-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KDVEr+cIZSP9f350+fAh5ONGXgJnHLpMNnRn8TnF1JCtc2p+vnmbP57Pj+joZs7y kZuBxIC1YHRFmM17aMPJDg== 0000950144-99-002655.txt : 19990316 0000950144-99-002655.hdr.sgml : 19990316 ACCESSION NUMBER: 0000950144-99-002655 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990315 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SIRROM CAPITAL CORP CENTRAL INDEX KEY: 0000933166 STANDARD INDUSTRIAL CLASSIFICATION: LOAN BROKERS [6163] IRS NUMBER: 621583116 STATE OF INCORPORATION: TN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 814-00154 FILM NUMBER: 99565357 BUSINESS ADDRESS: STREET 1: 500 CHURCH STREET STREET 2: STE 200 CITY: NASHVILLE STATE: TN ZIP: 37219 BUSINESS PHONE: 6152560701 10-K/A 1 SIRROM CAPTIAL CORPORATION 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K/A (AMENDMENT NO. 1) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM __________ TO ____________ COMMISSION FILE NO.: 0-25174 SIRROM CAPITAL CORPORATION (exact name of Registrant as specified in its charter) TENNESSEE 62-1583116 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 500 CHURCH STREET SUITE 200 NASHVILLE, TENNESSEE 37219 (Address of principal executive offices) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (615) 256-0701 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: COMMON STOCK, NO PAR VALUE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE 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 periods as the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] On February 5, 1999, the aggregate market value of the Registrant's common stock held by nonaffiliates of the Registrant was approximately $249,317,560 based upon a closing price of the Registrant's common stock of $8.00 on that date and assuming executive officers and directors of the Registrant are affiliates. On February 5, 1999, there were 37,229,196 shares of the Registrant's common stock, outstanding. DOCUMENTS INCORPORATED BY REFERENCE Certain exhibits previously filed with the Securities and Exchange Commission are incorporated by reference into Part IV. 2 PART II ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following analysis of the financial condition and results of operations of Sirrom should be read in conjunction with the Selected Financial Data, Sirrom's Financial Statements and the Notes thereto and the other financial data included elsewhere in this Report. The financial information provided below has been rounded in order to simplify its presentation. However, the ratios and percentages provided below are calculated using the detailed financial information contained in the Financial Statements and the Notes thereto and the financial data included elsewhere in this Report. The financial information contained herein has been restated to reflect the operations of Harris Williams as an unconsolidated subsidiary of Sirrom accounted for by the equity method of accounting in conformity with the requirements of the 1940 Act. OVERVIEW 2 3 Sirrom's principal investment objectives are to achieve a high level of income by collecting interest and processing and financial advisory fees and long-term growth in its shareholders' equity through the appreciation in value of equity interests in its portfolio companies. Sirrom's loans are typically secured debt with relatively high fixed interest rates accompanied by warrants to purchase equity securities of the borrower. in addition to interest on investments, Sirrom also typically collects an up-front processing fee on each loan it originates. Harris Williams typically obtains a monthly retainer fee for each transaction for which it is retained and, in addition, a success fee when the transaction is consummated. RESULTS OF OPERATIONS Sirrom's financial performance in the statements of operations included in the financial statements and accompanying notes consists of four primary elements. The first is "net operating income," which is Sirrom's income from interest, dividends, fees and Harris Williams' pretax income, minus its total operating expenses, including interest expense. The second element is "net realized gain (loss) on investments," which is the proceeds received from the disposition of portfolio assets minus their stated costs at the beginning of the period. The third element is the "change in unrealized appreciation (depreciation) of investments," which is the net change in the fair values of Sirrom's portfolio assets compared with their fair values at the beginning of the period or their stated costs, as appropriate. Generally, "net realized gain (loss) on investments "and "change in unrealized appreciation (depreciation) of investments" are inversely related. When an appreciated asset is sold to realize a gain, a decrease in unrealized appreciation occurs since the gain associated with the asset is transferred from the "unrealized" category to the "realized" category. Conversely, when a loss is realized on a depreciated portfolio asset, the reclassification of the loss from "unrealized" to "realized" causes an increase in unrealized appreciation and an increase in realized loss. The fourth element is "provision for income taxes," which primarily consists of taxes on the pre-tax income of Harris Williams. Fiscal Years Ended December 31, 1998, 1997 and 1996 Net Operating Income. During the year ended December 31, 1998, Sirrom earned interest on investments of $63.5 million, a 53.7% increase over the $41.3 million earned in 1997, which in turn was an 69.3% increase over the $24.4 million earned in 1996. The increases in interest income are a result of increases in the average dollar amount of loans outstanding during the applicable 3 4 periods. Sirrom also collects an up-front processing fee