NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 1 – NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Company Background

As used herein and except as otherwise noted, the term “Company” shall mean PSM Holdings, Inc., a Delaware corporation.

The Company was incorporated under the laws of the State of Utah on March 12, 1987, as Durban Enterprises, Inc. On July 19, 2001, Durban Enterprises, Inc., created a wholly­owned subsidiary called Durban Holdings, Inc., a Nevada corporation, to facilitate changing the domicile of the Company to Nevada. On August 17, 2001, Durban Enterprises, Inc. merged with and into Durban Holdings, Inc., leaving the Nevada corporation as the survivor. The Company retained the originally authorized 100,000,000 shares at $0.001 par value.

On May 18, 2005, Durban Holdings, Inc. completed the acquisition of all of the outstanding stock of PrimeSource Mortgage, Inc., a Texas corporation, by a stock for stock exchange in which the stockholders of PrimeSource Mortgage, Inc. received 10,250,000 shares, or approximately 92% of the outstanding stock of Durban Holdings, Inc. Following the acquisition, effective May 18, 2005, the name of the parent “Durban Holdings, Inc.”, was changed to “PSM Holdings, Inc.” For reporting purposes, the acquisition was treated as an acquisition of the Company by PrimeSource Mortgage, Inc. (reverse acquisition) and a recapitalization of PrimeSource Mortgage, Inc. The historical financial statements prior to May 18, 2005, are those of PrimeSource Mortgage, Inc. Goodwill was not recognized from the transaction.

On December 14, 2011, PSM Holdings, Inc., created a wholly­owned subsidiary called PSM Holdings, Inc., a Delaware corporation, to facilitate changing the domicile of the Company to the State of Delaware. On December 29, 2011, PSM Holdings, Inc. merged with and into PSM Holdings, Inc., leaving the Delaware corporation as the survivor. The Company retained the originally authorized 100,000,000 shares at $0.001 par value.

Business Activity

PSM Holdings, Inc., through its consolidated subsidiaries, (collectively the “Company” or “PSMH”) originates mortgage loans funded either directly off the Company’s warehouse lines of credit or through brokering transactions to other third parties. Approximately 95% of the Company’s mortgage origination volume is banked off of our current warehouse lines. The Company has relationships with multiple investors who purchase the loans funded on its warehouse lines. All of the Company’s lending activities are conducted by its subsidiary, PrimeSource Mortgage, Inc. (“PSMI”).

Historically, a significant portion of the Company’s business has been referral based and purchase orientated (versus refinance). The Company does not directly participate in the secondary markets and, further, does not maintain a servicing portfolio. Approximately 75% of total loan applications are generated from business contacts and previous client referrals. Realtor referrals and other lead sources like Costco and Path2Sell account for the balance of loan applications.

The Company currently operates in or is licensed in the following states: Arizona, Arkansas, California, Colorado, Florida, Georgia, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Missouri, Minnesota, Montana, Nebraska, New Jersey, New Mexico, North Dakota, Oklahoma, Oregon, Texas, Utah, Virginia, Washington, Wisconsin and Wyoming and has started the application process in additional states throughout the United States.

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission for the presentation of interim financial information, but do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. It is recommended that these consolidated financial statements be read in conjunction with the audited financial statements for the year ended June 30, 2013, which were filed with the Securities and Exchange Commission on September 30, 2013 on Form 10-K for the year ended June 30, 2013. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. Operating results for the three and nine months ended March 31, 2014 are not necessarily indicative of the results that may be expected for the year ending June 30, 2014.

PSM HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Summary of Significant Accounting Policies

The following summary of significant accounting policies of the Company is presented to assist in the understanding of the Company’s financial statements. The financial statements and notes are the representation of PSM Holdings, Inc.’s management who is responsible for their integrity and objectivity. The financial statements of the Company conform to accounting principles generally accepted in the United States of America (“GAAP”). The Financial Accounting Standards Board (“FASB”) is the accepted standard-setting body for establishing accounting and financial reporting principles.

Principles of Consolidation

The consolidated financial statements include the accounts of PSM Holdings, Inc., its wholly-owned subsidiary WWYH, Inc., and WWYH Inc.’s wholly-owned subsidiary Prime Source Mortgage, Inc. All material intercompany transactions have been eliminated in the consolidation.

Use of Estimates

Management uses estimates and assumptions in preparing financial statements.  Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses.  Accordingly, actual results could differ from those estimates.  Significant estimates include the value of other non-current assets, estimated depreciable lives of property, plant and equipment, estimated valuation of deferred tax assets due to net operating loss carry-forwards and estimates of uncollectible amounts of loans and notes receivable.

Cash and Cash Equivalents

For the purposes of the statement of cash flows, cash and cash equivalents include cash on hand and cash in checking and savings accounts, and all investment instruments with an original maturity of three months or less.

Restricted Cash

The Company has certain cash balances set aside as collateral to secure various bonds required pursuant to the licensing requirements in some of the states in which it conducts business. Additionally, the Company maintains cash in escrow accounts related to 203k loans funded in which the renovation project is still ongoing at the period end.

