<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 SEPTEMBER 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)
<TABLE>
<S> <C>
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)
</TABLE>
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 November 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)
<TABLE>
<CAPTION>
ASSETS
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
(UNAUDITED)
<S> <C> <C>
Lease financing receivables, net ................................................. $ 795,502 $ 337,162
Cash and cash equivalents ........................................................ 28,049 7,928
Other receivables ................................................................ 7,898 11,596
Investment in trust certificates ................................................. 9,171 7,288
Marketable securities ............................................................ 4,302 5,042
Goodwill and other intangible assets, net ........................................ 41,439 39,202
Furniture and equipment, net ..................................................... 10,087 9,909
Other assets ..................................................................... 6,477 6,923
Current tax receivables .......................................................... - 3,243
Deferred tax asset ............................................................... 663 -
------------- -----------
Total assets ................................................................ $ 903,588 $ 428,293
============= ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Debt:
Nonrecourse debt .............................................................. $ 650,776 $ 276,511
Other debt .................................................................... 28,811 23,026
Subordinated notes payable .................................................... 1,000 3,250
Other liabilities:
Accounts payable and accrued liabilities ...................................... 30,044 23,283
Holdback reserves payable ..................................................... 25,816 16,682
Income taxes payable .......................................................... 283 523
Deferred income taxes ......................................................... - 501
------------- -----------
Total liabilities ........................................................... 736,730 343,776
------------- -----------
Redeemable preferred stock ..................................................... 469 469
Stockholders' equity:
Common stock, $.01 par value, 100,000,000 shares authorized, 18,962,815
shares and 14,223,915 shares issued and outstanding as of 9/30/99 and
12/31/98, respectively .................................................. 190 142
Additional paid-in capital .................................................. 158,113 76,855
Retained earnings ........................................................... 7,853 6,859
Accumulated other comprehensive income ...................................... 233 192
------------- -----------
Total stockholders' equity .................................................. 166,389 84,048
------------- -----------
Total liabilities and stockholders' equity .................................. $ 903,588 $ 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 SEPTEMBER 30,
--------------------------
1999 1998
----------- -----------
<S> <C> <C>
Gains from direct sales of lease financing receivables ........................... $ 3,863 5,217
Interest income .................................................................. 20,148 4,862
Servicing income ................................................................. 1,795 785
Other income ..................................................................... 1,433 1,136
----------- -----------
Total revenues ................................................................ 27,239 12,000
----------- -----------
Salaries and benefits ............................................................ 7,629 8,577
Interest expense ................................................................. 9,954 1,411
Provision for credit losses on lease financing receivables and investment
in trust certificates ......................................................... 2,967 3,148
Depreciation and amortization .................................................... 1,429 1,087
Other general and administrative ................................................. 3,764 4,389
Merger and acquisition expenses .................................................. -- 1,529
Relocation of operations center .................................................. -- 9
----------- -----------
Total expenses ................................................................ 25,743 20,150
----------- -----------
Income (loss) before provision (benefit) for income taxes ........................ 1,496 (8,150)
Provision (benefit) for income taxes ............................................. 785 (3,201)
----------- -----------
Net income (loss) ................................................................ $ 711 $ (4,949)
=========== ===========
Earnings (loss) per common share, basic .......................................... $ 0.04 $ (0.35)
=========== ===========
Earnings (loss) per common share, diluted ........................................ $ 0.04 $ (0.35)
=========== ===========
</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 NINE MONTHS
ENDED SEPTEMBER 30,
--------------------------
1999 1998
----------- -----------
<S> <C> <C>
Gain on sale of lease financing receivables through securitization transactions .. $ -- $ 16,291
Gains from direct sales of lease financing receivables ........................... 10,538 13,931
Interest income .................................................................. 50,467 8,690
Servicing income ................................................................. 5,398 3,493
Other income ..................................................................... 3,929 3,381
----------- -----------
Total revenues ................................................................ 70,332 45,786
----------- -----------
Salaries and benefits ............................................................ 21,279 21,361
Interest expense ................................................................. 25,219 2,221
