================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 2008
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 001-14237
FINANCIAL FEDERAL CORPORATION
(Exact name of Registrant as specified in its charter)
Nevada 88-0244792
(State of incorporation) (I.R.S. Employer Identification No.)
733 Third Avenue, New York, New York 10017
(Address of principal executive offices)
Registrant's telephone number, including area code (212) 599-8000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
the definitions of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ]
Smaller reporting company [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes [ ] No [X]
The number of shares outstanding of the registrant's common stock on December 1,
2008 was 25,835,442.
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FINANCIAL FEDERAL CORPORATION AND SUBSIDIARIES
Quarterly Report on Form 10-Q
for the quarter ended October 31, 2008
TABLE OF CONTENTS
Part I - Financial Information Page No.
---------------------------------------------------------------------- --------
Item 1. Financial Statements:
Consolidated Balance Sheets at October 31, 2008 (unaudited)
and July 31, 2008 (audited) 1
Consolidated Income Statements for the three months ended
October 31, 2008 and 2007 (unaudited) 2
Consolidated Statements of Changes in Stockholders' Equity
for the three months ended October 31, 2008 and 2007
(unaudited) 3
Consolidated Statements of Cash Flows for the three months
ended October 31, 2008 and 2007 (unaudited) 4
Notes to Consolidated Financial Statements (unaudited) 5-11
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12-21
Item 3. Quantitative and Qualitative Disclosures about Market Risk 21
Item 4. Controls and Procedures 21
Part II - Other Information
----------------------------------------------------------------------
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 22
Item 5. Other Information 22
Item 6. Exhibits 22
Signatures 23
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
FINANCIAL FEDERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
===========================================================================================
October 31, 2008* July 31, 2008
===========================================================================================
ASSETS
Finance receivables $ 1,885,488 $ 1,940,792
Allowance for credit losses (24,789) (24,769)
-------------------------------------------------------------------------------------------
Finance receivables - net 1,860,699 1,916,023
Cash 10,319 8,232
Other assets 20,082 18,613
-------------------------------------------------------------------------------------------
TOTAL ASSETS $ 1,891,100 $ 1,942,868
===========================================================================================
LIABILITIES
Debt:
Long-term ($3,200 at October 31, 2008 and $1,400 at
July 31, 2008 owed to related parties) $ 1,173,000 $ 1,189,000
Short-term 235,000 278,000
Accrued interest, taxes and other liabilities 57,927 60,996
-------------------------------------------------------------------------------------------
Total liabilities 1,465,927 1,527,996
-------------------------------------------------------------------------------------------
STOCKHOLDERS' EQUITY
Preferred stock - $1 par value, authorized 5,000 shares -- --
Common stock - $.50 par value, authorized 100,000 shares,
shares issued and outstanding (net of 1,696 treasury
shares): 25,839 at October 31, 2008 and 25,673 at
July 31, 2008 12,919 12,836
Additional paid-in capital 141,769 139,490
Retained earnings 272,844 265,026
Accumulated other comprehensive loss (2,359) (2,480)
-------------------------------------------------------------------------------------------
Total stockholders' equity 425,173 414,872
-------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,891,100 $ 1,942,868
===========================================================================================
* Unaudited
See accompanying notes to consolidated financial statements
1
FINANCIAL FEDERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS *
(In thousands, except per share amounts)
============================================================================================
Three Months Ended October 31, 2008 2007
============================================================================================
Finance income $ 42,993 $ 49,596
Interest expense 15,386 22,081
--------------------------------------------------------------------------------------------
Net finance income before provision for credit
losses on finance receivables 27,607 27,515
Provision for credit losses on finance receivables 1,400 400
--------------------------------------------------------------------------------------------
Net finance income 26,207 27,115
Salaries and other expenses 7,169 6,509
--------------------------------------------------------------------------------------------
Income before provision for income taxes 19,038 20,606
Provision for income taxes 7,359 7,940
--------------------------------------------------------------------------------------------
NET INCOME $ 11,679 $ 12,666
============================================================================================
EARNINGS PER COMMON SHARE:
Diluted $ 0.47 $ 0.50
============================================================================================
Basic $ 0.48 $ 0.51
============================================================================================
* Unaudited
See accompanying notes to consolidated financial statements
2
FINANCIAL FEDERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY *
(In thousands)
====================================================================================================
Accumulated
Common Stock Additional Other
---------------- Paid-In Retained Comprehensive
Shares Amount Capital Earnings (Loss) Income Total
====================================================================================================
BALANCE - JULY 31, 2007 25,760 $12,880 $129,167 $244,646 $ 1,060 $387,753
Net income -- -- -- 12,666 -- 12,666
Unrealized loss on cash flow
hedge, after $(372) of tax -- -- -- -- (588) (588)
Reclassification of realized
gain in net income, after
$(40) of tax -- -- -- -- (62) (62)
--------
Comprehensive income 12,016
--------
Stock repurchased (retired) (423) (212) (2,197) (9,602) -- (12,011)
Stock plan activity:
Shares issued 323 162 1,727 -- -- 1,889
Compensation recognized -- -- 1,914 -- -- 1,914
Excess tax benefits -- -- 243 -- -- 243
Common stock cash dividends -- -- -- (3,888) -- (3,888)
----------------------------------------------------------------------------------------------------
BALANCE - OCTOBER 31, 2007 25,660 $12,830 $130,854 $243,822 $ 410 $387,916
====================================================================================================
====================================================================================================
Accumulated
Common Stock Additional Other
---------------- Paid-In Retained Comprehensive
Shares Amount Capital Earnings (Loss) Income Total
====================================================================================================
BALANCE - JULY 31, 2008 25,673 $12,836 $139,490 $265,026 $(2,480) $414,872
Net income -- -- -- 11,679 -- 11,679
Reclassification of realized
net loss in net income,
after $76 of tax -- -- -- -- 121 121
--------
Comprehensive income 11,800
--------
Stock repurchased (retired) (4) (2) (81) -- -- (83)
Stock plan activity:
Shares issued 170 85 369 -- -- 454
Compensation recognized -- -- 2,004 -- -- 2,004
Tax shortfall -- -- (13) -- -- (13)
Common stock cash dividends -- -- -- (3,861) -- (3,861)
----------------------------------------------------------------------------------------------------
BALANCE - OCTOBER 31, 2008 25,839 $12,919 $141,769 $272,844 $(2,359) $425,173
====================================================================================================
* Unaudited
See accompanying notes to consolidated financial statements
3
FINANCIAL FEDERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS *
(In thousands)
============================================================================================
Three Months Ended October 31, 2008 2007
============================================================================================
Cash flows from operating activities:
Net income $ 11,679 $ 12,666
Adjustments to reconcile net income to net cash provided
by operating activities:
Amortization of deferred origination costs and fees 4,463 4,220
Stock-based compensation 1,186 1,191
Provision for credit losses on finance receivables 1,400 400
Depreciation and amortization 382 93
Decrease in other assets 379 679
(Decrease) increase in accrued interest, taxes and
other liabilities (3,158) 409
Tax shortfall (excess tax benefits) from stock-based
awards 13 (243)
--------------------------------------------------------------------------------------------
Net cash provided by operating activities 16,344 19,415
--------------------------------------------------------------------------------------------
Cash flows from investing activities:
Finance receivables originated (225,007) (258,831)
Finance receivables collected and repossessed assets
sales proceeds 273,253 258,143
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Net cash provided by (used in) investing activities 48,246 (688)
--------------------------------------------------------------------------------------------
Cash flows from financing activities:
Bank borrowings, net increase 8,000 477,242
Commercial paper, net decrease (49,000) (219,492)
Repayments of term asset securitization borrowings (18,000) --
Asset securitization borrowings - revolving, net decrease -- (229,500)
Repayments of term notes -- (31,250)
Proceeds from stock option exercises 454 1,889
(Tax shortfall) excess tax benefits from stock-based awards (13) 243
Common stock repurchased (83) (12,011)
Common stock cash dividends (3,861) (3,888)
--------------------------------------------------------------------------------------------
Net cash used in financing activities (62,503) (16,767)
--------------------------------------------------------------------------------------------
NET INCREASE IN CASH 2,087 1,960
Cash - beginning of period 8,232 5,861
--------------------------------------------------------------------------------------------
CASH - END OF PERIOD $ 10,319 $ 7,821
============================================================================================
* Unaudited
See accompanying notes to consolidated financial statements
4
FINANCIAL FEDERAL CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
(Unaudited)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
Financial Federal Corporation and subsidiaries (the "Company") provide
collateralized lending, financing and leasing services nationwide to small and
medium sized businesses in the general construction, road and infrastructure
construction and repair, road transportation and refuse industries. We lend
against, finance and lease a wide range of new and used revenue-producing,
essential-use equipment including cranes, earthmovers, personnel lifts, trailers
and trucks.
