Back to GetFilings.com
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 June 30, 2004
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 July 31,
2004 was 39,244,203.
TABLE OF CONTENTS
PART I. - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Income Statements-
Three and six months ended June 30, 2004 and June 30, 2003 1
Consolidated Balance Sheets-
As of June 30, 2004 and December 31, 2003 2
Consolidated Statements of Cash Flows-
Six months ended June 30, 2004 and June 30, 2003 3
Notes to Consolidated Financial Statements 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION 11
AND RESULTS OF OPERATIONS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 29
ITEM 4. CONTROLS AND PROCEDURES 29
PART II. - OTHER INFORMATION
ITEM 2. CHANGES OF EQUITY SECURITIES, USE OF PROCEEDS AND ISSUER
PURCHASES OF EQUITY SECURITIES 30
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 30
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 30
SIGNATURE 31
INDEX OF EXHIBITS 32
PART I. - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
CREDIT ACCEPTANCE CORPORATION
CONSOLIDATED INCOME STATEMENTS
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- ----------------------------
(Dollars in thousands, except per share data) 2004 2003 2004 2003
---------- ---------- ----------- ----------
REVENUE:
Finance charges $ 33,731 $ 26,431 $ 60,964 $ 50,687
Ancillary product income 2,459 4,233 5,326 9,966
Lease revenue 405 1,784 1,052 4,120
Other income 4,694 3,598 9,468 8,258
---------- ---------- ----------- ----------
Total revenue 41,289 36,046 76,810 73,031
---------- ---------- ----------- ----------
COSTS AND EXPENSES:
Salaries and wages 8,963 8,687 17,759 17,204
General and administrative 5,214 5,272 10,968 10,812
Provision for credit losses 2,187 2,863 14,734 7,051
Sales and marketing 2,474 2,483 5,017 4,660
Interest 2,373 1,401 4,973 2,997
Stock-based compensation expense 864 1,428 1,431 1,803
United Kingdom asset impairment - 10,493 - 10,493
Other expense 324 1,376 781 3,023
---------- ---------- ----------- ----------
Total costs and expenses 22,399 34,003 55,663 58,043
---------- ---------- ----------- ----------
Operating income 18,890 2,043 21,147 14,988
Foreign exchange gain 906 14 1,057 29
---------- ---------- ----------- ----------
Income before provision for income taxes 19,796 2,057 22,204 15,017
Provision for income taxes 7,190 1,049 8,068 5,416
---------- ---------- ----------- ----------
Net income $ 12,606 $ 1,008 $ 14,136 $ 9,601
========== ========== =========== ==========
Net income per common share:
Basic $ 0.32 $ 0.02 $ 0.36 $ 0.23
========== ========== =========== ==========
Diluted $ 0.30 $ 0.02 $ 0.34 $ 0.23
========== ========== =========== ==========
Weighted average shares outstanding:
Basic 39,240,321 42,321,170 39,516,011 42,317,443
Diluted 41,413,308 42,868,265 41,790,255 42,629,844
See accompanying notes to consolidated financial statements.
1
CREDIT ACCEPTANCE CORPORATION
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
AS OF
------------------------------------
(Dollars in thousands, except per share data) JUNE 30, 2004 DECEMBER 31,2003
------------- ----------------
ASSETS:
Cash and cash equivalents $ 28,364 $ 36,044
Loans receivable 976,315 875,417
Allowance for credit losses (36,567) (17,615)
----------- -----------
Loans receivable, net 939,748 857,802
----------- -----------
Notes, lines of credit and floorplan receivables, net (including $1,617 and
$ 1,583 from affiliates as of June 30, 2004 and
December 31, 2003, respectively) 6,073 6,562
Investment in operating leases, net 1,888 4,447
Property and equipment, net 19,177 18,503
Income taxes receivable 7,458 5,795
Other assets 14,646 14,627
----------- -----------
Total Assets $ 1,017,354 $ 943,780
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY:
LIABILITIES:
Lines of credit $ 30,600 $ -
Secured financing 130,428 100,000
Mortgage note and capital lease obligations 10,254 6,467
Accounts payable and accrued liabilities 36,481 33,117
Dealer holdbacks, net 475,415 423,861
Deferred income taxes, net 13,820 24,529
----------- -----------
Total Liabilities 696,998 587,974
----------- -----------
SHAREHOLDERS' EQUITY:
Preferred stock, $.01 par value, 1,000,000 shares authorized, none issued - -
Common stock, $.01 par value, 80,000,000 shares authorized, 39,244,203 and
42,128,087 shares issued and outstanding as of June 30, 2004 and
December 31, 2003, respectively 392 421
Paid-in capital 76,394 125,078
Retained earnings 241,175 227,039
Accumulated other comprehensive income - cumulative translation adjustment 2,395 3,268
----------- -----------
Total Shareholders' Equity 320,356 355,806
----------- -----------
Total Liabilities and Shareholders' Equity $ 1,017,354 $ 943,780
=========== ===========
See accompanying notes to consolidated financial statements.
2
CREDIT ACCEPTANCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
SIX MONTHS ENDED JUNE 30,
-------------------------
(Dollars in thousands) 2004 2003
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 14,136 $ 9,601
Adjustments to reconcile cash provided by operating activities:
Provision for credit losses 14,734 7,051
Depreciation 3,031 4,946
Loss on retirement of property and equipment 151 -
Foreign currency gain on forward contracts (1,059) -
Credit for deferred income taxes (10,709) (5,585)
Stock-based compensation expense 1,431 1,803
Change in operating assets and liabilities:
Accounts payable and accrued liabilities 4,423 4,692
Income taxes receivable/payable (1,663) 5,606
Lease payment receivable 234 1,184
Unearned commissions, insurance premiums and reserves 131 (223)
Other assets (19) (365)
--------- ---------
Net cash provided by operating activities 24,821 28,710
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of investments - held to maturity - (283)
Principal collected on Loans receivable 218,967 183,754
Advances to dealers (237,451) (193,304)
Payments of dealer holdbacks (15,869) (15,111)
Accelerated payments of dealer holdbacks (10,276) (6,818)
Operating lease liquidations 1,667 3,446
(Increase) decrease in notes, lines of credit and floorplan receivables (139) 3,593
Purchases of property and equipment (1,952) (608)
--------- ---------
Net cash used in investing activities (45,053) (25,331)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (repayments) under lines of credit 30,600 (35,250)
Proceeds from secured financings 100,000 100,000
Repayments of secured financings (69,572) (58,153)
Principal payments under capital lease obligations (591) (427)
Proceeds from mortgage note refinancing 3,540 -
Repayment of mortgage note (408) (382)
Repurchase of common stock (50,706) (1,828)
Proceeds from stock options exercised 562 358
--------- ---------
Net cash provided by financing activities 13,425 4,318
--------- ---------
Effect of exchange rate changes on cash (873) 905
--------- ---------
Net (decrease) increase in cash and cash equivalents (7,680) 8,602
Cash and cash equivalents, beginning of period 36,044 13,466
--------- ---------
Cash and cash equivalents, end of period $ 28,364 $ 22,068
========= =========
SUPPLEMENTAL DISCLOSURE OF NON- CASH TRANSACTIONS:
Property and equipment acquired through capital lease obligations $ 1,829 $ 27
========= =========
See accompanying notes to consolidated financial statements.
3
CREDIT ACCEPTANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(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, 2003 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, 2003 for Credit Acceptance
Corporation (the "Company"). Certain prior period amounts have been reclassified
to conform to the current presentation.
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. SIGNIFICANT ACCOUNTING POLICIES
Finance Charges. The Company recognizes finance charge income in
accordance with the provisions of Statement of Financial Accounting Standards
("SFAS") No. 91, "Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases (an Amendment
of FASB Statements No. 13, 60, and 65 and a Rescission of FASB Statement No.
17)" ("SFAS No. 91"). SFAS No. 91 requires the Company to recognize finance
charges under the interest method such that income is recognized on a level
yield basis during the life of the underlying asset. During the first quarter of
2004, the Company revised its methodology for applying SFAS No. 91 such that
finance charge income and the amount of the provision for earned but unpaid
income at the time a retail installment contract (referred to as a "Loan") is
transferred to non-accrual status can be calculated for each individual Loan.
Prior to the first quarter of 2004, the Company calculated finance charge income
and the provision for earned but unpaid revenue using a pooling methodology. The
pooling methodology required the Company to make various assumptions and
estimates which impacted the timing of income recognition and the classification
of finance charge revenue and the provision for earned but unpaid revenue. The
Company believes that this revised methodology improves the precision of the
Company's calculation of finance charge revenue and the provision for earned but
unpaid revenue. This revised methodology resulted in a change in the timing of
revenue recognition as the actual term of the Loans on a Loan by Loan basis was
longer than the average Loan term as calculated under the pooling methodology,
resulting in an approximately $3.5 million reduction in finance charges during
the three months ended March 31, 2004, of which approximately $3.3 million
relates to periods prior to December 31, 2003. In addition, the revised
methodology resulted in a change in the amount of revenue recognized on a Loan
prior to the Loan transferring to non-accrual status, resulting in an increase
in finance charges and a corresponding increase in the provision for earned but
unpaid revenue of approximately $3.5 million for the three months ended March
31, 2004. The revised methodology did not materially impact reported earnings
for the three months ended June 30, 2004.
