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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
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 Number 000-20202
CREDIT ACCEPTANCE CORPORATION
(Exact name of registrant as specified in its charter)
MICHIGAN 38-1999511
(State or other jurisdiction of (IRS Employer Identification)
incorporation or organization)
25505 WEST TWELVE MILE ROAD, SUITE 3000
SOUTHFIELD, MICHIGAN 48034-8339
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: 248-353-2700
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 [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's class of
common stock, as of the latest practicable date.
THE NUMBER OF SHARES OUTSTANDING OF COMMON STOCK, PAR VALUE $.01, ON NOVEMBER 1,
2003 WAS 42,020,982.
TABLE OF CONTENTS
PART I. - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Income Statements -
Three and nine months ended September 30, 2003 and September 30, 2002 1
Consolidated Balance Sheets -
As of September 30, 2003 and December 31, 2002 2
Consolidated Statements of Cash Flows -
Nine months ended September 30, 2003 and September 30, 2002 3
Notes to Consolidated Financial Statements 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION 13
AND RESULTS OF OPERATIONS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS 37
ITEM 4. CONTROLS AND PROCEDURES 37
PART II. - OTHER INFORMATION
ITEM 5. OTHER INFORMATION 38
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 47
SIGNATURE 48
INDEX OF EXHIBITS 49
PART I. - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
CREDIT ACCEPTANCE CORPORATION
CONSOLIDATED INCOME STATEMENTS
(UNAUDITED)
(Dollars in thousands, except per share data) THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- --------------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
REVENUE:
Finance charges $ 25,770 $ 24,018 $ 76,457 $ 74,425
Lease revenue 1,251 3,614 5,371 13,201
Ancillary product income 4,369 5,500 14,335 12,919
Premiums earned 734 1,001 2,246 3,495
Other income 3,738 8,535 10,354 16,075
------------ ------------ ------------ ------------
Total revenue 35,862 42,668 108,763 120,115
------------ ------------ ------------ ------------
COSTS AND EXPENSES:
General and administrative 4,679 5,789 15,361 17,889
Salaries and wages 7,879 7,184 25,083 22,136
Sales and marketing 1,886 1,954 6,546 5,544
Stock-based compensation expense 1,027 535 2,830 1,582
Provision for insurance and service contract claims 329 590 637 1,723
Provision for credit losses 2,303 8,896 9,354 15,973
Depreciation of leased assets 853 2,251 3,568 7,758
United Kingdom asset impairment expense -- -- 10,493 --
Interest 2,267 2,364 5,264 7,126
------------ ------------ ------------ ------------
Total costs and expenses 21,223 29,563 79,136 79,731
------------ ------------ ------------ ------------
Operating income 14,639 13,105 29,627 40,384
Foreign exchange gain (loss) (1,066) (25) (1,037) 2
------------ ------------ ------------ ------------
Income before provision for income taxes 13,573 13,080 28,590 40,386
Provision for income taxes 4,755 4,468 10,171 17,111
------------ ------------ ------------ ------------
Net income $ 8,818 $ 8,612 $ 18,419 $ 23,275
============ ============ ============ ============
Net income per common share:
Basic $ 0.21 $ 0.20 $ 0.44 $ 0.55
============ ============ ============ ============
Diluted $ 0.20 $ 0.20 $ 0.43 $ 0.53
============ ============ ============ ============
Weighted average shares outstanding:
Basic 42,315,027 42,363,895 42,329,722 42,457,425
Diluted 43,959,924 43,122,046 43,247,518 43,517,380
See accompanying notes to consolidated financial statements.
1
CREDIT ACCEPTANCE CORPORATION
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(Dollars in thousands) AS OF
---------------------------------------
SEPTEMBER 30, 2003 DECEMBER 31, 2002
------------------ -----------------
ASSETS:
Cash and cash equivalents $ 15,450 $ 13,466
Investments-- held to maturity 9,789 173
Loans receivable 869,927 770,069
Allowance for credit losses (14,883) (20,991)
--------- ---------
Loans receivable, net 855,044 749,078
--------- ---------
Floorplan receivables, net 2,920 4,450
Lines of credit, net 2,290 3,655
Notes receivable, net (including $1,565 and $1,513 from affiliates as of September 30,
2003 and December 31, 2002, respectively) 2,076 3,899
Investment in operating leases 6,364 17,879
Property and equipment, net 18,294 19,951
Other assets 13,152 14,280
--------- ---------
Total Assets $ 925,379 $ 826,831
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY:
LIABILITIES:
Lines of credit $ -- $ 43,555
Secured financing 100,000 58,153
Mortgage note 5,618 6,195
Capital lease obligations 1,258 1,938
Accounts payable and accrued liabilities 33,858 28,341
Dealer holdbacks, net 420,759 347,040
Deferred income taxes, net 17,048 10,058
Income taxes payable 2,538 6,094
--------- ---------
Total Liabilities 581,079 501,374
--------- ---------
SHAREHOLDERS' EQUITY:
Common stock 422 423
Paid-in capital 123,477 124,772
Retained earnings 217,277 198,858
Accumulated other comprehensive income - cumulative translation adjustment 3,124 1,404
--------- ---------
Total Shareholders' Equity 344,300 325,457
--------- ---------
Total Liabilities and Shareholders' Equity $ 925,379 $ 826,831
========= =========
See accompanying notes to consolidated financial statements.
2
CREDIT ACCEPTANCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(Dollars in thousands) NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------------
2003 2002
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 18,419 $ 23,275
Adjustments to reconcile cash provided by operating activities:
Provision for credit losses 9,354 15,973
Depreciation 2,960 3,719
Depreciation of leased assets 3,568 7,758
Loss on retirement of property and equipment -- 276
Provision for deferred income taxes 6,990 8,400
Stock-based compensation 2,830 1,582
United Kingdom asset impairment 10,493 --
Change in operating assets and liabilities:
Accounts payable and accrued liabilities 4,681 (6,758)
Income taxes payable (3,556) (2,609)
Lease payment receivable 1,484 872
Unearned insurance premiums, insurance reserves and fees (370) (2,314)
Deferred dealer enrollment fees, net 836 (53)
Other assets 1,128 88
--------- ---------
Net cash provided by operating activities 58,817 50,209
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investments - held to maturity (9,616) (2)
Principal collected on loans receivable 259,994 257,041
Advances to dealers (286,741) (223,591)
Payments of dealer holdbacks (22,275) (25,746)
Operating lease acquisitions -- (874)
Deferred costs from lease acquisitions -- (201)
Operating lease liquidations 4,758 7,977
Decrease (increase) in floorplan receivables 1,165 (436)
Decrease in lines of credit 748 1,393
Decrease (increase) in notes receivable -- affiliates (52) 9
Decrease in notes receivable -- non-affiliates 1,860 520
Purchases of property and equipment (1,303) (4,881)
--------- ---------
Net cash (used in) provided by investing activities (51,462) 11,209
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (repayments) under lines of credit (43,555) 23,596
Proceeds from secured financings 100,000 28,551
Repayments of secured financings (58,153) (120,690)
Principal payments under capital lease obligations (680) 1,029
Repayment of mortgage note (577) (537)
Repurchase of common stock (4,740) (6,588)
Proceeds from stock options exercised 614 3,583
--------- ---------
Net cash used in financing activities (7,091) (71,056)
--------- ---------
Effect of exchange rate changes on cash 1,720 6,308
--------- ---------
Net increase (decrease) in cash and cash equivalents 1,984 (3,330)
Cash and cash equivalents, beginning of period 13,466 15,773
--------- ---------
Cash and cash equivalents, end of period $ 15,450 $ 12,443
========= =========
See accompanying notes to consolidated financial statements.
3
CREDIT ACCEPTANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America ("generally accepted accounting principles" or "GAAP")
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. The results of operations for interim periods
are not necessarily indicative of actual results achieved for full fiscal years.
The consolidated balance sheet at December 31, 2002 has been derived from the
audited financial statements at that date but does not include all the
information and footnotes required by generally accepted accounting principles
for complete financial statements. For further information, refer to the
consolidated financial statements and footnotes thereto included in the Annual
Report on Form 10-K for the year ended December 31, 2002 for Credit Acceptance
(the "Company"). Certain prior period amounts have been reclassified to conform
to the 2003 presentation.
As a result of a Securities and Exchange Commission review of the
Company's Form 10-K for the year ended December 31, 2002 and Form 10-Q for the
period ended June 30, 2003, the Company made two changes to its balance sheet
presentation and one change to its accounting policies. The Reserve for advance
losses which was previously classified within Dealer holdbacks, net was
eliminated and the balance transferred to the Allowance for credit losses which
is classified within Loans receivable, net. This treatment reflects the
conclusion that, from an accounting standpoint, losses covered by this reserve
are a result of uncollectible retail installment contracts (referred to as
"Contracts" or "Loans") and that advance losses do not represent a separate
event of loss. Previously, the Company utilized the Allowance for credit losses
to record losses of earned but unpaid revenue and the Reserve for advance losses
to record losses on advances that were determined to be uncollectible. Also, the
Company reclassified repossessed assets from Loans receivable to Other assets.
As discussed in Notes 2 and 3, the Company has implemented a revised charge-off
and recovery policy consistent with the reclassification of the Reserve for
advance losses discussed above.
Beginning in the second quarter of 2003, the Company changed its
segment disclosures and adopted the fair value recognition provisions of
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123") under the retroactive restatement method selected
by the Company as described in SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure".
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
2. ACCOUNTING STANDARDS
Pursuant to SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets", an impairment analysis is performed on the net asset value
of the United Kingdom, Canadian, and Automobile Leasing operations on a
quarterly basis. This analysis compares the undiscounted forecasted future net
cash flows (including future servicing expenses and any payments due to
dealer-partners under servicing agreements) of each operation to the operation's
net asset value at the balance sheet date. If this analysis indicates
impairment, the Company is required to write down the value of the asset to the
present value of the forecasted net cash flows. While the impairment analysis
for operations which are being liquidated reduces the future cash flows by the
amount of servicing expenses (under SFAS No. 144), the impairment analysis for
Loan portfolios relating to continuing operations does not (under SFAS No. 114).
United Kingdom -- Effective June 30, 2003, the Company decided to stop
originating Loans in the United Kingdom. In analyzing the expected cash flows
from this operation, the Company assumed lower collection rates than assumed
before the decision to liquidate. These lower collection rates reflect
uncertainties (such as potentially higher employee turnover or reduced morale)
in the servicing environment that may arise as a result of the decision to
liquidate. As a result of this analysis, in the second quarter of 2003, the net
asset value of the Loan portfolio was deemed to be impaired and the Company
recorded an after-tax expense of $6.4 million to reduce the carrying value of
the operation's Loan portfolio to the present value (using a discount rate of
13%) of the forecasted cash flows relating to the Loan portfolio less estimated
future servicing expenses. Based upon management's analysis, the net asset value
of the United Kingdom Loan portfolio approximates the Company's best estimate of
the discounted future cash flows relating to the portfolio as of September 30,
2003.
4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. ACCOUNTING STANDARDS -- (CONTINUED)
Canada -- Effective June 30, 2003, the Company decided to stop
originating Loans in Canada. Since Loans originated in Canada are serviced in
the United States, the Company evaluated cash flows related to the Canadian
operation based on the same collection rate assumptions as were used before the
decision to liquidate. Based upon management's analysis, the net asset value of
the Canadian Loan portfolio approximates the Company's best estimate of the
future cash flows relating to the portfolio as of September 30, 2003.
Leasing -- Effective January 1, 2002, the Company decided to stop
originating automobile leases. Through September 30, 2003 no write down of the
net asset value of this operation was necessary as, based upon management's
analysis, the undiscounted forecasted cash flows from the Automobile Leasing
operation exceed the net asset value by approximately $1.5 million. If future
cash flows equal the Company's forecast, this amount will be recorded into
income as individual leases mature.
In June 2002, the Financial Accounting Standards Board issued SFAS No.
146, "Accounting for Costs Associated with Exit or Disposal Activities," which
nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(Including Certain Costs Incurred in Restructuring)." SFAS No. 146 requires a
liability for a cost associated with an exit or disposal activity to be
recognized and measured initially at its fair value in the period in which the
liability is incurred, rather than at the time of commitment to an exit plan.
The Company adopted this standard for exit or disposal activities initiated
after December 31, 2002. As a result of the Company's decision to exit the
United Kingdom business in the second quarter of 2003, the Company recognized:
(i) $300,000 after-tax increase in salaries and wages resulting from employee
severance expenses and (ii) $100,000 after-tax reduction in other income due to
a refund of profit sharing income on ancillary products to an ancillary product
provider which was based on volume targets no longer attainable due to the
decision to stop Loan originations. As of September 30, 2003, the remaining
liability for these expenses was $151,000. The Company may record an additional
liability of up to $ 400,000 for payment of future lease obligations under a
rental agreement through September 2007 once the Company stops using the office
space in the United Kingdom. The Company expects to stop using the United
Kingdom office space in the fourth quarter of 2005 or first quarter of 2006.
Credit Loss Policy - The Company maintains an allowance for credit
losses to cover losses inherent in the Company's Loan portfolio. Such losses
consist of Loans receivable determined to be uncollectible or with expected
future collections less than the full contractual amount, less any losses
absorbed by dealer holdbacks. By definition, these losses equal the amount of
advances to dealer-partners plus accrued income (the "net investment") not
expected to be recovered by collections on the related Loans receivable.
To record losses, as required under "SFAS No. 114: Accounting by
Creditors for Impairment of a Loan - an amendment of FASB Statements No. 5 and
15", as amended by "SFAS No. 118: Accounting by Creditors for Impairment of a
Loan- Income Recognition and Disclosures", the Company utilizes a present value
methodology and compares the present value of estimated future collections for
each dealer-partner's Loan portfolio to the Company's net investment in that
portfolio. The Company maintains historical loss experience for each
dealer-partner on a static pool basis and uses this information to forecast the
timing and amount of the future collections on each dealer-partner's Loan
portfolio. In estimating future collections for each dealer-partner, the Company
considers: (i) a dealer-partner's actual loss data on a static pool basis and
(ii) the Company's historical loss and collection experience. The Company's
collection forecast for each dealer-partner is updated monthly, and considers
the most recent static pool data available for each dealer-partner and the
Company's entire portfolio of Loans. Forecasted collections are discounted to
present value using a rate equal to the rate of return expected at the
origination of the Loan. To the extent that the present value of future
collections is less than the Company's net investment in the portfolio, the
Company records an allowance equal to the difference between the net investment
and the present value of the estimated future collections. Proceeds from one
dealer-partner's portfolio cannot be used to offset losses relating to another
dealer-partner.
Effective July 1, 2003, the Company eliminated the Reserve for advance
losses balance of $19.4 million which was previously classified within Dealer
holdbacks, net and transferred the balance into the Allowance for credit losses
which is classified within Loans receivable, net. In addition, the Company
eliminated its charge-off policy related to dealer advances and modified its
Loans receivable charge-off policy to require charge-off of Loans receivable
after 270 days of no payment against dealer holdbacks, net and, if such holdback
is insufficient, against the Allowance for credit losses. In effect, the Company
combined its advance and Loans receivable charge-off policies into a single
policy whereby the Loan and related Advance are charged-off at the same time.
For the first six months of 2003, advances were charged off when the Company's
analysis forecasted no future collections on Loans relating to the
dealer-partner advance pool. Prior to January 1, 2003, advances were charged-off
or partially charged-off when the Company's analysis determined that the
expected discounted cash flows associated with the related Loans were
insufficient to recover the outstanding advance balance in the pool.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. ACCOUNTING STANDARDS -- (CONCLUDED)
In addition, effective July 1, 2003, the Company implemented a revised
policy related to collections of previously charged-off Loans ("recoveries").
Under the new policy, recoveries of Loans charged-off are credited to the
allowance for credit losses to the extent of any prior losses charged against
the allowance, with the remainder credited to Dealer holdbacks. Under the
Company's prior policy, generally 80% of recoveries were credited to Dealer
holdbacks and 20% to Finance charges.
A significant percentage of charged off Loans are absorbed by Dealer
Holdbacks and, as a result, do not result in losses to the Company. The
Company's primary protection against losses relates to appropriately managing
the spread between the collection rate and the amount advanced to dealer
partners at Loan inception.
The Company's allowance for credit losses also covers earned but unpaid
servicing fees on Loans receivable in non-accrual status. Servicing fees, which
are recorded as finance charges, are recognized under the interest method of
accounting until the earlier of the underlying obligation becoming 90 days past
due on a recency basis (no payments received for 90 days) or the repossession
and sale of the vehicle securing the Loan. At such time, the Company suspends
the recognition of revenue and records a provision for credit losses equal to
the earned but unpaid revenue. Once a Loan is classified in non-accrual status,
it remains in non-accrual status for the remaining life of the Loan. Revenue on
non-accrual Loans is recognized on a cash basis.
3. LOANS RECEIVABLE
Loans receivable consisted of the following (in thousands):
AS OF
-----------------------------------------------
SEPTEMBER 30, 2003 DECEMBER 31, 2002
----------------------- ----------------------
Gross Loans receivable $ 1,032,185 $ 910,417
Unearned finance charges (159,234) (136,954)
Unearned insurance premiums, insurance reserves and fees (3,024) (3,394)
----------- -----------
Loans receivable $ 869,927 $ 770,069
=========== ===========
Non-accrual Loans $ 203,241 $ 212,373
=========== ===========
Non-accrual Loans as a percent of gross Loans receivable 19.7% 23.3%
=========== ===========
A summary of changes in gross Loans receivable is as follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- ---------------------------------
2003 2002 2003 2002
--------------- --------------- --------------- ---------------
Balance, beginning of period $ 1,009,472 $ 937,093 $ 910,417 $ 900,961
Gross amount of Loans accepted 197,599 146,327 636,504 485,277
Net cash collections on Loans (114,544) (107,998) (342,107) (334,461)
Charge-offs * (67,223) (45,907) (187,445) (127,376)
Recoveries 7,120 -- 7,120 --
Net change in repossessed collateral (368) (1,317) 1,936 (2,547)
Currency translation 129 4,515 5,760 10,859
----------- ----------- ----------- -----------
Balance, end of period $ 1,032,185 $ 932,713 $ 1,032,185 $ 932,713
=========== =========== =========== ===========
* Charge-offs presented net of recoveries in periods prior to the three months
ended September 30, 2003.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. LOANS RECEIVABLE -- (CONCLUDED)
A summary of the change in the allowance for credit losses is as
follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- --------------------------------
2003 2002 2003 2002
--------------- -------------- --------------- ---------------
Balance, beginning of period $ 24,461 $ 15,225 $ 20,991 $ 13,906
Provision for Loan losses 1,363 5,798 6,652 9,579
Charge-offs * (14,201) (3,556) (16,188) (6,263)
Recoveries 3,233 -- 3,233 --
Currency translation 27 101 195 346
-------- -------- -------- --------
Balance, end of period $ 14,883 $ 17,568 $ 14,883 $ 17,568
======== ======== ======== ========
* Charge-offs presented net of recoveries in periods prior to the three months
ended September 30, 2003.
Effective July 1, 2003, the Company eliminated the Reserve for advance
losses balance of $19.4 million, which was previously classified within Dealer
holdbacks, net and transferred the balance into the Allowance for credit losses
as reported within Loans receivable, net. In addition, the Company eliminated
its charge-off policy related to dealer advances and modified its Loans
receivable charge-off policy to require charge-off of Loans receivable after 270
days of no payment against Dealer holdbacks, net and, if such holdback is
insufficient, against the Allowance for credit losses. Refer to Note 2 for
further discussion on the Company's charge-off policy.
The charge-offs for the quarter ended September 30, 2003 are presented
on a different basis than the other periods presented and as a result are not
comparable. The $14.2 million in charge-offs reported during the quarter
includes $12.4 million of prior period charge-offs recorded with the adoption of
the new charge-off policy and $1.8 million of charge-offs which occurred during
the quarter.
4. FLOORPLAN RECEIVABLES, LINES OF CREDIT, AND NOTES RECEIVABLE
A summary of the change in the allowance for floorplan receivables,
lines of credit, and notes receivable losses is as follows (in
thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- --------------------------------
2003 2002 2003 2002
--------------- -------------- --------------- ---------------
Balance, beginning of period $ 565 $ 2,910 $ 1,285 $ 2,405
Provision for credit losses 443 1,848 997 2,374
Recoveries, (Charge-offs), net * 123 6 (1,164) (15)
Currency translation -- (1) 13 (1)
------- ------- ------- -------
Balance, end of period $ 1,131 $ 4,763 $ 1,131 $ 4,763
======= ======= ======= =======
* Charge-offs presented net of recoveries.
