UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549-1004
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended December 31, 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 0-13084
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WARRANTECH CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 13-3178732
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2200 Highway 121, Suite 100, Bedford, Texas 76021
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (800) 544-9510
---------------------
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last year)
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 [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at February 1, 2005
- --------------------------------------- -------------------------------
Common stock, par value $.007 per share 15,398,674 shares
WARRANTECH CORPORATION AND SUBSIDIARIES
I N D E X
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Page No.
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PART I - Financial Information
Item 1: Financial Statements
Condensed Consolidated Statements of Operations -
For the Three and Nine Months Ended
December 31, 2004 and 2003 (Unaudited) ................. 2
Condensed Consolidated Balance Sheets at
December 31, 2004 (Unaudited) and March 31, 2004........ 3
Condensed Consolidated Statements of Cash Flows
For the Nine Months Ended
December 31, 2004 and 2003 (Unaudited).................. 4
Notes to Condensed Consolidated Financial Statements...... 6
Item 2: Management's Discussion and Analysis of
Financial Condition and Results of Operations........... 12
Item 3: Quantitative and Qualitative Disclosures About Market Risk.. 19
Item 4: Controls and Procedures..................................... 20
PART II - Other Information
Item 1: Legal Proceedings........................................... 21
Item 2: Changes in Securities and Use of Proceeds and Issuer
Purchases of Equity Securities.......................... 21
Item 3: Defaults Upon Senior Securities............................. 22
Item 4: Submission of Matters to a Vote of Security Holders......... 22
Item 5: Other Information *......................................... 22
Item 6: Exhibits.................................................... 22
Signature ........................................................... 23
* No information provided due to inapplicability of item.
1
PART I - Financial Information
Item 1: Financial Statements
--------------------
WARRANTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
For the Three Months Ended For the Nine Months Ended
December 31, December 31,
------------------------------ ------------------------------
2004 2003 * 2004 2003 *
------------- ------------- ------------- -------------
Gross revenues $ 33,276,929 $ 35,373,143 $ 89,839,132 $ 115,960,128
------------- ------------- ------------- -------------
Net (increase) decrease in deferred revenues (4,350,970) (5,530,759) (12,234,592) (22,748,698)
------------- ------------- ------------- -------------
Net revenues 28,925,959 29,842,384 77,604,540 93,211,430
Direct costs 22,088,120 21,175,797 58,627,041 68,247,423
------------- ------------- ------------- -------------
Gross profit 6,837,839 8,666,587 18,977,499 24,964,007
Operating expenses
Service, selling, and general and administrative 6,258,560 7,334,541 19,895,086 22,437,339
Provision for bad debt expense 53,760 165,000 296,317 425,000
Depreciation and amortization 527,378 718,893 1,978,054 2,539,866
------------- ------------- ------------- -------------
Total costs and expenses 6,839,698 8,218,434 22,169,457 25,402,205
------------- ------------- ------------- -------------
Income (loss) from operations (1,859) 448,153 (3,191,958) (438,198)
Other income 274,488 331,595 781,720 1,051,580
------------- ------------- ------------- -------------
Income (loss) before provision for income taxes 272,629 779,748 (2,410,238) 613,382
Provision (benefit) for income taxes 296,733 276,699 (32,559) 57,181
------------- ------------- ------------- -------------
Net income (loss) $ (24,104) $ 503,049 $ (2,377,679) $ 556,201
============= ============= ============= =============
Earnings (loss) per share:
Basic $ (0.00) $ 0.03 $ (0.15) $ 0.04
============= ============= ============= =============
Diluted $ (0.00) $ 0.03 $ (0.15) $ 0.04
============= ============= ============= =============
Weighted average number of shares outstanding:
Basic 15,398,677 15,357,385 15,395,576 15,331,253
============= ============= ============= =============
Diluted 15,398,677 15,686,552 15,395,576 15,682,616
============= ============= ============= =============
* Reclassified for Comparability
See accompanying notes to condensed consolidated financial statements.
2
WARRANTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
December 31,
2004 March 31,
(Unaudited) 2004
------------ ------------
ASSETS
------
Current assets:
Cash and cash equivalents $ 4,708,025 $ 5,229,773
Investments in marketable securities 1,467,391 1,370,731
Accounts receivable, (net of allowances of $487,775 19,444,777 23,369,612
and $233,667, respectively)
Other receivables, net 9,436,628 7,322,289
Deferred income taxes 3,478,250 3,478,250
Employee receivables 53,196 70,908
Prepaid expenses and other current assets 716,470 728,265
------------ ------------
Total current assets 39,304,737 41,569,828
------------ ------------
Property and equipment, net 4,616,159 5,746,851
Other assets:
Excess of cost over fair value of assets acquired
(net of accumulated amortization of $5,825,405) 1,637,290 1,637,290
Deferred income taxes 19,383,350 18,879,171
Deferred direct costs 200,425,929 186,513,417
Investments in marketable securities 677,578 1,083,400
Restricted cash 800,000 825,000
Split dollar life insurance policies 900,145 900,145
Other assets 34,831 29,448
------------ ------------
Total other assets 223,859,123 209,867,871
------------ ------------
Total Assets $267,780,019 $257,184,550
============ ============
See accompanying notes to condensed consolidated financial statements.
3
WARRANTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
December 31,
2004 March 31,
(Unaudited) 2004
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)
- ---------------------------------------------------------
Current liabilities:
Current maturities of long-term debt and capital lease obligations $ 529,293 $ 664,406
Insurance premiums payable 36,925,244 31,613,047
Income taxes payable 24,250 48,099
Accounts and commissions payable 6,370,139 7,083,459
Claims liability - Reliance 3,002,600 5,608,893
Accrued expenses and other current liabilities 4,257,886 3,776,199
------------- -------------
Total current liabilities 51,109,412 48,794,103
------------- -------------
Deferred revenues 241,019,932 228,955,971
Claims liability - Reliance 2,618,190 3,882,685
Long-term debt and capital lease obligations 923,633 980,903
Deferred rent payable 437,934 369,839
------------- -------------
Total liabilities 296,109,101 282,983,501
------------- -------------
Commitments and contingencies -- --
Stockholders' equity (Capital deficiency):
Preferred stock - $.0007 par value authorized - 15,000,000
Shares issued - none at December 31, 2004 and March 31, 2004 -- --
Common stock - $.007 par value authorized - 30,000,000
Shares issued - 16,586,280 shares at
December 31, 2004 and March 31, 2004 116,106 116,106
Additional paid-in capital 23,800,228 23,800,228
Loans to directors and officers (10,961,891) (10,747,470)
Accumulated other comprehensive income, net of taxes 213,102 150,801
Retained earnings (deficit) (37,308,738) (34,931,059)
------------- -------------
(24,141,193) (21,611,394)
Treasury stock - at cost, 1,187,606 shares at
December 31, 2004 and March 31, 2004 (4,187,889) (4,187,557)
------------- -------------
Total Stockholders' Equity (Capital Deficiency) (28,329,082) (25,798,951)
------------- -------------
------------- -------------
Total Liabilities and Stockholders' Equity (Capital Deficiency) $ 267,780,019 $ 257,184,550
============= =============
See accompanying notes to condensed consolidated financial statements.