Ancillary Product Income. The Company has relationships with third party
vehicle service contract administrators ("TPAs") whereby the TPAs process claims
on vehicle service contracts underwritten by third party insurers. The Company
receives a commission for all such vehicle service contracts sold by its
dealer-partners. The Company refers to dealers participating in the Company's
financing program and sharing the Company's commitment to changing customers'
lives as "dealer-partners". The Company recognizes the commission received from
the TPAs in accordance with SEC Staff Accounting Bulletin No. 104, "Revenue
Recognition" ("SAB 104"). Through December 31, 2003, the Company recognized
ancillary product income for commissions received on the sale of third party
vehicle service contracts upon the sale of the vehicle service contracts since
(i) delivery of the vehicle service contract occurs at this time, (ii) the
Company bears no further obligation under the vehicle service contract and (iii)
the Company's commission is not subject to refund. During the first quarter of
2004, the Company entered into agreements with two new TPAs. The two new
agreements differ from the prior agreement in three material respects: (i) the
new agreements provide a commission to the Company on all vehicle service
contracts sold by its dealer-partners, regardless of whether the vehicle service
contract is financed by the Company; (ii) the new agreements pay a higher
commission on vehicle service contracts financed by the Company and; (iii) the
new agreements allow the Company to participate in underwriting profits
depending on the level of future claims paid. Since the commission paid on
financed vehicle service contracts is higher than the commission paid on
non-financed vehicle
4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
2. SIGNIFICANT ACCOUNTING POLICIES - (CONCLUDED)
service contracts, the Company concluded this difference in commissions rates
was evidence of a multiple element revenue arrangement as defined under the
provisions of SAB 104 and EITF 00-21, "Revenue Arrangements with Multiple
Elements". As a result, the Company considers the amount received from TPAs for
financed vehicle service contracts to be comprised of two components, a
component relating to the fair value of the commission (a "broker fee") and a
larger component relating to providing the financing on the related Loan (a
"financing premium").
The two new agreements also require that net premiums on the vehicle
service contracts be placed in trust accounts by the TPA. Funds in the trust
accounts are utilized by the TPA to pay claims on the vehicle service contracts.
Underwriting profits, if any, on the vehicle service contracts are distributed
to the Company after the term of the vehicle service contracts have expired.
Under FASB Interpretation No. 46, "Consolidation of Variable Interest Entities"
("FIN 46"), the Company is considered the primary beneficiary of the trusts. As
a result, the assets and liabilities of the trusts have been consolidated on the
Company's balance sheet. As of June 30, 2004, the trusts had $3.8 million in
cash available to pay claims and a related claims reserve of $3.8 million. The
cash is included in cash and cash equivalents and the claims reserve is included
in accounts payable and accrued liabilities in the consolidated balance sheets.
A third party insures claims in excess of available funds in the trust accounts.
Beginning January 1, 2004, broker fees generated under the two new
agreements will be recognized over the life of the related vehicle service
contract. Broker fees generated under the old agreement, which does not meet the
requirements for consolidation under FIN 46, will be recognized upon the sale of
the vehicle service contract. Under all three agreements, the financing premium
will be deferred and amortized over the life of the underlying Loan as an
adjustment to the yield consistent with the Company's accounting for finance
charges under the interest method.
Under the new policy, the Company recognized $2.2 million and $4.3 million
in income during the three and six months ended June 30, 2004, respectively, and
deferred $4.0 million and $9.0 million of financing premiums for the three and
six months ended June 30, 2004, respectively. The Company estimates the deferred
portion will be recognized as follows (in thousands):
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 2004 JUNE 30, 2004
------------- -------------
2004 $1,107 $2,593
2005 1,739 3,993
2006 1,011 2,147
2007 170 265
------ ------
$4,027 $8,998
====== ======
Loans Receivable and Allowance for Credit Losses. The Company maintains an
allowance for credit losses that covers: (i) losses inherent in the Company's
Loan portfolio, and (ii) earned but unpaid revenue on Loans in non-accrual
status. Losses inherent in the Company's Loan portfolio result from Loans
receivable determined to be uncollectible or that have expected future
collections less than the full contractual amount, less any losses absorbed by
dealer holdbacks. By definition, these losses equal the amount by which advances
to dealer-partners plus accrued income (the "net investment") exceed the net
present value of future cash flows related to the Loans receivable less the
present value of estimated dealer holdback payments.
To record estimated losses on its Loan portfolio, 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 compares the present value of estimated future collections for each
dealer-partner's Loan portfolio to the Company's net investment in that
portfolio. During the first quarter of 2004 the Company developed a model for
estimating the amount and timing of future dealer holdback payments and began to
include the present value of expected future dealer holdback payments in its
loss estimate. Considering estimated future dealer holdback payments increases
the Company's loss estimate as cash flows used to evaluate impairment are
reduced. This change resulted in a $9.4 million increase in the allowance for
credit losses and reduced after-tax earnings by approximately $6.1 million for
the three months ended March 31, 2004. Deducting dealer holdback payments from
the cash flows used to evaluate impairment will not increase the cash amount of
losses or future charge-offs against the allowance. The change in estimate did
not materially impact reported earnings for the three months ended June 30,
2004.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
3. LOANS RECEIVABLE
Loans receivable consisted of the following (in thousands):
AS OF
------------------------------------------
JUNE 30, 2004 DECEMBER 31, 2003
------------- -----------------
Gross Loans receivable $ 1,169,468 $ 1,035,681
Unearned finance charges (190,465) (157,707)
Unearned commissions, insurance premiums and reserves (2,688) (2,557)
------------- --------------
Loans receivable $ 976,315 $ 875,417
============= ==============
Non-accrual Loans $ 202,106 $ 203,598
============= ==============
Non-accrual Loans as a percent of gross Loans receivable 17.3% 19.7%
============= ==============
A summary of the changes in gross Loans receivable is as follows (in
thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- --------------------------
2004 2003 2004 2003
----------- ----------- ----------- -----------
Balance, beginning of period $ 1,144,341 $ 965,372 $ 1,035,681 $ 912,629
Gross amount of Loans accepted 215,103 200,068 514,399 426,111
Net cash collections on Loans (139,102) (118,645) (281,128) (239,652)
Charge-offs * (72,496) (55,568) (145,844) (120,222)
Recoveries * 8,415 - 16,670 -
Other fees 15,044 12,903 30,115 24,883
Net change in repossessed collateral (709) 968 (791) 2,030
Currency translation (1,128) 6,312 366 5,631
----------- ----------- ----------- -----------
Balance, end of period $ 1,169,468 $ 1,011,410 $ 1,169,468 $ 1,011,410
=========== =========== =========== ===========
A summary of the changes in the allowance for credit losses is as follows
(in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------- ---------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Balance, beginning of period $ 34,521 $ 22,929 $ 17,615 $ 20,991
Provision for credit losses 1,894 2,296 14,106 5,289
Charge-offs * (4,916) (966) (5,958) (1,987)
Recoveries * 5,135 - 10,765 -
Currency translation (67) 202 39 168
---------- ---------- ---------- ----------
Balance, end of period $ 36,567 $ 24,461 $ 36,567 $ 24,461
========== ========== ========== ==========
* Charge-offs presented net of recoveries for the three and six months
ended June 30, 2003
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
4. 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, "Accounting
for the Impairment or Disposal of Long-Lived Assets", 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 June 30, 2004 and December 31, 2003,
repossessed assets totaled approximately $6.8 million and $6.0 million,
respectively.
5. DEALER HOLDBACKS
Dealer holdbacks, net consisted of the following (in thousands):
AS OF
----------------------------------------
JUNE 30, 2004 DECEMBER 31, 2003
------------- -----------------
Dealer holdbacks $ 933,239 $ 828,720
Less: advances (457,824) (404,859)
--------- -------------
Dealer holdbacks, net $ 475,415 $ 423,861
========= =============
6. 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. The Company accepts Loans from
affiliated dealer-partners and nonaffiliated dealer-partners on the same terms.
A summary of related party Loan activity is as follows (in thousands):
Affiliated % of Affiliated % of
dealer-partner consolidated dealer-partner consolidated
balance as of as of balance as of as of
June 30, 2004 June 30, 2004 December 31, 2003 December 31, 2003
------------- ------------- ----------------- -----------------
Gross Loans receivable $ 35,653 $3.0% $ 31,500 3.0%
Gross dealer holdbacks $ 27,814 $3.0% $ 24,800 3.0%
Advance balance $ 13,846 $3.0% $ 12,200 3.0%
For the Three Months ended For the Three Months ended
June 30, 2004 June 30, 2003
----------------------------------- ----------------------------------
Affiliated Affiliated
dealer-partner % of dealer-partner % of
activity consolidated activity consolidated
-------- ------------ -------- ------------
Loans accepted $ 6,500 3.0% $ 5,400 2.7%
Advances $ 3,100 2.9% $ 2,600 2.6%
For the Six Months ended For the Six Months ended
June 30, 2004 June 30, 2003
----------------------------------- ---------------------------------------
Affiliated Affiliated
dealer-partner % of dealer-partner % of
activity consolidated activity consolidated
-------- ------------ -------- ------------
Loans accepted $ 15,100 2.9% $ 11,900 2.8%
Advances $ 7,200 2.9% $ 5,400 2.7%
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
6. RELATED PARTY TRANSACTIONS - (CONCLUDED)
Pursuant to an employment agreement with the Company's President dated April 19,
2001, the Company loaned the President's dealerships $850,000. The note,
including all principal and interest, is due on April 19, 2011, bears interest
at 5.22%, is unsecured, and is personally guaranteed by the Company's President.
