U. S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from
to
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Commission file number: 0-12199
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SOURCE CAPITAL CORPORATION
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(Name of small business issuer in its charter)
Washington 91-0853890
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1825 N. Hutchinson Road
Spokane, Washington 99212
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(Address of principal (Zip Code)
executive offices)
Issuer's telephone number, including area code: 509 928-0908
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Securities registered under Section 12(b) of the Exchange Act:
Title of each class Name of each exchange on which registered
NONE
Securities registered under Section 12(g) of the Act:
Common stock, no stated par value
(Title of Class)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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
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<PAGE>
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained in this form, and no disclosure
will be contained, to the best of registrants knowledge, in definitive
proxy of information statements incorporated by reference in Part III
of this Form 10-KSB or any amendment to this Form 10-KSB. [ ]
The issuer's revenues for its most recent fiscal year: $5,129,610.
The aggregate market value of the voting common equity held by non-
affiliates as of March 5, 1998: $9,757,838.
The number of shares outstanding of each of the issuer's classes of
common equity, as of March 5, 1998: 1,355,818.
DOCUMENTS INCORPORATED BY REFERENCE.
Portions of the registrant's Proxy Statement to be filed with the
Securities and Exchange Commission prior to April 29, 1998, pursuant
to Regulation 14A of the Securities Exchange Act of 1934 in connection
with the 1998 annual meeting of registrant's shareholders are
incorporated herein by reference into Part III of this report.
Transitional Small Business Disclosure Format (check one):
Yes ; No X .
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<PAGE>
PART I
Item 1. Description of Business.
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This document contains some forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. A
forward-looking statement may contain words such as "will continue to
be," "will be," "continue to," "expect to," "anticipates that," "to
be," or "can impact." Management cautions that forward-looking
statements are subject to risks and uncertainties that could cause the
Company's actual results to differ materially from those projected in
forward-looking statements.
GENERAL
Source Capital Corporation (the "Company"), was incorporated under
the law of the State of Washington in 1969 and is headquartered in
Spokane, Washington. The Company is engaged in the business of
lending, primarily through direct loans to individuals and
corporations. Generally, its loans are collateralized, in whole or in
part by real estate or personal property.
The Company's wholly owned subsidiary, Source Capital Leasing Company,
is engaged in the business of providing lease financing for a wide
array of equipment and vehicle contracts. Leases are structured as
direct financing contracts and are generally collateralized through
collateral perfection and personal guarantees.
The Company's other wholly owned subsidiary, Source Capital Finance
Inc. is engaged in the business of purchasing accounts receivable from
various manufacturing and wholesale clients on a full recourse,
complete notification basis.
COMMERCIAL LENDING ACTIVITIES
The Company presently serves the financial needs of individuals and
middle-market businesses by providing commercial real estate loans,
secured lines of credit construction and development loans. Its
market niche centers on customers not served by other financing
companies or commercial lending institutions. The Company's customers
often use their equities in existing real estate as collateral for
loans made by the Company to restructure debt, upgrade underperforming
properties and make other commercial investments. For companies
unable to comply with bank covenants and for investors seeking maximum
flexibility, the Company offers credit lines in a structured borrowing
environment. The majority of loans made by the Company are primarily
collateralized by first mortgages on real estate.
<PAGE>
Loans originated during 1997 and 1996, together with their terms and
range of interest rates are as follows:
1997 1996
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Loan Amount $ 21,520,736 $ 25,529,608
Term 1-10 years 1-10 years
Interest rate 11.00-15.00% 9.96-16.25%
Included in the loans shown in the above table as originated in 1996
is a loan in the amount of $3,800,000 carried back upon the sale
during 1996 of a shopping center, acquired by the Company in a prior
year through foreclosure.
The Company typically charges its borrowers loan origination fees in
connection with its commercial lending activities, thereby increasing
the effective yields recognized on the loans. In some instances, the
Company purchases contracts which may carry below market rates of
interest. However, the Company discounts the purchase price of below
market rate contracts so that the yield on the discounted contract
will approximate the rates being charged on its originated loans.
Lending decisions are made by a loan committee comprised of the
Chairman, President and Executive Vice President of the Company.
Loans exceeding $1,250,000 require the approval of the Company's
primary lender, Seafirst Bank, to be eligible for inclusion in the
Company's collateral base. Loans exceeding $2,500,000 also require
approval by the Board of Directors' loan committee. The Company
originates commercial loans that are collateralized primarily by real
property. The principal factors considered in making lending
decisions are the amount of the loan in comparison to the value of the
collateral, the borrower's financial condition and the borrower's
capacity to repay the loan. The Company attempts to minimize lending
risk by limiting the total amount loaned to any one borrower.
Additionally, the Company monitors and restricts its credit exposure
to specific industries and geographical areas. The Company typically
requires significant collateral for its commercial and real estate
loans. The average loan to value percentages of the Company's
portfolio, at December 31, 1997, was estimated by management to be
49%. In addition, one or more of the Company's loan officers
personally inspect all real estate that is offered to the Company as
collateral.
For additional information concerning commercial loans, see Note 2 of
Notes to Consolidated Financial Statements (the "Financial
Statements") for the two years ended December 31, 1997 and 1996.
LEASING ACTIVITIES
Source Capital Leasing Co. ("SCLC"), a Washington corporation and a
wholly owned subsidiary of the Company, was formed in March 1997.
SCLC targets closely-held businesses for leasing transactions in the
$5,000 to $250,000 range with terms ranging from 24 months to 60
months. During the first nine months of operation, SCLC closed and
funded 82 equipment leases totaling approximately $3.7 million for
<PAGE>
customers located in Washington, Oregon, California, Idaho, Arizona
and Nevada. The average size of the leases in SCLC's portfolio at
December 31, 1997 was approximately $52,000. These leases were
written for the following types of business equipment:
agricultural/forest products, computer/data processing,
construction/heavy equipment, health care, manufacturing, office
equipment/furniture, restaurant equipment, retail/service equipment,
signage/marketing, and transportation. The largest lease amount
written during the year was for $150,000. Leases written in amounts
of $150,000 or more must be approved by Seafirst Bank pursuant to
terms of the Company's credit agreement with the Seafirst.
Lease contracts that meet the Company's credit requirements, but do
not meet management's minimum yield requirements, are sold in the
secondary market. Some lease contracts are participated or sold on a
non-recourse basis through lease brokers. SCLC originates the
majority of leases retained in its portfolio. However, the majority
of its clients are referred by lease brokers. Leases are approved on
a contract by contract basis. Leases up to $100,000 require the
approval of the President and the Chief Credit Officer of SCLC.
Leases exceeding $100,000 up to $250,000 requires the approval of the
President and Chief Credit Officer of SCLC as well as the President of
the Company. Lease contracts are collateralized by the underlying
equipment and are usually guaranteed by the principals of the lessee.
The Company's leasing credit practice is based upon the lessee's
financial position, creditworthiness and ability to meet cash flow
obligations. All other credit considerations are similar to those
followed by the commercial lending group.
For additional information concerning leasing, see Note 2 of Notes to
the Consolidated Financial Statements.
RECEIVABLES FINANCING ACTIVITIES
Source Capital Finance, Inc. ("SCFI"), a Washington corporation and a
wholly owned subsidiary of the Company, is a specialized financial
services company principally engaged in the business of providing
receivables-based commercial financing. SCFI began operations in
November 1997 targeting wholesalers, distributors, manufacturers and
service businesses having business customers within a 100-mile radius
of Spokane, Washington. Companies in the retail sector are not
expected to be a part of SCFI's market. Targeted businesses have
sales volume between $100,000 and $5 million. Generally, SCFI does
not finance receivables of less than $100 or greater than $150,000.
SCFI's concentration policy is to have no more than $250,000 in total
purchased invoices from any one client that are unpaid at any time.
SCFI presently leases space in the Company's corporate offices in
Spokane.
