SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
___________________
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
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 0-26324
ROCKFORD INDUSTRIES, INC.
(Exact name of registrant as specified in charter)
California 33-0075112
------------------------------- ---------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1851 East First Street, Suite 600
Santa Ana, California 92705
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (714) 547-7166
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock,
no par value
------------
(Title of Class)
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. Yes X No
----- -----
The aggregate market value of the Common Stock held by non-affiliates of the
Registrant was approximately $16,200,000 based upon the last reported sale price
of the Common Stock on NASDAQ on February 26, 1998.
As of February 26, 1998, the Registrant had 4,107,117 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates information by reference from the Registrant's definitive
Proxy Statement to be filed with the Commission within 120 days after the close
of the Registrant's fiscal year.
TABLE OF CONTENTS
ITEM PAGE
PART I
1. Business....................................................... 1
2. Properties..................................................... 7
3. Legal Proceedings.............................................. 7
4. Submission of Matters to a Vote of Security Holders............ 7
PART II
5. Market for the Registrant's Common Equity and
Related Stockholder Matters.................................... 8
6. Selected Financial Data........................................ 9
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................ 10
8. Financial Statements and Supplementary Data.................... 18
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure....................................... 18
PART III
10. Directors and Executive Officers of the Registrant............. 19
11. Executive Compensation......................................... 19
12. Security Ownership of Certain Beneficial Owners and Management. 19
13. Certain Relationships and Related Transactions................. 19
PART IV
14. Exhibits, Financial Statement Schedules and Reports
on Form 8-k.................................................... 21
Signatures..................................................... 22
ii
PART I
ITEM 1. BUSINESS
References to the "Company" are to Rockford Industries, Inc., a California
corporation, unless the context indicates otherwise.
General
Rockford Industries, Inc. (the "Company") is a specialty finance company
that originates or acquires, sells and services equipment leases. The underlying
leases financed by the Company relate to a wide range of equipment, including
medical, dental and diagnostic, computers and peripherals, computer software,
telecommunications, office and other. The equipment generally has a purchase
price of less than $250,000 (with an average of $23,700 as of December 31,
1997), and such leases are commonly referred to as "small ticket leases". The
Company initially funds the origination of its leases through its line of credit
facilities or from working capital and, upon achieving a sufficient portfolio
size, sells such leases principally through its securitization programs and non
recourse sales. The Company focuses on maximizing the spread between the yield
on its leases and its cost of funds by obtaining favorable terms on its line of
credit facilities and securitizations.
Since its inception in 1984, the Company's strategy has been to focus its
business development efforts on establishing marketing relationships with
vendors and other sources of small ticket equipment, in order to establish
itself as the recommended provider of financing for potential equipment
purchasers. The Company customizes lease financing products to meet the specific
equipment financing needs of it vendors, and in many cases, provides them with
servicing and technological support. By providing vendors and their customers
with timely, convenient and competitive equipment financing, the Company
promotes both equipment sales by the vendor and the utilization of the Company
as a financing source. The Company estimates that approximately 20% of its
equipment finance contract originations during 1997 were generated from
additional borrowings by existing customers.
The Company has originated equipment finance contracts for over
$596,000,000 of equipment since its founding in 1984 and has achieved
significant growth in the last few years. The Company financed approximately
$166,748,000 of equipment during 1997, which represented a 27.2% increase from
the $131,267,000 of equipment it financed in 1996. This increase in financing
volume also resulted in a 41% increase in the Company's revenues for 1997, after
considering pro forma adjustments due to the mandatory adoption of Statement of
Financial Accounting Standards No. 125 ("SFAS No. 125"), Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,
as of January 1, 1997. On a pro forma basis, assuming SFAS No. 125 was adopted
as of January 1, 1996, total revenues increased from $13,557,000 in 1996 to
$19,108,000 in 1997. Despite the record growth in originations, net income
decreased by 8.8% from $2,318,000 in 1996 to $2,120,000 in 1997 primarily due to
an increased provision for credit losses. (See Management's Discussion and
Analysis of Financial Condition and Results of Operations).
The Company was incorporated in California on December 27, 1984. The
Company's executive office is located at 1851 East First Street, Suite 600,
Santa Ana, California 92705, and its telephone number is (714) 547-7166.
As used in this report, unless otherwise indicated, the term "Company"
includes the Company's wholly-owned unconsolidated subsidiaries.
Business Strategy
The Company's objective is to become a leading provider of financing for
lower cost equipment. The Company believes that it has significant opportunities
to achieve its goal, while enhancing operating efficiency, through the
implementation of its business strategy, the principal components of which
include the following:
Point of Purchase Financing. The Company has made and continues to make
substantial investments in information processing and delivery systems that
facilitate the Company's processing of credit applications and finance
contracts. These systems increase the ease with which customers do business with
the Company and the attractiveness of the Company to vendors of the equipment it
finances.
Enhanced Vendor Relationships. The Company seeks to increase both the
number of relationships it has with vendors and the proportion of a vendor's
total financing business provided by the Company in existing relationships. The
Company plans to increase the number and scope of its vendor relationships by
expanding its marketing efforts. These efforts include (i) increased
participation by the Company at equipment vendor trade shows; (ii) initiation of
a direct marketing campaign to targeted equipment vendors; (iii) continuing to
recruit experienced marketing professionals; and (iv) improvement of the support
services provided to the Company's independent sales force in order to allow
these professionals to spend more time on business development and less time on
account servicing. The Company seeks to increase its penetration rate with its
existing vendor relationships by increasing the range of programs offered to
such vendors.
Target High Volume Vendors. Historically, a majority of the Company's
originations have been from vendors which generate less than $500,000 in
equipment financings annually. The Company seeks to increase its business
development efforts with accounts which are expected to produce $1.0 million to
$5.0 million annually in originations by: (i) developing vendor programs and
more formal relationships, including private label programs, designed
specifically to address the needs of this segment of the vendor market; (ii)
improving the Company's information systems which will allow the Company to
efficiently process a high volume of transactions; and (iii) expanding current
informal or local relationships with high volume vendors into formal or national
relationships.
Reduced Borrowing Costs. The Company uses several methods to fund its
financing activities, including asset securitization, nonrecourse loans from
institutional lenders and a revolving line of credit. Generally, asset
securitization provides the Company with the lowest cost of funds. During 1997,
the Company funded 77% of its total originations through its securitization
program, compared to 56% in 1996.
Pursue Strategic Acquisitions. The Company intends to pursue strategic
acquisitions of businesses that will complement or expand the Company's
business. The Company believes that acquisitions will enable it to expand its
vendor relationships and the services it offers to customers.
Industry Overview
The equipment financing industry in the United States includes a wide range of
entities that provide funding for the purchase of equipment, ranging from
specialized financing companies, which focus on a particular industry or
financing vehicle, to large multinational banking institutions, which offer a
full panoply of financial services. According to the Equipment Leasing
Association of America ("ELA"), lease financing has played a significant role in
the United States economy and represented 30% of all business investment in
productive assets during 1996. The ELA also estimates that approximately 80% of
all United States companies finance the purchase of some or all of their
equipment through lease financing.
According to recent information available from the United States Department
of Commerce ("DOC"), the annual volume of new capital equipment (measured by
original equipment cost) placed on lease in the United States grew from $85
billion in 1986 to $169 billion in 1996. The DOC had estimated that the overall
equipment leasing market would grow to approximately $176 billion in 1997.
The Company is a specialty finance company providing equipment financing
and related services. The Company primarily utilizes lease contracts as the
financing vehicle for these equipment financings, regardless of whether the
Company has a continuing economic interest in the underlying equipment. As a
specialty finance company, the Company believes that it has strategically
positioned itself to capitalize on the small ticket segment of the equipment
leasing industry, which is one of the most rapidly growing segments of the
industry in part due to (i) the consolidation of the banking industry, which has
eliminated many of the smaller community banks that traditionally provided
equipment financing for small to mid-size companies, forcing these businesses to
seek alternative financing rather than deal with the approval process of
commercial banks; (ii) stricter lending requirements of commercial banks; (iii)
a trend
2
toward instant approvals at the point of sale made possible by improved
technology; (iv) the accelerating pace of research and development in the high
technology medical equipment industry, which has led to a rapid introduction and
enhancement of medical equipment; and (v) the decline in the price of computer
hardware and software and increasing demand therefor.
Equipment Finance Contracts
General. The Company's revenues are primarily derived from its origination
and sale of equipment finance contracts pursuant to which the Company provided
financing for the purchase of various types of equipment. Substantially all of
the Company's finance contracts are noncancellable for a specified term during
which the Company generally receives scheduled payments sufficient, in the
aggregate, to cover the Company's borrowing costs and the costs of the
underlying equipment, and to provide the Company with an appropriate profit
margin. The initial noncancellable term of the contract is equal to or less than
the equipment's estimated economic life and a small portion of the Company's
equipment finance contracts provide the Company with additional revenues based
on the residual value at the end of the contract. Initial terms for new
equipment finance contracts generally range from 12 to 66 months. The average
cost of the equipment underlying the Company's equipment finance contracts
increased from an average of approximately $23,500 in 1996 to $23,700 in 1997.
The number of new equipment finance contracts originated by the Company
increased from 5,587 in 1996 to 7,040 in 1997.
Terms and Conditions. The terms and conditions of the Company's equipment
finance contracts, which are generally structured principally as sales-type
leases or direct finance leases, vary somewhat from transaction to transaction.
In substantially all cases, however, the Company's customers are required to (i)
maintain, service and operate the equipment in accordance with the
manufacturer's and government-mandated procedures; (ii) insure the equipment
against property and casualty loss; (iii) pay all taxes associated with the
equipment; and (iv) make all scheduled contract payments regardless of the
performance of the equipment. The Company's standard equipment finance contract
provides that, in the event of a default by the customer, the Company can
require payment of liquidated damages to make the Company whole and can seize
and remove the equipment for subsequent sale, refinancing or other disposal at
its discretion.
The Company's equipment finance contracts fall within three general
categories: (i) those which transfer ownership of the underlying equipment to
the customer automatically by granting the customer an option to purchase the
underlying equipment at a nominal price upon the expiration of the original
contract; (ii) those which grant the customer an option, or require the customer
to purchase the underlying equipment at fair market value or to renew the
contract at a fair market rate upon the expiration of the original contract term
(and, in some cases, include maximum and/or minimum pricing provisions); and
(iii) those which generally require the customer to purchase the underlying
equipment at a fixed price or renew the contract at a fixed rate upon the
expiration of the original contract term.
Credit Policies and Procedures. The Company has developed credit
underwriting policies and procedures that management believes have been
effective in the selection of creditworthy equipment lessees and in minimizing
the risks of delinquencies and credit losses. The Company's underwriting
guidelines generally require a credit investigation of an equipment lessee,
including an analysis of personal credit of the owner who typically guarantees
the lease, verification of time in business and corporate name and bank and
trade references. The lease approval process begins with the submission by
facsimile or electronic transmission of a credit application by a Company sales
representative or directly by the lease originator. Upon receipt of a credit
application, a credit analyst enters it into the Company's proprietary credit
processing system. The credit profile of the potential customer is checked with
commercial credit reporting agencies, such as TRW, Inc., Dun and Bradstreet and
Equifax Inc., and the customer's professional status is checked in various
listings with the appropriate professional organizations. The equipment type and
vendor are also considered in this assessment. A credit decision can frequently
be reached within one hour (more complicated transactions require three to four
days, particularly if extensive due diligence is required).
Once a determination to fund has been made, the Company requires receipt of
signed lease documentation before funding. Once the equipment is shipped and
installed, the vendor invoices the Company. The Company verifies that the
customer has received and accepted the equipment and obtains the customer's
authorization to pay the vendor. Following this telephone verification, the file
is forwarded to the contract administration department for audit, booking and
funding and to commence automated billing and transaction accounting procedures.
3
In connection with the Company's securitization programs, extensive reviews of
the Company's underwriting standards and procedures are conducted by financial
guaranty insurer and rating agencies.
Servicing and Administration
Prior to 1994, the Company assigned the majority of its finance contracts
to nonrecourse lenders who were also assigned the right to collect any service
fee income, late fee income and/or insurance fee income associated with these
contracts. The Company's asset securitization transactions give the Company the
opportunity to service the portfolio of finance contracts it has originated and
securitized. Servicing consists primarily of billing the equipment purchasers
for each finance payment and collecting payments. Servicing securitized
portfolios has generated additional revenue, including late fee income and fees
for servicing securitized finance contract portfolios originated by other
finance companies
Currently, pursuant to the Company's securitization programs with
SunAmerica Life Insurance Company ("SunAmerica") and CoreStates Bank, N.A.
("CoreStates"), the Company is entitled to receive a fee for servicing the
securitized contract portfolios. This fee is paid monthly and is calculated
based on 0.5% per annum of the outstanding principal balance due under the
contracts. Late fees are charged on overdue payments and are typically 10% of
the payment amount. In addition, the Company's finance contracts require that
its customers carry fire, theft and casualty insurance on the equipment financed
and customers have also requested that the Company offer life and disability
insurance with respect to their finance contracts. As of December 31, 1997, the
Company had a servicing portfolio of $198.0 million.
The small ticket leasing industry is operationally intensive due, in part,
to the small average lease size. Accordingly, state-of-the-art technology is
critical in keeping servicing costs to a minimum and providing quality customer
service. Recognizing the importance of servicing, the Company utilizes a lease
administration system tailored to support the Company's technological needs. The
system handles application tracking, invoicing, payment processing, automated
collection queuing, portfolio evaluation, cash forecasting and report writing.
The system is linked with a lockbox bank account for payment processing and
provides for direct withdrawal of lease payments. The system also allows users
to view all lease documents on-line.