Basis of Presentation and Principles of Consolidation
We prepared the accompanying unaudited Consolidated Financial Statements
according to the Securities and Exchange Commission's rules and regulations.
These rules and regulations permit condensing or omitting certain information
and note disclosures normally included in financial statements prepared
according to accounting principles generally accepted in the United States of
America (GAAP). The July 31, 2008 Consolidated Balance Sheet was derived from
audited financial statements but does not include all disclosures required by
GAAP. However, we believe the disclosures are sufficient to make the information
presented not misleading. These Consolidated Financial Statements and
accompanying notes should be read with the Consolidated Financial Statements and
accompanying notes included in our Annual Report on Form 10-K for the fiscal
year ended July 31, 2008.
In our opinion, the Consolidated Financial Statements include all
adjustments (consisting of only normal recurring items) necessary to present
fairly our financial position and results of operations for the periods
presented. The results of operations for the three months ended October 31, 2008
may not be indicative of full year results.
Use of Estimates
GAAP requires us to make significant estimates and assumptions to record
the amounts reported in the Consolidated Financial Statements and accompanying
notes for the allowance for credit losses, non-performing assets, residual
values, income taxes and stock-based compensation. Actual results could differ
from these estimates significantly.
New Accounting Standards
Statement of Financial Accounting Standards ("SFAS") No. 157, "Fair Value
Measurements" ("SFAS No. 157") and SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities - Including an amendment of FASB
Statement No. 115" became effective for us on August 1, 2008. SFAS No. 157
defines fair value (replacing all prior definitions) and creates a framework to
measure fair value, but does not create any new fair value measurements. SFAS
No. 159 permits companies to choose to measure many financial instruments and
certain other items at fair value at specified election dates and to report
unrealized gains and losses on these items in earnings at each subsequent
reporting date. We did not choose to measure any financial instruments or other
items at fair value. The only items we measure at fair value are impaired
finance receivables and assets received to satisfy finance receivables
(repossessed equipment, included in other assets). We were required to measure
these items at fair value before these statements took effect and these
statements did not change how we determine their fair value materially.
Therefore, these statements did not have a material impact on our consolidated
financial statements.
The FASB issued Staff Position ("FSP") EITF 03-6-1, "Determining Whether
Instruments Granted in Share-Based Payment Transactions Are Participating
Securities", in June 2008. Securities participating in dividends with common
stock according to a formula are participating securities. This FSP determined
unvested shares of restricted stock and stock units with nonforfeitable rights
to dividends are participating securities. Participating securities require the
"two-class" method to be used to calculate basic earnings per share. This method
lowers basic earnings per common share. This FSP takes effect in the first
quarter of fiscal years beginning after December 15, 2008 and will be applied
retrospectively for all periods presented. It will take effect for us on August
1, 2009. We have 1,316,000 unvested shares of restricted stock and stock units
with nonforfeitable rights to dividends. Based on this amount, our current
dividend rate and number of shares of common stock outstanding, we estimate
applying this FSP would reduce annual basic earnings per common share by $0.10.
This FSP will not affect diluted earnings per share or net income.
5
The FASB issued FSP APB 14-1, "Accounting for Convertible Debt Instruments
That May Be Settled in Cash upon Conversion (Including Partial Cash
Settlements)", in May 2008. This FSP requires a portion of this type of
convertible debt to be recorded as equity and to record interest expense on the
debt portion at a rate that would have been charged on non-convertible debt with
the same terms. This FSP takes effect in the first quarter of fiscal years
beginning after December 15, 2008 and will be applied retrospectively for all
periods presented. It will take effect for us on August 1, 2009. This FSP will
apply to our 2.0% convertible debentures and we are evaluating how it may affect
our consolidated financial statements.
NOTE 2 - FINANCE RECEIVABLES
Finance receivables comprise installment sale agreements and secured loans
(including line of credit arrangements), collectively referred to as loans, with
fixed or floating (indexed to the prime rate) interest rates, and direct
financing leases as follows:
==================================================================
October 31, 2008 July 31, 2008
==================================================================
Loans:
Fixed rate $1,562,789 $1,592,839
Floating rate 162,904 168,793
------------------------------------------------------------------
Total loans 1,725,693 1,761,632
Direct financing leases * 159,795 179,160
------------------------------------------------------------------
Finance receivables $1,885,488 $1,940,792
==================================================================
* includes residual values of $36,900 at October 31, 2008 and
$42,300 at July 31, 2008
Line of credit arrangements contain off-balance sheet risk and are subject
to the same credit policies and procedures as other finance receivables. The
unused portion of these commitments was $25,300 at October 31, 2008 and $21,600
at July 31, 2008.
Allowance for credit losses activity is summarized below:
==================================================================
Three Months Ended October 31, 2008 2007
==================================================================
Allowance - beginning of period $ 24,769 $ 23,992
Provision 1,400 400
Write-downs (2,122) (973)
Recoveries 742 601
------------------------------------------------------------------
Allowance - end of period $ 24,789 $ 24,020
==================================================================
Percentage of finance receivables 1.31% 1.13%
==================================================================
Net charge-offs * $ 1,380 $ 372
==================================================================
Loss ratio ** 0.29% 0.07%
==================================================================
* write-downs less recoveries
** net charge-offs over average finance receivables, annualized
Non-performing assets comprise impaired finance receivables and assets
received to satisfy finance receivables as follows:
==================================================================
October 31, 2008 July 31, 2008
==================================================================
Impaired finance receivables $ 30,704 $ 33,542
Assets received to satisfy
finance receivables 15,215 13,182
------------------------------------------------------------------
Non-performing assets $ 45,919 $ 46,724
==================================================================
The allowance for credit losses included $900 at October 31, 2008 and
July 31, 2008 specifically allocated to $9,600 and $9,400 respectively, of
impaired finance receivables. We did not recognize any income in the three
months ended October 31, 2008 or 2007 on impaired receivables before collecting
our net investment. We repossessed assets to satisfy $15,600 and $1,900 of
finance receivables in the three months ended October 31, 2008 and 2007,
respectively.
6
We recorded $8,900 of impaired finance receivables based on the fair value
of the collateral and $8,400 of assets received to satisfy finance receivables
at fair value at October 31, 2008. We measured fair value using significant
other observable inputs (Level 2); primarily quoted prices in active markets for
identical or similar assets adjusted for their condition.
NOTE 3 - DEBT
Debt is summarized below:
=========================================================================
October 31, 2008 July 31, 2008
=========================================================================
Fixed rate term notes:
4.31% - 4.60% due 2013 $ 75,000 $ 75,000
4.96% - 5.00% due 2010 - 2011 275,000 275,000
5.45% - 5.57% due 2011 - 2014 325,000 325,000
-------------------------------------------------------------------------
Total fixed rate term notes 675,000 675,000
2.0% convertible debentures due 2034 175,000 175,000
Asset securitization borrowings - term 151,000 169,000
-------------------------------------------------------------------------
Total term debt 1,001,000 1,019,000
Bank borrowings 377,000 369,000
Commercial paper 30,000 79,000
-------------------------------------------------------------------------
Total debt $1,408,000 $1,467,000
=========================================================================
Convertible Debentures
The debentures are due at maturity in April 2034, but we can redeem them
anytime starting in April 2009 and debenture holders can require us to
repurchase them on each five-year anniversary of issuance or when a specified
corporate transaction occurs by paying the principal amount in cash. The first
five-year anniversary is in April 2009. Debenture holders can also convert the
debentures before maturity into cash and common stock as discussed below.
The debentures can only be converted (i) in a fiscal quarter when the
closing price of our common stock is at least 30% higher than the adjusted
conversion price for at least 20 of the last 30 trading days of the prior fiscal
quarter (the "market price condition") (ii) if the debentures are rated 'BB' or
lower by Fitch Ratings, Inc. (four levels lower than the current rating) (iii)
if we call the debentures or (iv) if a specified corporate transaction occurs.
No event allowing for the debentures to be converted has occurred through
October 31, 2008. The market price condition would have been met at October 31,
2008 if the price of our common stock closed above $35.50 for the required
period. The closing price of our common stock was $23.15 on October 31, 2008.
