UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

Form 10-Q

 

(Mark One)

ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2006
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 033-19694

 

FirstCity Financial Corporation

(Exact name of registrant as specified in its charter)

 

 

(254) 761-2800

(Registrant’s telephone number, including area code)

 

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 ý     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.   (Check one.)

 

Large accelerated filer o              Accelerated filer ý              Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No ý

 

The number of shares of common stock, par value $.01 per share, outstanding at May 2, 2006 was 11,308,187.

 

 

TABLE OF CONTENTS

 

PART I
Item 1.  Financial Statements
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.  Quantitative and Qualitative Disclosures About Market Risk
Item 4.  Controls and Procedures
PART II
OTHER INFORMATION
Item 1.  Legal Proceedings
Item 1A.  Risk Factors
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.  Defaults Upon Senior Securities
Item 4.  Submission of Matters to a Vote of Security Holders
Item 5.  Other Information
Item 6.  Exhibits
SIGNATURES
Exhibit Index
Certification of CEO Pursuant to Section 302
Certification of CFO Pursuant to Section 302
Certification of CEO Pursuant to Section 906
Certification of CFO Pursuant to Section 906

 

Table of Contents

PART I

 

FINANCIAL INFORMATION

 

Item 1.  Financial Statements.

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

 

		March 31, 2006			December 31, 2005
		(Unaudited)
ASSETS
Cash and cash equivalents		$	9,248		$	12,901
Portfolio Assets, net		52,124			49,346
Loans receivable from Acquisition Partnerships held for investment		20,107			19,606
Equity investments		92,892			83,785
Deferred tax asset, net		20,101			20,101
Service fees receivable from affiliates		1,378			1,103
Other assets, net		7,605			7,870
Discontinued mortgage assets		91			157
Total Assets		$	203,546		$	194,869
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Notes payable other		$	95,330		$	89,653
Notes payable to affiliates		546			606
Minority interest		2,567			1,193
Liabilities from discontinued consumer operations		121			121
Other liabilities		4,016			4,385
Total Liabilities		102,580			95,958
Commitments and contingencies (note 11)
Stockholders’ equity:
Optional preferred stock (par value $.01 per share; 98,000,000 shares authorized; no shares issued or outstanding)		—			—
Common stock (par value $.01 per share; 100,000,000 shares authorized; shares issued and outstanding: 11,307,187 and 11,307,187, respectively)		113			113
Paid in capital		99,988			99,843
Accumulated deficit		(36		)	(2,058		)
Accumulated other comprehensive income		901			1,013
Total Stockholders’ Equity		100,966			98,911
Total Liabilities and Stockholders’ Equity		$	203,546		$	194,869

 

See accompanying notes to consolidated financial statements.

 

2

Table of Contents

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

 

		Three Months Ended March 31,
		2006			2005
Revenues:
Servicing fees from affiliates		$	2,647		$	3,172
Gain on resolution of Portfolio Assets		1,284			1,862
Interest income from affiliates		430			424
Loan interest income		774			478
Other income		580			384
Total revenues		5,715			6,320
Expenses:
Interest and fees on notes payable — other		1,698			872
Interest and fees on notes payable to affiliates		10			8
Salaries and benefits		3,738			4,158
Provision for loan and impairment losses		109			85
Occupancy, data processing, communication and other		1,564			1,913
Total expenses		7,119			7,036
Equity in earnings of investments		3,634			3,401
Earnings from continuing operations before income taxes and minority interest		2,230			2,685
Income tax expense		(122		)	(139		)
Minority interest		(11		)	3
Earnings from continuing operations		2,097			2,549
Discontinued operations
Loss from discontinued operations		(75		)	—
Income taxes		—			—
Net loss from discontinued operations		(75		)	—
Net earnings		$	2,022		$	2,549
Basic earnings per common share are as follows:
Earnings from continuing operations		$	0.19		$	0.23
Discontinued operations		$	(0.01	)	$	—
Net earnings to common stockholders		$	0.18		$	0.23
Weighted average common shares outstanding		11,307			11,262
Diluted earnings per common share are as follows:
Earnings from continuing operations		$	0.18		$	0.21
Discontinued operations		$	(0.01	)	$	—
Net earnings to common stockholders		$	0.17		$	0.21
Weighted average common shares outstanding		11,958			12,007

 

See accompanying notes to consolidated financial statements.