Accounts Receivable

Accounts receivable represent commissions earned and fees charged on closed loans that the Company has not received. Accounts receivable are stated at the amount management expects to collect from balances outstanding at period-end. The Company estimates the allowance for doubtful accounts based on an analysis of specific accounts.

Employee Advances and Loans Receivable

Employee advances and loans receivable are stated at the unpaid principal balance. Interest income, if any, is recognized in the period in which it is earned.

Loans Held For Sale

The Company originates all of its residential real estate loans with the intent to sell them in the secondary market. Loans held for sale consist primarily of residential first and second mortgage loans that are secured by residential real estate throughout the United States.

Loans held for sale are recorded at their fair value, with the exception of any loans that have been repurchased from investors on which the Company did not elect the fair value option. Approximately six loans held for sale as of March 31, 2014 have yet to be sold to investors. The Company is servicing these loans until they can be sold to an investor. The Company also has certain renovation loans that have been funded against the warehouse lines and cannot be sold to investors until the renovation project has been completed, typically 90 days from funding. The loans are not considered impaired and are being carried on the balance sheet at market value.

PSM HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The fair value of loans held for sale is determined using current secondary market prices for loans with similar coupons, maturities and credit quality. Loans held for sale are pledged as collateral under the Company’s warehouse lines of credit. The Company relies substantially on the secondary mortgage market as all of the loans originated are sold into this market.

Interest on mortgage loans held for sale is recognized as earned and is only accrued if deemed collectible. Interest is generally deemed uncollectible when a loan becomes three months or more delinquent or when a loan has a defect affecting its salability. Delinquency is calculated based on the contractual due date of the loan. Loans are written off when deemed uncollectible.

Prepaid Expenses

Generally, prepaid expenses are advance payments for products or services that will be used in operations during the next 12 months. However, the Company engages an independent third party to perform a five-year outreach campaign to borrowers after their loan is funded. These amounts are capitalized and amortized equally each quarter over five years. Other prepaid expenses consist of prepaid insurance, rents and prepaid services provided by outside consultants. Prepaid expenses amounted to $306,540 and $161,717 at March 31, 2014 and June 30, 2013, respectively.

Property and Equipment

Property and equipment are stated at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the assets as follows. Expenditures for maintenance and repairs are charged to expense as incurred.

Goodwill and Indefinite-Lived Intangible Assets

Goodwill acquired in business combinations is assigned to the reporting entity that is expected to benefit from the combination as of the acquisition date. Goodwill impairment is determined using a two­-step process. The first step of the process is to compare the fair value of a reporting unit with its carrying amount, including goodwill. In performing the first step, the Company determines the fair value of its reporting entity by using a discounted cash flow ("DCF") analysis. Determining fair value using a DCF analysis requires the exercise of significant judgments, including judgments about appropriate discount rates, perpetual growth rates and the amount and timing of expected future cash flows. If the fair value of a reporting entity exceeds its carrying amount, goodwill of the reporting entity is not impaired and the second step of the impairment test is not required. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is required to be performed to measure the amount of impairment, if any. The second step of the goodwill impairment test compares the implied fair value of the reporting entity’s goodwill with the carrying amount of that goodwill. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. If the carrying amount of the reporting entity’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.

The impairment test for indefinite-­lived intangible assets involves a comparison of the estimated fair value of the intangible asset with its carrying value. If the carrying value of the indefinite-­lived intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess.

Long-Lived Assets and Intangible Assets with Definite Lives

Long-­lived assets, including property and equipment and intangible assets with definite lives, are tested for recoverability whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. The carrying amount of a long-­lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. If the carrying amount is deemed to not be recoverable, an impairment loss is recorded as the amount by which the carrying amount of the long-­lived asset exceeds its fair value. Amortization of definite lived intangible assets is recorded on a straight line basis over their estimated lives.

PSM HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Income Taxes

Income taxes are provided for the tax effects of transactions reported in the financial statements and consist of taxes currently due plus deferred taxes related primarily to differences between the bases of certain assets and liabilities for financial and tax reporting. The deferred taxes represent the future tax return consequences of those differences, which will either be deductible or taxable when the assets and liabilities are recovered or settled. In addition, there is the deferred tax asset which represents the economic value of various tax carryovers.

Taxes Collected and Remitted to Governmental Authorities

When applicable, the Company collects gross receipts taxes from its customers and remits them to the required governmental authorities. Related revenues are reported net of applicable taxes collected and remitted to governmental authorities.

Advertising

Advertising costs are expensed as incurred. Advertising expense was $205,833 and $567,485 for the three and nine months ended March 31, 2014 compared to advertising expense of $245,795 and $675,436 for the three and nine months ended March 31, 2013, respectively. 

Share Based Payment Plan

Under the 2012 Stock Incentive Plan, the Company can grant stock or options to employees, related parties, and unrelated contractors in connection with the performance of services provided to the Company by the awardees. The Company uses the fair value method to account for employee stock compensation costs and to account for share based payments to non-employees.

