<PAGE> 1
===============================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-22525
-----------------------
FIRST SIERRA FINANCIAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 76-0438432
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
CHASE TOWER, SUITE 7050
600 TRAVIS STREET
HOUSTON, TEXAS 77002
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (713) 221-8822
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. Yes [X] No[ ]
The number of shares outstanding of the registrant's common stock, $.01
par value, at August 1, 1999 was 18,962,815.
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<PAGE> 2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FIRST SIERRA FINANCIAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
--------- ------------
(UNAUDITED)
<S> <C> <C>
Lease financing receivables, net ................................................. $ 671,439 $337,162
Cash and cash equivalents ........................................................ 71,930 7,928
Other receivables ................................................................ 4,748 11,596
Investment in trust certificates ................................................. 7,501 7,288
Marketable securities ............................................................ 4,614 5,042
Goodwill and other intangible assets, net ........................................ 40,965 39,202
Furniture and equipment, net ..................................................... 10,338 9,909
Other assets ..................................................................... 8,068 6,923
Current tax receivables .......................................................... 1,013 3,243
--------- --------
Total assets ................................................................ $ 820,616 $428,293
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Debt:
Nonrecourse debt .............................................................. $ 581,666 $276,511
Other debt .................................................................... 28,995 23,026
Subordinated notes payable .................................................... 1,000 3,250
Other liabilities:
Accounts payable and accrued liabilities ...................................... 28,461 23,283
Holdback reserves payable ..................................................... 24,420 16,682
Income taxes payable .......................................................... 184 523
Deferred income taxes ......................................................... 570 501
--------- --------
Total liabilities ........................................................... 665,296 343,776
--------- --------
Redeemable preferred stock ....................................................... 469 469
Stockholders' equity:
Common stock, $.01 par value, 100,000,000 shares authorized, 18,362,815
shares and 14,223,915 shares issued and outstanding as of 6/30/99 and
12/31/98, respectively .................................................. 184 142
Additional paid-in capital .................................................. 147,717 76,855
Retained earnings ........................................................... 7,142 6,859
Accumulated other comprehensive income ...................................... (192) 192
--------- --------
Total stockholders' equity .................................................. 154,851 84,048
--------- --------
Total liabilities and stockholders' equity .................................. $ 820,616 $428,293
========= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
1
<PAGE> 3
FIRST SIERRA FINANCIAL, INC. AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
ENDED JUNE 30,
---------------------
1999 1998
------- -------
(RESTATED)
<S> <C> <C>
Gain on sale of lease financing receivables through securitization transactions ... $ -- $ 9,741
Gains from direct sales of lease financing receivables ............................ 3,504 4,378
Interest income ................................................................... 17,154 2,221
Servicing income .................................................................. 1,956 1,501
Other income ...................................................................... 1,110 1,216
------- -------
Total revenues ................................................................. 23,724 19,057
------- -------
Salaries and benefits ............................................................. 7,172 7,146
Interest expense .................................................................. 8,945 411
Provision for credit losses on lease financing receivables ........................ 2,057 908
Depreciation and amortization ..................................................... 1,299 1,014
Other general and administrative .................................................. 3,586 3,469
Research and development costs of acquired companies .............................. -- 2,550
Relocation of operations center ................................................... -- 626
------- -------
Total expenses ................................................................. 23,059 16,124
------- -------
Income before provision for income taxes .......................................... 665 2,933
Provision for income taxes ........................................................ 413 1,259
------- -------
Net income ........................................................................ $ 252 $ 1,674
======= =======
Earnings per common share, basic .................................................. $ 0.02 $ 0.12
======= =======
Earnings per common share, diluted ................................................ $ 0.02 $ 0.11
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE> 4
FIRST SIERRA FINANCIAL, INC. AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
ENDED JUNE 30,
---------------------
1999 1998
------- -------
(RESTATED)
<S> <C> <C>
Gain on sale of lease financing receivables through securitization transactions ... $ -- $16,291
Gains from direct sales of lease financing receivables ............................ 6,674 8,714
Interest income ................................................................... 30,319 3,828
Servicing income .................................................................. 3,603 2,708
Other income ...................................................................... 2,496 2,245
------- -------
Total revenues ................................................................. 43,092 33,786
------- -------
Salaries and benefits ............................................................. 13,650 12,784
Interest expense .................................................................. 15,265 810
Provision for credit losses on lease financing receivables ........................ 4,144 1,637
Depreciation and amortization ..................................................... 2,559 1,697
Other general and administrative .................................................. 6,521 5,496
Research and development costs of acquired companies .............................. -- 2,550
Relocation of operations center ................................................... -- 1,511
------- -------
Total expenses ................................................................. 42,139 26,485
------- -------
Income before provision for income taxes .......................................... 953 7,301
Provision for income taxes ........................................................ 670 2,867
------- -------
Net income ........................................................................ $ 283 $ 4,434
======= =======
Earnings per common share, basic .................................................. $ 0.02 $ 0.34
======= =======
Earnings per common share, diluted ................................................ $ 0.02 $ 0.32
======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE> 5
FIRST SIERRA FINANCIAL, INC. AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
ENDED JUNE 30,
--------------------------
1999 1998
--------- ---------
(RESTATED)
<S> <C> <C>
Cash Flows from Operations:
Net Income ......................................................................... $ 283 $ 4,434
Reconciliation of net income to cash provided by operations:
Depreciation and amortization .................................................. 2,559 1,697
Provision for credit losses on lease financing receivables ..................... 4,144 1,637
Gain on sale of lease financing receivables .................................... (6,674) (25,005)
Research and development costs of acquired companies ........................... -- 2,550
Funding of lease financing receivables, held for sale .......................... (138,942) (370,576)
Principal payments received on lease financing receivables, held for sale ...... -- 9,999
Proceeds from sales of lease financing receivables, net of trust certificates
and marketable securities retained, if any ................................... 150,572 388,484
Repayments of warehouse credit facilities, net of proceeds from borrowings ..... -- (6,720)
Deferred income taxes .......................................................... 280 --
Accumulated translation adjustment ............................................. (384) --
Changes in assets and liabilities, net of effects from acquisitions:
Decrease (increase) in other receivables ..................................... 6,851 (17,748)
Decrease (increase) in other assets .......................................... (1,145) 273
Increase (decrease) in accounts payable and accrued liabilities .............. 5,148 (311)
Increase in holdback reserve payable ......................................... 7,536 2,646
Decrease in current income tax receivable, net of decrease in
income tax payable ......................................................... 1,813 198
--------- ---------
Net Cash Provided by (Used for) Operations .......................... 32,041 (8,442)
--------- ---------
Cash Flows from Investing Activities:
Funding of lease financing receivables, held for investment .................... (392,003) --
Principal payments received on lease financing receivables,
held for investment .......................................................... 58,611 --
Expenditures for furniture and equipment ....................................... (1,810) (2,987)
Expenditures for acquisitions, including acquisition costs,
less cash acquired ........................................................... (12,369) (6,731)
--------- ---------
Net Cash Used in Investing Activities ............................... (347,571) (9,718)
--------- ---------
Cash Flows from Financing Activities:
Proceeds from warehouse credit facilities, net of repayments ................... 311,124 --
Repayment of subordinated notes payable ........................................ -- (5,000)
Proceeds from issuance of common stock, net and exercise of
stock options ................................................................ 68,408 39,741
Distributions to stockholders .................................................. -- (255)
--------- ---------
Net Cash Provided by Financing Activities ........................... 379,532 34,486
--------- ---------
Net Increase in Cash and Cash Equivalents ............................................. 64,002 16,326
Cash and Cash Equivalents at January 1, ............................................... 7,928 14,569
--------- ---------
Cash and Cash Equivalents at June 30, ................................................. $ 71,930 $ 30,895
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE> 6
FIRST SIERRA FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. THE COMPANY
Organization
First Sierra Financial, Inc. ("First Sierra" or the "Company") customizes
lease financing products and offers servicing, consulting and technology
solutions for commercial customers. The Company was formed in June 1994 to
acquire, originate, sell and service equipment leases relating to a wide range
of equipment, including computers and peripherals, software, medical, dental,
diagnostic, telecommunications, office, automotive servicing, hotel security,
food services, tree service and industrial. The equipment we finance generally
has a purchase price of less than $250,000, with an average of approximately
$31,000 for leases originated in 1998 and $28,000 for leases originated during
the first six months of 1999. The Company funds the acquisition or origination
of its leases from working capital or through its securitized funding
facilities. From time to time, depending on market conditions, we securitize
the leases in our portfolio that meet pre-established eligibility criteria by
packaging them into a pool and selling beneficial interests in the leases
through public offerings and private placement transactions.
