fees charged is reflective of market conditions, as well as being indicative of changes in production management, including, among other changes, new incentive compensation plans that reward higher origination fees. The decrease in interest income is made up of a $3.5 million decrease in interest income from loans held for sale and investment, partially offset by a $0.9 million increase in interest income from short term investments. The decrease in interest income from loans resulted primarily from a decrease in average loans outstanding, along with a decrease in average yield. The decrease in average loans outstanding resulted from a focus on more efficient usage of the Company's warehouse lines of credit. The decrease in average yield resulted 21 primarily from a change in the mix of the Company's loans held for sale from 100% non-conforming, higher yielding loans to a combination of conforming and non-conforming loans, and a decline in market rates. The weighted average coupon rate on non-conforming loans for the 2001 period was 9.85%, while the weighted average coupon rate on conforming loans for the same period was 7.22%. The $1.1 million decrease in servicing fee income is primarily a result of the decrease in the average balance of loans serviced in the servicing retained securization pools. The decrease in other revenues resulted primarily from the Company's selling its loans more quickly than in prior years, which caused a corresponding decrease in late charge income and waived fee income. Total expenses for the nine months ended September 30, 2001 decreased $6.0 million (9.2%) compared to the nine months ended September 30, 2000. The decrease in total expenses was due, in large part, to a change in accounting principle resulting from operational changes which required the Company to capitalize $6.9 million in database development costs as an intangible asset with a twenty-four month life. The Company's previous accounting treatment of such expenses was to record them as prepaid expenses with a six month life. The same change in accounting principle resulted in an additional $2.1 million gain arising from the capitalization of certain database development costs recognized as expense in a prior period. In addition to the decrease attributable to the change in accounting principle, the Company also experienced a $2.1 million (93.0%) decrease in provision for credit losses, a $1.5 million (62.3%) decrease in restructuring costs, and a $1.6 million (55.4%) decrease in costs on owned real estate and defaulted loans, partially offset by a $4.5 million (20.9%) increase in personnel costs, a $0.6 million (3.9%) increase in interest expense, and a $2.1 million (13.3%) increase in other general and administrative expenses. The Company's reserve for credit losses is evaluated on a monthly basis. For the nine months ended September 30, 2001, the Company deemed $0.2 million provisions for credit losses necessary based on the performance of its loans held for sale. Restructuring costs were related to a restructuring of the Company's departmental reporting structure and the relocation of the Company's corporate headquarters from Greenville, SC to Lexington, SC in 2001. During the 2000 period, restructuring costs were related to post-merger activities of the combined companies. The primary costs in both periods were employee severance costs. Costs on real estate owned and defaulted loans decreased $1.6 million from 2000. The majority of prior year real estate owned has been sold in the current year. For the nine months ended September 30, 2001, the Company only had $655,000 of REO additions. The increase in personnel costs resulted primarily from the addition of employees due to the merger, the costs of which were decreased, to some extent, by eliminating certain overlapping positions resulting from the merger. Since the merger, the Company has also discontinued its wholesale division while expanding its retail division which essentially offset one another. In addition, three new production centers have begun operations in 2001. The increased interest expense is due principally to a $0.6 million increase in the interest due on the Company's notes payable to investors and subordinated debentures. The average outstanding balance on these securities for the nine months ended September 30, 2001 was $162.8 million, compared to an average outstanding balance of $133.1 million for the nine months ended September 30, 2000. This increase was partially offset by a decrease of $1.7 million in the Company's interest expense on warehouse lines, resulting from more efficient usage of the lines. The increase in other general administrative costs is the result of higher production and an increased number of production centers. Loan costs increased $2.5 million, telephone and data line costs increased $0.7 million, and outside office services increased $0.5 million. The extraordinary item resulted from the realized gain on the repurchase of senior subordinated debenture bonds. For the nine months ended September 30, 2001, the Company repurchased $211,000 of bonds resulting in a gain on the early extinguishment of debt of $153,000, compared to the repurchase of $920,000 of bonds resulting in a gain of $579,000 for the same period in 2000. The Company has recorded current tax expense of $607,000 and $515,000 for the nine months ended September 30, 2001 and 2000, respectively, although the Company generated a pre-tax loss for both periods. The current tax expense results from "excess inclusion income." Excess inclusion income is a result of the Company's securitizing loans in pools to third party investors. These transactions generate income for the Company that is included in the overall loss from operations. However, according to IRS regulations, a portion of that 22 income is subject to federal tax in the current period regardless of other period losses or NOL carryovers otherwise available to offset regular taxable income. The excess inclusion income approximates the net interest the Company receives on the loans in the pools after the bondholders are paid their share of the interest less the sum of the daily accruals, an amount allowed for tax purposes as a reasonable economic return on the retained ownership interest. The extraordinary gain on the extinguishment of debt is net of $0 tax since the gain was offset against prior NOLs and did not result in any incremental increase in current income tax expense. The most recent securitizations were structured utilizing alternatives to a REMIC which does not generate excess inclusion income. Three months ended September 30, 2001 compared to three months ended September 30, 2000 The Company recognized net income of $329,000 for the three months ended September 30, 2001 as compared to net income of $1.9 million for the three months ended September 30, 2000. Total revenues decreased $0.4 million (2.9%) for the three months ended September 30, 2001 compared to the three months ended September 30, 2000. The decrease in total revenues resulted primarily from a $1.3 million decrease (34.8%) in interest income, a $1.0 million decrease in servicing fee income, and a decrease of $0.7 million (19.8%) in gain on sale of loans, offset by a $3.1 million (73.1%) increase in net loan fees. The decrease in interest income is made up of a $1.4 million decrease in interest income from loans held for sale and investment, partially offset by a $0.1 million increase in interest income from short term investments. The decrease in interest income from loans resulted from both a decrease in average loans outstanding and a decrease in average yield. The decrease in average loans outstanding resulted from a focus on more efficient usage of the Company's warehouse lines of credit. The decrease in average yield