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, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 For the transition period
from _____ to_____
Commission file number 0-12199
SOURCE CAPITAL CORPORATION
(Name of small business issuer in its charter)
Washington 91-0853890
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1825 N. Hutchinson Road
Spokane, Washington 99212
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code 509 928-0908
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
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. [ X ]
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The issuer's revenues for its most recent fiscal year: $7,096,441.
The aggregate market value of the voting common equity held by non-affiliates
as of February 26, 1999: $7,487,812.
The number of shares outstanding of each of the issuer's classes of common
equity, as of February 26, 1999: 1,360,279.
DOCUMENTS INCORPORATED BY REFERENCE.
Portions of the registrant's Proxy Statement to be filed with the Securities and
Exchange Commission prior to April 29, 1999 pursuant to Regulation 14A of the
Securities Exchange Act of 1934 in connection with the 1999 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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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
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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.
COMMERCIAL LENDING ACTIVITIES
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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, however the Company does take
second mortgage positions on some real estate.
Loans originated during 1998 and 1997, together with their terms and range of
interest rates are as follows:
1998 1997
----- ----
Loan Amount $26,339,941 $21,683,232
Term 1-5 years 1-10 years
Interest rate 11.625 - 15.00% 11.00 - 15.00%
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 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 in specific
industries and geographic areas. The Company typically requires significant
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collateral for its commercial and real estate loans. The average loan to value
percentages of the Company's portfolio at December 31, 1998, 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 "Consolidated Financial Statements") for
the years ended December 31, 1998 and 1997.
LEASING ACTIVITIES
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Source Capital Leasing Co. ("SCLC"), a Washington corporation and a wholly owned
subsidiary of the Company, was formed in March 1997. SCLC is an independent
lessor providing direct finance leases in the small to middle markets, primarily
in eleven of the most western states. SCLC provides financing of lease
transactions generally from $10,000 to $150,000, with terms ranging from 24
months to 60 months.
Leases originated in 1998 and 1997, together with their terms and range of
interest rates are as follows:
1998 1997
---- ----
Lease amount $15,225,491 $3,717,495
Term 24 - 60 months 24 - 60 months
Interest rate 9.79 -29.12% 11.89 -20.45%
SCLC's average lease investment for contracts in its portfolio at December 31,
1998 was approximately $33,000, with the largest lease written during the year
approximating $170,000. At December 31, 1998 SCLC maintained leases of business
equipment in agricultural/forest products, computer/data processing,
construction/heavy equipment, health care, manufacturing, office
equipment/furniture, restaurant equipment, retail/service equipment,
signage/marketing, and transportation industries. SCLC maintains a diversified
portfolio in order to minimize its credit exposure to any single industry or
individual lessee. As of December 31, 1998, no single industry accounted for
more than 13% of SCLC's portfolio and no single lessee accounted for more than
1% of its portfolio.
Lease contracts that meet the Company's credit requirements, but do not meet
management's minimum yield requirements are sold in the secondary market.
Certain of these lease contracts are participated or sold on a non-recourse
basis through lease brokers. SCLC originates the majority of leases retained in
its portfolio through lease broker referrals. Leases are approved on a contract
by contract basis. Leases from $10,000 to $150,000 require the approval of the
Chief Credit Officer of SCLC. Leases exceeding $150,000 up to $250,000 also
require the approval of the President of the parent Company. The Company's
lender, must approve leases exceeding $150,000 pursuant to the terms of the
Company's credit facility agreement with the Bank. 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 3 of Notes to the
Consolidated Financial Statements.
LOANS, LEASES AND REAL ESTATE OWNED
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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 and equipment is recorded at the lower of cost or fair value less
estimated selling costs and is reviewed at least monthly thereafter until
disposition of the property.
At December 31, 1998 and 1997, the allowance for credit losses was approximately
$421,000 and $223,000, respectively, which in the opinion of management was
adequate.
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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.
Loans and leases are considered delinquent when a scheduled payment becomes 31
days past due. The following table sets forth the principal balances of
delinquent loans and leases in the Company's loan and lease portfolios at
December 31, 1998 and 1997.
Principal % of Total
1998 Balance Amount
---- ------- ------
Commercial loans $ 4,467,896 10.9%
Leases $ 668,829 3.9%
1997
----
Commercial loans $ 1,354,029 3.7%
Leases $ 27,916 .8%
Of the total past due loans at December 31, 1998, $1,786,809 exceeded 90 days
past due. Delinquent leases which exceeded 90 days past due at December 31,
1998, were $215,584. For additional information concerning delinquencies and
real estate owned see Notes 2, 3 and 5 of Notes to the Consolidated Financial
Statements.
SOURCES OF FUNDS
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Funding for new loans is provided from repayments of principal and interest on
current loans and from a $35,000,000 line of credit which expires on April 30,
1999. Borrowings under the Company's credit agreement bear interest at .25% over
the bank's prime rate (8% at December 31, 1998). 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, 1998 included
$18,000,000 in "LIBOR" contracts in the total $24,635,000 outstanding under the
credit agreement. The "LIBOR" contracts purchased by the Company bear interest
at 2.625% over the "LIBOR" rate on the date of purchase. The average rate on the
contracts held by the Company at December 31, 1998 was 8.05%. 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 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
$17,000,000. The credit line is annually renewable and the Company expects the
line will be renewed on its expiration date. See Note 7 of Notes to the
Consolidated Financial Statements.
At December 31, 1998 the Company was indebted on $6,000,000 of Convertible
Subordinated Debentures. The debentures carry an interest rate of 7.5%, mature
on March 1, 2008 and are convertible into common stock at the rate of $8.01 per
share. The debentures are convertible at any time until maturity. 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 repayment 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.
See Note 9 of Notes to the Consolidated Financial Statements.
Funding for new lease contracts is provided from repayments of current leases
and from a separate $17,000,000 line of credit. Borrowings under the line of
credit bear interest based upon the Bank's composite cost of funds, and vary by
terms of the contract financed. Rates at December 31, 1998 ranged from 6.98% to
8.1%. See Note 7 of Notes to the Consolidated Financial Statements.