Prior to July 1, 1998, the Company structured its securitization
transactions to meet the criteria for sales of lease financing receivables under
generally accepted accounting principles. Thus, for all securitizations
completed prior to such date, we recorded a gain on sale of lease financing
receivables when the receivables were included in a securitization. Effective as
of July 1, 1998, we made a strategic decision to alter the structure of our
securitization transactions so as to retain leases we acquire and originate on
our balance sheet as long-term investments rather than selling such leases
through securitization transactions. The Company also modified the structure of
its securitized funding facilities such that they would be considered debt under
generally accepted accounting principles. The cash flows available to the
Company, which are generally based on the advance rates and discount rates set
forth in the agreements, were unaffected by these modifications. The primary
effect from this move to emphasize portfolio lending is a shift from the
recognition of an immediate gain upon sale of the lease receivables to the
recognition of net interest margin over the lives of the receivables.
The Company acquires and originates leases primarily through its Private
Label, Wholesale, Retail, and Captive Finance programs. Under the Private Label
program, the Company is provided protection from credit losses on defaulted
leases through a first lien security interest in the underlying equipment,
recourse to the source of the lease (the "Source"), which is generally
supported by holdback reserves withheld from amounts paid to the Source upon
purchase of the lease, or a combination of the above. Leases acquired through
the Wholesale, Retail and Captive Finance programs are originated through
relationships with lease brokers, equipment vendors and individual lessees. In
addition, the Company has in the past generated, and may in the future
generate, income through the acquisition of lease portfolios and the subsequent
sale of such portfolios at a premium.
Since inception, the Company's underwriting, customer service and
collection staff had been located in its Jupiter, Florida office. In order to
consolidate its operations and maximize administrative efficiencies, the
Company relocated its operations center from Jupiter, Florida to its
headquarters in Houston, Texas. The relocation was commenced in late 1997 and
completed in the first half of 1998. The Company incurred in the second quarter
of 1998 approximately $626,000 of pre-tax expenses related to the relocation,
or $0.03 per diluted share. For the six month period ended June 30, 1998, the
Company incurred approximately $1,511,000 of pre-tax expenses related to the
relocation, or $0.07 per diluted share.
5
<PAGE> 7
FIRST SIERRA FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
2. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
and the rules and regulations of the Securities and Exchange Commission for
interim financial statements. Accordingly, the interim statements do not
include all of the information and disclosures required for annual financial
statements. In the opinion of the Company's management, all adjustments
(consisting solely of adjustments of a normal recurring nature) necessary for a
fair presentation of these interim results have been included. All significant
intercompany accounts and transactions have been eliminated in consolidation.
These financial statements and related notes should be read in conjunction with
the audited financial statements and notes thereto included in the Company's
Annual Report on Form 10-K. The results for the interim periods are not
necessarily indicative of the results to be expected for the entire year. All
dollar amounts in the tabulations in the notes to the financial statements are
stated in thousands unless otherwise indicated.
Gain on Sale of Lease Financing Receivables
Gain on portfolio sales of leases is calculated as the difference between
the proceeds received, net of related selling expenses, and the carrying amount
of the related leases adjusted for ongoing recourse obligations of the Company,
if any. At June 30, 1999, the Company believes that it does not have any
material recourse obligations related to receivables sold through portfolio
sales.
Exposure to Credit Losses
Management evaluates the collectibility of leases acquired or originated
based on the level or recourse provided, if any, delinquency statistics,
historical loss experience, current economic conditions and other relevant
factors. Prior to July 1, 1998, the Company structured its securitization
transactions to meet the criteria for sales of lease financing receivables
under generally accepted accounting principles. The Company provided an
allowance for credit losses for leases which were considered impaired during
the period from the funding of the leases through the date such leases were
sold through the Company's securitization program. When the securitizations
took place, the Company reduced the allowance for credit losses for any
provision previously recorded for such leases. Any losses expected to be
incurred on leases sold were taken into consideration in determining the fair
value of any Trust Certificates retained and recourse obligations accrued, if
any. Effective as of July 1, 1998, the Company made a strategic decision to
retain its leases as long-term investments on its balance sheet. As a result,
the Company now provides an allowance for credit losses for retained leases
which the Company considers impaired based on management's assessment of the
risks inherent in the lease receivables. Management monitors the allowance on an
ongoing basis based on its current assessment of the risks and losses identified
in the portfolio.
The Company's allowance for credit losses on lease receivables and its
valuation of the Trust Certificates retained in its securitization transactions
are based on management's current assessment of the risks inherent in the
Company's lease receivables from national and regional economic conditions,
industry conditions, concentrations, financial conditions of the obligors,
historical experience of certain origination channels, and other factors. These
estimates are reviewed periodically and as additional provisions or write-downs
become necessary, they are reported as reduction of earnings in the period in
which they become known.
In assessing the Company's exposure to credit losses, management generally
segregates the leases acquired under its Private Label program from those
acquired or originated under its Wholesale and Retail programs due to the
differing levels of credit protection available to the Company under the
various lease funding programs.
6
<PAGE> 8
FIRST SIERRA FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
Comprehensive Income
In January 1998, the Company adopted the provision of SFAS No. 130,
"Reporting Comprehensive Income." SFAS No. 130 establishes standards of
reporting and display of comprehensive income and its components of net income
and "other comprehensive income" in a full set of general-purpose financial
statements. "Other comprehensive income" refers to revenues, expenses, gains
and losses that are not included in net income but rather are recorded directly
in stockholders' equity. The only component of comprehensive income other than
net income was foreign currency translation adjustments that commenced with the
acquisition of the Company's first foreign subsidiary in July 1998.
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
-------------------- -------------------
1999 1998 1999 1998
----- ------ ----- ------
(RESTATED) (RESTATED)
<S> <C> <C> <C> <C>
Net income .................................... $ 252 $1,674 $ 283 $4,434
Other comprehensive income (loss):
Foreign currency translation adjustment,
net of tax ............................... (174) -- (384) --
----- ------ ----- ------
Comprehensive income (loss) ................... $ 78 $1,674 $(101) $4,434
===== ====== ===== ======
</TABLE>
Foreign Currency Translation
The financial statements of the Company's foreign subsidiaries were
prepared in their local currency and translated into U.S. dollars based on the
current exchange rate at the end of the period for the balance sheet and a
weighted-average rate for the period on the statement of operations. Balance
sheet translation adjustments, net of related deferred taxes, are reflected as
other comprehensive income (loss) in the stockholders' equity section of the
Company's balance sheet and accordingly, have no impact on net income or loss.
Recent Accounting Pronouncement
In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities."
SFAS No. 133 establishes accounting and reporting standards for derivative
instruments, certain derivative instruments imbedded in other contracts, and
hedging activities. In particular, SFAS No. 133 requires a company to record
every derivative instrument on the company's balance sheet as either an asset
or liability measured at fair value. In addition, SFAS No. 133 requires that
changes in the fair value of a derivative be recognized currently in earnings
unless specific hedge accounting criteria are satisfied. Special accounting for
qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the income statement, and requires that a company
must formally document, designate and assess the effect the effectiveness of
transactions that receive hedge accounting. Management has not quantified the
effect that SFAS No. 133 will have on the Company's financial statements,
however, the Statement could increase volatility in earnings and other
comprehensive income. In June 1999, the FASB issued SFAS No. 137, "Accounting
for Derivative Instruments and Hedging Activities Deferral of the Effective
Date of FASB Statement No. 133" which amends the effective date of SFAS No.
133. SFAS No. 133 is now effective for fiscal years beginning after June 15,
2000, but companies may adopt it on a going-forward basis as of the start of
any fiscal quarter beginning on or after June 16, 1998. SFAS No. 133 cannot be
applied retroactively. It must be applied to (a) derivative financial
instruments and (b) certain derivative instruments embedded in hybrid contracts
that were issued, acquired, or substantively modified after December 31, 1998
(and at the Company's election, before January 1, 1999). The Company expects to
adopt SFAS No. 133 on January 1, 2001 and is currently evaluating the impact of
such adoption on the consolidated financial statements.
