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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 January 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 February
29, 2008 was 25,466,649.
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FINANCIAL FEDERAL CORPORATION AND SUBSIDIARIES
Quarterly Report on Form 10-Q
for the quarter ended January 31, 2008
TABLE OF CONTENTS
Part I - Financial Information Page No.
----------------------------------------------------------------------- --------
Item 1. Financial Statements:
Consolidated Balance Sheets at January 31, 2008 (unaudited)
and July 31, 2007 (audited) 3
Consolidated Income Statements for the three and six months
ended January 31, 2008 and 2007 (unaudited) 4
Consolidated Statements of Changes in Stockholders' Equity for
the six months ended January 31, 2008 and 2007 (unaudited) 5
Consolidated Statements of Cash Flows for the six months ended
January 31, 2008 and 2007 (unaudited) 6
Notes to Consolidated Financial Statements (unaudited) 7-14
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 14-25
Item 3. Quantitative and Qualitative Disclosures about Market Risk 25
Item 4. Controls and Procedures 25
Part II - Other Information
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 5. Other Information 26
Item 6. Exhibits 27
Signatures 28
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
FINANCIAL FEDERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
=============================================================================================
January 31, 2008* July 31, 2007
=============================================================================================
ASSETS
Finance receivables $2,072,791 $2,128,353
Allowance for credit losses (24,133) (23,992)
---------------------------------------------------------------------------------------------
Finance receivables - net 2,048,658 2,104,361
Cash 6,073 5,861
Other assets 11,890 9,852
---------------------------------------------------------------------------------------------
TOTAL ASSETS $2,066,621 $2,120,074
=============================================================================================
LIABILITIES
Debt:
Long-term ($5,200 at January 31, 2008 and $5,700
at July 31, 2007 owed to related parties) $1,313,000 $1,335,850
Short-term 296,000 324,750
Accrued interest, taxes and other liabilities 66,455 71,721
---------------------------------------------------------------------------------------------
Total liabilities 1,675,455 1,732,321
---------------------------------------------------------------------------------------------
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): 25,464 at January 31, 2008 and 25,760 at
July 31, 2007 12,732 12,880
Additional paid-in capital 132,081 129,167
Retained earnings 249,041 244,646
Accumulated other comprehensive (loss) income (2,688) 1,060
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Total stockholders' equity 391,166 387,753
---------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $2,066,621 $2,120,074
=============================================================================================
* Unaudited
See accompanying notes to consolidated financial statements
3
FINANCIAL FEDERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS *
(In thousands, except per share amounts)
============================================================================================
Three Months Ended Six Months Ended
January 31, January 31,
-----------------------------------------
2008 2007 2008 2007
============================================================================================
Finance income $48,708 $47,383 $98,304 $94,313
Interest expense 20,527 21,073 42,608 41,965
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Net finance income before provision for credit
losses on finance receivables 28,181 26,310 55,696 52,348
Provision for credit losses on finance receivables 800 -- 1,200 --
--------------------------------------------------------------------------------------------
Net finance income 27,381 26,310 54,496 52,348
Salaries and other expenses 6,852 6,142 13,361 12,251
--------------------------------------------------------------------------------------------
Income before provision for income taxes 20,529 20,168 41,135 40,097
Provision for income taxes 7,945 7,773 15,885 15,472
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NET INCOME $12,584 $12,395 $25,250 $24,625
============================================================================================
EARNINGS PER COMMON SHARE:
Diluted $ 0.51 $ 0.46 $ 1.01 $ 0.92
============================================================================================
Basic $ 0.52 $ 0.47 $ 1.03 $ 0.94
============================================================================================
* Unaudited
See accompanying notes to consolidated financial statements
4
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, 2006 27,216 $13,608 $123,091 $253,128 $ 552 $390,379
Net income -- -- -- 24,625 -- 24,625
Unrealized gain on cash flow
hedge, net of tax -- -- -- -- 616 616
Reclassification adjustment
for realized gain included
in net income, net of tax -- -- -- -- (59) (59)
--------
Comprehensive income 25,182
--------
Stock repurchased (retired) (5) (3) (125) (6) -- (134)
Stock plan activity:
Shares issued 174 87 2,935 -- -- 3,022
Shares canceled (9) (4) 4 -- -- --
Compensation recognized -- -- 3,282 -- -- 3,282
Excess tax benefits -- -- 511 -- -- 511
Common stock cash dividends -- -- -- (6,836) -- (6,836)
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BALANCE - JANUARY 31, 2007 27,376 $13,688 $129,698 $270,911 $ 1,109 $415,406
=======================================================================================================
=======================================================================================================
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 -- -- -- 25,250 -- 25,250
Unrealized loss on cash flow
hedge, net of tax -- -- -- -- (3,624) (3,624)
Reclassification adjustment
for net realized gain
included in net income,
net of tax -- -- -- -- (124) (124)
---------
Comprehensive income 21,502
---------
Stock repurchased (retired) (633) (316) (3,290) (13,141) -- (16,747)
Stock plan activity:
Shares issued 337 168 1,968 -- -- 2,136
Compensation recognized -- -- 3,961 -- -- 3,961
Excess tax benefits -- -- 275 -- -- 275
Common stock cash dividends -- -- -- (7,714) -- (7,714)
-------------------------------------------------------------------------------------------------------
BALANCE - JANUARY 31, 2008 25,464 $12,732 $132,081 $249,041 $(2,688) $391,166
=======================================================================================================
* Unaudited
See accompanying notes to consolidated financial statements
5
FINANCIAL FEDERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS *
(In thousands)
============================================================================================
Six Months Ended January 31, 2008 2007
============================================================================================
Cash flows from operating activities:
Net income $ 25,250 $ 24,625
Adjustments to reconcile net income to net cash provided
by operating activities:
Amortization of deferred origination costs and fees 8,584 8,079
Stock-based compensation 2,440 1,838
Provision for credit losses on finance receivables 1,200 --
Depreciation and amortization 249 304
(Increase) decrease in other assets (2,431) 2,022
(Decrease) increase in accrued interest, taxes and
other liabilities (280) 7,964
Excess tax benefits from stock-based awards (275) (511)
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Net cash provided by operating activities 34,737 44,321
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Cash flows from investing activities:
Finance receivables originated (483,550) (603,777)
Finance receivables collected 530,990 537,930
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Net cash provided by (used in) investing activities 47,440 (65,847)
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Cash flows from financing activities:
Bank borrowings, net increase (decrease) 445,084 (132,242)
Asset securitization repayments (289,000) --
Commercial paper, net (decrease) increase (173,834) 178,349
Repayments of term notes (36,250) (25,000)
(Payments) proceeds from settlement of interest rate locks (5,915) 1,006
Proceeds from stock option exercises 2,091 2,977
Excess tax benefits from stock-based awards 275 511
Common stock issued 45 45
Repurchases of common stock (16,747) (134)
Common stock cash dividends (7,714) (6,836)
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Net cash (used in) provided by financing activities (81,965) 18,676
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NET INCREASE (DECREASE) IN CASH 212 (2,850)
Cash - beginning of period 5,861 8,143
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CASH - END OF PERIOD $ 6,073 $ 5,293
============================================================================================
* Unaudited
See accompanying notes to consolidated financial statements
6
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, 2007 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, 2007.
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 and six months ended January
31, 2008 may not be indicative of full year results.
Use of Estimates
GAAP requires us to make significant estimates and assumptions affecting
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
Financial Accounting Standards Board ("FASB") Interpretation No. 48,
"Accounting for Uncertainty in Income Taxes - An Interpretation of FASB 109",
("FIN No. 48") became effective for us on August 1, 2007. FIN No. 48 requires us
to determine if any tax positions taken on our income tax returns lowering the
amount of tax currently due would more likely than not be allowed by a taxing
authority. If tax positions pass this more-likely-than-not test, the benefits
recorded from them are limited to the amount having a greater than 50% chance of
being realized upon being challenged by a taxing authority. For tax positions
failing the more-likely-than-not test, no income tax benefits can be recorded.