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COMPETITION
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The market for non-regulated financial services providers such as the Company is
highly competitive and fragmented. The markets for small ticket commercial
equipment leases, 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)
Pacific Coast Investment, Olympic Coast Investments, Kennedy Funding,
Metropolitan Mortgage and Coast Business Credit in real estate financing; and
(ii) Financial Pacific leasing, SDI Capital, Summit Leasing and Westmark
Financial in equipment leasing.
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
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At December 31, 1998, the Company employed twenty-three 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.
- -----------------------------------
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 12 of Notes to the Consolidated
Financial Statements. The Company also occupies leased office space located at
200 First Ave. West, Suite 403, Seattle, Washington, 614 S. W. Eleventh Ave.
Suite D. Gallery Level, Portland, Oregon and 8655 East Via De Ventura G-221
Scottsdale, Arizona.
Additionally, the Company has properties obtained through foreclosure, which are
held for sale in the normal course of business. See Note 5 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.
- --------------------------
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.
- -------------------------------------------------------------
No matters were submitted to a vote of shareholders of the Company's common
stock during the fourth quarter of 1998.
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PART II
Item 5. Market for Common Equity and Related Stockholder Matters.
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The Company's common stock is traded on the NASDAQ Small Cap Market tier of the
Nasdaq Stock Market. As of February 26, 1999, there were approximately 870
holders of record of the Company's common stock. Market prices for the Company's
common stock were obtained from the Nasdaq stock activity reports and reflect
actual closing prices. The high and low prices for 1998 and 1997 are as follows:
1998 Common
---- ------
Quarter Ended High Low
------------- ---- ---
March 31 $9.75 $6.50
June 30 8.63 7.13
September 30 8.56 5.88
December 31 6.25 5.00
1997 Common
---- ------
Quarter Ended High Low
------------- ---- ---
March 31 $7.31 $6.25
June 30 7.00 5.38
September 30 6.75 5.63
December 31 7.63 5.53
On February 26, 1999 the closing price was $6.50.
The Company's dividend history is as follows:
Date paid Amount per share
--------- ----------------
April 19, 1996 $.15
February 28, 1997 .18
February 27, 1998 .18
February 26, 1999 .18
Item 6. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations.
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Results of Operations - 1998 Compared to 1997
- ---------------------------------------------
The Company reported net income of approximately $745,000 or $.50 per diluted
share for the year ended December 31, 1998 compared to net income of
approximately $739,000 or $.54 per diluted share for the year ended December 31,
1997. The Company's interest margin increased from approximately $3,039,000 in
1997 to approximately $3,836,000 for the year ended December 31, 1998. The
increase in interest margin was the result of an increase in interest and fees
of approximately $651,000 and an increase in leasing revenues of approximately
$1,293,000 over 1997. These revenue gains were partially offset by an increase
in interest expenses of approximately $1,147,000.
The increase in interest and lease revenue was due to the Company's ability to
grow its average earning asset portfolio by approximately $13.6 million, to $45
million in 1998. The growth in the Company's earning assets was primarily the
result of growth in the Company's lease portfolio, which grew from approximately
$2.9 million at December 31, 1997 to approximately $14 million at December 31,
1998. The primary growth in the Company's commercial real estate portfolio took
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place in the fourth quarter of 1998, thereby keeping the average lower than
would be expected considering the increase in the Company's assets from $43
million at the end of 1997 to $58.6 million at December 31, 1998. 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 provision for loan and lease losses increased by approximately $265,000 over
1997 primarily due to management's decision to increase the reserve for probable
lease losses to approximate 1.5% of the Company's net investment in leases at
December 31, 1998. The decision to increase the reserve was based on charged off
leases net of recoveries of approximately $81,000 in the fourth quarter of 1998
and an increase in past due leases more in line with industry averages as the
Company's lease portfolio matures.
Non-interest operating expenses increased by approximately $577,000 in 1998 as
compared to 1997. Salaries and benefits increased by approximately $261,000
primarily due to a 38% increase in the Company's work force. At December 31,
1998 the Company employed eleven personnel in its leasing operations, six
personnel in its real estate lending operations and six personnel in
administrative and support operations. Other operating expenses increased by
approximately $316,000 primarily due to an increase in general and
administrative expense of approximately $236,000, of which $149,000 related to
the Company's leasing operations, and an increase in occupancy expense of
approximately $80,000 related to the cost of occupying additional office space
in Spokane, increased rent in Seattle, and the opening of an additional office
in Phoenix, Arizona.
Net interest margin on earning assets decreased from 9.6% in 1997 to 8.5% in
1998. 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 3.22 to 1 at year end 1997 to 4.25 to 1 at December 31,
1998 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 decreased from 16.1% in 1997 to 15% in 1998 due to
lower interest rates charged to borrowers by reason of increased competition and
a general decrease in interest rates during 1998.
The income tax provision decreased from approximately $385,000 in 1997 to
approximately $384,000 in 1998. 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 $384,000 in income tax
expense for 1998 (in accordance with FASB Statement 109 "Accounting for Income
Taxes"), for income tax purposes, the actual current tax liability for 1998 was
approximately $297,000. As discussed in Note 6 of Notes to the Consolidated
Financial Statements, the deferred tax asset results primarily from net
operating loss carryforwards.
Financial Condition and Liquidity
- ---------------------------------
At December 31, 1998, the Company had approximately $750,000 of cash and cash
equivalents and $220,000 of marketable securities. The Company's primary sources
of cash during 1998 were approximately $39,500,000 from short-term borrowings,
$22,076,000 of principal repayments on outstanding loans, $6,000,000 from the
sale of subordinated convertible debentures, $3,799,000 from collections on
direct financing leases, $1,252,000 from operations, and $559,000 from the sale
of real estate and equipment. In 1998, the primary uses of cash were
approximately $31,257,000 repayment of short term borrowings, $26,047,000 of
loan originations, $15,225,000 additions to direct financing leases, $244,000
payment of dividends.
The Company has a $35,000,000 revolving line of credit, to fund its real estate
lending operations, which expires on April 30, 1999. Additionally the Company
has a separate $17,000,000 line of credit to fund its leasing operations. The
commitments under this line also expire on April 30, 1999. 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, 1998, normal loan and lease
repayments and the sale of part or all of the real estate owned will provide
sufficient cash to fund operating needs during 1999. 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.
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Effects of Inflation and Changes in Interest Rates.
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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, 1998, interest rates being charged on approximately 98% 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.