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. INVESTMENT IN OPERATING LEASES
The composition of investment in operating leases consisted of the
following (in thousands):
AS OF
-----------------------------------------
SEPTEMBER 30, 2003 DECEMBER 31, 2002
------------------ -----------------
Gross leased assets $ 13,855 $ 26,821
Accumulated depreciation (8,504) (12,304)
Gross deferred costs 2,088 3,956
Accumulated amortization of deferred costs (1,752) (2,706)
Lease payments receivable 677 2,112
-------- --------
Investment in operating leases $ 6,364 $ 17,879
======== ========
A summary of changes in the investment in operating leases is as
follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- ---------------------------------
2003 2002 2003 2002
--------------- -------------- ---------------- ---------------
Balance, beginning of period $ 9,328 $ 29,246 $ 17,879 $ 42,774
Gross operating leases originated -- -- -- 1,075
Depreciation of operating leases (853) (2,251) (3,568) (7,758)
Lease payments receivable 1,987 4,261 7,156 15,846
Collections on operating leases (1,398) (3,506) (5,987) (12,147)
Provision for lease losses (497) (1,250) (1,705) (4,020)
Operating lease liquidations (2,139) (3,054) (7,755) (12,571)
Currency translation (64) (224) 344 23
-------- -------- -------- --------
Balance, end of period $ 6,364 $ 23,222 $ 6,364 $ 23,222
======== ======== ======== ========
6. OTHER ASSETS
Loans receivable are collateralized by the related vehicles. The
Company has the right to repossess the vehicle in the event that the consumer
defaults on the payment terms of the Loan. In accordance with SFAS No. 144,
repossessed collateral is valued at the lower of the carrying amount of the
receivable or estimated fair value, less estimated costs of disposition, and is
classified in Other assets in the consolidated balance sheets. As of September
30, 2003 and December 31, 2002, repossessed assets totaled approximately $6.7
million and $8.6 million, respectively.
7. NET INCOME PER SHARE
Basic net income per share has been computed by dividing net income by
the weighted average number of common shares outstanding. Diluted net income per
share has been computed by dividing net income by the total weighted average
number of common shares and common stock equivalents outstanding. Common stock
equivalents included in the computation represent shares issuable upon assumed
exercise of stock options that would have a dilutive effect using the treasury
stock method. The share effect is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
2003 2002 2003 2002
------------- -------------- ------------- --------------
Weighted average common shares outstanding 42,315,027 42,363,895 42,329,722 42,457,425
Common stock equivalents 1,644,897 758,151 917,796 1,059,955
------------- -------------- ------------- --------------
Weighted average common shares and common stock equivalents 43,959,924 43,122,046 43,247,518 43,517,380
============= ============== ============= ==============
The diluted net income per share calculation excludes stock options to
purchase approximately 266,531 shares and 992,490 shares in the three and nine
months ended September 30, 2003, respectively, and 536,011 shares and 253,995
shares in the same periods in 2002 as inclusion of these options would be
anti-dilutive to the net income per share due to the relationship between the
exercise prices and the average market price of common stock during these
periods.
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. DEALER HOLDBACKS
As previously discussed, effective July 1, 2003, the Company eliminated
the Reserve for advance losses, which was presented in Dealer holdbacks, net and
reclassified the balance into the Allowance for credit losses as reported within
Loans receivable, net. Prior periods reflect this reclassification. Dealer
holdbacks, net consisted of the following (in thousands):
AS OF
-------------------------------------
SEPTEMBER 30, 2003 DECEMBER 31, 2002
------------------ -----------------
Dealer holdbacks $ 827,815 $ 734,625
Less: advances (407,056) (387,585)
----------------- -----------------
Dealer holdbacks, net $ 420,759 $ 347,040
================= =================
9. RELATED PARTY TRANSACTIONS
In the normal course of its business, the Company regularly accepts
assignments of Loans originated by affiliated dealer-partners owned by: (i) the
Company's majority shareholder and Chairman; (ii) the Company's President; and
(iii) a member of the Chairman's family. Loans accepted from these affiliated
dealer-partners were approximately $5.4 million and $17.2 million, respectively,
or 2.7% of total Loans accepted for the three and nine months ended September
30, 2003 and $4.2 million and $15.7 million or 2.9% and 3.2%, respectively, of
total Loans accepted for the same periods in 2002. Loans receivable from
affiliated dealer-partners represented approximately 2.9% and 2.8% of the gross
Loans receivable balance as of September 30, 2003 and December 31, 2002,
respectively. The Company accepts Loans from affiliated dealer-partners and
nonaffiliated dealer-partners on the same terms. Advance balances from
affiliated dealer-partners were $10.8 million and $10.4 million, or 2.7% and
2.8% of the Company's total advances as of September 30, 2003 and December 31,
2002, respectively. Total dealer enrollment fees and other fees earned from
affiliated dealer-partners were $9,000 and $45,000 for the three and nine months
ended September 30, 2003, respectively, and $7,000 and $35,000 for the same
periods in 2002.
The Company records interest income from unsecured notes receivable
from the Company's President with a total balance of $1.6 and $1.5 million as of
September 30, 2003 and December 31, 2002, respectively. The notes bear interest
at a rate of 5.22% with interest and principal due on April 19, 2011. Total
income earned on the notes receivable was $18,000 and $52,000 for the three and
nine months ended September 30, 2003 and 2002.
In the normal course of business, the Company records receivables from
dealer-partners for ancillary product chargebacks on repossessed leased
vehicles. Chargeback receivables from affiliated dealer-partners owned by the
Company's President were $11,000 and $10,000 as of September 30, 2003 and
December 31, 2002, respectively.
In the normal course of business, the Company analyzes the viability of
new products and services by first offering them to a small group of
dealer-partners, which includes affiliated dealer-partners, prior to offering
them to the entire network of dealer-partners. The Company received fees for
direct mail lead generation services provided to affiliated dealer-partners
owned by the Company's majority shareholder and Chairman totaling $6,000 and
$33,000 for the three and nine months ended September 30, 2002, respectively.
The Company did not provide these services to affiliated dealer-partners in
2003.
Beginning in 2000, the Company offered a line of credit arrangement to
certain dealers who were not participating in the Company's core business. These
lines of credit are secured primarily by loans originated and serviced by the
dealer, with additional security provided by the personal guarantee of the
dealer's owner. The Company ceased offering this program to new dealers in the
third quarter of 2001 and has been reducing the amount of capital invested in
this program since that time. Beginning in 2002, entities owned by the Company's
majority shareholder and Chairman began offering secured line of credit loans in
a manner similar to the Company's prior program, at his dealerships and at two
other dealers, one of whom also does business with the Company. The Company's
majority shareholder and Chairman does not intend to expand his line of credit
lending activities to additional borrowers.
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. INCOME TAXES
The Company's effective tax rate was 35.0% and 35.6% for the three and
nine months ended September 30, 2003 compared to 34.2% and 42.4% for the same
periods in 2002. Detail by business unit follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------- ----------------------------------
2003 2002 2003 2002
---------------- ---------------- ---------------- ----------------
Income (loss) before provision (credit) for income taxes:
United States $ 12,706 $ 10,274 $ 37,364 $ 34,636
United Kingdom 1,097 4,176 (8,115) 7,591
Automobile Leasing (126) (705) (892) (2,070)
Other (104) (665) 233 229
---------------- ---------------- ---------------- ----------------
Total income before provision for income taxes $ 13,573 $ 13,080 $ 28,590 $ 40,386
================ ================ ================ ================
Provision (credit) for income taxes:
United States $ 4,564 $ 3,801 $ 13,039 $ 15,681
United Kingdom 236 1,182 (2,688) 2,114
Automobile Leasing (57) (268) (353) (777)
Other 12 (247) 173 93
---------------- ---------------- ---------------- ----------------
Total provision for income taxes $ 4,755 $ 4,468 $ 10,171 $ 17,111
================ ================ ================ ================
Effective tax rate:
United States 35.9% 37.0% 34.9% 45.3%
United Kingdom 21.5% 28.3% 33.1% 27.8%
Automobile Leasing 45.2% 38.0% 39.6% 37.5%
Other (11.5%) 37.1% 74.2% 40.6%
---------------- ---------------- ---------------- ----------------
Total effective tax rate 35.0% 34.2% 35.6% 42.4%
================ ================ ================ ================
The changes in the effective tax rate are attributable to changes in
the provision (credit) for income taxes in the United States, United Kingdom,
Automobile Leasing, and Other segments, which are discussed for each segment in
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations. During the third quarter of 2003, the Company received an
independent valuation of its Loan portfolio in the United States for federal and
state tax purposes. This valuation resulted in a reduction of the Company's
currently payable income tax liability and a corresponding increase to the
Company's deferred income tax liability.
10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. CAPITAL TRANSACTIONS
As of September 30, 2003, the Company has two stock-based compensation
plans for employees and directors. Prior to April 1, 2003, the Company accounted
for those plans under the recognition and measurement principles of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", and
related Interpretations. In the second quarter of 2003, the Company adopted the
fair value recognition and measurement provisions of SFAS No. 123, "Accounting
for Stock-Based Compensation", as amended by SFAS No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure" for stock-based employee
compensation. Under the retroactive restatement transition method selected by
the Company described in SFAS No. 148, the Company restated all prior periods to
reflect the stock-based compensation expense that would have been recognized had
the recognition provisions of SFAS No. 123 been applied to all awards granted to
employees or directors after January 1, 1995. The following tables summarize the
reported and restated results:
(Dollars in thousands, except per share data) FOR THE YEARS ENDED FOR THE THREE MONTHS FOR THE NINE MONTHS
DECEMBER 31, ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------------- --------------------- --------------------
2002 2001 2000 1999 2002 2002
-------- -------- -------- --------- ---------------- ---------------
Net income, as reported $29,701 $29,203 $23,650 $(10,686) $ 9,431 $ 24,295
Stock-based compensation expense
included in reported net income, net of
related tax effects 9 241 - 158 (472) 9
Stock-based compensation expense
determined under the fair value based
method, net of related tax effects (1,341) (1,029) (1,271) (2,118) (347) (1,029)
-------- -------- -------- --------- ---------------- ---------------
Net income, restated $28,369 $28,415 $22,379 $(12,646) $ 8,612 $ 23,275
======== ======== ======== ========= ================ ===============
Earnings per share:
Basic - as reported $ 0.70 $ 0.69 $ 0.54 $ (0.23) $ 0.22 $ 0.57
======== ======== ======== ========= ================ ===============
Basic - restated $ 0.67 $ 0.67 $ 0.51 $ (0.27) $ 0.20 $ 0.55
======== ======== ======== ========= ================ ===============
Diluted - as reported $ 0.68 $ 0.68 $ 0.53 $ (0.23) $ 0.22 $ 0.56
======== ======== ======== ========= ================ ===============
Diluted - restated $ 0.65 $ 0.66 $ 0.51 $ (0.27) $ 0.20 $ 0.53
======== ======== ======== ========= ================ ===============
As of December 31, 1999, the cumulative decrease in retained earnings
as a result of this restatement was $12.6 million. The decrease in retained
earnings was offset by a $14.2 million increase in paid-in capital. The impact
on paid-in capital and retained earnings for the interim periods of 2002 and
2003 follows (in thousands):
2002 2003
----------------------------------------------------------------------------------------- ---------------------
1ST Q 2ND Q 3RD Q 4TH Q 1ST Q
--------------------- --------------------- --------------------- --------------------- --------------------
REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED
---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Paid-in capital $ 113,000 $ 129,102 $ 108,460 $ 124,000 $ 107,571 $ 124,263 $ 107,164 $ 124,772 $ 107,142 $ 124,534
Retained earnings $ 191,471 $ 176,692 $ 200,018 $ 185,156 $ 209,449 $ 193,769 $ 214,856 $ 198,858 $ 223,692 $ 207,451
11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONCLUDED)
12. BUSINESS SEGMENT INFORMATION
In the second quarter of 2003, the Company re-evaluated its business
segments as a result of the decision to stop Loan originations in the United
Kingdom and Canada. As a result, the Company has four reportable business
segments: United States, United Kingdom, Automobile Leasing, and Other. The
United States segment primarily consists of the Company's United States retail
automobile Loan operations. The United Kingdom segment primarily consists of the
Company's United Kingdom retail automobile Loan operations. The Automobile
Leasing segment consists of the Company's automobile leasing operations. The
Other segment consists of the Company's Canadian retail automobile Loan
operations and secured lines of credit and floorplan financing products. The
Company is currently liquidating its operations in all segments other than the
United States. Selected segment information is set forth below (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------- -----------------------------------
2003 2002 2003 2002
---------------- --------------- ---------------- ----------------
Revenue:
United States $ 30,698 $ 30,525 $ 90,591 $ 84,548
United Kingdom 2,431 6,923 9,294 17,368
Automobile Leasing 1,886 3,936 6,592 14,207
Other 847 1,284 2,286 3,992
---------------- --------------- ---------------- ----------------
Total revenue $ 35,862 $ 42,668 $ 108,763 $ 120,115
================ =============== ================ ================
Income (loss) before provision (credit) for income taxes:
United States $ 12,706 $ 10,274 $ 37,364 $ 34,636
United Kingdom 1,097 4,176 (8,115) 7,591
Automobile Leasing (126) (705) (892) (2,070)
Other (104) (665) 233 229
---------------- --------------- ---------------- ----------------
Total income before provision for income taxes $ 13,573 $ 13,080 $ 28,590 $ 40,386
================ =============== ================ ================
13. FORWARD CONTRACTS
In the third quarter of 2003, the Company entered into a series of
forward contracts with a commercial bank to manage foreign currency exchange
risk associated with the cash flows anticipated from the exit of the United
Kingdom operation. As of September 30, 2003, the Company has contracted to
deliver 22.5 million British pounds sterling to the commercial bank which will
be exchanged into United States dollars at a weighted average exchange rate of
1.59 United States dollars per British pound sterling on a monthly basis through
June 30, 2005. The Company believes that this transaction will minimize the
currency exchange risk associated with an adverse change in the relationship
between the United States dollar and the British pound sterling as it
repatriates cash from the United Kingdom operation. However, as the Company has
not designated these contracts as hedges as defined under SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities", as amended by
SFAS No. 138 and SFAS No. 149, future changes in the fair value of these forward
contracts will increase or decrease net income. As of September 30, 2003, the
exchange rate between the United States dollar and the British pound sterling
was 1.66. This change in exchange rate reduced the fair value of the forward
contracts. As a result, the Company recorded an after tax expense of $702,000
for the three and nine months ended September 30, 2003 to reduce the value of
the forward contracts to fair value.
.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The Company's business model relies on its ability to forecast Loan
performance. The Company's forecasts impact Loan pricing and structure as well
as the required allowance for credit losses. The following table presents
forecasted collection rates, advance rates, the spread (the forecasted
collection rate less the advance rate), and the percentage of the forecasted
collections which have been realized through September 30, 2003. The amounts
presented are expressed as a percent of the original Loan amount by year of Loan
origination.
As of September 30, 2003
------------------------------------------------------------
Forecasted % of Forecast
Year Collection % Advance % Spread % Realized
--------- --------------- ------------- ----------- ----------------
1992 81% 35% 46% 100%
1993 76% 37% 39% 100%
1994 62% 42% 20% 100%
1995 56% 46% 10% 99%
1996 56% 49% 7% 99%
1997 59% 49% 10% 99%
1998 67% 50% 17% 99%
1999 72% 54% 18% 98%
2000 71% 53% 18% 96%
2001 67% 49% 18% 80%
2002 70% 46% 24% 51%
The risk of a forecasting error declines as Loans age. For example, the risk
of a material forecasting error for business written in 1998 is very small since
99% of the total amount forecasted has already been realized. In contrast, the
Company's forecast for recent Loan originations is less certain. If the Company
produces disappointing operating results, it will likely be because the Company
overestimated future Loan performance.
A wider spread between the forecasted collection rate and the advance rate
reduces the Company's risk of credit losses. Because collections are applied to
advances on an individual dealer-partner basis, a wide spread does not eliminate
the risk of losses, but it does reduce the risk significantly. The Company made
no material changes in credit policy or pricing in the third quarter, other than
routine changes designed to maintain current profitability levels.
One method for evaluating the reasonableness of the Company's forecast is to
examine the trends in forecasted collection rates over time. The following table
compares the Company's forecast as of September 30, 2003 with the forecast as of
June 30, 2003.
June 30, 2003 September 30, 2003
Year Forecasted Collection % Forecasted Collection % Variance
- --------- -------------------------- --------------------------- ---------
1992 81% 81% 0%
1993 76% 76% 0%
1994 62% 62% 0%
1995 56% 56% 0%
1996 56% 56% 0%
1997 59% 59% 0%
1998 67% 67% 0%
1999 72% 72% 0%
2000 71% 71% 0%
2001 68% 67% (1%)
2002 70% 70% 0%
The Company first began publishing collection forecasts in its 2001 Annual
Report. Forecasted collection rates declined in 2002 when a difficult collection
system conversion negatively impacted collection results. The unanticipated
difficulties associated with the conversion resulted in a decreased number of
phone calls placed per delinquent account, which resulted in a reduction in
collection rates during the third and fourth quarters of 2002. During the fourth
quarter, collection system performance improved and by the end of the quarter
had returned to pre-system conversion levels as measured by call volumes and
charge-off rates. In the first quarter of 2003, the Company's collection
forecast continued to decline when post repossession
13
collection results (known as deficiency balance collections) declined from the
prior trend line. During the second and third quarters of 2003, forecasted
collection rates stabilized.
Accurately predicting future collection rates is critical to the Company's
success. Historically, the Company has experienced an adverse change in the
profitability of Loan originations during periods of high growth. While the
growth rates experienced in the United States in 2003 are higher than the
Company's expected long-term growth rate, the Company believes that the
investments in infrastructure in 2002, combined with decreases in Loan
origination volumes in 2002, have adequately prepared the Company for this
growth. The Company intends to make every possible effort to assess collection
rates as accurately as possible.
RESULTS OF OPERATIONS
Three and Nine Months Ended September 30, 2003 Compared to Three and Nine
Months Ended September 30, 2002
The following is a discussion of the results of operations and income
statement data for the Company on a consolidated basis and for each of the
Company's four business segments, United States, United Kingdom, Automobile
Leasing and Other.