SCFI provides financing to its clients through the purchase of sales
invoices owed to SCFI's clients by the client's customers on a full
recourse, complete notification basis. SCFI uses a seven-step process
which is designed to ensure the validity and collectibility of the
invoices that it purchases. Once SCFI has purchased an invoice, its
<PAGE>
client can elect to continue collections or can arrange to have SCFI
collect for an additional fee. Clients who elect to continue their
own collections have up to 90 days for payments to be made. At the
end of 90 days, clients have the option of repurchasing the invoice
from SCFI or replacing the invoice with an invoice of equal value and
acceptable credit risk. If SCFI is not able to collect an invoice for
its client, the invoice is subject to full recourse at the end of 180
days. The client can then repurchase the invoice or replace it with
one of equal value with acceptable credit risk to SCFI.
SCFI charges fees dependent upon whether it or the client is
responsible for collection. In cases where the client is to collect
on invoices, SCFI charges 1% for payments collected within 10 days and
an additional 1% for each additional ten day period that the invoice
remains outstanding, up to a total of 9% on an invoice that is
outstanding for 81 to 90 days. If an invoice for which it serves as
the collection agent has not paid within 90 days, an additional 3.5%
servicing fee is charged to the client. SCFI charges an up front
servicing fee of 1.5% in instances where it serves as the collection
agent.
LOANS, LEASES AND REAL ESTATE OWNED
To measure the quality of assets, or to determine the adequacy of the
reserve for possible loan and lease losses, the Company reviews the
performance of each loan and lease, the valuation of all collateral,
the payment history of the borrower, current economic conditions of
the geographical area in which the loan or lease was made and market
analysis of the type of collateral. This information is obtained
primarily through on-site inspections, market analysis, new
appraisals, financial performance of the borrower and purchase offers.
A specific allowance for credit losses is established for any non-
performing loans and leases where the underlying collateral value
(less costs of disposal) is below the recorded loan or lease
receivable. Upon repossession, real estate owned is recorded at the
lower of the cost or fair value less estimated selling costs and is
reviewed at least monthly thereafter until disposition of the
property.
At December 31, 1997 and 1996, the allowance for credit losses was
approximately $223,000 and $176,000, respectively, which in the
opinion of management was adequate.
Delinquent and problem loans and leases are a normal part of any
lending business. If a borrower fails to make a required payment when
due, the Company institutes collection procedures which include the
mailing of past due notices, follow-up phone calls and/or personal
contact. In most cases, delinquencies are cured promptly. If the
loan or lease remains delinquent, the Company initiates repossession,
foreclosure or other collection proceedings.
<PAGE>
Loans and leases are considered delinquent when a scheduled payment
becomes 30 days past due. The following table sets forth the
principal balances of delinquent loans and leases in the Company's
loan and lease portfolio at December 31, 1997 and 1996.
Principal % of Total
1997 Balance Amount
---------------- ---------- ----------
Commercial loans $1,354,029 3.7%
Leases $ 27,916 .8%
1996
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Commercial loans $1,270,503 4.8%
Of the total past due loans at December 31, 1997, $455,249 exceeded 90
days past due. There were no leases at December 31, 1997, which
exceeded 90 days past due. For additional information concerning
delinquencies and real estate owned see Notes 2 and 4 of Notes to the
Consolidated Financial Statements.
INVESTING ACTIVITIES
A covenant contained in the Company's credit agreement with Seafirst
Bank requires the Company to maintain $400,000 in liquid assets. To
comply with this requirement, the Company in the past invested in
short and intermediate term U.S. government securities and corporate
debt securities. In 1997 the Company liquidated its bond portfolio
and currently holds equity securities and money market funds to
satisfy this requirement. All excess cash is applied to reduce the
Company's credit line.
For additional information concerning investing activities, see Note 3
of Notes to the Consolidated Financial Statements.
SOURCES OF FUNDS
Funding for new loans is provided from repayments of principal and
interest on current loans and from a $30,000,000 line of credit from
Seafirst Bank, which expires on April 30, 1998. Borrowings under the
Company's credit agreement with Seafirst Bank bear interest at .375%
over the bank's prime rate (8.875% at December 31, 1997). The Company
at its option may purchase "LIBOR" (London Interbank Offered Rate)
contracts as a part of its line of credit. The Company's outstanding
debt at December 31, 1997 included $15,000,000 in "LIBOR" contracts in
the total $24,635,000 outstanding under the credit agreement. The
"LIBOR" contracts purchased by the Company bear interest at 2.75% over
the "LIBOR" rate on the date of purchase. The average rate on the
contracts held by the Company at December 31, 1997 was 8.57%. All
borrowings under the credit agreement are collateralized by loans
receivable. The credit agreement contains certain restrictive
covenants including maximum percentages of loan categories allocated
<PAGE>
to land loans, second mortgages and loan terms exceeding 24 months.
The credit agreement also contains covenants requiring the Company to
maintain a minimum level of cash and marketable securities of at least
$400,000 and tangible net worth plus subordinated debt of at least
$11,500,000. The credit line is annually renewable and the Company
expects the line will be renewed on its expiration date. See Notes 6
and 12 of Notes to the Consolidated Financial Statements.
The Company's funding for new leases is provided from repayments of
current leases and from a separate $4,000,000 line of credit from
Seafirst Bank. See Note 6 and 12 of Notes to the Consolidated
Financial Statements.
COMPETITION
The market for non-regulated financial services providers such as the
Company is highly competitive and fragmented. The markets for small
and medium-size commercial equipment leases, non-traditional accounts
receivable and real estate financing are extensive and growing
rapidly.
Competition in the markets in which the Company competes is intense
and includes many regional and national regulated financial
institutions with substantially greater resources than the Company.
The Company also competes against finance companies that provide low-
cost credit facilities to a proprietary customer base. Management
believes that the Company's primary competitors include: (i) Southern
Pacific Funding, Pacific Coast Investment and Olympic Coast
Investments, in real estate financing; (ii) ABCO Leasing, Summit
Leasing and Financial Pacific Leasing, in equipment leasing; and (iii)
Capco Financial and Access Financial in accounts receivable financing.
The Company believes it has positioned itself to compete against
providers of commercial business financing by reason of its high level
of service to customers, its experienced personnel and its ability to
provide turn-key financial solutions to small and mid-size business as
well as non-traditional commercial customers.
EMPLOYEES
At December 31, 1997, the Company employed seventeen people, none of
whom were represented by a collective bargaining unit. The Company
believes relations with its employees are good.
Item 2. Description of Properties
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The Company's headquarters are located in leased offices at 1825
N. Hutchinson Rd., Spokane, Washington 99212. The lease expires in
May 2001. For more information concerning this lease see Note 10 of
Notes to the Consolidated Financial Statements. The Company also
occupies leased office space located at 200 First Ave. West,
Suite 403, Seattle, Washington, and at 614 S. W. Eleventh Ave. Suite
D. Gallery Level, Portland, Oregon.
<PAGE>
Additionally, the Company has properties obtained through foreclosure,
which are held for sale in the normal course of business. See Note 4
of Notes to the Consolidated Financial Statements. See discussion of
real estate lending activities in Item 1, Description of Business
Commercial Lending Activities.
Item 3. Legal Proceedings.
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The Company is from time to time a party to various legal actions
occurring in the normal course of business. Management believes that
there are no threatened or pending proceedings against the Company
that, if determined adversely, would have a material effect on the
business or financial position, results of operations or cash flows of
the Company.
Item 4. Submission of Matters to a Vote of Security Holders.
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No matters were submitted to a vote of shareholders of the Company's
common stock during the fourth quarter of 1997.
PART II
Item 5. Market for Common Equity and Related Stockholder Matters.
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Since 1991, the Company's common stock has traded on the over-the-
counter market. In July 1996 the Company applied for and was accepted
for listing on the Nasdaq Small Cap Market tier of the Nasdaq Stock
Market. At the annual meeting of shareholders held on May 9, 1996, a
resolution was adopted to effect a one-for-five reverse split of the
Company's Class A common stock whereby one new share of Common stock
was issued in exchange for every five shares of Class A Common stock
formerly outstanding. Effective on May 31,1996 at 5:00 P.M. P.D.T.
the number of outstanding shares of common stock was reduced from
7,115,244 to 1,422,144. The new shares of Source Capital Corporation
are designated as "Source Capital Corporation Common Stock" having no
stated par value.
