UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C., 20549
FORM 10-Q/A-1
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
Commission file number 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 August 9, 1999, 61,990,404 shares of Common Stock ($0.01 par value) were
outstanding.
As of September 3, 1999, 61,159,000 shares of Common Stock ($0.01 par value)
were outstanding.
<PAGE>
THE FINOVA GROUP INC.
TABLE OF CONTENTS
Page No.
--------
Part I FINANCIAL INFORMATION............................................. 1
Item 1. Financial Statements.............................................. 1
Condensed Consolidated Balance Sheets................................. 1
Condensed Statements of Consolidated Income........................... 2
Condensed Statements of Consolidated Cash Flows....................... 3
Notes to Interim Condensed Consolidated Financial Information......... 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
Item 4. Submission of Matters to a Vote of Security Holders............... 16
Part II OTHER INFORMATION................................................. 16
Item 6. Exhibits and Reports on Form 8-K.................................. 16
Signatures................................................................ 17
<PAGE>
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
THE FINOVA GROUP INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
(Unaudited)
December 31,
June 30, 1998
1999 restated
------------ ------------
ASSETS:
Cash and cash equivalents $ 71,336 $ 49,518
Investment in financing transactions:
Loans and other financing contracts 8,596,590 7,354,736
Leveraged leases 804,455 773,942
Operating leases 651,856 648,185
Fee-based receivables 516,395 626,499
Direct financing leases 382,828 396,759
Financing contracts held for sale 243,542 220,100
------------ ------------
11,195,666 10,020,221
Less reserve for credit losses (237,602) (207,618)
------------ ------------
Net investment in financing transactions 10,958,064 9,812,603
Investments 226,096 124,792
Goodwill and other assets 601,036 454,323
------------ ------------
$ 11,856,532 $ 10,441,236
============ ============
LIABILITIES:
Accounts payable and accrued expenses $ 139,851 $ 154,137
Due to clients 98,244 205,655
Interest payable 75,975 65,817
Senior debt 9,523,630 8,394,578
Deferred income taxes 354,355 342,268
------------ ------------
10,192,055 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, 400,000,000 shares
authorized, 64,849,000 and 58,555,000 shares
issued, respectively 648 585
Additional capital 1,122,104 765,050
Retained income 600,035 515,057
Accumulated other comprehensive income 5,302 686
Common stock in treasury, 3,661,000 and 2,834,000
shares, respectively (175,162) (114,147)
------------ ------------
1,552,927 1,167,231
------------ ------------
$ 11,856,532 $ 10,441,236
============ ============
1
<PAGE>
THE FINOVA GROUP INC.
CONDENSED STATEMENTS OF CONSOLIDATED INCOME
(Dollars in Thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
---------------------------- ----------------------------
1998 1998
1999 restated 1999 restated
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Interest and income earned
from financing transactions $ 266,978 $ 214,643 $ 512,201 $ 414,813
Operating lease income 28,868 31,425 56,721 64,088
Interest expense (139,153) (114,696) (270,336) (224,975)
Operating lease depreciation (16,720) (20,495) (33,947) (37,665)
------------ ------------ ------------ ------------
Interest margins earned 139,973 110,877 264,639 216,261
Volume-based fees 11,264 19,104 23,999 41,259
------------ ------------ ------------ ------------
Operating margin 151,237 129,981 288,638 257,520
Provision for credit losses (17,000) (16,000) (26,500) (25,500)
------------ ------------ ------------ ------------
Net interest margins earned 134,237 113,981 262,138 232,020
Gains on disposal of assets 18,760 7,432 31,130 8,957
------------ ------------ ------------ ------------
152,997 121,413 293,268 240,977
Operating expenses (63,339) (53,207) (120,839) (106,085)
------------ ------------ ------------ ------------
Income before income taxes and
preferred dividends 89,658 68,206 172,429 134,892
Income taxes (35,050) (26,729) (66,819) (52,729)
------------ ------------ ------------ ------------
Income before preferred dividends 54,608 41,477 105,610 82,163
Preferred dividends, net of tax (945) (945) (1,891) (1,891)
------------ ------------ ------------ ------------
NET INCOME $ 53,663 $ 40,532 $ 103,719 $ 80,272
============ ============ ============ ============
Basic earnings per share $ 0.87 $ 0.72 $ 1.76 $ 1.43
============ ============ ============ ============
Adjusted weighted average shares
outstanding 61,412,000 56,230,000 58,869,000 56,189,000
============ ============ ============ ============
Diluted earnings per share $ 0.83 $ 0.68 $ 1.66 $ 1.34
------------ ------------ ------------ ------------
Adjusted weighted average shares
outstanding 66,042,000 61,138,000 63,693,000 61,092,000
============ ============ ============ ============
Dividends per common share $ 0.16 $ 0.14 $ 0.32 $ 0.28
============ ============ ============ ============
</TABLE>
2
<PAGE>
THE FINOVA GROUP INC.
