UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C., 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________
Commission file number 1-11011
THE FINOVA GROUP INC.
(Exact name of registrant as specified in its charter)
DELAWARE 86-0695381
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1850 North Central Ave., P. O. Box 2209, Phoenix, AZ 85002-2209
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code 602/207-6900
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months, (or such shorter period that the Registrant was
required to file such report), and (2) has been subject to such filing
requirements for the past 90 days.
YES [X} NO [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
As of May 13, 1999, 61,020,000 shares of Common Stock ($0.01 par value) were
outstanding.
<PAGE>
THE FINOVA GROUP INC.
TABLE OF CONTENTS
Page No.
--------
Part I - Financial Information
Item 1. Financial Statements
Consolidated Condensed Balance Sheets
as of March 31, 1999 and December 31, 1998 (restated) 1
Consolidated Condensed Statements of Income
for the three months ended March 31, 1999 and 1998 (restated) 2
Consolidated Condensed Statements of Cash Flows
for the three months ended March 31, 1999 and 1998 (restated) 3
Notes to Interim Consolidated Condensed Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures about Market Risk 15
Part II - Other Information 17
Item 6. Exhibits and Reports on Form 8-K 17
Signatures 18
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE FINOVA GROUP INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
(Dollars in Thousands)
(Unaudited)
December 31,
March 31, 1998
1999 restated
------------ ------------
ASSETS:
Cash and cash equivalents $ 91,032 $ 49,518
Investment in financing transactions:
Loans and other financing contracts 8,270,159 7,354,736
Leveraged leases 802,937 773,942
Operating leases 665,912 648,185
Fee-based receivables 618,779 626,499
Direct financing leases 382,746 396,759
Financing contracts held for sale 345,483 220,100
----------- -----------
11,086,016 10,020,221
Less reserve for credit losses (238,277) (207,618)
----------- -----------
Net investment in financing transactions 10,847,739 9,812,603
Investments 211,004 124,792
Goodwill and other assets 580,572 454,323
----------- -----------
$11,730,347 $10,441,236
=========== ===========
LIABILITIES:
Accounts payable and accrued expenses $ 140,015 $ 154,137
Due to clients 203,869 205,655
Interest payable 55,543 65,817
Senior debt 9,327,137 8,394,578
Deferred income taxes 334,621 342,268
----------- -----------
10,061,185 9,162,455
----------- -----------
Commitments and contingencies
Company-obligated mandatory redeemable convertible
preferred securities of subsidiary trust solely
holding convertible debentures of FINOVA, net of
expenses ("TOPrS") 111,550 111,550
SHAREOWNERS' EQUITY:
Common stock, $0.01 par value, 100,000,000 shares
authorized, 64,638,000 and 58,555,000 shares
issued, respectively 646 585
Additional capital 1,120,335 765,050
Retained income 556,147 515,057
Accumulated other comprehensive (loss) income (13,727) 686
Common stock in treasury, 2,447,000 and 2,834,000
shares, respectively (105,789) (114,147)
----------- -----------
1,557,612 1,167,231
----------- -----------
$11,730,347 $10,441,236
=========== ===========
See notes to interim consolidated condensed financial statements.
1
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THE FINOVA GROUP INC.
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(Dollars in Thousands)
(Unaudited)
Three Months Ended March 31,
-----------------------------
1998
1999 restated
------------ ------------
Interest and income earned from
financing transactions $ 245,222 $ 200,170
Operating lease income 27,853 32,663
Interest expense (131,183) (110,280)
Depreciation (17,226) (17,170)
------------ ------------
Interest margins earned 124,666 105,383
Volume-based fee income 12,735 22,156
------------ ------------
Operating margin 137,401 127,539
Provision for credit losses (9,500) (9,500)
------------ ------------
Net interest margins earned 127,901 118,039
Gains on disposal of assets 12,370 1,525
------------ ------------
140,271 119,564
Operating expenses (57,499) (52,878)
------------ ------------
Income before income taxes and
preferred dividends 82,772 66,686
Income taxes (31,769) (25,999)
------------ ------------
Income before preferred dividends 51,003 40,687
Preferred dividends, net of tax (946) (946)
------------ ------------
NET INCOME $ 50,057 $ 39,741
============ ============
Basic earnings per share $ 0.89 $ 0.71
============ ============
Adjusted weighted average shares outstanding 56,294,000 56,138,000
============ ============
Diluted earnings per share $ 0.83 $ 0.67
============ ============
Adjusted weighted average shares outstanding 61,318,000 61,079,000
============ ============
Dividends declared per common share $ 0.16 $ 0.14
============ ============
See notes to interim consolidated condensed financial statements.
