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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
Commission file number 1-11011
THE FINOVA GROUP INC.
(Exact name of registrant as specified in its charter)
Delaware 86-0695381
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
4800 North Scottsdale Road
Scottsdale, AZ 85251-7623
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: 480-636-4800
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months, (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS
DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by the court.
Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
As of May 9, 2003, approximately 122,041,000 shares of Common Stock ($0.01 par
value) were outstanding.
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THE FINOVA GROUP INC.
TABLE OF CONTENTS
PAGE NO.
--------
PART I FINANCIAL INFORMATION
Item 1. Financial Statements 1
Condensed Consolidated Balance Sheets 1
Condensed Statements of Consolidated Operations 2
Condensed Statements of Consolidated Cash Flows 3
Condensed Statements of Consolidated Stockholders' Equity 4
Notes to Interim Condensed Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 10
Special Note Regarding Forward-Looking Statements 18
Item 3. Quantitative and Qualitative Disclosure About Market Risk 19
Item 4. Controls and Procedures 19
PART II OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE FINOVA GROUP INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
MARCH 31, 2003 DECEMBER 31, 2002
(UNAUDITED) (AUDITED)
----------- -----------
ASSETS
Cash and cash equivalents $ 494,982 $ 575,215
FINANCING ASSETS:
Loans and other financing contracts, net 2,413,942 2,655,724
Direct financing leases 244,413 263,826
Leveraged leases 183,294 182,410
----------- -----------
Total financing assets 2,841,649 3,101,960
Reserve for credit losses (456,019) (540,268)
----------- -----------
Net financing assets 2,385,630 2,561,692
----------- -----------
OTHER FINANCIAL ASSETS:
Operating leases 103,577 111,826
Assets held for sale 94,898 393,125
Assets held for the production of income 43,189 67,867
Investments 15,498 21,641
----------- -----------
Total other financial assets 257,162 594,459
----------- -----------
TOTAL FINANCIAL ASSETS 2,642,792 3,156,151
Other assets 23,797 27,642
----------- -----------
$ 3,161,571 $ 3,759,008
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Berkadia Loan $ 1,525,000 $ 2,175,000
Senior Notes - (principal amount due of $3.07 billion) 2,389,999 2,381,643
----------- -----------
Total debt 3,914,999 4,556,643
Accounts payable and accrued expenses 187,674 156,338
Deferred income taxes, net 16,762 16,776
----------- -----------
TOTAL LIABILITIES 4,119,435 4,729,757
----------- -----------
STOCKHOLDERS' EQUITY:
Common stock, $0.01 par value, 400,000,000 shares
authorized and 125,873,000 shares issued 1,259 1,259
Additional capital 53,233 53,233
Accumulated deficit (1,008,074) (1,020,828)
Accumulated other comprehensive loss (3,746) (3,877)
Common stock in treasury, 3,832,000 shares (536) (536)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY (957,864) (970,749)
----------- -----------
$ 3,161,571 $ 3,759,008
=========== ===========
SEE NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
1
THE FINOVA GROUP INC.
CONDENSED STATEMENTS OF CONSOLIDATED OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
------------------------------
2003 2002
------------- -------------
REVENUES:
Interest income $ 49,441 $ 80,837
Rental income 7,993 10,136
Operating lease income 12,103 12,202
Fees and other income 11,174 14,342
------------- -------------
TOTAL REVENUES 80,711 117,517
Interest expense (83,694) (112,290)
Operating lease and other depreciation (8,174) (10,065)
------------- -------------
INTEREST MARGIN (11,157) (4,838)
------------- -------------
OTHER REVENUES AND (EXPENSES):
Provision for credit losses 53,999 25,184
Net (loss) gain on financial assets (3,142) 968
Portfolio expenses (10,524) (8,025)
General and administrative expenses (16,422) (25,468)
------------- -------------
TOTAL OTHER REVENUES AND (EXPENSES) 23,911 (7,341)
------------- -------------
Income (loss) before income taxes 12,754 (12,179)
Income tax expense (2)
------------- -------------
NET INCOME (LOSS) $ 12,754 $ (12,181)
============= =============
Basic/diluted earnings (loss) per share $ 0.10 $ (0.10)
============= =============
Weighted average shares outstanding 122,041,000 122,041,000
============= =============
SEE NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
2
THE FINOVA GROUP INC.
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED MARCH 31,
----------------------------
2003 2002
----------- -----------
OPERATING ACTIVITIES:
Net income (loss) $ 12,754 $ (12,181)
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities:
Provision for credit losses (53,999) (25,184)
Net cash gain on disposal of financial assets (18,560) (26,369)
Net non-cash charge-offs of financial assets 21,702 25,401
Depreciation and amortization 8,956 10,944
Deferred income taxes, net (14) 3,634
Other amortization 4,069 (2,699)
Change in assets and liabilities:
Decrease (increase) in other assets 3,063 (299)
Increase in accounts payable and accrued expenses 31,502 17,816
----------- -----------
NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES 9,473 (8,937)
----------- -----------
INVESTING ACTIVITIES:
Proceeds from disposals of leases and other owned assets 29,355 12,455
Proceeds from sales of investments 3,669 130,310
Proceeds from sales of financial assets 180,926 716
Collections from financial assets 429,220 821,300
Fundings under existing customer commitments (108,221) (319,669)
Recoveries of loans previously written off 25,345 13,132
----------- -----------
NET CASH PROVIDED BY INVESTING ACTIVITIES 560,294 658,244
----------- -----------
FINANCING ACTIVITIES:
Repayments of Berkadia Loan (650,000) (1,000,000)
----------- -----------
NET CASH USED BY FINANCING ACTIVITIES (650,000) (1,000,000)
----------- -----------
DECREASE IN CASH AND CASH EQUIVALENTS (80,233) (350,693)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 575,215 1,027,241
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 494,982 $ 676,548
=========== ===========
SEE NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
3
THE FINOVA GROUP INC.
CONDENSED STATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
(UNAUDITED)
ACCUMULATED
OTHER COMMON TOTAL
COMMON ADDITIONAL ACCUMULATED COMPREHENSIVE STOCK IN STOCKHOLDERS'
STOCK CAPITAL DEFICIT INCOME (LOSS) TREASURY EQUITY
--------- --------- ----------- ------------- --------- -----------
BALANCE, JANUARY 1, 2002 $ 1,259 $ 16,928 $(1,142,300) $ 4,080 $ (536) $(1,120,569)
--------- --------- ----------- --------- --------- -----------
Comprehensive income:
Net income 121,472 121,472
Net change in unrealized holding gains (losses) (10,743) (10,743)
Net change in foreign currency translation 2,786 2,786
-----------
Comprehensive income 113,515
-----------
Benefits realized from pre-confirmation NOLs 36,029 36,029
Other 276 276
--------- --------- ----------- --------- --------- -----------
BALANCE, DECEMBER 31, 2002 1,259 53,233 (1,020,828) (3,877) (536) (970,749)
--------- --------- ----------- --------- --------- -----------
Comprehensive income:
Net income 12,754 12,754
Net change in unrealized holding gains (losses) 111 111
Net change in foreign currency translation 20 20
-----------
Comprehensive income 12,885
--------- --------- ----------- --------- --------- -----------
BALANCE, MARCH 31, 2003 $ 1,259 $ 53,233 $(1,008,074) $ (3,746) $ (536) $ (957,864)
========= ========= =========== ========= ========= ===========
SEE NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
4
THE FINOVA GROUP INC.
NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(DOLLARS IN THOUSANDS IN TABLES)
(UNAUDITED)
A. NATURE OF OPERATIONS AND BASIS OF PRESENTATION
The accompanying financial statements and notes thereto should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the year ended December
31, 2002. Capitalized terms not defined herein are used as defined in the Form
10-K.
