HomeSpace, Inc. Consolidated Financial Statements for Fiscal Years Ended March 31, 2000 and 1999

Summary

This document presents the audited consolidated financial statements of HomeSpace, Inc. for the years ended March 31, 2000 and 1999, including the report of independent auditors Ernst & Young LLP. It details the company's financial position, results of operations, cash flows, and shareholders' equity. The report highlights significant losses and notes substantial doubt about the company's ability to continue as a going concern unless additional financing or a sale is secured. The statements are prepared in accordance with U.S. generally accepted accounting principles.

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EX-10.5 6 g64565ex10-5.txt CONSOLIDATED FINANCIAL STATEMENTS OF HOMESPACE 1 EXHIBIT 10.5 CONSOLIDATED FINANCIAL STATEMENTS HomeSpace, Inc. Years ended March 31, 2000 and 1999 with Report of Independent Auditors 2 HomeSpace, Inc. Consolidated Financial Statements Years ended March 31, 2000 and 1999 CONTENTS Report of Independent Auditors ...............................................1 Audited Consolidated Financial Statements Consolidated Balance Sheets...................................................3 Consolidated Statements of Operations.........................................5 Consolidated Statements of Shareholders' Equity...............................6 Consolidated Statements of Cash Flows.........................................7 Notes to Consolidated Financial Statements....................................8 3 Report of Independent Auditors The Board of Directors and Shareholders HomeSpace, Inc. We have audited the accompanying consolidated balance sheets of HomeSpace, Inc. as of March 31, 2000 and 1999, and the related consolidated statements of operations, shareholders' equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of HomeSpace, Inc. at March 31, 2000 and 1999, and the consolidated results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States. The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As shown in the consolidated financial statements, the Company has incurred losses of $38,115,039 and $13,465,420 for the years ended March 31, 2000 and 1999, respectively. These losses have significantly weakened the Company's financial position and its ability to meet current operating expenses, and, at March 31, 2000, the Company's current liabilities exceeded its current assets by $1,369,232. As further discussed in Note 1, the Company is currently seeking additional financing or a potential sale of the Company in an attempt to obtain additional sources of funds which, in management's opinion, would provide adequate cash flows to finance the Company's operations. The satisfactory completion of these negotiations is essential as the Company has no other immediate plans that will provide sufficient cash flows to meet current operating requirements. Because the negotiations are still in progress, there can be no assurance that the Company will have sufficient funds to finance its operations, which continue to show losses, through the period ending May 31, 2000. All of these matters 1 4 raise substantial doubt about the Company's ability to continue as a going concern and, in the event the negotiations for continued financing or a sale are unsuccessful, management will need to consider other alternatives including the potential liquidation of the Company. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts or classifications of liabilities that may result from the outcome of this uncertainty. ERNST & YOUNG LLP Los Angeles, California June 5, 2000 2 5 HomeSpace, Inc. Consolidated Balance Sheets
MARCH 31 2000 1999 ------------ ----------- ASSETS Current assets: Cash $ 4,842,340 $ 3,527,421 Prepaid expenses 88,056 37,500 Accounts receivable 137,785 641,939 Mortgage loans held for sale 5,529,000 -- ------------ ----------- Total current assets 10,597,181 4,206,860 Property and equipment, at cost 7,115,004 2,731,608 Accumulated depreciation (2,558,386) (1,118,430) ------------ ----------- 4,556,618 1,613,178 Capitalized software expenditures and enhancements 1,232,874 908,155 Accumulated depreciation -- (40,375) ------------ ----------- 1,232,874 867,780 Lease deposits and other assets 993,875 633,260 ------------ ----------- Total assets $ 17,380,548 $ 7,321,078 ============ ===========
