UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q
þ
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
For
the quarterly period ended March 31, 2008
o
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
MRU
Holdings, Inc.
(Exact
name of registrant as specified in its charter)
Delaware
(State
or Other Jurisdiction of
Incorporation
or Organization)
|
33-0954381
(I.R.S.
Employer
Identification
No.)
|
|
|
590
Madison Avenue, 13th
Floor
New
York, New York
(Address
of Principal Executive Offices)
|
10022
(Zip
Code)
|
Registrant’s
telephone number, including area code:
(212)
398-1780
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements
for
the past 90 days.
þ
Yes
¨
No
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company.
See
the definitions of “large accelerated filer”, “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
¨
Large
accelerated filer
¨
Accelerated filer
þ
Non-accelerated filer
¨
Smaller
reporting company
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
¨
Yes
þ
No
The
number of shares outstanding of the issuer’s common stock, $0.001 par value, as
of May 9, 2008 was 31,721,174 shares.
TABLE
OF CONTENTS
|
|
|
Page
|
Part
I. Financial Information
|
|
|
|
|
|
ITEM
1.
|
|
Financial
Statements
|
3
|
|
|
Condensed
Consolidated Balance Sheets as of March 31, 2008 (unaudited) and June
30, 2007 (audited)
|
3
|
|
|
Condensed
Consolidated Statements of Operations for the Three and Nine Months
Ended
March 31, 2008 and 2007 (unaudited)
|
4
|
|
|
Condensed
Consolidated Statements of Cash Flows for the Nine Months Ended March
31,
2008 and 2007 (unaudited)
|
5
|
|
|
Notes
to Condensed Consolidated Financial Statements
(unaudited)
|
6
|
ITEM
2.
|
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
26
|
ITEM
3.
|
|
Quantitative
and Qualitative Disclosures about Market Risk
|
33
|
ITEM
4.
|
|
Controls
and Procedures
|
33
|
|
|
|
|
Part
II. Other Information
|
|
|
|
|
|
ITEM
1.
|
|
Legal
Proceedings
|
34
|
ITEM
1A.
|
|
Risk
Factors
|
34
|
ITEM
2.
|
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
42
|
ITEM
3.
|
|
Defaults
upon Senior Securities
|
42
|
ITEM
4.
|
|
Submission
of Matters to a Vote of Security Holders
|
42
|
ITEM
5.
|
|
Other
Information
|
42
|
ITEM
6.
|
|
Exhibits
|
43
|
|
|
|
|
SIGNATURES
|
44
|
PART
I.
FINANCIAL
INFORMATION
Item
1. Financial Statements
MRU
HOLDINGS, INC. AND SUBSIDIARIES
|
CONDENSED
CONSOLIDATED BALANCE SHEETS
|
MARCH
31, 2008 AND JUNE 30, 2007
|
(Dollars
in Thousands)
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March
31,
|
|
June
30,
|
|
|
|
2008
|
|
2007
|
|
|
|
(unaudited)
|
|
(audited)
|
|
ASSETS:
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
17,223
|
|
$
|
11,606
|
|
Restricted
cash
|
|
|
2,652
|
|
|
3,154
|
|
Accounts
receivable
|
|
|
665
|
|
|
1,979
|
|
Private
student loans receivable, held for sale, lower of cost or
market
|
|
|
106,476
|
|
|
6,256
|
|
Valuation
Reserve for private student loans receivable
|
|
|
(2,827
|
)
|
|
(815
|
)
|
Federally
insured student loans receivable, held for sale, lower of cost
or
market
|
|
|
36,407
|
|
|
7,395
|
|
Accounts
receivable from securitizations
|
|
|
9,263
|
|
|
11,192
|
|
Original
issue discount - Senior Secured Notes
|
|
|
1,152
|
|
|
-
|
|
Fixed
assets, net of depreciation
|
|
|
1,957
|
|
|
1,553
|
|
Security
deposits
|
|
|
1,013
|
|
|
955
|
|
Intangible
assets, net of amortization
|
|
|
2,281
|
|
|
2,824
|
|
Goodwill
|
|
|
5,803
|
|
|
5,875
|
|
Investment
in Education Empowerment Fund I, LLC
|
|
|
670
|
|
|
322
|
|
Due
from affiliates
|
|
|
(34
|
)
|
|
803
|
|
Deferred
financing fees, net of amortization
|
|
|
2,198
|
|
|
-
|
|
Prepaid
expenses and other assets
|
|
|
1,775
|
|
|
1,094
|
|
|
|
|
|
|
|
|
|
TOTAL
ASSETS
|
|
$
|
186,674
|
|
$
|
54,192
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES
AND STOCKHOLDERS' EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES:
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
1,948
|
|
$
|
3,835
|
|
Accrued
expenses
|
|
|
2,510
|
|
|
458
|
|
Accrued
payroll
|
|
|
526
|
|
|
592
|
|
Client
deposits
|
|
|
2,467
|
|
|
899
|
|
Deferred
contract revenue
|
|
|
2,342
|
|
|
2,276
|
|
Notes
payable - Doral Bank FSB NY
|
|
|
2,943
|
|
|
1,399
|
|
Notes
payable - Merrill Lynch
|
|
|
112,924
|
|
|
11,711
|
|
Notes
payable - DZ
|
|
|
19,702
|
|
|
-
|
|
Senior
Secured Notes
|
|
|
11,200
|
|
|
-
|
|
Deferred
origination fee revenue
|
|
|
4,423
|
|
|
226
|
|
Obligations
under capital lease
|
|
|
609
|
|
|
-
|
|
Other
liabilities
|
|
|
1,220
|
|
|
63
|
|
|
|
|
|
|
|
|
|
Total
Liabilities
|
|
|
162,814
|
|
|
21,459
|
|
|
|
|
|
|
|
|
|
STOCKHOLDERS'
EQUITY
|
|
|
|
|
|
|
|
Preferred
Stock, Series B, $.001 par value; 12,000,000 shares
authorized
|
|
|
|
|
|
|
|
8,237,264
shares issued and outstanding as of March 31, 2008 and June 30,
2007
|
|
|
8
|
|
|
8
|
|
Common
Stock, $.001 par value; 20,000,000 shares authorized, 31,721,174
and
|
|
|
|
|
|
|
|
25,714,393
issued and outstanding as of March 31, 2008 and June 30,
2007
|
|
|
32
|
|
|
26
|
|
Additional
paid-in capital
|
|
|
92,026
|
|
|
68,788
|
|
Additional
paid-in capital - options
|
|
|
15,534
|
|
|
13,038
|
|
Additional
paid-in capital - Series B beneficial conversion feature
|
|
|
14,520
|
|
|
14,264
|
|
Additional
paid-in capital - warrants
|
|
|
18,464
|
|
|
15,454
|
|
Accumulated
other comprehensive income
|
|
|
-
|
|
|
2,757
|
|
Accumulated
deficit
|
|
|
(116,724
|
)
|
|
(81,602
|
)
|
|
|
|
|
|
|
|
|
Total
Stockholders' Equity
|
|
|
23,860
|
|
|
32,733
|
|
|
|
|
|
|
|
|
|
TOTAL
LIABILITIES AND STOCKHOLDERS' EQUITY
|
|
$
|
186,674
|
|
$
|
54,192
|
|
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
MRU
HOLDINGS, INC. AND SUBSIDIARIES
|
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
|
FOR
THE THREE AND NINE MONTHS ENDED MARCH 31, 2008 AND
2007
|
(UNAUDITED)
|
(Dollars
in Thousands - except per share data)
|
|
Three
Months Ended
|
|
Nine
Months Ended
|
|
|
|
March
31,
|
|
March
31,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
|
|
(Restated)
|
|
|
|
(Restated)
|
|
|
|
|
|
|
|
|
|
|
|
Interest
Income:
|
|
|
|
|
|
|
|
|
|
Loan
portfolio interest income - private student loans
|
|
$
|
2,295
|
|
$
|
2,242
|
|
$
|
4,666
|
|
$
|
5,124
|
|
Loan
portfolio interest income - federal student loans
|
|
|
444
|
|
|
41
|
|
|
870
|
|
|
104
|
|
Origination
fee revenue - private loans
|
|
|
178
|
|
|
32
|
|
|
218
|
|
|
78
|
|
Interest
Income - Residual Interest
|
|
|
343
|
|
|
-
|
|
|
1,105
|
|
|
-
|
|
Other
Interest income
|
|
|
225
|
|
|
78
|
|
|
591
|
|
|
375
|
|
Total
interest income
|
|
|
3,485
|
|
|
2,393
|
|
|
7,450
|
|
|
5,681
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
Expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Facility
interest and origination bank costs
|
|
|
2,108
|
|
|
1,754
|
|
|
4,989
|
|
|
4,139
|
|
Other
Interest expense
|
|
|
375
|
|
|
4
|
|
|
744
|
|
|
7
|
|
Total
interest expense
|
|
|
2,483
|
|
|
1,758
|
|
|
5,733
|
|
|
4,146
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Interest Income
|
|
|
1,002
|
|
|
635
|
|
|
1,717
|
|
|
1,535
|
|
Valuation
reserve provision - private student loans
|
|
|
815
|
|
|
283
|
|
|
3,643
|
|
|
2,449
|
|
Net
interest income after valuation provision
|
|
|
187
|
|
|
352
|
|
|
(1,926
|
)
|
|
(914
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securitization
income (loss), net
|
|
|
(2,270
|
)
|
|
-
|
|
|
1,795
|
|
|
-
|
|
Subscription
and service revenue
|
|
|
1,501
|
|
|
709
|
|
|
4,275
|
|
|
722
|
|
Origination
processing fees
|
|
|
140
|
|
|
111
|
|
|
680
|
|
|
353
|
|
Master
Oversight Fee
|
|
|
28
|
|
|
-
|
|
|
79
|
|
|
-
|
|
Other
non-interest income
|
|
|
-
|
|
|
10
|
|
|
-
|
|
|
11
|
|
Total
non-interest income
|
|
|
(601
|
)
|
|
830
|
|
|
6,829
|
|
|
1,086
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate
general and administrative expenses
|
|
|
4,236
|
|
|
3,376
|
|
|
12,284
|
|
|
7,128
|
|
Sales
and marketing expenses
|
|
|
2,299
|
|
|
2,582
|
|
|
9,541
|
|
|
8,023
|
|
Operations
expenses
|
|
|
1,219
|
|
|
1,242
|
|
|
5,380
|
|
|
3,751
|
|
Technology
development
|
|
|
902
|
|
|
691
|
|
|
2,817
|
|
|
2,151
|
|
Referral
marketing costs - private student loans
|
|
|
382
|
|
|
224
|
|
|
1,521
|
|
|
725
|
|
Consulting
and hosting
|
|
|
103
|
|
|
58
|
|
|
209
|
|
|
80
|
|
Cost
of subscription and service revenue
|
|
|
336
|
|
|
-
|
|
|
1,379
|
|
|
-
|
|
Servicing
and custodial costs
|
|
|
181
|
|
|
119
|
|
|
378
|
|
|
256
|
|
Legal
expenses
|
|
|
610
|
|
|
397
|
|
|
1,425
|
|
|
860
|
|
Other
operating expenses
|
|
|
396
|
|
|
366
|
|
|
927
|
|
|
564
|
|
Depreciation
and amortization
|
|
|
1,620
|
|
|
959
|
|
|
2,476
|
|
|
4,035
|
|
Total
non-interest expense
|
|
|
12,284
|
|
|
10,014
|
|
|
38,337
|
|
|
27,573
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss)
before provision for income taxes
|
|
|
(12,698
|
)
|
|
|
)
|
|
(33,434
|
)
|
|
(27,401
|
)
|
Provision
for income taxes
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
(Loss)
|
|
$
|
(12,698
|
)
|
$
|
(8,832
|
)
|
$
|
(33,434
|
)
|
$
|
(27,401
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Less
Preferred Stock Dividends
|
|
|
(484
|
)
|
|
(776
|
)
|
|
(1,687
|
)
|
|
(2,093
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
(loss) applicable to common shares
|
|
$
|
(13,182
|
)
|
$
|
(9,608
|
)
|
$
|
(35,121
|
)
|
$
|
(29,494
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
(Loss) per basic and diluted shares
|
|
$
|
(0.42
|
)
|
$
|
(0.47
|
)
|
$
|
(1.22
|
)
|
$
|
(1.60
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average number of common shares outstanding
|
|
|
31,669
|
|
|
20,658
|
|
|
28,880
|
|
|
18,401
|
|
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
MRU
HOLDINGS, INC. AND SUBSIDIARIES
|
CONDENSED CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
FOR
THE NINE MONTHS ENDED MARCH 31, 2008 AND 2007
|
(UNAUDITED)
|
(Dollars
in Thousands)
|
|
Nine
Months Ended
|
|
|
|
March
31,
|
|
|
|
2008
|
|
2007
|
|
|
|
|
|
(Restated)
|
|
CASH
FLOWS FROM OPERATING ACTIVITIES
|
|
|
|
|
|
Net
(loss)
|
|
$
|
(33,434
|
)
|
$
|
(27,401
|
)
|
Adjustments
to reconcile net loss to net cash
|
|
|
|
|
|
|
|
used
in operating activities:
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
2,476
|
|
|
4,035
|
|
Increase
in stock options outstanding - options expense
|
|
|
2,781
|
|
|
3,296
|
|
(Decrease)
in stock options outstanding - options exercise
|
|
|
(285
|
)
|
|
(105
|
)
|
(Increase)
in tax provision valuation stock options outstanding
|
|
|
(945
|
)
|
|
(1,121
|
)
|
Accretion
of interest income on A/R from securitization
|
|
|
(1,105
|
)
|
|
-
|
|
Impairment
loss - A/R from securitization
|
|
|
2,270
|
|
|
-
|
|
Increase
in valuation reserve - private student loans
|
|
|
3,994
|
|
|
2,449
|
|
(Decrease)
in valuation reserve - private student loans sold in
securitization
|
|
|
(821
|
)
|
|
-
|
|
(Decrease)
in valuation reserve - private student loans charged-off
|
|
|
(1,161
|
)
|
|
(280
|
)
|
|
|
|
|
|
|
|
|
Changes
in assets and liabilities
|
|
|
|
|
|
|
|
Decrease/(Increase)
in accounts receivable
|
|
|
1,314
|
|
|
(1,231
|
)
|
Decrease
in restricted cash
|
|
|
501
|
|
|
22
|
|
(Increase)
in prepaid expenses and other current assets
|
|
|
(398
|
)
|
|
(8
|
)
|
Decrease/(Increase)
in due from affiliates
|
|
|
837
|
|
|
(679
|
)
|
Decrease
in goodwill
|
|
|
72
|
|
|
-
|
|
(Increase)
in security deposits
|
|
|
(58
|
)
|
|
(1
|
)
|
(Increase)
in private student loans receivable, held for sale
|
|
|
(133,072
|
)
|
|
(79,444
|
)
|
(Increase)
in federal student loans receivable, held for sale
|
|
|
(29,013
|
)
|
|
(7,545
|
)
|
Sale
of private student loans receivable into securitization
|
|
|
32,852
|
|
|
-
|
|
(Decrease)/Increase
in accounts payable and accrued expenses, and other
liabilities
|
|
|
(854
|
)
|
|
2,233
|
|
(Decrease)/Increase
in accrued payroll
|
|
|
(4
|
)
|
|
61
|
|
Increase/(Decrease)
in deferred contract revenue
|
|
|
66
|
|
|
(548
|
)
|
Increase
in client deposits
|
|
|
1,569
|
|
|
1,061
|
|
Increase
in deferred origination fee revenue
|
|
|
4,197
|
|
|
2,930
|
|
|
|
|
|
|
|
|
|
Total
adjustments
|
|
|
(114,785
|
)
|
|
(74,875
|
)
|
|
|
|
|
|
|
|
|
Net
cash (used in) operating activities
|
|
|
(148,220
|
)
|
|
(102,276
|
)
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM INVESTING ACTIVITIES
|
|
|
|
|
|
|
|
Acquisition
of fixed assets
|
|
|
(1,082
|
)
|
|
(423
|
)
|
Acquisition
of intangible assets
|
|
|
-
|
|
|
(6,320
|
)
|
(Increase)
in receivables from securitizations
|
|
|
(1,993
|
)
|
|
-
|
|
(Increase)
in Education Empowerment Fund I, LLC
|
|
|
(348
|
)
|
|
(1,380
|
)
|
|
|
|
|
|
|
|
|
Net
cash (used in) investing activities
|
|
|
(3,423
|
)
|
|
(8,123
|
)
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITES
|
|
|
|
|
|
|
|
Increase
in advances - originating loan program agreements
|
|
|
137,995
|
|
|
77,823
|
|
(Decrease)
due to repayments - originating loan program agreements
|
|
|
(136,451
|
)
|
|
(77,971
|
)
|
Increase
in advances - Nomura Credit and Capital credit facility
|
|
|
-
|
|
|
731
|
|
(Decrease)
due to repayments - Nomura Credit and Capital credit
facility
|
|
|
-
|
|
|
(1,909
|
)
|
Increase
in advances - Merrill Lynch credit facility
|
|
|
148,267
|
|
|
83,660
|
|
(Decrease)
due to repayments - Merrill Lynch credit facility
|
|
|
(47,054
|
)
|
|
(4,393
|
)
|
Increase
in advances - DZ credit facility
|
|
|
19,702
|
|
|
-
|
|
Proceeds
from issuance of common stock
|
|
|
22,865
|
|
|
-
|
|
Proceeds
from issuance of senior secured notes
|
|
|
9,983
|
|
|
-
|
|
Proceeds
from conversion of warrants and options
|
|
|
1,161
|
|
|
25,342
|
|
(Decrease)
in paid-in capital for warrant conversions
|
|
|
-
|
|
|
(1,302
|
)
|
Increase
in deferred tax due to stock options outstanding
|
|
|
945
|
|
|
1,121
|
|
Increase
in obligation under capital lease agreement
|
|
|
609
|
|
|
-
|
|
Cash
used in other financing activities
|
|
|
(21
|
)
|
|
-
|
|
(Increase)
in deferred financing fees
|
|
|
(741
|
)
|
|
(804
|
)
|
|
|
|
|
|
|
|
|
Net
cash provided by financing activities
|
|
|
157,260
|
|
|
102,299
|
|
|
|
|
|
|
|
|
|
NET
INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS
|
|
|
5,617
|
|
|
(8,101
|
)
|
|
|
|
|
|
|
|
|
CASH
AND CASH EQUIVALENTS - BEGINNING OF PERIOD
|
|
|
11,606
|
|
|
17,900
|
|
|
|
|
|
|
|
|
|
CASH
AND CASH EQUIVALENTS - END OF PERIOD
|
|
$
|
17,223
|
|
$
|
9,799
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH
PAID DURING THE YEAR FOR:
|
|
|
|
|
|
|
|
Interest
expense
|
|
$
|
5,733
|
|
$
|
4,146
|
|
Income
taxes
|
|
$
|
-
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL
DISCLOSURE OF NON-CASH ACTIVITIES:
|
|
|
|
|
|
|
|
Accrued
Series B stock dividends
|
|
$
|
1,687
|
|
$
|
2,093
|
|
Cashless
exercise of warrants
|
|
$
|
500
|
|
$
|
-
|
|
Vesting
of warrants issued in connection with financings
|
|
$
|
2,225
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
The
Company purchased certain assets assumed certain liabilities
per the
Asset
|
|
|
|
|
|
|
|
Purchase
Agreement with The Princeton Review as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair
Value of Intangible Assets Acquired
|
|
$
|
-
|
|
$
|
3,000
|
|
Goodwill
|
|
$
|
-
|
|
$
|
5,875
|
|
Cash
paid
|
|
$
|
-
|
|
$
|
(6,320
|
)
|
Liabilites
Assumed
|
|
$
|
-
|
|
$
|
2,555
|
|
The
accompanying notes are an integral part of these condensed consolidated
financial statements.