The following discussion relates to The FINOVA Group Inc. and its subsidiaries
(collectively "FINOVA" or the "Company"), including its principal operating
subsidiary, FINOVA Capital Corporation and its subsidiaries ("FINOVA Capital").
FINOVA, a Delaware corporation incorporated in 1991, is a financial services
holding company. Through FINOVA Capital, the Company has provided a broad range
of financing and capital markets products, primarily to mid-size businesses.
FINOVA Capital has been in operation since 1954.
Since emergence from chapter 11 in August 2001, the Company's business
activities have been limited to maximizing the value of its portfolio through
the orderly collection of its assets. These activities include collection
efforts pursuant to underlying contractual terms and may include efforts to
retain certain customer relationships and restructure or terminate other
relationships. The Company has not and does not expect to engage in any new
lending activities, except to honor existing customer commitments and in certain
instances, to restructure financing relationships with existing customers to
maximize value. Operations have been restructured to more efficiently manage
these collection efforts. The Company has sold portions of asset portfolios and
will consider future sales if buyers can be found at acceptable prices; however,
there can be no assurance that the Company will be successful in efforts to sell
additional assets. Any funds generated from these activities in excess of cash
reserves permitted in the Company's debt agreements are used to reduce FINOVA's
obligations to its creditors.
GOING CONCERN
FINOVA has a substantial negative net worth and it is highly unlikely that the
Company will be able to repay its Senior Notes in their entirety at maturity in
November 2009. While FINOVA continues to pay its obligations as they become due,
the ability of the Company to continue as a going concern is dependent upon many
factors, particularly the ability of its borrowers to repay their obligations to
FINOVA and the Company's ability to realize the value of its portfolio. The
accompanying condensed consolidated financial statements do not include any
adjustments relating to the recoverability and classification of assets or the
amounts and classification of liabilities that might be necessary should the
Company be unable to continue as a going concern. The Company's independent
public accountants qualified their report on the Company's 2002, 2001 and 2000
financial statements due to concerns regarding the Company's ability to continue
as a going concern.
B. SIGNIFICANT ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting principles
generally accepted in the Unites States requires FINOVA to use estimates and
assumptions that affect reported amounts of assets and liabilities, revenues and
expenses and disclosure of contingent assets and liabilities. Those estimates
are subject to known and unknown risks, uncertainties and other factors that
could materially impact the amounts reported and disclosed in the financial
statements. Significant estimates include anticipated amounts and timing of
future cash flows used in the calculation of Fresh-Start Reporting adjustments,
the reserve for credit losses and measurement of impairment. Other estimates
include selection of appropriate risk adjusted discount rates used in net
present value calculations, determination of fair values of certain financial
assets for which there is not an active market, residual assumptions for leasing
transactions and determination of appropriate valuation allowances against
deferred tax assets. Actual results could differ from those estimated.
For a listing of the Company's significant accounting policies, see Note B
"Significant Accounting Policies" in the Company's Annual Report on Form 10-K
for the year ended December 31, 2002.
5
CONSOLIDATION POLICY FOR INTERIM REPORTING
The interim condensed consolidated financial statements present the financial
position, results of operations and cash flows of FINOVA and its subsidiaries,
including FINOVA Capital and its subsidiaries. These financial statements have
been prepared in accordance with accounting principles generally accepted in the
United States. All intercompany balances have been eliminated in consolidation.
The interim condensed consolidated financial information is unaudited. In the
opinion of management, all adjustments consisting of normal recurring items
necessary to present fairly the financial position as of March 31, 2003 and the
results of operations and cash flows presented herein have been included in the
condensed consolidated financial statements. Interim results are not necessarily
indicative of results of operations for the full year.
C. TOTAL FINANCIAL ASSETS
Total financial assets represents the Company's portfolio of investment
activities, primarily consisting of secured financing to commercial and real
estate enterprises principally under financing contracts (such as loans and
other financing contracts, direct financing leases and leveraged leases). In
addition to its financing contracts, the Company has other financial assets,
including assets held for sale, owned assets (such as operating leases and
assets held for the production of income) and investments (debt and equity
securities and partnership interests). As of March 31, 2003 and December 31,
2002, the carrying amount of total financial assets (before reserve for credit
losses) was $3.1 billion and $3.7 billion, respectively.
To date, the asset liquidation process has resulted in significant reductions in
size of many of the Company's niche portfolios. As a result, these portfolios
(commercial equipment, communications, corporate finance, franchise, healthcare,
mezzanine and rediscount) have been combined in the table below. The resort,
transportation and specialty real estate portfolios will continue to be reported
separately.
The following table details the composition and carrying amounts of the
Company's total financial assets at March 31, 2003:
REVENUE REVENUE NONACCRUING NONACCRUING OWNED TOTAL
ACCRUING ACCRUING IMPAIRED LEASES ASSETS & FINANCIAL
ASSETS IMPAIRED LOANS & OTHER INVESTMENTS ASSETS %
----------- ----------- ----------- ----------- ----------- ----------- ------
Resort $ 902,421 $ 34,697 $ 85,736 $ 22,988 $ 3,500 $ 1,049,342 33.9
Transportation 294,593 133,480 52,539 143,237 623,849 20.1
Specialty Real Estate 401,199 88,290 2,887 492,376 15.9
All Other Portfolios (1) 148,958 154,697 572,791 41,271 15,527 933,244 30.1
----------- ----------- ----------- ----------- ----------- ----------- ------
TOTAL FINANCIAL ASSETS $ 1,452,578 $ 483,987 $ 880,297 $ 119,685 $ 162,264 $ 3,098,811 100.0
Reserve for credit losses (456,019)
----------- ----------- ----------- ----------- ----------- -----------
TOTAL (2) $ 2,642,792
===========
- ----------
NOTES:
(1) During the first quarter of 2003, the Company completed the sale of
rediscount assets with a carrying amount of $188.8 million for $175.4
million of net cash proceeds and a $17.8 million participation in a
performing loan, resulting in a $4.4 million gain.
(2) Excludes $117.6 million of assets sold that the Company manages.
Since FINOVA's total financial assets are concentrated in certain specialized
industries (transportation and resort), the Company is subject to both general
economic risk and the additional risk of economic downturns within individual
sectors of the economy. Additionally, the Company has completed multiple
financial transactions with individual borrowers and their affiliates, resulting
in a greater total exposure to those borrowers beyond the typical transaction
size and increased concentration risk of economic events affecting the
industries of those borrowers and their affiliates.
6
At March 31, 2003, the Company's transportation portfolio consisted of the
following aircraft:
NUMBER OF APPROXIMATE
Aircraft Type AIRCRAFT PASSENGER CARGO AVERAGE AGE (YEARS)
- ------------- -------- --------- ----- -------------------
Airbus 300 8 4 4 13
Boeing 727 34 9 25 25
Boeing 737 33 33 19
Boeing 747 15 8 7 21
Boeing 757 9 9 10
Boeing 767 1 1 16
McDonnell Douglas DC 8 and DC 9 33 24 9 30
McDonnell Douglas DC 10 19 8 11 24
McDonnell Douglas MD series 30 30 17
Regional jets, corporate aircraft and turbo props 46 43 3 12
---- ---- ---- ----
Total 228 169 59 20
==== ==== ==== ====
At March 31, 2003, 78 aircraft with a carrying value of $349.8 million were
operated by U.S. domiciled carriers and 76 aircraft with a carrying value of
$211.1 million were operated by foreign carriers. Additionally, 74 aircraft with
a carrying value of $38.8 million were off-lease, classified as held for the
production of income and were parked at various storage facilities in the United
States and Europe. Some of these off-lease aircraft are periodically placed in
rental agreements with payments based on aircraft usage, commonly known as
power-by-the-hour agreements. Often under these agreements there are no minimum
rents due and future cash flows are difficult to project. FINOVA's railroad
portfolio (all domestic) and other transportation equipment had a carrying value
of $24.1 million at March 31, 2003.
