ITEM 1. BUSINESS
Historical Information
PSM Holdings, Inc. (“PSMH” or the “Company”) was incorporated under the laws of the State of Utah on March 12, 1987, as Durban Enterprises, Inc. On July 19, 2001, Durban Enterprises, Inc., created a wholly-owned subsidiary called Durban Holdings, Inc., a Nevada corporation, to facilitate changing the domicile of the Company to Nevada. On August 17, 2001, Durban Enterprises, Inc. merged with and into Durban Holdings, Inc., leaving the Nevada corporation as the survivor. On May 18, 2005, Durban Holdings, Inc. completed the acquisition of Prime Source Mortgage, Inc., a Texas corporation (now known as WWYH, Inc.). Following the acquisition, effective May 18, 2005, the name of the parent “Durban Holdings, Inc.”, was changed to “PSM Holdings, Inc.” On December 14, 2011, PSM Holdings, Inc., created a wholly-owned subsidiary called PSM Holdings, Inc., a Delaware corporation, to facilitate changing the domicile of the Company to the State of Delaware. On December 29, 2011, PSM Holdings, Inc. merged with and into PSM Holdings, Inc., leaving the Delaware corporation as the survivor.
Beginning in March of 2011, we began a campaign to attract additional mortgage banking operations to join our platform. We initially acquired five such entities between March and November 2011. Our current strategy is to recruit additional offices and or loan originators to our platform. We do not intend to acquire groups in the future.
Our corporate structure consists of PSMH as the parent holding company with PSMI acting as our principal operating entity in which all mortgage lending operations are conducted.
On February 4, 2013, we entered into a Stock Purchase Agreement (the “2013 SPA”) with LB Merchant PSMH-1, LLC (an entity managed by Michael Margolies, a director and principal shareholder of the Company) and Riverview Group LLC (each, individually a “Purchaser” or, together, the “Purchasers”), providing for the issuance and sale of $3,700,000 of our Series A 6% Convertible Preferred Stock (3,700 shares) at a purchase price of $1,000 per share (the “Series A Preferred Stock”) and issuance and sale of $2,000,000 of our Series B 6% Convertible Preferred Stock (2,000 shares) at $1,000 per share (the “Series B Preferred Stock”). Each share of Series A Preferred Stock and, subject to certain limitations, each share of Series B Preferred Stock is convertible into a number of shares of Common Stock of the Company equal to the quotient of (i) $1,000 (subject to adjustment for stock splits, stock dividends, recapitalizations, and the like) plus the amount of accrued but unpaid dividends, divided by (ii) the conversion price then in effect. The initial conversion price was $0.40, subject to adjustment for stock splits, and certain stock issuances outside the 2012 Stock Incentive Plan which are at a price lower than the initial conversion price. The holders of Series A Preferred Stock and Series B Preferred Stock are entitled to certain voting rights designated in the certificates of designations for the two series. Holders of the shares of Series A Preferred Stock and Series B Preferred Stock are entitled to receive cumulative cash dividends at the rate per share (as a percentage of the stated value per share) of 6% per annum, payable quarterly in arrears on April 15, July 15, October 15 and January 15, beginning on April 15, 2013. The closing of the 2013 SPA occurred on February 5, 2013.
Littlebanc Advisors, LLC, an associate of Wilmington Capital Securities, LLC, (the “Placement Agent”) acted as exclusive placement agent for the offering. In accordance with the placement agent agreement for the offering, warrants to purchase 1,140,000 shares of the Company’s Common Stock were issued to the Placement Agent and its associates as placement fees in the above transaction. The warrants are exercisable at $0.44 and expire on February 5, 2018. The fair value of warrants was determined to be $398,497 calculated using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.88%, volatility of 130.21%, a five year term and dividend yield of 0%. In addition to the warrants, we paid $456,000 to the Placement Agent for placement agent fees and incurred $71,965 in legal and other transaction fees.
Pursuant to the 2013 SPA, we granted the Purchasers demand and piggyback registration rights for the common shares issuable upon conversion of the preferred shares. Any demand for registration must be made by holders owning 50% or more of the Series A registerable securities or the Series B registerable securities, as provided in the 2013 SPA.
On April 1, 2014, we entered into a Stock Purchase Agreement (the “2014 SPA”) providing for the issuance and sale of $1,800,000 of our Series C 6% Convertible Preferred Stock (1,800 shares) at a purchase price of $1,000 per share (the “Series C Preferred Stock”) and $1,400,000 of our Series D 6% Convertible Preferred Stock (1,400 shares) at $1,000 per share (the “Series D Preferred Stock”). The closing of the 2014 SPA occurred on April 1, 2014, with the 1,800 shares of Series C Preferred Stock being sold to LB Merchant PSMH-2, LLC, an entity managed by Michael Margolies, a director and principal shareholder of the Company, and the 1,400 shares of Series D Preferred Stock being sold to two institutional investors and an individual affiliated with one of the institutional investors (each, individually a “2014 Purchaser” or, together, the “2014 Purchasers”). Each share of Series C Preferred Stock and, subject to certain limitations, each share of Series D Preferred Stock is convertible into a number of shares of common stock of the Company equal to the quotient of (i) $1,000 (subject to adjustment for stock splits, stock dividends, recapitalizations, and the like) plus the amount of accrued but unpaid dividends, divided by (ii) the conversion price then in effect. The initial conversion price was $0.08, subject to adjustment. The holders of Series C Preferred Stock and Series D Preferred Stock are entitled to certain voting rights designated in the certificates of designations for the two series. Holders of the shares of Series C Preferred Stock and Series D Preferred Stock are entitled to receive cumulative cash dividends at the rate per share (as a percentage of the stated value per share) of 6% per annum, payable quarterly in arrears on April 15, July 15, October 15 and January 15, beginning on July 15, 2014.
Pursuant to the provisions of the Certificates of Designation for the Series A Preferred Stock and Series B Preferred Stock regarding adjustments in conversion price, because we issued and sold additional shares at a price below the initial conversion price of the Series A Preferred Stock and Series B Preferred Stock, the conversion price was adjusted to $0.24 per share.
On November 26, 2014, we entered into a Stock Purchase Agreement dated effective November 24, 2014 (the “Series E SPA”) providing for the issuance and sale of up to $1,250,000 of our Series E 6% Convertible Preferred Stock (1,250 shares) at a purchase price of $1,000 per share (the “Series E Preferred Stock”). The first closing of the Series E SPA occurred on November 26, 2014, with 612.5 shares of Series E Preferred Stock being sold to LB Merchant PSMH-3, LLC, an entity controlled by Michael Margolies, a director and principal shareholder of the Company. Each share of Series E Preferred Stock is convertible into a number of shares of common stock of the Company equal to the quotient of (i) $1,000 (subject to adjustment for stock splits, stock dividends, recapitalizations, and the like) plus the amount of accrued but unpaid dividends, divided by (ii) the conversion price then in effect. The initial conversion price is $0.01, subject to adjustment. The holders of Series E Preferred Stock are entitled to certain voting rights designated in the certificate of designation for the series. Holders of the shares of Series E Preferred Stock are entitled to receive cumulative cash dividends at the rate per share (as a percentage of the stated value per share) of 6% per annum from the date of issuance, payable quarterly in arrears on April 15, July 15, October 15 and January 15, beginning on January 15, 2015.
On December 15, 2014, the second closing of the Series E SPA occurred with 210 shares of Series E Preferred Stock being sold to LB Merchant PSMH-3, LLC. In total, we sold 822.5 shares of Series E Preferred Stock convertible into 82,250,000 common shares. The holder of Series E Preferred Stock are entitled to certain voting rights designated in the certificate of designation for the series.
The holder of the Series E Preferred Stock will have demand and piggyback registration rights for the common stock issuable upon conversion of the Series E Preferred Stock. The registration rights are pari passu with the registration rights of the Company’s other outstanding series of issued preferred stock.
In connection with the first closing of the Series E SPA, we amended the 2013 SPA and the 2014 SPA. The amendments permitted the issuance of the Series E Preferred Stock senior to dividend and liquidation rights of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, and Series D Preferred Stock.
Pursuant to the provisions of the Certificates of Designation for the Series A Preferred Stock and Series B Preferred Stock regarding adjustments in conversion price, because we issued and sold additional shares at a price less than the existing $0.24 conversion price of the Series A Preferred Stock and Series B Preferred Stock, the conversion price was adjusted to $0.10 per share.
Pursuant to the provisions of the Certificates of Designation for the Series C Preferred Stock and Series D Preferred Stock regarding adjustments in conversion price, because we issued and sold additional shares at a price less than the existing $0.08 conversion price of the Series C Preferred Stock and Series D Preferred Stock, the conversion price was adjusted to $0.04 per share.
Currently, the outstanding shares of Series A Preferred Stock are convertible into 30,833,333 shares of the Company’s Common Stock; the outstanding shares of Series B Preferred Stock are convertible into 16,666,667 shares of the Company’s Common Stock; the outstanding shares of Series C Preferred Stock are convertible into 45,000,000 shares of the Company’s Common Stock; the outstanding shares of Series D Preferred Stock are convertible into 35,000,000 shares of the Company’s Common Stock; and the outstanding shares of Series E Preferred Stock are convertible into 82,250,000 shares of the Company’s Common Stock.
Business Operations
We are considered one reporting unit based on our one line of business and the way that management reviews results.
We originate mortgage loans funded either directly off our warehouse lines of credit or through brokering transactions to other third parties. Approximately 95% of our mortgage origination volume is banked off of our current warehouse lines. We have relationships with multiple investors who purchase the loans funded on our warehouse lines. All of our lending activities are conducted by our subsidiary, Prime Source Mortgage, Inc. (“PSMI”).
Historically, a significant portion of our business has been referral based and purchase oriented (versus refinance). We do not directly participate in the secondary markets and further do not maintain a servicing portfolio. Approximately 75% of our total loan applications are generated from business contacts and previous client referrals. Realtor referrals and other lead sources account for the balance of loan applications.
PSMI is currently licensed in Arizona, Arkansas, California, Colorado, Florida, Kansas, Missouri, Montana, New Jersey, New Mexico, North Dakota, Oklahoma, Oregon, Texas, Utah, Washington and Virginia.
PSMI solicits and receives applications for secured residential mortgage loans. As a licensed mortgage broker/banker, PSMI offers mortgage banking services using its existing warehouse lines of credit. The warehouse lines of credit are available for funding of mortgage loans for a short term period. The warehouse lines are secured by the underlying mortgage loans and are renewed annually. The warehouse lines of credit are repaid typically within an overall average of 15 days when the loan is sold to a third party. PSMI does not intend to hold and service the loans and these lines of credit can only be used to fund mortgage loans and cannot provide operating funds for the Company. It is estimated that approximately 95% of all of the residential mortgage loans processed by us are currently being closed using these available warehouse lines of credit. Warehouse capacity with our primary warehouse provider, a related party, is adequate to support our current volumes, as well as anticipated growth.
License Agreement with Nationwide
On April 14, 2006, we entered into a license agreement with Nationwide By Owner, Inc., a Texas corporation with offices in Fort Worth, Texas (“Nationwide”). The license agreement permits exclusive use of the technology to generate leads for the origination of mortgage applications for submission to PSMI. The initial cost of the license was $150,000 paid in cash, and the issuance of 150,000 shares of our common stock in favor of Nationwide and its principals, at a fair value for consideration received of $674,999 on the date of issue. The total consideration for the cost of the license amounted to $824,999. The principals of Nationwide, who were also loan originators for us, have transitioned off of our lending platform. As such, we wrote off the remaining unamortized balance of this license as of March 31, 2015.
On or about May 15, 2007, we loaned an aggregate of $167,000 to Nationwide for its operating expenses. This loan is evidenced by a promissory note which was originally due on May 30, 2008. The loan is secured by the 150,000 shares of PSMH Common Stock which we issued to Nationwide in the original agreement. Effective April 15, 2015, we extended the note with a new maturity date of September 30, 2016. The balance remaining on the note is $87,778 and the note rate is 6%. The note extension calls for minimum quarterly interest payments and fixed principal reduction payments based on the number of installations of the Path2sell technology. Concurrent with the note extension, we executed a termination agreement with NWBO whereby we mutually agreed to terminate our exclusive license agreement with NWBO and they agreed we did not have any further obligations under the original license agreement.
The loan to Nationwide plus accrued interest was under-collateralized by approximately $62,006 using the closing share price of $0.20 of our Common Stock as of June 30, 2015. Due to the high volatility of our share price and the execution of the termination agreement which calls for fixed principal reductions based on installations, we did not deem it necessary to record a provision for doubtful debts as of June 30, 2015 for the under collateralized amount.
Competition
The mortgage industry is highly competitive and many of our competitors are larger, have greater name recognition and have greater resources than we have. Further, many of our competitors generate revenue from a mortgage transaction in ways which we do not, such as servicing revenue. Still, other competitors are internet mortgage firms who have much greater experience than we do in generating internet leads. We compete with these lenders for both borrowers (loans) as well as loan officers, including our current loan officers and loan officers we are recruiting to our platform.
In terms of competing for talented loan officers, we strive to create an environment where our employees can become owners in our publicly-traded stock. We believe this can be a valuable recruiting and retention tool that some of our competition does not have available to them.
Government Regulations
Our mortgage services business is subject to the rules and regulations of the Department of Housing and Urban Development, Federal Housing Administration, Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, Government National Mortgage Association, the Consumer Financial Protection Bureau, and other regulatory agencies in connection with originating, processing and underwriting mortgage loans. We are also subject to state licensing requirements and laws. These rules and regulations, among other things, impose licensing obligations, prohibit discrimination and establish underwriting guidelines. Also, we are required to comply with regulatory financial requirements.
Mortgage origination activities are subject to the provisions of various federal and state statutes including the Equal Credit Opportunity Act, the Fair Housing Act, the Truth-in-Lending Act, the Fair Credit Reporting Act and the Real Estate Settlement Procedures Act. The Equal Credit Opportunity Act and the Fair Housing Act prohibit a company from discriminating against applicants on the basis of race, color, religion, national origin, familial status, sex, age, marital status or other protected characteristics.
We also are required to disclose reasons for credit denial and other matters to applicants. The Truth-in-Lending Act requires us to provide borrowers with uniform, understandable information about the terms and conditions of mortgage loans so they can compare credit terms. The signing and subsequent implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 has had the most significant impact on mortgage origination in the United States. Regulatory changes from Federal and State authorities have placed a significant amount of pressure on mortgage companies across the United States. The regulatory changes have applied a significant amount of operational pressure for deeper and more disciplined internal processes, changes that have made it difficult for small to mid-market mortgage brokerage and/or banking firms to continue functioning as independent businesses. This regulatory effect has driven many stable and profitable companies to join more established mortgage firms which meet the regulatory requirements. Furthermore, companies who are most susceptible to these market dynamics are increasingly challenged by reduced profit margins as a result of required changes in technology, increased staffing needs to meet more complex compliance requirements, and increased net worth requirements of HUD. This industry shift has left the remaining mortgage businesses forced to either make the financial investments in their business to operate in today’s environment or become part of a more stable, mature operation that is better suited to compete in a contracting market.
Intellectual Property
“We Walk You Home” (Reg. No. 4,389,917) was registered with the United States Patent and Trademark Office on August 26, 2013 to PSMI. As of August 10, 2015, we launched a new logo and name, “Prime Source Mortgage, Inc.”, and no longer use the “We Walk You Home” mark.
Employees
As of August 17, 2015, we had a total of 153 full-time employees, including approximately 48 who are active in loan origination. We are actively pursuing the recruitment of additional loan originators which is expected to increase these numbers during the next fiscal year.
ITEM 1A.
ITEM 1A. RISK FACTORS
The following risks and uncertainties, together with the other information set forth in this annual report on Form 10-K, should be carefully considered by those who invest in our securities. Any of the following risks could materially and adversely affect our business, financial condition or operating results and could decrease the value of our Common Stock.
Risks Related to Our Company and its Business
We are required to maintain certain levels of net worth to remain compliant with HUD net worth requirements. As of June 30, 2015, we were not in compliance with our HUD net worth.
We have notified HUD that we were not in compliance with our net worth requirements as of June 30, 2015. Maintaining our net worth as required by HUD is a critical part of our remaining licensed and being allowed to originate HUD loans. On October 1, 2015, we executed new note and security agreements with Quintium which cured any net worth deficiencies related to pledged assets.
There are no assurances that we will be able to maintain our net worth requirements going forward which could prevent us from originating HUD loans and would significantly impact our business and results of operations.
During the year ended June 30, 2015, we incurred operating losses due to a variety of factors such as certain offices being unable to reach profitability and lower production volume and corresponding revenues. Unless we are able to reverse or mitigate the losses through onboarding profitable operations, reducing expenses and restructuring compensation arrangements with management and loan originators, we may not be able to be profitable or to continue operations under our current operating model.
Operating losses as reported in our current financial statements will make it more difficult to attract and onboard additional mortgage operations. If we are unable to onboard a significant number of new profitable operations, we may not generate sufficient revenues to continue current operations.
There are no assurances that we will be able to successfully recruit additional profitable mortgage operations to our platform, or that we will successfully modify our current cost structure. If we are unsuccessful in these initiatives, our revenue and profitability may decline and we may not have enough capital to continue to implement our growth plans. Further, we may be required to raise additional operating capital which would require the issuance of additional equity securities which would dilute our current shareholders.
Because of our historic losses from operations, there are no assurances that we will be successful in obtaining an adequate level of financing needed to fund our operations and growth activities. If we will not have sufficient liquidity resources we may not be able to continue operations, or, without additional financing, may not be able to maintain our operations beyond the next fiscal year as we currently plan, or at all.
Our financial statements as of June 30, 2015, were prepared based on the assumption that we would continue as a going concern. Our net losses of $1,653,761 for the year ended June 30, 2015, and our current limited cash resources, raise substantial doubt about our ability to continue as a going concern. If the going-concern assumption was not appropriate for our financial statements, then adjustments would be necessary to the carrying values of the assets and liabilities, the reported revenues and expenses, and the balance sheet classifications used. Since June 30, 2015, we have continued to experience losses. Our future ability to continue as a going concern is subject to our ability to generate a profit and/or obtain necessary additional funding from outside sources. Except for potential proceeds from the sale of equity in offerings by us, debt offerings, for which we have no firm commitments, or profits from operations, we have no other source for additional funding. Our continued net losses and stockholders’ deficiency increase the difficulty in meeting such goals and there can be no assurances that such methods will prove successful. If we are unsuccessful in doing so, we would be required to substantially revise our business plan or our business could fail.
We have a promissory note due in the amount of $750,000 on February 1, 2016 which is secured by all of the assets of our company. If we are unable to pay the promissory note in full or arrange for an extension, the lender will be able to foreclose on the assets of our company.