Revenue Recognition

The Company’s revenue is derived primarily from revenue earned from the origination and sale of mortgage loans. Revenues earned from origination of mortgage loans is recognized on the earlier of the settlement date of the underlying transaction or the funding date of the loan. Loans are funded through warehouse lines of credit and are sold to investors, typically within 14 days. However, since October 2013, we have added additional investors and modified our processes to be fully delegated with these investors. Partly due to this newer process, we have been experiencing a longer delay in selling of our funded loans, greater than 30 days on average. We believe this is temporary and will return to more normal timeframes as our processes mature. The gain or loss on the sale of loans is realized on the date the loans are sold.

The Company receives an override fee on the warehouse lines of credit on loans closed on the lines. The revenue from the override fee is recognized as earned when the loan is sold off of the warehouse line. We have accrued revenue for all loans that were funded prior to March 31, 2014 that have subsequently been sold, or are anticipated being sold in a reasonable time frame.

Earnings Per Common Share

Earnings per common share are computed using the two-class method. Basic earnings per common share are computed by dividing net income allocated to common shares by the weighted average number of shares outstanding during the applicable period, excluding outstanding participating securities. Participating securities include unvested restricted shares. Unvested restricted shares are considered participating securities because holders of these securities receive non-forfeitable dividends at the same rate as holders of the Company’s common stock. Diluted earnings per share are computed by dividing net income allocated to common shares adjusted for reallocation of undistributed earnings of unvested restricted shares by the weighted average number of shares determined for the basic earnings per common share computation plus the dilutive effect of common stock equivalents using the treasury stock method.

PSM HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Compensated Absences

The Company records an accrual for accrued vacation at each period end. Other compensated absences are expensed as incurred.

Reclassification

Certain accounts in the prior-year financial statements have been reclassified for comparative purposes to conform with the presentation in the current-year financial statements.

Recent Accounting Pronouncements

The Company has evaluated the possible effects on its financial statements of the accounting pronouncements and accounting standards that have been issued or proposed by FASB that do not require adoption until a future date, and determined they are not expected to have a material impact on the consolidated financial statements upon adoption.

Other accounting standards that have been issued or proposed by FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption.

NOTE 2 – ALLOWANCE FOR DOUBTFUL ACCOUNTS

Accounts receivable is presented on the balance sheet net of estimated uncollectible amounts. Approximately 98% of the outstanding accounts receivable are due from one customer. The Company records an allowance for estimated uncollectible accounts in an amount approximating anticipated losses. Individual uncollectible accounts are written off against the allowance when collection of the individual accounts appears doubtful. The Company recorded an allowance for doubtful accounts of $0 for the periods ended March 31, 2014 and 2013.

Depreciation expense for the three and nine months ended March 31, 2014 was $40,043 and $114,100, respectively, compared to the depreciation expense for the three and nine months ended March 31, 2013 of $24,413 and $74,359, respectively.

PSM HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 5 – RELATED PARTY TRANSACTIONS

President/Chief Executive Officer and Director

The Company entered into an Employment Agreement (the “COO EA”) with a Director as its Interim Chief Operating and Chief Financial Officer effective February 7, 2013. Pursuant to the terms of the COO EA, the Company agreed to pay an annual compensation of $240,000. This individual has also served as our President and Chief Executive Officer since August 28, 2013. For the three and nine months ended March 31, 2014, the Company recorded compensation expense of $60,000 and $170,000, respectively. These amounts include 26,494 shares of common stock received in lieu of cash compensation, which were discounted at 25% to the market price on the date the compensation was earned. For both the three and nine month periods ended March 31, 2013, the Company recorded compensation expense of $40,000. The Company also pays the contributed health insurance premium which is currently at $345 per month.

Executive Vice-President and Director

The Company entered into an Employment Agreement (the “EA”) with its Executive Vice-President effective January 1, 2014. The term of the EA is one year. Under the EA, the Company agreed to pay an annual base salary of $250,000. Salary may be paid with shares of common stock under an equity compensation plan at a 25% discount to the fair market price at the end of the pay period. The EA also allows for an annual bonus of up to 100% of the then applicable base salary upon achievement of annual performance objectives to be determined by the Compensation Committee or board of directors. For the three and nine month periods ended March 31, 2014 and 2013, the Company recorded $52,053, $145,419, $100,000 and $200,000 in compensation expense, respectively. In the prior nine month period, $16,667 was paid by the issuance of 53,994 shares of common stock. Additionally, for both three and nine month periods the Company recorded $2,100 and $6,300 in car allowance, and paid the Company contributed health insurance premium which is currently at $345 per month.

Former President/Chief Executive Officer and Director

The Company entered into an Employment Agreement (the “Agreement”) with its former President/Chief Executive Officer effective January 1, 2011. Pursuant to the terms of the Agreement, the Company issued 750,000 shares of Common Stock valued at $525,000 as a signing bonus to induce him to enter into the Agreement, agreed to pay an annual compensation of $225,000, a monthly car allowance of $750, and a monthly allowance of $800 for health benefits for the officer and his family. On January 1, 2013, the annual compensation was increased to $275,000 pursuant to the terms of Agreement. For the three and nine months ended March 31, 2014, the Company recorded $2,696 and $140,196 in compensation expense, compared to $68,750 and $193,750 for the same periods in the prior year. During the nine months ended March 31, 2013, $18,750 of the compensation was paid with 67,492 shares of common stock which was valued at a 25% discount to market on the date the compensation was earned. For both the three and nine months ended March 31, 2014 and 2013, the Company paid a car allowance of $0, $5,500, $2,250 and 6,750, respectively. The Company also paid the Company contributed health insurance premium which is currently at $345 per month. On August 28, 2013, this individual resigned as the President and Chief Executive Officer and Director and all payments and amounts due under the original employment contract ceased as of December 31, 2013.