2
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THE FINOVA GROUP INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
(Unaudited)
Three Months Ended March 31,
-----------------------------
1998
1999 restated
------------ ------------
OPERATING ACTIVITIES:
Net income $ 50,057 $ 39,741
Adjustments to reconcile net income to net
cash (used) provided by operating activities:
Provision for credit losses 9,500 9,500
Depreciation and amortization 24,315 22,734
Gains on disposal of assets (12,370) (1,525)
Deferred income taxes 35,283 15,373
Change in assets and liabilities, net of
effects from acquisitions (227,056) (81,738)
Other (14,565) 1,739
--------- ---------
Net cash (used) provided by operating
activities (134,836) 5,824
--------- ---------
INVESTING ACTIVITIES:
Proceeds from sale of assets 56,204 48,955
Principal collections on financing transactions 614,752 321,553
Expenditures for financing transactions (937,869) (533,579)
Expenditures for CMBS transactions (179,219)
Net change in short-term financing transactions (329,787) (132,795)
Cash received in acquisition 20,890
Other 739 824
--------- ---------
Net cash used in investing activities (754,290) (295,042)
--------- ---------
FINANCING ACTIVITIES:
Net borrowings under commercial paper and
short-term loans 285,935 473,796
Long-term borrowings 956,000 100,000
Repayment of long-term borrowings (309,225) (223,430)
Proceeds from exercise of stock options 8,683 3,144
Dividends (8,967) (7,904)
Net change in due to clients (1,786) (39,414)
--------- ---------
Net cash provided by financing activities 930,640 306,192
--------- ---------
INCREASE IN CASH AND CASH EQUIVALENTS 41,514 16,974
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 49,518 33,190
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 91,032 $ 50,164
========= =========
See notes to interim consolidated condensed financial statements.
3
<PAGE>
THE FINOVA GROUP INC.
NOTES TO INTERIM CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998
NOTE A BASIS OF PRESENTATION
The consolidated condensed financial statements present the financial
position, results of operations and cash flows of The FINOVA Group Inc. and its
subsidiaries (collectively, "FINOVA" or the "Company"), including FINOVA Capital
Corporation and its subsidiaries (collectively, "FINOVA Capital").
The interim consolidated financial information is unaudited. In the
opinion of management all adjustments, consisting of normal recurring items,
necessary to present fairly the financial position as of March 31, 1999, and the
results of operations and cash flows for the three months ended March 31, 1999
and 1998, have been included. Interim results of operations are not necessarily
indicative of the results of operations for the full year. The enclosed
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K/A, Amendment No. 2 for the year ended December 31, 1998.
NOTE B SIGNIFICANT ACCOUNTING POLICIES
INVESTMENTS
In the normal course of business, the Company acquires various forms of
equity positions in other companies including marketable and non-marketable
common stocks, warrants to purchase common stock, preferred stock, and
partnership and joint venture interests. As discussed in Note E, FINOVA acquired
Sirrom Capital Corporation ("Sirrom") in March 1999. In connection with this
acquisition, the Company's investments in these types of assets increased by
approximately $150 million. The Company's accounting policies related to these
investments are as follows:
Marketable investments are designated as available for sale securities
and carried at fair value using the specific identification method with
unrealized gains or losses included in accumulated other comprehensive income
included in stockholders' equity, net of related taxes.
The Company accounts for investments in joint ventures and other
investments in which the Company has the ability to exercise significant
influence on the investee under the equity method of accounting. Under this
method, the Company recognizes its share of the earnings or losses of the joint
venture in the period in which they are earned by the joint venture.
Other investments in warrants, certain common and preferred stocks and
certain equity investments, which are not subject to the provisions of Statement
of Financial Accounting Standards No. 115, "Accounting for Certain Investments
in Debt and Equity Securities," are carried at cost. The valuation of these
investments is periodically reviewed and the investment balance is written down
to reflect declines in value determined to be other than temporary. Certain
other equity investments in limited partnership funds are accounted for under
the equity method of accounting in accordance with Accounting Principles Board
Opinion No. 18, "The Equity Method of Accounting for Investments in Common
Stock."
OTHER COMPREHENSIVE INCOME
The Company reports other comprehensive income in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income." Total comprehensive income was $35,644,000 and
$39,683,000 for the three months ended March 31, 1999 and 1998, respectively.
The primary component of comprehensive income other than net income was
unrealized losses on retained interest in securitization transactions.
4
<PAGE>
NEW ACCOUNTING STANDARDS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," ("SFAS No. 133") which is effective for
fiscal years beginning after June 15, 1999. This statement standardizes the
accounting for derivative instruments, including certain derivative instruments
embedded in other contracts, by recognition of those items as assets or
liabilities in the statement of financial position and measurement at fair
value. FINOVA will adopt this standard effective January 1, 2000, as required.
The impact of SFAS No. 133 on the Company's financial position and results of
operations has not yet been determined.
NOTE C INVESTMENTS
Investments increased significantly over the prior year due to the
acquisition of Sirrom (as discussed in Note E) on March 22, 1999. The following
table sets forth a summary of the major components of investments:
March 31, December 31,
1999 1998
-------- --------
Marketable investments $ 4,992 $ 1,713
Joint venture investments 96,177 89,217
Other investments 109,835 33,862
-------- --------
$211,004 $124,792
======== ========
Marketable investments are principally composed of publicly traded
shares of common stock and warrants for the purchase of common stock. Net
unrealized gains on these securities were not significant at March 31, 1999.
Joint venture investments include equity investments in non-public
entities in which the Company holds a 20% or greater equity interest.
Other investments include common stock, preferred stock and warrants
which are not publicly traded and equity investments in which the Company holds
less than 20% of the investee's equity.