On February 18, 2015, we entered into a Loan Agreement with Quintium Private Opportunities Fund, LP, whereby the lender agreed to loan to us an aggregate of $750,000, with an additional $250,000 to be loaned to us at the lender's discretion during the term of the loan. The interest rate on the note is 14% per annum (18% as of October 1, 2015) and monthly interest payments are due the first day of each month. The promissory note matures on February 1, 2016 and, due to our continued losses from operations, we may not be able to make the required payment when due. If we fail to make the payment due on maturity, are unable to refinance with the current lender or a new lender, or are unable to raise capital to pay off the note, the lender may foreclose on the assets of our company. If the lender forecloses on the assets of our company, we will have no remaining assets with which to conduct business and our business will fail.
An event of default occurred on our outstanding shares of Preferred Stock which grants the holders of Series A, Series C, and Series E Preferred Stock the right to control our board of directors.
On October 15, 2014, we failed to make mandatory dividend payments in the aggregate totaling $133,500 to the holders of Series A, B, C, and D Preferred Stock. On January 23, 2015, we failed to make mandatory dividend payments in the aggregate totaling $137,633 to the holders of Series A, B, C, D, and E Preferred Stock (the “Preferred Stock”). We did not have the cash available to pay the dividends as we have elected to allocate current cash flow to the on-boarding of new offices. The non-payment of these two dividends constitutes an event of default under the Certificates of Designation for the Preferred Stock. We have not made any quarterly dividend payments since the event of default described above.
Based on the event of default occur, the holders of the Series A Preferred Stock, the Series C Preferred Stock, and the Series E Preferred Stock, voting together as a separate class, have the right to increase the number of directors of the Company to seven persons and then have the right to elect or appoint, remove and re-appoint four directors of the Company. Directors appointed by the holders of Series A Preferred Stock, Series C Preferred Stock, and the Series E Preferred Stock may only be removed by the holders of a majority of the Series A Preferred Stock, Series C Preferred Stock, and the Series E Preferred Stock voting jointly.
As a result of the event of default on the Preferred Stock, the dividend rate payable on the Preferred Stock has increased and we are subject to damages caused to the holders of the Preferred Stock.
After the occurrence of the event of default on the Preferred Stock, the preferred dividend rate automatically, as of January 23, 2015, increased to a rate per annum of 20% of the Stated Value (as defined in the Certificates of Designation for the Preferred Stock), payable in cash on a monthly basis on the 15th day of each month until the event of default is cured, upon which the preferred dividend will return to a rate of 6% per annum of the Stated Value. We are unable to make the required dividend payments and the increased dividend rate will substantially increase our payables to the holders of these shares of Preferred Stock. In addition, the holders of the Preferred Stock are entitled to legal and equitable remedies for damages caused by the failure to pay the dividends. Enforcement of these remedies by the holders of the Preferred Stock would have a detrimental effect on our financial condition and could negatively affect our ability to implement our current business plan or conduct operations.
The industry in which we operate is highly competitive and our inability to compete successfully could adversely affect our business, financial condition and results of operations.
We operate in a highly competitive industry that could become even more competitive as a result of economic, technological and regulatory changes. Our mortgage loan origination business faces competition in mortgage loan offerings, rates, fees and levels of customer service. Competition to originate mortgage loans comes primarily from large commercial banks and savings institutions, but we also compete with a growing number of national and regional mortgage companies. Financial institutions generally have significantly greater resources and access to capital than we do, which gives them the benefit of a lower cost of funds and the ability to originate more mortgage loans.
In addition, technological advances and heightened e-commerce activities have increased consumers’ accessibility to products and services. This has intensified competition among banks and non-banks in offering mortgage loans and servicing them. We may be unable to compete successfully in our origination and servicing businesses, and this could materially and adversely affect our business, financial condition and results of operations.
We may experience financial difficulties which could adversely affect our business, financial condition and results of operations.
During the years ended June 30, 2015 and 2014, we incurred net losses from operations of $1,255,191 and $5,609,352, respectively. We have never generated an annual profit and if we are unsuccessful in adding additional profitable operations and reducing our current cost structure, our cash balances may not be able to support our future operating needs. We may be required to raise additional capital to meet our future cash flow requirements and currently have no commitment from any external or internal parties for funding of operations and working capital requirements. There is no guarantee that we will be successful in raising additional capital if necessary, and if we are unable to secure funding to meet our cash flow requirements in the future we may not be able to continue our business and expansion plans at the levels currently anticipated.
We may not be able to grow our mortgage origination volume to the level necessary to obtain profitability.
Our strategy is to grow our origination volume by adding additional existing operations to our platform. We can provide no assurance that we will be successful in identifying or recruiting origination platforms or businesses. Recruiting of existing operations is highly competitive and some of our competitors have greater resources, better product offerings and other advantages that make them a more attractive option for the operations we are trying to recruit. If we are unsuccessful in recruiting additional operations, our origination volume may not reach the levels necessary for us to generate profitable operations.
Further, as the refinance market continues to decline, the importance of loan originations business consisting of providing purchase money loans to homebuyers will become even more important. The origination of purchase money mortgage loans is greatly influenced by traditional business clients in the home buying process such as realtors and builders. As a result, our ability to secure relationships with such traditional business clients will influence our ability to grow our purchase money mortgage loan volume and, thus, our loan originations business.
The inability to retain key personnel could have a negative impact on our business operations.
If we are unable to retain certain members of our senior management team or certain loan officers responsible for loan origination volume, our results and financial condition may be adversely impacted. Further, we do not have agreements that would bind these individuals to the Company or restrict them from competing should they leave.
Downturn in the economy or a material increase in interest rates could indirectly have a material negative impact on our business operations.
We are dependent upon the commissions from the mortgage loans funded by us and our branch offices to generate revenue for our company. If mortgage interest rates increase significantly, as they did in June 2013, the number of persons who purchase or refinance homes could decline, which would also affect our ability to generate commissions. If because of an economic downturn or otherwise a significant number of borrowers default on their mortgage loans, additional lenders could discontinue providing mortgage loans which would make it more difficult to qualify customers or would reduce the number of loans we could place, either of which would result in reduced revenue for us.
We have significant financial compensation commitments due to various employment agreements with key members of management and loan originators. If we are unable to generate sufficient revenue, due to our significant commitments to salaries and other compensation, we may not be able to be profitable.
In our efforts to carry out our business model of attracting existing mortgage companies to join our network, we have committed to employment agreements with several key members of our management team which obligate the Company to substantial salary and other compensation expenses. During the year ended June 30, 2015, we incurred over $9.6 million in salary and commission expense pursuant to various employment agreements. If we are unable to produce significant revenue, we may not reach profitability due to salary and other compensation expenses due to key members of management and to our loan originators.
We are dependent upon warehouse lines of credit in order to provide loan funds for our lending services. Greater than 99% of our total lending through warehouse lines of credit for the year ended June 30, 2015 was derived from two lines of credit with a related party director. If we lose access to the related party lines of credit, we may not be able to access sufficient loan funds to maintain our lending services and our business may fail.
We have two warehouse lines of credit available for funding of mortgage loans for a short term period.
(i)
On August 3, 2008, we entered into a warehouse line of credit agreement with a related party mortgage banker for up to $1,000,000 bearing an annual interest rate of 5%. On October 13, 2013, the warehouse line of credit was increased to $75,000,000 for the purpose of funding residential mortgage loans. The warehouse line of credit matures on October 10, 2016. The outstanding balance on this line of credit as of June 30, 2015 was $1,409,373; and
(ii)
On November 18, 2011, we entered into a “Repo” warehouse line of credit agreement with a related party mortgage banker for up to $5,000,000 bearing an annual interest rate of 5% for funding residential mortgage loans. Pursuant to the terms of the agreement, we could be required to repurchase the loan subject to certain terms and conditions. On October 13, 2013, the warehouse line of credit was increased to $75,000,000 and now matures on October 10, 2016. The outstanding balance on this line of credit as of June 30, 2015 was $23,427,566.
The warehouse credit lines provide short-term funding for residential mortgage loans originated by our branch offices. The warehouse credit lines are repaid within an overall average of 16 days when the loan is sold to third party investors. We do not intend to hold and service the loans. The lines are used strictly to fund mortgage loans and not to provide operating funds for PSMI. As of June 30, 2015, the total aggregate outstanding on our two related party warehouse lines of credit was $24,836,939. We had $25,459,142 in loans held for sale which secure funds drawn against these lines of credit as of June 30, 2015. If we fail to maintain the two related party lines of credit, we may be unable to continue operations and our business may fail.
We have fully delegated status with multiple investors which means we may be required to repurchase loans sold to them in certain circumstances.
Per the terms of our agreements with our investors, in certain circumstances PSMI could be required to repurchase loans upon demand by the mortgage banker using PSMI resources, at the price at which the loan was originally funded plus fees and/or interest due to the mortgage banker; and/or pay to the mortgage banker any loss resulting from marketing the loan to a different target investor including, but not limited to, cash losses based on the then-current market value of the rejected loan as determined by the purchase price of the loan when sold and settled. If PSMI is required to repurchase a significant amount of loans we may not have the funds to meet our obligation to these investors, our working capital could be negatively impacted and our business could fail.
We are dependent upon obtaining and maintaining state licenses and bonding and federal HUD licensing for our business. If we fail to maintain our state licenses, bonding or our federal HUD license, we will not be able to legally carry out our business operations and our business may fail.
Regulatory changes from Federal and State authorities have placed a significant amount of pressure on mortgage companies across the United States. The regulatory changes have applied a significant amount of operational pressure for deeper and more disciplined internal processes, changes that have made it difficult for small to mid-sized mortgage brokerage and/or banking firms to continue functioning as independent businesses. This regulatory effect has driven many stable and profitable companies to join more established mortgage firms. Furthermore, companies who are most susceptible to these market dynamics are increasingly challenged by reduced profit margins as a result of required changes in technology, increased staffing needs to meet more complex compliance requirements and increased net worth requirements of HUD. Due to the uncertainty associated with existing and future requirements for obtaining and maintaining state and federal HUD licenses and maintaining bonding in various states we do business in, we may not be able to continue our growth into states in which we are not currently present. We also cannot guarantee continued federal HUD licensure. If we are unable to obtain or maintain our licenses, our business may fail.
The ongoing implementation of the Dodd-Frank Act will increase our regulatory compliance burden and associated costs and place restrictions on certain originations and servicing operations, all of which could adversely affect our business, financial condition and results of operations.
The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry in the United States. The Dodd-Frank Act includes, among other things: (i) the creation of a Financial Stability Oversight Council to identify emerging systemic risks posed by financial firms, activities and practices, and to improve cooperation among federal agencies; (ii) the creation of a Bureau of Consumer Financial Protection (CFPB) authorized to promulgate and enforce consumer protection regulations relating to financial products; (iii) the establishment of strengthened capital and prudential standards for banks and bank holding companies; (iv) enhanced regulation of financial markets, including the derivatives and securitization markets; and (v) amendments to the Truth in Lending Act aimed at improving consumer protections with respect to mortgage originations, including originator compensation, minimum repayment standards and prepayment considerations.
On January 10, 2013, the CFPB announced a rule to implement certain provisions of the Dodd-Frank Act relating to mortgage originations. Under the new originations rule, before originating a mortgage loan, lenders must determine on the basis of certain information and according to specified criteria that the prospective borrower has the ability to repay the loan. Lenders that issue loans meeting certain requirements will be presumed to comply with the new rule with respect to these loans. On January 17, 2013, the CFPB announced rules to implement certain provisions of the Dodd-Frank Act relating to mortgage servicing. The new servicing rules require servicers to meet certain benchmarks for customer service. Servicers must provide periodic billing statements and certain required notices and acknowledgments, promptly credit borrowers' accounts for payments received and promptly investigate complaints by borrowers and are required to take additional steps before purchasing insurance to protect the lender's interest in the property. The new servicing rules also call for additional notice, review and timing requirements with respect to delinquent borrowers, including early intervention, ongoing access to servicer personnel and specific loss mitigation and foreclosure procedures. Both the originations and servicing rules took effect on January 10, 2014. The CFPB also issued guidelines on October 13, 2011 and January 11, 2012 indicating that it would send examiners to banks and other institutions that service and/or originate mortgages to assess whether consumers' interests are protected. The CFPB will be conducting an examination of our business pursuant to these guidelines.
The ongoing implementation of the Dodd-Frank Act, including the implementation of the new originations and servicing rules by the CFPB will increase our regulatory compliance burden and associated costs, which could in turn adversely affect our business, financial condition and results of operations.
Technology failures could damage our business operations and increase our costs, which could adversely affect our business, financial condition and results of operations.
The financial services industry as a whole is characterized by rapidly changing technologies, and system disruptions and failures caused by fire, power loss, telecommunications failures, unauthorized intrusion, computer viruses and disabling devices, natural disasters and other similar events may interrupt or delay our ability to provide services to our clients. Security breaches, acts of vandalism and developments in computer capabilities could result in a compromise or breach of the technology that we use to protect our clients’ personal information and transaction data. Despite our efforts to ensure the integrity of our systems, it is possible that we may not be able to anticipate or implement effective preventive measures against all security breaches, especially because the techniques used change frequently or are not recognized until launched, and because security attacks can originate from a wide variety of sources, including third parties such as persons involved with organized crime or associated with external service providers. Those parties may also attempt to fraudulently induce employees, customers or other users of our systems to disclose sensitive information in order to gain access to our data or that of our customers or clients. These risks may increase in the future as we continue to increase our reliance on the internet and use of web-based product offerings and on the use of cyber security.
A successful penetration or circumvention of the security of our systems or a defect in the integrity of our systems or cyber security could cause serious negative consequences for our business, including significant disruption of our operations, misappropriation of our confidential information or that of our customers, or damage to our computers or operating systems and to those of our customers and counterparties. Any of the foregoing events could result in violations of applicable privacy and other laws, financial loss to us or to our customers, loss of confidence in our security measures, customer dissatisfaction, significant litigation exposure and harm to our reputation, all of which could adversely affect our business, financial condition and results of operations.
Any failure of our internal security measures or breach of our privacy protections could cause harm to our reputation and subject us to liability, any of which could adversely affect our business, financial condition and results of operations.
In the ordinary course of our business, we receive and store certain confidential information concerning borrowers. Additionally, we enter into third party relationships to assist with various aspects of our business, some of which require the exchange of confidential borrower information. If a third party were to compromise or breach our security measures or those of the vendors, through electronic, physical or other means, and misappropriate such information, it could cause interruptions in our operations and expose us to significant liabilities, reporting obligations, remediation costs and damage to our reputation. Any of the foregoing risks could adversely affect our business, financial condition and results of operations.
Negative public opinion could damage our reputation and adversely affect our earnings.
Reputation risk, or the risk to our business, earnings and capital from negative public opinion, is inherent in our business. Negative public opinion can result from our actual or alleged conduct in any number of activities, including lending and debt collection practices, technology failures, corporate governance, and actions taken by government regulators and community organizations in response to those activities. Negative public opinion can also result from media coverage, whether accurate or not. Negative public opinion can adversely affect our ability to attract and retain customers, trading counterparties and employees and can expose us to litigation and regulatory action. Although we take steps to minimize reputation risk in dealing with our customers and communities, this risk will always be present in our organization.
Our growth strategy includes adding existing mortgage operations to our lending platform, which may result in increased costs.
We are aggressively pursuing new groups or loan originators to join our Company. As we open new offices, or have loan originators join our Company, our cost structure will increase. If these new offices are not successful in generating sufficient revenue to cover the added costs, we may incur additional losses and may not be able to sustain our operations.
Risks Related to Our Common Stock
Because our shares are designated as “penny stock”, broker-dealers will be less likely to trade in our stock due to, among other items, the requirements for broker-dealers to disclose to investors the risks inherent in penny stocks and to make a determination that the investment is suitable for the purchaser.
Our shares are designated as “penny stock” as defined in Rule 3a51-1 promulgated under the Exchange Act and thus may be more illiquid than shares not designated as penny stock. The SEC has adopted rules which regulate broker-dealer practices in connection with transactions in “penny stocks.” Penny stocks are defined generally as non-NASDAQ equity securities with a price of less than $5.00 per share; that are not traded on a “recognized” national exchange; or in issuers with net tangible assets less than $2,000,000, if the issuer has been in continuous operation for at least three years, or $10,000,000, if in continuous operation for less than three years, or with average revenues of less than $6,000,000 for the last three years. The penny stock rules require a broker-dealer to deliver a standardized risk disclosure document prepared by the SEC, to provide the customer with current bid and offer quotations for the penny stock, the compensation of the broker-dealer and its salesperson in the transaction, monthly account statements showing the market value of each penny stock held in the customer’s account, to make a special written determination that the penny stock is a suitable investment for the purchaser and receive the purchaser’s written agreement to the transaction. These disclosure requirements may have the effect of reducing the level of trading activity, if any, in the secondary market for a stock that is subject to the penny stock rules. Since our securities are subject to the penny stock rules, investors in the shares may find it more difficult to sell their shares. Many brokers have decided not to trade in penny stocks because of the requirements of the penny stock rules and, as a result, the number of broker-dealers willing to act as market makers in such securities is limited. The reduction in the number of available market makers and other broker-dealers willing to trade in penny stocks may limit the ability of purchasers in this offering to sell their stock in any secondary market. These penny stock regulations, and the restrictions imposed on the resale of penny stocks by these regulations, could adversely affect our stock price.
Our Board of Directors can, without stockholder approval, cause Preferred Stock to be issued on terms that adversely affect common stockholders.
Under our Certificate of Incorporation, our Board of Directors is authorized to issue up to 10,000,000 shares of Preferred Stock, of which 3,700 are designated as Series A Preferred Stock, 2,000 are designated as Series B Preferred Stock, 1,800 are designated as Series C Preferred Stock, 1,400 are designated as Series D Preferred Stock and 822.5 are designated as Series E Preferred Stock, all of which are issued and outstanding as of the date of this report. Our Board of Directors has the right to determine the price, rights, preferences, privileges and restrictions, including voting rights, of the remaining Preferred shares without any further vote or action by our stockholders, except in certain instances the approval of a majority of the outstanding shares of Series A, Series B, Series C, Series D, and Series E Preferred Stock. If the Board causes any additional Preferred Stock to be issued, the rights of the holders of our Common Stock could be adversely affected. The Board’s ability to determine the terms of Preferred Stock and to cause its issuance, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. Additional Preferred shares issued by the Board of Directors could include voting rights, or even super voting rights, which could shift the ability to control the company to the holders of the additional shares of Preferred Stock. The additional shares of preferred shares could also have conversion rights into shares of Common Stock at a discount to the market price of the Common Stock which could negatively affect the market for our Common Stock. In addition, Preferred shares would have preference in the event of liquidation of our Company, which means that the holders of Preferred shares would be entitled to receive the net assets of our Company distributed in liquidation before the common stockholders receive any distribution of the liquidated assets. On February 4, 2013, April 2, 2014 and December 15, 2014, the Company entered into stock purchase agreements in which it issued 5,700, 3,200 and 822.5 shares of Preferred Stock, respectively.