As of March 5, 1998, there were approximately 975 holders of record of
the Company's common stock. Market prices since July 1996 were
obtained from the Nasdaq monthly stock activity reports. Prices for
the first half of 1996 were obtained from Nasdaq's "Electronic
Bulletin Board". The prices reported in the over-the-counter market
reflect inter-dealer prices, without regard to retail markups,
markdowns or commissions, and do not necessarily represent actual
transactions. The high and low prices for 1996 have been restated to
reflect the one for five reverse split and are as follows:
<PAGE>
1997 Common
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Quarter Ended High Low
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March 31 $ 7.31 6.25
June 30 7.00 5.38
September 30 6.75 5.63
December 31 7.63 5.53
1996 Common
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Quarter Ended High Low
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March 31 $ 9.40 6.15
June 30 9.55 8.80
September 30 10.00 7.75
December 31 8.50 7.25
On March 5, 1998 the closing price was $8.50.
The Company's dividend history is as follows:
Date paid Amount per share
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April 19, 1996 $.15
February 28, 1997 .18
February 27, 1998 .18
Item 6. Management's Discussion and Analysis of Financial Condition
and Results of Operations.
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RESULTS OF OPERATIONS - 1997 COMPARED TO 1996
The Company reported net income of approximately $739,000 or $.54 per
diluted share for the year ended December 31, 1997 compared to net
income of approximately $847,000 or $.59 per diluted share for the
year ended December 31, 1996. The decrease of $108,000 in 1997 net
income compared to 1996 net income, is primarily due to the net gain
of approximately $376,000 (net of income tax) realized on the sale of
real estate (including a retail shopping center) in 1996, compared to
net gains on the sale of real estate in 1997 of approximately $49,000.
The lack of a comparable gain in 1997 was mitigated by a 71%
(approximately $1,264,000) increase in interest margin, (interest and
lease income less interest expense) over 1996. The increase in
interest margin was the result of an increase in interest and fees of
approximately $2,023,000 and leasing revenues of approximately
$188,000 for which there was no corresponding revenue in 1996. These
revenue gains were partially offset by an increase in interest
expenses of approximately $947,000 and a decrease in rent revenue of
approximately $558,000.
<PAGE>
The increase in interest and fee income was due to the Company's
ability to grow its average earning asset portfolio by approximately
$10.2 million, to $30.5 million in 1997. The primary growth in the
Company's earning assets took place in the last half of 1997, thereby
keeping the average lower than would be expected considering the
increase in the Company's assets from $30.1 million at the end of 1996
to $43 million at December 31, 1997. The increase in interest expense
correlates directly to the increase in the Company's loan and lease
portfolio as the Company was able to increase its leverage thereby
positioning itself for future growth in its commercial real estate
lending and leasing portfolios. The sale of the Company's shopping
center had a negative impact of approximately $190,000 on the
Company's net margin for 1997 as compared to 1996.
Non-interest operating expenses increased by approximately $416,000 in
1997 as compared to 1996. Salaries and benefits increased by
approximately $333,000 primarily due to a near doubling of the
Company's work force. At December 31, 1997 the Company employed two
personnel in its factoring operation which was started in the fourth
quarter of 1997, four personnel in its leasing operations and five
personnel in its real estate lending operations and four personnel in
administrative and support operations. Other operating expenses
increased by approximately $84,000 primarily due to an increase in
rent expense of approximately $37,000 related to the cost of occupying
additional office space, in Spokane and the opening of a Portland
office. Appraisal fees increase by approximately $35,000 as the
Company ordered several appraisals on real estate collateral related
to several of its larger loans. The purpose of the appraisals was to
confirm collateral value in these loans and to enable the Company to
borrow under the Company's line of line of credit, at a higher
percentage of the loan amount.
Net interest margin on earning assets decreased from 11.5% in 1996 to
9.6% in 1997. This decrease is primarily due to the increased amount
of borrowed funds as a percentage of the loan portfolio. The
Company's earning asset to equity ratio increased from 2.18 to 1 at
year end 1996 to 3.22 to 1 at December 31, 1997 which resulted in a
lower interest margin but higher net revenues due to an increase in
the Company's earning assets. Additionally the yield on the Company's
loan portfolio was lower in 1997 due to lower loan fees charged to
borrowers by reason of increased competition.
The income tax provision decreased from approximately $437,000 in 1996
to approximately $385,000 in 1997. Although the Company has
significant net operating loss carryforwards available to reduce
income taxes payable, the utilization of these net operating losses is
limited each year due to the change in ownership of the Company which
occurred in 1991. Although for financial statement purposes the
Company reported approximately $385,000 in income tax expense for 1997
(in accordance with FASB Statement 109 "Accounting for Income Taxes"),
<PAGE>
for income tax purposes, the actual tax liability for 1997 was
approximately $156,000. As discussed in Note 5 of Notes to the
Consolidated Financial Statements, the deferred tax assets result
primarily from net operating loss carryforwards.
FINANCIAL CONDITION AND LIQUIDITY
At December 31, 1997, the Company had approximately $474,000 of cash
and cash equivalents and $251,000 of marketable securities. The
Company's primary sources of cash during 1997 were approximately
$23,500,000 from short-term borrowings, $10,923,000 of principal
repayments on outstanding loans, $952,000 from operations, $782,000
collections on direct financing leases and $477,000 sale of marketable
securities. In 1997, the primary uses of cash were approximately
$21,144,000 of loan originations, $10,523,000 repayment of short-term
borrowings, $3,717,000 additions to direct financing leases, $433,000
purchase and redemption of capital stock, and $255,000 payment of
dividends.
The Company has a $30,000,000 revolving line of credit with Seafirst
Bank which expires on April 30, 1998. Additionally the Company has a
separate $4,000,000 line from Seafirst Bank to fund its leasing
operations. The commitments under this line also expire on April 30,
1998. The Company anticipates that the lines will be renewed for
another year at that time. Management believes that the lines of
credit, coupled with the cash and short-term investments held at
December 31, 1997, normal loan and lease repayments, the sale of part
or all of the real estate owned and the funds received from the sale
of $6,000,000 of Subordinated Convertible Debentures subsequent to
year end, (see Note 12 of Notes to the Consolidated Financial
Statements), will provide sufficient cash to fund operating needs
during 1998. However, the Company may seek additional funds dependent
on the direct lending and leasing demand and other projects the
Company may endeavor to undertake during the year.
EFFECTS OF INFLATION AND CHANGES IN INTEREST RATES.
Interest rates earned on the Company's loan portfolio are subject to
change as inflationary pressures, and other factors, affect prime
interest rates. At December 31, 1997, interest rates being charged on
approximately 94% of the Company's loan portfolio were based upon the
prime interest rate or other indexes. The remaining loans have fixed
interest rates. The Company's line of credit agreement provides for
variable interest based upon the prime rate or, at the Company's
option, a "LIBOR" based rate.
Management believes that any negative effects of an increase in the
prime interest rate would be largely offset by the Company's
relatively short-term loan portfolio, balloon payments and the large
percentage of variable rate loans.
<PAGE>
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (the "FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 131,
Disclosures about Segments for an Enterprise and Related Information
("SFAS No. 131"). This Statement will require public companies to
report selected information about segments in their annual financial
statements and requires public companies to report selected segment
information in their reports to shareholders. It also requires
entity-wide disclosures about the products and services an entity
provides, and its major customers. The Statement is effective for
fiscal years beginning after December 15, 1997. The Company has not
yet determined the effect, if any, of SFAS No. 131 on its consolidated
financial statements.
In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive
Income. This Statement requires that comprehensive income be reported
in a financial statement and displayed with the same prominence as
other financial statements. This Statement will require the Company to
report unrealized gains and losses on investment securities as
components of comprehensive income. Management has not yet determined
which format it will choose to display comprehensive income. This
Statement is effective for fiscal years beginning after December 15,
1997.