The balance of the note including accrued but unpaid interest was approximately
$1,076,000 and $1,054,000 as of June 30, 2004 and December 31, 2003,
respectively. In addition, pursuant to the employment agreement, the Company
loaned the President approximately $478,000. The note, including all principal
and interest, is due on April 19, 2011, bears interest at 5.22% beginning
January 1, 2002, and is unsecured. The balance of the note including accrued
interest was approximately $541,000 and $528,000 as of June 30, 2004 and
December 31, 2003, respectively.
Total CAPS (the Company's Internet based Credit Approval Processing
System) and dealer enrollment fees earned from affiliated dealer-partners were
$9,000 and $23,000 for the three and six months ended June 30, 2004,
respectively, and $11,000 and $28,000 for the same periods in 2003.
The Company paid for air transportation services provided by a company
owned by the Company's majority shareholder and Chairman totaling $61,000 and
$82,000 for the three months and six months ended June 30, 2004, respectively,
and $60,000 and $75,000 for the same periods 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 dealers, except to dealerships which he owns or
controls.
7. 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 June 30, 2004 and December 31, 2003, the Company had contracts
outstanding to deliver 8.3 million British pounds sterling and 16.9 million
British pounds sterling, respectively, to the commercial bank which will be
exchanged into United States dollars at a weighted average exchange rate of 1.58
United States dollars per British pound sterling on a monthly basis through
June 30, 2005. The Company believes that this transaction minimizes 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. 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, changes in
the fair value of these forward contracts will increase or decrease net income.
The fair value of the forward contracts were less than the notional amount of
the contracts outstanding as of June 30, 2004 and December 31, 2003 by
$1,758,000 and $2,817,000, respectively, due to the weakening of the United
States dollar versus the British pound sterling since the date the contracts
were entered into. The Company recognized a foreign currency gain of $908,000
($590,000 after-tax) and $1,059,000 ($688,000 after-tax) for the three months
and six months ended June 30, 2004, respectively, related to the change in the
fair value of the forward contracts due to: (i) a decrease in the notional
amount of the forward contracts from December 31, 2003 to June 30, 2004, and
(ii) the strengthening of the United States dollar versus the British pound
sterling during the second quarter of 2004.
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
8. INCOME TAXES
A reconciliation of the U.S. federal statutory rate to the Company's
effective tax rate follows:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
2004 2003 2004 2003
---- ---- ---- ----
U.S. federal statutory rate 35.0% 35.0% 35.0% 35.0%
State income taxes 1.0 3.4 0.7 0.7
Foreign income taxes (0.1) 24.1 - 2.3
U.S. tax impact of foreign earnings - (12.0) 0.2 (2.0)
Other 0.4 0.5 0.4 0.1
---- ---- ---- ----
Effective tax rate 36.3% 51.0% 36.3% 36.1%
==== ==== ==== ====
The differences between the U.S. federal statutory rate and the Company's
consolidated effective tax rate are primarily related to: (i) state income taxes
that are included in the provision for income taxes, (ii) the impact of earnings
generated by the Company's foreign operations, which are taxed at a different
rate, and (iii) the impact of the exchange rate on the repatriation of foreign
earnings. Repatriations of foreign earnings are taxed by the U.S. based on
foreign exchange rates prevailing at the time of repatriation while foreign tax
credits are calculated based on the exchange rates that prevailed when the
income was originally earned.
9. BUSINESS SEGMENT INFORMATION
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 automobile financing business. The
United Kingdom segment primarily consists of the Company's United Kingdom
automobile financing business. The Automobile Leasing segment consists of the
Company's automobile leasing business. The Other segment consists of the
Company's Canadian automobile financing business 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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------- ----------------------
2004 2003 2004 2003
---------- ---------- -------- --------
Revenue:
United States $ 38,957 $ 30,618 $ 71,339 $ 60,023
United Kingdom 1,141 2,862 2,589 6,863
Automobile Leasing 929 2,077 2,311 4,706
Other 262 489 571 1,439
---------- ---------- -------- --------
Total revenue $ 41,289 $ 36,046 $ 76,810 $ 73,031
========== ========== ======== ========
Income (loss) before provision (credit) for income taxes:
United States $ 19,417 $ 13,147 $ 21,155 $ 24,659
United Kingdom 262 (10,963) 584 (9,212)
Automobile Leasing 345 (252) 831 (766)
Other (228) 125 (366) 336
---------- ---------- -------- --------
Total income before provision for income taxes $ 19,796 $ 2,057 $ 22,204 $ 15,017
========== ========== ======== ========
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
10. 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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- -------------------------
2004 2003 2004 2003
---------- ---------- ---------- ----------
Weighted average common shares outstanding 39,240,321 42,321,170 39,516,011 42,317,443
Common stock equivalents 2,172,987 547,095 2,274,244 312,401
---------- ---------- ---------- ----------
Weighted average common shares and common stock equivalents 41,413,308 42,868,265 41,790,255 42,629,844
========== ========== ========== ==========
The diluted net income per share calculation excludes stock options to
purchase approximately 243,334 shares and 202,290 shares for the three months
and six months ended June 30, 2004, respectively, and 1,041,309 shares and
1,657,430 shares for the same periods in 2003 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.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
EXECUTIVE SUMMARY
Since 1972, Credit Acceptance has provided auto loans to consumers,
regardless of their credit history. The Company's product is offered through a
nationwide network of automobile dealers who benefit by selling vehicles to
consumers who otherwise could not obtain financing. The Company delivers credit
approvals instantly through the Internet. The Company's revenues are generated
primarily through the servicing fees it receives for the collection and
administration of Loans assigned by dealer-partners to the Company, and to a
lesser extent, through the fees it receives through the sale of third-party
ancillary products.
The Company's strategy is to increase the amount of economic profit per
share by increasing its return on capital and profitably growing its business.
(See "Economic Profit" for the Company's definition of economic profit.) The
Company believes it has been successful in improving the profitability of Loan
originations in recent years as a result of increasing the spread between the
forecasted collection rate and the advance rate, and increasing revenue from
ancillary products. For the six months ended June 30, 2004, consolidated Loan
originations grew 21% while Loan originations in the United States grew 29%
compared to the same period in 2003 due to an increase in the number of active
dealer-partners and an increase in the average Loan size. Since the Company
believes it is the only financial services company offering "guaranteed credit
approval" for automobile dealers on a national scale, and the Company presently
serves only a small portion of its target market, the Company believes that it
has a good opportunity to grow its business profitably in the future.
Critical success factors for the Company include its access to capital and
its ability to accurately forecast Loan performance. The Company's strategy for
accessing the capital required to grow its business is to: (i) maintain
consistent financial performance, (ii) maintain modest financial leverage, and
(iii) maintain multiple funding sources. The Company's funded debt to equity
ratio is .5/1.0 at June 30, 2004. The Company currently funds its business
through a bank line of credit facility, privately placed secured financings and
commercial bank conduit financed secured financings. The ability to accurately
forecast Loan performance is critical to building a profitable company. On the
day of Loan origination, the Company forecasts future expected cash flows from
the Loan. Based on these forecasts, an advance is made to the related
dealer-partner at a level that allows the Company to achieve an acceptable
return on capital. If Loan performance equals or exceeds the Company's original
expectation, it is likely the Company's target return on capital will be
achieved.
FORECASTING LOAN PERFORMANCE IN THE UNITED STATES
The United States is the Company's only business segment that continues to
originate new Loans. The following table presents the United States forecasted
collection rates, advance rates, the spread (the forecasted collection rate less
the advance rate), and the percentage of the forecasted collections that have
been realized as of June 30, 2004. The amounts presented are expressed as a
percent of the original Loan amount by year of Loan origination.
As of June 30, 2004
------------------------------------------------------------
Forecasted % of Forecast
Year Collection % Advance % Spread % Realized
- ---- ------------ --------- -------- --------
1992 81.6% 35.3% 46.3% 100.0%
1993 75.8% 37.3% 38.5% 100.0%
1994 61.9% 41.8% 20.1% 100.0%
1995 55.1% 45.3% 9.8% 99.6%
1996 55.2% 48.4% 6.8% 99.1%
1997 58.1% 48.3% 9.8% 98.7%
1998 67.2% 49.4% 17.8% 98.6%
1999 71.5% 52.3% 19.2% 98.3%
2000 71.7% 50.9% 20.8% 97.4%
2001 66.7% 48.0% 18.7% 90.5%
2002 68.9% 45.7% 23.2% 74.4%
2003 73.2% 47.0% 26.2% 39.9%
11
Accurately predicting future collection rates is critical to the Company's
success. The risk of a forecasting error declines as Loans age. For example, the
risk of a material forecasting error for business written in 1999 is very small
since 98.3% 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. Although the Company
makes every effort to estimate collection rates as accurately as possible, there
can be no assurance that the Company's estimates will be accurate or that Loan
performance will be as predicted.
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 second quarter of 2004,
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 of collection rates in the United States
for Loans originated by year as of June 30, 2004 with the forecast as of
December 31, 2003.