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(Dollars in Thousands)
(Unaudited)
Six Months Ended June 30,
-------------------------
1999 1998
restated restated
----------- -----------
OPERATING ACTIVITIES:
Net income $ 103,719 $ 80,272
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for credit losses 26,500 25,500
Depreciation and amortization 49,204 48,836
Gains on disposal of assets (31,130) (8,957)
Deferred income taxes 55,017 22,084
Change in assets and liabilities, net of effects
from acquisitions:
Increase in other assets (35,444) (52,745)
Decrease in accounts payable and accrued expenses (64,953) (14,382)
Increase in interest payable 8,505 3,758
Other (5,057) 2,465
----------- -----------
Net cash provided by operating activities 106,361 106,831
----------- -----------
INVESTING ACTIVITIES:
Proceeds from sale of assets 92,312 167,065
Proceeds from sale of securitized assets 31,126
Proceeds from sale of commercial mortgage
backed securities ("CMBS") assets 168,294
Principal collections on financing transactions 1,181,835 902,960
Expenditures for financing transactions (1,630,586) (1,104,014)
Expenditures for CMBS transactions (280,624)
Net change in short-term financing transactions (490,811) (582,042)
Cash received in acquisition 20,942
Other 1,442 1,303
----------- -----------
Net cash used in investing activities (937,196) (583,602)
----------- -----------
FINANCING ACTIVITIES:
Net borrowings under commercial paper and
short-term loans 555,839 623,870
Long-term borrowings 955,000 610,000
Repayment of long-term borrowings (484,077) (653,316)
Proceeds from exercise of stock options 27,627 4,716
Common stock purchased for treasury (75,584) (9,771)
Dividends (18,741) (15,815)
Net change in due to clients (107,411) (83,326)
----------- -----------
Net cash provided by financing activities 852,653 476,358
----------- -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 21,818 (413)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 49,518 33,190
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 71,336 $ 32,777
=========== ===========
3
<PAGE>
THE FINOVA GROUP INC.
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL INFORMATION
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998
NOTE A BASIS OF PREPARATION
The consolidated 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 condensed 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 June 30, 1999, the
results of operations for the quarter and six months ended June 30, 1999 and
1998 and cash flows for the six months ended June 30, 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 connection 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.
Subsequent to the issuance of the Company's condensed consolidated
financial statements as of and for the six month period ended June 30, 1999, the
Company's management determined that certain noncash amounts had not been
properly reflected in the Condensed Statement of Consolidated Cash Flows. As a
result, the Condensed Statement of Consolidated Cash Flows for the six month
period ended June 30, 1999, has been restated from the amounts previously
reported.
NOTE B SIGNIFICANT ACCOUNTING POLICIES
The Company reports other comprehensive income in accordance with Statement
of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive
Income." Total comprehensive income was $72.7 million and $40.9 million for the
three months ended June 30, 1999 and 1998, respectively and $108.3 million and
$80.6 million for the six months ended June 30 1999 and 1998, respectively. The
primary component of comprehensive income other than net income was unrealized
holding gains.
NEW ACCOUNTING STANDARDS
In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivatives and
Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133,"
("SFAS No. 137"). This statement defers the effective date of SFAS No. 133 to
all fiscal quarters of all fiscal years beginning after June 15, 2000. SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS No.