We have not paid the quarterly dividends since the quarter ended June 30, 2014 as required on the outstanding preferred stock issued. The dividends are now accruing at a rate of 20% per year, until such time we bring the dividend payments current, if at all.
We have not paid, and do not intend to pay in the near term, dividends on our Common Stock, and therefore, unless our Common Stock appreciates in value, our investors may not benefit from holding our Common Stock.
We have not paid any cash dividends on our Common Stock since inception. Further, we cannot declare or pay any dividends on our Common Stock without the affirmative vote by the holders of a majority of the outstanding shares of Series A, B, C, D and E Preferred Stock. We do not anticipate paying any cash dividends on our Common Stock in the foreseeable future. As a result, our investors will not be able to benefit from owning our Common Stock unless the market price of our Common Stock becomes greater than the price paid for the stock by these investors and the cost to sell the shares.
The public trading market for our Common Stock is a volatile one and will likely result in higher spreads in stock prices.
Our Common Stock is trading in the over-the-counter market and is quoted on the OTC Markets and the OTC Bulletin Board. The over-the-counter market for securities has historically experienced extreme price and volume fluctuations during certain periods. These broad market fluctuations and other factors, such as economic conditions and quarterly variations in our results of operations, may adversely affect the market price of our Common Stock. In addition, the spreads on stock traded through the over-the-counter market are generally unregulated and higher than on the NASDAQ or other exchanges, which means that the difference between the price at which shares could be purchased by investors on the over-the-counter market compared to the price at which they could be subsequently sold would be greater than on these exchanges. Significant spreads between the bid and asked prices of the stock could continue during any period in which a sufficient volume of trading is unavailable or if the stock is quoted by an insignificant number of market makers. We cannot insure that our trading volume will be sufficient to significantly reduce this spread, or that we will have sufficient market makers to affect this spread. These higher spreads could adversely affect investors who purchase the shares at the higher price at which the shares are sold, but subsequently sell the shares at the lower bid prices quoted by the brokers. Unless the bid price for the stock increases and exceeds the price paid for the shares by the investor, plus brokerage commissions or charges, the investor could lose money on the sale. For higher spreads such as those on over-the-counter stocks, this is likely a much greater percentage of the price of the stock than for exchange listed stocks.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
We lease approximately 2,181 square feet of office space in Edmond, Oklahoma, which is used for our principal executive offices and as the operating location of PSMI. The one-year lease was executed May 7, 2015, and the monthly lease payments are $3,463.65. In addition, we lease office space for our branch offices under agreements that end at varying times through December 1, 2018. Current total monthly lease payments for the branch offices’ rental space are $86,717. We carry property and casualty insurance, renter’s insurance and liability insurance covering these spaces.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
On May 4, 2015, a former vendor filed a claim alleging breach of a certain contract that involved among other things, the vendor providing five year post marketing campaigns to previous borrowers. Although it is too early to determine the ultimate outcome of the case, the company intends to fight the claim vigorously. Management does not believe the outcome of the case will be significant to the Company.
On September 22, 2015, The Marriott International, Inc. filed a suit against the company for breach of an alleged contract. The suit claims the Company cancelled two conferences (one in June 2015 and one for January 2016) and claims the Hotel lost revenue including room and food and beverage revenue. The Company is just beginning its review of the merits of the case and intends to fight the case vigorously. At this time it is too early to determine the ultimate outcome of the case, however management does not believe the outcome will be significant to the Company.
From time to time, we may become involved in various lawsuits and legal proceedings, which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties, and an adverse result in these or other matters may arise from time to time that may harm our business.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
The disclosure required under this item is inapplicable to our company.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our Common Stock has been quoted on the OTC Bulletin Board since October 2009 and has been quoted on the OTC Markets (formerly the “Pink Sheets”) since October 2005. Our trading symbol is “PSMH.” The table below sets forth for the periods indicated the range of the high and low bid or trading information as reported by OTC Markets. These quotations reflect inter-dealer prices, without retail mark-up, mark-down, or commission and may not necessarily represent actual transactions.
Holders
As of October 13, 2015 we had approximately 535 record holders of our Common Stock. The number of holders was determined from the records of our transfer agent and does not include beneficial owners of Common Stock whose shares are held in the names of various security brokers, dealers, and registered clearing agencies. We have appointed Interwest Transfer Company, Inc., 1981 Murray Holladay Road, Suite 100, Salt Lake City, Utah 84117, to be the transfer agent of our Common Stock.
Dividends
We have never declared or paid any cash dividends on our Common Stock; however, holders of the shares of Series A, B, C, D and E Preferred Stocks are entitled to receive cumulative cash dividends at the rate per share (as a percentage of the stated value per share) of 6% per annum (20% per annum currently while event of default remains uncured). The dividends, when paid, are payable quarterly in arrears on April 15, July 15, October 15 and January 15. We do not anticipate paying any cash dividends to common stockholders in the foreseeable future. In addition, any future determination to pay cash dividends will be at the discretion of the Board of Directors, would be subject to a vote of the holders of shares of Series A, B, C, D and E Preferred Stock, and will be dependent upon our financial condition, results of operations, capital requirements, and such other factors as the Board of Directors deems relevant.
Purchases of Equity Securities
(1)
On July 3, 2014 and July 14, 2014, we closed the Asset Purchase Agreements effective January 31, 2014, by, between, and among the Company, and three former employees. Assets valued at $272,023, as defined by the agreement, were sold in exchange for 1,750,000 shares of our common stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
As a smaller reporting company, we have elected not to provide the information required by this item.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our consolidated financial statements and related notes thereto as filed with this report.
Overview
PSM Holdings, Inc. (the “Company” or “PSMH”) originates mortgage loans funded either directly off our warehouse lines of credit or through brokering transactions to other third parties. Approximately 95% of our mortgage origination volume is banked off of our current warehouse lines. We have relationships with multiple investors who purchase the loans funded on our warehouse lines. All of our lending activities are conducted by our subsidiary, Prime Source Mortgage, Inc. (“PSMI”).
Historically, a significant portion of our business has been referral based and purchase orientated (versus refinance). We do not directly participate in the secondary markets and further do not maintain a servicing portfolio. Approximately 75% of total loan applications are generated from business contacts and previous client referrals. Realtor referrals and other lead sources account for the balance of loan applications.
We have retail offices located around the United States from which we derive revenue from the loan origination volume of these offices. We are able to leverage our warehouse lines of credit relationships with related parties in order to provide us the funding capacity to support our growth. PSMI is licensed in 14 states and operates out of approximately 26 offices in these states.
Current Environment
Regulatory changes from Federal and State authorities have placed a significant amount of pressure on mortgage companies across the United States. The regulatory changes have applied operational pressure for deeper and more disciplined internal processes, limitations on loan officer compensation and increased compliance requirements all making it difficult for small to mid-market mortgage firms to operate profitably as independent businesses. This dynamic has spurred consolidation in the industry as many firms feel the need to join larger more established platforms. This industry shift has left the remaining mortgage businesses forced to either make the financial investments in their business to operate in today’s environment or become part of a more stable, mature operation that is better suited to compete in a contracting market.
Plan of Operation
Since May 2014, we have operated as a fully delegated correspondent lender. Under our delegated model, we generate income in multiple ways including yield spread on originated loans, file fees and volume bonus or delivery incentives from investors. Our Capital Markets and field operations team is based in Murrieta, CA. We closed our first loans as a fully delegated lender in October 2013.
During the year, we closed or terminated relationships with several under-performing offices. We have continued to recruit additional loan originators and offices to our platform.
Like most lenders in our industry, our production volumes have fluctuated greatly over the last three years. The following table represents a production matrix reflecting our past production by number of Loans and Dollar Volume:
As a result of the market consolidation in the mortgage banking industry, we continue to recruit and onboard new entities, as well as work with existing offices to increase their loan originators, locations and production. During the year ended June 30, 2015, we added a total of six locations through extensions of existing offices or onboarding of other mortgage operations. Subsequent to year-end, we have opened an additional eight offices (seven in California and one in Washington). We will continue to recruit loan originators and existing mortgage banking or broker operations as we believe our current infrastructure can support a significant scaling of our operations without the need for additional resources or capital.
Results of Operations
Our consolidated results of operations for the twelve months ended June 30, 2015, include the operating results of our wholly-owned subsidiary WWYH, Inc. and results of operations of Prime Source Mortgage, Inc.
Operational Improvements
We reported a net loss of $1,653,761 for the year ended June 30, 2015 compared to a loss of $5,853,081 for the same period ended June 30, 2014. In both periods our losses included net non-operating charges, primarily relating to disposal of assets that amounted to $296,940 for the year ended June 30, 2015 compared to $224,328 for the year ended June 30, 2014. The table below shows the operating income and loss generated each quarter in the current fiscal year. In January 2015, we closed five of our underperforming offices and made changes at one other to curtail losses being generated by these offices. Additionally, we have successfully recruited 14 new offices in the current fiscal year which are starting to build momentum and consistent cash flow. These actions resulted in us generating operating income during the fourth quarter of our fiscal year. We will continue to closely monitor results at all of our office locations and make necessary adjustments as needed, as well as work to assist our new offices to continue to scale to the origination volumes they were generating before they joined our platform (typically takes about 90 to 120 days for a transitioned office to scale back to the volume it was generating before transitioning). In the fourth quarter of this fiscal year, we opened 5 offices which have not fully ramped to their expected potential as of June 30, 2015. Subsequent to June 30, 2015, we have opened an additional eight locations.
Revenues
Total revenues increased by $5,023,355 to $17,561,590 for the year ended June 30, 2015, as compared to $12,538,235 for the same period in 2014 (the “comparable prior year period”). We closed 1,834 loans for a total loan production of $419,457,580 during the year ended June 30, 2015, as compared to 1,904 loans for a total production of $353,068,032 for the comparable prior year period. Our production increased by $66,389,548 on seventy fewer loans. This is primarily a result of more volume being driven in the western states like California and Utah during the current year. Our revenue per loan increased by $2,991, or 45.4% to $9,576 in the current year, compared to $6,585 in the prior year. The increase in revenue per loan in the current year is a direct result of more loans being originated and funded on our delegated platform where we get direct correspondent pricing and have the ability to charge and earn certain fees for various loan level activities including underwriting and processing loans.
Operating Expenses
Our total operating expenses increased by $669,194 or 3.7% to $18,816,781 for the year ended June 30, 2015, as compared to $18,147,587 for the comparable prior year period. In the current year, on our delegated platform and our new accounting software, we are able to break out certain loan level expenses that in the prior year were fees that third parties incurred and were netted in the revenue we received. For the year ended June 30, 2015, these fees, which include lender credits, warehouse fees, warehouse interest and investor fees charged, amongst others, amounted to $2,382,563. For the most part, all other operating expense decreased. Advertising decreased by $95,390 to $611,137 in the current year. This is primarily due to a shift in many of our offices focusing on purchase transactions (relationships with realtors) as opposed to buying leads from different sources. Conference expense was down $169,578 as we did not have a conference in the current fiscal year. Employee benefits decreased by $148,766 as we had fewer employees during the year ended June 30, 2015 compared to the prior year and fewer employees participating in the benefit plans. Depreciation and amortization were down by $170,096 to $119,211 for the year ended June 30, 2015 compared to $289,307 in the comparable prior year period. In July 2014 the Company sold assets to two offices that had left the platform and in March of 2015, the Company wrote off intangible assets associated with an office that left our platform. Our professional and legal fees were significantly higher in the current twelve month period ended June 30, 2015, amounting to $1,354,876, an increase of $802,658 over the prior year period where professional and legal fees amounted to $552,218. In the current year, we engaged a third party to perform certain loan level services at our Box Home Loan Division. This Division was new to the Company in January 2015. Our stock compensation increased by $121,132 to $142,235 in the current period as we put a significant emphasis on incentivizing our employees through stock options. Salaries and wages decreased by $577,890 from $10,177,817 in the prior period to $9,599,927 for the twelve months ended June 30, 2015. Salaries and wages were down despite the increased production volume as throughout the current year we have been switching our producing branch managers to salary only compensation plans.
Non-operating income (expense)
We incurred non-operating expense of $398,570 for the year ended June 30, 2015 compared to non-operating expense of $243,729 for the year ended June 30, 2014. In both periods, we incurred interest expense related to short term notes, $86,560 in interest expense for the year ended June 30, 2015 compared to $72,560 in the prior year. Both periods also included charges for the loss on sale of certain tangible assets (furniture and equipment) or disposal of various intangible assets like customer lists and site licenses. In the current twelve-month period, these charges amounted to $318,257 compared to $266,755 for the comparable prior year period.
Other income primarily consists of contributions, sponsorships and other advertising funds we receive from third parties for hosting our annual trade conference. This amounted to $88,500 for the twelve months ended June 30, 2014. We did not hold a trade show in the current fiscal year and as such did not receive sponsorship funds. The costs associated with the annual conference are included in operating expenses as they are considered costs related to marketing the Company.
Liquidity and Capital Resources
Our cash and cash equivalents were $898,200 as of June 30, 2015, compared to $764,931 as of June 30, 2014. As shown in the accompanying consolidated financial statements, we recorded a net loss of $1,653,761 for the year ended June 30, 2015, compared to a net loss of $5,853,081 for the comparable prior year period. Although we generated a net profit for the three months ended June 30, 2015, we have never generated an annual net income.
We believe certain cost saving initiatives, closing of certain offices and originating and funding loans on our delegated platform will allow us to reduce our losses and ultimately achieve sustainable profitability as demonstrated in the fourth fiscal quarter. Our growth strategy includes adding additional branch offices and loan officers. There is no assurance that our current working capital will allow us to pursue our growth strategy and in order to expand our business we may need to sell additional shares of our Common Stock or borrow funds from private lenders to help finance the anticipated growth. There are no assurances that we can raise additional capital if necessary, and as such, our liquidity and capital resources may be adversely affected.
Operating Activities
Net cash used in operating activities for the year ended June 30, 2015 was $(10,879,257) resulting primarily from an increase in our loans held for sale of $10,182,771. This increase was simply due to funding a large amount of loans at the end of June 2015. Greater than 95% of the loans were sold subsequent to year end. Our net loss of $(1,653,761) also contributed to our cash used by operating activities offset by our increase in accounts payable of $475,437, noncash disposition of assets amounting to $296,940 and depreciation and amortization of $119,211. For the year ended June 30, 2014, our net cash used by operating activities amounted to $(3,635,582). Two primary drivers of the cash used in operating activities were our net loss of $(5,853,081) and our sale and collection of loans held for sale amounting to $2,285,711. In the prior year charges for depreciation and amortization were $289,307, and there was an increase in our restricted cash of $(255,701), and a pay down of our accrued liabilities in the amount $(775,081).
Investing Activities
Net cash used in investing activities for the year ended June 30, 2015, was $(67,103) compared to net cash used in investing activities of $(316,020) in the prior period. For the year ended June 30, 2015, we purchased property and equipment amounting to $53,689 and funded additional security deposits of $13,414. During the year ended June 30, 2014, we purchased property and equipment amounting to $298,053 and funded additional security deposits of $17,967. We do not currently have material commitments for capital expenditures and do not anticipate entering into any such commitments during the next twelve months.
Financing Activities
Net cash provided by financing activities for the year ended June 30, 2015, amounted to $11,079,629 compared to net cash provided by financing activities of $200,915 for the prior year. Sale of Preferred Stock generated $787,201 ($822,500 gross proceeds less fees and costs of $35,299) and $2,864,000 ($3,200,000 gross proceeds less transaction costs of $336,000) for the years ended June 30, 2015 and 2014, respectively. Cash paid for preferred dividends amounted to $133,500 and $390,000 for the years ended June 30, 2015 and 2014, respectively. In terms of our warehouse lines of credit for the year ended June 30, 2015, we received cash proceeds of $419,457,580 to fund our loan originations and made cash repayments of $(409,563,422) when loans were sold. In the prior twelve month period, we received cash proceeds of $286,735,579 from our warehouse lines of credit and made cash payments of $(287,481,523). During the year ended June 30, 2015, we received cash proceeds of $120,000 from a related party note receivable, cash proceeds of $136,383 from a related party line of credit, and cash proceeds of $750,000 from a third party lender. During the year ended June 30, 2014, we received cash proceeds of $885,000 on loans from related parties, and made cash payments of $750,000 on loans from related parties. $135,000 of loans from related parties was converted into the 2014 Preferred Stock transaction.
As a result of the above activities, we experienced a net increase in cash of $133,269 for the year ended June 30, 2015 compared to a net decrease in cash of $(3,750,687) for the prior year period. Our ability to continue as a going concern is still dependent on our success in attracting profitable and stable mortgage businesses to join our lending platform, expanding the business of our existing branches, and controlling our costs as we execute our growth and expansion plans. During the year ended June 30, 2015, we ended our relationship with five underperforming offices. At the time of their departure, none of the locations were generating enough volume to cover their expense structure and thus these operations contributed negatively to our plan for sustainable profitability. Upon closing theses offices in January 2015, and adding more mature profitable offices, PSMI generating an operating profit each month from February 2015 through June 2015.
Critical Accounting Policies and Estimates
Management’s discussion and analysis of its financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles. Our financial statements reflect the selection and application of accounting policies which require management to make estimates and judgments. (See Note 1 to our consolidated financial statements, “Summary of Significant Accounting Policies”). We believe that the following paragraphs reflect accounting policies that currently affect our financial condition and results of operations:
Share Based Payment Plan
Under the 2012 and 2015 Stock Incentive Plans, we can grant stock or options to employees, related parties, and unrelated contractors in connection with the performance of services provided to us by the awardees. We use the fair value method to account for employee stock compensation costs and to account for share based payments to non-employees.
Revenue Recognition
Our revenue is derived primarily from revenue earned from the origination of mortgage loans that are funded on our warehouse lines of credit and sold to third party investors. Revenue is recognized as earned on the date the loan is funded.
Recent Accounting Pronouncements
We have evaluated the possible effects on it financial statements of the following accounting pronouncements:
Accounting Standards Update 2015-16-Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments
In September 2015, the FASB issued ASU2015-16, Simplifying the Accounting for Measurement-Period Adjustments. The amendments in this Update require that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments in this Update require that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The amendments in this Update are effective for fiscal years beginning after December 15, 2016, and interim periods within fiscal years beginning after December 15, 2017. We are currently evaluating the guidance under ASU 2015-16 and have not yet determined the impact, if any, on our consolidated financial statements.