4
WARRANTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the Nine Months Ended
December 31,
----------------------------
2004 2003*
------------ ------------
Cash flows from operating activities:
Net income (loss) $ (2,377,679) $ 556,204
Total adjustments to reconcile net income to net cash
provided (used) by operating activities: 2,581,754 (1,830,662)
------------ ------------
Net cash flows used by operating activities 204,075 (1,274,461)
------------ ------------
Cash flows from investing activities:
Property and equipment purchased (463,397) (201,046)
Purchase of marketable securities (1,110,000) (920,000)
Proceeds from sales of marketable securities 1,405,000 730,000
------------ ------------
Net cash used by investing activities (168,397) (391,046)
------------ ------------
Cash flows from financing activities:
Purchase of treasury stock (23,960) --
Issuance of common stock -- 6,270
Repayments, notes and capital leases (533,466) (665,366)
------------ ------------
Net cash used by financing activities (557,426) (659,096)
------------ ------------
Net increase (decrease) in cash and cash equivalents (521,748) (2,312,005)
Cash and cash equivalents at beginning of period 5,229,773 6,422,530
------------ ------------
Cash and cash equivalents at end of period $ 4,708,025 $ 4,110,525
------------ ------------
Supplemental Cash Flow Information:
Cash payments for:
Interest $ 109,740 $ 128,521
------------ ------------
Income taxes $ 370,276 $ 148,612
------------ ------------
Non-cash investing and financing activities:
Property and equipment financed through capital leases $ 383,959 $ 487,060
Increase in loans to officers and directors $ (214,421) $ (214,422)
Issuance of treasury stock $ 23,628 $ 87,113
* Reclassified for comparability.
See accompanying notes to condensed consolidated financial statements.
5
WARRANTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004
(Unaudited)
1. THE COMPANY
-----------
General Information
Warrantech, through its wholly owned subsidiaries, designs, develops, markets
and acts as a third party administrator for programs ("Programs") for service
contracts, limited warranties and replacement plans (collectively, "Plans"). The
Company provides these services to a variety of clients in selected industries.
On a Program by Program basis, the Company contracts with highly rated
independent insurance companies or risk retention groups available to provide
coverage for the Plans to be sold or issued under the Programs. This coverage
obligates the insurer to pay the cost of repairs or replacements of the products
covered by the Plans.
Plans issued under the Company's Programs provide consumers with expanded and/or
extended product breakdown coverage for a specified period of time (and/or
mileage in the case of automobiles and recreational vehicles), similar to that
provided by manufacturers under the terms of their product warranties. Coverage
generally provides for the repair or replacement of the product, or a component
thereof, in the event of its failure. The Company's Programs provide clients
with the opportunity for increased revenue and income without incurring the
costs and responsibilities of operating their own programs.
The Plans generally have terms extending up to one hundred twenty (120) months
or, in the case of mileage based Plans, up to one hundred fifty thousand
(150,000) miles. All repairs and/or replacements required under the Plans are
performed by independent third party repair facilities or dealers. The cost of
any repair or replacement is generally paid by the insurance company or
retention group with which the Company has contracted to provide coverage for
the Plan.
Contract Obligors
Each Plan contains the name of a designated obligor that is legally responsible
for the cost of any valid claim submitted under the Plan. The Company, however,
arranges for an independent insurance company to issue a policy on behalf of the
named obligor that covers all of the obligor's liabilities under the Plan. As a
result, the insurance company is ultimately responsible for paying the cost of
any and all valid claims submitted under the Plan. In the event, however, that
the insurance company refuses or is unable to pay a covered claim, the
designated obligor will be responsible for the payment and it will have recourse
against the insurance company or its estate (in the event of an insolvency or
liquidation) to recover the payment.
Prior to April 1, 2000, one of the Company's subsidiaries or a retailer/dealer
would routinely be named the obligor under the Plans. Since April 1, 2000,
however, Butler Financial Services, LLC ("Butler"), a company unrelated to
Warrantech but included in the Company's financial results due to its close
transactional ties with the Company, has served as the obligor under all Plans
sold or issued under a Program in exchange for a fee payable by the seller or
issuer of the Plan. Furthermore, Butler had contractually assumed the
liabilities of the obligor under all pre-existing Plans in which one of the
Company's subsidiaries was named as the designated obligor. Notwithstanding the
forgoing, however, a Company subsidiary continues to act as the designated
obligor for Plans sold in the States of California and Florida due to regulatory
considerations.
Certain of the Plans under which Butler is the designated obligor were insured
by Reliance. The liquidation of Reliance has eliminated Butler's insurance
coverage under those Plans. Warrantech Automotive is the obligor, as well as the
administrator, under some of the VSC's that were insured by Reliance. As the
obligor, Warrantech Automotive is ultimately responsible for paying the valid
claims submitted under those VSC's in which Warrantech Automotive is the
designated obligor. Prior to Reliance's liquidation, Reliance paid the cost of
6
such covered claims under the insurance policies it provided. Subsequent to the
liquidation of Reliance, however, insurance coverage for Warrantech Automotive's
obligations under those VSC's was no longer available.
While the Company had provided Butler notice of termination of the Obligor
Agreement between the two Companies effective Oct 22, 2004, it subsequently
amended the termination notice and Butler remains the obligor on certain service
contracts.
Other Recent Developments
On June 30, 2004, the Company terminated its policy with Cruz del Sur, its
primary insurance carrier in Chile, effective December 31, 2004. To arrange for
continuity of coverage, the Company has been issued a policy with ING Seguros
Generales S.A., effective with contracts written January 1, 2005.
On September 1, 2004, the Company began offering one-year extended home product
warranties. Unlike the Company's other Plans, these warranties will not be
insured by a third party insurance company, but will be obligations solely of
the Company.
2. BASIS OF PRESENTATION
---------------------
The accompanying consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America ("GAAP"). These consolidated financial statements include the accounts
of Warrantech Corporation, its subsidiaries, all of which are wholly owned, and
certain transactions involving Butler due to its related interest with the
Company. All intercompany accounts and transactions have been eliminated in
consolidation. In the opinion of management, all adjustments (consisting of
normal recurring accruals) considered necessary for a fair presentation of the
financial position and operating results of the Company for the interim period
have been included. Operating results for the three and nine months ended
December 31, 2004 are not necessarily indicative of the results that may be
expected for the fiscal year ending March 31, 2005. For further information,
refer to the consolidated financial statements and footnotes thereto included in
the Company's Annual Report on Form 10-K for the year ended March 31, 2004.
