UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
QUARTERLY REPORT UNDER SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2005
Commission File Number 000-29049
SILVERADO FINANCIAL, INC.
_________________________________________________________________
(Exact name of small business issuer as specified in its charter)
Nevada 86-0824125
________________________________________________________________________________
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
5976 W. Las Positas, Suite 218, Pleasanton, CA 94588
____________________________________________________
(Address of principal executive offices) (Zip Code)
___________________________________________________
Telephone Number: (925) 227-1500
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
As of September 30, 2005, 20,164,062 of the registrant's common stock, $0.01 par
value per share, were issued and outstanding and 100,000 shares of the
registrants preferred were issued and outstanding.
1
Silverado Financial, Inc.
Consolidated Financial Statements
For the Nine Months Ended September 30, 2005 and 2004
Table of Contents
INDEX TO FORM 10-QSB
PART I. FINANCIAL INFORMATION .............................................. 3
Item 1. Financial Statements .............................................. 3
Report of Independent Auditors .................................... 3
Consolidated Balance Sheet ..................................... 4 - 5
Consolidated Statements of Income .................................. 6
Consolidated Statements of Stockholders' Equity ............... 7
Consolidated Statements of Cash Flows ......................... 8 - 9
Notes to Financial Statements ................................ 10 - 22
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................. 23
Item 3. Controls and Procedures ........................................... 36
PART II. OTHER INFORMATION ................................................ 38
Item 1. Legal Proceedings ................................................. 38
Item 2. Changes in Securities ............................................. 39
Item 3. Defaults Upon Senior Securities ................................... 39
Item 4. Submissions of Matters to a Vote of Security Holders .............. 39
Item 5. Other Information ................................................. 39
Item 6. Exhibits and Reports on Form 8-K .................................. 39
Signatures ................................................................ 39
2
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Report of Independent Accountants
To the Board of Directors and Stockholders Silverado Financial, Inc.
Pleasanton, California
We have reviewed the accompanying consolidated balance sheets of Silverado
Financial, Inc. (a Nevada corporation), as of June 30, 2005 and 2004, and the
related consolidated statements of income, stockholders' equity and cash flows
for the three and six months then ended, in accordance with Statements on
Standards for Accounting and Review Services issued by the American Institute of
Certified Public Accountants. All information included in these financial
statements is the representation of the management of Silverado Financial, Inc.
A review consists principally of inquiries of Company personnel and analytical
procedures applied to financial data. It is substantially less in scope than an
audit in accordance with generally accepted auditing standards, the objective of
which is the expression of an opinion regarding the financial statements taken
as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying financial statements in order for them to be in
conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note One to the
financial statements, the Company's significant operating losses raise
substantial doubt about its ability to continue as a going concern. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
SALLMANN, YANG & ALAMEDA
An Accountancy Corporation
Pleasanton, California
3
Silverado Financial, Inc.
Consolidated Balance Sheets
September 30,
2005 2004
----------- -----------
Assets
Current assets
Cash $ 43,792 $ 63,927
Accounts receivable 87,010 3,324
Mortgage receivable 524,300 --
Investment receivable 22,510 --
Prepaid expenses 22,668 --
----------- -----------
Total current assets 700,280 67,251
Property and equipment
Furniture and equipment 406,543 146,271
Intellectual property 699,010 --
Accumulated depreciation and amortization (438,778) (38,843)
----------- -----------
Total property and equipment 666,775 107,428
Other assets
Deposits 58,571 11,547
Other intangibles -- 699,010
Goodwill 2,985,471 --
----------- -----------
Total other assets 3,044,042 710,557
----------- -----------
Total assets $ 4,411,097 $ 885,236
=========== ===========
See accountants' report and accompanying notes
4
Silverado Financial, Inc.
Consolidated Balance Sheets
September 30,
2005 2004
------------ ------------
Liabilities and stockholders' equity
Current liabilities
Accounts payable $ 289,190 $ 293,204
Warehouse facility payable 524,300 --
Notes payable current portion 531,114 --
Notes payable - stockholders 66,384 --
Due to affiliates -- 939
Equity advances 165,500 --
Convertible notes -- 36,000
Accrued liabilities 5,482 185,766
Accrued wages 529,514 --
Payroll taxes payable 287,601 --
Income taxes payable 2,400 --
------------ ------------
Total current liabilities 2,401,485 515,909
Long term debt
Notes payable - long term portion 1,297,000 275,000
------------ ------------
Total long term debt 1,297,000 275,000
------------ ------------
Total liabilities 3,698,485 790,909
Stockholders' equity
Preferred stock, $.001 par value,
1,000,000 shares authorized, 100,000 and 0
shares issued and oustanding, respectively 1,000,000 --
Common stock, $.001 par value,
20,000,000 shares authorized,
19,635,524 and 20,164,062 shares issued 19,635 18,077
and oustanding, respectively
Additional paid in capital 11,050,161 10,879,985
Deferred compensation -- (7,030)
Accumulated deficit (11,357,184) (10,796,705)
------------ ------------
Total stockholders' equity 712,612 94,327
------------ ------------
Total liabilities and stockholders' equity $ 4,411,097 $ 885,236
============ ============
See accountants' report and accompanying notes
5
Silverado Financial, Inc.
Consolidated Statements of Income
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
2005 2004 2005 2004
----------- ----------- ----------- -----------
Income
Net sales $ 1,026,469 $ 223,908 $ 2,434,091 $ 536,691
Cost of sales 136,376 -- 437,959 --
----------- ----------- ----------- -----------
Gross profit 890,093 223,908 1,996,132 536,691
Operating expenses
Selling, general and administrative expenses 1,134,921 350,273 2,550,529 1,043,498
Depreciation and amortization 92,511 7,114 231,841 20,942
----------- ----------- ----------- -----------
Total operating expenses 1,227,432 357,387 2,782,370 1,064,440
----------- ----------- ----------- -----------
Operating loss (337,339) (133,479) (786,238) (527,749)
Other income (expense)
Interest income 2,667 -- 10,481 --
Gain on sale of investments -- -- -- 9,813
Investment income 24,307 -- 51,297 --
Interest expense (52,989) (6,454) (76,010) (19,217)
Impairment -- (699,010) -- (699,010)
----------- ----------- ----------- -----------
Total other income (expense) (26,015) (705,464) (14,232) (708,414)
----------- ----------- ----------- -----------
Loss before income taxes (363,354) (838,943) (800,470) (1,236,163)
Provision for income taxes -- -- 3,200 --
----------- ----------- ----------- -----------
Net loss $ (363,354) $ (838,943) $ (803,670) $(1,236,163)
=========== =========== =========== ===========
Loss per share (basic) $ (0.02) $ (0.05) $ (0.04) $ (0.08)
=========== =========== =========== ===========
Loss per share (dilutive) $ (0.02) $ (0.05) $ (0.04) $ (0.08)
=========== =========== =========== ===========
See accountants' report and accompanying notes
6
Silverado Financial, Inc.
Consolidated Statements of Stockholders' Equity
For the Nine Months Ended September 30, 2005 and 2004
Additional Total
Common Stock Paid-in Deferred Accumulated Stockholders'
Shares Amount Capital Compensation Deficit Equity
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 2003 14,839,492 $ 14,839 $ 10,455,513 $ (16,000) $ (9,560,541) $ 893,811
Shares issued for payables 2,062,975 1,154 153,051 -- -- 154,205
Shares issued for services 2,115,325 1,183 154,921 8,970 -- 165,074
Shares issued for cash 1,146,270 901 116,500 -- -- 117,401
Net loss -- -- -- -- (1,236,164) (1,236,164)
------------ ------------ ------------ ------------ ------------ ------------
Balance, September 30, 2004 20,164,062 $ 18,077 $ 10,879,985 $ (7,030) $(10,796,705)$ 94,327
============ ============ ============ ============ ============ ============
Additional Total
Preferred Stock Common Stock Paid-in Accumulated Stockholders'
Shares Amount Shares Amount Capital Deficit Equity
------------ ------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 2004 -- $ -- 18,216,697 $ 18,217 $ 10,889,713 $(10,553,514) $ 354,416
Shares issued for payables 100,000 1,000,000 984,691 984 81,722 -- 1,082,706
Shares issued for services -- -- 634,136 634 86,383 -- 87,017
Shares returned for services (200,000) (200) (7,657) (7,857)
Net loss -- -- -- -- -- (803,670) (803,670)
------------ ------------ ------------ ------------ ------------ ------------ ------------
Balance, September 30, 2005 100,000 $ 1,000,000 19,635,524 $ 19,635 $ 11,050,161 $(11,357,184) $ 712,612
============ ============ ============ ============ ============ ============ ============
See accountants' report and accompanying notes
7
Silverado Financial, Inc.
Consolidated Statements of Cash Flows
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
2005 2004 2005 2004
----------- ----------- ----------- -----------
Operating activities
Net loss $ (363,354) $ (838,941) $ (803,670) $(1,236,163)
Adjustments to reconcile net loss to
cash flows from operating activities:
Depreciation and amortization 92,511 18,214 231,841 49,912
Loss on sale of marketable securities -- -- -- (9,813)
Stock for services and payables (59,465) 45,936 110,188 317,360
Impairment -- 699,010 -- 699,010
(Increase) decrease in:
Accounts receivable (55,682) (321) (70,124) 8,081
Mortgage receivable (279,300) -- (524,300) --
Investment receivable 4,480 -- (22,510) --
Prepaid expenses 5,018 -- (11,744) --
Deposits (13,893) -- (36,673) (4,647)
Increase (decrease) in:
Accounts payable 71,653 19,630 233,320 48,383
Warehouse facility payable 279,300 -- 524,300 --
Due to affiliates -- 53,500 -- 65,419
Equity advances 95,000 -- 165,500 --
Payroll taxes payable 40,527 -- 201,304 --
Income taxes payable 1,600 -- 2,400 --
Accrued wages 135,359 -- 323,082 --
Accrued liabilities (102,198) 5,458 (5,823) 19,217
----------- ----------- ----------- -----------
Net cash provided by (used in) operating activities (148,444) 2,486 317,091 (43,241)
Investing activities
Proceeds from the sale of investments -- -- -- 27,588
Purchases of property and equipment (12,479) -- (158,167) (12,000)
Purchase of goodwill -- -- (2,985,471) --
----------- ----------- ----------- -----------
Net cash provided by (used in) investing activities (12,479) -- (3,143,638) 15,588
See accountants' report and accompanying notes
8
Silverado Financial, Inc.