 

3

Table of Contents

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

AND COMPREHENSIVE INCOME

(Dollars in thousands)

 

		Number of Common Shares		Common Stock				Paid in Capital				Accumulated Deficit				Accumulated Other Comprehensive Income			Total Stockholders’ Equity
Balances, December 31, 2004		11,260,687		$	113			$		99,364		$	(10,289		)	$	3,235		$	92,423
Exercise of common stock options		46,500		—				196				—				—			196
Additional paid-in capital arising from sale of shares by investee		—		—				283				—				—			283
Comprehensive income:
Net earnings for 2005		—		—				—				8,231				—			8,231
Translation adjustments		—		—				—				—				(2,222		)	(2,222			)
Total comprehensive income																			6,009
Balances, December 31, 2005		11,307,187		113				99,843				(2,058			)	1,013			98,911
Exercise of common stock options		—		—				—				—				—			—
Additional paid-in capital arising from stock option compensation expense		—		—				145				—				—			145
Comprehensive income:
Net earnings for the first three months of 2006		—		—				—				2,022				—			2,022
Translation adjustments		—		—				—				—				(112		)	(112			)
Total comprehensive income																			1,910
Balances, March 31, 2006 (unaudited)		11,307,187		$		113		$	99,988			$		(36	)	$	901		$		100,966

 

See accompanying notes to consolidated financial statements.

 

4

Table of Contents

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

(Unaudited)

 

		Three Months Ended March 31,
		2006			2005
Cash flows from operating activities:
Net earnings		$	2,022		$	2,549
Adjustments to reconcile net earnings to net cash provided by (used in) operating activities:
Net loss from discontinued operations		75			—
Purchase and advances of Portfolio Assets and loans receivable, net		(8,231		)	(532		)
Proceeds applied to principal on Portfolio Assets and loans receivable		6,941			8,130
Gain on resolution of Portfolio Assets		(1,284		)	(1,862		)
Capitalized interest and costs on Portfolio Assets and loans receivable		(457		)	(96		)
Provision for loan and impairment losses		109			85
Equity in earnings of investments		(3,634		)	(3,401		)
Depreciation and amortization		157			214
Stock-based compensation expense related to stock options		145			—
(Increase) decrease in service fees receivable from affiliate		(275		)	384
Decrease in other assets		174			1,801
Change in debt imputed value		(60		)	73
Decrease in other liabilities		1,000			(1,184		)
Net cash provided by (used in) operating activities		(3,318		)	6,161
Cash flows from investing activities:
Property and equipment, net		(83		)	(39		)
Contributions to Acquisition Partnerships and Servicing Entities		(17,529		)	(3,690		)
Distributions from Acquisition Partnerships and Servicing Entities		11,992			6,533
Net cash provided by (used in) investing activities		(5,620		)	2,804
Cash flows from financing activities:
Borrowings under notes payable — other		28,885			15,332
Payments of notes payable to affiliates		—			(4		)
Payments of notes payable — other		(23,591		)	(17,344		)
Proceeds from issuance of common stock		—			8
Net cash provided by (used in) financing activities		5,294			(2,008		)
Net cash provided by (used in) continuing operations		(3,644		)	6,957
Cash flows from discontinued operations (Revised - see note 1):
Net cash used in operating activities		(9		)	(8,064		)
Net cash provided by investing activities		—			450
Net cash used in discontinued operations		(9		)	(7,614		)
Net decrease in cash and cash equivalents		(3,653		)	(657		)
Cash and cash equivalents, beginning of period		12,901			9,724
Cash and cash equivalents, end of period		$	9,248		$	9,067
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest		$	1,475		$	575
Income taxes		16			146

 

See accompanying notes to consolidated financial statements.

 

5

Table of Contents

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2006

(Dollars in thousands, except per share data)

(Unaudited)

 

(1)  Basis of Presentation and Summary of Significant Accounting Policies

 

The Company

 

FirstCity Financial Corporation (the “Company” or “FirstCity”) is a financial services company with offices throughout the United States and Mexico, with a presence in France, Germany and South America. At March 31, 2006, the Company was engaged in one principal reportable segment - Portfolio Asset acquisition and resolution.  The portfolio asset acquisition and resolution business involves acquiring portfolios of loans, real estate and other assets or single assets (collectively referred to as “Portfolios” or “Portfolio Assets”) at a discount to their legal principal balance or appraised value, and servicing and resolving such Portfolios in an effort to maximize the present value of the ultimate cash recoveries.