3. OTHER RECEIVABLES
-----------------
The nature and amounts of Other Receivables as of December 31, 2004 and March
31, 2004 are as follows:
---------------------------
December 31, March 31,
2004 2004
------------ ------------
Other receivables, net
Due from insurance companies $ 5,329,510 $ 4,555,772
Due from dealers 477,951 464,436
Due from insurance companies - reimbursement
of legal fees 2,982,889 1,865,399
------------ ------------
Due from insurance companies/dealers 8,790,350 6,885,607
Agent advances 75,190 109,604
Other 571,088 327,078
------------ ------------
9,436,628 7,322,289
Allowance for doubtful accounts -- --
------------ ------------
Total other receivables, net $ 9,436,628 $ 7,322,289
============ ============
The following table sets forth the carrying amounts and fair values of the
Company's other receivables at December 31, 2004.
7
Expected Maturity Date
----------------------------------------------------------------------------
2005 2006 2007 2008 2009 Thereafter Total Fair Value
---- ---- ---- ---- ---- ---------- ----- ----------
Other receivables, net $9,436,628 -- -- -- -- -- $9,436,628 $9,436,628
4. COMPREHENSIVE INCOME (LOSS)
---------------------------
The components of comprehensive income (loss) are as follows:
For the Three Months Ended For the Nine Months Ended
December 31, December 31,
---------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net income (loss) $ (24,104) $ 503,049 $ (2,377,679) $ 556,201
Other comprehensive income (loss), net of tax
Unrealized gain (loss) on investments (7,015) (4,954) (14,672) (14,703)
Foreign currency translation adjustments 123,262 134,099 77,300 245,747
------------ ------------ ------------ ------------
Comprehensive income (loss) $ 92,143 $ 632,194 $ (2,315,051) $ 787,245
============ ============ ============ ============
Comprehensive income (loss) per share: $ 0.01 $ 0.04 $ (0.15) $ 0.05
============ ============ ============ ============
The components of accumulated comprehensive income, net of related tax, as of
the periods ended December 31, 2004 and March 31, 2004, are as follows:
December 31, March 31,
2004 2004
------------ ------------
Unrealized gain/ (loss) on investments $ (14,036) $ 636
Accumulated translation adjustments 227,138 150,105
------------ ------------
Accumulated other comprehensive income $ 213,102 $ 150,801
============ ============
5. EARNINGS PER SHARE
------------------
The following table sets forth the calculation of earnings per share for the
three months and Nine Months ended December 31, 2004 and 2003.
For the Three Months Ended For the Nine Months Ended
December 31, December 31,
--------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Numerator:
Net income (loss) applicable to common stock $ (24,104) $ 503,049 $ (2,377,679) $ 556,201
============ ============ ============ ============
Denominator:
Average outstanding shares used in the
Computation of per share earnings:
Common Stock issued-Basic shares 15,398,677 15,357,385 15,395,576 15,331,253
Stock Options (treasury method) -- 329,167 -- 351,363
------------ ------------ ------------ ------------
Diluted shares 15,398,677 15,686,552 15,395,576 15,682,616
============ ============ ============ ============
Earnings (loss) Per Common Share:
Basic $ 0.00 $ 0.03 $ (0.15) $ 0.04
============ ============ ============ ============
Diluted $ 0.00 $ 0.03 $ (0.15) $ 0.04
============ ============ ============ ============
6. SHARED-BASED COMPENSATION
-------------------------
New Accounting Pronouncement
In December 2004, the FASB issued Statement 123R, "Share-Based Payment," to be
effective for interim or annual periods beginning after June 15, 2005; thereby,
becoming effective for Warrantech in the first quarter of fiscal 2006. Statement
8
123R requires all share-based payments to employees, including grants of
employee stock options, to be recognized as an operating expense in the income
statement. The cost is recognized over the requisite service period based on
fair values measured on grant dates. The new standard may be adopted using
either the modified prospective transition method or the modified retrospective
method. We are currently evaluating our share-based employee compensation
programs, the potential impact of this statement on our consolidated financial
position and results of operations, and the alternative adoption methods.
In December 2002, the FASB issued Statement of Financial Accounting Standards
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure,
an Amendment of FASB Statement No. 123" (SFAS No. 148). SFAS No. 148 provides
alternative methods of transition for companies making a voluntary change to
fair value-based accounting for stock-based employee compensation. The Company
continues to account for its stock option plan under the intrinsic value
recognition and measurement principles of APB Opinion No. 25, "Accounting for
Stock Issued to Employees," and related Interpretations. Effective for interim
periods beginning after December 15, 2002, SFAS No. 148 also requires disclosure
of pro-forma results on a quarterly basis as if the Company had applied the fair
value recognition provisions of SFAS No. 123.
As the exercise price of all options granted under the plan was equal to or
above the market price of the underlying common stock on the grant date, no
stock-based employee compensation is charged to operations. The following table
illustrates the effect on net income and earnings per share if the company had
applied the fair value recognition provisions of SFAS No. 123, as amended, to
options granted under the stock option plans and rights to acquire stock granted
under the Company's Stock Participation Plan, collectively called "options." For
purposes of this pro-forma disclosure, the value of the options is estimated
using the Black-Scholes option pricing model and amortized ratably to expense
over the options' vesting periods. Because the estimated value is determined as
of the date of grant, the actual value ultimately realized by the employee may
be significantly different.
For the Three Months Ended For the Nine Months Ended
March March
---------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net income (loss) as reported $ (27,104) $ 503,049 $ (2,377,679) $ 556,201
Net income (loss) pro forma $ (77,658) $ 452,495 $ (2,450,733) $ 528,856
Shares - Basic 15,398,677 15,357,385 15,395,576 15,331,253
Basic earnings (loss) per share as reported $ (0.00) $ 0.03 ($ 0.15) $ 0.04
Basic earnings (loss) per share pro forma $ (0.01) $ 0.03 ($ 0.16) $ 0.04
The fair value of the stock options used to compute pro forma net income and
earnings per share disclosures is the estimated value at grant date using the
Black-Scholes option-pricing model with the following weighted average
assumptions for the Nine Months ended December 31, 2004 and 2003, respectively:
expected dividend yield of 0%; expected volatility of 30% - 50%; a risk free
interest rate of 4.0% - 5.0%; and expected option life of 3 to 10 years.
Presented below is a summary of the status of the stock options in the plan and
the related transactions for the nine months ended December 31, 2004 and 2003.
2004 2003
-----------------------------------------------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
-----------------------------------------------------------
Options outstanding at beginning of the period 1,332,789 $ 1.35 1,306,380 $ 1.10
Granted 343,401 0.67 180,000 1.57
Canceled/Surrendered (25,000) 1.3125 (121,538) 2.13
Exercised -- -- (20,000) 0.60
Forfeited -- -- -- --
-----------------------------------------------------------
Options outstanding at end of period 1,651,190 $ 1.12 1,344,842 $ 1.19
===========================================================
-----------------------------------------------------------
Options exercisable at end of period 919,408 $ 1.31 784,604 $ 1.34
===========================================================
9
The weighted average fair value of stock options at date of grant, calculated
using the Black-Scholes option-pricing model, granted during the nine months
ended December 31, 2004 and 2003, was $0.38 and $0.54, respectively.