7
<PAGE> 9
FIRST SIERRA FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
Restatement of Results for 1998
Results for 1998 have been restated to reflect the July 1998 acquisition
of the Republic Group, Inc. which was accounted for under the
pooling-of-interests method.
Reclassifications
Certain reclassifications have been made to conform with the current
period presentation.
3. ALLOWANCE FOR CREDIT LOSSES
The following table sets forth the Company's allowance for credit losses
for its Private Label program and its Wholesale and Retail programs for the six
months ended June 30, 1998 and 1999:
<TABLE>
<CAPTION>
PRIVATE WHOLESALE/
LABEL RETAIL (1) TOTAL (2)
------- ---------- ---------
<S> <C> <C> <C>
Balance at December 31, 1998 ................................ $ 83 $ 4,680 $ 4,763
Provision for credit losses ............................ 144 4,000 4,144
Charge-offs, net of recoveries, on leases acquired or
originated by the Company .......................... (33) (912) (945)
Reduction of allowance for leases sold (1) ............. -- (431) (431)
Allowance related to leases acquired through
business combinations .............................. -- 354 354
Charge-offs, net of recoveries, on leases acquired
through business combinations ...................... -- (574) (574)
----- ------- -------
Balance at June 30, 1999 .................................... $ 194 $ 7,117 $ 7,311
===== ======= =======
Balance at December 31, 1997 ................................ $ 36 $ 945 $ 981
Provision for credit losses ............................ 42 1,595 1,637
Charge-offs, net of recoveries, on leases acquired or
originated by the Company .......................... (27) (116) (143)
Reduction of allowance for leases sold (1) ............. (41) (1,588) (1,629)
Allowance related to leases acquired through
business combinations .............................. -- 317 317
Charge-offs, net of recoveries on leases acquired
through business combinations ...................... -- (153) (153)
----- ------- -------
Balance at June 30, 1998 ............................... $ 10 $ 1,000 $ 1,010
===== ======= =======
</TABLE>
- -----------
(1) In connection with the sales of leases, the Company reduces the allowance
for credit losses for any provision previously recorded for such leases,
since once the leases are sold the Company retains no risk of loss
related to the leases sold.
(2) The Company began its Captive Finance program in March 1998 through the
acquisition of Integrated Lease Management, Inc. During the six months
ended June 30, 1998 and 1999, leases originated through its Captive
Finance program were approximately $108 million and $106 million,
respectively, all of which were either acquired with substantial cash
holdback from the vendor or financed with third parties at the time of
originations without recourse to the Company. Therefore, no allowance for
credit losses was provided for leases originated under the Captive
Finance program.
8
<PAGE> 10
FIRST SIERRA FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
The following table sets forth certain information regarding the Company's
allowance for credit losses for leases originated under its Private Label
program and its Wholesale and Retail programs as of June 30, 1999 (5):
<TABLE>
<CAPTION>
AS OF JUNE 30, 1999
-------------------------------------
PRIVATE WHOLESALE/
LABEL(1) RETAIL(4) TOTAL
----------- ---------- --------
<S> <C> <C> <C>
Lease financing receivables, net ................... $ 266,064 $380,530 $646,594(2)(3)
Allowance for credit losses ........................ 194 7,117 7,311
Allowance as a percentage of lease financing
receivables, net ................................ 0.07% 1.87% 1.13%
Credit protection available for leases outstanding
under the Private Label program:
Ratio of recourse to Private Label Source to lease
financing receivables outstanding under the
Private Label program (1) ....................... 11.13%
Ratio of holdback reserves outstanding to
total leases outstanding under the
Private Label program (1) ....................... 4.34%
</TABLE>
- ----------------
(1) Under the Private Label program, the Company seeks to minimize its losses
through a security interest in the equipment and leases funded, recourse to
the Private Label Source which is generally collateralized by holdback
reserves withheld from the Private Label Source upon purchase of the lease,
or a combination of the above. The recourse provisions generally require
the Private Label Source to repurchase a receivable when it becomes 90 days
past due. The recourse commitment generally ranges from 10% to 20% of the
aggregate purchase price of all leases acquired from the Private Label
Source. Holdback reserves withheld from the purchase price generally range
from 1% to 10% of the aggregate purchase price of the leases acquired from
the Private Label Source. In determining whether a lease acquired pursuant
to the Private Label program which is considered impaired will result in a
loss to the Company, management takes into consideration the ability of the
Private Label Source to honor its recourse commitments and the holdback
reserves withheld from the Private Label Source upon purchase of the lease,
as well as the credit quality of the underlying lessee and the related
equipment value.
(2) Does not reflect the reduction of allowance for credit losses provided for
the underlying lease financing receivables.
(3) Excludes lease financing receivables outstanding under the Captive Finance
program. As of June 30, 1999, lease financing receivables outstanding under
the Captive Finance program were $32,156,000. The Company began its Captive
Finance program in March 1998 through the acquisition of Integrated Lease
Management, Inc. Leases originated through its Captive Finance program were
either acquired with substantial cash holdback from the vendor or financed
with third parties at the time of originations without recourse to the
Company. Therefore no allowance for credit losses were provided for leases
originated under the Captive Finance program.
(4) Management analyzes the collectibility of leases acquired or originated
pursuant to its Wholesale and Retail programs based on its underwriting
criteria, delinquency statistics, historical loss experience, current
economic conditions and other relevant factors. While the Company owns the
underlying equipment, it does not have any recourse or holdback reserves
with respect to any leases acquired or originated pursuant to its Wholesale
and Retail programs.
(Footnotes continued on next page)
9
<PAGE> 11
FIRST SIERRA FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
(5) Prior to July 1, 1998, the Company structured its securitization
transactions to meet the criteria for sale of lease financing receivables
under generally accepted accounting principles. Effective July 1, 1998, we
altered the structure of our securitization transactions so as to retain
leases on our balance sheet. With the change, the allowance information as
of June 30, 1999 is not comparable to prior year. Therefore, the
information for 1998 is not presented.
The following table sets forth certain information as of June 30, 1999 and
December 31, 1998, with respect to leases which were held by the Company in its
portfolio:
<TABLE>
<CAPTION>
AS OF JUNE 30, 1999 AS OF DECEMBER 31, 1998
---------------------------------------------------- --------------------------------------------
PRIVATE WHOLESALE/ CAPTIVE PRIVATE WHOLESALE/ CAPTIVE
LABEL RETAIL FINANCE(1) TOTAL LABEL RETAIL FINANCE(1) TOTAL
--------- -------- ---------- ---------- ---------- -------- ---------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Gross leases outstanding . $331,172 $452,721 $36,479 $820,372 $171,195 $244,311 $1,610 $417,116
31-60 days past due ...... 0.90% 1.02% 4.40% 1.12% 0.41% 0.83% 0.00% 0.66%
61-90 days past due ...... 0.15% 0.46% 0.00% 0.31% 0.15% 0.36% 0.00% 0.27%
Over 90 days past due .... 0.11% 0.84% 0.00% 0.50% 0.28% 0.48% 0.00% 0.39%
--------- -------- ------- --------- --------- --------- ------ ---------
Total past due ...... 1.16% 2.32% 4.40% 1.93% 0.84% 1.67% 0.00% 1.32%
========= ======== ======== ========= ========= ========= ====== =========
</TABLE>
- ----------------
(1) The Company began its Captive Finance program in March 1998 through the
acquisition of Integrated Lease Management, Inc. Leases originated through
its Captive Finance program were either acquired with substantial cash
holdback from the vendor or financed with third parties at the time or
originations without recourse to the Company.
The following table sets forth the charge-off experience of the Company with
respect to leases in its portfolio (3):
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
ENDED JUNE 30, 1999
--------------------
<S> <C>
Average balance of leases outstanding during the period (1)(2) ................. $ 517,076
============
Net losses experienced on leases acquired:
Private Label program ....................................................... $ 33
Wholesale and Retail programs ............................................... 912
------------
Total ..................................................................... $ 945
============
Net Loss Ratio as a percentage of average balance of leases outstanding ........ 0.18%
============
</TABLE>
- ----------------------
(1) Excludes lease receivables and losses on lease receivables acquired through
business combinations.
(2) Represents net principal balance of leases held by the Company in its
portfolio.
(3) Prior to July 1, 1998, the Company structured its securitization
transactions to meet the criteria for sale of lease financing receivables
under generally accepted accounting principles. Effective July 1, 1998, we
altered the structure of our securitization transactions so as to retain
leases on our balance sheet. With this change, the allowance information as
of June 30, 1999 is not comparable to prior year; therefore, the
information for 1998 is not presented.