Other Directors

On February 7, 2013, the Company entered into a two-year consulting agreement with an entity controlled by one of the Company’s directors. The agreement calls for monthly compensation of $15,000 per month for strategic advisory and investor relation services. For the three and nine months ended March 31, 2014, the Company recorded consulting expense of $0 and $60,000 relating to this agreement. In October, the Company paid half of the consulting fee by the issuance of 39,741 shares of common stock that were issued at a 25% discount to the market on the date the compensation was earned. This entity waived the consulting fee for the months of November 2013 through March 2014. In the prior three and nine month period, the Company recorded expense of $30,000 and $30,000 related to this agreement. This director is also one of the accredited investors who invested in the Company’s Series A preferred stock offering in February 2013 and as such receives quarterly dividend payments consistent with all of the Series A preferred holders.

PSM HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

One of the Company’s directors is a principal stockholder of a management company that provides two revolving warehouse lines of credit to the Company. Amounts outstanding on the credit lines as of March 31, 2014 and June 30, 2013 amounted to $15,255,782 and $15,688,725, which were offset by $15,255,782 and $15,688,725 of funding receivables as of March 31, 2014 and June 30, 2013, respectively (See Note 8).

Former Directors

On March 15, 2011, the Company entered into an employment agreement with a director of the Company in connection with the acquisition of United Community Mortgage Corp. (“UCMC”). The term of the employment agreement is for two years, with automatic one-year extensions unless notice is given by either party. The individual resigned as a director concurrent with the capital raise completed on February 5, 2013. The individual remains a regional vice president of one the Company’s corporate lending centers. The agreement provides for an annual base salary of $120,000 with increases based upon increases in originations at the respective branch and incentive payments upon securing additional branches for PSMI. The Company recorded total compensation expense of $30,000 and $90,000 for the three and nine months ended March 31, 2014 and $30,000 and $90,000 for the three and nine months ended March 31, 2013, respectively.

On July 1, 2011, the Company entered into an employment agreement with a director of the Company, in connection with the acquisition of Brookside Mortgage, LLC (“Brookside”). The term of the original employment agreement was for two years, with automatic one-year extensions unless notice is given by either party. On November 1, 2012, the Company agreed to revise the employment agreement making the term at will with 60 days notice from either party and provided additional overrides based on production. The individual resigned as a director concurrent with the capital raise completed on February 5, 2013. The Company recorded total compensation expense of $10,412, $98,571, $66,271 and $139,187, for the three and nine months ended March 31, 2014 and March 31, 2013, respectively. Effective January 31, 2014, this individual resigned from all positions with the Company.

On August 8, 2011, the Company entered into an employment agreement with a director of the Company in connection with the acquisition of Fidelity Mortgage Company (“Fidelity”). The term of the original employment agreement was for two years, with automatic one-year extensions unless notice is given by either party. The agreement provides that, for each full year of employment, a bonus equal to 12.5 basis points of the loan production and 50% of net profit of the Fidelity branch in excess of $500,000 earned will be paid to the individual. Bonuses are to be earned upon closing of each loan and paid on a fixed interval basis. On January 1, 2013, the Company amended the employment agreement to provide additional bonuses based on production and removed any bonus opportunity based on profitability. The individual resigned as a director concurrent with the capital raise completed on February 5, 2013. Further, effective January 31, 2014, the individual resigned from all positions with the Company. The Company recorded total compensation expense of $92,415, $474,421, $224,058 and $838,132 for the three and nine months ended March 31, 2014 and 2013, respectively.

The Company leased an office space in a building that is 100% owned by this former employee. The terms of the operating lease under a non-cancellable lease agreement expire on September 1, 2015, and require a monthly rent of $21,720. Total rent paid for the office lease for the three months and nine months ended March 31, 2014 and 2013 were $0, $130,320, $65,161 and $130,320 respectively. Upon the resignation of this individual during the current quarter, the office lease was effectively terminated.

PSM HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Effective November 1, 2011, the Company entered into an employment agreement with a director of the Company, in connection with the Company’s acquisition of Iowa Mortgage Professionals, Inc. (“IMP”). The individual resigned as a director concurrent with the capital raise completed on February 5, 2013. The term of his original employment agreement was for two years, with automatic one-year extensions unless notice is given by either party. The agreement provides for an annual base salary of $120,000 plus a bonus equal to 25% of the net profit earned by the Iowa branch in excess of $400,000 annual profits earned. On March 11, 2013, the Company agreed to revise the employment agreement making the term at will with 60 days notice from either party and provided additional overrides based on production. Effective January 31, 2014, this individual resigned from all of his positions with the Company. The Company recorded total compensation expense of $18,829, $98,920, $40,552 and $121,348 in bonus and over-ride commissions for the three and nine months ended March 31, 2014 and 2013, respectively.