Applicable interest and penalties on any unrecognized tax benefits must be also
accrued.
Applying FIN No. 48 to account for uncertain tax positions was not
significantly different from how we previously accounted for uncertain tax
positions because our income taxes are straightforward. We have no foreign
operations, we are not involved in any questionable tax transactions and we file
in almost every state with a corporate income tax. Therefore, applying FIN No.
48 did not result in an adjustment to beginning retained earnings nor did it
affect our effective tax rate. Our fiscal 2005 and 2004 tax returns were audited
by the IRS in fiscal 2007 and our fiscal 1996 and 1995 tax returns were audited
by the IRS in fiscal 1997. These audits were completed with no changes to the
tax we reported. We only take uncertain positions on our income tax returns when
tax law is unclear and subject to interpretation and we believe not taking the
position would unfairly distort our income tax liability. One state is currently
examining our income tax returns. Our federal tax returns are open to
examination for three years and our state tax returns are generally open to
examination for three to five years.
We record interest and penalties related to uncertain tax positions in
income tax expense. The gross liability recorded for uncertain tax positions was
$1,200 on August 1, 2007 including $200 of interest and penalties. The entire
amount, net of $300 of federal income tax benefits on state income taxes, would
lower our effective tax rate if recognized. There were no material changes to
these amounts at January 31, 2008 and we do not expect any significant changes
in the next twelve months.
7
The FASB issued Statement of Financial Accounting Standards ("SFAS") No.
157, "Fair Value Measurements" ("SFAS No. 157") in September 2006 and SFAS No.
159, "The Fair Value Option for Financial Assets and Financial Liabilities -
Including an amendment of FASB Statement No. 115" in February 2007. 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. These statements are effective in the first quarter of fiscal
years beginning after November 15, 2007 and will become effective for us on
August 1, 2008. We are evaluating how they may affect our consolidated financial
statements, but we do not expect they will have a material impact.
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:
=========================================================================
January 31, 2008 July 31, 2007
=========================================================================
Loans:
Fixed rate $1,715,328 $1,757,211
Floating rate 160,369 168,574
Total loans 1,875,697 1,925,785
Direct financing leases * 197,094 202,568
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Finance receivables $2,072,791 $2,128,353
=========================================================================
* includes residual values of $44,300 at January 31, 2008 and $42,900
at July 31, 2007
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 $37,400 at January 31, 2008 and $31,400
at July 31, 2007.
Allowance for credit losses activity is summarized below:
==================================================================================
Three Months Ended Six Months Ended
January 31, January 31,
--------------------------------------------
2008 2007 2008 2007
==================================================================================
Allowance - beginning of period $24,020 $24,047 $23,992 $24,100
Provision 800 -- 1,200 --
Write-downs (1,351) (503) (2,324) (1,150)
Recoveries 664 604 1,265 1,198
----------------------------------------------------------------------------------
Allowance - end of period $24,133 $24,148 $24,133 $24,148
==================================================================================
Percentage of finance receivables 1.16% 1.18% 1.16% 1.18%
==================================================================================
Net charge-offs (recoveries) * $ 687 $ (101) $ 1,059 $ (48)
==================================================================================
Loss ratio ** 0.13% (0.02)% 0.10% (0.01)%
==================================================================================
* write-downs less recoveries
** net charge-offs (recoveries) over average finance receivables,
annualized
Non-performing assets comprise finance receivables classified as
non-accrual (income recognition has been suspended and the receivables are
considered impaired) and assets received to satisfy finance receivables
(repossessed equipment, included in other assets) as follows:
=========================================================================
January 31, 2008 July 31, 2007
=========================================================================
Finance receivables classified as
non-accrual $32,136 $18,817
Assets received to satisfy finance
receivables 5,544 2,342
-------------------------------------------------------------------------
Non-performing assets $37,680 $21,159
=========================================================================
8
The allowance for credit losses included $500 at January 31, 2008 and July
31, 2007 specifically allocated to $10,900 and $4,100 of impaired finance
receivables, respectively. We did not recognize any income in the six months
ended January 31, 2008 or 2007 on impaired loans before collecting our net
investment.
NOTE 3 - DEBT
Debt is summarized below:
=========================================================================
January 31, 2008 July 31, 2007
=========================================================================
Fixed rate term notes:
5.00% due 2010 - 2011 $ 250,000 $ 250,000
5.45% - 5.57% due 2011 - 2014 325,000 325,000
6.80% due 2008 -- 5,000
-------------------------------------------------------------------------
Total fixed rate term notes 575,000 580,000
Fixed rate term notes swapped to
floating rates due 2008 - 2010 112,000 143,250
2.0% convertible debentures due 2034 175,000 175,000
-------------------------------------------------------------------------
Total term debt 862,000 898,250
Asset securitization financings 136,000 425,000
Bank borrowings 495,134 50,050
Commercial paper 115,866 289,700
-------------------------------------------------------------------------
Total principal 1,609,000 1,663,000
Fair value adjustment of hedged debt -- (2,400)
-------------------------------------------------------------------------
Total debt $1,609,000 $1,660,600
=========================================================================
Term Notes
We repaid $31,250 of fixed rate term notes swapped to floating rates at
maturity in the first half of fiscal 2008. The floating rate on these notes was
8.58%. We also repaid a 6.80% $5,000 term note at maturity.
We issued $75,000 of five-year fixed rate term notes to two banks in
February 2008. Interest is payable semiannually at a 4.43% average rate and the
notes are due at maturity in February 2013. The notes replaced $75,000 of bank
credit facilities scheduled to expire in February 2008, March 2010 and January
2012.
Convertible Debentures
We issued the debentures in April 2004. The debentures are due at maturity
in April 2034, but we can redeem them anytime starting in April 2009 by paying
the principal amount in cash 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. Debenture holders can
also convert the debentures into cash and common stock before maturity 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. (three ratings levels lower than the initial
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 January 31, 2008. The market price condition would have been
met at January 31, 2008 if the price of our common stock closed above $36.26 for
the required period. The closing price of our common stock was $24.00 on January
31, 2008.
The debentures can only convert into shares of our common stock when their
value exceeds their principal amount because we irrevocably elected (under the
original terms of the debentures and without modifying the debentures) in fiscal
2005 to pay the value of converted debentures, not exceeding the principal
amount, in cash instead of issuing shares of our common stock. Their value
equals the number of convertible shares multiplied by the market value of our
common stock. There were 6,276,000 convertible (but not issuable) shares, the
adjusted conversion price was $27.89 per share and the adjusted conversion rate
was 35.86 shares for each $1 (one thousand) of principal at January 31, 2008. If
the value of converted debentures exceeds their principal amount, shares of
common stock needed to pay the value over principal would equal the difference
between the conversion date price of our common stock and the conversion price,
divided by the conversion date price and multiplied by the number of convertible
shares.
9
The conversion rate and number of convertible shares increased and the
conversion price decreased in the first half of fiscal 2008 because we paid cash
dividends on our common stock. The conversion rate, conversion price and number
of convertible shares were 35.43, $28.22 and 6,200,000, respectively at July 31,
2007. Future cash dividends will cause additional conversion rate and
convertible shares increases and conversion price decreases.
Asset Securitization Financings
We have a $425,000 asset securitization facility providing committed
revolving financing through April 2008. The facility was renewed in April 2007.
If the facility is not renewed again, we could convert borrowings outstanding
into term debt. The term debt would be repaid monthly from collections of
securitized receivables and would be repaid by August 2010 if the facility was
fully borrowed. Finance receivables include $384,000 and $480,000 of securitized
receivables at January 31, 2008 and July 31, 2007, respectively. We can
securitize an additional $440,000 of finance receivables at January 31, 2008. We
replaced $289,000 of borrowings under this facility in the first half of fiscal
2008 with borrowings under our committed bank credit facilities because the
interest rates were lower.