resulted primarily from a change in the mix of the Company's loans held for sale from 100% non-conforming, higher-yielding loans to a combination of conforming and non-conforming loans. The weighted average coupon rate on non-conforming loans for the 2001 period was 9.62%, while the weighted average coupon rate on conforming loans for the same period was 8.90%. The $1.0 million decrease in servicing fee income is primarily a result of the decrease in the average balance of loans serviced in the servicing retained securitization pools. In the three months ended September 30, 2001, the Company had mortgage whole loan sales of $155.1 million at an average net premium of 1.9% compared to mortgage whole loan sales of $173.9 million at an average net premium of 1.6% in the three months ended September 30, 2000. The sales in 2000 included the cleanup of the outstanding production generated by the Company's wholesale origination division, which was discontinued in August 2000. The average net premium for the 2000 period was negatively affected by the large percentage of wholesale loans sold. The increase in net loan fees is primarily the result of a $21.5 million increase in production, attributable to the expansion of the Company's production capabilities. However, the Company realized a decrease in average loan origination fees charged, to 4.06% from 4.17% for the three months ended September 30, 2001 and the three months ended September 30, 2000, respectively. Total expenses for the three months ended September 30, 2001 decreased $6.9 million (31.2%) compared to the three months ended September 30, 2000. The decrease in total expenses was due, in large part, to a change in accounting principle resulting from operational changes which allowed the Company to capitalize $6.9 million in database development costs as an intangible asset with a twenty-four month life. The Company's previous accounting treatment of such expenses was to record them as prepaid expenses with a six month life. The same change in accounting principle resulted in an additional $2.1 million gain arising from the capitalization of certain database development costs recognized as expense in a prior period. In addition to the decrease attributable to the change in accounting principle, the Company also experienced a $0.8 million (55.4%) decrease in costs on owned real estate and defaulted loans, a $0.5 million (70.5%) decrease in provision for credit losses, and a $0.4 million (448.4%) decrease in restructuring costs, partially offset by a $2.2 million (53.5%) increase in other general and administrative expenses and a $1.0 million (11.9%) increase in personnel costs. 23 Costs on real estate owned and defaulted loans decreased $0.8 million from 2000. The majority of prior year real estate owned has been sold in the current year. For the three months ended September 30, 2001, the Company only had no REO additions. The Company's reserve for credit losses is evaluated on a monthly basis. For the three months ended September 30, 2001, the Company deemed minimal additional provisions for credit losses necessary based on the performance of its loans held for sale. Restructuring costs were related to a restructuring of the Company's departmental reporting structure and the relocation of the Company's corporate headquarters in 2001. During the 2000 period, restructuring costs were related to post-merger activities of the combined companies. The primary costs in both periods were employee severance costs. The increase in other general and administrative costs is mainly due to the opening of three new production centers and the related operating expenses. The increase in personnel costs resulted primarily from the addition of employees due to the merger, as well as the opening of the three new production centers, the costs of which were decreased, to some extent, by eliminating certain overlapping positions resulting from the merger. Since the merger, but after September 30, 2000, the Company has also discontinued its wholesale division while expanding its retail division which essentially offset one another. The extraordinary item resulted from the realized gain on the repurchase of senior subordinated debenture bonds. During the three months ended September 30, 2001, the Company did not repurchase any bonds, compared to the repurchase of $365,000 of bonds resulting in a gain of $261,000 for the same period in 2000. The Company has recorded current tax expense of $127,400 and $180,000 for the three months ended September 30, 2001 and 2000, respectively, although the Company generated a pre-tax loss before extraordinary item for both periods. The current tax expense results from "excess inclusion income." Excess inclusion income is a result of the Company securitizing loans in pools to third party investors. These transactions generate income for the Company that is included in the overall loss from operations. However, according to IRS regulations, a portion of that income is subject to federal tax in the current period regardless of other period losses or NOL carryovers otherwise available to offset regular taxable income. The excess inclusion income approximates the net interest the Company receives on the loans in the pools after the bondholders are paid their share of the interest less the sum of the daily accruals, an amount allowed for tax purposes as a reasonable economic return on the retained ownership interest. The extraordinary gain on the extinguishment of debt is net of $0 tax since the gain was offset against prior NOLs and did not result in any incremental increase in current income tax expense. FINANCIAL CONDITION Net loans receivable increased to $53.0 million at September 30, 2001 from $51.7 million at December 31, 2000. The slight increase is a result of increased production during 2001, partially offset by increased loan sales and securitizations. The makeup of the loans has shifted from a mix of loans held for investment and loans held for sale to a portfolio of loans held for sale. The Company plans to return to its strategy of holding high-yielding loans for investment in the second half of 2001. Other receivables decreased to $11.1 million at September 30, 2001 from $11.5 million at December 31, 2000, primarily as a result of more timely settlement of amounts due to and due from one of the Company's warehouse lenders that is also one of the Company's primary loan purchasers. The residual receivables were $59.1 million at September 30, 2001, compared to $58.9 million at December 31, 2000. This increase resulted primarily from the residual retained on the small securitization transaction completed in May 2001, partially offset by the normal amortization and payoffs of the residual assets from prior securitizations. Net property and equipment decreased to $20.6 million at September 30, 2001, from $21.4 million at December 31, 2000, resulting primarily from depreciation of $2.1 million. Real estate and personal property acquired in foreclosure decreased to $0.5 million at September 30, 2001, from $1.3 million at December 31, 2000. This decrease resulted primarily from the sale of foreclosed properties, partially offset by additional foreclosures on mortgage loans within the period. 