Portfolio Diversity
From 1993 through 1997, the Company originated approximately 21,400 finance
contracts. During this period, most of the Company's financing contracts have
been with a variety of medical professionals, including physicians, dentists,
optometrists, chiropractors and home healthcare providers and also with
outpatient medical centers. Over the past two years, the Company has recently
expanded its business into the financing of small ticket general business and
other non-medical equipment.
While no individual customer accounted for more than 2.5% of the Company's
financing originations in 1997, certain types of customers are more prominent
than others. Finance contract originations in 1997 can be categorized by
business type as follows: medical doctors, 40.0%; other healthcare providers,
23.2%; and general business, 36.8%.
In addition to the diversity of the types of business served by the
Company, the equipment finance contracts originated have covered a diverse range
of high-technology medical diagnostic, therapeutic, surgical and related
equipment provided by over 1,100 vendors. Finance contract originations in 1997
can be categorized by equipment type as follows: medical 49%; computer, 25.2%;
and general equipment, 25.8%.
Residual Values
Equipment financing provided by the Company is generally structured such
that the full cost of the equipment and all financing costs are repaid during
the initial financing term. Of the equipment finance contracts originated by the
Company and outstanding as of December 31, 1997, 90% (as measured by net
investment) bore no residual value on the Company's books, generally because
they granted the customer a purchase option at a nominal price or required the
contract customer to purchase the equipment at a fixed price at the end of the
contract term. The balance of the contracts originated by the Company and
outstanding at December 31, l997, bore an estimated aggregate of $3,473,000
residual value, net of unearned income and valuation allowance.
4
At the inception of an equipment finance contract classified as a direct
finance lease, the Company estimates the fair market value of the underlying
equipment that would be obtained at the end of the initial contract term based
upon its judgment, as supported by data from the used equipment market,
discussions with manufacturers, and consultations with equipment users and
records that value as the residual value on its balance sheet. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Direct Finance Leases." Residual values ascribed to individual items of
equipment depend upon various factors including the technical specifications of
the equipment, obsolescence of the equipment, performance and capabilities of
the equipment, the financial strength and reputation of the equipment
manufacturer and the widespread availability of long-term maintenance for the
equipment.
Upon the expiration of an equipment finance contract for which a residual
value has been recorded, the original contract customer will: (i) purchase the
equipment outright; (ii) extend the contract for an additional term; or (iii)
return the equipment to the Company. Should the equipment be returned to the
Company, the Company generally would seek to sell or refinance it. The Company
reviews, on a quarterly basis, the residual value estimates recorded on its
books based on its own analysis and prevailing market data. Under generally
accepted accounting principles, any downward revision would result in an
immediate charge to reserves or earnings, while an upward revision may not be
recorded until actually realized as a gain. At the end of the initial contract
term, when the equipment is either sold or refinanced, the amount by which the
net proceeds exceed or fall short of the residual value is recorded as a gain or
loss. When a new finance contract is entered into for such equipment at a gain,
the Company recognizes the gain ratably over the new contract term.
The Company's results of operations depend in part upon its ability to
realize the residual equipment value reflected on its balance sheet as net
investment in direct financing leases. The balance of the contracts originated
by the Company and outstanding at December 31, 1997, bore an aggregate of
$3,473,000 residual value, net of unearned income and valuation allowance,
representing approximately 2.9% of the Company's total assets at December 31,
1997. The Company has historically realized proceeds, with respect to residuals
applicable to finance contract maturities, which are approximately equivalent to
the original recorded residual value.
Delinquencies
Delinquencies Relating to Contracts Serviced by the Company. The Company's
portfolio (comprised principally of equipment finance contracts securitized or
funded by the Company through a revolving line of credit facility (the
"Revolver") or by cash and held or warehoused by the Company on a full recourse
basis) is comprised primarily of medical equipment finance contracts entered
into with physicians and other medical professionals. The Company believes that
its specialization in medical equipment financing provides it with advantages in
the lower-priced equipment markets in controlling the delinquencies and
minimizing the losses in its contract portfolio, since health care practitioners
generally have higher incomes, making default rates relatively low. As the
Company's portfolio matured, its delinquency rate (payments more than thirty
days past due) rose from 4.5% at December 31, 1996 to 4.6% at December 31, 1997,
net of fully reserved contracts. The Company has reviewed the 1996 ELA Industry
Survey and, based upon the information contained in that survey, believes that
the Company's delinquencies and credit loss rates compare favorably to industry
norms. There can be no assurance that, as the Company's portfolio increases, it
will be able to sustain favorable levels of delinquencies.
Delinquencies Relating to Contracts Held by the Company's Lenders. The
Company sells or discounts on a nonrecourse basis or through its securitization
programs a portion of the equipment finance contracts it originates;
consequently, the Company has historically borne minimal credit risk on those
contracts. However, in an effort to foster strong relationships with its
lenders, the Company assists its nonrecourse lenders with collection matters and
endeavors to stay informed about the performance of the equipment finance
contracts originated by the Company and held in the lenders' portfolios. Based
on delinquency reports and credit loss information provided by many of the
Company's nonrecourse lenders, the Company believes that the portfolio of
equipment finance contracts which it has assigned to nonrecourse lenders has
experienced delinquency and credit loss percentages similar to those experienced
in the industry.
5
Allowance for Doubtful Accounts. The Company maintains an allowance for
doubtful accounts in connection with payments due under equipment finance
contracts held in the Company's portfolio at a level which the Company deems
sufficient to meet future asset writedowns, based on an analysis of the
delinquencies, problem accounts, and overall risks and probable losses
associated with such contracts, together with a review of the Company's
historical loss experience. There can be no assurance that this allowance will
prove to be adequate. Although the Company attempts to mitigate its credit risk
through the use of a variety of commercial credit reporting agencies when
processing the finance contract applications of its customers and through
various forms of nonrecourse financing, failure of the Company's customers to
make scheduled payments under their equipment finance contracts could require
the Company to forfeit its residual interest, if any, in the underlying
equipment, to make payments in connection with the recourse portion of its
borrowings and to forfeit cash collateral pledged as security in connection with
the Company's asset securitizations. Credit losses on the contracts maintained
by the Company in its owned or serviced portfolio have amounted to approximately
1.0 % and 0.6% of the Company's average receivables outstanding under its
contracts for 1997 and 1996, respectively. Any increase in such loss or in the
rate of payment defaults under any of the equipment finance contracts originated
by the Company could adversely affect the Company's ability to obtain additional
funding or to complete additional asset securitizations.
Estimated Recourse Obligations. As part of the sale and securitization of
direct finance leases, the Company writes a put option in the form of a recourse
obligation. This recourse obligation is recorded at its estimated fair value.
Although management uses the best information available to make these estimates,
future adjustments to the obligation may be necessary due to economic, operating
and other conditions that may be beyond the Company's control. Actual results
could differ from those estimates.
Funding Sources
The principal source of funding for the Company's financing transactions
are asset securitization programs with both SunAmerica and CoreStates backed
by pools of the Company's equipment finance contracts. In addition, the Company
obtains funding for financing transactions from nonrecourse loans made by
institutional lenders and, to a lesser extent, recourse borrowings under the
Company's line of credit. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources."
Sales and Marketing
The Company conducts its sales and marketing activities primarily through
59 exclusive independent or salaried sales representatives who are highly
incentivized through the Company's compensation program and who average over 10
years of industry experience. These sales representatives, along with 29
marketing support employees, work out of 31 regional locations which operate in
16 states. The Company's independent sales representatives and marketing staff
focus on establishing formal and informal relationships with equipment vendors.
The primary objectives of these relationships are to promote the vendors'
equipment sales by providing timely, convenient and competitive financing for
their equipment sales as well as the utilization of the Company as a financing
source.
Services provided by the Company include structuring the financing to meet
the needs of equipment vendors and purchasers, training vendors' sales and
marketing staffs to market the Company's various lease funding programs, and
customizing financial products to encourage equipment sales. In most cases, the
Company's sales representatives also work directly with equipment purchasers,
providing them with the guidance necessary to complete the equipment financing
transaction.
Competition
The Company operates in a highly competitive environment. The Company
competes with a number of national, regional and local finance companies,
including those which, similar to the Company, specialize in the financing of
small ticket equipment, for customers, relationships with equipment
manufacturers, vendors and distributors, financing sources and sales and other
personnel. In addition, the Company's competitors include those equipment
manufacturers which finance the sale or lease of their products themselves,
other traditional types of financial services companies,
6
such as commercial banks and savings and loan associations, and conventional
finance and leasing companies, all of which provide financing for the purchase
of medical and medical-related equipment. The Company competes on the basis of
conveniences with vendors and knowledge of vendors' products, responsiveness to
customer needs, flexibility in structuring lease transactions and price. Many of
the Company's competitors and potential competitors possess substantially
greater financial, marketing, and operational resources than the Company.
Moreover, the Company's future profitability will be directly related to the
Company's ability to access capital funding and to obtain favorable funding
rates as compared to the access to capital and costs of capital available to its
competitors. The Company's competitors and potential competitors include many
larger, more established companies that have a lower cost of funds than the
Company and access to capital markets and to other funding sources which may be
unavailable to the Company. There can be no assurance that the Company will be
able to continue to compete successfully in its targeted market.
Equal Credit Opportunity Act
Pursuant to the terms and conditions of agreements entered into by the
Company and certain of its nonrecourse lenders, the Company is required to
comply with the Equal Credit Opportunity Act ("ECOA"). Pursuant to the terms of
the ECOA, creditors, such as the Company, are required to give all credit
applicants notice of their right to receive a written statement of reasons if
their application for credit is denied, unless the applicant had gross revenues
exceeding $1,000,000 during its last fiscal year. Creditors are also required to
give oral or written notice of a credit denial within 30 days after receipt of
completed application (or a "reasonable time" thereafter for applicants whose
gross revenues exceed $1,000,000 during its last fiscal year).
Employees
As of December 31, 1997, the Company employed 121 persons. Of these
employees, 12 are principally engaged in management, 37 are engaged in
operations and collections, 27 are engaged in accounting and administration and
45 are engaged in sales and marketing (not including 38 exclusive independent
sales representatives). None of the Company's employees is represented by a
labor union. The Company considers its employee relations to be satisfactory.
ITEM 2. PROPERTIES
The Company owns no real property and leases all of its offices. The
Company occupies approximately 18,800 square feet of office space at its
executive offices in Santa Ana, California. The original lease term is for a
period of five years ending October 31, 1999, at a current rent of approximately
$29,000 per month. The lease is extendable, at the option of the Company, for a
period of five years, at a rental rate of 95% of the estimated prevailing market
rate.
Space for branch sales offices is generally leased from buildings that
provide executive suite arrangements under leases of one year or less in
duration. As of December 31, 1997, the Company maintained 40 sales branch
locations operating in 16 states throughout the United States. Aggregate rental
expense for the corporate headquarters and the regional sales offices was
$707,000 for the fiscal year ended December 31, 1997. In total, the Company
leases an aggregate of approximately 33,700 square feet of office space. The
Company believes that these facilities are adequate to meet its current needs
and will be adding space as necessary in the future.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any pending litigation or legal proceedings,
or to the best of its knowledge any threatened litigation or legal proceedings,
which, in the opinion of management, individually or in the aggregate, would
have a material adverse effect on the results of operations or financial
condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
7
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Market Information
Rockford Industries, Inc. trades under the symbol ROCF on the NASDAQ
National Market System. The following table sets forth high and low last
reported sales prices per share of Common Stock for the periods indicated.
High Low
--------- ---------
YEAR ENDED DECEMBER 31, 1996
- ----------------------------
First Quarter............................ 17.500 8.750
Second Quarter........................... 20.250 15.000
Third Quarter............................ 19.750 13.250
Fourth Quarter........................... 24.000 10.000
YEAR ENDED DECEMBER 31, 1997
- ----------------------------
First Quarter............................ 11.875 7.000
Second Quarter........................... 9.875 6.125
Third Quarter............................ 11.625 7.500
Fourth Quarter........................... 12.250 7.500
Dividend Policy
During its status as an S Corporation which ended on December 31, 1994, the
Company distributed to its shareholders certain cash dividends. Except for such
distributions, the Company has not paid dividends on its Common Stock since its
inception and does not intend to make any further distributions or to pay any
dividends on its Common Stock in the foreseeable future. The holder of the
Company's outstanding Series A Preferred Stock is entitled to receive cumulative
dividends, payable quarterly out of funds legally available commencing on August
31, 1995, at the annual rate of 4% of the par value of the Series A Preferred
Stock until May 31, 1996, 6% of the par value until May 31, 1997 and 8% of the
par value thereafter, each of which is subject to an increase by 1% should the
Company default in its payment obligations for two consecutive quarters until
the overdue amounts are paid. The Company currently intends to reinvest
earnings, if any, in the development and expansion of its business, except to
the extent required to satisfy its obligations under the terms of the Series A
Preferred Stock. The declaration of dividends in the future will be at the
election of the Board of Directors and will depend upon the earnings, capital
requirements and financial position of the Company, general economic conditions
and other relevant factors. In addition, the Company's ability to pay cash
dividends to holders of Common Stock is subject to the terms of the outstanding
shares of Series A Preferred Stock. Such terms include preferences in payment of
cash dividends, and if the Company shall be in arrears on one or more quarterly
dividend payments or shall have failed to redeem the Series A Preferred Stock
when required to so redeem, the Company may not declare or pay any dividends to
holders of Common Stock. The Company is also subject to certain other
restrictions pursuant to the terms of the Revolver, including the maintenance of
minimum levels of tangible net worth which have the effect of limiting the
payment of cash dividends to holders of Common Stock.