for each loan it originates. During fiscal 1998, Sirrom collected $7.2 million in processing and other fees, a 2.9% increase over the $7.0 million collected in 1997, which in turn was a 118.7% increase over the $3.2 million collected in 1996. The modest increase in processing and other fees in 1998 are a result of the modest increase in the dollar amount of loans originated during 1998. The large increase in processing fees collected in 1997 over 1996 was a result of the large increase in loans originated in 1997 as compared to 1996. In the first quarter of 1999, Sirrom intends to change its accounting for processing fees. This change will entail amortizing processing fees over the life of the investment. While the change will not affect the amount of processing fees collected, it will significantly reduce the amount of processing fee income recognized over the next several years. The reduction will be significant because fees collected in previous years have been fully recognized and therefore will have no impact on income in future years. However, after this transition period, the ratio of fee income to new loan originations should return to historical levels because a portion of processing fees collected in prior years will be recognized as income in the current year. Sirrom's loan portfolio increased to $477.1 million at December 31, 1998, an increase of 15.8% from $412.0 million at December 31, 1997, which in turn was an increase of 86.0% from $221.5 million at December 31, 1996. The $301.8 million of loans originated during fiscal 1998 was a 6.9% increase over the $282.4 million of loans originated during fiscal 1997, which in turn was a 113.9% increase over the $132.0 million of loans originated in 1996. The decline in growth of originations in 1998 as compared to 1997 loan originations was a result of management's decision to slow growth as described in more detail in the section entitled "Portfolio Turnover and Credit Quality." The weighted average interest rate charged on the loan portfolio at December 31, 1998 was 13.25% as compared to 13.28% and 13.18% at December 31, 1997 and 1996, respectively. Sirrom also earned income from miscellaneous sources in an amount equal to $34,000 in 1998, $61,000 in 1997, and $119,000 in 1996, primarily from interest paid on loans to employees made in connection with purchases of common stock of Sirrom. Sirrom's interest expense increased to $17.3 million in 1998, a 76.5% increase over the $9.8 million paid in 1997, which in turn was an 18.1% increase over the $8.3 million paid in 1996. The increase in interest expense from 1996 to 1998 was primarily attributable to an increase in the average amount outstanding under Sirrom's two revolving credit facilities and from the SBA. Sirrom's total borrowings were $250.0 million on December 31, 1998, $214.3 million on December 31, 1997, and $120.9 million on December 31, 1996. Overhead and amortization of borrowing costs totaled $15.8 million in 1998, $9.2 million in 1997, and $5.5 million in 1996. These increases can be largely attributed to the increase in the number of employees from 24 in December 1996 to 61 in December 1998 (excluding Harris Williams employees), the opening of additional offices and increased borrowings. Overhead expenses as a percentage of average assets was 2.5%, 2.1%, and 2.0% for 1998, 1997 and 1996, respectively. The increase in these percentages in 1998 was largely the result of management's decision to reduce loan originations during the last half of the year and an expected one to two quarter lag in related expense reductions. During 1998, Harris Williams had revenues of $12.5 million, an increase of 26.3% over $9.9 million in 1997, which in turn was a 47.8% increase over $6.7 million in 1996. During 1998, Harris Williams had pre-tax income of $3.8 million, an increase of 2.7% over $3.7 million in 1997, which was in turn a 12.1% increase over $3.3 million in 1996. The modest increase in 1998 was due to an increase in the size of the fees received on the transactions on which Harris Williams provided advisory services and the increase in 1997 was due to an increase in the number of transactions closed. Harris Williams provided advisory services on 14 transactions that closed during 1998, and 15 transactions in 1997, and 13 transactions during 1996. Income taxes of $1.1 million, $825,000 and $207,000 were provided on Harris Williams' pre-tax income in 1998, 1997 and 1996, respectively. Realized Gain (Loss) on Investments. Sirrom's net realized loss on investments was $61.4 million during the year ended December 31, 1998 compared to a net realized gain on investments of $10.7 million and $9.5 million during 4 5 the years ended December 31, 1997, and 1996, respectively. Realized losses for 1998 were $84.0 million offset in part by $22.6 million in realized gains. Approximately one third of the net realized loss for the year ended December 31, 1998 was attributable to loans to two borrowers, Saraventures Fixtures, Inc. and Precision Panel Products, Inc., whose manufacturing operations were consolidated during 1998 as part of a restructuring strategy that was ultimately unsuccessful and another third was attributable to the final resolution of loans that had been graded 4, 5 or 6 for at least one year. The net realized loss for 1998 was also increased by the reduction in realized gains during the second half of 1998. As a result of the decline in stock market valuations in the second half of 1998 and the virtual cessation of initial public offerings that followed. The following table sets forth the details of realized gains and losses that occurred during the year ended December 31, 1998. Schedule of realized gains (losses) for the year ended December 31, 1998.