Accounting Standards Update 2015-07- Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)
In May 2015, the FASB issued ASU 2015-07, Fair Value Measurement (Topic 820) :Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent). The amendments in this Update remove the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. The amendments also remove the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the net asset value per share practical expedient. Rather, those disclosures are limited to investments for which the entity has elected to measure the fair value using that practical expedient. The amendments in this Update are effective for public business entities for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. We are currently evaluating the guidance under ASU 2015-07 and have not yet determined the impact, if any, on our consolidated financial statements.
Accounting Standards Update 2015-05- Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement
In April 2015, the FASB issued ASU 2015-05, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement. The amendments in this Update provide guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. For public business entities, the Board decided that the amendments will be effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2015.We are currently evaluating the guidance under ASU 2015-05 and have not yet determined the impact, if any, on our consolidated financial statements.
Accounting Standards Update No. 2015-03-Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs
In April 2015, the FASB issued ASU 2015-03 Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. The amendments in this Update require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. For public business entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. We are currently evaluating the guidance under ASU 2015-03 and have not yet determined the impact, if any, on our consolidated financial statements.
Accounting Standards Update No. 2015-01- Income Statement-Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items
In January 2015, the FASB issued ASU 2015-01 Income Statement-Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items. This Update eliminates from GAAP the concept of extraordinary items. The amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. We are currently evaluating the guidance under ASU 2015-01 and have not yet determined the impact, if any, on our consolidated financial statements.
Accounting Standards Update No. 2014-18- Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination
In December 2014, the FASB issued ASU 2014-18 Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination. An entity within the scope of this Update that elects the accounting alternative to recognize or otherwise consider the fair value of intangible assets as a result of any in-scope transactions should no longer recognize separately from goodwill (1) customer-related intangible assets unless they are capable of being sold or licensed independently from the other assets of the business and (2) noncompetition agreements. The decision to adopt the accounting alternative in this Update must be made upon the occurrence of the first transaction within the scope of this accounting alternative in fiscal years beginning after December 15, 2015, and the effective date of adoption depends on the timing of that first in-scope transaction. We are currently evaluating the guidance under ASU 2014-18 and have not yet determined the impact, if any, on our consolidated financial statements.
Accounting Standards Update No. 2014-16- Derivatives and Hedging (Topic 815): Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity
In November 2014, the FASB issued ASU 2014-16 Derivatives and Hedging (Topic 815): Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity. The objective of this Update is to eliminate the use of different methods in practice and thereby reduce existing diversity under GAAP in the accounting for hybrid financial instruments issued in the form of a share. The amendments clarify how current GAAP should be interpreted in evaluating the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share. Specifically, the amendments clarify that an entity should consider all relevant terms and features-including the embedded derivative feature being evaluated for bifurcation-in evaluating the nature of the host contract. Furthermore, the amendments clarify that no single term or feature would necessarily determine the economic characteristics and risks of the host contract. Rather, the nature of the host contract depends upon the economic characteristics and risks of the entire hybrid financial instrument The amendments in this Update are effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December15, 2015. We are currently evaluating the guidance under ASU 2014-16 and have not yet determined the impact, if any, on our consolidated financial statements.
Accounting Standards Update 2014-15 - Presentation of Financial Statements - Going Concern
In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements-Going Concern. The amendments in this update provide guidance in GAAP about management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. In doing so, the amendments should reduce diversity in the timing and content of footnote disclosures. The amendments in ASU 2014-15 are effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. We are currently evaluating the guidance under ASU 2014-15 and have not yet determined the impact, if any, on our consolidated financial statements.
Accounting Standards Update 2014-12 - Compensation-Stock Compensation (Topic 718) Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period
In June 2014, the FASB issued ASU 2014-12, Compensation-Stock Compensation (Topic 718) Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. The amendments in this update require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. For all entities, the amendments in ASU 2014-12 are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. We are currently evaluating the guidance under ASU 2014-12 and have not yet determined the impact, if any, on our consolidated financial statements.
Off-Balance Sheet Arrangements
During the fiscal year ended June 30, 2015, and since that date, we have not entered into or created any off-balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, revenues, results of operations, liquidity, capital expenditures or capital resources.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As a smaller reporting company, we have elected not to provide the disclosure required by this item.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements required pursuant to this item are included immediately following the signature page of this report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There have been no changes in or disagreements with accountants reportable pursuant to this item.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain “disclosure controls and procedures,” as such term is defined in Rules 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer who also serves as our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
Kevin Gadawski, our principal executive and financial officer, carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures in effect as of June 30, 2015. Based on this evaluation, Mr. Gadawski concluded that our disclosure controls and procedures as of June 30, 2015, were effective in ensuring that information required to be disclosed by us in our periodic reports is recorded, processed, summarized and reported, within the time periods specified for each report and that such information is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of our company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed our internal control over financial reporting as of June 30, 2015, the end of our fiscal year. Management based its assessment on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Management’s assessment included evaluation of such elements as the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies, and our overall control environment.
Based on our assessment, management has concluded that our internal control over financial reporting was effective, as of the end of the fiscal year, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with generally accepted accounting principles
Changes in Internal Control Over Financial Reporting
We regularly review our system of internal control over financial reporting and make changes to our processes and systems to improve controls and increase efficiency, while ensuring that we maintain an effective internal control environment. There were no changes in our internal control over financial reporting that occurred during the year ended June 30, 2015, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
There are no events reportable under this Item.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Current Management
The following table sets forth as of October 13, 2015, the name and ages of, and position or positions held by, our executive officers and directors, including executive officers and directors of PSMI, certain significant employees, and the employment background of these persons:
Each director is elected for a term of one year or until his successor is elected and qualified, except as otherwise provided in the Bylaws or required by law.
We confirm, as required by regulations under the Exchange Act, that (1) there is no family relationship between any director or executive officer of the Company, (2) there was no arrangement or understanding between any director or officer and any other person pursuant to which the directors were elected to their positions with the Company. However, Mr. Gadawski and Mr. Margolies were appointed as directors per the Series A Preferred Stock designations as part of the capital raise completed February 4, 2013.
Legal Proceedings
During the past ten years there have been no events under any bankruptcy act, no criminal proceedings and no judgments, injunctions, orders or decrees material to the evaluation of the ability and integrity of any of our directors or executive officers.
Except for the proceeding described in Part I, Item 3 above, we are not aware of any legal proceedings in which any director, officer or affiliate of our Company, any owner of record or beneficially of more than five percent of any class of our voting securities, or any associate of any such director, officer, or affiliate of our Company, or security holder is a party adverse to us or our subsidiaries or has a material interest adverse to us or our subsidiaries.
Compliance with Section 16(a) of the Securities Exchange Act of 1934
The following table identifies each person who, at any time during the fiscal year ended June 30, 2015, was a director, executive officer, or beneficial owner of more than 10% of our common stock that failed to file on a timely basis reports required by Section 16(a) of the Exchange Act during the most recent fiscal year:
Code of Ethics
On September 27, 2010, the Board of Directors adopted a Code of Ethics. The purpose of the Code of Ethics is to set the expectations of the highest standards of ethical conduct and fair dealings. The Code of Ethics applies to our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. Our Code of Ethics is available for review at www.psmholdings.com.
Committees of the Board of Directors
The following chart sets forth the current membership of each board committee. The Board of Directors reviews and determines the membership of the committees at least annually.
Information about the committees, their respective roles and responsibilities is set forth below.
Audit Committee
The Audit Committee is currently comprised of Messrs. Gadawski, Margolies and Miller. Mr. Margolies is currently Chairman of the Audit Committee. The Audit Committee assists our Board of Directors in fulfilling its responsibility to oversee management’s conduct of our financial reporting process, including the selection of our outside auditors, review of the financial reports and other financial information we provide to the public, our systems of internal accounting, financial and disclosure controls and the annual independent audit of our financial statements.
The Audit Committee was first created on April 18, 2012.
None of the members of the Audit Committee is independent within the meaning of the NYSE MKT LLC. Mr. Gadawski is qualified as an audit committee financial expert.
The Audit Committee does not currently have a charter.
Compensation Committee
We have a standing Compensation Committee currently comprised of Messrs. Miller, Gadawski and Margolies. Mr. Margolies is currently Chairman of the Compensation Committee. The Compensation Committee represents our company in reviewing and approving (subject to approval of the independent directors) the executive employment agreements for our Officers and senior management. The Compensation Committee also administers our stock option and incentive plans, including our 2012 and 2015 Stock Incentive Plans. None of our Compensation Committee members are considered independent within the meaning of the NYSE MKT LLC. The Compensation Committee was first formed on July 11, 2012.
The Compensation Committee does not currently have a charter.
Nominating and Governance Committee
We do not currently have a Nominating and Governance Committee and do not feel one is required at this time due to the small size of the Board of Directors. There have been no material changes to the procedures by which security holders may recommend nominees to our Board of Directors
Overview of Director Nominating Process
The Board of Directors does not have a standing nominating committee or committee performing similar functions. The Board of Directors also does not currently have a policy for the qualification, identification, evaluation or consideration of director candidates. The Board of Directors does not believe that a defined policy with regard to the qualification, identification, evaluation or consideration of candidates recommended by stockholders is necessary at this time due to the fact that we have not received any stockholder recommendations in the past. Director nominees are considered solely by our current Board of Directors and we have not adopted procedures by which security holders may recommend nominees to our Board of Directors.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Executive Compensation
The following table sets forth information concerning the annual compensation awarded to, earned by, or paid to the named executive officers for all services rendered in all capacities to our Company and its subsidiaries for the years ended June 30, 2015 and 2014:
SUMMARY COMPENSATION TABLE
(1)
Represents the value of stock options issued to Mr. Gadawski in February and April of 2015.
(2)
This amount consists of $4,395 compensation for health insurance premiums for Mr. Gadawski and his family and $2,250 in car allowance.
(3)
Represents the value of stock options issued to Mr. Gadawski in April 2014.
(4)
Consists of health and life insurance premiums for Mr. Gadawski and his family.
(5)
This amount consists of $3,669 compensation for health insurance premiums for Mr. Smith and his family and $4,900 in car allowance.
(6)
Consists of stock received in lieu of cash compensation (salary).
(7)
This amount consists of $4,418 compensation for health insurance premiums for Mr. Smith and his family and $8,400 in car allowance.
(8)
Represents the value of stock options issued to Mr. Morelli in April 2015.
(9)
Represents health and life insurance premiums for Mr. Morelli and his family.
(10)
Represents the value of stock options issued to Ms. Chavez in April 2015.
(11)
Represents life insurance premiums paid for Ms. Chavez.
(12)
Represents the value of stock options issued to Ms. Chavez in April 2014.
CEO, CFO
On March 26, 2015, we entered into an Executive Employment Agreement with Mr. Gadawski to serve as its Chief Financial Officer, Chief Operating Officer, and Chief Executive Officer. In addition, Mr. Gadawski also assumed the roles of President, Chief Executive Officer, and Director of PSMI. The agreement was effective April 1, 2015 and the term of the agreement is three years, ending on March 31, 2018. Under the agreement, Mr. Gadawski’s annual base salary is $250,000. If the agreement is extended, the base salary will be reviewed no less frequently than annually, but at no time during the term of this agreement will Mr. Gadawski’s base salary be decreased. If we are reasonably unable to pay the base salary for any pay period, we and Mr. Gadawski may agree that the base salary be paid with shares of Common Stock under our 2015 Stock Incentive Plan at a 25% discount to the fair market price of the stock at the end of the pay period. As a signing bonus for entering into the agreement, we agreed to grant to Mr. Gadawski options to purchase up to 10,000,000 shares of Common Stock under the 2015 Stock Incentive Plan. Mr. Gadawski will be eligible to participate in any incentive bonus pool maintained for persons including executive officers of the Company. He will be eligible to receive an annual bonus as per the incentive bonus pool of up to 100% of the then applicable base salary, less applicable withholding taxes. In addition, we will provide Mr. Gadawski a car allowance in the amount of $750 per month as well as reimburse him for the cost of annual automobile insurance.
On November 4, 2013, we issued 26,494 shares of stock to Mr. Gadawski under the 2012 Stock Incentive Plan in lieu of salary and cash compensation that were due to him for services provided to us in October 2013.
Effective February 12, 2014, we entered into a short-term Loan Agreement dated February 10, 2014 with Mr. Gadawski. Under the terms of the Loan Agreement, Mr. Gadawski agreed to loan $10,000 for operating expenses of the Company and PSMI, as well as to fund our growth. The funds were received by us on February 13, 2014. The loan is evidenced by one-year 10% Convertible Promissory Notes which bears interest at 10% per annum. The Note is convertible at the lowest per share rate of Common Stock or Common Stock equivalents sold in a Qualified Offering by us. For purposes of this transaction, the term “Qualified Offering” means one or more offerings of debt or equity securities by us to non-affiliates in the aggregate amount of at least $1,000,000. In addition, Mr. Gadawski received one Common Stock purchase warrant for each $2.50 loaned to us. Each five-year warrant is exercisable at $0.40 per share, subject to adjustment in the event of the issuance of additional common shares or Common Stock equivalents at less than the exercise price. The warrants also provide for cashless exercise. The warrants are not transferable or assignable without the prior consent of the Company.
In connection with the 2014 SPA, Mr. Gadawski, as an associate of the Placement Agent, received warrants to purchase 640,810 shares of our Common Stock. The warrants are exercisable at $0.088 and expire on April 1, 2019.
On April 16, 2014, we granted 1,250,000 incentive options to Mr. Gadawski. The options were granted under the 2012 Stock Incentive Plan and are exercisable at $0.10. The options vest equally over three years and expire April 16, 2018.
In connection with the Series E SPA, Mr. Gadawski, as an associate of the Placement Agent, received warrants to purchase 1,400,000 shares of our Common Stock. The warrants are exercisable at $0.011 and expire on December 15, 2019.
On February 12, 2015, we granted 1,100,000 incentive options to Mr. Gadawski. The options were granted under the 2012 Stock Incentive Plan and are exercisable at $0.035. The options vest equally over three years and expire February11, 2018.
Former Chairman
Mr. Smith’s employment agreement was initially executed in February 2011 with terms that go through December 31, 2013. On January 1, 2014, we executed a new agreement with Mr. Smith which increased his salary to $250,000 and maintained the same benefits including health insurance, life insurance and a car allowance. The agreement was for one year and was not renewed.
On March 13, 2014, we entered into a Loan Agreement with LB MERCHANT PSMH-1, LLC, an entity controlled by Michael Margolies, a director of the Company (“LB”). Under the terms of the agreement, LB agreed to loan $500,000 for operating expenses of the Company and PSMI, as well as to fund growth of the Company. The funds were received by us on March 13, 2014. The loan is evidenced by a 10% Promissory Note which bears interest at 10% per annum. In addition, LB received four tenths (0.40) of one Common Stock purchase warrant for each $0.80 loaned to us (totaling 300,000 warrants), and such warrants were issued as directed by LB with LB receiving 50,000 warrants and Mr. Smith receiving 50,000 warrants. Each five-year warrant is exercisable at $0.40 per share, subject to adjustment in the event of the issuance of additional common shares or Common Stock equivalents at less than the exercise price. The warrants also provide for cashless exercise. The warrants are not transferable or assignable without the prior consent of the Company.
On September 12, 2014, we entered into a Loan Agreement with Mr. Smith. Under the terms of the Loan Agreement, Mr. Smith agreed to loan $120,000 for operating expenses of the Company and PSMI, as well as to fund growth of the Company. The funds were received by us on September 12, 2014. The loan is evidenced by a 10% Convertible Promissory Note which bears interest at 10% per annum and matured September 12, 2015. The Note is convertible at the per share rate of common stock sold pursuant to a Qualified Offering by us. In addition, Mr. Smith received four tenths (0.40) of one Common Stock purchase warrant for each $1.00 loaned to us (totaling 48,000 warrants). Each five-year warrant is exercisable at $0.40 per share, subject to adjustment in the event of the issuance of additional common shares or Common Stock equivalents at less than the exercise price. The warrants also provide for cashless exercise. The warrants are not transferable or assignable without the prior consent of the Company. On September 17, 2015, we executed a one year extension of the note and made a principal payment of $5,000.
Executive Vice President
On May 1, 2011, we entered into an employment agreement with Samuel Morelli as Executive Vice President and director of PSMI. The term of the employment agreement expired on December 31, 2011. A new employment agreement has not been executed, and Mr. Morelli remains an employee of the Company. We have agreed to annual compensation of $165,000 as well as life and health insurance benefits consistent with those offered other executives.
On November 4, 2013, we granted 125,000 incentive options to Mr. Morelli. The options were granted under the 2012 Stock Incentive Plan and are exercisable at $0.25. The options vest equally over three years and expire November 3, 2018.
On June 1, 2015, we granted 350,000 incentive options to Mr. Morelli. The options were granted under the 2015 Stock Incentive Plan and are exercisable at $0.206. The options vest equally over three years and expire June 1, 2019.
Vice President
We have agreed to annual compensation of $100,000 as well as life and health insurance benefits consistent with those offered other executives for Crystal Chavez.
On April 16, 2014, we granted 175,000 incentive options to Ms. Chavez. The options were granted under the 2012 Stock Incentive Plan and are exercisable at $0.10. The options vest equally over three years and expire April 16, 2018.
On February 12, 2015, we granted 300,000 incentive options to Ms. Chavez. The options were granted under the 2012 Stock Incentive Plan and are exercisable at $0.035. The options vest equally over three years and expire February 11, 2019.
On June 1, 2015, we granted 600,000 incentive options to Ms. Chavez. The options were granted under the 2015 Stock Incentive Plan and are exercisable at $0.206. The options vest equally over three years and expire June 1, 2019.
Equity Awards
We have not issued any stock awards. The named executive officers listed below received the following option awards:
On December 12, 2011, the stockholders adopted the 2012 Stock Incentive Plan (the “Plan”). The purpose of the Plan is to advance the interests of our stockholders by enhancing our ability to attract, retain and motivate persons who are expected to make important contributions to the Company and by providing such persons with equity ownership opportunities and performance-based incentives that are intended to better align the interests of such persons with those of our stockholders.
There are 6,000,000 shares of Common Stock authorized for non-statutory and incentive stock options and stock grants under the Plan, which are subject to adjustment in the event of stock splits, stock dividends, and other situations. As of June 30, 2015, 1,248,338 stock grants and 4,218,833 options grants have been made under the Plan. 533,329 shares remain available for future grants under the Plan.
