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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
OR
[ ] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
COMMISSION FILE NUMBER 0-23928
PDS FINANCIAL CORPORATION
(Exact name of Registrant as specified in its charter)
MINNESOTA 41-1605970
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
6171 MC LEOD DRIVE, LAS VEGAS, NEVADA 89120
(Address of principal executive offices)
(702) 736-0700
(Issuer's telephone number)
Indicate by check mark whether the registrant (1) 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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date:
CLASS OUTSTANDING AS OF OCTOBER 29, 1999
----- ----------------------------------
Common Stock, $.01 par value 3,706,971 shares
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PDS FINANCIAL CORPORATION
INDEX
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
PAGE
Condensed Consolidated Balance Sheets
As of September 30, 1999 (Unaudited) and December 31, 1998 3
Condensed Consolidated Statements of Operations and Comprehensive
Income (Loss) for the Three Months Ended September 30, 1999
and 1998 (Unaudited) 4
Condensed Consolidated Statements of Operations and Comprehensive
Income (Loss) for the Nine Months Ended September 30, 1999
and 1998 (Unaudited) 5
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1999 and 1998 (Unaudited) 6
Notes to Condensed Consolidated Financial Statements (Unaudited) 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 13
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 16
2
PDS FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
1999 1998
---- ----
(Unaudited)
ASSETS
Cash and cash equivalents $ 1,310,000 $ 1,269,000
Restricted cash -- 3,166,000
Accounts receivable, net 2,247,000 1,335,000
Notes receivable, net 25,829,000 21,878,000
Net investment in leasing operations:
Equipment under operating leases, net 64,627,000 27,751,000
Direct finance leases 13,067,000 9,668,000
Equipment held for sale or lease 7,421,000 10,002,000
Other assets, net 6,393,000 4,560,000
--------- ---------
Total assets $120,894,000 $79,629,000
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued expenses $ 3,612,000 $ 2,135,000
Deferred funds for pending transactions 3,996,000 13,427,000
Discounted lease rentals 334,000 806,000
Notes payable 82,510,000 36,699,000
Subordinated debentures, net 13,284,000 13,165,000
Other liabilities 6,891,000 2,863,000
--------- ---------
Total liabilities 110,627,000 69,095,000
Stockholders' equity:
Commonstock, $.01 par value, 20,000,000 shares authorized, 3,704,415 and
3,648,211 shares issued and outstanding as of
September 30, 1999 and December 31, 1998, respectively 37,000 36,000
Additional paid-in capital 11,426,000 11,268,000
Accumulated other comprehensive income -- (25,000)
Retained earnings (accumulated deficit) (1,196,000) (745,000)
---------- --------
Total stockholders' equity 10,267,000 10,534,000
---------- ----------
Total liabilities and stockholders' equity $120,894,000 $79,629,000
============ ===========
See accompanying notes to condensed consolidated financial statements.
3
PDS FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
THREE MONTHS ENDED
SEPTEMBER 30,
1999 1998
---- ----
Revenues:
Equipment sales $ 1,031,000 $2,517,000
Revenue from sales type leases 668,000 2,068,000
Rental revenue on operating leases 5,601,000 1,349,000
Fee income (loss) 1,303,000 (129,000)
Finance income 1,163,000 949,000
----------- ----------
Total revenues 9,766,000 6,754,000
Costs and expenses:
Equipment sales 1,249,000 1,323,000
Sales-type leases 549,000 1,845,000
Depreciation on operating leases 4,001,000 881,000
Selling, general and administrative 1,583,000 1,202,000
Provision for uncollectible receivables 250,000 --
Interest 2,803,000 1,434,000
----------- ----------
Total costs and expenses 10,435,000 6,685,000
Income (loss) before income taxes (669,000) 69,000
Provision (benefit) for income taxes (255,000) 27,000
----------- ----------
Net income (loss) $ (414,000) $ 42,000
============= ==========
Other comprehensive income, net of tax -- 13,000
----------- ----------
Comprehensive income (loss) $ (414,000) $ 55,000
============= ==========
Earnings (loss) per share:
Basic $ (0.11) $ 0.01
Diluted $ (0.11) $ 0.01
Weighted average shares outstanding:
Basic 3,705,000 3,644,000
Diluted 3,705,000 3,798,000
See accompanying notes to condensed consolidated financial statements.