 

Basis of Presentation

 

The unaudited consolidated financial statements of FirstCity reflect, in the opinion of management, all adjustments, consisting only of normal and recurring adjustments, necessary to present fairly FirstCity’s consolidated financial position at March 31, 2006, its results of operations for the three month periods ended March 31, 2006 and 2005 and cash flows for the three month periods ended March 31, 2006 and 2005.  Certain disclosures have been condensed or omitted from these financial statements. Accordingly, these financial statements should be read with the consolidated financial statements included in the Company’s 2005 Annual Report on Form 10-K.  Certain amounts in the consolidated financial statements for prior years have been reclassified to conform with current consolidated financial statement presentation.  In the first quarter of 2006, equity in earnings of investments was reclassified outside of revenues, which in prior periods was included with revenues.  Also in the first quarter of 2006, the Company has separately disclosed the operating, investing and financing portions of the cash flows attributable to its discontinued operations, which in prior periods were reported on a combined basis as a single amount.

 

Use of Estimates

 

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include (i) the estimation of future collections on purchased portfolio assets used in the calculation of net gain on resolution of portfolio assets, (ii) interest rate environments, (iii) valuation of the deferred tax asset, and (iv) prepayment speeds and collectibility of loans held in inventory, in securitization trusts and held for investment. Actual results could differ materially from those estimates.

 

Stock-Based Compensation

 

On January 1, 2006, FirstCity adopted Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (“SFAS 123(R)”), that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for either equity instruments of the enterprise or liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The statement eliminates the ability to account for share-based compensation transactions, as the Company formerly did, using the intrinsic value method as prescribed by Accounting Principles Board, or APB, Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and generally requires that such transactions be accounted for using a fair-value-based method and recognized as expenses in the consolidated statement of operations.

 

FirstCity adopted SFAS 123(R) using the modified prospective method which requires the application of the accounting standard as of January 1, 2006. The consolidated financial statements as of and for the first quarter of 2006 reflect the impact of adopting SFAS 123(R). In accordance with the modified prospective method, the consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). See Note 9 for further details.

 

6

Table of Contents

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

 

Stock-based compensation expense recognized during the period is based on the value of the portion of stock-based payment awards that is ultimately expected to vest. Stock-based compensation expense recognized in the consolidated statement of operations during the first quarter of 2006 included compensation expense for stock-based payment awards granted prior to, but not yet vested, as of December 31, 2005 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 148 and compensation expense for the stock-based payment awards granted subsequent to December 31, 2005, based on the grant date fair value estimated in accordance with SFAS 123(R). As stock-based compensation expense recognized in the statement of operations for the first quarter of 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. In the pro forma information required under SFAS 148 for the periods prior to 2006, we accounted for forfeitures as they occurred.

 

(2)  New Accounting Pronouncements

 

In November 2005, the FASB issued FASB Staff Position SFAS 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (“FSP 115-1”).  FSP 115-1 addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impaired loss.  FSP 115-1 also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments.  The provisions of FSP 115-1 were adopted on January 1, 2006, and did not have a significant impact on the Company’s consolidated financial statements.

 

(3)  Discontinued Operations

 

Discontinued operations are comprised of two components previously reported as the Company’s residential and commercial mortgage banking business (“Mortgage”) and the consumer lending business conducted through the Company’s minority interest investment in Drive (“Consumer”).  Earnings (loss) from discontinued operations are summarized as follows:

 

 

Mortgage

 

At March 31, 2006, the only asset remaining from discontinued mortgage operations is an investment security resulting from the retention of a residual interest in a securitization transaction. This security is in “run-off,” and the Company is contractually obligated to service these assets.  The cash flows are collected over a period of time and are valued using prepayment assumptions of 32% for fixed rate loans and 33% for variable rate loans. Overall loss rates are estimated at 14% of collateral.  The Company recorded provisions of $66 and zero in the first three months of 2006 and 2005, respectively, for losses from discontinued mortgage operations.

 

In April 2005, the Company exercised an early purchase option on the 1998-1 securitization.  Loans receivable were recorded at $6.1 million in accordance with EITF 02-9, Accounting for Changes That Result in a Transferor Regaining Control of Financial Assets Sold.  FirstCity evaluated each loan at the acquisition date to determine whether there was evidence of credit deterioration since origination.  At March 31, 2006, the acquired loans are included in Portfolio Assets in the consolidated balance sheet and classified as either “loans acquired with credit deterioration” or “loans acquired without credit deterioration.”