Borrowings under the facility are limited to 94% of eligible securitized
receivables. Securitized receivables ninety or more days past due, classified as
impaired or subject to a bankruptcy, 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 had $555,000 of committed unsecured revolving credit facilities from
eleven banks at January 31, 2008 expiring as follows; $85,000 within one year
and $470,000 between July 2009 and October 2012. Borrowings outstanding at
January 31, 2008 matured within three weeks, were rolled-over (reborrowed) and
remain outstanding. The amount of committed unsecured revolving credit
facilities is currently $455,000 because we replaced $75,000 of the facilities
with five-year term notes and a $25,000 facility expired in February 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 January 31, 2008.
None of the agreements have a material adverse change clause. All of our debt is
senior.
Long-term debt comprised the following:
=========================================================================
January 31, 2008 July 31, 2007
=========================================================================
Term notes $ 600,000 $ 599,100
Bank borrowings and commercial
paper supported by bank credit
facilities expiring after one year 470,000 339,750
Convertible debentures 175,000 175,000
Asset securitization financings 68,000 222,000
-------------------------------------------------------------------------
Total long-term debt $1,313,000 $1,335,850
=========================================================================
NOTE 4 - DERIVATIVES
We entered into interest rate locks (in the form of Treasury locks) with a
total notional amount of $75,000 in August 2007. We designated the rate locks as
cash flow hedges of our anticipated issuance of fixed rate term notes hedging
the risk of higher interest payments on the notes for the first five years from
increases in market interest rates before the notes were issued. We paid $5,915
when the rate locks expired in January 2008.
We determined there was no hedge ineffectiveness and therefore we recorded
the entire loss as a reduction of stockholders' equity in accumulated other
comprehensive loss net of deferred income tax of $2,291. We will reclassify the
after-tax amount into net income over the five year term of the notes issued in
February 2008 by increasing interest expense and deferred income tax. This
effectively increases the interest rate on the notes.
10
We have fixed to floating interest rate swaps with a total notional amount
of $112,000 at January 31, 2008 and $143,250 at July 31, 2007. The swaps
effectively converted fixed rate term notes into floating rate term notes. We
designated the swaps as fair value hedges of fixed rate term notes. The swaps
expire on the notes' maturity dates. Semiannually, we receive fixed amounts from
the swap counterparty banks equal to the interest we pay on the hedged fixed
rate notes, and we pay amounts to the swap counterparty banks equal to the
swaps' floating rates multiplied by the swaps' notional amounts. We record the
differences between these amounts in interest expense. The swaps' floating rates
change semiannually to a fixed amount over six-month LIBOR. The average pay rate
of 5.90% at January 31, 2008 exceeded the 4.50% average receive rate by 140
basis points (1.40%). The average pay rate was 6.90% and the average receive
rate was 4.88% at July 31, 2007. The fair value of the swaps was zero at January
31, 2008 and was a $2,400 liability at July 31, 2007.
NOTE 5 - STOCKHOLDERS' EQUITY
We repurchased and retired 633,000 shares of our common stock in the first
half of fiscal 2008 under our repurchase program for $16,747 at a $26.47 average
price per share. There was $28,459 available for future repurchases under the
program at January 31, 2008. We paid quarterly cash dividends of $0.30 per share
in the first half of fiscal 2008. In March 2008, we declared a $0.15 per share
quarterly cash dividend payable in April 2008.
NOTE 6 - 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
incentive or non-qualified stock options, shares of restricted stock, stock
appreciation rights, stock units and common stock to officers, other employees
and directors subject to annual participant limits, and expires in December
2016. Awards may be performance-based. The exercise price of stock options can
not be less than the fair market value of our common stock when granted and the
term of stock options is limited to ten years. There were 1,974,000 shares
available for future grants under the 2006 Plan at January 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 675,000 shares available for future grants
under the Amended MIP at January 31, 2008.
We also have a Supplemental Retirement Benefit ("SERP") for our CEO. We
awarded 150,000 stock units 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. There were 113,000 units
vested at January 31, 2008.
Options granted through the first half of fiscal 2005 were mostly
incentive stock options with a six-year term vesting 25% after two, three, four
and five years. Options granted in the second half of fiscal 2005 were
non-qualified stock options with a four-year term and 33 1/3% vested on July 31,
2005, 2006 and 2007. Options granted after fiscal 2005 were non-qualified stock
options with a five-year term vesting 25% after one, two, three and four years.
We granted 100,000 non-qualified stock options to employees in the first half of
fiscal 2008.
Shares of restricted stock awarded through fiscal 2007 (excluding 435,000
shares awarded to executive officers in February 2006) vest annually in equal
amounts over initial periods of three to eight years (seven year average).
Shares of restricted stock awarded to executive officers in February 2006 vest
when the officer's service terminates, other than upon a non-qualifying
termination, after six months (i) after the executive officer attains age 62 or
(ii) after August 2026 if earlier (twelve year average).
We awarded 150,000 shares of performance-based restricted stock to
executive officers under the 2006 Plan and 75,000 shares of performance-based
restricted stock to our CEO under the Amended MIP in the first half of fiscal
2008. Shares earned would vest in October 2012.
We awarded 12,000 restricted stock units under the 2006 Plan to
non-employee directors in December 2007. The units vest in one year or earlier
upon the sale of the Company or the director's death or disability, and are
subject to forfeiture. Each unit represents the right to receive one share of
common stock. Vested units will convert into shares of common stock when the
director's service terminates. We also issued 2,000 shares of common stock under
the 2006 Plan as payment of annual director retainer fees at the director's
election. The price of our common stock on the date we issued these shares was
$22.08.
11
All unvested shares of restricted stock and the SERP stock units would
vest immediately upon the sale of the Company or the employees' death or
disability. Unvested shares of restricted stock awarded before fiscal 2007 and
the SERP stock units would also vest immediately upon a qualifying employment
termination, but only a portion (based on the percentage of the vesting period
elapsed) of the shares awarded to executive officers in February 2006 would vest
immediately upon a qualifying employment termination. Unvested shares and units
would be forfeited upon any other employment termination. Dividends are paid on
all unvested shares of restricted stock and on all stock units. The restricted
stock agreements and the SERP also allow employees to pay income taxes required
to be withheld at vesting by surrendering a portion of the shares or units
vested.
Stock options, shares of restricted stock 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'
objectives with those of our stockholders. We issue new shares when options are
exercised or when we award shares of restricted stock, and we do not have a
policy to repurchase shares in the open market when options are exercised or
when we award shares of restricted stock.