4
PDS FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
1999 1998
---- ----
Revenues:
Equipment sales $ 5,726,000 $18,868,000
Revenue from sales type leases 4,099,000 3,335,000
Rental revenue on operating leases 11,554,000 4,974,000
Fee income 2,652,000 1,239,000
Finance income 3,103,000 2,066,000
---------- ----------
Total revenues 27,134,000 30,482,000
Costs and expenses:
Equipment sales 5,760,000 15,538,000
Sales-type leases 3,399,000 2,873,000
Depreciation on operating leases 8,213,000 3,729,000
Selling, general and administrative 3,578,000 3,551,000
Provision for uncollectible receivable 315,000 -
Interest 6,597,000 3,529,000
---------- ----------
Total costs and expenses 27,862,000 29,220,000
Income (loss) before income taxes (728,000) 1,262,000
Provision (benefit) for income taxes (277,000) 480,000
---------- ----------
Net income (loss) $ (451,000) $ 782,000
=========== ==========
Other comprehensive income (loss), net of
tax -- 1,000
---------- ----------
Comprehensive income (loss) $ (451,000) $ 783,000
=========== ==========
Earnings (loss) per share:
Basic $ (0.12) $ 0.22
Diluted $ (0.12) $ 0.21
Weighted average shares outstanding:
Basic 3,676,000 3,599,000
Diluted 3,676,000 3,815,000
See accompanying notes to condensed consolidated financial statements.
5
PDS FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
1999 1998
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (451,000) $ 782,000
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation and amortization 8,213,000 3,729,000
Gain on sale of financial assets (371,000) (2,205,000)
Purchases and originations of notes receivable and direct finance leases (13,437,000) (25,833,000)
Proceeds from:
Sale of notes receivable and direct finance leases 1,559,000 4,743,000
Collections of principal on notes receivable and direct finance leases 7,121,000 3,321,000
Changes in operating assets and liabilities:
Accounts receivable (912,000) (117,000)
Increase in customer deposit liabilities 5,281,000 66,000
Equipment held for sale or lease (653,000) (3,890,000)
Other, net (1,152,000) 2,047,000
------------ ------------
Net cash provided by (used in) operating activities 5,198,000 (17,357,000)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of equipment for leasing (55,669,000) (6,295,000)
Proceeds from sale of equipment under operating leases 1,920,000 3,703,000
Other, net (72,000) (187,000)
------------ ------------
Net cash used in investing activities (53,821,000) (2,779,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments made from restricted cash 3,166,000 (56,000)
Proceeds from notes payable 65,658,000 22,550,000
Proceeds from issuance of discounted lease rentals -- 692,000
Principal payments on notes payable (19,847,000) (13,957,000)
Payments on discounted lease rentals (472,000) (3,048,000)
Proceeds from issuance of subordinated debt and warrants -- 13,800,000
Payment of debt issue costs -- (1,560,000)
Principal payments on subordinated debentures -- (39,000)
Proceeds from exercise of stock options and warrants 159,000 292,000
------------ ------------
Net cash provided by financing activities 48,664,000 18,674,000
------------ ------------
Net increase (decrease) in cash and cash equivalents 41,000 (1,462,000)
Cash and cash equivalents at beginning of period 1,269,000 1,865,000
------------ ------------
Cash and cash equivalents at end of period $ 1,310,000 $ 403,000
============ ============
See accompanying notes to condensed consolidated financial statements.
6
PDS FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The condensed consolidated financial statements as of September 30, 1999 and for
the three and nine month periods ended September 30, 1999 and 1998 included in
this Form 10-Q have been prepared by the Company pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information and
footnote disclosures, normally included in financial statements prepared in
accordance with generally accepted accounting principles, have been condensed or
omitted pursuant to such rules and regulations. The consolidated balance sheet
at December 31, 1998 has been derived from the audited financial statements as
of that date and condensed. These condensed consolidated financial statements
should be read in conjunction with the financial statements and related notes
thereto included in the Company's Annual Report on Form 10-KSB for the year
ended December 31, 1998.