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MARCH 31 2000 1999 ------------ ------------ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Warehouse line of credit $ 5,463,946 $ -- Note payable 200,000 200,000 Accounts payable 3,977,771 1,649,191 Accrued expenses 426,806 482,959 Capital lease obligation - short-term portion 1,897,890 474,929 ------------ ------------ Total current liabilities 11,966,413 2,807,079 Capital lease obligation - long-term portion 1,867,573 464,801 ------------ ------------ 13,833,986 3,271,880 Commitments and contingencies (Note 10) Shareholders' equity: Series B preferred stock, $.001 par value 23,695,877 shares authorized, 23,180,413 and 2,561,855 shares issued and outstanding, respectively 23,181 2,562 Series C preferred stock, $.001 par value 10,745,327 shares authorized, 9,870,739 shares issued and outstanding 9,871 -- Common stock, $.001 par value 25,000,000 shares authorized, 5,847,043 and 5,222,457 shares issued and outstanding, respectively 5,847 5,222 Paid-in capital in excess of par 75,319,014 24,449,003 Preferred stock to be issued -- 12,666,653 Treasury stock (539,796) -- Note receivable for common stock (1,822,673) (1,740,399) Accumulated deficit (69,448,882) (31,333,843) ------------ ------------ Total shareholders' equity 3,546,562 4,049,198 ------------ ------------ Total liabilities and shareholders' equity $ 17,380,548 $ 7,321,078 ============ ============
See accompanying notes. 4 7 HomeSpace, Inc. Consolidated Statements of Operations
YEAR ENDED MARCH 31 2000 1999 ------------ ------------ REVENUES Mortgage services $ 2,783,023 $ 3,732,601 Real estate services 3,402,696 1,916,863 Home services 22,687 3,710 ------------ ------------ Total revenues 6,208,406 5,653,174 OPERATING EXPENSES Mortgage origination 429,099 668,369 Real estate referral costs 2,698,739 1,510,670 Depreciation and amortization 2,054,681 662,420 Equipment leasing and rentals 715,668 564,375 Compensation and related benefits 15,986,711 9,587,124 Occupancy and related costs 2,015,069 1,286,469 Technical expenses 7,291,760 328,437 General and administrative 10,654,197 4,187,887 Write-off of capitalized software expenditures 2,032,734 -- ------------ ------------ Total operating expenses 43,878,658 18,795,751 ------------ ------------ Operating loss (37,670,252) (13,142,578) Interest expense (362,502) (492,468) Other (expense) income (82,285) 169,625 ------------ ------------ Net loss $(38,115,039) $(13,465,420) ============ ============
See accompanying notes. 5 8 HomeSpace, Inc. Consolidated Statements of Shareholders' Equity
NOTES TOTAL SERIES B SERIES C ADDITIONAL PREFERRED RECEIVABLE FOR SHAREHOLDERS' PREFERRED PREFERRED COMMON TREASURY PAID-IN STOCK TO BE COMMON ACCUMULATED EQUITY STOCK STOCK STOCK STOCK CAPITAL ISSUED STOCK DEFICIT (DEFICIT) ---------------------------------------------------------------------------------------------------------- Balance at March 31, 1998 $ - $ - $ 3,881 $ - $14,541,217 $ - $(2,523,376) $(17,868,423) $ (5,846,701) Issuance of common stock in exchange for services at $1.94 per share - - 2 - 4,668 - - - 4,670 Issuance of common stock in exchange for note payable at $5.90 per share - - 1,339 - 7,905,681 - 782,977 - 8,689,997 Issuance of Series B preferred stock for cash at $.78 per share 2,562 - - - 1,997,437 - - - 1,999,999 Series B preferred stock to be issued - - - - - 12,666,653 - - 12,666,653 Net loss - - - - - - - (13,465,420) (13,465,420) --------------------------------------------------------------------------------------------------------- Balance at March 31, 1999 2,562 - 5,222 - 24,449,003 12,666,653 (1,740,399) (31,333,843) 4,049,198 Accrued interest - - - - - - (82,274) - (82,274) Repurchase of common stock at $1.94 per share - - - (539,796) - - - - (539,796) Issuance of Series B preferred stock for cash at $.97 per share 20,619 - - - 19,979,381 (12,666,653) - - 7,333,347 Issuance of Series C preferred stock for cash at $3.02 per share - 9,871 - - 29,898,467 - - - 29,908,338 Issuance of common stock issued for cash at $1.94 per share - - 425 - 604,363 - - - 604,788 Issuance of common stock issued to settle liability at $1.94 per share - - 200 - 387,800 - - - 388,000 Net loss - - - - - - - (38,115,039) (38,115,039) --------------------------------------------------------------------------------------------------------- Balance at March 31, 2000 $23,181 $ 9,871 $ 5,847 $(539,796) $75,319,014 $ - $(1,822,673) $(69,448,882) $ 3,546,562 =========================================================================================================
See accompanying notes. 6 9 HomeSpace, Inc. Consolidated Statements of Cash Flows