133") 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. The impact of SFAS No. 133 on the Company's financial
position and results of operations has not yet been determined.
NOTE C 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 include each segment's investment in financing
transactions plus securitizations and participations sold.
4
<PAGE>
Information for FINOVA's reportable segments reconciles to FINOVA's consolidated
totals as follows:
Six Months Ended June 30,
------------------------------
Dollars in Thousands 1999 1998
------------ ------------
Total net revenue (loss):
Commercial Finance $ 104,273 $ 91,222
Specialty Finance 187,296 167,676
Capital Markets 39,468 16,717
Corporate and other (11,269) (9,138)
------------ ------------
Consolidated total $ 319,768 $ 266,477
============ ============
Income (loss) before allocations:
Commercial Finance $ 40,827 $ 34,081
Specialty Finance 153,278 135,148
Capital Markets 12,747 3,936
Corporate and other, overhead and
unallocated provision for credit losses (34,423) (38,273)
------------ ------------
Income from continuing operations
before income taxes $ 172,429 $ 134,892
============ ============
June 30,
------------------------------
1999 1998
------------ ------------
Managed assets:
Commercial Finance $ 3,351,296 $ 2,811,352
Specialty Finance 7,367,903 6,253,533
Capital Markets 892,234 261,784
Corporate and other 96,615 126,201
------------ ------------
Consolidated total 11,708,048 9,452,870
Less securitizations and participations sold (512,382) (502,032)
------------ ------------
Investment in financing transactions $ 11,195,666 $ 8,950,838
============ ============
NOTE D 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 $621 million, including $67 million in goodwill and $278 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.
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 six months ended June 30,
1999 and 1998.
5
<PAGE>
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 potential
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.
There can be no assurance that FINOVA will realize cost savings or synergies
from this or any other acquisition. Included in the historical operations of
Sirrom for the first six months of 1999 are approximately $27 million of
nonrecurring charges, a significant portion of which related to the acquisition.
Six Months Ended June 30,
Comparative Pro Forma Information -----------------------------
(Dollars in thousands, except per share data) 1999 1998
---------- ----------
Total revenue $ 584,249 $ 522,758
Net income $ 51,078 $ 66,199
Earnings per share - diluted $ .79 $ 1.07
Earnings per share - basic $ .83 $ 1.12
---------- ----------
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 (261,992)
----------
Estimated excess purchase price $ 80,738
==========
Allocation of excess:
Elimination of unamortized debt costs $ (3,227)
Deferred income taxes 44,152
Assumed liabilities (26,802)
Goodwill 66,615
----------
$ 80,738
==========
NOTE E 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 six months ended June 30,
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.
6
<PAGE>
A summary of the significant effects of the restatements for the three and
six months ended June 30, 1998 is as follows:
Three Months Ended Six Months Ended
June 30, 1998 June 30, 1998
---------------------- ----------------------
As previously As previously
Reported As restated Reported As restated
--------- --------- --------- ---------
Interest margins earned $ 114,142 $ 110,877 $ 222,799 $ 216,261
Gains on disposal of assets 9,582 7,432 10,805 8,957
Operating expenses (57,779) (53,207) (114,737) (106,085)
Net income 41,035 40,532 80,112 80,272
Basic earnings per share $ 0.73 $ 0.72 $ 1.43 $ 1.43
Diluted earnings per share $ 0.69 $ 0.68 $ 1.34 $ 1.34
--------- --------- --------- ---------
NOTE F EARNINGS PER SHARE
Basic earnings per share exclude the effects of dilution and are computed
by dividing income available to common shareowners by the weighted average
amount of common stock outstanding for the period. Diluted earnings per share
reflect the potential dilution that could occur if options, convertible