In addition to the concentrated exposures within the transportation portfolio,
the Company has certain geographic concentrations within its resort portfolio.
At March 31, 2003, the carrying amount of the resort portfolio by state was as
follows:
CARRYING
AMOUNT %
---------- ------
Florida $ 271,736 25.9%
California 154,080 14.7%
Hawaii 130,596 12.4%
Arizona 114,756 10.9%
Nevada 106,516 10.2%
Other (less than 10%) 271,658 25.9%
---------- ------
Total $1,049,342 100.0%
========== ======
An analysis of nonaccruing assets included in total financial assets is as
follows:
MARCH 31, DECEMBER 31,
2003 2002
---------- ----------
Contracts $ 961,009 $1,345,191
Repossessed assets 38,973 48,041
---------- ----------
Total nonaccruing assets $ 999,982 $1,393,232
---------- ----------
Nonaccruing assets as a percentage of total
financial assets (before reserves) 32.3% 37.7%
========== ==========
Accounts classified as nonaccruing were $1.0 billion or 32.3% of total financial
assets (before reserves) at March 31, 2003 as compared to $1.4 billion or 37.7%
at December 31, 2002. The decline in nonaccruing assets was primarily attributed
to asset sales (including the first quarter rediscount sale), collections,
write-offs and the return of certain assets to accruing status following
demonstration of sustained performance.
7
At March 31, 2003, total financial assets included $94.9 million of assets held
for sale, down $298.2 million from December 31, 2002. The decrease was due to
$200.4 million of asset sales (primarily rediscount assets), $54.3 million of
assets no longer being held for sale and reclassified to loans, net runoff of
$37.0 million and markdowns of $6.5 million.
D. RESERVE FOR CREDIT LOSSES
The following table presents the balances and changes to the reserve for credit
losses:
THREE MONTHS ENDED MARCH 31,
----------------------------
2003 2002
----------- -----------
Balance, beginning of year $ 540,268 $ 1,019,878
Provision for credit losses (53,999) (25,184)
Write-offs (55,583) (47,803)
Recoveries 25,345 13,132
Other (12) 49
----------- -----------
Balance, end of period $ 456,019 $ 960,072
=========== ===========
For the three months ended March 31, 2003, the Company recorded a $54.0 million
negative provision for credit losses to reduce its reserve for credit losses.
The negative provision was primarily due to proceeds received from prepayments
and asset sales in excess of recorded carrying amounts (net of reserves),
collections and recoveries of amounts previously written off. Partially
offsetting these reversals were new impairment reserves established on specific
accounts.
A summary of the reserve for credit losses by impaired and other assets is as
follows:
MARCH 31, DECEMBER 31,
2003 2002
-------- --------
Reserves on impaired assets $381,694 $438,172
Other reserves 74,325 102,096
-------- --------
Reserve for credit losses $456,019 $540,268
======== ========
At March 31, 2003, the total carrying amount of impaired loans and leases was
$1.4 billion, of which $484.0 million were revenue accruing. The Company has
established impairment reserves of $381.7 million related to $961.2 million of
nonaccruing and impaired assets. At December 31, 2002, the total amount of
impaired loans and leases was $1.8 billion, of which $471.1 million were revenue
accruing. The impairment reserve at December 31, 2002 totaled $438.2 million
related to $1.2 billion of nonaccruing and impaired assets.
Reserves on impaired assets decreased due to write-offs (primarily associated
with the repossession of aircraft), a modest improvement in pay-off and
collection experience on certain assets previously reserved and the Company's
application of cash received on nonaccruing assets, reducing the impairment
reserves on those assets. Partially offsetting these reductions were new
impairment reserves established for assets reclassified to impaired status
during 2003 and additional reserves recorded on existing impaired assets.
Other reserves related to estimated inherent losses on unimpaired assets
decreased primarily as a result of asset sales, portfolio runoff, changes in
historical loss experience and reclassification of previously unimpaired assets
to impaired status.
8
E. DEBT
A summary of the Company's total debt outstanding is as follows:
MARCH 31, DECEMBER 31,
2003 2002
----------- -----------
Berkadia Loan $ 1,525,000 $ 2,175,000
Senior Notes:
Principal 3,067,949 3,067,949
Discount for Fresh-Start Reporting (677,950) (686,306)
----------- -----------
Total Senior Notes 2,389,999 2,381,643
----------- -----------
Total debt $ 3,914,999 $ 4,556,643
=========== ===========
During the first quarter of 2003, prepayments of the Berkadia Loan totaled $650
million, and subsequently, the Company has repaid an additional $225 million.
Principal payments made to Berkadia since emergence from chapter 11 have reduced
the Berkadia Loan to $1.3 billion as of the filing of this report. The pace of
loan repayments depends on numerous factors, including the rate of collections
from borrowers and asset sales. There can be no assurance that the Berkadia Loan
will continue to be repaid at this pace.
At March 31, 2003, the Senior Notes are reflected in the Company's balance sheet
net of a remaining $677.9 million unamortized discount, which was originally
recorded with the adoption of Fresh-Start Reporting upon emergence from chapter
11. The recorded book value of the Senior Notes is scheduled to increase to
$3.07 billion over time through amortization of the discount as interest
expense. The Company is obligated to repay the full $3.07 billion principal
amount of the Senior Notes.
F. COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES
CONTRACT
TERMINATION TERMINATION
BENEFITS COSTS
----------- -----------
Balance, beginning of year $ 8,878 $ 9,581
Payments (2,792) (1,802)
Net additions 394
------- -------
Balance, end of period $ 6,480 $ 7,779
======= =======
As of March 31, 2003, FINOVA had an outstanding liability for termination
benefits of $6.5 million covering approximately 103 individuals at various
levels throughout the Company, including staff and management. During the first
quarter of 2003, the Company paid termination benefits of $2.8 million. On
December 31, 2002, the Company implemented the provisions of SFAS No. 146,
"Accounting for Costs Associated with Exit or Disposal Activities," and must now
recognize all future liability for termination benefits ratably over the
employee's remaining service period. Accordingly, the Company recorded a net
charge of $0.4 million during the first quarter of 2003 for individuals notified
during the quarter of their pending termination.
As of March 31, 2003, the remaining liability for contract termination costs
related to office leases totaled $7.8 million. The decrease since December 31,
2002 was due to the payment of scheduled lease rentals and termination costs,
partially offset by sublease income.
G. INCOME TAXES
For the three months ended March 31, 2003, income tax expense related to pre-tax
book income was entirely offset by a decrease in valuation allowances, which
were previously established due to the Company's concern regarding its ability
to utilize deferred tax assets generated from losses in prior periods. The
reasons the Company may not be able to utilize all the deferred tax assets
include uncertainty about the amount of future earnings, a variety of loss or
other tax attribute carryover limitations in the various jurisdictions in which
9
the Company files tax returns and uncertainty about the timing of the reversal
of deferred tax liabilities. As of March 31, 2003, the Company had federal net
operating losses of $965 million available for carryforward.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of
Operations should be read in conjunction with the Company's Annual Report on
Form 10-K for the year ended December 31, 2002. Capitalized terms not defined
herein are used as defined in the Form 10-K.
The following discussion relates to The FINOVA Group Inc. and its subsidiaries
(collectively "FINOVA" or the "Company"), including its principal operating
subsidiary, FINOVA Capital Corporation and its subsidiaries ("FINOVA Capital").