24 The primary sources for funding the Company's receivables comes from borrowings issued under various credit arrangements (including the warehouse lines of credit, CII notes payable to investors and subordinated debentures, and the Company's Senior Notes) and the sale or securitization of loans. At September 30, 2001, the Company had $30.2 million outstanding under revolving warehouse lines of credit to banks, compared with $27.0 million at December 31, 2000. At September 30, 2001, the Company had $210.7 million of CII notes payable to investors and subordinated debentures outstanding, compared with $165.2 million at December 31, 2000. This increase is directly related to increased borrowings from CII investors caused by increased marketing efforts. The aggregate principal amount of outstanding Senior Notes was $11.0 million at September 30, 2001, compared to $11.2 million on December 31, 2000. In the nine months ended September 30, 2001, the Company purchased $211,000 of its Senior Notes for a purchase price of $58,000. The Company may, from time to time, purchase more of its Senior Notes depending on the Company's cash availability, market conditions, and other factors. In conjunction with the purchase, the Company received the consent of a majority of holders of a majority of the principal amount of the oustanding senior notes to eliminate the restrictive covenants summarized above. In September 2001, the Company capitalized costs related to the development of its Proprietary Leads Database ("the database"), which was recorded as an intangible asset with an initial life of twenty-four months. Prior to the three months ended September 30, 2001, the Company deferred most marketing expenditures over a six-month deferral period. The capitalized costs of the database represent expenditures incurred over the prior fourteen months. Expenditures totaling approximately $3.3 million which had been expensed during the final five months of 2000 were capitalized and amortized, resulting in a cumulative effect from a change in accounting principle of $2.1 million. Total shareholders' equity at September 30, 2001 was a deficit of $27.3 million, compared to a deficit of $10.8 million at December 31, 2000. This decrease is attributable to the net loss of $16.8 million for the nine months ended September 30, 2001, partially offset by collections of $285,000 received on the note receivable from shareholder. ALLOWANCE FOR CREDIT LOSSES AND CREDIT LOSS EXPERIENCE The Company is exposed to the risk of loan delinquencies and defaults with respect to loans retained in its portfolio. With respect to loans to be sold on a non-recourse basis, the Company is at risk for loan delinquencies and defaults on such loans while they are held by the Company pending such sale and, in certain cases, where the terms of sale include a warranty against first payment defaults. To provide for credit losses, the Company charges against current earnings an amount necessary to maintain the allowance for credit losses at levels expected to cover inherent losses in loans receivable. The percentage of total mortgage loans past due 30 days or more increased to 9.82% at September 30, 2001 compared to 7.39% at December 31, 2000. The Company incurred net recoveries on retained loans of $122,000 in the nine months ended September 30, 2001 compared to $1.8 million in net charge-offs on retained loans in the nine months ended September 30, 2000. Although management considers the allowance appropriate and adequate to cover inherent losses in the loan portfolio, management's judgment is based upon a number of assumptions about future events, which are believed to be reasonable, but which may or may not be realized. Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for credit losses or that additional increases in the allowance for possible credit losses will not be required. Management closely monitors delinquencies to measure the quality of its loan portfolio and securitized loans and the potential for credit losses. Accrual of interest is discontinued and reversed when a loan is either over 150 days past due, or the loan is over 90 days past due and the loan-to-value ratio is greater than 90%, or when foreclosure proceedings begin. Collection efforts on charged-off loans continue until the obligation is satisfied or until it is determined that such obligation is not collectible or the cost of continued collection efforts would exceed the potential recovery. Recoveries of previously charged-off loans are credited to the allowance for credit losses. The Company considers its allowance for credit losses at September 30, 2001 to be adequate in view of the Company's ability to sell a significant portion of its loans, improving loss experience and the secured nature of most of the Company's outstanding loans. The Company's allowance for loan loss as a percentage of gross loans was 8.31% at September 30, 2001 and 7.95% at December 31, 2000. LIQUIDITY AND CAPITAL RESOURCES The Company operates on a negative operating cash flow basis; therefore, the business requires continued access to short-term and long-term sources of cash in the form of debt financing and equity capital. As a result of increases in loan production and incurred operating expenses in excess of operating income, the Company experienced a $113.4 million net use of cash from operating activities during the first nine months of 2001. Although the Company's goal is to achieve a positive operating cash flow each quarter, no assurance can be given that this objective will be attained due to the higher level of cash required to fund the loans purchased and originated. Currently, 25 the Company's primary operating cash uses include the funding of (i) loan originations and purchases pending their securitization or sale, (ii) interest expense on CII investor savings notes, senior unsecured debt and revolving warehouse credit facilities ("Credit Facilities"), (iii) fees, expenses, overcollateralization and tax payments incurred in connection with the securitization program and (iv) ongoing general and administrative and other operating expenses. The Company's primary operating sources of cash are (i) cash proceeds of whole-loan mortgage loan sales, (ii) cash payments for contractual and ancillary servicing revenues received by the Company in its capacity as servicer for securitized loans, (iii) interest income on loans receivable and certain cash balances, (iv) fee income received in connection with its retail mortgage loan originations, (v) excess cash flow received in each period with respect to residual receivables, (vi) additional CII investor deposits, and (vii) borrowings under warehouse lines of credit. The Company believes that additional sources of funds are needed to meet its future liquidity requirements, and no assurance can be given that these additional sources of funds can be attained. Without continued access to cash, we may be restricted in the amount of mortgage loans that we will be able to originate, thereby eliminating our primary source of revenue. Unrestricted cash and cash equivalents were $24.2 million at September 30, 2001, compared to $3.7 million at December 31, 2000. Cash used by operating activities was $113.4 million and $67.5 million for the nine months ended September 30, 2001 and 2000, respectively. Cash provided by investing activities was $87.6 million and $41.4 million for the nine months ended September 30, 2001 and September 30, 2000, respectively. Cash provided by financing activities was $46.3 million and $10.0 million for the nine months ended September 30, 2001 and September 30, 2000, respectively. The cash used by operating activities was principally due to incurred operating expenses in excess of operating income and loans originated in excess of loans sold during the periods. The decrease in cash used in operating activities is primarily due to a decrease in loans originated in excess of loans sold from the nine months ended September 30, 2000 to the nine months ended September 30, 2001. Cash provided by investing activities in both the nine months ended September 30, 2001 and 2000, resulted primarily from principal collections on loans not sold. The cash provided in financing activities in the nine months ended September 30, 2001, resulted primarily from borrowings under notes payable to CII investors and