NOTE D SEGMENT REPORTING
MANAGEMENT'S POLICY FOR IDENTIFYING REPORTABLE SEGMENTS
FINOVA's reportable business segments are strategic business units that
offer distinctive products and services that are marketed through different
channels.
RECONCILIATION OF SEGMENT INFORMATION TO CONSOLIDATED AMOUNTS
Management evaluates the business performance of each group based on
total net revenue, income before allocations and managed assets. Total net
revenue is operating margin plus gains on disposal of assets. Income before
allocations is income before income taxes and preferred dividends, excluding
allocation of corporate overhead expenses and the unallocated portion of
provision for credit losses. Managed assets includes each segment's investment
in financing transactions plus securitizations and participations sold.
5
<PAGE>
Information for FINOVA's reportable segments reconciles to FINOVA's
consolidated totals as follows:
Three Months Ended March 31,
------------------------------
Dollars in Thousands 1999 1998
- -------------------- ------------ -----------
TOTAL NET REVENUE:
Commercial Finance $ 51,706 $ 45,999
Specialty Finance 94,231 74,351
Capital Markets 9,416 9,530
Corporate and other (5,582) (816)
------------ -----------
Consolidated total $ 149,771 $ 129,064
============ ===========
INCOME (LOSS) BEFORE ALLOCATIONS:
Commercial Finance $ 24,348 $ 17,954
Specialty Finance 77,743 59,251
Capital Markets (17) 3,121
Corporate and other, overhead and
unallocated provision for credit losses (19,302) (13,640)
------------ -----------
Income from continuing operations
before income taxes $ 82,772 $ 66,686
============ ===========
March 31,
------------------------------
1999 1998
------------ -----------
MANAGED ASSETS:
Commercial Finance $ 3,258,093 $ 2,763,155
Specialty Finance 7,337,715 6,151,661
Capital Markets 925,366 181,243
Corporate and other 94,477 57,729
------------ -----------
Consolidated total 11,615,651 9,153,788
Less securitizations and participations sold (529,635) (464,550)
------------ -----------
Investment in financing transactions $ 11,086,016 $ 8,689,238
============ ===========
NOTE E ACQUISITION OF SIRROM CAPITAL CORPORATION
In March 1999, FINOVA acquired Sirrom, a specialty finance company
headquartered in Nashville, Tennessee. The acquisition was accounted for using
the purchase method of accounting. The purchase price was approximately $343
million in FINOVA common stock, excluding converted stock options. Total assets
acquired were $620 million, including $66 million in goodwill and $277 million
in assumed liabilities and transaction costs. Goodwill is subject to change due
to a preliminary estimate of fair values of various private equities and loan
balances at the date of acquisition. Goodwill is being amortized over 25 years
and covenants not to compete, which are included in goodwill, are being
amortized over 3 years.
After making certain accounting adjustments, the accompanying unaudited
pro forma information gives effect to the merger as if it had occurred on
January 1, 1999 and 1998 and combines the historical consolidated information of
FINOVA and Sirrom for the quarters ended March 31, 1999 and 1998.
The unaudited comparative pro forma information is not necessarily
indicative of the results that actually would have occurred had the merger been
consummated on the dates indicated or that may be obtained in the future. The
unaudited pro forma financial information does not give effect to the
anticipated cost savings and other synergies that may result from the merger or
the possible cash-out of existing stock options held by employees of Sirrom that
became fully vested by reason of the adoption of the merger agreement by Sirrom
stockholders. Included in the historical operations of Sirrom for the first
quarter of 1999 are approximately $24 million of nonrecurring charges, a
significant portion of which related to the acquisition.
6
<PAGE>
Comparative Pro Forma Information Three Months Ended March 31,
(Dollars in thousands, except per share data) 1999 1998
- --------------------------------------------- -------- --------
Total revenue $288,402 $248,341
Net (Loss) income $ (4,793) $ 35,770
(Loss) Earnings per share - diluted $ (0.06) $ 0.55
(Loss) Earnings per share - basic $ (0.08) $ 0.58
The acquisition resulted in an excess purchase price over the
historical net assets acquired. The excess is allocated to the net assets
acquired and liabilities assumed, as follows:
Allocation of purchase price:
Purchase price $ 342,730
Elimination of historical stockholders' equity of Sirrom (262,000)
---------
Estimated excess purchase price $ 80,730
=========
Allocation of excess:
Elimination of unamortized debt costs $ (3,360)
Deferred income taxes 43,309
Assumed liabilities (25,127)
Goodwill 65,908
---------
$ 80,730
=========
NOTE F RESTATEMENT
Subsequent to the issuance of the Company's financial statements for
the year ended December 31, 1998, the Company's management determined that
expenses incurred in connection with the origination of new loans under SFAS No.
91, "Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases" (SFAS No. 91), should have
been deferred and amortized over the estimated loan life. Previously, the
Company was deferring loan origination fees received and amortizing them over
the lives of the loans in accordance with SFAS No. 91, but elected to expense
loan origination costs as incurred. Accordingly, the Company restated its
condensed consolidated financial statements for the three months ended March 31,
1998 to defer and amortize loan costs over the estimated loan life, in
accordance with SFAS No. 91 as well as to make several other adjustments.