FINOVA, a financial services holding company, is a Delaware corporation,
incorporated in 1991. Through FINOVA Capital, the Company has provided a broad
range of financing and capital markets products, primarily to mid-size
businesses. FINOVA's business is being operated under a Management Services
Agreement with Leucadia National Corporation ("Leucadia"), which expires in
2011. Leucadia has designated its employees to act as Chairman of the Board (Ian
M. Cumming), President (Joseph S. Steinberg) and Chief Executive Officer (Thomas
E. Mara). FINOVA Capital has been in operation since 1954.
CURRENT BUSINESS ACTIVITIES
Since emergence from chapter 11 in August 2001, the Company's business
activities have been limited to maximizing the value of its portfolio through
the orderly collection of its assets. These activities include collection
efforts pursuant to underlying contractual terms and may include efforts to
retain certain customer relationships and restructure or terminate other
relationships. The Company has not and does not expect to engage in any new
lending activities, except to honor existing customer commitments and in certain
instances, to restructure financing relationships with existing customers to
maximize value. Operations have been restructured to more efficiently manage
these collection efforts. The Company has sold portions of asset portfolios and
will consider future sales if buyers can be found at acceptable prices; however,
there can be no assurance that the Company will be successful in efforts to sell
additional assets. Any funds generated from these activities in excess of cash
reserves permitted in the Company's debt agreements are used to reduce FINOVA's
obligations to its creditors.
RECENT DEVELOPMENTS
During the first quarter of 2003, repayments of the Berkadia Loan totaled $650
million, and subsequently, the Company has repaid an additional $225 million.
Principal payments made to Berkadia since emergence from chapter 11 have reduced
the Berkadia Loan to $1.3 billion as of the filing of this report. The pace of
loan repayments depends on numerous factors, including the rate of collections
from borrowers and asset sales. There can be no assurance that the Berkadia Loan
will continue to be repaid at this pace.
During the first quarter of 2003, the Company completed the sale of rediscount
assets with a carrying amount of $188.8 million for $175.4 million of net cash
proceeds and a $17.8 million participation in a performing loan, resulting in a
$4.4 million gain.
APPLICATION OF CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES
The Company's consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States. The preparation
of these financial statements requires FINOVA to use estimates and assumptions
that affect reported amounts of assets and liabilities, revenues and expenses
and disclosure of contingent assets and liabilities. These estimates are subject
to known and unknown risks, uncertainties and other factors that could
materially impact the amounts reported and disclosed in the financial
statements. The Company believes the following to be among the most critical
judgment areas in the application of its accounting policies.
CARRYING AMOUNTS, IMPAIRMENT AND USE OF ESTIMATES
Several of the Company's accounting policies pertain to the ongoing
determination of impairment reserves on financing assets and the carrying amount
valuation of other financial assets. Determination of impairment reserves and
carrying amounts rely, to a great extent, on the estimation and timing of future
cash flows. FINOVA's cash flow estimates assume that its asset portfolios are
10
collected in an orderly fashion over time. These cash flows do not represent
estimated recoverable amounts if FINOVA were to liquidate its asset portfolios
over a short period of time. Management believes that a short-term asset
liquidation could have a material negative impact on the Company's ability to
recover recorded asset amounts.
FINOVA's process of determining impairment reserves and carrying amounts
includes a periodic assessment of its portfolios on a transaction by transaction
basis. Cash flow estimates are based on current information and numerous
assumptions concerning future general economic conditions, specific market
segments, the financial condition of the Company's customers and FINOVA's
collateral. In addition, assumptions are sometimes necessary concerning the
customer's ability to obtain full refinancing of balloon obligations or
residuals at maturity. Commercial lenders are conservative regarding advance
rates and interest margin requirements have increased. As a result, the
Company's cash flow estimates assume FINOVA incurs refinancing discounts for
certain transactions.
Changes in facts and assumptions have resulted in, and may in the future result
in, significant positive or negative changes to estimated cash flows and
therefore, impairment reserves and carrying amounts.
Impairment of financing assets is recorded through the Company's reserve for
credit losses, and accounting rules permit the reserve for credit losses to be
increased or decreased as facts and assumptions change. Impairment of other
financial assets is marked down directly against the asset's carrying amount.
Accounting rules permit further markdown if changes in facts and assumptions
result in additional impairment; however, most of these assets (except certain
investments and assets held for sale, which may be marked up for subsequent
events) may not be marked up if subsequent facts and assumptions result in a
projected increase in value. Recoveries of previous markdowns are recorded
through operations when realized.
The carrying amounts and reserve for credit losses recorded on FINOVA's
financial statements reflect the Company's expectation of collecting less than
the full contractual amounts owed by some of its customers and recovering less
than its original investment in certain owned assets. The Company continues to
pursue collection of full contractual amounts and original investments, where
appropriate, in an effort to maximize the value of its asset portfolios.
Since 2001, the Company's portfolio assessments have identified significant
impairment within its transportation portfolio, resulting in markdowns and
reserves. The current state of the aircraft industry includes significant excess
capacity for both new and used aircraft and lack of demand for certain classes
and configurations of aircraft in the portfolio. Accordingly, the Company
reduced the useful lives and anticipated scrap values of various aircraft and
reduced its estimates regarding its ability to lease or sell certain returned
aircraft.
FINOVA has a significant number of aircraft that are off lease and anticipates
that additional aircraft will be returned as leases expire or operators are
unable or unwilling to continue making payments. In accordance with the
provisions of SFAS No. 144 "Accounting for the Impairment or Disposal of
Long-Lived Assets," FINOVA has recorded impairment losses on owned aircraft by
calculating the present value of estimated cash flows. For many of these
aircraft, scrap value was assumed, but for certain aircraft, the Company elected
(or anticipates electing upon return of the aircraft) to park and maintain the
aircraft under the assumption that they will be re-leased or sold in the future
despite the lack of demand for those aircraft today. While the current inactive
market makes it difficult to quantify, the Company believes that the recorded
values determined under this methodology significantly exceed the values that
the Company would realize if it were to liquidate those aircraft today.
The process of determining appropriate carrying amounts for these aircraft is
particularly difficult and subjective, as it requires the Company to estimate
future demand, lease rates and scrap values for assets for which there is
currently little or no demand. The Company re-assesses its estimates and
assumptions each quarter. In particular, the Company assesses market activity
and the likelihood that certain aircraft types, which are forecast to go back on
lease in the future, will in fact be re-leased, and may further reduce carrying
amounts if it is determined that such re-leasing is unlikely to occur or that
lower market values have been established.
RESERVE FOR CREDIT LOSSES. The reserve for credit losses represents FINOVA's
estimate of losses inherent in the portfolio and includes reserves on impaired
assets and on assets that are not impaired. Impairment reserves are created if
the carrying amount of an asset exceeds its estimated recovery, which is
measured by estimating the present value of expected future cash flows
(discounted at contractual rates), market value, or the fair value of
collateral. These methodologies include the use of significant estimates and
assumptions regarding future customer performance, amount and timing of future
cash flows and collateral value. Reserves on assets that are not impaired are
based upon assumptions including general economic conditions, overall portfolio
performance, including loss experience, delinquencies and other inherent
portfolio characteristics. Actual results could differ from these estimates and
11
there can be no assurance that existing reserves will approximate actual future
losses. As of March 31, 2003 and December 31, 2002, the reserve for credit
losses totaled $456.0 million and $540.3 million, respectively.
OWNED ASSETS. Assets held for the production of income and operating leases are
carried at amortized cost with impairment adjustments, if any, recorded as
permanent markdowns through operations. An owned asset is considered impaired if
anticipated undiscounted cash flows are less than the carrying amount of the
asset. Once the asset has been deemed impaired, accounting rules allow for
several acceptable methods for measuring the amount of impairment. FINOVA's
typical method of measuring impairment is based on the comparison of the
carrying amount of those assets to the present value of estimated future cash
flows, using risk adjusted discount rates. These estimates include assumptions
regarding lessee performance, the amount and timing of future cash flows,
selection of risk adjusted discount rates for net present value calculations and
residual value assumptions for leases. If actual results differ from the
estimates used to determine impairment, additional markdowns may be necessary,
impacting financial condition and results from operations. As of March 31, 2003
and December 31, 2002, owned assets totaled $146.8 million and $179.7 million,
or 4.7% and 4.9% of total financial assets (before reserves), respectively.