advances on the Company's revolving warehouse lines of credit. The Company renewed its revolving warehouse line of credit with Household Commercial Financial Services, Inc. ("Household"), effective as of June 11, 2001, which bears interest at the Prime rate plus .25%, advances funds at 97% of the loan amount, and is collateralized by the mortgage loans funded. Household also holds a first mortgage on the Company's Pelham Road facilities in Greenville, South Carolina. The agreement requires, among other matters, positive net income in the Company's subsidiary, HomeGold, Inc., for the three months ending June 30, 2001 and for each month thereafter. The Company is currently in default under this covenant. On August 29, 2001, as a result of this Event of Default, Household executed an amendment to the June 11 warehouse line of credit in which Household agreed to (i) forebear through December 31, 2001 from accelerating the Loans or exercising any rights and remedies to which it is entitled and to (ii) continue to extend Loans to the Company's subsidiary in accordance with the June 11 agreement. The amendment reduced the maximum commitment to $20 million at September 30, 2001. The amendment further reduced the maximum commitment to $10 million on October 31, 2001. The amendment calls for a cessation of lending as of November 30, 2001, and requires all loans to be paid off the line by December 31, 2001. The Company has reached an oral agreement with Household to continue lending indefinitely at a level not to exceed $20 million. Availability under the credit agreement is expected to be determined based on eligible collateral as defined under the agreement, for which the Company has forwarded to the bank the required loan files and documentation. Based on the outstanding borrowings under the line of credit of $10.4 million, the Company had $9.6 million of immediate availability under this agreement at September 30, 2001. The Company has a $15 million revolving warehouse line of credit with The Provident Bank ("Provident"). Interest on the line varies on a loan by loan basis and ranges from the prime rate plus 1.5% to the prime rate plus 3.5%, depending on the grade and age of the mortgage funded. The agreement allows for a rate reduction from the base rates if certain monthly funded volume targets are met. For the month of September, 2001, the Company achieved the targeted funded volume for the second stage rate reduction of 0.25% from the initial base rates. Provident holds a first mortgage on the Company's Reed Avenue property in Lexington, South Carolina. The agreement contains no covenants related to the financial condition or results of operations of the Company; and the Company has not violated any other provisions of the agreement. All advances to the Company under the Provident warehouse were at Provident's sole discretion. The agreement allows Provident to retain the servicing rights to any loans funded on the line of credit. Availability under the credit agreement is determined based on eligible collateral as defined in the agreement, for which the Company has forwarded to the bank the required loan files and documentation. The line of credit terminates on October 31, 2002. At September 30, 2001, the balance of funded loans on the line was $7.3 million, and these loans were all sub-serviced by Provident. The Company has a $15 million warehouse line of credit with Impac Mortgage Acceptance Corp. ("Impac"). The facility bears interest at the prime rate plus 1.50%, requires a $1 million collateral deposit, and may be terminated by Impac 26 without notice. Advance rates on fundings range from 96% to 100% of the principal amount, depending on the type and source of the mortgage. The maximum commitment for this line of credit is $15 million. At September 30, 2001, the balance of funded loans on the line was $11.7 million. All of the Company's warehouse lines contain provisions whereby the lender can terminate their agreement without cause with certain notice requirements. The Company's management believes all current warehouse relationships will remain in place until maturity; however, there is no assurance that one or more of the lenders will not terminate their agreements prior to maturity, or that additional lines will be negotiated at maturity. Either occurrence would adversely affect the Company's ability to originate loans. During 1997, the Company sold $125.0 million aggregate principal amount of Senior Notes. The Senior Notes constitute unsecured indebtedness of the Company. The Senior Notes are redeemable at the option of the Company, in whole or in part, on or after September 15, 2001, at predetermined redemption prices plus accrued and unpaid interest to the date of redemption. This agreement contains, among other matters, restrictions on the payment of dividends. At September 30, 2001, management believes the Company was in compliance with such restrictive covenants. The Senior Notes are fully and unconditionally guaranteed (the "Subsidiary Guarantees") jointly and severally on an unsecured basis (each, a "Guarantee") by certain of the Company's subsidiaries (the "Subsidiary Guarantors"). With the exception of the Guarantee by CII, the Subsidiary Guarantees rank on par with the right of payment with all existing and future unsubordinated indebtedness of the Subsidiary Guarantors and senior in right of payment to all existing and future subordinated indebtedness of such Guarantors. The Guarantee by CII is equal in priority to CII's notes payable to investors and is senior to CII's subordinated debentures. At September 30, 2001 and December 31, 2000, $11.0 million and $11.2 million in aggregate principal amount of Senior Notes were outstanding, respectively. In October 2001, HGFN repurchased an additional $4,753,000 of the Senior Notes through a tender offer. In conjunction with the purchase, the Company received the consent of a majority of holders of a majority of the principal amount of the oustanding senior notes to eliminate the restrictive covenants summarized above. CII engages in the sale of CII notes to investors. The CII notes are comprised of investor notes and subordinated debentures bearing fixed rates of interest, which are sold by CII only to South Carolina residents. The offering of the CII notes is registered under South Carolina securities law and is believed to be exempt from Federal registration under the Federal intrastate exemption. CII believes it conducts its operations so as to qualify for the safe harbor provisions of Rule 147 promulgated pursuant to the Securities Act of 1933, as amended (the "Securities Act"). At September 30, 2001 and at December 31, 2000, CII had an aggregate of $186.0 million and $146.1 million of investor notes outstanding, respectively, and an aggregate of $24.6 million and $19.1 million, respectively, of subordinated debentures outstanding. The investor notes and subordinated debentures are subordinate in priority to the credit facility. Substantially all of the CII notes and debentures have original maturities of one or two years. The Company's primary objective for the remainder of 2001 is to increase profitability by expanding production capacity, becoming more active in the conforming mortgage market, reducing operating expenses, and improving production efficiency; however, monthly operating losses are anticipated into the fourth quarter of 2001. The Company continually evaluates the need to establish other sources of capital and will pursue those it considers appropriate based upon its needs and market conditions. The Company currently does not anticipate incurring any significant capital expenditures in 2001. LOAN SALES AND SECURITIZATIONS The Company sells or securitizes substantially all of its loans. The Company sells its production on a