preferred stock or other contracts to issue stock were exercised or converted
into common stock. These per share calculations are presented for the three and
six months ended June 30, 1999 and 1998 on the Condensed Statements of
Consolidated Income and are detailed below:
7
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------- ----------------------------
1998 1998
1999 RESTATED 1999 RESTATED
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
BASIC EARNINGS PER SHARE COMPUTATION:
Net income $ 53,663 $ 40,532 $ 103,719 $ 80,272
============ ============ ============ ============
Weighted averaverage shares outstanding 61,660,000 56,497,000 59,117,000 56,456,000
Contingently issued shares (248,000) (267,000) (248,000) (267,000)
------------ ------------ ------------ ------------
Adjusted weighted average shares 61,412,000 56,230,000 58,869,000 56,189,000
============ ============ ============ ============
Basic earnings per share $ 0.87 $ 0.72 $ 1.76 $ 1.43
============ ============ ============ ============
DILUTED EARNINGS PER SHARE COMPUTATION:
Net income $ 53,663 $ 40,532 $ 103,719 $ 80,272
Preferred dividends, net of tax 945 945 1,891 1,891
------------ ------------ ------------ ------------
Income before preferred dividends $ 54,608 $ 41,477 $ 105,610 $ 82,163
============ ============ ============ ============
Weighted average shares outstanding 61,660,000 56,497,000 59,117,000 56,456,000
Contingently issued shares (165,000) (185,000) (165,000) (185,000)
Incremental shares from assumed conversions:
Stock options 1,609,000 1,888,000 1,803,000 1,883,000
Convertible preferred securities 2,938,000 2,938,000 2,938,000 2,938,000
------------ ------------ ------------ ------------
Total potential dilutive common shares 4,547,000 4,826,000 4,741,000 4,821,000
------------ ------------ ------------ ------------
Adjusted weighted average shares 66,042,000 61,138,000 63,693,000 61,092,000
============ ============ ============ ============
Diluted earnings per share $ 0.83 $ 0.68 $ 1.66 $ 1.34
============ ============ ============ ============
</TABLE>
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
JUNE 30, 1999
(Dollars in Thousands)
<TABLE>
<CAPTION>
Revenue Accruing Nonaccruing
----------------------------------- -------------------------------- Total
Market Repossessed Repossessed Leases & Carrying
Rate (1) Impaired Assets (2) Impaired Assets Other Amount %
----------- ----------- -------- ----------- -------- -------- ----------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Transportation Finance (3) 2,063,772 $ 58,888 $ $ $ $ 7,295 $ 2,129,955 19.0
Resort Finance 1,316,295 28,520 16,413 3,292 24,775 1,389,295 12.4
Rediscount Finance 931,732 18,558 752 341 951,383 8.5
Corporate Finance 849,257 34,109 41,947 931 926,244 8.3
Commercial Equipment Finance 751,904 4,074 5,067 9,432 19,699 2,087 792,263 7.1
Specialty Real Estate Finance 683,957 16,837 31,425 9,632 7,649 194 749,694 6.7
Franchise Finance 721,173 1,448 7,039 2,849 217 732,726 6.5
Healthcare Finance 620,510 730 6,019 4,692 973 632,924 5.6
Communications Finance 553,649 5,546 21,413 580,608 5.2
Distribution & Channel Finance 428,705 69,635 13,267 511,607 4.6
Mezzanine Capital 440,273 16,357 456,630 4.1
Realty Capital 414,788 414,788 3.7
Business Credit 330,754 5,520 16,365 352,639 3.2
Public Finance 217,470 217,470 1.9
Commercial Services 174,822 1,057 5,607 873 182,359 1.6
Other (4) 68,771 27,844 96,615 0.9
Growth Finance 54,105 3,544 57,649 0.5
Investment Alliance 20,276 541 20,817 0.2
----------- -------- ------- -------- ------- ------- ----------- -----
TOTAL (5) $10,642,213 $226,364 $77,482 $153,880 $57,117 $38,610 $11,195,666 100.0
=========== ======== ======= ======== ======= ======= =========== =====
</TABLE>
NOTES:
(1) Represents original or renegotiated market rate terms, excluding impaired
transactions.
(2) The Company earned income totaling $2.9 million on repossessed assets year
to date during 1999, including $1.1 million in Specialty Real Estate
Finance, $0.6 million in Resort Finance, $0.3 million in Healthcare
Finance, $0.8 million in Rediscount Finance and $0.1 million in Commercial
Equipment Finance.