June 30, 2004 December 31, 2003
Year Forecasted Collection % Forecasted Collection % Variance
- ---- ----------------------- ----------------------- --------
1992 81.6% 81.5% 0.1%
1993 75.8% 75.7% 0.1%
1994 61.9% 61.8% 0.1%
1995 55.1% 55.2% -0.1%
1996 55.2% 55.3% -0.1%
1997 58.1% 58.1% 0.0%
1998 67.2% 67.2% 0.0%
1999 71.5% 71.5% 0.0%
2000 71.7% 71.7% 0.0%
2001 66.7% 67.0% -0.3%
2002 68.9% 69.4% -0.5%
2003 73.2% 72.8% 0.4%
12
RESULTS OF OPERATIONS
Three and Six Months Ended June 30, 2004 Compared to Three and Six Months
Ended June 30, 2003
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
THREE MONTHS THREE MONTHS
ENDED ENDED
JUNE 30, % OF JUNE 30, % OF
(Dollars in thousands) 2004 REVENUE 2003 REVENUE
------------ ------- ------------ -------
REVENUE:
Finance charges $33,731 81.7% $26,431 73.4%
Ancillary product income 2,459 6.0 4,233 11.7
Lease revenue 405 1.0 1,784 4.9
Other income 4,694 11.4 3,598 10.0
------------ ------- ------------ -------
Total revenue 41,289 100.0 36,046 100.0
COSTS AND EXPENSES:
Salaries and wages 8,963 21.7 8,687 24.1
General and administrative 5,214 12.6 5,272 14.6
Provision for credit losses 2,187 5.3 2,863 7.9
Sales and marketing 2,474 6.0 2,483 6.9
Interest 2,373 5.7 1,401 3.9
Stock-based compensation expense 864 2.1 1,428 4.0
United Kingdom asset impairment expense - - 10,493 29.1
Other expense 324 0.8 1,376 3.8
------------ ------- ------------ -------
Total costs and expenses 22,399 54.2 34,003 94.3
------------ ------- ------------ -------
Operating income 18,890 45.8 2,043 5.7
Foreign exchange gain 906 2.2 14 -
------------ ------- ------------ -------
Income before provision for income taxes 19,796 47.9 2,057 5.7
Provision for income taxes 7,190 17.4 1,049 2.9
------------ ------- ------------ -------
Net income $12,606 30.5% $ 1,008 2.8%
============ ======= ============ =======
13
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, % OF JUNE 30, % OF
(Dollars in thousands) 2004 REVENUE 2003 REVENUE
---------- ------- ----------- -------
REVENUE:
Finance charges $ 60,964 79.4% $ 50,687 69.4%
Ancillary product income 5,326 6.9 9,966 13.6
Lease revenue 1,052 1.4 4,120 5.6
Other income 9,468 12.3 8,258 11.3
---------- ----- ----------- -----
Total revenue 76,810 100.0 73,031 100.0
COSTS AND EXPENSES:
Salaries and wages 17,759 23.1 17,204 23.6
General and administrative 10,968 14.3 10,812 14.8
Provision for credit losses 14,734 19.2 7,051 9.7
Sales and marketing 5,017 6.5 4,660 6.4
Interest 4,973 6.5 2,997 4.1
Stock-based compensation expense 1,431 1.9 1,803 2.5
United Kingdom asset impairment expense - - 10,493 14.4
Other expense 781 1.0 3,023 4.1
---------- ----- ----------- -----
Total costs and expenses 55,663 72.5 58,043 79.6
---------- ----- ----------- -----
Operating income 21,147 27.5 14,988 20.5
Foreign exchange gain 1,057 1.4 29 -
---------- ----- ----------- -----
Income before provision for income taxes 22,204 28.9 15,017 20.6
Provision for income taxes 8,068 10.5 5,416 7.4
---------- ----- ----------- -----
Net income $ 14,136 18.3% $ 9,601 13.1%
========== ===== =========== =====
For the three months ended June 30, 2004, consolidated net income
increased to $12.6 million or $0.30 per diluted share from $1.0 million or $0.02
per diluted share for the same period in 2003. The increase in consolidated net
income was primarily due to: (i) the United Kingdom impairment expenses
recognized during the second quarter of 2003, (ii) an increase in the size of
the Loan portfolio due to an increase in Loan originations, (iii) an increase in
the average annualized yield on the Loan portfolio due to a decrease in the
percentage of non-accrual Loans to total Loans, and (iv) a decrease in operating
expenses (salaries and wages, general and administrative, and sales and
marketing) as a percentage of revenue due to increased operational efficiencies.
Partially offsetting these items was a decrease in ancillary product income due
to the Company's new policy for recognizing income on third-party vehicle
service contracts sold, as discussed in Note 2 to the consolidated financial
statements.
For the six months ended June 30, 2004, consolidated net income increased
to $14.1 million or $0.34 per diluted share from $9.6 million or $0.23 per
diluted share for the same period in 2003. The increase in consolidated net
income was primarily due to: (i) the United Kingdom impairment expenses
recognized during the second quarter of 2003, (ii) an increase in the size of
the Loan portfolio due to an increase in Loan originations, and (iii) a decrease
in operating expenses (salaries and wages, general and administrative, and sales
and marketing) as a percentage of revenue due to increased operational
efficiencies. Partially offsetting these items were: (i) an increase in the
provision for credit losses due to the Company's change in estimate for
recording losses on its Loan portfolio and the Company's revised methodology for
calculating finance charge income and the related provision for earned but
unpaid servicing fees, both as discussed in Note 2 to the consolidated financial
statements and (ii) a decrease in ancillary product income due to the Company's
new policy for recognizing income on third-party vehicle service contracts sold,
as discussed in Note 2 to the consolidated financial statements.
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 interest expense is provided on a
consolidated basis, as the explanation is not meaningful by business segment.
Interest. Consolidated interest expense increased to $2.4 and $5.0 million
for the three and six months ended June 30, 2004 from $1.4 million and $3.0
million for the same periods in 2003. The increase in consolidated interest
expense was due to: (i) an increase in average outstanding debt as a result of
stock repurchases and an increase in Loan originations and (ii) an increase in
the weighted average interest rate to 5.8% and 6.8% for the three and six months
ended June 30, 2004 from 5.5 % and 5.9 % for the same periods in 2003 as a
result of an increase in the total effective cost of borrowings due to the
impact of fixed fees on the Company's secured financings and line of credit
facility.
14
United States
THREE MONTHS THREE MONTHS
ENDED ENDED
JUNE 30, % OF JUNE 30, % OF
(Dollars in thousands) 2004 REVENUE 2003 REVENUE
----------- ------- ------------ -------
REVENUE:
Finance charges $ 32,395 83.3% $ 23,195 75.8%
Ancillary product income 2,459 6.3 4,189 13.8
Other income 4,103 10.5 3,234 10.6
----------- ----- ------------ -----
Total revenue 38,957 100.0 30,618 100.0
COSTS AND EXPENSES:
Salaries and wages 8,169 21.0 7,199 23.5
General and administrative 4,650 11.9 4,426 14.5
Provision for credit losses 2,030 5.2 1,490 4.9
Sales and marketing 2,474 6.4 1,818 5.9
Interest 2,231 5.7 958 3.1
Stock-based compensation expense 822 2.1 1,353 4.4
Other expense 70 0.2 209 0.7
----------- ----- ------------ -----
Total costs and expenses 20,446 52.5 17,453 57.0
----------- ----- ------------ -----
Operating income 18,511 47.5 13,165 43.0
Foreign exchange gain (loss) 906 2.3 (18) (0.1)
----------- ----- ------------ -----
Income before provision for income taxes 19,417 49.7 13,147 42.9
Provision for income taxes 7,076 18.2 4,444 14.5
----------- ----- ------------ -----
Net income $ 12,341 31.6% $ 8,703 28.4%
=========== ===== ============ =====
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, % OF JUNE 30, % OF
(Dollars in thousands) 2004 REVENUE 2003 REVENUE
---------- ------- ---------- -------
REVENUE:
Finance charges $ 57,984 81.3% $ 43,954 73.2%
Ancillary product income 5,326 7.5 9,037 15.1
Other income 8,029 11.3 7,032 11.7
---------- ----- ---------- -----
Total revenue 71,339 100.0 60,023 100.0
COSTS AND EXPENSES:
Salaries and wages 16,121 22.6 14,489 24.1
General and administrative 9,752 13.7 8,999 15.0
Provision for credit losses 14,342 20.1 4,330 7.2
Sales and marketing 5,017 7.0 3,656 6.1
Interest 4,591 6.4 1,904 3.2
Stock-based compensation expense 1,344 1.9 1,649 2.7
Other expense 89 0.1 308 0.5
---------- ----- ---------- -----
Total costs and expenses 51,256 71.8 35,335 58.9
---------- ----- ---------- -----
Operating income 20,083 28.2 24,688 41.1
Foreign exchange gain (loss) 1,072 1.5 (29) (0.0)
---------- ----- ---------- -----
Income before provision for income taxes 21,155 29.6 24,659 41.1
Provision for income taxes 7,711 10.8 8,476 14.1
---------- ----- ---------- -----
Net income $ 13,444 18.8% $ 16,183 27.0%
========== ===== ========== =====
Finance Charges. Finance charges increased to $32.4 million and $58.0
million for the three and six months ended June 30, 2004 from $23.2 million and
$44.0 million for the same periods in 2003 primarily due to increases in: (i)
the average size of the Loan portfolio resulting from an increase in Loan
originations in 2003 and 2004 and (ii) the average annualized yield on the
Company's Loan portfolio to 14.7% and 13.6% for the three and six months ended
June 30, 2004 from 13.2% and 13.0% for the same periods in 2003. The increase in
Loan originations in the United States in 2004 was due to an increase in the
number of active dealer-partners due to an increase in dealer-partner
enrollments, partially offset by a decrease in the number of Loans originated
per active dealer-partner. The increase in the average yield was primarily due
to: (i) a decrease in the percentage of
15
non-accrual Loans to 15.8% at June 30, 2004 from 18.4% at June 30, 2003
resulting primarily from the increase in Loan originations and, to a lesser
extent, improvements in credit quality, (ii) the Company's new policy,
implemented prospectively in the first quarter of 2004, for recognizing income
on third-party vehicle service contracts sold that resulted in the recognition
of a portion of vehicle service contract income as finance charges, defined as
the "financing premium," as discussed in Note 2 to the consolidated financial
statements, and (iii) the Company's revised methodology for calculating finance
charge income, as discussed in Note 2 to the consolidated financial statements.