We irrevocably elected (under the debentures' original terms and without
modifying the debentures) in fiscal 2005 to pay the value of converted
debentures, not exceeding their principal amount, in cash instead of issuing
shares of common stock. The value of converted debentures equals the number of
convertible shares multiplied by the market value of our common stock. We would
only issue shares if the value of converted debentures exceeded their principal
amount. Shares of common stock needed to pay any value over principal would
equal the difference between the conversion date closing price of our common
stock and the conversion price, divided by the conversion date closing price and
multiplied by the number of convertible shares. There were 6,409,000 convertible
(but not issuable) shares, the adjusted conversion price was $27.31 per share
and the adjusted conversion rate was 36.62 shares for each $1 (one thousand) of
principal at October 31, 2008.
The conversion rate and number of convertible shares increased and the
conversion price decreased in the three months ended October 31, 2008 because we
paid cash dividends on our common stock. The conversion rate, conversion price
and number of convertible shares were 36.35, $27.51 and 6,361,000, respectively
at July 31, 2008. Future cash dividends will cause additional conversion rate
and convertible shares increases and conversion price decreases.
We purchased $10,000 of the debentures in the open market in November 2008
for $9,215 resulting in a $785 gain.
7
Asset Securitization Borrowings
Our asset securitization facility was partially renewed and partially
converted into amortizing term debt in April 2008. The facility decreased to
$325,000 from $425,000 and we converted $200,000 of borrowings into term debt.
The two renewing banks increased their commitments $50,000 each and we converted
the amounts borrowed from the two non-renewing banks into term debt.
The $325,000 facility provides for committed revolving financing through
April 2009 and we can then convert borrowings outstanding into term debt if it
is not renewed. The full amount of the facility was available for us to borrow
at October 31, 2008. We are repaying the remaining $151,000 of term debt
monthly from collections of securitized receivables. The repayment amounts vary
based on the amount of securitized receivables collected and the amount borrowed
under the facility. Borrowing under the facility, or converting the facility
into term debt upon nonrenewal, would increase the monthly repayment amounts.
The term debt would be repaid substantially in three years based on these
amounts at October 31, 2008.
Finance receivables included $330,000 of securitized receivables at
October 31, 2008 and $410,000 at July 31, 2008. Our major operating subsidiary's
debt agreements limit securitized receivables to 40% of its total receivables.
Therefore, we could securitize an additional $420,000 of receivables at October
31, 2008.
Borrowings under the facility and the term debt combined are limited to
94% of eligible securitized receivables and are without recourse. Securitized
receivables classified as impaired or with terms outside of defined limits are
ineligible to be borrowed against. The facility also restricts the amount of net
charge-offs of securitized receivables and the amount of delinquent securitized
receivables. The facility would terminate if these restrictions are exceeded,
and borrowings outstanding would then be repaid monthly from collections of
securitized receivables.
Bank Borrowings
We have $480,000 of committed unsecured revolving credit facilities from
ten banks with $40,000 expiring within one year and $440,000 expiring between
February 2010 and February 2013, and $103,000 of these facilities was unused at
October 31, 2008. Borrowings under these facilities can mature between 1 and 270
days and their interest rates are based on domestic money market rates or LIBOR.
Borrowings outstanding at October 31, 2008 matured in November 2008, were
reborrowed and remain outstanding. We incur a fee on the unused portion of the
facilities. We renewed a $30,000 two-year facility for another two years in
September 2008.
Other
Our major operating subsidiary's debt agreements have restrictive
covenants including limits on its indebtedness, encumbrances, investments,
dividends and other distributions to us, sales of assets, mergers and other
business combinations, capital expenditures, interest coverage and net worth. We
were in compliance with all debt covenants and restrictions at October 31, 2008.
None of the agreements have a material adverse change clause and all of our debt
is senior.
Long-term debt comprised the following:
=========================================================================
October 31, 2008 July 31, 2008
=========================================================================
Term notes $ 675,000 $ 675,000
Bank borrowings and commercial paper
supported by bank credit facilities
expiring after one year 407,000 410,000
Asset securitization borrowings - term 91,000 104,000
-------------------------------------------------------------------------
Total long-term debt $1,173,000 $1,189,000
=========================================================================
NOTE 4 - STOCKHOLDERS' EQUITY
We increased the size of our common stock and convertible debt repurchase
program by $23,251 to $50,000 in September 2008, and $49,917 remained available
at October 31, 2008 and $40,702 remained available after the November 2008
purchase of convertible debentures. We established the program in fiscal 2008
and it does not have a set expiration.
8
NOTE 5 - STOCK PLANS
We have two stockholder approved stock plans; the 2006 Stock Incentive
Plan (the "2006 Plan") and the Amended and Restated 2001 Management Incentive
Plan (the "Amended MIP"). The 2006 Plan provides for the issuance of 2,500,000
shares of restricted stock, non-qualified or incentive stock options, stock
appreciation rights, stock units and common stock to officers, other employees
and directors with annual participant limits, and expires in December 2016.
Awards may be performance-based. The exercise price of stock options cannot be
less than the fair market value of our common stock when granted and their term
is limited to ten years. There were 1,787,000 shares available for future grants
under the 2006 Plan at October 31, 2008. The Amended MIP provides for the
issuance of 1,000,000 shares of restricted stock, with an annual participant
limit of 200,000 shares, and performance-based cash or stock bonuses to be
awarded to our CEO and other selected officers. The Amended MIP expires in
December 2011. There were 625,000 shares available for future grants under the
Amended MIP at October 31, 2008.
We also have a Supplemental Retirement Benefit ("SERP") for our CEO. We
awarded 150,000 stock units in fiscal 2002 vesting annually in equal amounts
over eight years. Subject to forfeiture, our CEO will receive shares of common
stock equal to the number of stock units vested when our CEO retires after
attaining age 62. There were 113,000 units vested at October 31, 2008.
In October 2008, we awarded 100,000 shares of performance-based restricted
stock to executive officers under the 2006 Plan vesting 25% after two, three,
four and five years, and 50,000 shares of performance-based restricted stock to
our CEO under the Amended MIP vesting in October 2013. These shares would be
forfeited if the performance condition, based on diluted earnings per share for
fiscal 2009, is not met. We also granted 5,000 non-qualified stock options to
employees with a five-year term vesting 25% after one, two, three and four
years.
Shares of restricted stock, stock options and stock units are the only
incentive compensation we provide (other than a cash bonus for the CEO) and we
believe these stock-based awards further align employees' and directors'
interests with those of our stockholders. We do not have a policy to repurchase
shares in the open market, and we issue new shares when we award shares of
restricted stock or when options are exercised.