Effective March 26, 2015 our Board of Directors approved the 2015 Stock Incentive Plan (the “2015 Plan”). Awards may be made under the 2015 Plan for up to 40,000,000 shares of our Common Stock at $0.001 par value per share. All of our employees, officers and directors, as well as consultants and advisors to us are eligible to be granted awards under the 2015 Plan. No awards can be granted under the 2015 Plan after the expiration of 10 years from the effective date, but awards previously granted may extend beyond that date. Awards may consist of both incentive and non-statutory options, restricted stock units, stock appreciation rights, and restricted stock awards.
As of June 30, 2015, 20,250,000 options grants have been made under the 2015 Plan. 18,750,000 shares remain for future grants under the 2015 Plan.
Both plans are administered by the Board of Directors. All of our employees, officers and directors, as well as consultants and advisors (as such terms consultants and advisors are defined and interpreted for purposes of Form S-8 under the Securities Act of 1933, as amended, or any successor form) are eligible to be granted awards under the plans. Options may be granted, or shares issued, only to consultants or advisors who are natural persons and who provide bona fide services to us or one of our subsidiaries, provided that the services are not in connection with the offer or sale of securities in a capital-raising transaction, and do not directly or indirectly promote or maintain a market for our securities.
The 2012 Plan will continue in effect until all of the stock available for grant or issuance has been acquired through exercise of options or grants of shares, or until December 31, 2021, whichever is earlier. The 2015 Plan will continue in effect until all of the stock available for grant or issuance has been acquired through exercise of options or grants of shares, or until March 26, 2025, whichever is earlier. The plans may also be terminated in the event of certain corporate transactions such as a merger or consolidation or the sale, transfer or other disposition of all or substantially all of our assets.
Compensation of Directors
The following table sets forth certain information concerning the compensation of our directors, excluding the named executive officers set forth in the Summary Compensation Table above, for the fiscal year ended June 30, 2015:
DIRECTOR COMPENSATION
(1)
Includes $45,000 of cash for paid for strategic services to an entity owned by Mr. Margolies as well as $27,669 cash compensation and insurance premiums.
In connection with the Series E SPA, Mr. Margolies, as an associate of the Placement Agent, received warrants to purchase 10,000,000 shares of the Company’s common stock. The warrants are exercisable at $0.011 and expire on December 15, 2019.
In connection with the 2014 SPA, Mr. Margolies, as an associate of the Placement Agent, received warrants to purchase 1,985,990 shares of the Company’s common stock. The warrants are exercisable at $0.088 and expire on April 1, 2019.
In connection with the 2013 SPA, Mr. Margolies, as an associate of the Placement Agent, received warrants to purchase 695,630 shares of the Company’s common stock. The warrants are exercisable at $0.44 and expire on February 5, 2018.
On November 4, 2013, we issued 39,741 shares of stock to LB Consulting, LLC under the 2012 Stock Incentive Plan in lieu of cash compensation that was due for investor relation services provided to us in October 2013.
Effective February 12, 2014, we entered into a short-term Loan Agreement dated February 10, 2014 with Messrs. Margolies and Miller. Under the terms of the Loan Agreement, Messrs. Margolies and Miller each agreed to loan $125,000 for operating expenses of the Company and PSMI, as well as to fund growth of the Company. The funds were received by us from February 13-18, 2014. The loan is evidenced by a one-year 10% Convertible Promissory Note which bears interest at 10% per annum. The Note is convertible at the lowest per share rate of Common Stock or Common Stock equivalents sold in a Qualified Offering by us. In addition, Messrs. Margolies and Miller each received one common stock purchase warrant for each $2.50 loaned to us. Each five-year warrant is exercisable at $0.40 per share, subject to adjustment in the event of the issuance of additional common shares or Common Stock equivalents at less than the exercise price. The warrants also provide for cashless exercise. The warrants are not transferable or assignable without the prior consent of the Company.
On March 13, 2014, we entered into a Loan Agreement with LB. Under the terms of the Loan Agreement, LB agreed to loan $500,000 for operating expenses of the Company and PSMI, as well as to fund growth of the Company. The funds were received by us on March 13, 2014. The loan is evidenced by a 10% Promissory Note which bears interest at 10% per annum. In addition, LB received four tenths (0.40) of one common stock purchase warrant for each $0.80 loaned to us (totaling 300,000 warrants), and such warrants were issued as directed by LB with LB receiving 50,000 warrants and Mr. Smith receiving 50,000 warrants. Each five-year warrant is exercisable at $0.40 per share, subject to adjustment in the event of the issuance of additional common shares or Common Stock equivalents at less than the exercise price. The warrants also provide for cashless exercise. The warrants are not transferable or assignable without the prior consent of the Company.
On May 25, 2015, Mr. Margolies and two entities affiliated with him, exercised, through cashless exercise, warrants which resulted in an issuance of a total of 10,817,178 shares of our Common Stock.
Directors are permitted to receive fixed fees and other compensation for their services as directors. The Board of Directors has the authority to fix the compensation of directors. The Board has not adopted a compensation policy for directors.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth certain information furnished by current management and others, concerning the ownership of our Common Stock as of October 13, 2015 of (i) each person who is known to us to be the beneficial owner of more than five percent of our Common Stock; (ii) all directors and named executive officers; and (iii) our directors and executive officers as a group:
* Less than 1%
(1) This table is based upon information supplied by officers, directors and principal stockholders in their reports pursuant to Sections 13 of the Securities and Exchange Act of 1934, as amended, and is believed to be accurate. Unless otherwise indicated in the footnotes to this table, we believe that each of the stockholders named in this table has sole voting and investment power with respect to the shares indicated as beneficially owned. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities. Shares of Common Stock subject to options, warrants, or other conversion privileges currently exercisable or convertible, or exercisable or convertible within 60 days of the date of this table, are deemed outstanding for computing the percentage of the person holding such option, warrant, or other convertible instrument but are not deemed outstanding for computing the percentage of any other person. Where more than one person has a beneficial ownership interest in the same shares, the sharing of beneficial ownership of these shares is designated in the footnotes to this table. As of October 13, 2015, we had 42,104,648 common shares outstanding.
(2) Includes 2,362,680 shares issuable upon the exercise of warrants held by Mr. Gadawski.
(3) Includes 695,630 shares issuable upon the exercise of warrants held by Mr. Margolies, 37,050,000 shares issuable upon conversion of the Series A Preferred Stock owned by an entity for which Mr. Margolies is managing member, 45,000,000 shares issuable upon conversion of Series C Preferred Stock owned by an entity for which Mr. Margolies is managing member, 82,500,000 shares issuable upon conversion of Series E Preferred Stock owned by an entity for which Mr. Margolies is managing member, 80,787 shares of Common Stock owned by entities of which Mr. Margolies is managing member, and 10,000 shares held by a trust of which Mr. Margolies is trustee.
(4) Includes 1,000,000 shares held by a trust for the benefit of Mr. Miller and for which he is a trustee and 50,000 shares issuable upon the exercise of warrants held by Mr. Miller.
(5) Includes 83,333 shares issuable upon exercise of options held by Mr. Morelli.
(6) Includes 58,333 shares issuable upon exercise of options held by Ms. Chavez.
(7) Includes 70,000 shares owned by companies controlled by Mr. Smith and for which he has 50% of the voting and investment power. Also includes 1,960,000 shares owned by Cindy Smith, his wife, 521,801 shares held in his brokerage account, and 98,000 shares issuable upon exercise of warrants held by Mr. Smith.
(8) Includes 3,368,791 shares beneficially owned by her husband, Jeffrey R. Smith and included above in his beneficial holdings.
(9) Mr. Margolies as Managing Member has voting control of the shares owned by LB Merchant PSMH-1, LLC. Mr. Margolis shares voting control over these shares which are included in the number of shares beneficially owned by him in this table.
(10) Includes 37,000,000 shares issuable upon conversion of the Series A Preferred Stock and 50,000 shares issuable upon the exercise of warrants held by the entity.
(11) Mr. Margolies as Managing Member has voting control of the shares owned by LB Merchant PSMH-2, LLC. Mr. Margolis shares voting control over these shares which are included in the number of shares beneficially owned by him in this table.
(12) Includes 45,000,000 shares issuable upon conversion of the Series C Preferred Stock.
(13) Mr. Margolies as Managing Member has voting control of the shares owned by LB Merchant PSMH-3, LLC. Mr. Margolis shares voting control over these shares which are included in the number of shares beneficially owned by him in this table.
(14) Includes 82,250,000 shares issuable upon conversion of the Series E Preferred Stock.
Equity Compensation Plan Information
The following table sets forth as of the most recent fiscal year ended June 30, 2015, certain information with respect to compensation plans (including individual compensation arrangements) under which our Common Stock is authorized for issuance:
(1)
Our 2012 Stock Incentive Plan authorizes the granting of up to 6,000,000 common shares, either as stock options or restricted stock grants. As of June 30, 2015, we had granted and issued 1,182,103 common shares and 4,218,333 options under the plan leaving a total of 533,329 available for future issuance.
(2)
Represents warrants granted to officers, employees, stockholders and placement agents as of June 30, 2015 related to Stock Purchase Agreements amounting to 3,582,810 warrants and 20,250,000 options granted under the 2015 Stock Incentive Plan. The plan authorizes the granting of up to 40,000,000 common shares, either as stock options or restricted stock grants. As of June 30, 2015, we had granted and issued 20,250,000 options under the plan leaving a total of 18,750,000 available for future issuance.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Certain Relationships and Related Transactions
We leased office space in a building that is 100% owned by a former employee and director. Effective February 1, 2014, this lease was canceled by mutual agreement of the parties when this employee resigned from all positions with us. Total rent paid for the office lease for the years ended June 30, 2015 and 2014 was $0 and $123,723, respectively.
On February 5, 2013, LB Merchant PSMH-1, LLC purchased 3,700 shares of the Company’s Series A 6% Convertible Preferred Stock at a purchase price of $1,000 per share (the “Series A Preferred Stock”). On April 1, 2014, LB Merchant PSMH-2, LLC purchased 1,800 shares of the Company’s Series C 6% Convertible Preferred Stock at a purchase price of $1,000 per share (the “Series C Preferred Stock”). On December 15, 2014, LB Merchant PSMH-3, LLC purchased 822.5 shares of the Company’s Series E 6% Convertible Preferred Stock at a purchase price of $1,000 per share (the “Series E Preferred Stock”). Michael Margolies, a director of the Company is a principal of LB Merchant PSMH-1, LLC, LB Merchant PSMH-2, LLC and LB Merchant PSMH-3, LLC.
James Miller, a director of the Company is a principal stockholder of CBB, Inc., a management company of American Southwest Mortgage. American Southwest Mortgage provides two revolving warehouse lines of credit to the Company. These are the two main credit facilities used by us to fund loan originations.
Director Independence
Our securities are not listed on a national securities exchange or in an inter-dealer quotation system which has requirements that directors be independent. As a result, we have adopted the independence standards of the American Stock Exchange, now known as the NYSE MKT LLC, to determine the independence of our directors and those directors serving on our committees. These standards provide that a person will be considered an independent director if he or she is not an officer of the Company and is, in the view of the Company’s Board of Directors, free of any relationship that would interfere with the exercise of independent judgment. Our Board of Directors has determined that none of our Board members are deemed independent.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Fees Billed
Accounting & Consulting Group, LLP served as our independent registered public accounting firm for the fiscal years ended June 30, 2015 and 2014. The following fees were billed by our independent registered public accounting firm for services rendered during our last two fiscal years:
Audit Fees
The aggregate fees billed for professional services rendered by our principal accountant for the audit of our annual financial statements, review of financial statements included in the quarterly reports and other fees that are normally provided by the accountant in connection with statutory and regulatory filings or engagements for the fiscal years ended June 30, 2015 and 2015, were $187,999 and $139,529, respectively.
Audit-Related Fees
There were no fees billed for assurance and related services by our principal accountant that are reasonably related to the performance of the audit or review of the financial statements, other than those previously reported above, for the fiscal years ended June 30, 2015 and 2014.
Tax Fees
The aggregate fees billed for professional services rendered by our principal accountant for tax compliance, tax advice and tax planning in the fiscal years ended June 30, 2015 and 2014 were $17,673 and $17,673.
All Other Fees
There were no other fees billed for products or services provided by the principal accountant, other than those previously reported above, for the fiscal years ended June 30, 2015 and 2014.
Audit Committee
Our Audit Committee, has considered whether the non-audit services provided by our auditors to us are compatible with maintaining the independence of our auditors and concluded that the independence of our auditors is not compromised by the provision of such services. Our Audit Committee pre-approves all auditing services and permitted non-audit services, including the fees and terms of those services, to be performed for us by our independent auditor prior to engagement.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
Financial Statements
The following financial statements are filed with this report:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at June 30, 2015 and 2014
Consolidated Statements of Operations and Comprehensive Loss for the years ended June 30, 2015 and 2014
Consolidated Statements of Stockholders’ Equity for the years ended June 30, 2015 and 2014
Consolidated Statements of Cash Flows for the years ended June 30, 2015 and 2014
Notes to Financial Statements
Exhibits
The following exhibits are included with this report:
*Management contract, or compensatory plan or arrangement, required to be filed as an exhibit.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
Name
Title
Date
/s/ Kevin J. Gadawski
Director, CEO, President, & CFO
October 13, 2015
Kevin Gadawski
(Principal Executive, Financial, and Accounting Officer)
/s/ Michael Margolies
Director
October 13, 2015
Michael Margolies
/s/ James C. Miller
Director
October 13, 2015
James C. Miller
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders
of PSM Holdings, Inc. and Subsidiaries
Edmond, Oklahoma
We have audited the accompanying consolidated balance sheets of PSM Holdings, Inc., (a Delaware corporation) and Subsidiaries (the “Company”), as of June 30, 2015 and 2014, and the related consolidated statements of operations and comprehensive income (loss), consolidated statements of cash flows and consolidated statement of stockholders’ equity for each of the years in the two year period ended June 30, 2015. The Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
The accompanying financial statemets have been prepared assuming that the company will continue as a going concern. As discussed in Note 16 to the financial statements, as of June 30, 2015, the Company has been unable to pay dividends to its preferred shareholders, is behind on certain expenses, and is in default under certain covenants of its note payable. On October 1, 2015, the Company was successful in negotiating modifications to the note payable that relaxed the restrictive covenants, the Company is continuing to implement cost reduction strategies and is considering an additional capital raise. The Company's ability to achieve the foregoing elements of its business plan, which may be necessary to permit the realization of assets and satisfaction of liabilities in the ordinary course of business, is uncertain. Those conditions raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our opinion is not modified with respect to that matter.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of PSM Holdings, Inc. and Subsidiaries as of June 30, 2015 and 2014, and the results of its operations and its cash flows for each of the years in the two year period ended June 30, 2015 in conformity with accounting principles generally accepted in the United States of America.
/s/Accounting & Consulting Group, LLP
Certified Public Accountants
Carlsbad, New Mexico
October 13, 2015
PSM HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
The accompanying notes are an integral part of these consolidated financial statements.
PSM HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS AND COMPREHENSIVE LOSS
Weighted average number of shares used to compute basic and diluted loss per share for the year ended June 30, 2015 and 2014 are the same since the effect of dilutive securities is anti-dilutive.
The accompanying notes are an integral part of these consolidated financial statements.
PSM HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
The accompanying notes are an integral part of these consolidated financial statements.
PSM HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
See Note 4 - Statement of Cash Flows Additional Disclosures
The accompanying notes are an integral part of these consolidated financial statements.
PSM HOLDINGS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2015
NOTE 1 - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Company Background
As used herein and except as otherwise noted, the terms “Company” or “PSMH” shall mean PSM Holdings, Inc.
The Company was incorporated under the laws of the State of Utah on March 12, 1987, as Durban Enterprises, Inc. On July 19, 2001, Durban Enterprises, Inc., created a wholly-owned subsidiary called Durban Holdings, Inc., a Nevada corporation, to facilitate changing the domicile of the Company to Nevada. On August 17, 2001, Durban Enterprises, Inc. merged with and into Durban Holdings, Inc., leaving the Nevada corporation as the survivor. The Company retained the originally authorized 100,000,000 shares at $0.001 par value.
On May 18, 2005, Durban Holdings, Inc. completed the acquisition of all of the outstanding stock of Prime Source Mortgage, Inc., a Texas corporation, by a stock for stock exchange in which the stockholders of Prime Source Mortgage, Inc. received 10,250,000 shares, or approximately 92% of the outstanding stock of the Company. Following the acquisition, effective May 18, 2005, the name of the parent “Durban Holdings, Inc.”, was changed to “PSM Holdings, Inc.” For reporting purposes, the acquisition was treated as an acquisition of the Company by Prime Source Mortgage, Inc. (reverse acquisition) and a recapitalization of Prime Source Mortgage, Inc. The historical financial statements prior to May 18, 2005, are those of Prime Source Mortgage, Inc. Goodwill was not recognized from the transaction.
On December 14, 2011, PSM Holdings, Inc., created a wholly-owned subsidiary called PSM Holdings, Inc., a Delaware corporation, to facilitate changing the domicile of the Company to Delaware. On December 29, 2011, PSM Holdings, Inc. merged with and into PSM Holdings, Inc., leaving the Delaware Corporation as the survivor. The Company retained the originally authorized 100,000,000 shares at $0.001 par value.
Business Activity
The Company originates mortgage loans funded either directly off its warehouse lines of credit or through brokering transactions to other third parties. Approximately 95% of the Company’s mortgage origination volume is banked off of its current warehouse lines. The Company has relationships with multiple investors who purchase the loans funded on its warehouse lines. All of our lending activities are conducted by the Company’s subsidiary, Prime Source Mortgage, Inc. (“PSMI”).
Historically, a significant portion of the Company’s business has been referral based and purchase orientated (versus refinance). The Company does not directly participate in the secondary markets and further does not maintain a servicing portfolio. The Company’s loan applications are generated from business contacts, previous client referrals and realtor referrals.
WWYH, Inc., a wholly-owned subsidiary of PSM Holdings, Inc., was incorporated February 15, 1991 under the laws of the State of Texas. Prime Source Mortgage, Inc. became a wholly-owned subsidiary of PSM Holdings, Inc., a Nevada corporation, on May 18, 2005. On March 15, 2011, Prime Source Mortgage Inc. completed the acquisition of United Community Mortgage Corp. (“UCMC”), a New Jersey corporation, and UCMC became a wholly-owned subsidiary of PrimeSource Mortgage, Inc.
On March 16, 2011, the Company completed its acquisition of UCMC and UCMC became a wholly-owned subsidiary of PrimeSource Mortgage, Inc. The Company purchased all the tangible assets, and all of the issued and outstanding shares of UCMC common stock and preferred stock, in exchange for 2,392,858 shares of the Company’s Common Stock valued at $1,675,000. The Company recorded intangible assets amounting to $1,087,432 as a result of this acquisition.