Consolidated Statements of Cash Flows (continued)
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
2005 2004 2005 2004
----------- ----------- ----------- -----------
Financing activities
Proceeds from private placements of stock $ -- $ 62,762 $ -- $ 90,350
Proceeds from issuance of preferred stock -- -- 1,000,000 --
Proceeds from issuance of notes payable -- -- 2,000,000 --
Proceeds from issuance of shareholder loan 22,617 -- 22,617 --
Repurchase of shareholder stock -- (43,767) -- --
Payment on notes payable (43,964) -- (171,886) --
----------- ----------- ----------- -----------
Net cash provided by (used in) financing activities (21,347) 18,995 2,850,731 90,350
Net increase (decrease) in cash (182,270) 21,481 24,184 62,697
Cash at beginning of period 226,062 42,446 19,608 1,230
----------- ----------- ----------- -----------
Cash at end of period $ 43,792 $ 63,927 $ 43,792 $ 63,927
=========== =========== =========== ===========
Supplemental disclosure of cash flow information:
Interest expense $ 52,989 $ -- $ 76,010 $ --
Income tax expense $ -- $ -- $ 1,600 $ --
Supplemental disclosure of non-cash
investing and financing activities:
Receipt of 461,822 common shares for decrease in
valuation of software purchased with Financial
Software, Inc. $ -- $ (23,091) $ -- $ (23,091)
Relinquishment of notes payable for decrease in
valuation of software purchased with
Financial Software, Inc. $ -- $ (275,000) $ -- $ (275,000)
Adjustment of Goodwill for vehicle not purchased in
acquisition of Core One Mortgage $ 3,945 $ -- $ 3,945 $ --
See accountants' report and accompanying notes
9
Silverado Financial, Inc.
Notes to Consolidated Financial Statements
September 30, 2005 and 2004
1. Organization and Basis of Presentation
Nature of Operations
Silverado Financial, Inc. (the Company) is incorporated under the laws of the
State of Nevada and based in Pleasanton, California in the San Francisco Bay
Area. This Company provides first and second mortgage products to borrowers in
California through its subsidiary Silverado Mortgage, Corporation.
The corporation was initially formed on February 26, 1987 as Toledo Medical
Corporation. The name was changed to Almaz Space Corporation on February 9, 1991
and to Ready When You Are Funwear, Inc. on April 14, 1992. On February 17, 1995
the name was changed to Rhombic Corporation. On March 19, 2003 the company
changed its name to Silverado Financial, Inc.
The Company's efforts, since inception, until October 2002, had been primarily
focused on the acquisition of the rights to intellectual property that could
lead to the development of innovative scientific technologies. During the years
1999 and 2000 it began to focus on the research and development of its portfolio
of acquired intellectual property. During 2001, the main objective was to
identify and develop specific applications from the intellectual property in
order to make them commercially marketable. In November 2002, the Company
acquired Financial Software, Inc. as the first part of its strategy to enter the
financial services sector.
As of September 30, 2005, the Company had three wholly owned subsidiaries as
follows:
o Financial Software, Inc. (FSI)
o Silverado Mortgage Corporation (SMC)
o Core One Mortgage, Inc. (Core One)
On November 19, 2002, the Company acquired all of the issued and outstanding
shares of Financial Software, Inc. (FSI) a New Jersey corporation engaged in the
development of Internet and Intranet financial software in addition to operating
several financial industry publishing websites. This acquisition was completed
on a share for share exchange basis for 4,400,000 shares of the Company's common
stock. FSI was acquired in order to gain access to certain proprietary software
products owned by FSI, which the Company intends to further develop and extend
into comprehensive mortgage platforms called MortgageCenter and FinanCenter. FSI
transferred its state of incorporation to California in February 2003.
On May 9, 2003, in a non-arms length transaction with John E. Hartman, the
Company's President, the Company issued 729,452 shares of restricted common
stock at a purchase price of $0.175 per share, which was based on the prior five
days average trading price, in exchange for all of the outstanding shares of
Silverado Mortgage Corporation (SMC). The purchase price of SMC was $127,654 and
was the net asset value of SMC, as determined by an independent, third party
valuation. The shares were issued under Section 4(2) of the 1933 Securities Act.
On May 5, 2005 the Company acquired all of the issued and outstanding shares of
Core One Mortgage, Inc., a Chicago based sub-prime mortgage broker ("Core One")
along with entitlement to fifty percent of the future net income of Liberty
Settlement Services (a Pennsylvania based title company), for $3,000,000 in a
combination of preferred stock and structured debt. Core One currently operates
10
1. Organization and Basis of Presentation - continued
from three branch office locations: Chicago, Illinois; Pittsburgh, Pennsylvania;
and Baltimore, Maryland; with licensing to do business in Florida and South
Carolina.
Additionally Rockford, Nanophase, ADEPT and RDT were held as subsidiaries until
sold in 2003. Rockford, Nanophase, ADEPT and RDT were never active, held any
assets or had any liabilities or operations. These subsidiaries were created for
the purpose of developing specific applications from scientific intellectual
property. The Company never implemented its plans to develop the scientific
intellectual property. All of its scientific intellectual properties, together
with certain marketable securities held for sale, were sold in 2003 to a
director, in exchange for the return of 62,000 shares of the Company's common
stock and the cancellation of $1,100 in debt.
Going Concern and Plan of Operations
The accompanying consolidated financial statements have been prepared on the
basis of accounting principles applicable to a going concern, which contemplates
the realization of assets and extinguishment of liabilities in the normal course
of business.
As shown in the accompanying financial statements, the Company had a net loss of
$803,670 for the nine months ended September 30, 2005. It has incurred an
accumulated deficit of $11,357,184 and has a deficit of working capital of
$1,701,205 as of September 30, 2005. The ability of the Company to continue as a
going concern is dependent on obtaining additional capital and financing and
operating at a profitable level. The Company intends to seek additional capital
either through debt or equity offerings, or a combination thereof, and to seek
acquisitions which will generate sales volume with operating margins sufficient
to achieve profitability. The financial statements do not include any
adjustments that might be necessary if the Company is unable to continue as a
going concern.
Basis of Presentation
The Company has prepared the financial statements on the accrual basis of
accounting in accordance with generally accepted accounting principles in the
United States of America. In the opinion of management, all adjustments
considered necessary for a fair presentation have been included.
2. Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the operations,
account balances and cash flows of the Company and its wholly owned
subsidiaries, Financial Services, Inc., Silverado Mortgage Corporation, and Core
One Mortgage, Inc. Intercompany transactions and account balances have been
eliminated in consolidation. The operations are consolidated from their
respective acquisition dates of November 19, 2002 (Financial Services, Inc.),
May 9, 2003 (Silverado Mortgage Corporation) and May 5, 2005 (Core One Mortgage,
Inc.).
Concentration of Credit Risk
The Company maintains its cash balances in several financial institutions
located in California. The balances held are insured by the Federal Deposit
11
2. Summary of Significant Accounting Policies - continued
Insurance Corporation up to $100,000. As of September 30, 2005 the Company's
account balances did not exceed these limits.
The Company's revenues are concentrated in the mortgage industry which is highly
competitive and subject to fluctuations in economic condition. The Company's
results of operations, financial condition and business prospects could be
materially adversely affected if competition intensifies or if competitors
significantly expand their activities in the Company's markets. Fluctuations in
interest rates and general economic conditions may also affect the Company's
competitive position.
Cash and Cash Equivalents
For the purpose of the statements of cash flows, the Company considers all
highly liquid debt instruments purchased with original maturities of three
months or less to be cash equivalents.
Financial Instruments
Financial instruments consist primarily of cash, investments in marketable
securities and obligations under accounts payable and accrued expenses. The
carrying amounts of cash, accounts receivable, accounts payable, notes payable
and accrued expenses approximate fair value because of the short term maturity
of those instruments.
Investments
Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for
Certain Investments in Debt and Equity Securities, requires that all applicable
investments be classified as trading securities, available for sale securities
or held to maturity securities. The Company did not have any investments
classified as trading securities or held-to-maturity securities. The statement
further requires that available for sale securities be reported at fair value,
with unrealized gains and losses excluded from earnings but reported in a
separate component of stockholders' equity (net of the effect of income taxes)
until they are sold. At the time of sale, any gains or losses are recognized as
a component of operating results.
At September 30, 2005, the Company's investments held for sale were $0. The
Company acquired an investment in Liberty Settlement Services, LLC on May 5,
2005. From that date, forward, 50% of the income is owned by the Company. The
Company's share of income through September 30, 2005 is valued at $51,297 of
which $28,787 was distributed during the third quarter of 2005.
Furniture and Equipment
Furniture and equipment are carried at cost less accumulated depreciation.
Depreciation is provided on the straight-line method over estimated useful lives
generally ranging from three to seven years. Intellectual property is carried at
cost less valuation impairment expense and is amortized using the straight-line
method over its estimated useful life of three years. Leasehold improvements are
carried at cost and are amortized over the shorter of their estimated useful
lives or the related lease term (including options), generally ranging from one
to six years. Expenditures for major renewals that extend useful lives of
furniture, equipment and improvements are capitalized. Expenditures for
maintenance and repairs are charged to expense as incurred. For income tax
purposes, depreciation is computed using the modified cost recovery system.
12
2. Summary of Significant Accounting Policies (continued)
Depreciation expense for the nine months ended September 30, 2005, was $57,088.
Amortization expense for the nine months ended September 30, 2005, was $174,753.
Intellectual Property
The Company's intellectual property is comprised of a software platform
purchased with Financial Services, Inc. in 2002. The Company periodically
evaluates the recoverability of intangible assets and takes into account events
or circumstances that warrant revised estimates of useful lives or that indicate
that an impairment exists. The Company put the software into productive use in
October 2004 and began amortizing the asset as of that date.
Impairment of Long-Lived Assets
On January 1, 2002, the Company adopted SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, which requires that long-lived
assets, that are to be held and used, will be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable.
In the event that facts and circumstances indicate that the cost of long-lived
assets, primarily intellectual property and patents, may be impaired, the
Company performs a recoverability evaluation. Recoverability of assets to be
held and used is measured by a comparison of the carrying amount of an asset to
future undiscounted cash flows expected to be generated by the asset. If assets
are considered to be impaired, the impairment to be recognized is measured by
the amount by which the carrying amounts exceed the fair values of the assets.
Assets to be disposed of are reported at the lower of carrying value or fair
value, less costs of disposal.
Compensating Absences
Employees of the company are entitled to paid vacation, paid sick days and
personal days off, depending on job classification, length of service and other
factors. It is impracticable to estimate the amount of compensation for future
absences, and, accordingly, no liability has been recorded in the accompanying
financial statements. The company's policy is to recognize the costs of
compensated absences when actually paid to employees.