Stock option activity and related information for the six months ended
January 31, 2008 are summarized below (options and intrinsic value in
thousands):
==========================================================================
Weighted-Average
----------------------
Exercise Remaining Intrinsic
Options Price Term (years) Value *
==========================================================================
Outstanding - August 1, 2007 1,124 $22.60
Granted 100 22.80
Exercised (110) 19.05
Forfeited (15)
---------------------------------------
Outstanding - January 31, 2008 1,099 $22.92 2.3 $2,300
==========================================================================
Exercisable - January 31, 2008 517 $21.24 1.3 $1,700
==========================================================================
* number of in-the-money options multiplied by the difference between
their average exercise price and the $24.00 closing price of our
common stock on January 31, 2008
Information on stock option exercises follows (in thousands, except
intrinsic value per option):
=========================================================================
Six Months Ended January 31, 2008 2007
=========================================================================
Number of options exercised 110 172
Total intrinsic value * $1,070 $1,850
Intrinsic value per option 9.73 10.77
Excess tax benefits realized 253 499
=========================================================================
* options exercised multiplied by the difference between their
exercise prices and the closing prices of our common stock on the
exercise dates
Restricted stock activity for the six months ended January 31, 2008 is
summarized below (shares in thousands):
=========================================================================
Weighted-Average
Shares Grant-Date Fair Value
=========================================================================
Unvested - August 1, 2007 1,050 $25.34
Granted 225 28.52
Vested (19) 26.02
Forfeited --
------------------------------------------
Unvested - January 31, 2008 1,256 $25.90
=========================================================================
Information on shares of restricted stock that vested follows (in
thousands, except intrinsic value per share):
=========================================================================
Six Months Ended January 31, 2008 2007
=========================================================================
Number of shares vested 19 19
Total intrinsic value * $ 500 $ 517
Intrinsic value per share 26.32 27.21
Excess tax benefits realized 22 12
=========================================================================
* shares vested multiplied by the closing prices of our common stock
on the dates vested
12
Future compensation expense (before deferral under SFAS No. 91) for
stock-based awards unvested at January 31, 2008 and expected to vest, and the
average expense recognition periods follow:
=========================================================================
Expense Weighted-Average Years
=========================================================================
Restricted stock $21,000 5.5
Stock options 1,300 2.6
Stock units 1,100 1.7
-------------------------------------------------------------------------
Total $23,400 5.2
=========================================================================
Total compensation recorded, compensation capitalized (deferred
recognizing) under SFAS No. 91, compensation included in salaries and other
expenses and tax benefits recorded for stock-based awards follow:
===================================================================================
Three Months Ended Six Months Ended
January 31, January 31,
----------------------------------------
2008 2007 2008 2007
===================================================================================
Compensation for stock options:
-------------------------------
Total recorded $ 186 $ 285 $ 356 $ 574
Capitalized under SFAS No. 91 119 174 227 351
-----------------------------------------------------------------------------------
Included in salaries and other expenses $ 67 $ 111 $ 129 $ 223
===================================================================================
Tax benefits recorded $ 15 $ 16 $ 27 $ 32
===================================================================================
Compensation for shares of restricted
stock and stock units:
-------------------------------------
Total recorded $1,862 $1,334 $3,605 $2,708
Capitalized under SFAS No. 91 679 535 1,294 1,093
-----------------------------------------------------------------------------------
Included in salaries and other expenses $1,183 $ 799 $2,311 $1,615
===================================================================================
Tax benefits recorded $ 446 $ 304 $ 870 $ 616
===================================================================================
Total stock-based compensation:
-------------------------------
Total recorded $2,048 $1,619 $3,961 $3,282
Capitalized under SFAS No. 91 798 709 1,521 1,444
-----------------------------------------------------------------------------------
Included in salaries and other expenses $1,250 $ 910 $2,440 $1,838
===================================================================================
Tax benefits recorded $ 461 $ 320 $ 897 $ 648
===================================================================================
NOTE 7 - EARNINGS PER COMMON SHARE
Earnings per common share ("EPS") was calculated as follows (in thousands,
except per share amounts):
==========================================================================
Three Months Ended Six Months Ended
January 31, January 31,
---------------------------------------
2008 2007 2008 2007
==========================================================================
Net income $12,584 $12,395 $25,250 $24,625
==========================================================================
Weighted-average common shares
outstanding (used for basic EPS) 24,338 26,289 24,510 26,242
Effect of dilutive securities:
Stock options 50 292 117 289
Shares of restricted stock and
stock units 330 321 360 297
Shares issuable from
convertible debt -- -- 87 --
--------------------------------------------------------------------------
Adjusted weighted-average common
shares outstanding (used for
diluted EPS) 24,718 26,902 25,074 26,828
==========================================================================
Earnings per common share:
Diluted $ 0.51 $ 0.46 $ 1.01 $ 0.92
Basic 0.52 0.47 1.03 0.94
==========================================================================
Antidilutive stock options,
shares of restricted stock and
stock units * 1,292 144 775 147
==========================================================================
* excluded from the calculation because they would have increased
diluted EPS
13
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 6,276,000 (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 87,000 dilutive
shares for the six months ended January 31, 2008.
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 ranging between two and five years and provide for 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 important. We borrow from banks
and insurance companies and we issue commercial paper to other investors.
Approximately 80% of our finance receivables were funded with debt at January
31, 2008.
We focus on (i) maximizing the difference between the rates we earn on our
receivables and the rates we incur on our debt ("net interest spread") (ii)
maintaining the asset quality of our receivables (iii) maintaining liquidity and
(iv) managing our interest rate risk. Interest rates on our finance receivables
were 92% fixed and 8% floating, and interest rates on our debt were 47% fixed
and 53% floating at January 31, 2008. Therefore, changes in market interest
rates affect our profitability significantly. Changes in the asset quality of
our finance receivables also affect our profitability significantly. Finance
income, provisions for credit losses and operating expenses can be affected by
reclassifying receivables to or from non-accrual status, incurring write-downs
and incurring costs associated with non-performing assets. We use various
strategies to manage our interest rate risk and credit risk.
Our main areas of focus are asset quality, liquidity and interest rate
risk. We discuss each in detail in separate sections of this discussion. These
areas are integral to our long-term profitability. Our key operating statistics
are net charge-offs, loss ratio, non-performing assets, delinquencies,
receivables growth, leverage, available liquidity, net interest margin and net
interest spread, and expense and efficiency ratios.
Significant events
A crisis started in the credit markets in August 2007. The credit crisis
has made it difficult and more expensive for companies, especially finance
companies, to obtain financing. The crisis is generally believed to have been
caused by problems in the subprime mortgage markets. We do not provide subprime
mortgage financing. The crisis initially (i) disrupted the asset-backed and
dealer commercial paper markets significantly (ii) caused LIBOR rates to
increase by over 50 basis points (0.50%) and (iii) caused credit spreads to
widen. Our asset securitization financings are funded with our bank lenders'
asset-backed commercial paper and the interest rates on our floating rate debt
are based on a credit spread over LIBOR.
Before the crisis started, we had $425.0 million of asset securitization
financings and $320.0 million of commercial paper outstanding at an average rate
of 5.5%. The crisis initially (i) caused the interest rates on our asset
securitization financings and commercial paper to exceed 6.0% (ii) made it
difficult for us to issue dealer commercial paper and (iii) caused our credit
spreads on term debt to more than double their pre-crisis levels.
In its initial response to the crisis, the Federal Reserve added
significant liquidity to the credit markets at more favorable rates. Major
United States banks then offered borrowings at favorable interest rates. We had
$560.0 million available under committed revolving unsecured bank credit
facilities with eleven banks when the crisis started. We discuss
14
these facilities in the Liquidity section. Therefore, we had the ability to
forgo issuing dealer commercial paper at over 6.0% and to repay a significant
amount of our asset securitization financings by borrowing under our bank credit
facilities. We borrowed the full amount under each facility. We estimate we
lowered our interest expense by $0.7 million during the first half of fiscal
2008 by replacing our commercial paper debt with bank borrowings.
The Federal Reserve also lowered its target Federal Funds Rate five times
by a total of 225 basis points (2.25%) since the crisis started. These were the
first decreases in over four years and the largest decreases since 2001. This
lowered the interest rates on our floating rate debt as discussed in the Market
Interest Risk and Sensitivity section.
As a result of the credit crisis, our commercial paper outstanding
decreased from $320.0 million to a low of $37.0 million and we repaid $289.0
million of asset securitization financings during the first half of fiscal 2008.
The commercial paper markets are not expected to return to their pre-crisis
state for some time. Therefore, we do not expect our commercial paper to
increase significantly.
Interest rates on our commercial paper and asset securitization financings
are normally lower than interest rates on our bank borrowings. This is why we
borrowed the full amount under our $425.0 million asset securitization facility,
had over $300.0 million of commercial paper and had over $500.0 million
available under our bank credit facilities before the credit crisis. But since
the crisis started, interest rates on our bank borrowings have been and continue
to be lower than rates on our asset securitization financings. Therefore, we
continue to borrow under our bank credit facilities.
Having over $500.0 million of committed unsecured revolving bank credit
facilities allowed us to fund our operations without being disrupted by the
credit crisis and mitigated the effects of higher interest rates on commercial
paper. We have always stressed the importance of having ample liquidity from
diverse, reliable sources.