Year Ended December 31, 1998 -------------- (in thousands) Vista Information Solutions, Inc. common stock $ 4,246 Hoveround Corporation warrants 4,100 Network Event Theaters, Inc. common stock 3,374 Master Graphics, Inc. common stock 2,203 NOVA Corporation common stock 1,360 Multimedia Learning, Inc. warrant 1,170 Towne Services, Inc. common stock 1,116 Hunt Leasing & Rental Corporation warrants 598 Bohdan Automation, Inc. warrants 477 PMTS Services, Inc. warrants 469 Atlantic Security Systems, Inc. warrants 434 QuadraMed Corporation common stock 357 Merge Technologies, Inc. common stock 355 Patton Management Corporation warrants 303 Voice FX Corporation common stock 245 Family Golf Centers, Inc. common stock 237 CellCall, Inc. common stock 228 Global Marine Electronics, Inc. warrants 200 Skillmaster, Inc. warrant 200 Protect America, Inc. warrants 185 Outdoor Promotions, LLC warrants 182 UOL Publishing, Inc. common stock 173 Quadravision Communications Limited warrant 156 Video Update common stock 99 Encore Medical corporation stock 17 Just Vacations, Inc. Foreign Exchange loan (59) Fypro, Inc. loan (79) Sherwood, Inc. preferred stock (100) Miscellaneous (110) Assured Power, Inc. loan (200) Valdawn Watch Company preferred stock (240) BankCard Services, Inc. loan (277) Hydrofuser Industries, Inc. loan (295) Home Link Services, Inc. loan (298) TCOM Systems, Inc. loan (346) National Health Systems, Inc. loan (420) H.S.A. International other investment (441) KWC Management Co., LLC loan (500) Sherwood, Inc. loan (500) Sirvys Systems loan (704) C.J. Spirits, Inc. loan (758) Daxxes Corporation loan (848) SWS6, Inc. loan (994)
5 6 Schedule of realized gains (losses) for the year ended December 31, 1998 - -- (continued)
Year Ended December 31, 1998 ------------- (in thousands) Home Link Services, Inc. preferred stock (1,000) Newfoundland Career Academy, Ltd. loan (1,160) Champion Glove Manufacturing, Inc. loan (1,250) Hancock Company other investment (1,400) Workout expenses (1,538) NRI Service and Supply, L.P. loan (1,550) IJL Holdings, Inc. loan (1,600) IOL 2000/Suncoast Medical Group loan (1,628) Wearever Health Products, LLC loan (1,650) Saraventures Fixtures, Inc. preferred stock (1,659) Multimedia 2000, Inc. common and preferred stock (2,085) Aero Products Corporation loan (2,300) Nationwide Engine Supply, Inc. loan (2,300) Summit Publishing Group, Ltd loan (2,375) Vision 2000, Inc. loan (2,403) Amscot Holdings, Inc. loan (2,437) SWS6, Inc. preferred stock (2,449) GC Management, Inc. loan (2,500) Valdawn Watch Company loan (3,022) Digital Transmission Systems, Inc. loan (3,500) Vision 2000, Inc. common and preferred stock (4,247) Fypro, Inc. preferred stock (4,659) Fulcrum Direct, Inc. loan (5,000) Mesa International, Inc. loan (5,667) Saraventures Fixtures, Inc. loan (8,478) Precision Panel, Inc. loan (8,892) -------- $(61,434) ========
Change in Unrealized Appreciation (Depreciation) of Investments. For the year ended December 31, 1998, Sirrom recorded a change in unrealized depreciation of $55.3 million. Sirrom recorded change in unrealized depreciation of investments of $1.6 million in 1997 and change in unrealized appreciation of investments of $2.6 million in 1996. The significant change in unrealized depreciation for 1998 was the result of the increase in the number and dollar amount of loans (from $76.7 million to $136.5 million) graded 4, 5 and 6 at December 31, 1998 versus December 31, 1997, and the additional unrealized depreciation taken against loans in those categories based upon with Sirrom's experience in 1998 that the amount ultimately recovered on loans graded 4, 5 and 6 was less than previously anticipated. The following table sets forth information regarding changes in unrealized appreciation (depreciation) of investments made during the year ended December 31, 1998.