The increases in finance charge income resulting from the Company's revised
methodology for calculating finance charge income and the Company's new policy
for recognizing income on third-party vehicle service contracts sold had no
impact on net income as these increases were offset by approximately equal
changes in the provision for credit losses and ancillary product income.
Selected Loan origination data follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- ----------------------
(dollars in thousands) 2004 2003 2004 2003
---------- ----------- --------- -----------
Loan originations $ 215,103 $ 184,079 $ 514,399 $ 398,359
Number of Loans originated 17,268 14,736 41,109 32,942
Number of active dealer-partners (1) 899 677 958 721
Loans per active dealer-partner 19.2 21.8 42.9 45.7
Average Loan size $ 12.5 $ 12.5 $ 12.5 $ 12.1
(1) Active dealer-partners are dealer-partners who submitted at least one
Loan during the period.
Ancillary Product Income. Ancillary product income decreased to $2.5
million and $5.3 million for the three and six months ended June 30, 2004 from
$4.2 million and $9.0 million for the same period in 2003 primarily due to the
Company's new policy implemented prospectively in the first quarter of 2004 for
recognizing income on third-party vehicle service contracts sold, as discussed
in Note 2 to the consolidated financial statements, that resulted in: (i) the
deferral of approximately $4.0 million and $9.0 million in financing premiums
for the three and six months ended June 30, 2004 and (ii) the amortization of
$1.2 million and $1.7 million of deferred financing premiums as finance charges
for the three and six months ended June 30, 2004. These decreases were
partially offset by an increase in revenue per vehicle service contract and an
increase in the number of third party vehicle service contract products sold
resulting from an increase in Loan originations during 2004 compared to 2003.
The decrease in ancillary product income resulting from the amortization of
deferred financing premiums had no impact on net income as this decrease was
offset by an approximately equal increase in finance charge income.
Salaries and Wages. Salaries and wages, as a percentage of revenue,
decreased to 21.0% and 22.6% for the three and six months ended June 30, 2004
from 23.5% and 24.1% for the same periods in 2003 primarily due to: (i) a
decrease in corporate support salaries, as a percentage of revenue, of 1.6% and
0.9% for the three and six months ended June 30, 2004 compared to the same
periods in 2003, which is consistent with the Company's business plan of growing
corporate infrastructure at a rate slower than the growth rate of the Loan
portfolio and (ii) a decrease in servicing salaries, as a percentage of revenue,
of 1.3% and 0.7% for the three and six months ended June 30, 2004 compared to
the same periods in 2003 as growth in servicing personnel tends to lag behind
periods of significant growth in the Loan portfolio such as that experienced
during the first quarter of 2004. Over the long term, the Company expects that
servicing salaries will grow at a rate commensurate with the growth in the
number of Loans serviced.
General and Administrative. General and administrative expenses, as a
percentage of revenue, decreased to 11.9% and 13.7% for the three and six months
ended June 30, 2004 from 14.5% and 15.0% for the same periods in 2003 primarily
due to: (i) a decrease in legal expenses, as a percentage of revenue, of 1.0%
and 0.9% for the three and six months ended June 30, 2004 compared to the same
periods in 2003 due to a reduction in litigation during 2004 and (ii) a decrease
in occupancy and equipment expenses, as a percentage of revenue, of 0.8% and
0.5% for the three and six months ended June 30, 2004 compared to the same
periods in 2003 due to a reduction in depreciation expense, as a percentage of
revenue, during 2004.
Provision for Credit Losses. The provision for credit losses increased to
$2.0 million and $14.3 million for the three and six months ended June 30, 2004
from $1.5 million and $4.3 million for the same periods in 2003. 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 three months ended June 30, 2004
compared to same period in 2003 was primarily due to the $1.9 million increase
in the provision for earned but unpaid revenue on Loans primarily due to the
Company's change in estimate for calculating finance charge income and the
related provision for earned but unpaid servicing fees, as discussed in Note 2
to the consolidated financial statements, partially offset by a $1.3 million
decrease in the provision for losses inherent in the Loan portfolio due to a
favorable trend in loss estimates during 2004. The increase in the provision for
credit losses resulting from the Company's revised methodology for calculating
the provision for earned but unpaid
16
servicing fees had no impact on net income as this increase was offset by an
approximately equal increase in finance charges resulting from the Company's
revised methodology for calculating finance charge income.
The increase in the provision for credit losses for the six months ended
June 30, 2004 compared to the same period in 2003 was primarily due to: (i) a
$3.5 million increase in the provision for earned but unpaid revenue on Loans
primarily due to the Company's change in estimate for calculating finance charge
income and the related provision for earned but unpaid servicing fees, as
discussed in Note 2 to the consolidated financial statements and (ii) a $6.7
million increase in the provision for losses inherent in the Loan portfolio. The
increase in the provision for losses inherent in the Loan portfolio was the
result of a $9.4 million increase in the provision during the first quarter of
2004 resulting from the Company's revised methodology for recording losses on
its Loan portfolio which now considers estimated future dealer holdback payments
in its analysis of Loan impairment, as discussed in Note 2 to the consolidated
financial statements, partially offset by a decrease in the provision during the
second quarter of 2004 due to a favorable trend in loss estimates during 2004.
Stock-based Compensation Expense. Stock-based compensation expense
decreased to $800,000 and $1.3 million for the three and six months ended June
30, 2004 from $1.4 million and $1.6 million for the same periods in 2003. The
decrease in expense was primarily the result of: (i) additional expense
recognized during the second quarter of 2003 as a result of a reduction in the
period over which certain performance-based stock options were expected to vest
and (ii) a decline in the number of stock options outstanding from the prior
year periods.
Foreign Exchange Gain (Loss). The foreign exchange gain increased to
$900,000 and $1.1 million for the three and six months ended June 30, 2004 from
negligible losses for the same periods in 2003. The foreign exchange gain for
the three and six months ended June 30, 2004 was primarily the result of an
increase in the fair value of forward contracts entered into during the third
quarter of 2003, as discussed in Note 7 to the consolidated financial
statements.
Provision for Income Taxes. The effective tax rate increased to 36.4% and
36.5% for the three and six months ended June 30, 2004 from 33.8% and 34.4% for
the same periods in 2003. The increase in the effective tax rate for the three
and six months ended June 30, 2004 was primarily due to the effects of foreign
exchange rates on the taxes associated with the repatriation of foreign
earnings.
United Kingdom
(Dollars in thousands) THREE MONTHS THREE MONTHS
ENDED ENDED
JUNE 30, % OF JUNE 30, % OF
2004 REVENUE 2003 REVENUE
---- ------- ---- -------
REVENUE:
Finance charges $ 1,141 100.0% $ 2,812 98.3%
Ancillary product income - - 44 1.5
Other income - - 6 0.2
------- ----- ------- ----
Total revenue 1,141 100.0 2,862 100.0
COSTS AND EXPENSES:
Salaries and wages 622 54.5 1,176 41.1
General and administrative 417 36.5 632 22.1
Provision for credit losses (202) (17.7) 811 28.3
Sales and marketing - - 638 22.3
Stock-based compensation expense 42 3.7 75 2.6
United Kingdom asset impairment expense - - 10,493 366.6
------- ----- ------- -----
Total costs and expenses 879 77.0 13,825 483.0
------- ----- ------- -----
Income before provision for income taxes 262 23.0 (10,963) (383.1)
Provision for income taxes 76 6.7 (3,369) (117.7)
------- ----- ------- -----
Net income $ 186 16.3% $(7,594) (265.3)%
======= ===== ======= =====
17
(Dollars in thousands) SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, % OF JUNE 30, % OF
2004 REVENUE 2003 REVENUE
---- ------- ---- -------
REVENUE:
Finance charges $ 2,589 100.0% $ 5,914 86.2%
Ancillary product income - - 929 1.8
Other income - - 20 12.1
---------- ----- ---------- -----
Total revenue 2,589 100.0 6,863 100.0
COSTS AND EXPENSES:
Salaries and wages 1,233 47.6 2,047 29.8
General and administrative 937 36.2 1,192 17.4
Provision for credit losses (252) (9.7) 1,245 18.1
Sales and marketing - - 944 13.8
Stock-based compensation expense 87 3.4 154 2.2
United Kingdom asset impairment expense - - 10,493 152.9
---------- ----- ---------- -----
Total costs and expenses 2,005 77.4 16,075 234.2
---------- ----- ---------- -----
Income before provision for income taxes 584 22.6 (9,212) (134.2)
Provision for income taxes 172 6.6 (2,924) (42.6)
---------- ----- ---------- -----
Net income $ 412 15.9% $ (6,288) (91.6)%
========== ===== ========== =====
Effective June 30, 2003, the Company decided to stop originating Loans in
the United Kingdom. As a result, the average size of the Loan portfolio in the
United Kingdom has declined significantly. The decline in the revenues and
expenses were primarily a result of this decision, except as discussed below.
