- -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 OR [ ] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999 COMMISSION FILE NUMBER 0-23928 PDS FINANCIAL CORPORATION (Exact name of Registrant as specified in its charter) MINNESOTA 41-1605970 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 6171 MC LEOD DRIVE, LAS VEGAS, NEVADA 89120 (Address of principal executive offices) (702) 736-0700 (Issuer's telephone number) Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the last practicable date: CLASS OUTSTANDING AS OF JULY 30, 1999 ----- ------------------------------- Common Stock, $.01 par value 3,704,415 shares - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PDS FINANCIAL CORPORATION INDEX PART I - FINANCIAL INFORMATION Item 1. Financial Statements PAGE Condensed Consolidated Balance Sheets As of June 30, 1999 (Unaudited) and December 31, 1998 3 Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the Three Months Ended June 30, 1999 and 1998 (Unaudited) 4 Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the Six Months Ended June 30, 1999 and 1998 (Unaudited) 5 Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 1999 and 1998 (Unaudited) 6 Notes to Condensed Consolidated Financial Statements (Unaudited) 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 3. Quantitative and Qualitative Disclosures About Market Risk 13 PART II - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders 16 Item 6. Exhibits and Reports on Form 8-K 17 2 PDS FINANCIAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS June 30, December 31, 1999 1998 ---- ---- (Unaudited) ASSETS Cash and cash equivalents $ 3,077,000 $ 1,269,000 Restricted cash 4,227,000 3,166,000 Accounts receivable, net 2,907,000 1,335,000 Notes receivable, net 28,251,000 21,878,000 Net investment in leasing operations: Equipment under operating leases, net 77,497,000 27,751,000 Direct finance leases 12,593,000 9,668,000 Equipment held for sale or lease 7,016,000 10,002,000 Other assets, net 5,335,000 4,560,000 ------------ ----------- Total assets $140,903,000 $79,629,000 ============ =========== LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable and accrued expenses $ 3,395,000 $ 2,135,000 Deferred funds for pending transactions 38,723,000 13,427,000 Discounted lease rentals 485,000 806,000 Notes payable 65,943,000 36,699,000 Subordinated debentures, net 13,244,000 13,165,000 Other liabilities 8,437,000 2,863,000 ------------ ----------- Total liabilities 130,227,000 69,095,000 Stockholders' equity: Common stock, $.01 par value, 20,000,000 shares authorized, 3,704,415 and 3,648,211 shares issued and outstanding June 30, 1999 and December 31, 1998, respectively 37,000 36,000 Additional paid-in capital 11,421,000 11,268,000 Accumulated other comprehensive income -- (25,000) Retained earnings (accumulated deficit) (782,000) (745,000) ------------ ----------- Total stockholders' equity 10,676,000 10,534,000 ------------ ----------- Total liabilities and stockholders' equity $140,903,000 $79,629,000 ============ =========== See accompanying notes to condensed consolidated financial statements. 3 PDS FINANCIAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED) Three Months Ended June 30, 1999 1998 ---- ---- Revenues: Equipment sales $ 3,408,000 $10,226,000 Revenue from sales type leases 2,416,000 1,267,000 Rental revenue on operating leases 3,409,000 1,644,000 Fee income 276,000 343,000 Finance income 1,003,000 797,000 ----------- ----------- Total revenues 10,512,000 14,277,000 Costs and expenses: Equipment sales 3,265,000 8,966,000 Sales-type leases 2,126,000 1,027,000 Depreciation on operating leases 2,412,000 1,290,000 Selling, general and administrative 969,000 1,258,000 Interest 2,015,000 1,267,000 ----------- ----------- Total costs and expenses 10,787,000 13,808,000 Income (loss) before income taxes (275,000) 469,000 Provision (benefit) for income taxes (105,000) 178,000 ----------- ----------- Net income (loss) $ (170,000) $ 291,000 =========== =========== Other comprehensive income, net of tax -- 6,000 ----------- ----------- Comprehensive income (loss) $(170,000) $297,000 =========== =========== Earnings (loss) per share: Basic $ (0.05) $ 0.08 Diluted $ (0.05) $ 0.08 Weighted average shares outstanding: Basic 3,675,000 3,605,000 Diluted 3,675,000 3,863,000 See accompanying notes to condensed consolidated financial statements. 