YEAR ENDED MARCH 31 2000 1999 ------------ ------------ OPERATING ACTIVITIES Net loss $(38,115,039) $(13,465,420) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization expense 2,196,366 662,419 Write-off of capitalized software 2,032,734 -- Write-off of uncollectible notes -- 20,000 (Increase) decrease in prepaid expenses (50,556) (946) Decrease (increase) in accounts receivable 504,154 (446,899) Increase in mortgage loans held for sale (5,529,000) (142,393) Decrease (increase) in lease deposits and other assets 360,615 (599,460) Increase in accounts payable and accrued expenses 2,272,427 1,086,556 Increase in warehouse line of credit 5,463,946 -- Other operating increases 598,603 209,296 ------------ ------------ Net cash used in operating activities (30,265,750) (12,886,143) ------------ ------------ INVESTING ACTIVITIES Purchase of property and equipment (4,383,395) (1,298,389) Capitalized software expenditures (2,782,553) (908,155) ------------ ------------ Net cash used in investing activities (7,165,948) (2,206,544) ------------ ------------ FINANCING ACTIVITIES Payments of capital lease obligation (1,773,793) (905,000) Increases of capital lease obligations 2,825,733 279,649 Repurchase of common stock (539,796) -- Issuance of common stock 992,788 -- Issuance of Series C preferred stock 29,908,338 3,202,020 Repayment of notes receivable -- 858,000 Issuance of Series B preferred stock 7,333,347 14,666,652 ------------ ------------ Net cash provided by financing activities 38,746,617 18,101,321 ------------ ------------ Net increase in cash 1,314,919 3,008,634 Cash at beginning of year 3,527,421 518,787 ------------ ------------ Cash at end of year $ 4,842,340 $ 3,527,421 ============ ============ SUPPLEMENTAL DISCLOSURES Non-cash transaction - issuance of common stock $ 388,000 $ 4,670 Interest paid 288,288 410,254
See accompanying notes. 7 10 HomeSpace, Inc. Notes to Consolidated Financial Statements March 31, 2000 1. DESCRIPTION OF BUSINESS ORGANIZATION HomeSpace, Inc. (the Company) was incorporated in the state of Florida and began operations on April 1, 1997. Prior to that date the Company was a development stage enterprise. The accompanying consolidated financial statements include the accounts and operations of the Company and its wholly owned subsidiaries (HomeSpace Services, Inc. and HomeSpace Delaware Inc.). All significant intercompany transactions and balances have been eliminated in consolidation. BUSINESS AND OPERATIONS The Company provides mortgage brokerage services and real estate services to consumers located throughout the United States. The Company markets its services through affinity relationships with retailers, corporations and member associations. Real estate services are provided through a network of real estate brokers, and the Company arranges mortgage financing through a number of financial institutions. In August 1997, Costco Wholesale Corporation (Costco) contracted with the Company to provide mortgage and real estate services to its 28 million members. The significance of this contract caused senior management to redirect its real estate broker strategy and to devote its primary attention to implementing the Costco program. Processes and procedures were modified in order to present mortgage loan options directly to Costco members and to take mortgage applications through the Company's National Transactions Center in Englewood, Colorado. Management has decided that it will use the Costco program to attract other affinity groups and corporate sponsors, which in turn, will increase the Company's real estate and mortgage loan market share. The Company developed and launched a web site in November 1999. Management has placed emphasis on growing the business to gain market share. 8 11 HomeSpace, Inc. Notes to Consolidated Financial Statements (continued) 1. DESCRIPTION OF BUSINESS (CONTINUED) LIQUIDITY AND CAPITAL RESOURCES From inception, the Company has incurred net losses and negative cash flows. The Company's continued existence is dependent upon its ability to generate sufficient revenues to produce profitable operations and/or obtaining additional debt and equity capital. Subsequent to year end (May 2000), the Company raised $3.8 million through a debt offering with existing shareholders. The Company anticipates a further round of financing in the third quarter of fiscal 2000 or a sale of the Company. However, there can be no assurance that additional financing will be available. If adequate funds are not available, or are not available on terms acceptable to the Company, the Company may be required