Provision for credit losses on lease financing receivables and investment
in trust certificates ......................................................... 7,112 4,785
Depreciation and amortization .................................................... 3,988 2,784
Other general and administrative ................................................. 10,285 9,800
Research and development costs of acquired companies ............................. -- 2,550
Merger and acquisition expenses .................................................. -- 1,614
Relocation of operations center .................................................. -- 1,520
----------- -----------
Total expenses ................................................................ 67,883 46,635
----------- -----------
Income (loss) before provision (benefit) for income taxes ........................ 2,449 (849)
Provision (benefit) for income taxes ............................................. 1,455 (334)
----------- -----------
Net income (loss) ................................................................ $ 994 $ (515)
=========== ===========
Earnings (loss) per common share, basic .......................................... $ 0.06 $ (0.04)
=========== ===========
Earnings (loss) per common share, diluted ........................................ $ 0.06 $ (0.04)
=========== ===========
</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 NINE MONTHS
ENDED SEPTEMBER 30,
-----------------------------
1999 1998
---------- ----------
<S> <C> <C>
Cash Flows from Operations:
Net Income (Loss) ............................................................... $ 994 $ (515)
Reconciliation of net income (loss) to cash provided by operations:
Depreciation and amortization ............................................... 3,988 2,784
Provision for credit losses on lease financing receivables and investment
in trust certificates ..................................................... 7,112 4,785
Gain on sale of lease financing receivables ................................. (10,538) (30,222)
Research and development costs of acquired companies ........................ -- 2,550
Merger and acquisition expenses ............................................. -- 1,614
Funding of lease financing receivables, held for sale ....................... (241,311) (525,758)
Principal payments received on lease financing receivables, held for sale ... 1,444 17,256
Proceeds from sales of lease financing receivables, net of trust certificates
and marketable securities retained, if any ................................ 234,248 407,687
Proceeds and repayments of warehouse credit facilities for leases held for
sale, net ................................................................. -- 118,989
Deferred income taxes ....................................................... (497) --
Accumulated translation adjustment .......................................... 41 171
Changes in assets and liabilities, net of effects from acquisitions:
Decrease (increase) in other receivables .................................. 3,701 (3,983)
Decrease in other assets .................................................. 328 307
Increase in accounts payable and accrued liabilities ...................... 6,731 4,121
Increase in holdback reserve payable ...................................... 8,932 3,674
Increase (decrease) in income taxes ....................................... 2,385 (3,600)
---------- ----------
Net Cash Provided by (Used for) Operations ....................... 17,558 (140)
---------- ----------
Cash Flows from Investing Activities:
Funding of lease financing receivables, held for investment ................. (543,391) --
Principal payments received on lease financing receivables,
held for investment ....................................................... 101,861 --
Expenditures for furniture and equipment .................................... (2,355) (5,739)
Expenditures for acquisitions, including acquisition costs,
less cash acquired ........................................................ (12,412) (15,046)
---------- ----------
Net Cash Used in Investing Activities ............................ (456,297) (20,785)
---------- ----------
Cash Flows from Financing Activities:
Proceeds from warehouse credit facilities, net of repayments ................ 380,050 --
Repayment of subordinated notes payable ..................................... -- (5,000)
Proceeds from issuance of common stock, net and exercise of
stock options ............................................................. 78,810 39,965
Distributions to stockholders ............................................... -- (255)
---------- ----------
Net Cash Provided by Financing Activities ........................ 458,860 34,710
---------- ----------
Net Increase in Cash and Cash Equivalents ........................................ 20,121 13,785
Cash and Cash Equivalents at January 1, .......................................... 7,928 14,569
---------- ----------
Cash and Cash Equivalents at September 30, ....................................... $ 28,049 $ 28,354
========== ==========
</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") is an
e-commerce technology and services provider to small businesses. The Company
customizes lease-financing products and offers servicing, consulting and
technology solutions to commercial customers through on-line connections to its
e-commerce software system. 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, telecommunications,
and diagnostic equipment as well as other specialized equipment for the
healthcare, automotive, food and hospitality industries. The equipment financed
generally has a purchase price of less than $250,000, with an average of
approximately $31,000 for leases originated in 1998 and $29,000 for leases
originated during the first nine months of 1999. The Company funds the
acquisition or origination of its leases from working capital or through its
securitized warehouse facilities. From time to time, depending on market
conditions, the Company securitizes the leases in its 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, the Company recorded a gain on sale of lease
financing receivables when the receivables were included in a securitization.