Restricted stock activity for the three months ended October 31, 2008 is
summarized below (shares in thousands):
====================================================================
Weighted-Average
Shares Grant-Date Fair Value
====================================================================
Unvested - August 1, 2008 1,176 $26.20
Granted 150 19.64
Vested (10) 25.95
--------------------------------------
Unvested - October 31, 2008 1,316 $25.45
====================================================================
Information on shares of restricted stock that vested follows (in
thousands, except intrinsic value per share):
====================================================================
Three Months Ended October 31, 2008 2007
====================================================================
Number of shares vested 10 10
Total intrinsic value * $ 234 $ 279
Intrinsic value per share 23.40 27.86
(Tax shortfall) excess tax benefits realized (6) 20
====================================================================
* shares vested multiplied by the closing prices of our common
stock on the dates vested
9
Stock option activity and related information for the three months ended
October 31, 2008 are summarized below (options and intrinsic value in
thousands):
=========================================================================
Weighted-Average
----------------------
Exercise Remaining Intrinsic
Options Price Term (years) Value*
=========================================================================
Outstanding - August 1, 2008 892 $24.31
Granted 5 23.77
Exercised (20) 22.63
-------------------------------------
Outstanding - October 31, 2008 877 $24.35 2.0 $400
=========================================================================
Exercisable - October 31, 2008 474 $24.11 1.4 $200
=========================================================================
* number of in-the-money options multiplied by the difference between
their average exercise price and the $23.15 closing price of our
common stock on October 31, 2008
Information on stock option exercises follows (in thousands, except
intrinsic value per option):
====================================================================
Three Months Ended October 31, 2008 2007
====================================================================
Number of options exercised 20 98
Total intrinsic value * $ 49 $1,000
Intrinsic value per option 2.45 10.20
(Tax shortfall) excess tax benefits realized (7) 223
====================================================================
* options exercised multiplied by the difference between their
exercise prices and the closing prices of our common stock on the
exercise dates
Future compensation expense (before deferral) for stock-based awards
unvested at October 31, 2008 and expected to vest, and the average expense
recognition periods follow:
====================================================================
Expense Weighted-Average Years
====================================================================
Restricted stock $20,300 5.1
Stock options 900 2.2
Stock units 600 1.1
-------------------------------------
Total $21,800 4.9
====================================================================
Compensation recorded, deferred, included in salaries and other
expenses, and tax benefits recorded for stock-based awards follow:
====================================================================
Three Months Ended October 31, 2008 2007
====================================================================
Total stock-based compensation $2,004 $1,914
Deferred stock-based compensation 818 723
--------------------------------------------------------------------
Net stock-based compensation in
salaries and other expenses $1,186 $1,191
====================================================================
Tax benefits $ 446 $ 436
====================================================================
10
NOTE 6 - EARNINGS PER COMMON SHARE
Earnings per common share ("EPS") was calculated as follows (in thousands,
except per share amounts):
====================================================================
Three Months Ended October 31, 2008 2007
====================================================================
Net income $11,679 $12,666
====================================================================
Weighted-average common shares outstanding
(used for basic EPS) 24,564 24,681
Effect of dilutive securities:
Shares of restricted stock and stock units 411 389
Stock options 13 184
Shares issuable from convertible debt -- 175
--------------------------------------------------------------------
Adjusted weighted-average common shares
outstanding (used for diluted EPS) 24,988 25,429
====================================================================
Net income per common share:
Diluted $ 0.47 $ 0.50
====================================================================
Basic $ 0.48 $ 0.51
====================================================================
Antidilutive shares of restricted stock,
stock units and stock options * 432 257
====================================================================
* excluded from the calculation because they would have increased
diluted EPS
The convertible debentures lower diluted EPS when the quarterly average
price of our common stock exceeds the adjusted conversion price. When this
occurs, shares of common stock needed to deliver the value of the debentures
over their principal amount based on the average stock price would be included
as shares outstanding in calculating diluted EPS. Shares to be included would
equal the difference between the average stock price and the adjusted conversion
price, divided by the average stock price and multiplied by the number of
convertible shares, currently 6,409,000 (referred to as the treasury stock
method). The average price of our common stock exceeded the adjusted conversion
price in the three months ended October 31, 2007 resulting in 175,000 dilutive
shares.
11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
Financial Federal Corporation is an independent financial services company
operating in the United States through three wholly owned subsidiaries. We do
not have any unconsolidated subsidiaries, partnerships or joint ventures. We
also do not have any off-balance sheet assets or liabilities (other than
commitments to extend credit), goodwill, other intangible assets or pension
obligations, and we are not involved in income tax shelters. We have one fully
consolidated special purpose entity we established for our on-balance-sheet
asset securitization facility.
We have one line of business. We lend money under installment sale
agreements, secured loans and leases (collectively referred to as "finance
receivables") to small and medium sized businesses for their equipment financing
needs. Finance receivable transactions generally range between $50,000 and $1.5
million, have terms between two and five years and require monthly payments. The
average transaction size is approximately $250,000. We earn revenue solely from
interest and other fees and amounts earned on our finance receivables. We need
to borrow most of the money we lend. Therefore, liquidity (money currently
available for us to borrow) is very important. We borrow from banks and
insurance companies and we issue commercial paper to other investors.
Approximately 75% of our finance receivables were funded with debt at October
31, 2008.
Our main areas of focus are (i) asset quality (ii) liquidity (iii) net
interest spread (the difference between the rates we earn on our receivables and
the rates we incur on our debt) and (iv) interest rate risk. Changes in the
asset quality of our finance receivables can affect our profitability
significantly. Finance income, provisions for credit losses and operating
expenses can be affected by reclassifying receivables to or from impaired
status, incurring write-downs and incurring costs associated with non-performing
assets. Changes in market interest rates can also affect our profitability
significantly because interest rates on our finance receivables were 91% fixed
and 9% floating, and interest rates on our debt were 60% fixed and 40% floating
at October 31, 2008. We use various strategies to manage our credit risk and
interest rate risk. Each of these four areas is integral to our long-term
profitability and we discuss them in detail in separate sections of this
discussion.
Our key operating statistics are net charge-offs, loss ratio,
non-performing assets, delinquencies, leverage, available liquidity, receivables
growth, return on equity, net interest margin and net interest spread, and
expense and efficiency ratios.
Significant events
The crisis in credit markets that began more than one year ago worsened
considerably during our first quarter of fiscal 2009 causing credit markets to
nearly collapse and causing a spike in short-term LIBOR rates (the base rates
for most of our floating rate debt). It is now even more difficult and expensive
for finance companies to obtain or renew financing. Banks and other lenders,
including all of our funding sources, are either reluctant or unable to provide,
or are charging prohibitively high credit spreads, on new financing. Credit
spread is the percentage amount lenders charge above a base market interest
rate. Our cost of debt will increase considerably as we obtain or renew
financing if credit spreads persist at these levels.
The Federal Reserve, United States Treasury Department and FDIC have taken
unprecedented, drastic steps to address the crisis including lowering the target
Federal Funds Rate nine times since September 2007 by a total of 425 basis
points (4.25%) to only 1.00%. This includes two decreases totaling 100 basis
points during this quarter. They also implemented programs to inject liquidity
into and restore confidence in credit markets and to encourage financial
institutions to lend. The U.S. Treasury has made $250.0 billion available to
invest in select financial institutions, the FDIC is guaranteeing for three
years the debt issued by FDIC insured banks with terms greater than thirty days
issued through June 30, 2009, and the Federal Reserve is purchasing three-month
commercial paper issued by companies with an A-1/P-1/F1 credit rating through
April 30, 2009. We are not eligible to participate in these programs because we
are not a bank holding company and our commercial paper is rated F2.
Our available liquidity has increased by $158.0 million during the crisis
to $398.0 million at October 31, 2008 from $240.0 million July 31, 2007. The
increase is from the combination of significantly lower receivable originations,
strong operating cash flows and the following transactions. We partially renewed
our $425.0 million asset securitization facility for another year in April 2008.
Two of the four banks in the facility increased their $225.0 million combined
commitment by $100.0 million and we converted the $200.0 million borrowed from
the other two banks into amortizing term debt. We renewed a $25.0 million bank
credit facility in March 2008 and a $30.0 million bank credit facility in
September 2008. We also converted $75.0 million of bank credit facilities into
five-year fixed rate term loans with a 4.43% average rate and we extended the
term of a $15.0 million bank credit facility with no change in credit spread in
12
February 2008. Based on our amount of available liquidity, the maturity and
expiration dates of our debt and credit facilities (including the expected
repayment of our convertible debentures in April 2009) and receivable
originations continuing at recent levels, we do not anticipate a need for any
financing until the third quarter of fiscal 2010. Our liquidity and debt are
discussed in the Liquidity and Capital resources section.
In addition, our cost of debt has declined during the crisis because (i)
short-term market interest rates decreased significantly (ii) the relatively
small amount of expiring credit facilities and maturing debt limited the impact
of higher credit spreads and (iii) we have $480.0 million of low-cost committed
bank credit facilities with no borrowing restrictions. Our cost of debt was
4.26% this quarter compared to 5.35% in the fourth quarter of fiscal 2007 (the
last quarter before the crisis started), although the spike in LIBOR rates this
quarter caused our cost of debt to increase by 12 basis points (0.12%) over the
prior quarter (the fourth quarter of fiscal 2008). We expect our cost of debt to
decline in the second quarter of fiscal 2009 because short-term market interest
rates have been significantly lower since the end of October 2008. Our cost of
debt is discussed in the Market Interest Rate Risk and Sensitivity section.
Maintaining conservative leverage and ample liquidity, having multi-year
committed bank credit facilities and term debt with staggered maturities, and
our approach to managing credit risk on our finance receivables (as discussed in
the Finance Receivables and Asset Quality section) have been integral to our
success during this difficult period.
Critical Accounting Policies and Estimates
Applying accounting principles generally accepted in the United States
requires judgment, assumptions and estimates to record the amounts in the
Consolidated Financial Statements and accompanying notes. We describe the
significant accounting policies and methods we use to prepare the Consolidated
Financial Statements in Note 1 to the Consolidated Financial Statements in our
Annual Report on Form 10-K for the fiscal year ended July 31, 2008. Accounting
policies involving significant judgment, assumptions and estimates are
considered critical accounting policies and are discussed below.