MRU
HOLDINGS, INC. AND SUBSIDIARIES
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE
1 -
|
ORGANIZATION
AND BASIS OF
PRESENTATION
|
MRU
Holdings, Inc. (the “Company”) was incorporated in Delaware on March 2, 2000. On
July 6, 2004 the Company changed its name to MRU Holdings, Inc. On May 20,
2005,
the Company’s board of directors approved a change in the Company’s year end
from December 31 to June 30.
On
November 19, 2007, the 2007 annual meeting of stockholders was held at the
New
York, New York offices of Withers Bergman, LLP. At the annual meeting, the
Company’s stockholders voted on, and approved by requisite stockholder vote, the
election of eight directors to the Company’s board of directors.
NOTE
2 -
|
SUMMARY
OF SIGNIFICANT ACCOUNTING
POLICIES
|
The
condensed unaudited interim consolidated financial statements included herein
have been prepared, without audit, pursuant to the rules and regulations
of the
Securities and Exchange Commission. The condensed consolidated financial
statements and notes are presented as permitted on Form 10-Q and do not contain
information included in the Company’s annual statements and notes. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America have been condensed or omitted pursuant to such
rules
and regulations, although the Company believes that the disclosures are adequate
to make the information presented not misleading. It is suggested that these
condensed consolidated financial statements be read in conjunction with the
Company’s June 30, 2007 audited consolidated financial statements and the
accompanying notes thereto. While management believes the procedures followed
in
preparing these condensed consolidated financial statements are reasonable,
the
accuracy of the amounts are in some respects dependent upon the facts that
will
exist, and procedures that will be accomplished by the Company later in the
year.
These
condensed unaudited consolidated financial statements reflect all adjustments,
including normal recurring adjustment, which, in the opinion of management,
are
necessary to present fairly the operations and cash flows for the period
presented.
Principles
of Consolidation
The
condensed consolidated financial statements include the accounts of the
Company and all its wholly owned subsidiaries. All intercompany accounts and
transactions were eliminated in consolidation.
Use
of Estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the date
of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Revenue
and Expense Recognition
The
Company records its revenue on an accrual basis, whereby revenue is recognized
when earned and expenses recognized when incurred.
Interest
Income
Interest
income on student loans receivable is recognized in accordance with SFAS 91,
Accounting
for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans
and Initial Direct Costs of Leases
.
The
Company follows SFAS 91 for the revenue recognition of origination fee revenue,
whereby loan origination fees are deferred and recognized over the life of
the
loan as an adjustment of yield (interest income).
For
the
nine months ended March 31, 2008, the Company accrued $4,666,000 in loan
portfolio interest income on its private student loans, $218,000 in origination
fee revenue on its private student loans, $870,000 in loan portfolio interest
income on its federal student loans, $1,105,000 in interest income on the
residual interest from its June 2007 securitization, and $591,000 of other
interest income.
For
the
nine months ended March 31, 2007, the Company accrued $5,124,000 in loan
portfolio interest income on its private student loans, $78,000 in origination
fee revenue on its private student loans, $104,000 in loan portfolio interest
income on its federal student loans and $375,000 of other interest
income.
Interest
Expense
For
the
nine months ended March 31, 2008, the Company incurred $4,989,000 in credit
facility interest and originating bank costs related to its student loan
receivables portfolios and $744,000 in other interest expense.
For
the
nine months ended March 31, 2007, the Company incurred $4,139,000 in credit
facility interest and originating bank costs related to its student loan
receivables portfolios and $7,000 in other interest expense.
Valuation
Reserve - Student Loan Receivables
The
Company’s private and federally insured student loans receivable portfolios are
both held for sale and valued at the lower of cost or market. The valuation
reserve represents management’s estimate of expected losses on these student
loans receivable portfolios. This evaluation process is subject to numerous
estimates and judgments. The Company evaluates the adequacy of the valuation
reserve on its federally insured loans receivable portfolio separately from
its
private student loans receivable portfolio.
In
determining the adequacy of the valuation reserve for the private student loans
receivable portfolio, the Company considers several factors including: United
States Department of Education’s cohort default rates for Title IV
post-secondary educational institutions (adjusted for particular characteristics
of individual borrowers including the university attended, program of study,
academic progress in the current or prior program of study, and current or
prior
employment history), portfolio loan performance of those loans in repayment
versus those in nonpayment status, and portfolio delinquency and default
performance. Should any of these factors change, the estimates made by
management would also change, which in turn would impact the level of the
Company’s future valuation reserve.
The
valuation reserve is maintained at a level management believes is adequate
to
provide for estimated possible credit losses inherent in the student loan
receivable portfolio. This evaluation is inherently subjective because it
requires estimates that may be susceptible to significant changes.
As
of
March 31, 2008, the Company maintained $2,827,000 as a valuation reserve
for its
private student loans receivable, representing an additional provision of
$3,643,000 and reductions of $810,000 due to charge-offs and a reversal of
$821,000 due to the sale of loans into a securitization compared to June
30,
2007.
The
Company places a private student loan receivable on nonaccrual status and
charges off the loan when the collection of principal and/or interest is 180
days past due or if the Company learns of an event or circumstance which in
the
Company’s judgment causes the loan to have a high probability of nonpayment,
even before the collection of principal and/or interest is 180 days past due.
The Company’s third party servicers work with borrowers who have temporarily
ceased making full payments due to hardship or other factors, according to
a
schedule approved by the Company and accepted by the third party servicers
that
is consistent with established loan program servicing procedures and policies.
Loans granted deferment or forbearance will likely cease principal and/or
interest repayment, although these loans will continue to accrue interest.
The
Company works with the servicer in identifying borrowers who may be delinquent
on their loans due to misinformation (students frequently change addresses)
or
availing the student borrower deferment or forbearance. The Company actively
manages its servicing and collection process to optimize the performance of
its
student loans receivable portfolios. For the nine months ended March 31, 2008,
the Company recorded charge-offs and placed on non-accrual loans totaling
$810,000.
An
analysis of the Company’s valuation reserve is presented in the following table
for the nine months ended March 31, 2008:
|
|
Nine Months
Ended
March
31, 2008
|
|
Balance
at beginning of period
|
|
$
|
815,000
|
|
Valuation
reserve increase/(decrease)
|
|
|
|
|
Federally insured loans
|
|
|
0
|
|
Private student loans
|
|
|
3,643,000
|
|
Total
valuation reserve change
|
|
|
3,643,000
|
|
|
|
|
|
|
Charge-offs
net of recoveries
|
|
|
|
|
Federally insured loans
|
|
|
0
|
|
Private student loans
|
|
|
(810,000
|
)
|
Net
Charge-offs
|
|
|
(810,000
|
)
|
|
|
|
|
|
Loans
sold into securitization
|
|
|
(821,000
|
)
|
|
|
|
|
|
Balance
at end of period
|
|
$
|
2,827,000
|
|
Private
student loan valuation reserve as a percentage of the private student
loans receivable portfolio
|
|
|
2.65
|
%
|
Non-Interest
Income
The
Company recognizes revenues from license/subscription fees for web-based
services over the life of the contract, which is typically one to three years.
The Company recognizes revenue from transaction processing fees, such as
web-based school admissions applications, as the transactions are
completed.
For
the
nine months ended March 31, 2008, the Company recognized $1,795,000 in
securitization income (net of impairment write-downs of the Company’s residual
interest in its securitization trust) from the sale of loans into its
securitization trust, $4,275,000 from subscription and service revenue, $680,000
from origination processing fees for originating Preprime™ loans on behalf of
Education Empowerment Fund I, LLC (f/k/a Achiever Fund I, LLC) (“EEF I, LLC”)
and $79,000 in master oversight fees for managing the Preprime™ portfolio
on behalf of EEF I, LLC.
For
the
nine months ended March 31, 2007, the Company recognized $722,000 from
subscription and service revenue and $353,000 from origination processing
fees for originating Preprime™ loans on behalf of EEF I, LLC.
Non-Interest
Expense
The
Company includes as costs of revenues all direct costs related to the production
of the various revenue streams of the Company’s business.
For
the
nine months ended March 31, 2008, the Company incurred $12,284,000 in corporate,
general and administrative expenses, $9,541,000 in sales and marketing expense,
$5,380,000 in operations expense, $2,817,000 in technology development,
$1,521,000 in referral marketing costs related to the generation of the
Company’s private student loans and admission application service
business, $209,000 in consulting and hosting costs for the scholarship
search and college application products, $1,379,000 in cost of subscription
and
service revenue related to college application products, $378,000 in student
loan servicing and custodial costs, $1,425,000 in legal expenses, and $927,000
in other operating expenses.
For
the
nine months ended March 31, 2007, the Company incurred $7,128,000 in corporate,
general and administrative expenses, $8,023,000 in sales and marketing expense,
$3,751,000 in operations expense, $2,151,000 in technology development, $725,000
in referral marketing costs related to the generation of the Company’s private
student loans, $80,000 in consulting and hosting costs for the scholarship
search product, $256,000 in student loan servicing and custodial costs, $860,000
in legal expenses, and $564,000 in other operating expenses.
Cash
and Cash Equivalents/Restricted Cash
The
Company considers all highly liquid debt instruments and other short-term
investments with an initial maturity of three months or less to be cash
equivalents. The Company maintains cash and cash equivalent balances at
financial institutions that are insured by the Federal Deposit Insurance
Corporation up to $100,000. At March 31, 2008 and June 30, 2007, the Company’s
uninsured cash balances total $17,852,000 and $13,507,000,
respectively.
Included
in cash and cash equivalents are restricted cash deposits that are not readily
available to the Company for working capital purposes. At March 31, 2008 and
June 30, 2007, the Company’s restricted cash balances were $2,652,000 and
$3,154,000, respectively.
Security
Deposits
As
of
March 31, 2008 and June 30, 2007, the Company had $1,013,000 and $955,000,
respectively, in security deposits held and controlled by other parties to
secure lease agreements the Company has for office space and facilities, on
deposit with the SEC for future filings, and on deposit related to
servicing agreements.
Fixed
Assets
Fixed
assets are stated at cost. Depreciation is computed primarily using the
straight-line method over the estimated useful life of the assets.
Computer
network equipment
|
3
Years
|
Leasehold
improvements
|
3
Years
|
Furniture
and fixtures
|
3
Years
|
Investment
in Education Empowerment Fund I, LLC (f/k/a Achiever Fund I, LLC) (“EEF I,
LLC”)
On
April
18, 2006, the Company entered into a definitive agreement with a consortium
of
European financial institutions with significant experience in consumer lending
and specialty financial products to support the launch and origination of
Preprime™ student loans. These private student loans address the market
of high academic achievement post-secondary school borrowers who are
currently unable to meet traditional private student loan underwriting criteria,
e.g.
thin or
no credit history, insufficient earnings history,
etc.
The
Company is both the managing member (through its EEF I, LLC affiliate) and
a
minority investor in EEF I, LLC. As of March 31, 2008, the Company’s investment
percentage in EEF I, LLC was less than five (5%) percent.
On
April
27, 2007, Education Empowerment SPV, LLC, a wholly-owned, special purpose
subsidiary of EEF I, LLC, entered into a $100 million revolving credit facility
for the origination and funding of Preprime™ student loans with an asset backed
commercial paper conduit managed by DZ Bank AG. The facility has a five year
term. The proceeds from the initial draw down on the facility were used to
return a significant portion of invested capital to EEF I, LLC’s members. The
line of credit expands the capacity of the fund to acquire Preprime™ student
loans originated by the Company. The line of credit is solely an obligation
of
the fund. There is no recourse to the Company.
The
Company has not consolidated these affiliates within its financial statements
per FASB Interpretation 46(R),
Consolidation
of Variable Interest Entities (revised December 2003) — an interpretation of ARB
No. 51
(“FIN
46R”), which requires consolidation by business entities of variable interest
entities, which have one or more of the following characteristics (the Company’s
application of the facts of the agreement to FIN 46 requirements are noted
after
each):
|
1.
|
The
equity investment at risk is not sufficient to permit the entity
to
finance its activities without additional subordinated financial
support
provided by any parties, including the equity holders. (The agreement
anticipated the need for more than the initial funding for each member
up
to a limit of $26 million. The Company is limited to $1 million in
potential equity investment in this agreement. This agreement was
amended
to a funding limit of $40 million, with the Company limit amended
to $1.5
million.)
|
|
2.
|
The
equity investors lack one or more of the following essential
characteristics of a controlling financial
interest:
|
|
a.
|
The
direct or indirect ability to make decisions about the entity’s activities
through voting rights or similar rights. (EEF I, LLC is controlled
by a
board of managers with voting rights held by the equity
investors.)
|
|
b.
|
The
obligation to absorb the expected losses of the entity. (Gains
and losses
are allocated to members based on their respective
investments.)
|
|
c.
|
The
right to receive the expected residual return of the entity. (Residual
interests are returned to the members in a pro rata distribution
based on
their respective percentage
interests.)
|
|
3.
|
The
equity investors have voting rights that are not proportionate to
their
economic interests, and the activities of the entity involved are
conducted on behalf of an investor with a disproportionately small
voting
interest. (Voting Rights: The agreement requires the unanimous
vote of the members; under Delaware law, managers who are also
members have the same rights and powers of other members unless the
operating agreement provides otherwise. Entity Activities: EEF I,
LLC
provides student loans to unrelated third parties and
thereby generates profits which are allocated to the
members in proportion to their respective percentage
interests.)
|
On
September 27, 2007 the limited liability company agreement of EEF I, LLC was
amended and restated to allow the Company to finance its private student loans
through the fund. As part of the amendment and restatement, separate series
of limited liability company interests, as contemplated by Section 18-215 of
the
Delaware Act, were established and designated as Series A and Series B.
Preprime™ loans acquired or to be acquired by the EEF I, LLC, and the associated
assets and liabilities and cash flow of EEF I, LLC are allocated to Series
A,
and the private student loans and the associated assets and liabilities and
cash
flow of EEF I, LLC, are allocated to Series B, of which the Company is sole
member and 100% owner.
As
the
governing documents of EEF I, LLC have been changed in a manner that changes
the
characteristics of the Company’s equity investment, the Company has undertaken a
review to reconsider the initial FIN46R determination described above and has
concluded that consolidation of EEF I, LLC and affiliates is not required per
FIN46R as the entity is not a variable interest entity. The Company will
consolidate the assets, liabilities and related cash flows of the separate
Series B, as the Company is the sole member and 100% owner of such separate
series.
On
November 9, 2007, the revolving credit facility with an asset backed commercial
paper conduit managed by DZ Bank AG was amended and restated, increasing the
facility from $100 million to $200 million. As it relates to the Preprime™
lending business conducted in separate Series A, the amendment and
restatement established a maximum borrowing limit of $150
million.
The
Company accounts for the investment in the separate Series A of EEF I, LLC
at
the lower of cost or fair value, which is the Company’s investment basis (cost)
per EITF 03-16,
Accounting
for Investments in Limited Liability Companies
.
Securitization
Accounting
To
meet
the sale criteria of SFAS No. 140, the Company’s June 2007 securitization used a
two-step structure with a Qualified Special Purpose Entity (“QSPE”) that legally
isolates the transferred assets from the Company, even in the event of
bankruptcy. The transactions are also structured, in order to meet sale
treatment, to ensure that the holders of the beneficial interests issued by
the
QSPE are not constrained from pledging or exchanging their interests, and that
the Company does not maintain effective control over the transferred
assets.
The
Company assessed the financial structure of the securitization to determine
whether the trust or other securitization vehicle meets the sale criteria as
defined in SFAS No. 140 and accounts for the transaction accordingly. To be
a
QSPE, the trust must meet all of the following conditions:
|
·
|
It
is demonstrably distinct from the Company and cannot be unilaterally
dissolved by the Company and at least ten percent of the fair value
of its
interests is held by independent third parties.
|
|
·
|
The
permitted activities in which the trust can participate are significantly
limited. These activities are entirely specified up-front in the
legal
documents creating the QSPE.
|
|
·
|
There
are limits to the assets the QSPE can hold; specifically, it can
hold only
financial assets transferred to it that are passive in nature, passive
derivative instruments pertaining to the beneficial interests held
by
independent third parties, servicing rights, temporary investments
pending
distribution to security holders and cash.
|
|
·
|
It
can only dispose of its assets in automatic response to the occurrence
of
an event specified in the applicable legal documents and must be
outside
the control of the Company.
|
Retained
Interests in Securitizations
The
Company securitizes its student loan assets and for transactions qualifying
as
sales, the Company retains residual interests, all of which are referred to
as the Company’s accounts receivable from securitizations. The residual interest
is the right to receive cash flows from the student loans and reserve accounts
in excess of the amounts needed to pay servicing, derivative costs (if any),
other fees, and the principal and interest on the bonds backed by the student
loans. The investors of the securitization trusts have no recourse to the
Company’s other assets should there be a failure of the student loans to pay
when due.
The
Company recognizes the resulting gain on student loan securitizations in the
condensed consolidated statements of operations. This gain is based upon
the difference between the allocated cost basis of the assets sold and the
relative fair value of the assets received. The component in determining the
fair value of the assets received that involves the most judgment is the
residual interest. The Company estimates the fair value of the residual
interest, both initially and each subsequent quarter, based on the present
value
of future expected cash flows using management’s best estimates of the following
key assumptions — defaults, recoveries, prepayment speeds, interest rates on the
asset backed bonds, and discount rates commensurate with the risks involved.
Quoted market prices are not available for the residual interest. The Company
accounts for its residual interests as available-for-sale securities.
Accordingly, residual interests are reflected at market value with temporary
changes in market value reflected as a component of accumulated other
comprehensive income in stockholders’ equity.
The
Company records interest income and periodically evaluates its residual
interests for other than temporary impairment in accordance with the Emerging
Issues Task Force (“EITF”) Issue No. 99-20,
Recognition
of Interest Income and
Impairment
on Purchased and Retained Beneficial Interests in Securitized Financial
Assets
.
Under
this guidance, each quarter, the Company estimates the cash flows to be received
from its residual interests which are used prospectively to calculate a yield
for income recognition. In cases where the Company’s estimate of future cash
flows results in a decrease in the yield used to recognize interest income
compared to the prior quarter, the residual interest is written down to fair
value, first to the extent of any unrealized gain in accumulated other
comprehensive income, then through earnings as an other than temporary
impairment.
Income
Taxes
The
income tax benefit is computed on the pretax income (loss) based on the current
tax law. Deferred income taxes are recognized for the tax consequences in future
years of differences between the tax basis of assets and liabilities and their
financial reporting amounts at each year-end based on enacted tax laws and
statutory tax rates.
Sales
and Marketing
The
Company expenses the costs associated with sales and marketing as incurred.
Sales and marketing expenses for both the Company's student loan and admission
application lines of business, included in the statements of operations for
the nine months ended March 31, 2008 and 2007 were $9,541,000 and $8,023,000,
respectively.
(Loss)
Per Share of Common Stock
Historical
net (loss) per common share is computed using the weighted average number of
common shares outstanding. Diluted earnings per share (“EPS”) includes
additional dilution from common stock equivalents, such as stock issuable
pursuant to the exercise of stock options and warrants.
The
following is a reconciliation of the computation for basic and diluted EPS
for
nine months ended March 31, 2008 and March 31, 2007:
|
|
March
31, 2008
|
|
March
31, 2007
|
|
|
|
|
|
(Restated)
|
|
Net
(loss) applicable to common shares
|
|
$
|
(35,121,000
|
)
|
$
|
(29,494,000
|
)
|
Weighted-average
common stock
|
|
|
|
|
|
|
|
Outstanding (Basic)
|
|
|
28,880,000
|
|
|
18,401,000
|
|
Weighted-average
common stock
|
|
|
|
|
|
|
|
equivalents:
|
|
|
|
|
|
|
|
Stock options
|
|
|
-
|
|
|
-
|
|
Warrants
|
|
|
-
|
|
|
-
|
|
Weighted-average
common stock
|
|
|
|
|
|
|
|
outstanding (Diluted)
|
|
|
28,880,000
|
|
|
18,401,000
|
|
For
March
31, 2008 and 2007, warrants (6,817,000 and 6,884,000, respectively) were not
included in the computation of diluted EPS because inclusion would have been
antidilutive. For March 31, 2008 and 2007, options (6,875,000 and 4,868,000,
respectively) were not included in the computation of diluted EPS because
inclusion would have been antidilutive.