Year Ended December 31, 1998 ------------------- (in thousands) LOANS: 2021 Interactive, LLC $ (1,250) Action Sports Group, LLC (750) Affinity Fund, Inc. (1,000) Air Age Services of San Antonio, Inc. (500) Altris Software, Inc. (2,571) Capital Network Systems, Inc. (1,000) Amscot Holdings, Inc. (900) Assured Power, Inc. 150 Auburn International, Inc. (2,375) Avionics Systems, Inc. (1,500) B & N Company, Inc. (2,600) Bankcard Services Corporation 150 BroadNet, Inc. (1,750) Bug Z., Inc. (1,500)
6 7 Schedule of significant unrealized appreciation (depreciation) for the year ended December 31, 1998 -- (continued)
Year Ended December 31, 1998 ------------- (in thousands) LOANS: CONTINUED Caldwell/VSR, Inc. (125) Cardiac Control Systems, Inc. (500) Carter Kaplan Holdings, LLC 549 Cedaron Medical, Inc. (500) Champion Glove Manufacturing Co., Inc. 1,200 C.J. Spirits, Inc. 650 Compass Plastics & Technologies, Inc. (6,686) Compression, Inc. (4,350) Corporate Link, Inc. (325) Cover-All Technologies, Inc. (2,700) Cybo Robotics, Inc. (275) Cytech Systems, Inc. (1,240) Dalts, Inc. (500) Data National Corporation (425) Digital Transmission Systems, Inc. (500) DynaGen, Inc. (900) Ergobilt, Inc. (1,800) Executrain (250) Express Shipping Centers, Inc. (2,150) Fortrend Engineering Corp. (1,000) Fypro, Inc. 150 GC Management, Inc. 250 Gloves, Inc. (1,500) Good Food Fast Companies, The (2,600) Great Train Store Company (750) H.S.A. International, Inc. other investment 250 Hancock Company other investment 1,250 Hunt Industries (100) IOL 2000, Inc. 1,225 Jim Bridges Acquisition Company (1,500) KOS Corp. Industries (200) KWC Management Company, LLC 450 Leisure Clubs International, Inc. (350) M.A.P.A., Inc. (2,325) MCG, Inc. (150) Mead-Higgs Company, Inc. (1,400) Multimedia 2000, Inc. (4,050) National Health Systems, Inc. 300 Nationwide Engine Supply, Inc. (100) NRI Service & Supply L.P. (400) Omni Home Medical, Inc. (450) One Call Comprehensive Care, Inc. (1,475) Pacific Linen, Inc. (2,000) Pipeliner Systems, Inc. 100 Recompute Corporation (600) Reef Chemical Company, Inc. (1,500) Rynel Ltd., Inc. (700) Saraventures Fixtures, Inc. 3,500 SFG Technologies Inc. (125) Sheet Metal Specialties, Inc. (325) Smartchoice Automotive Group, Inc. (650) Southern Specialty Brands, Inc. (175) Street Level Media Inc. (225) SWS3, Inc. other investment (250) TAC Systems, Inc. (900) Talent Metal Products (2,300) Telecontrol Systems, Inc. (200) Teltronics, Inc. (687) Tie & Track Systems, Inc. (750) Toccoa Associates, LLC (325) Tulsa Industries, Inc. (3,000) Umbrellas Unlimited, LLC (150) Universal Automotive Industries, Inc. (1,125) Valdawn Watch Company 635 Vision 2000, Inc. 250 Wearever Health Products, LLC (500) Wolfgang Puck Food Company, Inc. (500) Workout expenses other investment (350) Other Loans (236)
7 8 Schedule of significant unrealized appreciation (depreciation) for the year ended December 31, 1998 -- (continued)
Year Ended December 31, 1998 ------------- (in thousands) PRIVATE COMPANY EQUITY SECURITIES: Bravo Corporation common stock (350) DentalCare Partners, Inc. common stock (300) Front Royal, Inc. common stock 150 Fypro, Inc. preferred stock 611 Home Link, Inc. preferred stock 250 Multimedia 2000, Inc. preferred stock 1,973 PaySys International, Inc. common stock (175) Pipeliner Systems, Inc. preferred stock 200 Potomac Group, Inc. common stock 3,901 Potomac Group, Inc. preferred stock (1,000) Recycling Technologies, Inc. preferred stock (1,050) Saraventures Fixtures, Inc. preferred stock 1,659 Valdawn Watch Co., Inc. preferred stock 240 Vision 2000, Inc. common stock (175) Vision 2000, Inc. preferred stock 1,375 Zahren Alternative Power Corp. common stock 165 Zahren Alternative Power Corp. preferred stock (100) Other Private Company Equity Securities (65) PRIVATE COMPANY WARRANTS: American Rockwool Acquisition Corp. 675 Anton Airfoods, Inc. 350 Auburn International, Inc. (150) CF Data Corp. (150) Check into Cash, Inc. 3,839 CMHC Systems, Inc. 200 Columbus Medical Holdings, LLC 300 Co-Mack Technologies, Inc. (400) CSM, Inc. 150 Data National Corporation (450) Dyntec, Inc. 350 Endeavor Technologies, Inc. 5,025 Entek Scientific Corporation (350) Express Shipping Centers, Inc. (262) FaxNet Corporation 325 Front Royal, Inc. 350 GerAssist, Inc. 225 Gulfstream International Airlines, Inc. (130) Hoveround Corporation (3,750) Hunt Leasing & Rental Corporation (250) I. Schneid Holdings, LLC 150 ILD Communications, Inc. 500 Master Graphics, Inc. 1,050 Mesa International, Inc. (750) Metrolease, Inc. 470 Mobility Electronics, Inc. 950 Moore Diversified Products, Inc. 200 Multimedia Learning, Inc. (450) Mytech Corporation 175 NASC, Inc. 250 One Coast Network Corporation 1,700 Outdoor Promotions LLC 100 Pacific Linen, Inc. (548) Pathology Consultants of America, Inc. 500 Patton Management Corporation (185) Physicians Surgical Care, Inc. 407 Pritchard Paint & Glass Company 750 R&R International, Inc. 325 Ready Personnel, Inc. 1,100 Reef Chemical Company, Inc. (300) Relax the Back Corporation 700 Relevant Knowledge, Inc. 150 Stratford Safety Products, Inc. 175 Systech Group, Inc. 300 Talus Solutions, Inc. 200 Telecommunications Systems, Inc. 300 Teltrust, Inc. 825 Towne Services, Inc. 1,500 TRC Acquisitions, Inc. 100 Vision Software, Inc. 600 Voice FX Corporation (250) Wearever Health Products LLC (250) Zahren Alternative Power Corp. 350 Other Private Company Warrants 103
8 9 Schedule of significant unrealized appreciation (depreciation) for the year ended December 31, 1998 -- (continued)