Holders
As of December 31, 1997, there were approximately 600 beneficial holders
and 26 holders of record of the Company's Common Stock.
8
ITEM 6. SELECTED CONSOLIDATED FINANCIAL AND OPERATING INFORMATION
YEAR ENDED DECEMBER 31,
-----------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(in thousands, except per share data)
Statement of Operations Data:
Revenues...................................................... $ 19,108 $104,539 $ 74,330 $ 54,351 $ 40,702
Costs......................................................... 2,032 85,380 61,206 46,745 35,377
Gross profit.................................................. 17,076 19,159 13,124 7,606 5,325
Selling, general and administrative expenses.................. 13,613 15,296 9,637 6,056 4,229
Income before income taxes.................................... 3,463 3,863 3,487 1,550 1,096
Income taxes (1).............................................. 1,343 1,545 1,395 1,845 28
Net income (loss)............................................. 2,120 2,318 2,092 (295) 1,068
Basic net income per share (2)................................ 0.49 0.54 0.64 - -
Diluted net income per share (2).............................. 0.48 0.52 0.60 - -
Pro Forma Statement of Operations Data (3):
Historical income before income taxes................... $ 1,550 $ 1,096
Pro forma provision for income taxes.................... 620 438
Pro forma net income.................................... 930 658
Pro forma net income per share (2)...................... .38 .27
Weighted average common shares outstanding:
Basic.................................................... 4,106 4,103 3,219 2,454 2,454
Diluted.................................................. 4,441 4,452 3,504 2,454 2,454
Other Data:
Cost of equipment financed.................................... $166,748 $131,267 $ 87,881 $63,579 $48,798
Number of financed contracts.................................. 7,040 5,587 3,426 3,122 2,208
DECEMBER 31,
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(in thousands)
Balance Sheet Data:
Total assets................................................. $125,067 $157,698 $184,658 $129,542 $98,041
Total liabilities (4)........................................ 103,176 137,814 167,014 126,732 94,516
Total shareholders' equity................................... 21,891 19,884 17,644 2,810 3,525
__________
(1) Effective December 31, 1994, the Company revoked its election to be taxed as
an S Corporation for federal and certain state income tax purposes. In
connection with this election, the Company reclassified its retained
earnings at December 31, 1994 of $2,807,622 to Common Stock. As a result of
the Company's conversion to a C Corporation the Company recorded a one-time
charge against earnings for deferred income tax liabilities of approximately
$1,825,000 (reflecting the net tax effects of temporary differences between
the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes) at December 31, 1994.
(2) Historical net income per share has not been shown prior to the Company's
election to be taxed as a C Corporation on December 31, 1994, because it is
not indicative of the Company's ongoing operations. Pro forma net income per
share is shown for prior periods.
(3) Represents adjustments for federal and certain state income taxes as if the
Company had been taxed as a C Corporation rather than an S Corporation for
all periods presented.
(4) Consists primarily of nonrecourse debt. The release of SFAS No. 125 caused
the Company to reassess its balance sheet presentation of certain assets and
liabilities in light of current accounting literature and this new standard.
This reassessment resulted in the determination that the assets and
liabilities, previously recorded on the Company's balance sheet as
discounted lease rentals assigned to lenders and nonrecourse debt, should be
offset for associated finance transactions in which the Company has no
continuing economic interest and in which the Company is legally relieved of
all obligations as a result of the sale. Consequently, the Company has
recorded a reclassification of $39,939,044 resulting in a decrease of
discounted lease rentals assigned to lenders and nonrecourse debt at
December 31, 1995, in order to conform the December 31, 1995 balance sheet
to the December 31, 1996 presentation. This reclassification had no impact
on the Company's statements of income, cash flows, or shareholders' equity.
9
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the financial statements and notes thereto appearing elsewhere in this Annual
Report on Form 10-K.
Customer Finance Contract Accounting
The Company primarily structures equipment financing transactions with its
customers which are classified for accounting purposes as direct finance leases.
The Company may sell these contracts in bulk to nonrecourse lenders or
securitize these contracts, at which time the Company relinquishes control over
such contracts.
Presentation of Financial Statements. The Company adopted Statement of
Financial Accounting Standards (SFAS) No. 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities, which was
amended by SFAS No. 127, as of January 1, 1997. SFAS No. 125 has changed the
manner in which the Company determines and recognizes the gain recorded upon the
transfer of its interest in finance contracts subsequent to December 31, 1996.
Additionally, SFAS No. 125 allows the Company to record gains with respect to
transfers of its interest in leases previously accounted for as direct finance
leases. With the implementation of SFAS No. 125, the Company has altered the
presentation in the Company's consolidated financial statements of revenues,
expenses and certain assets and liabilities associated with finance contracts
sold. As a result, certain aspects of the Company's financial statements as of
December 31, 1997 and for the year then ended may not be directly comparable to
the prior year financial statements. Retroactive implementation of SFAS 125 was
not permitted. The following pro forma financial statement of operations for the
year ended December 31, 1996 reflects certain reclassifications to present the
results of the Company's operations for the year ended December 31, 1996 on a
basis comparable to the 1997 presentation. The reclassifications pertain to
sales of equipment, cost of equipment sold and the recording of initial direct
costs and estimated bad debt expense. The accompanying pro forma information
reflects only reclassification adjustments to conform presentation for
comparison purposes.
YEAR ENDED DECEMBER 31,
---------------------------------------------
Pro Forma Reclassifi- Actual
1997 1996 cations 1996
-------- --------- ---------- --------
(in thousands)
REVENUES:
Sales of equipment.......................... $ - $ - $ 93,613 $ 93,613
Gain on sale of financing transactions...... 10,027 5,728 (2,321) 3,407
Finance income.............................. 4,088 4,636 4,636
Servicing related income.................... 2,652 1,712 1,712
Other income................................ 2,341 1,481 (310) 1,171
------- ------- --------- --------
Total revenues........................ 19,108 13,557 90,982 104,539
COSTS:
Cost of equipment sold...................... - - 82,923 82,923
Interest expense............................ 2,032 2,457 2,457
------- ------- --------- --------
Total costs............................ 2,032 2,457 82,923 85,380
GROSS PROFIT................................ 17,076 11,100 8,059 19,159
SELLING, GENERAL & ADMINISTRATIVE EXPENSES.. 10,792 5,932 7,122 13,054
PROVISION FOR CREDIT LOSSES................. 2,821 1,305 937 2,242
------- ------- --------- --------
Total expenses......................... 13,613 7,237 8,059 15,296
INCOME BEFORE TAXES......................... 3,463 3,863 - 3,863
INCOME TAXES................................ 1,343 1,545 - 1,545
------- ------- --------- --------
NET INCOME.................................. $ 2,120 $ 2,318 $ - $ 2,318
======= ======= ========= ========
10
Equipment Sales. For leases in which the Company does not retain a
continuing economic interest at origination, sales are recognized upon
consummation of the lease assignment to the nonrecourse lender. The Company does
not retain a continuing economic interest in the transaction when the following
criteria are met: (i) at the time of origination, the transaction was assigned
on a nonrecourse basis to a third party, (ii) the Company had no residual
interest in the underlying transaction, and (iii) all rights to the underlying
payment stream and equipment were transferred to the third party assignee
(nonrecourse lender). For sales recognized prior to the implementation of SFAS
No. 125, the discounted value of aggregate lease payments is recorded as
discounted lease rentals assigned to lenders and sales of equipment and the
equipment cost is recorded as cost of sales. The related obligation resulting
from this discounting of the leases is recorded as nonrecourse debt. The related
interest income and expense for transactions recorded as sales are netted and
included in finance income. Subsequent to the Company's adoption of SFAS No. 125
as of January 1, 1997, the difference between the discounted value of aggregate
lease payments due under lease contract and the equipment cost is recognized as
gain or loss on sale of financing transactions.
Direct Finance Leases. Equipment financing transactions are classified as
direct finance leases when the Company retains a continuing economic interest in
the underlying finance contract which results from funding the transaction with
recourse debt or the Company's own working capital. Additionally, collectibility
of the contract payments must be reasonably certain and the transaction must
meet at least one of the following criteria: (i) the contract transfers
ownership of the equipment to the customer at the end of the contract term, (ii)
the contract contains a bargain purchase option, (iii) the contract term at
inception is at least 75% of the estimated economic life of the financed
equipment, or (iv) the present value of the minimum payments required of the
customer is at least 90% of the fair market value of the equipment at the
inception of the contract. For direct finance leases, the Company records the
total contract payments, estimated unguaranteed residual value and initial
direct costs (consisting of sales commissions, referral fees and other
origination costs) as the gross investment in the direct finance lease. The
difference between the gross investment in the direct finance lease and the cost
to the Company of the equipment being financed is recorded as unearned income.
Interest income is recognized over the term of the contract by amortizing the
unearned income using the interest method. Cash proceeds from a funding source
are recorded as nonrecourse debt or additions to notes payable to bank,
depending on the source of the funding. Interest expense is recognized over the
term of the contract using the respective discount rates of the Company's
nonrecourse lenders or the interest rate applicable to the Company's line of
credit. Included in net investment in direct finance leases at December 31, 1997
and 1996 are those transactions transferred prior to the adoption of SFAS No.
125 where the Company has a continuing economic interest in the lease.
Gain on Sale of Financing Transactions. Subsequent to origination, the
Company may sell its investment in direct finance leases in bulk to nonrecourse
lenders or securitize these contracts, at which time the Company relinquishes
any control over such contracts. The difference between the cash proceeds from
the assignment of the remaining payments due under these contracts and the total
of the unamortized net investment balance, fair value of estimated recourse
obligation and accrued letter of credit fees is recorded as gain on sale of
financing transactions. The present value of the Company's retained interest in
the unguaranteed residual value of the equipment under lease remains on the
consolidated balance sheet, classified as net investment in direct finance
leases.
In connection with these securitization transactions, the Company is
required to originate and maintain a letter of credit with a qualifying
financial institution. Such letter of credit serves as a credit enhancement for
the related trust. Withdrawals on the letter of credit are required in the event
of shortfalls in amounts due to investors. All projected costs of origination
and maintaining the letter of credit are accrued in the period in which the
securitization closes. As collateral for the letter of credit, the Company
initially deposits cash with the issuing bank. The amount set aside is available
for distribution to the issuing bank in the event of withdrawals on the letter
of credit. Cash amounts on deposit are invested in certain instruments as
permitted by the related securitization documents. To the extent amounts on
deposit exceed specified levels, distributions are made by the Company, and, at
termination of the related trust, any remaining amounts on deposit are
distributed to the Company. The amount on deposit at December 31, 1997 and 1996
is classified as restricted cash on the Company's consolidated balance sheet.
11
As part of the sale and securitization of direct finance leases, the
Company writes a put option in the form of a recourse obligation. For
transactions originated subsequent to the implementation of SFAS No. 125, this
recourse obligation is recorded at its estimated fair value. Although management
uses the best information available to make these estimates, future adjustments
to the obligation may be necessary due to economic, operating and other
conditions that may be beyond the Company's control. Actual results could differ
from those estimates.
Gain or Loss on Sale of Residuals. The estimated unguaranteed residual
value represents management's estimate of the amount expected to be received at
the termination of a direct finance lease as a result of remarketing the
equipment originally financed by such contract. Management reviews such
estimates quarterly and records a residual valuation allowance if the
equipment's estimated fair market value is below its recorded value. When
equipment is sold by the Company at the expiration of the contract term, a gain
or loss is recorded depending upon whether the net proceeds from the sale are
above or below the estimated unguaranteed residual value. The net gain or loss
from the sale of residuals is included in other income in the statement of
operations. See "Business - Finance Contracts - Residual Values."
Results of Operations
Years Ended December 31, 1997 and 1996
Finance Contract Originations. Finance contract originations increased by
approximately $35.4 million or 27% to $166.7 million for the year ended December
31,1997 from $131.3 million for the year ended December 31, l996, principally
due to significant investments in both personnel and systems allowing further
penetration into all targeted market niches: healthcare, information technology,
telecommunications and office products.
Revenues. Total revenues recognized for the year ended December 31, 1997
were $19.1 million compared to $104.5 million for the year ended December 31,
1996. This decrease is due to the adoption of SFAS No. 125 as of January 1,
1997. On a pro forma basis, assuming SFAS No. 125 had been adopted as of January
1, 1996, total revenues for the year ended December 31, 1997 were $19.1 million
compared to $13.5 million for the year ended December 31, 1996 which represents
an increase of $5.6 million, or 41%. This pro forma increase was primarily due
to increased sales of finance contracts and higher gain margins on those sales.
The improved gain margin was the result of lower cost of funds on the Company's
securitization facilities and a one-time gain of approximately $900,000 from
restructuring a securitization facility in the third quarter, as well as an
increase in servicing fees and other income associated with servicing the
securitized portfolio.
Gross Profit. Total gross profit realized for the year ended December 31,
1997 was $17.1 million compared to $19.2 million for the year ended December 31,
1996, which represented a decrease of $2.1 million. This decrease is due to the
adoption of SFAS No. 125 as of January 1, 1997. On a pro forma basis, assuming
SFAS No. 125 had been adopted as of January 1, 1996, gross profit for the year
ended December 31, 1997 was $17.1 million compared to $11.1 million for the year
ended December 31, 1996 which represents an increase of $6.0 million, or 54.1%.
This pro forma increase was primarily due to the increase in finance contract
originations, gains on sale of financing transactions, and from an increase of
other income, such as servicing fees.