10
<PAGE> 12
FIRST SIERRA FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
4. EARNINGS PER SHARE
The reconciliation of the numerators and denominators used for the
computation of basic and diluted earnings per share is as follows (dollars in
thousands, except per share amounts):
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------------------- -----------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
(RESTATED) (RESTATED)
<S> <C> <C> <C> <C>
Earnings per common share, basic:
Net income .................................... $ 252 $ 1,674 $ 283 $ 4,434
Preferred stock dividends .................. -- 18 -- 40
----------- ----------- ----------- -----------
Net income available to common stockholders ... $ 252 $ 1,656 $ 283 $ 4,394
=========== =========== =========== ===========
Weighted average shares outstanding ........... 14,704,204 13,763,379 14,466,602 13,099,880
=========== =========== =========== ===========
Earnings per common share, basic .............. $ 0.02 $ 0.12 $ 0.02 $ 0.34
=========== =========== =========== ===========
</TABLE>
<TABLE>
<S> <C> <C> <C> <C>
Earnings per common share, diluted:
Net income .................................... $ 252 $ 1,674 $ 283 $ 4,434
=========== =========== =========== ===========
Weighted average shares outstanding ........... 14,704,204 13,763,379 14,466,602 13,099,880
Dilutive securities:
Options .................................... 872,658 654,703 514,871 574,657
Redeemable preferred stock ................. 55,125 210,247 55,125 232,470
----------- ----------- ----------- -----------
Weighted average shares outstanding, diluted .. 15,631,987 14,628,329 15,036,598 13,907,007
=========== =========== =========== ===========
Earnings per common share, diluted ............ $ 0.02 $ 0.11 $ 0.02 $ 0.32
=========== =========== =========== ===========
</TABLE>
The second quarter of 1999 earnings per share calculation excludes options
to purchase approximately 59,000 shares of common stock at exercise prices
ranging from $23.9375 to $24.00 per share that were outstanding during the
second quarter of 1999 because the inclusion of such options would have been
antidilutive. In addition to the 59,000 options excluded in the second quarter
of 1999, the computation of diluted earnings per share for the six months ended
June 30, 1999 also excludes options to purchase approximately 944,203 shares of
common stock at exercise prices ranging from $11.25 per share to $18.375 per
share that were outstanding during the first quarter of 1999, because such
options were antidilutive.
5. LEASE FINANCING RECEIVABLES
The Company's lease financing receivables balance at June 30, 1999 and
December 31, 1998, consists of the following:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
--------- ------------
<S> <C> <C>
Minimum lease payments..................... $ 820,372 $ 417,116
Estimated unguaranteed residual value...... 10,285 4,120
Initial direct costs....................... 14,278 6,729
Unearned income............................ (166,185) (86,040)
Allowance for credit losses................ (7,311) (4,763)
--------- ---------
Lease financing receivables, net....... $ 671,439 $ 337,162
========= =========
</TABLE>
11
<PAGE> 13
FIRST SIERRA FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
6. DEBT
Total debt consisted of the following as of June 30, 1999 and December 31,
1998:
<TABLE>
<CAPTION>
June 30, DECEMBER 31,
1999 1998
-------- ------------
<S> <C> <C>
Nonrecourse Debt:
Securitized Warehouse Facilities ..... $272,256 $173,767
Securitized Transactions:
Series 1998-1 securitization ..... 86,225 101,247
Series 1999-1 securitization ..... 209,778 --
Other nonrecourse debt ............... 13,407 1,497
-------- --------
Total Nonrecourse Debt ........... 581,666 276,511
Other Debt ............................. 28,995 23,026
Subordinated Notes Payable ............. 1,000 3,250
-------- --------
Total Debt ....................... $611,661 $302,787
======== ========
</TABLE>
The Company classifies its indebtedness as either nonrecourse debt or debt
based on the structure of the debt instrument that defines the Company's
obligations. Nonrecourse debt includes amounts outstanding related to leases
included in Securitized Warehouse Facilities, securitized transactions, or
individual or groups of leases funded under nonrecourse funding arrangements
with specific financing sources. Amounts outstanding in these instances are
classified as nonrecourse debt because the Company has no obligation to ensure
that investors or funding sources receive the full amount of principal and
interest which may be due to them under their funding arrangement. In these
instances, the investors or financing sources may only look to specific leases
and the associated cashflows for the ultimate repayment of amounts due to them.
In the event the cashflow associated with specific leases funded under
circumstances are insufficient to fully repay amounts due, the investor or
financing source withstands the full risk of loss. Debt includes amounts due to
financing sources for which the Company is responsible for full repayment of
principal and interest.
7. PUBLIC EQUITY OFFERING
In June 1999, the Company completed the sale to the public of 4,000,000
shares of its common stock, from which it received cash proceeds of
approximately $68.4 million, net of expenses. In July 1999, the underwriters of
the Company's offering exercised their over-allotment option and purchased an
additional 600,000 shares of the Company's common stock, from which it received
cash proceeds of approximately $10.4 million, net of expenses. The Company
intends to use the net proceeds from the offering for general corporate
purposes, including to fund net asset originations and for other working
capital needs.
8. ACQUISITION
In June 1999, the Company acquired the small ticket leasing division of
Fifth Third Leasing Company, a subsidiary of Fifth Third Bank, for $12.3
million in cash. This acquisition was recorded under the purchase method of
accounting, and accordingly, the results of operations of such entity has been
included in the accompanying consolidated financial statements from the date
the entity was acquired. The purchase price was allocated based on the
estimated fair market value of the assets acquired and liabilities assumed at
the date of acquisition. Such allocation resulted in goodwill of approximately
$2.6 million, which is being amortized on a straight-line basis over 20 years.
12
<PAGE> 14
FIRST SIERRA FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
9. SEGMENT INFORMATION
The Company acquires and originates leases primarily through its Private
Label, Wholesale/Retail, and Captive Finance programs.
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------------ ------------------------
1999 1998 1999 1998
-------- -------- -------- --------
(RESTATED) (RESTATED)
<S> <C> <C> <C> <C>
Revenues by business segment:
Private Label ................................... $ 5,657 $ 2,950 $ 9,472 $ 6,141
Wholesale/Retail ................................ 16,148 15,189 31,035 25,828
Captive Finance ................................. 1,919 918 2,585 1,817
-------- -------- -------- --------
Total ......................................... $ 23,724 $ 19,057 $ 43,092 $ 33,786
======== ======== ======== ========
Income (loss) before provision for income taxes:
Private Label ................................... $ 1,639 $ 2,689 $ 2,642 $ 5,357
Wholesale/Retail ................................ 3,763 5,822 7,027 9,675
Captive Finance ................................. 312 160 213 263
Corporate ....................................... (5,049) (5,738) (8,929) (7,994)
-------- -------- -------- --------
Total ......................................... $ 665 $ 2,933 $ 953 $ 7,301
======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
AS OF
---------------------------
JUNE 30, DECEMBER 31,
1999 1998
-------- ------------
<S> <C> <C>
Total assets:
Private Label ...... $302,371 $158,446
Wholesale/Retail ... 393,902 255,146
Captive Finance .... 47,704 120
Corporate .......... 76,639 14,581
-------- --------
Total ............ $820,616 $428,293
======== ========
</TABLE>
13
<PAGE> 15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS - QUARTERS ENDED JUNE 30, 1999 AND 1998
Revenues increased $4.6 million, or 24%, from $19.1 million for the three
months ended June 30, 1998 to $23.7 million for the three months ended June 30,
1999, due to strong originations which generated higher interest income. The
$4.6 million increase in revenues in the second quarter 1999 was net of a $9.7
million decrease in gain on sale of lease financing receivables from the second
quarter of 1998 as a result of our strategic decision to alter the structure of
our securitization transactions, effective July 1, 1998, so as to retain the
leases on our balance sheet. With this change in the structure of our
securitization transactions, we did not recognize any gain on sale of lease
financing receivables during the second quarter of 1999.
Gains from direct sales of lease financing receivables decreased $0.9
million, or 20%, from $4.4 million for the three months ended June 30, 1998 to
$3.5 million for the three months ended June 30, 1999. The decrease is related
to a decrease in the volume of leases sold to third parties.