7
<PAGE>
A summary of the significant effects of the restatements for the three
months ended March 31, 1998 is as follows:
As previously
Reported As restated
-------- -----------
For the three months ended March 31, 1998
Interest margins earned $ 108,657 $ 105,383
Gains on disposal of assets 1,223 1,525
Operating expenses (56,958) (52,878)
Net income 39,077 39,741
Basic earnings per share $ 0.70 $ 0.71
Diluted earnings per share $ 0.66 $ 0.67
NOTE G PORTFOLIO QUALITY
The following table presents a distribution (by line of business) of
the Company's investment in financing transactions before the reserve for credit
losses at the dates indicated.
8
<PAGE>
INVESTMENT IN FINANCING TRANSACTIONS
BY LINE OF BUSINESS
MARCH 31, 1999
(Dollars in Thousands)
<TABLE>
<CAPTION>
Revenue Accruing Nonaccruing
---------------------------------- ---------------------------
Repos- Repos- Leases Total
Market sessed sessed & Carrying
Rate (1) Impaired Assets (2) Impaired Assets Other Amount %
----------- --------- ---------- -------- ------ ----- ----------- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Transportation Finance (3) $ 2,081,910 $ 60,426 $ $ $ $ $2,142,336 19.3
Resort Finance 1,286,026 16,829 668 24,982 1,328,505 12.0
Rediscount Finance 863,195 20,787 788 573 885,343 8.0
Corporate Finance 777,631 15,577 40,606 1,089 834,903 7.5
Commercial Equipment Finance 716,913 2,379 5,935 8,322 20,104 4,223 757,876 6.8
Specialty Real Estate Finance 637,180 16,890 34,004 9,702 7,684 194 705,654 6.4
Communications Finance 657,462 7,161 24,252 688,875 6.2
Franchise Finance 677,099 1,578 1,773 2,017 1,099 269 683,835 6.2
Healthcare Finance 633,446 750 6,313 5,375 1,942 647,826 5.8
Distribution & Channel Finance 578,734 6,325 585,059 5.3
Mezzanine Capital 465,156 12,337 477,493 4.3
Realty Capital 430,384 430,384 3.9
Business Credit 312,193 16,493 328,686 3.0
Public Finance 216,235 216,235 1.9
Commercial Services 195,088 147 6,451 898 202,584 1.8
Growth Finance 55,338 3,119 58,457 0.5
Other (4) 65,572 28,904 94,476 0.9
Investment Alliance 17,489 17,489 0.2
----------- -------- ------- -------- -------- ------- ----------- -----
TOTAL (5) $10,667,051 $104,908 $85,641 $136,455 $ 56,429 $35,532 $11,086,016 100.0
=========== ======== ======= ======== ======== ======= =========== =====
</TABLE>
- ----------
NOTES:
(1) Represents original or renegotiated market rate terms, excluding impaired
transactions.
(2) The Company earned income totaling $1.57 million on repossessed assets
during the three months ended March 31, 1999, including $0.59 million in
Specialty Real Estate Finance, $0.3 million in Resort Finance, $0.2 million
in Healthcare Finance, $0.4 million in Rediscount Finance, $.05 million in
Commercial Equipment Finance and $.03 million in Franchise Finance.
(3) Transportation Finance includes $420.5 million of aircraft financing
business originated in the London office.
(4) Primarily includes other assets retained from disposed or discontinued
operations.
(5) Excludes $529.6 million of assets securitized and participations sold which
the Company manages, including securitizations of $300.0 million in
Corporate Finance and $128.6 million in Franchise Finance and
participations sold of $43.4 million in Corporate Finance, $21.2 million in
Communications Finance, $5.6 million in Resort Finance, $10.5 million in
Rediscount Finance, $5.1 million in Business Credit, $11.2 million in
Transportation Finance, $2.1 million in Growth Finance and $1.9 million in
Distribution & Channel Finance.
--------------------
9
<PAGE>
RESERVE FOR CREDIT LOSSES:
The reserve for credit losses at March 31, 1999 represents 2.1% of the
Company's investment in financing transactions and securitized assets. Changes
in the reserve for credit losses were as follows:
Three Months Ended March 31,
-----------------------------
1999 1998
--------- ---------
(Dollars in Thousands)
Balance, beginning of period $ 207,618 $ 177,088
Provision for credit losses 9,500 9,500
Write-offs (9,142) (13,912)
Recoveries 739 806
Reserves related to acquisitions 25,151 2,460
Other 4,411 25
--------- ---------
Balance, end of period $ 238,277 $ 175,967
========= =========
At March 31, 1999 the total carrying amount of impaired loans was
$241.4 million, of which $104.9 million were revenue accruing. A reserve for
credit losses of $55.4 million has been established for $99.4 million of
nonaccruing impaired loans and $7.2 million has been established for $26.1
million of accruing impaired loans. The remaining $175.7 million of the reserve
for credit losses is designated for general purposes and represents management's
best estimate of potential losses in the portfolio considering delinquencies,
loss experience and collateral. Additions to the general and specific reserves
are reflected in current operations. Management may transfer reserves between
the general and specific reserves as considered necessary.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 1999
TO THE RESTATED THREE MONTHS ENDED MARCH 31, 1998
THE FOLLOWING DISCUSSION RELATES TO THE FINOVA GROUP INC. AND ITS
SUBSIDIARIES (COLLECTIVELY, "FINOVA" OR THE "COMPANY"), INCLUDING FINOVA CAPITAL
CORPORATION AND ITS SUBSIDIARIES (COLLECTIVELY, "FINOVA CAPITAL").