to curtail its operations significantly, forego market opportunities, or obtain funds through strategic partners or others that may require the Company to relinquish material rights to certain of its technologies or potential markets. The Company is currently seeking additional financing or a potential sale of the Company in an attempt to obtain additional sources of funds which, in management's opinion, would provide adequate cash flows to finance the Company's operations. The satisfactory completion of these negotiations is essential as the Company has no other immediate plans that will provide sufficient cash flows to meet current operating requirements. Because the negotiations are still in progress, there can be no assurance that the Company will have sufficient funds to finance its operations, which continue to show losses, through the period ending May 31, 2000. All of these matters raise substantial doubt about the Company's ability to continue as a going concern and, in the event the negotiations for continued financing or a sale are unsuccessful, management will need to consider other alternatives including the potential liquidation of the Company. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts or classifications of liabilities that may result from the outcome of this uncertainty. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES REVENUES Revenues and related direct costs are recognized at the time all significant services have been completed. For mortgage services, this is at the time loans are closed. For real estate services, revenue is recognized when cash payments are received from realtors. 9 12 HomeSpace, Inc. Notes to Consolidated Financial Statements (continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) PROPERTY AND EQUIPMENT Property and equipment are stated at cost less accumulated depreciation. Depreciation of property and equipment is provided on a straight-line basis over estimated useful lives of three to five years. CAPITALIZED SOFTWARE EXPENDITURES The Company capitalizes software expenditures for development of, and enhancements to, its real estate services and mortgage brokerage software and amortizes such costs over an estimated useful life of three years. The capitalized software expenditures as of March 31, 2000, are primarily for the development of, and enhancements to, the Company's Customer Relationship Management (CRM) System that will be used to offer mortgage brokerage, real estate and other homeowner services. Management determined that some of the previously capitalized expenditures associated with the development of software to be used internally was no longer useful and/or salable as of March 31, 2000. The costs for such software totaled $2,687,834 with prior period amortization of $655,100 for a net cost of $2,032,734, which was written off as of March 31, 2000. MORTGAGE LOANS HELD FOR SALE Mortgage loans held for sale are reported net of discounts and are valued at the lower of cost or market, determined on an aggregate basis. Any gain or loss on the sale of the loans is recognized at the time of sale. INCOME TAXES The Company utilizes the liability method of accounting for income taxes as set forth in SFAS No. 109, "Accounting for Income Taxes." Under the liability method, deferred taxes are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in the years in which the differences are expected to reverse. Recognition of deferred tax assets is limited to amounts considered by management to be realizable in future periods. 10 13 HomeSpace, Inc. Notes to Consolidated Financial Statements (continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) ADVERTISING COSTS Advertising costs, which consist of developing and printing costs of brochures and other marketing materials, are charged to expense when incurred. For the years ended March 31, 2000 and 1999, advertising costs totaled $2,098,961 and $41,618, respectively. ESCROW BALANCES The Company held escrow balances in trust of $149,409 and $156,474 as of March 31, 2000 and 1999, respectively. CASH FLOWS For purposes of the consolidated statement of cash flows, cash includes demand deposits with maturities of less than three months. None of the Company's cash is restricted. MANAGEMENT ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of 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. 