Convertible Notes
Statement of Financial Accounting Standards No. 150 (SFAS), Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity, is effective for financial instruments entered into or modified after
May 31, 2003, and otherwise is effective at the beginning of the first interim
period beginning after June 15, 2003, except for mandatory redeemable financial
instruments of nonpublic entities.
This Statement establishes standards for how an issuer classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some circumstances). Many of
those instruments were previously classified as equity. The Company has and will
continue to report convertible notes as liabilities.
13
2. Summary of Significant Accounting Policies (continued)
Stock-Based Compensation
Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for
Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, established accounting and disclosure
requirements using a fair-value based method of accounting for stock-based
employee compensation. The Company periodically issues options to consultants
and members of the Board of Directors. The estimated value of these options is
determined in accordance with SFAS No. 123 and expensed as the granted options
vest to the grantees.
The price of any options granted pursuant to these grants is not to be less than
100 percent of the fair market value of the shares on the date of grant. The
options expire one year from date of grant and are immediately vested. There was
no charge to expense for the value of the options during the nine months ended
September 30, 2005, as no options were issued.
Revenue Recognition
Sales consist of loans to third party investors in the secondary market. Sales
are generally recognized at the time of funding, provided that no significant
vendor obligations exist and collections of accounts receivable are probable.
Advertising
Advertising costs are expensed as incurred. For the nine months ended September
30, 2005, the Company did not incur any advertising costs.
Research and Development
Expenditures for research activities relating to software development and
improvement are charged to operations as incurred.
Income Taxes
The Company accounts for income taxes under the asset and liability method as
prescribed by Statement of Financial Accounting Standards (SFAS) No. 109,
Accounting for Income Taxes. As such, deferred income tax assets and liabilities
are recognized for the future tax consequences of the differences between the
financial statement carrying amount of existing assets and liabilities and their
respective tax bases. Deferred income tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America requires management to
make estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Accordingly, actual results could differ from
those estimates.
3. Intellectual Property
Since its inception, the Company entered into numerous agreements as a result of
having acquired certain rights to various complex intellectual scientific
properties. The Company periodically analyzes its investments in intellectual
property for impairment.
14
3. Intellectual Property (continued)
During the quarter ended June 30, 2003, in a non-arms length transaction with
Robert George Krushinsky, a director of the Company, the Company received 62,000
shares of its own common stock together with cancellation of an outstanding debt
in the amount of $1,100 in exchange for all of the scientific intellectual
property assets acquired prior to the acquisition of FSI in November 2002 as
well as all shares of Rockford Technology held for sale by the Company.
On November 19, 2002, in connection with the acquisition of Financial Software,
Inc., the Company acquired certain software, web sites and intellectual property
which can aggregate financial information from a large number of data sources on
an individual basis, amalgamate the host of disparate objectives as they relate
to a person's financial goals, be they investment or debt related or any
combination. This software suite, together with mortgage generation capabilities
can create a variety of new and different mortgage, investment or insurance
products. The Company recorded the software on its books at the seller's basis
of $1,398,020. The Company engaged an experienced software developer based in
Palo Alto, California to perform an independent, third party valuation of the
software during 2003.
During the fourth quarter of 2004, Silverado Financial, Inc. began implementing
its FinanCenter Software system, but in doing so found that the software was in
need of upgrades in both programming and technology. With that in mind,
management felt that it was necessary to impair the original valuation of
$1,398,020 down 50% to $699,010. Additionally, on November 24, 2004 the purchase
price of the intellectual property was renegotiated as follows: SRD Technologies
(former owner of Financial Services, Inc.), signed a debt cancellation and
release agreement which included the release of any and all liabilities owed to
SRD Technologies, the relinquishment of 574,953 shares of Silverado Financial,
Inc. stock, and a payment for auditing expenses in the amount of $7,500. An
additional 44,000 shares were relinquished from Mike Shultz in the
re-negotiation. On the date of the agreement 618,953 shares were valued at $0.05
a share or $30,948.
In September 2005, the Company received the remaining 157,131 shares due to
them. The note payable of $275,000, with corresponding accrued interest of
$41,047 and $7,500 in accounts payable have been reversed as of December 31,
2004 with a resulting impairment expense of $389,753.
The Company placed the software into service in October 2004 and is amortizing
the software over a three year period commencing upon the in-service date.
Amortization expense for the nine months ended September 30, 2005 was $174,761.
Amortization expense is estimated to be as follows for the years ended December
31:
Year Amount
---- --------
2005 $233,003
2006 233,003
2007 174,761
--------
$640,767
========
15
4. Acquisitions
On November 19, 2002, the Company acquired all of the issued and outstanding
shares of Financial Software, Inc. (FSI), a New Jersey corporation engaged in
the development of Internet and Intranet financial software in addition to
operating several financial industry publishing websites. This acquisition was
completed on a share for share exchange basis for 4,400,000 shares of the
Company's common stock. FSI was acquired in order to gain access to certain
proprietary software products owned by FSI, which the Company intends to further
develop and extend into comprehensive mortgage platforms called MortgageCenter
and FinanCenter.
Through the acquisition of FSI, the Company acquired assets of $26,775 in
marketable securities, $1,398,020 in intellectual property (MortgageCenter and
FinanCenter software), and $1,904 in computer equipment. The Company also
acquired liabilities of $61,796 in accounts payable and $275,000 through the
assumption of a note payable.
On May 9, 2003 the Board of Directors approved the acquisition of Silverado
Mortgage Corporation (SMC), a mortgage brokerage company, from John Hartman for
729,452 restricted common shares. Mr. Hartman (President of Silverado Financial,
Inc.) abstained from the vote. The acquisition was made at a trading value of
$127,654 which was the net asset value of SMC and the average closing bid price
of the Company on the prior five trading days. Mr. Hartman's holdings of
Silverado Financial, Inc. common stock were 103,511 shares (0.87% of total
shares outstanding) prior to acquisition and 832,963 shares (6.59% of total
shares outstanding) after the acquisition of SMC, respectively.
Through the acquisition of Silverado Mortgage Corporation , the Company acquired
total assets of $168,233, consisting of $33,963 in accounts receivable and
prepaid expenses, $49,284 in computers and equipment, and $84,986 in furniture.
The Company also acquired liabilities of $7,871 in accounts payable and $32,708
through the assumption of notes payable.
On April 29, 2005 the Board of Directors approved the acquisition of Core One
Mortgage, Inc., a mortgage brokerage company and fifty percent of Liberty
Settlement Services' future net profits for $3,000,000 in combination of
$1,000,000 of preferred stock to convert to $1,000,000 of common stock after
December 31, 2005, but not later than January 15, 2006, and a $2,000,000 note
payable with 8% interest, payable in monthly installments of $52,673.
Through the acquisition of Core One Mortgage, Inc., the Company acquired total
assets of $3,133,620 consisting of $129,467 of fixed assets, net of accumulated
depreciation, $5,227 prepaid expense, $17,400 security deposit and $2,981,526 in
goodwill. The Company also acquired liabilities of $13,620 in accounts payable
and incurred 120,000 in acquisition costs. Results of operations for Core One
Mortgage, Inc. are included in the consolidated financial statements as of the
purchase date of May 5, 2005.
16
4. Acquisitions (continued)
Following are pro forma amounts assuming that the acquisition was made on
January 1, 2005:
Net sales $ 3,277,062
Cost of sales 508,453
-----------
Gross profit 2,768,609
Operating expenses
Selling, general and administrative expense 3,176,026
Depreciation expense 231,841
-----------
Total operating expenses 3,407,867
-----------
Operating loss (639,258)
Other income
Interest income 13,893
Investment income 51,297
-----------
Total other income 65,190
Loss before taxes (574,068)
Provision for income taxes 6,581
-----------
Net loss $ (580,649)
===========
Contingent Payments
The Company issued $1,000,000 of convertible preferred stock for the purchase of
Core One Mortgage, Inc. as described above. The stock must be converted into
common stock after December 31, 2005, but not later than January 15, 2006, at
not less than $1,000,000 worth of the Company's common stock at the closing ask
price, as reported by www.nasdaq.com. Should Core One Mortgage, Inc.'s earnings
before interest, taxes and depreciation (EBITDA) for the year ended December 31,
2005 be greater than $900,000, the convertible preferred stock will be increased
to 1.5 times the dollar value in excess of $900,000. The Company can redeem the
convertible preferred stock at any time prior to conversion, for cash payments
of the unpaid principal balance due on that date.
5. Goodwill
Goodwill is assigned to specific reporting units and is reviewed for possible
impairment at least annually or more frequently upon the occurrence of an event
or when circumstances indicate that a reporting unit's carrying amount is
greater than its fair value. Goodwill of $2,985,471 arose in connection with the
acquisition or Core One, Mortgage, Inc. No impairment loss has been recognized
in the reporting unit.
6. Accounts Payable
As of September 30, 2005, the Company owes its vendors a total of $289,190, of
which approximately $147,277 was outstanding over ninety days.
17
7. Equity Advance
As of September 30, 2005, the Company had received advance payments on the
issuance of common stock for $165,500.
8. Long-Term Debt
Notes Payable
Through the acquisition of Financial Software, Inc., the
Company became obligated for the acquired accounts payable
in the amount of $30,000. In June 2003, the Company issued
33,000 shares of stock at a value of $5,000 and a note
payable for $25,000 in satisfaction of accounts payable to
one of the FSI vendors. The note carries interest at 5.0% $ 25,000
On October 11, 2004 John E. Hartman returned 729,452 shares,
valued at $43,767, of Silverado Financial, Inc. stock to
allow the Company the capability to issue more shares for
financing transactions and services. Silverado Financial,
Inc. will satisfy the note obligation with re-issuance of
shares and a 5% bonus of 36,472 shares, valued at $2,188. 43,767
During September 2005, Sean E. Radetich loaned the Company
$22,617 to cover operating expenses. 22,617
Per the purchase agreement of Core One Mortgage, Inc. on May
5, 2005, the Company issued a note in the amount of
$2,000,000, at 8.00%, with monthly payments of $62,673,
payable over three years, with a final payment of $491,505
on March 6, 2008, commencing May 6, 2005. As of the
financial statement date, $1,803,114 of the original amount
remains and $506,114 is the current portion. 1,803,114
---------------
1,894,498
Notes payable - current portion (531,114)
Notes payable - stockholder (66,384)
---------------
Notes payable - long term portion $ 1,297,000
===============
Minimum future commitments under notes payable are as follows for the years
ended December 31,
Year Amount
-------------- ----------
2005 $ 214,155
2006 516,304
2007 559,157
2008 604,882
and thereafter --
----------
$1,894,498
==========
18
8. Long-Term Debt (continued)
Warehouse Facility
On September 3, 2004, the Company's wholly owned subsidiary, Silverado Mortgage
Corporation signed an agreement for a $2,000,000 mortgage warehouse and security
facility.