Allowance for Credit Losses
The allowance for credit losses on finance receivables is our estimate of
losses inherent in our finance receivables at the balance sheet date. The
allowance is difficult to determine and requires significant judgment. The
allowance is based on total finance receivables, net charge-off experience,
impaired and delinquent finance receivables and our current assessment of the
risks inherent in our finance receivables from national and regional economic
conditions, industry conditions, concentrations, the financial condition of
customers and guarantors, collateral values and other factors. We may need to
change the allowance level significantly if unexpected changes in these
conditions or factors occur. Increases in the allowance would reduce net income
through higher provisions for credit losses. We would need to record a $1.9
million provision for each 0.10% required increase in the allowance. The
allowance was $24.8 million (1.31% of finance receivables) at October 31, 2008
including $0.9 million specifically allocated to impaired receivables.
The allowance includes amounts specifically allocated to impaired
receivables and an amount to provide for losses inherent in the remainder of
finance receivables (the "general allowance"). We evaluate the fair values of
impaired receivables and compare them to the carrying amounts. The carrying
amount is the amount receivables are recorded at when we evaluate them and may
include prior write-downs or a specific allowance. If our fair value estimate is
lower than the carrying amount, we record a write-down or establish a specific
allowance depending on (i) how we determined fair value (ii) how certain we are
of our estimate and (iii) the level and type of factors and items other than the
primary collateral supporting our fair value estimate, such as guarantees and
secondary collateral.
To estimate the general allowance, we analyze historical write-down
activity to develop percentage loss ranges by risk profile. Risk profiles are
assigned to receivables based on past due status and the customers' industry. We
do not use a loan grading system. We then adjust the calculated range of losses
for expected recoveries and we may also adjust the range for differences between
current and historical loss trends and other factors to arrive at the estimated
allowance. We record a provision for credit losses if the recorded allowance
differs from our current estimate. The adjusted calculated range of losses may
differ from actual losses significantly because we use significant estimates.
Non-Performing Assets
We record impaired finance receivables and repossessed equipment (assets
received to satisfy receivables) at their current estimated fair value (if less
than their carrying amount). We estimate fair value of these non-performing
assets by evaluating the market value and condition of the collateral or assets
and the expected cash flows of impaired receivables. We evaluate market value
13
based on recent sales of similar equipment, used equipment publications, our
market knowledge and information from equipment vendors. Unexpected adverse
changes in or incorrect estimates of expected cash flows, market value or the
condition of collateral or assets, or time needed to sell equipment would
require us to record a write-down. This would lower net income. Non-performing
assets totaled $45.9 million (2.4% of finance receivables) at October 31, 2008.
Residual Values
We record residual values on direct financing leases at the lowest of (i)
any stated purchase option (ii) the present value at the end of the initial
lease term of rentals due under any renewal options or (iii) our projection of
the equipment's fair value at the end of the lease. We may not fully realize
recorded residual values because of unexpected adverse changes in or incorrect
projections of future equipment values. This would lower net income. Residual
values totaled $36.9 million (2.0% of finance receivables) at October 31, 2008.
Historically, we have realized the recorded residual value on disposition.
Income Taxes
We record a liability for uncertain income tax positions by (i)
identifying the uncertain tax positions we take on our income tax returns (ii)
determining if these positions would more likely than not be allowed by a taxing
authority and (iii) estimating the amount of tax benefit to record if these tax
positions pass the more-likely-than-not test. Therefore, we record a liability
for tax benefits from positions failing the test and from positions where the
full amount of the tax benefits are not expected to be realized. Identifying
uncertain tax positions, determining if they pass the test and determining the
liability to record requires significant judgment because tax laws are
complicated and subject to interpretation, and because we have to assess the
likely outcome of hypothetical challenges to these positions by taxing
authorities. Actual outcomes of these uncertain tax positions differing from our
assessments significantly and taxing authorities examining positions we did not
consider uncertain could require us to record additional income tax expense
including interest and penalties on any underpayment of tax. This would lower
net income. The gross liability recorded for uncertain tax positions was $1.2
million at July 31, 2008 and we do not expect this amount to change
significantly during the remainder of fiscal 2009.
Stock-Based Compensation
We record compensation expense only for stock-based awards expected to
vest. Therefore, we must estimate expected forfeitures of stock awards. This
requires significant judgment and an analysis of historical data. We may have to
increase compensation expense for stock awards if actual forfeitures differ from
our estimates significantly.
Results of Operations
Comparison of three months ended October 31, 2008 to three months ended October
31, 2007
========================================================================
Three Months Ended
October 31,
($ in millions, except per ------------------
share amounts) 2008 2007 $ Change % Change
========================================================================
Finance income $43.0 $49.6 $ (6.6) (13)%
Interest expense 15.4 22.1 (6.7) (30)
Net finance income before
provision for credit losses 27.6 27.5 0.1 --
Provision for credit losses 1.4 0.4 1.0 250
Salaries and other expenses 7.2 6.5 0.7 10
Provision for income taxes 7.3 7.9 (0.6) (7)
Net income 11.7 12.7 (1.0) (8)
Diluted earnings per share 0.47 0.50 (0.03) (6)
Basic earnings per share 0.48 0.51 (0.03) (6)
Return on equity 11.0% 13.0%
========================================================================
Net income decreased by 8% to $11.7 million in the first quarter of fiscal
2009 from $12.7 million in the first quarter of fiscal 2008 because the effects
of the 10% decrease in average receivables and higher non-performing assets
exceeded the effects of lower short-term market interest rates.
Finance income decreased by 13% to $43.0 million in the first quarter of
fiscal 2009 from $49.6 million in the first quarter of fiscal 2008 because (i)
average finance receivables decreased 10% ($209.0 million) to $1.92 billion from
14
$2.13 billion (ii) the yield on finance receivables declined to 8.89% from 9.28%
mostly due to the prime rate averaging 300 basis points (3.00%) lower and, to a
lesser extent, (iii) non-accrual (impaired) receivables were higher. Changes in
the prime rate affect the yield on receivables because 9% of our receivables are
floating rate and indexed to prime.
Interest expense (incurred on debt used to fund finance receivables)
decreased by 30% to $15.4 million in the first quarter of fiscal 2009 from $22.1
million in the first quarter of fiscal 2008 because our cost of debt declined to
4.26% from 5.33% and our average debt decreased 13% ($216.0 million). Lower
short-term market interest rates caused the decline in our cost of debt because
the interest rates on 40% of our debt were indexed to short-term market interest
rates. This is discussed in the Market Interest Rate Risk and Sensitivity
section.
Net finance income before provision for credit losses on finance
receivables was $27.6 million in the first quarter of fiscal 2009 and $27.5
million in the first quarter of fiscal 2008. Net interest margin (net finance
income before provision for credit losses expressed as an annualized percentage
of average finance receivables) increased to 5.71% from 5.15% because of lower
short-term market interest rates.
The provision for credit losses on finance receivables was $1.4 million in
the first quarter of fiscal 2009 and $0.4 million in the first quarter of fiscal
2008. The provision for credit losses is the amount needed to change the
allowance for credit losses to our estimate of losses inherent in finance
receivables. Net charge-offs (write-downs of finance receivables less
recoveries) increased to $1.4 million in the first quarter of fiscal 2009 from
$0.4 million in the first quarter of fiscal 2008, and the loss ratio (net
charge-offs expressed as an annualized percentage of average finance
receivables) increased to 0.29% from 0.07%. Net charge-offs have been increasing
because of higher non-performing assets. The allowance and net charge-offs are
discussed further in the Finance Receivables and Asset Quality section.
Salaries and other expenses increased by 10% to $7.2 million in the first
quarter of fiscal 2009 from $6.5 million in the first quarter of fiscal 2008
because of higher non-performing assets costs. The expense ratio (salaries and
other expenses expressed as an annualized percentage of average finance
receivables) worsened to 1.48% from 1.22% because expenses increased and
receivables decreased. The efficiency ratio (expense ratio expressed as a
percentage of net interest margin) worsened to 26.0% from 23.7% because the
percentage increase in expenses exceeded the percentage increase in net finance
income before provision for credit losses.
Diluted earnings per share decreased by 6% to $0.47 per share in the first
quarter of fiscal 2009 from $0.50 per share in the first quarter of fiscal 2008,
and basic earnings per share decreased by 6% to $0.48 per share from $0.51 per
share. The percentage decreases in diluted and basic earnings per share were
lower than the percentage decrease in net income because of prior stock
repurchases.