Financial
Instruments Disclosures of Fair Value
Statement
of Financial Accounting Standard 107,
Disclosures
about Fair Value of Financial Instruments
(“FAS
107”) requires entities to disclose the fair value of all (recognized and
unrecognized) financial instruments that is practicable to estimate, including
liabilities. The estimates of fair value of financial instruments are summarized
as follows:
Carrying
amounts approximate fair value
|
|
March
31, 2008
(unaudited)
|
|
June
30, 2007
(audited)
|
|
Cash
|
|
$
|
17,223,000
|
|
$
|
11,606,000
|
|
Restricted
Cash
|
|
|
2,652,000
|
|
|
3,154,000
|
|
Accounts
Receivable
|
|
|
665,000
|
|
|
1,979,000
|
|
Federal
student loans, held for sale
|
|
|
36,407,000
|
|
|
7,395,000
|
|
Accounts
Payable
|
|
|
1,948,000
|
|
|
3,835,000
|
|
Notes
Payable - Doral Bank
|
|
|
2,943,000
|
|
|
1,399,000
|
|
Notes
Payable - Merrill Lynch
|
|
|
112,924,000
|
|
|
11,711,000
|
|
Note
Payable - DZ Bank
|
|
|
19,702,000
|
|
|
0
|
|
Senior
Secured Notes
|
|
|
11,200,000
|
|
|
0
|
|
Accounts
Receivable from Securitizations
|
|
|
9,263,000
|
|
|
11,192,000
|
|
The
fair
value of the accounts receivable from securitizations is internally calculated
by discounting the projected cash flows to be received over the life of the
trust. In projecting the cash flows to be received, the primary assumptions
the
Company makes relate to prepayment speeds, default and recovery rates, and
cost
of funds. These assumptions are developed internally. See Note 16 -
Securitization, for further discussions regarding these assumptions. Carrying
values approximate fair value for the other listed assets and liabilities
because of their short time to realization.
Assets
with fair values exceeding carrying amounts
|
|
March
31, 2008
(unaudited)
|
|
|
|
Carrying
Value
|
|
Fair
Value
|
|
Private
student loans receivable, held for sale, net of valuation
reserve
|
|
$
|
103,649,000
|
|
$
|
113,428,000
|
|
|
|
|
|
|
|
|
|
Investment
in EEF I, LLC
|
|
$
|
670,000
|
|
$
|
1,091,000
|
|
|
|
June 30, 2007
(audited)
|
|
|
|
Carrying
Value
|
|
Fair
Value
|
|
Private
student loan receivable, held for sale, net of valuation
reserve
|
|
$
|
5,441,000
|
|
$
|
6,023,000
|
|
|
|
|
|
|
|
|
|
Investment
in EEF I, LLC
|
|
$
|
322,000
|
|
$
|
342,000
|
|
The
Company determined the fair value of its student loans receivable through a
net
present value analysis on an individual loan basis. This analysis considered
the
United States Department of Education’s cohort default rates for Title IV
post-secondary educational institutions, the borrower’s program of study, the
borrower and co-borrower’s credit quality, the individual terms of the loan, and
estimated prepayment and recovery rates. As of March 31, 2008, the approximate
9.4% increase in fair value over the carrying value, which is the Company’s
cost, results from this net present value modeling of future cash flows from
the
borrowers servicing these loans tempered by all of the above
factors.
The
fair
value of the investment in EEF I, LLC was determined from the March 2008 net
asset value report provided to the investors in this entity.
Stock
Based Compensation
At
March
31, 2008, the Company had two stock-based compensation plans, the 2004
Incentive Plan and the 2005 Consultant Incentive Plan. During the quarter ended
December 31, 2005, the Company adopted the Financial Accounting Standards Board
(“FASB”) Statement 123(R),
Share-Based
Payments
(“FAS
123R”). FAS 123R requires compensation expense, measured as the fair value at
the grant date, related to share-based payment transactions to employees to
be
recognized in the financial statements over the period that an employee provides
service in exchange for the award.
The
Company recognized $2,787,000 in stock based compensation expense for the nine
months ended March 31, 2008.
The
Company recognized $3,296,000 in stock based compensation expense for the nine
months ended March 31, 2007.
Recent
Accounting Pronouncements
In
February 2006, the FASB issued SFAS 155,
Accounting
for Certain Hybrid Financial Instruments
,
an
amendment of FASB Statement 133
Accounting
for Derivative Instruments and Hedging Activities
and FASB
Statement 140,
Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities
(“SFAS
155”). SFAS 155 was effective for the Company beginning in the first quarter of
fiscal 2007. SFAS 155 permits interests in hybrid financial instruments that
contain an embedded derivative, which would otherwise require bifurcation,
to be
accounted for as a single financial instrument at fair value, with changes
in
fair value to be recognized in earnings. This election is permitted on an
instrument-by-instrument basis for all hybrid financial instruments held,
obtained, or issued as of the adoption date. The adoption of SFAS 155 did not
have any material impact on the Company’s condensed consolidated financial
condition or results of operations.
In
March
2006, the FASB issued SFAS 156,
Accounting
for the Servicing of Financial Assets
,
an
amendment of FASB Statement 140,
Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities
(“SFAS
156”). SFAS 140 required that all separately recognized servicing assets and
liabilities be initially measured at fair value, if practicable, and required
entities to elect either fair value measurement with changes in fair value
reflected in earnings or the amortization and impairment requirements of SFAS
140 for subsequent measurement. SFAS 156 was effective for the Company beginning
in the first quarter of fiscal 2007. The adoption of SFAS 156 did not have
any
material impact on the Company’s condensed consolidated financial condition
or results of operations.
In
September 2006, the FASB issued Statement of Financial Accounting Standards
No.
157,
Fair
Value Measurement
(“SFAS
157”). This standard provides guidance for using fair value to measure assets
and liabilities. SFAS 157 applies whenever other standards require (or permit)
assets or liabilities to be measured at fair value but does not expand the
use
of fair value in any new circumstances. Prior to SFAS 157, the methods for
measuring fair value were diverse and inconsistent, especially for items that
are not actively traded. The standard clarifies that for items that are not
actively traded, such as certain kinds of derivatives, fair value should reflect
the price in a transaction with a market participant, including an adjustment
for risk, not just the Company’s mark-to-model value. SFAS 157 also requires
expanded disclosure of the effect on earnings for items measured using
unobservable data. SFAS 157 is effective for financial statements issued for
fiscal years beginning after November 15, 2007, and interim periods within
those
fiscal years. The Company is currently evaluating the impact of this statement
on its financial statements.
In
February 2007, FASB issued Statement of Financial Accounting Standard No. 159,
The
Fair Value Option for Financial Assets and Financial Liabilities - Including
an
amendment of FASB Statement No. 115
(“SFAS
159”). SFAS 159 permits entities to elect to measure many financial instruments
and certain other items at fair value. Unrealized gains and losses on items
for
which the fair value option has been elected will be recognized in earnings
at
each subsequent reporting date. SFAS 159 is effective for fiscal years beginning
after November 15, 2007. The Company is currently assessing the impact of SFAS
159 on its condensed consolidated financial statements.
In
June
2007, the FASB ratified EITF Issue No. 06-11
Accounting
for Income Tax Benefits of Dividends on Share-Based Payment
Awards
(“EITF
06-11”), which requires entities to record tax benefits on dividends or dividend
equivalents that are charged to retained earnings for certain share-based awards
to additional paid-in capital. In a share-based payment arrangement, employees
may receive dividends or dividend equivalents on awards of nonvested equity
shares, nonvested equity share units during the vesting period and share options
until the exercise date. Generally, the payment of such dividends can be
treated as deductible compensation for tax purposes. The amount of tax benefits
recognized in additional paid-in-capital should be included in the pool of
excess tax benefits available to absorb tax deficiencies on share-based payment
awards. EITF 06-11 is effective for fiscal years beginning after December 15,
2007 and interim periods within those years. The Company is currently assessing
the impact of EITF 06-11 on its condensed consolidated financial
statements.
In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests
in Consolidated Financial Statements—an amendment of ARB No. 51.
The statement requires non-controlling interests (previously referred to
as minority interests) to be treated as a separate component of equity, not
as a
liability or other item outside of permanent equity. SFAS No. 160 is
effective for fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008. The company is currently
evaluating the impact of this statement on its financial
statements.
In
March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activities—an amendment of FASB Statement
No. 133. The statement requires companies with derivative instruments
to disclose information about how and why a company uses derivative instruments,
how derivative instruments and related hedged items are accounted for under
Statement No.133, and how derivative instruments and related hedged items affect
a company’s financial position, financial performance, and cash flows. SFAS
No. 161 is effective for financial statements issued for fiscal years and
interim periods beginning after November 15, 2008. The company is
currently evaluating the impact of this statement on its financial
statements.
Reclassification
Certain
amounts in the March 31, 2007 financial statements have been reclassified to
conform to the March 31, 2008 presentation. There was no effect on net loss
for
the periods.
NOTE
3 -
|
STUDENT
LOAN RECEIVABLES, HELD FOR
SALE
|
Student
loan receivables are private student loans made to post-secondary and/or
graduate students pursuing degree programs from selective colleges and
universities in the United States and abroad. Private student loans are
not guaranteed by any governmental entity and are unsecured consumer debt.
Interest accrues on these loans from date of advance, with the interest rate
dependent on the loan’s pricing tier as determined during underwriting and the
student borrower’s choice of repayment option (deferred, interest payment only,
and principal and interest payment). Once these loans begin to service,
borrower payments are applied to interest and principal consistent with the
effective interest rate method per SFAS 91,
Accounting
for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans
and Initial Direct Costs of Leases
.
Origination fee revenue is recognized, if applicable, over the principal
servicing life of the loan, also per SFAS 91.
The
Company values its student loan receivables at the lower of cost or market
on an
individual loan basis. The Company determines the fair market value of its
student loans receivable through a net present value analysis of its student
loan portfolios. This process is described in Note 2, Financial Instruments
Disclosures of Fair Value for private student loans receivable. The Company
completed its first sale of student loans to a securitization transaction in
June 2007 and plans to continue to securitize its student loan receivables
in
the future, subject to market conditions.
MRU
Lending, Inc. (“MRUL”) and MRU Funding SPV, Inc. (“MRUF”) and MRU
Originations, Inc. ("MRUO”) have loan purchase agreements with Doral Bank
Federal Savings Bank New York (the “Bank”), an affiliate of the Doral Financial
Corporation. Through November 30, 2005, MRUL had a loan purchase agreement
with
Webbank, a Utah state chartered financial institution and a wholly owned
subsidiary of WebFinancial Corporation.
The
Bank
loan program is secured by $3 million invested in seven-day certificates of
deposit held at the Bank, with assignment rights to the Bank. The Bank
also has the right to offset amounts due under the loan program against
origination fees payable to MRUL and MRUF.
Through
March 31, 2008, the Company purchased the following private student loan volumes
through its various subsidiary loan programs. All loans purchased through these
loans programs are purchased at par, i.e. no discount, and without recourse
or
redemption features available to the originating bank.
|
·
|
The
Bank-MRUL loan program purchased approximately $18.5 million in private
student loans.
|
|
·
|
The
Bank-MRUF loan program purchased approximately $237.6 million in
private
student loans.
|
|
·
|
The
Bank-MRUO loan program purchased approximately $19.9 million in private
student loans.
|
|
·
|
The
Webbank-MRUL loan program purchased approximately $1.5 million in
private
student loans.
|
The
Company has retained servicing rights on the loans purchased under its various
subsidiary loan programs and has outsourced the servicing function to a third
party, who remits funds collected to us along with monthly activity
reports.
Fixed
assets consist of the following at March 31, 2008 and June 30,
2007:
|
|
March
31,
2008
(unaudited)
|
|
June
30, 2007
(audited)
|
|
|
|
|
|
|
|
Computer
network equipment
|
|
$
|
2,821,816
|
|
$
|
2,081,701
|
|
Furniture
and fixtures
|
|
|
92,332
|
|
|
71,033
|
|
Leasehold
improvements
|
|
|
317,065
|
|
|
6,906
|
|
|
|
|
3,231,213
|
|
|
2,159,640
|
|
Less:
accumulated depreciation
|
|
|
(1,274,000
|
)
|
|
(606,754
|
)
|
|
|
|
|
|
|
|
|
Total
fixed assets
|
|
$
|
1,957,213
|
|
$
|
1,552,886
|
|
Depreciation
expense for the nine months ended March 31, 2007 and 2006 was $667,246 and
$239,838, respectively.
NOTE
5 -
|
INTANGIBLE
ASSETS
|
The
Company acquired a scholarship resource database in July 2005. After
identification of tangible assets in this asset purchase, the Company paid
and
assigned a valuation of $148,440 to this intangible asset. The Company is
amortizing this asset over a three year useful life.
As
of
March 31, 2008, the unaudited book value and accumulated amortization of
the Company’s intangible assets follows:
|
|
|
|
Accumulated
|
|
Intangible
Asset
|
|
Book Value
|
|
Amortization
(restated)
|
|
|
|
|
|
|
|
Customer
Contracts
|
|
$
|
1,093,750
|
|
$
|
406,250
|
|
Trademarks
& Technology
|
|
|
783,333
|
|
|
216,667
|
|
Non-compete
Agreement
|
|
|
391,666
|
|
|
108,333
|
|
Scholarship
Resource data
|
|
|
12,370
|
|
|
136,070
|
|
|
|
|
|
|
|
|
|
TOTAL
|
|
$
|
2,281,119
|
|
$
|
867,320
|
|
As
of
June 30, 2007, the audited book value and accumulated amortization of
the Company’s intangible assets follows:
|
|
|
|
Accumulated
|
|
Intangible
Asset
|
|
Book
Value
|
|
Amortization
|
|
|
|
|
|
|
|
Customer
Contracts
|
|
$
|
1,375,000
|
|
$
|
125,000
|
|
Trademarks
& Technology
|
|
|
933,333
|
|
|
66,667
|
|
Non-compete
Agreement
|
|
|
466,667
|
|
|
33,333
|
|
Scholarship
Resource data
|
|
|
49,480
|
|
|
98,960
|
|
|
|
|
|
|
|
|
|
TOTAL
|
|
$
|
2,824,480
|
|
$
|
323,960
|
|
The
following table summarizes the estimated amortization expense relating to the
Company’s intangible assets for the next five fiscal years:
2008
|
|
$
|
724,480
|
|
2009
|
|
$
|
675,000
|
|
2010
|
|
$
|
675,000
|
|
2011
|
|
$
|
550,000
|
|
2012
|
|
$
|
200,000
|
|
A
non-cash adjustment of $72,000 was made to the purchase price of the TPR
transaction during the three months ended September 30, 2007, reducing the
purchase price and the related goodwill.
NOTE
6 -
|
PROVISION
FOR INCOME
TAXES
|
Income
taxes are provided for the tax effects of transactions reported in the financial
statements and consist of taxes currently due. Deferred taxes related to
differences between the basis of assets and liabilities for financial and income
tax reporting will either be taxable or deductible when the assets or
liabilities are recovered or settled. The difference between the basis of assets
and liabilities for financial and income tax reporting are not material,
therefore the provision for income taxes from operations consist of income
taxes
currently payable.
The
nature of the timing difference generating the deferred tax asset is the
accumulated net operating loss carry forwards that can be applied towards
mitigating future tax liabilities of the Company. The Company has established
a
valuation account at the full value of the tax deferred asset.
There
were no provisions for income taxes for the quarters ended March 31, 2008 and
2007.
Deferred
income taxes are determined using the liability method for the temporary
differences between the financial reporting basis and income tax basis of the
Company’s assets and liabilities. Deferred income taxes will be measured based
on the tax rates expected to be in effect when the temporary differences are
included in the Company’s consolidated tax return. Deferred tax assets and
liabilities are recognized based on anticipated future tax consequences
attributable to differences between financial statements carrying amounts of
assets and liabilities and their respective tax bases.
The
Company’s deferred tax asset, which the Company has set aside a valuation
allowance at an equal amount, is due primarily to the expected tax benefit
of
the Company’s net operating losses. To date, the Company’s operations have not
generated any federal, state, or local taxes beyond the minimum filing
requirements, which can not and have not been mitigated by operating loss carry
forwards. The Company does not have an effective tax rate due to the Company’s
lack of taxable profits to-date.
|
|
March
31, 2008
|
|
June 30, 2007
|
|
|
|
|
|
|
|
Deferred
tax assets
|
|
$
|
40,845,000
|
|
$
|
18,760,000
|
|
Less:
valuation allowance
|
|
|
(40,845,000
|
)
|
|
(18,760,000
|
)
|
|
|
|
|
|
|
|
|
Totals
|
|
$
|
-
|
|
$
|
-
|
|
At
March
31, 2008 and June 30, 2007, the Company had accumulated net operating loss
deficits of $116.7 million and $53.6 million, respectively, available to
offset future taxable income through 2027. The Company established valuation
allowances equal to the full amount of the deferred tax assets due to the
uncertainty of the operating losses in future periods. Note that the Company’s
beneficial conversion features for the Series B Convertible Preferred Stock
increases the Company’s accumulated deficit but does not contribute to net
operating losses that can be used to offset future taxable income.
NOTE
7 -
|
STOCKHOLDERS’
EQUITY
|
Common
Stock
There
were 200,000,000 shares of common stock authorized, with 31,721,174 and
25,714,393 shares issued and outstanding at March 31, 2008 (unaudited) and
June 30, 2007 (audited), respectively. The par value for the common stock is
$0.001 per share.
On
November 5, 2007, the Company closed a private placement sale of 5,180,000
shares of its common stock, resulting in gross proceeds of $24,367,500.
$1,502,847 in commissions and other expenses related to the sale were
recorded as a reduction to additional paid-in capital.
There
were a total number of 659,731 warrants exercised for the nine months ended
March 31, 2008 at a weighted average price of $1.40.
There
were 137,505 options exercised for the nine months ended March 31, 2008 at
a
weighted average price of $3.33.
Series
B Convertible Preferred Stock
There
were 12,000,000 shares of Series B convertible preferred stock authorized,
with
8,237,264 shares issued and outstanding as of March 31, 2008 and June 30, 2007.
The par value for this preferred issuance is $0.001 per share.
As
further described in the Company’s charter, at the option of the majority
holders of the Series B Convertible Preferred Stock, at any time on or
after December 31, 2010, the Company shall mandatorily redeem, in two
annual installments commencing 90 days after the Company receives written notice
from the majority holders requesting redemption, all shares of Series B
Convertible Preferred Stock outstanding at a price per share equal to
the greater of (i) $3.80 per share, plus the value of all declared but unpaid
dividends; or (ii) the fair market value of a share of Series B Convertible
Preferred Stock on the date on which notice is delivered. Fair market
value will be determined by an expert selected by the mutual consent of the
Company’s board of directors and the holders of a majority of the Series B
Convertible Preferred Stock (or if the parties cannot agree on a single expert,
a committee of three experts), based upon all factors such expert or experts
deem relevant.
If
the
Company does not have sufficient funds to redeem on any redemption date all
shares of the Series B Convertible Preferred Stock outstanding immediately
prior
to such redemption date, the Company will redeem a pro rata portion of each
Series B holder's redeemable shares of such stock out of available funds, and
as
soon as practicable after the Company has funds available, it will redeem the
remaining shares to have been redeemed, at a price per share equal to the
original redemption price plus interest at the rate of 15% per annum, payable
quarterly, from such redemption date to the date when redemption actually
occurs.