The warehouse facility requires a demand note. The demand note, in the event of
a default, stipulates that any outstanding balance of the warehouse facility can
be called at any time, inclusive of interest. Interest is payable when loans are
sold (no later than 45 days) at 4.5% above the one month LIBOR rate. The note is
subject to mandatory prepayments and is collateralized by the mortgage loans and
other predetermined assets.
As of September 30, 2005 the outstanding balance was $524,300.
9. Operating Lease Commitments
During April 2004, the Company became responsible for a lease for 2,512 square
feet in an office building in Pleasanton, California. The lease is for a period
of three years ending on May 31, 2007 with an option to renew for an additional
three years. The base rental under the lease is $52,752 per annum ($4,396 per
month) during the first twelve-month period, $54,259 per annum ($4,522 per
month) for the second twelve-month period and $55,766 per annum ($4,647 per
month) during the third twelve-month period. The lease provides for the Company
to pay its proportionate share of the landlord's common costs.
During September 2004, the Company became responsible for a lease for 6,000
square feet in an office building in Campbell, California. The lease is for a
period of three years ending on October 31, 2007. The Company rented more space
in the current period resulting in an increase in lease costs and obligations.
Because of this, an amendment to the lease went into effect, June 1, 2005,
setting the rent at $160,560 per annum ($13,380 per month) during the next five
month period, $169,500 ($14,125 per month) during the subsequent twelve month
period and $178,380 ($14,865 per month) during the final eleven months. The
lease provides for the Company to pay its proportionate share of the landlord's
common costs.
During November 2004, the Company became responsible for a lease for 6,000
square feet in an office building in Phoenix, Arizona. The lease is for a period
of three years ending on January 31, 2008. The base rental under the lease is
$99,000 per annum ($8,250 per month) during the first thirty-six month period
except the Company shall pay $2,750 for the first ninety (90) days, $4,125 for
the second ninety (90) days and $6,875 for the third ninety (90) days of the
lease. The lease provides for the Company to pay its proportionate share of the
landlord's common costs.
During May 2005, the Company became responsible for a lease for 2,080 square
feet in an office building in Walnut Creek, California. The lease period is for
a period of three years ending on May 31, 2008. The base rental under the lease
is $58,656 per annum ($4,888 per month) during the first twelve month period,
$59,904 annum the following twelve month period ($4,992 per month), $61,152
annum the next twelve month period ($5,096 per month). The lease provides for
the Company to pay its proportionate share of the landlord's common costs.
19
9. Operating Lease Commitments - (continued)
As a result of the acquisition of Core One Mortgage, Inc., the Company assumed
lease obligations for properties in several states. A lease for office space in
Libertyville, Illinois for a period of three years ending on May 31, 2007 is
$40,200 per annum ($3,350 per month) throughout the term of the lease. A lease
for office space in Wexford, Pennsylvania for a period of three years ending on
September 30, 2008 is $93,555 per annum ($7,796 per month) throughout the term
of the lease. A lease for office space in Forest Hill Industrial Park, Maryland
for a period of three years ending on September 30, 2007 is $33,000 per annum
($2,750 per month) throughout the term of the lease.
Lease expense for the nine months ended September 30, 2005 was $258,500.
Minimum future commitments under all operating leases are as follows for the
years ended December 31:
Year Amount
--------------- ----------------
2005 $ 141,465
2006 568,522
2007 495,432
2008 120,483
and thereafter --
----------
$1,325,902
==========
10. Income Taxes
The components of the provision for income tax consist of the following for the
nine months ended September 30, 2005:
Current tax expense - state $ 1,600
Prior tax expense - state 1,600
Deferred tax benefit:
Federal 141,933
California 45,058
Change in valuation allowance (186,991)
---------
Total deferred tax expense --
---------
Provision for income taxes $ 3,200
=========
The Company's effective income tax rate is higher than what would be expected if
the federal statutory rate were applied to loss from operations primarily
because of net operating losses deductible for financial reporting purposes that
are not deductible for tax purposes. A full valuation allowance against the net
deferred tax assets was recorded at June 30, 2005, due to the Company's
uncertainty as to future realization of income tax loss carryforwards.
A reconciliation of the Company's income tax expense rate to U.S. federal
statutory rate for the nine months ended September 30, 2005 is as follows:
As of September 30, 2005, the Company had realized federal net operating losses
of approximately $8,825,215. Future realization of the net deferred tax assets
is dependent on generating sufficient taxable income prior to their expiration.
The net operating losses expire, as follows:
20
10. Income Taxes (continued)
Expiration Federal State State
---------- ---------- ----------
2009 44,994
2010 379,485 $2,109,954
2011 461,101 318,228
2012 236,028 76,034
2013 -- 522,756
2014 -- 119,873 $ 389,827
2018 861,526
2019 603,950
2020 3,670,269
2021 578,596
2022 126,723
2023 871,260
2024 991,283
---------- ---------- ----------
$8,825,215 $3,146,845 $ 389,827
========== ========== ==========
11. Loss Per Share
As of September 30, 2005, there were convertible notes with exercisable warrants
outstanding. Outstanding options, warrants and convertible securities to
purchase common stock were not considered in the calculation for diluted
earnings per share for the nine months ended September 30, 2005, because the
effect of their inclusion would be anti-dilutive. A reconciliation of the
numerator and denominator of the basic and diluted per share calculations for
the loss from continuing operations is as follows:
Basic (Loss) Diluted (Loss)
Net (Loss) Per Share Per Share
------------------------------------------------------------
Loss $ (803,670) $ (803,670) $ (803,670)
Shares 19,635,524 19,735,524
Per share $ (0.04) $ (0.04)
12. Related Party Transactions
On May 9, 2003 the Board of Directors approved the acquisition of Silverado
Mortgage Corporation SMC, a mortgage brokerage company, from John E. Hartman
(President of Silverado Financial, Inc.) for 729,452 restricted common shares.
Mr. Hartman abstained from the vote. The acquisition was made at a trading value
of $127,654 which was the net asset value of SMC and the average closing bid
price of the Company on the prior five trading days. Mr. Hartman's holdings of
Silverado Financial, Inc. common stock were 103,511 shares (0.87% of total
shares outstanding) prior to acquisition and 832,963 shares (6.59% of total
shares outstanding) after the acquisition of SMC, respectively.
On October 11, 2004 John E. Hartman returned 729,452 shares, valued at $43,767,
of Silverado Financial, Inc. stock to allow the Company the capability to issue
more shares for financing transactions and services. Silverado Financial, Inc.
will satisfy the note obligation with reissuance of shares and a 5% bonus of
36,472 shares, valued at $2,188.
During September, 2005 Sean E. Radetich loaned the Company $22,617 to cover
operating expenses.
21
13. Contingencies
On January 27, 2004 DL Pacific Center LP (DL Pacific) filed a lawsuit for
$40,444 plus costs and attorney's fees against the Company in San Diego County
Superior Court. The suit alleges that, after the purchase of San Francisco
Funding, Inc. (SFF) in November 2003, the Company assumed SFF's obligations
pursuant to DL Pacific's lease with SFF by accepting the benefits of such lease
and by negotiating with DL Pacific for amendments to the lease. The purchase was
never consummated. Silverado Financial Inc. has agreed to settle the lawsuit for
the nuisance value of $2,500.
Silverado Financial, Inc. has filed a cross-complaint against SFF and its major
stockholders, Mr. and Mrs. Daniel Selis, for indemnity for the cost of defending
the Vener lawsuit, and punitive damages resulting from breach of contract, fraud
and/or interference with the Company's advantageous business relationships.
On May 12, 2004 The Subway.Com filed for arbitration for $60,000 plus interest
against the Company in the state of Florida. The suit claims breach of contract
for stock promotion services. The Company believes it has meritorious defense
and that no contract was ever consummated. The August 2005 arbitration date has
been postponed.
On July 16, 2004, the Company was served with a complaint by the State of
California, Department of Industrial Relations on behalf of a former contractor
for back wages of $10,938 and penalties of $288 for an indeterminate number of
days. This case was settled by Silverado on November 21, 2005 for $10,000
payable in three payments in December 2005 and January 2006.
On August 17, 2005, a former loan advisor filed a lawsuit against the Company
claiming he was not paid for $10,000 in commissions he had earned. The Company
has settled out of court agreeing to pay $1,400 to resolve the dispute.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS REPORT CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION
21E OF THE SECURITIES EXCHANGE ACT OF 1934, INCLUDING, WITHOUT LIMITATION,
STATEMENTS REGARDING OUR EXPECTATIONS, BELIEFS, INTENTIONS OR FUTURE STRATEGIES
THAT ARE SIGNIFIED BY THE WORDS "EXPECTS", "ANTICIPATES", "INTENDS", "BELIEVES",
OR SIMILAR LANGUAGE. SUCH FORWARD-LOOKING STATEMENTS INCLUDE, BUT ARE NOT
LIMITED TO, THE SEEKING OF REVENUE PRODUCING ACQUISITIONS, THE DEVELOPMENT PLANS
FOR THE TECHNOLOGIES OF THE COMPANY, TRENDS IN THE RESULTS OF OUR DEVELOPMENT,
ANTICIPATED DEVELOPMENT PLANS, OPERATING EXPENSES AND OUR ANTICIPATED CAPITAL
REQUIREMENTS AND CAPITAL RESOURCES. THESE FORWARD-LOOKING STATEMENTS INVOLVE
RISKS, UNCERTAINTIES AND OTHER FACTORS. ALL FORWARD-LOOKING STATEMENTS INCLUDED
IN THIS DOCUMENT ARE BASED ON INFORMATION AVAILABLE TO THE COMPANY ON THE DATE
HEREOF AND SPEAK ONLY AS OF THE DATE HEREOF. THE FACTORS DISCUSSED BELOW UNDER
"FORWARD-LOOKING STATEMENTS" AND ELSEWHERE IN THIS QUARTERLY REPORT ON FORM
10-QSB ARE AMONG THOSE FACTORS THAT IN SOME CASES HAVE AFFECTED OUR RESULTS AND
COULD CAUSE THE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED IN THE
FORWARD-LOOKING STATEMENTS. IN ADDITION, THE FOLLOWING DISCUSSION IS INTENDED TO
PROVIDE AN ANALYSIS OF OUR FINANCIAL CONDITION AND PLAN OF OPERATION AND SHOULD
BE READ IN CONJUNCTION WITH OUR FINANCIAL STATEMENTS AND THE NOTES THERETO.