Gross Profit Percentage. On a pro forma basis, assuming SFAS No. 125 had
been adopted as of January 1, 1996, gross profit as a percentage of revenues
increased to 89.4% in 1997 from 81.9% in l996. The gross profit percentage was
positively impacted by gains on sales of financing transactions, by other
income, including servicing fees, associated with an increase in the size of the
portfolio of finance contracts serviced by the Company and by reduced funding
through nonrecourse debt which resulted in a decrease in interest expense.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses in 1997 were $10.8 million as compared to $13.1 million
in 1996, representing a decrease of $2.3 million or 17.6%. The decrease was
primarily due to substantial investments in automated systems during 1996 and
1997 which have resulted in productivity and processing efficiencies thereby
allowing the Company to increase origination volume with a minimal increase in
personnel for credit and documentation. The investment in systems enabled
electronic applications, electronic proposal generators and expanded financing
programs as well as development of a Wide Area Network establishing an
electronic link between the credit, documentation and sales functions.
12
Provision for Credit Losses. The provision for credit losses were $2.8
million in 1997 as compared to $2.2 million in 1996, representing an increase of
$600,000 or 27.2%. This increase stems primarily from an increase in the
Company's delinquency rate (payments more than 30 days past due) from 5.8% to
6.2% at December 31, 1996 and 1997, respectively, inclusive of fully reserved
contracts. Additionally, for transactions securitized subsequent to January 1,
1997, SFAS 125 requires the Company to record its estimated recourse obligations
under its securitization agreements at the time of recording the gain on sale of
financing transactions. In the aggregate, the Company's provision for estimated
credit losses for the year ended December 31, 1997 was $4.9 million, or 2.9% of
originations, compared to $2.2 million or 2% of originations for the year ended
December 31, 1996, representing an increase of $2.7 million or 122.7%. Although
management uses the best information available to make these estimates, future
adjustments may be necessary due to economic, operating and other conditions
that may be beyond the Company's control. Actual results could differ from these
estimates.
Net Income. Income before taxes was $3.5 million for the year ended
December 31, 1997 as compared to $3.9 million for the prior year, representing a
decrease of $0.4 million. The effective income tax rate remained consistent for
the comparative periods shown, decreasing to 39% for 1997 from 40% for 1996. Net
income decreased by $0.2 million or 8.5% to $2.1 million for 1997 from $2.3
million for 1996. Basic net income of $0.49 per share on weighted average shares
outstanding of 4,106,000 was earned during 1997, as compared to basic net income
of $0.54 per share on weighted average shares outstanding of 4,103,000 for 1996.
Diluted net income of $0.48 per share on weighted average shares outstanding of
4,441,000 was earned during 1997, as compared to diluted net income of $0.52 per
share on weighted average shares outstanding of 4,452,000 for 1996. The number
of the Company's outstanding shares increased during 1997 by 1,600 due to the
exercise of stock options.
Years Ended December 31, 1996 and 1995
Finance Contract Originations. Finance contract originations increased by
approximately $43.4 million or 49.4% to $131.3 million for the year ended
December 31,1996 from $87.9 million for the year ended December 31, l995,
principally due to the addition of 12 sales professionals during the year ended
December 31, 1996 and further penetration into the general business markets. The
percentage of the Company's equipment sales contracts decreased to approximately
83% of all of its finance contract originations in 1996 from 84% in 1995.
Revenues. Total revenues of $104.5 million for the year ended December 31,
1996 increased by $30.2 million or 40.6% from total revenues of $74.3 million
for the year ended December 31, 1995. The increase in revenues resulted from an
increase in sales of equipment of $28.6 million, an increase in financing gains
and other income of $2.4 million and a decrease in interest income of $770,000.
The increase in sales of equipment reflected the Company's lower cost of funds
which resulted from the securitization program, in addition to increased
marketing efforts in the medical and non-medical equipment marketplaces. The
primary reason for the increase in other income was due to $3.4 million in gains
derived from assignment of Company-held direct finance leases, and to a lesser
extent the increase in servicing fees and other income associated with servicing
the securitized portfolio. Since interest income primarily relates to the
portfolio of direct finance leases held by the Company, the lowering of the
average direct finance lease balance during the year resulted in a decrease in
interest income for 1996.
Gross Profit. Total gross profit of $19.2 million for the year ended
December 31, 1996 increased by approximately $6.0 million or 46.0% from $13.1
million for the year ended December 31, 1995. The increase in gross profit was
primarily attributable to the increase in finance contract originations, gains
on sale of financing transactions, and from an increase of other income, such as
servicing fees.
Gross Profit Percentage. Gross profit as a percentage of revenues
increased to 18.3% in 1996 from 17.7% in l995 reflecting the following
components: gross profit from equipment sales of 11.4% for 1996 versus 11.0% for
1995; and net interest (interest income less interest expense) margin percentage
for direct finance leases of 47.0% for 1996 versus 38.2% for 1995. The gross
profit percentage was positively impacted by gains on sales of financing
transactions and by other income, including servicing fees, associated with an
increase in the size of the portfolio of finance contracts serviced by the
Company.
Selling, General, Administrative Expenses, and Provision for Credit Losses.
Selling, general, administrative expenses, and provision for credit losses in
1996 were $15.3 million as compared to $9.6 million in 1995, representing
13
an increase of $5.7 million or 58.7%, which increase was primarily due to volume
related expenses associated with increased contract originations, increases in
legal and professional expenses associated with the Company's first year being
publicly traded, additional capitalized systems costs and related systems
support expenses, and additional provision for bad debt resulting from an
increase in customer delinquencies which continue to compare favorably to
industry norms. As a percentage of revenues, these expenses amounted to 14.6% in
1996, as compared to 13.0% in 1995 which was principally due to a higher
percentage of gains on sales of financing transactions in 1996 as compared to
the prior year.
14
Net Income. Income before taxes was $3.9 million for the year ended
December 31, 1996 as compared to $3.5 million for the prior year. The effective
income tax rate of 40% remained constant for the comparative periods shown. Net
income increased by $0.2 million or 10.8% to $2.3 million for 1996 from $2.1
million for 1995. Basic net income of $0.52 per share on weighted average shares
outstanding of 4,103,000 was earned during 1996, as compared to basic net income
of $0.60 per share on weighted average shares outstanding of 3,219,000 for 1995.
Diluted net income of $0.52 per share on weighted average shares outstanding of
4,452,000 was earned during 1996, as compared to diluted net income of $0.60 per
share on weighted average shares outstanding of 3,504,000 for 1995. The number
of the Company's outstanding shares increased during 1996 by 4,017 due to the
exercise of stock options.
Liquidity and Capital Resources
Because equipment financing is a capital intensive business, the Company
requires continual access to substantial short and long-term credit to generate
equipment financings and sales. The principal sources of funding for the
Company's equipment finance contracts are: (i) funding obtained from sales of
asset-backed securities (backed by pools of the Company's equipment finance
contracts) to SunAmerica and CoreStates, pursuant to the terms of each
securitization arrangement; (ii) nonrecourse borrowings from institutional
lenders; and (iii) standard recourse borrowings under its $17.0 million
revolving and $7.0 million working capital lines of credit used by the Company
from time to time to temporarily fund a portion of its equipment finance
contracts, pending more permanent funding arrangements for such contracts.
Securitization Facilities. Asset securitization is a process in which a
pool of equipment finance contracts is transferred to a wholly-owned special-
purpose entity which, in turn, transfers the contracts and the payments due
thereunder to a trust which issues trust certificates to investors relating to
the contract pool. The source of repayment for the trust certificates is the
stream of payments which are made on the equipment finance contracts included in
the corresponding pool of transferred contracts. In addition, the special
purpose entity pledges, as collateral to support payment of the trust
certificates, the equipment underlying the equipment finance contracts in each
pool. To the extent adequate payments on the trust certificates are not realized
by the investor, the investor (as opposed to the special purpose entity) has the
right to the residual value, if any, of the equipment underlying the contracts
in the pool should such equipment be resold. The Company provides credit
enhancement by maintaining, in the case of the Company's securitization program,
a letter of credit in connection with each transaction under the securitization
program. In connection with the securitization programs, the Company receives a
service fee from the certificate holder.
In connection with these securitization transactions, the Company is
required to originate and maintain a letter of credit with a qualifying
financial institution. Such letter of credit serves as credit enhancement for
the related trust. Withdrawals on the letter of credit are required in the event
of shortfalls in amounts due to investors. All projected costs of origination
and maintaining the letter of credit are accrued in the period in which the
securitization closes. As collateral for the letter of credit, the Company
initially deposits cash with the issuing bank. The amount set aside is available
for distribution to the issuing bank in the event of withdrawals on the letter
of credit. Cash amounts on deposit are invested in certain instruments as
permitted by the related securitization documents. To the extent amounts on
deposit exceed specified levels, distributions are made to the Company, and, at
termination of the related trust, any remaining amounts on deposit are
distributed to the Company. The amount on deposit at December 31, 1997 and 1996
is classified as restricted cash in the accompanying consolidated balance
sheets.
In August 1997, the Company and SunAmerica amended an agreement pursuant
to which SunAmerica agreed to purchase up to $250.0 million in principal amount
of trust certificates. This agreement, as amended with SunAmerica expires on
August 28, 2000. During 1997, the Company securitized $47.0 million of its
financing contracts with SunAmerica. Also under this amended agreement, the
Company has consolidated $95.8 million of financing contracts securitized with
SunAmerica under the previous agreement. In connection with the securitization
program with SunAmerica, the Company has agreed to continue to service the
equipment finance contracts included in each pool of transferred contracts on
behalf of SunAmerica. In consideration for servicing these contract pools, the
Company receives a service fee from SunAmerica.
In March 1997, the Company entered into an agreement with CoreStates that
provides the Company with a credit facility for the securitization of up to $150
million of finance contract obligations and provides financing at rates that are
approximately 65 basis points lower than the rates previously available to the
Company. Under this agreement, during December 31, 1997, the Company securitized
$81.5 million of it financing contracts with CoreStates.
15
The Company's ability to complete additional asset securitizations will
depend upon a number of factors, including general conditions in the credit
markets and the financial performance of already outstanding asset-backed
securities issued by the Company or others. There can be no assurance that the
Company will be able to continue to arrange securitization agreements.
Nonrecourse Debt. Prior to the utilization of the securitization funding
methodology described above, the Company's principal source of funding had been
nonrecourse borrowings from institutional lenders. Under a nonrecourse loan, the
Company borrows an amount from the institutional lender equal to the present
value of the payments due from the borrowers discounted at a fixed rate of
interest. The lender receives the payments due to the Company under the
particular finance contract in repayment of the nonrecourse debt, and takes a
security interest in the related equipment. The Company generally retains
ownership of the equipment during the term of the finance contract, subject to
the lender's security interest. Interest rates under this type of financing are
negotiated with each lender and reflect the financial condition of the equipment
finance customer, the term of the equipment finance contract and the dollar
amount being financed. The Company is not liable for the repayment of
nonrecourse loans unless the Company breaches certain limited representations
and warranties set forth in its loan agreements with the institutional lenders.
The Company's nonrecourse lenders assume the credit risk of each finance
contract assigned to them by the Company, and their only recourse, upon a
default under a finance contract, is against the customers and the financed
equipment.
This method of funding is still utilized by the Company for a portion of
its finance contract originations. To date, the Company has been successful in
attracting nonrecourse lenders and in extending the levels at which existing
lenders are willing to provide nonrecourse financing. At December 31, 1997, the
Company had recorded nonrecourse debt of $69.0 million from various
institutional lenders related to transactions recorded prior to January 1, 1997.
Each of these lenders has entered into funding arrangements with the Company and
agreements relating thereto which set forth the general terms and conditions
regulating the Company's borrowings from such lenders. Each of such arrangements
require that the noncancellable payments due to the Company under equipment
finance contracts funded by borrowings from such lenders be assigned by the
Company to the lenders as payment of the principal and interest on such borrowed
funds. The agreements also provide credit guidelines to assess the credit
quality of a potential customer and the interest rate to be charged by the
Company to its customers, depending upon the type of transaction. Certain of
such arrangements regarding the funding of the Company's future equipment
finance contracts (but not as they relate to outstanding borrowings from such
lenders) are terminable at any time by either party upon thirty-days to sixty-
days written notice. Certain lenders may, at their discretion, provide the
Company with funding for equipment finance contracts which do not meet their
credit guidelines if the Company deposits an amount equal to a designated
portion of the payments to be made by its customers under such contracts into a
reserve account as security for defaults by such customers. If any of its
nonrecourse lenders should terminate its lending relationship with the Company,
the Company believes that it would be able to enter into a comparable lending
relationship with another nonrecourse lender on substantially similar terms, if
necessary.
Short-Term Recourse Debt. The Company has maintained the Revolver and a
working capital facility with a bank which it uses from time to time for the
funding of certain of its financing and equipment transactions. On November 21,
1997, this credit facility was restructured to decrease the borrowing limit on
the line of credit to $17.0 from $30.0, eliminate the $5.0 million overdraft
protection facility and provide for an additional $7.0 million working capital
line of credit. The Revolver provides for advances through August 1998 and
contains a feature for pricing at LIBOR plus 1 1/2%. The working capital line
provides for advances through August 1998 and contains a feature for pricing at
the Bank's overnight borrowing rate plus 2%. At December 31, 1997, the Company
had $15.9 million outstanding under these credit facilities.
Under these credit facilities, the Company may convert borrowings to term
loans subject to certain conditions. The credit facilities are collateralized by
the finance contracts assigned to the bank simultaneously with each advance and
provides the bank with full recourse against the Company should the collateral
prove to be insufficient. The credit facilities contain various covenants,
including those requiring the Company to maintain certain levels of tangible net
worth and debt ratios. The Company was in compliance with these covenants at
December 31, 1997. The Company believes it would be able to enter into other
lines of credit on terms substantially similar to the terms of the existing
credit facilities, if necessary.