Interest income increased $15.0 million, or 672%, from $2.2 million for
the three months ended June 30, 1998 to $17.2 million for the three months
ended June 30, 1999. The increase was primarily related to a 852% increase in
our average balance of interest bearing assets during the second quarter of
1999 primarily as a result of our decision, effective July 1, 1998, to retain
lease receivables on our balance sheet after securitization.
Servicing income increased $0.5 million, or 30%, from $1.5 million for the
three months ended June 30, 1998 to $2.0 million for the three months ended
June 30, 1999. Servicing income consists of late charge income collected on
leases owned and serviced by the Company and servicing income earned on leases
sold under our securitization programs. This increase was primarily due to a
58% increase in late charges collected which resulted from a 69% increase in
the average balance of leases owned and serviced. The increase in servicing
income was partially offset by the change which was made to the structure of
our securitization transactions. Effective July 1, 1998, we began retaining
leases on our balance sheet after securitization. Servicing fees related to
lease receivables securitized after such date were recorded as reduction of
interest expense rather than servicing income.
Salaries and benefits were essentially unchanged comparing the second
quarter of 1998 to the second quarter of 1999. Continued enhancements made to
our e-commerce technology platform allowed us to increase efficiency and
maintain salaries and benefits at a stable level in relation to the increase in
the number of lease originations handled. Average balance of leases owned and
serviced increased 69% from the second quarter 1998 to the second quarter 1999.
Interest expense increased $8.5 million, or 2,076%, from $0.4 million for
the three months ended June 30, 1998 to $8.9 million for the three months ended
June 30, 1999. The increase is primarily related to an increase in outstanding
borrowings as a result of our decision, effective July 1, 1998, to retain lease
receivables and the related borrowings on our balance sheet after
securitization. The increase was partially offset by the servicing fees and
cash flows allocable to trust certificates that we received from lease
receivables securitized after July 1, 1998. As we retain lease receivables on
our balance sheet, the related servicing fees and cash flows allocable to the
trust certificates are recorded as a reduction of interest expense.
Provision for credit losses increased $1.2 million, or 127% from $0.9
million for the three months ended June 30, 1998 to $2.1 million for the three
months ended June 30, 1999. The increase is primarily due to an increase in
lease receivables retained on our balance sheet during the second quarter of
1999, which also resulted from our decision to retain leases on our balance
sheet effective July 1, 1998.
14
<PAGE> 16
Depreciation and amortization increased $0.3 million, or 28% from $1.0
million for the three months ended June 30, 1998 to $1.3 million for the three
months ended June 30, 1999. Such increase was primarily attributable to a 63%
increase in goodwill and other intangible assets from June 1998 to June 1999
resulting from acquisitions made in the second half of 1998 and in 1999.
Additionally, we experienced a 45% increase in fixed assets from June 1998 to
June 1999 as a result of our acquisitions of leasing companies during the
second half of 1998 and in 1999 and the overall expansion of our business.
Other general and administrative expenses increased $0.1 million, or 3%,
from $3.5 million for the three months ended June 30, 1998 to $3.6 million for
the three months ended June 30, 1999. Such increase was attributable to the
general expansion of our business.
In April 1998, we acquired Nexsoft, Inc. ("Nexsoft") of Denver, Colorado.
Nexsoft is a software development firm specializing in software for the
equipment leasing industry. We accounted for this transaction using the
purchase method of accounting. We allocated the purchase price to the net
assets acquired and to purchased in-process research and development. Purchased
in-process research and development includes the value of products in the
development stage which were not considered to have reached technological
feasibility. As a result, we expensed $2.6 million of acquisition costs during
the second quarter of 1998.
During the second quarter of 1998, we incurred approximately $0.6 million
of costs in connection with the relocation of our operations center from
Jupiter, Florida to Houston, Texas.
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 1998 AND 1999
Revenues increased $9.3 million, or 28% from $33.8 million for the six
months ended June 30, 1998 to $43.1 million for the six months ended June 30,
1999, due to strong originations which generated higher interest income. The
$9.3 million increase in revenues in the first six months of 1999 was net of a
$16.3 million decrease in gain on sale of lease financing receivables from the
first six months of 1998 as a result of our strategic decision to alter the
structure of our securitization transactions, effective July 1, 1998, so as to
retain the leases on our balance sheet. With this change in the structure of
our securitization transactions, we did not recognize any gain on sale of lease
financing receivables during the first six months of 1999.
Gains from direct sales of lease financing receivables decreased $2.0
million, or 23%, from $8.7 million for the six months ended June 30, 1998 to
$6.7 million for the six months ended June 30, 1999. The decrease is related to
a decrease in the volume of leases sold to third parties.
Interest income increased $26.5 million, or 692%, from $3.8 million for the
six months ended June 30, 1998 to $30.3 million for the six months ended June
30, 1999. The increase was primarily related to a 708% increase in our average
balance of interest bearing assets outstanding during the first six months of
1999 primarily as a result of our decision, effective July 1, 1998, to retain
lease receivables on our balance sheet after securitization.
Servicing income increased $0.9 million, or 33% from $2.7 million for the
six months ended June 30, 1998 to $3.6 million for the six months ended June 30,
1999. Servicing income consists of late charge income collected on leases owned
and serviced by the Company and servicing income earned on leases sold under our
securitization programs. This increase was primarily due to a 61% increase in
late charges collected which resulted from a 70% increase in the average balance
of leases owned and serviced. The increase in servicing income was partially
offset by the change that was made to the structure of our securitization
transactions. Effective July 1, 1998, we began retaining leases on our balance
sheet after securitization. Servicing fees related to lease receivables
securitized after such date were recorded as reduction of interest expense
rather than servicing income.
Other income increased $0.3 million, or 11% from $2.2 million for the six
months ended June 30, 1998 to $2.5 million for the six months ended June 30,
1999. The increase is primarily attributable to documentation fees and other
fees collected in connection with the origination and administration of the
leases due to the overall expansion of our business.
15
<PAGE> 17
Salaries and benefits increased $0.9 million, or 7% from $12.8 million for
the six months ended June 30, 1998 to $13.7 million for the six months ended
June 30, 1999. The increase in salaries and benefits is directly due to
increased origination activities and the overall expansion of our business.
Lease originations increased 20% from the first six months of 1998 to the first
six months of 1999. Average leases owned and serviced increased 70% from the
first six months of 1998 to the first six months of 1999. However, due to
continued enhancements made to our e-commerce technology platform, we were able
to increase efficiency and reduce the level of increase in salaries and benefits
in relation to the number of lease originations handled.
Interest expense increased $14.5 million, or 1,785%, from $0.8 million for
the six months ended June 30, 1998 to $15.3 million for the six months ended
June 30, 1999. The increase is primarily related to an increase in outstanding
borrowings as a result of our decision, effective July 1, 1998, to retain lease
receivables and the related borrowings on our balance sheet after
securitization. The increase was partially offset by the servicing fees and cash
flows allocable to trust certificates that we received from lease receivables
securitized after July 1, 1998. As we retain lease receivables on our balance
sheet, the related servicing fees and cash flows allocable to the trust
certificates are recorded as a reduction of interest expense.
Provision for credit losses increased $2.5 million, or 153%, from $1.6
million for the six months ended June 30, 1998 to $4.1 million for the six
months ended June 30, 1999. The increase is primarily due to an increase in
lease receivables retained on our balance sheet during the first six months of
1999, which also resulted from our decision to retain leases on our balance
sheet effective July 1, 1998.
Depreciation and amortization increased $0.9 million, or 51%, from $1.7
million for the six months ended June 30, 1998 to $2.6 million for the six
months ended June 30, 1999. Such increase was primarily attributable to a 63%
increase in goodwill and other intangible assets from June 1998 to June 1999
resulting from acquisitions made during the second half of 1998 and in 1999.
Additionally, we experienced a 45% increase in fixed assets from June 1998 to
June 1999 as a result of our acquisitions of leasing companies during the second
half of 1998 and in 1999 and the overall expansion of our business.
Other general and administrative expenses increased $1.0 million, or 19%,
from $5.5 million for the six months ended June 30, 1998 to $6.5 million for the
six months ended June 30, 1999. Such increase was attributable to the general
expansion of our business.
In April 1998, we acquired Nexsoft of Denver, Colorado. Nexsoft is a
software development firm specializing in software for the equipment leasing
industry. We accounted for this transaction using the purchase method of
accounting. We allocated the purchase price to the net assets acquired and to
purchased in-process research and development. Purchased in-process research
and development includes the value of products in the development stage which
were not considered to have reached technological feasibility. As a result, we
expensed $2.6 million of acquisition costs during the first six months of 1998.