Critical Accounting Policies and Estimates
Accounting principles generally accepted in the United States require
judgment, assumptions and estimates that affect the amounts reported in the
Consolidated Financial Statements and accompanying notes. In Note 1 to the
Consolidated Financial Statements in our Annual Report on Form 10-K for the
fiscal year ended July 31, 2007, we describe the significant accounting policies
and methods we use to prepare the Consolidated Financial Statements. 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,
non-accrual 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. If the allowance needed to be
increased by 0.10%, we would need to record a $2.1 million provision. The
allowance was $24.1 million (1.16% of finance receivables) at January 31, 2008
including $0.5 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 value 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
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.
Although our method is designed to calculate probable losses, because
significant estimates are used, the adjusted calculated range of losses may
differ from actual losses significantly.
15
Non-Performing Assets
We record non-accrual (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 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 $37.7 million (1.8% of finance receivables) at
January 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 $44.3 million (2.1% of finance receivables) at January 31, 2008.
Historically, we have realized the recorded residual value on disposition.
Income Taxes
We record a liability for uncertain income tax positions according to FIN
No. 48. FIN No. 48 requires us to (i) identify uncertain tax positions we take
on our income tax returns (ii) determine if these tax positions would more
likely than not be allowed by a taxing authority, and if tax positions pass this
more-likely-than-not test, (iii) estimate the amount of tax benefit to record.
Therefore, we must record a liability for tax benefits from positions that fail
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 FIN No. 48 requires us to assess the 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 $1.2 million on August 1, 2007 and we do not
expect this amount to change significantly.
Stock-Based Compensation
We record compensation expense for stock options under SFAS No. 123R using
the Black-Scholes option pricing model. This model requires us to estimate the
expected volatility of the price of our common stock, the expected life of
options and the expected dividend rate. SFAS No. 123R also requires us to
estimate forfeitures of stock awards. Estimating volatility, expected life,
dividend rate and forfeitures requires significant judgment and an analysis of
historical data. We may have to record more compensation expense for stock
awards if actual results differ from our estimates significantly.
RESULTS OF OPERATIONS
Comparison of three months ended January 31, 2008 to three months ended January
31, 2007
=========================================================================
Three Months Ended
January 31,
($ in millions, except per ------------------
share amounts) 2008 2007 $ Change % Change
=========================================================================
Finance income $48.7 $47.4 $ 1.3 3%
Interest expense 20.5 21.1 (0.6) (3)
Net finance income before
provision for credit losses 28.2 26.3 1.9 7
Provision for credit losses 0.8 -- 0.8 100
Salaries and other expenses 6.9 6.1 0.8 12
Provision for income taxes 7.9 7.8 0.1 2
Net income 12.6 12.4 0.2 2
Diluted earnings per share 0.51 0.46 0.05 11
Basic earnings per share 0.52 0.47 0.05 11
=========================================================================
16
Net income increased by 2% to $12.6 million in the second quarter of
fiscal 2008 from $12.4 million in the second quarter of fiscal 2007. The
increase resulted from the net effects of lower short-term market interest rates
and, to a lesser extent, the increase in average receivables, partially offset
by the effects of higher non-performing assets as discussed below.
Finance income increased by 3% to $48.7 million in the second quarter of
fiscal 2008 from $47.4 million in the second quarter of fiscal 2007. The
increase resulted from the 2% increase in average finance receivables ($50.0
million) to $2.10 billion in the second quarter of fiscal 2008 from $2.05
billion in the second quarter of fiscal 2007 and, to a lesser extent, the higher
net yield on finance receivables. Higher non-accrual finance receivables and
decreases in the prime rate partially offset these positive factors. The net
yield on finance receivables was 9.23% in the second quarter of fiscal 2008 and
9.17% in the second quarter of fiscal 2007.
Interest expense (incurred on debt used to fund finance receivables)
decreased by 3% to $20.5 million in the second quarter of fiscal 2008 from $21.1
million in the second quarter of fiscal 2007. The decrease resulted from the 36
basis point (0.36%) decrease in our cost of debt to 5.00% in the second quarter
of fiscal 2008 from 5.36% in the second quarter of fiscal 2007, partially offset
by the 5% ($73.0 million) increase in average debt. Our cost of debt decreased
because of lower short-term market interest rates as discussed in the Market
Interest Rate Risk and Sensitivity section.
Net finance income before provision for credit losses on finance
receivables increased by 7% to $28.2 million in the second quarter of fiscal
2008 from $26.3 million in the second quarter of fiscal 2007. Net interest
margin (net finance income before provision for credit losses expressed as an
annualized percentage of average finance receivables) increased to 5.34% in the
second quarter of fiscal 2008 from 5.09% in the second quarter of fiscal 2007
because of lower short-term market interest rates.
We recorded a $0.8 million provision for credit losses on finance
receivables in the second quarter of fiscal 2008. We did not record provisions
in the prior two fiscal years. 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) were $0.7 million in the second quarter of fiscal
2008 compared to a $0.1 million net recovery (recoveries exceeded write-downs of
finance receivables) in the second quarter of fiscal 2007, and the loss ratio
(net charge-offs expressed as an annualized percentage of average finance
receivables) was 0.13% in the second quarter of fiscal 2008 and (0.02)% in the
second quarter of fiscal 2007. Net charge-offs have been increasing because of
higher non-performing assets.
Salaries and other expenses increased by 12% to $6.9 million in the second
quarter of fiscal 2008 from $6.1 million in the second quarter of fiscal 2007.
The increase resulted from higher non-performing asset costs and, to a lesser
extent, general increases in other operating expenses including salary expense.
The expense ratio (salaries and other expenses expressed as an annualized
percentage of average finance receivables) worsened to 1.30% in the second
quarter of fiscal 2008 from 1.19% in the second quarter of fiscal 2007 because
the increase in expenses exceeded the increase in receivables. The efficiency
ratio (expense ratio expressed as a percentage of net interest margin) worsened
to 24.3% in the second quarter of fiscal 2008 from 23.3% in the second quarter
of fiscal 2007 because the increase in expenses exceeded the increase in net
finance income.
Diluted earnings per share increased by 11% to $0.51 per share in the
second quarter of fiscal 2008 from $0.46 per share in the second quarter of
fiscal 2007, and basic earnings per share increased by 11% to $0.52 per share in
the second quarter of fiscal 2008 from $0.47 per share in the second quarter of
fiscal 2007. The percentage increase in diluted and basic earnings per share was
higher than the percentage increase in net income because we repurchased 2.7
million shares of our common stock (10% of total shares outstanding) in the last
four fiscal quarters.
17
Comparison of six months ended January 31, 2008 to six months ended January 31,
2007
=========================================================================
Six Months Ended
January 31,
($ in millions, except per ----------------
share amounts) 2008 2007 $ Change % Change
=========================================================================
Finance income $ 98.3 $ 94.3 $ 4.0 4%
Interest expense 42.6 42.0 0.6 2
Net finance income before
provision for credit losses 55.7 52.3 3.4 6
Provision for credit losses 1.2 -- 1.2 100
Salaries and other expenses 13.3 12.2 1.1 9
Provision for income taxes 15.9 15.5 0.4 3
Net income 25.3 24.6 0.7 3
Diluted earnings per share 1.01 0.92 0.09 10
Basic earnings per share 1.03 0.94 0.09 10
=========================================================================
Net income increased by 3% to $25.3 million in the first half of fiscal
2008 from $24.6 million in the first half of fiscal 2007. The increase resulted
from the increase in average receivables and, to a lesser extent, the net
effects of lower short-term market interest rates, partially offset by the
effects of higher non-performing assets as discussed below.
Finance income increased by 4% to $98.3 million in the first half of
fiscal 2008 from $94.3 million in the first half of fiscal 2007. The increase
resulted from the 4% increase in average finance receivables ($78.0 million) to
$2.12 billion in the first half of fiscal 2008 from $2.04 billion in the first
half of fiscal 2007 and, to a lesser extent, the higher net yield on finance
receivables. Higher non-accrual finance receivables and decreases in the prime
rate partially offset these positive factors. The net yield on finance
receivables was 9.25% in the first half of fiscal 2008 and 9.19% in the first
half of fiscal 2007.