(3) Transportation Finance includes $454.9 million of aircraft financing
business booked through the London office.
(4) Primarily includes other assets retained from disposed or discontinued
operations.
(5) Excludes $512.4 million of assets securitized and participations sold which
the Company manages, including securitizations of $300.0 million in
Corporate Finance and $127.3 million in Franchise Finance and
participations of $50.7 million in Corporate Finance, $10.7 million in
Rediscount Finance, $9.6 in Transportation Finance, $8.1 million in
Business Credit and $6.0 million in Resort Finance.
9
<PAGE>
RESERVE FOR CREDIT LOSSES:
The reserve for credit losses at June 30, 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:
Six months Ended June 30,
----------------------------
1999 1998
--------- ---------
(Dollars in Thousands)
Balance, beginning of period $ 207,618 $ 177,088
Provision for credit losses 26,500 25,500
Write-offs (26,097) (28,272)
Recoveries 1,442 1,285
Reserves related to acquisitions 23,763 2,460
Other 4,376 9
--------- ---------
Balance, end of period $ 237,602 $ 178,070
========= =========
At June 30, 1999 the total carrying amount of impaired loans was $380.2
million, of which $226.4 million were revenue accruing. A reserve for credit
losses of $41.1 million has been established for $87.8 million of nonaccruing
impaired loans and $40.6 million has been established for $126.1 million of
accruing impaired loans. The remaining $155.9 million of the reserve for credit
losses is designated for general purposes and represents management's best
estimate of inherent 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 SIX MONTHS ENDED JUNE 30, 1999
TO THE SIX MONTHS ENDED JUNE 30, 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").
Net income for 1998 has been restated to reflect adjustments described in
the Company's report on Form 10-K/A Amendment No. 2 for the year ended December
31, 1998. The effects of the restatements for the six months ended June 30, 1998
are presented in Note E of the Notes to Interim Consolidated Financial
Statements, and have been reflected herein.
RESULTS OF OPERATIONS
Net income for the six months ended June 30, 1999 was $103.7 million ($1.66
per diluted share) compared to $80.3 million ($1.34 per diluted share) for the
six months ended June 30, 1998. The 1999 earnings per share computation includes
a higher average share count primarily due to the 6.3 million additional shares
issued in connection with the acquisitions of Sirrom Capital Corporation and
Preferred Business Credit, Inc. 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 increased by 22% and rose to $264.6 million in the six
months ended June 30, 1999 from $216.3 million in the same period in 1998.
10
<PAGE>
Interest margins earned as a percentage of average earning assets decreased
slightly to 5.2% for the first six months of 1999 from 5.3% for the six months
ended June 30, 1998. The decrease was primarily the result of higher interest
rate spreads on short-term borrowings and higher leverage for the Company in the
first quarter of 1999 (both of which recovered in the second quarter of 1999),
as well as lower pricing in the highly competitive asset-based lending lines of
business.
VOLUME-BASED FEES. Volume-based fees are generated by FINOVA's Distribution
& Channel Finance, Commercial Services and Realty Capital lines of business.
These fees are predominately based on volume-originated business rather than the
balance of outstanding financing transactions during the period. For the six
months ended June 30, 1999, volume-based fees were $24.0 million compared to
$41.3 million for the same period in 1998. Increased competition and a strategic
decision to limit the size of Realty Capital led to lower fee-based volume for
the first six months of 1999 compared to the first six months of 1998 ($3.0
billion vs. $3.8 billion) and to reduced commission rates earned on that volume
(0.80% vs. 1.10%). Primarily as a result of the decreases in fee-based volume
and commission rates earned on that volume, operating margin as a percentage of
average earning assets declined to 5.7% for the first six months of 1999 from
6.3% in the first six months of 1998.
PROVISION FOR CREDIT LOSSES. The provision for credit losses was $26.5
million for the six months ended June 30, 1999 compared to $25.5 million for the
same period last year. Net write-offs during the first six months of 1999 were
$24.7 million compared to $27.0 million for the same period in 1998. Corporate
Finance incurred nearly half of the Company's net write-offs in the first half
of 1999 ($12.1 million in 1999 vs. $2.4 million in the first six months of
1998). Net write-offs in Commercial Services were $3.1 million in the first half
of 1999 compared to $17.4 million in the first half of 1998. Net write-offs in
other lines of business for the first six months of 1999 were comparable to net
write-offs in the first six months of 1998.