3. SIGNIFICANT CUSTOMERS AND CONCENTRATIONS OF CREDIT RISK The majority of the Company's revenue is generated from services provided to executive members of Costco. The Company and Costco have a contractual agreement under which these services are provided, but the contract can be terminated by either party with 10-days written notice. All cash deposits are held by one financial institution and exceed the existing federal deposit insurance coverage limit. 11 14 HomeSpace, Inc. Notes to Consolidated Financial Statements (continued) 4. PROPERTY AND EQUIPMENT Property and equipment at March 31, 2000 and 1999, are recorded at cost and consisted of the following: 2000 1999 ----------- ----------- Computer equipment $ 2,209,502 $ 914,040 Furniture and fixtures 90,587 281,149 Equipment under capital leases 4,506,089 1,481,280 Leasehold improvements 308,826 55,139 ----------- ----------- Gross book value 7,115,004 2,731,608 Accumulated depreciation and amortization (2,558,386) (1,118,430) ----------- ----------- Net book value $ 4,556,618 $ 1,613,178 =========== =========== 5. WAREHOUSE LINE OF CREDIT In October 1999, the Company entered into a revolving Warehouse Line of Credit Agreement with a financial institution in the amount of $15,000,000 bearing interest at prime plus .25% to 1% depending upon the length of time of repayment. The line of credit is secured by mortgage loans and as of March 31, 2000, the outstanding balance was $5,463,946. 6. NOTE PAYABLE The Company secured a $200,000 demand loan from Costco on October 24, 1998. The note bears interest from the date of advance at a variable per annum rate (8.8% as of March 31, 2000). 7. SHAREHOLDERS' EQUITY The Company is authorized to issue 40,000,000 shares of convertible preferred stock of which 4,000,000, 23,695,877 and 10,745,327 shares have been designated as "Series A," Series B" and "Series C," respectively, having $3.03, $0.97 and $3.03 per share liquidation preferences, respectively. As of March 31, 2000 and 1999, there were no preferred Series A shares issued or outstanding. 12 15 HomeSpace, Inc. Notes to Consolidated Financial Statements (continued) 7. SHAREHOLDERS' EQUITY (CONTINUED) The preferred Series B shares are convertible into common shares at a rate of two shares of preferred Series B to one share of common as of March 31, 2000. The holders of the preferred Series B shares are entitled to receive, when and if declared by the board of directors, noncumulative cash dividends at a rate of $0.097 per share, in preference to any declaration or payment on the common shares. The holders of the preferred Series B shares are entitled to vote together with the shares of common stock as one class, at the equivalent amount of common shares as if converted. During November 1999, the Company received $29,908,338 in connection with an equity capital contribution transaction. Under the terms of this transaction, the Company issued 9,870,739 shares of Series C preferred stock. 8. EMPLOYEE BENEFIT PLAN On January 1, 1998, the Company established a defined contribution profit sharing and salary reduction plan covering all employees meeting general eligibility requirements. Pursuant to the provisions of Internal Revenue Code Section 401(k), the plan has received a favorable determination letter from the Internal Revenue Service. Employees are 100% vested in all personal salary reduction contributions and related earnings. Employer matching contributions equal 50% of the first 5% of employee contributions and vest over four years. For the years ended March 31, 2000 and 1999, employer contributions totaled $131,719 and $99,131, respectively. 9. INCOME TAXES At March 31, 2000 and 1999, the Company had net operating loss carryforwards of approximately $69,200,000 and $31,000,000, respectively. These carryforwards expire between the years 2007 and 2020 and may be subject to limitation of use under the provisions of Internal Revenue Code Section 382 and corresponding state sections. 13 16 HomeSpace, Inc. Notes to Consolidated Financial Statements (continued) 9. INCOME TAXES (CONTINUED) Pursuant to Statement of Financial Accounting Standards No. 109, the Company has recorded a deferred tax asset for the net operating loss carryforwards at March 31, 2000 and 1999, in the amounts below, which have been offset by a valuation allowance in the same amount, as follows: MARCH 31 2000 1999 ------------ ------------ Deferred tax asset: Net operating loss carryforwards $ 24,900,000 $ 10,540,000 Valuation allowance (24,900,000) (10,540,000) ------------ ------------ Net $ -- $ -- ============ ============ 10. COMMITMENTS AND CONTINGENCIES LEASES Beginning May 1, 1996, the Company leased facilities located in Ontario, California, from a