4 PDS FINANCIAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED) Six Months Ended June 30, 1999 1998 ---- ---- Revenues: Equipment sales $ 4,695,000 $16,351,000 Revenue from sales type leases 3,431,000 1,267,000 Rental revenue on operating leases 5,953,000 3,625,000 Fee income 1,349,000 1,368,000 Finance income 1,939,000 1,117,000 ----------- ----------- Total revenues 17,367,000 23,728,000 Costs and expenses: Equipment sales 4,511,000 14,215,000 Sales-type leases 2,850,000 1,027,000 Depreciation on operating leases 4,212,000 2,849,000 Selling, general and administrative 2,060,000 2,350,000 Interest 3,793,000 2,094,000 ----------- ----------- Total costs and expenses 17,426,000 22,535,000 Income (loss) before income taxes (59,000) 1,193,000 Provision (benefit) for income taxes (22,000) 453,000 ----------- ----------- Net income (loss) $ (37,000) $ 740,000 =========== =========== Other comprehensive income (loss), net of tax -- (12,000) ----------- ----------- Comprehensive income (loss) $(37,000) $728,000 =========== =========== Earnings (loss) per share: Basic $ (0.01) $ 0.21 Diluted $ (0.01) $ 0.19 Weighted average shares outstanding: Basic 3,662,000 3,577,000 Diluted 3,662,000 3,820,000 See accompanying notes to condensed consolidated financial statements. 5 PDS FINANCIAL CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Six Months Ended June 30, 1999 1998 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ (37,000) $ 740,000 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 4,212,000 2,848,000 Gain on sale of financial assets (257,000) (2,205,000) Purchases and originations of notes receivable and direct finance leases (12,602,000) (12,114,000) Proceeds from: Sale of notes receivable and direct finance leases 1,558,000 4,743,000 Collections of principal on notes receivable and direct finance leases 4,123,000 1,806,000 Changes in operating assets and liabilities: Accounts receivable (1,573,000) (3,547,000) Increase in Customer deposit liabilities 5,884,000 233,000 Other, net 887,000 3,951,000 Equipment held for sale or lease 1,707,000 (9,372,000) ------------ ------------ Net cash provided by (used in) operating activities 3,902,000 (12,917,000) ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Purchases of equipment for leasing (29,663,000) (3,173,000) Proceeds from sale of equipment under operating leases -- 3,697,000 Other, net (272,000) (65,000) ------------ ------------ Net cash provided by (used in) investing activities (29,935,000) 459,000 ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Payments made from restricted cash 3,165,000 -- Proceeds from notes payable 36,953,000 11,700,000 Proceeds from issuance of discounted lease rentals -- 692,000 Principal payments on notes payable (12,099,000) (10,537,000) Payments on discounted lease rentals (321,000) (2,359,000) Proceeds from issuance of subordinated debt and warrants -- 13,800,000 Payment of debt issue costs -- (1,550,000) Principal payments on subordinated debentures -- (29,000) Proceeds from exercise of stock options and warrants 143,000 263,000 ------------ ------------ Net cash provided by financing activities 27,841,000 11,980,000 ------------ ------------ Net increase (decrease) in cash and cash equivalents 1,808,000 (478,000) Cash and cash equivalents at beginning of period 1,269,000 1,865,000 ------------ ------------ Cash and cash equivalents at end of period $ 3,077,000 $ 1,387,000 ============ ============ See accompanying notes to condensed consolidated financial statements. 6 PDS FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The condensed consolidated financial statements as of June 30, 1999 and for the three and six month periods ended June 30, 1999 and 1998 included in this Form 10-Q have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures, normally included in financial statements prepared in accordance with generally accepted accounting principles, have been condensed or omitted pursuant to such rules and regulations. The consolidated balance sheet at December 31, 1998 has been derived from the audited financial statements as of that date and condensed. These condensed consolidated financial statements should be read in conjunction with the financial statements and related notes thereto included in the Company's Annual Report on Form 10-KSB for the year ended December 31, 1998. The condensed consolidated financial statements presented herein are unaudited, but in the opinion of management, reflect all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of financial position, results of operations and cash flows for the periods presented. The results of operations for any interim period are not necessarily indicative of results for the full year. 2. BORROWINGS The Company borrows funds in order to finance the origination or purchase of certain leases and notes receivable, and for the purchase of equipment held for sale or lease. Such borrowings are generally collateralized by the cash flow stream of the lease or note receivable funded, and the related equipment. Certain of the borrowings have recourse to the Company. Notes payable consists of the following: June 30, December 31, 1999 1998 ----------- ---------- Notes payable to banks, due either on demand or in 1999 through 2003, fixed interest rates between 8.75% to 12.9% or variable rates based on the prime rate plus 10% (8% at June 30,1999) collateralized by certain equipment under operating leases, equipment held for sale or lease and accounts