Effective as of July 1, 1998, the Company made a strategic decision to alter the
structure of its securitization transactions so as to retain leases acquired and
originated on its balance sheet as long-term investments rather than selling
such leases through securitization transactions. The Company also modified the
structure of its securitized warehouse 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. For the nine months ended September 30, 1998, the Company
incurred approximately $1.5 million 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 September 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 of 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 lease receivables 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 a 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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------ ------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net income (loss) ...................................... $ 711 $ (4,949) $ 994 $ (515)
Other comprehensive income (loss):
Foreign currency translation adjustment,
net of tax ........................................ 425 171 41 171
---------- ---------- ---------- ----------
Comprehensive income (loss) ............................ $ 1,136 $ (4,778) $ 1,035 $ (344)
========== ========== ========== ==========
</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)
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 nine
months ended September 30, 1999 and 1998:
<TABLE>
<CAPTION>
PRIVATE WHOLESALE/
LABEL RETAIL TOTAL (2)
---------- ---------- ----------
<S> <C> <C> <C>
Balance at December 31, 1998 ..................................... $ 83 $ 4,680 $ 4,763
Provision for credit losses ................................. 230 6,882 7,112
Charge-offs, net of recoveries, on leases acquired or
originated by the Company ............................... (27) (2,413) (2,440)
Reduction of allowance for leases sold (1) .................. -- (702) (702)
Allowance related to leases acquired through
business combinations ................................... -- 354 354
Charge-offs, net of recoveries, on leases acquired
through business combinations ........................... -- (595) (595)
---------- ---------- ----------
Balance at September 30, 1999 .................................... $ 286 $ 8,206 $ 8,492
========== ========== ==========
Balance at December 31, 1997 ..................................... $ 36 $ 945 $ 981
Provision for credit losses ................................. 70 2,715 2,785
Charge-offs, net of recoveries, on leases acquired or
originated by the Company ............................... (24) (112) (136)
Reduction of allowance for leases sold (1) .................. (41) (1,512) (1,553)
Allowance related to leases acquired through
business combinations ................................... -- 1,130 1,130
Recoveries, net of charge-offs, on leases acquired
through business combinations ........................... -- 92 92
---------- ---------- ----------
Balance at September 30, 1998 ............................... $ 41 $ 3,258 $ 3,299
========== ========== ==========
</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 nine months
ended September 30, 1998 and 1999, leases originated through its Captive
Finance program were approximately $137 million and $139 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 September 30, 1999 (5):
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1999
--------------------------------------------
PRIVATE WHOLESALE/
LABEL (1) RETAIL (4) TOTAL
---------- ---------- ----------
<S> <C> <C> <C>
Lease financing receivables, net ................................... $ 342,780 $ 430,834 $ 773,614 (2)(3)
Allowance for credit losses ........................................ 286 8,206 8,492
Allowance as a percentage of lease financing
receivables, net ................................................ 0.08% 1.90% 1.10%
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) ................................................... 11.33%
Ratio of holdback reserves outstanding to total leases
outstanding under the Private Label program (1) ............... 4.20%
</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 September 30, 1999, lease financing receivables outstanding
under the Captive Finance program were $30,380,000. 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 was 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 September 30, 1999 is not comparable to the prior year. Therefore, the
information for 1998 is not presented.
The following table sets forth the charge-off experience of the Company with
respect to leases in its portfolio (3):
<TABLE>
<CAPTION>
FOR THE NINE
MONTHS ENDED
SEPTEMBER 30, 1999
------------------
<S> <C>
Average balance of leases outstanding during the period (1)(2) ................. $ 588,016
===============
Net losses experienced on leases acquired:
Private Label program ....................................................... $ 27
Wholesale and Retail programs ............................................... 2,413
---------------
Total ..................................................................... $ 2,440
===============
Net Loss Ratio as a percentage of average balance of leases outstanding ........ 0.41%
===============
</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, the
Company altered the structure of its securitization transactions so as to
retain leases on its balance sheet. With this change, the allowance
information as of September 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. DELINQUENCY STATISTICS
The following table sets forth certain information as of September 30, 1999
and December 31, 1998, with respect to leases which were held by the Company in
its portfolio or serviced by the Company pursuant to its securitization
programs:
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1999
-------------------------------------------------------------
PRIVATE WHOLESALE/ CAPTIVE
LABEL RETAIL FINANCE (1) TOTAL (2)
---------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Gross leases outstanding ............... $ 749,394 $ 672,926 $ 34,107 $1,456,427
31-60 days past due .................... 0.92% 2.19% 0.85% 1.51%
61-90 days past due .................... 0.38% 0.73% 0.84% 0.55%
Over 90 days past due .................. 0.35% 1.27% 0.99% 0.79%
---------- ---------- ---------- ----------
Total past due .................... 1.65% 4.19% 2.68% 2.85%
========== ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1998
-------------------------------------------------------------
PRIVATE WHOLESALE/ CAPTIVE
LABEL RETAIL FINANCE (1) TOTAL
---------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Gross leases outstanding ............... $ 590,825 $ 478,139 $ 1,610 $1,070,574
31-60 days past due .................... 1.36% 1.30% 0.00% 1.33%
61-90 days past due .................... 0.63% 0.69% 0.00% 0.65%
Over 90 days past due .................. 0.40% 0.81% 0.00% 0.58%
---------- ---------- ---------- ----------
Total past due .................... 2.39% 2.80% 0.00% 2.56%
========== ========== ========== ==========
</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 of
originations without recourse to the Company.