The condensed consolidated financial statements presented herein are unaudited,
but in the opinion of management, reflect all adjustments, consisting of normal
recurring adjustments, necessary for a fair presentation of financial position,
results of operations and cash flows for the periods presented. The results of
operations for any interim period are not necessarily indicative of results for
the full year.
2. NOTES PAYABLE
The Company borrows funds in order to finance the origination or purchase of
certain leases and notes receivable, and for the purchase of equipment held for
sale or lease. Such borrowings are generally collateralized by the cash flow
stream of the lease or note receivable funded, and the related equipment.
Certain of the borrowings have recourse to the Company.
Notes payable consists of the following:
SEPTEMBER 30, DECEMBER 31,
1999 1998
---- ----
Recourse:
Notes payable to banks, due either on demand or
in 1999 through 2003, fixed interest rates between
8.75% to 12.9% or variable rates based on the prime
rate plus 1% (8% at September 30, 1999) collateralized
by certain equipment under operating leases equipment
held for sale or lease and accounts receivable $13,168,000 $ 3,701,000
Notes payable to financial institutions, due in
1999 through 2002, interest at 7.1% to 12.0%,
collateralized by certain notes receivable,
equipment under operating leases and direct
finance leases 27,119,000 16,919,000
Notes payable to manufacturers/distributors
due in 1999 through 2001, interest at 8.8%
to 14.0% collateralized by certain notes receivable,
equipment under operating leases and direct finance
leases 4,110,000 11,486,000
Other 31,000 36,000
---------- -----------
Total recourse 44,428,000 32,142,000
---------- ----------
7
PDS FINANCIAL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Non-recourse:
Notes payable to banks and financial institutions, due in 1999
through 2003, interest at 8.7% to 12.5%, collateralized
by certain notes receivable and equipment under operating
and direct finance leases 38,940,000 3,059,000
Notes payable to manufacturers/distributors due in
1999 through 2001, interest at 8.0% to 10.0%,
collateralized by certain equipment under operating
leases and direct finance leases 862,000 2,872,000
Other -- --
---------- ---------
Total non-recourse 39,802,000 5,931,000
---------- ---------
Less unamortized discounts (1,720,000) (1,374,000)
---------- ----------
$82,510,000 $36,699,000
=========== ===========
The Company has available revolving credit and working capital facilities
aggregating approximately $70 million as of October 29, 1999. Advances under
these agreements with banks and financial institutions were approximately $29.6
million at September 30, 1999, which are included in the recourse debt balances
in the above table.
3. EARNINGS PER SHARE
The Company calculated basic and diluted earnings (loss) per share as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1999 1998 1999 1998
---- ---- ---- ----
Net income (loss), basic $ (414,000) $ 42,000 $ (451,000) $ 782,000
Interest expense on convertible
subordinated debentures, net of tax -- -- -- 2,000
--------- --------- --------- ---------
Net income (loss), diluted $ (414,000) $42,000 $ (451,000) $ 784,000
--------- --------- --------- ---------
--------- --------- --------- ---------
Weighted average shares outstanding:
Basic (weighted average shares outstanding) 3,705,000 3,644,000 3,676,000 3,599,000
Effect of dilutive options -- 144,000 -- 184,000
Effect of dilutive warrants -- 3,000 -- 22,000
Effect of convertible subordinated
debentures -- 7,000 -- 10,000
--------- --------- --------- ---------
Diluted 3,705,000 3,798,000 3,676,000 3,815,000
--------- --------- --------- ---------
--------- --------- --------- ---------
Per share amounts:
Basic $ (0.11) $ 0.01 $ (0.12) $ 0.22
Diluted $ (0.11) $ 0.01 $ (0.12) $ 0.21
Options to purchase 369,000 shares of common stock, which were not included in
the computation of diluted earnings per share for the quarter ended September
30, 1999, because they would have been anti-dilutive. The weighted average
exercise price for these options was $3.30, as of September 30, 1999. These
options expire at various dates through 2008.
8
4. NOTES RECEIVABLE
The Company's notes receivable portfolio includes loans to two significant
customers who failed to make their regularly scheduled monthly payments to the
Company causing an event of default under the terms of the respective notes.