ASSETS HELD FOR SALE. Assets held for sale are comprised of assets previously
classified as financing transactions and other financial assets that management
does not have the intent and/or the ability to hold to maturity. These assets
are carried at the lower of cost or market less anticipated selling expenses,
with adjustment to estimated market value, if any, recorded as a loss on
financial assets. Market value is often determined by the estimation of
anticipated future cash flows discounted at risk adjusted market rates to
determine net present value. Valuation of assets held for sale includes
estimates regarding market conditions and ultimate sales prices. Actual sales
prices could differ from estimates, impacting results from operations. As of
March 31, 2003 and December 31, 2002, assets held for sale totaled $94.9 million
and $393.1 million, or 3.1% and 10.6% of total financial assets (before
reserves), respectively.
NONACCRUING ASSETS. Accounts are generally classified as nonaccruing and
recognition of income is suspended when a customer becomes 90 days past due on
the payment of principal or interest, or earlier, if in the opinion of
management, full recovery of contractual income and principal becomes doubtful.
The decision to classify accounts as nonaccruing on the basis of criteria other
than delinquency, is based on certain assumptions and estimates including
current and future general economic conditions, industry specific economic
conditions, customer financial performance, the ability of customers to obtain
full refinancing of balloons or residuals at maturity and FINOVA's ability or
willingness to provide such refinancing. In certain instances, accounts may be
returned to accruing status if sustained contractual performance is
demonstrated. Changes in assumptions or estimates could result in a material
change in nonaccruing account classification and income recognition. As of March
31, 2003 and December 31, 2002, $1.0 billion and $1.4 billion, or 32.3% and
37.7% of total financial assets (before reserves), were classified as
nonaccruing, respectively.
FRESH-START REPORTING. Upon emergence from chapter 11, the Company adopted
Fresh-Start Reporting, which resulted in material adjustments to the carrying
amounts of the Company's assets and liabilities. The $863.7 million adjustment
to assets was based on the present value of estimated future cash flows
discounted at appropriate risk adjusted interest rates. Of this amount, $365.4
million was scheduled to amortize into income over the life of the underlying
transactions. If the underlying transactions are classified as nonaccruing,
amortization ceases. The Senior Notes were initially recorded at $2.48 billion,
reflecting their estimated fair value. The $771.3 million discount to the Senior
Notes is amortized as additional interest expense over the term of the notes and
the liability recorded on the Reorganized Company's balance sheet increases in
an amount equal to such amortization. In the event that any Senior Notes are
repurchased and extinguished, as occurred in 2002, the unamortized fresh-start
adjustment related to those notes is recorded as an offset to any gain
recognized from extinguishment of the debt. Although the recorded balance is net
of the unamortized discount, the Company's repayment obligation is the principal
amount, which was $3.07 billion at March 31, 2003. Based on the Company's
current financial condition, it is highly unlikely that there will be funds
available to fully repay the principal amount of the Senior Notes at maturity.
The adjustments relating to the adoption of Fresh-Start Reporting were based on
estimates of anticipated future cash flows, risk adjusted discount rates and the
market value of the Company's debt securities shortly after emergence, which
were determined prior to September 11, 2001. Changes to estimated cash flows
could further impact the reserve for credit losses or cause additional write
downs of assets. Generally accepted accounting principles in the U.S. do not
permit additional fair value adjustments to the Senior Notes after the initial
Fresh-Start Reporting date, including those that would have resulted from the
impact of September 11.
12
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31,
---------------------------------
2003 2002 CHANGE
-------- -------- --------
(Dollars in thousands)
Interest margin $(11,157) $ (4,838) $ (6,319)
Provision for credit losses 53,999 25,184 28,815
Net (loss) gain on financial assets (3,142) 968 (4,110)
Portfolio expenses (10,524) (8,025) (2,499)
General and administrative expenses (16,422) (25,468) 9,046
Income tax expense (2) 2
-------- -------- --------
Net income (loss) $ 12,754 $(12,181) $ 24,935
======== ======== ========
THREE MONTHS ENDED MARCH 31, 2003 AND 2002
NET INCOME (LOSS). For the three months ended March 31, 2003, the Company
reported net income of $12.8 million compared to a net loss of $12.2 million for
the three months ended March 31, 2002. The results for 2003 included a $54.0
million negative provision for credit losses, partially offset by a negative
interest margin of $11.2 million, a net loss on financial assets of $3.1
million, portfolio expenses of $10.5 million and general administrative expenses
of $16.4 million. In general, the net income in 2003 was attributable to
somewhat better than anticipated realization on FINOVA's asset portfolios, with
the exception of its transportation assets, which have continued to deteriorate
consistent with the aircraft industry as a whole. The $12.2 million loss for
2002 was primarily the result of a $4.8 million negative interest margin,
portfolio expenses of $8.0 million and general and administrative expenses of
$25.5 million, partially offset by a $25.2 million negative provision for credit
losses and a $1.0 million net gain on financial assets.
INTEREST MARGIN. For the three months ended March 31, 2003, interest margin
declined $6.3 million to a negative $11.2 million. The negative margin is
primarily due to a significantly lower level of earning assets than outstanding
debt and increasing cost of funds. The reduction in earning assets was due to
the continuing collection or sale of the portfolio, valuation adjustments,
reduced funding requirements on existing customer commitments and
reclassification of earning assets to nonaccruing status. Also impacting the
negative interest margin is the trend in the aggregate cost of funds, which has
increased to 7.75% for the three months ended March 31, 2003 from 6.67% for the
same period in 2002. The cost of debt is expected to increase as the lower cost
Berkadia Loan (LIBOR plus 2.25%) is repaid and the higher cost Senior Notes
(7.5% stated rate and 10.83% aggregate fixed cost including fresh-start discount
amortization) becomes a higher percentage of outstanding debt. Partially
offsetting the negative interest margin trend has been a recent return to
earning status of certain assets following demonstration of sustained
performance and the partial recognition of suspended income upon the payoff and
collection of certain nonaccruing assets.
PROVISION FOR CREDIT LOSSES. For the three months ended March 31, 2003, the
Company recorded a $54.0 million negative provision for credit losses to reduce
its reserve for credit losses. The negative provision was primarily due to
proceeds received from prepayments and asset sales in excess of recorded
carrying amounts (net of reserves), collections and recoveries of amounts
previously written off. In addition, the Company's income recognition policy for
nonaccruing accounts can result in periodic reserve reductions. In accordance
with SFAS No. 114, "Accounting by Creditors for Impairment of a Loan,"
impairment reserves are recorded if the carrying amount of a loan exceeds the
net present value of expected cash flows, discounted at the risk-adjusted rates
used for Fresh-Start Reporting. For nonaccruing accounts, all cash received is
applied against the carrying amount of the transaction. As a result, carrying
amounts decline at a faster pace than net present value, thus reducing the
impairment reserve.
The $25.2 million negative provision for credit losses in 2002 was recorded
following the Company's detailed assessment of estimated inherent losses in its
portfolio, which indicated a slight improvement in estimated cash collections.
The pace of collections and account payoffs has been somewhat faster than
expected. In most portfolios, with the exception of transportation, amounts
collected have, to a certain extent, exceeded anticipated cash flows, resulting
in a partial reversal of previously established reserves.