Item 7. Financial Statements.
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Information required by this Item is included in the Consolidated
Financial Statements filed as a part of this report.
Item 8. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure.
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None.
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of The Exchange Act.
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To be included in the proxy statement to be filed by the registrant
with the Securities and Exchange Commission prior to April 29, 1998,
pursuant to Regulation 14A adopted under the Seucirities Exchange Act
of 1934 and incorporated herein by reference.
Item 10. Executive Compensation.
---------------------------------
To be included in the proxy statement to be filed by the registrant
with the Securities and Exchange Commission prior to April 29, 1998,
pursuant to Regulation 14A adopted under the Seucirities Exchange Act
of 1934 and incorporated herein by reference.
<PAGE>
Item 11. Security Ownership of Certain Beneficial Owners and
Management.
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To be included in the proxy statement to be filed by the registrant
with the Securities and Exchange Commission prior to April 29, 1998,
pursuant to Regulation 14A adopted under the Seucirities Exchange Act
of 1934 and incorporated herein by reference.
Item 12. Certain Relationships and Related Transactions.
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To be included in the proxy statement to be filed by the registrant
with the Securities and Exchange Commission prior to April 29, 1998,
pursuant to Regulation 14A adopted under the Seucirities Exchange Act
of 1934 and incorporated herein by reference.
Item 13. Exhibits and Reports on Form 8-K.
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(a) Exhibits Exhibit No.
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Articles of Incorporation of Source Capital
Corporation, incorporated by reference to
Exhibit A to Form 8-K dated February 7, 1994. 3.1
Articles of Amendment to the restated Articles
of Incorporation of Source Capital Corporation,
incorporated by reverence to Exhibit C to
Form 8-K dated May 16, 1996. 3.2
Bylaws of Source Capital Corporation, incorpor-
ated by reference to Exhibit A to Form 8-K
dated February 7, 1994. 3.3
Executive Compensation Plans Arrangements and
Other Management Contracts:
Employment Contract of Alvin J. Wolff, Jr.
effective January 1, 1995, incorporated by
reference to Exhibit A to Form 8-K dated
January 4, 1995. 10.1
Employment Agreement with D. Michael Jones
dated January 18, 1996. Incorporated by
reference to Exhibit 10.2 filed with the
Company's 10KSB dated December 31, 1996. 10.2
Statement re: Computation of earnings per
share. The computation of earnings per
share can be determined from the Financial
Statements filed as a part of this report.
Exhibit 11 is therefore omitted. 11
Financial Data Schedule 27
Report on Form 8-K
No Reports on Form 8-K were filed during
the last quarter of 1997.
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SOURCE CAPITAL CORPORATION
(Registrant)
Date: March 20, 1998 By: /s/ D. Michael Jones
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D. Michael Jones, President
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
Date: March 20, 1998 By: /s/ D. Michael Jones
-------------- ---------------------------------------
D. Michael Jones, President
(Principal Executive Officer), Director
Date: March 20, 1998 By: /s/ Lester L. Clark
-------------- ---------------------------------------
Lester L. Clark, Vice President,
Treasurer and Secretary (Principal
Accounting and Financial Officer)
Date: March 20 1998 By: /s/ Alvin J. Wolff, Jr.
------------- ---------------------------------------
Alvin J. Wolff, Jr., Director,
Chairman of the Board
Date: March 20, 1998 By: /s/ Clarence H. Barnes
-------------- ---------------------------------------
Clarence H. Barnes, Director
Date: March 20, 1998 By: /s/ Robert E. Lee
-------------- ---------------------------------------
Robert E. Lee, Director
Date: March 20, 1998 By: /s/ Daniel R. Nelson
-------------- ---------------------------------------
Daniel R. Nelson, Director
Date: March 20, 1998 By: /s/ Charles G. Stocker
-------------- ---------------------------------------
Charles G. Stocker, Director
Date: March 20, 1998 By: /s/ John A. Frucci
-------------- ---------------------------------------
John A. Frucci, Director
Date: March 20, 1998 By: /s/ William H. Roberts
-------------- ---------------------------------------
William H. Roberts, Director
<PAGE>
SOURCE CAPITAL CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Accountants
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Changes in Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Stockholders
Source Capital Corporation
Spokane, Washington
We have audited the accompanying consolidated balance sheets of Source
Capital Corporation as of December 31, 1997 and 1996 and the related
consolidated statements of income, changes in stockholders' equity and
cash flows for the years then ended. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements
based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well
as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position
of Source Capital Corporation as of December 31, 1997 and 1996, and
the consolidated results of their operations and their cash flows for
the years then ended, in conformity with generally accepted accounting
principles.
/S/ COOPERS & LYBRAND L.L.P.
Spokane, Washington
January 30, 1998, except for Note 12 as of which
the date is February 11, 1998.
<PAGE>
SOURCE CAPITAL CORPORATION
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and 1996
1997 1996
----------- -----------
ASSETS
Loans receivable, net $36,551,013 $26,059,031
Leases receivable, net 2,917,145
Finance receivables, net 104,244
Accrued interest receivable 345,424 295,047
Cash and cash equivalents 473,551 21,506
Marketable securities 250,724 740,004
Real estate owned 556,342 916,196
Other assets 391,614 360,839
Deferred income taxes 1,456,239 1,685,535
----------- -----------
Total assets $43,046,296 $30,078,158
=========== ===========
LIABILITIES
Note payable to bank $26,990,096 $14,000,000
Long-term debt 3,187,539 3,214,824
Accounts payable and accrued expenses 512,792 550,638
----------- -----------
Total liabilities 30,690,427 17,765,462
----------- -----------
Commitments (Notes 2, 8 and 10)
STOCKHOLDERS' EQUITY
Preferred stock, no par value, 10,000,000
shares authorized, none outstanding
Common stock, no par value, authorized
10,000,000 shares; issued and out-
standing, 1,355,818 and 1,417,200 shares 7,038,802 7,462,827
Additional paid-in capital 2,049,047 2,049,047
Net unrealized loss on marketable
securities (27,143) (10,480)
Retained earnings 3,295,163 2,811,302
----------- -----------
Total stockholders' equity 12,355,869 12,312,696
----------- -----------
Total liabilities and stockholders'
equity $43,046,296 $30,078,158
=========== ===========
The accompanying notes are an integral part of the consolidated
financial statements.
<PAGE>
SOURCE CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
for the years ended December 31, 1997 and 1996
1997 1996
----------- -----------
Financing income:
Interest and fee income $ 4,866,935 $ 2,843,874
Lease financing income 188,158
Rental income, net 25,960 584,005
Interest expense (2,016,322) (1,069,372)
----------- -----------
Net financing income 3,064,731 2,358,507
Other income and provision for loan
losses:
Gains on investments and real estate
(net) 48,557 570,577
Provision for loan and lease losses (23,000) (95,000)
----------- -----------
Income before operating expense 3,090,288 2,834,084
----------- -----------
Operating expense:
Employee compensation and benefits 1,253,593 920,850
Other operating expenses 712,835 629,279
----------- -----------
Total non-interest expenses 1,966,428 1,550,129
----------- -----------
Income before income taxes 1,123,860 1,283,955
----------- -----------
Income tax provision:
Current (155,604) (397,235)
Deferred (229,296) (39,765)
----------- -----------
Total income tax provision (384,900) (437,000)
----------- -----------
Net income $ 738,960 $ 846,955
=========== ===========
Net income per common share - basic $ .54 $ .60
=========== ===========
Net income per common share - diluted $ .54 $ .59
=========== ===========
Weighted average number of basic common
shares outstanding 1,373,850 1,422,111
=========== ===========
Weighted average number of diluted
common shares outstanding 1,373,850 1,443,115
=========== ===========
Cash dividends per share $ .18 $ .15
=========== ===========
The accompanying notes are an integral part of the consolidated
financial statements.