These notes receivable total approximately $13.6 million and are generally
collateralized by gaming equipment. Subsequent to the quarter end, the Company
completed the restructuring with the principals of the entity for which the
Company has notes receivable with current outstanding principal balances
totaling approximately $11.1 million. The interest rates and loan completion
dates will remain the same, however the monthly payments have been decreased
from approximately $.4 million to $0.2 million per month, creating significant
balloon payments due at the end of the notes. The Company and the borrower have
also been in negotiations with the borrowers senior mortgage lender, and it is
likely that these negotiations will result in the borrower seeking protection
under the bankruptcy code. The Company can not predict at this time what impact
there may be from a bankruptcy filing by this borrower.
Certain of these notes receivable are used to collateralize borrowings from
certain banks, financial institutions and distributors, and such borrowings
total approximately $7.7 million. An event of default under the notes receivable
from a customer allows these lenders to require either substitution of
collateral or repayment of the obligation. The Company has received consents
from these lenders for the restructuring described above.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The Company is engaged in the business of financing and leasing gaming
equipment and supplying reconditioned gaming devices to casino operators. The
gaming equipment financed by the Company consists mainly of slot machines, video
gaming machines and other gaming devices. In addition, the Company finances
furniture, fixtures and other gaming related equipment, including gaming tables
and chairs, restaurant and hotel furniture, vehicles, security and surveillance
equipment, computers and other office equipment. In 1996, the Company introduced
SlotLease, a specialized operating lease program for slot machines and other
electronic gaming devices. The Company believes it is currently the only
independent leasing company licensed in the states of Nevada , New Jersey,
Colorado, Iowa, Indiana, Mississippi and Minnesota to provide this financing
alternative. In 1997, the Company established PDS Slot Source, a reconditioned
gaming device sales and distribution division, to complement its leasing and
financing activities and to generate equipment sales to casino operators.
The Company's strategy is to increase its portfolio of assets under
lease, resulting in increased recurring revenues and cash flows. In addition to
its leasing activities, the Company also sells equipment under installment sale
contracts and makes loans to customers secured by promissory notes, and in each
case the Company retains a security interest in the underlying equipment. In
some instances, the Company sells individual leases or receivables to an
institution. The Company believes its ability to recondition and distribute used
gaming devices enhances the gaming devices' values at the end of an operating
lease and facilitates additional financing transactions.
The Company's quarterly operating results, including net income, have
historically fluctuated due to the timing of completion of large financing
transactions, as well as the timing of recognition of the resulting fee income
upon subsequent sale. These transactions can be in the negotiation and
documentation stage for several months, and recognition of the resulting fee
income by the Company may fluctuate greatly from quarter to quarter. Thus, the
results of any quarter are not necessarily indicative of the results which may
be expected for any other period.
ACCOUNTING FOR COMPANY ACTIVITIES
The accounting treatment for the Company's financing activities varies
depending upon the underlying structure of the transaction. The majority of the
Company's equipment financing transactions are structured as either notes
receivable or direct finance leases in which substantially all benefits and
risks of ownership are borne by the borrower or lessee. Direct finance leases
are afforded accounting treatment similar to that for notes receivable. The
Company structures some of its gaming equipment financings as operating leases,
under which the Company retains substantially all of the benefits and risks of
ownership. However, certain of its gaming equipment transactions are structured
as direct finance and sales-type leases. Consistent with the Company's strategy
to increase its leasing activities, the 1998 and 1999 originations involve a
greater mix of operating leases, which generate revenues throughout the lease
term, as opposed to notes or direct finance leases, which generate revenues
primarily upon sale.
The Company's revenue generating activities can be categorized as
follows: (i) equipment sales; (ii) revenue from sales-type leases; (iii) rental
revenue on operating leases; (iv) fee income, resulting principally from the
sale of lease or note receivable transactions; and (v) finance income, resulting
from financing transactions in which the direct finance lease or note receivable
is retained by the Company.
The types of income are further described below:
EQUIPMENT SALES. In mid-1997, the Company established a reconditioned
gaming device sales and distribution division, PDS Slot Source. Used gaming
devices are obtained by the Company either from its customers at the end of an
applicable lease term, or in the marketplace. The cost of this equipment is
recorded in the consolidated balance sheet as equipment held for sale or lease.