As
of
March 31, 2008 (unaudited) and June 30, 2007 (audited), the balances for
the additional paid-in capital account for the beneficial conversion feature
for
the Series B Convertible Preferred Stock were $14,520,000 and $14,264,000,
respectively. The Company will continue to record the beneficial conversion
feature for the Series B Convertible Preferred stock for any new issuances
or
dividends accrued on this instrument.
Stock
Options
Under
the
2004 Incentive Plan, as amended (the “Plan”), the Company may grant either
incentive stock options (“ISOs”) pursuant to Section 422 of the Internal Revenue
Code, non-qualified stock options (“NQOs”), restricted stock, restricted stock
units, performance grants, unrestricted common stock, or stock appreciation
rights to its officers, directors, and employees.
The
compensation committee of the Company's board of directors administers the
Plan. The compensation committee has the complete authority and discretion
to
determine the terms of the Plan grants.
ISOs
and
NQOs are granted at an exercise price not less than their fair value at the
date
of the grant. Options granted have a maximum term of ten years. Option-vesting
periods range from immediate vesting to three years, with approximately
31
%
of
stock option grants vesting ratably over three years. During the nine months
ended March 31, 2008, 1,774,819 options, with a weighted average fair value
of
$1.80 were granted under the Plan. There were 1,297,377 options granted under
the Plan for the nine months ended March 31, 2007.
The
key
assumptions for the Black-Scholes valuation method include the expected term
of
the option, stock price volatility, risk-free interest rate, dividend yield,
forfeiture rate, and exercise price. Many of these assumptions are judgmental
and highly sensitive. Following is a table of the key weighted average
assumptions used in the valuation calculations for the options granted in the
nine months ended March 31, 2008 and a discussion of our methodology for
developing each of the assumption used in the valuation model.
|
March
2008
|
Expected
term
|
6.5
yrs
|
Expected
volatility
|
57.89%
|
Risk-free
interest rate
|
3.357%
|
Dividend
yield
|
0%
|
At
March
31, 2008, there were 783,334 shares available for future grants under the
Plan and 1,425,000 shares available for future grants under the 2005 Consultant
Incentive Plan.
Expected
Term.
This
is
the period of time over which the options granted are expected to remain
outstanding. Options granted have a maximum term of ten years. The Company
lacks sufficient historical exercise data that it may rely on to determine
expected term for the grants issued through March 31, 2008. Therefore, the
Company relied on the simplified method for expected term as defined by the
SEC
Staff Accounting Bulletin 107 (SAB 107), where expected term equals the sum
of
the vesting term and the original contractual term, which is then divided by
two. SAB 107 originally prescribed that the simplified method for
estimating expected term would only be available for option grants through
December 31, 2007. In SEC Staff Accounting Bulletin 110 (SAB 110), the SEC
staff acknowledged that such detailed information about employee behavior may
not be widely available by December 31, 2007, and accordingly, the staff will
continue to accept, under certain circumstances, the use of the simplified
method beyond December 31, 2007. Due to the limited period of time the
Company’s shares have been publically traded through the Nasdaq Global Market,
and the lack of related historical exercise date, the Company considers the
continued use of the simplified method to be appropriate and consistent with
SAB
110.
Expected
Volatility
.
Actual
changes in the market value of our stock are used to calculate the volatility
assumption. The Company calculated daily market value changes during the period
that the grant was issued to determine volatility, which was then annualized.
An
increase in the expected volatility will increase share-based compensation
expense.
Risk-Free
Interest Rate
.
This is
the ten-year US Treasury zero coupon bond interest rate posted at the date
of
grant having a term equal to the expected term of the option. An increase in
the
risk-free interest rate will increase share-based compensation
expense.
Dividend
Yield
.
This is
the annual rate of dividends per share over the exercise price of the option.
The Company has no history of paying a dividend, so this has been 0%. An
increase in the dividend yield will increase share-based compensation
expense.
Forfeiture
Rate
.
This is
the estimated percentage of options granted that are expected to be forfeited
before becoming fully vested,
i.e.
service-based awards where the full award does not vest due non-completion
of
the service by the employee, director, or consultant. This percentage is derived
from historical experience. An increase in the forfeiture rate will decrease
compensation expense.
Warrants
There
were 200,000 warrants issued during the nine months ended March 31, 2008. There
were no warrants issued during the nine months ended March 31,
2007.
NOTE
8 -
|
CREDIT
LINE WITH NOMURA CREDIT & CAPITAL, INC.
(“NOMURA”)
|
On
February 4, 2005, MRUL, a wholly-owned subsidiary of the Company, entered into
a
credit agreement (the “Credit Agreement”), by and among Nomura, as Agent, a
subsidiary of Nomura Holdings, Inc., and the institutions from time to time
party thereto as lenders, pursuant to which the lenders agreed to provide MRUL
with a $165 million secured revolving credit facility for the origination and
warehousing of private student loans. The loans under the Credit Agreement
were
secured by, among other things, a lien on all of the student loans financed
under the Credit Agreement and any other student loans owned by MRUL and not
otherwise released, together with a pledge of 100% of the capital stock of
MRUL.
The Credit Agreement contained terms and provisions (including representations,
covenants and conditions) customary for transactions of this type. The Company
paid $206,500 in deferred financing fees in association with the Credit
Agreement.
The
Credit Agreement also provided for customary events of default, including
failure to pay principal, interest or fees when due, failure to comply with
covenants, breaches of certain representations and warranties, the bankruptcy
of
MRUL or MRU Lending Holdco, LLC (MRUL’s direct parent and wholly-owned
subsidiary of the Company), failure to maintain certain net worth ratios, a
material adverse change in MRUL’s ability to originate student loans, and
failure of the Company to indirectly own 100% of the outstanding capital stock
of MRUL. The facility had a three year term. Related to this transaction, Nomura
was granted a warrant, subject to certain terms and conditions, to purchase
common stock of the Company equal to an approximately 27.5% ownership interest
in the Company on a diluted basis. The Company valued the warrants granted
at
$6,079,581 and recorded a deferred financing fee in an equivalent amount (see
Note 17 - Restatement).
On
June
14, 2007, MRUL entered into an agreement with Nomura to terminate its credit
line seven business days after the close of the Company’s June 2007
securitization of private student loans. In connection with the early
termination of the Credit Agreement, Nomura agreed to waive its rights to be
paid all amounts that would otherwise become due and payable to Nomura upon
the
early termination of the Credit Agreement with respect to collateral securing
the loans under the Credit Agreement as well as waiving all past, present and
future fees due (or that may become due) and payable under the Credit Agreement.
Pursuant to this early termination agreement, the Credit Agreement was
terminated on July 5, 2007.
The
Company recognized amortization expense associated with the financing fees
of
$1,571,429 for the nine months ended March 31, 2007. The financing fees were
fully amortized as of June 30, 2007.
As
of
March 31, 2008, there were no amounts outstanding on the Nomura line of credit,
as the line was terminated on July 5, 2007.
NOTE
9 -
|
CREDIT
LINE WITH MERRILL LYNCH BANK USA
(“MLBU”)
|
On
January 23, 2006, the Company’s private student lending subsidiary, MRUF entered
into a definitive agreement with MLBU pursuant to which MLBU will provide MRUF
with a $175 million revolving credit facility for the origination and
warehousing of private student loans. The facility has a one year term, with
periodic renewals at the option of both parties. As a result of this
transaction, MLBU was granted a warrant, subject to certain terms and
conditions, to purchase up to 4.9% of the Company’s common stock.
On
September 28, 2007, the MRUF and MLBU amended the MRUF warehouse line, effective
October 15, 2007, to increase the cost of the warehouse line to market rates
and
to change the renewal amount to $145 million.,
On
December 21, 2007, MRUF and MLBU amended the MRUF warehouse line, effective
December 24, 2007, extending the term of the facility until July 15, 2008,
and
established the commitment amount available under the facility as $100 million
from the effective date through, but not including January 2, 2008, and $125
million on and after January 2, 2008.
In
connection with the December 21, 2007 amendment, the Company issued MLBU a
warrant to purchase 200,000 shares of the Company’s common stock at a purchase
price of $4.65 per share. The warrant will vest on July 14, 2008, if and
only if the facility is extended on or before the vesting date, for a minimum
of
one full year without any reduction in the commitment amount under the
facility.
On
December 21, 2007, the Company recorded deferred financing fees of $2,224,941
relating to the vesting of warrants previously issued to MLBU in connection
with
the facility.
The
Company recognized amortization expense associated with all deferred MLBU
financing fees of $1,199,731 and $2,130,260 for the nine months ended March
31,
2008 and 2007, respectively.
As
of
March 31, 2008, the MRUF obtained approximately $112.9 million in financing
through the MLBU line of credit by collateralization of loans originated through
the Doral Bank FSB New York-MRUF loan program.
NOTE
10 -
|
CREDIT
LINE WITH DZ BANK AG’s
CONDUIT
|
On
November 9, 2007, the Company obtained additional financing for its private
student loan business by amending a loan facility (the “Amended Loan Facility”)
under which its affiliate, Education Empowerment Fund SPV, LLC (“EEF SPV”) is
the borrower. The student loans to be financed under the Amended Loan Facility
will be originated pursuant to a Loan Program Agreement between MRUO and the
Bank. The student loans will then be purchased from the Bank by EEF I, LLC
pursuant to a Loan Sale Agreement and then contributed by EEF I, LLC to EEF
SPV.
The Loan Program Agreement and Loan Sale Agreement are existing agreements
which
have been effectively supplemented. The Amended Loan Facility described above
is
set forth in the Amended and Restated Receivables Loan and Security Agreement,
dated as of November 9, 2007, among Education Empowerment SPV, LLC, a Delaware
limited liability company, Autobahn Funding Company LLC, as the lender, DZ
Bank
AG Deutsche Zentral-Genossenschaftsbank, Frankfurt am Main, as agent for the
lender, and Lyon Financial Services, Inc. (d/b/a U.S. Bank Portfolio Services),
as the backup servicer. This agreement was originally entered into by the same
parties on April 11, 2007 and initially provided funding only for Preprime™
student loans in which the Company retained less than a 5% equity economic
interest due to the participation of third-party investors in EEF I, LLC (see
Note 2 - Investment in Education Empowerment Fund I, LLC).
Following
the amendment and restatement of the agreement on November 9, 2007, the loan
facility has been increased to $200 million in total commitment, of which up
to
$200 million is available to finance private student loans and up to $150
million is available to finance Preprime™ student loans. The economic interest
in the private student loans is retained 100% by the Company through its sole
membership and 100% ownership of the separate Series B of EEF I, LLC. The
assets, liabilities and cash flows of separate Series B are consolidated in
the
Company’s financial statements.
The
Amended Loan Facility terminates on April 11, 2012, unless terminated earlier
at
EEF SPV’s option or as a result of an event of default or similar occurrence.
The amount of the total commitment that can be drawn down and remain outstanding
at any time depends on a borrowing base calculation, which measures the
outstanding balance of the student loans pledged to the lender, less
non-performing loans or loans that exceed certain concentration limits. Each
student loan that is pledged to the lender is required to meet certain
eligibility criteria at the time of pledge.
As
of
March 31, 2008, the Company through its 100% ownership of Series B of EEF I,
LLC
obtained approximately $19.7 million in financing through this line of
credit.
NOTE
11 -
|
LOAN
PROGRAM
AGREEMENTS
|
On
July
25, 2005, MRUL, a wholly-owned subsidiary of the Company; entered into a
definitive agreement with the Bank. The agreements provide for the Bank’s
origination of private student loans to qualified applicants participating
in
MRUL’s private student loan program, the marketing of such program and
solicitation and qualification of such applicants by MRUL or its affiliates
and
the sale by the Bank and purchase by MRUL of such student loans at par,
i.e.
no
discount, and without recourse. The business purpose of the loan program and
loan sale agreements between MRUL and the Bank allow MRUL to purchase student
loans originated by a Federal Savings Bank. There are legal and regulatory
advantages to MRUL for purchasing loans originated by a Federal Savings Bank
that are not otherwise available to MRUL. The agreement between MRUL and the
Bank is evidenced by a loan program agreement and a loan sale agreement both
dated July 25, 2005. The agreements have a thirty-six (36) month term and are
automatically renewable for up to two (2) successive terms of twelve (12)
months.
There
were no balances due to the Bank for origination of MRUL private student loans
as of March 31, 2008 (unaudited) and June 30, 2007 (audited).
On
January 10, 2006, MRUO and MRUF, wholly-owned subsidiaries of the Company
entered into definitive agreements with the Bank. The agreement provides for
the
Bank’s origination of private student loans to qualified applicants
participating in MRUO’s private student loan program, the marketing of such
program and solicitation and qualification of such applicants by MRUO and the
sale by the Bank and purchase by MRUF of such student loans at par,
i.e.
no
discount, and without recourse. The business purpose of the loan program and
loan sale agreements between, MRUO, MRUF, and the Bank allow MRUF to purchase
student loans originated by a Federal Savings Bank. There are legal and
regulatory advantages to MRUF for purchasing loans originated by a Federal
Savings Bank that are not otherwise available to MRUF. The agreement between
MRUO and the Bank is evidenced by a loan program agreement dated January 10,
2006. The agreement between MRUF and the Bank is evidenced by a loan program
agreement dated January 10, 2006. The agreements have a thirty-six (36) month
term and are automatically renewable for up to two (2) successive terms of
twelve (12) months.
The
balances due to the Bank for origination of MRUO and MRUF private student loans
were $2,943,000 and $1,399,000 as of March 31, 2008 (unaudited) and June
30, 2007 (audited).
NOTE
12 -
|
SENIOR
SECURED
NOTES
|
On
October 19, 2007, the Company issued, in a private placement transaction, 12%
senior secured notes (the “Notes”) in an original aggregate principal of
$11,200,000. The Notes were issued with original issue discount in an
aggregate amount equal to $1,217,000 and have a three year term. The Notes
are guaranteed by the Company’s direct and indirect subsidiaries other than
those subsidiaries established as special purpose entities for the purpose
of
structured financing transactions.
In
connection with this transaction, the Company delivered to the investors an
Assignment Agreement, dated as of October 19, 2007, made by MRU ABS LLC, a
wholly owned subsidiary of the Company (“MRU ABS”), whereby MRU ABS, transferred
and conveyed to the Company, all of MRU ABS’ rights, title and interest in and
to the right to receive any residual payments from the MRU Student Loan Trust
2007-A. The Company also entered into a pledge and security agreement with
such investors, dated as of October 19, 2007, pursuant to which the Company
has
provided such investors with a first lien on and first perfected security
interest in (i) all of the equity interest in MRU ABS (“Pledged Interests”);
(ii) all other property in substitution for or in addition to the Pledged
Interests; (iii) any dividends or distribution from MRU ABS; and (iv) the
proceeds of any of the collateral described in clauses (i)-(iii)
inclusive.
The
original issue discount is amortized utilizing the effective interest
method. The Company recorded amortization expense of $57,009 related to
deferred fees and note issuance costs in the nine month period ended March
31,
2008.
The
Company has a patent pending for a business method. This business method enables
the Company to provide customized financial products to consumers.
NOTE
14 -
|
COMMITMENTS
AND
CONTINGENCIES
|
Earn
Out Feature of Acquisition
Related
to the Company’s transaction with TPR, the Company could be obligated to pay an
earn-out of up to $1.25 million in cash before December 31, 2008 based upon
certain performance targets of the assets purchased in this transaction. In
no
event, will TPR owe the Company any amounts based on the performance of the
assets the Company acquired from TPR.
Employment
Agreements
The
Company has three employment agreements with the following key management
personnel:
NAME
|
|
TITLE
|
|
EXPIRATION
DATE
|
Edwin
J. McGuinn, Jr.
|
|
CEO
|
|
October
31, 2008
|
Raza
Khan
|
|
President
|
|
April
1, 2009
|
Vishal
Garg
|
|
CFO
|
|
April
1, 2009
|
Legal
Matters
None
Operating
Leases
The
Company leases office equipment and corporate space under leases with terms
between one and seven years. Monthly payments under the current leases range
between $200 and $142,375. The Company is required to pay its pro-rata share
of
costs relating to certain of the leased facilities.
The
following is a schedule by fiscal years of future minimum rental payments
required under the operating leases which have an initial or remaining
non-cancelable lease term in excess of one year as of June 30,
2007:
2008
|
|
$
|
2,333,665
|
|
2009
|
|
$
|
2,444,180
|
|
2010
|
|
$
|
2,136,871
|
|
2011
|
|
$
|
2,220,621
|
|
2012
|
|
$
|
2,220,621
|
|
NOTE
15 -
|
RELATED
PARTY
TRANSACTIONS
|
The
obligations of the Company under the ISID Finance of America, Inc. sub-lease
are
guaranteed by Edwin J. McGuinn, Jr., the Company’s Chief Executive Officer, in
accordance with a Guaranty dated April 26, 2005 executed by Mr. McGuinn in
favor
of the Sub-landlord.
On
June
28, 2007, the Company closed its first securitization of its private student
loan assets. The transaction was accounted for as a sale of the $137.8 million
of private student loans securitized. In connection with the sale, the Company
booked a gain of $16.2 million based upon the excess of the proceeds and value
of the Residual Interest received over the carrying value of the assets sold.
On
September 25, 2007, the Company sold an additional $32.4 million of private
loans to the trust and booked a gain of $4.1 million. On November 29, 2007,
the
Company sold an additional $0.38 million of private loans to the trust. The
Company values the retained Residual Interest at $9.3 million, all of which are
referred to as the Company’s accounts receivable from the Securitization. The
Residual Interest is the right to receive cash flows from the student loans
and
reserve accounts in excess of the amounts needed to pay servicing, other fees,
and the principal and interest on the bonds backed by the student loans. The
residual cash flows are expected to be received by the Company over
approximately 28 years. The investors in the securitization trust have no
recourse to the Company’s other assets should there be a failure of the student
loans to pay when due.
The
following table summarizes the Company’s securitization activity for the nine
months ended March 31, 2008 and the fiscal year ended June 30,
2007.
($’s
in Thousands)
|
|
Nine
Months Ended March 31, 2008 (unaudited)
|
|
Fiscal
Year Ended June 30, 2007
(audited)
|
|
|
|
#
of
Sales
|
|
Amount of Loans
Sold
to
Securitizations
|
|
Pre-Tax
Gain
|
|
Gain
%
|
|
#
of
Sales
|
|
Amount of Loans
Sold
to
Securitizations
|
|
Pre-Tax
Gain
|
|
Gain
%
|
|
Private
Student Loans
|
|
|
2
|
|
|
|
|
$
|
32,851
|
|
$
|
4,066
|
|
|
12.4
|
%
|
|
1
|
|
|
|
|
$
|
137,792
|
|
$
|
16,205
|
|
|
11.8
|
%
|
Federal
Student Loans
|
|
|
0
|
|
|
|
|
|
0
|
|
|
0
|
|
|
0.0
|
%
|
|
0
|
|
|
|
|
|
0
|
|
|
0
|
|
|
0.0
|
%
|
Total
Sales to Securitization
|
|
|
2
|
|
|
|
|
$
|
32,851
|
|
$
|
4,066
|
|
|
12.4
|
%
|
|
1
|
|
|
|
|
$
|
137,792
|
|
$
|
16,205
|
|
|
11.8
|
%
|
Key
economic assumptions used in estimating the fair value of the Residual Interest
at the date of securitization were as follows.
|
|
Nine
Months Ended
March
31, 2008
(unaudited)
|
|
Fiscal
Year Ended June 30, 2007
(audited)
|
|
|
|
Private
Student
Loans
|
|
Federal
Student
Loans
|
|
Private
Student
Loans
|
|
Federal
Student
Loans
|
|
Annual
Prepayment Rate (1)
|
|
|
7
|
%
|
|
N/A
|
|
|
7
|
%
|
|
N/A
|
|
Cumulative
Default Rate (2)
|
|
|
4.5
|
%
|
|
N/A
|
|
|
4.5
|
%
|
|
N/A
|
|
Default
Recovery Rate (3)
|
|
|
20
|
%
|
|
N/A
|
|
|
20
|
%
|
|
N/A
|
|
Weighted
Average Life
|
|
|
9.0
yrs.
|
|
|
N/A
|
|
|
9.6
yrs.
|
|
|
N/A
|
|
Spread
between LIBOR and Auction Rate Indices (4)
|
|
|
0.48
|
%
|
|
N/A
|
|
|
0.01
|
%
|
|
N/A
|
|
Discount
Rate (5)
|
|
|
12
|
%
|
|
N/A
|
|
|
12
|
%
|
|
N/A
|
|
(1)
|
Annual
Prepayment Rate is expressed on a lifetime basis, is applied after
loans
enter repayment, and is in addition to impact of defaults on collateral
average life.
|
(2)
|
Cumulative
Default Rate is the loan balance of defaulted student loans as a
percentage of the aggregate principal balance of student loans upon
entry
into repayment.
|
(3)
|
Default
Recovery Rate is the percentage of the defaulted loan balance that
is
recovered over time.
|
(4)
|
The
senior tranches of the Company’s securitization are auction rate notes.