<PAGE>
SOURCE CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
for the years ended December 31, 1997 and 1996
<TABLE>
<CAPTION>
Net
Unrealized
Common Stock Additional Losses on
----------------------- Paid-in Marketable Retained
Shares Amount Capital Securities Earnings
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Balances, December 31, 1995 *1,423,079 $7,459,528 $2,049,047 $ 12,396 $2,177,804
Cash dividend ($.15 per share) paid April 19,
1996 (213,457)
Redemption and cancellation of outstanding
common stock (934) (8,252)
Cancellation of unclaimed common stock and
capitalization of unclaimed distributions (4,925) 11,551
Net income 846,955
Net change in unrealized losses on marketable
securities (22,876)
---------- ---------- ---------- ---------- ----------
Balances, December 31, 1996 1,417,220 7,462,827 2,049,047 (10,480) 2,811,302
Cash dividend ($.18 per share) paid February 28,
1997 (255,099)
Stock options granted 8,800
Redemption and cancellation of outstanding
common stock (62,588) (432,825)
Exercise of common stock options, net of reduction 1,186
Net income 738,960
Net change in unrealized losses on marketable
securities (16,663)
---------- ---------- ---------- ---------- ----------
Balances, December 31, 1997 1,355,818 $7,038,802 $2,049,047 $ (27,143) $3,295,163
========== ========== ========== ========== ==========
</TABLE>
* Share amounts have been restated to reflect a 1 for 5 reverse stock
split completed on May 31, 1996.
The accompanying notes are an integral part of the consolidated
financial statements.
<PAGE>
SOURCE CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the years ended December 31, 1997 and 1996
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 738,960 $ 846,955
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 31,665 21,745
Provision for loan and lease losses 23,000 95,000
Impairment loss on real estate owned 120,000
Deferred income tax provision 229,296 39,765
(Gain) loss on sale of marketable securities (4,559) 15,860
Gain on sale of real estate owned (43,998) (700,841)
Gain on sale of office furniture and equipment (5,594)
Compensation expense associated with options
granted 8,800
Change in:
Accrued interest and other assets (781) (380,776)
Accounts payable and accrued expenses (30,291) 409,274
----------- -----------
Net cash provided by operating activities 952,092 461,388
----------- -----------
Cash flows from investing activities:
Purchases of marketable securities (299,877)
Proceeds from sale of marketable securities 477,176 94,122
Loan originations (21,143,542) (21,729,608)
Loan repayments 10,923,154 10,943,335
Additions to direct financing leases (3,717,495)
Collections on direct financing leases 782,350
Additions to financed receivables (162,496)
Collections on financed receivables 58,252
Capitalization of costs related to real estate owned (5,929) (139,719)
Proceeds from sale of real estate owned 139,198 1,247,651
Purchase of office furniture and equipment (118,786) (95,172)
Proceeds from sale of office furniture and equipment 739 52,897
----------- -----------
Net cash used in investing activities (12,767,379) (9,926,371)
----------- -----------
Cash flows from financing activities:
Proceeds from line of credit borrowings 23,513,527 18,170,500
Payments on line of credit borrowings (10,523,431) (12,070,500)
Proceeds from long-term debt 3,220,000
Payments of long-term debt (34,840) (5,176)
Payments for redemption of common stock (432,825) (8,252)
Cash dividends paid (255,099) (213,457)
----------- -----------
Net cash provided by financing activities 12,267,332 9,093,115
----------- -----------
Net change in cash and cash equivalents $ 452,045 $ (371,868)
Cash and cash equivalents, beginning of year 21,506 393,374
----------- -----------
Cash and cash equivalents, end of year $ 473,551 $ 21,506
=========== ===========
</TABLE>
<PAGE>
SOURCE CAPITAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
for the years ended December 31, 1997 and 1996
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Supplemental disclosure of cash flow information:
Interest paid $ 1,945,234 $1,035,456
Income taxes paid 494,825 199,309
Non-cash financing and investing transactions:
Financing of sales of real estate owned 377,194 3,800,000
Loans and interest converted to real estate owned
through repossession (106,611) (293,845)
Conversion of accounts payable to capital (11,551)
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
<PAGE>
SOURCE CAPITAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
ORGANIZATION
Source Capital Corporation was incorporated in Washington in
October 1969. The Company is engaged in lending activities,
primarily making direct loans to individuals and corporations.
Approximately 85% of the Company's loan portfolio is
collateralized by real estate located in the Pacific Northwest.
In April 1997, the Company began equipment leasing operations
through its wholly owned subsidiary, Source Capital Leasing
Company, and in November 1997 began an accounts receivable
factoring operation though its other wholly owned subsidiary,
Source Capital Finance Inc.
PRINCIPLES OF CONSOLIDATION
The accompanying financial statements include the accounts of the
Company and its wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in
consolidation.
LOANS RECEIVABLE
Loans receivable are reported at outstanding balance, including
principal and accrued interest, and adjusted for the allowance for
losses and any deferred fees or costs.
Loan origination fees, net of certain direct origination costs,
are deferred and amortized as an adjustment of yield over the term
of the related loan.
ALLOWANCE FOR LOSSES ON LOANS AND LEASES
The allowance for credit losses is based on a current evaluation
of the probable losses in the Company's loan and lease portfolios.
Provision for loss is recognized based on the estimated fair value
of the underlying collateral, net of selling costs.
LEASES RECEIVABLE
The Company accounts for its portfolio of leases receivable as
direct financing leases, and accordingly, records the minimum
lease payments, including any unguaranteed residual value.
The Company reports its net investment in direct financing leases
as an asset in its consolidated balance sheet. Unearned revenue
from finance income, after deducting initial direct costs, is
recognized as revenue over the term of the lease so as to produce
a constant periodic rate of return on the Company's investment in
the lease.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,
CONTINUED:
FINANCE RECEIVABLES
The Company records the finance receivables under factoring
arrangements at the full balance of the factored receivable. The
Company expects that these amounts will be repaid through
collection of the receivable rather than by direct repayment from
the customer.
Fees related to factoring activities are recognized in income over
the period during which services are provided.
CASH EQUIVALENTS
The Company considers cash equivalents to be short-term, highly
liquid investments with maturities of three months or less at the
date of purchase. The Company, on occasion, has cash in
institutions which may exceed federal depository insurance limits.
The Company places such deposits with high-credit quality
institutions and has not experienced any losses.
MARKETABLE SECURITIES
The Company invests in corporate and U.S. government bonds and
minimizes its investment in any one corporate bond or industry.
Investments in debt securities are classified as available-for-
sale securities for which unrealized gains and losses are
recognized as a component of stockholders' equity. Realized gains
or losses on the sale of securities are reflected in operations
based on specific identification.
REAL ESTATE OWNED
The Company records foreclosed assets as real estate owned which
is stated at the lower of (a) the fair value of the asset minus
the estimated selling costs, or (b) the cost of the asset. Costs
for the development and improvement of the real estate are
capitalized during the period in which the real estate property is
being readied for its intended use. Pending the sale of certain
repossessed properties, the Company incurs certain expenses
associated with the properties, which are recognized in
operations.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,
CONTINUED:
OFFICE FURNITURE AND EQUIPMENT
Office furniture and equipment are stated at cost. Depreciation
is computed using the straight-line method over the estimated
useful lives of the assets (5-10 years). Major renewals or
betterments are capitalized and repairs and maintenance are
expensed to operations as incurred. When furniture and equipment
is sold or retired, the cost and related accumulated depreciation
are removed from the respective accounts, and the resulting gains
or losses are reflected in operations.
INCOME RECOGNITION
Interest income from loans is recognized using the accrual method.
Accrual of income is suspended when a loan is contractually
delinquent for 90 days or more, unless the value of the underlying
collateral exceeds the sum of the loan and accrued interest
balances. The accrual is resumed when the loan becomes
contractually current, and past-due interest income is recognized
at that time, unless collection of the loan and interest is
doubtful.
Loan origination fees net of direct loan costs are deferred and
amortized to interest income, using the interest method, over the
contractual term of the loan.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the future
income tax consequences of transactions that have been recognized
in the Company's financial statements, using enacted tax rates in
effect in the years in which the temporary differences between the
carrying amount and the tax basis are expected to reverse (see
Note 5).