whole loan basis (servicing released), principally to secure the additional cash flow associated with the premiums paid in connection with such sales and to eliminate the credit risk associated with the mortgage loans. However, no assurance can be given that the mortgage loans can be sold. To the extent that the loans are not sold, the Company retains the risk of loss. For the nine months ended September 30, 2001 and 2000, the Company sold $458.1 million and $375.0 million of mortgage loans, respectively. The Company has utilized securitizations in previous years principally to provide a lower cost of funds and reduce interest rate risk, while building servicing revenues by increasing the serviced portfolio. In connection with its securitizations, the Company has retained interest-only residual certificates representing residual interests in the trusts created by the securitization transactions. The Company completed a servicing released securitization in the third quarter of 2000 of $41.6 million. This transaction also resulted in a $12.1 million residual certificate. These subordinate residual securities totaled $59.1 million and $58.9 million, net of allowances, at September 30, 2001 and December 31, 2000, respectively. In a mortgage loan securitization, the Company sells mortgage loans it purchased or originated to a trust for cash. The trust sells asset-backed bonds secured by the loans to investors. The Company records certain assets and income based upon the difference between all principal and interest received from the loans sold and the following factors (i) all principal and interest required to 27 be passed through to the asset-backed bond investors, (ii) all excess contractual servicing fees, (iii) other recurring fees and (iv) an estimate of losses on the loans (collectively, the "Excess Cash Flow"). At the time of the securitization, the Company estimates these amounts based upon a declining principal balance of the underlying loans, adjusted by estimated prepayment and loss rates, and capitalizes these amounts using a discount rate that market participants would use for similar financial instruments. These capitalized assets are recorded as residual receivables. The Company believes the assumptions it has used in past securitizations, adjusted to current market conditions, are appropriate and reasonable. The Company generally retains the right to service the loans it securitizes. However, the Company released servicing rights for the two securitization transactions completed during 2000 and the 2001 transaction. Fees for servicing loans are based on a stipulated percentage (generally 0.50% per annum) of the unpaid principal balance of the associated loans. On its mortgage loan securitizations, the Company has recognized a servicing asset in addition to its gain on sale of loans. The servicing asset is calculated as the present value of the expected future net servicing income in excess of adequate compensation for a substitute servicer, based on common industry assumptions and the Company's historical experience. These factors include default and prepayment speeds. The Company generally expects to begin receiving excess cash flow on its mortgage loan securitizations approximately 16 months from the date of securitization, although this time period may be shorter or longer depending upon the securitization structure and performance of the loans securitized. Prior to such time, the monoline insurer requires a reserve provision to be created within the securitization trust which uses Excess Cash Flow to retire the securitization bond debt until the spread between the outstanding principal balance of the loans in the securitization trust and the securitization bond debt equals a specified percentage (depending on the structure of the securitization) of the initial securitization principal balance (the "overcollateralization limit"). Once this overcollateralization limit is met, excess cash flows are distributed to the Company. The Company begins to receive regular monthly servicing fees in the month following securitization. The gains recognized into income resulting from securitization transactions vary depending on the assumptions used, the specific characteristics of the underlying loan pools, and the structure of the transaction. The Company believes the assumptions it has used are appropriate and reasonable. The Company periodically assesses the carrying value of its residual receivables and servicing assets for impairment. There can be no assurance that the Company's estimates used to determine the gain on sale of loans, residual receivables valuations, and servicing assets valuations will remain appropriate for the life of each securitization. If actual loan prepayments or defaults exceed the Company's estimates, the carrying value of the Company's residual receivables and/or servicing assets may be decreased through a charge against earnings in the period management recognizes the impairment. In addition to the potentially adverse affect the poor performance of the Company's securitization pools would have on the Company's earnings, the affect of such performance on the Company's cash flows would be similarly adverse. ACCOUNTING CONSIDERATIONS In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards ("SFAS") No. 133 "Accounting for Derivative Instruments and Hedging Activities" which is effective for all fiscal quarters of fiscal years beginning after June 15, 2000, as amended by SFAS 137. This SFAS statement establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. Since the Company has no significant hedging positions outstanding, the implementation of this standard had no material impact on its financial statements. In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities--a replacement of FASB No. 125." It revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures but carries over most of FASB No. 125's provisions without reconsideration. SFAS No. 140 is effective for all transfers and servicing of financial assets and extinguishment of liabilities occurring after March 31, 2001. Retroactive and early adoption is prohibited. This statement is effective for disclosures related to securitization transactions and collateral for fiscal years ending after December 15, 2000. The adoption of provisions of SFAS No. 140 was not material to the Company. In the November 2000 meeting, the Emerging Issues Task Force (EITF) reached a consensus on EITF 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets." The issue deals with how interest income and impairment should be recognized for retained interests in securitizations. If upon evaluation, the holder determines that it is probable that there is a change in estimated cash flows (in both timing and estimates of projected cash flows) , 28 the amount of accretable yield should be recalculated and if that change in estimated cash flows is an adverse change, an other-than-temporary impairment should be considered to have occurred. The effective date of this EITF is March 15, 2001. The Company does not believe any permanent impairment has occurred in its securitized assets as of September 30, 2001. In June 2001, the FASB issued Statement of Financial Accounting Standard ("SFAS") No. 141 - Business Combinations. This FASB addresses accounting and reporting for all business combinations and defines the purchase method as the only acceptable method. This statement is effective for all business combinations initiated after September 30, 2001. During 2001, the Company has not participated in any business combinations. In June 2001, the FASB issued Statement of Financial Accounting Standard ("SFAS") No. 142 - Goodwill and Other Intangible Assets. This SFAS addresses how goodwill and other intangible assets should be accounted for at their