Consolidated
(Dollars in thousands) THREE MONTHS THREE MONTHS
ENDED ENDED
SEPTEMBER 30, % OF SEPTEMBER 30, % OF
2003 REVENUE 2002 REVENUE
------------- ---------- ------------- ----------
REVENUE:
Finance charges $ 25,770 71.9 % $ 24,018 56.3 %
Lease revenue 1,251 3.5 3,614 8.5
Ancillary product income 4,369 12.2 5,500 12.9
Premiums earned 734 2.0 1,001 2.3
Other income 3,738 10.4 8,535 20.0
-------------- --------- ------------- ----------
Total revenue 35,862 100.0 42,668 100.0
COSTS AND EXPENSES:
General and administrative 4,679 13.0 5,789 13.6
Salaries and wages 7,879 22.0 7,184 16.8
Sales and marketing 1,886 5.3 1,954 4.6
Stock-based compensation expense 1,027 2.9 535 1.3
Provision for insurance and service contract claims 329 0.9 590 1.4
Provision for credit losses 2,303 6.4 8,896 20.8
Depreciation of leased assets 853 2.4 2,251 5.3
Interest 2,267 6.3 2,364 5.5
-------------- --------- ------------- ----------
Total costs and expenses 21,223 59.2 29,563 69.3
-------------- --------- ------------- ----------
Operating income 14,639 40.8 13,105 30.7
Foreign exchange loss (1,066) (3.0) (25) -
-------------- ---------- ------------- ----------
Income before provision for income taxes 13,573 37.8 13,080 30.7
Provision for income taxes 4,755 13.2 4,468 10.5
-------------- ---------- ------------- ----------
Net income $ 8,818 24.6 % $ 8,612 20.2 %
============== ========== ============= ==========
14
(Dollars in thousands) NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, % OF SEPTEMBER 30, % OF
2003 REVENUE 2002 REVENUE
------------- ---------- ------------- ----------
REVENUE:
Finance charges $ 76,457 70.3 % $ 74,425 61.9 %
Lease revenue 5,371 4.9 13,201 11.0
Ancillary product income 14,335 13.2 12,919 10.8
Premiums earned 2,246 2.1 3,495 2.9
Other income 10,354 9.5 16,075 13.4
------------- ---------- ------------- ----------
Total revenue 108,763 100.0 120,115 100.0
COSTS AND EXPENSES:
General and administrative 15,361 14.2 17,889 15.0
Salaries and wages 25,083 23.1 22,136 18.4
Sales and marketing 6,546 6.0 5,544 4.6
Stock-based compensation expense 2,830 2.6 1,582 1.3
Provision for insurance and service contract claims 637 0.6 1,723 1.4
Provision for credit losses 9,354 8.6 15,973 13.3
Depreciation of leased assets 3,568 3.3 7,758 6.5
United Kingdom asset impairment expense 10,493 9.6 - -
Interest 5,264 4.8 7,126 5.9
------------- ---------- ------------- ----------
Total costs and expenses 79,136 72.8 79,731 66.4
------------- ---------- ------------- ----------
Operating income 29,627 27.2 40,384 33.6
Foreign exchange gain (loss) (1,037) (0.9) 2 -
------------- ---------- ------------- ----------
Income before provision for income taxes 28,590 26.3 40,386 33.6
Provision for income taxes 10,171 9.4 17,111 14.2
------------- ---------- ------------- ----------
Net income $ 18,419 16.9 % $ 23,275 19.4 %
============= ========== ============= ==========
For the three months ended September 30, 2003, consolidated net income
remained relatively consistent at $8.8 million compared to $8.6 million for the
same period in 2002. Consolidated net income for the three months ended
September 30, 2003 included: (i) an increase in net income in the United States
business segment to $8.1 million in 2003 from $6.5 million in 2002 and (ii) a
decrease in net income in the United Kingdom business segment to $900,000 in
2003 from $3.0 million in 2002.
The increase in net income in the United States was due to: (i) an increase
in finance charges to $23.1 million in 2003 from $19.0 million in 2002 as a
result of an increase in the average size of the Loan portfolio due to an
increase in Loan originations in 2003, (ii) a decrease in provision for credit
losses to $1.2 million in 2003 from $5.6 million in 2002 due to higher 2002
losses as a result of a difficult conversion to a new collection system and
(iii) an increase in ancillary product income to $4.4 million in 2003 from $3.3
million in 2002 due to an increase in the number of third-party service
contracts sold. Partially offsetting these increases in net income were: (i) a
decrease in other income to $2.5 million in 2003 from $7.3 million in 2002 due
primarily to interest income of $4.8 million from the Internal Revenue Service
received in 2002 in connection with a change in tax accounting methods that
affected the characterization and timing of revenue recognition for tax purposes
and (ii) an increase of $1.0 million in foreign exchange loss as a result of the
Company recognizing the fair value of forward contracts entered into to manage
foreign currency risk associated with the cash flows anticipated from the exit
of the United Kingdom operation.
The decrease in net income for the United Kingdom was primarily due to a
decrease in ancillary product revenue of $2.2 million primarily due to: (i) a
decrease of $1.5 million due to additional revenue recognized in the third
quarter of 2002 due to a change in the Company's revenue recognition policy for
ancillary products, (ii) a decrease of $500,000 in profit sharing income
received from an ancillary product provider, and (iii) a decrease of $200,000
due to the Company's decision to stop Loan originations effective June 30, 2003.
For the nine months ended September 30, 2003, consolidated net income
declined to $18.4 million from $23.3 million for the same period in 2002. The
decrease in consolidated net income for the period was primarily due to the $5.4
million loss incurred in the United Kingdom in 2003 compared to net income of
$5.5 million in 2002. The loss was primarily the result of $11.1 million in
asset impairment and other expenses recorded in connection with the Company's
decision to stop Loan originations in the United Kingdom. The impact of the loss
in the United Kingdom was partially offset by an increase in net income in the
United States to $24.3 million in 2003 from $19.0 million in 2002.
The increase in net income in the United States in 2003 was primarily due
to increases in: (i) finance charges to $67.1 million in 2003 from $59.0 million
in 2002 as a result of an increase in the average size of the Loan portfolio due
to an increase in Loan originations in 2003 and (ii) ancillary product income to
$13.4 million in 2003 from $9.8 million in 2002 due to an increase in the number
of third-party service contracts sold. To a lesser extent, the increase in net
income was due to two tax related adjustments
15
in 2002 that increased the provision for income taxes and decreased net income
by $2.6 million. Partially offsetting these increases in net income was: (i) a
decrease in other income to $7.9 million in 2003 from $12.3 million in 2002 due
to interest income of $4.8 million from the Internal Revenue Service received in
2002 in connection with a change in tax accounting methods that affected the
characterization and timing of revenue recognition for tax purposes, (ii) an
increase in salaries and wages to $21.2 million in 2003 from $17.8 million in
2002 due to increases of $1.1 million due to increased spending on corporate
support functions related primarily to Information Systems and Six Sigma,
$900,000 due to increased servicing expenses, $800,000 in employee bonus
expense, and $300,000 due to increased employee benefits and (iii) an increase
of $1.0 million in foreign exchange loss as a result of the Company
recognizing the fair value of forward contracts entered into to manage foreign
currency risk associated with the cash flows anticipated from the exit of the
United Kingdom operation.
The results of operations for the Company as a whole are attributable to
changes described by segment in the discussion of the results of operations in
the United States, United Kingdom, Automobile Leasing, and Other business
segments. The following discussion of the results of operations for interest
expense is provided on a consolidated basis, as the explanation is not
meaningful by business segment.
Interest. Consolidated interest expense decreased to $2.3 million and $5.3
million for the three and nine months ended September 30, 2003 from $2.4 million
and $7.1 million for the same periods in 2002. The decrease in consolidated
interest expense was primarily the result of a decrease in average outstanding
debt. The decrease was partially offset by an increase in the weighted average
interest rate to 8.1% and 6.5% for the three and nine months ended September 30,
2003 from 6.4% and 5.6% for the same periods in 2002. This increase was
primarily the result of an increased impact of borrowing fees and costs on
average interest rates due to lower average outstanding borrowings.
United States
The United States segment primarily consists of the Company's United States
retail automobile Loan operations.
(Dollars in thousands) THREE MONTHS THREE MONTHS
ENDED ENDED
SEPTEMBER 30, % OF SEPTEMBER 30, % OF
2003 REVENUE 2002 REVENUE
------------- ---------- ------------- ----------
REVENUE:
Finance charges $ 23,135 75.4 % $ 18,954 62.1 %
Ancillary product income 4,363 14.2 3,300 10.8
Premiums earned 734 2.4 1,001 3.3
Other income 2,466 8.0 7,270 23.8
------------- ---------- ------------- ----------
Total revenue 30,698 100.0 30,525 100.0
COSTS AND EXPENSES:
General and administrative 3,940 12.8 4,464 14.6
Salaries and wages 6,741 22.0 5,878 19.3
Sales and marketing 1,884 6.1 1,668 5.5
Stock-based compensation expense 962 3.1 426 1.4
Provision for insurance and service contract claims 329 1.1 590 1.9
Provision for credit losses 1,189 3.9 5,555 18.2
Interest 1,865 6.1 1,656 5.4
------------- ---------- ------------- ----------
Total costs and expenses 16,910 55.1 20,237 66.3
------------- ---------- ------------- ----------
Operating income 13,788 44.9 10,288 33.7
Foreign exchange loss (1,082) (3.5) (14) -
------------- ---------- ------------- ----------
Income before provision for income taxes 12,706 41.4 10,274 33.7
Provision for income taxes 4,564 14.9 3,801 12.5
------------- ---------- ------------- ----------
Net income $ 8,142 26.5 % $ 6,473 21.2 %
============= ========== ============= ==========
16
(Dollars in thousands) NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, % OF SEPTEMBER 30, % OF
2003 REVENUE 2002 REVENUE
------------- ---------- ------------- ----------
REVENUE:
Finance charges $ 67,089 74.0 % $ 58,961 69.8 %
Ancillary product income 13,401 14.8 9,805 11.6
Premiums earned 2,246 2.5 3,495 4.1
Other income 7,855 8.7 12,287 14.5
------------- ---------- ------------- ----------
Total revenue 90,591 100.0 84,548 100.0
COSTS AND EXPENSES:
General and administrative 12,808 14.1 13,471 15.9
Salaries and wages 21,230 23.4 17,822 21.1
Sales and marketing 5,540 6.1 4,757 5.6
Stock-based compensation expense 2,611 2.9 1,274 1.5
Provision for insurance and service contract claims 637 0.7 1,723 2.0
Provision for credit losses 5,521 6.1 6,748 8.0
Interest 3,769 4.2 4,115 4.9
------------- ---------- ------------- ----------
Total costs and expenses 52,116 57.5 49,910 59.0
------------- ---------- ------------- ----------
Operating income 38,475 42.5 34,638 41.0
Foreign exchange loss (1,111) (1.3) (2) -
------------- ---------- ------------- ----------
Income before provision for income taxes 37,364 41.2 34,636 41.0
Provision for income taxes 13,039 14.3 15,681 18.6
------------- ---------- ------------- ----------
Net income $ 24,325 26.9 % $ 18,955 22.4 %
============= ========== ============= ==========
Finance Charges. Finance charges increased to $23.1 million and $67.1
million for the three and nine months ended September 30, 2003 from $19.0
million and $59.0 million for the same periods in 2002 primarily due to
increases in the: (i) average size of the Loan portfolio resulting from an
increase in Loan originations in 2003 and (ii) average annualized yield on the
Company's Loan portfolio to 12.3% and 12.7% for the three and nine months ended
September 30, 2003 from 12.0% and 12.5% for the same periods in 2002. The
increase in Loan originations in the United States in 2003 is due to: (i) an
increase in the number of active dealer-partners due to an increase in
dealer-partner enrollments to 108 and 284 for the three and nine months ended
September 30, 2003 from 37 and 99 in the same periods in 2002 and reduced levels
of dealer-partner attrition, (ii) a continued increase in the number of Loans
per active dealer-partner and (iii) an increase in the average Loan size. The
increase in the average yield was primarily due to a decrease in the percent of
non-accrual Loans to 18.2% as of September 30, 2003 from 21.4% as of the same
period in 2002 due primarily to an increase in Loan originations in 2003.
Selected Loan origination data follows:
(Dollars in thousands) THREE MONTHS ENDED NINE MONTHS ENDED YEARS ENDED
SEPTEMBER 30, SEPTEMBER 30, DECEMBER 31,
------------------------- ------------------------ -------------------------------------
2003 2002 2003 2002 2002 2001 2000
------------ ------------ ----------- ----------- ----------- ----------- ----------
Loan originations $ 196,837 $ 134,191 $ 607,989 $ 441,074 $ 571,690 $ 646,572 $ 371,045
Number of Loans originated 15,545 11,410 48,487 38,891 49,650 61,277 45,898
Number of active dealer-partners (1) 724 561 824 738 789 1,120 1,130
Loans per active dealer-partner 21.5 20.3 58.8 52.7 62.9 54.7 40.6
Average Loan size $ 12.7 $ 11.8 $ 12.5 $ 11.3 $ 11.5 $ 10.6 $ 8.1
(1) Active dealer-partners are dealer-partners who submitted at least one
Loan during the period.
Ancillary Product Income. Ancillary product income increased to $4.4 million
and $13.4 million for the three and nine months ended September 30, 2003 from
$3.3 million and $9.8 million for the same periods in 2002 due to an increase in
the number of third party service contract products sold, primarily due to the
increase in Loan originations compared to the same periods in 2002.
Premiums Earned. Premiums earned decreased to $700,000 and $2.2 million for
the three and nine months ended September 30, 2003 from $1.0 million and $3.5
million for the same periods in 2002 primarily due to a decrease in penetration
rates on the Company's in-house service contract and credit life and accident
and health products in 2002 and 2003.
Other Income. Other income decreased to $2.5 million and $7.9 million for
the three and nine months ended September 30, 2003 from $7.3 million and $12.3
million for the same periods in 2002 primarily due to interest income of $4.8
million received from the Internal Revenue Service in the third quarter of 2002
in connection with a change in tax accounting methods that affected the
characterization and timing of revenue recognition for tax purposes.
17
General and Administrative. General and administrative expenses decreased to
$3.9 million and $12.8 million for the three and nine months ended September 30,
2003 from $4.5 million and $13.5 million for the same periods in 2002. For the
three and nine months ended September 30, 2003, the decreases were primarily due
to decreases of: (i) $300,000 and $500,000, respectively, in legal expenses
resulting from a reduction in the frequency and severity of legal proceedings in
which the Company is engaged and (ii) $200,000 and $100,000, respectively, in
tax related consulting expenses due to expenses incurred in 2002 related to the
restructuring of the Company's international subsidiaries.
Salaries and Wages. Salaries and wages increased to $6.7 million and $21.2
million for the three and nine months ended September 30, 2003 from $5.9 million
and $17.8 million for the same periods in 2002. For the three months ended
September 30, 2003, the increase was primarily due to a $700,000 increase in
employee bonus expense as a result of improved Company performance in 2003
compared to the prior year. For the nine months ended September 30, 2003, the
increase was primarily due to increases of: (i) $1.1 million due to increased
spending on corporate support functions related primarily to Information Systems
and Six Sigma, (ii) $900,000 due to increased servicing expenses, (iii) $800,000
in employee bonus expense, and (iv) $300,000 due to increased employee benefits.
Sales and Marketing. Sales and marketing expenses increased to $1.9 million
and $5.5 million for the three and nine months ended September 30, 2003 from
$1.7 million and $4.8 million for the same periods in 2002 due primarily to
increased sales commissions as a result of increased unit volumes.
Stock-based Compensation Expense. Stock-based compensation expense increased
to $1.0 million and $2.6 million for the three and nine months ended September
30, 2003 from $400,000 and $1.3 million for the same periods in 2002. While the
number of stock options outstanding declined during the periods, stock-based
compensation expense increased as a result of a change in assumptions that
reduced the period over which certain performance based stock options are
expected to vest.
Provision for Insurance and Service Contract Claims. The provision for
insurance and service contract claims, as a percent of premiums earned,
decreased to 44.8% and 28.4% for the three and nine months ended September 30,
2003 from 58.9% and 49.3% for the same periods in 2002. The decreases for the
three and nine months ended September 30, 2003 are due to the reserve for
incurred but not reported claims on the Company's in-house service contract
product not being reduced proportionally with the reduction in unearned premiums
in 2002, thereby increasing claims expense as a percentage of premiums earned.
For the nine months ended September 30, 2003, the decrease is also due to a
decrease in the number of outstanding service contract policies, which have a
higher claims ratio than the Company's credit life and accident and health
products.
Provision for Credit Losses. The provision for credit losses decreased to
$1.2 million and $5.5 million for the three and nine months ended September 30,
2003 from $5.6 million and $6.7 million for the same periods in 2002. The
provision for credit losses consists of three components: (i) a provision for
earned but unpaid revenue on Loans which were transferred to non-accrual status
during the period, (ii) a provision to reflect losses inherent in the Company's
Loan portfolio, and (iii) a provision for losses on notes receivable. The
decrease in the provision for credit losses for the three and nine months ended
September 30, 2003 was primarily due to a decrease in the provision for losses
inherent in the Company's Loan portfolio to $400,000 and $3.5 million from $3.8
million and $4.3 million in 2002 due to higher 2002 losses as a result of a
difficult conversion to a new collection system (see "--General").
Foreign exchange loss. The foreign exchange loss increased to $1.1 million
for the three and nine months ended September 30, 2003 from zero in the same
periods in 2002. During the quarter, the Company entered into forward contracts
to ensure that currency fluctuations would not reduce the amount of United
States dollars received from the liquidation of the United Kingdom operation.
From the date the contracts were entered into, the weakening of the United
States dollar versus the British pound sterling caused a reduction in the fair
value of the forward contracts and an approximately equal increase in the amount
of expected future cash flows.
Under generally accepted accounting principles, the Company is required to
record an expense to reduce the carrying value of the forward contracts to fair
value, and separately to record the change in the amount of cash flows expected
from the United Kingdom due to exchange rate fluctuations in shareholders'
equity. These amounts were not equal for the three months ended September 30,
2003 because the change in shareholders' equity reflects the change in exchange
rates for the quarter while the change in the value of the forward contracts
reflects the change in exchange rates from the date the contracts were entered
into until the end of the quarter. In future periods, the Company expects the
amount of the gain or loss recognized by the Company on the forward contracts
will be approximately offset by an increase or decrease in shareholders' equity.
Provision for Income Taxes. The effective tax rate decreased to 35.9% and
34.9% for the three and nine months ended September 30, 2003 from 37.0% and
45.3% for the same periods in 2002. The reduction in the effective tax rate for
the three and nine months ended September 30, 2003, was primarily due to
decreases of 1.9% and 12.5% resulting from expense recorded in 2002 for
estimated taxes due upon repatriation of prior years' earnings in the United
Kingdom. The reduction in the effective tax rate for the nine months ended
September 30, 2003 was partially offset by an increase of 2.0% resulting from a
change in estimate of state income tax owed.
18
United Kingdom
The United Kingdom segment primarily consists of the Company's United Kingdom
retail automobile Loan operations. This segment is being liquidated as the
Company decided to stop originating Loans in the United Kingdom effective June
30, 2003. The Company expects to liquidate substantially all of its investment
in this operation by December 2006.
(Dollars in thousands) THREE MONTHS THREE MONTHS
ENDED ENDED
SEPTEMBER 30, % OF SEPTEMBER 30, % OF
2003 REVENUE 2002 REVENUE
------------- ----------- ------------- -----------
REVENUE:
Finance charges $ 2,288 94.2% $ 4,667 67.4%
Ancillary product income 6 0.2 2,200 31.8
Other income 137 5.6 56 0.8
------------ ----------- ------------ -----------
Total revenue 2,431 100.0 6,923 100.0
COSTS AND EXPENSES:
General and administrative 502 20.6 687 9.9
Salaries and wages 841 34.6 903 13.0
Sales and marketing -- -- 232 3.4
Stock-based compensation expense 65 2.7 109 1.6
Provision for credit losses (74) (3.0) 728 10.5
Interest -- -- 87 1.3
------------ ----------- ------------ -----------
Total costs and expenses 1,334 54.9 2,746 39.7
------------ ----------- ------------ -----------
Operating income 1,097 45.1 4,177 60.3
Foreign exchange loss -- -- (1) --
------------ ----------- ------------ -----------
Income before provision for income taxes 1,097 45.1 4,176 60.3
Provision for income taxes 236 9.7 1,182 17.1
------------ ----------- ------------ -----------
Net income $ 861 35.4% $ 2,994 43.2%
============ =========== ============ ===========
(Dollars in thousands) NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, % OF SEPTEMBER 30, % OF
2003 REVENUE 2002 REVENUE
------------- ----------- ------------ -----------
REVENUE:
Finance charges $ 8,202 88.3% $ 14,176 81.7%
Ancillary product income 934 10.0 3,114 17.9
Other income 158 1.7 78 0.4
------------ ----------- ------------ -----------
Total revenue 9,294 100.0 17,368 100.0
COSTS AND EXPENSES:
General and administrative 1,694 18.1 2,040 11.8
Salaries and wages 2,888 31.1 2,989 17.2
Sales and marketing 944 10.2 563 3.2
Stock-based compensation expense 219 2.4 308 1.8
Provision for credit losses 1,171 12.6 3,234 18.6
United Kingdom asset impairment expense 10,493 112.9 -- --
Interest -- -- 645 3.7
------------ ----------- ------------ -----------
Total costs and expenses 17,409 187.3 9,779 56.3
------------ ----------- ------------ -----------
Operating income (loss) (8,115) (87.3) 7,589 43.7
Foreign exchange gain -- -- 2 --
------------ ----------- ------------ -----------
Income (loss) before provision for income taxes (8,115) (87.3) 7,591 43.7
Provision (credit) for income taxes (2,688) (28.9) 2,114 12.2
------------ ----------- ------------ -----------
Net income (loss) $ (5,427) (58.4)% $ 5,477 31.5%
============ =========== ============ ===========
Finance Charges. Finance charges decreased to $2.3 million and $8.2 million
for the three and nine months ended September 30, 2003 from $4.7 million and
$14.2 million for the same periods in 2002 primarily as the result of a decrease
in the average size of the Loan portfolio due to a decline in Loan originations
in 2002 and 2003 and the Company's decision to stop Loan originations in the
United Kingdom effective June 30, 2003. To a lesser extent, the decrease in
finance charges was due to a reduction in the average annualized yield on the
Company's Loan portfolio to 10.8% and 11.4% for the three and nine months ended
September 30, 2003 from 13.8% and 13.1% for the same periods in 2002. The
decreases in the average annual yield were primarily due to increases in the:
(i) average initial term of the Company's Loan portfolio as of September 30,
2003 compared to the same period in 2002 and (ii) non-accrual percentage to
33.2% as of September 30, 2003 from 29.1% as of the same period in
19
2002 due to a decline in Loan originations in 2002 and 2003. Selected Loan
origination data follows:
(Dollars in thousands) THREE MONTHS ENDED NINE MONTHS ENDED YEARS ENDED
SEPTEMBER 30, SEPTEMBER 30, DECEMBER 31,
-------------------- -------------------- --------------------------------
2003 2002 2003 2002 2002 2001 2000
-------- -------- -------- -------- -------- -------- --------
Loan originations (1) $ 560 $ 9,073 $ 23,344 $ 35,976 $ 43,325 $122,817 $142,228
Number of Loans originated 28 605 1,391 2,560 3,062 9,121 10,664
Number of active dealer-partners (2) 8 69 86 138 147 215 205
Loans per active dealer-partner 3.5 8.8 16.2 18.6 20.8 42.4 52.0
Average Loan size $ 20.0 $ 15.0 $ 16.8 $ 14.1 $ 14.1 $ 13.5 $ 13.3
(1) The Company stopped originating Loans in the United Kingdom
effective June 30, 2003. The United Kingdom had Loan
originations initiated in the second quarter of 2003 which
were processed early in the third quarter of 2003.