The Company files a consolidated income tax return with its
subsidiaries.
NET INCOME PER SHARE
Net income per share - basic is computed by dividing net income by
the weighted-average number of common shares outstanding during
the period. Net income per share diluted is computed by
dividing net income by the weighted-average number of common
shares outstanding increased by the additional common shares that
would have been outstanding if the dilutive potential common
shares had been issued.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,
CONTINUED:
NET INCOME PER SHARE, CONTINUED
The net income per share disclosures have been made in accordance
with SFAS No. 128, "Earnings per Share," which was applied by the
Company in 1997. In accordance with SFAS No. 128, all prior net
income per share data has been restated to conform to this
presentation. During the year ended December 31, 1997,
outstanding stock options were not included in the computation of
earnings per share because the effect was antidilutive. During the
year ended December 31, 1996, stock options outstanding resulted
in the addition of 21,004 weighted-average shares to the diluted
net income per share computation.
ESTIMATES
The preparation of financial statements in conformity with
generally accepted accounting principles, requires management to
make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (the
"FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 131, Disclosures about Segments for an Enterprise and
Related Information ("SFAS No. 131"). This Statement will require
public companies to report selected information about segments in
their annual financial statements and requires public companies to
report selected segment information in their reports to
shareholders. It also requires entity-wide disclosures about the
products and services an entity provides, and its major customers.
The Statement is effective for fiscal years beginning after
December 15, 1997. The Company has not yet determined the effect,
if any, of SFAS No. 131 on its consolidated financial statements.
In June 1997, the FASB issued SFAS No. 130, Reporting
Comprehensive Income. This Statement requires that comprehensive
income be reported in a financial statement and displayed with the
same prominence as other financial statements. This Statement
will require the Company to report unrealized gains and losses on
investment securities as components of comprehensive income.
Management has not yet determined which format it will choose to
display comprehensive income. This Statement is effective for
fiscal years beginning after December 15, 1997.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES,
CONTINUED:
RECLASSIFICATIONS
Certain 1996 balances have been reclassified to conform with the
1997 presentation with no effect on retained earnings or net
income as previously reported.
2. LOANS AND LEASES RECEIVABLE:
Loans receivable consist of short-term and long-term loans made to
individuals and corporations. Virtually all loans are
collateralized by real property. At December 31, 1997,
approximately 94% of the loans have interest rates that fluctuate
based upon changes in the prime interest rate. Loans receivable,
the weighted-average interest rate and effective yield (including
amortized loan fees) by type of loan at December 31, 1997 and 1996
consist of the following:
<TABLE>
<CAPTION>
Effective
Weighted- Yield
Average on Average
Contractual Loans
1997 Amount Interest Rate Outstanding
----------------------------- ----------- ------------- -----------
<S> <C> <C> <C>
Commercial real estate loans $ 36,553,916 12.58% 16.17%
Residential real estate loans 526,581 14.13 14.07
-----------
Gross loans receivable 37,080,497
Unearned discounts and fees (324,518)
Allowance for loan losses (204,966)
-----------
Loans receivable, net $ 36,551,013
===========
1996
-----------------------------
Commercial real estate loans $26,493,090 12.33% 17.10%
Residential real estate loans 169,646 10.36 14.83
-----------
Gross loans receivable 26,662,736
Unearned discounts and fees (427,659)
Allowance for loan losses (176,046)
-----------
Loans receivable, net $ 26,059,031
===========
</TABLE>
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
2. LOANS AND LEASES RECEIVABLE, CONTINUED:
Included in the 1997 totals above are two commercial loans
totaling approximately $455,000 which have been identified as non-
performing and are not accruing interest. Interest income of
$28,483 was recognized on these loans during the year ended
December 31, 1997. Had these loans performed in accordance with
their original terms, interest income of $61,856 would have been
recognized. There were five commercial real estate loans totaling
approximately $856,000, which were non-performing at December 31,
1996. Interest income of $48,113 was recognized on these loans
during the year ended December 31, 1996. Had these loans
performed in accordance with their original terms, interest income
of $63,982 would have been recognized. The average recorded
investment in impaired loans during the years ended December 31,
1997 and 1996 was $555,000 and $521,500, respectively.
The following table sets forth the final scheduled maturity dates
of the principal balances of loans in the portfolio at
December 31, 1997:
Loans Maturing in
Year Ending
December 31, Commercial Residential Total
----------------- ----------- ----------- -----------
1998 $25,900,981 $ 9,653 $25,910,634
1999 4,628,198 4,628,198
2000 1,441,594 4,139 1,445,733
2001 4,246 4,246
2002 384,055 19,691 403,746
Thereafter 4,199,088 488,852 4,687,940
----------- ----------- -----------
$36,553,916 $ 526,581 $37,080,497
=========== =========== ===========
The preceding table includes the total principal amount
outstanding in the year of loan maturity. However, most loans
require periodic payments (generally monthly) of principal and or
interest. The Company applies collection and foreclosure
procedures to delinquent and non-performing loans which may
significantly affect the actual loan payment schedule. This
schedule does not purport to present actual anticipated principal
payments on loans receivable.
The Company has outstanding loans to eleven borrowers exceeding
$1,000,000 individually, which aggregate approximately
$17,550,000 at December 31, 1997. Included in the aforementioned
total is a loan of approximately $3,800,000 which the Company
originated on the sale of its shopping center (see note 4). The
Company believes that the value of the real estate that
collateralizes these loans is sufficient to reduce the Company's
credit risk on these loans to a reasonable level. Actual results
could vary from estimates in the near term.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
2. LOANS AND LEASES RECEIVABLE, CONTINUED:
At December 31, 1997, the Company has outstanding loan
commitments aggregating approximately $1,800,000.
Following are the components of the Company's investment in
leases receivable at December 31, 1997:
Minimum lease payments receivable $ 3,671,404
Contingent rentals for interim rent receivable 13,498
Unguaranteed residual value 224,640
-----------
Gross leases receivable 3,909,542
Less unearned finance income (974,397)
Less allowance for uncollectible leases (18,000)
-----------
Net investment in leases receivable $ 2,917,145
===========
Future minimum lease payments receivable at December 31, 1997 are
as follows:
Year Ending
December 31,
------------
1998 $ 999,446
1999 992,907
2000 919,437
2001 508,075
2002 251,539
-----------
$ 3,671,404
===========
The following is a summary of the changes in the allowance for
loan and lease losses for the years ended December 31, 1997 and
1996:
1997 1996
----------- -----------
Beginning balance $ 176,076 $ 87,167
Recoveries 23,920
Provision 23,000 95,000
Write offs (6,121)
----------- -----------
Ending balance $ 222,996 $ 176,076
=========== ===========
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
3. MARKETABLE SECURITIES:
The amortized cost and estimated market values of available-for-
sale debt and equity securities at December 31, 1997 and 1996 are
as follows:
<TABLE>
<CAPTION>
Carrying/
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
1997:
Equity securities $ 277,867 $ 8,347 $ 35,490 $ 250,724
========= ========== ========== =========
1996:
Corporate debt securities $ 550,484 $ 26,718 $ 37,198 $ 540,004
Equity securities 200,000 200,000
--------- ---------- ---------- ---------
$ 750,484 $ 26,718 $ 37,198 $ 740,004
========= ========== ========== =========
</TABLE>
4. REAL ESTATE OWNED:
Real estate owned consists primarily of real estate obtained upon
loan foreclosures and development property as follows:
1997 1996
-------- --------
Undeveloped real estate $556,342 $511,212
Other 404,984
-------- --------
$556,342 $916,916
======== ========
In 1996, the Company recognized approximately $568,000 in net
rental income from a retail shopping center, which was acquired
through foreclosure in 1995. The income was partially offset by
interest carrying cost of approximately $280,000. In October
1996, the Company placed permanent financing on the shopping
center in the amount of $3,220,000. See Note 7.