receivable $10,317,000 $3,701,000 Notes payable to financial institutions, due in 1999 through 2002, interest at 7.1% to 12.0%, collateralized by certain notes receivable, equipment under operating leases and direct finance leases 21,726,000 16,919,000 Notes payable to manufacturers/distributors due in 1999 through 2001, interest at 8.8% to 14.0% collateralized by certain notes receivable, equipment under operating leases and direct finance leases 8,754,000 11,486,000 Other 32,000 36,000 ----------- ---------- Total recourse 40,829,000 32,142,000 ----------- ---------- 7 PDS FINANCIAL CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Non-recourse: Notes payable to banks and financial institutions, due in 1999 through 2003, interest at 8.7% to 12.5%, collateralized by certain notes receivable and equipment under operating and direct finance leases 25,200,000 3,059,000 Notes payable to manufacturers/distributors due in 1999 through 2001, interest at 8.0% to 10.0%, collateralized by certain equipment under operating leases and direct finance leases 1,646,000 2,872,000 Other -- -- ----------- ----------- Total non-recourse 26,846,000 5,931,000 ----------- ----------- Less unamortized discounts (1,732,000) (1,374,000) ----------- ----------- $65,943,000 $36,699,000 =========== =========== The Company has available revolving credit and working capital facilities aggregating approximately $70 million at June 30, 1999. Advances under these agreements with banks and financial institutions were approximately $22.8 million at June 30, 1999, which are included in the recourse debt balances in the above table. 3. EARNINGS PER SHARE The Company calculated basic and diluted earnings (loss) per share as follows: Three Months Ended Six Months Ended June 30, June 30, 1999 1998 1999 1998 ---- ---- ---- ---- Net income (loss), basic $ (170,000) $ 291,000 $ (37,000) $ 740,000 Interest expense on convertible subordinated debentures, net of tax -- 1,000 -- 1,000 ---------- ---------- ---------- ---------- Net income (loss), diluted $ (170,000) $292,000 $(37,000) $741,000 ========== ========== ========== ========== Weighted average shares outstanding: Basic (weighted average shares outstanding) 3,675,000 3,605,000 3,662,000 3,577,000 Effect of dilutive options -- 210,000 -- 195,000 Effect of dilutive warrants -- 41,000 -- 36,000 Effect of convertible subordinated debentures -- 7,000 -- 12,000 ---------- ---------- ---------- ---------- Diluted 3,675,000 3,863,000 3,662,000 3,820,000 ========== ========== ========== ========== Per share amounts: Basic $(0.05) $0.08 $(0.01) $0.21 Diluted $(0.05) $0.08 $(0.01) $0.19 Options to purchase 366,000 shares of common stock, which were in the money were not included in the computation of diluted earnings per share for the quarter ended June 30, 1999, because they would have been anti-dilutive. The weighted average exercise price for these options was $3.30, as of June 30, 1999. These options expire at various dates through 2008. 8 4. NOTES RECEIVABLE During the three months ended June 30, 1999, two customers with outstanding notes receivable balances totaling approximately $12 million, failed to make their regularly scheduled monthly payments to the Company causing an event of default under the terms of the respective notes. The notes receivable are generally collateralized by gaming equipment. The Company is currently in negotiation with the obligors and guarantors of these notes to cure these defaults and restructure the terms of these notes. Although there can be no asssurance, the Company currently believes that the revised terms will not result in a charge under the Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan." Certain of these notes receivable are used to collateralize borrowings from certain banks, financial institutions and distributors, and such borrowings total $7.7 million. An event of default under the notes receivable from a customer allows these lenders to require either substitution of collateral or repayment of the obligation. The Company is continuing to discuss its options with these lenders. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The Company is engaged in the business of financing and leasing gaming equipment and supplying reconditioned gaming devices to casino operators. The gaming equipment financed by the Company consists mainly of slot machines, video gaming machines and other gaming devices. In addition, the Company finances furniture, fixtures and other gaming related equipment, including gaming tables and chairs, restaurant and hotel furniture, vehicles, security and surveillance equipment, computers and other office equipment. In 1996, the Company introduced SlotLease, a specialized operating lease program for slot machines and other electronic gaming devices. The Company believes it is currently the only independent leasing company licensed in the states of Nevada , New Jersey, Colorado, Iowa, Indiana