corporation owned by two stockholders, one of whom is also a director, under a noncancelable operating lease expiring March 1999. In July 1997, the lease was renegotiated to a month-to-month basis and this lease was terminated in January 2000. For the years ended March 31, 2000 and 1999, rent expense under this lease totaled $95,119 and $126,825, respectively. Beginning September 1, 1996, the Company also leased office facilities in Englewood, Colorado, under a noncancelable operating lease expiring in May 2002. Additional Englewood facilities were leased on September 30, 1998, with a lease expiration on May 31, 2001. For the years ended March 31, 2000 and 1999, rent expense under these leases totaled $1,393,572 and $739,082, respectively. In March 2000, facilities originally leased in Englewood, Colorado, were subleased for the balance of the lease term. In November 1999, the Company leased office facilities in Pasadena, California, under a 60-month noncancelable operating lease. The Company occupied these facilities in June 2000. Rent expense under this lease will average $586,000 per year. 14 17 HomeSpace, Inc. Notes to Consolidated Financial Statements (continued) 10. COMMITMENTS AND CONTINGENCIES (CONTINUED) LEASES (CONTINUED) Future minimum lease payments required under the above operating and capital leases are as follows: OPERATING CAPITAL YEAR ENDING MARCH 31 LEASES LEASES ------------------------------------ 2001 $ 1,145,470 $ 1,897 ###-###-#### 663,602 1,605 ###-###-#### 669,344 750 ###-###-#### 669,344 170,093 2005 and thereafter 957,533 - ------------------------------------ 4,105,293 4,424,046 Less current portion - (1,897,890) Amount representing interest - (658,583) ------------------------------------ $ 4,105,293 $ 1,867,573 ==================================== SEVERANCE PLAN The Company adopted a Severance Plan on March 16, 2000 (the Plan), providing members of executive management with severance payments in the event of an involuntary termination of employment other than for cause or a voluntary termination of employment for good reason within 12 months following a change of control transaction via a triggering event as defined in the Plan. Senior vice presidents and higher level officers are entitled to one year's compensation and employee benefits and vice presidents are entitled to six months' compensation and employee benefits. Severance payments are conditioned upon release from liability, non-disclosure of confidential information, non-solicitation of employees and others, non-competition, and transitional assistance. As of March 31, 2000, the Company estimates that approximately $3,050,000 would be payable to all executive management upon the occurrence of a triggering event. 15 18 HomeSpace, Inc. Notes to Consolidated Financial Statements (continued) 10. COMMITMENTS AND CONTINGENCIES (CONTINUED) LITIGATION As of April 1, 1999, the Company was in dispute with a corporation over 1.4 million shares of Series A convertible preferred stock (convertible into 560,000 shares of common stock) that were to be issued pursuant to a proposed merger transaction. On December 15, 1999, the Company entered into a confidential settlement agreement with the other corporation releasing all claims. The Company transferred shares of its common stock and cash to the other corporation. Certain shareholders of the Company agreed to indemnify the Company in connection with the dispute and pledged shares of common stock to secure their indemnity obligations. Effective March 1, 2000, the Company repurchased certain pledged shares from two shareholders and accepted the equivalent cash value in satisfaction of such indemnification. 11. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company's financial instruments consist of cash, mortgage loans held for sale, accounts receivable, and a note payable. CASH The Company maintains its cash in bank deposit accounts which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts and management believes there are no significant credit risks affecting cash. MORTGAGE LOANS HELD FOR SALE Mortgage loans held for sale are sold to a third party upon origination by the Company on a flow basis and no significant credit or interest rate risk exists. Accordingly, management believes the carrying amounts of the loans represent fair value. ACCOUNTS RECEIVABLE Accounts receivable are short term in nature (less than 30 days). Management monitors amounts owed to the Company and no significant credit risks exist with respect to collectibility. Accordingly, management believes the carrying amounts of these receivables represent fair value. 