Rates earned on the Company's lease portfolio are fixed for the term of the
lease, however, the Company match funds its portfolio by borrowing under its
lease line of credit as soon as is practicable after funding the lease. At the
time of borrowing, the rate the Company pays its lender is fixed for the term of
the lease.
Year 2000 Issues and Status.
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As the end of the millennium approaches, the Company is addressing the impact of
the year 2000 (Y2K) on its information technology (IT) and non (IT) functions.
Currently, the Company's IT-related electronic infrastructure consists of
primary and backup domain controller servers utilizing the Windows NT operating
system, and independent workstations utilizing the Windows 95 operating system.
All leasing portfolio management, servicing and general ledger information is
maintained on this system. Additionally, the Company contracts with an external
third party service provider for all commercial loan sub-ledger and general
ledger systems.
In completing its assessment of Y2K compliance, the Company reviewed and
identified all of the major system components believed to be susceptible to Y2K
issues. These included all software components of its in-house network as well
as its commercial lending service provider. The Company has obtained written
confirmation from all software vendors and software service providers of Y2K
compliance. The Company also reviewed other components of its in-house system
and is currently working with a third party network administrator to identify
and resolve other non-major Y2K issues.
The Company estimates that its Y2K compliance effort is approximately 90%
complete as of the end of January 1999, and anticipates being 100% complete by
the end of June 1999. Remaining testing will be performed on the non-major
components of its in-house network workstations. The Company estimates total Y2K
compliance costs will not exceed $10,000. The majority of these costs relate to
the review and repair, if necessary, of major and non-major software components.
The Company expects to incur most of these costs during 1999.
The Company's exposure to a non-compliant system is considered minimal. System
software vendors utilized by the Company are nationally known and reputable
service providers that offer these and similar services to many subscribers. The
Company does not believe it is reasonable to assume a collapse of the entire or
a significant portion of its computer system as a result of a Y2K issue. Should
the entire system or major component fail as a result of a Y2K issue, the
Company maintains adequate historical records that would enable reconstruction
and maintenance of loan and lease information manually until the system is
corrected.
The Company will complete its assessment of non-IT related systems for Y2K
compliance by the end of the third quarter 1999. Major non-IT related systems
utilized by the Company include the telephone systems and building security
system. If the Company determines that any non-IT related systems are not Y2K
compliant, it will be necessary to adjust estimates of the cost of Y2K
compliance.
New Accounting Pronouncements
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In February 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No.132 ("SFAS No. 132"), Employers' Disclosures
about Pensions and Other Postretirement Benefits, which standardizes the
disclosure requirements for pension and other postretirement benefits. The
adoption of SFAS No. 132 is not expected to materially impact the Company's
current disclosures.
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In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 ("SFAS No. 133"), Accounting for
Derivative Instruments and Hedging Activities. SFAS No. 133 requires companies
to recognize all derivative contracts as either assets or liabilities in the
balance sheet and to measure them at fair value. If certain conditions are met,
a derivative may be specifically designated as a hedge, the objective of which
is to match the timing of gain or loss recognition on the hedging derivative
with the recognition of (i) the changes in the fair value of the hedged asset or
liability that are attributable to the hedged risk or (ii) the earnings effect
of the hedged forecasted transaction. For a derivative not designated as a
hedging instrument, the gain or loss is recognized as income in the period of
change. SFAS No. 133 is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. Based on its current and planned future
activities relative to derivative instruments, the Company believes that the
adoption of SFAS No. 133 on January 1, 2000 will not have a significant effect
on its financial statements.
In October 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 134, ("SFAS No. 134") Accounting for
Mortgage-Backed Securities Retained After the Securitization of Mortgage Loans
Held for Sale by a Mortgage Banking Enterprise, which effectively changes the
way mortgage banking firms account for certain securities and other interests
they retain after securitizing mortgage loans that were held for sale. The
adoption of SFAS No. 134 is not expected to have a material impact on the
Company's financial position.
In February, 1999 the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 135 (SFAS 135"), Rescission of Financial
Accounting Standards Board No. 75 ("SFAS 75") and Technical Corrections. SFAS
135 rescinds SFAS 75 and amends Statement of Financial Accounting Standards
Board No. 35. SFAS s135 also amends other existing authoritative literature to
make various technical corrections, clarify meanings, or describe applicability
under changed conditions. SFAS 135 is effective for financial statements issued
for fiscal years ending after February 15, 1999. The Company believes that the
adoption of SFAS 135 will not have a significant effect on its financial
statements
Item 7. Financial Statements.
- ------------------------------
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.
- --------------------
None.
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PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
- ----------------------------------------------------------------------
Compliance with Section 16(a) of The Exchange Act.
- --------------------------------------------------
To be included in the proxy statement to be filed by the registrant with the
Securities and Exchange Commission prior to April 28, 1999 pursuant to
Regulation 14A adopted under the Securities 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 28, 1999 pursuant to
Regulation 14A adopted under the Securities Exchange Act of 1934 and
incorporated herein by reference.
Item 11. Security Ownership of Certain Beneficial Owners and Management.
- -------------------------------------------------------------------------
To be included in the proxy statement to be filed by the registrant with the
Securities and Exchange Commission prior to April 28, 1999 pursuant to
Regulation 14A adopted under the Securities Exchange Act of 1934 and
incorporated herein by reference.
Item 12. Certain Relationships and Related Transactions.
- --------------------------------------------------------
To be included in the proxy statement to be filed by the registrant with the
Securities and Exchange Commission prior to April 28, 1999 pursuant to
Regulation 14A adopted under the Securities Exchange Act of 1934 and
incorporated herein by reference.
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Item 13. Exhibits and Reports on Form 8-K.
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<TABLE>
<CAPTION>
<S> <C> <C> <C>
(a) Exhibits Exhibit No.