and Minnesota to provide this financing alternative. In 1997, the Company established PDS Slot Source, a reconditioned gaming device sales and distribution division, to complement its leasing and financing activities and to generate equipment sales to casino operators. The Company's strategy is to increase its portfolio of assets under lease, resulting in increased recurring revenues and cash flows. In addition to its leasing activities, the Company also originates note transactions, which it generally sells to institutional investors. In some of its transactions, the Company holds the leases or notes for a period of time after origination, or retains a partial ownership interest in the leases or notes. The Company believes its ability to recondition and distribute used gaming devices enhances the gaming devices' values at the end of an operating lease and facilitates additional financing transactions. The Company's quarterly operating results, including net income, have historically fluctuated due to the timing of completion of large financing transactions, as well as the timing of recognition of the resulting fee income upon subsequent sale. These transactions can be in the negotiation and documentation stage for several months, and recognition of the resulting fee income by the Company may fluctuate greatly from quarter to quarter. Thus, the results of any quarter are not necessarily indicative of the results which may be expected for any other period. ACCOUNTING FOR COMPANY ACTIVITIES The accounting treatment for the Company's financing activities varies depending upon the underlying structure of the transaction. The majority of the Company's equipment financing transactions are structured as either notes receivable or direct finance leases in which substantially all benefits and risks of ownership are borne by the borrower or lessee. Direct finance leases are afforded accounting treatment similar to that for notes receivable. The Company structures some of its gaming equipment financings as operating leases, under which the Company retains substantially all of the benefits and risks of ownership. However, certain of its gaming equipment transactions are structured as direct finance and sales-type leases. Consistent with the Company's strategy to increase its leasing activities, the 1998 and 1999 originations involve a greater mix of operating leases, which generate revenues throughout the lease term, as opposed to notes or direct finance leases, which generate revenues primarily upon sale. The Company's revenue generating activities can be categorized as follows: (i) equipment sales; (ii) revenue from sales-type leases; (iii) rental revenue on operating leases; (iv) fee income, resulting principally from the sale of lease or note receivable transactions; and (v) finance income, resulting from financing transactions in which the direct finance lease or note receivable is retained by the Company. The types of income are further described below: EQUIPMENT SALES. In mid-1997, the Company established a reconditioned gaming device sales and distribution division, PDS Slot Source. Used gaming devices are obtained by the Company either from its customers at the end of an applicable lease term, or in the marketplace. The cost of this equipment is recorded in the consolidated balance sheet as equipment held for sale or lease. At the time of sale, the Company records revenue equal to the selling price of the related asset. Upon selling reconditioned gaming devices, the Company removes the underlying asset from its consolidated balance sheet and records the cost, including reconditioning cost, as cost of revenues. Equipment sales also includes the sale of equipment which may occur during the term of an operating lease. 10 REVENUE FROM SALES-TYPE LEASES. Sales-type leases, like direct finance leases, transfer substantially all the benefits and risks of ownership of the leased asset to the lessee. Unlike direct finance leases, sales-type leases also include either a dealer profit resulting from the Company leasing equipment which was purchased at a discount that is not available to the lessee, or a manufacturing profit resulting from the reconditioning process performed on used gaming devices. This dealer profit or manufacturing profit is recognized at the inception of the lease in the consolidated income statement as the difference between revenue from sales-type leases and sales-type lease cost. Revenue from sales-type leases is the present value of the future minimum lease payments. Sales-type lease cost is the Company's equipment cost, net of any discounts. Upon selling a sales-type lease to a third party, the Company removes the underlying asset from its consolidated balance sheet. RENTAL REVENUE ON OPERATING LEASES. Operating leases are defined as those leases in which substantially all the benefits and risks of ownership of the leased asset are retained by the