Year Ended December 31, 1998 ----------------- (in thousands) PUBLIC COMPANY WARRANTS AND EQUITY SECURITIES: ACT Teleconferencing, Inc. warrants (368) Altris Software, Inc. warrants (450) Altris Software, Inc. preferred stock (3,000) Biker's Dream, Inc. warrants 391 Clinicor, Inc. preferred stock (1,650) Compass Plastics & Technologies, Inc. common stock (1,878) Compass Plastics & Technologies, Inc. warrants (385) Consumat Systems, Inc. common stock (579) Dreams, Inc. warrants 302 Environmental Tectonics Corp. preferred stock 275 Ergobilt, Inc. warrants (182) Family Golf Centers common stock (250) Great Train Store Company warrants (110) Master Graphics, Inc. common stock (2,000) Medical Resources Inc. common stock (320) Merge Technologies, Inc. common stock (500) Network Event Theatres, Inc. common stock 780 Nova Corp. common stock (1,197) PMT Services, Inc. common stock 697 Premiere Technologies, Inc. common stock (430) Quadramed Corporation common stock (209) Recompute Corporation warrants 164 Smart Choice Automotive Group, Inc. warrants (150) Tava Technologies, Inc. warrants 110 Teltronics, Inc. preferred stock (650) Teltronics, Inc. warrants (102) Towne Services, Inc. common stock (580) UOL Publishing, Inc. common stock (354) Vista Information Solutions, Inc. common stock (3,385) Vista Information Solutions, Inc. warrants (185) Vista Information Solutions, Inc. preferred stock 650 Other public company warrants and equity securities (222) Amortization of loan discount 1,814 ---------- $ (55,336) ==========
Provision for Income Taxes. Beginning in February 1995, Sirrom elected to be taxed as a RIC as defined by the Internal Revenue Code. If Sirrom, as a RIC, satisfies certain requirements relating to the source of its income, the diversification of its assets and the distribution of its net income, Sirrom is generally taxed as a pass through entity that acts as a partial conduit of income to its shareholders. To maintain its RIC status, Sirrom must, in general: derive at least 90% of its gross income from dividends, interest and gains from the sale or disposition of securities; meet investment diversification requirements defined by the Internal Revenue Code; and distribute to shareholders at least 90% of its net income (other than long-term capital gains). Neither Sirrom, SII nor SFC will elect to be treated as a RIC in 1999. Therefore, in 1999 Sirrom, SII and SFC will make provisions for income taxes to the extent appropriate. During 1998, Sirrom paid dividends of $32.7 million compared to the $24.4 million paid in 1997 and $11.7 million paid in 1996. Of these dividends, $7.5 million, $16.9 million, and $11.0 million were derived from net operating income for 1998, 1997 and 1996, respectively, and $8.8 million, $7.5 million, and $577,000 million were derived from realized capital gains for 1998, 1997 and 1996, respectively. The remaining $16.3 million paid in 1998 was accounted for as a return of capital. Sirrom also elected to designate $10.6 million of the undistributed realized capital gains in 1996 as a "deemed" distribution to shareholders of record as of the end of 1996. Accordingly, $6.9 million for 1996, net of taxes of $3.7 million, of this "deemed" distribution has been retained and reclassified from undistributed net realized earnings to Common Stock. As a result of the realized losses taken by Sirrom in the third and fourth quarters of 1998, Sirrom was not required under the RIC regulations to pay additional dividends to shareholders. Therefore, in order to preserve capital, SCC elected not to pay dividends during the last half of 1998. As stated above, Sirrom will not elect to be treated as a RIC in 1999 and therefore does not presently intend to pay dividends in 1999. For the years ended December 31, 1998, 1997 and 1996, Sirrom also provided for federal income tax at a 35% rate on undistributed long-term capital gains and excise tax at a 4% rate on undistributed taxable net investment income and undistributed realized long-term capital gains and provided for federal and state 9 10 income taxes on Harris Williams' pre-tax income. These tax provisions totaled $1.1 million, $838,000, and $4.3 million for the years ended December 31, 1998, 1997 and 1996, respectively. FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES At December 31, 1998, Sirrom had $2.4 million in cash and cash equivalents. At December 31, 1998, Sirrom's investment portfolio included investments in stocks and warrants of publicly-traded companies that had an ascertainable market value and were being carried at a fair value of approximately $7.8 million and represent an additional source of liquidity. However, Sirrom's ability to realize such values on a short-term basis is limited by market conditions and various securities law restrictions. Traditionally, Sirrom's principal sources of capital to fund its portfolio growth have been borrowings of SII through the SBA-sponsored SBIC debenture program, private and public sales of Sirrom's equity securities and funds borrowed from banking institutions. In February 1995, Sirrom consummated an initial public offering and has completed four additional public offerings since that time, including a public offering of 6,000,000 shares of common stock completed in March 1998. These offerings have generated net proceeds of $361.5 million in the aggregate. Sirrom has used the proceeds of these offerings to temporarily repay debt and to originate new loans. At December 31, 1998, total SBA borrowings were $101.0 million, the maximum amount of SBA loans available to an SBIC at that time. Each borrowing from the SBA has a term of ten years, is secured by the assets of SII, is guaranteed by Sirrom and can be prepaid without penalty after five years. The average