On March 29, 2012, a management company of which this individual is a principal provided a revolving line of credit to the Company in the amount of $100,000. The line of credit was unsecured, bears a 6% annual rate of interest and was due on March 20, 2013. Upon maturity in March 2013, the line of credit was not renewed.

This individual is the principal of a third party processing company that provided processing services for loans funded in the Company’s Iowa branch through February 2014. The per file fees charged are believed to be under market pricing. The fees were paid by the borrower at closing and were not paid directly by the Company.

Other Employees

Effective January 1, 2013, the Company amended an employment agreement with the Vice President – Mountain Division. Under the new agreement, the term has been modified to at will with 60 days notice from either party. The employee is paid an annual salary of $95,000 and receives bonuses based on production. Additionally, the employee is eligible to receive 50% of the net profits of the Fidelity branch on annual net income in excess of $500,000. In January 2014, this individual resigned from his employment with the Company. The Company recorded total compensation expense of $42,325, $251,476, $89,255 and $409,635 for the three and nine months ended March 31, 2014 and 2013, respectively.

The Company entered into two Commercial Security Agreements dated November 16, 2006 and February 16, 2007 (the “Security Agreements”) with NWBO securing the loan amount of $167,000 with 150,000 shares of the Company’s own common stock held by NWBO. On June 15, 2012, the Company renegotiated the Security Agreements with NWBO and agreed to amend (i) the annual interest rate on the Security Agreements from 9.25% to 6%, and (ii) the maturity date to September 30, 2013. The note was subsequently amended through February 14, 2014 and the Company is finalizing an extension of the note through October 15, 2014. The extension has not been executed. All other terms and conditions of the Security Agreement will remain the same. The balance due on the loan receivable from NWBO amounted to $88,898 as of March 31, 2014. The loan receivable is under collateralized by $83,236 based upon the fair value of 150,000 shares at the closing share price of $0.10 on May 1, 2014. The Company recorded interest income of $1,344, $4,033, $1,344, and $4,033 from the loan receivable from NWBO for the three and nine months ended March 31, 2014 and 2013, respectively.

PSM HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 6 – NOTES RECEIVABLE AND EMPLOYEE ADVANCES

On December 1, 2010, the Company’s subsidiary, PSMI, formerly known as UCMC, executed a Promissory Note (“Note”) with an unrelated third party for a principal sum of $360,000. The principal and any unpaid interest are due and payable in full on December 1, 2016. Based on the inconsistent pattern of interest payments received by the Company in the past, there exists substantial doubt about the ultimate collectability of the Note. As such, the Company has reserved 100% of the outstanding balance as uncollectible.

On December 31, 2010, PSMI executed a Letter of Repayment with three employees in the amount of $189,654 for funds advanced to them as a loan. These loans are unsecured, non-interest bearing and due on demand. Payments of these loans are made from the portion of commissions earned by these employees. If the employees’ employment is terminated for any reason, the loan outstanding will become due and payable in full or specific arrangements will be made. The Company has reserved all but approximately $11,000 for these 2010 advances.

It is the Company’s policy to assess the carrying value of its intangible assets for impairment on a quarterly basis, or more frequently, if warranted by circumstances. During the current quarter, employees at certain offices resigned from their employment with the Company. Some of the intangible balances above relate to these offices. The Company is finalizing its transition with these offices which is expected to be completed during the fiscal fourth quarter. As such, the Company will assess the value of these intangibles as these transitions are finalized. It is possible that significant impairment charges relating to goodwill and or customer lists will be required during the quarter ending June 30 once these transitions are finalized. As of March 31, 2014, the balance of goodwill and other intangibles related to these offices amounted to approximately $2,045,000.

PSM HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)  

The amount allocated for the purchase of the customer list as a result of its acquisitions of UCMC, Brookside, Founders, Fidelity, and IMP amounted to $495,023. The Company amortizes customer lists over a period of eight years. Amortization expense recorded for the three and nine months ended March 31, 2014 and 2013 was $21,581, $64,743, respectively. Amortization expense to be recognized for the years ending June 30, 2014 to 2019 is $86,325, $49,151, $47,209, $47,209, $47,209 and $35,490, respectively.

On April 14, 2006, the Company entered into a five-year renewable license agreement with Nationwide By Owner, Inc. (“NWBO”), a Texas based company engaged in the business of providing proprietary technology to generate leads. The license agreement permits exclusive use of the technology to be used to generate leads for the origination of mortgage applications for submission to PSMI. The initial cost of the license was $150,000 paid in cash, and issuance of 150,000 shares of the Company’s common stock in favor of NWBO and its principals, at a fair value for consideration received of $674,999 on the date of issue. The total consideration for the cost of license amounted to $824,999. The Company is amortizing the cost of the license over 14 years, which is the initial five-year period of the agreement, plus three automatic three-year renewal terms. Amortization expense recorded for each of the three and nine months ended March 31, 2014 and 2013 was $14,732 and $44,196, respectively. Amortization expense to be recognized for each of the years ending June 30, 2014 through 2019 is $58,929 and for the year ending June 30, 2020 is $46,494.