Company. Revenue from operating leases consists of monthly rentals and is reflected in the consolidated income statement evenly over the life of the lease as rental revenue on operating leases. The cost of the related equipment is depreciated on a straight-line basis over the lease term to the Company's estimate of residual value. This depreciation is reflected on the consolidated income statement as depreciation on operating leases. For operating leases, the cost of equipment, less accumulated depreciation, is recorded in the consolidated balance sheet as equipment under operating leases, net. FEE INCOME. The Company funds much of the direct finance lease and note transactions it originates through a sale of such transactions (i.e., the sale of all of the Company's right, title and interest in the future payment stream from the related leases or notes). A sale may occur simultaneously with the origination or several months thereafter. At the time of sale, the Company records fee income equal to the difference between the selling price and the carrying value of the related financial asset. The calculation of fee income reflects many factors, including the credit quality of the borrowers or lessees, the type of underlying equipment, credit enhancements, if any and ultimately, the terms under which the transaction was both originated and sold. Fee income also includes commissions and advisory fees for arranging financing between unrelated parties. Upon the sale of a lease or note, the Company removes the underlying asset from its consolidated balance sheet. FINANCE INCOME. For the period during which the Company holds a note receivable or direct finance lease, finance income is recognized over the term of the underlying lease or note in a manner which produces a constant percentage rate of return on the asset carrying cost. For those direct finance leases held by the Company, the present value of the future minimum lease payments are recorded in the consolidated balance sheet as direct finance leases. RESULTS OF OPERATIONS Three Months Ended June 30, 1999 and 1998 Revenues for the second quarter of 1999 totaled $10.5 million, a 27% decrease from $14.3 million in the year earlier quarter. The decrease in revenues is primarily attributable to lower sales of equipment formerly out on operating leases and lower fee income offset by higher rental revenue and finance income. Gross originations of financing transactions for the three months ended June 30, 1999 totaled $55.3 million compared to $20.6 million for the year earlier quarter. Revenues from equipment sales and sales-type leases totaled $5.8 million in the second quarter of 1999, a 50% decrease from $11.5 million in the year earlier quarter. Such revenues include sales of both equipment which had been under operating leases, and used gaming devices which the Company reconditioned in its Slot Source division. Sales of equipment which has been under operating lease totaled $3.7 million in the year earlier quarter, and the cost of those sales totaled $3.5 million. No such sale of equipment under operating lease occurred in the current quarter. Revenue from sales and sale-type leases of Slot Source reconditioned gaming devices totaled $5.8 million in the current quarter, compared to $7.8 million in the year earlier quarter. The cost of such sales totaled $5.4 million in the current quarter, compared to $6.5 million in the year earlier quarter. The Company's average operating lease portfolio was $44.3 million during the second quarter of 1999, a 200% increase as compared to $14.0 million for the year earlier quarter. The increase in the average portfolio results from an increase in the volume of originations during 1998 and the first six months of 1999. Rental revenue on operating leases increased to $3.4 million in the current quarter, compared to $1.6 million in the year earlier quarter. Related depreciation increased to $2.4 million in the current quarter, compared to $1.3 million in the year earlier quarter. These leases are expected to generate revenues throughout their lease terms, which range from 24 to 48 months and are typically 36 months. 11 Fee income totaled $276,000 in the current quarter, compared to $343,000 in the year earlier quarter. The current quarter fee income was composed of fees for financial advisory services, compared to the year earlier quarter which primarily consisted of gains from the sale of financial transactions. Finance income totaled $1,003,000 in the current quarter, compared to $797,000 in the year earlier quarter. This increase primarily reflects the larger portfolio of notes receivable and direct finance leases held by the Company during the current quarter as compared to the year earlier quarter. Selling, general and administrative expenses totaled $969,000 in the current quarter, compared to $1.3 million in the prior year quarter. This decrease reflects the increase in costs capitalized