At the time of sale, the Company records revenue equal to the selling price of
the related asset. Upon selling reconditioned gaming devices, the Company
removes the underlying asset from its consolidated balance sheet and records the
cost, including reconditioning cost, as cost of revenues. Equipment sales also
includes the sale of equipment which may occur during the term of an operating
lease.
REVENUE FROM SALES-TYPE LEASES. Sales-type leases, like direct finance
leases, transfer substantially all the benefits and risks of ownership of the
leased asset to the lessee. Unlike direct finance leases, sales-type leases also
include either a dealer profit
10
resulting from the Company leasing equipment which was purchased at a
discount that is not available to the lessee, or a manufacturing profit
resulting from the reconditioning process performed on used gaming devices.
This dealer profit or manufacturing profit is recognized at the inception of
the lease in the consolidated income statement as the difference between
revenue from sales-type leases and sales-type lease cost. Revenue from
sales-type leases is the present value of the future minimum lease payments.
Sales-type lease cost is the Company's equipment cost, net of any discounts.
Upon selling a sales-type lease to a third party, the Company removes the
underlying asset from its consolidated balance sheet.
RENTAL REVENUE ON OPERATING LEASES. Operating leases are defined as
those leases in which substantially all the benefits and risks of ownership of
the leased asset are retained by the Company. Revenue from operating leases
consists of monthly rentals and is reflected in the consolidated income
statement evenly over the life of the lease as rental revenue on operating
leases. The cost of the related equipment is depreciated on a straight-line
basis over the lease term to the Company's estimate of residual value. This
depreciation is reflected on the consolidated income statement as depreciation
on operating leases. For operating leases, the cost of equipment, less
accumulated depreciation, is recorded in the consolidated balance sheet as
equipment under operating leases, net.
FEE INCOME. The Company funds much of the direct finance lease and note
transactions it originates through a sale of such transactions (i.e., the sale
of all of the Company's right, title and interest in the future payment stream
from the related leases or notes). A sale may occur simultaneously with the
origination or several months thereafter. At the time of sale, the Company
records fee income equal to the difference between the selling price and the
carrying value of the related financial asset. The calculation of fee income
reflects many factors, including the credit quality of the borrowers or lessees,
the type of underlying equipment, credit enhancements, if any and ultimately,
the terms under which the transaction was both originated and sold. Fee income
also includes commissions and advisory fees for arranging financing between
unrelated parties. Upon the sale of a lease or note, the Company removes the
underlying asset from its consolidated balance sheet.
FINANCE INCOME. For the period during which the Company holds a note
receivable or direct finance lease, finance income is recognized over the term
of the underlying lease or note in a manner which produces a constant percentage
rate of return on the asset carrying cost. For those direct finance leases held
by the Company, the present value of the future minimum lease payments are
recorded in the consolidated balance sheet as direct finance leases.
RESULTS OF OPERATIONS
Three Months Ended September 30, 1999 and 1998
Revenues for the third quarter of 1999 totaled $9.8 million, a 44%
increase from $6.8 million in the year earlier quarter. The increase in revenues
is primarily attributable to higher rental revenue, fee income and finance
income offset by lower sales of equipment and sales-type lease revenues. Gross
originations of financing transactions for the three months ended September 30,
1999 totaled $3.5 million compared to $11.5 million for the year earlier
quarter. During the quarter ended September 30, 1999 the Company amended certain
leases it had entered into with a significant customer, which reduced the assets
under lease by approximately $10 million. The Company continues to work to fund
the balance of these leases with this significant customer, but there can be no
assurance regarding such completion.
Revenues from equipment sales and sales-type leases totaled $1.7
million in the third quarter of 1999, a 63% decrease from $4.6 million in the
year earlier quarter. Such revenues generally include sales of both equipment
which had been under operating leases, and used gaming devices which the Company
reconditioned in its Slot Source division. There were no sales of equipment
under operating lease occurred in the current or prior year quarter. The cost of
equipment sales and sales type lease revenue totaled $1.8 million in the current
quarter, compared to $3.2 million in the year earlier quarter.