acquisition (except for those acquired in a business combination) and after they have been initially recognized in the financial statements. The statement is effective for all fiscal years beginning after December 15, 2001. The Company has not completed the evaluation of the effect this statement will have on the financial position of the Company. In July 2001, the SEC issued Staff Accounting Bulletin (SAB) No. 102 - Selected Loan Loss Allowance Methodology and Documentation Issues. This staff accounting bulletin clearly defines the required development, documentation , and application of a systematic methodology for determining allowances for loan and lease losses in accordance with generally accepted accounting principles. The Company believes that it is in compliance with SAB 102. In September 2001, the Company capitalized costs related to the development of its Proprietary Leads Database ("the database"), which was recorded as an intangible asset with an initial life of twenty-four months. Prior to the three months ended September 30, 2001, the Company deferred most marketing expenditures over a six-month deferral period. The capitalized costs of the database represent expenditures incurred over the prior fourteen months. Expenditures totaling approximately $3.3 million which had been expensed during the final five months of 2000 were capitalized and amortized, resulting in a cumulative effect from a change in accounting principle of $2.1 million. Additional accounting standards that have been issued or proposed by the FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption. TAX CONSIDERATIONS As a result of operating losses incurred by the Company, the Company has net operating losses ("NOL") that can be used to offset future earnings. Federal tax laws provide that net operating loss carryforwards are restricted or eliminated upon certain changes of control. Applicable federal tax laws provide that a 50% "change of control," which is calculated over a rolling three-year period, would cause the loss of substantially all of the NOL. The Company believes its maximum cumulative change of control during the relevant three-year period was less than 50%. At September 30, 2001 the Company's deferred tax asset was $22.0 million. The Company has not adjusted the net deferred tax asset during 2001. The amount of the deferred tax asset is deemed appropriate by management based on its belief that it is more likely than not that it will realize the benefit of this deferred tax asset, given the levels of historical taxable income and current projections for future taxable income over the periods in which the deferred tax assets would be realized. The Company had a federal NOL of approximately $103 million at December 31, 2000. HEDGING ACTIVITIES The Company's profitability may be directly affected by fluctuations in interest rates. While the Company monitors interest rates it may, from time to time, employ a strategy designed to hedge some of the risks associated with changes in interest rates, however, no assurance can be given that the Company's results of operations and financial condition will not be adversely affected during periods of fluctuations in interest rates. The Company's interest rate hedging strategy includes shorting interest rate futures and treasury forwards and entering into interest-rate lock agreements. Since the interest rates on the Company's warehouse line of credit used to fund and acquire loans is variable 29 and the rates charged on loans the Company originates are fixed, increases in the interest rates after loans are originated and prior to their sale could have a material adverse effect on the Company's results of operations and financial condition. The ultimate sale of the Company's loans generally will fix the spread between the interest rates paid by borrowers and the interest rates paid to investors in securitization transactions with respect to such loans, although increases in interest rates may narrow the potential spread that existed at the time the loans were originated by the Company. Without hedging these loans, increases in interest rates prior to sale of the loans may reduce the gain on sale or securitization of loans earned by the Company. In addition, a decline in short-tern or long-term interest rates could increase the prepayment rate of loans held in the Company's securitization pools. Any of these changes could adversely affect the Company's earnings and cash flows. There were no significant open hedging positions at September 30, 2001. IMPACT OF INFLATION Inflation affects the Company most significantly in the area of loan originations and can have a substantial effect on interest rates. Interest rates normally increase during periods of high inflation and decrease during periods of low inflation. Profitability may be directly affected by the level and fluctuation in interest rates that affect the Company's ability to earn a spread between interest received on its loans and the costs of its borrowings. The profitability of the Company is likely to be adversely affected during any period of unexpected or rapid changes in interest rates. A substantial and sustained increase in interest rates could adversely affect the ability of the Company to originate and purchase loans and affect the mix of first and second-lien mortgage loan products. Generally, first-lien mortgage production increases relative to second-lien mortgage production in response to low interest rates and second-lien mortgage production increases relative to first-lien mortgage production during periods of high interest rates. A significant decline in interest rates could decrease the size of the Company's loan servicing portfolio by increasing the level of loan prepayments. Additionally, to the extent servicing rights and residual receivables have been capitalized on the books of the Company, higher than anticipated rates of loan prepayments or losses could require the Company to write down the value of such servicing rights and residual receivables, adversely impacting earnings. Fluctuating interest rates may also affect the net interest income earned by the Company resulting from the difference between the yield to the Company on loans held pending sales and the interest paid by the Company for funds borrowed under the Company's warehouse line of credit. 30 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods. The Company's market risk arises primarily from interest rate risk inherent in its lending, its holding of residual receivables, and its investor savings activities. The structure of the Company's loan and investor savings portfolios is such that a significant rise or decline in interest rates may adversely impact net market values and net interest income. The Company does not maintain a trading account, nor is the Company subject to currency exchange risk or commodity price risk. Responsibility for monitoring interest rate risk rests with senior management. Senior management regularly reviews the Company's interest rate risk position and adopts balance sheet strategies that are intended to optimize operating earnings while maintaining market risk within acceptable guidelines. As a result of the Company's interest rate position, a 100 basis point immediate increase in interest rates would have a negative impact on projected net loss of approximately $263,000 and $3.3 million, computed for the quarter ending September 30, 2001, and the year ending December 31, 2000, respectively. A significant portion of this impact relates to a reduction in the anticipated sale premiums on loans being held for sale as well as higher interest expense on the warehouse line of credit, partially offset by an increase in interest earned on short term investments. An immediate reduction of 100 basis points in