16 19 HomeSpace, Inc. Notes to Consolidated Financial Statements (continued) 11. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) NOTE PAYABLE Management believes the carrying value of the note payable represents the fair value of this financial instrument because its terms are similar to those in the lending market for comparable loans with comparable risks. 12. STOCK OPTIONS The Company has granted common stock options to executive management and other employees and uses the intrinsic-value method of accounting for these stock options. Accordingly, no compensation cost for options granted has been recognized in the accompanying financial statements. All outstanding options are currently exercisable and they expire generally at employment termination. Exercise prices range from $1.94 to $6.25 per share. The following table summarizes information about the Company's stock options outstanding at March 31, 2000: WEIGHTED-AVERAGE RANGE OF NUMBER REMAINING WEIGHTED-AVERAGE EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE - -------------------------------------------------------------------------------- $1.94 5,609,000 4.8 YEARS $1.94 $5.25-$6.25 265,000 4.8 YEARS $5.99 17 20 HomeSpace, Inc. Notes to Consolidated Financial Statements (continued) 12. STOCK OPTIONS (CONTINUED) The following is a schedule of the activity relating to the Company's stock options for the year ended March 31, 2000: WEIGHTED- AVERAGE SHARES EXERCISE (000'S) PRICE ---------------------------- Options outstanding at beginning of year 4,982 $1.39 Granted 4,542 1.94 Exercised - - Expired/rescinded (3,650) 1.94 Options outstanding at end of year 5,874 2.12 Options exercisable at end of year 483 3.12 Weighted average fair value of options granted during the year - 1.94 13. SUBSEQUENT EVENTS CONVERTIBLE NOTE FINANCING In June 2000, the Company authorized the sale of up to $4,000,000 of 6% convertible Series D notes due October 20, 2000, to existing investors. The Company's Chief Executive Officer also agreed to purchase $60,000 of Series D notes in bi-monthly installments running through September 2000. The Series D notes will be convertible into Series E convertible preferred stock at the same price per share as offered in a financing in which the Company issues at least $10 million in a Series E equity financing. If the Series E financing does not occur before the due date of the notes or a change of control transaction, as defined, then the Series D notes will be convertible into Series D-2 preferred stock (described below) at $3.03 per share. As part of the convertible note financing, the Company also agreed to authorize the issuance of shares of Series D-1 and D-2 convertible preferred stock to the investors who will purchase Series D notes. The Series D-1 stock will have the same rights, preferences and privileges as the Series B convertible preferred stock and the Series D-2 stock will 18 21 HomeSpace, Inc. Notes to Consolidated Financial Statements (continued) 13. SUBSEQUENT EVENTS (CONTINUED) CONVERTIBLE NOTE FINANCING (CONTINUED) have the same rights, preferences and privileges as the Series C convertible preferred stock. The Series D-1 and Series D-2 stock will receive pari passu with each other and rank senior to all other equity of the Company. MORTGAGE PROCESSING OUTSOURCED In June 2000, the Company entered into an agreement with a third party to assume certain mortgage processing capabilities. As a result, the Company reduced its workforce in June 2000. 14. SALE OF COMPANY AND OTHER MATTERS (UNAUDITED) On June 26, 2000, the Company received a notice of default from Imperial Bank under its capital lease agreements described in Note 10. Additionally, as of June 30, 2000, the Company was delinquent in paying its trade payables, operating leases and substantially all other obligations. On July 19, 2000, the Company signed a letter of intent with LendingTree, Inc. to sell certain assets of HomeSpace Services, Inc. for $12 million in cash and stock. Subject to the signing of a definitive purchase agreement, the transaction is expected to close on or about August 4, 2000. Upon closing, the assets of the Company not sold will be liquidated. The cash proceeds to be received from the sale and subsequent liquidation may not be sufficient for the Company to satisfy all outstanding obligations and recover the full carrying value of its assets. Costco terminated its affinity marketing relationship with the Company on July 31, 2000. 19