In December 1996, the Company sold the shopping center for
approximately $4,800,000 (less selling costs) and financed a
contract in the amount of $3,800,000. This sale, combined with
other sales of real estate and a write down to market of the
remaining other real estate, resulted in a net gain on real
estate in 1996 of approximately $571,000.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
5. INCOME TAXES:
The income tax provision in the statements of income represents
34.0% of pre-tax income for the years ended December 31, 1997 and
1996, which approximates the federal statutory rate.
The tax effect of the temporary differences and carryforwards
giving rise to the Company's deferred tax assets at December 31,
1997 and 1996 is as follows:
1997 1996
---------- ----------
Net operating loss carryforwards $1,075,479 $1,227,853
Deferred compensation 319,215 285,900
Allowances for loan and lease losses 120,361 103,241
Other (58,816) 68,541
---------- ----------
$1,456,239 $1,685,535
========== ==========
Net operating loss carryforwards that will expire before
utilization have been excluded from the deferred tax asset. No
valuation allowance has been established for any of the Company's
deferred tax assets as it is more likely than not that these
assets will be realized. Realization is dependent on the
generation of sufficient taxable income in future years. The
amount of deferred tax asset considered realizable may be reduced
in the near term if estimates of future taxable income during the
carryforward period are reduced.
At December 31, 1997, the Company has regular and alternative
minimum tax net operating loss carryforwards available to offset
future taxable income. These carryforwards expire as follows:
Year Ending Alternative
December 31, Regular Minimum
------------ ---------- -----------
2001 $ 16,000
2002 499,000
2003 2,045,000 $ 446,000
2004 612,000 612,000
2006 26,000 26,000
---------- -----------
$3,198,000 $ 1,084,000
========== ===========
Due to the Company's change in ownership and its election to
limit the annual utilization of net operating losses rather than
reduce available net operating losses, the amount of net
operating losses that can be utilized in any given year to reduce
future taxable income are limited to approximately $448,000.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
6. LINE-OF-CREDIT AGREEMENT:
The Company has a $30,000,000 revolving line-of-credit agreement
with Seafirst Bank which expires on April 30, 1998. Borrowings
under the line-of-credit agreement bear interest at .375% over
the bank's prime rate (8.875% at December 31, 1997). At
December 31, 1997, there was $24,635,000 outstanding under the
line-of-credit agreement. All borrowings under the line-of-
credit agreement are collateralized by loans receivable. The
agreement requires the Company to maintain minimum levels of cash
or marketable securities and a tangible net worth plus
subordinated debt (see note 12) of at least $11,500,000. The
Company was in compliance with all terms and covenants of the
line of credit agreement at December 31, 1997. The line is
annually renewable and the Company expects the line will be
renewed on its expiration date.
Additionally, the Company's wholly owned subsidiary, Source
Capital Leasing Co. has a separate $4,000,000 line of credit with
Seafirst Bank. Each advance under this line is evidenced by a
separate note, and shall be no greater than 100% of equipment
cost less security deposits and advance payments. Advances under
the line of credit bear interest at a London Interbank Offered
Rate (LIBOR) based rate, which approximates prime less .50%.
Maturities shall not exceed 60 months and are matched to the
specific lease to which it applies. At December 31, 1997,
$2,355,096 was outstanding under the line-of-credit agreement.
The commitment under this line expires May 1, 1998 and is
renewable annually. The Company expects the line will be renewed
at that time.
7. LONG-TERM DEBT:
On October 16, 1996, the Company placed a mortgage on its
shopping center in California in the amount of $3,220,000. The
mortgage is amortized over 24 years with the entire balance due
in 10 years. The interest rate is 3.75% added to the six months
LIBOR and is subject to change each three-month period throughout
the term of the loan. Additionally there is a prepayment penalty
of 1% during the first 36 months of the loan. On December 20,
1996, the Company sold the shopping center and took back a
wrapped mortgage in the amount of $3,800,000. The Company
remains liable on the first mortgage.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
7. LONG-TERM DEBT, CONTINUED:
Aggregate amounts of principal due on this long-term debt are as
follows:
Year Ending
December 31,
------------
1998 $ 36,350
1999 40,009
2000 44,036
2001 48,468
2002 53,347
Thereafter 2,965,329
----------
$3,187,539
==========
8. CAPITAL STOCK:
The Company is authorized to issue 10,000,000 shares of Preferred
Stock having no par value, and 10,000,000 (post reverse split)
shares of Common Stock having no par value. In May 1996, the
Company's shareholders approved the five for one reverse stock
split of its Common Stock. All share amounts included herein
reflect this reverse stock split.
PREFERRED STOCK
The Preferred Stock may be issued upon resolution adopted by the
board of directors providing for the issuance and establishing
the terms of each preferred stock share. Terms established by
the board are to include voting rights, dividend rates,
conversion rights and any other rights granted to Preferred
stockholders. At December 31, 1997 and 1996, no Preferred Stock
is outstanding.
COMMON STOCK OPTIONS
The Company has three stock option plans (the Plans) for non-
employee directors, key employees and non-director, non-officer
employees. The Plans allow for the granting of options to
purchase up to 264,000 shares of Common Stock for terms up to ten
years. Non-employee directors receive an annual grant of options
to purchase 1,000 shares of the Company's Common Stock (as
adjusted) at fair market value not to exceed $10.00 per share.
Non-employee directors will be granted an additional 1,000
options if the Company's pre-tax income for the fiscal year
exceeds 110% of the immediate prior fiscal year's pre-tax income,
and an additional 1,000 options if the pre-tax income for the
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
8. CAPITAL STOCK, CONTINUED:
COMMON STOCK OPTIONS, CONTINUED
fiscal year exceeds 115% of the immediate prior fiscal year's
pre-tax income. The exercise price for the additional incentive
stock options shall be 85% of fair market value of the Common
Stock as defined in the Plan. The maximum annual grant to an
eligible participant in any one fiscal year of the Company shall
not exceed 3,000 shares. Key employee and non-director, non-
officer employee options are administered by the compensation
committee of the board of directors and options are granted at
their sole discretion.
In 1996 the Company adopted Statement of Financial Accounting
Standards No. 123, "Accounting for Stock Based Compensation"
(SFAS 123). As permitted by SFAS 123, the Company has chosen to
apply APB Opinion No. 25, "Accounting for Stock Issued to
Employees" (APB 25) and related Interpretations in accounting for
its Plans. Had compensation cost for the Company's Plans been
determined based on the fair value at the grant dates for awards
under the Plans consistent with SFAS 123, the Company's net
income and net income per share as reported would have been
reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1997 1996
-------------------- --------------------
As Pro As Pro
Reported Forma Reported Forma
-------- --------- -------- ---------
<S> <C> <C> <C> <C>
Net income $738,960 $682,516 $846,955 $755,116
======== ======== ======== ========
Net income per share - basic $ 0.54 $ 0.50 $ 0.60 $ 0.53
======== ======== ======== ========
Net income per share - diluted $ 0.54 $ 0.50 $ 0.59 $ 0.52
======== ======== ======== ========
</TABLE>
The fair value of each option grant is estimated on the date of
grant using an option-pricing model with the following weighted-
average assumptions used for grants in 1997 and 1996,
respectively: dividend yield of 0% in each year, as there has
been no regular dividend payment history, expected volatility of
27% and 60%; risk-free interest rates of 6.69% to 6.89% and 5.81%
to 5.91%; and expected lives of 7.03 and 5.02 years.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
8. CAPITAL STOCK, CONTINUED:
COMMON STOCK OPTIONS, CONTINUED
A summary of the status of the Company's Plans as of December 31,
1997 and 1996 and changes during the years ended on those dates
is presented below:
1997 1996
----------------- -----------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
------- -------- ------- --------
Outstanding at begin-
ning of year 116,900 $6.72 62,400 $6.39
Granted 25,000 5.73 64,500 7.09
Expired (4,000) 5.33
Canceled (6,000) 4.85
Exercised (3,000) 4.38
------- ----- ------- -----
Outstanding at end of
year 138,900 $6.54 116,900 $6.72
======= ===== ======= =====
Options exercisable at
end of year 111,180 $6.73 101,810 $6.66
======= ===== ======= =====
Weighted-average fair
value of options
granted during the
year $6.08 $4.50
===== =====
During 1997, option holders exercised 3,000 options through a
noncash transaction which resulted in 1,186 common shares being
issued.