During the first six months of 1998, we incurred approximately $1.5
million of costs in connection with the relocation of our operations center
from Jupiter, Florida to Houston, Texas.
LIQUIDITY AND CAPITAL RESOURCES
Our lease finance business is capital intensive and requires access to
substantial short-term and long-term credit to fund new equipment leases. Since
inception, we have funded our operations primarily through borrowings under our
funding facilities, sales of our common stock and by including our leases in
public and private securitization transactions. We expect to require access to
large amounts of capital to maintain and expand our volume of leases funded
and, depending upon market conditions, to complete acquisitions of additional
lease finance companies.
16
<PAGE> 18
Our uses of cash include the acquisition and origination of equipment
leases, payment of interest expenses, repayment of borrowings under our
securitized funding facilities, and the payment of operating and administrative
expenses, income taxes and capital additions. The structure of our lease
funding programs, including the holdback and recourse features of our Private
Label program, along with the structure of our securitized funding facilities
and public securitization transactions, enabled us to generate positive cash
flow from operations during the previous three years.
We use our securitized funding facilities to fund the acquisition and
origination of leases that satisfy the eligibility requirements established
under each facility. These funding facilities provide us with advance rates
that generally do not require us to utilize our capital during the period that
lease receivables are financed under such facilities. The liquidity provided
under certain facilities is generally interim in nature and we seek to refinance
or resell the lease receivables that were funded under these interim facilities
through our public securitization program within three to twelve months.
In April 1999, we filed a shelf registration statement with the Securities
and Exchange Commission relating to the proposed public offering from time to
time of up to $300,000,000 of our debt and/or equity securities. In June 1999,
we utilized the shelf registration to make a secondary underwritten public
offering of 4,000,000 shares of our common stock, from which we received cash
proceeds of approximately $68.4 million, net of expenses. In July 1999, the
underwriters of the Company's offering exercised their over-allotment option and
purchased an additional 600,000 shares of our common stock, from which we
received cash proceeds of approximately $10.4 million, net of expenses. We
intend to use the net proceeds from the offering for general corporate purposes,
including to fund net asset originations and for other working capital needs.
We believe that our existing cash and investment balances, cash flow from
our operations, net proceeds from future securitization transactions and
amounts available under our securitized funding facilities will be sufficient
to fund our operations for the foreseeable future.
Securitized Funding Facilities
As of June 30, 1999, our five securitized funding facilities had an
aggregate funding capacity of $538 million. As of July 31, 1999, $164 million
was available under these facilities.
Through June 30, 1998, our securitized funding facilities were structured
so that transfers to those facilities were considered sales under generally
accepted accounting principles. Effective July 1, 1998, concurrent with our
strategic decision to retain our lease receivables on our balance sheet as
long-term investments, we modified the structure of our securitized funding
facilities so that advances under the facilities would be considered debt under
generally accepted accounting principles. The cash flows available to us, which
are generally based on the advance rates and discount rates set forth in the
facility agreements, were generally unaffected by the modifications to the
agreements.
Public Securitization Transactions
To date, the proceeds that we have received in our public securitization
transactions have generally been sufficient to repay amounts we have borrowed
under our securitized funding facilities, as well as issuance expenses related
to each securitization. We generally structure our securitization transactions
to qualify as financings for income tax purposes. Therefore, no income tax is
payable in the current period on the gain recognized. We anticipate that our
future financings of equipment leases will be principally through
securitization transactions and, to a lesser extent, through portfolio sales
and sales to third-party financing sources.
As of June 30, 1999, we have completed five public securitization
transactions involving the issuance of $896 million of senior and subordinated
securities. We completed the Series 1996-1 and 1996-2 transactions in 1996, the
Series 1997-1 transaction in September 1997, the Series 1998-1 transaction in
December 1998, and the Series 1999-1 transaction in April 1999.
17
<PAGE> 19
In connection with the Series 1996-1 and 1996-2 transactions, Class A
certificates, rated AAA by Standard and Poor's, Aaa by Moody's Investor
Services and AAA by Duff & Phelps Credit Rating Co., were sold in the public
market. The Class B-1 and Class B-2 Certificates were rated BBB and BB,
respectively, by Duff & Phelps Credit Rating Co., and were sold on a
non-recourse basis in the private market.
In connection with the Series 1997-1 transaction, four tranches of Class A
Notes, rated AAA by Standard and Poor's, Aaa by Moody's Investor Services, Inc.
and AAA by Duff & Phelps Credit Rating Co., were sold in the public market. The
Class B-1 and Class B-2 Notes were rated BBB and AA, respectively, by Duff &
Phelps Credit Rating Co., and were sold on a non-recourse basis in the private
market. The Class B-2 Note was enhanced through a letter of credit with
Dresdner Bank AG, which resulted in the higher ratings. We retained a Class B-3
Note, which was rated B by Duff & Phelps Credit Rating Co., for future sale in
the private market.
In connection with the Series 1998-1 transaction, four tranches of Class A
Notes, rated AAA by Standard and Poor's, Aaa by Moody's Investor Services,
Inc., AAA by Duff & Phelps Credit Rating Co. and AAA by Fitch IBCA, Inc. were
sold in the public market. The Class B-1 and Class B-2 notes were rated BBB and
BB by Duff & Phelps Credit Rating Co. and Fitch IBCA, Inc., and were sold and
financed on a non-recourse basis in the private market. A Class B-3 Note was
rated B by Duff & Phelps Credit Rating Co., and Fitch IBCA, Inc. which we
retained for future sale in the private market.
In connection with the Series 1999-1 transaction, four tranches of Class A
Notes, rated AAA by Standard and Poor's, Aaa by Moody's Investor Services,
Inc., AAA by Duff & Phelps Credit Rating Co. and AAA by Fitch IBCA, Inc. were
sold in the public market. The Class B-1 and Class B-2 notes were rated BBB and
BB by Duff & Phelps Credit Rating Co. and Fitch IBCA, Inc., and were sold and
financed on a non-recourse basis in the private market. A Class B-3 Note was
rated B by Duff & Phelps Credit Rating Co. and Fitch IBCA, Inc., which we
retained for future sale in the private market.
We were able to realize approximately 94% of the present value of the
remaining scheduled payments of the equipment leases included in our Series
1996-1 and 1996-2 securitizations, approximately 96% of the present value of
the remaining scheduled payments of the equipment leases included in our Series
1997-1 securitization, and approximately 95% of the present value of the
remaining scheduled payments of the equipment leases included in our Series
1998-1 and 1999-1 securitization.
Subordinated Notes
In May 1997, we entered into a $5.0 million subordinated revolving credit
facility with an affiliate. The commitment level on this facility is scheduled
to decrease by $1.0 million per year. Advances under this facility bear
interest at 11% per annum. As of June 30, 1999, we had not borrowed any money
under this facility.
In connection with the acquisition of Heritage Credit Services, Inc. in
May 1997, we issued a $1.0 million subordinated note payable to the former
owner. Such note bears interest at 9% per annum, payable quarterly, with the
outstanding principal amount due in May 2002.
On October 1, 1998, we acquired all of the outstanding shares of capital
stock of Titan Finance Limited in exchange for $2,250,000 in cash and
$2,250,000 in convertible subordinated promissory notes. The notes were
converted into 112,500 shares of our common stock in May 1999 in accordance
with their terms. Prior to the conversion, the promissory notes bore interest
at a rate of 6% per annum, payable semi-annually, with the outstanding
principal amount due October 1, 2003.
18
<PAGE> 20
Interest Rate Management Activities
The implicit yield to us on all of our leases is on a fixed interest rate
basis because the leases have scheduled payments that are fixed at the time the
leases are originated. When we acquire or originate leases, we base our pricing
on the "spread" we expect to achieve between the implicit yield to us on each
lease and the effective interest cost we will pay when we sell or refinance
such lease through a public securitization transaction. Increases in interest
rates between the time the leases are acquired or originated by us and the time
they are sold or refinanced through a public securitization transaction could
narrow or eliminate the spread, or result in a negative spread.
We mitigate the volatility of interest rate movement between the time we
acquire or originate a lease and the time such lease is sold or refinanced
through a public securitization transaction by hedging movements in interest
rates using interest rate swap derivatives which match the underlying cash flow
associated with the leases originated. Under these swap agreements, we receive
interest on the notional amount at either the 30-day LIBOR or the 30-day AA
Corporate Commercial Paper Index, as applicable, and we pay a fixed rate which
is equal to a spread over the yield to maturity of U.S. Treasury securities
similar to the maturities of the specific leases being held for securitization.