(2) As the portfolio of leases owned and serviced by the Company matures, the
Company expects delinquency rates to approach levels of delinquencies
of the Company's earlier securitization pools, which are currently in
the range of 4% to 6%.
11
<PAGE> 13
FIRST SIERRA FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
5. 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 NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------ ------------------------------
1999(1) 1998 1999(2) 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Earnings per common share, basic:
Net income (loss) .............................. $ 711 $ (4,949) $ 994 $ (515)
Preferred stock dividends ................... -- 8 -- 48
------------ ------------ ------------ ------------
Net income (loss) available to common
stockholders ................................ $ 711 $ (4,957) $ 994 $ (563)
============ ============ ============ ============
Weighted average shares outstanding ............ 18,871,511 13,978,645 15,951,040 13,396,021
============ ============ ============ ============
Earnings (loss) per common share, basic ........ $ 0.04 $ (0.35) $ 0.06 $ (0.04)
============ ============ ============ ============
Earnings per common share, diluted:
Net income (loss) .............................. $ 711 $ (4,949) $ 994 $ (515)
============ ============ ============ ============
Weighted average shares outstanding ............ 18,871,511 13,978,645 15,951,040 13,396,021
Dilutive securities:
Options ..................................... 575,661 -- 535,135 --
Redeemable preferred stock .................. 55,125 -- 55,125 --
------------ ------------ ------------ ------------
Weighted average shares outstanding, diluted ... 19,502,297 13,978,645 16,541,300 13,396,021
============ ============ ============ ============
Earnings (loss) per common share, diluted ...... $ 0.04 $ (0.35) $ 0.06 $ (0.04)
============ ============ ============ ============
</TABLE>
- --------------------
(1) For the three months ended September 30, 1999, the computation of diluted
earnings per share excludes purchase options for approximately 332,000 shares of
common stock that have exercise prices (ranging from $18.375 to $24.00 per
share) greater than the $14.75 per share average market price for the period and
would thus be anti-dilutive if exercised.
(2) In addition to the 332,000 shares of common stock subject to purchase
options excluded in the third quarter of 1999, the computation of diluted
earnings per share for the nine months ended September 30, 1999 also excludes
options to purchase approximately 680,000 shares of common stock at an exercise
price of $11.25 per share that were outstanding during the first three months of
this period, because such options were anti-dilutive.
12
<PAGE> 14
FIRST SIERRA FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
6. LEASE FINANCING RECEIVABLES
The Company's lease financing receivables balance at September 30, 1999 and
December 31, 1998, consists of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Minimum lease payments ................................... $ 982,534 $ 417,116
Estimated unguaranteed residual value .................... 13,293 4,120
Initial direct costs ..................................... 17,164 6,729
Unearned income .......................................... (208,997) (86,040)
Allowance for credit losses .............................. (8,492) (4,763)
---------- ----------
Lease financing receivables, net ..................... $ 795,502 $ 337,162
========== ==========
</TABLE>
7. DEBT
Total debt consisted of the following as of September 30, 1999 and December
31, 1998:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Nonrecourse Debt:
Securitized Warehouse Facilities ..................................... $ 199,610 $ 173,767
Securitized Transactions:
Series 1998-1 securitization ..................................... 78,683 101,247
Series 1999-1 securitization ..................................... 193,283 --
Series 1999-2 securitization ..................................... 168,523 --
Other Nonrecourse Debt ............................................... 10,677 1,497
---------- ----------
Total Nonrecourse Debt ........................................... 650,776 276,511
Other Debt ............................................................. 28,811 23,026
Subordinated Notes Payable ............................................. 1,000 3,250
---------- ----------
Total Debt ....................................................... $ 680,587 $ 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 these
circumstances are insufficient to fully repay amounts due, the investor or
financing source withstands the full risk of loss. Other debt and subordinated
notes payable includes amounts due to financing sources for which the Company is
responsible for full repayment of principal and interest.
13
<PAGE> 15
FIRST SIERRA FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
8. 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.
9. 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 have 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 $2.7 million, which is
being amortized on a straight-line basis over 20 years.