The Company currently operates or is licensed in the following states: Arizona, Arkansas, California, Colorado, Florida, Kansas, Missouri, Montana, New Jersey, New Mexico, North Dakota, Oklahoma, Oregon, Texas, Utah, Washington and Virginia.
Summary of Significant Accounting Policies
The following summary of significant accounting policies of the Company is presented to assist in the understanding of the Company’s financial statements. The financial statements and notes are the representation of the Company’s management who is responsible for their integrity and objectivity. The financial statements of the Company conform to accounting principles generally accepted in the United States of America (GAAP). The Financial Accounting Standards Board (FASB) is the accepted standard-setting body for establishing accounting and financial reporting principles.
Principles of Consolidation
The consolidated financial statements include the accounts of PSM Holdings, Inc., its wholly-owned subsidiary WWYH, Inc., and WWYH's wholly-owned subsidiary Prime Source Mortgage, Inc. All material intercompany transactions have been eliminated in the consolidation.
Use of Estimates
Management uses estimates and assumptions in preparing financial statements. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Accordingly, actual results could differ from those estimates. Significant estimates include the value of intangibles, estimated depreciable lives of property, plant and equipment, estimated valuation of deferred tax assets due to net operating loss carry-forwards and estimates of uncollectible amounts of loans and notes receivable.
Cash and Cash Equivalents
For the purposes of the statement of cash flows, cash and cash equivalents include cash on hand and cash in checking and savings accounts, and all investment instruments with an original maturity of three months or less.
Restricted Cash
The Company has certain cash balances set aside as collateral to secure various bonds required pursuant to the licensing requirements in some of the states we conduct business in.
Accounts Receivable
Accounts receivable represent commissions earned and fees charged on closed loans that the Company has not received. Accounts receivable are stated at the amount management expects to collect from balances outstanding at period-end. The Company estimates the allowance for doubtful accounts based on an analysis of specific accounts.
Employee Advances and Loans Receivable
Employee advances and loans receivable are stated at the unpaid principal balance. Interest income is recognized in the period in which it is earned.
Loans Held For Sale
The Company originates all of its residential real estate loans with the intent to sell them in the secondary market. Loans held for sale consist primarily of residential first and second mortgage loans that are secured by residential real estate throughout the United States.
Although the Company does not intend to be a loan servicer, from time to time it is necessary for certain loans to be serviced for a period of time. Even in these situations the Company intends to service the loan only for the amount of time necessary to get the loan sellable to a third party investor. As of June 30, 2015, the Company had four such loans that required servicing before they could be sold to an investor. All four loans were performing and were carried on the books at their fair value, determined using current secondary market prices for loans with similar coupons, maturities and credit quality. As of June 30, 2015, the Company has not recorded any adjustment to the fair value of the remaining four loans as any accrued gain or loss would not be material to the Company.
As noted above, the fair value of loans held for sale is determined using current secondary market prices for loans with similar coupons, maturities and credit quality. Loans held for sale are pledged as collateral under the Company’s warehouse lines of credit. The Company relies substantially on the secondary mortgage market as all of the loans originated are sold into this market.
Interest on mortgage loans held for sale is recognized as earned and is only accrued if deemed collectible. Interest is generally deemed uncollectible when a loan becomes three months or more delinquent or when a loan has a defect affecting its salability. Delinquency is calculated based on the contractual due date of the loan. Loans are written off when deemed uncollectible.
Prepaid Expenses
Prepaid expenses are advance payments for products or services that will be used in operations during the next 12 or more months. Prepaid expenses consist of prepaid insurance, rents and prepaid investor relations and other third party services provided by outside consultants and amounted to $98,505 and $142,096 at June 30, 2015 and 2014, respectively.
Property and Equipment
Property and equipment are stated at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the assets as follows. Expenditures for maintenance and repairs are charged to expense as incurred.
Goodwill and Indefinite-Lived Intangible Assets
Goodwill and other intangible assets with an indefinite useful life are not subject to amortization but are reviewed for impairment annually or more frequently whenever events or changes in circumstances indicate that the carrying amount of an intangible asset may not be recoverable. The annual evaluation for impairment of goodwill and indefinite-lived intangibles is based on valuation models that incorporate assumptions and internal projections of expected future cash flows and operating plans by using a discounted cash flow ("DCF") analysis. Determining fair value using a DCF analysis requires the exercise of significant judgments, including judgments about appropriate discount rates, perpetual growth rates and the amount and timing of expected future cash flows. If the fair value of a reporting entity exceeds its carrying amount, goodwill of the reporting entity is not impaired and the second step of the impairment test is not required. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is required to be performed to measure the amount of impairment, if any. The second step of the goodwill impairment test compares the implied fair value of the reporting entity’s goodwill with the carrying amount of that goodwill. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. If the carrying amount of the reporting entity’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.
The impairment test for indefinite-lived intangible assets involves a comparison of the estimated fair value of the intangible asset with its carrying value. If the carrying value of the indefinite-lived intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess.
Long-Lived Assets and Intangible Assets with Definite Lives
Long-lived assets, including property and equipment and intangible assets with definite lives, are tested for recoverability whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. The carrying amount of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. If the carrying amount is deemed to not be recoverable, an impairment loss is recorded as the amount by which the carrying amount of the long-lived asset exceeds its fair value. Amortization of definite-lived intangible assets is recorded on a straight-line basis over their estimated lives.
Income Taxes
Income taxes are provided for the tax effects of transactions reported in the financial statements and consist of taxes currently due plus deferred taxes related primarily to differences between the bases of certain assets and liabilities for financial and tax reporting. The deferred taxes represent the future tax return consequences of those differences, which will either be deductible or taxable when the assets and liabilities are recovered or settled. In addition, there is the deferred tax asset which represents the economic value of various tax carryovers.
Taxes Collected and Remitted to Governmental Authorities
When applicable, the Company collects gross receipts taxes from its customers and remits them to the required governmental authorities. Related revenues are reported net of applicable taxes collected and remitted to governmental authorities.
Advertising
Advertising costs are expensed as incurred. Advertising expense was $611,139 and $706,527 for the years ended June 30, 2015 and 2014, respectively.
Share Based Payment Plan
The Company grants stock options and restricted stock units to certain executive officers, key employees, directors and independent contractors. Stock options have been granted for a fixed number of shares, vest equally over a three-year period and are valued using the Black-Scholes option pricing model. Stock grants have been awarded for a fixed number of shares with a value equal to the fair value of the Company’s common stock on the grant date. Stock-based compensation expense is recorded net of estimated forfeitures for the years ended June 30, 2015 and 2014 based on the stock-based awards that were expected to vest during such periods. Under the 2012 and 2015 Stock Incentive Plans, the Company can grant stock or options to employees, related parties, and unrelated contractors in connection with the performance of services provided to the Company by the awardees.
Revenue Recognition
The Company’s revenue is derived primarily from revenue earned from the origination and sale of mortgage loans. Revenues earned from origination of mortgage loans is recognized on the earlier of the settlement date of the underlying transaction or the funding date of the loan. Loans are funded through warehouse lines of credit and are sold to investors, typically within 15 days. The gain or loss on the sale of loans is realized on the date the loans are sold.
Loss Per Common Share
Basic and diluted loss per common share is computed by dividing the loss available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted loss per share does not reflect per share amounts that would have resulted if diluted potential Common Stock had been converted to Common Stock because the effect would be anti-dilutive. The weighted average number of common shares outstanding during the twelve months ended June 30, 2015 and 2014 were 28,827,170 and 29,397,729, respectively. Loss per common share from continuing operations for the twelve months ended June 30, 2015 and 2014 was $0.10 and $0.21, respectively.
Compensated Absences
The Company records an accrual for accrued vacation at each period end. Other compensated absences are expensed as incurred.
Reclassification
Certain accounts in the prior-year financial statements have been reclassified for comparative purposes to conform with the presentation in the current-year financial statements.
Recent Accounting Pronouncements
The Company has evaluated the possible effects on its financial statements of the accounting pronouncements and accounting standards that have been issued or proposed by FASB that do not require adoption until a future date, and that are not expected to have a material impact on the consolidated financial statements upon adoption.
Other accounting standards that have been issued or proposed by 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 2 - ALLOWANCE FOR DOUBTFUL ACCOUNTS
Accounts receivable is presented on the balance sheet net of estimated uncollectible amounts. The Company records an allowance for estimated uncollectible accounts in an amount approximating anticipated losses. Individual uncollectible accounts are written off against the allowance when collection of the individual accounts appears doubtful. The Company did not record an allowance for doubtful accounts for the years ended June 30, 2015 and 2014.
NOTE 3 - PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows:
Depreciation expense for the years ended June 30, 2015 and 2014 was $73,074 and $144,053, respectively.
NOTE 4 - STATEMENT OF CASH FLOWS ADDITIONAL DISCLOSURES
Supplemental information for cash flows at June 30, 2015 and 2014 consist of:
NOTE 5 - RELATED PARTY TRANSACTIONS
President/Chief Executive Officer and Director
Effective April 1, 2015, the Company entered into an Executive Employment Agreement with Mr. Kevin Gadawski to serve as its Chief Financial Officer, Chief Operating Officer, and Chief Executive Officer. In addition, Mr. Gadawski also assumed the roles of President, Chief Executive Officer, and Director of the Company’s wholly owned subsidiary PSMI. The agreement was effective April 1, 2015 and the term of the agreement is three years, ending on March 31, 2018. Under the agreement, Mr. Gadawski’s annual base salary is $250,000. If the agreement is extended, the base salary will be reviewed no less frequently than annually, but at no time during the term of this agreement will Mr. Gadawski’s base salary be decreased. If the Company is reasonably unable to pay the base salary for any pay period, the Company and Mr. Gadawski may agree that the base salary be paid with shares of Common Stock under the Company’s 2015 Stock Incentive Plan at a 25% discount to the fair market price of the stock at the end of the pay period. As a signing bonus for entering into the agreement, the Company agreed to grant to Mr. Gadawski options to purchase up to 10,000,000 shares of Common Stock. Mr. Gadawski will be eligible to participate in any incentive bonus pool maintained for persons including executive officers of the Company. He will be eligible to receive an annual bonus as per the incentive bonus pool of up to 100% of the then applicable base salary, less applicable withholding taxes. In addition, the Company will provide Mr. Gadawski a car allowance in the amount of $750 per month as well as reimburse him for the cost of annual automobile insurance.
For the year ended June 30, 2015, the Company recorded compensation expense of $576,333, of which $319,191 was related to stock options grants that will be amortized over the three year vesting period. In addition, the compensation included $2,250 for a car allowance and approximately $3,889 for health and life insurance premiums. For the year ended June 30, 2014, the Company recorded compensation expense of $213,627, of which $6,624 was paid in stock in lieu of cash and $4,158 in health insurance benefits.
Executive Vice-President and Director
The Company entered into an employment agreement with Mr. Jeff Smith, its Executive Vice-President effective January 1, 2011. Pursuant to the terms of the employment agreement, the Company agreed to pay an annual compensation of $200,000, a monthly car allowance of $700, and a monthly allowance of $1,290 for health benefits for Mr. Smith and his family. On January 1, 2014, the employment agreement was renewed for one year with annual compensation of $250,000. On December 24, 2014, the term of the employment agreement was amended to a month-to-month basis. For the years ended June 30, 2015 and 2014, the Company recorded (i) $131,205 and $205,916 in compensation expense, (ii) $4,900 and $8,400 in car allowance, and (iii) $3,669and $4,158 in life and health insurance benefits. Effective January 31, 2015, Mr. Smith resigned from all positions with the Company and its subsidiaries, and accordingly his employment agreement was not renewed.
On September 12, 2014, the Company entered into a loan agreement with Mr. Smith (the “ Lender”). Under the terms of the loan agreement, the Lender agreed to loan $120,000 for operating expenses of the Company and its operating subsidiary, as well as to fund growth of the Company. The funds were received by the Company on September 12, 2014. The loan is evidenced by a 10% Convertible Promissory Note which bears interest at 10% per annum and matures September 12, 2016, unless extended through mutual consent. The note is convertible at the per share rate of common stock sold pursuant to a Qualified Offering by the Company. The term “Qualified Offering” means one or more offerings (whether or not proceeds are received by the Company pursuant to such offering) of debt or equity securities of the Company to non-affiliates in the aggregate amount of at least $1,000,000 commenced after the note issuance date. The conversion price is determined by the lowest of either the offering price per common share or the conversion or exercise price for common stock in any such Qualified Offering. In addition, the Lender received four tenths (0.40) of one common stock purchase warrant for each $1.00 loaned to the Company (totaling 48,000 warrants). Each five-year warrant is exercisable at $0.40 per share, subject to adjustment in the event of the issuance of additional common shares or common stock equivalents at less than the exercise price. The warrants also provide for cashless exercise. The warrants are not transferable or assignable without the prior consent of the Company.
Former President/Chief Executive Officer and Director
The Company entered into an Employment Agreement with its President/Chief Executive Officer effective January 1, 2011. Pursuant to the terms of the agreement, the Company issued 750,000 shares of Common Stock valued at $525,000 as a signing bonus to induce him to enter into the agreement, agreed to pay an annual compensation of $225,000, a monthly car allowance of $750, and a monthly allowance of $800 for health benefits for the officer and his family. On January 1, 2012, the annual compensation was increased to $250,000 pursuant to the terms of agreement. For the years ended June 30, 2015 and 2014, the Company recorded (i) $0 and $141,444 in compensation expense (ii) $0 and $4,500 in car allowance, and (iii) $0 and $4,158 in life and health insurance benefits. On August 28, 2013, this individual resigned as the President and Chief Executive Officer and Director.
Other Directors
On February 7, 2013, the Company entered into a two-year consulting agreement with an entity controlled by one of the Company’s directors. The agreement calls for monthly compensation of $15,000 per month for strategic advisory and investor relation services. For the years ended June 30, 2015 and 2014, the Company recorded consulting expense of $45,000 and $60,000 respectively. $7,500 of the fees paid during the twelve months ending June 30, 2014 were paid in stock in lieu of cash. This director has at times agreed to suspend providing investor relation and strategic consulting services to the Company to assist in the Company’s cash needs at the time.
One of the Company’s directors is a principal stockholder and director of a management company that provides two revolving warehouse lines of credit to the Company. Amounts outstanding on the credit lines as of June 30, 2015 and June 30, 2014 were $24,836,939 and $14,942,781 which were offset by $25,459,142 and $15,416,781 of funding receivables as of June 30, 2015 and June 30, 2014, respectively (See Note 9). This entity also provided a line of credit to the Company which had an outstanding balance of $135,263 and $0 as of June 30, 2015 and 2014, respectively.
Former Directors
On March 15, 2011, the Company entered into an employment agreement with a director of the Company in connection with the acquisition of United Community Mortgage Corp. The term of the employment agreement was for two years, with automatic one-year extensions unless notice is given by either party. The individual resigned as a director concurrent with the capital raise completed on February 5, 2013. The agreement provided for an annual base salary of $120,000 with increases based upon increases in originations at the respective branch and incentive payments upon securing additional branches for PSMI. In January 2015, the Company amended the agreement reducing the base compensation and adding in incentive compensation for recruiting. The Company recorded total compensation expense of $127,520 and $148,247 for the years ended June 30, 2015 and 2014, respectively.
On July 1, 2011, the Company entered into an employment agreement with a director of the Company, in connection with the acquisition of Brookside Mortgage, LLC (“Brookside”). The term of the employment agreement was for two years, with automatic one-year extensions unless notice is given by either party. The individual resigned as a director concurrent with the capital raise completed on February 5, 2013. The agreement provided for an annual base salary of $120,000 plus a bonus equal to 25% of the net profit earned by Brookside in excess of $400,000 annual profits earned. On November 1, 2012, the Company agreed to revise the employment agreement making the term at will with sixty days notice from either party and provided additional overrides based on production. The revised agreement was never executed. The Company recorded total compensation expense of $0 and $227,731 for the years ended June 30, 2015 and 2014, respectively. Effective January 16, 2014, this individual resigned from all positions with the Company.
On August 8, 2011, the Company entered into an employment agreement with a director of the Company in connection with the acquisition of Fidelity Mortgage Company. The term of the employment agreement was for two years, with automatic one-year extensions unless notice is given by either party. The individual resigned as a director concurrent with the capital raise completed on February 5, 2013. The individual remained a regional vice president of one of the Company’s corporate lending centers. The agreement provided that for each full year of employment, a bonus equal to 12.5 basis points of the loan production and 50% of net profit of the Fidelity branch in excess of $500,000 earned will be paid to the individual. Bonuses were to be earned upon closing of each loan and paid on a fixed interval basis. On January 1, 2013, the Company amended the employment agreement to provide additional bonuses based on production and removed any bonus opportunity based on profitability. The Company recorded total compensation expense of $0 and $470,237 for the years ended June 30, 2015 and 2014, respectively. In January 2014, this individual resigned from all positions with the Company.
The Company leased an office space in a building that is 100% owned by this former director. The terms of the operating lease under a non-cancellable lease agreement were to expire on September 1, 2015, and required a monthly rent of $21,720. Total rent paid for the office lease for the years ended June 30, 2015 and 2014 were $0 and $123,723, respectively. The lease was terminated upon the resignation of this former director in January 2014.
Effective November 1, 2011, the Company entered into an employment agreement with a director of the Company, in connection with our acquisition of Iowa Mortgage Professionals. The individual resigned as a director concurrent with the capital raise completed on February 5, 2013. The term of his employment agreement was for two years, with automatic one-year extensions unless notice is given by either party. The agreement provided for an annual base salary of $120,000 plus a bonus equal to 25% of the net profit earned by the branch in excess of $400,000 annual profits earned. On March 11, 2013, the Company agreed to revise the employment agreement making the term at will with sixty days’ notice from either party and provided additional overrides based on production. The revised agreement was never executed. The Company recorded total compensation expense of $0 and $98,920 in bonus and over-ride commissions for the years ended June 30, 2015 and 2014, respectively. On January 31, 2014, this individual resigned from all positions with the Company.
This individual is the principal of a third party processing company that provided processing services for loans funded in our former Iowa branch. The per file fees charged are believed to be under market pricing. The fees are paid by the borrower at closing and are not paid directly by the Company. Upon this individual’s departure from the Company, the Company ceased utilizing any services from this third party processing company.
Other Employees
Effective January 1, 2013, the Company amended an employment agreement with the Vice President - Mountain Division. Under the new agreement, the term was modified to at will with 60 days notice from either party. The employee is paid an annual salary of $95,000 and receives bonuses based on production. Additionally, the employee was eligible to receive 50% of the net profits of the Fidelity branch on annual net income in excess of $500,000. The Company recorded total compensation expense of $0 and $420,828 for the years ended June 30, 2015 and 2014, respectively. On January 31, 2014, this individual resigned from all positions with the Company.