United Kingdom Asset Impairment Expense. As a result of the decision to
stop originating Loans in the United Kingdom, 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 that would 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 decrease in the present
value of forecasted cash flows relative to the United Kingdom's net asset value.
18
Automobile Leasing
(Dollars in thousands) THREE MONTHS THREE MONTHS
ENDED ENDED
JUNE 30, % OF JUNE 30, % OF
2004 REVENUE 2003 REVENUE
---- ------- ---- -------
REVENUE:
Lease revenue $ 405 43.6% $ 1,784 85.9%
Other income 524 56.4 293 14.1
------ ----- ---------- -----
Total revenue 929 100.0 2,077 100.0
COSTS AND EXPENSES:
Salaries and wages 146 15.7 247 11.9
General and administrative 75 8.1 139 6.7
Provision for credit losses - - 555 26.7
Interest 110 11.8 253 12.2
Other expense 253 27.2 1,167 56.2
------ ----- ---------- -----
Total costs and expenses 584 62.9 2,361 113.7
------ ----- ---------- -----
Operating gain (loss) 345 37.1 (284) (13.7)
Foreign exchange gain (loss) - - 32 1.5
------ ----- ---------- -----
Income (loss) before provision (credit) for income taxes 345 37.1 (252) (12.2)
Provision (credit) for income taxes 112 12.1 (99) (4.8)
------ ----- ---------- -----
Net income (loss) $ 233 25.1% $ (153) (7.4)%
====== ===== ========== =====
(Dollars in thousands) SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, % OF JUNE 30, % OF
2004 REVENUE 2003 REVENUE
---------- ------ -------- ---------
REVENUE:
Lease revenue $ 1,052 45.5% $ 4,120 87.5%
Other income 1,259 54.5 586 12.5
---------- ------ -------- ---------
Total revenue 2,311 100.0 4,706 100.0
COSTS AND EXPENSES:
Salaries and wages 332 14.4 520 11.0
General and administrative 137 5.9 437 9.3
Provision for credit losses - - 1,193 25.4
Interest 305 13.2 665 14.1
Other expense 691 29.9 2,715 57.7
---------- ------ ------- ---------
Total costs and expenses 1,465 63.4 5,530 117.5
---------- ------ ------- ---------
Operating gain (loss) 846 36.6 (824) (17.5)
Foreign exchange gain (loss) (15) (0.6) 58 1.2
---------- ------ ------- ---------
Income (loss) before provision (credit) for income taxes 831 36.0 (766) (16.3)
Provision (credit) for income taxes 294 12.7 (296) (6.3)
---------- ------ ------- ---------
Net income (loss) $ 537 23.2% $ (470) (10.0)%
========== ====== ======= =========
In January 2002, the Company decided to stop originating automobile
leases. As a result, the average size of the lease portfolio has declined
significantly. The decline in the revenues and expenses were primarily a result
of this decision, except as discussed below.
Other Income. Other income, as a percentage of revenue, increased to 56.4%
and 54.5% for the three and six months ended June 30, 2004 from 14.1% and 12.5%
for the same periods in 2003 primarily due to an increase in gains on lease
terminations, as a percentage of revenue, during 2004 resulting from an increase
in the proportion of lease terminations to total leases outstanding during 2004.
19
Other
(Dollars in thousands) THREE MONTHS THREE MONTHS
ENDED ENDED
JUNE 30, % OF JUNE 30, % OF
2004 REVENUE 2003 REVENUE
---- ------- ---- -------
REVENUE:
Finance charges $ 194 74.0% $ 424 86.7%
Other income 68 26.0 65 13.3
------- ----- -------- -----
Total revenue 262 100.0 489 100.0
COSTS AND EXPENSES:
Salaries and wages 26 9.9 65 13.3
General and administrative 73 27.9 75 15.3
Provision for credit losses 359 137.0 7 1.4
Sales an d marketing - - 27 5.5
Interest 32 12.2 190 38.9
------- ----- -------- -----
Total cost s and expenses 490 187.0 364 74.4
------- ----- -------- -----
Income (loss) before provision (credit) for income tax (228) (87.0) 125 25.6
Provision (credit) for income taxes (74) (28.2) 73 14.9
------- ----- -------- -----
Net income (loss) $ (154) (58.8)% $ 52 10.7%
======= ===== ======== =====
(Dollars in thousands) SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, % OF JUNE 30, % OF
2004 REVENUE 2003 REVENUE
---- ------- ---- -------
REVENUE:
Finance charges $ 390 68.3% $ 819 56.9%
Other income 181 31.7 620 43.1
--------- ----- ----- -----
Total revenue 571 100.0 1,439 100.0
COSTS AND EXPENSES:
Salaries and wages 73 12.8 148 10.3
General and administrative 143 25.0 184 12.8
Provision for credit losses 644 112.8 283 19.7
Sales and marketing - - 60 4.2
Interest 77 13.5 428 29.7
--------- ----- ----- -----
Total costs and expenses 937 164.1 1,103 76.7
--------- ----- ----- -----
Income (loss) before provision (credit) for income taxes (366) (64.1) 336 23.3
Provision (credit) for income taxes (109) (19.1) 160 11.1
--------- ----- ----- -----
Net income (loss) $ (257) (45.0)% $ 176 12.2%
========= ===== ===== =====
The Other segment consists of the Company's Canadian automobile Loan
business, floorplan, and secured line of credit financing businesses. Effective
June 30, 2003, the Company decided to stop originating Loans in Canada. As a
result, the average size of the Loan portfolio in Canada has declined
significantly. The Company has also decided to significantly reduce its
floorplan and secured line of credit portfolios since 2001. The decline in the
revenues and expenses were primarily a result of these decisions, except as
discussed below.
Provision for Credit Losses. The provision for credit losses increased to
$400,000 and $600,000 for the three and six months ended June 30, 2004 from a
negligible amount and $300,000 for the same periods in 2003. 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 lines of credit, and (iv) a provision
for losses on floorplan receivables. The increase in the provision for credit
losses for the three and six months ended June 30, 2004 compared to the same
periods in 2003 is primarily the result of increases of $300,000 in provisions
for losses on the secured lines of credit and floorplan receivables portfolios
during each period of 2004.
20
AVERAGE CAPITAL ANALYSIS
The following presentation of financial results and subsequent analysis is
based on analyzing the consolidated 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 on
a consolidated basis.