Finance Receivables and Asset Quality
We discuss trends and characteristics of our finance receivables and our
approach to managing credit risk in this section. The key aspect is asset
quality. Asset quality statistics measure our underwriting standards, skills and
policies and procedures and can indicate the direction of future net charge-offs
and non-performing assets.
========================================================================
October 31, July 31,
($ in millions) 2008 * 2008 * $ Change % Change
========================================================================
Finance receivables $1,885.5 $1,940.8 $(55.3) (3)%
Allowance for credit losses 24.8 24.8 -- --
Non-performing assets 45.9 46.7 (0.8) (2)
Delinquent finance receivables 22.4 22.9 (0.5) (2)
Net charge-offs 1.4 1.2 0.2 14
As a percentage of receivables:
-------------------------------
Allowance for credit losses 1.31% 1.28%
Non-performing assets 2.44 2.41
Delinquent finance receivables 1.19 1.18
Net charge-offs (annualized) 0.29 0.24
========================================================================
* as of and for the quarter ended
15
Finance receivables comprise installment sale agreements and secured loans
(collectively referred to as loans) and direct financing leases. Loans were 92%
($1.73 billion) of finance receivables and leases were 8% ($160 million) at
October 31, 2008. Finance receivables decreased $55.3 million or 3% in the first
quarter of fiscal 2009 because of lower originations and, to a lesser extent,
higher repossessions.
We originated $225.0 million of finance receivables in the first quarter
of fiscal 2009 and $259.0 million in the first quarter of fiscal 2008.
Originations decreased because of recessionary economic conditions and because
we are being more selective in approving transactions. We collected $273.0
million of finance receivables and repossessions in the first quarter of fiscal
2009 and $258.0 million in the first quarter of fiscal 2008. Collections
increased because of higher repossessions activity. Repossessions typically
increase during recessionary economic times.
Our primary focus is the credit quality of our receivables. We manage our
credit risk by adhering to disciplined and sound underwriting policies and
procedures, by monitoring our receivables closely and by handling non-performing
accounts effectively. Our underwriting policies and procedures require a first
lien on equipment financed. We focus on financing equipment with a remaining
useful life longer than the term financed, historically low levels of
technological obsolescence, use in more than one type of business, ease of
access and transporting, and broad, established resale markets. Securing our
receivables with equipment possessing these characteristics can mitigate
potential net charge-offs. We may also obtain additional equipment or other
collateral, third-party guarantees, advance payments or hold back a portion of
the amount financed. We do not finance or lease aircraft or railcars, computer
related equipment, telecommunications equipment or equipment located outside the
United States, and we do not lend to consumers.
Our underwriting policies also limit our credit exposure with any
customer. The limit was $46.0 million at October 31, 2008. Our ten largest
customers accounted for 6.5% ($124.0 million) of total finance receivables at
October 31, 2008 and 6.4% ($125.0 million) at July 31, 2008.
Our allowance for credit losses was $24.8 million at October 31, 2008 and
July 31, 2008, and the allowance level increased to 1.31% of finance receivables
from 1.28%. The allowance is our estimate of losses inherent in our finance
receivables. We determine the allowance quarterly based on our analysis of
historical losses and the past due status of receivables adjusted for expected
recoveries and any differences between current and historical loss trends and
other factors.
Net charge-offs of finance receivables (write-downs less recoveries) were
$1.4 million in the first quarter of fiscal 2009 compared to $1.2 million in the
fourth quarter of fiscal 2008 and the loss ratios were 0.29% and 0.24%. Net
charge-offs have been increasing because the slowing economy and construction
and transportation industries are reducing our customers' cash flows and
collateral values.
The net investments in impaired finance receivables, repossessed equipment
(assets received to satisfy receivables), total non-performing assets and
delinquent finance receivables (transactions with more than a nominal portion of
a contractual payment 60 or more days past due) follow ($ in millions):
=========================================================================
October 31, July 31, October 31,
2008 2008 2007
=========================================================================
Impaired finance receivables * $30.7 $33.5 $25.9
Repossessed equipment 15.2 13.2 2.1
-------------------------------------------------------------------------
Total non-performing assets $45.9 $46.7 $28.0
=========================================================================
Delinquent finance receivables $22.4 $22.9 $15.6
=========================================================================
Impaired finance receivables
not delinquent 47% 52% 55%
=========================================================================
* before specifically allocated allowance of $0.9 million at October 31,
2008, $0.9 million at July 31, 2008 and $0.4 million at October 31,
2007
We expect the trend of increases in net charge-offs, delinquent and
impaired receivables and repossessed equipment to continue because of
deteriorating economic and credit market conditions. This could require us to
record higher provisions for credit losses.
16
Liquidity and Capital Resources
We describe our need for raising capital (debt and equity), our need to
maintain a substantial amount of liquidity (money currently available for us to
borrow), our approach to managing liquidity and our current funding sources in
this section. Key indicators are leverage (the number of times debt exceeds
equity), available liquidity, credit ratings and debt diversification. Our
leverage is low for a finance company, we have ample liquidity available, we
have been successful in issuing debt and our debt is diversified with maturities
staggered over five years. We believe our liquidity sources are diversified, and
we are not dependent on any funding source or provider.
Liquidity and access to capital are vital to our operations and growth. We
need continued availability of funds to originate or acquire finance receivables
and to repay debt. To ensure we have enough liquidity, we project our financing
needs based on estimated receivables growth and maturing debt, we monitor
capital markets closely, we diversify our funding sources and we stagger our
debt maturities. Funding sources usually available to us include operating cash
flow, private and public issuances of term debt, committed unsecured revolving
bank credit facilities, conduit and term securitizations of finance receivables,
secured term financings, dealer placed and direct issued commercial paper and
sales of common and preferred equity. The external funding sources may not be
available to us currently or may only be available at unfavorable terms because
of conditions in credit markets. However, we have $398.0 million available to
borrow under our committed revolving bank credit and asset securitization
facilities (after subtracting commercial paper outstanding) at October 31, 2008.
Therefore, we do not have a current need for additional financing.
Our term notes are rated 'BBB+' by Fitch Ratings, Inc. ("Fitch", a
Nationally Recognized Statistical Ratings Organization) and our commercial paper
is rated 'F2' by Fitch. Fitch last affirmed these investment grade ratings in
January 2008 and maintained its stable outlook. As a condition of our 'F2'
credit rating, commercial paper outstanding is limited to the unused amount of
our committed credit facilities. Our ability to obtain or renew financing and
our credit spreads can be dependent on these investment grade credit ratings.
Our major operating subsidiary's debt agreements have restrictive
covenants including limits on its indebtedness, encumbrances, investments,
dividends and other distributions to us, sales of assets, mergers and other
business combinations, capital expenditures, interest coverage and net worth. We
have always complied with all debt covenants and restrictions. None of the
agreements have a material adverse change clause.
Debt decreased by 4% ($59.0 million) to $1.41 billion from $1.47 billion
during the first quarter of fiscal 2009 and stockholders' equity increased by 2%
($10.3 million) to $425.2 million from $414.9 million. Therefore, leverage
(debt-to-equity ratio) decreased to 3.3 at October 31, 2008 from 3.5 at July 31,
2008. Our leverage is low for a finance company allowing for substantial asset
growth and equity repurchases.
Debt comprised the following ($ in millions):
=========================================================================
October 31, 2008 July 31, 2008
------------------ ------------------
Amount Percent Amount Percent
=========================================================================
Term notes $ 675.0 48% $ 675.0 46%
Bank borrowings 377.0 27 369.0 25
Convertible debentures 175.0 12 175.0 12
Asset securitization
borrowings - term 151.0 11 169.0 12
Commercial paper 30.0 2 79.0 5
-------------------------------------------------------------------------
Total debt $1,408.0 100% $1,467.0 100%
=========================================================================
Term Notes
The term notes were issued between fiscal 2003 and 2008. They are five and
seven year fixed rate notes with principal due at maturity between April 2010
and April 2014. Their average maturity was 2.7 years at October 31, 2008.
Interest is payable semiannually.