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 reference to Exhibit C to Form 8-K
dated May 16, 1996. 3.2
Bylaws of Source Capital Corporation, incorporated by
reference to Exhibit A to Form 8-K dated February 7,
1994. 3.3
Indenture dated February 11, 1998 between Registrant
and Banker Trust Company, incorporated by reference to
Exhibit 4.1 to Registrant's Current Report on Form 8K
dated February 11, 1998. 4.1
Form of 7-1/2% Convertible Subordinated Debenture Due
March 1, 2008 issued by the Registrant to each Selling
Shareholder, incorporated by reference to Exhibit A to
Exhibit 4.1 filed with the Registrant's Current Report
on Form 8-K dated February 11, 1998. 4.2
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 10.1 reference to
Exhibit 10.2 filed with the Company's 10KSB Dated
December 31, 1996. 10.2
Other Material Contracts:
Registration Rights Agreement between the Registrant
and Pacific Crest Securities, Inc., incorporated by
reference to Exhibit 10.3 filed with the Registrant's
Current Report on Form 8-K dated February 11, 1998. 10.3
Subsidiaries of the Registrant 21
Financial Data Schedule 27
Reports on Form 8-K
No Reports on Form 8-K were filed during the last
quarter of 1998.
</TABLE>
10
<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.
<TABLE>
<CAPTION>
<S> <C>
SOURCE CAPITAL CORPORATION
--------------------------
(Registrant)
Date: March 22, 1999 By: /s/ D. Michael Jones
-------------------------- --------------------
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 22, 1999 By: /s/ D. Michael Jones
------------------------- --------------------
D. Michael Jones
President (Principal Executive Officer)
Director
Date: March 22, 1999 By: /s/ Lester L. Clark
------------------------- -------------------
Lester L. Clark
Vice President, Treasurer and Secretary
(Principal Accounting and Financial Officer)
Date: March 22, 1999 By: /s/ Alvin J. Wolff, Jr.
------------------------- -----------------------
Alvin J. Wolff, Jr.
Director, Chairman of the Board
Date: March 22, 1999 By: /s/ Clarence H. Barnes
------------------------- ----------------------
Clarence H. Barnes
Director
Date: March 22, 1999 By: /s/ Robert E. Lee
------------------------- -----------------
Robert E. Lee
Director
Date: March 22, 1999 By: /s/ Daniel R. Nelson
------------------------- --------------------
Daniel R. Nelson
Director
Date: March 22, 1999 By: /s/ Charles G. Stocker
------------------------- ----------------------
Charles G. Stocker
Director
Date: March 22, 1999 By: /s/ John A. Frucci
------------------------- ------------------
John A. Frucci
Director
</TABLE>
11
<PAGE>
Source Capital Corporation and Subsidiaries
Index to Consolidated Financial Statements
Page
----
Report of Independent Certified Public Accountants 13
Consolidated Balance Sheets 14
Consolidated Statements of Income and comprehensive income 15
Consolidated Statements of Changes in Stockholders' Equity 16
Consolidated Statements of Cash Flows 17
Notes to Consolidated Financial Statements 19
12
<PAGE>
Report of Independent Certified Public Accountants
The Board of Directors and Stockholders
Source Capital Corporation and Subsidiaries
Spokane, Washington
We have audited the accompanying consolidated balance sheets of Source Capital
Corporation and Subsidiaries as of December 31, 1998 and 1997 and the related
consolidated statements of income and comprehensive 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 audits 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 and Subsidiaries as of December 31, 1998 and 1997, and the
consolidated results of their operations and their cash flows for the years then
ended, in conformity with generally accepted accounting principles.
/s/ BDO Seidman, LLP
Spokane, Washington
January 26, 1999
13
<PAGE>
<TABLE>
<CAPTION>
Source Capital Corporation and Subsidiaries
Consolidated Balance Sheets
December 31, 1998 and 1997
1998 1997
---- ----
<S> <C> <C>
ASSETS
Loans receivable, net $ 40,411,783 $ 36,655,257
Leases receivable, net 14,006,137 2,917,145
Accrued interest receivable 463,986 345,424
Cash and cash equivalents 750,218 473,551
Marketable securities 219,502 250,724
Real estate and equipment owned 393,013 556,342
Other assets 853,942 391,614
Deferred income taxes 1,467,660 1,456,239
------------ ------------
Total assets $ 58,566,241 $ 43,046,296
============ ============
LIABILITIES
Note payable to bank $ 35,243,164 $ 26,990,096
Long-term debt 3,147,579 3,187,539
Accounts payable and accrued expenses 651,904 413,000
Customer deposits 687,802 99,792
Convertible subordinated debentures 6,000,000 --
------------ ------------
Total liabilities 45,730,449 30,690,427
------------ ------------
Commitments (Notes 2, 8,9,10 and 12)
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 outstanding, 1,350,279 and 1,355,818 shares 7,006,849 7,038,802
Additional paid-in capital 2,049,047 2,049,047
Accumulated other comprehensive loss (15,869) (27,143)
Retained earnings 3,795,765 3,295,163
------------ ------------
Total stockholders' equity 12,835,792 12,355,869
------------ ------------
Total liabilities and stockholders' equity $ 58,566,241 $ 43,046,296
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
14
<PAGE>
<TABLE>
<CAPTION>
Source Capital Corporation and Subsidiaries
Consolidated Statements of Income and Comprehensive Income
for the years ended December 31, 1998 and 1997
1998 1997
---- ----
<S> <C> <C>
Financing income:
Interest and fee income $ 5,516,650 $ 4,865,492
Lease financing income 1,482,206 189,601
Interest expense (3,162,855) (2,016,322)
----------- -----------
Net financing income 3,836,001 3,038,771
Other income and provision for loan losses:
Gains on investments and real estate (net) 97,585 48,557
Provision for loan and lease losses (287,486) (23,000)
----------- -----------
Income before operating expense 3,646,100 3,064,328
----------- -----------
Operating expense:
Employee compensation and benefits 1,514,266 1,253,593
Other operating expenses 1,003,085 686,875
----------- -----------
Total non-interest expenses 2,517,351 1,940,468
----------- -----------
Income before income taxes 1,128,749 1,123,860
----------- -----------
Income tax provision:
Current (395,521) (155,604)
Deferred 11,421 (229,296)
----------- -----------
Total income tax provision (384,100) (384,900)
----------- -----------
Net income $ 744,649 $ 738,960
=========== ===========
Net income per common share - basic $ .55 $ .54
=========== ===========
Net income per common share - diluted $ .50 $ .54
=========== ===========
Weighted average number of basic common shares outstanding 1,354,397 1,373,850
=========== ===========