in the Company's lease orginiation department, which resulted from the significant increase in originations in the current quarter as compared to the year earlier quarter. Interest expense totaled $2.0 million in the current quarter, compared to $1.3 million in the year earlier quarter. This increase was due to higher levels of outstanding borrowings which were utilized to fund the increased investment in the leasing operations and to fund the originations of notes receivable. The effective income tax rate was 38% in the three months ended June 30, 1999 and 1998. In both periods, the effective rate was higher than the federal statutory tax rate of 34%, due primarily to state income taxes. RESULTS OF OPERATIONS Six Months Ended June 30, 1999 and 1998 Revenues for the six months ended June 30, 1999 totaled $17.4 million, a 27% decrease from $23.7 million in the year earlier period. The decrease in revenues is primarily attributable to lower sales of equipment formerly out on operating leases offset by higher rental revenues and finance income. Gross originations of financing transactions for the six months ended June 30, 1999 totaled $63.9 million compared to $32.2 million for the year earlier period. Revenues from equipment sales and sales-type leases totaled $8.1 million in the six months ended June 30, 1999, a 54% decrease from $17.6 million in the year earlier period. Sales of equipment which has been under operating lease totaled $6.9 million in the year earlier period, and the cost of those sales totaled $6.1 million. No such sale of equipment under operating lease occurred in the current period. Revenue from sales and sale-type leases of Slot Source reconditioned gaming devices totaled $8.1 million during the six months ended June 30, 1999, compared to $10.7 million in the year earlier period. The cost of such sales totaled $7.4 million in the current period, compared to $9.1 million in the year earlier quarter. The Company's average operating lease portfolio was $36.3 million during the six months ended June 30, 1999, a 130% increase as compared to $15.8 million for the year earlier period. The increase in the average portfolio results from an increase in the volume of originations during 1999. Rental revenue on operating leases increased to $6.0 million for the six months ended June 30, 1999, compared to $3.6 million in the year earlier period. Related depreciation increased to $4.2 million for the six months ended June 30, 1999, compared to $2.8 million in the year earlier period. These leases are expected to generate revenues throughout their lease terms, which range from 24 to 48 months and are typically 36 months. Fee income totaled $1.3 million for the six months ended June 30, 1999, compared to $1.4 million in the year earlier period. The current period fee income is composed of both fees for financial advisory services and gains from the sale of financial transactions, compared to the year earlier period which consisted primarily from gains from the sale of financial transactions. Finance income totaled $1.9 million for the six months ended June 30, 1999, compared to $1.1 million in the year earlier period. This increase primarily reflects the larger portfolio of notes receivable and direct finance leases held by the Company during the period as compared to the year earlier period. 12 Selling, general and administrative expenses totaled $2.1 million for the six months ended June 30, 1999 compared to $2.3 million in the year earlier period. This decrease reflects the increase in costs capitalized in the Company's lease orginiation department, which resulted from the significant increase in originations in the six months ended June 30, 1999 as compared to the year earlier period. Interest expense totaled $3.8 million for the six months ended June 30, 1999, compared to $2.1 million in the year earlier period. This increase was due to higher levels of outstanding borrowings which were utilized to fund the increased investment in the leasing operations and to fund the originations of notes receivable. The effective income tax rate was 38% in the three months ended March 31, 1999 and 1998. In both periods, the effective rate was higher than the federal statutory tax rate of 34%, due primarily to state income taxes. LIQUIDITY AND CAPITAL RESOURCES The Company's strategy to increase its financing activities and its reconditioned gaming device sales, involves a higher level of investment in notes receivable, equipment under operating leases and equipment held for sale or lease, financed through discounted lease rentals and notes payable. The funds necessary to support the Company's activities have been provided by cash flow generated primarily from the operating activities described above, and various forms of recourse and non-recourse borrowings. The Company expects its lease portfolio to generate recurring cash flow throughout the lease term. The Company's