Interest expense increased by 2% to $42.6 million in the first half of
fiscal 2008 from $42.0 million in the first half of fiscal 2007. The increase
resulted from the 6% ($89.0 million) increase in average debt, partially offset
by the 20 basis point (0.20%) decrease in our cost of debt to 5.17% in the first
half of fiscal 2008 from 5.37% in the first half of fiscal 2007.
Net finance income before provision for credit losses on finance
receivables increased by 6% to $55.7 million in the first half of fiscal 2008
from $52.3 million in the first half of fiscal 2007. Net interest margin
increased to 5.24% in the first half of fiscal 2008 from 5.10% in the first half
of fiscal 2007 because of lower short-term market interest rates.
We recorded a $1.2 million provision for credit losses on finance
receivables in the first half of fiscal 2008. Net charge-offs were $1.1 million
in the first half of fiscal 2008 compared to a $48,000 net recovery in the first
half of fiscal 2007, and the loss ratio was 0.10% in the first half of fiscal
2008 and (0.01)% in the first half of fiscal 2007.
Salaries and other expenses increased by 9% to $13.3 million in the first
half of fiscal 2008 from $12.2 million in the first half of fiscal 2007. The
increase resulted from higher non-performing asset costs and, to a lesser
extent, salary increases. The expense ratio worsened to 1.26% in the first half
of fiscal 2008 from 1.19% in the first half of fiscal 2007 and the efficiency
ratio worsened to 24.0% in the first half of fiscal 2008 from 23.4% in the first
half of fiscal 2007.
Diluted earnings per share increased by 10% to $1.01 per share in the
first half of fiscal 2008 from $0.92 per share in the first half of fiscal 2007,
and basic earnings per share increased by 10% to $1.03 per share in the first
half of fiscal 2008 from $0.94 per share in the first half of fiscal 2007. The
percentage increase in diluted and basic earnings per share was higher than the
percentage increase in net income because we repurchased 2.7 million shares of
our common stock in the last four fiscal quarters.
18
FINANCE RECEIVABLES AND ASSET QUALITY
We discuss trends and characteristics of our finance receivables and our
approach to managing credit risk in this section. The key aspect is asset
quality. Asset quality statistics measure our underwriting standards, skills and
policies and procedures and can indicate the direction and levels of future net
charge-offs and non-performing assets.
========================================================================
January 31, July 31,
($ in millions) 2008 * 2007 * $ Change % Change
------------------------------------------------------------------------
Finance receivables $2,072.8 $2,128.4 $(55.6) (3)%
Allowance for credit losses 24.1 24.0 0.1 1
Non-performing assets 37.7 21.2 16.5 78
Delinquent finance receivables 25.2 9.9 15.3 155
Net charge-offs 1.1 0.2 0.9 579
As a percentage of receivables:
-------------------------------
Allowance for credit losses 1.16% 1.13%
Non-performing assets 1.82 0.99
Delinquent finance receivables 1.22 0.46
Net charge-offs (annualized) 0.10 0.01
========================================================================
* as of and for the six months ended
Finance receivables decreased $55.6 million during the first half of
fiscal 2008 to $2.07 billion at January 31, 2008. Finance receivables comprise
installment sale agreements and secured loans (collectively referred to as
loans) and direct financing leases. Loans were 90% ($1.88 billion) of finance
receivables and leases were 10% ($197 million) at January 31, 2008.
Finance receivables originated in the second quarter of fiscal 2008 and
2007 were $225 million and $284 million, respectively, and finance receivables
originated in the first half of fiscal 2008 and 2007 were $484 million and $604
million, respectively. Originations decreased because of the weak demand for
transportation and construction equipment financing. Finance receivables
collected in the second quarter of fiscal 2008 and 2007 were $273 million and
$275 million, respectively, and finance receivables collected in the first half
of fiscal 2008 and 2007 were $531 million and $538 million, respectively.
Our primary focus is the credit quality of our receivables. We manage our
credit risk by using 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 limit our credit exposure with any customer. The
limit was $42.6 million at January 31, 2008. Our ten largest customers accounted
for 6.2% ($127.5 million) of total finance receivables at January 31, 2008.
Our allowance for credit losses was $24.1 million at January 31, 2008 and
$24.0 million at July 31, 2007, and the allowance level was 1.16% and 1.13% of
finance receivables, respectively. 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
$1.1 million in the first six months of fiscal 2008 compared to $0.2 million in
the last six months of fiscal 2007 (the prior six month period) and the
annualized loss ratios were 0.10% and 0.01%. Net charge-offs were $0.7 million
in the second quarter of fiscal 2008 compared to $0.4 million in the first
quarter of fiscal 2008 and the annualized loss ratios were 0.13% and 0.07%. Net
charge-offs are increasing because there are more non-performing assets
resulting from the slowing economy and transportation and construction
industries.
19
The net investments in non-accrual (impaired) finance receivables,
repossessed equipment (assets received to satisfy receivables), total
non-performing assets and delinquent finance receivables (transactions with more
than a nominal portion of a contractual payment 60 or more days past due) follow
($ in millions):
=========================================================================
January 31, July 31, January 31,
2008 2007 2007
=========================================================================
Non-accrual finance receivables * $32.1 $18.8 $13.5
Repossessed equipment 5.6 2.4 2.0
-------------------------------------------------------------------------
Total non-performing assets $37.7 $21.2 $15.5
=========================================================================
Delinquent finance receivables $25.2 $ 9.9 $ 8.3
=========================================================================
Percentage of non-accrual
receivables not delinquent 45% 69% 62%
=========================================================================
* before specifically allocated allowance of $0.5 million at January 31,
2008, $0.5 million at July 31, 2007 and $0.2 million at January 31,
2007
We expect continued increases in delinquent and non-accrual receivables,
repossessed equipment and net charge-offs because of continued weakening
economic conditions and the effects of the crisis in the credit markets. This
would require us to record higher provisions for credit losses.
LIQUIDITY AND CAPITAL RESOURCES
We describe our need for raising capital (debt and equity), our need for 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 been successful in issuing debt, we have
ample liquidity available and our debt is diversified with maturities staggered
over six years.
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 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,
dealer placed and direct issued commercial paper and sales of common and
preferred equity. We believe our liquidity sources are diversified, and we are
not dependent on any funding source or provider.
The current credit crisis has made it difficult and more expensive for
companies to obtain financing. However, we do not anticipate a need for new
financing until some time in fiscal 2009 because (i) we currently have over
$200.0 million of liquidity (ii) receivables originations have been decreasing
(iii) our operating cash flow remains strong and (iv) aside from our asset
securitization facility (discussed below), we currently have only $30.0 million
of bank credit facilities expiring and $87.0 million of term notes maturing
before January 31, 2009.
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 recently 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 access to capital markets and our credit
spreads are partly dependent on these investment grade credit ratings.
We had $233.0 million available to borrow under our committed asset
securitization and bank credit facilities (after subtracting commercial paper
outstanding) at January 31, 2008. We believe we can increase our asset
securitization facility and issue more term notes. The increase in our asset
securitization facility would be limited to $350.0 million. We believe, but
cannot assure, sufficient capital is available to us to sustain our future
operations and growth.
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 January 31, 2008.
None of the agreements have a material adverse change clause.
20
Debt decreased by 3% ($51.6 million) to $1.61 billion at January 31, 2008
from $1.66 billion at July 31, 2007 and stockholders' equity increased by 1%
($3.4 million) to $391.2 million at January 31, 2008 from $387.8 million at July
31, 2007. Therefore, leverage (debt-to-equity ratio) decreased to 4.1 at January
31, 2008 from 4.3 at July 31, 2007. Our leverage is considered low allowing for
substantial asset growth and equity repurchases. Historically, our leverage has
not exceeded 5.5 which is also considered low for a finance company.