10. SEGMENT INFORMATION
The Company acquires and originates leases primarily through its Private
Label, Wholesale/Retail, and Captive Finance programs. The following tables
present certain financial information of the Company by operating segment.
<TABLE>
<CAPTION>
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- -----------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
Private Label ....................................... $ 7,052 $ 1,310 $ 16,524 $ 7,451
Wholesale/Retail .................................... 18,706 9,951 49,742 35,779
Captive Finance ..................................... 1,481 739 4,066 2,556
-------- -------- -------- --------
Total ............................................. $ 27,239 $ 12,000 $ 70,332 $ 45,786
======== ======== ======== ========
Income (loss) before provision (benefit) for income
taxes:
Private Label ....................................... $ 2,655 $ 902 $ 5,297 $ 6,259
Wholesale/Retail .................................... 3,207 (1,869) 10,234 7,806
Captive Finance ..................................... 189 77 402 340
Corporate ........................................... (4,555) (7,260) (13,484) (15,254)
-------- -------- -------- --------
Total ............................................. $ 1,496 $ (8,150) $ 2,449 $ (849)
======== ======== ======== ========
</TABLE>
14
<PAGE> 16
FIRST SIERRA FINANCIAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
AS OF
-------------------------------
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- -------------
<S> <C> <C>
Total assets:
Private Label ........................................... $ 357,047 $ 158,446
Wholesale/Retail ........................................ 483,388 255,146
Captive Finance ......................................... 30,560 120
Corporate ............................................... 32,593 14,581
------------ ------------
Total ................................................. $ 903,588 $ 428,293
============ ============
</TABLE>
15
<PAGE> 17
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS - QUARTERS ENDED SEPTEMBER 30, 1999 AND 1998
Revenues increased $15.2 million, or 127%, from $12.0 million for the three
months ended September 30, 1998 to $27.2 million for the three months ended
September 30, 1999, due to significant growth of balance sheet assets resulting
from strong originations which generated higher interest income.
Gains from direct sales of lease financing receivables decreased $1.3
million, or 26%, from $5.2 million for the three months ended September 30, 1998
to $3.9 million for the three months ended September 30, 1999. The decrease is
related to a decrease in the volume of leases sold to third parties.
Interest income increased $15.2 million, or 314%, from $4.9 million for the
three months ended September 30, 1998 to $20.1 million for the three months
ended September 30, 1999. The increase was due to a 536% increase in our average
balance of interest bearing assets during the third 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 $1.0 million, or 129%, from $0.8 million for the
three months ended September 30, 1998 to $1.8 million for the three months ended
September 30, 1999. Servicing income consists of late charge income collected on
leases owned and serviced by us and servicing income earned on leases sold under
our securitization programs. This increase was due to an increase in late
charges collected, which resulted from a 62% increase in the average balance of
leases owned and serviced. The increase in servicing income was partially offset
by the absence in the current year of servicing fees related to lease
receivables securitized after July 1998. 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 26%, from $1.1 million for the
three months ended September 30, 1998 to $1.4 million for the three months ended
September 30, 1999. The increase is primarily attributable to a higher level of
other fees collected in connection with origination and administration of leases
due to the overall expansion of the business.
Salaries and benefits decreased $1.0 million, or 11%, from $8.6 million for
the three months ended September 30, 1998 to $7.6 million for the three months
ended September 30, 1999. Continued enhancements made to our e-commerce
technology platform allowed us to increase efficiency and decrease salaries and
benefits in relation to the increase in the number of lease originations
handled. The average balance of leases owned and serviced increased 62% from the
third quarter of 1998 to the third quarter of 1999.
Interest expense increased $8.6 million, or 605%, from $1.4 million for the
three months ended September 30, 1998 to $10.0 million for the three months
ended September 30, 1999. This increase is primarily related to a 780% increase
in the average 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 decreased $0.1 million, or 6%, from $3.1
million for the three months ended September 30, 1998 to $3.0 million for the
three months ended September 30, 1999. The decrease is primarily due to a $2.0
million provision being recorded in the third quarter of 1998 to write down the
carrying value of our investment in trust certificates. This write-down only
affected the lease receivables securitized prior to July 1, 1998. Excluding the
$2.0 million provision in the third quarter of 1998, the provision for credit
losses increased $1.9 million, or 158%, over the third quarter of 1998 due to an
increase in lease receivables retained on our balance sheet which resulted from
our decision to retain leases on our balance sheet effective July 1, 1998.