The Company's average operating lease portfolio was $72.4 million
during the third quarter of 1999, a 395% increase as compared to $14.6 million
for the year earlier quarter. The increase in the average portfolio results from
an increase in the volume of originations in late 1998 and the first nine months
of 1999. Rental revenue on operating leases increased to $5.6 million in the
current quarter, compared to $1.3 million in the year earlier quarter. Related
depreciation increased to $4.0 million in the current quarter, compared to $1.9
million in the year earlier quarter. These leases are expected to generate
revenues throughout their lease terms, which range from 24 to 48 months and are
typically 36 months.
11
Fee income totaled $1.3 million in the current quarter, compared to a
loss of $129,000 in the year earlier quarter. The current quarter fee income was
composed of fees for financial advisory services, compared to the year earlier
quarter which primarily consisted of a prepayment premium paid.
Finance income totaled $1.2 million in the current quarter, compared to
$0.9 million in the year earlier quarter. This increase primarily reflects the
larger portfolio of notes receivable and direct finance leases held by the
Company during the current quarter as compared to the year earlier quarter.
Selling, general and administrative expenses totaled $1.6 million in
the current quarter, compared to $1.2 million in the prior year quarter. This
increase reflects a reduction in costs capitalized in the Company's lease
origination department, which resulted from the lower originations in the
current quarter as compared to the year earlier quarter. The Company also
increased its provision for uncollectible receivables by $250,000 based on its
estimates of the current exposure in its loan portfolio.
Interest expense totaled $2.8 million in the current quarter, compared
to $1.4 million in the year earlier quarter. This increase was due to higher
levels of outstanding borrowings which were utilized to fund the increased
investment in the leasing operations and to fund the originations of notes
receivable.
The effective income tax rate was 38% in the three months ended
September 30, 1999 and 1998. In both periods, the effective rate was higher than
the federal statutory tax rate of 34%, due primarily to state income taxes.
RESULTS OF OPERATIONS
Nine Months Ended September 30, 1999 and 1998
Revenues for the nine months ended September 30, 1999 totaled $27.1
million, an 11% decrease from $30.5 million in the year earlier period. The
decrease in revenues is primarily attributable to lower sales of equipment
formerly under operating leases offset by higher rental revenues and finance
income. Gross originations of financing transactions for the nine months ended
September 30, 1999 totaled $57.1 million compared to $43.7 million for the year
earlier period.
Revenues from equipment sales and sales-type leases totaled $9.8
million in the nine months ended September 30, 1999, a 56% decrease from $22.2
million in the year earlier period. Sales of equipment which has been under
operating lease totaled $6.9 million in the year earlier period, and the cost of
those sales totaled $6.1 million. No such sale of equipment under operating
lease occurred in the current period. Revenue from sales and sale-type leases of
Slot Source reconditioned gaming devices totaled $9.8 million during the nine
months ended September 30, 1999, compared to $15.3 million in the year earlier
period. The cost of such sales totaled $9.2 million in the current period,
compared to $12.3 million in the year earlier quarter.
The Company's average operating lease portfolio was $48.4 million
during the nine months ended September 30, 1999, a 214% increase as compared to
$15.4 million for the year earlier period. The increase in the average portfolio
results from an increase in the volume of originations during 1999. Rental
revenue on operating leases increased to $11.6 million for the nine months ended
September 30, 1999, compared to $5.0 million in the year earlier period. Related
depreciation increased to $8.2 million for the nine months ended September 30,
1999, compared to $3.7 million in the year earlier period.
Fee income totaled $2.7 million for the nine months ended September 30,
1999, compared to $1.2 million in the year earlier period. The current period
fee income is composed of both fees for financial advisory services and gains
from the sale of financial transactions, compared to the year earlier period
which consisted primarily from gains from the sale of financial transactions.
Finance income totaled $3.1 million for the nine months ended September
30, 1999, compared to $2.1 million in the year earlier period. This increase
primarily reflects the larger portfolio of notes receivable and direct finance
leases held by the Company during the period as compared to the year earlier
period.
Selling, general and administrative expenses totaled $3.6 million for
the nine months ended September 30, 1999 compared to $3.6 million in the year
earlier period. Increases in payroll and related costs and legal costs were
offset by an increase in the costs capitalized in the Company's lease
origination department as a result of the increase in total originations.