(Dollars in thousands) THREE MONTHS THREE MONTHS
ENDED ENDED
JUNE 30, % OF AVERAGE JUNE 30, % OF AVERAGE
2004 CAPITAL (1) 2003 CAPITAL (1)
---- ----------- ---- -----------
REVENUE:
Finance charges $ 33,731 28.2% $ 26,431 24.1%
Ancillary product income 2,459 2.1 4,233 3.9
Lease revenue 405 0.3 1,784 1.6
Other income 4,694 3.9 3,598 3.3
---------- ---- ---------- ----
Total revenue 41,289 34.5 36,046 32.9
COSTS AND EXPENSES:
Salaries and wages 8,963 7.5 8,687 7.9
General and administrative 5,214 4.4 5,272 4.8
Provision for credit losses 2,187 1.8 2,863 2.6
Sales and marketing 2,474 2.1 2,483 2.3
United Kingdom asset impairment expense - - 10,493 9.6
Interest 2,373 2.0 1,401 1.3
Stock-based compensation expense 864 0.7 1,428 1.3
Other expense 324 0.3 1,376 1.3
---------- ---- ---------- ----
Total costs and expenses 22,399 18.7 34,003 31.0
---------- ---- ---------- ----
Operating income 18,890 15.8 2,043 1.9
Foreign exchange gain 906 0.8 14 -
---------- ---- ---------- ----
Income before provision for income taxes 19,796 16.5 2,057 1.9
Provision for income taxes 7,190 6.0 1,049 1.0
---------- ---- ---------- ----
Net income $ 12,606 10.5% $ 1,008 0.9%
========== ==== ========== ====
Average capital (1) $ 478,593 $ 438,561
21
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, % OF AVERAGE JUNE 30, % OF AVERAGE
(Dollars in thousands) 2004 CAPITAL (1) 2003 CAPITAL (1)
------------ ------------ ------------ ------------
REVENUE:
Finance charges $ 60,964 26.1% $ 50,687 23.4%
Ancillary product income 5,325 2.3 9,966 4.6
Lease revenue 1,051 0.5 4,120 1.9
Other income 9,470 4.1 8,258 3.8
------------ ------------ ------------ ------------
Total revenue 76,810 32.9 73,031 33.7
COSTS AND EXPENSES:
Salaries and wages 17,759 7.6 17,204 7.9
General and administrative 10,969 4.7 10,812 5.0
Provision for credit losses 14,734 6.3 7,051 3.2
Sales and marketing 5,017 2.1 4,660 2.1
United Kingdom asset impairment expense - - 10,493 4.8
Interest 4,973 2.1 2,997 1.4
Stock-based compensation expense 1,430 0.6 1,803 0.8
Other expense 781 0.3 3,023 1.4
------------ ------------ ------------ ------------
Total costs and expenses 55,663 23.8 58,043 26.8
------------ ------------ ------------ ------------
Operating income 21,147 9.1 14,988 6.9
Foreign exchange gain 1,057 0.5 29 -
------------ ------------ ------------ ------------
Income before provision for income taxes 22,204 9.5 15,017 6.9
Provision for income taxes 8,068 3.5 5,416 2.5
------------ ------------ ------------ ------------
Net income $ 14,136 6.1% $ 9,601 4.4%
============ ============ ============ ============
Average capital (1) $ 467,005 $ 433,945
(1) Average capital is equal to the average amount of debt and equity
during the period, each calculated in accordance with generally
accepted accounting principles. The calculation of average capital
follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------- ----------------------------
(Dollars in thousands) 2004 2003 2004 2003
------------ ------------ ------------ ------------
Average debt $ 164,338 $ 101,821 $ 145,580 $ 101,147
Average shareholders' equity 314,255 336,740 321,425 332,798
------------ ------------ ------------ ------------
Average capital $ 478,593 $ 438,561 $ 467,005 $ 433,945
============ ============ ============ ============
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:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------------- -----------------------------
(Dollars in thousands) 2004 2003 2004 2003
------------ ------------ ------------ ------------
Net income $ 12,606 $ 1,008 $ 14,136 $ 9,601
Interest expense after-tax 1,542 911 3,232 1,948
------------ ------------ ------------ ------------
Net operating profit after-tax 14,148 1,919 17,368 11,549
============ ============ ============ ============
Average capital $ 478,593 $ 438,561 $ 467,005 $ 433,945
============ ============ ============ ============
Return on capital 11.8% 1.7% 7.4% 5.3%
22
The increase in the Company's return on capital for the three months ended
June 30, 2004 compared to the same period in 2003 was primarily the result of:
(i) an increase in the return on capital in the United Kingdom to 4.1% in 2004
from (55.3%) in 2003 primarily due to the asset impairment expense recognized
during 2003, as discussed further in connection with the United Kingdom results
of operations, (ii) an increase in the return on capital in the United States to
12.2% in 2004 from 10.3% in 2003 primarily due to an increase in the average
annualized yield on the Loan portfolio and a decrease in operating expenses as a
percentage of capital, partially offset by a decrease in ancillary product
income as a percentage of capital, as discussed further in connection with the
United States results of operations, and (iii) an increase in the percentage of
average total capital invested in the United States to 94.7% in 2004 from 82.5%
in 2003.
The increase in the Company's return on capital for the six months ended
June 30, 2004 compared to the same period in 2003 was primarily the result of:
(i) an increase in the return on capital in the United Kingdom to 3.8% in 2004
from (21.3%) in 2003 primarily due to the asset impairment expense recognized
during 2003, as discussed further in connection with the United Kingdom results
of operations and (ii) an increase in the percentage of average total capital
invested in the United States, the Company's business segment with the highest
return on capital, to 93.5% in 2004 from 80.8% in 2003. Partially offsetting
these items that positively impacted the Company's 2004 return on capital was a
decrease in the return on capital in the United States to 7.5% in 2004 from 9.9%
in 2003 primarily due to an increase in the provision for credit losses as a
percentage of average capital and a decrease in ancillary product income as a
percentage of average capital, partially offset by a decrease in operating
expenses as a percentage of capital, as discussed in connection with the United
States results of operations.
ECONOMIC PROFIT
The Company defines economic profit as 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 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 (loss) of $4,750,000, or
$0.11 per diluted share, and ($1,935,000), or ($0.05) per diluted share, for the
three and six months ended June 30, 2004, respectively, compared to
($7,411,000), or ($0.17) per diluted share, and ($7,039,000), or ($0.17) per
diluted share, for the same periods in 2003, respectively.
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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
ECONOMIC PROFIT
Net income (1) $ 12,606 $ 1,008 $ 14,136 $ 9,601
Imputed cost of equity at 10% (2) (7,856) (8,419) (16,071) (16,640)
------------ ------------ ------------ ------------
Total economic profit (loss) $ 4,750 $ (7,411) $ (1,935) $ (7,039)
============ ============ ============ ============
Diluted weighted average shares outstanding 41,413,308 42,868,265 41,790,255 42,629,844
Economic profit (loss) per share (3) $ 0.11 $ (0.17) (0.05) (0.17)
(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 average
shareholders' equity, which was $314,255,000 and $321,425,000 for
the three months and six months ended June 30, 2004, respectively,
and $336,740,000 and $332,798,000 for the same periods in 2003.
(3) Economic profit (loss) per share equals the economic profit (loss)
divided by the diluted weighted average number of shares
outstanding.
23
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 recognition of finance charge revenue
and the allowance for credit losses. 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. See Note 2 to the
consolidated financial statements included in this Quarterly Report on Form
10-Q, which is incorporated herein by reference, for material changes to the
estimates and judgments associated with the finance charge revenue, allowance
for credit losses, and ancillary product income accounting policies during the
three months ended March 31, 2004. There were no material changes to the
estimates and assumptions associated with these accounting policies during the
three months ended June 30, 2004.
LOSS EXPERIENCE
The following sets forth the components of the provision for credit
losses, charge-offs related to the Company's Loan portfolio, and the allowance
for credit losses as a percentage of gross Loans receivable:
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------- ----------------------------
(Dollars in thousands) 2004 2003 2004 2003
------------ ------------ ------------ ------------
Provision for credit losses:
Loans receivable (1) $ 1,894 $ 2,292 $ 14,106 $ 5,302
Leased vehicles - 555 - 1,193
Other 293 16 628 556
------------ ------------ ------------ ------------
Total provision for credit losses $ 2,187 $ 2,863 $ 14,734 $ 7,051
============ ============ ============ ============
Net charge-offs related to the Company's
Loan portfolio absorbed through:
Dealer holdbacks $ 51,440 $ 43,682 $ 107,185 $ 94,588
Unearned finance charges 12,860 10,920 26,796 23,647
Allowance for credit losses (2) (219) 966 (4,807) 1,987
------------ ------------ ------------ ------------
Total net charge-offs $ 64,081 $ 55,568 $ 129,174 $ 120,222
============ ============ ============ ============
(1) The increase in provision for credit losses for the six months ended
June 30, 2004 was primarily due to: (i) the Company's change in
estimate for recording losses on its Loan portfolio which now
considers estimated future dealer holdback payments in its analysis
of Loan impairment, and (ii) credit losses associated with the
Company's revised methodology for calculating finance charge income
and the related provision for earned but unpaid servicing fees, both
as discussed in Note 2 to the consolidated financial statements.
(2) The net recoveries for the three and six months ended June 30, 2004
are primarily the result of changes to the Company's write-off
policy, which were implemented in the third quarter of 2003.
The allowance for credit losses as a percentage of gross Loans receivable
was 3.1% and 1.7% at June 30, 2004 and December 31, 2003, respectively.
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
line of credit and secured financings. The Company's principal need for capital
is 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.
The Company's cash and cash equivalents decreased to $28.4 million as of
June 30, 2004 from $36.0 million at December 31, 2003 and the Company's total
balance sheet indebtedness increased to $171.3 million at June 30, 2004 from
$106.5 million at December 31, 2003. These changes are primarily a result of
$50.7 million in stock repurchases during the first quarter of 2004 and an
increase in advances to dealers resulting from an increase in Loan originations
during the period. In the fourth quarter of 2003, the Board of Directors
authorized the repurchase of 2.6 million common shares through a modified Dutch
tender offer. Upon expiration of the tender offer in January 2004, the Company
repurchased 2.2 million shares at a cost of $37.4 million.
24
The following table summarizes the Company's stock repurchases for the three
months ended June 30, 2004:
TOTAL NUMBER OF MAXIMUM NUMBER
SHARES PURCHASED AS OF SHARES THAT MAY
TOTAL NUMBER PART OF PUBLICLY YET BE PURCHASED
OF SHARES AVERAGE PRICE ANNOUNCED PLANS UNDER THE PLANS
PERIOD PURCHASED PAID PER SHARE OR PROGRAMS OR PROGRAMS (A)
- ---------- ------------ -------------- ------------------- ------------------
April 2004 - $ - - 756,231
May 2004 - - - 756,231
June 2004 - - - 756,231
------------ -------------- -------------------
- $ - -
============ ============== ===================
(a) On August 5, 1999 the Company announced a stock repurchase program
of up to 1,000,000 shares of the Company's common stock. The program
authorized the Company to purchase common shares in the open market
or in privately negotiated transactions at price levels the Company
deems attractive. Since August 1999, the board of directors has
authorized several increases to the stock repurchase program, the
most recent occurring on March 10, 2004, which increased the total
number of shares authorized to be repurchased to 7,000,000 shares.