Debt comprised the following ($ in millions):
================================================================================
January 31, 2008 July 31, 2007
------------------ -----------------
Amount Percent Amount Percent
================================================================================
Term notes $ 687.0 43% $ 723.3 43%
Asset securitization financings 136.0 8 425.0 26
Convertible debentures 175.0 11 175.0 11
Borrowings under bank credit facilities 495.1 31 50.0 3
Commercial paper 115.9 7 289.7 17
--------------------------------------------------------------------------------
Total principal 1,609.0 100% 1,663.0 100%
Fair value adjustment of hedged debt -- (2.4)
--------------------------------------------------------------------------------
Total debt $1,609.0 $1,660.6
================================================================================
Term Notes
We repaid $31.3 million of fixed rate term notes swapped to floating rates
at maturity in the first half of fiscal 2008. The floating rate on these notes
was 8.58%. We also repaid a 6.80% $5,000 term note at maturity.
We issued $75.0 million of five-year fixed rate term notes to two banks in
February 2008. Interest is payable semiannually at a 4.43% average rate and the
notes are due at maturity in February 2013. The notes replaced $75.0 million of
bank credit facilities scheduled to expire in February 2008, March 2010 and
January 2012.
Asset Securitization Financings
We have a $425.0 million asset securitization facility. We established the
facility in July 2001. The facility provides for committed revolving financing
for one year. The facility was renewed a sixth time in April 2007 and expires in
April 2008. If the facility is not renewed again, we could convert borrowings
into term debt. The term debt would be repaid monthly from collections of
securitized receivables and would be repaid by August 2010 if the facility was
fully borrowed.
We replaced $289.0 million of borrowings under this facility with
borrowings under our committed bank credit facilities in the first half of
fiscal 2008. The interest rates on bank borrowings were lower because of the
crisis in the credit markets and falling short-term market interest rates.
Borrowings under the facility are limited to 94% of eligible securitized
receivables. Securitized receivables ninety or more days past due, classified as
impaired or subject to a bankruptcy, 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.
The unsecured debt agreements of our major operating subsidiary allow 40%
of its finance receivables to be securitized ($824.0 million at January 31,
2008). Finance receivables include $384.0 million of securitized receivables at
January 31, 2008 and we could securitize an additional $440.0 million of finance
receivables.
Convertible Debentures
We issued the convertible debentures in April 2004. They are due at
maturity in April 2034, but we can redeem them (commonly referred to as a
"call") anytime starting in April 2009 by repaying the principal amount in cash
and debenture holders can require us to repurchase them (commonly referred to as
a "put") 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 into cash and common stock before maturity 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
21
price condition") (ii) if the debentures are rated 'BB' or lower by Fitch (three
ratings levels lower than the initial 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 January 31, 2008. The market
price condition would have been met at January 31, 2008 if the price of our
common stock closed above $36.26 for the required period. The closing price of
our common stock was $24.00 on January 31, 2008.
The debentures can only convert into shares of our common stock when their
value exceeds their principal amount because we irrevocably elected in fiscal
2005 to pay the value of converted debentures, not exceeding the principal
amount, in cash instead of issuing shares of our common stock. Their value
equals the number of convertible shares multiplied by the market value of our
common stock. There are 6.3 million convertible (but not issuable) shares, the
adjusted conversion price is $27.89 per share and the adjusted conversion rate
is 35.86 shares for each $1,000 of principal. If the value of converted
debentures exceeds their principal amount, shares of common stock needed to pay
the value over principal would equal the difference between the conversion date
price of our common stock and the conversion price, divided by the conversion
date price and multiplied by the number of convertible shares. The conversion
rate and number of convertible shares increase and the conversion price
decreases when we pay dividends on our common stock.
Bank Credit Facilities
We currently have $455.0 million of committed unsecured revolving credit
facilities after replacing $75.0 million of facilities with five-year term notes
and after a $25.0 million facility expired in February 2008. The facilities have
original terms ranging from two to five years. The average remaining term is 3.3
years. 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 January 31, 2008 matured within three weeks, were rolled-over (reborrowed)
and remain outstanding. We borrow amounts mostly for one day, and also for one
week or one month depending on the 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.
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
can not exceed the unused amount of our committed credit facilities ($348.9
million January 31, 2008).
Stockholders' Equity
We repurchased 0.6 million shares of our common stock in the first half of
fiscal 2008 for $16.7 million at a $26.47 average price per share. We financed
the repurchases with borrowings under our bank credit facilities. There was
$28.5 million available for future repurchases under our program at January 31,
2008. Repurchases are discretionary and future repurchases are contingent upon
many conditions.
We paid $7.7 million of cash dividends and we received $2.4 million from
stock option exercises and excess tax benefits from stock-based awards in the
first half of fiscal 2008.
MARKET INTEREST RATE RISK AND SENSITIVITY
We discuss how changes in market interest rates 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 Six Months Ended
January 31, January 31,
--------------------------------------
2008 2007 2008 2007
=======================================================================
Net yield of finance receivables 9.23% 9.17% 9.25% 9.19%
Cost of debt 5.00 5.36 5.17 5.37
-----------------------------------------------------------------------
Net interest spread 4.23% 3.81% 4.08% 3.82%
=======================================================================
22
Our net interest spread was 0.42% (42 basis points) higher in the second
quarter of fiscal 2008 compared to the second quarter of fiscal 2007, and was
0.26% (26 basis points) higher in the first half of fiscal 2008 compared to the
first half of fiscal 2007 because (i) recent decreases in short-term market
interest rates lowered our cost of debt and (ii) the yield on our finance
receivables increased slightly.
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 currently occurring) 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 53% of our debt is floating rate compared to floating
rate finance receivables of only 8%.
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 partially 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. The yield curve remained inverted during most of the
first half of fiscal 2008.
Our net interest spread is also affected by credit spreads. Credit spread
is the percentage amount lenders charge borrowers above a market interest rate.
Changes in credit spreads affect the yield on our receivables when originated
and the cost of debt when issued. Credit spreads increased significantly because
of the crisis in the credit markets.
Short-term market interest rates decreased in the first half of fiscal
2008 significantly because the Federal Reserve lowered the target Federal Funds
Rate 225 basis points (2.25%). As a result, our cost of debt decreased by 36
basis points (0.36%) and should continue to decrease. Long-term market interest
rates also decreased significantly. Lower long-term market interest rates would
normally decrease the cost of future issuances of fixed-rate term debt and also
result in lower yields on finance receivables, but these effects have been
mostly offset by significantly higher credit spreads caused by the crisis in the
credit markets.