(2) Active dealer-partners are dealer-partners who submitted at
least one Loan during the period.
Ancillary product income. Ancillary product income decreased to zero and
$900,000 for the three and nine months ended September 30, 2003 from $2.2
million and $3.1 million for the same periods in 2002 primarily due to: (i) a
decrease of $1.5 million due to a change in the Company's revenue recognition
policy for ancillary products in the third quarter of 2002 and (ii) a decrease
of $200,000 and $600,000, respectively, in ancillary product revenue due to the
decline in Loan originations in 2003 and the Company's decision to stop Loan
originations effective June 30, 2003. For the three months ended September 30,
2003, the decrease in ancillary product income was also due to a decrease of
$500,000 in profit sharing income on ancillary products from an ancillary
product provider.
Other Income. Other income remained relatively consistent for the three and
nine months ended September 30, 2003 and 2002.
General and Administrative. General and administrative expenses decreased to
$500,000 and $1.7 million for the three and nine months ended September 30, 2003
from $700,000 and $2.0 million for the same periods in 2002 as a result of a
general reduction in the amount of resources dedicated to the United Kingdom
operations.
Salaries and Wages. Salaries and wages remained relatively consistent at
$800,000 and $2.9 million for the three and nine months ended September 30, 2003
compared to $900,000 and $3.0 million for the same periods in 2002. Salaries and
wages expenses for the three and nine months ended September 30, 2003 included
an increase of $250,000 in expenses related to employee severance costs
associated with the Company's decision to stop Loan originations in the United
Kingdom, offset by a decline in headcount resulting from this decision.
Sales and Marketing. There were no sales and marketing expenses for the
three months ended September 30, 2003 due to the Company's decision to stop Loan
originations in the United Kingdom effective June 30, 2003. Sales and marketing
expenses increased to $900,000 for the nine months ended September 30, 2003 from
$600,000 for the same period in 2002 primarily due to employee severance costs
of $250,000 associated with the Company's decision to stop Loan originations in
the United Kingdom.
Stock-based Compensation Expense. Stock-based compensation expense remained
relatively consistent at $100,000 and $200,000 for the three and nine months
ended September 30, 2003 compared to $100,000 and $300,000 for the same periods
in 2002.
Provision for Credit Losses. The provision for credit losses decreased to
($100,000) and $1.2 million for the three and nine months ended September 30,
2003 from $700,000 and $3.2 million in the same periods in 2002. The provision
for credit losses consists of two components: (i) a provision for earned but
unpaid revenue on Loans which were transferred to non-accrual status during the
period and (ii) a provision to reflect losses inherent in the Company's Loan
portfolio. The decreases in the provision for credit losses were primarily due
to decreases in the provision for losses inherent in the Company's Loan
portfolio to ($100,000) and $1.0 million in the three and nine months ended
September 30, 2003, respectively, from $600,000 and $2.8 million for the same
periods in 2002 due primarily to the asset impairment expense the Company
recorded to reduce the carrying value of the Loan portfolio to present value
during the second quarter of 2003 as a result of the Company's decision to stop
originating Loans in the United Kingdom. The Company will continue to evaluate
the Loan portfolio for impairment as required under Statement of Financial
Accounting Standards No. 144, "Accounting for Impairment or Disposal of
Long-Lived Assets" ("SFAS No. 144") and will record additional asset impairment
expense as necessary. As such, the Company does not expect to record a provision
for credit losses in future periods.
20
United Kingdom Asset Impairment Expense. Effective June 30, 2003, the
Company elected to stop originating Loans in the United Kingdom. As a result of
this decision, the Company recorded an expense in the second quarter of 2003
consisting of: (i) $9.8 million to reduce the carrying value of the operation's
net asset value of the Loan portfolio to the present value (using a discount
rate of 13%) of the forecasted cash flows relating to the Loan portfolio less
estimated future servicing expenses and (ii) a write-off of $700,000 of fixed
assets which will no longer be used in the operation. In determining the
impairment of the Loan portfolio, the Company analyzed the expected cash flows
from this operation assuming lower collection rates than were assumed before the
decision to liquidate. These lower collection rates reflect uncertainties (such
as potentially higher employee turnover or reduced morale) in the servicing
environment that may arise as a result of the decision to liquidate. The Company
does not expect to record additional impairment expense unless the actual
results are less than the forecast used by management in the impairment
analysis, resulting in a net decrease in the present value of forecasted cash
flows relative to the United Kingdom's net asset value. Refer to Notes to
Consolidated Financial Statements -- Note 2 for further discussion on the
impairment analysis in accordance with SFAS No. 144.
As a result of the Company's decision to stop Loan originations in the
United Kingdom, the capital invested in the United Kingdom is being reinvested
in the United States. As of June 30, 2003, the effective date of the Company's
decision to stop Loan originations in the United Kingdom, the Company estimated
future cash flows from the United Kingdom of approximately $50.9 million.
Through September 30, 2003, approximately $11.2 million in cash flows have been
repatriated. The Company expects that approximately 70% of the estimated cash
flows will be recovered and reinvested in the United States within one year, 90%
within two years, and the remainder within three years. In order to manage the
foreign currency risk associated with the expected cash flows, the Company
entered into a series of forward contracts to deliver British pounds sterling,
representing approximately 90% of the total expected cash to be repatriated, to
a commercial bank in exchange for United States dollars at an agreed upon rate
through June 30, 2005.
Provision (Credit) for Income Taxes. The effective tax rate decreased to
21.5% for the three months ended September 30, 2003 from 28.3% for the same
period in 2002. The effective tax rate increased to 33.1% for the nine months
ended September 30, 2003 from 27.8% for the same period in 2002. The changes in
the effective rate for the three and nine months ended September 30, 2003 were
attributable to a restructuring of the legal entities within this business
segment. This restructuring provides the United Kingdom business segment with a
fixed dollar amount of tax benefit. The impact of this fixed benefit on the
effective tax rates varies based upon (i) whether the business segment reports
income or loss, and (ii) the amount of the income or loss. For the three months
ended September 30, 2003, the restructuring tax benefit had a greater impact on
the effective tax rate compared to the same period in 2002 due to the reduction
in pre-tax income in 2003 compared to the same period in 2002. For the nine
months ended September 30, 2003, since the business segment reported a pre-tax
loss, the restructuring tax benefit increased the amount of the credit for
income taxes, thereby increasing the effective tax rate.
21
Automobile Leasing
The Automobile Leasing segment consists of the Company's automobile leasing
operations. This segment is being liquidated as the Company decided to stop
originating leases in January 2002. The Company expects to liquidate
substantially all of its investment in this operation during 2004.
(Dollars in thousands) THREE MONTHS THREE MONTHS
ENDED ENDED
SEPTEMBER 30, % OF SEPTEMBER 30, % OF
2003 REVENUE 2002 REVENUE
------------- ----------- ------------- -----------
REVENUE:
Lease revenue $ 1,251 66.3% $ 3,614 91.8%
Other income 635 33.7 322 8.2
------------ ----------- ------------ -----------
Total revenue 1,886 100.0 3,936 100.0
COSTS AND EXPENSES:
General and administrative 162 8.5 399 10.1
Salaries and wages 250 13.3 334 8.5
Provision for credit losses 497 26.4 1,251 31.8
Depreciation of leased assets 853 45.2 2,251 57.2
Interest 266 14.1 396 10.1
------------ ----------- ------------ -----------
Total costs and expenses 2,028 107.5 4,631 117.7
------------ ----------- ------------ -----------
Operating loss (142) (7.5) (695) (17.7)
Foreign exchange gain (loss) 16 0.8 (10) (0.2)
------------ ----------- ------------ -----------
Loss before credit for income taxes (126) (6.7) (705) (17.9)
Credit for income taxes (57) (3.0) (268) (6.8)
------------ ----------- ------------ -----------
Net loss $ (69) (3.7)% $ (437) (11.1)%
============ =========== ============ ===========
(Dollars in thousands) NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, % OF SEPTEMBER 30, % OF
2003 REVENUE 2002 REVENUE
------------- ----------- ------------ -----------
REVENUE:
Lease revenue $ 5,371 81.5% $ 13,201 92.9%
Other income 1,221 18.5 1,006 7.1
------------ ----------- ------------ -----------
Total revenue 6,592 100.0 14,207 100.0
COSTS AND EXPENSES:
General and administrative 599 9.2 1,678 11.9
Salaries and wages 770 11.7 1,126 7.9
Sales and marketing -- -- 21 0.1
Provision for credit losses 1,690 25.6 4,100 28.9
Depreciation of leased assets 3,568 54.1 7,758 54.6
Interest 931 14.1 1,596 11.2
------------ ----------- ------------ -----------
Total costs and expenses 7,558 114.7 16,279 114.6
------------ ----------- ------------ -----------
Operating loss (966) (14.7) (2,072) (14.6)
Foreign exchange gain 74 1.2 2 --
------------ ----------- ------------ -----------
Loss before credit for income taxes (892) (13.5) (2,070) (14.6)
Credit for income taxes (353) (5.3) (777) (5.5)
------------ ----------- ------------ -----------
Net loss $ (539) (8.2)% $ (1,293) (9.1)%
============ =========== ============ ===========
Lease Revenue. Lease revenue decreased to $1.3 million and $5.4 million for
the three and nine months ended September 30, 2003 from $3.6 million and $13.2
million for the same periods in 2002 primarily due to the Company's decision to
stop originating automobile leases in January 2002.
Other Income. Other income, as a percent of revenue, increased to 33.7% and
18.5% for the three and nine months ended September 30, 2003 from 8.2% and 7.1%
for the same periods in 2002 due to gains recognized on leases terminated before
their maturity date increasing as lease revenue declined.
General and Administrative. General and administrative expenses, as a
percent of revenue, decreased to 8.5% and 9.2% for the three and nine months
ended September 30, 2003 from 10.1% and 11.9% for the same periods in 2002
primarily due to a decrease of $100,000 and $400,000, respectively, in the
provision for uncollectible receivables from dealer-partners for ancillary
product chargebacks on repossessed leased vehicles. For the nine months ended
September 30, 2003, the decrease was also due to: (i) a reduction of $200,000 in
third party lease servicing costs due to a reduction in the number of leases
serviced and (ii) an
22
expense of $100,000 recorded in 2002 for the impairment of certain assets. The
remaining decreases for the three and nine months ended September 30, 2003
reflect a general reduction in the amount of resources necessary to support the
Automobile Leasing operations as a result of the Company's decision to stop
originating automobile leases in January 2002.
Salaries and Wages. Salaries and wages, as a percent of revenue, increased
to 13.3% and 11.7% for the three and nine months ended September 30, 2003 from
8.5% and 7.9% for the same periods in 2002 primarily due to servicing salaries
and wages expenses declining at a slower rate than the decline in revenue
producing leases.
Sales and Marketing. There were no sales and marketing expenses for the
three and nine months ended September 30, 2003 due to discontinuing automobile
lease originations in January 2002.
Provision for Credit Losses. The provision for credit losses, as a percent
of lease revenue, increased to 39.7% and 31.5% for the three and nine months
ended September 30, 2003 from 34.6% and 31.1% for the same period in 2002
primarily due to the frequency of lease repossessions declining at a slower rate
than the decline in revenue producing leases. The Company will continue to
evaluate the net asset value of the Automobile Leasing operation for impairment
as required under SFAS No. 144 and will record additional impairment expense as
necessary. As such, the Company does not expect to record a provision for lease
losses in future periods.
Depreciation of Leased Assets. Depreciation of leased assets, including the
amortization of initial direct lease costs and insurance costs paid to third
parties, is recorded on a straight-line basis to the residual value of leased
vehicles over their scheduled lease terms. Depreciation expense, as a percent of
lease revenue, increased to 57.1% and 56.0% for the three and nine months ended
September 30, 2003 from 51.3% and 48.4% for the same periods in 2002 primarily
due to a reduction in the average residual value, as a percent of original lease
value, in the lease portfolio. Amortization of initial direct lease costs and
insurance costs paid to third parties, as a percent of lease revenue, remained
relatively consistent at 11.1% and 10.5% for the three and nine months ended
September 30, 2003 from 11.0% and 10.4% for the same periods in 2002.
Credit for Income Taxes. The effective tax rate increased to 45.2% and 39.6%
for the three and nine months ended September 30, 2003 from 38.0% and 37.5% for
the same periods in 2002. The changes in the effective tax rates did not have a
material impact on the segment's financial results.
Other
The Other segment consists of the Company's Canadian retail automobile Loan
operations and secured lines of credit and floorplan financing products. In June
2003, the Company decided to stop originating Loans in Canada. The Company is
also reducing its investment in secured lines of credit and floorplan financing
products.
(Dollars in thousands) THREE MONTHS THREE MONTHS
ENDED ENDED
SEPTEMBER 30, % OF SEPTEMBER 30, % OF
2003 REVENUE 2002 REVENUE
------------- ----------- ------------- -----------
REVENUE:
Finance charges $ 347 41.0% $ 397 30.9%
Other income 500 59.0 887 69.1
------------ ----------- ------------- -----------
Total revenue 847 100.0 1,284 100.0
COSTS AND EXPENSES:
General and administrative 75 8.9 239 18.6
Salaries and wages 47 5.5 69 5.4
Sales and marketing 2 0.2 54 4.2
Provision for credit losses 691 81.6 1,362 106.1
Interest 136 16.1 225 17.5
------------ ----------- ------------- -----------
Total costs and expenses 951 112.3 1,949 151.8
------------ ----------- ------------- -----------
Income (loss) before
provision (credit) for income taxes (104) (12.3) (665) (51.8)
Provision (credit) for income taxes 12 1.4 (247) (19.2)
------------ ----------- ------------- -----------
Net loss $ (116) (13.7)% $ (418) (32.6)%
============ =========== ============= ===========
23
(Dollars in thousands) NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, % OF SEPTEMBER 30, % OF
2003 REVENUE 2002 REVENUE
------------- ----------- ------------ -----------
REVENUE:
Finance charges $ 1,166 51.0% $ 1,288 32.3%
Other income 1,120 49.0 2,704 67.7
------------ ----------- ------------ -----------
Total revenue 2,286 100.0 3,992 100.0
COSTS AND EXPENSES:
General and administrative 260 11.4 700 17.5
Salaries and wages 195 8.5 199 5.0
Sales and marketing 62 2.7 203 5.1
Provision for credit losses 972 42.5 1,891 47.4
Interest 564 24.7 770 19.3
------------ ----------- ------------ -----------
Total costs and expenses 2,053 89.8 3,763 94.3
------------ ----------- ------------ -----------
Income before provision for income taxes 233 10.2 229 5.7
Provision for income taxes 173 7.6 93 2.3
------------ ----------- ------------ -----------
Net income $ 60 2.6% $ 136 3.4%
============ =========== ============ ===========
Finance charges. Finance charges decreased to $300,000 and $1.2 million for
the three and nine months ended September 30, 2003 from $400,000 and $1.3
million for the same periods in 2002. Finance charges decreased for the three
and nine months ended September 30, 2003 primarily due to a decrease in the
average size of the Canadian Loan portfolio due to a decline in Loan
originations in Canada in 2003 and the Company's decision to stop Loan
originations in Canada effective June 30, 2003. To a lesser extent, the decrease
in finance charges was due to a reduction in the average annualized yield on the
Company's Canadian Loan portfolio to 11.1% and 12.2% for the three and nine
months ended September 30, 2003 from 11.7% and 12.7% for the same periods in
2002. The decrease was primarily due to an increase in the percent of
non-accrual Loans to 24.5% as of September 30, 2003 from 20.5% as of the same
period in 2002 due to a decline in Loan originations in 2003.
Other Income. Other income decreased to $500,000 and $1.1 million for the
three and nine months ended September 30, 2003 from $900,000 and $2.7 million
for the same periods in 2002. The decreases for the three and nine months ended
September 30, 2003 are primarily due to decreases of $300,000 and $1.5 million,
respectively, in revenue from secured lines of credit and floorplan financing
offered to certain dealer-partners as the Company continues to reduce its
investment in these products.
General and Administrative. General and administrative expenses decreased to
$100,000 and $300,000 for the three and nine months ended September 30, 2003
from $200,000 and $700,000 for the same periods in 2002 due to a general
reduction in the amount of resources necessary to support the Canadian
operations as a result of the Company's decision to stop Loan originations in
Canada effective June 30, 2003.
Salaries and Wages. Salaries and wages, as a percent of revenue, increased
to 5.6% and 8.5% for the three and nine months ended September 30, 2003 from
5.4% and 5.0% for the same periods in 2002 primarily due to salaries and wages
relating to the Company's floorplan and line of credit loan products remaining
relatively constant as the income from these products declined as a result of
the Company's decision to decrease its investment in these products.
Sales and Marketing. Sales and marketing expenses decreased to zero and
$100,000 for the three and nine months ended September 30, 2003 from $100,000
and $200,000 for the same periods in 2002 due primarily to decreased sales
commissions in the Canadian automobile Loan operations as a result of decreased
unit volumes and the Company's decision to stop Loan originations in Canada
effective June 30, 2003.
Provision for Credit Losses. The provision for credit losses decreased to
$700,000 and $1.0 million for the three and nine months ended September 30, 2003
from $1.4 million and $1.9 million for the same periods in 2002. The provision
for credit losses consists of four components: (i) a provision for earned but
unpaid revenue on Loans which were transferred to non-accrual status during the
period, (ii) a provision to reflect losses inherent in the Company's Loan
portfolio, (iii) a provision for losses on secured line of credit loans, and
(iv) a provision for floorplan loan losses. The decrease in the provision for
credit losses for the three and nine months ended September 30, 2003 was
primarily due to decreases of $1.2 million and $1.6 million, respectively, in
the provision for floorplan loan losses as the Company continues to reduce its
investment in this product. These decreases were partially offset by increases
of $500,000 and $400,000 in the provision for secured line of credit loan losses
for the three and nine months ended September 30, 2003.
Provision for Income Taxes. The effective tax rate decreased to 11.5% for
the three months ended September 30, 2003 from 37.1% for the same period in
2002. While the business segment reported a loss for the three months ended
September 30, 2003, the business segment did not report a credit for income
taxes as a result of the provision for taxes on earnings of the Canadian
operation, which has a higher effective rate than the businesses based in the
United States, exceeding the amount of the credit for
24
taxes on losses reported on the secured line of credit and floorplan products.