Weighted average number of diluted common shares outstanding 2,058,487 1,373,850
=========== ===========
Cash dividends per share $ .18 $ .18
=========== ===========
Net income $ 744,649 $ 738,960
Other comprehensive income, net of tax:
Unrealized gain (loss) on marketable securities
net of $3,833 and ($5,665) income tax (benefit) 7,441 (10,998)
----------- -----------
Comprehensive income $ 752,090 $ 727,962
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
15
<PAGE>
<TABLE>
<CAPTION>
Source Capital Corporation and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity
for the years ended December 31, 1998 and 1997
Accumulated
Additional Other
Common Stock Paid-in Comprehensive Retained
Shares Amount Capital Loss Earnings
------ ------ ------- ---- --------
<S> <C> <C> <C> <C> <C>
Balances, December 31, 1996 1,417,220 $ 7,462,827 $ 2,049,047 $ (10,480) $ 2,811,302
Cash dividend ($.18 per share) paid February 28, 1997 -- -- -- -- (255,099)
Stock options granted -- 8,800 -- -- --
Redemption and cancellation of outstanding common stock (62,588) (432,825) -- -- --
Exercise of common stock options, net of reduction 1,186 -- -- -- --
Net income -- -- -- -- 738,960
Net change in unrealized losses on marketable securities -- -- -- (16,663) --
----------- ----------- ----------- ----------- -----------
Balances, December 31, 1997 1,355,818 7,038,802 2,049,047 (27,143) 3,295,163
Cash dividend ($.18 per share) paid February 27, 1998 -- -- -- -- (244,047)
Redemption and cancellation of outstanding common stock (5,539) (31,953) -- -- --
Net income -- -- -- -- 744,649
Net change in unrealized losses on marketable securities -- -- -- 11,274 --
----------- ----------- ----------- ----------- -----------
Balances, December 31, 1998 1,350,279 $ 7,006,849 $ 2,049,047 $ (15,869) $ 3,795,765
=========== =========== =========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
16
<PAGE>
<TABLE>
<CAPTION>
Source Capital Corporation and Subsidiaries
Consolidated Statements of Cash Flows
for the years ended December 31, 1998 and 1997
1998 1997
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 744,649 $ 738,960
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 50,059 31,665
Provision for loan and lease losses 287,486 23,000
Impairment loss on real estate owned 14,500 --
Deferred income tax (benefit) provision (11,421) 229,296
Gain on sale of marketable securities (55,204) (4,559)
Gain on sale of real estate owned (56,881) (43,998)
Compensation expense associated with options granted -- 8,800
Change in:
Accrued interest and other assets (547,636) (781)
Accounts payable and accrued expenses 238,904 (30,291)
Customer deposits 588,010 --
------------ ------------
Net cash provided by operating activities 1,252,466 952,092
------------ ------------
Cash flows from investing activities:
Proceeds from sale of marketable securities 97,700 477,176
Loan originations (26,046,948) (21,306,038)
Loan repayments 22,075,724 10,981,406
Additions to direct financing leases (15,225,491) (3,717,495)
Collections on direct financing leases 3,798,862 782,350
Capitalization of costs related to real estate owned (70,566) (5,929)
Proceeds from sale of real estate and equipment owned 559,094 139,198
Purchase of office furniture and equipment (101,282) (118,786)
Proceeds from sale of office furniture and equipment -- 739
------------ ------------
Net cash used in investing activities (14,912,907) (12,767,379)
------------ ------------
Cash flows from financing activities:
Proceeds from line of credit borrowings 39,510,238 23,513,527
Payments on line of credit borrowings (31,257,170) (10,523,431)
Proceeds from sale of subordinated convertible debentures 6,000,000 --
Payments of long-term debt (39,960) (34,840)
Payments for redemption of common stock (31,953) (432,825)
Cash dividends paid (244,047) (255,099)
------------ ------------
Net cash provided by financing activities 13,937,108 12,267,332
------------ ------------
</TABLE>
17
<PAGE>
<TABLE>
<CAPTION>
Source Capital Corporation and Subsidiaries
Consolidated Statements of Cash Flows, Continued
for the years ended December 31, 1998 and 1997
1998 1997
---- ----
<S> <C> <C>
Net increase in cash and cash equivalents $ 276,667 $ 452,045
Cash and cash equivalents, beginning of year 473,551 21,506
-------------- --------------
Cash and cash equivalents, end of year $ 750,218 $ 473,551
============== ==============
Supplemental disclosure of cash flow information:
Interest paid $ 3,024,127 $ 1,945,234
Income taxes paid 241,088 494,825
Non-cash financing and investing transactions:
Financing of sales of real estate owned 292,993 377,194
Deferred interest on financing of real estate sold 56,442 -
Loans and interest converted to real estate owned
through repossession 458,218 106,611
Leases converted to repossessed assets 61,150 -
</TABLE>
See accompanying notes to consolidated financial statements.
18
<PAGE>
Source Capital Corporation and Subsidiaries
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. In the fourth quarter of 1998 the Company redeployed the
personnel in its factoring operations to the Company's leasing operations
to facilitate the more rapid growth in its leasing operations.
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. Accordingly, the minimum lease payments, including any
residual values are included in the gross lease receivable. The
difference between the gross lease receivable and the carrying value of
the equipment is recorded as unearned income
The Company reports its net investment in direct financing leases as an
asset in its consolidated balance sheet. Unearned income and initial
direct costs are amortized to income over the term of the lease so as to
produce a constant periodic rate of return on the Company's investment in
the leases.
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.
19
<PAGE>
1. Organization and Summary of Significant Accounting Policies, Continued:
Marketable Securities
The Company invests in limited amounts of equity securities and minimizes
its investment in any one company or industry. Investments in equity
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.
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 6).
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.
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. During the year ended December 31, 1998 stock options outstanding
resulted in the addition of 17,448 weighted average shares to the diluted
net income per share
20
<PAGE>
1. Organization and Summary of Significant Accounting Policies, Continued:
computation. 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.