17
Bank Credit Facilities
We have $480.0 million of committed unsecured revolving credit facilities
from ten banks and $103.0 million was unused and available to borrow at October
31, 2008. This includes $455.0 million of facilities with original terms
ranging from two to five years and a $25.0 million facility with a one year
original term. The multi-year facilities have an average remaining term of 2.8
years and expire between February 2010 and February 2013. These facilities
range from $15.0 million to $110.0 million. Borrowings under these facilities
can mature between 1 and 270 days. Borrowings outstanding at October 31, 2008
matured in November 2008, were reborrowed and remain outstanding. We borrow
amounts usually for one day, and also for one week or one month depending on
interest rates, and roll the borrowings over when they mature depending on
whether we issue or repay other debt.
These committed facilities are a low-cost source of funds and support our
commercial paper program. We can borrow the full amount under each facility
immediately. None of the facilities are for commercial paper back-up only and
the facilities do not have usage fees. These facilities may be renewed, extended
or increased before they expire. We renewed a $30.0 million two-year facility
for another two years in September 2008.
Convertible Debentures
We issued the convertible debentures in April 2004. They are due at
maturity in April 2034, but we can redeem (call) them anytime starting in April
2009 and debenture holders can require us to repurchase (put) them on each
five-year anniversary of issuance or when a specified corporate transaction
occurs by paying the principal amount in cash. Debenture holders can also
convert the debentures before maturity into cash and common stock as discussed
below.
The debentures can only be converted (i) in a fiscal quarter when the
closing price of our common stock is at least 30% higher than the adjusted
conversion price for at least 20 of the last 30 trading days of the prior fiscal
quarter (the "market price condition") (ii) if the debentures are rated 'BB' or
lower by Fitch (four levels lower than the current rating) (iii) if we call the
debentures or (iv) if a specified corporate transaction occurs. No event
allowing for the debentures to be converted has occurred through October 31,
2008. The market price condition would have been met at October 31, 2008 if the
price of our common stock closed above $35.50 for the required period. The
closing price of our common stock was $23.15 on October 31, 2008. Therefore, it
is highly unlikely the debentures will be converted before the April 2009 put
date.
Based on the recent price range of our common stock and current credit
market conditions, it is likely holders will exercise their put option in April
2009 requiring us to repay the debentures with cash. We also purchased $10.0
million of the debentures in the open market in November 2008 for $9.2 million.
Repaying the debentures in April 2009 and repurchasing them in the open market
will reduce our available liquidity by the amounts paid plus another $17.0
million for the payment of related deferred income taxes.
We irrevocably elected (under the debentures' original terms and without
modifying the debentures) in fiscal 2005 to pay the value of converted
debentures, not exceeding their principal amount, in cash instead of issuing
shares of common stock. The value of converted debentures equals the number of
convertible shares multiplied by the market value of our common stock. We would
only issue shares if the value of converted debentures exceeded their principal
amount. Shares of common stock needed to pay any value over principal would
equal the difference between the conversion date closing price of our common
stock and the conversion price, divided by the conversion date closing price and
multiplied by the number of convertible shares. There were 6.4 million
convertible (but not issuable) shares, the adjusted conversion price was $27.31
per share and the adjusted conversion rate was 36.62 shares for each $1,000 of
principal at October 31, 2008. The conversion rate and number of convertible
shares increase and the conversion price decreases when we declare dividends on
our common stock. The additional number of convertible shares from paying
dividends on our common stock (0.5 million through October 31, 2008) will have
no effect on the amount we would pay in April 2009 if holders exercise their put
option on the debentures for their principal amount.
Asset Securitization Financings
Our asset securitization facility was partially renewed and partially
converted into amortizing term debt in April 2008. The facility decreased to
$325.0 million from $425.0 million and we converted $200.0 million of borrowings
into term debt. The two renewing banks increased their commitments $50.0 million
each and we converted the amounts borrowed from the two non-renewing banks into
term debt. We established the facility in July 2001 with one bank for $125.0
million and this was the seventh renewal.
18
The $325.0 million facility provides for committed revolving financing
through April 2009 and we can then convert borrowings outstanding into term debt
if it is not renewed. The full amount of the facility was available for us to
borrow at October 31, 2008. We are repaying the remaining $151.0 million of term
debt monthly from collections of securitized receivables. The repayment amounts
vary based on the amount of securitized receivables collected and the amount
borrowed under the facility. Borrowing under the facility, or converting the
facility into term debt upon nonrenewal, would increase the monthly repayment
amounts. The term debt would be substantially repaid in three years based on
these amounts at October 31, 2008.
Finance receivables included $330.0 million of securitized receivables at
October 31, 2008 and $410.0 million at July 31, 2008. Our major operating
subsidiary's debt agreements limit securitized receivables to 40% of its total
receivables. Therefore, we could securitize an additional $420.0 million of
receivables at October 31, 2008.
Borrowings under the facility and the term debt combined are limited to
94% of eligible securitized receivables and are without recourse. Securitized
receivables classified as impaired or with terms outside of defined limits, are
ineligible to be borrowed against. The facility also restricts the amount of net
charge-offs of securitized receivables and the amount of delinquent securitized
receivables. The facility would terminate if these restrictions are exceeded,
and borrowings outstanding would then be repaid monthly from collections of
securitized receivables.
Commercial Paper
We issue commercial paper direct and through a $500.0 million program with
maturities between 1 and 270 days. The amount of commercial paper we could issue
is limited to the unused amount of our committed credit facilities ($428.0
million at October 31, 2008).
Deteriorating credit market conditions have further decreased demand for
and increased credit spreads on commercial paper and we have not issued any
commercial paper under our program since September 2008. As a result, our
commercial paper decreased from $79.0 million to $30.0 million during the
quarter and was repaid from operating cash flows and bank borrowings.
Stockholders' Equity
We increased the size of our common stock and convertible debt repurchase
program by $23.3 million to $50.0 million in September 2008, and $49.9 million
remained available at October 31, 2008. We established the program in fiscal
2008 and it does not have a set expiration. Repurchases are discretionary and
contingent upon many conditions.
We paid $3.9 million of cash dividends and we received $0.1 million from
stock option exercises in the first quarter of fiscal 2009.
Market Interest Rate Risk and Sensitivity
We discuss how changes in market interest rates and credit spreads affect
our net interest spread and how we manage interest rate risk in this section.
Net interest spread (net yield of finance receivables less cost of debt) is an
integral part of a finance company's profitability and is calculated below:
================================================================
Three Months Ended October 31, 2008 2007
================================================================
Net yield of finance receivables 8.89% 9.28%
Cost of debt 4.26 5.33
----------------------------------------------------------------
Net interest spread 4.63% 3.95%
================================================================
Our net interest spread was 0.68% (68 basis points) higher in the first
quarter of fiscal 2009 compared to the first quarter of fiscal 2008 because
decreases in market interest since the first quarter of fiscal 2008 lowered our
cost of debt more than the net yield on our finance receivables as explained
below. Short-term market interest rates declined significantly because the
Federal Reserve has lowered its target Federal Funds Rate 425 basis points
(4.25%) in response to credit market and economic conditions. Short-term LIBOR
rates have declined on average 300 basis points (3.00%) with overnight LIBOR
declining 500 basis points to 0.41% at October 31, 2008. Interest rates on most
of our floating rate debt are indexed to short-term LIBOR rates. This is the
primary reason our cost of debt declined by 107 basis points (1.07%). Decreases
in short-term market interest rates also lowered the net yield because the
rates on our floating rate receivables are indexed to the prime
19
rate. The prime rate also declined 425 basis points. Long-term market interest
rates also decreased significantly. Lower long-term market interest rates would
normally decrease the cost of new fixed-rate term debt and also result in lower
yields on finance receivable originations, but these effects have been largely
offset by significantly higher credit spreads.
Our net interest spread is sensitive to changes in short-term and
long-term market interest rates (includes LIBOR, rates on U.S. Treasury
securities, money-market rates, swap rates and the prime rate). Increases in
short-term rates reduce our net interest spread and decreases in short-term
rates increase it (this is occurring currently) because our floating rate debt
(includes short-term debt) exceeds our floating rate finance receivables by a
significant amount. Interest rates on our debt change faster than the yield on
our receivables because 40% of our debt is floating rate compared to floating
rate receivables of only 9%.
Our net interest spread is also affected by credit spreads. Changes in
credit spreads affect the yield on our receivables when originated and the cost
of our debt when issued. Credit spreads have increased significantly since the
crisis in credit markets began.
Our net interest spread is also affected when the differences between
short-term and long-term rates change. Long-term rates normally exceed
short-term rates. When this excess narrows (resulting in a "flattening yield
curve") or when short-term rates exceed long-term rates (an "inverted yield
curve"), our net interest spread should decrease and when the yield curve widens
our net interest spread should increase because the rates we charge our
customers are largely determined by long-term market interest rates and rates on
our floating rate debt are largely determined by short-term market interest
rates. We can mitigate the effects of an inverted yield curve by issuing
long-term fixed rate debt.