Cash Flows. The Company's cash and cash equivalents at December 31, 1997
was $1.1 million compared to $4.0
16
million at December 31, 1996. During the year ended December 31, 1997 the
Company's cash position decreased by $2.9 million, reflecting the use of cash in
operations of $24.3 million and the cash provided by investing and financing
activities respectively, of $16.6 million and $4.8 million. The most significant
aspects of the change during this period was from cash invested in equipment for
financing of $166.7 million, gains on sale of financing transactions of $10.0
million, an increase in restricted cash of $9.5 million, increase in notes
payable to bank of $4.9 million (net of proceeds of $160.3 million), and
proceeds and payments from sales and assignments of leases of $192.2 million,
which was largely due to the higher level of the Company's finance contract
originations. In comparison, the Company's cash position decreased by $5.4
million during the year ended December 31, 1996, reflecting the use of cash in
operations and investing activities of $6.8 million and $68.3 million,
respectively, and the cash provided from financing activities of $69.7 million.
The change in cash was primarily due to cash used to purchase equipment for
financing of $131.3 million, increases in receivables and prepaids of $6.2
million, an increase in notes payable to bank of $11.0 million (net of proceeds
of $17.6 million), proceeds and payments from sales and assignments of leases of
$57.2 million from nonrecourse debt of $58.8 million.
In order to meet its operating, investing and financing needs for the next
twelve months, in addition to existing cash balances, cash flows from
activities, proceeds from securitization arrangements, nonrecourse assignments
and bank credit lines, the Company may need to seek additional capital through
incurrence of additional indebtedness or the issuance of common or preferred
stock, depending on market conditions.
Impact of Inflation
The Company funds a majority of its equipment finance contracts with fixed
rate loans in order to maintain a spread between the interest rates charged to
the Company and those implicit in the financing the Company provides. Due to
this timely matching of finance contract yields with funding rates, the Company
generally has mitigated the effects of rising interest rates during inflationary
periods. While the Company is subject to inflation as described above, the
Company believes that inflation does not have a material effect on its operating
results.
Recently Issued Accounting Standards
In June 1997, FASB issued SFAS No. 130, Reporting Comprehensive Income,
which is effective for annual and interim periods beginning after December 15,
1997. This statement requires that all items that are required to be recognized
under accounting standards as comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements.
In June 1997, FASB issued SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information, which is effective for annual and interim
periods beginning after December 15, 1997. This statement establishes standards
for the method that public entities report information about operating segments
in annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports
issued to shareholders. It also establishes standards for related disclosures
about product and services, geographical areas and major customers. The adoption
of this standard is not expected to have a material effect on the Company's
financial reporting.
17
Year 2000 Compliance
The Company recognizes that the arrival of the Year 2000 poses a unique
worldwide challenge to the ability of all systems to recognize the date change
from December 31, 1999 to January 1, 2000 and, like other companies, has
assessed and is repairing its computer applications and business processes to
provide for their continued functionality. An assessment of the readiness of
external entities which it interfaces with, such as vendors, counterparties,
customers, payment systems, and others, is ongoing.
The total cost to the Company of these Year 2000 Compliance activities has
not been and is not anticipated to be material to its financial position or
results of operations in any given year. These costs and the date on which the
Company plans to complete the Year 2000 modification and testing processes are
based on management's best estimates, which were derived utilizing numerous
assumptions of future events including the continued availability of certain
resources, third party modification plans and other factors. However, there can
be no guarantee that these estimates will be achieved and actual results could
differ from those plans.
Safe Harbor Statement
Statements which are not historical facts, including statements about the
Company's confidence and strategies and its expectations regarding reductions in
cost of funds, plans to increase market share, plans to enter new markets, and
the impact of SFAS No. 125 are forward looking statements that involve risks and
uncertainties. These include but are not limited to (i) reducing borrowing costs
by expanding the Company's asset-backed securitization funding program; (ii)
increasing origination of equipment finance contracts by maintaining and
expanding strategic relationships with vendors of medical and medical-related
equipment; (iii) increasing business with high volume vendors; (iv) increasing
its financing of non-medical equipment; (v) expanding into new market niches and
the international market; (vi) reducing indirect costs associated with the
Company's financings; (vii) minimizing delinquencies relating to contracts
retained and serviced by the Company, as well as contracts held by the Company's
lenders; (viii) the Company's ability to realize the residual equipment value
reflected on its balance sheet; (ix) maintaining a diverse base of customers to
which the Company provides equipment financing; (x) successfully enlarging the
Company's sales force and the Company's geographic penetration of the medical
equipment market; and (xi) the size and growth rate of the medical equipment
leasing industry. The historical results acheived are not necessarily indicative
of future prospects of the Company.
The forward-looking statements included herein are based upon current
expectations that involve a number of risks and uncertainties. These forward-
looking statements are based upon assumptions that the Company will continue to
finance equipment on a regular and predictable basis, that competitive
conditions within the equipment financing market will not change materially or
adversely, that the equipment financing market will continue to experience
steady growth, that demand for the Company's financing will remain strong, that
the Company will retain existing sales representatives and key management
personnel, that the Company's will accurately anticipate market demand that
planned financing arrangements will be completed satisfactorily and that there
will be no material adverse change in the Company's operations or business.
Assumptions relating to the foregoing involve judgments with respect to, among
other things, future economic, competitive and market conditions and future
business decisions, all of which are difficult or impossible to predict
accurately and many of which are beyond the control of the Company. Although the
Company believes that the assumptions underlying the forward-looking statements
are reasonable, any of the assumptions could prove inaccurate and, therefore,
there can be no assurance that the results contemplated in the forward looking
statements will be realized. In addition, as disclosed above, the business and
operations of the Company are subject to substantial risks which increase the
uncertainty inherent in such forward-looking statements. Any of the other
factors disclosed above could cause the Company's net income or growth in net
income to differ materially from prior results.
18
ITEM 8. SEE CONSOLIDATED FINANCIAL STATEMENTS BEGINNING ON PAGE F-1 OF THIS
ANNUAL REPORT ON FORM 10-K
ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None
19
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information regarding the Company's Directors and Executive Officers is
incorporated herein by reference to the Company's definitive proxy statement
filed not later than April 30, 1998, with the Securities and Exchange Commission
pursuant to Regulation 14A under the Securities Exchange Act of 1934, as
amended.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 402 of Regulation S-K is incorporated herein by
reference to the Company's definitive proxy statement to be filed not later than
April 30, 1998 with the Securities and Exchange Commission pursuant to
Regulation 14A under the Securities Exchange Act of 1934, as amended.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 403 of Regulation S-K is incorporated herein by
reference to the Company's definitive proxy statement to be filed not later than
April 30, 1998, with the Securities and Exchange Commission pursuant to
Regulation 14A under the Securities Exchange Act of 1934, as amended.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 404 of Regulation S-K is incorporated herein by
reference to the Company's definitive proxy statement to be filed not later than
April 30, 1998, with the Securities and Exchange Commission pursuant to
Regulation 14A under the Securities Exchange Act of 1934, as amended.
20
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT:
(1) Financial Statements:
See Index to Consolidated Financial Statements included as part of this
Form 10-K at Page F-1.
(2) Financial Statement Schedules:
SCHEDULE PAGE
NUMBER DESCRIPTION NUMBER
------ ----------- ------
II. Valuation and Qualifying Accounts F-18
All other schedules are omitted because of the absence of conditions under
which they are required or because all material information required to be
reported is included in the consolidated financial statements and notes
thereto.
(3) Exhibits:
EXHIBIT
NUMBER DESCRIPTION
------- -----------
3.1 Restated Articles of Incorporation of the registrant. (1)
3.2 Certificate of Determination of the Registrant. (1)
3.3 Amended and Restated Bylaws of the Registrant. (1)
4.1 Specimen Copy of Stock Certificate for shares of Common
Stock of the Registrant. (1)
10.1 Employment Agreement, dated as of January 1, 1995, between
the Registrant and Gerry Ricco. (1)
10.2 Employment Agreement, dated as of January 1, 1995, between
the Registrant and Brian Seigel. (1)
10.3 Employment Agreement, dated as of January 1, 1995, between
the Registrant and Larry Hartmann. (1)
10.4 Bonus Agreement, dated as of May 20, 1995, between the
Registrant and Larry Davis. (1)
10.5 Promissory Note, dated May 20, 1995, executed by Larry Davis
in favor of the Registrant in the principal amount of
$175,000. (1)
10.6 Non-competition Agreement, dated as of May 20, 1995, between
the Registrant and Larry Davis. (1)
10.7 Shareholders Agreement, dated May 1, 1995, between Gerry
Ricco, Larry Hartmann, and Brian Seigel. (1)
10.8 Office space lease for the Registrant's corporate
headquarters, dated as of August 15, 1994, by and between
Xerox Centre Partners and the Registrant. (1)
10.9 1995 Stock Option Plan. (1)
10.10 Form of Registrant's standard financing agreement. (1)
10.11 Form of Registrant's "snap" financing agreement. (1)
10.12 Credit Agreement, between the Company and CoreStates Bank,
N. A., dated August 6, 1993, as amended. (1)
10.13 Pooling and Servicing Agreement, dated as of January 31,
1995 by and among Rockford Limited I, the Registrant, Texas
Commerce Bank national Association and Sun Life Insurance
Company of America. (1)
10.14 Equipment and Lease Purchase Agreement, dated as of January
31, 1995, by and between Rockford Limited I and the
Registrant. (1)
10.15 Purchase Agreement, dated as of January 31, 1995, by and
among Rockford Limited I, the Registrant, Texas Commerce
Bank National Association and Sun Life Insurance Company of
America. (1)
10.16 Form of Rockford Limited I Fixed Rate Lease Receivables -
Backed Senior Certificate, Series 1995-A (Class A). (1)
10.17 Form of Rockford Limited I Fixed Rate Lease Receivables -
Backed Senior Certificate, Series 1995-A (Class B). (1)
10.18 Form of Rockford Limited I Fixed Rate Lease Receivables -
Backed Senior Certificate, Series 1995-A (Class C). (1)
10.19 Amendments to office space lease for the registrant's
corporate headquarters, dated October 23, 1995, by and
between Xerox Centre Partners and the Registrant. (2)
10.20 Revised credit agreement, between the registrant and
CoreStates Bank, N.A., dated March 7, 1996. (2)
10.21 Pooling and Servicing Agreement, dated as of February 23,
1996, by and among Rockford Limited II, the registrant,
Texas Commerce Bank National Association and SunAmerica Life
Insurance Company. (2)
21
10.22 Equipment and Lease Purchase Agreement, dated as of February
23, 1996, by and between Rockford Limited II and the
registrant. (2)
10.23 Purchase Agreement, dated as of February 23, 1996, by and
among Rockford Limited II, the registrant, Texas Commerce
Bank National Association and SunAmerica Life Insurance
Company. (2)
10.24 Form of Rockford Limited II Fixed Rate Lease Receivables -
Backed Senior Certificate, Series 1996-A (Class A). (2)
10.25 Form of Rockford Limited II Fixed Rate Lease Receivables -
Backed Senior Certificate, Series 1996-A (Class B). (2)
10.26 Form of Rockford Limited II Fixed Rate Lease Receivables -
Backed Senior Certificate, Series 1996-A (Class C). (2)
10.27 Subscription Agreement dated May 25, 1995, by and between
Anchor National Life Insurance Company (a wholly-owned
subsidiary of SunAmerica, Inc.) and the registrant
(incorporation by reference to Exhibit 10.19 of the
registrant's Registration Statement on Form S-1 declared
effective on July 19, 1995 (File No. 33-92756)).
10.28 Form of Warrant Agreement dated July 19, 1995, by and among
Commonwealth Associates, Cruttenden Roth Incorporated and
the registrant (incorporation by reference to Exhibit 10.20
of the registrant's Registration Statement on Form S-1
declared effective on July 19, 1995 (File No. 33-92756))
10.29 Amendment to Master Agreement and Master Security Agreement
dated March 7, 1996 by and between CoreStates and the
registrant. (3)
10.30 Master Demand Note in the principal amount of $5.0 million
issued by the registrant in favor of CoreStates. (3)
10.31 Cash pivot Investment/Loan Agreement by and between the
registrant and CoreStates. (3)
23.1 Consent of Deloitte & Touche LLP.
27.1 Financial data schedule.
- ----------------------
(1) Filed previously as an Exhibit to the Company's Registration Statement on
Form S-1 declared effective July 19, 1995 (File No. 33-92756) and by this
reference incorporated herein.
(2) Filed previously as an Exhibit to the Company's Form 10-K for the year
ended December 31, 1995 (File No. 0-26324) and by this reference
incorporated herein.
(3) Filed previously as an Exhibit to the Company's Form 10-K for the year
ended December 31, 1996 (File No. 0-26324) and by this reference
incorporated herein.
(B) REPORTS ON FORM 8-K:
There were no reports on Form 8-K filed during the fourth quarter of the year
ended December 31, 1997.
22
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this amendment to be signed
on its behalf by the undersigned, thereunto duly authorized.
Rockford Industries, Inc.