Subsequent to the issuance of the Company's financial statements for
the year ended December 31, 1998, the Company's management determined that
expenses incurred in connection with the origination of new loans under SFAS No.
91, "Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases" (SFAS No. 91), should have
been deferred and amortized over the estimated loan life. Previously, the
Company was deferring loan origination fees received and amortizing them over
the lives of the loans in accordance with SFAS No. 91, but elected to expense
loan origination costs as incurred. Accordingly, the Company restated its
condensed consolidated financial statements for the three months ended March 31,
1998 to now defer and amortize loan costs over the estimated loan life, in
accordance with SFAS No. 91 as well as to make several other adjustments.
The effects of the restatements for the three months ended March 31,
1998 are presented in Note F of the Notes to Interim Consolidated Financial
Statements, and have been reflected herein.
10
<PAGE>
RESULTS OF OPERATIONS
Net income for the three months ended March 31, 1999 was $50.1 million
($0.83 per diluted share) compared to a restated $39.7 million ($0.67 per
diluted share) for the three months ended March 31, 1998. The 1999 earnings per
share computation includes a higher average share count due to the 6.1 million
additional shares issued on March 22, 1999 for the acquisition of Sirrom Capital
Corporation and 0.2 million shares for the acquisition of Preferred Business
Credit, Inc. ("PBC") on February 17, 1999. The 1998 net income has been restated
to reflect the deferral of costs incurred in connection with new loan and lease
originations in accordance with SFAS No. 91, among other adjustments described
more fully in the Company's report on Form 10-K/A, Amendment No. 2 for the year
ended December 31, 1998. The effect of deferring expenses in accordance with
SFAS 91 increased net income by $1.2 million ($0.02 per diluted share) in the
first quarter of 1999.
INTEREST MARGINS EARNED. Interest margins earned represents the
difference between (a) interest and income earned from financing transactions
and operating lease income and (b) interest expense and depreciation on
operating leases. Interest margins earned were $124.7 million for the first
three months of 1999, an increase of 18.3% over interest margins earned of
$105.4 million for the first quarter of 1998. The increase was primarily due to
a 27% increase in managed assets to $11.62 billion at March 31, 1999 from $9.15
billion at March 31, 1998. Interest margins earned as a percentage of average
earning assets declined to 5.1% in the first quarter of 1999 compared to 5.3% in
the first quarter of 1998. Approximately 10 to 15 basis points of the decrease
in spread was the result of average leverage being higher in 1999 compared to
the first quarter of 1998. Another portion of the decrease was due to the
strategy in the fourth quarter of 1998 of funding the balance sheet into the
first quarter of 1999. This eliminated liquidity risk for the Company, but
resulted in a modestly higher cost of funds. Additionally, competitive pressures
impacted the Commercial Finance segment.
VOLUME-BASED FEE INCOME. Volume-based fee income is generated by
FINOVA's Distribution & Channel Finance, Commercial Services and Realty Capital
lines of business. These fees are predominately based on volume originated
rather than the balance of outstanding financing transactions during the period.
Volume-based fee income for the first quarter of 1999 was $12.7 million compared
to $22.2 million in the first quarter of 1998. The decline relates to a lower
fee-based volume generated by Realty Capital and Commercial Services during the
1999 quarter and the effect of a $4.5 million fee received from one of Realty
Capital's trading partners in early 1998. On a comparable basis, the average fee
received during the quarter by the Company per dollar of fee-based volume
decreased by 11 basis points in 1999 from the 1998 first quarter. The lower fees
combined with higher leverage caused the operating margin as a percentage of
average earning assets to decline to 5.6% in the first quarter of 1999 from 6.4%
in the first quarter of 1998. Fee-based volume for the first three months of
1999 totaled $1.47 billion compared to $1.80 billion in the same period one year
ago.
PROVISION FOR CREDIT LOSSES. The provision for credit losses was $9.5
million for the three months ended March 31, 1999 and 1998. Net write-offs
during the first three months of 1999 totaled $8.4 million, compared to $13.1
million in the first quarter of 1998.
GAINS ON DISPOSAL OF ASSETS. Gains on the disposal of assets were $12.4
million in the first quarter of 1999, compared to $1.5 million during the same
period a year ago. The gains in 1999 were principally realized by FINOVA's
Specialty Finance segment and were primarily from the sale of assets coming off
lease and other assets. While, in the aggregate, FINOVA has historically
recognized gains on such disposals, the timing and amount of these gains is
sporadic in nature. The Company has added a number of businesses that rely on
gains to achieve their returns. These businesses supplement FINOVA's core
11
<PAGE>
spread-based business. Typically these gains have approximated 10% to 15% of
FINOVA's annual net income. There can be no assurance FINOVA will recognize such
gains in the future, depending, in part, on market conditions at the time of
sale.
OPERATING EXPENSE. Operating expenses were generally higher in all
major categories and increased to $57.5 million during the first three months of
1999 compared to $52.9 million for the three months ended March 31, 1998, an
increase of 9%. The increase was primarily due to personnel added (1,362 vs.