The Company may issue options to purchase common stock to officers,
non-employees, non-employee directors or others as part of settlements in
disputes and/or incentives to perform services for the Company. The Company
accounts for stock options issued to vendors and non-employees of the Company
under SFAS No. 123 "Accounting for Stock-based Compensation." The fair value of
each option grant is estimated on the date of grant, using the Black-Scholes
option-pricing model, is charged to operations utilizing weighted average
assumptions identical to those used for options granted to employees.
The following table summarizes the status of all Warrantech's stock options
outstanding and exercisable at December 31, 2004.
Stock Options Stock Options
Outstanding Exercisable
----------------------------- ----------------------------
Weighted Weighted
Average Average
Exercise Exercise
Range Of Exercise Prices Shares Price Shares Price
----------------------------------- ------------ ------------ ------------ ------------
$0.42 to $0.94 944,600 $0.73 411,250 $0.78
$1.00 1,738,235 $1.00 1,659,804 $1.00
$1.26 to $1.595 592,065 $1.41 472,065 $1.36
$3.25 to $3.375 101,290 $3.26 101,290 $3.26
------------ ------------ ------------ ------------
Total at December 31, 2004 3,376,190 $1.55 2,644,409 $1.12
============ ============ ============ ============
7. SEGMENTS
--------
The Company operates in three major business segments: Automotive, Consumer
Products and International segments. The category "Other" includes intersegment
eliminations of revenues and receivables and net unallocated corporate expenses.
The Automotive segment designs, develops, markets and acts as a third party
administrator for vehicle service contract programs and other related automotive
after-sale products, all of which enhance the dealer's profitability from the
sale of automobiles, light trucks, recreational vehicles, personal watercraft
and automotive components. These products are sold principally by franchised and
independent automobile dealers, leasing companies, repair facilities, retail
stores, financial institutions and other specialty marketers.
The Consumer Products segment develops, markets and administers extended
warranties and product replacement plans on household appliances, consumer
electronics, televisions, computers and home office equipment, which are sold
principally through retailers, distributors, manufacturers, utility companies,
financial institutions and other specialty marketers. The Company also markets
these warranties and plans directly to the ultimate consumer on behalf of the
retailer/dealer and/or the manufacturer through telemarketing and direct mail
campaigns. In addition, the Company offers call center and technical computer
services.
The International segment designs, develops, markets and acts as a third party
administrator for many of the same Programs and services outside the United
States that Warrantech Automotive and Warrantech Consumer Products market and
administer in the United States and Canada. The International segment is
currently operating in Puerto Rico, Guatemala, El Salvador, Chile and Peru.
10
Three Months Ended Consumer Reportable
December 31, 2004 Automotive Products International Segments Other Total
- ----------------- ------------- ------------- ------------- ------------- ------------- -------------
Gross revenues $ 18,068,190 $ 12,918,475 $ 2,665,288 $ 33,651,953 $ (375,024) $ 33,276,929
Gross profit (loss) 2,168,077 4,183,863 619,575 6,971,515 (133,676) 6,837,839
Profit (loss) from operations 621,845 1,424,675 (260,378) 1,786,142 (1,788,001) (1,859)
Pretax income (loss) (251,785) 503,974 (258,116) (5,927) 278,556 272,629
Net interest income/expense 63,964 55,977 2,025 121,966 (86,579) 35,387
Depreciation/amortization 55,266 125,361 19,056 199,683 327,695 527,378
December 31, 2003
- -----------------
Gross revenues $ 22,552,246 $ 12,082,939 $ 2,103,230 $ 36,738,415 $ (1,365,272) $ 35,373,143
Gross profit 7,115,234 5,442,432 1,141,662 13,699,328 (5,032,741) 8,666,587
Profit (loss) from operations 253,740 1,733,708 148,199 2,135,647 (1,687,494) 448,153
Pretax income (loss) (1,403,055) 1,255,595 187,589 40,129 739,619 779,748
Net interest income/expense (130,130) (24,886) 7,387 (147,629) 596,177 448,548
Depreciation/amortization 93,663 239,298 18,526 351,487 367,406 718,893
Nine Months Ended Consumer Reportable
December 31, 2004 Automotive Products International Segments Other Total
- ----------------- ------------- ------------- ------------- ------------- ------------- -------------
Gross revenues $ 51,892,042 $ 32,285,036 $ 6,607,910 $ 90,784,988 $ (945,856) $ 89,839,132
Gross profit 6,032,056 11,293,952 1,590,079 18,916,087 61,412 18,977,499
Profit (loss) from operations 677,795 2,813,666 (969,618) 2,521,843 (5,713,801) (3,191,958)
Pretax income (loss) (2,257,135) (267,109) (966,675) (3,490,919) 1,080,681 (2,410,238)
Net interest income/expense (113,207) (51,748) 3,953 (161,002) 266,883 105,881
Depreciation/amortization 213,674 619,047 58,734 891,455 1,086,599 1,978,054
Total assets 182,825,298 73,223,398 9,014,639 265,063,335 2,716,684 267,780,019
December 31, 2003
- -----------------
Gross revenues $ 80,575,477 $ 29,593,473 $ 6,501,939 $ 116,670,889 $ (710,761) $ 115,960,128
Gross profit 12,345,524 14,533,616 3,181,849 30,060,989 (5,096,982) 24,964,007
Profit (loss) from operations 311,054 2,676,066 1,110,922 4,098,042 (4,536,240) (438,198)
Pretax income (loss) (4,397,054) 1,357,198 1,150,093 (1,889,763) 2,503,145 613,382
Net interest income/expense (275,740) (37,136) 11,130 (301,746) 820,787 519,041
Depreciation/amortization 286,556 1,043,553 62,168 1,392,277 1,147,589 2,539,866
Total assets 189,263,887 74,132,765 4,745,594 268,142,246 8,662,199 276,804,445
11
WARRANTECH CORPORATION AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations
- -------------
Except for the historical information contained herein, the matters discussed
below or elsewhere in this Quarterly Report on Form 10-Q may contain
forward-looking statements that involve risks and uncertainties that could cause
actual results to differ materially from those contemplated by the
forward-looking statements. The Company makes such forward-looking statements
under the provisions of the "safe harbor" section of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements reflect the Company's
views and assumptions, based on information currently available to management,
including, among other things, the Company's operating and financial performance
over recent years and its expectations about its business for the current and
future fiscal years. When used in this Quarterly Report on Form 10-Q, the words
"believes," "estimates," "plans," "expects," and "anticipates" and similar
expressions as they relate to the Company or its management are intended to
identify forward-looking statements.