16
<PAGE> 18
Depreciation and amortization increased $0.3 million, or 31%, from $1.1
million for the three months ended September 30, 1998 to $1.4 million for the
three months ended September 30, 1999. Such increase was primarily attributable
to a 19% increase in goodwill and other intangible assets from September 1998 to
September 1999 resulting from acquisitions made in the last quarter of 1998 and
in 1999. Additionally, we experienced a 31% increase in fixed assets from
September 1998 to September 1999 as a result of our acquisitions of leasing
companies during the last quarter of 1998 and in 1999 and the overall expansion
of our business.
Other general and administrative expenses decreased $0.6 million, or 14%,
from $4.4 million for the three months ended September 30, 1998 to $3.8 million
for the three months ended September 30, 1999. Such decrease was attributable to
increased efficiency due to continued enhancements made to our e-commerce
technology platform.
During the third quarter of 1998, we incurred approximately $1.5 million of
merger and acquisition expenses in connection with the acquisition or proposed
acquisition of companies accounted for or to be accounted for under the
pooling-of-interests method. Approximately $0.6 million of this amount was
incurred in connection with the terminated merger with the Oliver-Allen
Corporation.
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1999
Revenues increased $24.5 million, or 54%, from $45.8 million for the nine
months ended September 30, 1998 to $70.3 million for the nine months ended
September 30, 1999, due to strong originations which generated higher interest
income. The $24.5 million increase in revenues in the first nine months of 1999
was net of a $16.3 million decrease in gain on sale of lease financing
receivables from the first nine 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 nine months of
1999.
Gains from direct sales of lease financing receivables decreased $3.4
million, or 24%, from $13.9 million for the nine months ended September 30, 1998
to $10.5 million for the nine months ended September 30, 1999. The decrease is
related to a decrease in the volume of leases sold to third parties.
Interest income increased $41.8 million, or 481%, from $8.7 million for the
nine months ended September 30, 1998 to $50.5 million for the nine months ended
September 30, 1999. The increase was primarily related to a 575% increase in our
average balance of interest bearing assets outstanding during the first nine
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 $1.9 million, or 55%, from $3.5 million for the
nine months ended September 30, 1998 to $5.4 million for the nine months ended
September 30, 1999. Servicing income consists of late charge income collected on
leases owned and serviced by us and servicing income earned on leases sold under
our securitization programs. This increase was due to an 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 absence in the current year of servicing fees related to lease
receivables securitized after July 1998. 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 $0.5 million, or 16%, from $3.4 million for the nine
months ended September 30, 1998 to $3.9 million for the nine months ended
September 30, 1999. The increase is primarily attributable to a higher level of
documentation fees and other fees collected in connection with the origination
and administration of the leases due to the overall expansion of our business.
17
<PAGE> 19
Salaries and benefits were essentially unchanged for the nine months ended
September 30, 1999 compared to the nine months ended September 30, 1998.
Continued enhancements made to our e-commerce technology platform allowed us to
increase efficiency and maintain the same level of salaries and benefits while
handling a higher number of lease originations. Lease originations increased 19%
from the first nine months of 1998 to the first nine months of 1999. Average
leases owned and serviced increased 69% from the first nine months of 1998 to
the first nine months of 1999.
Interest expense increased $23.0 million, or 1,035%, from $2.2 million for
the nine months ended September 30, 1998 to $25.2 million for the nine months
ended September 30, 1999. The increase is primarily related to a 1,281% increase
in the average 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 $2.3 million, or 49%, from $4.8
million for the nine months ended September 30, 1998 to $7.1 million for the
nine months ended September 30, 1999. The increase is primarily due to an
increase in lease receivables retained on our balance sheet during the first
nine months of 1999, which also resulted from our decision to retain leases on
our balance sheet effective July 1, 1998. The provision for the nine months
ended September 30, 1998 included a $2.0 million provision to write down the
carrying value of our investment in trust certificates. This write-down only
affected the lease receivables securitized prior to July 1, 1998.
Depreciation and amortization increased $1.2 million, or 43%, from $2.8
million for the nine months ended September 30, 1998 to $4.0 million for the
nine months ended September 30, 1999. Such increase was primarily attributable
to a 19% increase in goodwill and other intangible assets from September 1998 to
September 1999, resulting from acquisitions made during the last quarter of 1998
and in 1999. Additionally, we experienced a 31% increase in fixed assets from
September 1998 to September 1999 as a result of our acquisitions of leasing
companies during the last quarter of 1998 and in 1999 and the overall expansion
of our business.