NOTE 8 – WAREHOUSE LINES OF CREDIT

The Company has five warehouse lines of credit available as of March 31, 2014 for its funding of mortgage loans for a short term period.

PSM HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The lines of credit provide short term funding for mortgage loans originated by the branch offices. The lines of credit are repaid when the loan is sold to third party investors. The Company does not intend to hold and service the loans. The lines are used strictly to fund mortgage loans and not to provide operating funds for the Company. The Company had $15,428,636 in loans outstanding against the warehouse lines of credit as of March 31, 2014. Subsequent to March 31, 2014, approximately 90% of the loans outstanding on the credit lines have been purchased by investors.

NOTE 9 – STOCKHOLDERS’ EQUITY AND ISSUANCES

The Company’s capitalization at March 31, 2014 was 100,000,000 authorized common shares and 10,000,000 authorized preferred shares, both with a par value of $0.001 per share.

Following is the status of the share based payment plans during the nine months ended March 31, 2014 and 2013:

2012 Stock Option/Stock Issuance Plan

On December 12, 2011, the shareholders of the Company authorized and approved the 2012 Stock Incentive Plan (the “2012 Plan”) to issue up to 6,000,000 shares of common stock of the Company at $0.001 par value per share. The 2012 Plan became effective January 1, 2012. No awards will be granted under the 2012 Plan after the expiration of 10 years from the effective date, but awards previously granted may extend beyond that date.

On July 1, 2013, the Company granted 125,000 options to an employee of the Company. The options vest equally over three years and were valued at $21,664 using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.33%, volatility 92.2%, three-year term and dividend yield of 0%.

On July 8, 2013, the Company granted 250,000 options to an employee of the Company. The options vest equally over three years and were valued at $47,061 using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.33%, volatility 91.6%, three-year term and dividend yield of 0%.

On September 5, 2013 the Company granted 325,000 options to various employees as a signing bonus. The options vest equally over three years and were valued at $78,663 using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.33%, volatility 97.8%, three-year term and dividend yield of 0%.

On November 4, 2013, the Company granted 225,000 options as a signing bonus to three individuals. The options were granted under the 2012 Plan. The options vest equally over three years and were valued at $37,203 using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.33%, volatility 110.11%, three-year term and dividend yield of 0%.

On November 4, 2013, the Company granted 125,000 incentive options to an employee. The options were granted under the 2012 Plan. The options vest equally over three years and were valued at $20,668 using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.33%, volatility 110.11%, three-year term and dividend yield of 0%.

PSM HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

On November 4, 2013, the Company issued 26,494 shares of stock to an employee and 39,741 shares of stock to a consultant (both of whom are directors) under the 2012 Plan in lieu of salary and cash compensation that were due these individuals for services provided the Company in October 2013.

On February 20, 2014, the Company granted 250,000 incentive options to an employee. The options were granted under the 2012 Plan. The options vest equally over three years and were valued at $20,733 using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.33%, volatility 117.12%, three-year term and dividend yield of 0%.

As of March 31, 2014, the Company has granted 2,823,338 shares of common stock or stock options valued at $863,845 to employees and consultants under 2012 Plan and 3,176,662 common shares remained unissued and available for future issuances.

Other Stock Issuances

On January 31, 2012, the Company entered into an agreement with a consultant for providing investor relations and business advisory services and issued a total of 600,000 shares of common stock valued at $390,000, of which 50,000 shares were issued on February 2, 2012 and 550,000 shares were issued on March 8, 2012. On May 9, 2012, the Company entered into another agreement with the same consultant for business advisory services and issued 125,000 shares of common stock valued at $81,250. As part of the same contractual agreement dated May 9, 2012, the Company issued shares to two other consultants on May 16, 2012 totaling 850,000 shares. The common shares issued were valued at the contractual agreement dates of January 31, 2012 and May 9, 2012. The shares underlying these agreements were issued as follows: the Company issued 125,000 shares valued at $81,250 on April 30, 2012, 850,000 shares valued at $552,500 on June 4, 2012. On June 25, 2012, the Company issued 100,000 shares valued at $59,000 to another consultant. The common shares issued were valued at the closing share price on the date of closing of the transaction or at the fair value on the contractual agreement date.

On July 15, 2012, the Company and the consultant mutually agreed to cancel the January 31, 2012 and May 9, 2012 agreements, and agreed to enter into a new consulting agreement dated July 16, 2012 for the issuance of 425,000 shares of common stock for providing business advisory and consulting services to the Company for a period of six months. On July 15, 2012, the Company and the consultant mutually agreed that the consultant will accept the remaining unvested common shares from the January 31, 2012 and May 9, 2012 contracts amounting to 434,492 common shares for a value of $82,670 instead of receiving 425,000 newly issued shares per the July 16, 2012 agreement.

On August 17, 2012, the Company cancelled the unvested 637,498 shares of the 850,000 common shares issued to the two remaining consultants pursuant to the May 9, 2012 agreement and recorded the cancellation as a charge of $637 to common stock and additional paid in capital. The Company recorded a charge of $204,715 to additional paid in capital and reduced the prepaid expenses for the same amount upon cancellation of these two agreements.