By /s/ GERRY J. RICCO
------------------------
Gerry J. Ricco
President
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ GERRY J. RICCO President and Chief March 30, 1998
------------------------- Executive Officer
Gerry J. Ricco and Director (Principal
Executive Officer)
/s/ LARRY HARTMANN Executive Vice President March 30, 1998
- ----------------------------- and Director
Larry Hartmann
/s/ BRIAN SIEGEL Executive Vice President March 30, 1998
------------------------- and Director
Brian Siegel
/s/ KEVIN MCDONNELL Executive Vice President March 30, 1998
------------------------- and Chief Financial Officer
Kevin McDonnell (Principal Financial and
Accounting Officer)
/s/ ROBERT S. VATERS Director March 30, 1998
-------------------------
Robert S. Vaters
/s/ FLOYD S. ROBINSON Director March 30, 1998
-------------------------
Floyd S. Robinson
23
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Number
---------
Consolidated Balance Sheets as of December 31, 1997 and 1996...... F-2
Consolidated Statements of Operations for the years ended
December 31, 1997, 1996 and 1995................................ F-3
Consolidated Statements of Shareholders' Equity for the years
Ended December 31, 1997, 1996 and 1995.......................... F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995................................ F-5
Notes to Consolidated Financial Statements........................ F-7
Independent Auditors' Report...................................... F-19
F-1
ROCKFORD INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
-----------------------------
1997 1996
------------- -------------
ASSETS
Cash and cash equivalents $ 1,077,056 $ 3,985,350
Restricted cash 15,590,153 6,109,559
Accounts receivable (Note 2) 14,532,094 10,039,818
Note receivable from officer (Note 2) - 143,831
Prepaid expenses 1,767,185 884,184
Income taxes receivable (Note 8) 2,606,295 953,234
Net investment in direct finance leases (Note 4) 24,345,620 35,530,325
Net fixed assets (Note 3) 3,263,778 1,900,810
Discounted lease rentals assigned to lendors (Note 7) 61,884,943 98,151,318
------------ ------------
$125,067,124 $157,698,429
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Lines of credit (Note 6) $ 15,862,275 $ 10,981,549
Accounts payable 8,566,382 6,030,482
Accrued expenses and other liabilities 1,887,706 5,919,187
Estimated recourse obligations 2,122,985 -
Deferred income taxes (Note 8) 5,719,641 1,820,346
Nonrecourse debt (Notes 7 and 12) 69,017,039 113,062,823
------------ ------------
Total liabilities 103,176,028 137,814,387
Commitments and contingencies (Note 9)
Shareholders' equity (Notes 1 and 10):
Redeemable preferred stock, par value $25.00; authorized,
1,000,000 shares; issued and outstanding, 70,000 shares 1,575,000 1,575,000
Common stock, no par value; authorized, 10,000,000 shares;
outstanding, 4,107,117 shares (1997) and 4,105,517 shares
(1996) 14,044,891 14,032,491
Retained earnings 6,271,205 4,276,551
------------ ------------
Total shareholders' equity 21,891,096 19,884,042
------------ ------------
$125,067,124 $157,698,429
============ ============
See notes to consolidated financial statements.
F-2
ROCKFORD INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
-----------------------------------------
1997 1996 1995
------------ ------------ ------------
REVENUES:
Sales of equipment $ - $ 93,613,257 $ 64,998,934
Gain on sale of financing transactions 10,026,678 3,406,815 2,889,717
Finance income 4,088,338 4,635,725 5,405,571
Servicing income 2,651,779 1,712,100 409,711
Other income 2,341,337 1,171,405 626,005
------------ ------------ ------------
Total revenue 19,108,132 104,539,302 74,329,938
COSTS:
Cost of equipment sold - 82,922,839 57,865,782
Interest expense 2,031,877 2,457,619 3,340,050
------------ ------------ ------------
Total costs 2,031,877 85,380,458 61,205,832
------------ ------------ ------------
GROSS PROFIT 17,076,255 19,158,844 13,124,106
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSES (Notes 1 and 9) 10,791,629 13,053,972 8,898,780
PROVISION FOR CREDIT LOSSES 2,821,451 2,242,292 738,540
------------ ------------ ------------
Total expenses 13,613,080 15,296,264 9,637,320
INCOME BEFORE INCOME TAXES 3,463,175 3,862,580 3,486,786
INCOME TAXES (Note 8) 1,343,000 1,545,000 1,394,715
------------ ------------ ------------
NET INCOME $ 2,120,175 $ 2,317,580 $ 2,092,071
============ ============ ============
NET INCOME ATTRIBUTABLE TO
COMMON SHAREHOLDERS: $ 1,994,654 $ 2,209,220 $ 2,067,331
============ ============ ============
NET INCOME PER SHARE (Note 13) $ 0.49 $ 0.54 $ 0.64
Basic ============ ============ ============
Diluted $ 0.48 $ 0.52 $ 0.60
============ ============ ============
Weighted average number of common shares
outstanding:
Basic 4,105,772 4,102,780 3,218,911
============ ============ ============
Diluted 4,440,512 4,451,711 3,504,449
============ ============ ============
See notes to consolidated financial statements.
F-3
ROCKFORD INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Redeemable
Preferred Stock Common Stock Total
--------------------- ------------------------ Retained Shareholders'
Shares Amount Shares Amount Earnings Equity
-------- ---------- ---------- ------------ ------------ ------------
Balance at December 31, 1994 -- $ -- 2,454,000 $ 2,810,322 $ - $ 2,810,322
Net proceeds from sale of
preferred stock 70,000 1,575,000 1,575,000
Net proceeds from initial public
offering of common stock
(Note 1) 1,647,500 11,191,038 11,191,038
Net income 2,092,071 2,092,071
Preferred stock dividends (24,740) (24,740)
-------- ---------- ---------- ------------ ------------ ------------
Balance at December 31, 1995 70,000 1,575,000 4,101,500 14,001,360 2,067,331 17,643,691
Net proceeds from exercise
of stock options 4,017 31,131 31,131
Net income 2,317,580 2,317,580
Preferred stock dividends (108,360) (108,360)
-------- ---------- ---------- ------------ ------------ ------------
Balance at December 31, 1996 70,000 1,575,000 4,105,517 14,032,491 4,276,551 19,884,042
Net proceeds from exercise
of stock options 1,600 12,400 12,400
Net income 2,120,175 2,120,175
Preferred stock dividends (125,521) (125,521)
-------- ---------- ---------- ------------ ------------ ------------
Balance at December 31, 1997 70,000 $1,575,000 4,107,117 $ 14,044,891 $ 6,271,205 $ 21,891,096
======== ========== ========== ============ ============ ============
See notes to consolidated financial statements.
F-4
ROCKFORD INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
---------------------------
1997 1996 1995
------------- ------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,120,175 $ 2,092,071 $ 2,317,580
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization 548,597 305,459 140,619
Change in lease receivable and residual
valuation allowance 230,000 815,000 200,000
Gain on sale of residuals (2,057,014) (511,358) (330,985)
Gain on sale of financing transactions (10,026,678) (3,406,815) (2,889,717)
Initial direct cost amortization 1,146,875 1,275,593 1,421,940
Net amortization of deferred interest (4,396,928) (2,178,106) (3,487,460)
Changes in assets and liabilities:
Restricted cash (9,480,594) (3,234,015) (2,875,544)
Accounts receivable, officer note receivable
and prepaid expenses (5,231,446) (6,167,276) (3,813,541)
Income taxes receivable (1,653,061) (953,234) -
Accounts payable and accrued expenses and
other liabilities (1,495,581) 5,354,902 3,157,393
Estimated recourse obligations 2,122,985
Income taxes payable - (1,204,283) 1,204,283
Deferred income taxes 3,899,295 746,346 (826,000)
------------ ------------ -------------
Net cash used in operating activities (24,273,375) (6,840,207) (6,006,941)
CASH FLOWS FROM INVESTING ACTVITIES:
Proceeds from sales and assignments of
leases and payments received from lessees 192,158,229 65,056,118 4,594,050
Proceeds from sale of residuals 3,201,505 1,361,690 964,734
Purchase of fixed assets (1,911,565) (1,337,149) (704,622)
Initial direct cost capitalization (10,102,693) (2,076,552) (1,137,479)
Equipment purchased for financing (166,748,000) (131,266,745) (87,881,000)
------------- ------------- -------------
Net cash provided by (used in) investing
activities 16,597,476 (68,262,638) (84,164,317)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from nonrecourse debt - 58,774,571 90,479,518
Proceeds from line of credit 160,347,423 28,539,402 6,792,326
Proceeds from sale of preferred stock - - 1,575,000
Proceeds from sale of common stock 12,400 31,131 -
Proceeds from initial public offering - - 11,191,038
Preferred stock dividends (125,521) (108,360) (24,740)
Payments on line of credit (155,466,697) (17,557,854) (13,068,622)
------------- ------------ -------------
Net cash provided by financing activities 4,767,605 69,678,890 96,944,520
------------- ------------ -------------
NET (DECREASE) INCREASE IN CASH
AND CASH EQUIVALENTS (2,908,294) (5,423,955) 6,773,262
CASH AND CASH EQUIVALENTS
beginning of year 3,985,350 9,409,305 2,636,043
------------- ------------ -------------
CASH AND CASH EQUIVALENTS
end of year $ 1,077,056 $ 3,985,350 $ 9,409,305
============= ============ =============
See notes to consolidated financial statements.
F-5
ROCKFORD INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEAR ENDED DECEMBER 31,
--------------------------------------------------
1997 1996 1995
--------------- --------------- --------------
SUPPLEMENTAL DISCLOSURE -
Income taxes paid $ 414,357 $ 2,970,078 $ 1,024,957
=========== =========== ===========
Interest paid $ 891,580 $ 222,522 $ 221,794
=========== =========== ===========
SUPPLEMENTAL SCHEDULE OF NONCASH
INVESTING AND FINANCING ACTIVITIES -
Estimated lessee payments made directly to
nonrecourse lending institutions $44,045,784 $49,000,240 $56,435,079
=========== =========== ===========
See notes to consolidated financial statements.
F-6
ROCKFORD INDUSTRIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS AND SIGNIFICANT ACCOUNTING PRINCIPLES
Business - Rockford Industries, Inc. (the "Company") was incorporated on
December 27, 1984 and commenced operations in January 1985. The Company is a
specialty finance company that originates or acquires, sells and services
leases related to a wide range of equipment, including medical, dental and
diagnostic, computers and peripherals, computer software, telecommunications,
office and other. The Company may sell these contracts in bulk to nonrecourse
lenders or securitize these contracts, at which time the Company relinquishes
any control over such contracts. In July 1995 the Company completed an
initial public offering of 1,647,500 shares of its Common Stock at a price of
$7.75 per share, netting proceeds to the Company of $11,191,038.
Principles of Consolidation - The accompanying consolidated financial
statements include the accounts of Rockford Industries, Inc. and its wholly-
owned subsidiaries. All significant intercompany balances and transactions
have been eliminated.
Use of Estimates - The preparation of the Company's consolidated financial
statements in conformity with generally accepted accounting principles
require management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent liabilities at
the date of the financial statements and the reported amount of revenues and
expenses during the reporting period. Actual results could differ from these
estimates.
Lease Accounting - The Company adopted Statement of Financial Accounting
Standards (SFAS) No. 125 Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities, which was amended by SFAS No. 127
as of January 1, 1997. SFAS No. 125 has changed the manner in which the
Company determines and recognizes the gain recorded upon the transfer of its
interest in finance contracts subsequent to December 31, 1996. Additionally,
SFAS No. 125 allows the Company to record gains with respect to transfers of
its interest in leases previously accounted for as direct finance leases.
With the implementation of SFAS No. 125, the Company has altered the
presentation in the consolidated financial statements for revenues, expenses
and certain assets and liabilities associated with finance contracts sold. As
a result, as described below, certain aspects of the Company's financial
statements as of December 31, 1997 and for the year then ended may not be
directly comparable to the prior year financial statements. Retroactive
implementation of SFAS No. 125 was not permitted. There was no material
impact on the Company's net income from the adoption of SFAS No. 125.
Certain of the Company's direct finance leases are initially funded with
recourse debt or with the Company's own working capital. The Company
warehouses these contracts for a period of time. For these transactions, the
Company records total lease rentals, estimated unguaranteed residual value
and initial direct costs as the gross investment in the lease. The difference
between the gross investment in the lease and the cost of the leased
equipment is defined as "unearned income." Interest income is recognized over
the term of the lease by amortizing the unearned income and deferred initial
direct costs using the interest method. The gross investment in the lease and
unearned income are included in net investment in direct finance leases.
Included in net investment in direct finance leases are those transactions
transferred to third parties prior to the Company's adoption of SFAS No. 125,
where the Company has a continuing economic interest in the lease, typically
in the form of a residual interest in the underlying equipment. These
transactions are accounted for in a manner consistent with direct finance
leases funded with recourse debt or with the Company's own working capital.
Prior to the adoption of SFAS No. 125, for leases in which the Company did
not retain a continuing economic interest at origination, sales were
recognized upon consummation of the lease assignment to the nonrecourse
lender. The related obligation resulting from this discounting of the leases
was recorded as nonrecourse debt. Under the assignment, the lender takes a
first lien against the lease equipment. In the event of default by the
lessee, the lender would exercise its rights under the lien with no further
recourse against the Company. The related interest income and expense for
transactions recorded as sales are netted and included in finance income. For
sales recognized prior to the implementation of SFAS No. 125, the discounted
value of aggregate lease payments is recorded as discounted lease rentals
assigned to lenders and sales of
F-7
equipment and the equipment cost is recorded as cost of sales. Subsequent to
SFAS No. 125, the difference between the discounted value of aggregate lease
payments due under lease contract and the equipment cost is recognized as
gain or loss on sale of financing transactions.
Securitization Accounting - During the years ended December 31, 1997 and
1996, the Company completed the securitization and sale of approximately
$128.5 million and $57.2 million, respectively, in direct finance leases in
the form of asset-backed pass-through certificates and recognized gains of
approximately, $9.0 million and $2.4 million, respectively. These
certificates are held in a trust independent of the Company. The Company acts
as a servicer for the trust and receives a stated servicing fee. Because the
difference between the Company's servicing costs and the stated servicing fee
is not significant, no servicing asset or liability has been recorded.