The measurement of credit impairment and asset valuation is dependent upon the
significant use of estimates and management discretion when predicting expected
cash flows. These estimates are subject to known and unknown risks,
uncertainties and other factors that could materially impact the amounts
13
reported and disclosed herein. See the "Special Note Regarding Forward-Looking
Statements" for a discussion of these and additional factors impacting the use
of estimates.
NET LOSS ON FINANCIAL ASSETS. The Company realized a net loss on financial
assets of $3.1 million for the three months ended March 31, 2003 compared to a
net gain of $1.0 million for the three months ended March 31, 2002. Significant
components of the net loss for 2003 consisted of a $20.1 million net markdown of
owned assets within the transportation portfolio, partially offset by a net gain
of $4.4 million realized on the rediscount asset sale and net gains resulting
from collections and individual asset sales exceeding the carrying amounts of
those assets. The net loss on the transportation portfolio resulted from the
Company's revised estimate of future cash flows expected to be realized through
the operation or sale of its aircraft portfolio. Due to the current state of the
aircraft industry, which includes significant excess capacity for both new and
used aircraft and lack of demand for certain classes and configurations of
aircraft in the Company's portfolio, the Company reduced cash flows expected to
be received on certain aircraft and reduced its estimate regarding its ability
to lease or sell certain returned aircraft. Most of the Company's aircraft are
of older vintage with limited demand in the aircraft market. As a result, the
Company lowered its previous estimates of future cash flows expected from its
aircraft portfolio, resulting in an increased level of impairment losses.
The $1.0 million net gain for the three months ended March 31, 2002 included
$29.1 million of gains offset by $28.1 million of additional losses. The most
significant item was a $6.7 million gain realized on the sale of investments
during the first quarter of 2002.
The measurement of owned asset impairment is dependent upon the significant use
of estimates and management discretion when predicting expected future cash
flows and asset values. An asset is considered impaired if anticipated
undiscounted cash flows are less than the carrying amount of the asset. Once the
asset has been deemed impaired, the accounting rules provide for several
acceptable methods for measuring the amount of the impairment. FINOVA's typical
practice is to compare the carrying amount of the asset to the present value of
the estimated future cash flows, using an appropriate risk adjusted discount
rate. The process of measuring impairment requires judgment and estimation, and
the actual results may differ from the estimates. See the "Special Note
Regarding Forward-Looking Statements" for a discussion of many factors that
could impact these estimates.
PORTFOLIO EXPENSES. For the three months ended March 31, 2003, portfolio
expenses totaled $10.5 million compared to $8.0 million for 2002. The increase
was primarily attributable to FINOVA's transportation portfolio, which incurred
expenses of $7.5 million for the three months ended March 31, 2003 compared to
$3.6 million in 2002. This increase is directly related to the large number of
off-lease aircraft and includes the cost of storing, maintaining and preparing
certain of these aircraft for potential return to service. Partially offsetting
this increase was a decrease in expenses pertaining to the remainder of the
asset portfolios, resulting from a reduction in portfolio size and the timing of
certain expenses anticipated in 2003.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
decreased $9.0 million to $16.4 million for the three months ended March 31,
2003. The decrease was primarily due to $6.1 million of cost savings resulting
from staffing and office occupancy reductions (276 employees at March 31, 2003
compared to 441 at March 31, 2002). The remainder of the decrease was the result
of an overall decline in general and administrative expenses caused by decreases
in portfolio and staffing levels. The Company expects the dollar level of
general and administrative expenses to continue to decrease as portfolio and
staffing levels decrease; however, general and administrative expenses as a
percentage of assets or revenues will likely increase over time as a result of
certain fixed costs and the high level of work intensive assets in the
portfolio.
INCOME TAX EXPENSE. For the three months ended March 31, 2003, income tax
expense related to pre-tax book income was entirely offset by a decrease in
valuation allowances, which were previously established due to the Company's
concern regarding its ability to utilize income tax benefits generated from
losses in prior periods. As of March 31, 2003, the Company had federal net
operating losses of $965 million available for carryforward.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Because virtually all of the Company's assets are pledged to secure the
obligations under the Berkadia Loan and the Intercompany Notes, FINOVA's ability
to obtain additional or alternate financing is severely restricted. Berkadia has
no obligation to lend additional sums to or to further invest in the Company.
Accordingly, FINOVA intends to rely on internally generated cash flows to meet
its liquidity needs.
At March 31, 2003, the Senior Notes are reflected in the Company's balance sheet
net of a remaining $677.9 million unamortized discount, which was originally
recorded with the adoption of Fresh-Start Reporting upon emergence from chapter
14
11. The recorded book value of the Senior Notes is scheduled to increase to
$3.07 billion over time through amortization of the discount as interest
expense. The Company is obligated to repay the full $3.07 billion principal
amount of the Senior Notes.
During the first quarter of 2003, repayments of the Berkadia Loan totaled $650
million, and subsequently, the Company has repaid an additional $225 million.
Principal payments made to Berkadia since emergence from chapter 11 have reduced
the Berkadia Loan to $1.3 billion as of the filing of this report. The pace of
loan repayments depends on numerous factors, including the rate of collections
from borrowers and asset sales. There can be no assurance that the Berkadia Loan
will continue to be repaid at this pace.
As a result of FINOVA's current financial condition and restrictions contained
in its debt agreements that do not allow FINOVA to incur any meaningful amount
of new debt, the estimation of cash reserves is critical to the overall
liquidity of the Company. Cash reserve estimations are subject to known and
unknown risks, uncertainties and other factors that could materially impact the
amounts determined. Failure to adequately estimate a cash reserve in one period
could result in insufficient liquidity to meet obligations in that period, or in
a subsequent period, if actual cash requirements exceed the cash reserve
estimates.
BASED ON THE COMPANY'S CURRENT FINANCIAL CONDITION, IT IS HIGHLY UNLIKELY THAT
THERE WILL BE FUNDS AVAILABLE TO FULLY REPAY THE OUTSTANDING PRINCIPAL ON THE
SENIOR NOTES AT MATURITY, AND AS A RESULT, THERE WILL NOT BE A RETURN TO THE
COMPANY'S STOCKHOLDERS. The Company has a negative net worth of $957.9 million
as of March 31, 2003 ($1.6 billion if the Senior Notes are considered at their
principal amount due); the financial condition of many of its customers is
weakened, impairing their ability to meet obligations to the Company; much of
the Company's portfolio of owned assets is not income producing and the Company
is restricted from entering into new business activities or issuing new
securities to generate substantial cash flow. For these reasons, THE COMPANY
BELIEVES THAT INVESTING IN FINOVA'S DEBT AND EQUITY SECURITIES INVOLVES A HIGH
LEVEL OF RISK TO THE INVESTOR.
In August 2002, in accordance with the Company's debt agreements, FINOVA's Board
of Directors, with Berkadia's consent, approved the use of up to $300 million of
cash to repurchase Senior Notes rather than make mandatory prepayments of the
Berkadia Loan. In consideration for Berkadia's consent, FINOVA and Berkadia
agreed that they would share equally in the "Net Interest Savings" resulting
from any repurchase. Net Interest Savings will be calculated as the difference
between (a) the reduction in interest expense on the Senior Notes (resulting
from the repurchase of such Senior Notes) and (b) the increase in interest
expense on the Berkadia Loan (resulting from the use of cash to repurchase
Senior Notes and to pay 50% of the Net Interest Savings to Berkadia rather than
make mandatory prepayments on the Berkadia Loan). On each date that interest is
paid on the outstanding Senior Notes (a "Note Interest Payment Date"), 50% of
the Net Interest Savings accrued since the last Note Interest Payment Date will
be paid to Berkadia. The other 50% of the Net Interest Savings will be retained
by FINOVA. Upon repayment in full of the Berkadia Loan, Berkadia will not have
the right to receive any Net Interest Savings accruing after that repayment.