Such hedging arrangements are generally implemented when our portfolio of
unhedged leases reaches $10.0 million.
At certain times, changes in the interest rate market present favorable
conditions to hedge against future rate movement. We may, from time to time,
enter into hedges against interest rate movement in anticipation of future
origination volume in order to take advantage of unique market conditions, but
this activity is generally limited to levels where we are confident of
origination in the near term.
YEAR 2000
The "Year 2000 problem" exists because many computer programs, embedded
systems and components were designed to refer to a year by the last two digits
of the year, such as "99" for "1999." As a result, some of these systems may
not properly recognize that the year that follows "1999" is "2000" and not
"1900." If those problems are not corrected, the systems could fail or produce
erroneous results. No one knows the extent of the potential impact of the Year
2000 problem generally.
State of Readiness
During 1998, we began our Year 2000 program by making initial inquiries of
the software vendors for our major applications as to the Year 2000 readiness
of such applications. We received assurances from these vendors that these
applications are Year 2000 ready. We also began making inquiries of significant
customers and other counterparties as to their Year 2000 readiness. For
purposes of our Year 2000 program, we have divided all of our applications,
systems, relationships and services into three groups:
- Mission critical items are those that we require to operate our
business without disruption,
- Important items are those that we do not require to operate our
business without disruption but that are important to our
day-to-day operations, and
- Ordinary items are those that do not depend on date specific
data or are not important to our day-to-day operations.
The Year 2000 program for all of our hardware, software, operating
systems, relationships and services consists of the following six phases:
Inventory
During this first phase of our Year 2000 program, we compiled information
relating to all hardware, software, operating systems, relationships and
services that may be affected by the Year 2000 problem. As of the date of this
report, we have substantially completed this phase.
19
<PAGE> 21
Impact Analysis
This phase encompassed the initial analysis of all of our hardware and
software, including embedded technologies and other "non-information
technology" applications, and our operating systems, significant customers and
counterparties, to determine whether there is a possibility that they are not
Year 2000 ready, and how this may affect us. We also investigated and
categorized the hardware, software, systems, significant customers and
counterparties as mission critical, important, or ordinary. This phase is now
complete, except for the identification and categorization of significant
customers and other counterparties as to the Year 2000 readiness which is
expected to be completed during the third quarter of 1999.
Solution Planning
Based upon the results of our impact analysis, we have identified the
necessary steps to ensure Year 2000 readiness for all of our hardware and
software, including embedded technologies and other "non-information
technology" applications, and our systems.
Corrective Procedures
In this phase, we will detail and perform the steps outlined from the
results of the Solution Planning phase to identify those fields or processes
that contain a Year 2000 problem, and to develop appropriate corrective
procedures. These corrective procedures may include remediation, replacement,
or retirement. We expect this phase to be completed during the third quarter of
1999 for mission critical applications and during the fourth quarter of 1999
for important applications.
Quality Assurance
During this phase, we will ensure that the necessary steps that are taken
to test any date related issues can be properly executed to create Year 2000
readiness for the specific process or system. In addition, this phase will
ensure that all related processes and systems are not affected by the
corrective action. We expect this phase to be completed during the third
quarter of 1999 for mission critical applications and during the fourth quarter
of 1999 for important applications.
Contingency Planning
In the event that we are unable to correct a Year 2000 problem in a
mission critical process or system prior to September 30, 1999, or we identify
Year 2000 problems with respect to significant customers and other
counterparties, a contingency plan will be completed to ensure continued
operation after December 31, 1999. In completing this contingency plan, we will
identify alternatives, including manual processes, the expected correction
date, and any conversion issues from the manual process to the corrected
system.
Costs To Address The Year 2000 Issues
We did not incur any material cost to address Year 2000 issues during the
year ended December 31, 1998. We estimate that we will incur costs
approximating $300,000, exclusive of internal costs, during 1999 to complete
our resolution of Year 2000 issues. The Company does not separately track
internal Year 2000 costs that are largely salaries and benefits of Company
personnel working on the project.
Risks Of The Year 2000 Issues
Based upon our Year 2000 initiatives to date, we have not identified any
specific known Year 2000 events, trends or uncertainties which are reasonably
likely to have a material effect on our business, results of operations, or
financial condition. We will continue to review these issues as we evaluate the
progress of our Year 2000 program.
20
<PAGE> 22
The foregoing constitutes a Year 2000 statement and readiness disclosure
subject to the protections afforded it by the Federal Year 2000 Information and
Readiness Disclosure Act of 1998.
FORWARD-LOOKING INFORMATION
We refer you to "Item 1. Business - Safe Harbor Statement Under the
Private Securities Litigation Reform Act of 1995" in our Annual Report on Form
10-K for the year ended December 31, 1998 as supplemented by "Item 5. Other
Information" in our Form 10-Q for the quarter ended March 31, 1999.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The nature of our business exposes us to market risk arising from changes
in interest rates, credit spreads, and exchange rates. We have instituted risk
management policies to monitor and limit these exposures as follows:
Interest Rate Risk
To manage our interest rate risk, we have implemented policies that are
designed to minimize changes in our cost of funds associated with changes in
benchmark interest rates after lease receivables have been funded. The
measurement of market risk associated with financial instruments is meaningful
when all related and offsetting transactions are aggregated, and the resulting
net positions are identified.
Our implicit yield on all of our leases is based on a fixed interest rate.
We generally obtain initial funding for lease acquisitions and originations
through borrowings under our securitized funding facilities and, from time to
time, depending on market conditions, we include the lease receivables in a
securitization transaction or portfolio sale. Because the securitized funding
facilities bear interest at floating rates, whereas the permanent
securitizations or portfolio sales bear interest at a spread over the benchmark
Treasury rate which is fixed at the time the transaction is completed, we are
exposed to the risk of an increase in the cost of funds from adverse interest
rate movements during the period from the date of borrowing through the date
that the underlying leases are included in a securitization transaction or
otherwise sold. We seek to minimize our exposure by entering into amortizing
interest rate swap transactions under which the notional amount of the contract
changes monthly to match the anticipated amortization of the underlying leases.
As of June 30, 1999, we were engaged in various interest rate swap
transactions. The total notional amount involved in these transactions closely
matched our outstanding balance of lease receivables that were not permanently
securitized.
The following earnings sensitivity analysis assumes an immediate closing
of a permanent securitization transaction on lease receivables outstanding as
of June 30, 1999 and an increase of 50 basis points in the benchmark Treasury.
As indicated in the analysis, an immediate change in the interest rate would
have a minimal impact on our earnings because the increase in our cost of funds
from an increase in the benchmark Treasury would be substantially offset by a
reduction in our cost of funds from the amortization of swap settlement
proceeds received when our swap positions are unwound.
12-month pre-tax earnings change from increase in benchmark Treasury by 50 basis
points:
(Dollars in thousands)
<TABLE>
<S> <C>
Decrease in pre-tax earnings from increase in interest expense ....... $(1,252)
Increase in pre-tax earnings from decrease in interest expense
due to the amortization of swap proceeds ......................... 1,204
-------
Net decrease in pre-tax earnings ..................................... $ (48)
=======
</TABLE>
21
<PAGE> 23
Credit Spread Risk
We are also exposed to the risk of an increase in credit spreads between
the time we borrow money under our Securitized Funding Facilities and the time
we securitize or otherwise sell the leases. We can partially offset this type
of increase in our cost of funds by engaging in interest rate swap transactions
and benefiting from an increase in interest rate swap spreads. However, it is
not possible for us to completely offset our credit spread risk through hedging
transactions. Based on our lease receivables outstanding as of June 30, 1999,
an increase of 50 basis points in the credit spread would result in a
$1,252,000 decrease in our pre-tax earnings in the next 12 months, provided
that there is no corresponding increase in the swap spread which would
partially offset the decrease in pre-tax earnings.
Foreign Exchange Risk
We entered the small ticket leasing market in the United Kingdom in the
third quarter of 1998 through our acquisition of Suffolk Street Group. As of
June 30, 1999, our pound sterling denominated lease receivables totaled
approximately $31.3 million. As of the same date, our pound sterling
denominated borrowings had an aggregate outstanding balance of approximately
$24.1 million. We are exposed to changes in exchange rates when translating
these pound sterling denominated revenues and expenses to United States
dollars. Based on lease receivables and borrowings outstanding as of June 30,
1999, a 5% decrease in the relative value of the British pound compared to the
United States dollar would result in a $65,000 decrease in our pretax earnings
in the next 12 months.