Although the Company believes that the expectations reflected in the
forward-looking statements are reasonable, it can give no assurance that its
expectations will prove to be correct. These statements are subject to certain
risks, uncertainties and assumptions, including, but not limited to,
o prevailing economic conditions which may significantly deteriorate,
thereby reducing the demand for the Company's products and services,
o availability of technical support personnel or increases in the rate
of turnover of such personnel, resulting from increased demand for
such qualified personnel,
o changes in the terms or availability of insurance coverage for the
Company's programs,
o regulatory or legal changes affecting the Company's business,
o loss of business from, or significant change in relationships with,
any major customer,
o the Company's ability to replace lost revenues in its Automotive
segment,
o the ability to successfully identify and contract new business
opportunities, both domestically and internationally,
o the ability to secure necessary capital for general operating or
expansion purposes,
o the adverse outcomes of litigation,
o the non-payment of notes due from an officer and two directors of the
Company in 2007, which would result in a charge against earnings in
the period in which the event occurred,
o the inability of any of the insurance companies which insure the
service contracts marketed and administered by the Company to pay
claims under the service contracts,
o the termination of extended credit terms being provided by the
Company's current insurance company, and
o the illiquidity of the Company's stock.
Should one or more of these or any other risks or uncertainties materialize or
develop in a manner adverse to the Company, or should the Company's underlying
assumptions prove incorrect, actual results of operations, cash flows and/or the
Company's financial condition may vary materially from those anticipated,
estimated or expected.
12
Results of Operations
- ---------------------
Gross Revenues
For the Three Months For the Nine Months
December 31, December 31,
------------------------------ ------------------------------
2004 2003 2004 2003
------------- ------------- ------------- -------------
Automotive segment $ 18,068,190 $ 22,552,246 $ 51,892,042 $ 80,575,477
Consumer Products segment 12,918,475 12,082,939 32,285,036 29,593,473
International segment 2,665,288 2,103,230 6,607,910 6,501,939
Other (375,024) (1,365,272) (945,856) (710,761)
------------- ------------- ------------- -------------
Total gross revenues $ 33,276,929 $ 35,373,143 $ 89,839,132 $ 115,960,128
============= ============= ============= =============
Gross revenues for the three month period ended December 31, 2004 decreased
$2,096,214, or 6%, from the same period in 2003. Gross revenues for the nine
month period ended December 31, 2004 decreased $26,120,996, or 23%, from the
same period in 2003.
The Automotive segment reported decreased gross revenues of $4,484,056, or 20%,
in the three month period ended December 31, 2004 over 2003 and $28,683,435, or
36%, in the nine month period. The decrease in gross revenues in the Automotive
segment was due to a reduction in volume arising from premium rate increases and
the downturn in sales of new cars.
The Consumer Products segment reported increased gross revenues of $835,536 or
7%, in the three month period ended December 31, 2004 over 2003 and $2,691,563
or 9%, in the nine month period. The increase in the Consumer Products segment
was due to the opening of additional stores by one of the Company's top dealers.
The International segment increase in gross revenues resulted from higher sales
volume from customers in South America, partially offset by lower sales volumes
in Puerto Rico due to the suspension of auto warranty sales until programs with
a new underwriter can be established.
Gross Profit
For the Three Months For the Nine Months
December 31, December 31,
------------------------------ -----------------------------
2004 2003 2004 2003
------------- ------------- ------------- -------------
Automotive segment $ 2,168,077 $ 7,115,234 $ 6,032,056 $ 12,345,524
Consumer Products segment 4,183,863 5,442,432 11,293,952 14,533,616
International segment 619,575 1,141,662 1,590,079 3,181,849
Other (133,676) (5,032,741) 61,412 (5,096,982)
------------- ------------- ------------- -------------
Total gross profit $ 6,837,839 $ 8,666,587 $ 18,977,499 $ 24,964,007
============= ============= ============= =============
Gross profit for the three months and nine months ended December 31, 2004
decreased $1,828,748, or 21%, and $5,986,508, or 24%, over the same periods in
2003. Gross profit in those periods decreased, respectively, within the
Automotive segment by $4,947,157, or 70%, and $6,313,468, or 51%; within the
Consumer Products segment by $1,258,569, or 23%, and $3,239,664, or 22%; and
within the International segment by $522,087, or 46%, and $1,591,770, or 50%.
13
SG&A
For the Three Months For the Nine Months
December 31, December 31,
----------------------------- -----------------------------
2004 2003 2004 2003
------------- ------------- ------------- -------------
Total SG&A $ 6,258,560 $ 7,334,541 $ 19,895,086 $ 22,437,339
============= ============= ============= =============
Service, selling and general and administrative ("SG&A") for the three months
and nine months ended December 31, 2004 decreased $1,075,981, or 15%, and
$2,542,253, or 11%, compared to the same periods in the prior year. The decrease
was the result, primarily, because employee salary costs were lower at
$3,837,013 and $12,157,071 during the respective 2004 periods, compared to
$4,221,249 and $13,261,042 in the respective 2003 periods and lower sales
related costs which were $208,110 and $791,983 during the respective 2004
periods, compared to $389,919 and $967,975 in the respective 2003 periods.
Provision for Bad Debts
For the Three Months For the Nine Months
Ended December 31, Ended December 31,
----------------------------- -----------------------------
2004 2003 2004 2003
------------- ------------- ------------- -------------
Provision for bad debts $ 53,760 $ 165,000 $ 296,317 $ 425,000
============= ============= ============= =============
The Company began providing for bad debts during fiscal year 2003 in
anticipation of not being able to collect certain receivables in its Consumer
Products and International segments.
Depreciation and amortization
For the Three Months For the Nine Months
December 31, December 31,
----------------------------- -----------------------------
2004 2003 2004 2003
------------- ------------- ------------- -------------
Total depreciation and amortization $ 527,378 $ 718,893 $ 1,978,054 $ 2,539,866
============= ============= ============= =============
As a result of the maturation of the Company's assets and reduced capital
expenditures over the past several years, depreciation and amortization expenses
were reduced by $191,515, or 27%, and by $561,812, or 22%, respectively, during
the three months and nine months ended December 31, 2004 from the same periods
in 2003.
Other Income
For the Three Months For the Nine Months
December 31, December 31,
---------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Interest and dividend income $ 161,923 $ 379,598 $ 450,497 $ 1,016,857
Interest expense (126,536) (217,260) (344,616) (497,816)
Gain (loss) on sale of assets 95 -- 1,195 2,976
Credit card usage rebate 170,950 133,009 607,124 337,177
Miscellaneous income 68,056 36,248 67,520 192,386
------------ ------------ ------------ ------------
Total other income $ 274,488 $ 331,595 $ 781,720 $ 1,051,580
============ ============ ============ ============
Other income for three and nine months ended December 31, 2004 decreased
compared to the three and nine months ended December 31, 2003 as a result of
lower interest income. That decrease was partially offset by higher income from
credit card usage rebates.
14
Income Tax Expense (Benefit)
For the Three Months For the Nine Months
December 31, December 31,
--------------------------- ----------------------------
2004 2003 2004 2003
------------ ------------ ------------ ------------
Total income tax expense (benefit) $ 296,733 $ 276,699 $ (32,559) $ 57,181
============ ============ ============ ============
Income taxes expense (benefit) increased $20,034 in the three months ended
December 31, 2004 from the same period in 2003, primarily due to a reduction in
taxable income and the $103,000 payment of foreign income taxes; similarly, the
income tax benefit increased $89,740 for the nine months ended December 31, 2004
compared to the nine months ended December 31, 2003 due to the same reasons.