Loans Receivable
Loans receivable from a related party as of June 30, 2015 and 2014 consists of:
The Company entered into two Commercial Security Agreements dated November 16, 2006 and February 16, 2007 (the “Security Agreements”) with Nationwide securing the loan amount of $167,000 with 150,000 shares of the Company’s own Common Stock held by Nationwide. On June 15, 2012, the Company renegotiated the Security Agreements with Nationwide and agreed to amend (i) the annual interest rate on the Security Agreement to 6%, and (ii) the maturity date to September 30, 2013. On May 13, 2014, the Company extended the maturity date to October 15, 2014. All other terms and conditions of the Security Agreement remained the same. The Company recorded interest income of $5,300 and $5,334 from the loan receivable from Nationwide for each of the years ended June 30, 2015 and 2014. Subsequent to June 30, 2015, the Company executed a note extension and general release agreement with Nationwide which contains a general agreement among the parties that no further commitments are required by either side. It further allows Nationwide to utilize its technology with other companies. Finally, the note extension calls for quarterly principal payments based on how many “installations” of the Nationwide technology exist during the quarter.
Loan Agreements
On March 13, 2014, the Company entered into a Loan Agreement with LB MERCHANT PSMH-1, LLC, an entity controlled by Michael Margolies, a director of the Company. Under the terms of the Loan Agreement, the lender agreed to loan $500,000 for operating expenses of the Company and PSMI, as well as to fund growth of the Company. The funds were received by the Company on March 13, 2014. The loan is evidenced by a 10% Promissory Note which bears interest at 10% per annum. In addition, the lender received four tenths (0.40) of one Common Stock purchase warrant for each $0.80 loaned to the Company (totaling 300,000 warrants), and such warrants were issued as directed by the lender with the lender receiving 50,000 warrants and Jeffrey R. Smith, a director and Executive Vice President of the Company receiving 50,000 warrants. The remaining 200,000 warrants were issued to Citizens State Bank. Each five-year warrant is exercisable at $0.40 per share, subject to adjustment in the event of the issuance of additional common shares or Common Stock equivalents at less than the exercise price. The warrants also provide for cashless exercise. The warrants are not transferable or assignable without the prior consent of the Company.
NOTE 6 - NOTE RECEIVABLE AND EMPLOYEE ADVANCES
On December 31, 2010, PSMI executed a Letter of Repayment with three employees in the amount of $189,654 for funds advanced to them as a loan. These loans are unsecured, non-interest bearing and due on demand. Payments of these loans are made from a portion of commissions earned by these employees. If the employees’ employment is terminated for any reason, the loan outstanding will become due and payable in full or specific arrangements will be made. During the year ended June 30, 2014, these employees were terminated and the remaining outstanding balance of the loans were written-off.
From time to time the Company advances payroll amounts to employees. The advances are short-term in nature. The Company has not reserved anything against these employee advances as of June 30, 2015.
NOTE 7 - INTANGIBLE ASSETS
Intangible assets consist of:
It is the Company’s policy to assess the carrying value of its intangible assets for impairment on an annual basis, or more frequently, if warranted by circumstances. The Company completed an annual impairment test of goodwill as of June 30, 2015 and no impairment losses were incurred. As of that date, the fair value of equity exceeded the carrying value (including goodwill) by 300%, indicating no impairment of goodwill. This test involved the use of estimates related to the fair value of the goodwill, and requires a significant degree of judgment and the use of subjective assumptions. The fair value of the goodwill and other intangible assets was determined using a discounted cash flow method. This method required management to make estimates related to future revenue, expenses and income tax rates.
The valuation methodology assumes the Company will generate an operating profit beginning in the next fiscal year ending June 30, 2016. Although the Company has made significant improvements in the last two quarters in maximizing revenue per funded loan and in reducing fixed and variable expenses, the Company has never generated an annual operating profit.
Any of the following events or changes in circumstances could reasonably be expected to negatively affect our key assumptions:
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Significant change in mortgage interest rates;
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Loss of the Company’s primary warehouse lender;
●
Additional or new regulatory and compliance requirements that restrict our plan for growth;
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The loss of key production personnel; or
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Any default on our obligation to preferred shareholders or secured note holders.
The amount allocated for the purchase of the Customer List as a result of previous acquisitions amounted to $495,023. The Company amortizes Customer Lists over a period of three to eight years. Amortization expense recorded for the years ended June 30, 2015 and 2014 were $46,138 and $86,325. During the year, the Company ended its relationship with certain offices and as such wrote off $224,328 of unamortized balances related to Customer Lists. These amounts are shown as a loss on sale of assets in the accompanying financial statements. The balance in Customer Lists was fully amortized as of June 30, 2015.
On April 14, 2006, the Company entered into a five-year renewable license agreement with Nationwide. The license agreement permits exclusive use of their technology to generate leads for the origination of mortgage applications for submission to PSMI. The initial cost of the license was $150,000 paid in cash, and issuance of 150,000 shares of the Company’s stock in favor of Nationwide and its principals, at a fair value for consideration received of $674,999 on the date of issue. The total consideration for the cost of the license amounted to $824,999. The principals of Nationwide, who were also loan originators for the Company, have transitioned off of the Company’s lending platform. As such, the Company wrote off the remaining unamortized balance of this license as of June 30, 2015.
NOTE 8 - NOTES PAYABLE
On February 18, 2015, the Company executed a Loan Agreement, Security Agreement, and Promissory Note (collectively the “Loan”) with an unrelated third party lender. The Loan requires monthly interest only payments at fourteen percent annually (14%) beginning March 1, 2015. The principle balance will become due on February 1, 2016. The amount of the Loan is $750,000 and can be increased to $1,000,000 at the sole discretion of the lender. The Loan is secured by all the Company’s tangible and intangible assets. The Company incurred legal fees and other loan costs of $50,000 in the aggregate which were deducted from proceeds received by the Company. The Loan restricts the amount of the proceeds that can be used to settle payables already incurred. Please also see Note 18 “Subsequent Events”.
NOTE 9 - WAREHOUSE LINES OF CREDIT
The Company has two warehouse lines of credit available as of June 30, 2015 for its funding of mortgage loans for a short term period.
(i)
On August 3, 2008, the Company entered into a warehouse line of credit agreement with a related party mortgage banker for up to $1,000,000 bearing an annual interest rate of 5%. On October 13, 2013, the warehouse line of credit was increased to $75,000,000 for the purpose of funding residential mortgage loans. The warehouse line of credit matures on October 10, 2016. The outstanding balance on this line of credit as of June 30, 2015 was $1,409,373;
(ii)
On November 18, 2011, the Company entered into a “Repo” warehouse line of credit agreement with a related party mortgage banker for up to $5,000,000 bearing an annual interest rate of 5% for funding residential mortgage loans. Pursuant to the terms of the agreement, the Company could be required to repurchase the loan subject to certain terms and conditions. On October 10, 2013, the warehouse line of credit was increased to $75,000,000 and now matures on October 10, 2016. The outstanding balance on this line of credit as of June 30, 2015 was $23,427,566.
The warehouse lines of credit provide short term funding for mortgage loans originated by the Company’s branch offices. The warehouse lines of credit are repaid when the loans are sold to third party investors, typically within 15 days for most loans. The loans outstanding at year end have been on the line an average of 15 days. Subsequent to June 30, 2015, approximately 93% of the loans outstanding on the credit lines have been purchased by the secondary lenders.
The Company does not intend to hold and service the loans. The warehouse lines are used strictly to fund mortgage loans and not to provide operating funds for the Company. The Company had $25,459,142 in loans held for sale against the warehouse lines of credit as of June 30, 2015.
NOTE 10 - ACCRUED LIABILITIES
Accrued liabilities consist of:
NOTE 11 - STOCKHOLDERS’ EQUITY AND ISSUANCES
The Company’s capitalization at June 30, 2015 was 400,000,000 authorized common shares and 10,000,000 authorized preferred shares, both with a par value of $0.001 per share.
Preferred Stock Issuance
On February 4, 2013, the Company entered into a Stock Purchase Agreement (the “2013 SPA”) with LB Merchant PSMH-1, LLC (an entity managed by Michael Margolies, a director and principal shareholder of the Company) and Riverview Group LLC, providing for the issuance and sale of $3,700,000 of the Company’s Series A 6% Convertible Preferred Stock (3,700 shares) at a purchase price of $1,000 per share (the “Series A Preferred Stock”) and issuance and sale of $2,000,000 of the Company’s Series B 6% Convertible Preferred Stock (2,000 shares) at $1,000 per share (the “Series B Preferred Stock”). Each share of Series A Preferred Stock and, subject to certain limitations, each share of Series B Preferred Stock is convertible into a number of shares of Common Stock of the Company equal to the quotient of (i) $1,000 (subject to adjustment for stock splits, stock dividends, recapitalizations, and the like) plus the amount of accrued but unpaid dividends, divided by (ii) the conversion price then in effect. The initial conversion price is $0.40, subject to adjustment for stock splits, and certain stock issuances outside the 2012 Stock Incentive Plan which are at a price lower than the initial conversion price. If all of the shares of Series A Preferred Stock and Series B Preferred Stock were converted at the initial conversion price, the Company would have been obligated to issue 14,250,000 shares of Common Stock to the holders of the Preferred shares. The holders of Series A Preferred Stock and Series B Preferred Stock are entitled to certain voting rights designated in the certificates of designations for the two series. Holders of the shares of Series A Preferred Stock and Series B Preferred Stock are entitled to receive cumulative cash dividends at the rate per share (as a percentage of the stated value per share) of 6% per annum, payable quarterly in arrears on April 15, July 15, October 15 and January 15, beginning on April 15, 2013. The closing of the 2013 SPA occurred on February 5, 2013.
Littlebanc Advisors, LLC, an associate of Wilmington Capital Securities, LLC, (the “Placement Agent”) acted as exclusive placement agent for the offering. In accordance with the placement agent agreement for the offering, warrants to purchase 1,140,000 shares of the Company’s Common Stock were issued to the Placement Agent and its associates as placement fees in the above transaction. The warrants are exercisable at $0.44 and expire on February 5, 2018. The fair value of warrants was determined to be $398,497 calculated using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.88%, volatility of 130.21%, a 5 year term and dividend yield of 0%. In addition to the warrants, the Company paid $456,000 to the Placement Agent for placement agent fees and incurred $71,965 in legal and other transaction fees.
Pursuant to the 2013 SPA, the Company granted the purchasers demand and piggyback registration rights for the common shares issuable upon conversion of the preferred shares. Any demand for registration must be made by holders owning 50% or more of the Series A registerable securities or the Series B registerable securities, as provided in the 2013 SPA.
On April 1, 2014, the Company entered into a Stock Purchase Agreement (the “2014 SPA”) providing for the issuance and sale of $1,800,000 of the Company’s Series C 6% Convertible Preferred Stock (1,800 shares) at a purchase price of $1,000 per share (the “Series C Preferred Stock”) and $1,400,000 of the Company’s Series D 6% Convertible Preferred Stock (1,400 shares) at $1,000 per share (the “Series D Preferred Stock”). The closing of the 2014 SPA occurred on April 1, 2014, with the 1,800 shares of Series C Preferred Stock being sold to LB Merchant PSMH-2, LLC, an entity managed by Michael Margolies, a director and principal shareholder of the Company, and the 1,400 shares of Series D Preferred Stock being sold to two institutional investors and an individual affiliated with one of the institutional investors. Each share of Series C Preferred Stock and, subject to certain limitations, each share of Series D Preferred Stock is convertible into a number of shares of Common Stock of the Company equal to the quotient of (i) $1,000 (subject to adjustment for stock splits, stock dividends, recapitalizations, and the like) plus the amount of accrued but unpaid dividends, divided by (ii) the conversion price then in effect. The initial conversion price is $0.08, subject to adjustment. If all of the shares of Series C Preferred Stock and Series D Preferred Stock were converted at the present conversion price, the Company would be obligated to issue 40,000,000 shares of Common Stock to the holders of the Series C Preferred Stock and Series D Preferred Stock subject to certain limitations with respect to the Series D Preferred Stock. The holders of Series C Preferred Stock and Series D Preferred Stock are entitled to certain voting rights designated in the certificates of designations for the two series. Holders of the shares of Series C Preferred Stock and Series D Preferred Stock are entitled to receive cumulative cash dividends at the rate per share (as a percentage of the stated value per share) of 6% per annum, payable quarterly in arrears on April 15, July 15, October 15 and January 15, beginning on July 15, 2014.
Pursuant to the provisions of the Certificates of Designation for the Series A Preferred Stock and Series B Preferred Stock regarding adjustments in conversion price, because the Company issued and sold additional shares at a price below the initial conversion price of the Series A Preferred Stock and Series B Preferred Stock, the conversion price was adjusted to $0.24 per share. After this adjustment to the conversion price of the Series A Preferred Stock and Series B Preferred Stock, the Series A Preferred Stock and Series B Preferred Stock would convert into a total of 24,782,609 shares of Common Stock (adjusted from 14,250,000).
On November 26, 2014, the Company entered into a Stock Purchase Agreement dated effective November 24, 2014 (the “Series E SPA”) providing for the issuance and sale of up to $1,250,000 of the Company’s Series E 6% Convertible Preferred Stock (1,250 shares) at a purchase price of $1,000 per share (the “Series E Preferred Stock”). The first closing of the Series E SPA occurred on November 26, 2014, with 612.5 shares of Series E Preferred Stock being sold to LB Merchant PSMH-3, LLC, an entity controlled by Michael Margolies, a director and principal shareholder of the Company. Each share of Series E Preferred Stock is convertible into a number of shares of common stock of the Company equal to the quotient of (i) $1,000 (subject to adjustment for stock splits, stock dividends, recapitalizations, and the like) plus the amount of accrued but unpaid dividends, divided by (ii) the conversion price then in effect. The initial conversion price is $0.01, subject to adjustment. The holders of Series E Preferred Stock are entitled to certain voting rights designated in the certificate of designation for the series. Holders of the shares of Series E Preferred Stock are entitled to receive cumulative cash dividends at the rate per share (as a percentage of the stated value per share) of 6% per annum from the date of issuance, payable quarterly in arrears on April 15, July 15, October 15 and January 15, beginning on January 15, 2015.
On December 15, 2014, the second closing of the Series E SPA occurred with 210 shares of Series E Preferred Stock being sold to the purchaser. In total, the Company sold to the purchaser 822.5 shares of Series E Preferred Stock convertible into 82,250,000 common shares. The holders of Series E Preferred Stock are entitled to certain voting rights designated in the certificate of designation for the series.
Holders of the Series E Preferred Stock will have demand and piggyback registration rights for the common stock issuable upon conversion of the Series E Preferred Stock. The registration rights are pari passu with the registration rights of the Company’s Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, and Series D Preferred Stock.
In connection with the first closing of the Series E SPA, the Company amended the 2013 SPA entered into in connection with the sale of the Series A Preferred Stock and Series B Preferred Stock and also amended the 2014 SPA, entered into in connection with the sale of the Series C Preferred Stock and Series D Preferred Stock. The amendments permitted the issuance of the Series E Preferred Stock senior to dividend and liquidation rights of the Series A Preferred Stock, Series B Preferred Stock, Series C Preferred Stock, and Series D Preferred Stock.
Pursuant to the provisions of the Certificates of Designation for the Series A Preferred Stock and Series B Preferred Stock regarding adjustments in conversion price, because the Company issued and sold additional shares at a price less than the current $0.24 conversion price of the Series A Preferred Stock and Series B Preferred Stock, the conversion price was adjusted to $0.10 per share. After this adjustment to the conversion price of the Series A Preferred Stock and Series B Preferred Stock, the Series A Preferred Stock and Series B Preferred Stock would convert into a total of 57,000,000 shares of Common Stock (adjusted from 24,782,609).
Pursuant to the provisions of the Certificates of Designation for the Series C Preferred Stock and Series D Preferred Stock regarding adjustments in conversion price, because the Company issued and sold additional shares at a price less than the current $0.08 conversion price of the Series C Preferred Stock and Series D Preferred Stock, the conversion price was adjusted to $0.04 per share. After this adjustment to the conversion price of the Series C Preferred Stock and Series D Preferred Stock, the Series C Preferred Stock and Series D Preferred Stock would convert into a total of 80,000,000 shares of Common Stock (adjusted from 40,000,000).
Following is the status of the share based payment plans during the year ended June 30, 2015 and 2014:
2012 and 2015 Stock Option Plans
On December 12, 2011, the stockholders of the Company authorized and approved the 2012 Stock Incentive Plan (the “2012 Plan”) to issue up to 6,000,000 shares of Common Stock of the Company of $0.001 par value per share. The 2012 Plan became effective January 1, 2012. No awards shall be granted under the 2012 Plan after the expiration of 10 years from the effective date, but awards previously granted may extend beyond that date.
On March 26, 2015, the Board of Directors of the Company approved the 2015 Stock Incentive Plan (the “2015 Plan”). Awards may be made under the Plan for up to 40,000,000 shares of Common Stock of the Company at $0.001 par value per share. All of the Company’s employees, officers and directors, as well as consultants and advisors to the Company are eligible to be granted awards under the 2015 Plan. No awards can be granted under the 2015 Plan after the expiration of 10 years from the Effective Date, but awards previously granted may extend beyond that date. Awards may consist of both incentive and non-statutory options, restricted stock units, stock appreciation rights, and restricted stock awards.
During the year ended June 30, 2015, the Company granted 2,125,000 Common Stock options valued at $66,764 to employees as a bonus under the 2012 Plan and granted 20,150,000 Common Stock options valued at $2,011,429 under the 2015 Plan. Also during the year 816,667 options were forfeited by former employees. The value of the options is amortized over the thirty-six month vesting period.
On June 1, 2015, the Board of Directors granted four-year options to various employees to purchase an aggregate of 9,150,000 shares of common stock at $0.206 per share vesting over a three-year period. The options were granted under the Company’s 2015 Stock Incentive Plan. The fair value of options was determined to be $1,680,610 calculated using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.33%, volatility of 159.59%, a four-year term and dividend yield of 0%.
Pursuant to the employment agreement executed with Mr. Gadawski effective April 1, 2015, the Company issued Mr. Gadawski 10,000,000 stock options. The options were granted under the 2015 Plan. The options vest equally over three years and were valued at $284,804 using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.97%, volatility of 124.54%, a three-year term and dividend yield of 0%.
Pursuant to the Consulting Agreement executed, effective April 7, 2015, the Company issued a consultant 1,000,000 stock options. The options were granted under the 2015 Plan. The options vest equally over three years and were valued at $46,015 using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.97%, volatility of 143.68%, a three-year term and dividend yield of 0%.