While the earnings sensitivity analyses presented above represent our best
estimate of the impact on our earnings and balance sheet of various market rate
movements, the actual behavior will likely differ from what we project. From
time to time, we recalibrate our assumptions and adjust our modeling techniques
as needed to improve the accuracy of the risk measurement results. You should
also be aware that actual movements of market interest rates can include
changes in the shape of the yield curve and changes in the basis relationship
between various market rates, among other changes, which are not captured in
the sensitivity analyses presented here.
22
<PAGE> 24
PART II - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) On May 3, 1999, we held our Annual Meeting of Stockholders. At the
meeting the only matter voted upon was the election of directors.
(b) The persons specified in (c) below were elected to serve as Class II
directors of the Company, each for a term of three years or until a successor
is elected and qualified. Continuing as directors after the meeting were
Richard J. Campo, Thomas J. Depping, David C. Shindeldecker, and David L.
Solomon.
(c) Set forth below is a tabulation of the votes with respect to the
election of the specified persons as Class II directors:
<TABLE>
<CAPTION>
VOTES VOTES
FOR WITHHELD
--------- ---------
<S> <C> <C>
Robert Ted Enloe, III .... 9,951,437 4,272,478
Brian E. McManus ......... 9,951,437 4,272,478
Norman J. Metcalfe ....... 9,962,037 4,261,878
</TABLE>
ITEM 5. OTHER INFORMATION
Since the beginning of the second quarter of 1999, we have undertaken a
number of initiatives to further our strategy to become a leading provider of
e-commerce financial products and services.
Name Change to SierraCities.com. In August 1999, we announced that we will
change our name to SierraCities.com during the third quarter. The name change
reflects the evolution of First Sierra into a Company that offers much more to
small businesses than equipment lease financing. As the business-to-business
e-commerce services we offer continue to expand, we are building a community of
small businesses who will rely on us to deliver a comprehensive range of
business services. The success of our e-commerce strategy is reflected in our
new partnerships and in the continued growth of our customer base. Now it also
will be reflected in our new name, SierraCities.com.
Strategic Alliance with Intuit Inc. In August 1999, we entered into a
strategic alliance with Intuit. This alliance will further strengthen our
position as a market leader in offering on-line financing solutions to the
small business market. Our LeasingOnline program will provide Intuit's more
than 5.5 million small business customers with access to Internet-based
financing. Our lease financing will be made available through QuickBooks, the
best-selling small business accounting software, and Intuit's small business
Web sites, www.quickbooks.com and www.quicken.com/small_business/. Intuit is
the leader in small business accounting, personal finance, and tax preparation
software. Nearly 90% of QuickBooks' users currently use the Internet for a
variety of business purposes.
Agreement with Fifth Third Bank. In June 1999, we entered into an
exclusive agreement, under which we will utilize LeasingOnline to finance
equipment purchases for Fifth Third Bank's business customers. LeasingOnline
will be made available to Fifth Third's branch network of nearly 500 branches,
and will enable credit approval in minutes and on-line reporting and tracking
of transactions. In addition, we acquired, in June 1999, the assets, ongoing
business and staff of the small ticket leasing division of Fifth Third Leasing
Company.
IBM Corp. In June 1999, we announced that using our LeasingOnline
application, we will finance the IBM Hosting Services Offering for small to
medium business customers. IBM Global Services will refer prospective customers
from a variety of sources to us and we will fully underwrite, fund and service
the leases originated.
23
<PAGE> 25
Agreement with Sensormatic Electronics Corp. In June 1999, we entered into
an agreement with Sensormatic to design, build, and manage Sensormatic's U.S.
customer lease program and underwrite its leases. Sensormatic supplies
electronic security systems to the retail, commercial and industrial
marketplace. Sensormatic will utilize our system to originate and service lease
transactions from its headquarters in Boca Raton, Florida.
Partnership with Stax Research. In May 1999, we entered into a partnership
with Stax, Inc., a firm dedicated to increasing the efficiency with which small
businesses develop and acquire intellectual capital. Through this partnership,
we are offering small businesses three new online services, including Online
Corporate Library, Business Analyst Group, and Interim Professional Staffing,
in partnership with Stax, Inc.
Launch of LeasingOnline.com. In May 1999, we launched LeasingOnline.com, a
fully automated, direct online leasing program businesses can use to obtain
financing directly from us via the Internet. This new business origination
channel expands our successful on-line vendor and private label capabilities
and enables businesses to complete an application form and receive credit
approval on-line in as little as two minutes. For the first time, businesses
can receive approval for credit via the Web in advance of making a purchase
decision.
Planned Establishment of the First Internet-Based Business-to-Business
Bank. In April 1999, we announced our plan to establish the first
Internet-based business-to-business bank. By establishing the bank, we will be
able to expand our equipment lease financing offerings to include a broad range
of business banking products. Our internet bank will be devoted exclusively to
the banking and financing needs of small business customers. Our goal in
establishing the bank is to diversify our funding sources, lower our costs of
funds, and allow us to offer additional e-commerce products to our base of
business customers. The bank is expected to be operational by the end of 1999,
subject to regulatory approval.
Expansion of Financial Services Offering. In April 1999, we announced that
we will offer working capital financing to business customers via e-commerce
channels. The Company expects to begin offering this product by the end of the
third quarter of 1999.
24
<PAGE> 26
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT NO.
27.1 (*) - Financial Data Schedule for the six months ended June 30, 1999
27.2 (*) - Financial Data Schedule for the restated six months ended June 30,
1998
- --------------
(*) Filed herewith
(b) Reports on Form 8-K - the Registrant filed a Current Report on Form 8-K
dated June 16, 1999 (Date of Event: June 16, 1999) in respect of the
Underwriting Agreement dated June 16, 1999 between First Sierra
Financial, Inc. and E*Offering Corp. The item reported in such Current
Report was Item 7, Financial Statement and Exhibits.
25
<PAGE> 27
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FIRST SIERRA FINANCIAL, INC.
(REGISTRANT)
August 13, 1999 /S/ SANDY B. HO
- ------------------- -------------------------------
Date Executive Vice President
and Chief Financial Officer
(principal financial officer)
26
<PAGE> 28
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
<S> <C>
27.1 (*) - Financial Data Schedule for the six months ended June 30, 1999
27.2 (*) - Financial Data Schedule for the restated six months ended June 30,
1998
- --------------
(*) Filed herewith
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 71,930
<SECURITIES> 4,614
<RECEIVABLES> 678,750
<ALLOWANCES> 7,311
<INVENTORY> 0
<CURRENT-ASSETS> 90,373
<PP&E> 14,829
<DEPRECIATION> 4,491
<TOTAL-ASSETS> 820,616
<CURRENT-LIABILITIES> 53,065
<BONDS> 610,661
469
0
<COMMON> 184
<OTHER-SE> 154,667
<TOTAL-LIABILITY-AND-EQUITY> 820,616
<SALES> 0
<TOTAL-REVENUES> 43,092
<CGS> 0
<TOTAL-COSTS> 13,650
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 4,144
<INTEREST-EXPENSE> 15,265
<INCOME-PRETAX> 953
<INCOME-TAX> 670
<INCOME-CONTINUING> 283
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 283
<EPS-BASIC> 0.02
<EPS-DILUTED> 0.02
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 30,895
<SECURITIES> 3,507
<RECEIVABLES> 24,181
<ALLOWANCES> 799
<INVENTORY> 0
<CURRENT-ASSETS> 60,951
<PP&E> 10,223
<DEPRECIATION> 2,078
<TOTAL-ASSETS> 129,333
<CURRENT-LIABILITIES> 30,645
<BONDS> 9,680
1,789
0
<COMMON> 138
<OTHER-SE> 85,851
<TOTAL-LIABILITY-AND-EQUITY> 129,333
<SALES> 0
<TOTAL-REVENUES> 33,786
<CGS> 0
<TOTAL-COSTS> 12,784
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1,637
<INTEREST-EXPENSE> 810
<INCOME-PRETAX> 7,301
<INCOME-TAX> 2,867
<INCOME-CONTINUING> 4,434
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,434
<EPS-BASIC> 0.34
<EPS-DILUTED> 0.32
</TABLE>