Line of Credit Facility. At June 30, 2004, the Company had a $135.0
million credit agreement with a commercial bank syndicate. The facility has a
commitment period through June 9, 2006. The agreement provides that, at the
Company's discretion, interest is payable at either the eurodollar rate plus 130
basis points (2.40% at June 30, 2004), or at the prime rate (4.0% at June 30,
2004). 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 (as reflected in the consolidated
financial statements and related notes) plus 65% of Loans purchased by the
Company (not to exceed $13.0 million), 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 June 30, 2004, there was $30.6 million
outstanding under this facility. There were no amounts outstanding under this
facility as of December 31, 2003. The weighted average interest rate on line of
credit borrowings outstanding as of June 30, 2004 was 2.9%.
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 $100.0 million in notes to qualified institutional investors. A financial
insurance policy was issued in connection with the transaction. 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 &
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 line of
credit. Until December 15, 2003, the Company and Funding 2003-1 received
additional proceeds from the transaction by having the Company convey additional
dealer-partner advances to Funding 2003-1 that were then conveyed by Funding
2003-1 to the trust and used by the trust as collateral to support additional
borrowings. Additional dealer-partner advances having a carrying amount of
approximately $35.0 million were conveyed by the Company after the completion of
the initial funding. After December 15, 2003, the debt outstanding under the
facility began 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 all the 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. All the assets of Funding 2003-1 have been
encumbered to secure Funding 2003-1'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 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
25
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. As of June 30, 2004 and December 31, 2003, there was
$30.4 million and $100.0 million, respectively, outstanding under this facility.
In the third quarter of 2003, the Company's wholly-owned subsidiary, CAC
Warehouse Funding Corp. II ("Warehouse Funding" or "2003-2"), 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. During the second
quarter of 2004, $111.7 million in dealer-partner advances were contributed,
resulting in $80 million in additional financing proceeds. 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, 2004. If this does not occur, the
transaction will cease to revolve, will amortize as collections are received
and, at the option of the institutional investor, may be subject to 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, which has been limited to a maximum rate of 6.25% through an interest
rate cap agreement executed in the fourth quarter of 2003. 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 will receive 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 will 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. There were no amounts outstanding under this
facility as of December 31, 2003. As of June 30, 2004, there was $100.0 million
outstanding under this facility.
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 June 30, 2004 June 30, 2004 Balance
- ------ -------------- -------- ----------------- ------------------ ----------
2003-1 June 2003 $100,000 $ 30,428* $ 82,777 30%
2003-2 September 2003 $100,000 100,000 145,645 n/a
* Anticipated to fully amortize by October 31, 2004.
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. There was $8.6 million and $5.4 million
outstanding on this loan as of June 30, 2004 and December 31, 2003,
respectively. During the quarter, the loan, which matures on June 9, 2009, was
refinanced and increased by $3.5 million under similar terms and conditions. The
loan bears interest at a fixed rate of 5.35%, and requires monthly payments of
$92,156 and a balloon payment at maturity for the balance of the loan.
Capital Lease Obligations. As of June 30, 2004, the Company has various
capital lease obligations outstanding for computer equipment, with monthly
payments totaling $59,000. These capital lease obligations bear interest at
rates ranging from 4.45% to 9.31% and have maturity dates between October 2004
and March 2008.
26
In addition to the balance sheet indebtedness as of June 30, 2004, 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 < 1 YEAR 1-3 YEARS 3-5 YEARS > 5 YEARS TOTAL
---------- ---------- ---------- ---------- ----------
Long-term debt obligations $ 131,086 $ 32,803 $ 5,689 $ - $ 169,578
Capital lease obligations 203 1,403 98 - 1,704
Operating lease obligations 510 1,459 348 - 2,317
Purchase obligations (1) 73 146 - - 219
Other long-term obligations (2) (3) - - - - -
---------- ---------- ---------- ---------- ----------
Total contractual obligations $ 131,872 $ 35,811 $ 6,135 $ - $ 173,818
========== ========== ========== ========== ==========
(1) Purchase obligations consist of commitments that the Company entered
into in June 2004 for two 36 month capital lease obligations for
computer equipment commencing in July 2004.
(2) The Company has dealer holdback liabilities on its balance sheet;
however, as payments of dealer holdbacks are contingent upon the
receipt of customer payments on Loans receivable and the repayment
of dealer advances, these obligations are excluded from the above
table.
(3) The Company has entered into a series of forward contracts to
deliver British pound sterling in exchange for United States
dollars. As the forward contracts are derivatives that are recorded
on the balance sheet at their fair value and as this fair value does
not represent the amounts that will ultimately be received or paid
under these contracts, these obligations are excluded from the above
table.
Liquidation of Non-Core Businesses. As of June 30, 2004, the Company
expects to receive approximately $19.0 million from the liquidation of its
United Kingdom, Canadian, and Automobile Leasing businesses. The expected
liquidation proceeds have been determined based on the Company's forecast of
cash inflows and outflows during the estimated remaining years of operation for
each business. Detail of expected future net liquidation proceeds follows:
AS OF
(Dollars in thousands) JUNE 30, 2004
-------------
United Kingdom $ 15,900
Canada 2,200
Automobile Leasing 900
-------------
$ 19,000
=============
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 second quarter of 2004, the Company
received $7.6 million in liquidation proceeds.
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.
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,"
"assumptions," "forecasts," "estimates" or similar expressions, it is making
forward-looking statements.
27
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 include, but are not limited to, the following:
- the Company's potential inability to accurately forecast and
estimate the amount and timing of future collections,
- 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,
- 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
statements whether as a result of new information, future events or otherwise,
except as required by applicable law.
28
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, 2003 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 2003 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 Accounting
Officer (acting as its principal 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 Accounting Officer
(acting as its principal 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 June 30, 2004 that have materially
affected, or are reasonably likely to materially affect, the Company's internal
controls over financial reporting.
29
PART II. - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
The information required in Part II, Item 2 is incorporated by reference
from the information in Part I, Item 2 under the caption "Liquidity and Capital
Resources" in this Form 10-Q.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its Annual Meeting of Shareholders on May 13, 2004 at
which the shareholders considered: (i) the election of six directors, and (ii)
the adoption of the Credit Acceptance Corporation Incentive Compensation Plan
and the approval of the performance goals thereunder. The following table
summarizes the votes for the election and proposal:
Nominee Votes For Votes Withheld
- ------- --------- --------------
Donald A. Foss 38,782,908 3,505
Harry E. Craig 38,739,775 46,638
Glenda Flanagan 38,764,008 22,405
Daniel P. Leff 38,735,178 51,235
Brett A. Roberts 38,782,608 3,805
Thomas N. Tryforos 38,739,675 46,738
Proposal Votes For Votes Against Votes Withheld
- -------- --------- ------------- --------------
Incentive Compensation Plan 35,311,746 102,530 11,344
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 5,
7 and 12, dated May 10, 2004, reporting that the Company issued a
press release announcing that it was filing a Form 12b-25 with the
Securities and Exchange Commission to extend the filing date of its
quarterly report on Form 10-Q for the period ended March 31, 2004, a
copy of which was filed as Exhibit 99.1.
The Company filed a current report on Form 8-K pursuant to Items 7
and 12, dated May 14, 2004, reporting that the Company issued a
press release announcing its financial results for the three months
ended March 31, 2004, a copy of which was filed as Exhibit 99.1.
The Company filed a current report on Form 8-K pursuant to Items 5
and 7, dated May 19, 2004, reporting that the Company issued a press
release announcing the appointments of Chief Accounting Officer and
Treasurer, 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 May 25, 2004, furnishing materials which were prepared
for inclusion on its investor relations website, a copy of which was
filed as Exhibit 99.1
The Company filed a current report on Form 8-K pursuant to Items 5
and 7, dated June 9, 2004, reporting that the Company issued a press
release announcing that it has extended the maturity of its $135
million credit agreement, a copy of which was filed as Exhibit 99.1.
No financial statements were filed with the Forms 8-K.
30
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/ Kenneth S. Booth
----------------------------------------
Kenneth S. Booth
Chief Accounting Officer
August 4, 2004
(acting as Principal Financial Officer,
Principal Accounting Officer and Duly
Authorized Officer)
31
INDEX OF EXHIBITS
EXHIBIT
NO. DESCRIPTION
- ------- -----------
4 (c)(13) Third Amended and Restated Credit Agreement, dated as of June 9,
2004, among the Company, certain of the Company's subsidiaries,
Comerica Bank, as Administrative Agent and Collateral Agent, and the
banks signatory thereto.
4 (g)(7) Release and Fourth Amendment To Second Amended and Restated Security
Agreement, dated June 9, 2004 between Comerica Bank, as Collateral
Agent and the Company.
4 (g)(8) Fifth Amendment To Second Amended and Restated Security Agreement,
dated June 30, 2004 between Comerica Bank, as Collateral Agent and
the Company.
10(q) Credit Acceptance Corporation Incentive Compensation Plan, effective
April 1, 2004
31(a) Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
of the Securities Exchange Act.
31(b) Certification of Chief Accounting Officer (acting as principal
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 Accounting Officer (acting as principal
financial officer), pursuant to 18 U.S.C. Section 1350 and Rule
13a-14(b) of the Securities Exchange Act.