GAINS ON DISPOSAL OF ASSETS. Gains on disposal of assets were $31.1 million
for the six months ended June 30, 1999 compared to $9.0 million for the first
six months of 1998. Net gains of $10.6 million were earned from the sale of
assets through CMBS transactions in the first half of 1999 ($9.5 million
resulted from mini-CMBS transactions). Including the $10.0 million loss reported
in 1998, the completed mini-CMBS transaction has resulted in a net loss of $500
thousand through June 30, 1999. No additional losses are anticipated from this
transaction. The remaining gains on disposal of assets in the first six months
of 1999 primarily related to 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 are sporadic in nature. 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 EXPENSES. Operating expenses increased $14.7 million to $120.8
for the first six months of 1999 compared to $106.1 million for the first six
months of 1998. This increase was attributable to Company growth including the
addition of 177 employees (primarily through acquisitions) through the twelve
months ended June 30, 1999. Operating expenses improved as a percentage of
operating margins plus gains to 37.8% for the six months ended June 30, 1999
from 39.8% in the comparable period in 1998.
INCOME TAXES. Income taxes were higher for the first six months of 1999
compared to the corresponding period in 1998 primarily due to the increase in
pre-tax income.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Managed assets were $11.71 billion at June 30, 1999 compared to $10.56
billion at December 31, 1998. Included in managed assets at June 30, 1999 were
$11.20 billion in funds employed (including $243.5 million of financing
contracts held for sale generated by FRC), $427.3 million of securitized assets
managed by FINOVA and $85.0 million of participations sold to third parties. The
increase in managed assets was due to funded new business of $2.14 billion for
the six months ended June 30, 1999, compared to $1.45 billion for the six months
ended June 30, 1998, plus managed assets acquired in the first quarter of 1999
of $486 million, partially offset by an unusually high amount of prepayments and
asset sales accompanied by normal portfolio amortization.
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The reserve for credit losses increased to $237.6 million at June 30, 1999
from $207.6 million at December 31, 1998. At June 30, 1999, the reserve for
credit losses represented 2.1% of ending managed assets (excluding
participations and financing contracts held for sale) compared to 2.0% at year
end. Nonaccruing assets increased to $249.6 million or 2.1% of ending managed
assets (excluding participations) at June 30, 1999 from $205.2 million or 2.0%
of ending managed assets (excluding participations) at the end of 1998. Both the
reserve and nonaccruing assets increased in part due to the acquisition of
Sirrom Capital Corporation in the first quarter of 1999.
At June 30, 1999, FINOVA had $9.52 billion of debt outstanding,
representing 5.72 times the Company's equity base of $1.66 billion (including
$111.6 million of convertible preferred securities). Included in debt at June
30, 1999 was approximately $4.30 billion of commercial paper and short-term
borrowings supported by unused long-term revolving-credit agreements. At
year-end 1998, FINOVA's debt was 6.56 times the equity base of $1.28 billion.
The reduction in the Company's leverage was primarily the result of adding $343
million of equity in conjunction with the Sirrom acquisition partially offset by
the repurchase of 1.5 million shares which reduced outstanding equity by $75.6
million during the first six months of 1999.
Growth in funds employed is financed by FINOVA's internally generated funds
and new borrowings. During the six months ended June 30, 1999, FINOVA issued
$1.06 billion of new long-term borrowings and recognized a net increase in
commercial paper outstanding of $555.8 million. During the same period, FINOVA
repaid $484.1 million of long-term borrowings.
FINOVA repurchased 1,525,000 shares of its common stock during the first
six months of 1999. These shares are intended to fund awards under FINOVA's
stock incentive plan or for other uses approved by the Company's Board or its
Executive Committee.
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 revenue, income before allocations and
managed assets in evaluating the business performance of each reportable
segment.