Liquidity and Financial Resources
- ---------------------------------
During the nine months ended December 31, 2004, the Company had a decrease in
cash and cash equivalents of $521,748. The cash was primarily used to pay claims
arising under Reliance insured service contracts. Working capital was a negative
$11.8 million at December 31, 2004, compared to a negative $7.2 million at March
31, 2004, primarily due to reduced receivables caused by reduced automotive
business. While the downturn in the automotive industry and premium rate
increases have reduced volumes in the automotive segment, management believes
that new programs and products will enable the Automotive segment to recover
some of the reductions and increase its existing volumes.
The Company believes that internally generated funds as determined by its
business plan and the extended payment terms, combined with the additional $3
million extended payment terms from Great American Insurance Company ("GAIC") in
use during the quarter ended December 31, 2004, will be sufficient to finance
its current operations for at least the next twelve months. The Company is
aggressively pursuing new business both domestically and internationally to fund
future working capital requirements. The Company intends to continue to contain
its SG&A costs and utilize technologies for operational efficiencies to further
enhance both its operating income and cash flows from operating activities.
As a result of a change in regulations, the State of Ohio no longer requires a
cash reserve. Accordingly, during the period ended September 30, 2004, the
Company reduced its restricted cash balance by $25,000.
During nine months ended December 31, 2004, the Company repurchased 32,500
shares of Company common stock at a cost of $23,960.
On June 30, 2004, the Company terminated its policy with Cruz del Sur, its
primary insurance carrier in Chile, effective December 31, 2004. To arrange for
continuity of coverage, the Company has been issued a policy with ING Seguros
Generales S.A., effective with contracts written January 1, 2005.
On September 1, 2004, the Company began offering one-year extended home product
warranties. Unlike the Company's other Plans, these warranties will not be
insured by third party insurance companies but will be obligations solely of the
Company.
The effect of inflation has not been significant to the Company.
Commitments
- -----------
The Company has ongoing relationships with equipment financing companies and
intends to continue financing certain future equipment needs through
lease/purchase transactions. The total amount financed through these
transactions during the nine months ended December 31, 2004 amounted to $383,959
compared to $487,060 during the nine months ended December 31, 2003.
15
During the fiscal quarter ended December 31, 2004, the Company paid claims
totaling $1,023,418 under service contracts previously insured by Reliance
Insurance Company ("Reliance-insured contracts"). The total amount of claims
paid by the Company under such contracts during the first nine months of the
current fiscal year is $3,870,788. Set forth below is information about the
Company's commitments outstanding at December 31, 2004.
Payments due by period
-----------------------------------------------------------------------------
Less than 1 - 3 3 - 5 More than
Total 1 year Years Years 5 years
-----------------------------------------------------------------------------
Capital lease obligations $ 1,486,690 $ 563,057 $ 745,788 $ 177,845 $ --
Operating leases 10,425,701 1,299,720 2,488,979 2,557,040 4,079,962
Employment agreements 4,747,313 2,241,063 1,737,500 697,500 71,250
Claims loss liability 5,620,790 3,002,600 2,618,190 -- --
-----------------------------------------------------------------------------
Total $ 22,280,494 $ 7,106,440 $ 7,590,457 $ 3,432,385 $ 4,151,212
=============================================================================
Lines of Credit
- ---------------
The Company executed an agreement with GAIC on October 9, 2002, whereby, GAIC
agreed to provide funding by extending a favorable change of its credit terms to
the Company. GAIC also agreed to a separate line of credit for an amount up to
$3 million by extending payment terms to the Company, subject to certain
adjustments, to fund unanticipated working capital requirements. Interest is
charged on monies advanced from the line of credit at an annual rate equal to
the prime interest rate plus 2%. As of September 30, 2004, the $3 million
available line of credit from GAIC has been drawn down by the Company through
GAIC's further extension of payment on premium due. This amount is reflected in
premium payable.
The Company maintains a $750,000 letter of credit for the benefit of the
landlord of its headquarters office building. This letter of credit is
automatically renewed annually through January 31, 2013.
The Company also maintains a $200,000 letter of credit for the benefit of its
credit card processor. This letter of credit, which is automatically renewed
annually, was renewed on December 16, 2004 for another year.
General Information
- -------------------
Warrantech, through its wholly owned subsidiaries, designs, develops, markets
and acts as a third party administrator for programs ("Programs") for service
contracts, limited warranties and replacement plans (collectively, "Plans"). The
Company provides these services to a variety of clients in selected industries.
On a Program by Program basis, the Company contracts with highly rated
independent insurance companies or risk retention groups available to provide
coverage for the Plans to be sold or issued under the Programs. This coverage
obligates the insurer to pay the cost of repairs or replacements of the products
covered by the Plans.
Plans issued under the Company's Programs provide consumers with expanded and/or
extended product breakdown coverage for a specified period of time (and/or
mileage in the case of automobiles and recreational vehicles), similar to that
provided by manufacturers under the terms of their product warranties. Coverage
generally provides for the repair or replacement of the product, or a component
thereof, in the event of its failure. The Company's Programs provide clients
with the opportunity for increased revenue and income without incurring the
costs and responsibilities of operating their own programs.
The Plans generally have terms extending up to one hundred twenty (120) months
or, in the case of mileage based Plans, up to one hundred fifty thousand
(150,000) miles. All repairs and/or replacements required under the Plans are
performed by independent third party repair facilities or dealers. The cost of
any repair or replacement is generally paid by the insurance company or
retention group with which the Company has contracted to provide coverage for
the Plan.
16
Contract Obligors
- -----------------
Each Plan contains the name of a designated obligor that is legally responsible
for the cost of any valid claim submitted under the Plan. The Company, however,
arranges for an independent insurance company to issue a policy on behalf of the
named obligor that covers all of the obligor's liabilities under the Plan. As a
result, the insurance company is ultimately responsible for paying the cost of
any and all valid claims submitted under the Plan. In the event, however, that
the insurance company refuses or is unable to pay a covered claim, the
designated obligor will be responsible for the payment and it will have recourse
against the insurance company or its estate (in the event of an insolvency or
liquidation) to recover the payment.
Prior to April 1, 2000, one of the Company's subsidiaries or a retailer/dealer
would routinely be named the obligor under the Plans. Since April 1, 2000,
however, Butler Financial Services, LLC ("Butler"), a company unrelated to
Warrantech but included in the Company's financial results due to its close
transactional ties with the Company, has served as the obligor under all Plans
sold or issued under a Program in exchange for a fee payable by the seller or
issuer of the Plan. Furthermore, and prior to October 22, 2004, Butler had
contractually assumed the liabilities of the obligor under all pre-existing
Plans in which one of the Company's subsidiaries was named as the designated
obligor ("Obligor Agreement".) The liabilities of the designated obligor under
these pre-existing Plans were insured by an independent insurance company and,
as a result of this assumption by Butler, the coverage afforded by these
insurance policies now benefits Butler as the named obligor. Notwithstanding the
forgoing, however, a Company subsidiary continues to act as the designated
obligor for Plans sold in the States of California and Florida due to regulatory
considerations.
