CALIFORNIA FIRST LEASING CORP - Quarter Report: 2005 September (Form 10-Q)

The accompanying notes are an integral part
of these consolidated financial statements.

The accompanying notes are an integral part
of these consolidated financial statements.

The accompanying notes are an integral part
of these consolidated financial statements.

In the opinion of management, the unaudited financial statements contain all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the balance sheet as of September 30, 2005 and the statements of earnings and cash flows for the three-month periods ended September 30, 2005 and 2004. The results of operations for the three-month period ended September 30, 2005 are not necessarily indicative of the results of operations to be expected for the entire fiscal year ending June 30, 2006.

NOTE 2 - STOCK-BASED COMPENSATION

During the quarter ended September 30, 2005, the Company recognized pre-tax stock-based compensation expense of $46,837 as a result of adopting SFAS 123R. Such expense related to options granted during the fiscal years ended June 2001 through June 2004. The Company has not awarded any new grants since fiscal 2004 and has calculated the stock-based compensation expense based upon the original grant date fair value as allowed under SFAS No. 123R. The valuation variables utilized at the grant dates are discussed in the Company's Annual Report on Form 10-K in the respective years of the original grants. As of September 30, 2005, approximately $348,000 of total unrecognized compensation expense related to unvested shares is expected to be recognized over a weighted average period of approximately 2 years.

The following table summarizes the stock option activity for the periods indicated:

(1) All options granted during the year ended June 30, 2005 were the result of the special dividend in December 2004, which resulted in all unexercised options as of the record date being re-priced under FIN 44 to preserve the economic benefit of the stock options at such time.

The Company has two leasing subsidiaries, California First Leasing Corporation ("CalFirst Leasing") and Amplicon, Inc. ("Amplicon"), collectively the "Leasing Companies". The Company has a bank subsidiary, California First National Bank ("CalFirst Bank" or the "Bank"), which is an FDIC-insured national bank.

     The Company's direct finance income includes interest income earned on the Company's investment in lease receivables and residuals. Other income primarily includes gains realized on the sale of leased property, income from sales-type and operating leases and gains realized on the sale of leases, and other fee income. Income from sales-type leases relates to the re-lease of off-lease property ("lease extensions") and new lease transactions that qualify as sales-type leases, generally where the fair value of the property subject to the lease differs from the Company's carrying cost. Income from operating leases generally involves the re-lease of off-lease property that is booked as an operating lease rather than as a sales-type lease.

     The Company's operating results are subject to quarterly fluctuations resulting from a variety of factors, including the volume and profitability of leased property being re-marketed through re-lease or sale, the size and credit quality of the lease portfolio, the interest rate environment, the volume of new lease originations, including variations in the mix and funding of such originations, and economic conditions in general. The Company's principal market risk exposure is interest rate risk, which is the exposure due to differences in the repricing characteristics of interest-earning assets and interest-bearing liabilities. The Company's balance sheet structure is primarily short-term in nature, with a greater portion of assets that reprice or mature within one year. As a result, changes in interest rates in general have a greater impact on the yield earned on the investment in lease receivables, securities and other interest earning assets, with less impact on interest-bearing liabilities.

     The Company conducts its leasing business in a manner designed to mitigate risks. However, the assumption of risk is a key source of earnings in the leasing and banking industries and the Company is subject to risks through its investment in lease receivables held in its own portfolio, lease transactions in process, and residual investments. The Company takes steps to manage risks through the implementation of strict credit management processes and on-going risk management review procedures.

     The preparation of the Company's financial statements requires management to make certain critical accounting estimates that impact the stated amount of assets and liabilities at a financial statement date and the reported amount of income and expenses during a reporting period. These accounting estimates are based on management's judgment and are considered to be critical because of their significance to the financial statements and the possibility that future events may differ from current judgments, or that the use of different assumptions could result in materially different estimates. The critical accounting policies and estimates have not changed from and should be read in conjunction with the Company's Annual Report filed on Form 10-K for the year ended June 30, 2005.