In July 2011, the Company commenced a private placement offering to raise capital up to $975,000 through the sale of up to 13 Units at $75,000 per Unit, with each Unit consisting of 100,000 shares of common stock and 100,000 warrants. The warrants issued in conjunction with the offering are exercisable at $1.00 per share and are exercisable starting on the closing date of the offering and expiring September 14, 2014. As of March 31, 2014, the Company had sold 1,234,328 shares to accredited investors and received cash proceeds of $925,738.

Total common shares issued and outstanding under all stock plans at March 31, 2014 were 29,468,259.

PSM HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Warrant issuances

Pursuant to short-term notes issued on February 12, 2014 and March 13, 2014, the Company issued warrants to purchase 454,000 shares of the Company’s common stock. The warrants were initially exercisable at $0.40 and included adjustments for certain events such as capital being raised at less than the initial exercise price. As part of the Preferred Stock issuance on April 1, 2014 (See Subsequent Events note), the exercise price was adjusted to $0.24. The warrants expire on February 12, 2019 and March 13, 2019. The fair value of the warrants was determined to be $36,490 using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.88%, volatility of 135.0%, five year term and dividend yield of 0%. Since the warrants were issued in conjunction with the capital raise, no expense was recorded related to the warrants.

Pursuant to the preferred stock transaction on February 5, 2013, and in accordance with the placement agent agreement, the Company issued warrants to purchase 1,140,000 shares of the Company’s common stock to the placement agent and its associates as placement fees in the above transaction. The warrants are exercisable at $0.44 and expire on February 5, 2018. The fair value of the warrants was determined to be $398,497 calculated using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.88%, volatility 130.21%, five-year term and dividend yield of 0%. Since the warrants were issued in conjunction with the capital raise, no expense was recorded related to the warrants.

Pursuant to the terms of the private placement offering in July 2011, the Company issued to accredited investors 1,234,328 warrants to purchase 1,234,328 shares of common stock at an exercise price of $1.00. The warrants are exercisable at any time through September 14, 2014. The fair value of warrants was $412,169 calculated using the Black-Scholes option pricing model using the assumptions of risk free discount rates of 0.20% to 0.51%, volatility between 119.07% to 182.59%, three-year term and dividend yield of 0%. Since the warrants were issued in conjunction with capital raise, no expense was recorded in the accompanying financial statements as of March 31, 2014.

On March 25, 2010, the Company granted 2,000,000 warrants to the Chairman of the Board of Directors and 2,000,000 warrants to the former President of the Company for past services, at the exercise price of $1.00 per share for a five-year term.

The Company has a total of 6,828,328 warrants outstanding as of March 31, 2014 at a weighted average exercise price of $0.86.

NOTE 10 – INCOME (LOSS) PER COMMON SHARE

The Company’s outstanding options and warrants to acquire common stock and unvested shares of restricted stock totaled 8,403,328 as of March 31, 2014. These common stock equivalents may dilute earnings per share.

For the three and nine months ended March 31, 2014 and 2013, basic and diluted loss per share was the same as the effect of dilutive securities would have been anti-dilutive.

Basic and diluted net income per share for the three and nine months ended March 31, 2014 and 2013 was calculated as follows:

PSM HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 11 – COMMITMENTS

Nationwide By Owners License

The agreement between NWBO and the Company calls for the establishment of a National Processing Center for the collection, origination and tracking of the sales lead database. Upon completion of a National Processing Center, the Company has also committed to provide year-end bonuses under the license agreement which the parties can elect to take in cash, stock, or any combination of the two. Bonus cash will be calculated by multiplying the annual net profit of the National Processing Center by the following percentage rates: 15% for the initial five-year term of the license agreement, 20% for the first automatic renewal term, 25% for the second automatic renewal term, and 30% for the third automatic renewal term and all subsequent annual renewal terms. Should the parties elect to take all or part of the bonus in common stock, the number of shares awarded will be calculated according to the base value of the shares as defined in the agreement. No accrual has been recorded for the year-end bonuses because the National Processing Center has not been established. As agreed to by NWBO and the Company, the National Processing Center has been delayed indefinitely while NWBO rolls out its new product offering and strategy discussed below.

Also, pursuant to the agreement with NWBO, the Company has committed to pursue obtaining, in good faith and diligently, the appropriate licenses to originate mortgages in all 50 states of the United States.

Historically, the Company has not gathered data on the number of leads and loans closed, and commissions earned and paid, relating to the NWBO license since the branch offices are managed independently and may choose not to use these lead generating opportunities. Because some of the branches have taken advantage of the NWBO opportunity, management has recently begun tracking some of the results from those offices. Based on this limited information, management believes there are approximately 7% of the loans being derived from the NWBO signs. However, management believes this number could grow significantly based on the new strategy and product offering available to the Company. NWBO has dramatically evolved from their original model which focused solely on sale by owners.  The revised model is now focused around a consumer-centric realtor model with a significant focus on mobile technology tools and social media marketing strategies. NWBO expanded its initial Smart Sign technology into a proprietary software called eNfoDelivered ^TM , which is now a lead acquisition, lead development and lead delivery platform.  A second proprietary software called Path2Sell Systems ^TM  was launched in August of 2013.  These two platforms combine to provide PSMI access to the feature-rich toolkit of marketing tools mentioned above as well as training, administration and support.  While helping to add to a loan origination pipeline, Path2Sell Systems ^TM  allows a much greater focus on tools deliverable in each lending center/branch; tools specific to create greater leverage with local realtor and home builder contacts.