1,130) through acquisitions and as a result of growth in managed assets.
Operating expenses improved as a percent of operating margin plus gains to 38.4%
in 1999 from 41.0% in the first quarter of 1998.
INCOME TAXES. Income taxes were higher in the first quarter of 1999
than the first quarter of 1998 primarily due to the increase in pre-tax income.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1999, managed assets totaled $11.62 billion compared to
$10.56 billion at December 31, 1998 an increase of 10%. Included in managed
assets at March 31, 1999 are $11.09 billion in funds employed (including $345.5
million of financing contracts held for sale generated by FINOVA Realty Capital;
$176.8 million at April 30, 1999), $428.6 million of securitized assets managed
by FINOVA and $101.0 million of participations sold to third parties. The
increase in managed assets was due to funded new business of $1.06 billion for
the three months ended March 31, 1999, compared to $692.1 million for the
quarter ended March 31, 1998, plus acquired managed assets of $486 million,
partially offset by normal portfolio amortization and prepayments.
The reserve for credit losses increased to $238.3 million at March 31,
1999 from $207.6 million at December 31, 1998. At March 31, 1999, the reserve
for credit losses represents 2.1% of ending managed assets (excluding
participations) compared to 2.0% at year-end. Non-accruing assets at March 31,
1999 increased to $228.4 million, or 2.0% of ending managed assets (excluding
participations), compared to $205.2 million, or 2.0% of ending managed assets
(excluding participations) at year end. The Sirrom acquisition included $469
million of lending assets, $12 million (2.6%) of which were nonaccruing. The
reserve for credit losses against the acquired Sirrom lending assets was $24.9
million or 5.3%.
At March 31, 1999, FINOVA had $9.33 billion of debt outstanding
compared to $8.39 billion at December 31, 1998. Included in debt at March 31,
1999 is approximately $4.13 billion of commercial paper and short-term
borrowings supported by unused long-term revolving-credit agreements. FINOVA's
debt at the end of the first quarter of 1999 is 5.59 times the company's equity
base of $1.67 billion (including $111.6 million of convertible preferred stock).
At year-end 1998, FINOVA's debt was 6.56 times the equity base of $1.28 billion.
Growth in funds employed is financed by FINOVA's internally generated
funds and new borrowings. During the three months ended March 31, 1999, FINOVA
issued $956 million of new long-term borrowings and recognized a net increase in
commercial paper outstanding of $286 million. During the same period, FINOVA
repaid $309 million of long-term borrowings.
12
<PAGE>
SEGMENT REPORTING
FINOVA's business is organized into three market groups, which are also
its reportable segments: Commercial Finance, Specialty Finance and Capital
Markets. Management principally relies on total net revenue, income before
allocations and managed assets in evaluating the business performance of each
reportable segment.
Total net revenue is the sum of operating margin and gains on disposal
of assets. Income before allocations is income before income taxes, preferred
dividends, corporate overhead expenses and the unallocated portion of the
provision for credit losses. Managed assets include each segment's investment in
financing transactions plus securitizations and participations sold.
COMMERCIAL FINANCE. Commercial Finance includes traditional asset-based
businesses that lend against collateral such as cash flows, inventory,
receivables and leased assets.
Total net revenue was $51.7 million in 1999 compared to $46.0 million
for the first quarter of 1998, an increase of 12.4%. The increase was primarily
due to a 17.9% increase in managed assets over the first quarter of 1998,
partially offset by a decrease in fee-based volume in Commercial Services.
Overall, fee-based volume decreased to $1.09 billion in 1999 from $1.15 billion
in the first quarter of 1998.
Income before allocations increased 35.6% to $24.3 million in 1999
compared to $18.0 million in the first quarter of 1998. In addition to portfolio
growth, the increase resulted from lower write-offs in 1999.
Managed assets grew to $3.3 billion in the first quarter of 1999 from
$2.8 billion in 1998. Strong growth in Rediscount Finance, Business Credit and
the recent acquisitions of Growth Finance and Preferred Business Credit drove
the growth in managed assets. Excluding the recent acquisitions, managed assets
grew by 15.7%.
SPECIALTY FINANCE. Specialty Finance includes businesses that lend to a
variety of highly focused industry-specific niches.
Total net revenue increased 26.7% to $94.2 million in the first quarter
of 1999, compared to $74.4 million in 1998, while income before allocations grew
31.2% to $77.7 million in the first quarter of 1999 compared to $59.3 million in
1998. Both increases were primarily due to 19.7% growth in average earning
assets. The segment was able to keep net write-offs at a relatively constant
rate, while decreasing operating expenses as a percentage of spread and average
managed assets.
Managed assets grew to $7.3 billion in the first quarter of 1999 from
$6.2 billion in 1998, an increase of 19.3%. The growth in managed assets was
driven by new business of $3.2 billion during the 12 months ended in March 1999
compared to $2.5 billion during the 12 months ended in March 1998. The growth
was spread across all business units with Transportation Finance and Franchise
Finance contributing most to the growth in managed assets.
CAPITAL MARKETS. Capital Markets, in conjunction with institutional
investors, provides commercial mortgage banking services and debt and equity
capital funding. Mezzanine Capital (formerly Sirrom Capital Corporation) was
added to this segment at the acquisition date, March 22, 1999.