     The Company's estimates are reviewed continuously to ensure reasonableness. However, the amounts the Company may ultimately realize could differ from such estimated amounts.

Overview of Results and Trends

     The following discussion is provided in addition to the required analysis of earnings in order to discuss trends in our business. We believe this analysis provides additional meaningful information on a comparative basis.

Consolidated Statement of Earnings Analysis

      Summary -- For the first quarter ended September 30, 2005, net earnings of $2.4 million increased 53% from $1.6 million for the first quarter ended September 30, 2004. Diluted earnings per share increased 50% to $.21 for the quarter ended September 30, 2005, compared to $.14 per share for the same quarter of the prior year. The smaller increase in diluted earnings per share compared to net earnings reflects the impact of a larger number of diluted shares outstanding during the period.

      Net Direct Finance and Interest Income -- Net direct finance and interest income is the difference between interest earned on the investment in capital leases, securities and other interest earning investments and interest paid on deposits or other borrowings. Net direct finance and interest income is affected by changes in the volume and mix of interest earning assets, the movement of interest rates, and funding and pricing strategies.

     Net direct finance and interest income was $4.8 million for the quarter ended September 30, 2005, compared to $4.3 million for the quarter ended September 30, 2004, an increase of $469,000, or 12%. Direct finance income of $5.0 million increased by $728,000, or 17%, as a result a higher average investment in capital leases held in the Company's own portfolio offset slightly by lower average yields. The average yield on the portfolio was down due to in part to market conditions and as a result of a higher percentage of tax-exempt leases in the portfolio. The increase of $34,000 in interest and investment income is due to improved yields on lower investment balances. Interest expense on deposits was $458,000 for the first quarter of fiscal 2006 compared to $165,000 for the same quarter of the prior year, reflecting a 104% increase in the average balances of interest bearing deposits and an increase in the average interest rates paid.

    The following table presents the components of the increases (decreases) in net direct finance and interest income before provision for lease losses by volume and rate:

    The following tables present the Company's average balance sheets, direct finance income and interest earned or interest paid, the related yields and rates on major categories of the Company's interest-bearing assets and interest-bearing liabilities. Yields/rates are presented on an annualized basis.

      The Company monitors the performance of all leases held in its own portfolio, transactions in process, as well as lease transactions assigned to lenders, if the Company retains a residual investment in the leased property subject to those leases. An ongoing review of all leases ten or more days delinquent is conducted. Lessees who are delinquent with the Company or an assignee are coded in the Company's accounting and tracking systems in order to provide management visibility, periodic reporting, and appropriate reserves. The accrual of interest income on leases will generally be discontinued when the lessee becomes ninety days or more past due on its lease payments with the Company, unless the Company believes the investment is otherwise recoverable. Leases may be placed on non-accrual earlier if the Company has significant doubt about the ability of the lessee to meet its lease obligations, as evidenced by consistent delinquency, deterioration in the lessee's financial condition or other relevant factors.

The following table summarizes the Company's non-performing capital leases:

      The increase in non-accrual leases is primarily due to the placement of certain leases located in New Orleans impacted by Hurricane Katrina on non-accrual pending further information on the status of the property and the lessees. All such leases were current in their payments at September 30, 2005. In addition to the non-performing capital leases identified above, there was $2.4 million of investment in capital leases at September 30, 2005 for which management has concerns regarding the ability of the lessees to continue to meet existing lease obligations, compared with $2.0 million at June 30, 2005. This amount consists of leases classified as substandard or doubtful, or with lessees that currently are experiencing financial difficulties or that management believes may experience financial difficulties in the future. Although these leases have been identified as potential problem leases, they may never become non-performing. The increase reflects the identification of additional special mention credits, which offset the benefit from the paydown on other substandard leases. These potential problem leases are considered in the determination of the allowance for lease losses.