Certain of the Plans under which Butler is the designated obligor were insured
by Reliance. The liquidation of Reliance has eliminated Butler's insurance
coverage under those Plans. Warrantech Automotive is the obligor, as well as the
administrator, under some of the VSC's that were insured by Reliance. As the
obligor, Warrantech Automotive is ultimately responsible for paying the valid
claims submitted under those VSC's in which Warrantech Automotive is the
designated obligor. Prior to Reliance's liquidation, Reliance paid the cost of
such covered claims under the insurance policies it provided. Subsequent to the
liquidation of Reliance, however, insurance coverage for Warrantech Automotive's
obligations under those VSC's was no longer available.
While the Company had provided Butler notice of termination of the Obligor
Agreement between the two Companies effective Oct 22, 2004, it subsequently
amended the termination notice and Butler remains the obligor on certain service
contracts.
Critical Accounting Policies
- ----------------------------
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the dates
of the financial statements and the reported amounts of revenues and expenses
during the reporting periods. Note 1 to the Company's Consolidated Financial
Statements set forth in "Item 8. - Financial Statements and Supplementary Data,"
in the Company's Annual Report on Form 10-K for the year ended March 31, 2004,
describes the significant accounting policies and methods used in the
preparation of the Consolidated Financial Statements. The following lists some
of the Company's critical accounting policies affected by judgments, assumptions
and estimates.
17
Revenue Recognition
Revenue from administrator-obligor contracts is recognized in accordance with
Financial Accounting Standards Board Technical Bulletin 90-1, "Accounting for
Separately Priced Extended Warranty and Product Maintenance Contracts," ("TB
90-1"). The Company recognizes such revenue over the life of the contract on a
straight-line basis. In addition the Company charges the costs of contracts to
operations over the life of the contracts on a straight-line basis.
Historically, through June 30, 2003, the Company recognized revenues from
dealer-obligor service contracts, in which the retailer/dealer or a third party
is designated as the obligor, in direct proportion to the costs incurred in
providing the service contract programs to the Company's clients. Revenues in
amounts sufficient to meet future administrative costs and a reasonable gross
profit were deferred. With the issuance of EITF Abstracts Issue No. 00-21 (EITF
No. 00-21), "Revenue Arrangements with Multiple Deliverables", as of July 1,
2003, the Company recognizes revenue from these dealer-obligor contracts on a
straight-line basis over the life of the service contract, pursuant to Staff
Accounting Bulletin 101.
Since Butler has been determined to be a nominally capitalized entity, all
transactions concerning Butler obligor-contracts are treated in a manner similar
to the accounting principles discussed in Financial Accounting Standards Board
Emerging Issues Task Force Topic No. D-14, "Transactions Involving
Special-Purpose Entities." The Company treats the Butler-obligor contracts as if
they were administrator-obligor contracts and recognizes revenues under such
contracts pursuant to TB 90-1. Additionally, because the Company is treating the
Butler-obligor contracts as Warrantech-obligor contracts for financial reporting
purposes only, the Company eliminated the transactions between Warrantech and
Butler from its financial statements.
Reflecting these transactions for financial reporting purposes does not alter
the legal obligations under the applicable agreements in which the Company is
not responsible for, and has not assumed the obligations of Butler. Butler
remains legally obligated under such agreements and the service contracts in
which it is the named obligor. Butler is not deemed a "consolidated subsidiary"
of the Company, as that term is used in this Report, including, but not limited
to, the Certifications pursuant to Sections 302 and 906 of the Sarbanes-Oxley
Act of 2002 which are annexed to this Report. Butler's income, expenses, assets
and liabilities have not been consolidated with those of the Company. Butler is
an independent entity owned by parties unrelated to the Company and, except for
the transactions between Butler and Warrantech as described in this Report,
Warrantech does not have knowledge of, or control over, Butler's affairs or
financial reporting. Warrantech also has no knowledge of, nor has it established
or evaluated, Butler's internal controls or disclosure controls or procedures.
Any reference to "consolidated subsidiary," internal controls or disclosure
controls and procedures in this Report, including, but not limited to, the
Certifications pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act of
2002 which are annexed to this Report, do not pertain to Butler.
Now that the Company is required to recognize revenues from all service
contracts over the life of the service contracts, the Company believes that it
is unlikely that the Company will be able to report operating profits until at
least 2008 when the Company expects that the revenues recognized from prior
periods will begin to equal the revenue being deferred to future periods.
However, there can be no assurance that the Company will be profitable at that
time. In the meantime, the revenue recognition policies adopted by the Company
do not have an impact on the Company's cash flows which are an important measure
of the Company financial condition and are reflected in the Statements of Cash
Flows which are part of these financial statements.
Direct Costs
Direct costs, consisting primarily of insurance premiums and commissions, are
costs directly related to the production and acquisition of service contracts.
Effective with the application of the revenue recognition policy(s) described
above on all service contracts, the Company recognizes direct costs according to
Statement of Financial Accounting Standards No. 113 ("SFAS 113"), "Accounting
and Reporting for Reinsurance of Short-Duration and Long Duration Contracts"
18
which requires that insurance premium costs be ratably expensed over the life of
the service contract.
Impairment of Long-Lived Assets
The Company assesses potential impairment of its long-lived assets, which
include its property and equipment and its identifiable intangibles such as
software development costs, goodwill and deferred charges under the guidance of
SFAS 144 "Accounting for the Impairment or Disposal of Long-Lived Assets." Once
annually, or as events or circumstances indicate that an asset may be impaired,
the Company assesses potential impairment of its long-lived assets. The Company
determines impairment by measuring the undiscounted future cash flows generated
by the assets, comparing the result to the assets' carrying value and adjusting
the assets to the lower of their carrying value or fair value and charging
current operations for any measured impairment. At December 31, 2004 and 2003,
the Company found no impairment to its property and equipment or its other
identifiable intangibles.
Income Taxes
Deferred tax assets and liabilities are determined using enacted tax rates for
the effects of net operating losses and temporary differences between the book
and tax bases of assets and liabilities. The Company records a valuation
allowance on deferred tax assets when appropriate to reflect the expected future
tax benefits to be realized. In determining the appropriate valuation allowance,
certain judgments are made relating to recoverability of deferred tax assets,
use of tax loss carryforwards, level of expected future taxable income and
available tax planning strategies. These judgments are routinely reviewed by
management. At December 31, 2004, the Company had deferred tax assets of
$22,861,600, net of a valuation allowance of $330,324.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
----------------------------------------------------------
As of December 31, 2004, the Company did not have any derivatives, debt or
hedges outstanding. Therefore, the Company was not subject to interest rate
risk. In addition, the risk of foreign currency fluctuation was and is not
material to the Company's financial position or results of operations.