The following table summarizes information about the Plan's stock
options at December 31, 1997:
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
8. CAPITAL STOCK, CONTINUED:
COMMON STOCK OPTIONS, CONTINUED
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------------------- ------------------------------------
Number Weighted-Average Number
Range of Outstanding at Remaining Weighted-Average Exercisable at Weighted-Average
Exercise Prices December 31, 1997 Contractual Life Exercise Price December 31, 1997 Exercise Price
--------------- ----------------- ---------------- ---------------- ----------------- ----------------
<S> <C> <C> <C> <C> <C>
$4.00-$4.99 24,400 7.0 years $4.60 21,580 $4.62
$5.00-$5.99 25,000 7.0 5.18 10,000 5.00
$6.00-$6.99 20,000 6.1 6.51 20,000 6.51
$7.00-$7.99 29,500 9.0 7.25 22,000 7.25
$8.00-$8.99 38,000 5.6 8.19 35,600 8.15
$9.00-$9.99 2,000 6.4 9.40 2,000 9.40
------- -------
138,900 111,180
======= =======
</TABLE>
The Company recognized $8,800 of compensation expense in 1997
under the Plans.
9. BENEFIT PLANS:
The Company has a non-qualified retirement plan for its Chairman
of the Board and former President (the Chairman) under which (at
his annual election), all or a portion of his salary and bonuses
are placed into an off-balance sheet trust fund. The assets in
the trust fund are subject to the claims of the general creditors
of the Company. Excluding this claim, the assets of the trust
fund are restricted solely for the distribution to the Chairman
upon his retirement, termination or death. From the date of the
plan, the Chairman has elected to defer all salary and bonus.
From its inception in January 1992, $938,868 of salary and
bonuses has been placed into the trust.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
9. BENEFIT PLANS, CONTINUED:
During 1993, the Company implemented a 401(k) defined
contribution plan. All employees are eligible to participate in
the Plan. Employees may contribute from 1% to 15% of their
compensation to the Plan. The Company may at its discretion,
make contributions to the Plan in accordance with applicable
rules. The Company's contribution in 1997 and 1996 was $29,572
and $21,576, respectively.
10. OPERATING LEASE:
The Company leases office space in a building owned by a
partnership in which the partners are adult children of the
Chairman of the Board of the Company. The lease requires minimum
monthly payments through May 6, 2001 of $8,213 which is subject
to adjustment on March 1, 1998 based on the increase in the
consumer price index over the prior year. The Company leases the
entire first floor of the building. The Company may, at its
option, sublease any unoccupied portion of its space. The
Company additionally assumed an existing lease on its Seattle
office.
Future minimum lease payments under these non-cancelable lease
agreements are as follows:
Year Ending
December 31,
------------
1998 $ 128,508
1999 128,508
2000 128,508
2001 59,865
----------
$ 445,389
==========
Total rent expense for the years ended December 31, 1997 and 1996
was approximately $113,000 and $76,000, respectively.
11. FAIR VALUE OF FINANCIAL INSTRUMENTS:
The following methods and assumptions were used to estimate the
value of each class of financial instrument for which it is
practicable to estimate that value. Potential income tax
ramifications related to the realization of unrealized gains and
losses that would be incurred in an actual sale and/or settlement
have not been taken into consideration.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
11. FAIR VALUE OF FINANCIAL INSTRUMENTS, CONTINUED:
CASH AND CASH EQUIVALENTS - Carrying value approximates fair
value.
MARKETABLE SECURITIES - Fair value is determined by quoted
market prices.
LOANS RECEIVABLE - Fair values are determined using the
discounted value of future cash flows at a rate currently
offered for loans of similar characteristics.
LEASES RECEIVABLE - Fair values are determined using the
discounted value of future cash flows at a rate currently
offered for leases of similar characteristics.
NOTE PAYABLE TO BANK AND LONG-TERM DEBT - Fair value
approximates the carrying value because the notes bear current
interest rates.
The estimated fair values of the following financial
instruments as of December 31, 1997 and 1996 are as follows:
<TABLE>
<CAPTION>
1997 1996
------------------------ ------------------------
Carrying Fair Carrying Fair
Value Value Value Value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash
equivalents $ 473,551 $ 473,551 $ 21,506 $ 21,506
Marketable securities 250,724 250,724 740,004 740,004
Loans receivable
(face):
Commercial 36,553,916 37,484,613 26,493,090 27,888,306
Real estate 526,581 659,119 169,646 189,930
Leases receivable 3,909,542 3,973,398
Financial liabilities:
Note payable to bank 26,990,096 26,990,096 14,000,000 14,000,000
Long-term debt 3,187,539 3,187,539 3,214,824 3,214,824
</TABLE>
LIMITATIONS - The fair value estimates are made at a discrete
point in time based on relevant market information and
information about the financial instruments. Because no market
exists for a portion of these financial instruments, fair value
estimates are based on judgments regarding current economic
conditions and other factors. These estimates are subjective
in nature and involve uncertainties and matters of significant
judgment and, therefore, cannot be determined with precision.
Changes in assumptions could significantly affect the
estimates.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
11. FAIR VALUE OF FINANCIAL INSTRUMENTS, CONTINUED:
Accordingly, the estimates presented herein are not necessarily
indicative of what the Company could realize in a current market
exchange.
12. SUBORDINATED DEBENTURES:
On February 11, 1998, the Company sold $6,000,000 of Subordinated
Convertible Debentures. The debentures carry an interest rate of
7.50%, mature on March 1, 2008 and are convertible into common
stock at the rate of $8.01 per share. These debentures were sold
through a private placement to institutional investors. The
Company intends to file a registration statement prior to
July 31, 1998 to register the shares of common stock into which
the debentures may be converted. The debentures are convertible
at any time after the earlier of September 30, 1998, or the date
the registration statement becomes effective, until maturity.
Interest on the debentures is payable semiannually in arrears
each March 1 and September 1, commencing September 1, 1998. The
debentures are redeemable, in whole or in part, at any time on or
after March 1, 2001, at the option of the Company. The
debentures are unsecured general obligations of the Company
subordinate in right of payment to all existing and future Senior
indebtedness of the Company. Senior indebtedness includes, but
is not limited to, all current bank lines-of-credit and any
future increases to these lines as well as any new borrowings
from financial institutions.
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1997
<PERIOD-END> DEC-31-1996 DEC-31-1997
<CASH> 21506 473551
<SECURITIES> 740004 250724
<RECEIVABLES> 26059031 39572402
<ALLOWANCES> 176046 222966
<INVENTORY> 0 0
<CURRENT-ASSETS> 0 0
<PP&E> 0 0
<DEPRECIATION> 0 0
<TOTAL-ASSETS> 30078158 43046296
<CURRENT-LIABILITIES> 0 0
<BONDS> 0 0
0 0
0 0
<COMMON> 7462827 7038802
<OTHER-SE> 2049047 2049047
<TOTAL-LIABILITY-AND-EQUITY> 30078158 43046296
<SALES> 342879 5081053
<TOTAL-REVENUES> 0 0
<CGS> 0 0
<TOTAL-COSTS> 0 0
<OTHER-EXPENSES> 1550129 1966428
<LOSS-PROVISION> 95000 41000
<INTEREST-EXPENSE> 1069372 2016322
<INCOME-PRETAX> 1283955 1123860
<INCOME-TAX> 437000 384900
<INCOME-CONTINUING> 846955 738960
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 846955 738960
<EPS-PRIMARY> .60<F1> .54
<EPS-DILUTED> .59<F1> .54
<FN>
<F1>Reflects the adoption in fourth quarter 1997 of FAS 128, a new standard
of computing and presenting both basic and diluted net income per share.
</FN>
</TABLE>