The difference between the cash proceeds from the assignment of the remaining
payments due under these contracts and the total of the unamortized net
investment balance, fair value of estimated recourse obligation and accrued
letter of credit fees is recorded as gain on sale of financing transactions.
The present value of the Company's retained interest in the unguaranteed
residual value of the equipment under lease remains on the consolidated
balance sheet, classified as net investment in direct finance leases.
In connection with these securitization transactions, the Company is required
to originate and maintain a letter of credit with a qualifying financial
institution. Such letter of credit serves as credit enhancement for the
related trust. Withdrawals on the letter of credit are required in the event
of shortfalls in amounts due to investors. All projected costs of origination
and maintaining the letter of credit are accrued in the period in which the
securitization closes. As collateral for the letter of credit, the Company
initially deposits cash with the issuing bank. The amount set aside is
available for distribution to the issuing bank in the event of withdrawals on
the letter of credit. Cash amounts on deposit are invested in certain
instruments as permitted by the related securitization documents. To the
extent amounts on deposit exceed specified levels, distributions are made to
the Company, and, at termination of the related trust, any remaining amounts
on deposit are distributed to the Company. The amount on deposit to support
the letter of credit at December 31, 1997 and 1996 is classified as
restricted cash.
Cash Equivalents - The Company considers cash equivalents to be all highly-
liquid debt instruments purchased with an original maturity of three months
or less.
Allowance for Doubtful Accounts - The Company maintains an allowance for
doubtful accounts in connection with payments due under equipment finance
contracts held in the Company's portfolio. The allowance is determined by
management's estimate of future uncollectible contract receivables, based on
an analysis of delinquencies and historical loss experience. There can be no
assurance that historical delinquencies and loss experience will continue in
the future. Increases in delinquencies and loss rates in the future could
have a material adverse effect on the Company's business, operating results
and financial condition. The Company's policy is to write-off accounts when
deemed uncollectible and historically, such write-offs have been consistent
with management's expectation.
Fixed Assets - Fixed assets are stated at cost less accumulated depreciation
and amortization. Depreciation and amortization are computed using the
straight-line method over estimated useful lives which range from five to
seven years.
Estimated Recourse Obligations As part of the sale and securitization of
direct finance leases, the Company writes a put option in the form of a
recourse obligation. This recourse obligation is recorded at its estimated
fair value. Although management uses the best information available to
estimate fair value, future adjustments to the obligation may be necessary
due to economic, operating and other conditions that may be beyond the
Company's control. Actual results could differ from those estimates.
F-8
Revenue Recognition - The Company derives its revenue principally from gains
on sales of financing transactions, servicing and other fees, finance income
and other income. Gains on sales of financing transactions are recognized as
discussed previously under lease accounting. Servicing and other fees are
recorded as earned. Finance income is recorded as earned and represents the
interest earned on finance lease contracts during the period prior to their
securitization or sale. Other income is comprised of miscellaneous income,
which is recorded as earned, and gains from the sale of residual interests in
equipment leased, which is recognized at the end of a lease contract based on
the difference between the cash proceeds from the sale of a residual interest
and the remaining unamortized net investment balance.
Selling, General and Administrative Expenses - A portion of the Company's
selling, general and administrative expenses directly related to originating
direct finance lease transactions is deferred and amortized under the
interest method as a reduction of interest income over the lease term. Total
deferred initial direct costs, net of accumulated amortization, are included
in the Company's net investment in direct finance leases (Note 4).
Income Taxes - The Company accounts for income taxes in accordance with SFAS
No. 109, Accounting for Income Taxes. Deferred taxes on income result from
temporary differences between the reporting of income for financial
statements and tax reporting purposes (Note 8).
Net Income Per Share - In February 1997, the Financial Accounting Standards
Board ("FASB") issued SFAS No. 128, Earnings Per Share, which is effective
for annual and interim periods ending after December 15, 1997, and requires
retroactive application to all periods presented. It supercedes the
presentation of primary earnings per share with a presentation of basic
earnings per share which does not consider the effect of common stock
equivalents. The computation of diluted earnings per share, which gives
effect to all dilutive potential common shares that were outstanding during
the period, is consistent with the computation of fully diluted earnings per
share per Accounting Principles Board Opinion No. 15. The adoption of this
standard did not have a material effect on the Company's net income per share
in 1997, 1996 and 1995.
Stock Split - On May 10, 1995, the Company's Board of Directors approved a
818-for-one stock split of the Company's common stock, subject to stockholder
approval. All share and per share amounts included in the accompanying
financial statements and notes have been restated to reflect the stock split.
Additionally, the Company increased the number of shares of common stock
authorized to 10,000,000 shares.
Recent Accounting Pronouncements - In June 1997, FASB issued SFAS No. 130,
Reporting Comprehensive Income, which is effective for annual and interim
periods beginning after December 15, 1997. This statement requires that all
items that are required to be recognized under accounting standards as
comprehensive income be reported in a financial statement that is displayed
with the same prominence as other financial statements.
In June 1997, FASB issued SFAS No. 131, Disclosures about Segments of an
Enterprise and Related Information, which is effective for annual and interim
periods beginning after December 15, 1997. This statement establishes
standards for the method that public entities report information about
operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in interim
financial reports issued to shareholders. It also establishes standards for
related disclosures about product and services, geographical areas and major
customers. The adoption of this standard is not expected to have a material
effect on the Company's financial reporting.
F-9
2. ACCOUNTS RECEIVABLE AND NOTE RECEIVABLE FROM OFFICER
The Company's accounts receivable and note receivable from officer consist of
the following:
AS OF DECEMBER 31,
-------------------------
1997 1996
----------- -----------
Receivable from sale and assignments of leases $11,901,504 $ 5,467,395
Receivable from lessees 627,771 1,476,237
Receivable from trusts 1,564,895 2,241,218
Other 1,048,374 1,239,968
Less allowance for doubtful accounts (610,000) (385,000)
----------- -----------
$14,532,094 $10,039,818
=========== ===========
Note receivable from officer $ - $ 143,831
=========== ===========
Included in other accounts receivable at December 31, 1997 is a note receivable
from a former officer of the Company for $109,760. The note is unsecured, bears
interest at 6.75% per year and is due in 1998.
3. FIXED ASSETS
The Company's fixed assets consist of the following:
AS OF DECEMBER 31,
-----------------------
1997 1996
---------- ----------
Office equipment $1,979,607 $1,325,327
Furniture and fixtures 718,950 503,377
Computer software 1,806,375 764,663
---------- ----------
4,504,932 2,593,367
Less accumulated depreciation and amortization (1,241,154) (692,557)
---------- ----------
$3,263,778 $1,900,810
========== ==========
4. NET INVESTMENT IN DIRECT FINANCE LEASES
The Company's net investment in direct finance leases consists of the following:
AS OF DECEMBER 31,
-------------------------
1997 1996
----------- -----------
Minimum lease payments receivable $26,243,829 $39,053,042
Estimated unguaranteed residual value 4,208,754 4,350,948
----------- -----------
30,452,583 43,403,990
----------- -----------
Deferred initial direct costs 1,013,263 2,480,698
Less unearned income (5,675,226) (9,139,363)
Less lease receivable and residual valuation
allowance (1,445,000) (1,215,000)
----------- ----------
(6,106,963) (7,873,665)
----------- ----------
Net investment in direct finance leases $24,345,620 $35,530,325
=========== ===========
The estimated unguaranteed residual value represents management's estimate of
the amount expected to be received at lease termination as a result of
disposition of equipment under the direct finance leases. Management reviews
such estimates quarterly and records a residual valuation allowance if the
equipment's estimated fair market value is below its recorded value.
F-10
At December 31, 1997, a summary of installments due on minimum lease payments
receivable and expected realization of the Company's estimated unguaranteed
residual value, net of the related valuation allowance is as follows:
MINIMUM ESTIMATED
LEASE PAYMENTS UNGUARANTEED
RECEIVABLE RESIDUAL VALUE TOTAL
-------------------- -------------------- -------------
Year ending December 31:
1998 $12,051,339 $ 673,401 $12,724,740
1999 5,937,093 900,673 6,837,766
2000 3,862,358 913,300 4,775,658
2001 2,382,773 749,158 3,131,931
2002 1,548,332 686,027 2,234,359
Thereafter 461,934 286,195 748,129
----------- ---------- ------------
26,243,829 4,208,754 30,452,583
----------- ---------- ------------
Initial direct costs 1,013,263 - 1,013,263
Less unearned income (4,917,376) (757,850) (5,675,226)
Less lease receivable and residual valuation
allowance (1,320,000) (125,000) (1,445,000)
----------- ---------- ------------
(5,224,113) (882,850) (6,106,963)
----------- ---------- ------------
Net investment in direct finance leases $21,019,716 $3,325,904 $24,345,620
=========== ========== ============
5. SERVICING PORTFOLIO
Trust and other custodial funds, relating to lease contracts serviced for
others, totaled $6.2 million and $1.8 million at December 31, 1997 and 1996,
respectively. Such funds, which are maintained in separate bank accounts, are
excluded from the company's assets and liabilities.
Total lease contracts serviced amounted to $198 million and $63 million at
December 31, 1997 and 1996, respectively.
6. LINES OF CREDIT
The Company has maintained a revolving line of credit facility ("The Revolver")
and a working capital facility with a bank which it uses from time to time for
the funding of certain of its financing and equipment transactions. On November
21, 1997, this credit facility was restructured to decrease the borrowing limit
on the line of credit to $17.0 from $30.0, eliminate the $5 million overdraft
protection facility and provide for an additional $7.0 million working capital
line of credit. The Revolver provides for borrowings at rates based on a short-
term index plus 150 basis points, allows for advances through August 31, 1998,
and grants the Company the option of converting borrowings thereunder to term
loans, provided certain conditions are met by the Company. Term loans are
collateralized by qualifying equipment finance contracts and bear interest at
fixed rates quoted by the Bank. The working capital facility provides for
borrowings at rates based on the Bank's overnight borrowing rate plus 200 basis
points and allows for advances through August 31, 1998. As of December 31, 1997,
the balance outstanding under these credit facilities was $15,862,275 and there
were no outstanding term loans with the Bank.
The credit facilities are collateralized by the leases assigned to the Bank
under each advance and is granted with full recourse against the Company should
the collateral prove to be insufficient. The credit facilities exclude an
arrangement for compensating balances. Under the provisions of the credit
facilities, the Company must maintain certain minimum net worth requirements
($16,127,250 at December 31, 1997) and a defined debt to net worth ratio of not
greater than 3.25. The Company was in compliance with all covenants at
December 31, 1997.
The following table presents data on the line of credit for the years ended
December 31:
1997 1996 1995
------------- ------------ -------------
Weighted average interest rate for the period 7.57% 6.41% 7.00%
Weighted average interest rate at the end of the period 8.25% 8.50% 7.00%
Average amount outstanding for the period $13,548,123 $ 5,824,349 $2,201,425
Maximum amount outstanding at any month-end $28,774,701 $11,145,106 $7,440,885
F-11
Nonrecourse debt, which relates to direct finance leases and discounted lease
rentals assigned to lenders or permanently funded through asset securitizations,
bears interest at rates ranging from 8% to 18%. Maturities of such obligations
at December 31, 1997 are as follows:
Discounted
Lease Rentals Total
Direct Assigned to Lenders Nonrecourse
Finance Leases or Securitized Debt
-------------- ------------------- -----------
Year ending December 31:
1998 $4,669,201 $33,204,803 $37,874,004
1999 2,414,678 22,178,825 24,593,503
2000 706,582 10,238,189 10,944,771
2001 143,497 3,524,072 3,667,569
2002 - 79,596 79,596
---------- ----------- -----------
7,933,958 69,225,485 77,159,443
Less deferred interest expense (801,862) (7,340,542) (8,142,404)
---------- ----------- -----------
$7,132,096 $61,884,943 $69,017,039
========== =========== ===========
Installments made by lessees on discounted lease rentals assigned to lenders
match the related maturity amounts set forth above.
In August 1997, the Company and SunAmerica amended an agreement pursuant
to which SunAmerica agreed to purchase up to $250.0 million in principal amount
of trust certificates. This agreement, as amended with SunAmerica expires on
August 28, 2000. During 1997, the Company securitized $47.0 million of its
financing contracts with SunAmerica. Also under this amended agreement, the
Company has consolidated $95.8 million of financing contracts securitized with
SunAmerica under the previous agreement. In connection with the securitization
program with SunAmerica, the Company has agreed to continue to service the
equipment finance contracts included in each pool of transferred contracts on
behalf of SunAmerica. In consideration for servicing these contract pools, the
Company receives a service fee from SunAmerica.
In March 1997, the Company entered into an agreement with CoreStates Bank
which provides the Company with a credit facility for the securitization of up
to $150 million of finance contract obligations. During 1997, the Company has
securitized $81.5 million of its financing contracts with CoreStates. This
agreement with CoreStates expires on September 28, 1998. In connection with the
securitization program with CoreStates, the Company has agreed to continue to
service the equipment finance contracts included in each pool of transferred
contracts on behalf of CoreStates. In consideration for servicing these contract
pools, the Company receives a service fee from CoreStates.