cash and cash equivalents totaled $3.1 million at June 30, 1999, an increase of $1.8 million from December 31, 1998. During the first six months of 1999, cash provided in operating activities totaled $3.9 million, an increase of $16.8 million from the first six months of 1998. The higher level of cash provided in 1999 primarily reflects an increase in customer deposits and lesser amounts of cash used to acquire inventory. The cash used in investing activities in 1999 primarily reflects $29.7 million of investment in equipment for leasing. The $27.8 million of net cash provided by financing activities in 1999 was primarily the result of borrowings and cash transferred from restricted to non-restricted accounts, which was used principally to fund the purchases of equipment for leasing. At June 30, 1999 total borrowings under notes and lines of credit were $65.9 million, compared to $36.7 million at December 31, 1998. The majority of the proceeds from the borrowings were invested in the Company's leasing operations and were primarily non-recourse to the Company. At June 30, 1999, the Company's revolving credit and working capital facilities aggregated approximately $70 million. Advances under these agreements aggregated approximately $22.8 million at June 30, 1999. The Company's current financial resources, including the estimated cash flows from operations and the revolving credit facilities are expected to be sufficient to fund the Company's anticipated working capital needs. In addition to the borrowing activities summarized above, the Company has developed a network of financial institutions to which it sells transactions on a regular basis. The Company is, from time to time, dependent upon the need to liquidate or externally finance transactions originated and held in its investment portfolio. In the future the Company may seek to raise capital to fund its growth strategy through debt or financings, however we cannot predict when such an event will occur, nor if such capital would be available at favorable terms, if at all. Inflation has not been a significant factor in the Company's operations. 13 YEAR 2000 ISSUE The Company is continuing to evaluate the potential impact of the situation referred to as the "Year 2000 Issue." The Year 2000 Issue concerns the inability of computer software programs to properly recognize and process date sensitive information beyond December 31, 1999. The Company has evaluated its major automated systems to determine if they are Year 2000 compliant and has contacted the suppliers of certain of those systems to inquire about Year 2000 compliance. Although the Company believed its existing accounting system was Year 2000 compliant, the company purchased and began installing a new management information system in January 1999. The new system has been certified as Year 2000 compliant by the software provider. The total cost of the new system is approximately $100,000 and is expected to be fully operational during the third quarter of 1999. The Company also has electronic interfaces with certain of its suppliers. The Company has made inquiries and received assurances from such suppliers with respect to Year 2000 issues. The Company has also made inquiries of and is contacting certain suppliers with respect to Year 2000 issues. Even assuming that all material third parties confirm that they are or expect to be Year 2000 compliant by December 31, 1999, it is not possible to state with certainty that such parties will be so compliant. It is impossible to fully assess the potential consequences in the event service interruptions from suppliers occur or in the event that there are disruptions in such infrastructure areas as utilities, communications, transportation, banking and government. To date, the Company has not incurred material costs associated with the Year 2000 Issue. The Company believes that any future costs associated with, and the potential impact of, the Year 2000 Issue will not be material. Based upon its assessments to date, the Company believes it will not experience any material disruption in its operations as a result of Year 2000 problems in internal financial systems, reconditioning activities and to the process control systems, or in its interface with major customers and suppliers. However, if major suppliers, including those providing inventory, banking, electricity and communications services, experience difficulties resulting in disruption of critical supplies or services to the Company, a shutdown of the Company's operations could occur for the duration of the disruption. The Company has begun to develop a contingency plan to provide for continuity of normal business operations in the event problem scenarios, such as those described above, arise, however that plan is not yet complete. Assuming no major disruption in service from critical third party providers, the Company believes that it will be able to manage the