The Company has developed a method to measure the value of the NWBO license. The method is a computation based on revenue from new and existing branches and the incremental volume the NWBO license should generate for the Company’s existing and future branches. The computation is prepared each quarter. The computed value of the license is compared to the book value of the license at the end of each period to determine if there is any impairment in the carrying value of the license. The book value is determined by the original cost of the license less accumulated amortization as of the end of the period. The value of the license recorded on the balance sheet is at its book value. The book value of the license was less than the estimated computed value at March 31, 2014 and March 31, 2013.

PSM HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Employment agreements

The Company entered into employment agreements with its officers and key employees to retain their services through the year ended June 30, 2014. The Company’s practice is to revise employment agreements as they become due to make the agreements at will requiring no more than 60 days termination notice by either party. The Company did recently renew the employment agreement for its Executive Vice President and Chairman which was renewed as a one year agreement.  

Lease commitments

On April 8, 2013, the Company executed a five-year lease on approximately 4,000 square feet of office space for its corporate office location in Oklahoma City. The lease requires an initial deposit of $90,000 for build out of the office space and a monthly lease payment of $8,132 in year one, increasing to $8,636 in year five.

The Company leases office space for its branches and property and equipment under cancellable and non-cancellable lease commitments. The current monthly rent for office premises and property and equipment is $57,192. The leases expire between September 2014 and July 2018. Total rent expense recorded for the three and nine months ended March 31, 2014 and 2013 was $190,674, $730,820, $199,531 and $623,084, respectively.

Total minimum lease commitments for branch offices and property and equipment leases at March 31, 2014 are as follows:

NOTE 12 – FAIR VALUE MEASUREMENTS

The Company uses a hierarchy that prioritizes the inputs used in measuring fair value such that the highest priority is given to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).  The three levels of the fair value hierarchy are described below:

If the asset or liability has a specified (contractual) term, the Level 2 input must be observable for substantially the full term of the asset or liability.

PSM HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used maximize the use of observable inputs and minimize the use of unobservable inputs. See Note 1 for discussion of valuation methodologies used to measure fair value of investments.

The valuation methodologies described above may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.

Other than cash, which is determined using Level 1 inputs, and intangible assets, which were determined using Level 3 inputs, the fair value of the assets and liabilities was determined using Level 2 inputs. The carrying amounts and fair values of the Company’s financial instruments at March 31, 2014 and June 30, 2013 are as follows:

NOTE 13 - INDUSTRY RISKS

The mortgage industry has gone through a significant change over the past four years. Foreclosures have caused a credit tightening, making qualifying for loans more difficult for many borrowers. The Company has not experienced credit losses because the Company either has sold the loan prior to or shortly after closing or simply does not fund the loans they originate. The U.S. housing market as a whole has undergone a significant contraction with lenders and investors tightening their credit standards, making the mortgage origination volumes decrease. The historically low rates that the industry experienced during most of 2012 and 2013 had generated a significant volume of refinance business. In June of 2013, the rates increased noticeably which has led to less refinance business and more competitive pricing pressures for the remaining lenders. The impact of the changing rate environment on the Company’s operations has directly impacted the Company’s volume and gross revenue in the most recently completed quarter. In addition, the mortgage industry is experiencing significant regulatory changes which began during 2011 and are continuing through 2014 and beyond, requiring mortgage brokers to significantly modify their operations or seek out merger or sale opportunities in order to comply with the new regulations. Although the Company is trying to combat these issues through various cost adjustments and recruiting of new production, the future impact of these initiatives cannot be determined with any certainty.

PSM HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 14 - CONCENTRATIONS

Concentration of Customer

The Company entered into two warehouse line of credit agreements with a mortgage banker whose Executive Vice President is a member of the Board of Directors of the Company, for up to $75,000,000 each, bearing annual interest rates of 5% each, for funding residential mortgage loans. Per the terms of the agreements, the Company could be required to repurchase the loans subject to certain terms and conditions. The outstanding combined balance on these two warehouse lines of credit as of March 31, 2014 was $15,255,782. Subsequent to March 31, 2014, approximately 90% of the loans outstanding on the credit lines have been purchased by investors.

Historically, the Company has recorded a significant portion of its total revenues from one investor, who is a related party. In October 2013, the Company began funding loans on its delegated platform which includes delivery options to multiple investors. This has significantly deceased the reliance on any one investor. As an example, for the three months ended March 31, 2014, approximately 35% of all loans funded were sold to this related party investor, while the balance of loans sold were delivered to approximately ten other investors. It is anticipated that as the Company continues to expand its delegated platform and increases its approvals from additional investors, concentrations among any one investor will continue to decrease.

Concentration of Credit Risk

The Company maintains its cash in bank and financial institution deposits that at times may exceed federally insured limits. The Company has not experienced any losses in such accounts through March 31, 2014. As of March 31, 2014, the Company’s bank balances in some instances exceed FDIC insured amounts.