 

Consumer

 

On September 21, 2004, FirstCity and certain of its subsidiaries entered into a definitive agreement to sell a 31% beneficial ownership interest in Drive Financial Services LP (“Drive”) and its general partner, Drive GP LLC, to IFA Drive GP Holdings LLC (“IFA-GP”), IFA Drive LP Holdings LLC (“IFA-LP”) and Drive Management LP (“MG-LP”) for a total purchase price of $108.5 million in cash, resulting in distributions and payments to FirstCity in the aggregate amount of $86.8 million in cash, from various

 

7

Table of Contents

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

 

sources.  The sale was completed on November 1, 2004, and net cash proceeds from these transactions were primarily used to pay off debt.

 

Pursuant to SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the consolidated financial statements have been reclassified for all periods presented to reflect the operations, assets and liabilities of the consumer business segment as discontinued operations.  There were no consumer assets held for sale as of March 31, 2006 and December 31, 2005.  The liabilities of such operations have been classified as “Liabilities from discontinued consumer operations,” respectively on the March 31, 2006 and December 31, 2005 balance sheets and consisted of state taxes payable at March 31, 2006.

 

(4)  Portfolio Assets

 

Portfolio Assets are summarized as follows:

 

 

Portfolio Assets are pledged to secure notes payable that are non-recourse to FirstCity or any affiliate other than the entity that incurred the debt.  See Note 2 to the Company’s 2005 Annual Report on Form 10-K for a description of the Revolving Credit agreement between FH Partners, L.P. and Bank of Scotland, which is guaranteed by FirstCity and the primary wholly-owned subsidiaries of FirstCity.

 

The Company recorded a provision for loan and impairment losses on Portfolio Assets of approximately $109 for the three month period ended March 31, 2006, which is comprised of $2 impairment charge on real estate portfolios and $107 allowance for loan losses.  For the three month period ended March 31, 2005, the Company recorded an allowance for impairment on Portfolio Assets of $85, which is comprised wholly of allowance for loan losses, with no impairment charge on real estate portfolios.

 

The change in the valuation allowance for loan losses for the quarters ended March 31, 2006 and 2005 respectively, are as follows:

 

 

8

Table of Contents

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

 

Changes in accretable yield at March 31, 2006 were as follows:

 

 

Loans acquired during each period for which it was probable at acquisition that all contractually required payments would not be collected follow.  There were no loans acquired during the first quarter of 2005.

 

 

(5)  Loans Receivable from Acquisition Partnerships Held for Investment

 

Loans receivable from Acquisition Partnerships held for investment consist primarily of loans from certain partnerships located in Mexico and are summarized as follows:

 

 

There were no provisions recorded on these loans during the first quarter of 2006 and 2005.  The loans receivable from Acquisition Partnerships are secured by the assets/loans acquired by the partnerships with purchase money loans provided by affiliates of the investors to the partnerships to purchase the asset pools held in those entities. These loans are evaluated for impairment by analyzing the expected future cash flows from the underlying assets within each pool to determine that the cash flows were sufficient to repay these notes. The Company applies the asset valuation methodology consistently in all venues and uses the same proprietary asset management system to evaluate impairment on all asset pools. The results of this evaluation indicated that cash flows from the pools will be sufficient to repay the loans and no allowances for impairment were necessary.

 

Equity method earnings (losses) which were recorded to reduce the loans and interest receivable from certain Mexican partnerships were $.3 million and ($.2) million during the first three months of 2006 and 2005, respectively, in compliance with EITF 98-13, Accounting by an Equity Method Investor for Investee Losses When the Investor Has Loans to and Investments in Other Securities of the Investee.

 

(6)  Equity Investments

 

The Company has investments in Acquisition Partnerships and their general partners and investments in servicing entities that are accounted for under the equity method.  The condensed combined financial position and results of operations of the Acquisition Partnerships (excluding servicing entities), which include the domestic and foreign Acquisition Partnerships and their general partners, are summarized below:

 

9

Table of Contents

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

 

 

 

10

Table of Contents

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

 

The assets and equity of the Acquisition Partnerships and equity investments in the Acquisition Partnerships are summarized by geographic region below. The WAMCO Partnerships represent limited partnerships and limited liability companies in which the Company has a common ownership with Cargill.  MinnTex Investment Partners LP is considered to be a significant subsidiary of FirstCity.

 

 

11

Table of Contents

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

 

Revenues and earnings (loss) of the Acquisition Partnerships and equity in earnings (loss) of the Acquisition Partnerships are summarized by geographic region below.

 

 

12

Table of Contents

 

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

 

Combining statements of operations for the WAMCO Partnerships follow. WAMCO XXX, WAMCO 31 and WAMCO 33 are considered to be significant subsidiaries of FirstCity.

 

Three Months Ended March 31, 2006