8. INCOME TAXES
For the years ended December 31, 1997, 1996 and 1995 income tax expense consists
of the following:
YEAR ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
---------- ---------- ----------
Current
Federal $ - $ 572,248 $1,735,522
State 50,000 367,297 485,193
----------------------------------
50,000 939,545 2,220,715
Deferred
Federal 1,051,088 510,963 (622,319)
State 241,912 94,492 (203,681)
----------------------------------
1,293,000 605,455 (826,000)
----------------------------------
$1,343,000 $1,545,000 $1,394,715
==================================
The reconciliation of income tax expense computed at U.S. federal statutory
rates to income tax expense for the years ended December 31, 1997, 1996 and 1995
is as follows:
YEAR ENDED DECEMBER 31,
---------------------------------
1997 1996 1995
---------- ---------- ----------
Tax at U.S. federal statutory rates $1,170,565 $1,313,277 $1,220,376
State income taxes 192,662 180,769 185,798
Restoration of deferred income tax
liabilities in connection with the
Company's conversion to a C Corporation - - (11,459)
Other (20,227) 50,954 -
----------------------------------
$1,343,000 $1,545,000 $1,394,715
==================================
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax assets and liabilities as of December 31, 1997 and
1996 are as follows:
AS OF DECEMBER 31,
------------------------
1997 1996
----------- ----------
Deferred tax assets:
Net Operating Losses $ 4,156,994 $ -
Allowance for doubtful accounts 844,455 657,554
State income taxes 293,753 116,254
Other 62,919 101,046
------------------------
Total deferred assets 5,358,121 874,854
Deferred tax liabilities:
Book to tax basis difference on certain
leased equipment 1,887,172 2,689,828
Book to tax difference in recognition of
securitizations 9,150,626 -
Other 39,964 5,372
------------------------
Total deferred tax liabilities 11,077,762 2,695,200
------------------------
Net deferred tax liabilities $ 5,719,641 $1,820,346
========================
F-13
9. COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS OF RISK
Leases - The Company leases its corporate offices and certain fixed assets under
operating and capital leases which expire on various dates through 2002. Rent
expense was $706,748 (1997), $573,269 (1996), and $385,731 (1995). Amortization
of assets under capital leases is included in depreciation expense.
Future minimum lease payments under these non-cancelable leases are as follows:
CAPITAL OPERATING
LEASES LEASES TOTAL
---------- ---------- ----------
Year ending December 31:
1998 $ 218,217 $ 599,913 $ 818,130
1999 201,380 560,210 761,590
2000 158,213 115,646 273,859
2001 135,788 48,764 189,552
Thereafter - 24,382 24,382
---------- ---------- ----------
Less amount representing $ 713,598 $1,348,915 $2,062,513
interest (88,138) - (88,138)
---------- ---------- ----------
$ 625,460 $1,348,915 $1,974,375
========== ========== ==========
Employment Agreements - The Company has employment agreements with three company
officers that call for minimum annual salaries and annual bonuses payable to
each officer in 1998.
Employee Benefit Plan - In January 1996 the Company adopted an Employee Savings
Plan pursuant to Internal Revenue Code Section 401(k). The plan provides for
contributions by the Company as defined in the plan.
Litigation - The Company is involved in litigation both as a plaintiff and
defendant in matters arising out of the Company's normal business activities.
Management does not expect the outcome of these lawsuits to have a material
adverse effect on the financial statements of the Company.
Concentrations - At December 31, 1997, lease contacts related to equipment
located in the state of California comprised approximately 13% of the total
serviced lease contract portfolio while no other state comprised more than 8%.
The Company funds substantially all of the lease contracts it originates through
borrowings under its line of credit facilities and internally generated funds.
These borrowings are in turn repaid with the proceeds received by the Company
from selling such leases through securitizations. Any failure to renew or
obtain adequate funding under those line of credit facilities, or other
borrowings, or any substantial reduction in the size of or pricing in the
markets for the Company's leases, could have a material adverse effect on the
Company's operations. To the extent that the Company is not successful in
maintaining or replacing existing financing, it could have a material adverse
effect on the company's consolidated financial condition and consolidated
results of operations.
Since 1995, the Company has pooled and sold through securitizations an
increasing percentage of the lease contracts that it originates. The Company
derives a significant portion of its income by recognizing gains upon the sales
of leases through securitizations. Adverse changes in the securitization market
could impair the company's ability to sell lease contracts through
securitizations on a favorable or timely basis. Any such impairment could have
a material adverse effect upon the Company's consolidated balance sheet and
consolidated results of operations.
The Company has relied on credit enhancement to achieve a "AAA/aaa" rating for
the interests of the trusts in its securitizations. The credit enhancement has
generally been in the form of an insurance policy issued by an insurance company
insuring the timely repayment of the regular interests in each of the
securitization trusts. There can be no assurance that the Company will be able
to obtain credit enhancement in any form from the current insurer or any other
provider of credit enhancement on acceptable terms or that future
securitizations will be similarly rated. A downgrading of the insurer's credit
rating or its withdrawal of credit enhancement could have a material adverse
effect on the Company's consolidated balance sheet and consolidated results of
operations.
F-14
10. REDEEMABLE PREFERRED STOCK
Series A Redeemable Preferred Stock - In May 1995, the Company issued 70,000
shares of Series A Redeemable Preferred Stock ("Preferred Stock") for net
proceeds of approximately $1,575,000. The holder of the Preferred Stock is
entitled to receive dividends, when declared by the Company's Board of
Directors, at the rate of 4% of the par value of Preferred Stock until May 31,
1996, 6% from June 1, 1996 to May 31, 1997 and 8% thereafter. The dividends
accrue quarterly and are cumulative. Net income applicable to common
shareholders represents net income less preferred stock dividends. The Company,
at its option may redeem the outstanding shares of Preferred Stock subsequent to
May 1997 at 120% of the original purchase price, plus unpaid dividends. The
Company's redemption price is subject to reduction under certain circumstances.
The Preferred Stock is convertible, at the election of the holders, into 275,373
shares of the Company's Common Stock.
11. STOCK OPTION PLAN
In May 1995, the Board of Directors adopted, and the shareholders approved, the
Company's 1995 Stock Option Plan. The Stock Option Plan provides for the grant
of (i) options that are intended to qualify as incentive stock options
("Incentive Stock Options") to certain employees and consultants and (ii)
options not intended to so qualify ("Nonqualified Stock Options") to employees
(including directors and officers who are employees of the Company), directors
and consultants. The total number of shares of Common Stock for which options
may be granted under the Stock Option Plan is 350,000 shares. On June 18,
1997, the Stock Option Plan was amended to increase the number of shares
authorized to be issued under the plan to 550,000. The exercise price of all
stock options granted under the Stock Option Plan must be at least equal to the
fair market value of such shares on the date of grant, will expire not later
than 10 years from the date of grant, and vest over a period not exceeding 5
years.
The following table summarizes information with respect to the Plan for the
years ended December 31, 1996 and 1997:
WEIGHTED
AVERAGE
EXERCISE
OPTION SHARES PRICE
------------------ ------------
Outstanding at December 31, 1995 153,861 7.77
Granted during 1996 7,100 $12.33
Canceled during 1996 (7,161) $ 7.75
Exercised during 1996 (4,017) $ 7.75
-------
Outstanding at December 31, 1996 149,783 $ 7.99
Granted during 1997 394,750 $ 7.67
Canceled during 1997 (18,781) $ 8.28
Exercised during 1997 (1,600) $ 7.75
-------
Outstanding at December 31, 1997 524,152 $ 7.74
=======
Additional information regarding options outstanding as of December 31, 1997 is
as follows:
REMAINING
NUMBER CONTRACTUAL NUMBER
EXERCISE PRICE OUTSTANDING LIFE (YRS) EXERCISABLE
-------------- ----------- ----------- ----------
$ 7.00 185,000 9.31 2,000
$ 7.75 126,052 7.55 90,980
$ 8.125- 8.50 181,000 9.50 -
$ 9.25 27,000 9.89 -
$10.38 3,000 8.17 600
$16.88 -17.00 2,100 6.5 1,700
------- ------
524,152 95,280
======= ======
F-15
The Company applies Accounting Principles Board No. 25, Accounting for Stock
Issued to Employees, and related interpretations in accounting for its stock-
based awards. Accordingly, no compensation expense has been recognized in the
financial statements for employee stock arrangements.
SFAS No. 123, Accounting for Stock-Based Compensation, requires the disclosure
of pro forma net income and net income per share had the Company adopted the
fair value method in accounting for stock-based awards. Under SFAS No. 123, the
fair value of stock-based awards to employees is calculated through the use of
option pricing models, even though such models were developed to estimate the
fair value of freely tradable, fully transferable options without vesting
restrictions, which significantly differ from the Company's stock option awards.
These models also require subjective assumptions, including future stock price
volatility and expected time to exercise, which greatly affect the calculated
values. The Company's calculations were made using the Black-Scholes option
pricing model with the following weighted average assumptions: expected life, 48
months; stock volatility, 61.7% - 94.8% in 1997 and 25.9% - 48.0% in 1996; risk
free interest rates, 6.0% in 1997 and 1996; no dividends during the expected
term and forfeitures are recognized as they occur.
If the computed fair value of the awards granted through December 31, 1997 had
been amortized to expense over the vesting period of the awards, pro forma net
income would have been $1,634,000 in 1997 and $2,205,000 in 1996. Pro forma
basic and diluted net income per share would have been $0.37 and 0.37,
respectively, in 1997 and $0.51 and 0.50, respectively, in 1996.
12. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS
In accordance with SFAS No. 107, Disclosures About Fair Value of Financial
Instruments, a summary of the estimated fair value of the Company's consolidated
financial instruments at December 31, 1997 and 1996 is presented below. The
estimated fair value amounts have been determined by the Company using available
market information and appropriate valuation methodologies. However,
considerable judgment is necessary to interpret market data to develop the
estimated fair values. Accordingly, the estimates presented herein are not
necessarily indicative of the amounts the Company could realize in a current
market exchange. The use of different market assumptions and/or estimation
methodologies may have a material effect on the estimated fair value amounts.
The carrying value and estimated fair value of nonrecourse debt at December 31,
1997 was $69,017,039 and $68,666,098, respectively and was $113,062,823 and
$113,147,000, respectively, at December 31, 1996. The Company estimated the
fair value of nonrecourse debt using the Company's funding rates at December 31,
1997 and 1996.
The carrying values of cash and cash equivalents, restricted cash, receivables,
lines of credit and accounts payable, approximate fair values at December 31,
1997 and 1996 due to the relatively short maturities of these instruments.
The estimated recourse obligations at December 31, 1997 was $2,122,985. The
Company believes this approximates the fair value of this obligation at December
31, 1997.
The Company believes the carrying value of Net investments in direct finance
leases and discounted lease rentals assigned to lenders are a reasonable
estimate of their fair value at December 31, 1997 and 1996.
F-16
13. NET INCOME PER SHARE
A reconciliation of the numerators and denominators used in basic and diluted
net income per share are as follows for the years ended December 31:
1997 1996 1995
-------------- -------------- --------------
Net income $2,120,175 $2,317,580 $2,092,071
Preferred stock dividends (125,521) (108,360) (24,740)
-------------- -------------- --------------
Net income available to common shareholders $1,994,654 $2,209,220 $2,067,331
============== ============== ==============
Weighted average number of common shares
Basic 4,105,772 4,102,780 3,218,911
Effect of dilutive securities - stock options 334,740 348,931 285,538
-------------- -------------- --------------
Diluted 4,440,512 4,451,711 3,504,449
Net income per share:
Basic $ 0.49 $ 0.54 $ 0.64
Effect of dilutive securities - stock options (0.01) (0.02) (0.04)
-------------- -------------- --------------
Diluted $ 0.48 $ 0.52 $ 0.60
14. SELECTED QUARTERLY DATA (UNAUDITED)
------------ ------------ ------------ -------------
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr. Year-end
March 31 June 30 Sept. 30 Dec. 31 Dec. 31
------------ ------------ ------------ ------------- -------------
FISCAL YEAR 1997
Total revenue $ 4,596,001 $ 4,514,396 $ 5,401,865 $ 4,595,870 $ 19,108,132
Gross profit 3,975,027 3,990,103 4,979,094 4,132,029 17,076,255
Income before taxes 1,400,194 1,068,459 1,396,735 (402,215) 3,463,175
Net income 840,194 640,998 884,131 (245,150) 2,120,175
Basic net income per share 0.20 0.15 0.21 (0.07) 0.49
Diluted net income per share 0.19 0.15 0.20 (0.07) 0.48
FISCAL YEAR 1996
Total revenue $22,566,747 $24,100,580 $30,341,619 $27,530,356 $104,539,302
Gross profit 4,352,433 4,465,152 5,597,022 4,744,237 19,158,844
Income before taxes 1,098,014 1,256,997 1,253,649 253,920 3,862,580
Net income 658,764 754,243 752,189 152,384 2,317,580
Basic net income per share 0.15 0.18 0.18 0.03 0.54
Diluted net income per share 0.15 0.17 0.17 0.03 0.52
F-17
ROCKFORD INDUSTRIES, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Additions
Balance at Charged to
Beginning Costs and Balance at
Classification of Year Expenses Recoveries Written Off End of Year
- --------------------------------------------------- ---------- ---------- ---------- ----------- -----------
Year ended December 31, 1997 -
Allowance for doubtful accounts $1,600,000 $2,821,451 - $2,366,451 $2,055,000
========== ========== ========== ========== ===========
Year ended December 31, 1996 -
Allowance for doubtful accounts $ 600,000 $2,242,292 $1,242,292 $1,600,000
========== ========== ========== ========== ===========
Year ended December 31, 1995 -
Allowance for doubtful accounts $ 400,000 $ 738,540 $ 538,540 $ 600,000
========== ========== ========== ========== ===========
F-18
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
Rockford Industries, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Rockford
Industries, Inc. and its subsidiaries (the "Company") as of December 31, 1997
and 1996, and the related consolidated statements of operations, shareholders'
equity and cash flows for each of the three years in the period ended December
31, 1997. Our audits also included the financial statement schedule listed in
the Index at Item 14(a)(2). These consolidated financial statements and
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Rockford Industries, Inc. and its
subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.
Also, in our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Costa Mesa, California
February 26, 1998
F-19