market rates would result in a positive impact on projected net loss of approximately $163,000 and $2.1 million for the quarter ending September 30, 2001, and the year ending December 31, 2000, respectively. This impact is related to higher gains from the sale of loans, which is the primary reason for the positive impact on projected earnings at December 31, 2000 under the same interest rate scenario, and a decrease in interest paid on warehouse lines of credit, partially offset by the assumption that prepayment speeds on the securitization pools would increase approximately ten percent if market interest rates declined by 100 basis points. The Company no longer believes, in the absence of other external factors, that it would experience an increase in prepayment speeds if market rates declined by 100 basis points due to the "burn-out" principal. In other words, since the borrowers have already had several opportunities to refinance because rates have been 100 basis points lower in the last twelve months, but have not, the likelihood of the remaining borrowers prepaying given further interest rate reductions is diminished. The Company assumes that it would not experience a significant benefit from a reduction in the rates paid on investor notes. The rates offered on the investor notes have not historically moved with changes in market rates. 31 While the Company monitors interest rates and may, from time to time, employ a strategy designed to hedge some of the risks associated with changes in interest rates, no assurance can be given that the Company's results of operations and financial condition will not be adversely affected during periods of fluctuations in interest rates. As of September 30, 2001, the Company did not hedge its loans held for whole-loan sales. The Company's strategy for the remainder of 2001 is to sell a substantial portion of the current month's production that is designated for whole-loan sales in the following month and securitizing a small portion of its loan production on a quarterly basis. Because the interest rates on the Company's warehouse lines of credit used to fund and acquire loans are variable and the rates charged on loans the Company originates are fixed, increases in the interest rates after loans are originated and prior to their sale may reduce the gain on loan sales earned by the Company. There were no significant open hedging positions at September 30, 2001. On loans originated for inclusion in securitized pools, the Company may employ a strategy designed to hedge some of the risks associated with changes in interest rates. The Company's interest rate hedging strategies include shorting interest rate futures and treasury forwards and entering into interest-rate lock agreements relating to loans pending a securitization transaction. The ultimate sale of the Company's loans included in a securitized transaction generally will fix the spread between the interest rates paid by borrowers and the interest rates paid to investors in securitization transactions with respect to such loans, although increases in interest rates may narrow the potential spread that existed at the time the loans were originated by the Company. However, a significant reduction in market rates could accelerate the prepayment speed on loans held in the various securitized mortgage pools. An acceleration of prepayment on loans held in the securitized pools would have a negative impact on the carrying value of the residual assets. There were no significant open hedging positions at September 30, 2001. Projected percentage changes in operating results brought about by changes in interest rates could be material relative to the Company's operating results. If simulation results indicate earnings sensitivity in excess of management's acceptable limits, management will seek to identify on-balance sheet and/or off-balance sheet strategies to bring earnings sensitivity within target guidelines. Management will continue to monitor the Company's interest rate risk position to manage the possible adverse impact on earnings caused by changes in interest rates. These analyses do not consider the effects of the reduced level of overall economic activity that could exist in such an environment. Further, in the event of a change of such magnitude, management would likely take actions to further mitigate its exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, the sensitivity analysis assumes no changes in the Company's financial structure. 32 PART II. OTHER INFORMATION Item 2. Changes in Securities and Use of Proceeds. On October 15, 2001, the Company consummated a tender offer and consent solicitation with respect to its 10.75% Senior Notes due 2004 that are guaranteed by certain of the Company's subsidiaries (the "Senior Notes"). Following consummation of the tender offer, $6,250,000 in principal amount of the Senior Notes remain outstanding. The Company received consents from holders of $811,000 in principal amount of its then outstanding Senior Notes, which constitutes in excess of a majority of the then outstanding principal amount of the Senior Notes, to an amendment to the Senior Notes indenture. This amendment generally (i) deletes in their entireties most of the restrictive covenants set forth in the indenture and events of default related solely to the deleted covenants, (ii) deletes certain other additional events of default, (iii) deletes definitions referenced only in the deleted covenants and events of default and (iv) makes conforming amendments to the Senior Notes. The Company expects to consummate the amendment of the indenture pursuant to the consents promptly. The remaining outstanding Senior Notes will be subject to the indenture as amended by this amendment. The form of the amendment is filed as an exhibit hereto. Item 3. Defaults Upon Senior Securities. The Company's revolving warehouse line of credit with Household Commercial Financial Services, Inc. requires, among other matters, positive net income in the Company's subsidiary HomeGold, Inc. for the three months ended June 30, 2001 and for each month thereafter. The Company is currently in default under this covenant. Household continues to make advances under the line of credit. On August 29, 2001, as a result of this Event of Default, Household executed an amendment to the June 11 warehouse line of credit in which Household agreed to (i) forebear through December 31, 2001 from accelerating the Loans or exercising any rights and remedies to which it is entitled and to (ii) continue to extend Loans to the Company's subsidiary in accordance with the June 11 agreement. The amendment reduced the maximum commitment to $20 million at September 30, 2001. The amendment further reduced the maximum commitment to $10 million on October 31, 2001. The amendment calls for a cessation of lending as of November 30, 2001, and requires all loans to be paid off the line by December 31, 2001. The Company has reached an oral agreement with Household to continue lending indefinitely at a level not to exceed $20 million. Item 4. Submission of Matters to a Vote of Security Holders. The Company offered to purchase some or all of and solicited consents to amendment of the indenture pertaining to its Senior Notes pursuant to an Offer to Purchase and Consent Solicitation dated September 10, 2001. The offer and consent solicitation expired on October 15, 2001. The results of the consent solicitation are described in "Item 2: Changes in Securities and Use of Proceeds" above, which description is incorporated herein by reference. Item 6. Exhibits and Reports on Form 8-K a) Exhibits -------- 4.1.7 Form of Supplemental Indenture #2 dated October 15, 2001 related to the Company's 10-3/4% Senior Notes, due 2004. b) Reports on Form 8-K ------------------- None 33 