Because it is highly unlikely there will be sufficient funds to repay the Senior
Notes at maturity, the Company, if it elects to repurchase additional Senior
Notes, intends to do so only at substantial discounts to par. The agreement
between FINOVA and Berkadia was approved by the "Special Committee" of FINOVA's
Board of Directors, which is comprised solely of directors unaffiliated with
Berkadia, Berkshire or Leucadia.
During 2002, the Company repurchased $185.0 million (face amount) of Senior
Notes at an average price of 29.93% or $55.4 million, plus accrued interest.
There can be no assurance that the Company will repurchase any additional Senior
Notes or that additional Senior Notes will become available at an acceptable
price.
15
OBLIGATIONS AND COMMITMENTS. The following is a listing of FINOVA's significant
contractual obligations and contingent commitments at March 31, 2003 and
December 31, 2002. A detailed repayment schedule has not been provided because
the Company's most significant obligations are contractual as to amount but
contingent regarding the timing of repayment. The listing is not intended to be
all encompassing and excludes normal recurring trade and other accounts payable
obligations.
MARCH 31, 2003 DECEMBER 31, 2002
-------------------------- --------------------------
OBLIGATIONS AND COMMITMENTS CONTRACTUAL CONTINGENT CONTRACTUAL CONTINGENT
- --------------------------- ----------- ----------- ----------- -----------
(Dollars in thousands)
Berkadia Loan $ 1,525,000 $ $ 2,175,000 $
Management Services Agreement 62,000 64,000
Senior Notes 3,067,949 3,067,949
Contingent interest on Senior Notes 94,313 94,313
Unfunded customer commitments 341,016 568,267
Nonrecourse debt associated with the leveraged lease
portfolio 962,106 990,908
Lease obligations 23,182 25,878
----------- ----------- ----------- -----------
$ 5,640,237 $ 435,329 $ 6,323,735 $ 662,580
=========== =========== =========== ===========
Principal repayment of the Berkadia Loan is contingent on available cash in
excess of cash reserves. All unpaid principal and accrued interest are due at
maturity on August 20, 2006. In addition to amounts included in the table,
FINOVA is obligated to pay Berkadia 50% of the Net Interest Savings, resulting
from the Senior Note repurchases noted above. Based on interest rates in effect
as of March 31, 2003, 50% of the Net Interest Savings for repurchases to date is
estimated to be approximately $6.0 million per year. The Net Interest Savings
will fluctuate with changes in interest rates and would change if additional
Senior Notes are repurchased.
FINOVA's business is being operated under a Management Services Agreement with
Leucadia, which expires in 2011. FINOVA pays Leucadia an annual management fee
of $8.0 million, paid quarterly in advance.
Principal repayments of the Senior Notes, other than repurchases approved by
Berkadia and the Company's Board of Directors, cannot commence until the
Berkadia Loan is paid in full and is contingent on the availability of excess
cash. Contingent interest cannot commence until the Senior Notes are paid in
full. Based on the Company's current financial condition, it is highly unlikely
that there will be funds available to fully repay the outstanding principal on
the Senior Notes at maturity in November 2009 or to pay any contingent interest
through its expiration in 2016.
Unfunded customer commitments (primarily unused lines of credit) have declined
from $568.3 million at December 31, 2002 to $341.0 million at March 31, 2003,
primarily due to the elimination of outstanding commitments associated with the
rediscount assets sold during the first quarter of 2003 and the termination
and/or expiration of other outstanding committed lines of credit. Because of the
primarily revolving nature of its commitments, the Company is unable to estimate
with accuracy what portion of the commitments will be funded. Historically, in
the aggregate, actual fundings have been significantly below the commitment
amounts.
The nonrecourse debt associated with leveraged leases represents principal
amounts due to third party lenders under lease arrangements. Nonrecourse debt
declined to $962.1 million during the first quarter of 2003, primarily due to
scheduled principal payments.
Lease obligations represent the total contractual obligations (rent and
operating costs) due under operating leases (primarily leased office space), as
well as commitments made for tenant improvements and lease damages related to
the resolution of previously rejected lease space. Lease obligations declined to
$23.2 million during the first quarter of 2003, primarily due to scheduled rent
payments.
16
COLLECTION OF THE PORTFOLIO. As noted previously, the Company's current business
activities are limited to maximizing the value of its portfolio through the
orderly collection of its receivables. These activities include continued
collection of its portfolio pursuant to contractual terms and may include
efforts to retain certain customer relationships and restructure or terminate
other relationships. The Company will consider the sale of certain portfolios if
buyers can be found at acceptable prices. Due to restrictions contained in
FINOVA's debt agreements as well as its general inability to access capital in
the public and private markets, the Company's only viable source of cash flow is
from the collection of its portfolio. The following table presents the activity
in total financial assets, net of the reserve for credit losses for the quarter
ended March 31, 2003:
(Dollars in
thousands)
-----------
TOTAL FINANCIAL ASSETS AT DECEMBER 31, 2002 $ 3,156,151
CASH ACTIVITY:
Fundings under outstanding customer commitments 108,221
Collections and proceeds from financial assets (649,955)
-----------
Net cash flows (541,734)
-----------
NON-CASH ACTIVITY:
Reversal of provision for credit losses 53,999
Net charge-offs of financial assets (21,868)
Other non-cash activity (3,756)
-----------
Net non-cash activity 28,375
-----------
TOTAL FINANCIAL ASSETS AT MARCH 31, 2003 $ 2,642,792
===========
Total financial assets, net of the reserve for credit losses, declined to $2.6
billion at March 31, 2003, down from $3.2 billion at December 31, 2002. During
the first quarter of 2003, net cash flow from the portfolio totaled $541.7
million, while non-cash activity resulted in a $28.4 million increase in net
financial assets. Components of net cash flow included $454.5 million from
collections on financial assets (including recoveries), $195.4 million from the
sale of assets (excluding cash gains), offset by $108.2 million of fundings
under outstanding customer commitments. Collections on financial assets included
a significant level of prepayments (customer payments in advance of scheduled
due dates). Prepayments are not predictable and given the decline in the size of
FINOVA's asset portfolio and the higher level of nonaccruing assets in the
remaining portfolio, prepayment levels as well as scheduled amortization are
expected to decline over time. Non-cash activity included the reversal of $54.0
million of provision for credit losses, offset by a $21.9 million reduction
related to markdowns of owned assets and just over $3.7 million of other
non-cash activity, primarily operating lease depreciation offset by fresh-start
accretion.
FINOVA's reserve for credit losses decreased to $456.0 million at March 31, 2003
from $540.3 million at December 31, 2002. At March 31, 2003, the total carrying
amount of impaired loans and leases was $1.4 billion, of which $484.0 million
were revenue accruing. The Company has established impairment reserves of $381.7
million related to $961.2 million of nonaccruing and impaired assets. At
December 31, 2002, the total amount of impaired loans and leases was $1.8
billion, of which $471.1 million were revenue accruing. The impairment reserves
at December 31, 2002 totaled $438.2 million related to $1.2 billion of
nonaccruing and impaired assets.
Reserves on impaired assets decreased due to write-offs (primarily associated
with the repossession of aircraft), improvement in pay-off and collection
experience on certain assets previously reserved and the Company's application
of cash received on nonaccruing assets, reducing the impairment reserves
required on those assets. Partially offsetting these reductions were new
impairment reserves established for assets reclassified to impaired status
during 2003 and additional reserves recorded on existing impaired assets.
Other reserves related to estimated inherent losses on unimpaired assets,
decreased primarily as a result of asset sales, portfolio runoff, changes in
historical loss experience and reclassification of previously unimpaired assets
to impaired status.