The interest rate on auction rate notes is reset through an auction
process periodically (currently every 28-days). Based upon market
conditions at the time of each auction, the spread to LIBOR of the
interest rate required by investors could be more or less than the
initial
spread to LIBOR at which the transaction was priced. Since November
2007,
the interest rate on the Company’s student loan auction rate notes has
widened to approximately 1.65% over LIBOR. In booking the gain on
the
loans sold in September 2007 and November 2007 and in valuing the
Residual
Interest, the Company has assumed that these higher spreads will
continue
through the June 2008 and then return over the next twelve months
to
approximately 0.275% over LIBOR for the remaining life of the transaction.
The spread indicated above is the weighted average over the life
of the
transaction.
|
(5)
|
Discount
Rate is the rate of return used to discount the residual cash flows
projected given the collateral assumptions and the securitization
structure.
|
The
following table summarizes cash flows received from or paid to the
securitizations trust during nine months ended March 31, 2008 and the fiscal
year ended June 30, 2007.
|
|
Nine Months Ended
March
31, 2008
(unaudited)
|
|
Fiscal
Year Ended
June 30, 2007
(audited)
|
|
Net
proceeds from sales of loans to securitizations
|
|
$
|
32,923
|
|
$
|
138,095
|
|
Repurchases
of securitized loans due to delinquency
|
|
|
0
|
|
|
0
|
|
Cash
distributions from trusts related to Residual Interests
|
|
|
0
|
|
|
0
|
|
Residual
Interest in Securitized Receivables
The
following table summarizes the fair value of the Company’s Residual Interests
(and the assumptions used to value such Residual Interests), along with the
underlying off-balance sheet student loans that relate to those Securitizations
as of March 31, 2008 and June 30, 2007.
($’s
in Thousands)
|
|
As
of March 31, 2008
(unaudited)
|
|
As
of June 30, 2007
(audited)
|
|
|
|
Private
Student
Loans
|
|
Federal
Student
Loans
|
|
Private
Student
Loans
|
|
Federal
Student
Loans
|
|
Fair
value of Residual Interests
|
|
$
|
9,263
|
|
|
N/A
|
|
$
|
11,192
|
|
|
N/A
|
|
Underlying
securitized loan balance
|
|
$
|
170,835
|
|
|
N/A
|
|
$
|
137,828
|
|
|
N/A
|
|
Weighted
average life
|
|
|
8.7
yrs.
|
|
|
N/A
|
|
|
9.6
yrs.
|
|
|
N/A
|
|
Annual
Prepayment Rate
|
|
|
7
|
%
|
|
N/A
|
|
|
7
|
%
|
|
N/A
|
|
Cumulative
Default Rate
|
|
|
4.5
|
%
|
|
N/A
|
|
|
4.5
|
%
|
|
N/A
|
|
Default
Recovery Rate
|
|
|
20
|
%
|
|
N/A
|
|
|
20
|
%
|
|
N/A
|
|
Spread
between LIBOR and Auction Rate Indices (1)
|
|
|
0.72
|
%
|
|
N/A
|
|
|
0.01
|
%
|
|
N/A
|
|
Discount
Rate
|
|
|
12
|
%
|
|
N/A
|
|
|
12
|
%
|
|
N/A
|
|
(1)
|
Spread
between LIBOR and Auction Rate Indices is the weighted average
spread over
the life of the transaction. As of March 31, 2008, the Company
assumes
that its auction rate notes will continue to price at or near
the maximum
rate (LIBOR + 1.50% for AAA-rated securities and LIBOR + 2.50%
for A-rated
securities) for another 18 and 24 months for the AAA-rated and
A-rated
securities, respectively, and then gradually decline to a spread
over
LIBOR that is lower than the maximum rate but higher than historical
auction rate pricing.
|
The
following table summarizes the changes in our estimate of the fair value
of the
Residual Interest for the nine months ended March 31,
2008.
($’s
in thousands)
|
|
|
Nine
months ended
March
31, 2008
|
|
|
|
|
|
|
Fair
value at beginning of period
|
|
|
$
|
11,192
|
|
Additions
from new securitzations
|
1,993
|
|
|
|
|
Accretion
of interest income
|
1,105
|
|
|
|
|
Reversal
of unrealized gain in other comprehensive income
|
(2,757
|
)
|
|
|
|
Impairment
recorded in Securitizaton Income/(Loss), net
|
(2,270
|
|
|
|
|
Net
change
|
|
|
|
(1,929
|
)
|
|
|
|
|
|
|
Fair
value at end of period
|
|
|
$
|
9,263
|
|
The
following table summarizes the sensitivity of the value of the Residual Interest
to variations in the key economic assumptions described above as of March 31,
2008.
($’s
in Thousands)
|
|
Percentage
Change
in
Assumptions
|
|
Residual
Balance
|
|
Percentage
Change
in
Assumptions
|
|
|
|
Down
20%
|
|
Down
10%
|
|
|
|
Up
10%
|
|
Up
20%
|
|
Annual
Prepayment Rate
|
|
|
|
|
|
|
|
|
|
|
|
Residual Balance
|
|
$
|
9,648
|
|
$
|
9,472
|
|
$
|
9,263
|
|
$
|
9,061
|
|
$
|
8,867
|
|
% Change
|
|
|
4.55
|
%
|
|
2.25
|
%
|
|
|
|
|
(2.18
|
%)
|
|
(4.28
|
%)
|
Cumulative
Default Rate
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residual Balance
|
|
$
|
9,972
|
|
$
|
9,616
|
|
$
|
9,263
|
|
$
|
8,916
|
|
$
|
8,570
|
|
% Change
|
|
|
7.65
|
%
|
|
3.81
|
%
|
|
|
|
|
(3.75
|
%)
|
|
(7.48
|
%)
|
Default
Recovery Rate
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residual Balance
|
|
$
|
9,124
|
|
$
|
9,193
|
|
$
|
9,263
|
|
$
|
9,334
|
|
$
|
9,403
|
|
% Change
|
|
|
(1.50
|
%)
|
|
(0.75
|
%)
|
|
|
|
|
0.76
|
%
|
|
1.52
|
%
|
Discount
Rate
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residual Balance
|
|
$
|
10,934
|
|
$
|
10,057
|
|
$
|
9,263
|
|
$
|
8,542
|
|
$
|
7,887
|
|
% Change
|
|
|
18.04
|
%
|
|
8.57
|
%
|
|
|
|
|
(7.78
|
%)
|
|
(14.86
|
%)
|
($’s
in Thousands)
|
|
Percentage
Change
in
Assumptions
|
|
Residual
Balance
|
|
Percentage
Change
in
Assumptions
|
|
|
|
Tighten
25 basis points
|
|
Tighten
10 basis points
|
|
|
|
Widen
10 basis points
|
|
Widen
25 basis points
|
|
Spread
between LIBOR and Auction Rate Indices
|
|
|
|
|
|
|
|
|
|
|
|
Residual Balance
|
|
$
|
11,468
|
|
$
|
10,175
|
|
$
|
9,263
|
|
$
|
8,440
|
|
$
|
7,211
|
|
% Change
|
|
|
23.80
|
%
|
|
9.84
|
%
|
|
|
|
|
(8.89
|
)%
|
|
(22.16
|
)%
|
These
sensitivities are hypothetical and should be used with caution. The effect
of
each change in assumption must be calculated independently, holding all other
assumptions constant. Because the key assumptions may not in fact be
independent, the net effect of simultaneous adverse changes in key assumptions
may differ from the sum of the individual effect above.
The
table
below shows the Company’s off-balance sheet private student loan delinquency
trends as of March 31, 2008 and June 30, 2007.
($’s
in Thousands)
|
|
As
of March 31, 2008
|
|
As
of June 30, 2007
|
|
Loans
in-school /grace/deferment (1)
|
|
$
|
119,814
|
|
|
|
|
$
|
109,778
|
|
|
|
|
Loans
in forbearance (2)
|
|
|
3,709
|
|
|
7.3
|
%
|
|
789
|
|
|
2.8
|
%
|
Loans
in repayment
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
|
43,653
|
|
|
85.6
|
%
|
|
26,763
|
|
|
95.4
|
%
|
Delinquent
31-60 Days (3)
|
|
|
1,352
|
|
|
2.7
|
%
|
|
409
|
|
|
1.5
|
%
|
Delinquent
61-90 Days
|
|
|
791
|
|
|
1.6
|
%
|
|
87
|
|
|
0.3
|
%
|
Delinquent
91 Days or More
|
|
|
1,515
|
|
|
3.0
|
%
|
|
0
|
|
|
0.0
|
%
|
Total
Loans in repayment and forbearance
|
|
$
|
51,020
|
|
|
100.0
|
%
|
$
|
28,048
|
|
|
100.0
|
%
|
Total
off-balance sheet private student loans
|
|
$
|
170,835
|
|
|
|
|
$
|
137,828
|
|
|
|
|
(1)
|
Loans
for borrowers who are not required to make payments because they
are still
in or have returned to school, have recently graduated, or are in
other
valid non-repayment statuses (
e.g.
,
military service, medical /dental residency,
etc.
).
|
(2)
|
Loans
for borrowers who have entered repayment but have requested a moratorium
on making payments due to economic hardship or other factors, in
keeping
with established program
guidelines.
|
(3)
|
Delinquency
is the number of days that scheduled payments are contractually past
due.
|
The
Company is restating the condensed consolidated statements of operations
and cash flows for the nine months ended March 31, 2007.
As
identified in Note 8, on February 4, 2005, MRUL, a wholly-owned subsidiary
of
the Company entered into a Credit Agreement with Nomura under which Nomura
agreed to provide MRUL with a $165 million secured revolving credit facility
for
the origination and warehousing of private student loans. Related to this
transaction, Nomura was granted a warrant, subject to certain terms and
conditions, to purchase common stock of the Company equal to, at that point
in
time, 27.5% ownership interest in the Company on a diluted basis.
Financial
Accounting Standards No. 123R -
Share
Based Payments
,
requires, with respect to share based transactions with other than employees,
that the consideration received for the issuance of equity instruments
shall be accounted for based on the fair value of the consideration received
or
the fair value of the equity instruments issued, whichever is more reliably
measurable.
As
a
result of a review by management of the data considered in deriving the value
of
the warrants issued to Nomura, management has determined that a restatement
is
required to appropriately reflect the value of the warrants.
The
impact on the condensed consolidated statement of operations for the nine
months ended March 31, 2007 is as follows:
·
|
Depreciation
and amortization has been increased by $1,519,895, from $2,514,991
to
$4,034,886.
|
·
|
Loss
applicable to common shares has increased $1,519,895, from $(27,974,213)
to $(29,494,108).
|
·
|
Net
loss per basic and diluted shares has increased $0.08 from $(1.52)
to
$(1.60).
|
Net
loss,
and depreciation and amortization as reported in the condensed consolidated
statement of cash flows for the nine months ended March 31, 2007 have been
restated as described above.
Since
March 31, 2008, the two auctions that have been held for the subordinate,
single-A-rated auction rate notes in the Company’s securitization have failed
(
i.e.
,
there
was no clearing bid from investors and the broker-dealer did not otherwise
provide a clearing bid). The economic impact of the failure of the subordinate,
single-A-rated auction rate note auctions has been immaterial as the bonds
had
previously been pricing at very close to the maximum rate (LIBOR + 2.50%),
where
they priced upon the failure of the auction. The senior, triple-A-rated auction
rate notes in the Company’s securitization have never experienced an auction
failure but continue to price very near at the maximum rate (LIBOR +
1.50%).
Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations.
You
should read the following discussion and analysis of our financial condition
and
results of operations together with our condensed consolidated financial
statements and accompanying notes included within this quarterly report. In
addition to the historical information, the discussion contains certain
forward-looking statements that involve risks and uncertainties. Our actual
results could differ materially from those expressed or implied by the
forward-looking statements due to applications of our critical accounting
policies and factors including, but not limited to, those set forth under the
caption “Risk Factors” in Part II, Item 1A of this quarterly report on Form
10-Q.
OVERVIEW
We
are a
specialty finance company that facilitates and provides students with funds
for
higher education. Equipped with proprietary analytical models and decision
tools, we are able to identify and provide customized financial products to
students in a more competitive and customer friendly manner. We entered the
student lending market as an originator and holder of private student loans
and
now also originate, lend, and hold FFELP loans.
In
originating our private student loans, we use a unique and proprietary
underwriting model which we believe provides us with a compelling competitive
advantage. By combining traditional FICO™-based credit scoring methods with our
proprietary underwriting matrix, which considers the loan applicant’s academic
data, prior work experience, course of study, the educational institution which
they are attending
,
and the
amount being borrowed, we generate our own credit and repayment capability
index
which we believe is more insightful and predictive in determining an applicant’s
future repayment capabilities. Our approach allows us to competitively price
loans for students that would be viewed as undifferentiated under traditional
methods employed by other student loan companies. We believe that no other
educational finance company currently uses a similar approach to evaluating
loan
applicants or determining loan pricing. Our underwriting process adds another
layer of analytical precision to traditional evaluation tools and helps us
make
more informed lending decisions.
As
of
March 31, 2008, the Company’s managed private student loan portfolio had the
following characteristics:
|
|
Off
Balance
Sheet
Portfolio
|
|
Balance
S
heet
Portfolio
|
|
Total
Managed
Portfolio
|
|
Number
of Loans
|
|
11,700
|
|
7,563
|
|
19,263
|
|
Aggregate
Loan Balance
|
|
$
|
170.8
million
|
|
$
|
104.5
million
|
|
$
|
275.3
million
|
|
Weighted
average Qualifying FICO ™
|
|
|
718
|
|
|
711
|
|
|
715
|
|
Percentage
of loans with co-borrowers
|
|
|
64
|
%
|
|
73
|
%
|
|
67
|
%
|
Percentage
of Loans with a borrower who is attending a graduate or professional
school
|
|
|
37
|
%
|
|
31
|
%
|
|
35
|
%
|
Weighted
average federal cohort default rate for the schools attended by
borrowers
|
|
|
2.1
|
%
|
|
2.2
|
%
|
|
2.2
|
%
|
We
began
originating student loans in June 2005, so our performance history is limited.
Currently, approximately 25% of the managed private student loan portfolio
has
entered repayment. For the last twelve months, 30+ days delinquencies as a
percentage of repayment eligible loans has averaged 5.3%, and loans in
forbearance as a percentage of repayment eligible loans has averaged 3.3%.
These
performance statistics are substantially better than industry average for
private student loans.
The
increase in delinquencies and forbearance that has occurred in the last three
months is typical for student loan portfolios. In general, there is an annual
seasonal bump in negative performance in January due to a newly graduating
class
entering repayment, of which many may be late due to servicer delays in locating
borrowers who have moved from school to another address post graduation.
As
illustrated in the chart below, delinquencies have been declining since their
peak in January.
In
addition to our unique underwriting methodology, we take a highly focused
approach to our marketing while maintaining one of the most diverse sourcing
channels in the industry. Of the approximately 6,500 accredited institutions
of
higher education in the United States, we focus on a targeted subset of
approximately 3,000 undergraduate and professional graduate institutions.
The professional graduate disciplines that we target include law, business
administration, engineering and medicine. These criteria define our lending
and
marketing methods. We believe that this targeted approach will consistently
yield the optimal mix of attractive pricing, acceptable credit risk and a
sufficiently deep base of potential customers. We use a highly diverse approach
to sourcing potential customers which we believe will create more sustainable
distribution channels than our competitors. Our direct marketing channels
include print advertising campaigns, direct mail campaigns, radio campaigns,
Internet marketing campaigns and our branded MyRichUncle® web site:
www.MyRichUncle.com
.
We also
employ co-branded direct marketing, leveraging our marketing agreements with
The
Princeton Review™ and STA Travel™ to reach further customers. In addition, we
have developed indirect origination sources including referrals from third
party
referral companies for whom we may provide a private labeled set of student
loan
products. In the future, we intend to leverage our Embark subsidiary’s access to
college-bound students and their parents who utilize Embark’s internet
admissions portal, Embark.com, to apply to colleges on-line. As of March 31,
2008, Embark.com has generated over 375,000 opt-ed in customers who are
interested in being provided a variety of products relevant to college bound
students, ranging from discounted student travel, marketing from schools who
wish to attract students with their particular characteristics and financing
for
attending college. Embark.com’s opt-ed in customer base to date represents
approximately 20% of the total number of students applying to college each
year.
Equipped with our unique credit model, our focused marketing and diverse
distribution channels, we believe we are well positioned to grow in the market
for higher education products and services.
The
student loan business is seasonal in nature and activity generally corresponds
with the timing of tuition payments and other student-related borrowing needs
throughout the school year. Our first fiscal quarter, the three months ending
September 30, when students are starting or returning to school, is the busiest
time of the year for us in originating loans. We typically receive the largest
amount of loan applications during this quarter and correspondingly underwrite
the most loans. There is a second surge in applications and originations as
students prepare to meet their financial obligations for the semester that
begins in January. This activity typically benefits our second fiscal quarter,
the three months ending December 31, and our third fiscal quarter, the three
months ending March 31.
In
the
first quarter of fiscal 2008, we originated a record number of loans aggregating
approximately $129.0 million in our private and federal student loan programs.
For the quarter ending March 31, 2008, we originated approximately $42.8 million
in our private and federal student loan programs. The current fiscal year volume
(through nine months) of approximately $230.2 million represents 92% growth
compared to the comparable period in the prior fiscal year, when we originated
approximately $119.8 million in our private and federal student loan programs.
Additionally, as we add to our product offerings, we expect that new products
will be additive to our results and as we introduce them in any given quarter
that particular quarter could also have variations when compared to the
comparable quarter in previous years.
Student
Loan Originations
($’s
in Millions)
|
|
FY
2008
|
|
FY
2007
|
|
|
|
Q3
|
|
Q2
|
|
Q1
|
|
Q4
|
|
Q3
|
|
Q2
|
|
Q1
|
|
Private
Student Loans
|
|
$
|
27.0
|
|
$
|
33.1
|
|
$
|
72.4
|
|
$
|
24.8
|
|
$
|
24.1
|
|
$
|
22.1
|
|
$
|
31.8
|
|
Preprime™
Student Loans
|
|
|
14.0
|
|
|
20.0
|
|
|
34.0
|
|
|
9.2
|
|
|
9.7
|
|
|
10.6
|
|
|
13.8
|
|
Federal
Student Loans
|
|
|
1.8
|
|
|
5.4
|
|
|
22.5
|
|
|
0.6
|
|
|
3.5
|
|
|
2.4
|
|
|
1.8
|
|
Total
Student Loan Originations
|
|
$
|
42.8
|
|
$
|
58.4
|
|
$
|
129.0
|
|
$
|
34.6
|
|
$
|
37.3
|
|
$
|
35.1
|
|
$
|
47.4
|
|
Note:
Totals may not sum due to rounding.