Other general and administrative expenses increased $0.5 million, or 5%,
from $9.8 million for the nine months ended September 30, 1998 to $10.3 million
for the nine months ended September 30, 1999. Such increase was attributable to
the general expansion of our business.
In April 1998, we acquired Nexsoft, Inc. of Denver, Colorado. Nexsoft, Inc.
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 nine months ended
September 30, 1998.
During the nine months ended September 30, 1998, we incurred approximately
$1.6 million of merger and acquisition expenses in connection with the
acquisition or proposed acquisition of companies accounted for or to be
accounted for under the pooling-of-interests method. Approximately $0.6 million
of this amount was incurred in connection with the terminated merger with the
Oliver-Allen Corporation.
During the first nine 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.
18
<PAGE> 20
LIQUIDITY AND CAPITAL RESOURCES
Our equipment finance business is capital intensive and requires access to
substantial short-term and long-term credit to fund the acquisition and
origination of equipment leases. Since inception, we have funded our operations
primarily through borrowings under our warehouse facilities, sales of our common
stock and by including certain of 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 equipment leases and, depending
upon market conditions, to complete acquisitions of additional equipment finance
businesses.
We use capital to acquire and originate leases, to pay interest expenses,
to repay obligations in connection with borrowings under our securitized
warehouse facilities, and to pay operating and administrative expenses, income
taxes and capital additions. The structure of our funding programs and our
securitized warehouse facilities and public securitization transactions enabled
us to generate positive cash flow from operations during the previous three
years.
We use our securitized warehouse facilities to fund the acquisition and
origination of leases that satisfy the eligibility requirements established
under each warehouse facility. These warehouse 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 of our warehouse 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 million 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 our 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, amounts
available under our securitized warehouse facilities and proceeds from our
securities offerings will be sufficient to fund our operations for the
foreseeable future.
Securitized Warehouse Facilities
As of September 30, 1999, our five securitized warehouse facilities had an
aggregate funding capacity of $779 million. As of October 31, 1999, $438 million
was available under these facilities.
In September 1999, we entered into a securitized warehouse facility with
Merrill Lynch Mortgage Capital, Inc., and the maximum amount available under
such facility is $250 million.
Through June 30, 1998, our securitized warehouse facilities were structured
such 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 warehouse
facilities such that advances under the facilities would be considered debt
under generally accepted accounting principles. The cash flow available to us,
which is generally based on the advance rates and discount rates set forth in
the facility agreements, was generally unaffected by the modifications to the
agreements.
19
<PAGE> 21
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 warehouse 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 September 30, 1999, we have completed six public securitization
transactions involving the issuance of $1.1 billion 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, the Series 1999-1 transaction in April 1999 and the Series 1999-2
transaction in September 1999.
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.
In connection with the Series 1999-2 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. Class B Notes rated A by Standard and Poor's, A by Duff &
Phelps Credit Rating Co., A by Fitch IBCA, Inc. and A2 by Moody's Investor
Services, Inc. were also sold in the public market. The Class C note, rated BBB
by Duff & Phelps Credit Rating Co. and Fitch IBCA, Inc. and the Class D note,
rated BB by Duff & Phelps Credit Rating Co. and Fitch IBCA, Inc., were sold and
financed on a non-recourse basis in the private market. A Class E note was rated
B by both Duff & Phelps Credit Rating Co. and Fitch IBCA, Inc. and was retained
by us 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, 1999-1 and 1999-2 securitizations.
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<PAGE> 22
Subordinated Notes
In May 1997, we entered into a $5.0 million subordinated revolving credit
facility with an affiliate. Due to availability of funds under other facilities,
it was determined that this revolving credit facility was no longer needed and
was terminated, based upon mutual agreement of all parties involved, during the
third quarter of 1999. The commitment level on this facility was scheduled to
decrease by $1.0 million per year. Advances under this facility bore interest at
11% per annum.
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.
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.
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 counter-parties as
21
<PAGE> 23
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. We have taken several
overlapping approaches to our inventory process as a means to ensure a thorough
inventory. We have now completed this phase.
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
counter-parties, 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
counter-parties as mission critical, important, or ordinary. This phase is now
complete.
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 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. Corrective
procedures may include remediation, replacement, or retirement. As of the date
of this report, corrective procedures have been initiated for all Year 2000
problems identified. Corrective procedures for important applications are
substantially completed, but will continue through the fourth quarter of 1999
for the few identified remaining problems.
Quality Assurance
During this phase, we ensure that date-related issues can be properly
executed and the respective systems are Year 2000 ready. In addition, this phase
ensures that all related processes and systems are not affected by the
corrective action. The Quality Assurance phase will be an ongoing process with
any corrective procedures we make.