Total net revenue was $9.4 million in the first quarter of 1999
compared to $9.5 million in 1998. Loss before allocations was $17 thousand
compared to income of $3.1 million in 1998. The decrease in net revenue and
13
<PAGE>
income before allocations was primarily attributable to a decline in
volume-based fees to $1.6 million in the first quarter of 1999 compared to $9.3
million in 1998, resulting from the lower fee-based volume generated, lower
returns on fee volume generated and higher operating expenses during the
quarter. Offsetting the 1999 decline were increases in loan revenue and gains on
disposal of assets.
Managed assets grew to $925 million at March 31, 1999 compared to $181
million at March 31, 1998, from the acquisition of Mezzanine Capital and the
increase in financing contracts held for sale.
YEAR 2000 COMPLIANCE
FINOVA continues to implement changes necessary to help assure accurate
date recognition and data processing with respect to the year 2000. To be year
2000 compliant means (1) significant information technology ("IT") systems in
use by FINOVA demonstrate performance and functionality that is not materially
affected by processing dates on or after January 1, 2000, (2) customers and
collateral included in FINOVA's portfolio of business are year 2000 compliant
and (3) vendors of services critical to FINOVA's business processes are year
2000 compliant.
FINOVA's non-IT systems used to conduct business at its facilities
consist primarily of office equipment (other than computer and communications
equipment) and other equipment at leased office facilities. FINOVA has
inventoried its non-IT systems and has sent year 2000 questionnaires to office
equipment vendors and landlords to determine the status of their year 2000
readiness.
Primary internal activities related to this issue are modifications to
existing computer programs and conversions to new programs. FINOVA has a
five-phase plan for assuring year 2000 compliance of its internal systems:
1) Identifying each area, function and application that could be affected by
the change in date.
2) Determining the extent to which each area, function or application will be
affected by the change in date and identifying the proper course of action
to eliminate adverse effects.
3) Making the changes necessary to bring the system into year 2000 compliance.
4) Testing the integrated system.
5) Switching to year 2000 compliant applications.
As of March 31, 1999, FINOVA has completed all the necessary changes to
make mission critical applications year 2000 compliant. FINOVA now estimates
that 99% of its portfolio is on systems that are ready for the change in
century. Acquisitions made during 1998 are expected to be on compliant systems
by the end of the second quarter. Similarly, acquisitions made or proposed in
1999 are being reviewed with year 2000 compliance issues to be addressed in a
prompt manner. Where possible, new acquisitions will be migrated to existing
FINOVA applications that are already year 2000 ready.
Costs incurred to bring FINOVA's internal systems into year 2000
compliance are not expected to have a material impact on FINOVA's results of
operations. Maintenance and modification costs are expensed as incurred, while
the costs of new hardware and software are capitalized and amortized over their
estimated useful lives. FINOVA estimates it will incur approximately $300,000 in
expenses and $1.8 million in capital costs related to year 2000 compliance.
Estimates are reviewed and revised as necessary on a quarterly basis. Through
March 31, 1999, FINOVA has incurred expenses of $158,000 and capital costs of
$1.5 million.
FINOVA's aggregate cost estimate does not include time and costs that
may be incurred as a result of the failure of any third parties to become year
2000 compliant. FINOVA is communicating with customers, software vendors and
14
<PAGE>
others to determine if their applications or services are year 2000 compliant
and to assess the potential impact on FINOVA related to this issue.
Risks to FINOVA include that third parties may not have accurately
assessed their state of readiness. Similarly, FINOVA cannot assure that the
systems of other companies and government agencies on which FINOVA relies will
be converted in a timely manner. While FINOVA believes all necessary work on
internal systems will be completed in a timely fashion, there can be no
guarantee that all systems will be compliant by the year 2000 and within the
estimated cost. Any of these occurrences could cause a material adverse effect
on FINOVA's results of operations.
FINOVA routinely assesses the year 2000 compliance status of its
borrowers and generally requires that they provide representations and
warranties regarding the status. FINOVA also attempts to monitor their progress
with questionnaires and other means.
FINOVA believes under its reasonably possible worst case year 2000
scenario, a number of its borrowers and service providers would not be capable
of performing their contractual obligations to FINOVA. The financial impact of
this scenario and the Company's responses are currently under assessment.
FINOVA is assessing the need for contingency plans related to year 2000
compliance in the first half of 1999. It plans to develop additional contingency
plans as necessary throughout 1999. FINOVA maintains and deploys contingency
plans designed to address various other potential business interruptions. In
some respects, these plans may address interruptions resulting from FINOVA or a
third party's failure to be year 2000 compliant, but the plans have not been
updated to specifically address the year 2000 issue as of March 31, 1999.
15
<PAGE>
RECENT DEVELOPMENTS AND BUSINESS OUTLOOK
FINOVA continues to seek new business by emphasizing customer service,
providing competitive interest rates and focusing on selected market niches.
Additionally, FINOVA continues to evaluate potential acquisition opportunities
it believes are consistent with its business strategies.
In April 1999, approximately 70% of the mini-CMBS loans were sold into
a permanent CMBS structure.