interest rate on these borrowings was 6.9% as of December 31, 1998, and none of these borrowings mature before 2002. Because the significant realized losses Sirrom recorded during fiscal 1998 would have caused a breach of certain asset quality covenants contained in the First Union credit facility, Sirrom repaid approximately $9.4 million outstanding under the facility on January 21, 1999 and terminated the commitment extended thereunder. In connection with the termination of the First Union credit facility, Sirrom obtained the consent of the SBA to transfer approximately $45.8 million of assets from SII to Sirrom. These assets will be used as additional collateral to be sold to SFC which will allow additional borrowings under the ING credit facility. Sirrom has also established the $200 million ING credit facility. SFC, a wholly owned, special purpose, bankruptcy remote subsidiary of Sirrom, is the borrower under the ING credit facility. SFC purchases loans originated by Sirrom and the related warrants and uses these loans and warrants as collateral to secure borrowings from ING. SFC is generally able to borrow up to 70% of the principal amount of conforming loans collateralizing the ING credit facility. At December 31, 1998, $132.2 million was outstanding under the ING credit facility and $258.5 million and $266.3 million of loans and warrants at cost and fair value, respectively, were collateralizing the ING credit facility. To manage interest rate risk associated with the variable interest rate under the ING credit facility, Sirrom has entered into various hedging arrangements. Sirrom may borrow under the ING credit facility until December 31, 2001, and it expires on January 5, 2007. The ING credit facility is not guaranteed by Sirrom. However, certain actions by Sirrom can trigger an event of default under the ING credit facility, including a reduction in Sirrom's tangible net worth below approximately $270.0 million. These would cause termination of further funding and the application of the collateral pledged for repayment of the amounts outstanding under the ING credit facility. In addition, the ING credit facility provides that an event of default is triggered if any two of George M. Miller, II, David M. Resha and Carl W. Stratton are no longer employed by Sirrom. 10 11 Sirrom believes that anticipated borrowings under the ING credit facility, together with cash on hand, loan repayments and cash flow from operations plus realized gains on investments, will only be adequate to fund the continuing growth of Sirrom's investment portfolio through the second quarter of 1999. Sirrom presently anticipates that it will be able to consummate the proposed merger transaction with the FINOVA Group, Inc., which transaction will provide for continued growth of the loan portfolio. In the event that Sirrom does not complete the transaction, Sirrom will need to incur additional short and long-term borrowings from other sources, and sell equity in private transactions or sell certain non-core business assets, in order to provide the funds necessary for Sirrom to continue its growth strategy beyond that period. The availability and terms of borrowings, sales of equity and sales of assets, will depend upon market conditions, the interest rate environment and various other conditions, including the performance of Sirrom's portfolio. There can be no assurances that additional funding will be available on terms acceptable to Sirrom and failure to procure additional funding would require Sirrom to significantly reduce its loan originations which would materially affect its profitability and market presence. PORTFOLIO TURNOVER AND CREDIT QUALITY During the year ended December 31, 1998, Sirrom made loans to 178 companies totaling approximately $301.8 million and received repayments (either partial or full) from 66 companies aggregating $94.9 million. During the year ended December 31, 1997, Sirrom made loans to 150 companies totaling approximately $282.3 million and received repayments (either partial or full) from 47 companies aggregating $67.7 million. During the year ended December 31, 1996, Sirrom made loans to 84 companies totaling approximately $132.0 million and received repayments (either partial or full) from 24 companies aggregating $32.6 million. Since inception, Sirrom has originated $901.0 million in total loans and $220.2 million, or 24.4% have been repaid. Sirrom cannot control changes in its portfolio of investments, as borrowers have the right to prepay loans made by Sirrom without penalty. Sirrom has implemented a system by which it grades all loans on a scale of 1 to 6. The system was intended to reflect the performance of the borrower's business, as well as the collateral coverage of the loans and other relevant factors. To monitor and manage the risk in the overall portfolio, management tracks the weighted average portfolio grade. The weighted average grade was 3.26 and 3.04 at December 31, 1998 and 1997, respectively. Sirrom believes that weighted average grades between 2.75 and 3.25 represent the current normal range for the portfolio. Management believes that loans with a grade 1 involve the least amount of risk in Sirrom's portfolio, as the borrower is performing well above expectations financially, and other risk factors are clearly favorable. Management believes that loans with a grade 2 involve low risk relative to other loans in Sirrom's portfolio, as the borrower is performing above expectations financially and the majority of risk factors are favorable. Management believes that loans with a grade 3 involve an acceptable risk, as the borrower is