12
Interest expense totaled $6.6 million for the nine months ended
September 30, 1999, compared to $3.5 million in the year earlier period. This
increase was due to higher levels of outstanding borrowings which were utilized
to fund the increased investment in the leasing operations and to fund the
originations of notes receivable.
LIQUIDITY AND CAPITAL RESOURCES
The Company's strategy to increase its financing activities and its
reconditioned gaming device sales, involves a higher level of investment in
notes receivable, equipment under operating leases and equipment held for sale
or lease, financed through discounted lease rentals and notes payable. The funds
necessary to support the Company's activities have been provided by cash flow
generated primarily from the operating activities described above, and various
forms of recourse and non-recourse borrowings. The Company expects its lease
portfolio to generate recurring cash flow throughout the lease term.
The Company's cash and cash equivalents totaled $1.3 million at
September 30, 1999. The higher level of cash provided in 1999 primarily reflects
an increase in customer deposits and lesser amounts of cash used to acquire
inventory. The cash used in investing activities in 1999 primarily reflects
$55.7 million of investment in equipment for leasing. The $48.7 million of net
cash provided by financing activities in 1999 was primarily the result of
borrowings and cash transferred from restricted to non-restricted accounts,
which was used principally to fund the purchases of equipment for leasing.
At September 30, 1999 total borrowings under notes and lines of credit
were $82.5 million, compared to $36.7 million at December 31, 1998. The majority
of the proceeds from the borrowings were invested in the Company's leasing
operations and were primarily non-recourse to the Company.
At October 29, 1999, the Company's revolving credit and working capital
facilities aggregated approximately $70 million. Advances under these agreements
aggregated approximately $29.6 million at September 30, 1999.
The Company's current financial resources, including the estimated cash
flows from operations and the revolving credit facilities are expected to be
sufficient to fund the Company's anticipated working capital needs. In addition
to the borrowing activities summarized above, the Company has developed a
network of financial institutions to which it sells transactions on a regular
basis. The Company is, from time to time, dependent upon the need to liquidate
or externally finance transactions originated and held in its investment
portfolio. In the future the Company may seek to raise capital to fund its
growth strategy through debt or financings, however we cannot predict when such
an event will occur, nor if such capital would be available at favorable terms,
if at all.
Inflation has not been a significant factor in the Company's
operations.
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YEAR 2000 ISSUE
The Company is continuing to evaluate the potential impact of the
situation referred to as the "Year 2000 Issue." The Year 2000 Issue concerns the
inability of computer software programs to properly recognize and process date
sensitive information beyond December 31, 1999. The Company has evaluated its
major automated systems to determine if they are Year 2000 compliant and has
contacted the suppliers of certain of those systems to inquire about Year 2000
compliance. Although the Company believed its existing accounting system was
Year 2000 compliant, the company purchased and began installing a new management
information system in January 1999. The new system has been certified as Year
2000 compliant by the software provider. The total cost of the new system is
approximately $100,000 and is expected to be fully operational during the fourth
quarter of 1999.
The Company also has electronic interfaces with certain of its
suppliers. The Company has made inquiries and received assurances from such
suppliers with respect to Year 2000 issues.
The Company has also made inquiries of and is contacting certain
suppliers with respect to Year 2000 issues. Even assuming that all material
third parties confirm that they are or expect to be Year 2000 compliant by
December 31, 1999, it is not possible to state with certainty that such parties
will be so compliant. It is impossible to fully assess the potential
consequences in the event service interruptions from suppliers occur or in the
event that there are disruptions in such infrastructure areas as utilities,
communications, transportation, banking and government.
To date, the Company has not incurred material costs associated with
the Year 2000 Issue. The Company believes that any future costs associated with,
and the potential impact of, the Year 2000 Issue will not be material. Based
upon its assessments to date, the Company believes it will not experience any
material disruption in its operations as a result of Year 2000 problems in
internal financial systems, reconditioning activities and to the process control
systems, or in its interface with major customers and suppliers. However, if
major suppliers, including those providing inventory, banking, electricity and
communications services, experience difficulties resulting in disruption of
critical supplies or services to the Company, a shutdown of the Company's
operations could occur for the duration of the disruption. The Company has begun
to develop a contingency plan to provide for continuity of normal business
operations in the event problem scenarios, such as those described above, arise,
however that plan is not yet complete. Assuming no major disruption in service
from critical third party providers, the Company believes that it will be able
to manage the Year 2000 transition without any material effect on the Company's
results of operations or financial position. There can be no assurance, however,
that unexpected difficulties will not arise and, if so, that the Company will be
able to timely develop and implement a contingency plan.