Year 2000 transition without any material effect on the Company's results of operations or financial position. There can be no assurance, however, that unexpected difficulties will not arise and, if so, that the Company will be able to timely develop and implement a contingency plan. ITEM 3. QUANTITATIVE AND QUALITATIVE FACTORS ABOUT MARKET RISK Interest Rate Risk The Company generally provides financing (both leases and traditional loans) to customers at fixed rates of interest (either with stated interest rates or implicit rates). The Company either sells such transactions to investors, or holds such transactions in its portfolio. For larger transactions retained in the portfolio, the Company obtains fixed rate commitments from financing sources such as banks and financial institutions prior to providing such financing to customers, which substantially reduces the interest rate risk during the origination process. For smaller transactions, the Company may originate the transaction using internally available funds, and shortly after origination use the transaction as collateral for borrowing on one of several lines of credit. Such lines of credit have floating rates of interest until a specific amount is borrowed under the facility, at which time the amount borrowed will be assigned a fixed rate of interest payable over its remaining term. Therefore changes in interest rates have not historically had a direct impact on the Company's earnings. The Company does not currently manage this interest rate risk with derivative financial instruments and does not believe this risk is material. The Company's existing portfolio of fixed rate receivables and borrowings will fluctuate in value based on changes in market rates of interest. However the Company does not believe that the changes in the fair values are material. Currency Risk All of our transactions are conducted and accounts are denominated in United States Dollars and as such we do not currently have exposure to foreign currency risk. 14 FORWARD-LOOKING STATEMENTS Certain statements contained herein which are not historical facts are forward-looking statements with respect to events, the occurrence of which involves risks and uncertainties, including without limitation strict regulation by gaming authorities, competition the Company faces or may face in the future, uncertainty of market acceptance of the SlotLease program and PDS Slot Source, the ability of the Company to continue to obtain adequate financing, the ability of the Company to recover its investment in gaming equipment leased under operating leases as well as its investment in used gaming machines purchased for refurbishment and resale to customers, the risk of default with respect to the Company's financing transactions, the Company's dependence on key employees, potential fluctuations in the Company's quarterly results, general economic and business conditions, and other risk factors detailed from time to time in the Company's reports filed with the Securities and Exchange Commission. 15 PART II- OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The company held its annual meeting of shareholders on May 14, 1999 for the purposes of (1) electing members of the Board of Directors of the Company, (2) approval of the Company's Employee Stock Purchase Plan and (3) ratifying the appointment of PricewaterhouseCoopers LLP as the independent accountants of the Company for the fiscal year ending December 31, 1999. There were 3,648,211 shares of Common Stock entitled to vote at the meeting and a total of 3,013,613 shares (82.6%) were represented at the meeting . The shareholder voting was as follows: 1. Election of Directors: Withhold FOR AGAINST AUTHORITY Johan P. Finley 2,959,413 5700 48,500 Peter D. Cleary 2,959,413 5700 48,500 Joel M. Koonce 2,959,413 5700 48,500 James L. Morrell 2,959,413 5700 48,500 Lona M.B. Finley 2,959,413 5700 48,500 2. To approve the Company's Stock Purchase Plan: FOR AGAINST ABSTAIN BROKER NON-VOTE --------- -------- -------- --------------- 1,636,206 59,025 13,300 636,796 3. To ratify the appointment of PricewaterhouseCoopers LLP as the independent accountants of the Company for the fiscal year ending December 31, 1999 FOR AGAINST ABSTAIN --------- ------- ------- 3,009,233 2,380 2,000 16 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a) The following exhibits are included with this quarterly report on Form 10-Q as required by Item 601 of Regulation S-X. EXHIBIT NUMBER DESCRIPTION 27 Financial Data Schedule b) Reports on Form 8-K. There were no reports on Form 8-K filed during the quarter ended June 30, 1999 or during the period from June 30, 1999 to the date of this Quarterly Report on Form 10-Q. SIGNATURE In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PDS FINANCIAL CORPORATION Dated: August 13, 1999 BY: /s/ Steven M. Des Champs ----------------------------- Chief Financial Officer (a duly authorized officer) 17