Our income is subject to the risk of rising short-term market interest
rates and a flat or inverted yield curve because floating rate debt exceeded
floating rate receivables by $395.1 million at October 31, 2008 (see the table
below). The terms and prepayment experience of fixed rate receivables mitigate
this risk. Receivables are collected monthly over short periods of two to five
years with $655.0 million (38%) of fixed rate receivables scheduled to be
collected in one year at October 31, 2008 and the average remaining life of
fixed rate receivables excluding prepayments is approximately twenty months.
Historically, annual collections have exceeded 50% of average receivables. We
do not match the maturities of our debt to our receivables.
We monitor and manage our exposure to potential adverse changes in market
interest rates with derivative financial instruments and by changing the
proportion of our fixed and floating rate debt. We may use derivatives to hedge
our exposure to interest rate risk on existing debt and debt expected to be
issued. We do not speculate with or trade derivatives. We had no derivatives
outstanding during the first quarter of fiscal 2009.
We quantify interest rate risk by calculating the effect on net income of
a hypothetical, immediate 100 basis point (1.0%) rise in market interest rates.
This hypothetical change in rates would reduce quarterly net income by
approximately $0.4 million at October 31, 2008 based on scheduled repricings of
floating rate debt, fixed rate debt maturing within one year and the expected
effects on the yield of new receivables. This amount increases to $0.7 million
excluding the effect on the yield of new receivables. We believe these amounts
are acceptable considering the cost of floating rate debt is lower than fixed
rate debt. Actual future changes in market interest rates and the effects on net
income may differ from these amounts materially. Other factors that may
accompany an actual immediate 100 basis point rise in market interest rates were
not considered in the calculation. These hypothetical reductions of net income
at October 31, 2007 were $0.7 million and $1.1 million excluding the effects on
the yield of new receivables. The impact of this hypothetical increase in rates
was lower in the first quarter of fiscal 2009 because our floating rate debt
declined to $558.0 million from $905.0 million in the first quarter of fiscal
2008.
The fixed and floating rate amounts and percentages of our receivables and
capital at October 31, 2008 follow ($ in millions):
==========================================================================
Fixed Rate Floating Rate
----------------- ---------------
Amount Percent Amount Percent Total
==========================================================================
Finance receivables $1,722.6 91% $162.9 9% $1,885.5
==========================================================================
Debt $ 850.0 60% $558.0 40% $1,408.0
Stockholders' equity 425.2 100 -- -- 425.2
--------------------------------------------------------------------------
Total debt and equity $1,275.2 70% $558.0 30% $1,833.2
==========================================================================
20
The fixed and floating rate amounts and percentages of our receivables and
capital at July 31, 2008 follow ($ in millions):
==========================================================================
Fixed Rate Floating Rate
----------------- ---------------
Amount Percent Amount Percent Total
==========================================================================
Finance receivables $1,772.0 91% $168.8 9% $1,940.8
==========================================================================
Debt $ 850.0 58% $617.0 42% $1,467.0
Stockholders' equity 414.9 100 - - 414.9
--------------------------------------------------------------------------
Total debt and equity $1,264.9 67% $617.0 33% $1,881.9
==========================================================================
Floating rate debt comprises bank borrowings, term asset securitization
borrowings and commercial paper, and reprices (interest rates change based on
current short-term market interest rates) after October 31, 2008 as follows:
$504.0 million (90%) in one month, $50.0 million (9%) in two to three months and
$4.0 million (1%) in four to six months. Floating rate receivables only reprice
when the prime rate changes. The repricing frequencies of floating rate debt
follow (in millions):
=========================================================================
Balance Repricing Frequency
=========================================================================
Bank borrowings $377.0 1 to 30 days
Asset securitization
borrowings - term 151.0 1 to 30 days
Commercial paper 30.0 1 to 150 days (60 day average)
=========================================================================
New Accounting Standards
Refer to Note 1 (Summary of Significant Accounting Policies) to the
consolidated financial statements.
Forward-Looking Statements
Statements in this report containing the words or phrases "expect,"
"anticipate," "may," "believe," "appears," "estimate," "intend," "could,"
"should," "would," "if," "outlook," "likely," "unlikely" and other words and
phrases expressing our expectations are "forward-looking statements." Actual
results could differ from those contained in the forward-looking statements
materially because they involve various assumptions and known and unknown risks
and uncertainties. Information about risk factors that could cause actual
results to differ materially is discussed in "Part I, Item 1A Risk Factors" in
our Annual Report on Form 10-K for the year ended July 31, 2008 and other
sections of this report. Risk factors include (i) an economic slowdown (ii) the
inability to collect finance receivables and the sufficiency of the allowance
for credit losses (iii) the inability to obtain capital or maintain liquidity
(iv) rising short-term market interest rates and adverse changes in the yield
curve (v) increased competition (vi) the inability to retain key employees and
(vii) adverse conditions in the construction and road transportation industries.
Forward-looking statements do not guarantee our future performance and apply
only as of the date made. We are not required to update or revise them for
future or unanticipated events or circumstances.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
See Item 2, Market Interest Rate Risk and Sensitivity.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures.
Our management (with our Chief Executive Officer's and Chief Financial
Officer's participation) evaluated our disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934)
at the end of the period covered by this report. Based on this evaluation, our
Chief Executive Officer and Chief Financial Officer concluded our disclosure
controls and procedures are effective to ensure information required to be
disclosed in reports we file or submit under the Securities Exchange Act of 1934
is recorded, processed, summarized and reported timely.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting
during the first quarter of fiscal 2009 that materially affected or are
reasonably likely to materially affect our internal control over financial
reporting.
21
PART II - OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
ISSUER PURCHASES OF EQUITY SECURITIES
For the Quarter Ended October 31, 2008
==========================================================================================
(c) Total Number of (d) Maximum Number
(a) Total Shares Purchased (or Approximate Dollar
Number (b) Average as Part of Publicly Value) of Shares that May
of Shares Price Paid Announced Plans or Yet Be Purchased Under
Month Purchased per Share Programs the Plans or Programs
==========================================================================================
September 2008 2,432 $ 23.99 2,432 $49,942,000
October 2008 1,094 22.09 1,094 49,917,000
--------------------------------------------------------------
Total 3,526 $ 23.40 3,526
==========================================================================================
We established our common stock and convertible debt repurchase program in
June 2008. We increased the size of the program by $23.3 million to $50.0
million in September 2008 and $49.9 million remained available at October 31,
2008. The full amount can be used to repurchase either common stock or
convertible debentures or any combination.
We did not sell any unregistered shares of our common stock during the
first quarter of fiscal 2009.
Item 5. Other Information
We issued a press release on December 3, 2008 reporting our results for
the quarter ended October 31, 2008. The press release is attached as Exhibit
99.1. Exhibit 99.1 shall not be deemed "filed" for purposes of Section 18 of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), or subject to
the liabilities of that section, nor shall it be deemed incorporated by
reference in any filing under the Securities Act of 1933, as amended, or the
Exchange Act, except as shall be expressly set forth by specific reference.
Item 6. Exhibits
Exhibit No. Description of Exhibit
--------------------------------------------------------------------------------
3.1 (a) Articles of Incorporation
3.2 (b) Certificate of Amendment of Articles of Incorporation dated
December 9, 1998
3.3 (c) Amended and Restated By-laws dated March 5, 2007
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
32.1 Section 1350 Certification of Chief Executive Officer
32.2 Section 1350 Certification of Chief Financial Officer
99.1 Press release dated December 3, 2008
Previously filed with the Securities and Exchange Commission as an exhibit to
-----------------------------------------------------------------------------
our:
----
(a) Registration Statement on Form S-1 (Registration No. 33-46662) filed
May 28, 1992
(b) Form 10-Q for the quarter ended January 31, 1999
(c) Form 10-Q for the quarter ended January 31, 2007
22
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.
FINANCIAL FEDERAL CORPORATION
-----------------------------
(Registrant)
By: /s/ Steven F. Groth
------------------------------
Senior Vice President and
Chief Financial Officer
(Principal Financial Officer)
By: /s/ David H. Hamm
------------------------------
Vice President and Controller
(Principal Accounting Officer)
December 4, 2008
----------------
(Date)
23