MANAGEMENT'S PLAN OF OPERATION
Silverado Financial, Inc. (the "Company", "We", "Us" and "Our") is incorporated
under the laws of the State of Nevada and based in Pleasanton, California in the
East San Francisco Bay Area. The Company provides first and second mortgage
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
products to borrowers in California and Colorado through its operating
subsidiary, Silverado Mortgage Corporation (SMC).
The corporation was initially formed on February 26, 1987 as Toledo Medical
Corporation. The name was changed to Almaz Space Corporation on February 9, 1991
and to Ready When You Are Funwear, Inc. on April 14, 1992. On December 30, 1994
a group of individuals acquired control of the Company. On February 17, 1995,
they changed the name to Rhombic Corporation. On March 19, 2003, the company
changed its name to Silverado Financial, Inc.
In November 2002, the Company acquired Financial Software, Inc. as the first
part of its strategy to enter the lucrative consumer finance sector. In May of
2003 the Company acquired Realty Capital Corporation, a California based
mortgage brokerage, and renamed the wholly owned subsidiary Silverado Mortgage
Corporation in August of 2004.
During the 1st Quarter the company had one wholly owned subsidiary: Silverado
Mortgage Corporation ("SMC").
Silverado acquired Financial Software, Inc. on November 19, 2002 in a share for
share exchange basis for 4,400,000 shares of common stock. Financial Software,
Inc. (FSI), a New Jersey corporation engaged in the development of Internet and
Intranet financial software in addition to operating several financial industry
publishing websites. Silverado acquired FSI in order to gain access to certain
proprietary software products owned by FSI which we intend to further develop
and extend into a comprehensive back office platform necessary to accomplish
managements business objectives. Financial Software has been merged into
Silverado Financial, Inc. effective the first quarter of 2005.
On May 9, 2003, Silverado acquired Realty Capital Corporation in exchange for
729,452 shares of restricted common stock from John E. Hartman, the President
and Chief Executive Officer of the Company and a director. The Company was
renamed Silverado Mortgage Corporation in August of 2004. SMC operates as a
mortgage brokerage and mortgage banking company licensed by the California
Department of Real Estate and by the California Department of Corporations as a
Consumer Finance Lender. SMC generated all of the Company's 2004 revenue through
its offices in Campbell and Pleasanton, California and Phoenix Arizona.
In addition to continuing, and expanding, the operation of SMC, other activities
have consisted of developing the business plan, obtaining a warehouse line of
credit, raising capital, business plan implementation and recruiting and
training sales people. For the year ending December 31, 2004, the Company had
revenues of $919,930, and has expensed operating costs in the amount of
$1,590,650. Historically, the Company has had nominal cash resources and has
been largely dependent on the direct financial support from a few shareholders,
directors and officers along with limited revenue to pay for cash expenditures.
In addition, the Company has been dependent on its officers; directors and
certain key vendors accepting restricted common stock for their services.
BUSINESS OF THE ISSUER
General
Silverado Financial Incorporated is a mortgage banking company focused on
providing non-prime borrowers, individuals who generally do not satisfy the
credit, documentation or other underwriting standards set by more traditional
sources of mortgage credit, with access to capital for the purchase and
23
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
refinancing of one to four-family residential properties. The Company originates
mortgage loans, which include fixed and adjustable-rate loans, for purposes such
as debt consolidation, refinancing, education, home improvement and real estate
purchase.
As the primary aspect of the Company's business and finance strategy, Silverado
sells its loans to third-party investors (correspondent investors) in the
secondary mortgage market. Presently the Company sells its loans through whole
loan sales to correspondent investors, but as the Company grows it will dispose
of its loan production through a combination of whole loan sales and
securitization.
The Company's mortgage business has two principal components. First, Silverado
makes mortgage loans to individual borrowers. Each loan is a cash and expense
outlay for the Company, because its total cost incurred in originating a loan
exceeds the fees it collects at the time it originates the loan. At the time of
origination, Silverado either finances the loan by borrowing under a warehouse
line of credit, or acts as an agent and brokers the loan to another mortgage
lender. Second, the Company sells the loans on a whole-loan basis, and uses the
net proceeds from these transactions to repay its warehouse lines of credit and
for working capital.
Silverado currently operates 3 offices in California, corporate headquarters and
retail sales office in Pleasanton, California, a sales office in Campbell,
California, a sales office in Walnut Creek California and a sales office in
Phoenix, Arizona.
Because of Silverado's focus on the Non-Prime borrower, and the subsequent
growth of that market segment, the Company is largely insulated from interest
rate increases unlike many of its competitors in the highly sensitive Prime "A"
paper market segment.
Strengths and Competitive Advantages
We believe that we have several strengths and competitive advantages that allow
us to compete effectively in our business, including:
o Low Interest Rate Sensitivity: Due to Silverado's focus on the non-prime
borrower, and the subsequent growth of that market, Silverado is largely
insulated from increases in interest rates.
o Performance-Based Compensation Structure. Our compensation structure helps
keep fixed costs at a minimum and allows us to weather industry down-turns.
o Proprietary Training Program. We have developed and implemented a proprietary
training program, which broadens the hiring pool and helps to accelerate
internal growth.
o Position as a Direct Lender. As the industry consolidates Silverado's position
as a direct lender helps it to attract employees and insulates it against the
proposed regulatory changes
Competition
We face competition in the business of originating, purchasing and selling
mortgage loans. Our competitors include other consumer finance companies,
mortgage banking companies, commercial banks, credit unions, thrift
24
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
institutions, credit card issuers and insurance finance companies. Other
financial institutions have gradually expanded their lending capabilities. Many
of these companies have greater access to capital at a cost lower than our cost
of capital under our warehouse, aggregation, and asset backed commercial paper
facilities. Federally chartered banks and thrifts can preempt some of the state
and local lending laws to which we are subject, thereby giving them a
competitive advantage. In addition, many of these competitors have considerably
greater technical and marketing resources than we have.
Competition among industry participants can take many forms, including
convenience in obtaining a loan, customer service, marketing and distribution
channels, amount and term of the loan, loan origination fees and interest rates.
Additional competition may lower the rates we can charge borrowers, thereby
potentially lowering gain on future loan sales and securitizations. In 2004, the
most significant form of competition was pricing pressure among mortgage
originators. Some of our competitors lowered rates and fees to preserve or
expand their market share.
FORWARD LOOKING STATEMENTS
Certain statements made in this report on Form 10-QSB are "forward looking"
statements within the meaning of the Private Securities Litigation Reform Act of
1995. Such statements involve known and unknown risks, uncertainties and other
factors that may cause our actual results, performance or achievements to be
materially different from any future results implied by such forward looking
statements. Although we believe that the expectations reflected in such forward
looking statements are based upon reasonable assumptions, our actual results
could differ materially from those set forth in the forward-looking statements.
Certain factors that might cause such a difference might include: the failure of
the registrants efforts to secure additional equity capital, the inability to
successfully execute the revised business plan, the success or failure to
implement the management to operate possible acquisitions profitably, and the
registrant's planned marketing, public relations and promotional campaigns.
RISK FACTORS
Stockholders and prospective purchasers of our common stock should carefully
consider the risks described below before making a decision to buy our common
stock. If any of the following risks actually occurs, our business could be
harmed. In that case, the trading price of our common stock could decline, and
you may lose all or part of your investment. When determining whether to buy our
common stock, stockholders and prospective purchasers should also refer to the
other information in this Form 10-K, including our financial statements and the
related notes.
A prolonged economic slowdown or a lengthy or severe recession could hurt our
operations, particularly if it results in a decline in the real estate market.
The risks associated with our business are more acute during periods of economic
slowdown or recession because these periods may be accompanied by decreased
demand for consumer credit and declining real estate values. Declining real
estate values reduce the ability of borrowers to use home equity to support
borrowings because they negatively affect loan-to-value ratios of the home
equity collateral. In addition, because we make a substantial number of loans to
credit-impaired borrowers, the actual rates of delinquencies, foreclosures and
losses on these loans could be higher during economic slowdowns. Any sustained
period of increased delinquencies, foreclosures or losses could adversely affect
25
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
our ability to sell loans, the prices we receive for our loans, the value of our
mortgage loans held for investment or our residual interests in securitizations,
which could have a material adverse effect on our results of operations,
financial condition and business prospects.
Our earnings may decrease because of increases or decreases in interest rates.
Our profitability may be directly affected by changes in interest rates. The
following are some of the risks we face related to an increase in interest
rates:
o An interest rate increase may affect our earnings by reducing the spread
between the interest we receive on our loans and our funding costs.
o A substantial and sustained increase in interest rates could adversely affect
our loan origination volume because refinancing an existing loan would be less
attractive and qualifying for a purchase loan may be more difficult.
o During periods of rising interest rates, the value and profitability of our
loans may be negatively affected between the date of origination or purchase and
the date we sell or securitize the loan.
o When and if we securitize loans, the value of residual interests we retain and
the income we receive from the securitizations structured as financings are
based primarily on the London Inter-Bank Offered Rate ("LIBOR"). This is because
the interest on the underlying mortgage loans is based on fixed rates payable on
the loans for the first two or three years while the bondholders are generally
paid based on an adjustable LIBOR-based yield. An increase in LIBOR reduces the
net income we would receive from, and the value of, these mortgage loans and
residual interests.
o Our adjustable-rate mortgage loans have periodic and lifetime interest rate
caps above, which the interest rate on the loans may not rise. In the event of
general interest rate increases, the rate of interest on these mortgage loans
could be limited, while the rate payable on the senior certificates representing
interests in a securitization trust into which these loans are sold may be
uncapped. This would reduce the amount of cash we receive over the life of the
loans in securitizations structured as financings and our residual interests,
and could require us to reduce the carrying value of our residual interests.
We are also subject to risks from decreasing interest rates. For example, a
significant decrease in interest rates could increase the rate at which loans
are prepaid, which also could require us to reduce the carrying value of any
residual interests. If prepayments were greater than expected, the cash we would
receive over the life of our residual interests would be reduced.
Higher-than-expected prepayments could also have a negative effect on the value
of any servicing portfolio.
Any such changes in interest rates could have a material adverse effect on our
results of operations, financial condition and business prospects.
An interruption or reduction in the securitization and whole loan markets could
hurt our financial position.