performing as expected financially and the other risk factors are generally favorable. Loans graded 4 typically involve a borrower that is performing marginally below expectations and the existence of short-term negative trends or negative events that have created some concern. Sirrom's management believes that loans in this category require a proactive action plan to be executed by the borrower's management and monitored by the responsible Company officer. A grade 4 is typically a temporary rating that is followed by an upgrade or downgrade within six months as the borrower's business improves or declines. As of December 31, 1998 and 1997, Sirrom's portfolio consisted of 32 and 18 loans, respectively, graded 4. The aggregate principal balance of loans graded 4 at December 31, 1998 11 12 and 1997, respectively, was $66.9 million and $49.0 million, which represented 11.9% and 10.2%, respectively, of the total portfolio balance at such dates. Loans graded 5 and 6 are placed on Sirrom's Credit Watch List and are serviced by a member of Sirrom's workout group. Loans with a grade 5 are generally in default and interest is generally not being accrued, but Sirrom's management believes the borrower's management is capable of executing a plan to return the borrower to an acceptable risk level. Loans with a grade 6 involve an unacceptable level of risk with substantial probability of loss. These loans are on non-accrual and Sirrom has charged off or expects to charge off a significant part of the loan. At December 31, 1998 and 1997, Sirrom had loans to 31 companies with an aggregate principal balance of $69.2 million and 16 companies with an aggregate principal balance of $27.7 million, respectively, that were graded a 5 or 6 and that were not accruing interest, which represented 12.3% and 6.5%, respectively, of the total portfolio balance. Since late 1995 when Sirrom refined its loan grading system to reflect management's additional experience in monitoring its growing portfolio, the percentage of the principal balance of loans graded 4 to the total portfolio balance has typically ranged between 10% and 15%, with an occasional decrease below that range. Also since that time, the percentage of the principal balance of loans graded 5 and 6 to the total portfolio balance has typically ranged between 6% and 10%. Given the nature of Sirrom's business, making loans to small companies, and the risks associated with this business, Sirrom expects the absolute dollar amount of loans graded 4, 5 and 6 and the ratio of these loans to the total portfolio to vary greatly, individually and in the aggregate, on a quarter to quarter basis. Sirrom believes the percentage of grade 4 loans at December 31, 1998 to be within the current normal range of variability. Sirrom also believes the percentage of grade 5 and 6 loans to be above the current normal range of variability as a result of a combination of factors, including the following: - The substantial growth in the portfolio over the last two years, coupled with the concept that non-performance on new loans typically comes early in the loan's life cycle, has significantly impacted the percentage increase of loans graded 4, 5 and 6. - Due to the tightening of credit standards within many commercial banks and other lenders during the second half of 1998, senior lenders to certain of Sirrom's portfolio companies have instituted interest payment blockages with respect to Sirrom's loans under circumstances in which they might not have done so in the past. These interest payment blockages have caused the loans to be put on Sirrom's credit watch list when they otherwise would not have been placed on the list. Sirrom is closely monitoring the recent upward trend in the ratio of loans in the lower three credit grades to the total portfolio, has decided to reduce the rate of growth of loan originations and continues to redefine its operating model to seek to improve overall asset quality. A full discussion of the operating changes made during the second half of 1998 is included in Item 1 under the heading "Operations." No assurance, however can be given that the trends in total loans classified in the lower three loan categories will not continue, or that the total loans classified 5 and 6 will not continue to grow, particularly if overall economic conditions nationally, internationally or in the Southeastern United States deteriorate. YEAR 2000 COMPLIANCE The Year 2000 issue, in general terms, is that many existing computer systems and microprocessors with date-based functions, including non-information technology equipment and systems, use only two digits to identify a year. This 12 13 equipment and systems assumes that the first two digits of the year are always "19." Consequently, on January 1, 2000, computers that are not Year 2000 compliant may read the year as 1900. The concern is that systems that calculate, compare or sort using the incorrect date may malfunction. If these malfunctions are not corrected, business operations could be disrupted. In an attempt to prevent these problems, Sirrom has begun implementing a Year 2000 compliance program. Sirrom created a Year 2000 Compliance Committee that is focusing on three primary areas of concern: Sirrom's information technology and other systems, third parties and portfolio companies. Most of the software used in Sirrom's information technology systems is provided by outside vendors. Sirrom uses two primary software programs, one to track its investment portfolio and one to provide accounting functions. These programs have been designated as Year 2000 compliant by the vendors. Additionally, Sirrom