For the nine months ended September 30, 2003, the effective tax rate increased
to 74.2% from 40.6% compared to the same period in 2002. The increase in the
effective rate for the nine months ended September 30, 2003 compared to the same
period in 2002 was due to losses reported in the floorplan and line of credit
businesses in 2003. These businesses are based in the United States, and have a
lower effective tax rate than the Canadian automobile Loan business. As a
result, the tax benefit from losses incurred in these businesses does not fully
offset taxes relating to profits earned in the Canadian operation, thereby
increasing the effective tax rate for the business segment.
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
As a result of a Securities and Exchange Commission review of the Company's
Form 10-K for the year ended December 31, 2002 and Form 10-Q for the period
ended June 30, 2003, the Company is including the results of operations for its
four business segments for the prior year in this Form 10-Q. The segment results
include adjustments for SFAS No. 123, "Accounting for Stock-Based Compensation",
as amended by SFAS No. 148, "Accounting for Stock-Based Compensation --
Transition and Disclosure". Refer to Notes to Consolidated Financial Statements
- -- Note 11 for further discussion on the Company's adoption of the fair value
recognition and measurement provisions of SFAS No. 123. The results of
operations for the Company as a whole are attributable to changes described by
segment in the discussion of the results of operations in the United States,
United Kingdom, Automobile Leasing, and Other business segments.
United States
(Dollars in thousands) YEAR ENDED % OF YEAR ENDED % OF
DECEMBER 31, 2002 REVENUE DECEMBER 31, 2001 REVENUE
----------------- ------- ----------------- -------
REVENUE:
Finance charges $ 78,414 70.8% $ 66,306 71.2%
Ancillary product income 13,183 11.9 10,221 11.0
Premiums earned 4,512 4.1 6,572 7.1
Other income 14,622 13.2 9,953 10.7
----------------- ------- ----------------- -------
Total revenue 110,731 100.0 93,052 100.0
COSTS AND EXPENSES:
General and administrative 19,185 17.4 13,537 14.5
Salaries and wages 23,745 21.4 19,989 21.5
Sales and marketing 6,522 5.9 6,226 6.7
Stock-based compensation expense 1,686 1.5 1,632 1.8
Provision for insurance and service contract claims 1,861 1.7 1,544 1.7
Provision for credit losses 11,749 10.6 2,720 2.9
Interest 5,408 4.9 7,721 8.3
----------------- ------- ----------------- -------
Total costs and expenses 70,156 63.4 53,369 57.4
----------------- ------- ----------------- -------
Operating income 40,575 36.6 39,683 42.6
Foreign exchange loss (6) -- (37) --
----------------- ------- ----------------- -------
Income before provision for
income taxes 40,569 36.6 39,646 42.6
Provision for income taxes 16,779 15.1 16,584 17.8
----------------- ------- ----------------- -------
Net income $ 23,790 21.5% $ 23,062 24.8%
================= ======= ================= =======
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
Finance Charges. Finance charges increased to $78.4 million in 2002 from
$66.3 million in 2001 primarily due to an increase in the average size of the
Loan portfolio due to an increase in Loan originations in 2001. This increase
was partially offset by a reduction in the average annualized yield on the
Company's Loan portfolio to 12.5% in 2002 from 12.8% in 2001. The decrease in
the average yield was primarily due to an increase in the percent of non-accrual
Loans to 21.9% as of December 31, 2002 from 18.6% for the same period in 2001
due primarily to a reduction in Loan originations in 2002.
Ancillary Product Income. Ancillary product income increased to $13.2
million in 2002 from $10.2 million in 2001 primarily due to increases in: (i)
penetration rates on third party service contract products offered by
dealer-partners and (ii) the average amount earned per service contract in 2002
compared to 2001.
Premiums Earned. Premiums earned decreased to $4.5 million in 2002 from $6.6
million in 2001 primarily due to a decrease in penetration rates on the
Company's in-house service contract product in 2002 and 2001.
25
Other Income. Other income increased to $14.6 million in 2002 from $10.0
million in 2001 primarily due to: (i) interest income of $4.8 million from the
Internal Revenue Service received in connection with a change in tax accounting
methods that affected the characterization and timing of revenue recognition for
tax purposes and (ii) an increase of $1.2 million in monthly fees paid by
dealer-partners for the use of the Company's Internet origination system. These
increases were partially offset by the one-time gain of $1.1 million in 2001 to
record the exercise of a clean-up call relating to the July 1998 securitization
of advance receivables.
General and Administrative. General and administrative expenses increased to
$19.2 million in 2002 from $13.5 million in 2001 due to: (i) the reversal in
2001 of Michigan single business taxes of $4.7 million, which were paid from
1993 to 2000, resulting from a re-characterization of the Company's revenue as a
result of an Internal Revenue Service examination. This reversal of Michigan
single business taxes was partially offset by an increase in state income taxes
(see "Provision for Income Taxes"). The increase was also due to losses of $1.4
million on the disposal of computer hardware in 2002.
Salaries and Wages. Salaries and wages increased to $23.7 million in 2002
from $20.0 million in 2001 primarily due to an increase of $2.9 million
resulting primarily from increased spending on corporate support areas such as
Information Systems, Finance, and a Six Sigma initiative.
Sales and Marketing. Sales and marketing expenses increased to $6.5 million
in 2002 from $6.2 million in 2001 as a result of expense associated with a
direct mail lead generation services product provided to dealer-partners and an
increase in the average sales commission per Loan originated.
Stock-based Compensation Expense. Stock-based compensation expense remained
relatively consistent at $1.7 million in 2002 compared to $1.6 million in 2001.
Provision for Insurance and Service Contract Claims. The provision for
insurance and service contract claims, as a percent of premiums earned,
increased to 41.2% in 2002 from 23.5% in 2001 due to an increase in the percent
of total claims paid relating to the Company's credit life and accident and
health products, which have a lower ratio of claims paid to premiums earned than
the Company's service contract product.
Provision for Credit Losses. The provision for credit losses increased to
$11.7 million in 2002 from $2.7 million in 2001. The provision for credit losses
consists of three components: (i) a provision for earned but unpaid revenue on
Loans which were transferred to non-accrual status during the period, (ii) a
provision to reflect losses inherent in the Company's Loan portfolio, and (iii)
a provision for losses on notes receivable. The increase in the provision for
credit losses for the year ended December 31, 2002 compared to the year ended
December 31, 2001 was primarily due to increases of: (i) $6.1 million in the
provision for losses inherent in the Company's Loan portfolio due to higher
losses in 2002 as a result of a difficult conversion to a new collection system
(see Part I, Item 2 "--General"); and (ii) $2.6 million in the provision for
earned but unpaid revenue due to an increase in the percent of non-accrual Loans
to 21.9% as of December 31, 2002 from 18.6% for the same period in 2001.
Provision for Income Taxes. The effective tax rate remained relatively
consistent at 41.4% in 2002 compared to 41.8% in 2001. The effective tax rate in
2002 includes an 8.9% increase in the effective tax rate resulting from expense
of $3.6 million recorded in 2002 for estimated taxes due upon repatriation of
prior years' earnings in the United Kingdom, partially offset by a 2.6% decrease
related to a reversal of expense in 2002 due to a change in estimate of state
income tax owed. The effective tax rate in 2001 includes a 6.8% increase in the
effective tax rate resulting from a $2.7 million change in estimate of state
income tax owed.
26
United Kingdom
(Dollars in thousands) YEAR ENDED % OF YEAR ENDED % OF
DECEMBER 31, 2002 REVENUE DECEMBER 31, 2001 REVENUE
----------------- ------- ----------------- -------
REVENUE:
Finance charges $ 17,671 83.7% $ 21,802 88.6%
Ancillary product income 3,254 15.4 2,670 10.8
Other income 195 0.9 140 0.6
----------------- ------- ----------------- -------
Total revenue 21,120 100.0 24,612 100.0
COSTS AND EXPENSES:
General and administrative 2,509 11.9 2,838 11.6
Salaries and wages 3,620 17.1 4,904 19.9
Sales and marketing 849 4.0 922 3.7
Stock-based compensation expense 386 1.8 123 0.5
Provision for credit losses 4,489 21.3 3,399 13.8
Interest 647 3.1 2,196 8.9
----------------- ------- ----------------- -------
Total costs and expenses 12,500 59.2 14,382 58.4
----------------- ------- ----------------- -------
Operating income 8,620 40.8 10,230 41.6
Foreign exchange gain 5 -- - --
----------------- ------- ----------------- -------
Income before provision for
income taxes 8,625 40.8 10,230 41.6
Provision for income taxes 2,343 11.1 3,020 12.3
----------------- ------- ----------------- -------
Net income $ 6,282 29.7% $ 7,210 29.3%
================= ======= ================= =======
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
Finance Charges. Finance charges decreased to $17.7 million in 2002 from
$21.8 million in 2001 primarily as the result of decreases in: (i) the average
size of the Loan portfolio due to a decrease in Loan originations in 2002 and
(ii) the average annualized yield on the Company's Loan portfolio to 12.7% in
2002 from 13.6% in 2001. The decrease in the average yield was primarily due to
an increase in the percent of non-accrual Loans to 31.3% as of December 31, 2002
from 22.4% for the same period in 2001 due to a reduction in Loan originations
in 2002. Loan originations decreased in 2002 to $43.3 million from $122.8
million in 2001 as the result of the Company decreasing the amount advanced to
dealer-partners and discontinuing its relationship with certain dealer-partners
whose business did not meet the Company's return on capital objectives.
Ancillary Product Income. Ancillary product income increased to $3.3 million
in 2002 from $2.7 million in 2001 primarily due to a change in revenue
recognition, which increased revenue by $1.5 million. This change was the result
of a complete review of the Company's revenue recognition policies, which
determined that, while conservative, the policies relative to ancillary product
revenue recognition in the United Kingdom were inconsistent with those employed
in the United States. Therefore, the Company adopted the accounting treatment
that was appropriate and consistent with the policies employed in the United
States. This increase in income resulting from the change in revenue recognition
was partially offset by a $300,000 decrease in revenue under a profit sharing
agreement with an insurance provider.
Other Income. Other income remained relatively consistent in 2002 and 2001.
General and Administrative. General and administrative expenses decreased to
$2.5 million in 2002 from $2.8 million in 2001 as a result of accounting and
legal expenses incurred in 2001 related to the restructuring of legal entities
within this business segment. Salaries and Wages. Salaries and wages decreased
to $3.6 million in 2002 from $4.9 million in 2001 primarily due to executive
severance agreement expenses of $700,000 incurred in 2001 and a reduction in
staffing levels in 2002.
Sales and Marketing. Sales and marketing expenses remained relatively
consistent at $800,000 in 2002 compared to $900,000 in 2001.
Stock-based Compensation Expense. Stock-based compensation expense increased
to $400,000 in 2002 from $100,000 in 2001 due to an increase in the number of
stock options outstanding as a result of stock options granted during the second
half of 2001 and in 2002.
Provision for Credit Losses. Provision for credit losses increased to $4.5
million in 2002 from $3.4 million in 2001. The provision for credit losses
consists of two components: (i) a provision for earned but unpaid revenue on
Loans that were transferred to non-accrual status during the period; and (ii) a
provision to reflect losses inherent in the Company's Loan portfolio. The
increase was primarily due to an increase of $1.4 million in the provision for
losses inherent in the Company's Loan portfolio due to a decline in credit
quality of Loans originated in 2001, partially offset by a decrease of $300,000
in the provision for earned but unpaid revenue. As a result of the decline in
credit quality of Loans originated in 2001, the Company stopped originating
Loans in Ireland and decreased the amount advanced to dealer-partners in the
United Kingdom.
Provision for Income Taxes. The effective tax rate decreased to 27.2% in
2002 from 29.5% in 2001. The reduction in the effective rate in 2002 was
attributable to a restructuring of the legal entities within this business
segment. This restructuring provides the United Kingdom business segment with a
fixed dollar amount of tax benefit. The impact of this fixed benefit on the
effective tax rates varies based upon: (i) whether the business segment reports
income or loss and (ii) the amount of the income or loss. For the year ended
December 31, 2002, the decrease in the effective tax rate was due to the
reduction in pre-tax income in 2002.
27
Automobile Leasing
(Dollars in thousands) YEAR ENDED % OF YEAR ENDED % OF
DECEMBER 31, 2002 REVENUE DECEMBER 31, 2001 REVENUE
----------------- -------- ----------------- --------
REVENUE:
Lease revenue $ 16,101 92.6 % $ 21,853 94.2 %
Other income 1,279 7.4 1,339 5.8
----------------- -------- ----------------- --------
Total revenue 17,380 100.0 23,192 100.0
COSTS AND EXPENSES:
General and administrative 2,048 11.9 3,195 13.9
Salaries and wages 1,409 8.1 1,827 7.9
Sales and marketing 23 0.1 288 1.2
Provision for credit losses 5,134 29.5 6,126 26.4
Depreciation of leased assets 9,669 55.6 12,485 53.8
Interest 1,992 11.5 3,365 14.5
----------------- -------- ----------------- --------
Total costs and expenses 20,275 116.7 27,286 117.7
----------------- -------- ----------------- --------
Operating loss (2,895) (16.7) (4,094) (17.7)
Foreign exchange gain (loss) 1 - (5) -
----------------- -------- ----------------- --------
Loss before provision for
income taxes (2,894) (16.7) (4,099) (17.7)
Credit for income taxes (1,070) (6.2) (1,465) (6.3)
----------------- -------- ----------------- --------
Net loss $ (1,824) (10.5)% $ (2,634) (11.4)%
================= ========= ================= ========
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
Lease Revenue. Lease revenue decreased to $16.1 million in 2002 from $21.9
million in 2001 primarily due to the decrease in the dollar value of the
Company's lease portfolio. This decrease was the result of the Company's
decision to stop originating automobile leases in the first quarter of 2002.
Other Income. Other income remained relatively consistent in 2002 and 2001.
General and Administrative. General and administrative expenses, as a
percentage of revenue, decreased to 11.9% in 2002 from 13.9% in 2001 due
primarily to expense of $725,000 for the impairment of certain assets recorded
in 2001 relating to the Company's decision to stop new lease originations.
Salaries and Wages. Salaries and wages, as percentage of revenue, increased
to 8.1% for 2002 from 7.9% in 2001 primarily due to servicing salaries and wages
declining at a slower rate than the decline in revenue producing leases.
Sales and Marketing. Sales and marketing expenses decreased to a negligible
amount in 2002 from $300,000 in 2001 due to discontinuing automobile lease
originations in the first quarter of 2002.
Provision for Credit Losses. Provision for credit losses decreased to $5.1
million in 2002 from $6.1 million in 2001 primarily due to a decrease in the
dollar value of the Company's lease portfolio.
Depreciation of Leased Assets. Depreciation of leased assets, including the
amortization of initial direct lease costs and insurance costs paid to third
parties, is recorded on a straight-line basis to the residual value of leased
vehicles over their scheduled lease terms. Depreciation expense, as a percent of
lease revenue, increased to 49.4% in 2002 from 46.2% in 2001 primarily due to a
reduction in the average residual value, as a percent of original lease value,
in the lease portfolio. Amortization of initial direct lease costs and insurance
costs paid to third parties, as a percent of lease revenue, remained relatively
consistent at 10.6% in 2002 from 10.9% in 2001.
Credit for Income Taxes. The effective tax rate increased to 37.0% in 2002
from 35.7% in 2001. The change in the effective tax rates did not have a
material impact on the segment's financial results.
28
Other
(Dollars in thousands) YEAR ENDED % OF YEAR ENDED % OF
DECEMBER 31, 2002 REVENUE DECEMBER 31, 2001 REVENUE
----------------- ------- ----------------- -------
REVENUE:
Finance charges $ 1,659 32.5 % $ 2,061 31.8 %
Other income 3,444 67.5 4,412 68.2
------- ------ ------- ------
Total revenue 5,103 100.0 6,473 100.0
COSTS AND EXPENSES:
General and administrative 804 15.7 1,355 21.0
Salaries and wages 268 5.3 450 7.0
Sales and marketing 229 4.5 249 3.8
Provision for credit losses 2,563 50.2 1,789 27.6
Interest 1,011 19.8 1,406 21.7
------- ------ ------- ------
Total costs and expenses 4,875 95.5 5,249 81.1
------- ------ ------- ------
Income before provision for income taxes 228 4.5 1,224 18.9
Provision for income taxes 106 2.1 447 6.9
------- ------ ------- ------
Net income $ 122 2.4 $ 777 12.0
======= ====== ======= ======
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
Finance charges. Finance charges decreased to $1.7 in 2002 from $2.1 in
2001 primarily due to an decrease in the average size of the Canadian Loan
portfolio due to a decrease in Loan originations in Canada in 2002. To a lesser
extent, the decrease in finance charges was due to a reduction in the average
annualized yield on the Company's Canadian Loan portfolio to 12.4% in 2002 from
14.7% in 2001. The decrease in the average yield was primarily due to an
increase in the percent of non-accrual Loans to 21.4% as of December 31, 2002
from 16.9% as of the same period in 2001 due to a decline in Loan originations
in 2002.
Other Income. Other income decreased to $3.4 million in 2002 from $4.4
million in 2001 primarily due to a decrease of $1.0 million in revenue from
secured lines of credit and floorplan financing offered to certain
dealer-partners due to a reduction in the amount of capital invested in these
products.
General and Administrative. General and administrative expenses decreased to
$800,000 in 2002 from $1.4 million in 2001 due to a general reduction in the
amount of resources necessary to support the Canadian operations.
Salaries and Wages. Salaries and wages, as a percent of revenue, decreased
to 5.3% in 2002 from 7.0% in 2001 primarily due to a reduction in salaries and
wages relating to the Company's floorplan and line of credit loan products, as
well as a reduction in the amount of resources necessary to support the Canadian
operations.
Sales and Marketing. Sales and marketing expenses remained relatively
consistent in 2002 and 2001.
Provision for Credit Losses. The provision for credit losses increased to
$2.6 million in 2002 from $1.8 million in 2001. The provision for credit losses
consists of four components: (i) a provision for earned but unpaid revenue on
Loans which were transferred to non-accrual status during the period, (ii) a
provision to reflect losses inherent in the Company's Loan portfolio, (iii) a
provision for losses on secured line of credit loans, and (iv) a provision for
floorplan loan losses. The increase in the provision for credit losses in 2002
was primarily due to an increase of $800,000 in the provision for floorplan and
secured line of credit loan losses in 2002.
Provision for Income Taxes. The effective tax rate increased to 46.5% in 2002
from 36.5% in 2001. The increase in the effective rate was due to losses
reported in the floorplan business in 2002. This business is based in the United
States, and has a lower effective tax rate than the Canadian automobile Loan
business. As a result, the tax benefit from losses incurred in these businesses
does not fully offset taxes relating to profits earned in the Canadian
operation, thereby increasing the effective tax rate for the business segment.
29
AVERAGE CAPITAL ANALYSIS
The following presentation of financial results and subsequent analysis is
based on analyzing the income statement as a percent of capital invested. This
information provides an additional perspective on the financial performance of
the Company in addition to the presentation of the Company's results as a
percent of revenue. The Company believes this information provides a useful
measurement of how effectively the Company is utilizing its capital.