Contingency Planning
In the event that we are unable to correct a Year 2000 problem in a mission
critical process or system, or if we identify Year 2000 problems with respect to
significant customers and other counter-parties, a contingency plan will be
completed during the fourth quarter of 1999 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.
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<PAGE> 24
Costs To Address the Year 2000 Issues
We did not incur any material costs 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. We do not separately track internal Year 2000 costs that are
largely salaries and benefits of our personnel working on the project and are
not incremental costs.
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. We will continue to monitor the status of
software from our vendors and key business relationships for any changes in Year
2000 compliance status. In addition to our contingency planning, we have
identified key issues that will be continually monitored to ensure validity.
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 warehouse 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 warehouse
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 September 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.
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<PAGE> 25
The following earnings sensitivity analysis assumes an immediate closing of
a permanent securitization transaction on lease receivables outstanding as of
September 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 ................. $ (983)
Increase in pre-tax earnings from decrease in interest expense
due to the amortization of swap proceeds ................................... 800
--------
Net decrease in pre-tax earnings ............................................... $ (183)
========
</TABLE>
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 Warehouse 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 September 30,
1999, an increase of 50 basis points in the credit spread would result in a
$983,000 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
September 30, 1999, our pound sterling denominated lease receivables totaled
approximately $35.2 million. As of the same date, our pound sterling denominated
borrowings had an aggregate outstanding balance of approximately $23.6 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 September 30, 1999, a 5%
decrease in the relative value of the British pound compared to the United
States dollar would result in a $135,000 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.
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<PAGE> 26
PART II - OTHER INFORMATION
ITEM 5. OTHER INFORMATION
Since the beginning of the third 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.
Strategic Alliance with Intuit Inc. In August 1999, we entered into a
strategic alliance with Intuit under which our LeasingOnline financing program
is being 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/. Our LeasingOnline program provides Intuit's
more than 5.5 million small business customers with access to Internet-based
financing. 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. This alliance will further
strengthen our position as a market leader in offering on-line financing
solutions to the small business market.
Working Capital Financing Program Launched. In November 1999, we began
offering our Working Capital Financing product to the small business market over
the internet. This new program, announced in April 1999, is part of our ongoing
strategy to expand our e-commerce product offerings to our growing electronic
community of business customers. Our Working Capital Financing program enables
businesses to obtain capital for general business purposes, not limited to a
specific equipment purchase. Under the program, qualified applicants can be
approved in as little as two minutes and funds can be dispersed as quickly as 24
hours from time of approval.
Partnership with VerticalNet, Inc. In October 1999, First Sierra and
VerticalNet, Inc. jointly announced an agreement whereby VerticalNet's online
customers will be offered First Sierra's Working Capital Financing and
LeasingOnline products. VerticalNet, Inc. (www.verticalnet.com) owns and
operates 47 industry-specific web sites designed as online business-to-business
communities, known as vertical trade communicators.
Second Alliance with Intuit, Inc. In October 1999, we announced that we
formed a second alliance with Intuit under which we will offer our new online
Working Capital Financing product to Intuit's QuickBooks and QuickBooks.com
customers.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT NO.
27 (*) - Financial Data Schedule for the nine months ended September 30, 1999
- --------------
(*) Filed herewith
(b) Reports on Form 8-K - there were no reports on Form 8-K filed during the
quarter ended September 30, 1999.
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)
November 10, 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 (*) - Financial Data Schedule for the nine months ended
September 30, 1999
</TABLE>
- --------------
(*) Filed herewith
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 28,049
<SECURITIES> 4,302
<RECEIVABLES> 803,994
<ALLOWANCES> 8,492
<INVENTORY> 0
<CURRENT-ASSETS> 46,726
<PP&E> 15,293
<DEPRECIATION> 5,206
<TOTAL-ASSETS> 903,588
<CURRENT-LIABILITIES> 56,143
<BONDS> 679,587
469
0
<COMMON> 190
<OTHER-SE> 166,199
<TOTAL-LIABILITY-AND-EQUITY> 903,588
<SALES> 0
<TOTAL-REVENUES> 70,332
<CGS> 0
<TOTAL-COSTS> 21,279
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 7,112
<INTEREST-EXPENSE> 25,219
<INCOME-PRETAX> 2,449
<INCOME-TAX> 1,455
<INCOME-CONTINUING> 994
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 994
<EPS-BASIC> 0.06
<EPS-DILUTED> 0.06
</TABLE>