We
generate operating revenues from: interest accrued and origination fees on
our
student loan portfolio, origination and management fees paid to us by
the EEF I, LLC for the generation and management of
Preprime
TM
loans,
and subscription and service revenues from our online college application
business. Gains from the sale or Securitizations of portfolios of our student
loans are recorded in Non-Interest Income.
Our
earnings and growth in earnings are directly affected by the size of our
portfolio of student loans, the interest rate characteristics of our student
loan portfolios, and the costs associated with originating, financing, and
managing our student loan portfolios. Our income is primarily generated by
Securitization income and interest income, or net interest earned on our student
loan portfolios. Our quarterly revenue, operating results and profitability
vary
and may continue to vary on a quarterly basis, primarily because of the timing
and volume of the loans we originate and because of the timing, size and
structure of any Securitizations we may execute.
In
June
2007, we completed our first Securitization of private student loans.
Securitization refers to the technique of pooling loans and selling them to
a
special purpose, bankruptcy remote entity, typically a trust, which issues
securities to investors backed by those loans. The debt instruments that the
trust issues to finance the purchase of these student loans are obligations
of
the trust, and not obligations of the Company. On a going forward basis, we
plan
to either sell or securitize student loan portfolios, which will generate a
gain
on sale for us for this asset. The timing of such an event is dependent on
several factors, including but not limited to the following: the size of our
student loan portfolios, our financial ability to hold this asset, the market
at
the time of the transaction for this asset class, and our ability to support
the
requirements for a sale or securitization transaction. We are currently working
on a Securitization that we plan to execute, subject to market conditions,
prior
to the conclusion of the current fiscal year on June 30, 2008.
The
gain
that the Company books when it securitizes is driven by the ability of the
Company to book the expected future residual cash flow, the excess of the
securitized portfolios collections and releases from transaction reserve funds
over the amount required to service the securitization debt, as an asset on
its
balance sheet post the sale of loans to the securitization trust. Because there
are no readily available prices for such residual assets, GAAP accounting allows
the Company to compute the fair value by discounting projected residual cash
flows, which are determined based upon assumptions regarding collateral
performance and discount rates that the Company believes are reasonable. If
actual performance were to deviate negatively from these assumptions, the
Company would be required to write-down its residual interest to its new fair
value assumption resulting in a loss. The Company is required to re-evaluate
its
valuation of the residual interest in its Securitization on a quarterly
basis.
For
the
quarter ended March 31, 2008, the Company adjusted its auction rate assumptions
used to value its Residual Interest in its securitization, leading to a $2.4
million reduction in the value of its residual, which resulted in a $0.1 million
adjustment to other comprehensive income and a $2.3 million write-down, recorded
as a negative Securitization Income. Despite the fact that the Company’s
securitization’s senior, triple-A auction rate notes have not had a failed
auction and the subordinate, single-A notes have only recently experienced
their
first failed auctions, due to the general dislocation of the student loan
auction rate market in general, we have extended the period through which the
auction rate securities would price at the maximum rate through the next 18
to
24 months and assumed that rates would thereafter decline over 18 to 24 months
to a rate in excess of the levels that the Company’s securities priced at the
inception of the transaction. We do not believe that such markets will remain
dislocated forever. Logically speaking, if in the future the spreads on term
asset backed securities fall below the maximum rates at which auction rate
notes
are pricing now, we believe that investor demand for such assets should be
rekindled at such time. We believe that this process will be aided by the fact
that the broker-dealers who conduct the auctions are required by the terms
of
their contract to continue to hold an auction every 28 days. Our valuation
of
our residual assumes that this normalization may begin to occur in 18 to 24
months. The table below illustrates how the valuation of our residual might
change if such normalization took more or less time to occur.
Months
at Maximum Rate for AAA’s
|
6
|
12
|
18
|
24
|
30
|
Months
at Maximum Rate for A’s
|
12
|
18
|
24
|
30
|
36
|
Residual
Valuation ($’s in Millions)
|
$10.9
|
$10.0
|
$9.3
|
$8.6
|
$7.9
|
Interest
income is primarily impacted by the size of the portfolio and the Company’s
management of its portfolio for defaults and delinquencies. Since the Company’s
private student loan portfolio floats with LIBOR either monthly or quarterly,
the Company feels it has very limited interest rate exposure on this asset.
Post-origination, the private student loan portfolio is most affected by rates
of default, delinquencies, recoveries, and prepayments. The Company originated
its first private student loan in June 2005, so its portfolio is not highly
seasoned.
In
determining the adequacy of the allowance for the loan losses on our private
student loan portfolio, the Company considers several factors, including loans
in repayment vs. those in deferred status, delinquency or default status, and
recoveries.
The
expenses we incur in operating our business include: bank fees charged for
the
origination of our student loans, referral marketing fees paid to our private
label origination partners, interest and fee expense on the lines of credit
with
which we finance our student loans, servicing and custodial costs for our
student loan portfolio, cost associated with hosting and developing our online
college application business, the cost of marketing to our customers through
direct-to-consumer channels such as direct mail, print and radio, and general
corporate and administrative expenses, such as salaries and facilities expense.
Operating expenses also include the depreciation of capital assets and
amortization of intangible assets.
The
Company does not believe inflation has a significant effect on its
operations.
RESULTS
OF OPERATIONS FOR THE NINE MONTHS ENDED MARCH 31, 2008, COMPARED TO THE NINE
MONTHS ENDED MARCH 31, 2007
INTEREST
INCOME
The
Company’s interest income is comprised of interest income on the private and
federal loan portfolios and the accrual of interest income on the Residual
Interest from the Company’s Securitization. Total interest income increased by
$1,769,000: $7,450,000 for the nine months ended March 31, 2008 compared
to
$5,681,000 for the nine months ended March 31, 2007. This increase is primarily
attributable to the increase in federal student loan volume and the Residual
Interest income from the securitization. Federal student loan interest income
increased to $870,000 for nine months ended March 31, 2008 compared to $104,000
for the nine months ended March 31, 2007. The interest income on the Residual
Interest totaled $1,105,000 for the nine months ended March 31,
2008.
INTEREST
EXPENSE
The
total interest expense increased to $5,733,000 for the nine month period
ended
March 31, 2008 compared to $4,146,000 for the nine month period ended March
31,
2007. Facility interest and origination bank costs increased by 21% from
$4,139,000 to $4,989,000 for the nine month periods ended March 31, 2007
and
2008, respectively. The Other Interest Expense of $744,000 for the nine month
period ended March 31, 2008 is comprised of interest costs related to the
Senior
Secured Notes detailed in Note 12 of the Notes to the Financial
Statements.
NON-INTEREST
INCOME
The
Company’s non-interest income is primarily comprised of income from the
Securitization as well as the subscription and service revenue fees from the
Company’s Embark subsidiary, an online college admissions application
business acquired by the Company in February 2007. Securitization income (net)
totaled $1,795,000 for the nine month period ended March 31, 2008 which was
generated by the Company’s sale in the six months ended December 31, 2007 of the
second and third pools of loans to the securitization trust established in
June
2007, and reduced by impairment write-downs of the Company’s Residual Interest
in its Securitization trust that were recorded for the three-months ended March
31, 2008. Subscription and service revenue, primarily from the Company’s Embark
subsidiary, was $4,275,000 for the nine months ended March 31, 2008 compared
to
$722,000 for the nine months ended March 31, 2007. Origination processing fees
generated by the Company’s origination of PrePrime
TM
loans
for EEF I, LLC increased 93% to $680,000 for the nine months ended March 31,
2008 compared to $353,000 from the comparable period a year ago, proportionate
with the growth in origination volume.
NON-INTEREST
EXPENSE
The
Company’s total non-interest expense increased by 39% to $38,337,000 for the
nine month period ended March 31, 2008 over the same period for 2007. Not
including the expenses for the Company’s Embark subsidiary, the Company’s
non-interest expense increased by 13% to $30,515,000 for the nine month period
ended March 31, 2008 over the same period for 2007. This compares favorably
with
the 92% increase in loan originations for the same period, demonstrating the
scale that the Company’s business model is achieving.
Corporate
general and administrative expenses increased from $7,128,000 for the nine
month
period ended March 31, 2007 to $12,284,000 for the nine month period ended
March
31, 2008, out of which $1,821,000 of the corporate G&A expenses are related
to the Embark subsidiary. The 47% increase in non-Embark related corporate
general and administrative expenses is primarily due to the increase in the
size
of the organization and the additional employees thus an increase in salaries
and stock compensation. Stock compensation expense totaled $2,787,000 of the
total corporate general and administrative expense. The Company also moved
to a
larger corporate office and the rent expense increased by $692,957 over the
same
period in 2007.
Sales
and
marketing expense for the nine month period ended March 31, 2008 totaled
$9,541,000 compared to $8,023,000 for the same period in 2007. This increase
is
primarily due to sales and marketing expenses for the Embark subsidiary in
the
amount of $1,752,000. Not including Embark, the Company’s sales and marketing
expenses was $7,789,000, approximately equal to the amount expended in the
same
period of 2007, which compared to a growth of 92% in loan originations,
indicates increasing scalability of the Company’s brand and marketing
activities.
Operations
expense increased from $3,751,000 for the nine month period ended March 31,
2007
to $5,380,000 for the same period in 2008. The 43% increase in operations
expenses should be compared to the 92% increase in the Company’s loan volume for
the period, which indicates that our customer service and origination processing
functions are evidencing increased efficiency.
The
cost
of subscription and service revenue of $1,379,000 is associated with costs
related to the processing of admissions applications at the Company’s Embark
subsidiary. The increase of $796,000 in referral marketing costs (from $725,000
for the nine month period ended March 31, 2007 compared to $1,521,000 for the
same period in 2008) is proportionate with increased origination of private
student loans by the Company’s private label marketing partners. Legal expenses
increased by $565,000 in 2008 due to legal documentation related to the renewal
and expansion of credit facilities.
Depreciation
and amortization expense was $2,476,000 in the nine months ended March 31,
2008
compared to $4,035,000 in the nine months ended March 31, 2007. The decrease
is
primarily due to the deferred financing fees related to the MLBU and Nomura
credit facilities, which were fully amortized as of June 30, 2007.
NET
LOSS
For nine
months ended March 31, 2008, the Company incurred a net loss applicable to
common shares of $35,121,000, or $1.22 per share compared to a net loss of
$29,494,000, or $1.60 per share for the nine months ended March 31, 2007. The
weighted average number of shares outstanding for nine months ended March 31,
2008 was 28,880,000 shares compared to 18,401,000 shares for the nine months
ended March 31, 2007.
LIQUIDITY
AND CAPITAL RESOURCES
As
of March 31, 2008, the Company had $325 million of warehouse line capacity
to
fund its private and federal student loan originations, $125 million from
Merrill Lynch Bank USA and $200 million from DZ Bank AG. The Company is
currently in discussions with Merrill Lynch regarding the potential to renew
the
line before July 15, 2008. The Company’s DZ Bank facility is a five-year
facility that does not come up for renewal until April 2012. The Company
is holding discussion with other banks regarding the additional warehouse lines
or whole loan sales, which would increase its loan origination capacity.
Additionally, the Company is currently working on structuring a securitization
which will allow it to refresh its existing warehouse line
capacity.
CASH
AND CASH EQUIVALENTS AND ACCOUNTS RECEIVABLE
As of
March 31, 2008, the Company had unrestricted cash and cash equivalents of
$17,223,000, restricted cash of $2,652,000, and accounts receivable of $665,000
compared to unrestricted cash of $11,606,000, restricted cash of $3,154,000,
and
accounts receivable of $1,979,000 as of June 30, 2007. $2.1 million of the
March
31, 2008 balance of restricted cash is security for the Company’s subsidiaries’
loan purchase and sale agreements with the Bank which fluctuates with the
volume of the loans originated. Accounts receivable are related to business
activity generated by our Embark subsidiary.
The
Company maintains cash and cash equivalent balances at financial institutions
that are insured by the Federal Deposit Insurance Corporation up to $100,000.
The Company’s uninsured cash balances were $17,852,000 and $13,507,000,
respectively; for the nine months ended March 31, 2008 and year ended June
30,
2007.
STUDENT
LOAN RECEIVABLES
As of
March 31, 2008; the Company had a balance of private student loans receivables
(net of reserves) of $103,649,000 compared to $5,441,000 as of June 30, 2007.
The amount on the Company’s balance sheet increased as a result of the increased
loan volume during the months of July through March, reduced by the sale of
approximately $32.8 million of loans into the Company’s securitization
transaction.
At
March
31, 2008, the Company had a balance of $36,407,000 of federal student loan
receivables compared to $7,395,000 at June 30, 2007. The Company launched its
federal student loan program in fiscal 2007.
FIXED
ASSETS
At March
31, 2008 the Company had $1,957,000 of net fixed assets compared to $1,553,000
at June 30, 2007. The increase is mainly due to additional technology
spending at the Company’s Embark subsidiary.
OTHER
ASSETS
At March
31, 2008, the Company had $13,706,000 in other assets compared to $11,873,000
at
June 30, 2007. Other assets primarily include security deposits, intangibles,
goodwill and deferred financing fees. Security deposits were $1,013,000 at
March
31, 2008 associated with the Company’s leases for office space and loan
servicing contracts. The intangible assets and goodwill total $8,084,000
at
March 31, 2008 and are mainly related to the TPR transaction (described in
Note 5 to the Condensed Consolidated Financial Statements). The deferred
financing fees (net of amortization) total $2,198,000 at March 31,
2008.
LIABILITIES
Total
liabilities were $162,814,000 at March 31, 2008 compared to $21,459,000 at
June
30, 2007. The increase is primarily due to additional borrowing on the MLBU
and
DZ lines for funding of loan originations. Client deposits and deferred contract
revenues were $4,809,000 related to prepaid annual school contracts and
application fees collected on behalf of client schools generated by our Embark
subsidiary. As of March 31, 2008, the Company had $1,948,000 in accounts payable
and $2,510,000 in accrued expenses, compared to $3,835,000 and $458,000,
respectively as of June 30, 2007.
CONTRACTUAL
OBLIGATIONS AND COMMERCIAL COMMITMENTS
Contractual
Obligations
|
|
Total
|
|
Less
than 1 year
|
|
1-3
years
|
|
3-5
years
|
|
|
Long
Term Debt Obligations
|
|
$
|
0
|
|
$
|
0
|
|
$
|
0
|
|
$
|
0
|
|
$
|
0
|
Capital
Lease Obligations
|
|
$
|
0.8
million
|
|
$
|
0.2
million
|
|
$
|
0.5
million
|
|
$
|
0.1
million
|
|
$
|
0
|
Operating
Lease Obligations
|
|
$
|
14.3
million
|
|
$
|
2.3
million
|
|
$
|
4.5
million
|
|
$
|
3.9
million
|
|
$
|
3.6
million
|
Unconditional
Purchase Obligations
|
|
$
|
0
|
|
$
|
0
|
|
$
|
0
|
|
$
|
0
|
|
$
|
0
|
Other
Long-Term Obligations
|
|
$
|
11.2
million
|
|
$
|
0
|
|
$
|
11.2
million
|
|
$
|
0
|
|
$
|
0
|
Total
Contractual Cash Obligations
|
|
$
|
26.3
million
|
|
$
|
2.5
million
|
|
$
|
16.2
million
|
|
$
|
4.0
million
|
|
$
|
3.6
million
|
The
Company leases office equipment and corporate space under leases with terms
between one and seven years. The capital lease obligations are related to
Embark's leasing of fixed assets. Monthly payments under the current operating
leases range from $200 to $142,375; the monthly rent on the Company’s
headquarters increases to $150,750 after the first three years. The Company
is
required to pay its pro rata share of costs related to certain of the leased
facilities. The Other Long-Term Obligations includes the Senior Secured Notes
detailed in Note 12 - Senior Secured Notes, which had a three-year
term.
Commercial
Commitments
|
|
Total
|
|
Less
than 1 year
|
|
1-3
years
|
|
3-5
years
|
|
More
than 5 years
|
Lines
of Credit
|
|
$
|
325.0
million
|
|
$
|
125.0
million
|
|
$
|
0
|
|
$
|
200.0
million
|
|
$
|
0
|
Standby
Letters of Credit
|
|
$
|
0
|
|
$
|
0
|
|
$
|
0
|
|
$
|
0
|
|
$
|
0
|
Guarantees
|
|
$
|
0
|
|
$
|
0
|
|
$
|
0
|
|
$
|
0
|
|
$
|
0
|
Standby
Repurchase Obligations
|
|
$
|
0
|
|
$
|
0
|
|
$
|
0
|
|
$
|
0
|
|
$
|
0
|
Other
Commercial Commitments
|
|
$
|
2.9
million
|
|
$
|
2.9
million
|
|
$
|
0
|
|
$
|
0
|
|
$
|
0
|
Total
Commercial Commitments
|
|
$
|
327.9
million
|
|
$
|
127.9
million
|
|
$
|
0
|
|
$
|
200.0
million
|
|
$
|
0
|
The
Company has a renewable $125 million credit facility with MLBU, terms of
which
are described in the Notes to the Condensed Consolidated Financial
Statements included in this quarterly report on Form 10-Q. The Company had
an
outstanding balance of $112,924,000 on its credit facility with MLBU at March
31, 2008 and $11,711,000 at June 30, 2007. The Company has a $200 million
credit
facility with DZ Bank AG’s conduit, Autobahn Funding Company LLC (“DZ Bank”),
terms of which are described in the Notes to the Condensed Consolidated
Financial Statements included in this quarterly report on Form 10-Q. The
Company
had an outstanding balance of $19,702,000 with DZ Bank at March 31,
2008. During fiscal 2007, the Company paid off the Nomura credit facility.
The Company’s subsidiaries have loan purchase and sale agreements with Doral
Bank and at March 31, 2008, the Company had total commitments to Doral Bank
of $2,943,000 compared to $1,399,000 at June 30, 2007.
OFF-BALANCE
SHEET ARRANGEMENTS/TRANSACTIONS
We
securitized student loans through a bankruptcy remote, qualified special purpose
trust. See “Summary of Significant Accounting Policies - Securitization
Accounting” for a discussion of our determination to not consolidate the
securitization trust.
CRITICAL
ACCOUNTING POLICY AND ESTIMATES
The
Company’s Management and Discussion and Analysis of Financial Condition and
Results of Operations section discusses its condensed consolidated
financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States of America. The preparation
of these financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reported period. On an ongoing basis, management evaluates
its estimates and judgments, including but not limited to those related to
revenue recognition, accrued expenses, financing operations, contingencies,
and
litigation. Management bases its estimates and judgments on historical
experience and on various other factors that are believed to be reasonable
under
the circumstances, the results of which form the basis for making judgments
about the carrying value of assets and liabilities that are not readily apparent
from other sources. Such estimates may be the most significant accounting
estimates inherent in the preparation of our financial statements. Actual
results may differ from these estimates under different assumptions or
conditions. These accounting policies are described and disclosed in relevant
sections in this discussion and analysis and in the notes to the
condensed consolidated financial statements included in this quarterly
report on Form 10-Q.
Note
on Forward-Looking Statements
Except
for historical information contained herein, this quarterly report on Form
10-Q
contains forward-looking statements within the meaning of the Section 21E of
the
Securities and Exchange Act of 1934, as amended (the "Exchange Act"), which
involve certain risks and uncertainties. Forward-looking statements are included
with respect to, among other things, our current business plan, business and
investment strategy and portfolio management. These forward-looking statements
are identified by their use of such terms and phrases as “intends,” “intend,”
“intended,” “goal,” “estimate,” “estimates,” “expects,” “expect,” “expected,”
“project,” “projected,” “projections,” “plans,” “anticipates,” “anticipated,”
“should,” “designed to,” “foreseeable future,” “believe,” “believes” and
“scheduled” and similar expressions. Our actual results or outcomes may differ
materially from those anticipated. Readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of the date
the statement was made. We assume no obligation to publicly update or revise
any
forward-looking statements, whether as a result of new information, future
events or otherwise.