ITEM 3. QUANTITATIVE AND QUALITATIVE FACTORS ABOUT MARKET RISK
Interest Rate Risk
The Company generally provides financing (both leases and traditional
loans) to customers at fixed rates of interest (either with stated interest
rates or implicit rates). The Company either sells such transactions to
investors, or holds such transactions in its portfolio. For larger transactions
retained in the portfolio, the Company obtains fixed rate commitments from
financing sources such as banks and financial institutions prior to providing
such financing to customers, which substantially reduces the interest rate risk
during the origination process. For smaller transactions, the Company may
originate the transaction using internally available funds, and shortly after
origination use the transaction as collateral for borrowing on one of several
lines of credit. Such lines of credit generally have floating rates of interest
until a specific amount is borrowed under the facility, at which time the amount
borrowed will be assigned a fixed rate of interest payable over its remaining
term. Therefore changes in interest rates have not historically had a direct
impact on the Company's earnings. The Company does not currently manage this
interest rate risk with derivative financial instruments and does not believe
this risk is material.
The Company's existing portfolio of fixed rate receivables and borrowings
will fluctuate in value based on changes in market rates of interest. However
the Company does not believe that the changes in the fair values are material.
Currency Risk
All of our transactions are conducted and accounts are denominated in
United States Dollars and as such we do not currently have exposure to foreign
currency risk.
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FORWARD-LOOKING STATEMENTS
Certain statements contained herein which are not historical facts are
forward-looking statements with respect to events, the occurrence of which
involves risks and uncertainties, including without limitation strict regulation
by gaming authorities, competition the Company faces or may face in the future,
uncertainty of market acceptance of the SlotLease program and PDS Slot Source,
the ability of the Company to continue to obtain adequate financing, the ability
of the Company to recover its investment in gaming equipment leased under
operating leases as well as its investment in used gaming machines purchased for
refurbishment and resale to customers, the risk of default with respect to the
Company's financing transactions, the Company's dependence on key employees,
potential fluctuations in the Company's quarterly results, general economic and
business conditions, and other risk factors detailed from time to time in the
Company's reports filed with the Securities and Exchange Commission.
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Part II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES
(c) Effective June 16, 1999, the Company granted certain
warrants to Digideal Corporation and certain shareholders
of Digideal Corporation. As is more fully described in
Exhibit 10.1 to this Form 10-Q, upon reaching certain
milestones, these warrants allow the holders to acquire up
to 9.98% of the Company's Common Stock, or approximately
370,000 shares, at $3.75 per share. These warrants have a
five year term. In granting this warrant, the Company relied
on the exemption for registration provided under Section 4(2)
of the Securities Act for transactions not involving public
offering.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) The following exhibits are included with this quarterly report
on Form 10-Q as required by Item 601 of Regulation S-X.
EXHIBIT
NUMBER DESCRIPTION
10.1 Agreement for Technology Transfer,
Manufacture, Distribution and Affecting
Patent, Trademark and Copyrights
10.2 Agreement for Technology Transfer,
Manufacture, Distribution and Affecting
Patent, Trademark and Copyrights
(Sovereign Nations)
10.3 First Modification of Agreement for Technology,
Transfer, Manufacture, Distribution and
Affecting Patent, Trademark and Copyrights
27 Financial Data Schedule
b) Reports on Form 8-K. There were no reports on Form 8-K filed
during the quarter ended September 30, 1999 or during the
period from September 30, 1999 to the date of this Quarterly
Report on Form 10-Q.
SIGNATURE
In accordance with the requirements of the Securities Exchange Act of 1934, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
PDS FINANCIAL CORPORATION
Dated: November 10, 1999 BY:/s/STEVEN M. DES CHAMPS
-----------------------------
Chief Financial Officer
(a duly authorized officer)
16