As we implement our plan to become a full service mortgage banking company, we
will become increasingly dependent on the securitization market for the sale of
our loans because we intend to securitize loans directly in the future and many
of the whole loan buyers who purchase loans do so with the intention to
26
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
securitize them. The securitization market is dependent upon a number of
factors, including general economic conditions, conditions in the securities
market generally and conditions in the asset-backed securities market
specifically. In addition, poor performance of previously securitized loans
could harm our access to the securitization market. Accordingly, a decline in
the securitization market or a change in the market's demand for loans could
have a material adverse effect on our results of operations, financial condition
and business prospects.
If we are unable to maintain adequate financing sources, our earnings and our
financial position will suffer and jeopardize our ability to continue
operations.
We require substantial cash to support our operating activities and growth
plans. Our primary sources of cash are profits generated by sales of mortgage
products and the sale of our capital stock; however, we intend to generate
income from warehouse and aggregation credit facilities, asset-backed commercial
paper and the proceeds from the sales and securitizations of loans. We also
intend to finance residual interests in securitization transactions using Net
Interest Margin, or NIM, structures. As of December 31, 2003, we had no
short-term warehouse and aggregation credit facilities or asset-backed
commercial paper providing us with any committed or uncommitted borrowing
capacity to fund loan originations and purchases pending the pooling and sale of
such loans.
On August 11, 2004 our wholly owned subsidiary, Silverado Mortgage Corporation
(formerly Realty Capital Corporation) received approval for a $2,000,000
Mortgage Warehouse and Security Facility. A signed agreement was executed on
September 3, 2004 and we started utilizing the warehouse and security facility
on November 22, 2004.
During volatile times in the capital and secondary markets, access to warehouse,
aggregation and residual financing as well as access to the securitization and
secondary markets for the sale of loans has been severely constricted. If we are
unable to maintain adequate financing or other sources of capital are not
available, we would be forced to suspend or curtail our operations, which could
have a material adverse effect on our results of operations, financial condition
and business prospects.
New legislation could restrict our ability to make mortgage loans, which could
adversely impact our earnings.
Several states and cities are considering or have passed laws, regulations or
ordinances aimed at curbing predatory lending practices. The federal government
is also considering legislative and regulatory proposals in this regard. In
general, these proposals involve lowering the existing federal Homeownership and
Equity Protection Act thresholds for defining a "high-cost" loan, and
establishing enhanced protections and remedies for borrowers who receive such
loans. However, many of these laws and rules extend beyond curbing predatory
lending practices to restrict commonly accepted lending activities, including
some of our planned activities. For example, some of these laws and rules
prohibit any form of prepayment charge or severely restrict a borrower's ability
to finance the points and fees charged in connection with his or her loan. In
addition, some of these laws and regulations provide for extensive assignee
liability for warehouse lenders, whole loan buyers and securitization trusts.
Because of enhanced risk and for reputation reasons, many whole loan buyers
elect not to purchase any loan labeled as a "high cost" loan under any local,
27
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
state or federal law or regulation. Accordingly, these laws and rules could
severely constrict the secondary market for a significant portion of our loan
production. This would effectively preclude us from continuing to originate
loans that fit within the newly defined thresholds. For example, after the
October 1, 2002 effective date of the Georgia Fair Lending Act, many lenders and
secondary market buyers refused to finance or purchase Georgia loans. As a
result, many companies were forced to cease providing mortgages in Georgia until
the law's amendment a few months later. Similar laws have gone into effect in
New Jersey, as of November 27, 2003 ("New Jersey Home Ownership Act of 2002"),
and in New Mexico, as of January 1, 2004 ("New Mexico Home Loan Protection
Act"), that have impacted origination of loans in those states. The potential
long-term reduction in loans in New Jersey and in New Mexico could be quite
severe. Moreover, some of our competitors who are national banks or federally
chartered thrifts may not be subject to these laws and may as a consequence be
able to capture market share from us and other lenders. For example, the Office
of the Comptroller of the Currency recently issued regulations effective January
7, 2004 that preempt state and local laws that seek to regulate mortgage-lending
practices. Passage of such laws could increase compliance costs, reduce fee
income and reduce origination volume, all of which would have a material adverse
effect on our results of operations, financial condition and business prospects.
We are no longer able to rely on the Alternative Mortgage Transactions Parity
Act to preempt certain state law restrictions on prepayment penalties, which
could adversely impact our earnings.
The value of a mortgage loan depends, in part, upon the expected period of time
that the mortgage loan will be outstanding. If a borrower pays off a mortgage
loan in advance of this expected period, the holder of the mortgage loan does
not realize the full value expected to be received from the loan. A prepayment
penalty payable by a borrower who repays a loan earlier than expected helps
offset the reduction in value resulting from the early payoff. Consequently, the
value of a mortgage loan is enhanced to the extent the loan includes a
prepayment penalty, and a mortgage lender can offer a lower interest rate and/or
lower loan fees on a loan which has a prepayment penalty. Prepayment penalties
are an important feature used to obtain value on loans.
Certain state laws restrict or prohibit prepayment penalties on mortgage loans,
and until July 2003, lenders could rely on the federal Alternative Mortgage
Transactions Parity Act (the "Parity Act") and related rules issued in the past
by the Office of Thrift Supervision (the "OTS") to preempt state limitations on
prepayment penalties. The Parity Act was enacted to extend to financial
institutions, other than federally chartered depository institutions, the
federal preemption that federally chartered depository institutions enjoy.
However, on September 25, 2002, the OTS released a new rule that reduced the
scope of the Parity Act preemption and, as a result; we are not able to rely on
the Parity Act to preempt state restrictions on prepayment penalties. The
effective date of the new rule, originally January 1, 2003, was subsequently
extended by the OTS until July 1, 2003 in response to concerns from interested
parties about the burdens associated with compliance. The elimination of this
federal preemption requires us to comply with state restrictions on prepayment
penalties. These restrictions prohibit us from charging any prepayment penalty
in eight states and limit the amount or other terms and conditions of our
prepayment penalties in several other states. This may place us at a competitive
disadvantage relative to financial institutions that continue to enjoy federal
preemption of such state restrictions. Such institutions are able to charge
prepayment penalties without regard to state restrictions and, as a result, may
be able to offer loans with interest rate and loan fee structures that are more
28
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
attractive than the interest rate and loan fee structures that we are able to
offer.
The scope of our lending operations exposes us to risks of noncompliance with an
increasing and inconsistent body of complex laws and regulations at the federal,
state and local levels.
Currently, we are licensed to originate mortgage loans only in California,
however we are in the process of applying for licenses to generate loans in all
50 states, and when licensed we will be forced to comply with the laws and
regulations, as well as judicial and administrative decisions, for all of these
jurisdictions, as well as an extensive body of federal law and regulations. The
volume of new or modified laws and regulations has increased in recent years,
and, individual cities and counties have begun to enact laws that restrict
non-prime loan origination activities in those cities and counties. The laws and
regulations of each of these jurisdictions are different, complex and, in some
cases, in direct conflict with each other. As our operations continue to grow,
it may be more difficult to comprehensively identify, to accurately interpret
and to properly program our technology systems and effectively train our
personnel with respect to all of these laws and regulations, thereby potentially
increasing our exposure to the risks of noncompliance with these laws and
regulations.
Our failure to comply with these laws can lead to:
o civil and criminal liability;
o loss of approved status;
o demands for indemnification or loan repurchases from purchasers of our loans;
o class action lawsuits; or
o administrative enforcement actions.
Any of these results could have a material adverse effect on our results of
operations, financial condition and business prospects. If warehouse lenders and
securitization underwriters face exposure stemming from legal violations
committed by the companies to whom they provide financing or underwriting
services, this could increase our borrowing costs and negatively affect the
market for whole loans and mortgage-backed securities.
In June 2003, a California jury found a warehouse lender and securitization
underwriter liable in part for fraud on consumers committed by a lender to whom
it provided financing and underwriting services. The jury found that the
investment bank was aware of the fraud and substantially assisted the lender in
perpetrating the fraud by providing financing and underwriting services that
allowed the lender to continue to operate, and held the bank liable for 10% of
the plaintiff's damages. This is the first case we know of in, which an
investment bank was held partly responsible for violations committed by the
bank's mortgage lender customer. If other courts or regulators adopt this
theory, investment banks may face increased litigation as they are named as
defendants in lawsuits and regulatory actions against the mortgage companies
with which they do business. Some investment banks may exit the business, charge
more for warehouse lending or reduce the prices they pay for whole loans in
order to build in the costs of this potential litigation. This could, in turn,
have a negative effect on our results of operations, financial condition and
business prospects.
29
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
High delinquencies or losses on mortgage loans in securitizations may decrease
cash flows or impair our ability to sell or securitize loans in the future.
Loans made to lower credit grade borrowers, including credit-impaired borrowers,
entail a higher risk of delinquency and higher losses than loans made to
borrowers with better credit. We plan to make a substantial portion of our loans
to borrowers who do not qualify for loans from conventional mortgage lenders. No
assurance can be given that our underwriting criteria or methods will afford
adequate protection against the higher risks associated with loans made to lower
credit grade borrowers. We will be subject to risks of default and foreclosure
following the sale of loans through securitization. To the extent such losses
are greater than expected; the cash flows received through residual interests
and from securitizations structured as financings would be reduced. Increased
delinquencies or losses may also reduce or eliminate our ability to sell or
securitize loans in the future and could have a substantial, material adverse
effect on our operations, financial condition and business prospects.
Our inability to realize cash proceeds from loan sales and securitizations in
excess of the loan acquisition cost could adversely affect our financial
position.
The net cash proceeds received from loan sales consist of the premiums received
on sales of loans in excess of the outstanding principal balance, plus the cash
proceeds received from securitizations, minus the discounts on any loans that
are sold for less than the outstanding principal balance. If we are unable to
originate loans at a cost lower than the cash proceeds realized from loan sales,
our results of operations, financial condition and business prospects could be
materially adversely affected.
Warehouse and aggregation financing is subject to margin calls based on the
lender's opinion of the value of loan collateral. An unanticipated large margin
call could adversely affect our liquidity.
The amount of financing we may receive under any warehouse and
aggregation-financing agreements depends in large part on the lender's valuation
of the mortgage loans that secure the financings. Asset-backed commercial paper
facilities have similar provisions. Each such facility provides the lender the
right, under certain circumstances, to reevaluate the loan collateral that
secures outstanding borrowings at any time. In the event the lender determines
that the value of the loan collateral has decreased, it has the right to
initiate a margin call. A margin call would require us to provide the lender
with additional collateral or to repay a portion of the outstanding borrowings.
Any such margin call could have a material adverse effect on our results of
operations, financial condition and business prospects.
We face intense competition that could adversely affect our market share and our
revenues.