will either conduct its own tests for compliance or use third party test results. Approximately 90% of Sirrom's remaining vendors have provided software or software upgrades designated by the software vendor as Year 2000 compliant. In addition, Sirrom has developed a Year 2000 contingency plan to address vendor-supplied software which does not meet Sirrom's Year 2000 compliance deadlines. Sirrom's non-information technology systems used to conduct business at its facilities consist primarily of office equipment besides computers and communications equipment. Sirrom has inventoried its non-information technology systems and has contacted its office equipment vendors to determine the status of their Year 2000 readiness. Sirrom does not currently believe that it faces material adverse issues for its non-information technology systems. Sirrom has been actively communicating with third parties about the status of their Year 2000 readiness. These third parties include Sirrom's banks, vendors, landlords and suppliers of telecommunication services and other utilities. As part of the process of evaluating its options and attempting to mitigate third party risks, Sirrom is collecting and analyzing information from third parties. Sirrom is also investigating the impact of the Year 2000 issue on its portfolio companies. Beginning in February 1998, Sirrom submitted a series of questionnaires to its portfolio companies as of December 31, 1997, to determine their potential exposure to Year 2000 problems and the adequacy of their plans to address any exposure. Additionally, since January 1998, Sirrom has performed due diligence regarding the Year 2000 issue for all new borrowers. Sirrom plans to complete its evaluation of its portfolio companies and will then complete any necessary follow up by March 31, 1999 with those portfolio companies whom Sirrom believes have material exposure and inadequate contingency plans. Based upon the disclosure received from the responding companies, Sirrom believes that companies whose loans represent approximately 90% of its portfolio have either no material exposure to Year 2000 or are finalizing their contingency plans to address this exposure. Sirrom has not made a determination with respect to the balance of its portfolio as it is in the process of finalizing its review of those companies. Through March 31, 1999, Sirrom will continue with the testing and remediation of its information technology and non-information technology systems and the evaluation of its third party and portfolio company Year 2000 risks. Sirrom will take further steps designed to reduce its exposure to these risks. Sirrom will also further develop its contingency plan for business continuation in the event of a Year 2000 systems failure. This contingency plan is based upon Sirrom's existing disaster recovery plan with modifications for Year 2000 risks. Because Sirrom has maintenance contracts with most of its software vendors, it has not been required to purchase most of the software upgrades necessary to insure Year 2000 compliance. As a result, the cost of Sirrom's Year 2000 project is expected to be relatively minor, not exceeding $200,000. This amount includes the costs of: 13 14 - additional software; - Sirrom's systems professionals dedicated to achieving Year 2000 compliance for Sirrom's information technology systems; - the costs of analyzing the Year 2000 readiness of the portfolio companies; and - other employee and management costs. Sirrom has included the cost of the Year 2000 project in its annual budgets for information technology. Sirrom has postponed some minor non-Year 2000 information technology expenditures and initiatives until after 2000 so it can concentrate resources on the Year 2000 issue. Sirrom does not expect that this postponement will have a material effect on Sirrom's financial condition and results of operations. It is hard to predict the effect of Year 2000 non-readiness on the business of Sirrom. Significant Year 2000 failures in Sirrom's systems or in the systems of third parties could have a material adverse effect on Sirrom's business. Given the size and age of its portfolio companies and the service-based industries in which they primarily operate, Sirrom anticipates that few of its portfolio companies will face any material issues regarding the Year 2000. However, no assurance can be given that some of Sirrom's portfolio companies will not suffer material adverse effects from Year 2000 issues. If the adverse effects impact the companies' ability to repay their loans, Sirrom's operating results and financial condition could be adversely effected. Sirrom believes that its reasonably likely worst case Year 2000 scenario is a material increase in Sirrom's credit losses due to Year 2000 problems for Sirrom's portfolio and disruption in financial markets causing liquidity stress to Sirrom. The magnitude of these potential credit losses or disruption cannot be determined at this time. IMPACT OF INFLATION Sirrom does not believe that inflation materially affects its business, other than the impact that it may have on the securities markets, the valuations of business enterprises and the relationship of the valuations to underlying earnings. Those could all influence the value of Sirrom's investments. 14 15 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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 in Nashville, Tennessee, on this 15th day of March, 1999. SIRROM CAPITAL CORPORATION By: /s/ George M. Miller, II ------------------------------ George M. Miller, II Chief Executive Officer 15 -----END PRIVACY-ENHANCED MESSAGE-----