Short-term marketable securities and long-term investments are comprised of
municipal bonds which bear interest at fixed rates. Interest income from these
securities is generally affected by changes in the U.S. interest rates. The
following tables provide information about the Company's financial instruments
that are sensitive to changes in interest rates. The tables present principal
cash flows and weighted-average interest rates by expected maturity dates. All
of the investments are considered "available for sale." The resultant
differences between amortized cost and fair value, net of taxes, have been
reflected as a separate component of accumulated other comprehensive income.
Principal amounts by expected maturity as of December 31, 2004 of marketable
securities are as follows:
Expected Maturity Date as of December 31,
----------------------------------------------------------------
1 year 2 years 3 years 4 years 5 years Thereafter Total Cost Fair Value
------ ------- ------- ------- ------- ---------- ---------- ----------
Available for sale
securities $1,445,000 $ 660,000 -- -- -- -- $2,105,000 $2,144,969
Interest rate 3.67% 4.09% -- -- -- --
19
Item 4. Controls and Procedures
-----------------------
Disclosure Controls and Procedures
The Company's Chief Executive Officer (CEO) and Chief Financial Officer (CFO)
are primarily responsible for the accuracy of the financial information that is
presented in this Quarterly Report on Form 10-Q. Each of them has, within 90
days before the filing date of this Quarterly Report, evaluated the Company's
disclosure controls and procedures, as defined under SEC rules, and have
determined that such controls and procedures were effective in ensuring that
material information relating to the Company and its consolidated subsidiaries
was made known to them during the period covered by this Quarterly Report.
Internal Controls
To meet their responsibility for financial reporting, the CEO and CFO have
established internal controls and procedures which they believe are adequate to
provide reasonable assurance that the Company's assets are protected from loss.
These internal controls are reviewed by the Company's independent accountants to
support their audit work. In addition, the Board meets regularly with the
independent accountants and such other members of management as they deem
necessary. The Board and the independent accountants have free access to each
other, with or without management being present.
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect internal controls subsequent to the date
of the CEO's and CFO's most recent evaluation.
20
PART II - Other Information
Item 1. Legal Proceedings
-----------------
Universal Insurance Company
---------------------------
In the Matter of Arbitration between Universal Insurance Company and
Warrantech Consumer Product Services, Inc.; Jane Doe; and ABC Corporation
Universal Insurance Company ("Universal") provided insurance for the
vehicle service contracts marketed and administered by Warrantech
International in Puerto Rico pursuant to an Administrative Agreement that
was effective as of April 1, 1998. On October 16, 2003, Universal, claiming
a material breach of the agreement by Warrantech, terminated the agreement
and assumed responsibility for administering the applicable service
contracts.
Universal served Warrantech with a Demand for Arbitration, dated October
15, 2004, seeking to recover a portion of the fees Warrantech received to
provide administrative services under the contracts, approximating
$2,155,000, together with interest thereon from the effective date of
termination. Subsequent to receipt of Universal's Demand for Arbitration,
Warrantech commenced an action against Universal in the State of
Connecticut to recover fees owed to Warrantech pursuant to the terms of a
certain Fee Agreement. Although it is difficult at this time to determine
the exact amount owed to Warrantech, it is believed that the amount will be
in excess of $1,000,000. Universal has moved in local court to have the
Connecticut action combined with the arbitration in Puerto Rico. In
response to that motion, Warrantech has moved to have the Connecticut
action remanded to federal court in Connecticut. No discovery has taken
place as yet.
Management believes Universal's case is without merit. At this time,
however, it is not able to predict the outcome of either the arbitration or
the Connecticut action. For this reason, the Company is unable to determine
its potential liability, if any, and as such, the accompanying financial
statements do not reflect any estimate for losses.
Item 2. Changes in Securities and Use of Proceeds and Issuer Purchases
--------------------------------------------------------------
of Equity Securities
--------------------
Purchase of Equity Securities for the Nine Months Ended December 31, 2004
-------------------------------------------------------------------------
Total
Number of Average
Shares Price Paid
Period purchased Cost per Share
--------------------------------------------------------------------------
4/1/04 - 7/31/04 -- -- --
8/1/04 - 8/31/04 5,000 $ 3,860 $0.77
9/1/04 - 9/30/04 27,500 $ 20,100 $0.73
10/1/04 - 12/31/04 -- -- --
--------------- ---------------
Total 32,500 $ 23,960 $0.73
=============== ===============
These shares were not purchased pursuant to a publicly announced plan or
program regarding stock repurchases in as much as the Company has no such
plan or program. The shares were purchased in open market transactions.
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Item 3. Defaults Upon Senior Securities
-------------------------------
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
(a) On January 13, 2005, the Annual Meeting of the Stockholders of the Company
was held in Bedford, Texas for the purpose of electing a Board of Directors and
voting on the proposal described below. There were no solicitations in the
opposition to management's nominees for director as listed in the proxy
statement.
(c) Each of the directors nominated by the Board (which number constitutes the
entire Board of the Company) and listed in proxy statement was elected with the
votes as follows:
Nominees Votes For Votes Withheld
-------- --------- --------------
Joel San Antonio 13,706,902 1,181,810
William Tweed 13,706,942 1,181,770
Jeff J. White 13,706,842 1,181,870
Richard Rodriguez 13,706,642 1,182,170
Donald Senderowitz 13,789,167 1,099,545
A proposal to change the Company's state of incorporation from
Delaware to Nevada was approved with the following vote: 9,341,645
shares for; 965,888 shares against.
Item 5. Other Information
-----------------
Not applicable.
Item 6. Exhibits
--------
10.1 Employment Agreement dated December 1, 2004, between Warrantech
Corporation and Laurence Tutt.
10.2 Amendment and supplement number one, dated January 16, 2004 to certain
Warrantech and Butler agreements.
10.3 Warrantech Corp. Guaranty of Payment and Performance by RWC Corp.
10.4 Security Agreement dated as of January 16, 2004, by Reliance Warranty
Company, in favor of Warrantech Corporation.
10.5 Indemnity Agreement by and between Warrantech Corporation (the
"Indemnitor") and Butler Financial Solutions, LLC, Reliance Warranty
Company, SPG Financial Corp., the current members and officers of
Butler, RWC and SPG, Harris Miller, Karen Parker and Paula Graff,
(collectively and individually, the "Indemnitee(s)").
31.1 Certification by the Chief Executive Officer pursuant to Rule
13a-14(a) of the Securities Exchange Act of 1934, as amended.
31.2 Certification by the Chief Financial Officer pursuant to Rule
13a-14(a) of the Securities Exchange Act of 1934, as amended.
32.1 Statement by the Chief Executive Officer and the Chief Financial
Officer furnished pursuant to Rule 13a-14(b) of the Securities
Exchange Act of 1934, as amended.
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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.
WARRANTECH CORPORATION
---------------------------------------------------------
(Registrant)
/s/ RICHARD F. GAVINO
---------------------------------------------------------
Richard F. Gavino - Executive Vice President, Principal
Financial Officer, Chief Accounting Officer and Treasurer
(Chief Financial Officer and Duly Authorized Officer)
Dated: February 14, 2005
23