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 February 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No.132 ("SFAS No. 132"),
Employers' Disclosures about Pensions and Other Postretirement Benefits,
which standardizes the disclosure requirements for pension and other
postretirement benefits. The adoption of SFAS No. 132 is not expected to
materially impact the Company's current disclosures.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133 ("SFAS No. 133"), Accounting
for Derivative Instruments and Hedging Activities. SFAS No. 133 requires
companies to recognize all derivative contracts as either assets or
liabilities in the balance sheet and to measure them at fair value. If
certain conditions are met, a derivative may be specifically designated
as a hedge, the objective of which is to match the timing of gain or loss
recognition on the hedging derivative with the recognition of (I) the
changes in the fair value of the hedged asset or liability that are
attributable to the hedged risk or (ii) the earnings effect of the hedged
forecasted transaction. For a derivative not designated as a hedging
instrument, the gain or loss is recognized as income in the period of
change. SFAS No. 133 is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. Based on its current and planned future
activities relative to derivative instruments, the Company believes that
the adoption of SFAS No. 133 on January 1, 2000 will not have a
significant effect on its financial statements.
In October 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 134, ("SFAS No. 134"),
Accounting for Mortgage-Backed Securities Retained After the
Securitization of Mortgage Loans Held for Sale by a Mortgage Banking
Enterprise, which effectively changes the way mortgage banking firms
account for certain securities and other interests they retain after
securitizing mortgage loans that were held for sale. The adoption of SFAS
No. 134 is not expected to have a material impact on the Company's
financial position.
In February, 1999 the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 135 (SFAS 135"),
Rescission of Financial Accounting Standards Board No. 75 ("SFAS 75") and
Technical Corrections. SFAS 135 rescinds SFAS 75 and amends Statement of
Financial Accounting Standards Board No. 35. SFAS 135 also amends other
existing authoritative literature to make various technical corrections,
clarify meanings, or describe applicability under changed conditions.
SFAS 135 is effective for financial statements issued for fiscal years
ending after February 15, 1999. The Company believes that the adoption of
SFAS 135 will not have a significant effect on its financial statements
Reclassifications
Certain 1997 balances have been reclassified to conform with the 1998
presentation with no effect on retained earnings or net income as
previously reported.
21
<PAGE>
2. Loans 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, 1998, approximately 98% 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,
1998 and 1997 consist of the following:
<TABLE>
<CAPTION>
Weighted-
Average Effective Yield
Contractual on Average Loans
1998 Amount Interest Rate Outstanding
---- -------------- -------------------- ------------------
<S> <C> <C> <C>
Commercial real estate loans $ 41,117,069 11.88% 15.08%
Unearned discounts and fees (497,294)
Allowance for loan losses (207,992)
--------------
Loans receivable, net $ 40,411,783
==============
1997
----
Commercial real estate loans $37,184,741 12.63% 16.30%
Unearned discounts and fees (324,518)
Allowance for loan losses (204,966)
--------------
Loans receivable, net $ 36,655,257
==============
</TABLE>
Included in the 1998 totals above are four commercial loans totaling
approximately $493,000 which have been identified as non-performing and
are not accruing interest. Interest income of $25,997 was recognized on
these loans during the year ended December 31, 1998. Had these loans
performed in accordance with their original terms, interest income of
$63,204 would have been recognized. There were two commercial real estate
loans totaling approximately $455,000, which were non-performing at
December 31, 1997. 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. The average recorded investment in impaired loans
during the years ended December 31, 1998 and 1997 was $1,053,746 and
$555,000, respectively.
The following table sets forth the final scheduled maturity dates of the
principal balances of loans in the portfolio at December 31, 1998:
Loans Maturing in
Year Ending
December 31, Commercial
-------------------- --------------
1999 $ 31,674,119
2000 4,585,314
2001 -
2002 397,236
2003 427,701
Thereafter 4,032,699
--------------
$ 41,117,069
==============
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 ten borrowers exceeding $1,000,000
individually, which aggregate
22
<PAGE>
2. Loans Receivable, Continued:
approximately $15,401,000 at December 31, 1998. Included in the
aforementioned total is a loan of approximately $3,700,000 which the
Company originated on the sale of a shopping center (see note 8). 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.
At December 31, 1998, the Company has outstanding loan commitments
aggregating approximately $8,809,000. Subsequent to year end the Company
sold approximately $3,212,000 of the commitments to a participant bank.
The following is a summary of the changes in the allowance for loan
losses for the years ended December 31, 1998 and 1997:
1998 1997
---- ----
Beginning balance $204,966 $176,046
Recoveries 7,026 23,920
Provision 11,000 5,000
Write offs (15,000) -
--------- --------
Ending balance $207,992 $204,966
========= ========
3. Leases Receivable:
Leases receivable consist of small ticket lease contracts with an average
contract size of approximately $33,000. All leases are collateralized by
the underlying equipment, additional collateral or personal guarantee by
the lessee or surety. Leases are originated with varying terms from 24 to
60 months and are priced at the market rate for similar contracts. All
leases are accounted for as direct financing capital leases and are
reported net of unearned income.
Following are the components of the Company's investment in leases
receivable at December 31,
1998 1997
---- ----
Minimum lease payments receivable $ 17,408,810 $ 3,671,404
Contingent rentals for interim rent receivable 203,796 13,498
Initial direct costs 45,604 --
Guaranteed residual value 866,017 224,640
------------ ------------
Gross leases receivable 18,524,227 3,909,542
Less unearned finance income (4,304,790) (974,397)
Less allowance for uncollectible leases (213,300) (18,000)
------------ ------------
Net investment in leases receivable $ 14,006,137 $ 2,917,145
============ ============
The following table sets forth the expected future minimum lease payments
to be received as of December 31, 1998.