On February 12, 2015, the Board of Directors granted four-year options to various employees to purchase an aggregate of 1,900,000 shares of common stock at $0.035 per share vesting over a three-year period. The options were granted under the Company’s 2012 Stock Incentive Plan. The fair value of options was determined to be $59,396 calculated using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.33%, volatility of 175.11%, a four-year term and dividend yield of 0%. Employees who were granted 100,000 of these options left the Company before executing the grant forms and for purposes of our summary of option table below only 1,800,000 of these options are reflected as awarded. The 100,000 option grants forfeited were valued at $3,126.
On February 5, 2015, the Board of Directors granted four-year options to ten employees to purchase an aggregate of 325,000 shares of common stock at $0.03 per share vesting over a three-year period. The options were granted under the Company’s 2012 Stock Incentive Plan. The fair value of options was determined to be $7,368 calculated using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.33%, volatility of 171.85%, a four-year term and dividend yield of 0%. The Company has ended its relationship with both offices represented by these 10 employees and all option issuances have been forfeited and are not shown in the totals outstanding as of June 30, 2015 or listed as awarded in the summary option table below.
On February 20, 2014, the Company issued 250,000 incentive options to an employee. The options were granted under the 2012 Plan. The options vest equally over three years and were valued at $20,733 using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.33%, volatility of 117.12%, a three-year term and dividend yield of 0%. In February 2015, the Company eliminated this individual’s position and all previously issued options were forfeited.
On November 4, 2013, the Company issued 26,494 shares of stock to an employee and 39,741 shares of stock to a consultant (both of who are directors) under the 2012 Plan in lieu of salary and cash compensation that were due these individuals for services provided the Company in October 2013.
On November 4, 2013, the Company granted 225,000 options as a signing bonus to three individuals. The options were granted under the 2012 Plan. The options vest equally over three years and were valued at $37,203 using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.33%, volatility of 110.11%, a three-year term and dividend yield of 0%.
On November 4, 2013, the Company granted 125,000 incentive options to an employee. The options were granted under the 2012 Plan. The options vest equally over three years and were valued at $20,668 using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.33%, volatility of 110.11%, a three-year term and dividend yield of 0%.
On September 5, 2013 the Company granted 325,000 options to various employees as a signing bonus. The options vest equally over three years and were valued at $78,663 using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.33%, volatility of 97.8%, a three-year term and dividend yield of 0%. In April of 2014, all but one of the employees left the Company forfeiting 300,000 of the previously issued options.
On July 8, 2013, the Company granted 250,000 options to an employee of the Company. The options vest equally over three years and were valued at $47,061 using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.33%, volatility of 91.6%, a three-year term and dividend yield of 0%. In June 2014 this individual resigned from the Company and all previously issued options were forfeited.
On July 1, 2013, the Company granted 125,000 options to an employee of the Company. The options vest equally over three years and were valued at $21,664 using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.33%, volatility of 92.2%, a three-year term and dividend yield of 0%.
As of June 30, 2015, the Company has granted 5,466,671 shares of Common Stock or Common Stock Options valued at $891,708 to employees and a consultant under the 2012 Plan and 533,329 common shares remained unissued and available for future issuances under the 2012 Plan. Under the 2015 Plan, the Company has granted 20,150,000 shares valued at $2,011,429 and 19,850,000 remained unissued and available for future issuance under the 2015 Plan.
A summary of stock option activity for the last two years is as follows:
The Company did not issue stock grants during the year ended June 30, 2015. During the year ended June 30, 2014 the Company issued 26,494 shares to an employee and 39,741 to a consultant in lieu of cash compensation due. The shares were valued at $16,559.
Repurchase of Stock
On July 3, 2014, the Company closed the Asset Purchase Agreement by, between, and among the Company, and two former employees, directors and related parties, whereby certain assets valued at $227,752 were sold in exchange for 1,500,000 shares of our Common Stock.
On July 14, 2014, the Company closed the Asset Purchase Agreement by, between, and among the Company, and a former employee, director and related party, whereby certain assets valued at $44,271 were sold in exchange for 250,000 shares of our Common Stock.
Total common shares issued and outstanding at June 30, 2015 were 40,354,648.
Warrant Issuances
Pursuant to the Preferred Series E Stock transaction in November and December 2014, and in accordance with the placement agent agreement, the Company issued warrants to purchase 13,160,000 shares of the Company’s Common Stock to the placement agent and its associates as placement fees in the above transaction. The warrants are exercisable at $0.011 and expire on November 26, 2019. The fair value of warrants was determined to be $124,698 calculated using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.88%, volatility of 174.98%, a five-year term and dividend yield of 0%. Since the warrants were issued in conjunction with the capital raise, no expense was recorded in the accompanying financial statements as of June 30, 2015.
On September 12, 2014, the Company entered into a loan agreement with Jeffrey R. Smith, a director of the Company. Under the terms of the loan agreement, the lender agreed to loan $120,000 for operating expenses of the Company and PSMI, as well as to fund growth of the Company. The funds were received by the Company on September 12, 2014. The loan is evidenced by a 10% Convertible Promissory Note which bears interest at 10% per annum and matures September 12, 2015, unless extended through mutual consent. The note is convertible at the per share rate of Common Stock sold pursuant to a Qualified Offering by the Company. The term “Qualified Offering” means one or more offerings (whether or not proceeds are received by the Company pursuant to such offering) of debt or equity securities of the Company to non-affiliates in the aggregate amount of at least $1,000,000 commenced after the note issuance date. The conversion price is determined by the lowest of either the offering price per common share or the conversion or exercise price for Common Stock in any such Qualified Offering. In addition, the lender received four tenths (0.40) of one Common Stock purchase warrant for each $1.00 loaned to the Company (totaling 48,000 warrants). Each five-year warrant is exercisable at $0.40 per share, subject to adjustment in the event of the issuance of additional common shares or Common Stock equivalents at less than the exercise price. The warrants also provide for cashless exercise. The warrants are not transferable or assignable without the prior consent of the Company.
The 76,000 Common Stock purchase warrants issued in September and November 2014 contained provisions requiring adjustment to the exercise price in the event the Company were to issue or sell additional shares of Common Stock pursuant to convertible securities or Common Stock equivalents at a price per share less than the exercise price of these warrants. Given the exercise price of the Series E Preferred Stock of $0.01 (less than the exercise price of the Common Stock Warrants of $0.40), the adjusted exercise price of these warrants became $0.125 at the first closing of the Series E SPA.
Pursuant to the Preferred Series C and D Stock transaction on April 1, 2014, and in accordance with the placement agent agreement, the Company issued warrants to purchase 3,200,000 shares of the Company’s Common Stock to the Placement Agent and its associates as placement fees in the above transaction. The warrants are exercisable at $0.088 and expire on April 1, 2019. The fair value of warrants was determined to be $250,909 calculated using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.88%, volatility of 142.99%, five-year term and dividend yield of 0%. Since the warrants were issued in conjunction with the capital raise, no expense was recorded in the accompanying financial statements as of June 30, 2015.
Pursuant to the loan agreement dated March 13, 2014, the Company issued 300,000 warrants to designees directed by the lender. The warrants are five-year warrants and have a strike price of $0.24.
Pursuant to the loan agreement dated February 10, 2014, the Company issued 154,000 warrants to the lenders as a group. The warrants are five-year warrants and have a strike price of $0.24. The 454,000 Common Stock purchase warrants issued in February and March 2014, as amended, contained provisions requiring adjustment to the exercise price in the event the Company were to issue or sell additional shares of Common Stock pursuant to convertible securities or Common Stock equivalents at a price per share less than the exercise price of these warrants. Given the exercise price of the Series E Preferred Stock of $0.01 (less than the exercise price of the Common Stock Warrants of $0.24), the adjusted exercise price of these warrants became $0.10 at the first closing of the Series E SPA.
Warrant Conversion
On May 25, 2015, the placement agent from the Series A, B, C, D and E Stock Purchase Agreements, and some of its affiliates, including Mr. Michael Margolies, a director of the Company, exercised 14,447,130 warrants on a cashless basis which converted into 12,846,889 shares of our Common Stock. 1,600,241 warrants were canceled upon the cashless exercise. The exercise price of the warrants ranged from $0.011 to $0.10. 14,319,130 of the warrants exercised were issued pursuant to the Stock Purchase Agreements executed in February 2013, April 2014 and December 2014. 128,000 of the warrants exercised were issued to Mr. Margolies, or entities he controls for short term loans to the Company in February, March and December 2014.
The Company has a total of 3,582,810 warrants outstanding as of June 30, 2015 at an exercise price ranging between $0.088 and $0.44. The warrants have expiration dates ranging from February 5, 2018 through December 15, 2019.
NOTE 12 - INCOME TAXES
Income tax expense (benefit) for the years ended June 30, 2015 and 2014 is summarized as follows:
The following is a reconciliation of the provision for income taxes at the U.S. federal income tax rate to the income taxes reflected in the Consolidated Statement of Operations at June 30, 2015 and 2014:
The tax effects of temporary differences that gave rise to significant portions of deferred tax assets and liabilities at June 30, 2015 are as follows:
Deferred income taxes are provided for the tax effects of transactions reported in the financial statements and consist of deferred taxes related primarily to differences between the bases of certain assets and liabilities for financial and tax reporting. The deferred taxes represent the future tax return consequences of those differences, which will either be deductible or taxable when the assets and liabilities are recovered or settled.
The Company’s provision for income taxes differs from applying the statutory U.S. federal income tax rate to income before income taxes. The primary differences result from providing for state income taxes and from deducting certain expenses for financial statement purposes but not for federal income tax purposes.
At June 30, 2015, the Company has accumulated deficit carry forwards of approximately $19,118,000 for U.S. federal income tax purposes available to offset future taxable income expiring on various dates through 2035. The net change in the valuation allowance during the years ended June 30, 2015 and 2014 was an increase of $873,000 and $2,280,000, respectively.
In the normal course of business, the Company’s tax returns are subject to examination by various taxing authorities. Such examinations may result in future tax and interest assessment by these taxing authorities. Accordingly, the Company believes that it is more likely than not that it will realize the benefits of tax positions it has taken in its tax returns or for the amount of any tax benefit that exceeds the cumulative probability threshold in accordance with FASB ASC 740-10-15. Differences between the estimated and actual amounts determined upon ultimate resolution, individually or in the aggregate, are not expected to have a material adverse effect on the Company’s financial position.
The Company is not under examination for any open tax years.
NOTE 13 - COMMITMENTS
Assets pledged as security
On February 17, 2015, PSM Holdings, Inc., the Company, executed a note in the amount of $1,000,000 and a related security agreement with Quintium Private Opportunities Fund, LP. Only $750,000 of the note has been disbursed and is outstanding. The original loan documents contained a pledge of all the assets of PSM Holdings, Inc.’s wholly owned subsidiaries, including Prime Source Mortgage, Inc. As the Prime Source Mortgage assets were pledged, it caused the Prime Source to fail its net worth requirements with HUD as of June 30, 2015. Please also see subsequent events under Note 18.
Nationwide By Owners License
The agreement between Nationwide and the Company calls for the establishment of a National Processing Center for the collection, origination and tracking of the sales lead database. Upon completion of a National Processing Center, the Company has also committed to provide year-end bonuses under the license agreement which the parties can elect to take in cash, stock, or any combination of the two. Bonus cash will be calculated by multiplying the annual net profit of the National Processing Center by the following percentage rates: 15% for the initial five year term of the license agreement, 20% for the first automatic renewal term, 25% for the second automatic renewal term, and 30% for the third automatic renewal term and all subsequent annual renewal terms. Should the parties elect to take all or part of the bonus in Common Stock, the number of shares awarded will be calculated according to the base value of the shares as defined in the agreement. No accrual has been recorded for the year-end bonuses because the National Processing Center has not been established. As agreed to by Nationwide and the Company, the National Processing Center has been delayed indefinitely while Nationwide rolls out its new product offering and strategy discussed below.
During the current year, the Company was informed that the principals of Nationwide, who also managed a loan origination office for the Company, were resigning from employment with the Company. As such, during the period, we recorded a charge for the full unamortized balance of the license agreement in the amount of $296,941.
Lease Commitments
The Company leases approximately 2,181 square feet of office space in Edmond, Oklahoma, which is used for the principal executive offices and as the operating location of PSMI. The one year lease was executed May 7, 2015, and the monthly lease payments are $3,464.
The Company leases office space for its branches and property and equipment under cancellable and non-cancellable lease commitments. The monthly rent for office premises and property and equipment is $86,717. The leases expire between July 2015 and December 2018. Total rent expense recorded for the years ended June 30, 2015 and 2014 was $773,031 and $900,340, respectively.
Total minimum lease commitments for branch offices and property and equipment leases at June 30, 2015 are as follows:
NOTE 14 - LOSS PER COMMON SHARE
Basic and diluted loss per common share is computed by dividing the loss available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted loss per share does not reflect per share amounts that would have resulted if diluted potential Common Stock has been converted to Common Stock because the effect would be anti-dilutive. The weighted average number of common shares outstanding during the years ended June 30, 2015 and 2014 was 28,928,540 and 29,437,446, respectively. Loss per common share from continuing operations for the years ended June 30, 2015 and 2014 was $0.11 and $0.21, respectively.
NOTE 15 - FAIR VALUE MEASUREMENTS
The Company uses a hierarchy that prioritizes the inputs used in measuring fair value such that the highest priority is given to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy are described below:
Level 1
Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets that the Company has the ability to access.
Level 2
Inputs to the valuation methodology include:
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Quoted prices for similar assets or liabilities in active markets;
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Quoted prices for identical or similar assets or liabilities in inactive markets;
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Inputs other than quoted prices that are observable for the asset or liability;
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Inputs that are derived principally from or corroborated by observable market data by correlation or other means.
If the asset or liability has a specified (contractual) term, the Level 2 input must be observable for substantially the full term of the asset or liability.
Level 3
Inputs to the valuation methodology are unobservable and significant to the fair value measurement.
The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used maximize the use of observable inputs and minimize the use of unobservable inputs. See Note 1 for discussion of valuation methodologies used to measure fair value of investments.
The valuation methodologies described above may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.
The fair value of all the assets and liabilities, other than warehouse lines of credit, loans held for sale and marketable securities which were all level 1 inputs, and intangible assets which were level three inputs, were determined using Level 2 inputs The carrying amounts and fair values of the Company’s financial instruments at June 30, 2015 and 2014 are as follows:
NOTE 16 - INDUSTRY AND COMPANY RISKS - GOING CONCERN
The Company is not current in paying all the costs and expenses of the parent company. It is unlikely that the Company will be able to cure the default and pay current the dividends due the Series A, B, C, D and E preferred shareholders. Further, the Company may be unable to pay the principal balance of the Quintium note when due on February 1, 2016 and there is no assurance that the lender will be willing to extend the maturity un acceptable terms if at all. These factors give rise to uncertainty about the Company’s continuing as a going concern.
In addition, the Company is dependent on either the operations of its wholly owned subsidiary PSMI to generate the cash needed to meet the expenses of the Company or in raising capital. Although PSMI has began to show consecutive months of profitability, the Company’s board has indicated their intention of not burdening PSMI with the obligations of the Company. Unless PSMI’s growth accelerates beyond current levels contemplated by the board or the Company raises additional capital, the Company may not be able to meet its obligations.
Management is continuing to implement cost reduction strategies, which may include ending its status as a fully reporting company. Management is also considering an additional capital raise which, if successful, would be highly dilutive to the holdings of the current common shareholders.
There is no certainty that the Company will be successful in these initiatives in a timely enough manner to curtail the continuing consolidated losses, meet short term debt obligations, and continue as a fully reporting company.
NOTE 17 - CONCENTRATIONS
Concentration of Customer
The Company entered into two warehouse lines of credit agreements with a mortgage banker whose former Executive Vice President and current Board member is also a member of the Board of Directors of PSMH. Each agreement is for up to $75,000,000, and bears annual interest rates of 5%, for funding residential mortgage loans. Per the terms of the agreements, the Company could be required to repurchase the loans subject to certain terms and conditions. The outstanding balance on these two warehouse lines of credit as of June 30, 2015 and 2014 was $24,836,939 and $14,942,781, respectively.
The Company recorded revenues of $234,012 and $10,526,199 for the years ended June 30, 2015 and 2014, respectively, from one customer whose former Executive Vice President is a member of the Board of Directors of PSMH. This represented approximately 1% and 83% of the total revenues earned for the years ended June 30, 2015 and June 30, 2014, respectively.
Concentration of Credit Risk
The Company maintains its cash in bank and financial institution deposits that at times may exceed federally insured limits. The Company has not experienced any losses in such accounts through June 30, 2015. As of June 30, 2015, the Company’s bank balances in some instances exceed FDIC insured amounts.
NOTE 18 - SUBSEQUENT EVENTS
Subsequent events have been evaluated through the date these financial statements were issued. Employment agreements in the ordinary course of business, other than those for Executive Officers or individuals considered related parties are not included in this disclosure.
Annual Recertification with HUD
Prime Source Mortgage, Inc. has not completed its annual recertification with HUD. The recertification was due on or before September 30, 2015. On October 1, 2015, Prime Source Mortgage, Inc. filed a notice of material event with HUD detailing that it had not meet the HUD minimum net worth requirement due to the pledge of assets relating to the loan with Quintium Opportunities Fund, LP. Prime Source Mortgage is awaiting instruction from HUD whether to continue the recertification process or follow other steps as detailed by HUD.
Modification of loan and security agreement
On October 1, 2015, we executed modifications to the loan agreement and related documents with Quintium Opportunities Fund, LP. The modified documents exclude from the loan collateral any acceptable assets of Prime Source Mortgage, Inc. that are required to satisfy the minimum net worth Prime Source Mortgage is required to maintain to be compliant with HUD guidelines.
NWBO note extension and termination of exclusive license agreement
On September 8, 2015, we executed a note extension (effective April 15, 2015) with NWBO in which the maturity date was extended until September 30, 2016 and NWBO agreed to fixed payments of principal reduction based on the number of installations of the NWBO technology. In addition, we executed a termination agreement in which NWBO and the Company mutually released one another from any obligations under the original license agreement.
Note extension with related party
Effective September 12, 2015, we executed a one year note extension with a related party lender. As part of the extension, we made a principal reduction payment in the amount of $5,000. The balance of the loan, $115,000, accrues interest at 10% annually.
New offices
The Company opened eight new offices (seven in California and one in Washington).
Preferred Dividend Payment
The board decided not to make the dividend payments due July 15, 2015 for the periods ended June 30, 2015 or September 30, 2015. The Company remains in default on its obligations to the Preferred Shareholders and total dividends accrued as of September 30, 2015 are $1,729,508.