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HOMEGOLD FINANCIAL, INC. Date: November 14, 2001 By: \s\ Ronald J. Sheppard ------------------------------------------- Ronald J. Sheppard Chief Executive Officer Date: November 14, 2001 By: \s\ Forrest E. Ferrell ------------------------------------------- Forrest E. Ferrell President Date: November 14, 2001 By: \s\ Kevin G. Martin ------------------------------------------- Kevin G. Martin Chief Financial Officer 34 EX-4 3 suppindenture2.txt SUPPLEMENTAL INDENTURE #2 SUPPLEMENTAL INDENTURE #2 This Supplemental Indenture #2 is entered into by and among HomeGold Financial, Inc. (f/k/a Emergent Group, Inc., hereinafter, the "Company"), the current Subsidiary Guarantors as defined in the indenture dated September 23, 1997 pertaining to the Company's 10-3/4% Senior Notes, due 2004, and the guarantees thereof, (the "Senior Notes") all as supplemented prior to the date hereof by any other supplemental indentures (the "Indenture"), and Bankers Trust Company, as trustee under the Indenture (the "Trustee"). This Supplemental Indenture #2 shall be effective as of October 15, 2001, and shall amend the terms of the Indenture as provided below. Capitalized terms used herein and not otherwise defined shall have the meaning ascribed to such terms in the Indenture. WHEREAS, in response to that certain Offer to Purchase and Consent Solicitation of the Company dated September 10, 2001, the Holders of a majority in principal amount of the Outstanding Securities have consented to the amendment of the Indenture substantially as provided herein below as required by Section 902 of the Indenture for amendments thereto, evidence of which has been provided to the Trustee; NOW THEREFORE, in consideration for the mutual agreements contained herein, the parties hereto agree as follows: 1. DELETION OF COVENANTS. The following sections of the Indenture are hereby deleted in their entireties: 1.1. Section 801 (entitled " Company May Consolidate, Etc. Only on Certain Terms"). 1.2. Section 802 (entitled "Mergers, Consolidations and Certain Sales of Assets by Subsidiary Guarantors"). 1.3. Section 1004 (entitled "Existence"). 1.4. Section 1005 (entitled "Maintenance of Properties"). 1.5. Section 1006 (entitled "Payment of Taxes and Other Claims"). 1.6. Section 1007 (entitled "Maintenance of Insurance"). 1.7. Section 1008 (entitled "Limitation on Additional Indebtedness"). 1.8. Section 1010 (entitled "Limitation on Restricted Payments"). 1.9. Section 1011 (entitled "Limitation on Dividend and Other Payment Restrictions Affecting Restricted Subsidiaries"). 1 1.10. Section 1012 (entitled "Limitation on Liens"). 1.11. Section 1013 (entitled "Limitation on Sales of Assets"). 1.12. Section 1014 (entitled "Limitation on Preferred Stock of Subsidiaries"). 1.13. Section 1015 (entitled "Limitation on Transactions with Affiliates"). 1.14. Section 1016 (entitled "Payments for Consent"). 1.15. Section 1017 (entitled "Change of Control Offer"). 1.16. Section 1021 (entitled "Available Information"). 1.17. Section 1022 (entitled "Acquisition of Securities"). 2. DELETION OF EVENTS OF DEFAULT RELATED SOLELY TO DELETED COVENANTS. All events included in the definition of "Event of Default" set forth in Section 501 of the Indenture related solely to the covenants deleted by Section 1 of the Supplemental Indenture #2 are hereby deleted in their entireties from the definition of "Event of Default," including but not limited to Section 501(4) of the Indenture, and such events shall no longer constitute Events of Default as of the date hereof. 3. DELETION OF OTHER EVENTS OF DEFAULT. The events described in Sections 501(6) and 501 (7) of the Indenture are hereby deleted in their entireties from the definition of "Event of Default" set forth in Section 501 of the Indenture, and such events shall no longer constitute Events of Default as of the date hereof. 4. DELETION OF DEFINITIONS REFERENCES SOLELY IN DELETED PROVISIONS. All definitions set forth in the Indenture pertaining to defined terms referenced solely in the provisions of the Indenture deleted therefrom by Sections 1, 2 and 3 of this Supplemental Indenture #2 are hereby deleted in their entireties, including but not limited to the following definitions: 4.1. "Adjusted Indebtedness." 4.2. "Affiliate Transaction." 4.3. "Asset Sale." 4.4. "Asset Sale Proceeds." 4.5. "Change of Control." 4.6. "Consolidated Leverage Ratio." 4.7. "Consolidated Net Income." 4.8. "Permitted Indebtedness." 2 4.9. "Permitted Lien." 4.10. "Permitted Mortgage Warehouse Indebtedness." 4.11. "Permitted Warehouse Indebtedness." 4.12. "Purchase Facility." 4.13. "Refinance." 4.14. "Refinancing Indebtedness." 4.15. "Restricted Payment." 4.16. "Successor Company." 4.17. "Warehouse Facility." 4.18. "Warehouse Indebtedness." 5. CONFORMING AMENDMENTS TO SECURITIES AND SUBSIDIARY GUARANTEES. The terms and provisions of the Securities and the Subsidiary Guaranties and the forms thereof are hereby amended and/or modified as necessary to reflect the amendments to the Indenture set forth in Sections 1, 2, 3 and 4 of this Supplemental Indenture #2. 6. NO OTHER AMENDMENT. All other provisions of the Indenture shall remain unaffected by this Supplemental Indenture #2 and shall remain in full force and effect. 7. TRUSTEE'S ACKNOWLEDGMENT OF REQUIRED ACTS OF HOLDERS. The Trustee hereby acknowledges that it has received, as required by the terms of the Indenture, Acts of Holders from Holders of a majority in principal amount of the Outstanding Securities consenting to the substance of this Supplemental Indenture #2. 8. EFFECT OF HEADINGS AND TABLE OF CONTENTS. The Section headings herein and the references to Section headings in the Indenture are for convenience only and shall not affect the construction of any provision hereof. 9. SEVERABILITY CLAUSE. In case any provision in this Supplemental Indenture #2 shall be invalid, illegal or unenforceable, the validity, legality and enforceability of the remaining provisions shall not in any way be affected or impaired thereby. 10. GOVERNING LAW. THIS SUPPLEMENTAL INDENTURE #2 SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK WITHOUT REGARD TO CONFLICTS OF LAW PRINCIPLES. 11. MULTIPLE COUNTERPARTS. This Supplemental Indenture #2 may be executed in multiple counterparts each of which shall constitute an original and each of which may bear the signature(s) of one or more of the parties hereto but which 3 together shall constitute one document. The parties hereto hereby agree that proof of execution hereof by any party may be rebuttably made by a copy of this Supplemental Indenture #2 bearing a facsimile copy of such party's signature hereon. IN WITNESS WHEREOF, the parties hereto have caused this Supplemental Indenture #2 to be duly executed to be effective as of the date first written above. HOMEGOLD FINANCIAL, INC. HOMEGOLD, INC. By: By: -------------------------------- --------------------------- Name: Name: ------------------------------- ------------------------- Title: Title: ------------------------------ ------------------------ CAROLINA INVESTORS, INC. EMERGENT MORTGAGE CORP. OF TENNESSEE By: By: -------------------------------- --------------------------- Name: Name: ------------------------------- ------------------------- Title: Title: ------------------------------ ------------------------ Emergent Insurance Agency Emergent Business Capital CORP. Asset Based Lending, Inc. By: By: -------------------------------- --------------------------- Name: Name: ------------------------------- ------------------------- Title: Title: ------------------------------ ------------------------ BANKERS TRUST COMPANY By: -------------------------------- Name: ------------------------------ Title: ----------------------------- 4 -----END PRIVACY-ENHANCED MESSAGE-----