Year Ending
December 31,
------------
1999 $ 5,420,497
2000 4,827,635
2001 3,773,603
2002 2,420,019
2003 967,056
--------------
$ 17,408,810
==============
23
<PAGE>
3. Leases, Receivable continued:
The following is a summary of the changes in the allowance for lease
losses for the years ended December 31, 1998 and 1997:
1998 1997
---- ----
Beginning balance $ 18,000 $ -
Recoveries 8,814 -
Provision 276,486 18,000
Write offs (90,000) -
--------- -------------
Ending balance $ 213,300 $ 18,000
========= =============
4. Marketable Securities:
The amortized cost and estimated market values of available-for-sale
equity securities at December 31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
Carrying/
Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
---- ----- ------ -----
<S> <C> <C> <C> <C>
1998:
Equity securities $ 235,371 $ 20,299 $ 36,168 $ 219,502
=========== =========== =========== ==========
1997:
Equity securities $ 277,867 $ 8,347 $ 35,490 $ 250,724
============ ============ ============ ===========
</TABLE>
5. Real Estate and Equipment Owned:
Real estate and equipment owned consists primarily of real estate and
equipment obtained upon loan and lease foreclosures as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Undeveloped real estate $ 374,492 $ 556,342
Equipment held for resale 18,521 -
------------ ------------
$ 393,013 $ 556,342
============ ============
</TABLE>
6. Income Taxes:
The income tax provision in the statements of income represents 34.0% of
pre-tax income for the years ended December 31, 1998 and 1997, 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, 1998 and 1997 is as
follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Net operating loss carryforwards $ 935,106 $ 1,075,479
Deferred compensation 319,215 319,215
Allowances for loan and lease losses 142,900 120,361
Other 70,439 (58,816)
------------ ------------
$ 1,467,660 $ 1,456,239
============ ============
</TABLE>
24
<PAGE>
6. Income Taxes, continued:
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, 1998, 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
------------ ------------ ------------
2002 $ 67,000 $ -
2003 2,045,000 -
2004 612,000 610,000
2006 26,000 26,000
------------ ------------
$ 2,750,000 $ 636,000
============ ============
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.
7. Line-of-Credit Agreement:
The Company has a $35,000,000 revolving line-of-credit agreement with a
commercial bank which expires on April 30, 1999. Borrowings under the
line-of-credit agreement bear interest at .25% over the bank's prime rate
(8% at December 31, 1998). 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, 1998 included
$18,000,000 in "LIBOR" contracts in the total $24,635,000 outstanding
under the line of credit agreement. The "LIBOR" contracts purchased by
the Company bear interest at 2.625% over the "LIBOR" rate on the date of
purchase. The average rate on the contracts held by the Company at
December 31, 1998, was 8.05%. 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
of $400,000 and a tangible net worth plus subordinated debt (see note 9)
of at least $17,000,000. The Company was in compliance with all terms and
covenants of the line of credit agreement at December 31, 1998. 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 $17,000,000 line of credit. 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 the Bank's composite
cost of funds, and vary by maturity. Rates at December 31, 1998 ranged
from 6.98% to 8.10%. Maturities shall not exceed 60 months and are
matched to the specific lease to which it applies. At December 31, 1998,
$10,608,164 was outstanding under the line-of-credit agreement. The
commitment under this line expires April 30, 1999 and is renewable
annually. The Company expects the line will be renewed at that time.
8. Long-Term Debt:
On October 16, 1996, the Company placed a mortgage on a shopping center
acquired through foreclosure 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.
25
<PAGE>
8. Long-Term Debt, continued:
Aggregate amounts of principal due on this long-term debt are as follows:
Year Ending
December 31,
------------
1999 $ 45,421
2000 46,734
2001 51,181
2002 56,052
2003 61,386
Thereafter 2,886,805
------------
$ 3,147,579
============
9. Convertible Subordinated Debentures:
On February 11, 1998, the Company sold $6,000,000 of Convertible
Subordinated 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 filed a registration
statement in July, 1998 to register the shares of common stock into which
the debentures may be converted. The registration statement became
effective on September 22, 1998. The debentures are convertible at any
time until maturity. Interest on the debentures is payable semiannually
in arrears each March 1 and September 1. 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.
10. Capital Stock:
The Company is authorized to issue 10,000,000 shares of Preferred Stock
having no par value, and 10,000,000 shares of Common Stock having no
par value.
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, 1998 and 1997, 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 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,
26
<PAGE>
10. Capital Stock, continued:
"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>
1998 1997
------------------------ ------------------------
As Pro As Pro
Reported Forma Reported Forma
-------- ----- -------- -----
<S> <C> <C> <C> <C>
Net income $ 744,649 $ 577,449 $ 738,960 $ 682,516
=========== =========== ========== ===========
Net income per share - basic $ 0.55 $ 0.43 $ 0.54 $ 0.50
=========== =========== ========== ===========
Net income per share - diluted $ 0.50 $ 0.42 $ 0.54 $ 0.50
=========== =========== ========== ===========
</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 1998 and 1997, respectively: dividend
yield of 0% in each year, as there has been no regular dividend payment
history, expected volatility of 30% and 27%; risk-free interest rate of
5.50% and 6.69% to 6.89%; and expected lives of 7.07 and 7.03 years.
A summary of the status of the Company's Plans as of December 31, 1998
and 1997 and changes during the years ended on those dates is presented
below:
<TABLE>
<CAPTION>
1998 1997
---------------------- ---------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
------ ----- ------ -----
<S> <C> <C> <C> <C>
Outstanding at beginning of year 138,900 $ 6.59 116,900 $6.72
Granted 72,000 6.54 25,000 5.73
Expired - - - -
Canceled (7,500) 6.54 - -
Exercised - - (3,000) 4.38
-------- -------- ---------- -------
Outstanding at end of year 203,400 $ 6.58 138,900 $6.59
======== ======== ========== =======
Options exercisable at end of year 163,350 $ 6.63 111,810 $6.73
======== ======== ========== =======
Weighted-average fair value of options granted
during the year $6.54 $6.08
===== =====
</TABLE>
The following table summarizes information about the Plan's stock options
at December 31, 1998:
<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, 1998 Contractual Life Exercise Price December 31, 1998 Exercise Price
--------------- ----------------- ----------------- ---------------- ----------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
$4.00-$4.99 24,400 6.0 years $4.60 24,400 $4.60
$5.00-$5.99 25,000 6.0 5.18 16,000 5.11
$6.00-$6.99 84,500 8.2 6.53 57,650 6.53
$7.00-$7.99 29,500 8.0 7.25 26,200 7.25
$8.00-$8.99 38,000 4.6 8.19 37,100 8.18
$9.00-$9.99 2,000 5.4 9.40 2,000 9.40
-------- ---------
203,400 163,350
======== =========
</TABLE>
27
<PAGE>
11. Benefit Plans:
The Company has a non-qualified retirement plan for its Chairman of the
Board 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 until January
1, 1998, the Chairman 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.
The Company provides a 401(k) defined contribution plan for its
employees. 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 1998
and 1997 was $50,019 and $29,572, respectively.
12. 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, each year 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,
------------
1999 $ 128,508
2000 128,508
2001 59,865
------------
$ 316,881
============
Total rent expense for the years ended December 31, 1998 and 1997 was
approximately $153,000 and $113,000, respectively.