Total 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 $104.3 million in 1999 compared to $91.2 for the
first six months of 1998, an increase of 14.3%. The increase was primarily due
to a 19.2% increase in managed assets over the first six months of 1998,
partially offset by competitive pricing for asset-based lending business, a
decrease in fee-based volume and a 24 basis point decline in the average rate
earned on that volume. Overall, fee-based volume decreased to $2.07 billion in
1999 from $2.24 billion in the first six months of 1998.
Income before allocations increased 19.8% to $40.8 million in 1999 compared
to $34.1 million in the first six months of 1998. In addition to portfolio
growth, the increase resulted from lower net write-offs in 1999 in the
Commercial Services line of business ($3.1 million in 1999 vs. $17.4 million in
the first half of 1998), partially offset by higher net write-offs in Corporate
Finance ($12.1 million in 1999 vs. $2.4 million in the first half of 1998).
Three unusually large write-offs in Corporate Finance in 1999 totaled $9.4
million.
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Managed assets grew to $3.35 billion in the first six months of 1999 from
$2.81 billion in the same period in 1998. Rediscount Finance was the largest
contributor, with an increase in managed assets of 45% over June 30, 1998. The
addition of Growth Finance, which is composed of two small acquisitions, also
added to the growth in managed assets at June 30, 1999. New term loan and lease
business in Commercial Finance for the first six months of 1999 was $642.6
million compared to $377.1 for the first six months of 1998. Growth in this
segment was partially offset by prepayments of $225.6 million in the first half
of 1999 which exceeded prepayments of $154.8 million in the first half of 1998.
SPECIALTY FINANCE. Specialty Finance includes businesses that lend to a
variety of highly focused industry-specific niches.
Total net revenue increased 11.7% to $187.3 million in the first six months
of 1999, compared to $167.7 million in the same period of 1998. The increase in
revenue was attributable to 17.8% growth in managed assets, partially offset by
lower yields on new business in Resort Finance due to competitive pressures and
a reduction in lease income. The reduction in lease income was due to the
refinancing of non-recourse debt in a leveraged lease in the Specialty Real
Estate Finance portfolio which increased income in 1998, and to Healthcare
Finance experiencing a reduction in lease income in 1999 due to assets coming
off lease.
Income before allocations increased 13.4% to $153.3 million for the six
months ended June 30, 1999 from $135.1 million for the same period in 1998. The
increase in income was primarily due to the growth in total net revenue over the
six months ended June 30, 1998, while write-offs and operating expenses in total
for the first half of 1999 were only $1.5 million higher than for the first half
of 1998.
Managed assets grew to $7.37 billion in the first six months of 1999 from
$6.25 billion in the same period of 1998, an increase of 17.8%. The growth in
managed assets was driven by new term loan and lease business of $1.39 billion
during the 1999 period, compared to $1.07 billion in 1998, partially offset by a
39.1% increase in prepayments and asset sales in 1999 over the same period in
1998. Communications Finance recorded the highest amount of prepayments ($162.3
million in 1999 vs. $14.7 million in the first half of 1998), most of which
occurred due to acquisitions and consolidations in the communications industry.
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 late in the first quarter of 1999.
Total net revenue increased to $39.5 million in the six months ended June
30, 1999 from $16.7 million in the same period of 1998. The increase was
primarily due to the acquisition of Mezzanine Capital and to the recognition of
$10.6 million in gains in Realty Capital ($9.5 million of which resulted from
mini-CMBS transactions) in the 1999 period, compared to no gain or loss on
disposal of assets for the same period in 1998.
Income before allocations increased to $12.7 million in the first six
months of 1999 from $3.9 million in the first six months of 1998. The increase
in income was primarily due to higher total net revenue in the first six months
of 1999 than in the same period in 1998.
Managed assets increased to $892.2 million at June 30, 1999 from $261.8
million at June 30, 1998. The acquisition of Mezzanine Capital in the first
quarter of 1999 added $469 million of managed assets to the segment. The
remaining increase was due to the additional fundings of Realty Capital's
held-to-maturity portfolio and continued origination of CMBS loans, partially
offset by sales of $167.3 million in assets in the first six months of 1999.