We face intense competition from finance and mortgage banking companies and from
Internet-based lending companies. In addition, certain government-sponsored
entities, such as Fannie Mae and Freddie Mac, are also expanding their
participation in the non-prime mortgage industry. These government-sponsored
entities have a size and cost-of-funds advantage that allows them to purchase
loans with lower rates or fees than we are willing to offer. While the
government-sponsored entities presently do not have the legal authority to
originate mortgage loans, including non-prime loans, they do have the authority
to buy loans. A material expansion of their involvement in the market to
purchase non-prime loans could change the dynamics of the industry by virtue of
30
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
their sheer size, pricing power and the inherent advantages of a government
charter. In addition, if as a result of their purchasing practices, these
government-sponsored entities experience significantly higher-than-expected
losses; such experience could adversely affect the overall investor perception
of the non-prime mortgage industry.
Competitors with lower costs of capital have a competitive advantage over us. In
addition, establishing a lending operation such as ours requires a relatively
small commitment of capital and human resources. This low barrier to entry
permits new competitors to enter our markets quickly and compete with us. This
could have a material adverse effect on our results of operations, financial
condition and business prospects.
Some thrifts, national banks and their operating subsidiaries are also expanding
their lending activities. By virtue of their charters, these institutions are
exempt from complying with many of the state and local laws that affect our
operations. For example, they can offer loans with prepayment charges in many
jurisdictions where we cannot. If more of these federally chartered institutions
are able to use their preemptive ability to provide more competitive pricing and
terms than we can offer, it could have a material adverse effect on our results
of operations, financial condition and business prospects.
The intense competition in the mortgage industry has also led to rapid
technological developments, evolving industry standards and frequent releases of
new products and enhancements. As mortgage products are offered more widely
through alternative distribution channels, such as the Internet, we may be
required to make significant changes to our information systems to compete
effectively. Our inability to continue enhancing our current capabilities, or to
adapt to other technological changes in the industry, could have a material
adverse effect on our results of operations, financial condition and business
prospects.
Our hedging strategies may not be successful in mitigating our risks associated
with changes in interest rates.
We intend to use various derivative financial instruments to provide a level of
protection against changes in interest rates, but no hedging strategy can
protect us completely. When rates change we expect to record a gain or loss on
derivatives, which would be offset by an inverse change in the value of loans or
residual interests. We cannot assure you, however, that our use of derivatives
will offset the risks related to changes in interest rates. It is likely that
there will be periods in the future, during which we will incur losses after
accounting for our derivative financial instruments. The derivative financial
instruments we select may not have the effect of reducing our interest rate
risk. In addition, the nature and timing of hedging transactions may influence
the effectiveness of these strategies. Poorly designed strategies or improperly
executed transactions could actually increase our risk and losses. In addition,
hedging strategies involve transaction and other costs. We cannot assure you
that our hedging strategy and the derivatives that we use will adequately offset
the risk of interest rate volatility or that our hedging transactions will not
result in losses.
The complex federal, state and municipal laws governing loan-servicing
activities could increase our exposure to the risk of noncompliance.
We intend to service the loan we originate on a nationwide basis. Therefore, we
must comply with the laws and regulations, as well as judicial and
31
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
administrative decisions, of all relevant jurisdictions pertaining to loan
servicing, as well as an extensive body of federal laws and regulations. The
volume of new or modified laws and regulations has increased in recent years,
and, in addition, some individual municipalities have begun to enact laws that
restrict loan-servicing activities. The laws and regulations of each of these
jurisdictions are different, complex and, in some cases, in direct conflict with
each other. As our servicing operations continue to grow, it may be more
difficult to comprehensively identify, to accurately interpret and to properly
program our technology systems and effectively train our personnel with respect
to all of these laws and regulations, thereby potentially increasing our
exposure to the risks of noncompliance with the laws and regulations pertaining
to loan servicing. Our failure to comply with these laws could lead to, among
other things: (i) civil and criminal liability, including potential monetary
penalties; (ii) legal defenses causing delaying or otherwise adversely affecting
the servicer's ability to enforce loans, or giving the borrower the right to
rescind or cancel the loan transaction; (iii) class action lawsuits; and (iv)
administrative enforcement actions. This could result in a material adverse
effect on our results of operations, financial condition and business prospects.
Any non-prime loans we originate will generally have higher delinquency and
default rates, which could result in losses on loans that we are required to
repurchase.
Non-prime mortgage loans generally have higher delinquency and default rates
than prime mortgage loans. Delinquency interrupts the flow of projected interest
income from a mortgage loan, and default can ultimately lead to a loss if the
net realizable value of the real property securing the mortgage loan is
insufficient to cover the principal and interest due on the loan. Also, our cost
of financing and servicing a delinquent or defaulted loan is generally higher
than for a performing loan. We bear the risk of delinquency and default on loans
beginning when we originate them. In whole loan sales our risk of delinquency
typically only extends to the first payment, but when we securitize we continue
to bear some exposure to delinquencies and losses through our residual interests
and the loans underlying our on-balance sheet securitization transactions. We
are required to establish reserves based on our anticipated delinquencies and
losses. We also re-acquire the risks of delinquency and default for loans that
we are obligated to repurchase. We attempt to manage these risks with risk-based
loan pricing and appropriate underwriting policies and loan collection methods.
However, if such policies and methods are insufficient to control our
delinquency and default risks and do not result in appropriate loan pricing and
appropriate loss reserves, our business, financial condition, liquidity and
results of operations could be harmed.
We are subject to losses due to fraudulent and negligent acts on the part of
loan applicants, mortgage brokers, other vendors and our employees. When we
originate mortgage loans, we rely heavily upon information supplied by third
parties including the information contained in the loan application, property
appraisal, title information and employment and income documentation. If any of
this information is intentionally or negligently misrepresented and such
misrepresentation is not detected prior to loan funding, the value of the loan
may be significantly lower than expected. Whether a misrepresentation is made by
the loan applicant, the mortgage broker, another third party or one of our
employees, we generally bear the risk of loss associated with the
misrepresentation. A loan subject to a material misrepresentation is typically
unsaleable or subject to repurchase if it is sold prior to detection of the
misrepresentation, and the persons and entities involved are often difficult to
32
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
locate and it is often difficult to collect any monetary losses that we have
suffered from them.
There are controls and processes designed to help us identify misrepresented
information in our loan origination operations. We cannot assure you, however,
that we have detected or will detect all misrepresented information in our loan
originations.
We may be subject to fines or other penalties based upon the conduct of our
independent brokers.
The mortgage brokers from whom we obtain loans have parallel and separate legal
obligations to which they are subject. While these laws may not explicitly hold
the originating lenders responsible for the legal violations of mortgage
brokers, increasingly federal and state agencies have sought to impose such
assignee liability. Recently, for example, the United States Federal Trade
Commission ("FTC") entered into a settlement agreement with a mortgage lender
where the FTC characterized a broker that had placed all of its loan production
with a single lender as the "agent" of the lender. The FTC imposed a fine on the
lender in part because, as "principal," the lender was legally responsible for
the mortgage broker's unfair and deceptive acts and practices. The United States
Justice Department in the past has sought to hold a non-prime mortgage lender
responsible for the pricing practices of its mortgage brokers, alleging that the
mortgage lender was directly responsible for the total fees and charges paid by
the borrower under the Fair Housing Act even if the lender neither dictated what
the mortgage broker could charge nor kept the money for its own account.
Accordingly, we may be subject to fines or other penalties based upon the
conduct of our independent mortgage brokers.
Our business is dependent upon conditions in California where we conduct a
significant amount of our business.
In 2004, 100% of the mortgage loans we originated were secured by property in
California. An overall decline in the economy or the residential real estate
market, or the occurrence of a natural disaster, such as an earthquake, or a
major terrorist attack in California could adversely affect the value of the
mortgaged properties in California and increase the risk of delinquency,
foreclosure, bankruptcy, or loss on mortgage loans in our portfolio. This would
negatively affect our ability to purchase, originate and securitize mortgage
loans, which could have a material adverse effect on our business, financial
condition and results of operations.
If many of our borrowers become subject to the Soldiers' and Sailors' Civil
Relief Act of 1940, as amended our cash flows from our residual securities and
our securitizations structured as financings may be adversely affected.
Under the Soldiers' and Sailors' Civil Relief Act of 1940, a borrower who enters
military service after the origination of his or her mortgage loan generally may
not be charged interest above an annual rate of 6% during the period of the
borrower's active duty status. The Act also applies to a borrower who was on
reserve status and is called to active duty after origination of the mortgage
loan. A prolonged, significant military mobilization as part of the war on
terrorism or the war in Iraq could increase the number of the borrowers in our
securitized pools who are subject to this Act and thereby reduce the interest
payments collected from those borrowers. To the extent the number of borrowers
who are subject to this Act is significant, the cash flows we receive from loans
underlying our on-balance sheet securitizations and from our residual interests
33
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
would be reduced, which could cause us to reduce the carrying value of our
residual interests and would decrease our earnings. In addition, the Soldiers'
and Sailors' Civil Relief Act of 1940, imposes limitations that would impair the
ability of the servicer to foreclose on an affected mortgage loan during the
borrower's period of active duty status, and under certain circumstances, during
an additional three month period thereafter. Any such reduction in our cash
flows or impairment in our performance could have a material adverse effect on
our results of operations, financial condition and business prospects.
The inability to attract and retain qualified employees could significantly harm
our business.
We are dependent on our account executives and retail loan officers to attract
borrowers by, among other things, developing relationships with financial
institutions, other mortgage companies and brokers, real estate agents,
borrowers and others. We believe that these relationships lead to repeat and
referral business. The market for skilled account executives and loan officers
is highly competitive and historically has experienced a high rate of turnover.
In addition, if a manager leaves New Century, there is an increased likelihood
that other members of his or her team will follow. Competition for qualified
account executives and loan officers may lead to increased hiring and retention
costs. If we are unable to attract or retain a sufficient number of skilled
account executives at manageable costs, we will be unable to continue to
originate quality mortgage loans that we are able to sell for a profit, which
would have a material adverse effect on our results of operations, financial
condition and business prospects.
An interruption in or breach of our information systems may result in lost
business.
We rely heavily upon communications and information systems to conduct our
business. Any failure or interruption or breach in security of our information
systems or the third-party information systems on which we rely could cause
underwriting or other delays and could result in fewer loan applications being
received, slower processing of applications and reduced efficiency in loan
servicing. We are required to comply with significant federal and state
regulations with respect to the handling of customer information, and a failure,
interruption or breach of our information systems could result in regulatory
action and litigation against us. We cannot assure you that such failures or
interruptions will not occur or if they do occur that they will be adequately
addressed by the third parties or us on which we rely. The occurrence of any
failures or interruptions could have a material adverse effect on our results of
operations, financial condition and business prospects.