13. 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.
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.
Note Payable to Bank and Long-Term Debt - Fair value approximates the
carrying value because the notes bear current interest rates.
28
<PAGE>
13. Fair Value of Financial Instruments, continued:
The estimated fair values of the following financial instruments as of
December 31, 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
1998 1997
----------------------------- -----------------------------
Carrying Fair Carrying Fair
Value Value Value Value
----- ----- ----- -----
<S> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents $ 750,218 $ 750,218 $ 473,551 $ 473,551
Marketable securities 219,502 219,502 250,724 250,724
Loans receivable (face):
Commercial real estate 40,411,783 43,044,562 36,655,257 38,143,732
Financial liabilities:
Note payable to bank 35,243,164 35,243,164 26,990,096 26,990,096
Long-term debt 3,147,579 3,147,579 3,187,539 3,187,539
</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.
Accordingly, the estimates presented herein are not necessarily
indicative of what the Company could realize in a current market
exchange.
14. Earnings Per Share Computation:
<TABLE>
<CAPTION>
For the Year ended December 31, 1998
Weighed- Per-share
Net Income Average shares Amount
---------- -------------- ------
<S> <C> <C> <C>
Basic Earnings Per Share:
Income available to
Stockholders $ 744,649 1,354,397 $ .55
======
Effect of Dilutive Securities
Interest on convertible subordinated
debentures (net of tax) 294,433 686,642
Common stock options - 17,448
----------- ----------
Diluted Earnings Per Share
Income available to common
stockholders + assumed conversions $ 1,039,082 2,058,487 $ .50
=========== ========== =======
</TABLE>
<TABLE>
<CAPTION>
For the Year ended December 31, 1997
Weighed- Per-share
Net Income Average shares Amount
---------- -------------- ------
<S> <C> <C> <C>
Basic and Diluted Earnings Per Share:
Income available to stockholders $ 738,960 1,373,850 $ .54
========== ========= =======
</TABLE>
29
<PAGE>
14. Reportable Segments-Source Capital Leasing Co:
The Company's consolidated financial statements include certain
reportable segment information. This segment, Source Capital Leasing
Co., a wholly owned subsidiary is engaged in the business of providing
equipment lease financing in the small to middle market. All accounting
policies of the segment are the same as those described in the summary
of significant accounting policies. The Company evaluates the
performance of the segment based upon multiple variables including
lease income, interest expense and profit or loss after tax. The
Company does not allocate any unusual items to the segment.
The segment's profit and loss components and schedule of assets as of
December 31, 1998 an 1997 is as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Lease financing income $ 1,482,206 $ 189,601
Interest expense 465,719 38,105
Depreciation and amortization 9,695 3,081
Income tax expense (benefit) 45,000 (23,200)
Leasing net income (loss) 87,062 (45,034)
Significant non-cash items
other than depreciation 276,486 18,000
Leasing assets $ 14,405,417 $3,446,109
</TABLE>
Reconciliation of segment net income, total assets, notes payable and
other significant items for the year ended December 31, 1998 and 1997
follows:
<TABLE>
<CAPTION>
Profit or loss 1998 1997
---- ----
<S> <C> <C>
Leasing net income (loss) $ 87,062 $ (45,034)
Adjustment for income taxes (339,100) (361,700)
Unallocated amounts:
Revenue of parent 5,606,840 4,981,528
Expenses of parent (4,610,153) (3,835,834)
------------ ------------
Consolidated net income after tax $ 744,649 $ 738,960
============ ============
Total Assets
Leasing total assets $14,405,417 $ 3,446,109
Elimination of intercompany (197,978) (497,647)
Unallocated assets of parent 44,358,802 40,097,834
------------ ------------
Consolidated assets $58,566,241 $ 43,046,296
============ ============
Note Payable to Bank
Leasing note payable $10,608,164 $ 2,355,096
Note payable of parent 24,635,000 24,635,000
------------ ------------
Consolidated notes payable $35,243,164 $ 26,990,096
============ ============
</TABLE>
<TABLE>
<CAPTION>
Other Significant Items Segment Consolidated
1998 Totals Adjustment Totals
------- ---------- ------
<S> <C> <C> <C>
Interest expense $465,719 $2,697,136 $ 3,162,855
Provision for lease losses $276,486 $ 11,000 $ 287,486
1997
Interest expense $ 38,104 $1,978,218 $ 2,016,322
Provision for lease losses $ 18,000 $ 5,000 $ 23,000
</TABLE>
Reconciling items to adjust interest expense and provision for losses
to consolidated totals represent amounts incurred by the parent
company.
30
The wholly owned subsidiaries of the Registrant are as follows:
Source Capital Leasing Co.
1825 N. Hutchinson Rd.
Spokane, WA 00212
Source Capital Finance Inc.
1825 N. Hutchinson Rd.
Spokane, WA 99212
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-END> DEC-31-1998 DEC-31-1997
<CASH> 750,218 473,551
<SECURITIES> 219,502 250,724
<RECEIVABLES> 54,839,212 39,795,368
<ALLOWANCES> 421,292 222,966
<INVENTORY> 0 0
<CURRENT-ASSETS> 0 0
<PP&E> 0 0
<DEPRECIATION> 0 0
<TOTAL-ASSETS> 58,566,241 43,046,296
<CURRENT-LIABILITIES> 0 0
<BONDS> 0 0
0 0
0 0
<COMMON> 7,006,849 7,038,802
<OTHER-SE> 2,049,047 2,049,047
<TOTAL-LIABILITY-AND-EQUITY> 58,566,241 43,046,296
<SALES> 7,096,441 5,103,650
<TOTAL-REVENUES> 0 0
<CGS> 0 0
<TOTAL-COSTS> 0 0
<OTHER-EXPENSES> 2,517,351 1,940,468
<LOSS-PROVISION> 287,486 23,000
<INTEREST-EXPENSE> 3,162,855 2,016,322
<INCOME-PRETAX> 1,128,749 1,123,860
<INCOME-TAX> 384,100 384,900
<INCOME-CONTINUING> 744,649 738,960
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 744,649 738,960
<EPS-PRIMARY> .55 .54
<EPS-DILUTED> .50 .54
</TABLE>