     The allowance for lease losses provides coverage for probable and estimatable losses in the Company's lease portfolios. The allowance recorded is based on a quarterly review of all leases outstanding and transactions in process. Lease receivables or residuals are charged off when they are deemed completely uncollectible. The determination of the appropriate amount of any provision is based on management's judgment at that time and takes into consideration all known relevant internal and external factors that may affect the lease portfolio.

     The amortized cost, fair value, and carrying value of investment securities at September 30, 2005 were as follows:

     The Company funds its operating activities through internally generated funds, bank deposits and non-recourse debt. At September 30, 2005 and June 30, 2005, the Company's cash and cash equivalents were $34.6 million and $43.3 million, respectively. Stockholders' equity at September 30, 2005 was $188.4 million, or 68% of total assets, compared to $186.9 million, or 67% of total assets, at June 30, 2005. At September 30, 2005, the Company and the Bank exceed their regulatory capital requirements and are considered "well-capitalized" under guidelines established by the FRB and OCC.

     The need for cash for operating activities will increase as the Company expands. The Company believes that existing cash balances, cash flow from operations, cash flows from its financing and investing activities, and assignments (on a non-recourse basis) of lease payments will be sufficient to meet its foreseeable financing needs.

     Inflation has not had a significant impact upon the operations of the Company.

                    This Form 10-Q contains forward-looking statements. Statements that are not historical or current facts, including statements about beliefs and expectations, are forward-looking statements. Forward-looking statements involve inherent risks and uncertainties, and certain factors could cause actual results to differ materially from those anticipated. Factors that might affect forward-looking statements include, among other things:

• General economic or industry conditions could be less favorable than expected, resulting in a reduced demand for capital assets, deterioration in credit quality, deterioration in the recoverability of our investment in leased property and lease residual values, and a change in the allowance for lease losses;

• Changes in the domestic interest rate environment, including the continuation of a flat yield curve, could reduce net interest income and negatively affect certain lessees, which could increase lease losses;

• As CalFirst Bank has expanded and now represents a greater portion of the Company's assets, the Company's sensitivity to changes in interest rates has increased;

• The Company's subsidiaries have retained an increasing number of lease transactions in their own portfolios which has increased the Company's exposure to credit risk;

• CalFirst Bank may not attract or retain sufficient deposits at attractive interest rates to fund its lease portfolio, and therefore could require additional investment by the Company and produce lower lease growth;

• Security breaches, systems failures, computer viruses or other similar events could damage CalFirst Bank's reputation, or Internet banks in general, and inhibit the ability to raise deposits;

• The conditions of the securities markets could change, adversely affecting certain lessees and the value or credit quality of the Company's assets, or the availability and terms of non-recourse financing obtained to complete certain lease transactions;

• The Company's Common Stock trades on the NASDAQ National Market System, but the volume of trading has been limited and the low volume of trading limits the liquidity of the Common Stock;

• Changes in the extensive laws, regulations and policies governing financial services companies could alter the Company's business environment, strategies or affect operations;

• Catastrophic events could impair the Company's business operations or systems, or that of its lessees, resulting in losses;

• All the above factors could impact the Company's ability to remain in compliance with commitments made to federal bank regulators in connection with the formation of CalFirst Bank.

     The result of these and other factors could cause a difference from expectations of the risk characteristics of the lease portfolio, the level of defaults and a change in the provision for lease losses. Forward-looking statements speak only as of the date made. The Company undertakes no obligations to update any forward-looking statements to reflect events or circumstances arising after the date on which they are made.

As of the end of the period covered by this report, the Company's management, including its principal executive officer and its principal financial officer, evaluated the effectiveness of the Company's disclosure controls and procedures, as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of September 30, 2005 to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. There were no changes made during the most recent fiscal quarter to the Company's internal controls over financial reporting that materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

ITEM 6. EXHIBITS

There was one report on Form 8-K filed during the three months ended September 30, 2005. The report filed on August 4, 2005 related to the release of the Company's earnings for the year ended June 30, 2005.

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.