The success and growth of our business will depend upon our ability to adapt to
and implement technological changes.
Our mortgage loan origination business is currently dependent upon our ability
to effectively interface with our brokers, borrowers and other third parties and
to efficiently process loan applications and closings. The origination process
is becoming more dependent upon technological advancement, such as the ability
to process applications over the Internet, accept electronic signatures, provide
process status updates instantly and other customer-expected conveniences that
are cost-efficient to our process. In addition, we are in the process of
implementing a new loan origination system. Implementing and becoming proficient
with the new loan origination system and other new technology will require
significant financial and personnel resources. There is no guarantee that the
34
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
implementation of our new loan origination system or other new technology will
be successful. To the extent that we become reliant on any particular technology
or technological solution, we may be adversely affected to the extent that such
technology or technological solution (i) becomes non-compliant with existing
industry standards, (ii) fails to meet or exceed the capabilities of our
competitors' equivalent technologies or technological solutions, or (iii)
becomes increasing expensive to service, retain and update. Any failure to
acquire technology or technology solutions when necessary could limit our
ability to remain competitive in our industry and could also limit our ability
to increase the cost-efficiencies of our operating model, which would have a
material adverse effect on our results of operations, financial condition and
business prospects. We may be required to repurchase mortgage loans or indemnify
investors if we breach representations and warranties, which could adversely
impact our earnings.
When we sell loans, we are required to make customary representations and
warranties about such loans to the loan purchaser. Our whole loan sale
agreements require us to repurchase or substitute loans in the event we breach a
representation or warranty given to the loan purchaser or make a
misrepresentation during the mortgage loan origination process. In addition, we
may be required to repurchase loans as a result of borrower fraud or in the
event of early payment default on a mortgage loan. Likewise, we are required to
repurchase or substitute loans if we breach a representation or warranty in
connection with our securitizations. The remedies available to a purchaser of
mortgage loans are generally broader than those available to us against the
originating broker or correspondent. Further, if a purchaser enforces its
remedies against us, we may not be able to enforce the remedies we have against
the sellers. The repurchased loans typically can only be financed at a steep
discount to their repurchase price, if at all. They are also typically sold at a
significant discount to the unpaid principal balance. Significant repurchase
activity could negatively affect our cash flow and results of operations.
We are exposed to risk of environmental liabilities with respect to properties
to which we take title.
In the course of our business, we may foreclose and take title to residential
properties, and could be subject to environmental liabilities with respect to
these properties. We may be held liable to a governmental entity or to third
parties for property damage, personal injury, investigation, and clean-up costs
incurred by these parties in connection with environmental contamination, or may
be required to investigate or clean up hazardous or toxic substances, or
chemical releases at a property. The costs associated with investigation or
remediation activities could be substantial. In addition, as the owner or former
owner of a contaminated site, we may be subject to common law claims by third
parties based on damages and costs resulting from environmental contamination
emanating from the property. If we ever become subject to significant
environmental liabilities, our business, financial condition and results of
operations could be materially and adversely affected.
Our charter and bylaws and Nevada law contain provisions that could discourage a
takeover.
Our amended and restated certificate of incorporation and our amended and
restated bylaws include various provisions that could delay, defer or prevent a
takeover attempt that may be in the best interest of our stockholders. These
provisions include the existence of a classified board of directors, the ability
of our board of directors to issue shares of our preferred stock without any
35
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (continued)
further stockholder approval and requirements that (i) our stockholders give
advance notice with respect to certain proposals they may wish to present for a
stockholder vote, (ii) our stockholders act only at annual or special meetings
and (iii) two-thirds of all directors approve a change in the number of
directors on our board of directors. Issuance of our preferred stock could
discourage bids for the common stock at a premium as well as create a depressive
effect on the market price of our common stock.
We are also subject to Nevada General Corporation Law, which could discourage
potential acquisition proposals, delay or prevent a change of control and
prevent changes in our management.
If we do not manage our growth effectively, our financial performance could be
harmed.
Rapid growth places, and will continue to place, certain pressures on our
management, administrative, operational and financial infrastructure. As of
December 31, 2003, we had no employees, as all of our personnel were independent
contractors; however, we have recently applied for licensure under the
California Department of Corporations as a Consumer Finance Lender and will
begin hiring loan executives as employees. Many of these employees have a
limited understanding of our systems and controls. The increase in the size of
our operations may make it more difficult for us to ensure that we originate
quality loans and that we service them effectively. We will need to attract and
hire additional sales and management personnel in an intensely competitive
hiring environment in order to preserve and increase our market share. At the
same time, we will need to continue to upgrade and expand our financial,
operational and managerial systems and controls.
Various factors may cause the market price of our common stock to become
volatile, which could adversely affect our ability to access the capital markets
in the future.
The market price of our common stock may experience fluctuations that are
unrelated to our operating performance. In particular, the price of our common
stock may be affected by general market price movements as well as developments
specifically related to the consumer finance industry and the financial services
sector. These could include, among other things, interest rate movements,
quarterly variations or changes in financial estimates by securities analysts,
or a significant reduction in the price of the stock of another participant in
the consumer finance industry. This volatility may make it difficult for us to
access the capital markets through additional secondary offerings of our common
stock, regardless of our financial performance.
ITEM 3: CONTROLS AND PROCEDURES
a) Evaluation of disclosure controls and procedures. Our Chief Executive
Officer, after evaluating the effectiveness of the our "disclosure controls and
procedures" (as defined in the Securities Exchange Act of 1934 Rules 13a-15(e)
and 15d-15(e)) as of the end of the period covered by this annual report (the
"Evaluation Date"), has concluded that as of the Evaluation Date, our disclosure
controls and procedures were adequate and designed to ensure that material
information relating to the Company and our consolidated subsidiaries would be
made known to him by others within those entities.
36
ITEM 3: CONTROLS AND PROCEDURES (continued)
(b) Changes in internal control over financial reporting. There were no
significant changes in the our internal control over financial reporting during
the fourth fiscal quarter that materially affected, or are reasonably likely to
materially affect, the our internal control over financial reporting.
37
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On January 27, 2004 DL Pacific Center LP ("DL Pacific") filed a lawsuit for
$40,444 plus costs and attorney's fees against us in San Diego County Superior
Court. The suit alleges that, after we purchased San Francisco Funding, Inc.
("SFF") in November 2003, we assumed SFF's obligations pursuant to DL Pacific's
lease with SFF by accepting the benefits of such lease and by negotiating with
DL Pacific for amendments to the lease. Silverado has agreed to settle the
lawsuit.
On March 9, 2004 Robert E. Vener ("Vener") filed an amendment to his lawsuit for
$7,500 per month from November 2003 to March 2006 plus costs and attorney's fees
against us in Marin County Superior Court. The suit alleges that, after we
purchased San Francisco Funding, Inc. ("SFF") in November 2003, we assumed SFF's
obligations pursuant to Vener's lease with SFF by stating and representing to
Vener that we would be responsible for any amounts due from SFF pursuant to the
lease, and that Vener relied on our representations by allowing SFF to remain on
the premises following SFF's default in the payment of rent on the lease. We
have agreed to settle the suit.
We have filed a cross-complaint against SFF and its major stockholder(s) Mr. and
Mrs. Daniel Selis, for indemnity for the cost of defending the Veneer lawsuit,
and punitive damages resulting from breach of contract, fraud and/or
interference with our advantageous business relationships because of: (1) SFF's
material breaches of the SFF stock purchase agreement and SFF's material
misrepresentations to us of SFF's liabilities and obligations, (2) SFF's written
false statements to its creditors that we had assumed their debts, and (3) SFF's
forwarding of its phone calls tour offices and directing their creditors to call
our offices concerning payment of their liabilities and obligations. On May 12,
2004 The Subway. Com filed for Arbitration for $60,000 plus interest against us
in the state of Florida. The suit claims breach of contract for stock promotion
services. The Company believes it has meritorious defense and that no contract
was ever consummated.
On July 16, 2004, the company was served with a complaint by the State of
California, Department of Industrial Relations on behalf of a former contractor
for back wages of $10,937.50 and penalties of $288.46 for an indeterminate
number. It is management's opinion, that we have meritorious defenses based upon
the facts, among others, that claimant was acting as an independent contractor
who was paid for services performed and her claims are baseless.
On November 24, 2004, SRD Technologies signed a debt cancellation and release
agreement which included the release of any and all liabilities owed to SRD
Technologies, the relinquishing of 574,953 shares of Silverado Financial, Inc.
(SLVO) stock, and a payment to be made by SRD Technologies for auditing expenses
in the amount of $7,500. On the date of the agreement the 574,953 shares were
worth $.05 a share or $28,748. The affect on our books would be the release of
debt in the form of a note payable in the amount of $275,000 plus accrued
interest of $41,047. The $7,500 payment would reduce our payable to our auditors
and there would be a reduction in shares issued and outstanding.
On November 24, 2004, John Shebanow signed a general release agreement, which
included the relinquishing of any and all shares of Silverado Financial, Inc.
held by himself (575,870 shares), friends and family and releases any and all of
Silverado Financials liability to Mr. Shebanow on the date of the agreement the
575,870 shares were worth $0.05 a share or $28,794. The affect on our books
would be a reduction in accounts payable of approximately $20,660 and a
reduction in the number of shares issued and outstanding.
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ITEM 2. CHANGES IN SECURITIES
On January 14, 2005 the Company issued 410,000 S-8 shares in payment for legal
services and as retainer for future service to out corporate attorney David
Kahn. The value of the securities at the time was $37,000. The company also
issued 32,675 shares to Martin Fisher for work on the Company's software the
value of the shares was $$2,950. We also issued 20,750 shares to Allen Suzuki
for accounting services the value of the shares was $1,867.50. Juan Negron was
issued 4,572 S-8 share in payment for work on computers and network
infrastructure at a value of $1000.00.
On January 14, 2005 the Company issued 10,000 shares of restricted stock in
exchange for furniture and fixtures for the Phoenix, Arizona of to Justin Berry.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
31.1 Certificate of Chief Executive Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certificate of Chief Financial Officer pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certificate of Chief Executive Officer and Chief Financial Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
Report on Form 8-K filed with the Security and Exchange Commission on May 17,
2005 reporting Acquisition of CoreOne Mortgage and Liberty Settlement.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized. SILVERADO FINANCIAL, INC.
/s/ John E. Hartman
-------------------------------------
By: John E. Hartman
President, Chief Executive Officer
& Interim Chief Financial Officer
Date: December 22, 2005
39