Important
factors that we believe might cause actual results to differ from any results
expressed or implied by these forward-looking statements are discussed in Item
1A of Part II of this Form 10-Q. In assessing forward-looking statements
contained herein, readers are urged to read carefully all cautionary statements
contained in this quarterly report on Form 10-Q.
Item
3. Quantitative and Qualitative Disclosures about Market
Risk.
Risks
Related to Cash and Cash Equivalents
We
have
market risk exposure related to changes in interest rates applicable to our
cash
and cash equivalents. We manage our market risk through a conservative
investment policy, the primary objective of which is preservation of capital.
As
of March 31, 2008, cash and cash equivalents consisted primarily of
highest-rated money market funds investing in government and implicitly
government backed securities, bank demand deposits which are immediately
available and certificates of deposit of up to 7-days maturity. As a result,
we
do not believe a change in interest rates would have a material impact on the
fair value of cash and cash equivalents.
Risks
Related to Student Loans held for Sale
We
also
have market risk exposure to our student loans held for sale. Our loans held
for
sale at March 31, 2008, consisted of $106.5 million of private student loans
and
$36.4 million of federal student loans. Our loans held for sale are recorded
at
lower of cost or market. Since all of our student loans are floating rate and
are financed using floating rate liabilities, we do not believe that a change
in
interest rates would materially impact the value of the loans. The value of
the
loans is primarily sensitive to credit spreads associated with the cost of
financing such loans, whether on a short term basis or long term through
securitization.
Risks
Related to Residual Interests in Securitization
Because
there are no quoted market prices for our Residual Interests, we use discounted
cash flow modeling techniques and various assumptions to estimate their values.
We base these estimates on the individual terms of the loans, borrower and
co-borrower credit characteristics, the federal cohort default rate as reported
by the U.S. Department of Education for the institution attended, the borrower’s
programs of study, industry data regarding the performance of other private
student loans, the terms of the Securitization and the expected cost of funds.
Increases in our estimates of defaults, prepayments and discount rates,
increases in the spread between LIBOR indices and auctions rates, as well as
decreases in default recovery rates, would have a negative effect on the value
of our residuals. For an analysis of the estimated change in residual
receivables balance at March 31, 2008 based on changes in these loan performance
assumptions, see Note 16 in the Notes to the condensed consolidated
financial statements contained in this quarterly report on Form
10-Q.
Item
4. Controls and Procedures.
Evaluation
of Disclosure Controls and Procedures
An
evaluation of the effectiveness of the design and operation of our “disclosure
controls and procedures” (as defined in Rule 13a-15(e) under the Securities
Exchange Act of 1934, as amended (the “Exchange Act”) as of the end of the
period covered by this quarterly report was made under the supervision and
with
the participation of our management, including our Chief Executive Officer
and
Chief Financial Officer. Based upon this evaluation, our Chief Executive Officer
and Chief Financial Officer have concluded that our disclosure controls and
procedures (a) are effective to ensure that information required to be disclosed
by us in reports filed or submitted under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified by
Securities and Exchange Commission rules and forms and (b) include, without
limitation, controls and procedures designed to ensure that information required
to be disclosed by us in reports filed or submitted under the Exchange Act
is
accumulated and communicated to our management, including our Chief Executive
Officer and Chief Financial Officer, as appropriate to allow timely decisions
regarding required disclosure.
Changes
in Internal Control over Financial Reporting
There
have been no significant changes in our “internal control over financial
reporting” (as defined in Rule 13a-15(f) of the Exchange Act) that occurred
during the period covered by this quarterly report that have materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
PART
II. OTHER INFORMATION
Item
1.
|
Legal
Proceedings
|
None.
Except
with respect to the risk factors titled:
|
(i)
|
“Our
assumptions regarding the future cost of funding of auction rate
notes are
highly uncertain and greatly affect the valuation of our residual
interest
in our securitization,”
|
|
(ii)
|
“Proposed
changes to GAAP Accounting by the Financial Accounting Standards
Board, if
passed in the future, could make it more difficult to account for
a
securitization transaction as a sale of assets, which could prevent
us
from recognizing a gain from such transaction”
and
|
|
(iii)
|
“The
growth of our business could be adversely affected by changes in
federal
student loan programs or expansions in the population of students
eligible
for loans under federal student loan
programs”
|
which
have been added since the filing of our annual report on Form 10-KSB for the
year ended June 30, 2007, and the risk factor titled:
|
(i)
|
“Our
business could be adversely affected if our student loan servicers
fail to
provide adequate or timely services or if our relationship with
a servicer
terminates”,
|
which
we
have made material changes to as compared to the version disclosed in our annual
report on Form 10-KSB for the year ended June 30, 2007, there have been no
material changes to the risk factors previously disclosed in our annual report
on Form 10-KSB for the year ended June 30, 2007. In addition to the other
information discussed in this quarterly report on Form 10-Q, please consider
the
risk factors provided below which could materially affect our business,
financial condition or future results. Additional risks and uncertainties not
currently known to us or that we currently deem to be immaterial also may
adversely affect our business, financial condition or operating
results.
We
have a history of losses and, because we expect our operating expenses to
increase in the future, we may not be profitable in the near term, if
ever.
We
have
accumulated net operating loss deficits of $116.7 million through March 31,
2008. The fourth quarter of the 2007 fiscal year, in which we had net income
of
$0.8 million, was our first and, thus far, only profitable quarter due to the
securitization. There can be no assurance that we will generate net income
for
our stockholders on a consistent basis.
We
expect to generate a significant portion of our income from gains on the sale
of
our student loans to securitizations; our financial results and future growth
would be adversely affected if we are unable to
securitize.
Securitization
refers to the technique of pooling loans and selling them to a special purpose,
bankruptcy remote entity, typically a trust, which issues securities backed
by
those loans. We completed our first securitization in June 2007, in which we
recognized a gain of $16.2 million from the sale of $137.8 million of private
student loans to a trust established by us; in September 2007, we sold $32.4
million of additional private student loans to the trust and recorded a gain
of
$4.1 million; in November 2007, we sold $0.38 million of additional private
student loans to the trust without gain. We intend to continue to securitize
our
student loans from time to time as sufficient volumes of loans are originated
to
efficiently execute such transactions. The amount of gain we will recognize
from
these securitizations will be affected by the timing, size and structure of
the
securitization transactions, as well as the composition of the loan pools to
be
securitized, the return expectations of investors and assumptions we make
regarding loan portfolio performance, including defaults, recoveries,
prepayments and the cost of funds. Because we expect the gain on sale of student
loans to securitizations to comprise a significant portion of future income,
the
size and timing of such transactions will greatly affect our quarterly results.
Until such time as we originate sufficient volume to efficiently securitize
loans every quarter, our income will vary significantly from one quarter to
the
next depending upon whether a securitization is executed in a given quarter
or
not.
A
number
of factors could make securitization more difficult, more expensive or
unavailable, including, but not limited to, financial results and losses,
changes within our organization, specific events that have an adverse impact
on
our reputation, changes in the activities of our business partners, disruptions
in the capital markets, specific events that have an adverse impact on the
financial services industry, counter-party availability, changes affecting
our
assets, our corporate and regulatory structure, interest rate fluctuations,
ratings agencies’ actions, general economic conditions and the legal,
regulatory, accounting and tax environments governing our funding transactions.
We are dependent on the securitization markets for the long-term financing
of
our student loans. If this market continues to experience difficulties or if
our
asset quality were to deteriorate, we may be unable to securitize our student
loans or to do so on favorable terms, including pricing. If we were unable
to
securitize our student loans on favorable terms, we would seek alternative
funding sources to fund increases in student loans and meet our other liquidity
needs. These may include selling the loans to other financial institutions
or
holding the loans on warehouse lines to term. If we were unable to find
cost-effective and stable funding alternatives, our funding capabilities and
liquidity would be negatively impacted and our cost of funds could increase,
adversely affecting our results of operations, and our ability to grow would
be
limited.
Our
assumptions regarding the future cost of funding of auction rate notes are
highly uncertain and greatly affect the valuation of our residual interest
in
our securitization.
Our
securitization trust issued auction rate notes to finance, in part, the purchase
of student loans. Interest rates for the auction rate notes are determined
from
time to time at auctions. We use a spread over LIBOR to project the future
cost
of funding of the auction rate notes issued by the trust in determining the
value of our service receivables.
Historically,
the spread over LIBOR that we used to estimate the future cost of funding was
based on historical trends, then current auction rates for each trust and
assumptions for future auction rates. During the second quarter of fiscal 2008,
material deterioration of the debt capital markets resulted in actual auction
rates that trended significantly higher than the rates we had assumed in the
past. We also concluded that the higher actual auction rates would persist,
resulting in a greater spread over LIBOR, for a longer period of time than
we
had previously estimated. Our assumption with regard to future auction rates,
like our other key valuation assumptions, requires our subjective judgment
and
is susceptible to change.
The
interest rate on each outstanding auction rate note is limited by a maximum
rate. The maximum rate is the least of three rates: a floating interest rate
(generally one month LIBOR plus a margin), a fixed interest rate and the maximum
legally permissible rate. The margin applicable to the floating interest rate
is
dependent upon the then current ratings of the notes subject to an auction.
If
the notes are downgraded, the applicable margin, and the maximum floating rate,
would increase. If the interest rate determined pursuant to the auction
procedures would exceed the maximum rate, the interest rate for the applicable
interest period would be set at the maximum rate, but the amount of the “excess”
interest would accrue as “carryover interest.” A noteholder’s right to receive
carryover interest is superior to our residual interest in the securitization
trust. As a result, our projected cash releases from the securitization trust
that have issued auction rate notes, including the timing of receipt, could
be
materially adversely affected by increased costs of funding of auction rate
notes, including the extent to which the trust accrues carryover interest.
Broker-dealers
may submit orders in auctions for their own account. As a result of such
bidding, a broker-dealer may prevent a failed auction, or the interest rate
resulting from an auction may be lower than the rate that would have prevailed
had the broker-dealer not bid. A failed auction occurs when an existing owner
does not have its notes purchased through the auction procedures because the
amount of notes submitted for sale exceeds the amount of purchase orders. Broker
dealers, which have served as underwriters of our securitization, have bid,
and
may continue to bid, in auctions relating to our trust’s auction rate notes.
These bids in the past have both prevented failed auctions and supported
interest rates determined at auction. Broker-dealers have no obligation to
submit orders in auctions, and to the extent broker-dealers do not submit such
bids in the future, the interest rates on our trusts’ auction rate notes could
be higher than they have been historically, including higher than the maximum
rate, which would result in carryover interest, and there could be failed
auctions for such notes.
As
of
March 31, 2008, we had not had any failed auctions. However, since that
time two of the auctions of our single-A rated auction rate notes have failed.
These auctions may continue to fail and there can be no assurance that the
auctions of our triple-A rated auction rate notes will not fail in the future,
given that triple-A auction rate securities of other student loan issuers have
been experiencing auction failures since February 2008. Because the
auctions of our single-A rated auction rate note failed, their interest rate
was
set at the maximum rate for their rating category, which is one-month LIBOR
plus
2.50%. While our triple-A rated auction rate notes have not experienced a
failed auction, they have been pricing at very nearly the maximum rate for
their
rating category, which is one-month LIBOR plus 1.50%. During the third
quarter of fiscal 2008, we revised our assumption with regard to the future
cost
of funding of auction rate notes. We assumed at March 31, 2008 that all
outstanding auction rate notes will continue to bear interest at the current
spreads over one-month LIBOR for 18 months in the case of AAA/Aaa-rated
securities and 24 months in the case of A2/A-rated securities and thereafter
decline over 18 and 24 months, respectively, to spreads that are lower but
higher than historical levels for auction rates. As a result, during the
third quarter of fiscal 2008, we decreased the estimated fair value of our
securitization receivable by $2.4 million. See Note 16 - Securitization to
the
condensed consolidated financial statements
Illiquidity
as a result of failed auctions in the future could result in higher interest
rates determined by future auctions, derogatory rating agency action, including
ratings downgrades, and impairment charges by the holders of the outstanding
auction rate notes, each of which could materially adversely affect future
demand for auction rate notes.
Proposed
changes to GAAP Accounting by the Financial Accounting Standards Board, if
passed in the future, could make it more difficult to account for a
securitization transaction as a sale of assets, which could prevent the Company
from recognizing a gain from such
transactions.
The
Company has securitized student loans through a qualified special purpose,
bankruptcy remote trust. We do not consolidate the financial results of
the trust with our own financial results. See Note 2 “Summary of
Significant Accounting Policies - Securitization Accounting” for a discussion of
our determination to not consolidate the securitization trust.
On
April
2, 2008, the Financial Accounting Standards Board (FASB) held a board meeting
to
discuss the FASB staff recommendation to amend the criteria under which
securitizations of financial assets can be treated as sales off-balance sheet
and thus allow for the recognition of a gain- or loss-on-sale, as governed
by
FASB Statement No. 140,
Accounting
for Transfers and Servicing of Financial Assets and Extinguishment of
Liabilities.
A
majority of the board agreed with FASB staff recommendations to increase the
standard that must be met for sale treatment of securitized financial assets.
The process of amending Financial Accounting Standards can be lengthy and
generally involves input from companies that could be affected by the proposed
changes. When or if such proposed amendment is made, or the exact implications
of the final version cannot be predicted. While such an amendment, if it were
to
come about, would not prevent the Company securitizing its assets, it could
potentially, depending upon the final version, require the Company to account
for the securitization transaction as a financing rather than a sale, which
would prevent the recording of a gain. Such a change, if it were to come to
pass, could have a significant impact on the Company’s planned recognition of
revenue, causing the Company to recognize income on the loans it had originated
over the life of the assets rather than having a significant gain recorded
at
the time of securitization and trailing residual income thereafter.
In
connection with our recognition of revenue from securitization transactions,
if
the estimates we make, or the assumptions on which we rely, in preparing our
financial statements prove inaccurate, our actual results may vary
materially from those reflected in our financial
statements.
In
our
securitization, we have the right to receive any excess cash flow generated
by
the trust that is not needed to pay the trust’s liabilities. This right to
future cash flow is referred to as a “residual” interest. We have recorded the
residual as a receivable on our balance sheet at our estimate of its fair value.
Because there are no quoted market prices for our residual receivable,
accounting rules require that we use discounted cash flow modeling
techniques and certain assumptions to estimate fair value. We have estimated
the
fair value initially and will estimate the fair value in each subsequent quarter
and reflect the change in our estimate of fair value in the other comprehensive
income component of stockholders’ equity for that period. Our key assumptions to
estimate the fair value include prepayment and discount rates, interest rates
and the expected defaults from the underlying securitized loan portfolio and
the
recoveries thereon. If the actual performance of the securitization trust varies
from the key assumptions we use, the actual residuals that we receive from
the
trust could be significantly less than reflected in our current financial
statements, and we may incur a material negative adjustment to our earnings
in the period in which our assumptions change. In addition, our securitization
yields, or our residuals from a new securitization transaction expressed as
a
percentage of the total principal and accrued interest securitized, realized
on
future securitized transactions could decrease if the actual performance of
the
securitization trust varies from the key assumptions we have used. In
particular, economic, regulatory, competitive and other factors affecting
prepayment, default and recovery rates on the underlying securitized loan
portfolio, including full or partial prepayments and prepayments as a result
of
loan consolidation activity, could cause or contribute to differences between
the actual performance of the securitization trusts and our key
assumptions.
Our
residual in our securitization is subordinate to securities issued to investors
by the trust and may fail to generate any cash flow for us if the
securitized assets only generate enough cash flow to pay the debt holders.
We
may be unable to meet our capital requirements in the
future.
We
may
need additional capital in the future, which may not be available to us on
reasonable terms or at all. The raising of additional capital may dilute your
ownership in us. We may need to raise additional funds through public or private
debt or equity financings in order to meet various objectives. Any additional
capital raised through the sale of equity may dilute your ownership percentage
in us. This could also result in a decrease in the fair market value of our
equity securities because our assets would be owned by a larger pool of
outstanding equity. The terms of securities we issue in future capital
transactions may be more favorable to our new investors, and may include
preferences, security interests in specific assets, superior voting rights
and
the issuance of warrants or other derivative securities, which may have a
further dilutive effect. Furthermore, any additional debt or equity financing
we
may need may not be available on terms favorable to us, or at all. If we are
unable to obtain required additional capital, we may be forced to curtail our
growth plans or cut back our existing business and, further, we may not be
able
to continue operating if we do not generate sufficient revenues from operations
we need to stay in business. We may incur substantial costs in pursuing future
capital financing, including investment banking fees, legal fees, accounting
fees, securities law compliance fees, printing and distribution expenses and
other costs. We may also be required to recognize non-cash expenses in
connection with certain securities we may issue, such as convertible notes
and
warrants, which will impact our financial statements.
There
are market, credit and liquidity risks associated with our business which could
have a material adverse effect on us.
Due
to
continuing disruptions in the credit markets precipitated by the subprime
mortgage crisis and the credit and liquidity problems of other student loan
finance companies, banks have grown significantly more conservative in their
lending practices. Given the dramatic change in the overall credit environment
and economy, we are not able to predict the terms, if any, under which our
existing lenders would renew our credit facilities. In anticipation of this
outcome, we have begun discussions with a number of other banks to broaden
our
warehouse funding channels and to ensure competitive economic terms. However,
no
assurance can be given that our efforts to secure additional credit facilities
on the same or more favorable terms will prove successful.
The
uncertainty and volatility of the credit markets may have a significant impact
on the revenues derived from our securitization transactions, or may prevent
us
from accessing the securitization market at all. The securitization of our
loan
portfolios rely heavily on key assumptions, such as credit spreads and expected
defaults. If credit spreads continue to widen and the defaults of borrowers
under our existing loan portfolios increase, the revenues generated by our
loan
portfolios may be significantly reduced, and accordingly, we may be unable
to
continue to recover the same level of residual interest from our securitization
trusts which we achieved in the past under more favorable market conditions.
If
we are unable to securitize, we will not be able to recognize a gain-on-sale
on
the loans we have originated, and consequently our net income will be
lower.
Our
risk control and eligibility scoring system may have defects or turn out to
be
ineffective, which could materially and adversely affect our prospects,
business, and results of operations.
The
proprietary system we use to score our students in determining their eligibility
for and/or cost of financing and to control risk is based on our existing
knowledge and available actuarial data and may be incomplete and/or inaccurate.
If this system turns out to be ineffective, our prospects, business, financial
condition, and results of operations could be materially and adversely
affected.
Our
business could be adversely affected if our student loan servicers fail to
provide adequate or timely services or if our relationship with a servicer
terminates.
All
of
our student loans are serviced by third-parties. This arrangement allows us
to
increase the volume of loans without incurring the overhead investment in
servicing operations. Our reliance on external service providers for loan
servicing subjects us to risks associated with inadequate or untimely services,
such as inadequate notice of developments in prepayments, delinquencies and
defaults. A substantial increase in these rates could adversely affect our
ability to access profitably the securitization market and the value of our
residual receivables. Because securitization involves the creation of a new
legal entity to become the owner of the loans, our servicers must execute a
new
servicing contract with the new legal entity. Generally, we would expect that
these new contracts would mirror the terms of the existing servicing contracts,
but it is possible that the servicer could demand alternative terms that could
make it more difficult to securitize our loans. In such a
circumstance, we might conclude that we should transfer servicing to
another servicer in order to maximize the liquidity of our assets. In addition,
if our relationship with any third-party servicer terminates, we would need
to
transfer servicing to another third-party servicer of student loans, which
could
be time consuming and costly. In such event, our business could be adversely
affected.