Our income is subject to the risk of rising short-term market interest
rates and a flat or inverted yield curve at January 31, 2008 because floating
rate debt exceeded floating rate receivables by $698.6 million (see the table
below). The terms and prepayment experience of our fixed rate receivables
mitigate this risk. Finance receivables are collected monthly over short periods
of two to five years and have been accelerated by prepayments. At January 31,
2008, $669.3 million (35%) of fixed rate finance receivables are scheduled to be
collected in one year and the average remaining life of fixed rate finance
receivables excluding prepayments is approximately twenty months. Historically,
annual collections have exceeded 50% of average receivables. We do not match the
maturities of our debt to our finance receivables. The fixed and floating rate
amounts and percentages of our finance receivables and capital at January 31,
2008 follow ($ in millions):
==================================================================================
Fixed Rate Floating Rate
------------------- -----------------
Amount Percent Amount Percent Total
==================================================================================
Finance receivables $1,912.4 92% $160.4 8% $2,072.8
==================================================================================
Debt (principal) $ 750.0 47% $859.0 53% $1,609.0
Stockholders' equity 391.2 100 -- -- 391.2
----------------------------------------------------------------------------------
Total debt and equity $1,141.2 57% $859.0 43% $2,000.2
==================================================================================
Floating rate debt comprises bank borrowings, asset securitization
financings, floating rate swaps of fixed rate notes and commercial paper, and
reprices (interest rates change based on current short-term market interest
rates) at January 31, 2008 as follows: $690.2 million (80%) within one month,
$147.1 million (17%) in two to three months and $21.7 million (3%) in four to
six months. Asset securitization financings reprice daily as the underlying
commercial paper matures. The
23
floating rate swaps of fixed rate notes last repriced in October 2007. The
repricing frequency of floating rate debt follows (in millions):
=========================================================================
Balance Repricing Frequency
-------------------------------------------------------------------------
Bank borrowings $495.1 1 to 30 days
Asset securitization financings 136.0 generally daily
Commercial paper 115.9 1 to 180 days (50 day average)
Floating rate swaps of fixed
rate notes 112.0 semiannually (in 90 days)
=========================================================================
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 $0.6 million at January 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 $1.0 million
excluding the expected increase in the yield of new receivables. We believe
these amounts are acceptable considering the cost of floating rate debt has been
historically lower than fixed rate debt. Actual future changes in market
interest rates and the effect on net income may differ materially from these
amounts. These hypothetical reductions of quarterly net income at January 31,
2007 were $0.5 million and $1.0 million. Other factors that may accompany an
actual immediate 100 basis point rise in market interest rates were not
considered in the calculation.
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 entered into interest rate locks (in the form of Treasury locks) with a
total notional amount of $75.0 million in August 2007. We designated the rate
locks as cash flow hedges of our anticipated issuance of fixed rate term notes
hedging the risk of higher interest payments on the notes for the first five
years from increases in market interest rates before the notes were issued. We
paid $5.9 million when the rate locks expired in January 2008.
We determined there was no hedge ineffectiveness and therefore we recorded
the entire loss as a reduction of stockholders' equity in accumulated other
comprehensive loss net of deferred income tax of $2.3 million. We will
reclassify the after-tax amount into net income over the five year term of the
notes issued in February 2008 by increasing interest expense and deferred income
tax. This effectively increases the interest rate on the notes.
We also have fixed to floating interest rate swaps with a total notional
amount of $112.0 million at January 31, 2008. The swaps effectively converted
fixed rate term notes into floating rate term notes. Semiannually, we receive
fixed amounts from the swap counterparty banks equal to the interest we pay on
the hedged fixed rate notes, and we pay amounts to the swap counterparty banks
equal to the swaps' floating rates multiplied by the swaps' notional amounts.
The swaps' floating rates change semiannually to a fixed amount over six-month
LIBOR (3.04% at January 31, 2008). The swaps increased interest expense by $0.4
million and $0.8 million in the second quarter of fiscal 2008 and 2007,
respectively, and by $1.0 million and $1.5 million in the first half of fiscal
2008 and 2007, respectively. The average pay rate of 5.90% at January 31, 2008
exceeded the 4.50% average receive rate by 140 basis points (1.40%). The average
pay rate was 6.90% and the average receive rate was 4.88% at July 31, 2007. The
average remaining term of the swaps at January 31, 2008 is nine months. In the
first half of fiscal 2008, a swap with a $31.3 million notional amount and an
8.58% rate expired when the swapped 6.23% fixed rate term notes matured. The
swaps have no value at expiration.
NEW ACCOUNTING STANDARDS
Financial Accounting Standards Board ("FASB") Interpretation No. 48,
"Accounting for Uncertainty in Income Taxes - An Interpretation of FASB 109",
("FIN No. 48") became effective for us on August 1, 2007. FIN No. 48 requires us
to determine if any tax positions taken on our income tax returns lowering the
amount of tax currently due would more likely than not be allowed by a taxing
authority. If tax positions pass this more-likely-than-not test, the benefits
recorded from them are limited to the amount having a greater than 50% chance of
being realized upon being challenged by a taxing authority. For tax positions
failing the more-likely-than-not test, no income tax benefits can be recorded.
Applicable interest and penalties on any unrecognized tax benefits must be also
accrued.
24
Applying FIN No. 48 to account for uncertain tax positions was not
significantly different from how we previously accounted for uncertain tax
positions because our income taxes are straightforward. We have no foreign
operations, we are not involved in any questionable tax transactions and we file
in almost every state with a corporate income tax. Therefore, applying FIN No.
48 did not result in an adjustment to beginning retained earnings nor did it
affect our effective tax rate. Our fiscal 2005 and 2004 tax returns were audited
by the IRS in fiscal 2007 and our fiscal 1996 and 1995 tax returns were audited
by the IRS in fiscal 1997. These audits were completed with no changes to the
tax we reported. We only take uncertain positions on our income tax returns when
tax law is unclear and subject to interpretation and we believe not taking the
position would unfairly distort our income tax liability. One state is currently
examining our income tax returns. Our federal tax returns are open to
examination for three years and our state tax returns are generally open to
examination for three to five years.
We record interest and penalties related to uncertain tax positions in
income tax expense. The gross liability recorded for uncertain tax positions was
$1.2 million on August 1, 2007 including $0.2 million of interest and penalties.
The entire amount, net of $0.3 million of federal income tax benefits on state
income taxes, would lower our effective tax rate if recognized. There were no
material changes to these amounts at January 31, 2008 and we do not expect any
significant changes in the next twelve months.
The FASB issued Statement of Financial Accounting Standards ("SFAS") No.
157, "Fair Value Measurements" ("SFAS No. 157") in September 2006 and SFAS No.
159, "The Fair Value Option for Financial Assets and Financial Liabilities -
Including an amendment of FASB Statement No. 115" in February 2007. 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. These statements are effective in the first quarter of fiscal
years beginning after November 15, 2007 and will become effective for us on
August 1, 2008. We are evaluating how they may affect our consolidated financial
statements, but we do not expect they will have a material impact.
FORWARD-LOOKING STATEMENTS
Statements in this report containing the words or phrases "expect,"
"anticipate," "may," "believe," "appears," "estimate," "intend," "could,"
"should," "would," "if," "outlook" 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, 2007 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 second quarter of fiscal 2008 that materially affected or are
reasonably likely to materially affect our internal control over financial
reporting.
25
PART II - OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
ISSUER PURCHASES OF EQUITY SECURITIES
For the Quarter Ended January 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
----------------------------------------------------------------------------------------
December 2007 210,006 $22.55 210,006 $28,459,000
========================================================================================
We did not sell any unregistered shares of our common stock during the
second quarter of fiscal 2008. We established our $50.0 million common stock and
convertible debt repurchase program in June 2007.
Item 4. Submission of Matters To a Vote of Security Holders
Our stockholders voted on the following at our December 11, 2007 Annual
Meeting of Stockholders:
The following nominees were elected to the Board of Directors:
==========================================================
Number of Votes
--------------------------
Nominee For Withheld
==========================================================
Lawrence B. Fisher 21,196,860 1,988,104
Michael C. Palitz 14,442,792 8,742,172
Paul R. Sinsheimer 22,944,274 240,690
Leopold Swergold 23,021,305 163,659
H. E. Timanus, Jr. 23,021,305 163,659
Michael J. Zimmerman 23,021,274 163,690
==========================================================
The appointment of KPMG LLP as our independent registered public
accounting firm for our fiscal year ending July 31, 2008 was ratified by a vote
of 22,920,511 shares for, 15,856 shares against and 248,597 shares abstained.
Item 5. Other Information
We issued a press release on March 3, 2008 reporting our results for the
quarter ended January 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.
We issued a press release on March 3, 2008 announcing our Board of
Directors declared a quarterly dividend of $0.15 per share on our common stock.
The press release is attached as Exhibit 99.2. The dividend is payable on April
10, 2008 to stockholders of record at the close of business on March 21, 2008.
The dividend rate is the same as the previous quarter.
26
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 March 3, 2008
99.2 Press release dated March 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
27
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
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Vice President and Controller
(Principal Accounting Officer)
March 5, 2008
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(Date)
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