Consolidated
(Dollars in thousands) THREE MONTHS THREE MONTHS
ENDED ENDED
SEPTEMBER 30, % OF AVERAGE SEPTEMBER 30, % OF AVERAGE
2003 CAPITAL (1) 2002 CAPITAL (1)
------------- ------------ ------------- -------------
REVENUE:
Finance charges $ 25,770 23.0 % $ 24,018 20.6 %
Lease revenue 1,251 1.1 3,614 3.1
Ancillary product income 4,369 3.9 5,500 4.7
Premiums earned 734 0.7 1,001 0.9
Other income 3,738 3.3 8,535 7.3
--------- ---- --------- ----
Total revenue 35,862 32.0 42,668 36.6
COSTS AND EXPENSES:
General and administrative 4,679 4.2 5,789 5.0
Salaries and wages 7,879 7.0 7,184 6.2
Sales and marketing 1,886 1.7 1,954 1.7
Stock-based compensation expense 1,027 0.9 535 0.5
Provision for insurance and service contract claims 329 0.3 590 0.5
Provision for credit losses 2,303 2.1 8,896 7.6
Depreciation of leased assets 853 0.8 2,251 1.9
Interest 2,267 2.0 2,364 2.0
--------- ---- --------- ----
Total costs and expenses 21,223 19.0 29,563 25.4
--------- ---- --------- ----
Operating income 14,639 13.0 13,105 11.2
Foreign exchange loss (1,066) (0.9) (25) -
--------- ---- --------- ----
Income before provision for income taxes 13,573 12.1 13,080 11.2
Provision for income taxes 4,755 4.2 4,468 3.8
--------- ---- --------- ----
Net income $ 8,818 7.9 % $ 8,612 7.4 %
========= ==== ========= ====
Average capital (1) $ 448,913 $ 466,763
30
(Dollars in thousands) NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, % OF AVERAGE SEPTEMBER 30, % OF AVERAGE
2003 CAPITAL (1) 2002 CAPITAL (1)
------------- ------------ ------------- -------------
REVENUE:
Finance charges $ 76,457 22.7% $ 74,425 20.8%
Lease revenue 5,371 1.6 13,201 3.7
Ancillary product income 14,335 4.3 12,919 3.6
Premiums earned 2,246 0.7 3,495 1.0
Other income 10,354 3.1 16,075 4.5
--------- ---------- --------- ----------
Total revenue 108,763 32.5 120,115 33.6
COSTS AND EXPENSES:
General and administrative 15,361 4.5 17,889 4.9
Salaries and wages 25,083 7.5 22,136 6.2
Sales and marketing 6,546 2.0 5,544 1.6
Stock-based compensation expense 2,830 0.8 1,582 0.4
Provision for insurance and service contract claims 637 0.2 1,723 0.5
Provision for credit losses 9,354 2.8 15,973 4.5
Depreciation of leased assets 3,568 1.1 7,758 2.2
United Kingdom asset impairment expense 10,493 3.1 - -
Interest 5,264 1.6 7,126 2.0
--------- ---------- --------- ----------
Total costs and expenses 79,136 23.6 79,731 22.3
--------- ---------- --------- ----------
Operating income 29,627 8.8 40,384 11.3
Foreign exchange gain (loss) (1,037) (0.3) 2 -
--------- ---------- --------- ----------
Income before provision for income taxes 28,590 8.5 40,386 11.3
Provision for income taxes 10,171 3.0 17,111 4.8
--------- ---------- --------- ----------
Net income $ 18,419 5.5% $ 23,275 6.5%
========= ========== ========= ==========
Average capital (1) $ 447,214 $ 476,081
(1) Average capital is equal to the average amount of debt and equity during
the period in accordance with generally accepted accounting principles in
the United States of America ("GAAP"). The calculation of average capital
follows:
(Dollars in thousands) THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2003 2002 2003 2002
-------- -------- -------- --------
Average debt $109,204 $152,986 $111,927 $172,512
Average shareholders' equity 339,709 313,777 335,287 303,569
-------- -------- -------- --------
Average capital $448,913 $466,763 $447,214 $476,081
======== ======== ======== ========
RETURN ON CAPITAL ANALYSIS
Return on capital is equal to net operating profit after-tax (net income
plus interest expense after-tax) divided by average capital as follows:
(Dollars in thousands) THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2003 2002 2003 2002
-------- -------- -------- --------
Net income $ 8,818 $ 8,612 $ 18,419 $ 23,275
Interest expense $ 2,267 $ 2,364 $ 5,264 $ 7,126
Tax rate 65.0% 65.2% 65.0% 65.5%
-------- -------- -------- --------
Interest expense after-tax $ 1,474 $ 1,541 $ 3,422 $ 4,664
-------- -------- -------- --------
Net operating profit after-tax $ 10,292 $ 10,153 $ 21,841 $ 27,939
======== ======== ======== ========
Average capital $448,913 $466,763 $447,214 $476,081
======== ======== ======== ========
Return on capital 9.2% 8.7% 6.5% 7.8%
The Company's return on capital increased to 9.2% for the three months ended
September 30, 2003 from 8.7% for the same period in 2002. The increase in the
return on capital was due to an increase in the return on capital in the United
States and an increase in the percent of total capital invested in the United
States to 87.9% in 2003 from 74.8% in 2002. Partially offsetting the increase in
the return on capital in the United States was a decrease in the return on
capital in the United Kingdom. The increase in the return on capital in the
United States was due to: (i) a decrease in provision for credit losses due to a
decrease in the provision for losses inherent in the Company's Loan portfolio
and (ii) an increase in finance charges, as a percent of average
31
capital, due to a reduction in the amount advanced to dealer-partners as a
percent of the gross Loan amount. This increase in return on capital was
partially offset by: (i) a decrease in other income, as a percent of average
capital, due to interest income from the Internal Revenue Service received in
2002 in connection with a change in tax accounting methods that affected the
characterization and timing of revenue recognition for tax purposes and (ii) an
increase in foreign exchange loss as a result of the Company recognizing the
fair value of forward contracts entered into to manage foreign currency risk
associated with the cash flows anticipated from the exit of the United Kingdom
operation.
The Company's return on capital decreased to 6.5% for the nine months ended
September 30, 2003 from 7.8% for the same period in 2002. The decrease in return
on capital was primarily due to a reduction in the return on capital in the
United Kingdom, partially offset by an increase in return on capital in the
United States and an increase in the percent of total capital invested in the
United States to 84.4% in 2003 from 73.4% in 2002. The decrease in the return on
capital in the United Kingdom was primarily a result of the $7,238,000 after-tax
adjustment for asset impairment and accrued expenses related to the Company's
decision to stop originating Loans in the United Kingdom effective June 30,
2003. This adjustment decreased the Company's reported return on capital by 2.2%
for the nine months ended September 30, 2003.
The increase in the return on capital in the United States was due to: (i)
an increase in finance charges as a percent of average capital due to a
reduction in the amount advanced to dealer-partners as a percent of the gross
Loan amount, (ii) a decrease in the provision for income taxes for two tax
related adjustments in 2002 and (iii) an increase in ancillary product income,
which is recognized upon the sale of the ancillary product. Ancillary product
income, as a percent of average capital, increased as a result of Loan
originations increasing at a faster rate than average capital in the United
States. This increase in return on capital was partially offset by: (i) a
decrease in other income, as a percent of average capital, due to interest
income from the Internal Revenue Service received in 2002 in connection with a
change in tax accounting methods that affected the characterization and timing
of revenue recognition for tax purposes and (ii) an increase in foreign exchange
loss as a result of the Company recognizing the fair value of forward contracts
entered into to manage foreign currency risk associated with the cash flows
anticipated from the exit of the United Kingdom operation.
ECONOMIC PROFIT
Economic profit represents net operating profit after-tax less an imputed
cost of equity. Economic profit measures how efficiently the Company utilizes
its total capital, both debt and equity. To consider the cost of both debt and
equity, the Company's calculation of economic profit deducts from net income as
determined under GAAP a cost of equity equal to 10% of average equity, which
approximates the S&P 500's rate of return since 1965. Management uses economic
profit to assess the Company's performance and the amount of value created for
shareholders as well as to make capital allocation decisions. Management
believes this information is important to shareholders because it allows
shareholders to compare the returns earned by the Company investing capital in
its core business with the return they could expect if the Company returned
capital to shareholders and they invested in other securities. The Company
generated an economic profit of $325,000, or $0.01 per diluted share, for the
three months ended September 30, 2003 compared to $768,000, or $0.02 per diluted
share, for the same period in 2002. The Company generated an economic loss of
($6,728,000), or ($0.16) per diluted share, for the nine months ended September
30, 2003 compared to an economic profit of $507,000, or $0.01 per diluted share,
for the same period in 2002.
The following table presents the calculation of the Company's economic
profit (loss) for the periods indicated (dollars in thousands, except per share
data):
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- --------------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
ECONOMIC PROFIT (LOSS)
Net income (1) $ 8,818 $ 8,612 $ 18,419 $ 23,275
Imputed cost of equity at 10% (2) (8,493) (7,844) (25,147) (22,768)
------------ ------------ ------------ ------------
Total economic profit (loss) $ 325 $ 768 $ (6,728) $ 507
Diluted weighted average shares outstanding 43,959,924 43,122,046 43,247,518 43,517,380
Economic profit (loss) per share (3) $ 0.01 $ 0.02 $ (0.16) $ 0.01
(1) Consolidated net income from the Consolidated Statement of Income. See
"Item 1. Consolidated Financial Statements."
(2) Cost of equity is equal to 10% (on an annual basis) of total average
shareholders' equity, which was $339,709,000 and $335,287,000 for the
three and nine months ended September 30, 2003, respectively, and
$313,777,000 and $303,569,000 for the same periods in 2002,
respectively, calculated as described in the Average Capital Analysis.
(3) Economic profit (loss) per share equals the economic profit (loss)
divided by the weighted average number of shares outstanding.
32
CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in accordance
with GAAP. The preparation of these financial statements requires the Company to
make estimates and judgments 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. On an on-going basis, the Company evaluates its
estimates, including those related to the Allowance for credit losses, including
the allowance for earned but unpaid revenue on Loans which were transferred to
non-accrual status and the allowance for losses inherent in the Company's Loan
portfolio. Item 7 of the Company's Annual Report on Form 10-K discusses several
critical accounting policies, which the Company believes involve a high degree
of judgment and complexity. There have been no material changes to the estimates
and judgments associated with these accounting policies during the three and
nine months ended September 30, 2003 other than the stock-based compensation
policy described below.
Stock-based compensation expense. Effective June 30, 2003, the Company
adopted the fair value recognition and measurement provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation", as amended by SFAS No. 148,
"Accounting for Stock-Based Compensation -- Transition and Disclosure" for
stock-based employee compensation. Under the retroactive restatement transition
method selected by the Company described in SFAS No. 148, the Company restated
all prior periods to reflect the stock-based compensation expense that would
have been recognized had the recognition provisions of SFAS No. 123 been applied
to all awards granted to employees or directors after January 1, 1995. In
adopting this accounting method, the Company made valuation assumptions in order
to calculate the fair value of options granted. These assumptions are estimated
on the date of grant using the Black-Scholes option-pricing model. The use of
different estimates or assumptions could produce materially different financial
results.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of capital are cash flows from operating
activities, collections on Loans receivable and borrowings under the Company's
credit agreements and secured financings. The Company's principal need for
capital has been to fund cash advances made to dealer-partners in connection
with the acceptance of Loans and for the payment of dealer holdbacks to
dealer-partners who have repaid their advance balances.
The Company's cash flow requirements are dependent on future levels of Loan
originations. In the three and nine months ended September 30, 2003, the Company
experienced increases in Loan originations compared to the same periods in 2002
primarily due to increases in the number of active dealer-partners and Loans per
active dealer-partner. The Company expects Loan originations to increase in
future periods and, to the extent this trend does continue, the Company will
experience an increase in its need for capital.
The Company currently finances its operations through: (i) a bank line of
credit facility; (ii) secured financings; (iii) a mortgage loan; and (iv)
capital lease obligations.
Line of Credit Facility -- At September 30, 2003, the Company had a $135.0
million credit agreement with a commercial bank syndicate. The facility has a
commitment period through June 9, 2005. The agreement provides that, at the
Company's discretion, interest is payable at either the eurodollar rate plus 140
basis points, or at the prime rate (4.0% as of September 30, 2003). The
eurodollar borrowings may be fixed for periods of up to six months. Borrowings
under the credit agreement are subject to a borrowing base limitation equal to
65% of advances to dealer-partners and leased vehicles (as reflected in the
consolidated financial statements and related notes), less a hedging reserve
(not exceeding $1.0 million), the amount of letters of credit issued under the
line of credit, and the amount of other debt secured by the collateral which
secures the line of credit. Currently, the borrowing base limitation does not
inhibit the Company's borrowing ability under the line of credit. The credit
agreement has certain restrictive covenants, including a minimum required ratio
of the Company's assets to debt, its liabilities to tangible net worth, and its
earnings before interest, taxes and non-cash expenses to fixed charges.
Additionally, the agreement requires that the Company maintain a specified
minimum level of net worth. Borrowings under the credit agreement are secured by
a lien on most of the Company's assets. The Company must pay annual and
quarterly fees on the amount of the commitment. As of September 30, 2003, there
were no borrowings outstanding under this facility.
Secured Financing -- In the second quarter of 2003, the Company's wholly-
owned subsidiary, Credit Acceptance Funding LLC 2003-1 ("Funding 2003-1"),
completed a secured financing transaction, in which Funding 2003-1 received
$100.0 million in financing. In connection with this transaction, the Company
conveyed, for cash and the sole membership interest in Funding 2003-1,
dealer-partner advances having a carrying amount of approximately $134.0 million
to Funding 2003-1, which, in turn, conveyed the advances to a trust, which
issued $100 million in notes to qualified institutional investors. A financial
insurance policy was issued in connection with the transaction by Radian Asset
Assurance. The policy guarantees the timely payment of interest and ultimate
repayment of principal on the final scheduled distribution date. The notes are
rated "AA" by Standard &
33
Poor's Rating Services. The proceeds of the conveyance to Funding 2003-1 were
used by the Company to reduce outstanding borrowings under the Company's credit
facility. Until December 15, 2003, the Company and Funding 2003-1 will receive
additional proceeds from the transaction by having the Company convey additional
dealer-partner advances to Funding 2003-1 that will then be conveyed by Funding
2003-1 to the trust and used by the trust as collateral to support additional
borrowings. As of September 30, 2003, additional dealer-partner advances having
a carrying amount of approximately $16.7 million have been conveyed by the
Company after the completion of the initial funding. After December 15, 2003,
the debt outstanding under the facility will begin to amortize. The total
expected term of the facility is 16 months. The secured financing creates loans
for which the trust is liable and which are secured by security interests in all
assets of the trust and of Funding 2003-1. Such loans are non-recourse to the
Company, even though the trust, Funding 2003-1 and the Company are consolidated
for financial reporting purposes. The notes bear interest at a fixed rate of
2.77%. The expected annualized cost of the secured financing, including
underwriters fees, the insurance premium and other costs is approximately 6.8%.
As Funding 2003-1 is organized as a separate legal entity from the Company,
assets of Funding 2003-1 (including the conveyed dealer-partner advances) will
not be available to satisfy the general obligations of the Company. The Company
receives a monthly servicing fee paid out of collections equal to 6% of the
collections received with respect to the conveyed dealer-partner advances and
related Loans. Except for the servicing fee and payments due to dealer-partners,
the Company does not receive, or have any rights in, any portion of such
collections until the trust's underlying indebtedness is paid in full, either
through collections or through a prepayment of the indebtedness. Thereafter,
remaining collections would be paid over to Funding 2003-1 as the sole
beneficiary of the trust where they would be available to be distributed to the
Company as the sole member of Funding 2003-1, or the Company may choose to cause
Funding 2003-1 to repurchase the remaining dealer-partner advances from the
trust and then dissolve, whereby the Company would become the owner of such
remaining collections.
In the third quarter of 2003, the Company's wholly-owned subsidiary, CAC
Warehouse Funding Corp. II ("Warehouse Funding"), completed a revolving secured
financing transaction with an institutional investor, in which Warehouse Funding
may receive up to $100.0 million in financing when the Company conveys
dealer-partner advances to Warehouse Funding for equity in Warehouse Funding.
Warehouse Funding will in turn pledge the dealer-partner advances as collateral
to the institutional investor to secure loans that will fund the cash portion of
the purchase price of the dealer-partner advances. No dealer-partner advances
were contributed and no financing proceeds were received at the time of closing.
This revolving facility allows conveyances of dealer-partner advances by the
Company and related borrowing by Warehouse Funding in which Warehouse Funding
will receive 70% of the net book value of the contributed dealer-partner
advances up to the $100.0 million facility limit. The facility has a commitment
period through September 28, 2004. Provided that the commitment is renewed,
there is a requirement that any amounts outstanding under the facility be
refinanced, and the facility paid to zero, by December 23, 2003 or the
transaction will cease to revolve, will amortize as collections are received
and, at the option of the institutional investor, may be the subject of
acceleration and foreclosure. Upon completion of the refinancing and pay down,
the full facility will again be available to Warehouse Funding. Although
Warehouse Funding will be liable for any secured financing under the facility,
the loans will be non-recourse to the Company, even though Warehouse Funding and
the Company are consolidated for financial reporting purposes. Such loans will
bear interest at a floating rate equal to the commercial paper rate plus 65
basis points with a maximum rate limited by an interest rate cap agreement,
which will be executed prior to the time the Company draws on the facility. As
Warehouse Funding is organized as a separate special purpose legal entity from
the Company, assets of Warehouse Funding (including the conveyed dealer-partner
advances) will not be available to satisfy the general obligations of the
Company. All the assets of Warehouse Funding have been encumbered to secure
Warehouse Funding's obligations to its creditors. The Company receives a monthly
servicing fee paid out of collections equal to 6% of the collections received
with respect to the conveyed dealer-partner advances and related Loans. Except
for the servicing fee and payments due to dealer-partners, the Company does not
receive, or have any rights in, any portion of such collections until Warehouse
Funding's underlying indebtedness is paid in full either through collections or
through a prepayment of the indebtedness.
The Company has completed a total of ten secured financing transactions,
eight of which have been repaid in full. Information about the currently
outstanding secured financing transactions is as follows (dollars in thousands):
Balance as
Secured Financing Secured Dealer Percent of
Issue Facility Balance at Advance Balance at Original
Number Close Date Limit September 30, 2003 September 30, 2003 Balance
- --------- -------------- -------- ------------------ ------------------ ----------
2003-1 June 2003 $100,000 $100,000 * $134,599 100%
2003-2 September 2003 $100,000 ** - - -
* Bears a fixed interest rate of 2.77% and is anticipated to fully amortize
within 13 months.
** Revolving facility which allows the Company to receive proceeds up to the
facility limit until the maturity of the facility.
34
Mortgage Loan -- The Company has a mortgage loan from a commercial bank that
is secured by a first mortgage lien on the Company's headquarters building and
an assignment of all leases, rents, revenues and profits under all present and
future leases of the building. The loan matures on May 1, 2004, bearing interest
at a fixed rate of 7.07%, and requires monthly payments of $99,582 and a balloon
payment at maturity for the balance of the loan. The Company believes that the
monthly payments under the mortgage loan can be made from cash resources
available to the Company and that the balloon payment will be refinanced at the
time it is due.
Capital Lease Obligations -- As of September 30, 2003, the Company has
twelve capital lease obligations outstanding related to various computer
equipment, with monthly payments totaling $82,598. These capital lease
obligations bear interest at rates ranging from 4.45% to 9.22% and have maturity
dates between June 2004 and March 2006. The Company believes that capital lease
obligation payments can be made from cash resources available to the Company at
the time such payments are due.
The Company's total balance sheet indebtedness decreased to $106.9 million
at September 30, 2003 from $109.8 million at December 31, 2002. In addition to
the balance sheet indebtedness as of September 30, 2003, the Company also has
contractual obligations resulting in future minimum payments under operating
leases.
A summary of the total future contractual obligations requiring repayments
is as follows (in thousands):
PERIOD OF REPAYMENT
-----------------------------------------------------
CONTRACTUAL OBLIGATIONS LESS THAN 1 YEAR 1-3 YEARS GREATER THAN 3 YEARS TOTAL
---------------- --------- -------------------- -------
Secured financing $ 92,308 $ 7,692 $ - $100,000
Mortgage loan 5,618 - - 5,618
Capital lease obligations 780 478 - 1,258
Non-cancelable operating lease obligations 295 448 224 967
-------- -------- -------- --------
Total contractual cash obligations $ 99,001 $ 8,618 $ 224 $107,843
======== ======== ======== ========
Liquidation of Non-Core Businesses -- As a result of the decision in the
second quarter to stop Loan originations in the United Kingdom and Canada and
the decision to stop lease originations in early 2002, the Company expects to
receive approximately $49.7 million from the liquidation of its United Kingdom,
Canadian, and Automobile Leasing businesses. Detail of expected future net
liquidation proceeds follows:
(Dollars in thousands) AS OF SEPTEMBER 30, 2003
------------------------
United Kingdom $ 39,500
Canada 6,000
Automobile Leasing 4,200
----------
$ 49,700
==========
The Company intends to utilize proceeds from businesses being liquidated to:
(i) fund dealer-partner advances on loans originated in the United States and
(ii) fund share repurchases. During the three months ended September 30, 2003,
the Company received $15.9 million in liquidation proceeds and made share
repurchases of $2.8 million.