The
growth of our business could be adversely affected by changes in federal student
loan programs or expansions in the population of students eligible for loans
under federal student loan programs.
More
than
90% of our loan volume comes from private student loans originated to finance
post-secondary education. The availability and terms of loans that the
federal government originates or guarantees affects the demand for private
student loans because students and their families often rely on private loans
to
bridge a gap between available funds, including family savings, grants and
federal and state loans, and the costs of post-secondary education. The federal
government currently places both annual and aggregate limitations on the amount
of federal loans that any student can receive and determines the criteria for
student eligibility. These guidelines are generally adjusted in connection
with
funding authorizations from the United States Congress for programs under the
Higher Education Act. The Deficit Reduction Act of 2005 increased amounts that
first and second year college students may borrow and made Parent Loans for
Undergraduate Students, or PLUS, loans available to graduate and professional
students. The loan limit increases took effect July 1, 2007 while most
other provisions took effect July 1, 2006. Recent federal legislation has
sought to expand federal grant and loan assistance, which could weaken the
demand for private student loans. In addition, legislation such as the College
Cost Reduction and Access Act of 2007 has significantly reduced the profit
margins of traditional providers of federal loans, which could result in
increased competition in the market for private student loans, which could
adversely affect the volume of private loans and securitization transactions
and, as a result, the growth of our business. Bills recently passed by the
U.S.
Senate and the House of Representative, intended to inject liquidity into the
student loan asset-backed securitization market, would enable the Department
of
Education to buy only federally guaranteed student loans, not private student
loans. On May 7, 2008, the President signed into law the “Ensuring Continued
Access to Student Loans Act of 2008,” which contains provisions which might
adversely impact the demand for private educational loans, availability and
flow
of funds for private educational loans, and our liquidity position. Among other
things, the Act:
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permits
a parent borrower under the federal PLUS Loan program to defer repayment
of the PLUS loan until six months after the student ceases to carry
at
least one-half the normal full-time academic workload;
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extends
eligibility for a parent PLUS loan to an applicant who, during the
period
beginning January 1, 2007 and ending December 31, 2009, has not
been delinquent for more than 180 days on mortgage loan payments
or
medical bill payments nor more than 89 days delinquent on the repayment
of
any other debt, in any case, during such period; and
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increases
the loan limits for unsubsidized Stafford loans for undergraduate
students.
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Demand
for our products may decrease.
Demand
for higher education financing may decrease. This may be as a result of a
decrease in demand for higher education or increased affordability for higher
education. This increased affordability may be the result of universities
reducing costs, families having more funds available to pay for higher
education, increases in the amount of availability of free financing such as
scholarships or grants, or other factors unknown to us. Additionally, further
government support of higher education through increased funding for students
and tax or other incentives related to higher education may reduce the costs,
increase the affordability and decrease the demand for our private student
loan
products.
Our
primary marketing strategy is to target parents and students directly. We
accomplish this principally through our website,
www.MyRichUncle.com
,
which
provides an interactive forum for parents and students to learn about our
products and services and to apply for them from us. There can be no assurance
that the Internet will be an effective means of reaching our prospective
customers, or that we will be able to effectively utilize any alternative means
that may become available, or that our marketing plans will succeed in
attracting customers.
Public
relations are an important part of our marketing program and our effort to
build
our reputation and brand identity. As our products and services become better
known, they may become less newsworthy, and we may receive less media coverage,
or we may have to increase our public relations efforts and expenditures to
maintain or increase the amount of media coverage we receive. We cannot assure
you that media coverage will be accurate and/or positive. Inaccurate and/or
negative representations of us in the media may have a material adverse effect
on our financial condition and results of operations.
Other
sources of higher education financing may be preferred by
borrowers.
We
compete with other options that students and families may have available to
them
to finance the costs of post-secondary education. Families and students may
simply prefer other options. These options include, among others: home equity
loans, prepaid tuition plans, 529 plans, education IRAs, and credit cards.
There
is no assurance that we will be able to compete successfully against other
providers of funds, including but not limited to traditional and established
student loan providers, credit card or mortgage lenders or any new forms of
competition. If we are unable to compete effectively with these sources of
funding, our business, financial condition, and results of operations will
suffer and may require us to revise or abandon our business plan or seek to
sell, curtail, or discontinue our business.
We
must be able to compete effectively with other providers of higher education
financing products and services in order to succeed.
The
market for higher education finance is highly competitive, and if we are not
able to compete effectively, our revenue and results of operations may be
adversely affected. The student loan origination market has a large number
of
competitors and is dominated by a number of large institutions, including Sallie
Mae, Wells Fargo, Bank of America, JP Morgan Chase and Citibank. Most of our
competitors have, among other competitive advantages, greater financial,
technical and marketing resources, larger customer bases, greater name
recognition and more established relationships than we have. Larger competitors
with greater financial resources may be better able to respond to the need
for
technological changes, compete for skilled professionals, build upon
efficiencies based on a larger volume of transactions, procure capital at a
lower cost, fund internal growth and compete for market share generally. As
to
our alternative financing products and services where we hope to establish
a
niche, third parties may enter these markets and compete against us. If third
parties choose to provide the range of services that we provide, pricing for
our
services may become more competitive, which could lower our profitability or
eliminate profitability altogether.
If
we do not comply with applicable governmental regulations, our business may
suffer.
Our
business operations and product offerings may be subject to various governmental
regulations. We are in the process of ascertaining the applicability of various
laws to us and our operations. If we become subject to additional government
regulation, our compliance costs could increase significantly. Regulatory
compliance activities could also divert our human and other resources from
revenue-generating activities.
Changes
in the regulatory regime could impair our business.
We
operate in a heavily regulated industry and new laws and changes in existing
laws could affect our business. The federal government and state governments
regulate extensively the financial institutions and other entities that offer
consumer finance products. The applicable laws and regulations are subject
to
change and generally are intended to benefit and protect borrowers rather than
our stockholders or us. Failure to comply with government regulations could
subject us to civil and criminal penalties and affect the value of our assets.
We could also be required to indemnify our employees in connection with any
expenses or liabilities that they may incur individually in connection with
regulatory action against them. As a result, there could be a material adverse
effect on our prospects, business, financial condition and our results of
operations.
If
we violate applicable privacy laws our business could be materially adversely
affected.
The
federal government and state governments have enacted fraud and abuse laws
and
laws to protect borrowers' privacy. Violations of these laws or regulations
governing our operations or our third party business partners and our and their
clients could result in the imposition of civil or criminal penalties, the
cancellation of our contracts to provide services or exclusion from
participating in education finance programs. These penalties or exclusions,
were
they to occur, would negatively impair our ability to operate our business.
In
some cases, such violations may also render the loan assets unenforceable.
We
could also have liability to consumers if we do not maintain their privacy,
or
if we do not abide by our own privacy policy and any such violations could
damage our reputation and the value and goodwill of our brand name. Violations
of these regulations could have a material adverse effect on our financial
condition, business and results of operations.
Our
business may suffer if we experience technical problems.
If
our
technology does not function properly, is breached or interrupted, or contains
errors that we have not corrected, we may not achieve the performance we expect.
Any interruption in or breach of our information systems may result in lost
business. For instance, our technology may contain "bugs" or become infected
by
computer viruses or worms that may interfere with the functionality of our
technology or negatively impact our proprietary databases. We may not
immediately detect and fix these problems, which may increase damage to our
business. These problems may result in, among other consequences, our
over-estimating cash flows from borrowers or underestimating default rates.
Third parties who have relied on our financial models or projections may have
recourse against us in the event of inaccuracies caused by technical or other
problems. Individually or cumulatively, these types of problems may have a
material adverse effect on our business, financial condition and results of
operations.
We
rely heavily on our technology and our technology could become ineffective
or
obsolete.
We
rely
on technology to interact with consumers to originate our products and to
perform some servicing functions pertaining to our financing products. It is
possible that our technology may not be effective, or that consumers will not
perceive it to be effective. We will be required to continually enhance and
update our technology to maintain its efficacy and to avoid obsolescence. The
costs of doing so may be substantial, and may be higher than the costs that
we
anticipate for technology maintenance and development. If we are unable to
maintain the efficacy of our technology, we may lose market share. Further,
even
if we are able to maintain technical effectiveness, our technology may not
be
the most efficient means of reaching our objectives, in which case we may incur
higher operating costs than we would were our technology more efficient. The
impact of technical shortcomings could have a material adverse effect on our
business, financial condition and results of operation.
If
our systems are unable to accommodate a high volume of traffic on our web site,
the growth of our revenue could be reduced or limited.
If
existing or future customers’ use of our web site infrastructure increases
beyond our capacity, customers may experience delays and interruptions in
service. As a result, they may seek the products of our competitors and our
revenue growth could be limited or reduced. Because we seek to generate a high
volume of traffic and accommodate a large number of customers on our web site,
the satisfactory performance, reliability, and availability of our web site,
processing systems, and network infrastructure are critical to our reputation
and our ability to serve customers. If use of our web site continues to
increase, we will need to expand and upgrade our technology, processing systems,
and network infrastructure. Currently, customer response times have not had
a
material detrimental effect on our results of operations to date. Our online
services may in the future experience slower response times due to increased
traffic if this risk is not effectively addressed.
Our
reliance on technology, including the Internet, as a means of offering and
servicing our products and services may result in damages.
We
offer
and sell our products and services to borrowers using technology. Although
the
use of the Internet has become commonplace, people may approach the entering
of
private information, as well as conducting transactions through the Internet,
hesitantly. We have implemented security measures within our systems, but
skilled computer-users could potentially circumvent some of these precautions.
While we are dedicated to maintaining a high level of security, it is impossible
to guarantee total and absolute security. Any security breach could cause us
to
be in violation of regulations regarding information privacy and as such cause
us to pay fines or to lose our ability to provide our products. Consumers may
also be hesitant or unwilling to use our products if they are or become aware
of
a security problem or potential security problem. We could also be liable to
consumers or other third parties if we do not maintain the confidentiality
of
our data and the personal information of our consumers.
Monitoring
unauthorized use of the systems and processes that we developed is difficult,
and we cannot be certain that the steps that we have taken will prevent
unauthorized use of our technology. Furthermore, others may independently
develop substantially equivalent proprietary information and techniques or
otherwise gain access to our proprietary information. If we are unable to
protect the confidentiality of our proprietary information and know-how, the
value of our technology and services will be adversely affected. This may have
a
material adverse effect on our financial condition and results of operation.
Legal
protection we seek for our intellectual property assets may not prove to be
available or effective.
We
have
filed a patent for protecting our intellectual property assets and continue
to
patent new innovations. These patents provide an important competitive advantage
to us, and our prospects, business, financial condition and results of
operations may be materially adversely affected if these patents are not granted
or upheld. In addition to seeking patent protection, we rely on copyright,
trademark and trade secret protection for our intellectual property. These
methods may not be adequate to deter third parties from misappropriating our
intellectual property or to prevent the disclosure of confidential information
or breaches of non-competition agreements between us and our employees or
consultants, and may not provide us with adequate remedies for misappropriation.
Our technology could also be designed around, replicated or reverse-engineered
by competitors, and we may not have the ability to pursue legal remedies against
them. For example, competitors could replicate data or acquire data comparable
to that which we have assembled in our proprietary databases, which could erode
our competitive advantage. We also may fail to detect infringement of our
intellectual property rights and may thereby lose those rights. In addition,
obtaining, monitoring and enforcing our intellectual property rights will likely
be costly, and may distract our management and employees from pursuing their
other objectives, which could impair our performance. If we are unable to
protect our intellectual property, our business may be materially adversely
affected.
We
may be subject to litigation for infringing the intellectual property rights
of
others.
Should
we
infringe (or be accused of infringing) an existing patent, copyright, trademark,
trade secret or other proprietary rights of third parties, we may be subject
to
litigation. Such litigation will be costly. If we settle or are found culpable
in such litigation, we may be required to pay damages, including punitive
damages (such as treble damages) if we are found to have willfully infringed,
and we may also be required to pay license fees or cease to use that
intellectual property which is found to have been infringed by us. The amount
of
damages we are required to pay may be substantial, and may require us to obtain
additional sources of revenue or additional capital to continue operating.
We
also may be precluded from offering products or services that rely on
intellectual property that is found to have been infringed by us. Further,
we
may also be required to cease offering the affected products or services while
a
determination as to infringement is considered by a court. If we are not able
to
offer products or services, our business, financial condition and results from
operations may be materially adversely affected.
We
may be unable to attract and retain key employees.
Failure
to attract and retain necessary technical personnel and skilled management
could
adversely affect our business. Our success depends to a significant degree
upon
our ability to attract, retain and motivate highly skilled and qualified
personnel. If we fail to attract, train and retain sufficient numbers of these
highly qualified people, our business, financial condition and results of
operations will be materially and adversely affected. We may issue stock options
or other equity-based compensation to attract and retain employees. The issuance
of these securities could be dilutive to the holders of our other equity
securities.
Senior
management may be difficult to replace if they leave.
The
loss
of the services of one or more members of our senior management team or the
inability to attract, retain and maintain additional senior management personnel
could harm our business, financial condition, results of operations and future
prospects. Our operations and prospects depend in large part on the performance
of our senior management team, including in particular Messrs. Raza Khan and
Vishal Garg. We do not maintain key man insurance policies on any of our
officers or key employees. We may not be able to find qualified replacements
for
any of these individuals if their services are no longer
available.
Insiders and
significant stockholders have substantial control over us and could limit your
ability to influence the outcome of key transactions, including a change of
control.
As
of May
14, 2008, our directors and executive officers beneficially owned approximately
23.8% of the outstanding voting shares and our two largest institutional
stockholders owned an additional 26.4% of our outstanding voting shares. As
a result, these stockholders, if acting together, could substantially influence
matters requiring approval by our stockholders, including the election of
directors and the approval of mergers or other extraordinary transactions.
They
may also have interests that differ from yours and may vote in a way with which
you disagree and which may be adverse to your interests. The concentration
of
ownership may have the effect of delaying, preventing or deterring a change
of
control of our company, could deprive our stockholders of an opportunity to
receive a premium for their common stock as part of a sale of our company and
might ultimately affect the market price of our common stock.
The
rights of our Series B preferred stockholders may adversely affect the holders
of our common stock.
Our
charter documents provide our board of directors with the authority to issue
series of preferred stock without a vote or action by our stockholders. Our
board of directors also has the authority to determine the terms of our
preferred stock, including designations, powers, preferences and voting rights.
The rights granted to the holders of our outstanding Series B preferred stock
may adversely affect the rights of holders of our common stock. For example,
the
holders of our Series B preferred stock are entitled to receive a liquidation
preference over all other equity securities that are junior to the Series B
preferred stock. In addition, subject to certain conditions, our charter
documents provide protective provisions to the holders of our Series B preferred
stock requiring us to first obtain the written consent of the majority of the
holders of our Series B preferred stock prior to undertaking certain actions,
including, without limitation, the sale of substantially all of our assets
or
our liquidation and winding up, amending our charter documents in a manner
adverse to the Series B preferred stockholders, the issuance of additional
shares of our stock or any options or convertible securities, and paying
dividends to our stockholders. Furthermore, our charter documents provide that,
subject to certain conditions, the Series B preferred stockholders have a right
of first offer to purchase any new securities offered by us which are junior
to
the Series B preferred stock. As a result, the rights granted to the holders
of
our Series B preferred stock may significantly impair our ability to raise
equity capital if the majority of the holders of our Series B preferred stock
do
not consent to the offer, sale and issuance of the new securities or we are
unable to obtain a waiver of each of our Series B preferred stockholder’s right
of first offer.
We
may not be able to effectively manage our growth.
Our
strategy requires growing our business. If we fail to effectively manage our
growth, our financial results could be adversely affected. Growth may place
a
strain on our management systems and resources. We must continue to refine
and
expand our business development capabilities, our systems and processes and
our
access to financing sources. As we grow, we must continue to hire, train,
supervise and manage new employees. If we are unable to manage our growth and
our operations our financial results could be adversely
affected.
Our
business is subject to seasonal fluctuations, which may cause volatility in
our
quarterly operating results.
We
experience, and expect to continue to experience, seasonal fluctuations in
our
revenue because the markets in which we operate are subject to seasonal
fluctuations based on the typical school year. We typically originate the
largest proportion of our student loan receivables volume in our first quarter.
These fluctuations could result in volatility or adversely affect our stock
price.
The
price of our common stock may be volatile.
The
trading price of our common stock may fluctuate substantially, depending on
many
factors, some of which are beyond our control and may not be related to our
operating performance. These fluctuations could cause you to lose part or all
of
your investment in our shares of common stock. Those factors that could cause
fluctuations include, but are not limited to, the following: actual or
anticipated changes in our earnings or fluctuations in our operating results
or
in the expectations of securities analysts; difficulties we may encounter in
securitizing our loans; any variance between the actual performance of the
securitization trust and the key assumptions that we have used to estimate
the
fair value of our residual receivable; changes in the key assumptions we use
to
estimate the fair value of our residual receivables, including discount, default
and prepayment rates; announcement by us, our competitors or our potential
competitors of acquisitions, new products or services, significant contracts,
commercial relationships or capital commitments; price and volume fluctuations
in the overall stock market from time to time; significant volatility in the
market price and trading volume of financial services companies; general
economic conditions and trends; negative publicity about the student loan market
generally or us specifically; legislative initiatives effecting federal or
private student loans; major catastrophic events; loss of a significant client
or clients; purchases or sales of large blocks of our stock; or departures
of
key personnel.
Item
2.
|
Unregistered
Sales of Equity Securities and Use of
Proceeds.
|
During
the quarterly period covered by this quarterly report on Form 10-Q, we issued
3,500 shares of our common stock in connection with the exercise of previously
issued warrants.
The
dates of issuance and issue price of the shares is as follows:
Date
of Issuance
|
Number
of Shares Issued
|
Exercise
or Issuance Price
|
January
10, 2008
|
3,500
|
$1.60
|
The
warrant exercises generated total proceeds to us of
$5,600. We used all of these proceeds for working capital and general
corporate purposes. The issuance of our shares of common stock upon
exercise of the warrants was exempt from the registration requirements of
the
Securities Act of 1933 pursuant to Section 4(2) thereof and/or Regulation
D
promulgated thereunder.
In
March
2008, 2,657 shares of common stock were purchased for $5,899 in exchange
for the
payment of witholding taxes due upon the vesting of restricted stock. The
average fair value of the common stock was $2.22 per share.
Item
3.
|
Defaults
Upon Senior Securities.
|
None.
Item
4.
|
Submission
of Matters to a Vote of Security
Holders.
|
None.
Item
5.
|
Other
Information.
|
None.
*
|
31.1
|
Certification
of Edwin J. McGuinn, Jr., Chief Executive Officer, as adopted pursuant
to
Section 302 of the Sarbanes-Oxley Act of 2002.
|
*
|
31.2
|
Certification
of Vishal Garg, Chief Financial Officer, as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
|
*
|
32.1
|
Certification
of Edwin J. McGuinn, Jr., Chief Executive Officer, pursuant to 18
U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act
of 2002.
|
*
|
32.2
|
Certification
of Vishal Garg, Chief Financial Officer, pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of
2002.
|
___________
*
Filed
herewith
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.
|
MRU
HOLDINGS, INC.
|
|
|
|
|
Date:
May 15, 2008
|
|
/s/
Edwin J. McGuinn, Jr.
|
|
|
Edwin
J. McGuinn, Jr.
|
|
Chief
Executive Officer
(Principal
Executive Officer)
|
|
|
Date:
May 15, 2008
|
|
/s/
Vishal Garg
|
|
|
Vishal
Garg
|
|
Chief
Financial Officer
(Principal
Financial and Accounting
Officer)
|
Mru Holdings (MM) (NASDAQ:UNCL)
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