A summary of the revaluation of the sale of assets into the mini-CMBS
structure and the subsequent results of the sale of approximately 70% of the
mini CMBS loans into a permanent CMBS structure in April 1999 is as follows. The
results of the April 1999 transaction will be reported in the second quarter.
Mini-CMBS Structure - 1998 1999
---------------------------------------
As Previously As Sale of 70%
Reported restated in April
-------- -------- --------
Dollars in Thousands
Loans sold into CMBS Structure $724,257 $724,257 $
Proceeds - Permanent CMBS Structure 526,270
Principal A (Senior security interest) 678,686 678,686 474,650
Principal B (Subordinated retained interest) 91,708 65,033 45,206
-------- -------- --------
Basis 770,394 743,719 519,856
Gross gain 46,137 19,462 6,414
Commissions & expenses (3,862) (3,156) (4,433)
Recourse obligations (278) (5,827) 4,091
Hedge (losses) gains (20,443) (20,443) 6,223
Valuation adjustment (5,500)
-------- -------- --------
Net gain/(loss) $ 16,054 $ (9,964) $ 12,295
======== ======== ========
Including stock repurchases to date in the second quarter, FINOVA
repurchased 1.5 million shares of its common stock during 1999. These shares are
intended to fund awards under FINOVA's stock incentive plan.
In the second quarter of 1999, FINOVA expanded its credit facilities
supporting its commercial paper program to an aggregate of $4.5 billion, through
the addition of a new $500 million, 364 day revolving credit agreement with
various lenders.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There were no material changes from the information provided in the
report on Form 10-K/A, Amendment No. 2 for the year ended December 31, 1998.
16
<PAGE>
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The following exhibits are filed herewith:
Exhibit No. Document
----------- --------
11 Computation of Earnings Per Share.
12 Computation of Ratio of Income to Fixed Charges and
Preferred Stock Dividends (interim period).
27 Financial Data Schedule for the three months ended
March 31, 1999.
(b) Reports on Form 8-K:
A Report on Form 8-K, dated May 7, 1999, was filed by Registrant
which reported under Items 5 and 7 the revenues, net income and
selected financial data and ratios for the first quarter ended March
31, 1999 (unaudited) and certain additional information.
17
<PAGE>
THE FINOVA GROUP INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE FINOVA GROUP INC.
(Registrant)
Dated: May 17, 1999 By: /s/ Bruno A. Marszowski
-------------------------------------------
Bruno A. Marszowski, Senior Vice President,
Chief Financial Officer and Controller
Principal Financial and Accounting Officer
18
<PAGE>
THE FINOVA GROUP INC.
COMMISSION FILE NUMBER 1-11011
EXHIBIT INDEX
MARCH 31, 1999 FORM 10-Q
Exhibit No Document
---------- --------
11 Computation of Earnings Per Share.
12 Computation of Ratio of Income to Fixed Charges
and Preferred Stock Dividends (interim period).
27 Financial Data Schedule for the three months ended
March 31, 1999.
19
EXHIBIT 11
THE FINOVA GROUP INC.
COMPUTATION OF EARNINGS PER SHARE
(Dollars in Thousands, except per share data)
Three Months Ended March 31,
-----------------------------
1998
1999 restated
------------ ------------
BASIC EARNINGS PER SHARE COMPUTATION:
Net income $ 50,057 $ 39,741
============ ============
Weighted average shares outstanding 56,545,000 56,414,000
Contingently issued shares (251,000) (276,000)
------------ ------------
Adjusted weighted average shares 56,294,000 56,138,000
============ ============
Basic Earnings per share $ 0.89 $ 0.71
============ ============
DILUTED EARNINGS PER SHARE COMPUTATION:
Net income $ 50,057 $ 39,741
Preferred dividends, net of tax 946 946
------------ ------------
Income before preferred dividends $ 51,003 $ 40,687
============ ============
Weighted average shares outstanding 56,545,000 56,414,000
Contingently issued shares (167,000) (135,000)
Incremental shares from assumed conversions:
Stock options 2,002,000 1,862,000
Convertible preferred securities 2,938,000 2,938,000
------------ ------------
Total potential dilutive common shares 4,940,000 4,800,000
------------ ------------
Adjusted weighted average shares 61,318,000 61,079,000
============ ============
Diluted earnings per share $ 0.83 $ 0.67
============ ============
EXHIBIT 12
THE FINOVA GROUP INC.
COMPUTATION OF RATIO OF INCOME TO FIXED CHARGES
AND PREFERRED STOCK DIVIDENDS
(Dollars in Thousands)
Three Months Ended March 31,
-----------------------------
1998
1999 restated
------------ ------------
Income before income taxes and preferred
dividends $ 82,772 $ 66,686
Add fixed charges:
Interest expense 131,183 110,280
One-third rentals 1,111 926
-------- --------
Total fixed charges 132,294 111,206
-------- --------
Income as adjusted $215,066 $177,892
======== ========
Ratio of income to fixed charges 1.63 1.60
======== ========
Preferred stock dividends on a pre-tax basis $ 1,581 $ 1,581
Total fixed charges and preferred stock
dividends $133,875 $112,787
======== ========
Ratio of income to fixed charges and preferred
stock dividends 1.61 1.58
======== ========
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