Repurchase and Retirement of Common Stock -- In 1999, the Company began
acquiring shares of its common stock in connection with a stock repurchase
program announced in August 1999. That program authorized the Company to
purchase up to 1.0 million common shares on the open market or pursuant to
privately negotiated transactions at price levels the Company deems attractive.
On each of February 7, 2000, June 7, 2000, July 13, 2000, November 10, 2000, and
May 20, 2002, the Company's Board of Directors authorized increases in the
Company's stock repurchase program of an additional 1.0 million shares. As of
September 30, 2003, the Company has repurchased approximately 5.4 million shares
of the 6.0 million shares authorized to be repurchased under this program at a
cost of $37.2 million. The 6.0 million shares represent approximately 13.0% of
the shares outstanding at the beginning of the program.
Based upon anticipated cash flows, management believes that cash flows from
operations and its various financing alternatives will provide sufficient
financing for debt maturities and for future operations. The Company's ability
to borrow funds may be impacted by many economic and financial market
conditions. If the various financing alternatives were to become limited or
unavailable to the Company, the Company's operations could be materially and
adversely affected.
35
FORWARD-LOOKING STATEMENTS
The Company makes forward-looking statements in this report and may make
such statements in future filings with the Securities and Exchange Commission.
It may also make forward-looking statements in its press releases or other
public or shareholder communications. The Company's forward-looking statements
are subject to risks and uncertainties and include information about its
expectations and possible or assumed future results of operations. When the
Company uses any of the words "believes," "expects," "anticipates," "estimates,"
"forecasts" or similar expressions, it is making forward-looking statements.
The Company claims the protection of the safe harbor for forward-looking
statements contained in the Private Securities Litigation Reform Act of 1995 for
all of its forward-looking statements. These forward-looking statements
represent the Company's outlook only as of the date of this report. While the
Company believes that its forward-looking statements are reasonable, actual
results could differ materially since the statements are based on our current
expectations, which are subject to risks and uncertainties. Factors that might
cause such a difference, without limitation, include the following:
- increased competition from traditional financing sources and from
non-traditional lenders,
- the unavailability of funding at competitive rates of interest,
- the Company's potential inability to continue to obtain third party
financing on favorable terms,
- the Company's potential inability to generate sufficient cash flow to
service its debt and fund its future operations,
- adverse changes in applicable laws and regulations,
- adverse changes in economic conditions,
- adverse changes in the automobile or finance industries or in the
non-prime consumer finance market,
- the Company's potential inability to maintain or increase the volume of
Loans,
- the Company's potential inability to accurately forecast and estimate
future collections and historical collection rates,
- the Company's potential inability to accurately estimate the residual
values of the lease vehicles,
- an increase in the amount or severity of litigation against the Company,
- the loss of key management personnel, and
- the effect of terrorist attacks and potential attacks.
Other factors not currently anticipated by management may also
materially and adversely affect the Company's results of operations. The Company
does not undertake, and expressly disclaims any obligation, to update or alter
its forward-looking statements whether as a result of new information, future
events or otherwise, except as required by applicable law.
36
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS.
Refer to the Company's Annual Report on Form 10-K for the year ended
December 31, 2002 for a complete discussion of the Company's market risk. There
have been no material changes to the market risk information included in the
Company's 2002 Annual Report on Form 10-K.
ITEM 4. CONTROLS AND PROCEDURES.
As of the end of the period covered by this report, the Company carried
out an evaluation, under the supervision and with the participation of the
Company's management, including its Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of the Company's
disclosure controls and procedures pursuant to Rule 13a-15 of the Securities
Exchange Act of 1934. Based upon that evaluation, the Company's Chief Executive
Officer and Chief Financial Officer concluded that the Company's disclosure
controls and procedures are effective to cause the material information required
to be disclosed by the Company in the reports that it files or submits under the
Securities Exchange Act of 1934 to be recorded, processed, summarized and
reported within the time periods specified in the Commission's rules and forms.
There were no changes in the Company's internal controls over financial
reporting during the quarter ended September 30, 2003 that have materially
affected, or are reasonably likely to materially affect, the Company's internal
controls over financial reporting.
37
PART II. - OTHER INFORMATION
ITEM 5. OTHER INFORMATION
As a result of a Securities and Exchange Commission review of the Company's
Form 10-K for the year ended December 31, 2002 and Form 10-Q for the period
ended June 30, 2003, the Company has enhanced its description of its business
and operations.
GENERAL
Credit Acceptance Corporation (the "Company" or "Credit Acceptance"),
incorporated in Michigan in 1972, is a financial services company specializing
in products and services for a network of automobile dealers. Credit Acceptance
provides participating dealers with financing sources for consumers with limited
access to credit by offering "guaranteed credit approval." The Company delivers
credit approvals through the Internet. Other services include marketing, sales
training and a wholesale purchasing cooperative. Through its financing program,
Credit Acceptance helps consumers change their lives by helping them obtain
quality transportation and providing them an opportunity to strengthen and
reestablish their credit standing by making timely monthly payments. The Company
refers to participating dealers who share its commitment to changing customers'
lives as "dealer-partners."
Credit Acceptance was founded to service and collect retail installment
contracts (referred to as "Contracts" or "Loans") originated and funded by
automobile dealerships owned by the Company's founder and current Chairman,
Donald Foss. During the 1980's, the Company began to market this service to
non-affiliated dealers and, at the same time, began to offer dealer-partners a
non-recourse cash payment (an "advance") against anticipated future collections
on Loans serviced for that dealer-partner. Today, the Company's program is
offered to dealers throughout the United States.
The Company's Internet address is www.creditacceptance.com. The Company
makes available, free of charge on the web site, copies of reports it files with
the Securities and Exchange Commission as soon as reasonably practicable after
the Company electronically files such reports.
Principal Business
A customer who does not qualify for conventional automobile financing can
purchase a vehicle from a Credit Acceptance dealer-partner and finance the
purchase through the Company. As payment for the vehicle, the dealer-partner
receives the following:
(i) a down payment from the customer;
(ii) a cash advance from the Company; and
(iii) after the advance has been recovered, the cash from payments made
on the Loan, net of certain collection costs and the Company's
servicing fee.
The Company's servicing fee is equal to a fixed percentage (typically 20%)
of each payment collected. In addition, the Company receives fees for other
products and services. Customers and dealer-partners benefit as follows:
Customers. The Company helps change the lives of customers who do not
qualify for conventional automobile financing by helping them obtain quality
transportation and, equally important, providing an opportunity to establish
or reestablish their credit through the timely repayment of their Loan.
Dealer-Partners. The Company's program increases dealer-partners' profits in
the following ways:
- Enabling dealer-partners to sell cars to customers who may not be able
to obtain financing without the Company's program. In addition,
customers often become repeat customers by financing future vehicle
purchases either through the Company's program or, after they have
successfully rehabilitated their credit, through conventional
financing.
- The ability to advertise "guaranteed credit approval" attracts many
customers who mistakenly assume they do not qualify for conventional
financing, but who can actually qualify.
- The customers attracted to dealer-partners by "guaranteed credit
approval" often use other services of the dealer-partners and refer
friends and relatives to them.
- As part of the Company's unique business model, dealer-partners share
in the profits not only from the sale of the vehicle, but also from its
financing.
38
Credit Acceptance derives its revenues from the following principal sources:
(i) servicing fees (recorded as finance charges) earned as a result of
servicing Loans originated and assigned to the Company by
dealer-partners;
(ii) lease revenue from investments in operating leases; and
(iii) other income, which primarily consists of fees earned from the
Company's third party service contract programs, premiums earned on
service contract and credit life insurance programs, monthly fees
from the Internet origination system, interest income and fees from
loans made directly to dealer-partners for floorplan financing and
working capital purposes, revenue from secured line of credit loans
offered to certain dealer-partners, and fees charged to
dealer-partners at the time they enroll in the Company's program.
The following table sets forth the percent relationship to total revenue of
each of these sources.
FOR THE NINE MONTHS ENDED FOR THE YEARS ENDED
SEPTEMBER 30, DECEMBER 31,
-------------------------- --------------------------
PERCENT OF TOTAL REVENUE 2003 2002 2002 2001
------------------------- ------------ ----------- ------------ -----------
Finance charges 70.3% 61.9% 63.3% 61.2%
Lease revenue 4.9% 11.0% 10.4% 14.8%
Ancillary product income 13.2% 10.8% 10.7% 8.7%
Premiums earned 2.1% 2.9% 2.9% 4.5%
Other income 9.5% 13.4% 12.7% 10.8%
------------ ----------- ------------ -----------
Total revenue 100.0% 100.0% 100.0% 100.0%
============ =========== ============ ===========
The Company's business is seasonal with peak Loan originations occurring
during February and March. However, this seasonality does not have a material
impact on the Company's interim results.
The Company is organized into four primary business segments: United States,
United Kingdom, Automobile Leasing and Other. In early 2002, the Company stopped
originating automobile leases and effective June 30, 2003 stopped originating
Loans in the United Kingdom and Canada. The Company is in the process of
liquidating these portfolios. See Note 12 to the consolidated financial
statements for information regarding the Company's reportable segments.
Operations
United States
Sales and Marketing. The Company's target market is a select group of the
more than 75,000 independent and franchised automobile dealers in the United
States. The Company's market development process identifies high quality dealers
in each geographic market and limits the number of automobile dealers in each
geographic market that can participate in the Company's program. The selective
marketing of the Company's program is intended to: (i) result in a network
consisting of the highest quality dealer-partners who share the Company's
commitment to changing lives; and (ii) increase the value of the Company's
program to the Company's dealer-partners. Dealer-partners pay a one time
enrollment fee of $9,850 to join the Company's program. The Company provides
the dealer-partner with sales promotion kits, signs, training and initial
installation of CAPS. The Company also has a program by which it measures
various criteria for each dealer-partner against other dealer-partners in their
area as well as the top performing dealer-partners. Sales representatives are
required to present the results to the dealer-partner and to develop an action
plan on a quarterly basis with the dealer-partner to improve the
dealer-partner's overall success with the Company's program. A new
dealer-partner is required to execute a Servicing Agreement, which defines the
legal relationship between the Company and the dealer-partner.
The Servicing Agreement assigns the responsibilities for administering,
servicing and collecting the amounts due on Loans to the Company. The Servicing
Agreement provides that collections received by Credit Acceptance during a
calendar month on Loans assigned by a dealer-partner are applied on a
pool-by-pool basis as follows:
- First, to reimburse Credit Acceptance for some third-party collection
costs;
- Second, to pay Credit Acceptance its servicing fee;
- Third, to reduce the aggregate advance balance and to pay any other
amounts owing from the dealer-partner to the Company; and
- Fourth, to the dealer-partner as payment of dealer holdback.
Under the typical Servicing Agreement, a dealer-partner represents that it
will only submit Loans to Credit Acceptance which satisfy criteria established
by the Company, meet certain conditions with respect to the binding nature and
the status of the security interest in the purchased vehicle, and comply with
applicable state, federal and foreign laws and regulations. Dealer-partners
receive a monthly statement from the Company, summarizing all transactions on
Loans originated by such dealer-partner.
39
In the event that the Company discovers a misrepresentation by the
dealer-partner relating to a Loan submitted to the Company, the Company can
demand that the Loan be repurchased for the then current balance owed on the
Loan less the amount of any unearned finance charge plus the applicable
termination fee, generally $500. Upon receipt in full of such amount, the
Company will reassign the Loan receivable and its security interest in the
financed vehicle to the dealer-partner.
The typical Servicing Agreement may be terminated by the Company or by the
dealer-partner upon written notice. The Company may terminate the Servicing
Agreement immediately in the case of an event of default by the dealer-partner.
Events of default include, among other things:
(i) the dealer-partner's refusal to allow the Company to audit it
records relating to the Loans assigned to the Company;
(ii) the dealer-partner, without the Company's consent, is dissolved;
merges or consolidates with an entity not affiliated with the
dealer-partner; or sells a material part of its assets outside the
course of its business to an entity not affiliated with the
dealer-partner; or
(iii) the appointment of a receiver for, or the bankruptcy or insolvency
of, the dealer-partner.
While a dealer-partner can cease submitting Loans to the Company at any time
without terminating the Servicing Agreement, if the dealer-partner elects to
terminate the Servicing Agreement or in the event of a default, the
dealer-partner must immediately pay the Company:
(i) any unreimbursed collection costs;
(ii) any unpaid advances and all amounts owed by the dealer-partner to
the Company; and
(iii) a termination fee equal to 15% of the then outstanding amount of
the Loans accepted by the Company.
Upon receipt in full of such amounts, the Company will reassign the Loan
receivable and its security interest in the financed vehicle to the
dealer-partner. In the event of a termination by the Company (or any other
termination if the Company and the dealer-partner agree), the Company may
continue to service Loans accepted prior to termination in the normal course of
business without charging a termination fee.
Loan Origination. Once a dealer-partner has enrolled in the Company's
program, the dealer-partner may begin submitting Loans to the Company for
approval and funding. A Loan occurs when an individual (the "debtor") enters
into a Contract with a dealer-partner that sets forth the terms of the agreement
between the individual and the dealer-partner for the payment of the purchase
price of the automobile. The amount of the Loan consists of the total principal
and interest that the individual is required to pay over the term of the Loan.
Applications are submitted to the Company either by facsimile or through the
Company's Internet based Credit Application Processing System ("CAPS"). CAPS was
installed on a pilot basis in August 2000 and was offered to all dealer-partners
located in the United States beginning in January 2001. For the nine months
ended September 30, 2003, approximately 99.5% of the Company's Loans were
processed through CAPS. CAPS allows dealer-partners to input a credit
application and view the response from the Company on-line. CAPS, which is
patent pending, allows dealer-partners to: (i) receive an approval from the
Company much faster than with traditional methods; and (ii) interact with the
Company's credit scoring system to improve the structure of each transaction
prior to delivery. All responses include the amount of the advance, as well as
any stipulations required for funding. The amount of the advance is determined
by using a computer model which considers a number of factors including the
timing and amount of cash flows expected on the related Loan and the Company's
target return on capital at the time the Loan is originated. The estimated
future cash flows are determined based upon a proprietary credit scoring system,
which considers numerous variables, including the customer's credit bureau
report, data contained in the customer's credit application, the structure of
the proposed transaction, vehicle information and other factors, to calculate a
composite credit score that corresponds to an expected collection rate. The
Company's credit scoring system predicts the probability of default based upon
the historical performance of Loans in the Company's portfolio that share
similar characteristics. The performance of the credit scoring system is
evaluated monthly by comparing projected to actual Loan performance. Adjustments
are made to the credit scoring system when necessary.
While a dealer-partner can assign any Contract to the Company for servicing,
administration and collection, the decision whether to pay an advance to the
dealer-partner and the amount of any advance, is made solely by the Company. The
Company performs all significant functions relating to the processing of the
Loan applications and bears certain costs of origination, including the cost of
assessing the adequacy of Loan documentation, compliance with underwriting
guidelines and the cost of verifying employment, residence and other information
submitted by the dealer-partner.
CAPS interfaces with the Company's Application and Contract System ("ACS").
ACS has been used by the Company to originate Loans in North America since May
1997. Loan information is entered into ACS either manually or through a download
from CAPS. ACS provides credit scoring capability as well as the ability to
process Loan packages. ACS compares Loan data against information provided
during the approval process and allows the funding analyst to check that all
stipulations have been met prior to funding. Loan contracts are written on a
contract form provided by the Company and the Loan transaction typically is not
completed until the dealer-partner has received approval from the Company. The
assignment of the Loan from the dealer-
40
partner to the Company occurs simultaneously with the vehicle buyer's signing of
the Loan contract. Although the dealer-partner is named in the Loan contract,
the dealer-partner does not have ownership of the Loan for more than a moment
and the Company, not the dealer-partner, is listed as lien holder on the vehicle
title. The debtor's payment obligation is directly to the Company. Payments are
generally made by the debtor directly to the Company. For these reasons, the
Company views the Loan to be an asset of the Company, not the dealer-partner.
The customer's failure to pay amounts due under the Loan will result in
collection action by the Company and may result in a charge-off of the Loan. See
"Credit Loss Policy" for a description of the Company's charge-off policy.
In exchange for the assignment, the Company offers the dealer-partner a
non-recourse advance against anticipated future collections on the Loan. Since
typically the combination of the advance and the customer's down payment
provides the dealer-partner with a cash profit at the time of sale, the
dealer-partner's risk in the Loan is limited. The dealer-partner would typically
view any future cash flows from dealer holdback payments to be additional
profit. The Company cannot demand repayment from the dealer-partner of the
advance except in certain situations (e.g. the dealer-partner commits fraud in
submitting the credit application and related information). Advances are made
only after the Loan is approved, accepted by and assigned to the Company and all
other stipulations required for funding have been satisfied.
As advances are originated, they are automatically assigned to the
originating dealer-partner's open pool of advances. Periodically, pools are
closed and subsequent advances are assigned to a new pool. All advances due from
a dealer-partner are secured by the future collections on the dealer-partner's
portfolio of Loans. Collections on all related Loans within the pool, after
payment of the Company's servicing fee and reimbursement of certain collection
costs, are applied to reduce the aggregate advance balance owing against those
Loans. Once the advance balance has been repaid, the dealer-partner is entitled
to receive future collections from Loans within that pool, after payment of the
Company's servicing fee and reimbursement of certain collection costs. If the
collections on Loans from a dealer-partner's pool are not sufficient to repay
the advance balance, the dealer-partner will not receive the dealer holdback.
The Company's acceptance of Loans is generally without recourse to the general
assets of the dealer-partner.
The Company records the total payments due under the Loan as a Loan
receivable and the amount of its servicing fee as an unearned finance charge
which, for balance sheet purposes, is netted from the gross amount of the Loan.
The servicing fee represents the portion of the Loan payments above the amount
of the advance that the Company is entitled to retain and therefore becomes the
interest element on the Loan from the Company's perspective. Amounts
contractually due to the dealer-partner, generally 80% of the gross Loan amount
are reflected as a liability (dealer holdback) from which the advance on the
Loan is netted. The dealer holdback is a contractual obligation to the
dealer-partner from the Company and includes the dealer-partner's profit on the
sale of the vehicle as well as the dealer-partner's share of the profits from
the financing. Actual payments of dealer holdback will be contingent on
collections of the related Loans assigned to the Company.
The Company's business model allows it to share the risk and reward of
collecting on the Loans with the dealer-partners. Such sharing is intended to
motivate the dealer-partner to assign better quality Loans, follow the Company's
underwriting guidelines, provide appropriate service and support to the customer
after the sale, and occasionally assist the Company in the collection process.
The Company believes this arrangement aligns the interests of the Company, the
dealer-partner and the debtor.
Information on the Company's Loan originations for each of the last four
years and the nine months ended September 30, 2003 and September 30, 2002 is
presented in the following table:
FOR THE PERIOD
ENDED
SEPTEMBER 30, FOR THE PERIOD ENDED DECEMBER 31,
----------------- ------------------------------------------------------
AVERAGE LOAN DATA 2003 2002 2001 2000 1999
- ---------------------------------------------------------- ----------------- ------------ ------------- ------------- ------------
Average size of Loan accepted $12,177 $11,316 $10,724 $ 8,867 $ 8,849
Percentage growth in average size of Loan 7.6% 5.5% 21.0% 0.2% 5.3%
Average initial maturity (in months) 37 36 36 32 32
Average Advance per Loan $ 5,716 $ 5,243 $ 5,288 $ 4,657 $ 4,744
Average Advance as a percent of average Loan accepted 46.9% 46.3% 49.3% 52.5% 53.6%
Servicing and Collections. The Company's pre-repossession collectors are
organized into teams. The Company's first payment miss team services Loans of
customers who have failed to make one of their first three payments on time. A
collection call is generally placed to these customers within three days after
the payment is due. Once a customer has made their first three payments, a
regional collection team services their Loan. Regional teams service all Loans
originated by dealer-partners within their geographic area. The Company has
implemented an incentive system to encourage collectors to collect the full
amount due and eliminate the delinquency on Loans assigned to their team.
Collectors may recommend repossession of the vehicle based on a variety of
factors including the amount of the delinquency and the estimated value of the
vehicle. These recommendations are typically reviewed by a collection team
supervisor.
When a Loan is approved for repossession, the account is transferred to the
repossession department. Repossession personnel continue to service the Loan as
it is being assigned to a third party repossession agent, who works on a
contingency fee basis.