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
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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 June 30, 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 were migrated to compliant systems during the
second quarter. FINOVA intends to promptly address year 2000 issues for any
acquisitions consummated after this filing. Where appropriate, 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
have not been and 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. As of June 30, 1999, FINOVA has incurred expenses
of $207,000 and capital costs of $1.7 million related to year 2000 compliance
efforts. FINOVA estimates that 90% of anticipated costs have been recognized but
will continue to review and revise these figures as necessary on a quarterly
basis.
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 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.
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FINOVA is developing contingency plans for the change in century by
reviewing departmental needs and establishing procedures to operate manually in
the event of a system failure. Existing Business Resumption Plans are expected
to be updated by the end of the third quarter to address year 2000 issues as
well as various other potential business interruptions. Vacation schedules and
holiday schedules are being adjusted to help assure that sufficient staffing is
available to address material problems. Critical support relationships will be
contacted to help assure that they will be capable of servicing material issues
that should arise in a prompt manner. There can be no assurance, however, that
trained technical support personnel will be available at that time, as demand
for their services could grow considerably.
RECENT DEVELOPMENTS AND BUSINESS OUTLOOK
On July 15, 1999, FINOVA dismissed their independent auditors, Deloitte &
Touche LLP. On that date, the Company appointed Ernst & Young LLP as independent
auditors for the Company.
From July 1, 1999 to August 13, 1999 FINOVA repurchased 290,000 shares of
its common stock. These shares are intended to fund awards under FINOVA's stock
incentive plan or for other uses approved by the Company's Board or its
Executive Committee.
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.
NEW ACCOUNTING STANDARDS
In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivatives and
Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133,"
("SFAS No. 137"). This statement defers the effective date of SFAS No. 133 to
all fiscal quarters of all fiscal years beginning after June 15, 2000. SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS No.
133") standarizes 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. The impact of SFAS No. 133 on the Company's financial
position and results of operations has not yet been determined.
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.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Shareowners of the Company was held on May 13, 1999.
At that meeting, Shareowners owing 49,973,058 shares of the Company's common
stock ("Shares") were present in person or by proxy. The Shareowners approved
each matter submitted by the following votes:
Item For Against Abstain*
---- --- ------- --------
1. Election of Ms. Connie R. Curran
as a Director 49,843,445 N/A 129,613
Election of Mr. G. Robert Durham
as a Director 49,826,435 N/A 146,623
Election of Mr. Kenneth R. Smith
as a Director 49,833,814 N/A 139,224
2. Increase in the number of shares
of common stock authorized from
100 million to 400 million shares
and the number of preferred shares
from 5 million to 20 million 28,296,390 17,308,897 4,367,770
3. Appointment of Deloitte & Touche LLP
as Auditors for 1999** 49,184,605 727,304 61,148
* Abstain includes broker non-votes.
** See "Recent Developments and Business Outlook" above.
PART II OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) The following exhibits are filed herewith:
Exhibit No. Document
- ----------- --------
3 Amended and Restated Certificate of Incorporation of the
Company (incorporated by reference from the Company's
Registration Statement on Form S-3/A, SEC File No. 333-74473,
filed on May 28, 1999, Exhibit 4.1).
12 Computation of Ratio of Income to Fixed Charges and Preferred
Stock Dividends (interim period). (incorporated by reference
from the Company's Form 10-Q for the period ended June 30,
1999, filed on August 13, 1999.
27 Financial Data Schedule (incorporated by reference from the
Company's Form 10-Q for the period ended June 30, 1999,
filed on August 13, 1999.
(b) Reports on Form 8-K:
A report on Form 8-K, dated July 15, 1999 was filed by Registrant
which reported under Items 4, 5 and 7 a change in FINOVA's certifying
accountant to Ernst & Young LLP from Deloitte & Touche LLP, and the
revenues, net income and selected financial data and ratios for the second
quarter ended June 30, 1999 (unaudited).
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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: September 8, 1999 By: /s/ Bruno A. Marszowski
----------------------------------------
Bruno A. Marszowski, Senior Vice
President, Chief Financial Officer and
Controller Principal Financial and
Accounting Officer
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