Accounts classified as nonaccruing were $1.0 billion or 32.3% of total financial
assets (before reserves) at March 31, 2003 as compared to $1.4 billion or 37.7%
at December 31, 2002. The decline in nonaccruing assets was primarily attributed
to asset sales (including the first quarter rediscount sale), cash collections,
write-offs and the return of certain assets to accruing status following
demonstration of sustained performance.
17
Nonaccruing assets continue to be affected by the Company's concerns regarding
its ability to fully collect principal and interest on certain transactions that
have significant balloon payments or residual values due at maturity. The
current economic climate has resulted in a general reduction of operating cash
flow for the typical FINOVA borrower and in more conservative industry wide
lending practices. As a result, FINOVA is concerned that certain of its
customers will not have the ability to obtain refinancing at maturity for the
full amount of these residual/balloon payments. FINOVA's ability or willingness
to continue to extend credit to these borrowers may be affected by its
restricted access to the capital markets and its assessment of the costs and
benefits of doing so. In certain of these cases, FINOVA has classified
transactions as nonaccruing even though principal and interest payments are
current. If necessary, impairment reserves on these transactions are established
in accordance with SFAS No. 114.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in this report are "forward-looking," in that they do not
discuss historical fact, but instead note future expectations, projections,
intentions or other items. Forward-looking statements are made pursuant to the
safe-harbor provisions of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements include assumptions, estimates and valuations
implicit in the financial statements and related notes as well as matters
discussed in the sections of this report captioned "Item 2. Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Item 3. Quantitative and Qualitative Disclosure About Market Risk." They are
also made in documents incorporated in this report by reference, or in which
this report may be incorporated.
Forward-looking statements are inherently subject to risks and uncertainties,
many of which cannot be predicted or quantified. When used in this report, the
words "estimate," "expects," "anticipates," "believes," "plans," "intends" and
similar expressions are intended to identify forward-looking statements that
involve known and unknown risks and uncertainties. Risks, uncertainties and
other factors may cause FINOVA's actual results or performance to differ
materially from those contemplated by the forward-looking statements. Many of
these factors are discussed in this report and include, but are not limited to:
* The extent to which FINOVA is successful in implementing its business
strategy, including the efforts to maximize the value of its portfolio
through orderly collection or sales of assets. Portfolio decisions are
based on estimates of asset value and actual results may differ from the
estimated amounts. Failure to fully implement its business strategy might
result in adverse effects, impair the Company's ability to repay
outstanding secured debt and other obligations and have a materially
adverse impact on its financial position and results of operations. The
current focus on maximizing portfolio values and the absence of new
business generation will cause future financial results to differ
materially from prior periods. Similarly, adoption of Fresh-Start Reporting
upon emergence from bankruptcy has resulted in revaluation of certain
assets and liabilities and other adjustments to the financial statements,
so that prior results are not indicative of future expectations.
* Several of the Company's accounting policies pertain to the ongoing
determination of portfolio impairment. These amounts rely, to a great
extent, on the estimation and timing of future cash flows. Actual results
may differ from the estimates.
* The effect of economic conditions and the performance of FINOVA's
borrowers. Economic conditions in general or in particular market segments
could impair the ability of FINOVA's borrowers to operate or expand their
businesses, which might result in decreased performance, adversely
affecting their ability to repay their obligations. The rate of borrower
defaults or bankruptcies may increase. Changing economic conditions could
adversely affect FINOVA's ability to realize estimated cash flows.
* The cost of FINOVA's capital has increased significantly since the first
quarter of 2000 and will continue to negatively impact results. Failure to
comply with its credit obligations could result in additional increases in
interest charges. In addition, changes in interest rate indices may
negatively impact interest margin due to lack of matched funding of the
Company's assets and liabilities.
* Loss of employees. FINOVA must retain a sufficient number of employees with
relevant knowledge and skills to continue to monitor, collect and sell its
portfolio. Failure to do so could result in additional losses. Retention
incentives intended to retain that employee base may not be successful in
the future.
18
* Conditions affecting the Company's aircraft portfolio, including changes in
Federal Aviation Administration directives and conditions affecting the
demand for used aircraft and the demand for aircraft spare parts. FINOVA's
aircraft are often of older vintage and contain configurations of engines,
avionics, fuel tanks and other components that may not be as high in demand
as other available aircraft in that class. Future demand for those aircraft
may decrease further as newer or more desirable aircraft and components
become available.
* Changes in government regulations, tax rates and similar matters. For
example, government regulations could significantly increase the cost of
doing business or could eliminate certain tax advantages of some FINOVA
financing transactions. The Company has not recorded a benefit in its
financial statements for its existing tax attributes and estimated future
tax deductions since it does not expect to generate the future taxable
income needed to use those tax benefits. The Company may never be able to
use those tax attributes.
* Necessary technological changes, such as implementation of information
management systems, may be more difficult, expensive or time consuming to
implement than anticipated.
* Potential liabilities associated with dispositions of assets.
* The accuracy of information relied upon by FINOVA, which includes
information supplied by its borrowers or prepared by third parties, such as
appraisers. Inaccuracies in that information could lead to inaccuracies in
the estimates.
* As the portfolio declines, increasing concentrations of financial assets in
certain industries such as resort and transportation could make the overall
portfolio more subject to changes in performance in those industries.
* Other risks detailed in this and FINOVA's other SEC reports or filings.
FINOVA does not intend to update forward-looking information to reflect actual
results or changes in assumptions or other factors that could affect those
statements. FINOVA cannot predict the risk from reliance on forward-looking
statements in light of the many factors that could affect their accuracy.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
There were no material changes from the information provided in the Company's
Annual Report on Form 10-K for the year ended December 31, 2002.
ITEM 4. CONTROLS AND PROCEDURES
(a) Based on their evaluation as of a date within 90 days of the filing date of
this Form 10-Q, the Company's Chief Executive Officer and Chief Financial
Officer have concluded that the Company's disclosure controls and
procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Exchange
Act) are effective to ensure that information required to be disclosed by
the Company in reports that it files or submits under the Exchange Act are
recorded, processed, summarized and reported within the time periods
specified in Securities and Exchange Commission rules and forms.
(b) There were no significant changes in the Company's internal controls or in
other factors that could significantly affect these controls subsequent to
the date of their evaluation, including any corrective actions with regard
to significant deficiencies and material weaknesses. However, the Company
continues to reduce its workforce, consolidate its operations and outsource
certain functions. Accordingly, responsibility for administration,
management and review of many of the Company's assets has transitioned
among FINOVA's remaining personnel. Management has supervised these
transitions and has implemented procedures designed to provide effective
controls and processes during and after this transition. The Company will
continue to assess the efficacy of these procedures in subsequent periods.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There were no material changes from the information provided in the Company's
Annual Report on Form 10-K for the year ended December 31, 2002.
19
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
99.1 Certification of the Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification of the Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
b) Reports on Form 8-K
None.
20
THE FINOVA GROUP INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE FINOVA GROUP INC.
(Registrant)
Dated: May 12, 2003 By: /s/ Stuart A. Tashlik
------------------------------------
Stuart A. Tashlik, Senior Vice
President, Chief Financial Officer
Principal Financial and Accounting
Officer
21
CERTIFICATIONS
I, Thomas E. Mara, Chief Executive Officer of The FINOVA Group Inc., certify
that:
1. I have reviewed this quarterly report on Form 10-Q of The FINOVA Group Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 8, 2003 /s/ Thomas E. Mara
------------------------------
Thomas E. Mara
Chief Executive Officer
22
CERTIFICATIONS
I, Stuart A. Tashlik, Chief Financial Officer of The FINOVA Group Inc., certify
that:
1. I have reviewed this quarterly report on Form 10-Q of The FINOVA Group Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 12, 2003 /s/ Stuart A. Tashlik
------------------------------
Stuart A. Tashlik
Chief Financial Officer
23
EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION
- -------------- -----------
99.1 Certification of the Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification of the Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
24