41
Once a vehicle has been repossessed, the customer can negotiate a redemption
with the Company, whereby the vehicle is returned to the customer in exchange
for paying off the Loan balance, or where appropriate or if required by law, the
vehicle is returned to the customer and the Loan reinstated, in exchange for
reducing or eliminating the past due balance. If the redemption process is not
successful, the vehicle is shipped to a wholesale automobile auction and
scheduled for sale. Prior to sale, the vehicle is usually inspected by the
Company's remarketing representatives who authorize repair and reconditioning
work in order to increase the net sale proceeds at auction.
If the vehicle sale proceeds are not sufficient to satisfy the balance owing
on the Loan, the Loan is assigned either to: (i) the Company's senior collection
team, in the event that the customer is willing to make payments on the
deficiency balance; or, where permitted by law (ii) the Company's legal team, if
it is believed that legal action is required to reduce the deficiency balance
owing on the Loan. The Company's legal team assigns Loans to third party
collection attorneys who file a claim and upon obtaining a judgment, garnish
wages or other assets.
Collectors rely on two systems to service accounts, the Collection System
("CS") and the Loan Servicing System ("LSS"). LSS and CS are connected through a
batch interface. The present CS has been in service since June 2002. The system
interfaces with a predictive dialer and records all activity on a Loan,
including details of past phone conversations with the customer, collection
letters sent, promises to pay, broken promises, repossession orders and
collection attorney activity. LSS was installed in 1997. The system maintains a
record of all transactions relating to Loans originated after July 1990 and is
the primary source of management reporting including data utilized to:
(i) evaluate the Company's proprietary credit score;
(ii) forecast future collections;
(iii) establish the Company's allowance for credit losses; and
(iv) analyze the profitability of the Company's program.
Service Contracts and Insurance Products
The Company maintains relationships with certain insurance carriers which
provide dealer-partners the ability to offer customers credit life and
disability insurance. Should the consumer elect to purchase this insurance, the
premium on the insurance policy is added to the amount due under the Loan and to
the advance balance. The Company is not involved in the actual sale of the
insurance; however, the insurance carrier cedes the premiums, less a fee, to a
wholly-owned subsidiary of the Company, which reinsures the coverage under the
policy. As a result, the Company, through its subsidiary, bears the risk of
loss, and earns revenues from premiums ceded and the investment of such funds.
The Company provides dealer-partners located in the United States the
ability to offer vehicle service contracts to customers. Under this program, the
premium on the service contract is added to the amount due under the Loan. The
cost of the service contract, plus a commission earned by the dealer-partner on
the sale of the service contract is added to the advance balance. A portion of
the amount added to the advance balance is retained by the Company as a fee.
Generally, a third party bears all of the risk of loss on claims relating to
these service contracts. Historically, the Company also offered a vehicle
service contract program where the Company bore the risk of loss on claims. The
Company discontinued offering this product effective November 1, 2003.
Revenues derived from the Company's service contract and insurance
product businesses during 2002 and 2001 and for the nine months ending September
30, 2003 and September 30, 2002 are as follows:
(Dollars in thousands) FOR THE NINE MONTHS FOR THE YEARS ENDED
ENDED SEPTEMBER 30, DECEMBER 31,
---------------------------- -----------------------------
2003 2002 2002 2001
------------- ------------- ------------- -------------
Insurance Products:
Fees $ 247 $ 1,962 $ 2,056 $ 1,230
Premiums 1,781 1,902 2,709 3,304
------- ------- ------- -------
$ 2,028 $ 3,864 $ 4,765 $ 4,534
------- ------- ------- -------
Service contracts:
Fees $14,088 $10,957 $14,381 $11,661
Premiums 465 1,593 1,803 3,268
------- ------- ------- -------
$14,553 $12,550 $16,184 $14,929
======= ======= ======= =======
Total $16,581 $16,414 $20,949 $19,463
======= ======= ======= =======
42
Businesses in Liquidation
Other
Floorplan Financing. Floorplan financing is offered on a limited basis to
certain dealers, most of which participate in the Company's core program. Under
these financing arrangements, loans are provided to finance the dealer's
inventory. Dealers are charged documentation fees in connection with each
vehicle financed, plus interest on the unpaid balance at rates which generally
range from 12% to 18% per annum. Security for these loans generally consists of:
(i) a lien on the financed inventory;
(ii) a security interest in the dealer's assets, including the
dealer-partners' portfolio of Loans serviced by the Company; and
(iii) the personal guaranty of the owner.
In 2002 and 2003, the Company significantly reduced its investment in the
floorplan portfolio after concluding this business was not likely to generate an
acceptable return on capital. The Company intends to continue to reduce the
amount of capital invested in this business. As of September 30, 2003, the
amount of capital invested in this product was $3.2 million.
Secured Line of Credit Loans. Beginning in 2000, the Company offered line of
credit arrangements to certain dealers who were not participating in the
Company's core program. These lines of credit are secured primarily by loans,
originated and serviced by the dealer, with additional security provided by the
personal guarantee of the owner. The effective interest rate on these loans
varies based upon the amount advanced to the dealer and the percentage of
collections on the loan portfolio required to be remitted to the Company. During
the third quarter of 2001, the Company discontinued offering this program to new
dealers, and is in the process of reducing the amount of capital invested in
this business. As of September 30, 2003, the amount of capital invested in this
product was $2.5 million.
Beginning in 2000, the Company offered a line of credit arrangement to
certain dealers who were not participating in the Company's core business. These
lines of credit are secured primarily by loans originated and serviced by the
dealer, with additional security provided by the personal guarantee of the
dealer's owner. The Company ceased offering this program to new dealers in the
third quarter of 2001 and has been reducing the amount of capital invested in
this program since that time. Beginning in 2002, entities owned by the Company's
majority shareholder and Chairman began offering secured line of credit loans in
a manner similar to the Company's prior program, at his dealerships and at two
other dealers, one of whom also does business with the Company. The Company's
majority shareholder and Chairman does not intend to expand his line of credit
lending activities to additional borrowers.
Canada. Effective June 30, 2003, the Company decided to stop originating
automobile Loans in Canada. This decision was based upon the conclusion that the
Canadian automobile lending business was unlikely to produce a higher return on
capital than the Company's United States automobile lending business over the
long-term. Prior to this decision, the Company originated and serviced Loans in
Canada on approximately the same basis as in the United States. As of September
30, 2003, the amount of capital invested in this product was $5.5 million.
Automobile Leasing
In early 2002, the Company decided to exit the automobile leasing business.
This decision was based upon the conclusion that the automobile leasing business
was unlikely to produce a higher return on capital than the Company's automobile
lending business over the long-term. Prior to this decision, the Company
purchased automobile leases from dealer-partners for an amount based on the
value of the vehicle as determined by an industry guidebook, assumed ownership
of the related vehicle from the dealer-partner and received title to the
vehicle. This program differed from the Company's principal business in that, as
leases were purchased outright, the Company assumed no liability to the
dealer-partner for dealer holdback payments. Additionally, the customer was
required to remit a security deposit to the Company. At lease termination, the
Company is responsible for the ultimate disposal of the vehicle, which is sold
directly to the dealer-partner, to the customer or at auction. Leases generally
have an original term ranging from 24 to 48 months, with an average of 37
months. As of September 30, 2003, the amount of capital invested in this product
was $3.1 million.
United Kingdom
Effective June 30, 2003, the Company decided to stop originating automobile
Loans in the United Kingdom. This decision was based upon the conclusion that
the United Kingdom automobile lending business was unlikely to produce a higher
return on capital than the Company's United States automobile lending business
over the long-term. Prior to this decision, the Company originated and serviced
Loans in the United Kingdom on approximately the same basis as in the United
States. As of September 30, 2003, the amount of capital invested in this product
was $38.0 million.
CREDIT LOSS POLICY
The Company maintains an allowance for credit losses to cover losses
inherent in the Company's Loan portfolio. Such losses consist of uncollectible
Loans receivable determined to be uncollectible or with expected future
collections less than the full contractual amount, less any losses absorbed by
dealer holdbacks. By definition, these losses equal the amount of advances to
dealer-partners plus accrued income (the "net investment") not expected to be
recovered by collections on the related Loans receivable.
43
To record losses, as required under "SFAS No. 114: Accounting by Creditors
for Impairment of a Loan - an amendment of FASB Statements No. 5 and 15", as
amended by "SFAS No. 118: Accounting by Creditors for Impairment of a Loan-
Income Recognition and Disclosures", the Company utilizes a present value
methodology and compares the present value of estimated future collections for
each dealer-partner's Loan portfolio to the Company's net investment in that
portfolio. The Company maintains historical loss experience for each
dealer-partner on a static pool basis and uses this information to forecast the
timing and amount of the future collections on each dealer-partner's Loan
portfolio. In estimating future, collections for each dealer-partner, the
Company considers: (i) a dealer-partner's actual loss data on a static pool
basis and (ii) the Company's historical loss and collection experience. The
Company's collection forecast for each dealer-partner is updated monthly, and
considers the most recent static pool data available for each dealer-partner
and the Company's entire portfolio of Loans. Forecasted collections are
discounted to present value using a rate equal to the rate of return expected
at the origination of the Loan. To the extent that the present value of future
collections is less than the Company's net investment in the portfolio, the
Company records an allowance equal to the difference between the net investment
and the present value of the estimated future collections. Proceeds from one
dealer-partner's portfolio cannot be used to offset losses relating to another
dealer-partner.
Effective July 1, 2003, the Company eliminated the Reserve for advance
losses balance of $19.4 million which was previously classified within Dealer
holdbacks, net and transferred the balance into the Allowance for credit losses
which is classified within Loans receivable, net. In addition, the Company
eliminated its charge-off policy related to dealer advances and modified its
Loans receivable charge-off policy to require charge-off of Loans receivable
after 270 days of no payment against dealer holdbacks, net and, if such holdback
is insufficient, against the Allowance for credit losses. In effect, the Company
combined its advance and Loans receivable charge-off policies into a single
policy whereby the Loan and related Advance are charged-off at the same time.
For the first six months of 2003, advances were charged off when the Company's
analysis forecasted no future collections on Loans relating to the
dealer-partner advance pool. Prior to January 1, 2003, advances were charged-off
or partially charged-off when the Company's analysis determined that the
expected discounted cash flows associated with the related Loans were
insufficient to recover the outstanding advance balance in the pool.
In addition effective July 1, 2003, the Company implemented a revised policy
related to collections of previously charged-off Loans ("recoveries"). Under the
new policy, recoveries of Loans charged off are credited to the allowance for
credit losses to the extent of any prior losses charged against the allowance,
with the remainder credited to Dealer holdbacks. Under the Company's prior
policy, 80% of recoveries were credited to Dealer holdbacks and 20% to Finance
charges.
A significant percentage of charged off Loans are absorbed by Dealer
holdbacks and, as a result, do not result in losses to the Company. The
Company's primary protection against losses relates to appropriately managing
the spread between the collection rate and the amount advanced to dealer
partners at Loan inception.
The Company's allowance for credit losses also covers earned but unpaid
servicing fees on Loans receivable in non-accrual status. Servicing fees, which
are recorded as finance charges, are recognized under the interest method of
accounting until the earlier of the underlying obligation becoming 90 days past
due on a recency basis (no payments received for 90 days) or the repossession
and sale of the vehicle securing the Loan. At such time, the Company suspends
the recognition of revenue and records a provision for credit losses equal to
the earned but unpaid revenue. Once a Loan is classified in non-accrual status,
it remains in non-accrual status for the remaining life of the Loan. Revenue on
non-accrual Loans is recognized on a cash basis.
COMPETITION
The market for customers who do not qualify for conventional automobile
financing is large and highly competitive. The market is currently served by
banks, captive finance affiliates of automobile manufacturers, credit unions and
independent finance companies both publicly and privately owned. Many of these
companies are much larger and have greater resources than the Company. These
companies typically target higher credit tier customers within the Company's
market. While the Company currently is not aware of any other company offering
guaranteed credit approval on a national scale, there can be no assurance that
direct competition will not emerge and that the Company will be able to compete
successfully.
CUSTOMER AND GEOGRAPHIC CONCENTRATIONS
Generally. As of September 30, 2003 approximately 38% of United States
dealer-partners were located in Michigan, New York, Ohio, Illinois, and
Maryland. These dealer-partners accounted for approximately 35% of the number of
Loans accepted in the United States for the nine months ended September 30,
2003. No single dealer-partner accounted for more than 10% of total revenues
during any of the last three years.
Affiliated Parties. The Company regularly accepts assignments of Loans
originated by affiliated dealer-partners owned by: (i) the Company's majority
shareholder and Chairman; (ii) the Company's President; and (iii) a member of
the Chairman's family. Loans accepted from these affiliated dealer-partners were
approximately $17.2 million, $19.1 million and $21.2 million for the nine months
ended September 30, 2003 and years ended December 31, 2002 and 2001,
respectively. Loans receivable from
44
affiliated dealer-partners represented approximately 2.9%, 2.8% and 2.6% of the
gross Loans receivable balance as of September 30, 2003, December 31, 2002 and
December 31, 2001, respectively. The Company accepts Loans from affiliated
dealer-partners and nonaffiliated dealer-partners on the same terms.
Prior to the decision to exit the leasing business, the Company regularly
accepted automobile leases originated by affiliated dealer-partners owned by:
(i) the Company's majority shareholder and Chairman; and (ii) the Company's
President. Automobile leases accepted from affiliated dealer-partners were zero,
$11,000, and $1.4 million in the nine months ended September 30, 2003 and years
ended December 31, 2002 and 2001, respectively. Affiliated dealer-partners
originated approximately 1.0% and 4.6% of the value of automobile leases
accepted and approximately 0.8% and 4.2% of the number of automobile leases
accepted by the Company during 2002 and 2001, respectively. The Company accepted
automobile leases from affiliated dealer-partners and nonaffiliated
dealer-partners on the same terms.
GEOGRAPHIC FINANCIAL INFORMATION
The following table sets forth, for each of the last three years for the
Company's domestic and foreign operations, the amount of revenues from customers
and long-lived assets (in thousands):
AS OF AND FOR NINE MONTHS ENDED AS OF AND FOR YEARS ENDED
SEPTEMBER 30, DECEMBER 31,
------------------------------------ -------------------------------
2003 2002 2002 2001
----------------- ----------------- --------------- --------------
Revenues from customers
United States $ 96,950 $ 101,192 $ 128,893 $ 118,646
United Kingdom 8,950 14,984 20,038 23,674
Other foreign 2,863 3,939 5,403 5,009
----------------- ----------------- --------------- --------------
Total revenues from customers $108,763 $ 120,115 $ 154,234 $ 147,329
================= ================= =============== ==============
Long-lived assets
United States $ 17,749 $ 19,840 $ 19,284 $ 18,806
United Kingdom 545 692 667 840
Other foreign - - - -
----------------- ----------------- --------------- --------------
Total long-lived assets $ 18,294 $ 20,532 $ 19,951 $ 19,646
================= ================= =============== ==============
The Company's operations are structured to achieve consolidated objectives.
As a result, significant interdependencies and overlaps exist among the
Company's domestic and foreign operations. Accordingly, the revenue and
identifiable assets shown may not be indicative of the amounts which would have
been reported if the domestic and foreign operations were independent of one
another.
REGULATION
The Company's businesses are subject to various state, federal and foreign
laws and regulations, which:
(i) require licensing and qualification,
(ii) regulate interest rates, fees and other charges,
(iii) require specified disclosures by automobile dealer-partners to
customers,
(iv) govern the sale and terms of the ancillary products; and
(v) define the Company's rights to collect Loans and repossess and sell
collateral.
Failure to comply with, or an adverse change in, these laws or regulations could
have a material adverse effect on the Company by, among other things, limiting
the states or countries in which the Company may operate, restricting the
Company's ability to realize the value of the collateral securing the Loans and
leases, or resulting in potential liability related to Loans and leases accepted
from dealer-partners. In addition, governmental regulations depleting the supply
of used vehicles, such as environmental protection regulations governing
emissions or fuel consumption, could have a material adverse effect on the
Company. The Company is not aware of any such legislation currently pending.
The sale of insurance products in connection with Loans and leases assigned
to the Company by dealer-partners is also subject to state laws and regulations.
As the holder of the Loans and leases that contain these products, some of these
state laws and regulations may apply to the Company's servicing and collection
of the Loans and leases. However, as the Company does not deal directly with
consumers in the sale of insurance products, it does not believe that such laws
and regulations significantly
45
affect its business. Nevertheless, there can be no assurance that insurance
regulatory authorities in the jurisdictions in which such products are offered
by dealer-partners will not seek to regulate the Company or restrict the
operation of the Company's business in such jurisdictions. Any such action could
materially adversely affect the income received from such products. The
Company's credit life and disability reinsurance and property and casualty
insurance subsidiaries are licensed and subject to regulation in the state of
Arizona and in the Turks and Caicos Islands.
The Company's operations in the United Kingdom and Canada are also subject
to various laws and regulations. Generally, these requirements tend to be no
more restrictive than those in effect in the United States.
The Company believes that it maintains all material licenses and permits
required for its current operations and is in substantial compliance with all
applicable laws and regulations. The Company's Servicing Agreement with
dealer-partners provides that the dealer-partner shall indemnify the Company
with respect to any loss or expense the Company incurs as a result of the
dealer-partner's failure to comply with applicable laws and regulations.
EMPLOYEES
As of September 30, 2003 the Company employed 678 persons. The Company's
employees have no union affiliations and the Company believes its relationship
with its employees is good. The table below presents employees by department:
NUMBER OF
DEPARTMENT EMPLOYEES
------------------------------------------- --------------
Collection and Servicing 443
Loan Origination and Processing 36
Sales and Marketing 60
Finance and Accounting 38
Information Systems 48
Management and Support 53
--------------
TOTAL 678
==============
46
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
See Index of Exhibits following the signature page.
(b) Reports on Form 8-K
The Company filed a current report on Form 8-K pursuant to Items
7 and 12, dated August 7, 2003, reporting that the Company
issued a press release announcing financial results for the
three and nine months ended June 30, 2003, a copy of which was
filed as Exhibit 99.1.
The Company filed a current report on Form 8-K pursuant to Items
9 and 12, dated September 24, 2003, furnishing presentation
materials which were prepared for a presentation to an
institutional investor occurring on September 24, 2003, a copy
of which was filed as Exhibit 99.1.
The information included in the reports was furnished rather
than filed with the SEC. No financial statements were filed with
the Forms 8-K.
47
SIGNATURE
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.
CREDIT ACCEPTANCE CORPORATION
(Registrant)
By: /s/ Douglas W. Busk
------------------------------------------------
Douglas W. Busk
Chief Financial Officer and Treasurer
November 14, 2003
(Principal Financial Officer, Accounting Officer
and Duly Authorized Officer)
48
INDEX OF EXHIBITS
EXHIBIT NO. DESCRIPTION
----------- -----------
4(f)(53) Contribution Agreement dated September 30, 2003 between
the Company and CAC Warehouse Funding Corporation II.
4(f)(54) Loan and Security Agreement dated September 30, 2003
among the Company, CAC Warehouse Funding Corporation II,
Wachovia Bank, National Association, Variable Funding
Capital Corporation, Wachovia Capital Markets, LLC, and
Systems & Services Technologies, Inc.
4(f)(55) Back-Up Servicing Agreement dated September 30, 2003 among
the Company, Systems & Services Technologies, Inc., Wachovia
Capital Markets, LLC, and CAC Warehouse Funding Corporation
II.
4(f)(56) Intercreditor Agreement, dated September 30, 2003, among
the Company, CAC Warehouse Funding Corporation II,
Credit Acceptance Funding LLC 2003-1, Credit Acceptance
Auto Dealer Loan Trust 2003-1, Wachovia Capital Markets,
LLC, JPMorgan Chase Bank, and Comerica Bank.
31(a) Certification of Chief Executive Officer pursuant to Rule
13a-14(a) of the Securities Exchange Act.
31(b) Certification of Chief Financial Officer pursuant to Rule
13a-14(a) of the Securities Exchange Act.
32(a) Certification of Chief Executive Officer, pursuant to 18
U.S.C. Section 1350 and Rule 13a-14(b) of the Securities
Exchange Act.
32(b) Certification of Chief Financial Officer, pursuant to 18
U.S.C. Section 1350 and Rule 13a-14(b) of the Securities
Exchange Act.
49